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Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
Amendment No. -
ANNUAL REPORT
Pursuant to Section 13 or 15(D)
of the Securities Exchange Act of 1934 ( "the Act")
For the Fiscal Year Ended December 31, 1999
Commission File Number 000-23775
Approved Financial Corp.
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(Exact Name of Registrant as Specified in its Charter)
Virginia 52-0792752
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
1716 Corporate Landing Parkway, Virginia Beach, Virginia 23452
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(Address of Principal Executive Office) (Zip Code)
757-430-1400
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(Registrant's Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(g) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
Common, $1.00 par value per share OTC Bulletin Board
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Securities to be Registered Pursuant to Section 12(g) of the Act:
None
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant is
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ____ .
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Indicate by check mark if disclosure of delinquent filers pursuant to item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ].
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date: 5,482,114 shares at March 15,
2000.
DOCUMENTS INCORPORATED BY REFERENCE IN FORM 10-K
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INCORPORATED DOCUMENTS WHERE INCORPORATED IN FORM 10-K
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1. Certain portions of the Corporation's Proxy Part III -Items 10, 11, 12 and 13.
Statement for the Annual Meeting of Stockholders
to be held on June 7, 2000 ("Proxy Statement").
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Approved Financial Corp.
Annual Report on Form 10-K
Amendment No. -
For the Fiscal Year Ended December 31, 1999
INFORMATION REQUIRED IN ANNUAL REPORT
TABLE OF CONTENTS
PART I
Item 1. Business.
General.......................................................................... 7
Business Strategy................................................................ 9
The Company's Borrowers and its Loan Products.................................... 11
Underwriting Guidelines.......................................................... 13
Mortgage Loan Servicing.......................................................... 18
Marketing........................................................................ 19
Company's Sources of Funds and Liquidity......................................... 20
Bank's Sources of Funds......................................................... 20
Taxation......................................................................... 21
Employees........................................................................ 21
Service Marks.................................................................... 22
Effect of Adverse Economic Conditions............................................ 22
Concentration of Operations in Seven States...................................... 22
Future Risks Associated with Loan Sales through Securitizations.................. 22
Contingent Risks................................................................. 22
Competition...................................................................... 23
Regulation....................................................................... 23
OTS Regulation of the Company.................................................... 25
Regulation of the Bank.......................................................... 26
Legislative Risk................................................................. 32
Environmental Factors............................................................ 32
Dependence on Key Personnel...................................................... 33
Control by Certain Shareholders.................................................. 33
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Item 2. Properties.
Properties....................................................................... 34
Item 3. Legal Proceedings.
Legal Proceedings................................................................ 35
Item 4. Submission of Matters to a Vote of Security Holders.
Submission of Matters to a Vote of Security Holders.............................. 35
PART II
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters.
Market Price of and Cash Dividends on Company's Common Equity.................... 36
Absence of Active Public Trading Market and Volatility of Stock Price............ 37
Transfer Agent and Registrar..................................................... 37
Recent Open Market Purchase of Common Stock by the Company ...................... 37
Recent Sales of Unregistered Securities.......................................... 37
Item 6. Selected Financial Data.
Selected Financial Data.......................................................... 39
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations
General.......................................................................... 41
Results of Operations - Years Ended December 31, 1999 and 1998................... 41
Results of Operations - Years Ended December 31, 1998 and 1997................... 53
Financial Condition - December 31, 1999, 1998 and 1997........................... 61
Liquidity and Capital Resources.................................................. 63
Hedging Activities............................................................... 66
New Accounting Standards......................................................... 66
Impact of Inflation and Changing Prices.......................................... 67
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Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market Risk Management - Asset/Liability Management.......................... 69
Interest Rate Risk........................................................... 71
Asset Quality................................................................ 72
Item 8. Financial Statements and Supplementary Data.
Financial Statements and Supplementary Data.................................. 73
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.
Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................................... 73
PART III
Item 10. Directors and Executive Officers of the Registrant.
Information regarding certain relationships and related transactions appears in
the definitive proxy statement for the Annual Shareholder's Meeting to be held
on June 7, 2000 and is incorporated herein by reference.
Item 11. Executive Compensation.
Information regarding executive compensation appears in the definitive proxy
statement for the Annual Shareholder's Meeting to be held on June 7, 2000 and is
incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Information regarding security ownership of certain beneficial owners and
management appears in the definitive proxy statement for the Annual
Shareholder's Meeting to be held on June 7, 2000 and is incorporated herein by
reference.
Item 13. Certain Relationships and Related Transactions.
Information regarding certain relationships and related transactions appears in
the definitive proxy statement for the Annual Shareholder's Meeting to be held
on June 7, 2000 and is incorporated herein by reference.
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PART IV
Item 14. Exhibits, Financial Statement Schedules
And Reports on Form 8-K.
Financial Statements and Exhibits................................... 75
Signatures.......................................................... 79
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PART I
ITEM 1 - BUSINESS
Certain statements in this report which are not merely historical facts are
forward-looking statements within the meaning of the Private Securities
Litigation Act of 1995 concerning Approved Financial Corp. and its subsidiaries
("Approved" or "Company") concerning future loan production volume, revenues
from loan sales, restructuring and expense reduction initiatives, ability to
profitably participate in the conforming mortgage business or any other past,
present or future business strategy or operation are forward-looking statements.
There are a number of important factors that could cause the actual results of
Approved to differ materially from those indicated in such forward-looking
statements. Those factors include, but are not limited to the ability of the
Company's management to implement restructuring and expense reduction plans,
Company's ability to retain experienced personnel, any changes in residential
real estate values, changes in industry competition, general economic
conditions, changes in interest rates, changes in the demand for non-conforming
or conforming mortgage loans, the Company's availability of affordable funding
sources for capital liquidity, changes in loan prepayment speeds, delinquency
and default and loss rates, changes in regulatory issues concerning mortgage
companies or federal banks, changes in GAAP accounting standards effecting the
Company's financial statements, and any changes which influence any market for
profitable sales of all types of mortgage loans.
General
The Company is a Virginia-chartered financial institution, principally
involved in originating, purchasing, servicing and selling loans secured
primarily by first and junior liens on owner-occupied, one- to four-family
residential properties. The Company offers both fixed-rate and adjustable-rate
loans for debt consolidation, home improvements and other purposes. The
Company's specialty is lending to the "non-conforming" borrower who does not
meet traditional "conforming" or government agency credit qualification
guidelines, but who exhibits both the ability and willingness to repay the loan.
The Company focuses on lending to individuals whose borrowing needs are
generally not being served by traditional financial institutions due to such
individuals' impaired credit profiles often resulting from personal issues such
as divorce, family illness or death and a temporary loss of employment due to
corporate downsizing as well as other factors. Operating under current
management for the past sixteen years, the Company has helped non-conforming
mortgage customers satisfy their financial needs and in many cases has helped
them improve their credit profile. During 1999 the Company initiated the in-
house funding of traditional conforming mortgage products and government
mortgage products such as VA and FHA.
Incorporated in 1952 as a subsidiary of Government Employees Insurance Co.
("GEICO"), the Company was acquired in September 1984 by, among others, several
members of current management. The Company, headquartered in Virginia Beach,
Virginia, holds a Virginia industrial loan association charter and is subject to
the supervision, regulation and examination of the Virginia State Corporation
Commission's Bureau of Financial Institutions. In September 1996 the Company
acquired Approved Federal Savings Bank (the "Bank"), a federally-chartered
institution. The Bank is subject to the supervision, regulation and examination
of the Office of Thrift Supervision (the "OTS") and the Federal Deposit
Insurance Corporation ("FDIC"). The Company is a registered and loan holding
company under the federal Home Owner's Loan Act ("HOLA") because of its
ownership of the Bank. As such, the Company is subject to the regulation,
supervision and examination of the OTS. The Bank is also subject to the
regulations of the Board of Governors of the Federal Reserve System governing
reserves required to be maintained against deposits.
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The Company historically has derived its income from gains on loans sold
through whole loan sales to institutional purchasers, net warehouse interest
earned on loans held for sale, net interest income on loans held for yield,
origination and other fees received as part of the loan application process and
to a lesser extent from fees associated with the portfolio of loans serviced and
from its insurance operations. In future periods, the Company may generate
revenue from loans sold through alternative loan sale strategies such as
securitization, from other types of consumer finance lending and from the sale
of other financial products and services.
The Company utilizes broker and retail channels to originate loans. At the
broker level, an extensive network of independent mortgage brokers generates
referrals. This loan source has been a successful and profitable mainstay of the
business for many years. The Company began making residential mortgage loans
through retail offices during the fourth quarter of 1994. In 1999, the dollar
volume in the broker lending division accounted for 32.5% of total originations
and the retail lending division accounted for 67.5% of total originations. The
Company's current initiatives focus on increasing future origination volume in a
cost-effective manner through the broker and retail channels.
Once loan applications are received from the broker and retail networks,
the underwriting process is completed and the loans are funded, the Company
typically packages the loans and sells them on a whole loan basis to
institutional investors consisting primarily of larger financial institutions.
The Company sells conforming loans to large financial institutions and to
government and quasi-government agencies. The proceeds from the sales release
funds for additional lending.
The Company has four operating subsidiaries, Approved Residential Mortgage,
Inc. ("ARMI"), Approved Federal Savings Bank ("Bank"), MOFC dba ConsumerOne
Financial ("ConsumerOne") and Approved Financial Solutions ("AFS").
Approved Residential Mortgage, Inc. ("ARMI") was formed in April 1993. Its
primary business activity is to originate non-conforming residential mortgage
loans. ARMI originated loans through the broker network from inception and
opened the Company's first retail office in 1994.
The principal business activity of the Bank, also headquartered in Virginia
Beach, is attracting deposits and originating, investing in and selling loans
primarily secured by first and junior mortgage liens on single-family dwellings,
including condominium units. To a lesser extent the Bank from time to time
originates consumer loans to credit worthy customers. The Bank also invests in
certain U.S. Government and agency obligations and other investments permitted
by applicable laws and regulations. The operating results of the Bank are highly
dependent on net interest income, the difference between interest income earned
on loans and investments and the cost of deposits and borrowed funds. The Bank's
charter provides for ease of entry into new markets, with reduced legal costs.
By taking advantage of the flexible provisions of the charter, the Bank is able
to make real estate-secured loans in several states where the Company's retail
or broker units associated with other subsidiaries of the Company are not
licensed. The Bank originates loans utilizing a network of mortgage brokers for
loan referrals and through retail mortgage lending offices. The Bank has
contracted the Company to provide the processing, underwriting and closing
capabilities of the Company. The Company has agreed to purchase all
nonconforming mortgage loans made by the Bank. The Company has sold in the
secondary market most of the loans it has purchased from the Bank. Deposit
accounts of the Bank up to $100,000 are insured by the Association Insurance
Fund, administered by the FDIC. The Bank is a member of the Federal Home Loan
Bank (the "FHLB") of Atlanta. The Company and the Bank are subject to the
supervision, regulation and examination of the OTS and the FDIC. The Bank is
also subject to the regulations of the Board of Governors of the Federal Reserve
System governing reserves required to be maintained against deposits.
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MOFC, Inc. d/b/a/ ConsumerOne Financial ("ConsumerOne") was acquired in
December of 1998 and originates loans directly with mortgage borrowers.
ConsumerOne is located in Birmingham, Michigan and serves as a disaster "hot"
site for the Company. (See: The Purchase of MOFC, Inc. d.b.a. ConsumerOne
Financial).
Approved Financial Solutions, Inc. ("AFS") was formed in November of 1998
for the initial purpose of offering life insurance to the Company's loan
customers. To date, insurance sales have not represented a material source of
revenue. During 1999, AFS purchased the Bank's title insurance operations at
book value for the purpose of centralizing all current and future insurance
operations under one operating division of the Company.
Business Strategy & Corporate Mission Statement
The primary focus of Approved's Corporate Mission Statement is two fold;
. To deliver impeccable service to our customers in an efficient, professional
and consistent manner.
. To protect and enhance the future value of the Company for our shareholder's.
Current corporate business strategies designed to attain the Corporate Mission
Statement include but are not limited to the following;
(i) Maintain quality loan underwriting and servicing standards.
(ii) Maintain strict cost controls and reduce expenses through the continued
application of new technologies.
(iii) Increase revenues by expanding the level of profitable volume from retail
branches, through strategic alliances and from broker referrals.
(iv) Diversify loan sale strategies and investors with a commitment to prudent
management of cash flow.
(v) Expand product and financial service offerings.
(vi) Build on the opportunities available through the Bank.
(vii) Leverage the marketing and advertising division with new applications.
(i) Maintain Quality Loan Underwriting and Servicing Standards. The
Company's underwriting and servicing staff have experience in the non-
conforming, home equity loan industry. The Company's management believes that
the experience of its underwriting and servicing staff provides the Company with
the infrastructure and skills necessary to maintain its commitment to solid
underwriting standards during periods of rapid growth as well as times of
unprecedented competition which the mortgage industry has experienced over
recent years.
(ii) Maintain strict cost controls and reduce expenses through the
continued application of new technologies. During 1999 the Company successfully
implemented many successful campaigns, one of which centralized all marketing
and advertising efforts in the Virginia Beach headquarters location.
Additionally, during December of 1999 the Company combined the home office staff
of three Virginia Beach locations into its new headquarters building. This move
facilitates greater operating efficiencies and improved internal communication.
Also, throughout 1999, the company initiated numerous system-wide expense
reduction projects which it continues to implement in the year 2000. One such
project, which was introduced in October of 1999, is the conversion to a new
systems platform. The benefits anticipated from this conversion include but are
not limited to, a significant reduction in the amount of multiple data entry,
the transfer of documents electronically ("e-docs"), real-time management
reporting, remote location interactive training for users and greatly enhanced
data integrity and quality control.
(iii) Increase revenues by expanding the level of profitable volume from
retail branches, through strategic alliances, from broker referrals and through
utilization of the internet.
Retail. The Company intends to expand its loan origination volume from its
retail branch network by building larger sales staffs in each location and
retaining highly seasoned mortgage professionals as branch
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managers and as corporate sales trainers.
Strategic Alliances. The Company looks to strengthen its retail loan
production capabilities not only through internal growth, but from time to time
through the development of strategic alliances with other mortgage companies.
The Company's management believes that these relationships can accelerate the
pace of growth in a cost-effective manner with minimal initial investment or
long-term financial commitment by the Company. These candidates must exhibit
management styles compatible with the Company's management team and with
business strategies that complement those of the Company's. Senior management
adheres to the belief that "people" are more important than "location" in the
lending business, therefore the Company seeks qualified individuals with proven
track records for management positions and or strategic relationships in lieu of
targeting a geographic area and then looking for an appropriate candidate.
Broker Referrals. The Company's wholesale division sales efforts are
conducted through account executives with extensive experience in the non-
conforming mortgage business located in several states. To augment their sales
efforts management is currently exploring an effective structure to facilitate
an inside sales staff who will solicit broker referral business from the home
office in Virginia Beach.
Internet Applications. The Company is currently developing a business to
business web-based platform to facilitate more efficient and cost-effective
service to its broker network and to its off site sales staff. Expected for
introduction during 2000, this password secured application will allow off site
loan origination personnel to access their loan files in process, retrieving
underwriting status and outstanding stipulations needed. Management feels that
business to business applications present immediate value to the Company.
However, a loan origination web site is expected to be introduced in the future.
(iv) Diversify loan sale strategies and investors with a commitment to
prudent management of cash flow. The Company historically has sold its loans on
a whole loan basis receiving cash at the time of sale. Beginning in the second
half of 1998, many of the Company's investors that utilized the securitization
market as their primary loan sale strategy experienced significant difficulty
with capital and liquidity issues. Since 1998, the secondary market place has
experienced unprecedented turmoil as a result of the liquidity issues faced by
many in the non-conforming mortgage industry, the result of which explains the
drop in average loan sale premiums received by the Company from 5,4% in 1998 to
3.1% in 1999 excluding seasoned loan sales. In order to reduce the Company's
dependence any individual investor management initiated a campaign to diversify
the Company's investor base by increasing the number of relationships and the
types of investors. The Company has been successful in obtaining new investors
having reduced the percentage of loans sold to a single investor from 66% in
1997 to 30% in 1998 and down to 16% in 1999. Management continues to
aggressively expand its investor base for loan sales.
Alternative or complementary loan sale strategies, such as asset backed
securitization, may be utilized by the Company in the future in addition to
whole loan sales. However, any new strategy will be adopted only after prudent
economic analysis has been performed to determine the long term effects that
such a strategy would have on the Company's profitability, capital base and
liquidity.
(v) Broaden Product Offerings. The Company frequently reviews its
traditional non-conforming pricing and loan offerings for competitiveness
relative to the origination and secondary markets. The Company introduces new
loan products to meet the needs of its brokers and borrowers and to expand its
market share to new customers who are not traditionally part of the Company's
market. During 1999 two new divisions were introduced.
(i) Conforming Division: In order to facilitate the funding of conforming loans
in-house in lieu of funding these loans through other lenders, a strategic
alliance was formed with a Virginia Beach based conforming lender in March
1999 which facilitates the funding of conforming, VA and FHA loans in-
house.
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(ii) Title Insurance Division: In the fourth quarter of 1999 the Company
restructured its title insurance operation and retained an individual with
many years of experience in the title business to run the operation. This
division is licensed in the state of Virginia and is in the licensing
process in other states that the Company has a strong retail presence.
In addition the Company is currently developing various ancillary financial
products and services which are presently being assessed for the profit
potential to the Company and the value they represent to our customer base.
(vi) Building on the Company's Investment in the Bank. The Bank's ability
to raise FDIC-insured deposits and to obtain Federal Home Loan Bank advances to
finance its activities is a significant benefit to the Company providing a lower
cost source of funds. The Bank facilitates easy of entry into new states by way
of the charter which exempts many expensive and time consuming licensing
procedures. The Bank as a federal thrift charter provides many additional
opportunities not yet developed by the Company, such as Small Business
Administration (SBA) and Small Business Investment Corporation (SBIC) and Trust
activities. The Company plans to explore these areas in the future.
(vii) Leverage the marketing and advertising division with new
applications. A targeted advertising and marketing division is centralized in
the Virginia Beach facility, using out-bound and in-bound telemarketing, direct
mail, newspaper advertising and various other mediums to obtain potential
customers leads for the retail branches. The Company centralized all of its
advertising and marketing activities in order to better measure the
effectiveness of various advertising campaigns, achieve economies of scale,
ensure the quality of its marketing efforts, and to secure compliance with
various regulations associated with these activities. The Company leverages this
operation by generating leads for sale to other companies and for additional
internal marketing campaigns unrelated to individual mortgage lead generation.
The Company's Borrowers and its Loan Products
The Company has historically committed the majority of its resources to
serving the non-conforming residential mortgage market. Prior to the recent
development of a conforming origination division in March 1999, the Company
catered solely to individuals who do not meet the strict qualification
guidelines established by most conforming lending programs. These customers
historically have experienced limited access to credit, but their financial
needs are none the less real. By consolidating their debts with a mortgage loan
from the Company, these customers can often save several hundred dollars per
month in cash flow, amounts that can make a significant difference in a
customer's financial situation and quality of life. Personal circumstances
including divorce, family illnesses or deaths and temporary job loss due to
layoffs and corporate downsizing will often impair an applicant's credit record.
Among the Company's specialties is the ability to identify and assist this type
of borrower in the establishment of improved credit. In this segment of the
mortgage loan business, the interest rate or origination costs charged on loans
is not the overriding concern of customers but rather the size of their monthly
payment. Therefore, these customers are less rate-sensitive than conforming loan
customers and therefore lenders compete more often by flexibility in
underwriting criteria and through the quality and speed of service.
Loans made to such credit-impaired borrowers generally entail a higher
frequency of delinquency and loan losses than those for more creditworthy
borrowers. The severity of loan losses is normally related to the loan to value
ratios associated with a mortgage loan. In order to compensate the Company for
the increased credit risks associated with its non-conforming borrowers, higher
interest rates and origination fees or points are charged for these loans
compared to higher credit quality conforming real estate loans. No assurance can
be given that the
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Company's underwriting policies and collection procedures will substantially
reduce such risks. In the event that warehoused loans or pools of loans sold and
serviced by the Company experience higher than anticipated delinquency,
foreclosure, loss or prepayment speed rates, the Company's results of operations
or financial condition would be adversely affected.
Most loans made by the Company are used by the borrowers for debt
consolidation, property improvement, home purchase and other purposes.
Borrowers can gain the income tax advantages of real estate-secured debt by
paying off higher-rate credit cards on which interest payments are generally not
tax-deductible. The company offers fixed and adjustable rate mortgages, however,
most of the loans carry fixed interest rates with 20- to 30-year terms and
provide for a prepayment penalty. The average size of non-conforming loans
funded in-house by the Company during 1999 was approximately $63,000. The
average size of non-conforming loans originated by the Company, including retail
loans funded through other lenders ("brokered loans"), during 1999 was
approximately $71,000. The average size of conforming loans originated by the
Company, during 1999 was approximately $101,000.
There is an active secondary market for most types of mortgage loans
originated by the Company. The majority of the loans originated by the Company
are sold to other mortgage companies, finance companies and other financial
institutions including federally chartered banking institutions. The loans are
sold for cash on a whole loan, servicing-released basis. Consistent with
industry practices, the loans are sold with certain representations and
warranties. However, the Company may adopt alternative or complimentary loan
sale strategies in the future. The Company plans to make additional investments
in technology to further streamline its operating procedures, enhance
productivity, reduce expenses and provide for future expansion. However, the
Company expects that it would have to invest in additional capabilities if it
enters the securitization business.
The Company has the ability to originate loans through the Bank that are
not secured by real estate collateral, including consumer installment debt. If
offered, these products will be underwritten based on the borrower's credit
worthiness. As is the case with its other loan products, the Company's intention
would be to sell these loans in the secondary market, to limit its exposure to
future losses. To date, the amount of non-real estate secured loans originated
by the company has not been material.
Broker Loan Originations. The Company originates non-conforming residential
mortgage loans through a network of independent mortgage brokers who offer the
Company's products to their clients. During 1999, loans originated from this
source declined both in the absolute dollar amount of loans originated and as a
percentage of total loan volume. Loans originated from mortgage broker referrals
declined to $126.9 million or 32.5% of the total loan volume compared to $203.9
or 39.0% of 1998 loan volume.
In cultivating this broker network, the Company stresses its superior
service, efficiency, flexibility and professionalism. Due to concentrated size
and centrally -organized operations, the Company offers one business day
turnaround on underwriting decisions and can close loans in as few as two
business days with appropriate documentation provided to the underwriting and
processing department. A wide variety of loan products have been designed to
assist brokers in supporting a broader spectrum of borrowers. A team of regional
sales managers and account executives assist mortgage brokers in the field. The
majority of the loans are underwritten at the Company's Virginia Beach, Virginia
headquarters.
Management plans to continue to develop the broker sales force with ongoing
training programs. The Company is designing an inside sales division to augment
the efforts of the account executives in the field.
Retail Loan Originations. During 1999 loans originated from the retail
division totaled $263.9 or 67.5% of total volume for the year compared to $318.0
or 60.9% during 1998. The Company initiated retail loan origination in December
1994. As a result of the drastic changes that occurred in the in the mortgage
industry beginning in the fourth quarter of 1998, revenues from premiums
received on whole-loan sales dropped
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materially from 5.3% during the third quarter of 1998 to 3.1% in the fourth
quarter of 1999. As a result, the smaller retail branch structure, which
comprised many of the locations in 1998, no longer represented a profitable
business model and had to be eliminated. Management found it necessary to
dramatically restructure its retail operations. At the end of 1998 the company
had 29 retail branches compared to 11 offices at December 31, 1999, a reduction
of 62 percent. The new retail branch strategy encompasses a "super branch"
structure with larger sales staffs, greater loan volume per location and highly
seasoned mortgage professionals serving as branch managers. As illustration,
while the number of retail sales offices decreased by 62% from yearend 1998 to
1999, the dollar volume of loans originated from this source declined by only
17%. The Company intends to expand its loan origination volume from its retail
branch network by continuing this super branch strategy with continuous product
and sales training for loan officers.
To support the retail sales efforts, integrated marketing programs have
been designed to generate new business. Retail customer demand is generated
through targeted outbound telemarketing, direct mail and multimedia advertising
which generated in-bound telemarketing leads.
Strategic Alliances. In order to increase volume and to diversify its
sources of loan originations, the Company seeks to enter into strategic
alliances with selected mortgage originators as opportunities occur. The company
has no predefined structure of such alliances because it anticipates that each
will provide unique opportunities.
During 1999, the Company entered into a strategic alliance with a Virginia
Beach based conforming mortgage operation ("ConformCo"). Under the initial
arrangement, the Bank hired operational employees that were previously employees
of ConformCo to underwrite, process and sell conforming mortgage loans for the
company's retail operations and for ConformCo existing sales staff. The overhead
expenses, were initially shared based on a pro-rata basis determined by the
percentage of conforming loan volume originated by the Company and by ConformCo.
This relationship has evolved such that today operational employees work for the
Bank and facilitate in-house funding of conforming, VA and FHA loans solely for
the Company's retail system.
Underwriting Guidelines
The Company underwrites Non-conforming, Conforming Conventional and
Government Mortgage Loans. Underwriting Criteria for all mortgage loans reflects
the underwriting criteria of our whole-loan investors. Historically, the
majority of mortgage loans funded by the Company have been non-conforming loans.
The Company began funding Conforming Conventional and Government Mortgages in
the second half of 1999.
Non-Conforming Mortgage Loans. Historically, the Company has focused on the
non-conforming mortgage business. The following is a general description of the
non-conforming underwriting guidelines currently employed by the Company with
respect to mortgage loans it originate. The Company revises such guidelines from
time to time in connection with changing economic and market conditions. The
Company may make exceptions to these guidelines for special types of loans,
including loans with loan-to-value ratios over 80%, and for other reasons. The
Company relies on the judgment of the underwriting staff in making these
exceptions. Also, the Company will substitute underwriting guidelines of other
lenders to which the Company anticipates it will sell such loans under an
established buy-sell agreement.
Loan applications received from retail offices and brokers are classified
according to certain characteristics including available collateral, loan size,
debt ratio, loan-to-value ratio and the credit history of the applicant. Loan
applicants with less favorable credit ratings generally are offered loans with
higher interest rates and lower loan-to-value ratios than applicants with more
favorable credit ratings. The Company's underwriting standards are designed to
provide a program for all qualified applicants in an amount and for a period of
time consistent with each applicant's demonstrated willingness and ability to
repay. The Company's underwriters make determinations on loans without regard to
sex, marital status, race, color, religion, age or national origin.
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Each application is evaluated on its individual merits, applying the guidelines
set forth below, to ensure that each application is considered on an equitable
basis.
A current credit report by an independent and nationally recognized credit
reporting agency reflecting the applicant's complete credit history is required.
The credit report will disclose whether any instances of adverse credit appear
on the applicant's record. Such information might include delinquencies,
repossessions, judgements, foreclosures, bankruptcies and similar instances of
adverse credit that can be discovered by a search of public records. An
applicant's recent credit performance weighs heavily in the evaluation of risk
by the Company. A lack of credit history will not necessarily preclude a loan if
the borrower has sufficient equity in the property. Slow payments on the
borrower's credit report must be satisfactorily explained and will normally
reduce the amount of the loan for which the applicant can be approved.
The Company maintains a staff of experienced underwriters based in its
Virginia Beach, Virginia office. The Company's loan application and approval
process generally is conducted via facsimile submission of the credit
application to the Company's underwriters. An underwriter reviews the
applicant's employment history and financial status as contained in the loan
application, current bureau reports and the real estate property characteristics
as presented on the application in order to determine if the loan is acceptable
under the Company's underwriting guidelines. Based on this review, the
underwriter assigns a preliminary rating to the application. The proposed terms
of the loan are then communicated to the retail loan officer or broker
responsible for the application who in turn discusses the proposal with the loan
applicant. When a potential borrower applies for a loan through a branch office,
the underwriter may discuss the proposal directly with the applicant. The
Company endeavors to respond with preliminary proposed loan terms, and in most
cases does respond, to the broker or borrower within one business day from when
the application is received. If the applicant accepts the proposed terms, the
underwriter will contact the broker or the loan applicant to gather additional
information necessary for the closing and funding of the loan.
All loan applicants must have an appraisal of their collateral property
prior to closing the loan. The Company requires loan officers and brokers to use
licensed appraisers that are listed on or qualify for the Company's approved
appraiser list. The Company approves appraisers based upon a review of sample
appraisals, professional experience, education, membership in related
professional organizations, client recommendations and review of the appraiser's
experience with the particular types of properties that typically secure the
Company's loans.
The decision to provide a loan to an applicant is based upon the value of
the underlying collateral, the applicant's creditworthiness and the Company's
evaluation of the applicant's willingness and ability to repay the loan. A
number of factors determine a loan applicant's creditworthiness, including debt
ratios (the borrower's average monthly expenses for debts, including fixed
monthly expenses for housing, taxes and installment debt, as a percentage of
gross monthly income), payment history on existing mortgages, customer's history
of bankruptcy, the credit score of the applicant provided from services accepted
by the various investor's who buy our loans and the combined loan-to-value ratio
for all existing mortgages on a property.
Assessment of the applicant's demonstrated willingness and ability to pay
is one of the principal elements in distinguishing the Company's lending
specialty from methods employed by traditional lenders. All lenders utilize debt
ratios and loan-to-value ratios in the approval process. Many lenders rely on
software packages to score an applicant for loan approval and fund the loan
after auditing the data provided by the borrower. The Company primarily relies
upon experienced non-conforming mortgage loan underwriters to scrutinize an
applicant's credit profile and to evaluate whether an impaired credit history is
a result of previous adverse circumstances or a continuing inability or
unwillingness to meet credit obligations in a timely manner. Personal
circumstances including divorce, family illnesses or deaths and temporary job
loss due to layoffs and corporate downsizing will often impair an applicant's
credit record.
