SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
-
AMENDMENT NO. 2
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF
- --- 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 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 [ ] No [ X ]*.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date: 5,512,114 shares, $1.00 par
value, at April 30, 1998.
* Registration is pending, all reports that would have been required if
registered have been filed.
<PAGE>
APPROVED FINANCIAL CORP.
INDEX
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements
Consolidated Balance Sheets as of
March 31, 1998 and December 31, 1997 1
Consolidated Statements of Income
for the three months ended March 31, 1998
and March 31, 1997. 2
Consolidated Statements of Cash Flows for
the three months ended March 31, 1998
and March 31, 1997. 3
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 7
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
<PAGE>
PART I. FINANCIAL INFORMATION
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1998 AND DECEMBER 31, 1997
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
1998 1997
--------- ---------
ASSETS (Unaudited)
<S> <C> <C>
Cash $ 12,235 $ 11,869
Mortgage loans, net 72,565 80,696
Real estate owned, net 1,938 2,367
Securities, available for sale 17,173 15,201
Premises and equipment, net 4,727 4,530
Goodwill, net 3,980 775
Loan sale receivable 5,756 --
Other assets 3,078 2,687
--------- ---------
Total assets $ 121,452 $ 118,125
========= =========
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loans $ 49,793 $ 52,488
Certificates of deposit 18,614 17,815
Federal Home Loan Bank advance 1,380 1,000
Mortgage loans payable 1,196 1,216
Notes payable - related parties 6,611 6,684
Certificates of indebtedness 2,312 2,396
Loan proceeds payable 6,077 6,364
Accrued and other liabilities 4,010 2,837
Income taxes payable 819 1,161
Deferred income tax liability 2,385 1,109
--------- ---------
Total liabilities 93,197 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 7,950 6,854
Additional capital 552 0
Retained earnings 14,240 12,805
--------- ---------
Total equity 28,255 25,055
--------- ---------
Total liabilities and equity $ 121,452 $ 118,125
========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
Page 1
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME
for the three months ended March 31, 1998 and 1997 (Dollars in thousands, except
share and per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
--------- ---------
Revenue:
<S> <C> <C>
Gain on sale of loans $ 9,754 $ 7,252
Interest income 2,602 1,950
Other fees and income 1,482 788
--------- ---------
13,838 9,990
--------- ---------
Expenses:
Compensation and related 6,019 3,556
General and administrative 3,909 2,251
Interest expense 1,548 1,337
Provision for loan and foreclosed property losses (111) 281
--------- ---------
11,365 7,425
--------- ---------
Income before income taxes 2,473 2,565
Provision for income taxes 1,038 1,026
--------- ---------
Net income $ 1,435 $ 1,539
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains (loss) arising during period 1,096 (1,440)
--------- ---------
Comprehensive income $ 2,531 $ 99
========= =========
Net income per share:
Basic $ 0.26 $ 0.30
========= =========
Diluted $ 0.26 $ 0.29
========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
Page 2
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the three months ended March 31, 1998 and 1997
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
---------- ----------
Operating activities:
<S> <C> <C>
Net income $ 1,435 $ 1,539
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation of premises and equipment 180 95
Amortization of goodwill 88 4
Provision for loan losses 17 372
Provision for losses on real estate owned (127) 96
Loss on sale of real estate owned 178 149
Gain on sale of loans (9,754) (7,252)
Proceeds from sales and prepayments of loans 133,366 100,115
Loans held for sale originations (116,256) (111,070)
Real estate owned capital improvements (67) --
Changes in operating assets and liabilities:
Loan sale receivable (5,756) (16,263)
Other assets (393) 294
Accrued and other liabilities 884 (1,745)
Income taxes payable (342) (269)
Deferred income taxes 541 (2,110)
---------- ----------
Net cash provided by (used in) operating activities 3,994 (36,045)
Investing activities:
Purchases of premises and equipment (390) (405)
Goodwill (3,293) --
Sales of premises and equipment 13 --
Sales of real estate owned 1,181 472
Recoveries on loans charged off 23 97
Purchases of ARM fund shares (51) --
Purchases of FHLB stock (96) --
---------- ----------
Net cash provided by (used in) investing activities (2,613) 164
</TABLE>
Page 3
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
for the three months ended March 31, 1998 and 1997
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
---------- ----------
Financing activities:
<S> <C> <C>
Proceeds from revolving warehouse loans $ 98,257 $ 123,503
Principal payments on revolving warehouse loans (100,952) (87,366)
Proceeds from FHLB advances 380 --
Principal payments on mortgage loans payable (20) (12)
Net increase (decrease) in:
Notes payable - related parties (73) 298
Certificates of indebtedness (83) (10)
Certificates of deposit 799 200
Issuance of common stock 677 --
Exercise of common stock warrants -- 68
---------- ----------
Net cash provided by (used in) financing activities (1,015) 36,681
---------- ----------
Net increase in cash 366 800
Cash at beginning of period 11,869 3,440
---------- ----------
Cash at end of period $ 12,235 $ 4,240
========== ==========
Supplemental cash flow information:
Cash paid for interest $ 1,553 $ 1,097
Cash paid for income taxes 834 817
Supplemental non-cash information:
Loan balances transferred to real estate owned $ 736 $ 999
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
Page 4
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the three months ended March 31, 1998 and 1997 (Unaudited)
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
ORGANIZATION: Approved Financial Corp., a Virginia corporation ("Approved"), and
its subsidiaries (collectively, 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") had broker operations in eleven states and 26 retail
offices in eleven states for the period ended March 31, 1998. Approved Federal
Savings Bank (the "Savings Bank") is a federally chartered thrift institution.
