Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT
Pursuant to Section 13 or 15(D)
of the Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 1997
Commission File Number 000-23775
Approved Financial Corp.
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(Exact Name of Registrant as Specified in its Charter)
Virginia 52-0792752
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
3420 Holland Road, Suite 107, Virginia Beach, Virginia 23452
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(Address of Principal Executive Office) (Zip Code)
757-430-1400 or 800-486-5237
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(Registrant's Telephone Number, Including Area Code)
Securities to be Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Resistered
Common, $1.00 par value per share OTC Bulletin Board
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Securities to be Registered Pursuant to Section 12(g) of the Act:
None
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant is
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [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 at March 15,
1998.
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Approved Financial Corp.
Annual Report on Form 10-K
For the Fiscal Year Ended December 31, 1997
INFORMATION REQUIRED IN ANNUAL REPORT
TABLE OF CONTENTS
PART I
Item 1. Business.
General .............................................................6
Business Strategy .............................................................8
Purchase of the Assets of Funding Center of Georgia, Inc......................11
The Company's Borrowers and its Loan Products.................................12
Underwriting Guidelines.......................................................15
Mortgage Loan Servicing.......................................................19
Marketing ............................................................21
Company's Sources of Funds and Liquidity......................................22
Savings Bank's Sources of Funds...............................................23
Taxation ............................................................26
Employees ............................................................27
Service Marks ............................................................27
Effect of Adverse Economic Conditions.........................................27
Reliance on IMC Mortgage Company..............................................28
Concentration of Operations in Seven States...................................28
Asset/Liability Management....................................................28
Interest Rate Risk............................................................29
Asset Quality ............................................................30
Future Risks Associated with Loan Sales through Securitizations...............31
Liquidity - Negative Cash Flow................................................32
Year 2000 Issues ............................................................32
Contingent Risks ............................................................32
Competition ............................................................33
Regulation ............................................................34
OTS Regulation of the Company.................................................36
Regulation of the Savings Bank................................................38
Legislative Risk ............................................................46
Environmental Factors.........................................................46
Dependence on Key Personnel...................................................47
Control by Certain Shareholders...............................................47
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Item 2. Properties.
Properties ............................................................48
Item 3. Legal Proceedings.
Legal Proceedings ............................................................48
Item 4. Submission of Matters to a Vote of Security Holders.
Submission of Matters to a Vote of Security Holders...........................48
PART II
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters.
Market Price of and Cash Dividends on Company's Common Equity.................49
Absence of Active Public Trading Market and Volatility of Stock Price.........50
Transfer Agent and Registrar..................................................50
Recent Sales of Unregistered Securities.......................................50
Item 6. Selected Financial Data.
Selected Financial Data.......................................................52
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations
General ............................................................55
Results of Operations - Years Ended December 31, 1997, 1996 and 1995..........55
Financial Condition - December 31, 1997, 1996 and 1995........................67
New Accounting Standards......................................................73
Hedging Activities............................................................74
Impact of Inflation and Changing Prices.......................................74
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Item 8. Financial Statements and Supplementary Data.
Financial Statements and Supplementary Data...................................76
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.
Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure........................................76
PART III
Item 10. Directors and Executive Officers of the Registrant.
Directors and Executive Officers..............................................77
Board of Directors............................................................80
Item 11. Executive Compensation.
Summary of Cash and Other Compensation........................................82
Stock Option/Stock Appreciation Right Grants in the Last Year.................83
Aggregate Option Exercises and Period-End Values..............................84
1996 Incentive Stock Option Plan..............................................84
401(k) Retirement Plan........................................................86
Employment Agreements.........................................................87
Directors' Compensation.......................................................89
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Security Ownership of Certain Beneficial Owners...............................90
Security Ownership of Directors and Executive Officers........................91
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Item 13. Certain Relationships and Related Transactions.
Agreement with IMC Mortgage Company...........................................92
Agreement with Mills Value Advisors, Inc......................................92
Termination of Armada Residential Mortgage, LLC...............................93
Indebtedness of Management....................................................93
Promissory Notes ............................................................93
PART IV
Item 14. Exhibits, Financial Statement Schedules
And Reports on Form 8-K.
Financial Statements and Exhibits.............................................94
Signatures ............................................................97
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PART I
ITEM 1 - BUSINESS
The statements in this report, which are not merely reports of
historical facts, are forward-looking statements, and actual results could
differ materially due to important factors, including among others, reduced
consumer demand for loans, competitive forces, excessive expectations of
acquired companies, limitations on available funds, and market forces affecting
share prices of Approved Financial Corp. (the "Company").
General
The Company is a Virginia-chartered financial institution, principally
involved in originating, purchasing, servicing and selling loans secured
primarily by first and junior liens on owner-occupied, one- to four-family
residential properties. The Company offers both fixed-rate and adjustable-rate
loans for debt consolidation, home improvements and other purposes. The
Company's specialty is lending to the "non-conforming" borrower who does not
meet traditional "conforming" or government agency credit qualification
guidelines. The Company focuses on lending to individuals whose borrowing needs
are generally not being served by traditional financial institutions due to such
individuals' impaired credit profiles and other factors. For over forty-five
years, the Company has helped its customers to satisfy their financial needs and
to improve their credit ratings.
Incorporated in 1952 as a subsidiary of Government Employees Insurance
Co. ("GEICO"), the Company was acquired in September 1984 by, among others,
several members of current management. The Company, headquartered in Virginia
Beach, Virginia, holds a Virginia industrial loan association charter and is
subject to the supervision, regulation and examination of the Virginia State
Corporation Commission's Bureau of Financial Institutions. In September 1996 the
Company acquired Approved Federal Savings Bank (the "Savings Bank"), a
federally-chartered savings institution. The Savings Bank is subject to the
supervision, regulation and examination of the Office of Thrift Supervision (the
"OTS") and the Federal Deposit Insurance Corporation ("FDIC"). The Company is a
registered savings and loan holding company under the federal Home Owner's Loan
Act ("HOLA") because of its ownership of the Savings Bank. As such, the Company
is subject to the regulation, supervision and examination of the OTS. The
Savings Bank is also subject to the regulations of the Board of Governors of the
Federal Reserve System governing reserves required to be maintained against
deposits.
The Company derives its income from gains on loans sold through whole
loan sales to institutional purchasers, net warehouse interest earned on loans
held for sale, net interest income on loans held for investment, and origination
and other fees received as part of the loan application process. In future
periods, the Company may generate revenue from loans sold through
securitizations and non-real estate secured consumer finance lending.
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The Company utilizes broker and retail channels to originate loans. At
the broker level, an extensive network of independent mortgage brokers generates
referrals. This loan source has been a successful and profitable mainstay of the
business for many years. The Company began making residential mortgage loans
through retail offices during the fourth quarter of 1994. In 1997, the dollar
volume in the broker lending division accounted for 54.7% of total originations
and the retail lending division accounted for 45.3% of total originations. The
Company is seeking to expand its broker network and its direct consumer lending
by opening branch offices and increasing its use of advertising, direct mail and
other marketing strategies, and through strategic acquisitions. The Company is
also committing resources to grow and improve the profitability of each
operating unit, and to enhance the corporate and underwriting infrastructure.
Once loan applications are received from the broker and retail
networks, the underwriting process is completed and the loans are funded, the
Company typically packages the loans and sells them on a whole loan basis to
institutional investors, usually other mortgage and finance companies. The
proceeds from the sales release funds for additional lending.
The Company has two operating subsidiaries. Approved Residential
Mortgage, Inc. ("ARMI") was formed in April 1993 to originate non-conforming
residential mortgage loans through its broker network and retail outlets. ARMI
initially concentrated on continuing the Company's broker network business.
During the fourth quarter of 1994, the Company opened its first retail loan
origination center through a joint venture. The Company opened three retail
centers in 1995, seven retail centers in 1996 and twelve retail centers in 1997.
ARMI operates most of its retail offices under the service mark "Armada"
Residential Mortgage.
The Company's other operating subsidiary is the Savings Bank. The
Savings Bank's principal business activities are attracting savings deposits
from the general public through its Virginia Beach banking office and
originating, investing in and selling loans secured by first and junior mortgage
liens on single-family dwellings, including condominium units. The Savings Bank
employs two mortgage loan broker account representatives in the state of
Tennessee. In future periods, the Savings Bank may also lend funds to banking
customers by means of home equity loans and also installment loans not secured
by real estate collateral, and may originate residential construction loans and
loans secured by manufactured housing units. The Savings Bank invests in certain
U.S. Government and agency obligations and other investments permitted by
applicable laws and regulations. The operating results of the Savings Bank are
highly dependent on net interest income, the difference between interest income
earned on loans and investments and the cost of savings deposits and borrowed
funds. The Savings Bank has one operating subsidiary, Global Title Insurance
Agency, Inc.
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Following its acquisition of the Savings Bank in September 1996, the
Company moved quickly to change the Savings Bank's profile and operations. The
Company installed new management and the Savings Bank's operations were moved to
Virginia Beach, Virginia, to be in close proximity to the Company's corporate
headquarters. During 1997, the Savings Bank's operations consisted of making
loans similar to those typically made by the Company. The Savings Bank's charter
gives it quick entry into new markets, with reduced legal costs. By taking
advantage of the flexible provisions of the charter, the Savings Bank has been
able to make non-conforming real estate-secured loans in several states where
the Company's retail or broker units have not yet obtained licenses, or where
the Company's current licenses have restricted it from doing this type of
business without expensive application costs. In making these loans, the Savings
Bank has utilized the Company's existing network of brokers and retail branches,
and has utilized on a contract basis the processing, underwriting and closing
capabilities of the Company. The Company has agreed to purchase all of the loans
made by the Savings Bank during this period. The Company has sold in the
secondary market most of the loans it has purchased from the Savings Bank.
Deposit accounts of the Savings Bank up to $100,000 are insured by the
Savings Association Insurance Fund, administered by the FDIC. The Savings Bank
is a member of the Federal Home Loan Bank (the "FHLB") of Atlanta. The Company
and the Savings Bank are subject to the supervision, regulation and examination
of the OTS and the FDIC. The Savings Bank is also subject to the regulations of
the Board of Governors of the Federal Reserve System governing reserves required
to be maintained against deposits.
Business Strategy
The Company's strategies are: (i) maintaining the strong commitment to
loan underwriting and servicing standards; (ii) expanding direct retail lending;
(iii) increasing the number of brokers in its network and increasing the amount
of loans originated from brokers; (iv) building on the Company's initial
investment in the Savings Bank; (v) prudent management of cash flow; (vi)
acquiring additional loan production capability through acquisitions and
strategic alliances; (vii) broadening its product offerings; and (viii)
diversifying loan sale strategies.
Maintenance of Quality Underwriting and Loan Servicing. The Company's
underwriting and servicing staff have experience in the non-conforming home
equity loan industry. The Company's management believes that the experience of
its underwriting and servicing staff provide the Company with the infrastructure
necessary to sustain its recent growth and maintain its commitment to high
standards in its underwriting and servicing of portfolio and warehouse loans.
Expansion of Retail (Direct to Consumer) Lending. The Company intends
to expand its retail (direct to consumer) lending efforts by opening additional
retail branch offices in the next twelve months. The use of retail branch
offices allows the Company to focus on developing contacts with individual
borrowers and referral sources such as accountants, attorneys and financial
planners, with a view toward expanding its retail loan business.
