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Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
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Amendment No. -
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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, 2000
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Commission File Number 000-23775
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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 23454
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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 |_|.
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,
2001.
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 Part III -Items 10, 11, 12 and 13.
Corporation's Proxy Statement
for the Annual Meeting of
Stockholders to be held on June
11, 2001 ("Proxy Statement").
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Approved Financial Corp.
Annual Report on Form 10-K
Amendment No. -
For the Fiscal Year Ended December 31, 2000
INFORMATION REQUIRED IN ANNUAL REPORT
TABLE OF CONTENTS
PART I
Item 1. Business.
General ................................................................... 2
Business Strategy ......................................................... 5
Our Borrowers and Loan Products ........................................... 8
Underwriting Guidelines ................................................... 12
Mortgage Loan Servicing ................................................... 19
Marketing ................................................................. 21
Sources of Funds and Liquidity ............................................ 23
Bank's Sources of Funds ................................................... 24
Taxation .................................................................. 26
Employees ................................................................. 27
Service Marks ............................................................. 27
Effect of Adverse Economic Conditions ..................................... 27
Concentration of Operations ............................................... 28
Future Risks Associated with Loan Sales through
Securitizations .......................................................... 28
Contingent Risks .......................................................... 28
Competition ............................................................... 29
Regulation ................................................................ 30
OTS Regulation of Approved Financial Corp ................................. 33
Regulation of the Bank .................................................... 36
Legislative Risk .......................................................... 46
Environmental Factors ..................................................... 47
Dependence on Key Personnel ............................................... 47
Control by Certain Shareholders ........................................... 47
Item 2. Properties.
Properties ................................................................ 49
Item 3. Legal Proceedings.
Legal Proceedings ......................................................... 50
Item 4. Submission of Matters to a Vote of Security Holders.
Submission of Matters to a Vote of Security Holders ....................... 50
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Market Price of and Cash Dividends on Common Equity ....................... 51
Absence of Active Public Trading Market and Volatility
of Stock Price ........................................................... 52
Transfer Agent and Registrar .............................................. 52
Recent Open Market Purchase of Common Stock by the
Company .................................................................. 52
Recent Sales of Unregistered Securities ................................... 52
Item 6. Selected Financial Data.
Selected Financial Data ................................................... 54
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General ................................................................... 56
Results of Operations - Years Ended December 31, 2000 and 1999 ............ 57
Results of Operations - Years Ended December 31, 1999 and 1998 ............ 69
Financial Condition - December 31, 2000, 1999 and 1998 .................... 83
Liquidity and Capital Resources ........................................... 85
Interest Rate Risk Management ............................................. 89
New Accounting Standards .................................................. 90
Impact of Inflation and Changing Prices ................................... 92
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market Risk Management - Asset/Liability Management ....................... 94
Interest Rate Risk ........................................................ 97
Asset Quality ............................................................. 99
Item 8. Financial Statements and Supplementary Data.
Financial Statements and Supplementary Data .............................. 100
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ................................... 100
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 11, 2001 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 11, 2001 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 11, 2001 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 11, 2001 and is incorporated herein by reference.
PART IV
Item 14. Exhibits, Financial Statement Schedules And Reports on Form 8-K.
Financial Statements and Exhibits ........................................ 101
Signatures ............................................................... 106
PART I
ITEM 1 - BUSINESS
Forward Looking Statements
Some of the information in this report may contain forward-looking statements.
These forward-looking statements regarding our business and prospects are based
upon numerous assumptions about future conditions, which may ultimately prove to
be inaccurate. Actual events and results may materially differ from anticipated
results described in those statements. Forward-looking statements involve risks
and uncertainties described under "Risk Factors", "Business", "Management's
Discussion And Analysis Of Financial Condition And Results Of Operations",
"Interest Rate Risk" And "Quantitative And Qualitative Discussion About Market
Risk" Sections, as well as other portions of the report, which could cause
actual results to differ materially from historical earnings and those presently
anticipated. When considering forward-looking statements, you should keep these
risk factors in mind as well as the other cautionary statements in this report.
You should not place undue reliance on any forward-looking statement.
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 our subsidiaries
concerning future loan production volume, revenues from loan sales,
restructuring and expense reduction initiatives, ability to profitably
participate in any present or future line of business or operation are
forward-looking statements. You can identify these statements by words or
phrases such as "will likely result," "may," "expected to," "will continue to,"
"is anticipated," "estimate," "projected," "intends to", "plans to", "is likely"
or other similar words. There are a number of important factors that could cause
our actual results to differ materially from those indicated in such
forward-looking statements. Those factors include, but are not limited to our
ability to implement restructuring and expense reduction plans, our 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, our 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, federal banks, or
insurance companies, changes in GAAP accounting standards effecting our
financial statements, and any
changes which influence any market for profitable sales of all of our products
and services including mortgage loans.
General
Primary Business. Approved Financial Corp. is a Virginia-chartered financial
institution, principally involved in originating, purchasing, servicing and
selling loans secured primarily by conforming and non-conforming first and
junior liens on owner-occupied, one-to-four-family residential properties. We
offer both fixed-rate and adjustable-rate loans for debt consolidation, home
improvements, purchase and other purposes. Through our retail division we also
originate, service and sell traditional conforming mortgage products and
government mortgage products such as VA and FHA. Historically, our specialty was
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. However, during the
year ended December 30, 2000, approximately twenty percent of the loans funded
in-house were conforming or government loans and eighty percent (80%) were
non-conforming. Of the non-conforming loans slightly over eighty-one percent
(81%) were 'A' credit quality, approximately seventeen percent (17%) were 'B'
credit quality, and less than two percent (2%) were 'C' credit grades.(For
explanation of credit quality ratings see: "non-conforming underwriting")
We utilize 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. We began making residential mortgage loans through retail offices
during the fourth quarter of 1994. In 2000, the dollar volume in the broker
lending division accounted for 48.7% of total originations and the retail
lending division accounted for 51.3% of total originations. 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. Our
current initiatives for the mortgage business 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 risk analysis is completed and the loans are funded, we typically
package the loans and sell them on a whole loan basis to institutional investors
consisting primarily of larger financial institutions. We sell conforming loans
to large financial institutions and to government and quasi-government agencies.
The proceeds from these sales release funds for additional lending.
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We historically have derived our income primarily from the premiums received on
whole loan sales to institutional investors, 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 ancillary fees associated with the portfolio of loans serviced and
from our other financial services offered through Approved Financial Solutions.
In future periods, we may generate revenue from loans sold through alternative
loan sale strategies such as securitization, from other types of lending
activity and from the sale of other financial products and services.
Corporate History. Incorporated in 1952 as a subsidiary of Government Employees
Insurance Co. ("GEICO"), Approved Financial Corp. was acquired in September 1984
by, among others, several members of current management. We are headquartered in
Virginia Beach, Virginia, and hold a Virginia industrial loan association
charter and are therefore subject to the supervision, regulation and examination
of the Virginia State Corporation Commission's Bureau of Financial Institutions.
As of December 31, 2000, Approved Financial Corp. had four primary operating
subsidiaries:
o Approved Federal Savings Bank ("Bank")
o Approved Residential Mortgage, Inc. ("ARMI")
o Approved Financial Solutions ("AFS").
o Global Title of Maryland, Inc.
Bank. In September 1996 we 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"). We are a registered savings
and loan holding company under the federal Home Owner's Loan Act ("HOLA")
because of our ownership of the Bank. As such, we are 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.
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
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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 many states
without the expense and time involved in the licensing process for non-bank
mortgage companies. The Bank originates loans utilizing a network of mortgage
brokers for loan referrals and through retail mortgage lending offices. The Bank
has contracted us to provide the processing, underwriting and closing procedures
for Bank operations. We have agreed to purchase all nonconforming mortgage loans
made by the Bank. We have sold in the secondary market most of the loans
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. Therefore, the Bank and we 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.
Approved Residential Mortgage, Inc. ("ARMI") was formed in April 1993. Initially
ARMI originated loans through broker referrals. In 1994 ARMI opened its first
retail operation. Currently, ARMI's primary business activity is to originate
non-conforming residential mortgage loans on a retail basis.
Approved Financial Solutions, Inc. ("AFS") was formed in November of 1998 for
the initial purpose of offering life insurance to our loan customers. To date,
life insurance sales have not represented a material source of revenue and are
not anticipated to do so in the near future. AFS offers title insurance in
certain states where it holds licenses and ofers other ancillary financial
products such as Mortgage Acceleration Program ("MAP") and Debt Free Solutions
Program. (See: "Business Strategy (v) Expand product and financial service
offerings")
Global Title of Maryland, Inc. To facilitate the restructure of our title
insurance division, this subsidiary was formed during the first part of the year
2000 and offers title insurance products to our customers in Maryland.
Inactive Subsidiary. A fifth wholly owned subsidiary, MOFC, Inc. d/b/a/
ConsumerOne Financial ("ConsumerOne"), located in Birmingham, Michigan was
acquired in December of 1998. The operations of ConsumerOne were transferred to
the Bank during 2000 and currently operate as a retail loan origination branch
of the Bank and serves as a disaster "hot" site for us.
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Business Strategy
Our current corporate business strategies 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 residential
mortgage volume from the retail division, through strategic alliances and
from broker referrals and through utilization of the internet.
(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 business opportunities provided by a federal savings bank
charter.
(vii) Enhance our capital base by evaluation of opportunities afforded to us
from various sources.
(i) Maintain Quality Loan Underwriting and Servicing Standards. Our underwriting
and servicing staff have experience in the non-conforming, home equity loan
industry. We believe that the experience of our underwriting and servicing staff
provides us with the infrastructure and skills necessary to maintain our
commitment to solid underwriting standards during periods of rapid growth as
well as through 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 we implemented several cost cutting
campaigns, one of which centralized all marketing and advertising efforts in the
Virginia Beach headquarters location. Additionally, during December of 1999 we
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. Another campaign introduced in October of 1999,
was 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.
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(iii) Increase revenues by expanding the level of profitable mortgage volume
from retail division, through strategic alliances, from broker referrals and
through utilization of the internet.
Retail. We intend to expand our loan origination volume from its retail branch
network by maintaining larger sales staffs in fewer locations and retaining
highly seasoned mortgage professionals as branch managers and as corporate sales
trainers.
Strategic Alliances. We look to strengthen our retail loan production
capabilities not only through internal growth, but also from time to time
through the development of strategic alliances with other mortgage companies. We
believe that these relationships can accelerate the pace of growth in a
cost-effective manner with minimal initial investment or long-term financial
commitment. These candidates must exhibit management styles compatible with our
management team and offer and implement business strategies that complement our
own. We adhere to the belief that "people" are more important than "location" in
the lending business, therefore we seek 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. Our wholesale division sales efforts are conducted through
account executives with extensive experience in the non-conforming mortgage
business located in several states. To augment these sales efforts we are
building an inside sales staff who solicit and coordinate broker referral
business from the home office in Virginia Beach. We launched, during September
of 2000, and are currently developing a new wholesale division, located in
Huntington Beach, California, to service the western portion of the United
States.
Internet Applications. We continue to refine our business-to-business and
business-to-customer web-based platform to facilitate more efficient,
cost-effective service and ready access to information to our broker network,
our off site sales staff as well as consumers. This password secured application
allows off site loan origination personnel to access their loan files in
process, retrieving underwriting status and outstanding stipulations needed. We
feel that this type of application presents immediate value to us. We launched a
web site http://www.approvedfinancialsolutions.com during 2000 related to our
new financial services products (see (v) Broaden Product Offerings in this
section).
(iv) Diversify loan sale strategies and investors with a commitment to prudent
management of cash flow. We historically have sold our loans on a whole loan
basis receiving cash at the time of sale. Beginning in the second half of 1998,
many of our
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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 our average non-conforming
loan sale premiums received from 5.4% in 1998 to 3.1% in 1999 and 2000,
excluding seasoned loan sales. In order to reduce our dependence on any
individual investor, we initiated a campaign to diversify our investor base by
increasing the number of relationships and the types of investors to whom we
sell loans. We have been successful in obtaining new investors having reduced
the percentage of loans sold to a single investor from 66% in 1997 to 34% in
2000. We continue to aggressively pursue expansion of our investor base for loan
sales.
While we have no current plans to do so, alternative or complementary loan sale
strategies, such as asset-backed securitization, may be utilized 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 our profitability, capital base and
liquidity.
(v) Broaden Product Offerings. We frequently review our traditional
non-conforming pricing and loan offerings for competitiveness relative to the
origination and secondary markets. We introduce 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 our market.
Ancillary product offerings are developed with the goal of leveraging current
customer base internally. Examples of such offerings follow:
a. Title Insurance Division: Over the past year, we restructured our title
insurance operation and retained an individual with many years of
experience to manage the operation. This division is licensed in the
states of Maryland and Virginia and is in the licensing process in other
states where we have a strong retail presence.
b. During 2000, we launched ancillary financial products and services, such
as a Mortgage Acceleration Program and Debt Free Solutions program. Both
of these programs are designed to assist consumers in accelerating the
repayment of their outstanding consumer and/or mortgage debt. A web site
http://www.approvedfinancialsolutions.com is operational for illustration
of the benefits offered by these products.
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(vi) Building on Our 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 us by providing a lower cost source
of funds. The Bank facilitates ease 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 that
we have not yet developed, such as Small Business Administration (SBA) and Small
Business Investment Corporation (SBIC) and Trust activities. We are currently
exploring the possibility of launching an SBA lending operation.
(viii) Enhance Our Capital Base.
We evaluate opportunities as afforded to us from time to time to
strengthen our capital position by means of a variety of business options
including but not limited to the following types of activity.
a. Industry Consolidation and Strategic Relationships. Recent industry
trends reflect high levels of industry consolidation through merger
and acquisition activity and the formation of various strategic
relationships among participants.
Capital Offerings. The issuance of private or public, equity or debt securities.
On December 14,2000 we filed for registration of subordinated debt securities on
Form S1 with the Securities and Exchange Commission ("SEC"). This filing is for
the continuous offering of securities pursuant to Rule 415 under the Securities
Act of 1933. The filing is not yet 'effective' with the SEC or the various
states where we have applied for its registration. There can be no assurance at
this time that we will finalize this registration nor that we will issue any of
the related securities as a source of capital.
Our Borrowers and Our Loan Products
Our primary products are fixed-rate and adjustable-rate mortgage loans for
purposes such as debt consolidation, home improvements and home purchase,
serving both conforming and non-conforming borrowers. These loans secured
primarily by first and junior liens on owner-occupied, one-to-four-family
residential properties. Borrowers may 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.
Prior to the establishment of a conforming origination division in March 1999,
we catered primarily to individuals who do not meet the strict qualification
guidelines established by most conforming lending programs. However, the credit
grade of our funded loans has moved up the credit grade scale over the past few
years. Approximately twenty percent (20%) of loans funded in-
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house during the year 2000 were conforming loans and eighty percent (80%) were
non-conforming. However, of the non-conforming loans funded, over eighty-one
percent (81%) were 'A' credit quality, approximately seventeen percent (17%)
were 'B' credit quality, and less than two percent (2%) were 'C' credit
grades.(For explanation of credit quality ratings see: "non-conforming
underwriting")
Non-conforming customers historically have experienced limited access to credit,
but their financial needs are nonetheless real. By consolidating their debts
with a mortgage loan from us, 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 our 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. 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 us 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 our underwriting policies and collection procedures will
substantially reduce such risks. In the event that warehoused loans or portfolio
loans held and serviced by us experience higher than anticipated delinquency,
foreclosure, loss or prepayment speed rates, our results of operation or
financial condition would be adversely affected.
The average size of non-conforming loans that we funded in-house during the year
ended December 31, 2000 and 1999 was $71,455 and $63,000, respectively. The
average size of non-conforming loans that we originated, including retail loans
funded through other lenders ("brokered loans") during the year ended December
31, 2000 and 1999 was $73,714 and $71,000, respectively. The average size of
conforming loans that we funded during the year ended December 31, 2000 and 1999
was $104,062 and $101,000, respectively.
There is an active secondary market for most types of mortgage loans that we
originate. The majority of our loans are sold to
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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, while
we have no plans to do so at the present time, we may adopt alternative or
complimentary loan sale strategies such as securitization in the future. We
continue to invest in technology to further streamline our operating procedures,
enhance productivity, reduce expenses and provide for future expansion. However,
we expect that additional investments would be required if we enter the
securitization business.
We have the ability to originate loans through the Bank that are not secured by
real estate collateral, including consumer installment debt. To date, the amount
of non-real estate secured loans originated by us have not been material.
However, when offered, these products are underwritten based on the borrower's
credit worthiness.
Broker Loan Originations. We originate non-conforming residential mortgage loans
through a network of independent mortgage brokers who offer our products to
their clients. During 2000, loans originated from mortgage broker referrals
increased to $135.0 million or 48.7% of the total loan volume compared to $126.9
or 32.5% of 1999 loan volume.
In cultivating this broker network, we stress superior service, efficiency,
flexibility and professionalism. Due to concentrated size and
centrally-organized operations, we normally offer 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 and an inside sales
staff is operated from our headquarters in Virginia Beach The loans are
underwritten primarily in Virginia and to a lesser extent in the regional
operation centers in Florida and California under the supervision of our chief
Credit Officer.
In late September 2000, we launched the new wholesale operations center located
in Huntington Beach, California in order to better service the western portion
of the United States. Our goal for this new center is to profitably increase
broker referred loan origination volume and its geographic diversification.
Retail Loan Originations. During 2000 loans originated from the retail division
totaled $142.1 or 51.3% of total volume for the year compared to $263.9 or 67.5%
during 1999.
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As a result of the drastic changes that occurred in the mortgage industry
beginning in the fourth quarter of 1998, revenues from premiums received on
whole-loan sales, excluding loans owned in excess of 180 days ("seasoned
loans"), dropped materially from 5.3% during the third quarter of 1998 to a low
of 2.8% in the first quarter of 2000. As a result, the smaller retail branch
structure, which comprised many of the locations in 1998, could no longer
operate profitably. We found it necessary to dramatically restructure our retail
operations. At the end of 1998, we had 26 retail branches compared to 10 as of
December 31, 2000 a reduction of 62% percent. As of February 29, 2001 we have
seven (7) retail production offices.
The current retail branch strategy encompasses a "super branch" structure with
larger sales staffs and greater loan volume per location than in past years. We
intend to continue use of this super branch strategy and to continue to build
our retail sales staff located in the home office that services customers in
several states.
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
in turn generate inbound telemarketing leads. (See "Marketing")
Strategic Alliances. In order to increase volume and to diversify our sources of
loan originations, we seek to enter into strategic alliances with selected
mortgage originators as opportunities occur. We have no predefined structure of
such alliances because we anticipate that each will provide unique
opportunities.
In early 2000, we began marketing for strategic partners under the name
"Partners in Banking". However, in the very early stages, we determined that the
expenses associated with our due diligence efforts as a result of the quality of
individuals responding to our marketing efforts was not cost effective. Instead
we enter negotiations from time to time with known industry professionals and/or
referrals from employees and other business associates where we feel there is
opportunity for creation of mutually beneficial and cost effective relationship.
During 2000, we made agreements with the management of two smaller mortgage
operations located in New Jersey and Georgia. To facilitate each, we formed new
retail branches that are run by management of the prior companies, hired the
loan origination employees of the operations, assumed the operating expenses for
their loan origination staff and provide the branches with services such as
underwriting, closing, quality control, secondary marketing, human resource,
legal and payroll. We had
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prior knowledge of or direct experience with the management of these two
operations.
Underwriting Guidelines
We underwrite 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 us have been non-conforming loans. We began funding conforming
conventional and government mortgages in the second half of 1999.
