1
EXHIBIT 13.1
RESOURCE BANCSHARES MORTGAGE GROUP, INC.
TABLE OF CONTENTS
Mission Statement
Letter to Our Shareholders
Production and Servicing Highlights
Selected Financial Highlights
Management's Discussion and Analysis of Financial
Condition and Results of Operations
Consolidated Financial Statements and Notes
Report of Independent Accountants
Stock Data
Directors and Officers
Corporate Information
MISSION STATEMENT
To maximize shareholders' value by engaging primarily in the business of
correspondent, wholesale and retail mortgage banking, while maintaining
flexibility in our review of other opportunities.
To service our clients and our clients' customers in an efficient, economically
responsible and fair manner.
To support our people and the communities in which they reside.
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LETTER TO OUR SHAREHOLDERS:
As we reflect back on 1996, a year of records, we remain focused on the future.
After all, it is our vision for the future, rather than our achievements of
the past, that will ensure your investment in the Company provides the returns
you are seeking.
1996-A RECORD YEAR
During 1996, your Company achieved record market share, loan production, total
revenue and net income. But for the non-recurring, fourth-quarter charge of
$3.2 million ($0.17 per share), earnings per share would also have set a new
record of $1.25. During the year we also successfully completed a $63.9
million follow-on stock offering, instituted a quarterly cash dividend program,
and acquired over $1.4 billion in servicing through bulk transactions. By the
close of 1996, we had solidified our presence in the mortgage marketplace,
becoming the 11th-largest loan originator in the country (up from 13th in 1995
and 37th in 1994).
All this was achieved without neglecting our loan production platform, the
heart and soul of the Company. During 1996, we hired two new account
executives to facilitate our entry into the California market and expanded our
number of approved correspondents from 726 to 871. Similarly, we opened three
new wholesale branches in the major metropolitan markets of Baltimore, Denver
and St. Louis. The total number of approved brokers who deliver product
through RBMG increased from 1,144 to 2,322, a rise of 103%. These investments
in the agency-eligible side of our business are expected to help expand both
market share and profitability in the years ahead.
Although these achievements continued our year-in, year-out track record of
creating enhanced shareholder value, we candidly acknowledge we did not meet
all of our financial goals for 1996. Returns on equity and assets of 16.8% and
2.2%, respectively (prior to consideration of the non-recurring 1996 charge),
were below our long-term targets, but we look to improve on these percentages
in the future.
ESTIMATED MARKET SHARE
1993 1994 1995 1996
- ---------------------------------
0.42% 0.37% 1.11% 1.26%
MORTGAGE LOANS PURCHASED/ORIGINATED
(In Millions)
1992 1993 1994 1995 1996
- ------- ------- ------- ------- -------
$2,458 $4,239 $2,875 $7,136 $9,996
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THE FUTURE
It is with great excitement that we report to you our plans for the future -- a
plan whose essence is captured in the theme of this year's Annual Report:
GROWTH THROUGH DIVERSIFICATION.
Recognizing that the Company serves two distinct customer groups -- small loan
producers and large mortgage loan servicers -- we are now positioned as a
nationwide loan wholesaler, providing efficient secondary market access to
smaller producers of agency-eligible loan products. Simultaneously, we are
also positioned among the largest national suppliers of servicing rights to the
still-consolidating mortgage servicing industry. Although our financial
achievements testify to the prudence of our strategic approach, we are
nonetheless perceived by the marketplace as a non-diversified, single-industry
lender operating in an increasingly commoditized market. We believe our plan
of GROWTH THROUGH DIVERSIFICATION can overcome this perception -- leading to
enhanced shareholder value in the form of improved price-to-earnings and
price-to-book multiples.
After considerable study, we selected the subprime mortgage marketplace, which
is countercyclical to the agency-eligible market, as a nearly ideal opportunity
for diversifying our revenue sources. Specifically, we can access this
marketplace as a wholesaler with the same objective of providing efficient
secondary market access to small producers of subprime loan products.
Simultaneously, we can leverage our low-cost operational infrastructure and our
existing loan production platform -- along with our reputation for exceptional
customer service -- to rapidly establish a nationwide presence in this
industry.
We are pleased to report that our plan is already well underway. In January,
1997, we signed a letter of intent to merge with Meritage Mortgage Corporation,
a wholesale originator of subprime mortgages on the West Coast. Meritage was
formed just over a year ago, but its key personnel have over a decade of
successful experience as subprime mortgage lenders. By merging with Meritage
and its management expertise, we would expect to jump-start our plans to make
an aggressive entry into this marketplace. Simultaneously, we've assembled a
staff of experienced subprime lenders in Columbia, who have started building an
East Coast operation to complement the efforts of Meritage on the West Coast.
Upon consummation of the Meritage merger, which we expect to complete during
the second quarter, we are increasingly confident that these initiatives will
contribute significantly to our 1997 earnings performance.
TOTAL REVENUES NET INCOME
($000) ($000)
1993 1994 1995 1996 1992 1993 1994 1995 1996
- ------- ------- ------- -------- ------- ------- ------- ------- -------
$47,756 $56,622 $76,697 $126,617 $11,250 $17,580 $18,043 $14,219 $19,623
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OUR GOAL
On June 3, 1993 the Company went public at a stock dividend-adjusted offering
price of $6.12 per share. In just a little over three and one-half years, our
stock price has risen 133% to close at $14.25 as of December 31, 1996. In
short, our goal over the next three and one-half years is to replicate our
superior stockholder returns through implementation of our plan of GROWTH
THROUGH DIVERSIFICATION.
We appreciate your continued commitment and support. In return, we will
continue to apply the very best of our talents, our abilities and our energies
with the objective of creating ever greater value for you, our stockholder.
Edward J. Sebastian
Chairman & Chief Executive Officer
March 18, 1997
PROFITABILITY REVIEW
BEFORE NON-RECURRING CHARGE
1993 1994 1995 1996
------------------------------------------------------------------
Earnings Per Share $ 0.80 $ 1.16 $ 0.92 $ 1.25
ROA 4.81% 5.25% 1.95% 2.22%
ROE 38.50% 25.98% 17.00% 16.78%
Note: All earnings per share data has been adjusted for the Stock Dividends
PROFITABILITY REVIEW
AFTER NON-RECURRING CHARGE
1993 1994 1995 1996
------------------------------------------------------------------
Earnings Per Share $ 0.80 $ 1.16 $ 0.92 $ 1.08
ROA 4.81% 5.25% 1.95% 1.91%
ROE 38.50% 25.98% 17.00% 14.43%
Note: All earnings per share data has been adjusted for the Stock Dividends
STOCK PERFORMANCE
MAY 26, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1993 1993 1994 1995 1996
- -------------------------------------------------------------------------------------
RBMG 100 121.4 132.3 217.7 233.0
NASDAQ 100 110.4 108.0 152.7 187.8
MBA Peer Group 100 97.4 87.2 126.4 158.2
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PRODUCTION AND SERVICING HIGHLIGHTS
INCREASED PRODUCTION
TOP MORTGAGE ORIGINATORS IN 1996 (VOLUME IN BILLIONS)
- --------------------------------------------------------------------------------------------
RANK RANK LENDER VOLUME MARKET SHARE
(1996) (1995)
- --------------------------------------------------------------------------------------------
1 1 Norwest Mortgage, Inc.* $51.48 6.4%
2 2 Countrywide Home Loans $38.82 4.8%
3 4 Chase Manhattan Mortgage* $33.56 4.2%
4 20 HomeSide Lending $19.64 2.4%
(BancBoston)*
5 6 Fleet Mortgage $17.81 2.2%
11 13 RBMG, Inc. $ 9.96 1.2%
*Chase Manhattan Mortgage's numbers reflect merger with Chemical, Norwest
Mortgage's numbers reflect acquisition of Prudential Home Mortgage, and
HomeSide Lending's numbers reflect the acquisition of Barnett Mortgage. Source:
Inside Mortgage Finance, January 24, 1997
Production volume rose over 40% in 1996, the Company's second straight year of
exceptional growth and fourth in the past five. Our market share also rose,
from 1.11% to 1.26% (a 13.5% increase), pushing the Company into 11th place
nationally among mortgage loan originators, up from 13th place in 1995.
PRODUCTION MIX
1994 1995 1996
---- ---- ----
Correspondent 99% 88% 79%
Wholesale 1% 9% 14%
Retail 3% 7%
---- ---- ----
Total 100% 100% 100%
As our wholesale and retail channels increased their percentage contribution to
the Company's volume, core margins showed steady improvement over the last half
of the year, growing from $0.61 per share on $5.6 billion in production in the
first six months, to $0.64 (prior to the non-recurring item in the fourth
quarter) on only $4.4 billion in production from July through December. These
improved margins bode well for future profitability.
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CORRESPONDENT LENDING
CORRESPONDENT LOAN PRODUCTION
($ millions)
1992 1993 1994 1995 1996
- ------- ------- ------- ------- -------
$2,458 $4,239 $2,855 $6,252 $7,915
Correspondent mortgage banking remains the Company's primary production
channel, still providing nearly 80% of total Company origination volume in
1996. As evidence of our commitment to correspondent lending, the Company
chose this line of business to lead the Company's first venture into
California, placing two new account executives there late in the year. Growth
in this division remained solid, as correspondent production for the year rose
to $7.9 billion, a 27% increase over 1995. The number of approved
correspondents rose by 145, representing a 20% increase.
GROWTH OF THE CORRESPONDENT NETWORK
- -------------------------------------------------------------------------------
12/31/94 12/31/95 12/31/96
- -------------------------------------------------------------------------------
Approved Correspondents 485 726 871
Regional Account Executives 9 10 11
Production (in billions) $2.9 $6.3 $7.9
TOP CORRESPONDENT/BROKER ORIGINATORS IN 1996
(VOLUME IN BILLIONS)
- --------------------------------------------------------------------------------------------
RANK LENDER WHOLESALE* TOTAL WHOLESALE AS
(1996) ORIGINATIONS ORIGINATIONS % OF TOTAL
- --------------------------------------------------------------------------------------------
1 Countrywide Home Loans $30.54 $38.82 78.7%
2 Norwest Mortgage, Inc. $25.16 $51.48 48.9%
3 HomeSide Lending (BancBoston) $18.74 $19.64 95.4%
4 Chase Manhattan Mortgage $22.09 $33.56 65.8%
5 Fleet Mortgage $14.29 $17.81 80.2%
6 RBMG, Inc. $ 9.29 $ 9.96 93.3%
*Wholesale includes correspondent and broker originations.
Source: Inside Mortgage Finance, February 14, 1997
EXCEPTIONAL CUSTOMER SERVICE KEEPS OUR CORRESPONDENTS/BROKERS HAPPY. THE
RESULTS SPEAK FOR THEMSELVES.
As a result of continued strong performance by the Company's correspondent
division, plus continued investment in our wholesale division, the Company
retained its position as
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the country's sixth-largest correspondent/broker mortgage originator. The
addition of the California market and continued emphasis on the Texas and
Pacific Northwest markets should position RBMG as a top-five
correspondent/broker originator. 93.3% of RBMG's 1996 loan production was
originated through correspondent/broker channels, which is the Company's
primary business focus because of its inherent lower cost structure. According
to Inside Mortgage Finance, RBMG's percentage is among the highest of the top
15 lenders in this category.
PLATFORM EXPANSION
WHOLESALE LENDING
WHOLESALE LOAN PRODUCTION
($ thousands)
1994 1995 1996
- --------- --------- -----------
$19,931 $673,201 $1,411,643
Since the formation of this division in late 1994, it has grown dramatically,
now contributing 14% of the Company's production volume. 1996 production
outpaced that of 1995 by nearly $750 million, a 110% increase.
NUMBER OF BRANCHES APPROVED BROKERS
1994 1995 1996 1994 1995 1996
- ------ ------ ------ ------ ------ ------
3 10 13 190 1,144 2,322
The number of approved brokers more than doubled in 1996. The recent addition
of branches in Denver, St. Louis and the metropolitan Baltimore area, bringing
the number of the Company's wholesale branches to 13, affords opportunity for
future growth as well. The Company continues to evaluate other new markets as
candidates for additional wholesale branches, including various California
locations. The Company also intends to leverage its wholesale branch network
as a base on which to build its subprime originations platform. Continued
consolidation among the larger banks and mortgage companies will cause a steady
stream of brokers entering the business as these companies downsize and merge
operations.
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DIRECT OPERATING EXPENSES
(AS BASIS POINTS OF PRODUCTION)
1994 1995 1996
- --------- --------- ---------
214 bps 55bps 60bps
With further expansion of the wholesale division and resulting increased
production from 1994 to 1996, the Company has been able to reduce the
division's operating expenses as a percentage of production.
RBMG'S EXPANSION INTO WHOLESALE AND RETAIL OPERATIONS HAS BEEN SUCCESSFUL.
BOTH DIVISIONS ARE NOW OPERATING PROFITABLY.
RETAIL LENDING
RETAIL LOAN PRODUCTION
($ thousands)
1995 1996
- ------------- -----------
$210,565 $668,759
In 1996, the Company began to fully realize the results of its entrance into
the retail mortgage market in May 1995. Production from this channel grew
from $211 million in 1995 to $669 million in 1996, an increase of $458 million,
or 218%. Five new "satellite" branches were opened during the year to
facilitate further market penetration. In addition, two joint ventures were
initiated late in the year that are expected to further contribute to profits.
DIRECT OPERATING EXPENSES
(AS BASIS POINTS OF PRODUCTION)
1995 1996
--------- ---------
359 bps 239 bps
As production has increased from 1995 to 1996, there has been a corresponding
decrease in direct operating expenses as a percentage of production. The
Company has been able to manage costs by leveraging the expertise of its
seasoned retail management group, who have worked together for more than 13
years. Opportunities to fine tune and enhance the retail operations are still
abundant. A closing operation is now operative in New York that will enable
RBMG to retain a greater portion of fee income while incurring little
additional expense.
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EXPANDING SERVICING PORTFOLIO
LOAN SERVICING HIGHLIGHTS
SERVICING PORTFOLIO BALANCES
($ in millions)
1992 1993 1994 1995 1996
- -------- -------- ------- ------- -------
$1,198 $1,921 $4,040 $5,563 $6,670
The Company continued to pursue its strategy of bargain hunting in the
acquisition of bulk servicing packages in 1996. By utilizing a combination of
in-house and analyst portfolio valuation techniques, we identified and acquired
several reasonably priced packages, totaling $1.4 billion for 1996. Given the
current fierce competition for servicing, resulting in agressive bidding for
most packages offered for sale, the Company began to execute an alternative
approach to build its longer-term portfolio in 1996 by routinely retaining a
percentage of our own production each quarter.
BY ROUTINELY SELLING A HIGH PERCENTAGE OF THE SERVICING IT PRODUCES, RBMG CAN
EFFECTIVELY MANAGE PREPAYMENT RISK AND IMMEDIATELY REALIZE THE CASH VALUE OF
THE SERVICING IT CREATES.
SERVICING PORTFOLIO SUMMARY
- -----------------------------------------------------------------------------
12/31/95 12/31/96
- -----------------------------------------------------------------------------
OWNED:
Portfolio Balance ($000) $5,562,930 $6,670,267
Loans Serviced 64,579 75,572
Average Loan Size $ 86,141 $ 88,758
Weighted Average Note Rate 7.84% 7.92%
Weighted Average Maturity (Months) 302 288
Weighted Average Service Fee 42bps 39bps
Total Delinquencies (Loan Count) 3.42% 3.75%
Basis - Multiple of Service Fee 4.26x 4.22x
SUBSERVICED:
Portfolio Balance ($000) $2,258,806 $1,988,475
Loans Serviced 25,484 20,515
Average Loan size $ 88,636 $ 96,928
Average Owned and Subserviced Portfolio Balance
($000) $6,397,186 $8,814,560
Although the subservicing portfolio balance at the end of 1996 was 12% less
than the 1995 year-end balance, the average portfolio balance for 1996 that is
owned and subserviced has increased by 38% over the 1995 average. As a
combined result of acquisitions and retentions, the Company grew its servicing
portfolio nearly 20% over the
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past year. Our intent for 1997 is to accelerate this growth, using both
approaches, with a goal of $10 billion by sometime during 1998.
EXPANDING INTO SUBPRIME MARKET
SUBPRIME LENDING
Perhaps the most exciting prospect the Company faces currently is its venture
into the subprime lending market. Assuming our pending merger with Meritage
Mortgage, Corporation closes, the Company would gain an immediate foothold in
this market. Even more promising, Meritage is still a young company - despite
the substantial cumulative experience of its key personnel - with considerable
potential for rapid growth.
