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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
AMENDMENT NO. -
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934 ("THE ACT")
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
COMMISSION FILE NUMBER 000-23775
APPROVED FINANCIAL CORP.
(Exact Name of Registrant as Specified in its Charter)
VIRGINIA 52-0792752
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
3420 HOLLAND ROAD, SUITE 107, VIRGINIA BEACH, VIRGINIA 23452
(Address of Principal Executive Office) (Zip Code)
757-430-1400
(Registrant's Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(g) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
Common, $1.00 par value per share OTC Bulletin Board
Securities to be Registered Pursuant to Section 12(g) of the Act:
None
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,
1999.
DOCUMENTS INCORPORATED BY REFERENCE IN FORM 10-K
INCORPORATED DOCUMENTS WHERE INCORPORATED IN FORM 10-K
1. Certain portions of the Corporation's Proxy Part III -- Items 10, 11, 12 and 13.
Statement for the Annual Meeting of Stockholders
to be held on June 14, 1999 ("Proxy Statement").
APPROVED FINANCIAL CORP.
ANNUAL REPORT ON FORM 10-K
AMENDMENT NO. -
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
INFORMATION REQUIRED IN ANNUAL REPORT
TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS.
General ................................................................7
Business Strategy..............................................................9
Purchase of the Assets of Funding Center of Georgia, Inc......................11
Purchase of MOFC Inc. d/b/a ConsumerOne Financial............................ 12
The Company's Borrowers and its Loan Products.................................12
Underwriting Guidelines.......................................................14
Mortgage Loan Servicing.......................................................18
Marketing ...............................................................20
Company's Sources of Funds and Liquidity......................................21
Savings Bank's Sources of Funds...............................................21
Taxation ...............................................................22
Employees ...............................................................22
Service Marks ...............................................................23
Effect of Adverse Economic Conditions.........................................23
Concentration of Operations in Seven States...................................23
Future Risks Associated with Loan Sales through Securitizations...............23
Contingent Risks..............................................................23
Competition ...............................................................24
Regulation ...............................................................24
OTS Regulation of the Company.................................................26
Regulation of the Savings Bank................................................27
Legislative Risk..............................................................34
Environmental Factors.........................................................34
Dependence on Key Personnel...................................................35
Control by Certain Shareholders...............................................35
ITEM 2. PROPERTIES.
Properties ...............................................................36
ITEM 3. LEGAL PROCEEDINGS.
Legal Proceedings.............................................................37
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Submission of Matters to a Vote of Security Holders...........................37
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS.
Market Price of and Cash Dividends on Company's Common Equity.................38
Absence of Active Public Trading Market and Volatility of Stock Price.........39
Transfer Agent and Registrar..................................................39
Recent Open Market Purchase of Common Stock by the Company .................. 39
Recent Sales of Unregistered Securities.......................................39
ITEM 6. SELECTED FINANCIAL DATA.
Selected Financial Data.......................................................41
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General ...............................................................43
Results of Operations - Years Ended December 31, 1998 and 1997 ...............43
Results of Operations - Years Ended December 31, 1997 and 1996 ...............52
Financial Condition - December 31, 1998, 1997 and 1996........................61
Liquidity and Capital Resources...............................................63
New Accounting Standards......................................................66
Hedging Activities............................................................67
Impact of Inflation and Changing Prices.......................................67
Year 2000 Issues..............................................................68
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Management - Asset/Liability Management...........................70
Interest Rate Risk............................................................72
Asset Quality ...............................................................73
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Financial Statements and Supplementary Data...................................74
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure........................................74
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 14, 1999 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 14, 1999 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 14, 1999 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 14, 1999 and is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K.
Financial Statements and Exhibits.............................................77
Signatures ...............................................................81
PART I
ITEM 1 - BUSINESS
Certain statements in this report which are not merely historical facts
are forward-looking statements within the meaning of the Private Securities
Litigation Act of 1995 concerning Approved Financial Corp. and its subsidiaries
("Approved" or Company") concerning future loan production volume, revenues from
loan sales, restructuring and expense reduction plans, ability to profitably
enter the conforming mortgage business and any other mentioned business strategy
concerning the profitability of any current or future operations of the Company
are forward-looking statements. There are a number of important factors that
could cause the actual results of Approved to differ materially from those
indicated in such forward-looking statements. Those factors include, but are not
limited to the ability of the Company's management to implement restructuring
and expense reduction plans, any changes in residential real estate values,
changes in industry competition, general economic conditions, changes in
interest rates, changes in the demand for non-conforming or conforming mortgage
loans, the Company's availability of funding sources for capital liquidity,
changes in loan prepayment speeds, delinquency and default rates, changes in
regulatory issues concerning mortgage companies or federal savings banks,
changes in GAAP accounting standards effecting the Company's financial
statements, and any changes which influence any market for profitable sales of
all types of mortgage loans.
GENERAL
The Company is a Virginia-chartered financial institution, principally
involved in originating, purchasing, servicing and selling loans secured
primarily by first and junior liens on owner-occupied, one- to four-family
residential properties. The Company offers both fixed-rate and adjustable-rate
loans for debt consolidation, home improvements and other purposes. The
Company's specialty is lending to the "non-conforming" borrower who does not
meet traditional "conforming" or government agency credit qualification
guidelines. The Company focuses on lending to individuals whose borrowing needs
are generally not being served by traditional financial institutions due to such
individuals' impaired credit profiles and other factors. For over forty-five
years, the Company has helped non-conforming mortgage customers satisfy their
financial needs and in many cases has helped them improve their credit ratings.
The company plans to begin offering conforming mortgage loans during 1999.
Incorporated in 1952 as a subsidiary of Government Employees Insurance
Co. ("GEICO"), the Company was acquired in September 1984 by, among others,
several members of current management. The Company, headquartered in Virginia
Beach, Virginia, holds a Virginia industrial loan association charter and is
subject to the supervision, regulation and examination of the Virginia State
Corporation Commission's Bureau of Financial Institutions. In September 1996 the
Company acquired Approved Federal Savings Bank (the "Savings Bank"), a
federally-chartered savings institution. The Savings Bank is subject to the
supervision, regulation and examination of the Office of Thrift Supervision (the
"OTS") and the Federal Deposit Insurance Corporation ("FDIC"). The Company is a
registered savings and loan holding company under the federal Home Owner's Loan
Act ("HOLA") because of its ownership of the Savings Bank. As such, the Company
is subject to the regulation, supervision and examination of the OTS. The
Savings 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 Company historically has derived its income from gains on loans sold
through whole loan sales to institutional purchasers, net warehouse interest
earned on loans held for sale, net interest income on loans held for investment,
and origination and other fees received as part of the loan application process.
In future periods, the Company may generate revenue from loans sold through
securitizations, non-real estate secured consumer finance lending and the sale
of other financial products such as insurance policies.
The Company utilizes broker and retail channels to originate loans. At
the broker level, an extensive network of independent mortgage brokers generates
referrals. This loan source has been a successful and profitable mainstay of the
business for many years. The Company began making residential mortgage loans
through retail offices during the fourth quarter of 1994. In 1998, the dollar
volume in the broker lending division accounted for 39% of total originations
and the retail lending division accounted for 61% of total originations. The
Company is seeking to expand its broker network and its direct consumer lending
by developing larger sales staff in current or new branch offices, increasing
its use of advertising, direct mail and other marketing strategies including its
National Sales Center in Virginia Beach, and through strategic acquisitions or
relationship with other companies or individuals.
Once loan applications are received from the broker and retail networks,
the underwriting process is completed and the loans are funded, the Company
typically packages the loans and sells them on a whole loan basis to
institutional investors, usually other mortgage companies, banking institutions
and finance companies. The Company expects to begin selling conforming loans to
government and quasi-government agencies during 1999. The proceeds from the
sales release funds for additional lending.
The Company has four operating subsidiaries. One subsidiary, Approved
Residential Mortgage, Inc. ("ARMI") was formed in April 1993 to originate
non-conforming residential mortgage loans through its broker network and retail
outlets. ARMI initially concentrated on continuing the Company's broker network
business. During the fourth quarter of 1994, the Company opened its first retail
loan origination center through a joint venture. ARMI operates most of its
retail offices under the service mark "Armada" Residential Mortgage and operates
one retail office under the name "The Funding Center of Georgia".
Another operating subsidiary is the Savings Bank, also headquartered in
Virginia Beach, Virginia.. The Savings Bank's principal business activities are
attracting savings deposits and originating, investing in and selling loans
primarily secured by first and junior mortgage liens on single-family dwellings,
including condominium units and to a lesser extent originates consumer loans to
credit worthy customers. The Savings Bank also invests in certain U.S.
Government and agency obligations and other investments permitted by applicable
laws and regulations. The operating results of the Savings Bank are highly
dependent on net interest income, the difference between interest income earned
on loans and investments and the cost of savings deposits and borrowed funds.
The Savings Bank has one operating subsidiary, Global Title Insurance Agency,
Inc.
The Savings Bank's charter provides for ease of entry into new markets,
with reduced legal costs. By taking advantage of the flexible provisions of the
charter, the Savings Bank is able to make real estate-secured loans in several
states where the Company's retail or broker units associated with other
subsidiaries of the Company are not licensed. The Savings Bank originates loans
utilizing a network of mortgage brokers for loan referrals and through retail
mortgage lending offices. The Savings Bank has contracted the Company to provide
the processing, underwriting and closing capabilities of the Company. The
Company has agreed to purchase all of the loans made by the Savings Bank. The
Company has sold in the secondary market most of the loans it has purchased from
the Savings Bank.
Deposit accounts of the Savings Bank up to $100,000 are insured by the
Savings Association Insurance Fund, administered by the FDIC. The Savings Bank
is a member of the Federal Home Loan Bank (the "FHLB") of Atlanta. The Company
and the Savings Bank are subject to the supervision, regulation and examination
of the OTS and the FDIC. The Savings 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.
Additional subsidiaries of the Company include MOFC, Inc. d/b/a/
ConsumerOne Financial ("ConsumerOne") and Approved Financial Solutions, Inc.
ConsumerOne was acquired in December of 1998 and originates loans directly with
mortgage borrowers. (See: The Purchase of MOFC, Inc. d.b.a. ConsumerOne
Financial). Approved Financial Solutions, Inc. was formed in November of 1998
for the initial purpose of offering life insurance to the Company's loan
customers. To date, insurance sales have not represented a material source of
revenue
BUSINESS STRATEGY
The Company's business strategies are: (i) maintain quality loan
underwriting and servicing standards; (ii) reduce expenses through
centralization of all marketing, advertising, underwriting and processing
functions (iii) increase origination volume per retail branch (iv) acquire
additional loan production capability through acquisitions and strategic
alliances; (v) diversify loan sale strategies with a commitment to prudent
management of cash flow (vi); broaden product offerings (viii) increase loan
originations from broker referrals; (vii) build on the Company's initial
investment in the Savings Bank;
MAINTAIN QUALITY LOAN UNDERWRITING AND SERVICING STANDARDS. The
Company's underwriting and servicing staff have experience in the non-conforming
home equity loan industry. The Company's management believes that the experience
of its underwriting and servicing staff provide the Company with the
infrastructure necessary to sustain its recent growth and maintain its
commitment to high standards in its underwriting and servicing of portfolio and
warehouse loans. In March of 1999, the Company hired several individuals with
extensive experience in conforming lending in an attempt to maintain solid
underwriting standards and to provide quality service in the conforming mortgage
area.
REDUCE EXPENSES THROUGH CENTRALIZATION OF ALL MARKETING, ADVERTISING,
UNDERWRITING AND PROCESSING FUNCTIONS. Currently the Company is implementing
plans to further centralize operations in the home office. All marketing and
advertising campaigns will be launched from the marketing department in Virginia
Beach. Underwriting and servicing is currently centralized and most processing
functions formerly handled in the branch locations are also being directed to
the home office. The Company is implementing this plan to take advantage of
economies of scale and to enhance quality control.
INCREASE ORIGINATION VOLUME PER RETAIL BRANCH. The Company intends to
expand its loan origination volume from existing retail branches by increasing
the sales staffs. Additionally, centralizing operating and marketing functions
in the home office as explained above, allows the Company to restructure the
branches as highly focused sales centers.
The Company has developed a National Sales Center ("Center") at the
Virginia Beach headquarters during 1999. The Center functions as a lead
generation source for the retail branch network by answering and screening
in-bound calls from various forms of advertising and marketing campaigns
centralized at the home office for the retail branches. In addition, the Center
originates mortgages through an on-site staff of loan officers.
The Company also utilizes targeted out-bound telemarketing to obtain
potential customers leads for the retail branches. Prior to 1999, a large
portion of the telemarketing activity was performed in the retail branches.
However, during 1999, the Company has centralized its telemarketing activities
in the Virginia Beach, Virginia location to achieve economies of scale and to
obtain greater quality control over this operation.
ACQUIRE ADDITIONAL LOAN PRODUCTION CAPABILITY THROUGH ACQUISITIONS AND
STRATEGIC ALLIANCES. The Company intends to strengthen its loan production
capabilities not only through internal growth, but from time to time through
acquisitions and the establishment of strategic alliances. The Company's
management believes that acquisitions not only accelerate the pace of growth,
but also are often the most cost-effective growth strategy, enabling the Company
to realize significant operational economies of scale. The Company will continue
to seek out candidates for acquisition which operate in geographic and product
areas that complement its existing businesses. These candidates may include
mortgage brokers or retail offices of other mortgage operations, which exhibit
management styles compatible with the Company's management team and that have
business strategies that complement those of the Company's.
See the discussions below regarding the January 26, 1998 acquisition of
the assets of a Georgia-based mortgage lender, Funding Center of Georgia, Inc.
and the December 15, 1998 acquisition of MOFC, Inc. d/b/a ConsumerOne Financial.
The Company has no specific plans for additional acquisitions of ongoing
businesses at this time.
DIVERSIFY LOAN SALE STRATEGIES WITH PRUDENT MANAGEMENT OF FINANCIAL CASH
FLOW. The Company historically has sold its loans on a whole loan basis
receiving cash at the time of sale. During the second half of 1998, many
companies in the mortgage business that previously utilized the securitization
market as their primary loan sale strategy experienced significant difficulty
with capital and liquidity issues and diverted to whole loan sales in order to
generate current cash flow. This strategic shift resulted in excess supply and a
reduction in premiums received on whole loan sales ("premiums"). While the
Company has been successful in obtaining new investors for whole loan sales, the
average cash premiums received on the Company's loan sales decreased from 6.39%
in 1997 to 4.92% in 1998.
Alternative or complementary loan sale strategies may be utilized by the
Company in the future in addition to whole loan sales. However, any new strategy
will be adopted only after prudent economic analysis has been performed to
determine the long term effects that such a strategy would have on the Company's
profitability and capital liquidity.
In future periods, the Company may sell a portion of the loans it
originates through a securitization program and either sell or retain the rights
to service the loans. The sale of loans through a securitization program would
be a significant departure from the Company's previous business operations. In
order to fund a securitization program, the Company would likely have to obtain
an additional credit facility and a means to either sell or finance the interest
only and residual assets created through a securitization. To the extent that
the Company is not successful in maintaining or replacing existing financing, it
would not be able to hold a large volume of loans pending securitization and
therefore would have to curtail its loan production activities or sell loans
either through whole loan sales or in smaller securitized pools which, could
have a material adverse effect on the Company's results of operations.
From time to time, the Company varies the quantity of mortgage loans
that it holds for sale on its balance sheet. This permits the Company to sell
loans in various quantities and on a flexible time schedule, which is adjusted
according to short term shifts in the market demand for its loans.
INCREASE LOAN ORIGINATIONS FROM BROKER REFERRALS. While loan volume from
broker referrals was less in 1998 as compared to 1997, both on an absolute
dollar basis and as a percentage of total originations, the Company intends to
continue to develop its loan production from this source. The Company plans to
expand this business geographically when and where it sees opportunity to add
profitable volume. The Company believes that relationships with brokers are
strengthened by providing attractive products and responsive service in
conjunction with consistent underwriting, substantial funding sources and
competitive prices. However, the Company will not waiver on its commitment to
prudent risk adjusted pricing of mortgage loans simply to be competitive.
EXPAND PRODUCT OFFERINGS. The Company frequently reviews its pricing and
loan offerings for competitiveness relative to the market. The Company
introduces new loan products to meet the needs of its brokers and borrowers and
to expand its market share to new customers who are not traditionally part of
the Company's market. In order to facilitate the funding of conforming loans
in-house in lieu of funding these loans through other lenders, a strategic
alliance was formed with a Virginia Beach based conforming lender in March 1999
which is expected to increase the Company's revenue and profit potential from
conforming loans. The Company's recent development of a conforming mortgage
division is an example of its efforts to add products that will provide service
for a larger customer base.
BUILDING ON THE COMPANY'S INITIAL INVESTMENT IN THE SAVINGS BANK. The
principal reason for the acquisition of the Savings Bank was to allow the
Company to utilize the opportunities offered by the federal thrift charter to
compliment the products and services currently being offered by the Company. The
Savings Bank's ability to raise FDIC-insured deposits and to obtain FHLB
advances secured by its loan portfolio to finance its activities should serve
over time to reduce the cost of funds.
In 1999, the Company has initiated plans which give the Savings Bank the
capability to originate loans in the "conforming" segment of the mortgage loan
market. Most of the Savings Bank's fixed rate conforming loans would be sold in
the secondary market, while its adjustable rate conforming loans could either be
sold or held in the Savings Bank's loan portfolio. As a FHLB member, the Savings
Bank will be able to pledge qualifying loans to obtain additional funds to
expand its lending operations.
On July 10, 1997, the Savings Bank formed a title insurance agency
subsidiary named Global Title Insurance Agency, Inc. ("Global"), and has
obtained regulatory approval to begin title policy sales operations. Global has
negotiated to issue title policies through First American Title Insurance
Company. It is expected that Global will eventually be offering title policies
to all of the Company's loan customers. However, in 1998 Global provided very
little of the Company's loan customer's need for title policies.
The Savings Bank may enter other lines of business that could provide
complimentary benefits, or synergies, with the Company's main strategic goals.
At a time when banks and savings institutions are using branch networks
to attract deposits as a primary source of funding, the Savings Bank instead
relies primarily upon certificates of deposit obtained through direct
solicitation of institutional investors and brokered certificates of deposit
obtained from customers of Wall Street investment banks. The Savings Bank's
management believes that certificates of deposit raised in this manner are a
more efficient and cost effective approach to obtain funds as compared to a
branch network with its salaries and overhead costs.
PURCHASE OF THE ASSETS OF FUNDING CENTER OF GEORGIA, INC.
Effective January 26, 1998, ARMI purchased substantially all of the
assets of Funding Center of Georgia, Inc. ("FCGA"), a Georgia corporation. All
of the employees of FCGA have become employees of ARMI, and the business will be
conducted under the name of ARMI d/b/a Funding Center of Georgia. The original
purchase price for the assets of FCGA's assets, which included deferred payments
that are subject to reduction or forfeit in the event of a failure to meet
agreed-upon pre-tax profit targets each year ("earn out payments"), was
$3,300,000. ARMI paid $600,000 at closing and paid $100,000 in semi-monthly
installments from February 1998 through January 1999. The potential "earn out
payments" of $2,400,000 were to be payable in three annual installments on
January 1, 1999, 2000 and 2001, with interest at 6%, However, no payment was
earned and was therefore forfeited for the initial installment on January 1,
1999. Currently, the maximum future payment is $1,800,000, however, due to
current market conditions the Company does not expect a payment to be earned for
January 1, 2000.
THE PURCHASE OF MOFC, INC. D.B.A. CONSUMERONE FINANCIAL
On December 15, 1998, the Company acquired all of the outstanding shares
of stock of ConsumerOne, located in Birmingham, Michigan. The Company paid an
initial payment of $575,000 in cash for the purchase of ConsumerOne and entered
into a three-year employment agreement with Keith Lewis, prior owner and
president of ConsumerOne. Mr. Lewis has the potential of earning an additional
purchase payment up to a maximum of $1,575,000 over a three-year period based on
minimum profit levels achieved each year by ConsumerOne. Future payments, if
earned, are payable fifty percent in cash and fifty percent in cash or stock at
the Company's option. During 1998, ConsumerOne originated an average of
approximately $6 million of mortgage loans per month.
THE COMPANY'S BORROWERS AND ITS LOAN PRODUCTS
The Company has historically committed the majority of its resources to
serving the non-conforming residential mortgage market. Prior to the very recent
development of a conforming origination division in March 1999, the Company
catered to individuals who do not meet the strict qualification guidelines
established by most government insured lending programs. These customers usually
have limited access to sources of available credit, but their financial needs
are none the less real. By consolidating their debts with a loan from the
Company, these customers can often save several hundred dollars per month in
cash flows, amounts that can make a significant difference in a customer's
financial situation and quality of life. Personal circumstances including
divorce, family illnesses or deaths and temporary job loss due to layoffs and
corporate downsizing will often impair an applicant's credit record. Among the
Company's specialties is the ability to identify and assist this type of
borrower in the establishment of improved credit. In this segment of the
mortgage loan business, the interest rate charged on loans is not the overriding
concern of customers but rather their monthly payment size. Therefore, these
customers are less rate-sensitive than conforming loan customers and therefore
lenders compete more often by the level, quality and speed of service to the
customer.
Loans made to such credit-impaired borrowers generally entail a higher
risk of delinquency and possibly higher losses, depending on associated loan to
value ratios, than delinquency and loss ratios for more creditworthy borrowers.
No assurance can be given that the Company's underwriting policies and
collection procedures will substantially reduce such risks. In the event that
warehoused loans or pools of loans sold and serviced by the Company experience
higher delinquency, foreclosure, loss or prepayment speed rates than
anticipated, the Company's results of operations or financial condition would be
adversely affected.
Most loans made by the Company are used by the borrowers for debt
consolidation, property improvement, home purchase and other purposes. Borrowers
can gain income tax advantages of real estate-secured debt, instead of paying
higher-rate credit cards on which interest payments are generally not
tax-deductible. Most of the loans carry fixed interest rates and are usually
made for a 20- to 30-year term. The average size of loans funded in-house by the
Company during 1998 was approximately $58,344. The average size of loans
originated by the Company, including loans funded through other lenders, during
1998 was approximately $61,678. In order to compensate the Company for the
increased credit risks associated with its non-conforming borrowers, higher
interest rates and origination fees or points are charged for these loans
compared to higher credit quality, conforming real estate loans.
There is an active secondary market for most types of mortgage loans
originated by the Company. The majority of the loans originated by the Company
are sold to other mortgage companies, finance companies and other financial
institutions including federally chartered banking institutions. The loans are
sold for cash on a whole loan, servicing-released basis. Consistent with
industry practices, the loans are sold with certain representations and
warranties. However, the Company may adopt alternative or complimentary loan
sale strategies in the future. The Company plans to make additional investments
in technology to further streamline its operating procedures, enhance
productivity, reduce expenses and provide for future expansion. However, the
Company expects that it would have to invest in additional capabilities if it
enters the securitization business. (see: DIVERSIFY LOAN SALE STRATEGIES WITH
PRUDENT MANAGEMENT OF FINANCIAL CASH FLOW)
A significant portion of the mortgage leads generated by Approved's
centralized out-bound telemarketing center and the Company's new National Sales
Center in Virginia Beach reflect a conforming credit profile. Therefore, the
addition of conforming mortgage loans to our product menu allows us to service
these conforming leads and is expected to add additional revenue on a
cost-effective basis. In order to facilitate the funding of conforming loans
in-house in lieu of funding these loans through other lenders, a strategic
alliance was formed with a Virginia Beach based conforming lender in March of
1999.
The Company has the ability to originate loans through the Savings Bank
that are not fully secured by real estate collateral, including consumer
installment debt. If offered, these products will be underwritten based on the
borrower's credit worthiness. As is the case with its other loan products, the
Company's intention would be to sell these loans in the secondary market, to
limit its exposure to future losses. To date, the Company has not originated a
material amount of non-real estate secured loans.
BROKER LOAN ORIGINATIONS. ARMI originates residential mortgage loans
through a network of independent mortgage brokers who offer the Company's
products to their clients.
During 1998, loans originated from this source declined both in the
absolute dollar amount of loans originated and as a percentage of total loan
volume. Loans originated from mortgage broker referrals declined to 39% of the
total loan volume of $522.0 million for the year of 1998, compared to 55% of
1997 loan volume.
In cultivating this broker network, the Company stresses its superior
service, efficiency, flexibility and professionalism. Due to concentrated size
and centrally-organized operations, the Company offers one business day
turnaround on underwriting decisions and can close loans in as few as two
business days. 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, but the
majority of the loans are currently underwritten at the Company's Virginia
Beach, Virginia headquarters.
The Company's geographic focus for broker operations includes the
Southeast and Midwest. Management intends to strengthen the broker origination
channel in these regions by developing new markets and capturing a greater share
of existing ones. The Company uses modern technology to accommodate its growing
service area. This minimizes overhead without compromising operations. It also
allows for easy expansion through the further development of the mortgage broker
network.
Management plans to continue to develop the broker sales force with
ongoing training programs. Management intends to continue to expand this
division.
RETAIL LOAN ORIGINATIONS. The Company initiated retail loan originations
in December 1994, when ARMI formed a joint venture to originate mortgage loans
through retail branches. The joint venture, Armada Residential Mortgage, LLC
("Armada LLC "), opened its first office in Lanham, Maryland. Armada LLC's
senior officer was a 17% owner of the joint venture. The Armada LLC legal entity
was folded into ARMI beginning in January 1997 so that all of the Company's
retail branches could be managed and accounted for in a consistent manner.
Concluding the joint venture structure reduced the costs of separate accounting
and eliminated the need to file federal and state partnership returns. Armada
LLC's senior officer has remained with the Company in a management capacity.
The Company's retail offices are the result of developing
successful relationships with established industry professionals who want to
work in an entrepreneurial setting and can participate in the growth and
profitability of our retail business. The joint venture and purchase of Armada
LLC and the purchase of FCGA and ConsumerOne are examples of such relationships.
To support the retail expansion, integrated marketing programs have been
designed to generate new business. Retail customer demand is generated through
targeted outbound telemarketing, direct mail and multimedia advertising. As
these programs are tested and refined, they will be implemented in all retail
locations. In future periods, the Company plans to market the Savings Bank's
loan products and other services through its retail loan network.
During the first quarter of 1999, the Company has opened the National
Sales Center ("Sales Center") at its headquarters in Virginia Beach. This new
unit was developed to enhance loan production volume and boost lead generation
capacity to accommodate an expanding sales force in the branch network.
Additionally, it creates the potential for savings in advertising and marketing
costs through economies of scale since system wide advertising and marketing
campaigns are now centralized in Virginia Beach and the Sales Center services
in-bound calls from these campaigns. The unit functions as both a lead
generation source for the retail branch network and a new source of retail loan
originations through its on-site staff of loan officers.
Also, during the first quarter of 1999, seven retail locations that
previously operated under ARMI were transferred to the Savings Bank.
STRATEGIC ALLIANCES. In order to increase volume and to diversify its
sources of loan originations, the Company seeks to enter into strategic
alliances with selected mortgage originators as opportunities occur. The company
has no predefined structure of such alliances because it anticipates that each
will provide unique opportunities to generate new sources for revenues.
