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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-K

(MARK ONE)

x            ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

OR

o            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to              

Commission file number 333-42623

THE THAXTON GROUP, INC.

(Exact name of registrant as specified in its charter)

1524 PAGELAND HIGHWAY, LANCASTER, SOUTH CAROLINA 29720

(Address of principal executive offices)

Registrant’s telephone number, including area code: 803-285-4337

Securities registered pursuant to Section 12(b) of the Act:

Securities registered under Section 12(g) of the Act:
Title of each class
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 was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

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. x

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes o No x

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based upon the price at which the stock was last sold, was approximately $1,905,671.

At March 21, 2003, there were 6,867,390 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE: NONE

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THE THAXTON GROUP, INC.
FORM 10-K

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PART I

NOTE REGARDING FORWARD-LOOKING STATEMENTS

The Thaxton Group’s (the Company) Annual Report on Form 10-K, specifically certain of the statements set forth under Item 1 – Business, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations, Item 7A – Quantitative & Qualitative Disclosures about Market Risk, and elsewhere in this Form 10-K contain forward-looking statements, identified as such for purposes of the safe harbor provided in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are based on current expectations, estimates, and projections about the Company’s industry, management’s beliefs, and certain assumptions made by the Company’s management. Words such as anticipates, expects, intends, plans, believes, estimates, or variations of such words and similar expressions, are intended to identify forward-looking statements. Readers are cautioned that any forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties, and that actual results could differ materially from those indicated by forward-looking statements. Important factors that could cause actual results to differ materially from those indicated by forward-looking statements include, but are not limited to, the following: (1) that the information is of a preliminary nature and may be subject to further and/or continuing review and adjustment; (2) changes in the financial industry regulatory environment; (3) changes in the economy in areas served by the Company and its subsidiaries; (4) the impact of competition; (5) the management of the Company’s operations; (6) changes in the market interest rate environment and/or the Federal Reserve’s monetary policies; and (7) the other risks and uncertainties described from time to time in the Company’s periodic reports filed with the SEC. The Company disclaims any obligation to update any forward-looking statements.

ITEM 1.          DESCRIPTION OF BUSINESS

We are a diversified consumer financial services company engaged in the origination and servicing of direct consumer loans made to credit-impaired borrowers, used automobile lending through the purchase and servicing of used automobile sales contracts, insurance premium finance lending through the purchase of insurance premium finance contracts, selling insurance products on an agency basis, and the factoring of accounts receivable and the origination and servicing of small commercial loans to small and medium sized businesses. For purposes of the following discussion, “revenues” means the sum of our interest and fee income, insurance commissions, net and other income. We were organized in 1985.

Direct Consumer Lending. Making small loans to borrowers with impaired credit is our largest line of business in our Consumer Finance division, comprising approximately 86% of our total revenues in 2002. Direct loans are relied upon by credit-impaired borrowers to meet short-term cash needs, finance purchases of consumer goods or refinance existing indebtedness. The usual term of a direct loan is 15 months. Interest rates on direct loans vary based on a number of factors, the most important of which is the extent to which the borrower’s state of residence regulates interest rates. Some states in which we operate permit consumer lenders to simply post a maximum rate of interest in filings with regulatory authorities. In these states we typically post a maximum annual interest rate of 69%. Other states where we have offices impose specific maximum annual interest rates on direct loans that range from 10% to 36%. Other factors that we consider in setting the interest rate on a particular direct loan are credit profile of the borrower, the type and value of any collateral and competitive market conditions.

Each applicant for a direct loan must pass a credit review. This review is conducted by the manager or personnel under his or her supervision in the office where the application is taken. This review generally takes into account the borrower’s credit history, ability to pay, stability of residence, employment history, income, discretionary income, debt service ratio and the value of any collateral. We use an industry standard application analysis score sheet to compile information on the factors described above. If a direct loan is to be secured by real estate, we obtain an appraisal of the property, obtain a title opinion from an attorney and verify filing of a mortgage or deed of trust before disbursing funds to the borrower. A senior officer must approve any direct loan to be secured by real estate. The principal competitive factors for these types of loans are the interest rate charged and customer service.

In connection with making direct consumer loans we also offer, as agent, credit life and credit accident and health insurance. Instead of filing financing statements to perfect our security interest in the collateral on all direct consumer loans secured by personal property other than an automobile, we purchase non-filing insurance from an unaffiliated insurer. On these loans we charge an amount approximately equal to the filing fees that we would have charged to the customer if we had filed financing statements to perfect our security interest. This amount is typically included in the amount of the loan. We use this amount to pay premiums for non-filing insurance against losses resulting from failure to file. Under our non-filing insurance arrangements, approximately 90% of the premiums paid are refunded to us on a quarterly basis and are netted against charge-offs for the period.

Used Automobile Sales Finance. Another line of business in our Consumer Finance division is the financing of used automobile purchases, which comprised approximately 7% of our total revenues in 2002. We purchase sales contracts from independent automobile dealers who have been approved by the manager of an individual finance office or a regional supervisor. Office managers

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and regional supervisors periodically evaluate independent dealers in their market areas to ensure that we purchase sales contracts only from reputable dealers carrying an inventory of quality used automobiles. We enter into a non-exclusive agreement with each dealer which sets forth the terms and conditions on which we will purchase sales contracts. The dealer agreement generally provides that sales contracts are sold to us without recourse to the dealer with respect to the credit risk of the borrower. However, if the dealer breaches the terms of the sales contract or a customer withholds payment because of a dispute with the dealer regarding the quality of the automobile purchased, the dealer typically is obligated to repurchase the sales contract on our demand for its net unpaid balance. If the purchaser of the automobile recovers any amount from us as a result of a claim against the dealer, the dealer agreement provides that the dealer will reimburse us for any amount paid the customer and for any costs we incur as a result of the claim.

