<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: November 30, 1996
- -----------------------------------------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________________to __________________
Commission file number: 0-21689
- ----------------------------------------------------------------------------
MEGO MORTGAGE CORPORATION
- -----------------------------------------------------------------------------
(Exact name of registrant as specified charter)
<TABLE>
<S> <C>
Delaware 88-0286042
- --------------------------------------------- -------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
</TABLE>
1000 Parkwood Circle, Suite 500, Atlanta, Georgia 30339
- -----------------------------------------------------------------------------
(Address of principal executive offices)(Zip Code)
(770) 952-6700
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ ] No [X]
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of January 6, 1997, there were 12,300,000 shares of Common Stock, $.01 par
value per share, of the Registrant outstanding.
<PAGE> 2
MEGO MORTGAGE CORPORATION
INDEX
<TABLE>
<CAPTION>
Page
<S> <C> <C>
PART I FINANCIAL INFORMATION:
Item 1. Financial Statements
Statements of Financial Condition at
November 30, 1996 and August 31, 1996 (Unaudited) . . . . . . . . . . . . . . . . . . . . . . . 1
Statements of Operations for the Three Months Ended
November 30, 1996 and 1995 (Unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Statements of Stockholders' Equity for
the Three Months Ended November 30, 1996 (Unaudited) . . . . . . . . . . . . . . . . . . . . . . 3
Statements of Cash Flows for the Three Months Ended
November 30, 1996 and 1995 (Unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Notes to Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . 7
PART II OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
SIGNATURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
</TABLE>
<PAGE> 3
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MEGO MORTGAGE CORPORATION
STATEMENTS OF FINANCIAL CONDITION
(thousands of dollars, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
NOVEMBER 30, AUGUST 31,
1996 1996
----------- ---------
<S> <C> <C>
ASSETS
Cash and cash equivalents $26,615 $ 443
Cash deposits, restricted 2,044 4,474
Loans held for sale, net of allowance for credit losses of $227 and $95 6,538 4,610
Mortgage related securities, at fair value 23,049 22,944
Excess servicing rights 22,742 12,121
Mortgage servicing rights 4,789 3,827
Other receivables 321 59
Property and equipment, net of accumulated depreciation
of $355 and $279 1,741 865
Organizational costs, net of amortization 434 482
Prepaid debt expenses 2,852 216
Prepaid commitment fee 3,045 -
Other assets 578 565
------- -------
TOTAL ASSETS $94,748 $50,606
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Notes and contracts payable $ 1,662 $14,197
Accounts payable and accrued liabilities 5,946 4,066
Allowance for credit losses on loans sold with recourse 2,475 920
Due to parent company 3,412 11,994
Due to affiliated company 324 819
State income taxes payable 91 909
------- -------
Total liabilities 13,910 32,905
------- -------
Subordinated Debt 40,000 -
------- -------
Stockholders' equity:
Common Stock, $.01 par value per share
Authorized -- 50,000,000 shares;
Issued and outstanding -- 12,300,000 at November 30, 1996 123 100
and 10,000,000 at August 31, 1996
Additional paid-in capital 29,185 8,550
Retained earnings 11,530 9,051
------- -------
Total stockholders' equity 40,838 17,701
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $94,748 $50,606
======= =======
</TABLE>
See notes to financial statements.
1
<PAGE> 4
MEGO MORTGAGE CORPORATION
STATEMENTS OF OPERATIONS
(thousands of dollars, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
NOVEMBER 30,
----------------------------
1996 1995
----------- -----------
<S> <C> <C>
REVENUES
Gain on sale of loans $ 9,601 $ 5,965
Net unrealized loss on mortgage related securities (235) -
Loan servicing income 638 891
Interest income, net of interest expense of $645 and $468 355 138
----------- -----------
Total revenues 10,359 6,994
----------- -----------
COSTS AND EXPENSES
Provision for credit losses 1,711 297
Depreciation and amortization 140 101
Other interest 47 47
General and administrative:
Payroll and benefits 1,816 1,084
Commissions and selling 583 512
Professional services 112 232
Servicing fees paid to affiliate 285 128
Management services by affiliate 242 168
FHA insurance 203 231
Other 1,208 349
----------- -----------
Total costs and expenses 6,347 3,149
----------- -----------
INCOME BEFORE INCOME TAXES 4,012 3,845
INCOME TAXES 1,533 1,538
----------- -----------
NET INCOME $ 2,479 $ 2,307
=========== ===========
EARNINGS PER COMMON SHARE:
Primary:
Net income $ 0.24 $ 0.23
=========== ===========
Weighted average number of common shares and
common share equivalents outstanding 10,317,102 10,000,000
Fully diluted: =========== ===========
Net income $ 0.24 $ 0.23
=========== ===========
Weighted average number of common shares and
common share equivalents outstanding 10,319,051 10,000,000
=========== ===========
</TABLE>
See notes to financial statements.
2
<PAGE> 5
MEGO MORTGAGE CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
(thousands of dollars, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
COMMON STOCK
---------------------
$0.01 PAR VALUE ADDITIONAL
--------------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
---------- ------ --------- -------- -------
<S> <C> <C> <C> <C> <C>
Balance at August 31, 1996 10,000,000 $100 $ 8,550 $ 9,051 $17,701
Sale of common stock, net of
issuance costs 2,300,000 23 20,635 - 20,658
Net income for the three months ended
November 30, 1996 - - - 2,479 2,479
---------- ---- ------- ------- -------
Balance at November 30, 1996 12,300,000 $123 $29,185 $11,530 $40,838
========== ==== ======= ======= =======
</TABLE>
See notes to financial statements.