The Company's recent strategic alliance with a Virginia Beach based
conforming mortgage operation ("ConformCo") is the only strategic alliance that
the Company has at this time. The relationship is one by which the Savings Bank
hired operational employees that were previously employees of the ConformCo. The
Company and ConformCo will utilize these Savings Bank employees to underwrite,
process and sell conforming mortgage loans. The overhead expenses, will be
shared based on a pro-rata basis determined by the percentage of conforming loan
volume originated by the Company and the ConformCo which is facilitated by the
Savings Bank.
UNDERWRITING GUIDELINES
Historically, the Company has focused on the non-conforming mortgage
business. However, the Company plans to begin funding conforming mortgage loans
in 1999 as a result of its recent strategic alliance with ConformCo (See:
Strategic Alliances) Conforming mortgages are loans with characteristics meeting
conventional underwriting standards such as the standards required by the
Federal National Mortgage Association and other quasi government type lenders.
The Company's conforming underwriting guidelines are currently under development
and will reflect the guidelines established by the ultimate investors for such
loans targeted by the Company.
The following is a general description of the non-conforming
underwriting guidelines currently employed by the Company with respect to
mortgage loans it originate. The Company revises such guidelines from time to
time in connection with changing economic and market conditions. The Company may
make exceptions to these guidelines for special types of loans, including loans
with loan-to-value ratios over 80%, and for other reasons. The Company relies on
the judgment of the underwriting staff in making these exceptions. Also, the
Company will substitute underwriting guidelines of other lenders to which the
Company anticipates it will sell such loans under an established buy-sell
agreement.
Loan applications received from retail offices and brokers are
classified according to certain characteristics including available collateral,
loan size, debt ratio, loan-to-value ratio and the credit history of the
applicant. Loan applicants with less favorable credit ratings generally are
offered loans with higher interest rates and lower loan-to-value ratios than
applicants with more favorable credit ratings. The Company's underwriting
standards are designed to provide a program for all qualified applicants in an
amount and for a period of time consistent with each applicant's demonstrated
willingness and ability to repay. The Company's underwriters make determinations
on loans without regard to sex, marital status, race, color, religion, age or
national origin. Each application is evaluated on its individual merits,
applying the guidelines set forth below, to ensure that each application is
considered on an equitable basis.
A current credit report by an independent and nationally recognized
credit reporting agency reflecting the applicant's complete credit history is
required. The credit report will disclose whether any instances of adverse
credit appear on the applicant's record. Such information might include
delinquencies, repossessions, judgements, foreclosures, bankruptcies and similar
instances of adverse credit that can be discovered by a search of public
records. An applicant's recent credit performance weighs heavily in the
evaluation of risk by the Company. A lack of credit history will not necessarily
preclude a loan if the borrower has sufficient equity in the property. Slow
payments on the borrower's credit report must be satisfactorily explained and
will normally reduce the amount of the loan for which the applicant can be
approved.
The Company maintains a staff of experienced underwriters based in its
Virginia Beach, Virginia office. The Company's loan application and approval
process generally is conducted via facsimile submission of the credit
application to the Company's underwriters. An underwriter reviews the
applicant's employment history and financial status as contained in the loan
application, current bureau reports and the real estate property characteristics
as presented on the application in order to determine if the loan is acceptable
under the Company's underwriting guidelines. Based on this review, the
underwriter assigns a preliminary rating to the application. The proposed terms
of the loan are then communicated to the retail loan officer or broker
responsible for the application who in turn discusses the proposal with the loan
applicant. When a potential borrower applies for a loan through a branch office,
the underwriter may discuss the proposal directly with the applicant. The
Company endeavors to respond with preliminary proposed loan terms, and in most
cases does respond, to the broker or borrower within one business day from when
the application is received. If the applicant accepts the proposed terms, the
underwriter will contact the broker or the loan applicant to gather additional
information necessary for the closing and funding of the loan.
All loan applicants must have an appraisal of their collateral property
prior to closing the loan. The Company requires loan officers and brokers to use
licensed appraisers that are listed on or qualify for the Company's approved
appraiser list. The Company approves appraisers based upon a review of sample
appraisals, professional experience, education, membership in related
professional organizations, client recommendations and review of the appraiser's
experience with the particular types of properties that typically secure the
Company's loans.
The decision to provide a loan to an applicant is based upon the value
of the underlying collateral, the applicant's creditworthiness and the Company's
evaluation of the applicant's willingness and ability to repay the loan. A
number of factors determine a loan applicant's creditworthiness, including debt
ratios (the borrower's average monthly expenses for debts, including fixed
monthly expenses for housing, taxes and installment debt, as a percentage of
gross monthly income), payment history on existing mortgages, customer's history
of bankruptcy, the credit score of the applicant provided from services accepted
by the various investor's who buy our loans and the combined loan-to-value ratio
for all existing mortgages on a property.
Assessment of the applicant's demonstrated willingness and ability to
pay is one of the principal elements in distinguishing the Company's lending
specialty from methods employed by traditional lenders. All lenders utilize debt
ratios and loan-to-value ratios in the approval process. Many lenders rely on
software packages to score an applicant for loan approval and fund the loan
after auditing the data provided by the borrower. The Company primarily relies
upon experienced non-conforming mortgage loan underwriters to scrutinize an
applicant's credit profile and to evaluate whether an impaired credit history is
a result of previous adverse circumstances or a continuing inability or
unwillingness to meet credit obligations in a timely manner. Personal
circumstances including divorce, family illnesses or deaths and temporary job
loss due to layoffs and corporate downsizing will often impair an applicant's
credit record.
Upon completion of the underwriting and processing functions, the loan
is closed through a closing attorney or agent approved by the Company. The
closing attorney or agent is responsible for completing the loan transaction in
accordance with applicable law and the Company's operating procedures.
The Company requires title insurance coverage issued by an approved ALTA
title insurance company of all property securing mortgage loans it originates or
purchases. The Company and its assignees are generally named as the insured.
Title insurance policies indicate the lien position of the mortgage loan and
protect the Company against loss if the title or lien position is not as
indicated. The applicant is also required to secure hazard and, in certain
instances, flood insurance in an amount sufficient to cover the building
securing the loan for the entire term of the loan, for an amount that is at
least equal to the outstanding principal balance of the loan or the maximum
limit of coverage available under applicable law, whichever is less. Evidence of
adequate homeowner's insurance naming the Company as an additional insured is
required on all loans.
The Company has established classifications with respect to the credit
profiles of loans based on certain of the applicant's characteristics. Each loan
applicant is placed into one of four letter ratings "A" through "D," with
sub-ratings within those categories. Ratings are based upon a number of factors
including the applicant's credit history, the value of the property and the
applicant's employment status. The Company also relies on the judgment of its
underwriting staff, which may make exceptions to the general criteria and
upgrade a rating due to factors considered appropriate to the underwriting
staff. Terms of loans made by the Company, as well as the maximum loan-to-value
ratio and debt service-to-income coverage (calculated by dividing fixed monthly
debt payments by gross monthly income), vary depending upon the classification
of the borrower. Borrowers with lower credit ratings generally pay higher rates
and loan origination fees.
Subject to the judgment of the Company's underwriting staff to make
exceptions to the general criteria, the general criteria currently used by the
Company in classifying loan applicants are set forth below:
"A" Risk. Under the "A" risk category, a loan applicant must have
generally repaid installment or revolving debt according to its terms.
o Existing mortgage loans: required to be current at the time the
application is submitted, with a maximum of one (or two on a
case-by-case basis) 30-day late payment(s) within the last 12 months
being acceptable.
o Non-mortgage credit: minor derogatory items are allowed, but a letter
of explanation is required; any recent open collection accounts or
open charge-offs, judgements or liens would generally disqualify a
loan applicant from this category.
o Bankruptcy filings: must have been discharged more than four years
prior to closing with credit re-established.
o Maximum loan-to-value ratio: up to 80% (or 90% on an exception basis
with compensating factors) is permitted for a loan secured by an
owner-occupied oneto four-family residence; 80% for a loan secured by
an owner-occupied condominium; and 70% (or up to 80% on an exception
basis with compensating factors) for a loan secured by a non-owner
occupied one- to four-family residence.
o Debt service-to-income ratio: generally 45% or less.
"B" Risk. Under the "B" risk category, a loan applicant must have
generally repaid installment or revolving debt according to its terms.
o Existing mortgage loans: required to be current at the time the
application is submitted, with a maximum of three (or four on a
case-by-case basis) 30-day late payments within the last 12 months
being acceptable.
o Non-mortgage credit: some prior defaults may have occurred, but major
credit paid or installment debt paid as agreed may offset some
delinquency; any open charge-offs, judgements or liens would
generally disqualify a loan applicant from this category.
o Bankruptcy filings: must have been discharged more than two years
prior to closing with credit re-established.
o Maximum loan-to-value ratio: up to 80% (or 85% on an exception basis
with compensating factors) is permitted for a loan secured by an
owner-occupied oneto four-family residence; and 70% (or 80% on an
exception basis with compensating factors) for a loan secured by a
non-owner occupied one- to four-family residence.
o Debt service-to-income ratio: generally 45% or less (up to 50% on
an exception basis with compensating factors).
"C" Risk. Under the "C" risk category, a loan applicant may have
experienced significant credit problems in the past.
o Existing mortgage loans: must be brought current from loan proceeds;
applicant is allowed a maximum of four 30-day late payments and one
60-day late payment within the last 12 months.
o Non-mortgage credit: significant prior delinquencies may have
occurred, but major credit paid or installment debt as agreed may
offset some delinquency; all delinquent credit must be current or
paid off.
o Bankruptcy filings: must have been discharged, and a
minimum one-year of re-established credit is required.
o Maximum loan-to-value ratio: up to 75% (or 80% on an exception basis
with compensating factors for first liens only) is permitted for a
loan secured by an owner-occupied one- to four-family residence; 65%
for a loan secured by an owner-occupied condominium; and 65% for a
non-owner occupied one- to four- family residence.
o Debt service-to-income ratio: generally 50% or less.
"D" Risk. Under the "D" risk category a loan applicant may have
experienced significant credit problems in the past.
o Existing mortgage loans: must be brought current from loan proceeds
and no more than 149 days delinquent at closing; an explanation for
such delinquency is required.
o Non-mortgage credit: significant prior defaults may have occurred,
but the applicant must be able to demonstrate regularity in payment
of some credit obligations; all charge-offs, judgements, liens or
collection accounts must be paid off.
o Bankruptcy filings: open Chapter 13 bankruptcies will be considered
with evidence that the plan is being paid according to terms;
outstanding balance must be paid in full and discharged from loan
proceeds.
o Maximum loan-to-value ratio: generally 65% (or 70% on an exception
basis with compensating factors for first liens only) for a loan
secured by an owner-occupied one- to four-family residence; 60% for a
loan secured by an owner-occupied condominium; and 60% for a
non-owner occupied one- to four-family residence.
o Debt service-to-income ratio: generally 50% or less (up to 55% on
an exception basis with compensating factors).
The Company uses the foregoing categories and characteristics only as
guidelines. On a case-by-case basis, the underwriting staff may determine that
the prospective borrower warrants a risk category upgrade, a debt
service-to-income ratio exception, a pricing exception, a loan-to-value
exception or an exception from certain requirements of a particular risk
category. An upgrade or exception may generally be allowed if the application
reflects certain compensating factors, among others: low loan-to-value ratio;
stable employment or length of occupancy at the applicant's current residence.
For example, a higher debt ratio may be acceptable with a lower loan-to-value
ratio. An upgrade or exception may also be allowed if the applicant places a
down payment in escrow equal to at least 20% of the purchase price of the
mortgaged property, or if the new loan reduces the applicant's monthly aggregate
debt load. Accordingly, the Company may classify in a more favorable risk
category certain mortgage loans that, in the absence of such compensating
factors, would satisfy only the criteria of a less favorable risk category. The
foregoing examples of compensating factors are not exclusive. The underwriting
staff has discretion to make exceptions to the criteria and to upgrade ratings
on case-by-case basis.
MORTGAGE LOAN SERVICING
The Company has been servicing its portfolio and warehouse loans for
many years. Since January 1, 1997, the Savings Bank's portfolio of loans held
for sale and for investment has been serviced by the Company under a contractual
arrangement.
The Company's loan servicing operation has two functions: collections
and customer service for borrowers. The servicing department monitors loans,
collects current payments due from borrowers. The collections specialists
furnish reports and enforce the holder's rights, including recovering delinquent
payments, instituting loan foreclosures and liquidating the underlying
collateral.
The Company closes loans throughout the month. Most of the Company's
loans require a first payment thirty to forty-five days after funding.
Accordingly, the Company's servicing portfolio consists of loans with payments
due at varying times each month.
The Company's collections policy is designed to identify payment
problems sufficiently early to permit the Company to address delinquency
problems quickly and, when necessary, to act to preserve equity before a
property goes to foreclosure. The Company believes that these policies, combined
with the experience level of independent appraisers engaged by the Company, help
to reduce the incidence of charge-offs on a first or second mortgage loan.
Collection procedures commence upon identification of a past due account
by the Company's automated servicing system. Five days before the first payment
is due on every loan, the borrower is contacted by telephone to welcome the
borrower, to remind the borrower of the payment date and to answer any questions
the borrower may have. If the first payment due is delinquent, a collector will
immediately telephone to remind the borrower of the payment. Five days after any
payment is due, a written notice of delinquency is sent to the borrower and
follow up calls are made. A second written notice is sent on the fifteenth day
after payment is due and follow up calls are continued to be made by the
collector. During the delinquency period, the collector will continue to
frequently contact the borrower. Company collectors have computer access to
telephone numbers, payment histories, loan information and all past collection
notes. All collection activity, including the date collection letters were sent
and detailed notes on the substance of each collection telephone call, is
entered into a permanent collection history for each account. Notice of the
Company's intent to start foreclosure proceedings is sent at thirty days past
due. Further guidance with respect to the collection and foreclosure process is
derived through frequent communication with the Company's senior management.
The Company's loan servicing software also tracks and maintains
homeowners' insurance information. Expiration reports are generated weekly
listing all policies scheduled to expire within 30 days. When policies lapse, a
letter is issued advising the borrower of the lapse and that the Company will
obtain force-placed insurance at the borrower's expense. The Company also has an
insurance policy in place that provides coverage automatically for the Company
in the event the Company fails to obtain force-placed insurance.
At the time the foreclosure process begins through the time of
liquidation of real estate owned ("REO") the account is transferred to the
foreclosure and REO department. There are occasions when a foreclosures and
charge-off occurs. Prior to a foreclosure sale, the Company performs a
foreclosure analysis with respect to the mortgaged property to determine the
value of the mortgaged property and the bid that the Company will make at the
foreclosure sale. This analysis includes: (i) a current valuation of the
property obtained through a drive-by appraisal conducted by an independent
appraiser; (ii) an estimate of the sales price of the mortgaged property by
sending two local realtors to inspect the property; (iii) an evaluation of the
amount owed, if any, to a senior mortgagee and for real estate taxes; and (iv)
an analysis of the marketing time, required repairs and other costs, such as for
real estate broker fees, that will be incurred in connection with the
foreclosure sale.
All foreclosures are assigned to outside counsel located in the same
state as the secured property. Bankruptcies filed by borrowers are also assigned
to appropriate local counsel who are required to provide monthly reports on each
loan file.
At the present time the Company does not service mortgage loans for
other investors. However, in future periods the Company may securitize loans and
retain the servicing component on those securities. In this event, the Company
would need to enhance its servicing capabilities. If the Company were to adopt a
securitization loan sale strategy, it may engage one or more companies to
sub-service a portion of it's the loans securitized.
MARKETING
MARKETING TO BROKER NETWORKS. Marketing to brokers is conducted through
the Company's staff of account executives ("AE"), who establish and maintain
relationships with the Company's network of mortgage brokers that refer loans to
the Company. Loans made through the broker networks amounted to 39% of total
originations in 1998, compared to 55% of total loan originations in 1997. See
the table on page 45 for divisional loan originations by state. The AEs provide
various levels of information, assistance and training to the mortgage brokers
regarding the Company's products and non-traditional prospecting strategies, and
are principally responsible for maintaining the Company's relationships with its
clients. AEs endeavor to increase the volume of loan originations from brokers
located within the geographic territory assigned to them. The AEs and the
national and regional broker AE sales managers visit brokers offices and attend
trade shows. The AEs also provide feedback to the Company relating to the
current marketplace relative to products and pricing offered by competitors and
new market entrants, all of which assist the Company in refining its programs in
order to offer competitive products. The AEs are compensated with a base salary
and commissions based on the volume of loans that are originated as a result of
their efforts.
MARKETING OF RETAIL LENDING PRODUCTS. The Company markets its direct
consumer lending services through a sales staff of loan officers in its branch
offices located in several states. Loans made through the retail lending
division amounted to 61% of total originations in 1998, compared to 45% of total
loan originations in 1997. See the table on page 45 for divisional loan
originations by state.
The branch office network is used for marketing to and meeting with
the Company's local borrowers. During the first quarter of 1999, we have
consolidated or closed several small retail branch locations and initiated plans
to restructure the retail branches as highly focused sales centers. Retail
branches are currently expanding their sales staffs and directing the
telemarketing, advertising and most processing functions that were formerly
handled in the branches to the Company's home office in Virginia Beach.
The Company uses targeted outbound telemarketing that is centralized
from the Virginia Beach headquarters. An automatic dialer telemarketing system
is used for targeted lead generation campaigns for each retail branch. This
centralized system allows the Company to efficiently purchase and use lists of
potential leads and to maintain the required "do not call" list of names. The
campaigns are rotated to provide the appropriate number of leads to each branch
based on the number of loan officers.
To enhance retail loan production volume and boost lead generation
capacity for accommodation of an expanding sales force, the Company established
a new National Sales Center in its Virginia Beach office during the first
quarter of 1999. This division services in-bound calls from various forms of
advertising and marketing campaigns initiated from the home office in the
geographic locations surrounding retail branch locations. It functions both as a
lead generation source for the retail branch network and originates mortgages
through an on-site staff of retail loan officers.
Occasionally, when a potential retail customer applies for a loan and
does not fall within the Company's underwriting guidelines, the Company may
submit the application to other lending institutions. If the loan is approved by
another lending institution, the Company will not fund the loan but will act as
a mortgage broker, receiving a broker fee at the time the loan is closed.
COMPANY'S SOURCES OF FUNDS AND LIQUIDITY
At December 31, 1998, the Company had warehouse and other credit
facilities with an aggregate commitment of $125 million. The Company expects to
be able to maintain existing warehouse and other credit facilities (or obtain
replacement or additional financing) as current arrangements expire or become
fully utilized; however, there can be no assurance that such financing will be
obtainable on favorable terms. Any failure to renew or obtain adequate funding
under these warehouse facilities or other financing, or any substantial
reduction in the size of or pricing in the markets for the Company's loans,
could have a material adverse effect on the Company's operations. (See page 63
for further discussion).
SAVINGS BANK SOURCES OF FUNDS
DEPOSITS. The primary source of deposits for the Savings Bank has been
brokered certificates of deposit obtained through national investment banking
firms, which, pursuant to agreements with the Savings Bank, solicit funds from
their customers for deposit with the Savings Bank ("brokered deposits"). Such
deposits amounted to $3,560,000, or 12.0%, of the Savings Bank's deposits at
December 31, 1998. The Savings Bank solicits deposits via a computer bulletin
board where the rates of many other banks and savings institutions are
advertised. At December 31, 1998, the Savings Bank had deposits of $26,168,000,
or 88.0%, of total deposits from this source.
The fees paid to deposit brokers are amortized using the interest method
and included in interest expense on certificates of deposit.
The Savings Bank's management believes that the effective cost of
brokered and other wholesale deposits is more attractive than deposits obtained
on a retail basis from branch offices after the general and administrative
expense associated with the maintenance of branch offices is taken into account.
Moreover, brokered and other wholesale deposits generally give the Savings 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, 1998, $15,749,000 of the Savings Bank's certificates of deposit
were scheduled to mature within one year (53.0% of total deposits).
Although management of the Savings Bank believes that brokered and other
wholesale deposits are advantageous in certain respects, such funding sources,
when compared to retail deposits attracted through a branch network, are
generally more sensitive to changes in interest rates and volatility in the
capital markets and are more likely to be compared by the investor to competing
instruments. In addition, such funding sources may be more sensitive to
significant changes in the financial condition of the Savings Bank. There are
also various regulatory limitations on the ability of all but well-capitalized
insured financial institutions to obtain brokered deposits; see "Regulation of
the Savings Bank Brokered Deposits." These limitations currently are not
applicable because the Savings Bank is a well-capitalized financial institution
under applicable laws and regulations. There can be no assurances, however, that
the Savings Bank will not become subject to such limitations in the future. In
addition, the Company's reliance on wholesale deposits effects its ability to
rollover deposits as they mature due to the fact that in general the wholesale
customer is highly interest rate-sensitive. The total deposit asset size of the
Savings Bank was under $4 million prior to October of 1997, therefore, the rate
at which the Savings Bank was able to rollover maturing deposits does not
represent a meaningful measurement, nor is it useful in assessing the Company's
ability or likelihood to do so in the future. However, management is of the
opinion that it will be able to readily obtain funding from the wholesale
deposit market in future periods at the then current competitive interest rates
being offered by other institutions.
As a result of the Savings 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 Savings Bank's financial condition, among
other factors, could affect the Savings Bank's liquidity and results of
operations much more significantly than might be the case with an institution
that obtained a greater portion of its funds from retail or core deposits
attracted through a branch network. (See page 20 of the audited financial
statements for a table that sets forth various interest rate categories for the
certificates of deposit of the Savings Bank.)
BORROWINGS. The Savings Bank is able to obtain advances from the FHLB of
Atlanta upon the security of certain of its residential first mortgage loans,
and other assets, including FHLB stock, provided certain standards related to
the creditworthiness of the Savings Bank have been met. FHLB advances are
available to member institutions such as the Savings Bank for investment and
lending activities and other general business purposes. FHLB advances are made
pursuant to several different credit programs, each of which has its own
interest rate, which may be fixed or adjustable, and which has its own range of
maturities. FHLB members are required to hold shares of the capital stock of the
regional FHLB in which they are a member in an amount at least equal to the
greater of 1% of the member's home mortgage loans or 5% of the member's advances
from the FHLB. The Savings Bank did not obtain any advances from the FHLB of
Atlanta during the period September 12, 1996 through December 15, 1997. On
December 16, 1997, the Savings Bank borrowed $1,000,000 from the FHLB, and this
amount was outstanding at December 31, 1997. During 1998, the outstanding
balance grew to $2 million before it was paid off on December 30, 1998. The
Savings Bank held $146,000 and $50,000 of the FHLB stock at December 31, 1998
and December 31, 1997, respectively. Management expects to utilize FHLB advances
as the Savings Bank builds a portfolio of loans.
TAXATION
GENERAL. The Company and all of its subsidiaries currently file, and
expect to continue to file, a consolidated federal income tax return based on a
calendar year. Consolidated returns have the effect of eliminating intercompany
transactions, including dividends, from the computation of taxable income.
The Company's income is subject to tax in most of the states in
which it is making loans. The Company's taxable income in most states is
determined based on certain apportionment factors.
ALTERNATIVE MINIMUM TAX. In addition to the regular corporate income
tax, corporations, including qualifying savings institutions, can be subject to
an alternative minimum tax. The 20% tax is computed on Alternative Minimum
Taxable Income ("AMTI") and applies if it exceeds the regular tax liability.
AMTI is equal to regular taxable income with certain adjustments. For taxable
years beginning after 1989, AMTI includes an adjustment for 75% of the excess of
"adjusted current earnings" over regular taxable income. Net operating loss
carrybacks and carryforwards are permitted to offset only 90% of AMTI.
Alternative minimum tax paid can be credited against regular tax due in later
years. The Company is not currently subject to the AMT.
EMPLOYEES
As of December 31, 1998, the Company and its subsidiaries had a total of
482 full-time employees and 149 part-time employees or 556 full time equivalent
employees. None of the Company's employees were covered by a collective
bargaining agreement. The Company considers its relations with its employees to
be good.
SERVICE MARKS
The Company has four service marks that have become federally
registered. They are "Armada" which became registered on July 23, 1996,
"Approved Residential Mortgage" which became registered on May 15, 1995,
"Approved Financial Corp." which became registered July 21, 1998 and
"ConsumerOne Financial" which became registered on December 18, 1998. "Approved
Federal Savings Bank" and "Step Two Loan" are two additional service marks
currently pending registration.
EFFECT OF ADVERSE ECONOMIC CONDITIONS
The Company's business may be adversely affected by periods of economic
slowdown or recession, which may be accompanied by decreased demand for consumer
credit and declining real estate values. Any material decline in real estate
values reduces the ability of borrowers to use home equity to support borrowings
and increases the loan-to-value ratios of loans previously made by the Company,
thereby weakening collateral coverage and increasing the possibility of a loss
in the event of default. In addition, delinquencies, foreclosures and losses
generally increase during economic slowdowns or recessions.
CONCENTRATION OF OPERATIONS IN SEVEN STATES
During 1998, 90.5% of the aggregate principal balance of the loans
originated by the Company were secured by properties located in seven states
(Florida, Georgia, South Carolina, North Carolina, Virginia, Maryland and
Ohio). Although the Company has expanded its wholesale and retail mortgage
origination networks outside this region, the Company's origination business is
likely to remain concentrated in those states for the foreseeable future.
Consequently, the Company's results of operations and financial condition are
dependent upon general trends in the economy and the residential real estate
markets in those states.
FUTURE RISKS ASSOCIATED WITH LOAN SALES THROUGH SECURITIZATIONS
In future periods, the Company may sell a portion of the loans it
originates through a securitization program and retain the rights to service the
loans. The sale of loans through a securitization program would be a significant
departure from the Company's previous business operations. While a possible
securitization program is being considered, no decision has been made whether to
do so, and management has no specific time frame for such a program.
Adverse changes in the securitization market could impair the Company's
ability to originate and sell loans through securitizations on a favorable or
timely basis. Any such impairment could have a material adverse effect upon the
Company's results of operations and financial condition. Furthermore, the
Company's quarterly operating results in future periods may fluctuate
significantly as a result of the timing and level of securitizations. If
securitizations do not close when expected, the Company's results of operations
may be adversely affected for that period.
CONTINGENT RISKS
In the ordinary course of its business, the Company is subject to claims
made against it 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
employees, officers, and agents of the Company (including its appraisers),
incomplete documentation and failures by the Company to comply with various laws
and regulations applicable to its business. Management is not aware of any
material claims.
Although the Company sells substantially all loans that it originates
and purchases on a non-recourse basis, during the period of time that loans are
held pending sale, the Company is subject to the various business risks
associated with lending, including the risk of borrower default, loan
foreclosure and loss, and the risk that an increase in interest rates or a
change in secondary market conditions for any reason would result in a decline
in the value of loans to potential purchasers.
COMPETITION
The Company faces intense competition from other mortgage banking
companies, banks, credit unions, thrift institutions, credit card issuers, and
finance companies. Many of these competitors in the financial services business
are substantially larger and have more capital and financial resources than the
Company. Also, the larger national finance companies, banks, quasi-governmental
agencies and other originators of conforming mortgage loans have been adapting
their conforming origination programs to expand into the non-conforming loan
business and are targeting the Company's prime customer base. There can be no
assurance that the Company will not face increased competition from such
institutions.
Competition can take on many forms, including convenience in obtaining a
loan, service, loan pricing terms such as the loan to value ratio and interest
rate, marketing and distribution channels and competition for employees through
compensation plans and benefit packages.
The quantity and quality of competition for the Company may also be
affected by fluctuations in interest rates and general economic conditions.
