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Securities and Exchange Commission
Washington, D.C. 20549

Form 10-Q

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.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of November 1, 2002: 5,482,114 shares

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APPROVED FINANCIAL CORP.

INDEX

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PART I.      FINANCIAL INFORMATION

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APPROVED FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)

The accompanying notes are an integral part of the consolidated financial statements.

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APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Nine months ended September 30, 2002 and 2001

Note 1.    Organization and Summary of Significant Accounting Policies:

Organization:    Approved Financial Corp., a Virginia corporation (“Approved”), and its subsidiaries (collectively, the “Company”) operate primarily in the consumer finance business of originating, servicing and selling mortgage loans secured primarily by first and second liens on one-to-four family residential properties. The Company sources mortgage loans through two origination channels; a network of mortgage brokers who refer mortgage customers to the Company (“broker” or “wholesale”) and an internal sales staff that originate mortgages directly with borrowers (“retail” and “direct”).  Approved has one wholly owned subsidiary through which it originated residential mortgages during the years of 2002 and 2001, Approved Federal Savings Bank (the “Bank”), a federally chartered thrift institution. During 2001, it originated residential mortgages through another wholly-owned subsidiary, Approved Residential Mortgage, Inc. (“ARMI”).  ARMI had no active loan origination operations for the nine months ended September 30, 2002. A third wholly owned subsidiary, Approved Financial Solutions (“AFS”), previously offered other financial products such as Debt Free Solutions, Mortgage Acceleration Program and insurance products to its mortgage customers. 

Principles of accounting and consolidation:  The consolidated financial statements of the Company include the accounts of Approved and its wholly-owned subsidiaries.  All significant inter-company accounts and transactions have been eliminated.

Use of estimates:  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (US GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Cash and cash equivalents:  Cash and cash equivalents consist of cash on deposit at financial institutions and short-term investments that are considered cash equivalents if they were purchased with an original maturity of three months or less.

Loans held for sale:  Loans, which are held for sale, are carried at the lower of aggregate cost or market value.  Market value is determined by investor pricing on sales of similar loans and net realizable values for loans in special circumstance.

Loans held for yield:  Loans are stated at the amount of unpaid principal less net deferred fees and an allowance for loan losses.  Interest on loans is accrued and credited to income based upon the principal amount outstanding.  Fees collected and costs incurred in connection with loan originations are deferred and recognized over the term of the loan.

Allowance for loan losses:  The allowance for loan losses (“ALLL”) is maintained at a level believed adequate by management to absorb probable inherent losses in the held for yield loan portfolio on the balance sheet date.  Management’s determination of the adequacy of the allowance is based on an evaluation of the current loan portfolio characteristics including criteria such as delinquency, default and foreclosure rates and trends, credit grade of borrowers, loan to value ratios, current economic and secondary market conditions, regulatory guidance and other relevant factors. The allowance is increased by provisions for loan losses charged against income. Loan losses are charged against the allowance when management believes it is unlikely that the loan is collectable. Prior to the third quarter of 2001, the ALLL

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reflected loan loss reserves for all loans owned at the end of the reporting period including held for yield and held for sale.

Valuation allowance:  Beginning in the third quarter of 2001, as of each financial reporting date, management evaluates and reports all held for sale loans at the lower of cost or market value. Any decline in value, including those attributable to credit quality, are accounted for as a charge to provision for valuation allowance for held-for-sale loans, not as adjustments to the ALLL. Such provision is charged against income and not reported as part of ALLL, and therefore is not eligible for inclusion in Tier 2 capital for risk based capital purposes. Valuation allowances are established based on the lien position and age of the loan as well as special circumstances known to management that merit a valuation allowance. Loans held 90 days or less, which do not fall into a special circumstance category, are carried at cost. All loans considered to be special circumstance are carried at the net realizable value. The net realizable value represents the current appraised or listed property valuation less estimated cost to liquidate the property. The difference in the principal value of the loan and the net realizable value is recorded as a valuation allowance.

