<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: FEBRUARY 28, 1997
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 IN ITS 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
(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 [X] No [ ]
------------------------
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of April 11, 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
PART I FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
Item 1. Financial Statements
Statements of Financial Condition at February 28, 1997 and August 31, 1996
(Unaudited).................................................................... 1
Statements of Operations for the Three and Six Months Ended February 28, 1997
and February 29, 1996 (Unaudited).............................................. 2
Statements of Stockholders' Equity for the Six Months Ended February 28, 1997
(Unaudited).................................................................... 3
Statements of Cash Flows for the Six Months Ended February 28, 1997 and
February 29, 1996 (Unaudited).................................................. 4
Notes to Financial Statements.................................................. 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations..................................................................... 9
PART II OTHER INFORMATION
Item 1. Legal Proceedings.............................................................. 19
Item 6. Exhibits and Reports on Form 8-K............................................... 19
SIGNATURE................................................................................ 20
</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>
FEBRUARY 28, AUGUST 31,
1997 1996
------------ ----------
<S> <C> <C>
ASSETS
Cash and cash equivalents............................................. $ 14,885 $ 443
Cash deposits, restricted............................................. 5,562 4,474
Loans held for sale, net of allowance for credit losses of $372 and
$95................................................................. 10,762 4,610
Mortgage related securities, at fair value............................ 64,535 22,944
Excess servicing rights............................................... -- 12,121
Mortgage servicing rights............................................. 5,805 3,827
Other receivables..................................................... 403 59
Property and equipment, net of accumulated depreciation of $444 and
$279................................................................ 1,816 865
Organizational costs, net of amortization............................. 385 482
Prepaid debt expenses................................................. 2,747 216
Prepaid commitment fee................................................ 2,886 --
Other assets.......................................................... 593 565
-------- --------
TOTAL ASSETS................................................ $110,379 $ 50,606
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Notes and contracts payable......................................... $ 10,986 $ 14,197
Accounts payable and accrued liabilities............................ 9,408 4,066
Allowance for credit losses on loans sold with recourse............. 1,471 920
Due to parent company............................................... 3,744 11,994
Due to affiliated company........................................... 324 819
State income taxes payable.......................................... 237 909
-------- --------
Total liabilities........................................... 26,170 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 February 28, 1997 and
10,000,000 at August 31, 1996).................................. 123 100
Additional paid-in capital.......................................... 29,185 8,550
Retained earnings................................................... 14,901 9,051
-------- --------
Total stockholders' equity.................................. 44,209 17,701
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................. $110,379 $ 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 SIX MONTHS ENDED
----------------------------- -----------------------------
FEBRUARY 28, FEBRUARY 29, FEBRUARY 28, FEBRUARY 29,
1997 1996 1997 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
REVENUES
Gain on sale of loans............... $ 10,428 $ 4,845 $ 20,029 $ 10,810
Net unrealized gain on mortgage
related securities............... 3,143 -- 2,908 --
Loan servicing income, net.......... 560 870 1,198 1,761
Interest income..................... 2,029 195 3,029 526
Less: Interest expense.............. (1,503) (198) (2,148) (391)
----------- ----------- ----------- -----------
Net interest income................. 526 (3) 881 135
----------- ----------- ----------- -----------
Total revenues.............. 14,657 5,712 25,016 12,706
----------- ----------- ----------- -----------
COSTS AND EXPENSES
Provision for credit losses......... 3,805 200 5,516 497
Depreciation and amortization....... 156 273 296 374
Other interest...................... 51 31 98 78
General and administrative:
Payroll and benefits............. 2,497 1,167 4,313 2,251
Commissions and selling.......... 651 505 1,234 1,017
Credit reports................... 380 43 533 98
Rent and lease expenses.......... 180 81 451 157
Professional services............ 195 41 307 145
Servicing fees paid to
affiliate...................... 372 163 657 291
Management services by
affiliate...................... 242 168 484 335
FHA insurance.................... 75 103 278 334
Other............................ 604 338 1,388 685
----------- ----------- ----------- -----------
Total costs and expenses.... 9,208 3,113 15,555 6,262
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES............ 5,449 2,599 9,461 6,444
INCOME TAXES.......................... 2,078 1,040 3,611 2,578
----------- ----------- ----------- -----------
NET INCOME............................ $ 3,371 $ 1,559 $ 5,850 $ 3,866
=========== =========== =========== ===========
EARNINGS PER COMMON SHARE:
Primary:
Net income....................... $ 0.27 $ 0.16 $ 0.51 $ 0.39
=========== =========== =========== ===========
Weighted average number of common
shares and common share
equivalents outstanding........ 12,476,069 10,000,000 11,463,259 10,000,000
=========== =========== =========== ===========
Fully Diluted:
Net income....................... $ 0.27 $ 0.16 $ 0.51 $ 0.39
=========== =========== =========== ===========
Weighted average number of common
shares and common share
equivalents outstanding........ 12,544,291 10,000,000 11,539,168 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
$.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 six months ended
February 28, 1997........................ -- -- -- 5,850 5,850
---------- ---- ------- ------- -------
Balance at February 28, 1997............... 12,300,000 $123 $29,185 $14,901 $44,209
========== ==== ======= ======= =======
</TABLE>
See notes to financial statements.