During periods of rising rates, competitors which have "locked in" low borrowing
costs may have a competitive advantage. During periods of declining interest
rates, competitors may solicit the Company's borrowers to refinance their
mortgage loans. During an economic slowdown or recession, the Company's
borrowers may have new financial difficulties and may be receptive to offers by
the Company's competitors.
The Company uses mortgage brokers as a source of origination of new
loans. The Company's competitors also seek to establish relationships with the
brokers with which the Company does business. The Company's future results may
become more exposed to fluctuations in the volume and costs of its wholesale
loans (loans sourced from mortgage brokers) resulting from competition from
other originators of such loans, market conditions and other factors.
REGULATION
The Company's business is subject to extensive regulation, supervision
and licensing by federal, state and local government authorities and is subject
to various laws and judicial and administrative decisions imposing requirements
and restrictions on part or all of its operations. Regulated matters include
loan origination, credit activities, maximum interest rates and finance and
other charges, disclosure to customers, the terms of secured transactions, the
collection, repossession and claims-handling procedures utilized by the Company,
multiple qualification and licensing requirements for doing business in various
jurisdictions and other trade practices. The following discussion and other
references to and descriptions of the regulation of financial institutions
contained in this document constitute brief summaries of the regulations as
currently in effect. This discussion is not intended to constitute a complete
statement of all the legal restrictions and requirements applicable to the
Company and the Savings Bank and all such descriptions are qualified in their
entirety by reference to applicable statutes, regulations and other regulatory
pronouncements.
The Company's consumer lending activities are subject to the federal
Truth-in-Lending Act ("TILA") and Regulation Z (including the Home Ownership and
Equity Protection Act of 1994); the federal Equal Credit Opportunity Act and
Regulation B, as amended (the "ECOA"); the Home Mortgage Disclosure Act and the
Fair Credit Reporting Act of 1970, as amended ("FCRA"); the federal Real Estate
Settlement Procedures Act ("RESPA") and Regulation X; the federal Home Mortgage
Disclosure Act; and the federal Fair Debt Collection Practices Act. The Company
is also subject to state statutes and regulations affecting its activities.
TILA and Regulation Z promulgated thereunder contain disclosure
requirements designed to provide consumers with uniform, understandable
information with respect to the terms and conditions of loans and credit
transactions in order to give them the ability to compare credit terms. TILA
also guarantees consumers a three-day right to cancel certain credit
transactions including loans of the type originated by the Company. Management
of the Company believes that it is in compliance with TILA in all material
respects.
In September 1994, the Riegle Community Development and Regulatory
Improvement Act of 1994 (the "Riegle Act") was enacted. Among other things, the
Riegle Act made certain amendments to TILA. The TILA Amendments, which became
effective in October 1995, generally apply to mortgage loans with (i) total
points and fees upon origination in excess of the greater of eight percent of
the loan amount or $424 or (ii) an annual percentage rate of more than ten
percentage points higher than comparable maturing U.S. Treasury securities.
Loans covered by the TILA Amendments are known as "Section 32 Loans."
The TILA Amendments impose additional disclosure requirements on lenders
originating Section 32 Loans and prohibit lenders from originating Section 32
Loans that are underwritten solely on the basis of the borrower's home equity
without regard to the borrower's ability to repay the loan. In accordance with
TILA Amendments, the Company applies underwriting criteria that take into
consideration the borrower's ability to repay all Section 32 Loans.
The TILA Amendments also prohibit lenders from including prepayment fee
clauses in Section 32 loans to borrowers with a debt-to-income ratio in excess
of 50%. In addition, a lender that refinances a Section 32 Loan previously made
by such lender will not be able to enforce any prepayment penalty clause
contained in such refinanced loan. The Company will continue to collect
prepayment fees on loans originated prior to the effectiveness of the TILA
Amendments and on non-Section 32 Loans as well as on Section 32 Loans in
permitted circumstances following the effectiveness of the TILA Amendments. The
TILA Amendments impose other restrictions on Section 32 Loans, including
restrictions on balloon payments and negative amortization features, which the
Company believes will not have a material impact on its operations.
The Company is also required to comply with the ECOA, which prohibits
creditors from discriminating against applicants on the basis of race, color,
sex, age or marital status. Regulation B promulgated under ECOA restricts
creditors from obtaining certain types of information from loan applicants. It
also requires certain disclosures by the lender regarding consumer rights and
requires lenders to advise applicants of the reasons for any credit denial. In
instances where the applicant is denied credit or the rate or charge for a loan
increases as a result of information obtained from a consumer credit agency,
another statute, the FCRA requires the lender to supply the applicant with a
name and address of the reporting agency. The Company is also subject to the
Real Estate Settlement Procedures Act and is required to file an annual report
with the Department of Housing and Urban Development pursuant to the Home
Mortgage Disclosure Act.
The Company is also subject to the rules and regulations of, and
examinations by, the U.S. Department of Housing and Urban Development and state
regulatory authorities with respect to originating, processing, underwriting,
selling and servicing loans. These rules and regulations, among other things,
impose licensing obligations on the Company, establish eligibility criteria for
mortgage loans, prohibit discrimination, provide for inspections and appraisals
of properties, require credit reports on loan applicants, regulate assessment,
collection, foreclosure and claims handling, investment and interest payments on
escrow balances and payment features, and mandate certain loan amounts.
Failure to comply with these requirements can lead to loss of approved
status, termination or suspension of servicing contracts without compensation to
the servicer, demands for indemnification or mortgage loan repurchases, certain
rights of rescission for mortgage loans, class action lawsuits and
administrative enforcement actions. There can be no assurance that the Company
will maintain compliance with these requirements in the future without
additional expenses, or that more restrictive federal, state or local laws,
rules and regulations will not be adopted that would make compliance more
difficult for the Company. Management believes that the Company is in compliance
in all material respects with applicable federal and state laws and regulations.
The Company is also subject to various other federal and state laws
regulating the issuance and sale of securities, relationships with entities
regulated by the Employee Retirement Income Security Act of 1974, as amended,
and other aspects of its business.
The laws, rules and regulations applicable to the Company are subject to
regular modification and change. There are currently proposed various laws,
rules and regulations, which, if adopted, could impact the Company. There can be
no assurance that these proposed laws, rules and regulations, or other such
laws, rules or regulations, will not be adopted in the future which could make
compliance much more difficult or expensive, restrict the Company's ability to
originate, purchase, broker or sell loans, further limit or restrict the amount
of commissions, interest and other charges earned on loans originated or sold by
the Company, or otherwise adversely affect the business or prospects of the
Company.
OTS REGULATION OF THE COMPANY
GENERAL. The Company is a registered savings and loan holding company
under the federal Home Owner's Loan Act ("HOLA") because of its ownership of the
Savings Bank. As such, the Company is subject to the regulation, supervision and
examination of the OTS.
ACTIVITIES RESTRICTION. There are generally no restrictions on the
activities of a savings and loan holding company, such as the Company, which
holds only one subsidiary savings institution. However, if the Director of the
OTS determines that there is reasonable cause to believe that the continuation
by a savings and loan holding company of an activity constitutes a serious risk
to the financial safety, soundness or stability of its subsidiary savings
institution, the Director may impose such restrictions as deemed necessary to
address such risk, including the limitation of: (i) payment of dividends by the
savings institution; (ii) transactions between the savings institution and its
affiliates; and (iii) any activities of the savings institution that might
create a serious risk that the liabilities of the holding company and its
affiliates may be imposed on the savings institution. Notwithstanding the above
rules as to the permissible business activities of unitary savings and loan
holding companies, if the savings institution subsidiary of such a holding
company fails to meet a qualified thrift lender ("QTL") test set forth in OTS
regulations, then such unitary holding company shall become subject to the
activities and regulations applicable to multiple savings and loan holding
companies and, unless the savings institution qualifies as a QTL within one year
thereafter, shall register as, and become subject to the restriction applicable
to, a bank holding company. See "Regulation of the Savings Bank - Qualified
Thrift Lender Test."
If the Company were to acquire control of another savings institution
other than through merger or other business combination with the Savings Bank,
the Company would become a multiple savings and loan holding company. Except
where such acquisition is pursuant to the authority to approve emergency thrift
acquisition and where each subsidiary savings institution meets the QTL test, as
set forth below, the activities of the Company and any of its subsidiaries
(other than the Savings Bank or other subsidiary savings institutions) would
thereafter be subject to further restrictions. Among other things, no multiple
savings and loan holding company or subsidiary thereof which is not a savings
institution generally shall commence or continue for a limited period of time
after becoming a multiple savings and loan holding company or subsidiary thereof
any business activity, other than: (i) furnishing or performing management
services for a subsidiary savings institution; (ii) conducting an insurance
agency or escrow business; (iii) holding, managing, or liquidating assets owned
by or acquired from a subsidiary savings institution; (iv) holding or managing
properties used or occupied by a subsidiary savings institution; (v) acting as
trustee under deeds of trust; (vi) those activities authorized by regulation as
of March 5, 1987 to be engaged in by multiple savings and loan holding
companies; or (vii) unless the Director of the OTS by regulation prohibits or
limits such activities for savings and loan holding companies, those activities
authorized by the Federal Reserve Board as permissible for bank holding
companies. Those activities described in clause (vii) above also must be
approved by the Directors of the OTS prior to being engaged in by a multiple
savings and loan holding company.
RESTRICTIONS ON ACQUISITIONS. Except under limited circumstances,
savings and loan holding companies such as the Company are prohibited from
acquiring, without prior approval of the Director of the OTS, (i) control of any
other savings institution or savings and loan holding company or substantially
all the assets thereof or (ii) more than 5% of the voting shares of a savings
institution or holding company thereof which is not a subsidiary. Except with
the proper approval of the Director of the OTS, no director or officer of a
savings and loan holding company or person owning or controlling by proxy or
otherwise more than 25% of such company's stock, may acquire control of any
savings institution, other than a subsidiary savings institution, or of any
other savings and loan holding company.
The Director of the OTS may approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state only if (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office located in the state of the institution to be acquired as of March
5, 1987; (ii) the acquirer is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provision of the Federal
Deposit Insurance Act ("FDIA"); or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by state-chartered savings institutions located in the state where the
acquiring entity is located (or by a holding company that controls such
state-chartered savings institutions).
RESTRICTIONS ON TRANSACTIONS WITH AFFILIATES. Transactions between the
Company or any of its non-bank subsidiaries and the Savings Bank are subject to
various restrictions, which are described under "Regulation of the Savings
Bank-Affiliate Transactions."
REGULATION OF THE SAVINGS BANK
GENERAL. The Savings Bank is a federally chartered savings bank
organized under the HOLA. As such, the Savings Bank is subject to regulation,
supervision and examination by the OTS. The deposit accounts of the Savings Bank
are insured up to applicable limits by the SAIF administered by the FDIC and, as
a result, the Savings Bank also is subject to regulation, supervision and
examination by the FDIC. The Savings 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 Savings Bank is a member of the FHLB of
Atlanta.
The business and affairs of the Savings 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 Savings Bank may make,
transactions with affiliates, community and consumer lending laws, internal
policies and controls, reporting by and examination of the Savings Bank and
changes in control of the Savings Bank.
INSURANCE OF ACCOUNTS. Deposit accounts of the Savings 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 Savings Bank paid $23,000 for this assessment.
The new legislation also provides for the merger, subject to certain
conditions, of the SAIF into the Bank Insurance Fund ("BIF") by 1999 and also
requires 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
pay deposit insurance premiums at the annual rate of 6.4 basis points of their
insured deposits and BIF-insured institutions will pay 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. Under the current risk
classification system, institutions are assigned on one of three capital groups
which are based solely on the level of an institution's capital - "well
capitalized," "adequately capitalized" and "undercapitalized" - which are
defined in the same manner as the regulations establishing the prompt corrective
action system under Section 38 of the FDIA, as discussed below. These three
groups are then divided into three subgroups, which are based on supervisory
evaluations by the institution's primary federal regulator, resulting in nine
assessment classifications. Assessment rates currently range from zero basis
points for well capitalized, healthy institutions to 27 basis points for
undercapitalized institutions with substantial supervisory concerns.
The re-capitalization of the SAIF is expected to result in lower deposit
insurance premiums in the future for most SAIF-insured financial institutions,
including the Savings Bank.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Savings Bank, if it determines after a hearing that
the institution has engaged or is engaging in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances, which would result
in termination of the Savings 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, 1998, the Savings Bank's regulatory capital exceeded applicable
requirements for categorization as "well-capitalized."
Federally-insured savings associations are subject to three capital
requirements: a tangible capital requirement, a core or leverage capital
requirement and a risk-based capital requirement. All savings associations
currently are required to maintain tangible capital of at least 1.5% of adjusted
total assets (as defined in the regulations), core capital equal to 3% of
adjusted total assets and total capital (a combination of core and supplementary
capital) equal to 8% of risk-weighted assets (as defined in the regulations).
For purposes of the regulation, tangible capital is core capital less all
intangibles other than qualifying purchased mortgage-servicing rights, of which
the Savings Bank had none at December 31, 1998. Core capital includes common
stockholders' equity, non-cumulative perpetual preferred stock and related
surplus, minority interest in the equity accounts of fully consolidated
subsidiaries and certain nonwithdrawable accounts and pledged deposits. Core
capital generally is reduced by the amount of a savings association's intangible
assets, other than qualifying mortgage-servicing rights.
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital included does not exceed the savings association's core capital.
Supplementary capital consists of certain 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
generally are not limited: taxes paid in prior carryback years and future
reversals of existing taxable temporary differences. To the extent that the
realization of deferred tax assets depends on an institution's future taxable
income (exclusive of reversing temporary differences and carryforwards), or its
tax-planning strategies, such deferred tax assets are limited for regulatory
capital purposes to the lesser of the amount that can be realized within one
year of the quarter-end report date or 10% of core capital. The foregoing
considerations did not affect the calculation of the Savings Bank's regulatory
capital at December 31, 1998.
In August 1993, the OTS adopted a final rule incorporating an
interest-rate risk component into the risk-based capital regulation. Under the
rule, an institution with a greater than "normal" level of interest rate risk
will be subject to a deduction of its inherent rate risk component from total
capital for purposes of calculating the risk-based capital requirement. As a
result, such an institution will be required to maintain additional capital in
order to comply with the risk-based capital requirement. Although the final rule
was originally scheduled to be effective as of January 1994, the OTS has
indicated that it will delay invoking its interest rate risk rule requiring
institutions with above normal interest rate risk exposure to adjust their
regulatory capital requirement until appeal procedures are implemented and
evaluated. The OTS has not yet established an effective date for the capital
deduction. Management of the Company does not believe that the OTS' adoption of
an interest rate risk component to the risk-based capital requirement will
adversely affect the Savings Bank if it becomes effective in its current form.
In April 1991, the OTS proposed to modify the 3% of adjusted total
assets core capital requirement in the same manner as was done by the
Comptroller of the Currency for national savings banks. Under the OTS proposal,
only savings 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 savings associations, the minimum core capital ratio will be 3% plus
at least an additional 100 to 200 basis points, which will increase the 4% core
capital ratio requirement to 5% of adjusted total assets or more. In determining
the amount of additional capital, the OTS will assess both the quality of risk
management systems and the level of overall risk in each individual savings
association through the supervisory process on a case-by-case basis.
PROMPT CORRECTIVE ACTION. Federal law provides the federal banking
regulators with broad power to take "prompt corrective action" to resolve the
problems of undercapitalized institutions. The extent of the regulators' powers
depends on whether the institution in question is "well capitalized,"
"adequately capitalized," "under-capitalized," "significantly undercapitalized"
or "critically undercapitalized." Under regulations adopted by the federal
banking regulators, an institution shall be deemed to be (i) "well capitalized"
if it has a total risk-based capital ratio of 10.0% or more, has a Tier I
risk-based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of
5.0% or more and is not subject to specified requirements to meet and maintain a
specific capital level for any capital measure; (ii) "adequately capitalized" if
it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based
capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or
more (3.0% under certain circumstances) and does not meet the definition of
"well capitalized," (iii) "undercapitalized" if it has a total risk-based
capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is
less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0%
under certain circumstances), (iv) "significantly undercapitalized" if it has a
total risk-based capital ratio that is less than 6.0%, a Tier I risk-based
capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is
less than 3.0%, and (v) "critically undercapitalized" 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 Savings 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, 1998,
the Savings Bank was a "well capitalized" institution under the prompt
corrective action regulations of the OTS.
Depending upon the capital category to which an institution is assigned,
the regulators' corrective powers, many of which are mandatory in certain
circumstances, include prohibition on capital distributions; prohibition on
payment of management fees to controlling persons; requiring the submission of a
capital restoration plan; placing limits on asset growth; limiting acquisitions,
branching or new lines of business; requiring the institution to issue
additional capital stock (including additional voting stock) or to be acquired;
restricting transactions with affiliates; restricting the interest rates that
the institution may pay on deposits; ordering a new election of directors of the
institution; requiring that senior executive officers or directors be dismissed;
prohibiting the institution from accepting deposits from correspondent banks;
requiring the institution to divest certain subsidiaries; prohibiting the
payment of principal or interest on subordinated debt; and, ultimately,
appointing a receiver for the institution.
QUALIFIED THRIFT LENDER TEST. All savings associations are required to
meet the QTL test set forth in the HOLA and regulations to avoid certain
restrictions on their operations. A savings 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
Savings Bank met the QTL test throughout 1998.
RESTRICTIONS ON CAPITAL DISTRIBUTIONS. The OTS has promulgated a
regulation governing capital distributions by savings associations, which
include cash dividends, stock redemption's or repurchases, cash-out mergers,
interest payments on certain convertible debt and other transactions charged to
the capital account of a savings 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 savings associations that before and after the
proposed distribution meet or exceed their fully phased-in regulatory capital
requirements. Tier 1 associations may make capital distributions during any
calendar year equal to the greater of (i) 100% of net income for the calendar
year-to-date plus 50% of its "surplus capital ratio" at the beginning of the
calendar year and (ii) 75% of its net income over the most recent four-quarter
period. The "surplus capital ratio" is defined to mean the percentage by which
the association's ratio of total capital to assets exceeds the ratio of its
"fully phased-in capital requirement" to assets, and "fully phased-in capital
requirement" is defined to mean an association's capital requirement under the
statutory and regulatory standards applicable on December 31, 1994, as modified
to reflect any applicable individual minimum capital requirement imposed upon
the association. At December 31, 1998, the Savings Bank was a Tier 1 association
under the OTS capital distribution regulation.
In December 1994, the OTS published a notice of proposed rulemaking to
amend its capital distribution regulation. Under the proposal, the three tiered
approach contained in existing regulations would be replaced and institutions
would be permitted to make capital distributions that would not result in their
capital being reduced below the level required to remain "adequately
capitalized," as defined above under "Prompt Corrective Action."
LOAN-TO-ONE BORROWER. Under applicable laws and regulations the amount
of loans and extensions of credit which may be extended by a savings institution
such as the Savings 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 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, 1998, the Savings Bank's unimpaired capital and surplus
amounted to $5,058,000, resulting in a general loans-to-one borrower limitation
of $759,000 under applicable laws and regulations.
BROKERED DEPOSITS. Under applicable laws and regulations, an insured
depository institution may be restricted in obtaining, directly or indirectly,
funds by or through any "deposit broker," as defined, for deposit into one or
more deposit accounts at the institution. The term "deposit broker" generally
includes any person engaged in the business of placing deposits, or facilitating
the placement of deposits, of third parties with insured depository institutions
or the business of placing deposits with insured depository institutions for the
purpose of selling interest in those deposits to third parties. In addition, the
term "deposit broker" includes any insured depository institution, and any
employee of any insured depository institution, which engages, directly or
indirectly, in the solicitation of deposits by offering rates of interest (with
respect to such deposits) which are significantly higher than the prevailing
rates of interest on deposits offered by other insured depository institutions
have the same type of charter in such depository institution's normal market
area. As a result of the definition of "deposit broker," all of the Savings
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 Savings Bank's direct solicitation efforts of institutional
investors and high net worth individuals, are potentially subject to the
restrictions described below. Under FDIC regulations, well-capitalized
institutions are subject to no brokered deposit limitations, while
adequately-capitalized institutions are able to accept, renew or roll over
brokered deposits only (i) with a waiver from the FDIC and (ii) subject to the
limitation that they do not pay an effective yield on any such deposit which
exceeds by more than (a) 75 basis points the effective yield paid on deposits of
comparable size and maturity in such institution's normal market area for
deposits accepted in its normal market area or (b) by 120% for retail deposits
and 130% for wholesale deposits, respectively, of the current yield on
comparable maturity U.S. Treasury obligations for deposits accepted outside the
institution's normal market area. Undercapitalized institutions are not
permitted to accept brokered deposits and may not solicit deposits by offering
any effective yield that exceeds by more than 75 basis points, the prevailing
effective yields on insured deposits of comparable maturity in the institution's
normal market area or in the market area in which such deposits are being
solicited. At December 31, 1998, the Savings Bank was a well-capitalized
institution, which was not subject to restrictions on brokered deposits.
See "Business - Savings Bank Sources of Funds - Deposits."
LIQUIDITY REQUIREMENTS. All savings associations are required to
maintain an average daily balance of liquid assets, which include specified
short-term assets and certain long-term assets, equal to a certain percentage of
the sum of its average daily balance of net deposit accounts and borrowings
payable in one year or less, which can be withdrawn. The liquidity requirement
may vary from time to time (between 3% and 10%) depending upon economic
conditions and savings flows of all savings associations. At the present time,
the required liquid asset ratio is 3%. Historically, the Savings 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 savings association. As a result, the Company and its non-bank
subsidiaries are affiliates of the Savings 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 savings association as those prevailing at the time
for comparable transactions with non-affiliated companies. Savings associations
are required to make and retain detailed records of transactions with
affiliates.
Notwithstanding the foregoing, a savings association is not permitted to
make a loan or extension of credit to any affiliate unless the affiliate is
engaged only in activities the Federal Reserve Board has determined to be
permissible for bank holding companies. Savings associations also are prohibited
from purchasing or investing in securities issued by an affiliate, other than
shares of a subsidiary of the savings association.
Savings associations are also subject to various limitations and
reporting requirements on loans to insiders. These limitations require, among
other things, that all loans or extensions of credit to insiders (generally
executive officers, directors or 10% stockholders of the institution) or their
"related interest" be made on substantially the same terms (including interest
rates and collateral) as, and follow credit underwriting procedures that are not
less stringent than, those prevailing for comparable transactions with the
general public and not involve more than the normal risk of repayment or present
other unfavorable features.
COMMUNITY INVESTMENT AND CONSUMER PROTECTION LAWS. In connection with
its lending activities, the Savings Bank is subject to the same federal and
state laws applicable to the Company generally, laws designed to protect
borrowers and promote lending to various sectors of the economy and population.
In addition, the Savings Bank is subject to the federal Community Reinvestment
Act ("CRA"). The CRA requires each bank or savings association to identify the
communities it serves and the types of credit or other financial services the
bank or savings association is prepared to extend to those communities. The CRA
also requires the OTS to assess a savings 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 has not conducted
a CRA review of the Savings Bank since the Company acquired the Savings Bank on
September 11, 1996. However, management believes the OTS will have a favorable
view of the Savings Bank's recent CRA record.
Under the CRA and implementing OTS regulations, a savings association
has a continuing and affirmative obligation to help meet the credit needs of its
local communities, including low- and moderate-income neighborhoods, consistent
with the safe and sound operation of the institution. Until July 1, 1997, the
OTS implementing regulations required the board of directors of each savings
association to adopt a CRA statement for each delineated local community that,
among other things, describes its efforts to help meet community credit needs
and the specific types of credit that the institution is willing to extend.
Under new standards, the OTS will assign a CRA rating based on a Lending Test,
Investment Test and Service Test keyed to, respectively, the number of loans,
the number of investments, and the level of availability of retail banking
services in a savings association's assessment area. The Lending Test will be
the primary component of the assigned composite rating. An "outstanding" rating
on the Lending Test automatically will result in at least a "satisfactory"
rating in the composite, but an institution cannot receive a "satisfactory" or
better rating on the composite if it does not receive at least a "low
satisfactory" rating on the Lending Test. Alternatively, a savings association
may elect to be assessed by complying with a strategic plan approved by the OTS.
Evaluation under the new rules is mandatory after June 30, 1997; however, a
savings association could elect to be evaluated under the new rules beginning on
January 1, 1996, although the Savings Bank did not elect to do so. Data
collection requirements became effective January 1, 1996.
SAFETY AND SOUNDNESS. Other regulations which were recently adopted or
are currently proposed to be adopted pursuant to recent legislation include: (i)
real estate lending standards for insured institutions, which provide guidelines
concerning loan-to-value ratios for various types of real estate loans; (ii)
revisions to the risk-based capital rules to account for interest rate risk,
concentration of credit risk and the risks posed by "non-traditional
activities;" (iii) rules requiring depository institutions to develop and
implement internal procedures to evaluate and control credit and settlement
exposure to their correspondent banks; and (iv) rules addressing various "safety
and soundness" issues, including operations and managerial standards, standards
for asset quality, earnings and stock valuations, and compensation standards for
the officers, directors, employees and principal stockholders of the insured
institution.
LEGISLATIVE RISK
Members of Congress and government officials from time to time have
suggested the elimination of the mortgage interest deduction for federal income
tax purposes, either entirely or in part, based on borrower income, type of loan
or principal amount. Because many of the Company's loans are made to borrowers
for the purpose of consolidating consumer debt or financing other consumer
needs, the competitive advantages of tax deductible interest, when compared with
alternative sources of financing, could be eliminated or seriously impaired by
such government action. Accordingly, the reduction or elimination of these tax
benefits could have a material adverse effect on the demand for loans of the
kind offered by the Company.
ENVIRONMENTAL FACTORS
To date, the Company has not been required to perform any investigation
or clean up activities, nor has it been subject to any environmental claims.
There can be no assurance, however, that this will remain the case in the
future. In the ordinary course of its business, the Company from time to time
forecloses on properties securing loans. Although the Company primarily lends to
owners of residential properties, there is a risk that the Company could be
required to investigate and clean up hazardous or toxic substances or chemical
releases at such properties after acquisition by the Company, and could be held
liable to a governmental entity or to third parties for property damage,
personal injury, and investigation and cleanup costs incurred by such parties in
connection with the contamination. The costs of investigation, correction of or
removal of such substances may be substantial, and the presence of such
substances, or the failure to properly correct such property, may adversely
affect the owner's ability to sell or rent such property or to borrow using such
property as collateral. Persons who arrange for the disposal or treatment of
hazardous or toxic substances also may be liable for the costs of removal or
correction of such substances at the disposal or treatment facility, whether or
not the facility is owned or operated by such person. In addition, the owner or
former owners of a contaminated site may be subject to common law claims by
third parties based on damages and costs resulting from environmental
contamination emanating from such property.
In the course of its business, the Company may acquire properties as a
result of foreclosure. There is a risk that hazardous or toxic waste could be
found on such properties. In such event, the Company could be held responsible
for the cost of cleaning up or removing such waste, and such cost could exceed
the value of the underlying properties.
DEPENDENCE ON KEY PERSONNEL
The Company's growth and development to date have been largely dependent
upon the services of Allen D. Wykle, Chairman of the Board, President and Chief
Executive Officer. The loss of Mr. Wykle's services for any reason could have a
material adverse effect on the Company. Certain of the Company's principal
credit agreements contain a provision which permit the lender to accelerate the
Company's obligations in the event that Mr. Wykle were to leave the Company for
any reason and not be replaced with an executive acceptable to such lender.
