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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, 2001
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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:
Common, $1.00 par value per share OTC Bulletin Board
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Title of Each Class Name of Each Exchange
on Which Registered
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,
2002.
DOCUMENTS INCORPORATED BY REFERENCE IN FORM 10-K
INCORPORATED DOCUMENTS WHERE INCORPORATED IN FORM 10-K
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1. Certain portions of the Corporation's Part III -Items 10, 11, 12 and 13.
Proxy Statement for the Annual Meeting
of Stockholders to be held on June 10, 2002
("Proxy Statement").
Approved Financial Corp.
Annual Report on Form 10-K
Amendment No. -
For the Fiscal Year Ended December 31, 2001
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.......................................................................... 10
Mortgage Loan Servicing.......................................................................... 17
Marketing ....................................................................................... 18
Sources of Funds and Liquidity................................................................... 20
Bank's Sources of Funds.......................................................................... 21
Taxation ........................................................................................ 22
Employees ....................................................................................... 23
Service Marks ................................................................................... 23
Effect of Adverse Economic Conditions............................................................ 23
Concentration of Operations ..................................................................... 24
Future Risks Associated with Loan Sales through
Securitizations ................................................................................ 24
Contingent Risks ................................................................................ 24
Competition ..................................................................................... 25
Regulation ...................................................................................... 26
OTS Regulation of Approved Financial Corp........................................................ 29
Regulation of the Bank........................................................................... 30
Legislative Risk ................................................................................ 39
Environmental Factors............................................................................ 39
Dependence on Key Personnel...................................................................... 40
Control by Certain Shareholders.................................................................. 40
Item 2. Properties
Properties ...................................................................................... 41
Item 3. Legal Proceedings
Legal Proceedings ............................................................................... 41
Item 4. Submission of Matters to a Vote of Security Holders.
Submission of Matters to a Vote of Security Holders.............................................. 42
PART II
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters.
Market Price of and Cash Dividends on Common Equity.............................................. 43
Absence of Active Public Trading Market and Volatility
of Stock Price ................................................................................. 44
Transfer Agent and Registrar..................................................................... 44
Recent Open Market Purchase of Common Stock by the
Company ........................................................................................ 44
Recent Sales of Unregistered Securities.......................................................... 44
Item 6. Selected Financial Data
Selected Financial Data.......................................................................... 44
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations
General.......................................................................................... 47
Results of Operations - Years Ended December 31, 2001
and 2000........................................................................................ 48
Results of Operations - Years Ended December 31, 2000
and 1999 ....................................................................................... 60
Financial Condition - December 31, 2001, 2000 and 1999........................................... 71
Liquidity and Capital Resources.................................................................. 73
Interest Rate Risk Management.................................................................... 84
New Accounting Standards......................................................................... 84
Impact of Inflation and Changing Prices.......................................................... 85
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market Risk Management - Asset/Liability Management.............................................. 86
Interest Rate Risk............................................................................... 89
Asset Quality.................................................................................... 90
Item 8. Financial Statements and Supplementary Data.
Financial Statements and Supplementary Data...................................................... 91
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.
Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure........................................................... 91
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 10, 2002 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 10, 2002 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 10, 2002 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 10, 2002 and is incorporated herein by reference.
PART IV
Item 14. Exhibits, Financial Statement Schedules
And Reports on Form 8-K.
Financial Statements and Exhibits................................................................ 93
Signatures....................................................................................... 98
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, corporate
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 but not limited to "will likely result," "may," "expected to,"
"will continue to," "is anticipated," "estimate," "projected," "intends to",
"plans to", "is likely". 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, our ability to comply and be released from outstanding
regulatory issues, 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.("AFC", "Holding Company", "Parent
Company") 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 31, 2001, approximately
17 percent of the loans funded in-house were conforming or government loans and
83 percent were non-conforming. Of the non-conforming loans 84 percent were `A'
credit quality, 13 percent were `B' credit quality and three percent were `C'
credit quality (For an explanation of credit quality ratings see:
"non-conforming underwriting").
We utilize wholesale broker and retail channels to originate mortgage loans. At
the broker level, an extensive network of independent mortgage brokers generates
referrals. Both loan sources have been our primary source of revenue for many
years.
We began making residential mortgage loans through retail offices during the
fourth quarter of 1994. In 2001, including retail loans brokered to other
lenders, the dollar volume in the broker lending division accounted for 73% of
total originations and the retail lending division accounted for 27% of total
originations. In 2000, the dollar volume in the broker lending division
accounted for 49% of total originations and the retail lending division
accounted for 51% of total originations. Our current initiatives for the
mortgage business focus on increasing future origination volume in a
cost-effective manner primarily through the broker and retail channels.
Once loan application packages are received from the wholesale 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 well capitalized
financial institutions and reputable mortgage companies. 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 and
operational expenses.
We historically have derived our income primarily from the premiums received on
whole loan sales to institutional investors,
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net interest earned on loans held for sale, net interest income on loans held
for yield, various origination fees received as part of the loan application and
closing process and to a lesser extent from ancillary fees associated with the
portfolio of loans serviced and from other financial services offered in past
periods. In future periods, we may generate revenue from loans sold through
alternative loan sale strategies, 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, 2001, Approved Financial Corp. had four subsidiaries:
. Approved Federal Savings Bank ("Bank")
. Approved Residential Mortgage, Inc. ("ARMI")
. Approved Financial Solutions ("AFS").
. 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 wholesale jumbo certificate of deposit accounts and certain
money market deposits, and originating in and selling loans primarily secured by
first and junior mortgage liens on single-family dwellings, including
condominium units. The Bank may from time to time invest 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
loan sale premiums from whole loan sales and net interest income, which is the
difference between interest income earned on loans and investments and the cost
of deposits and borrowed funds.
The flexible provisions of the Bank charter offers ease of entry
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to new markets by facilitating our origination of 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 residential mortgage loans utilizing a network of mortgage
brokers for loan referrals and through a retail mortgage lending division. Under
an agreement with, the holding company, the Bank is provided with various
services related to the origination of residential mortgages, such as
processing, underwriting, docprep/closing, quality control, servicing and
collections, payroll processing, MIS functions and secondary marketing.
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 AFC 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 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 have
been discontinued. During 2001, AFS offered title insurance in certain states
where it holds licenses and offers other ancillary financial products such as
Mortgage Acceleration Program ("MAP") and Debt Free Solutions Program. However,
these services are currently not being marketed or sold.
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 Subsidiaries. Other wholly owned subsidiaries include, 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 operated as a retail loan origination branch of the
Bank and served as a disaster "hot" site until we closed the operation due to
lack of profitability in May of 2001.
Approved Residential Mortgage, Inc. ("ARMI") was formed in April 1993. Initially
ARMI originated loans through broker referrals. However, as of August 1, 1999,
all wholesale broker originations were transferred to the Bank. In 1994 ARMI
opened its first retail operation. All ARMI retail offices have been closed and
the company is inactive.
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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 through strategic alliances and from broker referrals
(iv) Diversify loan sale strategies and investors with a commitment to prudent
management of cash flow and expansion of competitive mortgage product
development.
(v) Build on the business opportunities provided by a federal savings bank
charter. Evaluate opportunities to diversify into other types of lending
and other financial service areas.
(vi) Enhance our capital base by evaluation of opportunities afforded to us
from various sources including private or public offering of securities
and merger and acquisition activity.
(i) Maintain Quality Loan Underwriting and Servicing Standards. Our underwriting
and servicing staff have experience in the non-conforming, conforming and 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. We implemented several cost cutting campaigns,
over the past few years. Such initiatives include consolidation of all Virginia
Beach locations into one office. This centralization in conjunction with
implementation of a new systems platform greatly improved the productivity of
our staff and was a key element in our ability to reduce compensation expense
while maintaining loan production capacity, data integrity, management reporting
capabilities and quality controls. During 2001, we upgraded the method by which
our staff in remote locations access our loan production applications through
the utilization of a frame relay network. This has dramatically improved
communications and operational efficiencies throughout the company in addition
to enhancement of data integrity and compliance controls. A document imaging
system to enhance loan file retention and storage is under consideration. This
method will significantly reduce operational and storage cost, while improving
operational efficiencies.
(iii) Increase revenues by expanding the level of profitable
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mortgage volume from our wholesale broker division, retail division, through
strategic alliances and through utilization of the internet.
Wholesale Broker Referrals. Our wholesale division sales efforts are conducted
through account executives with extensive experience in the non-conforming
mortgage business located throughout the United States. To augment these sales
efforts continue to build an inside sales staff who solicit and coordinate
broker referral business from the home office in Virginia Beach. The majority of
our wholesale operations are handled through our Virginia Beach office. We have
a small wholesale lending operation in Florida and in September 2000 we
established a wholesale lending operation in California to service the western
portion of the United States. Current initiatives are currently under
development to expand wholesale lending in the mid-western states during 2002.
Retail. Initiatives for expansion of retail loan origination volume is
centralized in our corporate home office location. Our current plan is to build
a larger sales staff that will originate residential mortgages throughout the
country. The sales staff will have ready access to processing and underwriting
departments which should enhance the ability to provide timely service to
potential customers.
Strategic Alliances. We believe that strategic relationships, structures for
which are not pre-defined, may allow for opportunities to accelerate the pace of
growth in a cost-effective manner with minimal initial investment or long-term
financial commitment. Our only pre-determined criteria for initial consideration
of a relationship opportunity relates to the candidate's attributes. Candidates
must exhibit management styles compatible with our management team and who's
business philosophy complements our own. We adhere to the belief that "people"
are the most significant component in any successful operation.
Internet Applications. During 2001, we continued 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 our off site wholesale loan origination personnel to
access their loan files in process, retrieving underwriting status and
outstanding stipulations needed.
(iv) Diversify loan sale strategies and investors with a commitment to prudent
management of cash flow. We sell our loans on a whole loan basis receiving cash
at the time of sale. Beginning in the second half of 1998, many of our investors
that utilized the securitization market experienced significant difficulty with
capital and liquidity issues. As a result, the
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secondary market place has experienced unprecedented turmoil 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 and 3.6% in 2001, excluding seasoned loan sales. With
an objective to expand our menu of mortgage product offerings and to enhance
revenues and profits related to loan sales we continue to aggressively pursue
new investors for loan sales and opportunities to engage in forward loan sale
commitments with various investors.
(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 our brokers and borrowers and to expand our 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: After the restructure of our title insurance
operation, we continue to retain an individual with many years of
experience to manage the operation. This division is licensed in the
states of Maryland and Virginia. During the past year, we performed
minimal title business due to the reduction in retail branches.
b. During 2001, we offered an ancillary financial product, a Mortgage
Acceleration Program. This program is designed to assist consumers in
accelerating the repayment of their outstanding mortgage debt. A web site
http://www.approvedfinancialsolutions.com is operational for illustration
of the benefits offered by this product.
(vi) Building on Our Investment in the Bank. The Bank's ability to raise
FDIC-insured deposits to finance its activities is a significant benefit to us
by providing a lower cost source of funds. The Bank facilitates ease of entry
for our mortgage operations 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 opportunities may include other types of lending activity such
as consumer, SBA and commercial, SBIC, trust and investment advisory activities.
We plan to evaluate development of these opportunities in the future either
internally, by means of strategic relationships, or through merger and
acquisition activity.
(vii) 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
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business options including but not limited to the following types of
activity, private investment opportunities, public offerings and merger
and acquisition opportunities.
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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 are 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 17 percent of loans funded in-house during the year 2001
were conforming loans and 83 percent were non-conforming. Of the non-conforming
loans 84 percent were 'A' credit quality, 13 percent were 'B' credit quality and
three percent were 'C' credit quality (For an explanation of credit quality
ratings see: "non-conforming underwriting").
Non-conforming customers often experience limited access to credit, but their
financial needs are nonetheless real. By consolidating their debts with a
mortgage loan, 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. Non-conforming loans are priced on a
risk-adjusted and case-by-case basis, taking into consideration the borrower's
creditworthiness, payment history, current debt level, employment status, earned
income and the property appraised value relative to the loan amount. Normally,
these borrowers are concerned with access to funds and the size of their monthly
mortgage payment rather than the interest rate or origination costs associated
with obtaining the credit. 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
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normally related to the loan to value ratios associated with a mortgage loan. 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, 2001 and 2000 were $102,596 and $71,455, 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, 2001 and 2000 was $103,191 and $73,714, respectively. The average size of
conforming loans that we funded during the year ended December 31, 2001 and 2000
was $138,782 and $104,062, respectively. The primary reason for the increase in
average loan size in 2001 was expansion into new states with higher real estate
values and larger loan sizes.
There is an active secondary market for of the types of mortgage loans that we
originate. The majority of our loans are sold to other mortgage companies,
finance companies and other financial institutions including federally chartered
banking institutions. The loans are sold for cash on a whole loan,
servicing-released basis. Consistent with industry practices, the loans are sold
with certain representations and warranties. However, while we have no plans to
do so at the present time, we may adopt alternative or complimentary loan sale
strategies in the future.
Broker Loan Originations. We originate non-conforming residential mortgage loans
through a network of independent wholesale mortgage brokers who offer our loan
products to their clients. During 2001, loans originated from mortgage broker
referrals increased to $269.9 million or 71.6% of the total loan volume compared
to $135.0 or 48.7% of 2000 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 to augment their
efforts. The loans are primarily underwritten at the headquarter location in
Virginia and to a lesser extent in the regional operation centers in Florida and
California under the supervision of our chief Credit Officer located in
Virginia.
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Retail Loan Originations. During 2001 loans originated from the retail division
totaled $107 million or 28% of total volume, including loans brokered to other
lenders for the year compared to $142 or 51% during 2000.
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, dropped materially. As a result, our retail lending structure
and business model that existed in 1998 was not able to produce profits. Over
the past three years we dramatically restructured our retail business model and
continuously analyzed the actual and projected results. The result was a
material reduction in retail offices from twenty-six at the end of 1998 to one
as of December 31, 2001, which is located in our corporate headquarters in
Virginia Beach, Virginia.
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 other than a compatible management philosophy and the integrity
of the candidates because we anticipate that each will provide unique
opportunities. As of December 31, 2001, we had no active strategic alliances.
Underwriting Guidelines
We underwrite non-conforming, conforming conventional and government mortgage
loans. Underwriting criteria for all mortgage loans originated reflects the
lending criteria of our 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 changes in our investors underwriting guidelines and related to
economic and market conditions.
Loan applications received from retail loan officers 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. From
the foundation built on these criteria loan approvals are priced on a
risk-adjusted basis. 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
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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
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 wholesale operation 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 our retail division, 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, review of the appraiser's experience with the particular types
of properties that typically secure our loans and based on our investor
requirements.
11
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. 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 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.