Upon completion of the underwriting and processing functions, the loan is
closed through a closing attorney or agent approved by the Company. The closing
attorney or agent is responsible for completing the loan transaction in
accordance with applicable law and the Company's operating procedures.
The Company requires title insurance coverage issued by an approved ALTA
title insurance company
14
of all property securing mortgage loans it originates or purchases. The Company
and its assignees are generally named as the insured. Title insurance policies
indicate the lien position of the mortgage loan and protect the Company against
loss if the title or lien position is not as indicated. The applicant is also
required to secure hazard and, in certain instances, flood insurance in an
amount sufficient to cover the building securing the loan for the entire term of
the loan, for an amount that is at least equal to the outstanding principal
balance of the loan or the maximum limit of coverage available under applicable
law, whichever is less. Evidence of adequate homeowner's insurance naming the
Company as an additional insured is required on all loans.
The Company has established classifications with respect to the credit
profiles of loans based on certain characteristics of the applicant. Each loan
applicant is placed into one of three letter ratings "A" through "C," with sub-
ratings within those categories. Ratings are based upon a number of factors
including the applicant's credit history, the value of the property and the
applicant's employment status. The Company also relies on the judgment of its
underwriting staff, which may make exceptions to the general criteria and
upgrade a rating due to factors considered appropriate to the underwriting
staff. Terms of loans made by the Company, as well as the maximum loan-to-value
ratio and debt service-to-income coverage (calculated by dividing fixed monthly
debt payments by gross monthly income), vary depending upon the classification
of the borrower. Borrowers with lower credit ratings generally pay higher rates
and loan origination fees.
Subject to the judgment of the Company's underwriting staff to make exceptions
to the general criteria, the general criteria currently used by the Company in
classifying loan applicants are set forth below:
"A" Risk. Under the "A" risk category, a loan applicant must have
generally repaid installment or revolving debt according to its terms.
. Existing mortgage loans: A maximum of two (case-by-case exceptions are
made provided the credit score is greater than 599) 30-day late
payment(s) within the last 12 months being acceptable.
. Non-mortgage credit: minor derogatory items are allowed, but a letter of
explanation is required.
. Bankruptcy filings: must have been discharged more than two years prior
to closing with credit re-established.
. Maximum loan-to-value ratio: up to 100% for attached and detached single
family residence, 90% for a loan secured by a two-to-four family
residence; and 85% for a loan secured by a non-owner occupied single
family residence and 80% on a loan secured by a two-to-four family
residence.
. Debt service-to-income ratio: 60% or less.
"B" Risk. Under the "B" risk category, a loan applicant must have
generally repaid installment or revolving debt according to its terms.
. Existing mortgage loans: Maximum of two (case-by-case exceptions are
allowed provided the credit score is greater than 550) 60-day late
payments within the last 12 months being acceptable.
. Non-mortgage credit: some prior defaults may have occurred, but major
credit paid or installment debt paid as agreed may offset some
delinquency; any open charge-offs, judgements or liens may be left open
at underwriters discretion.
. Bankruptcy filings: must have been discharged more than two years prior
to closing with credit re-established.
15
. Maximum loan-to-value ratio: up to 90% for attached and detached single
family residence, 90% for a loan secured by a two-to-four family
residence; and 70% for a loan secured by a non-owner occupied single
family residence and 70% on a loan secured by a two-to-four family
residence.
. Debt service-to-income ratio: 55% or less
"C" Risk. Under the "C" risk category, a loan applicant may have
experienced significant credit problems in the past.
. Existing mortgage loans: must be brought current from loan proceeds;
applicant is allowed up to 119 days late payment 12 months. Foreclosures
and Notices of Default are not allowed within the last 12 months.
. Non-mortgage credit: significant prior delinquencies may have occurred.
. Bankruptcy filings: must have been discharged.
. Maximum loan-to-value ratio: up to 80% for detached single family
residence, 70% for a loan secured by a two-to-four family residence;
non-owner occupied loans are not eligible.
. Debt service-to-income ratio: generally 50% or less.
The Company uses the foregoing categories and characteristics only as
guidelines. On a case-by-case basis, the underwriting staff may determine that
the prospective borrower warrants a risk category upgrade, a debt service-to-
income ratio exception, a pricing exception, a loan-to-value exception or an
exception from certain requirements of a particular risk category. An upgrade or
exception may generally be allowed if the application reflects certain
compensating factors, among others: low loan-to-value ratio; stable employment
or length of occupancy at the applicant's current residence. For example, a
higher debt ratio may be acceptable with a lower loan-to-value ratio. An upgrade
or exception may also be allowed if the applicant places a down payment in
escrow equal to at least 20% of the purchase price of the mortgaged property, or
if the new loan reduces the applicant's monthly aggregate debt load.
Accordingly, the Company may classify in a more favorable risk category certain
mortgage loans that, in the absence of such compensating factors, would satisfy
only the criteria of a less favorable risk category. The foregoing examples of
compensating factors are not exclusive. The underwriting staff has discretion to
make exceptions to the criteria and to upgrade ratings on case-by-case basis.
Conforming Conventional Mortgage Loans. Conforming Conventional mortgages
are investment quality loans meeting underwriting criteria as required by the
Federal National Mortgage Association (Fannie Mae), and Federal Home Loan
Mortgage Corporation (Freddie Mac). The Company's Conventional underwriting
guidelines adhere to general standards set forth by the ultimate investors for
these loans including but not limited to, Countrywide Mortgage, Fleet Financial,
Freddie Mac and Fannie Mae. The Company is an approved Fannie Mae and Freddie
Mac Seller/Servicer, and has delegated underwriting authority with most of our
investors.
The Company's underwriting analysis is accomplished with aid of Desktop
Underwriter (Fannie Mae) and Loan Prospector (Freddie Mac). Through the use of
these Automated Underwriting Systems (AUS) upon input of loan data a three
repository credit report is pulled and a response is received to either approve
the loan or to refer it to a human underwriter for further evaluation. It is the
underwriter's key responsibility to assess the accuracy of the information input
into the AUS and to determine if the value of the collateral is acceptable. The
majority of the Company offered Conventional Conforming programs encompass a
minimum credit score of 620. However, any cases that a credit score fall under
the "industry standard" of 620, we send the application
16
to the investor for approval.
In the event the loan has been referred to a human underwriter for
traditional underwriting, the AUS has recognized that significant layerings of
risk may be associated with the application. The Company's underwriters will
closely scrutinize the findings given by the AUS to determine if erroneous
information was reported by one or all of the credit agencies that may have
prohibited an acceptable rating. If credit has been determined to be acceptable
by the Company's underwriters by reviewing a credit explanation and/or other
supporting information, the loan application is sent to our investor for their
approval.
The Company has a vast array of Conventional Expanded Criteria and
Conventional Non-Conforming programs available, most of which are underwritten
through the investor specific Automated Underwriting Systems. These availability
of these programs varies from time to time and may include, but are not limited
to, "Jumbo" products, high LTV Rate/Term & Cash-out loans, stated income and/or
asset loans, high LTV investor and 2nd home properties, home equity lines of
credit (HELOC's) and closed end seconds.
The Company's Conforming loan division requires Private Mortgage Insurance
on all 1st Lien programs exceeding an 80% LTV. The insurance can be accomplished
by our direct delegated authority with several mortgage insurance companies, or
through various lender paid insurance options that may include pricing
adjustments.
Government Mortgage Loans. The Company offers FHA Title II first mortgage
loans, and will be soon offering FHA Title I subordinate lien mortgages, in many
areas of the country. The Company has FHA Direct Endorsement underwriters,
allowing all credit and collateral decisions to be made in-house. The Company
approves FHA loans which are of investment quality and which meet the
requirements of the Government National Mortgage Association (Ginnie Mae)
standards for sale on the secondary mortgage market. FHA Mortgage Insurance
endorsement is obtained directly by the Company through direct submission to HUD
Area Offices.
The underwriters approve loan applications in direct accordance to
established FHA written standards, but recognize that FHA loans require
extensive analysis. As per FHA's encouragement, the many aspects of a loan must
to be evaluated before making an underwriting decision. While a poor credit
history is, in and of itself, sufficient reason to reject a loan application, no
minimum credit score has been established and applicants with tarnished credit
histories are given the opportunity to explain any adverse credit and to present
supporting documentation that may establish that the situation was beyond their
control and may assist an applicant in successfully obtaining an FHA insured
mortgage. FHA establishes certain debt-to-income ratio requirements, however
these ratios may be exceeded if underwriting determines that certain FHA-
established compensating factors exist. Overall, each case tends to be unique
and the totality of the loan package must be evaluated before a credit decision
can be rendered.
FHA has approved the use of Fannie Mae's Desktop Underwriter (DU) and
Freddie Mac's Loan Prospector (LP) for evaluating loan applications. The Company
utilizes these AUS tools, but takes a firm stance on evaluating the totality of
each loan application not approved through an AUS. The Company offers owner-
occupied fixed and adjustable rate loans for purchase and for FHA streamline,
rate/term, and cash-out refinances. Non-owner occupied loans are limited to FHA
streamline refinances.
The Company offers first mortgage loans guaranteed by the Veterans
Administration (VA) in many regions of the country to qualified active
duty/retired/reservist military personnel. The Company employs "VA Automatic"
underwriters, allowing credit decisions for nearly all VA loan applications to
be made in-house. We have also obtained VA LAPP authority (Lenders Appraisal
Processing Program) which allows our underwriters to review VA appraisals
without prior endorsement from the VA. All loans are underwritten in strict
accordance to VA guidelines and all submissions for Loan Guaranty are performed
by the Company. The Company underwrites VA loans to ensure conformance to
Government National Mortgage Association (Ginnie Mae) standards in order to
facilitate the sale of loans in the secondary mortgage market.
17
Underwriting standards are similar to that of FHA. VA has approved DU and
LP for evaluating VA loan applications, and the Company follows the same
underwriting practices based on AUS findings as it does for FHA loans. The
Company offers owner-occupied fixed-rate VA purchase loans, Interest Rate
Reduction Refinancing Loans (IRRRL), and cash-out refinance loans. Non-owner
occupied loans are limited to VA IRRRL.
Mortgage Loan Servicing
The Company has been servicing its portfolio and warehouse loans for many
years. Since January 1, 1997, the Bank's portfolio of loans held for sale and
for investment has been serviced by the Company under a contractual arrangement.
The Company's loan servicing operation has two functions: collections and
customer service for borrowers. The servicing department monitors loans,
collects current payments due from borrowers. The collections specialists
furnish reports and enforce the holder's rights, including recovering delinquent
payments, instituting loan foreclosures and liquidating the underlying
collateral.
The Company closes loans throughout the month. Most of the Company's loans
require a first payment thirty to forty-five days after funding. Accordingly,
the Company's servicing portfolio consists of loans with payments due at varying
times each month.
The Company's collections policy is designed to identify payment problems
sufficiently early to permit the Company to address delinquency problems quickly
and, when necessary, to act to preserve equity before a property goes to
foreclosure. The Company believes that these policies, combined with the
experience level of independent appraisers engaged by the Company, help to
reduce the incidence of charge-offs on a first or second mortgage loan.
Collection procedures commence upon identification of a past due account by
the Company's automated servicing system. Five days before the first payment is
due on every loan, the borrower is contacted by telephone to welcome the
borrower, to remind the borrower of the payment date and to answer any questions
the borrower may have. If the first payment due is delinquent, a collector will
immediately telephone to remind the borrower of the payment. Five days after any
payment is due, a written notice of delinquency is sent to the borrower and
follow up calls are made. A second written notice is sent on the fifteenth day
after payment is due and follow up calls are continued to be made by the
collector. During the delinquency period, the collector will continue to
frequently contact the borrower. Company collectors have computer access to
telephone numbers, payment histories, loan information and all past collection
notes. All collection activity, including the date collection letters were sent
and detailed notes on the substance of each collection telephone call, is
entered into a permanent collection history for each account. Notice of the
Company's intent to start foreclosure proceedings is sent at thirty days past
due. Further guidance with respect to the collection and foreclosure process is
derived through frequent communication with the Company's senior management.
The Company's loan servicing software also tracks and maintains homeowners'
insurance information. Expiration reports are generated weekly listing all
policies scheduled to expire within 30 days. When policies lapse, a letter is
issued advising the borrower of the lapse and that the Company will obtain
force-placed insurance at the borrower's expense. The Company also has an
insurance policy in place that provides coverage automatically for the Company
in the event the Company fails to obtain force-placed insurance.
At the time the foreclosure process begins through the time of liquidation
of real estate owned ("REO") the account is transferred to the foreclosure and
REO department. There are occasions when foreclosures and charge-off occurs.
Prior to a foreclosure sale, the Company performs a foreclosure analysis with
respect to the mortgaged property to determine the value of the mortgaged
property and the bid that the Company will make at the foreclosure sale. This
analysis includes: (i) a current valuation of the property obtained through a
drive-by appraisal conducted by an independent appraiser; (ii) an estimate of
the sales price of the mortgaged property by sending two local realtors to
inspect the property; (iii) an evaluation of the amount owed, if any, to a
senior mortgagee and for real estate taxes; and (iv) an analysis of the
marketing time, required repairs and other costs,
18
such as for real estate broker and legal fees, that will be incurred in
connection with the foreclosure sale.
All foreclosures are assigned to outside counsel located in the same state
as the secured property. Bankruptcies filed by borrowers are also assigned to
appropriate local counsel who are required to provide monthly reports on each
loan file.
At the present time the Company does not service mortgage loans for other
investors. However, in future periods the Company may securitize loans and
retain the servicing component on those securities. In this event, the Company
would need to enhance its servicing capabilities. If the Company were to adopt
a securitization loan sale strategy, it may engage one or more companies to sub-
service a portion of it's the loans securitized.
Marketing
Marketing to Broker Networks. Marketing to brokers is conducted through the
Company's staff of account executives ("AE"), who establish and maintain
relationships with the Company's network of mortgage brokers that refer loans to
the Company. Loans made through the broker networks amounted to 32.4% of total
originations or $127 million in 1999, compared to 39% or $204 million of total
loan originations in 1998. (See the table on page 45 for divisional loan
originations by state.)
The AE's provide various levels of information, assistance and training to
the mortgage brokers regarding the Company's products and non-traditional
prospecting strategies, and are principally responsible for maintaining the
Company's relationships with its clients. AE's endeavor to increase the volume
of loan originations from brokers located within the geographic territory
assigned to them. The AE's and the national and regional broker AE sales
managers visit brokers offices and attend trade shows. The AE's also provide
feedback to the Company relating to the current marketplace relative to products
and pricing offered by competitors and new market entrants, all of which assist
the Company in refining its programs in order to offer competitive products.
The AE's are compensated with a base salary and commissions based on the volume
of loans that are originated as a result of their efforts. To augment the sales
efforts performed by the Account Executives in the field, management is
currently exploring an effective structure to facilitate inside telemarketing
solicitation of broker referral business from inside sales representatives in
the home office in Virginia Beach.
Marketing of Retail Lending Products. The Company markets its direct
consumer lending services through a sales staff of loan officers in its branch
offices located in several states. Loans made through the retail lending
division amounted to $263.9 million or 68% of total originations in 1999,
compared to $318.1 million or 61% of total loan originations in 1998. (See the
table on page 47 for divisional loan originations by state.)
During the first quarter of 1999, several small retail branch locations
were either consolidated or closed reducing the number of locations from 29 at
December 31, 1998 to 15 at March 30, 1999. Additional consolidation occurred
during 1999 resulting in eleven retail branches at December 31, 1999. The retail
lending division is now structured as highly focused super sales centers with a
larger average number of loan officers per branch than in recent years and with
more seasoned managers. While the total number of retail branches decreased by
62% from December 1998 to December 1999, the dollar of loans originated by the
retail division only decreased by 17%.
To generate customer leads for the retail loan officers, the Company uses
targeted outbound and in-bound telemarketing centralized in the Virginia Beach
headquarters. An automatic dialer telemarketing system is used for targeted lead
generation campaigns for each retail branch. This centralized system allows the
Company to efficiently purchase and use lists of potential leads and to maintain
the required "do not call" list of names. The campaigns are rotated to provide
the appropriate number of leads to each branch based on the number of loan
officers. The company's in-bound call center that receives inquiries from
various forms of advertising and marketing campaigns initiated from the home
office in the geographic locations surrounding retail branch locations provides
a solid source of leads to the sales staff. The more experienced telemarketing
agents are cross-trained to work both in-bound and out-bound calls which
provides for more flexibility with new campaigns and efficient use of the staff.
19
In the event that a potential retail customer's loan application does not
fall within the Company's underwriting guidelines, the underwriter may authorize
the application for submission to another lending institution. If the loan is
approved and funded, the Company acts in the capacity of a mortgage broker,
receiving fee income ("brokered loans"). Brokered loans are primarily non-
conforming mortgages that do not meet the Company's underwriting guidelines.
While less profitable, this type of retail loan production allows the Company to
accommodate loan customers during competitive periods while adhering to solid
underwriting standards. Brokered loans as a percent of total retail loan
origination decreased to approximately 40% in the fourth quarter of 1999 down
from and average of 63% for the nine months ended September 30, 1999. In October
of 1999, management instituted strict controls to ensure that only loans not
meeting the company's underwriting criteria are brokered to other lenders.
Company's Sources of Funds and Liquidity
At December 31, 1999, the Company had combined warehouse lines of credit of
$ 70.0 million with an outstanding balance of $17.5 million. Additionally, the
Company had subordinated debt outstanding of $5.1 million, FDIC insured
certificates of deposit outstanding of $55.3 million and consolidated
stockholder's equity of $11.3 million.
One of the Company's warehouse facilities for $15.0 million will expire on
June 7, 2000 and will not be renewed. The remaining $55.0 million in warehouse
financing consists of a facility for $40.0 million that will expire on November
10, 2001 and a $15.0 million line of credit available to the Bank from the
Federal Home Loan Bank. The Company may seek additional warehouse financing as
the need becomes available. However, if the current facilities become fully
utilized, there can be no assurance that additional financing will be obtainable
on favorable terms. Any failure to renew or obtain adequate funding under
warehouse facilities or other financing, or any substantial reduction in the
size of or pricing in the markets for the Company's loans, could have a material
adverse effect on the Company's operations. (See page 63 for further
discussion).
Bank Sources of Funds
Certificates of Deposits. The Bank had $55.3 million FDIC insured
certificates of deposits outstanding at December 31, 1999.
The primary source of deposits for the Bank has been brokered certificates
of deposit obtained through national investment banking firms, which, pursuant
to agreements with the Bank, solicit funds from their customers for deposit with
the Bank ("brokered deposits"). Such deposits amounted to $25.0 million, or
45.21%, of the Bank's deposits at December 31, 1999. The Bank solicits deposits
via a computer bulletin board where the rates of many other banks and
institutions are advertised. At December 31, 1999, the Bank had deposits from
this source of $30.0 million, or 54.79%, of total deposits. The fees paid to
deposit brokers are amortized using the interest method and included in interest
expense on certificates of deposit.
The Bank's management believes that the effective cost of brokered and
other wholesale deposits is more attractive than deposits obtained on a retail
basis from branch offices after the general and administrative expense
associated with the maintenance of branch offices is taken into account.
Moreover, brokered and other wholesale deposits generally give the Bank more
flexibility than retail sources of funds in structuring the maturities of its
deposits and in matching liabilities with comparable maturing assets. At
December 31, 1999, $44.9 million of the Bank's certificates of deposit were
scheduled to mature within one year (81.2% of total deposits).
Although management of the Bank believes that brokered and other wholesale
deposits are advantageous in certain respects, such funding sources, when
compared to retail deposits attracted through a branch network, are generally
more sensitive to changes in interest rates and volatility in the capital
markets and are more likely to be compared by the investor to competing
instruments. In addition, such funding sources may be more sensitive to
significant changes in the financial condition of the Bank. There are also
various regulatory limitations
20
on the ability of all but well-capitalized insured financial institutions to
obtain brokered deposits; see "Regulation of the Bank - Brokered Deposits."
These limitations currently are not applicable because the Bank is a well-
capitalized financial institution under applicable laws and regulations. There
can be no assurances, however, that the Bank will not become subject to such
limitations in the future. In addition, the Company's reliance on wholesale
deposits effects its ability to rollover deposits as they mature due to the fact
that in general the wholesale customer is highly interest rate-sensitive.
However, management is of the opinion that it will be able to readily obtain
funding from the wholesale deposit market in future periods at the then current
competitive interest rates being offered by other institutions.
As a result of the Bank's reliance on brokered and other wholesale
deposits, significant changes in the prevailing interest rate environment, in
the availability of alternative investments for individual and institutional
investors or in the Bank's financial condition, among other factors, could
affect the Bank's liquidity and results of operations much more significantly
than might be the case with an institution that obtained a greater portion of
its funds from retail or core deposits attracted through a branch network. (See
page 20 of the audited financial statements for a table that sets forth various
interest rate categories for the certificates of deposit of the Bank.)
Borrowings. The Bank is able to obtain advances from the FHLB of Atlanta
upon the security of certain of its residential first mortgage loans, and other
assets, including FHLB stock, provided certain standards related to the
creditworthiness of the Bank have been met. FHLB advances are available to
member institutions such as the Bank for investment and lending activities and
other general business purposes. FHLB advances are made pursuant to several
different credit programs, each of which has its own interest rate, which may be
fixed or adjustable, and which has its own range of maturities. FHLB members are
required to hold shares of the capital stock of the regional FHLB in which they
are a member in an amount at least equal to the greater of 1% of the member's
home mortgage loans or 5% of the member's advances from the FHLB.
At December 31, 1999 the Bank had a line of credit with the FHLB of $15
million. During the year ended December 31, 1999, the Bank had advances of $13.0
million from the FHLB and paid down principal on advances of $8.4 million. For
the year ended December 31, 1998, the Bank had advances of $1.0 million and paid
down principal on advances of $2.0 million. The Bank held $407,000 and $146,000
of the FHLB stock at December 31, 1999 and December 31, 1998, respectively.
Management expects to utilize FHLB advances as the Bank builds a portfolio of
loans.
Taxation
General. The Company and all of its subsidiaries currently file, and expect
to continue to file, a consolidated federal income tax return based on a
calendar year. Consolidated returns have the effect of eliminating inter-company
transactions, including dividends, from the computation of taxable income.
The Company's income is subject to tax in most of the states in which it is
making loans. The Company's taxable income in most states is determined based on
certain apportionment factors.
Alternative Minimum Tax. In addition to the regular corporate income tax,
corporations, including qualifying institutions, can be subject to an
alternative minimum tax. The 20% tax is computed on Alternative Minimum Taxable
Income ("AMTI") and applies if it exceeds the regular tax liability. AMTI is
equal to regular taxable income with certain adjustments. For taxable years
beginning after 1989, AMTI includes an adjustment for 75% of the excess of
"adjusted current earnings" over regular taxable income. Net operating loss
carrybacks and carryforwards are permitted to offset only 90% of AMTI.
Alternative minimum tax paid can be credited against regular tax due in later
years. The Company is not currently subject to the AMT.
Employees
As of December 31, 1999, the Company and its subsidiaries had a total of
295 full-time employees and
21
13 part-time employees or 301.5 full time equivalent employees. None of the
Company's employees were covered by a collective bargaining agreement. The
Company considers its relations with its employees to be good.
Service Marks
The Company has four service marks that have become federally registered.
They are "Armada" which became registered on July 23, 1996, "Approved
Residential Mortgage" which became registered on May 15, 1995, "Approved
Financial Corp." which became registered July 21, 1998 and "ConsumerOne
Financial" which became registered on December 18, 1998. "Approved Federal
Savings Bank" and "Approved Financial Solutions" are additional service marks
currently pending registration.
Effect of Adverse Economic Conditions
The Company's business may be adversely affected by periods of economic
slowdown or recession, which may be accompanied by decreased demand for consumer
credit and declining real estate values. Any material decline in real estate
values reduces the ability of borrowers to use home equity to support borrowings
and increases the loan-to-value ratios of loans previously made by the Company,
thereby weakening collateral coverage and increasing the possibility of a loss
in the event of default. In addition, delinquencies, foreclosures and losses
generally increase during economic slowdowns or recessions.
Concentration of Operations in Eight States
During 1999, 90.3% of the aggregate principal balance of the loans
originated by the Company were secured by properties located in eight states
(Florida, Georgia, South Carolina, North Carolina, Virginia, Maryland, Michigan,
and Ohio). Although the Company has expanded its wholesale and retail mortgage
origination networks outside this region, the Company's origination business is
likely to remain concentrated in those states for the foreseeable future.
Consequently, the Company's results of operations and financial condition are
dependent upon general trends in the economy and the residential real estate
markets in those states.
Future Risks Associated with Loan Sales through Securitizations
In future periods, the Company may sell a portion of the loans it
originates through a securitization program and retain the rights to service the
loans. The sale of loans through a securitization program would be a significant
departure from the Company's previous business operations. While management has
explored securitization as a possible alternative loan sale strategy, no
affirmative decision or specific time frame for such a program has been
established.
Adverse changes in the securitization market could impair the Company's
ability to originate and sell loans through securitization on a favorable or
timely basis. Any such impairment could have a material adverse effect upon the
Company's results of operations and financial condition. Furthermore, the
Company's quarterly operating results in future periods may fluctuate
significantly as a result of the timing and level of securitizations. If
securitizations do not close when expected, the Company's results of operations
may be adversely affected for that period. Whether or not the Company adopts
this loan sale strategy in the future, adverse changes in the securitization
market could impair the Company's ability to originate and sell loans to other
financial institutions that utilize the securitization market.
Contingent Risks
In the ordinary course of its business, the Company is subject to claims
made against it by borrowers and
22
private investors arising from, among other things, losses that are claimed to
have been incurred as a result of alleged breaches of fiduciary obligations,
misrepresentations, errors and omissions of employees, officers, and agents of
the Company (including its appraisers), incomplete documentation and failures by
the Company to comply with various laws and regulations applicable to its
business. Management is not aware of any material claims.
Although the Company sells substantially all loans that it originates and
purchases on a non-recourse basis, during the period of time that loans are held
pending sale, the Company is subject to the various business risks associated
with lending, including the risk of borrower default, loan foreclosure and loss,
and the risk that an increase in interest rates or a change in secondary market
conditions for any reason would result in a decline in the value of loans in the
secondary market.
Competition
The Company faces intense competition from other mortgage banking
companies, banks, credit unions, thrift institutions, credit card issuers,
finance companies and other financial institution. Many of these competitors in
the financial services business are substantially larger and have more capital
and financial resources than the Company. Also, the larger national finance
companies, banks, quasi-governmental agencies and other originators of
conforming mortgage loans have been adapting their conforming origination
programs to expand into the non-conforming loan business and are targeting the
Company's prime customer base. There can be no assurance that the Company will
not face increased competition from such institutions.
Competition can take on many forms, including convenience in obtaining a
loan, service, loan pricing terms such as the loan to value ratio and interest
rate, marketing and distribution channels and competition for employees through
compensation plans and benefit packages.
The quantity and quality of competition for the Company may also be
affected by fluctuations in interest rates and general economic conditions.
During periods of rising rates, competitors which have "locked in" low borrowing
costs may have a competitive advantage. During periods of declining interest
rates, competitors may solicit the Company's borrowers to refinance their
mortgage loans. During an economic slowdown or recession, the Company's
borrowers may have new financial difficulties and may be receptive to offers by
the Company's competitors.
The Company uses mortgage brokers as a source of origination of new loans.
The Company's competitors also seek to establish relationships with the brokers
with which the Company does business. The Company's future results may become
more exposed to fluctuations in the volume and costs of its wholesale loans
(loans sourced from mortgage brokers) resulting from competition from other
originators of such loans, market conditions and other factors.
Regulation
The Company's business is subject to extensive regulation, supervision and
licensing by federal, state and local government authorities and is subject to
various laws and judicial and administrative decisions imposing requirements and
restrictions on part or all of its operations. Regulated matters include loan
origination, credit activities, maximum interest rates and finance and other
charges, disclosure to customers, the terms of secured transactions, the
collection, repossession and claims-handling procedures utilized by the Company,
multiple qualification and licensing requirements for doing business in various
jurisdictions and other trade practices. The following discussion and other
references to and descriptions of the regulation of financial institutions
contained in this document constitute brief summaries of the regulations as
currently in effect. This discussion is not intended to constitute a complete
statement of all the legal restrictions and requirements applicable to the
Company and the Bank and all such descriptions are qualified in their entirety
by reference to applicable statutes, regulations and other regulatory
pronouncements.
The Company's consumer lending activities are subject to the federal Truth-
in-Lending Act ("TILA")
23
and Regulation Z (including the Home Ownership and Equity Protection Act of
1994); the federal Equal Credit Opportunity Act and Regulation B, as amended
(the "ECOA"); the Home Mortgage Disclosure Act and the Fair Credit Reporting Act
of 1970, as amended ("FCRA"); the federal Real Estate Settlement Procedures Act
("RESPA") and Regulation X; the federal Home Mortgage Disclosure Act; and the
federal Fair Debt Collection Practices Act. The Company is also subject to state
statutes and regulations affecting its activities.
TILA and Regulation Z promulgated thereunder contain disclosure
requirements designed to provide consumers with uniform, understandable
information with respect to the terms and conditions of loans and credit
transactions in order to give them the ability to compare credit terms. TILA
also guarantees consumers a three-day right to cancel certain credit
transactions including loans of the type originated by the Company. Management
of the Company believes that it is in compliance with TILA in all material
respects.
In September 1994, the Riegle Community Development and Regulatory
Improvement Act of 1994 (the "Riegle Act") was enacted. Among other things, the
Riegle Act made certain amendments to TILA. The TILA Amendments, which became
effective in October 1995, generally apply to mortgage loans with (i) total
points and fees upon origination in excess of the greater of eight percent of
the loan amount or $424 or (ii) an annual percentage rate of more than ten
percentage points higher than comparable maturing U.S. Treasury securities.