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The Company generally enters a new target market by way of the broker
network. The Company targets cities where the population density and economic
indicators are favorable for home equity lending, the foreclosure rate is within
normal ranges and the non-conforming loan market has been under-served. Before
establishing a branch office, the Company may test the target market, where
local regulations permit, via newspaper, radio and direct mail advertising and
through a toll-free telephone number which routes a borrower directly to a loan
officer in the Virginia Beach, Virginia office. The Company will generally
establish a small branch office, generally with an initial staff of one or two
business development representatives. These sales centers do not require heavy
investments which allows the Company to exit the market easily if the office
does not meet expectations. The branch office network is used for marketing and
meeting with the Company's local borrowers. The Company has also successfully
used targeted outbound telemarketing and direct mail to reach potential loan
customers.
The Company currently utilizes targeted out-bound telemarketing to
obtain leads for potential customers. Most of the telemarketing activity has
previously been performed in the retail branches. The Company is planning to
centralize all of its telemarketing activities in the Virginia Beach, Virginia
area to achieve economies of scale and to obtain greater quality control over
this operation. Also, in-bound telemarketing (customer responses to mailings and
advertisements) will be added in 1998.
Expansion of Broker Networks. In 1997 and 1996, 54.7% and 62.9%,
respectively, of the dollar volume of the Company's loan production was
originated through its broker network. The Company intends to continue to
increase its loan production brokers by expanding its networks to include new
brokers and increasing the efficiency and production of the brokers that are a
part of the Company's network. The Company plans to implement this strategy of
increasing its market share through geographic expansion, tailored marketing
strategies and a continued focus on servicing smaller brokers in cities which
have historically been under-served. The Company believes that relationships
with brokers are strengthened by providing attractive products and responsive
service in conjunction with consistent underwriting, substantial funding sources
and competitive prices.
Building on the Company's Initial Investment in the Savings Bank. The
principal reason for the acquisition of the Savings Bank was to allow the
Company to utilize the opportunities offered by the federal thrift charter to
compliment the products and services currently being offered by the Company. The
Savings Bank's ability to raise FDIC-insured deposits and to obtain FHLB
advances secured by its loan portfolio to finance its activities should serve
over time to reduce the cost of funds.
In future periods, the Company expects the Savings Bank to develop the
capability to originate loans in the "conforming" segment of the mortgage loan
market. Most of the Savings Bank's fixed rate conforming loans would be sold in
the secondary market, while its adjustable rate conforming loans could either be
sold or held in the Savings Bank's loan portfolio. As a FHLB member, the Savings
Bank will be able to pledge qualifying loans to obtain additional funds to
expand its lending operations.
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On July 10, 1997, the Savings Bank formed a title insurance agency
subsidiary named Global Title Insurance Agency, Inc. ("Global"), and has
obtained regulatory approval to begin title policy sales operations. Global has
negotiated to issue title policies through First American Title Insurance
Company. It is expected that Global will eventually be offering title policies
to all of the Company's loan customers. However, in 1998 Global will focus its
sales efforts on the Company's retail customers in Virginia. The Company's
management believes that Global will be successful in gaining a substantial
portion of the title insurance business for the Company's retail customers whose
loans require such coverage, and should also be moderately successful in
penetrating the title insurance market for its originations through mortgage
brokers.
The Savings Bank is expected to introduce additional products that
compliment the Company's menu of offerings. Future product offerings by the
Savings Bank may include consumer installment loans. There is a secondary market
for consumer finance paper, and it is expected that the Savings Bank will sell a
substantial portion of these loans rather than hold them in its portfolio.
The Savings Bank may enter other lines of business that could provide
complimentary benefits, or synergies, with the Company's main strategic goals.
At a time when banks and savings institutions are using branch networks
to attract deposits as a primary source of funding, the Savings Bank instead
relies primarily upon certificates of deposit obtained through direct
solicitation of institutional investors and brokered certificates of deposit
obtained from customers of Wall Street investment banks. The Savings Bank's
management believes that certificates of deposit raised in this manner are a
more efficient and cost effective approach to obtain funds as compared to a
branch network with its salaries and overhead costs.
Prudent Management of Financial Cash Flow. The Company intends to
maximize its financial flexibility in a number of ways, including maintaining a
significant quantity of mortgage loans for sale on its balance sheet.
Maintenance of a substantial amount of mortgage loans held for sale, which the
Company can sell when necessary or desirable, permits the Company to improve
management of its cash flow by increasing its net interest income and to reduce
its exposure to the volatility of the capital markets.
Expansion through Acquisitions. The Company intends to strengthen its
loan production capabilities not only through internal growth, but from time to
time through acquisitions and the establishment of strategic alliances. The
Company's management believes that acquisitions not only accelerate the pace of
growth, but also are often the most cost-effective growth strategy, enabling the
Company to realize significant operational economies of scale. The Company will
continue to seek out candidates for acquisition which operate in geographic and
product areas that complement its existing businesses. These candidates may
include both brokers and retail offices of other non-conforming lenders, which
exhibit management styles compatable with the Company's management team.
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The Company will also seek to develop additional business units that
can compliment the current business. The Company's recent acquisition of the
Savings Bank is an example of such a strategic acquisition.
See the discussion below regarding the January 26, 1998 acquisition of
the assets of a Georgia-based mortgage lender, Funding Center of Georgia, Inc.
Expand Product Offerings. The Company frequently reviews its pricing
and loan offerings for competitiveness relative to the market. The Company
introduces new loan products to meet the needs of its brokers and borrowers and
to expand its market share to new customers who are not traditionally part of
the Company's market.
Diversify Loan Sale Strategies. In future periods, the Company may sell
a portion of the loans it originates through a securitization program and retain
the rights to service the loans. The sale of loans through a securitization
program would be a significant departure from the Company's previous business
operations. The Company would apply the net proceeds of the securitizations to
pay down its warehouse credit facilities in order to make these facilities
available for future funding of mortgage loans. Recent operational improvements
allow the Company to efficiently originate, underwrite and service securitized
loans and meet the requirements of rating agencies, credit enhancers and
investors. In order to fund its securitization program, the Company would likely
have to obtain an additional line of credit facility and other residual
financing. To the extent that the Company is not successful in maintaining or
replacing existing financing, it would not be able to hold a large volume of
loans pending securitization and therefore would have to curtail its loan
production activities or sell loans either through whole loan sales or in
smaller securitizations, thereby having a material adverse effect on the
Company's results of operations.
Purchase of the Assets of Funding Center of Georgia, Inc.
Effective January 26, 1998, ARMI purchased substantially all of the
assets of Funding Center of Georgia, Inc. ("FCGI"), a Georgia corporation. FCGI
is originating approximately $4,500,000 in mortgage loans per month. All of the
employees of FCGI have become employees of ARMI, and the business will be
conducted under the assumed name of "Funding Center of Georgia." The purchase
price for FCGI's assets was $3,300,000. ARMI paid $600,000 at closing, will pay
$300,000 in semi-monthly installments for a period of 36 months, and the balance
of $2,400,000 is payable in three annual installments on January 1, 1999, 2000
and 2001, with interest at 6%. The $2,400,000 in deferred payments is subject to
reduction in the event of a failure to meet agreed-upon pre-tax profit targets
each year. The two principal owners of FCGI entered into three-year employment
agreements with ARMI, and they will manage the office.
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The Company's Borrowers and its Loan Products
The Company has committed the majority of its resources to serving the
non-conforming residential mortgage market. The Company caters to individuals
who do not meet the strict qualification guidelines established by most
government insured lending programs. These customers usually have limited access
to sources of available credit, but their financial needs are none the less
real. By consolidating their debts with a loan from the Company, these customers
can often save several hundred dollars per month in cash flows, amounts that can
make a significant difference in a customer's financial situation and quality of
life. Personal circumstances including divorce, family illnesses or deaths and
temporary job loss due to layoffs and corporate downsizing will often impair an
applicant's credit record. Among the Company's specialties is the ability to
identify and assist this type of borrower in the establishment of improved
credit. In this segment of the mortgage loan business, the interest rate charged
on loans is not the overriding concern of customers, who are less rate-sensitive
than conforming loan customers. Rather, what differentiates lenders is the
level, quality and speed of service.
Loans made to such credit-impaired borrowers generally entail a higher
risk of delinquency and possibly higher losses than loans made to more
creditworthy borrowers. No assurance can be given that the Company's
underwriting policies and collection procedures will substantially reduce such
risks. In the event that warehoused loans or pools of loans sold and serviced by
the Company experience higher delinquencies, foreclosures or losses than
anticipated, the Company's results of operations or financial condition would be
adversely affected.
Most loans made by the Company are used by the borrowers for debt
consolidation, property improvement, home purchase and other purposes. Borrowers
can gain income tax advantages of real estate-secured debt, instead of paying
higher-rate credit cards on which interest payments are generally not
tax-deductible. Most of the loans carry fixed interest rates and are usually
made for a 20- to 30-year term. The average loan size during 1997 was
approximately $56,000.
In evaluating loan requests, several risk management strategies are
employed. Currently, the Company limits its credit exposure by securing all
loans with real estate. The loans are usually for less than the unencumbered
appraised value of the real estate. The loan-to-value ratio will fluctuate in
accordance with borrower qualifications. Favorable credit and low risk factors
yield higher loan-to-value ratios and lower interest rates. The opposite is true
for poor credit and high risk factors. Occasionally, a loan secured by real
estate is made for an amount greater than the collateral value. These loans are
underwritten based on the borrower's creditworthiness according to underwriting
criteria of lenders who specialize in and purchase high loan-to-value loans.
Such loans are immediately sold in the secondary market on a whole loan basis.
In future periods, the Company intends to offer products not fully
secured by real estate collateral. This may include consumer installment debt.
If offered, these future products will be underwritten based on the borrower's
credit worthiness. As is the case with its other loan products, the Company
intends to sell these loans in the secondary market, to limit its exposure to
future losses.
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In order to compensate the Company for the increased credit risks
associated with its borrowers, higher interest rates and more points are charged
than on conforming real estate 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. This practice frees funds for additional
lending and increases revenues. For 1997, the weighted-average premium realized
by the Company on its loan sales was 6.39%.
A smaller portion of the loans originated by the Company is retained
for the Company's loan portfolio. In future periods, the Savings Bank will be
building a portfolio of loans held for investment. The income generated by a
loan portfolio is used to help offset overhead and operational costs. Growing a
loan portfolio is an ongoing strategy and an important part of the Savings
Bank's long-term, income-producing plans. As the loan portfolio grows,
management will address the need to hedge against interest rate risk as deemed
prudent.
The Company has invested in technology to further streamline loan
processing and servicing procedures. New software has enhanced the Company's
ability to manage the loan portfolio and analyze pools of loans for sale in the
secondary market. Such investments in technology have supported growth
objectives including originating higher loan volumes, increasing profit margins
and reducing loan acquisition costs. The Company expects that it would have to
invest in additional capabilities if it enters the securitization business.
Broker Loan Originations. ARMI originates residential mortgage loans
through a network of independent mortgage brokers who offer the Company's
products to their clients.
During 1996 and 1997, the broker division increased the number of
account executives and the states of operations. The Company began doing
business in Illinois, Ohio, Michigan, Wisconsin, and Tennessee in 1996. These
new additions and increased performance from existing business helped increase
1996 broker loan originations 165.4% from 1995. The Company began doing business
in Kentucky in 1997, and those new additions and increased performance from
existing business helped increase broker loan originations in 1997 by 57.4% over
the previous year.