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 our underwriting
12
staff, which may make exceptions to the general criteria and upgrade a rating
due to compensating factors considered appropriate to the underwriting staff.
Customary for risk-adjusted pricing, terms of loans including interest rate,
fees, maximum loan-to-value ratio and debt service-to-income ratio (calculated
by dividing fixed monthly debt payments by gross monthly income), vary depending
upon the classification of the application. Applicants falling into a 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.
. Existing mortgage loans: a maximum of two 30-day late payment(s)
within the last 12 months. Non-mortgage credit: minor derogatory
items are allowed, but a letter of explanation is required.
. Bankruptcy filings: must have been discharged more than two years
prior to closing with credit re-established.
. Maximum loan-to-value ratio: up to 100% for attached and detached
single family residence or duplex, 90% for a loan secured by a
three-to-four family residence; and 85% for a loan secured by a
non-owner occupied single family residence or duplex and 80% on a
loan secured by a three-to-four family residence.
. Debt service-to-income ratio: 55% or less.
"B" Risk. Under the "B" risk category, a loan applicant must have
generally repaid installment or revolving debt according to its terms.
. Existing mortgage loans: maximum of two 60-day late payments within
the last 12 months. 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 unless attached
to the property title or child support related or open tax lien.
. Bankruptcy filings: must have been discharged more than
13
two years prior to closing with credit re-established.
. Maximum loan-to-value ratio: up to 90% for attached and detached
single family residence or duplex, 90% for a loan secured by a
three-to-four family residence; and 70% for a loan secured by a
non-owner occupied single family residence or duplex and 70% on a
loan secured by a three-to-four family residence.
. Debt service-to-income ratio: 55% or less
"C" Risk. Under the "C" risk category, a loan applicant may have
experienced significant credit problems in the past.
. Existing mortgage loans: must be brought current from loan proceeds;
applicant is allowed up to 119 days late payment within the last 12
months. Foreclosures and Notices of Default are not allowed within
the last 12 months.
. Non-mortgage credit: significant prior delinquencies may have
occurred.
. Bankruptcy filings: must have been discharged.
. Maximum loan-to-value ratio: up to 80% for detached single-family
residence or duplex, 70% for a loan secured by a three-to-four
family residence; non-owner occupied loans are not eligible.
. 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. The
underwriting staff has discretion to make exceptions to the
14
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. 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
the credit reporting services 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 first
lien programs exceeding an 80% LTV. Our direct-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 loans programs established
15
under the Federal Housing Authority ("FHA") such as Title II first mortgage
loans and FHA subordinate lien loans. 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
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. 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 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.
16
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.
Payments are processed through a lock box arrangement with a large national
banking institution. 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. 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 collection history for each
account. Notice of our intent to
17
start foreclosure proceedings is sent at sixty 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 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. A senior
officer approves 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 through an analysis of
properties sold or listed in the immediate geographic market (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.
Currently, our servicing activity is predominantly related to our held for yield
portfolio and interim servicing on loans held for sale. In future periods we may
retain the servicing component when selling our loans 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 wholesale brokers is conducted
through our staff of account executives ("AE") and
18
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, 2001, loans made through the broker networks amounted to 72% of
total originations or $270 million compared to $135 million or 49% during the
same period in 2000. (See the table on page 63 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 primarily compensated with a combination of base salary or
commission draw and commission schedule 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.
Marketing of Retail Lending Products. We market our direct consumer lending
services through a sales staff of loan officers located in Virginia Beach as of
December 31, 2001. During the year 2001, the number of retail loan origination
offices was reduced from a total of 10 on December 31, 2000 due to conditions as
described in "Retail Loan Originations" above. Retail lending division loan
volume amounted to $107 million or 28% of total originations during the year
ended December 31, 2001 compared to $142 million or 51% for the same period in
2000. (See the table on page 63 for divisional loan originations by state.)
Loans Brokered to Other Lenders: 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
19
approximately 4% during the twelve month period ended December 31, 2001 down
from an average of 17% and 33% for the twelve months ended December 31, 2000 and
1999, respectively.
Our Sources of Funds and Liquidity
- ------------------------------------------------------------------
SUMMARY
- ------------------------------------------------------------------
As of Date: December 31, 2001 December 31, 2000
Warehouse Credit Lines $22 million $60 million
FHLB credit line $15 million
FDIC Bank Deposits $62 million $38 million
Subordinated $ 5 million $ 5 million
Stockholder's Equity $ 5 million $ 8 million
- ------------------------------------------------------------------
At December 31, 2001, we had combined warehouse lines of credit of $22.0
million, with an outstanding balance of $2.8 million. Additionally, we had
subordinated debt outstanding of $4.6 million; FDIC insured certificates of
deposit outstanding of $59.9 million, FDIC insured money market accounts of $2.2
million and consolidated stockholder's equity of $7.3 million.
In November 2001, we obtained a $7.0 million bank line of credit. The interest
charged is based on the one month LIBOR rate and ranges from 4.43% to 5.43% over
the one month LIBOR for various loans, additionally rates for Aged outstanding
loans ranges from 7.43% to 8.43% over the one month LIBOR rate. All advances are
subject to various transactions fees based upon the number of loans funded. As
of December 31, 2001, we were in compliance with all financial covenants.
In December 2001 we obtained a $15.0 million repurchase agreement with interest
at prime plus 1.25% and certain transaction fees. The line has various financial
requirements including a minimum tangible net worth to exceed $916,000. As of
December 31, 2001, we were in compliance with all financial covenants.
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. As of
December 31, 2000, we were in compliance with all financial covenants. This
credit line was terminated by us during the third quarter of 2001.
On November 10, 1999, we obtained a $20.0 million sub-prime line of credit and a
$20.0 million conforming loan line from the same lender. As of December 31,
2000, there were no borrowings outstanding under either of these facilities. The
lines of credit expired on November 10, 2001 and were not renewed. As of
December 31, 2000, we were in compliance with all financial covenants.
20
Our credit facility with the Federal Home Loan Bank (FHLB) which was for $15
million with a 50% advance rate was terminated effective October 26, 2001.
Bank Sources of Funds
Certificates of Deposits. The Bank had $59.9 million of FDIC insured
certificates of deposits outstanding at December 31, 2001. The Bank had $34.4
million FDIC insured certificates of deposits outstanding at December 31, 2000.
The Bank also had $2.2 million in FDIC insured money market deposits through an
arrangement with a local NYSE member broker/dealer at December 31, 2001. The
bank had $3.9 million in FDIC money market deposits at December 31, 2000.
The primary source of FDIC insured deposits for the Bank are deposits solicited
via a computer bulletin board where the rates of many other banks and
institutions are advertised. At December 31, 2001 and December 31, 2000, the
Bank had deposits from this source of $59.9 million or 96% and $34.4 million or
90% of total deposits, respectively. We also procure FDIC insured certificates
of deposit 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 $17.2 million or 28%
and $12.8 million, or 37%, of the Bank's deposits at December 31, 2001 and
December 31, 2000, respectively. The fees paid to deposit brokers are amortized
using the interest method and are 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 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, 2001, $40.0 million
of the Bank's certificates of deposit were scheduled to mature within one year
(66.7% of total deposits). 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).
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
21
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 28 of the audited financial statements for a table that sets forth various
interest rate categories for the certificates of deposit of the Bank.)
Borrowings
Effective October 26, 2001, the credit line for $15,000,000 with the
Federal Home Loan Bank (FHLB), was terminated. During the year ended December
31, 2001, the Bank had advances of $71.9 million from the FHLB and paid down
principal on advances of $74.9 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. For the year ended December 31, 1999, the Bank had
advances of $13.0 million and paid down principal on advances of $8.4 million.
The Bank held $1.1 million and $589,000 of the FHLB stock at December 31, 2001
and December 31, 2000, respectively.
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.
22
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 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.
Legislation passed in March 2002 allows net operating losses to offset up to
100% of AMTI for tax years 2001 and 2002. 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, 2001, we had, including our subsidiaries, a total of 100
full-time employees and 2 part-time employees or 101 full time equivalent
employees, representing a reduction in excess of 50% from December 31, 2000. The
reduction in staff resulted from our expense reduction initiatives,
implementation of technology, and discontinuation of remote retail branch
offices. 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.
23
Risk from Concentration of Operations in Certain States
During 2001, 98.1% of the aggregate principal balance of the loans we originated
is secured by properties located in ten states (California, Virginia, Florida,
Maryland, Ohio, North Carolina, Pennsylvania, New Jersey, Georgia and South
Carolina). While we aim to expand lending initiatives into other states, our
origination business is likely to remain concentrated in a limited number of
states in the foreseeable 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.
Risks Associated with the Securitization Market
While we have no current plans and do not expect to enter into transactions
in the foreseeable future, we are affected by changes in the securitization
market as many of our investors access securitization as a form of financing. In
the future, if changes in our capital structure related to regulatory capital
ratio restrictions were to present an opportunity to do so, 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.
If such strategy was adopted in the future, 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
24
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.
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 the speed and 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.
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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 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
26
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 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
27
balances and payment features, and mandate certain loan amounts.
Failure to comply with these requirements can lead to loss of approved status,
termination or suspension of servicing contracts without compensation to the
servicer, demands for indemnification or mortgage loan repurchases, certain
rights of rescission for mortgage loans, class action lawsuits and
administrative enforcement actions. There can be no assurance that 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
28
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
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. 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 have developed 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
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.
The Bank is a federally chartered bank organized under the HOLA. As such, the
Bank is subject to regulation, supervision and examination by the OTS. The
deposit accounts of the Bank are insured up to applicable limits by the SAIF
administered by the FDIC and, as a result, the Bank also is subject to
regulation, supervision and examination by the FDIC. The Bank is also subject to
the regulations of the Board of Governors of the Federal Reserve System
governing reserves required to be maintained against deposits. The Bank is a
member of the FHLB of Atlanta.
29
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 are assessed the same FICO rate for
both BIF and SAIF insured deposits. The new rate paid by the Bank and a BIF
insured institution with the same risk classification is 2.12 basis points.
Under the current risk classification system, institutions are assigned on one
of three capital groups which are based solely on the level of an institution's
capital - "well capitalized," "adequately capitalized" and "undercapitalized" -
which are defined in the same manner as the regulations establishing the prompt
corrective action system under Section 38 of the FDIA, as discussed below. These
three groups are then divided into three subgroups, which are based on
supervisory evaluations by the institution's primary federal regulator,
30
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, 2001, the Bank's regulatory capital exceeded the OTS definition for
"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).
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, 2001. 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-withdrawlable 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
31
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.
In August 1993, the OTS adopted a final rule incorporating an interest-rate risk
component into the risk-based capital regulation. Under the rule, an institution
with a greater than "normal" level of interest rate risk will be subject to a
deduction of its inherent rate risk component from total capital for purposes of
calculating the risk-based capital requirement. As a result, such an institution
will be required to maintain additional capital in order to comply with the
risk-based capital requirement.
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
32
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, 2001, the Bank was "well capitalized", 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,
33
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 2001.
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
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.
34
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.
At December 31, 2001, the Bank's unimpaired capital and surplus amounted to
$7,349,000 resulting in a general loans-to-one borrower limitation of $1,155,000
under applicable laws and regulations. At December 31, 2000, the Bank's
unimpaired capital and surplus amounted to $9,175,000 resulting in a general
loans-to-one borrower limitation of $1,376,000.
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
35
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.
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.
36
Notwithstanding the foregoing, a savings association is not permitted to make a
loan or extension of credit to any affiliate unless the affiliate is engaged
only in activities the Federal Reserve Board has determined to be permissible
for bank holding companies. Savings associations also are prohibited from
purchasing or investing in securities issued by an affiliate, other than shares
of a subsidiary of the savings association.
Savings associations are also subject to various limitations and reporting
requirements on loans to insiders. These limitations require, among other
things, that all loans or extensions of credit to insiders (generally executive
officers, directors or 10% stockholders of the institution) or their "related
interest" be made on substantially the same terms (including interest rates and
collateral) as, and follow credit underwriting procedures that are not less
stringent than, those prevailing for comparable transactions with the general
public and not involve more than the normal risk of repayment or present other
unfavorable features.
Community Investment and Consumer Protection Laws. In connection with its
lending activities, the Bank is subject to the same federal and state laws
applicable to 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
37
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 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.
OTS Guidance on Subprime Lending
On February 2, 2001, the OTS issued CEO memorandum #137, 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
38
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 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, 2001, our internal credit grade classification system identified 82.7% of
our total loans funded in house as non-conforming or subprime, of which 86.3%
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.
As discussed in Item 7, MD & A, the Bank is subject to a supervisory agreement.
(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
39
rent such property or to borrow using such property as collateral. Persons who
arrange for the disposal or treatment of hazardous or toxic substances also may
be liable for the costs of removal or correction of such substances at the
disposal or treatment facility, whether or not the facility 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 since 1984 has 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.
Control by Certain Shareholders
As of December 31, 2001, Allen D. Wykle, Chairman of the Board, President and
Chief Executive Officer and Leon H. Perlin, Director, beneficially own an
aggregate of 50.2% 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.
40
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
location on December 6, 1999. The building consists of approximately 30,985
square feet.
Our former headquarters building was sold during the year ended December 31,
2001. Our present building location was subject to total mortgage debt of
$1,745,000 as of December 31, 2001. The current and former headquarter buildings
were subject to total mortgage debt of $2,245,000 as of December 31, 2000.
As of December 31, 2001 we had leases for two active regional wholesale lending
operations centers, various closed retail lending offices, and the `disaster hot
site' location for the Bank. These facilities are leased under terms that vary
as to duration and in general the leases expire between 2002 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 $587,000, $755,000, and $2,027,000 in 2001,
2000 and 1999, respectively.
Total minimum lease payments under non-cancelable operating leases with
remaining terms in excess of one year as of December 31, 2001 were as follows
(in thousands):
2002 $335
2003 151
2004 59
2005 0
----
Total 2002-2005 $545
====
We anticipate that in the normal course of business we will lease additional
office space as we open new locations or assume leases associated with any
future acquisitions or strategic alliances.
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.
41
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS
None.
42
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 2001, 2000, and 1999.
Stock Prices
High Low Close
2001:
Fourth Quarter $ .50 $ .21 $ .21
Third Quarter .47 .25 .35
Second Quarter .60 .30 .30
First Quarter .50 .40 .47
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 $ .50 $ .50
Third Quarter 2.75 .78 .81
Second Quarter 3.25 2.38 2.38
First Quarter 4.13 2.88 3.00
We did not pay any cash dividends on our Common Stock in 2001, 2000, and 1999.
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, regulatory restrictions and capital requirements, financial
condition and other factors deemed relevant by the Board.
43
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 as a result of
investor's analysis of our past and present financial position and operating
performance and or investor's estimate of such for future periods. The market
price for our common stock may also fluctuate for reasons 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
Tyron Street, 11th Floor, Charlotte, North Carolina 28288-1153.