The Savings Bank 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 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," was issued, effective for fiscal years beginning after
December 15, 1997. 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 months ended March 31, 1998 and 1997 is an unrealized
holding gain 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 allocate resources to segments. The Company is
currently evaluating the effect this statement will have on the financial
statements.
Page 5
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the three months ended March 31, 1998 and 1997 (Unaudited)
NOTE 4. ACQUISITION:
Effective January 26, 1998, ARMI purchased substantially all of the assets of
Funding Center of Georgia, Inc. ("FCGA"), a Georgia corporation. FCGA originated
$12,278,000 in mortgage loans from the acquisition date through March 31, 1998.
All of the employees of FCGA have become employees of ARMI, and the business
will be 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 will manage the office. 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 6
<PAGE>
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 months ended March 31, 1998 and 1997 and its
consolidated financial position at March 31, 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, competitive forces, 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 and 10-K 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 MONTHS ENDED MARCH 31, 1998 AND 1997
NET INCOME. The Company's net income for the three months ended March 31,
1998 was $1,435,000 compared to net income of $1,539,000 for the same period in
1997. On a per share basis (diluted), income for the three months ended March
31, 1998 was $0.26, compared to $0.29 for the same period in 1997.
The per-share figures have been adjusted to reflect a 100% stock dividend
of the Company's common stock, which occurred 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 months ended March 31, 1998 and 1997:
(Dollars in thousands) Three Months Ended
March 31, 1998 1998 1997
- ----------------------------------------- --------- ---------
Dollar Volume of Loan Originations:
Broker $ 49,295 $ 63,821
Retail 59,529 47,156
--------- ---------
Total $ 108,824 $ 110,977
========= =========
Number of Loans Originated:
Broker 905 1,038
Retail 1,122 869
--------- ---------
Total 2,027 1,907
========= =========
The Company also brokers loans to various other lenders when loans do not meet
the Company's underwriting guidelines. For the three months ended March 31,
1998, the Company brokered $15 million in loans. No records on brokered loan
volume were kept for the three months ended March 31, 1997. (See Item 2 section
"Other Income" for discussion on brokered loan fees)
Page 7
<PAGE>
The following tables summarize mortgage loan originations, by state, for the
three months ended March 31, 1998 and 1997:
(In thousands)
Periods Ended
March 31, 1998 1997
- --------- --------------------- ---------------------
Dollars Percent Dollars Percent
---------- ------- ---------- -------
Broker Division:
Florida $ 13,907 12.8% $ 12,675 11.4%
Georgia 9,479 8.7 15,404 13.9
Ohio 6,951 6.4 4,160 3.7
Maryland 6,477 6.0 6,470 5.8
North Carolina 5,666 5.2 7,604 6.9
South Carolina 3,187 2.9 2,535 2.2
Virginia 1,580 1.5 2,527 2.3
Tennessee 750 0.7 424 0.4
Illinois 659 0.6 5,754 5.2
Michigan 567 0.5 2,472 2.2
Indiana 72 0.1 3,796 3.4
---------- ------ ---------- ------
Total Broker Division $ 49,295 45.4% $ 63,821 57.4%
========== ====== ========== ======
Retail Division:
Maryland $ 16,024 14.7% $ 15,793 14.2%
North Carolina 12,213 11.2 7,842 7.1
Virginia 9,458 8.7 6,958 6.3
Georgia 5,781 5.3 7,175 6.5
Ohio 4,686 4.3 2,401 2.2
South Carolina 4,358 4.0 1,981 1.8
Delaware 2,869 2.6 4,735 4.3
Kentucky 2,633 2.4 -- --
Florida 965 0.9 0 0
Indiana 542 0.5 -- --
Illinois -- -- 271 0.2
---------- ------ ---------- ------
Total Retail Division $ 59,529 54.6% $ 47,156 42.6%
========== ====== ========== ======
Total originations:
Maryland $ 22,501 20.7% $ 22,263 20.1%
North Carolina 17,879 16.5 15,446 14.0
Georgia 15,260 14.0 22,579 20.3
Florida 14,872 13.7 12,675 11.4
Ohio 11,637 10.7 6,561 5.9
Virginia 11,038 10.1 9,485 8.5
South Carolina 7,545 6.9 4,516 4.1
Delaware 2,869 2.6 4,735 4.3
Kentucky 2,633 2.4 -- --
Tennessee 750 0.7 424 0.4
Illinois 659 0.6 6,025 5.4
Indiana 614 0.6 3,796 3.4
Michigan 567 0.5 2,472 2.2
---------- ------ ---------- ------
Total originations $ 108,824 100.0% $ 110,977 100.0%
========== ====== ========== ======
The decrease in the dollar volume of loan originations of 1.9% during the
first three months of 1998 compared to the same period of a year ago, reflects
an increase in competition for non-conforming mortgages.
