Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
- ----- Act of 1934 for the quarterly period ended June 30, 1998.
Transition Report Pursuant to Section 13 or 15(d) of the Securities
- ----- Exchange Act of 1934.
Commission File Number 000-23775
Approved Financial Corp.
(Exact Name of Registrant as Specified in its Charter)
Virginia 52-0792752
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
3420 Holland Road, Suite 107, Virginia Beach, Virginia 23452
(Address of Principal Executive Office) (Zip Code)
757-430-1400
(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 is
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
--- ---
The number of shares outstanding of the registrant's $1.00 par value common
stock, as of August 8, 1998 : 5,512,114 shares
-----------------
<PAGE>
APPROVED FINANCIAL CORP.
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets as of
June 30, 1998 and December 31, 1997 1
Consolidated Statements of Income
for the three months ended June 30, 1998
and June 30, 1997. 2
Consolidated Statements of Income
for the six months ended June 30, 1998
and June 30, 1997. 3
Consolidated Statements of Cash Flows for
the six months ended June 30, 1998
and June 30, 1997. 4
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 8
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 25
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 2. Changes in Securities 29
Item 3. Defaults Upon Senior Securities 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 29
<PAGE>
PART I . FINANCIAL INFORMATION
<PAGE>
Item 1. Financial Statements
<TABLE>
APPROVED FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
As of June 30,1998 and December 31, 1997
(Dollars in thousands)
<CAPTION>
1998 1997
-------- --------
ASSETS (Unaudited)
<S> <C>
Cash $ 10,468 $ 11,869
Mortgage loans, net 66,792 80,696
Real estate owned, net 2,633 2,367
Securities, available for sale 13,168 15,201
Premises and equipment, net 4,767 4,530
Goodwill, net 3,878 775
Loan sale receivable 1,794 --
Other assets 5,550 2,687
-------- --------
Total assets $109,050 $118,125
======== ========
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse lines of credit $ 37,491 $ 52,488
Certificates of deposit 21,977 17,815
Federal Home Loan Bank advance 1,380 1,000
Mortgage loans payable 1,176 1,216
Notes payable - related parties 6,537 6,684
Certificates of indebtedness 2,337 2,396
Loan proceeds payable 5,415 6,364
Accrued and other liabilities 3,994 2,837
Income taxes payable -- 1,161
Deferred income tax liability 1,798 1,109
-------- --------
Total liabilities 82,105 93,070
-------- --------
Shareholders' equity:
Preferred stock - Series A, $10 par value; noncumulative, voting:
Authorized 100 shares, 90 shares issued and outstanding 1 1
Preferred stock - Series B, $10 par value; noncumulative, voting:
Authorized 50,000 shares, none issued and outstanding -- --
Common stock, par value - $1.00:
Authorized 40,000,000 shares,
Issued and outstanding 5,512,114 shares in 1998
and 5,395,408 in 1997 5,512 5,395
Accumulated other comprehensive income 6,127 6,854
Additional capital 552 0
Retained earnings 14,753 12,805
-------- --------
Total equity 26,945 25,055
-------- --------
Total liabilities and equity $109,050 $118,125
======== ========
The accompanying notes are an integral part of the consolidated financial statements.
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME
for the three months ended June 30, 1998 and 1997
(Dollars in thousands, except share and per share amounts)
(Unaudited)
<CAPTION>
1998 1997
----------- -------------
Revenue:
Gain on sale of loans $ 8,779 $ 8,133
Interest income 2,653 2,946
Other fees and income 1,678 772
----------- -------------
13,110 11,851
----------- -------------
Expenses:
Compensation and related benefits 5,980 4,016
General and administrative 2,820 2,600
Loan production expenses 972 452
Interest expense 1,535 1,521
Provision for loan and foreclosed property losses 949 417
----------- -------------
12,256 9,006
----------- -------------
Income before income taxes 854 2,845
Provision for income taxes 341 1,170
----------- -------------
Net income $ 513 $ 1,675
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains (loss) arising during period (1,823) 3,164
----------- -------------
Comprehensive income/(loss) $ (1,310) $ 4,839
=========== =============
Net income per share:
Basic $ 0.09 $ 0.31
=========== =============
Diluted $ 0.09 $ 0.31
=========== =============
Weighted average number of shares outstanding:
Basic 5,512,114 5,376,884
Diluted 5,515,702 5,376,884
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME
for the six months ended June 30, 1998 and 1997
(Dollars in thousands, except share and per share amounts)
(Unaudited)
<CAPTION>
1998 1997
-------- --------
Revenue:
Gain on sale of loans $ 18,533 $ 15,385
Interest income 5,254 4,897
Other fees and income 3,161 1,560
-------- --------
26,948 21,842
-------- --------
Expenses:
Compensation and related benefits 11,999 7,516
General and administrative 5,832 4,638
Loan production expense 1,868 721
Interest expense 3,084 2,858
Provision for loan and foreclosed property losses 838 698
-------- --------
23,621 16,431
-------- --------
Income before income taxes 3,327 5,411
Provision for income taxes 1,380 2,197
-------- --------
Net income $ 1,947 $ 3,214
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains (loss) arising during period (726) (215)
-------- --------
Comprehensive income $ 1,221 $ 2,999
======== ========
Net income per share:
Basic $ 0.35 $ 0.62
======== ========
Diluted $ 0.35 $ 0.62
======== ========
Weighted average number of shares outstanding:
Basic 5,509,535 5,224,966
========= =========
Diluted 5,515,072 5,224,966
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the six months ended June 30, 1998 and 1997
(In thousands)
(Unaudited)
<CAPTION>
1998 1997
--------- ---------
Operating activities:
Net income $ 1,948 $ 3,214
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation of premises and equipment 526 149
Provision for loan losses 720 485
Provision for losses on real estate owned 119 200
Loss on sale of real estate owned 243 353
Gain on sale of loans (18,533) (15,385)
Proceeds from sales and prepayments of loans 256,736 221,979
Loans held for sale originations (227,952) (228,907)
Loss on sale of securities 1 --
Changes in operating assets and liabilities:
Loan sale receivable (1,794) (16,413)
Goodwill (3,293) --
Other assets (1,151) (1,518)
Accrued and other liabilities, net of effects from
acquisition of Armada LLC 884 1,154
Income taxes payable (2,874) 26
Deferred income taxes 1,176 141
--------- ---------
Net cash provided by (used in) operating activities 6,756 (34,522)
Investing activities:
Purchases of premises and equipment (590) (1,879)
Sales of premises and equipment 17 --
Sales of real estate owned 2,305 1,152
Purchases of securities (188) (1,005)
Sales of securities 1,000 --
--------- ---------
Net cash provided by (used in) investing activities 2,544 (1,732)
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
for the six months ended June 30, 1998 and 1997
(In thousands)
(Unaudited)
<CAPTION>
1998 1997
--------- ---------
Financing activities:
Proceeds from revolving warehouse line of credit $ 206,151 $ 244,703
Principal payments on revolving warehouse line of credit (221,148) (211,038)
Principal payments on mortgage loans payable (40) (24)
Proceeds from mortgage loans payable -- 800
Proceeds from FHLB advances 380 --
Net increase (decrease) in:
Notes payable - related parties (146) 167
Certificates of indebtedness (60) (6)
Certificates of deposit 4,162 883
Exercise of common stock warrants -- 332
--------- ---------
Net cash provided by (used in) financing activities (10,701) 35,817
--------- ---------
Net decrease in cash (1,401) (437)
Cash at beginning of period 11,869 3,440
--------- ---------
Cash at end of period $ 10,468 $ 3,003
========= =========
Supplemental cash flow information:
Cash paid for interest $ 3,094 $ 1,565
Cash paid for income taxes 3,078 2,383
Supplemental non-cash information:
Loan balances transferred to real estate owned $ 2,731 $ 1,998
Exchange of stock for acquisition of Armada Residential
Mortgage LLC 669 --
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the three and six months ended June 30, 1998 and 1997 (Unaudited)
Note 1. Organization and Summary of Significant Accounting Policies:
Organization: Approved Financial Corp., a Virginia corporation, and its
subsidiaries (collectively, "Approved", the "Company") engage in the consumer
finance business of originating, servicing and selling home equity loans secured
primarily by first and second liens on one-to-four family residential
properties. Approved has two wholly owned subsidiaries, Approved Residential
Mortgage, Inc. ("ARMI") and Approved Federal Savings Bank (the "Savings Bank").
