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Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
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ANNUAL REPORT
Pursuant to Section 13 or 15(D)
of the Securities Exchange Act of 1934 ( "the Act")
For the Fiscal Year Ended December 31, 2002
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Commission File Number 000-23775
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Approved Financial Corp.
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(Exact Name of Registrant as Specified in its Charter)
Virginia 52-0792752
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
1716 Corporate Landing Parkway, Virginia Beach, Virginia 23454
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(Address of Principal Executive Office) (Zip Code)
757-430-1400
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(Registrant's Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(g) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
Common, $1.00 par value per share OTC Bulletin Board
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Securities to be Registered Pursuant to Section 12(g) of the Act:
None
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant is
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___ .
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Indicate by check mark if disclosure of delinquent filers pursuant to item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_].
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date: 5,482,114 shares at April 15,
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2003.
Approved Financial Corp.
Annual Report on Form 10-K
For the Fiscal Year Ended December 31, 2002
INFORMATION REQUIRED IN ANNUAL REPORT
TABLE OF CONTENTS
PART I
Item 1. Business.
General ..................................................................................... 5
Business Strategy ........................................................................... 9
Our Borrowers and Loan Products ............................................................. 11
Underwriting Guidelines ..................................................................... 13
Mortgage Loan Servicing ..................................................................... 21
Marketing ................................................................................... 23
Sources of Funds and Liquidity .............................................................. 25
Bank's Sources of Funds ..................................................................... 26
Taxation .................................................................................... 28
Employees ................................................................................... 29
Service Marks ............................................................................... 29
Effect of Adverse Economic Conditions ....................................................... 29
Concentration of Operations ................................................................. 30
Future Risks Associated with Loan Sales through Securitizations ............................. 30
Contingent Risks ............................................................................ 31
Competition ................................................................................. 31
Regulation .................................................................................. 32
OTS Regulation of Approved Financial Corp. .................................................. 36
Regulation of the Bank ...................................................................... 36
Legislative Risk ............................................................................ 47
Environmental Factors ....................................................................... 48
Dependence on Key Personnel ................................................................. 49
Control by Certain Shareholders ............................................................. 49
Item 2. Properties.
Properties .................................................................................. 50
Item 3. Legal Proceedings.
Legal Proceedings ........................................................................... 51
Item 4. Submission of Matters to a Vote of Security Holders.
Submission of Matters to a Vote of Security Holders ......................................... 51
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Market Price of and Cash Dividends on Common Equity ......................................... 52
Absence of Active Public Trading Market and Volatility of Stock Price ....................... 53
Transfer Agent and Registrar ................................................................ 53
Recent Open Market Purchase of Common Stock by the Company .................................. 53
Recent Sales of Unregistered Securities ..................................................... 53
Item 6. Selected Financial Data.
Selected Financial Data ..................................................................... 54
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General ..................................................................................... 57
Results of Operations - Years Ended December 31, 2002 and 2001 .............................. 58
Results of Operations - Years Ended December 31, 2001 and 2000 .............................. 73
Financial Condition - December 31, 2002, 2001, and 2000 ..................................... 86
Liquidity and Capital Resources ............................................................. 88
Interest Rate Risk Management ............................................................... 98
New Accounting Standards .................................................................... 101
Impact of Inflation and Changing Prices ..................................................... 103
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market Risk Management - Asset/Liability Management ......................................... 104
Interest Rate Risk .......................................................................... 107
Asset Quality ............................................................................... 108
Item 8. Financial Statements and Supplementary Data.
Financial Statements and Supplementary Data ................................................. 109
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ........ 109
PART III
Item 10. Directors and Executive Officers of the Registrant.
Information regarding certain relationships and related transactions ........................ 110
Item 11. Executive Compensation.
Information regarding executive compensation ................................................ 112
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Information regarding security ownership of certain beneficial owners and management ........ 118
Item 13. Certain Relationships and Related Transactions.
Information regarding certain relationships and related transactions appears ................ 120
Item 14. Controls and Procedures ............................................................ 122
PART IV
Item 15. Exhibits, Financial Statement Schedules
And Reports on Form 8-K.
Financial Statements and Exhibits ........................................................... 123
Signatures .................................................................................. 127
PART I
ITEM 1 - BUSINESS
Forward Looking Statements
Some of the information in this report may contain forward-looking statements
within the meaning of the Private Securities Litigation Act of 1995 concerning
Approved Financial Corp. and our subsidiaries. These forward-looking statements
regarding our business and prospects are based upon numerous assumptions about
future conditions, which may ultimately prove to be inaccurate. Actual events
and results may materially differ from anticipated results described in those
statements. Forward-looking statements involve risks and uncertainties described
under various sections of this report including but not limited to, "Risk
Factors", "Business", "Management's Discussion And Analysis Of Financial
Condition And Results Of Operations", "Interest Rate Risk" And "Quantitative And
Qualitative Discussion About Market Risk". When considering forward-looking
statements, you should keep these risk factors in mind as well as the other
cautionary statements in this report. You should not place undue reliance on any
forward-looking statement.
Certain statements in this report which are not merely historical facts
concerning loan production volume, revenues from loan sales, corporate
restructuring and expense reduction initiatives, current status and future
consequences of regulatory issues, ability to profitably participate in any
present or future line of business or operation are forward-looking statements.
You can identify these statements by words or phrases such as but not limited to
"will likely result," "may," "expected to," "will continue to," "is
anticipated," "estimate," "projected," "intends to", "plans to", "is likely".
There are a number of important factors that could cause our actual results to
differ materially from those indicated in such forward-looking statements. Those
factors include, but are not limited to our ability to implement restructuring
and expense reduction plans, our ability to retain experienced personnel, any
changes in residential real estate values, changes in industry competition,
general economic conditions, changes in interest rates, changes in the demand
for non-conforming or conforming mortgage loans, our availability of affordable
funding sources for capital liquidity, changes in loan prepayment speeds,
delinquency and default and loss rates, changes in regulatory issues concerning
mortgage companies, federal banks, or insurance companies, our ability to comply
and be released from outstanding regulatory issues, changes in GAAP accounting
standards effecting our financial statements, and any changes which influence
any market for profitable sales of all of our products and services including
mortgage loans.
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General
Corporate History. Approved Financial Corp.("AFC" or "holding company"), was
incorporated in 1952 as a subsidiary of Government Employees Insurance Co.
("GEICO") and was acquired in September 1984 by, among others, certain members
of current management and the board of directors. We are headquartered in
Virginia Beach, Virginia, and hold a Virginia industrial loan association
charter and are therefore subject to the supervision, regulation and examination
of the Virginia State Corporation Commission's Bureau of Financial Institutions.
A wholly owned subsidiary, Approved Federal Savings Bank (the "Bank" or "AFSB"),
a federally chartered institution was acquired by AFC in 1996 and is also
headquartered in Virginia Beach. The flexible provisions of the Bank charter
offers ease of entry to new markets by facilitating our origination of real
estate-secured loans in many states without the expense and time involved in the
licensing process for non-bank mortgage companies. The Bank is subject to the
supervision, regulation and examination of the Office of Thrift Supervision (the
"OTS") and the Federal Deposit Insurance Corporation ("FDIC"). The Bank is a
member of the Federal Home Loan Bank (the "FHLB") of Atlanta. The Bank is also
subject to the regulations of the Board of Governors of the Federal Reserve
System. AFC is a registered savings and loan holding company under the federal
Home Owner's Loan Act ("HOLA") because of our ownership of the Bank. As such, we
are subject to the regulation, supervision and examination of the OTS. The Bank
is also subject to the regulations of the Board of Governors of the Federal
Reserve System governing reserves required to be maintained against deposits.
AFC and the Bank operate under an OTS directive dated April 2001 and a Consent
Supervisory Agreement dated December 2001.
Other wholly owned inactive subsidiaries include, Approved Residential Mortgage,
Inc. ("ARMI"), which was formed in April 1993. Initially ARMI originated loans
through wholesale sources. In 1994 ARMI opened its first retail operation. As of
August 1, 1999 all wholesale broker originations were transferred to the Bank.
All ARMI retail offices were closed as of May 2001 and the company is inactive.
A second inactive subsidiary, Approved Financial Solutions, Inc. ("AFS") formed
in November of 1998 for the initial purpose of offering life insurance to our
loan customers. Life insurance sales never represented a material source of
revenue and have been discontinued. During 2001, AFS offered title insurance in
certain states where it holds licenses and offered other ancillary financial
products such as Mortgage Acceleration Program ("MAP") and Debt Free Solutions
Program. However, these products were discontinued during 2001 in conjunction
with the downsizing of the retail division. A third inactive subsidiary is MOFC,
Inc. d/b/a/ ConsumerOne Financial ("ConsumerOne"), previously located in
Birmingham, Michigan was
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acquired by AFC in December of 1998. The operations of ConsumerOne, retail loan
origination office, were transferred to the Bank during 2000 and operated as a
branch of the Bank and served as a disaster "hot" site until we closed the
operation due to lack of profitability in May of 2001. The fourth inactive
subsidiary, Global Title of Maryland, Inc. was formed during the first part of
the year 2000 to offer title insurance products to our customers in Maryland and
has been inactive since closing of Maryland retail loan origination offices in
May 2001.
Primary Business. Our primary business is the origination and sale of loans
secured by conforming and non-conforming first and junior liens on
one-to-four-family residential properties that are primarily owner occupied. We
offer both fixed-rate and adjustable-rate loans for debt consolidation, home
improvements, home purchase and other purposes.
We utilize wholesale ("wholesale" or "broker") and retail channels to originate
mortgage loans. The wholesale originations are sourced from an extensive network
of independent mortgage brokers that utilize our mortgage product offerings to
service the needs of their customers. As illustrated in the following table, in
2002, the dollar volume of originations generated by the wholesale division
accounted for 96% of total originations and the retail lending division
accounted for 4% of total originations. In 2001, including retail loans brokered
to other lenders, the dollar volume in the wholesale lending division accounted
for 72% of total originations and the retail lending division accounted for 28%
of total originations. In 2000, the dollar volume in the broker lending division
accounted for 49% of total originations and the retail lending division
accounted for 51% of total originations. Our current initiatives for the
mortgage business focus on increasing future origination volume in a
cost-effective manner primarily through the wholesale division. The table below
also illustrates the transition of loan origination volume from ARMI to the
Bank. The percentage of total loan originations generated by the Bank has
increased from thirty-two percent (32%) in 1998 to one hundred percent (100%) in
2002. (See: Item 7 for additional discussion of mortgage loan origination
activity).
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Residential Mortgage Loan Origination Volume
($ in millions) 1998 1999 2000 2001 2002
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Total Dollars $ 522 $ 391 $ 277 $ 377 $ 212
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% Change Year to Year 11% -25% -29% 36% -44%
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Wholesale Division - Dollars $ 204 $ 127 $ 136 $ 270 $ 203
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Wholesale % Total Volume 39% 32% 49% 72% 96%
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Retail Division Dollars $ 318 $ 264 $ 141 $ 107 $ 9
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Retail % Total Volume 61% 68% 51% 28% 4%
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Bank - Dollars $ 166 $ 188 $ 228 $ 364 $ 212
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Bank - % of total 32% 48% 82% 96% 100%
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ARMI - Dollars $ 356 $ 203 $ 49 $ 13 $ -
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ARMI - % of total 68% 52% 18% 3% 0%
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The business of the Bank, in addition to residential mortgage loan origination
activity, includes the procurement and administration of wholesale jumbo
certificate of deposit accounts and certain money market deposits. Deposit
accounts of the Bank are insured by the Association Insurance Fund, administered
by the FDIC up to $100,000. The Bank may from time to time invest in certain
U.S. Government and agency obligations and other investments permitted by
applicable laws and regulations. The operating results of the Bank are highly
dependent on loan sale premiums from whole loan sales and net interest income,
which is the difference between interest income earned on loans and investments
and the cost of deposits and borrowed funds.
Under an agreement, AFC provides various services to the Bank related to the
origination of residential mortgages, such as processing, underwriting, loan
documentation preparation and closing, quality control, servicing and
collections, secondary marketing of loans, human resource administration and
management information systems maintenance.
Sources of Revenue
Our primary source of revenues under our present business structure is derived
from loan sale premiums earned upon the sale of mortgage loans on a
service-released basis to other financial institutions, which is recorded as
gain on sale in the period that the loan is sold. Two of our investors
contributed more than 10% of the total revenue of the Bank during the year of
2002. The revenue earned from these sources consisted of loan sale premiums
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received by the Bank on the sale of pools of loans to CitiFinancial Mortgage
Company, Inc. and Countrywide Home Loans, Inc.
Since April 2001, all mortgage loans have been originated with the intent to
sell and are reflected in the balance sheet as `mortgage loans held for sale'.
These loans are pooled and sold on a whole loan basis to institutional investors
consisting primarily of larger well capitalized financial institutions,
reputable mortgage companies, government and quasi-government agencies. The
proceeds from these sales release funds for additional lending and operational
expenses. In periods prior to April 2001, a small amount of loans were
originated to hold in the Bank portfolio and to generate net interest income.
Such loans are reflected in the Balance Sheet as `mortgage loans held for
yield'.
Other sources of income include net interest earned on loans held for sale, net
interest income on loans held for yield, various origination fees received as
part of the loan application and closing process and to a lesser extent from
ancillary fees associated with the portfolio of loans serviced and from other
financial services offered in past periods.
In future periods, we may generate revenue from new sources by participating in
business activities other than residential mortgage lending that are permissible
activities for banks and bank holding companies. Additionally, while there are
no plans to do so at this time, alternative loan sale strategies available in
the marketplace may be considered for use in future periods. Examples of
alternative strategies in past periods, not adopted by Approved, include loans
sale through direct issuance of mortgage backed securities ("MBS") or through an
agreement for participation in an MBS issued by a larger institution.
Business Strategy
Our current corporate business strategies include but are not limited to the
following:
i. Enhance our capital base through the private or public issuance of
securities or merger and acquisition opportunities.
We presently are aggressively exploring opportunities to enhance our capital
base by means of potential private investments into Approved and/or a merger or
acquisition transaction. There is no assurance that we will successfully secure
such investors and/or an investment transaction structure suitable for the
required OTS approval. Failure to do so may negatively affect our financial
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and operating condition and invoke additional OTS regulatory action.
ii. Maintain quality loan underwriting and solid customer service
standards.
Our underwriting and servicing staff have experience in the non-conforming,
conforming, and home equity loan industry. We believe that the experience of our
underwriting and servicing staff provides us with the infrastructure and skills
necessary to maintain our commitment to solid underwriting standards during
periods of rapid growth as well as through times of unprecedented competition,
which the mortgage industry has experienced over recent years.
iii. Maintain strict cost controls and reduce expenses through the continued
application of new technologies.
We implemented several cost cutting campaigns, over the past few years. Such
initiatives include consolidation of all Virginia Beach locations into one
office. This centralization in conjunction with implementation of a new systems
platform greatly improved the productivity of our staff and was a key element in
our ability to reduce compensation expense while maintaining loan production
capacity, data integrity, management reporting capabilities and quality
controls. During 2001, we upgraded the method by which our staff in remote
locations access our loan production applications through the utilization of a
frame relay network, which seamlessly joins our remote offices to our corporate
headquarters and provides for a single point of information technology and data
management. This has dramatically improved communications and operational
efficiencies throughout the company in addition to enhancement of data integrity
and compliance controls. A document imaging system to enhance loan file
retention and storage is under consideration. This method will significantly
reduce operational and storage cost, while improving operational efficiencies.
(iv) Increase revenues by expanding the level of profitable mortgage volume.
We monitor our traditional non-conforming pricing and loan offerings for
competitiveness and introduce new loan products to meet the needs of our brokers
and borrowers and to expand our market share to new customers who are not
traditionally part of our market.
Our wholesale division sales efforts are conducted through account executives
with extensive experience in the non-conforming mortgage business located
throughout the United States. We constantly monitor the quality of service
provided to
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our network of mortgage brokers with the goal of increasing profitable loan
volume.
Our retail, direct to the borrower, loan origination activity is centralized in
our corporate home office location. The retail sales staff has ready access to
processing and underwriting departments in order to enhance the ability to
provide timely service to potential borrowers.
(v) Build our loan sale investor base in compliance with the Consent Supervisory
Agreement (See: Bank Regulatory Actions), increase loan sale revenue, interest
rate risk management and prudent management of cash flow and expansion of
competitive mortgage product development.
We sell our loans on a whole loan basis receiving cash at the time of sale. With
an objective to expand our menu of mortgage product offerings and to enhance
revenues and profits related to loan sales, we continue to aggressively pursue
new investors for loan sales and opportunities to engage in forward loan sale
commitments with various investors. There is an active secondary market for the
types of mortgage loans that we originate. Currently all loans are originated
for sale to other mortgage companies, finance companies and other financial
institutions including federally chartered banking institutions. The loans are
sold for cash on a whole loan, servicing-released basis. Consistent with
industry practices, the loans are sold with customary representations and
warranties for the industry, which normally provide for an obligation to
repurchase the loan upon events such as a first payment default or discovery of
fraud.
Our Borrowers and Our Loan Products
Our primary products are fixed-rate and adjustable-rate mortgage loans for
purposes such as debt consolidation, home improvements and home purchase,
serving both conforming and non-conforming borrowers. These loans are secured
primarily by first and junior liens on owner-occupied, one-to-four-family
residential properties. Borrowers may gain the income tax advantages of real
estate-secured debt by paying off higher-rate credit cards on which interest
payments are generally not tax-deductible.
Non-conforming customers often experience limited access to credit, but their
financial needs are nonetheless real. By consolidating their debts with a
mortgage loan, these customers can often save several hundred dollars per month
in cash flow, amounts that can make a significant difference in a customer's
financial situation and quality of life. Personal circumstances including
divorce, family illnesses or deaths and temporary job loss due to layoffs and
corporate downsizing will often impair an applicant's credit record. Among our
specialties is the ability
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to identify and assist this type of borrower in the establishment of improved
credit. Non-conforming loans are priced on a risk-adjusted and case-by-case
basis, taking into consideration the borrower's creditworthiness, payment
history, current debt level, employment status, earned income and the property
appraised value relative to the loan amount. Normally, these borrowers are
concerned with access to funds and the size of their monthly mortgage payment
rather than the interest rate or origination costs associated with obtaining the
credit. Therefore, these customers are less rate-sensitive than conforming loan
customers. Loans made to such credit-impaired borrowers generally entail a
higher frequency of delinquency and loan losses than those for more creditworthy
borrowers. The severity of loan losses is normally related to the loan to value
ratios associated with a mortgage loan. No assurance can be given that our
underwriting policies and collection procedures will substantially reduce such
risks. In the event that warehoused loans or portfolio loans held and serviced
by us experience higher than anticipated delinquency, foreclosure, loss or
prepayment speed rates, our results of operation or financial condition would be
adversely affected.
The average loan size of loans funded in-house during the year ended December
31, 2002, 2001 and 2000 were $101,340, $108,880 and $76,330, respectively. The
average loan size of all originated, including retail loans funded through other
lenders ("brokered loans") during the year ended December 31, 2002, 2001 and
2000 was $101,630 and $109,110 and $75,120, respectively. The primary reason for
the higher average loan size in 2001 and 2002 was expansion into new states with
higher real estate values and larger loan sizes.
Wholesale Division. We originate the majority of our non-conforming residential
mortgage loans through a network of independent wholesale mortgage brokers who
offer our loan products to their clients. We have approximately 2,000 mortgage
brokers approved to do business with us, of which approximately 25% have
actually closed loans with Approved during 2001 and 2002.
. Brokers are not contractually bound to Approved and can do business
with other lenders with whom they are approved to do business.
. Brokers do not receive a commission from Approved. They normally are
compensated in the form of a broker fee through a separate agreement
made directly between the broker and the borrower and or origination
fees as they negotiate with the borrower, which are paid at closing.
. Any remuneration paid to the broker by Approved is in accordance with
our wholesale loan rate sheets applicable at that time.
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During 2002, loans originated from wholesale division decreased to $203 million
or 96% of the total loan volume compared to $270 million or 72% in 2001 loan
volume.
In cultivating this broker network, we stress superior service, efficiency,
flexibility and professionalism. Due to concentrated size and
centrally-organized operations, we normally offer one business day turnaround on
underwriting decisions and can close loans in as few as two business days with
appropriate documentation provided to the underwriting and processing
department. A wide variety of loan products have been designed to assist brokers
in supporting a broader spectrum of borrowers. Regional sales managers and
account executives assist mortgage brokers understanding and use of our product
offerings. The loans are primarily underwritten at the headquarter location in
Virginia and to a lesser extent in the regional operation centers in Florida and
California under the supervision of our Chief Credit Officer located in
Virginia.
Retail Loan Originations. During 2002 loans originated from the retail division
totaled $9 million or 4% of total volume, including loans brokered to other
lenders compared to $107 million or 28% during 2001.
Drastic changes occurred in the mortgage industry beginning in the fourth
quarter of 1998, whereby revenues in the form of loan sale premiums received on
whole-loan sales, dropped materially. As a result, over the past four years we
restructured our mortgage loan origination business model and reduced the number
of retail loan origination offices from twenty-six at the end of 1998 to one as
of December 31, 2001 and as of December 31, 2002, which is located in our
corporate headquarters in Virginia Beach, Virginia.
Underwriting Guidelines
We presently offer a broad range of mortgage loan products in order to provide
maximum flexibility to individual borrowers and mortgage brokers. We underwrite
non-conforming, ALT-A, conforming conventional and government mortgage loans.
Underwriting criteria for all mortgage loans originated reflects the lending
criteria of our loan investors.
Loan applications received from retail loan officers and brokers are classified
according to certain characteristics including available collateral, loan size,
debt ratio, loan-to-value ratio and the credit history of the applicant. From
the foundation built on these criteria, loan approvals are priced on a
risk-adjusted basis. Loan applicants with less favorable credit ratings
generally are offered loans with higher interest rates and lower loan-to-value
ratios than applicants with more
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favorable credit ratings. Our underwriting standards are designed to provide a
program for all qualified applicants, in an amount and for a period of time
consistent with each applicant's demonstrated willingness and ability to repay.
Our underwriters make determinations on loans without regard to sex, marital
status, race, color, religion, age or national origin. Each application is
evaluated on its individual merits, applying the guidelines set forth below, to
ensure that each application is considered on an equitable basis.
A current credit report by an independent and nationally recognized credit
reporting agency reflecting the applicant's complete credit history is required.
The credit report discloses instances of adverse credit that were reported on
the applicant's record. Such information might include delinquencies,
repossessions, judgments, foreclosures, bankruptcies and similar instances of
adverse credit that can be discovered by a search of public records. An
applicant's recent credit performance weighs heavily in our evaluation of risk.
A lack of credit history will not necessarily preclude a loan if the borrower
has sufficient equity in the property. Slow payments on the borrower's credit
report must be satisfactorily explained and will normally reduce the amount of
the loan for which the applicant can be approved.
The underwriting department is headquartered in our Virginia Beach, Virginia
office. We have underwriters located in the wholesale operation centers in
Florida and California. Our loan application and approval process generally is
conducted via facsimile submission of the credit application to our
underwriters. An underwriter reviews the applicant's employment history and
financial status as contained in the loan application, current bureau reports
and the real estate property characteristics as presented on the application in
order to determine if the loan is acceptable under our underwriting guidelines.
Based on this review, the underwriter assigns a preliminary rating to the
application. The proposed terms of the loan are then communicated to the retail
loan officer or broker responsible for the application who in turn discusses the
proposal with the loan applicant. When a potential borrower applies for a loan
through our retail division, the underwriter may discuss the proposal directly
with the applicant. We endeavor to respond with preliminary proposed loan terms,
and in most cases do respond, to the broker or borrower within one business day
from when the application is received. If the applicant accepts the proposed
terms, the underwriter will contact the broker or the loan applicant to gather
additional information necessary for the closing and funding of the loan.
All loan applicants must have an appraisal of their collateral property prior to
closing the loan. We require loan officers and brokers to use licensed
appraisers that are listed on or qualify for our approved appraiser list. We
approve appraisers based
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upon a review of sample appraisals, professional experience, education,
membership in related professional organizations, client recommendations, review
of the appraiser's experience with the particular types of properties that
typically secure our loans and based on our investor requirements.
Assessment of the applicant's demonstrated willingness and ability to repay a
loan is one of the principal elements in distinguishing our lending philosophy.
Like other lenders, as part of the loan approval process we utilize "debt
ratios" (calculated as the borrower's monthly expenses for debts including fixed
monthly expenses for housing, taxes and installment debt, as a percentage of
gross monthly income), "loan-to-value ratio" or "LTV" (the gross loan amount
divided by the appraised value of the property), payment history on existing
mortgages, customer's history of bankruptcy, and the combined loan-to-value
ratio for all existing mortgages on a property. We use an applicant's credit
score as an underwriting tool along with these other criteria. We rely upon
experienced mortgage loan underwriters to scrutinize an applicant's credit
profile and to evaluate whether an impaired credit history is a result of
previous adverse circumstances or a continuing inability or unwillingness to
meet credit obligations in a timely manner. Personal circumstances including
divorce, family illnesses or deaths and temporary job loss due to layoffs and
corporate downsizing will often impair an applicant's credit record.
Upon completion of the underwriting and processing functions, the loan is closed
through a closing attorney or agent approved by us. The closing attorney or
agent is responsible for completing the loan transaction in accordance with
applicable law and our operating procedures.
We require title insurance coverage issued by an approved ALT-A title insurance
company of all property securing mortgage loans we originate or purchase. Our
assignees and we are generally named as the insured. Title insurance policies
indicate the lien position of the mortgage loan and protect us against loss if
the title or lien position is not as indicated. The applicant is also required
to secure hazard and, in certain instances, flood insurance in an amount
sufficient to cover the building securing the loan for the entire term of the
loan, for an amount that is at least equal to the outstanding principal balance
of the loan or the maximum limit of coverage available under applicable law,
whichever is less. Evidence of adequate homeowner's insurance, naming us as an
additional insured, is required on all loans.
Non-Conforming Mortgage Loans.
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These guidelines are intended as a general guideline only and are subject to
change at any time based on changes in our investors underwriting guidelines and
economic and market conditions.
We have general internal classifications with respect to the credit profiles of
loans based on certain characteristics of the applicant in conjunction with
other loan characteristics such as the loan-to-value ratio. Credit grade
classifications for non-conforming loans are extremely objective in nature and
vary greatly between lenders.
Our classifications place each loan application into one of three letter ratings
"A" through "C," with sub-ratings within those categories. Ratings are based
upon a number of factors including the applicant's credit history, the loan size
relative to the value of the property and the applicant's employment history and
current status. We also rely on the judgment of our underwriting staff, which
may make exceptions to the general criteria and upgrade a rating due to
compensating factors considered appropriate to the underwriting staff. Customary
for risk-adjusted pricing, terms of loans including interest rate, fees, maximum
loan-to-value ratio and debt service-to-income ratio (calculated by dividing
fixed monthly debt payments by gross monthly income), vary depending upon the
classification of the application. Applicants falling into a lower credit
classification will generally pay higher rates and loan origination fees than
those in higher credit classifications in order to compensate the lender for
assuming greater credit risk.
The credit classification criteria used by the investors to whom we sell our
loans have significant influence on our general loan classifications as set
forth below. The following are subject to adjustments from time to time and the
underwriting staff's judgment of compensating factors that merit exceptions.
"A" Risk. Under the "A" risk category, a loan applicant must have
generally repaid installment or revolving debt according to its terms.
.. Existing mortgage loans: a maximum of two 30-day late payment(s) within the
last 12 months. Non-mortgage credit: minor derogatory items are allowed, but
a letter of explanation is required.
.. Bankruptcy filings: must have been discharged more than two years prior to
closing with credit re-established.
.. Maximum loan-to-value ratio: up to 100% for attached and detached single
family residence or duplex, 95% for a loan secured by a three-to-four family
residence; and 90% for a loan secured by a non-owner occupied single family
residence
16
or duplex and 85% on a loan secured by a three-to-four family residence.
.. Debt service-to-income ratio: 55% or less.
"B" Risk. Under the "B" risk category, a loan applicant must have
generally repaid installment or revolving debt according to its terms.
.. Existing mortgage loans: maximum of one 60-day late payment within the last
12 months. Non-mortgage credit: some prior defaults may have occurred, but
major credit paid or installment debt paid as agreed may offset some
delinquency; any open charge-offs, judgments or liens may be left open at
underwriters discretion unless attached to the property title or child
support related or open tax lien.
.. Bankruptcy filings: must have been discharged more than two years prior to
closing with credit re-established.
.. Maximum loan-to-value ratio: up to 95% for attached and detached single
family residence or duplex, 90% for a loan secured by a three-to-four family
residence; and 80% for a loan secured by a non-owner occupied single family
residence or duplex and 80% on a loan secured by a three-to-four family
residence.
.. Debt service-to-income ratio: 55% or less
"C" Risk. Under the "C" risk category, a loan applicant may have
experienced significant credit problems in the past.
.. Existing mortgage loans: must be brought current from loan proceeds;
applicant is allowed up to 119 days late payment within the last 12 months.
Foreclosures and Notices of Default are not allowed within the last 12
months.
.. Non-mortgage credit: significant prior delinquencies may have occurred.
.. Bankruptcy filings: must have been discharged minimum of 1 year.
.. Maximum loan-to-value ratio: up to 80% for detached single-family residence
or duplex, 80% for a loan secured by a three-to-four family residence;
non-owner occupied loans are eligible up to 70% LTV.
. Debt service-to-income ratio: generally 50% or less.
17
We use the foregoing categories and characteristics only as guidelines. On a
case-by-case basis, the underwriting staff may determine that the prospective
borrower warrants a risk category upgrade, a debt service-to-income ratio
exception, a pricing exception, a loan-to-value exception or an exception from
certain requirements of a particular risk category. An upgrade or exception may
generally be allowed if the application reflects certain compensating factors,
among others: low loan-to-value ratio, stable employment or length of occupancy
at the applicant's current residence. For example, a higher debt ratio may be
acceptable with a lower loan-to-value ratio. An upgrade or exception may also be
allowed if the applicant places a down payment in escrow equal to at least 20%
of the purchase price of the mortgaged property, or if the new loan reduces the
applicant's monthly aggregate debt load. Accordingly, we may classify in a more
favorable risk category certain mortgage loans that, in the absence of such
compensating factors, would satisfy only the criteria of a less favorable risk
category. The foregoing examples of compensating factors are not exclusive. The
underwriting staff has discretion to make exceptions to the criteria and to
upgrade ratings on case-by-case basis.
ALT-A LOANS
Alt A loans may not satisfy certain elements of the agency underwriting
criteria, such as those relating to documentation, employment history, income
verification, loan to value ratios, qualifying ratios, or other compensating
factors. No Doc loans serve a particular niche of borrowers willing to pay a
premium in the form of higher interest rates and provide larger down payments in
return of expedient loan processing by virtue of providing less income and asset
information, as compared to loans underwritten in conformance with Agency
standards.
ALT-A Credit Parameters
Loan amount limits, maximum loan-to-value ratios and loan pricing are guided by
an evaluation of a borrower's credit history and the loan purpose. This
evaluation results in a borrower being classified in a particular credit grade
category, to which lending parameters have been assigned by the Company. In
making this determination, we obtain credit verification from three independent
credit bureaus prior to loan approval. Factors considered in the approval
process include prior consumer credit history, prior mortgage loan payment
histories, collection and charge-off experience, and prior bankruptcies and
foreclosures. We also consider the borrowers credit score under a credit
evaluation methodology developed by Fair, Isaac and Company ("FICO").
18
Conforming Conventional Mortgage Loans. Conforming conventional mortgages are
investment quality loans meeting underwriting criteria as required by financial
institutions such as the Federal National Mortgage Association (Fannie Mae), and
Federal Home Loan Mortgage Corporation (Freddie Mac). Our conventional
underwriting guidelines adhere to general standards set forth by the ultimate
investors for these loans. We are an approved Fannie Mae and Freddie Mac
Seller/Servicer, and have delegated underwriting authority with most of our
investors.
Our underwriting analysis is accomplished with aid of Desktop Underwriter
(Fannie Mae) and Loan Prospector (Freddie Mac). Through the use of these
Automated Underwriting Systems (AUS) upon input of loan data a three-repository
credit report is pulled and a response is received to either approve the loan or
to refer it to a human underwriter for further evaluation. It is the
underwriter's key responsibility to assess the accuracy of the information input
into the AUS and to determine if the value of the collateral is acceptable. The
majority of our offered conventional conforming programs encompass a minimum
credit score of 620. However, any cases that a credit score fall under the
"industry standard" of 620, we send the application to the investor for
approval.
In the event the loan has been referred to a human underwriter for traditional
underwriting, the AUS has recognized that significant layering of risk may be
associated with the application. Our underwriters will closely scrutinize the
findings given by the AUS to determine if erroneous information was reported by
the credit reporting services that may have prohibited an acceptable rating. If
credit has been determined to be acceptable by our underwriters by reviewing a
credit explanation and/or other supporting information, the loan application is
sent to our investor for their approval.
We offer a vast array of conventional expanded criteria and conventional
non-conforming programs, most of which are underwritten through the investor
specific automated underwriting systems. The availability of these programs
varies from time to time and may include, but are not limited to, "Jumbo"
products, high LTV Rate/Term & Cash-out loans, stated income and/or asset loans,
high LTV investor and 2nd home properties and closed end seconds.
Our conforming loan division requires Private Mortgage Insurance on all first
lien programs exceeding an 80% LTV. Our direct-delegated authority can
accomplish the insurance with several mortgage insurance companies, or through
various lender paid insurance options that may include pricing adjustments.
19
Government Mortgage Loans. We offer loans programs established under the Federal
Housing Authority ("FHA") such as Title II first mortgage loans and FHA
subordinate lien loans. We have FHA Direct Endorsement underwriters, allowing
all credit and collateral decisions to be made in-house. We approve FHA loans
which are of investment quality and which meet the requirements of the
Government National Mortgage Association (Ginnie Mae) standards for sale on the
secondary mortgage market. FHA Mortgage Insurance endorsement is obtained
directly by us through direct submission to HUD Area Offices.
The underwriters approve loan applications in direct accordance to established
FHA written standards, but recognize that FHA loans require extensive analysis.
As per FHA's encouragement, the many aspects of a loan must be evaluated before
making an underwriting decision. While a poor credit history is, in and of
itself, sufficient reason to reject a loan application, no minimum credit score
has been established and applicants with tarnished credit histories are given
the opportunity to explain any adverse credit and to present supporting
documentation that may establish that the situation was beyond their control and
may assist an applicant in successfully obtaining an FHA insured mortgage. FHA
establishes certain debt-to-income ratio requirements, however these ratios may
be exceeded if underwriting determines that certain FHA-established compensating
factors exist. Overall, each case tends to be unique and the totality of the
loan package must be evaluated before a credit decision can be rendered.
FHA has approved the use of Fannie Mae's Desktop Underwriter (DU) and Freddie
Mac's Loan Prospector (LP) for evaluating loan applications. We utilize these
AUS tools, but take a firm stance on evaluating the totality of each loan
application not approved through an AUS. We offer owner-occupied fixed and
adjustable rate loans for purchase and for FHA streamline, rate/term, and
cash-out refinances. Non-owner occupied loans are limited to FHA streamline
refinances.
We offer first mortgage loans guaranteed by the Veterans Administration (VA) in
many regions of the country to qualified active duty/retired/reservist military
personnel. All loans are underwritten in strict accordance to VA guidelines and
we perform all submissions for Loan Guaranty. We underwrite VA loans to ensure
conformance to Government National Mortgage Association (Ginnie Mae) standards
in order to facilitate the sale of loans in the secondary mortgage market.
Underwriting standards are similar to that of FHA. DU and LP have been approved
for evaluating VA loan applications, and we follow the same underwriting
practices based on AUS findings as we do for FHA loans. We offer owner-occupied
fixed-rate VA purchase loans, Interest Rate Reduction Refinancing Loans (IRRRL),
and
20
cash-out refinance loans. Non-owner occupied loans are limited to VA IRRRL.
Mortgage Loan Servicing
We conduct mortgage loan servicing and collections for our held for yield
portfolio and on an interim basis until sold for our held for sale loans . All
loans that we service are owned by Approved as either Held for Sale or as Held
for Yield and therefore we do not receive revenue in the form of `loan service
fee - servicing for others'. To date, all loans sold by Approved are sold on a
service-released basis. If in future periods, our business plan changes whereby
Approved retains servicing and or services loans for other institutions our
public disclosures will reflect this change.
The customer service department monitors loans, addresses customer inquiries and
collects current loan payments due from borrowers. The collection department
furnishes reports and enforces the rights of the holder or owner of the loan,
including recovery of delinquent payments, institution of loan foreclosure
proceedings and liquidation of the underlying collateral.
Loan payments are directed to a lock box arrangement that the Bank has with a
large national banking institution. The accounting department is responsible for
posting all payments to the borrower's loan accounts and to the general ledger
system. This provides a "separation" in duties between payments and the
servicing operation personnel whose performance is measured by factors such as
delinquency and loss levels.
We close loans throughout the month. Most of our loans require a first payment
thirty to forty-five days after funding. Accordingly, our servicing portfolio
consists of loans with payments due at varying times each month.
Our collection policy is designed to identify payment problems sufficiently
early to permit us to address delinquency problems quickly and, when necessary,
to act to preserve equity before a property goes to foreclosure. We believe that
these policies, combined with the experience level of our staff and the use of
the independent appraisers and attorneys engaged by us, help to reduce the
incidence of loss on a first or second mortgage loan.
Collection procedures commence upon identification of a past due account by our
servicing system. Five days before the first payment is due on every loan, the
borrower is contacted by telephone to welcome the borrower, to remind the
borrower of the payment date and to answer any questions the borrower may have.