Origination fees:  Net origination fees are recognized over the life of the loan or upon the sale of the loan, if earlier.

Real estate owned:  Assets acquired through loan foreclosure are recorded as real estate owned (“REO”) at the lower of cost or fair market value, net of estimated disposal costs.  Cost includes loan principal and certain capitalized improvements to the property. The estimated fair market value is reviewed periodically by management, and any write-downs are charged against current earnings using a valuation account, which has been netted against real estate owned in the financial statements.

Premises and equipment:  Premises, leasehold improvements and equipment are stated at cost less accumulated depreciation and amortization.  The buildings are depreciated using the straight-line method over thirty and thirty-nine years.  Leasehold improvements are amortized over the lesser of the terms of the lease or the estimated useful lives of the improvements.  Depreciation of equipment is computed using the straight-line method over the estimated useful lives of three to five years.  Expenditures for betterments and major renewals are capitalized and ordinary maintenance and repairs are charged to operations as incurred.

Investments:  Company’s investment in the stock of the Federal Home Loan Bank (“FHLB”) of Atlanta is stated at cost.

All other investment securities, except the FHLB stock, are classified as available-for-sale and reported at fair value, with unrealized gains and losses excluded from earnings and reported as other comprehensive income in shareholders’ equity. Realized gains and losses on sales of securities are computed using the specific identification method.

Loan originations and income recognition:  The Company applies a financial-components approach that focuses on control when accounting and reporting for transfers and servicing of financial assets and extinguishments of liabilities. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished.  This approach provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings.  Gains on the sale of mortgage loans, representing the difference between the sales proceeds and the net carrying value of the loans, are recognized when mortgage loans are sold and delivered to investors.

Interest on loans is credited to income based upon the principal amount outstanding. Interest is accrued on

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loans until they become 60 days or more past due.

Advertising costs:  Advertising costs are expensed when incurred.

Income taxes:  Taxes are provided on substantially all income and expense items included in earnings, regardless of the period in which such items are recognized for tax purposes.  The Company uses an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the estimated future tax consequences of events that have been recognized in the Company’s financial statements or tax returns.  In estimating future tax consequences, the Company generally considers all expected future events other than enactments of changes in the tax laws or rates.  The Company maintains a valuation allowance based upon an assessment by management of future taxable income and its relationship to realizability of deferred tax assets.  The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. 

Earnings per share:  The Company computes “basic earnings per share” by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. “Diluted earnings per share” reflects the effect of all potentially dilutive potential common shares such as stock options and warrants and convertible securities.

Comprehensive income:  The Company classifies items of other comprehensive income by their nature in the financial statements and displays the accumulated balance of other comprehensive income separately from retained earnings and additional capital in the equity section of the consolidated balance sheets.  For the nine months ended September 30, 2002 and 2001, we had no other comprehensive income or loss.

Goodwill recognition policy:  Goodwill represents the excess of purchase price and related costs over the value assigned to the net tangible and intangible assets of businesses acquired.  Periodically, the company reviews the recoverability and the estimated remaining life of goodwill.  The measurement of possible impairment is based primarily on the ability to recover the balance of the goodwill from expected future operating cash flows on an undiscounted basis.

Liquidity:  The Company finances its operating cash requirements primarily through certificates of deposit, warehouse credit facilities, and other borrowings.  Our borrowings were 93.7% of total assets at September 30, 2002, compared to 91.3% at December 31, 2001. 

Segments:  A public business enterprise is required to report financial and descriptive information about its reportable operating segments.  Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate and in assessing performance.  Generally, financial information is required to be reported on the basis that it is used internally for evaluating segment performance and deciding how to allocate resources to segments. The Company has evaluated this requirement and determined it operates in one segment.

Reclassifications:  Certain 2001 amounts have been reclassified to conform to the 2002 presentation.