Recent Open Market Purchase of Common Stock
No repurchase transactions occurred in 1999, 2000 or 2001.
Recent Unregistered Security Transactions
There were no unregistered stock sales during the years of 1999, 2000 and 2001.
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.
44
APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
Years Ended December 31,
----------- ----------- ----------- ----------- -----------
2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- -----------
Revenue:
Gain on sale of
loans $ 13,831 $ 10,971 $ 13,202 $ 29,703 $ 33,501
Interest income 5,428 5,191 7,698 10,308 10,935
Gain on sale of
securities -- -- -- 1,750 2,796
Other fees and
income 2,680 4,480 7,834 7,042 4,934
----------- ----------- ----------- ----------- -----------
Total revenue 21,939 20,642 28,734 48,803 52,166
----------- ----------- ----------- ----------- -----------
Expenses:
Compensation 9,462 11,477 17,765 23,397 16,447
General
and
administrative 7,664 8,930 14,427 15,306 14,188
Write down of
Goodwill 845 -- 1,131 -- --
Loss on
sale/disposal
of fixed assets 162 42 796 -- --
Loss on write off of
securities -- -- 73 -- --
Interest expense 3,853 3,852 4,957 6,252 6,157
Provision for loan
and foreclosed
property losses 1,110 1,089 2,256 2,896 1,676
----------- ----------- ----------- ----------- -----------
Total expenses 23,096 25,390 41,405 47,851 38,468
----------- ----------- ----------- ----------- -----------
Income (loss) before
income taxes (1,157) (4,748) (12,671) 952 13,698
Income taxes 1,483 (1,456) (4,749) 473 5,638
----------- ----------- ----------- ----------- -----------
Net Income (loss) $ (2,640) $ (3,292) $ (7,922) $ 479 $ 8,060
=========== =========== =========== =========== ===========
Net income (loss) per
share (diluted) $ (.48) $ (.60) ($1.45) $ 0.09 $ 1.51
=========== =========== =========== =========== ===========
Cash dividends per
share $ -- $ -- $ -- $ -- $ --
=========== =========== =========== =========== ===========
Dividend payout ratio -- -- -- -- --
=========== =========== =========== =========== ===========
Weighted average number
of shares outstanding
(diluted) 5,482,114 5,482,114 5,482,114 5,511,372 5,345,957
=========== =========== =========== =========== ===========
(In thousands, except share and per share data)
45
APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
(In thousands, except per share data)
--------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
SELECTED BALANCES AT YEAR END
Loans held for sale, net $ 47,886 $ 22,438 $ 62,765 $100,820 $ 76,766
Loans held for yield, net 10,348 14,274 4,006 4,224 3,930
Securities 1,056 2,847 2,640 3,472 15,201
Total assets 78,525 59,819 98,600 136,118 118,125
Revolving warehouse loans 3,280 1,694 17,465 72,546 52,488
FDIC-insured deposits 62,135 38,358 55,339 29,728 17,815
Subordinated debt 4,562 4,861 5,081 6,042 9,080
Total liabilities 73,142 51,808 87,301 116,851 93,070
Shareholders' equity 5,383 8,011 11,299 19,267 25,055
Loans originated (1) $377,258 $277,169 $390,816 $522,045 $468,955
Loans sold 334,194 253,158 265,873 389,589 420,498
Amount of loans
serviced at year-end 59,811 38,602 69,054 109,500 83,512
Loans delinquent 31 days or
more as percent of loans at
year-end 4.49% 4.75% 4.50% 5.42% 5.50%
SELECTED RATIOS
Return on average assets (3.49%) (4.77%) (8.45%) 0.40% 7.68%
Return on average
Shareholders' equity (35.30%) (32.54%) (49.01%) 1.93% 32.69%
Shareholders' equity
to assets 6.86% 13.39% 11.46% 14.15% 21.21%
Book value per share $ .98 $ 1.46 $ 2.07 $ 3.51 $ 4.64
- -------------
(1) Includes $16.9 million and $47.6 million retail loans brokered to other
lenders in 2001 and 2000 respectively.
46
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, 2001, 2000 and
1999 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, or who has a need to obtain financing in a more timely manner than
that available through other sources. However, we lend only to individuals that
exhibit 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. Since 1984, 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 and diversify source of revenues and reduce operating expenses. To
achieve these goals, we may consider various technologies and electronic
commerce initiatives, strategic relationships and merger and acquisition
transactions, or entering into new lines of business within the financial
services industry. 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.
47
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 revised our lending policies in light of these
actions against other lenders and believe that we are currently in compliance
with all lending related guidelines and the lending policies required of us by
the OTS. 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 competition and regulatory requirements. 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, 2001 compared to the year
ended December 31, 2000.
Net Loss
The net loss decreased by 21% for 2001 to $2.6 million compared to $3.3 million
in 2000. On a per share basis, the net loss in 2001 was $0.48 compared to $.60
for 2000.
Origination of Mortgage Loans
48
The following table shows the loan originations in dollars and units for our
broker and retail divisions for 2001 and 2000. The retail division originates
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) 2001 2000
-----------------
Dollar Volume of Loans Originated:
Broker $269.9 $135.0
Retail funded through other lenders 16.9 47.6
Retail funded in-house non-conforming 10.7 47.9
Retail funded in-house conforming and government 79.8 46.7
-----------------
Total $377.3 $277.2
=================
Number of Loans Originated:
Broker 2,574 1,846
Retail funded through other lenders 148 682
Retail funded in-house non-conforming 161 714
Retail funded in-house conforming and government 575 448
-----------------
Total 3,458 3,690
=================
The dollar volume of loans, originated in 2001, (including retail loans brokered
to other lenders) increased 36.1% when compared to the same period in 2000. The
increase in loan originations was primarily the result of the increase in
broker-originated loans, partially offset by the reduction in the number of
retail loan origination centers from ten offices at December 31, 2000 to one at
December 31, 2001.
The dollar volume of loans funded in-house increased by 57.0% during 2001
compared to 2000, primarily due to our initiative to reduce the amount of retail
loans brokered to other lenders and the increase in broker originations which
are all funded in house. Brokered loans generated by the retail division were
$16.9 million during 2001, which was a 64.5% decrease compared to $47.6 million
during the same period in 2000.
The decrease in retail loan origination centers resulted in a 24.5% decrease in
our retail loan volume including retail loans
49
brokered to other lenders for the year ended December 31, 2001 when compared to
the same period in 2000.
The volume of loans originated through the Company's wholesale division, which
originates loans through referrals from a network of mortgage brokers increased
99.9% to 269.9 million for the year ended December 31, 2001, compared to $135.0
million for the year ended December 31, 2000. The increase was primarily the
result of expansion in the wholesale division and the streamlining of the
Company's service to brokers.
50
The following table summarizes the mortgage loan origination activity, including
brokered loans, by state, for the years ended December 31, 2001 and 2000.
Years Ended
December 31 2001 2000
-------------------- --------------------
(In thousands) Dollars Percent Dollars Percent
-------- ------ -------- ------
Broker Division
California $ 88,447 23.4 $ 5,041 1.8
Florida 37,977 10.1 37,032 13.4
Virginia 31,440 8.3 21,858 7.9
Maryland 26,703 7.1 14,375 5.2
North Carolina 26,023 6.9 23,172 8.4
Pennsylvania 24,477 6.5 18,566 6.7
Ohio 15,181 4.0 7,613 2.7
Georgia 10,920 2.9 6,483 2.3
South Carolina 5,553 1.5 854 .3
Tennessee 3,156 .8 0 0
-------- ------ -------- ------
Total Broker
Division $269,877 71.5% $134,994 48.7%
======== ====== ======== ======
Retail Division:
New Jersey $ 50,905 13.5 $ 25,541 9.2
Virginia 23,600 6.3 18,470 6.7
Georgia 12,901 3.4 10,842 4.0
Maryland 6,731 1.8 29,203 10.5
South Carolina 5,004 1.3 14,755 5.3
Michigan 4,124 1.1 19,303 6.9
Ohio 954 0.3 15,857 5.8
North Carolina 1,058 0.3 0 0.0
Florida 1,146 0.3 0 0.0
Pennsylvania 958 0.2 0 0.0
Colorado -- 0.0 8,203 2.9
-------- ------ -------- ------
Total Retail
Division $107,381 28.5% $142,174 51.1%
======== ====== ======== ======
Total Originations:
California $ 88,447 23.4 $ 5,041 1.8
Virginia 55,040 14.6 40,328 14.6
New Jersey 50,905 13.5 25,541 9.2
Florida 39,123 10.4 37,032 13.4
Maryland 33,434 8.9 43,578 15.7
North Carolina 27,081 7.2 23,172 8.4
Pennsylvania 25,435 6.7 18,566 6.7
Georgia 23,821 6.3 17,325 6.3
Ohio 16,135 4.3 23,470 8.5
South Carolina 10,557 2.8 15,609 5.6
Michigan 4,124 1.1 19,303 6.9
Tennessee 3,156 .8 0 0
Colorado -- 0.0 8,203 2.9
-------- ------ -------- ------
Total
Originations $377,258 100.0 $277,168 100.0%
======== ====== ======== ======
Gain on Sale of Loans
The largest component of our revenue is gain on sale of loans.
51
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 $252.8 million including loans owned in excess
of 180 days ("seasoned loans") for the year ended December 31, 2001, compared to
$208.2 million for the same period in 2000.
For the year ended December 31, 2001, the Company sold $5.1 million of seasoned
loans, at a weighted average discount to par value of 5.0%. The loss was fully
reserved for in prior periods. 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%.
Conforming and government loan sales were $81.2 million for year ended December
31, 2001, compared to $44.9 million for the year ended December 31, 2000.
The combined gain on the sale of loans was $13.8 million for the year ended
December 31, 2001, which compares with $11.0 million for the same period in
2000. The increase in the combined gain on sale of loans was primarily the
result of an increase in the amount of loans sold. For the year ended December
31, 2001, approximately 87% of loans sold (conforming & non-conforming) were
originated by the wholesale division, compared to 45% for the year ended
December 31, 2000. Gain on the sale of mortgage loans represented 63.0% of total
revenue for the year ended December 31, 2001, compared to 53.1 % of total
revenue for the same period in 2000. This was primarily a result of our
initiative to decrease the level of retail Brokered loans, revenues from which
are reported in other income, and to increase the percentage of 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 4.0%
(excluding seasoned loans), during the year ended December 31, 2001, compared to
3.14% for the same period in 2000. The weighted-average premium realized on its
conforming and government loans sales was 1.6% during the year ended December
31, 2001, compared to 1.37% for the year ended December 31, 2000.
While we have never used securitization as a loan sale strategy,
52
changes in the securitization marketplace have a residual affect on us to the
extent our loan investor's use this strategy as a form of financing their loan
acquisition volume. 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 companies accessing the securitization market place
experienced terminal liquidity problems and others 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 into 2000 when compared to earlier periods. The increase in
average loan sale premiums in 2001 compared to 2000 is primarily the result of
the gradual demand and supply equilibrium returning to the non-conforming whole
loan sale marketplace.
The increase in non-conforming loan sale premiums due to this rebalancing in the
marketplace was partially offset in 2001 due to a shift in our loan origination
volume to higher credit grade loans and the associated decrease in the Weighted
Average Coupon ("WAC") on higher grade mortgages. 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, 2001 was $2.8 million, compared to $4.4
million for the year ended December 31, 2000. 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
53
year ended December 31, 2001 comprised 13% of total non-conforming loan sales,
with average loan origination fee income earned of 2.9%. For the year ended
December 31, 2000, non-conforming retail loan sales were 32.7% of total
non-conforming loan sales with average origination fee income of 4.64%. Average
origination fee income from conforming and government loans was 2.26% for the
year ended December 31, 2001 compared to 3.38% for the year ended December 31,
2000. Costs associated with selling loans were approximately 5 basis points for
the year ended December 31, 2001 compared to 20 basis points for the year ended
December 31, 2000.
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 services rendered fees paid on mortgage broker referral originations for
the year ended December 31, 2001 was 50 basis points compared to 46 basis points
for the year ended December 31, 2000.
Interest Income and Expense
Interest income for the year ended December 31, 2001 was $5.4 million compared
with $5.2 million for the same period ended in 2000. The increase in interest
income for the year ended December 31, 2001 was primarily due to a higher
average balance of loans held for sale and was partially offset by a reduction
in the WAC related to these loans due to an increase in credit grade of loans
and an increase in adjustable rate mortgage loans.
Interest expense for the year ended December 31, 2001 was $3.9 million compared
with $3.9 million for the year ended December 31, 2000.
Changes in the average yield received on the loan portfolio, as mortgages are
based on long term borrowing rates, may not coincide with changes in interest
rates we must pay on revolving warehouse loans, the Bank's FDIC-insured
deposits, and other borrowings, which are primarily based on short term
borrowing rates. As a result, in times of rising or falling interest rates, the
difference or spread between the yield received on loans and other investments
and the rate paid on borrowings will occur.
The following tables reflect the average yields earned and rates paid during
2001 and 2000. 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.
54
(In thousands) 2001 2000
--------------------------------------------- -------------------------------------------
Average Average % Average Average %
Balance Interest Yield/Rate Balance Interest Yield/Rate
------------ ------------- ------------ ----------- ---------- -------------
Interest-earning assets:
Loan receivable (1) $51,188 $5,095 9.95 $42,978 $4,568 10.63
Cash and other interest-
Earning assets 14,263 333 2.33 12,512 623 4.98
------------ ------------- ------------ ----------- ---------- -------------
65,451 5,428 8.29 55,490 5,191 9.35
------------- ------------ ---------- -------------
Non-interest-earning assets:
Allowance for loan losses (1,245) (1,203)
Investment in IMC 0
Premises and equipment, net 4,768 5,763
Other 6,770 8,975
------------ -----------
Total assets $75,744 $69,025
============ ===========
Interest-bearing liabilities:
Revolving warehouse lines $ 5,838 318 5.45 $ 4,234 294 6.94
FDIC - insured deposits 52,585 2,877 5.47 44,782 2,773 6.19
Other interest-bearing
liabilities 6,955 658 9.46 8,074 785 9.72
------------ ------------- ------------ ----------- ---------- -------------
65,378 3,853 5.89 57,090 3,852 6.75
------------- ------------ ---------- -------------
Non-interest-bearing liabilities 2,888 1,818
------------ -----------
Total liabilities 68,266 58,908
Shareholders' equity 7,478 10,117
------------ -----------
Total liabilities and equity $75,744 $69,025
============ ===========
Average dollar difference between
Interest-earning assets and
interest- bearing liabilities $ 73 $(1,600)
============ ===========
Net interest income $1,575 $1,339
============= ==========
Interest rate spread (2) 2.40 2.60
============ =============
Net annualized yield on average
Interest-earning assets 2.41 2.41
============ =============
(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.