If the first payment due is delinquent, a collector will immediately telephone
to remind the borrower of the payment. Five days after any payment is due, a
written notice of
21
delinquency is sent to the borrower and follow up calls are made. A second
written notice is sent on the fifteenth day after payment is due and our
collectors make follow up calls. During the delinquency period, the collector
will continue to frequently contact the borrower. Our collectors have computer
access to telephone numbers, payment histories, loan information and all past
collection notes. All collection activity, including the date collection letters
were sent and detailed notes on the substance of each collection telephone call,
is entered into a collection history for each account. Notice of our intent to
start foreclosure proceedings, unless a loan is brought current, is sent at
thirty days past due. Further guidance with respect to the collection and
foreclosure process is derived through frequent communication with senior
management.
Our loan servicing software also tracks and maintains homeowners' insurance
information. Expiration reports are generated listing all policies scheduled to
expire within 30 days. When policies lapse, a letter is issued advising the
borrower of the lapse and that we will obtain force-placed insurance at the
borrower's expense. We also have an insurance policy in place that provides
coverage automatically for us in the event an employee fails to obtain
force-placed insurance.
At the time the foreclosure process begins through the time of liquidation of
real estate owned ("REO") the account is handled by the foreclosure and REO
team, which is coordinated by the collection department manager who directs
items to our resources both internal and external as appropriate. A senior
officer approves the major steps in this procedure. There are occasions when
foreclosures and charge-off occurs. Prior to a foreclosure sale, we perform a
foreclosure analysis with respect to the mortgaged property to determine the
value of the mortgaged property and the bid that we will make at the foreclosure
sale. This analysis includes: (i) a current valuation of the property obtained
through a drive-by appraisal conducted by an independent appraiser; (ii) an
estimate of the sales price of the mortgaged property through an analysis of
properties sold or listed in the immediate geographic market (iii) an evaluation
of the amount owed, if any, to a senior mortgagee and for real estate taxes; and
(iv) an analysis of the marketing time, required repairs and other costs, such
as for real estate broker and legal fees, that will be incurred in connection
with the foreclosure sale.
All foreclosures are assigned to outside counsel located in the same state as
the secured property. Bankruptcies filed by borrowers are also assigned to
appropriate local counsel who is required to provide monthly reports on each
loan file.
Currently, our servicing activity is predominantly related to our held for yield
portfolio and interim servicing on loans held for sale. In future periods we may
retain the servicing component
22
when selling our loans or we may provide interim servicing for investors who
acquire the loans and contract us to service the loans on their behalf. In this
event, we would need to enhance our servicing capabilities. If we were to adopt
a securitization loan sale strategy, we may engage one or more companies to
sub-service a portion of the loans securitized.
Marketing
Marketing to Broker Networks. Marketing to wholesale brokers is conducted
through our staff of account executives ("AE") that establish and maintain
relationships with a network of mortgage brokers that use our product offerings
to service the needs of their customers. During the year ended December 31,
2002, loans made through the broker networks amounted to 96% of total
originations or $203 million compared to 72% or $270 million in 2001 and 49% or
$136 million in 2000.
The AE's provide various levels of information, assistance and training to the
mortgage brokers regarding our products and non-traditional prospecting
strategies, and are principally responsible for maintaining our relationships
with our clients. AE's endeavor to increase the volume of loan originations from
brokers located within the geographic territory assigned to them. The AE's and
the their sales managers visit brokers offices and attend trade shows. The AE's
also provide feedback to us relating to the current marketplace relative to
products and pricing offered by competitors and new market entrants, all of
which assist us in refining our programs in order to offer competitive products.
The AE's are primarily compensated with a combination of base salary or
commission draw and commission schedule based on the volume of loans that are
originated as a result of their efforts.
Marketing of Retail Lending Products. We currently market our direct consumer
lending services through a sales staff of loan officers located in Virginia
Beach. During 2001, the number of retail loan origination offices was reduced
from a total of 10 on December 31, 2000 to one as of December 31, 2001. Retail
lending division loan volume amounted to approximately $9 million or 4% of total
originations in 2002 compared to $107 million or 28% of total originations
during the year ended December 31, 2001 and $141 million or 51% in 2000.
The sales staff procures prospective borrowers from leads obtained from market
sources such as Lending Tree, through direct mail campaigns, through local
networking for potential prospects and referrals. In the event that a potential
retail customer's loan application does not fall within our underwriting
guidelines, the underwriter may authorize the application for
23
submission to another lending institution. If the loan is approved and funded,
we act in the capacity of a mortgage broker, receiving fee income ("brokered
loans"). This type of retail loan production allows us to accommodate the
diverse needs of our loan customers while adhering to solid underwriting
standards. Brokered loans as a percent of total retail loan origination
represented approximately 15% during the twelve month period ended December 31,
2002, compared to 16% and 33% for the years 2001 and 2000. respectively.
Competitive Position in the Relevant Market
The primary business of the company is the origination of residential mortgage
loans and attracting the wholesale deposits through the Bank.
Origination activity is conducted throughout the United States and therefore our
competitors and relevant market position varies in different locations. The
United States mortgage market is highly fragmented and we face substantial
competition originating mortgage loans. This competition comes principally from
banks, other savings institutions, mortgage banking companies and other
residential mortgage lenders . Many of our competitors enjoy competitive
advantages including greater financial resources, a wider geographic presence or
more accessible branch office locations, greater name recognition and marketing
budgets to support their sales efforts, the ability to offer additional services
or more favorable loan terms , pricing alternatives , lower origination fees and
operating costs. This competition could result in a decrease in loans originated
by us that could adversely affect our results of operations, and financial
condition.
To successfully address these competitive forces, we focus on solid and
consistent customer service including timely response as to our underwriting
decision upon receipt of loan packages and expediting the loan closing process.
Our wholesale division competes directly with other lenders and our retail
division competes with loan officers representing other financial institutions
and mortgage brokers.
In attracting wholesale deposits, we compete with insured depository
institutions such as savings institutions, credit unions and banks, as well as
institutions offering uninsured investment alternatives including money market
funds. These competitors may offer higher interest rates than we do, which could
result in either our attracting fewer deposits or in our being required to
increase our rates in order to attract deposits. Increased deposit competition
could increase our cost of funds and adversely affect our ability to generate
the funds necessary for our lending operations, thereby adversely affecting our
results of operations and financial condition.
24
Our Sources of Funds and Liquidity
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SUMMARY
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As of December 31: 2002 2001 2000
Warehouse Credit Lines $25 million $22 million $60 million
FHLB credit line $15 million
FDIC Bank Deposits $40 million $62 million $38 million
Subordinated $ 5 million $ 5 million $ 5 million
Stockholder's Equity $ 2 million $ 5 million $ 8 million
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At December 31, 2002, we had combined warehouse lines of credit of $25.0
million, with an outstanding balance of $10.4 million. Additionally, we had
subordinated debt outstanding of $4.6 million; FDIC insured certificates of
deposit outstanding of $37.8 million, FDIC insured money market accounts of $1.8
million and consolidated stockholder's equity of $2.2 million.
In November 2001, the Bank obtained a $7.0 million warehouse line of credit. The
interest charged was based on the one month LIBOR rate and ranges from 4.43% to
5.43% over the one month LIBOR for various loans, additionally rates for aged
outstanding loans ranges from 7.43% to 8.43% over the one month LIBOR rate at
December 31, 2001. All advances were subject to various transactions fees based
upon the number of loans funded. This credit facility required active use of the
line to retain access for use of the line in the future. Administrative
procedures required by the lender were not easily adaptable for use with our
wholesale origination source, which is our primary origination channel and
therefore, we did not use the line and thus allowed the line to terminate in the
first quarter of 2002.
In December 2001 the Bank obtained a $15.0 million repurchase agreement with a
financial institution for funding residential mortgage loans. The agreement has
no stated expiration date, provides for interest at prime plus 1.25% and certain
transaction fees. The line has various financial requirements including a
minimum tangible net worth to exceed $916,000. In June 2002 the line of credit
was increased to $25.0 million. As of December 31, 2002, we were in compliance
with all financial covenants. There is no stated expiration date for this credit
facility.
On July 21, 2000, we obtained a $40.0 million line of credit from Bank United.
However, effective December 29, 2000, we obtained an amendment to the credit
line, which reduced the size of the warehouse facility to $20.0 million. We
terminated this credit line during the third quarter of 2001.
On November 10, 1999, we obtained a $20.0 million sub-prime line
25
of credit and a $20.0 million conforming loan line from the same lender. The
lines of credit expired on November 10, 2001 and were not renewed.
The Bank credit facility with the Federal Home Loan Bank (FHLB), which was for
$15 million with a 50% advance rate terminated effective October 26, 2001. We
understand that this credit facility was terminated by FHLB as a result of their
review conducted during 2001 of changes in our operating and financial
condition.
Bank Sources of Funds
Certificates of Deposits. The Bank had $37.8 million of FDIC insured
certificates of deposits outstanding at December 31, 2002. The Bank had $59.9
million FDIC insured certificates of deposits outstanding at December 31, 2001.
The Bank also had $1.8 million in FDIC insured money market deposits through an
arrangement with a local NYSE member broker/dealer at December 31, 2002. The
bank had $2.2 million in FDIC money market deposits at December 31, 2001.
The primary source of FDIC insured deposits for the Bank are deposits solicited
via a computer bulletin board where the rates of many other banks and
institutions are advertised. At December 31, 2002 and December 31, 2001, the
Bank had deposits from this source of $30.9 million or 78% and $59.9 million or
96% of total deposits, respectively. We also procure FDIC insured certificates
of deposit through national investment banking firms, which, pursuant to
agreements with the Bank, solicit funds from their customers for deposit with
the Bank ("brokered deposits"). Such deposits amounted to $6.9 million or 17%
and $17.2 million, or 28%, of the Bank's deposits at December 31, 2002 and
December 31, 2001, respectively. The fees paid to deposit brokers are amortized
using the interest method and are included in interest expense on certificates
of deposit.
We believe that the Bank's effective cost of brokered and other wholesale
deposits is more attractive than deposits obtained on a retail basis from branch
offices after the general and administrative expense associated with the
maintenance of branch offices is taken into account. Moreover, brokered and
other wholesale deposits generally give the Bank more flexibility than retail
sources of funds in structuring the maturities of its deposits and in matching
liabilities with comparable maturing assets. At December 31, 2002, $37.0 million
of the Bank's certificates of deposit were scheduled to mature within one year
26
(98.0% of total deposits). At December 31, 2001, $40.4 million of the Bank's
certificates of deposit were scheduled to mature within one year (67.5% of total
deposits).
Although we believe that the Bank's brokered and other wholesale deposits are
advantageous in certain respects, such funding sources, when compared to retail
deposits attracted through a branch network, are generally more sensitive to
changes in interest rates and volatility in the capital markets and are more
likely to be compared by the investor to competing instruments. In addition,
such funding sources may be more sensitive to significant changes in the
financial condition of the Bank. There are also various regulatory limitations
on the ability of all but well-capitalized insured financial institutions to
obtain brokered deposits; see "Regulation of the Bank - Brokered Deposits."
These limitations currently are not applicable because the Bank is a
well-capitalized financial institution under applicable laws and regulations.
There can be no assurances, however, that the Bank will not become subject to
such limitations in the future. In addition, our reliance on wholesale deposits
effects our ability to rollover deposits as they mature due to the fact that in
general the wholesale customer is highly interest rate-sensitive. However, we
are of the opinion that we will be able to readily obtain funding from the
wholesale deposit market in future periods at the then current competitive
interest rates being offered by other institutions.
As a result of the Bank's reliance on brokered and other wholesale deposits,
significant changes in the prevailing interest rate environment, in the
availability of alternative investments for individual and institutional
investors or in the Bank's financial condition, among other factors, could
affect the Bank's liquidity and results of operations much more significantly
than might be the case with an institution that obtained a greater portion of
its funds from retail or core deposits attracted through a branch network. (See
page 23 of the audited financial statements for a table that sets forth various
interest rate categories for the certificates of deposit of the Bank.)
Borrowings
Effective October 26, 2001, the credit line for $15,000,000 with the Federal
Home Loan Bank (FHLB), was terminated. We understand that this credit facility
was terminated by FHLB as a result of their review conducted during 2001 of
changes in our operating and financial condition. During the year ended December
31, 2001, the Bank had advances of $71.9 million from the FHLB and paid down
principal on advances of $74.9 million. During the year ended December 31, 2000,
the Bank had advances of $10.4 million from the FHLB and paid down principal on
advances of $12.0 million. The Bank held $1.1 million and $589,000 of the FHLB
27
stock at December 31, 2001 and December 31, 2000, respectively.
In November 2001, the Bank obtained a $7.0 million warehouse line of credit. The
interest charged was based on the one month LIBOR rate and ranges from 4.43% to
5.43% over the one month LIBOR for various loans, additionally rates for aged
outstanding loans ranges from 7.43% to 8.43% over the one month LIBOR rate at
December 31, 2001. All advances were subject to various transactions fees based
upon the number of loans funded. This credit facility required active use of the
line to retain access for use of the line in the future. Administrative
procedures required by the lender were not easily adaptable for use with our
wholesale origination source, which is our primary origination channel and
therefore, we did not use the line and thus allowed the line to terminate in the
first quarter of 2002.
In December 2001 the Bank obtained a $15.0 million repurchase agreement with a
financial institution for funding residential mortgage loans. The agreement has
no stated expiration date, provides for interest at prime plus 1.25% and certain
transaction fees. The line has various financial requirements including a
minimum tangible net worth to exceed $916,000. In June 2002 the line of credit
was increased to $25.0 million. As of December 31, 2002, we were in compliance
with all financial covenants.
Taxation
General. We currently file, and expect to continue to file a consolidated
federal income tax return based on a calendar year. Consolidated returns have
the effect of eliminating inter-company transactions, including dividends, from
the computation of taxable income.
Our income is subject to tax in most of the states in which we make loans. Our
taxable income in most states is determined based on certain apportionment
factors.
Alternative Minimum Tax. In addition to the regular corporate income tax,
corporations, including qualifying institutions, can be subject to an
alternative minimum tax. The 20% tax is computed on Alternative Minimum Taxable
Income ("AMTI") and applies if it exceeds the regular tax liability. AMTI is
equal to regular taxable income with certain adjustments. For taxable years
beginning after 1989, AMTI includes an adjustment for 75% of the excess of
"adjusted current earnings" over regular taxable income. Net operating loss
carry backs and carry forwards are permitted to offset only 90% of AMTI.
Legislation passed in March 2002 allows net operating losses to offset up to
100% of AMTI for tax years 2001 and 2002. Alternative minimum tax paid
28
can be credited against regular tax due in later years. We are not currently
subject to the AMT.
Deferred Tax Asset: Deferred tax asset was decreased during 2002 by means of an
increase in the related valuation allowance. In the first quarter of 2002 a
valuation allowance was recorded based on management's estimates and projections
for the remainder of 2002 at that time. The additional second quarter of 2002
write down of the deferred tax asset by means of an increase in a related
valuation allowance was primarily attributed to a reduction in managements
expectations for loan origination activity for the remainder of 2002, due to the
closure of the California wholesale loan origination division required under
contractual obligations with its prior manager. This reduction in projected loan
volume reduced management's projected financial results.
Tax Refund Benefit 2002. A federal income tax benefit was recorded in 2002 based
on the revised Federal tax law, enacted in 2002, whereby, in 2002 a company that
experiences tax losses can carry the loss back up to five years to obtain a
current tax refund. The anticipated amount of such tax refund from 1997 is
approximately $1,047,000.
Employees
As of December 31, 2002, we had, including our subsidiaries, a total of 76
full-time employees and 1 part-time employee or 76.5 full time equivalent
employees, representing a reduction in excess of 24% from December 31, 2001. The
reduction in staff resulted from attrition, reduction in staff related to
closing the California wholesale operations center in April 2002, expense
reduction initiatives, and implementation of technology. None of our employees
are covered by a collective bargaining agreement. We consider the relations with
our employees to be good.
Service Marks
We have four service marks that have become federally registered. They are
"Armada" which became registered on July 23, 1996, "Approved Residential
Mortgage" which became registered on May 15, 1995, "Approved Financial Corp."
which became registered July 21, 1998 and "ConsumerOne Financial" which became
registered on December 18, 1998.
Effect and Risk of Adverse Economic Conditions
Our business may be adversely affected by periods of economic slowdown or
recession, which may be accompanied by decreased demand for consumer credit and
declining real estate values. Any material decline in real estate values reduces
the ability of
29
borrowers to use home equity to support borrowings and increases the
loan-to-value ratios of loans previously made by us, thereby weakening
collateral coverage and increasing the possibility of a loss in the event of
default. In addition, delinquencies, foreclosures and losses generally increase
during economic slowdowns or recessions.
Risk from Concentration of Operations in Certain States
During 2002, 98% of our loan origination volume was secured by properties in ten
states, Florida, Virginia, North Carolina, Pennsylvania, California, Ohio,
Maryland, Michigan, South Carolina and Georgia. During 2001, 98% of the
aggregate principal balance of the loans we originated are secured by properties
located in ten states California, Virginia, Florida, Maryland, Ohio, North
Carolina, Pennsylvania, New Jersey, Georgia and South Carolina. While we aim to
expand lending initiatives into other states, our origination business is likely
to remain concentrated in a limited number of states in the foreseeable future.
Consequently, our results of operation and financial condition are dependent
upon general trends in the economy and the residential real estate markets in
those states.
Risks Associated with the Securitization Market
While we have no current plans and do not expect to enter into transactions in
the foreseeable future, we are affected by changes in the securitization market
as many of our investors access securitization as a form of financing. While we
have no plans to participate in the Securitization market at this time, if
changes in our capital structure related to regulatory capital ratio
restrictions were to present an opportunity to do so, we may sell a portion of
the loans we originate through a securitization program and retain the rights to
service the loans. The sale of loans through a securitization program would be a
significant departure from our previous business operations.
If such strategy was adopted in the future, adverse changes in the
securitization market could impair our ability to originate and sell loans
through securitization on a favorable or timely basis. Any such impairment could
have a material adverse effect upon our results of operation and financial
condition. Furthermore, our quarterly operating results in future periods may
fluctuate significantly as a result of the timing and level of securitization.
If a securitization does not close when expected, our results of operation may
be adversely affected for that period.
Whether or not we adopt this loan sale strategy in the future, adverse changes
in the securitization market have in the past and could in the future impair our
ability to originate and sell
30
loans to other financial institutions that utilize the securitization market.
Contingent Risks
In the ordinary course of business, we are subject to claims made against us by
borrowers and private investors arising from, among other things, losses that
are claimed to have been incurred as a result of alleged breaches of fiduciary
obligations, misrepresentations, errors and omissions of our employees,
officers, and agents (including our appraisers), incomplete documentation and
failures by us to comply with various laws and regulations applicable to our
business. We are not aware of any material claims.
Our business strategy is to sell all loans that we originate on a whole loan,
service released, non-recourse basis with the exception of our loan investor's
requirements for customary representations and warranties, such as first payment
default and fraud. However, during the period of time from loan funding date to
loan sale date, we are subject to the various business risks associated with
lending, including the risk of borrower default, loan foreclosure and loss, and
the risk that a change in interest rates or a change in the secondary market
conditions for residential mortgage loans would result in a decline in the
market value of our loans.
Risk from Competition
We face intense competition from other mortgage banking companies, banks, credit
unions, thrift institutions, credit card issuers, finance companies and other
financial institution. Many of these competitors in the financial services
business are substantially larger and have more capital and financial resources
than us. Also, the larger national finance companies, banks, quasi-governmental
agencies and other originators of conforming mortgage loans have been adapting
their conforming origination programs to expand into the non-conforming loan
business and are targeting our prime customer base. There can be no assurance
that we will not face increased competition and erosion of operating margins
from such institutions in the future.
Competition can take on many forms, including the speed and convenience in
obtaining a loan, service, loan pricing terms such as the loan to value ratio,
origination fees and interest rate, marketing and distribution channels and
competition for employees through compensation plans and benefit packages.
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The quantity and quality of our competition may also be affected by fluctuations
in interest rates and general economic conditions. During periods of rising
rates, competitors that "locked in" low borrowing costs may have a competitive
advantage. During periods of declining interest rates, competitors may solicit
our borrowers to refinance their mortgage loans. During an economic slowdown or
recession, our borrowers may have new financial difficulties and may be
receptive to offers by our competitors.
We use mortgage brokers as a source of origination of new loans. Our competitors
also seek to establish relationships with the brokers with whom we do business.
Our future results may become more exposed to fluctuations in the volume and
costs of our wholesale loans (loans sourced from mortgage brokers) resulting
from competition from other originators of such loans, market conditions and
other factors.
Regulation
General
The capital stock of approved Financial Corp. ("AFC") is registered under
Section 12(g) of the Securities Exchange Act ("SEC") of 1934, and therefore we
are subject to various reporting and other requirements of the SEC. Our capital
stock is quoted on the OTC Bulletin Board(R) ("OTCBB") and is subject to many of
the provisions of the Sarbanes-Oxley Act of 2002 (the "Act"), including the
certification requirements mandated by Section 302 of the Act. We are required
to remain in compliance with these requirements and must remain current in our
filings, subject to a 30 or 60-day grace period, with the SEC or applicable
regulatory authority, in order to remain eligible for quotation on the OTCBB.
Our business is subject to extensive regulation, supervision and licensing by
federal, state and local government authorities and is subject to various laws
and judicial and administrative decisions imposing requirements and restrictions
on part or all of our operations.
Our consumer lending activities are subject to the federal Truth-in-Lending Act
("TILA") and Regulation Z (including the Home Ownership and Equity Protection
Act of 1994 "HOEPA"); the federal Equal Credit Opportunity Act and Regulation B,
as amended (the "ECOA"); the Home Mortgage Disclosure Act and the Fair Credit
Reporting Act of 1970, as amended ("FCRA"); the federal Real Estate Settlement
Procedures Act ("RESPA") and Regulation X; the federal Home Mortgage Disclosure
Act; and the federal Fair Debt Collection Practices Act. We are also subject to
state statutes and regulations affecting our activities.
32
TILA and Regulation Z promulgated there under contain disclosure requirements
designed to provide consumers with uniform, understandable information with
respect to the terms and conditions of loans and credit transactions in order to
give them the ability to compare credit terms. TILA also guarantees consumers a
three-day right to cancel certain credit transactions including loans of the
type we originate. We believe that we are in compliance with TILA in all
material respects.
Among other things, the Riegle Community Development and Regulatory Improvement
Act of 1994 (the "Riegle Act") made certain amendments to TILA that generally
apply to mortgage loans with (i) total points and fees upon origination in
excess of the greater of eight percent of the loan amount or $465 or (ii) an
annual percentage rate of more than ten percentage points higher than comparable
maturing U.S. Treasury securities. Loans covered by the TILA Amendments are
known as "Section 32 Loans." The TILA Amendments impose additional disclosure
requirements on lenders originating Section 32 Loans and prohibit lenders from
originating Section 32 Loans that are underwritten solely on the basis of the
borrower's home equity without regard to the borrower's ability to repay the
loan. The TILA Amendments also prohibit lenders from including prepayment fee
clauses in Section 32 loans to borrowers with a debt-to-income ratio in excess
of 50%. In addition, a lender that refinances a Section 32 Loan previously made
by such lender will not be able to enforce any prepayment penalty clause
contained in such refinanced loan. We will continue to collect prepayment fees
on loans originated prior to the effectiveness of the TILA Amendments and on
non-Section 32 Loans as well as on Section 32 Loans in permitted circumstances
following the effectiveness of the TILA Amendments. The TILA Amendments impose
other restrictions on Section 32 Loans, including restrictions on balloon
payments and negative amortization features. We stopped funding Section 32 loans
as of April 1, 2001.
We are also required to comply with the Equal Credit Opportunity Act ("ECOA"),
which prohibits creditors from discriminating against applicants on the basis of
race, color, sex, age or marital status. Regulation B promulgated under ECOA
restricts creditors from obtaining certain types of information from loan
applicants. It also requires certain disclosures by the lender regarding
consumer rights and requires lenders to advise applicants of the reasons for any
credit denial. In instances where the applicant is denied credit or the rate or
charge for a loan increase as a result of information obtained from a consumer
credit agency, another statute; the FCRA requires the lender to supply the
applicant with a name and address of the reporting agency. We are also subject
to the Real Estate Settlement Procedures Act and AFC, as a savings and loan
holding company, is
33
required to file an annual report with the OTS pursuant to the Home Mortgage
Disclosure Act.
We are also subject to the rules and regulations of, and examinations by, the
U.S. Department of Housing and Urban Development and state regulatory
authorities with respect to originating, processing, underwriting, selling and
servicing loans. These rules and regulations, among other things, impose
licensing obligations on us, establish eligibility criteria for mortgage loans,
prohibit discrimination, provide for inspections and appraisals of properties,
require credit reports on loan applicants, regulate assessment, collection,
foreclosure and claims handling, investment and interest payments on escrow
balances and payment features, and mandate certain loan amounts.
Failure to comply with these requirements can lead to loss of approved status,
termination or suspension of servicing contracts without compensation to the
Servicer, demands for indemnification or mortgage loan repurchases, certain
rights of rescission for mortgage loans, class action lawsuits and
administrative enforcement actions. There can be no assurance that we will
maintain compliance with these requirements in the future without additional
expenses, or that more restrictive federal, state or local laws, rules and
regulations will not be adopted that would make compliance more difficult for
us. We believe that we are in compliance in all material respects with
applicable federal and state laws and regulations.
Additionally, we are subject to the regulations enforced by, and the reporting
requirements of, the Equal Employment Opportunity Commission ("EEOC"). In
addition, we are subject to various other federal and state laws regulating the
issuance and sale of securities, relationships with entities regulated by the
Employee Retirement Income Security Act of 1974, as amended, and other aspects
of our business.
The laws, rules and regulations applicable to us are subject to regular
modification and change. There are currently proposed various laws, rules and
regulations, which, if adopted, could impact us. There can be no assurance that
these proposed laws, rules and regulations, or other such laws, rules or
regulations, will not be adopted in the future which could make compliance much
more difficult or expensive, restrict our ability to originate, purchase, broker
or sell loans, further limit or restrict the amount of commissions, interest and
other charges earned on loans we originate or sell, or otherwise adversely
affect the business or prospects.
The previously described laws and regulations are subject to legislative,
administrative and judicial interpretation. Some of these laws and regulations
have recently been enacted.
34
Some of these laws and regulations are rarely challenged in or interpreted by
the courts. Infrequent interpretations of these laws and regulations or an
insignificant number of interpretations of recently enacted regulations can make
it difficult for us to know what is permitted conduct under these laws and
regulations. Any ambiguity under the laws and regulations to which we are
subject may lead to regulatory investigations or enforcement actions and private
causes of action, such as class action lawsuits, with respect to our compliance
with the applicable laws and regulations.
Federal and state government agencies have recently begun to consider, and in
some instances have adopted, legislation to restrict lenders' ability to
originate certain non-conforming and subprime loans and to charge rates and fees
in connection with certain non-conforming and subprime residential mortgage
loans made to borrowers with problem credit histories. Such legislation also
imposes various loan term restrictions, e.g., limits on balloon loan features.
Frequently referred to generally as "predatory lending" legislation, such
legislation may limit our ability to impose fees, charge interest rates on
consumer loans to those borrowers with problem credit and may impose new
calculation methodology for loss reserves associated with non-conforming loans
as well as additional regulatory restrictions on the mortgage industry of which
we are a participant.
The Gramm-Leach-Bliley Act, which was signed into law at the end of 1999,
contains comprehensive consumer financial privacy restrictions. The various
federal enforcement agencies, including the Federal Trade Commission, have
issued final regulations to implement this act. These restrictions fall into two
basic categories. First, a financial institution must provide various notices to
consumers about an institution's privacy policies and practices. Second, this
act gives consumers the right to prevent the financial institution from
disclosing non-public personal information about the consumer to non-affiliated
third parties, with exceptions. Further, the Act states that if state law
affords greater consumer protections than federal law in the area of third-party
information sharing, the state law will supersede federal law. We have developed
the appropriate disclosures and internal procedures to assure compliance with
these new requirements.
Although we believe that we have implemented systems and procedures to make sure
that we comply with all regulatory requirements, if more restrictive laws, rules
and regulations are enacted or more restrictive judicial and administrative
interpretations of those laws are issued, compliance with the laws could become
more expensive or difficult for us to operate. Failure to comply with the laws
described above, as well as new legislation affecting us may result in civil and
criminal liability.
35
OTS Regulation
As discussed in Item 7, Management Discussion & Analysis ("MD&A"), the Bank
operates under a Consent Supervisory Agreement with the OTS dated December 3,
2001 ("Agreement").
General. We are a registered unitary savings and loan holding company under the
federal Home Owner's Loan Act ("HOLA") because of our ownership of the Bank. As
such, we are subject to the regulation, supervision and examination of the OTS.
The Bank is a federally chartered bank organized under the HOLA. As such, the
Bank is subject to regulation, supervision and examination by the OTS. The
deposit accounts of the Bank are insured up to applicable limits by the SAIF
administered by the FDIC and, as a result, the Bank also is subject to
regulation, supervision and examination by the FDIC. The Bank is also subject to
the regulations of the Board of Governors of the Federal Reserve System
governing reserves required to be maintained against deposits. The Bank is a
member of the FHLB of Atlanta.
The business and affairs of the Bank are regulated in a variety of ways.
Regulations apply to, among other things, insurance of deposit accounts, capital
ratios, payment of dividends, liquidity requirements, the nature and amount of
the investments that the Bank may make, transactions with affiliates, community
and consumer lending laws, internal policies and controls, reporting by and
examination of the Bank and changes in control of the Bank.
As a savings and loan holding company, the Company is required by federal law to
report with, and otherwise comply with, the rules and regulations of the OTS.
The Bank is subject to extensive regulation, examination and supervision by the
OTS, as its primary federal regulator, and the FDIC, as the deposit insurer. The
Bank is a member of the Federal Home Loan Bank System and, with respect to
deposit insurance, of the Savings Association Insurance Fund ("SAIF") managed by
the FDIC. The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition in addition to obtaining regulatory approvals
prior to entering into certain transactions such as mergers with, or
acquisitions of, other savings institutions and transactions resulting in change
in control as defined by regulations. The OTS and/or the FDIC conduct periodic
examinations to test the Bank's safety and soundness and compliance with various
regulatory requirements. This regulation and supervision establishes a
comprehensive framework of activities in which an institution can engage. The
safety and soundness regulation is intended primarily for the protection of the
insurance fund and depositors. Additionally, regulation and supervision
establishes rules related to lending and banking
36
activities such as but not limited to the loan origination process, marketing to
and solicitation of customers, credit activities, maximum interest rates and
finance and other charges, disclosure to customers, the terms of secured
transactions, the collection, repossession and claims-handling procedures
utilized by us, multiple qualification and licensing requirements for doing
business in various jurisdictions, privacy and protection of consumer
information, and other trade practices.
The regulatory structure also gives the regulatory authorities extensive
discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of
assets and the establishment of adequate loan loss reserves and capital ratios
and operating procedures for regulatory purposes.
Any change in regulatory requirements and policies, whether for all financial or
banking institutions in general or specific regulatory requirements directed to
AFC and the Bank, whether by the OTS, the FDIC or the Congress, could have a
material adverse impact on the Company, the Bank and their operations. Certain
of the regulatory requirements applicable to the Bank and to the AFC are
referred below or elsewhere herein. The description and discussion of statutory
provisions and regulations applicable to savings institutions and their holding
companies set forth in this Form 10-K is not intended to constitute a complete
statement of all the legal restrictions and requirements applicable to us and
the Bank and the effects of such on AFC and the Bank. All such descriptions are
qualified in their entirety by reference to applicable statutes, regulations and
other regulatory pronouncements. (See also: "Regulatory Capital Requirements")
Insurance of Accounts. Deposit accounts of the Bank up to $100,000 are insured
by the Savings Association Insurance Fund (the "SAIF"), administered by the
FDIC. Pursuant to legislation enacted in September 1996, a fee was paid by all
SAIF insured institutions at the rate of $0.657 per $100 of deposits held by
such institutions at March 31, 1995. The money collected capitalized the SAIF
reserve to the level of 1.25% of insured deposits as required by law. In 1996,
the Bank paid $23,000 for this assessment.
This legislation also provided for the merger, subject to certain conditions, of
the SAIF into the Bank Insurance Fund ("BIF") by 1999. The BIF/SAIF legislation
provided for a merger of BIF and SAIF on January 1, 1999, but only if no insured
institution was an association. Associations would have had to change charters
in order to achieve a merger of the two insurance funds. This provision has now
expired. Though the statutory date for a funds merger has passed, the Congress
could, at any time, without condition, permit FDIC to merge the funds.
37
The legislation also required BIF-insured institutions to share in the payment
of interest on the bonds issued by a specially created government entity
("FICO"), the proceeds of which were applied toward resolution of the thrift
industry crisis in the 1980s. Beginning on January 1, 1997, in addition to the
insurance premium that is paid by SAIF-insured institutions to maintain the SAIF
reserve at its required level pursuant to the current risk classification
system, SAIF-insured institutions paid deposit insurance premiums at the annual
rate of 6.4 basis points of their insured deposits and BIF-insured institutions
paid deposit insurance premiums at the annual rate of 1.3 basis points of their
insured deposits towards the payment of interest on the FICO bonds. Assessments
paid for the period starting January 1, 2000 are assessed the same FICO rate for
both BIF and SAIF insured deposits. The new rate paid by the Bank and a BIF
insured institution with the same risk classification is 1.7 basis points.
Under the current risk classification system, institutions are assigned on one
of three capital groups which are based solely on the level of an institution's
capital - "well capitalized," "adequately capitalized" and "undercapitalized" -
which are defined in the same manner as the regulations establishing the prompt
corrective action system under Section 38 of the FDIA, as discussed below. These
three groups are then divided into three subgroups, which are based on
supervisory evaluations by the institution's primary federal regulator,
resulting in nine assessment classifications. Assessment rates currently range
from zero basis points for well-capitalized, healthy institutions to 27 basis
points for undercapitalized institutions with substantial supervisory concerns.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. We are not aware of any existing circumstances, which would result in
termination of the Bank's deposit insurance.
Regulatory Capital Requirements. Federally insured savings associations are
required to maintain minimum levels of regulatory capital. These standards
generally must be as stringent as the comparable capital requirements imposed on
national banks. The OTS also is authorized to impose capital requirements in
excess of these standards on individual
38
associations on a case-by-case basis. At December 31, 2002, the Bank's
regulatory capital exceeded the OTS definition for "well-capitalized."
Federally insured savings associations are subject to three capital
requirements: a tangible capital requirement, a core or leverage capital
requirement and a risk-based capital requirement. All savings associations
currently are required to maintain tangible capital of at least 1.5% of adjusted
total assets (as defined in the regulations), core capital equal to 3% of
adjusted total assets and total capital (a combination of core and supplementary
capital) equal to 8% of risk-weighted assets (as defined in the regulations).
See table on page 91 for the Bank's capital position at December 31, 2002.
For purposes of the regulation, tangible capital is core capital less all
intangibles other than qualifying purchased mortgage-servicing rights, of which
the Bank had none at December 31, 2002. Core capital includes common
stockholders' equity, non-cumulative perpetual preferred stock and related
surplus; minority interest in the equity accounts of fully consolidated
subsidiaries and certain non-withdrawlable accounts and pledged deposits. Core
capital generally is reduced by the amount of a savings association's intangible
assets, other than qualifying mortgage-servicing rights.
A savings association is allowed to include both core capital and supplementary
capital in the calculation of its total capital for purposes of the risk-based
capital requirements, provided that the amount of supplementary capital included
does not exceed the savings association's core capital. Supplementary capital
consists of certain capital instruments that do not qualify as core capital,
including subordinated debt, which meets specified requirements, and general
allowance for loan and lease loss up to a maximum of 1.25% of risk-weighted
assets. In determining the required amount of risk-based capital, total assets,
including certain off-balance sheet items, are multiplied by a risk weight based
on the risks inherent in the type of assets. The risk weights assigned by the
OTS for principal categories of assets currently range from 0% to 100%,
depending on the type of asset.
OTS policy imposes a limitation on the amount of net deferred tax assets under
SFAS No. 109 that may be included in regulatory capital. (Net deferred tax
assets represent deferred tax assets, reduced by any valuation allowances, in
excess of deferred tax liabilities.) Application of the limit depends on the
possible sources of taxable income available to an institution to realize
deferred tax assets. Deferred tax assets that can be realized from the following
are generally not limited: taxes paid in prior carry back years and future
reversals of existing taxable temporary differences. To the extent that the
realization of deferred tax assets depends on an institution's future taxable
39
income (exclusive of reversing temporary differences and carry forwards), or its
tax-planning strategies, such deferred tax assets are limited for regulatory
capital purposes to the lesser of the amount that can be realized within one
year of the quarter-end report date or 10% of core capital. The deferred tax
asset is fully reserved at December 31, 2002.
In August 1993, the OTS adopted a final rule incorporating an interest-rate risk
component into the risk-based capital regulation. Under the rule, an institution
with a greater than "normal" level of interest rate risk will be subject to a
deduction of its inherent rate risk component from total capital for purposes of
calculating the risk-based capital requirement. As a result, such an institution
will be required to maintain additional capital in order to comply with the
risk-based capital requirement.
Under the OTS policy, only associations rated composite 1 under the CAMEL rating
system will be permitted to operate at the regulatory minimum core capital ratio
of 3%. For all other associations, the minimum core capital ratio is 4%.
However, on a case by case basis the OTS will determine an amount of additional
core capital that an institution must maintain by assessing both the quality of
risk management systems and the level of overall risk in each individual
association through the supervisory process.