Non-Conforming Mortgage Loans. Historically, we have focused on the
non-conforming mortgage business. The following is a general description of the
non-conforming underwriting guidelines that we currently use with respect to
mortgage loans; we originate. We revise such guidelines from time to time in
connection with changing economic and market conditions. We may make exceptions
to these guidelines for special types of loans. We rely on the judgment of the
underwriting staff in making these exceptions. Also, we will substitute
underwriting guidelines of other lenders to which we anticipate selling 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. Our 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.
Our underwriters make determinations on loans without regard to sex, marital
status, race, color, religion, age or national origin. 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 discloses instances of adverse credit that were reported on
the applicant's record. Such information might include delinquencies,
repossessions, judgments, 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 our evaluation of risk.
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
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report must be satisfactorily explained and will normally reduce the amount of
the loan for which the applicant can be approved.
The underwriting department is headquartered in our Virginia Beach, Virginia
office. We have underwriters located in the broker operations centers in Florida
and California. Our loan application and approval process generally is conducted
via facsimile submission of the credit application to our 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 our 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. We endeavor to respond with preliminary proposed loan terms, and in
most cases do 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. We require loan officers and brokers to use licensed
appraisers that are listed on or qualify for our approved appraiser list. We
approve 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 our loans.
Assessment of the applicant's demonstrated willingness and ability to repay a
loan is one of the principal elements in distinguishing our lending philosophy.
Like other lenders, as part of the loan approval process we utilize "debt
ratios" (calculated as the borrower's monthly expenses for debts including fixed
monthly expenses for housing, taxes and installment debt, as a percentage of
gross monthly income), "loan-to-value ratio" or "LTV" (the gross loan amount
divided by the appraised value of the property), payment history on existing
mortgages, customer's history of bankruptcy, and the combined loan-to-value
ratio for all existing mortgages on a property. While many lenders base
approvals primarily on credit scores from various service providers, we use an
applicant's credit score as an underwriting tool along with these other
criteria. We rely upon experienced mortgage loan underwriters to scrutinize an
13
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 us. The closing attorney or
agent is responsible for completing the loan transaction in accordance with
applicable law and our operating procedures.
We require title insurance coverage issued by an approved ALTA title insurance
company of all property securing mortgage loans we originate or purchase. Our
assignees and we are generally named as the insured. Title insurance policies
indicate the lien position of the mortgage loan and protect us 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 us, as an
additional insured is required on all loans.
We have general classifications with respect to the credit profiles of loans
based on certain characteristics of the applicant in conjunction with other loan
characteristics such as the loan-to-value ratio. Credit grade classifications
for non-conforming loans are extremely objective in nature and vary greatly
between lenders. Over time gradual adjustments to the criteria defining loan
classifications may occur throughout the industry as the performance, in terms
of delinquency and default rates, of aged pools of loans are analyzed relative
to the borrower and loan characteristics of the associated loan pools.
Our classifications place each loan application 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 loan size
relative to the value of the property and the applicant's employment history and
current status. We also rely on the judgment of its underwriting staff, which
may make exceptions to the general criteria and upgrade a rating due to
compensating factors considered appropriate to the underwriting staff. Terms of
loans made by us, 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
application. Applicants falling into a
14
lower credit classification will generally pay higher rates and loan origination
fees than those in higher credit classifications in order to compensate the
lender for assuming greater credit risk.
The credit classification criteria used by the investors to whom we sell our
loans have significant influence on our general loan classifications as set
forth below. The following are subject to adjustments from time to time and the
underwriting staff's judgment of compensating factors that merit exceptions.
"A" Risk. Under the "A" risk category, a loan applicant must have
generally repaid installment or revolving debt according to its terms.
o Existing mortgage loans: a maximum of two 30-day late payment(s)
within the last 12 months. (case-by-case exceptions are made
provided the credit score is greater than 599) Non-mortgage credit:
minor derogatory items are allowed, but a letter of explanation is
required.
o Bankruptcy filings: must have been discharged more than two years
prior to closing with credit re-established.
o 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.
o 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.
o Existing mortgage loans: maximum of two 60-day late payments within
the last 12 months. (case-by-case exceptions are allowed provided
the credit score is greater than 550)
o 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, judgments or liens may be left
open at underwriters discretion.
o Bankruptcy filings: must have been discharged more than two years
prior to closing with credit re-established.
15
o 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.
o 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.
o Existing mortgage loans: must be brought current from loan proceeds;
applicant is allowed up to 119 days late payment within the last 12
months. Foreclosures and Notices of Default are not allowed within
the last 12 months.
o Non-mortgage credit: significant prior delinquencies may have
occurred.
o Bankruptcy filings: must have been discharged.
o 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.
o Debt service-to-income ratio: generally 50% or less.
We use 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, we 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.
16
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 financial
institutions such as the Federal National Mortgage Association (Fannie Mae), and
Federal Home Loan Mortgage Corporation (Freddie Mac). Our 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. We are an approved Fannie Mae and
Freddie Mac Seller/Servicer, and have delegated underwriting authority with most
of our investors.
Our 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 our 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 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 layering of risk may be
associated with the application. Our 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 our underwriters by reviewing
a credit explanation and/or other supporting information, the loan application
is sent to our investor for their approval.
We offer a vast array of conventional expanded criteria and conventional
non-conforming programs, most of which are underwritten through the investor
specific automated underwriting systems. The 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")
and closed end seconds.
Our conforming loan division requires Private Mortgage Insurance on all 1st Lien
programs exceeding an 80% LTV. Our direct-
17
delegated authority can accomplish the insurance with several mortgage insurance
companies, or through various lender paid insurance options that may include
pricing adjustments.
Government Mortgage Loans. We offer FHA Title II first mortgage loans, and will
be soon offering FHA Title I subordinate lien mortgages, in many areas of the
country. We have FHA Direct Endorsement underwriters, allowing all credit and
collateral decisions to be made in-house. We approve 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 us 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. We utilize these
AUS tools, but take a firm stance on evaluating the totality of each loan
application not approved through an AUS. We offer 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.
We offer first mortgage loans guaranteed by the Veterans Administration (VA) in
many regions of the country to qualified active duty/retired/reservist military
personnel. We employ "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 we perform all
submissions for Loan Guaranty. We underwrite VA loans to ensure conformance to
18
Government National Mortgage Association (Ginnie Mae) standards in order to
facilitate the sale of loans in the secondary mortgage market.
Underwriting standards are similar to that of FHA. DU and LP have been approved
for evaluating VA loan applications, and we follow the same underwriting
practices based on AUS findings as we do for FHA loans. We offer 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
We have serviced our portfolio and warehouse loans since 1984. Since January 1,
1997, the Bank's portfolio of loans held for sale and for investment has been
serviced by us under a contractual arrangement.
Our loan servicing operation has two functions: collection and customer service
for borrowers. The customer service department monitors loans, addresses
customer inquiries and collects current loan payments due from borrowers. The
collection department furnishes reports and enforces the rights of the holder or
owner of the loan, including recovery of delinquent payments, institution of
loan foreclosure proceedings and liquidation of the underlying collateral.
The accounting department is responsible for posting all payments to the
borrower's loan accounts. This provides a "separation" in duties between
payments and the servicing operation personnel whose performance is measured by
factors such as delinquency and loss levels.
We close loans throughout the month. Most of our loans require a first payment
thirty to forty-five days after funding. Accordingly, our servicing portfolio
consists of loans with payments due at varying times each month.
Our collection policy is designed to identify payment problems sufficiently
early to permit us to address delinquency problems quickly and, when necessary,
to act to preserve equity before a property goes to foreclosure. We believe that
these policies, combined with the experience level of independent appraisers
engaged by us, 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 our
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.
19
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 our collectors make follow up calls. During the delinquency period, the
collector will continue to frequently contact the borrower. Our 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 our 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 senior
management.
Our 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 we will obtain force-placed
insurance at the borrower's expense. We also have an insurance policy in place
that provides coverage automatically for us in the event an employee 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 handled by the foreclosure and REO
team, which is coordinated by the collection department manager who directs
items to our resources both internal and external as appropriate. The Chief
Financial Officer or Chief Executive Officer must approve the major steps in
this procedure. There are occasions when foreclosures and charge-off occurs.
Prior to a foreclosure sale, we perform a foreclosure analysis with respect to
the mortgaged property to determine the value of the mortgaged property and the
bid that we 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, 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 is required to provide monthly reports on each
loan file.
20
At the present time we do not service mortgage loans for other investors.
However, in future periods we may securitize loans and retain the servicing
component on those securities or we may provide interim servicing for investors
who acquire the loans and contract us to service the loans on their behalf. In
this event, we would need to enhance our servicing capabilities. If we were to
adopt a securitization loan sale strategy, we may engage one or more companies
to sub-service a portion of the loans securitized.
Marketing
Marketing to Broker Networks. Marketing to brokers is conducted through our
staff of account executives ("AE") and inside sales personnel, which establish
and maintain relationships with a network of mortgage brokers that refer loans
to us. During the year ended December 31, 2000, loans made through the broker
networks amounted to 48.7% of total originations or $135 million compared to
$127 million or 32.5% during the same period in 1999. (See the table on page 58
for divisional loan originations by state.)
The AE's provide various levels of information, assistance and training to the
mortgage brokers regarding our products and non-traditional prospecting
strategies, and are principally responsible for maintaining our relationships
with our 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 their sales managers visit brokers offices and attend trade shows. The AE's
also provide feedback to us relating to the current marketplace relative to
products and pricing offered by competitors and new market entrants, all of
which assist us in refining our 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. The inside sales
staff, who do not require experience as extensive as the outside AE staff, are
compensated with a base salary and a per unit commission.
In late September of 2000, we launched a new wholesale division located in
Huntington Beach, California. The goal of this new operation is to develop a
broker referral network in the western portion of the United States that will
add new sources of loan volume for us while augmenting our geographical
diversification of mortgage origination business.
Marketing of Retail Lending Products. We market our direct consumer lending
services through a sales staff of loan officers in our branch offices located in
several states. Loans made through the retail lending division amounted to
$142.1 million or
21
51.3% of total originations during the year ended December 31, 2000 compared to
$263.9 million or 67.5% for the same period in 1999. (See the table on page 58
for divisional loan originations by state.)
Due to narrower operating margins throughout the industry, beginning in mid 1998
retail branch locations were either consolidated or closed reducing the number
of locations from 26 at December 31, 1998 to 10 as of December 31, 2000 and 7 as
of February 28, 2001. We continue to monitor financial and operational
performance of branches on a monthly basis in order to restructure or close down
those branches not attaining established revenue and expense goals.
To generate customer leads for the retail loan officers, we use targeted
outbound and inbound 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 us
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.
Our inbound 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 inbound and outbound calls, which provides for more
flexibility with new campaigns and efficient use of the staff.
In the event that a potential retail customer's loan application does not fall
within our underwriting guidelines, the underwriter may authorize the
application for submission to another lending institution. If the loan is
approved and funded, we act in the capacity of a mortgage broker, receiving fee
income ("brokered loans"). Brokered loans are primarily non-conforming mortgages
that do not meet our underwriting guidelines. While less profitable, this type
of retail loan production allows us to accommodate loan customers during
competitive periods while adhering to solid underwriting standards. In October
of 1999, we instituted strict controls to ensure that only loans not meeting our
underwriting criteria are brokered to other lenders. As a result, brokered loans
as a percent of total retail loan origination decreased to approximately 33.5%
during the twelve month period ended December 31, 2000 down from an average of
57.4% for the twelve months ended December 31, 1999.
22
Our Sources of Funds and Liquidity
- --------------------------------------------------------------------------------
SUMMARY
- --------------------------------------------------------------------------------
As of Date: December 31, 2000 December 31, 1999
Warehouse Credit Lines $60 million $55 million
FHLB credit line $15 million $15 million
FDIC Bank Deposits $38 million $55 million
Subordinated $ 5 million $ 5 million
Stockholder's Equity $ 8 million $11 million
- --------------------------------------------------------------------------------
At December 31, 2000, we had combined warehouse lines of credit of $75 million,
including a $15.0 million line of credit available to the Bank from the Federal
Home Loan Bank ("FHLB"), with an outstanding balance of $1.7 million.
Additionally, we had subordinated debt outstanding of $4.9 million; FDIC insured
certificates of deposit outstanding of $38.4 million and consolidated
stockholder's equity of $8.0 million.
On July 21, 2000, we obtained a $40.0 million line of credit from Bank United.
However, effective December 29, 2000, we obtained an amendment to the credit
line, which reduced the size of the warehouse facility to $20.0 million since
there was low utilization of the credit line in 2000. The credit line can be
used for prime and sub-prime mortgage loans and is secured by loans that we
originate. The line bears interest at a rate of 2.00% and 2.75% over the
one-month LIBOR rate for prime and sub-prime loans respectively. We may receive
warehouse credit advances of 98%, 97%, and 90% for prime, sub-prime, and high
LTV loans (loans with LTV's greater than 90%), respectively, of the collateral
value amount on pledged mortgage loans for a period of 90 days after advance of
funds on each loan. If an investor has not purchased a loan within 90 days of
such advance, the interest rate on the loan increases to 3.75% over the
one-month LIBOR and we have an additional 30 days to sell the loan or purchase
the loan back from the warehouse. All interest rates reflect a 25 basis point
increase from the original interest rates, which was the result of the December
29th amendment. The aged loan sub limit is $2.0 million. As of December 31, 2000
there were $1.7 million in borrowings, secured by sub-prime mortgage loans
originated within 90 days prior to December 31, 2000, outstanding under this
facility. The line of credit is scheduled to expire on July 21, 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, 2000 we were in compliance with
all financial covenants.
On November 10, 1999, we obtained a $20.0 million sub-prime line of credit from
Regions Bank. The line is secured by loans originated by us and bears interest
at a rate of 3.25% over the one-month LIBOR rate. We may receive warehouse
credit advances of 100% of the net loan value amount on pledged mortgage loans
23
for a period of 90 days after origination. As of December 31, 2000 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, 2000 we were in compliance with all financial covenants.
On November 10, 1999, we obtained a $20.0 million conforming loan line of credit
from Regions Bank. The line is secured by loans originated by us and bears
interest ranging from 2.25% to 2.75% over the one-month LIBOR rate based upon
the monthly advance levels. We 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, 2000 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, 2000 we were in
compliance with all financial covenants.
Bank Sources of Funds
Certificates of Deposits. The Bank had $34.4 million of FDIC insured
certificates of deposits outstanding at December 31, 2000. The Bank had $55.3
million FDIC insured certificates of deposits outstanding at December 31, 1999.
The Bank also had $3.9 million in money market deposits through an arrangement
with a local NYSE member broker/dealer at December 31, 2000. The bank did not
have any money market deposits 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 $12.8 million or 37%
and $25.0 million, or 45.2%, of the Bank's deposits at December 31, 2000 and
December 31, 1999, respectively. The Bank solicits deposits via a computer
bulletin board where the rates of many other banks and institutions are
advertised. At December 31, 2000 and December 31, 1999, the Bank had deposits
from this source of $34.4 million or 89.8% and $55.3 million or 100% of total
deposits, respectively. The fees paid to deposit brokers are amortized using the
interest method and included in interest expense on certificates of deposit.
We believe that the Bank's 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
24
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, 2000, $15.4 million
of the Bank's certificates of deposit were scheduled to mature within one year
(44.9% of total deposits). 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 we believe that the Bank's 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
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, our reliance on wholesale deposits
effects our ability to rollover deposits as they mature due to the fact that in
general the wholesale customer is highly interest rate-sensitive. However, we
are of the opinion that we 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 23 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 and subject to new restrictions on
collateral characteristics described in this section. FHLB advances are
available to member institutions such as the Bank for investment
25
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, 2000 the Bank had a line of credit with the FHLB for $15
million. During the year ended December 31, 2000, the Bank had advances of $10.4
million from the FHLB and paid down principal on advances of $12.0 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 $589,000 and $407,000 of
the FHLB stock at December 31, 2000 and December 31, 1999, respectively. We
expect the Bank to utilize FHLB advances as the Bank builds a portfolio of
loans.
The Federal Home Loan Bank ("FHLB") Board of Atlanta announced to its member
institutions on November 27, 2000 the adoption of "Policies to Promote
Responsible Lending". The policy restricts the general characteristics of
mortgage loans or the mortgage loans backing mortgage backed securities that a
member institution, such as our Bank, can pledge as collateral for advances of
credit from the FHLB. In general collateral pledged cannot (i) meet the interest
requirements of high cost mortgages under the HOEPA of 1994 (ii) include
prepaid, single premium credit insurance (iii) include points and fees,
excluding discount points, in excess of 5% (iv) include prepayment penalty if
the interest rate at time of origination is 300 basis points higher than
conventional rates.
Taxation
General. We 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.
Our income is subject to tax in most of the states in which we make loans. Our
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
26
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 carry backs and carry forwards are permitted
to offset only 90% of AMTI. Alternative minimum tax paid can be credited against
regular tax due in later years. We are not currently subject to the AMT.
Employees
As of December 31, 2000, we had, including our subsidiaries, a total of 207
full-time employees and 8 part-time employees or 211 full time equivalent
employees. None of our employees are covered by a collective bargaining
agreement. We consider the relations with our employees to be good.
Service Marks
We have 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.
Effect and Risk of Adverse Economic Conditions
Our 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 us, 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.
Risk from Concentration of Operations in Certain States
During 2000, 95.2% of the aggregate principal balance of the loans we originated
is secured by properties located in ten states (Maryland, Virginia, Florida,
Ohio, North Carolina, Pennsylvania, Michigan, New Jersey, Georgia and South
Carolina). Although we are currently attempting to expand our wholesale
operation into the western portion of the United States and to develop
multi-state retail origination volume, if these efforts are not successful, our
origination business is likely to remain concentrated in a limited number of
states in the foreseeable
27
future. Consequently, our results of operation 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
While we have no current plans to do so, in future periods, we may sell a
portion of the loans we originate 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 our previous business operations.
Adverse changes in the securitization market could impair our ability to
originate and sell loans through securitization on a favorable or timely basis.
Any such impairment could have a material adverse effect upon our results of
operation and financial condition. Furthermore, our quarterly operating results
in future periods may fluctuate significantly as a result of the timing and
level of securitization. If a securitization does not close when expected, our
results of operation may be adversely affected for that period.
Whether or not we adopt this loan sale strategy in the future, adverse changes
in the securitization market have in the past and could in the future impair our
ability to originate and sell loans to other financial institutions that utilize
the securitization market.
Contingent Risks
In the ordinary course of business, we are subject to claims made against us by
borrowers and 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 our employees,
officers, and agents (including our appraisers), incomplete documentation and
failures by us to comply with various laws and regulations applicable to our
business. We are not aware of any material claims.
Although we sell substantially all loans that we originate and purchase on a
non-recourse, service released basis, during the period of time that loans are
held pending sale, we are 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.
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Risk from Competition
We face 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 us. 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 our prime customer base. There can be no assurance
that we will not face increased competition and erosion of operating margins
from such institutions in the future.
Competition can take on many forms, including convenience in obtaining a loan,
service, loan pricing terms such as the loan to value ratio, origination fees
and interest rate, marketing and distribution channels and competition for
employees through compensation plans and benefit packages.
The quantity and quality of our competition may also be affected by fluctuations
in interest rates and general economic conditions. During periods of rising
rates, competitors that "locked in" low borrowing costs may have a competitive
advantage. During periods of declining interest rates, competitors may solicit
our borrowers to refinance their mortgage loans. During an economic slowdown or
recession, our borrowers may have new financial difficulties and may be
receptive to offers by our competitors.
We use mortgage brokers as a source of origination of new loans. Our competitors
also seek to establish relationships with the brokers with whom we do business.
Our future results may become more exposed to fluctuations in the volume and
costs of our wholesale loans (loans sourced from mortgage brokers) resulting
from competition from other originators of such loans, market conditions and
other factors.