3
<PAGE> 6
MEGO MORTGAGE CORPORATION
STATEMENTS OF CASH FLOWS
(thousands of dollars)
(unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-----------------------------
FEBRUARY 28, FEBRUARY 29,
1997 1996
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.......................................................... $ 5,850 $ 3,866
--------- --------
Adjustments to reconcile net income to net cash used in operating
activities:
Additions to mortgage servicing rights............................ (3,086) (695)
Additions to excess servicing rights.............................. -- (11,826)
Net unrealized gain on mortgage related securities................ (2,908) --
Additions to mortgage related securities.......................... (26,715) --
Provisions for estimated credit losses............................ 5,516 497
Depreciation and amortization expense............................. 296 374
Amortization of excess servicing rights........................... -- 1,322
Amortization of mortgage servicing rights......................... 1,108 164
Accretion of residual interest in mortgage related securities..... (1,306) --
Payments on mortgage related securities........................... 503 --
Amortization of mortgage related securities....................... 956 --
Loans originated for sale, net of loan fees....................... (173,722) (56,093)
Payments on loans held for sale................................... 520 130
Proceeds from sale of loans....................................... 167,441 56,421
Changes in operating assets and liabilities:
Increase in cash deposits, restricted........................... (1,088) (2,958)
Increase in other assets, net................................... (5,895) (70)
Increase (decrease) in state income taxes payable............... (672) 387
Increase in other liabilities, net.............................. 5,342 713
Additions to due to affiliated company.......................... 1,764 916
Payments on due to affiliated company........................... (2,259) (21)
--------- --------
Total adjustments............................................ (34,205) (10,739)
--------- --------
Net cash used in operating activities.................... (28,355) (6,873)
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment.................................. (1,155) (468)
Proceeds from the sale of property and equipment.................... 5 --
--------- --------
Net cash used in investing activities.................... (1,150) (468)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings on notes and contracts payable............. 123,067 52,446
Payments on notes and contracts payable............................. (126,278) (50,832)
Additions in due to parent company.................................. 3,669 6,066
Payments on due to parent company................................... (14,919) --
Issuance of subordinated debt....................................... 37,750 --
Sale of common stock................................................ 20,658 --
--------- --------
Net cash provided by financing activities................ 43,947 7,680
--------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS............................. 14,442 339
--------- --------
CASH AND CASH EQUIVALENTS -- BEGINNING OF PERIOD...................... 443 752
--------- --------
CASH AND CASH EQUIVALENTS -- END OF PERIOD............................ $ 14,885 $ 1,091
========= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest.......................................................... $ 1,041 $ 486
========= ========
State income taxes................................................ $ 1,241 $ 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.
4
<PAGE> 7
MEGO MORTGAGE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 1997 AND FEBRUARY 29, 1996
(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 offering, the
accompanying unaudited Financial Statements contain all of the information
necessary to present fairly the financial position of Mego Mortgage Corporation
at February 28, 1997 and the results of its operations for the three and six
months ended February 28, 1997 and February 29, 1996. Certain reclassifications
have been made to conform prior periods with the current period presentation.
The preparation of financial statements in conformity with generally accepted
accounting principles (GAAP) requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures 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. The results
of operations for the three and six months ended February 28, 1997, 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 corespondents and home
improvement contractors, is primarily engaged in the business of originating,
selling, servicing and pooling home improvement and other consumer 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 have been and will be 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 March 10, 1997, $89.7 million of loans were repurchased, securitized and
sold by the Company, comprised of $21.9 million of Title I Loans and $67.8
million of conventional loans. Pursuant to this securitization, asset-backed
notes secured by the 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 on the
remaining principal 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 notes. The Company
5
<PAGE> 8
MEGO MORTGAGE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 1997 AND FEBRUARY 29, 1996
(unaudited)
may be required to repurchase loans that do not conform to the representations
and warranties made by the Company in the securitization agreements. As of
February 28, 1997, the gain on certain whole loan sales during the quarter has
been recorded which approximates the gain on this securitization sale.
4. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1996, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities",
(SFAS 125) which provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities. This statement
also provides consistent standards for distinguishing transfers of financial
assets that are sales from transfers that are secured borrowings. It requires
that liabilities and derivatives incurred or obtained by transferors as part of
a transfer of financial assets be initially measured at fair value. SFAS 125
also requires that servicing assets be measured by allocating the carrying
amount between the assets sold and retained interests based on their relative
fair values at the date of transfer. Additionally, this statement requires that
the servicing assets and liabilities be subsequently measured by (a)
amortization in proportion to and over the period of estimated net servicing
income or loss and (b) assessment for asset impairment or increased obligation
based on their fair values. The statement requires the Company's existing and
future excess servicing rights be measured at fair market value and reclassified
as interest only strip receivables, carried as mortgage related securities, and
accounted for in accordance with SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities."
As required by the statement, the Company adopted the new requirements
effective January 1, 1997 and applied them prospectively. The book value of the
Company's mortgage related securities approximates fair value. No material
impact resulted from the implementation of SFAS 125.
The following table reflects the components of mortgage related securities
as required by SFAS 125, at February 28, 1997:
<TABLE>
<S> <C>
Interest only receivables (formerly excess servicing
rights).................................................. $12,870
Interest only strip securities............................. 7,300
Residual interest securities............................... 44,365
-------
Total mortgage related securities................ $64,535
=======
</TABLE>
All mortgage related securities are classified as trading securities and
are recorded at their estimated fair value. Changes in the estimated fair values
are recorded in current operations.
The FASB issued SFAS No. 128, "Earnings per Share" (SFAS 128) in March
1997, effective for financial statements issued after December 15, 1997. The
statement provides simplified standards for the computation and presentation of
earnings per share (EPS), making EPS comparable to international standards. SFAS
128 requires dual presentation of "Basic" and "Diluted" EPS, by entities with
complex capital structures, replacing "Primary" and "Fully Diluted" EPS under
APB Opinion No. 15.
Basic EPS excludes dilution from common stock equivalents and is computed
by dividing income available to common stockholders by the weighted-average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution from common stock equivalents, similar to fully diluted EPS,
but uses only the average stock price during the period as part of the
computation.
6
<PAGE> 9
MEGO MORTGAGE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 1997 AND FEBRUARY 29, 1996
(unaudited)
Data utilized in calculating proforma earnings per share under the SFAS 128
statement are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------------- ---------------------------
FEBRUARY 28, FEBRUARY 29, FEBRUARY 28, FEBRUARY 29,
1997 1996 1997 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
BASIC:
Net income................................ $ 3,371,000 $ 1,559,000 $ 5,850,000 $ 3,866,000
=========== =========== =========== ===========
Weighted average number of common
shares................................. 12,300,000 10,000,000 11,296,133 10,000,000
=========== =========== =========== ===========
DILUTED:
Net income................................ $ 3,371,000 $ 1,559,000 $ 5,850,000 $ 3,866,000
=========== =========== =========== ===========
Weighted average number of common shares
and common share equivalents
outstanding............................... 12,476,069 10,000,000 11,463,259 10,000,000
=========== =========== =========== ===========
</TABLE>
The following tables reconcile the net income applicable to common
stockholders, and basic and diluted shares and EPS for the following periods:
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
FEBRUARY 28, 1997 FEBRUARY 29, 1996
----------------------------------- -----------------------------------
PER-SHARE PER-SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
---------- ---------- --------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Net income.................. $3,371,000 $1,559,000
---------- ----------
BASIC EPS:
Income applicable to
common stockholders....... 3,371,000 12,300,000 $0.27 1,559,000 10,000,000 $0.16
===== =====
Effect of dilutive
securities:
Warrants.................. -- -- -- --
Stock options............. -- 176,069 -- --
---------- ---------- ---------- ----------
DILUTED EPS:
Income applicable to
common stockholders and
assumed conversions....... $3,371,000 12,476,069 $0.27 $1,559,000 10,000,000 $0.16
========== ========== ===== ========== ========== =====
</TABLE>
7
<PAGE> 10
MEGO MORTGAGE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 1997 AND FEBRUARY 29, 1996
(unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED SIX MONTHS ENDED
FEBRUARY 28, 1997 FEBRUARY 29, 1996
----------------------------------- -----------------------------------
PER-SHARE PER-SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
---------- ---------- --------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Net income.................. $5,850,000 $3,866,000
---------- ----------
BASIC EPS
Income available to common
stockholders.............. 5,850,000 11,296,133 $0.52 3,866,000 10,000,000 $0.39
===== =====
Effect of dilutive
securities:
Warrants.................. -- -- -- --
Stock options............. -- 167,126 -- --
---------- ---------- ---------- ----------
DILUTED EPS
Income available to common
stockholders and assumed
conversions............... $5,850,000 11,463,259 $0.51 $3,866,000 10,000,000 $0.39
========== ========== ===== ========== ========== =====
</TABLE>
8
<PAGE> 11
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, securitizes and services consumer
loans consisting primarily of home improvement, home equity, and debt
consolidation loans generally secured by liens on improved property, through its
network of correspondents and dealers. The conventional 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 generally 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
conventional home improvement loans through its dealer division and debt
consolidation loans to its borrowers through both its correspondent and dealer
divisions. Since the Company began offering conventional loans in May 1996,
conventional loans have accounted for an increasing portion of loan
originations.