Prompt Corrective Action. Federal law provides the federal banking regulators
with broad power to take "prompt corrective action" to resolve the problems of
undercapitalized institutions. The extent of the regulators' powers depends on
whether the institution in question is "well capitalized," "adequately
capitalized," "under-capitalized," "significantly undercapitalized" or
"critically undercapitalized." Under regulations adopted by the federal banking
regulators, an institution shall be deemed to be (i) "well capitalized" if it
has a total risk-based capital ratio of 10.0% or more, has a Tier I risk-based
capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or
more and is not subject to specified requirements to meet and maintain a
specific capital level for any capital measure; (ii) "adequately capitalized" if
it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based
capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or
more (3.0% under certain circumstances) and does not meet the definition of
"well capitalized," (iii) "undercapitalized" if it has a total risk-based
capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is
less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0%
under certain circumstances), (iv) "significantly undercapitalized" if it has a
total risk-based capital ratio that is less than 6.0%, a Tier I risk-based
capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is
less than
40
3.0%, and (v) "critically undercapitalized" if it has a ratio of tangible equity
to adjusted total assets that is equal to or less than 2.0%. The regulations
also permit the appropriate federal banking regulator to downgrade an
institution to the next lower category (provided that a significantly
undercapitalized institution may not be downgraded to critically
undercapitalized) if the regulator determines (i) after notice and opportunity
for hearing or response, that the institution is an unsafe or unsound condition
or (ii) that the institution has received (and not corrected) a
less-than-satisfactory rating for any of the categories of asset quality,
management, earnings or liquidity in its most recent exam. At December 31, 2002,
the Bank was "well capitalized", as defined under the prompt corrective action
regulations of the OTS.
Depending upon the capital category to which an institution is assigned, the
regulators' corrective powers, many of which are mandatory in certain
circumstances, include prohibition on capital distributions; prohibition on
payment of management fees to controlling persons; requiring the submission of a
capital restoration plan; placing limits on asset growth; limiting acquisitions,
branching or new lines of business; requiring the institution to issue
additional capital stock (including additional voting stock) or to be acquired;
restricting transactions with affiliates; restricting the interest rates that
the institution may pay on deposits; ordering a new election of directors of the
institution; requiring that senior executive officers or directors be dismissed;
prohibiting the institution from accepting deposits from correspondent banks;
requiring the institution to divest certain subsidiaries; prohibiting the
payment of principal or interest on subordinated debt; and, ultimately,
appointing a receiver for the institution.
Qualified Thrift Lender Test. All associations are required to meet the QTL test
set forth in the HOLA and regulations to avoid certain restrictions on their
operations. An association that does not meet the QTL test set forth in the HOLA
and implementing regulations must either convert to a bank charter or comply
with the following restrictions on its operations: (i) the association may not
engage in any new activity or make any new investment, directly or indirectly,
unless such activity or investment is permissible for a national bank; (ii) the
branching powers of the association shall be restricted to those of a national
bank; (iii) the association shall not be eligible to obtain any advances from
its FHLB; and (iv) payment of dividends by the association shall be subject to
the rules regarding payment of dividends by a national bank. Upon the expiration
of three years from the date the association ceases to be a QTL, it must cease
any activity and not retain any investment not permissible for a national bank
and immediately repay any outstanding FHLB advances (subject to safety and
soundness considerations). The Bank met the QTL test throughout 2002.
41
Restrictions on Capital Distributions. The OTS has promulgated a regulation
governing capital distributions by associations, which include cash dividends,
stock redemption's or repurchases, cash-out mergers, interest payments on
certain convertible debt and other transactions charged to the capital account
of association as a capital distribution. Generally, the regulation creates
three tiers of associations based on regulatory capital, with the top two tiers
providing a safe harbor for specified levels of capital distributions from
associations so long as such associations notify the OTS and receive no
objection to the distribution from the OTS. Associations that do not qualify for
the safe harbor provided for the top two tiers of associations are required to
obtain prior OTS approval before making any capital distributions.
Tier 1 associations may make the highest amount of capital distributions, and
are defined as associations that before and after the proposed distribution meet
or exceed their fully phased-in regulatory capital requirements. Tier 1
associations may make capital distributions during any calendar year equal to
the greater of (i) 100% of net income for the calendar year-to-date plus 50% of
its "surplus capital ratio" at the beginning of the calendar year and (ii) 75%
of its net income over the most recent four-quarter period. The "surplus capital
ratio" is defined to mean the percentage by which the association's ratio of
total capital to assets exceeds the ratio of its "fully phased-in capital
requirement" to assets, and "fully phased-in capital requirement" is defined to
mean an association's capital requirement under the statutory and regulatory
standards applicable on December 31, 1994, as modified to reflect any applicable
individual minimum capital requirement imposed upon the association.
On April 1, 1999 the OTS adopted regulations changing the notification
requirements on capital distributions. The updated regulation provides that an
OTS-regulated institution will not have to file a capital distribution notice
with the OTS upon meeting certain conditions. These conditions include that the
institution has a composite 1 or 2 CAMELS rating; a compliance rating of 1 or 2;
a Community Reinvestment Act rating of at least "satisfactory"; is not otherwise
in troubled condition; limits capital distribution plans for the calendar year
to no more than the sum of it's current retained net income and the preceding
two years; remains well-capitalized after the capital distribution; and will not
use the proposed capital distribution to reduce or retire stock or debt
instruments. An institution that fails to meet any of the required conditions
must submit a full application to the OTS. The OTS imposed restrictions for the
Bank paying dividends to AFC by means of the Directive Letter dated April 20,
2001 and the Consent Supervisory Agreement dated December 2001. (See also: "Bank
Regulatory Actions")
42
Loan-to-One Borrower. Under applicable laws and regulations the amount of loans
and extensions of credit which may be extended by an institution such as the
Bank to any one borrower, including related entities, generally may not exceed
the greater of $500,000 or 15% of the unimpaired capital and unimpaired surplus
of the institution. Loans in an amount equal to an additional 10% of unimpaired
capital and unimpaired surplus also may be made to a borrower if the loans are
fully secured by readily available marketable securities. An institution's
"unimpaired capital and unimpaired surplus" includes, among other things, the
amount of its core capital and supplementary capital included in its total
capital under OTS regulations.
At December 31, 2002, the Bank's unimpaired capital and surplus amounted to
$5,206,000 resulting in a general loans-to-one borrower limitation of $781,000
under applicable laws and regulations. At December 31, 2001, the Bank's
unimpaired capital and surplus amounted to $7,348,000 resulting in a general
loans-to-one borrower limitation of $1,155,000.
Brokered Deposits. Under applicable laws and regulations, an insured depository
institution may be restricted in obtaining, directly or indirectly, funds by or
through any "deposit broker," as defined, for deposit into one or more deposit
accounts at the institution. The term "deposit broker" generally includes any
person engaged in the business of placing deposits, or facilitating the
placement of deposits, of third parties with insured depository institutions or
the business of placing deposits with insured depository institutions for the
purpose of selling interest in those deposits to third parties. In addition, the
term "deposit broker" includes any insured depository institution, and any
employee of any insured depository institution, which engages, directly or
indirectly, in the solicitation of deposits by offering rates of interest (with
respect to such deposits) which are significantly higher than the prevailing
rates of interest on deposits offered by other insured depository institutions
having the same type of charter in such depository institution's normal market
area. As a result of the definition of "deposit broker," all of the Bank's
brokered deposits, as well as possibly its deposits obtained through customers
of regional and local investment banking firms and the deposits obtained from
the Bank's direct solicitation efforts of institutional investors and high net
worth individuals, are potentially subject to the restrictions described below.
Under FDIC regulations, well-capitalized institutions are subject to no brokered
deposit limitations, while adequately-capitalized institutions are able to
accept, renew or roll over brokered deposits only (i) with a waiver from the
FDIC and (ii) subject to the limitation that they do not pay an effective yield
on any such deposit which exceeds by more than (a) 75 basis points the
43
effective yield paid on deposits of comparable size and maturity in such
institution's normal market area for deposits accepted in its normal market area
or (b) by 120% for retail deposits and 130% for wholesale deposits,
respectively, of the current yield on comparable maturity U.S. Treasury
obligations for deposits accepted outside the institution's normal market area.
Undercapitalized institutions are not permitted to accept brokered deposits and
may not solicit deposits by offering any effective yield that exceeds by more
than 75 basis points, the prevailing effective yields on insured deposits of
comparable maturity in the institution's normal market area or in the market
area in which such deposits are being solicited.
Liquidity Requirements. All savings associations are required to maintain an
average daily balance of liquid assets, which include specified short-term
assets and certain long-term assets, equal to a certain percentage of the sum of
its average daily balance of net deposit accounts and borrowings payable in one
year or less, which can be withdrawn. The liquidity requirement may vary from
time to time (between 3% and 10%) depending upon economic conditions and flows
of all savings associations. At the present time, the required liquid asset
ratio is 4%. Historically, the Bank has operated in compliance with these
requirements.
Affiliate Transactions. Under Sections 23A and 23B of the Federal Reserve Act
and applicable regulations, transactions between a savings association and its
affiliates are subject to quantitative and qualitative restrictions. Affiliates
of a savings association include, among other entities, companies that control,
are controlled by or are under common control with the association. As a result,
we and our non-bank subsidiaries are affiliates of the Bank.
Savings associations are restricted in their ability to engage in "covered
transactions" with their affiliates. The term "covered transactions" includes
the making of loans, purchase of assets, issuance of a guaranty and similar
other types of transactions between a savings institution and affiliates. The
aggregate amount of covered transactions with any individual affiliate is
limited to 10% of the capital and surplus of the savings institution. The
aggregate amount of covered transactions with all affiliates is limited to 20%
of the savings institution's capital and surplus. Certain transactions with
affiliates are required to be secured by collateral in the amount and of a type
described in federal law. The purchase of low quality assets from affiliates is
generally prohibited. In addition, covered transactions between a savings
association and an affiliate, as well as certain other transactions with or
benefiting an affiliate, must be on terms and conditions at least as favorable
to the association as those prevailing at the time for comparable transactions
with non-affiliated companies. Associations are
44
required to make and retain detailed records of transactions with affiliates.
Notwithstanding the foregoing, a savings association is not permitted to make a
loan or extension of credit to any affiliate unless the affiliate is engaged
only in activities the Federal Reserve Board has determined to be permissible
for bank holding companies. Savings associations also are prohibited from
purchasing or investing in securities issued by an affiliate, other than shares
of a subsidiary of the savings association.
Savings associations are also subject to various limitations and reporting
requirements on loans to insiders. These limitations require, among other
things, that all loans or extensions of credit to insiders (generally executive
officers, directors or 10% stockholders of the institution) or their "related
interest" be made on substantially the same terms (including interest rates and
collateral) as, and follow credit underwriting procedures that are not less
stringent than, those prevailing for comparable transactions with the general
public and not involve more than the normal risk of repayment or present other
unfavorable features.
Restrictions on Acquisitions. Except under limited circumstances, savings and
loan holding companies are prohibited from acquiring, without prior approval of
the Director of the OTS, (i) control of any other savings association or savings
and loan holding company or substantially all the assets thereof or (ii) more
than 5% of the voting shares of a savings association or holding company thereof
which is not a subsidiary. Except with the prior approval of the Director of the
OTS, no director or officer of a savings and loan holding company or person
owning or controlling by proxy or otherwise more than 25% of such company's
stock, may acquire control of any savings association, other than a subsidiary
savings association, or of any other savings and loan holding company.
Community Investment and Consumer Protection Laws. In connection with its
lending activities, the Bank is subject to the same federal and state laws
applicable to us in general, laws designed to protect borrowers and promote
lending to various sectors of the economy and population. In addition, the Bank
is subject to the federal Community Reinvestment Act ("CRA"). The CRA requires
each bank or association to identify the communities it serves and the types of
credit or other financial services the bank or association is prepared to extend
to those communities. The CRA also requires the OTS to assess an association's
record of helping to meet the credit needs of its community and to take the
assessment into consideration when evaluating applications for mergers,
applications and other transactions. The OTS may assign a rating of
"outstanding," "satisfactory," "needs to improve," or
45
"substantial noncompliance." A less than satisfactory CRA rating may be the
basis for denying such applications.
Under the CRA and implementing OTS regulations, an association has a continuing
and affirmative obligation to help meet the credit needs of its local
communities, including low- and moderate-income neighborhoods, consistent with
the safe and sound operation of the institution. The CRA requires the OTS, in
connection with its examination of an institution, to assess the institution's
record of meeting the credit needs of its community and to take such record into
account in its evaluation of applications by such institution. OTS will assign a
CRA rating based on a Lending Test, Investment Test and Service Test keyed to,
respectively, the number of loans, the number of investments, and the level of
availability of retail banking services in an association's assessment area. The
Lending Test will be the primary component of the assigned composite rating. An
"outstanding" rating on the Lending Test automatically will result in at least a
"satisfactory" rating in the composite, but an institution cannot receive a
"satisfactory" or better rating on the composite if it does not receive at least
a "low satisfactory" rating on the Lending Test. Alternatively, an association
may elect to be assessed by complying with a strategic plan approved by the OTS.
The CRA requires public disclosure of an institution's CRA rating. The latest
CRA rating of the Bank as of July 2002 received from the OTS was "Satisfactory."
Safety and Soundness. Other regulations which were recently adopted or are
currently proposed to be adopted pursuant to recent legislation include but are
not limited to: (i) real estate lending standards for insured institutions,
which provide guidelines concerning loan-to-value ratios for various types of
real estate loans; (ii) revisions to the risk-based capital rules to account for
interest rate risk, concentration of credit risk and the risks posed by
"non-traditional activities;" (iii) rules requiring depository institutions to
develop and implement internal procedures to evaluate and control credit and
settlement exposure to their correspondent banks; and (iv) rules addressing
various "safety and soundness" issues, including operations and managerial
standards, standards for asset quality, earnings and stock valuations, and
compensation standards for the officers, directors, employees and principal
stockholders of the insured institution.
OTS Guidance on Subprime Lending
On February 2, 2001, the OTS issued CEO memorandum #137, regarding "Expanded
Guidance for Subprime Lending Programs". The memorandum provides more specific
definitions of the term `subprime' but focuses on the adequacy of allowances for
loan
46
losses and capital to support subprime lending programs. The guidance applies
specifically to institutions with a significant subprime credit exposure by
establishing a threshold of 25% or more of an institution's Tier I regulatory
capital as the starting point for greater supervisory scrutiny. A key underlying
principle in the guidance is that each subprime lender is responsible for
quantifying the additional risks in its subprime lending activities and
determining the appropriate amounts of ALLL and capital it needs to offset those
risks. The capital adequacy analysis should include a stress test of an
institution's subprime loan pools to project performance over varying economic
business and market conditions. The institution is expected to fully document
its methodology and analysis. Regulatory Examiners are directed to evaluate the
capital adequacy of subprime lenders on a case-by-case basis, and encouraged to
use judgment in determining the appropriate level of capital needed to support
subprime lending activities. It notes that some subprime loans may be only
marginally more risky than prime loans and, thus, may warrant increased
supervisory scrutiny and monitoring, but not necessarily additional capital. For
instance, well-secured mortgage loans to individuals who experienced minor
credit difficulties in the past may have no more credit risk than similar prime
loans, provided adequate controls are in place. The term "subprime" refers to
the credit characteristics of individual borrowers in the CEO Memorandum #137
and states that these borrowers typically have weakened credit histories that
include payment delinquencies, and possibly more severe problems such as
charge-offs, judgments, and bankruptcies. It also states that these borrowers
may also display reduced repayment capacity as measured by credit scores,
debt-to-income ratios, or other criteria that may encompass borrowers with
incomplete credit histories and lists several general illustrative types of
credit risk parameters for consideration in determining a loan to be subprime,
one of which is a credit bureau risk score (FICO) of 660 or below. During the
year ended December 31, 2002, our internal credit classification system
identified 97% of our total loans funded in house as non-conforming or subprime
and the weighted average FICO credit score for these loans was 667. We feel that
we have instituted adequate controls, capital and reserves to support our
subprime lending activity at this time. The ultimate interpretation of this
memorandum on a case-by-case basis by OTS examiners and therefore the ultimate
effect on the Bank is uncertain at this time. "Subprime" definitions vary
significantly by regulators and lenders alike.
Legislative Risk (See: "Regulation" and "OTS Regulation of Approved Financial
Corp.")
Members of Congress and government officials from time to time have suggested
the elimination of the mortgage interest deduction for federal income tax
purposes, either entirely or in part,
47
based on borrower income, type of loan or principal amount. Because many of our
loans are made to borrowers for the purpose of consolidating consumer debt or
financing other consumer needs, the competitive advantages of tax-deductible
interest, when compared with alternative sources of financing, could be
eliminated or seriously impaired by such government action. Accordingly, the
reduction or elimination of these tax benefits could have a material adverse
effect on the demand for loans of the kind offered by us.
Federal Home Loan Bank System. The Bank is a member of the FHLB of Atlanta,
which is one of 12 regional FHLBs that administers the home financing credit
function of savings associations. Each FHLB serves as a reserve or central bank
for its members within its assigned region. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System. It makes
loans to members (i.e., advances) in accordance with policies and procedures
established by the Board of Directors of the FHLB.
As a member, the Bank is required to purchase and maintain stock in the FHLB in
an amount at least equal to 1% of its aggregate unpaid residential mortgage
loans, home purchase contracts or similar obligations, 3/10 of 1% of total
assets at the end of the calendar year, or 5% of its advances from the FHLB,
whichever is greater. At December 31, 2002, the Bank had $816,000 in FHLB stock,
which was in compliance with this requirement.
Enforcement. The OTS has primary enforcement responsibility over savings
institutions and has the authority to bring actions against the institutions and
all institutions-affiliated parties who knowingly or recklessly participate in
wrongful actions likely to have an adverse effect on an insured institution.
Formal enforcement action may range for the issuance of a capital directive or
cease and desist order to removal of officers and/or directors to institution of
receivership, conservatorship or termination of deposit insurance. The FDIC has
the authority to recommend to the Director of the OTS that enforcement action is
taken with respect to a particular savings institution. If the Director does not
take action, the FDIC has authority to take such action under certain
circumstances. Federal law also establishes civil and criminal penalties for
certain violations.
Environmental Risk Factors
To date, we have not been required to perform any investigation or clean up
activities, nor have we been subject to any environmental claims. There can be
no assurance, however, that this will remain the case in the future. In the
ordinary course of our business, we from time to time foreclose on properties
securing loans. Although we primarily lend to owners of
48
residential properties, there is a risk that we could be required to investigate
and clean up hazardous or toxic substances or chemical releases at such
properties after acquisition by us, and could be held liable to a governmental
entity or to third parties for property damage, personal injury, and
investigation and cleanup costs incurred by such parties in connection with the
contamination. The costs of investigation, correction of or removal of such
substances may be substantial, and the presence of such substances, or the
failure to properly correct such property, may adversely affect the owner's
ability to sell or rent such property or to borrow using such property as
collateral. Persons who arrange for the disposal or treatment of hazardous or
toxic substances also may be liable for the costs of removal or correction of
such substances at the disposal or treatment facility, whether or not the
facility is owned or operated by such person. In addition, the owner or former
owners of a contaminated site may be subject to common law claims by third
parties based on damages and costs resulting from environmental contamination
emanating from such property.
In the course of our business, we may acquire properties as a result of
foreclosure. There is a risk that hazardous or toxic waste could be found on
such properties. In such event, we could be held responsible for the cost of
cleaning up or removing such waste, and such cost could exceed the value of the
underlying properties.
Dependence on Key Personnel
Our growth and development since 1984 has been largely dependent upon the
services of Allen D. Wykle, Chairman of the Board, President and Chief Executive
Officer. The loss of Mr. Wykle's services for any reason could have a material
adverse effect on us.
Control by Certain Shareholders
As of December 31, 2002, Allen D. Wykle, Chairman of the Board, President and
Chief Executive Officer and Leon H. Perlin, Director, beneficially own an
aggregate of 50.2% of the outstanding shares of Common Stock of Approved
Financial Corp. Accordingly, a risk factor exists in the fact that if they were
to act in concert, they would have voting control with the ability to approve
certain fundamental corporate transactions and the election of the entire Board
of Directors.
49
ITEM 2 - PROPERTIES
Our executive and administrative offices are located at 1716 Corporate Landing
Parkway, Virginia Beach, Virginia, 23454. We purchased and moved to this
location on December 6, 1999. The building consists of approximately 30,985
square feet.
Our former headquarters building was sold during the year ended December 31,
2001. Our present building location was subject to total mortgage debt of
$1,679,000 as of December 31, 2002. The current and former headquarter buildings
were subject to total mortgage debt of $1,745,000 as of December 31, 2001.
As of December 31, 2002 we had leases for two active regional wholesale lending
operations centers, various closed retail lending offices, and the `disaster hot
site' location for the Bank. These facilities are leased under terms that vary
as to duration and in general the leases expire between 2003 and 2004, and
provide rent escalations tied to either increases in the operating expenses of
the lessor or fluctuations in the consumer price index in the relevant
geographic area. Lease expense was $501,000, 587,000, and $755,000 in 2002, 2001
and 2000, respectively.
Total minimum lease payments under non-cancelable operating leases with
remaining terms in excess of one year as of December 31, 2002 were as follows
(in thousands):
2003 $ 331
2004 156
2005 36
----------------
Total $ 523
================
We anticipate that in the normal course of business we will lease additional
office space as we open new locations or assume leases associated with any
future acquisitions or strategic alliances.
50
ITEM 3 - LEGAL PROCEEDINGS
We are a party to various routine legal proceedings arising out of the ordinary
course of our business. We believe that none of these open actions, individually
or in the aggregate, will have a material adverse effect on our results of
operations or financial condition.
As previously disclosed on Form 8K, in February 2003, AFC and the Bank, settled
a lawsuit in the case of Epstein vs. Approved Financial Corp., Approved Federal
Savings Bank, et al. The case was filed in the U.S. District Court for the
Eastern District of Virginia wherein Plaintiff alleged, among other things,
breach of contract, wrongful termination of employment, fraud and civil
conspiracy against Approved Federal Savings Bank, the Company and certain
current and prior officers and directors (the "Defendants"). The Defendants
filed a counterclaim alleging breach of fiduciary duty. The parties entered a
settlement agreement by which, without the admission of any liability, the
Plaintiff was paid $1,250,000, a portion of which was paid by insurance. A final
net settlement expense of approximately $800,000 was recorded in the fourth
quarter of 2002. The claim and counterclaim were thereafter dismissed with
prejudice.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS
None.
51
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
Market Price of and Cash Dividends on the Common Equity
The following table shows the quarterly high, low and closing prices of the
common stock of Approved Financial Corp. for 2002, 2001, and 2000.
Stock Prices
High Low Close
2002:
Fourth Quarter $ .17 $ .12 $ .12
Third Quarter .20 .14 .17
Second Quarter .30 .15 .15
First Quarter .35 .13 .25
2001:
Fourth Quarter $ .50 $ .21 $ .21
Third Quarter .47 .25 .35
Second Quarter .60 .30 .30
First Quarter .50 .40 .47
2000:
Fourth Quarter $ .69 $ 0.31 $ 0.31
Third Quarter 1.00 0.53 0.69
Second Quarter 1.19 1.00 1.00
First Quarter 2.25 .69 1.13
We did not pay any cash dividends on our Common Stock in 2002, 2001, and 2000.
We intend to retain all of our earnings to finance our operations and do not
anticipate paying cash dividends for the foreseeable future. Any decision made
by the Board of Directors to declare dividends in the future will depend on our
future earnings, regulatory restrictions and capital requirements, financial
condition and other factors deemed relevant by the Board.
52
Absence of Active Public Trading Market and Volatility of Stock Price
Our capital stock is quoted on the OTC Bulletin Board(R) ("OTCBB") under the
symbol "APFN." and is subject to many of the provisions of the Sarbanes-Oxley
Act of 2002 (the "Act"), including the certification requirements mandated by
Section 302 of the Act. We are required to remain in compliance with these
requirements and must remain current in our filings, subject to a 30 or 60 day
grace period, with the SEC or applicable regulatory authority, in order to
remain eligible for quotation on the OTCBB.
There has been a limited market for the Common Stock. As a result, the prices
reported for the Common Stock reflect the relative lack of liquidity and may not
be reliable indicators of valuation. There can be no assurance that an active
public trading market for the Common Stock will be created in the future. In the
event that we enter into a transaction to enhance our capital base, as described
under "Business Strategy" section, the transaction structure may result in
further restriction or elimination of the liquidity for our stock.
The market price of the Common Stock may experience fluctuations as a result of
investor's analysis of our past and present financial position and operating
performance and or investor's estimate of such for future periods. The market
price for our common stock may also fluctuate for reasons unrelated to our
operating performance. In particular, the price of the Common Stock may be
affected by general market price movements as well as developments specifically
related to the financial services industry such as, among other things, interest
rate movements, loan delinquencies, loan prepayment speeds, interest-only,
residual and servicing asset valuations, sources of liquidity to the industry
participants and profit or loss trends.
Transfer Agent and Registrar
The Transfer Agent for our Common Stock is Wachovia, 230 South Tyron Street,
11th Floor, Charlotte, North Carolina 28288-1153.
Recent Open Market Purchase of Common Stock
No repurchase transactions occurred in 2000, 2001 or 2002.
53
Recent Unregistered Security Transactions
There were no unregistered stock sales during the years of 2000, 2001 or 2002.
ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA
You should consider our consolidated financial information set forth below
together with the more detailed consolidated financial statements, including the
related notes and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" included elsewhere in this report.
54
APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
Years Ended December 31,
----------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------------------------------------------------------------------------------
Revenue:
Gain on sale of loans $ 6,736 $ 13,831 $ 10,971 $ 13,202 $ 29,703
Interest income 4,102 5,428 5,191 7,698 10,308
Gain on sale of securities - - - - 1,750
Brokered loan fee income 15 656 2,399 6,078 4,275
Other fees and income 1,495 2,024 2,081 1,756 2,767
----------------------------------------------------------------------------------
Total revenue 12,348 21,939 20,642 28,734 48,803
----------------------------------------------------------------------------------
Expenses:
Compensation 5,243 9,462 11,477 17,765 23,397
General and administrative 6,501 7,664 8,930 14,427 15,306
Write down of Goodwill - 845 - 1,131 -
Loss on sale/ disposal of
fixed assets 1 162 42 796 -
Loss on write off of securities - - - 73 -
Interest expense 2,945 3,853 3,852 4,957 6,252
(Recovery) provision for loan losses (60) 873 638 2,041 3,064
Provision for foreclosed property
losses 384 237 451 215 (168)
----------------------------------------------------------------------------------
Total expenses 15,014 23,096 25,390 41,405 47,851
----------------------------------------------------------------------------------
(Loss) income before taxes (2,666) (1,157) (4,748) (12,671) 952
Income taxes (benefit) 561 1,483 (1,456) (4,749) 473
----------------------------------------------------------------------------------
Net (loss) income $ (3,227) $ (2,640) $ (3,292) $ (7,922) $ 479
==================================================================================
Net (loss) income per share (basic and
diluted) $ (.59) $ (.48) $ (.60) ($1.45) $ 0.09
==================================================================================
Cash dividends/share $ - $ - $ - $ - $ -
==================================================================================
Dividend payout ratio - - - - -
==================================================================================
Weighted average number of shares
outstanding (basic and diluted) 5,482,114 5,452,114 5,482,114 5,482,114 5,511,372
55
(In thousands, except share and per share data)
APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
(In thousands, except per share data)
2002 2001 2000 1999 1998
SELECTED BALANCES AT YEAR END
Loans held for sale, net $ 36,306 $ 47,886 $ 22,438 $ 62,765 $ 100,820
Loans held for yield, net 6,309 10,348 14,274 4,006 4,224
Securities 816 1,056 2,847 2,640 3,472
Total assets 60,643 78,525 59,819 98,600 136,118
Revolving warehouse loans 10,379 3,280 1,694 17,465 72,546
FDIC-insured deposits 39,675 62,135 38,358 55,339 29,728
Subordinated debt 4,601 4,562 4,861 5,081 6,042
Total liabilities 58,487 73,142 51,808 87,301 116,851
Shareholders' equity 2,156 5,383 8,011 11,299 19,267
Loans originated (1) $ 212,595 $ 377,258 $ 277,169 $ 390,816 $ 522,045
Loans sold 220,800 334,194 253,158 265,873 389,589
Amount of loans serviced at
year-end 43,788 59,811 38,602 69,054 109,500
Loans delinquent 31 days or more
as percent of loans at year-end 5.47% 4.49% 4.75% 4.50% 5.42%
SELECTED RATIOS
Return on average assets (4.64%) (3.49%) (4.77%) (8.45%) 0.40%
Return on average
Shareholders' equity (85.60%) (35.30%) (32.54%) (49.01%) 1.93%
Shareholders' equity to assets 3.56% 6.86% 13.39% 11.46% 14.15%
Book value per share $ .39 $ .98 $ 1.46 $ 2.07 $ 3.51
- ---------------
(1) Includes $1.4 million and $16.9 million retail loans brokered to other
lenders in 2002 and 2001 respectively.
56
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following financial review and analysis of the financial condition and
results of operations, for the fiscal years ended December 31, 2002, 2001, and
2000 should be read in conjunction with the consolidated financial statements
and the accompanying notes to the consolidated financial statements, and other
detailed information appearing in this document.
General
Approved Financial Corp. is a Virginia-chartered financial institution operating
throughout the United States through its wholly owned subsidiary Approved
Federal Savings Bank. Our Primary Business is originating, servicing and selling
conforming and non-conforming residential mortgage loans secured primarily by
first and junior liens on one- to four-family residential properties, primarily
owner-occupied. We offer both fixed-rate and adjustable-rate loans for purchase,
debt consolidation, home improvements and other purposes serving both conforming
and non-conforming borrowers. Through our retail division, we also originate,
service and sell traditional conforming mortgage products and government
mortgage products such as VA and FHA.
In compliance with regulatory instruction from the OTS, initiatives to enhance
our capital base by means of potential private investments into Approved and/or
a merger or acquisition transaction are part of our current business strategy.
We cannot assure you that we will successfully secure such investors and/or an
investment transaction structure suitable for the required OTS approval. Failure
to do so may negatively affect our financial and operating condition and invoke
additional OTS regulatory action. Our current business strategy is also
dependent upon our ability to originate mortgage products that provide economic
value. The implementation of our business strategy depends in large part on a
variety of factors outside of our control, including, but not limited to, our
ability to obtain capital investors and other forms of financing on favorable
terms and which is suitable to OTS, retain qualified employees to implement our
plans, profitably sell our loans on a regular basis and to expand in the face of
competition and regulatory restrictions. Our failure with respect to any of
these factors could impair our ability to successfully implement our strategy,
which would adversely affect our results of operations and financial condition.
57
Results of Operations
Results of Operations for the year ended December 31, 2002 compared to the year
ended December 31, 2001.
Net Loss
The net loss increased by 22% for 2002 to $3.2 million compared to $2.6 million
in 2001. On a per share basis, the net loss in 2002 was $0.59 compared to $.48
for 2001.
Origination of Mortgage Loans
The following table shows the loan originations in dollars and units for our
broker and retail divisions for 2002 and 2001. The retail division originates
mortgages that are funded through other lenders ("brokered loans"). Brokered
loans consist primarily of non-conforming mortgages that do not meet our
underwriting criteria and conforming loans.
Year Ended
December 31,
(dollars in millions) 2002 2001
-------------------------------
Dollar Volume of Loans Originated:
Total Wholesale $ 203.3 $ 269.9
Retail funded through other lenders 1.3 16.9
Retail funded in-house non-conforming 1.8 10.7
Retail funded in-house conforming and government 6.1 79.8
-------------------------------
Total Retail 9.2 107.4
-------------------------------
Total $ 212.5 $ 377.3
===============================
Number of Loans Originated:
Total Wholesale 2,027 2,574
Retail funded through other lenders 8 148
Retail funded in-house non-conforming 12 161
Retail funded in-house conforming and government 47 575
-------------------------------
Total Retail 67 884
-------------------------------
Total 2,094 3,458
===============================
The dollar volume of loans, originated in 2002, (including retail loans brokered
to other lenders) decreased 43.8% when compared to
58
the same period in 2001. The decrease in loan originations was primarily the
result of the decrease in broker-originated loans. During 2000 to 2001 retail
loan origination centers decreased from ten locations to one. At December 31,
2002 there was only one active retail loan origination center.
The dollar volume of loans funded in-house decreased by 41.4% during 2002
compared to 2001, primarily due to our initiative to reduce the amount of retail
loans brokered to other lenders and the decrease in retail in-house
originations. Brokered loans generated by the retail division were $1.3 million
during 2002, which was a 92.3% decrease compared to $16.9 million during the
same period in 2001.
The volume of loans originated through the Company's wholesale division, which
originates loans through referrals from a network of mortgage brokers decreased
24.7% to 203.3 million for the year ended December 31, 2002, compared to $269.9
million for the year ended December 31, 2001. The increase was primarily the
result of expansion in the wholesale division and the streamlining of the
Company's service to brokers.
59
The following table summarizes the mortgage loan origination activity, including
brokered loans, by state, for the years ended December 31, 2002 and 2001.
Years Ended December 31 2002 2001
(In Thousands) Dollars Percent Dollars Percent
Broker Division
Florida $ 39,049 18.4 $ 37,977 10.1
North Carolina 28,065 13.2 26,023 6.9
Pennsylvania 26,663 12.5 24,477 6.5
California 25,956 12.2 88,447 23.4
Ohio 23,528 11.1 15,181 4.0
Maryland 22,638 10.7 26,703 7.1
Virginia 20,628 9.7 31,440 8.3
Michigan 6,633 3.1 - -
South Carolina 4,170 2.0 5,553 1.5
Georgia 2,820 1.3 10,920 2.9
Tennessee 2,152 1.0 3,156 .8
Indiana 842 0.4 - -
Iowa 215 0.1 - -
----------------- ----------------- -------------- --------------
Total Broker Division $ 203,359 95.7% $ 269,877 71.5%
================= ================= ============== ==============
Retail Division:
Virginia $ 9,200 4.3 $ 23,600 6.3
New Jersey - - 50,905 13.5
Georgia - - 12,901 3.4
Maryland - - 6,731 1.8
South Carolina - - 5,004 1.3
Michigan - - 4,124 1.1
Ohio - - 954 0.3
North Carolina - - 1,058 0.3
Florida - - 1,146 0.3
Pennsylvania - - 958 0.2
----------------- ----------------- -------------- ---------------
Total Retail Division $ 9,200 4.3% $ 107,381 28.5%
================= ================= ============== ===============
Total Originations:
Florida 39,049 18.4 $ 39,123 10.4
Virginia 29,828 14.0 55,040 14.6
North Carolina 28,065 13.2 27,081 7.2
Pennsylvania 26,663 12.5 25,435 6.7
California 25,956 12.2 88,447 23.4
Ohio 23,528 11.1 16,135 4.3
Maryland 22,638 10.7 33,434 8.9
Michigan 6,633 3.1 4,124 1.1
South Carolina 4,170 2.0 10,557 2.8
Georgia 2,820 1.3 23,821 6.3
Tennessee 2,152 1.0 3,156 0.8
Indiana 842 0.4 - -
Iowa 215 0.1 - -
New Jersey - - 50,905 13.5
----------------- ----------------- -------------- ---------------
Total Originations $ 212,559 100% $ 377,258 100%
================= ================= ============== ===============
60
Gain on Sale of Loans
The largest component of our revenue is gain on sale of loans. There is an
active secondary market for most types of mortgage loans originated. The
majority of the loans originated are sold to other financial institutions. We
receive cash at the time loans are sold. The loans are sold service-released on
a non-recourse basis, except for normal representations and warranties, which is
consistent with industry practices. By selling loans in the secondary mortgage
market, we are able to obtain funds that may be used for additional lending and
investment purposes. Gain on sale of loans is comprised of several components,
as follows: (a) the difference between the sales price and the net carrying
value of the loan; plus (b) loan origination fee income collected at loan
closing and deferred until the loan is sold; less (c) loan sale recapture
premiums and loan selling costs.
Nonconforming loan sales including discounted loan sales totaled $212.4 million
for the year ended December 31, 2002, compared to $252.8 million for the same
period in 2001.
Nonconforming loan sales excluding discounted loan sales totaled $203.5 million
for the year ended December 31, 2002, compared to $247.7 million for the same
period in 2001, and earned an average weighted premium of 3.2% and 4%,
respectively.
For the year ended December 31, 2002, the Company sold $8.9 million of loans, at
a weighted average discount to par value of 3.2%. For the year ended December
31, 2001, the Company sold $5.1 million of loans at a weighted average discount
to par value of 5.0%. All discounted loan sales for the year 2002 were from Held
for Sale portfolio and the majority of discounted loan sales in 2001 were from
Held for Sale with a significantly smaller amount from held for yield.
Conforming and government loan sales totaled $8.4 million for the year ended
December 31, 2002, compared to $81.2 million for the year ended December 31,
2001 and earned a weighted-average premium of 1.9% compared to 1.6%,
respectively.
Total loan sales were $220.8 million for the year ended December 31, 2002
compared to total loan sales of $339.1 for 2001
The total gain on sale of loans was $6.7 million at December 31, 2002 compared
with $13.8 million for the same period in 2001. The decrease in the combined
gain on sale of loans was primarily the result of a decrease in the amount of
loans sold. For the year ended December 31, 2002, approximately 96% of loans
sold (conforming & non-conforming) were originated by the wholesale division,
compared to 72% for the year ended December 31, 2001. Gain on the sale of
mortgage loans represented 54.5% of total revenue for the year ended December
31, 2002, compared to 63.0%
61
of total revenue for the same period in 2001. This was primarily a result of the
lower total dollar volume of loans sold.