Add to this scenario the simultaneous formation of an East-Coast subprime unit,
also laden with experience, and the Company is poised to become a significant
player in the industry.
To generate even greater returns from our new subprime operations, the Company
is aggressively pursuing the capacity to perform its own securitizations. In
fact, current plans foresee completing our first securitization perhaps as
early as the second quarter of 1997.
"REMI's entry into the subprime market should position it for strong future
growth."
UBS Securities,
Equity Research, (REMI),
February 27, 1997
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STOCK PERFORMANCE
STOCK PERFORMANCE
- --------------------------------------
12/31/93 12/31/94 12/31/95 12/31/96
- --------------------------------------
$7.43 $8.09 $13.32 $14.25
"REMI is still in its initial growth stage."
UBS Securities,
Equity Research, (REMI),
February 27, 1997
"Resource's stock remains a bargain at $14.25 a share ... selling at just 8.1
times projected 1997 earnings. Industry leader Countrywide Credit, by
contrast, with more modest growth prospects, is trading at 10.7 times projected
earnings."
Smart Money Magazine
March 1997
"The company has always been able to make money when others weren't...They know
what they are doing."
Rick Lawson, Weitz & Company
as quoted in
Smart Money Magazine
March 1997
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SELECTED FINANCIAL HIGHLIGHTS
($ in thousands, except share information)
- -------------------------------------------------------------------------------------------------------------------------------
At or for the Year Ended December 31,
1996 1995 1994 1993 1992
- -------------------------------------------------------------------------------------------------------------------------------
INCOME STATEMENT
Net interest income $ 16,902 $ 8,635 $ 7,686 $ 9,616 $ 9,200
Net gain on sale of mortgage loans 79,178 33,822 1,160 2,167 2,262
Gain on sale of mortgage
servicing rights 1,105 7,346 33,375 29,202 17,491
Loan servicing fees 28,763 24,205 14,196 6,128 3,216
Total revenues 126,617 76,697 56,622 47,756 32,826
Salary and employee benefits 55,578 31,199 15,986 12,203 10,048
Total expenses (including taxes) 106,994 62,478 38,579 30,176 21,576
Net income 19,623 14,219 18,043 17,580 11,250
PER COMMON SHARE DATA (2)
Net income per common share $ 1.08 $ 0.92 $ 1.16 $ 0.80 (1) N/A
Market value per common share at year-end 14.25 13.32 8.09 7.43 N/A
Book value per common share at year-end 8.16 6.00 5.21 4.04 N/A
Cash dividends per common share 0.06
BALANCE SHEET
Mortgage loans held for sale
and mortgage-backed securities $ 802,335 $ 1,035,229 $ 119,044 $ 587,208 $ 330,305
Mortgage servicing rights, net 109,815 99,912 65,840 15,123 10,630
Total assets 1,028,394 1,231,097 237,631 639,425 364,328
Total liabilities 871,093 1,137,693 157,017 576,942 344,388
Stockholders' equity and parent
equity in the division 157,301 93,404 80,614 62,483 19,940
STATISTICS
Total loan production $ 9,995,725 $ 7,135,774 $ 2,875,265 $ 4,239,100 $ 2,458,302
Total servicing portfolio
(including subservicing) 8,658,742 7,821,736 5,876,508 3,049,270 1,830,825
Return on average assets 1.91% 1.95% 5.25% N/A (3) N/A (3)
Return on average equity 14.43% 17.00% 25.98% N/A (3) N/A (3)
(1) Resource Bancshares Mortgage Group, Inc.'s initial public offering was
consummated on June 3, 1993. Net income per common share for 1993 was
calculated based on net income subsequent to the date of the initial public
offering through December 31, 1993, of $12,465.
(2) Amounts have been adjusted for Stock Dividends as defined elsewhere in this
Annual Report.
(3) Because of the significantly different capital structure of the Company
prior to its initial public offering, these statistics are not comparatively
meaningful for periods prior to, and including the date on which, the initial
public offering was consummated.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the financial information and the Consolidated Financial Statements of the
Company (including the notes thereto) contained elsewhere in this document. To
the extent that any statement below (or elsewhere in this document) is not a
statement of historical fact and could be considered a forward-looking
statement, the "Risk Factors" discussion set forth in the Company's final
Prospectus dated March 11, 1996, identifies important factors that could cause
actual results to differ materially from those in the forward-looking statement.
THE COMPANY
Resource Bancshares Mortgage Group, Inc. (the Company), was organized
under Delaware law in 1992 to acquire and operate the mortgage banking business
of Resource Bancshares Corporation (RBC), which commenced operations in May
1989. The assets and liabilities of the mortgage banking business of RBC were
transferred to the Company on June 3, 1993, when the Company sold 58% of its
common stock in an initial public offering. As a result, RBC retained a
significant ownership interest in the Company. As of December 31, 1996, RBC
owned approximately 38% of the outstanding common stock of the Company.
The Company is principally engaged in the purchase and origination of
residential mortgage loans, which it aggregates into mortgage-backed securities
issued or guaranteed by the Federal Home Loan Mortgage Corporation (FHLMC), the
Federal National Mortgage Association (FNMA) and the Government National
Mortgage Association (GNMA). The Company sells the mortgage-backed securities it
creates to institutional purchasers with the rights to service the underlying
loans being retained by the Company. The servicing rights retained are generally
sold separately but may be held for extended periods by the Company.
LOAN PRODUCTION
The Company purchases mortgage loans from its correspondents and
through its wholesale division. The Company originates mortgage loans through
its retail division.
A summary of loan production by source for the periods indicated is set
forth below:
($ IN THOUSANDS) FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------
1996 1995 1994
---------- ---------- ----------
Loan Production:
Correspondent Division $7,915,323 $6,252,008 $2,855,334
Wholesale Division 1,411,643 673,201 19,931
Retail Division 668,759 210,565
---------- ---------- ----------
Total Loan Production $9,995,725 $7,135,774 $2,875,265
========== ========== ==========
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Historically, the Company was exclusively focused on purchasing loans
through its correspondents. In order to diversify its sources of loan volume,
the Company started a wholesale operation, which purchased its first loan in May
1994, and a retail operation, which originated its first loan in May 1995.
Accordingly, correspondent operations have accounted for a diminishing
percentage of the Company's loan production (79% for 1996, as compared to 88%
for 1995 and 99% for 1994) as the wholesale and retail operations have grown.
Management anticipates that wholesale and retail operations will continue to
account for an increasing percentage of total loan production as those divisions
are further expanded and approach capacity. In general, management has targeted
as a near-term goal a production mix of approximately 70% correspondent , 20%
wholesale and 10% retail.
A summary of key information relevant to industry loan production activity is
set forth below:
($ IN THOUSANDS) AT OR FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------
1996 1995 1994
------------ ------------ ------------
U.S. 1-4 Family Mortgage Originations Statistics (1):
U.S. 1-4 Family Mortgage Originations $791,000,000 $644,000,000 $769,000,000
Adjustable Rate Mortgage Market Share 27.00% 30.00% 39.00%
Company Information:
Loan Production $ 9,995,725 $ 7,135,774 $ 2,875,265
Estimated Company Market Share 1.26% 1.11% 0.37%
(1) Source: Mortgage Bankers Association of America, Economics Department.
Although nationwide production increased by 23% from 1995 to 1996, the
Company was able to increase its production by 40% during the same time period,
thereby increasing its 1996 market share by 14% over that for 1995. The 40%
increase in Company loan production was primarily due to the combined positive
impact of: 1) the overall increase in the market volume of originations
nationwide, which is related to the mortgage interest-rate environment among
other factors; 2) expansion of the Company's production network, including
realization of a full year's production from the wholesale and retail divisions;
and 3) the decline in the adjustable-rate mortgage (ARM) share of the U.S.
market, from 30% in 1995 to 27% for 1996. The Company is primarily focused on
purchase and origination of fixed-rate, 1-4 family residential mortgage loans.
As such, the Company is competitively disadvantaged in economic environments
that tend to favor ARMs over fixed-rate mortgages (Generally lower long-term
fixed-rate and flatter yield-curve environments tend to favor fixed-rate
originations.)
Although nationwide production decreased by 16% from 1994 to 1995, the
Company was able to increase its production by 148% during the same time period,
thereby nearly tripling its market share from 0.37% for 1994 to 1.11% for 1995.
The increase in the Company's loan production was primarily due to the expansion
of the Company's production network and the decline in the ARM share of the U.S.
market from 39% in 1994 to 30% for 1995.
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Correspondent Loan Production
Through its correspondents, the Company purchases loans that have been
originated by such correspondents with property owners. Correspondents are
primarily mortgage lenders, larger mortgage brokers and smaller savings and loan
associations and commercial banks.
The Company continues to emphasize correspondent loan production as its
primary business focus because of the lower fixed expenses and capital
investment required of the Company. That is, the Company can develop a cost
structure that is more directly variable with loan production because the
correspondent incurs most of the fixed costs of operating and maintaining branch
office networks and of identifying and interacting directly with loan
applicants.
A summary of key information relevant to the Company's correspondent loan
production activities is set forth below:
($ IN THOUSANDS) AT OR FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------
1996 1995 1994
---------- ---------- ----------
Correspondent Loan Production $7,915,323 $6,252,008 $2,855,334
Estimated Correspondent Market Share 1.00% 0.97% 0.37%
Approved Correspondents 871 726 485
The Company's correspondent market share increased slightly, to 1.00%
for 1996 as compared to 0.97% for 1995. This rise is primarily due to the
Company's correspondent production increasing by 27% for 1996, while nationwide
production increased by only 23%. The Company's correspondent production
outpaced nationwide trends primarily due to the Company's 20% growth in the
network of approved correspondents, to 871 at December 31, 1996, from 726 at
December 31, 1995.
The 119% increase in correspondent loan production, from $2.9 billion
for 1994 to $6.3 billion for 1995, was primarily due to the combined positive
impact of expansion of the Company's correspondent network and the decline in
the ARM share of the U.S. market, from 39% in 1994 to 30% for 1995. The number
of approved correspondents increased by 241 or 50% during 1995, from 485 at
December 31, 1994, to 726 at December 31, 1995. These positive factors more than
offset the negative effects of the 16% reduction in the overall U.S. market for
1-4 family residential mortgage loans. As a result, the Company's correspondent
market share nearly tripled, to 0.97% for 1995 from 0.37% for 1994.
Wholesale Loan Production
In May 1994, the Company began its expansion into the wholesale
mortgage banking business. In connection therewith, the Company receives loan
applications through brokers, underwrites the loan, funds the loan at closing
and prepares all closing documentation. The wholesale branches also handle all
shipping and follow-up procedures on loans. Although the establishment of
wholesale branch offices involves the incurrence of the fixed expenses
associated with maintaining those offices, wholesale operations also provide for
higher profit margins than correspondent loan production. Additionally, each
branch office can serve a relatively sizable geographic area by establishing
relationships with large numbers of
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independent mortgage loan brokers who bear much of the cost of identifying and
interacting directly with loan applicants.
A summary of key information relevant to the Company's wholesale
production activities is set forth below:
($ IN THOUSANDS) AT OR FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------
1996 1995 1994
---------- ---------- ----------
Wholesale Loan Production $1,411,643 $ 673,201 $ 19,931
Estimated Wholesale Market Share 0.18% 0.10% 0.00%
Wholesale Division Direct Operating Expenses $ 8,540 $ 3,697 $ 427
Approved Brokers 2,322 1,144 190
Number of Branches 13 10 3
Number of Employees 126 98 15
The 110% ($738 million) increase in wholesale loan production, from
$673 million for 1995 to $1.4 billion for 1996, was driven primarily by the full
year impact for 1996 of production out of the new branches added during 1995. As
a result thereof, together with the associated significant increase in broker
relationships, our wholesale market share increased 80% year to year.
Similarly, the $653 million increase in wholesale production from 1994
to 1995 resulted from a combination of branch expansion during 1995, and the
associated growth in established broker relationships.
Management anticipates the wholesale division will continue to account
for an increasing percentage of the Company's total loan production as existing
operations approach capacity and as the branch network is further expanded.
Retail Loan Production
In mid-1995, the Company expanded into the retail mortgage banking
business in the northeast. The establishment of the retail division was made in
the context of the demographics and market conditions affecting the northeast
and is expected to be unique within the context of the Company's primary
business strategies of continuing to increase the number of correspondents and
expand its wholesale division. The retail operation further diversifies the
Company's sources of loan volume and permitted management to retain a group of
seasoned and profitable originators who had previously worked together for 13
years. Management believes that in this particular case these positive
considerations, together with the higher relative profit margins typical for
retail originations, outweigh the increased earnings risk associated with the
retail division's higher fixed-cost structure.
A summary of key information relevant to the Company's retail
production activities that commenced in May 1995 is set forth below:
17
($ IN THOUSANDS) AT OR FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994
-------- -------- --------
Retail Loan Production $668,759 $210,565 N/A
Estimated Retail Market Share 0.08% 0.03% N/A
Retail Division Direct Operating Expenses $ 15,963 $ 7,584 N/A
Number of Branches 6 6 N/A
Number of Employees 209 158 N/A
The $458 million increase in retail loan production, to $669 million
for 1996 from $211 million for 1995, relates to the Company's initial May 1995
expansion into this production channel. The increase in market share to 0.08%
for 1996 from 0.03% for 1995 resulted primarily from realization of a full
year's production from the retail channel in 1996.
Management anticipates that the retail division will account for an
increasing percentage of the Company's total loan production as the existing
operations approach capacity. However, there are no current plans to increase
the number of retail branches.
LOAN SERVICING
Loan servicing includes collecting and remitting mortgage loan
payments, accounting for principal and interest, holding escrow funds for
payment of mortgage-related expenses such as taxes and insurance, making
advances to cover delinquent payments, making inspections as required of the
mortgaged premises, contacting delinquent mortgagors, supervising foreclosures
and property dispositions in the event of unremedied defaults and generally
administering mortgage loans.
The Company's strategy is to sell a substantial portion of its produced
mortgage servicing rights to other approved servicers. Typically, the Company
sells mortgage servicing rights within 90 to 180 days of purchase or
origination. However, for strategic reasons, the Company also strives to
maintain a servicing portfolio whose size is determined by reference to the
Company's cash operating costs which, in turn, is largely determined by
reference to the size of its loan production platform. By continuing to focus on
the low-cost correspondent production channel, the Company is able to minimize
the cash operating cost of its loan production platform and thus the
strategically required size of its loan servicing operation.
A summary of key information relevant to the Company's loan servicing
activities is set forth below:
18
($ IN THOUSANDS) AT OR FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1995 1994
----------- ----------- -----------
Underlying Unpaid Principal Balances:
Beginning Balance $ 5,562,930 $ 4,039,847 $ 1,920,593
Loan Production (net of servicing-
released production) 9,912,365 6,615,441 2,875,265
Net Change in Work-in-Process 535,847
Bulk Acquisitions 1,354,592 390,632 3,352,928
Sales of Servicing (9,521,451) (4,622,018) (3,802,498)
Paid-In-Full Loans (504,312) (400,897) (133,289)
Amortization, Curtailments, and Other, net (669,704) (460,075) (173,152)
----------- ----------- -----------
Ending Balance 6,670,267 5,562,930 4,039,847
Subservicing Ending Balance 1,988,475 2,258,806 1,836,661
----------- ----------- -----------
Total Underlying Unpaid Principal Balances $ 8,658,742 $ 7,821,736 $ 5,876,508
=========== =========== ===========
Loan Servicing Fees $ 28,763 $ 24,205 $ 14,196
Cash Operating Expenses $ 81,135 $ 45,053 $ 24,972
Coverage Ratio 35% 54% 57%
Average Underlying Unpaid Principal Balances
(including subservicing) $ 8,814,560 $ 6,397,186 $ 4,298,435
Weighted Average Note Rate 7.92% 7.84% 7.87%
Weighted Average Servicing Fee 0.39% 0.42% 0.46%
Delinquency (30+ days), Including Bankruptcies
and Foreclosures 3.75% 3.42% 3.36%
Number of Servicing Division Employees 128 115 85
The $2.4 billion or 38% increase in the average underlying unpaid
principal balance of mortgage loans being serviced for 1996 as compared to 1995
is primarily related to the Company's increased loan production volumes during
1996 and the Company's $1.4 billion in bulk acquisitions of servicing primarily
during the third quarter of 1996. Since the Company generally sells servicing
rights related to the loans it produces within 90 to 180 days of purchase or
origination, increased production volumes generally result in a higher volume of
mortgage servicing rights held in inventory pending sale. The $2.1 billion or
49% increase in the average underlying unpaid principal balance of mortgage
loans being serviced for 1995 as compared to 1994 is primarily related to the
Company's increased loan production volumes during 1995. The 35% coverage ratio
for 1996 is below the Company's strategic goal to generally maintain such ratio
at between 50% and 80%. The Company is continuing to review bulk purchase
opportunities with the objective of increasing this ratio.