The dealer agreement allows us to withhold a specified percentage of the principal amount of each sales contract purchased. This dealer reserve arrangement is designed to protect us from credit losses on sales contracts. These dealer reserves, which range from 5% to 10% of the net amount of each sales contract, are negotiated on a dealer-by-dealer basis and are subject to change based upon the collection history on sales contracts we have purchased from the dealer.

In purchasing used automobile sales contracts, underwriting standards are used that take into account principally the degree of a proposed buyer’s creditworthiness and the market value of the vehicle being financed. The office manager, or other office personnel under the manager’s supervision, conducts the credit evaluation review. This review generally takes into account factors similar to those performed in our review of direct consumer loans. We generally do not finance more than 100% of the average trade-in value of the automobile as listed in the current edition of the National Association of Automobile Dealers Official Used Car Guide.

From time to time we purchase used automobile sales contracts in bulk from dealers who have originated and accumulated contracts over a period of time. By doing so, we are able to obtain large volumes of sales contracts in a cost-effective manner. For bulk purchases, our underwriting standards take into account principally the borrowers’ payment history and the collateral value of the automobiles financed. These purchases are typically made at discounts ranging from 25% to 50% of the financed portion of the contract. Generally no dealer reserve arrangements are established with bulk purchases. In connection with bulk purchases, we review all credit evaluation information collected by the dealer and the servicing and collection history of the sales contracts.

We compete with others in used car financing primarily based on the price paid for used automobile sales contracts, which is a function of the amount of the dealer reserve and the reliability of service to participating dealers. We generally do not compete based on the same type of used automobile to be financed because our competition concentrates their financing activities on late-model used automobiles purchased from franchised dealers rather than older-model used automobiles purchased from independent dealers, which is the target market of our used automobile sales financing activities. The size of our average used automobiles sales contract is considerably smaller than that of many other companies engaged in purchasing used automobiles sales contracts. We believe this is due in large part to the fact that most of our competitors are seeking to do business primarily with franchised dealers selling late-model, lower mileage used automobiles, coming off leases or which were rental cars, for significantly higher prices than the prices for automobiles offered for sale by the independent dealers with whom we have relationships. The independent dealers from whom we purchase used automobile sales contracts typically sell automobiles that tend to be somewhat older, higher mileage vehicles. Because the costs of servicing and collecting a portfolio of finance receivables increase with the number of accounts included in the portfolio, we believe that many apparent potential competitors will choose not to do business with independent dealers.

In connection with the origination of used automobile sales contracts, we offer, as agent, credit life, and credit accident and health insurance. Borrowers under sales contracts and direct loans secured by an automobile are required to obtain comprehensive and collision insurance on the automobile that designates us as loss payee. A loss payee is the person who receives insurance proceeds in the event an automobile is damaged in a collision. If the borrower allows the insurance to lapse during the term of the contract or loan, we will purchase a vendor’s single interest insurance policy, which insures us against a total loss on the automobile. The cost of the premium will then be added to the borrower’s account balance. We also offer, as agent, limited physical damage insurance, which satisfies the requirement that the borrower purchase comprehensive and collision insurance.

Insurance Premium Finance. Also in our Consumer Finance division we provide short-term financing of insurance premiums purchased indirectly through independent insurance agents. Our insurance premium finance business made up approximately 2% of our total revenues in 2002. The premiums are primarily for personal lines of insurance that are typically too high for a credit-impaired borrower to pay in six-month increments, such as automobile insurance. Financing the premium allows the insured to pay it in smaller increments, usually monthly. Most agents who refer premium finance business to us are located in North Carolina, South Carolina, and Virginia. A small amount of our business involves financing premiums for commercial lines of insurance for small businesses, including property and casualty, business automobile, general liability, and workers’ compensation. Substantially all of our premium finance business is derived from customers of the 48 insurance offices owned and operated by Thaxton RBE, Inc. (“RBE”), which is owned by Thaxton Group CEO James D. Thaxton and members of his family.

When an individual purchases an insurance policy from an agent with whom we have a relationship, the agent will offer the opportunity to enter into a premium finance contract that allows the insured to make a down payment and finance the balance of the

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premium. The typical term of a premium finance contract ranges from three to eight months depending primarily upon the term of the underlying insurance policy. The required down payment ranges from 20% to 50% of the premium. In accordance with our arrangement with RBE, we allow RBE agencies to charge a smaller down payment. In those instances, we have an arrangement where RBE reimburses our premium finance company for any losses incurred in excess of 5% of the premium and in turn we pay back 85% of the net income in accordance with our arrangement with RBE. We generally impose the maximum finance charges and late fees that applicable state law permits for premium finance contracts, which are extensively regulated in the states where we engage in this business. In all of the states in which we operate, we charge the maximum interest rate permitted by law. Because we are able to cancel the insurance policy generally within a period of 23 to 28 days after the due date of a delinquent payment and receive a refund of the unearned portion of the premium, the creditworthiness of the insured is a less important factor than the size of the down payment and an efficient and effective system for servicing and collecting our portfolio of premium finance contracts.

Insurance Agency Activities. We sell, on an agency basis, various lines of automobile, property and casualty, life, accident, and health insurance. Our insurance agency activities comprised approximately 4% of our total revenues in 2002. The insurance companies that we represent assume all underwriting risk on most of the policies we sell. The insurance company that issues a policy we sell pays us a commission based on a standard or negotiated schedule. We are eligible for additional commission payments from some of the companies we represent if the loss experience on the policies we sell for those companies falls below specified levels and the total premiums on such policies exceed a specified minimum.