While we have never used securitization as a loan sale strategy, changes in the
securitization marketplace have a residual affect on us to the extent our loan
investor's use this strategy as a form of financing their loan acquisition
volume. Excessive competition during 1998 and 1999 and a coinciding reduction in
interest rates in general caused an increase in the prepayment speeds for
non-conforming loans. The valuation method applied to interest-only and residual
assets ("Assets"), the capitalized assets created from securitization, include
an assumption for average prepayment speed in order to determine the average
life of a loan pool and an assumption for loan losses. The increased prepayment
speeds as well as the magnitude of loan losses experienced in the industry were
greater than the assumptions previously used by many securitization issuers and
have resulted in an impairment or write down of Asset values for several
companies in the industry. Additionally, in September of 1998, due to the
Russian crisis, and again in the fourth quarter of 1999, due to Y2K concerns, a
flight to quality among fixed income investors negatively impacted the pricing
spreads for mortgage-backed securitizations compared to earlier periods and
negatively impacted the associated economics to the issuers. Consequently, many
companies accessing the securitization market place experienced terminal
liquidity problems and others diverted to whole loan sale strategies in order to
generate cash. This shift has materially decreased the demand for and increased
the supply of non-conforming mortgage loans in the secondary marketplace, which
resulted in significantly lower premiums on non-conforming whole-loan mortgage
sales beginning in the fourth quarter of 1998 and continuing into 2000 when
compared to earlier periods. The increase in average loan sale premiums in 2001
compared to 2000 is primarily the result of the gradual demand and supply
equilibrium returning to the non-conforming whole loan sale marketplace.
The increase in non-conforming loan sale premiums due to this rebalancing in the
marketplace was partially offset in 2001 and 2002 due to a shift in our loan
origination volume to higher credit grade loans and the associated decrease in
the Weighted Average Coupon ("WAC") on higher grade mortgages. These premiums do
not include loan origination fees collected at the time the loans are closed,
which are included in the computation of gain on sale when the loans are sold.
We defer recognizing income from the loan origination fees we receive at the
time a loan is closed. These fees are recognized over the lives of the related
loans as an adjustment of the loan's yield using the level-yield method.
Deferred income pertaining to loans held for sale is taken into income at the
62
time of sale of the loan. Origination fee income is primarily derived from our
retail lending division. Origination fee income included in the gain on sale of
loans for the year ended December 31, 2002 was $0.5 million, compared to $2.8
million for the year ended December 31, 2001. The decrease is the result of a
decrease in the volume of loans sold, which were generated by our retail
division. Our non-conforming retail loan sales for the year ended December 31,
2002 comprised 1% of total non-conforming loan sales, with average loan
origination fee income earned of 0.2%. For the year ended December 31, 2001,
non-conforming retail loan sales were 13% of total non-conforming loan sales
with average origination fee income of 2.9%. Average origination fee income from
conforming and government loans was 1.27% for the year ended December 31, 2002
compared to 2.26% for the year ended December 31, 2001. Costs associated with
selling loans were approximately 5 basis points for the year ended December 31,
2002 compared to 5 basis points for the year ended December 31, 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 mortgage broker referral originations for
the year ended December 31, 2002 was 20 basis points compared to 50 basis points
for the year ended December 31, 2001.
Interest Income and Expense
Interest income for the year ended December 31, 2002 was $4.1 million compared
with $5.4 million for the same period ended in 2001. The decrease in interest
income for the year ended December 31, 2002 was primarily due to a lower average
balance of loans held for sale.
Interest expense for the year ended December 31, 2002 was $2.9 million compared
with $3.9 million for the year ended December 31, 2001. The decrease was due to
the decrease in the FDIC-Insured Certificates held of $37.8 million compared to
$59.9 million at December 31, 2002 and 2001, respectively.
Changes in the average yield received on the loan portfolio, as mortgages are
based on long term borrowing rates, may not coincide with changes in interest
rates we must pay on revolving warehouse loans, the Bank's FDIC-insured
deposits, and other borrowings, which are primarily based on short term
borrowing rates. As a result, in times of rising or falling interest rates, the
difference or spread between the yield received on loans and
63
other investments and the rate paid on borrowings will occur.
The following tables reflect the average yields earned and rates paid during
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.
64
2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Average Average
% %
Average Yield/ Average Yield/
(In thousands) Balance Interest Rate Balance Interest Rate
------------------------------------------------------------------------------------
Interest-earning assets:
Loan receivable (1) $ 40,827 $ 3,805 9.32 $ 51,188 $ 5,095 9.95
Cash and other interest-
Earning assets 23,047 297 1.29 14,263 333 2.33
-----------------------------------------------------------------------------------
63,874 4,102 6.42 65,451 5,428 8.29
---------------------- ------------------------
Non-interest-earning assets:
Allowance for loan losses (1,338) (1,245)
Investments 995 -
Premises and equipment, net 3,507 4,768
Other 3,226 6,770
------------ ------------
Total assets $ 70,264 $ 75,744
============ ============
Interest-bearing liabilities:
Revolving warehouse lines $ 8,183 514 6.28 $ 5,838 318 5.45
FDIC-insured deposits 50,622 1,845 3.64 52,585 2,877 5.47
Other interest-bearing liabilities 6,346 586 9.24 6,955 658 9.46
-----------------------------------------------------------------------------------
65,151 2,945 4.52 65,378 3,853 5.89
---------------------- ------------------------
Non-interest-bearing liabilities 1,772 2,888
------------ ------------
Total liabilities 66,923 68,266
Shareholders' equity 3,341 7,478
------------ ------------
Total liabilities and equity $ 70,264 $ 75,744
============ ============
Average dollar difference between
Interest-earning assets and interest-
Bearing liabilities
$ (1,277) $ 73
============ ============
Net interest income $ 1,157 $ 1,575
========= ===========
Interest rate spread (2) 1.90 2.40
========== ==========
Net annualized yield on average
Interest-earning assets 1.81 2.41
========== ==========
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
(2) Average yield on total interest-earning assets less average rate paid on
total interest-bearing liabilities.
65
The following table shows the change in net interest income, which can be
attributed to rate (change in rate multiplied by old volume) and volume (change
in volume multiplied by old rate) for the year ended December 31, 2002 compared
to the year ended December 31, 2001. The changes in net interest income due to
both volume and rate changes have been allocated to volume and rate in
proportion to the relationship of absolute dollar amounts of the change of each.
The table demonstrates that the decrease of $418,000 in net interest income for
the year ended December 31, 2002 compared to the year ended December 31, 2001
was primarily the result of a decrease in the average balance of
interest-earning assets.
($ In thousands)
2002 Versus 2001
Increase (Decrease) due to:
Volume Rate Total
----------- ---------- ----------
Interest-earning assets:
Loans receivable (981) (309) (1,290)
Cash and other interest-
earning assets (132) 96 (36)
---------- --------- ----------
(1,113) (213) (1,326)
---------- --------- ----------
Interest-bearing liabilities:
Revolving warehouse lines 142 54 196
FDIC-insured deposits (104) (928) (1,032)
Other interest-
bearing liabilities (57) (15) (72)
---------- --------- ----------
(19) (889) (908)
---------- --------- ----------
Net interest income (expense) (1,094) 676 (418)
========== ========= ==========
Broker Fee Income
We derive income from origination fees earned on brokered loans generated by our
retail offices. For the year ended December 31, 2002, broker fee income totaled
$15,000 compared to $649,000 for the same period in 2001. The decrease was
primarily the result of our initiatives to fund more retail loans in-house.
Other Income
In addition to net interest income (expense), and gain on sale of loans, and
broker fee income, we derive income from other fees earned on the loans funded
such as underwriting fees, prepayment penalties, and late charge fees for
delinquent loan payments. Revenues associated with the financial products
marketed by
66
Approved Financial Solutions are also recorded in other income. For the year
ended December 31, 2002, other income totaled $1.5 million compared to $2.0
million for the same period in 2001. The level of other income was affected by a
reduction in the retail division, which marketed the financial products offered
by AFS, and the increase in wholesale originations, which earn underwriting
fees.
Comprehensive Income/Loss
For the year ended December 31, 2002 and 2001 we had other comprehensive income
of $0 and $12,000, respectively, in the form of unrealized holding gains/losses
on an Asset Management Fund investment.
Compensation and Related Expenses
The largest component of expenses is compensation and related expenses, which
decreased by $4.2 million to $5.2 million for the year, ended December 31, 2002
from 2001. The decrease was directly attributable to a decrease in the number of
employees, related to our productivity enhancement and cost cutting initiatives.
For the year ended December 31, 2002, salary expense decreased by $2.5 million
when compared to the same period in 2001. For the year ended December 31, 2002
the commissions to loan officers decreased by $1.2 million when compared to the
same period ended December 31, 2001. The decrease was primarily due to a lower
loan volume. Payroll taxes and related benefits decreased by $.50 million for
the year ended December 31, 2002 when compared to the same period in 2001. As of
December 31, 2002, the number of full time equivalent employees was 77 compared
to 101 as of December 31, 2001.
General and Administrative Expenses
General and administrative expenses are comprised of various expenses such as
advertising, rent, postage, printing, general insurance, travel & entertainment,
telephone, utilities, depreciation, professional fees and other miscellaneous
expenses. General and administrative expenses for the year ended December 31,
2002 decreased by $0.6 million to $5.3 million, compared to the year ended
December 31, 2001. The decrease was the result of a reduction in retail
marketing expenses, a decline in our employee count, and our continued cost
cutting efforts.
Loan Production Expense
Loan production expenses are comprised of expenses for appraisals, credit
reports, and payment of fees to mortgage brokers, for services rendered on loan
originations, and verification of mortgages. Loan production expenses for the
year ended December 31, 2002 were $1.2 million compared to $1.8 million for the
year ended December 31, 2001. The decrease was
67
primarily the result of the decreased origination volume in the wholesale broker
division.
Provision for Loan Losses - Held for Yield ("HFY") Loans
The following table presents the activity in the allowance for loan losses for
HFY loans which includes general and specific allowances and selected loan loss
data for the year ended December 31, 2002 and 2001.
(In thousands)
2002 2001
Balance at beginning of year $ 880 $ 1,479
Provision charged to expense (292) 91
Loans charged off (258) (746)
Recoveries of loans previously charged off 189 56
------- --------
* Balance at end of period $ 519 $ 880
======= ========
HFY loans receivable at December 31, 2002 and 2001,
gross of allowance for losses and deferred fees 6,932 11,378
Ratio of allowance for loan losses to gross
HFY loans receivable at the end of periods 7.49% 7.73%
The provision for loan losses was a reduction of $292,000 for the year ended
December 31, 2002 compared to expense of $91,000 for the year ended December 31,
2001. The provision for loan losses is based on management's assessment of the
loan loss risk for the associated loans. For the year ended December 31, 2002,
the net decrease in the allowance for loan losses was primarily due to the
reduction in the principal amount of loans held for yield. The valuation
allowance provisions for loans held for yield are established at levels that we
consider adequate to cover future loan losses relative to the composition of the
current portfolio of loans. We consider characteristics of our current loan
portfolio such loan to value ratio, combined loan to value ratio, estimated net
realizable value of loans, and the portfolio's delinquency and loss history and
current status in the determination of an appropriate allowance. Other criteria
such as covenants associated with our credit facilities, trends in the demand
for and pricing for loans sold in the secondary market for similar mortgage
loans and general economic conditions, including interest rates, are also
considered when establishing the allowance.
68
Allowance for Loan Loss (ALL)- Reserve Methodology
The percentage described below related to general allowance for loan and lease
loss are based on secondary marketing management opinion as to risk levels of
the loans, review of secondary market pricing for sales of loans with similar
characteristics and OTS regulatory guidance.
Loans Current to 90 Days Delinquent:
First Mortgage Lien Position- General ALL reserve of 5.0% of the outstanding
balance of loans. Subordinate Lien Position - General ALL reserve of 10.0% of
the outstanding balance of loans Loans 91 to 120 Days Delinquent: First Mortgage
Lien Position - General ALL reserve of 10.0% of the outstanding balance of
loans. Subordinate Lien Position - Outstanding balance is charged off at 91 days
absent specific information indicating an estimated recoverable loan balance.
Loans over 120 Days Delinquent:
First Mortgage Lien Position - Specific Reserve equal to the outstanding loan
balance less a current assessment of the "net realizable value" of the loan.
General Reserve equal to the outstanding balance of loans in this category less
the Specific Reserve times 10.0%. Specific Reserves on loans that had been 120+
days delinquent should remain until the borrower has shown a renewed willingness
and ability to repay the loan. The borrower should have made at least three
consecutive minimum monthly payments or the equivalent cumulative amount prior
to reversal of the specific reserve.
Adjustments to the reserve for loan losses may be made in future periods due to
changes that may affect anticipated loss levels in the future.
% of
HFY - Allowance for Loan Loss Summary 12/31/2002 Balance Balance Allowance
- ------------------------------------------------
HFY 1st Mortgage Lien (Current to 90 Days Late) (G) 5,228,555 5.0% 261,428
HFY Subordinate Mortgage Lien (Current to 90 Days Late) (G) 987,423 10.0% 98,742
HFY 1st Mortgage Lien (91 to 120 Days Late) (S) 76,411 8.22% 6,280
HFY 1st Mortgage Lien (121+ Days Late) (S) 635,361 15.7% 99,476
HFY 1st Mortgage Lien (121+ Days Late) (G) 535,886 10.0% 53,589
HFY 1st Mortgage Lien (With Prior Reserve) (S) - 0.0% -
Other Loans 4,119 0.0% -
- --------------------------------------------------------------------------------------------------------
Total 6,931,869 7.5% 519,515
% of
HFY - Allowance for Loan Loss Summary 12/31/2001 Balance Balance Allowance
- ------------------------------------------------
HFY 1st Mortgage Lien (Current to 90 Days Late) (G) 8,222,942 5.0% 411,147
HFY Subordinate Mortgage Lien (Current to 90 Days Late) (G) 1,560,501 10.0% 156,050
HFY 1st Mortgage Lien (91 to 120 Days Late) (S) 75,569 10.0% 7,557
69
HFY 1st Mortgage Lien (121+ Days Late) (S) 1,314,046 10.4% 136,661
HFY 1st Mortgage Lien (121+ Days Late) (G) 1,177,744 10.0% 117,774
HFY 1st Mortgage Lien (With Prior Reserve) (S) 174,803 28.796% 50,337
Other Loans 29,989 0.0% -
- ------------------------------------------------------------------------------------------------------------
Total 11,377,850 7.7% 879,526
Provision for Valuation Allowance - Held For Sale ("HFS") Loans:
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 the amount of valuation allowance is
included on the balance sheet with mortgage loans held for sale, net.
Valuation allowances are based on managements opinion as to risk
levels of the loans, review of secondary market pricing for sales of
loans with similar characteristics, OTS regulatory guidance, 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. Loans held over 90 days carry a general valuation
allowance based on the lien position of the loan. This percentage of
the general valuation allowance is based on loan sale pricing of loan
pools with similar characteristics of the current HFS portfolio. A
specific valuation allowance equal to the estimated net realizable
value of a loan is carried on all loans considered to be special
circumstance, which is in addition to any general valuation allowance.
The net realizable value represents the most recent appraised value of
the underlying property less estimated cost to liquidate. The
difference in the principal value of the loan and the net realizable
value is recorded as a valuation allowance. (See also Footnote no. 3
to Audited Consolidated Financial Statements.)
------------------------------------------------------------------------------------------------------------
HFS - Valuation Allowance ("VA")Summary As of December 31, 2002
------------------------------------------------------------------------------------------------------------
CATEGORY $ Loans in Category % VA $ VA
------------------------------------------------------------------------------------------------------------
HFS (Non-Conforming) * 90 Days Old 31,599,830 0.0% 0
------------------------------------------------------------------------------------------------------------
HFS (Conforming) * 90 Days Old 358,496 0.0% 0
------------------------------------------------------------------------------------------------------------
HFS (Special Circumstances) 1,019,768 20.5% 208,516
------------------------------------------------------------------------------------------------------------
HFS (Non-Conforming) 1st Mortgage Lien ** 90 Days Old 3,509,348 5.5% 193,014
------------------------------------------------------------------------------------------------------------
HFS (Non-Conforming) Subordinate Mortgage 1,295,760 20.0% 259,152
------------------------------------------------------------------------------------------------------------
70
* means less than
** means more than
- --------------------------------------------------------------------------------------------------------------------------
Lien ** 90 Days Old
- --------------------------------------------------------------------------------------------------------------------------
HFS (Conforming) 1st Mortgage Lien ** 90 Days Old 96,460 0.0% 0
- --------------------------------------------------------------------------------------------------------------------------
HFS (Conforming) Subordinate Mortgage Lien ** 90 Days Old 0 0.0% 0
- --------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------
Total Held For Sale - Valuation Allowance 36,859,894 1.8% 660,682
- --------------------------------------------------------------------------------------------------------------------------
See Footnote 3 pg 71 for valuation allowance activity
table.
- --------------------------------------------------------------------------------------------------------------------------
HFS - Valuation Allowance ("VA")Summary As of December 31, 2001
- --------------------------------------------------------------------------------------------------------------------------
CATEGORY $ Loans in % VA $ VA
Category
- --------------------------------------------------------------------------------------------------------------------------
HFS (Non-Conforming) * 90 Days Old 37,998,779 0.0% 0
- --------------------------------------------------------------------------------------------------------------------------
HFS (Conforming) * 90 Days Old 3,097,845 0.0% 0
- --------------------------------------------------------------------------------------------------------------------------
HFS (Special Circumstances) 811,069 4.3% 35,274
- --------------------------------------------------------------------------------------------------------------------------
HFS (Non-Conforming) 1st Mortgage Lien ** 90 Days Old 5,644,605 5.5% 310,453
- --------------------------------------------------------------------------------------------------------------------------
HFS (Non-Conforming) Subordinate Mortgage Lien ** 90 Days Old 1,357,394 20.0% 271,479
- --------------------------------------------------------------------------------------------------------------------------
HFS (Conforming) 1st Mortgage Lien ** 90 Days Old 288,244 0.0% 0
- --------------------------------------------------------------------------------------------------------------------------
HFS (Conforming) Subordinate Mortgage Lien ** 90 Days Old 76,399 0.0% 0
- --------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------
Total Held For Sale - Valuation Allowance 48,463,266 1.3% 617,206
- --------------------------------------------------------------------------------------------------------------------------
* means less than
** means more than
Provision for Foreclosed Property Losses
The provision for foreclosed property losses was $384,000 for the year ended
December 31, 2002 compared to $237,000 for the year ended December 31, 2001. The
allowance for REO losses increased for the year ended December 31, 2002,
compared to December 31, 2001 primarily due to the decrease in the estimated net
realizable value of the loans. The allowance was established such that the book
value of the asset reflects the estimated net realizable value of the underlying
property.
Sales of real estate owned yielded net losses of $305,000 for the year ended
December 31, 2002 versus $500,000 for the year ended December 31, 2001.
71
The following table presents the activity in the allowance for foreclosed
property losses and selected real estate owned data for the year ended December
31, 2002 and 2001:
(In thousands)
2002 2001
----------------- -----------------
Balance at beginning of year $ 113 $ 377
Provision charged to expense 384 236
Loss on sale of foreclosures (305) (500)
----------------- -----------------
Balance at end of period $ 192 $ 113
================= =================
Real estate owned at the end of period, gross
of allowance for losses $ 636 $ 702
Ratio of allowance for foreclosed property losses
to gross real estate owned at the end of period 30.19% 16.10%
Assets acquired through loan foreclosure are recorded as real estate owned
("REO"). When a property is transferred to REO status, a new appraisal is
ordered on the property. An allowance for REO loss is then established on that
property based upon the estimated net realizable value, which is the lower of
the appraised or listed price of the property less the estimated expense to
liquidate. While we believe that our present allowance for foreclosed property
losses is adequate, future adjustments may be necessary.
72
Results of Operations
Results of Operations for the year ended December 31, 2001 compared to
the year ended December 31, 2000.
Net Loss
The net loss decreased by 21% for 2001 to $2.6 million compared to
$3.3 million in 2000. On a per share basis, the net loss in 2001 was
$0.48 compared to $.60 for 2000.
Origination of Mortgage Loans
The following table shows the loan originations in dollars and units
for our broker and retail divisions for 2001 and 2000. The retail
division originates mortgages that are funded through other lenders
("brokered loans"). Brokered loans consist primarily of non-conforming
mortgages that do not meet our underwriting criteria and conforming
loans.
Year Ended
December 31,
(dollars in millions) 2001 2000
----------------------------------
Dollar Volume of Loans Originated:
Total Wholesale $ 269.9 $ 135.0
----------------------------------
Retail funded through other lenders 16.9 47.6
Retail funded in-house non-conforming 10.7 47.9
Retail funded in-house conforming and government 79.8 46.7
----------------------------------
Total Retail 107.4 142.2
----------------------------------
Total $ 377.3 $ 277.2
==================================
Number of Loans Originated:
Total Wholesale 2,574 1,846
Retail funded through other lenders 148 682
Retail funded in-house non-conforming 161 714
Retail funded in-house conforming and government 575 448
----------------------------------
Total Retail 884 1,844
----------------------------------
Total 3,458 3,690
==================================
The dollar volume of loans, originated in 2001, (including retail
loans brokered to other lenders) increased 36.1% when compared to the
same period in 2000. The increase in loan originations was primarily
the result of the increase in broker-originated loans, partially
offset by the reduction in the number of retail loan origination
centers from ten offices at December 31, 2000 to one at December 31,
2001.
73
The dollar volume of loans funded in-house increased by 57.0% during
2001 compared to 2000, primarily due to our initiative to reduce the
amount of retail loans brokered to other lenders and the increase in
broker originations which are all funded in house. Brokered loans
generated by the retail division were $16.9 million during 2001, which
was a 64.5% decrease compared to $47.6 million during the same period
in 2000.
The decrease in retail loan origination centers resulted in a 24.5%
decrease in our retail loan volume including retail loans brokered to
other lenders for the year ended December 31, 2001 when compared to
the same period in 2000.
The volume of loans originated through the Company's wholesale
division, which originates loans through referrals from a network of
mortgage brokers increased 99.9% to 269.9 million for the year ended
December 31, 2001, compared to $135.0 million for the year ended
December 31, 2000. The increase was primarily the result of expansion
in the wholesale division and the streamlining of the Company's
service to brokers.
74
The following table summarizes the mortgage loan origination activity, including
brokered loans, by state, for the years ended December 31, 2001 and 2000.
Years Ended
December 31 2001 2000
-------------------------------- -----------------------------------
(In thousands) Dollars Percent Dollars Percent
-------------- -------------- ---------------- -------------
Broker Division
California $ 88,447 23.4 $ 5,041 1.8
Florida 37,977 10.1 37,032 13.4
Virginia 31,440 8.3 21,858 7.9
Maryland 26,703 7.1 14,375 5.2
North Carolina 26,023 6.9 23,172 8.4
Pennsylvania 24,477 6.5 18,566 6.7
Ohio 15,181 4.0 7,613 2.7
Georgia 10,920 2.9 6,483 2.3
South Carolina 5,553 1.5 854 .3
Tennessee 3,156 .8 0 0
-------------- -------------- ---------------- -------------
Total Broker Division $269,877 71.5% $134,994 48.7%
============== ============== ================ =============
Retail Division:
New Jersey $ 50,905 13.5 $ 25,541 9.2
Virginia 23,600 6.3 18,470 6.7
Georgia 12,901 3.4 10,842 4.0
Maryland 6,731 1.8 29,203 10.5
South Carolina 5,004 1.3 14,755 5.3
Michigan 4,124 1.1 19,303 6.9
Ohio 954 0.3 15,857 5.8
North Carolina 1,058 0.3 0 0.0
Florida 1,146 0.3 0 0.0
Pennsylvania 958 0.2 0 0.0
Colorado - 0.0 8,203 2.9
-------------- -------------- ---------------- -------------
Total Retail Division $107,381 28.5% $142,174 51.3%
============== ============== ================ =============
Total Originations:
California $ 88,447 23.4 $ 5,041 1.8
Virginia 55,040 14.6 40,328 14.6
New Jersey 50,905 13.5 25,541 9.2
Florida 39,123 10.4 37,032 13.4
Maryland 33,434 8.9 43,578 15.7
North Carolina 27,081 7.2 23,172 8.4
Pennsylvania 25,435 6.7 18,566 6.7
Georgia 23,821 6.3 17,325 6.3
Ohio 16,135 4.3 23,470 8.5
South Carolina 10,557 2.8 15,609 5.6
Michigan 4,124 1.1 19,303 6.9
Tennessee 3,156 .8 0 0
Colorado - 0.0 8,203 2.9
-------------- -------------- ---------------- ------------
Total Originations $377,258 100.0% $277,168 100.0%
============== ============== ================ =============
75
Gain on Sale of Loans
The largest component of our revenue is gain on sale of loans. There is an
active secondary market for most types of mortgage loans originated. The
majority of the loans originated are sold to other financial institutions. We
receive cash at the time loans are sold. The loans are sold service-released on
a non-recourse basis, except for normal representations and warranties, which is
consistent with industry practices. By selling loans in the secondary mortgage
market, we are able to obtain funds that may be used for additional lending and
investment purposes. Gain on sale of loans is comprised of several components,
as follows: (a) the difference between the sales price and the net carrying
value of the loan; plus (b) loan origination fee income collected at loan
closing and deferred until the loan is sold; less (c) loan sale recapture
premiums and loan selling costs.
Nonconforming loan sales totaled $252.8 million including loans sold at a
discount to par value ("discounted loan sales") for the year ended December 31,
2001, compared to $208.2 million for the same period in 2000.
For the year ended December 31, 2001, discounted loan sales consisted of $5.1
million, at a weighted average discount to par value of 5.0%. The loss was fully
reserved for in prior periods. For the year ended December 31, 2000, discounted
loan sales consisted of $3.6 million, at a weighted average discount to par
value of 15.9%.
Conforming and government loan sales were $81.2 million for year ended December
31, 2001, compared to $44.9 million for the year ended December 31, 2000.
The combined gain on the sale of loans was $13.8 million for the year ended
December 31, 2001, which compares with $11.0 million for the same period in
2000. The increase in the combined gain on sale of loans was primarily the
result of an increase in the amount of loans sold. For the year ended December
31, 2001, approximately 87% of loans sold (conforming & non-conforming) were
originated by the wholesale division, compared to 45% for the year ended
December 31, 2000. Gain on the sale of mortgage loans represented 63.0% of total
revenue for the year ended December 31, 2001, compared to 53.1 % of total
revenue for the same period in 2000. This was primarily a result of our
initiative to decrease the level of retail loans funded by other lenders,
revenues from which are reported in other income, and to increase the percentage
of originations funded in-house, revenues from which are reported in gain on
sale of loans.
The weighted-average premium, realized on non-conforming loan sales was 4.0%
(excluding discounted loan sales), during the year
76
ended December 31, 2001, compared to 3.14% for the same period in 2000. The
weighted-average premium realized on its conforming and government loans sales
was 1.6% during the year ended December 31, 2001, compared to 1.37% for the year
ended December 31, 2000.
While we have never used securitization as a loan sale strategy, changes in the
securitization marketplace have a residual affect on us to the extent our loan
investor's use this strategy as a form of financing their loan acquisition
volume. Excessive competition during 1998 and 1999 and a coinciding reduction in
interest rates in general caused an increase in the prepayment speeds for
non-conforming loans. The valuation method applied to interest-only and residual
assets ("Assets"), the capitalized assets created from securitization, include
an assumption for average prepayment speed in order to determine the average
life of a loan pool and an assumption for loan losses. The increased prepayment
speeds as well as the magnitude of loan losses experienced in the industry were
greater than the assumptions previously used by many securitization issuers and
have resulted in an impairment or write down of Asset values for several
companies in the industry. Additionally, in September of 1998, due to the
Russian crisis, and again in the fourth quarter of 1999, due to Y2K concerns, a
flight to quality among fixed income investors negatively impacted the pricing
spreads for mortgage-backed securitizations compared to earlier periods and
negatively impacted the associated economics to the issuers. Consequently, many
companies accessing the securitization market place experienced terminal
liquidity problems and others diverted to whole loan sale strategies in order to
generate cash. This shift has materially decreased the demand for and increased
the supply of non-conforming mortgage loans in the secondary marketplace, which
resulted in significantly lower premiums on non-conforming whole-loan mortgage
sales beginning in the fourth quarter of 1998 and continuing into 2000 when
compared to earlier periods. The increase in average loan sale premiums in 2001
compared to 2000 is primarily the result of the gradual demand and supply
equilibrium returning to the non-conforming whole loan sale marketplace.
The increase in non-conforming loan sale premiums due to this rebalancing in the
marketplace was partially offset in 2001 due to a shift in our loan origination
volume to higher credit grade loans and the associated decrease in the Weighted
Average Coupon ("WAC") on higher grade mortgages. These premiums do not include
loan origination fees collected at the time the loans are closed, which are
included in the computation of gain on sale when the loans are sold.
We defer recognizing income from the loan origination fees we receive at the
time a loan is closed. These fees are recognized over the lives of the related
loans as an adjustment of the
77
loan's yield using the level-yield method. Deferred income pertaining to loans
held for sale is taken into income at the time of sale of the loan. Origination
fee income is primarily derived from our retail lending division. Origination
fee income included in the gain on sale of loans for the year ended December 31,
2001 was $2.8 million, compared to $4.4 million for the year ended December 31,
2000. The decrease is the result of a decrease in the volume of loans sold,
which were generated by our retail division. Our non-conforming retail loan
sales for the year ended December 31, 2001 comprised 13% of total non-conforming
loan sales, with average loan origination fee income earned of 2.9%. For the
year ended December 31, 2000, non-conforming retail loan sales were 32.7% of
total non-conforming loan sales with average origination fee income of 4.64%.
Average origination fee income from conforming and government loans was 2.26%
for the year ended December 31, 2001 compared to 3.38% for the year ended
December 31, 2000. Costs associated with selling loans were approximately 5
basis points for the year ended December 31, 2001 compared to 20 basis points
for the year ended December 31, 2000.
We also defer recognition of the expense incurred, from the payment of fees to
mortgage brokers, for services rendered on loan originations. These costs are
deferred and recognized over the lives of the related loans as an adjustment of
the loan's yield using the level-yield method. The remaining balance of expenses
associated with fees paid to brokers is recognized when the loan is sold.
Average services rendered fees paid on mortgage broker referral originations for
the year ended December 31, 2001 was 50 basis points compared to 46 basis points
for the year ended December 31, 2000.
Interest Income and Expense
Interest income for the year ended December 31, 2001 was $5.4 million compared
with $5.2 million for the same period ended in 2000. The increase in interest
income for the year ended December 31, 2001 was primarily due to a higher
average balance of loans held for sale and was partially offset by a reduction
in the weighted average coupon related to these loans due to an increase in
credit grade of loans and an increase in adjustable rate mortgage loans.
Interest expense for the year ended December 31, 2001 was $3.9 million compared
with $3.9 million for the year ended December 31, 2000.
Changes in the average yield received on the loan portfolio, as mortgages are
based on long term borrowing rates, may not coincide with changes in interest
rates we must pay on revolving warehouse loans, the Bank's FDIC-insured
deposits, and other
78
borrowings, which are primarily based on short term borrowing rates. As a
result, in times of rising or falling interest rates, the difference or spread
between the yield received on loans and other investments and the rate paid on
borrowings will occur.
The following tables reflect the average yields earned and rates paid during
2001 and 2000. In computing the average yields and rates, the accretion of loan
fees is considered an adjustment to yield. Information is based on average
month-end balances during the indicated periods.
79
(In thousands) 2001 2000
--------------------------------------------------------------------------------
Average Average % Average Average %
Balance Interest Yield/Rate Balance Interest Yield/Rate
----------- ------------ ------------ ----------- ------------ ------------
Interest-earning assets:
Loan receivable (1) $51,188 $ 5,095 9.95 $42,978 $ 4,568 10.63
Cash and other interest-
Earning assets 14,263 333 2.33 12,512 623 4.98
----------- ------------ ------------ ----------- ------------ ------------
65,451 5,428 8.29 55,490 5,191 9.35
------------ ------------ ------------ ------------
Non-interest-earning assets:
Allowance for loan losses (1,245) (1,203)
Premises and equipment, net 4,768 5,763
Other 6,770 8,975
----------- -----------
Total assets $75,744 $69,025
=========== ===========
Interest-bearing liabilities:
Revolving warehouse lines $ 5,838 318 5.45 $ 4,234 294 6.94
FDIC - insured deposits 52,585 2,877 5.47 44,782 2,773 6.19
Other interest-bearing
Liabilities 6,955 658 9.46 8,074 785 9.72
----------- ------------ ------------ ----------- ------------ ------------
65,378 3,853 5.89 57,090 3,852 6.75
------------ ------------ ------------ ------------
Non-interest-bearing
liabilities 2,888 1,818
----------- -----------
Total Liabilities 68,266 58,908
Shareholders' equity 7,478 10,117
----------- -----------
Total liabilities and equity $75,744 $69,025
=========== ===========
Average dollar difference
between Interest-earning
assets and interest-bearing
liabilities $ 73 $(1,600)
=========== ===========
Net interest income $ 1,575 $ 1,339
============ ============
Interest rate spread (2) 2.40 2.60
============ ============
80
Net annualized yield on average ----------- -----------
Interest-earning assets 2.41 2.41
=========== ===========
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
(2) Average yield on total interest-earning assets less average rate paid on
total interest-bearing liabilities.
81
The following table shows the change in net interest income, which can be
attributed to rate (change in rate multiplied by old volume) and volume (change
in volume multiplied by old rate) for the year ended December 31, 2001 compared
to the year ended December 31, 2000. The changes in net interest income due to
both volume and rate changes have been allocated to volume and rate in
proportion to the relationship of absolute dollar amounts of the change of each.
The table demonstrates that the increase of $236,000 in net interest income for
the year ended December 31, 2001 compared to the year ended December 31, 2000
was primarily the result of an increase in the average balance of
interest-earning assets.
($ In thousands)
2001 Versus 2000
Increase (Decrease) due to:
Volume Rate Total
------------ ----------- -----------
Interest-earning assets:
Loans receivable 789 (262) 527
Cash and other interest-
earning assets 104 (394) (290)
------------ ----------- -----------
893 (656) 237
------------ ----------- -----------
Interest-bearing liabilities:
Revolving warehouse lines 56 (32) 24
FDIC-insured deposits 313 (209) 104
Other interest-
bearing liabilities (106) (21) (127)
------------ ----------- -----------
263 (262) 1
------------ ----------- -----------
Net interest income (expense) 630 (394) 236
============ =========== ===========
Broker Fee Income
We derive income from origination fees earned on brokered loans generated by our
retail offices. For the year ended December 31, 2001, broker fee income totaled
$649,000 compared to $2.4 million for the same period in 2000. The decrease was
primarily the result of our initiatives to fund more retail loans in-house and
due to a decrease in the number of retail office locations.
Other Income
In addition to net interest income (expense), and gain on sale of loans, and
broker fee income, we derive income from other fees earned on the loans funded
such as underwriting fees, prepayment
82
penalties, and late charge fees for delinquent loan payments. Revenues
associated with the financial products marketed by Approved Financial Solutions
are also recorded in other income. For the year ended December 31, 2001, other
income totaled $2.0 million compared to $2.1 million for the same period in
2000. The level of other income was affected by a reduction in the retail
division, which marketed the financial products offered by AFS, and the increase
in wholesale originations, which earn underwriting fees.
Comprehensive Income/Loss
For the year ended December 31, 2001 and 2000 we had other comprehensive income
of $12,000 and $4,000, respectively, in the form of unrealized holding
gains/losses on an Asset Management Fund investment.
Compensation and Related Expenses
The largest component of expenses is compensation and related expenses, which
decreased by $2.0 million to $9.5 million for the year, ended December 31, 2001
from 2000. The decrease was directly attributable to a decrease in the number of
employees, related to our productivity enhancement and cost cutting initiatives.
For the year ended December 31, 2001, salary expense decreased by $2.0 million
when compared to the same period in 2000. For the year ended December 31, 2001
the commissions to loan officers increased by $.07 million when compared to the
same period ended December 31, 2000. The increase was primarily due to higher
loan volume. Payroll taxes and related benefits decreased by $.08 million for
the year ended December 31, 2001 when compared to the same period in 2000. As of
December 31, 2001, the number of full time equivalent employees was 101 compared
to 207 as of December 31, 2000.
General and Administrative Expenses
General and administrative expenses are comprised of various expenses such as
advertising, rent, postage, printing, general insurance, travel & entertainment,
telephone, utilities, depreciation, professional fees and other miscellaneous
expenses. General and administrative expenses for the year ended December 31,
2001 decreased by $1.9 million to $5.9 million, compared to the year ended
December 31, 2000. The decrease was the result of a reduction in retail loan
origination offices, the reduction in retail marketing expenses, a decline in
our employee count, and our continued cost cutting efforts.
Loan Production Expense
Loan production expenses are comprised of expenses for appraisals, credit
reports, and payment of fees to mortgage brokers, for services rendered on loan
originations, and
83
verification of mortgages. Loan production expenses for the year ended December
31, 2001 were $1.8 million compared to $1.2 million for the year ended December
31, 2000. The increase was primarily the result of increased origination volume
in the wholesale broker division.