During the six month period ended June 30, 1998, ARMI originated loans through
its broker network in eleven states and through 26 retail origination offices in
eleven states. The Company's retail offices also generate loans, which are
funded through other lenders and the Company acts in a broker capacity
("Brokered loans"). Brokered loans are normally loans that do not meet the
Company's underwriting guidelines. The Savings Bank is a federally chartered
thrift institution located in Virginia Beach, Virginia, and has a wholly owned
subsidiary operating as a title insurance agency.
Principles of accounting and consolidation: The consolidated financial
statements of the Company include the accounts of Approved and its wholly owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated.
Note 2. Basis of Presentation:
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the interim periods are not necessarily
indicative of financial results for the full year. These unaudited condensed
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-K/A for the year ended December 31, 1997.
Note 3. New accounting pronouncements:
Effective January 1, 1998 the Company adopted SFAS No. 130, "Reporting
Comprehensive Income". The new statement requires that an enterprise (a)
classify items of other comprehensive income by their nature in a financial
statement and (b) display the accumulated balance of other comprehensive income
separately from retained earnings and additional capital in the equity section
of the statement of financial condition. The only item the Company has in
Comprehensive income for the three and six months ended June 30, 1998 and 1997
is an unrealized holding gain or loss on securities, net of deferred taxes.
In June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information" was issued, effective for fiscal years beginning after
December 15, 1997. The new statement requires that a public business enterprise
report financial and descriptive information about its reportable operating
segments. Operating segments are components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision-maker in deciding how to allocate resources and in
assessing performance. Generally, financial information is required to be
reported on the basis that it is used internally for evaluating segment
performance and deciding how to
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the three and six months ended June 30, 1998 and 1997
(Unaudited)
allocate resources to segments. The Company is currently evaluating the effect
this statement will have on the financial statements.
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" was issued, effective for fiscal year ends beginning after June 15,
1999. This statement establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, (collectively referred to as derivatives) and for hedging
activities. It requires that entities recognize all derivatives as either assets
or liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as (a) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment, (b)
a hedge of the exposure to variable cash flows of a forecasted transaction, or
(c) a hedge of the foreign currency exposure of a net investment in a foreign
operation, an unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. The Company is currently
evaluating the effect this statement will have on the financial statements.
Note 4. Acquisition:
Effective January 26, 1998, ARMI purchased substantially all of the assets of
Funding Center of Georgia, Inc. ("FCGA"), which is located in Atlanta. FCGA
generated loan volume of $26.4 million, from the acquisition date through June
30, 1998, including Brokered loans. All of the employees of FCGA have become
employees of ARMI, and the business is conducted under the assumed name of
"Funding Center of Georgia." The purchase price for FCGA's assets was
$3,300,000. ARMI paid $600,000 at closing, will pay $100,000 in 1998, $900,000
in 1999, $900,000 in 2000 and $800,000 in 2001, with interest at 6%. Payment
amounts of $800,000 each in 1999, 2000 and 2001 are subject to reduction in the
event of a failure to meet agreed-upon pre-tax profit targets each year. The two
principal owners of FCGA entered into three-year employment agreements with ARMI
and they manage the operations of FCGA. This transaction was accounted for under
the purchase method of accounting. Net assets of $7,000 were acquired with an
associated intangible asset (goodwill) recorded in the amount of $3,293,000.
This goodwill will be amortized over 10 years.
<PAGE>
<TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
The following commentary discusses major components of the Company's business
and presents an overview of the Company's consolidated results of operations for
the three and six month periods ended June 30, 1998 and 1997 and its
consolidated financial position at June 30, 1998 and December 31, 1997. The
discussion includes some forward-looking statements involving estimates and
uncertainties. The Company's actual results could differ materially from those
anticipated in the forward-looking statements, as a result of certain factors
such as reduced demand for loans, competition, limits on available funds and
market forces affecting the price of the Company's common stock and other risk
factors as disclosed in the Company's Form 10/A and 10-K/A filed with the
Securities and Exchange Commission. This discussion should be reviewed in
conjunction with the consolidated financial statements and accompanying notes
and other statistical information.
Results of Operations for the Three and Six month Periods ended June 30, 1998
Compared to the Three and Six Month Periods Ended June 30, 1997.
Net Income.
Net income for the three and six months ended June 30, 1998 was $0.5 million and
$1.9 million representing a decrease of $1.2 million and $1.3 million compared
to net income of $1.7 million and $3.2 million for the three and six months
ended June 30, 1997. On a per share basis (diluted), income for the three and
six months ended June 30, 1998 was $0.09 and $0.35 compared to $0.31 and $0.62
for the three and six months ended June 30, 1997. The per-share figures have
been adjusted to reflect a 100% stock dividend paid on common stock, of the
Company on November 21, 1997.
Origination of Mortgage Loans.
The following table shows the loan originations in dollars and units for the
Company's broker and retail units for the three and six month periods ended June
30, 1998 and 1997. The table excludes $20.9 million and $36.4 million Brokered
loans generated by the Company's retail unit during the three and six month
periods ended June 30, 1998.
<CAPTION>
(Dollars in thousands) Three Months Six Months
Ended June 30 Ended June 30
1998 1997 1998 1997
---- ---- ---- ----
<S> <C>
Dollar Volume of Loan Originations:
Broker $ 55,788 $ 61,106 $ 105,083 $ 124,927
Retail 63,340 50,668 122,869 97,824
-------- -------- --------- ----------
Total $119,128 $111,774 $ 227,952 $ 222,751
======== ======== ========= =========
Number of Loans Originated:
Broker 999 1,108 1,862 2,146
Retail 1,148 1,011 2,270 1,887
-------- -------- --------- ----------
Total 2,147 2,119 4,132 4,033
======== ======== ========= =========
The increase of 6.6 percent and 2.3 percent in dollar volume of loans originated
during the three and six month periods ended June 30, 1998, respectively,
compared to the same periods in 1997 was due to growth in retail loan volume.
Loans originated through the Company's retail offices increased 25.0 percent to
$63.3 million and 25.6 percent to $122.9 million during the three and six month
periods ended June 30, 1998, compared to $50.7 million and $97.8 million during
the respective periods in 1997. In addition, the retail division generated $20.9
million and $36.4 million in Brokered loans during the three and six month
periods ended June 30, 1998. Brokered loan volume created during the three and
six month periods ended June 30, 1997 was not material and therefore the dollar
volumes were not recorded. The growth in retail originations was due to an
increase in retail office locations from internal growth and due to the
acquisition of FCGA.
The volume of loans originated through referrals from the Company's network of
mortgage brokers decreased 8.7 percent to $55.8 million and decreased 15.9
percent to $105.1 million during the three and six month periods ended June 30,
1998, respectively, compared to $61.1 million and $124.9 million during the
three and six month periods ended June 30, 1997. Contributing to this decrease
in volume from broker referrals is the refinance boom for conforming mortgages
created by the low interest rate environment, increased competition in the
non-conforming mortgage industry and the Company's acquisition of FCGA, a former
broker who referred loans to the Company.