Regulation
Our 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
29
charges, disclosure to customers, the terms of secured transactions, the
collection, repossession and claims-handling procedures utilized by us, 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 us and
the Bank and all such descriptions are qualified in their entirety by reference
to applicable statutes, regulations and other regulatory pronouncements. (See
also: "Regulatory Capital Requirements")
Our consumer lending activities are subject to the federal Truth-in-Lending Act
("TILA") and Regulation Z (including the Home Ownership and Equity Protection
Act of 1994 "HOEPA"); 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. We are also subject to
state statutes and regulations affecting our activities.
TILA and Regulation Z promulgated there under 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 we originate. We believe that we are 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
$465 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, we apply underwriting criteria that take into
30
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. We 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 we believe will not have a material impact
on our operations. We will no longer fund Section 32 loans as of April 1, 2001.
We are 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. We are also subject to the Real Estate Settlement
Procedures Act and AFC, as a savings and loan holding company, is required to
file an annual report with the Office of Thrift Supervision pursuant to the Home
Mortgage Disclosure Act.
We are 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 us, 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
31
enforcement actions. There can be no assurance that we will maintain compliance
with these requirements in the 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 us. We believe that we are
in compliance in all material respects with applicable federal and state laws
and regulations.
Additionally, we are subject to the regulations enforced by, and the reporting
requirements of, the Equal Employment Opportunity Commission ("EEOC"). In
addition, we are 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 our business.
The laws, rules and regulations applicable to us are subject to regular
modification and change. There are currently proposed various laws, rules and
regulations, which, if adopted, could impact us. 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 our ability to originate, purchase, broker
or sell loans, further limit or restrict the amount of commissions, interest and
other charges earned on loans we originate or sell, or otherwise adversely
affect the business or prospects.
The previously described laws and regulations are subject to legislative,
administrative and judicial interpretation. Some of these laws and regulations
have recently been enacted.
Some of these laws and regulations are rarely challenged in or interpreted by
the courts. Infrequent interpretations of these laws and regulations or an
insignificant number of interpretations of recently enacted regulations can make
it difficult for us to know what is permitted conduct under these laws and
regulations. Any ambiguity under the laws and regulations to which we are
subject may lead to regulatory investigations or enforcement actions and private
causes of action, such as class action lawsuits, with respect to our compliance
with the applicable laws and regulations.
Federal and state government agencies have recently begun to consider, and in
some instances have adopted, legislation to restrict lenders' ability to
originate certain non-conforming and subprime loans and to charge rates and fees
in connection with certain non-conforming and subprime residential mortgage
loans made to borrowers with problem credit histories. Such legislation also
imposes various loan term restrictions, e.g., limits on balloon loan features.
Frequently referred to generally as "predatory lending" legislation, such
legislation may limit our
32
ability to impose fees, charge interest rates on consumer loans to those
borrowers with problem credit and may impose new calculation methodology for
loss reserves associated with non-conforming loans as well as additional
regulatory restrictions on the mortgage industry of which we are a participant.
The Gramm-Leach-Bliley Act, which was signed into law at the end of 1999,
contains comprehensive consumer financial privacy restrictions. The various
federal enforcement agencies, including the Federal Trade Commission, have
issued final regulations to implement this act; however, compliance with the new
regulations is voluntary until July 1, 2001. These restrictions fall into two
basic categories. First, a financial institution must provide various notices to
consumers about an institution's privacy policies and practices. Second, this
act gives consumers the right to prevent the financial institution from
disclosing non-public personal information about the consumer to non-affiliated
third parties, with exceptions. We continue to develop and refine the
appropriate disclosures and internal procedures to assure compliance with these
new requirements.
Although we believe that we have implemented systems and procedures to make sure
that we comply with all regulatory requirements, if more restrictive laws, rules
and regulations are enacted or more restrictive judicial and administrative
interpretations of those laws are issued, compliance with the laws could become
more expensive or difficult for us to operate. Failure to comply with the laws
described above, as well as new legislation affecting us may result in civil and
criminal liability.
OTS Regulation of Approved Financial Corp.
General. We are a registered savings and loan holding company under the federal
Home Owner's Loan Act ("HOLA") because of our ownership of the Bank. As such, we
are subject to the regulation, supervision and examination of the OTS.
Activities Restriction. Currently there are no restrictions on the activities of
a savings and loan holding company, such as us, 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 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
33
institution. Notwithstanding the above rules as to the permissible business
activities of unitary savings 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
savings 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." However, on October 25, 2000, the OTS issued a
draft proposal seeking public comment concerning its oversight of savings and
loan holding companies. If the proposal is adopted as proposed in the draft we
will be required to provide 30 days notice to the OTS before undertaking certain
significant new business activities that would result in an increase in our debt
at the holding company level or a reduction in our capital or in relation to
certain asset acquisitions. The draft proposal indicates that this is for the
purpose of allowing time for the OTS to access the potential impact that such
activity will have on our risk profile and on the risk profile of our Bank. The
ultimate resolution of this OTS proposal is uncertain at this time.
If we were to acquire control of another institution other than through merger
or other business combination with the Bank, we would become a multiple savings
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, our activities (other than
the Bank) would thereafter be subject to further restrictions. Among other
things, no multiple savings 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 savings 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 savings and loan holding companies; or
(vii) unless the Director of the OTS by regulation prohibits or limits such
activities for savings 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 a multiple savings and loan
holding company.
34
Restrictions on Acquisitions. Except under limited circumstances, savings and
loan holding companies are prohibited from acquiring, without prior approval of
the Director of the OTS, (i) control of any other institution or savings and
loan holding company or substantially all the assets thereof or (ii) more than
5% of the voting shares of an 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 savings 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 savings and loan holding company.
The Director of the OTS may approve acquisitions resulting in the formation of a
multiple savings and loan holding company which controls institutions in more
than one state only if (i) the multiple savings 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. Our transactions (or any of our
non-bank subsidiaries transactions) with the Bank are subject to various
restrictions, which are described under "Regulation of the Bank- Affiliate
Transactions."
Also, the OTS issued a draft proposal during 2000 concerning its oversight of
savings and loan holding companies. If the proposal is adopted we will be
required to provide 30 days notice to the OTS before undertaking certain
significant new business activities that would result in an increase in our debt
at the holding company level or a reduction in our capital or in relation to
certain asset acquisitions. The draft proposal indicates that this is for the
purpose of allowing time for the OTS to access the potential impact that such
activity will have on our risk profile and on the risk profile of our Bank. The
ultimate resolution of this OTS proposal is uncertain at this time.
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
35
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 Savings 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 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
36
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 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. We are not aware of any 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, 2000, 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).
37
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 non-withdrawable 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 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 carry back 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 carry forwards), 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, 2000.
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.
38
As a result, such an institution will be required to maintain additional capital
in order to comply with the risk-based capital requirement.
Under the OTS policy, 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 is 4%.
However, on a case by case basis the OTS will determine an amount of additional
core capital that an institution must maintain by assessing both the quality of
risk management systems and the level of overall risk in each individual
association through the supervisory process.
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" 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, 2000,
the Bank was a "well
39
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 2000.
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 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
40
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, 2000, the Bank was a Tier 1 association under the OTS capital distribution
regulation.
On April 1, 1999 the OTS 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.
41
At December 31, 1999, the Bank's unimpaired capital and surplus amounted to
$6,356,000 resulting in a general loans-to-one borrower limitation of $953,000
under applicable laws and regulations. At December 31, 2000, the Bank's
unimpaired capital and surplus amounted to $6,651,000 resulting in a general
loans-to-one borrower limitation of $998,000.
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
having 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 being solicited. At December 31, 2000, the Bank was a
well-capitalized institution, which was not subject to restrictions on brokered
deposits. See "Business - Bank Sources of Funds - Deposits."
42
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, we and our 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
43
federal and state laws applicable to us in general, 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 an 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.
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
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 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, an association may elect to be assessed by
complying with a strategic plan approved by the OTS. Evaluation under the new
rules became mandatory after June 30, 1997.
Safety and Soundness. Other regulations which were recently adopted or are
currently proposed to be adopted pursuant to recent legislation include but are
not limited to: (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
44
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.
Collateral Restrictions of the Federal Home Loan Bank. The Federal Home Loan
Bank ("FHLB") Board of Atlanta announced to its member institutions on November
27, 2000 the adoption of "Policies to Promote Responsible Lending". The policy
restricts the general characteristics of mortgage loans or the mortgage loans
backing mortgage backed securities that a member institution, such as our Bank,
can pledge as collateral for advances of credit from the FHLB. In general
collateral pledged cannot (i) meet the interest requirements of high cost
mortgages under the HOEPA of 1994 (ii) include prepaid, single premium credit
insurance (iii) include points and fees, excluding discount points, in excess of
5% (iv) include prepayment penalty if the interest rate at time of origination
is 300 basis points higher than conventional rates.
OTS Guidance on Subprime Lending
On February 2, 2001, the OTS issued a memorandum to CEOs of institutions under
its regulation, regarding "Expanded Guidance for Subprime Lending Programs". The
memorandum provides more specific definitions of the term `subprime' but focuses
on the adequacy of allowances for loan losses and capital to support subprime
lending programs. The guidance applies specifically to institutions with a
significant subprime credit exposure by establishing a threshold of 25% or more
of an institution's Tier I regulatory capital as the starting point for greater
supervisory scrutiny. A key underlying principle in the guidance is that each
subprime lender is responsible for quantifying the additional risks in its
subprime lending activities and determining the appropriate amounts of ALLL and
capital it needs to offset those risks. The capital adequacy analysis should
include a stress test of an institution's subprime loan pools to project
performance over varying economic business and market conditions. The
institution is expected to fully document its methodology and analysis.
Regulatory Examiners are directed to evaluate the capital adequacy of subprime
lenders on a case-by-case basis, and encouraged to use judgment in determining
the appropriate level of capital needed to support subprime lending activities.
It notes that some subprime loans may be only marginally more risky than prime
loans and, thus, may warrant increased supervisory scrutiny and monitoring, but
not necessarily additional capital. For instance, well-secured mortgage loans to
individuals who experienced minor credit difficulties in the past may have no
more credit risk than
45
similar prime loans, provided adequate controls are in place. The ultimate
interpretation of this memorandum on a case-by-case basis by OTS examiners and
therefore the ultimate effect on the Bank is uncertain at this time. "Subprime"
definitions vary significantly by regulators and lenders alike. During the year
ended December 31, 2000, our internal credit grade classification system
identified 80% of our total loans funded in house as non-conforming or subprime,
of which over 81% fell into our "A" credit grade classification. We feel that we
have instituted adequate controls, capital and reserves to support our subprime
lending activity at this time.
Legislative Risk (See: "Regulation" and "OTS Regulation of Approved Financial
Corp.")
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 our 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 us.
(See also: "Regulatory Capital Requirements")
Environmental Risk Factors
To date, we have not been required to perform any investigation or clean up
activities, nor have we 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 our business, we from time to time foreclose on properties
securing loans. Although we primarily lend to owners of residential properties,
there is a risk that we could be required to investigate and clean up hazardous
or toxic substances or chemical releases at such properties after acquisition by
us, 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
46
removal or correction of such substances at the disposal or treatment facility,
whether or not the facility 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 our business, we 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, we 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
Our 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 us. Certain of our principal credit agreements contain a provision
which permit the lender to accelerate our obligations in the event that Mr.
Wykle, Mr. Yeakel or Ms. Schwindt leave us for any reason and are not replaced
with an executive acceptable to such lender. The dependence on these individuals
is a risk factor for the holder's of subordinated debt securities as well as
investors in senior debt and our common stock.
Control by Certain Shareholders
As of December 31, 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 Approved
Financial Corp. Accordingly, a risk factor exists in the fact that if they were
to act in concert, they would have voting control with the ability to approve
certain fundamental corporate transactions and the election of the entire Board
of Directors.
47
ITEM 2 - PROPERTIES
Our executive and administrative offices are located at 1716 Corporate Landing
Parkway, Virginia Beach, Virginia, 23454. We purchased and moved to this new
location on December 6, 1999. The building consists of approximately 30,985
square feet.
We continue to own our prior executive and administrative offices located at
3420 Holland Road, Virginia Beach, Virginia 23451. This building is currently
listed for sale. The two buildings are subject to total mortgage debt of
$2,245,000 and $2,341,000 as of December 31, 2000 and 1999, respectively.
As of December 31, 2000 we had leases for two regional broker lending offices,
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 operating expenses of the lessor or fluctuations in the
consumer price index in the relevant geographic area. Lease expense was
$755,000, $2,027,000, and $1,394,000 in 2000, 1999 and 1998, respectively
Total minimum lease payments under non-cancelable operating leases with
remaining terms in excess of one year as of December 31, 2000 were as follows
(in thousands):
2001 $ 754
2002 627
2003 144
2004 53
------
Total 2000-2004 $1,578
======
We anticipate that in the normal course of business we will lease additional
office space as we open new loan origination locations or assumes leases
associated with any future acquisitions or strategic alliances.
48
ITEM 3 - LEGAL PROCEEDINGS
We are a party to various routine legal proceedings arising out of the ordinary
course of our business. We believe that none of these actions, individually or
in the aggregate, will have a material adverse effect on our results of
operations or financial condition.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS
None.
49
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
Market Price of and Cash Dividends on the Common Equity
The following table shows the quarterly high, low and closing prices of the
common stock of Approved Financial Corp. for 2000, 1999, and 1998.
Stock Prices
High Low Close
2000:
Fourth Quarter $ .69 $ 0.31 $ 0.31
Third Quarter 1.00 0.53 0.69
Second Quarter 1.19 1.00 1.00
First Quarter 2.25 .69 1.13
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
We did not pay any cash dividends on our Common Stock in 2000, 1999, and 1998.
We intend to retain all of our earnings to finance our operations and do 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 our
future earnings, capital requirements, financial condition and other factors
deemed relevant by the Board.
50
Absence of Active Public Trading Market and Volatility of Stock Price
Our 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 Common Stock. As a result, the prices reported for the 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
Common Stock will be created in the future.
The market price of the Common Stock may experience fluctuations that are
unrelated to our operating performance. In particular, the price of the Common
Stock may be affected by general market price movements as well as developments
specifically related to the financial services industry such as, among other
things, interest rate movements, loan delinquencies, loan prepayment speeds,
interest-only, residual and servicing asset valuations, sources of liquidity to
the industry participants and profit or loss trends.
Transfer Agent and Registrar
The Transfer Agent for our 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
The Board of Directors approved a stock repurchase plan at a regular board
meeting on November 2, 1998. We 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
We 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 us. These shares represented the final payment associated with our
acquisition of Armada LLC. The stock bears a restrictive legend, is subject to
an administrative stop, may not be resold without an opinion from our legal
counsel, and is subject to the resale requirements of Rule 144. No broker or
general solicitation was involved. We relied on an exemption from registration
under Section 4(2) of the Securities Act of 1933, and the regulations issued
there under, and Rule 701.
51
ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA
You should consider our consolidated financial information set forth below
together with the more detailed consolidated financial statements, including the
related notes and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" included elsewhere in this report. 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.
52
APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
Years Ended December 31,
---------------------------------------------------------------------
2000 1999 1998 1997 1996
---------------------------------------------------------------------
Revenue:
Gain on sale of loans $ 10,971 $ 13,202 $ 29,703 $ 33,501 $ 17,955
Interest income 5,191 7,698 10,308 10,935 4,520
Gain on sale of securities -- -- 1,750 2,796 --
Other fees and income 4,480 7,834 7,042 4,934 2,407
---------------------------------------------------------------------
Total revenue 20,642 28,734 48,803 52,166 24,882
---------------------------------------------------------------------
Expenses:
Compensation 11,477 17,765 23,397 16,447 8,017
General and administrative 8,930 14,427 15,306 14,188 6,853
Write down of Goodwill -- 1,131 -- -- --
Loss on sale/disposal of fixed assets 42 796 -- -- --
Loss on write off of securities -- 73 -- -- --
Interest expense 3,852 4,957 6,252 6,157 3,121
Provision for loan and foreclosed property losses 1,089 2,256 2,896 1,676 1,308
---------------------------------------------------------------------
Total expenses 25,390 41,405 47,851 38,468 19,299
---------------------------------------------------------------------
Income (loss) before income taxes (4,748) (12,671) 952 13,698 5,583
Income taxes (1,456) (4,749) 473 5,638 2,259
---------------------------------------------------------------------
Net Income (loss) $ (3,292) $ (7,922) $ 479 $ 8,060 $ 3,324
=====================================================================
Net income (loss) per share (diluted) $ (.60) $ (1.45) $ 0.09 $ 1.51 $ 0.63
=====================================================================
Cash dividends per share $ -- $ -- $ -- $ -- $ 0.04
=====================================================================
Dividend payout ratio -- -- -- -- 6.35%
=====================================================================
Weighted average number of shares outstanding (diluted) 5,482,114 5,482,114 5,511,372 5,345,957 5,281,103
=====================================================================
(In thousands, except share and per share data)
53
APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
(In thousands, except per share data)
2000 1999 1998 1997 1996
--------- --------- --------- --------- ---------
SELECTED BALANCES AT YEAR END
Loans held for sale, net $ 22,438 $ 62,765 $ 100,820 $ 76,766 $ 44,371
Loans held for yield, net 14,274 4,006 4,224 3,930 1,052
Securities 2,847 2,640 3,472 15,201 20,140
Total assets 59,819 98,600 136,118 118,125 75,143
Revolving warehouse loans 1,694 17,465 72,546 52,488 32,030
FDIC-insured deposits 38,358 55,339 29,728 17,815 1,576
Subordinated debt 4,861 5,081 6,042 9,080 9,183
Total liabilities 51,808 87,301 116,851 93,070 53,934
Shareholders' equity 8,011 11,299 19,267 25,055 21,209
SELECTED LOAN DATA
Loans originated (1) $ 277,169 $ 390,816 $ 522,045 $ 468,955 $ 258,833
Loans sold 253,158 265,873 389,589 420,498 228,918
Amount of loans serviced at year-end 38,602 69,054 109,500 83,512 48,785
Loans delinquent 31 days or more
as percent of loans at year-end 4.75% 4.50% 5.42% 5.50% 6.61%
SELECTED RATIOS
Return on average assets (4.77%) (8.45%) 0.40% 7.68% 7.32%
Return on average Shareholders' equity (32.54%) (49.01%) 1.93% 32.69% 36.44%
Shareholders' equity to assets 13.39% 11.46% 14.15% 21.21% 28.22%
Book value per share $ 1.46 $ 2.07 $ 3.51 $ 4.64 $ 4.21
==============
(1) Includes $47.6 million and $151.3 million retail loans brokered to other
lenders in 2000 and 1999 respectively.
54
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following financial review and analysis of the financial condition and
results of operations, for the fiscal years ended December 31, 2000, 1999 and
1998 should be read in conjunction with the consolidated financial statements
and the accompanying notes to the consolidated financial statements, and other
detailed information appearing in this document.
General
Approved Financial Corp. is a diversified financial services company with
subsidiaries operating throughout the United States. We are 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. We offer both
fixed-rate and adjustable-rate loans for debt consolidation, home improvements
and other purposes serving both conforming and non-conforming borrowers.
Our specialty is mortgage 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.
These borrowers include credit impaired borrowers, 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, and other
borrowers who would qualify for loans from traditional sources but who are
attracted to our loan products due to our personalized service and timely
response to loan applications. Operating under current management for the past
sixteen years, we have helped non-conforming mortgage customers satisfy their
financial needs and in many cases have helped them improve their credit profile.
Through our retail division we also originate, service and sell traditional
conforming mortgage products and government mortgage products such as VA and
FHA.
We continue to explore a variety of opportunities to broaden product offerings,
increase revenues and reduce operating expenses. To achieve these goals, we may
consider various technologies and electronic commerce initiatives, strategic
relationships with other financial institutions or related companies, or
entering into new lines of business such as the origination and servicing of
loans insured by the Small Business Administration. We cannot assure you that we
will engage in any of the activities listed above or the impact of those
activities on our financial condition or results of operations.