Provision for Loan Losses
The following table presents the activity in the allowance for loan losses for
HFY loans which includes general and specific allowances and selected loan loss
data for the year ended December 31, 2001 and the allowance for loan losses for
HFY and HFS loans for the year ended December 31, 2000:
(In thousands)
2001 2000
Balance at beginning of year $ 1,479 $ 1,382
Provision charged to expense 91 639
Loans charged off (746) (1,086)
Recoveries of loans previously charged off 56 544
------------ ------------
* Balance at end of period $ 880 $ 1,479
============ ============
HFS loans receivable at December 31, 2001,
gross of valuation allowance and deferred $ 48,464 $ 30,685
fees
HFY loans receivable at December 31, 2001,
gross of allowance for losses and deferred
fees 11,347 7,917
HFS and HFY Loans receivable at the end of
period, gross of allowance for losses $ 59,811 $ 38,602
Ratio of allowance for loan losses to gross
loans receivable at the end of periods 1.47% 3.83%
* Valuation Allowance Charges for HFS loans
not recorded in allowance for loan losses
as of December 31, 2001
The provision for loan losses was $91,000 for the year ended December 31, 2001
compared to $639,000 for the year ended December 31, 2000. The provision for
loan losses is based on management's assessment of the loan loss risk for the
associated loans. For the year ended December 31, 2001, the net decrease in the
allowance for loan losses was primarily due to the change in loss reserve
methodology integrating the valuation allowance for HFS loans beginning in the
second quarter of 2001. The valuation allowance for HFS loans is charged as an
expense to income reducing the book value of the HFS loan receivable and is not
included in allowance for loan losses or in calculation of regulatory capital
ratios. The valuation allowance provisions for
84
loans held for sale and the Allowance for Loan Losses on loans held for yield
are established at levels that we consider adequate to cover future loan losses
relative to the composition of the current portfolio of loans. We consider
characteristics of our current loan portfolio such as credit quality, the
weighted average coupon, the weighted average loan to value ratio, the combined
loan to value ratio, the age of the loan portfolio, recent loan sale pricing for
loans with similar characteristics, estimated net realizable value of loans, and
the portfolio's delinquency and loss history and current status in the
determination of an appropriate allowance. Other criteria such as covenants
associated with our credit facilities, trends in the demand for and pricing for
loans sold in the secondary market for similar mortgage loans and general
economic conditions, including interest rates, are also considered when
establishing the allowance. Adjustments to the reserve for loan losses may be
made in future periods due to changes in the factors mentioned above and any
additional factors that may effect anticipated loss levels in the future.
Provision for Foreclosed Property Losses
The provision for foreclosed property losses was $237,000 for the year ended
December 31, 2001 compared to $451,000 for the year ended December 31, 2000. The
allowance for REO losses decreased for the year ended December 31, 2001,
compared to December 31, 2000 primarily due to the change in loss reserve
methodology adopted in 2001 to comply with regulatory guidance and because of
the decline in the unit and dollar amount of REO properties. The allowance in
2001 was established such that the book value of the asset reflects the
estimated net realizable value of the underlying property. The allowance in 2000
was established at approximately 75% of the appraised property value.
Sales of real estate owned yielded net losses of $500,000 for the year ended
December 31, 2001 versus $792,000 for the year ended December 31, 2000.
85
The following table presents the activity in the allowance for foreclosed
property losses and selected real estate owned data for the year ended December
31, 2001 and 2000:
(In thousands)
2001 2000
----------------- ----------------
Balance at beginning of year $ 377 $ 718
Provision charged to expense 236 451
Loss on sale of foreclosures (500) (792)
----------------- ----------------
Balance at end of period $ 113 $ 377
================= ================
Real estate owned at the end of period, gross
of allowance for losses $ 702 $ 1,528
Ratio of allowance for foreclosed property losses
to gross real estate owned at the end of period 16.10% 24.67%
Assets acquired through loan foreclosure are recorded as real estate owned
("REO"). When a property is transferred to REO status, a new appraisal is
ordered on the property. An allowance for REO loss is then established on that
property based upon the estimated net realizable value, which is the lower of
the appraised or listed price of the property less the estimated expense to
liquidate. While we believe that our present allowance for foreclosed property
losses is adequate, future adjustments may be necessary.
Financial Condition at December 31, 2002 and 2001
Assets
The total assets were $60.6 million at December 31, 2002 compared to total
assets of $78.5 million at December 31, 2001.
Cash and cash equivalents decreased by $0.1 million to $11.5 million at December
31, 2002, from $11.6 million at December 31, 2001.
Net mortgage loans receivable decreased by $15.6 million to $42.6 million at
December 31, 2002. The 36.7% decrease in 2002 is primarily due to a decrease in
the dollar amount of new loan originations held for sale, loan sales exceeding
total loan originations in 2002, no new loans were originated for the held for
yield ("HFY") portfolio and the customary principal runoff from loan pay off,
loan payments and loan foreclosure activity in the existing HFY portfolio as of
December 2001.
The table below illustrates origination volume for the forth quarter of 2002
and 2001.
Fourth Quarter Loan Origination Volume (in thousands)
-----------------------
Division 4Q - 02 4Q - 01
-----------------------
Wholesale - Western United States 3.6 16.0
-----------------------
Wholesale - Eastern and Central United States 55.4 52.9
-----------------------
Retail * 1.8 10.6
-----------------------
TOTAL $ 60.8 $ 79.5
-----------------------
* Number of retail Offices at 12-31 1 1
86
Real estate owned ("REO") decreased by $145,000 to $444,000 at December 31,
2002. The 24.6% decrease in REO resulted from the sale of $1.8 million in REO
properties compared to additions of $1.7 million to REO offset by a net increase
to the allowance of $78,000 during the twelve months ended December 31, 2002.
Investments decreased by $0.2 million to $0.8 million at December 31, 2002.
Investments consist of FHLB stock owned by the Bank. The 22.7% decrease in
investments in 2002 is due to the decrease of shares of FHLB stock owned by the
bank.
Premises and equipment decreased by $0.6 million to $3.2 million at December 31,
2002. The decrease is due to the depreciation of current assets and the sale or
charge off of equipment from closed operations for the year ended December 31,
2002.
Goodwill (net) totaled $71,000 at December 31, 2002 and 2001.
Income tax receivable increased by $1.0 million to 1.2 million at December 31,
2002. The increase represents Federal income taxes to be refunded to the
Company.
The deferred tax asset decreased by $1.6 million and is fully reserved at
December 31, 2002.
The write down of the deferred tax asset by means of an increase in a related
valuation allowance in the first quarter of 2002 was based on management's
estimates and projections for the remainder of 2002 at that time. The write down
of the deferred tax asset by means of an increase in a related valuation
allowance recorded in the second quarter of 2002 was primarily a reduction in
managements expectations for loan origination activity for the remainder of
2002, primarily due to the closure of a wholesale loan origination division
required under contractual obligations with its prior manager. This reduction in
projected loan volume reduced management's projected financial results. The
current income tax benefit recorded in the third quarter was the result of
conversations with our tax advisers related to a revised Federal tax law,
enacted in 2002, whereby, in 2002 a company that experiences tax losses can
carry the loss back up to five years to obtain a current tax refund. In the
third quarter of 2002, the company estimated, based on projections of 2002 tax
losses, that it should be able to obtain a minimum tax refund from 1997 of
approximately $500,000. Based on final year-end tax computations, a refund of
approximately $1 million was calculated and a benefit for this amount was
recorded.
Other assets decreased by $584,000 to $770,000 at December 31, 2002. Other
assets consist of accrued interest receivable, prepaid assets, brokered loan
fees receivable, deposits, and various other assets. The majority of the
decrease was due to collections of some receivables.
Liabilities
Outstanding balances for our revolving warehouse loans increased by $7.1 million
to $10.4 million at December 31, 2002. The
87
increase in 2002 was primarily attributable to the increase in the use of the
line of credit.
The Bank's deposits totaled $37.8 million at December 31, 2002 compared to $59.9
million at December 31, 2001. Of the certificate accounts on hand as of December
31, 2002, a total of $37.0 million is scheduled to mature in the twelve-month
period ending December 31, 2002.
Through an arrangement with a local NASD broker/dealer we held $1.8 million and
$2.2 million in FDIC insured money market deposits as of December 31, 2002 and
December 31, 2001, respectively.
Promissory notes and certificates of indebtedness totaled $4.6 million at
December 31, 2002 compared to $4.6 million at December 31, 2001. There was no
change in the total at December 31, 2002 compared to 2001. During the years of
2002 and 2001, we were not soliciting new promissory notes or certificates of
indebtedness. We have utilized promissory notes and certificates of
indebtedness, which are subordinated to our warehouse lines of credit, to help
fund its operations since 1984. Promissory notes outstanding carry terms of one
to three years and interest rates between 5% and 10%, with a weighted-average
rate of 7.48% at December 31, 2002. Certificates of indebtedness are uninsured
deposits authorized for financial institutions, which have Virginia industrial
loan association charters. The certificates of indebtedness carry terms of one
to five years and interest rates between 6.75% and 10.00%, with a
weighted-average rate of 9.76% at December 31, 2002.
Mortgage loans payable totaled $1.68 million at December 31, 2002 compared to
$1.75 million at December 31, 2001. The decrease is attributable to the normal
principal payments on the mortgage held on the company's corporate headquarters
building.
Accrued and other liabilities were $2.2 million at December 31, 2002 compared to
$1.4 million at December 31, 2001. The increase of $0.7 million was primarily
attributable to the increase in accrued expenses for 2002. This category
includes accounts payable, accrued interest payable, deferred income, accrued
bonuses, and other payables.
Shareholders' Equity
Total shareholders' equity at December 31, 2002 was $2.2 million compared to
$5.4 million at December 31, 2001. The $3.2 million decrease in 2002 was due
primarily to the loss for the twelve months ended December 31, 2002.
Liquidity and Capital Resources
88
Our operations require access to short and long-term sources of cash. Our
primary sources of cash flow result from the sale of loans through whole loan
sales, loan origination fees, processing, underwriting and other fees associated
with loan origination and servicing, revenues generated by Approved Financial
Solutions and Global Title of Md., Inc., net interest income, and borrowings
under our warehouse facilities, certificates of indebtedness issued by Approved
Financial Corp. and FDIC insured deposits issued by the Bank to meet working
capital needs. Our primary operating cash requirements include the funding of
mortgage loan originations pending their sale, operating expenses, income taxes
and capital expenditures.
Adequate credit facilities and other sources of funding, including the ability
to sell loans in the secondary market, are essential to our ability to continue
to originate loans. We have in certain prior periods experienced negative cash
flow from operations. This was due to the timing of cash used to fund new loan
originations and the subsequent receipt of cash from the sale of the loan. Loan
sales normally occur 30 to 45 days after proceeds are used to fund the loan. For
the twelve months ended December 31, 2002, we had positive cash flow from
operating activities of $13.4 million. For the twelve months ended December 31,
2001, we had negative cash flow from operations of $21.4 million.
We finance our operating cash requirements primarily through warehouse and other
credit facilities, and the issuance of other debt. For the twelve months ended
December 31, 2002, we decreased debt from financing activities of $15.4 million,
this was primarily the result of decrease in certificates of deposits. For the
twelve months ended December 31, 2001, we increased debt from financing
activities of $21.2 million.
Our borrowings (revolving warehouse and other credit facilities, FDIC-insured
deposits, mortgage loans on our office building, subordinated debt and loan
proceeds payable) were 92.9% of assets at December 31, 2002 compared to 91.3% at
December 31, 2001.
Whole Loan Sale Program
89
The most important source of liquidity and capital resources is the ability to
profitably sell conforming and non-conforming loans in the secondary market. The
market value of the loans funded is dependent on a number of factors, including
but not limited to loan delinquency and default rates, the original term and
current age of the loan, the interest rate and loan to value ratio, whether or
not the loan has a prepayment penalty, the credit grade of the loan, the credit
score of the borrower, the geographic location of the real estate, the type of
property and lien position, the supply and demand for conforming and
non-conforming loans in the secondary market, general economic and market
conditions, market interest rates and governmental regulations. Adverse changes
in these conditions may affect our ability to sell mortgages in the secondary
market for acceptable prices, which is essential to the continuation of our
mortgage origination operations.
Bank Sources of Capital
The Bank's deposits totaled $37.8 million at December 31, 2002 compared to $59.9
million at December 31, 2001. The Bank currently utilizes funds from deposits
and lines of credit to fund first lien and junior lien mortgage loans. We plan
to increase the use of credit facilities and seek additional funding sources in
future periods.
Warehouse and Other Credit Facilities
In November 2001, we obtained a $7.0 million bank line of credit. The interest
charged is based on the one month LIBOR rate and ranges from 4.43% to 5.43% over
the one month LIBOR for various loans, additionally rates for Aged outstanding
loans ranges from 7.43% to 8.43% over the one month LIBOR rate. All advances are
subject to various transactions fees based upon the number of loans funded. As
of December 31, 2001 we were in compliance with all financial covenants. This
line was terminated the first quarter of 2002.
In December 2001, we obtained a $15.0 million repurchase agreement with interest
at prime plus 1.25%. In June 2002 the line was increased to $25.0 million. The
line has various financial requirements including a minimum tangible net worth
to exceed $916,000. As of December 31, 2002 we were in compliance with all
financial covenants. There is no stated expiration date for this credit
facility.
Other Capital Resources
Uninsured promissory notes and certificates of indebtedness issued by Approved
Financial Corp. have been a source of capital since 1984 and are issued
primarily according to an intrastate exemption from security registration.
Promissory notes and
90
certificates of indebtedness totaled $4.6 million at December 31, 2002 and 2001,
respectively. These borrowings are subordinated to FDIC insured deposits and our
warehouse lines of credit. We cannot issue subordinated debt to new investors
under the exemption since the state of Virginia is no longer our primary state
of operation.
We had cash and cash equivalents of $11.5 million at December 31, 2002. We have
sufficient resources to fund our current operations. Alternative sources for
future liquidity and capital resource needs may include private security sales,
the public issuance of debt or equity securities, increase in FDIC insured
deposits and new lines of credit. Each alternative source of liquidity and
capital resources will be evaluated with consideration for maximizing
shareholder value, regulatory requirements, the terms and covenants associated
with the alternative capital source. We expect that we will continue to be
challenged by a limited availability of capital, fluctuations in the market
price of and premiums received on whole loan sales in the secondary market
compared to premiums realized in recent years, new competition and a slow
economic environment leading to a possible rise in loan delinquency and the
associated loss rates.
Bank Regulatory Liquidity
Liquidity is the ability to meet present and future financial obligations,
either through the acquisition of additional liabilities or from the sale or
maturity of existing assets, with minimal loss. Regulations of the OTS require
thrift associations and/or banks to maintain liquid assets at certain levels. At
present, the required ratio of liquid assets to borrowings, which can be
withdrawn and are due in one year or less is 4.0%. Penalties are assessed for
noncompliance. In 2002 and 2001, the Bank maintained liquidity in excess of the
required amount, and we anticipate that we will continue to do so.
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Bank Regulatory Capital
At December 31, 2002, the Bank's book value under accounting principles
generally accepted in the United States of America ("US GAAP") was $5.2 million.
OTS Regulations require that institutions maintain the following capital levels:
(1) tangible capital of at least 1.5% of total adjusted assets, (2) core capital
of 4.0% of total adjusted assets, and (3) overall risk-based capital of 8.0% of
total risk-weighted assets. As of December 31, 2001, the Bank satisfied all of
the regulatory capital requirements, as shown in the following table reconciling
the Bank's GAAP capital to regulatory capital:
Tangible Core Risk-Based
(In thousands) Capital Capital Capital
GAAP capital $ 5,206 $ 5,206 $ 5,206
Add: unrealized loss on securities
Nonallowable asset: goodwill (71) (71) (71)
Additional capital item: general allowance
- - 420
Deferred Taxes - - -
---------------- ---------------- ---------------
Regulatory capital - computed 5,135 5,135 5,555
Minimum capital requirement 895 2,386 3,229
---------------- ---------------- ---------------
Excess regulatory capital $ 4,240 $ 2,749 $ 2,326
================ ================ ===============
Ratios:
Regulatory capital-computed 8.61% 8.61% 13.76%
Minimum capital requirement 1.50% 4.00% 8.00%
---------------- ---------------- ---------------
Excess regulatory capital 7.11% 4.61% 5.76%
================ ================ ===============
The OTS issued CEO Memorandum #137 in February of 2001 providing guidance to
those institutions with a significant subprime credit exposure which established
a threshold of 25% or more of an institution's Tier I regulatory capital as the
starting point for greater supervisory scrutiny. A key underlying principle in
the guidance is that each subprime lender is responsible for quantifying the
additional risks in its subprime lending activities and determining the
appropriate amounts of ALLL and capital it needs to offset those risks. We
believe that our current capital ratios are appropriate for the risk levels
related to our current lending activity and loan portfolio. The revised
computation methodology adopted in 2001 for loan losses also assist in
monitoring and providing for these risks.
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Bank Regulatory Actions
As disclosed in the SEC filings beginning with the Form 10Q for March 31, 2001,
the OTS issued a written directive to Approved Financial Corp. ( "AFC") and
Approved Federal Savings Bank ( "AFSB") dated April 20, 2001, stating that as a
result of AFSB's practice of assigning loans to AFC, its holding company, it was
declaring AFSB a "problem association" and was declaring AFC in "troubled
condition" as set forth in applicable laws and regulations.
The practice of inter-company loan assignments has been standard operating
procedure between AFSB and AFC for several years. This operating procedure was
disclosed during prior audits, including audits by the Company's independent
public accountants and has no effect on previously audited consolidated
financial statements. The Board of Directors of AFSB and AFC acknowledge and
respect the authority and power of the OTS and acted promptly to implement
corrective actions requested by the OTS.
Management and the Boards of Directors submitted a Business Plan ("Plan") with
revised inter-company operating procedures to the OTS and the Board of Directors
of the Bank entered into a Consent Supervisory Agreement ("Agreement") with the
OTS on December 3, 2001 as filed on Form 8K. In addition to the required
adherence to all banking and lending regulations and various confirmation of
compliance oversight required from the Board of Directors, the primary
corrective actions and new operating procedures outlined in the Plan and/or the
Agreement include the following.
1. Organizational Structure and Management: Immediately upon receipt of the
Directive Letter, the Chairman of the Board and the President of AFSB
resigned their positions. A revised organizational structure was
submitted in the Plan and has been implemented that establishes a "wall"
between AFSB and AFC. Under the revised structure all AFC staff report to
a manager or officer of AFC and all AFSB staff report to a manager or
officer of AFSB. The OTS issued a non-objection letter relating to the
following slate of Bank officers and their compensation arrangements.
These officers consist of qualified individuals who were employed by AFSB
or AFC prior to April 20, 2001 thus eliminating the expense and time
involved in making a transition to outside independent management as
initially directed by the OTS.
[_] Jean S. Schwindt, President & COO of AFSB. Ms. Schwindt has
served as Director of AFC since 1992, Director of AFSB since
1996 and as an officer of AFC since 1998. Ms. Schwindt has over
twenty years of financial services experience working primarily
in highly regulated environments.
[_] Neil Phelan, Executive Vice President and Director of AFSB. Mr.
Phelan has served as a Director of AFC since 1997, Director of
AFSB since 1996 and as an officer of AFC since 1995. Mr. Phelan
has over twenty years of
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financial services experience primarily in the mortgage lending
area.
2. Board of Directors: The Board of Directors of AFSB, in addition to the
three Directors that are employed by either AFC or AFSB, has three
outside Directors as follows.
[_] Leon Perlin has served on the Board of Directors of the Bank since
1996. Mr. Perlin was an initial investor in AFC when current
management purchased the company in 1984 and has served on the board
of AFC since 1984.
[_] Dennis J. Pitocco has served as an outside Director of AFSB
since May 25, 2001. Mr. Pitocco's experience includes 27 years
in the financial services industry having served in management
positions for domestic regulated banking institutions and
domestic and international non-bank lending institutions.
[_] Eric Yeakel, who has been a Director of AFSB since 1996 and the
Chief Financial Officer of AFC since 1994, resigned his
position as Chief Financial Officer in July of 2001. Mr. Yeakel
now serves as an outside Director of AFSB.
3. Loan Assignments: AFSB ceased assignment of loans to AFC on April 19,
2001. However, as of June 27, 2001, the OTS permitted AFSB to assign
loans to AFC with AFSB receiving the full principal amount of the loan at
time of assignment, which provided for the temporary use of a warehouse
credit facility available to AFC at that time to fund loans. AFSB entered
into separate warehouse credit facilities in the fourth quarter of 2001
and such loan assignments between AFSB and AFC were no longer applicable.
4. Transfer of Assets and Promissory Note: Loans assigned to AFC by AFSB
prior to April 21, 2001 and other assets owned by AFC including mortgage
loans, the home office building, land and furniture and equipment were
transferred from AFC to AFSB during the second quarter of 2001. AFSB
recorded a charge to income as a provision to valuation allowance for
intercompany receivable in 2001 equal to the net inter-company receivable
due to AFSB after the transfer of these assets. There was no related
effect on the consolidated statements of income (loss) and comprehensive
income (loss). In November of 2001, AFC and AFSB executed an intercompany
Promissory Note equal to the amount charged off by AFSB for this
intercompany receivable. The Promissory Note provides for quarterly
interest payments commencing January 1, 2002 and quarterly principal
payments commencing July 1, 2002 with the remaining balance due in full
on July 1, 2007. The note can be prepaid without penalty at any time. As
this is an intercompany transaction, there is no effect on the
consolidated income statement. As of December 31, 2002, all principal and
interest payments are current.
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5. Limitation of Growth of Assets and Lending Policy: We are required to
underwrite mortgage loans according to the underwriting criteria of our
investors, according to risk-based pricing guidelines and to insure that
consumer disclosure and file documentation is in compliance with lending
regulations. Asset growth is limited to the extent that we must not
increase the dollar amount or number of loans in our held for yield
portfolio, thus loans originated are held for sale and marketed to market
monthly.
6. Transactions with Affiliates. All transactions between the Bank and AFC
or AFC non-bank affiliates must comply with the provisions of 12 U.S.C.
ss.1468. A fee-for-services agreement has been adopted and applied in the
calculation of intercompany settlements since June 2001, whereby AFC
performs services such as underwriting, processing, doc/closing, loan
servicing and collections, quality control, secondary marketing, Human
Resource/corporate administration and information systems maintenance.
7. Financial Modeling tool: An internal financial projection model was used
as the primary development tool for the Plan and the revised
inter-company procedures and fee schedules. Stress testing was conducted
to evaluate the financial position of AFC and AFSB under various business
conditions and applying various assumptions for loan volume and whole
loan sale revenue. The model is a dynamic tool and therefore is revised
periodically to adjust to changes in operations. Projections are reported
to the Board of Directors quarterly as required by the Consent
Supervisory Agreement.
8. Provision for Loan Loss Methodology: In accordance with interagency
guidance issued in 2001, we revised our methodology for determining and
recording loss reserves on loans held for sale, held for yield and real
estate acquired through foreclosure.
As of each financial reporting date, management evaluates and reports all held
for sale loans at the lower of cost or market value. Any decline in value,
including those attributable to credit quality, are accounted for as a charge to
provision for valuation allowance for held-for-sale loans, not as adjustments to
the allowance for loan and lease losses (ALLL). Such provision is charged
against income and not reported as part of ALLL, and therefore is not eligible
for inclusion in Tier 2 capital for risk based capital purposes. Valuation
allowances are established based on the age of the loan as well as special
circumstances known to management that merit a valuation allowance. The general
valuation allowance percentage guidelines are based on secondary marketing
management opinion as to risk levels of the loans, review of secondary market
pricing for sales of loans with similar characteristics and OTS regulatory
guidance. Loans held 90 days or less that do not fall into a special
circumstance category are carried at cost. A valuation allowance of 5.5% is
charged against first lien non-conforming mortgage loans held over 90 days and a
valuation allowance of 20% is charged against subordinated liens held over 90
days that do not fall into a special circumstance category. All loans considered
to be special circumstance are carried at the net realizable value. The net
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realizable value represents the current appraised or listed property valuation
less estimated cost to liquidate the property. The difference in the principal
value of the loan and the net realizable value is recorded as a Valuation
Allowance and is not recorded in ALLL.
Held for Yield Loans ("HFY"): The methodology adopted for determining
the ALLL is in accordance with interagency guidance issued July 2001.
ALLL is calculated based on delinquency status of loans held for yield
or based on other special circumstance known to management that requires
a loss reserve. Currently, a general reserve is recorded in ALLL of 5%
for first lien and 10% for second lien mortgage loans with current
payment status. A 10% general reserve is established for first lien
mortgage loans delinquent 91 to 120 days and 100% (charge off) general
reserve is established for second lien mortgage loans delinquent over 90
days. For first lien mortgages over 120 days delinquent a specific
reserve is established based on the net realizable value of the loan.
The net realizable value represents the current appraised or listed
property valuation less estimated cost to liquidate the property. The
difference in the principal value of the loan and the net realizable
value is recorded as a Valuation Allowance and is not recorded in ALLL.
Real Estate Owned ("REO") Property acquired through foreclosure is
carried at the net realizable value. The net realizable value represents
the current appraised or listed property valuation less estimated cost
to liquidate the property.
9. Warehouse Line of Credit: The Agreement requires AFSB to use its best
efforts to obtain adequate warehouse line of credit facilities at the
Association for the purpose of providing additional funding sources for
loans held for sale. We acquired two credit facilities in the fourth
quarter of 2001 for a total of $22 million. One of these credit
facilities was allowed to expire as it was not administratively suitable
to the Bank's funding needs. The second credit facility lending limit
was increased from $15 million to $25 million in June of 2002.
10. Dividend Policy: The Bank adopted a policy whereby a request for
dividends will not be made to the OTS until the Bank's regulatory
capital levels are restored to at least the levels reported as of
December 31, 2000 and the Bank will remain well-capitalized following
the payment of the dividend.
11. Financial Reporting Policy
The OTS is provided with the following Daily Financial Reports based on
consolidated activity for AFC as of the 15th and final day of each calendar
month:
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i. Loan Funding Report, listing by day the number and dollar
amount of loans funded, categorized by retail conforming, retail
non-conforming, retail government, wholesale -East Division, and wholesale -
West Division;
ii. Loan Sales Report, listing by day the number and dollar
amount of loans sold to investors and average sales premiums, categorized by
investor;
iii. Sources of Funds Report, listing by day the aggregate balance
of deposit liabilities, the balance and unused capacity of all other
borrowings, categorized by source, and the balance of liquid assets,
categorized by type; and
12. The OTS is provided with the following Monthly Financial Reports no
later than the 30th day of the month following the month for which the
report is prepared:
i. Monthly Income Statement (AFC and AFSB-only);
ii. Month-end Statement of Financial Condition (AFC and AFSB
only); and
iii. Month-end Deposit Maturity Schedule.
13. We elected to establish a policy concerning Loans to Officers, Directors
and Other Affiliated Parties, whereby such activity is not allowed.
14. As a result of the Directive Letter, AFC and AFSB are subject to
additional fees, applications, notices and loss of expedited status.
Related to such a $523 fee is associated with the application for new
directors and a fee of $500 was associated with the application for each
of the new executive officers. The OTS semi annual assessment increased
from $24,000 to $28,000 for the 2nd half of 2002.
15. In addition to the provisions included in the Consent Supervisory
Agreement and Directive, as requested by the OTS, we are aggressively
seeking procurement of private investors and/or a merger or acquisition
transaction for AFC to enhance the management and capital of the Bank.
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Interest Rate Risk Management
We originate mortgage loans for sale as whole loans. We mitigate our interest
rate exposure, and the related need for hedging activity, by selling most of the
loans within sixty days of origination. Currently loans held for yield by the
Bank are primarily composed of adjustable rate mortgages in order to minimize
the Bank's interest rate risk exposure. However, excluding the Bank's loans held
for investment the majority of loans held beyond the normal sixty-day holding
period are fixed rate instruments. Since most of our borrowings have variable
interest rates, we have exposure to interest rate risk. For example, if market
interest rates were to rise between the time we originate the loans and the time
the loans are sold, the original interest rate spread on the loans narrows,
resulting in a loss in value of the loans. To offset the effects of interest
rate fluctuations on the value of our fixed rate mortgage loans held for sale,
we, in certain cases, may enter into transactions such as Treasury security lock
contracts, which function similar to short sales of U.S. Treasury securities. If
the value of an interest rate hedge position decreases, offsetting an increase
in the value of the hedged loans, upon settlement with the counter-party, we
will pay the hedge loss in cash and realize the corresponding increase in the
value of the loans. Conversely, if the value of a hedge position increases,
offsetting a decrease in the value of the hedged loans, we will receive the
hedge gain in cash at settlement. We may in the future enter into forward loan
sale commitments with investors for our non-conforming mortgages. Prior to
entering into any type of hedge transaction or forward loan sale commitment, we
perform an analysis of the loan associated with the transaction or commitment
taking into account such factors as credit quality of the loans, interest rate
and term of the loans, as well as current economic market trends, in order to
determine the appropriate structure and/or size of a hedge transaction or loan
sale commitment that will limit our exposure to interest rate risk. We had no
hedge contracts or forward commitments outstanding at December 31, 2001. We had
one forward commitment for loan sales outstanding as of December 31, 2002.
The Board adopted a policy for mitigating interest rate risk exposure in August
2002 including the following guidelines.
The Bank originates mortgage loans according to investor underwriting guidelines
and intended for sale as whole loans to these investors within thirty (30) to
ninety (90) days. This operating strategy mitigates our interest rate exposure,
and the related need for hedging activity. The majority of current
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mortgage originations are fixed rate instruments. Therefore, our primary
exposure to interest rate risk is the period of days, on average forty-five (45)
days, between approval of a loan rate and the eventual sale of the loan. For
example, if benchmark market interest rates were to rise between the time we
approve the interest rate for a fixed rate loan and the time the loan is sold,
the theoretical interest rate spread to the investor narrows, resulting in a
reduction in the market value of the loan, excluding other valuation criteria
applied by our investors.
The restriction imposed on the Bank by means of OTS Directive Letter dated April
20, 2001 and Consent Supervisory Agreement dated December 3, 2001 currently
prohibits the Bank from increasing the dollar amount or number of loans in the
Held For Yield portfolio. The average weighted coupon (interest rate) on these
loans have coupon rates higher than those available from current mortgage
origination activity. Therefore, the reduction in general interest rates in
recent years accompanied by a natural reduction in the size of this portfolio
from `runoff' (principal reduction through regular loan payments and payoff) and
the fact that loans are currently not being originated for addition to this
portfolio, has mitigated the associated level of interest rate risk exposure.
In recent years, pricing for our product offering rate sheets was normally
adjusted upon receipt of notice from investors of changes in their pricing
criteria. Pricing of a loan approval is normally honored if the loan is closed
within a fifteen-day period. Therefore, to mitigate the risks associated with
interest rate fluctuations our secondary marketing division now monitors the
daily market prices and associated interest rate yields of bonds and/or other
market interest rates used by investors as benchmarks for pricing pools of loans
and adjusts our product offering rate sheets based on material changes as deemed
appropriate, which may be before pricing change notice has been received from
the investor.
Corporate Policy is to honor rate locks for fifteen (15) days from loan
approval. Any request for extension of a rate lock beyond 15 days must be
approved by the officer in charge of secondary marketing department after
reviewing the effect on projected loan valuation.
In certain cases we may enter into forward loan sale commitments with investors
and/or make use of similar transactions such as mandatory loan sales. Under
these arrangements, we are normally allowed an agreed number of days to deliver
a specified amount of loans meeting the investor's underwriting criteria and
according to a prearranged pricing formula. Under these agreements, the investor
assumes the risk for increases in interest rates for the term of the agreement
and we are obligated to deliver the loan
99
volume. Since the investor is normally a larger institution that purchases pools
of loans from many investors under similar agreements, the investor utilizes the
advantages from economy of scale and can implement a cost effective hedging
strategy to mitigate the assumed interest rate risk. Therefore, we will use this
strategy to mitigate interest rate risk when the appropriate opportunities are
presented based on overall risk reward evaluation.
The only 'perfect' hedging strategy is one that is structured with transactions
involving the identical security; in other words, there is no perfect hedge.
Therefore, implementation of a hedging strategy, in and by itself presents an
additional risk component to any institution engaging in such activity.
Additionally, successful hedging strategies require employment of the
appropriate level of expertise and the accessibility of high level modeling
tools. Therefore, the adoption of a hedging strategy must be scrutinized on a
risk reward basis and closely monitored. Our current level of interest rate risk
exposure ensuing from the present classification between HFS and HFY for our
outstanding loan portfolio and new loan originations, our secondary market plan
using whole loan sales and the expense related to adoption of a sophisticated
hedging policy for our current level of origination activity does not merit
implementation of such at this time. In the future, the Board may determine it
appropriate to adopt a more complex interest rate hedging strategy and may enter
into typical transactions such as short sales of U.S. Treasury securities. Any
type of hedge transaction or forward loan sale commitment, is evaluated on a
risk reward basis and intended to limit our exposure to interest rate risk.
As part of the quarterly Board of Director meeting, secondary market activity
and current secondary market conditions are reviewed including the effect of
interest rate fluctuations on loan sale premiums, initiatives to procure and
opportunities available for entering into forward loan sale commitments, rate
sheet pricing activity. The Board reviews OTS guidance on interest rate risk and
the interest rate NPV reports concerning the Bank.
Critical Accounting Policies and Estimates
The accounting and reporting policies of the corporation are in accordance with
accounting principles generally accepted in the United States of America and
conform with general practices in the banking industry. The preparation of
financial statements in conformity with these principles requires management to
make estimates and assumptions that effect the reported amounts of assets and
liabilities, revenues and expenses, and related disclosures of contingent assets
and liabilities at the date of the financial statements. These estimates and
assumptions are based on information available at the date of the financial
statements and actual results may differ under different assumptions or
conditions.
Deferred Tax Asset: The book net value of deferred tax assets are based on
management's estimates and projections for loan origination and financial
results for future periods. If management deems the deferred tax asset as not
realizable, the deferred tax asset book value is adjusted by means of an
increase in a related valuation allowance.
Loan Loss Reserve: The loan loss reserve for loans held for sale is recorded as
a valuation allowance. The loan loss reserve for loans held for yield is
recorded as an allowance for loan and lease loss. The methodology for
calculating these loan loss reserves is described in detail in footnote 1 of the
consolidated financial statements.
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New Accounting Standards
In September 2000, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,
a replacement of SFAS No. 125. It revises the standards for accounting for
securitizations and other transfers of financial assets and collateral and
requires certain disclosures, but it carries over most of provisions of SFAS No.
125 without reconsideration. The Statement requires a debtor to reclassify
financial assets pledged as collateral and report these assets separately in the
statement of financial position. It also requires a secured party to disclose
information, including fair value, about collateral that it has accepted and is
permitted by contract or custom to sell or repledge. The Statement includes
specific disclosure requirements for entities with securitized financial assets
and entities that securitize assets. This Statement is effective for transfers
and servicing of financial assets and extinguishments of liabilities occurring
after March 31, 2000 and is effective for recognition and reclassification of
collateral and for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2000. The adoption of SFAS
No. 140 did not have a material effect on financial condition or results of
operation of the Company.
In July 2001, FASB issued SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS No. 142 requires the use of a non-amortization approach to account for
purchased goodwill and certain intangibles, effective January 1, 2002. The
adoption of this pronouncement did not have a material impact on our financial
statements.
In April 2002, FASB issued SFAS No. 145, Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This
statement rescinds FASB No. 4, Reporting Gains and Losses from Extinguishment of
Debt, and an amendment of that Statement, FASB Statement No. 64, Extinguishment
of Debt Made to Satisfy Sinking-Fund Requirements. This Statement also rescinds
FASB Statement No. 44, Accounting for Intangible Assets of Motor Carriers. This
Statement amends FASB No. 13, Accounting for Leases, to eliminate an
inconsistency between the required accounting for sale-leaseback transactions.
This Statement also amends other existing authoritative pronouncements to make
various technical corrections, clarify meanings, or describe their applicability
under changed conditions. The provisions of this statement related to the
recission of Statement No. 4 are effective for fiscal years beginning after May
15, 2002. The provisions related to Statement No. 13 are effective for
transactions occurring after May 15, 2002. All other provisions are effective
for financial statements issued on or after May 15, 2002. The adoption of this
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pronouncement did not have a material impact on our financial statements.
In June 2002, FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. This Statement addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)." The provisions of this statement
are effective for exit or disposal activities initiated after December 31, 2002.
The adoption of this pronouncement is not expected to have a material impact on
our financial statements.
In October 2002, FASB issued SFAS No. 147, Acquisitions of Certain Financial
Institutions-an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9. FASB Statement No. 72, Accounting for Certain Acquisitions
of Banking or Thrift Institutions, and FASB Interpretation No. 9, Applying APB
Opinions No. 16 and 17 When a Savings and Loan Association or a Similar
Institution Is Acquired in a Business Combination Accounted for by the Purchase
Method, provided interpretive guidance on the application of the purchase method
to acquisitions of financial institutions. Except for transactions between two
or more mutual enterprises, this Statement removes acquisitions of financial
institutions from the scope of both Statement 72 and Interpretation 9 and
requires that those transactions be accounted for in accordance with FASB
Statements No. 141, Business Combinations, and No. 142, Goodwill and Other
Intangible Assets. Thus, the requirement in paragraph 5 of Statement 72 to
recognize (and subsequently amortize) any excess of the fair value of
liabilities assumed over the fair value of tangible and identifiable intangible
assets acquired as an unidentifiable intangible asset no longer applies to
acquisitions within the scope of this Statement. In addition, this Statement
amends FASB Statement No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, to include in its scope long-term customer-relationship
intangible assets of financial institutions such as depositor- and
borrower-relationship intangible assets and credit cardholder intangible assets.