55
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, 2001 compared
to the year ended December 31, 2000. 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 increase of $236,000 in net interest income for
the year ended December 31, 2001 compared to the year ended December 31, 2000
was primarily the result of an increase in the average balance of
interest-earning assets.
($ In thousands)
2001 Versus 2000
Increase (Decrease) due to:
Volume Rate Total
------ ---- -----
Interest-earning assets:
Loans receivable 789 (262) 527
Cash and other interest-
earning assets 104 (394) (290)
---- ---- ----
893 (656) 237
---- ---- ----
Interest-bearing liabilities:
Revolving warehouse lines 56 (32) 24
FDIC-insured deposits 313 (209) 104
Other interest-
bearing liabilities (106) (21) (127)
---- ---- ----
263 (262) 1
---- ---- ----
Net interest income (expense) 630 (394) 236
==== ==== ====
Broker Fee Income
We derive income from origination fees earned on brokered loans generated by our
retail offices. For the year ended December 31, 2001, broker fee income totaled
$649,000 compared to $2.4 million for the same period in 2000. The decrease was
primarily the result of our initiatives to fund more retail loans in-house and
due to a decrease in the number of retail office locations.
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 fees, prepayment penalties, and late charge fees for
delinquent loan payments.
56
Revenues associated with the financial products marketed by Approved Financial
Solutions are also recorded in other income. For the year ended December 31,
2001, other income totaled $2.0 million compared to $2.1 million for the same
period in 2000. The level of other income was affected by a reduction in the
retail division, which marketed the financial products offered by AFS, and the
increase in wholesale originations, which earn underwriting fees.
Comprehensive Income/Loss
For the year ended December 31, 2001 and 2000 we had other comprehensive income
of $12,000 and $4,000, respectively, in the form of unrealized holding
gains/losses on an Asset Management Fund investment.
Compensation and Related Expenses
The largest component of expenses is compensation and related expenses, which
decreased by $2.0 million to $9.5 million for the year, ended December 31, 2001
from 2000. The decrease was directly attributable to a decrease in the number of
employees, related to our productivity enhancement and cost cutting initiatives.
For the year ended December 31, 2001, salary expense decreased by $2.0 million
when compared to the same period in 2000. For the year ended December 31, 2001
the commissions to loan officers increased by $.07 million when compared to the
same period ended December 31, 2000. The increase was primarily due to higher
loan volume. Payroll taxes and related benefits decreased by $.08 million for
the year ended December 31, 2001 when compared to the same period in 2000. As of
December 31, 2001, the number of full time equivalent employees was 101 compared
to 207 as of December 31, 2000.
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, depreciation, professional fees and other miscellaneous
expenses. General and administrative expenses for the year ended December 31,
2001 decreased by $1.9 million to $5.9 million, compared to the year ended
December 31, 2000. The decrease was the result of a reduction in retail loan
origination offices, the reduction in retail marketing expenses, a decline in
our employee count, and our continued cost cutting efforts.
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, 2001 were $1.8 million compared to $1.2 million for the
year ended December 31, 2000. The increase was
57
primarily the result of increased origination volume in the wholesale broker
division.
Provision for Loan Losses
The following table presents the activity in the allowance for loan losses for
HFY loans which includes general and specific allowances and selected loan loss
data for the year ended December 31, 2001 and the allowance for loan losses for
HFY and HFS loans for the year ended December 31, 2000:
(In thousands)
2001 2000
---- ----
Balance at beginning of year $ 1,479 $ 1,382
Provision charged to expense 91 639
Loans charged off (746) (1,086)
Recoveries of loans previously charged off 56 544
------- -------
* Balance at end of period $ 880 $ 1,479
======= =======
HFS loans receivable at December 31, 2001,
gross of valuation allowance and deferred fees $48,464
HFY loans receivable at December 31, 2001,
gross of allowance for losses and deferred fees 11,347
HFS and HFY Loans receivable at the end of
period, gross of allowance for losses $59,811 $38,602
Ratio of allowance for loan losses to gross
loans receivable at the end of periods 1.47% 3.83%
* Valuation Allowance Charges for HFS loans not recorded in allowance for loan
losses as of December 31, 2001
The provision for loan losses was $91,000 for the year ended December 31, 2001
compared to $639,000 for the year ended December 31, 2000. The provision for
loan losses is based on management's assessment of the loan loss risk for the
associated loans. For the year ended December 31, 2001, the net decrease in the
allowance for loan losses was primarily due to the change in loss reserve
methodology integrating the valuation allowance for HFS loans beginning in the
second quarter of 2001. The valuation allowance for HFS loans is charged as an
expense to income reducing the book value of the HFS loan receivable and is not
included in allowance for loan losses or in calculation of regulatory capital
ratios. The valuation allowance provisions for loans held for sale and the
Allowance for Loan Losses on loans held for yield are established at levels that
we consider
58
adequate to cover future loan losses relative to the composition of the current
portfolio of loans. 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,
recent loan sale pricing for loans with similar characteristics, estimated net
realizable value of loans, 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.
Provision for Foreclosed Property Losses
The provision for foreclosed property losses was $237,000 for the year ended
December 31, 2001 compared to $451,000 for the year ended December 31, 2000. The
allowance for REO losses decreased for the year ended December 31, 2001,
compared to December 31, 2000 primarily due to the change in loss reserve
methodology adopted in 2001 to comply with regulatory guidance and because of
the decline in the unit and dollar amount of REO properties. The allowance in
2001 was established such that the book value of the asset reflects the
estimated net realizable value of the underlying property. The allowance in 2000
was established at approximately 75% of the appraised property value.
Sales of real estate owned yielded net losses of $500,000 for the year ended
December 31, 2001 versus $792,000 for the year ended December 31, 2000.
59
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, 2001 and 2000:
(In thousands)
2001 2000
------ ------
Balance at beginning of year $ 377 $ 718
Provision charged to expense 236 451
Loss on sale of foreclosures (500) (792)
------ ------
Balance at end of period $ 113 $ 377
====== ======
Real estate owned at the end of period, gross
of allowance for losses $ 702 $1,528
Ratio of allowance for foreclosed property losses
to gross real estate owned at the end of period 16.10% 24.67%
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. An allowance for REO loss is then established on that
property based upon the estimated net realizable value, which is the lower of
the appraised or listed price of the property less the estimated expense to
liquidate. While we believe that our present allowance for foreclosed property
losses is adequate, future adjustments may be necessary.
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.
Origination of Mortgage Loans
60
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.
61
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.
62
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%
======== ====== ======== ======
63
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
division 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.
64
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 government loans sales was 1.37% during the year ended December
31, 2000, compared to 1.85% for the year ended December 31, 1999.
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 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.
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.
65
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 Average
Average Yield/ Average Yield
Balance Interest Rate Balance Interest /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.
66
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.
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
67
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, 1999. 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, 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
68
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.
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
69
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.
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
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
70
REO properties. While we believe that our present allowance for foreclosed
property losses is adequate, future adjustments may be necessary.
Financial Condition at December 31, 2001 and 2000
Assets
The total assets were $78.5 million at December 31, 2001 compared to total
assets of $59.8 million at December 31, 2000.
Cash and cash equivalents increased by $4.0 million to $11.6 million at December
31, 2001, from $7.6 million at December 31, 2000.
Net mortgage loans receivable increased by $21.5 million to $58.2 million at
December 31, 2001. The 58.6% increase in 2001 is primarily due to originating
more loans than were sold in-house during 2001. We generally sell loans within
sixty days of origination.
Real estate owned ("REO") decreased by $562,000 to $589,000 at December 31,
2001. The 48.8% decrease in REO resulted from the sale of $2.2 million in REO
properties compared to additions of $1.4 million to REO offset by a net
reduction to the allowance of $200,000 during the twelve months ended December
31, 2001.
Investments decreased by $1.8 million to $1.1 million at December 31, 2001.
Investments consist primarily of an Asset Management Fund, Inc. Adjustable Rate
Mortgage Portfolio and FHLB stock owned by the Bank. The 62.9% decrease in
investments in 2001 is primarily due to the sale of shares of FHLB stock.
Premises and equipment decreased by $1.6 million to $3.8 million at December 31,
2001. The decrease is due to the depreciation of current assets and the charge
off of equipment from closed operations for the year ended December 31, 2001 and
the sale of the company's former headquarters land and building.
Goodwill (net) decreased by $912,000 to $71,000 at December 31, 2001. The
decrease is due to the write down of the intangible assets for the year ended
December 31, 2001 related to the closing of certain retail offices related to
previous acquisitions.
Income tax receivable increased by $194,000 at December 31, 2001. The increase
represents taxes to be refunded to the Company.
The deferred tax asset decreased by $1.9 million to $1.6 million at December 31,
2001. The decrease related primarily to an increase in the valuation allowance
for future unrealizable benefits for the deferred tax asset of $1.9 million. The
valuation allowance is based upon an assessment by management of
71
future taxable income and its relationship to reliability of deferred tax
assets. Based upon the managements expected improvements of sufficient taxable
income and reversing of the 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 $263,000 to $1.4 million at December 31, 2001. Other
assets consist of accrued interest receivable, prepaid assets, brokered loan
fees receivable, deposits, and various other assets. The majority of the
decrease was due to collections of some receivables.
Liabilities
Outstanding balances for our revolving warehouse loans increased by $1.6 million
to $3.3 million at December 31, 2001. The decrease in 2001 was primarily
attributable to the increase in loans receivable.
The Bank's deposits totaled $59.9 million at December 31, 2001 compared to $34.4
million at December 31, 2000. Of the certificate accounts on hand as of December
31, 2001, a total of $40.5 million is scheduled to mature in the twelve-month
period ending December 31, 2002.
Through an arrangement with a local NYSE member broker/dealer we held $2.2
million and $3.9 million in FDIC insured money market deposits as of December
31, 2001 and December 31, 2000, respectively
As of December 31, 2001, the Bank had no loans outstanding from the Federal Home
Loan Bank (FHLB), compared to $3.0 million at December 31, 2000.
Promissory notes and certificates of indebtedness totaled $4.6 million at
December 31, 2001 compared to $4.9 million at December 31, 2000. The 6.1%
decrease is primarily due to the redemption of maturing promissory notes and
certificates. During the years of 2001 and 2000, 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% and
10%, with a weighted-average rate of 9.57% at December 31, 2001. 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 five years and interest rates between 6.75%
and 10.00%, with a
72
weighted-average rate of 9.37% at December 31, 2001.
Mortgage loans payable totaled $1.7 million at December 31, 2001 compared to
$2.5 million at December 31, 2000. The decrease is attributable to the payoff of
the mortgage held on the former headquarters building that was sold during 2001,
the normal principal payments on the mortgage held on the company's current home
office building and an additional principal payment of $200,000 on the same,
made in 2001. The December 31, 2001 mortgage loan payable is solely related to
the present home office building.
Accrued and other liabilities were $1.4 million at December 31, 2001 and 2000.
This category includes accounts payable, accrued interest payable, deferred
income, accrued bonuses, and other payables.
Shareholders' Equity
Total shareholders' equity at December 31, 2001 was $5.4 million compared to
$8.0 million at December 31, 2000. The $2.6 million decrease in 2001 was due
primarily to the loss for the twelve months ended December 31, 2001.
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 FDIC insured deposits 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, 2001, we used
cash from operating activities of $21.4 million. For the twelve months ended
December 31, 2000, cash provided by operating activities of $29.2 million.
We finance our operating cash requirements primarily through warehouse and other
credit facilities, and the issuance of other
73
debt. For the twelve months ended December 31, 2001, we increased debt from
financing activities of $21.2 million, this was primarily the result of
increases in certificates of deposits. For the twelve months ended December 31,
2000, we paid down debt from financing activities of $34.4 million.
Our borrowings (revolving warehouse and other credit facilities, FDIC-insured
deposits, mortgage loans on our office building, subordinated debt and loan
proceeds payable) were 91.3% of assets at December 31, 2001 compared to 84.3% at
December 31, 2000.
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 $59.9 million at December 31, 2001 compared to $34.4
million at December 31, 2000. The Bank currently utilizes funds from deposits
and lines of credit to fund first lien and junior lien mortgage loans. We plan
to increase the use of credit facilities and seek additional funding sources in
future periods.
Warehouse and Other Credit Facilities
In November 2001, we obtained a $7.0 million bank line of credit. The interest
charged is based on the one month LIBOR rate and ranges from 4.43% to 5.43% over
the one month LIBOR for various loans, additionally rates for Aged outstanding
loans ranges from 7.43% to 8.43% over the one month LIBOR rate. All advances are
subject to various transactions fees based upon the number of loans funded. As
of December 31, 2001 we were in compliance with all financial covenants.
In December 2001, we obtained a $15.0 million repurchase agreement with interest
at prime plus 1.25%. The line has various financial requirements including a
minimum tangible net worth to exceed $916,000. As of December 31, 2001 we were
in compliance
74
with all financial covenants.
On July 21, 2000, we obtained a $40.0 million line of credit from Bank United.
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. As of
December 31, 2000, $1.8 million was outstanding under this facility. The line of
credit expired on July 21, 2001 and was not renewed. 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 and a
$20.0 million conforming loan line of credit from Regions Bank. The lines were
secured by loans originated. As of December 31, 2000 there were no borrowings
outstanding under these facilities. The lines of credit expired on November 10,
2001. As of December 31, 2000 we are in compliance with all financial covenants.
Our credit facility with the Federal Home Loan Bank (FHLB) which was for $15
million with a 50% advance rate was terminated effective October 26, 2001.
Other Capital Resources
Uninsured promissory notes and certificates of indebtedness issued by Approved
Financial Corp. 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 $4.6 million at
December 31, 2001 compared to $4.9 million at December 31, 2000. These
borrowings are subordinated to FDIC insured deposits and 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 $11.6 million at December 31, 2001. We have
sufficient resources to fund our current operations. Alternative sources for
future liquidity and capital resource needs may include private security sales,
the public issuance of debt or equity securities, increase in FDIC insured
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, fluctuations in the market
price of and premiums received on whole loan sales in the secondary market
compared to premiums realized in recent years, new competition and a slow
economic environment leading to a possible rise in loan delinquency and the
associated loss rates.
Bank Regulatory Liquidity
75
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 2001 and 2000, the Bank maintained liquidity in excess of the
required amount, and we anticipate that we will continue to do so.