Commercial Finance. In 1998, we began making commercial loans and offering factoring services to small business clients. Our commercial finance activities made up approximately 1% of our total revenues in 2002. Our commercial loans usually are secured, most often with real estate. In factoring, we advance funds to the client based upon the balance of designated accounts receivable due from their customers. The client then assigns or sells these receivables to us, notifies its customers to send payment directly to us and we collect the receivables and credit the amount advanced to the client. Generally, we advance to our factoring client 80% to 95% of the dollar value of each receivable, holding the difference in reserve. We charge a fee equal to one to four percent of the amount advanced for this service and may also charge interest on any uncollected balances. Almost all of our factoring contracts are with recourse, which allows us to charge any uncollected receivables back to the client after a period ranging from 60 to 90 days.

The Consumer Finance and Insurance Agency Industries

The segment of the consumer finance industry in which we operate is commonly called the “non-prime credit market.” Our borrowers of direct loans and automobile sales contracts typically have limited credit histories, low incomes and/or past credit problems. These borrowers generally do not have access to the same sources of consumer credit as borrowers with long credit histories, no defaults and stable employment because they do not meet the stringent objective credit standards that most traditional lenders use. The non-prime credit market for used automobile finance and loans is highly competitive and fragmented, consisting of many national, regional and local competitors. New competitors are able to enter this market with relative ease. Historically, commercial banks, savings and loans, credit unions, financing arms of automobile manufacturers, and other lenders providing traditional consumer financing have not consistently served this segment of the consumer finance market. Several large bank holding companies, in an effort to recapture some of the customers their bank subsidiaries have traditionally rejected on the basis of their rigid credit scoring systems, now serve the non-prime credit market through automobile finance subsidiaries. We also face increasing competition from a number of companies, including bank credit card companies, providing similar financing to individuals that cannot qualify for traditional financing. Many of these competitors or potential competitors have significantly greater resources than we do and have pre-existing relationships with established networks of dealers. To the extent that any of these lenders significantly expand their activities in the markets where we operate or plan to operate, our profitability could be threatened.

Although the primary service-providers in the premium finance industry are different than those who serve the non-prime credit market for direct loans and used automobile finance, credit-impaired borrowers also are the primary borrowers under premium finance contracts. Insurance companies that engage in direct writing of insurance policies generally provide premium financing to their customers who need the service. Numerous small independent finance companies like us are engaged in providing premium financing for personal lines of insurance purchased by credit-impaired borrowers through independent insurance agents. Because the rates they charge are highly regulated, these companies compete primarily on the basis of efficiency in providing the financing and servicing the loans. A significant number of independent insurance agents provide premium financing to their customers either directly or through affiliated entities. As banks are allowed to enter the insurance business, they also are increasingly engaging in the premium finance business.

Independent insurance agencies represent numerous insurance carriers and typically place a customer’s business with the carrier whose combination of features and price best match the customer’s needs. In comparison, direct agents represent only one carrier. Most carriers find the use of independent agencies to be a more cost-effective method of selling their products than using a direct agent force. Competition among independent insurance agencies is intense. Numerous other independent agencies operate in most of the markets where our insurance offices are located. Direct agents for various insurance companies located in some of our markets also compete with us. We compete primarily on the basis of service and convenience. We attempt to develop and maintain long-term

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customer relationships through low employee turnover and responsive service and offer virtually all types of insurance products.

Banks and commercial finance companies dominate the commercial lending industry. Many banks, however, do not offer factoring services, and most banks do not make loans to the higher risk business clients that we finance. Most commercial finance companies engage in lending to larger businesses or engage in lending to specialized businesses. Our primary competition comes from independent factoring companies who, like us, specialize in smaller, higher risk clients.

Regulation

Consumer finance companies and insurance agents are extensively supervised and regulated under state and federal statutes and regulations. Depending upon the nature of a particular transaction and the state of residence of the borrower or the customer, we may be required to:

•         Obtain licenses and meet specified minimum qualifications;

•         Limit the interest rates, fees, and other charges for which the borrower may be assessed;

•         Limit or prescribe specified other terms and conditions of the financing;

•         Govern the sale and terms of insurance products; and

•         Define and limit the right to repossess and sell collateral.

Federal and state laws also require us to provide various disclosures to prospective borrowers, prohibit misleading advertising, protect against discriminatory lending practices, and prohibit unfair credit practices. We believe we comply in all material respects with applicable governmental regulations. These requirements change frequently however, and we cannot be certain that future changes or modifications in these laws will not have a material adverse effect on our business with increased compliance costs or prohibition or limitation of a profitable line of business.

EMPLOYEES

As of February 28, 2003, we employed 967 full-time employees and 90 part-time employees, none of whom were covered by a collective bargaining agreement. Of that total, 55 were located in the Company’s headquarters in Lancaster, South Carolina and 1,002 were located in our other offices. We generally consider our relationships with our employees to be good.

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ITEM 2.          DESCRIPTION OF PROPERTY

Our executive offices are located at 1524 Pageland Highway Lancaster, South Carolina 29720 in leased office facilities of approximately 28,000 square feet. The lease expires in August 2012, and includes an option to renew for an additional five-year term. We lease all of our branch office facilities. In some instances we lease these facilities from related parties. These offices range in size from approximately 800 square feet to 2,200 square feet. Since most of our business with automobile dealers is conducted by facsimile machine and telephone, we do not believe that the particular locations of our finance offices are critical to our business of purchasing used automobile sales contracts or our premium finance operations. Location is somewhat more important for our direct loan and insurance agency operations. Other satisfactory locations are, however, generally available for lease at comparable rates and for comparable terms in each of our markets.