The following table summarizes mortgage loan originations, by state, for the
three month periods ended June 30, 1998 and 1997:
($ In thousands)
<CAPTION>
1998 1997
------------------------ ----------------------
Dollars Percent Dollars Percent
------- ------- ------- -------
Broker Division:
Florida $ 13,292 11.2% $ 16,180 14.5%
Maryland 10,776 9.0 6,240 5.6
Georgia 10,774 9.0 15,176 13.6
North Carolina 6,968 5.8 5,638 5.0
Ohio 5,772 4.8 4,841 4.3
Virginia 2,737 2.3 1,171 1.0
South Carolina 2,485 2.1 1,067 1.0
Tennessee 1,267 1.1 2,331 2.1
Illinois 1,169 1.0 4,715 4.2
Michigan 548 0.5 658 .6
Indiana 0 0 3,089 2.8
-------- ---- -------- ----
Total Broker Division $ 55,788 46.8% $ 61,106 54.7%
======== ==== ======== ====
Retail Division:
Maryland $ 14,400 12.1% $ 18,363 16.4%
Virginia 10,908 9.2 7,822 7.0
North Carolina 10,430 8.8 7,722 6.9
Georgia 7,396 6.2 1,131 1.0
South Carolina 6,175 5.2 5,403 4.8
Ohio 5,813 4.9 3,189 2.9
Kentucky 3,196 2.7 -- --
Delaware 2,344 2.0 5,217 4.7
Florida 1,926 1.6 429 0.4
Indiana 752 0.5 498 0.4
Illinois -- -- 894 0.8
-------- ---- -------- ----
Total Retail Division $ 63,340 53.2% $ 50,668 45.3%
======== ==== ======== ====
Total originations:
Maryland $ 25,176 21.0% $ 24,603 22.0%
Georgia 18,170 15.3 16,307 14.6
North Carolina 17,398 14.5 13,360 12.0
Florida 15,218 12.8 16,609 14.9
Virginia 13,645 11.5 8,993 8.0
Ohio 11,585 9.7 8,030 7.2
South Carolina 8,660 7.3 6,470 5.7
Kentucky 3,196 2.7 -- --
Delaware 2,344 2.0 5,217 4.7
Tennessee 1,267 1.1 2,331 2.1
Illinois 1,169 1.0 5,609 5.0
Indiana 752 0.6 3,587 3.2
Michigan 548 0.5 658 0.6
-------- ---- -------- ----
Total originations $119,128 100.0% $111,774 100.0%
======== ==== ======== ====
The following table summarizes mortgage loan originations, by state, for the six
month periods ended June 30, 1998 and 1997:
($ In thousands)
<CAPTION>
1998 1997
-------------------------- --------------------------
Dollars Percent Dollars Percent
------- ------- ------- -------
Broker Division:
Florida $ 27,199 11.9% $ 28,855 13.0%
Georgia 20,253 8.9 30,580 13.7
Maryland 17,253 7.6 12,710 5.7
Ohio 12,723 5.6 9,001 4.0
North Carolina 12,634 5.5 13,242 6.0
South Carolina 5,672 2.5 3,602 1.6
Virginia 4,317 1.9 3,698 1.7
Tennessee 2,017 0.9 2,755 1.2
Illinois 1,828 0.8 10,469 4.7
Michigan 1,115 0.5 3,130 1.4
Indiana 72 0.0 6,885 3.1
-------- ---- -------- ----
Total Broker Division $105,083 46.1% $124,927 56.1%
======== ===== ======== =====
Retail Division:
Maryland $ 30,424 13.3% $ 33,890 15.2%
North Carolina 22,643 9.9 15,564 7.0
Virginia 20,366 8.9 15,046 6.8
Georgia 13,177 5.8 8,306 3.7
South Carolina 10,533 4.6 7,384 3.3
Ohio 10,499 4.6 5,590 2.5
Kentucky 5,829 2.6 -- --
Delaware 5,213 2.3 9,952 4.5
Florida 2,891 1.3 429 0.2
Indiana 1,294 0.6 498 0.2
Illinois -- -- 1,165 0.5
-------- ---- -------- ----
Total Retail Division $122,869 53.9% $ 97,824 43.9%
======== ===== ======== =====
Total originations:
Maryland $ 47,677 20.9% $ 46,600 20.9%
North Carolina 35,277 15.4 28,806 13.0
Georgia 33,430 14.7 38,886 17.5
Florida 30,090 13.2 29,284 13.1
Virginia 24,683 10.8 18,744 8.4
Ohio 23,222 10.2 14,591 6.6
South Carolina 16,205 7.1 10,986 4.9
Kentucky 5,829 2.6 -- --
Delaware 5,213 2.3 9,952 4.5
Tennessee 2,017 0.9 2,755 1.2
Illinois 1,828 0.8 11,634 5.2
Indiana 1,366 0.6 7,383 3.3
Michigan 1,115 0.5 3,130 1.4
-------- ---- -------- ----
Total originations $227,952 100.0% $222,751 100.0%
======== ===== ======== =====
Gain on Sale of Loans.
The largest component of the Company's net income is gain on sale of loans.
There is an active secondary market for most types of mortgage loans originated
by the Company. The majority of the loans originated by the Company are sold to
other financial institutions. The Company receives cash at the time loans are
sold. The loans are sold service-released on a non-recourse basis, except for
normal representations and warranties, which is consistent with industry
practices. By selling loans in the secondary mortgage market, the Company is
able to obtain funds that may be used for additional lending and investment
purposes. Gains from the sale of loans is comprised of several components, as
follows: (a) the difference between the sales price and the net carrying value
of the loan; plus (b) loan origination fee income collected at loan closing and
deferred until the loan is sold; less (c) recapture premiums and loan selling
costs.
Loan sales totaled $117.0 million and $221.6 million for the three and six
months ended June 30, 1998, compared to $108.1 million and $198.5 million for
the same periods in 1997. Loan sales during the three month period ended June
30, 1998, include the sale of approximately $10.0 million of loans owned by the
Company for more than 180 days ("Seasoned Loans"), at an 8% discount to par
value.
Gain on the sale of loans, excluding the sale of $10 million of Seasoned Loans,
was $8.8 million and $18.5 million for the three and six months ended June 30,
1998, which compares with $8.1 million and $15.4 million for the same periods in
1997. The increase for the three-month period ended June 30, 1998 was due to an
increase in the loan origination fee income. The increase for the six-month
period ended June 30, 1998, was the direct result of the increase in the volume
of loans sold and an increase in loan origination fee income. Gain on the sale
of mortgage loans represented 67.0% and 68.8% of total revenue during the three
and six months ended June 30, 1998, compared to 68.6% and 70.4% of total revenue
for the same periods in 1997.
The weighted-average premium realized by the Company on its loan sales decreased
to 5.59% and 5.89%, excluding the $10 million Seasoned Loan sale, during the
three and six months ended June 30, 1998, from 6.30% and 6.53% for the same
periods in 1997. The premium percentage has decreased due to a decrease in the
Weighted Average Coupon ("WAC") on loan originations, which was primarily the
result of an increase in adjustable rate mortgage originations during the first
six months of 1998 compared to the first six months of 1997. These premiums do
not include loan fees collected by the Company at the time the loans are closed,
which are included in the computation of gain on sale when the loans are sold.
<PAGE>
The Company defers fees it receives in loan origination, commitment and purchase
transactions. Loan origination fees are deferred and recognized over the lives
of the related loans as an adjustment of the loan's yield using the level-yield
method. Deferred income pertaining to loans held for sale is taken into income
at the time of sale of the loan. Origination fee income is primarily derived
from the Company's retail lending division. Origination fee income included in
the gain on sale of loans for the three and six months ended June 30, 1998 was
$3.0 million and $6.0 million, compared to $1.7 million and $3.0 million for the
same period in 1997. This increase is the result of the Company selling more
loans generated by its retail lending division. The Company's retail loan sales
during the three and six months ended June 30, 1998 comprised 54.0% and 54.6% of
total loan sales, with average loan origination fee income earned of 5.4% and
5.0%. For the same period in 1997, the Company's retail loan sales were 40% and
41% of total loan sales with average origination fee income earned of 4.0% and
3.8%. Fees associated with selling loans remained constant at approximately 20
basis points of the dollar volume of loans sold for the three and six months
ended June 30, 1998 and 1997.
A substantial portion of the Company's loan sales during the three month period
ended June 30, 1998 were to IMC Mortgage Company ("IMC"), a non-conforming
residential mortgage lender. The Company was the owner of approximately 3.2% of
the issued and outstanding stock of IMC at June 30, 1998. The Company sold IMC
723 and 1,641 loans totaling $41.1 million and $97.2 million for the three and
six months ended June 30, 1998, compared to 744 and 1,919 loans totaling $44.8
million and $122.1 million for the same period ended in 1997. The loans sold to
IMC represented 33.0% and 43.9% of the dollar volume of the Company's loan sales
for the three and six months ended June 30, 1998, compared to 41.4% and 61.5%
for the same periods ended 1997. The Company's Chairman and Chief Executive
Officer, Allen D. Wykle, was a member of IMC's Board of Directors from April
1996 until June 1998.
Interest Income and Expense.
The Company's net interest income is dependent on the difference, or "spread,"
between the interest income it receives from its loans and its cost of funds,
consisting principally of the interest expense paid on the warehouse lines of
credit and other borrowings and the Savings Bank's deposit accounts.
Interest income for the three and six months ended June 30, 1998 was $2.7
million and $5.3 million compared with $2.9 million and $4.9 million for the
same period ended in 1997. The decrease in interest income for the three months
ended June 30, 1998 was primarily due to a lower weighted average coupon for the
balance of loans held for sale. The increase in interest income for the six
month period ended June 30, 1998, compared to the same period in 1997, was
primarily due to a larger average balance of loans held for sale.