76
Bank Regulatory Capital
At December 31, 2001, the Bank's book value under accounting principles
generally accepted in the United States of America ("US GAAP") was $7.3 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, 2001, 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 $ 7,348 $ 7,348 $ 7,348
Add: unrealized loss on securities
Nonallowable asset: goodwill (71) (71) (71)
Additional capital item: general
allowance -- -- 689
Deferred Taxes (365) (365) (365)
------- ------- -------
Regulatory capital - computed 6,912 6,912 7,601
Minimum capital requirement 1,159 3,091 4,483
------- ------- -------
Excess regulatory capital $ 5,753 $ 3,821 $ 3,118
======= ======= =======
Ratios:
Regulatory capital - computed 8.94% 8.94% 13.57%
Minimum capital requirement 1.50% 4.00% 8.00%
------- ------- -------
Excess regulatory capital 7.44% 4.94% 5.57%
======= ======= =======
The OTS issued CEO Memorandum #137 in February of 2001 providing guidance to
those institutions with a significant subprime credit exposure which established
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. We
believe that our current capital ratios are appropriate for the risk levels
related to our current lending activity and loan portfolio. The revised
computation methodology adopted in 2001 for loan losses also assist in
monitoring and providing for these risks.
77
Bank Regulatory Actions
As disclosed in the 10Q filings for March 31, 2001, June 30, 2001 and September
30, 2001, the Office of Thrift Supervision (the "OTS") issued a written
directive to Approved Financial Corp. ( "AFC") and Approved Federal Savings Bank
( "AFSB") dated April 20, 2001, stating that as a result of AFSB's practice of
assigning loans to AFC, its holding company, it was declaring AFSB a "problem
association" and was declaring AFC in "troubled condition" as set forth in
applicable laws and regulations.
The practice of inter-company loan assignments has been standard operating
procedure between AFSB and AFC for several years. This operating procedure was
disclosed during prior audits, including audits by the Company's independent
public accountants and has no effect on previously audited consolidated
financial statements. The Board of Directors of AFSB and AFC acknowledge and
respect the authority and power of the OTS and acted promptly to implement
corrective actions requested by the OTS.
Management and the Boards of Directors revised inter-company operating
procedures and submitted a formal Business Plan ("Plan") to the OTS detailing
such on September 24, 2001. The Board of Directors of the Bank entered into a
Consent Supervisory Agreement ("Agreement") with the Office of Thrift
Supervision on December 3, 2001 as filed on Form 8K. In addition to the required
adherence to all banking and lending regulations and various confirmation of
compliance oversight required from the Board of Directors, the primary
corrective actions and new operating procedures outlined in the Plan and/or the
Agreement include the following.
1. Organizational Structure and Management: Immediately upon receipt of
the Directive Letter, the Chairman of the Board and the President of
AFSB resigned their positions. A revised organizational structure
was submitted in the Plan and has been implemented that establishes
a "wall" between AFSB and AFC. Under the revised structure all AFC
staff report to a manager or officer of AFC and all AFSB staff
report to a manager or officer of AFSB. The OTS issued a
non-objection letter relating to the following slate of Bank
officers and their compensation arrangements. These officers consist
of qualified individuals who were employed by AFSB or AFC prior to
April 20, 2001 thus eliminating the expense and time involved in
making a transition to outside independent management as initially
directed by the OTS.
|_| Jean S. Schwindt, President & COO of AFSB. Ms. Schwindt has
served as Director of AFC since 1992, Director of AFSB since
1996 and as an officer of AFC since 1998. Ms. Schwindt has
over twenty years of financial services experience working
primarily in highly regulated environments.
78
|_| Neil Phelan, Executive Vice President and Director of AFSB.
Mr. Phelan has served as a Director of AFC since 1997,
Director of AFSB since 1996 and as an officer of AFC since
1995. Mr. Phelan has over twenty years of financial services
experience primarily in the mortgage lending area.
|_| Phil Gray, Senior Vice President and Controller of AFSB. Mr.
Gray has served as Controller of AFC since 1997 and as
controller of AFSB since 2000. Mr. Gray is a Certified Public
Accountant and has over eighteen years of experience with
various companies where he served in the capacity of Chief
Financial Officer or Controller.
|_| Lynn-LaVigne-Fiamingo, Vice President of AFSB. Ms.
LaVigne-Fiamingo has served as a member of AFSB management
since 1998 and as Vice President of AFSB since 2000. Ms.
LaVigne-Fiamingo has over twenty years of experience in the
financial services industry, primarily with credit unions and
banking institutions.
2. Board of Directors: OTS issued non-objection letters approving two
new AFSB Director nominee requests. The Board of Directors of AFSB,
in addition to the four Directors that are employed by either AFC or
AFSB, has four outside Directors as follows.
|_| Leon Perlin has served on the Board of Directors of the Bank
since 1996. Mr. Perlin was an initial investor in AFC when
current management purchased the company in 1984 and has
served on the board of AFC since 1984.
|_| The Board of Directors nominated Dennis J. Pitocco as a new
outside Director of AFSB at a meeting held on April 25, 2001.
This nomination became effective upon receipt of a letter
dated May 25, 2001, from the OTS approving Mr. Pitocco as a
Director. Mr. Pitocco's experience includes 27 years in the
financial services industry having served in management
positions for domestic regulated banking institutions and
domestic and international non-bank lending institutions.
|_| Eric Yeakel, who has been a Director of AFSB since 1996 and
the Chief Financial Officer of AFC since 1994, resigned his
position as Chief Financial Officer in July of 2001. Mr.
Yeakel now serves as an outside Director of AFSB.
|_| Thomas Frunzi, joined the Board effective upon receipt of a
non-objection letter from the OTS related to his nomination
for such on January 24, 2002. Mr. Frunzi has extensive
management background in the financial
79
services industry primarily in insurance related products.
3. Loan Assignments: AFSB ceased assignment of loans to AFC on April
19, 2001. However, as of June 27, 2001, the OTS permitted AFSB to
assign loans to AFC with AFSB receiving the full principal amount of
the loan at time of assignment, which provided for the temporary use
of a warehouse credit facility available to AFC at that time to fund
loans. AFSB entered into separate warehouse credit facilities in the
fourth quarter of 2001 and such loan assignments between AFSB and
AFC were no longer applicable.
4. Transfer of Assets and Promissory Note: Loans assigned to AFC by
AFSB prior to April 21, 2001 and other assets owned by AFC including
mortgage loans, the home office building, land and furniture and
equipment were transferred from AFC to AFSB during the second
quarter of 2001. In the March Thrift Financial Report filed with the
OTS, AFSB recorded a charge to income as a provision to an Allowance
established for an estimated loss on the net inter-company
receivable due to AFSB after the transfer of these assets. This
first quarter expense related to the inter-company Allowance was
estimated and recorded on AFSB's income statement as an expense and
recorded as an Allowance on AFSB's balance sheet in the first
quarter of 2001. The Allowance was then charged against the
inter-company receivable on AFSB balance sheet in the second quarter
of 2001 after adjusting for the final valuation of all assets
transferred during the second quarter. There was no related effect
on the consolidated statements of income (loss) and comprehensive
income (loss). In November of 2001, AFC and AFSB executed an
intercompany Promissory Note equal to the amount charged off by AFSB
for the loss intercompany receivable. The Promissory Note provides
for quarterly interest payments commencing January 1, 2002 and
quarterly principal payments commencing July 1, 2002 with the
remaining balance due in full on July 1, 2007. The note can be
prepaid without penalty at any time. As this is an intercompany
transaction, there is no effect on the consolidated income
statement.
5. Limitation of Growth of Assets and Lending Policy: We are required
to underwrite mortgage loans according to the underwriting criteria
of our investors, according to risk-based pricing guidelines and to
insure that consumer disclosure and file documentation is in
compliance with lending regulations. Asset growth is limited to the
extent that we must not increase the dollar amount or number of
loans in our held for yield portfolio, thus loans originated are
held for sale and marketed to market monthly.
80
6. Transactions with Affiliates. All transactions between the Bank and
AFC or AFC non-bank affiliates must comply with the provisions of 12
U.S.C. Section 1468. A fee schedule for services rendered by AFC for
AFSB has been developed whereby AFC performs services such as
underwriting, processing, doc/closing, loan servicing and
collections, quality control, secondary marketing, Human Resource,
MIS and Corporate Administration. Payments to AFC from AFSB for
services rendered applying this fee schedule for the months of June
2001 through December 2001 was approved by the OTS.
7. Financial Modeling tool: An internal financial projection model was
used as the primary development tool for the Plan and the revised
inter-company procedures and fee schedules. Stress testing was
conducted to evaluate the financial position of AFC and AFSB under
various business conditions and applying various assumptions for
loan volume and whole loan sale revenue. The model is a dynamic tool
and therefore is revised periodically to adjust to changes in
operations.
8. Provision for Loan Loss Methodology: We revised our methodology for
loss allowances on loans held for sale, held for yield and real
estate acquired through foreclosure.
As of each financial reporting date, management evaluates and
reports all held for sale loans at the lower of cost or market
value. Any decline in value, including those attributable to credit
quality, are accounted for as a charge to provision for valuation
allowance for held-for-sale loans, not as adjustments to the
allowance for loan and lease losses (ALLL). Such provision is
charged against income and not reported as part of ALLL, and
therefore is not eligible for inclusion in Tier 2 capital for risk
based capital purposes. Valuation allowances are established based
on the age of the loan as well as special circumstances known to
management that merit a valuation allowance. Loans held 90 days or
less that do not fall into a special circumstance category are
carried at cost. A valuation allowance of 5.5% is charged against
first lien non-conforming mortgage loans held over 90 days and a
valuation allowance of 20% is charged against subordinated liens
held over 90 days that do not fall into a special circumstance
category. All loans considered to be special circumstance are
carried at the net realizable value. The net realizable value
represents the current appraised or listed property valuation less
estimated cost to liquidate the property. The difference in the
principal value of the loan and the net realizable value is recorded
as a Valuation Allowance and is not recorded in ALLL.
81
Held for Yield Loans ("HFY"): The methodology adopted for
determining the ALLL is in accordance with interagency guidance
issued July 2001. ALLL is calculated based on delinquency status of
loans held for yield or based on other special circumstance known to
management that requires a loss reserve. Currently, a general
reserve is recorded in ALLL of 5% for first lien and 10% for second
lien mortgage loans with current payment status. A 10% general
reserve is established for first lien mortgage loans delinquent 91
to 120 days and 100% (charge off) general reserve is established for
second lien mortgage loans delinquent over 90 days. For first lien
mortgages over 120 days delinquent a specific reserve is established
based on the net realizable value of the loan. The net realizable
value represents the current appraised or listed property valuation
less estimated cost to liquidate the property. The difference in the
principal value of the loan and the net realizable value is recorded
as a Valuation Allowance and is not recorded in ALLL.
Real Estate Owned ("REO") Property acquired through foreclosure is
carried at the net realizable value. The net realizable value
represents the current appraised or listed property valuation less
estimated cost to liquidate the property.
9. Warehouse Line of Credit: The Agreement requires AFSB to use its
best efforts to obtain adequate warehouse line of credit facilities
at the Association for the purpose of providing additional funding
sources for loans held for sale. We acquired two credit facilities
in the fourth quarter of 2001 for a total of $22 million.
10. Dividend Policy: The Bank adopted a policy whereby a request for
dividends will not be made to the OTS until the Bank's regulatory
capital levels are restored to at least the levels reported as of
December 31, 2000 and the Bank will remain well-capitalized
following the payment of the dividend.
11. Financial Reporting Policy
The OTS is provided with the following Daily Financial Reports based on
consolidated activity for AFC as of the 15th and final day of each
calendar month:
i. Loan Funding Report, listing by day the number and dollar amount
of loans funded, categorized by retail conforming, retail non-conforming,
retail government, wholesale -East Division, and wholesale - West
Division;
ii. Loan Sales Report, listing by day the number and
82
dollar amount of loans sold to investors and average sales premiums,
categorized by investor;
iii. Sources of Funds Report, listing by day the aggregate balance
of deposit liabilities, the balance and unused capacity of all other
borrowings, categorized by source, and the balance of liquid assets,
categorized by type; and
12. The OTS is provided each Daily Financial Report, as of the 15th day of
the month, no later than the 20th day of the month and each Daily Financial
Report, as of month end, no later than the 5th day of the following month.
The OTS is provided with the following Monthly Financial Reports no later
than the 30th day of the month following the month for which the report is
prepared:
i. Monthly Income Statement (AFC and AFSB-only);
ii. Month-end Statement of Financial Condition (AFC and AFSB only);
and
iii. Month-end Deposit Maturity Schedule.
13. We elected to establish a policy concerning Loans to Officers,
Directors and Other Affiliated Parties, whereby such activity is not allowed.
14. As a result of the Directive Letter, AFC and AFSB are subject to
additional fees, applications, notices and loss of expedited status. Related to
such a $523 fee was associated with the application for the two new directors of
AFSB. A fee of $500 was associated with the application for each of the new
executive officers. The OTS semi annual assessment increased from $9,000 to
$18,000 for the 2nd half of 2001.
Many provisions stated in the Directive and the Plan were addressed by means of
execution of the Agreement in December 2001. The OTS has responded verbally
and/or in writing to various parts of the Plan and issued a letter to the
President of the Bank, dated March 14, 2002 requesting that the Bank submit a
Revised Plan consisting of Plan items not addressed in the Agreement, revisions
of the formal presentation of two sections to reflect the implemented changes as
discussed with the examiners and to expand on the Bank's Policies related to the
minimum capital requirements for sub-prime lending as discussed in the OTS CEO
#137 memorandum dated February 2, 2001 and related to interest rate risk
monitoring.
83
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 origination. Currently loans held for yield 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 transactions such as 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, we
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 may in the future enter into forward loan
sale commitments with investors for our 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, 2001. We have
not entered into any hedge contracts since the fourth quarter of 1997.
New Accounting Standards
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
84
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
re-pledge. 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. FAS 140 did not have a material effect on financial condition
or results of operations.
In July 2001, FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets."
SFAS No. 142 requires the use of a non-amortization approach to account for
purchased goodwill and certain intangibles, effective January 1, 2002. We do not
believe that the adoption of this pronouncement will have a material impact on
our financial statements.
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.
85
The loans we originate are intended for sale in the whole loan secondary market;
therefore, the effect on interest rates from inflation trends has a diminished
effect on the results of operations. However, the portfolio of loans held for
yield, is 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").
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.
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
86
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 2000 and 2001, approximately 98.6% of the total loans
originated and funded in-house during the year ended December 31, 2000. Also, we
sold, during 2001 approximately 95.4% of loans originated and funded in-house
during the period beginning January 1, 2001 and ending November 30, 2001. 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, 2001, as anticipated, and is expected to
remain negative in future periods. We have no quantitative target range for past
gap positions, nor any 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.