New accounting pronouncements:
In July 2001, FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 requires the use of a non-amortization approach to account for purchased goodwill and certain intangibles, effective January 1, 2002. The adoption of this pronouncement did not have a material impact on our financial statements.

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Note 2.  Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with US GAAP for interim financial information and with the instructions to Form 10Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by US GAAP for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the nine month period ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2001.

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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following financial review and analysis of the financial condition and results of operations, for the nine months ended September 30, 2002 and 2001 should be read in conjunction with the consolidated financial statements and the accompanying notes to the consolidated financial statements, and other detailed information appearing in this document.

General

Approved Financial Corp. (“AFC”, “Holding Company”, “Parent Company”) is a Virginia-chartered financial institution, principally involved in originating, purchasing, servicing and selling loans secured primarily by conforming and non-conforming first and junior liens on owner-occupied, one-to-four-family residential properties. We offer both fixed-rate and adjustable-rate loans for debt consolidation, home improvements, purchase and other purposes.  Through our retail division we also originate, service and sell government mortgage products such as VA and FHA.  The term “non-conforming” as used in this report relates to a borrower that for various reasons may not fit the underwriting guidelines of traditional conforming/ government agency mortgage products, but who exhibits the ability and willingness to repay the loan.

We utilize wholesale (through mortgage brokers) and retail (direct to the consumer) channels to originate mortgage loans.  At the broker level, we originate residential mortgages through relationships with an extensive network of independent mortgage brokers. 

In the nine months ended September 30, 2002, the dollar volume in the wholesale lending division accounted for 95.3% of total originations and the retail lending division accounted for 4.7% of total originations.  In the nine months ended September 30, 2001, the dollar volume in the wholesale lending division accounted for 69.5% of total originations and the retail lending division accounted for 30.5% of total originations. Our current initiatives for the mortgage business focus on increasing future origination volume in a cost-effective manner primarily through the wholesale channel.

Once loan application packages are received from the wholesale and retail networks, the underwriting risk analysis and the processing of required documentation are completed and the loans are funded. We typically package the loans and sell them on a whole loan basis to institutional investors consisting primarily of larger well-capitalized financial institutions and reputable mortgage companies. We sell conforming loans to large financial institutions and to government and quasi-government agencies. The proceeds from these sales release funds for additional lending and operational expenses.

We historically have derived our income primarily from the premiums received on whole loan sales to institutional investors, net interest earned on loans held for sale, net interest income on loans held for yield, various fees received as part of the loan origination process and to a lesser extent from ancillary fees from servicing activity related to loans held for yield and loans held for sale and from other financial services offered in past periods. While there are no plans to do such at this time, in future periods, we may generate revenue from loans sold through alternative loan sale strategies, from other types of lending activity and from the sale of other financial products and services that are permissible activities for a Bank or Bank Holding Company.

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Results of Operations

Net Income (Loss)

For the three months ended September 30, 2002, we reported a net loss of $47,000 compared to net income of $53,000 for the three months ended September 30, 2001. For the nine month period ended September 30, 2002, we reported a net loss of $2.6 million compared to a $0.4 million net loss in 2001. On a per share basis, the net loss for the three months ended September 30, 2002 was $0.01 compared to net income of $0.01 for the same period in 2001. On a per share basis, the net loss for the nine months ended September 30, 2002 was $0.47 compared to $0.07 for 2001.  The net loss for the three month period is primarily due to a reduction in loan origination volume and the associated gain on sale revenues, which was partially offset by the recording in the same period an income tax benefit of $0.5 million for an expected tax refund of prior year taxes under current net operating loss carryback rules, which is anticipated to be filed for year end 2002. The increase in the net loss for the nine-month period is also due to a reduction in loan origination volume and the associated gain on sale revenue as well as an increase in the deferred tax valuation allowance of $1.6 million, which was partially offset by the $0.5 million tax benefit recorded in the third quarter of 2002 as mentioned above. 