CONTROL BY CERTAIN SHAREHOLDERS
As of March 15, 1999, Allen D. Wykle, Chairman of the Board, President
and Chief Executive Officer and Leon H. Perlin, Director, beneficially own an
aggregate of 50.3% of the outstanding shares of Common Stock of the Company.
Accordingly, such persons, if they were to act in concert, would have control of
the Company, with the ability to approve certain fundamental corporate
transactions and the election of the entire Board of Directors.
ITEM 2 - PROPERTIES
PROPERTIES
The Company's executive and administrative offices are located at 3420
Holland Road, Virginia Beach, Virginia. The building consists of approximately
15,000 square feet and is owned by the Company. In June 1997, the Company
purchased a building adjacent to its headquarters to accommodate its growth
plans. The purchase price of the building was $1,060,000 and it was financed
with a mortgage loan of $800,000. The second building consists of approximately
20,000 square feet. The Company occupies approximately 17,000 square feet in
this building, and the remainder is leased to third-party tenants. The two
buildings are subject to total mortgage debt of $1,134,000 as of December 31,
1998. (See Note 23 of audited financial statements for information regarding the
sale of the second office building in February 1999.)
As of December 31, 1998 the Company had leases for regional broker
lending offices, retail lending offices, and the administrative office for the
Savings Bank. These facilities are leased under terms that vary as to duration
and in general, the leases expire between 1999 and 2003, and provide rent
escalations tied to either increases in the lessor's operating expenses or
fluctuations in the consumer price index in the relevant geographic area. Lease
expense was $1,394,000, $966,000, and $317,000 in 1998, 1997 and 1996,
respectively. Total minimum lease payments under non-cancelable operating leases
with remaining terms in excess of one year as of December 31, 1998 were as
follows (IN THOUSANDS):
1999 $ 1,669
2000 891
2001 492
2002 330
2003 144
----------------
Total 1999-2003 $ 3,526
================
The Company anticipates that in the normal course of business it will
lease additional office space as it opens new retail loan origination locations
or assumes leases associated with any future acquisitions or strategic
alliances.
The Company is also considering relocating the Virginia Beach, Virginia
headquarters to a new facility, which would house all home office operations in
one building. The Company purchased approximately 8 acres of land ("Property")
from the City of Virginia Beach Development Authority ("City") in March of 1999
for $ 660,450 dollars for the purpose of building a new facility. In the event
that the Company has not begun construction of the new facility at one year from
the date of purchase of the Property, then the City has the right or option to
return to the Company the purchase price less certain related expenses in
exchange for the conveyance of the Property to the City.
ITEM 3 - LEGAL PROCEEDINGS
The Company is a party to various routine legal proceedings arising out
of the ordinary course of its business. Management believes that none of these
actions, individually or in the aggregate, will have a material adverse effect
on the results of operations or financial condition of the Company.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS
NONE.
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
MARKET PRICE OF AND CASH DIVIDENDS ON THE COMPANY'S COMMON EQUITY
The following table shows the quarterly high, low and closing prices of
the Company's common stock for 1998, 1997, and 1996 and cash dividends paid per
share. All stock price and dividend data has been adjusted to reflect
two-for-one stock splits which occurred on August 30, 1996 and December 16,
1996, and a 100% stock dividend that occurred on November 21, 1997.
Stock Prices
---------------------------------------------- Cash
High Low Close Dividends
------------- ------------- ------------ -------------
1998:
Fourth Quarter $ 6.50 $ 2.88 $ 3.38 $ -
Third Quarter 13.63 7.00 7.00 -
Second Quarter 15.63 13.13 13.88 -
First Quarter 15.08 12.08 13.13 -
1997:
Fourth Quarter $ 17.00 $ 12.75 $ 14.75 $ -
Third Quarter 17.00 8.00 15.00 -
Second Quarter 10.00 6.00 8.25 -
First Quarter 13.50 8.50 9.75 -
1996:
Fourth Quarter $ 11.50 $ 8.00 $ 8.50 $ 0.01
Third Quarter 9.13 3.75 9.00 0.01
Second Quarter 4.75 2.13 3.88 0.01
First Quarter 2.25 2.06 2.19 0.01
The Company did not pay any cash dividends on its Common Stock in 1998
and 1997. The Company intends to retain all of its earnings to finance its
operations and does not anticipate paying cash dividends for the foreseeable
future. Any decision made by the Board of Directors to declare dividends in the
future will depend on the Company's future earnings, capital requirements,
financial condition and other factors deemed relevant by the Board.
ABSENCE OF ACTIVE PUBLIC TRADING MARKET AND VOLATILITY OF STOCK PRICE
The Company's Common Stock is traded on the National Quotation Bureau,
Inc. OTC Bulletin Board under the symbol "APFN." Historically, there has been a
limited market for the Company's Common Stock. As a result, the prices reported
for the Company's Common Stock reflect the relative lack of liquidity and may
not be reliable indicators of market value. There can be no assurance that an
active public trading market for the Company's Common Stock will be created in
the future.
The market price of the Common Stock may experience fluctuations that
are unrelated to the operating performance of the Company. In particular, the
price of the Common Stock may be affected by general market price movements as
well as developments specifically related to the residential mortgage lending
industry such as, among other things, interest rate movements, delinquencies,
loan prepayment speeds, interest-only and residual asset valuations, sources of
liquidity to the industry participants and profit or loss trends.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent for the Company's Common Stock is First Union
National Bank, 230 South Tryon Street, 11th Floor, Charlotte, North Carolina
28288-1153.
RECENT OPEN MARKET PURCHASE OF COMMON STOCK BY THE COMPANY
The Board of Directors approved a stock repurchase plan at a regular
board meeting on November 2, 1998. The Company purchased a total of 30,000
shares of Approved Financial Corp. stock at a price of $3.75 per share on trade
dates between December 21, 1998 and December 29, 1998.
RECENT UNREGISTERED SECURITY TRANSACTIONS
The Company issued 116,706 shares of unregistered shares of common stock
on January 5, 1998 to the owners of the portion of Armada LLC which was not
owned by the Company. These share represented the final payment associated with
the Company's acquisition of Armada LLC. . The stock bears a restrictive legend,
is subject to an administrative stop, may not be resold without an opinion of
the Company's legal counsel, and is subject to the resale requirements of Rule
144. No broker or general solicitation was involved. The Company relied on an
exemption from registration under Section 4(2) of the Securities Act of 1933,
and the regulations issued thereunder, and Rule 701.
ITEM 6 - SELECTED FINANCIAL DATA
The historical consolidated financial data for the five years ended
December 31, 1998 were derived from the consolidated financial statements of the
Company included elsewhere herein. The historical consolidated financial data
are not necessarily indicative of the results of operations for any future
period. This information should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the historical consolidated financial statements and notes thereto included
elsewhere herein. Unless otherwise indicated, all financial data has been
adjusted to reflect two-for-one stock splits which occurred on August 30, 1996
and December 16, 1996, and a 100% stock dividend that occurred on November 21,
1997.
APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Years Ended
December 31 1998 1997 1996 1995 1994
- -----------
----------- ----------- ---------- ---------- ----------
Revenue:
Gain on sale of loans $29,703 $33,501 $17,955 $ 7,298 $ 2,184
Interest income 10,308 10,935 4,520 3,065 2,556
Gain on sale of securities 1,750 2,796 - - -
Other fees and income 7,042 4,934 2,407 1,535 639
----------- ----------- ---------- ---------- ----------
Total revenue 48,803 52,166 24,882 11,898 5,379
----------- ----------- ---------- ---------- ----------
Expenses:
Compensation (1) 23,397 16,447 8,017 3,880 1,452
General and administrative (2) 15,306 14,188 6,853 3,050 1,337
Interest expense 6,252 6,157 3,121 2,194 1,700
Provision for loan and
foreclosed property losses 2,896 1,676 1,308 731 191
----------- ----------- ---------- ---------- ----------
Total expenses 47,851 38,468 19,299 9,855 4,680
----------- ----------- ---------- ---------- ----------
Income before income taxes 952 13,698 5,583 2,043 699
Income taxes 473 5,638 2,259 876 328
----------- ----------- ---------- ---------- ----------
Net income $ 479 $ 8,060 $ 3,324 $ 1,167 $ 371
=========== =========== ========== ========== ==========
Net income per share (diluted) (3) $ 0.09 $1.51 $0.63 $0.23 $0.07
=========== =========== ========== ========== ==========
Cash dividends per share (3) $ - $ - $0.04 $0.04 $0.04
=========== =========== ========== ========== ==========
Dividend payout ratio - - 6.35% 17.39% 57.14%
=========== =========== ========== ========== ==========
Weighted average number
of shares outstanding (diluted) 5,511,372 5,345,957 5,281,103 5,062,809 5,035,350
=========== =========== ========== ========== ==========
- -------------
(1) This document reclassifies "minority interests in consolidated
subsidiaries" as "compensation."
(2) Amount includes Loan Production expense.
(3) All per-share data has been adjusted to reflect two-for-one stock splits
which occurred on August 30, 1996 and December 16, 1996, and a 100% stock
dividend which occurred on November 21, 1997.
APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Years Ended
December 31 1998 1997 1996 1995 1994
- -----------
----------- ------------ ------------ ------------ ----------
SELECTED BALANCES AT YEAR END
Loans receivable, net $ 105,044 $ 80,696 $ 45,423 $ 28,430 $18,021
Securities 3,472 15,201 20,140 - -
Total assets 136,118 118,125 75,143 34,485 23,109
Revolving warehouse loans 72,546 52,488 32,030 19,566 7,727
FDIC-insured deposits 29,728 17,815 1,576 - -
Subordinated debt 6,042 9,080 9,183 6,905 8,546
Total liabilities (1) 116,851 93,070 53,934 28,250 17,465
Shareholders' equity 19,267 25,055 21,209 6,236 5,645
SELECTED LOAN DATA
Loans originated (2) $ 522,045 $ 468,955 $ 258,833 $ 111,505 $43,079
Loans sold 389,589 420,498 228,918 83,328 34,409
Amount of loans serviced
at year-end 109,500 83,512 48,785 29,249 18,482
Loans delinquent 31 days or
More as percent of
loans at year-end 5.42% 5.50% 6.61% 8.88% 7.03%
SELECTED RATIOS
Return on average assets 0.40% 7.68% 7.32% 4.06% 1.67%
Return on average
Shareholders' equity 1.93% 32.69% 36.44% 19.86% 6.80%
Shareholders' equity
to assets 14.15% 21.21% 28.22% 18.08% 24.43%
Book value per share (3) $ 3.51 $ 4.64 $ 4.21 $ 1.28 $ 1.09
- -------------
(1) Includes minority interests in subsidiaries.
(2) Includes $92.3 million brokered loans in 1998.
(3) All per-share data has been adjusted to reflect two-for-one stock splits
which occurred on August 30, 1996 and December 16, 1996, and a 100% stock
dividend which occurred on November 21, 1997.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
The following commentary discusses major components of the Company's
business and presents an overview of the Company's consolidated results of
operations for each year in the three-year period ended December 31, 1998 and
its consolidated financial position at December 31, 1998, and 1997. The
discussion includes some forward-looking statements involving estimates and
uncertainties. The Company's actual results could differ materially from those
anticipated in the forward-looking statements as a result of certain factors
such as reduced demand for loans, competitive forces, limits on available funds
and market forces affecting the price of the Company's common stock. This
discussion should be reviewed in conjunction with the consolidated financial
statements and accompanying notes and other statistical information presented in
the Company's 1998 audited financial statements.
Results of Operations for the Year Ended December 31, 1998 compared to the Year
Ended December 31, 1997.
Net Income
The Company's net income for 1998 was $0.5 million compared to net income of
$8.1 million in 1997. On a per share basis (diluted), income for 1998 was $0.09
compared to $1.51 for 1997. The return on average assets was 0.40% in 1998,
compared to 7.68% in 1997. Return on average shareholders' equity was 1.93% in
1998, compared to 32.69% in 1997.
Origination of Mortgage Loans
The following table shows the loan originations in dollars and units for the
Company's broker and retail divisions in 1998 and 1997. The table includes $92.3
million of loans generated by the Company's retail division that were funded
through other lenders ("Brokered Loans") during 1998.
Year Ended Year Ended
(dollars in millions) December 31, 1998 December31, 1997
----------------- ----------------
Dollar Volume of Loans Originated:
Broker $ 203.9 $ 256.4
Retail - funded through other lenders 92.3 *NM
Retail - funded in-house 225.8 212.5
-------- --------
Total $ 522.0 $ 468.9
======== ========
Number of Loans Originated:
Broker 3,484 4,399
Retail - funded through other lenders 1,099 *NM
Retail - funded in-house 3,882 4,022
-------- --------
Total 8,465 8,421
======== ========
*NM = Not Material
The decrease of 8.4% in dollar volume of loans, excluding $92.3 million in
Brokered Loans, originated during the year ended December 31, 1998, compared to
the same period in 1997 was due primarily to increased competition in the
non-conforming mortgage industry.
Loans originated through the Company's retail offices, excluding $92.3 million
in Brokered Loans, increased 6.3% to $225.8 million, compared to $212.5 million
during the same period in 1997. The growth in retail originations for the year
ended December 31, 1998 was due to an increase in retail office locations from
internal growth and due to the acquisition of FCGA.
Brokered Loans generated by the retail division were $92.3 million during the
year ended December 31, 1998. Brokered loan volume originated during the year
ended December 31, 1997 was not material and therefore the dollar volumes were
not recorded. (See: Item 2-Other Income)
The volume of loans originated through referrals from the Company's network of
mortgage brokers decreased 20.5% to $203.9 million for the year ended December
31, 1998, compared to $256.4 million for the year ended December 31, 1997.
Contributing to this decrease in volume from broker referrals is the refinance
boom for conforming mortgages created by the low interest rate environment,
increased competition in the non-conforming mortgage industry and the Company's
acquisition of FCGA. Before the Company acquired FCGA in January 1998, FCGA was
a mortgage broker organization that referred loans to the Company.
The following tables summarize mortgage loan originations, by state, for the
years ended December 31, 1998, 1997, and 1996.
(In thousands)
Years Ended
December 31 1998 1997 1996
--------------------- --------------------- ---------------------
Dollars Percent Dollars Percent Dollars Percent
------- ------- ------- ------- ------- -------
Broker Division
Florida $ 53,874 10.3% $ 61,897 13.2% $ 36,711 14.2%
Maryland 35,690 6.8 29,997 6.4 9,609 3.7
North Carolina 25,315 4.9 28,957 6.1 29,748 11.5
Georgia 34,617 6.7 59,792 12.8 54,488 21.1
Ohio 22,233 4.3 32,478 6.9 3,314 1.3
Virginia 11,698 2.2 5,415 1.2 9,405 3.6
South Carolina 9,444 1.8 4,463 1.0 3,820 1.5
Tennessee 6,391 1.2 7,826 1.7 886 0.3
Illinois 3,059 0.6 12,781 2.7 8,631 3.3
Michigan 1,115 0.2 3,680 0.8 3,514 1.4
Kentucky 361 0.1 -- -- -- --
Indiana 72 0.0 9,131 1.9 2,761 1.1
Pennsylvania 43 0.0 -- -- -- --
-------- ----- -------- ----- -------- -----
Total Broker Division $203,912 39.1% $256,417 54.7% $162,887 63.0%
======== ===== ======== ===== ======== =====
Retail Division:
North Carolina $ 49,912 9.6% $ 39,007 8.3% $ 12,353 4.8%
Maryland 66,911 12.8 66,954 14.4 45,089 17.3
Virginia 52,856 10.1 34,442 7.3 11,108 4.3
Georgia 58,558 11.2 12,886 2.7 25,599 9.9
Ohio 23,301 4.5 12,666 2.7 61 --
South Carolina 21,682 4.1 18,611 4.0 -- --
Delaware 15,905 3.0 16,056 3.4 1,736 0.7
Kentucky 14,368 2.8 85 -- -- --
Florida 6,374 1.2 4,141 0.9 -- --
Michigan 4,001 0.8 -- -- -- --
Illinois 2,065 0.4 4,877 1.0 -- --
Indiana 2,200 0.4 2,813 0.6 -- --
-------- ----- -------- ----- -------- -----
Total Retail Division $318,133 60.9% $212,538 45.3% $ 95,946 37.0%
======== ===== ======== ===== ======== =====
Total Originations:
North Carolina $ 75,227 14.4% $ 67,964 14.5% $ 42,101 16.3%
Maryland 102,601 19.7 96,951 20.8 54,698 21.0
Georgia 93,175 17.9 72,678 15.5 80,087 31.0
Florida 60,248 11.5 66,038 14.1 36,711 14.2
Virginia 64,554 12.4 39,857 8.5 20,513 7.9
Ohio 45,534 8.7 45,144 9.6 3,375 1.3
South Carolina 31,126 6.0 23,074 4.9 3,820 1.5
Delaware 15,905 3.0 16,056 3.4 1,736 0.7
Kentucky 14,729 2.8 85 -- -- --
Tennessee 6,391 1.2 7,826 1.7 886 0.3
Michigan 5,116 1.0 3,680 0.8 3,514 1.4
Illinois 5,124 1.0 17,658 3.7 8,631 3.3
Indiana 2,272 0.4 11,944 2.5 2,761 1.1
Pennsylvania 43 0.0 -- -- -- --
-------- ----- -------- ----- -------- -----
Total Originations $522,045 100.0% $468,955 100.0% $258,833 100.0%
======== ===== ======== ===== ======== =====
Gain on Sale of Loans
The largest component of the Company's net income is gain on sale of loans.
There is an active secondary market for most types of mortgage loans originated
by the Company. The majority of the loans originated by the Company are sold to
other financial institutions. The Company receives cash at the time loans are
sold. The loans are sold service-released on a non-recourse basis, except for
normal representations and warranties, which is consistent with industry
practices. By selling loans in the secondary mortgage market, the Company is
able to obtain funds that may be used for additional lending and investment
purposes. Gains from the 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) recapture premiums and loan selling
costs.
Loan sales totaled $389.6 million for the year ended December 31, 1998,
including the sale of approximately $12.0 million of loans owned by the Company
for more than 180 days ("Seasoned Loans") at a discount to par value, as
compared to $420.5 million for the same period in 1997. The Company sold $2.3
million of Seasoned Loans at a 21% discount to par value in July 1998 and $9.6
million of Seasoned Loans at an 8% discount to par value in June 1998.
Gain on the sale of loans was $29.7 million for the year ended December 31,
1998, which compares with $33.5 million for the same period in 1997. These gains
exclude the sale of $12.0 million of Seasoned Loans at a discount in 1998. The
decrease for the year ended December 31, 1998, was the direct result of a
decrease in the weighted-average premium paid by investors for the Company's
loans. Gain on the sale of mortgage loans represented 60.9% of total revenue
during the year ended December 31, 1998, compared to 64.2% of total revenue for
the same period in 1997.
The weighted-average premium realized by the Company on its loan sales decreased
to 5.4%, excluding the sale of $12.0 million Seasoned Loans at a discount to
par, during the year ended December 31, 1998, from 6.4% for the same period in
1997. Including the discounted sale of $12.0 million of Seasoned Loans, the
weighted-average premium realized by the Company during the year ended December
31, 1998 decreased to 4.9% from 6.4% for the same period in 1997.
The decrease in premium percentage was caused by material changes in the
secondary market conditions for non-conforming mortgage loans. The Company has
never used securitization as a loan sale strategy. However, the whole-loan sale
marketplace was impacted by changes that affected companies who previously used
securitizations to sell loans. Excessive competition during 1997 and 1998 and a
coinciding reduction in interest rates in general caused an increase in the
prepayment speeds for non-conforming loans. The valuation method applied to
interest-only and residual assets ("Assets"), the capitalized assets created
from securitization, include an assumption for average prepayment speed in order
to determine the average life of a loan pool. The increased prepayment speeds
experienced in the industry were greater than the assumptions previously used by
many securitization issuers and led to an impairment of Asset values for several
companies in the industry. Additionally, in September 1998, a flight to quality
among fixed income investors negatively impacted the pricing spreads for
mortgage-backed securitizations compared to earlier periods and negatively
impacted the associated economics to the issuers. Consequently, many of these
companies reported material losses, experienced reductions in liquidity sources
and diverted to whole loan sale strategies in order to generate cash. This shift
caused excess supply in the whole-loan marketplace, which lead to lower premiums
on whole-loan sales.
In addition, the premium percentage has decreased due to a decrease in the
Weighted Average Coupon ("WAC") on the Company's loan originations, which was
primarily the result of an increase in adjustable rate mortgage originations
during 1998 compared to 1997. These premiums do not include loan origination
fees collected by the Company at the time the loans are closed, which are
included in the computation of gain on sale when the loans are sold.
The Company defers recognizing income from the loan origination fees it receives
at the time a loan is closed. These fees are deferred and recognized over the
lives of the related loans as an adjustment of the loan's yield using the
level-yield method. Deferred income pertaining to loans held for sale is taken
into income at the time of sale of the loan. Origination fee income is primarily
derived from the Company's retail lending division. Origination fee income
included in the gain on sale of loans, excluding the sale of $12.0 million of
Seasoned Loans at a discount, for the year ended December 31, 1998 was $10.4
million, compared to $8.6 million in the year ended December 31, 1997. The
increase is the result of the Company selling more loans generated by its retail
division. The Company's retail loan sales during the year ended December 31,
1998 comprised 55.5% of total loan sales, with average loan origination fee
income earned of 5.0%, excluding the Seasoned Loan sale of $ 12.0 million at a
discount. For the same period of 1997, the Company's retail loan sales were
48.5% of total loan sales with average origination fee income earned of 4.2%.
Fees associated with selling loans decreased to approximately 20 basis points of
the dollar volume of loans sold for the year ended December 31, 1998 from 35
basis points for the year ended December 31, 1997.
The Company also defers recognition of the expense it incurs, from the payment
of fees to mortgage brokers, for services rendered on loan originations. These
fees are deferred and recognized over the lives of the related loans as an
adjustment of the loan's yield using the level-yield method. Deferred expenses
pertaining to loans held for sale are taken into income at the time of the sale
of the loan.
Interest Income and Expense
The Company's net interest income is dependent on the difference, or "spread",
between the interest income it receives from its loans and its cost of funds,
consisting principally of the interest expense paid on the warehouse lines of
credit, the Savings Bank's deposit accounts and other borrowings.
Interest income for the year ended December 31, 1998 was $10.3 million compared
with $10.9 million for the same period ended in 1997. The decrease in interest
income for the year ended December 31, 1998 was primarily due to a lower
weighted-average coupon associated with the balance of loans held for sale.
Interest expense for the year ended December 31, 1998 was $6.3 million compared
with $6.2 million for the year ended December 31, 1997. The increase in interest
expense for the year ended December 31, 1998, was the direct result of an
increase in the average balance of interest-bearing liabilities.
Changes in the average yield received on the Company's loan portfolio may not
coincide with changes in interest rates the Company must pay on its revolving
warehouse loans, the Savings 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 Savings Bank's deposits usually occur.
The following tables reflect the average yields earned and rates paid by the
Company during 1998 and 1997. In computing the average yields and rates, the
accretion of loan fees is considered an adjustment to yield. Information is
based on average month-end balances during the indicated periods.
(In thousands) 1998 1997
----------------------------------------- --------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
--------- --------- ---------- --------- --------- ----------
Interest-earning assets:
Loan receivable (1) $ 83,522 $ 9,761 11.69% $ 74,116 $ 10,662 14.39%
Cash and other interest-
earning assets 12,754 547 4.28 4,240 273 6.44
--------- --------- ----- --------- --------- -----
96,276 10,308 10.71 78,356 10,935 13.96
--------- ----- --------- -----
Non-interest-earning assets:
Allowance for loan losses (1,789) (1,231)
Investment in IMC 8,136 17,376
Premises and equipment, net 4,770 3,372
Other 11,875 7,112
--------- ---------
Total assets $ 119,268 $ 104,985
========= =========
Interest-bearing liabilities:
Revolving warehouse lines $ 49,810 3,888 7.80 $ 59,681 4,834 8.10
FDIC - insured deposits 22,858 1,361 5.96 6,076 357 5.88
Other interest-bearing
liabilities 10,677 1,003 9.39 10,307 966 9.37
--------- --------- ----- --------- --------- -----
83,345 6,252 7.50 76,064 6,157 8.09
--------- ----- --------- -----
Non-interest-bearing liabilities 11,126 4,264
--------- ---------
Total liabilities 94,471 80,328
Shareholders' equity 24,797 24,657
--------- ---------
Total liabilities and equity $ 119,268 $ 104,985
========= =========
Average dollar difference between
interest-earning assets and
interest-bearing liabilities $ 12,931 $ 2,292
========= =========
Net interest income $ 4,056 $ 4,778
========= =========
Interest rate spread (2) 3.21% 5.87%
===== =====
Net annualized yield on average
interest-earning assets 4.21% 6.10%
===== =====
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
(2) Average yield on total interest-earning assets less average rate paid on
total interest-bearing liabilities.
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, 1998 compared
to the year ended December 31, 1997. The changes in net interest income due to
both volume and rate changes have been allocated to volume and rate in
proportion to the relationship of absolute dollar amounts of the change of each.
The table demonstrates that the decrease of $723,000 in net interest income for
the year ended December 31, 1998 compared to the year ended December 31, 1997
was primarily the result of a decrease in the average yield on interest-earning
assets.
($ In thousands)
1998 Versus 1997
Increase (Decrease) due to:
Volume Rate Total
------- ------- -------
Interest-earning assets:
Loan receivable $ 1,884 $(2,785) $ (901)
Cash and other interest-
earning assets 328 (55) 273
------- ------- -------
2,212 (2,840) (628)
------- ------- -------
Interest-bearing liabilities:
Revolving warehouse lines (776) (170) (946)
FDIC-insured deposits 999 5 1,004
Other interest-
bearing liabilities 35 2 37
------- ------- -------
258 (163) 95
------- ------- -------
Net interest income (expense) $ 1,954 $(2,677) $ (723)
======= ======= =======
Gain on Sale of Securities
The Company sold 558,400 shares of IMC stock for $1.9 million, which resulted in
a pre-tax gain of $1.8 million, during 1998. The Company sold 233,241 shares of
IMC stock for $3.7 million, which resulted in a pre-tax gain of $2.8 million,
during 1997.
Other Income
In addition to net interest income (expense), and gain on the sale of loans, the
Company derives income from origination fees earned on Brokered Loans generated
by the Company's retail offices and other fees
earned on the loans funded by the Company, such as document preparation fees,
underwriting service fees, prepayment penalties, and late charge fees for
delinquent loan payments. Brokered Loans fees were $4.3 million for the year
ended December 31, 1998, compared to $1.0 million for the year ended December
31, 1997. For the year ended December 31, 1998, other income totaled $7.0
million compared to $5.0 million for the same period in 1997. The increase was
primarily the result of the increase in Brokered Loan fees, which was offset by
a reduction in underwriting fee income due to a lower volume of loans closed.
Comprehensive Income
The Company has other comprehensive income (loss) in the form of unrealized
holding gains (losses) on securities held for sale. The shares of IMC Mortgage
Company common stock owned by the Company is the primary component of the
Company's security holdings (See Item 2 section "Assets"). For the year ended
December 31, 1998, other comprehensive loss was $6.8 million compared to other
comprehensive loss of $4.5 million for the year ended December 31, 1997. The
losses for the years ended December 31, 1998 and 1997, were related to a
decrease in the market price of IMC Mortgage Company common stock. The Company
owned 435,634 shares of IMC Mortgage Company common stock on December 31, 1998.