Loans covered by the TILA Amendments are known as "Section 32 Loans."
The TILA Amendments impose additional disclosure requirements on lenders
originating Section 32 Loans and prohibit lenders from originating Section 32
Loans that are underwritten solely on the basis of the borrower's home equity
without regard to the borrower's ability to repay the loan. In accordance with
TILA Amendments, the Company applies underwriting criteria that take into
consideration the borrower's ability to repay all Section 32 Loans.
The TILA Amendments also prohibit lenders from including prepayment fee
clauses in Section 32 loans to borrowers with a debt-to-income ratio in excess
of 50%. In addition, a lender that refinances a Section 32 Loan previously made
by such lender will not be able to enforce any prepayment penalty clause
contained in such refinanced loan. The Company will continue to collect
prepayment fees on loans originated prior to the effectiveness of the TILA
Amendments and on non-Section 32 Loans as well as on Section 32 Loans in
permitted circumstances following the effectiveness of the TILA Amendments. The
TILA Amendments impose other restrictions on Section 32 Loans, including
restrictions on balloon payments and negative amortization features, which the
Company believes will not have a material impact on its operations.
The Company is also required to comply with the ECOA, which prohibits
creditors from discriminating against applicants on the basis of race, color,
sex, age or marital status. Regulation B promulgated under ECOA restricts
creditors from obtaining certain types of information from loan applicants. It
also requires certain disclosures by the lender regarding consumer rights and
requires lenders to advise applicants of the reasons for any credit denial. In
instances where the applicant is denied credit or the rate or charge for a loan
increase as a result of information obtained from a consumer credit agency,
another statute, the FCRA requires the lender to supply the applicant with a
name and address of the reporting agency. The Company is also subject to the
Real Estate Settlement Procedures Act and is required to file an annual report
with the Department of Housing and Urban Development pursuant to the Home
Mortgage Disclosure Act.
The Company is also subject to the rules and regulations of, and
examinations by, the U.S. Department of Housing and Urban Development and state
regulatory authorities with respect to originating, processing, underwriting,
selling and servicing loans. These rules and regulations, among other things,
impose licensing obligations on the Company, establish eligibility criteria for
mortgage loans, prohibit discrimination, provide for inspections and appraisals
of properties, require credit reports on loan applicants, regulate assessment,
collection, foreclosure and claims handling, investment and interest payments on
escrow balances and payment features, and mandate certain loan amounts.
Failure to comply with these requirements can lead to loss of approved
status, termination or suspension of servicing contracts without compensation to
the servicer, demands for indemnification or mortgage loan repurchases, certain
rights of rescission for mortgage loans, class action lawsuits and
administrative enforcement actions. There can be no assurance that the Company
will maintain compliance with these requirements in the
24
future without additional expenses, or that more restrictive federal, state or
local laws, rules and regulations will not be adopted that would make compliance
more difficult for the Company. Management believes that the Company is in
compliance in all material respects with applicable federal and state laws and
regulations.
The Company is also subject to various other federal and state laws
regulating the issuance and sale of securities, relationships with entities
regulated by the Employee Retirement Income Security Act of 1974, as amended,
and other aspects of its business.
The laws, rules and regulations applicable to the Company are subject to
regular modification and change. There are currently proposed various laws,
rules and regulations, which, if adopted, could impact the Company. There can be
no assurance that these proposed laws, rules and regulations, or other such
laws, rules or regulations, will not be adopted in the future which could make
compliance much more difficult or expensive, restrict the Company's ability to
originate, purchase, broker or sell loans, further limit or restrict the amount
of commissions, interest and other charges earned on loans originated or sold by
the Company, or otherwise adversely affect the business or prospects of the
Company.
OTS Regulation of the Company
General. The Company is a registered and loan holding company under the
federal Home Owner's Loan Act ("HOLA") because of its ownership of the Bank. As
such, the Company is subject to the regulation, supervision and examination of
the OTS.
Activities Restriction. There are generally no restrictions on the
activities of a loan holding company, such as the Company, which holds only one
subsidiary institution. However, if the Director of the OTS determines that
there is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary institution, the Director may
impose such restrictions as deemed necessary to address such risk, including the
limitation of: (i) payment of dividends by the institution; (ii) transactions
between the institution and its affiliates; and (iii) any activities of the
institution that might create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the institution. Notwithstanding
the above rules as to the permissible business activities of unitary and loan
holding companies, if the institution subsidiary of such a holding company fails
to meet a qualified thrift lender ("QTL") test set forth in OTS regulations,
then such unitary holding company shall become subject to the activities and
regulations applicable to multiple and loan holding companies and, unless the
institution qualifies as a QTL within one year thereafter, shall register as,
and become subject to the restriction applicable to, a bank holding company. See
"Regulation of the Bank - Qualified Thrift Lender Test."
If the Company were to acquire control of another institution other than
through merger or other business combination with the Bank, the Company would
become a multiple and loan holding company. Except where such acquisition is
pursuant to the authority to approve emergency thrift acquisition and where each
subsidiary institution meets the QTL test, as set forth below, the activities of
the Company and any of its subsidiaries (other than the Bank or other subsidiary
institutions) would thereafter be subject to further restrictions. Among other
things, no multiple and loan holding company or subsidiary thereof which is not
a institution generally shall commence or continue for a limited period of time
after becoming a multiple and loan holding company or subsidiary thereof any
business activity, other than: (i) furnishing or performing management services
for a subsidiary institution; (ii) conducting an insurance agency or escrow
business; (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary institution; (iv) holding or managing properties used or
occupied by a subsidiary institution; (v) acting as trustee under deeds of
trust; (vi) those activities authorized by regulation as of March 5, 1987 to be
engaged in by multiple and loan holding companies; or (vii) unless the Director
of the OTS by regulation prohibits or limits such activities for and loan
holding companies, those activities authorized by the Federal Reserve Board as
permissible for bank holding companies. Those activities described in clause
(vii) above also must be approved by the Directors of the OTS prior to being
engaged in by
25
a multiple and loan holding company.
Restrictions on Acquisitions. Except under limited circumstances, and loan
holding companies such as the Company are prohibited from acquiring, without
prior approval of the Director of the OTS, (i) control of any other institution
or and loan holding company or substantially all the assets thereof or (ii) more
than 5% of the voting shares of a institution or holding company thereof which
is not a subsidiary. Except with the proper approval of the Director of the OTS,
no director or officer of a and loan holding company or person owning or
controlling by proxy or otherwise more than 25% of such company's stock, may
acquire control of any institution, other than a subsidiary institution, or of
any other and loan holding company.
The Director of the OTS may approve acquisitions resulting in the formation
of a multiple and loan holding company which controls institutions in more than
one state only if (i) the multiple and loan holding company involved controls an
institution which operated a home or branch office located in the state of the
institution to be acquired as of March 5, 1987; (ii) the acquirer is authorized
to acquire control of the institution pursuant to the emergency acquisition
provision of the Federal Deposit Insurance Act ("FDIA"); or (iii) the statutes
of the state in which the institution to be acquired is located specifically
permit institutions to be acquired by state-chartered institutions located in
the state where the acquiring entity is located (or by a holding company that
controls such state-chartered institutions).
Restrictions on Transactions with Affiliates. Transactions between the
Company or any of its non-bank subsidiaries and the Bank are subject to various
restrictions, which are described under "Regulation of the Bank-Affiliate
Transactions."
Regulation of the Bank
General. The Bank is a federally chartered bank organized under the HOLA.
As such, the Bank is subject to regulation, supervision and examination by the
OTS. The deposit accounts of the Bank are insured up to applicable limits by the
SAIF administered by the FDIC and, as a result, the Bank also is subject to
regulation, supervision and examination by the FDIC. The Bank is also subject to
the regulations of the Board of Governors of the Federal Reserve System
governing reserves required to be maintained against deposits. The Bank is a
member of the FHLB of Atlanta.
The business and affairs of the Bank are regulated in a variety of ways.
Regulations apply to, among other things, insurance of deposit accounts, capital
ratios, payment of dividends, liquidity requirements, the nature and amount of
the investments that the Bank may make, transactions with affiliates, community
and consumer lending laws, internal policies and controls, reporting by and
examination of the Bank and changes in control of the Bank.
Insurance of Accounts. Deposit accounts of the Bank up to $100,000 are
insured by the Association Insurance Fund (the "SAIF"), administered by the
FDIC. Pursuant to legislation enacted in September 1996, a fee was paid by all
SAIF insured institutions at the rate of $0.657 per $100 of deposits held by
such institutions at March 31, 1995. The money collected capitalized the SAIF
reserve to the level of 1.25% of insured deposits as required by law. In 1996,
the Bank paid $23,000 for this assessment.
This legislation also provided for the merger, subject to certain
conditions, of the SAIF into the Bank Insurance Fund ("BIF") by 1999. The
BIF/SAIF legislation provided for a merger of BIF and SAIF on January 1, 1999,
but only if no insured institution was an association. Associations would have
had to change charters in order to achieve a merger of the two insurance funds.
This provision has now expired. Though the statutory date for a funds merger has
passed, the Congress could, at any time, without condition, permit FDIC to merge
the funds.
The legislation also required BIF-insured institutions to share in the
payment of interest on the bonds
26
issued by a specially created government entity ("FICO"), the proceeds of which
were applied toward resolution of the thrift industry crisis in the 1980s.
Beginning on January 1, 1997, in addition to the insurance premium that is paid
by SAIF-insured institutions to maintain the SAIF reserve at its required level
pursuant to the current risk classification system, SAIF-insured institutions
paid deposit insurance premiums at the annual rate of 6.4 basis points of their
insured deposits and BIF-insured institutions paid deposit insurance premiums at
the annual rate of 1.3 basis points of their insured deposits towards the
payment of interest on the FICO bonds. Assessments paid for the period starting
January 1, 2000 will be assessed the same FICO rate for both BIF and SAIF
insured deposits. The new rate paid by the Bank and a BIF insured institution
with the same risk classification is 2.12 basis points. Under the current risk
classification system, institutions are assigned on one of three capital groups
which are based solely on the level of an institution's capital - "well
capitalized," "adequately capitalized" and "undercapitalized" -which are defined
in the same manner as the regulations establishing the prompt corrective action
system under Section 38 of the FDIA, as discussed below. These three groups are
then divided into three subgroups, which are based on supervisory evaluations by
the institution's primary federal regulator, resulting in nine assessment
classifications. Assessment rates currently range from zero basis points for
well capitalized, healthy institutions to 27 basis points for undercapitalized
institutions with substantial supervisory concerns.
The re-capitalization of the SAIF is expected to result in lower deposit
insurance premiums in the future for most SAIF-insured financial institutions,
including the Bank.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances, which would result
in termination of the Bank's deposit insurance.
Regulatory Capital Requirements. Federally insured savings associations are
required to maintain minimum levels of regulatory capital. These standards
generally must be as stringent as the comparable capital requirements imposed on
national banks. The OTS also is authorized to impose capital requirements in
excess of these standards on individual associations on a case-by-case basis. At
December 31, 1999, the Bank's regulatory capital exceeded applicable
requirements for categorization as "well-capitalized."
Federally-insured savings associations are subject to three capital
requirements: a tangible capital requirement, a core or leverage capital
requirement and a risk-based capital requirement. All savings associations
currently are required to maintain tangible capital of at least 1.5% of adjusted
total assets (as defined in the regulations), core capital equal to 3% of
adjusted total assets and total capital (a combination of core and supplementary
capital) equal to 8% of risk-weighted assets (as defined in the regulations).In
January of 2000, media reports indicated that FDIC is considering raising
capital requirements for lenders specializing in subprime consumer loans. A
final proposal from the FDIC was reported to be expected at the end of the year
2000 and must be endorsed by the Federal Reserve, the US Treasury's Office of
Comptroller of the Currency and the OTS.
For purposes of the regulation, tangible capital is core capital less all
intangibles other than qualifying purchased mortgage-servicing rights, of which
the Bank had none at December 31, 1999. Core capital includes common
stockholders' equity, non-cumulative perpetual preferred stock and related
surplus, minority interest in the equity accounts of fully consolidated
subsidiaries and certain nonwithdrawable accounts and pledged deposits. Core
capital generally is reduced by the amount of a savings association's intangible
assets, other than qualifying mortgage-servicing rights.
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital included does not exceed the savings association's core capital.
Supplementary capital consists of certain
27
capital instruments that do not qualify as core capital, including subordinated
debt which meets specified requirements, and general valuation loan and lease
loss allowances up to a maximum of 1.25% of risk-weighted assets. In determining
the required amount of risk-based capital, total assets, including certain off-
balance sheet items, are multiplied by a risk weight based on the risks inherent
in the type of assets. The risk weights assigned by the OTS for principal
categories of assets currently range from 0% to 100%, depending on the type of
asset.
OTS policy imposes a limitation on the amount of net deferred tax assets
under SFAS No. 109 that may be included in regulatory capital. (Net deferred tax
assets represent deferred tax assets, reduced by any valuation allowances, in
excess of deferred tax liabilities.) Application of the limit depends on the
possible sources of taxable income available to an institution to realize
deferred tax assets. Deferred tax assets that can be realized from the following
are generally not limited: taxes paid in prior carryback years and future
reversals of existing taxable temporary differences. To the extent that the
realization of deferred tax assets depends on an institution's future taxable
income (exclusive of reversing temporary differences and carryforwards), or its
tax-planning strategies, such deferred tax assets are limited for regulatory
capital purposes to the lesser of the amount that can be realized within one
year of the quarter-end report date or 10% of core capital. The foregoing
considerations did not affect the calculation of the Bank's regulatory capital
at December 31, 1999.
In August 1993, the OTS adopted a final rule incorporating an interest-rate
risk component into the risk-based capital regulation. Under the rule, an
institution with a greater than "normal" level of interest rate risk will be
subject to a deduction of its inherent rate risk component from total capital
for purposes of calculating the risk-based capital requirement. As a result,
such an institution will be required to maintain additional capital in order to
comply with the risk-based capital requirement. Although the final rule was
originally scheduled to be effective as of January 1994, the OTS has indicated
that it will delay invoking its interest rate risk rule requiring institutions
with above normal interest rate risk exposure to adjust their regulatory capital
requirement until appeal procedures are implemented and evaluated. The OTS has
not yet established an effective date for the capital deduction. Management of
the Company does not believe that the OTS' adoption of an interest rate risk
component to the risk-based capital requirement will adversely affect the Bank
if it becomes effective in its current form.
In April 1991, the OTS proposed to modify the 3% of adjusted total assets
core capital requirement in the same manner as was done by the Comptroller of
the Currency for national banks. Under the OTS proposal, only associations rated
composite 1 under the CAMEL rating system will be permitted to operate at the
regulatory minimum core capital ratio of 3%. For all other associations, the
minimum core capital ratio will be 3% plus at least an additional 100 to 200
basis points, which will increase the 4% core capital ratio requirement to 5% of
adjusted total assets or more. In determining the amount of additional capital,
the OTS will assess both the quality of risk management systems and the level of
overall risk in each individual association through the supervisory process on a
case-by-case basis.
Prompt Corrective Action. Federal law provides the federal banking
regulators with broad power to take "prompt corrective action" to resolve the
problems of undercapitalized institutions. The extent of the regulators' powers
depends on whether the institution in question is "well capitalized,"
"adequately capitalized," "under-capitalized," "significantly undercapitalized"
or "critically undercapitalized." Under regulations adopted by the federal
banking regulators, an institution shall be deemed to be (i) "well capitalized"
if it has a total risk-based capital ratio of 10.0% or more, has a Tier I risk-
based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0%
or more and is not subject to specified requirements to meet and maintain a
specific capital level for any capital measure; (ii) "adequately capitalized" if
it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based
capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or
more (3.0% under certain circumstances) and does not meet the definition of
"well capitalized," (iii) "undercapitalized" if it has a total risk-based
capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is
less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0%
under certain circumstances), (iv) "significantly undercapitalized" if it has a
total risk-based capital ratio that is less than 6.0%, a Tier I risk-based
capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is
less than 3.0%, and (v) "critically undercapitalized"
28
if it has a ratio of tangible equity to adjusted total assets that is equal to
or less than 2.0%. The regulations also permit the appropriate federal banking
regulator to downgrade an institution to the next lower category (provided that
a significantly undercapitalized institution may not be downgraded to critically
undercapitalized) if the regulator determines (i) after notice and opportunity
for hearing or response, that the institution is an unsafe or unsound condition
or (ii) that the institution has received (and not corrected) a less-than-
satisfactory rating for any of the categories of asset quality, management,
earnings or liquidity in its most recent exam. At December 31, 1999, the Bank
was a "well capitalized" institution, as defined under the prompt corrective
action regulations of the OTS.
Depending upon the capital category to which an institution is assigned,
the regulators' corrective powers, many of which are mandatory in certain
circumstances, include prohibition on capital distributions; prohibition on
payment of management fees to controlling persons; requiring the submission of a
capital restoration plan; placing limits on asset growth; limiting acquisitions,
branching or new lines of business; requiring the institution to issue
additional capital stock (including additional voting stock) or to be acquired;
restricting transactions with affiliates; restricting the interest rates that
the institution may pay on deposits; ordering a new election of directors of the
institution; requiring that senior executive officers or directors be dismissed;
prohibiting the institution from accepting deposits from correspondent banks;
requiring the institution to divest certain subsidiaries; prohibiting the
payment of principal or interest on subordinated debt; and, ultimately,
appointing a receiver for the institution.
Qualified Thrift Lender Test. All associations are required to meet the QTL
test set forth in the HOLA and regulations to avoid certain restrictions on
their operations. A association that does not meet the QTL test set forth in the
HOLA and implementing regulations must either convert to a bank charter or
comply with the following restrictions on its operations: (i) the association
may not engage in any new activity or make any new investment, directly or
indirectly, unless such activity or investment is permissible for a national
bank; (ii) the branching powers of the association shall be restricted to those
of a national bank; (iii) the association shall not be eligible to obtain any
advances from its FHLB; and (iv) payment of dividends by the association shall
be subject to the rules regarding payment of dividends by a national bank. Upon
the expiration of three years from the date the association ceases to be a QTL,
it must cease any activity and not retain any investment not permissible for a
national bank and immediately repay any outstanding FHLB advances (subject to
safety and soundness considerations). The Bank met the QTL test throughout 1999.
Restrictions on Capital Distributions. The OTS has promulgated a regulation
governing capital distributions by associations, which include cash dividends,
stock redemption's or repurchases, cash-out mergers, interest payments on
certain convertible debt and other transactions charged to the capital account
of a association as a capital distribution. Generally, the regulation creates
three tiers of associations based on regulatory capital, with the top two tiers
providing a safe harbor for specified levels of capital distributions from
associations so long as such associations notify the OTS and receive no
objection to the distribution from the OTS. Associations that do not qualify for
the safe harbor provided for the top two tiers of associations are required to
obtain prior OTS approval before making any capital distributions.
Tier 1 associations may make the highest amount of capital distributions,
and are defined as associations that before and after the proposed distribution
meet or exceed their fully phased-in regulatory capital requirements. Tier 1
associations may make capital distributions during any calendar year equal to
the greater of (i) 100% of net income for the calendar year-to-date plus 50% of
its "surplus capital ratio" at the beginning of the calendar year and (ii) 75%
of its net income over the most recent four-quarter period. The "surplus capital
ratio" is defined to mean the percentage by which the association's ratio of
total capital to assets exceeds the ratio of its "fully phased-in capital
requirement" to assets, and "fully phased-in capital requirement" is defined to
mean an association's capital requirement under the statutory and regulatory
standards applicable on December 31, 1994, as modified to reflect any applicable
individual minimum capital requirement imposed upon the association. At December
31, 1999, the Bank was a Tier 1 association under the OTS capital distribution
29
regulation.
In December 1994, the OTS published a notice of proposed rulemaking to
amend its capital distribution regulation. Under the proposal, the three tiered
approach contained in existing regulations would be replaced and institutions
would be permitted to make capital distributions that would not result in their
capital being reduced below the level required to remain "adequately
capitalized," as defined above under "Prompt Corrective Action."
On April 1, 1999 the OTS has adopted regulations changing the notification
requirements on capital distributions. The updated regulation provides that an
OTS-regulated institution will not have to file a capital distribution notice
with the OTS upon meeting certain conditions. These conditions include that the
institution has a composite 1 or 2 CAMELS rating; a compliance rating of 1 or 2;
a Community Reinvestment Act rating of at least "satisfactory"; is not otherwise
in troubled condition; limits capital distribution plans for the calendar year
to no more than the sum of it's current retained net income and the preceding
two years; remains well-capitalized after the capital distribution; and will not
use the proposed capital distribution to reduce or retire stock or debt
instruments. An institution that fails to meet any of the required conditions
must submit a full application to the OTS.
Loan-to-One Borrower. Under applicable laws and regulations the amount of
loans and extensions of credit which may be extended by an institution such as
the Bank to any one borrower, including related entities, generally may not
exceed the greater of $500,000 or 15% of the unimpaired capital and unimpaired
surplus of the institution. Loans in an amount equal to an additional 10% of
unimpaired capital and unimpaired surplus also may be made to a borrower if the
loans are fully secured by readily available marketable securities. An
institution's "unimpaired capital and unimpaired surplus" includes, among other
things, the amount of its core capital and supplementary capital included in its
total capital under OTS regulations.
At December 31, 1999, the Bank's unimpaired capital and surplus amounted to
$6,606,000, resulting in a general loans-to-one borrower limitation of $991,000
under applicable laws and regulations.
Brokered Deposits. Under applicable laws and regulations, an insured
depository institution may be restricted in obtaining, directly or indirectly,
funds by or through any "deposit broker," as defined, for deposit into one or
more deposit accounts at the institution. The term "deposit broker" generally
includes any person engaged in the business of placing deposits, or facilitating
the placement of deposits, of third parties with insured depository institutions
or the business of placing deposits with insured depository institutions for the
purpose of selling interest in those deposits to third parties. In addition, the
term "deposit broker" includes any insured depository institution, and any
employee of any insured depository institution, which engages, directly or
indirectly, in the solicitation of deposits by offering rates of interest (with
respect to such deposits) which are significantly higher than the prevailing
rates of interest on deposits offered by other insured depository institutions
have the same type of charter in such depository institution's normal market
area. As a result of the definition of "deposit broker," all of the Bank's
brokered deposits, as well as possibly its deposits obtained through customers
of regional and local investment banking firms and the deposits obtained from
the Bank's direct solicitation efforts of institutional investors and high net
worth individuals, are potentially subject to the restrictions described below.
Under FDIC regulations, well-capitalized institutions are subject to no brokered
deposit limitations, while adequately-capitalized institutions are able to
accept, renew or roll over brokered deposits only (i) with a waiver from the
FDIC and (ii) subject to the limitation that they do not pay an effective yield
on any such deposit which exceeds by more than (a) 75 basis points the effective
yield paid on deposits of comparable size and maturity in such institution's
normal market area for deposits accepted in its normal market area or (b) by
120% for retail deposits and 130% for wholesale deposits, respectively, of the
current yield on comparable maturity U.S. Treasury obligations for deposits
accepted outside the institution's normal market area. Undercapitalized
institutions are not permitted to accept brokered deposits and may not solicit
deposits by offering any effective yield that exceeds by more than 75 basis
points, the prevailing effective yields on insured deposits of comparable
maturity in the institution's normal market area or in the market area in which
such deposits are
30
being solicited. At December 31, 1999, the Bank was a well-capitalized
institution, which was not subject to restrictions on brokered deposits. See
"Business - Bank Sources of Funds - Deposits."
Liquidity Requirements. All savings associations are required to maintain
an average daily balance of liquid assets, which include specified short-term
assets and certain long-term assets, equal to a certain percentage of the sum of
its average daily balance of net deposit accounts and borrowings payable in one
year or less, which can be withdrawn. The liquidity requirement may vary from
time to time (between 3% and 10%) depending upon economic conditions and flows
of all savings associations. At the present time, the required liquid asset
ratio is 4%. Historically, the Bank has operated in compliance with these
requirements.
Affiliate Transactions. Under federal law and regulation, transactions
between a savings association and its affiliates are subject to quantitative and
qualitative restrictions. Affiliates of a savings association include, among
other entities, companies that control, are controlled by or are under common
control with the association. As a result, the Company and its non-bank
subsidiaries are affiliates of the Bank.
Savings associations are restricted in their ability to engage in "covered
transactions" with their affiliates. In addition, covered transactions between a
savings association and an affiliate, as well as certain other transactions with
or benefiting an affiliate, must be on terms and conditions at least as
favorable to the association as those prevailing at the time for comparable
transactions with non-affiliated companies. associations are required to make
and retain detailed records of transactions with affiliates.
Notwithstanding the foregoing, a savings association is not permitted to
make a loan or extension of credit to any affiliate unless the affiliate is
engaged only in activities the Federal Reserve Board has determined to be
permissible for bank holding companies. Savings associations also are prohibited
from purchasing or investing in securities issued by an affiliate, other than
shares of a subsidiary of the savings association.
Savings associations are also subject to various limitations and reporting
requirements on loans to insiders. These limitations require, among other
things, that all loans or extensions of credit to insiders (generally executive
officers, directors or 10% stockholders of the institution) or their "related
interest" be made on substantially the same terms (including interest rates and
collateral) as, and follow credit underwriting procedures that are not less
stringent than, those prevailing for comparable transactions with the general
public and not involve more than the normal risk of repayment or present other
unfavorable features.
Community Investment and Consumer Protection Laws. In connection with its
lending activities, the Bank is subject to the same federal and state laws
applicable to the Company generally, laws designed to protect borrowers and
promote lending to various sectors of the economy and population. In addition,
the Bank is subject to the federal Community Reinvestment Act ("CRA"). The CRA
requires each bank or association to identify the communities it serves and the
types of credit or other financial services the bank or association is prepared
to extend to those communities. The CRA also requires the OTS to assess a
association's record of helping to meet the credit needs of its community and to
take the assessment into consideration when evaluating applications for mergers,
applications and other transactions. The OTS may assign a rating of
"outstanding," "satisfactory," "needs to improve," or "substantial
noncompliance." A less than satisfactory CRA rating may be the basis for denying
such applications. The OTS conducted a CRA review of the Bank on April 27, 1998
at which time the Bank received a "satisfactory record of meeting community
credit needs" rating. Management believes the OTS will continue to have a
favorable view of the Bank's CRA record.
Under the CRA and implementing OTS regulations, an association has a
continuing and affirmative obligation to help meet the credit needs of its local
communities, including low- and moderate-income neighborhoods, consistent with
the safe and sound operation of the institution. Until July 1, 1997, the OTS
implementing regulations required the board of directors, of each association,
to adopt a CRA statement for each delineated local community that, among other
things, describes its efforts to help meet community credit needs and the
specific types of credit that the institution is willing to extend. Under new
standards, the OTS will assign
31
a CRA rating based on a Lending Test, Investment Test and Service Test keyed to,
respectively, the number of loans, the number of investments, and the level of
availability of retail banking services in a association's assessment area. The
Lending Test will be the primary component of the assigned composite rating. An
"outstanding" rating on the Lending Test automatically will result in at least a
"satisfactory" rating in the composite, but an institution cannot receive a
"satisfactory" or better rating on the composite if it does not receive at least
a "low satisfactory" rating on the Lending Test. Alternatively, a association
may elect to be assessed by complying with a strategic plan approved by the OTS.
Evaluation under the new rules is mandatory after June 30, 1997; however, a
association could elect to be evaluated under the new rules beginning on January
1, 1996, although the Bank did not elect to do so. Data collection requirements
became effective January 1, 1996.
Safety and Soundness. Other regulations which were recently adopted or are
currently proposed to be adopted pursuant to recent legislation include: (i)
real estate lending standards for insured institutions, which provide guidelines
concerning loan-to-value ratios for various types of real estate loans; (ii)
revisions to the risk-based capital rules to account for interest rate risk,
concentration of credit risk and the risks posed by "non-traditional
activities;" (iii) rules requiring depository institutions to develop and
implement internal procedures to evaluate and control credit and settlement
exposure to their correspondent banks; and (iv) rules addressing various "safety
and soundness" issues, including operations and managerial standards, standards
for asset quality, earnings and stock valuations, and compensation standards for
the officers, directors, employees and principal stockholders of the insured
institution.
Legislative Risk
Members of Congress and government officials from time to time have
suggested the elimination of the mortgage interest deduction for federal income
tax purposes, either entirely or in part, based on borrower income, type of loan
or principal amount. Because many of the Company's loans are made to borrowers
for the purpose of consolidating consumer debt or financing other consumer
needs, the competitive advantages of tax deductible interest, when compared with
alternative sources of financing, could be eliminated or seriously impaired by
such government action. Accordingly, the reduction or elimination of these tax
benefits could have a material adverse effect on the demand for loans of the
kind offered by the Company.
In January of 2000, media reports indicated that FDIC is considering
raising capital requirements for lenders specializing in sub-prime consumer
loans. A final proposal from the FDIC was reported to be expected at the end of
the year 2000 and must be endorsed by the Federal Reserve, the US Treasury's
Office of Comptroller of the Currency and the OTS.