The following table sets forth certain data regarding loans originated,
sold, securitized and serviced by the Company during the three months ended
February 28, 1997 and February 29, 1996 (thousands of dollars):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------
FEBRUARY 28, 1997 FEBRUARY 29, 1996
------------------ ------------------
<S> <C> <C> <C> <C>
Loan Originations:
Principal amount of loans:
Correspondents:
Title I........................................... $ 11,346 10.2% $ 14,317 64.0%
Conventional...................................... 87,911 79.0 -- --
-------- ----- -------- -----
Total Correspondents................................... 99,257 89.2 14,317 64.0
-------- ----- -------- -----
Dealers:
Title I........................................... 10,186 9.2 8,061 36.0
Conventional...................................... 1,817 1.6 -- --
-------- ----- -------- -----
Total Dealers.......................................... 12,003 10.8 8,061 36.0
-------- ----- -------- -----
Total.................................................. $111,260 100.0% $ 22,378 100.0%
======== ===== ======== =====
Number of Loans Originated:
Correspondents:
Title I........................................... 551 12.5% 997 64.0%
Conventional...................................... 2,884 65.7 -- --
-------- ----- -------- -----
Total Correspondents................................... 3,435 78.2 997 64.0
-------- ----- -------- -----
Dealers:
Title I........................................... 873 19.9 561 36.0
Conventional...................................... 83 1.9 -- --
-------- ----- -------- -----
Total Dealers.......................................... 956 21.8 561 36.0
-------- ----- -------- -----
Total.................................................. 4,391 100.0% 1,558 100.0%
======== ===== ======== =====
Loans Serviced at end of period (including loans
securitized, sold to investors, and held for sale):
Title I................................................ $237,633 64.5% 139,138 100.0%
Conventional........................................... 130,736 35.5 -- --
-------- ----- -------- -----
Total.................................................. $368,369 100.0% $139,138 100.0%
======== ===== ======== =====
</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 of $12.5 million plus any issuance of capital
9
<PAGE> 12
stock or other capital instruments since August 31, 1995 plus 50% of the
Company's cumulative net income since May 1, 1996. At February 28, 1997, the
Company's minimum tangible net worth requirement was $37.1 million.
Additionally, the Company is required to maintain a minimum level of
profitability of at least $500,000 per rolling 6 month period.
On December 17, 1996, $67.3 million of loans were repurchased, securitized
and sold by the Company, comprised of $36.7 million of Title I Loans and $30.6
million of 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 on the balance of each loan. The Company received
certificates and contractual rights which have been 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. See Note 3 of Notes to Financial Statements for a description of a
securitization which took place on March 10, 1997.
The Company recognizes revenue from the gain on sale of loans, unrealized
gain on mortgage related securities, 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 through January 1, 1997, the date of adoption of
SFAS 125. Mortgage servicing rights and excess servicing rights were amortized
over the estimated lives of the loans.
The following tables set forth the principal balance of loans sold or
securitized and related gain on sale data for the three and six months ended
February 28, 1997 and February 29, 1996 (thousands of dollars):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------------- -----------------------------
FEBRUARY 28, FEBRUARY 29, FEBRUARY 28, FEBRUARY 29,
1997 1996 1997 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Principal amount of loans sold:
Title I Loans............................ $ 22,277 $21,395 $ 55,665 $56,421
Conventional............................. 84,655 -- 111,776 --
-------- ------- -------- -------
Total............................ $106,932 $21,395 $167,441 $56,421
======== ======= ======== =======
Gain on sale of loans...................... $ 10,428 $ 4,845 $ 20,029 $10,810
======== ======= ======== =======
Gain on sale of loans as a percentage of
principal balance of loans sold.......... 9.8% 22.6% 12.0% 19.2%
======== ======= ======== =======
Net unrealized gain on mortgage related
securities............................... $ 3,143 $ -- $ 2,908 $ --
======== ======= ======== =======
Gain on sale of loans plus net unrealized
gain on mortgage related securities as a
percentage of principal balance of loans
sold..................................... 12.7% 22.6% 13.7% 19.2%
======== ======= ======== =======
</TABLE>
The combined gain on sale and net unrealized gain on mortgage related
securities for the 3 month period ended February 28, 1997, was $15,220,000, or
14.23% of loans sold during the period, before adjustments totaling $1,649,000
relating to Title I Loans originated prior to March 1, 1996. The adjustment was
approximately 1.1% of the original principal balances of such loans.