Compensation and Related Expenses
The largest component of expenses is compensation and related expenses, which
increased by $4.9 million to $23.4 million for the year ended December 31, 1998,
compared to the same period in 1997. The increase was directly attributable to
an increase in the number of employees. During the year ended December 31, 1998,
approximately 60% of the increase was attributed to staffing needs for seven
additional retail origination offices compared to the same period in 1997. The
remaining 40% of the increase in compensation and related benefits expense for
the year ended December 31, 1998, was due to a higher number of employees in the
corporate headquarters during the first six months of 1998. During the first six
months of 1998, the Company had an increase of 68.1% in corporate office staff
compared to the same period in 1997, with a corresponding increase in base
salaries and benefits of approximately $2.0 million. However, in July 1998, the
Company initiated a plan to reduce the number of employees in the corporate
office. As of December 31, 1998, the home office staff had been reduced by 21%
compared to March 31, 1998.
General and Administrative Expenses
General and administrative expenses for the year ended December 31, 1998
increased by $1.5 million to $11.7 million, compared to the year ended December
31, 1997. This increase is attributed to the addition of seven retail lending
offices during the year ended December 31, 1998.
Loan Production Expense
The largest component of loan production expense is fees paid by the Company to
mortgage brokers for services rendered in the preparation of loan packages.
Other items that comprise loan production expenses are appraisals, credit
reports, leads research and telemarketing expenses. Loan production expenses for
the year ended December 31, 1998 were $3.6 million compared to $1.9 million for
the year ended December 31, 1997. The increase was primarily the result of an
increase in services rendered fees.
Provision for Loan Losses
The following table presents the activity in the Company's allowance for loan
losses and selected loan loss data for 1998 and 1997:
(In thousands)
Years Ended
December 31 1998 1997
- ----------- --------- ---------
Balance at beginning of year $ 1,687 $ 924
Provision charged to expense 3,064 1,534
Acquisition of MOFC, Inc. 49 --
Loans charged off (2,372) (953)
Recoveries of loans previously charged off 162 182
--------- ---------
Balance at end of year $ 2,590 $ 1,687
========= =========
Loans receivable at year-end, gross
of allowance for losses $ 107,634 $ 82,383
Ratio of allowance for loan losses to gross
loans receivable at year-end 2.41% 2.05%
The Company added $3.1 million during the year ended December 31, 1998 to the
allowance for loan losses, compared to an increase of $1.5 million for the year
ended December 31, 1997. The increase was primarily the result of two Seasoned
Loan sales, of approximately $9.6 million, at 92% and $2.3 million, at 79%, of
the carrying value of the loans. Also contributing to the increase in the
provision for loan losses was an increase in the balance of gross mortgage loans
held by the Company for the respective dates. All losses ("charge offs" or
"write downs") and recoveries realized on loans previously charged off, are
accounted for in the allowance for loan losses.
The allowance is established at a level that management considers adequate
relative to the composition of the current portfolio of loans held for sale.
Management considers current characteristics of the portfolio such as credit
quality, the weighted average coupon and the weighted average loan to value
ratio, and the delinquency status in the determination of an appropriate
allowance. Other criteria such as covenants associated with the Company's credit
facilities, trends in the demand for non-conforming mortgage loans in the
secondary market and general economic conditions, including interest rates, are
also considered when establishing the allowance. Adjustments to the reserve for
loan losses may be made in future periods due to changes in the factors
mentioned above and any additional factors that may effect anticipated loss
levels in the future.
Provision for Foreclosed Property Losses
The Company decreased its provision for foreclosed property losses by $168,000
for the year ended December 31, 1998, compared to an increase of $142,000 for
the year ended December 31, 1997.
Sales of real estate owned yielded net losses of $660,000 for the year ended
December 31, 1998 versus $654,000 for the year ended December 31, 1997.
The following table presents the activity in the Company's allowance for
foreclosed property losses and selected real estate owned data for 1998 and
1997:
(In thousands)
Years Ended
December 31 1998 1997
------- -------
Balance at beginning of year $ 671 $ 529
Provision charged to (reducing) expense (168) 142
------- -------
Balance at end of year $ 503 $ 671
======= =======
Real estate owned at year-end, gross
of allowance for losses $ 2,211 $ 3,038
Ratio of allowance for foreclosed property losses
to gross real estate owned at year-end 22.80% 22.09%
The Company maintains a reserve on its real estate owned ("REO") based upon
management's assessment of appraised values at the time of foreclosure. The
decrease in the provision for foreclosed property losses relates to a decrease
in the dollar amount of outstanding REO at December 31, 1998 when compared to
December 31, 1997. While the Company's management believes that its present
allowance for foreclosed property losses is adequate, future adjustments may be
necessary.
Results of Operations for the Year Ended December 31, 1997 compared to the Year
Ended December 31, 1996.
Net Income
The Company's net income for 1997 was $8.1 million compared to net income of
$3.3 million in 1996. On a per share basis (diluted), income for 1997 was $1.51,
compared to $0.63 for 1996.
The per share figures have been adjusted to reflect a two-for-one stock split of
the Company's common stock on August 30, 1996, a two-for-one stock split of the
Company's common stock on December 16, 1996, and a 100% stock dividend which
occurred on November 21, 1997.
The return on average assets was 7.68% in 1997, compared to 7.32% in 1996.
Return on average shareholders' equity was 32.69% in 1997, compared to 36.44% in
1996.
Origination of Mortgage Loans
The following table shows the loan originations in dollars and units for the
Company's broker and retail units in 1997 and 1996:
(Dollars in thousands)
Years Ended
December 31 1997 1996
- ----------- -------- --------
Broker $256,417 $162,887
Retail 212,538 95,946
-------- --------
Total $468,955 $258,833
======== ========
Number of Loans Originated:
Broker 4,399 2,670
Retail 4,022 1,683
-------- --------
Total 8,421 4,353
======== ========
The increases in the dollar volume of loan originations of 81.2% in 1997, 132.1%
in 1996 reflect strong growth in both broker and retail lending operations.
The Company's broker lending division originated $256.4 million of residential
mortgage loans during 1997, compared to $162.9 million in 1996. The 57.4%
increase in originations in 1997 compared to 1996 was attributed to the increase
in the Company's retail locations. On a unit basis, the Company originated 4,399
loans in its broker operation in 1997, compared to 2,670 loans in 1996 .
The Company's retail lending division originated $212.5 million of residential
mortgage loans in 1997, compared to $95.9 million in 1996. The 121.5% increase
in 1997 compared to 1996 is attributed to additional retail loan offices and
back-office capabilities. On a unit basis, the Company originated 4,022 loans in
its retail operation in 1997, compared to 1,683 loans in 1996.
In addition to originating residential mortgage loans, the Company occasionally
purchases loans to obtain geographic diversity and yields not obtainable in the
Company's normal lending areas. However, purchases during 1997 and 1996 were
minimal and the Company has no current plans to expand the activity of
purchasing pools of loans.
Gain on Sale of Loans
The Company sold $420.5 million of mortgage loans during 1997, compared to
$228.9 million in 1996. Sales volume increased by 83.7% in 1997, by 174.7% in
1996. The magnitudes of the period-to-period changes in loan sales are
consistent with and reflect the percentage changes in mortgage loan originations
in those periods.
For 1997, gain on the sale of loans was $33.5 million which compares with $18.0
million in 1996. The year-to-year increases in the gain on loan sales were the
direct result of increased loan originations, which enabled the Company to sell
more loans. Gain on the sale of mortgage loans represented 64.2% of total
revenue in 1997, compared to 72.2% of total revenue in 1996.
The weighted-average premium realized by the Company on its loan sales increased
to 6.39% in 1997, compared to 6.34% in 1996. These premiums do not include loan
fees collected by the Company at the time the loans are closed and included in
the computation of gain when the loans are sold.
Origination fee income included in the gain on sale of loans in 1997 was $8.2
million compared to $3.9 million in 1996. The increases of 108.4% in 1997 is the
result of the Company originating and selling more loans generated by the retail
lending division. The Company's retail originations increased by $116.6 million
or 121.5%, in 1997. The Company's retail loan sales in 1997 comprised 48.5% of
total loan sales, with an average loan origination fee income earned of 4.2%.
For 1996, the Company's retail loan sales were 35.0% of total loan sales with an
average loan fee income earned of 4.9%. Total recapture premium and fees
associated with selling loans represented approximately 35 basis points of loans
sold in 1997 compared with 30 basis points in 1996.
Interest Income and Expense
Interest income in 1997 was $10.9 million compared with $4.5 million in 1996.
The 141.9% increase in interest income in 1997 was primarily due to a higher
average balance of loans held for sale resulting from the increase in loan
originations. The average holding period in 1997 for mortgage loans in inventory
remained consistent with the average 1996 holding period.
Interest expense in 1997 was $6.2 million compared with $3.1 million in 1996.
The year-to-year increases in interest expense were the direct result of
increased borrowings under the Company's warehouse lines of credit, which were
used to fund the increase in loan origination volume.
The following tables reflect the average yields earned and rates paid by the
Company during 1997 and 1996. 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)
1997 1996
-------------------------------------- ----------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
--------- --------- ------- --------- --------- -------
Interest-earning assets:
Loans receivable (1) $ 74,116 $ 10,662 14.39% $ 36,519 $ 4,464 12.22%
Cash and other interest-
earning assets 4,240 273 6.44 1,107 56 5.06
--------- --------- ----- --------- --------- -----
78,356 10,935 13.96 37,626 4,520 12.01
--------- ----- --------- -----
Non-interest-earning assets:
Allowance for loan losses (1,231) (754)
Investment in IMC 17,376 2,438
Premises and equipment, net 3,372 1,671
Other 7,112 4,423
--------- ---------
Total assets $ 104,985 $ 45,404
========= =========
Interest-bearing liabilities:
Revolving warehouse lines $ 59,681 4,834 8.10 $ 25,810 2,373 9.19
FDIC-insured deposits 6,076 357 5.88 470 21 4.47
Other interest-bearing
liabilities 10,307 966 9.37 8,690 727 8.37
--------- --------- ----- --------- --------- -----
76,064 6,157 8.09 34,970 3,121 8.92
--------- ----- --------- -----
Non-interest-bearing liabilities 4,264 1,314
--------- ---------
Total liabilities 80,328 36,284
Shareholders' equity 24,657 9,120
--------- ---------
Total liabilities and equity $ 104,985 $ 45,404
========= =========
Average dollar difference between
interest-earning assets and interest-
bearing liabilities $ 2,292 $ 2,656
========= =========
Net interest income $ 4,778 $ 1,399
========= =========
Interest rate spread (2) 5.87% 3.09%
====== =====
Net annualized yield on average
interest-earning assets 6.10% 3.72%
====== =====
- ----------
(2) Loans shown gross of allowance for loan losses, net of premiums/discounts.
(3) Average yield on total interest-earning assets less average rate paid on
total interest-bearing liabilities.
The following table shows the amounts of the changes in interest income and
expense which can be attributed to rate (change in rate multiplied by old
volume) and volume (change in volume multiplied by old rate) for 1997. The
changes in net interest income due to both volume and rate changes have been
allocated to volume and rate in proportion to the relationship of absolute
dollar amounts of the change of each. The table demonstrates that the $3.4
million increase in net interest income in 1997 was the net result of a growing
balance sheet positively affected by lower rates on borrowed funds.
1997 Versus 1996
Increase (Decrease) Due to
---------------------------------
(in thousands) Volume Rate Total
------- ------- -------
Total interest-earning assets
Loans receivable $ 5,289 $ 909 $ 6,198
Cash and other
interest-earning assets 198 19 217
------- ------- -------
5,487 928 6,415
------- ------- -------
Total interest-bearing liabilities
Revolving warehouse loans 2,706 (245) 2,461
FDIC-insured deposits 327 9 336
Other 145 94 239
------- ------- -------
3,178 (142) 3,036
------- ------- -------
Net interest income $ 2,309 $ 1,070 $ 3,379
======= ======= =======
Income from the IMC Partnership and IMC Mortgage Company
The Company was an original limited partner in Industry Mortgage Company, L.P.
(the "IMC Partnership"), a non-conforming residential mortgage company based in
Tampa, Florida. The Company's initial ownership interest represented
approximately 9.09% of the IMC Partnership and was accounted for under the
equity method of accounting. Therefore, the Company recognized the portion of
the IMC Partnership's net income equal to its ownership percentage in the IMC
Partnership. In 1996, the Company recognized $480,000.
The IMC Partnership converted to a corporation, IMC Mortgage Company ("IMC"),
immediately before its initial public offering on June 24, 1996. The limited
partners received common stock of IMC in exchange for their IMC Partnership
interests as of June 24, 1996. The Company was issued 1,199,768 shares of IMC
common stock at that time. During 1997, the Company sold 233,241 shares of IMC
stock for $3.7 million which resulted in a pre-tax gain of $2.8 million. The
Company is likely to experience volatility in its capital account in future
periods because of market price fluctuations of this investment security.
Other Income
In addition to interest on the loan portfolio and gains from the sale of loans,
the Company derives income from broker fees, document preparation fees,
underwriting service fees, prepayment penalties, late charge fees for delinquent
loan payments and rental income on office space. For 1997, other income totaled
$4.9 million compared to $1.9 million in 1996. The increase of $3.0 million or
156.0%, in 1997 was due to several factors.
Underwriting service and document preparation fees increased by $2.0 million in
1997 due to an increase in loan origination volume. These fees are charged to a
borrower at the time a loan is closed. The unit volume of loan closings
increased by 4,068 loans to 8,421 in 1997.
The Company brokers to various lenders loans that do not meet its underwriting
guidelines. Broker fee income increased by $0.5 million to $1.0 million in 1997.
Increases in prepayment penalty and late charge income are attributed to the
Company's larger loan portfolio.
Comprehensive Income
The Company has comprehensive income (loss) in the form of unrealized holding
gain (loss) on securities held for sale. The shares of IMC Mortgage Company
common stock owned by the Company is the primary component of the Company's
security holdings (See Item 2 section "Assets"). For the year ended December 31,
1997, comprehensive loss was $4.5 million compared to comprehensive income of
$11.4 million for the year ended December 31, 1996. The loss for the year ended
December 31, 1997 was related to a decrease in the market price of IMC Mortgage
Company common stock. The gain for the year ended December 31, 1996 was related
to an increase in the market price of the IMC Mortgage Company common stock for
the respective periods. The Company owned approximately 975,592 shares of IMC
Mortgage Company common stock on December 31, 1997.
Compensation and Related Expenses
The largest component of expenses is compensation expense. Compensation expense
in 1997 increased by $8.4 million to $16.4 million. The increase of 105.2% in
1997 was directly attributable to the addition of new employees. The Company had
552 full-time equivalent employees at December 31, 1997 (443 full-time and 217
part-time employees), compared to 287 at December 31, 1996. The Company's
corporate office staff increased by 122.3% in 1997, with a corresponding
increase in base salaries of approximately $1,700,000. The broker division
increased its staffing by 63.6% and the increase in base salaries associated
with the new employees was approximately $500,000. The Company opened twelve
retail lending offices in 1997, and the retail lending staff increased by
100.7%, resulting in a base salary increase in the retail division of
approximately $3,000,000. Commission and bonus expense in 1997 increased by
approximately $2,500,000 due to increased production. Finally, additional 1997
costs due to merit and cost of living increases were approximately $700,000.
General and Administrative Expenses
General and administrative expenses in 1997 increased by $7.3 million to $14.2
million. The increase of 107.0% in 1997 was attributed to the growth of the
Company. The Company opened twelve retail offices in 1997. In addition, seven
offices opened in 1996 operated for a full year in 1997. The total general and
administrative expenses associated with the new retail offices was $1.8 million
in 1997. For offices open for all of 1997 and 1996, general and administrative
expenses increased by $0.9 million to $2.1 million in 1997, as a result of a
32.0% loan production volume increase in those offices. General and
administrative expenses related to the Company's corporate office staff
increased by $3.0 million to $5.6 million in 1997, as the Company increased
corporate staff expenditures to support the increased loan volume. These
expenses included increases in utilities, postage, office supplies, travel and
entertainment, depreciation on office equipment, and professional fees.
The broker division began paying fees to brokers in 1997 for services rendered
in the preparation of loan packages. The total expense associated with those
fees was $1.4 million in 1997.
Provision for Loan Losses
The Company provided $1.5 million during 1997 as additions to the allowance for
loan losses, compared to $1.1 million in 1996.
The following table presents the activity in the Company's allowance for loan
losses and selected loan loss data for 1997 and 1996:
(In thousands)
Years Ended
December 31 1997 1996
- -------------- -------- --------
Balance at beginning of year $ 924 $ 594
Provision charged to expense 1,534 1,145
Acquisition of the Savings Bank -- 20
Loans charged off (953) (863)
Recoveries of loans previously charged off 182 28
-------- --------
Balance at end of year $ 1,687 $ 924
======== ========
Loans receivable at year-end, gross
of allowance for losses $ 82,383 $ 46,347
Ratio of allowance for loan losses to gross
loans receivable at year-end 2.05% 1.99%
Provision for Foreclosed Property Losses
The Company provided $0.1 million during 1997 as additions to the allowance for
foreclosed property losses, compared to $0.2 million in 1996.
Sales of real estate owned yielded net losses of $0.7 million in 1997 and $0.2
million in 1996.
The following table presents the activity in the Company's allowance for
foreclosed property losses and selected real estate owned data for 1997 and
1996:
(In thousands)
Years Ended
December 31 1997 1996
- ------------- ------ ------
Balance at beginning of year $ 529 $ 366
Provision charged to expense 142 163
------ ------
Balance at end of year $ 671 $ 529
====== ======
Real estate owned at year-end, gross
of allowance for losses $3,038 $2,606
Ratio of allowance for foreclosed property losses
to gross real estate owned at year-end 22.09% 20.30%
Minority Interest in Net Income of Subsidiary. Contained in the consolidated
statements of income for 1996 was minority interests in earnings of a
subsidiary. This portion of the subsidiary's earnings was an element of
compensation paid to an officer of the Company. In 1997, the Company has
recharacterized this item as compensation expense.
Income Taxes. Income tax expense for 1997 was $5.6 million resulting in an
effective tax rate of 41.2%. By comparison, the Company had income tax expense
of $2.3 million for an effective tax rate of 40.5% in 1996.
The effective tax rates differ from the statutory federal rates due primarily to
state income taxes and certain nondeductible expenses.
Financial Condition at December 31, 1998 and 1997
Assets
The total assets of the Company were $136.1 million at December 31, 1998,
compared to total assets of $118.1 million at December 31, 1997.
Cash and cash equivalents decreased by $5.6 million to $6.3 million at December
31, 1998, from $11.9 million at December 31, 1997. There was a conscious effort
to reduce excess cash holdings in 1998.
Net mortgage loans receivable increased by $24.3 million to $105.0 million at
December 31, 1998. The 30.2% increase in 1998 is primarily due to the Company's
management deciding to hold loans in December instead of selling loans at very
low premiums. The premiums in the fourth quarter were very low due to increased
competition in the whole loan sale market. The Company generally sells loans
within sixty days of origination.
Real estate owned decreased by $0.7 million to $1.7 million at December 31,
1998. The primary reason for the 27.9% decrease in real estate owned was that
fewer properties were foreclosed on and more properties were sold in 1998 as
compared to 1997.
Investments consist primarily of shares of IMC Mortgage Company ("IMC") owned by
the Company and the Adjustable Rate Mortgage Fund and FHLB stock owned by the
Savings Bank. The market value of the IMC shares owned was $0.1 million at
December 31, 1998 and $11.6 million at December 31, 1997. The decrease in
investments was primarily due to the sale of 558,400 shares of IMC stock and a
decline in the market price of IMC stock from $11.875 on December 31, 1997 to
$0.28 per share on December 31, 1998.
Premises and equipment increased by $1.0 million to $5.6 million at December 31,
1998. The primary reason for the 1998 increase was the acquisition of
ConsumerOne Financial. At the date of acquisition, ConsumerOne's premises and
equipment totaled $1.0 million, of which $0.6 million were capitalized leased
assets.
Goodwill (net) increased by $3.8 million to $4.6 million at December 31, 1998.
The 1998 increase is due to the acquisitions of Funding Center of Georgia and
ConsumerOne Financial. The goodwill attributed to the Funding Center of Georgia
acquisition was $0.7 million and the remaining increase of $3.2 million was
goodwill attributed to the ConsumerOne Financial acquisition.
The Company had an income tax receivable of $2.0 million at December 31, 1998,
which was the result of overpayment of second quarter estimated tax payments. At
December 31, 1997 the Company had an income tax payable of $1.2 million.
The deferred tax asset was $3.3 million at December 31, 1998 compared to a
deferred tax liability of $1.1 million at December 31, 1997. The change was the
result of a decrease of $1.7 million in the deferred tax liability on
securities.
Other assets increased by $1.5 million to $4.1 million at December 31, 1998.
Accrued interest receivable
increased $224,000 in 1998, which is the result of higher average loans held for
sale. Also, prepaid assets increased by $270,000 in 1998. Prepaid assets include
syndicated bank fees, insurance, taxes and rent. Broker fee receivable increased
by approximately $350,000 in 1998 to $559,000. The Company's brokered loan
origination's increased by 245.8% to $55.9 million in the final six months of
1998 compared to $16.2 million for the same period in 1997. The Company also
began originating non-mortgage consumer loans in 1998 which attributed to a
$246,000 increase in other assets. Also, the impound receivables increased by
$374,000 to $480,000 in 1998. Impound receivables are receivables due the
Company for force placed insurance, as well as legal fees incurred by the
Company on accounts that are in bankruptcy or in the process of foreclosure.
Liabilities
Outstanding balances for the Companies revolving warehouse loans increased by
$20.1 million to $72.5 million at December 31, 1998. The 38.2% increase in 1998
was primarily attributable to the increase in loans receivable and the $6.2
million balance on ConsumerOne Financial's warehouse at December 31, 1998.
The Company draws on its revolving warehouse lines of credit as needed to fund
loan production. As of December 31, 1998, the Company had issued loan funding
checks totaling $2.0 million which had not cleared the Company's checking
account and for which the Company had not drawn funds from its warehouse lines.
These checks cleared the Company's bank accounts in the first few business days
of January 1999 and most were funded with cash on hand or new warehouse line
draws.
The Savings Bank's deposits totaled $29.7 million at December 31, 1998, compared
to $17.8 million at December 31, 1997. The Savings Bank substantially increased
its deposits in 1998 in order to fund loans. Of the certificate accounts as of
December 31, 1998, a total of $15.7 million was scheduled to mature in the
twelve-month period ending December 31, 1999.
On December 16, 1997, the Savings Bank borrowed $1.0 million from the FHLB, and
this amount was outstanding at December 31, 1997. The $1.0 million was paid off
in 1998.
Promissory notes and certificates of indebtedness totaled $6.0 million at
December 31, 1998, compared to $9.1 million at December 31, 1997. The reduction
was caused by redemption of $3.0 million promissory note from a shareholder. The
Company has utilized promissory notes and certificates of indebtedness to help
fund its operations. These borrowings are subordinated to the Company's
warehouse lines of credit. The promissory notes are loans from insiders
(shareholders, directors, and employees) for periods of one to five years and
interest rates between 8.00% and 10.25%, with a weighted-average rate of 9.59%
at December 31, 1998. The certificates of indebtedness are uninsured deposits
authorized for financial institutions like 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 and interest rates
between 6.75% and 10.00%, with a weighted-average rate of 9.46% at December 31,
1998. The Company is not currently soliciting new promissory notes or
certificates of indebtedness. (See notes 11 and 12 of audited financial
statements for maturity schedule for the promissory notes and certificates of
indebtedness.)
Accrued and other liabilities increased by $1.9 million to $4.8 million at
December 31, 1998. This category includes accounts payable, accrued interest
payable, deferred income, accrued bonuses, and other payables. The 67.7%
increase in 1998 is primarily attributable to the acquisition of ConsumerOne
Financial. Included in accrued and other liabilities is $520,000 of capitalized
lease obligations and an
investment payable of $1,575,000 due in three equal payments in 1999, 2000, and
2001. These payments are subject to reduction in the event of failure to meet
agreed upon pre-tax profit targets each year.
Shareholders' Equity
Total shareholders' equity at December 31, 1998 was $19.3 million compared to
$25.1 million at December 31, 1997. The $5.8 million decrease in 1998 was
primarily due to the reduction of $6.8 million in the unrealized gain on
securities. This reduction was offset by net income of $479,000. The Company
issued common stock in the amount of $669,000 for the acquisition of 17%
interest in Armada Residential Mortgage LLC. The Company also repurchased common
stock in the amount of $113,000, which caused a reduction in shareholders'
equity.
Liquidity and Capital Resources
The Company's operations require access to short- and long-term sources of cash.
The Company uses cash flow from the sale of loans through whole loan sales, loan
origination fees, processing and underwriting fees, net interest income, and
borrowings under its warehouse facilities and other debt to meet its working
capital needs. The Company's primary operating cash requirements include the
funding of mortgage loan originations pending their sale, operating expenses,
income taxes and capital expenditures.
Adequate credit facilities and other sources of funding, including the ability
to sell loans in the secondary market, are essential to the Company's ability to
continue to originate loans. The Company has operated, and expects to continue
to operate, on a negative cash flow basis due to the increased volume of loan
originations. For the years ended December 31, 1998 and 1997, the Company used
cash from operating activities of $31.8 million and $31.0 million, respectively.
The net cash used from operating activities was primarily used to fund mortgage
loan originations.
The Company finances its operating cash requirements primarily through warehouse
and other credit facilities, and the issuance of other debt. For the years ended
December 31, 1998 and 1997, the Company received cash from financing activities
of $22.2 million and $38.7 million, respectively.
The Company's borrowings (revolving warehouse loans, FDIC-insured deposits,
mortgage loans on Company office buildings, FHLB advances, subordinated debt and
loan proceeds payable) at December 31, 1998 were 82.3%, compared to 74.5% of
assets at December 31, 1997.
Warehouse and Other Credit Facilities
On December 10, 1997, the Company obtained a $100.0 million warehouse line of
credit from a commercial bank syndicate. The syndicate's lead bank is Chase Bank
of Texas. Other banks in the syndicate are BankBoston, National City Bank,
Comerica Bank and Compass Bank. The line is secured by loans originated by the
Company and bears interest at a rate of 1.5% over the one-month LIBOR rate. This
line of credit replaced three existing lines of credit. The line expires on
December 31, 1999 and is subject to renewal. The Company may receive warehouse
credit advances of 98% of the original principal balances on pledged mortgage
loans for a maximum period of 180 days after origination. As of December 31,
1998, $59.3 million was outstanding under this facility.
Also on December 10, 1997, the Company obtained a $25.0 million seasoned loan
line of credit from certain members of the commercial bank syndicate. This line
is secured by loans originated by the Company. The seasoned loan line of credit
bears interest at a rate of 2.5% over the one-month LIBOR rate, and the Company
may receive credit advances of 90% of the current principal balances on pledged
mortgage loans. There is not a time limit as to the number of days from
origination for the loans pledged to secure this line of credit. As of December
31, 1998, $7.1 million was outstanding under this facility.