Interest expense for the three and six months ended June 30, 1998 was $1.5
million and $3.1 million compared with $1.5 million and $2.9 million for the
same period ended in 1997. The increase in interest expense for the six month
period ended June 30, 1998, was the direct result of increased borrowings under
the Company's warehouse lines of credit and an increase in outstanding
certificates of deposit issued by the Savings Bank.
The Company's net interest income for the three and six month periods ended June
30, 1998 was $1.2 million and $2.2 million compared to $1.4 million and $2.0
million for the same period ended in 1997. The decrease in net interest income
for the three month period ended June 30, 1998, was caused by a lower "WAC" on
the company's loan portfolio. The increase in net interest income for the six
month period ended June 30, 1998, compared to the same period in 1997.
The average yield received on the Company's loan portfolio may not change at the
same pace as the interest rates it must pay on its revolving warehouse loans and
other borrowings and the Savings Bank's FDIC-insured deposits. As a result, in
times of rising interest rates, decreases in the difference between the yield
received on loans and other investments and the rate paid on borrowings and the
Savings Bank's deposits usually occur.
<PAGE>
The following tables reflect the average yields earned and rate paid by the
Company during the six months ended June 30, 1998 and 1997. In computing the
average yields and rates, the accretion of loan fees is considered an adjustment
to yield. Information is based on average month-end balances during the
indicated periods.
<CAPTION>
(In thousands) June 30, 1998 June 30, 1997
------------------------------- -----------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ------ ------- -------- -------
Interest-earning assets:
Loans receivable (1) $ 79,802 $ 5,031 12.71% $ 68,806 $ 4,815 14.11%
Cash and other interest-
earning assets 6,982 223 6.44 2,754 82 6.00
--------- ------- ----- -------- -------- -----
86,784 5,254 12.21 71,560 4,897 13.80
------- ----- -------- -----
Non-interest-earning assets:
Allowance for loan losses (1,642) (1,316)
Investment in IMC 12,336 18,723
Premises and equipment, net 4,689 2,638
Other 16,906 5,781
--------- --------
Total assets $ 119,073 $ 97,386
========= ========
Interest-bearing liabilities:
Revolving warehouse lines $ 55,169 1,978 7.23 $ 59,883 2,335 7.86
FDIC-insured deposits 19,561 585 6.03 1,958 56 5.77
Other interest-bearing
liabilities 11,350 521 9.26 10,056 467 9.36
--------- ------- ----- -------- -------- -----
86,080 3,084 7.22 71,897 2,858 8.02
-------- ------- ------- ------
Non-interest-bearing liabilities 5,957 1,669
--------- --------
Total liabilities 92,037 73,566
Shareholders' equity 27,036 23,820
--------- --------
Total liabilities and equity $119,073 $ 97,386
======== ========
Average dollar difference between
interest-earning assets and interest-
bearing liabilities $ 704 $ (337)
======== ========
Net interest income $2,170 $ 2,039
====== ========
Interest rate spread (2) 4.99% 5.78%
====== ======
Net annualized yield on average
interest-earning assets 5.04% 5.75%
====== ======
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
(2) Average yield on total interest-earning assets less average rate paid on
total interest-bearing liabilities.
<PAGE>
The following table shows the change in net interest income which can be
attributed to rate (change in rate multiplied by old volume) and volume (change
in volume multiplied by old rate) for 1998 and 1997. The changes in net interest
income due to both volume and rate changes have been allocated to volume and
rate in proportion to the relationship of absolute dollar amounts of the change
of each. The table demonstrates that the $131,000 increase in net interest
income for the six months ended June 30, 1998 and 1997 was the net result of a
growing balance sheet positively affected by lower rates on borrowed funds.
<CAPTION>
($ In Thousands)
Three Months Ended Three Months Ended
June 30, 1998 June 30, 1997
Compared to Compared to
June 30, 1997 June 30, 1996
------------- -------------
Increase Increase
(Decrease) due to (Decrease) due to
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
Interest-Earning Assets:
Loan Receivable $ 568 $ (352) $ 216 $2,539 34 $ 2,573
Cash and Other Interest-
Earning Assets 135 6 141 75 0 75
--------- ------ ------ ------- ------- ------
703 (346) 357 2,614 34 2,648
--------- ------ ------ ------- ------- ------
Interest-Bearing Liabilities:
Revolving Warehouse Lines (176) (181) (357) 1,333 (217) 1,116
FDIC-Insured Deposits 526 3 529 56 0 56
Other Interest-
Bearing Assets 59 (5) 54 95 47 142
--------- ------ ------ ------- ------- ------
409 (183) 226 1,484 (170) 1,314
--------- ------ ------ ------- ------- ------
Net Interest Income $ 294 $ (163) $ 131 $ 1,130 $ 204 $1,334
========= ====== ====== ======= ======= ======
Other Income.
In addition to net interest income, and gain on the sale of loans, the Company
derives income from origination fees earned on Brokered loans generated by the
Company's retail offices and additional fees earned on the loans funded by the
Company such as document preparation fees, underwriting service fees, prepayment
penalties, and late charge fees for delinquent loan payments. Brokered loan fees
were $1.0 million and $1.7 million for the three and six months ended June 30,
1998, compared to $0.15 million and $0.22 million for the three and six months
ended June 30, 1997. For the three and six months ended June 30, 1998, other
income totaled $1.7 million and $3.2 million compared to $0.8 million and $1.6
million for the same period in 1997. The increase was primarily the result of
the increase in Brokered loan fees. Increases in underwriting service and
document preparation fees contributed to the remainder of the increase.
Comprehensive Income.
The Company has comprehensive income in the form of unrealized holding gain
(loss) on securities held for sale. The shares of IMC Mortgage Company common
stock owned by the Company is the primary component of the Company's security
holdings (See Item 2 section "Assets"). For the three and six months ended June
30, 1998, comprehensive income (loss) was ($1.3) million and $1.2 million
compared to comprehensive income of $4.8 million and $3.0 million for the three
and six months ended June 30, 1997. The loss for the three months ended June 30,
1998 was related to a decrease in the market price of IMC Mortgage Company
stock. The gain for the six month period ended June 30, 1998 and the gain for
the three and six month periods ended June 30, 1997 was related to an increase
in the market price of the IMC Mortgage Company stock for the respective
periods.
Compensation and Related Expenses.
The largest component of expenses is compensation and related expenses, which
increased by $2.0 million and $4.5 million to $6.0 million and $12.0 million for
the three and six months ended June 30, 1998, respectively, compared to the same
periods in 1997. The increases were directly attributable to an increase in the
number of employees. The Company had 623 full-time equivalent ("FTE") employees
at June 30, 1998, (534 full-time and 179 part-time). This compares to 447 FTE's
at June 30, 1997 (369 full-time and 156 part-time). The Company's corporate
office staff increased by 68.1% for the period ended June 30, 1998, with a
corresponding increase in base salaries and benefits for the three and six month
periods ended June 30, 1998 of approximately $1.0 million and $2.0 million. The
corporate office staff increases were made to accommodate anticipated loan
growth and to staff the centralized telemarketing division at the home office.
The Company had five and eight additional retail lending offices for the three
and six month periods ended June 30, 1998, compared to the same period in 1997,
which increased the size of the retail lending staff. The Company's increase in
staff size resulted in base salary and benefit increases for the three and six
month periods ended June 30, 1998 of approximately $0.7 million and $1.4
million. The additional increase was related to merit and cost of living
increases as well as increases in commissions.
On June 26, 1998, the Company reduced its home office staff by 31 employees,
this reduction is not reflected in the FTE numbers stated above.
General and Administrative Expenses.
General and administrative expenses for the three and six month periods ended
June 30, 1998 increased by $0.2 million and $1.2 million to $2.8 million and
$5.8 million, compared to the three and six month periods ended June 30, 1997.
The Company had five and eight additional retail lending offices for the three
and six month periods ended June 30, 1998 compared to the same periods in 1997,
with increases of general and administrative expenses associated with the new
retail offices of approximately $0.4 million and $1.0 million for the three and
six months ended June 30, 1998. General and administrative expenses related to
the Company's corporate office and mature retail offices decreased for the three
month period ended June 30, 1998, by approximately $0.2 million. General and
administrative expenses related to the Company's corporate office and mature
retail offices increased for the six month period ended June 30, 1998, by
approximately $0.4 million. The reduction in general and administrative expenses
during the second quarter of 1998 compared to the first quarter of 1998 were the
result of the Company's cost cutting procedures implemented in the first quarter
of 1998.