19
RESULTS OF OPERATIONS - YEAR ENDED DECEMBER 31, 1996, COMPARED TO YEAR ENDED
DECEMBER 31, 1995
SUMMARY
Total revenues of the Company increased 65%, to $126.6 million for 1996
as compared to $76.7 million for 1995. The $49.9 million increase in revenues
was primarily due to an $8.3 million increase in net interest income and a $39.1
million increase in gains on sales of mortgage loans and mortgage servicing
rights. These increases in revenues were partially offset by a $36.1 million
increase in operating expenses (exclusive of amortization and taxes). The
increase in net interest income is due to the increase in annual production
volumes as well as the steeper 1996 yield-curve environment. Similarly, the
increase in gains on sales of loans and servicing rights is related to the
Company's increased loan production volumes for 1996. The increase in operating
expenses is primarily attributable to increased costs associated with increased
loan production and loan servicing volumes, increased costs associated with
further development of the wholesale and retail operations, and a non-recurring
charge. Direct costs related to the Company's development of its retail and
wholesale operations account for approximately $8.4 million and $4.8 million, or
23% and 13%, respectively, of the total increase in operating expenses
(exclusive of amortization and taxes) for 1996. Approximately $5.2 million of
the increase in operating expenses, which is partially offset by a $2.0 million
decrease in income taxes, is attributable to a non-recurring charge related to
certain contractual employment obligations.
As a consequence of the foregoing, pre-tax net income increased 37% or
$8.3 million. After-tax net income also increased 38%, or $5.4 million, for 1996
as compared to 1995.
The following sections discuss the components of the Company's results
of operations in greater detail.
NET INTEREST INCOME
The following table analyzes net interest income in terms of rate and
volume variances of the interest spread (the difference between interest rates
earned on loans and mortgage-backed securities and interest rates paid on
interest-bearing sources of funds).
20
Variance
Average Volume Average Rate Interest Attributable to
- -------------------- ------------- ----------------- -----------------
1996 1995 1996 1995 1996 1995 Variance Rate Volume
- -------- -------- ---- ---- ------- ------- -------- ------- -------
($ in thousands) INTEREST INCOME ($ in thousands)
Mortgage Loans Held for Sale and
$816,597 $603,735 7.70% 7.86% Mortgage-Backed Securities $62,858 $47,477 $15,381 $(1,358) $16,739
- -------- -------- ---- ---- ------- ------- ------- ------- -------
INTEREST EXPENSE
331,356 250,767 4.52% 5.46% Warehouse Line 14,993 13,695 1,298 (3,103) 4,401
462,058 304,680 5.66% 6.11% Gestation Line 26,135 18,621 7,514 (2,104) 9,618
15,336 49,358 8.19% 7.77% Servicing Secured Line 1,256 3,835 (2,579) 64 (2,643)
18,639 4,776 5.89% 6.18% Servicing Sales Receivable Line 1,098 295 803 (53) 856
7,842 8,479 8.50% 8.46% Other Borrowings 667 717 (50) 4 (54)
Facility Fees and Other Charges 1,807 1,679 128 128
- -------- -------- ---- ---- ------- ------- ------- ------- -------
835,231 618,060 5.50% 6.28% Total Interest Expense 45,956 38,842 7,114 (5,192) 12,306
- -------- -------- ---- ---- ------- ------- ------- ------- -------
N/A N/A 2.20% 1.58% NET INTEREST INCOME $16,902 $ 8,635 $ 8,267 $ 3,834 $ 4,433
- -------- -------- ---- ---- ------- ------- ------- ------- -------
Net interest income increased 96% to $16.9 million for 1996 compared to
$8.6 million for 1995. The $8.3 million increase in net interest income is
primarily attributable to the 35% increase in the average volume of mortgages
held for sale and mortgage-backed securities for 1996 from that of 1995. Net
interest income also increased due to a 62 basis-point increase in the
interest-rate spread, to 220 basis points for 1996 as compared to 158 basis
points for 1995. The increase in interest-rate spread was associated primarily
with the steeper 1996 yield curve environment. The Company's mortgages and
mortgage-backed securities are generally sold and replaced within 30 to 35 days.
The Company generally borrows at rates based upon short-term indices, while its
asset yields are primarily based upon long-term mortgage rates.
NET GAINS ON SALES OF MORTGAGE LOANS AND MORTGAGE SERVICING RIGHTS
Net gains on sales of mortgage loans and mortgage servicing rights
increased $39.1 million to $80.3 million for 1996 as compared to $41.2 million
for 1995. As further discussed below, this increase is primarily due to higher
volumes of mortgage loans and mortgage servicing rights sold during 1996
compared to 1995, as well as the effects of increased profit margins on sales.
Net Gain on Sale of Mortgage Loans
A reconciliation of gain on sale of mortgage loans for the periods
indicated follows:
21
($ IN THOUSANDS) FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995
------------ -----------
Gross proceeds on sale of mortgage loans $ 10,307,177 $ 6,275,802
Initial allocated acquisition basis of mortgage loans sold 10,296,282 6,275,415
------------ -----------
Unadjusted gain on sale of mortgage loans 10,895 387
Loan origination and correspondent program administrative fees 34,405 15,497
------------ -----------
Unadjusted aggregate margin 45,300 15,884
Acquisition basis allocated to mortgage servicing rights 34,181 18,913
Gains deferred to reduce mortgage servicing rights (922)
Net change in deferred administrative fees (303) (53)
------------ -----------
Net gain on sale of mortgage loans $ 79,178 $ 33,822
============ ===========
The Company sold loans during 1996 with an aggregate unpaid principal
balance of $10.3 billion compared to sales of $6.3 billion for 1995. The amount
of proceeds received on sales of mortgage loans exceeded the initial unadjusted
acquisition cost of the loans sold by $10.9 million (11 basis points) for 1996
as compared to $0.4 million (1 basis point) for 1995. The Company received loan
origination and correspondent program administrative fees of $34.4 million (33
basis points) on these loans during 1996 and $15.5 million (25 basis points)
during 1995. The Company had allocated $34.2 million (33 basis points) to basis
in mortgage servicing rights for loans sold in 1996 as compared to $18.9 million
(30 basis points) allocated to loans sold in 1995. This is a result of the
adoption of SFAS No. 122 for loans acquired after April 1, 1995. Also, there is
no gain deferred against mortgage servicing rights during 1996 due to the
adoption of SFAS No. 122, while $0.9 million was deferred for 1995 prior to
implementation of SFAS No. 122 on April 1, 1995. As a result, net gain on sale
of mortgage loans increased to $79.2 million for 1996 versus $33.8 million for
1995. This increase was primarily due to the 65% increase in the volume of
mortgage loans sold, as well as an 18 basis-point increase in the unadjusted
aggregate margin on the sale of mortgage loans, from 25 basis points for 1995 to
43 basis points for 1996.
Gain on Sale of Mortgage Servicing Rights
A reconciliation of the components of gain on sale of mortgage
servicing rights for the periods indicated follows:
22
($ IN THOUSANDS) FOR THE YEAR ENDED DECEMBER 31,
--------------------------
1996 1995
----------- -----------
Underlying unpaid principal balances of mortgage loans on
which servicing rights were sold during the period $ 9,528,240 $ 4,622,018
=========== ===========
Gross proceeds from sales of mortgage servicing rights 196,406 94,027
Initial allocated acquisition basis, net of amortization 164,611 77,484
----------- -----------
Unadjusted gain on sale of mortgage servicing rights 31,795 16,543
Acquisition basis allocated from mortgage loans, net of
amortization (30,690) (12,803)
Previously deferred administrative fees and gain on sale of
mortgage loans recognized 3,606
----------- -----------
Gain on sale of mortgage servicing rights $ 1,105 $ 7,346
=========== ===========
During 1996, the Company completed 34 sales of mortgage servicing
rights representing $9.5 billion of underlying unpaid principal mortgage loan
balances. This compares to 24 sales of mortgage servicing rights representing
$4.6 billion of underlying unpaid principal mortgage loan balances in 1995. The
unadjusted gain on the sale of mortgage servicing rights was $31.8 million (33
basis points) for 1996, up from $16.5 million (36 basis points) for 1995. The
Company reduced this unadjusted gain by $30.7 million in 1996, compared with a
$12.8 million reduction in 1995, due to the adoption of SFAS No. 122 effective
April 1, 1995. Also, prior to adoption of SFAS No. 122, the Company recognized
$3.6 million in previously deferred administrative fees and gains on sales of
mortgage loans. The acquisition basis allocated from mortgage loans, net of
amortization, as a percentage of unadjusted gain on sale of mortgage servicing
rights, is 97% for 1996 as compared to 77% for 1995. The lower percentage for
1995 is because SFAS No. 122 was not adopted until the second quarter of 1995.
As such, a basis allocation adjustment was not recorded for the first quarter of
1995.
NET SERVICING MARGIN
Loan servicing fees were $28.8 million for 1996, compared to $24.2
million for 1995, an increase of 19%. This increase is primarily related to an
increase in the average aggregate underlying unpaid principal balance of
mortgage loans serviced, to $8.8 billion during 1996 from $6.4 billion during
1995, an increase of 38%. Similarly, amortization of mortgage servicing rights
also increased, to $14.9 million during 1996 from $9.4 million during 1995, an
increase of 60%. The increase in amortization is primarily attributed to the
growth in the average balance of the mortgage loans serviced and the higher
basis in the servicing rights resulting from SFAS No. 122. As a result, net
servicing margin decreased 7% to $13.8 million during 1996, from $14.9 million
during 1995.
Included in loan servicing fees for 1996 and 1995 are subservicing fees
received by the Company of $960,000 and $695,000, respectively. The subservicing
fees are associated with temporary subservicing agreements between the Company
and purchasers of mortgage servicing rights.
The following table summarizes the net servicing margin for both 1996
and 1995:
23
($ IN THOUSANDS) FOR THE YEAR ENDED DECEMBER 31,
------------------------
1996 1995
---------- ----------
Loan servicing fees $ 28,763 $ 24,205
Amortization of mortgage servicing rights 14,934 9,352
---------- ----------
Net servicing margin $ 13,829 $ 14,853
========== ==========
Average underlying unpaid principal balance of
mortgage loans serviced $8,814,560 $6,397,186
OTHER INCOME
Other income decreased during 1996 compared to 1995, primarily due to
the prospective recharacterization of certain loan-related gain and loss amounts
in connection with the implementation of SFAS No. 122.
EXPENSES
The $36.1 million increase in operating expenses (excluding
amortization of mortgage servicing rights) was centered in salary and employee
benefits, which increased $24.4 million or 78%. Approximately $5.2 million of
the increase in operating expenses, partially offset by a $2.0 million decrease
in income taxes, is attributable to recognition of a non-recurring charge
related to certain contractual employment obligations. The Company increased its
employee headcount by 147, from 880 at December 31, 1995, to 1,027 at December
31, 1996. The increased employee headcount and associated increase in salary and
employee benefit costs were necessitated by the Company's increased loan
production and increased servicing volume for 1996 as compared to 1995, which
were up 40% and 38%, respectively. Employee headcount attributable to expansion
of the wholesale and retail divisions accounted for 79 of the total 147 increase
and for $13.2 million of the total $36.1 million increase in operating expenses
(excluding amortization of mortgage servicing rights).
INCOME TAX EXPENSE
Income tax expense includes both federal and state income taxes. The
effective tax rates for 1996 and 1995 were 35.8% and 36.2%, respectively. Income
tax expense increased by 35%, to $10.9 million for 1996 from $8.1 million for
1995, due to the above-described factors that resulted in a 37% or $8.3 million
increase in income before taxes, which was partially offset by the Company
utilizing certain primarily non-recurring state tax credits of $1.7 million.
24
RESULTS OF OPERATIONS - YEAR ENDED DECEMBER 31, 1995, COMPARED TO YEAR ENDED
DECEMBER 31, 1994
SUMMARY
Total revenues of the Company increased 35% to $76.7 million for 1995
as compared to $56.6 million for 1994. The $20.1 million increase in revenues
was centered in loan servicing fees, which increased $10.0 million (due to the
increase in the average underlying unpaid principal balance of mortgage loans
being serviced by the Company), and in gains on sales of mortgage loans and
mortgage servicing rights, which increased $6.7 million (due to increases in the
Company's loan production). Similarly, expenses of the Company (exclusive of
income tax expense) increased 84%, to $54.4 million for 1995 as compared to
$29.5 million for 1994. The $24.9 million increase in expenses was centered in
personnel expense, which increased $15.2 million (due to increased employee
headcount associated with the higher volumes of loan production and loan
servicing activities, as well as the Company's expansion into wholesale and
retail operations) and in amortization of mortgage servicing rights, which
increased $4.8 million (due to the increased size of the Company's mortgage
servicing portfolio).
As a consequence of the foregoing, pre-tax net income decreased 18% or
$4.8 million, while after-tax net income decreased 21% or $3.8 million for 1995
as compared to 1994.
NET INTEREST INCOME
The following table analyzes net interest income in terms of rate and
volume variances of the interest spread (the difference between interest rates
earned on loans and mortgage-backed securities and interest rates paid on
interest-bearing sources of funds).
Variance
Average Volume Average Rate Interest Attributable to
- ------------------- ------------ ----------------- -----------------
1995 1994 1995 1994 1995 1994 Variance Rate Volume
- -------- -------- ---- ---- ------- ------- -------- ------- -------
($ in thousands) INTEREST INCOME ($ in thousands)
Mortgage Loans Held for Sale and
$603,735 $274,855 7.86% 7.63% Mortgage-Backed Securities $47,477 $20,974 $26,503 $ 1,406 $25,097
- -------- -------- ---- ---- ------- ------- ------- ------- -------
INTEREST EXPENSE
250,767 86,901 5.46% 4.76% Warehouse Line 13,695 4,137 9,558 1,757 7,801
304,680 159,329 6.11% 4.52% Gestation Line 18,621 7,194 11,427 4,864 6,563
49,358 382 7.77% 7.33% Servicing Secured Line 3,835 28 3,807 217 3,590
4,776 6.18% Servicing Sales Receivable Line 295 295 295
8,479 8.46% Other Borrowings 717 717 717
Facility Fees and Other Charges 1,679 1,929 (250) (250)
- -------- -------- ---- ---- ------- ------- ------- ------- -------
618,060 246,612 6.28% 5.39% Total Interest Expense 38,842 13,288 25,554 6,588 18,966
- -------- -------- ---- ---- ------- ------- ------- ------- -------
N/A N/A 1.58% 2.24% Net Interest Income $ 8,635 $ 7,686 $ 949 $(5,182) $ 6,131
======== ======== ==== ==== ======= ======= ======= ======= =======
Net interest income increased 12% to $8.6 million for 1995 as compared
to $7.7 million for 1994. The $0.9 million increase in net interest margin is
primarily attributable to the 120% increase in the average volume of mortgages
held for sale and mortgage-backed securities for 1995 as compared to 1994. This
increase in volume more than offset the negative effects of the decrease in the
interest-rate spread of 66 basis points. The decrease in interest-rate spread
was
25
primarily the result of the narrower spreads between long-and short-term rates
in 1995 as compared to 1994. That is, since the Company's mortgages and
mortgage-backed securities are generally sold and replaced within 30-35 days,
the Company generally borrows at rates based upon short-term indices, while its
asset yields are primarily based upon long-term mortgage rates.
NET GAINS ON SALES OF MORTGAGE LOANS AND MORTGAGE SERVICING RIGHTS
Net gains on sales of mortgage loans and mortgage servicing rights
increased $6.7 million or 19% to $41.2 million for 1995 as compared to $34.5
million for 1994. As further discussed below, this increase was primarily due to
higher production volumes, which caused the volumes of mortgage loans and
mortgage servicing rights sold for 1995 to increase as compared to 1994. The
positive effects of increased sales volumes were partially offset by thinner
profit margins on sales.