Page 8
<PAGE>
GAIN ON SALE OF LOANS. The largest component of the Company's net income is
the gain from the sale of mortgage loans, which is the premium paid by investors
to purchase the loans and the origination fees and points received at the time
of origination on those 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 mortgage and finance companies. The
loans are sold for cash as whole loans on a servicing-released basis. Consistent
with industry practices, the loans are sold with certain representations and
warranties. By originating loans for subsequent sale in the secondary mortgage
market, the Company is able to obtain funds which may be used for lending and
investment purposes. Gains from the sale of mortgage 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.
The Company sold $114,626,000 of mortgage loans during the first three
months of 1998, compared to $90,420,000 for the same period one year earlier.
Sales volume increased by 26.8%.
Gain on the sale of loans was $9,754,000, for the three months ended March
31, 1998, which compares with $7,252,000 for the same period in 1997. The
period-to-period increase in the gain on loan sales was the direct result of the
increase in the volume of loans sold. Gain on the sale of mortgage loans
represented 70.5% of total revenue during the first three months of 1998,
compared to 72.6% of total revenue for the same period in 1997.
The weighted-average premium realized by the Company on its loan sales
decreased to 6.16% during the first three months of 1998, from 6.80% for the
same period in 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 when the loans are sold.
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 months-ended March 31,1998
was $2,983,000, compared to $2,072,000 for the same period in 1997. The increase
of 44.0% is the result of the Company originating and selling more loans
generated by the retail lending division. The Company's retail originations
increased by $12,373,000, or 26.2% during the first three months of 1998,
compared with the same period in 1997. The Company's retail loan sales during
the first three months of 1998 comprised 55% of total loan sales, with average
loan origination fee income earned of 4.5%. For the same period in 1997, the
Company's retail loan sales were 42.4% of total loan sales with an average loan
fee income earned of 5.4%. Total recapture premium and fees associated with
selling loans represented approximately 20 basis points of loans sold for the
three months ended March 31, 1998 and 1997.
A substantial portion of the Company's loan sales during the three-month
period ended March 31, 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 March 31, 1998.
The Company sold IMC 918 loans totaling $56,063,000 for the three months ended
March 31, 1998, compared to 823 loans totaling $57,939,000 for the same period
ended in 1997. The loans sold to IMC represented 49% and 64% of the dollar
volume of the Company's loan sales for the three months ended March 31, 1998 and
1997 respectively. The Company's Chairman and Chief Executive Officer, Allen D.
Wykle, is a member of IMC's Board of Directors. Also, Jean S. Schwindt, a member
of the Company's Board of Directors and Executive Committee, is an officer of
IMC.
Page 9
<PAGE>
INTEREST INCOME AND EXPENSE. Interest income for the three months ended
March 31, 1998 was $2,602,000, compared with $1,950,000 for the same period
ended in 1997. The 33.4% increase in interest income for the three months ended
March 31, 1998 was primarily due to a higher average balance of loans held for
sale. The average holding period for mortgage loans in inventory remained
consistent for the periods ended March 31, 1998 and 1997.
Interest expense for the three months ended March 31, 1998 was $1,548,000
compared with $1,337,000 for the same period ended in 1997. The period-to-period
increases in interest expense was the direct result of increased borrowings
under the Company's warehouse lines of credit, which were used to fund the
higher average balance of loans held for sale.
The Company's net interest income for the three months ended March 31, 1998
was $1,053,000, compared to $613,000 for the same period ended in 1997. Net
interest income increased by $440,000 or 71.7% for the three months ended March
31, 1998, compared to the same period ended in 1997.
The Company's net earnings are dependent on the difference, or "spread,"
between the income it receives from its loan and investment portfolios and its
cost of funds, consisting principally of the interest paid on the revolving
warehouse loans and other borrowings and the Savings Bank's deposit accounts.
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. However, interest
received on short-term investments and adjustable rate mortgage loans also
increase as a result of upward trends in short-term interest rates, which
enables the Company to partially compensate for increased borrowing and deposit
costs.
Page 10
<PAGE>
The following tables reflect the average yields earned and rates paid by
the Company during the three months ended March 31, 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.