55
A recent focus by state and federal banking regulatory agencies, state attorneys
general offices, the Federal Trade Commission, the U.S. Department of Justice
and the U.S. Department of Housing and Urban Development relates to predatory
lending practices by companies in our industry. Sanctions have been imposed on
selected industry competitors for practices including but not limited to
charging borrowers excess fees, imposing higher interest rates than the
borrower's credit risk warrants and failing to disclose the material terms of
loans to the borrowers. We have reviewed our lending policies in light of these
actions against other lenders and we believe that we are in compliance with all
lending related guidelines. To date, no sanctions or recommendations from
governmental regulatory agencies regarding our practices related to predatory
lending have been imposed. We are unable to predict whether state or federal
regulatory authorities will require changes in our lending practices in the
future or the impact of those changes on our profitability. See "Regulation".
Our business strategy is dependent upon our ability to identify and emphasize
lending related activities that will provide us with the most economic value.
The implementation of this strategy will depend in large part on a variety of
factors outside of our control, including, but not limited to, our ability to
obtain adequate financing on favorable terms, retain qualified employees to
implement our plans, profitably sell our loans on a regular basis and to expand
in the face of increasing competition. Our failure with respect to any of these
factors could impair our ability to successfully implement our strategy, which
would adversely affect our results of operations and financial condition.
Results of Operations
Results of Operations for the year ended December 31, 2000 compared to the year
ended December 31, 1999.
Net Loss
The net loss decreased by 58% for 2000 to $3.3 million compared to $7.9 million
in 1999. On a per share basis, the net loss in 2000 was $0.60 compared to $1.45
for 1999.
56
Origination of Mortgage Loans
The following table shows the loan originations in dollars and units for our
broker and retail divisions for 2000 and 1999. During the second quarter of
1999, we 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 our
underwriting criteria and conforming loans.
Year Ended
December 31,
(dollars in millions) 2000 1999
---------------------
Dollar Volume of Loans Originated:
Broker $ 135.0 $ 126.9
Retail funded through other lenders 47.6 151.7
Retail funded in-house non-conforming 47.9 78.5
Retail funded in-house conforming and government 46.7 33.7
---------------------
Total $ 277.2 $ 390.8
=====================
Number of Loans Originated:
Broker 1,846 2,029
Retail funded through other lenders 682 1,809
Retail funded in-house non-conforming 714 1,219
Retail funded in-house conforming and government 448 333
---------------------
Total 3,690 5,390
=====================
The dollar volume of loans, originated in 2000, (including retail loans brokered
to other lenders) decreased 29.1% when compared to the same period in 1999. The
decrease in loan originations was primarily the result of the reduction in the
number of retail loan origination centers from an average of 19 offices in 1999
to 10 at December 31, 2000.
The dollar volume of loans funded in-house decreased by only 4.0% during 2000
compared to 1999, primarily due to our initiative to reduce the amount of retail
loans brokered to other lenders. Brokered loans generated by the retail division
were $47.6 million during 2000, which was a 68.6% decrease compared to $151.7
million during the same period in 1999.
The decrease in retail loan origination centers resulted in a 46.1% decrease in
our retail loan volume including retail loans brokered to other lenders for the
year ended December 31, 2000 when compared to the same period in 1999. The
decrease was the result of our initiative to close more in-house loans.
The volume of loans originated through the Company's wholesale division, which
originates loans through referrals from a network of mortgage brokers increased
6% to $135.0 million for the year ended December 31, 2000, compared to $126.9
million for the year ended December 31, 1999. The increase was primarily the
result of a decline in the number of competitors in the non-conforming
marketplace, an expanded product line and the streamlining of the Company's
service to brokers. Average services rendered fees paid on mortgage broker
referral originations for the year ended December 31, 2000 was 46 basis points
compared to 41 basis points for the year ended December 31, 1999.
57
The following table summarizes the mortgage loan origination activity, including
brokered loans, by state, for the years ended December 31, 2000 and 1999.
Years Ended
December 31 2000 1999
---------------------- -----------------------
(In thousands) Dollars Percent Dollars Percent
--------- ------- --------- -------
Broker Division
Florida $ 37,032 13.4% $ 41,415 10.6%
North Carolina 23,172 8.4 21,718 5.6
Virginia 21,858 7.9 13,520 3.5
Pennsylvania 18,566 6.7 12,723 3.3
Ohio 7,613 2.7 11,406 2.9
Maryland 14,375 5.2 11,215 2.9
Georgia 6,483 2.3 6,408 1.6
South Carolina 854 .3 2,677 .7
Kentucky 0 0 2,097 .5
Tennessee 0 0 1,896 .5
Illinois 0 0 1,172 .3
Indiana 0 0 619 .1
California 5,041 1.8 0 0
-------- ----- -------- -----
Total Broker Division $134,994 48.7% $126,866 32.5%
======== ===== ======== =====
Retail Division:
Maryland $ 29,203 10.5% $ 68,986 17.7%
Virginia 18,470 6.7 51,407 13.3
Michigan 19,303 6.9 50,090 12.8
Georgia 10,842 4.0 21,596 5.5
South Carolina 14,755 5.3 20,482 5.2
Ohio 15,857 5.8 18,754 4.8
North Carolina 0 0 11,517 2.9
Colorado 8,203 2.9 7,540 1.9
Delaware 0 0 5,619 1.4
Kentucky 0 0 3,886 1.0
Florida 0 0 1,592 .4
New Jersey 25,541 9.2 1,546 .4
Texas 0 0 844 .2
Pennsylvania 0 0 91 0
-------- ----- -------- -----
Total Retail Division $142,174 51.1% $263,950 67.5%
======== ===== ======== =====
Total Originations:
Maryland $ 43,578 15.7% $ 80,201 20.5%
Virginia 40,328 14.6 64,927 16.6
Michigan 19,303 6.9 50,090 12.8
Florida 37,032 13.4 43,007 11.1
North Carolina 23,172 8.4 33,235 8.5
Ohio 23,470 8.5 30,160 7.7
Georgia 17,325 6.3 28,004 7.2
South Carolina 15,609 5.6 23,159 5.9
Pennsylvania 18,566 6.7 12,814 3.3
Colorado 8,203 2.9 7,540 1.9
California 5,041 1.8 0 0
Kentucky 0 0 5,983 1.5
Delaware 0 0 5,619 1.4
Tennessee 0 0 1,896 .5
New Jersey 25,541 9.2 1,546 .4
Illinois 0 0 1,172 .3
Texas 0 0 844 .2
Indiana 0 0 619 .2
-------- ----- -------- ------
Total Originations $277,168 100.0% $390,816 100.0%
======== ===== ======== ======
58
Gain on Sale of Loans
The largest component of our net income is gain on sale of loans. There is an
active secondary market for most types of mortgage loans originated. The
majority of the loans originated are sold to other financial institutions. We
receive 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, we are 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.
Nonconforming loan sales totaled $208.2 million including loans owned in excess
of 180 days ("seasoned loans") for the year ended December 31, 2000, compared to
$235.5 million for the same period in 1999.
For the year ended December 31, 2000, the Company sold $3.6 million of seasoned
loans, at a weighted average discount to par value of 15.9%. The loss was fully
reserved for in prior periods. 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%.
Conforming and government loan sales were $44.9 million for year ended December
31, 2000, compared to $30.3 million for the year ended December 31, 1999. The
Company began originating conforming loans in May 1999.
The combined gain on the sale of loans was $11.0 million for the year ended
December 31, 2000, which compares with $13.2 million for the same period in
1999. The decrease in the combined gain on sale of loans was primarily the
result of a decrease in the amount of loans sold that were originated by the
retail lending division. For the year ended December 31, 2000, approximately 45%
of loans sold (conforming & non-conforming) were originated by the retail
division, compared to 58% for the year ended December 31, 1999. The retail
divivion earns fees such as origination, doc-prep, processing, etc. at the time
loans are funded, which are recorded as gain on sale of loans at the time the
loan is sold. Gain on the sale of mortgage loans represented 53.1% of total
revenue for the year ended December 31, 2000, compared to 45.9% of total revenue
for the same period in 1999. This was primarily a result of our initiative to
decrease brokered loans, revenues from which are reported in other income, and
to increase the percentage of retail loan originations funded in-house, revenues
from which are reported in gain on sale of loans.
The weighted-average premium, realized on non-conforming loan sales was 3.14%
(excluding seasoned loans), during the year ended December 31, 2000, compared to
3.14% for the same period in 1999. The weighted-average premium realized on its
conforming and
59
government loans sales was 1.37% during the year ended December 31, 2000,
compared to 1.85% for the year ended December 31, 1999.
We have 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 this loan sale strategy.
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 and an assumption for loan losses. The increased prepayment
speeds as well as the magnitude of loan losses experienced in the industry were
greater than the assumptions previously used by many securitization issuers and
have resulted in an impairment or write down 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 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 the third quarter 2000 when
compared to earlier periods.
Furthermore, the loan sale premium percentage has decreased due to a decrease in
the Weighted Average Coupon ("WAC") on loan originations, which was primarily
the result of a shift in our origination profile to a higher credit grade
customer. These premiums do not include loan origination fees collected at the
time the loans are closed, which are included in the computation of gain on sale
when the loans are sold.
We defer recognizing income from the loan origination fees we receive 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 our
retail lending division. Origination fee income included in the gain on sale of
loans for the year ended December 31, 2000 was $4.4 million, compared to $6.1
million for the year
60
ended December 31, 1999. The decrease is the result of a decrease in the volume
of loans sold, which were generated by our retail division. Our non-conforming
retail loan sales for the year ended December 31, 2000 comprised 32.7% of total
non-conforming loan sales, with average loan origination fee income earned of
4.64%. For the year ended December 31, 1999, non-conforming retail loan sales
were 53.4% of total non-conforming loan sales with average origination fee
income of 4.83%. Average origination fee income from conforming and government
loans was 3.38% for the year ended December 31, 2000 compared to 4.46% for the
year ended December 31, 1999. Fees associated with selling loans were
approximately 20 basis points for the year ended December 31, 2000 compared to
10 basis points for the year ended December 31, 1999.
We also defer recognition of the expense incurred, 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.
Interest Income and Expense
Interest income for the year ended December 31, 2000 was $5.2 million compared
with $7.7 million for the same period ended in 1999. The decrease in interest
income for the year ended December 31, 2000 was due to a lower average balance
of loans held for sale.
Interest expense for the year ended December 31, 2000 was $3.9 million compared
with $5.0 million for the year ended December 31, 1999. The decrease in interest
expense for the year ended December 31, 2000, was the direct result of a
decrease in the average balance of interest-bearing liabilities.
Changes in the average yield received on the loan portfolio may not coincide
with changes in interest rates we must pay on 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.
61
The following tables reflect the average yields earned and rates paid during
2000 and 1999. 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) 2000 1999
------------------------------------- -----------------------------------
Average Interest Average Average Interest Average
Balance Yield/Rate Balance Yield/Rate
-------- ---------- ---------- -------- -------- ----------
Interest-earning assets:
Loan receivable (1) $ 42,978 $ 4,568 10.63% $ 67,665 $ 7,246 10.71%
Cash and other interest-
Earning assets 12,512 623 4.98 9,227 452 4.90
-------- -------- ----- -------- -------- -----
55,490 5,191 9.35% 76,892 7,698 10.01%
-------- ----- -------- -----
Non-interest-earning assets:
Allowance for loan losses (1,203) (2,481)
Investment in IMC 0 71
Premises and equipment, net 5,763 5,375
Other 8,975 13,941
-------- --------
Total assets $ 69,025 $ 93,798
======== ========
Interest-bearing liabilities:
Revolving warehouse lines $ 4,234 294 6.94% $ 33,380 2,405 7.20%
FDIC - insured deposits 44,782 2,773 6.19 32,365 1,835 5.67
Other interest-bearing
liabilities 8,074 785 9.72 7,792 717 9.20
-------- -------- ---- -------- -------- -----
57,090 3,852 6.75% 73,537 4,957 6.74%
-------- ---- -------- -----
Non-interest-bearing liabilities 1,818 4,096
-------- --------
Total liabilities 58,908 77,633
Shareholders' equity 10,117 16,165
-------- --------
Total liabilities and equity $ 69,025 $ 93,798
======== ========
Average dollar difference between
Interest-earning assets and
interest-bearing liabilities $ (1,600) $ 3,355
======== ========
Net interest income $ 1,339 $ 2,741
======== ========
Interest rate spread (2) 2.60% 3.27%
===== =====
Net annualized yield on average
Interest-earning assets 2.41% 3.57%
===== =====
(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.
62
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, 2000 compared
to the year ended December 31, 1999. 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 $1.4 million in net interest income
for the year ended December 31, 2000 compared to the year ended December 31,
1999 was primarily the result of a decrease in the average balance on
interest-earning assets.
($ In thousands)
2000 Versus 1999
Increase (Decrease) due to:
Volume Rate Total
------- ------- -------
Interest-earning assets:
Loans receivable $(2,624) $ (54) $(2,678)
Cash and other interest-
earning assets 163 8 171
------- ------- -------
(2,461) (46) (2,507)
------- ------- -------
Interest-bearing liabilities:
Revolving warehouse lines (2,027) (84) (2,111)
FDIC-insured deposits 756 182 938
Other interest-
bearing liabilities 27 41 68
------- ------- -------
(1,244) 139 (1,105)
------- ------- -------
Net interest income (expense) $(1,217) $ (185) $(1,402)
======= ======= =======
Broker Fee Income
In addition to net interest income (expense), and gain on sale of loans, we
derive income from origination fees earned on brokered loans generated by our
retail offices. For the year ended December 31, 2000, broker fee income totaled
$2.4 million compared to $6.1 million for the same period in 1999. The decrease
was primarily the result of a decrease in brokered loan volume.
63
Other Income
In addition to net interest income (expense), and gain on sale of loans, and
broker fee income we derive income from other fees earned on the loans funded
such as underwriting service fees, prepayment penalties, and late charge fees
for delinquent loan payments. Revenues associated with the financial products
marketed by Approved Financial Solutions are also recorded in other income. For
the year ended December 31, 2000, other income totaled $2.1 million compared to
$1.8 million for the same period in 1999. The increase was primarily the result
of new financial products sold by Approved Financial Solutions. For the year
ended December 31, 2000 these revenues were $0.2 million compared to zero for
the year ended December 31, 1999.
Comprehensive Income/Loss
For the year ended December 31, 2000 we had other comprehensive income of $4,000
in the form of unrealized holding gains/losses on an Asset Management Fund
investment. For the year ended December 31, 1999, we had other comprehensive
losses of $46,000 in the form of unrealized holding losses on an Asset
Management Fund investment.
Compensation and Related Expenses
The largest component of expenses is compensation and related expenses, which
decreased by $6.3 million to $11.5 million for the year ended December 31, 2000
from 1999. The decrease was directly attributable to a decrease in the number of
employees and lower commissions expense caused by the decrease in loan volume.
For the year ended December 31, 2000, salary expense decreased by $3.3 million
when compared to the same period in 1999. Also the payroll and related benefits
decreased by $1.3 million for the year ended December 31, 2000 when compared to
the same period in 1999. The decrease was caused by a lower average number of
employees, which was attributed to our cost cutting initiative. For the year
ended December 31, 2000, the average full time equivalent employee count was
241.8 compared to 371 for the year ended December 31, 1999. For the year ended
December 31, 2000 the commissions to loan officers decreased by $1.6 million
when compared to the same period ended December 31, 2000. The decrease was
primarily due to lower loan volume.
General and Administrative Expenses
General and administrative expenses are comprised of various expenses such as
advertising, rent, postage, printing, general insurance, travel & entertainment,
telephone, utilities,
64
depreciation, professional fees and other miscellaneous expenses. General and
administrative expenses for the year ended December 31, 2000 decreased by $4.7
million to $7.8 million, compared to the year ended December 31, 1999. The
decrease was the result of a reduction in retail loan origination offices, a
decline in our employee count, and our cost cutting initiative.
Loan Production Expense
Loan production expenses are comprised of expenses for appraisals, credit
reports, and payment of fees to mortgage brokers, for services rendered on loan
originations, and verification of mortgages. Loan production expenses for the
year ended December 31, 2000 were $1.2 million compared to $1.9 million for the
year ended December 31, 1999. The decrease was primarily the result of decreases
in appraisal and credit report expenses, which resulted from lower loan volume.
We also eliminated payments to outside consultants for research of customer
leads due to the creation of the centralized advertising and marketing
departments. The expenses for those leads were classified in loan production
expenses for the year ended December 31, 1999.
65
Provision for Loan Losses
The following table presents the activity in the allowance for loan losses and
selected loan loss data for the year ended December 31, 2000 and 1999:
(In thousands)
2000 1999
Balance at beginning of year $ 1,382 $ 2,590
Provision charged to expense 639 2,042
Loans charged off (1,086) (3,286)
Recoveries of loans previously charged off 544 36
-------- --------
Balance at end of period $ 1,479 $ 1,382
======== ========
Loans receivable at the end of period, gross
of allowance for losses $ 38,602 $ 69,054
Ratio of allowance for loan losses to gross
loans receivable at the end of period 3.83% 2.00%
The provision for loan losses was $0.6 million for the year ended December 31,
2000 compared to $2.0 million for the year ended December 31, 1999. For the year
ended December 31, 2000, there was an increase in the allowance for loan losses
based upon management's assessment of credit risk of loans held for yield. The
provision during 1999 was a result of changes in the secondary market
environment for whole loan sales, which changed the composition of loans held
for sale. 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 we consider adequate to cover
future loan losses relative to the composition of the current portfolio of loans
held for sale. We consider characteristics of our current loan portfolio such as
credit quality, the weighted average coupon, the weighted average loan to value
ratio, the combined loan to value ratio, the age of the loan portfolio and the
portfolio's delinquency and loss history and current status in the determination
of an appropriate allowance. Other criteria such as covenants associated with
our credit facilities, trends in the demand for and pricing for loans sold in
the secondary market for similar mortgage loans 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.
66
Provision for Foreclosed Property Losses
The provision for foreclosed property losses was $0.5 million for the year ended
December 31, 2000 compared to $0.9 million for the year ended December 31, 1999.
The allowance for REO losses decreased for the year ended December 31, 2000,
compared to December 31, 1999 because of the decline in the unit and dollar
amount of REO properties.
Sales of real estate owned yielded net losses of $792,000 for the year ended
December 31, 2000 versus $648,000 for the year ended December 31, 1999.
The following table presents the activity in the allowance for foreclosed
property losses and selected real estate owned data for the year ended December
31, 2000 and 1999:
(In thousands)
2000 1999
------- -------
Balance at beginning of year $ 718 $ 503
Provision charged to expense 451 863
Loss on sale of foreclosures (792) (648)
------- -------
Balance at end of period $ 377 $ 718
======= =======
Real estate owned at the end of period, gross
of allowance for losses $ 1,528 $ 2,992
Ratio of allowance for foreclosed property losses
to gross real estate owned at the end of period 24.67% 24.00%
Assets acquired through loan foreclosure are recorded as real estate owned
("REO"). When a property is transferred to REO status a new appraisal is ordered
on the property. The property is written down to the value of the new appraisal.
An allowance for REO losses is then established on that property based upon
current market conditions and historical results with the sale of REO
properties. While we believe that our present allowance for foreclosed property
losses is adequate, future adjustments may be necessary.
67
Results of Operations for the Year Ended December 31, 1999 compared to the Year
Ended December 31, 1998.
Net Income (loss)
The 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
$0.09 income for 1998. The return on average assets was (8.45%) in 1999,
compared to 0.40% in 1998. Return on average shareholders' equity was (49.01%)
in 1999, compared to 1.93% in 1998.