At December 31, 1998, Consumer One the Michigan based mortgage company acquired
by Approved had an existing warehouse credit agreement with a California
corporation. The line of credit commenced on June 10, 1998 and terminates one
year from the commencement date. The maximum, credit availability is $10
million. This line is collaterized by mortgage loans originated by ConsumerOne
company and bears interest at a rate of prime plus 1.75%. As of December 31,
1998, $6.2 million was outstanding under this facility. During February 1999,
the Company paid off this line of credit.
Whole Loan Sale Program
The Company's most important capital resource for generating cash to fund new
loans and for making payments on its warehouse facilities has been its ability
to sell its loans in the secondary market. The market value of the Company's
loans is dependent on a number of factors, including loan delinquency rates, the
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, general economic and market conditions, market interest
rates and governmental regulations. Adverse changes in these conditions may
affect the Company's ability to sell loans in the secondary market for
acceptable prices. The ability to sell loans in the secondary market is
essential to the continuation of the Company's loan origination operations.
Other Capital Resources
The Savings Bank's deposits totaled $29.7 million at December 31, 1998, compared
to $17.8 million at December 31, 1997. The Savings Bank substantially increased
its deposits in 1998 in order to fund loans. The Savings Bank currently utilizes
funds from the deposits and a line of credit with the FHLB of Atlanta to fund
first lien and junior lien mortgage loans.
The Company has utilized promissory notes and certificates of indebtedness to
help funds its operations. Promissory notes and certificates of indebtedness
totaled $6.0 million at December 31, 1998, compared to $9.1 million at December
31, 1997. These borrowings are subordinated to the Company's warehouse lines of
credit. The Company is not currently soliciting new promissory notes or
certificates of indebtedness. (See notes 11 and 12 of audited financial
statements for maturity schedule for the promissory notes and certificates of
indebtedness.)
The Company had cash and cash equivalents of $6.3 million at December 31, 1998.
The Company has sufficient cash resources to fund its operations at current
levels through the end of 1999. However, loan origination volume is expected to
continue to grow in 1999, and management anticipates that it will need
additional capital to fund this growth and to continue its expansion. New debt
financing, equity financing, and lines of credit will be evaluated with
consideration for maximizing shareholder value. Management expects that the
Company and the industry will be challenged by continued competition and rising
delinquencies.
Savings Bank Regulatory Liquidity
Liquidity is the ability to meet present and future financial obligations,
either through the acquisition of additional liabilities or from the sale or
maturity of existing assets, with minimal loss. Regulations of the OTS require
thrift associations and/or savings banks to maintain liquid assets at certain
levels. At present, the required ratio of liquid assets to savings and
borrowings, which can be withdrawn and are due in one year or less is 5.0%.
Penalties are assessed for noncompliance. In 1998 and 1997, the Savings Bank
maintained liquidity in excess of the required amount, and management
anticipates that it will continue to do so.
Savings Bank Regulatory Capital
At December 31, 1998, the Savings Bank's book value under generally accepted
accounting principles ("GAAP") was $5.1 million. OTS Regulations require that
savings 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, 1998, the Savings Bank satisfied all of
the regulatory capital requirements, as shown in the following table reconciling
the Savings Bank's GAAP capital to regulatory capital:
Tangible Core Risk-Based
(In thousands) Capital Capital Capital
------- ------- -------
GAAP capital $ 5,058 $ 5,058 $ 5,058
Add: unrealized loss on securities 15 15 15
Nonallowable asset: goodwill (116) (116) (116)
Additional capital item: general allowance -- -- 276
------- ------- -------
Regulatory capital - computed 4,957 4,957 5,233
Minimum capital requirement 578 1,157 2,166
------- ------- -------
Excess regulatory capital $ 4,379 $ 3,800 $ 3,067
======= ======= =======
Ratios:
Regulatory capital - computed 12.86% 12.86% 19.33%
Minimum capital requirement 1.50 4.00 8.00
------- ------- -------
Excess regulatory capital 11.36% 8.86% 11.33%
======= ======= =======
Management believes that the Savings Bank can remain in compliance with its
capital requirements.
The Company is not aware of any other trends, events or uncertainties which will
have or that are likely to have a material effect on the Company's or the
Savings Bank's liquidity, capital resources or operations. The Company is not
aware of any current recommendations by regulatory authorities which if they
were implemented would have such an effect.
New Accounting Standards
Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings per
Share," which superseded APB Opinion No. 15, "Earnings per Share." This new
statement requires that "basic earnings per share" be computed by dividing
income available to common shareholders by the weighted-average number of common
shares outstanding for the period. "Diluted earnings per share," if different,
reflects potential dilution if stock options or other contracts would result in
the issue or exercise of additional shares of common stock that shared in the
earnings. "Basic earnings per share" and "diluted earnings per share" will
replace "primary earnings per share" and "fully diluted earnings per share,"
respectively, as described under APB Opinion No. 15, and must be reported on the
income statement. There was no material change in the earnings per share amounts
as a result of adopting this new standard.
Effective January 1, 1998 the Company adopted SFAS No 130, "Reporting
Comprehensive Income". The new statement requires that an enterprise (a)
classify items of other comprehensive income by their nature in a financial
statement and (b) display the accumulated balance of other comprehensive income
separately from retained earnings and additional capital in the equity section
of the statement of financial condition. The only item the Company has in
Comprehensive Income for the year ended December 31, 1998 is an unrealized
holding gain or loss on securities, net of deferred taxes.
In June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information," was issued, effective for fiscal years beginning after
December 15, 1997. The new statement requires that a public business enterprise
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. This statement does not have any material
impact on the financial statements.
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" was issued, effective for fiscal years beginning after June 15,
1999. This statement establishes the accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contract, (collectively referred to as derivatives) and for hedging
activities. It requires that entities recognize all derivative as either assets
or liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as (a) a hedge of the exposure to changes in the fair
value of recognized asset or liability or an unrecognized firm commitment, (b) a
hedge of the exposure to variable cash flows of a forecasted transaction, or (c)
a hedge of the foreign currency exposure of a net investment in a foreign
operation, an unrecognized firm commitment, an available-for-sale security, or
foreign-currency-denominated forecasted transaction. The company is currently
evaluating the effect this statement will have on the financial statements.
In October 1998, SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise" was issued, effective for the first fiscal quarter beginning
after December 15, 1998. The new statement requires that after an entity that
engaged in mortgage banking activities has securitized mortgage loans that it
held for sale, it must classify the resulting retained mortgage-backed
securities or other retained interest based on its ability
and intent to sell or hold those investments. Any retained mortgage-backed
securities that are committed for sale before or during the securitization
process must be classified as trading. This statement does not have any impact
on the Company's financial statements since the Company has never securitized
loans.
Hedging Activities
The Company originates mortgage loans for sale as whole loans. The Company
mitigates its interest rate exposure by selling most of the loans within sixty
days of origination. However, the Company may choose to hold certain loans for a
longer period prior to sale in order to increase net interest income. In
addition, certain loans must be "seasoned" for periods of six to twelve months
before they can be sold. The majority of loans held by the Company beyond the
normal sixty-day holding period are fixed rate instruments. Since most of the
Company's borrowings have variable interest rates, the Company has exposure to
interest rate risk. For example, if market interest rates were to rise between
the time the Company originates the loans and the time the loans are sold, the
original interest rate spread on the loans narrows, resulting in a loss in value
of the loans. To offset the effects of interest rate fluctuations on the value
of its fixed rate mortgage loans held for sale, the Company in certain cases
will enter into Treasury security lock contracts, which function similar to
short sales of U.S. Treasury securities. Prior to entering into a hedge
transaction, the Company performs an analysis of its loans, taking into account
such factors as interest rates and maturities, to determine the proportion of
contracts to sell so that the risk value of the loans will be most effectively
hedged. The Company in 1997 used one of the commercial banks in its syndicated
bank group to arrange hedge contracts. The Company had no hedge contracts
outstanding at December 31, 1998.
If the value of a hedge decreases, offsetting an increase in the value of the
hedged loans, the Company, upon settlement with its counter-party, will pay the
hedge loss in cash and realize the corresponding increase in the value of the
loans. Conversely, if the value of a hedge increases, offsetting a decrease in
the value of the hedged loans, the Company will receive the hedge gain in cash
at settlement.
The Company's management believes that its current hedging strategy using
Treasury rate lock contracts is an effective way to manage interest rate risk on
fixed rate loans prior to sale.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented in this
document have been prepared in accordance with generally accepted accounting
principles, which require the measurement of the financial position and
operating results of the Company in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation.
Virtually all of the assets of the Company are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or with the same magnitude as the
prices of goods and services. Inflation affects the Company most significantly
in the area of loan originations and can have a substantial effect on interest
rates. Interest rates normally increase during periods of high inflation and
decrease during periods of low inflation.
Because the Company sells a significant portion of the loans it originates,
inflation and interest rates have
a diminished effect on the Company's results of operations. The Savings Bank is
expected to continue to build its portfolio of loans held for investment, and
this portfolio will be more sensitive to the effects of inflation and changes in
interest rates.
Profitability may be directly affected by the level and fluctuation of interest
rates, which affect the Company's ability to earn a spread between interest
received on its loans and the costs of its borrowings. The profitability of the
Company is likely to be adversely affected during any period of unexpected or
rapid changes in interest rates. A substantial and sustained increase in
interest rates could adversely affect the ability of the Company to originate
and purchase loans and affect the mix of first and junior lien mortgage loan
products. Generally, first mortgage production increases relative to junior lien
mortgage production in response to low interest rates and junior lien mortgage
loan production increases relative to first mortgage loan production during
periods of high interest rates. A significant decline in interest rates could
decrease the size of the Company's future loan servicing portfolio by increasing
the level of loan prepayments and it may also affect the net interest income
earned by the Company resulting from the difference between the yield to the
Company on loans held pending sales and the interest paid by the Company for
funds borrowed under the Company's warehouse facilities. Additionally, to the
extent servicing rights and interest-only and residual classes of certificates
are capitalized on the Company's books from future loan sales through
securitization, higher than anticipated rates of loan prepayments or losses
could require the Company to write down the value of such servicing rights and
interest-only and residual certificates, adversely affecting earnings.
Conversely, lower than anticipated rates of loan prepayments or lower losses
could allow the Company to increase the value of interest-only and residual
certificates, which could have a favorable effect on the Company's results of
operations and financial condition.
YEAR 2000 ISSUES
The Year 2000 issue relates to the way computer systems and programs
define and handle calendar issues. Non-compliant systems could fail or make
miscalculations due to interpretations of dates that fall past the millennium.
For example, the year value "00" could be interpreted to mean the year "1900",
rather than "2000". Other systems not normally thought of as computer related
may also contain embedded hardware or software that may contain a date or time
element. Approved, similar to other financial service institutions, is sensitive
and subject to the potential impact of the Year 2000 issue.
Approved initiated a Year 2000 project in late 1997 under the direction
of a project leader, supervised by the Company's Board of Directors. Management
has placed a high priority on Year 2000 issues, in recognition of the business
risk inherent in non-compliance. The project is proceeding ahead of schedule,
with expected completion by the end of first quarter 1999.
PROJECT. The Approved Year 2000 project generally follows suggested OTS
and FFIEC guidelines. The scope of the project includes: ensuring the compliance
of all systems and applications of significance, operating systems and hardware
of the Company's LAN and PC platforms; addressing issues related to other
systems not normally thought of as computer related, and addressing the
compliance of key business partners.
There are five (5) phases of the project: Awareness, Assessment,
Renovation, Validation and Implementation. During the Assessment phase, the
Company determined to concentrate physical upgrades to those computers
representing "current technologies". Older units may still be used in
non-critical applications, but would be phased out and replaced before the Year
2000. The Assessment phase also identified several systems that are classified
as "mission-critical" and represent the Company's core business of mortgage
lending. Project efforts have focused on getting these systems to year 2000
compliance levels.
Approved has no internally generated programmed software to correct, as
substantially all of the software utilized by the Company is purchased or
licensed from external providers. The Company is currently completing the
Renovation phase of the project. Virtually all "mission-critical" applications
and hardware have been upgraded to Year 2000 compliance release levels.
In addition, the Company has contracted for a new Human Resource and
Payroll system, which is certified by the vendor as being Year 2000 compliant.
Installation of these systems occurred in the fourth quarter 1998, with full
integration expected by the end of the first quarter 1999. All PC equipment
located at corporate headquarters, including hardware BIOS, and software, have
been upgraded to Year 2000 compliance release levels.
The final portion of the Renovation phase consists of field upgrades of
systems and software located in our branch offices, which was substantially
complete as of December 31, 1998.
The Company has initiated formal communications with significant outside
vendors and business partners to determine the extent to which the Company is
vulnerable to those third parties' failure to remedy their own Year 2000 issues.
Approved is requesting that third party vendors represent their products and
services to be Year 2000 compliant and that they have a program to test for that
compliance.
The majority of the Company's mission-critical systems are already
certified by their respective vendors to being Year 2000 compliant. Certified
compliant systems include mortgage loan origination and processing, closing,
servicing, secondary marketing, and account systems. All named systems are
installed at current release levels. One system used for Indirect Lending is not
compliant. However, the vendor has scheduled replacement with a compliant
version by the end of first quarter 1999.
The majority of the Company's non-computer-related systems and equipment
are currently Year 2000 compliant, based primarily upon verbal and written
communication with vendors. Compilation of written documentation regarding this
compliance is virtually complete.
Validation of internal mission-critical applications has begun upon
those applications certified by their vendors as being fully Year 2000
compliant. Validations of several of the Company's mission-critical systems have
been completed. Approved Financial expects to meet the FFIEC milestone of having
"internal testing of mission-critical systems substantially complete" by the end
of the first quarter 1999.
COSTS. The total cost associated with required modifications and testing
to become Year 2000 compliant has been budgeted at $200,000, and is not
considered material to the Company's financial position. Costs are expensed as
incurred in the current period. This estimate does not include Approved
Financial's potential share of Year 2000 costs that may be incurred by
partnerships or ventures in which the company may participate but is not the
operator.
RISKS. The failure to correct a material Year 2000 problem could result
in interruption in, or failure of certain normal business activities or
operations. Such failures could materially and adversely affect the company's
results of operations, liquidity and financial position.
The Company's Year 2000 project has resulted in a significantly reduced
level of uncertainty about the Company's mission-critical systems and software.
The Company believes that the completion of the Year 2000 project as scheduled
will vastly reduce the possibility of significant interruptions of normal
business operations.
Due to the general uncertainty inherent in the Year 2000 problem,
resulting in part for the uncertainty of the Year 2000 readiness of third-party
suppliers, the Company is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the company's
results of operations, liquidity or financial condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Management - Asset/Liability Management
The Company's primary market risk exposure is interest rate risk. Fluctuations
in interest rates will impact both the level of interest income and interest
expense and the market value of the Company's interest-earning assets and
interest-bearing liabilities.
Management strives to manage the maturity or repricing match between assets and
liabilities. The degree to which the Company is "mismatched" in its maturities
is a primary measure of interest rate risk. In periods of stable interest rates,
net interest income can be increased by financing higher yielding long-term
mortgage loan assets with lower cost short-term Savings Bank deposits and
borrowings. Although such a strategy may increase profits in the short run, it
increases the risk of exposure to rising interest rates and can result in
funding costs rising faster than asset yields. The Company attempts to limit its
interest rate risk by selling a majority of the fixed rate mortgage loans that
it originates.
Contractual principal repayments of loans do not necessarily reflect the actual
term of the Company's loan portfolio. The average lives of mortgage loans are
substantially less than their contractual terms because of loan prepayments and
because of enforcement of due-on-sale clauses, which gives the Company the right
to declare a loan immediately due and payable in the event, among other things,
the borrower sells the real property subject to the mortgage and the loan is not
repaid. In addition, certain borrowers increase their equity in the security
property by making payments in excess of those required under the terms of the
mortgage.
The majority of the loans originated by the Company are sold through the
Company's loan sale strategies in an attempt to limit its exposure to interest
rate risk in addition to generating cash revenues. The Company sold during 1998
and 1997, approximately 78.5% and 90.0% of the total loans originated and
funded in-house during the years ended December 31,1998 and 1997, respectively,
and expects to sell the majority of its loan originations during the same
twelve-month period in which they are funded by the Company in future periods.
December 1998 loan production represented approximately 30% of the total unsold
1998 loans. The majority of these loans were sold in January 1999. As a result,
loans are held on average for less than 12 months in the Company's portfolio of
Loans Held for Sale. The "gap position", defined as the difference between
interest-earning assets and interest-bearing liabilities maturing or repricing
in one year or less, was negative at December 31, 1998, as anticipated, and is
expected to remain negative in future periods. The Company has no quantitative
target range for past gap positions, nor any anticipated ranges for future
periods due to the fact that the Company sells the majority of its loans within
a twelve month period while the gap position is a static illustration of the
contractual repayment schedule for loans.
The Company's one-year gap was a negative 32.12% of total assets at December 31,
1998, as illustrated in the following table:
One Year Two Three to More Than
Description Total Or Less Years Four Years Four Years
- ---------------------------------------- --------- --------- --------- ---------- ----------
Interest earning assets:
Loans receivable (1) $ 107,634 $ 35,961 $ 1,399 $ 3,337 $ 66,937
Cash and other
Interest-earning assets 9,634 9,634
--------- --------- --------- --------- ---------
Interest-earning assets 117,268 45,595 1,399 3,337 66,937
Allowance for loan losses (2,590)
Investment in IMC 123
Premises and equipment, net 5,579
Other 15,738
---------
Total assets $ 136,118
=========
Interest-bearing liabilities:
Revolving warehouse lines $ 72,546 72,546
FDIC - insured deposits 29,728 15,749 7,742 3,667 2,570
Other interest-bearing
liabilities 7,252 1,015 1,574 2,082 2,581
--------- --------- --------- --------- ---------
109,526 89,310 9,316 5,749 5,151
========= ========= ========= =========
Non-interest-bearing liabilities 7,325
---------
Total liabilities 116,851
Shareholders' equity 19,267
---------
Total liabilities and equity $ 136,118
=========
Maturity/repricing gap $ (43,715) $ (7,917) $ (2,412) $ 61,786
========= ========= ========= =========
Cumulative gap $ (43,715) $ (51,632) $ (54,044) $ 7,742
========= ========= ========= =========
As percent of total assets (32.12)% (37.93)% (39.70)% 5.69%
========= ========= ========= =========
Ratio of cumulative interest earning
Assets to cumulative interest earning
Liabilities .51x .48x .48x 1.07x
========= ========= ========= =========
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
Interest Rate Risk
The principal quantitative disclosure of the Company's market risks are the gap
table on page 71. The gap table shows that the Company's one-year gap was a
negative 32.1% of total assets at December 31, 1998. The Company originates
fixed-rate, fixed-term mortgage loans for sale in the secondary market. While
most of these loans are sold within a month or two of origination, for purposes
of the gap table the loans are shown based on their contractual scheduled
maturities. As of December 31, 1998, 62.3% of the principal on the loans was
expected to be received more than four years from that date. However, the
Company's activities are financed with short-term loans and credit lines, 81.5%
of which reprice within one year of December 31, 1998. The Company attempts to
limit its interest rate risk by selling a majority of the fixed rate loans that
it originates. If the Company's ability to sell such fixed-rate, fixed-term
mortgage loans on a timely basis were to be limited, the Company could be
subject to substantial interest rate risk.
Profitability may be directly affected by the levels of and fluctuations in
interest rates, which affect the Company's ability to earn a spread between
interest received on its loans and the costs of borrowings. The profitability of
the Company is likely to be adversely affected during any period of unexpected
or rapid changes in interest rates. For example, a substantial or sustained
increase in interest rates could adversely affect the ability of the Company to
purchase and originate loans and would reduce the value of loans held for sale.
A significant decline in interest rates could decrease the size of the Company's
loan servicing portfolio by increasing the level of loan prepayments.
Additionally, to the extent mortgage loan servicing rights in future periods
have been capitalized on the books of the Company, higher than anticipated rates
of loan prepayments or losses could require the Company to write down the value
of these assets, adversely affecting earnings.
In an environment of stable interest rates, the Company's gains on the sale of
mortgage loans would generally be limited to those gains resulting from the
yield differential between mortgage loan interest rates and rates required by
secondary market purchasers. A loss from the sale of a loan may occur if
interest rates increase between the time the Company establishes the interest
rate on a loan and the time the loan is sold. Fluctuating interest rates also
may affect the net interest income earned by the Company, resulting from the
difference between the yield to the Company on loans held pending sale and the
interest paid by the Company for funds borrowed, including the Company's
warehouse facilities and the Savings Bank's FHLB advances and FDIC-insured
customer deposits. Because of the uncertainty of future loan origination volume
and the future level of interest rates, there can be no assurance that the
Company will realize gains on the sale of financial assets in future periods.
The Savings Bank is building a portfolio of loans to be held for net interest
income. The sale of fixed rate product is intended to protect the Savings Bank
from precipitous changes in the general level of interest rates. The valuation
of adjustable rate mortgage loans is not as directly dependent on the level of
interest rates as is the value of fixed rate loans. Decisions to hold or sell
adjustable rate mortgage loans are based on the need for such loans in the
Savings Bank's portfolio, which is influenced by the level of market interest
rates and the Savings Bank's asset/liability management strategy. As with other
investments, the Savings Bank regularly monitors the appropriateness of the
level of adjustable rate mortgage loans in its portfolio and may decide from
time to time to sell such loans and reinvest the proceeds in other adjustable
rate investments.
Asset Quality
The following table summarizes all of the Company's delinquent loans at December
31, 1998, 1997, and 1996:
(in thousands)
1998 1997 1996
-------- -------- --------
Delinquent 31 to 60 days $ 697 $ 866 $ 1,519
Delinquent 61 to 90 days 1,115 1,124 390
Delinquent 91 to 120 days 1,460 970 363
Delinquent 121 days or more 2,658 1,567 794
-------- -------- --------
Total delinquent loans (1) $ 5,930 $ 4,527 $ 3,042
======== ======== ========
Total loans receivable outstanding, gross of the
allowance for loan losses, net of unearned loan fees (1) $107,634 $ 82,383 $ 46,347
======== ======== ========
Delinquent loans as a percentage of total loans outstanding:
Delinquent 31 to 60 days 0.65% 1.05% 3.28%
Delinquent 61 to 90 days 1.04 1.36 0.84
Delinquent 91 to 120 days 1.36 1.19 0.78
Delinquent 121 days or more 2.46 1.90 1.71
-------- -------- --------
Total delinquent loans as a percentage
of total loans outstanding 5.51% 5.50% 6.61%
======== ======== ========
- ----------
(1) Includes loans in foreclosure proceedings and delinquent loans to borrowers
in bankruptcy proceedings, but excludes real estate owned.
Interest on most loans is accrued until they become 31 days or more past due.
Interest on loans held for investment by the Savings Bank is accrued until the
loans become 90 days or more past due. The amount of additional interest that
would have been recorded had the loans not been placed on non-accrual status was
approximately $212,000, $154,000, and $91,000 in 1998, 1997, and 1996,
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 F-1 of this report,
which financial statements, report, notes and data are incorporated by
reference.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company are as follows:
Position(s) and Offices Presently
Name Age Held with the Company
---- --- ---------------------
Allen D. Wykle 52 Chairman of the Board, President
and Chief Executive Officer, and member
of Executive and Compensation Committees
Leon H. Perlin 71 Director, member of the Executive,
Audit, Compensation and Option Committees
Oscar S. Warner 82 Director, member of the Audit,
Compensation and Option Committees
Arthur Peregoff 80 Director
Stanley W. Broaddus 49 Director, Vice President and Secretary,
and member of the Executive Committee
Robert M. Salter 51 Director, member of the Compensation and
Option Committees
Jean S. Schwindt 43 Director, Executive Vice President and
member of the Executive and Audit Committees
Neil W. Phelan 41 Director, Executive Vice President
Barry C. Diggins 35 Director, Executive Vice President
Gregory J.Witherspoon 52 Director, Chairman of the Audit
Committee
Eric S. Yeakel 34 Chief Financial Officer and Treasurer
Gregory W. Gleason 46 President, Approved Federal Savings Bank
In addition to the foregoing, information regarding directors and executive
officers appears in the definitive proxy statement for the Annual Shareholder's
Meeting to be held on June 14, 1999 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 14, 1999
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 14, 1999 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 14, 1999 and is incorporated herein by reference.
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K
AUDITED FINANCIAL STATEMENTS
The following 1998 Consolidated Financial Statements of Approved Financial
Corp. and Subsidiaries are included:
- Report of Independent Public Accountants.................... 3
- Consolidated Balance Sheets................................. 4
- Consolidated Statements of Income and Comprehensive
Income (Loss).......................................... 5
- Consolidated Statements of Shareholders' Equity ............ 6
- Consolidated Statements of Cash Flows .....................7 - 8
- Notes to Consolidated Financial Statements.................9 - 35
- Stock Price and Dividend Information........................36
- Consolidating Balance Sheet.................................37
- Consolidating Income Statement..............................38
EXHIBIT INDEX
Exhibit
Number Description
3.1 Amended and Restated Articles of Incorporation of the Company (Incorporated
by Reference to Appendix A of the Form 10 Registration Statement Filed
February 11, 1998)
3.2 Bylaws of the Company (Incorporated by Reference to Appendix B of the Form 10
Registration Statement Filed February 11, 1998)
10.1 Approved Financial Corp. Incentive Stock Option Plan (Incorporated by
Reference to Appendix C of the Form 10 Registration Statement Filed February
11, 1998)
10.2 Employment Agreement between the Company and Neil W. Phelan (Incorporated by
Reference to Appendix D of the Form 10 Registration Statement Filed February
11, 1998)
10.3 Employment Agreement between the Company and Stanley W. Broaddus
(Incorporated by Reference to Appendix E of the Form 10 Registration Statement
Filed February 11, 1998)
10.4 Employment Agreement between the Company and Barry C. Diggins (Incorporated
by Reference to Appendix F of the Form 10 Registration Statement Filed
February 11, 1998)
10.5 Purchase Agreement of Barry C. Diggins' Interest in Armada
Residential Mortgage, LLC, and related Nonqualified Stock Option
Agreement (Incorporated by Reference to Appendix G of the Form 10
Registration Statement Filed February 11, 1998)
10.6 Employment Agreement between the Company and Eric S. Yeakel (Incorporated by
Reference to Appendix H of the Form 10 Registration Statement Filed February
11, 1998)
10.7 Mills Value Adviser, Inc, Investment Management Agreement/Contract with the
Company (Incorporated by Reference to Appendix I of the Form 10 Registration
Statement Filed February 11, 1998)
10.8 Share Purchase Agreement for Purchase of Controlling Interest in
Approved Federal 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)
Exhibit
Number Description
10.9 Stock Appreciation Rights Agreement with Jean S. Schwindt (Incorporated by
Reference to Appendix K of the Form 10 Registration Statement Filed February
11, 1998)
10.10 Asset Purchase Agreement with Funding Center of Georgia, Inc. (Incorporated
by Reference to Appendix L of the Form 10 Registration Statement Filed
February 11, 1998)
10.11 Gregory J. Witherspoon Registration Rights Agreement (Incorporated by
Reference to Appendix M of the Form 10 Registration Statement Filed February
11, 1998)
10.12 Pre-IPO Agreement between the Company and Industry Mortgage
Company, L.P., dated March 30, 1996 (Incorporated by Reference to
Appendix N of the Form 10 Registration Statement Filed February
11, 1998)
10.13 Employment Agreement between the Company and Barry C. Diggins dated February 1999
10.14 Purchase Agreement between the Company and MOFC, Inc.
10.15 Agreement between United Mortgagee Inc. and Approved Federal Savings Bank
10.16 Option Agreement between the Company and Allen D. Wykle
10.17 Option Agreement between the Company and Jean S. Schwindt
10.18 Option Agreement between the Company and Barry C. Diggins
10.19 Option Agreement between the Company and Neil W. Phelan
10.20 Option Agreement between the Company and Stanley Broaddus
10.21 Option Agreement between the Company and Gregory Gleason
10.22 Amendment to Stock Appreciation Rights Agreement with Jean S. Schwindt
10.23 Employment Agreement between the Company and Jean S. Schwindt dated February 1999
10.24 Employment Agreement between the Company and Eric S. Yeakel dated February 1999
10.25 Employment Agreement between MOFC Inc. and Keith Lewis dated December 15, 1998
10.26 Option Agreement between the Company and Eric Yeakel
21 Subsidiaries of the Company (Appendix N)
27 Financial Data Schedule
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Form 10-K to be signed
on its behalf by the undersigned, thereunto duly authorized.