3
<PAGE> 6
MEGO MORTGAGE CORPORATION
STATEMENTS OF CASH FLOWS
(thousands of dollars)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
November 30,
--------------------
1996 1995
--------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,479 $ 2,307
-------- -------
Adjustments to reconcile net income to net cash used in operating activities:
Additions to mortgage servicing rights (1,209) (447)
Additions to excess servicing rights (11,349) (6,599)
Net unrealized loss on mortgage related securities 235 -
Provisions for estimated credit losses 1,711 297
Depreciation and amortization expense 140 101
Amortization of excess servicing rights 728 511
Amortization of mortgage servicing rights 247 11
Accretion of residual interest in mortgage related securities (551) -
Repayments of mortgage related securities 211 -
Loans originated for sale, net of loan feees (62,462) (33,715)
Repayments on loans held for sale 31 57
Proceeds from sale of loans 60,509 34,548
Changes in operating assets and liabilities:
Decrease (increase) in cash deposits, restricted 2,430 (1,657)
Decrease (increase) in other assets, net (868) 71
Increase (decrease) in state income taxes payable (818) 206
Increase in other liabilities, net 1,880 339
Additions to due to affiliated company 850 3,013
Payments on due to affiliated company (1,345) (5)
-------- -------
Total adjustments (9,630) (3,269)
-------- -------
Net cash used in operating activities (7,151) (962)
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (968) (350)
-------- -------
Net cash used in investing activities (968) (350)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings on notes and contracts payable 51,919 31,430
Payments on notes and contracts payable (64,454) (31,560)
Additions in due to parent company 1,892 1,307
Payments on due to parent company (13,474) -
Issuance of subordinated debt 37,750 -
Sale of common stock 20,658 -
-------- -------
Net cash provided by financing activities 34,291 1,177
-------- -------
NET INCREASE (DECREASE) IN CASH 26,172 (135)
CASH AND CASH EQUIVALENTS BEGINNING OF PERIOD 443 752
-------- -------
CASH AND CASH EQUIVALENTS END OF PERIOD $ 26,615 $ 617
======== =======
</TABLE>
See notes to financial statements.
4
<PAGE> 7
MEGO MORTGAGE CORPORATION
STATEMENTS OF CASH FLOWS (Continued)
(thousands of dollars)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
November 30,
------------------
1996 1995
------ -----
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 758 $257
====== ====
State income taxes $1,060 $25
====== ====
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
Addition to prepaid commitment fee and due to parent in
connection with loan sale commitment received $3,000 $ -
====== ====
</TABLE>
See notes to financial statements.
5
<PAGE> 8
MEGO MORTGAGE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED NOVEMBER 30, 1996 AND 1995
(UNAUDITED)
1. FINANCIAL STATEMENTS
In the opinion of management, when read in conjunction with the
audited Financial Statements for the years ended August 31, 1996 and 1995,
contained in Mego Mortgage Corporation's Registration Statements on Form S-1
filed in conjunction with the registration of its common stock and debt
offerings, the accompanying unaudited Financial Statements contain all of the
information necessary to present fairly the financial position of Mego Mortgage
Corporation at November 30, 1996 and the results of its operations and cash
flows for the three months ended November 30, 1996 and 1995. The results of
operations for the three months ended November 30, 1996 are not necessarily
indicative of the results to be expected for the full year.
2. NATURE OF OPERATIONS
Mego Mortgage Corporation (the Company) was incorporated on June 12,
1992, in the State of Delaware. The Company, through its loan correspondents
and home improvement contractors, is primarily engaged in the business of
originating, selling, servicing and pooling home improvement loans, certain of
which qualify under the provisions of Title I of the National Housing Act which
is administered by the U.S. Department of Housing and Urban Development (HUD).
Pursuant to that program, 90% of the principal balances of the loans are U.S.
government insured (Title I Loans), with cumulative maximum coverage equal to
10% of all Title I Loans originated by the Company. In May 1996, the Company
commenced the origination of conventional home improvement, debt consolidation,
and home equity loans through its network of loan correspondents and dealers.
The Company was a wholly-owned subsidiary of Mego Financial Corp.
(Mego Financial) until November 1996, when the Company issued 2,300,000 shares
of its common stock in an underwritten public offering at $10.00 per share. As
a result of this transaction, Mego Financial's ownership in the Company
declined from 100% at August 31, 1996 to 81.3%. Mego Financial continues to
have voting control on all matters submitted to the stockholders of the
Company, including the election of directors and approval of extraordinary
corporate transactions. Concurrently with the common stock offering, the
Company issued $40 million of 12.5% Senior Subordinated Notes due in 2001 in an
underwritten public offering. The proceeds received by the Company were used
to repay borrowings and provide funds for future originations and
securitizations of loans. See Management's Discussion and Analysis of
Financial Condition and Results of Operations for further discussion.
3. SUBSEQUENT EVENT
On December 17, 1996, $67.3 million of loans were repurchased,
securitized and sold by the Company, comprised of $36.7 million in Title I
Loans and $30.6 million in conventional loans. Pursuant to this
securitization, pass-through certificates evidencing interests in the pools of
loans were sold in a public offering. The Company continues to service the
sold loans and is entitled to receive from payments with respect to interest on
the sold loans, a servicing fee equal to 1.00% per annum of the balance of each
loan. The Company received certificates and contractual rights which will be
recorded as mortgage related securities on the Statements of Financial
Condition, representing the interest differential, after payment of servicing
and other fees, between the interest paid by the obligors of the sold loans and
the yield on the sold certificates. The Company may be required to repurchase
loans that do not conform to the representations and warranties made by the
Company in the securitization agreements.