Origination of Mortgage Loans
The following table shows the loan originations in dollars and units for our
broker and retail divisions in 1999 and 1998. During the second quarter of 1999,
we initiated in-house funding of conforming and government mortgages originated
by the retail division. Additionally, the retail branches originate mortgages
that are funded through other lenders ("brokered loans"). Brokered loans consist
primarily of non-conforming mortgages that do not meet our underwriting criteria
and conforming loans. We did not fund conforming loans in-house during 1998.
68
- --------------------------------------------------------------------------------
Year Ended December 31
- --------------------------------------------------------------------------------
($ in millions) 1999 1998
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
DOLLAR OF LOANS 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 our 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.
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 our 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
69
non-conforming mortgage industry was the primary reason for the decrease in
loans from this source. Also, since we 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.
70
The following table summarizes the mortgage loan origination activity, including
brokered loans, by state, for the years ended December 31, 1998 and 1997.
Years Ended
December 31 1998 1997
---------------------- ----------------------
(In thousands) Dollars Percent Dollars Percent
--------- ------- --------- -------
Broker Division
Florida $ 53,874 10.3% $ 61,897 13.2%
North Carolina 25,315 4.9 28,957 6.1
Virginia 11,698 2.2 5,415 1.2
Pennsylvania 43 0.0 -- --
Ohio 22,233 4.3 32,478 6.9
Maryland 35,690 6.8 29,997 6.4
Georgia 34,617 6.7 59,792 12.8
South Carolina 9,444 1.8 4,463 1.0
Kentucky 361 0.1 -- --
Tennessee 6,391 1.2 7,826 1.7
Illinois 3,059 0.6 12,781 2.7
Indiana 72 0.0 9,131 1.9
Michigan 1,115 0.2 3,680 0.8
-------- ----- -------- -----
Total Broker Division $203,912 39.1% $256,417 54.7%
======== ===== ======== =====
Retail Division:
Maryland $ 66,911 12.8% $ 66,954 14.4%
Virginia 52,856 10.1 34,442 7.3
Michigan 4,001 0.8 0 0
Georgia 58,558 11.2 12,886 2.7
South Carolina 21,682 4.1 18,611 4.0
Ohio 23,301 4.5 12,666 2.7
North Carolina 49,912 9.6 39,007 8.3
Colorado 0 0 0 0
Delaware 15,905 3.0 16,056 3.4
Kentucky 14,368 2.8 85 --
Florida 6,374 1.2 4,141 0.9
New Jersey 0 0 0 0
Texas 0 0 0 0
Pennsylvania 0 0 0 0
Illinois 2,065 0.4 4,877 1.0
Indiana 2,200 0.4 2,813 0.6
-------- ----- -------- -----
Total Retail Division $318,133 60.9% $212,538 45.3%
======== ===== ======== =====
Total Originations:
Maryland $102,601 19.7% $ 96,951 20.8%
Virginia 64,554 12.4 39,857 8.5
Michigan 5,116 1.0 3,680 0.8
Florida 60,248 11.5 66,038 14.1
North Carolina 75,227 14.4 67,964 14.5
Ohio 45,534 8.7 45,144 9.6
Georgia 93,175 17.9 72,678 15.5
South Carolina 31,126 6.0 23,074 4.9
Pennsylvania 43 0.0 0 0
Colorado 0 0 0 0
Kentucky 14,729 2.8 85 0
Delaware 15,905 3.0 16,056 3.4
Tennessee 6,391 1.2 7,826 1.7
New Jersey 0 0 0 0
Illinois 5,124 1.0 17,658 3.7
Texas 0 0 0 0
Indiana 2,272 0.4 11,944 2.5
-------- ----- -------- -----
Total Originations $522,045 100.0% $468,955 100.0%
======== ===== ======== =====
71
Gain on Sale of Loans
The largest component of net income is gain on sale of loans. There is an active
secondary market for most types of mortgage loans originated. The majority of
the loans originated are sold to other financial institutions. We receive 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, we are 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 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, we 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, we 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. We 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
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 on 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
72
conditions for non-conforming mortgage loans. The weighted-average premium
realized on conforming and government loans sales was 1.85% during the year
ended December 31, 1999.
We have 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
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 loan originations, which was primarily
the result of a lower interest rate market and a shift in our origination
profile to a higher credit grade customer. These premiums do not include loan
origination fees collected at the time the loans are closed, which are included
in the computation of gain on sale when the loans are sold.
We defer recognizing income from the loan origination fees we receive 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 our
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 our
73
retail division. Our 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 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.
We also defer recognition of the expense incurred, 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
Net interest income is dependent on the difference, or "spread", between the
interest income we receive from our loans and our 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.
Changes in the average yield received on the loan portfolio may not coincide
with changes in interest rates we must pay on 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.
74
The following tables reflect the average yields earned and rates paid 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 Yield/
Balance Interest Yield/Rate Balance Interest Rate
--------- -------- ---------- ------- -------- -------
Interest-earning assets:
Loan receivable (1) $ 67,665 $ 7,246 10.7% $ 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 10.0% 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, net 5,375 4,770
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
Liabilities 7,792 717 9.20 10,677 1,003 9.39
--------- ------- ------- --------- ------- -------
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.
75
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)
======= ======= =======
Broker Fee and Other Income
In addition to net interest income (expense), and gain on sale of loans, we
derive income from origination fees earned on brokered loans generated by our
retail offices and other fees earned on the loans funded, 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
76
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.
Comprehensive Income
We have other comprehensive income (loss) in the form of unrealized holding
losses on securities available 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 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 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, we
continue to pay rent on many retail offices
77
that we closed while we are 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 a 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 we reevaluated our 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 we 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 construct a new corporate headquarters building in Virginia Beach.
These construction plans were cancelled when our current building became
available for purchase and was acquired in late 1999.
Loan Production Expense
The largest component of loan production expense is fees paid to mortgage
brokers for services rendered in the preparation of loan packages. Other items
that comprise loan production expenses are appraisals, credit reports, lead
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. We also eliminated payments to
outside consultants for research of customer leads due to the creation of the
centralized advertising and marketing departments.
78
Provision for Loan Losses
The following table presents the activity in the 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%
We 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 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 we consider adequate relative to
the composition of the current portfolio of loans held for sale. We consider
characteristics of the 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
our 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 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.
79
Provision for Foreclosed Property Losses
We increased our 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 our 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
of allowance for losses $ 2,992 $ 2,211
Ratio of allowance for foreclosed property losses
to gross real estate owned at year-end 24.00% 22.80%
We maintain a reserve on our real estate owned ("REO") based upon our 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
we believe that our present allowance for foreclosed property losses is
adequate, future adjustments may be necessary.
Income Taxes. The income tax benefit for 1999 was $4.7 million resulting from
net operating loss carrybacks with an effective tax rate of 38.62%. By
comparison, we had income tax expense of $0.5 million for an effective tax rate
of 39.78% in 1998.
The effective tax rates differ from the statutory federal rates due primarily to
state income taxes and certain nondeductible expenses.
80
Financial Condition at December 31, 2000 and 1999
Assets
The total assets were $59.8 million at December 31, 2000 compared to total
assets of $98.6 million at December 31, 1999.
Cash and cash equivalents decreased by $3.1 million to $7.6 million at December
31, 2000, from $10.7 million at December 31, 1999. The Company paid down its
credit line in order to reduce interest expense.
Net mortgage loans receivable decreased by $30.1 million to $36.7 million at
December 31, 2000. The 45.1% decrease in 2000 is primarily due to selling more
loans than were originated in-house during 2000. We generally sell loans within
sixty days of origination.
Real estate owned ("REO") decreased by $1.1 million to $1.2 million at December
31, 2000. The 49.4% decrease in REO resulted from the sale of $3.6 million in
REO properties compared to additions of $2.2 million to REO during the twelve
months ended December 31, 2000.
Investments increased by $0.2 million to $2.8 million at December 31, 2000.
Investments consist primarily of an Asset Management Fund, Inc. Adjustable Rate
Mortgage Portfolio and FHLB stock owned by the Bank. The 7.8% increase in
investments in 2000 is primarily due to the purchase of shares of FHLB stock.
Premises and equipment decreased by $0.7 million to $5.4 million at December 31,
2000. The decrease is due to the depreciation of these assets for the year ended
December 31, 2000.
Goodwill (net) decreased by $0.1 million to $1.0 million at December 31, 2000.
The decrease is due to the amortization of the intangible asset for the year
ended December 31, 2000.
Income tax receivable decreased by $5.6 million to $0 million at December 31,
2000. The 100.0% decrease represents the receipt of a refund due on federal
taxes based upon actual tax return filing.
The deferred tax asset increased by $1.8 million to $3.5 million at December 31,
2000. The increase related to a net operating loss carryforward of $2.1 million.
This was partially offset by the establishment of a $0.5 million valuation
allowance for future unrealizable benefits for the deferred tax asset. The
valuation allowance is based upon an assessment by management of future taxable
income and its relationship to realizability of deferred tax assets. Based upon
the managements expected improvements of sufficient taxable income and reversing
of the
81
temporary differences, management believes that it is more likely than not that
the Company will realize the net amount of the deferred tax asset. However,
there can be no assurances that the Company will generate taxable income in any
future period. The remainder of the decrease relates to changes in timing
differences of the deferred tax asset.
Other assets decreased by $0.1 million to $1.6 million at December 31, 2000.
Other assets consist of accrued interest receivable, prepaid assets, brokered
loan fees receivable, deposits, and various other assets. The majority of the
decrease was in accrued interest receivable, which was due to lower average
loans held for sale at December 31, 2000.
Liabilities
Outstanding balances for our revolving warehouse loans decreased by $15.8
million to $1.7 million at December 31, 2000. The 90.3% decrease in 2000 was
primarily attributable to the decrease in loans receivable.
The Bank's deposits totaled $34.4 million at December 31, 2000 compared to $55.3
million at December 31, 1999. Of the certificate accounts on hand as of December
31, 2000, a total of $15.4 million was scheduled to mature in the twelve-month
period ending December 31, 2001.
During the twelve month period ended December 31, 2000, we received $3.9 million
in money market deposits through an arrangement with a local NYSE member
broker/dealer. There were no money market deposits in 1999.
As of December 31, 2000, the Bank borrowed $3.0 million from the Federal Home
Loan Bank (FHLB) to fund loan production compared to $4.6 million at December
31, 1999.
Promissory notes and certificates of indebtedness totaled $4.9 million at
December 31, 2000 compared to $5.1 million at December 31, 1999. The 4.3%
decrease is primarily due to the redemption of maturing promissory notes and
certificates. During the years of 2000 and 1999, we were not soliciting new
promissory notes or certificates of indebtedness. We have utilized promissory
notes and certificates of indebtedness, which are subordinated to our warehouse
lines of credit, to help fund its operations since 1984. Promissory notes
outstanding carry terms of one to five years and interest rates between 8.00%
and 10.00%, with a weighted-average rate of 9.78% at December 31, 2000.
Certificates of indebtedness are uninsured deposits authorized for financial
institutions, which have Virginia industrial loan association charters. The
certificates of indebtedness carry terms of one to
82
five years and interest rates between 6.75% and 10.00%, with a weighted-average
rate of 9.6% at December 31, 2000.
Mortgage loans payable totaled $2.5 million at December 31, 2000 compared to
$2.3 million at December 31, 1999. The $0.2 million increase is a combination of
a $0.3 first mortgage payable on one of its REO properties as well as a minimal
decrease in mortgage loans payable due to the normal principal reduction with
payments made on the note payable.
Accrued and other liabilities decreased by $1.1 million to $1.4 million at
December 31, 2000. This category includes accounts payable, accrued interest
payable, deferred income, accrued bonuses, and other payables. The 43.7%
decrease is the result of various payments of year end accrued expenses.
Shareholders' Equity
Total shareholders' equity at December 31, 2000 was $8.0 million compared to
$11.3 million at December 31, 1999. The $3.3 million decrease in 2000 was due to
the $3.3 million loss for the twelve months ended December 31, 2000.
Liquidity and Capital Resources
Our operations require access to short and long-term sources of cash. Our
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, revenues generated by Approved Financial
Solutions and Global Title of Md., Inc., net interest income, and borrowings
under our warehouse facilities, certificates of indebtedness issued by Approved
Financial Corp. and certificates of deposit issued by the Bank to meet working
capital needs. Our 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 our ability to continue
to originate loans. We have historically operated, and expect to operate in the
future on a negative cash flow basis from operations based upon the timing of
proceeds used to fund loan originations and the subsequent receipt of cash from
the sale of the loan. Loan sales normally occur 30 to 45 days after proceeds are
used to fund the loan. For the twelve months ended December 31, 2000, we used
cash from operating activities of $9.5 million. For the twelve months ended
December 31, 1999 we used cash from operating activities of $17.2 million.
83
We finance our operating cash requirements primarily through warehouse and other
credit facilities, and the issuance of other debt. For the twelve months ended
December 31, 2000, we paid down debt from financing activities of $34.4 million,
this was primarily the result of proceeds from loan sales in excess of new
borrowings for funding loan originations. For the twelve months ended December
31, 1999, we paid down debt from financing activities of $26.7 million.
Our borrowings (revolving warehouse loans, FDIC-insured deposits, mortgage loans
on our office buildings, FHLB advances, subordinated debt and loan proceeds
payable) were 84.3% of assets at December 31, 2000 compared to 86.1% at December
31, 1999.
Whole Loan Sale Program
The 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 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 and lien position, 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 our ability to sell mortgages in the secondary
market for acceptable prices, which is essential to the continuation of our
mortgage origination operations.
Bank Sources of Capital
The Bank's deposits totaled $34.4 million at December 31, 2000 compared to $55.3
million at December 31, 1999. 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. We plan to increase the use of credit facilities and
funding opportunities available to the Bank.
Warehouse and Other Credit Facilities
In addition to our $15 million line of credit with the FHLB of Atlanta, we have
available funding from warehouse facilities with other non-affiliated financial
institutions.
On July 21, 2000, we obtained a $40.0 million line of credit from Bank United.
However, effective December 29, 2000, the Company obtained an amendment to the
credit line, which reduced the size
84
of the warehouse facility to $20.0 million, since the utilization of the credit
line has been very low in 2000. The credit line can be used for prime and
sub-prime mortgage loans and is secured by loans originated. The line bears
interest at a rate of 2.25% and 3.00% over the one-month LIBOR rate for prime
and sub-prime loans respectively. We may receive warehouse credit advances of
98%, 97%, and 90% for prime, sub-prime, and high LTV loans (loans with LTV's
greater than 90%), respectively, of the collateral value amount on pledged
mortgage loans for a period of 90 days after advance of funds on each loan. If
an investor has not purchased a loan within 90 days of such advance, the
interest rate on the loan increases to 4.00% over the one-month LIBOR and we
have an additional 30 days to sell the loan or purchase the loan back from the
warehouse. All interest rates reflect a 25 basis point increase from the
original interest rates, which was the result of the December 29th amendment.
The aged loan sub limit is $2.0 million. As of December 31, 2000, $1.8 million
was outstanding under this facility. The line of credit is scheduled to expire
on July 21, 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, 2000
we are in compliance with all financial covenants.
On November 10, 1999, we obtained a $20.0 million sub-prime line of credit from
Regions Bank. The line is secured by loans originated and bears interest at a
rate of 3.25% over the one-month LIBOR rate. We 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, 2000 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, 2000 we are in compliance with all financial covenants.
On November 10, 1999, we obtained a $20.0 million conforming loan line of credit
from Regions Bank. The line is secured by loans originated and bears interest
ranging from 2.25% to 2.75% over the one-month LIBOR rate based upon the monthly
advance levels. We 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, 2000 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, 2000 we are in
compliance with all financial covenants.
Effective on December 8, 1999, we obtained an amendment to the warehouse line of
credit agreement with Chase Bank of Texas. Since the utilization of the credit
line was very low in 1999, the amendment reduced the size of the warehouse
facility to $15.0
85
million, and all bank syndicate members other than Chase were released from the
commitment. The line is secured by loans originated and bears interest at a rate
of 1.75% over the one-month LIBOR rate. We 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. This line expired on June 7, 2000
and will not be renewed.
Other Capital Resources
Promissory notes and certificates of indebtedness, have been a source of capital
since 1984 and are issued primarily according to an intrastate exemption from
security registration. Promissory notes and certificates of indebtedness totaled
$4.9 million at December 31, 2000 compared to $5.1 million at December 31, 1999.
These borrowings are subordinated to our warehouse lines of credit. We cannot
issue subordinated debt to new investors under the exemption since the state of
Virginia is no longer our primary state of operation.
We had cash and cash equivalents of $7.6 million at December 31, 2000. We have
sufficient resources to fund our 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. We
expect that we 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 borrowings, which can be
withdrawn and are due in one year or less is 4.0%. Penalties are assessed for
noncompliance. In 2000 and 1999, the Bank maintained liquidity in excess of the
required amount, and we anticipate that we will continue to do so.
86
Bank Regulatory Capital
At December 31, 2000, the Bank's book value under generally accepted accounting
principles ("GAAP") was $9.4 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, 2000, 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 $ 9,440 $ 9,440 $ 9,440
Add: unrealized loss on securities 9 9 9
Nonallowable asset: goodwill (546) (546) (546)
Additional capital item: general allowance -- -- 272
------- ------- -------
Regulatory capital - computed 8,903 8,903 9,175
Minimum capital requirement 782 2,084 3,435
------- ------- -------
Excess regulatory capital $ 8,121 $ 6,819 $ 5,740
======= ======= =======
Ratios:
Regulatory capital - computed 17.08% 17.08% 21.37%
Minimum capital requirement 1.50% 4.00% 8.00%
------- ------- -------
Excess regulatory capital 15.58% 13.08% 13.37%
======= ======= =======
Recently an FDIC discussion draft proposal has been made public regarding
requirements for subprime lenders. Under the proposal, regulatory capital
required to be held for certain loan classes included in the institution's
portfolio could be increased. The ultimate resolution of this proposal is
uncertain at this time. However, we believe that the Bank can remain in
compliance with its capital requirements.
We are not aware of any other trends, events or uncertainties other than those
discussed in this document, which will have or that are likely to have a
material effect on our or the Bank's liquidity, capital resources or operations.
We are not aware of any other current recommendations by regulatory authorities,
which if they were implemented would have such an effect.
Interest Rate Risk Management
We originate mortgage loans for sale as whole loans. We mitigate our interest
rate exposure, and the related need for hedging activity, by selling most of the
loans within sixty days of
87
origination. However, we 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 beyond the normal
sixty-day holding period are fixed rate instruments. Since most of our
borrowings have variable interest rates, we have exposure to interest rate risk.
For example, if market interest rates were to rise between the time we originate
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 our fixed rate mortgage
loans held for sale, we 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, offsetting an increase
in the value of the hedged loans, upon settlement with the 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, we will receive the hedge gain in
cash at settlement. We believe that our current hedging strategy using Treasury
rate lock contracts is an effective way to manage interest rate risk on fixed
rate loans prior to sale. We may in the future enter into similar transactions
with government and quasi-government agency securities in relation to our
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, we perform 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
limit our exposure to interest rate risk. We had no hedge contracts or forward
commitments outstanding at December 31, 2000. We have not entered into any hedge
contracts since the fourth quarter of 1997. That commitment expired during the
first quarter of 1998.
New Accounting Standards
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
88
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 did not have
any material impact on the financial statements.
Securities and Exchange Commission Staff Accounting Bulletin 101 (SAB 101),
"Revenue Recognition in Financial Statements", as amended by SAB 101B, must be
adopted no later than the fourth calendar quarter of the year 2000. Adoption of
SAB101 is not expected to have any material impact on the recognition,
presentation, and disclosure of revenue.