Environmental Factors
To date, the Company has not been required to perform any investigation or
clean up activities, nor has it been subject to any environmental claims. There
can be no assurance, however, that this will remain the case in the future. In
the ordinary course of its business, the Company from time to time forecloses on
properties securing loans. Although the Company primarily lends to owners of
residential properties, there is a risk that the Company could be required to
investigate and clean up hazardous or toxic substances or chemical releases at
such properties after acquisition by the Company, and could be held liable to a
governmental entity or to third parties for property damage, personal injury,
and investigation and cleanup costs incurred by such parties in connection with
the contamination. The costs of investigation, correction of or removal of such
substances may be substantial, and the presence of such substances, or the
failure to properly correct such property, may adversely affect the owner's
ability to sell or rent such property or to borrow using such property as
collateral. Persons who arrange for the disposal or treatment of hazardous or
toxic substances also may be liable for the costs of removal or correction of
such substances at the disposal or treatment facility, whether or not the
facility
32
is owned or operated by such person. In addition, the owner or former owners of
a contaminated site may be subject to common law claims by third parties based
on damages and costs resulting from environmental contamination emanating from
such property.
In the course of its business, the Company may acquire properties as a
result of foreclosure. There is a risk that hazardous or toxic waste could be
found on such properties. In such event, the Company could be held responsible
for the cost of cleaning up or removing such waste, and such cost could exceed
the value of the underlying properties.
Dependence on Key Personnel
The Company's growth and development to date have been largely dependent
upon the services of Allen D. Wykle, Chairman of the Board, President and Chief
Executive Officer. The loss of Mr. Wykle's services for any reason could have a
material adverse effect on the Company. Certain of the Company's principal
credit agreements contain a provision which permit the lender to accelerate the
Company's obligations in the event that Mr. Wykle were to leave the Company for
any reason and not be replaced with an executive acceptable to such lender.
Control by Certain Shareholders
As of March 15, 2000, Allen D. Wykle, Chairman of the Board, President and
Chief Executive Officer and Leon H. Perlin, Director, beneficially own an
aggregate of 50.5% of the outstanding shares of Common Stock of the Company.
Accordingly, such persons, if they were to act in concert, would have control of
the Company, with the ability to approve certain fundamental corporate
transactions and the election of the entire Board of Directors.
33
ITEM 2 - PROPERTIES
Properties
The Company's executive and administrative offices are located at 1716
Corporate Landing Parkway, Virginia Beach, Virginia. The Company moved to this
new location on December 6, 1999. The building consists of approximately 30,985
square feet and is owned by the Company. The Company still owns its prior
executive and administrative offices located at 3420 Holland Road, Virginia
Beach, Virginia. This building is currently listed for sale. The two buildings
are subject to total mortgage debt of $2,341,000 as of December 31, 1999. In
February 1999, the Company sold the building purchased in June 1997 which was
adjacent to its prior headquarters located on Holland Road. (See Note 22 of
audited financial statements for information regarding the sale of this office
building.)
As of December 31, 1999 the Company had leases for one regional broker
lending office, retail lending offices, and the administrative office for the
Bank. These facilities are leased under terms that vary as to duration and in
general, the leases expire between 2000 and 2004, and provide rent escalations
tied to either increases in the lessor's operating expenses or fluctuations in
the consumer price index in the relevant geographic area. Lease expense was
$2,027,000, $1,394,000, and $966,000 in 1999, 1998 and 1997, respectively. Total
minimum lease payments under non-cancelable operating leases with remaining
terms in excess of one year as of December 31, 1999 were as follows (in
thousands):
2000 $ 724
2001 344
2002 152
2003 64
2004 48
--------------
Total 2000-2004 $ 1,332
==============
The Company anticipates that in the normal course of business it will lease
additional office space as it opens new retail loan origination locations or
assumes leases associated with any future acquisitions or strategic alliances.
34
ITEM 3 - LEGAL PROCEEDINGS
The Company is a party to various routine legal proceedings arising out of
the ordinary course of its business. Management believes that none of these
actions, individually or in the aggregate, will have a material adverse effect
on the results of operations or financial condition of the Company.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS
NONE.
35
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
Market Price of and Cash Dividends on the Company's Common Equity
The following table shows the quarterly high, low and closing prices of the
Company's common stock for 1999, 1998, and 1997 and cash dividends paid per
share. All stock price and dividend data has been adjusted to reflect a 100%
stock dividend that occurred on November 21, 1997.
Stock Prices Cash
High Low Close Dividends
1999:
Fourth Quarter $ 1.75 $ 0.50 $ 0.50 $ -
Third Quarter 2.75 0.78 0.81 -
Second Quarter 3.25 2.38 2.38 -
First Quarter 4.13 2.88 3.00 -
1998:
Fourth Quarter $ 6.50 $ 2.88 $ 3.38 $ -
Third Quarter 13.63 7.00 7.00 -
Second Quarter 15.63 13.13 13.88 -
First Quarter 15.08 12.08 13.13 -
1997:
Fourth Quarter $ 17.00 $ 12.75 $ 14.75 $ -
Third Quarter 17.00 8.00 15.00 -
Second Quarter 10.00 6.00 8.25 -
First Quarter 13.50 8.50 9.75 -
The Company did not pay any cash dividends on its Common Stock in 1999,
1998, and 1997. The Company intends to retain all of its earnings to finance its
operations and does not anticipate paying cash dividends for the foreseeable
future. Any decision made by the Board of Directors to declare dividends in the
future will depend on the Company's future earnings, capital requirements,
financial condition and other factors deemed relevant by the Board.
36
Absence of Active Public Trading Market and Volatility of Stock Price
The Company's Common Stock is traded on the National Quotation Bureau, Inc.
OTC Bulletin Board under the symbol "APFN." Historically, there has been a
limited market for the Company's Common Stock. As a result, the prices reported
for the Company's Common Stock reflect the relative lack of liquidity and may
not be reliable indicators of market value. There can be no assurance that an
active public trading market for the Company's Common Stock will be created in
the future.
The market price of the Common Stock may experience fluctuations that are
unrelated to the operating performance of the Company. In particular, the price
of the Common Stock may be affected by general market price movements as well as
developments specifically related to the residential mortgage lending industry
such as, among other things, interest rate movements, delinquencies, loan
prepayment speeds, interest-only and residual asset valuations, sources of
liquidity to the industry participants and profit or loss trends.
Transfer Agent and Registrar
The Transfer Agent for the Company's Common Stock is First Union National
Bank, 230 South Tryon Street, 11th Floor, Charlotte, North Carolina 28288-1153.
Recent Open Market Purchase of Common Stock by the Company
The Board of Directors approved a stock repurchase plan at a regular board
meeting on November 2, 1998. The Company purchased a total of 30,000 shares of
Approved Financial Corp. stock at a price of $3.75 per share on trade dates
between December 21, 1998 and December 29, 1998.
Recent Unregistered Security Transactions
The Company issued 116,706 shares of unregistered shares of common stock on
January 5, 1998 to the owners of the portion of Armada LLC, a joint venture,
which was not owned by the Company. These share represented the final payment
associated with the Company's acquisition of Armada LLC. The stock bears a
restrictive legend, is subject to an administrative stop, may not be resold
without an opinion of the Company's legal counsel, and is subject to the resale
requirements of Rule 144. No broker or general solicitation was involved. The
Company relied on an exemption from registration under Section 4(2) of the
Securities Act of 1933, and the regulations issued thereunder, and Rule 701.
37
ITEM 6 - SELECTED FINANCIAL DATA
The historical consolidated financial data for the five years ended
December 31, 1999 were derived from the consolidated financial statements of the
Company included elsewhere herein. The historical consolidated financial data
are not necessarily indicative of the results of operations for any future
period. This information should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the historical consolidated financial statements and notes thereto included
elsewhere herein. Unless otherwise indicated, all financial data has been
adjusted to reflect two-for-one stock splits which occurred on August 30, 1996
and December 16, 1996, and a 100% stock dividend that occurred on November 21,
1997.
38
APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
(In thousands, except share and per share data)
Years Ended
December 31 1999 1998 1997 1996 1995
- ----------- ---------- ---------- ---------- ---------- ----------
Revenue:
Gain on sale of loans $ 13,202 $ 29,703 $ 33,501 $ 17,955 $ 7,298
Interest income 7,698 10,308 10,935 4,520 3,065
Gain on sale of securities - 1,750 2,796 - -
Other fees and income 7,834 7,042 4,934 2,407 1,535
---------- ---------- ---------- ---------- ----------
Total revenue 28,734 48,803 52,166 24,882 11,898
---------- ---------- ---------- ---------- ----------
Expenses:
Compensation (1) 17,765 23,397 16,447 8,017 3,880
General and administrative (2) 14,427 15,306 14,188 6,853 3,050
Write down of goodwill 1,131 - - - -
Loss on sale/disposal
of fixed assets 796 - - - -
Loss on write off of
securities 73 - - - -
Interest expense 4,957 6,252 6,157 3,121 2,194
Provision for loan and
foreclosed property losses 2,256 2,896 1,676 1,308 731
---------- ---------- ---------- ---------- ----------
Total expenses 41,405 47,851 38,468 19,299 9,855
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes (12,671) 952 13,698 5,583 2,043
Income taxes (4,749) 473 5,638 2,259 876
---------- ---------- ---------- ---------- ----------
Net Income (loss) $ (7,922) $ 479 $ 8,060 $ 3,324 $ 1,167
========== ========== ========== ========== ==========
Net income (loss) per share
(diluted) ($1.45) $ 0.09 $ 1.51 $ 0.63 $ 0.23
========== ========== ========== ========== ==========
Cash dividends per share $ - $ - $ - $ 0.04 $ 0.04
========== ========== ========== ========== ==========
Dividend payout ratio - - - 6.35% 17.39%
========== ========== ========== ========== ==========
Weighted average number of
shares outstanding (diluted) 5,482,114 5,511,372 5,345,957 5,281,103 5,062,809
========== ========== ========== ========== ==========
(1) This document reclassifies "minority interests in consolidated
subsidiaries" as "compensation."
(2) Amount includes Loan Production expense.
39
APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
(In thousands, except per share data)
Years Ended
December 31 1999 1998 1997 1996 1995
- ----------- --------------- --------------- --------------- ------------- --------------
SELECTED BALANCES AT YEAR END
Loans receivable, net $ 66,771 $105,044 $ 80,696 $ 45,423 $ 28,430
Securities 2,640 3,472 15,201 20,140 -
Total assets 98,600 136,118 118,125 75,143 34,485
Revolving warehouse loans 17,465 72,546 52,488 32,030 19,566
FDIC-insured deposits 55,339 29,728 17,815 1,576 -
Subordinated debt 5,081 6,042 9,080 9,183 6,905
Total liabilities (1) 87,301 116,851 93,070 53,934 28,250
Shareholders' equity 11,299 19,267 25,055 21,209 6,236
SELECTED LOAN DATA
Loans originated (2) $390,816 $522,045 $468,955 $258,833 $111,505
Loans sold 265,873 389,589 420,498 228,918 83,328
Amount of loans serviced
at year-end 69,054 109,500 83,512 48,785 29,249
Loans delinquent 31 days or 4.50% 5.42% 5.50% 6.61% 8.88%
More as percent of
loans at year-end
SELECTED RATIOS
Return on average assets (8.45%) 0.40% 7.68% 7.32% 4.06%
Return on average
Shareholders' equity (49.01%) 1.93% 32.69% 36.44% 19.86%
Shareholders' equity
to assets 11.46% 14.15% 21.21% 28.22% 18.08%
Book value per share $ 2.07 $ 3.51 $ 4.64 $ 4.21 $ 1.28
_____________
(1) Includes minority interests in subsidiaries.
(2) Includes $151.3 million and $92.3 million brokered loans in 1999 and 1998
respectively.
40
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
The following commentary discusses major components of the Company's
business and presents an overview of the Company's consolidated results of
operations for each year in the three-year period ended December 31, 1999 and
its consolidated financial position at December 31, 1999 and 1998. The
discussion includes some forward-looking statements involving estimates and
uncertainties. The Company's actual results could differ materially from those
anticipated in the forward-looking statements as a result of certain factors
such as reduced demand for loans, competitive forces, availability of adequate
capital funding, loan delinquency, default and loss rates, general economic
environment, market forces affecting the value of the loans originated by the
Company and the price of the Company's common stock. This discussion should be
reviewed in conjunction with the consolidated financial statements and
accompanying notes and other statistical information presented in the Company's
1999 audited financial statements. (See also disclosure in Part I, Item 1)
Results of Operations for the Year Ended December 31, 1999 compared to the Year
Ended December 31, 1998.
Net Income
The Company's net loss for 1999 was $7.9 million compared to net income of $0.5
million in 1998. On a per share basis (diluted), loss for 1999 was ($1.45)
compared to $0.09 for 1998.The return on average assets was (8.45%) in 1999,
compared to 0.40% in 1998. Return on average shareholders' equity was (49.01%)
in 1999, compared to 1.93% in 1998.
41
Origination of Mortgage Loans
The following table shows the loan originations in dollars and units for the
Company's broker and retail divisions in 1999 and 1998. During the second
quarter of 1999, the Company initiated in-house funding of conforming and
government mortgages originated by the retail division. Additionally, the
retail branches originate mortgages that are funded through other lenders
("brokered loans"). Brokered loans consist primarily of non-conforming
mortgages that do not meet the Company's underwriting criteria and conforming
loans. The Company did not fund conforming loans in-house during 1998.
Year Ended
December 31,
(dollars in millions) 1999 1998
-------------- ---------------
Dollar Volume of Loan Originated:
Broker Referrals $ 126.9 $ 203.9
Retail - brokered loans 151.7 92.3
Retail - funded in-house non-conforming 78.5 225.8
Retail - funded in-house conforming and
government 33.7 0
-------------- ---------------
Total Retail 263.9 318.1
-------------- ---------------
Total $ 390.8 $ 522.0
============== ===============
Number of Loans Originated:
Broker Referrals 2,029 3,484
Retail - brokered loans 1,809 1,099
Retail - funded in-house non-conforming 1,219 3,882
Retail - funded in-house conforming and
government 333 0
-------------- ---------------
Total Retail 3,361 4,981
-------------- ---------------
Total 5,390 8,465
============== ===============
The decrease of 44.4% in dollar volume of loans, excluding $151.7 million in
brokered loans, originated during the year ended December 31, 1999, compared to
the same period in 1998 was due primarily to increased competition in the non-
conforming mortgage industry.
Loans originated through the Company's retail offices, excluding $151.7 million
in brokered loans, decreased 50.3% to $112.2 million, compared to $225.8 million
during the same period in 1998. The decrease was primarily the result of
increased pricing competition in the non-conforming mortgage area and a decrease
in the number of retail loan origination centers from 26 at December 31, 1998 to
11 at December 31, 1999.
42
Brokered loans generated by the retail division were $151.7 million during the
year ended December 31, 1999 which was a 64.4% increase compared to $92.3
million during the same period in 1998. The increase was primarily the result of
pricing competition in the non-conforming mortgage market.
The volume of loans originated through broker referrals from the Company's
network of mortgage brokers decreased 37.8% to $126.9 million for the year ended
December 31, 1999, compared to $203.9 million for the year ended December 31,
1998. The pricing competition in the non-conforming mortgage industry was the
primary reason for the decrease in loans from this source. Also, since the
Company did not offer conforming and government loan products through the broker
division, the refinance boom for conforming mortgages created by the low
interest rate environment contributed to the decrease in loan volume from this
division.
43
The following tables summarize mortgage loan origination activity, including
brokered loans, by state, for the years ended December 31, 1999, 1998, and 1997.
(In thousands)
Years Ended
December 31 1999 1998 1997
--------------------------- -------------------------------- -----------------------------
Dollars Percent Dollars Percent Dollars Percent
------------- ---------- ----------------- ----------- --------------- ----------
Broker Division
Florida $ 41,415 10.6% $ 53,874 10.3% $ 61,897 13.2%
North Carolina 21,718 5.6 25,315 4.9 28,957 6.1
Virginia 13,520 3.5 11,698 2.2 5,415 1.2
Pennsylvania 12,723 3.3 43 0.0 - -
Ohio 11,406 2.9 22,233 4.3 32,478 6.9
Maryland 11,215 2.9 35,690 6.8 29,997 6.4
Georgia 6,408 1.6 34,617 6.7 59,792 12.8
South Carolina 2,677 .7 9,444 1.8 4,463 1.0
Kentucky 2,097 .5 361 0.1 - -
Tennessee 1,896 .5 6,391 1.2 7,826 1.7
Illinois 1,172 .3 3,059 0.6 12,781 2.7
Indiana 619 .1 72 0.0 9,131 1.9
Michigan 0 0 1,115 0.2 3,680 0.8
------------- ---------- ----------------- ----------- --------------- ----------
Total Broker Division $126,866 32.5% $203,912 39.1% $256,417 54.7%
============= ========== ================= =========== =============== ==========
Retail Division:
Maryland $ 68,986 17.7% $ 66,911 12.8% $ 66,954 14.4%
Virginia 51,407 13.3 52,856 10.1 34,442 7.3
Michigan 50,090 12.8 4,001 0.8 0 0
Georgia 21,596 5.5 58,558 11.2 12,886 2.7
South Carolina 20,482 5.2 21,682 4.1 18,611 4.0
Ohio 18,754 4.8 23,301 4.5 12,666 2.7
North Carolina 11,517 2.9 49,912 9.6 39,007 8.3
Colorado 7,540 1.9 0 0 0 0
Delaware 5,619 1.4 15,905 3.0 16,056 3.4
Kentucky 3,886 1.0 14,368 2.8 85 -
Florida 1,592 .4 6,374 1.2 4,141 0.9
New Jersey 1,546 .4 0 0 0 0
Texas 844 .2 0 0 0 0
Pennsylvania 91 0 0 0 0 0
Illinois 0 0 2,065 0.4 4,877 1.0
Indiana 0 0 2,200 0.4 2,813 0.6
------------- ---------- ----------------- ----------- --------------- ----------
Total Retail Division $263,950 67.5% $318,133 60.9% $212,538 45.3%
============= ========== ================= =========== =============== ==========
Total Originations:
Maryland $ 80,201 20.5% $102,601 19.7% $ 96,951 20.8%
Virginia 64,927 16.6 64,554 12.4 39,857 8.5
Michigan 50,090 12.8 5,116 1.0 3,680 0.8
Florida 43,007 11.1 60,248 11.5 66,038 14.1
North Carolina 33,235 8.5 75,227 14.4 67,964 14.5
Ohio 30,160 7.7 45,534 8.7 45,144 9.6
Georgia 28,004 7.2 93,175 17.9 72,678 15.5
South Carolina 23,159 5.9 31,126 6.0 23,074 4.9
Pennsylvania 12,814 3.3 43 0.0 0 0
Colorado 7,540 1.9 0 0 0 0
Kentucky 5,983 1.5 14,729 2.8 85 -0
Delaware 5,619 1.4 15,905 3.0 16,056 3.4
Tennessee 1,896 .5 6,391 1.2 7,826 1.7
New Jersey 1,546 .4 0 0 0 0
Illinois 1,172 .3 5,124 1.0 17,658 3.7
Texas 844 .2 0 0 0 0
Indiana 619 .2 2,272 0.4 11,944 2.5
------------- ---------- ----------------- ----------- --------------- ----------
Total Originations $390,816 100.0% $522,045 100.0% $468,955 100.0%
============= ========== ================= =========== =============== ==========
44
Gain on Sale of Loans
The largest component of the Company's net income is gain on sale of loans.
There is an active secondary market for most types of mortgage loans originated
by the Company. The majority of the loans originated by the Company are sold to
other financial institutions. The Company receives cash at the time loans are
sold. The loans are sold service-released on a non-recourse basis, except for
normal representations and warranties, which is consistent with industry
practices. By selling loans in the secondary mortgage market, the Company is
able to obtain funds that may be used for additional lending and investment
purposes. Gain on sale of loans is comprised of several components, as follows:
(a) the difference between the sales price and the net carrying value of the
loan; plus (b) loan origination fee income collected at loan closing and
deferred until the loan is sold; less (c) loan sale recapture premiums and loan
selling costs.
Non-conforming loan sales totaled $235.5 million including loans owned by the
Company in excess of 180 days ("seasoned loans") for the year ended December 31,
1999, compared to $389.6 million including seasoned loans for the same period in
1998. The decrease was caused primarily by the decrease in loan origination
volume.
For the year ended December 31, 1999, the Company sold $15.4 million of seasoned
loans, at a weighted average discount to par value of 7.8%. The loss was fully
reserved for in prior periods. For year ended December 31, 1998, the Company
sold $12.0 million of seasoned loans, at a weighted average discount to par
value of 10.5%. These losses were recorded as charge offs during 1998.
Conforming and government loan sales were $30.3 million for the year ended
December 31, 1999. The Company did not fund conforming or government loans
during the same period ended in 1998.
The combined gain on the sale of loans was $13.2 million for the year ended
December 31, 1999, which compares with $29.7 million for the same period in
1998. The decrease for the year ended December 31, 1999, was the direct result
of a decrease in the weighted-average premium paid by investors for the
Company's non-conforming mortgage loans, the addition of conforming and
government loan sales that normally carry lower loan sale premiums and a lower
volume of loans sold. Gain on the sale of mortgage loans represented 46.3% of
total revenue for the year ended December 31, 1999, compared to 60.9% of total
revenue for the same period in 1998.
The weighted-average premium realized by the Company on its non-conforming loan
sales decreased to 3.1% (excluding seasoned loan sales), during the year ended
December 31, 1999, from 5.4% (excluding seasoned loan sales) for the same period
in 1998. The decrease in premium percentage was caused by material changes in
the secondary market conditions for non-conforming mortgage loans. The weighted-
average premium realized by the Company on its conforming and government loans
sales was 1.85% during the year ended December 31, 1999.
The Company has never used securitization as a loan sale strategy. However, the
whole-loan sale marketplace for non-conforming mortgage loans was impacted by
changes that affected companies who previously used securitizations to sell
loans. Excessive competition during 1998 and 1999 and a coinciding reduction in
interest rates in general caused an increase in the prepayment speeds for non-
conforming loans. The valuation method applied to interest-only and residual
assets ("Assets"), the capitalized assets created from securitization, include
an assumption for average prepayment speed in order to determine the average
life of a loan pool. The increased prepayment speeds experienced in the industry
were greater than the assumptions previously used by many securitization issuers
and led to an impairment of Asset values for several companies in the industry.
Additionally, in September of 1998, due to the Russian crisis, and again in the
fourth quarter of 1999, due to Y2K concerns, a flight to quality among fixed
income investors negatively impacted the pricing spreads for mortgage-backed
45
securitizations compared to earlier periods and negatively impacted the
associated economics to the issuers. Consequently, many of these companies have
experienced terminal liquidity problems. and others have diverted to whole loan
sale strategies in order to generate cash. This shift has materially decreased
the demand for and increased the supply of non-conforming mortgage loans in the
secondary marketplace, which resulted in significantly lower premiums on non-
conforming whole-loan mortgage sales beginning in the fourth quarter of 1998 and
continuing throughout 1999 when compared to earlier periods.
Furthermore, the loan sale premium percentage has decreased due to a decrease in
the Weighted Average Coupon ("WAC") on the Company's loan originations, which
was primarily the result of a lower interest rate market and a shift in the
Company's origination profile to a higher credit grade customer. These premiums
do not include loan origination fees collected by the Company at the time the
loans are closed, which are included in the computation of gain on sale when the
loans are sold.
The Company defers recognizing income from the loan origination fees it receives
at the time a loan is closed. These fees are recognized over the lives of the
related loans as an adjustment of the loan's yield using the level-yield method.
Deferred income pertaining to loans held for sale is taken into income at the
time of sale of the loan. Origination fee income is primarily derived from the
Company's retail lending division. Origination fee income included in the gain
on sale of loans for the year ended December 31, 1999 was $6.1 million, compared
to $10.4 million for the year ended December 31, 1998. The decrease is the
result of a decrease in the volume of loans sold, which were generated by the
Company's retail division. The Company's retail loan sales for the year ended
December 31, 1999 comprised 53.4% of total loan sales, with average loan
origination fee income earned of 4.62%, including conforming loans. Excluding
conforming loans the average loan origination fee income earned was 4.83% for
the year ended December 31, 1999. For the year ended December 31, 1998 the
Company's retail loan sales were 55.5% of total loan sales with average
origination fee income of 5.0%. Fees associated with selling loans were
approximately 10 basis points for the year ended December 31, 1999 compared to
20 basis points for the year ended December 31, 1998.
The Company also defers recognition of the expense it incurs, from the payment
of fees to mortgage brokers, for services rendered on loan originations. These
costs are deferred and recognized over the lives of the related loans as an
adjustment of the loan's yield using the level-yield method. The remaining
balance of expenses associated with fees paid to brokers is recognized when the
loan is sold. Average fees paid to mortgage brokers for the year ended December
31, 1999 was 41 basis points compared to 39 basis points in 1998.
Interest Income and Expense
The Company's net interest income is dependent on the difference, or "spread",
between the interest income it receives from its loans and its cost of funds,
consisting principally of the interest expense paid on the warehouse lines of
credit, the Bank's deposit accounts and other borrowings.
Interest income for the year ended December 31, 1999 was $7.7 million compared
with $10.3 million for the same period ended in 1998. The decrease in interest
income for the year ended December 31, 1999 was due to a lower weighted-average
coupon associated with the balance of loans held for sale and a lower average
balance of loans held for sale.
Interest expense for the year ended December 31, 1999 was $5.0 million compared
with $6.3 million for the year ended December 31, 1998. The decrease in interest
expense for the year ended December 31, 1999, was the direct result of a
decrease in the average balance of interest-bearing liabilities and a lower
weighted average coupon associated with interest bearing liabilities.
46
Changes in the average yield received on the Company's loan portfolio may not
coincide with changes in interest rates the Company must pay on its revolving
warehouse loans, the Bank's FDIC-insured deposits, and other borrowings. As a
result, in times of rising interest rates, decreases in the difference between
the yield received on loans and other investments and the rate paid on
borrowings and the Bank's deposits usually occur.
47
The following tables reflect the average yields earned and rates paid by the
Company during 1999 and 1998. In computing the average yields and rates, the
accretion of loan fees is considered an adjustment to yield. Information is
based on average month-end balances during the indicated periods.
(In thousands) 1999 1998
------------------------------------------------ ------------------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
-------------- -------------- ------------- ------------- ------------ ---------------
Interest-earning assets:
Loan receivable (1) $67,665 $7,246 10.71% $ 83,522 $ 9,761 11.69%
Cash and other interest-
Earning assets 9,227 452 4.90 12,754 547 4.28
-------------- -------------- ------------- ------------- ------------ ---------------
76,892 7,698 10.01% 96,276 10,308 10.71
-------------- ------------- ------------ ---------------
Non-interest-earning assets:
Allowance for loan losses (2,481) (1,789)
Investment in IMC 71 8,136
Premises and equipment, 5,375 4,770
net
Other 13,941 11,875
-------------- -------------
Total assets $93,798 $119,268
============== =============
Interest-bearing liabilities:
Revolving warehouse lines 33,380 2,405 7.20 $ 49,810 3,888 7.80
FDIC - insured deposits 32,365 1,835 5.67 22,858 1,361 5.96
Other interest-bearing 7,792 717 9.20 10,677 1,003 9.39
Liabilities
-------------- -------------- ------------- ------------- -------------- ---------------
73,537 4,957 6.74 83,345 6,252 7.50
-------------- ------------- ------------ ---------------
Non-interest-bearing
liabilities 4,096 11,126
-------------- -------------
Total liabilities 77,633 94,471
Shareholders' equity 16,165 24,797
-------------- -------------
Total liabilities and
equity $93,798 $119,268
============== =============
Average dollar difference
between
Interest-earning assets
and interest-
Bearing liabilities $ 3,354 $ 12,931
============== =============
Net interest income $2,741 $ 4,056
============== ============
Interest rate spread (2) 3.27% 3.21%
============= ===============
Net annualized yield on average
Interest-earning assets 3.57% 4.21%
============= ===============
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
(2) Average yield on total interest-earning assets less average rate paid on
total interest-bearing liabilities.
48
The following table shows the change in net interest income, which can be
attributed to rate (change in rate multiplied by old volume) and volume (change
in volume multiplied by old rate) for the year ended December 31, 1999 compared
to the year ended December 31, 1998. The changes in net interest income due to
both volume and rate changes have been allocated to volume and rate in
proportion to the relationship of absolute dollar amounts of the change of each.
The table demonstrates that the decrease of $1.3 million in net interest income
for the year ended December 31, 1999 compared to the year ended December 31,
1998 was primarily the result of a decrease in the average balance on interest-
earning assets.
($ In thousands)
1999 Versus 1998
Increase (Decrease) due to:
Volume Rate Total
------------- ------------ -------------
Interest-earning assets:
Loan receivable $(1,746) $(769) $(2,515)
Cash and other interest-
earning assets (196) 101 (95)
------------- ------------ -------------
(1,942) (668) (2,610)
------------- ------------ -------------
Interest-bearing liabilities:
Revolving warehouse lines (1,202) (281) (1,483)
FDIC-insured deposits 536 (62) 474
Other interest-
bearing liabilities (266) (20) (286)
------------- ------------ -------------
(932) (363) (1,295)
------------- ------------ -------------
Net interest income (expense) $(1,010) $(305) $(1,315)
============= ============ =============
Other Income
In addition to net interest income (expense), and gain on sale of loans, the
Company derives income from origination fees earned on brokered loans generated
by the Company's retail offices and other fees earned on the loans funded by the
Company, such as document preparation fees, underwriting service fees,
prepayment penalties, and late charge fees for delinquent loan payments.
Brokered loan fees were $6.1 million for the year ended December 31, 1999,
compared to $4.3 million for the year ended December 31, 1998. For the year
ended December 31, 1999, other income totaled $7.8 million compared to $7.0
million for the same period in 1998. The increase was primarily the result of
the increase in brokered loan fees which was generated by an increase in
brokered loan volume. The increase in brokered loan fees was offset by a
reduction in underwriting fee income due to a lower volume of loans closed.
Underwriting fee income was $1.3 million for the year ended December 31, 1999
compared to $2.3 million for the year ended December 31, 1998.