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
sells loans through securitizations. Certain of the regular interests of the
related securitizations are sold, with the interest only and residual interest
securities retained by the Company.
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<PAGE> 13
As a holder of residual interest 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 of
cash flows is subject to the satisfaction of certain overcollateralization or
reserve requirements which are specific to each securitization and are used as a
means of credit enhancement.
Delinquencies -- The following table sets forth the delinquency and Title I
insurance claims experience of loans serviced by the Company at the dates
indicated (thousands of dollars):
<TABLE>
<CAPTION>
FEBRUARY 28, AUGUST 31,
1997 1996
------------ ----------
<S> <C> <C>
Delinquency period(1)
31-60 days past due................................. 2.46% 2.17%
61-90 days past due................................. 1.06 0.85
91 days and over past due(2)........................ 3.86 4.53
91 days and over past due, net of claims filed(3)... 2.03 1.94
Outstanding claims filed with HUD(4).................. 1.83 2.59
Outstanding number of Title I insurance claims........ 394 255
Total servicing portfolio............................. $368,368 $ 214,189
Title I Loans serviced................................ 237,633 202,766
Amount of FHA insurance available(5).................. 23,342 21,205
Amount of FHA insurance available as a percentage of
Title I Loans serviced.............................. 9.82%(5) 10.46%
Losses on liquidated loans(6)......................... $ 58 $ 32
</TABLE>
- ------------------------------------------------------------------------------
(1) Represents the dollar amount of delinquent loans as a percentage of the
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 six months ended February 28,
1997, 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 the total dollar amount of total loans serviced by the Company
(including loans owned by the Company) as of the dates 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 the total
dollar amount of total loans serviced by the Company (including loans owned
by the Company) as of the dates indicated.
(5) If all claims filed with HUD had been processed as of February 28, 1997, the
amount of FHA insurance available would have been reduced to $16.9 million,
which as a percentage of Title I Loans serviced would have been 7.3%.
(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 relates to 290 Title I
insurance claims made by the Company, as servicer, since commencing
operations through February 28, 1997. 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 and sale 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, if
exceeded, would allow the termination of the Company's right to service the
related loans. At February 28, 1997, the rolling three month average annual
default rate on the pool of loans
11
<PAGE> 14
sold in the March 1996 securitization transaction, exceeded 6.5%, 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 amount of such mortgage servicing rights ($1.2 million before
tax and $731,000 after tax at February 28, 1997) on the date of termination.
The pooling and servicing agreements and sale and servicing agreements also
require that certain delinquency and default rates not exceed certain
thresholds. 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 security.
Delinquencies of loans serviced by the Company have also decreased the
amount of loan servicing income recorded during the 6 months ended February 28,
1997, as the Company's loan servicing income has been reduced by the amount of
interest advanced to the owners of these loans.
Delinquencies have increased during the six months ended February 28, 1997
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 loan 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 operations: 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 five
days and also by written correspondence before the loan becomes 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
12
<PAGE> 15
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 February 28, 1997 compared to Three Months Ended February 29,
1996
The Company originated $111.3 million of loans during the 3 months ended
February 28, 1997 compared to $22.4 million of loans during the 3 months ended
February 29, 1996, an increase of 397.2%. The increase is a result of the
overall growth in the Company's business, including an increase in the number of
active Correspondents and an increase in the number of states served. At
February 28, 1997, the Company had approximately 484 active Correspondents and
467 active Dealers, compared to approximately 212 active Correspondents and 469
active Dealers at February 29, 1996. Of the $111.3 million of loans originated
in the 3 months ended February 28, 1997, $89.7 million were conventional loans.
The Company did not originate conventional loans during the three months ended
February 29, 1996.
Total revenues increased 156.6% to $14.7 million for the 3 months ended
February 28, 1997 from $5.7 million for the 3 months ended February 29, 1996.