Origination of Mortgage Loans

The following table shows the loan originations in dollars and units for our wholesale and retail divisions for the three and nine months ended September 30, 2002 and 2001.  The retail division originates mortgages that are funded in-house and through other lenders (“brokered loans”). Brokered loans consist primarily of mortgages that do not meet our underwriting criteria or product offerings.

The dollar volume of loans originated in the three and nine months ended September 30, 2002 (including retail loans brokered to other lenders) decreased 47.8% and 49.1%, respectively, when compared to the same period in 2001.  The decrease in loan originations was primarily due to reduction in retail loan origination offices from nine (9) at the beginning of year 2001 to one (1) at the beginning of year 2002 and, the closure in April 2002 of the previous West wholesale operation. A new California wholesale operations center was established in July 2002 and is currently under development.

The dollar volume of loans funded in-house decreased 44.7% and 46.6% in the three and nine months ended September 30, 2002 compared to the same period in 2001, primarily due to the reduction in retail loan origination centers. Brokered loans generated by the retail division were $0 million and $0.7 million during the three and nine months ended September 30, 2002, which was a 100% and 95.5% decrease compared to $4.6 and $15.4 million during the same period in 2001.

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The decrease in retail loan origination centers resulted in a 92.2% decrease in our retail loan volume including retail loans brokered to other lenders for the nine months ended September 30, 2002 when compared to the same period in 2001.

The volume of loans originated through the Company’s wholesale division, which originates loans through a network of mortgage brokers, decreased 29.2% and 30.2% to $40.9 million and $144.3 million for the three and nine months ended September 30, 2002, compared to $57.8 million and $206.7 million for the three and nine months ended September 30, 2001.  The decrease was primarily the result of the company closing down the West wholesale division.   As of the third quarter 2002, a new California operations center is under development. 

Gain on Sale of Loans

The largest component of our net income is gain on sale of loans.  There is an active secondary market for residential mortgage loans. Under our current business strategy, we originate loans to be sold to other financial institutions.  We receive cash at the time loans are sold. The loans are sold service-released on a non-recourse basis, except for normal representations and warranties, which is consistent with industry practices.  By selling loans in the secondary mortgage market, we are able to obtain funds that may be used for additional lending and investment purposes.  Gain on sale of loans is comprised of several components, as follows:  (a) the difference between the sales price and the net carrying value of the loan (loan sale premium or discount); plus (b) loan origination fee income collected at loan closing and deferred until the loan is sold; less (c) loan sale recapture premiums and loan selling costs.

Nonconforming loan sales, including loans sold at a discount to a principal balance outstanding, for various reasons from time to time, totaled $30.0 million and $157.3 million for the three and nine months ended September 30, 2002 compared to $66.6 million and $202.7 million for the same periods in 2001. Nonconforming loan sales, excluding discounted loan sales totaled $26.4 million and $149.7 million for the three and nine months ended September 30, 2002, compared to $66.6 and $201.5 million for the same period in 2001. Conforming and government loan sales were $1.4 million and $7.4 million for the three and nine months ended September 30, 2002, compared to $22.8 million and $67.3 million for the three and nine months ended September 30, 2001. 

The average premium received on nonconforming loan sales, including discounted loan sales, was 3.09% and 2.79% for the three and nine months ended September 30, 2002, compared to 3.87% and 3.89% for the three and nine months ended September 30, 2001.  The average premium received on nonconforming loan sales, excluding discounted loan sales was 4.23% and 3.12% for the three and nine months ended September 30, 2002, compared to 3.87% and 4.06% for the three and nine months ended September 30, 2001.  The average premium received on the conforming loan sales was 1.52% and 0.91% for the three and nine months ended September 30, 2002, compared to 1.66% and 1.50% for the three and nine months ended September 30, 2001. 

For the three and nine month period ended September 30, 2002, we sold $3.6 and $7.6 million of loans at a weighted average discount to par value of 5.26% and 3.61%.  For the nine month period ended September 30, 2001, we sold $1.2 million loans at a weighted average discount to par value of 5.4%, none of these sales occurred in the three months ended September 30, 2001.