Loan Production Expense.
The largest component of loan production expense is services rendered fees.
These fees are paid by the Company to mortgage brokers for services rendered in
the preparation of loan packages. Other items that comprise loan production
expenses are appraisals, credit reports, leads research and telemarketing
expenses. Loan production expenses for the three and six month periods ended
June 30, 1998 were $1.0 million and $1.9 million compared to $0.5 million and
$0.7 million for the three and six months ended June 30, 1997. The increase was
primarily the result of an increase in services rendered fees. Services rendered
fee expenses increased $0.3 million and $0.6 million for three and six month
periods ended June 30, 1998 compared to the same period a year earlier. The
additional increase related to telemarketing and leads research expenses.
Provision for Loan Losses.
The Company added $703,000 and $720,000 during the three and six months ended
June 30, 1998 to the allowance for loan losses, compared to decrease of $10,000
and an increase of $338,000 dollars for the three and six month periods ended
June 30, 1997. The increase was caused by a Seasoned loan sale, of approximately
$10.0 million, at 92% of the carrying value of the loans.
The following table presents the activity in the Company's allowance for loan
losses and selected loan loss data for the six months ended June 30, 1998 and
the year ended December 31, 1997
($ In thousands):
1998 1997
------------ --------
Balance at beginning of period $1,687 $ 924
Provision charged to expense 720 1,534
Loans charged off (1,133) (953)
Recoveries of loans previously charged off 59 182
------ -------
Balance at end of period $ 1,333 $ 1,687
========= =======
Loans receivable at period-end, gross
of allowance for losses $64,068 $83,512
Ratio of allowance for loan losses to gross
loans receivable at period-end 2.08% 2.02%
The decrease in allowance for losses at June 30, 1998 compared to December 31,
1997 relates to the decrease in the balance of net mortgage loans for the
respective dates. All losses ("charge offs" or "write downs") and recoveries
realized on the sale of properties for which write downs were previously
recorded at the time of foreclosure, are accounted for in the allowance for loan
losses.
The allowance is established at a level that management considers adequate
relative to the composition of the current portfolio of loans held for sale.
Management considers current characteristics of the portfolio such as credit
quality, the weighted average coupon and the weighted average loan to value
ratio in the determination of an appropriate allowance. Other criteria such as
covenants associated with the Company's credit facilities, trends in the demand
for non-conforming mortgage loans in the secondary market and general economic
conditions, including interest rates, are also considered when establishing the
allowance. Adjustments to the reserve for loan losses may be made in future
periods due to changes in the factors mentioned above and any additional factors
that may effect anticipated loss levels in the future.
<PAGE>
Provision for Foreclosed Property Losses.
The Company increased its provision for foreclosed property losses by $246,000
and $119,000 for the three and six months ended June 30, 1998, compared to an
increase of $416,000 and $348,000 for the three and six months ended June 30,
1997.
Sales of real estate owned yielded net losses of $100,000 and $370,000 for the
three and six months ended June 30, 1998 versus $204,000 and $352,000 for the
three and six months ended June 30, 1997.
The following table presents the activity in the Company's allowance for
foreclosed property losses and selected real estate owned data for the six
months ended June 30, 1998 and the year ended December 31, 1997 ($ In
thousands):
1998 1997
-------- --------
Balance at beginning of period $ 671 $ 529
Provision charged to expense 119 142
-------- --------
Balance at end of period $ 790 $ 671
======== ========
Real estate owned at period-end, gross
of allowance for losses $ 3,423 $ 3,038
Ratio of allowance for REO losses
to gross real estate owned at period-end 23.08% 22.09%
Note: This reserve is in addition to the reserve for loan losses.
The Company maintains a reserve on its REO's based upon management's assessment
of appraised values. The increase in the provision for foreclosed property
losses relates to an increase in the amount of outstanding REO's at June 30,
1998 when compared to December 31, 1997. While the Company's management believes
that its present allowance for foreclosed property losses is adequate, future
adjustments may be necessary.
Income Taxes.
Income tax expense for the three and six months ended June 30, 1998 was $0.3
million and $1.4 million, resulting in an effective tax rate of 39.9% and 41.5%.
By comparison, the Company had income tax expense of $1.2 million and $2.2
million for an effective tax rate of 41.1% and 41.0% for the same period in
1997.
The effective tax rates differ from the statutory federal rates due primarily to
state income taxes and certain nondeductible expenses.
<PAGE>
Financial Condition at June 30, 1998 Compared to December 31, 1997
Assets.
The total assets of the Company were $109.1 million at June 30, 1998, compared
to total assets of $118.1 million at December 31, 1997.
Cash and cash equivalents were $10.5 million at June 30, 1998, representing a
decrease of $1.4 million over cash and cash equivalents of $11.9 million at
December 31, 1997. The principal reason for the decrease was that funds in the
amount of $1.8 million relating to a June 1998 loan sale were not received until
July 1998. See loan sale receivable section for more details.
Net mortgage loans receivable decreased by $13.9 million to $66.8 million at
June 30, 1998. The 17.2% decline was primarily the result of the Company selling
more loans than it originated during the first six months of 1998. The Company
generally sells loans within sixty days after origination.
Real estate owned increased by $0.3 million, from December 31, 1997, to $2.6
million at June 30, 1998. The increase was the result of a net gain in loan
balances transferred to real estate owned compared to real estate owned sales.
In 1994, the Company adopted SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity Securities." The adoption of SFAS 115 had no effect on the
operations of the Company at that time. SFAS No. 115 addressed the accounting
and reporting of investments in equity securities that have readily determinable
fair values and for all investments in debt securities. Investments in
securities are classified under SFAS No. 115 as held to maturity, trading or
available-for-sale. Investments in debt securities that the Company has the
intent and ability to hold to maturity are classified as "held to maturity"
securities and reported at amortized cost. Debt and equity securities that are
purchased and held principally for the purpose of selling them are classified as
trading securities and reported at fair value, with unrealized gains and losses
included in earnings. Debt and equity securities not classified as either held
to maturity or trading securities are classified as available-for-sale
securities and are reported at fair value, with unrealized gains and losses
excluded from earnings and reported as a separate component of shareholders'
equity. Following the conversion of the Industry Mortgage L.P. into a public
corporation in 1996, the Company received shares of IMC Mortgage Company ("IMC")
common stock (NASDAQ: IMCC). The Company's investment in IMC is accounted for as
a trading security under SFAS No. 115 and is carried at the market value of the
stock. The market value of this stock was $10.4 million at June 30, 1998 and
$11.6 million at December 31, 1997. Other securities are comprised of the
Savings Bank's Adjustable Rate Mortgage Fund and Federal Home Loan Bank Stock
("FHLB"). These investments decreased in value by $0.8 million, to $2.8 million
at June 30, 1998, from December 31, 1997.
Premises and equipment increased by $0.2 million, from December 31, 1997, to
$4.8 million at June 30, 1998. The primary reason for the increase was the
purchase of computers for a centralized telemarketing center located at the
Company's headquarters in Virginia Beach.
Goodwill increased $3.1 million, from December 31, 1997, to $3.9 million at June
30, 1998. The increase is a result of the Company's purchase of the Funding
Center of Georgia, which resulted in goodwill of $3.3 million.
At June 30, 1998, the Company finalized a loan sale with an investor for $1.8
million. The funds were not received until July 1998; therefore, creating a loan
sale receivable.
<PAGE>
Other assets increased by $1.2 million, from December 31, 1997, to $3.8 million
at June 30, 1998. The 1998 increase is primarily the result of an income tax
receivable of $1.7 million relating to the overpayment of second quarter
estimated tax payments. This was offset by a decrease in prepaid expenses.
Liabilities.
Revolving warehouse loans decreased by $15.0 million, from December 31, 1997, to
$37.5 million at June 30, 1998. The 28.6% decrease in 1998 was primarily
attributable to the decrease in net mortgage loans held for sale and the
increase in certificates of deposit issued by the Savings Bank.