6
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the Financial Statements, including the notes thereto, contained elsewhere
herein.
GENERAL
The Company originates, purchases, sells and services consumer loans
consisting primarily of home improvement loans generally secured by liens on
improved property through its network of correspondents and dealers. The home
equity debt consolidation and conventional home improvement loans are purchased
or originated by the Company in amounts up to a maximum of $75,000 with fixed
rates and up to 25 year maturities, and are secured by a lien on the respective
primary residence. The Title I Loans are purchased or originated by the Company
in amounts up to a maximum of $25,000 with maturities up to 20 years. During
the first quarter of fiscal 1997, the Company began offering non-FHA insured
loans through its dealer division and debt consolidation loans to its borrowers
through both its correspondent and dealer divisions.
The following table sets forth certain data regarding loans
originated, securitized and serviced by the Company during the three months
ended November 30, 1996 and 1995:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NOVEMBER 30,
--------------------------------------------
1996 1995
------------------------ ------------------
<S> <C> <C> <C> <C>
Loan Originations:
- -----------------
Principal amount of loans:
Correspondents:
Title I $ 19,165,042 30.7% $ 21,882,179 64.9%
Conventional 30,850,495 49.4 - -
------------ ----- ------------ ----
Total Correspondents 50,015,537 80.1 21,882,179 64.9
------------ ----- ------------ ----
Dealers:
Title I 12,238,858 19.6 11,832,670 35.1
Conventional 207,279 0.3 - -
------------ ----- ------------ ----
Total Dealers 12,446,137 19.9 11,832,670 35.1
------------ ----- ------------ ----
Total $62,461,674 100.0% $ 33,714,849 100.0%
============ ===== ============ =====
Number of Loans Originated:
- --------------------------
Correspondents:
Title I 942 30.8% 1,440 64.9%
Conventional 1,076 35.1 - -
----------- ---- ------------ ----
Total Correspondents 2,018 65.9 1,440 64.9
----------- ---- ------------ ----
Dealers:
Title I 1,034 33.8 778 35.1
Conventional 10 0.3 - -
----------- ---- ------------ ----
Total Dealers 1,044 34.1 778 35.1
----------- ---- ------------ ----
Total 3,062 100.0% 2,218 100.0%
============ ===== ============ =====
Loans Serviced at end of period (including
- -------------------------------------------
notes securitized, sold to investors, and
- -----------------------------------------
held for sale):
--------------
Title I $225,895,679 84.5% $123,278,994 100.0%
Conventional 41,590,163 15.5 - -
----------- ---- ------------ ----
Total $267,485,842 100.0% $123,278,994 100.0%
============ ===== ============ =====
</TABLE>
7
<PAGE> 10
The following table sets forth the principal balance of loans sold or
securitized and related gain on sale data for the three months ended November
30, 1996 and 1995 (thousands of dollars):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
NOVEMBER 30,
--------------------------
1996 1995
------------ ---------
<S> <C> <C>
Principal amount of loans sold:
Title I Loans $33,388 $35,026
Conventional 27,121 -
------- -------
Total $60,509 $35,026
======= =======
Gain on sale of loans $ 9,601 $ 5,965
======= =======
Net unrealized loss on mortgage related securities $ (235) $ -
Gain on sale of loans and unrealized gain on mortgage
related securities $ 9,366 $ 5,965
Gain on sale of loans as a percentage of principal balance
of loans sold 15.9% 17.0%
</TABLE>
The Company is obligated under certain agreements for the sale of
loans and certain loan agreements to maintain various minimum net worth
requirements. The most restrictive of these agreements requires the Company to
maintain a minimum tangible net worth requirement of $12.5 million plus any
issuance of capital stock or other capital instruments since August 31, 1995,
plus 50% of the Company's cumulative net income since May 1, 1996. At November
30, 1996, the Company's minimum tangible net worth requirement was $36.7
million. Additionally, the Company is required to maintain a minimum level of
profitability of at least $500,000 per rolling 6 month period.
During the first quarter of fiscal 1997, no loans were sold through
securitizations. In December 1996, $67.3 million of loans were repurchased and
securitized. See Note 3 of Notes to Financial Statements for further
discussion.
The Company recognizes revenue from the gain on sale of loans,
interest income and servicing income. Interest income, net, represents the
interest received on loans in the Company's portfolio prior to their sale, net
of interest paid under its debt agreements. The Company continues to service
all loans sold to date. Net loan servicing income represents servicing fee
income and other ancillary fees received for servicing loans less the
amortization of capitalized mortgage servicing rights and excess servicing
rights. Mortgage servicing rights and excess servicing rights are amortized
over the estimated lives of the future net servicing fee income.
The Company sells its loans through whole loan sales to third party
purchasers, retaining the right to service the loans and to receive any amounts
in excess of the guaranteed yield to the purchasers. In addition, the Company
has sold loans through securitizations. Certain of the regular interests of
the related securitizations are sold, with the interest only and residual class
securities retained by the Company.