In cultivating this broker network, the Company stresses its superior
service, efficiency, flexibility and professionalism. Due to concentrated size
and centrally-organized operations, the Company offers one business day
turnaround on underwriting decisions and can close loans in as few as two
business days. A wide variety of loan products has been designed to assist
brokers in supporting a broader spectrum of borrowers. A team of regional sales
managers and account executives assist mortgage brokers in the field, but the
majority of the loans are currently underwritten at the Company's Virginia
Beach, Virginia headquarters.
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The Company's geographic focus for broker operations includes the
Southeast and Midwest. Management intends to strengthen the broker origination
channel in these regions by developing new markets and capturing a greater share
of existing ones. The Company uses modern technology to accommodate its growing
service area. This minimizes overhead without compromising operations. It also
allows for easy expansion through the further development of the mortgage broker
network.
Management plans to continue to develop the broker sales force with
ongoing training programs. Management intends to continue to expand this
division.
Retail Loan Originations. In December 1994, ARMI formed a joint venture
to originate mortgage loans through retail branches. The joint venture, Armada
Residential Mortgage, LLC ("Armada LLC "), opened its first office in Lanham,
Maryland. Armada LLC's senior officer was a 17% owner of the joint venture. The
Armada LLC legal entity has since been folded into ARMI. Armada's senior officer
has remained with the Company in a management capacity.
Using the service mark "Armada" in most of its markets, ARMI expanded
its retail mortgage origination sources in 1996, opening seven new offices,
which brought the total retail branch network to twelve at the end of 1996.
These new additions and increased performance from existing business helped
increase 1996 retail loan originations 91.4% over the previous year. In 1997,
ARMI opened retail locations, in South Carolina, Illinois, Indiana, Virginia and
Maryland. These new additions and increased performance from existing business
helped increase 1997 retail loan originations 121.5% over the previous year.
There are currently plans to open new retail centers in Georgia, Indiana,
Virginia, Kentucky and North Carolina. Management expects to build the value of
its franchise by increasing the "Armada" Residential Mortgage name recognition
in its markets.
The Company's retail offices are the result of developing successful
relationships with established industry professionals who want to work in an
entrepreneurial setting and can participate in the growth and profitability of
our retail business. The use of retail branch offices allows the Company to
focus on developing contacts with individual borrowers and referral sources such
as accountants, attorneys and financial planners, with a view toward expanding
its retail loan business.
To support the retail expansion, integrated marketing programs have
been designed to generate new business. Retail customer demand is generated
through targeted outbound telemarketing, direct mail and multimedia advertising.
As these programs are tested and refined, they will be implemented in all retail
locations. In future periods, the Company plans to market the Savings Bank's
loan products and other services through its retail loan network.
Strategic Alliances. In order to increase volume and to diversify its
sources of loan originations, the Company seeks to enter into strategic
alliances with selected mortgage lenders, pursuant to which the Company provides
working capital and financing arrangements and a commitment to purchase
qualifying loans. In return, the Company expects to receive a more predictable
flow of loans and, in some cases, an option or obligation to acquire an equity
interest in the related strategic participant. To date, the Company has
completed a strategic alliance with American Family Services, a mortgage company
based in Atlanta, Georgia.
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Underwriting Guidelines
The following is a general description of the underwriting guidelines
currently employed by the Company with respect to mortgage loans it originates
or purchases from others. The Company revises such guidelines from time to time
in connection with changing economic and market conditions. The Company may make
exceptions to these guidelines for special types of loans, including loans with
loan-to-value ratios over 80%, and for other reasons. The Company relies on the
judgment of the underwriting staff in making these exceptions. Also, the Company
will substitute underwriting guidelines of other lenders to which the Company
anticipates it will sell such loans under an established buy-sell agreement.
Loan applications received from retail offices and brokers are
classified according to certain characteristics including available collateral,
loan size, debt ratio, loan-to-value ratio and the credit history of the
applicant. Loan applicants with less favorable credit ratings generally are
offered loans with higher interest rates and lower loan-to-value ratios than
applicants with more favorable credit ratings. The Company's underwriting
standards are designed to provide a program for all qualified applicants in an
amount and for a period of time consistent with each applicant's demonstrated
willingness and ability to repay. All of the Company's underwriting
determinations are made without regard to sex, marital status, race, color,
religion, age or national origin. Each application is evaluated on its
individual merits, applying the guidelines set forth below, to ensure that each
application is considered on an equitable basis.
A current credit report by an independent and nationally recognized
credit reporting agency reflecting the applicant's complete credit history is
required. The credit report will disclose whether any instances of adverse
credit appear on the applicant's record. Such information might include
delinquencies, repossessions, judgements, foreclosures, bankruptcies and similar
instances of adverse credit that can be discovered by a search of public
records. An applicant's recent credit performance weighs heavily in the
evaluation of risk by the Company. A lack of credit history will not necessarily
preclude a loan if the borrower has sufficient equity in the property. Slow
payments on the borrower's credit report must be satisfactorily explained and
will normally reduce the amount of the loan for which the applicant can be
approved.
The Company maintains a staff of experienced underwriters, the majority
of whom are based in its Virginia Beach, Virginia office. The Company's loan
application and approval process generally is conducted via facsimile submission
of the credit application to the Company's underwriters. An underwriter reviews
the applicant's employment history and financial status as contained in the loan
application, current bureau reports and the real estate property characteristics
as presented on the application in order to determine if the loan is acceptable
under the Company's underwriting guidelines. Based on this review, the
underwriter assigns a preliminary rating to the application. The proposed terms
of the loan are then communicated to the retail loan officer or broker
responsible for the application who in turn discusses the proposal with the loan
applicant. When a potential borrower applies for a loan through a branch office,
the underwriter may discuss the proposal directly with the applicant. The
Company endeavors to respond with preliminary proposed loan terms, and in most
cases does respond, to the broker or borrower within one business day from when
the application is received. If the applicant accepts the proposed terms, the
underwriter will contact the broker or the loan applicant to gather additional
information necessary for the closing and funding of the loan.
15
<PAGE>
All loan applicants must have an appraisal of their collateral property
prior to closing the loan. The Company requires loan officers and brokers to use
licensed appraisers that are listed on or qualify for the Company's approved
appraiser list. The Company approves appraisers based upon a review of sample
appraisals, professional experience, education, membership in related
professional organizations, client recommendations and review of the appraiser's
experience with the particular types of properties that typically secure the
Company's loans.
The decision to provide a loan to an applicant is based upon the value
of the underlying collateral, the applicant's creditworthiness and the Company's
evaluation of the applicant's willingness and ability to repay the loan. A
number of factors determine a loan applicant's creditworthiness, including debt
ratios (the borrower's average monthly expenses for debts, including fixed
monthly expenses for housing, taxes and installment debt, as a percentage of
gross monthly income), payment history on existing mortgages and the combined
loan-to-value ratio for all existing mortgages on a property.
Assessment of the applicant's demonstrated willingness and ability to
pay is one of the principal elements in distinguishing the Company's lending
specialty from methods employed by traditional lenders. All lenders utilize debt
ratios and loan-to-value ratios in the approval process. Many lenders simply use
software packages to score an applicant for loan approval and fund the loan
after auditing the data provided by the borrower. The Company primarily relies
upon experienced non-conforming mortgage loan underwriters to scrutinize an
applicant's credit profile and to evaluate whether an impaired credit history is
a result of previous adverse circumstances or a continuing inability or
unwillingness to meet credit obligations in a timely manner. Personal
circumstances including divorce, family illnesses or deaths and temporary job
loss due to layoffs and corporate downsizing will often impair an applicant's
credit record. The willingness to identify and assist this type of borrower in
establishing and improving their credit gives the Company access to a market
that has traditionally been under-served by the financial community.
Upon completion of the loan's underwriting and processing, the closing
of the loan is scheduled with a closing attorney or agent approved by the
Company. The closing attorney or agent is responsible for completing the loan
transaction in accordance with applicable law and the Company's operating
procedures.
The Company requires title insurance coverage issued by an approved
ALTA title insurance company of all property securing mortgage loans it
originates or purchases. The Company and its assignees are generally named as
the insured. Title insurance policies indicate the lien position of the mortgage
loan and protect the Company against loss if the title or lien position is not
as indicated. The applicant is also required to secure hazard and, in certain
instances, flood insurance in an amount sufficient to cover the building
securing the loan for the entire term of the loan, for an amount that is at
least equal to the outstanding principal balance of the loan or the maximum
limit of coverage available under applicable law, whichever is less. Evidence of
adequate homeowner's insurance naming the Company as an additional insured is
required on all loans.
16
<PAGE>
The Company has established classifications with respect to the credit
profiles of loans based on certain of the applicant's characteristics. Each loan
applicant is placed into one of four letter ratings "A" through "D," with
sub-ratings within those categories. Ratings are based upon a number of factors
including the applicant's credit history, the value of the property and the
applicant's employment status. The Company also relies on the judgment of its
underwriting staff, which may make exceptions to the general criteria and
upgrade a rating due to factors considered appropriate to the underwriting
staff. Terms of loans made by the Company, as well as the maximum loan-to-value
ratio and debt service-to-income coverage (calculated by dividing fixed monthly
debt payments by gross monthly income), vary depending upon the classification
of the borrower. Borrowers with lower credit ratings generally pay higher rates
and loan origination fees.
Subject to the judgment of the Company's underwriting staff to make
exceptions to the general criteria, the general criteria currently used by the
Company in classifying loan applicants are set forth below:
"A" Risk. Under the "A" risk category, a loan applicant must have
generally repaid installment or revolving debt according to its terms.
o Existing mortgage loans: required to be current at the time the
application is submitted, with a maximum of one (or two on a
case-by-case basis) 30-day late payment(s) within the last 12
months being acceptable.
o Non-mortgage credit: minor derogatory items are allowed, but a
letter of explanation is required; any recent open collection
accounts or open charge-offs, judgements or liens would generally
disqualify a loan applicant from this category.
o Bankruptcy filings: must have been discharged more than four
years prior to closing with credit re-established.
o Maximum loan-to-value ratio: up to 80% (or 90% on an exception
basis with compensating factors) is permitted for a loan secured
by an owner-occupied one- to four-family residence; 80% for a loan
secured by an owner-occupied condominium; and 70% (or up to 80% on
an exception basis with compensating factors) for a loan secured
by a non-owner occupied one- to four-family residence.
o Debt service-to-income ratio: generally 45% or less.
"B" Risk. Under the "B" risk category, a loan applicant must have
generally repaid installment or revolving debt according to its terms.
o Existing mortgage loans: required to be current at the time the
application is submitted, with a maximum of three (or four on a
case-by-case basis) 30-day late payments within the last 12 months
being acceptable.
17
<PAGE>
o Non-mortgage credit: some prior defaults may have occurred, but
major credit paid or installment debt paid as agreed may offset
some delinquency; any open charge-offs, judgements or liens would
generally disqualify a loan applicant from this category.
o Bankruptcy filings: must have been discharged more than two years
prior to closing with credit re-established.
o Maximum loan-to-value ratio: up to 80% (or 85% on an exception
basis with compensating factors) is permitted for a loan secured
by an owner-occupied one- to four-family residence; and 70% (or
80% on an exception basis with compensating factors) for a loan
secured by a non-owner occupied one- to four-family residence.
o Debt service-to-income ratio: generally 45% or less (up to 50% on
an exception basis with compensating factors).