The Company draws on its revolving warehouse lines of credit as needed to fund
loan production. As of June 30, 1998, the Company had issued checks to fund
loans totaling $5.4 million which had not cleared the Company's checking account
and for which the Company had not drawn funds from its warehouse lines. These
checks cleared the Company's bank accounts in the first few business days of
July 1998 and most were funded with cash on hand or by funds from warehouse
lines of credit.
The Savings Bank's deposits totaled $22.0 million at June 30, 1998, compared to
$17.8 million at December 31, 1997. The Savings Bank increased its deposits in
1998 in order to fund loans. Of the certificate accounts as of June 30, 1998, a
total of $13.9 million was scheduled to mature in the next twelve-months.
The Savings Bank increased its borrowings from the FHLB to $1.4 million at June
30, 1998, from $0.4 million at December 31, 1997. The Savings Bank held $145,800
of FHLB stock at June 30, 1998. Management expects to utilize FHLB advances as
the Savings Bank builds a portfolio of loans.
Mortgage loans payable decreased by $0.04 million, from December 31, 1997, to
$1.2 million at June 30, 1998. The decrease was the result of principal payments
in the amount of $0.02 million. Mortgage loans payable is related to the
Company's headquarters buildings. The weighted-average interest rate on these
mortgages at June 30, 1998 was 8.40%.
Promissory notes and certificates of indebtedness totaled $8.9 million at June
30, 1998, compared to $9.1 million at December 31, 1997. The Company has
utilized promissory notes and certificates of indebtedness to help fund its
operations. These borrowings are subordinated to the Company's warehouse lines
of credit, and are for periods of one to five years and with interest rates
between 8.00% and 10.25%. The certificates of indebtedness are uninsured
deposits authorized for financial institutions like the Company, which own
Virginia industrial loan association charters. The Company is not currently
soliciting new promissory notes or certificates of indebtedness.
Accrued and other liabilities increased by $1.2 million to $4.0 million at June
30, 1998. This category includes accounts payable, accrued interest payable,
deferred income, accrued bonuses, and other payables. The increase was the
result of a payable being established in connection with the acquisition of the
Funding Center of Georgia. The acquisition payable was $2.7 million at June 30,
1998.
Shareholders' Equity.
Total shareholders' equity at June 30, 1998 was $26.9 million, compared to $25.1
million at December 31, 1997. The $1.8 million increase in 1998 was primarily
due to net income of $1.9 million. There was a decrease of $0.7 million in
accumulated other comprehensive income, related to a decrease in the market
value of the shares of IMC Mortgage Company owned by the Company. This was
offset by an increase in common stock and additional paid in capital of $0.7
million related to the purchase of the remaining 17% interest in Armada
Residential Mortgage, L.L.C.
Liquidity and Capital Resources
The Company's operations require access to short and long-term sources of
capital. The Company receives cash from the sale of loans through whole loan
sales, loan origination fees, processing and underwriting fees, net interest
income, and borrowings under its warehouse facilities and other debt to meet its
working capital needs. The Company's primary operating cash requirements include
the funding of mortgage loan originations pending their sale, operating
expenses, income taxes and capital expenditures.
Adequate credit facilities and other sources of funding, including the ability
to sell loans in the secondary market, are essential to the Company's ability to
continue to originate loans. The Company has operated, and expects to continue
to operate, on a negative cash flow basis due to the increased volume of loan
originations. The Company received cash from operating activities of $6.8
million for the six months ended June 30, 1998. The Company used cash from
operating activities of $34.5 million for the six months ended June 30, 1997.
The net cash provided from operating activities during the six month period
ended June 30, 1998 resulted because the Company sold more loans than it
originated. The net cash used from operating activities is primarily used to
fund mortgage loan originations.
The Company finances its operating cash requirements primarily through warehouse
and other credit facilities, and the issuance of other debt. For the six months
ended June 30, 1998, the Company used cash from financing activities of $10.7
million, compared to positive cash received from financing activities of $35.8
million for the six months ended June 30, 1997. During the first six months of
1998, the Company's repayments on its warehouse line of credit exceeded
borrowings because loan sales exceeded loan originations.
The Company had cash and cash equivalents of $10.5 million at June 30, 1998. The
Company has sufficient cash resources to fund its operations at current levels
through the end of 1998. However, loan origination volume is expected to
continue to grow in future periods, and management anticipates that it will need
additional capital to fund this growth and to continue its expansion. New debt
financing, equity financing, and lines of credit will be evaluated with
consideration for maximizing shareholder value. However, the company has no
commitments for additional bank borrowings or additional debt or equity
financing and there can be no assurance that the Company will be successful in
consummating any such financing transaction in the future on terms the Company
would consider to be favorable. Management expects that rising competition will
challenge the Company and the mortgage industry.
The Company's outstanding borrowings from all sources plus loan proceeds payable
represented 70.0% of total assets at June 30, 1998, compared to 74.5% of total
assets at December 31, 1997.
Warehouse and Other Credit Facilities. The Company has a $100.0 million
warehouse line of credit from a syndicate of commercial banks. The syndicate is
led by Chase Bank of Texas. Other banks in the syndicate are BankBoston,
National City Bank, Comerica Bank and Compass Bank. The line is secured by loans
originated by the Company and bears interest at a rate of 1.5% over the
one-month LIBOR rate. The line expires on December 31, 1999 and is subject to
renewal. The Company may receive warehouse credit advances of 98% of the
original principal balances on pledged mortgage loans for a maximum period of
180 days after origination. As of June 30, 1998, $26.7 million was outstanding
under this facility.
<PAGE>
The Company also has a $25.0 million seasoned loan line of credit from a
commercial bank syndicate. This line is secured by loans originated by the
Company. The seasoned loan line of credit bears interest at a rate of 2.5% over
the one-month LIBOR rate, and the Company may receive credit advances of 90% of
the current principal balances on pledged mortgage loans. As of June 30, 1998,
$10.8 million was outstanding under this facility.
Whole Loan Sale Program. The Company's primary source of funding is the sale of
its loans in the secondary market. The market value of the Company's loans is
dependent on a number of factors, including but not limited to the credit
quality of the loans, prepayment penalties attached to the loans, performance of
loans previously sold by the Company, general economic conditions, market
interest rates and governmental regulations. Adverse changes in these conditions
may affect the Company's ability to sell loans in the secondary market for
acceptable prices. The ability to sell loans in the secondary market is
essential to the continuation of the Company's loan origination operations.
Other Capital Resources. The Savings Bank's deposits totaled $22.0 million at
June 30, 1998, compared to $17.8 million at December 31, 1997. The Savings Bank
increased its deposits in order to fund loans. The Savings Bank currently
utilizes funds from the deposits and a line of credit with the FHLB of Atlanta
to fund first lien and junior lien mortgage loans.
Savings Bank Regulatory Liquidity
Liquidity is the ability to meet present and future financial obligations,
either through the acquisition of additional liabilities or from the sale or
maturity of existing assets, with minimal loss. Regulations of the OTS require
thrift associations and/or savings banks to maintain liquid assets at certain
levels. At present, the required ratio of liquid assets to withdrawal savings
and borrowings due in one year or less is 5.0%. Penalties are assessed for
noncompliance. In 1998 and 1997, the Savings Bank maintained liquidity in excess
of the required amount, and management anticipates that it will continue to do
so.
<PAGE>
Savings Bank Regulatory Capital.
At June 30, 1998, the Savings Bank's book value under generally accepted
accounting principles ("GAAP") was $4.1 million. OTS Regulations require that
savings institutions maintain the following capital levels: (1) tangible capital
of at least 1.5% of total adjusted assets, (2) core capital of 4.0% of total
adjusted assets, and (3) overall risk-based capital of 8.0% of total
risk-weighted assets. As of June 30, 1998, the Savings Bank satisfied all of the
regulatory capital requirements, as shown in the following table reconciling the
Savings Bank's GAAP capital to regulatory capital:
<CAPTION>
Tangible Core Risk-Based
($ In thousands) Capital Capital Capital
------- ------- -------
GAAP capital $ 4,057 $ 4,057 $ 4,057
Add: unrealized loss on securities 7 7 7
Nonallowable asset: goodwill (124) (124) (124)
Additional capital item: general allowance - - 176
------- ------- -------
Regulatory capital - computed 3,940 3,940 4,116
Minimum capital requirement 439 1,170 1,632
------- ------- -------
Excess regulatory capital $ 3,501 $ 2,770 $ 2,484
======= ======= =======
Ratios:
Regulatory capital - computed 13.47% 13.47% 20.17%
Minimum capital requirement 1.50 4.00 8.00
------- ------- -------
Excess regulatory capital 11.97% 9.47% 12.17%
======= ======= =======
The Company is not aware of any other trends, events or uncertainties which will
have or that are likely to have a material effect on the Company's or the
Savings Bank's liquidity, capital resources or operations. The Company is not
aware of any current recommendations by regulatory authorities, which if they
were implemented would have such an effect.