As the holder of the residual securities, the Company is entitled to
receive certain excess cash flows. These excess cash flows are calculated as
the difference between (a) principal and interest paid by borrowers and (b) the
sum of (i) pass-through interest and principal to be paid to the holders of the
regular securities and interest only securities, (ii) trustee fees, (iii)
third-party credit enhancement and FHA insurance fees, (iv) servicing fees and
(v) estimated loan pool losses. The Company's right to receive the excess cash
flows is subject to the satisfaction of certain reserve requirements which are
specific to each securitization and are used as a means of credit enhancement.
8
<PAGE> 11
Delinquencies--The following table sets forth the delinquency and
Title I insurance claims experience of loans serviced by the Company as of the
dates indicated (thousands of dollars):
<TABLE>
<CAPTION>
NOVEMBER 30, AUGUST 31,
1996 1996
------------ ------------
<S> <C> <C>
Delinquency period (1)
31-60 days past due 2.59% 2.17%
61-90 days past due 0.88 0.85
91 days and over past due (2) 4.25 4.53
91 days and over past due, net of claims filed (3) 1.72 1.94
Outstanding claims filed with HUD (4) 2.53 2.59
Outstanding number of Title I insurance claims 320 255
Total servicing portfolio $ 267,486 $ 214,189
Title I Loans serviced 225,896 202,766
Amount of FHA insurance available (5) 23,167 21,205
Amount of FHA insurance available as a percentage
of Title I Loans serviced 10.26%(5) 10.46%
Losses on liquidated loans (6) $ 20 $ 32
</TABLE>
- -----------------------
(1) Represents the dollar amount of delinquent loans as a percentage of
total dollar amount of loans serviced by the Company (including loans
owned by the Company) as of the dates indicated.
(2) During the year ended August 31, 1996 and the quarter ended November
30, 1996, the processing and payment of claims filed with HUD was
delayed.
(3) Represents the dollar amount of delinquent loans net of delinquent
Title I Loans for which claims have been filed with HUD and payment is
pending as a percentage of total dollar amount of loans serviced by
the Company (including loans owned by the Company) as of the date
indicated.
(4) Represents the dollar amount of delinquent Title I Loans for which
claims have been filed with HUD and payment is pending as a percentage
of total dollar amount of loans serviced by the Company (including
loans owned by the Company) as of the date indicated.
(5) If all claims with HUD had been processed as of November 30, 1996, the
amount of FHA insurance available would have been reduced to $17.1
million, which as a percentage of Title I Loans serviced would have
been 7.6%.
(6) On Title I Loans, a loss is recognized upon receipt of payment of a
claim or final rejection thereof. Claims paid in a period may relate
to a claim filed in an earlier period. Since the Company commenced
its Title I lending operations in March 1994, there has been no final
rejection of a claim by the FHA. Aggregate losses on liquidated Title
I Loans related to 154 of the 474 Title I insurance claims made by the
Company since commencing operations through November 30, 1996. Losses
on Title I Loans liquidated will increase as the balance of the
claims are processed by HUD. The Company has received an average
payment from HUD equal to 90% of the outstanding principal balance of
such Title I Loans, plus appropriate interest and costs.
Pooling and servicing agreements relating to the Company's
securitization transactions contain provisions with respect to the maximum
permitted loan delinquency rates and loan default rates, which, if exceeded,
would allow the termination of the Company's right to service the related
loans. At November 30, 1996, the delinquency rates on the pool of loans sold
in the March 1996 securitization transaction exceeded the permitted limit set
forth in the related pooling and servicing agreement. Accordingly, this
condition could result in the termination of the Company's servicing rights
with respect to that pool of loans by the trustee, the master servicer or the
insurance company providing credit enhancement for that transaction. Although
the insurance company has indicated that it, and to its knowledge, the trustee
and the master servicer, have no present intention to terminate the Company's
servicing rights related to that pool of loans, no assurance can be given that
one or more of such parties will not exercise its right to terminate. In the
event of such termination, there would be a material adverse effect on the
valuation of the Company's mortgage servicing rights and the results of
operations in the
9
<PAGE> 12
amount of mortgage servicing rights ($1.8 million before tax and $1.1 million
after tax at November 30, 1996) on the date of termination.
The pooling and servicing agreements also require that certain
delinquency and default rate thresholds be maintained. When these thresholds
are exceeded, higher levels of overcollateralization are required which can
cause a delay in cash receipts to the residual interest holders, causing an
adverse valuation adjustment to the residual interest security. At November 30,
1996, such an adjustment was made for $235,000 on mortgage related securities
related to the March 1996 securitization.
Delinquencies have also decreased the amount of servicing fee revenue
recorded during the period, as the Company's loan servicing revenue has been
reduced by the amount of interest advanced to the owners of these loans. Loan
servicing income decreased for the 3 months ended November 30, 1996 partially
due to the advance of interest on delinquent loans.
Delinquencies have increased during the three months ended November
30, 1996 from the August 31, 1996 levels. Since the Company began originating
loans in 1994, an increasing level of delinquencies appear as expected on loans
less than two years old. After this initial period, the level of delinquencies
is not anticipated to increase. Management has transferred its entire
collection function to Atlanta, Georgia to improve efficiency and coordination
of collection efforts and to ensure consistent collection strategies with
borrowers. The Company's loan collection functions are organized into two
areas of operation: routine collections and management of nonperforming loans.
Routine collection personnel are responsible for collecting loan payments that
are less than 60 days contractually past due and providing prompt and accurate
responses to all customer inquiries and complaints. Borrowers are contacted on
the due date for each of the first six payments in order to encourage continued
prompt payment. Generally, after six months of seasoning, collection activity
will commence if the loan payment has not been made within five days of the due
date. Borrowers usually will be contacted by telephone at least once every 5
days and also by written correspondence before the loan become 60 days
delinquent. With respect to loan payments that are less than 60 days late,
routine collection personnel utilize a system of mailed notices and telephonic
conferences for reminding borrowers of late payments and encouraging borrowers
to bring their accounts current. Installment payment invoices and return
envelopes are mailed to each borrower on a monthly basis.