"C" Risk. Under the "C" risk category, a loan applicant may have
experienced significant credit problems in the past.
o Existing mortgage loans: must be brought current from loan
proceeds; applicant is allowed a maximum of four 30-day late
payments and one 60-day late payment within the last 12 months.
o Non-mortgage credit: significant prior delinquencies may have
occurred, but major credit paid or installment debt as agreed may
offset some delinquency; all delinquent credit must be current or
paid off.
o Bankruptcy filings: must have been discharged, and a minimum
one-year of re-established credit is required.
o Maximum loan-to-value ratio: up to 75% (or 80% on an exception
basis with compensating factors for first liens only) is permitted
for a loan secured by an owner-occupied one- to four-family
residence; 65% for a loan secured by an owner-occupied
condominium; and 65% for a non-owner occupied one- to four- family
residence.
o Debt service-to-income ratio: generally 50% or less.
"D" Risk. Under the "D" risk category a loan applicant may have
experienced significant credit problems in the past.
o Existing mortgage loans: must be brought current from loan
proceeds and no more than 149 days delinquent at closing; an
explanation for such delinquency is required.
o Non-mortgage credit: significant prior defaults may have occurred,
but the applicant must be able to demonstrate regularity in
payment of some credit obligations; all charge-offs, judgements,
liens or collection accounts must be paid off.
18
<PAGE>
o Bankruptcy filings: open Chapter 13 bankruptcies will be
considered with evidence that the plan is being paid according to
terms; outstanding balance must be paid in full and discharged
from loan proceeds.
o Maximum loan-to-value ratio: generally 65% (or 70% on an exception
basis with compensating factors for first liens only) for a loan
secured by an owner-occupied one- to four-family residence; 60%
for a loan secured by an owner-occupied condominium; and 60% for a
non-owner occupied one- to four-family residence.
o Debt service-to-income ratio: generally 50% or less (up to 55% on
an exception basis with compensating factors).
The Company uses the foregoing categories and characteristics only as
guidelines. On a case-by-case basis, the underwriting staff may determine that
the prospective borrower warrants a risk category upgrade, a debt
service-to-income ratio exception, a pricing exception, a loan-to-value
exception or an exception from certain requirements of a particular risk
category. An upgrade or exception may generally be allowed if the application
reflects certain compensating factors, among others: low loan-to-value ratio;
stable employment or length of occupancy at the applicant's current residence.
For example, a higher debt ratio may be acceptable with a lower loan-to-value
ratio. An upgrade or exception may also be allowed if the applicant places a
down payment in escrow equal to at least 20% of the purchase price of the
mortgaged property, or if the new loan reduces the applicant's monthly aggregate
debt load. Accordingly, the Company may classify in a more favorable risk
category certain mortgage loans that, in the absence of such compensating
factors, would satisfy only the criteria of a less favorable risk category. The
foregoing examples of compensating factors are not exclusive. The underwriting
staff has discretion to make exceptions to the criteria and to upgrade ratings
on case-by-case basis.
In future periods the Company intends to offer products not fully
secured by real estate collateral, such as consumer installment debt. If
offered, these future products will nevertheless be underwritten based on the
borrower's credit worthiness. As is the case with its other loan products, the
Company intends to sell these loans in the secondary market, to limit its
exposure to future losses.
Mortgage Loan Servicing
The Company has been servicing its portfolio and warehouse loans for
many years. Since January 1, 1997, the Savings Bank's portfolio of loans for
sale and for investment has been serviced by the Company under a contractual
arrangement.
The Company's loan servicing operation has two functions: collections
and customer service for borrowers. The servicing department monitors loans,
collects current payments due from borrowers. The collections specialists
furnish reports and enforce the holder's rights, including recovering delinquent
payments, instituting loan foreclosures and liquidating the underlying
collateral.
The Company closes loans throughout the month. Most of the Company's
loans require a first payment thirty to forty-five days after funding.
Accordingly, the Company's servicing portfolio consists of loans with payments
due at varying times each month. This system ameliorates the cyclical highs and
lows that some servicing companies experience as a result of heavily
concentrated payment dates.
19
<PAGE>
The Company's collections policy is designed to identify payment
problems sufficiently early to permit the Company to address delinquency
problems quickly and, when necessary, to act to preserve equity before a
property goes to foreclosure. The Company believes that these policies, combined
with the experience level of independent appraisers engaged by the Company, help
to reduce the incidence of charge-offs on a first or second mortgage loan.
Collection procedures commence upon identification of a past due
account by the Company's automated servicing system. Five days before the first
payment is due on every loan, the borrower is contacted by telephone to welcome
the borrower, to remind the borrower of the payment date and to answer any
questions the borrower may have. If the first payment due is delinquent, a
collector will telephone to remind the borrower of the payment. Five days after
any payment is due, a written notice of delinquency is sent to the borrower.
Eleven days after payment is due, the account is automatically placed in the
appropriate collector's queue and the collector will send a late notice to the
borrower. During the delinquency period, the collector will continue to
frequently contact the borrower. Company collectors have computer access to
telephone numbers, payment histories, loan information and all past collection
notes. All collection activity, including the date collection letters were sent
and detailed notes on the substance of each collection telephone call, is
entered into a permanent collection history for each account. Additional
guidance with respect to the collection process is derived through frequent
communication with the Company's senior management.
The Company's loan servicing software also tracks and maintains
homeowners' insurance information. Expiration reports are generated weekly
listing all policies scheduled to expire within 30 days. When policies lapse, a
letter is issued advising the borrower of the lapse and that the Company will
obtain force-placed insurance at the borrower's expense. The Company also has an
insurance policy in place that provides coverage automatically for the Company
in the event the Company fails to obtain force-placed insurance.
Notwithstanding the above, there are occasions when a charge-off
occurs. Prior to a foreclosure sale, the Company performs a foreclosure analysis
with respect to the mortgaged property to determine the value of the mortgaged
property and the bid that the Company will make at the foreclosure sale. This
analysis includes: (i) a current valuation of the property obtained through a
drive-by appraisal conducted by an independent appraiser; (ii) an estimate of
the sales price of the mortgaged property by sending two local realtors to
inspect the property; (iii) an evaluation of the amount owed, if any, to a
senior mortgagee and for real estate taxes; and (iv) an analysis of the
marketing time, required repairs and other costs, such as for real estate broker
fees, that will be incurred in connection with the foreclosure sale.
All foreclosures are assigned to outside counsel located in the same
state as the secured property. Bankruptcies filed by borrowers are also assigned
to appropriate local counsel who are required to provide monthly reports on each
loan file.
At the present time the Company does not service mortgage loans for
other investors. However, in future periods the Company may securitize loans and
retain the servicing component on those securities. In this event, the Company
would need to enhance its servicing capabilities. The Company may engage one or
more companies to sub-service a portion of its servicing portfolio.
20
<PAGE>
Marketing
Marketing to Broker Networks. Marketing to brokers is conducted through
the Company's business development representatives, who establish and maintain
relationships with the Company's principal sources of loan purchases and
originations, including financial institutions and mortgage brokers. The
business development representatives provide various levels of information and
assistance to brokers, provide training to the loan originators regarding the
Company's products and non-traditional prospecting strategies, and are
principally responsible for maintaining the Company's relationships with its
clients. Business development representatives endeavor to increase the volume of
loan originations from brokers located within the geographic territory assigned
to that representative. The representatives and broker sales managers visit
customers' offices, attend trade shows and supervise advertisements in broker
trade magazines. The representatives also provide the Company with information
relating to borrowers and brokers, and products and pricing offered by
competitors and new market entrants, all of which assist the Company in refining
its programs in order to offer competitive products. The business development
representatives are compensated with a base salary and commissions based on the
volume of loans that are purchased or originated as a result of their efforts.
Marketing of Retail Lending Products. The Company markets its direct
consumer lending services through branch offices in several states. The Company
generally enters a new target market by way of the broker network. The Company
targets cities where the population density and economic indicators are
favorable for home equity lending, the foreclosure rate is within normal ranges
and the non-conforming loan market has been under-served. When broker marketing
efforts are successful in a new geographic area, the Company will generally
establish a small branch office, generally with an initial staff of three to
five business development representatives. These sales centers do not require
heavy investments and allow the Company to exit the market easily if the office
does not meet expectations. The branch office network is used for marketing to
and meeting with the Company's local borrowers. The Company has also
successfully used targeted outbound telemarketing and direct mail to reach
potential loan customers. Occasionally, when a potential customer applies for a
loan and does not fall within the Company's underwriting guidelines, the Company
may submit the application to other lending institutions. If the loan is
approved by another lending institution, the Company will not fund the loan but
will act as a mortgage broker, receiving a broker fee at the time the loan is
closed.
21
<PAGE>
Company's Sources of Funds and Liquidity
Warehouse Lines of Credit. The Company funds substantially all of the
loans which it originates and purchases through borrowings under warehouse
facilities, secured by pledges of its loans and through internally generated
funds. These borrowings are in turn repaid with the proceeds received by the
Company from selling such loans through whole loan sales. In future periods,
other loan sale strategies including securitizations may be adopted to
supplement the current whole loan sale program.
On December 10, 1997, the Company obtained a $100,000,000 warehouse
line of credit from a commercial bank syndicate. 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. This line of credit replaced three existing lines of
credit. 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. Also on December 10, 1997, the Company obtained 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.
The Company draws on its revolving warehouse lines of credit as needed
to fund loan production. As of December 31, 1997, the Company had issued loan
funding checks totaling $6,364,000 which had not cleared the Company's checking
account and for which the Company had not drawn funds from its warehouse line.
These checks cleared the Company's bank accounts in the first few business days
of January 1998 and most were funded with new warehouse line draws.
Prior to December 10, 1997, the Company had three warehouse facilities.
The Company had a $70,000,000 warehouse and seasoned loan line of credit with a
commercial bank. The line was secured by loans originated by the Company and
bears interest at a rate of 1.75% over the one-month LIBOR rate. As of September
30, 1997, the outstanding balance on this line was $33,189,000 and the interest
rate was 7.41%. The Company could receive warehouse credit advances of 98% of
the original principal balances on pledged mortgage loans for a maximum period
of 180 days after origination. If a mortgage loan was not sold within 180 days
after it is originated, it was transferred to the seasoned loan sublimit within
the line of credit. The seasoned loan sublimit had a maximum capacity of
$15,000,000 and bore interest at a rate of 2.5% over the one-month LIBOR rate.
As of September 30, 1997, the outstanding balance on the seasoned loan sublimit
was $6,227,000 and the interest rate was 8.41%. The Company could receive
advances under the seasoned loan sublimit up to 90% of current principal
balance, and loans could be financed in this manner for an indefinite period.
The Company also had a $25,000,000 warehouse line of credit with a
commercial bank. The line was secured by loans originated by the Company and
bore interest at a rate of 1.75% over the one-month LIBOR rate or the prime
interest rate. As of September 30, 1997, the outstanding balance on this line
was $3,788,000 and the interest rate was 7.41%. The Company could receive
warehouse credit advances of 98% of the original principal balances on pledged
mortgage loans for a maximum period of 120 days after origination.