87
Our one-year gap was a negative 17.86% of total assets at December 31, 2001, 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) 48,503 17,033 1,464 3,053 26,953
Loans held for yield (1) 11,228 3,770 229 762 6,467
Cash and other
interest-earning assets 11,627 11,627 -- -- --
---------------------------------------------------------------------
71,358 32,430 1,693 3,815 33,420
======================================================
Allowance for loan losses (1,497)
Premises and equipment, net 3,793
Other 4,871
--------
Total assets $ 78,525
========
Interest-bearing liabilities:
Revolving warehouse lines 3,280 3,280 -- -- --
FDIC - insured deposits 59,903 40,055 10,053 9,795 --
FDIC - insured money market account 2,232 2,232 -- -- --
Other interest-bearing
Liabilities 6,327 890 1,167 2,639 1,631
---------------------------------------------------------------------
71,742 46,457 11,220 12,434 1,631
======================================================
Non-interest-bearing liabilities 1,400
--------
Total liabilities 73,142
Shareholders' equity 5,383
--------
Total liabilities and equity $ 78,525
========
Maturity/repricing gap $(14,027) $ (9,527) $ (8,619) $ 31,789
======================================================
Cumulative gap $(14,027) $(23,554) $(32,173) $ (384)
======================================================
As percent of total assets (17.86)% (30.00)% (40.97)% (0.49)%
Ratio of cumulative interest earning
Assets to cumulative interest
bearing liabilities 0.70 0.59 0.54 0.99
================================================================================
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
88
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 17.9% of total
assets at December 31, 2001. 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, 2001, 56.0%
of the principal on the loans were expected to be received more than four years
from that date. However, our activities are financed with short-term loans and
credit lines, 64.8% of which re-price within one year of December 31, 2001. We
attempt to limit our interest rate risk by selling a majority of the 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.
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.
As with other investments, the Bank regularly monitors mortgage loans in its
portfolio and may decide from time to time to sell such loans as part of its
overall asset liability and interest rate risk monitoring activity.
89
Asset Quality
The following table summarizes all of our delinquent loans at December 31, 2001
and 2000:
(in thousands)
2001 2000
------- -------
Delinquent 31 to 60 days $ 51 $ 362
Delinquent 61 to 90 days 710 164
Delinquent 91 to 120 days 398 354
Delinquent 121 days or more 1,525 955
------- -------
Total delinquent loans (1) $ 2,684 $ 1,835
======= =======
Total loans receivable
outstanding, gross $59,811 $38,602
======= =======
Delinquent loans as a percentage
of total loans outstanding:
Delinquent 31 to 60 days 0.09 0.94
Delinquent 61 to 90 days 1.19 0.42
Delinquent 91 to 120 days 0.67 0.92
Delinquent 121 days or more 2.55 2.47
------- -------
Total delinquent loans as a percentage
of total loans outstanding 4.49 4.75
------- -------
Reserve as a % of delinquent loans 32.79 80.6
======= =======
- ----------
(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 60 days or more past due.
Non-accrual loans were $2.6 million and $1.4 million at December 31, 2001 and
2000, respectively. The amount of additional interest that would have been
recorded had the loans not been placed on non-accrual status was approximately
$256,000 and $148,000 for the year ended December 31, 2001 and 2000,
respectively. The amount of interest income on the non-accrual loans that was
included in net income for the year ended December 31, 2001 and 2000 was
$108,000 and $95,000, respectively.
Loans delinquent 31 days or more as a percentage of total loans outstanding
decreased to 4.49% at December 31, 2001 from 4.75% at December 31, 2000.
At December 31, 2001 and 2000 the recorded investment in loans for which
impairment has been determined, which includes loans
90
delinquent in excess of 90 days, totaled $1.9 million and $1.3 million,
respectively. The average recorded investment in impaired loans for the year
ended December 31, 2001 and 2000 was approximately $1.4 million and $1.9
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, reports, notes and data
are incorporated by reference.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
The company changed accountants during the twelve months ended December 31, 2001
to Grant Thornton LLP. There were no disagreements with the prior accountants,
PricewaterhouseCoopers LLP.
91
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 10, 2002
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 10, 2002 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 10, 2002 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 10, 2002 and is incorporated herein by reference.
92
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 ................................... 6
- - Consolidated Balance Sheets ......................................... 8
- - Consolidated Statements of Income and Comprehensive Income (Loss) ... 9
- - Consolidated Statements of Shareholders' Equity ..................... 10
- - Consolidated Statements of Cash Flows ............................... 11 - 12
- - Notes to Consolidated Financial Statements .......................... 13 - 44
- - Consolidating Balance Sheet ......................................... 45
- - Consolidating Income Statement ...................................... 46
93
EXHIBIT INDEX
- --------------------------------------------------------------------------------
Exhibit Description Page Number
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.)
- --------------------------------------------------------------------------------
94
- --------------------------------------------------------------------------------
Exhibit Description Page Number
Number
- --------------------------------------------------------------------------------
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)
- --------------------------------------------------------------------------------
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 the Company and Jean S.
Schwindt dated February 1999 (Incorporated by
reference to exhibit 10.23 of Form 10K filed March 31,
1999.)
- --------------------------------------------------------------------------------
10.7 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)
- --------------------------------------------------------------------------------
10.8 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)
- --------------------------------------------------------------------------------
10.9 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)
- --------------------------------------------------------------------------------
10.10 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)
- --------------------------------------------------------------------------------
95
- --------------------------------------------------------------------------------
Exhibit Description Page Number
Number
- --------------------------------------------------------------------------------
10.11 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
- --------------------------------------------------------------------------------
10.12 Purchase Agreement between the Company and MOFC, Inc.,
Incorporated by reference to exhibit 10.14 of Form 10K
filed March 30,2000)
- --------------------------------------------------------------------------------
10.13 Option Agreement between the Company and Allen D.
Wykle.(Incorporated by reference to exhibit 10.16 of
Form 10K filed March 30,2000)
- --------------------------------------------------------------------------------
10.14 Option Agreement between the Company and Jean S.
Schwindt.(Incorporated by reference to exhibit 10.17
of Form 10K filed March 30,2000)
- --------------------------------------------------------------------------------
10.15 Option Agreement between the Company and Neil S.
Phelan.(Incorporated by reference to exhibit 10.19 of
Form 10K filed March 30,2000)
- --------------------------------------------------------------------------------
10.16 Option Agreement between the Company and Stanley
Broaddus.(Incorporated by reference to exhibit 10.20
of Form 10K filed March 30,2000)
- --------------------------------------------------------------------------------
96
- --------------------------------------------------------------------------------
Exhibit Description Page Number
Number
- --------------------------------------------------------------------------------
10.17 Stock Appreciation Rights Agreement with Jean S.
Schwindt (Incorporated by Reference to Appendix K of
the Form 10 Registration Statement Filed February 11,
1998)
- --------------------------------------------------------------------------------
10.18 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)
- --------------------------------------------------------------------------------
10.19 Gregory J. Witherspoon Registration Rights Agreement
(Incorporated by Reference to Appendix M of the Form
10 Registration Statement Filed February 11, 1998)
- --------------------------------------------------------------------------------
10.20 IMPAC Warehouse Lending Group dated November 7, 2001
- --------------------------------------------------------------------------------
16.1 Letter of resignation of PriceWaterhouseCoopers LLP
confirming no disagreements with Registrant to statement in
Form 8-K (incorporated by reference to Form 8-K as filed on
September 26, 2001).
- --------------------------------------------------------------------------------
16.2 Engagement of Grant Thorton LLP as certified public accountant
(incorporated by reference to Form 8-K filed on October 29, 2001)
- --------------------------------------------------------------------------------
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)
- --------------------------------------------------------------------------------
99.2 Consent Supervisory Agreement with OTS (incorporated by reference
to Form 8-K filed on December 18, 2001)
- --------------------------------------------------------------------------------
97
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, 2002 By:
Treasurer and
Chief Financial Officer
Date: March 31, 2002 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, 2002 By:
Treasurer and
Chief Financial Officer
Date: March 31, 2002 By: /s/ Allen D. Wykle
---------------------------------
Allen D. Wykle
Chairman of the Board of Directors
President, and Chief Executive
Officer
Date: March 31, 2002 By: /s/ Stanley W. Broaddus
--------------------------------
Stanley W. Broaddus
Director, Vice President and
Secretary
Date: March 31, 2002 By: /s/ Jean S. Schwindt
-----------------------------------
Jean S. Schwindt
Director and Executive Vice
President
Date: March 31, 2002 By: /s/ Neil W. Phelan
----------------------------------
Neil W. Phelan
98
Date: March 31, 2002 By: /s/ Arthur Peregoff
----------------------------------
Arthur Peregoff
Director
Date: March 31, 2002 By: /s/ Leon H. Perlin
-----------------------------------
Leon H. Perlin
Director
Date: March 31, 2002 By: /s/ Oscar S. Warner
----------------------------------
Oscar S. Warner
Director
Date: March 31, 2002 By: /s/ Gregory Witherspoon
--------------------------------------
Gregory Witherspoon
Director
99
APPROVED FINANCIAL CORP.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 2001, 2000 AND 1999
APPROVED FINANCIAL CORP.
Contents
Pages
- -----
Reports of Independent Accountants .................................... 6 - 7
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2001 and 2000 .......... 8
Consolidated Statements of Income (Loss) and Comprehensive
Income (Loss) for the years ended December 31, 2001, 2000 and 1999 .... 9
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 2001, 2000 and 1999 ................................ 10
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999 ...................................... 11 - 12
Notes to Consolidated Financial Statements ............................ 13 - 43
Quarterly Financial Data .............................................. 44
Consolidating Balance Sheet as of December 31, 2001 ................... 45
Consolidating Statements of Income (Loss) for the year ended
December 31, 2001 ..................................................... 46
Report of Independent Accountants
To the Board of Directors and Shareholders of
Approved Financial Corp.
We have audited the accompanying consolidated balance sheet of Approved
Financial Corp. and Subsidiaries (the Company) as of December 31, 2001, and the
related consolidated statements of income (loss) and comprehensive income
(loss), shareholders' equity and cash flows for the year then ended. 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 audit. The consolidated financial statements of the Company as of December
31, 2001 and for the two years ended December 31, 2000 and 1999, were audited by
other auditors whose report dated February 23, 2001, expressed an unqualified
opinion on those statements.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards 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. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the 2001 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company as of December 31, 2001, and the consolidated results of their
operations and their cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States of America.
Our audit of the consolidated financial statements referred to above were
conducted for the purpose of forming an opinion on the consolidated financial
statements as a whole. The supplemental consolidating balance sheet as of
December 31, 2001 and the supplemental consolidating statement of income (loss)
for the year ended December 31, 2001, are presented for purposes of additional
analysis of the consolidated financial statements rather than to present the
financial position and results of operations of the individual companies. The
consolidating information has been subjected to the audit procedures applied in
the audit of the consolidated financial statements and, in our opinion, is
fairly stated in all material respects in relation to the consolidated financial
statements taken as a whole.
/s/ Grant Thornton, LLP
Vienna, Virginia
February 27, 2002
Report of Independent Accountants
To the Board of Directors and Shareholders of
Approved Financial Corp.:
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income (loss) and comprehensive income (loss),
shareholders' equity and cash flows present fairly, in all material respects,
the financial position of Approved Financial Corp. and subsidiaries at December
31, 2000, and the results of their operations and their cash flows for each of
the two years in the period ended December 31, 2000 in conformity with
accounting principles generally accepted in the United States. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States, which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Harrisburg, PA
February 23, 2001
APPROVED FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
December 31, 2001 and 2000
(Dollars in thousands, except per share amounts)
ASSETS 2001 2000
------- -------
Cash $11,627 $ 7,597
Mortgage loans held for sale, net 47,886 22,438
Mortgage loans held for yield, net 10,348 14,274
Real estate owned, net 589 1,151
Investments 1,056 2,847
Income taxes receivable 194 --
Deferred tax asset, net 1,607 3,504
Premises and equipment, net 3,793 5,408
Goodwill, net 71 983
Other assets 1,354 1,617
------- -------
Total assets $78,525 $59,819
======= =======
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 3,280 $ 1,694
FHLB bank advances and line of credit -- 3,000
Mortgage notes payable 1,745 2,529
Notes payable-related parties 2,499 2,818
Certificate of indebtedness 2,063 2,043
Certificates of deposits 59,903 34,432
Money market account 2,232 3,926
Accrued and other liabilities 1,420 1,366
------- -------
Total liabilities 73,142 51,808
------- -------
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)
Additional capital 552 552
Retained (deficit) earnings (652) 1,988
------- -------
Total equity 5,383 8,011
------- -------
Total liabilities and equity $78,525 $59,819
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
8
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
for the years ended December 31, 2001, 2000 and 1999
(In thousands, except per share amounts)
2001 2000 1999
Revenue:
Gain on sale of loans $ 13,831 $ 10,971 $ 13,202
Interest income 5,428 5,191 7,698
Broker fee income 649 2,399 6,077
Other fees and income 2,031 2,081 1,757
-------- -------- --------
21,939 20,642 28,734
-------- -------- --------
Expenses:
Compensation and related 9,462 11,477 17,765
General and administrative 5,872 7,779 12,497
Write down of goodwill 845 -- 1,131
Loss on sale/disposal of fixed assets 162 42 796
Loss on write off of securities -- -- 73
Loan production expense 1,792 1,151 1,930
Interest expense 3,853 3,852 4,957
Provision for loan and foreclosed property losses 1,110 1,089 2,256
-------- -------- --------
23,096 25,390 41,405
-------- -------- --------
Loss before income taxes (1,157) (4,748) (12,671)
Provision for (benefit from) income taxes 1,483 (1,456) (4,749)
-------- -------- --------
Net loss (2,640) (3,292) (7,922)
Other comprehensive loss, net of tax:
Unrealized gain (losses) on securities:
Unrealized holding gain (loss) during period 12 4 (46)
-------- -------- --------
Comprehensive loss $ (2,628) $ (3,288) $ (7,968)
======== ======== ========
Net income (loss) per share:
Basic $ (0.48) $ (0.60) $ (1.45)
======== ======== ========
Diluted $ (0.48) $ (0.60) $ (1.45)
======== ======== ========
Weighted average shares outstanding:
Basic 5,482 5,482 5,482
======== ======== ========
Diluted 5,482 5,482 5.482
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
9
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
for the years ended December 31, 2001, 2000 and 1999
(Dollars in thousands)
Preferred Stock
Series A Common Stock
------------------- ------------------------
Shares Amount Shares Amount
------ ------ --------- ------
Balance at December 31, 1998 90 $1 5,482,114 $5,482
Net loss
Issuance of common stock
Repurchase 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
Issuance of common stock
Unrealized loss on investments
available for sale, net of tax of $5.9
------ ------ --------- ------
Balance at December 31, 2000 90 1 5,482,114 5,482
Net loss
Unrealized loss on investments
Available for sale, net of tax of $5.9
------ ------ --------- ------
Balance at December 31, 2001 90 $1 5,482,114 $5,482
====== ====== ========= ======
Accumulated
Other
Additional Comprehensive Retained
Capital Income (Loss) Earnings Total
---------- ------------- ----------- -------
Balance at December 31, 1998 $552 $ 30 $13,902 $19,267
Net loss (7,922) (7,922)
Issuance of common stock
Repurchase 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)
Issuance of common stock
Unrealized loss on investments
available for sale, net of tax of $5.9 4 4
---------- ------------- ----------- -------
Balance at December 31, 2000 552 (12) 1,988 8,011
Net loss (2,640) (2,640)
Unrealized loss on investments 12 12
Available for sale, net of tax of $5.9
---------- ------------- ----------- -------
Balance at December 31, 2001 $552 $ -- $(652) $5,383
========== ============= =========== =======
The accompanying notes are an integral part of the consolidated financial
statements.