In March 2000, the Financial Accounting Standards Board, (FASB) issued
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation - an interpretation of APB Opinion No. 25 (FIN 44), providing new
accounting rules for stock-based compensation under APB Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25). FIN 44 does not change FASB
Statement No. 123, Accounting for Stock-Based Compensation (FAS 123). FIN 44 is
generally effective for transactions occurring after July 1, 2000 however, the
accounting must be applied prospectively to certain transactions consummated
after December 15, 1998. The Company is not aware of any transactions that will
cause FIN 44 to have a material effect on its financial condition or results of
operations.
In September 2000, the FASB issued SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, a replacement
of SFAS No. 125. It revises the standards for accounting for securitizations and
other transfers of financial assets and collateral and requires certain
disclosures, but it carries over most of provisions of SFAS No. 125 without
reconsideration. The Statement requires a debtor to reclassify financial assets
pledged as collateral and report these assets separately in the statement of
financial position. It also requires a secured party to disclose information,
including fair value, about collateral that it has accepted and is permitted by
contract or custom to sell or repledge. The Statement includes specific
disclosure requirements for entities with securitized financial assets and
entities that securitize assets. This Statement is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2000 and is effective for recognition and
89
reclassification of collateral and for disclosures relating to securitization
transactions and collateral for fiscal years ending after December 15, 2000. We
do not expect that FAS 140 will have a material effect on financial condition or
results of operations.
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 in terms of historical dollars, without considering changes in
the relative purchasing power of money over time due to inflation.
The majority of the assets are monetary in nature. As a result, interest rates
have a more significant impact on our performance than the effects of general
levels of inflation. Inflation affects us most significantly in the area of
residential real estate values and inflation's effect on interest rates. Real
estate values generally increase during periods of high inflation and are
stagnant during periods of low inflation. While, interest rates do not
necessarily move in the same direction or with the same magnitude as the prices
of goods and services, normally interest rates increase during periods of high
inflation and decrease during periods of low inflation.
Loan origination volume generally increases as residential real estate values
increase because homeowners have new home equity values against which they can
borrow. A large portion of our loan volume is related to refinancing and debt
consolidation mortgages, therefore, an increase in real estate values enhances
the marketplace for this type of loan origination. Conversely, as residential
real estate values decrease, the market for home equity and debt consolidation
loan origination decreases. Additionally, an increase or decrease in residential
real estate values may have a positive or negative effect, respectively, on the
liquidation of foreclosed property.
Because we sell a significant portion of the loans we originate, the effect that
inflation has on interest rates has a diminished effect on the results of
operations. However, we hold a portfolio of loans held for investment, the size
of which varies from time to time 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
our ability to earn a spread between interest received on loans and the costs of
borrowings. Our profitability is likely to be adversely affected during any
period of unexpected or rapid changes in interest rates. (See also: "Interest
Rate Risk Management").
90
A substantial and sustained increase in interest rates could adversely affect
our ability 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.
While we have no plans to adopt a Securitization loan sale strategy at this
time, if we were to do so in the future, then to the extent servicing rights and
interest-only and residual classes of certificates are capitalized on the books
from future loan sales through securitization, higher than anticipated rates of
loan prepayments or losses could require us to write down the value of such
servicing rights and interest-only and residual certificates, adversely
affecting earnings. A significant decline in interest rates could increase the
level of loan prepayments. Conversely, lower than anticipated rates of loan
prepayments or lower losses could allow us to increase the value of
interest-only and residual certificates, which could have a favorable effect on
our results of operations and financial condition.
91
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Management - Asset/Liability Management
Our 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 our interest-earning assets and interest-bearing liabilities.
We strive to manage the maturity or repricing match between assets and
liabilities. The degree to which we are "mismatched" in our 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. We attempt to limit our interest rate risk by selling a
majority of the fixed rate mortgage loans that we originate.
Contractual principal repayments of loans do not necessarily reflect the actual
term of our 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 us 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 are sold through loan sale strategies in an
attempt to limit exposure to interest rate risk in addition to generating cash
revenues. We sold, during 1999 and 2000, approximately 98.5% of the total loans
originated and funded in-house during the year ended December 31, 1999. Also, we
sold, during 2000 approximately 96.0% of loans originated and funded in-house
during the period beginning January 1, 2000 and ending November 30, 2000. We
expect to sell the majority of our loan originations, other than loans
specifically originated to hold for investment and yield, during the same
twelve-month period in which they are funded in future periods. As a result,
loans are held on average for less than 12 months in our 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, 2000, as anticipated, and is expected to
remain negative in future periods. We have no quantitative target range for past
gap positions, nor any
92
anticipated ranges for future periods due to the fact that we sell the majority
of our loans within a twelve month period while the gap position is a static
illustration of the contractual repayment schedule for loans.
93
Our one-year gap was a negative 2.72% of total assets at December 31, 2000, 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 held for sale (1) $ 22,537 $ 9,601 $ 412 $ 967 $ 11,558
Loans held for yield (1) 15,655 6,323 297 698 8,337
Cash and other interest-earning assets 7,597 7,597
-------------------------------------------------------------------------------
45,789 $ 23,521 $ 709 $ 1,665 $ 19,895
==============================================================
Allowance for loan losses (1,479)
Premises and equipment, net 5,408
Other 10,101
--------
Total assets $ 59,819
========
Interest-bearing liabilities:
Revolving warehouse lines $ 1,694 1,694
FDIC - insured deposits 34,432 15,449 8,878 7,133 2,972
FDIC - insured money market account 3,926 3,926
Other interest-bearing liabilities 10,486 4,080 839 1,898 3,669
-------------------------------------------------------------------------------
50,538 $ 25,149 $ 9,717 $ 9,031 $ 6,641
==============================================================
Non-interest-bearing liabilities 1,270
--------
Total liabilities 51,808
Shareholders' equity 8,011
--------
Total liabilities and equity $ 59,819
========
Maturity/repricing gap $ (1,628) $ (9,008) $ (7,366) $ 13,254
==============================================================
Cumulative gap $ (1,628) $(10,636) $(18,002) $ (4,748)
==============================================================
As percent of total assets (2.72)% (17.78)% (30.09)% (7.94)%
Ratio of cumulative interest earning
Assets to cumulative interest
bearing liabilities 0.94 0.69 0.59 0.91
================================================================================
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
94
Interest Rate Risk
The principal quantitative disclosure of our market risks is the above gap
table. The gap table shows that the one-year gap was a negative 2.72% of total
assets at December 31, 2000. We originate 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, 2000, 52.1%
of the principal on the loans was expected to be received more than four years
from that date. However, our activities are financed with short-term loans and
credit lines, 49.8% of which reprice within one year of December 31, 2000. We
attempt to limit our interest rate risk by selling a majority of the fixed rate
loans that we originate. If our ability to sell such fixed-rate, fixed-term
mortgage loans on a timely basis were to be limited, we could be subject to
substantial interest rate risk.
Profitability may be directly affected by the level of, and fluctuations in
interest rates, which affect our ability to earn a spread between interest
received on our loans and the cost of borrowing. Our profitability 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 our ability 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 our 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 our books, higher than
anticipated rates of loan prepayments or losses could require us to write down
the value of these assets, adversely affecting earnings.
In an environment of stable interest rates, our 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 we establish the interest rate on a
loan and the time the loan is sold. Fluctuating interest rates also may affect
the net interest income earned, resulting from the difference between the yield
to us on loans held pending sale and the interest paid for funds borrowed,
including our warehouse facilities, subordinated debt, 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 we will realize gains on the sale of financial assets in
future periods.
95
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.
96
Asset Quality
The following table summarizes all of our delinquent loans at December 31, 2000
and 1999:
(in thousands)
2000 1999
---------- ----------
Delinquent 31 to 60 days $ 362 $ 864
Delinquent 61 to 90 days 164 264
Delinquent 91 to 120 days 354 513
Delinquent 121 days or more 955 1,466
---------- ----------
Total delinquent loans (1) $ 1,835 $ 3,107
========== ==========
Total loans receivable outstanding, gross $ 38,602 $ 69,054
========== ==========
Delinquent loans as a percentage of
total loans outstanding:
Delinquent 31 to 60 days .94% 1.25%
Delinquent 61 to 90 days .42 0.39
Delinquent 91 to 120 days .92 0.74
Delinquent 121 days or more 2.47 2.12
---------- ----------
Total delinquent loans as a percentage
of total loans outstanding 4.75% 4.50%
---------- ----------
Reserve as a % of delinquent loans 80.6% 44.5%
========== ==========
- -------------
(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 $1.4 million and $2.2
million at December 31, 2000 and 1999 respectively. The amount of additional
interest that would have been recorded had the loans not been placed on
non-accrual status was approximately $148,000 and $152,000 for the year ended
December 31, 2000 and 1999, respectively. The amount of interest income on the
non-accrual loans, that was included in net income for the year ended December
31, 2000 and 1999 was $95,000 and $109,000, respectively.
Loans delinquent 31 days or more as a percentage of total loans outstanding
increased to 4.75% at December 31, 2000 from 4.50% at December 31, 1999.
At December 31, 2000 and 1999 the recorded investment in loans for which
impairment has been determined, which includes loans delinquent in excess of 90
days, totaled $1.3 million and $2.0 million, respectively. The average recorded
investment in
97
impaired loans for the year ended December 31, 2000 and 1999 was approximately
$1.9 million and $3.5 million, respectively.
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 1 of the financial
statements in 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.
98
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 11,
2001 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 11, 2001 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 11, 2001 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 11, 2001 and is incorporated herein by reference.
99
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
Audited Financial Statements
The following 2000 Consolidated Financial Statements of Approved Financial Corp.
and Subsidiaries are included:
- - Report of Independent Accountants...................................... 2
- - Consolidated Balance Sheets............................................ 3
- - Consolidated Statements of Income and Comprehensive Income (Loss) ..... 4
- - Consolidated Statements of Shareholders' Equity........................ 5
- - Consolidated Statements of Cash Flows.................................. 6 - 7
- - Notes to Consolidated Financial Statements............................. 8 - 39
- - Consolidating Balance Sheet................................. .......... 40
- - Consolidating Income Statement............................ ............ 41
- - Stock Price and Dividend Information (Unaudited)............... ....... 42
100
EXHIBIT INDEX
- --------------------------------------------------------------------------------
Exhibit Number Description Page Number
- --------------------------------------------------------------------------------
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)
- --------------------------------------------------------------------------------
4.1 Trust Indenture Agreement by Approved
Financial Corp., a Virginia corporation
(the "Company"), and US Bank Trust,
national association as trustee (the
"Trustee"). Incorporated by reference
to the S-1 registration statement date
December 14, 2000)
- --------------------------------------------------------------------------------
3.2 Amended and Restated 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 Neil W. Phelan as amended November 17,
2000. (Incorporated by reference to exhibit
10.3 of S-1 debt registration statement filed
December 14, 2000.)
- --------------------------------------------------------------------------------
10.4 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)
- --------------------------------------------------------------------------------
101
- --------------------------------------------------------------------------------
Exhibit Number Description Page Number
- --------------------------------------------------------------------------------
10.5 Employment Agreement between the
Company and Stanley W. Broaddus dated
December 1, 2000 (Incorporated by
reference to exhibit 10.5 of S-1 debt
registration statement filed December
14, 2000.)
- --------------------------------------------------------------------------------
10.6 Employment Agreement between Company
and Eric S. Yeakel dated February 1999
(Incorporated by reference to exhibit
10.24 of Form 10K filed March 31, 1999.)
- --------------------------------------------------------------------------------
10.7 Employment Agreement as amended between
Company and Eric S. Yeakel dated
December 1, 2000. (Incorporated by
reference to exhibit 10.7 of S-1 debt
registration statement filed December
14, 2000)
- --------------------------------------------------------------------------------
10.8 Employment Agreement between the
Company and Jean S. Schwindt dated
February 1999 (Incorporated by
reference to exhibit 10.23 of Form 10K
filed March 31, 1999.)
- --------------------------------------------------------------------------------
10.9 Employment Agreement as amended between
Company and Jean S. Schwindt dated
December 1, 2000. (Incorporated by
reference to exhibit 10.9 of S-1 debt
registration statement filed on December
14, 2000)
- --------------------------------------------------------------------------------
10.10 Employment Contract between the Company
and Barry Epstein dated September 18,
2000 (Incorporated by reference to
Exhibit 10 filed with Form 10Q on
September 14, 2000)
- --------------------------------------------------------------------------------
10.11 Employment Contract between the Company
and Allen D. Wykle dated December 1,
2000. (Incorporated by reference to
exhibit 10.11 of S-1 debt registration
statement filed December 14, 2000)
- --------------------------------------------------------------------------------
102
- --------------------------------------------------------------------------------
Exhibit Number Description Page Number
- --------------------------------------------------------------------------------
10.12 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)
- --------------------------------------------------------------------------------
10.13 Share Purchase Agreement for Purchase of
Controlling Interest in Approved Federal
Savings Bank (Formerly First Security
Federal Savings Bank, Inc.)
(Incorporated by Reference to Appendix J
of the Form 10 Registration Statement
Filed February 11, 1998) Description
- --------------------------------------------------------------------------------
10.14 Purchase Agreement between the Company
and MOFC, Inc., Incorporated by
reference to exhibit 10.14 of Form 10K
filed March 30,2000)
- --------------------------------------------------------------------------------
10.16 Option Agreement between the Company
and Allen D. Wykle. (Incorporated by
reference to exhibit 10.16 of Form 10K
filed March 30,2000)
- --------------------------------------------------------------------------------
10.17 Option Agreement between the Company
and Eric S. Yeakel. (Incorporated by
reference to exhibit 10.26 of Form 10K
filed March 30,2000)
- --------------------------------------------------------------------------------
10.18 Option Agreement between the Company
and Jean S. Schwindt. (Incorporated by
reference to exhibit 10.17 of Form 10K
filed March 30,2000)
- --------------------------------------------------------------------------------
10.19 Option Agreement between the Company
and Neil S. Phelan. (Incorporated by
reference to exhibit 10.19 of Form 10K
filed March 30,2000)
- --------------------------------------------------------------------------------
103
- --------------------------------------------------------------------------------
Exhibit Number Description Page Number
- --------------------------------------------------------------------------------
10.20 Option Agreement between the Company
and Gregory Gleason. (Incorporated by
reference to exhibit 10.21 of Form 10K
filed March 30,2000)
- --------------------------------------------------------------------------------
10.21 Option Agreement between the Company
and Stanley Broaddus. (Incorporated by
reference to exhibit 10.20 of Form 10K
filed March 30,2000)
- --------------------------------------------------------------------------------
10.22 Stock Appreciation Rights Agreement
with Jean S. Schwindt (Incorporated by
Reference to Appendix K of the Form 10
Registration Statement Filed February
11, 1998)
- --------------------------------------------------------------------------------
10.23 Amendment to Stock Appreciation Rights
Agreement with Jean S. Schwindt
(Incorporated by reference to Exhibit
10.22 of Form 10K filed on March
30,2000)
- --------------------------------------------------------------------------------
10.24 Gregory J. Witherspoon Registration
Rights Agreement (Incorporated by
Reference to Appendix M of the Form 10
Registration Statement Filed February
11, 1998)
- --------------------------------------------------------------------------------
21 Subsidiaries of the registrant
(Incorporated by reference to exhibit
21 of S-1 debt registration statement
filed December 14, 2000)
- --------------------------------------------------------------------------------
25 FORM T-1. Statement of eligibility and
qualification under the Trust Indenture
Act of 1939 of corporation designated
to act as trustee. (Incorporated by
reference to the S-1 debt registration
statement filed December 14, 2000)
- --------------------------------------------------------------------------------
99.1 Form of Prospectus Supplement, Order
Form and Other materials. (Incorporated
by reference to the S-1 debt
registration statement filed December
14, 2000)
- --------------------------------------------------------------------------------
104
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, 2001 By: /s/ Eric S. Yeakel
-----------------------------------
Eric S. Yeakel
Treasurer and
Chief Financial Officer
Date: March 31, 2001 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, 2001 By: /s/ Eric S. Yeakel
-----------------------------------
Eric S. Yeakel
Treasurer and
Chief Financial Officer
Date: March 31, 2001 By: /s/ Allen D. Wykle
---------------------------------
Allen D. Wykle
Chairman of the Board of Directors
President, and Chief Executive Officer
Date: March 31, 2001 By: /s/ Leon H. Perlin
-----------------------------------
Leon H. Perlin
Director
Date: March 31, 2001 By: /s/ Jean S. Schwindt
-----------------------------------
Jean S. Schwindt
Director and Executive Vice President
105
Date: March 31, 2001 By: /s/ Neil W. Phelan
----------------------------------
Neil W. Phelan
Director and Executive Vice President
Date: March 31, 2001 By: /s/ Stanley W. Broaddus
--------------------------------
Stanley W. Broaddus
Director, Vice President and Secretary
Date: March 31, 2001 By: /s/ Robert M. Salter
-----------------------------------
Robert M. Slater
Director
Date: March 31, 2001 By: /s/ Oscar S. Warner
----------------------------------
Oscar S. Warner
Director
Date: March 31, 2001 By: /s/ Arthur Peregoff
----------------------------------
Arthur Peregoff
Director
Date: March 31, 2001 By: /s/ Gregory Witherspoon
--------------------------------------
Gregory Witherspoon
Director
106
APPROVED FINANCIAL CORP.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 2000, 1999 AND 1998
APPROVED FINANCIAL CORP.
Contents Pages
-----
Report of Independent Accountants ..................................... 2
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2000 and 1999 .......... 3
Consolidated Statements of Income (Loss) and Comprehensive
Income (Loss) for the years ended December 31, 2000, 1999 and 1998 .... 4
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 2000, 1999 and 1998 ................................ 5
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998 ...................................... 6 - 7
Notes to Consolidated Financial Statements ............................ 8 - 39
Consolidating Balance Sheet as of December 31, 2000 ................... 40
Consolidating Statements of Income (Loss)for the year ended
December 31, 2000 ..................................................... 41
Quarterly Financial Data .............................................. 42
Report of Independent Accountants
To the Board of Directors and Shareholders 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, 2000 and 1999, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2000, in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of the statements in accordance with auditing standards generally
accepted in the United States of America, 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.