(In thousands)
<TABLE>
<CAPTION>
March 31, 1998 March 31, 1997
------------------- -----------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Interest-earning assets:
<S> <C> <C> <C> <C> <C> <C> <C>
Loans receivable (1) $ 79,378 $ 2,487 12.71% $63,207 $1,909 12.25%
Cash and other interest-
earning assets 7,612 115 6.13 3,107 41 5.35
--------- -------- ----- ------- ------ -----
86,990 2,602 12.13% 66,314 1,950 11.93%
-------- ----- ------ -----
Non-interest-earning assets:
Allowance for loan losses (1,629) (1,181)
Investment in IMC 12,012 19,496
Premises and equipment, net 4,636 2,249
Other 17,926 5,623
--------- --------
Total assets $ 119,935 $ 92,501
========= ========
Interest-bearing liabilities:
Revolving warehouse lines $ 54,350 1,003 7.48% $53,112 1,079 8.24
FDIC-insured deposits 18,979 285 6.09% 1,726 24 5.64
Other interest-bearing
liabilities 11,270 260 9.36% 11,640 234 8.15
--------- -------- ----- ------- ------ -----
84,599 1,548 7.42% 66,478 1,337 8.16
-------- ----- ------ -----
Non-interest-bearing liabilities 8,963 1,281
--------- --------
Total liabilities 93,562 67,759
Shareholders' equity 26,373 24,742
--------- --------
Total liabilities and equity $ 119,935 $ 92,501
========= ========
Average dollar difference between
interest-earning assets and interest-
bearing liabilities $ 2,391 $ (164)
========= ========
Net interest income $ 1,054 $ 613
========= ======
Interest rate spread (2) 4.71% 3.77%
===== =====
Net annualized yield on average
interest-earning assets 4.91% 3.75%
===== =====
</TABLE>
- --------------------------------------------------------------------------------
(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 11
<PAGE>
The following table shows the amounts of the changes in interest income and
expense which can be attributed to rate (change in rate multiplied by old
volume) and volume (change in volume multiplied by old rate) for 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 $441,000
increase in net interest income for the three months ended March 31, 1998 and
1997 was the net result of a growing balance sheet positively affected by lower
rates on borrowed funds.
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
March 31, 1998 March 31, 1997
Compared to Compared to
March 31, 1997 March 31, 1996
-------------------------- --------------------------
Increase (Decrease) due to Increase (Decrease) due to
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
Interest-Earning Assets:
<S> <C> <C> <C> <C> <C> <C>
Loan Receivable $ 504 $ 74 $ 578 $ 913 $(122) $ 791
Cash and Other Interest-
Earning Assets 67 7 74 38 0 38
----- ----- ----- ----- ----- -----
571 81 652 951 (122) 829
----- ----- ----- ----- ----- -----
Interest-Bearing Liabilities:
Revolving Warehouse Lines 26 (102) (76) 598 (54) 544
FDIC-Insured Deposits 259 2 261 24 0 24
Other Interest-
Bearing Assets (7) 33 26 95 (10) 85
----- ----- ----- ----- ----- -----
278 (67) 211 717 (64) 653
----- ----- ----- ----- ----- -----
Net Interest Income $ 293 $ 148 $ 441 $ 234 $ (58) $ 176
===== ===== ===== ===== ===== =====
</TABLE>
OTHER INCOME. In addition to interest on the loan portfolio and gains from the
sale of loans, the Company derives income from fees on loans originated by the
Company's retail offices acting in a broker capacity through other lenders,
"brokered loan fees". Also, the Company obtains income from other fees charged
to the borrowers such as document preparation fees, underwriting service fees,
prepayment penalties, and late charge fees for delinquent loan payments. For the
three months ended March 31, 1998, other income totaled $1,483,000, compared to
$788,000 for the same period in 1997. The increase of $695,000, for the three
months ended March 31, 1998 was primarily the result of increases in brokered
loan fees. Brokered loan fees increased by $624,000 to $701,000 for the three
months ended March 31, 1998, from $77,000 for the three months ended March 31,
1997. 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 gains on securities. The largest component of securities is
the companies stock holdings in IMC mortgage company (See Item 2 section
"Assets"). For the three months ended March 31, 1998, comprehensive income was
$1,096,000 compared to a comprehensive loss of $1,440,000 for the three months
ended March 31, 1997. The gain for the three months ended March 31, 1998 was
related to an increase in the market price of IMC stock from December 31, 1997
to March 31, 1998. The loss for the three months ended March 31, 1997 was
related to a decrease in the Market price of the IMC stock from December 31,
1996 to March 31, 1997.
Page 12
<PAGE>
COMPENSATION EXPENSES. The largest component of expenses is compensation
expense. Compensation expense for the three months ended March 31, 1998
increased by $2,463,000 to $6,018,000. The increase of 105.2% for the three
months ended March 31, 1998 was directly attributable to the addition of new
employees. The Company had 599 full-time equivalent employees at March 31, 1998,
(496 full time and 206 part-time). This compares to 360 full time equivalents at
March 31, 1997 (318 full time and 84 part time). The Company's corporate office
staff increased by 102.8% for the period ended March 31, 1998, with a
corresponding increase in quarterly base salaries of approximately $870,000. 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 eight additional retail lending offices for the period ending
March 31, 1998, compared to the same period in 1997, which increased the retail
lending staff by 102.4%. This resulted in a quarterly base salary increase in
the retail division of approximately $1,500,000.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
for the period ended March 31, 1998 increased by $1,658,000 to $3,909,000,
compared to the same period in 1997. The Company had eight additional retail
lending offices for the period ending March 31, 1998 compared to the same period
in 1997, with increases of general and administrative expenses associated with
the new retail offices of approximately $600,000 for the three months ended
March 31, 1998. General and administrative expenses related to the Company's
corporate office increased by approximately $600,000, as the Company increased
corporate expenditures to support the anticipated increased loan volume.