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 35.6% to $560,000 for the 3 months ended
February 28, 1997 from $870,000 for the 3 months ended February 29, 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 $27.2 million in delinquencies at February 28, 1997
compared to $9 million at February 29, 1996.
Interest income on loans held for sale and mortgage related securities, net
of interest expense, increased to $526,000 during the 3 months ended February
28, 1997 from a negative $3,000 during the 3 months ended February 29, 1996. The
increase was primarily the result of the increase in the average size of the
portfolio of loans held for sale and the increase in the mortgage related
securities portfolio to $64.5 million at February 28, 1997 from $0 at February
29, 1996.
The provision for credit losses increased to $3.8 million for the 3 months
ended February 28, 1997 from $200,000 for the 3 months ended February 29, 1996
as a result of the increased ratio of conventional loans to Title I Loans. The
increase in the provision was directly related to the increase in volume and mix
of loans originated in the three months ended February 28, 1997 compared to the
three months ended February 29, 1996. 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 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 risk of loss associated with
conventional loans, which are not FHA insured.
Total general and administrative expenses increased 99.2% to $5.2 million
for the 3 months ended February 28, 1997 compared to $2.6 million for the 3
months ended February 29, 1996. 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 114% to $2.5 million for the 3
months ended February 28, 1997 from $1.2 million for the 3 months ended February
29, 1996. The number of employees increased to 277 at February 28, 1997 from 147
at February 29, 1996, due to increased staff necessary to support the business
expansion and improve quality control.
Commissions and selling expenses increased 28.9% to $651,000 for the 3
months ended February 28, 1997 from $505,000 for the 3 months ended February 29,
1996 while loan originations increased by $88.9 million to $111.3 million during
the period. The sales network has now expanded to substantially all states,
adding new personnel and offices to further the loan origination growth
strategy.
13
<PAGE> 16
Professional services increased to $195,000 for the 3 months ended February
28, 1997 from $41,000 for the 3 months ended February 29, 1996 due primarily to
increased audit and legal fees as the Company expands its operations.
Servicing fees paid to affiliate increased 128.2% to $372,000 for the 3
months ended February 28, 1997 from $163,000 for the 3 months ended February 29,
1996 due primarily to a larger loan servicing portfolio. Management services by
affiliate increased 44.1% to $242,000 for the 3 months ended February 28, 1997
from $168,000 for the 3 months ended February 29, 1996. 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 27.2% to $75,000 for the 3 months ended February
28, 1997 from $103,000 for the 3 months ended February 29, 1996 due primarily to
a decrease in Title I Loan originations.
Other general and administrative expenses increased 78.7% to $604,000 for
the 3 months ended February 28, 1997 from $338,000 for the 3 months ended
February 29, 1996 due primarily to added expenses related to the ongoing
expansion of facilities and increased communications costs.
Income before income taxes increased to $5.4 million for the 3 months ended
February 28, 1997 from $2.6 million for the 3 months ended February 29, 1996.
As a result of the foregoing, the Company's net income increased 116.2% to
$3.4 million for the 3 months ended February 28, 1997 from $1.6 million for the
3 months ended February 29, 1996.
RESULTS OF OPERATIONS
Six Months Ended February 28, 1997 compared to Six Months Ended February 29,
1996
The Company originated $173.7 million of loans during the 6 months ended
February 28, 1997 compared to $56.1 million of loans during the 6 months ended
February 29, 1996, an increase of 209.7%. The increase is a result of the
overall growth in the Company's business, including an increase in the number of
active Correspondents and an increase in the number of states served. At
February 28, 1997, the Company had approximately 484 active Correspondents and
467 active Dealers, compared to approximately 212 active Correspondents and 469
active Dealers at February 29, 1996. Of the $173.7 million of loans originated
in the 6 months ended February 28, 1997, $120.8 million were conventional loans.
The Company did not originate conventional loans during the six months ended
February 29, 1996.
Total revenues increased 96.9% to $25 million for the 6 months ended
February 28, 1997 from $12.7 million for the 6 months ended February 29, 1996.
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 32% to $1.2 million for the 6 months ended
February 28, 1997 from $1.8 million for the 6 months ended February 29, 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 $27.2 million in delinquencies at February 28,
1997 compared to $9 million at February 29, 1996.
Interest income on loans held for sale and mortgage related securities, net
of interest expense, increased 552.6% to $881,000 during the 6 months ended
February 28, 1997 from $135,000 during the 6 months ended February 29, 1996. 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 to $5.5 million for the 6 months
ended February 28, 1997 from $497,000 for the 6 months ended February 29, 1996.