Once a loan becomes 30 days past due, a collection supervisor
generally analyzes the account to determine the appropriate course of remedial
action. On or about the 45th day of delinquency, the supervisor determines if
the property needs immediate inspection to determine if it is occupied or
vacant. Depending upon the circumstances surrounding the delinquent account, a
temporary suspension of payments or a repayment plan to return the account to
current status may be authorized. It is the Company's policy to work with the
delinquent customer to resolve the past due balance before Title I claim
processing or legal action is initiated.
Nonperforming loan management personnel are responsible for collection
of severely delinquent loan payments (over 60 days late), filing Title I
insurance claims or initiating legal action for foreclosure and recovery.
Collection and Title I insurance claim personnel are responsible for collecting
delinquent loan payments and seeking to mitigate losses by providing various
alternatives for further actions, including modifications, managing Title I
insurance claims, and utilizing a claim management system designed to track
insurance claims for Title I Loans so that all required conditions precedent to
claim perfection are met. A foreclosure coordinator will review all previous
collection activity for conventional loans, evaluate the lien and equity
position and obtain any additional information as necessary. Foreclosure
regulations and practices and the rights of the owner in default vary from
state to state, but generally procedures may be initiated if: (i) the loan is
90 days (120 days under California law) or more delinquent; (ii) a notice of
default on a senior lien is received; or (iii) the Company discovers
circumstances indicating potential for loss exposure.
RESULTS OF OPERATIONS
Three Months Ended November 30, 1996 compared to Three Months Ended November
30, 1995
The Company originated $62.5 million of loans during the 3 months
ended November 30, 1996 compared to $33.7 million of loans during the 3 months
ended November 30, 1995, an increase of 85.3%. The increase is a result of the
overall growth in the Company's business, including an increase in the number
of active Correspondents and Dealers and an increase in the number of states
served. At November 30, 1996, the Company had approximately 402 active
Correspondents and 459 active Dealers, compared to approximately 289 active
Correspondents and 467 active Dealers at November 30, 1995. Of the $62.5
million of loans originated for the 3 months ended November 30, 1996, $31.1
million were conventional loans. The Company did not originate conventional
loans in the 3 months ended November 30, 1995.
10
<PAGE> 13
Total revenues increased 48.1% to $10.4 million for the 3 months ended
November 30, 1996 from $7 million for the 3 months ended November 30, 1995.
The increase was primarily the result of the increased volume of loans
originated and the gain on sale of such loans.
Loan servicing income decreased 28.4% for the 3 months ended November
30, 1996 from $891,000 for the 3 months ended November 30, 1995 to $638,000 for
the 3 months ended November 30, 1996. The decrease was primarily the result of
increased amortization of excess servicing rights and mortgage servicing
rights, and interest advances and reduced servicing fees related to $20.7
million in delinquencies at November 30, 1996 compared to $5.2 million at
November 30, 1995.
Interest income on loans held for sale and mortgage related
securities, net of interest expense, increased 157.3% to $355,000 during the 3
months ended November 30, 1996 from $138,000 during the 3 months ended November
30, 1995. The increase was primarily the result of the increase in the average
size of the portfolio of loans held for sale, and the increased mortgage
related securities portfolio.
The provision for credit losses increased 476.1% to $1.7 million for
the 3 months ended November 30, 1996 from $297,000 for the 3 months ended
November 30, 1995. The increase in the provision was directly related to the
increase in volume and mix of loans originated in the 3 months ended November
30, 1996 compared to the 3 months ended November 30, 1995. The provision for
credit losses is based upon periodic analysis of the portfolio, economic
conditions and trends, historical credit loss experience, borrowers' ability to
repay, collateral values, and estimated FHA insurance recoveries on loans
originated and sold. As the Company increased its mix of conventional loan
originations as compared to Title I Loan originations, the provision for credit
losses as a percentage of loans originated increased due to the greater credit
risk associated with conventional loans.
Total general and administrative expenses increased 64.5% to $4.4
million for the 3 months ended November 30, 1996 compared to $2.7 million for
the 3 months ended November 30, 1995. The increase was primarily a result of
increased payroll related to the hiring of additional underwriting, loan
processing, administrative, loan quality control and other personnel as a result
of the expansion of the Company's business and costs related to the opening of
additional offices.
Payroll and benefits expense increased 67.5% to $1.8 million for the 3
months ended November 30, 1996 from $1.1 million for the 3 months ended
November 30, 1995. The number of employees increased to 206 at November 30,
1996 from 130 at November 30, 1995, due to increased staff necessary to support
the business expansion and improve quality control.
Commissions and selling expenses increased 13.9% to $583,000 for the 3
months ended November 30, 1996 from $512,000 for the 3 months ended November
30, 1995 while loan originations increased by $28.7 million to $62.5 million at
November 30, 1996. The sales network expanded to substantially all states,
adding new personnel and offices to further the loan origination growth
strategy.
Professional services decreased 51.7% to $112,000 for the 3 months
ended November 30, 1996 from $232,000 for the 3 months ended November 30, 1995
due primarily to decreased audit and legal fees. The level of professional
service fees in fiscal 1997 is not anticipated to be as high as in fiscal
1996.