10
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 2001, 2000 and 1999
(In thousands)
2001 2000 1999
--------- --------- ---------
Operating activities
Net income (loss) $ (2,640) $ (3,292) $ (7,922)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation of premises and equipment 796 643 1,105
Amortization of goodwill 67 137 455
Provision for loan losses 91 639 2,042
Provision for losses on real estate owned 237 (341) 214
Unrealized loss on loans held for sale 782 -- --
Deferred tax expense 1,897 (1,337) 1,706
(Gain) loss on sale of securities 6 -- 81
Loss on sale of real estate owned -- 792 648
Loss on sale/disposal of fixed assets 162 42 796
Loss on write down of goodwill 845 -- 1,131
Proceeds from sale and prepayments of loans 350,404 268,185 286,089
Originations of loans, net (360,340) (229,490) (240,017)
Gain on sale of loans (13,831) (10,971) (13,202)
Changes in assets and liabilities:
Loan sale receivable 4 (2) 25
Income tax receivable (194) -- --
Other assets 263 118 2,384
Accrued and other liabilities 54 (1,060) (450)
Income tax payable -- 5,153 (3,621)
Loan proceeds payable -- -- (2,565)
--------- --------- ---------
Net cash (used in) provided by operating activities (21,397) 29,216 28,899
Cash flows from investing activities:
Purchase of securities -- -- (125)
Sales of securities -- 240 --
Sales of ARM fund shares 2,310 -- 4,619
Purchase of premises and equipment (105) (253) (1,706)
Sales of premises and equipment 762 246 1,322
Sales of real estate owned 1,748 2,777 2,587
Real estate owned capital improvements (55) (408) (648)
Purchases of ARM fund shares (46) (150) (3,623)
Purchases of FHLB stock (467) (297) (261)
--------- --------- ---------
Net cash provided by investing activities 4,147 2,155 2,165
Continued on Next Page
11
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
for the years ended December 31, 2001, 2000 and 1999
(In thousands)
2001 2000 1999
Cash flows from financing activities:
Borrowings - warehouse $ 39,247 $ 54,289 $ 169,576
Repayments of borrowings - warehouse (37,661) (70,060) (224,657)
FHLB and LOC advances (repayments), net (3,000) (1,648) 4,648
Principal payments on mortgage notes payable (784) 188 (894)
Net increase (decrease) in:
Notes payable (319) (174) (635)
Certificates of indebtedness 20 (44) (326)
Certificates of deposit 25,471 (20,907) 25,611
FDIC-insured money market account (1,694) 3,926 --
Net cash (used in) provided by financing activities 21,280 (34,430) (26,677)
Net increase (decrease) in cash 4,030 (3,059) 4,387
Cash at beginning of year 7,597 10,656 6,269
Cash at end of year $ 11,627 $ 7,597 $ 10,656
Supplemental cash flow information:
Cash paid for interest $ 3,853 $ 3,960 $ 5,233
Cash paid for income taxes 41 -- --
Supplemental non-cash information:
Loan balances transferred to real estate $ 1,370 $ 2,232 $ 4,019
Owned
Purchase of building in exchange for note $ -- $ -- $ 2,025
Payable
The accompanying notes are an integral part of the consolidated financial
statements.
12
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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 originated residential mortgages during the years
of 1999, 2000 and 2001. Approved Federal Savings Bank (the "Bank") is a
federally chartered thrift institution and Approved Residential Mortgage, Inc.
("ARMI"), which had no active loan origination operations as of December 31,
2001. 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. The operations related to ConsumerOne were
discontinued during 2001.
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.
13
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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 ("ALLL") 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, credit grade of borrowers, loan to
value ratios, current economic and secondary market conditions, regulatory
guidance 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.
Prior to the third quarter of 2001, the ALLL reflected loan loss reserves for
all loans including held for yield and held for sale.
Valuation Allowance: Beginning in the third quarter of 2001, as of each
financial reporting date, management evaluates and reports all held for sale
loans at the lower of cost or market value. Any decline in value, including
those attributable to credit quality, are accounted for as a charge to provision
for valuation allowance for held-for-sale loans, not as adjustments to the ALLL.
Such provision is charged against income and not reported as part of ALLL, and
therefore is not eligible for inclusion in Tier 2 capital for risk based capital
purposes. Valuation allowances are established based on the age of the loan as
well as special circumstances known to management that merit a valuation
allowance. Loans held 90 days or less that do not fall into a special
circumstance category are carried at cost. A valuation allowance of 5.5% is
charged against first lien non-conforming mortgage loans held over 90 days and a
valuation allowance of 20% is charged against subordinated liens held over 90
days that do not fall into a special circumstance category. All loans considered
to be special circumstance are carried at the net realizable value. The net
realizable value represents the current appraised or listed property valuation
less estimated cost to liquidate the property. The difference in the principal
value of the loan and the net realizable value is recorded as a Valuation
Allowance.
14
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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.
15
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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.
16
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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 maintains a
valuation allowance 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,
2001, are unrealized holding gains and losses 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.
17
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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 91.3% of total assets at December 31, 2001
compared to 84.3% at December 31, 2000.
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 2000 and 1999 amounts have been reclassified to
conform to the 2001 presentation.
18
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 1. Organization and Summary of Significant Accounting Policies,
continued:
New accounting pronouncements:
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 did not have a material effect on financial condition or results of
operation of the Company.
In July 2001, FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets."
SFAS No. 142 requires the use of a non-amortization approach to account for
purchased goodwill and certain intangibles, effective January 1, 2002. We do not
believe that the adoption of this pronouncement will have a material impact on
our financial statements.
19
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 2. Investments:
The cost basis and fair value of the Company's investments at December 31, 2001
and 2000, are as follows (in thousands):
2001 2000
-------------------------------- ------------------------------------
Cost Fair Cost Fair
Basis Value Basis Value
-------------- -------------- --------------- -----------------
Asset Management Fund, Inc. ARM Portfolio $ - $ - $2,273 $2,258
FHLB stock 1,056 1,056 589 589
-------------- -------------- --------------- -----------------
$1,056 $1,056 $2,862 $2,847
============== ============== =============== =================
20
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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, 2001 and 2000, were as follows (in thousands):
2001 2000
-------------------------- --------------------------
Mortgage loans held for sale, net of valuation
allowance of $617 and $0, respectively $ 47,846 $ 22,597
Net deferred origination fees and other costs 40 (60)
Allowance for loan losses - (99)
-------------------------- --------------------------
Total mortgage loans, net $ 47,886 $ 22,438
========================== ==========================
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, 2001
and 2000 were (in thousands):
2001 2000
--------------------- -----------------------
Balance at beginning of year $ 99 $ 251
Transfer to held for yield loans (99) (152)
--------------------- -----------------------
Balance at end of year $ 0 $ 99
===================== =======================
21
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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, 2001 and 2000 were as follows
(in thousands):
2001 2000
-------------------------- --------------------------
Mortgage loans held for yield $ 11,378 $ 16,004
Net deferred origination fees and other costs (150) (350)
Specific allowance for loan losses (187) 0
General allowance for loan losses (693) (1,380)
-------------------------- --------------------------
Total mortgage loans, net $ 10,348 $ 14,274
========================== ==========================
At December 31, 2001, and 2000, the recorded investment in impaired loans
totaled $1.3 million, and $1.2 million, respectively. The average recorded
investment in impaired loans for the year ended December 31, 2001, and 2000 was
$1.4 million and $1.9 million, respectively. Interest income recognized related
to these loans was $99,000, and $95,000 during 2001 and 2000 respectively.
Nonaccrual loans were $1.6 million and $1.4 million at December 31, 2001 and
2000, respectively. The amount of additional interest that would have been
recorded had these loans not been placed on nonaccrual status was approximately
$168,000 and $148,000 in 2001 and 2000, respectively.
Changes in the allowance for loan losses for the years ended December 31, 2001
and 2000 were (in thousands):
2001 2000
--------------------- -----------------------
Balance at beginning of year $ 1,380 $ 1,131
Transfer from held for sale loans 99 0
Charge Offs (746) (1,086)
Recoveries 56 544
Provision 91 791
--------------------- -----------------------
Balance at end of year $ 880 $ 1,380
===================== =======================
22
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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, 2001, 2000 and 1999 were (in thousands):
2001 2000 1999
------------------- ------------------- ---------------------
Balance at beginning of year $ 376 $ 717 $ 503
Provision 237 (341) 214
Charge off (500) 0 0
------------------- ------------------- ---------------------
Balance at end of year $ 113 $ 376 $ 717
=================== =================== =====================
Note 6. Premises and Equipment:
Premises and equipment at December 31, 2001 and 2000, were summarized as follows
(in thousands):
2001 2000
-------------------- ---------------------
Land $ 1,173 $ 1,413
Building & Improvements 2,005 2,959
Office Equipment & Furniture 1,656 1,713
Computer Software/Equipment 1,971 1,873
Vehicles 92 136
-------------------- ---------------------
6,897 8,094
Less accumulated depreciation and amortization 3,104 2,686
-------------------- ---------------------
Premises and equipment, $ 3,793 $ 5,408
==================== =====================
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.
23
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 7. Capital Leases:
Assets recorded under capital leases at December 31, 2001 and 2000, consist of
the following (in thousands):
2000 1999
------------------- -------------------
Computer equipment $ 154 $ 154
Furniture & equipment 224 224
Less: Accumulated amortization (361) (290)
------------------- -------------------
$ 17 $ 88
=================== ===================
Amortization expense for the years ended December 31, 2001 and 2000,
approximated $71,000 and $114,000, respectively.
Future minimum rental commitments of $21,000 are all due during the next twelve
months ending December 31, 2002.
The Company has the option to purchase these assets at an established price at
the end of the lease terms. The Company recognized approximately $7,000 and
$20,000 of interest expense related to the lease obligations for the years ended
December 31, 2001 and 2000, respectively.
24
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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 $0.6
million, $0.8 million, and $2.0 million in 2001, 2000 and 1999, respectively.
Total minimum lease payments under non-cancelable operating leases with
remaining terms in excess of one year as of December 31, 2001, were as follows
(in thousands):
2002 $335
2003 151
2004 59
------------------------
$545
========================
25
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 9. Revolving Warehouse Facilities:
Amounts outstanding under revolving warehouse facilities at December 31, 2001
and 2000, were as follows (in thousands):
2001 2000
-------------------------- ----------------------------
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) $ 0 $ 1,694
Warehouse facility with commercial bank collateralized
by mortgages/deeds of trust; with interest at 4.43% to
5.43% over one month LIBOR rate (2.12% at December
31, 2001); total credit available $7 million.(2) 504 0
Warehouse facility with commercial bank collateralized
by mortgages/deeds of trust; with interest at 1.25% over
Prime rate (4.75% at December 31, 2001); total credit
available $15 million.(3) 2,776 0
-------------------------- ----------------------------
$ 3,280 $ 1,694
========================== ============================
(1) Line expired on November 10, 2001.
(2) Advance rates are based on the sole discretion of the bank.
(3)The company receives advances of 98% of first mortgages and 96% on 2nd
mortgages.
26
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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, 2001 and
2000(in thousands):
2001 2000
------------------------------------- --------------------------------------
Weighted Weighted
Average % Average %
Rate Amount Rate Amount
----------- ---------------------- ------------- ---------------------
2.99% or less 2.75 $ 10,554 - $ -
3.00 - 3.49 3.21 15,504 - -
3.50 - 3.99 3.81 3,469 - -
4.00 - 4.49 4.25 1,587 - -
4.50 - 4.99 4.82 3,269 - -
5.00 - 5.49 5.16 16,573 5.38 $4,258
5.50 - 5.99 5.60 4,458 5.81 3,664
6.00 - 6.49 6.10 1,289 6.21 2,478
6.50 - 6.99 6.77 2,603 6.86 12,704
7.00 and above 7.08 597 7.13 11,328
----------- ---------------------- ------------- ---------------------
4.25 $ 59,903 6.60 $ 34,432
=========== ====================== ============= =====================
The following table sets forth the amount and maturities of the certificates of
deposit of the Bank at December 31, 2001 (in thousands):
Six Months or Over Six Over One Year Over Two Years Total
Less Months and and Less than
Less than One Two Years
Year
----------------- ---------------- ---------------- --------------- -----------------
2.99% or less $ 2,594 $ 7,960 $ - $ - $10,554
3.00 - 3.49 1,390 13,916 198 - 15,504
3.50 - 3.99 1,189 2,280 - - 3,469
4.00 - 4.49 99 1,289 199 - 1,587
4.50 - 4.99 - 3,071 198 - 3,269
5.00 - 5.49 - 5,376 5,367 5,830 16,573
5.50 - 5.99 - 990 1,091 2,377 4,458
6.00 - 6.49 - - - 1,289 1,289
6.50 - 6.99 - 297 2,306 - 2,603
7.00 and above - - 298 299 597
----------------- ---------------- ---------------- --------------- -----------------
$ 5,272 $ 35,179 $ 9,657 $ 9,795 $59,903
================= ================ ================ =============== =================
At December 31, 2001 and December 31, 2000 117 and 51 certificates of
deposit totaling 29.5 million and 14.0 million were in amounts of $100,000 or
greater.
27
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 11. Money Market Deposits
At December 31, 2001, the Bank had $2.2 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, 2001 the interest rate on all money market deposits was 1.87%.
Note 12. Federal Home Loan Bank Advances:
Federal Home Loan Bank Advances occurred through two types of borrowings, a
Federal Home Loan Bank Warehouse Line of credit and a daily rate credit program.
The $15.0 million warehouse line of credit with the Federal Home Loan Bank was
terminated in October 2001. The line was secured by loans originated by the Bank
and bears interest at the lenders cost of overnight funds. The interest rate on
December 31, 2000 was 6.60%. Interest expense on FHLB advances totaled $136,000,
$33,000 and $36,000 in 2001, 2000 and 1999, respectively.
At December 31, 2000, the Bank had 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. Interest was computed based on the lender's
cost of overnight funds. The interest rate on December 31, 2000 was 6.35%. The
daily credit program facility was terminated in October 2001.