We currently have a total of 214 finance offices and 15 insurance agency offices in the following states.

ITEM 3.          LEGAL PROCEEDINGS

We presently are not a party to any material legal proceedings nor is our management aware of any material threatened litigation against us.

ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of shareholders during the fourth quarter of 2002.

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PART II

ITEM 5.          MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Due to the relatively small number of shares held by non-affiliates, there is no active trading market for our common stock, although trades in the stock occur occasionally in the over-the-counter market. At March 21, 2003, there were 145 shareholders of record.

We have not paid any dividends on common stock during the last three fiscal years and we have no plans to pay any cash dividends on common stock in the foreseeable future. In addition, we intend to retain future earnings for working capital purposes. As a holding company, we depend on dividends and other payments from our subsidiaries to meet our working capital needs. Our credit facility with FINOVA Capital Corporation (“FINOVA”) prohibits us from paying any cash dividends on common stock.

ITEM 6.          SELECTED CONSOLIDATED FINANCIAL DATA

   (1)    Includes unearned finance charges, dealer reserves, and discounts on bulk purchases.

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ITEM 7.          MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

We are a diversified consumer financial services company. The primary divisions of our business include:

•         origination and servicing of direct consumer loans made to credit-impaired borrowers,

•         used automobile lending through the purchase and servicing of used automobile sales contracts,

•         insurance premium finance lending through the purchase of insurance premium finance contracts,

•         selling insurance products on an agency basis, and the factoring of accounts receivable and

•         the origination and servicing of small commercial loans to small and medium sized businesses.

Recent Expansion Activities:

Over the past four years, we have added approximately 175 branch offices and have begun the process of identifying the offices that are more profitable than others, seeking to enhance the performance of each office and determining whether to close or dispose of offices that are marginally profitable or operate at a loss. While we continue to expand existing operations and consider acquisition opportunities, our business strategy focuses primarily on making our current business more profitable. As part of this strategy, we periodically make bulk purchases of loan contracts to improve our competitive position and portfolio mix.

Acquisitions: In November 1999, we acquired all of the outstanding shares of Thaxton Investment Corporation (“Thaxton Investment”), a corporation controlled by Mr. James D. Thaxton, for 3,223,000 shares of our common stock. At that time, Thaxton Investment owned and operated 144 consumer finance offices in six states. Thaxton Investment had acquired these offices from FirstPlus Consumer Finance, Inc. in February 1999. When we acquired Thaxton Investment, the estimated aggregate fair market value of the common stock issued to Mr. Thaxton was approximately $30 million. Because we had been under common ownership and control with Thaxton Investment since February 1999, our acquisition of Thaxton Investment was accounted for at historical cost in a manner similar to pooling of interests accounting.

On August 18, 2000, we acquired all of the stock of Quick Credit Corporation, a consumer finance company with 25 branch offices located in South Carolina, for $12.75 million in cash. This acquisition was accounted for as a purchase and resulted in goodwill of approximately $3.8 million.

Discontinued Operations: We discontinued the operations of two of our businesses in 2000. On March 1, 2000, we transferred all of the assets and liabilities of 32 insurance agency operations to a newly formed entity, Thaxton RBE, Inc. The purpose of the transfer was to place the insurance operations in a separate entity to facilitate raising capital to fund the specialized non-standard automobile insurance business of Thaxton RBE. Immediately after the transfer, Thaxton Life Partners, Inc. acquired 90% of the equity of Thaxton RBE for $2 million in cash. During the third quarter of 2000, Thaxton Life Partners purchased our remaining 10% interest in Thaxton RBE and all amounts owed to us by Thaxton RBE were paid in full. We recorded a loss, net of income tax benefit, from operations of Thaxton RBE of approximately $1.5 million for the year ended December 31, 1999 and $374,683 for the year ended December 31, 2000.

In December 2000, we adopted a plan to discontinue the operations of the mortgage banking business conducted by Paragon, Inc. Paragon ceased operations in December of 2000, and its assets have been sold. We recorded a loss, net of income tax benefit, from the operations of Paragon of $100,355 for the year ended December 31, 1999 and approximately $3 million for the year ended December 31, 2000.

For additional information about the effects of the discontinued operations, see Note 13 to our consolidated financial statements contained elsewhere in this annual report.

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Sources of Income

We derive revenues and our resulting income from direct consumer lending, used automobile sales finance, insurance premium finance, the sale of insurance products on an agency basis and commercial finance. For purposes of the following discussion, “revenues” means the sum of our interest and fee income, insurance commissions, net and other income.

Direct Consumer Lending. We make small loans to borrowers with impaired credit. In connection with these loans, our income consists of interest and fees paid by the borrowers. Our interest income is based on the interest rates we charge borrowers for loans. Interest rates vary from loan to loan based on several factors, including the extent to which interest rates are regulated in the state where the loan is originated. Substantially all of the fee income we derive from these loans consists of late fees. Interest and fee income from our direct consumer lending business comprised approximately 86% of our total revenues in 2002.

Used Automobile Sales Finance. We finance used automobile purchases by individuals with impaired credit by purchasing sales contracts from independent automobile dealers. Our income in this line of business also consists of interest and fees charged to borrowers. Like our direct consumer loans, interest rates charged on automobile sales contracts vary from contract to contract based on several factors, including the extent to which the interest rates are regulated in the state where the contract is originated. Substantially all of the fee income we generate consists of late fees. Interest and fee income from our used automobile sales finance business comprised approximately 7% of our total revenues in 2002.