Hedging Activities
The Company originates mortgage loans for sale as whole loans. The Company
mitigates its interest rate exposure by selling most of the loans within sixty
days of origination. However, the Company may choose to hold certain loans for a
longer period prior to sale in order to increase net interest income. The
majority of loans held by the Company beyond the normal sixty-day holding period
are fixed rate instruments. Since most of the Company's borrowings have variable
interest rates, the Company has exposure to interest rate risk. For example, if
market interest rates were to rise between the time the Company originates the
loans and the time the loans are sold, the original interest rate spread on the
loans narrows, resulting in a loss in value of the loans. From time to time, the
Company will attempt to offset the effects of interest rate fluctuations on the
value of its fixed rate mortgage loans held for sale by entering into Treasury
security lock contracts, which function similar to short sales of U.S. Treasury
securities. However, the Company does not find this cost effective in most
instances, since the majority of the loans are sold within a sixty-day period.
The Company did not have any treasury security contracts at June 30, 1998.
<PAGE>
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented in this
document have been prepared in accordance with generally accepted accounting
principles, which require the measurement of the financial position and
operating results of the Company in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation.
Virtually all of the assets of the Company are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or with the same magnitude as the
prices of goods and services. Inflation affects the Company most significantly
in the area of loan originations and can have a substantial effect on interest
rates. Interest rates normally increase during periods of high inflation and
decrease during periods of low inflation.
Because the Company sells a significant portion of the loans it originates,
inflation and interest rates have a diminished effect on the Company's results
of operations. The Savings Bank is expected to continue to build its portfolio
of loans held for investment, and this portfolio will be more sensitive to the
effects of inflation and changes in interest rates. (Also see "Interest Rate"
section on page 25).
Year 2000 Issues
The Company's management is aware of the Year 2000 issues and is currently
assessing how these issues will affect the Company. The Company's
"mission-critical" applications are supplied by outside vendors with whom the
Company maintains current relationships. Most of the Company's mission-critical
systems already accommodate four-digit year values. The most recent release of
the mortgage loan origination and processing system is being used by the Company
and has been certified by the vendor as Year 2000 compliant. The Company has
implemented a new accounting system that has been certified by the vendor as
Year 2000 compliant. The Company is currently reviewing its hardware systems,
and will upgrade as needed for Year 2000 compliance. The Company is also working
with key loan sale customers, vendors, brokers and service providers to
determine whether data systems utilized by these parties are Year 2000
compliant. The Company is developing lists of alternative providers in the event
any of the current customers or providers cannot be certified as Year 2000
compliant. The cost of compliance is not expected to exceed $200,000.
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset/Liability Management
Management strives to manage the maturity or repricing match between assets and
liabilities. The degree to which the Company is "mismatched" in its maturities
is a primary measure of interest rate risk. In periods of stable interest rates,
net interest income can be increased by financing higher yielding long-term
mortgage loan assets with lower cost short-term Savings Bank deposits and
borrowings. Although such a strategy may increase profits in the short run, it
increases the risk of exposure to rising interest rates and can result in
funding costs rising faster than asset yields. The Company attempts to limit its
interest rate risk by selling a majority of the fixed rate mortgage loans that
it originates.
Contractual principal repayments of loans do not necessarily reflect the actual
term of the Company's loan portfolio. The average lives of mortgage loans are
substantially less than their contractual terms because of loan prepayments and
because of enforcement of due-on-sale clauses, which gives the Company the right
to declare a loan immediately due and payable in the event, among other things,
the borrower sells the real property subject to the mortgage and the loan is not
repaid. In addition, certain borrowers increase their equity in the security
property by making payments in excess of those required under the terms of the
mortgage.
The majority of the loans originated by the Company are sold through the
Company's loan sale program in an attempt to limit its exposure to interest rate
risk in addition to generating cash revenues. The Company sold approximately 88%
of the total loans originated during the year ended December 31, 1997. At June
30, 1998, the Company had sold approximately 92% of loans originated during the
first five months of 1998. The Company expects to sell the majority of its loan
originations within a twelve month period from the date the loans are funded by
the Company. The "gap position", defined as the difference between
interest-earning assets and interest-bearing liabilities maturing or repricing
in one year or less, was negative at June 30, 1998, as anticipated, and is
expected to remain negative in future periods. The Company has no quantitative
target range for past gap positions, nor any anticipated ranges for future
periods due to the fact that the Company sells the majority of its loans within
a twelve month period while the gap position is a static illustration of the
contractual repayment schedule for loans. The Company's one-year gap was a
negative 36.09% of total assets at June 30, 1998, as illustrated in the
following table:
<PAGE>
Asset and liability management strategies impact the one year maturity "gap,"
which is the difference between interest-earning assets and interest-bearing
liabilities maturing or repricing in one year or less. The Company's one-year
gap was a negative 36.09% of total assets at June 30, 1998, as follows:
<CAPTION>
($ In thousands)
One Year Three to More Than
Total or Less Two Years Four Years Four Years
----- ------- --------- ---------- ----------
Interest-earning assets:
Loans receivable (1) $ 68,125 $ 12,469 $ 902 $ 2,186 $ 52,569
Cash and other interest-
earning assets 6,047 6,047 - - -
-------- ---------- --------- --------- ---------
74,172 $ 18,516 $ 902 $ 2,186 $ 52,569
========= ========= ========= =========
Non-interest-earning assets:
Allowance for loan losses (1,333)
Investment in IMC 10,377
Premises and equipment, net 4,767
Other 21,067
---------
Total assets $109,050
=========
Interest-bearing liabilities:
Revolving warehouse lines $ 37,490 $ 37,490 $ - $ - $ -
FDIC-insured deposits 21,977 15,334 4,757 1,390 496
Other interest-
bearing liabilities 11,430 5,047 903 2,459 3,021
--------- --------- ------- --------- ---------
70,897 $ 57,871 $ 5,660 $ 3,849 $ 3,517
========= ========= ========= =========
Non-interest-bearing liabilities 11,207
---------
Total liabilities 82,104
Shareholders' equity 26,946
---------
Total liabilities and equity $ 109,050
=========
Maturity/repricing gap $ (39,355) $ (4,758) $ (1,663) $ 49,052
========= ========= ========== =========
Cumulative gap $ (39,355) $ (44,113) $ (45,776) $ 3,276
========= ========= ========= ==========
As percent of total assets - 36.09% - 40.45% - 41.98% 3.00%
========= ========= ========== =========
As percent of total interest earning assets - 53.06% -59.48% -61.72% 4.42%
========= ========= ========== =========
Ratio of Cumulative Interest Earning Assets to
Cumulative Interest Earning Liabilities .32x .31x .32x 1.05x
- -------------
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
<PAGE>
The Company originates fixed-rate, fixed-term mortgage loans for sale in the
secondary market. While most of these loans are expected to be sold within sixty
days of origination, for purposes of the gap table the loans are shown based on
their contractual scheduled maturities. As of June 30, 1998, 70.9% of the
principal on the loans was expected to be received more than four years from
that date. However, the Company's activities are financed with short-term loans
and credit lines, 81.6% of which reprice within one year of June 30, 1998. The
Company attempts to limit its interest rate risk by selling a majority of the
fixed-rate loans that it originates. If the Company's ability to sell such
fixed-rate, fixed-term mortgage loans on a timely basis were to be limited, the
Company could be subject to substantial interest rate risk.
Interest Rate Risk
Profitability may be directly affected by the levels of and fluctuations in
interest rates, which affect the Company's ability to earn a spread between
interest received on its loans and the costs of borrowings. The profitability of
the Company is likely to be adversely affected during any period of unexpected
or rapid changes in interest rates. For example, a substantial or sustained
increase in interest rates could adversely affect the ability of the Company to
purchase and originate loans and would reduce the value of loans held for sale.
A significant decline in interest rates could decrease the size of the Company's
loan servicing portfolio by increasing the level of loan prepayments.