The broker division pays fees to brokers for services rendered in the
preparation of loan packages. The total expense associated with those fees was
$445,000 for the three months ended March 31, 1998. These fees were not paid for
the three months ended March 31, 1997.
PROVISION FOR LOAN LOSSES. The Company added $17,000 during the three
months ended March 31, 1998 to the allowance for loan losses, compared to
$349,000 for the same period ended in 1997.
The following table presents the activity in the Company's allowance for
loan losses and selected loan loss data for the three months ended March 31,
1998 and the year ended December 31, 1997
(In thousands):
1998 1997
-------- --------
Balance at beginning of period $ 1,687 $ 924
Provision charged to expense 17 1,534
Loans charged off (198) (953)
Recoveries of loans previously charged off 23 182
-------- --------
Balance at end of period $ 1,529 $ 1,687
======== ========
Loans receivable at period-end, gross
of allowance for losses $ 74,094 $ 83,512
Ratio of allowance for loan losses to gross
loans receivable at period-end 2.06% 2.02%
Page 13
<PAGE>
The company maintains a reserve for loan losses of approximately 2% of the
outstanding gross loans receivable balance. The decrease in the allowance for
loan losses relates to a decrease in the balance of gross loans receivable at
March 31, 1998, when compared to the balance at December 31, 1997. All
charge-offs and recoveries related to mortgage loans, and writedowns of
foreclosed properties to appraised value at the time of repossession are
recorded in the allowance for mortgage loan losses.
The Company's management evaluates the allowance requirements by examining
current delinquencies, the characteristics of the accounts, the value of the
underlying collateral, loan covenants and general economic conditions and
trends. While management believes that its present allowance for loan losses is
adequate, future adjustments may be necessary.
PROVISION FOR FORECLOSED PROPERTY LOSSES. The Company reduced its provision
for foreclosed property losses by $127,000 for the three months ended March 31,
1998, compared to a reduction of $68,000 for the three months ended March 31,
1997.
Sales of real estate owned yielded net losses of $269,000 for the three
months ended March 31, 1998 versus $149,000 for the three months ended March 31,
1997.
The following table presents the activity in the Company's allowance for
foreclosed property losses and selected real estate owned data for the three
months ended March 31, 1998 and the year ended December 31, 1997 (In thousands):
1998 1997
------- -------
Balance at beginning of period $ 671 $ 529
Provision charged to expense (127) 142
------- -------
Balance at end of period $ 544 $ 671
======= =======
Real estate owned at period-end, gross
of allowance for losses $ 2,482 $ 3,038
Ratio of allowance for REO losses
to gross real estate owned at period-end 21.92% 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 decrease in the provision for foreclosed
property losses relates to a decrease in the amount of outstanding REO's at
March 31, 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 months ended March 31, 1998
was $1,038,000, resulting in an effective tax rate of 42.0%. By comparison, the
Company had income tax expense of $1,026,000 for an effective tax rate of 40.0%
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 14
<PAGE>
FINANCIAL CONDITION AT MARCH 31, 1998 AND DECEMBER 31, 1997
ASSETS. The total assets of the Company were $121,452,000 at March 31,
1998, compared to total assets of $118,125,000 at December 31, 1997.
The primary uses of funds by the Company, is funding of loan originations
and the expenses associated with loan production. Net mortgage loans receivable
decreased by $8,132,000 to $72,565,000 at March 31, 1998. The 10.1% decline was
the result of the Company selling more loans than were originated during the
first quarter of 1998. The Company generally sells loans within sixty days after
origination.
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
positive 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 in the
near term 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 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 IMC Partnership to
corporate form, the Company's investment in IMC is accounted for as an equity
security under SFAS No. 115 and is carried at the market value of the stock. The
market value of this stock was $13,414,390 at March 31, 1998 and $11,585,000 at
December 31, 1997.
Other securities are comprised of the Savings Bank's ARM Fund and FHLB
Stock. These investments increased $143,000 to $3,760,000 at March 31, 1998.
Cash and cash equivalents increased by $365,000 to $12,235,000 at March 31,
1998. The principal reason for the increase for the period ending March 31, 1998
was the receipt of proceeds from loan sales in the final week of March 1998.
These proceeds were used to fund new loans in the first week of April 1998.
Premises and equipment increased by $198,000 to $4,727,000 at March 31,
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.
Real estate owned decreased by $429,000 to $1,938,000 at March 31, 1998.
The decrease was the result of increased REO sales.