22
<PAGE>
The Company also had an $8,000,000 warehouse line of credit with IMC.
The line was secured by loans originated by the Company and bore interest at a
rate of 1.75% over the one-month LIBOR rate. There was no outstanding balance on
this line at September 30, 1997. The Company could receive warehouse credit
advances of 100% of the original principal balances on pledged mortgage loans
for a maximum period of 30 days after origination.
Dependence on Funding Sources. The Company is dependent upon a few
lenders to provide the primary credit facilities for its loan originations. At
December 31, 1997, the Company had warehouse and other credit facilities with
certain financial institutions with aggregate commitments of $125,000,000. The
Company's warehouse and other credit facilities expire on December 31, 1999. In
addition, the Company's growth strategies are expected to require significant
increases in the amount of the Company's warehouse and other credit facilities.
The Company expects to be able to maintain existing warehouse and other credit
facilities (or to obtain replacement or additional financing) as current
arrangements expire or become fully utilized; however, there can be no assurance
that such financing will be obtainable on favorable terms. Any failure to renew
or obtain adequate funding under these warehouse facilities or other financings,
or any substantial reduction in the size of or pricing in the markets for the
Company's loans, could have a material adverse effect on the Company's
operations.
The Company's management is currently considering the securitization of
some of its mortgage loan production. In order to fund its securitization
program, the Company would likely have to obtain an additional line of credit
facility and other residual financing. To the extent that the Company is not
successful in maintaining or replacing existing financing, it would not be able
to hold a large volume of loans pending securitization and therefore would have
to curtail its loan production activities or sell loans either through whole
loan sales or in smaller securitizations, thereby having a material adverse
effect on the Company's results of operations.
Savings Bank Sources of Funds
Deposits. The primary source of deposits for the Savings Bank has been
brokered certificates of deposit obtained through national investment banking
firms, which, pursuant to agreements with the Savings Bank, solicit funds from
their customers for deposit with the Savings Bank ("brokered deposits"). Such
deposits amounted to $4,443,000, or 24.9%, of the Savings Bank's deposits at
December 31, 1997. The Savings Bank solicits deposits via a computer bulletin
board where the rates of many other banks and savings institutions are
advertised. At December 31, 1997, the Savings Bank had deposits of $12,876,000,
or 72.3%, of total deposits from this source. The Savings Bank also directly
solicits certificates of deposit from institutional investors. At December 31,
1997, $496,000, or 2.8%, of the Savings Bank's total deposits consisted of
deposits obtained by the Savings Bank from such efforts.
The fees paid to deposit brokers are amortized using the interest
method and included in interest expense on certificates of deposit.
23
<PAGE>
The Savings Bank's management believes that the effective cost of
brokered and other wholesale deposits is more attractive than deposits obtained
on a retail basis from branch offices after the general and administrative
expense associated with the maintenance of branch offices is taken into account.
Moreover, brokered and other wholesale deposits generally give the Savings Bank
more flexibility than retail sources of funds in structuring the maturities of
its deposits and in matching liabilities with comparable maturing assets. At
December 31, 1997, $13,268,000 of the Savings Bank's certificates of deposit
were scheduled to mature within one year (74.5% of total deposits).
Although management of the Savings Bank believes that brokered and
other wholesale deposits are advantageous in certain respects, such funding
sources, when compared to retail deposits attracted through a branch network,
are generally more sensitive to changes in interest rates and volatility in the
capital markets and are more likely to be compared by the investor to competing
instruments. In addition, such funding sources may be more sensitive to
significant changes in the financial condition of the Savings Bank. There are
also various regulatory limitations on the ability of all but well-capitalized
insured financial institutions to obtained brokered deposits; see "Regulation of
the Savings Bank - Brokered Deposits." These limitations currently are not
applicable because the Savings Bank is a well-capitalized financial institution
under applicable laws and regulations. There can be no assurances, however, that
the Savings Bank will not become subject to such limitations in the future.
As a result of the Savings Bank's reliance on brokered and other
wholesale deposits, significant changes in the prevailing interest rate
environment, in the availability of alternative investments for individual and
institutional investors or in the Savings Bank's financial condition, among
other factors, could affect the Savings Bank's liquidity and results of
operations much more significantly than might be the case with an institution
that obtained a greater portion of its funds from retail or core deposits
attracted through a branch network.
The following table sets forth various interest rate categories for the
certificates of deposit of the Savings Bank as of the dates indicated.
24
<PAGE>
(Dollars in thousands)
December 31, 1997 December 31, 1996
------------------------ -------------------
Weighted Weighted
Average Average
Rate Amount Rate Amount
-------- ---------- -------- --------
5.24% or less - $ - 5.18% $ 396
5.25 - 5.49% 5.30% 198 5.34 495
5.50 - 5.74 5.56 300 5.65 288
5.75 - 5.99 5.91 8,318 5.93 397
6.00 - 6.24 6.11 8,010 - -
6.25 - 6.49 6.32 989 - -
----- -------- ----- -------
6.01% $ 17,815 5.50% $ 1,576
===== ======== ===== =======
The following table sets forth the amount and maturities of the
certificates of deposit of the Savings Bank at December 31, 1997.
(Dollars in thousands)
<TABLE>
<CAPTION>
Over Six Months Over One Over
Six Months and Less than Year and Less Two
Or Less One Year Than Two Years Years Total
------- -------- -------------- ----- -----
<S> <C> <C> <C> <C> <C>
5.25 - 5.49% $ 99 $ 99 $ -- $ -- $ 198
5.50 - 5.74 300 -- -- -- 300
5.75 - 5.99 5,945 2,373 -- -- 8,318
6.00 - 6.24 99 4,353 3,558 -- 8,010
6.25 - 6.49 -- -- 791 198 989
------ ------ ------ ------- -------
$6,443 $6,825 $4,349 $ 198 $17,815
====== ====== ====== ======= =======
</TABLE>
At December 31, 1997, twenty-four certificates of deposit totaling
$2,400,000 were in amounts of $100,000.
25
<PAGE>
Borrowings. The Savings Bank is able to obtain advances from the FHLB
of Atlanta upon the security of certain of its residential first mortgage loans,
and other assets, including FHLB stock, provided certain standards related to
the creditworthiness of the Savings Bank have been met. FHLB advances are
available to member institutions such as the Savings Bank for investment and
lending activities and other general business purposes. FHLB advances are made
pursuant to several different credit programs, each of which has its own
interest rate, which may be fixed or adjustable, and which has its own range of
maturities. FHLB members are required to hold shares of the capital stock of the
regional FHLB in which they are a member in an amount at least equal to the
greater of 1% of the member's home mortgage loans or 5% of the member's advances
from the FHLB. The Savings Bank did not obtain any advances from the FHLB of
Atlanta during the period September 12, 1996 through December 15, 1997. On
December 16, 1997, the Savings Bank borrowed $1,000,000 from the FHLB, and this
amount was outstanding at December 31, 1997. The Savings Bank held $50,000 of
the FHLB stock at December 31, 1997. Management expects to utilize FHLB advances
as the Savings Bank builds a portfolio of loans.
Taxation
General. The Company and all of its subsidiaries currently file, and
expect to continue to file, a consolidated federal income tax return based on a
calendar year. Consolidated returns have the effect of eliminating intercompany
transactions, including dividends, from the computation of taxable income.
The Company's income is subject to tax in most of the states in which
it is making loans. The Company's taxable income in most states is determined
based on certain apportionment factors.
For taxable years beginning prior to January 1, 1996, a savings
institution such as the Savings Bank that met certain definitional tests
relating to the composition of its assets and the sources of its income (a
"qualifying savings institution") was permitted to establish reserves for bad
debts and to claim annual tax deductions for additions to such reserves. A
qualifying savings institution was permitted to make annual additions to such
reserves based on the institution's loss experience. Alternatively, a qualifying
savings institution could elect, on an annual basis, to use the "percentage of
taxable income" method to compute its addition to its bad debt reserve on
qualifying real property loans (generally, loans secured by an interest in
improved real estate). The percentage of taxable income method permitted the
institution to deduct a specified percentage of its taxable income before such
deduction, regardless of the institution's actual bad debt experience, subject
to certain limitations.
The Small Business Job Protection Act repealed the reserve method of
accounting for bad debts for savings institutions effective for taxable years
beginning after 1995 and provides for recapture of a portion of the reserves
existing at the close of the last taxable year beginning before January 1, 1996.
As of December 31, 1997, the retained earnings of the Savings Bank were deemed
to include $143,000 of bad debt reserves for income tax purposes for which
deferred taxes of $49,000 have been provided. The deferred taxes are payable
over a six-year period, or are subject to immediate tax if removed from such bad
debt reserve status for purposes other than absorbing losses. For its tax years
beginning on or after January 1, 1996, the Savings Bank is required to account
for its bad debts under the specific charge-off method. Under this method,
deductions may be claimed only as and to the extent that loans become wholly or
partially worthless.
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Alternative Minimum Tax. In addition to the regular corporate income
tax, corporations, including qualifying savings institutions, are subject to an
alternative minimum tax. The 20% tax is computed on Alternative Minimum Taxable
Income ("AMTI") and applies if it exceeds the regular tax liability. AMTI is
equal to regular taxable income with certain adjustments. For taxable years
beginning after 1989, AMTI includes an adjustment for 75% of the excess of
"adjusted current earnings" over regular taxable income. Net operating loss
carrybacks and carryforwards are permitted to offset only 90% of AMTI.
Alternative minimum tax paid can be credited against regular tax due in later
years.
Employees
As of December 31, 1997, the Company and its subsidiaries had a total
of 443 full-time employees. None of the Company's employees were covered by a
collective bargaining agreement. The Company considers its relations with its
employees to be good. Several members of senior management have previously
worked as a team at other lending institutions. Many employees have been
associated with senior management in previous employment positions. The
Company's management believes that these long-term working relationships will
continue to contribute to its growth and success.
Service Marks
The Company has two service marks that have become federally
registered. They are "Armada," which became registered on July 23, 1996, and
"Approved Residential Mortgage," which became registered on May 15, 1995. The
Company also has two service marks that are in the process of registration; they
are "Approved Financial Corp." and "Approved Federal Savings Bank."
Effect of Adverse Economic Conditions
The Company's business may be adversely affected by periods of economic
slowdown or recession which may be accompanied by decreased demand for consumer
credit and declining real estate values. Any material decline in real estate
values reduces the ability of borrowers to use home equity to support borrowings
and increases the loan-to-value ratios of loans previously made by the Company,
thereby weakening collateral coverage and increasing the possibility of a loss
in the event of default. In addition, delinquencies, foreclosures and losses
generally increase during economic slowdowns or recessions.
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Reliance on IMC Mortgage Company
During 1997 and 1996, the Company sold 55.9% and 43.7%, respectively,
of its loans to IMC. The Company's contract with IMC requires the Company to
sell a minimum of $2.0 million of loans to IMC each month. These loan sale
transactions are subject to prevailing secondary market terms for pools of
non-conforming mortgage loans. Historically, these transactions have resulted in
the payment of a cash premium from IMC to the Company. From time to time,
various other purchasers purchase more than 10% of the Company's loan
production. While there are several other major purchasers of non-conforming
mortgage loans as large or larger than IMC, the Company maintains a good working
relationship with IMC. IMC offers to buy a wide range of the Company's loan
products at competitive prices. However, there can be no assurance that IMC will
be in a position to continue to purchase the Company's loan production at
margins favorable to the Company. The Company owned approximately 3.2% of the
outstanding common stock of IMC at December 31, 1997, and 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.