NET GAIN ON SALE OF MORTGAGE LOANS
A reconciliation of selected components of gain on sale of mortgage
loans for the periods indicated follows:
($ IN THOUSANDS) FOR THE YEAR ENDED DECEMBER 31,
------------------------------
1995 1994
----------- -----------
Gross proceeds on sales of mortgage loans $ 6,275,802 $ 3,353,880
Initial allocated acquisition basis of mortgage loans sold 6,275,415 3,343,429
----------- -----------
Unadjusted gain on sale of mortgage loans 387 10,451
Loan origination and correspondent program administrative fees 15,497 9,047
----------- -----------
Adjusted gain on sale of mortgage loans 15,884 19,498
Acquisition basis allocated to mortgage servicing rights 18,913
Gains deferred to reduce mortgage servicing rights (922) (18,338)
Net change in deferred administrative fees (53)
=========== ===========
Net gain on sale of mortgage loans $ 33,822 $ 1,160
=========== ===========
The Company sold loans during 1995 with an aggregate unpaid principal
balance of $6.3 billion, compared to sales of $3.4 billion for 1994. Since the
Company sells substantially all the loans it produces, the $2.9 billion or 87%
increase in gross proceeds on sales of mortgage loans is due primarily to the
previously discussed increase in loan production for 1995 as compared to 1994.
The amount of proceeds received on sales of mortgage loans exceeded the initial
acquisition basis in the loans sold by $0.4 million for 1995 and $10.5 million
for 1994. The Company received loan origination and correspondent program
administrative fees of $15.5 million on these loans during 1995 and $9.0
million during 1994. As a result, adjusted gain on sale of mortgage loans
decreased 19%, to $15.9 million for 1995 versus $19.5 million for 1994, in
spite of an 87% increase in the volume of mortgage loans sold, primarily due to
the implementation of SFAS No. 122. The positive effects of increased sales
volume were partially offset by a 33 basis-point decrease in the margin of
unadjusted gain on sale of mortgage loans, from 58 basis points for 1994 to 25
basis points for
26
1995. The thinner profit margin is primarily attributable to competitive pricing
conditions in the Company's primary markets for 1995 as compared to 1994.
Prior to April 1, 1995, and in conjunction with the acquisition of
mortgage loans, the Company capitalized as mortgage servicing rights the portion
of the purchase price that represented the premium paid for the right to service
the mortgage loans. The amount capitalized was subsequently reduced, if the
mortgage loans were sold at a gain, by the amount of such gain. Effective April
1, 1995, the Company adopted Statement of Financial Accounting Standards (SFAS)
No. 122, ("Accounting for Mortgage Servicing Rights-An Amendment of FASB
Statement No. 65"), and, as required thereby, the Company began allocating the
total cost of a whole mortgage loan to the mortgage servicing right and the loan
(without servicing rights) based on relative fair market values. The amount
capitalized as mortgage servicing rights is no longer required to be reduced if
the loan is sold at a gain. Accordingly, the reduction in the amount of gains
deferred to reduce mortgage servicing rights, from $18.3 million for 1994 to
$0.9 million for 1995, is due to implementation of SFAS No. 122 effective April
1, 1995. Although implementation of SFAS No. 122 accounts for a significant
portion of the increase in the amount reported as net gain on sale of mortgage
loans, the implementation also accounts for a significant portion of the
decrease in the amount reported as gain on sale of mortgage servicing rights, as
discussed below.
Gain on Sale of Mortgage Servicing Rights
A reconciliation of selected components of gain on sale of mortgage
servicing rights for the periods indicated follows:
($ IN THOUSANDS) FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1995 1994
----------- ----------
Underlying unpaid principal balances of mortgage loans on
which servicing rights were sold during the period $ 4,622,018 $3,802,498
=========== ==========
Gross proceeds from sales of mortgage servicing rights 94,027 60,805
Initial allocated acquisition basis, net of amortization 77,484 54,005
----------- ----------
Unadjusted gain on sale of mortgage servicing rights 16,543 6,800
Acquisition basis allocated from mortgage loans, net of
amortization (12,803)
Previously deferred administrative fees and gain on sale of
mortgage loans recognized 3,606 26,575
=========== ==========
Gain on sale of mortgage servicing rights $ 7,346 $ 33,375
=========== ==========
During 1995, the Company completed 24 sales of mortgage servicing
rights representing $4.6 billion of underlying unpaid principal mortgage loan
balances, compared to 11 sales of mortgage servicing rights representing $3.8
billion of underlying unpaid principal balances in 1994. Unadjusted gain on sale
of mortgage servicing rights was $16.5 million for 1995, compared to $6.8
million for 1994. This increase was primarily due to implementation of SFAS No.
122, which provides for initial capitalization of mortgage servicing rights
using a relative fair value allocation approach that has resulted in narrower
unadjusted margins upon sales.
27
Similarly, the decline in previously deferred administrative fees and gain on
sale of mortgage loans recognized is due to adoption of SFAS No. 122 effective
April 1, 1995, which eliminated the requirement that gains on sale of mortgage
loans and administrative fees be deferred as a reduction of basis in mortgage
servicing rights. Thus, the $26.0 million decline in gain on sale of mortgage
servicing rights is primarily related to adoption of SFAS No. 122.
The prices obtained by the Company upon the sale of its mortgage
servicing rights depend upon a number of factors, including the general supply
of, and demand for, mortgage servicing rights, as well as prepayment and
delinquency rates on the portfolio of mortgage servicing rights being sold.
Interest-rate changes and product mix can affect the ability to sell or the
profitability of a sale of mortgage servicing rights to a third party.
Additionally, competitive pressures impact prices paid to acquire mortgage
servicing rights, which impact profitability upon disposition. Purchasers of
mortgage servicing rights analyze a variety of factors, including prepayment
sensitivity of servicing rights, to determine the purchase price they are
willing to pay. Thus, sales of mortgage servicing rights related to higher
interest-rate loans may be less profitable than sales of mortgage servicing
rights related to lower interest-rate loans. Because these factors are largely
beyond the control of the Company, there can be no assurance as to the level of
future profitability from the sale of mortgage servicing rights.
NET SERVICING MARGIN
The following table summarizes the net servicing margin for both 1995
and 1994:
($ IN THOUSANDS) FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1995 1994
---------- ----------
Loan servicing fees $ 24,205 $ 14,196
Amortization of mortgage servicing rights 9,352 4,574
---------- ----------
Net servicing margin $ 14,853 $ 9,622
========== ==========
Average underlying unpaid principal balance of
mortgage loans serviced $6,397,186 $4,298,435
Loan servicing fees were $24.2 million for 1995, compared to $14.2
million for 1994. Similarly, amortization of mortgage servicing rights increased
to $9.4 million during 1995 from $4.6 million during 1994. As a result, net
servicing margin increased to $14.8 million during 1995, compared to $9.6
million during 1994, an increase of 54%. These increases primarily relate to a
49% increase in the average aggregate underlying unpaid principal balance of
mortgage loans serviced, to $6.4 billion during 1995 from $4.3 billion during
1994.
Included in loan servicing fees for 1995 and 1994 are subservicing fees
received by the Company of $695,000 and $565,000, respectively. The subservicing
fees are associated with temporary subservicing agreements between the Company
and purchasers of mortgage servicing rights.
28
OTHER INCOME
Other income increased during 1995 compared to 1994, primarily due to
increased administrative fees received from sales of servicing-released loans
during 1995 as compared to 1994.
EXPENSES
The $20.1 million increase in operating expenses (excluding
amortization of mortgage servicing rights) was centered in salary and employee
benefits, which increased $15.2 million, or 95%. During 1995, the Company
increased its employee headcount by 529, from 351 at December 31, 1994, to 880
at December 31, 1995. The increased employee headcount and associated 95%
increase in salary and employee benefit costs were necessitated by the Company's
increased loan production and average loan servicing volumes, which were up 148%
and 54%, respectively. Employee headcount attributable to expansion of the
wholesale division and establishment of the retail division accounted for 241 of
the total 529 increase and for $10.9 million of the total $20.1 million increase
in operating expenses. The $4.9 million increase in operating expense categories
other than salaries and wages is also attributable to the Company's increased
level of core business activities, which caused most other such categories of
expense to increase.
INCOME TAX EXPENSE
Income tax expense includes both federal and state income taxes. The
effective tax rates for 1995 and 1994 were 36.2% and 33.4%, respectively. Income
tax expense decreased by 11% to $8.1 million during 1995 from $9.0 million
during 1994 due to the above-described factors, which resulted in an 18% or $4.8
million decrease in income before taxes. Additionally, the effective tax rate
for 1994 was reduced by the qualification of the Company for a corporate
headquarters tax credit from the state of South Carolina, $1.5 million of which
was reflected as a reduction of tax expense for 1994.
29
FINANCIAL CONDITION
During 1996, the Company experienced a 40% increase in the volume of
mortgage loans originated and acquired compared to 1995. Mortgage loan
production increased to $10.0 billion during 1996 from $7.1 billion during 1995.
The December 31, 1996, mortgage application pipeline (mortgage loans not yet
closed but for which the interest rate has been locked) was approximately $500
million.
The Company continued to establish new correspondent relationships
during 1996. The number of correspondents approved to do business in the
Company's correspondent lending program increased to 871 at December 31, 1996,
from 726 at December 31, 1995.
The Company continued expansion of the wholesale network during 1996,
with the addition of branches in Colorado, Missouri, and Maryland. This
increased the number of wholesale branches in operation at December 31, 1996, to
13. In addition to the 13 wholesale branches, each of the Company's six retail
branches operated through Intercounty Mortgage, Inc. (IMI) is eligible to do
business in the wholesale market. At December 31, 1996, there were approximately
2,322 wholesale brokers approved to do business with the Company as compared to
approximately 1,144 at December 31, 1995. Of the 2,322 approved brokers, 186 are
approved to do business with IMI branches.
The Company's retail division, IMI, employed 209 people at December 31,
1996, with offices in New York (4), New Jersey and Pennsylvania.
The Company continues to face the same challenges as other companies
within the mortgage banking industry and as such is not immune from significant
volume declines precipitated by a rise in interest rates or other factors beyond
the Company's control. Management of the Company recognizes these challenges and
continues to manage the Company accordingly.
Mortgage loans held for sale and mortgage-backed securities totaled
$802.3 million at December 31, 1996, versus $1.0 billion at December 31, 1995, a
decrease of 22%. The Company's servicing portfolio (exclusive of loans under
subservicing agreements) increased to $6.7 billion at December 31, 1996, from
$5.6 billion at December 31, 1995, an increase of 20%.
Short-term borrowings, which are the Company's primary source of funds,
totaled $805.7 million at December 31, 1996, compared to $1.0 billion at
December 31, 1995, a decrease of 20%. The decrease in the balance outstanding at
December 31, 1996, resulted from decreased funding requirements related to the
decrease in the balance of mortgage loans held for sale and mortgage-backed
securities at December 31, 1996, as compared to the balance at December 31,
1995. At December 31, 1996, there were no long-term borrowings, compared with
$65.5 million at December 31, 1995.
Other liabilities totaled $54.0 million as of December 31, 1996,
compared to the December 31, 1995, balance of $56.6 million, a decrease of $2.6
million, or 5%. The decrease in other
30
liabilities resulted primarily from a decrease at month end in the volume of
loans acquired through certain correspondent funding programs of the Company.
In connection with the Company's primary business activities, which involve loan
servicing activities and the purchase or origination of loans and the sale of
the related loans and servicing rights, the Company is actively involved in
certain risk management activities as more fully described in Note 13 to the
Consolidated Financial Statements.
31
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary cash-flow requirement involves the funding of
loan production, which is met primarily through external borrowings. The Company
has entered into a 364-day, $570 million warehouse line of credit provided by a
syndicate of unaffiliated banks that expires in July 1997. The credit agreement
includes covenants requiring the Company to maintain (i) a minimum net worth of
$130 million, plus net income subsequent to July 31, 1996, and capital
contributions and minus permitted dividends, (ii) a ratio of total liabilities
to net worth of not more than 8.0 to 1.0, excluding debt incurred pursuant to
gestation and repurchase financing agreements, (iii) its eligibility as a
servicer of GNMA, FHA, VA, FNMA and FHLMC mortgage loans and (iv) a mortgage
servicing rights portfolio with an underlying unpaid principal balance of at
least $4 billion. The provisions of the agreement also restrict the Company's
ability (i) to pay dividends in any fiscal quarter which exceed 50% of the
Company's net income for the quarter or (ii) to engage significantly in any type
of business unrelated to the mortgage banking business and the servicing of
mortgage loans.
Additionally, the Company entered into a $200 million, 364-day term
revolving credit facility with a syndicate of unaffiliated banks. An $80 million
portion of the revolver facility converts on July 31,1997, into a four-year term
loan. The facility is secured by the Company's servicing portfolio designated as
"available-for-sale". A $70 million portion of the revolver facility matures on
July 31, 1997, and is secured by the Company's servicing portfolio designated as
"held-for-sale". A $50 million portion of the revolver facility matures on July
31, 1997, and is secured by a first-priority security interest in receivables on
servicing rights sold. The facility includes covenants identical to those
described above with respect to the warehouse line of credit.
The Company was in compliance with the above-mentioned debt covenants
at December 31, 1996. Although management anticipates continued compliance,
there can be no assurance that the Company will be able to comply with the debt
covenants specified for each of these financing agreements. Failure to comply
could result in the loss of the related financing.
The Company has also entered into an uncommitted gestation financing
arrangement. The interest rate on funds borrowed pursuant to the gestation line
is based on a spread over the Federal Funds rate. The gestation line has a
funding limit of $1 billion.
The Company entered into a $5 million unsecured line of credit in
September 1996. The line of credit expires in September 1997.
The Company entered into a $6.6 million, 364-day revolving credit
facility secured by certain real property of the Company. This revolving credit
facility was retired in the third quarter of 1996.
32
Beginning in June 1995, the Company had from time to time borrowed up
to $19 million on a short-term unsecured basis from RBC. Interest on those
borrowings was at the prime rate. There was no indebtedness to RBC at December
31, 1996. The Company has no plans in the foreseeable future to borrow from RBC.
The Company issued five percent stock dividends on March 8, 1994,
September 12, 1994, May 8, 1995, and August 31, 1995. A ten percent stock
dividend was issued on June 30, 1995, and a seven percent stock dividend was
issued on September 24, 1996. All of the above are collectively referred to as
the Stock Dividends. On March 15, 1996, the Company completed a public offering
of 3,512,961 shares of common stock (3,758,868 shares after consideration of the
Stock Dividends) priced at $14.50 per share ($13.55 after consideration of the
Stock Dividends). The Company sold 2,200,000 shares (2,354,000 shares after
consideration of the Stock Dividends) in the offering, while certain
stockholders sold the remaining 1,312,961 shares (1,404,868 shares after
consideration of the Stock Dividends). In a concurrent private placement, the
Company sold an additional 896,552 shares of common stock at the offering price
of $14.50 per share ($13.55 after consideration of the Stock Dividends) to RBC,
which owned approximately 41% of the Company's outstanding common stock prior to
the public offering and private placement and approximately 39% immediately
thereafter. Net proceeds to the Company after underwriting discounts and
offering expenses totaled approximately $43 million. Proceeds of the offering
were used to repay indebtedness to RBC and were otherwise used for other general
corporate purposes, including the continued growth and general expansion of the
Company's business activities.
33
RESOURCE BANCSHARES MORTGAGE GROUP, INC.
CONSOLIDATED BALANCE SHEET
($ in thousands, except share information)
- --------------------------------------------------------------------------------------------------
DECEMBER 31,
1996 1995
- --------------------------------------------------------------------------------------------------
ASSETS
Cash $ 2,492 $ 2,161
Receivables 60,668 57,893
Mortgage-backed securities 123,447 22,391
Mortgage loans held for sale 678,888 1,012,838
Mortgage servicing rights, net 109,815 99,912
Premises and equipment, net 21,135 16,314
Accrued interest on loans held for sale 4,491 9,464
Other assets 27,458 10,124
----------- -----------
Total assets $ 1,028,394 $ 1,231,097
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Short-term borrowings $ 805,730 $ 1,005,557
Long-term borrowings 65,530
Accrued expenses 11,386 10,036
Other liabilities 53,977 56,570
----------- -----------
Total liabilities 871,093 1,137,693
----------- -----------
Stockholders' equity
Preferred stock - par value $.01 - 5,000,000 shares authorized; no
shares issued or outstanding
Common stock - par value $.01 - 25,000,000 shares authorized;
19,285,020 and 14,550,462 shares issued and outstanding at
December 31, 1996 and 1995, respectively 193 146
Additional paid-in capital 149,653 84,533
Retained earnings 12,007 10,725
Unearned shares of employee stock ownership plan (4,552) (2,000)
----------- -----------
Total stockholders' equity 157,301 93,404
----------- -----------
Commitments and contingencies (Notes 7 and 13)
----------- -----------
Total liabilities and stockholders' equity $ 1,028,394 $ 1,231,097
=========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
34
RESOURCE BANCSHARES MORTGAGE GROUP, INC.