Servicing fees paid to affiliate increased 122.7% to $285,000 for the 3
months ended November 30, 1996 from $128,000 for 3 months ended November 30,
1995 due primarily to a larger loan servicing portfolio. Management services by
affiliate increased 44% to $242,000 for the 3 months ended November 30, 1996
from $168,000 for the 3 months ended November 30, 1995. These expenses
represent services provided by Preferred Equities Corporation (PEC), including
executive, accounting, legal, management information, data processing, human
resources, advertising and promotional materials.
FHA insurance decreased 12.1% to $203,000 for the 3 months ended
November 30, 1996 from $231,000 for the 3 months ended November 30, 1995 due
primarily to a decrease of $2.3 million in Title I Loan originations.
Other general and administrative expenses increased 246.1% to $1.2
million for the 3 months ended November 30, 1996 from $349,000 for the 3 months
ended November 30, 1995, due primarily to increased expenses related to the
ongoing expansion of facilities and increased communications costs and
adjustments related to prior securitizations.
11
<PAGE> 14
Income before income taxes increased to $4 million for the 3 months
ended November 30, 1996 from $3.8 million for the 3 months ended November 30,
1995.
As a result of the foregoing, net income increased 7.5% to $2.5
million for the 3 months ended November 30, 1996 from $2.3 million for the 3
months ended November 30, 1995.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents for the Company was $26.6 million at November
30, 1996 compared to $443,000 at August 31, 1996. The increase was primarily
due to the proceeds received from the common stock and debt offerings of the
Company. The Company's principal cash requirements which relate to loan
originations require continued access to sources of debt financing and sales in
the secondary market of loans.
As a result of the substantial growth in loan originations, the
Company has operated since March 1994, and expects to continue to operate for
the foreseeable future, on a negative cash flow basis. During the 3 months
ended November 30, 1996, the Company operated on a negative cash flow basis
using $7.2 million in operations that was funded primarily from borrowings, due
primarily to an increase in loans originated and the Company's sale of loans.
In connection with whole loan sales and securitizations, the Company recognizes
a gain on sale of the loans upon the closing of the transaction and the
delivery of the loans, but does not receive the cash representing such gain
until it receives the excess servicing spread, which is payable over the actual
life of the loans sold. The Company incurs significant expenses in connection
with securitizations and incurs tax liabilities as a result of the gain on
sale. The Company must maintain external sources of cash to fund its
operations and pay its taxes and therefore must maintain warehouse lines of
credit and other external funding sources. If the capital sources of the
Company were to decrease, the rate of growth of the Company would be negatively
affected.
In November 1996, the Company issued 2,300,000 shares of its common
stock in an underwritten public offering at $10.00 per share. As a result of
this transaction, Mego Financial's ownership in the Company declined from 100%
at August 31, 1996 to 81.3%. Mego Financial continues to have voting control
on all matters submitted to stockholders of the Company, including the election
of directors and approval of extraordinary corporate transactions.
Concurrently with the common stock offering, the Company issued $40 million of
12.5% Senior Subordinated Notes due in 2001 in an underwritten public offering.
The Company used approximately $13.9 million of the aggregate net proceeds
received from the offerings to repay amounts due to Mego Financial and an
affiliate and approximately $21.5 million reducing the amounts outstanding
under the Company's warehouse and revolving lines of credit. The warehouse
line of credit currently bears interest at 1% over the prime rate and will
expire in August 1997. The revolving line of credit has been repaid.
Additionally, the Company repaid $3 million under a repurchase agreement. The
remaining funds received by the Company will be used to provide capital to
originate and securitize loans. Pending such use, approximately $18 million of
the remaining funds have been invested in high quality, short term
interest-bearing investment and deposit accounts.
The pooling and servicing agreements relating to the Company's
securitizations require the Company to build over-collateralization levels
through retention within each securitization trust of excess servicing
distributions and application thereof to reduce the principal balances of the
senior interests issued by the related trust or cover interest shortfalls.
This retention causes the aggregate principal amount of the loans in the
related pool to exceed the aggregate principal balance of the outstanding
investor certificates. Such over-collateralization amounts serve as credit
enhancement for the related trust and therefore are available to absorb losses
realized on loans held by such trust. The Company continues to be subject to
the risks of default and foreclosure following the sale of loans through
securitizations to the extent excess servicing distributions are required to be
retained or applied to reduce principal or cover interest shortfalls from time
to time. Such retained amounts are predetermined by the entity insuring the
related senior interests and are a condition to obtaining insurance and an
AAA/Aaa rating thereon. In addition, such retention delays cash distributions
that otherwise would flow to the Company through its retained interests,
thereby adversely affecting the flow of cash to the Company.
The Company's cash requirements arise from loan originations, payments
of operating and interest expenses, taxes, and deposits to reserve accounts
related to loan sale transactions. Loan originations are initially funded
principally through the Company's $20 million warehouse line of credit pending
the sale of loans in the secondary market. Substantially all of the loans
originated by the Company are sold. Net cash used in the Company's operating
activities was funded primarily from the reinvestment of proceeds from the sale
of loans in the secondary market totaling approximately $60.5 million for the 3
months ended November 30, 1996. The loan sale transactions required the
subordination of certain cash flows payable
12
<PAGE> 15
to the Company to the payment of scheduled principal and interest due to the
loan purchasers. In connection with certain of such sale transactions, a
portion of amounts payable to the Company from the excess interest spread is
required to be maintained in a reserve account to the extent of the
subordination requirements. The subordination requirements generally provide
that the excess interest spread is payable to the reserve account until a
specified percentage of the principal balances of the sold loans is accumulated
therein.