Goodwill increased $3,205,000 to $3,980,000 at March 31, 1998. The increase
is a result of the Company's purchase of the Funding Center of Georgia, which
resulted in Goodwill of $3,293,000.
At March 31, 1998, the Company finalized a loan sale with an investor for
$5,756,000. The funds were not received until April 1998; therefore, creating a
loan sale receivable.
Other assets increased by $392,000 to $3,078,000 at March 31, 1998. The
1998 increase is primarily the result of an increase in prepaid expenses.
Page 15
<PAGE>
LIABILITIES. Revolving warehouse loans decreased by $2,694,000 to
$49,793,000 at March 31, 1998. The 5.1% decrease in 1998 was primarily
attributable to the decrease in loans receivable.
The Company draws on its revolving warehouse lines of credit as needed to
fund loan production. As of March 31, 1998, the Company had issued loan funding
checks totaling $6,076,586 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
April 1998 and most were funded with cash on hand or new warehouse line draws.
The Savings Bank's deposits totaled $18,614,000 at March 31, 1998, compared
to $17,815,000 at December 31, 1997. The Savings Bank increased its deposits in
1998 in order to fund loans. Of the certificate accounts as of March 31, 1998, a
total of $13,856,000 was scheduled to mature in the next twelve-months.
The Savings Bank increased its borrowings from the FHLB from $380,000 to
$1,380,000, and this amount was outstanding at March 31, 1998. The Savings Bank
held $146,000 of FHLB stock at March 31, 1998. Management expects to utilize
FHLB advances as the Savings Bank builds a portfolio of loans.
Mortgage loans payable decreased by $20,000 to $1,196,000 at March 31,
1998. The decrease was the result of principal payments in the amount of
$20,000. The mortgage debt is for the Company's executive and administrative
offices. The weighted-average rate of the mortgage loans at March 31, 1998 was
8.40%.
Promissory notes and certificates of indebtedness totaled $8,924,000 at
March 31, 1998, compared to $9,080,000 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. The promissory notes are loans from insiders (shareholders, directors
and employees) for periods of one to five years and interest rates between 8.00%
and 10.25%. The certificates of indebtedness are uninsured deposits authorized
for financial institutions like the Company which have Virginia industrial loan
association charters. The certificates of indebtedness are loans from Virginia
residents for periods of one to five years and interest rates between 6.75% and
10.00%. The Company is not currently soliciting new promissory notes or
certificates of indebtedness.
Accrued and other liabilities increased by $1,172,000 to $4,010,000 at
March 31, 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 $2,678,000 at March
31, 1998.
SHAREHOLDERS' EQUITY. Total shareholders' equity at March 31, 1998 was
$28,255,000, compared to $25,055,000 at December 31, 1997. The $3,200,000
increase in 1998 was primarily due to net income of $1,435,000 and the increase
of $1,096,000 in the accumulated other comprehensive income. The increase in the
accumulated other comprehensive income relates to an increase in the market
value of the company's stock holding in IMC Mortgage Company.
Also common stock and additional paid in capital increased by $669,000 with
the issuance of stock in exchange for the remaining 17% interest in Armada
Residential Mortgage, L. L. C.
Page 16
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES. The Company's operations require access to
short- and long-term sources of cash. The Company uses cash flow 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 was provided cash from operating activities of
$3,994,000 for the three months ended March 31, 1998; and, the Company used cash
from operating activities of $36,045,000 for the three months ended March 31,
1997. The net cash used from operating activities was 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
three months ended March 31, 1998 and 1997, the Company used cash from financing
activities of $1,015,000 and received cash from financing activities of
$36,680,000 for the three months ended March 31, 1997.
The Company's borrowings, revolving warehouse loans, FDIC-insured deposits,
mortgage loans on Company office buildings, FHLB advances, subordinated debt and
loan proceeds payable, at March 31, 1998 were 70.8% of assets at March 31, 1998,
compared to 74.5% of assets at December 31, 1997.
WAREHOUSE AND OTHER CREDIT FACILITIES. The Company has a $100,000,000
warehouse line of credit from a commercial bank syndicate. The syndicate's lead
bank is 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 March 31, 1998, $41,782,000 was outstanding
under this facility.
The Company also has a $25,000,000 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 March 31, 1998,
$8,011,000 was outstanding under this facility.
WHOLE LOAN SALE PROGRAM. The Company's most important capital resource for
generating cash to fund new loans and for making payments on its warehouse
facilities has been its ability to sell its loans in the secondary market. The
market value of the Company's loans is dependent on a number of factors,
including 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 $18,614,000 at
March 31, 1998, compared to $17,815,000 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.
Page 17
<PAGE>
The Company has utilized promissory notes and certificates of indebtedness
to help funds its operations. Promissory notes and certificates of indebtedness
totaled $8,924,000 at March 31, 1998, compared to $9,080,000 at December 31,
1997. These borrowings are subordinated to the Company's warehouse lines of
credit. The Company is not currently soliciting new promissory notes or
certificates of indebtedness.