CONSOLIDATED STATEMENT OF INCOME
($ in thousands, except share information)
FOR THE YEAR ENDED DECEMBER 31,
1996 1995 1994
- ------------------------------------------------------------------------------------------
REVENUES
Interest income $ 62,858 $ 47,477 $ 20,974
Interest expense (45,956) (38,842) (13,288)
- ------------------------------------------------------------------------------------------
Net interest income 16,902 8,635 7,686
Net gain on sale of mortgage loans 79,178 33,822 1,160
Gain on sale of mortgage servicing rights 1,105 7,346 33,375
Loan servicing fees 28,763 24,205 14,196
Other income 669 2,689 205
- ------------------------------------------------------------------------------------------
Total revenues 126,617 76,697 56,622
- ------------------------------------------------------------------------------------------
EXPENSES
Salary and employee benefits 55,578 31,199 15,986
Occupancy expense 5,640 3,066 1,595
Amortization of mortgage servicing rights 14,934 9,352 4,574
General and administrative expenses 19,917 10,788 7,391
- ------------------------------------------------------------------------------------------
Total expenses 96,069 54,405 29,546
- ------------------------------------------------------------------------------------------
Income before income taxes 30,548 22,292 27,076
Income tax expense (10,925) (8,073) (9,033)
- ------------------------------------------------------------------------------------------
Net income $ 19,623 $ 14,219 $ 18,043
- ------------------------------------------------------------------------------------------
Weighted average common shares outstanding 18,240,994 15,411,036 15,498,607
Net income per common share $ 1.08 $ 0.92 $ 1.16
The accompanying notes are an integral part of these
consolidated financial statements.
35
RESOURCE BANCSHARES MORTGAGE GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
($ in thousands, except share information)
ADDITIONAL UNEARNED TOTAL
COMMON STOCK PAID-IN RETAINED ESOP STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS SHARES EQUITY
---------------------------------------------------------------------------
Balance, December 31, 1993 10,825,000 $ 108 $ 55,061 $ 7,314 $ $ 62,483
Issuance of restricted stock 8,878 * 89 89
Stock dividend adjustment 1,110,426 11 5,007 (5,019) (1)
Net income 18,043 18,043
---------------------------------------------------------------------------
Balance, December 31, 1994 11,944,304 119 60,157 20,338 80,614
Issuance of restricted stock 43,402 * 406 406
Stock dividend adjustment 2,550,258 27 23,805 (23,832)
Loans to Employee Stock Ownership Plan (2,000) (2,000)
Shares issued under Dividend
Reinvestment and Stock Purchase Plan 12,498 * 165 165
Net income 14,219 14,219
---------------------------------------------------------------------------
Balance, December 31, 1995 14,550,462 146 84,533 10,725 (2,000) 93,404
Issuance of restricted stock 16,410 * 256 256
Net proceeds of public offering 3,426,552 34 47,417 47,451
Stock dividend adjustment 1,261,332 13 17,115 (17,128)
Cash dividends (1,119) (1,119)
Shares issued or purchased under Dividend
Reinvestment and Stock Purchase Plan
and Stock Investment Plan 30,264 * 180 (94) 86
Loans to Employee Stock Ownership Plan (3,000) (3,000)
Shares committed to be released under
Employee Stock Ownership Plan 152 448 600
Net income 19,623 19,623
---------------------------------------------------------------------------
Balance, December 31, 1996 19,285,020 $ 193 $149,653 $ 12,007 $ (4,552) $157,301
===========================================================================
*Amount less than $1
The accompanying notes are an integral part of these
consolidated financial statements.
36
RESOURCE BANCSHARES MORTGAGE GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
($ in thousands)
- -----------------------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 19,623 $ 14,219 $ 18,043
Adjustments to reconcile net income to cash
provided by (used in) operating activities:
Depreciation and amortization 17,566 10,991 5,671
Deferred income tax (benefit) expense (2,463) 11,046 4,467
Employee Stock Ownership Plan Compensation 600
Provision for estimated foreclosure losses 817 168 635
Increase in receivables (2,775) (26,999) (13,698)
Acquisition of mortgage loans (9,995,725) (7,135,774) (2,875,265)
Proceeds from sales of mortgage loans
and mortgage-backed securities 10,307,177 6,275,802 3,353,880
Acquisition of mortgage servicing rights (220,335) (129,641) (92,012)
Sales of mortgage servicing rights 196,406 94,027 60,805
Net gain on sales of mortgage loans and servicing rights (80,283) (41,168) (34,535)
Decrease (increase) in accrued interest on loans 4,973 (8,787) 1,348
Increase in other assets (16,897) (23,281) (1,319)
Increase (decrease) in accrued expenses and other liabilities 1,220 23,647 (18,079)
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 229,904 (935,750) 409,941
- -----------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchases of furniture, fixtures and equipment (7,453) (5,510) (3,565)
- -----------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (7,453) (5,510) (3,565)
- -----------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Proceeds from borrowings 31,468,370 23,478,835 9,631,764
Repayment of borrowings (31,733,727) (22,533,020) (10,038,712)
Debt issuance costs (437) (1,197) (1,700)
Issuance of restricted stock 256 406 89
Stock dividend adjustments (1)
Activity under Employee Stock Ownership Plan (3,000) (2,000)
Shares issued under Dividend Reinvestment and Stock Purchase Plan 86 165
Net proceeds from public offering 47,451
Cash dividends (1,119)
- -----------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (222,120) 943,189 (408,560)
- -----------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 331 1,929 (2,184)
Cash, beginning of year 2,161 232 2,416
- -----------------------------------------------------------------------------------------------------------------
Cash, end of year $ 2,492 $ 2,161 $ 232
=================================================================================================================
SUPPLEMENTAL ACTIVITIES
Interest paid $ 46,860 $ 36,264 $ 14,636
Taxes paid 11,245 3,710 6,846
Non-cash activity under Employee Stock Ownership Plan 600
The accompanying notes are an integral part of these
consolidated financial statements.
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ IN THOUSANDS, EXCEPT SHARE INFORMATION)
Note 1 - The Company:
Resource Bancshares Mortgage Group, Inc. (the Company), was organized
under Delaware law in 1992 to acquire and operate the mortgage banking business
of Resource Bancshares Corporation (RBC), which commenced operations in May
1989. The assets and liabilities of the mortgage banking business of RBC were
transferred to the Company on June 3, 1993, when the Company sold 58% of its
common stock in an initial public offering. As a result, RBC retained a
significant ownership interest in the Company. As of December 31, 1996, RBC
owned approximately 38% of the outstanding common stock of the Company.
Following consummation of the initial public offering, the Company continued to
engage in the mortgage banking business that was formerly conducted by RBC.
The Company is principally engaged in the purchase and origination of
residential mortgage loans, which it aggregates into mortgage-backed securities
issued or guaranteed by the Federal Home Loan Mortgage Corporation (FHLMC), the
Federal National Mortgage Association (FNMA) and the Government National
Mortgage Association (GNMA). The Company sells the mortgage-backed securities it
creates to institutional purchasers with the rights to service the underlying
loans being retained by the Company. The servicing rights retained are generally
sold separately but may be held for extended periods by the Company.
Note 2 - Summary of Significant Accounting Policies:
The accounting and reporting policies of the Company reflect industry
practices and conform in all material respects with generally accepted
accounting principles. Certain minor amounts from prior years have been
reclassified to conform to current period presentation.
Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary, Intercounty Mortgage, Inc. (IMI). All
significant intercompany accounts and transactions have been eliminated.
Significant Estimates
In preparing the financial statements, management is required to make
estimates based on available information that can affect the reported amounts of
assets, liabilities and disclosures as of the balance sheet date and revenues
and expenses for the related periods. Such estimates relate principally to the
Company's allowance for foreclosure losses. Additionally, estimates concerning
the fair values of mortgage loans held for sale, servicing rights, servicing
hedges and the Company's other hedging instruments are all relevant to ensuring
that mortgage loans are carried at the lower of cost or market, and that
potential impairments of servicing rights are recognized as and if required.
Because of the inherent uncertainties associated with any
38
estimation process and due to possible future changes in market and economic
conditions that will affect fair values, it is possible that actual future
results in realization of the underlying assets and liabilities could differ
significantly from the amounts reflected as of the balance sheet date.
Investment Securities
Investments in debt securities are classified in three categories:
held-to-maturity securities (reported at amortized cost); trading securities
(reported at fair value, with unrealized gains or losses included in earnings);
and available-for-sale securities (reported at fair value, with unrealized gains
and losses excluded from earnings and reported as a separate component of
stockholders' equity). Substantially all of the Company's investments are in the
form of mortgage-backed securities that are held for sale in conjunction with
the Company's mortgage banking activities. Such securities are classified as
trading securities. The cost of securities sold is based on the specific
identification method.
Mortgage Loans Held for Sale
Mortgage loans held for sale are stated at the lower of aggregate cost
or market.
Mortgage Servicing Rights
Prior to April 1, 1995, and in conjunction with the acquisition of
mortgage loans, the Company capitalized as mortgage servicing rights the portion
of the purchase price that represented the premium paid for the right to service
the mortgage loans. The amount capitalized was subsequently reduced if the
mortgage loans were sold at a gain. Effective April 1, 1995 the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 122, "Accounting for
Mortgage Servicing Rights - An Amendment of FASB Statement No. 65." Accordingly,
effective April 1, 1995, and as required by SFAS No. 122, the Company now
allocates the total cost of a whole mortgage loan to the mortgage servicing
rights and the loan (without servicing rights) based on relative fair values.
The amount capitalized is no longer required to be reduced if the mortgage loan
is sold at a gain. The market value of servicing rights acquired in bulk
transactions, rather than as a by-product of the Company's loan production
activities, is initially capitalized at the lower of cost or the estimated
present value of future expected net servicing income. Amounts capitalized as
mortgage servicing rights are amortized over the period of, and in proportion
to, estimated future net servicing income. The Company periodically assesses its
capitalized mortgage servicing rights for impairment (on a stratified basis)
based on the estimated market values of those rights. Impairments are recognized
as a valuation allowance for each impaired stratum. Market value is estimated by
reference to a third-party analysis that values such rights in consideration of
current forward committed delivery prices, prevailing interest, prepayment and
default rates, and other relevant factors as appropriate or allocable to each
valuation stratum.
Loan Origination and Correspondent Program Administration Fees
Fees charged in connection with loan origination and fees charged to
loan correspondents in conjunction with certain administrative functions
performed by the Company in connection with the acquisition of mortgage loans
are deferred and reduce the carrying value of the underlying
39
mortgage loans. Allocable portions of such fees are included in the
determination of the gain or loss when the related mortgage loans or servicing
rights are sold.
Sales of Mortgage Loans and Mortgage Servicing Rights
Gains or losses on sales of mortgage loans are determined at settlement
date and are measured by the difference between the net proceeds, adjusted for
the value of excess servicing fees, and the carrying amount of the underlying
mortgage loans. Prior to implementation of SFAS No. 122, gains not in excess of
the amortized basis of mortgage servicing rights capitalized in conjunction with
the acquisition of the loans were applied as a reduction of mortgage servicing
rights and gains in excess of the amortized basis in mortgage servicing rights
and losses on the sales of mortgage loans were recognized at settlement date.
Effective with the implementation of SFAS No. 122, gains on sales of mortgage
loans are no longer required to be deferred as a reduction of basis in mortgage
servicing rights, and gains and losses on sales of mortgage servicing rights are
recognized at the sale date, which is the date the sales contract is closed and
substantially all risks and rewards of ownership pass to the buyer.
Stock Based Compensation
In October 1995, the Financial Accounting Standards Board issued SFAS
No. 123, "Accounting for Stock-Based Compensation," which is effective for
transactions entered into in fiscal years beginning after December 15, 1995.
SFAS No. 123 defines a fair-value-based method of accounting for stock-based
compensation. The statement allows measurement of compensation cost generally in
conformity with past practice under Accounting Principles Board Opinion No. 25,
(APB No. 25), "Accounting for Stock Issued to Employees," provided pro forma
disclosure is made concerning net income as if the fair value approach had been
applied. The Company adopted the disclosure approach permitted by SFAS No. 123
effective January 1, 1996, and, as also permitted, continues to apply the
compensatory measurement principles of APB No. 25.
Premises and Equipment
Premises and equipment are stated at cost less accumulated
depreciation. Depreciation is computed using the straight-line method over the
estimated useful lives of the assets. Maintenance and repairs are expensed as
incurred.
Estimated Foreclosure Losses
As a servicer of mortgage loans, the Company will incur certain losses
in the event it becomes necessary to carry out foreclosure actions on loans
serviced. Generally, such losses relate to FHA or VA loans, which are insured or
guaranteed on a limited basis. Substantially all other serviced loans are fully
guaranteed against such losses by the securitizing government agency. The
allowance for estimated losses on foreclosure, which is part of the mortgage
servicing rights basis, is determined based on delinquency trends and
management's evaluation of the probability that foreclosure actions will be
necessary. The allowance for estimated losses on foreclosure was $1,550, $1,000,
and $1,150 at December 31, 1996, 1995 and 1994, respectively.
40
Income Taxes
The Company records taxes under an asset and liability approach,
recognizing deferred tax liabilities and assets for the expected future tax
consequences of temporary differences between the carrying amounts and tax bases
of assets and liabilities. Deferred income taxes arise primarily from timing
differences between the accounting methods used for mortgage servicing rights
and estimated foreclosure losses for income tax and financial reporting
purposes. Current tax expense (benefit) of $13,388, ($2,973) and $4,566 for the
years ended December 31, 1996, 1995 and 1994, are included in other liabilities.
Statement of Cash Flows
The Company has adopted the indirect method of reporting cash flows.
New Accounting Standards
In June 1996, the Financial Accounting Standards Board issued SFAS No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities", which is effective for transfers and servicing
of financial assets and extinguishments of liabilities occurring after December
31, 1996. SFAS No. 125 is based upon consistent application of a
financial-components approach that focuses on control. Under this approach,
after a transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and the liabilities it has incurred, derecognizes
financial assets when control has been surrendered, and derecognizes liabilities
when extinguished. The standard is not expected to materially impact the
Company's financial condition or results of operations. The Company plans to
adopt SFAS No. 125 effective January 1, 1997, as required.
Note 3 - Joint Ventures:
In August 1996, Intercounty Mortgage, Inc. (IMI), entered into a joint
venture agreement with ERA Specht Realty, Inc. The joint venture, Corridor
Mortgage Company, LLC (Corridor), is engaged primarily in the business of
providing broker services on first-lien mortgage loans to mortgage bankers. IMI
owns 51% of Corridor and made an initial contribution of $10 in January 1997.
Corridor did not become operational until the first quarter of 1997.
Accordingly, there are no transactions recorded in the Company's 1996
consolidated financial statements relating to Corridor. For financial reporting
purposes, Corridor's assets, liabilities and earnings will be consolidated with
those of IMI, and the minority member's interest in the joint venture will be
included in the Company's consolidated financial statements as minority
interest.
In December 1996, IMI entered into a joint venture agreement with
Lawyers Title Insurance Corporation. The joint venture, Excel Title Agency, LLC
(ETA), is engaged primarily in the business of providing core title services in
connection with the closing of real estate transactions and acts as a title
insurance agent. IMI owns 49% of ETA and made an initial $25 contribution to
form the joint venture in December 1996. The Company will account for this
investment on the equity method. Accordingly, IMI's investment is reported as an
investment in joint venture within other assets on the balance sheet. ETA did
not become operational until the first quarter
41
of 1997. Accordingly, there is no share of operational income or loss recorded
in the Company's 1996 consolidated financial statements.
Note 4 - Receivables:
Receivables consist primarily of amounts due to the Company related to
sales of mortgage servicing rights and advances of delinquent principal,
interest, tax and insurance payments related to loans serviced. Management does
not anticipate any significant losses on realization of the receivables.