49
Comprehensive Income
The Company has other comprehensive income (loss) in the form of unrealized
holding losses on securities held for sale. For the year ended December 31,
1999, other comprehensive loss was $0.05 million compared to other comprehensive
loss of $6.8 million for the year ended December 31, 1998. The loss for the year
ended December 31, 1999 related to the decrease in the market price of the Asset
Management Fund, Inc. Adjustable Rate Mortgage Portfolio investment and in 1998
the loss was related to a decrease in the market price of IMC Mortgage Company
common stock.
Compensation and Related Expenses
The largest component of expenses is compensation and related expenses, which
decreased by $5.6 million to $17.8 million for the year ended December 31, 1999
from 1998. The decrease was directly attributable to a decrease in the number of
employees and lower commissions expense caused by the decrease in loan volume.
Salary expense decreased by $4.4 million and payroll related benefits decreased
by $0.5 million. The decrease was caused by a lower average number of employees,
which was attributed to the Companies cost cutting initiative. For the year
ended December 31, 1999 the average full time equivalent employee count was 371
compared to 578 for the year ended December 31, 1998. Commissions to loan
officers decreased by $1.1 million due to lower loan volume.
General and Administrative Expenses
General and administrative expenses for the year ended December 31, 1999
increased by $0.8 million to $12.5 million, compared to the year ended December
31, 1998. The increase is attributed to increases in advertising expense, rent
expense and depreciation expense. For the year ended December 31, 1999 these
three expense items increased $3.3 million compared to the same period ended
December 31, 1998. The increase in advertising was caused by the Company's
formation of a centralized advertising and marketing department in order to
consolidate its marketing. The sale lease back of the building that housed the
advertising and marketing department in Virginia Beach prior to relocation to
the new corporate office building in December of 1999 caused the increase in
rent. Also, the Company continues to pay rent on a many of offices that it has
closed while it is attempting to sublease these locations. The increase in
depreciation expense was caused by the acquisition of ConsumerOne Financial,
which has depreciable equipment of $0.8 million. Expenses in all other general
and administrative categories decreased by $4.1 million during the year ended
December 31, 1999, compared to the year ended December 31, 1998. These expenses
were part of the Company's cost reduction initiative.
Write down of Goodwill
Goodwill related to the 1998 purchase of MOFC, Inc. d/b/a ConsumerOne Financial
and the Funding Center of Georgia was written down during the year ended
December 31, 1999. The anticipated net income from these acquisitions was not
realized due to the decreasing margins in the nonconforming mortgage industry,
therefore the Company reevaluated its intangible assets associated with the
acquisitions. The total write down for the year ended December 31, 1999 was $1.1
million.
Loss on Sale/Disposal of Fixed Assets
For the year ended December 31, 1999 the Company disposed of computers and
equipment no longer in service because of branch closings which resulted in a
loss of $0.4 million. There was also an expense of $0.3 million regarding the
charge taken for previously capitalized legal and architectural costs related to
previous plans to
50
construct a new corporate headquarters building in Virginia Beach. These
construction plans were cancelled when the Company's current building became
available for purchase and was acquired by the Company in late 1999.
Loan Production Expense
The largest component of loan production expense is fees paid by the Company to
mortgage brokers for services rendered in the preparation of loan packages.
Other items that comprise loan production expenses are appraisals, credit
reports, leads research and telemarketing list expenses. Loan production
expenses for the year ended December 31, 1999 were $1.9 million compared to $3.6
million for the year ended December 31, 1998. The decrease was primarily the
result of a decrease in services rendered fees of $1.2 million. Also, appraisal
and credit report expense decreased due to lower loan volume. The company also
eliminated payments to outside consultants for research of customer leads due to
the creation of the centralized advertising and marketing departments.
Provision for Loan Losses
The following table presents the activity in the Company's allowance for loan
losses and selected loan loss data for 1999 and 1998:
(In thousands)
Years Ended
December 31
- ----------- 1999 1998
-------------- ------------
Balance at beginning of year $ 2,590 $ 1,687
Provision charged to expense 2,042 3,064
Acquisition of MOFC, Inc. 0 49
Loans charged off (3,286) (2,372)
Recoveries of loans previously charged off 36 162
-------------- ------------
Balance at end of year $ 1,382 $ 2,590
============== ============
Loans receivable at year-end, gross
of allowance for losses $69,054 $107,634
Ratio of allowance for loan losses to gross
loans receivable at year-end 2.00% 2.41%
The Company added $2.0 million during the year ended December 31, 1999 to the
allowance for loan losses, compared to an increase of $3.1 million for the year
ended December 31, 1998. The decrease in the provision was primarily the result
of a decrease in the balance of gross mortgage loans held by the Company for the
respective dates. All losses ("charge offs" or "write downs") and recoveries
realized on loans previously charged off, are accounted for in the allowance for
loan losses.
The allowance is established at a level that management considers adequate
relative to the composition of the current portfolio of loans held for sale.
Management considers characteristics of the Company's current loan portfolio
such as credit quality, the weighted average coupon, the weighted average loan
to value ratio, the age of the loan portfolio and the portfolio's delinquency
status in the determination of an appropriate allowance. Other criteria such as
covenants associated with the Company's credit facilities, trends in the demand
for and pricing for loans sold in the secondary market for non-conforming
mortgages and general economic conditions, including interest rates, are also
considered when establishing the allowance. Adjustments to the reserve for loan
51
losses may be made in future periods due to changes in the factors mentioned
above and any additional factors that may effect anticipated loss levels in the
future.
Provision for Foreclosed Property Losses
The Company increased its provision for foreclosed property losses by $215,000
for the year ended December 31, 1999, compared to an decrease of $168,000 for
the year ended December 31, 1998.
Sales of real estate owned yielded net losses of $648,000 for the year ended
December 31, 1999 versus $660,000 for the year ended December 31, 1998.
The following table presents the activity in the Company's allowance for
foreclosed property losses and selected real estate owned data for 1999 and
1998:
(In thousands)
Years Ended
December 31 1999 1998
- ----------- ------------------- -----------------
Balance at beginning of year $ 503 $ 671
Provision charged to (reducing) expense 215 (168)
-------------------- -----------------
Balance at end of year $ 718 $ 503
==================== =================
Real estate owned at year-end, gross $ 2,992 $ 2,211
of allowance for losses
Ratio of allowance for foreclosed property losses 24.00% 22.80%
to gross real estate owned at year-end
The Company maintains a reserve on its real estate owned ("REO") based upon
management's assessment of appraised values at the time of foreclosure. The
increase in the provision for foreclosed property losses relates to an increase
in the dollar amount of outstanding REO at December 31, 1999 when compared to
December 31, 1998. While the Company's management believes that its present
allowance for foreclosed property losses is adequate, future adjustments may be
necessary.
52
Results of Operations for the Year Ended December 31, 1998 compared to the Year
Ended December 31, 1997.
Net Income
The Company's net income for 1998 was $0.5 million compared to net income of
$8.1 million in 1997. On a per share basis (diluted), income for 1998 was $0.09,
compared to $1.51 for 1997. The return on average assets was 0.40% in 1998,
compared to 7.68% in 1997. Return on average shareholders' equity was 1.93% in
1998, compared to 32.69% in 1997.
Origination of Mortgage Loans
The following table shows loan originations in dollars and units for the
Company's broker and retail units in 1998 and 1997:
(Dollars in millions)
Years Ended
December 31 1998 1997
- ----------- ---------------- ----------------
Broker $ 203.9 $ 256.4
Retail - funded through other lenders 92.3 NM
Retail - funded in-house 225.8 212.5
Total $ 522.0 $ 468.9
================ ================
Number of Loan Originated:
Broker 3,484 4,399
Retail - funded through other lenders 1,099 NM
Retail - funded in-house 3,882 4,022
--------------- ----------------
Total 8,465 8,421
=============== ================
NM = Not Material
The decrease of 8.4% in dollar volume of loans, excluding $92.3 million in
brokered loans, originated during the year ended December 31, 1998, compared to
the same period in 1997 was due primarily to increased competition in the non-
conforming mortgage industry.
Loans originated through the Company's retail offices, excluding $92.3 million
in brokered loans, increased 6.3% to $225.8 million, compared to $212.5 million
during the same period in 1997. The growth in retail origination's for the year
ended December 31, 1998 was due to an increase in retail office locations from
internal growth and due to the acquisition of FCGA.
Brokered loans generated by the retail division were $92.3 million during the
year ended December 31, 1998. Brokered loan volume originated during the year
ended December 31, 1997 was not material and therefore the dollar volumes were
not recorded. (See: Other Income on page 57)
The volume of loans originated through referrals from the Company's network of
mortgage brokers decreased
53
20.5% to $203.9 million for the year ended December 31, 1998, compared to $256.4
million for the year ended December 31, 1997. Contributing to this decrease in
volume from broker referrals is the refinance boom for conforming mortgages
created by the low interest rate environment, increased competition in the non-
conforming mortgage industry and the Company's acquisition of FCGA. Before the
Company acquired FCGA in January 1998, FCGA was a mortgage broker organization
that referred loans to the Company.
Gain on Sale of Loans
The largest component of the Company's net income is gain on sale of loans.
There is an active secondary market for most types of mortgage loans originated
by the Company. The majority of the loans originated by the Company are sold to
other financial institutions. The Company receives cash at the time loans are
sold. The loans are sold service-released on a non-recourse basis, except for
normal representations and warranties, which is consistent with the industry
practices. By selling loans in the secondary mortgage market, the Company is
able to obtain funds that may be used for additional lending and investment
purposes Gain on sale of loans is comprised of several components, as follows:
(a) the difference between the sales price and the net carrying value of the
loan; plus (b) loan origination fee income collected at loan closing and
deferred until the loan is sold; (c) loan sale recapture premiums and loan
selling costs.
Loan sales totaled $389.6 million for the year ended December 31, 1998,
including the sale of approximately $12.0 million of loans owned by the Company
for more than 180 days ("Seasoned Loans") at a discount to par value, as
compared to $420.5 million for the same period in 1997. The Company sold $2.3
million of Seasoned Loans at a 21% discount to par value in July 1998 and $9.6
million of Seasoned Loans at an 8% discount to par value in June 1998.
Gain on sale of loans was $29.7 million for the year ended December 31, 1998,
which compares with $33.5 million for the same period in 1997. These gains
exclude the sale of $12.0 million of Seasoned Loans at a discount in 1998. The
decrease for the year ended December 31, 1998, was the direct result of a
decrease in the weighted-average premium paid by investors for the Company's
loans. Gain on the sale of mortgage loans represented 60.9% of total revenue
during the year ended December 31, 1998, compared to 64.2% of total revenue for
the same period in 1997.
The weighted average premium realized by the Company on its loan sales decreased
to 5.4%, excluding the sale of $12.0 million Seasoned Loans at a discount to
par, during the year ended December 31, 1998, from 6.4% for the same period in
1997. Including the discounted sale of $12.0 million of Seasoned Loans, the
weighted average premium realized by the Company during the year ended December
31, 1998 decreased to 4.9% from 6.4% for the same period in 1997.
The decrease in premium percentage was caused by material changes in the
secondary market conditions for non-conforming mortgage loans. The Company has
never used securitization as a loan sale strategy. However, the whole-loan sale
marketplace for non-conforming mortgage loans was impacted by changes that
affected companies who previously used securitizations to sell loans. Excessive
competition during 1997 and 1998 and a coinciding reduction in interest rates in
general caused an increase in the prepayment speeds for non-conforming loans.
The valuation method applied to interest-only and residual assets ("Assets"),
the capitalized assets created from securitization, include an assumption for
average prepayment speed in order to determine the average life of a loan pool.
The increased prepayment speeds experienced in the industry were greater than
the assumptions previously used by many securitization issuers and led to an
impairment of Asset values for several companies in the industry. Additionally,
in September 1998, a flight to quality among fixed income investors negatively
impacted the pricing spreads for mortgage-backed securitizations compared to
earlier periods and negatively
54
impacted the associated economics to the issuers. Consequently, many of these
companies have and continue to report material losses, experienced reductions in
liquidity sources and diverted to whole loan sale strategies in order to
generate cash. This shift materially decreased the demand and increased the
supply of non-conforming mortgage loans in the secondary marketplace, which
resulted in significantly lower premiums on non-conforming whole-loan mortgage
sales.
In addition, the premium percentage has decreased due to a decrease in the
Weighted Average Coupon ("WAC") on the Company's loan origination's, which was
primarily the result of an increase in adjustable rate mortgage origination's
during 1998 compared to 1997. These premiums do not include loan origination
fees collected by the Company at the time the loans are closed, which are
included in the computation of gain on sale when the loans are sold.
The Company defers recognizing income from the loan origination fees it receives
at the time a loan is closed. These fees are deferred and recognized over the
lives of the related loans as an adjustment of the loan's yield using the level-
yield method. Deferred income pertaining to loans held for sale is taken into
income at the time of sale of the loan. Origination fee income is primarily
derived from the Company's retail lending division. Origination fee income
included in the gain on sale of loans, excluding the sale of $12.0 million of
Seasoned Loans at a discount, for the year ended December 31, 1998 was $10.4
million, compared to $8.6 million in the year ended December 31, 1997. The
increase is the result of the Company selling more loans generated by its retail
division. The Company's retail loan sales during the year ended December 31,
1998 comprised 55.5% of total loan sales, with average loan origination fee
income earned of 5.0%, excluding the Seasoned Loan sale of $12.0 million at a
discount. For the same period of 1997, the Company's retail loan sales were
48.5% of total loan sales with average origination fee income earned of 4.2%.
Fees associated with selling loans decreased to approximately 20 basis points of
the dollar volume of loans sold for the year ended December 31, 1998 from 35
basis points for the year ended December 31, 1997.
The Company also defers recognition of the expense it incurs, from the payment
of fees to mortgage brokers, for services rendered on loan originations. These
fees are deferred and recognized over the lives of the related loans as an
adjustment of the loan's yield using the level-yield method. Deferred expenses
pertaining to loans held for sale are taken into income at the time of the sale
of the loan.
Interest Income and Expense
The Company's net interest income is dependent on the difference, or "spread",
between the interest income it receives from its loans and its cost of funds,
consisting principally of the interest expense paid on the warehouse lines of
credit, the Bank's deposit accounts and other borrowings.
Interest income for the year ended December 31, 1998 was $10.3 million compared
with $10.9 million for the same period ended in 1997. The decrease in interest
income for the year ended December 31, 1998 was primarily due to a lower
weighted-average coupon associated with the balance of loans held for sale.
Interest expense for the year ended December 31, 1998 was $6.3 million compared
with $6.2 million for the year ended December 31, 1997. The decrease in interest
expense for the year ended December 31, 1998, was the direct result of an
increase in the average balance of interest-bearing liabilities.
Changes in the average yield received on the Company's loan portfolio may not
coincide with changes in interest rates the Company must pay on its revolving
warehouse loans, the Bank's FDIC-insured deposits, and other borrowings. As a
result, in times of rising interest rates, decreases in the difference between
the yield received on loans and other investments and the rate paid on
borrowings and the Bank's deposits usually occur.
55
The following tables reflect the average yield earned and rates paid by the
Company during 1998 and 1997. In computing the average yields and rates, the
accretion of loan fees is considered an adjustment to yield. Information is
based on average month-end balances during the indicated periods.
(In thousands)
1998 1997
------------------------------------------------- -----------------------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------------- ------------ ------------- -------------- -------------- -------------
Interest-earning assets:
Loans receivable (1) $ 83,522 $ 9,761 11.69% $ 74,116 $10,662 14.39%
Cash and other interest-
Earning assets 12,754 547 4.28 4,240 273 6.44
------------- ------------ ------------- -------------- -------------- -------------
96,276 10,308 10.71 78,356 10,935 13.96
------------ ------------- -------------- -------------
Non-interest-earning assets:
Allowance for loan losses (1,789) (1,231)
Investment in IMC 8,136 17,376
Premises and equipment, net 4,770 3,372
Other 11,875 7,112
------------- --------------
Total assets $119,268 $104,985
============= ==============
Interest-bearing liabilities:
Revolving warehouse lines $ 49,810 3,888 7.80 $ 59,681 4,834 8.10
FDIC-insured deposits 22,858 1,361 5.96 6,076 357 5.88
Other interest-bearing
Liabilities 10,677 1,003 9.39 10,307 966 9.37
------------- ------------ ------------- -------------- -------------- -------------
83,345 6,252 7.50 76,064 6,157 8.09
------------ ------------- -------------- -------------
Non-interest-bearing
liabilities 11,126 4,264
------------- --------------
Total liabilities 94,471 80,328
Shareholders' equity 24,797 24,657
------------- --------------
Total liabilities and
equity $119,268 $104,985
============= ==============
Average dollar difference
between
Interest-earning assets
and interest-
Bearing liabilities $ 12,931 $ 2,292
============= ==============
Net interest income $ 4,056 $ 4,778
============ ==============
Interest rate spread (2) 3.21% 5.87%
============= =============
Net annualized yield on
average
Interest-earning assets 4.21% 6.10%
============= =============
_____________
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
(2) Average yield on total interest-earning assets less average rate paid on
total interest-bearing liabilities.
56
The following table shows the amounts of the changes in interest income and
expense which can be attributed to rate (change in rate multiplied by old
volume) and volume (change in volume multiplied by old rate) for the year ended
December 31, 1998 compared to the year ended December 31, 1997. The changes in
net interest income due to both volume and rate changes have been allocated to
volume and rate in proportion to the relationship of absolute dollar amounts of
the change of each. The table demonstrates that the decrease of $723,000 in net
interest income for the year ended December 31, 1998 compared to the year ended
December 31, 1997 was primarily result of a decrease in the average yield on
interest-earning assets
1998 Versus 1997
Increase (Decrease) Due to
--------------------------------------------------------------
(in thousands) Volume Rate Total
-------------------- ---------------- ----------------
Total interest-earning assets
Loans receivable $ 1,884 $ (2,785) $ (901)
Cash and other
Interest-earning assets 328 (55) 273
-------------------- ---------------- ----------------
2,212 (2,840) (628)
-------------------- ---------------- ----------------
Total interest-bearing liabilities
Revolving warehouse loans (776) (170) (946)
FDIC-insured deposits 999 5 1,004
Other 35 2 37
-------------------- ---------------- ----------------
258 (163) 95
-------------------- ---------------- ----------------
Net interest income $ 1,954 $ (2,677) $ (723)
==================== ================ ================
Gain on Sale of Securities
The Company sold 558,400 shares of IMC stock for $1.9 million, which resulted in
a pre-tax gain of $1.8 million, during 1998. The Company sold 233,241 shares of
IMC stock for $3.7 million, which resulted in a pre-tax gain of $2.8 million,
during 1997.
Other Income
In addition to net interest income (expense), and gain on the sale of loans, the
Company derives income from origination fees earned on brokered loans generated
by the Company's retail offices and other fees earned on the loans funded by the
Company, such as document preparation fees, underwriting service fees,
prepayment penalties, and late charge fees for delinquent loan payments.
Brokered loan fees were $4.3 million for the year ended December 31, 1998,
compared to $1.0 million for the year ended December 31, 1997. For the year
ended December 31, 1998, other income totaled $7.0 million compared to $5.0
million for the same period in 1997. The increase was primarily the result of
the increase in brokered loan fees, which was offset by a reduction in
underwriting fee income due to a lower volume of loans closed.
Comprehensive Income
The Company has comprehensive income (loss) in the form of unrealized holding
gain (loss) on securities held for sale. The shares of IMC Mortgage Company
common stock owned by the Company is the primary
57
component of the Company's security holdings (See Item 2 section "Assets"). For
the year ended December 31, 1998, other comprehensive loss was $6.8 million
compared to comprehensive loss of $4.5 million for the year ended December 31,
1997. The losses for the year ended December 31, 1998 and 1997, were related to
a decrease in the market price of IMC Mortgage Company common stock. The Company
owned approximately 435,634 shares of IMC Mortgage Company common stock on
December 31, 1998.
Compensation and Related Expenses
The largest component of expenses is compensation and related expenses, which
increased by $4.9 million to $23.4 million for the year ended December 31, 1998,
compared to the same period in 1997. The increase was directly attributable to
an increase in the number of employees. During the year ended December 31, 1998,
approximately 60% of the increase was attributed to staffing needs for seven
additional retail origination offices compared to the same period in 1997. The
remaining 40% of the increase in compensation and related benefits expense for
the year ended December 31, 1998, was due to a higher number of employees in the
corporate headquarters during the first six months of 1998. During the first six
months of 1998, the Company had an increase of 68.1% in corporate office staff
compared to the same period in 1997, with a corresponding increase in base
salaries and benefits of approximately $2.0 million. However, in July 1998, the
Company initiated a plan to reduce the number of employees in the corporate
office. As of December 31, 1998, the home office had been reduced by 21%
compared to March 31, 1998.
General and Administrative Expenses
General and administrative expenses for the year ended December 31, 1998
increased by $1.5 million to $11.7 million, compared to the year ended December
31, 1997. This increase is attributed to the addition of seven retail-lending
offices during the year ended December 31, 1998.
Loan Production Expense
The largest component of loan production expense is fees paid by the Company to
mortgage brokers for services rendered in the preparation of loan packages.
Other items that comprise loan production expenses are appraisals, credit
reports, leads research and telemarketing expenses. Loan production expenses for
the year ended December 31, 1998 were $3.6 million compared to $1.9 million for
the year ended December 31, 1997. The increase was primarily the result of an
increase in services rendered fees.
58
Provision for Loan Losses
The following table presents the activity in the Company's allowance for loan
losses and selected loan loss data for 1998 and 1997:
(In thousands)
Years Ended
December 31 1998 1997
------------------ -------------------
Balance at beginning of year $ 1,687 $ 924
Provision charged to expense 3,064 1,534
Acquisition of MOFC, Inc. 49 -
Loans charged off (2,372) (953)
Recoveries of loans previously charged off 162 182
------------------ -------------------
Balance at end of year $ 2,590 $ 1,687
================== ===================
Loans receivable at year-end, gross
of allowance for losses $ 107,634 $ 82,383
Ratio of allowance for loan losses to gross
loans receivable at year-end 2.41% 2.05%
The Company added $3.1 million during the year ended December 31, 1998 to the
allowance for loan losses, compared to an increase of $1.5 million for the year
ended December 31, 1997. The increase was primarily the result of two Seasoned
Loan sales, of approximately $9.6 million, at 92% and $2.3 million, at 79%, of
the carrying value of the loans. Also contributing to the increase in the
provision for loan losses was an increase in the balance of gross mortgage loans
held by the Company for the respective dates. All losses ("charge offs" or
"write downs") and recoveries realized on loans previously charged off, are
accounted for in the allowance for loan losses.
The allowance is established at a level that management considers adequate
relative to the composition of the current portfolio of loans held for sale.
Management considers characteristics of the Company's current loan portfolio
such as credit quality, the weighted average coupon, the weighted average loan
to value ratio, the age of the loan portfolio and the portfolio's delinquency
status in the determination of an appropriate allowance. Other criteria such as
covenants associated with the Company's credit facilities, trends in the demand
and loan sale pricing for non-conforming mortgage loans in the secondary market
and general economic conditions, including interest rates, are also considered
when establishing the allowance. Adjustments to the reserve for loan losses may
be made in future periods due to changes in the factors mentioned above and any
additional factors that may effect anticipated loss levels in the future.
59
Provision for Foreclosed Property Losses
The Company decreased its provision for foreclosed property losses by $168,000
for the year ended December 31, 1998, compared to an increase of $142,000 for
the year ended December 31, 1997.
Sales of real estate owned yielded net losses of $660,000 for the year ended
December 31, 1998 versus $654,000 for the year ended December 31, 1997.
The following table presents the activity in the Company's allowance for
foreclosed property losses and selected real estate owned data for 1998 and
1997:
(In thousands)
Years Ended
December 31 1998 1997
---------------- ----------------
Balance at beginning of year $ 671 $ 529
Provision charged to expense (168) 142
---------------- ----------------
Balance at end of year $ 503 $ 671
================ ================
Real estate owned at year-end, gross
of allowance for losses $ 2,211 $ 3,038
Ratio of allowance for foreclosed property losses
to gross real estate owned at year-end 22.80% 22.09%
The Company maintains a reserve on its real estate owned ("REO") based upon
management's assessment of appraised values at the time of foreclosure. The
decrease in the provision for foreclosed property losses relates to a decrease
in the dollar amount of outstanding REO at December 31, 1998 when compared to
December 31, 1997. While the Company's management believes that its present
allowance for foreclosed property losses is adequate, future adjustments may be
necessary.
60
Financial Condition at December 31, 1999 and 1998
Assets
The total assets of the Company were $98.6 million at December 31, 1999,
compared to total assets of $136.1 million at December 31, 1998.
Cash and cash equivalents increased by $4.4 million to $10.7 million at December
31, 1999, from $6.3 million at December 31, 1998. The increase was the result of
the Company's banking subsidiary increasing its cash position due to Y2K
concerns.
Net mortgage loans receivable decreased by $38.3 million to $66.8 million at
December 31, 1999. The 36.4% decrease in 1999 is primarily due to the Company
selling more loans than were originated in-house during 1999. The Company
generally sells loans within sixty days of origination.
Real estate owned ("REO") increased by $0.6 million to $2.3 million at December
31, 1999. The 33.2% increase in REO resulted from the sale of $3.2 million in
REO properties and additions of $4.0 million to REO during the twelve months
ended December 31, 1999.
Investments decreased by $0.8 million to $2.6 million at December 31, 1999.
Investments consist primarily of an Asset Management Fund, Inc. Adjustable Rate
Mortgage Portfolio and FHLB stock owned by the Bank. The 24.0% decrease in
investments in 1999 is primarily due to the sale of shares in the Asset
Management Fund, Inc. Adjustable Rate Mortgage Portfolio.
Premises and equipment increased by $0.5 million to $6.1 million at December 31,
1999. The change in premises and equipment is due to several transactions. The
Company purchased a new administrative and executive office building located in
Virginia Beach, Virginia for $2,250,000, had additions of $0.7 million in
equipment and improvements and purchased 7.77 acres of land for $0.6 million.
This was offset by the sale of one of the Company's office buildings in Virginia
Beach for $1.1 million and the disposition of $2.1 million of equipment located
in the retail branches recently closed by the Company and the disposition of old
equipment at the headquarters locations offset the increase from the purchase of
the new administrative and executive office building.
Goodwill (net) decreased by $3.4 million to $1.1 million at December 31, 1999.
The decrease is due to the write down of goodwill associated with the 1998
purchase of MOFC, Inc. d.b.a. ConsumerOne Financial and the Funding Center of
Georgia. The anticipated net income from both acquisitions was not realized due
to the decreasing margins in the nonconforming mortgage industry, therefore the
company reevaluated its intangible assets associated with these acquisitions. It
was determined that the Funding Center of Georgia goodwill would be written down
to zero. This resulted in a write down of goodwill, which was a charge to
income, of $358,000 and a write down of goodwill of $272,000, which was not a
charge to income because it was offset by a corresponding write down of an
accrued payable for anticipated "earnout" payments to acquisitions. It was
determined that the goodwill related to MOFC, Inc. dba ConsumerOne would be
written down to the initial payment of $575,000. This resulted in a write off of
goodwill in the amount of $773,000 which was a charge to income and a write down
of $1.6 million which was not a charge to income because it was offset by a
corresponding write down of an accrued payable for anticipated "earnout"
payments to acquisitions. The remaining decrease is associated in goodwill with
the 1999 amortization expense.
Income tax receivable increased by $3.6 million to $5.6 million at December 31,
1999. The 179.0% increase can be attributed to the Company's before tax net loss
of $12.7 million for the twelve months ended December
61
31, 1999, which results in net tax loss carry forwards.
The deferred tax asset decreased by $1.6 million to $1.7 million at December 31,
1999. The change was the result of a combination of a reduction of the state tax
rate from 8.75% in 1998 to 7.0% in 1999 and the elimination of unearned loan
fees (FAS 91) as a timing difference in the calculation of the Company's tax
provision.
Other assets decreased by $2.4 million to $1.7 million at December 31, 1999.
Other assets consist of accrued interest receivable, prepaid assets, brokered
loan fees receivable, deposits, and various other assets. Accrued interest
receivable decreased $0.2 million, which was due to a lower average loans held
for sale at December 31, 1999. In addition, prepaid assets decreased by $1.0
million. At December 31, 1998 there were $0.7 million in loans that had been
funded that did not close until January 1999. In addition prepaid syndicated
bank fees decreased from $0.2 million at December 31, 1998 to zero for the same
period ended December 31, 1999. Other receivables decreased by $0.4 million and
impounds (net) decreased by $0.2 million due to the creation of a 25% allowance
for impound losses created in December 1999. The remainder of the decrease is
due to a lower brokered loan fee receivable for the twelve months ended December
31, 1999.
Liabilities
Outstanding balances for the Company's revolving warehouse loans decreased by
$55.1 million to $17.5 million at December 31, 1999. The75.9% decrease in 1999
was primarily attributable to the decrease in loans receivable.
The Company draws on its revolving warehouse lines of credit as needed to fund
loan production. As of December 31, 1999, the Company had issued loan funding
checks totaling $1.0 million which had not cleared the Company's checking
account and for which the Company had not drawn funds from its warehouse lines.
These checks cleared the Company's bank accounts in the first few business days
of January 2000 and most were funded with cash on hand or new warehouse line
draws.
The Bank's deposits totaled $55.3 million at December 31, 1999 compared to $29.7
million at December 31, 1998. The Bank substantially increased its deposits in
1999 in order to fund loans. Of the certificate accounts as of December 31,
1999, a total of $44.9 million was scheduled to mature in the twelve-month
period ending December 31, 2000.
As of December 31, 1999 the Bank borrowed $4.6 million from the Federal Home
Loan Bank (FHLB) to fund loan production. There were no borrowings at December
31, 1998.