Concentration of Operations in Seven States
During 1997, 81.6% of the aggregate principal balance of the loans
originated by the Company were secured by properties located in seven states
(Florida, Georgia, South Carolina, North Carolina, Virginia, Maryland and
Delaware). Although the Company has expanded its wholesale and retail mortgage
origination networks outside this region, the Company's origination business is
likely to remain concentrated in those states for the foreseeable future.
Consequently, the Company's results of operations and financial condition are
dependent upon general trends in the economy and the residential real estate
markets in those states.
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.
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In future periods, it is expected that the Savings Bank will build a
portfolio of loans for investment, while the majority of the loans currently
being held by the Company are expected to be sold through the Company's loan
sale strategies.
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.
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Asset Quality
The following table summarizes all of the Company's delinquent loans at
December 31, 1997, 1996 and 1995:
(in thousands) 1997 1996 1995
------- ------- -------
Delinquent 31 to 60 days $ 866 $ 1,519 $ 1,039
Delinquent 61 to 90 days 1,124 390 670
Delinquent 91 to 120 days 970 363 245
Delinquent 121 days or more 1,567 794 624
------- ------- -------
Total delinquent loans (1) $ 4,527 $ 3,066 $ 2,578
======= ======= =======
Total loans receivable outstanding, gross of
the allowance for loan losses (1) $82,383 $46,347 $29,024
======= ======= =======
Delinquent loans as a percentage of
total loans outstanding:
Delinquent 31 to 60 days 1.05% 3.28% 3.58%
Delinquent 61 to 90 days 1.36 0.84 2.31
Delinquent 91 to 120 days 1.19 0.78 0.84
Delinquent 121 days or more 1.90 1.71 2.15
------- ------- -------
Total delinquent loans as a percentage
of total loans outstanding 5.50% 6.61% 8.88%
======= ======= =======
- -------------
(1) Includes loans in foreclosure proceedings and delinquent loans to borrowers
in bankruptcy proceedings, but excludes real estate owned.
Interest on most loans is accrued until they become 31 days or more
past due. Interest on loans held for investment by the Savings Bank is accrued
until the loans become 90 days or more past due. The amount of additional
interest that would have been recorded had the loans not been placed on
nonaccrual status was approximately $154,000, $91,000, and $69,000 in 1997, 1996
and 1995, respectively.
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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 30 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.
The adoption of SFAS 114 and 118 did not result in any additional
provision for credit losses at January 1, 1995. At December 31, 1997 and 1996,
the recorded investment in loans for which impairment has been determined in
accordance with SFAS 114 totaled $2,500,000 and $1,200,000. The average recorded
investment in impaired loans for the years ended December 31, 1997 and 1996 was
approximately $780,000 and $64,000, 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. Interest income recognized related to these loans was
approximately $47,000 and $13,000 during 1997 and 1996, respectively. Due to the
homogenous nature and the collateral securing these loans, there is no
corresponding valuation allowance.
Future Risks Associated with Loan Sales through Securitizations
In future periods, the Company may sell a portion of the loans it
originates through a securitization program and retain the rights to service the
loans. The sale of loans through a securitization program would be a significant
departure from the Company's previous business operations.
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Adverse changes in the securitization market could impair the Company's
ability to originate and sell loans through securitizations on a favorable or
timely basis. Any such impairment could have a material adverse effect upon the
Company's results of operations and financial condition. Furthermore, the
Company's quarterly operating results in future periods may fluctuate
significantly as a result of the timing and level of securitizations. If
securitizations do not close when expected, the Company's results of operations
may be adversely affected for that period.
Liquidity - Negative Cash Flow
As a result of its increased volume of loan originations, the Company
has operated, and expects to continue to operate, on a negative cash flow basis.
During 1997, 1996 and 1995, the Company operated on a negative cash flow basis,
using $30,830,000, $15,040,000 and $9,502,000 respectively, more in operations
than was generated, due primarily to an increase in mortgage loans originated.
While the sale of loans through whole loan sales generates immediate cash flows
on the date of sale, the increases in originations have been outpacing its
sales. If the available capital sources of the Company were to decrease
significantly, the rate of growth of the Company would be negatively affected.
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 which 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 is in
the process of implementing 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 estimated cost of compliance is not
considered material to the Company's financial condition.
Contingent Risks
In the ordinary course of its business, the Company is subject to
claims made against it by borrowers and private investors arising from, among
other things, losses that are claimed to have been incurred as a result of
alleged breaches of fiduciary obligations, misrepresentations, errors and
omissions of employees, officers, and agents of the Company (including its
appraisers), incomplete documentation and failures by the Company to comply with
various laws and regulations applicable to its business.
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Although the Company sells substantially all loans that it originates
and purchases on a non-recourse basis, during the period of time that loans are
held pending sale, the Company is subject to the various business risks
associated with lending, including the risk of borrower default, loan
foreclosure and loss, and the risk that an increase in interest rates would
result in a decline in the value of loans to potential purchasers.
Competition
The Company faces intense competition from other mortgage banking
companies, commercial banks, credit unions, thrift institutions, credit card
issuers, and finance companies. Many of these competitors in the financial
services business are substantially larger and have more capital and financial
resources than the Company. Also, the larger national finance companies and
originators of conforming mortgage loans have been adapting their conforming
origination programs to expand into the non-conforming loan business and are
targeting the Company's prime customer base. There can be no assurance that the
Company will not face increased competition from such institutions. Further, a
number of the Company's competitors have recently increased their access to the
capital markets, which helps foster their growth and therefore increases
competition.
Competition can take on many forms, including convenience in obtaining
a loan, service, marketing and distribution channels and interest rates. The
current level of loan sale gains realized by the Company and its competitors is
attracting additional potential competitors, including at least one
quasi-governmental agency, to this market segment, and this additional
competition may lower the gains that the Company can realize in future periods.
The quantity and quality of competition for the Company may also be
affected by fluctuations in interest rates and general economic conditions.
During periods of rising rates, competitors which have "locked in" low borrowing
costs may have a competitive advantage. During periods of declining interest
rates, competitors may solicit the Company's borrowers to refinance their
mortgage loans. During an economic slowdown or recession, the Company's
borrowers may have new financial difficulties and may be receptive to offers by
the Company's competitors.
The Company depends largely on mortgage brokers, for purchases and
originations of new loans. The Company's competitors also seek to establish
relationships with the brokers with which the Company does business. The
Company's future results may become more exposed to fluctuations in the volume
and costs of its wholesale loans resulting from competition from other
purchasers of such loans, market conditions and other factors.
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Regulation
The Company's business is subject to extensive regulation, supervision
and licensing by federal, state and local government authorities and is subject
to various laws and judicial and administrative decisions imposing requirements
and restrictions on part or all of its operations. Regulated matters include
loan origination, credit activities, maximum interest rates and finance and
other charges, disclosure to customers, the terms of secured transactions, the
collection, repossession and claims-handling procedures utilized by the Company,
multiple qualification and licensing requirements for doing business in various
jurisdictions and other trade practices. The following discussion and other
references to and descriptions of the regulation of financial institutions
contained in this document constitute brief summaries of the regulations as
currently in effect. This discussion is not intended to constitute a complete
statement of all the legal restrictions and requirements applicable to the
Company and the Savings Bank and all such descriptions are qualified in their
entirety by reference to applicable statutes, regulations and other regulatory
pronouncements.
The Company's consumer lending activities are subject the federal
Truth-in-Lending Act ("TILA") and Regulation Z (including the Home Ownership and
Equity Protection Act of 1994); the federal Equal Credit Opportunity Act and
Regulation B, as amended (the "ECOA"); the Home Mortgage Disclosure Act and the
Fair Credit Reporting Act of 1970, as amended ("FCRA"); the federal Real Estate
Settlement Procedures Act ("RESPA") and Regulation X; the federal Home Mortgage
Disclosure Act; and the federal Fair Debt Collection Practices Act. The Company
is also subject to state statutes and regulations affecting its activities.
TILA and Regulation Z promulgated thereunder contain disclosure
requirements designed to provide consumers with uniform, understandable
information with respect to the terms and conditions of loans and credit
transactions in order to give them the ability to compare credit terms. TILA
also guarantees consumers a three-day right to cancel certain credit
transactions including loans of the type originated by the Company. Management
of the Company believes that it is in compliance with TILA in all material
respects.
In September 1994, the Riegle Community Development and Regulatory
Improvement Act of 1994 (the "Riegle Act") was enacted. Among other things, the
Riegle Act made certain amendments to TILA. The TILA Amendments, which became
effective in October 1995, generally apply to mortgage loans with (i) total
points and fees upon origination in excess of the greater of eight percent of
the loan amount or $424 or (ii) an annual percentage rate of more than ten
percentage points higher than comparable maturing U.S. Treasury securities.
Loans covered by the TILA Amendments are known as "Section 32 Loans."
The TILA Amendments impose additional disclosure requirements on
lenders originating Section 32 Loans and prohibit lenders from originating
Section 32 Loans that are underwritten solely on the basis of the borrower's
home equity without regard to the borrower's ability to repay the loan. In
accordance with TILA Amendments, the Company applies underwriting criteria that
take into consideration the borrower's ability to repay all Section 32 Loans.
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The TILA Amendments also prohibit lenders from including prepayment fee
clauses in Section 32 loans to borrowers with a debt-to-income ratio in excess
of 50%. In addition, a lender that refinances a Section 32 Loan previously made
by such lender will not be able to enforce any prepayment penalty clause
contained in such refinanced loan. The Company will continue to collect
prepayment fees on loans originated prior to the effectiveness of the TILA
Amendments and on non-Section 32 Loans as well as on Section 32 Loans in
permitted circumstances following the effectiveness of the TILA Amendments. The
TILA Amendments impose other restrictions on Section 32 Loans, including
restrictions on balloon payments and negative amortization features, which the
Company believes will not have a material impact on its operations.
The Company is also required to comply with the ECOA, which prohibits
creditors from discriminating against applicants on the basis of race, color,
sex, age or marital status. Regulation B promulgated under ECOA restricts
creditors from obtaining certain types of information from loan applicants. It
also requires certain disclosures by the lender regarding consumer rights and
requires lenders to advise applicants of the reasons for any credit denial. In
instances where the applicant is denied credit or the rate or charge for a loan
increases as a result of information obtained from a consumer credit agency,
another statute, the FCRA requires the lender to supply the applicant with a
name and address of the reporting agency. The Company is also subject to the
Real Estate Settlement Procedures Act and is required to file an annual report
with the Department of Housing and Urban Development pursuant to the Home
Mortgage Disclosure Act.
The Company is also subject to the rules and regulations of, and
examinations by, the U.S. Department of Housing and Urban Development and state
regulatory authorities with respect to originating, processing, underwriting,
selling and servicing loans. These rules and regulations, among other things,
impose licensing obligations on the Company, establish eligibility criteria for
mortgage loans, prohibit discrimination, provide for inspections and appraisals
of properties, require credit reports on loan applicants, regulate assessment,
collection, foreclosure and claims handling, investment and interest payments on
escrow balances and payment features, and mandate certain loan amounts.