Receivables consist of the following at:
DECEMBER 31,
--------------------
1996 1995
-------- --------
Mortgage servicing rights sales $ 33,609 $ 31,764
Servicing advances 14,752 8,791
Other 12,307 17,338
======== ========
$ 60,668 $ 57,893
======== ========
Note 5 - Fair Value and Impairments of Mortgage Servicing Rights:
For purposes of evaluating its servicing portfolio for impairment, the
Company disaggregates its portfolio into two primary segments:
available-for-sale and held-for-sale.
The segment of the portfolio designated as available-for-sale is
comprised of servicing rights that were purchased in bulk transactions or that
were retained out of production pursuant to individual portfolio retention
decisions. The available-for-sale portfolio is disaggregated for purposes of
measuring potential impairments according to each individual bulk purchase or
portfolio retention decision, which the Company has determined to be the
appropriate approach to disaggregation by predominant risk characteristic for
this portfolio segment. However, as permitted by SFAS No. 122, the portion of
this portfolio acquired prior to implementation is not further disaggregated for
purposes of measuring potential impairments. With respect to each such risk
tranche, the fair value thereof, which is based upon a third-party analysis that
considers current forward committed delivery prices, prevailing interest,
prepayment and default rates and other relevant factors, together with the fair
value of hedges allocated thereto (which is based upon broker quotes) is
compared to amortized carrying values of the mortgage servicing rights for
purposes of measuring potential impairment. At December 31, 1996, the underlying
unpaid principal balance of the available-for-sale portfolio totaled $4,842,253,
its fair value was estimated as $91,508, the fair value of hedges allocated
thereto was estimated as $5,056, and the carrying value of the portfolio was
$76,136, which is net of accumulated amortization of $18,198. At December 31,
1995, the underlying unpaid principal balance of the available-for-sale
portfolio totaled $3,047,554, its fair value was estimated as $49,340, the fair
value of hedges allocated thereto was estimated as $8,916, and the carrying
value of the portfolio was $49,979.
42
No impairment provisions were required for 1996 or for 1995 with respect to this
segment of the portfolio.
The segment of the portfolio designated as held-for-sale is comprised
of recently produced servicing rights that are scheduled for sale and have been
allocated to specific forward servicing sales contracts. The held-for-sale
portfolio is disaggregated for purposes of measuring possible impairments
according to the specific forward sales contracts to which allocated, which the
Company has determined to be the appropriate approach to disaggregation by
predominant risk characteristic for this portfolio segment. For each such risk
tranche, the fair value thereof, which is based upon the allocated forward
committed delivery price, is compared to amortized carrying value for purposes
of measuring potential impairment. At December 31, 1996, the underlying unpaid
principal balance of the held-for-sale portfolio totaled $1,828,014, its fair
value was estimated as $37,109, and its carrying value was $36,057, which is net
of accumulated amortization of $683. At December 31, 1995, the underlying unpaid
principal balance of the held-for-sale portfolio totaled $2,515,376, its fair
value was estimated as $50,811, and its carrying value was $49,933. No
impairment provisions were required for 1996 or for 1995 with respect to this
segment of the portfolio.
Note 6 - Premises and Equipment:
Premises and equipment are summarized as follows:
Estimated
Useful DECEMBER 31,
Lives 1996 1995
----------- -------- --------
Building 25 years $ 6,714 $ 6,579
Building improvements 10-15 years 939 103
Furniture, fixtures and equipment 5-10 years 16,772 11,586
-------- --------
24,425 18,268
Less-Accumulated depreciation (6,337) (3,714)
-------- --------
18,088 14,554
Land 3,047 1,760
-------- --------
$ 21,135 $ 16,314
======== ========
Depreciation expense was $2,632 in 1996, $1,639 in 1995 and $1,097 in 1994.
Note 7 - Lease Commitments:
The Company has entered into various non-cancelable operating lease
agreements, primarily for office space. Certain of these leases contain renewal
options and escalation clauses.
43
At December 31, 1996, the annual minimum rental commitments for
non-cancelable leases with remaining terms in excess of one year are as follows:
1997 $ 1,891
1998 1,566
1999 1,282
2000 850
2001 and thereafter 254
=======
$ 5,843
=======
Minimum rental commitments have not been reduced by minimum sublease
rentals of $1,721 that are due in the future under non-cancelable subleases.
Rent expense for operating leases, exclusive of sublease rental income of $385
for 1996, $354 for 1995, and $217 for 1994, was $1,905 in 1996, $1,147 in 1995,
and $552 in 1994.
Note 8 - Short-Term and Long-Term Borrowings:
The Company has entered into a 364-day, $570,000 warehouse line of
credit provided by a syndicate of unaffiliated banks that expires in July 1997.
The credit agreement includes covenants requiring the Company to maintain (i) a
minimum net worth of $130,000, plus net income subsequent to July 31, 1996, and
capital contributions and minus permitted dividends, (ii) a ratio of total
liabilities, excluding debt incurred pursuant to gestation and repurchase
financing agreements, to adjusted net worth of not more than 8.0 to 1.0, (iii)
its eligibility as a servicer of GNMA, FHA, VA, FNMA and FHLMC mortgage loans
and (iv) a mortgage servicing rights portfolio with an underlying unpaid
principal balance of at least $4,000,000. The provisions of the agreement also
restrict the Company's ability to pay dividends in any fiscal quarter that
exceed 50% of the Company's net income for the quarter; or to engage
significantly in any type of business unrelated to the mortgage banking business
and the servicing of mortgage loans. At December 31, 1996 and 1995, the total
amounts outstanding under this and its predecessor facilities were $540,900 and
$468,020, respectively.
Additionally, the Company has entered into a $200,000, 364-day
revolving credit facility with a syndicate of unaffiliated banks. An $80,000
portion of the revolver facility converts on July 31, 1997, into a four-year
term loan and is secured by the portion of the Company's servicing portfolio
designated as "available-for-sale". A $70,000 portion of the revolver facility
matures on July 31, 1997, and is secured by the portion of the Company's
servicing portfolio designated as "held-for-sale". A $50,000 portion of the
revolver facility matures on July 31, 1997, and is secured by a first-priority
security interest in receivables on servicing rights sold. The facility includes
covenants identical to those described above with respect to the warehouse line
of credit. At December 31, 1996 and 1995, the total amounts outstanding under
this and its predecessor facilities were $35,000 and $90,150, respectively.
The Company was in compliance with the above-mentioned debt covenants
at December 31, 1996. Although management anticipates continued compliance,
there can be no assurance that
44
the Company will be able to comply with the debt covenants specified for each of
its financing agreements. Failure to comply could result in the loss of the
related financing.
The Company has also entered into an uncommitted gestation financing
arrangement. The interest rate on funds borrowed pursuant to the gestation line
is based on a spread over the Federal Funds rate. The gestation line has a
funding limit of $1,000,000. The total amounts outstanding under this and its
predecessor facility at December 31, 1996 and 1995 were $229,831 and $487,336,
respectively.
The Company entered into a $5,000 unsecured line of credit in September
1996. The line of credit expires in September 1997. The interest rate on funds
borrowed through this line of credit is prime plus 0.5%. There were no amounts
outstanding on this line of credit at December 31, 1996.
The Company had entered into a $6,580, 364-day revolving credit
facility secured by certain real property of the Company. This revolving credit
facility was retired in the third quarter of 1996. The interest rate on funds
borrowed through this facility approximated the average Federal Funds rate plus
2.125%.
Beginning in June 1995, the Company had from time to time borrowed up
to $19,000 on a short-term, unsecured basis from RBC. Interest on the loans was
at the prime rate, and the Company incurred interest expense of $258 and $527
related to these borrowings during 1996 and 1995, respectively. There was no
indebtedness to RBC at December 31, 1996. The Company has no plans in the
foreseeable future to borrow from RBC.
The monthly average outstanding amount under these credit agreements
during 1996 was $835,231, at a weighted average rate of 5.50%. The Company
incurred interest expense of $45,956 on these borrowings in 1996. The Company
also incurred facility fees related to these credit agreements totaling $1,266,
which is included in interest expense. The Company incurred initial arrangement
fees of $437 in 1996, which have been capitalized and are included in other
assets in the accompanying consolidated balance sheet. These initial fees are
being amortized to interest expense over the term of the related credit
agreements. Amortization expense for 1996 was $490. Additional advances
available to the Company under these credit agreements at December 31, 1996,
amounted to $969,270.
The monthly average outstanding amount under these credit agreements
during 1995 was $618,060, at a weighted average rate of 6.28%. The Company
incurred interest expense of $38,842 on these borrowings in 1995. The Company
also incurred facility fees related to these credit agreements totaling $1,092,
which is included in interest expense. The Company incurred initial arrangement
fees of $1,197, which have been capitalized and are included in other assets in
the accompanying consolidated balance sheet. These initial fees are being
amortized to interest expense over the term of the related credit agreements.
Amortization during 1995 was $812. Additional advances available to the Company
under these credit agreements at December 31, 1995, amounted to $765,493.
45
Note 9 - Capital Transactions:
The Company issued five percent stock dividends on March 8, 1994,
September 12, 1994, May 8, 1995, and August 31, 1995. A ten percent stock
dividend was issued on June 30, 1995, and a seven percent stock dividend was
issued on September 24, 1996. All of the above are collectively referred to as
the Stock Dividends. Earnings per share have been restated for the effects of
the Stock Dividends.
On March 15, 1996, the Company completed a second public offering of
3,512,961 shares of common stock (3,758,868 shares after consideration of the
Stock Dividends) priced at $14.50 per share ($13.55 after consideration of the
Stock Dividends). The Company sold 2,200,000 shares (2,354,000 shares after
consideration of the Stock Dividends) in the offering while certain selling
stockholders sold the remaining 1,312,961 shares (1,404,868 shares after
consideration of the Stock Dividends). In concurrent private placements the
Company sold an additional 896,552 shares of common stock at the offering price
of $14.50 per share (959,311 shares at $13.55 after consideration of the Stock
Dividends) to RBC, which owned approximately 41% of the Company's outstanding
common stock prior to the public offering and private placement and
approximately 39% immediately thereafter. Net proceeds to the Company after
underwriting discounts and estimated offering expenses totaled approximately $43
million. Proceeds of the offering were used to repay indebtedness to RBC and for
other general corporate purposes, including the continued growth and general
expansion of the Company's business activities.
During the fourth quarter of 1995, the Company established the Dividend
Reinvestment and Stock Purchase Plan (DRIP). The DRIP offers stockholders a
convenient method of purchasing Company common stock at a 5% discount from
market prices through the reinvestment of cash dividends and through optional
cash payments. Optional cash payments may be made quarterly up to $15 per
quarter. The price per common share will be 95% of the average closing sale
price per common share for the 20 trading days prior to the date on which
dividends are paid, in the case of a dividend reinvestment transaction, or on
the date on which the Company's fiscal quarter ends, in the case of an optional
cash payment transaction. The Company reserves the right to modify the pricing
terms or any other provisions of the DRIP at any time. To meet demands of the
optional quarterly cash contributions received through the DRIP and for the
reinvestment of dividends through the DRIP, the Company either issues new shares
or the DRIP agent purchases shares on the open market. The Board of Directors
has authorized the issuance of 1,000,000 shares under the DRIP (1,070,000 after
consideration of the Stock Dividends). At December 31, 1996 there were 223,642
shares outstanding under the DRIP.
46
Note 10 - Income Taxes:
Income tax expense (benefit) consists of the following:
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------
1996 1995 1994
-------- -------- ------
Current:
Federal $ 13,060 $ (2,519) $4,566
State 328 (454)
-------- -------- ------
13,388 (2,973) 4,566
Deferred (2,463) 11,046 4,467
======== ======== ======
$ 10,925 $ 8,073 $9,033
======== ======== ======
During 1996 and 1995, the Company qualified for state tax headquarters
credits of $1,687 and $1,663, respectively, reducing current state tax expense
that otherwise would have been payable for 1996 and 1995. In addition, during
1994 the Company initially elected a new method of accounting for mortgage
servicing rights for purposes of filing its tax returns for the period beginning
June 3, 1993, and ending December 31, 1993. This new tax accounting method
accelerated tax deductions related to mortgage servicing rights into earlier
periods and accounts for the reallocation of approximately $5,744 from current
to deferred tax expenses during 1994.
The effective tax rate varied from the statutory federal tax rate of
35% for 1996, 1995 and 1994 due to the following:
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
1996 1995 1994
------------------ ----------------- --------------------
% of % of % of
Pretax Pretax Pretax
Amount Income Amount Income Amount Income
------- ------ ------ ------ ------- -------
Tax expense at statutory rate $10,692 35.0% $7,802 35.0% $ 9,477 35.0 %
State tax, net of federal benefit 107 .4% 178 .8% 30 .1 %
Other, net 126 .4% 93 .4% (474) (1.7)%
------- ---- ------ ---- ------- ----
$10,925 35.8% $8,073 36.2% $ 9,033 33.4 %
======= ==== ====== ==== ======= ====
Deferred tax expense (benefit) results from timing differences in the
recognition of revenue and expenses for income tax and financial reporting
purposes. The sources and the tax effects of each are as follows:
47
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
-------- -------- -------
Mortgage servicing rights $ 92 $ 12,528 $ 4,752
Deferred compensation (2,204) (383)
Mark to market loans held for sale 521 (521)
Foreclosure reserve (1,053) (44) (243)
State headquarters tax credit
carryforwards generated (370) 135 (135)
Depreciation 511 15 148
Other, net 40 (684) (55)
-------- -------- -------
$ (2,463) $ 11,046 $ 4,467
======== ======== =======
Deferred tax (assets) liabilities are summarized as follows:
DECEMBER 31,
----------------------
1996 1995
-------- --------
Deferred compensation $ (2,671) $ (467)
Mark to market loans held for sale (521)
Foreclosure reserve (1,537) (484)
State headquarters tax credit carryforwards (370)
Other, net (615) (671)
-------- --------
(5,193) (2,143)
-------- --------
Mortgage servicing rights 13,975 13,883
Depreciation 912 401
Other, net
16
-------- --------
14,887 14,300
======== ========
Net deferred tax liability $ 9,694 $ 12,157
======== ========
There are no valuation allowances provided for any of the Company's
deferred tax assets based on management's belief that it is more likely than not
that deferred tax assets will be realized.
Note 11 - Related Party Transactions:
In connection with the initial public offering, RBC entered into an
agreement with two officers of the Company to pay each $200 per year through
2000, provided they remained in the employment of the Company. During 1996 and
1995, RBC paid $400 for each year, pursuant to the terms of these agreements.
The Company recorded no expenses related to these agreements during 1996 or
1995.
Beginning in June 1995, the Company had from time to time borrowed up
to $19,000 on a short-term unsecured basis from RBC. Interest on the loans was
at the prime rate, and the Company incurred interest expense of $258 related to
these borrowings during 1996. Interest
48
expense incurred for 1995 was $527. The average outstanding balance under this
financing arrangement was $3,000 for 1996 and $6,099 for 1995. At December 31,
1995, the principal amount of such indebtedness aggregated $19,000. There was no
indebtedness to RBC at December 31, 1996. The Company has no plans in the
foreseeable future to borrow from RBC.
Note 12 - Stock Options and Restricted Stock Plan:
Contemporaneous with the initial public offering, certain executives of
the Company were granted options to purchase 600,000 shares of common stock of
the Company at the initial offering price of the stock of $8.75 per share
(858,390 shares at $6.12 per share after giving effect to the Stock Dividends).
The options have a term of ten years and become exercisable at a rate of 20% per
year during the period from May 26, 1994 through May 26, 1998. At December 31,
1996, 515,034 options were exercisable. No additional options have been granted,
and none have been exercised or forfeited.
In addition, in connection with the employment of certain officers,
such officers are entitled to receive restricted stock as part of their
compensation. In connection therewith, the Company issued 16,410 restricted
shares at a price of $15.58 per share on January 27, 1996 (17,558 shares at
$14.56 per share after giving effect to the Stock Dividends), 43,402 restricted
shares at a price of $9.36 per share on January 26, 1995 (56,320 shares at $7.21
per share after giving effect to the Stock Dividends), and 8,878 restricted
shares at a price of $10.41 per share on January 21, 1994 (12,700 shares at
$7.28 per share after giving effect to the Stock Dividends). Costs associated
with these grants are included as compensation expense of the Company in the
accompanying consolidated financial statements.
On October 21, 1993, the Company adopted a phantom stock plan that
provided for the awarding of up to 300,000 (429,195 after giving effect to the
Stock Dividends) deferred compensation units to officers and certain key
employees. The plan specified a five-year vesting schedule. In addition, from
time to time the Board of Directors has approved participation in a special
phantom stock plan for certain officers of the Company.