Insurance Premium Finance. We provide short-term financing of insurance premiums for customers of independent insurance agents primarily of a related party, Thaxton Life Partners. The premiums are for personal lines of insurance that are typically too high for a credit-impaired borrower to pay in six-month increments, such as automobile insurance. A smaller amount of this business involves financing premiums for commercial lines of insurance for small businesses. Substantially all of our premium finance business is derived from customers of the 48 insurance offices owned and operated by Thaxton Life Partners, Inc. which is owned by James D. Thaxton and members of his family.

Our income from our premium finance business consists of interest charges and fees, both of which are extensively regulated in the states where we operate. The fee income we derive consists primarily of an origination fee of up to $15 on each contract and late fees as permitted under applicable state law. Our insurance premium finance business made up approximately 2% of our total revenues in 2002.

Insurance Agency Activities. We sell, on an agency basis, various lines of automobile, property and casualty, life, accident and health insurance. Our income from the sale of these products consists of commissions paid by the insurance company that issues the policy we sell. The commission rates are based on a standard or negotiated schedule. Our insurance agency activities comprised approximately 4% of our total revenues in 2002.

Commercial Finance. We offer commercial loans and factoring services to small business clients. We derive interest and fee income from these financing activities. The interest rates we charge are typically negotiated with commercial borrowers because the interest rates are generally not regulated by state laws. In factoring the accounts receivable, we typically charge a fee of 1% to 4% of the amount we advance. We may also charge interest on uncollected balances. Approximately 1% of our total revenues in 2002 was derived from our commercial finance activities.

Over the next 12 months, we plan to grow our direct consumer lending portfolio by about five percent, grow our automobile sales finance portfolio by about two percent and maintain our insurance premium finance portfolio at approximately its level at December 31, 2002. We do not intend to make any new loans secured by real estate in the future and expect that our existing portfolio of these loans will either be sold or liquidated over time as the loans are paid off.

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Finance Receivables

Our finance receivables are comprised of direct loans, used automobile sales contracts, real estate secured loans, premium finance contracts and commercial loans. Our financial performance depends in part on the growth of our outstanding loan receivables and the maintenance of loan quality. The following table sets forth certain information about the components of our finance receivables as of the end of the period presented.

   (1)    Finance receivable balances are presented net of unearned finance charges, dealer reserves on Automobile Sales Contracts and discounts on bulk purchases (“Net Finance Receivables”).

NET INTEREST MARGIN

The principal component of our profitability is our net interest margin, which is the difference between interest earned on finance receivables and interest expense paid on borrowed funds. Statutes in some states regulate the interest rates that we may charge our borrowers while interest rates in other states competitive market conditions establish the interest rate borrowers may be charged. Significant differences exist in the interest rates earned on the various components of our finance receivable portfolio. The interest rate earned on used automobile sales contracts and real estate secured loans generally are lower than the interest rates earned on direct consumer loans due to competition from other lenders, superior collateral and longer terms. The interest rates earned on premium finance contracts are state regulated and vary based on the type of underlying insurance and the term of the contract.

Unlike our interest income, our interest expenses are sensitive to general market fluctuations in interest rates. The interest rates paid to our primary lender, FINOVA, are based upon a published prime rate plus set percentages. Thus, general market fluctuations in interest rates directly impact our cost of funds. Our general inability to increase the interest rates earned on finance receivables may impair our ability to adjust to increases in the cost of funds resulting from changes in market conditions. Accordingly, increases in market interest

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rates generally will narrow our interest rate margin and lower our profitability, while decreases in market interest rates generally will widen our interest rates spreads and increase profitability.

The following table presents important data relating to our net interest margin for the years ended December 31, 2000, 2001, and 2002.

(1)      Averages are computed using month-end balances during the year presented

(2)      Net interest margin represents net interest income divided by average Net Finance Receivables.

RESULTS OF OPERATIONS

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

Our aggregate finance receivables grew 3% from $182,684,000 on December 31, 2001 to $188,318,000 on December 31, 2002. We continued to change the mix of our portfolio during 2002. Our direct loan finance receivables increased by $19 million due to increased emphasis on the growth and quality of this division by management. Our Premium Finance and Commercial loans balances declined $4.5 million and $1.3 million for the year, respectively. Due to the profitability of our direct loan finance receivables, we plan to continue to grow this category of our business.

Interest and fee income grew 6.3% during 2002 primarily because of an increase in direct loan receivables. Interest and fee income was $80,939,000 in 2002 compared to $76,138,000 in 2001. Interest expense decreased 20.2% to $15,211,000 in 2002 from $19,069,000 in 2001. Our overall interest expense decreased due to the substantial decrease in interest rates compared to the prior year. As we increase our direct loan finance receivables, we expect our interest income to increase in future periods. Our average interest rate earned decreased slightly due to less growth in our higher yielding small loan business. We do not expect the prime interest rate to decrease as substantially in the future, if at all, and may increase which would cause our interest expense to rise.

We increased our allowance for credit losses by 16% to $13,964,000 at December 31, 2001 versus $12,012,000 at December 31, 2001 due to the 17% increase in credit losses experienced during 2002. Credit losses increased to $21,141,000 for 2002 versus $18,024,000 for 2001 and our provision for credit losses increased comparably between years from $16,584,000 in 2001 to $21,285,000 in 2002, or a 28% increase. As our finance receivables portfolio mix changes to more direct loans, we expect our credit losses will increase, and the weakening economy may cause an additional increase in credit losses as well.