The increase in the provision was directly related to the increase in volume and
mix of loans originated in the six months ended February 28, 1997 compared to
the six months ended February 29, 1996 from the increased ratio of conventional
loans to Title I Loans. 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 conventional loan originations as
14
<PAGE> 17
compared to Title I Loan originations, the provision for credit losses as a
percentage of loans originated increased due to the greater risk of loss
associated with conventional loans, which are not FHA insured.
Total general and administrative expenses increased 81.5% to $9.6 million
for the 6 months ended February 28, 1997 compared to $5.3 million for the 6
months ended February 29, 1996. 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 91.6% to $4.3 million for the 6
months ended February 28, 1997 from $2.3 million for the 6 months ended February
29, 1996. The number of employees increased to 277 at February 28, 1997 from 147
at February 29, 1996, due to increased staff necessary to support the business
expansion and improve quality control.
Commissions and selling expenses increased 21.3% to $1.2 million for the 6
months ended February 28, 1997 from $1 million for the 6 months ended February
29, 1996 while loan originations increased by $117.6 million or 209.7% to $173.7
million at February 28, 1997. The sales network expanded to substantially all
states, adding new personnel and offices to further the loan origination growth
strategy.
Professional services increased 111.7% to $307,000 for the 6 months ended
February 28, 1997 from $145,000 for the 6 months ended February 29, 1996 due
primarily to increased audit and legal fees attributable to continued growth.
Servicing fees paid to affiliate increased 125.8% to $657,000 for the 6
months ended February 28, 1997 from $291,000 for the 6 months ended February 29,
1996 due primarily to a larger loan servicing portfolio. Management services by
affiliate increased 44.5% to $484,000 for the 6 months ended February 28, 1997
from $335,000 for the 6 months ended February 29, 1996. These expenses represent
services provided by PEC, an affiliate of the Company including executive,
accounting, legal, management information, data processing, human resources,
advertising and promotional materials.
FHA insurance decreased 16.8% to $278,000 for the 6 months ended February
28, 1997 from $334,000 for the 6 months ended February 29, 1996 due primarily to
a decrease in Title I Loan originations.
Other general and administrative expenses increased 102.6% to $1.4 million
for the 6 months ended February 28, 1997 from $685,000 for the 6 months ended
February 29, 1996 due primarily to increased expenses related to the ongoing
expansion of facilities and increased communications costs.
Income before income taxes increased to $9.5 million for the 6 months ended
February 28, 1997 from $6.4 million for the 6 months ended February 29, 1996.
As a result of the foregoing, the Company's net income increased 51.3% to
$5.9 million for the 6 months ended February 28, 1997 from $3.9 million for the
6 months ended February 29, 1996.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents for the Company was $14.9 million at February 28,
1997 compared to $443,000 at August 31, 1996. The increase was primarily due to
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.
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 operating cash flow basis. During the 6 months
ended February 28, 1997, the Company operated on a negative operating cash flow
basis due primarily to an increase in loans originated and sold, using $28.4
million in operations that was funded primarily from borrowings and the proceeds
of its stock and debt public offerings. 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
15
<PAGE> 18
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 PEC and approximately $21.5
million to reduce the amounts outstanding under the Company's warehouse and
revolving lines of credit. The revolving line of credit has been repaid.
Additionally, the Company repaid $3 million under a repurchase agreement.
The pooling and servicing agreements and sale 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 securities. 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 securities 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 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 $167.4 million and the proceeds from the
Company's offerings for the 6 months ended February 28, 1997. The loan sale
transactions required the subordination of certain cash flows payable 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 February 28, 1997, amounts on deposit in such
reserve accounts totaled $5.6 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 February 28,
1997, the Company had a $20 million warehouse line of credit (warehouse line)
for the financing of loan originations which expires in August 1997. The Company
is presently negotiating a $60 million warehouse line from 3 banking
institutions to replace this existing warehouse line. There is no assurance that
16
<PAGE> 19
the proposed warehouse line will be obtained. At February 28, 1997, $9.3 million
was outstanding under the warehouse line and $10.7 million was available due to
the repayment of the outstanding balance from the proceeds of the Company's
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 February 28, 1997, the Company's minimum tangible net worth
requirement was $37.1 million and its tangible net worth was $44.2 million.
While the Company believes that it will be able to maintain its existing credit
facilities and obtain replacement financing as its 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 has
entered into agreements with 3 financial institutions to which an aggregate of
$397.3 million in principal amount of loans had been sold at February 28, 1997,
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 which provision has been waived from time to
time. 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 February 28, 1997, $1.8
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 securitizations.