/s/ PricewaterhouseCoopers LLP
Virginia Beach, Virginia
February 23, 2001
2
APPROVED FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
December 31, 2000 and 1999
(Dollars in thousands, except per share amounts)
ASSETS 2000 1999
-------- --------
Cash $ 7,597 $ 10,656
Mortgage loans held for sale, net 22,438 49,618
Mortgage loans held for yield, net 14,274 17,153
Real estate owned, net 1,151 2,274
Investments 2,847 2,640
Income taxes receivable -- 5,153
Deferred tax asset, net 3,504 2,167
Premises and equipment, net 5,408 6,086
Goodwill, net 983 1,120
Other assets 1,617 1,733
-------- --------
Total assets $ 59,819 $ 98,600
======== ========
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 1,694 $ 17,465
FHLB bank advances and line of credit 3,000 4,648
Mortgage notes payable 2,529 2,341
Notes payable-related parties 2,818 2,993
Certificate of indebtedness 2,043 2,087
Certificates of deposits 34,432 55,339
Money market account 3,926
Accrued and other liabilities 1,366 2,428
-------- --------
Total liabilities 51,808 87,301
-------- --------
Commitments and contingencies -- --
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 5,482 5,482
Authorized shares - 40,000,000
Issued and outstanding shares - 5,482,114
Accumulated other comprehensive loss (12) (16)
Additional capital 552 552
Retained earnings 1,988 5,280
-------- --------
Total equity 8,011 11,299
-------- --------
Total liabilities and equity $ 59,819 $ 98,600
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
3
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
for the years ended December 31, 2000, 1999 and 1998
(In thousands, except per share amounts)
2000 1999 1998
Revenue:
Gain on sale of loans $ 10,971 $ 13,202 $ 29,703
Interest income 5,191 7,698 10,308
Gain on sale of securities 0 0 1,750
Broker fee income 2,399 6,077 4,277
Other fees and income 2,081 1,757 2,765
-------- -------- --------
20,642 28,734 48,803
-------- -------- --------
Expenses:
Compensation and related 11,477 17,765 23,397
General and administrative 7,779 12,497 11,713
Write down of goodwill 0 1,131 0
Loss on sale/disposal of fixed assets 42 796 0
Loss on write off of securities 0 73 0
Loan production expense 1,151 1,930 3,593
Interest expense 3,852 4,957 6,252
Provision for loan and foreclosed property losses 1,089 2,256 2,896
-------- -------- --------
25,390 41,405 47,851
-------- -------- --------
Income (loss) before income taxes (4,748) (12,671) 952
Provision for (benefit from) income taxes (1,456) (4,749) 473
-------- -------- --------
Net income (loss) (3,292) (7,922) 479
Other comprehensive loss, net of tax:
Unrealized gain (losses) on securities:
Unrealized holding gain (loss) during period 4 (46) (6,824)
-------- -------- --------
Comprehensive loss $ (3,288) $ (7,968) $ (6,345)
======== ======== ========
Net income (loss) per share:
Basic $ (0.60) $ (1.45) $ 0.09
======== ======== ========
Diluted $ (0.60) $ (1.45) $ 0.09
======== ======== ========
Weighted average shares outstanding:
Basic 5,482 5,482 5,465
======== ======== ========
Diluted 5,482 5.482 5,511
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
4
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
for the years ended December 31, 2000, 1999 and 1998
(Dollars in thousands)
Preferred Stock
Series A Common Stock
---------------------- -----------------------
Shares Amount Shares Amount
-------- --------- --------- ----------
Balance at December 31, 1997 90 $ 1 5,395,408 $ 5,395
Net income
Issuance of common stock 116,706 117
Repurchase common stock (30,000) (30)
Unrealized loss on investments
available for sale, net of tax of $0.7
-------- --------- --------- ----------
Balance at December 31, 1998 90 1 5,482,114 5,482
Net loss
Issuance of common stock
Unrealized loss on investments
available for sale, net of tax of $10.1
-------- --------- --------- ----------
Balance at December 31, 1999 90 1 5,482,114 5,482
Net loss
Unrealized gain on investments
available for sale, net of tax of $5.9
-------- --------- --------- ----------
Balance at December 31, 2000 90 $ 1 5,482,114 $ 5,482
======== ========= ========= ==========
Accumulated
Other
Additional Comprehensive Retained
Capital Income (Loss) Earning Total
---------- ---------- ---------- ----------
Balance at December 31, 1997 $ 0 $ 6,854 $ 12,805 $ 25,055
Net income 479 479
Issuance of common stock 552 669
Repurchase common stock (82) (112)
Unrealized loss on investments
available for sale, net of tax of $0.7 (6,824) (6,824)
---------- -------- -------- --------
Balance at December 31, 1998 552 30 13,202 19,267
Net loss (7,922) (7,922)
Issuance of common stock
Unrealized loss on investments
available for sale, net of tax of $10.1 (46) (46)
---------- -------- -------- --------
Balance at December 31, 1999 552 (16) 5,280 11,299
Net loss (3,292) (3,292)
Unrealized gain on investments
available for sale, net of tax of $5.9 4 4
---------- -------- -------- --------
Balance at December 31, 2000 $ 552 $ (12) $ 1,988 $ 8,011
========== ======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
5
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 2000, 1999 and 1998
(In thousands)
2000 1999 1998
--------- --------- ---------
Operating activities
Net income (loss) $ (3,292) $ (7,922) $ 479
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation of premises and equipment 643 1,105 750
Amortization of goodwill 137 455 395
Provision for loan losses 639 2,042 3,064
Provision for losses on real estate owned (341) 214 (168)
Deferred tax expense (1,337) 1,706 112
(Gain) loss on sale of securities -- 81 (1,750)
Loss on sale of real estate owned 792 648 660
Loss on sale/disposal of fixed assets 42 796 --
Loss on write down of goodwill -- 1,131 --
Gain on sale of loans (10,971) (13,202) (29,703)
Change in deferred hedging loss -- -- 91
Changes in assets and liabilities:
Loan sale receivable (2) 25 (28)
Other assets 118 2,384 (2,931)
Accrued and other liabilities (1,060) (450) (709)
Income tax payable 5,153 (3,621) (3,184)
Loan proceeds payable -- (2,565) (3,799)
--------- --------- ---------
Net cash used in operating activities (9,479) (17,173) (36,721)
Cash flows from investing activities:
Purchase of securities -- (125) --
Sales of securities 240 -- 1,844
Sales of ARM fund shares -- 4,619 4,957
Purchase of premises and equipment (253) (1,706) (1,036)
Sales of premises and equipment 246 1,322 29
Sales of real estate owned 2,777 2,587 4,440
Proceeds from sale and prepayments of loans 268,185 286,089 434,682
Originations of loans, net (229,490) (240,017) (429,555)
Real estate owned capital improvements (408) (648) (343)
Purchases of ARM fund shares (150) (3,623) (4,563)
Purchases of FHLB stock (297) (261) (96)
Net cash paid for acquisitions -- -- (1,395)
--------- --------- ---------
Net cash provided by investing activities 40,850 48,237 8,964
Continued on Next Page
6
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
for the years ended December 31, 2000, 1999 and 1998
(In thousands)
2000 1999 1998
--------- --------- ---------
Cash flows from financing activities:
Borrowings - warehouse $ 54,289 $ 169,576 $ 380,182
Repayments of borrowings - warehouse (70,060) (224,657) (365,705)
FHLB and LOC advances (repayments),net (1,648) 4,648 (1,000)
Principal payments on mortgage notes payable 188 (894) (83)
Net increase (decrease) in:
Notes payable (174) (635) (3,056)
Certificates of indebtedness (44) (326) 18
Certificates of deposit (20,907) 25,611 11,914
FDIC-insured money market account 3,926 -- --
Redemption of common stock -- -- (113)
--------- --------- ---------
Net cash (used in) provided by financing activities (34,430) (26,677) 22,157
--------- --------- ---------
Net increase (decrease) in cash (3,059) 4,387 (5,600)
Cash at beginning of year 10,656 6,269 11,869
--------- --------- ---------
Cash at end of year $ 7,597 $ 10,656 $ 6,269
========= ========= =========
Supplemental cash flow information:
Cash paid for interest $ 3,960 $ 5,233 $ 6,231
Cash paid for income taxes -- -- 3,546
Supplemental non-cash information:
Loan balances transferred to real estate
Owned $ 2,232 $ 4,019 $ 3,930
Exchange of stock for acquisition of Armada
Residential Mortgage LLC -- -- 669
Purchase of building in exchange for note
payable $ -- $ 2,025 --
The accompanying notes are an integral part of the consolidated financial
statements.
7
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
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 two 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 twelve states and nine retail offices as of December 31,
2000; and Approved Residential Mortgage, Inc. ("ARMI") with one retail location
at December 31, 2000. Approved has a third wholly owned subsidiary, Approved
Financial Solutions ("AFS"), through which it offers other financial products
such as Debt Free Solutions, Mortgage Acceleration Program and insurance
products to its mortgage customers. On April 1, 2000 the Company, as part of its
expense reduction initiatives, transferred all assets of Mortgage One Financial
Corporation ("MOFC") d/b/a ConsumerOne Financial ("ConsumerOne"), a wholly owned
subsidiary of Approved, to the Bank.
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.
8
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 1. Organization and Summary of Significant Accounting Policies, continued:
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.
Loans held for yield: Loans are stated at the amount of unpaid principal less
net deferred fees and an allowance for loan losses. Interest on loans is accrued
and credited to income based upon the principal amount outstanding. Fees
collected and costs incurred in connection with loan originations are deferred
and recognized over the term of the loan.
Allowance for loan losses: The allowance for loan losses is maintained at a
level believed adequate by management to absorb probable inherent losses in the
held for yield loan portfolio at the balance sheet date. 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
against income. Loan losses are charged against the allowance when management
believes it is unlikely that the loan is collectable.
The loans held for sale are recorded at the lower of cost or market as of the
balance sheet date. Then an allowance for loan losses is established based upon
the credit quality of the loans and prior experience regarding default rates.
The allowance for loan losses on the held for yield loans are based upon the
credit quality of the loans and prior history regarding default and foreclosure
rates.
9
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 1. Organization and Summary of Significant Accounting Policies, continued:
Origination fees: Net origination fees are recognized over the life of the loan
or upon the sale of the loan, if earlier.
Real estate owned: Assets acquired through loan foreclosure are recorded as real
estate owned ("REO")at the lower of cost or fair market value, net of estimated
disposal costs. Cost includes loan principal and certain capitalized
improvements to the property. 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.
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 and thirty-nine 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.
10
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 1. Organization and Summary of Significant Accounting Policies, continued:
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.
Loan originations and income recognition: 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. Gains on the sale of
mortgage loans, representing the difference between the sales proceeds and the
net carrying value of the loans, 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.
11
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 1. Organization and Summary of Significant Accounting Policies, continued:
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. The Company established a
$0.4 million valuation allowance for future unrealizable benefits for the
deferred tax asset. The valuation allowance is based upon an assessment by
management of future taxable income and its relationship to realizability of
deferred tax assets. The effect on deferred taxes of a change in tax rates is
recognized in income in the period that includes the enactment date.
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.
Comprehensive Income: The Company classifies items of other comprehensive loss
by their nature in a financial statement and displays the accumulated balance of
other comprehensive 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 Loss for the three years ended December 31,
2000, is an unrealized holding loss on securities, net of deferred taxes.
Goodwill recognition policy: Goodwill represents the excess of purchase price
and related costs over the value assigned to the net tangible and intangible
assets of businesses acquired. Goodwill is amortized on a straight-line basis
over 10 years. Periodically, the company reviews the recoverability and the
estimated remaining life of goodwill. The measurement of possible impairment is
based primarily on the ability to recover the balance of the goodwill from
expected future operating cash flows on an undiscounted basis.
12
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 1. Organization and Summary of Significant Accounting Policies, continued:
Liquidity: The company finances its operating cash requirements primarily
through certificates of deposit, warehouse credit facilities, and other
borrowings. Our borrowings were 84.3% of total assets at December 31, 2000
compared to 86.1% at December 31, 1999.
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.
Reclassifications: Certain 1999 and 1998 amounts have been reclassified to
conform to the 2000 presentation.
New accounting pronouncements:
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" as
amended by SFAS 137 and SFAS 138, is effective for fiscal years 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 did not have
any material impact on the financial statements.
Securities and Exchange Commission Staff Accounting Bulletin 101 (SAB 101),
"Revenue Recognition in Financial Statements", as amended by SAB 101B, was
adopted in the fourth calendar quarter of the year 2000.
13
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 1. Organization and Summary of Significant Accounting Policies, continued:
Adoption of SAB101 did not have any material impact on the recognition,
presentation, and disclosure of revenue.
In March 2000, the Financial Accounting Standards Board, (FASB) issued
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation - an interpretation of APB Opinion No. 25 (FIN 44), providing new
accounting rules for stock-based compensation under APB Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25). FIN 44 does not change FASB
Statement No. 123, Accounting for Stock-Based Compensation (FAS 123). FIN 44 was
generally effective for transactions occurring after July 1, 2000 however, the
accounting must be applied prospectively to certain transactions consummated
after December 15, 1998. FIN 44 did not have a material effect on financial
condition or results of operations of the Company.
In September 2000, the FASB issued SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, a replacement
of SFAS No. 125. It revises the standards for accounting for securitizations and
other transfers of financial assets and collateral and requires certain
disclosures, but it carries over most of provisions of SFAS No. 125 without
reconsideration. The Statement requires a debtor to reclassify financial assets
pledged as collateral and report these assets separately in the statement of
financial position. It also requires a secured party to disclose information,
including fair value, about collateral that it has accepted and is permitted by
contract or custom to sell or repledge. The Statement includes specific
disclosure requirements for entities with securitized financial assets and
entities that securitize assets. This Statement is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2000 and is effective for recognition and reclassification of
collateral and for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2000. The adoption of FAS
140 will did not have a material effect on financial condition or results of
operation of the Company.
14
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 2. Investments:
The cost basis and fair value of the Company's investments at December 31, 2000
and 1999, are as follows (in thousands):
2000 1999
-------------------------- --------------------------
Cost Fair Cost Fair Value
Basis Value Basis
----------- ----------- ----------- -----------
Asset Management Fund, Inc. ARM Portfolio $ 2,273 $ 2,258 $ 2,134 $ 2,108
FHLB stock 589 589 407 407
Other investments 0 0 125 125
----------- ----------- ----------- -----------
$ 2,862 $ 2,847 $ 2,666 $ 2,640
=========== =========== =========== ===========
15
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
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, 2000 and 1999, were as follows (in thousands):
2000 1999
-------- --------
Mortgage loans held for sale $ 22,597 $ 50,527
Net deferred origination fees and hedging costs (60) (658)
Allowance for loan losses (99) (251)
-------- --------
Total mortgage loans, net $ 22,438 $ 49,618
======== ========
The Company originated a first mortgage loan for $220,000 to an officer of the
company in December 2000. The loan was sold in February 2001.
Changes in the allowance for loan losses for the years ended December 31, 2000
and 1999 were (in thousands):
2000 1999
---------- ----------
Balance at beginning of year $ 251 $ 356
Provision (152) (105)
---------- ----------
Balance at end of year $ 99 $ 251
========== ==========
16
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 4. Mortgage Loans Held for Yield:
The Savings Bank holds certain first-lien mortgage loans to obtain a favorable
interest margin. The loans are carried at cost. These loans are obtained either
by direct purchase from AFC or designated as held for yield when funded by the
Bank. Certain of these loans have been pledged as collateral for the FHLB
financing. Loans held for yield at December 31, 2000 and 1999 were as follows
(in thousands):
2000 1999
-------- --------
Mortgage loans held for yield $ 16,004 $ 18,527
Net deferred origination fees and hedging costs (350) (243)
Allowance for loan losses (1,380) (1,131)
-------- --------
Total mortgage loans, net $ 14,274 $ 17,153
======== ========
At December 31, 2000, and 1999, the recorded investment in impaired loans
totaled $1.2 million, and $2.0 million, respectively. The average recorded
investment in impaired loans for the year ended December 31, 2000, and 1999 was
$1.9 million and $3.5 million, respectively. Interest income recognized related
to these loans was $95,000, and $89,000 during 2000 and 1999 respectively
Nonaccrual loans were $1.4 million and $2.2 million at December 31, 2000 and
1999, respectively. The amount of additional interest that would have been
recorded had these loans not been placed on nonaccrual status was approximately
$148,000 and $152,000 in 2000 and 1999, respectively.
Changes in the allowance for loan losses for the years ended December 31, 2000
and 1999 were (in thousands):
2000 1999
------- -------
Balance at beginning of year $ 1,131 $ 2,234
Charge Offs (1,086) (3,286)
Recoveries 544 36
Provision 791 2,147
------- -------
Balance at end of year $ 1,380 $ 1,131
======= =======
17
APROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 5. 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, 2000, 1999 and 1998 were (in thousands):
2000 1999 1998
-------- ------- --------
Balance at beginning of year $ 717 $ 503 $ 671
Provision (341) 214 (168)
-------- ------- --------
Balance at end of year $ 376 $ 717 $ 503
======== ======= ========
Note 6. Premises and Equipment:
Premises and equipment at December 31, 2000 and 1999, were summarized as follows
(in thousands):
2000 1999
-------- --------
Land $ 1,413 $ 1,413
Building & Improvements 2,959 2,947
Office Equipment & Furniture 1,713 1,780
Computer Software/Equipment 1,873 1,766
Vehicles 136 223
-------- --------
8,094 8,129
Less accumulated depreciation and amortization 2,686 2,043
-------- --------
Premises and equipment, net $ 5,408 $ 6,086
======== ========
The Company has several capital leases for computer and other equipment included
in the premises and equipment table above. See Note 7 for further discussion on
capital leases.
18
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 7. Capital Leases:
Assets recorded under capital leases at December 31, 2000 and 1999, consist of
the following (in thousands):
2000 1999
-------- --------
Computer equipment $ 154 $ 154
Furniture & equipment 224 224
Less: Accumulated amortization (290) (176)
-------- --------
$ 88 $ 202
======== ========
Amortization expense for the years ended December 31, 2000 and 1999,
approximated $114,000 and $167,000, 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, 2000, are as follows (in thousands):
2001 $ 82
2002 22
--------------
104
Less - amount representing interest 7
--------------
Present value of net minimum lease payments $ 97
==============
The Company has the option to purchase these assets at an established price at
the end of the lease terms. The Company recognized approximately $20,000 and
$49,000 of interest expense related to the lease obligations for the years ended
December 31, 2000 and 1999, respectively.
19
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 8. Leases
The Company leases some of its office facilities and equipment under operating
leases, which expire at various times through 2005. Lease expense was $0.8
million, $2.0 million, and $1.4 million in 2000, 1999 and 1998, respectively.
Total minimum lease payments under non-cancelable operating leases with
remaining terms in excess of one year as of December 31, 2000, were as follows
(in thousands):
2001 $ 754
2002 627
2003 144
2004 53
------------
$ 1,578
============
20
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 9. Revolving Warehouse Facilities:
Amounts outstanding under revolving warehouse facilities at December 31, 2000
and 1999, were as follows (in thousands):
2000 1999
----------- -----------
Warehouse facility with commercial bank collateralized by
mortgages/deeds of trust; expires July 21, 2001, with
interest at 2.25% to 4.00% over applicable LIBOR rates
(6.56% at December 31, 2000); total credit available $20
million. (1) $ 1,694 $ 0
Warehouse facility with commercial bank collateralized by
mortgages/deeds of trust; expired June 7, 2000, with
interest at 1.75% over applicable LIBOR rate (5.82% at
December 31, 1999); total credit available $15 million.(2) 0 12,142
Warehouse facility with commercial bank collateralized by
mortgages/deeds of trust; expires November 10, 2001,
with interest at 3.25% over applicable LIBOR rate (5.82%
at December 31, 1999); total credit available $20 million.(3) 0 5,323
----------- -----------
$ 1,694 $ 17,465
=========== ===========
(1) On July 21, 2000, the Company obtained a $40.0 million line of credit from
Bank United. However, effective December 29, 2000, the Company obtained an
amendment to the credit line, which reduced the size of the warehouse facility
to $20.0 million, since the utilization of the credit line has been very low in
2000. The credit line can be used for prime and sub-prime mortgage loans and is
secured by loans originated by the Company. The line bears interest at a rate of
2.25% and 3.00% over the one-month LIBOR rate for prime and sub-prime loans
respectively. The Company may receive warehouse credit advances of 98%, 97%, and
90% for prime, sub-prime, and high LTV loans (loans with LTV's greater than
90%), respectively, of the collateral value amount on pledged mortgage loans for
a period 90 days after advance of funds on each loan. If a loan has not been
purchased by an investor within 90 days of such advance, the interest rate on
the loan increases to 4.00% over the one-month LIBOR and the Company has an
additional 30 days to sell the loan or repay the loan back from the warehouse.
All interest rates reflect a 25 basis point increase from the original interest
rates, which was the result of the December 29th amendment. The aged loan
sublimit is $2.0 million.
21
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 9. Revolving Warehouse Facilities, continued:
As of December 31, 2000, $1.7 million was outstanding under this facility. The
line of credit is scheduled to expire on July 21, 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, 2000 the Company is in compliance with all
financial covenants.