Promissory notes and certificates of indebtedness totaled $5.1 million at
December 31, 1999 compared to $6.0 million at December 31, 1998. The 15.9%
decrease is primarily due to the redemption of maturing promissory notes and
certificates. In 1999 the Company was not soliciting new promissory notes or
certificates of indebtedness. The Company has utilized promissory notes and
certificates of indebtedness to help fund its operations since 1984, which are
subordinated to the Company's warehouse lines of credit. Promissory notes
outstanding carry terms of one to five years and interest rates between 8.00%
and 10.25%, with a weighted-average rate of 9.62% at December 31, 1999.
Certificates of indebtedness are uninsured deposits authorized for financial
institutions like the Company, which have Virginia industrial loan association
charters. The certificates of indebtedness carry terms of one to five years and
interest rates between 6.75% and 10.00%, with a weighted-average rate of 9.69%
at December 31, 1999.
Mortgage loans payable increased by $1.1 million to $2.3 million at December 31,
1999. The increase is due
62
to the purchase of a new administrative and executive office building in
Virginia Beach, VA. The purchase price was $2,250,000 and the Company carries a
mortgage note payable for $2,025,000. The Company also sold one of its
headquarters buildings for which the Company was carrying a mortgage note
payable of $0.8 million.
Accrued and other liabilities decreased by $4.9 million to $2.4 million at
December 31, 1999. This category includes accounts payable, loan proceeds
payable, accrued interest payable, deferred income, accrued bonuses, and other
payables. The 66.8% decrease is primarily attributable to the elimination of the
$1.6 million investment payable attributed to the 1998 acquisition of a Michigan
based loan origination office, and the elimination of the $0.3 million
investment payable attributed to the Georgia based loan origination office. In
1998 the Company also had $2.6 million in loan proceeds payable compared to zero
for the same period ending December 31, 1999. The remaining decrease is
attributable to payment of year end accrued payables and the cancellation of
capitalized lease obligations.
Shareholders' Equity
Total shareholders' equity at December 31, 1999 was $11.3 million compared to
$19.3 million at December 31, 1998. The $8.0 million decrease in 1999 was
primarily due to the $7.9 million loss for the twelve months ended December 31,
1999.
Liquidity and Capital Resources
The Company's operations require access to short and long-term sources of cash.
The Company's primary sources of cash flow result from the sale of loans through
whole loan sales, loan origination fees, processing, underwriting and other fees
associated with loan origination and servicing, net interest income, and
borrowings under its warehouse facilities, certificates of indebtedness issued
by Approved Financial Corp. and certificates of deposit issued by the Bank to
meet its working capital needs. The Company's primary operating cash
requirements include the funding of mortgage loan originations pending their
sale, operating expenses, income taxes and capital expenditures.
Adequate credit facilities and other sources of funding, including the ability
to sell loans in the secondary market, are essential to the Company's ability to
continue to originate loans. The Company has historically operated, and expects
to operate in the future on a negative cash flow basis from operations due to
the fact that origination's normally exceed loan sales. However, for the year
ended December 31, 1999, the Company was provided cash from operating activities
of $28.0 million, due to the fact that the Company sold a greater volume of
loans than it funded during the period. The net cash provided by operating
activities was primarily used to fund mortgage loan originations. For the year
ended December 31, 1998 the Company used cash from operating activities of $31.8
million.
The Company finances its operating cash requirements primarily through warehouse
and other credit facilities, and the issuance of other debt. For the year ended
December 31, 1999, the Company paid down debt from financing activities of $24.7
million, due to the fact that the Company had repayments of debt in excess of
borrowings, which was the result of loan sales exceeding loan origination's. For
the year ended December 31, 1998 the Company received cash from financing
activities of $22.2 million.
The Company's borrowings (revolving warehouse loans, FDIC-insured deposits,
mortgage loans on Company office buildings, FHLB advances, subordinated debt and
loan proceeds payable) were 86.1% of assets at December 31, 1999 compared to
82.3% at December 31, 1998.
63
Whole Loan Sale Program
The Company's most important source of liquidity and capital resources is the
ability to profitably sell conforming and non-conforming loans in the secondary
market. The market value of the loans funded by the Company is dependent on a
number of factors, including but not limited to loan delinquency and default
rates, the original term and current age of the loan, the interest rate and loan
to value ratio, whether or not the loan has a prepayment penalty, the credit
grade of the loan, the credit score of the borrower, the geographic location of
the real estate, the type of property, the supply and demand for conforming and
non-conforming loans in the secondary market, general economic and market
conditions, market interest rates and governmental regulations. Adverse changes
in these conditions may affect the Company's ability to sell mortgages in the
secondary market for acceptable prices, which is essential to the continuation
of the Company's mortgage origination operations.
Bank Sources of Capital
The Bank's deposits totaled $55.3 million at December 31, 1999, compared to
$29.7 million at December 31, 1998. The Bank currently utilizes funds from
deposits and a $15 million line of credit with the FHLB of Atlanta to fund first
lien and junior lien mortgage loans. The Company plans to increase the use of
credit facilities and funding opportunities available to the Bank.
Warehouse and Other Credit Facilities
On November 10, 1999 the Company obtained a $20.0 million sub-prime line of
credit from Regions Bank. The line is secured by loans originated by the Company
and bears interest at a rate of 3.25% over the one-month LIBOR rate. The Company
may receive warehouse credit advances of 100% of the net loan value amount on
pledged mortgage loans for a period of 90 days after origination. As of December
31, 1999 $5.3 million was outstanding under this facility. The line of credit is
scheduled to expire on November 10, 2001. The line of credit is subject to
financial covenants for a current ratio, tangible net worth and a leverage
ratio. As of December 31, 1999 the Company is in compliance with all financial
covenants.
On November 10, 1999 the Company obtained a $20.0 million conforming loan line
of credit from Regions Bank. The line is secured by loans originated by the
Company and bears interest ranging from 2.25% to 2.75% over the one-month LIBOR
rate based upon the monthly advance levels. The Company may receive warehouse
credit advances of 100% of the net loan value amount on pledged mortgage loans
for a period of 90 days after origination. As of December 31, 1999 there were no
borrowings outstanding under this facility. The line of credit is scheduled to
expire on November 10, 2001. The line of credit is subject to financial
covenants for a current ratio, tangible net worth and a leverage ratio. As of
December 31, 1999 the Company is in compliance with all financial covenants.
Effective on December 8, 1999, the Company obtained an amendment to their
warehouse line of credit agreement with Chase Bank of Texas. Since the
utilization of the credit line has been very low in 1999, the amendment reduced
the size of the warehouse facility to $15.0 million, and all bank syndicate
members other than Chase were released from the commitment. The line is secured
by loans originated by the Company and bears interest at a rate of 1.75% over
the one-month LIBOR rate. The Company may receive warehouse credit advances of
95% of the original principal balances on pledged mortgage loans for a maximum
period of 180 days after origination. As of December 31, 1999, $12.1 million was
outstanding under this facility. The line is scheduled to expire on June 7, 2000
and will not be renewed. The line of credit is subject to financial covenants
for tangible net worth and a leverage ratio. As of December 31, 1999 the Company
is in compliance with all financial
64
covenants.
Other Capital Resources
Promissory notes and certificates of indebtedness have been a source of capital
for the Company since current management acquired the Company in 1984.
Promissory notes and certificates of indebtedness totaled $5.1 million at
September 30, 1999 compared to $6.0 million at December 31, 1998. These
borrowings are subordinated to the Company's warehouse lines of credit.
The Company had cash and cash equivalents of $10.7 million at December 31, 1999.
The Company has sufficient resources to fund its current operations. Alternative
sources for future liquidity and capital resource needs may include the issuance
of debt or equity securities, increase in Saving Bank deposits and new lines of
credit. Each alternative source of liquidity and capital resources will be
evaluated with consideration for maximizing shareholder value, regulatory
requirements, the terms and covenants associated with the alternative capital
source. Management expects that the Company and the industry will continue to be
challenged by a limited availability of capital, a reduction in premiums
received on non-conforming mortgage loans sold in the secondary market compared
to premiums realized in recent years, new competition and a rise in loan
delinquency and the associated loss rates.
Bank Regulatory Liquidity
Liquidity is the ability to meet present and future financial obligations,
either through the acquisition of additional liabilities or from the sale or
maturity of existing assets, with minimal loss. Regulations of the OTS require
thrift associations and/or banks to maintain liquid assets at certain levels. At
present, the required ratio of liquid assets to and borrowings, which can be
withdrawn and are due in one year or less is 4.0%. Penalties are assessed for
noncompliance. In 1999 and 1998, the Bank maintained liquidity in excess of the
required amount, and management anticipates that it will continue to do so.
Bank Regulatory Capital
At December 31, 1999, the Bank's book value under generally accepted accounting
principles ("GAAP") was $6.4 million. OTS Regulations require that institutions
maintain the following capital levels: (1) tangible capital of at least 1.5% of
total adjusted assets, (2) core capital of 4.0% of total adjusted assets, and
(3) overall risk-based capital of 8.0% of total risk-weighted assets. As of
December 31, 1999, the Bank satisfied all of the regulatory capital
requirements, as shown in the following table reconciling the Bank's GAAP
capital to regulatory capital:
Tangible Core Risk-Based
(In thousands) Capital Capital Capital
GAAP capital $ 6,356 $ 6,356 $ 6,356
Add: unrealized loss on securities 16 16 16
Nonallowable asset: goodwill (101) (101) (101)
Additional capital item: general allowance - - 336
-------- ------- --------
Regulatory capital - computed 6,271 6,271 6,607
Minimum capital requirement 1,106 2,949 4,004
-------- ------- --------
Excess regulatory capital $ 5,165 $ 3,322 $ 2,603
======== ======= ========
Ratios:
Regulatory capital - computed 8.51% 8.51% 13.20%
Minimum capital requirement 1.50% 4.00% 8.00%
65
------ ------- --------
Excess regulatory capital 7.01% 4.51% 5.20%
====== ======= ========
Management believes that the Bank can remain in compliance with its capital
requirements.
The Company is not aware of any other trends, events or uncertainties other than
those discussed in the section "Gain on Sale of Loans" which will have or that
are likely to have a material effect on the Company's or the Bank's liquidity,
capital resources or operations. The Company is not aware of any current
recommendations by regulatory authorities, which if they were implemented would
have such an effect.
Hedging Activities
The Company originates mortgage loans for sale as whole loans. The Company
mitigates its interest rate exposure by selling most of the loans within sixty
days of origination. However, the Company may choose to hold certain loans for a
longer period prior to sale in order to increase net interest income. Currently
loans held for investment by the Bank are primarily composed of adjustable rate
mortgages in order to minimize the Bank's interest rate risk exposure. However,
excluding the Bank's loans held for investment the majority of loans held by the
Company beyond the normal sixty-day holding period are fixed rate instruments.
Since most of the Company's borrowings have variable interest rates, the Company
has exposure to interest rate risk. For example, if market interest rates were
to rise between the time the Company originates the loans and the time the loans
are sold, the original interest rate spread on the loans narrows, resulting in a
loss in value of the loans. To offset the effects of interest rate fluctuations
on the value of its fixed rate mortgage loans held for sale, the Company in
certain cases, may enter into Treasury security lock contracts, which function
similar to short sales of U.S. Treasury securities. If the value of an interest
rate hedge position decreases in value, offsetting an increase in the value of
the hedged loans, the Company, upon settlement with its counter-party, will pay
the hedge loss in cash and realize the corresponding increase in the value of
the loans. Conversely, if the value of a hedge position increases, offsetting a
decrease in the value of the hedged loans, the Company will receive the hedge
gain in cash at settlement. The Company's management believes that its current
hedging strategy using Treasury rate lock contracts is an effective way to
manage interest rate risk on fixed rate loans prior to sale. The Company may in
the future enter into similar transactions with government and quasi-government
agency securities in relation to its origination and sale of conforming mortgage
loans or similar forward loan sale commitments concerning non-conforming
mortgages. Prior to entering into any type of hedge transaction or forward loan
sale commitment, the Company performs an analysis of the loan associated with
the transaction or commitment taking into account such factors as credit quality
of the loans, interest rate and term of the loans, as well as current economic
market trends, in order to determine the appropriate structure and/or size of a
hedge transaction or loan sale commitment that will to limit the Company's
exposure to interest rate risk. The Company had no hedge contracts or forward
commitments outstanding at December 31, 1999. The Company has not entered into
any hedge contracts since the fourth quarter of 1997. That commitment expired
during the first quarter of 1998.
New Accounting Standards
As amended, SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" is effective for fiscal years beginning after June 15, 2000. This
statement establishes the accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contract, (collectively referred to as derivatives) and for hedging activities.
It requires that entities recognize all derivative as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign
66
operation, an unrecognized firm commitment, an available-for-sale security, or
foreign-currency-denominated forecasted transaction. This statement should not
have any material impact on the financial statements.-
In October 1998, SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise" was issued, effective for the first fiscal quarter beginning
after December 15, 1998. The new statement requires that after an entity that
engaged in mortgage banking activities has securitized mortgage loans that it
held for sale, it must classify the resulting retained mortgage-backed
securities or other retained interest based on its ability and intent to sell or
hold those investments. Any retained mortgage-backed securities that are
committed for sale before or during the securitization process must be
classified as trading. This statement did not have any impact on the Company's
financial statements since the Company has never securitized loans.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented in this
document have been prepared in accordance with generally accepted accounting
principles, which require the measurement of the financial position and
operating results of the Company in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation.
Virtually all of the assets of the Company are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or with the same magnitude as the
prices of goods and services. Inflation affects the Company most significantly
in the area of loan originations and can have a substantial effect on interest
rates. Interest rates normally increase during periods of high inflation and
decrease during periods of low inflation.
Because the Company sells a significant portion of the loans it originates,
inflation and interest rates have a diminished effect on the Company's results
of operations. The Bank is expected to continue to build its portfolio of loans
held for investment, and this portfolio will be more sensitive to the effects of
inflation and changes in interest rates.
Profitability may be directly affected by the level and fluctuation of interest
rates, which affect the Company's ability to earn a spread between interest
received on its loans and the costs of its borrowings. The profitability of the
Company is likely to be adversely affected during any period of unexpected or
rapid changes in interest rates. A substantial and sustained increase in
interest rates could adversely affect the ability of the Company to originate
and purchase loans and affect the mix of first and junior lien mortgage loan
products. Generally, first mortgage production increases relative to junior lien
mortgage production in response to low interest rates and junior lien mortgage
loan production increases relative to first mortgage loan production during
periods of high interest rates. A significant decline in interest rates could
decrease the size of the Company's future loan servicing portfolio by increasing
the level of loan prepayments and it may also affect the net interest income
earned by the Company resulting from the difference between the yield to the
Company on loans held pending sales and the interest paid by the Company for
funds borrowed under the Company's warehouse facilities. Additionally, to the
extent servicing rights and interest-only and residual classes of certificates
are capitalized on the Company's books from future loan sales through
securitization, higher than anticipated rates of loan prepayments or losses
could require the Company to write down the value of such servicing rights and
interest-only and residual certificates, adversely affecting earnings.
Conversely, lower than anticipated rates of loan prepayments or lower losses
could allow the Company to increase the value of interest-only and residual
certificates, which could have a favorable effect on the Company's results of
operations and financial condition.
67
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Management - Asset/Liability Management
The Company's primary market risk exposure is interest rate risk. Fluctuations
in interest rates will impact both the level of interest income and interest
expense and the market value of the Company's interest-earning assets and
interest-bearing liabilities.
Management strives to manage the maturity or repricing match between assets and
liabilities. The degree to which the Company is "mismatched" in its maturities
is a primary measure of interest rate risk. In periods of stable interest rates,
net interest income can be increased by financing higher yielding long-term
mortgage loan assets with lower cost short-term Bank deposits and borrowings.
Although such a strategy may increase profits in the short run, it increases the
risk of exposure to rising interest rates and can result in funding costs rising
faster than asset yields. The Company attempts to limit its interest rate risk
by selling a majority of the fixed rate mortgage loans that it originates.
Contractual principal repayments of loans do not necessarily reflect the actual
term of the Company's loan portfolio. The average lives of mortgage loans are
substantially less than their contractual terms because of loan prepayments and
because of enforcement of due-on-sale clauses, which gives the Company the right
to declare a loan immediately due and payable in the event, among other things,
the borrower sells the real property subject to the mortgage and the loan is not
repaid. In addition, certain borrowers increase their equity in the security
property by making payments in excess of those required under the terms of the
mortgage.
The majority of the loans originated by the Company are sold through the
Company's loan sale strategies in an attempt to limit its exposure to interest
rate risk in addition to generating cash revenues. The Company sold, during 1999
and 1998, approximately 77.3% and 78.5% of the total loans originated and funded
in-house during the years ended December 31, 1999 and 1998, respectively, and
expects to sell the majority of its loan originations during the same twelve-
month period in which they are funded by the Company in future periods. December
1999 loan production represented approximately 49% of the total unsold 1999
loans. The majority of these loans were sold in January 2000. As a result, loans
are held on average for less than 12 months in the Company's portfolio of Loans
Held for Sale. The "gap position", defined as the difference between interest-
earning assets and interest-bearing liabilities maturing or repricing in one
year or less, was negative at December 31, 1999, as anticipated, and is expected
to remain negative in future periods. The Company has no quantitative target
range for past gap positions, nor any anticipated ranges for future periods due
to the fact that the Company sells the majority of its loans within a twelve
month period while the gap position is a static illustration of the contractual
repayment schedule for loans.
68
The Company's one-year gap was a negative 37.55% of total assets at December 31,
1999, as illustrated in the following table:
One Year Two Three to More Than
Description Total Or Less Years Four Years Four Years
Interest earning assets:
Loans receivable (1) $68,153 $ 19,081 $ 3,297 $ 7,716 $38,058
Cash and other 12,764 12,764
Interest-earning assets
-------- --------- --------- --------- -------
80,917 $ 31,845 $ 3,297 $ 7,716 $38,058
========= ========= ========= =======
Allowance for loan losses (1,382)
Investment in IMC 0
Premises and equipment, net 6,086
Other 12,979
--------
Total assets $ 98,600
========
Interest-bearing liabilities:
Revolving warehouse lines $ 17,465 17,465
FDIC - insured deposits 55,339 44,939 5,943 4,358 99
Other interest-bearing 12,285 6,371 664 1,781 3,469
Liabilities
-------- --------- --------- --------- -------
85,089 $ 68,775 $ 6,607 $ 6,139 $ 3,568
========= ========= ========= =======
Non-interest-bearing liabilities 2,212
--------
Total liabilities 87,301
Shareholders' equity 11,299
--------
Total liabilities and equity $98,600
========
Maturity/repricing gap $ (36,930) $ (3,310) $ 1,577 $34,490
========= ========= ========= =======
Cumulative gap $ (36,930) $(40,240) $(38,663) $(4,173)
========= ========= ========= =======
As percent of total assets (37.45) (40.81) (39.21) (4.23)
Ratio of cumulative interest earning
Assets to cumulative interest earning Liabilities 0.46 0.47 0.53 0.95
- --------------------------------------------------------------------------------
(1) Loans shown gross of allowance for loan losses, net of
premiums/discounts.
69
Interest Rate Risk
The principal quantitative disclosure of the Company's market risks are the gap
table on page 70. The gap table shows that the Company's one-year gap was a
negative 37.45% of total assets at December 31, 1999. The Company originates
fixed-rate, fixed-term mortgage loans for sale in the secondary market. While
most of these loans are sold within a month or two of origination, for purposes
of the gap table the loans are shown based on their contractual scheduled
maturities. As of December 31, 1999, 55.8% of the principal on the loans was
expected to be received more than four years from that date. However, the
Company's activities are financed with short-term loans and credit lines, 80.8%
of which reprice within one year of December 31, 1999. The Company attempts to
limit its interest rate risk by selling a majority of the fixed rate loans that
it originates. If the Company's ability to sell such fixed-rate, fixed-term
mortgage loans on a timely basis were to be limited, the Company could be
subject to substantial interest rate risk.
Profitability may be directly affected by the levels of and fluctuations in
interest rates, which affect the Company's ability to earn a spread between
interest received on its loans and the costs of borrowings. The profitability of
the Company is likely to be adversely affected during any period of unexpected
or rapid changes in interest rates. For example, a substantial or sustained
increase in interest rates could adversely affect the ability of the Company to
purchase and originate loans and would reduce the value of loans held for sale.
A significant decline in interest rates could decrease the size of the Company's
loan servicing portfolio by increasing the level of loan prepayments.
Additionally, to the extent mortgage loan servicing rights in future periods
have been capitalized on the books of the Company, higher than anticipated rates
of loan prepayments or losses could require the Company to write down the value
of these assets, adversely affecting earnings.
In an environment of stable interest rates, the Company's gains on the sale of
mortgage loans would generally be limited to those gains resulting from the
yield differential between mortgage loan interest rates and rates required by
secondary market purchasers. A loss from the sale of a loan may occur if
interest rates increase between the time the Company establishes the interest
rate on a loan and the time the loan is sold. Fluctuating interest rates also
may affect the net interest income earned by the Company, resulting from the
difference between the yield to the Company on loans held pending sale and the
interest paid by the Company for funds borrowed, including the Company's
warehouse facilities and the Bank's FHLB advances and FDIC-insured customer
deposits. Because of the uncertainty of future loan origination volume and the
future level of interest rates, there can be no assurance that the Company will
realize gains on the sale of financial assets in future periods.
The Bank is building a portfolio of loans to be held for net interest income.
The sale of fixed rate product is intended to protect the Bank from precipitous
changes in the general level of interest rates. The valuation of adjustable rate
mortgage loans is not as directly dependent on the level of interest rates as is
the value of fixed rate loans. Decisions to hold or sell adjustable rate
mortgage loans are based on the need for such loans in the Bank's portfolio,
which is influenced by the level of market interest rates and the Bank's
asset/liability management strategy. As with other investments, the Bank
regularly monitors the appropriateness of the level of adjustable rate mortgage
loans in its portfolio and may decide from time to time to sell such loans and
reinvest the proceeds in other adjustable rate investments.
70
Asset Quality
The following table summarizes all of the Company's delinquent loans at December
31, 1999, 1998, and 1997:
(in thousands)
1999 1998 1997
-------- --------- --------
Delinquent 31 to 60 days $ 864 $ 697 $ 866
Delinquent 61 to 90 days 264 1,115 1,124
Delinquent 91 to 120 days 513 1,460 970
Delinquent 121 days or more 1,466 2,658 1,567
-------- --------- --------
Total delinquent loans (1) $ 3,106 $ 5,930 $ 4,527
======== ========= ========
Total loans receivable outstanding, gross $69,054 $109,500 $83,512
======== ========= ========
Delinquent loans as a percentage of
Total loans outstanding:
Delinquent 31 to 60 days 1.25% 0.64% 1.04%
Delinquent 61 to 90 days 0.39 1.02 1.35
Delinquent 91 to 120 days 0.74 1.33 1.16
Delinquent 121 days or more 2.12 2.43 1.87
-------- --------- --------
Total delinquent loans as a percentage
of total loans outstanding 4.50% 5.42% 5.42%
======== ========= ========
_____________
(1) Includes loans in foreclosure proceedings and delinquent loans to borrowers
in bankruptcy proceedings, but excludes real estate owned.
Interest on most loans is accrued until they become 31 days or more past due.
Interest on loans held for investment by the Bank is accrued until the loans
become 90 days or more past due. Non-accrual loans were $2.2 million and $5.2
million at December 31, 1999 and 1998 respectively. The amount of additional
interest that would have been recorded had the loans not been placed on non-
accrual status was approximately $235,000, $212,000 and $154,000 for the years
ended December 31, 1999, 1998 and 1997, respectively. The amount of interest
income on the non-accrual loans, that was included in net income for the twelve
months ended December 31, 1999 was $109,000. The data for interest income on
non-accrual loans, that was included in net income for the year ended December
31, 1998 was not available.
Loans delinquent 31 days or more as a percentage of total loans outstanding
decreased to 4.50% at December 31, 1999 from 5.42% at December 31, 1998.
At December 31, 1999 and 1998 the recorded investment in loans for which
impairment has been determined in accordance with SFAS 114 totaled $2.0 million
and $4.1 million, respectively. The average recorded investment in impaired
loans for the years ended December 31, 1999 and 1998 was approximately $3.5
million and $2.6 million respectively.
SFAS 118 allows a creditor to use existing methods for recognizing interest
income on an impaired loan. Consistent with the Company's method for non-accrual
loans, interest receipts for impaired loans are recognized as interest income or
are applied to principal when the principal is in doubt of being collected. Due
to the homogenous nature and the collateral securing these loans, there is no
corresponding valuation allowance.
71
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements, the report thereon, the
notes thereon and the supplementary data commencing on page F-1 of this report,
which financial statements, report, notes and data are incorporated by
reference.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
72
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS
Information regarding Directors and Executive Officers appears in the
definitive proxy statement for the Annual Shareholder's Meeting to be held on
June 7, 2000 and is incorporated herein by reference.
ITEM 11 - EXECUTIVE COMPENSATION
Information regarding executive compensation appears in the definitive
proxy statement for the Annual Shareholder's Meeting to be held on June 7, 2000
and is incorporated herein by reference.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and
management appears in the definitive proxy statement for the Annual
Shareholder's Meeting to be held on June 7, 2000 and is incorporated herein by
reference.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions
appears in the definitive proxy statement for the Annual Shareholder's Meeting
to be held on June 7, 2000 and is incorporated herein by reference.
73
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K
Audited Financial Statements
The following 1999 Consolidated Financial Statements of Approved Financial
Corp. and Subsidiaries are included:
- Report of Independent Accountants........................................... 3
- Consolidated Balance Sheets................................................. 4
- Consolidated Statements of Income and Comprehensive Income (Loss)........... 5
- Consolidated Statements of Shareholders' Equity ............................ 6
- Consolidated Statements of Cash Flows ...................................... 7 - 8
- Notes to Consolidated Financial Statements................................. 9 - 35
-
- Consolidating Balance Sheet ................................................ 36
- Consolidating Income Statement ............................................. 37
- Stock Price and Dividend Information (Unaudited) ........................... 38
74
Exhibit Index
Exhibit
Number Description
- ------ -----------
3.1 Amended and Restated Articles of Incorporation of the Company
(Incorporated by Reference to Appendix A of the Form 10 Registration
Statement Filed February 11, 1998)
3.2 Bylaws of the Company (Incorporated by Reference to Appendix B of the
Form 10 Registration Statement Filed February 11, 1998)
10.1 Approved Financial Corp. Incentive Stock Option Plan (Incorporated by
Reference to Appendix C of the Form 10 Registration Statement Filed
February 11, 1998)
10.2 Employment Agreement between the Company and Neil W. Phelan
(Incorporated by Reference to Appendix D of the Form 10 Registration
Statement Filed February 11, 1998)
10.3 Employment Agreement between the Company and Stanley W. Broaddus
(Incorporated by Reference to Appendix E of the Form 10 Registration
Statement Filed February 11, 1998)
10.4 Employment Agreement between the Company and Barry C. Diggins
(Incorporated by Reference to Appendix F of the Form 10 Registration
Statement Filed February 11, 1998)
10.5 Purchase Agreement of Barry C. Diggins' Interest in Armada Residential
Mortgage, LLC, and related Nonqualified Stock Option Agreement
(Incorporated by Reference to Appendix G of the Form 10 Registration
Statement Filed February 11, 1998)
10.6 Employment Agreement between the Company and Eric S. Yeakel
(Incorporated by Reference to Appendix H of the Form 10 Registration
Statement Filed February 11, 1998)
10.7 Mills Value Adviser, Inc, Investment Management Agreement/Contract
with the Company (Incorporated by Reference to Appendix I of the Form
10 Registration Statement Filed February 11, 1998)
10.8 Share Purchase Agreement for Purchase of Controlling Interest in
Approved Federal Bank (Formerly First Security Federal Bank, Inc.)
(Incorporated by Reference to Appendix J of the Form 10 Registration
Statement Filed February 11, 1998)
75
Exhibit
Number Description
- ------ -----------
10.9 Stock Appreciation Rights Agreement with Jean S. Schwindt
(Incorporated by Reference to Appendix K of the Form 10 Registration
Statement Filed February 11, 1998)
10.10 Asset Purchase Agreement with Funding Center of Georgia, Inc.
(Incorporated by Reference to Appendix L of the Form 10 Registration
Statement Filed February 11, 1998)
10.11 Gregory J. Witherspoon Registration Rights Agreement (Incorporated by
Reference to Appendix M of the Form 10 Registration Statement Filed
February 11, 1998)
10.12 Pre-IPO Agreement between the Company and Industry Mortgage Company,
L.P., dated March 30, 1996 (Incorporated by Reference to Appendix N of
the Form 10 Registration Statement Filed February 11, 1998)
10.13 Employment Agreement between the Company and Barry C. Diggins dated
February 1999 (Incorporated by Reference to exhibit 10.13 of the 1998
10K filed March 31, 1999)
10.14 Purchase Agreement between the Company and MOFC, Inc. (Incorporated by
Reference to exhibit 10.14 of the 1998 10K filed March 31, 1999)
10.15 Agreement between United Mortgagee Inc. and Approved Federal Savings
Bank (Incorporated by Reference to exhibit 10.15 of the 1998 10K filed
March 31, 1999)
10.16 Option Agreement between the Company and Allen D. Wykle (Incorporated
by Reference to exhibit 10.16 of the 1998 10K filed March 31, 1999)
10.17 Option Agreement between the Company and Jean S. Schwindt
(Incorporated by Reference to exhibit 10.17 of the 1998 10K filed
March 31, 1999)
10.18 Option Agreement between the Company and Barry C. Diggins
(Incorporated by Reference to exhibit 10.18 of the 1998 10K filed
March 31, 1999)
10.19 Option Agreement between the Company and Neil W. Phelan (Incorporated
by Reference to exhibit 10.19 of the 1998 10K filed March 31, 1999)
10.20 Option Agreement between the Company and Stanley Broaddus
(Incorporated by Reference to exhibit 10.20 of the 1998 10K filed
March 31, 1999)
10.21 Option Agreement between the Company and Gregory Gleason (Incorporated
by Reference to exhibit 10.21 of the 1998 10K filed March 31, 1999)
10.22 Amendment to Stock Appreciation Rights Agreement with Jean S. Schwindt
(Incorporated by Reference to exhibit 10.22 of the 1998 10K filed
March 31, 1999)
10.23 Employment Agreement between the Company and Jean S. Schwindt dated
February 1999 (Incorporated by Reference to exhibit 10.23 of the 1998
10K filed March 31, 1999)
76
10.24 Employment Agreement between the Company and Eric S. Yeakel dated
February 1999 (Incorporated by Reference to exhibit 10.24 of the 1998
10K filed March 31, 1999)
10.25 Employment Agreement between MOFC Inc. and Keith Lewis dated December
15, 1998 (Incorporated by Reference to exhibit 10.25 of the 1998 10K
filed March 31, 1999)
10.26 Option Agreement between the Company and Eric Yeakel (Incorporated by
Reference to exhibit 10.26 of the 1998 10K filed March 31, 1999)
21 Subsidiaries of the Company (Appendix N)
27 Financial Data Schedule
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Form 10-K to be signed
on its behalf by the undersigned, thereunto duly authorized.