Consequently, those intangible assets are subject to the same undiscounted cash
flow recoverability test and impairment loss recognition and measurement
provisions that Statement 144 requires for other long-lived assets that are held
and used. The provisions of this statement are effective for acquisitions for
which the date of the acquisition is on or after October 1, 2002. The adoption
of this pronouncement did not have a material impact on our financial
statements.
In December 2002, FASB issued SFAS No. 148, Accounting for Stock Based
Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123.
This Statement amends FASB Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative
102
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of Statement 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. The Company continues to follow APB 25 and has
complied with the disclosure requirements of SFAS 123 and 148.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented in this
document have been prepared in accordance with generally accepted accounting
principles, which require the measurement of the financial position and
operating results in terms of historical dollars, without considering changes in
the relative purchasing power of money over time due to inflation.
The majority of the assets are monetary in nature. As a result, interest rates
have a more significant impact on our performance than the effects of general
levels of inflation. Inflation affects us most significantly in the area of
residential real estate values and inflation's effect on interest rates. Real
estate values generally increase during periods of high inflation and are
stagnant during periods of low inflation. While, interest rates do not
necessarily move in the same direction or with the same magnitude as the prices
of goods and services, normally interest rates increase during periods of high
inflation and decrease during periods of low inflation.
Loan origination volume generally increases as residential real estate values
increase because homeowners have new home equity values against which they can
borrow. A large portion of our loan volume is related to refinancing and debt
consolidation mortgages, therefore, an increase in real estate values enhances
the marketplace for this type of loan origination. Conversely, as residential
real estate values decrease, the market for home equity and debt consolidation
loan origination decreases. Additionally, an increase or decrease in residential
real estate values may have a positive or negative effect, respectively, on the
liquidation of foreclosed property.
The loans we originate are intended for sale in the whole loan secondary market;
therefore, the effect on interest rates from inflation trends has a diminished
effect on the results of operations. However, the portfolio of loans held for
yield, is more sensitive to the effects of inflation and changes in interest
rates. Profitability may be directly affected by the level and fluctuation of
interest rates, which affect our ability to earn a spread between interest
received on loans and the costs
103
of borrowings. Our profitability is likely to be adversely affected during any
period of unexpected or rapid changes in interest rates. (See also: "Interest
Rate Risk Management").
A substantial and sustained increase in interest rates could adversely affect
our ability to originate and purchase loans and affect the mix of first and
junior lien mortgage loan products. Generally, first mortgage production
increases relative to junior lien mortgage production in response to low
interest rates and junior lien mortgage loan production increases relative to
first mortgage loan production during periods of high interest rates.
While we have no plans to adopt a Securitization loan sale strategy at this
time, if we were to do so in the future, then to the extent servicing rights and
interest-only and residual classes of certificates are capitalized on the books
from future loan sales through securitization, higher than anticipated rates of
loan prepayments or losses could require us to write down the value of such
servicing rights and interest-only and residual certificates, adversely
affecting earnings. A significant decline in interest rates could increase the
level of loan prepayments. Conversely, lower than anticipated rates of loan
prepayments or lower losses could allow us to increase the value of
interest-only and residual certificates, which could have a favorable effect on
our results of operations and financial condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Management - Asset/Liability Management
Our primary market risk exposure is interest rate risk. Fluctuations in interest
rates will impact both the level of interest income and interest expense and the
market value of our interest-earning assets and interest-bearing liabilities.
We strive to manage the maturity or repricing match between assets and
liabilities. The degree to which we are "mismatched" in our maturities is a
primary measure of interest rate risk. In periods of stable interest rates, net
interest income can be increased by financing higher yielding long-term mortgage
loan assets with lower cost short-term Bank deposits and borrowings. Although
such a strategy may increase profits in the short run, it increases the risk of
exposure to rising interest rates and can result in funding costs rising faster
than asset yields. We attempt to limit our interest rate risk by selling a
majority of the fixed rate mortgage loans that we originate.
Contractual principal repayments of loans do not necessarily reflect the actual
term of our loan portfolio. The average lives of mortgage loans are
substantially less than their contractual
104
terms because of loan prepayments and because of enforcement of due-on-sale
clauses, which gives us the right to declare a loan immediately due and payable
in the event, among other things, the borrower sells the real property subject
to the mortgage and the loan is not repaid. In addition, certain borrowers
increase their equity in the security property by making payments in excess of
those required under the terms of the mortgage.
The majority of the loans originated are sold through loan sale strategies in an
attempt to limit exposure to interest rate risk in addition to generating cash
revenues. We sold, during 2001 and 2002, approximately 99.7% of the total loans
originated and funded in-house during the year ended December 31, 2001. Also, we
sold, during 2002 approximately 91.4% of loans originated and funded in-house
during the period beginning January 1, 2002 and ending November 30, 2002. We
expect to sell the majority of our loan originations, other than loans
specifically originated to hold for investment and yield, during the same
twelve-month period in which they are funded in future periods. As a result,
loans are held on average for less than 12 months in our portfolio of Loans Held
for Sale. The "gap position", defined as the difference between interest-earning
assets and interest-bearing liabilities maturing or repricing in one year or
less, was negative at December 31, 2002, as anticipated, and is expected to
remain negative in future periods. We have no quantitative target range for past
gap positions, nor any anticipated ranges for future periods due to the fact
that we sell the majority of our loans within a twelve month period while the
gap position is a static illustration of the contractual repayment schedule for
loans.
105
Our one-year gap was a negative 36.76% of total assets at December 31, 2002, as
illustrated in the following table:
One Year Two Three to More Than Four
Description Total Or Less Years Four Years Years
Interest earning assets:
Loans held for sale (1) $ 37,313 $ 14,205 $ 781 $ 1,782 $ 20,545
Loans held for yield (1) 6,481 2,467 136 309 3,529
Cash and other
interest-earning assets 11,470 11,470 - - -
-------------------------------------------------------------------------------------
55,264 28,142 917 2,091 24,114
=====================================================================
Allowance for loan losses (1,180)
Premises and equipment, net 3,216
Other 3,343
----------------
Total assets $ 60,643
================
Interest-bearing liabilities:
Revolving warehouse lines 10,379 10,379 - - -
FDIC - insured deposits 37,830 37,037 793 - -
FDIC - insured money market account 1,845 1,845 - - -
Other interest-bearing
Liabilities 6,280 1,174 624 2,405 2,077
-------------------------------------------------------------------------------------
56,334 50,435 1,417 2,405 2,077
=====================================================================
Non-interest-bearing liabilities 2,153
----------------
Total liabilities 58,487
Shareholders' equity 2,156
----------------
Total liabilities and equity $ 60,643
================
Maturity/repricing gap $ (22,293) $ (500) $ (314) $ 22,037
=====================================================================
Cumulative gap $ (22,293) $ (22,793) $ (23,107) $ (1,070)
=====================================================================
As percent of total assets (36.76)% (37.59)% (38.10)% (1.76)%
Ratio of cumulative interest earning
Assets to cumulative interest bearing
Liabilities 0.56 0.56 0.57 0.98
=================================================================================================================================
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
106
The principal quantitative disclosure of our market risks is the above gap
table. The gap table shows that the one-year gap was a negative 36.76% of total
assets at December 31, 2002. We originate fixed-rate, fixed-term mortgage loans
for sale in the secondary market. While most of these loans are sold within a
month or two of origination, for purposes of the gap table the loans are shown
based on their contractual scheduled maturities. As of December 31, 2002, 55.1%
of the principal on the loans were expected to be received more than four years
from that date. However, our activities are financed with short-term loans and
credit lines, 89.5% of which re-price within one year of December 31, 2002. We
attempt to limit our interest rate risk by selling a majority of the loans that
we originate. If our ability to sell such fixed-rate, fixed-term mortgage loans
on a timely basis were to be limited, we could be subject to substantial
interest rate risk.
Profitability may be directly affected by the level of, and fluctuations in,
interest rates, which affect our ability to earn a spread between interest
received on our loans and the cost of borrowing. Our profitability is likely to
be adversely affected during any period of unexpected or rapid changes in
interest rates. For example, a substantial or sustained increase in interest
rates could adversely affect our ability to purchase and originate loans and
would reduce the value of loans held for sale. A significant decline in interest
rates could decrease the size of our loan-servicing portfolio by increasing the
level of loan prepayments. Additionally, to the extent mortgage loan servicing
rights in future periods have been capitalized on our books, higher than
anticipated rates of loan prepayments or losses could require us to write down
the value of these assets, adversely affecting earnings.
In an environment of stable interest rates, our gains on the sale of mortgage
loans would generally be limited to those gains resulting from the yield
differential between mortgage loan interest rates and rates required by
secondary market purchasers. A loss from the sale of a loan may occur if
interest rates increase between the time we establish the interest rate on a
loan and the time the loan is sold. Fluctuating interest rates also may affect
the net interest income earned, resulting from the difference between the yield
to us on loans held pending sale and the interest paid for funds borrowed.
Because of the uncertainty of future loan origination volume and the future
level of interest rates, there can be no assurance that we will realize gains on
the sale of financial assets in future periods.
As with other investments, the Bank regularly monitors mortgage loans in its
portfolio and may decide from time to time to sell such loans as part of its
overall asset liability and interest rate risk monitoring activity.
107
Asset Quality
The following table summarizes all of our delinquent loans at December 31, 2002
and 2001:
(in thousands)
2002 2001
--------------------------- ----------------------------
HFS HFY HFS HFY
Delinquent 31 to 60 days $ 135 $ 145 $ - $ 51
Delinquent 61 to 90 days 304 65 411 299
Delinquent 91 to 120 days - 77 63 335
Delinquent 121 days or more 1,020 649 453 1,072
------------- ------------- ------------- -------------
Total delinquent loans (1) $ 1,459 $ 936 $ 927 $ 1,757
============= ============= ============= =============
Total loans receivable outstanding, gross $ 36,860 $ 6,932 $ 48,464 $11,378
============= ============= ============= =============
Delinquent loans as a percentage of
total loans outstanding:
Delinquent 31 to 60 days 0.37% 2.10% 0.00% 0.45%
Delinquent 61 to 90 days 0.82 0.94 0.85 2.63
Delinquent 91 to 120 days 0.00 1.11 0.13 2.94
Delinquent 121 days or more 2.77 9.36 0.93 9.42
------------- ------------- ------------- -------------
Total delinquent loans as a percentage
of total loans outstanding 3.96% 13.50% 1.91% 15.44%
------------- ------------- ------------- -------------
Reserve as a % of delinquent loans 45.30% 55.45% 66.56% 50.09%
============= ============= ============= =============
- -------------
(1) Includes loans in foreclosure proceedings and delinquent loans to borrowers
in bankruptcy proceedings, but excludes real estate owned.
Interest on most loans is accrued until they become 60 days or more past due.
HFS non-accrual loans were $1.32 million and $0.93 million at December 31, 2002
and 2001, respectively. HFY non-accrual loans were $0.92 million and $1.75
million at December 31, 2002 and 2001, respectively. The amount of additional
interest that would have been recorded had the HFS loans not been placed on
non-accrual status was approximately $110,000 and $88,000 for the year ended
December 31, 2002 and 2001, respectively. The amount of additional interest that
would have been recorded had the HFY loans not been placed on non-accrual status
was approximately $85,000 and $168,000 for the year ended December 31, 2002 and
2001, respectively. The amount of interest income on the non-accrual HFS loans
that was included in net income for the year ended December 31, 2002 and 2001
was $36,000 and $10,000, respectively. The amount of interest income on the
non-accrual HFY loans that was included in net income for the year ended
December 31, 2002 and 2001 was $44,000 and $98,000, respectively.
HFS loans delinquent 31 days or more as a percentage of total loans outstanding
increased to 3.96% at December 31, 2002 from 1.91% at December 31, 2001. HFY
loans delinquent 31 days or more as a percentage of total loans outstanding
decreased to 13.50% at December 31, 2002 from 15.44% at December 31, 2001.
At December 31, 2002 and 2001, the recorded investment in HFS loans for which
impairment has been determined, which includes loans delinquent in excess of 90
days, totaled $1.0 million and $0.5 million, respectively. At December 31, 2002
and 2001, the recorded investment in HFY loans for which impairment has been
determined, which includes loans delinquent in excess of 90 days, totaled $0.7
million and $1.4 million, respectively. The average recorded investment in HFS
impaired loans for the year ended December 31, 2002 and 2001 was approximately
$1.1 million and $0.2 million, respectively. The average recorded investment in
HFY impaired loans for the year ended December 31, 2002 and 2001 was
approximately $0.8 million and $1.2 million, respectively.
108
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements, the report thereon, the notes
thereon and the supplementary data commencing on page 1 of the financial
statements in this report, which financial statements, reports, notes and data
are incorporated by reference.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
As filed on Form 8-K on September 26, 2001
On September 19, 2001, PricewaterhouseCoopers LLP, in conjunction with the sale
of its office in Virginia Beach, Virginia, resigned as independent accountant
for the Registrant whose principal office is in Virginia Beach, Virginia. In
connection with its audits for the two fiscal years ended December 31, 1999 and
2000, and the subsequent interim period through September 19, 2001, there have
been no disagreements with PricewaterhouseCoopers LLP on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope or procedure, which disagreements if not resolved to the satisfaction of
PricewaterhouseCoopers LLP would have caused them to make reference thereto in
their reports on the financial statements for such years. The reports of
PricewaterhouseCoopers LLP on the consolidated financial statements of the
Registrant as of and for the years ended December 31, 1999 and 2000 contained no
adverse opinion or disclaimer of opinion and were not qualified or modified as
to uncertainty, audit scope or accounting principle.
The Registrant requested that PricewaterhouseCoopers LLP furnish it with a
letter addressed to the SEC stating whether or not it agrees with the above
statements. A copy of such letter, dated September 26, 2001, is filed as Exhibit
16.1. The change was not recommended by the Board of Directors or its Audit
Committee.
As filed on Form 8-K on October 29, 2001
On October 24, 2001, Grant Thornton LLP was engaged as the independent
accountant for the Registrant whose principal office is in Virginia Beach,
Virginia. The Audit Committee of the Board of Directors approved engaging Grant
Thornton, LLP.
109
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS
Class I Directors - (Term expiring at the annual meeting of shareholders to be
held in 2004 or until their successor is duly elected and qualified)
Allen D. Wykle (56) Mr. Wykle, in addition to being an initial investor,
organized and headed the initial management team that acquired the Company from
Government Employees Insurance Corporation (GEICO) in September of 1984. He has
served as Chairman of the Board, President and Chief Executive Officer of
Approved Financial Corp. since September 1984. Mr. Wykle served as a Director of
IMC Mortgage Company from April 1996 until June 1998. Mr. Wykle was owner,
President and Chief Executive Officer of Best Homes of Tidewater, Inc., a
residential construction and remodeling company in Virginia, from 1972 to 1986.
Leon H. Perlin (75) Mr. Perlin was an initial investor in the Company in 1984
and has been a Director of the Approved Financial Corp. since 1984. Mr. Perlin,
since 1996, has served as a director of the Company's subsidiary Approved
Federal Savings Bank. Mr. Perlin has served as President and Chief Executive
Officer of Leon H. Perlin Company, Inc., a commercial construction concern, for
over 30 years.
Oscar S. Warner (86) Mr. Warner was an initial investor in the Company in 1984
and has been a Director and Shareholder of the Company since 1984. Mr. Warner,
retired, previously was owner and operator of Oscar Warner Corporation, an
import company.
Class II Directors -
(Term expiring at the annual meeting of shareholders to be held in 2003 or until
their successor is duly elected and qualified)
Arthur Peregoff (84) Mr. Peregoff was an initial investor and has been a
Director of the Company since 1985. Mr. Peregoff has served as Chief Executive
Officer of Globe Iron Construction Company, Inc., a commercial construction
company, for over 25 years.
Stanley W. Broaddus (53) Mr. Broaddus was an initial investor and has been a
Director since 1985. Mr. Broaddus has served as Vice President, Chief Credit
Officer and Secretary of the Company since April 1987. Mr. Broaddus has served
as Director of the Company's subsidiary, Approved Federal Savings Bank since
1996. Previous experience includes fourteen years as Regional Sales Manager with
the building products unit of Atlantic Richfield Co.
Jean S. Schwindt (47) Ms. Schwindt has been a Director of the Company since
1992. She joined the Company on a fulltime basis in June 1998 as Executive Vice
President. Currently she serves as Director, President and COO of Approved
Federal Savings Bank. From March 1996 until June 1998, she served as Vice
President and Director of Investor Relations and Strategic Planning for IMC
Mortgage Company ("IMC"). Ms. Schwindt served on the Board of Directors of IMC
from April 2000 until September 2001. From April 1989 to March 1996 she served
on the Board of Directors and as Senior Vice President/Secretary of Anderson and
Strudwick, Inc., a member of the New York Stock Exchange. Ms. Schwindt, a
Chartered Financial Analyst (CFA) and a Registered Investment Advisor,
affiliated with the firm of Mills Value Advisers, Inc. from
January 1995 until December 2001 and with Gardner and Robertson Advisers since
January 2002.
Class III Directors
(Term expiring at the annual meeting of shareholders to be held in 2005 or until
their successor is duly elected and qualified)
Neil W. Phelan (45) Mr. Phelan is Director of AFC and AFSB and serves as
Executive Vice President of Approved Federal Savings Bank. He has been with the
Company since April 1995. He has been a Director of Approved Financial Corp.
since 1996. His primary responsibility with the Company is management of the
wholesale lending sales staff. Immediately prior to joining the Company, Mr.
Phelan served on the senior management team of ITT Financial Services for 17
years.
Gregory J. Witherspoon (56) Mr. Witherspoon has been a Director since 1998. He
is president of Witherspoon & Associates, a company that provides financial and
management consulting services. He served as a Director of Aames Financial
Corporation from 1991 to March 1998, as Chief Financial Officer from 1987 until
1997, after which, he served as Executive Vice President for Strategic Planning.
He is a Certified Public Accountant. Mr. Witherspoon previously served on the
Board of Directors of Approved from July 1996 until January 1997. Mr.
Witherspoon provides consulting services to the company from time to time. (See:
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS)
Executive Officers -
Allen D. Wykle (56) President and Chief Executive Officer (Class I Director)
Stanley W. Broaddus (53) Vice President (Class II Director)
Jean S. Schwindt (47) President and COO AFSB (Class II Director)
Neil W. Phelan (45) Executive Vice President of AFSB (Class III Director)
Audit Committee Activities: The Audit Committee makes recommendations concerning
the engagements of independent public accountants, reviews with the independent
public accountants the plans and results of the audit engagement, approves
professional services provided by the independent public accountants, reviews
the independence of the independent public accountants, considers the range of
audit and non-audit fees and reviews the adequacy of the Company's internal
accounting controls. It also reviews and accepts the reports of the Company's
regulatory examiners. The audit committee has discussed the required
Communication with Audit Committees as set forth in SAS 61, as amended by SAS
90, with Grant Thornton LLP. They have received the written disclosures and
letter from Grant Thornton LLP as required by ISB 1, Independence Discussions
with Audit Committees, and disclosure of all relationships between Grant
Thornton LLP and Approved Financial Corp. and its management. The Committee
considered all non-audit services provided to Approved by Grant Thornton LLP in
determining that they were independent. The audit committee has reviewed and
discussed the audited financial statements with the Company's management. Based
on the above activities, the audit committee recommended to the Board of
Directors that the audited financial statements for Approved
Financial Corp. be included in the Annual Report to Shareholders and in the
annual report filed with the Securities and Exchange Commission on Form 10-K for
the fiscal years ended December 31, 2002 and 2001. The Audit Committee met on
June 11, 2001, April 25, 2002, March 18, 2003 and March 31, 2003. Grant Thornton
spoke with the Audit Committee on March 31, 2003 where the Audit Committee
accepted the financial statements and the 10-k. The Audit Committee reviewed the
independence of the auditors and was satisfactory.
Audit Committee Members:
[X] Mr. Witherspoon, as Chairman - audit committee financial expert and is not
independent. See Class III Director
[X] Mr. Perlin
[X] Mr. Warner
ITEM 11 - EXECUTIVE COMPENSATION
Summary of Cash and Other Compensation
The following table sets forth the compensation paid to the Company's Chief
Executive Officer and the most highly compensated Executive Officers other than
the Chief Executive Officer (collectively, the "Named Executive Officers")
during the three years ended December 31, 2002:
Summary Compensation Table
Annual Compensation (1) Long-term Compensation
-----------------------------------------------------------------------
Securities All Other
Year Salary Bonus underlying Compensation (2)
Name and Principal Position Options
-----------------------------------------------------------------------
Allen D. Wykle 2002 $ 188,266 $ - - $ 5,417
Chairman, President and CEO 2001 260,676 - - 5,250
AFC 2000 392,250 - - 5,250
Jean S. Schwindt
President & COO AFSB 2002 $ 144,000 $ - - $ 4,320
Executive Vice President AfC 2001 144,000 - - 4,320
Director AFC and AFSB 2000 150,107 - - 4,032
Neil W. Phelan
Executive Vice President AFSB 2002 $ 125,000 $ 16,324 - $ 4,240
Executive Vice President AFC 2001 128,020 12,495 - 4,214
Director AFC and AFSB 2000 155,968 - - 4,540
Stanley W. Broaddus
Director, Vice President & 2002 $ 95,000 $ - - $ 2,850
Secretary AFC 2001 95,000 - - 2,850
Director AFSB 2000 93,970 - - 2,806
- -----------------------
1) All benefits that might be considered of a personal nature did not exceed the
lesser of $50,000 or 10% of total annual salary and bonus for the officer
named in the table and therefore are omitted according to SEC rules.
2) Other compensation amounts reflect the Company's matching contribution under
its 401(k) retirement plan.
STOCK OPTION/STOCK APPRECIATION RIGHT GRANTS IN THE LAST YEAR
No new stock options or stock appreciation rights were granted to employees or
Named Executive Officers 2002.
Aggregate Option Exercises and Period-End Values
The following table sets forth information concerning the December 31,
2002 value of unexercised options held by the Company's Named Executive Officers
on May 10, 2002.
Number of Securities Value of Unexercised
Underlying Unexercised In-the-money options
Options at Fiscal Year End at Fiscal Year End (1)
Name Exercisable Unexercisable Exercisable Unexercisable
- ------------------------------------------------------------------------------------
Allen Wykle 21,000 0 0 0
Jean Schwindt 12,500 0 0 0
Neil Phelan 9,500 0 0 0
Stanley Broaddus 8,000 0 0 0
(1) Value of Unexercised Options is calculated using the price of Approved
Common Stock on 12/31/02 of $0.12 per share less the exercise prices of
$4.00, $9.75 & $13.50 per share, multiplied by the number of shares
represented by the options. There were no common stock options issued and
outstanding to Executive Officers with an exercise price lower than the
year-end common stock market price ("in the money options") on December
31, 2002 and thus having a value based on this formula at 12/31/02.
1996 INCENTIVE STOCK OPTION PLAN
On June 28, 1996, the Company adopted the 1996 Incentive Stock Option Plan (the
"Incentive Plan"), pursuant to which key employees of the Company are eligible
for awards of stock options.
Purpose. The Board of Directors believes that long-term incentive compensation
is one of the fundamental components of compensation for the Company's key
employees and that stock options under the Incentive Plan will play an important
role in encouraging employees to have a greater financial investment in the
Company. The Board of Directors believes that the Incentive Plan will help
promote long-term growth and profitability by further aligning Shareholder and
employee interests.
The purpose of the Incentive Plan is to promote the interests of the Company and
its Shareholders by affording participants an opportunity to acquire a
proprietary interest in the Company and by providing participants with long-term
financial incentives for outstanding performance. Under the terms of the
Incentive Plan, the Option Committee has a great deal of flexibility in the
types and amounts of awards that can be made and the terms and conditions
applicable to those awards.
Description of the Incentive Plan. The aggregate number of shares of Common
Stock that are available for grants under the Incentive Plan is 252,000 shares
(adjusted for the two-for-one stock splits paid to Shareholders of record on
August 30, 1996 and December 16, 1996 and the 100% stock dividend paid to
Shareholders of record on November 21, 1997.) All shares allocated to awards
under the Incentive Plan that are cancelled or forfeited are available for
subsequent awards.
There have been no awards made under the Long Term Incentive Plan during fiscal
year 2002.
QUALIFIED RETIREMENT PLANS
On January 1, 1995, the Company implemented a 401(k) Retirement Plan (the
"401(k) Plan"). The 401(k) Plan is a defined contribution plan covering all
employees who have completed at least one year of service. The 401(k) Plan is
subject to the provisions of the Employee Retirement Income Security Act of
1974. The Company contributes an amount equal to 50% of a participant's payroll
savings contribution up to a maximum of 6% of a participant's annual
compensation. The Company's matching contribution to the 401(k) Plan was$
68,000, 65,000 and $94,000 in the years 2002, 2001 and 2000, respectively. The
Company's matching contribution has a vesting schedule.
The Company has a defined contribution profit sharing plan, which is
administered by officers of the Company. Company contributions to the plan are
discretionary, as authorized by the Board of Directors. There were no
contributions for 2002, 2001 and 2000. Participants are also eligible to make
voluntary contributions to the plan, at the discretion of the administrator.
There were no voluntary contributions to the plan for the years ended December
31, 2002, 2001 and 2000.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Mr. Wykle is the only member of the Compensation Committee that is also an
employee. The other members, Messrs. Warner and Perlin are outside Directors. No
interlocking relationships exist between the Company's Board of Directors or
Officers responsible for compensation decisions and the Board of Directors or
compensation committee of any company, nor has any such interlocking
relationship existed in the past.
EMPLOYMENT AGREEMENTS
As of December 31, 2002, Approved Financial Corp. had employment agreements
with four Executive Officers, Messrs. Wykle, Broaddus, Phelan and Ms. Schwindt.
We had an Employment Agreement with Eric Yeakel, prior to resignation of his
position as CFO effective July 2001. Mr. Yeakel continues to serve on the Board
of Directors of our wholly-owned subsidiary, Approved Federal Savings Bank.
Mr. Wykle voluntarily commenced a 50% reduction in salary effective July 1,
2001. Mr. Broaddus voluntarily forgave an increase in base salary or bonus
compensation due to him under the terms of his employment agreement during 2001.
Ms. Schwindt voluntarily forgave the increase in base salary due to her in
January 2001 under the terms of her employment agreement.
Allen D. Wykle
Chairman, President and Chief Executive Officer AFC
Prior to December 1, 2000, Allen D. Wykle had no formal employment agreement
with us and the Compensation Committee of the Board of Directors determined his
base salary and bonus. Mr. Wykle entered into an employment agreement with us on
December 1, 2000.
TERM, RENEWAL AND CHANGE IN CONTROL. The initial term of this agreement is from
December 1, 2000 until December 31, 2001. After December 31, 2001, this
Agreement is renewable on a year to year basis. Either party must give one
hundred and eighty (180) days written notice if this Agreement is not going to
be renewed after December 31, 2001. Upon failure to give such notice, this
Agreement will automatically renew for an additional year on the same terms.
This notice requirement shall continue for all subsequent renewal periods. In
the event of a Change of Control (i.e. (i) a reduction in the percentage of our
common stock owned and controlled by Allen D. Wykle of 50% or greater, or (ii)
the cessation of Allen D. Wykle's full time employment with us as Chairman of
the Board, President or Chief Executive Officer) and during the calendar year in
which the Change of Control occurred he is notified of nonrenewal of this
Employment Agreement 180 or more days before the end of the then current
calendar year term then that term shall be extended for six (6) months i.e.
until June 30 of the following calendar year, thereby allowing the Employee at
least one full year of remaining employment. If the notice of nonrenewal is
given with less than 180 days remaining before the end of the then current
calendar year term the then current term will not be extended because the then
current term will automatically renew for another year (due to failure to give
180 days notice) thereby assuring him of at least one full year of continued
employment.
SALARY: The agreement provides for an initial base salary at an annual rate
of $418,368 and provides for increases of 3% or 10% per year effective as of
January for any renewal term. The yearly salary increase is 10% if our net
income after tax increases by 10% or greater from the prior year and increases
by 3% if our net income after tax does not increase by a minimum of 10%. Mr.
Wykle voluntarily reduced his base salary by 10% to $376,531 due to the
Company's financial condition during 2000 and reduced his base salary by an
additional 50% to $188,265 as of July 2001. He is entitled to transportation and
all standard group employee benefits.
BONUS: The bonus plan under the agreement provides for a bonus beginning in
the year 2001 of up to a maximum of 100% of the annual salary for each year. The
bonus is based on the annual return on equity ("ROE") percentage per share in
excess of a base annual ROE of 20% (after accrual for bonuses.) A bonus is
payable 50% in cash or stock at our discretion and 50% in cash or stock at the
employee's discretion.
Bonus Example.
If ROE per share for a year is 30%
Then he will be entitled to a bonus equal to 50% of his base salary
(30%-20%)/20% = 50%
If his Base Salary is $418,368
Then his bonus would be $418,368 * 50% =$209,184
NON-COMPETE: Under the Employment Agreement he has agreed not to compete
with us for a period of one year after termination within a prescribed
geographic area and not to solicit or employ our employees for two years after
termination. These restrictive covenants apply upon termination by either party,
with or without cause and upon expiration of the Agreement.
COMPENSATION AFTER TERMINATION. If he dies, becomes permanently disabled,
terminates his employment or is terminated for cause as defined in the
Agreement, this contract
shall cease, and no further compensation or benefits in any form shall be paid
to the Employee or heirs. If this Agreement is terminated by us without cause,
then he shall be entitled to the compensation and benefits which he would have
received but for the termination without cause.
Jean S. Schwindt
Director and Executive Vice President AFC
Director, President and COO AFSB
TERM, RENEWAL AND CHANGE IN CONTROL. The employment agreement with Ms. Schwindt
dated July 1, 1998 and amended December 1, 2000 was for an initial term from
July 1, 1998 through December 31, 1998. On January 1, 1999 it automatically
renewed for a three (3) year term with each year running from January 1st
through December 31st. After December 31, 2001, this Agreement is renewable on a
year to year basis. Either party must give one hundred and eighty (180) days
written notice if this Agreement is not going to be renewed after December 31,
2001. Upon failure to give such notice, this Agreement will automatically renew
for an additional year on the same terms. This notice requirement shall continue
for all subsequent renewal periods. In the event of a Change of Control (i.e.
(i) a reduction in the percentage of our common stock owned and controlled by
Allen D. Wykle of 50% or greater, or (ii) the cessation of Allen D. Wykle's full
time employment with us as Chairman of the Board, President or Chief Executive
Officer) and during the calendar year in which the Change of Control occurred
she is notified of nonrenewal of this Employment Agreement 180 or more days
before the end of the then current calendar year term then that term shall be
extended for six (6) months i.e. until June 30 of the following calendar year,
thereby allowing her at least one full year of remaining employment. If the
notice of nonrenewal is given with less than 180 days remaining before the end
of the then current calendar year term the then current term will not be
extended because the then current term will automatically renew for another year
(due to failure to give 180 days notice) thereby assuring her of at least one
full year of continued employment.
SALARY: It provides for an initial base salary in 1999 at an annual rate of
$160,000, and provides for increases of 6% or 10% per year effective as of
January 2000 and January 2001 and any renewal terms. Her yearly salary increase
is 10% if our net income after tax increases by 10% or greater from the prior
year and increases by 6% if our net income after tax does not increase by a
minimum of 10%.
The Employment Agreement with Ms. Schwindt, as described above, provides for a
base salary during the year 2001 of $179,776. However, as contribution to our
expense reduction program, she voluntarily forgave the 6% salary increases due
January of 2000, 2001 and 2002 and reduced her current annualized base salary to
$144,000, a reduction of 26% from the 2002 base salary amount provided for in
the agreement.
BONUS: The bonus plan under the agreement beginning in 2001 provides for a bonus
of up to a maximum of 100% of the annual salary for each year. The bonus is
based on the annual return on equity ("ROE") percentage per share in excess of a
base annual ROE of 20% (after accrual for bonuses.) A bonus is payable 50% in
cash or stock at our discretion and 50% in cash or stock at the employee's
discretion.
Bonus Example.
If ROE per share for a year is 30%:
Then she will be entitled to a bonus equal to 50% of her base salary
(30%-20%)/20% = 50%
If her Base Salary is $160,000
Then her bonus would be $160,000 * 50% = $80,000
NON-COMPETE: Under the Employment Agreement, she has agreed not to compete with
us for a period of one year after termination within a prescribed geographic
area and not to solicit or employ our employees for two years after termination.
These restrictive covenants apply upon termination by either party, with or
without cause and upon expiration of the Agreement.
COMPENSATION AFTER TERMINATION. If she dies, becomes permanently disabled,
terminates her employment or is terminated for cause as defined in the
Agreement, this contract shall cease, and no further compensation or benefits in
any form shall be paid to her. If this Agreement is terminated by us without
cause, then she shall be entitled to the compensation and benefits which she
would have received but for the termination without cause.
Neil W. Phelan
Director and Executive Vice President AFC
Director and Executive Vice President AFSB
TERM: The Employment Agreement that commenced January 1, 1998 for a three-
year initial term, was amended in November of 2000 for a term ending December
31, 2001. The agreement automatically renews for additional one-year terms
absent three months written notice of non-renewal by either party prior to end
of a term.
SALARY & OTHER BENEFITS: Mr. Phelan's employment Agreement was amended in
November 2000. Under the amended agreement Mr. Phelan, in addition to an
override bonus as described below, was paid a base salary of annualized rate of
$125,000 for the remainder of the term of the agreement. He also is entitled to
all standard group employee benefits.
BONUS: Mr. Phelan's amended agreement provides for a bonus plan consisting
of two parts, (1) an override bonus on production of certain account executives
and (2) participation in the senior management bonus.
Override Bonus: Mr. Phelan will earn a 5 basis points commission for monthly
loan origination volume produced by new wholesale account executives hired after
October 1, 2000 who are directly managed by Mr. Phelan. To qualify in the
calculation of this bonus the individual sales person must produce a minimum of
$750,000 per month in loan volume.
Senior Management Bonus: The senior management bonus provides for a bonus of
up to a maximum of 100% of the annual salary for each year. The bonus is based
on the annual return on equity ("ROE") percentage per share in excess of a base
annual ROE of 20% (after accrual for bonuses.) A bonus is payable 50% in cash or
stock at our discretion and 50% in cash or stock at the employee's discretion.
Bonus Example.
If ROE per share for a year is 30%
Then he will be entitled to a bonus equal to 50% of his base salary
(30%-20%)/20% = 50%
If his Base Salary is $125,000
Then his bonus would be $125,000 * 50% = $62,500
NON-SOLICITATION: Under the Employment Agreement Mr. Phelan has agreed not
to solicit our employees for two years after termination. This restrictive
covenant applies upon termination for any reason by Mr. Phelan or termination
for cause by us.
Stanley W. Broaddus
Director, Chief Credit Officer, Vice President and Secretary AFC
Director AFSB
TERM: The Employment Agreement which commenced January 1, 1997 was for a one
year initial term and automatically renews on January 1, of each subsequent year
for additional one-year terms absent ninety day written notice by either party
prior to the end of a renewed term. The agreement was amended December 1, 2000.
SALARY & OTHER BENEFITS: His current base annual salary is $95,000. He is
entitled to a car and all standard group employee benefits.
BONUS: The bonus plan under the agreement beginning in 2001 provides for a
bonus of up to a maximum of 100% of the annual salary for each year. The bonus
is based on the annual return on equity ("ROE") percentage per share in excess
of a base annual ROE of 20% (after accrual for bonuses.) A bonus is payable 50%
in cash or stock at our discretion and 50% in cash or stock at the employee's
discretion.
Bonus Example.
If ROE per share for a year is 30%
Then he will be entitled to a bonus equal to 50% of his base salary
(30%-20%)/20% = 50%
If his Base Salary is $95,000
Then his bonus would be $95,000 * 50% = $47,500
TERMINATION & NON-COMPETE: The Employment Agreement provides for termination
"for cause" as defined in the Agreement with notice and for termination upon 90
days prior written notice without cause. Under the Employment Agreement he has
agreed not to compete with us for a period of one (1) year after termination
within a prescribed geographic area and not to solicit or employ our employees
for two (2) years after termination. These restrictive covenants apply upon
termination by either party, with or without cause and upon expiration of the
Agreement. He is also entitled to one year's annual salary in the event that we
experience a change in control, which results in Allen D. Wykle no longer being
employed by us and if we terminate Mr. Broaddus without cause.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The following table sets forth information as of February 19, 2003 regarding the
number of shares of Common Stock beneficially owned by all Directors, Executive
Officers, and 5% Shareholders. Beneficial ownership includes shares, if any,
held in the name of the spouse, minor children or other relatives of the nominee
living in such person's home, as well as shares, if any, held in the name of
another person under an arrangement whereby the
Director, Executive Officer or 5% Shareholder can vest title in himself within
sixty days of May 10, 2002.
Common Stock Percentage of
Name Beneficially Owned Class
---- ------------------ -----
Allen D. Wykle (1)(2)(3)
1716 Corporate Landing Parkway
Virginia Beach, VA 23454 1,847,469 33.6
Leon H. Perlin (4)
3360 South Ocean Boulevard
Apartment 5H2
Palm Beach, FL 33480 929,256 17.0
Gregory J. Witherspoon (1)
1601 Blue Jay Way
Los Angeles, CA 90069 234,300 4.3
Stanley W. Broaddus (1)(3)
1716 Corporate Landing Parkway
Virginia Beach, VA 23454 148,551 2.7
Jean S. Schwindt (1)
1062 Normandy Trace Road
Tampa, FL 33602 90,150 1.6
Oscar S. Warner (5)
215 Brooke Avenue, Apt #905
Norfolk, VA 23510 72,000 1.3
Arthur Peregoff (6)
816 Oriole Drive
Virginia Beach, VA 23451 51,750 *
Neil W. Phelan (1)
1716 Corporate Landing Parkway
Virginia Beach, VA 23454 22,620 *
All present Executive
Officers, Directors & Nominees
as a group (8 persons) (1,2,3,4,6,7) 3,396,095 61.3%
- ---------------------
* Owns less than 1% of class.