Excess interest spread payable to the Company is subject to being
utilized first to replenish cash paid from the reserve account to fund
shortfalls in collections of interest from borrowers who default on the
payments on the loans until the Company's deposits into the reserve account
equal the specified percentage. The excess interest required to be deposited
and maintained in the respective reserve accounts is not available to support
the cash flow requirements of the Company. At November 30, 1996, amounts on
deposit in such reserve accounts totaled $2 million.
Adequate credit facilities and other sources of funding, including the
ability of the Company to sell loans in the secondary market, are essential for
the continuation of the Company's loan origination operations. At November 30,
1996, the Company had a $20 million warehouse line of credit (Warehouse Line)
for the financing of loan originations which expires in August 1997. At
November 30, 1996, $0 was outstanding under the Warehouse Line and $20 million
was available due to the repayment of the outstanding balance from the proceeds
of the common stock and debt offerings. The Warehouse Line bears interest at
the prime rate plus 1% per year and is secured by loans prior to sale. The
agreement with the lender requires the Company to maintain a minimum tangible
net worth of $12.5 million plus any issuance of capital stock or other capital
instruments since August 31, 1995, plus 50% of the Company's cumulative net
income after May 1, 1996, and a minimum level of profitability of at least
$500,000 per rolling 6 month period. At November 30, 1996, the Company's
minimum tangible net worth requirement was $36.7 million. While the Company
believes that it will be able to maintain its existing credit facilities and
obtain replacement financing as it credit arrangements mature and additional
financing, if necessary, there can be no assurance that such financing will be
available on favorable terms, or at all.
The Company also sells loans through whole loan sales. The Company
entered into 3 agreements with financial institutions to which an aggregate of
$290.3 million in principal amount of loans had been sold at November 30, 1996,
for an amount equal to their remaining principal balances and accrued interest.
Pursuant to the agreements, the purchasers are entitled to receive interest at
various rates. The Company retained the right to service the loans and the
right to receive the difference (excess interest) between the sold loans'
stated interest rate and the yield to the purchasers. The Company is required
to maintain reserve accounts ranging from 1% to 2% of the declining principal
balance of the loans sold pursuant to the agreement funded from the excess
interest received by the Company less its servicing fee to fund shortfalls in
collections from borrowers who default in the payment of principal or interest.
In November 1996, the Company entered into an agreement with a
financial institution, providing for the purchase of up to $2 billion of loans
over a 5 year period. Pursuant to the agreement, Mego Financial issued to the
financial institution four-year warrants to purchase 1,000,000 shares of Mego
Financial's common stock at an exercise price of $7.125 per share. The
agreement also provides (i) that so long as the aggregate principal balance of
loans purchased by the financial institution and not resold to third parties
exceeds $100 million, the financial institution shall not be obligated to
purchase, and the Company shall not be obligated to sell, loans under the
agreement and (ii) that the percentage of conventional loans owned by the
financial institution at any one-time and acquired pursuant to the agreement
shall not exceed 65% of the total amount of loans owned by the financial
institution at such time and acquired pursuant to the agreement. The value of
the warrants of $3 million (0.15% of the commitment amount) as of the commitment
date, was charged to the Company and is being amortized as the commitment for
the purchase of loans is utilized. At November 30, 1996, $1.9 billion remained
available to be sold under the commitment. The financial institution has also
agreed to provide the Company a separate one-year facility of up to $11 million
for the financing of the interest only and residual certificates from future
securitizations.
During the 3 months ended November 30, 1996 and November 30, 1995, the
Company used cash of $7.2 million and $962,000, respectively, in operating
activities. During the 3 months ending November 30, 1996 and 1995, the Company
used cash of $968,000 and $350,000, respectively, in investing activities, which
was substantially expended for office equipment and furnishings and data
processing equipment. During the 3 months ended November 30, 1996 and 1995, the
Company provided cash of $34.3 million and $1.2 million, respectively, in
financing activities.
13
<PAGE> 16
The Company believes that its capital requirements will be met from
the recent stock and debt offering proceeds, cash balances, internally
generated cash, existing lines of credit, sales and securitizations of loans,
and the modification, replacement or addition to its credit lines.
FINANCIAL CONDITION
November 30, 1996 compared to August 31, 1996
Cash and cash equivalents increased 5,907.9% to $26.6 million at
November 30, 1996 from $443,000 at August 31, 1996 primarily as a result of the
proceeds from the Company's common stock and debt offerings used to acquire
short term investments after repayment of debt.
Restricted cash deposits decreased 54.3% to $2 million at November 30,
1996 from $4.5 million at August 31, 1996 due to a reduction in the level
required from an agreement with a financial institution, of $1.4 million at
November 30, 1996.
Loans held for sale, net, increased 41.8% to $6.5 million at November
30, 1996 from $4.6 million at August 31, 1996 primarily as a result of
increased loan originations and timing of loan sales.