APPROVED FINANCIAL CORP.
(Registrant)
Date: March 31, 2000 By: /s/ Eric S. Yeakel
-----------------------------------
Eric S. Yeakel
Treasurer and
Chief Financial Officer
Date: March 31, 2000 By: /s/ Allen D. Wykle
-----------------------------------
Allen D. Wykle
Chairman of the Board of Directors
President, and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Date: March 31, 2000 By: /s/ Eric S. Yeakel
-----------------------------------
Eric S. Yeakel
Treasurer and
Chief Financial Officer
Date: March 31, 2000 By: /s/ Allen D. Wykle
-----------------------------------
Allen D. Wykle
Chairman of the Board of Directors
President, and Chief Executive Officer
Date: March 31, 2000 By: /s/ Leon H. Perlin
-----------------------------------
Leon H. Perlin
Director
Date: March 31, 2000 By: /s/ Jean S. Schwindt
-----------------------------------
Jean S. Schwindt
Director and Executive Vice President
Date: March 31, 2000 By: /s/ Barry C. Diggins
-----------------------------------
Barry C. Diggins
Director and Executive Vice President
Date: March 31, 2000 By: /s/ Neil W. Phelan
-----------------------------------
Neil W. Phelan
Director and Executive Vice President
Date: March 31, 2000 By: /s/ Stanley W. Broaddus
-----------------------------------
Stanley W. Broaddus
Director, Vice President
and Secretary
Date: March 31, 2000 By: /s/ Robert M. Salter
-----------------------------------
Robert M. Slater
Director
Date: March 31, 2000 By: /s/ Oscar S. Warner
-----------------------------------
Oscar S. Warner
Director
Date: March 31, 2000 By: /s/ Arthur Peregoff
-----------------------------------
Arthur Peregoff
Director
Date: March 31, 2000 By: /s/ Gregory Witherspoon
-----------------------------------
Gregory Witherspoon
Director
APPROVED FINANCIAL CORP.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
APPROVED FINANCIAL CORP.
CONTENTS
Pages
-----
Report of Independent Accountants........................................ 3
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1999 and 1998.......... 4
Consolidated Statements of Income (Loss) and Comprehensive Income
(Loss) for the years ended December 31, 1999, 1998 and 1997 ....... 5
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1999, 1998 and 1997................................... 6
Consolidated Statements of Cash Flows for the years ended December
31, 1999, 1998 and 1997............................................ 7 - 8
Notes to Consolidated Financial Statements............................ 9 - 35
Consolidating Balance Sheet as of December 31, 1999................... 36
Consolidating Statements of Income (Loss) for the year ended
December 31, 1999.................................................. 37
Stock Price and Dividend Information.................................. 38
2
Report of Independent Accountants
To the Board of Directors of
Approved Financial Corp.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income (loss) and comprehensive income (loss), of
shareholders' equity and of cash flows present fairly, in all material respects,
the consolidated financial position of Approved Financial Corp. and Subsidiaries
(the "Company") at December 31, 1999 and 1998, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States. 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 in
accordance with auditing standards generally accepted in the United States,
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 our opinion.
Virginia Beach, Virginia
March 2, 2000
3
APPROVED FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
December 31, 1999 and 1998
(Dollars in thousands, except per share amounts)
ASSETS 1999 1998
--------- ----------
Cash $ 10,656 $ 6,269
Mortgage loans held for sale, net 66,771 105,044
Real estate owned, net 2,274 1,707
Investments 2,640 3,472
Income taxes receivable 5,644 2,023
Deferred tax asset 1,676 3,330
Premises and equipment, net 6,086 5,579
Goodwill, net 1,120 4,554
Other assets 1,733 4,140
--------- ----------
Total assets $ 98,600 $ 136,118
========= ==========
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 17,465 $ 72,546
FHLB bank advances 4,648 -
Mortgage notes payable 2,341 1,210
Notes payable-related parties 2,993 3,628
Certificate of indebtedness 2,087 2,414
Certificates of deposits 55,339 29,728
Accrued and other liabilities 2,428 7,325
--------- ----------
Total liabilities 87,301 116,851
--------- ----------
Shareholders' equity:
Preferred stock series A, $10 par value; 1 1
Noncumulative, voting:
Authorized shares - 100
Issued and outstanding shares - 90
Common stock, par value - $1.00 5,482 5,482
Authorized shares - 40,000,000
Issued and outstanding shares - 5,482,114
Accumulated other comprehensive income (loss) (16) 30
Additional capital 552 552
Retained earnings 5,280 13,202
--------- ----------
Total equity 11,299 19,267
--------- ----------
Total liabilities and equity $ 98,600 $ 136,118
========= ==========
The accompanying notes are an integral part of the consolidated financial
statements.
4
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
for the years ended December 31, 1999, 1998 and 1997
(In thousands, except per share amounts)
1999 1998 1997
---------- ---------- ----------
Revenue:
Gain on sale of loans $ 13,202 $ 29,703 $ 33,501
Interest income 7,698 10,308 10,935
Gain on sale of securities 0 1,750 2,796
Other fees and income 7,834 7,042 4,934
---------- ---------- ----------
28,734 48,803 52,166
---------- ---------- ----------
Expenses:
Compensation and related 17,765 23,397 18,535
General and administrative 12,497 11,713 10,205
Write down of goodwill 1,131 0 0
Loss on sale/disposal of fixed assets 796 0 0
Loss on write off of securities 73 0 0
Loan production expense 1,930 3,593 1,895
Interest expense 4,957 6,252 6,157
Provision for loan and foreclosed property losses 2,256 2,896 1,676
---------- ---------- ----------
41,405 47,851 38,468
---------- ---------- ----------
Income (loss) before income taxes (12,671) 952 13,698
Provision for (benefit from) income taxes (4,749) 473 5,638
---------- ---------- ----------
Net income (loss) (7,922) 479 8,060
Other comprehensive income, net of tax:
Unrealized losses on securities:
Unrealized holding loss arising during period (46) (6,824) (4,547)
---------- ---------- ----------
Comprehensive income (loss) $ (7,968) $ (6,345) $ 3,513
========== ========== ==========
Net income (loss) per share:
Basic $ (1.45) $ 0.09 $ 1.52
========== ========== ==========
Diluted $ (1.45) $ 0.09 $ 1.51
========== ========== ==========
The accompanying notes are an integral part of the consolidated financial
statements.
5
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
for the years ended December 31, 1999, 1998 and 1997
Accumulated
Preferred Stock Other
Series A Common Stock Additional Comprehensive Retained
--------------------- ---------------------
Shares Amount Shares Amount Capital Income (Loss) Earnings
---------- ---------- ---------- --------- ----------- --------------- ----------
Balance at December 31, 1996 90 $ 1 2,519,368 $ 630 $ 1,485 $ 11,401 $ 7,692
Net income 8,060
Exercise of warrants 176,836 44 288
Change par value of stock 2,022 (1,773) (249)
Issuance of common stock 1,500 1
Stock dividend 2,697,704 2,698 (2,698)
Unrealized loss on investments
Available for sale, net of tax (4,547)
---------- ---------- ---------- --------- ----------- --------------- ----------
Balance at December 31, 1997 90 $ 1 5,395,408 $ 5,395 $ 0 $ 6,854 $ 12,805
Net income 479
Issuance of common stock 116,706 117 552
Repurchase common stock (30,000) (30) (82)
Unrealized loss on investments
available for sale, net of tax (6,824)
---------- ---------- ---------- --------- ----------- --------------- ----------
Balance at December 31, 1998 90 $ 1 5,482,114 $ 5,482 $ 552 $ 30 $ 13,202
Net loss (7,922)
Issuance of common stock
Unrealized loss on investments
available for sale, net of tax (46)
---------- ---------- ---------- --------- ----------- --------------- ----------
Balance at December 31, 1999 90 $ 1 5,482,114 $ 5,482 $ 552 $ (16) $ 5,280
========== ========== ========== ========= =========== =============== ==========
Total
-----------
Balance at December 31, 1996 $ 21,209
Net income 8,060
Exercise of warrants 332
Change par value of stock 0
Issuance of common stock 1
Stock dividend 0
Unrealized loss on investments
Available for sale, net of tax (4,547)
-----------
Balance at December 31, 1997 $ 25,055
Net income 479
Issuance of common stock 669
Repurchase common stock (112)
Unrealized loss on investments
available for sale, net of tax (6,824)
-----------
Balance at December 31, 1998 $ 19,267
Net loss (7,922)
Issuance of common stock
Unrealized loss on investments
available for sale, net of tax (46)
-----------
Balance at December 31, 1999 $ 11,299
===========
The accompanying notes are an integral part of the consolidated financial
statements.
6
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1999, 1998 and 1997
(In thousands)
1999 1998 1997
--------------- ---------------- ---------------
Operating activities
Net income (loss) $ (7,922) $ 479 $ 8,060
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating
activities:
Depreciation of premises and equipment 1,105 750 609
Amortization of goodwill 455 395 -
Provision for loan losses 2,042 3,064 1,534
Provision for losses on real estate owned 214 (168) 142
Deferred tax expense 1,706 112 (1,325)
(Gain) loss on sale of securities 81 (1,750) (2,796)
Loss on sale of real estate owned 648 660 654
Gain on sale of loans (13,202) (29,703) (32,696)
Loss on write down of goodwill 1,131 - -
Proceeds from sale and prepayments of loans 286,089 434,682 479,317
Change in deferred hedging loss - 91 -
Originations of loans held for sale, net (240,017) (429,555) (490,397)
Changes in assets and liabilities:
Loan sale receivable 25 (28) -
Other assets 2,384 (2,931) (882)
Accrued and other liabilities (450) (709) 6,773
Income tax payable (3,621) (3,184) 177
Loan proceeds payable (2,565) (3,799) -
--------------- ---------------- ---------------
Net cash provided by (used in) operating activities 28,103 (31,594) (30,830)
Cash flows from investing activities:
Purchase of securities (125) - (4,304)
Sales of securities - 1,844 4,458
Sales of ARM fund shares 4,619 4,957 -
Purchase of premises and equipment (1,706) (1,036) (2,313)
Sales of premises and equipment 1,322 29 199
Loss on sale/disposal of fixed assets 796 - -
Sales of real estate owned 2,587 4,440 3,735
Real estate owned capital improvements (648) (343) -
Purchases of ARM fund shares (3,623) (4,563) -
Purchases of FHLB stock (261) (96) -
Net cash paid for acquisitions - (1,395) (382)
--------------- ---------------- ---------------
Net cash provided by investing activities 2,961 3,837 1,393
7
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
for the years ended December 31, 1999, 1998 and 1997
(In thousands)
1999 1998 1997
--------------- ---------------- ---------------
Cash flows from financing activities:
Borrowings - warehouse $ 169,576 $ 380,182 $ 471,717
Repayments of borrowings - warehouse (224,657) (365,705) (451,259)
Proceeds from (repayments of) FHLB advances 4,648 (1,000) 1,000
Principal payments on mortgage notes payable (894) (83) (62)
Net increase (decrease) in:
Notes payable (635) (3,056) (155)
Certificates of indebtedness (326) 18 53
Certificates of deposit 25,611 11,914 16,238
Exercise of common stock warrants - - 332
Redemption of common stock - (113) -
Common stock shares issued - - 2
--------------- ---------------- ---------------
Net cash (used in) provided by financing activities (26,677) 22,157 37,866
--------------- ---------------- ---------------
Net increase (decrease) in cash 4,387 (5,600) 8,429
Cash at beginning of year 6,269 11,869 3,440
--------------- ---------------- ---------------
Cash at end of year $ 10,656 $ 6,269 $ 11,869
=============== ================ ===============
Supplemental cash flow information:
Cash paid for interest $ 5,233 $ 6,231 $ 5,991
Cash paid for income taxes - 3,546 5,461
Supplemental non-cash information:
Loan balances transferred to real estate owned $ 4,019 $ 3,930 $ 4,641
Exchange of stock for acquisition of Armada
Residential Mortgage LLC - 669 -
Accounts payable incurred in exchange for goodwill
in connection with the ConsumerOne acquisition - 1,575 -
Purchase of building in exchange for note payable 2,025 - 800
The accompanying notes are an integral part of the consolidated financial
statements.
8
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 1. Organization and Summary of Significant Accounting Policies:
Organization: Approved Financial Corp., a Virginia corporation ("Approved"),
and its subsidiaries (collectively, the "Company") operate primarily in the
consumer finance business of originating, servicing and selling mortgage loans
secured primarily by first and second liens on one-to-four family residential
properties. The Company sources mortgage loans through two origination channels;
a network of mortgage brokers who refer mortgage customers to the Company
("broker" or "wholesale") and an internal sales staff that originate mortgages
directly with borrowers ("retail" and "direct"). Approved has three wholly
owned subsidiaries through which it originates residential mortgages: Approved
Federal Savings Bank (the "Bank") is a federally chartered thrift institution
with broker operations in seven states and nine retail offices as of December
31, 1999; Approved Residential Mortgage, Inc. ("ARMI") with one retail location
at December 31, 1999; and MOFC d/b/a ConsumerOne Financial ("ConsumerOne") with
one retail office in Michigan at December 31, 1999. Approved has a fourth
wholly owned subsidiary, Approved Financial Solutions ("AFS"), through which it
offers insurance products to its mortgage customers.
The Bank had a wholly owned subsidiary, Global Title Company ("Global Title"),
which was licensed as a title insurance agency. Global Title did not produce
material revenues during the twelve month period ended December 31, 1999.
During the fourth quarter of 1999, ownership of Global Title was transferred to
AFS from the bank in order to consolidate the Company's insurance operations.
Principles of accounting and consolidation: The consolidated financial
statements of the Company include the accounts of Approved and its wholly-owned
subsidiaries. All significant inter-company accounts and transactions have been
eliminated.
Use of estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and cash equivalents: Cash and cash equivalents consist of cash on deposit
at financial institutions and short-term investments that are considered cash
equivalents if they were purchased with an original maturity of three months or
less.
Loans held for sale: Loans, which are all held for sale, are carried at the
lower of aggregate cost or market value. Market value is determined by current
investor yield requirements.
Allowance for loan losses: The allowance for loan losses is maintained at a
level believed adequate by management to absorb probable losses in the loan
portfolio. Management's determination of the adequacy of the allowance is based
on an evaluation of the current loan portfolio characteristics including
criteria such as delinquency, default and foreclosure rates and trends, age of
the loans, credit grade of borrowers, loan to value ratios, current economic and
secondary market conditions, current and anticipated levels of loan volume, and
other relevant factors. The allowance is increased by provisions for loan
losses charged
9
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 1. Organization and Summary of Significant Accounting Policies,
continued:
against income. Loan losses are charged against the allowance when management
believes it is unlikely that the loan is collectable.
Origination fees: The Company accounts for origination fees on mortgage loans
held for sale in conformity with Statement of Financial Accounting Standards
("SFAS") No. 91, "Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases." The statement requires
that net origination fees be recognized over the life of the loan or upon the
sale of the loan, if earlier.
Hedging: To offset the effects of interest rate fluctuations on the value of
its fixed rate mortgage loans held for sale, the Company in certain cases will
enter into Treasury security lock contracts, which function similarly to short
sales of U.S. Treasury securities. Gains or losses from these contracts are
deferred and recognized as an adjustment to gains on sale of loans when the
loans are sold or when the related hedge position is closed.
Real estate owned: Real estate owned is valued at the lower of cost or fair
market value, net of estimated disposal costs. Cost includes loan principal and
certain capitalized expenses. Any excess of cost over the estimated fair market
value at the time of acquisition is charged to the allowance for loan losses.
The estimated fair market value is reviewed periodically by management and any
write-downs are charged against current earnings using a valuation account which
has been netted against real estate owned in the financial statements. Income
from temporary rental of the properties is credited against the investment when
collected. Capital improvements are capitalized to the extent of net realizable
value. Additional carrying costs, including taxes, utilities and insurance, are
also capitalized to the property, to the extent of net realizable value.
Premises and equipment: Premises, leasehold improvements and equipment are
stated at cost less accumulated depreciation and amortization. The buildings
are depreciated using the straight line method over thirty years. Leasehold
improvements are amortized over the lesser of the terms of the lease or the
estimated useful lives of the improvements. Depreciation of equipment is
computed using the straight line method over the estimated useful lives of three
to five years. Expenditures for betterments and major renewals are capitalized
and ordinary maintenance and repairs are charged to operations as incurred.
Investments: The Company's investment in the stock of the Federal Home Loan Bank
("FHLB") of Atlanta is stated at cost.
All other investment securities, except the FHLB stock, are classified as
available-for-sale and reported at fair value, with unrealized gains and losses
excluded from earnings and reported as other comprehensive income in
shareholders' equity.
Realized gains and losses on sales of securities are computed using the specific
identification method.
10
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 1. Organization and Summary of Significant Accounting Policies,
continued:
Transfers of financial assets: The Company applies a financial-components
approach that focuses on control when accounting and reporting for transfers and
servicing of financial assets and extinguishments of liabilities. Under that
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. This approach provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings.
Income recognition: Gains on the sale of mortgage loans, representing the
difference between the sales price and the net carrying value of the loan, are
recognized when mortgage loans are sold and delivered to investors.
Interest on loans is credited to income based upon the principal amount
outstanding. Interest is accrued on loans until they become 31 days or more past
due.
Advertising costs: Advertising costs are expensed when incurred.
Income taxes: Taxes are provided on substantially all income and expense items
included in earnings, regardless of the period in which such items are
recognized for tax purposes. The Company uses an asset and liability approach
that requires the recognition of deferred tax assets and liabilities for the
estimated future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events other
than enactments of changes in the tax laws or rates.
Earnings per share: The Company computes "basic earnings per share" by dividing
income available to common shareholders by the weighted-average number of common
shares outstanding for the period. "Diluted earnings per share" reflects the
effect of all potentially dilutive potential common shares such as stock options
and warrants and convertible securities.
The Company declared a 100% stock dividend effective November 21, 1997. The
share and per share figures in this report have been adjusted to reflect this
stock dividend.
Comprehensive Income: The Company classifies items of other comprehensive income
(loss) by their nature in a financial statement and displays the accumulated
balance of other comprehensive income (loss) separately from retained earnings
and additional capital in the equity section of the consolidated balance sheets.
The only item the Company has in Comprehensive Income (Loss) for the three years
ended December 31, 1999, is an unrealized holding loss on securities, net of
deferred taxes.
11
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 1. Organization and Summary of Significant Accounting Policies,
continued:
Segments: A public business enterprise is required to report financial and
descriptive information about its reportable operating segments. Operating
segments are components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision-maker in deciding how to allocate and in assessing performance.
Generally, financial information is required to be reported on the basis that it
is used internally for evaluating segment performance and deciding how to
allocate resources to segments. The Company has evaluated this requirement and
determined it operates in one segment.
New accounting pronouncements:
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" as
amended by SFAS 137, is effective for fiscal year ends beginning after June 15,
2000. This statement establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. It requires that entities recognize all derivatives as either
assets or liabilities in the financial statements and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designed as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a foreign-
currency-denominated forecasted transaction. This statement should not have any
material impact on the financial statements.
In October 1998, SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise," was issued, effective for the first fiscal quarter
beginning after December 15, 1998. The new statement requires that after an
entity that is engaged in mortgage banking activities has securitized mortgage
loans that are held for sale, it must classify the resulting retained mortgage-
backed securities or other retained interests based on its ability and intent to
sell or hold those investments. Any retained mortgage-backed securities that
are committed for sale before or during the securitization process must be
classified as trading. This statement does not have any impact on the Company's
financial statements since the Company has never securitized loans.
12
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 2. Investments:
The cost basis and fair value of the Company's investments at December 31, 1999
and 1998, are as follows (in thousands):
1999 1998
---------------------------- ------------------------------
Cost Fair Cost Fair
Basis Value Basis Value
------------ ------------ ------------- -------------
Asset Management Fund, Inc. ARM Portfolio $2,134 $2,108 $3,219 $3,203
FHLB stock 407 407 146 146
IMC Mortgage Company common stock - - 73 123
Other investments 125 125 - -
------------ ------------ ------------- -------------
$2,666 $2,640 $3,438 $3,472
============ ============ ============= =============
The Company's investment in IMC Mortgage Company ("IMC") common stock had gross
unrealized gains of $0 and $50,000 at December 31, 1999 and 1998, respectively.
The Company's investment in the adjustable rate mortgage mutual fund had
unrealized losses of $26,000 and $16,000 at December 31, 1999 and 1998,
respectively.
The Company was an original limited partner in Industry Mortgage Company, L.P.
(the "IMC Partnership"), a non-conforming residential mortgage company based in
Tampa, Florida. The Company's initial ownership interest represented
approximately 9.09% of the IMC partnership.
The IMC Partnership converted to a corporation, IMC, immediately before its
initial public offering on June 24, 1996. The limited partners received common
stock of IMC in exchange for their IMC Partnership interests as of June 24,
1996. The Company was issued 1,199,768 shares of IMC common stock at that time.
Following the partnership's conversion to corporate form, the Company's
investment in IMC is accounted for as an investment security available for sale
under SFAS No. 115. As of December 31, 1999, the Company owned 435,634 shares
of IMC stock; however, the stock has a minimal value. During 1998, the Company
sold 558,400 shares of IMC stock for $1.9 million which resulted in a pre-tax
gain of $1.8 million. During 1997, the Company sold 233,241 shares of IMC stock
for $3.7 million which resulted in a pre-tax gain of $2.8 million. The Company
also received 27,507 shares of IMC common stock as an incentive award relating
to the volume of loans sold by the Company to IMC. All of the share figures
above reflect a two-for-one split of IMC shares on February 13, 1997.
13
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 3. Mortgage Loans Held for Sale:
The Company owns first and second mortgages which are being held as inventory
for future sale. The loans are carried at the lower of cost or market. These
mortgage loans have been pledged as collateral for the warehouse financing.
Loans at December 31, 1999 and 1998, were as follows (in thousands):
1999 1998
------------------ ------------------
Mortgage loans held for sale $69,054 $109,500
Net deferred origination fees and hedging costs (901) (1,866)
Allowance for loan losses (1,382) (2,590)
------------------ ------------------
Total mortgage loans, net $66,771 $105,044
================== ==================
As of December 31, 1999, 1998 and 1997, the recorded investment in loans for
which impairment has been determined in accordance with SFAS No. 114 totaled
$2.0 million, $4.1 million, and $2.5 million, respectively. The average recorded
investment in impaired loans for the years ended December 31, 1999, 1998 and
1997 was $3.5 million, $2.6 million and $0.8 million, respectively. Interest
income recognized related to these loans was $89,000, $86,000 and $94,000 during
1999, 1998 and 1997, respectively. Due to the homogenous nature and collateral
for these loans, there is no corresponding valuation allowance.
Nonaccrual loans were $2.2 million and $5.9 million at December 31, 1999 and
1998, respectively. The amount of additional interest that would have been
recorded had these loans not been placed on nonaccrual status was approximately
$152,000, $212,000, and $154,000 in 1999, 1998 and 1997, respectively.
Changes in the allowance for loan losses for the years ended December 31, 1999,
1998 and 1997 were (in thousands):
1999 1998 1997
---------------- ---------------- -----------------
Balance at beginning of year $ 2,590 $ 1,687 $ 924
Acquisitions 0 49 0
Charge-offs (3,286) (2,372) (953)
Recoveries 36 162 182
Provision 2,042 3,064 1,534
---------------- ---------------- -----------------
Balance at end of year $ 1,382 $ 2,590 $1,687
================ ================ =================
14
APROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 4. Real Estate Owned:
Real estate owned is valued at the lower of cost or fair market value, net of
estimated disposal costs.
Changes in the real estate owned valuation allowance for the years ended
December 31, 1999, 1998 and 1997 were (in thousands):
1999 1998 1997
---------------- ---------------- -----------------
Balance at beginning of year $ 503 $ 671 $ 529
Provision 214 (168) 142
---------------- ---------------- -----------------
Balance at end of year $ 717 $ 503 $ 671
================ ================ =================
Note 5. Premises and Equipment:
Premises and equipment at December 31, 1999 and 1998, were summarized as follows
(in thousands):
1999 1998
------------------ -------------------
Land $1,413 $ 240
Building & Improvements 2,947 2,513
Office Equipment & Furniture 1,780 2,303
Computer Software/Equipment 1,766 2,346
Vehicles 223 235
------------------ -------------------
8,129 7,637
Less accumulated depreciation and amortization 2,043 2,058
------------------ -------------------
Premises and equipment, net $6,086 $5,579
================== ===================
The Company has several capital leases for computer and other equipment included
in the premises and equipment table above. See Note 6 for further discussion on
capital leases.
15
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 6. Capital Leases:
Assets recorded under capital leases at December 31, 1999 and 1998, consist of
the following (in thousands):
1999 1998
------------------- --------------------
Computer equipment $ 154 $ 322
Furniture & equipment 224 302
Less: Accumulated amortization (176) (116)
------------------- --------------------
$ 202 $ 508
=================== ====================
Amortization expense for the years ended December 31, 1999 and 1998,
approximated $167,000 and $116,000, respectively.
Future minimum rental commitments, including the bargain purchase option
exercisable at the end of the lease terms and the present value of the net
minimum lease payments as of December 31, 1999, are as follows (in thousands):
2000 $139
2001 85
2002 22
---------------
246
Less - amount representing interest 31
---------------
Present value of net minimum lease payments $215
===============
The Company has the option to purchase these assets at an established price at
the end of the lease terms. The Company recognized approximately $49,000 and
$36,000 of interest expense related to the lease obligations for the years ended
December 31, 1999 and 1998, respectively.
16
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 7. Leases
The Company leases some of its office facilities and equipment under operating
leases which expire at various times through 2004. Lease expense was $2.0
million, $1.4 million, and $1.0 million in 1999, 1998 and 1997, respectively.
Total minimum lease payments under non-cancelable operating leases with
remaining terms in excess of one year as of December 31, 1999, were as follows
(in thousands):
2000 $ 724
2001 344
2002 152
2003 64
2004 48
----------
$ 1,332
==========
17
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 8. Revolving Warehouse Facilities:
Amounts outstanding under revolving warehouse facilities at December 31, 1999
and 1998, were as follows (in thousands):
1999 1998
------------------------ -----------------------
Warehouse facility with commercial bank collateralized by $12,142 $ 0
mortgages/deeds of trust; expires June 7, 2000, with
interest at 1.75% over applicable LIBOR rate (5.8225% at
December 31, 1999); total credit available $15 million.
Warehouse facility with commercial bank collateralized by 5,323 0
mortgages/deeds of trust; expires November 10, 2001,
with interest at 3.25% over applicable LIBOR rate
(5.8225% at December 31, 1999); total credit available
$20 million.
Syndicated warehouse facility with commercial bank 0 59,261
collateralized by mortgages/deeds of trust; expired in
1999.
Syndicated seasoned loan line of credit with commercial
banks collateralized by mortgages/deeds of trust;
expired in 1999. 0 7,076
Subsidiaries warehouse facility with investor 0 6,209
collateralized by mortgages/deeds of trust; expired in
1999.
------------------------ -----------------------
$17,465 $72,546
======================== =======================
18
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 8. Revolving Warehouse Facilities, continued:
On November 10, 1999, the Company obtained a $20.0 million subprime line of
credit from Regions Bank. The line is secured by loans originated by the Company
and bears interest at a rate of 3.25% over the one-month LIBOR rate. The Company
may receive warehouse credit advances of 100% of the net loan value amount on
pledged mortgage loans for a period of 90 days after origination. As of December
31, 1999, $5.3 million was outstanding under this facility. The line of credit
is scheduled to expire on November 10, 2001.
On November 10, 1999, the Company obtained a $20.0 million conforming loan line
of credit from Regions Bank. The line is secured by loans originated by the
Company and bears interest ranging from 2.25% to 2.75% over the one-month LIBOR
rate based upon the monthly advance levels. The Company may receive warehouse
credit advances of 100% of the net loan value amount on pledged mortgage loans
for a period of 90 days after origination. As of December 31, 1999, there were
no borrowings outstanding under this facility. The line of credit is scheduled
to expire on November 10, 2001.
Effective on December 8, 1999, the Company obtained an amendment to their
warehouse line of credit agreement with Chase Bank of Texas. Since the
utilization of the credit line has been very low in 1999, the amendment reduced
the size of the warehouse facility to $15.0 million, and all bank syndicate
members other than Chase were released from the commitment. The line is secured
by loans originated by the Company and bears interest at a rate of 1.75% over
the one-month LIBOR rate. The Company may receive warehouse credit advances of
95% of the original principal balances on pledged mortgage loans for a maximum
period of 180 days after origination. As of December 31, 1999, $12.1 million was
outstanding under this facility. The line is scheduled to expire on June 7,
2000, and will not be renewed.