Failure to comply with these requirements can lead to loss of approved
status, termination or suspension of servicing contracts without compensation to
the servicer, demands for indemnifications or mortgage loan repurchases, certain
rights of rescission for mortgage loans, class action lawsuits and
administrative enforcement actions. There can be no assurance that the Company
will maintain compliance with these requirements in the future without
additional expenses, or that more restrictive federal, state or local laws,
rules and regulations will not be adopted that would make compliance more
difficult for the Company. Management believes that the Company is in compliance
in all material respects with applicable federal and state laws and regulations.
The Company is also subject to various other federal and state laws
regulating the issuance and sale of securities, relationships with entities
regulated by the Employee Retirement Income Security Act of 1974, as amended,
and other aspects of its business.
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The laws, rules and regulations applicable to the Company are subject
to regular modification and change. There are currently proposed various laws,
rules and regulations which, if adopted, could impact the Company. There can be
no assurance that these proposed laws, rules and regulations, or other such
laws, rules or regulations, will not be adopted in the future which could make
compliance much more difficult or expensive, restrict the Company's ability to
originate, purchase, broker or sell loans, further limit or restrict the amount
of commissions, interest and other charges earned on loans originated or sold by
the Company, or otherwise adversely affect the business or prospects of the
Company.
OTS Regulation of the Company
General. The Company is a registered savings and loan holding company
under the federal Home Owner's Loan Act ("HOLA") because of its ownership of the
Savings Bank. As such, the Company is subject to the regulation, supervision and
examination of the OTS.
Activities Restriction. There are generally no restrictions on the
activities of a savings and loan holding company, such as the Company, which
holds only one subsidiary savings institution. However, if the Director of the
OTS determines that there is reasonable cause to believe that the continuation
by a savings and loan holding company of an activity constitutes a serious risk
to the financial safety, soundness or stability of its subsidiary savings
institution, the Director may impose such restrictions as deemed necessary to
address such risk, including the limitation of: (i) payment of dividends by the
savings institution; (ii) transactions between the savings institution and its
affiliates; and (iii) any activities of the savings institution that might
create a serious risk that the liabilities of the holding company and its
affiliates may be imposed on the savings institution. Notwithstanding the above
rules as to the permissible business activities of unitary savings and loan
holding companies, if the savings institution subsidiary of such a holding
company fails to meet a qualified thrift lender ("QTL") test set forth in OTS
regulations, then such unitary holding company shall become subject to the
activities and regulations applicable to multiple savings and loan holding
companies and, unless the savings institution requalifies as a QTL within one
year thereafter, shall register as, and become subject to the restriction
applicable to, a bank holding company. See "Regulation of the Savings Bank -
Qualified Thrift Lender Test."
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If the Company were to acquire control of another savings institution
other than through merger or other business combination with the Savings Bank,
the Company would become a multiple savings and loan holding company. Except
where such acquisition is pursuant to the authority to approve emergency thrift
acquisition and where each subsidiary savings institution meets the QTL test, as
set forth below, the activities of the Company and any of its subsidiaries
(other than the Savings Bank or other subsidiary savings institutions) would
thereafter be subject to further restrictions. Among other things, no multiple
savings and loan holding company or subsidiary thereof which is not a savings
institution generally shall commence or continue for a limited period of time
after becoming a multiple savings and loan holding company or subsidiary thereof
any business activity, other than: (i) furnishing or performing management
services for a subsidiary savings institution; (ii) conducting an insurance
agency or escrow business; (iii) holding, managing, or liquidating assets owned
by or acquired from a subsidiary savings institution; (iv) holding or managing
properties used or occupied by a subsidiary savings institution; (v) acting as
trustee under deeds of trust; (vi) those activities authorized by regulation as
of March 5, 1987 to be engaged in by multiple savings and loan holding
companies; or (vii) unless the Director of the OTS by regulation prohibits or
limits such activities for savings and loan holding companies, those activities
authorized by the Federal Reserve Board as permissible for bank holding
companies. Those activities described in clause (vii) above also must be
approved by the Directors of the OTS prior to being engaged in by a multiple
savings and loan holding company.
Restrictions on Acquisitions. Except under limited circumstances,
savings and loan holding companies such as the Company are prohibited from
acquiring, without prior approval of the Director of the OTS, (i) control of any
other savings institution or savings and loan holding company or substantially
all the assets thereof or (ii) more than 5% of the voting shares of a savings
institution or holding company thereof which is not a subsidiary. Except with
the proper approval of the Director of the OTS, no director or officer of a
savings and loan holding company or person owning or controlling by proxy or
otherwise more than 25% of such company's stock, may acquire control of any
savings institution, other than a subsidiary savings institution, or of any
other savings and loan holding company.
The Director of the OTS may approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state only if (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office located in the state of the institution to be acquired as of March
5, 1987; (ii) the acquirer is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provision of the Federal
Deposit Insurance Act ("FDIA"); or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by state-chartered savings institutions located in the state where the
acquiring entity is located (or by a holding company that controls such
state-chartered savings institutions).
Restrictions on Transactions with Affiliates. Transactions between the
Company or any of its non-bank subsidiaries and the Savings Bank are subject to
various restrictions, which are described under "Regulation of the Savings
Bank-Affiliate Transactions."
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Regulation of the Savings Bank
General. The Savings Bank is a federally chartered savings bank
organized under the HOLA. As such, the Savings Bank is subject to regulation,
supervision and examination by the OTS. The deposit accounts of the Savings Bank
are insured up to applicable limits by the SAIF administered by the FDIC and, as
a result, the Savings Bank also is subject to regulation, supervision and
examination by the FDIC. The Savings Bank is also subject to the regulations of
the Board of Governors of the Federal Reserve System governing reserves required
to be maintained against deposits. The Savings Bank is a member of the FHLB of
Atlanta.
The business and affairs of the Savings Bank are regulated in a variety
of ways. Regulations apply to, among other things, insurance of deposit
accounts, capital ratios, payment of dividends, liquidity requirements, the
nature and amount of the investments that the Savings Bank may make,
transactions with affiliates, community and consumer lending laws, internal
policies and controls, reporting by and examination of the Savings Bank and
changes in control of the Savings Bank.
Insurance of Accounts. Deposit accounts of the Savings Bank up to
$100,000 are insured by the Savings Association Insurance Fund (the "SAIF"),
administered by the FDIC. Pursuant to legislation enacted in September 1996, a
fee was paid by all SAIF insured institutions at the rate of $0.657 per $100 of
deposits held by such institutions at March 31, 1995. The money collected
recapitalized the SAIF reserve to the level of 1.25% of insured deposits as
required by law. In 1996, the Savings Bank paid $23,000 for this assessment.
The new legislation also provides for the merger, subject to certain
conditions, of the SAIF into the Bank Insurance Fund ("BIF") by 1999 and also
requires BIF-insured institutions to share in the payment of interest on the
bonds issued by a specially created government entity ("FICO"), the proceeds of
which were applied toward resolution of the thrift industry crisis in the 1980s.
Beginning on January 1, 1997, in addition to the insurance premium that is paid
by SAIF-insured institutions to maintain the SAIF reserve at its required level
pursuant to the current risk classification system, SAIF-insured institutions
pay deposit insurance premiums at the annual rate of 6.4 basis points of their
insured deposits and BIF-insured institutions will pay deposit insurance
premiums at the annual rate of 1.3 basis points of their insured deposits
towards the payment of interest on the FICO bonds. Under the current risk
classification system, institutions are assigned on one of three capital groups
which are based solely on the level of an institution's capital - "well
capitalized," "adequately capitalized" and "undercapitalized" - which are
defined in the same manner as the regulations establishing the prompt corrective
action system under Section 38 of the FDIA, as discussed below. These three
groups are then divided into three subgroups which are based on supervisory
evaluations by the institution's primary federal regulator, resulting in nine
assessment classifications. Assessment rates currently range from zero basis
points for well capitalized, healthy institutions to 27 basis points for
undercapitalized institutions with substantial supervisory concerns.
The recapitalization of the SAIF is expected to result in lower deposit
insurance premiums in the future for most SAIF-insured financial institutions,
including the Savings Bank.
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The FDIC may terminate the deposit insurance of any insured depository
institution, including the Savings Bank, if it determines after a hearing that
the institution has engaged or is engaging in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which would result in
termination of the Savings Bank's deposit insurance.
Regulatory Capital Requirements. Federally-insured savings associations
are required to maintain minimum levels of regulatory capital. These standards
generally must be as stringent as the comparable capital requirements imposed on
national banks. The OTS also is authorized to impose capital requirements in
excess of these standards on individual associations on a case-by-case basis. At
December 31, 1997, the Savings Bank's regulatory capital exceeded applicable
requirements for categorization as "well-capitalized."
Federally-insured savings associations are subject to three capital
requirements: a tangible capital requirement, a core or leverage capital
requirement and a risk-based capital requirement. All savings associations
currently are required to maintain tangible capital of at least 1.5% of adjusted
total assets (as defined in the regulations), core capital equal to 3% of
adjusted total assets and total capital (a combination of core and supplementary
capital) equal to 8% of risk-weighted assets (as defined in the regulations).
For purposes of the regulation, tangible capital is core capital less all
intangibles other than qualifying purchased mortgage servicing rights, of which
the Savings Bank had none at December 31, 1997. Core capital includes common
stockholders' equity, non-cumulative perpetual preferred stock and related
surplus, minority interest in the equity accounts of fully consolidated
subsidiaries and certain nonwithdrawable accounts and pledged deposits. Core
capital generally is reduced by the amount of a savings association's intangible
assets, other than qualifying mortgage servicing rights.
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital included does not exceed the savings association's core capital.
Supplementary capital consists of certain capital instruments that do not
qualify as core capital, including subordinated debt which meets specified
requirements, and general valuation loan and lease loss allowances up to a
maximum of 1.25% of risk-weighted assets. In determining the required amount of
risk-based capital, total assets, including certain off-balance sheet items, are
multiplied by a risk weight based on the risks inherent in the type of assets.
The risk weights assigned by the OTS for principal categories of assets
currently range from 0% to 100%, depending on the type of asset.
39
<PAGE>
OTS policy imposes a limitation on the amount of net deferred tax
assets under SFAS No. 109 that may be included in regulatory capital. (Net
deferred tax assets represent deferred tax assets, reduced by any valuation
allowances, in excess of deferred tax liabilities.) Application of the limit
depends on the possible sources of taxable income available to an institution to
realize deferred tax assets. Deferred tax assets that can be realized from the
following generally are not limited: taxes paid in prior carryback years and
future reversals of existing taxable temporary differences. To the extent that
the realization of deferred tax assets depends on an institution's future
taxable income (exclusive of reversing temporary differences and carryforwards),
or its tax-planning strategies, such deferred tax assets are limited for
regulatory capital purposes to the lesser of the amount that can be realized
within one year of the quarter-end report date or 10% of core capital. The
foregoing considerations did not affect the calculation of the Savings Bank's
regulatory capital at December 31, 1997.
In August 1993, the OTS adopted a final rule incorporating an
interest-rate risk component into the risk-based capital regulation. Under the
rule, an institution with a greater than "normal" level of interest rate risk
will be subject to a deduction of its inherent rate risk component from total
capital for purposes of calculating the risk-based capital requirement. As a
result, such an institution will be required to maintain additional capital in
order to comply with the risk-based capital requirement. Although the final rule
was originally scheduled to be effective as of January 1994, the OTS has
indicated that it will delay invoking its interest rate risk rule requiring
institutions with above normal interest rate risk exposure to adjust their
regulatory capital requirement until appeal procedures are implemented and
evaluated. The OTS has not yet established an effective date for the capital
deduction. Management of the Company does not believe that the OTS' adoption of
an interest rate risk component to the risk-based capital requirement will
adversely affect the Savings Bank if it becomes effective in its current form.