The Company provides an allowance for credit losses, in an amount which
in the Company's judgment will be adequate to absorb losses on loans and after
FHA insurance recoveries on the loans, that may become uncollectible. The
Company's judgment in determining the adequacy of this allowance is based on its
continual review of its portfolio which utilizes historical experience and
current economic factors. These reviews take into consideration changes in the
nature and level of the portfolio, historical rates, collateral values, and
current and future economic conditions which may affect the obligors' ability to
pay, collateral values and overall portfolio quality. Changes in the allowance
for credit losses for loans consist of the following (thousands of dollars):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
NOVEMBER 30,
1996
--------
<S> <C>
Balance at August 31, 1996 $1,015
Provisions for credit losses 1,711
Amounts charged to allowance for credit losses (24)
-------
Balance at November 30, 1996 $2,702
======
Allowance for credit losses $ 227
Allowance for credit losses on loans sold with recourse 2,475
------
Total $2,702
======
</TABLE>
Excess servicing rights increased 87.6% to $22.7 million at November
30, 1996 from $12.1 million at August 31, 1996. The increase is
due to $60.5 million of loan sales during the period using prepayment, default
and interest rate assumptions that the Company believes market participants
would use for similar rights. The Company believes that the excess servicing
rights recognized at the time of sale do not exceed the amount that would be
received if such rights were sold at fair market value in the marketplace. The
excess cash flow created through securitization which had been recognized as
excess servicing rights on loans reacquired and securitized are included in the
cost basis of the mortgage related securities. Mortgage related securities
were $23 million at November 30, 1996 and $22.9 million at August 31, 1996.
The Company had no securitization transactions during the 3 months ended
November 30, 1996.
14
<PAGE> 17
Activity in excess servicing rights consist of the following
(thousands of dollars):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
NOVEMBER 30,
1996
----------------------
<S> <C>
Balance at August 31, 1996 $12,121
Plus: Additions 11,349
Less: Amortization (728)
------------
Balance at November 30, 1996 $22,742
===========
</TABLE>
As of November 30, and August 31, 1996, excess servicing rights
consisted of excess cash flows on serviced loans totaling $137.1
million and $81.5 million, yielding weighted average interest rates of 12.9%
and 12.8%, net of normal servicing and pass-through fees and weighted average
pass-through yields to the investor of 7.8% and 8.1%, respectively. These
loans were sold under recourse provisions.
Mortgage servicing rights increased 25.1% to $4.8 million at November
30, 1996 from $3.8 million at August 31, 1996 as a result of additional sales of
loans and the resulting increase in sales of loans serviced to $60.5 million
during the first quarter of fiscal 1997 from $35 million during the first
quarter of fiscal 1996.
Property and equipment, net, increased 101.3% to $1.7 million at
November 30, 1996 from $865,000 at August 31, 1996 due to increased purchases
of office equipment related to facility expansion.
Notes and contracts payable decreased 88.3% to $1.7 million at
November 30, 1996 from $14.2 million at August 31, 1996 due to the paydown of
debt from the proceeds of the stock and debt offerings.
Accounts payable and accrued liabilities increased 46.2% to $5.9
million at November 30, 1996 from $4.1 million at August 31, 1996, primarily
as a result of increases in accrued payroll, interest and other unpaid
operational costs.
Due to parent company decreased 71.6% to $3.4 million at November 30,
1996 from $12 million at August 31, 1996. The decrease was primarily
attributable to the payment of federal income taxes owed to Mego Financial as a
result of the filing of a consolidated federal tax return and advances due Mego
Financial.
Stockholder's equity increased 130.7% to $40.8 million at November 30,
1996 from $17.7 million at August 31, 1996 as a result of the sale of the
Company's stock and additional paid-in capital, and net income of $2.5 million
during the 3 months ended November 30, 1996.
CAUTIONARY STATEMENT RELATING TO FORWARD-LOOKING STATEMENTS
The foregoing Management's Discussion and Analysis of Financial
Condition and Results of Operations contains various "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which represent the Company's expectations and beliefs concerning future
events, including the sufficiency of the Company's cash flow for the Company's
future liquidity and capital resource needs. The Company cautions that these
statements are further qualified by important factors that could cause actual
results to differ materially from those in the forward-looking statements,
including, without limitation, the following: decline in demand for home
improvement and debt consolidation loans; the effect of general economic
conditions generally and specifically changes in interest rates; the effect of
competition; the Company's dependence on the ability to sell its loans; and the
regulation of the Company by federal, state and local regulatory authorities.
Actual events or results may differ as a result of these and other factors.
15
<PAGE> 18
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
No reportable events occurred during the three month period ended November 30,
1996.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit Number Description
- ------------- ---------------------------
27.1 Financial Data Schedule
(For SEC Use Only)
16
<PAGE> 19
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MEGO MORTGAGE CORPORATION
By: /s/ DAVID A. CLEVELAND
-------------------------------------------
David A. Cleveland
Vice President and Chief Accounting Officer
Date: January 13, 1997
-------------------
17
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0001023334
<NAME> MEGO MORTGAGE CORP
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-START> SEP-01-1996
<PERIOD-END> NOV-30-1996
<CASH> 28,659
<SECURITIES> 0
<RECEIVABLES> 6,765
<ALLOWANCES> 227
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 2,096
<DEPRECIATION> 355
<TOTAL-ASSETS> 94,748
<CURRENT-LIABILITIES> 0
<BONDS> 1,662
0
0
<COMMON> 123
<OTHER-SE> 40,715
<TOTAL-LIABILITY-AND-EQUITY> 94,748
<SALES> 0
<TOTAL-REVENUES> 10,359
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 6,347
<LOSS-PROVISION> 1,711
<INTEREST-EXPENSE> 47
<INCOME-PRETAX> 4,012
<INCOME-TAX> 1,533
<INCOME-CONTINUING> 2,479
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,479
<EPS-PRIMARY> 0.24
<EPS-DILUTED> 0.24
</TABLE>