APPROVED FINANCIAL CORP.
(Registrant)
Date: March 31, 1999 By: /s/ Eric S. Yeakel
-----------------------------------
Eric S. Yeakel
Treasurer and
Chief Financial Officer
Date: March 31, 1999 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, 1999 By: /s/ Eric S. Yeakel
-----------------------------------
Eric S. Yeakel
Treasurer and
Chief Financial Officer
Date: March 31, 1999 By: /s/ Allen D. Wykle
---------------------------------
Allen D. Wykle
Chairman of the Board of Directors
President, and Chief Executive
Officer
Date: March 31, 1999 By: /s/ Leon H. Perlin
-----------------------------------
Leon H. Perlin
Director
Date: March 31, 1999 By: /s/ Jean S. Schwindt
-----------------------------------
Jean S. Schwindt
Director and
Executive Vice President
Date: March 31, 1999 By: /s/ Barry C. Diggins
------------------------------------
Barry C. Diggins
Director and
Executive Vice President
Date: March 31, 1999 By: /s/ Neil W. Phelan
----------------------------------
Neil W. Phelan
Director and
Executive Vice President
Date: March 31, 1999 By: /s/ Stanley W. Broaddus
--------------------------------
Stanley W. Broaddus
Director, Vice President
and Secretary
Date: March 31, 1999 By: /s/ Robert M. Salter
-----------------------------------
Robert M. Slater
Director
Date: March 31, 1999 By: /s/ Oscar S. Warner
-----------------------------------
Oscar S. Warner
Director
Date: March 31, 1999 By: /s/ Arthur Peregoff
-----------------------------------
Arthur Peregoff
Director
Date: March 31, 1999 By: /s/ Gregory Witherspoon
-----------------------------------
Gregory Witherspoon
Director
APPROVED FINANCIAL CORP.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
CONTENTS
Pages
-----
Report of Independent Accountants ...................................... 3
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1998 and 1997 ....... 4
Consolidated Statements of Income and Comprehensive Income (Loss)
for the years ended December 31, 1998, 1997 and 1996 ......... 5
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1998, 1997 and 1996 ........................ 6
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 .............................. 7 - 8
Notes to Consolidated Financial Statements ......................... 9 - 35
Consolidating Balance Sheet as of December 31, 1998 ................ 36
Consolidating Statements of Income for the year ended
December 31, 1998 ............................................. 37
Report of Independent Accountants
To the Board of Directors of
Approved Financial Corp.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income and comprehensive income (loss), shareholders'
equity and cash flows present fairly, in all material respects, the consolidated
financial position of Approved Financial Corp. and Subsidiaries (the "Company")
at December 31, 1998 and 1997, and the consolidated results of their operations
and their cash flows for each of the years ended December 31, 1998, 1997, and
1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
Virginia Beach, Virginia
March 3, 1999
APPROVED FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and 1997
(Dollars in thousands, except per share amounts)
ASSETS 1998 1997
-------- --------
Cash $ 6,269 $ 11,869
Mortgage loans held for sale, net 105,044 80,696
Real estate owned, net 1,707 2,367
Investments 3,472 15,201
Income taxes receivable 2,023 --
Deferred tax asset 3,330 --
Premises and equipment, net 5,579 4,530
Goodwill, net 4,554 775
Other assets 4,140 2,687
-------- --------
Total assets $136,118 $118,125
======== ========
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 72,546 $ 52,488
FHLB bank advances -- 1,000
Deferred tax liability -- 1,109
Mortgage payable 1,210 1,216
Notes payable-related parties 3,628 6,684
Certificate of indebtedness 2,414 2,396
Certificates of deposits 29,728 17,815
Loan proceeds payable 2,565 6,364
Accrued and other liabilities 4,760 2,837
Income taxes payable -- 1,161
-------- --------
Total liabilities $116,851 $ 93,070
-------- --------
Shareholders' equity:
Preferred stock series A, $10 par value; $ 1 $ 1
Noncumulative, voting:
Authorized shares - 100
Issued and outstanding shares - 90
Common stock, par value - $1.00 in 1998 and 1997: 5,482 5,395
Authorized shares - 40,000,000
Issued and outstanding shares - 5,482,114
In 1998 and 5,395,408 in 1997
Accumulated other comprehensive income 30 6,854
Additional paid in capital 552 --
Retained earnings 13,202 12,805
-------- --------
Total equity 19,267 25,055
-------- --------
Total liabilities and equity $136,118 $118,125
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS) for the years
ended December 31, 1998, 1997, and 1996 (Dollars in thousands, except share and
per share amounts)
1998 1997 1996
-------- -------- --------
Revenue:
Gain on sale of loans $ 29,703 $ 33,501 $ 17,955
Interest income 10,308 10,935 4,520
Income from limited partnership -- -- 480
Gain on sale of securities 1,750 2,796 --
Other fees and income 7,042 4,934 1,927
-------- -------- --------
48,803 52,166 24,882
-------- -------- --------
Expenses:
Compensation and related 23,397 18,535 8,017
General and administrative 11,713 10,205 6,680
Loan production expense 3,593 1,895 173
Interest expense 6,252 6,157 3,121
Provision for loan and foreclosed property losses 2,896 1,676 1,308
-------- -------- --------
47,851 38,468 19,299
-------- -------- --------
Income before income taxes 952 13,698 5,583
Provision for income taxes 473 5,638 2,259
-------- -------- --------
Net income 479 8,060 3,324
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gain/(loss) arising during period (6,824) (4,547) 11,401
-------- -------- --------
Comprehensive (loss)/income $ (6,345) $ 3,513 $ 14,725
======== ======== ========
Net income per share:
Basic $ 0.09 $ 1.52 $ 0.67
======== ======== ========
Diluted $ 0.09 $ 1.51 $ 0.63
======== ======== ========
Weighted average number of shares outstanding:
Basic 5,465 5,310 4,964
======== ======== ========
Diluted 5,511 5,346 5,281
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY for the years ended December 31,
1998, 1997, and 1996 (Dollars in thousands)
Preferred Stock Accumulated
Series A Common Stock Additional Other
---------------------- ---------------------- Paid In Comprehensive Retained
Shares Amount Shares Amount Capital Income Earnings Total
---------- -------- ---------- -------- -------- -------- -------- --------
Balance at December 31, 1995 90 $ 1 606,680 $ 607 $ 1,142 $ 0 $ 4,486 $ 6,236
Net income 3,324 3,324
Reissuance of common stock 22,000 22 336 82 440
2:1 Stock split 628,680 0
2:1 Stock split 1,257,360 0
Exercise of warrants 4,648 1 7 8
Dividends on common stock (200) (200)
Unrealized gain on investments 11,401 11,401
available for sale, net of tax
-------- -------- ---------- -------- -------- -------- -------- --------
Balance at December 31, 1996 90 $ 1 2,519,368 $ 630 $ 1,485 $ 11,401 $ 7,692 $ 21,209
Net income 8,060 8,060
Redemption of warrants 176,836 44 288 332
Change par value of stock 2,022 (1,773) (249) 0
Issuance of common stock 1,500 1 1
Stock dividend 2,697,704 2,698 (2,698) 0
Unrealized gain on investments (4,547) (4,547)
available for sale, net of tax
-------- -------- ---------- -------- -------- -------- -------- --------
Balance at December 31, 1997 90 $ 1 5,395,408 $ 5,395 $ 0 $ 6,854 $ 12,805 $ 25,055
Net income 479 479
Issuance of common stock 116,706 117 552 669
Repurchase common stock (30,000) (30) (82) (112)
Unrealized loss on investments (6,824) (6,824)
available for sale, net of tax
-------- -------- ---------- -------- -------- -------- -------- --------
Balance at December 31, 1998 90 $ 1 5,482,114 $ 5,482 $ 552 $ 30 $ 13,202 $ 19,267
======== ======== ========== ======== ======== ======== ======== ========
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1998, 1997 and 1996
(In thousands)
1998 1997 1996
--------- --------- ---------
Operating activities
Net income $ 479 $ 8,060 $ 3,324
Adjustments to reconcile net income
to net cash used in operating activities:
Depreciation of premises and equipment 750 609 133
Amortization of goodwill 395 -- --
Provision for loan losses 3,064 1,534 1,145
Provision for losses on real estate owned (168) 142 163
(Gain) on sale of securities (1,750) (2,796) --
Loss on sale of real estate owned 660 654 192
(Gain) on sale of loans (29,703) (32,696) (17,954)
Income from limited partnership -- -- (480)
Proceeds from sale and prepayments of loans 434,682 479,317 258,335
Change in unearned loan fees 909 -- --
Change in deferred loan costs (263) -- --
Change in deferred hedging loss 91 -- --
Loans held for sale in originations (430,363) (490,579) (258,826)
Changes in assets and liabilities:
Loan sale receivable (28) -- --
Other assets (2,931) (882) (545)
Accrued and other liabilities (709) 6,773 (110)
Income tax payable (3,184) 177 443
Deferred tax asset 112 (1,325) (888)
Loan proceeds payable (3,799) -- --
--------- --------- ---------
Net cash used in operating activities (31,756) (31,012) (15,068)
Cash flows from investing activities:
Purchase of securities -- (4,304) (1,000)
Sales of securities 1,844 4,458 --
Sales of ARM fund shares 4,957 -- --
Distribution from limited partnership -- -- 1,098
Purchase of premises and equipment (1,036) (3,113) (946)
Sales of premises and equipment 29 199 --
Sales of real estate owned 4,440 3,735 1,501
Real estate owned capital improvements (343) -- --
Recoveries on loans charged off 162 182 28
Purchases of ARM fund shares (4,563) -- --
Purchases of FHLB stock (96) -- --
Net cash paid for acquisitions (1,395) (382) (244)
--------- --------- ---------
Net cash provided by investing activities 3,999 775 437
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued for the years ended December
31, 1998, 1997 and 1996 (In thousands)
1998 1997 1996
--------- --------- ---------
Cash flows from financing activities:
Borrowings - warehouse $ 380,182 $ 471,717 $ 262,854
Repayments of borrowings - warehouse (365,705) (451,259) (248,243)
(Repayments of) proceeds from FHLB advances (1,000) 1,000 --
Proceeds from mortgage loan payables -- 800 --
Principal payments on mortgages payable (83) (62) (46)
Net increase (decrease) in:
Notes payable (3,056) (155) 1,966
Certificates of indebtedness 18 53 311
Certificates of deposit 11,914 16,238 197
Redemption of common stock warrants -- 332 8
Redemption of common stock (113) -- --
Common stock shares issued -- 2 440
Cash dividends paid -- -- (200)
--------- --------- ---------
Net cash provided by financing activities 22,157 38,666 17,287
--------- --------- ---------
Net (decrease) increase in cash (5,600) 8,429 2,656
Cash at beginning of year 11,869 3,440 784
--------- --------- ---------
Cash at end of year $ 6,269 $ 11,869 $ 3,440
========= ========= =========
Supplemental cash flow information:
Cash paid for interest $ 6,231 $ 5,991 $ 3,070
Cash paid for income taxes 3,546 5,461 2,880
Supplemental non-cash information:
Loan balances transferred to real estate owned $ 3,930 $ 4,641 $ 3,245
Exchange of stock for acquisition of Armada Residential
Mortgage LLC 669 -- --
Conversion of and recognition of unrealized gains of
Partnership interest to common stock 19,001
Accounts payable incurred in exchange for goodwill in
connection with the Consumer One acquisition 1,575
The accompanying notes are an integral part of the consolidated financial
statements.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 1. Organization and Summary of Significant Accounting Policies:
Organization: Approved Financial Corp., a Virginia corporation ("Approved"), and
its subsidiaries (collectively, the "Company") engage in the consumer finance
business of originating, servicing and selling home equity loans secured
primarily by first and second liens on one-to-four family residential
properties. Approved has three wholly-owned subsidiaries. Approved Residential
Mortgage, Inc. ("ARMI") had broker operations in nine states, and twenty-four
retail operations in ten states at the end of 1998. Approved Federal Savings
Bank (the "Savings Bank") is a federally chartered thrift institution. The
Savings Bank has a wholly-owned subsidiary operating as a title insurance
agency. The Savings Bank had broker operations in two states and two retail
offices in Virginia. Mortgage One Financial Corporation d/b/a ConsumerOne
Financial ("ConsumerOne") had three retail offices in two states at the end of
1998.
Principles of accounting and consolidation: The consolidated financial
statements of the Company include the accounts of Approved and its wholly-owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated.
Use of estimates: The preparation of financial statements in conformity with
generally accepted accounting principles require management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and cash equivalents: Cash and cash equivalents consist of cash on deposit
at financial institutions and short-term investments that are considered cash
equivalents if they were purchased with an original maturity of three months or
less.
Loans held for sale: Loans, which are all held for sale, are carried at the
lower of aggregate cost or market value. Market value is determined by current
investor yield requirements.
Allowance for loan losses: The allowance for loan losses is maintained at a
level believed adequate by management to absorb potential losses in the loan
portfolio. Management's determination of the adequacy of the allowance is based
on an evaluation of current economic conditions, volume, growth, 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 collectibility is unlikely.
Origination fees: The Company accounts for origination fees on mortgage loans
held for sale in conformity with Statement of Financial Accounting Standards
("SFAS") No. 91, "Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases." The statement requires that
net origination fees be recognized over the life of the loan or upon the sale of
the loan, if earlier.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997 and 1996
Note 1. Organization and Summary of Significant Accounting Policies, continued:
Hedging: To offset the effects of interest rate fluctuations on the value of its
fixed rate mortgage loans held for sale, the Company in certain cases will enter
into Treasury security lock contracts, which function similar to short sales of
U.S. Treasury securities. Gains or losses from these contracts are deferred and
recognized as an adjustment to gains on sale of loans when the loans are sold or
when the related hedge position is closed.
Real estate owned: Real estate owned is valued at the lower of cost or fair
market value, net of estimated disposal costs. Cost includes loan principal and
certain capitalized expenses. Any excess of cost over the estimated fair market
value at the time of acquisition is charged to the allowance for loan losses.
The estimated fair market value is reviewed periodically by management and any
write-downs are charged against current earnings using a valuation account which
has been netted against real estate owned in the financial statements. Income
from temporary rental of the properties is credited against the investment when
collected. Capital improvements are capitalized to the extent of net realizable
value. Additional carrying costs, including taxes, utilities and insurance, are
also capitalized to the property.
Premises and equipment: Premises, leasehold improvements and equipment are
stated at cost less accumulated depreciation and amortization. The buildings are
depreciated using the straight line method over thirty years. Leasehold
improvements are amortized over the lesser of the terms of the lease or the
estimated useful lives of the improvements. Depreciation of equipment is
computed using the straight line method over the estimated useful lives of three
to five years. Expenditures for betterments and major renewals are capitalized
and ordinary maintenance and repairs are charged to operations as incurred.
Securities: All investment securities 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.
The Company's investment in the stock of the Federal Home Loan Bank ("FHLB") of
Atlanta is stated at cost.
Income recognition: Gains on the sale of mortgage loans representing the
difference between the sales price and the net carrying value of the loan are
recognized when mortgage loans are sold and delivered to investors.
Interest on loans is credited to income based upon the principal amount
outstanding. Interest is accrued on loans until they become 31 days or more past
due.
Advertising costs: Advertising costs are expensed when incurred.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997 and 1996
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.
Earnings per share: Effective December 31, 1997, the Company adopted SFAS No.
128, "Earnings per Share," which supersedes Accounting Principles Board ("APB")
Opinion No. 15, "Earnings per Share." The new statement requires that "basic
earnings per share" be computed 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 dilutive
potential common shares such as stock options and warrants and convertible
securities. "Basic earnings per share" and "diluted earnings per share" replaced
"primary earnings per share" and "fully diluted earnings per share,"
respectively, as described under APB Opinion No. 15, and are reported on the
income statement.
The Company declared two-for-one stock splits effective August 30, 1996,
December 16, 1996 and a 100% stock dividend effective November 21, 1997. The
share and per share figures in this report have been adjusted to reflect these
splits.
New accounting pronouncements: Effective January 1, 1998 the Company adopted
SFAS No. 130, "Reporting Comprehensive Income". The new statement requires that
an enterprise (a) classify items of other comprehensive income by their nature
in a financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and additional capital in
the equity section of the statement of financial condition. The only item the
Company has in Comprehensive Income is an unrealized holding gain or loss on
securities, net of deferred taxes.
In June 1994, SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information" was issued, effective for fiscal years beginning after
December 15, 1997. The new statement requires that a public business enterprise
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 resources 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. This statement
does not have any material impact on the financial statements.
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" was issued, effective for fiscal year ends beginning after June 15,
1999. This statement establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, (collectively referred to as derivatives) and for hedging
activities. It requires that entities
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997 and 1996
Note 1. Organization and Summary of Significant Accounting Policies, continued:
New accounting pronouncements (cont.): recognize all derivative as either assets
or liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designed as (a) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment, (b)
a hedge of the exposure to variable cash flows of a forecasted transaction, or
(c) a hedge of the foreign currency exposure of a net investment in a foreign
operation, an unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. The Company is currently
evaluating the effect this statement will have on the financial statements.
In October 1998, SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise" was issued, effective for the first fiscal quarter beginning
after December 15, 1998. The new statement requires that after an entity that is
engaged in mortgage banking activities has securitized mortgage loans that are
held for sale, it must classify the resulting retained mortgage-backed
securities or other retained interests based on its ability and intent to sell
or hold those investments. Any retained mortgage-backed securities that are
committed for sale before or during the securitization process must be
classified as trading. This statement does not have any impact on the Company's
financial statements since the company has never securitized loans.
Reclassifications: Certain reclassifications have been made to amounts
previously reported in 1997 and 1996 to conform with the 1998 presentation.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 2. Securities:
The cost basis and fair value of the Company's securities at December 31, 1998
and 1997 are as follows (in thousands):
1998 1997
----------------- -----------------
Cost Fair Cost Fair
Basis Value Basis Value
------- ------- ------- -------
IMC Mortgage Company common stock $ 73 $ 123 $ 162 $11,585
Adjustable rate mortgage mutual fund 3,219 3,203 3,569 3,566
FHLB stock 146 146 50 50
------- ------- ------- -------
$ 3,438 $ 3,472 $ 3,781 $15,201
======= ======= ======= =======
The Company's investment in IMC Mortgage Company ("IMC") common stock had gross
unrealized gains of $50,000 and $11,423,000 at December 31, 1998 and 1997,
respectively. The Company's investment in the adjustable rate mortgage mutual
fund had unrealized losses of $15,000 and $2,000 at December 31, 1998 and 1997,
respectively.
The Company was an original limited partner in Industry Mortgage Company, L.P.
(the "IMC Partnership"), a non-conforming residential mortgage company based in
Tampa, Florida. The Company's initial ownership interest represented
approximately 9.09% of the IMC partnership and was accounted for under the
equity method of accounting. Therefore, the Company recognized the portion of
the IMC Partnership's net income equal to its ownership percentage in the IMC
Partnership. In 1996, the Company recognized income of $480,000, from the IMC
Partnership.
The IMC Partnership converted to a corporation, IMC, immediately before its
initial public offering on June 24, 1996. The limited partners received common
stock of IMC in exchange for their IMC Partnership interests as of June 24,
1996. The Company was issued 1,199,768 shares of IMC common stock at that time.
Following the partnership's conversion to corporate form, the Company's
investment in IMC is accounted for as an investment security available for sale
under SFAS No. 115. As of December 31, 1998, the Company owned 435,634 shares of
IMC stock. The Company's stock position represented approximately 1.3% of IMC's
outstanding stock at that date. During 1998, the Company sold 558,400 shares of
IMC stock for $1.9 million which resulted in a pre-tax gain of $1.8 million.
During 1997, the Company sold 233,241 shares of IMC stock for $3.7 million which
resulted in a pre-tax gain of $2.8 million. The Company also received 27,507
shares of IMC common stock as an incentive award relating to the volume of loans
sold by the Company to IMC. All of the share figures above reflect a two-for-one
split of IMC shares on February 13, 1997.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997 and 1996
Note 2. Securities, continued:
Shares of IMC common stock are traded on the NASDAQ National Exchange under the
trading symbol "IMCC." However, the shares received by the Company have not been
registered with the Securities and Exchange Commission ("SEC") under the
Securities Act of 1933. Sales of IMC stock by the Company are subject to SEC
Rule 144.
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, 1998 and 1997 were as follows (in thousands):
1998 1997
--------- ---------
Mortgage loans held for sale $ 109,500 $ 83,512
Net deferred origination fees and hedging costs (1,866) (1,129)
Allowance for loan losses (2,590) (1,687)
--------- ---------
Total mortgage loans, net $ 105,044 $ 80,696
========= =========
As of December 31, 1998, 1997 and 1996, the recorded investment in loans for
which impairment has been determined in accordance with SFAS No. 114 totaled,
$4,119,000, $2,500,000, and $1,200,000 respectively. The average recorded
investment in impaired loans for the years ended December 31, 1998 1997, and
1996 was $2,603,000, $780,000 and $64,000, respectively. Interest income
recognized related to these loans was $86,000, $94,000 and $13,000 during 1998,
1997 and 1996, respectively. Due to the homogenous nature and collateral for
these loans, there is no corresponding valuation allowance.
Nonaccrual loans were $5,930,000 and $4,511,000 at December 31, 1998 and 1997,
respectively. The amount of additional interest that would have been recorded
had these loans not been placed on nonaccrual status was approximately $212,000,
$154,000, and $91,000 in 1998, 1997 and 1996, respectively.
As of December 31, 1997, the Company had one open interest rate hedge position
with a notional amount of $15,000,000 under a contract which expired March 2,
1998. The Company had a deferred loss of $91,000 at December 31, 1997 related to
this hedge position. The Company did not have an open interest rate hedge
position at December 31, 1998.
The Company sold to IMC Mortgage Company 1,942 loans in 1998, 3,791 loans in
1997 and 1,536 loans in 1996, totaling $118,009,000, $235,228,000, and
$100,095,000 and recognized gains on the sale of these loans of $7,444,000,
$16,153,000, and $6,648,000 during the years ended December 31, 1998, 1997 and
1996, respectively. The Company has not sold any loans to IMC Mortgage Company
since September 1998.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997,and 1996
Note 3. Mortgage Loans Held for Sale, continued:
Changes in the allowance for loan losses for the years ended December 31, 1998,
1997, and 1996 were (in thousands):
1998 1997 1996
------- ------- -------
Balance at beginning of year $ 1,687 $ 924 $ 594
Acquisitions 49 0 20
Charge-offs (2,372) (953) (863)
Recoveries 162 182 28
Provision 3,064 1,534 1,145
------- ------- -------
Balance at end of year $ 2,590 $ 1,687 $ 924
======= ======= =======
Note 4. Real Estate Owned:
Real estate owned is valued at the lower of cost or fair market value, net of
estimated disposal costs.
Changes in the real estate owned valuation allowance for the years ended
December 31, 1998, 1997, and 1996 were (in thousands):
1998 1997 1996
----- ----- -----
Balance at beginning of year $ 671 $ 529 $ 366
Provision (168) 142 163
----- ----- -----
Balance at end of year $ 503 $ 671 $ 529
===== ===== =====
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 5. Premises and Equipment:
Premises and equipment at December 31, 1998 and 1997 were summarized as follows
(in thousands):
1998 1997
------ ------
Land $ 240 $ 240
Building & Improvements 2,513 2,101
Office Equipment & Furniture 2,303 1,465
Computer Software/Equipment 2,346 1,613
Vehicles 235 225
------ ------
7,637 5,644
Less accumulated depreciation 2,058 1,114
------ ------
Premises and equipment, net $5,579 $4,530
====== ======
The Company has several capital leases for computer and other equipment included
in the premises and equipment table above. See Note 6 for further discussion on
capital leases.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 6. Capital Leases:
Capital leases at December 31, 1998 and 1997 consist of the following (in
thousands):
1998 1997
----- -----
Computer equipment $ 322 --
Furniture & equipment 302 --
Less:
Accumulated amortization (116) --
----- -----
$ 508 --
===== =====
Amortization expense for the years ended December 31, 1998 and 1997 approximated
$116,000 and $0 respectively.
Future minimum rental commitments, including the bargain purchase option
exercisable at the end of the lease terms and the present value of the net
minimum lease payments as of December 31, 1998 are as follows (in thousands):
1999 $230
2000 230
2001 120
2002 30
----
610
Less - amount representing interest 94
----
Present value of net minimum lease payments $516
====
The Company has the option to purchase these assets at an established price at
the end of the lease terms. The Company recognized approximately $36,000 and $0
of interest expense related to the lease obligations for the years ended
December 31, 1998 and 1997, respectively.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 7. Leases
The Company leases some of its office facilities and equipment under operating
leases which expire at various times through 2003. Lease expense was $1.4
million, $1.0 million, and $0.3 million in 1998, 1997, and 1996, respectively.
Total minimum lease payments under non-cancelable operating leases with
remaining terms in excess of one year as of December 31, 1998 were as follows:
1999 $1,669
2000 891
2001 492
2002 330
2003 144
------
$3,526
======
Note 8. Revolving Warehouse Facilities:
Amounts outstanding under revolving warehouse facilities at December 31, 1998
and 1997 were as follows (in thousands):
1998 1997
-------- --------
Syndicated warehouse facility with commercial bank
collateralized by mortgages/deeds of trust; expires December 31, 1999, with
interest at 1.50% over applicable LIBOR rate (5.54581% at December
31, 1998); total credit available $100 million. $ 59,261 $ 46,734
Syndicated seasoned loan line of credit with commercial banks collateralized by
mortgages/deeds of trust; expires December 31, 1999, with interest at 2.50% over
applicable LIBOR rate (5.54581% at December 31, 1998); total credit available
$25 million. 7,076 5,754
Subsidiaries warehouse facility with investor collateralized by mortgages/deeds
of trust; expires June 10, 1999 with interest at 1.75% over applicable prime
rate (7.750% at December 31,
1998); total credit available $10 million. 6,209 -0-
-------- --------
$ 72,546 $ 52,488
======== ========
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 8. Revolving Warehouse Facilities, continued:
On December 10, 1997, the Company obtained a $100,000,000 warehouse line of
credit from a commercial bank syndicate. The line is collateralized by loans
originated by the Company and bears interest at a rate of 1.50% over the
one-month LIBOR rate. This line of credit replaced three existing lines of
credit. The line expires on December 31, 1999 and is subject to renewal. The
Company may receive warehouse credit advances of 98% of the original principal
balances on pledged mortgage loans for a maximum period of 180 days after
origination. Also on December 10, 1997, the Company obtained a $25,000,000
seasoned loan line of credit from a commercial bank syndicate. This line is
secured by loans originated by the Company. The seasoned loan line of credit
bears interest at a rate of 2.50% over the one-month LIBOR rate, and the Company
may receive credit advances of 90% of the current principal balances on pledged
mortgage loans.