(1) For Mr. Wykle, includes beneficial ownership of 21,000 shares that may be
issued upon the exercise of stock options exercisable within 60 days of
April 20, 2002. For Mr. Witherspoon, includes beneficial ownership of
4,500 shares subject to non-qualified stock options that may be exercised
within 60 days of April 20, 2002. For Ms. Schwindt, includes beneficial
ownership of 12,500 shares that may be issued upon the exercise of stock
options exercisable within 60 days of April 20, 2002. For Mr. Phelan,
includes the beneficial ownership of 9,500 shares that may be issued upon
the exercise of stock options exercisable within 60 days of April 20,
2002. For Mr. Broaddus, includes beneficial ownership of 8,000 shares
that may be issued upon the exercise of stock options exercisable within
60 days of April 20, 2002.
(2) Excludes 7,000 shares registered to his adult children and his
grandchildren, as to which Mr. Wykle disclaims beneficial ownership.
(3) Mr. Wykle and Mr. Broaddus are Co-Trustees of the Company's
profit-sharing Plan ("Plan") that owns 39,680 of the Company's Common
Stock. They share voting power. Mr. Wykle's ownership interest in the
Plan is 71% and Mr. Broaddus' share is 17%. Included under Mr. Wykle's
shares for the purposes of this disclosure are 28,173 Plan shares, which
excludes the 11,507 shares (29% of the Plan shares), which represent the
percentage of the profit sharing plan owned by others. Included under Mr.
Broaddus's shares for the purposes of this disclosure are 6,746 Plan
shares, which excludes the 32,934 shares (83% of the Plan shares), which
represent the percentage of the profit sharing plan owned by others. Mr.
Wykle and Mr. Broaddus claim voting rights but disclaim beneficial
ownership of all but 71% and 17% of the profit sharing plan shares,
respectively.
(4) Includes 594,000 shares owned by Mr. Perlin's wife.
(5) Includes shares owned by Mr. Warner's wife.
(6) Mr. Peregoff's shares are held jointly with his wife.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company has maintained business relationships and engaged in certain
transactions with affiliated companies and the parties as described below. It is
the policy of the Company to engage in transactions with related parties only on
terms that, in the opinion of the Company, are no less favorable to the Company
than could be obtained from unrelated parties and each of the transactions
described below conforms to that policy.
Agreement with Investment Advisers
The Company entered an investment management agreement on March 28, 1996, with
Mills Value Adviser, Inc. ("MVAI"), a registered investment advisor. The
agreement with MVAI was terminated as of December 31, 2001 and an investment
management agreement was entered into with Gardner & Robertson (G&R). Under the
agreements, MVAI and G&R, both registered investment advisers, manage a portion
of the Company's profit-
sharing Plan. The Plan's trustees retain all proxy voting rights for securities
managed by the advisers. During 2001, the Company paid $4,462 in advisory fees
to MVAI. During 2002, the Company paid $3,993 in advisory fees to G&R. Jean S.
Schwindt, an officer, Director and member of the Executive Committee, is a
portfolio manager for a small number of individual advisory clients with the
advisers.
Witherspoon and Associates
Mr. Witherspoon, President of Witherspoon and Associates, is a Director of the
Company and was paid consulting fees during 2002 and 2001 of $ 21,515.05 and
$17,268.91, respectively, in addition to his customary board fees and related
expenses.
Indebtedness of Management
The Company and the Savings Bank have no outstanding extensions of credit to
members of the Board of Directors or management as of March 31, 2002.
Promissory Notes
The Company has, from time to time, issued promissory notes to assist in cash
flow. The notes are usually issued to Directors, Officers or Qualified
Shareholders. As of December 31, 2002, the following Directors and Executive
Officers were holders of subordinate debt and/or promissory notes in the amounts
and interest rates specified below and with a stated maturity of September 30,
2005 with the exception of Mr. Broaddus. Mr. Broaddus's notes have stated
maturities of June 30, 2004 and January 1, 2005 and have a 30 days notice demand
feature for early withdrawal.
Allen D. Wykle $714,803 5.00%
Stanley W. Broaddus 525,870 10.00
Leon H. Perlin 372,319 5.00
Oscar S. Warner 155,107 5.00
Arthur Peregoff 30,000 5.00
STOCK PERFORMANCE GRAPH
The following graph depicts the cumulative total return on the Company's Common
Stock compared to the cumulative total return for The Russell 2000 Index
("Russell 2000") and the Russell 2000 Financials Index ("Russell 2000
Financials"), a peer group selected by the Company on an industry and
line-of-business basis, commencing June 30, 1994 and ending December 31, 2002.
The graph assumes an investment in Approved Financial Corp. Common Stock of $100
on June 30, 1994, which is the first date for which public market trading data
is available. The graph assumes an investment of $100 in Russell 2000 on June
30, 1994 and an investment of $171 in the Russell 2000 Financials on June 30,
1995. June 30, 1995 is the first semi-annual date for which the pricing
information was available for the Russell 2000 Financials and $171 represents
the equivalent value of Approved's Common Stock on that date for purposes of
this graph.
GRAPH FOR PROXY
- ------------------------------------------------------------------------------------------------------------------------------------
30-Jun-94 30-Dec-94 30-Jun-95 29-Dec-95 28-Jun-96 31-Dec-96
- ------------------------------------------------------------------------------------------------------------------------------------
Approved Financial Corp. 100 94 171 221 400 929
Russell 2000 Index 100 104 118 131 144 151
Russell 2000 Financial Index 171 189 198 232
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
30-Jun-97 31-Dec-97 30-Jun-98 31-Dec-98 30-Jun-99
- ------------------------------------------------------------------------------------------------------------------------------------
Approved Financial Corp. 981 1600 1432 348 245
Russell 2000 Index 165 182 190 176 190
Russell 2000 Financial Index 259 302 297 263 273
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------
31-Dec-99 30-Jun-00 31-Dec-00 30-Jun-01 31-Dec-01
- ------------------------------------------------------------------------------------------------------------------------------------
Approved Financial Corp. 90 103 41 31 22
Russell 2000 Index 210 215 201 213 203
Russell 2000 Financial Index 241 236 277 302 301
- ------------------------------------------------------------------------------------------------------------------------------------
30-Jun-02 31-Dec-02 ######
- --------------------------------------------------------------------------------------
Approved Financial Corp. 15 12
Russell 2000 Index 193 159
Russell 2000 Financial Index 338 300
- --------------------------------------------------------------------------
ITEM 14 - CONTROLS AND PROCEDURES
Within the 90 days prior to the filing date of this report, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's management, including the Company's Chief Executive Officer and
Primary Accounting Officer, of the effectiveness of the design and operation of
the Company's disclosure controls and procedures pursuant to Rule 13a-14 and
15d-14 under the Securities Exchange Act of 1934. Based on that evaluation, the
Company's Chief Executive Office and Primary Accounting Officer concluded that
the Company's disclosure controls and procedures are effective in timely
alerting them to material information related to the Company required to be
included in the Company's periodic filings with the Securities and Exchange
Commission.
Since the date of the evaluation, there have been no significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls, including any corrective actions with regard to significant
deficiencies or material weaknesses.
PART IV
ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K
EXHIBIT INDEX
- -------------------------------------------------------------------------------------------------------------
Exhibit Number Description Page Number
- -------------------------------------------------------------------------------------------------------------
3.1 Amended and Restated Articles of Incorporation of the
Company (Incorporated by Reference to Appendix A of the
Form 10 Registration Statement Filed February 11, 1998)
- -------------------------------------------------------------------------------------------------------------
4.1 Trust Indenture Agreement by Approved Financial Corp., a
Virginia corporation (the "Company"), and US Bank Trust,
national association as trustee (the "Trustee").
Incorporated by reference to the S-1 registration
statement date December 14, 2000)
- -------------------------------------------------------------------------------------------------------------
3.2 Amended and Restated Bylaws of the Company Incorporated
by Reference to Appendix B of the Form 10 Registration
Statement Filed February 11, 1998)
- -------------------------------------------------------------------------------------------------------------
10.1 Approved Financial Corp. Incentive Stock Option Plan
(Incorporated by Reference to Appendix C of the Form 10
Registration Statement Filed February 11, 1998)
- -------------------------------------------------------------------------------------------------------------
10.2 Employment Agreement between the Company and Neil W.
Phelan (Incorporated by Reference to Appendix D of the
Form 10 Registration Statement Filed February 11, 1998)
- -------------------------------------------------------------------------------------------------------------
10.3 Employment Agreement between the Company and Neil W.
Phelan as amended November 17, 2000. (Incorporated by
reference to exhibit 10.3 of S-1 debt registration
statement filed
- -------------------------------------------------------------------------------------------------------------
111
- -------------------------------------------------------------------------------------------------------------
Exhibit Number Description Page Number
- -------------------------------------------------------------------------------------------------------------
December 14, 2000.)
- -------------------------------------------------------------------------------------------------------------
10.4 Employment Agreement between the Company and Stanley W.
Broaddus (Incorporated by Reference to Appendix E of the
Form 10 Registration Statement Filed February 11, 1998)
- -------------------------------------------------------------------------------------------------------------
10.5 Employment Agreement between the Company and Stanley W.
Broaddus dated December 1, 2000 (Incorporated by
reference to exhibit 10.5 of S-1 debt registration
statement filed December 14, 2000.)
- -------------------------------------------------------------------------------------------------------------
10.6 Employment Agreement between the Company and Jean S.
Schwindt dated February 1999 (Incorporated by reference
to exhibit 10.23 of Form 10K filed March 31, 1999.)
- -------------------------------------------------------------------------------------------------------------
10.7 Employment Agreement as amended between Company and Jean
S. Schwindt dated December 1, 2000. (Incorporated by
reference to exhibit 10.9 of S-1 debt registration
statement filed on December 14, 2000)
- -------------------------------------------------------------------------------------------------------------
10.8 Employment Contract between the Company and Barry Epstein
dated September 18, 2000 (Incorporated by reference to
Exhibit 10 filed with Form 10Q on September 14, 2000)
- -------------------------------------------------------------------------------------------------------------
10.9 Employment Contract between the Company and Allen D.
Wykle dated December 1, 2000. (Incorporated by reference
to exhibit 10.11 of S-1 debt registration statement filed
December 14, 2000)
- ------------------------------------------------------------------------------------------------------------
10.10 Mills Value Adviser, Inc, Investment Management
Agreement/Contract with the Company (Incorporated by
Reference to Appendix I of the Form 10 Registration
Statement Filed February 11, 1998)
- -------------------------------------------------------------------------------------------------------------
112
- -------------------------------------------------------------------------------------------------------------
Exhibit Number Description Page Number
- -------------------------------------------------------------------------------------------------------------
10.11 Share Purchase Agreement for Purchase of Controlling
Interest in Approved Federal Savings Bank (Formerly First
Security Federal
Savings Bank, Inc.) (Incorporated by Reference to
Appendix J of the Form 10 Registration Statement Filed
February 11, 1998) Description
- -------------------------------------------------------------------------------------------------------------
10.12 Purchase Agreement between the Company and MOFC, Inc.,
Incorporated by reference to exhibit 10.14 of Form 10K
filed March 30, 2000)
- -------------------------------------------------------------------------------------------------------------
10.13 Option Agreement between the Company and Allen D.
Wykle.(Incorporated by reference to exhibit 10.16 of Form
10K filed March 30, 2000)
- -------------------------------------------------------------------------------------------------------------
10.14 Option Agreement between the Company and Jean S.
Schwindt.(Incorporated by reference to exhibit 10.17 of
Form 10K filed March 30, 2000)
- -------------------------------------------------------------------------------------------------------------
10.15 Option Agreement between the Company and Neil S.
Phelan.(Incorporated by reference to exhibit 10.19 of
Form 10K filed March 30, 2000)
- -------------------------------------------------------------------------------------------------------------
10.16 Option Agreement between the Company and Stanley
Broaddus.(Incorporated by reference to exhibit 10.20 of
Form 10K filed March 30, 2000)
- -------------------------------------------------------------------------------------------------------------
10.17 Stock Appreciation Rights Agreement with Jean S.
Schwindt (Incorporated by Reference to Appendix K of the
Form 10 Registration Statement Filed February 11, 1998)
- -------------------------------------------------------------------------------------------------------------
113
- -------------------------------------------------------------------------------------------------------------
Exhibit Number Description Page Number
- -------------------------------------------------------------------------------------------------------------
10.18 Amendment to Stock Appreciation Rights Agreement with
Jean S. Schwindt (Incorporated by reference to Exhibit
10.22 of Form 10K filed on March 30, 2000)
- -------------------------------------------------------------------------------------------------------------
10.19 Witherspoon Registration Rights Agreement
(Incorporated by Reference to Appendix M of the Form 10
Registration Statement Filed February 11, 1998)
- -------------------------------------------------------------------------------------------------------------
10.20 IMPAC Warehouse Lending Group dated November 7, 2001
- -------------------------------------------------------------------------------------------------------------
16.1 Letter of resignation of PriceWaterhouseCoopers LLP
confirming no disagreements with Registrant to
statement in Form 8-K (incorporated by reference to
form 8-K as filed on September 26, 2001).
- -------------------------------------------------------------------------------------------------------------
16.2 Engagement of Grant Thornton LLP as certified public
accountant (incorporated by reference to Form 8-K filed
on October 29, 2001)
- -------------------------------------------------------------------------------------------------------------
21 Subsidiaries of the registrant (Incorporated by reference
to exhibit 21 of S-1 debt registration statement filed
December 14, 2000)
- -------------------------------------------------------------------------------------------------------------
FORM T-1. Statement of eligibility and qualification
under the Trust Indenture Act of 1939 of corporation
25 designated to act as trustee. (Incorporated by reference
to the S-1 debt registration statement filed December 14,
2000)
- -------------------------------------------------------------------------------------------------------------
99.1 Form of Prospectus Supplement, Order Form and Other
materials. (Incorporated by reference to the S-1 debt
registration statement filed December 14, 2000)
- -------------------------------------------------------------------------------------------------------------
99.2 Consent Supervisory Agreement with OTS (incorporated by
reference to Form 8-K filed on December 18, 2001)
- -------------------------------------------------------------------------------------------------------------
114
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Form 10-K to be signed on its
behalf by the undersigned, thereunto duly authorized.
APPROVED FINANCIAL CORP.
(Registrant)
Date: April 15, 2003 By: /s/ Allen D. Wykle
---------------------------------
Allen D. Wykle
Chairman of the Board of Director
President,and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Date: April 15, 2003 By: /s/ Allen D. Wykle
---------------------------------
Allen D. Wykle
Chairman of the Board of
Directors,President,and Chief
Executive Officer
Date: April 15, 2003 By: /s/ Stanley W. Broaddus
--------------------------------
Stanley W. Broaddus
Director, Vice President and
Secretary
Date: April 15, 2003 By: /s/ Jean S. Schwindt
-----------------------------------
Jean S. Schwindt
Director President and COO
Approved Federal Savings Bank
Date: April 15, 2003 By: /s/ Neil W. Phelan
----------------------------------
Neil W. Phelan
Director Executive Vice President
Approved Federal Savings Bank
Date: April 15, 2003 By: /s/ Arthur Peregoff
----------------------------------
Arthur Peregoff
115
Director
Date: April 15, 2003 By: /s/ Leon H. Perlin
-----------------------------------
Leon H. Perlin
Director
Date: April 15, 2003 By: /s/ Oscar S. Warner
----------------------------------
Oscar S. Warner
Director
Date: April 15, 2003 By: /s/ Gregory Witherspoon
-----------------------------------
Gregory Witherspoon
Director
CERTIFICATIONS
Pursuant to Section 1350, Chapter 63 of Title 18, United States
Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the
undersigned hereby certifies in his capacity as Chief Executive Officer of
Approved Financial Corp. (the "Company") that the annual report of the Company
on Form 10-K for the period ended December 31, 2002 fully complies with the
requirements of Section 13(a) of the Securities and Exchange Act of 1934 and
that the information contained in such report fairly presents, in all material
respects, the financial condition and results of operations of the Company as of
the dates and for the periods presented in the financial statements included in
such report.
Date: April 15, 2003 By: /s/ Allen D. Wykle
------------------ ----------------------------------------
Allen D. Wykle
Chairman, President, and Chief
Executive Officer
I, Allen D. Wykle, CEO, certify that:
1. I have reviewed this annual report on Form 10-K of Approved
Financial Corp.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
116
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a
117
significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: April 15, 2003 By: /s/ Allen D. Wykle
--------------------------------
Allen D. Wykle
Chairman, President, and
Chief Executive Officer
I, Leslie Hodges, AVP Finance and Administration, certify that:
1. I have reviewed this annual report on Form 10-K of Approved
Financial Corp.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during
118
the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: April 15, 2003 By: /s/ Leslie Hodges
---------------------------------
Leslie Hodges
AVP Accounting and Finance
133
APPROVED FINANCIAL CORP.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 2002, 2001 AND 2000
APPROVED FINANCIAL CORP.
Contents Pages
- -------- -----
Reports of Independent Accountants 2 - 4
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2002 and 2001 5
Consolidated Statements of Income (Loss) and Comprehensive
Income (Loss) for the years ended December 31, 2002, 2001 and 2000 6
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 2002, 2001 and 2000 7
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000 8 - 9
Notes to Consolidated Financial Statements 10 - 46
Quarterly Financial Data 47
Consolidating Balance Sheet as of December 31, 2002 48
Consolidating Statements of Income (Loss) for the year ended December 31, 2002 49
F-1
Report of Independent Accountants
To the Board of Directors and Shareholders of
Approved Financial Corp.
We have audited the accompanying consolidated balance sheet of Approved
Financial Corp. and Subsidiaries (the Company) as of December 31, 2002 and 2001,
and the related consolidated statements of operations and comprehensive income,
shareholders' equity and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. The consolidated financial statements of the Company for the year
ended December 31, 2000, were audited by other auditors whose report dated
February 23, 2001, expressed an unqualified opinion on those statements.
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 audits 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 2002 and 2001 consolidated financial statements referred to
above present fairly, in all material respects, the consolidated financial
position of the Company as of December 31, 2002 and 2001, and the consolidated
results of their operations and their cash flows for the years then ended, in
conformity with accounting principles generally accepted in the United States of
America.
F-2
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. The Company has incurred net losses in recent
years. Effective December 3, 2001, a bank subsidiary of the Company entered into
a Consent Supervisory Agreement with the OTS, which is further described in Note
23. The ability of the Company to continue as a going concern is dependent on
many factors, including the securing of additional capital and returning to
profitable operations. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
Our audit of the consolidated financial statements referred to above were
conducted for the purpose of forming an opinion on the consolidated financial
statements as a whole. The supplemental consolidating balance sheet as of
December 31, 2002 and the supplemental consolidating statement of operations for
the year ended December 31, 2002, are presented for purposes of additional
analysis of the consolidated financial statements rather than to present the
financial position and results of operations of the individual companies. The
consolidating information has been subjected to the audit procedures applied in
the audits of the consolidated financial statements and, in our opinion, is
fairly stated in all material respects in relation to the consolidated financial
statements taken as a whole.
/s/ Grant Thornton, LLP
Vienna, Virginia
February 21, 2003
F-3
Report of Independent Accountants
To the Board of Directors and Shareholders
of Approved Financial Corp.:
In our opinion, the accompanying consolidated statements of income (loss) and
comprehensive income (loss), of shareholders' equity and of cash flows for the
year ended December 31, 2000 present fairly, in all material respects, the
results of operations and cash flows of Approved Financial Corp. and its
subsidiaries for the year ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Harrisburg, PA
February 23, 2001
F-4
APPROVED FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
(Dollars in thousands, except per share amounts)
ASSETS 2002 2001
--------------- ------------------
Cash $ 11,470 $ 11,627
Mortgage loans held for sale, net 36,306 47,886
Mortgage loans held for yield, net 6,309 10,348
Real estate owned, net 444 589
Investments 816 1,056
Income taxes receivable 1,241 194
Deferred tax asset, net - 1,607
Premises and equipment, net 3,216 3,793
Other assets 841 1,425
--------------- ------------------
Total assets $ 60,643 $ 78,525
=============== ==================
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 10,379 $ 3,280
Mortgage notes payable 1,679 1,745
Subordinated Promissory Notes 2,525 2,499
Subordinated Certificate of indebtedness 2,076 2,063
FDIC Certificates of deposits 37,830 59,903
FDIC Money market account 1,845 2,232
Accrued and other liabilities 2,153 1,420
--------------- ------------------
Total liabilities 58,487 73,142
--------------- ------------------
Commitments and contingencies - -
Shareholders' equity:
Preferred stock series A, $10 par value; 1 1
Noncumulative, voting:
Authorized shares - 100
Issued and outstanding shares - 90
Common stock, par value - $1 5,482 5,482
Authorized shares - 20,000,000
Issued and outstanding shares - 5,482,114
Additional capital 552 552
Retained deficit (3,879) (652)
--------------- ------------------
Total equity 2,156 5,383
--------------- ------------------
Total liabilities and equity $ 60,643 $ 78,525
=============== ==================
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
for the years ended December 31, 2002, 2001 and 2000
(In thousands, except per share amounts)
2002 2001 2000
Revenue:
Gain on sale of loans $ 6,736 $ 13,831 $ 10,971
Interest income 4,102 5,428 5,191
Broker fee income 15 649 2,399
Other fees and income 1,495 2,031 2,081
--------------- ---------------- ----------------
12,348 21,939 20,642
--------------- ---------------- ----------------
Expenses:
Compensation and related 5,243 9,462 11,477
General and administrative 5,323 5,872 7,779
Write down of goodwill - 845 -
Loss on sale/disposal of fixed assets - 162 42
Loan production expense 1,179 1,792 1,151
Interest expense 2,945 3,852 3,852
Provision for loan losses - Held for Yield & - - 638
Held for Sale
Provision for loan losses - Held for Yield (292) 91 -
Provision for losses on real estate owned 384 237 451
Unrealized loss on loans held for sale 232 782 -
--------------- ---------------- ----------------
15,014 23,096 25,390
--------------- ---------------- ----------------
Loss before income taxes (2,666) (1,157) (4,748)
Provision for (benefit from) income taxes 561 1,483 (1,456)
--------------- ---------------- ----------------
Net loss (3,227) (2,640) (3,292)
Other comprehensive loss, net of tax:
Unrealized gain on securities:
Unrealized holding gain during period - 12 4
--------------- ---------------- ----------------
Comprehensive loss $ (3,227) $ (2,628) $ (3,288)
=============== ================ ================
Net loss per share:
Basic and Diluted $ (0.59) $ (0.48) $ (0.60)
=============== ================ ================
=============== ================ ================
Weighted average shares outstanding:
Basic and Diluted 5,482 5,482 5,482
=============== ================ ================
=============== ================ ================
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
for the years ended December 31, 2002, 2001 and 2000
(Dollars in thousands)
Accumulated
Preferred Stock Other
Series A Common Stock Additional Comprehensive Retained
--------------------------------------------
Shares Amount Shares Amount Capital Income (Loss) Earnings Total
-------- --------------------- ----------- -----------------------------------------------------
Balance at December 31,
1999 90 $ 1 5,482,114 $ 5,482 $ 552 $ (16) $ 5,280 $ 11,299
Net loss (3,292) (3,292)
Unrealized loss on
investments
Available for sale,
net of tax of $5.9 4 4
-------- --------------------- ----------- -----------------------------------------------------
Balance at December 31,
2000 90 1 5,482,114 5,482 552 (12) 1,988 8,011
Net loss (2,640) (2,640)
Unrealized loss on
investments
Available for sale,
net of tax of $5.9 12 12
-------- --------------------- ----------- -----------------------------------------------------
Balance at December 31,
2001 90 1 5,482,114 5,482 552 - (652) 5,383
Net loss (3,227) (3,227)
-------- --------------------- ----------- -----------------------------------------------------
Balance at December 31,
2002 90 $ 1 5,482,114 $ 5,482 $ 552 $ - $ (3,879) $ 2,156
======== ===================== =========== =====================================================
The accompanying notes are an integral part of the consolidated financial
statements.
F-7
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 2002, 2001 and 2000
2002 2001 2000
------------------- ------------------ ------------------
Operating activities
Net loss $ (3,227) $ (2,640) $ (3,292)
Adjustments to reconcile net loss to net
cash provided by (used in) operating
activities:
Depreciation of premises and equipment 595 796 643
Amortization of goodwill - 67 137
Provision for loan losses - Held for Yield (292) 91 639
Provision for losses on real estate owned 384 237 (341)
Unrealized loss on loans held for sale 232 782 -
Deferred tax expense 1,607 1,897 (1,337)
Loss on sale of securities - 6 -
Loss on sale of real estate owned 305 - 792
Loss on sale/disposal of fixed assets (1) 162 42
Loss on write down of goodwill - 845 -
Proceeds from Sale and Prepayments of Loans 231,658 350,404 268,185
Originations of Loans, Net (211,220) (360,340) (229,490)
Gain on sale of loans (6,736) (13,831) (10,971)
Changes in assets and liabilities:
Loan sale receivable - 4 (2)
Income tax receivable (1,047) (194) -
Other assets 584 263 118
Accrued and other liabilities 733 54 (1,060)
Income tax payable - - 5,153
------------------- ------------------ ------------------
Net cash provided by (used in) operating activities 13,575 (21,397) 29,216
Cash flows from investing activities:
Sales of securities 240 - 240
Sales of ARM fund shares - 2,310 -
Purchase of premises and equipment (20) (105) (253)
Sales of premises and equipment 2 762 246
Sales of real estate owned 1,465 1,748 2,777
Real estate owned capital improvements (31) (55) (408)
Purchases of ARM fund shares - (46) (150)
Purchases of FHLB stock - (467) (297)
------------------- ------------------ ------------------
Net cash provided by (used in) investing activities 1,656 (4,147) 2,155
Continued on Next Page
F-8
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
for the years ended December 31, 2002, 2001 and 2000
(In thousands)
2002 2001 2000
------------------ ------------------ -----------------
Cash flows from financing activities:
Borrowings - warehouse $ 91,538 $ 39,247 $ 54,289
Repayments of borrowings - warehouse (84,439) (37,661) (70,060)
FHLB and LOC repayments, net - (3,000) (1,648)
Principal payments on mortgage notes payable (66) (784) 188
Net increase (decrease) in:
Subordinated Notes Payable 26 (319) (174)
Subordinated Certificates of indebtedness 13 20 (44)
FDIC Certificates of deposit (22,073) 25,471 (20,907)
FDIC-insured money market account (387) (1,694) 3,926
------------------ ------------------ -----------------
Net cash (used in) provided by financing activities (15,388) 21,280 (34,430)
------------------ ------------------ -----------------
Net (decrease) increase in cash (157) 4,030 (3,059)
Cash at beginning of year 11,627 7,597 10,656
------------------ ------------------ -----------------
Cash at end of year $ 11,470 $ 11,627 $ 7,597
================== ================== =================
Supplemental cash flow information:
Cash paid for interest $ 2,945 $ 3,853 $ 3,960
Cash paid for income taxes 38 41 -
Supplemental non-cash information:
Loan balances transferred to real estate $ 1,671 $ 1,370 $ 2,232
Owned
The accompanying notes are an integral part of the consolidated financial
statements.
F-9
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
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 by
first and subordinated liens on primarily one-to-four family residential
properties. The Company sources mortgage loans through two origination channels;
a network of mortgage brokers who use mortgage products offered by Approved to
serve the needs of their customers who are individual borrowers ("broker" or
"wholesale") and an internal sales staff that originate mortgages directly with
borrowers ("retail" and "direct"). Approved has two wholly owned subsidiaries
through which it originated residential mortgages during the years of 2000, and
2001. The subsidiaries are Approved Federal Savings Bank (the "Bank"), a
federally chartered thrift institution and Approved Residential Mortgage, Inc.
("ARMI"). ARMI had no active loan origination operations as of December 31, 2001
and all loan originations were conducted through the Bank in 2002. Approved has
a third wholly owned subsidiary, Approved Financial Solutions ("AFS"), through
which it offered other financial products such as Debt Free Solutions, Mortgage
Acceleration Program and insurance products to its mortgage customers during
2000 and 2001, however, it ceased offering these products in 2002. On April 1,
2000 the Company, as part of its expense reduction initiatives, transferred all
assets of Mortgage One Financial Corporation ("MOFC") d/b/a ConsumerOne
Financial ("ConsumerOne"), a wholly owned subsidiary of Approved, to the Bank.
The operations related to ConsumerOne, which was origination of retail mortgage
loans, were discontinued during 2001.
Principles of accounting and consolidation: The consolidated financial
statements of the Company include the accounts of Approved and its wholly owned
subsidiaries. All significant inter-company accounts and transactions have been
eliminated.
Use of estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-10
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 1. Organization and Summary of Significant Accounting Policies,
continued:
Cash and cash equivalents: Cash and cash equivalents consist of cash on deposit
at financial institutions and short-term investments that are considered cash
equivalents if they were purchased with an original maturity of three months or
less.
Loans held for sale: Loans, held for sale, are carried at the lower of aggregate
cost or market value. Market value is determined by current investor yield
requirements net of deferred fees and valuation allowance.
Loans held for yield: Loans are stated at the amount of unpaid principal less
net deferred fees and an allowance for loan losses. Interest on loans is accrued
and credited to income based upon the principal amount outstanding. Fees
collected and costs incurred in connection with loan originations are deferred
and recognized over the term of the loan.
Allowance for loan losses: The allowance for loan losses ("ALLL") is maintained
at a level believed adequate by management to absorb probable inherent losses in
the held for yield loan portfolio at the balance sheet date. Management's
determination of the adequacy of the allowance is based on an evaluation of the
current loan portfolio characteristics including criteria such as delinquency,
default and foreclosure rates and trends, credit grade of borrowers, loan to
value ratios, current economic and secondary market conditions, regulatory
guidance and other relevant factors. The allowance is increased by provisions
for loan losses charged against income. Loan losses are charged against the
allowance when management believes it is unlikely that the loan is collectable.
Valuation Allowance: 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.
Valuation allowances are established based on the age of the loan as well as
special circumstances known to management that merit a valuation allowance.
Loans held 90 days or less that do not fall into a special circumstance category
are
F-11
carried at cost. A valuation allowance of 5.5% is charged against first lien
non-conforming mortgage loans held over 90 days and a valuation allowance of 20%
is charged against subordinated liens held over 90 days that do not fall into a
special circumstance category. All loans considered to be special circumstance
are carried at the net realizable value. The net realizable value represents the
current appraised or listed property valuation less estimated cost to liquidate
the property. The difference in the principal value of the loan and the net
realizable value is recorded as a Valuation Allowance. Provision for valuation
allowance is charged against income and is not eligible for inclusion in Tier 2
capital for risk based capital purposes. The impact on Tier 2 capital is the
primary difference between loss reserves for HFS (valuation allowance) loans and
HFY (ALLL) loans.
F-12
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 1. Organization and Summary of Significant Accounting Policies,
continued:
Origination fees: Net origination fees are recognized over the life of the loan
or upon the sale of the loan, if earlier.
Real estate owned: Assets acquired through loan foreclosure are recorded as real
estate owned ("REO") at the lower of cost or fair market value, net of estimated
disposal costs. Cost includes loan principal and certain capitalized
improvements to the property. The estimated fair market value is reviewed
periodically by management, and any write-downs are charged against current
earnings using a valuation account, which has been netted against real estate
owned in the financial statements.
Premises and equipment: Premises, leasehold improvements and equipment are
stated at cost less accumulated depreciation and amortization. The buildings are
depreciated using the straight-line method over thirty and thirty-nine years.
Leasehold improvements are amortized over the lesser of the terms of the lease
or the estimated useful lives of the improvements. Depreciation of equipment is
computed using the straight-line method over the estimated useful lives of three
to five years. Expenditures for betterments and major renewals are capitalized
and ordinary maintenance and repairs are charged to operations as incurred.
F-13
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 1. Organization and Summary of Significant Accounting Policies,
continued:
Investments: The Company's investment in the stock of the Federal Home Loan Bank
("FHLB") of Atlanta is stated at cost.
All other investment securities, except the FHLB stock, are classified as
available-for-sale and reported at fair value, with unrealized gains and losses
excluded from earnings and reported as other comprehensive income in
shareholders' equity. Realized gains and losses on sales of securities are
computed using the specific identification method.
Loan originations and income recognition: The Company applies a
financial-components approach that focuses on control when accounting and
reporting for transfers and servicing of financial assets and extinguishments of
liabilities. Under that approach, after a transfer of financial assets, an
entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished. This approach
provides consistent standards for distinguishing transfers of financial assets
that are sales from transfers that are secured borrowings. Gains on the sale of
mortgage loans, representing the difference between the sales proceeds and the
net carrying value of the loans, are recognized when mortgage loans are sold and
delivered to investors.
Interest on loans is credited to income based upon the principal amount
outstanding. Interest is accrued on loans until they become 59 days or more past
due. All interest accrued but not collected for loans that are placed on
nonaccrual or changed off is reversed against interest income. The interest on
these loans is accounted for on the cash-basis, until qualifying for return to
accrual. Loans are returned to accrual status when all the principal and
interest amounts contractually due are brought current and future payments are
reasonably assured.
Advertising costs: Advertising costs are expensed when incurred.
F-14
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 1. Organization and Summary of Significant Accounting Policies, continued:
Income taxes: Taxes are provided on substantially all income and expense items
included in earnings, regardless of the period in which such items are
recognized for tax purposes. The Company uses an asset and liability approach
that requires the recognition of deferred tax assets and liabilities for the
estimated future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events other
than enactments of changes in the tax laws or rates. The Company maintains a
valuation allowance based upon an assessment by management of future taxable
income and its relationship to realizability of deferred tax assets. The effect
on deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date.
Earnings per share: The Company computes "basic earnings per share" by dividing
income available to common shareholders by the weighted-average number of common
shares outstanding for the period. "Diluted earnings per share" reflects the
effect of all potentially dilutive potential common shares such as stock options
and warrants and convertible securities.
Comprehensive Income: The Company classifies items of other comprehensive loss
by their nature in a financial statement and displays the accumulated balance of
other comprehensive loss separately from retained earnings and additional
capital in the equity section of the consolidated balance sheets. The only item
the Company has in Comprehensive Loss for the three years ended December 31,
2002, are unrealized holding gains and losses on securities, net of deferred
taxes.
Goodwill recognition policy: Goodwill represents the excess of purchase price
and related costs over the value assigned to the net tangible and intangible
assets of businesses acquired. 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.
In fiscal years 2001 and 2000, goodwill was amortized using the straight-line
method over 10 years. In 2002, in accordance with Statement of Financial
Accounting Standards (SFAS) No. 142, Goodwill and Other
F-15
Intangible Assets, amortization of goodwill was not applied. The adoption of
this pronouncement did not have a material impact on the financial statements.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 1. Organization and Summary of Significant Accounting Policies, continued:
Liquidity: The company finances its operating cash requirements primarily
through certificates of deposit, warehouse credit facilities, and other
borrowings. Our borrowings were 82.5% of total assets at December 31, 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 and 2000 amounts have been reclassified to
conform to the 2002 presentation.
F-16
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 1. Organization and Summary of Significant Accounting Policies, continued:
New accounting pronouncements:
In September 2000, the Financial Accounting Standards Board (FASB) issued SFAS
No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, a replacement of SFAS No. 125. It revises the
standards for accounting for securitizations and other transfers of financial
assets and collateral and requires certain disclosures, but it carries over most
of provisions of SFAS No. 125 without reconsideration. The Statement requires a
debtor to reclassify financial assets pledged as collateral and report these
assets separately in the statement of financial position. It also requires a
secured party to disclose information, including fair value, about collateral
that it has accepted and is permitted by contract or custom to sell or repledge.
The Statement includes specific disclosure requirements for entities with
securitized financial assets and entities that securitize assets. This Statement
is effective for transfers and servicing of financial assets and extinguishments
of liabilities occurring after March 31, 2000 and is effective for recognition
and reclassification of collateral and for disclosures relating to
securitization transactions and collateral for fiscal years ending after
December 15, 2000. The adoption of SFAS No. 140 did not have a material effect
on financial condition or results of operation of the Company.
In April 2002, FASB issued SFAS No. 145, Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This
statement rescinds FASB No. 4, Reporting Gains and Losses from Extinguishment of
Debt, and an amendment of that Statement, FASB Statement No. 64, Extinguishment
of Debt Made to Satisfy Sinking-Fund Requirements. This Statement also rescinds
FASB Statement No. 44, Accounting for Intangible Assets of Motor Carriers. This
Statement amends FASB No. 13, Accounting for Leases, to eliminate an
inconsistency between the required accounting for sale-leaseback transactions.
This Statement also amends other existing authoritative pronouncements to make
various technical corrections, clarify meanings, or describe their applicability
under changed conditions. The provisions of this statement related to the
rescission of Statement No. 4 are effective for fiscal years beginning after May
15, 2002. The provisions related to Statement No. 13 are effective for
transactions occurring after May 15, 2002. All other provisions are effective
for financial statements issued on or after May 15, 2002. The adoption of this
F-17
pronouncement did not have a material impact on the financial statements.
In June 2002, FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. This Statement addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)." The provisions of this statement
are effective for exit or disposal activities initiated after December 31, 2002.
The adoption of this pronouncement is not expected to have a material impact on
the financial statements.