The Company had cash and cash equivalents of $12,235,000 at March 31, 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 1998, 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 competition and rising
delinquencies may challenge the Company and the industry.
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.
SAVINGS BANK REGULATORY CAPITAL. At March 31, 1998, the Savings Bank's
book value under generally accepted accounting principles ("GAAP") was
$3,531,000. 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 March
31, 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:
<TABLE>
<CAPTION>
Tangible Core Risk-Based
(In thousands) Capital Capital Capital
------- ------- -------
<S> <C> <C> <C>
GAAP capital $ 3,531 $ 3,531 $ 3,531
Add: unrealized loss on securities 3 3 3
Nonallowable asset: goodwill (127) (127) (127)
Additional capital item: general allowance -- -- 116
------- ------- -------
Regulatory capital - computed 3,407 3,407 3,523
Minimum capital requirement 356 949 1,451
------- ------- -------
Excess regulatory capital $ 3,051 $ 2,458 $ 2,072
======= ======= =======
Ratios:
Regulatory capital - computed 14.35% 14.35% 19.43%
Minimum capital requirement 1.50 4.00 8.00
------- ------- -------
Excess regulatory capital 12.85% 10.35% 11.43%
======= ======= =======
</TABLE>
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.
Page 18
<PAGE>
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 try 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 March 31, 1998.
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.
Profitability may be directly affected by the level and fluctuation of
interest rates, which affect the Company's ability to earn a spread between
interest received on its loans and the costs of its borrowings. The
profitability of the Company is likely to be adversely affected during any
period of unexpected or rapid changes in interest rates. A substantial and
sustained increase in interest rates could adversely affect the ability of the
Company to originate and purchase loans and affect the mix of first and junior
lien mortgage loan products. Generally, first mortgage production increases
relative to junior lien mortgage production in response to low interest rates
and junior lien mortgage loan production increases relative to first mortgage
loan production during periods of high interest rates. A significant decline in
interest rates could decrease the size of the Company's future loan servicing
portfolio by increasing the level of loan prepayments. Additionally, to the
extent servicing rights and interest-only and residual classes of certificates
are capitalized on the Company's books from future loan sales through
securitization, higher than anticipated rates of loan prepayments or losses
could require the Company to write down the value of such servicing rights and
interest-only and residual certificates, adversely affecting earnings.
Conversely, lower than anticipated rates of loan prepayments or lower losses
could allow the Company to increase the value of interest-only and residual
certificates, which could have a favorable effect on the Company's results of
operations and financial condition. 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.
Page 19
<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 strategies in an attempt to limit its exposure to interest
rate risk in addition to generating cash revenues. The Company sold
approximately 90% and 88% of the total loans originated during the years ended
December 31,1996 and 1997, respectively, and expects to sell the majority of its
loan originations during the same twelve month period in which they are funded
by the Company in future periods. As a result, loans are held on average for
less than 12 months in the Company's portfolio of Loans Held for Sale. The "gap
position", defined as the difference between interest-earning assets and
interest-bearing liabilities maturing or repricing in one year or less, was
negative at March 31, 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 50.23% of total assets at
March 31, 1998, as illustrated in the following table:
Page 20
<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 50.23% of total assets at March 31, 1998,
as follows:
(In thousands)
<TABLE>
<CAPTION>
One Year Three to More Than
Total or Less Two Years Four Years Four Years
----- ------- --------- ---------- ----------
Interest-earning assets:
<S> <C> <C> <C> <C> <C>
Loans receivable (1) $ 74,093 $ 1,317 $ 779 $ 1,908 $ 70,088
Cash and other interest-
earning assets 7,565 7,565 -- -- --
--------- --------- --------- --------- ---------
81,658 $ 8,882 $ 779 $ 1,908 $ 70,088
========= ========= ========= =========
Non-interest-earning assets:
Allowance for loan losses (1,529)
Investment in IMC 13,414
Premises and equipment, net 4,727
Other 23,182
---------
Total assets $ 121,452
=========
Interest-bearing liabilities:
Revolving warehouse lines $ 49,793 $ 49,793 $ -- $ -- $ --
FDIC-insured deposits 18,614 13,856 3,963 795 --
Other interest-
bearing liabilities 11,500 6,234 1,561 2,241 1,464
--------- --------- --------- --------- ---------
79,907 $ 69,883 $ 5,524 $ 3,036 $ 1,464
========= ========= ========= =========
Non-interest-bearing liabilities 13,290
---------
Total liabilities 93,197
Shareholders' equity 28,255
---------
Total liabilities and equity $ 121,452
=========
Maturity/repricing gap $ (61,001) $ (4,745) $ (1,128) $ 68,624
========= ========= ========= =========
Cumulative gap $ (61,001) $ (65,746) $ (66,874) $ 1,750
========= ========= ========= =========
As percent of total assets - 50.23% - 54.13% - 55.06% 1.44%
========= ========= ========= =========
As percent of total interest earning assets - 74.70% - 80.51% - 81.90% 2.14%
========= ========= ========= =========
Ratio of Cumulative Interest Earning Assets to
Cumulative Interest Earning Liabilities .13x .14x .63x 48x
========= ========= ========= =========
</TABLE>
=============
Loans shown gross of allowance for loan losses, net of premiums/discounts
Page 21
<PAGE>
The Company originates fixed-rate, fixed-term mortgage loans for sale in
the secondary market. While most of these loans are sold within a month or two
of origination, for purposes of the gap table the loans are shown based on their
contractual scheduled maturities. As of March 31, 1998, 86.0% 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, 84.4% of which reprice within one year of March 31, 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.