Fluctuating interest rates may also affect the net interest income earned by the
Company resulting from the difference between the yield to the Company on loans
held pending sales and the interest paid by the Company for funds borrowed under
the Company's warehouse facilities.
In an environment of stable interest rates, the Company's gains on the sale of
mortgage loans would generally be limited to those gains resulting from the
yield differential between mortgage loan interest rates and rates required by
secondary market purchasers. A loss from the sale of a loan may occur if
interest rates increase between the time the Company establishes the interest
rate on a loan and the time the loan is sold. Fluctuating interest rates also
may affect the net interest income earned by the Company, resulting from the
difference between the yield to the Company on loans held pending sale and the
interest paid by the Company for funds borrowed, including the Company's
warehouse facilities and the Savings Bank's FHLB advances and FDIC-insured
customer deposits. Because of the uncertainty of future loan origination volume
and the future level of interest rates, there can be no assurance that the
Company will realize gains on the sale of financial assets in future periods.
The Savings Bank is building a portfolio of loans to be held for net interest
income. The sale of fixed rate products is intended to protect the Savings Bank
from precipitous changes in the general level of interest rates. The valuation
of adjustable rate mortgage loans is not as directly dependent on the level of
interest rates as is the value of fixed rate loans. Decisions to hold or sell
adjustable rate mortgage loans are based on the need for such loans in the
Savings Bank's portfolio, which is influenced by the level of market interest
rates and the Savings Bank's asset/liability management strategy. As with other
investments, the Savings Bank regularly monitors the appropriateness of the
level of adjustable rate mortgage loans in its portfolio and may decide from
time to time to sell such loans and reinvest the proceeds in other adjustable
rate investments.
<PAGE>
Asset Quality
The following table summarizes all of the Company's delinquent loans at June 30,
1998 and December 31, 1997:
<CAPTION>
($ in thousands) June 30, 1998 December 31, 1997
------------- -----------------
Delinquent 31 to 60 days $ 1,375 $ 866
Delinquent 61 to 90 days 1,068 1,124
Delinquent 91 to 120 days 886 970
Delinquent 121 days or more 1,600 1,567
--------- ---------
Total delinquent loans (1) $ 4,929 $ 4,527
========= =========
Total loans receivable outstanding, gross of
the allowance for loan losses (1) $ 64,068 $ 82,512
========= =========
Delinquent loans as a percentage of
total loans outstanding:
Delinquent 31 to 60 days 2.15% 1.05%
Delinquent 61 to 90 days 1.67 1.36
Delinquent 91 to 120 days 1.38 1.19
Delinquent 121 days or more 2.50 1.90
--------- ---------
Total delinquent loans as a percentage
of total loans outstanding 7.70% 5.50%
========= =========
</TABLE>
- -------------
(1) Includes loans in foreclosure and in bankruptcy, but excludes real estate
owned.
Loans delinquent 31 days or more as a percentage of total loans outstanding
increased to 7.70% at June 30, 1998 from 5.50% at December 31, 1997 primarily as
a result of an increase in the dollar amount of loans delinquent 31-60 days and
a decrease in the dollar amount of total loans outstanding. The dollar amount of
loans delinquent 31-60 days increased from $866 thousand at December 31, 1997 to
$1,375 thousand on June 30, 1998. The dollar amount of total loans outstanding
decreased because the Company sold more loans than it originated during the six
month period ended June 30, 1998.
Effective January 1, 1995, the Company adopted the provisions of SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan." The Statement was issued in
May 1993 and is effective for fiscal years beginning after December 15, 1994.
Statement 114 was amended in October 1994 by SFAS No. 118, "Accounting by
Creditors for Impairment of a Loan - Income Recognition and Disclosures."
Statement 114, as amended by SFAS 118, requires that an impaired loan be
measured based on the present value of expected future cash flows discounted at
the effective interest rate of the loan, or at the fair value of the loan's
collateral for "collateral dependent" loans. A loan is considered impaired when
it is probable that a creditor will be unable to collect all interest and
principal payments as scheduled in the loan agreement. A loan is not considered
impaired during a period of delay in payment if the ultimate collectibility of
all amounts due is expected. A valuation allowance is required to the extent
that the measure of the impaired loans is less than the recorded investment.
SFAS 114 does not apply to larger groups of homogeneous loans such as consumer
installment and real estate mortgage loans, which are collectively evaluated for
impairment. Impaired loans are therefore primarily business loans, which include
commercial loans and income property and construction real estate loans. Most of
the Company's loans are collectively evaluated for impairment. The Company's
impaired loans are nonaccrual loans, as generally loans are placed on nonaccrual
status on the earlier of the date that principal or interest amounts are 60 days
or more past due (90 days or more in the case of loans held by the Savings Bank)
or the date that collection of such amounts is judged uncertain based on an
evaluation of the net realizable value of the collateral and the financial
strength of the borrower. Nonaccrual loans were $3.5 million and $2.3 million at
June 30, 1998 and 1997, respectively. The amount of interest that would have
been recorded had these loans not been placed on nonaccrual status was
approximately $136,000 and $88,700 for the six months ended June 30, 1998 and
1997, respectively. The amount of interest income on the nonaccrual loans, that
was included in net income for the six months ended June 30, 1998 was $62,700.
The data for interest income on nonaccrual loans, that was included in net
income for the three months ended June 30, 1997 was not available.
The adoption of SFAS 114 and 118 did not result in any additional provision for
credit losses at January 1, 1995. At June 30, 1998 and December 31, 1997 the
recorded investment in loans for which impairment has been determined in
accordance with SFAS 114 totaled $2.5 million and $2.5 million, respectively.
The average recorded investment in impaired loans for the six months ended June
30, 1998 and the year ended December 31, 1997 was approximately $2.5 million and
$0.8 million, respectively.
SFAS 118 allows a creditor to use existing methods for recognizing interest
income on an impaired loan. Consistent with the Company's method for nonaccrual
loans, interest receipts for impaired loans are recognized as interest income or
are applied to principal when the ultimate collectibility of principal is in
doubt. Due to the homogenous nature and the collateral securing these loans,
there is no corresponding valuation allowance.
<PAGE>
PART II. OTHER INFORMATION
<PAGE>
Item 1. Legal Proceedings - The Company is party to various legal
proceedings arising out of the ordinary course of its business. Management
believes that none of these actions, individual or in the aggregate, will have a
material adverse effect on the results of operations or financial condition of
the Company.
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K -
(a) Exhibits:
27 Financial Data Schedule
(b) Reports on Form 8-K:
No reports on Form 8-K have been filed during the
three (3) months ending June 30, 1998.
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.
Date: ______________________ APPROVED FINANCIAL CORP.
By: /s/ Allen D. Wykle
--------------------------------
Allen D. Wykle,
Chairman, President, and Chief
Executive Officer
By: /s/ Eric S. Yeakel
--------------------------------
Eric S. Yeakel,
Its Treasurer and Chief Financial
Officer
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED FINANCIAL STATEMENTS FOR THE SIX-MONTH PERIOD ENDED JUNE 30, 1998 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-mos
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-END> Jun-30-1998
<CASH> 7,225
<INT-BEARING-DEPOSITS> 490
<FED-FUNDS-SOLD> 2,753
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 13,022
<INVESTMENTS-CARRYING> 146
<INVESTMENTS-MARKET> 146
<LOANS> 68,125
<ALLOWANCE> 1,333
<TOTAL-ASSETS> 109,050
<DEPOSITS> 21,977
<SHORT-TERM> 38,871
<LIABILITIES-OTHER> 11,207
<LONG-TERM> 10,050
0
1
<COMMON> 26,944
<OTHER-SE> 0
<TOTAL-LIABILITIES-AND-EQUITY> 109,050
<INTEREST-LOAN> 5,031
<INTEREST-INVEST> 223
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 5,254
<INTEREST-DEPOSIT> 585
<INTEREST-EXPENSE> 3,084
<INTEREST-INCOME-NET> 2,170
<LOAN-LOSSES> 720
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 19,699
<INCOME-PRETAX> 3,327
<INCOME-PRE-EXTRAORDINARY> 1,947
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,947
<EPS-PRIMARY> 0.35
<EPS-DILUTED> 0.35
<YIELD-ACTUAL> 5.04
<LOANS-NON> 3,472
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,687
<CHARGE-OFFS> 1,134
<RECOVERIES> 60
<ALLOWANCE-CLOSE> 1,333
<ALLOWANCE-DOMESTIC> 1,333
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