In October 2002, FASB issued SFAS No. 147, Acquisitions of Certain Financial
Institutions-an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9. FASB Statement No. 72, Accounting for Certain Acquisitions
of Banking or Thrift Institutions, and FASB Interpretation No. 9, Applying APB
Opinions No. 16 and 17 When a Savings and Loan Association or a Similar
Institution Is Acquired in a Business Combination Accounted for by the Purchase
Method, provided interpretive guidance on the application of the purchase method
to acquisitions of financial institutions. Except for transactions between two
or more mutual enterprises, this Statement removes acquisitions of financial
institutions from the scope of both Statement 72 and Interpretation 9 and
requires that those transactions be accounted for in accordance with FASB
Statements No. 141, Business Combinations, and No. 142, Goodwill and Other
Intangible Assets. Thus, the requirement in paragraph 5 of Statement 72 to
recognize (and subsequently amortize) any excess of the fair value of
liabilities assumed over the fair value of tangible and identifiable intangible
assets acquired as an unidentifiable intangible asset no longer applies to
acquisitions within the scope of this Statement. In addition, this Statement
amends FASB Statement No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, to include in its scope long-term customer-relationship
intangible assets of financial institutions such as depositor- and
borrower-relationship intangible assets and credit cardholder intangible assets.
Consequently, those intangible assets are subject to the same undiscounted cash
flow recoverability test and impairment loss recognition and measurement
provisions that Statement 144 requires for other long-lived assets that are held
and used. The provisions of this statement are effective for acquisitions for
which the date of the acquisition is on or after October 1, 2002. The adoption
of this pronouncement did not have a material impact on the financial
statements.
In December 2002, FASB issued SFAS No. 148, Accounting for Stock Based
Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123.
This Statement amends FASB Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative
F-18
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of Statement 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. The Company continues to follow APB 25 and has
complied with the disclosure requirements of SFAS 123 and 148.
2002 2001 2000
--------------- -------------- --------------
Net Loss $ (3,227) $ (2,640) $(3,292)
Add: Stock-based employee compensation expense included in reported net - - -
loss, net of related tax effects
Deduct: Total stock-based employee compensation expense determined under - 5 11
fair value based method for all awards, net of related tax effects
--------------- -------------- --------------
Pro forma net loss (3,227) (2,645) (3,303)
=============== ============== ==============
Loss per share:
Basic and diluted - as reported (0.59) (0.48) (0.60)
=============== ============== ==============
Basic and diluted - pro forma (0.59) (0.48) (0.60)
=============== ============== --------------
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 2. Investments:
The cost basis and fair value of the Company's investments at December 31, 2002
and 2001, are as follows (in thousands):
2002 2001
------------------------------ -----------------------------------
Cost Fair Cost Fair
Basis Value Basis Value
----------- ------------- -------------- ----------------
FHLB stock 816 816 1,056 1,056
----------- ------------- -------------- ----------------
$ 816 $ 816 $1,056 $1,056
=========== ============= ============== ================
F-19
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 3. Mortgage Loans Held for Sale:
The Company owns first and second mortgages, which are being held as inventory
for future sale. The loans are carried at the lower of cost or market. Loans
pledged totaled $274,000 at December 31, 2002. All of these loans are pledged as
collateral for the warehouse financing. Loans at December 31, 2002 and 2001,
were as follows (in thousands):
2002 2001
----------------------- ----------------------
Mortgage loans held for sale, net of valuation allowance of $661
and $617, respectively $ 36,199 $ 47,846
Net deferred origination fees and other costs 107 40
----------------------- ----------------------
Total mortgage loans, net $ 36,306 $ 47,886
======================= ======================
Changes in the valuation allowance for loans held for sale for the years ended
December 31, 2002 and 2001 were (in thousands):
2002 2001
------------------ -------------------
Balance at beginning of year $ 617 $ -
Provision 245 903
Charge off (201) (286)
------------------ -------------------
Balance at end of year $ 661 $ 617
================== ===================
F-20
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 4. Mortgage Loans Held for Yield:
The Savings Bank holds certain first-lien mortgage loans to obtain a favorable
interest margin. The loans are carried at cost. These loans are obtained either
by direct purchase from AFC or designated as held for yield when funded by the
Bank. Certain of these loans have been pledged as collateral for the FHLB
financing. Loans held for yield at December 31, 2002 and 2001 were as follows
(in thousands):
2002 2001
--------------------- --------------
Mortgage loans held for yield $ 6,932 $ 11,378
Net deferred origination fees and other costs (104) (150)
Specific allowance for loan losses (99) (187)
General allowance for loan losses (420) (693)
--------------------- --------------
Total mortgage loans, net $ 6,309 $ 10,348
===================== ==============
At December 31, 2002, and 2001, the recorded investment in impaired loans
totaled $0.7 million, and $1.3 million, respectively. The average recorded
investment in impaired loans for the year ended December 31, 2002, and 2001 was
$0.8 million and $1.4 million, respectively. Interest income recognized related
to these loans was $36,000, and $99,000 during 2002 and 2001 respectively.
Nonaccrual loans were $0.8 million and $1.6 million at December 31, 2002 and
2001, respectively. The amount of additional interest that would have been
recorded had these loans not been placed on nonaccrual status was approximately
$44,000 and $168,000 in 2002 and 2001, respectively.
Changes in the allowance for loan losses for the years ended December 31, 2002
and 2001 were (in thousands):
2002 2001
-------------------- ----------------------
Balance at beginning of year $ 880 $ 1,380
Transfer from held for sale loans - 99
Charge Offs (258) (746)
Recoveries 189 56
Provision (292) 91
-------------------- ---------------------
Balance at end of year $ 519 $ 880
==================== =====================
All held for yield loans, including impaired loans, have a related allowance for
loan losses.
F-21
APROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 5. Real Estate Owned:
Real estate owned is valued at the lower of cost or fair market value, net of
estimated disposal costs.
Changes in the real estate owned valuation allowance for the years ended
December 31, 2002, 2001 and 2000 were (in thousands):
2002 2001 2000
--------------- ---------------- ---------------
Balance at beginning of year $ 113 $ 376 $ 717
Provision 384 237 (341)
Charge Off (305) (500) 0
--------------- ---------------- ---------------
Balance at end of year $ 192 $ 113 $ 376
=============== ================ ===============
Note 6. Premises and Equipment:
Premises and equipment at December 31, 2002 and 2001, were summarized as follows
(in thousands):
2002 2001
------------------- --------------------
Land $ 1,173 $ 1,173
Building & Improvements 2,005 2,005
Office Equipment & Furniture 1,529 1,656
Computer Software/Equipment 1,990 1,971
Vehicles 92 92
------------------- --------------------
6,789 6,897
Less accumulated depreciation and amortization 3,573 3,104
------------------- --------------------
Premises and equipment, $ 3,216 $ 3,793
=================== ====================
The Company has several capital leases for computer and other equipment included
in the premises and equipment table above. See Note 7 for further discussion on
capital leases.
F-22
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 7. Capital Leases:
Assets recorded under capital leases at December 31, 2002 and 2001, consist of
the following (in thousands):
2001 2000
------------------ ------------------
Computer equipment $ 154 $ 154
Furniture & equipment 141 224
Less: Accumulated amortization (295) (361)
------------------ ------------------
$ - $ 17
================== ==================
Amortization expense for the years ended December 31, 2002 and 2001,
approximated $17,000 and $71,000, respectively.
Future minimum rental commitments of $21,000 are all due during the next twelve
months ending December 31, 2002. All capital leases expired in 2002 and there
are no further rental commitments as of December 31, 2002.
The Company has the option to purchase these assets at an established price at
the end of the lease terms. The Company recognized approximately $500 and $7,000
of interest expense related to the lease obligations for the years ended
December 31, 2002 and 2001, respectively.
F-23
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 8. Leases
The Company leases some of its office facilities and equipment under operating
leases, which expire at various times through 2005. Lease expense was $0.2
million, $0.6 million, and $0.8 million in 2002, 2001 and 2000, respectively.
Total minimum lease payments under non-cancelable operating leases with
remaining terms in excess of one year as of December 31, 2002, were as follows
(in thousands):
2003 $ 331
2004 156
2005 36
-----------
$ 523
===========
F-24
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 9. Revolving Warehouse Facilities:
Amounts outstanding under revolving warehouse facilities at December 31,
2002 and 2001, were as follows (in thousands):
2002 2001
------------------ -----------------
Warehouse facility with commercial bank collateralized by
mortgages/deeds of trust; with interest at 4.43% to 5.43% over
one month LIBOR rate (2.12% at December 31, 2001); total credit
available $7 million.(1) $ - $ 504
Warehouse facility with commercial bank collateralized by
mortgages/deeds of trust; with interest at 1.25% over Prime rate
(4.75% at December 31, 2002); total credit available
$25 million.(2)
10,379 2,776
------------------ -----------------
$ 10,379 $ 3,280
================== =================
(1) The Bank allowed this credit facility to expire because it was more
costly than other facilities and was not administratively compatible
with the wholesale lending process.
(2) The company receives advances of 98% of first mortgages and 96% on
2/nd/ mortgages. There is no stated expiration date for this credit
facility.
F-25
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 10. Certificates of Deposits:
The following table sets forth various interest rate categories for the
FDIC-insured certificates of deposit of the Bank as of December 31, 2002 and
2001(in thousands):
2002 2001
------------------------------------- --------------------------------------
Weighted Weighted
Average Average
& Rate Amount % Rate Amount
----------- ---------------------- ------------- ---------------------
2.99% or less 2.26 $ 22,595 2.75 $ 10,554
3.00 - 3.49 3.12 6,632 3.21 15,504
3.50 - 3.99 3.50 396 3.81 3,469
4.00 - 4.49 - - 4.25 1,587
4.50 - 4.99 - - 4.82 3,269
5.00 - 5.49 5.25 4,740 5.16 16,573
5.50 - 5.99 5.62 2,376 5.60 4,458
6.00 - 6.49 6.06 1,091 6.10 1,289
6.50 - 6.99 - - 6.77 2,603
7.00 and above - - 7.08 597
----------- ---------------------- ------------- ---------------------
3.12 $ 37,830 4.25 $ 59,903
=========== ====================== ============= =====================
The following table sets forth the amount and maturities of the certificates of
deposit of the Bank at December 31, 2002 (in thousands):
Over Six Over One
Months and Year and
Six Months Less than Less than Over Two
or Less One Year Two Years Years Total
---------------- --------------- --------------- -------------- ----------------
2.99% or less $ 20,713 $ 1,832 $ - $ - $ 22,595
3.00 - 3.49 2,970 3,563 99 - 6,632
3.50 - 3.99 297 99 - - 396
4.00 - 4.49 - - - - -
4.50 - 4.99 - - - - -
5.00 - 5.49 3748 298 694 - 4,740
5.50 - 5.99 693 1,683 - - 2,376
6.00 - 6.49 298 793 - - 1,091
---------------- --------------- --------------- -------------- ----------------
$ 28,719 $ 8,318 $ 793 $ - $ 37,830
================ =============== =============== ============== ================
At December 31, 2002 and December 31, 2001, 73 and 117 certificates of deposit
totaling $7.3 million and $29.5 million were in amounts of $100,000 or greater.
F-26
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 11. Money Market Deposits
At December 31, 2002, the Bank had $1.8 million in money market deposits. All
money market deposits have a variable rate of interest and can be redeemed at
any time. The interest rate is based upon a four-week average of the 90-day
LIBOR rate less 25 basis points. The interest rate is adjusted monthly. At
December 31, 2002 the interest rate on all money market deposits was 1.22%.
Note 12. Federal Home Loan Bank Advances:
Federal Home Loan Bank Advances occurred through two types of borrowings, a
Federal Home Loan Bank Warehouse Line of credit and a daily rate credit program.
The $15.0 million warehouse line of credit with the Federal Home Loan Bank was
terminated in October 2001. The line was secured by loans originated by the Bank
and bears interest at the lenders cost of overnight funds. The interest rate on
December 31, 2000 was 6.60%. Interest expense on FHLB advances totaled $136,000,
$33,000 and $36,000 in 2001, 2000 and 1999, respectively.
At December 31, 2000, the Bank had pledged qualifying residential mortgage loans
with an aggregate balance of $5.9 million as collateral for the daily rate
credit program advances under a specific collateral agreement with a limit of up
to 20% of the Banks total assets at December 31, 2000. Total advances at
December 31, 2000 were $3.0 million. Interest was computed based on the lender's
cost of overnight funds. The interest rate on December 31, 2000 was 6.35%. The
daily credit program facility was terminated in October 2001.
F-27
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 13. Subordinated Promissory Notes:
Subordinated Promissory Notes are due primarily, to affiliated individuals who
are officers and or directors of the company representing 71% of the amounts
outstanding, and to non-affiliated parties representing 29% of the amount
outstanding, at December 31, 2002. These notes are subordinate to the line of
credit and all other collateralized indebtedness of the Company. Interest
expense on subordinated promissory notes was $228,000, $255,000, and $282,000,
in 2002, 2001 and 2000, respectively. The interest rates on the notes range from
5.00% to 10.00% and the notes mature as follows (in thousands):
2003 $ 835
2004 125
2005 1,565
---------------
$ 2,525
===============
F-28
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 14. Certificates of Indebtedness:
Certificates of indebtedness are uninsured deposits authorized for financial
institutions such as the Company, which have Virginia industrial loan
association charters. The certificates of indebtedness are loans from Virginia
residents for periods of one to five years at interest rates between 6.75% and
10.50%. Interest expense on the certificates was $209,000, $211,000, and
$196,000 in 2002, 2001 and 2000, respectively.
Certificates of indebtedness maturities were due as follows as of December 31,
2002 (in thousands):
2003 $ 286
2004 443
2005 533
2006 179
2007 635
-------------
$ 2,076
=============
F-29
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 15. Mortgage Notes Payable:
The Company had two mortgage notes payable to a commercial bank at December 31,
2000, which were collateralized by the present and former office buildings used
by the Company as corporate headquarters. The former office building was sold
during 2001 and the associated mortgage note was paid in full.
The mortgage note is summarized as follows (in thousands):
2002 2001
---------- ----------
Mortgage note with commercial bank
collateralized by office building; original
amount $2,025,000; monthly payments of $21,170;
matures January 2016; with interest at 8.625% $ 1,679 $ 1,745
---------- ----------
$ 1,679 $ 1,745
========== ==========
Interest expense on mortgage loans payable was $148,000, $186,000 and $205,000
in 2002, 2001 and 2000 respectively.
Aggregate maturities for mortgage payable are as follows as of December 31, 2002
(in thousands):
2003 $ 74
2004 81
2005 88
2006 96
2007 104
Thereafter 1,236
------------
$ 1,679
============
F-30
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 16. Stock Options:
On June 28, 1996, the Company adopted the 1996 Incentive Stock Option Plan. The
Company's stock option plan provides primarily for the granting of nonqualified
stock options to certain key employees. Generally, options are granted at prices
equal to the market value of the Company's stock on the date of grant, vest
evenly over a three-year period, and expire ten years from the date of the
award.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations in accounting for its
stock option plans. SFAS No. 123, "Accounting for Stock-Based Compensation," was
issued in 1995 and, if fully adopted, changes the method of recognition of cost
on plans similar to those of the Company. The Company has adopted the
alternative disclosure established by SFAS No. 123. Therefore, pro forma
disclosures as if the Company adopted the fair value recognition requirements
under SFAS No. 123 are presented.
F-31
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 16. Stock Options, continued:
A summary of the Company's stock options, including weighted average exercise
price (Price) as of December 31, 2002, 2001, and 2000, and the changes during
the years is presented below:
2002 2001
-------------------------- --------------------------
Shares Price Shares Price
------------ ------------ ------------ ------------
Outstanding at beginning of year 87,650 $ 4.13 117,700 $ 4.21
Granted - - - -
Cancelled - - 1,000 9.75
Cancelled 8,000 4.00 29,050 4.00
------------ ------------ ------------ ------------
Outstanding at end of year 79,650 $ 4.14 117,700 $ 4.13
============ ============ ============ ============
Options available for future grant 168,850 138,800
============ ============
Weighted-average fair value of
options granted during year $ - $ -
============ ============
2000
--------------------------
Shares Price
------------ ------------
Outstanding at beginning of year 118,400 $ 4.37
Granted 19,000 4.00
Cancelled 1,800 9.75
Cancelled 600 13.50
Cancelled 17,300 4.00
------------ ----------
Outstanding at end of year 117,700 $ 4.21
============ ==========
Options available for future grant 138,800
============
Weighted-average fair value of
options granted during year $ 1.01
==========
F-32
The weighted-average remaining contractual life of options granted at
December 31, 2002, 2001 and 2000 was 6 years, 7 years, and 8 years respectively.
At December 31, 2002 there were 77,900, 1,400, and 350 options exercisable at
$4.00, $9.75, and $13.50 per share, respectively. The fair value of each option
granted during 2000 is estimated on the date of grant using the Black-Scholes
option-pricing model with the following assumptions: dividend yield of zero;
expected volatility of 151.42% in 2000; risk-free interest rate of 6.26% for
options granted in March 2000, 5.74% for options granted in October 2000. The
assumption for the expected life of the options is 10 years for the date of
issuance for all options.
F-33
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 16. Stock Options, continued:
The fair value of each option granted during 2000is estimated on the date of
grant using the Black-Scholes option-pricing model with the following
assumptions: dividend yield of zero; expected volatility of 151.42%; risk-free
interest rate of 6.26% for options granted in March 2000 and 5.74% for options
granted in October 2000. The assumption for the expected life of the options is
10 years for the date of issuance for all options.
Had compensation cost for the years 2002, 2001 and 2000 for stock-based
compensation plans been recorded by the Company, the Company's pro forma net
loss and pro forma net loss per common share for 2002, 2001 and 2000 would have
been as follows:
(In thousands, except per share amounts)
Year Ended Year Ended
December 31, 2002 December 31, 2001
--------------------------------- ---------------------------------
As Reported Pro Forma As Reported Pro Forma
--------------------------------- ---------------------------------
Net loss $ (3,227) $ (3,227) $ (2,640) $ (2,645)
Net loss per common share - Basic (0.59) (0.59) (0.48) (0.48)
Net loss per common share - Dilutive (0.59) (0.59) (0.48) (0.48)
Year Ended
December 31, 2000
---------------------------------
As Reported Pro Forma
---------------------------------
Net loss $ (3,292) $ (3,303)
Net loss per common share - Basic (0.60) (0.60)
Net loss per common share - Dilutive (0.60) (0.60)
F-34
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. There were no awards prior to 1997 and additional
awards in future years are anticipated. As a result of the 1999 repricing of
9,150 options, the Company is subject to compensation expense if the fair value
of the company's stock were to go above $4.00 per share.
F-35
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 17. Shareholders' Equity
The Capital Stock of the Company consists of 20,000,000 shares of Common Stock
having a par value of $1.00 per share, 100 shares of Preferred Stock Series A
having a par value of $10.00 per share, and 50,000 shares of Preferred Stock
Series B having a par value of $10.00. At December 31, 2002 and 2001 there were
5,482,114 shares of common stock issued and outstanding, 90 shares of Preferred
Stock Series A issued and outstanding, and no shares of Preferred Stock Series B
were issued and outstanding.
The Common Stock and Preferred Stock Series A have voting powers, with each
share of stock having an equal vote with every other share. The holders of
Preferred Stock Series B are not entitled to vote.
The Preferred Stock Series A is subject to redemption at any time at a price of
$10.20 per share and the Preferred Stock Series B is subject to redemption at
any time at a price equal to its par value.
The holders of Preferred Stock Series A and Preferred Stock Series B are
entitled to be paid in full, upon any distribution of the assets of the
Corporation, first the amount of their Preferred Stock Series B at par and then
the amount of their Preferred Stock Series A at par, before any payment upon
dissolution or upon any distribution is made to the holders of common stock.
F-36
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 18. Earnings Per Share:
The Company's earnings per share have been calculated in accordance with SFAS
No. 128, "Earnings Per Share." The statement requires calculations of basic and
diluted earnings per share. These calculations are described in Note 1. The
following table shows the reconciling components between basic and diluted
earnings per share, outstanding common stock equivalents are not included as
they are currently anti-dilutive:
Weighted Average
Shares
Net Loss Outstanding Loss Per
(Numerator) (Denominator) Share
------------------------------------------------------------
For the Year Ended December 31, 2002
Basic and dilutive earnings per share $(3,227,000) 5,482,114 $ (.59)
================== ================== ==============
For the Year Ended December 31, 2001
Basic and dilutive earnings per share $(2,640,000) 5,482,114 $ (.48)
================== ================== ==============
For the Year Ended December 31, 2000
Basic and dilutive earnings per share $(3,292,000) 5,482,114 $ (.60)
================== ================== ==============
F-37
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 19. Income Taxes:
The components of income tax (benefit) expense for the years ended December 31,
2002, 2001 and 2000, were as follows (in thousands):
2002 2001 2000
------------ ------------ ------------
Current $ (1,046) $ (414) $ (119)
Deferred 1,607 1,897 (1,337)
------------ ------------ ------------
$ 561 $ 1,483 $ (1,456)
============ ============ ============
The provision for (benefit from) income taxes for financial reporting purposes
differs from the amount computed by applying the statutory federal tax rate of
34% to income before taxes. The principal reasons for these differences for the
years ended December 31, 2002, 2001 and 2000, were (in thousands):
2002 2001 2000
------------ ------------ ------------
Provision for (benefit from)
income taxes at statutory
federal rate $ (906) $ (393) $ (1,614)
State income taxes, net (119) (52) (219)
of federal benefit
Nondeductible expenses 24 26 24
Allowance for deferred tax asset 1,562 2,343 479
IRS examination adjustments - (443) -
Other, net - 2 (126)
------------ ------------ ------------
$ 561 $ 1,483 $ (1,456)
============ ============ ============
F-38
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 19. Income Taxes, continued:
Significant components of the Company's deferred tax assets and liabilities at
December 31, 2002 and 2001, were (in thousands):
2002 2001
------------ ------------
Deferred tax assets:
Allowance for loan and real estate
owned losses $ 530 $ 622
Deferred loan fees - 103
Mark to market on mortgage loans
held for sale 107 646
Net Operating Loss carryforward (1) 2,765 2,181
Deferred income 3 15
Accrued premium recapture 9 21
Accrued expenses 406 70
Accrued 401(k) match - 87
Accrued insurance expense 49 64
Goodwill 779 712
------------ ------------
Total deferred tax assets 4,648 4,521
Deferred tax liabilities:
Depreciation 264 92
------------ ------------
Total deferred tax liabilities 264 92
------------ ------------
Deferred tax asset, net of liabilities 4,384 4,429
Valuation allowance 4,384 2,822
------------ ------------
Net deferred tax asset - $ 1,607
============ ============
F-39
(1) The net operating loss carryforward expires on December 31, 2020.
At December 31, 2002 and 2001, management of the Company reviewed recent
operating results and projected future operating results. Realization of the tax
loss and credit carryforwards is contingent on future taxable earnings in the
appropriate jurisdictions. Valuation allowances have been recorded for deferred
income tax assets which may not be realized. There was a net increase in the
valuation allowance of $1,562,000 and $2,343,000 in 2002 and 2001, respectively.
As of December 31, 2002, the deferred tax asset is fully reserved, as future
income to be earned to utilize the asset is uncertain.
F-40
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 20. Retirement Plans:
The Company has a defined contribution profit sharing plan, which is
administered by officers of the Company. Company contributions to the plan are
discretionary, as authorized by the Board of Directors. There were no
contributions for 2002, 2001 and 2000. Participants are also eligible to make
voluntary contributions to the plan, at the discretion of the administrator.
There were no voluntary contributions to the plan for the years ended December
31, 2002, 2001 and 2000.
Subsequent to year end the Company dissolved their nonqualified retirement plan.
The plan allowed several key members of management to defer compensation from
the current year. The Company made no contributions for the years ended December
31, 2002, 2001 and 2000.
The Company sponsors a 401(k) Retirement Plan. The Plan is a defined
contribution plan covering all employees who have completed at least one year of
service. The Plan is subject to the provisions of the Employee Retirement Income
Security Act of 1974. The Company contributes an amount equal to 50% of a
participant's payroll contribution up to 6% of a participant's annual
compensation. The Company's contributions to the plan for the years ended
December 31, 2002, 2001 and 2000, were $68,000, $65,000, and $94,000,
respectively.
Note 21. Commitments and Contingencies:
The Company is, from time to time, subject to routine litigation incidental to
its business. The Company believes that the results of any pending legal
proceedings, net of expense accruals recorded as of December 31, 2002, will not
have a material adverse effect on the financial condition, results of operations
or liquidity of the Company.
In February 2003, the Company settled a lawsuit with a former employee. As this
was a contingent liability at December 31, 2002, an expense of $800,000 was
recorded in the statement of operations related to this liability as of December
31, 2002. The liability is included in "Accrued and other liabilities" on the
statement of financial condition.
Note 22. Employment Agreements:
F-41
The Company has employment agreements with various employees. Absent
notification of termination, the agreements provide for automatic term renewals
of one year. Among other things, the agreements provide for severance benefits
payable to the officers upon termination of employment following a change of
control in the Company.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 23. Regulatory Capital:
Financial institutions, such as the Bank, Are subject to various regulatory
capital requirements administered by federal banking agencies. Failure to meet
minimum capital requirements can initiate mandatory - and possibly discretionary
- - actions by regulators that, if undertaken, could have a direct, material
effect on the Bank's financial statements. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practice. The Bank's capital amounts and classifications
are also subject to the qualitative judgments by the regulators about
components, risk weightings and other factors. Regulations of the Office of
Thrift Supervision (OTS) currently maintain three capital standards: a tangible
capital requirement, a core capital requirement, and a risk-based capital
requirement.
The tangible capital standard requires the Bank to maintain tangible capital of
not less than 1.5% of total adjusted assets. As it applies to the Bank,
"tangible capital" means core capital (as defined below).
The core capital standard requires the Bank to maintain core capital of not less
than 4.0%. Core capital includes the Bank's common shareholder's equity,
adjusted for certain non-allowable assets.
The risk-based standard requires the Bank to maintain capital equal to 8.0% of
risk-weighted assets. The rules provide that the capital ratio applicable to an
asset will be adjusted to reflect the degree of credit risk associated with such
asset, and the asset base used for computing the capital requirement includes
off-balance sheet assets.
At December 31, 2002 and 2001, the most recent notification from the OTS
categorized the Bank as well-capitalized, under the
F-42
regulatory framework for prompt corrective action. There are no conditions or
events since that notification that management believes have changed the Bank's
category. The following table reconciles the Bank's capital to regulatory
capital (in thousands):
Tangible Core Risk-Based
Capital Capital Capital
-------------- -------------- --------------
December 31, 2002
GAAP capital $ 5,206 $ 5,206 $ 5,206
Non-allowable asset: goodwill (71) (71) (71)
Additional capital item: general allowance - - 420
-------------- -------------- --------------
Regulatory capital (computed) 5,135 5,135 5,555
Minimum capital requirement 895 2,386 3,229
-------------- -------------- --------------
Excess regulatory capital $ 4,240 $ 2,749 $ 2,326
============== ============== ==============
Ratios:
Regulatory capital (computed) 8.61% 8.61% 13.76%
Minimum capital requirement 1.50 4.00 8.00
-------------- -------------- --------------
Excess regulatory capital 7.11% 4.61% 5.76%
============== ============== ==============
F-43
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 23. Regulatory Capital, continued:
Tangible Core Risk-Based
Capital Capital Capital
-------------- -------------- --------------
December 31, 2001
GAAP capital $ 7,348 $ 7,348 $ 7,348
Non-allowable asset: goodwill (71) (71) (71)
Deferred Taxes (365) (365) (365)
Additional capital item: general allowance - - 689
-------------- -------------- --------------
Regulatory capital (computed) 6,912 6,912 7,601
Minimum capital requirement 1,159 3,091 4,483
-------------- -------------- --------------
Excess regulatory capital $ 5,753 $ 3,821 $ 3,118
============== ============== ==============
Ratios:
Regulatory capital (computed) 8.94% 8.94% 13.57%
Minimum capital requirement 1.50 4.00 8.00
-------------- -------------- --------------
Excess regulatory capital 7.44% 4.94% 5.57%
============== ============== ==============
The payment of cash dividends by the Bank is subject to regulation by the OTS.
The OTS measures an institution's ability to make capital distributions, which
includes the payment of dividends, according to the institution's capital
position. For institutions, such as the Bank, that meet their fully phased-in
capital requirements, the OTS has established "safe harbor" amounts of capital
distributions that institutions can make after providing notice to the OTS, but
without needing prior approval. Effective April 1, 1999, the OTS has adopted
regulations that provide that an OTS-regulated institution will not have to file
a capital distribution notice with OTS upon meeting certain conditions.
Institutions can distribute amounts in excess of the safe harbor amount without
the prior approval of the OTS. The Bank did not pay cash dividends to Approved
in 2002, 2001 or 2000. The Bank is currently restricted from paying dividends by
the OTS.
Effective December 3, 2001, the Bank entered into a Consent Supervisory
Agreement (Agreement) with the OTS. This agreement required the Bank to revise
various operation procedures, adopt new policies, and submit various interim
reports to the OTS. The Bank believes it is in compliance with all provisions of
the Agreement.
Note 24. Disclosures About Fair Value of Financial Instruments:
SFAS No. 107, "Disclosures about Fair Values of Financial Instruments," requires
disclosure of fair value information about financial instruments, whether or not
recognized in the financial statements, for which it is practicable to estimate
that value. In cases where quoted market prices are not available, fair values
are based upon estimates using present value or other valuation techniques.
Those techniques are significantly affected by the assumptions used, including
the discount rate and the
F-44
estimated future cash flows. In that regard, the derived fair value estimates
cannot be substantiated by comparison to
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 24. Disclosures About Fair Value of Financial Instruments, continued:
independent markets and, in many cases, could not be realized in immediate
settlement of the instrument. SFAS No. 107 excludes certain financial
instruments and all non-financial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts do not represent the underlying
value of the Company.
The following methods and assumptions were used to estimate the fair value of
the Company's financial instruments:
Cash and cash equivalents: The carrying amount of cash on hand and on deposit at
financial institutions is considered to be a reasonable estimate of fair market
value.
Securities: Fair values are based on quoted market prices or dealer quotes.
Mortgage loans held for sale: The estimate of fair value is based on current
pricing of whole loan transactions that a purchaser unrelated to the seller
would demand for a similar loan. The fair value of mortgage loans held for sale
approximated $36,778,000 and $49,322,000 at December 31, 2002 and 2001,
respectively.
Mortgage loans held for yield: The estimate of fair value is based on current
pricing of whole loan transactions that a purchaser unrelated to the seller
would demand for a similar loan. The fair value of mortgage loans held for yield
approximated $6,235,000 and $10,657,000 at December 31, 2002 and 2001,
respectively.
Interest receivable and interest payable: The carrying amount approximates fair
value.
Revolving warehouse lines: Collateralized borrowings consist of warehouse
finance facilities and term debt. The warehouse finance facilities have
maturities of less than one year and bear interest at market rates and,
therefore, the carrying value is a reasonable estimate of fair value.
Certificates of deposit: The fair values for certificates of deposit are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on
F-45
certificates to a schedule of aggregated contractual maturities on such time
deposits. The fair value of certificates of deposit approximated $38,089,000 and
$60,290,000 at December 31, 2002 and 2001, respectively.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 24. Disclosures About Fair Value of Financial Instruments, continued:
Mortgage loans payable: The fair value of mortgage loans payable is based on the
discounted value of expected cash flows. The discount rates used are those
currently offered for mortgage loans with similar remaining contractual
maturities and terms. The fair value of the mortgage loans payable approximated
$1,879,000 and $1,960,000 at December 31, 2002 and 2001, respectively.
Other term debt: The carrying amount of outstanding term debt such as the
certificates of indebtedness and related party notes, which bears market rates
of interest, approximates its fair value.
Note 25. Impairment of Assets:
In the second quarter 2001, the Company recorded a charge of $845,000 for the
write-off of goodwill related to the acquisitions of MOFC, Inc." d/b/a
ConsumerOne Financial and Armada Residential Mortgage LLC. The rapidly changing
and competitive environment, which has resulted in shrinking margins, has
prevented the Company from achieving operating profits at levels that existed
prior to the acquisitions. The Company elected to close the remaining retail
branches associated with these acquisitions.
F-46
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2002, 2001 and 2000
Note 26. Quarterly Financial Data (Unaudited):
The following is a summary of selected quarterly operating results for each of
the four quarters in 2002 and 2001:
(In thousands, except per share data)
March 31 June 30 September 30 December 31
-------------- -------------- -------------- --------------
2002:
Gain on sale of loans $ 1,937 $ 1,802 $ 1,144 $ 1,852
Net interest income 280 291 289 297
Provision for losses 90 8 31 194
Other income 479 383 294 355
Other expenses 3,080 2,919 2,243 3,503
-------------- -------------- -------------- --------------
Income (loss) before income
taxes (474) (451) (547) (1,193)
Provision for income taxes 275 1,333 (500) (547)
-------------- -------------- -------------- --------------
Net income (loss) $ (749) $(1,784) $ (47) $ (646)
============== ============== ============== ==============
Basic and diluted net income
(loss) per share $ (0.14) $ (0.33) $ (0.01) $ (0.12)
============== ============== ============== ==============
2001:
Gain on sale of loans $ 2,777 $ 5,179 $ 3,586 $ 2,289
Net interest income 378 496 328 373
Provision for losses 112 76 (19) 158
Other income 660 942 579 499
Other expenses 4,727 6,212 4,400 3,577
-------------- -------------- -------------- --------------
Income (loss) before income
taxes (1,024) 329 112 (574)
Provision for income taxes (378) 124 59 1,678
-------------- -------------- -------------- --------------
Net income (loss) $ (646) $ 205 $ 53 $(2,252)
============== ============== ============== ==============
Basic and diluted net income
(loss) per share $ (0.12) $ 0.04 $ 0.01 $ (0.41)
============== ============== ============== ==============
During 2001 and 2002, a valuation allowance of $1.9 million and $1.6 million,
respectively was recorded against the deferred tax asset.
F-47
Approved Financial Corp.
Consolidating Balance Sheet
December 31, 2002
(dollars in thousands)
Approved
Approved Approved Federal Approved
Financial Residential Savings Financial
ASSETS Consolidated Eliminations Corp. Mortgage Bank Solutions
---------------- ---------------- --------------- --------------- ------------- -------------
Cash $ 11,470 $ - $ 157 $ (5) $ 11,212 $ 106
Mortgage loans held for
sale, net 36,306 - - - 36,306 -
Mortgage loans held for
yield, net 6,309 - - - 6,309 -
Real estate owned, net 444 - 20 54 370 -
Investments 816 (5,342) 5,342 - 816 -
Income taxes receivable 1,241 - 393 52 796 -
Premises and equipment,
net 3,216 - 90 9 3,114 3
Due from affiliates - (1,518) 1,518 - - -
Other assets 841 - 24 6 811 -
---------------- ---------------- --------------- --------------- ------------- -------------
Total assets $ 60,643 $ (6,860) $ 7,544 $ 116 $ 59,734 $ 109
================ ================ =============== =============== ============= =============
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 10,379 $ - $ - $ - $10,379 $ -
Mortgage payable 1,679 - - - 1,679 -
Subordinated promissory
notes 2,525 - 2,525 - - -
Certificates of
indebtedness 2,076 - 2,076 - - -
Certificates of deposits 37,830 - - - 37,830 -
FDIC insured Money market
deposits 1,845 - - - 1,845 -
Due to affiliates - (1,518) 116 69 1,328 5
Accrued and other
liabilities 2,153 - 671 4 1,467 11
---------------- ---------------- --------------- --------------- ------------- -------------
Total liabilities 58,487 (1,518) 5,388 73 54,528 16
---------------- ---------------- --------------- --------------- ------------- -------------
Shareholder's equity:
Preferred stock-series A 1 - 1 - - -
Common stock 5,482 (298) 5,482 250 32 16
Additional capital 552 (9,824) 552 5,282 4,542 -
Retained (deficit) earnings (3,879) 4,780 (3,879) (5,489) 632 77
---------------- ---------------- --------------- --------------- ------------- -------------
Total equity 2,156 (5,342) 2,156 43 5,206 93
---------------- ---------------- --------------- --------------- ------------- -------------
Total liabilities
and equity $ 60,643 $ (6,860) 7,544 $ 116 $ 59,734 $ 109
================ ================ =============== =============== ============= =============
F-48
Approved Financial Corp.
Consolidating Statement of Operations
For the year ended December 31, 2002
(dollars in thousands)
Approved
Approved Approved Federal Approved
Financial Residential Savings Financial
ASSETS Consolidated Eliminations Corp. Mortgage Bank Solutions
---------------- ---------------- --------------- --------------- ------------- -------------
Revenue:
Gain on sale of loans $ 6,736 - - - 6,736 -
Interest income 4,102 - (129) 1 4,229 1
Other fees and income 1,510 - 78 - 1,404 28
---------------- ---------------- --------------- --------------- ------------- -------------
12,348 - (51) 1 12,369 29
Expenses:
Compensation and related $ 5,243 - 1,762 - 3,469 12
General and administrative 5,323 - (1,770) 78 7,000 15
Loan production expense 1,179 - 4 54 1,121 -
Interest expense 2,945 - 437 - 2,508 -
Provision for inter-company
promissory note - - 152 - -152 -
Provision for loan/REO
losses 324 - 55 - 269 -
---------------- ---------------- --------------- --------------- ------------- -------------
15,014 - 640 132 14,215 27
(Loss) income before income
taxes (2,666) - (691) (131) (1,846) 2
Provision for (benefit from)
income taxes 561 - 131 151 296 (17)
---------------- ---------------- --------------- --------------- ------------- -------------
Net (loss) income $ (3,227) - (822) (282) (2,142) 19
================ ================ =============== =============== ============= =============
F-49