The year over year reduction in the weighted-average premium percent received on loan sales for the nine month period was primarily the result of the sale of loans during 2002, which were funded as part of a short-term promotional loan product offered in December 2001 and January 2002 that yielded lower premiums.

The combined gain on the sale of loans was $1.1 million and $4.9 million for the three and nine months ended September 30, 2002, which compares with $3.6 million and $11.5 million for the same period in 2001. The decrease in the combined gain on sale of loans was primarily the result of a reduction in loan volume and a change in the mix of loans sold shifting away from retail loans to wholesale loans. Retail

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origination fees and points earned at time of origination are recognized at the time of sale and included in the gain on sale calculation.  For the three and nine months ended September 30, 2002, approximately 94.2% and 95.2% of loans sold (conforming & non-conforming) were originated by the wholesale division, compared to 96.5% and 90.7% for the three and nine months ended September 30, 2001. Gain on the sale of mortgage loans represented 49.0% and 53.0% of total revenue for the three and nine months ended September 30, 2002, compared to 65.2% and 64.4% of total revenue for the same period in 2001. This was primarily a result of reduced loan sale premiums.

We defer recognizing income from the loan origination fees we receive at the time a loan is closed.  These fees are recognized over the lives of the related loans as an adjustment of the loan’s yield using the level-yield method.  Deferred income pertaining to loans held for sale is taken into income at the time of sale of the loan.  Origination fee income is primarily derived from our retail lending division.  Origination fee income included in the gain on sale of loans for the three and nine months ended September 30, 2002 was $0.05 million and $0.4 million, compared to $0.7 million and $2.4 million for the three and nine months ended September 30, 2001. The decrease is the result of a decrease in the volume of loans sold, which were generated by our retail division.  Average origination fee income from conforming and government loans was 0.73% and 0.90% for the three and nine months ended September 30, 2002 compared to 2.67% and 2.40% for the three and nine months ended September 30, 2001.  Costs associated with selling loans were approximately 5 basis points for the three and nine months ended September 30, 2002 compared to 0.04 basis points for the three and nine months ended September 30, 2001.

We also defer recognition of the expense incurred, from the payment of fees to mortgage brokers, for services rendered on loan originations.  These costs are deferred and recognized over the lives of the related loans as an adjustment of the loan’s yield using the level-yield method.  The remaining balance of expenses associated with fees paid to brokers is recognized when the loan is sold.  Average services rendered fees paid on wholesale originations for the three and nine months ended September 30, 2002 was 31 and 27 basis points compared to 47 and 58 basis points for the three and nine months ended September 30, 2001.

Interest Income and Expense

Interest income for the three and nine months ended September 30, 2002 was $0.9 million and $3.2 million compared with $1.3 million and $4.2 million for the same period ended in 2001. The decrease in interest income for the three and nine months ended September 30, 2002 was due to a lower average interest rate on loans held for sale and a decrease in loans receivable.

Interest expense for the three and nine months ended September 30, 2002 was $0.6 million and $2.3 million compared with $1.0 million and $3.0 million for the three and nine months ended September 30, 2001.  The decrease in interest expense was due to a decrease in the amount of certificates of deposit (FDIC-insured deposits) at the Bank, as well as a decrease in loan origination and average outstanding balance of loans receivable.

Changes in the average yield received on the loan portfolio, as mortgages are based on long term borrowing rates, may not coincide with changes in interest rates we must pay on revolving warehouse

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loans, the Bank’s FDIC-insured deposits, and other borrowings, which are primarily based on short term borrowing rates. As a result, in times of changing interest rates, decreases in the difference or spread between the yield received on loans and other investments and the rate paid on borrowings will occur.

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The following tables reflect the average yields earned and rates paid during the nine months ended September 30, 2002 and 2001. 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.