Total operating expenses increased 1.2% during 2002 due primarily to an increase in normal operating expenses. Operating expenses were $58,425,000 during 2002 versus $57,737,000 during 2001. We have experienced and expect to continue to experience nominal increases in operating expenses associated with normal growth.

We generated pretax income of $8,264,000 and net income of $5,134,000 in 2002 compared to pretax income of $5,130,000 and net income of $3,035,000 in 2001.

Our net income, after payment of preferred stock dividends, increased our stockholders’ equity to $10,879,000 from $6,285,000 for the year ended December 31, 2002.

Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

Our aggregate finance receivables grew slightly during 2001. Finance receivables grew 3% from $177,944,000 on December 31, 2000 to $182,684,000 on December 31, 2001. In addition, the mix of our portfolio changed during 2001. Our direct loan finance receivables increased by $13 million due to the addition of new branches and increased emphasis on the growth and quality of this division by management. Our automobile sales finance receivables decreased by approximately $8 million due to a management decision to liquidate portions of this portfolio. Due to the profitability of our direct loan finance receivables, we plan to continue to grow this category of our business, while we maintain our other portfolios.

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Interest and fee income grew 14.2% during 2001 primarily because of an increase in receivables as a result of the full year effect of the August 2000 acquisition of Quick Credit and the change in the mix of our portfolio. Interest and fee income was $76,138,000 in 2001 compared to $66,662,000 in 2000. Interest expense decreased 9.3% to $19,069,000 in 2001 from $21,024,000 in 2000. Even though our average notes payable for the year increased, our overall interest expense decreased due to the substantial decrease in interest rates during the year. As we increase our direct loan finance receivables, we expect our interest income to increase in future periods. If the prime interest rate continues to decline, we expect our interest expense to decrease.

We increased our allowance for credit losses by 3% to $12,012,000 at December 31, 2001 versus $11,631,000 at December 31, 2000 due to the 12% increase in credit losses experienced during 2001. Credit losses increased to $18,024,000 for 2001 versus $16,052,000 for 2000 and our provision for credit losses increased comparably between years from $14,658,000 in 2000 to $16,584,000 in 2001, or a 13% increase. As our finance receivables portfolio expands, we expect our credit losses will increase as well, and the weakening economy may cause an additional increase in credit losses.

Insurance commissions, net of insurance cost, increased by 4.4% during 2001 primarily due to increased sales of insurance products to borrowers. Insurance commissions, net of insurance costs, were $18,554,000 in 2001 versus $17,764,000 in 2000. Other income increased from $4,239,000 in 2000 to $5,640,000 in 2001 primarily due to law changes in Georgia, Tennessee and Oklahoma that allowed us to charge increased fees to borrowers and the opening of five additional branches in those states.

Total operating expenses increased 11.5% during 2001 due primarily to an increase in normal operating expenses and the full year of operating expenses associated with Quick Credit. Operating expenses were $57,737,000 during 2001 versus $51,781,000 during 2000. We only incurred 4 months of operating expenses in 2000 due to the Quick Credit acquisition. We do not expect to continue to see comparable increases in our operating expenses in the future. However, we have experienced and expect to continue to experience nominal increases in operating expenses associated with normal growth.

We generated pretax income of $5,130,000 and net income of $3,035,000 in 2001 compared to pretax income from continuing operations of $153,000 and a net loss from continuing operations of $397,000 in 2000.

Our net income, after payment of preferred stock dividends, increased our stockholders’ equity to $6,285,000 from $3,759,000 at December 31, 2001.

CREDIT LOSS EXPERIENCE

Provisions for credit losses are charged to income in amounts sufficient to maintain the allowance for loan losses at a level considered adequate to cover the expected future losses of principal and interest in our existing finance receivable portfolio as of December 31, 2002. Credit loss experience, contractual delinquency of finance receivables, the value of underlying collateral, and management’s judgment are factors used in assessing the overall adequacy of the allowance and resulting provision for credit losses. Our reserve methodology is designed to provide an allowance for credit losses that, at any point in time, is adequate to absorb the charge-offs expected to be generated by the finance receivable portfolio, based on events or losses that have occurred or are known to be inherent in the portfolio. The model utilizes historical charge-off data to predict the charge-offs likely to be generated in the future by the existing finance receivable portfolio. The model takes into consideration overall loss levels, as well as losses by originating office and by type, and develops historical loss factors which are applied to the current portfolio. In addition, changes in dealer and bulk purchase reserves are reviewed for each individual dealer and bulk purchase, and additional reserves are established for any dealer or bulk purchase if coverage is deemed to have declined below adequate levels. Our charge-off policy is based on an account by account review of delinquent receivables. Losses on finance receivables secured by automobiles are recognized at the time the collateral is repossessed. Other finance receivables are charged off when they become contractually past due 180 days, unless extenuating circumstances exist leading management to believe such finance receivables will be collectible. Finance receivables may be charged off prior to the normal charge-off period if management deems them to be uncollectible.