During 1996, the Company terminated all of its phantom stock plans and
canceled all outstanding grants thereunder. In connection therewith, each former
participant in the phantom stock plans was awarded an option under a new
nonqualified stock option plan for each unit canceled under the phantom stock
plans. Other terms of the awarded options were substantially similar to the
underlying canceled units.
49
Activity in the phantom stock plans and the new nonqualified stock
option plan is summarized below:
UNITS FORFEITED
UNITS CANCELED OR UNITS
PHANTOM STOCK PLANS: GRANTED REDEEMED OUTSTANDING
- ---------------------------------------------------------------------------------
Balance at December 31, 1994 114,109 3,307 110,802
-1995 activity 121,250 36,846 84,404
-Effect of Stock Dividends 47,632 8,543 39,089
-------- ------- --------
Balance at December 31, 1995 282,991 48,696 234,295
-1996 activity 35,084 (35,084)
-Effect of Stock Dividends 2,419 42 2,377
-Plan cancellation (285,410) (83,822) (201,588)
-------- ------- --------
Balance at December 31, 1996
======== ======= ========
UNITS UNITS FORFEITED UNITS
NONQUALIFIED STOCK OPTION PLAN: GRANTED OR EXERCISED OUTSTANDING
- ---------------------------------------------------------------------------------
Balance at December 31, 1995
- 1996 activity 201,588 201,588
- Effect of Stock Dividends 11,569 11,569
------- ------ -------
Balance at December 31, 1996 213,157 213,157
======= ====== =======
Of the 213,157 units outstanding at December 31, 1996 under the
nonqualified stock option plan, the following are strike prices and percents
vested:
EXPIRATION UNITS STRIKE PERCENT
DATE OUTSTANDING PRICE VESTED
----------------------------------------------------------
January 21, 2004 101,578 $ 7.28 40%
January 26, 2005 19,465 7.19 20%
January 26, 2005 75,261 7.22 20%
July 1, 2005 16,853 11.17 20%
During 1995, the Company established an Omnibus Employee Stock Award
Plan (the Omnibus Plan). The purpose of this plan is to provide key employees
who are largely responsible for the Company's growth and continued success with
the opportunity to have or increase their proprietary interest in the Company
through the granting of any one or any combination of options, stock
appreciation rights, restricted stock and unrestricted stock. This plan is
authorized to issue up to 200,000 shares of common stock (224,700 shares after
giving effect to the Stock Dividends). Units issued under this plan vest 20% per
year on each anniversary of the grant date and expire 10 years after the grant
date.
50
Activity in the Omnibus Plan is summarized below:
UNITS UNITS FORFEITED UNITS
OMNIBUS PLAN: GRANTED OR EXERCISED OUTSTANDING
- ----------------------------------------------------------------------------------
- -1995 activity 100,000 100,000
------- ------- -------
Balance at December 31, 1995 100,000 100,000
- -1996 activity 104,000 104,000
- -Effect of Stock Dividends 12,040 12,040
------- ------- -------
Balance at December 31, 1996 216,040 216,040
======= ======= =======
Of the 216,040 units outstanding at December 31, 1996 under the Omnibus
Employee Stock Award Plan, the following are strike prices and percents vested:
EXPIRATION UNITS STRIKE PERCENT
DATE OUTSTANDING PRICE VESTED
---------------------------------------------------------
January 26, 2006 23,540 $14.56 0%
October 30, 2005 107,000 14.96 20%
March 21, 2006 53,500 14.03 0%
November 8, 2006 17,000 15.03 0%
November 12, 2006 7,500 14.98 0%
December 3, 2006 7,500 14.56 0%
During 1995, the Company established a Formula Stock Option Plan. The
purpose of this plan is to provide annually (on each September 1) to the
non-employee directors of the Company options to purchase 10,000 shares of the
common stock of the Company. All options vest 20% on the date of grant and 20%
each year thereafter on the anniversary date of the grant and expire 10 years
after the grant date. The plan is authorized to issue up to 150,000 shares of
common stock (168,525 shares after giving effect to the Stock Dividends). On
September 1, 1995, 50,000 options were issued at a market strike price of $15.91
per share (53,500 options at a strike price of $14.87 per share after giving
effect to the Stock Dividends). On September 1, 1996, 50,000 options were issued
at a market strike price of $13.25 per share (53,500 at a strike price of $12.38
after consideration of the Stock Dividends).
The phantom stock plan was a variable stock award plan for accounting
purposes. Accordingly, compensation expense was accrued by reference to the
difference between current market value over the value base adjusted for the
cumulative vested status of the underlying units. The Company's other
aforedescribed option plans are considered fixed stock award plans for
accounting purposes. Accordingly, total compensation expense for these fixed
plans is measured as the difference between the market value on the date of the
grant over the strike price which fixed total expense is then recognized over
the vesting period. The Company recognized compensation expense related to the
aforedescribed plans (exclusive of the restricted stock plan which is expensed
as incurred) of $283, $748 and $60 for 1996, 1995 and 1994, respectively.
51
For purposes of providing the pro forma disclosures required under SFAS
No. 123, the fair value of stock options granted in 1996 and 1995 was estimated
at the date of grant using a Black-Scholes option pricing model. The
Black-Scholes option pricing model was originally developed for use in
estimating the fair value of traded options which have different characteristics
than the Company's employee stock options. The model is also sensitive to
changes in the subjective assumptions which can materially affect fair value
estimates. As a result, management believes that the Black-Scholes model may not
necessarily provide a reliable single measure of the fair value of employee
stock options.
For purposes of SFAS No. 123, each award was separately valued using
the 10 year constant maturity treasury rate on the date of grant (rates ranged
from 5.634% to 6.941%) as the risk-free interest rate. The expected life of each
grant was assumed to be equal to the term to expiration as of the grant date
(expected lives ranged from 7.2 to 10.0 years). The expected dividend yield was
established based upon the dividend policies of the Company as of the date of
award. Finally, for purposes of assigning a volatility factor, the historical
100 day volatility factor was reviewed for selected points in time over the past
two-years and the average of all such selected points of 44.89% was assigned to
all 1995 and 1996 awards for purposes of the SFAS No. 123 valuation.
SFAS No. 123, for purposes of the required pro forma disclosures,
permits straight-line amortization of the estimated fair value of the options
over the vesting period. Had compensation cost for the Company's 1996 and 1995
stock-based option awards been determined consistent with the requirements of
SFAS No. 123, net income and earnings per share would have been reported as
follows for 1996 and 1995.
For the Year Ended
December 31,
--------------------
1996 1995
-------- --------
Net income as reported $ 19,623 $ 14,219
After-tax adjustment for SFAS No. 123 (409) (134)
-------- --------
Pro forma net income as adjusted $ 19,214 $ 14,085
======== ========
Pro forma net income per common share $ 1.05 $ 0.91
Due to the inclusion of only 1995 and 1996 option grants, the effects
of applying SFAS No. 123 in 1995 and 1996 may not be representative of the pro
forma impact in future years.
Note 13 - Commitments and Contingencies:
The Company was servicing and subservicing 96,087, 90,063 and 78,136
loans owned by others, with unpaid balances aggregating approximately
$8,700,000, $7,800,000 and $5,900,000, at December 31, 1996, 1995 and 1994,
respectively. Related escrow funds totaled approximately $56,900, $56,800 and
$31,200 as of December 31, 1996, 1995 and 1994, respectively. Loans serviced for
others and the related escrow funds are not included in the accompanying
consolidated balance sheet.
52
The Company has issued mortgage-backed securities under programs
sponsored by GNMA and FNMA. In connection with servicing mortgage-backed
securities guaranteed by GNMA or FNMA, the Company advances certain principal
and interest payments to security holders prior to their collection from
specific mortgagors. Additionally, the Company must remit certain payments of
property taxes and insurance premiums in advance of collecting them from
specific mortgagors and make certain payments of attorney's fees and other costs
related to loans in foreclosure. These amounts are included in servicing
advances under the caption receivables in the accompanying consolidated
financial statements.
In the ordinary course of business, the Company is exposed to liability
under representations and warranties made to purchasers and insurers of mortgage
loans and the purchasers of servicing rights. Under certain circumstances, the
Company may be required to repurchase mortgage loans or indemnify the purchasers
of loans or servicing rights for losses if there has been a breach of
representations or warranties. Liabilities are estimated at the date of sale and
included in the determination of the gain or loss on sale. Such estimated
liabilities are included in the allowance for foreclosure losses, a reduction of
mortgage servicing rights basis.
In the ordinary course of its business, the Company is from time to
time subject to litigation. The Company is not a party to any material legal
proceedings.
Note 14 - Employee Benefits:
On July 1, 1993, the Company established a 401(k) Retirement Savings
Plan which is available to all regular, full-time active employees with 12
months continuous service. The plan allows employees to contribute up to 15% of
their gross earnings on a before-tax basis annually, subject to the maximum
established by law. Employees become eligible to participate in the plan as of
January 1, or July 1, following the completion of 12 months continuous service.
The Company contributes to the plan on a matching basis in an amount determined
annually by the Board of Directors. The Company match percentage for 1996 and
1995 was 50% of the employee's contribution up to a maximum of 3% of the
employee's gross earnings. An employee vests in the Company's matching
contribution at a rate of 25% per year. The Company recorded $375, $147 and $116
of matching contributions as compensation expense during 1996, 1995 and 1994
respectively.
On January 1, 1994, the Company established a defined benefit pension
plan covering substantially all employees. Under the plan, retirement benefits
are based upon years of service and the employee's level of compensation during
the last five years prior to retirement. It is the Company's funding policy to
make, at a minimum, the annual contribution required by the Employee Retirement
Income Security Act of 1974, as amended.
53
Pension expense included the following:
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995
----- -----
Service cost $ 263 $ 129
Interest cost on projected benefit obligation 90 48
Actual return on assets (4) (7)
Amortization of unrecognized prior service costs 30 30
Amortization of unrecognized losses (gains) 10 (8)
Asset loss deferred (23) (1)
----- -----
$ 366 $ 191
===== =====
The projected benefit obligation under the plan at December 31, 1996
and 1995 is presented below:
DECEMBER 31,
-----------------
1996 1995
------- -----
Actuarial present value of benefit obligations:
Vested benefit obligation $ 369 $ 190
Nonvested benefit obligation 293 218
------- -----
Accumulated benefit obligation 662 408
Benefits attributable to future salaries 454 362
------- -----
Projected benefit obligation 1,116 770
Fair value of plan assets (420) (275)
------- -----
696 495
Items not recognized:
Unrecognized prior service cost (321) (351)
Unrecognized net gain (6) (18)
Asset loss deferred (23) (1)
------- -----
Total unrecognized items (350) (370)
------- -----
Accrued pension expense 346 125
Adjustment for minimum liability 8
------- -----
Net pension liability $ 346 $ 133
======= =====
Assumptions used in accounting for the plan were:
1996 1995
----- -----
Weighted average discount rate 7.50% 7.25%
Average rate of increase in compensation levels 4.00% 5.00%
Expected long-term rate of return on plan assets 8.00% 8.00%
On January 1, 1995, the Company established the Stock Investment Plan
(the Stock Plan) covering substantially all employees. Under the Stock Plan,
eligible employees may contribute,
54
through payroll deductions, a minimum of $10.00 per month to a maximum of
$1,500.00 per month, to acquire common stock of the Company. The purchase price
of such stock will be equal to 85% of the fair market value on the purchase date
with the Company subsidizing the remaining 15% of the cost. The Company is
responsible for custodian charges (including brokerage expenses incurred in
connection with the purchase of shares) and all costs of maintaining and
executing transfers. This plan will continue until 100,000 shares of stock
(129,764 shares after giving effect to the Stock Dividends) have been purchased
by employees. As of December 31, 1996, 52,710 shares have been purchased under
the Stock Plan. The Company has subsidized approximately $94 and $46 relating to
the noncompensatory Stock Plan discount for 1996 and 1995, respectively.
On January 1, 1995, the Company established the Employee Stock
Ownership Plan (the ESOP) covering substantially all employees. Contributions to
the ESOP, which are at the discretion of and determined annually by the Board of
Directors, are not to exceed the maximum amount deductible under the applicable
sections of the Internal Revenue Code and are funded annually. However, such
contributions must be adequate to meet the required principal and interest
payments on the underlying loans discussed below.
During 1996 and 1995, the ESOP borrowed $3,000 and $2,000,
respectively, from the Company to purchase 224,169 and 200,944 shares of the
Company's common stock which are pledged to secure loans outstanding. The
principal amount of the 1995 loan is repayable in equal quarterly installments
of $100, which commenced in January 1996. The principal amount of the 1996 loan
is repayable in annual installments of $600 which commence in May 1997. In
accordance with these loan agreements, the ESOP repaid $400 to the Company in
1996. An additional $48 was paid on these loans in 1996 from the cash dividends
paid on the unallocated ESOP shares. In accordance with the Accounting Standards
Executive Committee of the American Institute of Certified Public Accountants
Statement of Position 93-6, "Employers' Accounting for Employee Stock Ownership
Plans", the Company records compensation expense equal to the fair value of
shares on the date such shares are committed to be released to employees. Shares
are considered committed to be released under the applicable plan formula as the
principal amount of the underlying loans are repaid. There was no compensation
expense related to the ESOP for 1995 since debt repayments did not begin until
January 1996. For the year ended December 31, 1996, 40,323 shares were released
and compensation expense related to the ESOP was $600. The fair market value of
the 409,752 unallocated shares held at December 31, 1996 was $5,839. Fair market
value of the 40,323 allocated shares was $575 at December 31, 1996.
Administrative expenses of the ESOP for 1996 and 1995 paid by the Company
totaled $19 and $27, respectively, and have been included as a component of
salaries and employee benefits.
Note 15 - Financial Instruments and Risk Management:
The Company is a party to various derivative financial instruments and
financial instruments with off-balance sheet risk in the normal course of
business to meet the financing needs of its customers and to reduce its own
exposure to risks related to fluctuating interest rates. These
55
financial instruments include mortgage purchase commitments, mandatory delivery
commitments, put and call option contracts, futures contracts and interest rate
floor contracts. The Company uses these financial instruments exclusively for
purposes of managing its resale pricing and interest rate risks.
The Company's mortgage loans held for sale are acquired or originated
through a network of correspondents, wholesale brokers and retail branches. In
connection therewith, the Company routinely enters into optional mortgage
purchase commitments to acquire or originate specific in-process mortgage loans
when and if closed by the counterparty, at the option of the mortgagor. Mortgage
purchase commitments obligate the Company to acquire mortgage loans on a delayed
delivery basis, which may extend for a period of 60 days, at a price which is
fixed as of the date of the contract.
Accordingly, the Company is subject to the risk that the market value
of its on-balance sheet mortgage loans held for sale and the mortgage loans it
is obligated to purchase under its mortgage purchase commitments may change
significantly prior to resale. In order to limit its resale price exposure, the
Company enters into mandatory delivery commitments which are contracts for
delayed delivery of mortgage loans to third parties. Mandatory delivery
commitments obligate the Company to sell mortgage loans on a delayed delivery
basis at a price which is fixed as of the date of the contract. Since mandatory
delivery commitments enable the Company to fix its resale prices for both
on-balance sheet mortgage loans held for sale (for which a fixed price has
already been paid) and for anticipated loan closures subject to mortgage
purchase commitments (which fix the delayed purchase price for the resultant
mortgage loans), these instruments can effectively limit the Company's resale
price exposures.
The percentages of anticipated loan closures under mortgage purchase
commitments that are covered by mandatory delivery commitments not allocated to
on-balance sheet mortgages held for sale are monitored continuously. The
Company's resultant expected exposure to resale pricing risk is continuously
adjusted to consider changing expectations regarding anticipated loan closure
percentages and other market conditions. Generally, the Company buys put and
call option contracts on U.S. Government Securities to effect modest adjustments
of its overall exposure to resale pricing exposures.
Purchased call option contracts enable the Company, at its option, to
acquire an underlying financial security from a third party at a specified price
for a fixed period of time. Purchased put option contracts enable the Company,
at its option, to sell an underlying financial security to a third party at a
specified price and for a fixed period of time. Since these financial
instruments essentially enable the Company to fix the purchase or sale price on
financial instruments whose changes in value have historically correlated
closely with changes in value of mortgage loans, these instruments can be used
effectively to adjust the Company's overall exposure to resale pricing risks. In
addition, these instruments have the advantages of being available in smaller
denominations than are typical of the Company's mandatory delivery commitments
and of being traded in a highly liquid and efficient secondary market.