19
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 9. Deposits:
The following table sets forth various interest rate categories for the FDIC-
insured certificates of deposit of the Bank as of December 31, 1999 and 1998 (in
thousands):
1999 1998
------------------------------------ ----------------------------------
Weighted Weighted
Average Rate Amount Average Rate Amount
--------------- ---------------- -------------- ---------------
5.24% or less 5.18% $ 793 5.18% $ 1,883
5.25 - 5.49% 5.36 8,813 5.34 5,651
5.50 - 5.74 5.61 1,389 5.65 2,179
5.75 - 5.99 5.89 7,733 5.86 12,789
6.00 - 6.24 6.18 14,152 6.12 6,039
6.25 - 6.49 6.37 19,391 6.40 1,187
6.50 - 6.74 6.65 3,068 - -
--------------- ---------------- -------------- ---------------
6.07% $55,339 5.78% $29,728
=============== ================ ============== ===============
The following table sets forth the amount and maturities of the certificates of
deposit of the Bank at December 31, 1999 (in thousands):
Six Months Over Six Months and Over One Year and Over Two Total
or Less Less than One Year Less than Two Years Years
-------------- ----------------------- ---------------------- ------------ -------------
5.24% or less $ 495 $ 199 $ 99 $ - $ 793
5.25 - 5.49% 2,670 1,984 2,475 1,684 8,813
5.50 - 5.74 397 100 297 595 1,389
5.75 - 5.99 2,978 1,983 1,883 889 7,733
6.00 - 6.24 8,436 4,328 198 1,190 14,152
6.25 - 6.49 6,533 11,867 892 99 19,391
6.50 - 6.74 - 2,969 99 - 3,068
-------------- ----------------------- ---------------------- ------------ -------------
$21,509 $23,430 $5,943 $4,457 $55,339
============== ======================= ====================== ============ =============
At December 31, 1999, sixty-eight certificates of deposit totaling $27,159,000
were in amounts of $100,000 or greater.
20
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 10. Federal Home Loan Bank Advances:
At December 31, 1999, the Bank has pledged its FHLB stock and qualifying
residential mortgage loans with an aggregate balance of $3.6 million as
collateral for such FHLB advances under a specific collateral agreement with a
limit of $15.0 million at December 31, 1999. Interest is computed based on the
lender's cost of overnight funds. The interest rates on December 31, 1999 and
1998, were 4.55% and 5.10%, respectively. Interest expense on FHLB advances
totaled $36,000, $76,000 and $3,000 in 1999, 1998 and 1997, respectively.
Note 11. Notes Payable - Related Parties:
Notes payable - related parties are amounts due to shareholders, officers and
others related to the Company. These notes are subordinate to the line of credit
and all other collateralized indebtedness of the Company. Interest expense on
notes payable - related parties was $332,000, $554,000, and $666,000, in 1999,
1998 and 1997, respectively. The interest rates on the notes range from 8.00%
to 10.25% and the notes mature as follows (in thousands):
2000 $ 748
2001 0
2002 96
2003 596
2004 1,553
------------
$2,993
============
21
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 12. Certificates of Indebtedness:
Certificates of indebtedness are uninsured deposits authorized for financial
institutions such as the Company, which have Virginia industrial loan
association charters. The certificates of indebtedness are loans from Virginia
residents for periods of one to five years at interest rates between 6.75% and
10.00%. Interest expense on the certificates was $225,000, $224,000, and
$225,000 in 1999, 1998 and 1997, respectively.
Certificates of indebtedness maturities were as follows as of December 31, 1999
(in thousands):
2000 $ 760
2001 476
2002 552
2003 263
2004 36
-----------
$ 2,087
===========
22
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 13. Mortgage Notes Payable:
The Company has two remaining mortgage notes payable to a commercial bank. The
notes are collateralized by two office buildings used by the Company for its
corporate headquarters. The mortgage notes are summarized as follows (in
thousands):
1999 1998
---------------- ----------------
Mortgage note with commercial bank collateralized $ 316 $ 375
by office building; original amount of $590,000;
monthly payments of $7,186; matures May 2004;
with interest at 7.99%
Mortgage note with commercial bank collateralized 2,025 0
by office building; original amount $2,025,000;
monthly payments of $21,170; matures November 2019;
with interest at 8.625%
Mortgage note with commercial bank paid off March 1999. 0 759
Mortgage note payable- 0 76
foreclosed properties
---------------- ----------------
$2,341 $1,210
================ ================
Interest expense on mortgage loans payable was $62,000, $99,000 and $73,000 in
1999, 1998 and 1997 respectively.
Aggregate maturities for mortgage payable are as follows as of December 31, 1999
(in thousands):
2000 $ 96
2001 112
2002 122
2003 132
2004 86
Thereafter 1,793
----------------
$ 2,341
================
23
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 14. Shareholders' Equity:
In January 1998, the Company issued 104,146 split-adjusted shares of its Common
Stock to purchase a senior officer's 17% ownership interest in Armada
Residential Mortgage, LLC ("Armada LLC") which was terminated in September 1997.
The senior officer terminated his employment with Armada LLC and became an
employee of Approved Residential Mortgage, Inc. ("ARMI"). The Company also
issued 12,560 split-adjusted shares to a key employee of Armada LLC.
In December 1998, the Company repurchased 30,000 shares of its Common Stock at
$3.75 per share. The Company's Board of Directors authorized this stock buy
back plan at its quarterly board meeting held on November 2, 1998. The Company
was authorized to repurchase up to 1 million shares of its Common Stock. As of
December 31, 1999, the Company is still authorized to purchase up to 1 million
shares.
Note 15. Stock Options:
On June 28, 1996, the Company adopted the 1996 Incentive Stock Option Plan. The
Company's stock option plan provides primarily for the granting of nonqualified
stock options to certain key employees. Generally, options are granted at prices
equal to the market value of the Company's stock on the date of grant, vest over
a three-year period, and expire ten years from the date of the award.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations in accounting for its
stock option plans. SFAS No. 123, "Accounting for Stock-Based Compensation,"
was issued in 1995 and, if fully adopted, changes the method of recognition of
cost on plans similar to those of the Company. The Company has adopted the
alternative disclosure established by SFAS No. 123. Therefore, pro forma
disclosures as if the Company adopted the cost recognition requirements under
SFAS No. 123 are presented on the following table:
24
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 15. Stock Options, continued:
A summary of the Company's stock options, including weighted average exercise
price (Price) as of December 31, 1999, 1998 and 1997, and the changes during the
years is presented below:
1999 1998
------------------------------------- --------------------------------------
Shares Price Shares Price
--------------- ------------------ --------------- -------------------
Outstanding at beginning of year 108,325 $ 5.19 9,200 $ 9.75
Granted 21,425 4.00 8,050 13.50
Granted - - 91,475 4.00
Repriced 9,150 4.00 - -
Cancelled 5,000 9.75 400 4.00
Cancelled 7,100 13.50 -
Cancelled 8,400 4.00 - -
--------------- ------------------ --------------- -------------------
Outstanding at end of year 118,400 $ 4.37 108,325 $ 5.19
=============== ================== =============== ===================
Options available for future grant 138,100 148,175
=============== ===============
Weighted-average fair value of
options granted during year $ 1.00 $ 1.20
================== ===================
1997
-------------------------------------
Shares Price
--------------- ------------------
Outstanding at beginning of year - -
Granted 9,200 $9.75
--------------- ------------------
Outstanding at end of year 9,200 $9.75
=============== ==================
Options available for future grant 242,800
===============
Weighted-average fair value of
options granted during year $3.49
==================
The weighted-average remaining contractual life of options granted at
December 31, 1999, 1998 and 1997 was 9 years, 8 years, and 7 years respectively.
25
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 15. Stock Options, continued:
The fair value of each option granted during 1999, 1998 and 1997 is estimated on
the date of grant using the Black-Scholes option-pricing model with the
following assumptions: dividend yield of zero; expected volatility of 48.99% in
1999, 34.48% in 1998 and 34.12% in 1997; risk-free interest rate of 5.75% for
options granted in June 1999, 5.99% for options granted in November 1999, risk-
free interest rate of 5.42% for options granted in January 1998, 4.54% for
options granted in November 1998, and 6.00% for options granted in 1997.
Had compensation cost for the 1999, 1998 and 1997 grants for stock-based
compensation plans been recorded by the Company, the Company's pro forma net
income (loss) and pro forma net income (loss) per common share for 1999, 1998
and 1997 would have been as follows:
(In thousands, except per share amounts)
Year Ended Year Ended
December 31, 1999 December 31, 1998
--------------------------------------- --------------------------------------
As Reported Pro Forma As Reported Pro Forma
--------------------------------------- --------------------------------------
Net income (loss) $(7,922) $(7,939) $ 479 $ 371
Net income (loss) per common share - Basic (1.45) (1.45) 0.09 0.07
Net income (loss) per common share - (1.45) (1.45) 0.09 0.07
Dilutive
Year Ended
December 31, 1997
-----------------------------------
As Reported Pro Forma
-----------------------------------
Net income $8,060 $8,041
Net income per common share - Basic 1.52 1.52
Net income per common share - Dilutive 1.51 1.51
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts.
There were no awards prior to 1997 and additional awards in future years are
anticipated.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 16. Earnings Per Share:
The Company's earnings per share have been calculated in accordance with SFAS
No. 128, "Earnings Per Share." The statement requires calculations of basic and
diluted earnings per share. These calculations are described in Note 1. The
following table shows the reconciling components between basic and diluted
earnings per share:
Weighted Average
Shares Earnings (Loss)
Net Income (Loss) Outstanding Per
For the Year Ended December 31, 1999 (Numerator) (Denominator) Share
- ------------------------------------- ----------------------- --------------------- ------------------
Basic and dilutive earnings per share $(7,922,000) 5,482,114 $(1.45)
====================== ===================== =================
For the Year Ended December 31, 1998
- ------------------------------------
Basic earnings per share $ 479,000 5,465,034 $ 0.09
Effect of dilutive securities:
Common stock issued - 46,338 -
---------------------- --------------------- -----------------
Diluted earnings per share $ 479,000 5,511,372 $ 0.09
====================== ===================== =================
For the Year Ended December 31, 1997
- ------------------------------------
Basic earnings per share $ 8,060,000 5,310,263 $ 1.52
Effect of dilutive securities:
Stock options - 1,162 -
Common stock payable - 34,532 (.01)
---------------------- --------------------- -----------------
Diluted earnings per share $ 8,060,000 5,345,957 $ 1.51
====================== ===================== =================
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 17. Income Taxes:
The components of income tax expense (benefit) for the years ended December 31,
1999, 1998 and 1997, were as follows (in thousands):
1999 1998 1997
---------------- ---------------- ---------------
Current $(6,455) $ 361 $ 6,963
Deferred 1,706 112 (1,325)
---------------- ---------------- ---------------
$(4,749) $ 473 $ 5,638
================ ================ ===============
The provision for (benefit from) income taxes for financial reporting purposes
differs from the amount computed by applying the statutory federal tax rate of
34% to income before taxes. The principal reasons for these differences for the
years ended December 31, 1999, 1998 and 1997, were (in thousands):
1999 1998 1997
----------------- ------------------ -----------------
Provision for (benefit from) income
taxes at statutory
federal rate $(4,308) $ 339 $4,731
State income taxes, net
of federal benefit (585) 58 827
Nondeductible expenses 37 71 79
Other, net 107 5 1
----------------- ------------------ -----------------
$(4,749) $ 473 $5,638
================= ================== =================
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 17. Income Taxes, continued:
Significant components of the Company's deferred tax assets and liabilities at
December 31, 1999 and 1998, were (in thousands):
1999 1998
--------------------- ---------------------
Deferred tax assets: $ 811 $1,231
Allowance for loan and real estate
owned losses
Deferred loan fees - 847
Mark to market on mortgage loans 300 670
held for sale
Deferred income 8 1
Accrued premium recapture 193 229
Accrued expenses 89 196
Accrued 401(k) match 68 60
Accrued insurance expense 189 60
Other 18 79
--------------------- ---------------------
Total deferred tax assets 1,676 3,373
Deferred tax liabilities:
Unrealized appreciation of investments - 19
Other - 24
--------------------- ---------------------
Total deferred tax liabilities - 43
--------------------- ---------------------
Net deferred tax asset $1,676 $3,330
===================== =====================
The Company believes that a valuation allowance with respect to the realization
of the gross total deferred tax assets is not necessary. Based on the
management's expected improvements of sufficient taxable income and reversing
temporary differences, management believes it is likely that the Company will
realize the gross deferred tax assets existing at December 31, 1999. However,
there can be no assurances that the Company will generate taxable income in any
future period.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 18. Retirement Plans:
The Company has a defined contribution profit sharing plan, which is
administered by officers of the Company. Company contributions to the plan are
discretionary, as authorized by the Board of Directors. There were no
contributions for 1999, 1998 and 1997. Participants are also eligible to make
voluntary contributions to the plan, at the discretion of the administrator.
There were no voluntary contributions to the plan for the years ended December
31, 1999, 1998 and 1997.
The Company has a nonqualified retirement plan for several key members of
management. The plan allows participants to defer compensation from the current
year. Company contributions to the plan are discretionary, as authorized by the
Board of Directors. Contributions for the years ended December 31, 1999, 1998
and 1997, were $0, $0, and $10,000, respectively.
The Company sponsors a 401(k) Retirement Plan. The Plan is a defined
contribution plan covering all employees who have completed at least one year of
service. The Plan is subject to the provisions of the Employee Retirement
Income Security Act of 1974. The Company contributes an amount equal to 50% of a
participant's payroll contribution up to 6% of a participant's annual
compensation. The Company's contributions to the plan for the years ended
December 31, 1999, 1998 and 1997, were $141,000, $162,000, and $115,000,
respectively.
Note 19. Employment Agreements:
The Company has employment agreements with various employees. The agreements
expire at various times from 1999 through 2001. Among other things, the
agreements provide for severance benefits payable to the officers upon
termination of employment following a change of control in the Company.
30
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 20. Regulatory Capital:
Financial institutions, such as the Bank, must maintain specific capital
standards that are no less stringent than the capital standards applicable to
national banks. Regulations of the OTS currently maintain three capital
standards: a tangible capital requirement, a core capital requirement, and a
risk-based capital requirement.
The tangible capital standard requires the Bank to maintain tangible capital of
not less than 1.5% of total adjusted assets. As it applies to the Bank,
"tangible capital" means core capital (as defined below).
The core capital standard requires the Bank to maintain "core capital" of not
less than 4.0%. Core capital includes the Bank's common shareholders' equity,
adjusted for certain non-allowable assets.
The risk-based standard requires the Bank to maintain capital equal to 8.0% of
risk-weighted assets. The rules provide that the capital ratio applicable to an
asset will be adjusted to reflect the degree of credit risk associated with such
asset, and the asset base used for computing the capital requirement includes
off-balance sheet assets.
At December 31, 1999 and 1998, the Bank was classified as a "well-capitalized"
institution (financial institutions that maintain total risk based capital in
excess of 10%) as determined by the OTS and satisfied all regulatory capital
requirements, as shown in the following table reconciling the Bank's capital to
regulatory capital (in thousands):
Tangible Core Risk-Based
Capital Capital Capital
------------- ------------ --------------
December 31, 1999
GAAP capital $ 6,356 $ 6,356 $ 6,356
Add: unrealized loss on securities 16 16 16
Non-allowable asset: goodwill (101) (101) (101)
Additional capital item: general allowance - - 336
------------- ------------ --------------
Regulatory capital - computed 6,271 6,271 6,607
Minimum capital requirement 1,106 2,949 4,004
------------- ------------ --------------
Excess regulatory capital $ 5,165 $ 3,322 $ 2,603
============= ============ ==============
Ratios:
Regulatory capital - computed 8.51% 8.51% 13.20%
Minimum capital requirement 1.50 4.00 8.00
------------- ------------ --------------
Excess regulatory capital 7.01% 4.51% 5.20%
============= ============ ==============
31
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 20. Regulatory Capital, continued:
Tangible Core Risk-Based
Capital Capital Capital
------------- ------------ --------------
December 31, 1998
GAAP capital $5,058 $5,058 $5,058
Add: unrealized loss on securities 15 15 15
Non-allowable asset: goodwill (116) (116) (116)
Additional capital item: general allowance - - 276
------------- ------------ --------------
Regulatory capital - computed 4,957 4,957 5,233
Minimum capital requirement 578 1,157 2,166
------------- ------------ --------------
Excess regulatory capital $4,379 $3,800 $3,067
============= ============ ==============
Ratios:
Regulatory capital - computed 12.86% 12.86% 19.33%
Minimum capital requirement 1.50 4.00 8.00
------------- ------------ --------------
Excess regulatory capital 11.36% 8.86% 11.33%
============= ============ ==============
The payment of cash dividends by the Bank is subject to regulation by the OTS.
The OTS measures an institution's ability to make capital distributions, which
includes the payment of dividends, according to the institution's capital
position. For institutions, such as the Bank, that meet their fully phased-in
capital requirements, the OTS has established "safe harbor" amounts of capital
distributions that institutions can make after providing notice to the OTS, but
without needing prior approval. Effective April 1, 1999, the OTS has adopted
regulations that provide that an OTS-regulated institution will not have to file
a capital distribution notice with OTS upon meeting certain conditions.
Institutions can distribute amounts in excess of the safe harbor amount without
the prior approval of the OTS. The Bank did not pay cash dividends to Approved
in 1999, 1998 or 1997.
Note 21. Disclosures About Fair Value of Financial Instruments:
SFAS No. 107, "Disclosures about Fair Values of Financial Instruments," requires
disclosure of fair value information about financial instruments, whether or not
recognized in the financial statements, for which it is practicable to estimate
that value. In cases where quoted market prices are not available, fair values
are based upon estimates using present value or other valuation techniques.
Those techniques are significantly affected by the assumptions used, including
the discount rate and the estimated future cash flows. In that regard, the
derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate
settlement of the instrument. SFAS No. 107 excludes certain financial
instruments and all non-financial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts do not represent the
underlying value of the Company.
32
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 21. Disclosures About Fair Value of Financial Instruments, continued:
The following methods and assumptions were used to estimate the fair value of
the Company's financial instruments:
Cash and cash equivalents: The carrying amount of cash on hand and on deposit at
financial institutions is considered to be a reasonable estimate of fair market
value.
Securities: Fair values are based on quoted market prices or dealer quotes.
Mortgage loans: The estimate of fair value is based on current pricing of whole
loan transactions that a purchaser unrelated to the seller would demand for a
similar loan. The fair value of mortgage loans held for sale approximated
$69,623,000 and $109,637,000 at December 31, 1999 and 1998, respectively.
Interest receivable and interest payable: The carrying amount approximates fair
value.
Revolving warehouse lines: Collateralized borrowings consist of warehouse
finance facilities and term debt. The warehouse finance facilities have
maturities of less than one year and bear interest at market rates and,
therefore, the carrying value is a reasonable estimate of fair value.
Certificates of deposit: The fair values for certificates of deposit are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated contractual
maturities on such time deposits. The fair value of certificates of deposit
approximated $55,064,000 and $29,853,000 at December 31, 1999 and 1998,
respectively.
Mortgage loans payable: The fair value of mortgage loans payable is based on the
discounted value of expected cash flows. The discount rates used are those
currently offered for mortgage loans with similar remaining contractual
maturities and terms. The fair value of the mortgage loans payable approximated
$1,765,000 and $1,058,000 at December 31, 1999 and 1998, respectively.
Other term debt: The carrying amount of outstanding term debt, which bears
market rates of interest, approximates its fair value.
Note 22. Sale of Building:
The Company sold the administrative and executive office building located at
3386 Holland Road, Virginia Beach, Virginia. The sale price was $1,081,250,
which resulted in a break-even transaction for the Company. The Company had a
mortgage note payable on this property in the amount of $751,674 at the time of
sale. The closing date for this transaction was March 26, 1999. The Company
has also entered into a lease agreement with the purchaser to lease back 15,574
square feet of the premises for an initial term commencing from the closing date
to September 30, 1999, with the option to renew the lease for three additional
one month terms. The Company renewed this lease for a three month term ending
December 31, 1999. The lease payment is $15,000 per month.
33
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 23. Purchase of Land:
The Company purchased 7.77 acres of land from the City of Virginia Beach
Development Authority on March 11, 1999, on which it originally planned to
construct a new administrative and executive office building to consolidate the
Virginia Beach locations. The purchase price of the land was approximately
$642,000. Subsequently, another building located in the same office park
development that accommodates the Company's space requirements became available
for purchase and was acquired by the Company (see Note 24).
Note 24. Purchase of Building:
On October 15, 1999, the Company entered into an agreement to purchase an office
building in Virginia Beach, Virginia, to be used as the Company's new
administrative and executive office building. The purchase price of the
building was $2,250,000. The Company financed this transaction through a non-
affiliated Virginia Beach lender with a mortgage note in the amount of
$2,025,000.
Note 25. Significant Fourth Quarter Events:
In the fourth quarter 1999, the Company recorded a charge of $1.1 million for
the writeoff of goodwill related to the 1998 acquisition of the Funding Center
of Georgia ("FCGA") and Mortgage One Financial Corp. ("MOFC, Inc."). The
rapidly changing and competitive environment, which has resulted in shrinking
margins, has prevented the Company from achieving operating profits at levels
that existed prior to the acquisitions. The Company evaluated goodwill by
comparing the unamortized goodwill with revised projected operating results.
This resulted in writing off all of the goodwill for the FCGA acquisition and
writing the MOFC, Inc. acquisition goodwill down to $575,000.
Also, in the fourth quarter of 1999, the Company recorded a charge of $0.4
million for the writeoff of computers and equipment no longer in service because
of the branch closings in 1999. There was also an expense of $0.3 million
regarding legal and architectural costs, which were previously capitalized, for
construction of a new corporate headquarters. Since the Company purchased an
office building for its corporate headquarters, plans to build a corporate
headquarters were cancelled, and therefore the capitalized costs were expensed.
34
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 26. Quarterly Financial Data (Unaudited):
The following is a summary of selected quarterly operating results for each of
the four quarters in 1999 and 1998:
(In thousands, except per share data)
March 31 June 30 September 30 December 31
---------- ---------- -------------- -------------
1999:
Gain on sale of loans $ 4,396 $ 3,127 $ 2,920 $ 2,759
Net interest income 1,013 731 656 341
Provision for losses 1,279 (33) 179 831
Other income 2,290 2,106 1,971 1,467
Other expenses 8,253 8,115 7,672 10,152
---------- ---------- -------------- -------------
Income (loss) before income taxes (1,833) (2,118) (2,304) (6,416)
Provision for income taxes (598) (808) (901) (2,442)
---------- ---------- -------------- -------------
Net income (loss) $ (1,235) $ (1,310) $ (1,403) $ (3,974)
---------- ---------- -------------- -------------
Basic net income (loss) per share $ (.23) $ (.24) $ (.26) $ (.73)
========== ========== ============== =============
1998:
Gain on sale of loans $ 9,754 $ 8,779 $ 7,060 $ 4,110
Net interest income 1,054 1,118 828 1,056
Provision for losses (111) 949 718 1,340
Other income 1,482 1,678 2,806 2,826
Other expenses 9,928 9,772 9,694 9,309
---------- ---------- -------------- -------------
Income (loss) before income taxes 2,473 854 282 (2,657)
Provision for income taxes 1,038 341 121 (1,027)
---------- ---------- -------------- -------------
Net income (loss) $ 1,435 $ 513 $ 161 $ (1,630)
---------- ---------- -------------- -------------
Basic net income (loss) per share $ 0.26 $ 0.09 $ 0.03 $ (0.30)
========== ========== ============== =============
35
Approved Financial Corp.
Consolidating Balance Sheet
December 31, 1999
MOFC,
Inc. d/b/a
Approved Approved Approved Approved Consumer
ASSETS Financial Residential Federal Financial One
Consolidated Eliminations Corp. Mortgage Bank Solutions Financial
------------ ------------ --------- ----------- -------- --------- ----------
Cash $ 10,656 $ 0 $ 1,225 $ 503 $ 8,894 $ 57 $ (23)
Mortgage loans held for
sale, net 66,771 0 3,726 2,197 59,653 0 1,195
Real estate owned, net 2,274 0 279 1,957 0 0 38
Investments 2,640 (4,463) 4,588 0 2,515 0 0
Income taxes receivable 5,644 (2,876) 8,226 0 0 9 285
Deferred tax asset 1,676 0 376 406 785 0 109
Premises and equipment, net 6,086 0 4,918 514 195 0 459
Goodwill, net 1,120 0 501 0 101 0 518
Due from affiliates 0 (3,123) 1,821 63 1,221 18 0
Other assets 1,733 0 680 526 453 7 67
------------ ------------ --------- ----------- -------- --------- ----------
Total assets $ 98,600 $ (10,462) $ 26,340 $ 6,166 $ 73,817 $ 91 $ 2,648
============ ============ ========= =========== ======== ========= ==========
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 17,465 $ 0 $ 6,576 $ 4,885 $ 5,323 $ 0 $ 681
FHLB bank advances 4,648 0 0 0 4,648
Mortgage payable 2,341 0 2,341 0 0 0 0
Notes payable-related
parties 2,993 0 2,993 0 0 0 0
Certificates of
indebtedness 2,087 0 2,087 0 0 0 0
Certificates of deposits 55,339 0 0 0 55,339 0 0
Due to affiliates 0 (3,123) 21 1,230 1,827 41 4
Accrued and other
liabilities 2,428 o 1,023 585 324 19 477
Income taxes payable 0 (2,876) 0 2,876 0 0 0
------------ ------------ --------- ----------- -------- --------- ----------
Total liabilities 87,301 (5,999) 15,041 9,576 67,461 60 1,162
------------ ------------ --------- ----------- -------- --------- ----------
Shareholder's equity:
Preferred stock-series A 1 0 1 0 0 0 0
Common stock 5,482 (299) 5,482 250 32 16 1
Unrealized gain on securities (16) 16 (16) 0 (16) 0 0
Additional paid in capital 552 (6,838) 552 492 3,056 0 3,290
Retained earnings 5,280 2,658 5,280 (4,152) 3,284 15 (1,805)
------------ ------------ --------- ----------- -------- --------- ----------
Total equity 11,299 (4,463) 11,299 (3,410) 6,356 31 1,486
------------ ------------ --------- ----------- -------- --------- ----------
Total liabilities and
equity $ 98,600 $ (10,462) $ 26,340 $ 6,166 $ 73,817 $ 91 $ 2,648
============ ============ ========= =========== ======== ========= ==========
36
Approved Financial Corp.
Consolidating Statement of Income (Loss)
For the year ended December 31, 1999
(dollars in thousands)
MOFC,
Inc. d/b/a
Approved Approved Approved Approved Consumer
ASSETS Financial Residential Federal Financial One
Consolidated Eliminations Corp. Mortgage Bank Solutions Financial
------------ ------------ --------- ----------- -------- --------- ----------
Revenue:
Gain on sale of loans $ 13,202 0 $ 194 $ 3,961 $ 7,166 $ 0 $ 1,881
Interest income 7,698 0 454 2,788 4,133 1 322
Other fees and income 7,834 0 93 3,080 3,234 2 1,425
------------ ------------ --------- ----------- -------- --------- ----------
28,734 0 741 9,829 14,533 3 3,628
Expenses:
Compensation and
related $ 17,765 0 $ 4,778 $ 6,696 $ 4,803 23 1,465
General and
administrative 12,497 0 2,608 3,338 4,579 3 1,969
Write down of goodwill 1,131 0 358 0 0 0 773
Loss on sale/disposal
fixed assets 796 0 707 78 11 0 0
Loss on write off of
securities 73 0 73 0 0 0 0
Loan production expense 1,930 0 97 582 1,091 0 160
Interest expense 4,957 0 974 1,999 1,893 0 91
Provision for loan/REO
losses 2,256 0 (1,394) 3,311 63 0 276
------------ ------------ --------- ----------- -------- --------- ----------
41,405 0 8,201 16,004 12,440 26 4,734
Income before income taxes (12,671) 0 (7,460) (6,175) 2,093 (23) (1,106)
Provision for income taxes (4,749) 0 (4,990) (120) 791 (9) (421)
------------ ------------ --------- ----------- -------- --------- ----------
Net income $ (7,922) 0 $ (2,470) $ (6,055) $ 1,302 $ (14) $ (685)
============ ============ ========= =========== ======== ========= ==========
37
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Stock Price and Dividend Information (Unaudited):
The following tables show the quarterly high, low and closing prices of the
Company's common stock for 1999 and 1998. All stock price and dividend data
have been adjusted to reflect two- for-one stock splits which occurred on August
20, 1996 and December 16, 1996, and a 100% stock dividend, which occurred on
November 21, 1997.
Stock Prices
High Low Close
-------- ------------ ---------
1999:
Fourth Quarter $ 1.75 $ 0.875 $ 0.875
Third Quarter 2.75 0.781 0.781
Second Quarter 3.25 2.750 2.750
First Quarter 3.50 3.125 3.125
1998:
Fourth Quarter $ 6.50 $ 2.88 $ 3.38
Third Quarter 13.63 7.00 7.00
Second Quarter 15.63 13.13 13.88
First Quarter 15.08 12.08 13.13
The Company did not pay any cash dividends on its Common Stock in 1999 and 1998.
The Company intends to retain all of its earnings to finance its operations and
does not anticipate paying cash dividends for the foreseeable future. Any
decision made by the Board of Directors to declare dividends in the future will
depend on the Company's future earnings, capital requirements, financial
condition and other factors deemed relevant by the Board.
38