Under our dealer reserve arrangements, when a dealer assigns a used automobile sales contract to us, we withhold a certain percentage of the principal amount of the contract, usually between five and ten percent. The amounts withheld from a particular dealer are recorded in a specific reserve account. Any losses incurred on used automobile sales contracts purchased from that dealer are charged against its specific reserve account. If at any time the balance of a dealer’s specific reserve account exceeds the amount derived by applying the withheld percentage to the total amount of principal and interest due under all outstanding used automobile sales contracts purchased from the dealer, the dealer is entitled to receive distributions from the specific reserve account in an amount equal to the excess. If we continue to purchase used automobile sales contracts from a dealer, distributions of excess dealer reserves generally are paid quarterly. If we do not continue to purchase used automobile sales contracts from a dealer, distributions of excess dealer reserves are not paid out until all used automobile sales contracts originated by that dealer have been paid in full. The aggregate balance of all specific reserve accounts, including unpaid excess dealer reserves, are reflected in the balance sheet as a reduction of finance receivables. Our allowance for credit losses is charged only to the extent that the loss on a used automobile sales contract exceeds the originating dealer’s specific reserve account at the time of the loss.

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We periodically purchase used automobile sales contracts in bulk. In a bulk purchase arrangement, we typically purchase a portfolio of used automobile sales contracts from a dealer at a discount to par upon our management’s review and assessment of the portfolio. This discount is maintained in a separate account against which losses on the bulk portfolio purchased are charged. To the extent losses experienced are less than the discount, the remaining discount is accreted into income.

The following table sets forth our allowance for credit losses and credit loss experience at or over the periods presented.

   (1)    Net finance receivable balances are presented net of unearned finance charges, net of unearned insurance premiums, dealer holdbacks and bulk purchase discounts, deferred loan costs, and exclude commercial finance receivables.

   (2)    Average net receivables computed using month end balances

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The following table sets forth certain information concerning our finance contracts at the end of the periods indicated:

Finance receivable balances are presented net of unearned finance charges.

LIQUIDITY AND CAPITAL RESOURCES

We finance our operations through cash flow from operations, borrowings under our credit facility with FINOVA Capital Corporation (“FINOVA”) and the sale to public investors of our subordinated notes.

As of December 31, 2002, our credit facility with FINOVA included a term loan and a revolving credit line used to finance receivables. Advances under the term loan accrued interest at the prime rate plus 2%, or 6.25% as of December 31, 2002. We had $6.6 million outstanding under the term loan as of December 31, 2002. Advances under the revolving credit line accrued interest at prime rate plus 1%, or 5.25% as of December 31, 2002. We had $116.6 million outstanding under the revolving credit line as of December 31, 2002.

On February 24, 2003, we amended our credit facility with FINOVA. In connection with the amendment, we repaid the $6.6 million outstanding under the term loan. Our credit facility now consists of a revolving credit line with advances accruing interest at the prime rate plus 1%, or 5.25% at February 28, 2003. The prime rate is the prime rate published by Citibank, N.A., or other money center bank as FINOVA may select. The interest rates are adjusted monthly to reflect fluctuations in this designated prime rate. Accrued interest on borrowings is payable monthly. Principal is due in full on the maturity date and can be prepaid without penalty. Maximum borrowings under the credit facility as of February 28, 2003 are limited to the lesser of $135 million, or 85% of eligible consumer finance receivables as defined by the agreement. Our maximum borrowing amount decreases on a quarterly basis and will decrease $13.5 million during the remainder of 2003, $18 million in 2004, $18 million in 2005 and $9 million in 2006. The credit facility matures in 2006 and requires us to comply with restrictive covenants, including financial condition covenants. As of December 31, 2002 and February 24, 2003, we met all such requirements.

Substantially all of our and our subsidiaries’ assets secure the credit facility. James D. Thaxton also guarantees our repayment obligations under the credit facility.

As of February 28, 2003, we had borrowed $113.3 under the credit facility and an additional $21.7 million was available under the terms of the credit facility to borrow against existing collateral.

We also fund our liquidity needs through the sale of subordinated notes. In February 1998, we began offering subordinated notes in several states by registering $50 million of subordinated notes with the Securities and Exchange Commission (“SEC”). In May 2001, we registered an additional $75 million offering of subordinated notes with the SEC. In December 2002, we registered an additional $125 million offering of subordinated notes. The notes are sold primarily to individual investors. The maturity terms range from daily

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(demand) notes to sixty-month notes. Interest rates vary based on the principal amounts and maturity dates of the notes. Notes currently being offered carry interest rates ranging from 5.25% to 8.0%. The notes are unsecured and issued under an indenture which we entered into with The Bank of New York, as trustee, in February 1998. The terms of the indenture do not require us to comply with any financial covenants nor do they impose any material restrictions on the operations of our business.

As of February 28, 2003, we had $105.5 million of these registered subordinated notes outstanding and $2.8 million notes registered in predecessor state registrations. To date, we have used the proceeds from the sale of these notes to reduce, on a temporary basis, the amount of our revolving credit facility with FINOVA. We intend to continue this note program by seeking to register additional offerings of subordinated notes with the SEC. The sale of subordinated notes is an important aspect of the financing of our business. It enables us to reduce our overall borrowing costs, particularly during periods of increasing interest rates. In addition, it allows us to hedge the interest rate risk inherent in our variable rate credit facility, and to diversify our sources of borrowed funds.

We plan to continue to reduce borrowings under our credit facility and replace those borrowings with an increasing principal amount of subordinated notes. Although the maximum amount we can borrow under our credit facility will be decreasing, we anticipate that our cash flow from operations, available borrowings under our credit facility and the proceeds from the sale of subordinated notes will be adequate to meet the cash requirements necessary to fund our operating, investing and financing activities. We estimate that the amount required to fund these activities will be approximately $35 million during the fiscal year ending December 31, 2003.