56
Periodically, the Company also buys or sells futures contracts as part
of its hedging activities. Generally, futures positions are outstanding for
short periods of time and are used to hedge against price movements of another
financial instrument while execution of that instrument is bid among brokers.
Futures may be similarly used to hedge against price movements when another
financial instrument is illiquid due to temporary market conditions. There were
no open futures positions as of December 31, 1996 or 1995.
The Company typically sells its produced mortgage servicing rights
between 90 and 180 days of origination or purchase of the related loan pursuant
to committed prices under forward sales contracts. The Company also maintains a
portfolio of mortgage servicing rights which though available-for-sale, are not
currently scheduled for sale pursuant to the Company's forward sales contracts.
In connection therewith, the Company is subject to the risk that the economic
value of those mortgage servicing rights may decline in the event of a
significant decline in long-term interest rates. A significant decline in
interest rates generally causes an increase in mortgage loan prepayments (for
example increased refinancing) which in turn tends to reduce the future expected
cash flows (and economic value) of associated mortgage servicing rights.
Interest rate floor contracts provide for the Company to receive an interest
rate differential on a notional amount of outstanding principal to the extent
that interest rates decline below a specified rate which is fixed as of the date
of the contract. Accordingly, the value of an interest rate floor contract tends
to increase while the value of a mortgage servicing right tends to decrease in a
declining interest rate environment. As such, interest rate floor contracts can
effectively mitigate the Company's exposure to declines in the economic value of
its servicing rights in a declining interest rate environment.
The above described financial instruments involve, to varying degrees,
elements of credit and interest rate risk which are in excess of the amounts
recognized in the balance sheet. The Company believes that these instruments do
not represent a significant exposure to credit loss since the amounts subject to
credit risks are controlled through collateral requirements, credit approvals,
limits and monitoring procedures. The Company is exposed to credit losses in the
event of non-performance by counter parties to certain of its financial
instruments, but it does not expect any counter parties to fail since such risks
are managed through limits and monitoring procedures. The Company does not have
a significant exposure to any individual customer, correspondent or counterparty
in connection with these financial instruments. Except for mortgage purchase
commitments, the Company does not require collateral or other security to
support the financial instruments with credit risk whose contract or notional
amounts are summarized as follows:
57
CONTRACT AMOUNT AT DECEMBER 31,
1996 1995
----------- -----------
Financial instruments whose contract amounts represent credit risk:
Mortgage purchase commitments $ 528,672 $ 786,800
Financial instruments whose contract amounts exceed the amount of credit risk:
Mandatory delivery commitments (allocated against mortgages
held for sale) 644,200 1,025,300
Mandatory delivery commitments (allocated against mortgage
purchase commitments) 400,708 705,900
Purchased option contracts 100,000 175,000
Forward servicing sales contracts 11,469,076 12,290,700
Interest rate floor contracts 528,200 453,200
Mortgage loan purchase commitments expose the Company to credit loss in
the event the purchase commitments are funded as mortgage loans and if counter
parties default prior to resale. The maximum credit loss to which the Company is
exposed is the notional amount of the commitments. However, the Company does not
believe the commitments represent a significant exposure to credit loss because
the related loans are secured by 1-4 family homes, most loans are insured or
guaranteed through private mortgage insurance or government approval programs
and subjected to underwriting standards specified by government agencies or
private mortgage insurance. The estimated credit exposure on financial
instruments whose contract amounts exceed the amount of credit risk is the
increase in market value of the instrument.
The Company generally does not charge a premium to its correspondents
in connection with issuance of its mortgage purchase commitments nor is a
premium charged to the Company in connection with its acquisition of mandatory
delivery or forward servicing sales contracts.
Premiums paid for purchased put and call option and futures contracts
are initially deferred and included in other assets in the balance sheet. Other
assets included $934 and $1,412 at December 31, 1996 and 1995, respectively, of
such deferred premiums. Ultimately, such deferred premiums and related realized
gains or losses from these activities are recorded as a component of gains and
losses on sales of mortgage loans at the earlier of the expiration of the
underlying contract or when exercise of the contract is deemed remote.
Premiums paid for interest rate floor contracts are initially deferred
and included in other assets in the balance sheet and subsequently amortized
over the term of the underlying contract. Amounts received as interest rate
differentials under floor contracts are recorded as a reduction of basis in
mortgage servicing rights. Other assets included $2,611 and $1,695 at December
31, 1996 and 1995, respectively, of unamortized premiums. For the years ended
December 31, 1996 and 1995, respectively, $620 and $464 of deferred premiums
paid for interest rate floor contracts were amortized to expense. Open contracts
and the cost thereof are considered in determining the market value and cost of
mortgage servicing rights held for investment.
58
The current variable rate index (CMT Treasury rate) was 6.42% and 5.57%
at December 31, 1996 and 1995, respectively. Other terms of the interest rate
floor contracts outstanding at December 31, 1996, are summarized as follows:
Notional
Contract Date Expiration Date Amount Floor Rate
- -------------------------------------------------------------------------------
September 19, 1994 September 19, 1997 $ 75,000 6.845%
September 19, 1994 September 19, 1999 81,000 6.345%
September 19, 1994 September 19, 1999 51,000 6.845%
February 13, 1995 February 13, 1998 21,200 7.067%
February 13, 1995 February 13, 2000 20,000 7.067%
February 13, 1995 February 13, 2000 45,000 6.567%
June 7, 1996 June 7, 1999 50,000 6.600%
August 20, 1996 August 20, 2001 60,000 5.570%
August 20, 1996 August 20, 2001 65,000 5.570%
August 20, 1996 August 20, 2001 60,000 5.570%
--------
$528,200
========
59
Note 17 - Fair Value of Financial Instruments:
The following table presents the carrying amounts and fair values of
the Company's financial instruments at December 31, 1996 and 1995.
1996 1995
-------------------- -----------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
-------- ---------- ---------- ----------
Assets
Cash $ 2,492 $ 2,492 $ 2,161 $ 2,161
Receivables 60,668 60,668 57,893 57,893
Mortgage loans held for sale and
mortgage-backed securities 802,335 803,137 1,035,229 1,036,415
Liabilities
Short-term borrowings 805,730 805,730 1,005,557 1,005,557
Long-term borrowings 65,530 65,530
1996 1995
============================= ===============================
Notional Carrying Estimated Notional Carrying Estimated
Amount Value Fair Value Amount Value Fair Value
-------- -------- ---------- -------- -------- ----------
Off-balance sheet instruments
Mortgage purchase commitments $528,672 $ $(1,450) $786,800 $ $ 7,539
Mandatory delivery commitments
(allocated to mortgage purchase
commitments) 400,708 1,598 705,900 (5,400)
Purchased option contracts 100,000 934 502 175,000 1,412 1,513
Interest rate floor contracts 528,200 2,611 5,056 453,200 1,695 11,058
The following notes summarize the significant methods and assumptions
used in estimating the fair values of financial instruments.
Cash, receivables and short-term borrowings are short-term in nature.
Accordingly, they are valued at their carrying amounts which are a reasonable
estimation of fair value.
Mortgage loans held for sale and mortgage-backed securities covered by
mandatory delivery commitments allocated thereto are valued based upon
commitment delivery prices. Uncommitted mortgage loans held for sale are valued
by reference to quoted market prices for mortgage-backed securities, after
appropriate adjustments thereto. For purposes of developing the estimated fair
value, the portfolio has been segregated by product type, term and coupon
interest rate.
Short-term and long-term borrowings are all tied to near term variable
rate indices. Accordingly they are valued at their carrying amounts, which are a
reasonable estimation of fair values.
60
Mortgage purchase commitments are valued based upon the difference
between quoted mandatory delivery commitment prices (which are used by the
Company to price its mortgage purchase commitments) and the committed prices.
Mandatory delivery commitments are valued based upon the difference
between quoted prices for such commitments and the prices applicable to the
underlying commitment.
Purchased option contracts are valued based upon quoted prices for such
option contracts.
Interest rate floor contracts are valued based upon broker quotations.
Note 18 - Subsequent Events:
The Company and Meritage Mortgage Corporation (Meritage) have signed a
letter of intent for the Company to merge with Meritage. Meritage is a wholesale
originator of subprime mortgages headquartered in Portland, Oregon that was
organized in November 1995 and has origination offices in the Portland, San
Jose, Tacoma/Seattle, Tulsa and Denver metropolitan areas. During the year ended
December 31, 1996, Meritage produced approximately $107,000 of subprime mortgage
loans. Subprime mortgage production was approximately $40,000 for the fourth
quarter. As of December 31, 1996, Meritage employed 66 people. The Company will
exchange approximately $2,000 of cash and 926,000 shares of the Company's common
stock, for all of the outstanding common stock of Meritage. Approximately
427,000 of the 926,000 Company shares are being issued contingent upon Meritage
achieving specified increasingly higher levels of subprime mortgage production
during the 30 months following closing.
In January 1997, the Company reached resolution concerning certain of its
contractual employment obligations. In connection therewith, the Company
recorded a non-recurring charge of $5,200 (partially offset by a $2,000
reduction of income tax expense) in the accompanying consolidated financial
statements for 1996.
61
Note 16 - Quarterly Financial Data (Unaudited):
First Second Third Fourth
1996 Quarter Quarter Quarter Quarter Year
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income $ 3,243 $ 5,037 $ 4,500 $ 4,122 $ 16,902
Net gain on sale of mortgage loans 18,533 21,503 19,312 19,830 79,178
Gain on sale of mortgage servicing rights 66 123 775 141 1,105
Loan servicing fees 7,130 6,729 7,520 7,384 28,763
Other income 78 220 106 265 669
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenues 29,050 33,612 32,213 31,742 126,617
- -----------------------------------------------------------------------------------------------------------------------------------
Salary and employee benefits 12,666 12,849 12,315 17,748(1) 55,578
Occupancy expense 1,276 1,364 1,485 1,515 5,640
Amortization of mortgage servicing rights 3,670 3,646 3,748 3,870 14,934
Provision for foreclosure losses 100 100 91 526 817
General and administrative expenses 4,087 5,463 4,767 4,783 19,100
- -----------------------------------------------------------------------------------------------------------------------------------
Total expenses 21,799 23,422 22,406 28,442 96,069
- -----------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 7,251 10,190 9,807 3,300 30,548
Income tax expense (2,791) (3,923) (3,626) (585) (10,925)
- -----------------------------------------------------------------------------------------------------------------------------------
Net income $ 4,460 $ 6,267 $ 6,181 $ 2,715 $ 19,623
- -----------------------------------------------------------------------------------------------------------------------------------
Net income per common share $ 0.28 $ 0.33 $ 0.33 $ 0.14 $ 1.08
First Second Third Fourth
1995 Quarter Quarter Quarter Quarter Year
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income $ 794 $ 1,428 $ 3,172 $ 3,241 $ 8,635
Net gain on sale of mortgage loans 550 2,547 13,733 16,992 33,822
Gain on sale of mortgage servicing rights 1,816 4,024 188 1,318 7,346
Loan servicing fees 5,851 5,237 6,344 6,773 24,205
Other income 537 721 446 985 2,689
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenues 9,548 13,957 23,883 29,309 76,697
- -----------------------------------------------------------------------------------------------------------------------------------
Salary and employee benefits 3,800 4,876 9,842 12,681 31,199
Occupancy expense 393 676 886 1,111 3,066
Amortization of mortgage servicing rights 2,028 2,119 2,458 2,747 9,352
Provision for foreclosure losses 16 19 40 93 168
General and administrative expenses 1,636 2,278 3,220 3,486 10,620
- -----------------------------------------------------------------------------------------------------------------------------------
Total expenses 7,873 9,968 16,446 20,118 54,405
- -----------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 1,675 3,989 7,437 9,191 22,292
Income tax expense (642) (1,529) (2,841) (3,061) (8,073)
- -----------------------------------------------------------------------------------------------------------------------------------
Net income $ 1,033 $ 2,460 $ 4,596 $ 6,130 $ 14,219
- -----------------------------------------------------------------------------------------------------------------------------------
Net income per common share $ 0.06 $ 0.16 $ 0.30 $ 0.40 $ 0.92
(1) Includes non-recurring charge of $5,200.
62
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Resource Bancshares
Mortgage Group, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of changes in stockholders' equity, and of
cash flows present fairly, in all material respects, the financial position of
Resource Bancshares Mortgage Group, Inc. and its subsidiary at December 31, 1996
and 1995, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 2 to the consolidated financial statements, the Company
changed its method of accounting for mortgage servicing rights in 1995.
Price Waterhouse LLP
Columbia, South Carolina
February 3, 1997
63
STOCK DATA
Information pertaining to high and low stock prices for each quarter
during 1996, 1995 and 1994 is given in the following chart. All per share data
have been adjusted to reflect the Stock Dividends issued by the Company.
The Company began paying cash dividends in 1996. Cash dividends, each
of $0.03 per share, were paid to shareholders of record as of September 3, 1996
and November 29, 1996. These cash dividends were paid on September 24, 1996 and
December 13, 1996. (See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for restrictions on the Company's ability
to pay cash dividends.)
As of February 28, 1997, there were approximately 812 record holders of
the Company's common stock.
[GRAPH]
Quarter 12-31-93 3-31-94 6-30-94 9-30-94 12-31-94 3-31-95 6-30-95 9-30-95 12-31-95 3-31-96 6-30-96 9-30-96 12-31-96
High $9.41 $8.98 $8.44 $8.28 $8.86 $8.47 $11.34 $17.06 $15.66 $17.06 $14.84 $14.25 $15.75
Low $6.97 $6.61 $6.42 $6.23 $7.50 $6.17 $ 7.70 $10.02 $12.61 $12.91 $10.16 $10.63 $12.88
64
DIRECTORS OFFICERS
Edward J. Sebastian Edward J. Sebastian Thomas S. Palmer
Chairman of the Board Chairman of the Board Senior Vice President
Chief Executive Officer Chief Executive Officer Correspondent Production
Resource Bancshares Mortgage Group, Inc.
Columbia, South Carolina David W. Johnson, Jr. Larry W. Reed
Vice Chairman Senior Vice President
David W. Johnson, Jr. Managing Director Subprime Lending
Vice Chairman
Managing Director Steven F. Herbert Gregory A. Samp
Resource Bancshares Mortgage Group, Inc. Senior Executive Vice President Senior Vice President
Columbia, South Carolina Chief Financial Officer Director of Operations
John W. Currie Richard M. Duncan Judy B. Schneider
Attorney Senior Executive Vice President Senior Vice President
McNair Law Firm P.A. Production Loan Operations
Columbia, South Carolina
law firm D. Hugh Burgess Joseph P. Sheridan, Jr.
Senior Vice President Senior Vice President
Stuart M. Cable General Auditor Retail Production
Attorney
Goodwin, Proctor & Hoar, LLP Jordan D. Dorchuck Ronald C. Simpson, Jr.
Boston, Massachusetts Senior Vice President Senior Vice President
law firm General Counsel Secondary Marketing
John C. Baker D. Keith Gettman Edward F. Wallace, Jr.
Baker Capital Corp. Senior Vice President Senior Vice President
New York, New York Secondary Marketing and Wholesale Production
venture capital firm Subprime Lending
Steven D. Walls
*Boyd M. Guttery Robin H. Holmes Senior Vice President
Business Consultant Senior Vice President Controller
Private Investor Underwriting and Insuring and Guaranteeing
Atlanta, Georgia
Brian L. Kunar
*John O. Wolcott Senior Vice President
Executive Vice President Loan Administration
Olayan America Corporation
New York, New York Thomas J. Little, Jr.
investment company Senior Vice President
Human Resources
*Audit Committee
65
CORPORATE INFORMATION
Exchange: NASDAQ
Symbol: REMI
Internet Address: http://www.rbmg.com
INVESTOR RELATIONS CONTACT
Steven F. Herbert
Senior Executive Vice President
and Chief Financial Officer
Resource Bancshares Mortgage Group, Inc.
7909 Parklane Road
Columbia, South Carolina 29223
Tel: (803) 741-3539
Fax: (803) 741-3586
DIVIDEND REINVESTMENT PLAN
Resource Bancshares Mortgage Group, Inc.
has an optional Dividend Reinvestment and
Stock Purchase Plan. Shareholders interested
in participating can contact the Investor Relations
Contact listed above.
FORM 10K AND OTHER INFORMATION
Copies of the Resource Bancshares
Mortgage Group, Inc., Annual Report
on Form 10K, as filed with the Securities
and Exchange Commission, will be furnished
without charge to shareholders upon
written request to Steven F. Herbert
at the address set forth above.