(2) On December 8, 1999, the Company had obtained an amendment to their
warehouse line of credit agreement with Chase Bank of Texas. Since the
utilization of the credit line had 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 was secured
by loans originated by the Company with interest at a rate of 1.75% over the
one-month LIBOR rate. The Company received warehouse credit advances of 95% on
the original principal balances on pledged mortgage loans for a maximum period
of 180 days after origination. The line expired on June 7, 2000.
(3) 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, 2000, there were no borrowings 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, 2000, there were
no borrowings outstanding under this facility. The line of credit is scheduled
to expire on November 10, 2001.
22
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 10. Certificates of Deposits:
The following table sets forth various interest rate categories for the
FDIC-insured certificates of deposit of the Bank as of December 31, 2000 and
1999 (in thousands):
2000 1999
------------------- --------------------
Weighted Weighted
Average Average
Rate Amount Rate Amount
-------- ------ --------- ------
5.24% or less 5.20% $ 99 5.18% $ 793
5.25 - 5.49% 5.40 4,159 5.36 8,813
5.50 - 5.74 5.61 892 5.61 1,389
5.75 - 5.99 5.88 2,772 5.89 7,733
6.00 - 6.24 6.07 1,388 6.18 14,152
6.25 - 6.49 6.37 1,090 6.37 19,391
6.50 - 6.74 6.59 497 6.65 3,068
6.75 - 6.99 6.84 12,207 -- --
7.00 - 7.24 7.12 9,640 -- --
7.25 - 7.49 7.28 1,688 -- --
---- ------- ---- -------
6.60% $34,432 6.07% $55,339
==== ======= ==== =======
The following table sets forth the amount and maturities of the certificates of
deposit of the Bank at December 31, 2000 (in thousands):
Over Six Months Over One Year
Six Months or and Less than and Less than
Less One Year Two Years Over Two Years Total
------------- --------------- ------------- -------------- ----------
5.24% or less $ -- $ -- $ -- $ 99 $ 99
5.25 - 5.49% -- -- -- 4,059 4,059
5.50 - 5.74 -- -- -- 892 892
5.75 - 5.99 -- -- -- 2,772 2,772
6.00 - 6.24 -- -- 99 1,388 1,487
6.25 - 6.49 -- 99 396 595 1,090
6.50 - 6.74 99 199 199 -- 497
6.75 - 6.99 295 8,514 3,398 -- 12,207
7.00 - 7.24 397 4,655 4,290 299 9,641
7.25 - 7.49 -- 1,192 496 -- 1,688
---------- ---------- ---------- ---------- ----------
$ 791 $ 14,659 $ 8,878 $ 10,104 $ 34,432
========== ========== ========== ========== ==========
At December 31, 2000, 51 certificates of deposit totaling $14,057,000 were in
amounts of $100,000 or greater.
23
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 11. Money Market Deposits
At December 31, 2000, the Bank had $3.9 million in money market deposits. All
money market deposits have a variable rate of interest and can be redeemed at
any time. The interest rate is based upon a four-week average of the 90-day
Libor rate less 25 basis points. The interest rate is adjusted monthly. At
December 31, 2000 the interest rate on all money market deposits was 6.48%
Note 12. Federal Home Loan Bank Advances:
Federal Home Loan Bank Advances occur through two types of borrowings. There is
a Federal Home Loan Bank Warehouse Line of credit and a daily rate credit
program.
At December 31, 2000, the Bank has pledged qualifying residential mortgage loans
with an aggregate balance of $5.9 million as collateral for the daily rate
credit program advances under a specific collateral agreement with a limit of up
to 20% of the Banks total assets at December 31, 2000. Total advances at
December 31, 2000 were $3.0 million and were $2.6 million at December 31, 1999.
Interest is computed based on the lender's cost of overnight funds. The interest
rates on December 31, 2000 and 1999, were 6.35% and 4.55%, respectively.
The Bank has a $15.0 million warehouse line of credit with the Federal Home Loan
Bank. The line is secured by loans originated by the Bank and bears interest at
the lenders cost of overnight funds. The interest rates on December 31, 2000 and
1999, were 6.60% and 4.80%, respectively. There were no advances outstanding on
the line of credit at December 31, 2000. Total advances at December 31, 1999
were $2.0 million.
Interest expense on FHLB advances totaled $33,000, $36,000 and $76,000 in 2000,
1999 and 1998, respectively.
24
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 13. 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 $282,000, $332,000, and $554,000, in 2000,
1999 and 1998, respectively. The interest rates on the notes range from 8.00% to
10.00% and the notes mature as follows (in thousands):
2001 $ 0
2002 102
2003 1,252
2004 108
2005 1,356
-----------
$ 2,818
===========
25
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 14. 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 $196,000, $225,000, and
$224,000 in 2000, 1999 and 1998, respectively.
Certificates of indebtedness maturities were as follows as of December 31, 2000
(in thousands):
2001 $ 619
2002 584
2003 283
2004 37
2005 520
-----------
$ 2,043
===========
26
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 15. 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):
2000 1999
---------- ----------
Mortgage note with commercial bank
collateralized by office building; original
amount of $590,000; monthly payments of $7,186;
matures May 2004; with interest at 7.99% $ 253 $ 316
Mortgage note with commercial bank
collateralized by office building; original
amount $2,025,000; monthly payments of $21,170;
matures November 2019; with interest at 8.625% 1,992 2,025
Mortgage note payable- foreclosed properties 284 0
---------- ----------
$ 2,529 $ 2,341
========== ==========
Interest expense on mortgage loans payable was $205,000, $62,000 and $99,000 in
2000, 1999 and 1998 respectively.
Aggregate maturities for mortgage payable are as follows as of December 31, 2000
(in thousands):
2001 $ 396
2002 122
2003 132
2004 86
2005 62
Thereafter 1,731
-----------
$ 2,529
===========
27
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 16. 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
evenly 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 page 30.
28
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 16. Stock Options, continued:
A summary of the Company's stock options, including weighted average exercise
price (Price) as of December 31, 2000, 1999 and 1998, and the changes during the
years is presented below:
2000 1999
---------------------- ----------------------
Shares Price Shares Price
------- ----------- ------- -----------
Outstanding at beginning of year 118,400 $ 4.37 108,325 $ 5.19
Granted 19,000 4.00 21,425 4.00
Repriced -- -- 9,150 4.00
Cancelled 1,800 9.75 5,000 9.75
Cancelled 600 13.50 7,100 13.50
Cancelled 17,300 4.00 8,400 4.00
------- ----------- ------- -----------
Outstanding at end of year 117,700 $ 4.21 118,400 $ 4.37
======= =========== ======= ===========
Options available for future grant 138,800 138,100
======= =======
Weighted-average fair value of
options granted during year $ 1.01 $ 1.00
=========== ==========
1998
----------------------------
Shares Price
------- ---------
Outstanding at beginning of year 9,200 $ 9.75
Granted 8,050 13.50
Granted 91,475 4.00
Cancelled 400 4.00
------- ---------
Outstanding at end of year 108,325 $ 5.19
======= =========
Options available for future grant 148,175
=======
Weighted-average fair value of
options granted during year $ 1.20
=========
The weighted-average remaining contractual life of options granted at
December 31, 2000, 1999 and 1998 was 8 years, 9 years, and 10 years
respectively. At December 31, 2000 there were 56,477, 3,000, and 500 options
exercisable at $4.00, $9.75, and $13.50 per share, respectively.
29
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 16. Stock Options, continued:
The fair value of each option granted during 2000, 1999 and 1998 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 151.42% in
2000, 48.99% in 1999 and 34.48% in 1998; risk-free interest rate of 6.26% for
options granted in March 2000, 5.74% for options granted in October 2000, 5.75%
for options granted in June 1999, 5.99% for options granted in November 1999,
5.42% for options granted in January 1998, and 4.54% for options granted in
November 1998. The assumption for the expected life of the options is 10 years
for the date of issuance for all options.
Had compensation cost for the years 2000, 1999 and 1998 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 2000, 1999,
1998, and 1997 would have been as follows:
(In thousands, except per share amounts)
Year Ended Year Ended
December 31, 2000 December 31, 1999
------------------------ ------------------------
As Reported Pro Forma As Reported Pro Forma
----------- --------- ----------- ---------
Net income (loss) $ (3,292) $ (3,303) $ (7,922) $ (7,939)
Net income (loss) per common share - Basic (.60) (.60) (1.45) (1.45)
Net income (loss) per common share - Dilutive (.60) (.60) (1.45) (1.45)
Year Ended Year Ended
December 31, 1998 December 31, 1997
------------------------ ------------------------
As Reported Pro Forma As Reported Pro Forma
----------- --------- ----------- ---------
Net income (loss) $ 479 $ 371 $ 8,060 $ 8,041
Net income (loss) per common share - Basic 0.09 0.07 1.52 1.52
Net income (loss) per common share - Dilutive 0.09 0.07 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. As a result of the 1999 repricing of
9,150 options, the Company is subject to compensation expense if the fair value
of the companies stock were to go above $4.00 per share.
30
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 17. Shareholders' Equity
The Capital Stock of the Company consists of 40,000,000 shares of Common Stock
having a par value of $1.00 per share, 100 shares of Preferred Stock Series A
having a par value of $10.00 per share, and 50,000 shares of Preferred Stock
Series B having a par value of $10.00. At December 31, 2000 and 1999 there were
5,482,114 shares of common stock issued and outstanding, 90 shares of Preferred
Stock Series A issued and outstanding, and no shares of Preferred Stock Series B
were issued and outstanding.
The Common Stock and Preferred Stock Series A have voting powers, with each
share of stock having an equal vote with every other share. The holders of
Preferred Stock Series B are not entitled to vote.
The Preferred Stock Series A is subject to redemption at any time at a price of
$10.20 per share and the Preferred Stock Series B is subject to redemption at
any time at a price equal to its par value.
The holders of Preferred Stock Series A and Preferred Stock Series B are
entitled to be paid in full, upon any distribution of the assets of the
Corporation, first the amount of their Preferred Stock Series B at par and then
the amount of their Preferred Stock Series A at par, before any payment upon
dissolution or upon any distribution is made to the holders of common stock.
31
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 18. 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
Net Income (Loss) Outstanding (Loss) Per
(Numerator) (Denominator) Share
-------------------------------------------------------
For the Year Ended December 31, 2000
Basic and dilutive earnings per share $(3,292,000) 5,482,114 $ (.60)
=========== ========= ===========
For the Year Ended December 31, 1999
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 payable -- 46,338 --
----------- --------- -----------
Diluted earnings per share $ 479,000 5,511,372 $ 0.09
=========== ========= ===========
32
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 19. Income Taxes:
The components of income tax expense (benefit) for the years ended December 31,
2000, 1999 and 1998, were as follows (in thousands):
2000 1999 1998
-------- -------- --------
Current $ (119) $ (6,455) $ 361
Deferred (1,337) 1,706 112
-------- -------- --------
$ (1,456) $ (4,749) $ 473
======== ======== ========
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, 2000, 1999 and 1998, were (in thousands):
2000 1999 1998
--------- --------- --------
Provision for (benefit from) income $ (1,614) $ (4,308) $ 339
taxes at statutory
federal rate
State income taxes, net (219) (585) 58
of federal benefit
Nondeductible expenses 24 37 71
Allowance for deferred tax asset 479
Other, net (126) 107 5
--------- --------- --------
$ (1,456) $ (4,749) $ 473
========= ========= ========
33
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 19. Income Taxes, continued:
Significant components of the Company's deferred tax assets and liabilities at
December 31, 2000 and 1999, were (in thousands):
2000 1999
--------- ---------
Deferred tax assets: $ 718 $ 811
Allowance for loan and real estate
owned losses
Deferred loan fees 103 57
Mark to market on mortgage loans held for sale 262 300
Net Operating Loss carryforward (1) 2,087 --
Deferred income 15 8
Accrued premium recapture 48 194
Accrued expenses 84 7
Accrued 401(k) match 57 68
Accrued insurance expense 58 189
Goodwill 647 604
Other 10 0
--------- ---------
Total deferred tax assets 4,089 2,238
Deferred tax liabilities:
Depreciation 106 71
Total deferred tax liabilities 106 71
--------- ---------
Deferred tax asset, net of liabilities 3,983 2,167
Valuation allowance 479 --
--------- ---------
Net deferred tax asset $ 3,504 $ 2,167
========= =========
(1) The net operating loss carryforward expires on December 31, 2020.
The Company anticipates that sufficient taxable income will be generated during
the next five years to utilize a portion of the Net Operating Loss carryforwards
and reversing temporary differences. A valuation allowance has been set up for
the portion of the carryforwards and temporary differences that the company
anticipates will not be recognized over the next five years. However, there can
be no assurance that the Company will generate taxable income in any future
period.
34
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 20. 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 2000, 1999 and 1998. 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, 2000, 1999 and 1998.
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. There were no contributions for the years ended December 31,
2000, 1999 and 1998.
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, 2000, 1999 and 1998, were $94,000, $141,000, and $162,000,
respectively.
Note 21. Employment Agreements:
The Company has employment agreements with various employees. The agreements
expire at various times from 2000 through 2002. 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.
35
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 22. 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, 2000 and 1999, 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, 2000
GAAP capital $ 9,440 $ 9,440 $ 9,440
Add: unrealized loss on securities 9 9 9
Non-allowable asset: goodwill (546) (546) (546)
Additional capital item: general allowance -- -- 272
------- ------- -------
Regulatory capital (computed) 8,903 8,903 9,175
Minimum capital requirement 782 2,084 3,435
------- ------- -------
Excess regulatory capital $ 8,121 $ 6,819 $ 5,740
======= ======= =======
Ratios:
Regulatory capital (computed) 17.08% 17.08% 21.37%
Minimum capital requirement 1.50 4.00 8.00
------- ------- -------
Excess regulatory capital 15.58% 13.08% 13.37%
======= ======= =======
36
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 22. Regulatory Capital, continued:
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%
======= ======= =======
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 2000, 1999 or 1998.
Note 23. 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
37
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 23. Disclosures About Fair Value of Financial Instruments, continued:
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.
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 held for sale: 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 $23,103,000 and $51,928,000 at December 31, 2000 and 1999,
respectively.
Mortgage loans held for yield: 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 yield
approximated $14,689,000 and $17,695,000 at December 31, 2000 and 1999,
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 $34,405,000 and $55,064,000 at December 31, 2000 and 1999,
respectively.
38
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 23. Disclosures About Fair Value of Financial Instruments, continued:
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
$2,266,000 and $1,765,000 at December 31, 2000 and 1999, respectively.
Other term debt: The carrying amount of outstanding term debt such as the
certificates of indebtedness and related party notes, which bears market rates
of interest, approximates its fair value.
Note 24. 1999 Impairment of Assets:
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.
39
Approved Financial Corp.
Consolidating Balance Sheet
December 31, 2000
(dollars in thousands)
Approved
Approved Approved Federal Approved
Financial Residential Savings Financial
ASSETS Consolidated Eliminations Corp. Mortgage Bank Solutions
------------ ------------ --------- ----------- -------- ---------
Cash $ 7,597 $ 0 $ 5,344 $ 257 $ 1,822 $ 174
Mortgage loans held for sale, net 22,438 0 279 52 22,107 0
Mortgage loans held for yield, net 14,274 0 6,543 0 7,731 0
Real estate owned, net 1,151 0 512 530 109 0
Investments 2,847 (5,360) 5,360 0 2,847 0
Deferred tax asset, net 3,504 (2,320) 4,588 121 1,115 0
Premises and equipment, net 5,408 0 4,624 44 727 13
Goodwill, net 983 0 437 0 546 0
Due from affiliates 0 (19,142) 3,941 38 15,099 64
Other assets 1,617 0 1,003 68 545 1
--------- --------- --------- -------- --------- -------
Total assets $ 59,819 $ (26,822) $ 32,631 $ 1,110 $ 52,648 $ 252
========= ========= ========= ======== ========= =======
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 1,694 $ 0 $ 1,694 $ 0 $ 0 $ 0
FHLB bank advances 3,000 0 0 0 3,000 0
Mortgage payable 2,529 0 2,245 284 0 0
Notes payable-related parties 2,818 0 2,818 0 0 0
Certificates of indebtedness 2,043 0 2,043 0 0 0
Certificates of deposits 34,432 0 0 0 34,432 0
Money market account 3,926 0 0 0 3,926 0
Due to affiliates 0 (19,142) 15,130 2,435 1,387 190
Accrued and other liabilities 1,366 0 689 220 463 (6)
Income taxes payable 0 (2,320) 1 2,311 0 8
--------- --------- --------- -------- --------- -------
Total liabilities 51,808 (21,462) 24,620 5,250 43,208 192
--------- --------- --------- -------- --------- -------
Shareholder's equity:
Preferred stock-series A 1 0 1 0 0 0
Common stock 5,482 (298) 5,482 250 32 16
Unrealized gain on securities (12) 9 (12) 0 (9) 0
Additional capital 552 (5,035) 552 493 4,542 0
Retained earnings 1,988 (36) 1,988 (4,883) 4,875 44
--------- --------- --------- -------- --------- -------
Total equity 8,011 (5,360) 8,011 (4,140) 9,440 60
--------- --------- --------- -------- --------- -------
Total liabilities and equity $ 59,819 $ (26,822) $ 32,631 $ 1,110 $ 52,648 $ 252
========= ========= ========= ======== ========= =======
40
Approved Financial Corp.
Consolidating Statement of Income (Loss)
For the year ended December 31, 2000
(dollars in thousands)
Approved
Approved Approved Federal Approved
Financial Residential Savings Financial
ASSETS Consolidated Eliminations Corp. Mortgage Bank Solutions
------------ ------------ --------- ----------- -------- ---------
Revenue:
Gain on sale of loans $ 10,971 0 $ (797) $ 523 $11,245 $ 0
Interest income 5,191 0 258 (578) 5,509 2
Other fees and income 4,480 0 186 367 3,716 211
----------- --------- ---------- ----------- ------- -------
20,642 0 (353) 312 20,470 213
Expenses:
Compensation and related $ 11,477 0 $ 3,494 $ 538 $ 7,295 $ 150
General and administrative 7,779 0 650 400 6,712 17
Loss on sale/disposal fixed assets 42 0 42 0 0 0
Loan production expense 1,151 0 (54) 294 911 0
Interest expense 3,852 0 959 0 2,893 0
Provision for loan/REO losses 1,089 0 826 209 54 0
----------- --------- ---------- ----------- ------- -------
25,390 0 5,917 1,441 17,865 167
Income (loss) before income taxes (4,748) 0 (6,270) (1,129) 2,605 46
Provision for income taxes (1,456) 0 (2,093) (396) 1,015 18
----------- --------- ---------- ----------- ------- -------
Net income (loss) $ (3,292) 0 $ (4,177) $ (733) $ 1,590 $ 28
=========== ========= ========== =========== ======= =======
41
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2000, 1999 and 1998
Note 25. Quarterly Financial Data (Unaudited):
The following is a summary of selected quarterly operating results for each of
the four quarters in 2000 and 1999:
(In thousands, except per share data)
March 31 June 30 September 30 December 31
---------- ---------- ------------ -----------
2000:
Gain on sale of loans $ 3,926 $ 2,502 $ 2,280 $ 2,263
Net interest income 461 358 274 245
Provision for losses 55 92 396 546
Other income 1,202 1,197 1,164 917
Other expenses 5,626 5,215 4,740 4,867
---------- ---------- ---------- -----------
Income (loss) before income taxes (92) (1,250) (1,418) (1,988)
Provision for income taxes (32) (472) (176) (776)
---------- ---------- ---------- -----------
Net income (loss) $ (60) $ (778) $ (1,242) $ (1,212)
========== ========== ========== ===========
Basic and diluted net income (loss) per
share $ (.01) $ (.14) $ (.23) $ (.22)
========== ========== ========== ===========
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 and diluted net income (loss) per
share $ (.23) $ (.24) $ (.26) $ (.73)
========== ========== ========== ===========
42