During the 6 months ended February 28, 1997 and February 29, 1996, the
Company used net cash of $28.4 million and $6.9 million, respectively, in
operating activities. During the 6 months ended February 28, 1997 and February
29, 1996, the Company used net cash of $1.2 million and $468,000, respectively,
in investing activities, which was substantially expended for office equipment
and furnishings and data processing equipment. During the 6 months ended
February 28, 1997, the Company provided net cash of $43.9 million, from
financing activities, primarily due to the issuance of subordinated debt and
common stock, compared to $7.7 million during the 6 months ended February 29,
1996.
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
February 28, 1997 compared to August 31, 1996
Cash and cash equivalents increased 3,260% to $14.9 million at February 28,
1997 from $443,000 at August 31, 1996, primarily as a result of the use of
proceeds from the Company's common stock and debt offerings to acquire short
term investments after repayment of debt.
17
<PAGE> 20
Restricted cash deposits increased 24.3% to $5.6 million at February 28,
1997 from $4.5 million at August 31, 1996 primarily due to an increase in the
level of securitizations.
Loans held for sale, net, increased 133.5% to $10.8 million at February 28,
1997 from $4.6 million at August 31, 1996 primarily as a result of loan
originations increasing and the 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 for the three and six months ended February 28, 1997
consist of the following (thousands of dollars):
<TABLE>
<S> <C>
Balance at November 30, 1996....................................... $ 2,702
Provisions for credit losses....................................... 3,805
Amounts charged to allowance for credit losses..................... (4,664)
-------
Balance at February 28, 1997............................. $ 1,843
=======
Balance at August 31, 1996......................................... $ 1,015
Provisions for credit losses....................................... 5,516
Amounts charged to allowance for credit losses..................... (4,688)
-------
Balance at February 28, 1997............................. $ 1,843
=======
Allowance for credit losses........................................ $ 372
Allowance for credit losses on loans sold with recourse............ 1,471
-------
Total.................................................... $ 1,843
=======
</TABLE>
Excess servicing rights decreased to $0 at February 28, 1997 from $12.1
million at August 31, 1996 due to the implementation of SFAS 125, which requires
the reclassification of excess servicing rights as mortgage related securities
which are carried at fair market value. 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 $64.5 million at February
28, 1997 and $22.9 million at August 31, 1996. The increase is due to the
increased value of loans originated and securitized and the reclassification of
excess servicing rights. See Note 4 of Notes to Financial Statements.
Mortgage servicing rights increased 51.7% to $5.8 million at February 28,
1997 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 $167.4 million
during the first half of fiscal 1997 from $56.4 million during the first half of
fiscal 1996.
Property and equipment, net, increased 109.9% to $1.8 million at February
28, 1997 from $865,000 at August 31, 1996 due to increased purchases of office
equipment related to facility expansion.
Notes and contracts payable decreased 22.6% to $11 million at February 28,
1997 from $14.2 million at August 31, 1996 due to the paydown of debt from the
proceeds from the stock and debt offerings.
Accounts payable and accrued liabilities increased to $9.4 million at
February 28, 1997 from $4.1 million at August 31, 1996 primarily as a result of
the timing of accruals and payments.
Due to parent company decreased 68.8% to $3.7 million at February 28, 1997
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 repayment of advances made by
the parent to the Company.
18
<PAGE> 21
Stockholders' equity increased 149.8% to $44.2 million at February 28, 1997
from $17.7 million at August 31, 1996 as a result of the Company's stock
offering, and net income of $5.9 million during the 6 months ended February 28,
1997.
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; increases in the level of delinquencies on the Company's
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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
No reportable events occurred during the quarter ended February 28, 1997.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ --------------------------------------------------------------------------
<C> <S>
27.1 Financial Data Schedule (for SEC use only)
</TABLE>
No reports on Form 8-K were filed during the period.
19
<PAGE> 22
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/ JAMES L. BELTER
------------------------------------
James L. Belter
Executive Vice President,
Chief Financial Officer and
Treasurer
Date: April 14, 1997
20
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0001023334
<NAME> MEGO MORTGAGE CORP.
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-START> SEP-01-1996
<PERIOD-END> FEB-28-1997
<EXCHANGE-RATE> 1
<CASH> 20,447
<SECURITIES> 0
<RECEIVABLES> 11,134
<ALLOWANCES> 372
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 2,260
<DEPRECIATION> 444
<TOTAL-ASSETS> 110,379
<CURRENT-LIABILITIES> 0
<BONDS> 10,986
0
0
<COMMON> 123
<OTHER-SE> 44,086
<TOTAL-LIABILITY-AND-EQUITY> 110,379
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<INTEREST-EXPENSE> 98
<INCOME-PRETAX> 9,461
<INCOME-TAX> 3,611
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