Mortgage One Financial Corporation, Inc. d/b/a ConsumerOne Financial,
("ConsumerOne") the Michigan based mortgage company acquired by Approved, had an
existing warehouse credit agreement with a California corporation. The line of
credit commenced on June 10, 1998 and terminates one year from the commencement
date. The maximum credit availability is $10,000,000. This line is
collateralized by mortgage loans originated by ConsumerOne and bears interest at
a rate of prime plus 1.75%. This line of credit was paid off in February 1999.
ConsumerOne also has a $150,000 Small Business Line of Credit.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 9. Deposits:
The following table sets forth various interest rate categories for the
FDIC-insured certificates of deposit of the Savings Bank as of December 31, 1998
and 1997:
(In thousands)
1998 1997
------------------- -------------------
Weighted Weighted
Average Average
Rate Amount Rate Amount
-------- ------- -------- -------
5.24% or less 5.18% $ 1,883 -- $ --
5.25 - 5.49% 5.34 5,651 5.30% 198
5.50 - 5.74 5.65 2,179 5.56 300
5.75 - 5.99 5.86 12,789 5.91 8,318
6.00 - 6.24 6.12 6,039 6.11 8,010
6.25 - 6.49 6.40 1,187 6.32 989
------- ------- ------- -------
5.78% $29,728 6.01% $17,815
======= ======= ======= =======
The following table sets forth the amount and maturities of the certificates of
deposit of the Savings Bank at December 31, 1998.
(In thousands)
Six Over Six Months Over One Year Over
Months or and Less than and Less than Two
Less One Year Two Years Years Total
--------- --------------- ------------- ------- -------
5.24% or less $ 397 $ 1,387 $ 99 $ -- $ 1,883
5.25 - 5.49% 200 1,984 2,183 1,284 5,651
5.50 - 5.74 1,088 99 199 793 2,179
5.75 - 5.99 2,580 2,971 4,466 2,772 12,789
6.00 - 6.24 3,062 992 696 1,289 6,039
6.25 - 6.49 198 791 99 99 1,187
------- ------- ------- ------- -------
$ 7,525 $ 8,224 $ 7,742 $ 6,237 $29,728
======= ======= ======= ======= =======
At December 31, 1998, fifty-eight certificates of deposit totaling $5,800,000
were in amounts of $100,000.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 10. Federal Home Loan Bank Advances:
Advances from the Federal Home Loan Bank ("FHLB") of Atlanta at December 31,
1997 of $1,000,000 were due and repaid in 1998.
At December 31, 1998, the Savings Bank has pledged its FHLB stock and qualifying
residential mortgage loans with an aggregate balance of $3,300,000 as collateral
for such FHLB advances under a specific collateral agreement. Interest is
computed based on the lender's cost of overnight funds. The interest rates on
December 31, 1998 and 1997 were 5.10% and 6.50%, respectively. Interest expense
on FHLB advances totaled $76,000 and $3,000 in 1998 and 1997; the Savings Bank
did not borrow from the FHLB in 1996.
Note 11. Notes Payable - Related Parties:
Notes payable - related parties are amounts due to shareholders, officers and
others related to the Company. These notes are subordinate to the line of credit
and all other collateralized indebtedness of the Company. Interest expense on
notes payable related parties was $554,000, $666,000, and $547,000 in 1998, 1997
and 1996, respectively. The interest rates on the notes range from 8.00% to
10.25% and the notes mature as follows (in thousands):
1999 $ 459
2000 748
2001 309
2002 482
2003 1,630
------
$3,628
======
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 12. Certificates of Indebtedness:
Certificates of indebtedness are uninsured deposits authorized for financial
institutions such as the Company, which have Virginia industrial loan
association charters. The certificates of indebtedness are loans from Virginia
residents for periods of one to five years and interest rates between 6.75% and
10.00%. Interest expense on the certificates was $224,000, $225,000, and
$139,000 in 1998, 1997, and 1996, respectively.
Certificates of indebtedness maturities were as follows as of December 31, 1998
(in thousands):
1999 $ 390
2000 729
2001 556
2002 516
2003 223
------
$2,414
======
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 13. Mortgage Notes Payable:
The Company has two mortgage loans payable to a commercial bank. The loans are
collateralized by two office buildings used by the Company for its corporate
headquarters. The mortgage loans are summarized as follows (in thousands):
1998 1997
--------- ---------
Mortgage loan 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% $ 375 $ 428
Mortgage loan with commercial bank collateralized
by office building; original amount of $800,000;
monthly payments of $7,953; matures June 2012;
with interest at 8.625% 759 788
Mortgage loan payable-
Foreclosed properties 76 --
--------- ---------
$ 1,210 $ 1,216
========= =========
Interest expense on mortgage loans payable was $99,000, $73,000, and $40,000 in
1998, 1997, and 1996 respectively.
Aggregate maturities for mortgage payable are as follows as of December 31,
1998:
1999 $ 166
2000 97
2001 105
2002 114
2003 124
Thereafter 604
------
$1,210
======
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 14. Shareholders' Equity:
In January 1998, the Company issued 104,146 split-adjusted shares of its Common
Stock to purchase a senior officer's 17% ownership interest in Armada
Residential Mortgage, LLC ("Armada LLC") which was terminated in September 1997.
The senior officer terminated his employment with Armada LLC and became an
employee of Approved Residential Mortgage, Inc. ("ARMI"). The Company also
issued 12,560 split-adjusted shares to a key employee of Armada LLC.
In December 1998, the Company repurchased 30,000 shares of its Common Stock at
$3.75 per share. The Company's Board of Directors authorized this stock buy back
plan at its quarterly board meeting held on November 2, 1998. The Company was
authorized to repurchase up to 1 million shares of its Common Stock.
Note 15. Stock Options:
On June 28, 1996, the Company adopted the 1996 Incentive Stock Option Plan. The
Company's stock option plan provides primarily for the granting of nonqualified
stock options to certain key employees. Generally, options are granted at prices
equal to the market value of the Company's stock on the date of grant, vest over
a three-year period, and expire ten years from the date of the award.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" and related interpretations in accounting for its
stock option plans. SFAS No. 123, "Accounting for Stock-Based Compensation," was
issued in 1995 and, if fully adopted, changes the method of recognition of cost
on plans similar to those of the Company. The Company has adopted the
alternative disclosure established by SFAS No. 123. Therefore, pro forma
disclosures as if the Company adopted the cost recognition requirements under
SFAS No. 123 are presented below.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 15. Stock Options, continued:
A summary of the Company's stock options as of December 31, 1998 and 1997 and
the changes during the years is presented below:
1998 1997
-------------------------- --------------------------
Weighted Weighted
Average Average
Shares Exercise Price Shares Exercise Price
------- -------------- ------- --------------
Outstanding at beginning of year 9,200 $ 9.75 --
Granted 8,050 13.50 9,200 $ 9.75
91,375 4.00
Cancelled 400 4.00
------- ----------- ------- -----------
Outstanding at end of year 108,225 $ 5.19 9,200 $ 9.75
======= =========== ======= ===========
Options available for future grant 148,275 242,800
======= =======
Weighted average fair value of
options granted during year $ 1.20 $ 3.49
=========== ===========
The weighted-average remaining contractual life of options granted at December
31, 1998 was 9.0 years and 8.0 years for options granted in 1997.
The fair value of each option granted during 1998 and 1997 is estimated on the
date of grant using the Black-Scholes option-pricing model with the following
assumptions: dividend yield of zero; expected volatility of 34.48% in 1998 and
34.12% in 1997; risk-free interest rate of 5.42% for options granted in January
1998, 4.54% for options granted in November 1998, and 6.00% for options granted
in 1997.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 15. Stock Options, continued:
Had compensation cost for the 1998 and 1997 grants for stock-based compensation
plans been recorded by the Company, the Company's pro forma net income and pro
forma net income per common share for 1998 and 1997 would have been as follows:
(In thousands, except per share amounts)
Year Ended Year Ended
December 31, 1998 December 31, 1997
------------------------ --------------------------
As Reported Pro Forma As Reported Pro Forma
---------- --------- ----------- ---------
Net income $ 479 $ 371 $ 8,060 $ 8,041
Net income per common share - Basic 0.09 0.07 1.52 1.52
Net income per common share - Dilutive 0.09 0.07 1.51 1.51
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. There were no awards prior to 1997 and additional
awards in future years are anticipated.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 16. Earnings Per Share:
The Company's earnings per share have been calculated in accordance with SFAS
No. 128, "Earnings Per Share." The statement requires calculations of basic and
diluted earnings per share. These calculations are described in Note 1. The
following table shows the reconciling components between basic and diluted
earnings per share:
Weighted Average
Shares
Net Income Outstanding Earnings Per
(Numerator) (Denominator) Share
----------- ---------------- ------------
For the Year Ended December 31, 1998
Basic earnings per share $ 479,000 5,465,034 $ 0.09
Effect of dilutive securities:
Common stock issued -- 46,338 --
---------- ---------- ----------
Diluted earnings per share $ 479,000 5,511,372 $ 0.09
========== ========== ==========
For the Year Ended December 31, 1997
Basic earnings per share $8,060,000 5,310,263 $ 1.52
Effect of dilutive securities:
Stock options -- 1,162 --
Common stock payable -- 34,532 (.01)
---------- ---------- ----------
Diluted earnings per share 8,060,000 5,345,957 $ 1.51
========== ========== ==========
For the Year Ended December 31, 1996
Basic earnings per share $3,324,000 4,964,244 $ 0.67
Effect of dilutive securities:
Warrants -- 316,859 (.04)
---------- ---------- ----------
Diluted earnings per share $3,324,000 5,281,103 $ 0.63
========== ========== ==========
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 17. Income Taxes:
The components of income tax expense for the years ended December 31, 1998,
1997, and 1996 were as follows (in thousands):
1998 1997 1996
------- ------- -------
Current $ 361 $ 6,963 $ 3,147
Deferred 112 (1,325) (888)
------- ------- -------
$ 473 $ 5,638 $ 2,259
======= ======= =======
The provision for income taxes for financial reporting purposes differs from the
amount computed by applying the statutory federal tax rate to income before
taxes. The principle reasons for these differences for the years ended December
31, 1998, 1997, and 1996 were (in thousands):
1998 1997 1996
------- ------- -------
Provision for income
Taxes at statutory $ 339 $ 4,731 $ 1,898
federal rate
State income taxes, net 58 827 332
of federal benefit
Nondeductible expenses 71 79 30
Other, net 5 1 (1)
------- ------- -------
$ 473 $ 5,638 $ 2,259
======= ======= =======
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 17. Income Taxes, continued:
Significant components of the Company's deferred tax assets and liabilities at
December 31, 1998 and 1997 were (in thousands):
1998 1997
------- -------
Deferred tax assets:
Allowance for loan and real estate $ 1,231 $ 912
owned losses
Deferred loan fees 847 487
Mark to market on mortgage loans 670 1,790
held for sale
Deferred income 1 52
Accrued premium recapture 229 160
Accrued expenses 196 --
Accrued 401K match 60 32
Accrued insurance expense 60 52
Other 79 --
------- -------
Total deferred tax assets 3,373 3,485
Deferred tax liabilities:
Market value of securities 19 4,568
Other 24 26
------- -------
Total deferred tax liabilities 43 4,594
------- -------
Net deferred asset (liability) $ 3,330 $(1,109)
======= =======
The Company believes that a valuation allowance with respect to the realization
of the gross total deferred tax assets is not necessary. Based on the Company's
historical earnings, future expectations of taxable income and potential net
operating loss carrybacks, management believes it is more likely than not that
the Company will realize the gross deferred tax assets existing at December 31,
1998. However, there can be no assurances that the Company will generate taxable
income in any future period.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 18. Retirement Plans:
The Company has a defined contribution profit sharing plan, which is
administered by officers of the Company. Company contributions to the plan are
discretionary, as authorized by the Board of Directors. There were no
contributions for 1998, 1997, and 1996. 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, 1998, 1997, and 1996.
The Company has a nonqualified retirement plan for several key members of
management. The plan allows participants to defer compensation from the current
year. Company contributions to the plan are discretionary, as authorized by the
Board of Directors. Contributions for the years ended December 31, 1998, 1997,
and 1996 were $0, $10,000, and $0, respectively.
The Company sponsors a 401(k) Retirement Plan. The Plan is a defined
contribution plan covering all employees who have completed at least one year of
service. The Plan is subject to the provisions of the Employee Retirement Income
Security Act of 1974. The Company contributes an amount equal to 50% of a
participant's payroll savings contribution up to 6% of a participant's annual
compensation. The Company's contributions to the plan for the years ended
December 31, 1998, 1997, and 1996 were $162,000, $115,000, and $33,000,
respectively.
Note 19. Employment Agreements:
The Company has employment agreements with various employees. The agreements
expire at various times from 1999 through 2001. Among other things, the
agreements provide for severance benefits payable to the officers upon
termination of employment following a change of control in the Company.
Note 20. Acquisitions:
Effective January 26, 1998, Approved Residential Mortgage, Inc. ("ARMI")
purchased substantially all of the assets of Funding Center of Georgia, Inc.
("FCGA"), which is located in Atlanta. All of the employees of FCGA have become
employees of ARMI, and the business is conducted under the assumed name of
"Funding Center of Georgia". The purchase price for FCGA's assets was
$1,000,000. ARMI paid $600,000 at closing, paid $100,000 in 1998 and will pay
$100,000 in 1999, 2000, and 2001, with interest at 6%. The two principal owners
of FCGA entered in three-year employment agreements with ARMI to manage the
operations of FCGA. This transaction was accounted for under the purchase method
of accounting. Net assets of $7,000 were acquired with an associated intangible
asset (goodwill) recorded in the amount of $990,000. This goodwill will be
amortized over 10 years.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997, and 1996
Note 20. Acquisitions, continued:
Effective December 15, 1998, Approved Financial Corp. ("Approved") purchased
100% of the outstanding stock of Mortgage One Financial Corporation ("MOFC,
Inc.") a Michigan based mortgage company doing business as ConsumerOne Financial
("ConsumerOne"). ConsumerOne is now a wholly owned subsidiary of Approved and
continues under the management of its founder who entered into a three-year
employment contract with Approved. Approved paid $575,000 at closing and will
pay $525,000 in 1999, 2000, and 2001. Payment amounts of $525,000 in 1999, 2000,
and 2001 are subject to reduction in the event of a failure to meet agreed upon
pre-tax profit targets each year. This transaction was accounted for using the
purchase method of accounting. The associated intangible asset (goodwill) was
recorded in the amount of $3,184,000. This goodwill will be amortized over 10
years.
Note 21. Regulatory Capital:
Savings institutions, such as the Savings 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 Savings Bank to maintain tangible
capital of not less than 1.5% of total adjusted assets. As it applies to the
Savings Bank, "tangible capital" means core capital (as defined below).
The core capital standard requires the Savings Bank to maintain "core capital"
of not less than 4.0%. Core capital includes the Savings Bank's common
shareholders' equity, adjusted for certain non-allowable assets.
The risk-based standard requires the Savings 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.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997 and 1996
Note 21. Regulatory Capital, continued:
At December 31, 1998 and 1997, the Savings 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
Savings Bank's capital to regulatory capital (in thousands):
Tangible Core Risk-Based
Capital Capital Capital
-------- ------- ----------
December 31, 1998
- -----------------
GAAP capital $ 5,058 $ 5,058 $ 5,058
Add: unrealized loss on securities 15 15 15
Non-allowable asset: goodwill (116) (116) (116)
Additional capital item: general allowance -- -- 276
------- ------- -------
Regulatory capital - computed 4,957 4,957 5,233
Minimum capital requirement 578 1,157 2,166
------- ------- -------
Excess regulatory capital $ 4,379 $ 3,800 $ 3,067
======= ======= =======
Ratios:
Regulatory capital - computed 12.86% 12.86% 19.33%
Minimum capital requirement 1.50 4.00 8.00
------- ------- -------
Excess regulatory capital 11.36% 8.86% 11.33%
======= ======= =======
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997 and 1996
Note 21. Regulatory Capital, continued:
Tangible Core Risk-Based
Capital Capital Capital
-------- ------- ----------
December 31, 1997
GAAP capital $ 3,242 $ 3,242 $ 3,242
Add: unrealized loss on securities 2 2 2
Non-allowable asset: goodwill (132) (132) (132)
Additional capital item: general allowance -- -- 73
------- ------- -------
Regulatory capital - computed 3,112 3,112 3,185
Minimum capital requirement 336 895 1,249
------- ------- -------
Excess regulatory capital $ 2,776 $ 2,217 $ 1,936
======= ======= =======
Ratios:
Regulatory capital - computed 13.91% 13.91% 20.40%
Minimum capital requirement 1.50 4.00 8.00
------- ------- -------
Excess regulatory capital 12.41% 9.91% 12.40%
======= ======= =======
The payment of cash dividends by the Savings Bank is subject to regulation by
the OTS. The OTS measures an institution's ability to make capital
distributions, which includes the payment of dividends, according to the
institution's capital position. For institutions, such as the Savings Bank, that
meet their fully phased-in capital requirements, the OTS has established "safe
harbor" amounts of capital distributions that institutions can make after
providing notice to the OTS, but without needing prior approval. Institutions
can distribute amounts in excess of the safe harbor amount without the prior
approval of the OTS. The Savings Bank did not pay cash dividends to Approved in
1998, 1997 or 1996.
Note 22. Disclosures About Fair Value of Financial Instruments:
SFAS No. 107, "Disclosures about Fair Values of Financial Instruments," requires
disclosure of fair value information about financial instruments, whether or not
recognized in the financial statements, for which it is practicable to estimate
that value. In cases where quoted market prices are not available, fair values
are based upon estimates using present value or other valuation techniques.
Those techniques are significantly affected by the assumptions used, including
the discount rate and the estimated future cash flows. In that regard, the
derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate
settlement of the instrument.
SFAS No. 107 excludes certain financial instruments and all non-financial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts do not represent the underlying value of the Company.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997 and 1996
The following methods and assumptions were used to estimate the fair value of
the Company's financial instruments:
Cash and cash equivalents: The carrying amount of cash on hand and on deposit at
financial institutions is considered to be a reasonable estimate of fair market
value.
Securities: Fair values are based on quoted market prices or dealer quotes.
Mortgage loans: The estimate of fair value is based on current pricing of whole
loan transactions that a purchaser unrelated to the seller would demand for a
similar loan. The fair value of mortgage loans held for sale approximated
$109,637,000 and $83,996,000 at December 31, 1998 and 1997, 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 $29,853,000 and $17,828,000 at December 31, 1998 and 1997,
respectively.
Mortgage loans payable: The fair value of mortgage loans payable is based on the
discounted value of expected cash flows. The discount rates used are those
currently offered for mortgage loans with similar remaining contractual
maturities and terms. The fair value of the mortgage loans payable approximated
$1,058,000 and $1,190,000 at December 31, 1998 and 1997, respectively.
Other term debt: The carrying amount of outstanding term debt, which bear market
rates of interest, approximates its fair value.
Note 23. Sale of Building:
The Company entered into an agreement on December 8, 1998 for the sale of the
administrative and executive office building located at 3386 Holland Road,
Virginia Beach, Virginia. The sales price is $1,081,250. The Company has a
mortgage note payable on this property in the amount of $759,000 at December 31,
1998. (See note 13) The closing date for this transaction was February 15, 1999.
The Company has also entered into a lease agreement with the purchaser to lease
back 15,574 square feet of the premises for an initial term commencing from the
closing date to September 30, 1999, with the option to renew the lease for three
additional one month terms. The lease payment will be $15,000 per month. The
expected gain on sale of the building is approximately $42,000.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1998, 1997 and 1996
Note 24. Purchase of Land:
The Company entered into an agreement, on August 20, 1998, with the City of
Virginia Beach Development Authority to purchase 7.77 acres of land for a new
administrative and executive office building. The purchase price of the land
will be approximately $650,000. The transaction is scheduled to close in March
1999.
Note 25. Quarterly Financial Data (Unaudited):
The following is a summary of selected quarterly operating results for each of
the four quarters in 1998 and 1997:
(In thousands, except per share data)
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
1998:
Gain on sale of loans $ 9,754 $ 8,779 $ 7,060 $ 4,110
Net interest income 1,054 1,118 828 1,056
Provision for losses (111) 949 718 1,340
Other income 1,482 1,678 2,806 2,826
Other expenses 9,928 9,772 9,694 9,309
------- ------- ------- -------
Income before income taxes 2,473 854 282 (2,657)
Provision for income taxes 1,038 341 121 (1,027)
------- ------- ------- -------
Net income $ 1,435 $ 513 $ 161 $(1,630)
======= ======= ======= =======
Basic net income per share $ 0.26 $ 0.09 $ 0.03 $ (0.30)
======= ======= ======= =======
1997:
Gain on sale of loans $ 7,252 $ 8,133 $ 8,656 $ 9,460
Net interest income 613 1,426 1,520 1,219
Provision for losses 281 417 435 543
Other income 788 772 4,366 1,815
Other expenses 5,807 7,068 8,255 9,516
------- ------- ------- -------
Income before income taxes 2,565 2,846 5,852 2,435
Provision for income taxes 1,026 1,171 2,416 1,025
------- ------- ------- -------
Net income $ 1,539 $ 1,675 $ 3,436 $ 1,410
======= ======= ======= =======
Basic net income per share $ 0.30 $ 0.32 $ 0.64 $ 0.26
======= ======= ======= =======
Approved Financial Corp.
Consolidating Balance Sheet
December 31, 1998
($ IN THOUSANDS)
MOFC,
Inc.
Approved d/b/a
Approved Approved Federal Consumer
ASSETS Financial Residential Savings Global One
Consolidated Eliminations Corp. Mortgage Bank Title Financial
------------ ------------ --------- ----------- -------- -------- ---------
Cash $ 6,269 $ 1,457 $ 1,134 $ 3,508 $ 50 $ 120
Mortgage loans held for
sale, net 105,044 13,929 56,036 28,904 -- 6,175
Real estate owned, net 1,707 359 1,348 -- -- --
Investments 3,472 (9,903) 9,996 -- 3,379 -- --
Income taxes receivable 2,023 (4,742) 6,765 -- -- -- --
Deferred tax asset 3,330 (23) 1,107 2,246 -- -- --
Premises and equipment, net 5,579 3,769 966 62 -- 782
Goodwill, net 4,554 1,254 -- 116 -- 3,184
Due from affiliates -- (692) 692 -- -- -- --
Other Assets 4,140 1,568 2,042 479 6 45
-------- -------- -------- -------- -------- -------- --------
Total Assets $136,118 $(15,360) $ 40,896 $ 63,772 $ 36,448 $ 56 $ 10,306
======== ======== ======== ======== ======== ======== ========
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 72,546 $ 11,592 $ 54,744 $ -- -- $ 6,210
Deferred tax liability -- (23) -- -- 23 -- --
Mortgage payable 1,210 1,210 -- -- -- --
Notes payable-related 3,628 3,628 -- -- -- --
parties
Certificates of indebtedness 2,414 2,414 -- -- -- --
Certificates of deposits 29,728 -- -- 29,728 -- --
Loan proceeds payable 2,565 -- 1,029 1,536 -- --
Due to affiliates -- (692) -- 56 35 1 600
Accrued and other 4,760 2,785 566 68 17 1,324
liabilities
Income taxes payable -- (4,743) -- 4,734 -- 9 --
-------- -------- -------- -------- -------- -------- --------
Total Liabilities 116,851 (5,458) 21,629 61,129 31,390 27 8,134
-------- -------- -------- -------- -------- -------- --------
Shareholder's equity:
Preferred stock-series A 1 1 -- -- -- --
Common stock 5,482 (299) 5,482 250 32 16 1
Unrealized gain on securities 30 15 30 -- (15) -- --
Additional paid in capital 552 (6,837) 552 491 3,056 -- 3,290
Retained earnings 13,202 (2,781) 13,202 1,902 1,985 13 (1,119)
-------- -------- -------- -------- -------- -------- --------
Total Equity 19,267 (9,902) 19,267 2,643 5,058 29 2,172
-------- -------- -------- -------- -------- -------- --------
Total liabilities and
equity $136,118 $(15,360) $ 40,896 $ 63,772 $ 36,448 $ 56 $ 10,306
======== ======== ======== ======== ======== ======== ========
Approved Financial Corp.
Consolidating Statement of Income
For the year ended December 31, 1998
($ IN THOUSANDS)
MOFC,
Inc.
Approved d/b/a
Approved Approved Federal Consumer
Financial Residential Savings Global One
Consolidated Eliminations Corp. Mortgage Bank Title Financial
------------ ------------ --------- ----------- -------- -------- ---------
Revenue:
Gain on sale of loans $ 29,703 $ -- $ 26,592 $ 2,900 $ -- $ 211
Interest income 10,308 7,356 14 2,909 1 28
Gain on sale of securities 1,750 1,753 -- (3) -- --
Other fees and income 7,042 313 6,649 53 27 --
-------- -------- -------- -------- -------- -------- --------
48,803 -- 9,422 33,255 5,859 28 239
Expenses:
Compensation and related $ 23,397 $ 7,033 $ 15,608 $ 669 7 80
General and administrative 11,713 5,281 5,824 503 3 102
Loan production expense 3,593 140 3,345 108 -- --
Interest expense 6,252 4,780 5 1,437 -- 30
Provision for loan/REO losses 2,896 5 2,688 203 -- --
-------- -------- -------- -------- -------- -------- --------
47,851 17,239 27,470 2,920 10 212
Income before Income taxes 952 -- (7,817) 5,785 2,939 18 27
Provision for income taxes 473 (3,147) 2,487 1,121 7 5
-------- -------- -------- -------- -------- -------- --------
Net Income $ 479 -- $ (4,670) $ 3,298 $ 1,818 $ 11 $ 22
======== ======== ======== ======== ======== ======== ========
Stock Price and Dividend Information:
The following tables show the quarterly high, low and closing prices of the
Company's common stock for 1998 and 1997. All stock price and dividend data has
been adjusted to reflect two- for-one stock splits which occurred on August 20,
1996 and December 16, 1996, and a 100% stock dividend, which occurred on
November 21, 1997.
Stock Prices
High Low Close
------ ------------ ------
1998:
Fourth Quarter $ 6.50 $ 2.88 $ 3.38
Third Quarter 13.63 7.00 7.00
Second Quarter 15.63 13.13 13.88
First Quarter 15.08 12.08 13.13
1997:
Fourth Quarter $17.00 $12.75 $14.75
Third Quarter 17.00 8.00 15.00
Second Quarter 10.00 6.00 8.25
First Quarter 13.50 8.50 9.75
The Company did not pay any cash dividends on its Common Stock in 1998 and 1997.
The Company intends to retain all of its earnings to finance its operations and
does not anticipate paying cash dividends for the foreseeable future. Any
decision made by the Board of Directors to declare dividends in the future will
depend on the Company's future earnings, capital requirements, financial
condition and other factors deemed relevant by the Board.