IMPACT OF INFLATION AND GENERAL ECONOMIC CONDITIONS

Although we do not believe that inflation has a direct material adverse effect on our financial condition or results of operations, increases in the inflation rate generally are associated with increased interest rates. Because we borrow funds on a floating rate basis and generally extend credit at fixed interest rates, increased interest rates increases our cost of funds and could materially impair our profitability. We intend to explore opportunities to fix or cap the interest rates on all or a portion of our borrowings. We can, however, give no assurance that fixed rate or capped rate financing will be available on terms acceptable to us. Inflation also may affect our operating expenses. Other general economic conditions in the United States could affect our business, including economic factors affecting the ability of our customers or prospective customers to purchase used automobiles and to obtain and repay loans.

Recent Accounting Pronouncements

Impact of Recently Adopted Accounting standards – Effective January 1, 2002, the Company adopted the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets”. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with its provisions. SFAS 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values. In connection with adoption of SFAS 142, the Company is required to perform an initial assessment of whether there is an indication that goodwill is impaired. During the second quarter of 2002, the Company completed its initial analysis of potential impairment under the provisions of SFAS No. 142, and determined based on that analysis that goodwill was not impaired. The Company also completed its annual impairment test at December 31, 2002 and determined based on that analysis that goodwill was not impaired. Goodwill will be tested for impairment annually, or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

SFAS 144, “Accounting for the Impairment or Disposal of Long-lived Assets”, was issued in August 2001 and supersedes SFAS No. 121. SFAS No. 144 establishes standards for the financial accounting and reporting requirements for the impairment or disposal of long-lived assets. The provisions of SFAS No. 144 were adopted effective January 1, 2002. The adoption of the provisions of SFAS No. 144 did not have a material impact on the consolidated financial statements of the Company.

SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections”, was issued in April 2002. The adoption of the provisions of this statement did not have a significant effect on financial position or results of operation of the Company.

SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”, was issued in June 2002 and addresses financial accounting and reporting for costs associated with exit or disposal activities. This statement is effective for exit or disposal activities initiated after December 31, 2002 and is not expected to have a material impact on the financial statements of the Company.

SFAS No. 147, “Acquisitions of Certain Financial Institutions an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9”, was issued in October 2002 and provides guidance on the application of the purchase method to acquisitions of financial institutions. This statement is effective for acquisitions on or after October 1, 2002 and is not expected to have a material impact on the financial statements of the Company.

SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – An Amendment of FASB Statement No.

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123”, was issued in December 2002 and provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement is effective for fiscal years ending after December 15, 2002 and is not expected to have a material impact on the financial statements of the Company.

Critical Accounting Policies

Our accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the finance company industry. The significant accounting policies used in the preparation of the consolidated financial statements are discussed in Note 1 to the consolidated financial statements.

Certain critical accounting policies require our management to make estimates and assumptions, which affect the reported amounts of assets, liabilities, income and expenses. As a result, changes in these estimates and assumptions could significantly affect our financial position and results of operations. We consider our policies regarding the allowance and resulting provision for loan losses to be our most critical accounting policy due to the significant degree of management judgment that is applied in establishing the allowance and the provision. We have developed policies and procedures for assessing the adequacy of the allowance for loan losses, which take into consideration various assumptions and estimates with respect to the loan portfolio. The assumptions and estimates used by management may be significantly affected in the future by changes in economic conditions, among other factors.

ITEM 7A:       QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our outstanding debt under the Revolving Credit Facility and Term Loan was $123.2 million at December 31, 2002. Interest on borrowings under these facilities is based on the prime rate. Based on the outstanding balance at December 31, 2002, a change of 1% in the prime interest rate would cause a change in interest expense of approximately $1,232,000 on an annual basis.

Our outstanding receivables are not affected by external interest rate changes because we usually charges rates typically fixed at the maximum rate allowable by law or, in states where there are no legal maximum rates, at competitive rates commensurate with the increased default risk and the higher cost of servicing and administering a portfolio of loans to credit impaired borrowers. This causes the interest rate risk on our outstanding receivables to be minimal.

Interest rates being charged by competitors, even those outside our markets, also influence the interest rates we are able to charge customers. A decrease in the interest rates being charged by others in the market could impact our ability to attract new customers and/or retain the customers we currently serve. Similarly, new market entrants and the resulting increased competition for customers in our market could adversely affect our profitability.

Additionally, changes in the maximum interest rate allowable by law would affect our profitability. A decrease in the maximum rate would cause the interest rates we are able to charge to be commensurately decreased and, as a result, our interest rate margin would be reduced. A legally imposed maximum interest rate adopted by a state where we operate that previously did not have a limit could also impair our profitability because our interest rates may be reduced to fall within the legal limit.

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ITEM 8.          FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

THE THAXTON GROUP, INC.

CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2002, 2001, AND 2000

(WITH INDEPENDENT AUDITORS’ REPORT THEREON)

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Independent Auditors’ Report

The Board of Directors
The Thaxton Group, Inc.

We have audited the accompanying consolidated balance sheets of The Thaxton Group, Inc. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three year period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Thaxton Group, Inc. and subsidiaries as of December 31, 2002 and 2001 and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 1 to the financial statements, the Company changed its method of accounting for goodwill in 2002.

Charlotte, North Carolina
March 10, 2003

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THE THAXTON GROUP, INC.
Consolidated Balance Sheets
December 31, 2002 and 2001

See accompanying notes to consolidated financial statements.

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THE THAXTON GROUP, INC.
Consolidated Statements of Income
Years Ended December 31, 2002, 2001, and 2000

See accompanying notes to consolidated financial statements.

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THE THAXTON GROUP, INC.
Consolidated Statements of Stockholders’ Equity
Years Ended December 31, 2002, 2001, and 2000