Additionally, to the extent mortgage loan servicing rights in future periods
have been capitalized on the books of the Company, higher than anticipated rates
of loan prepayments or losses could require the Company to write down the value
of these assets, adversely affecting earnings.
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 product 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 22
<PAGE>
ASSET QUALITY
The following table summarizes all of the Company's delinquent loans at
March 31, 1998 and December 31, 1997:
(in thousands) March 31, 1998 December 31, 1997
-------------- -----------------
Delinquent 31 to 60 days $ 2,418 $ 866
Delinquent 61 to 90 days 1,304 1,124
Delinquent 91 to 120 days 779 970
Delinquent 121 days or more 2,270 1,567
-------- --------
Total delinquent loans (1) $ 6,771 $ 4,527
======== ========
Total loans receivable outstanding, gross of
the allowance for loan losses (1) $ 74,094 $ 82,383
======== ========
Delinquent loans as a percentage of
total loans outstanding:
Delinquent 31 to 60 days 3.26% 1.05%
Delinquent 61 to 90 days 1.76 1.36
Delinquent 91 to 120 days 1.05 1.19
Delinquent 121 days or more 3.06 1.90
-------- --------
Total delinquent loans as a percentage
of total loans outstanding 9.13% 5.50%
======== ========
=============
(1) Includes loans in foreclosure proceedings and delinquent loans to borrowers
in bankruptcy proceedings, but excludes real estate owned.
Loans delinquent 31 days as a percentage of total loans outstanding
increased to 9.13% at March 31, 1998 from 5.50% at December 31, 1998 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 $866,000 at December 31,
1997 to $2,418,000 on March 31, 1998 as a result of normal seasonal factors
related to an increase in current payment liabilities of many customers due to
holiday credit charges. The dollar amount of total loans outstanding decreased
because the Company sold more loans than it originated during the quarter.
Page 23
<PAGE>
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 loan 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 $4,352,000 and
$716,000 at March 31, 1998 and 1997, respectively. The amount of interest that
would have been recorded had these loans not been placed on nonaccrual status
was approximately $131,000 and $21,000 for the three months ended March 31, 1998
and 1997, respectively. The amount of interest income on the nonaccrual loans,
that was included in net income for the three months ended March 31, 1998 was
$13,000. The data for interest income on nonaccrual loans, that was included in
net income for the three months ended March 31, 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 March 31, 1998 and December 31, 1997
the recorded investment in loans for which impairment has been determined in
accordance with SFAS 114 totaled $3,049,000 and $2,500,000 respectively. The
average recorded investment in impaired loans for the years ended March 31, 1998
and December 31, 1997 was approximately $2,424,000 and $780,000, 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 24
<PAGE>
PART II. OTHER INFORMATION
<PAGE>
PART II. OTHER INFORMATION
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 March 31, 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: ________________________________
Allen Wykle,
President and Chairman of the Board
By: ________________________________
Eric S. Yeakel,
Its Treasurer and
Chief Financial Officer
Page 25
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED FINANCIAL STATEMENTS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 1998
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 10,294
<INT-BEARING-DEPOSITS> 350
<FED-FUNDS-SOLD> 1,591
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 17,027
<INVESTMENTS-CARRYING> 146
<INVESTMENTS-MARKET> 146
<LOANS> 74,094
<ALLOWANCE> 1,529
<TOTAL-ASSETS> 121,452
<DEPOSITS> 18,614
<SHORT-TERM> 56,026
<LIABILITIES-OTHER> 13,291
<LONG-TERM> 5,266
0
1
<COMMON> 28,254
<OTHER-SE> 0
<TOTAL-LIABILITIES-AND-EQUITY> 121,452
<INTEREST-LOAN> 2,487
<INTEREST-INVEST> 115
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 2,604
<INTEREST-DEPOSIT> 285
<INTEREST-EXPENSE> 1,548
<INTEREST-INCOME-NET> 1,054
<LOAN-LOSSES> 17
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 9,928
<INCOME-PRETAX> 2,473
<INCOME-PRE-EXTRAORDINARY> 1,435
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,435
<EPS-PRIMARY> .26
<EPS-DILUTED> .26
<YIELD-ACTUAL> 4.91
<LOANS-NON> 6,771
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,687
<CHARGE-OFFS> 198
<RECOVERIES> 23
<ALLOWANCE-CLOSE> 1,529
<ALLOWANCE-DOMESTIC> 1,529
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