28
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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 $255,000, $282,000, and $332,000, in 2001,
2000 and 1999, respectively. The interest rates on the notes range from 8.00% to
10.00% and the notes mature as follows (in thousands):
2002 $ 134
2003 852
2004 120
2005 1,393
--------------------
$ 2,499
====================
29
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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 $211,000, $196,000, and
$225,000 in 2001, 2000 and 1999, respectively.
Certificates of indebtedness maturities were as follows as of December 31, 2001
(in thousands):
2002 $ 670
2003 238
2004 443
2005 520
2006 192
----------------------
$ 2,063
======================
30
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 15. Mortgage Notes Payable:
The Company had two mortgage notes payable to a commercial bank at December 31,
2000, which were collateralized by the present and former office buildings used
by the Company as corporate headquarters. The former office building was sold
during 2001 and the associated mortgage note was paid in full.
The mortgage notes are summarized as follows (in thousands):
2001 2000
--------------- ---------------
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% $ 0 $ 253
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% 1,745 1,992
Mortgage note payable- foreclosed properties 0 284
--------------- ---------------
$ 1,745 $ 2,529
=============== ===============
Interest expense on mortgage loans payable was $186,000, $205,000 and $62,000 in
2001, 2000 and 1999 respectively.
Aggregate maturities for mortgage payable are as follows as of December 31, 2001
(in thousands):
2002 $ 66
2003 72
2004 78
2005 85
2006 93
Thereafter 1,351
------------------
$1,745
==================
31
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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.
32
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 16. Stock Options, continued:
A summary of the Company's stock options, including weighted average exercise
price (Price) as of December 31, 2001, 2000, and 1999, and the changes during
the years is presented below:
2001 2000
------------------------------------- ------------------------------------
Shares Price Shares Price
--------------- ------------------ -------------- -----------------
Outstanding at beginning of year 117,700 $4.21 118,400 $ 4.37
Granted - - 19,000 4.00
Cancelled 1,000 9.75 1,800 9.75
Cancelled - - 600 13.50
Cancelled 29,050 4.00 17,300 4.00
--------------- ------------------ -------------- -----------------
Outstanding at end of year 87,650 4.13 117,700 $ 4.21
=============== ================== ============== =================
Options available for future grant 168,850 138,800
=============== ==============
Weighted-average fair value of
options granted during year - $ 1.01
================== =================
1999
-------------------------------------
Shares Price
--------------- ------------------
Outstanding at beginning of year 108,325 $ 5.19
Granted 21,425 4.00
Repriced 9,150 4.00
Cancelled 5,000 9.75
Cancelled 7,100 13.50
Cancelled 8,400 4.00
--------------- ------------------
Outstanding at end of year 118,400 $ 4.37
=============== ==================
Options available for future grant 138,100
===============
Weighted-average fair value of
options granted during year $ 1.00
==================
The weighted-average remaining contractual life of options granted at
December 31, 2001, 2000 and 1999 was 7 years, 8 years, and 9 years respectively.
At December 31, 2001 there were 85,900, 1,400, and 350 options exercisable at
$4.00, $9.75, and $13.50 per share, respectively.
33
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 16. Stock Options, continued:
The fair value of each option granted during 2000 and 1999 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 and
48.99% in 1999; 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 2001, 2000 and 1999 for stock-based
compensation plans been recorded by the Company, the Company's pro forma net
loss and pro forma net loss per common share for 2001, 2000 and 1999 would have
been as follows:
(In thousands, except per share amounts)
Year Ended Year Ended
December 31, 2001 December 31, 2000
------------------------------------ ---------------------------------
As Reported Pro Forma As Reported Pro Forma
--------------- --- ---------------- --------------- -- --------------
Net loss $(2,640) $ (2,645) $ (3,292) $ (3,303)
Net loss per common share - Basic (0.48) (0.48) (.60) (.60)
Net loss per common share - Dilutive (0.48) (0.48) (.60) (.60)
Year Ended
December 31, 1999
------------------------------------
As Reported Pro Forma
------------------- ----------------
Net loss $ (7,922) $ (7,939)
Net loss per common share - Basic (1.45) (1.45)
Net loss per common share - Dilutive (1.45) (1.45)
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.
34
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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, 2001 and 2000 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.
35
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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
Net Loss Outstanding Loss Per
(Numerator) (Denominator) Share
-------------------- --- ------------------ --------------
For the Year Ended December 31, 2001
Basic and dilutive earnings per share $ (2,640,000) 5,482,114 $ (.48)
==================== ================== ==============
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)
==================== ================== ==============
36
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 19. Income Taxes:
The components of income tax expense (benefit) for the years ended December 31,
2001, 2000 and 1999, were as follows (in thousands):
2001 2000 1999
-------------------- -------------------- ------------------
Current $ (414) $ (119) $ (6,455)
Deferred 1,897 (1,337) 1,706
-------------------- -------------------- ------------------
$ 1,483 $ (1,456) $ (4,749)
==================== ==================== ==================
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, 2001, 2000 and 1999, were (in thousands):
2001 2000 1999
----------------- ----------------- -----------------
Provision for (benefit from) income $ (393) $ (1,614) $ (4,308)
taxes at statutory
federal rate
State income taxes, net (52) (219) (585)
of federal benefit
Nondeductible expenses 26 24 37
Allowance for deferred tax asset 2,343 479 -
IRS examination adjustments (443) - -
Other, net 2 (126) 107
----------------- ----------------- -----------------
$ 1,483 $ (1,456) $ (4,749)
================= ================= =================
37
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 19. Income Taxes, continued:
Significant components of the Company's deferred tax assets and liabilities at
December 31, 2001 and 2000, were (in thousands):
2001 2000
-------------------- --------------------
Deferred tax assets: $ 622 $ 718
Allowance for loan and real estate
owned losses
Deferred loan fees 103 103
Mark to market on mortgage loans 646 262
held for sale
Net Operating Loss carryforward (1) 2,181 2,087
Deferred income 15 15
Accrued premium recapture 21 48
Accrued expenses 70 84
Accrued 401(k) match 87 57
Accrued insurance expense 64 58
Goodwill 712 647
Other 0 10
-------------------- --------------------
Total deferred tax assets 4,521 4,089
Deferred tax liabilities:
Depreciation 92 106
-------------------- --------------------
Total deferred tax liabilities 92 106
-------------------- --------------------
Deferred tax asset, net of liabilities 4,429 3,983
Valuation allowance 2,822 479
-------------------- --------------------
Net deferred tax asset $ 1,607 $ 3,504
==================== ====================
(1) The net operating loss carryforward expires on December 31, 2020.
At December 31, 2001 and 2000, management of the Company reviewed recent
operating results and projected future operating results. Realization of the tax
loss and credit carryforwards is contingent on future taxable earnings in the
appropriate jurisdictions. Valuation allowances have been recorded for deferred
income tax assets which may not be realized. The amount of the deferred tax
asset is considered realizable, however, could be reduced in the near term if
estimates of future taxable income during the carryforward period are reduced.
There was a net increase in the valuation allowance of $2,343,000 and $479,000
in 2001 and 2000, respectively.
38
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
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 2001, 2000 and 1999. 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, 2001, 2000 and 1999.
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,
2001, 2000 and 1999.
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, 2001, 2000 and 1999, were $65,000, $94,000, and $141,000,
respectively.
Note 21. Commitments and Contingencies:
The Company is, from time to time, subject to routine litigation incidental to
its business. The Company believes that the results of any pending legal
proceedings will not have a material adverse effect on the financial condition,
results of operations or liquidity of the Company.
Note 22. Employment Agreements:
The Company has employment agreements with various employees. Absent
notification of termination, the agreements provide for automatic term renewals
of one year. 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.
39
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 23. 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, 2001 and 2000, 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, 2001
GAAP capital $ 7,348 $ 7,348 $ 7,348
Add: unrealized loss on securities - - -
Non-allowable asset: goodwill (71) (71) (71)
Deferred Taxes (365) (365) (365)
Additional capital item: general allowance - - 689
------------------- ----------------- ------------------
Regulatory capital (computed) 6,912 6,912 7,601
Minimum capital requirement 1,159 3,091 4,483
------------------- ----------------- ------------------
Excess regulatory capital $ 5,753 $ 3,821 $ 3,118
=================== ================= ==================
Ratios:
Regulatory capital (computed) 8.94% 8.94% 13.57%
Minimum capital requirement 1.50 4.00 8.00
------------------- ----------------- ------------------
Excess regulatory capital 7.44% 4.94% 5.57%
=================== ================= ==================
40
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 23. Regulatory Capital, continued:
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%
================== =============== ===============
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 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 2001,
2000 or 1999. The Bank is currently restricted from paying dividends by Office
of Thrift Institution. Effective December 3, 2001, the Bank entered into a
Consent Supervisory Agreement with the OTS. This agreement required the Bank to
adopt new operating procedures and submit various interim reports to the OTS.
Note 24. 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
41
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 24. 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 $49,322,000 and $23,103,000 at December 31, 2001 and 2000,
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 $10,657,000 and $14,689,000 at December 31, 2001 and 2000,
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 $60,290,000 and $34,405,000 at December 31, 2001 and 2000,
respectively.
42
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 24. 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
$1,960,000 and $2,266,000 at December 31, 2001 and 2000, 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 25. Impairment of Assets:
In the second quarter 2001, the Company recorded a charge of $845,000 for the
write-off of goodwill related to the acquisitions of MOFC, Inc." d/b/a
ConsumerOne Financial and Armada Residential Mortgage LLC. 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 elected to close the remaining retail
branches associated with these acquisitions.
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 write-off 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.
43
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
Note 26. Quarterly Financial Data (Unaudited):
The following is a summary of selected quarterly operating results for each of
the four quarters in 2001 and 2000:
(In thousands, except per share data)
March 31 June 30 September 30 December 31
---------------- ---------------- ------------------ -----------------
2001:
Gain on sale of loans $2,777 $5,179 $3,586 $2,289
Net interest income 378 496 328 373
Provision for losses 112 76 (19) 158
Other income 660 942 579 499
Other expenses 4,727 6,212 4,400 3,577
---------------- ---------------- ------------------ -----------------
Income (loss) before income taxes (1,024) 329 112 (574)
Provision for income taxes (378) 124 59 1,678
---------------- ---------------- ------------------ -----------------
Net income (loss) $(646) $205 $53 (2,252)
================ ================ ================== =================
Basic and diluted net income (loss) per $(0.12) $0.04 $0.01 $(0.41)
share
================ ================ ================== =================
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 $ (.01) $ (.14) $ (.23) $ (.22)
share
================ ================ ================== =================
During the fourth quarter of 2001, the valuation allowance for the deferred tax
asset was increased by $1.9 million.
44
Approved Financial Corp.
Consolidating Balance Sheet
December 31, 2001
(dollars in thousands)
Approved
Approved Approved Federal Approved
Financial Residential Savings Financial
ASSETS Consolidated Eliminations Corp. Mortgage Bank Solutions
------------- ------------- ----------- ----------- --------- ------------
Cash $11,627 $ - $ 191 $ 78 $11,089 $269
Mortgage loans held for
sale, net 47,886 - - 52 47,834 -
Mortgage loans held for
yield, net 10,348 - - - 10,348 -
Real estate owned, net 589 - 125 53 411 -
Investments 1,056 (2,956) 2,956 - 1,056 -
Income taxes receivable 194 - 194 - - -
Deferred tax asset, net 1,607 (2,210) 2,522 203 1,092 -
Premises and equipment, net 3,793 - 155 20 3,610 8
Goodwill, net 71 - - - 71 -
Due from affiliates - (4,048) 3,946 38 - 64
Other assets 1,354 - 87 57 1,210 -
------------- ------------- ----------- ----------- --------- ------------
Total assets $78,525 $(9,214) $10,176 $ 501 $76,721 $341
============= ============= =========== =========== ========= ============
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 3,280 $ $ - $ - $ 3,280 $ -
FHLB bank advances - - - - - -
Mortgage payable 1,745 - - - 1,745 -
Notes payable-related
parties 2,499 - 2,499 - - -
Certificates of indebtedness 2,063 - 2,063 - - -
Certificates of deposits 59,903 - - - 59,903 -
Money market account 2,232 - - - 2,232 -
Due to affiliates - (4,048) (151) 2,673 1,275 251
Accrued and other
liabilities 1,420 - 382 100 938 -
Income taxes payable - (2,210) - 2,193 - 17
------------- ------------- ----------- ----------- --------- ------------
Total liabilities 73,142 (6,258) 4,793 4,966 69,373 268
------------- ------------- ----------- ----------- --------- ------------
Shareholder's equity:
Preferred stock-series A 1 - 1 - - -
Common stock 5,482 (298) 5,482 250 32 16
Unrealized gain on securities - - - - - -
Additional capital 552 (5,034) 552 492 4,542 -
Retained earnings (652) 2,376 (652) (5,207) 2,774 57
------------- ------------- ----------- ----------- --------- ------------
Total equity 5,383 (2,956) 5,383 (4,465) 7,348 73
------------- ------------- ----------- ----------- --------- ------------
Total liabilities and $78,525 $(9,214) 10,176 $ 501 $76,721 $341
equity
============= ============= =========== =========== ========= ============
45
Approved Financial Corp.
Consolidating Statement of Income (Loss)
For the year ended December 31, 2001
(dollars in thousands)
Approved
Approved Approved Federal Approved
Financial Residential Savings Financial
Consolidated Eliminations Corp. Mortgage Bank Solutions
------------- ------------- ----------- ----------- ------------ ------------
Revenue:
Gain on sale of loans $13,831 0 (10) 95 13,746 -
Interest income 5,428 (17) 342 10 5,090 3
Other fees and income 2,680 (13) 77 - 2,512 104
------------- ------------- ----------- ----------- ------------ ------------
21,939 (30) 409 105 21,348 107
Expenses:
Compensation and related $ 9,462 - 2,851 176 6,373 62
General and administrative 5,872 (13) (1,854) 292 7,425 22
Loss on sale/disposal 162 - 159 - 3 -
fixed assets
Write down of goodwill 845 409 436
Loan production expense 1,792 - (9) 82 1,719 -
Interest expense 3,853 (17) 766 3,104 -
Provision for loan/REO 1,110 - 14 84 1,012 -
losses
Write off of intercompany rec - - (3,049) - 3,049 -
------------- ------------- ----------- ----------- ------------ ------------
23,096 (30) (713) 634 23,121 84
Income (loss) before income (1,157) 1,122 (529) (1,773) 23
taxes
Provision for income taxes 1,483 - 1,351 (204) 327 9
------------- ------------- ----------- ----------- ------------ ------------
Net income (loss) $ (2,640) - (229) (325) (2,100) 14
============= ============= =========== =========== ============ ============
46