In April 1991, the OTS proposed to modify the 3% of adjusted total
assets core capital requirement in the same manner as was done by the
Comptroller of the Currency for national savings banks. Under the OTS proposal,
only savings associations rated composite 1 under the CAMEL rating system will
be permitted to operate at the regulatory minimum core capital ratio of 3%. For
all other savings associations, the minimum core capital ratio will be 3% plus
at least an additional 100 to 200 basis points, which will increase the 4% core
capital ratio requirement to 5% of adjusted total assets or more. In determining
the amount of additional capital, the OTS will assess both the quality of risk
management systems and the level of overall risk in each individual savings
association through the supervisory process on a case-by-case basis.
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Prompt Corrective Action. Federal law provides the federal banking
regulators with broad power to take "prompt corrective action" to resolve the
problems of undercapitalized institutions. The extent of the regulators' powers
depends on whether the institution in question is "well capitalized,"
"adequately capitalized," "under-capitalized," "significantly undercapitalized"
or "critically undercapitalized." Under regulations adopted by the federal
banking regulators, an institution shall be deemed to be (i) "well capitalized"
if it has a total risk-based capital ratio of 10.0% or more, has a Tier I
risk-based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of
5.0% or more and is not subject to specified requirements to meet and maintain a
specific capital level for any capital measure; (ii) "adequately capitalized" if
it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based
capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or
more (3.0% under certain circumstances) and does not meet the definition of
"well capitalized," (iii) "undercapitalized" if it has a total risk-based
capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is
less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0%
under certain circumstances), (iv) "significantly undercapitalized" if it has a
total risk-based capital ratio that is less than 6.0%, a Tier I risk-based
capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is
less than 3.0%, and (v) "critically undercapitalized" if it has a ratio of
tangible equity to adjusted total assets that is equal to or less than 2.0%. The
regulations also permit the appropriate federal Savings Banking regulator to
downgrade an institution to the next lower category (provided that a
significantly undercapitalized institution may not be downgraded to critically
undercapitalized) if the regulator determines (i) after notice and opportunity
for hearing or response, that the institution is an unsafe or unsound condition
or (ii) that the institution has received (and not corrected) a
less-than-satisfactory rating for any of the categories of asset quality,
management, earnings or liquidity in its most recent exam. At December 31, 1997,
the Savings Bank was a "well capitalized" institution under the prompt
corrective action regulations of the OTS.
Depending upon the capital category to which an institution is
assigned, the regulators' corrective powers, many of which are mandatory in
certain circumstances, include prohibition on capital distributions; prohibition
on payment of management fees to controlling persons; requiring the submission
of a capital restoration plan; placing limits on asset growth; limiting
acquisitions, branching or new lines of business; requiring the institution to
issue additional capital stock (including additional voting stock) or to be
acquired; restricting transactions with affiliates; restricting the interest
rates that the institution may pay on deposits; ordering a new election of
directors of the institution; requiring that senior executive officers or
directors be dismissed; prohibiting the institution from accepting deposits from
correspondent banks; requiring the institution to divest certain subsidiaries;
prohibiting the payment of principal or interest on subordinated debt; and,
ultimately, appointing a receiver for the institution.
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Qualified Thrift Lender Test. All savings associations are required to
meet the QTL test set forth in the HOLA and regulations to avoid certain
restrictions on their operations. A savings association that does not meet the
QTL test set forth in the HOLA and implementing regulations must either convert
to a bank charter or comply with the following restrictions on its operations:
(i) the association may not engage in any new activity or make any new
investment, directly or indirectly, unless such activity or investment is
permissible for a national bank; (ii) the branching powers of the association
shall be restricted to those of a national bank; (iii) the association shall not
be eligible to obtain any advances from its FHLB; and (iv) payment of dividends
by the association shall be subject to the rules regarding payment of dividends
by a national bank. Upon the expiration of three years from the date the
association ceases to be a QTL, it must cease any activity and not retain any
investment not permissible for a national bank and immediately repay any
outstanding FHLB advances (subject to safety and soundness considerations). The
Savings Bank met the QTL test throughout 1997.
Restrictions on Capital Distributions. The OTS has promulgated a
regulation governing capital distributions by savings associations, which
include cash dividends, stock redemption's or repurchases, cash-out mergers,
interest payments on certain convertible debt and other transactions charged to
the capital account of a savings association as a capital distribution.
Generally, the regulation creates three tiers of associations based on
regulatory capital, with the top two tiers providing a safe harbor for specified
levels of capital distributions from associations so long as such associations
notify the OTS and receive no objection to the distribution from the OTS.
Associations that do not qualify for the safe harbor provided for the top two
tiers of associations are required to obtain prior OTS approval before making
any capital distributions.
Tier 1 associations may make the highest amount of capital
distributions, and are defined as savings associations that before and after the
proposed distribution meet or exceed their fully phased-in regulatory capital
requirements. Tier 1 associations may make capital distributions during any
calendar year equal to the greater of (i) 100% of net income for the calendar
year-to-date plus 50% of its "surplus capital ratio" at the beginning of the
calendar year and (ii) 75% of its net income over the most recent four-quarter
period. The "surplus capital ratio" is defined to mean the percentage by which
the association's ratio of total capital to assets exceeds the ratio of its
"fully phased-in capital requirement" to assets, and "fully phased-in capital
requirement" is defined to mean an association's capital requirement under the
statutory and regulatory standards applicable on December 31, 1994, as modified
to reflect any applicable individual minimum capital requirement imposed upon
the association. At December 31, 1997, the Savings Bank was a Tier 1 association
under the OTS capital distribution regulation.
In December 1994, the OTS published a notice of proposed rulemaking to
amend its capital distribution regulation. Under the proposal, the three tiered
approach contained in existing regulations would be replaced and institutions
would be permitted to make capital distributions that would not result in their
capital being reduced below the level required to remain "adequately
capitalized," as defined above under "Prompt Corrective Action."
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Loan-to-One Borrower. Under applicable laws and regulations the amount
of loans and extensions of credit which may be extended by a savings institution
such as the Savings Bank to any one borrower, including related entities,
generally may not exceed the greater of $500,000 or 15% of the unimpaired
capital and unimpaired surplus of the institution. Loans in an amount equal to
an additional 10% of unimpaired capital and unimpaired surplus also may be made
to a borrower if the loans are fully secured by readily marketable securities.
An institution's "unimpaired capital and unimpaired surplus" includes, among
other things, the amount of its core capital and supplementary capital included
in its total capital under OTS regulations.
At December 31, 1997, the Savings Bank's unimpaired capital and surplus
amounted to $3,242,000, resulting in a general loans-to-one borrower limitation
of $500,000 under applicable laws and regulations.
Brokered Deposits. Under applicable laws and regulations, an insured
depository institution may be restricted in obtaining, directly or indirectly,
funds by or through any "deposit broker," as defined, for deposit into one or
more deposit accounts at the institution. The term "deposit broker" generally
includes any person engaged in the business of placing deposits, or facilitating
the placement of deposits, of third parties with insured depository institutions
or the business of placing deposits with insured depository institutions for the
purpose of selling interest in those deposits to third parties. In addition, the
term "deposit broker" includes any insured depository institution, and any
employee of any insured depository institution, which engages, directly or
indirectly, in the solicitation of deposits by offering rates of interest (with
respect to such deposits) which are significantly higher than the prevailing
rates of interest on deposits offered by other insured depository institutions
have the same type of charter in such depository institution's normal market
area. As a result of the definition of "deposit broker," all of the Savings
Bank's brokered deposits, as well as possibly its deposits obtained through
customers of regional and local investment banking firms and the deposits
obtained from the Savings Bank's direct solicitation efforts of institutional
investors and high net worth individuals, are potentially subject to the
restrictions described below. Under FDIC regulations, well-capitalized
institutions are subject to no brokered deposit limitations, while
adequately-capitalized institutions are able to accept, renew or roll over
brokered deposits only (i) with a waiver from the FDIC and (ii) subject to the
limitation that they do not pay an effective yield on any such deposit which
exceeds by more than (a) 75 basis points the effective yield paid on deposits of
comparable size and maturity in such institution's normal market area for
deposits accepted in its normal market area or (b) by 120% for retail deposits
and 130% for wholesale deposits, respectively, of the current yield on
comparable maturity U.S. Treasury obligations for deposits accepted outside the
institution's normal market area. Undercapitalized institutions are not
permitted to accept brokered deposits and may not solicit deposits by offering
any effective yield that exceeds by more than 75 basis points, the prevailing
effective yields on insured deposits of comparable maturity in the institution's
normal market area or in the market area in which such deposits are being
solicited. At December 31, 1997, the Savings Bank was a well-capitalized
institution which was not subject to restrictions on brokered deposits. See
"Business - Savings Bank Sources of Funds - Deposits."
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Liquidity Requirements. All savings associations are required to
maintain an average daily balance of liquid assets, which include specified
short-term assets and certain long-term assets, equal to a certain percentage of
the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings associations. At the present time, the required liquid
asset ratio is 4%. Historically, the Savings Bank has operated in compliance
with these requirements.
Affiliate Transactions. Under federal law and regulation, transactions
between a savings association and its affiliates are subject to quantitative and
qualitative restrictions. Affiliates of a savings association include, among
other entities, companies that control, are controlled by or are under common
control with the savings association. As a result, the Company and its non-bank
subsidiaries are affiliates of the Savings Bank.
Savings associations are restricted in their ability to engage in
"covered transactions" with their affiliates. In addition, covered transactions
between a savings association and an affiliate, as well as certain other
transactions with or benefiting an affiliate, must be on terms and conditions at
least as favorable to the savings association as those prevailing at the time
for comparable transactions with non-affiliated companies. Savings associations
are required to make and retain detailed records of transactions with
affiliates.
Notwithstanding the foregoing, a savings association is not permitted
to make a loan or extension of credit to any affiliate unless the affiliate is
engaged only in activities the Federal Reserve Board has determined to be
permissible for bank holding companies. Savings associations also are prohibited
from purchasing or investing in securities issued by an affiliate, other than
shares of a subsidiary of the savings association.
Savings associations are also subject to various limitations and
reporting requirements on loans to insiders. These limitations require, among
other things, that all loans or extensions of credit to insiders (generally
executive officers, directors or 10% stockholders of the institution) or their
"related interest" be made on substantially the same terms (including interest
rates and collateral) as, and follow credit underwriting procedures that are not
less stringent than, those prevailing for comparable transactions with the
general public and not involve more than the normal risk of repayment or present
other unfavorable features.
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Community Investment and Consumer Protection Laws. In connection with
its lending activities, the Savings Bank is subject to the same federal and
state laws applicable to the Company generally, laws designed to protect
borrowers and promote lending to various sectors of the economy and population.
In addition, the Savings Bank is subject to the federal Community Reinvestment
Act ("CRA"). The CRA requires each bank or savings association to identify the
communities it serves and the types of credit or other financial services the
bank or savings association is prepared to extend to those communities. The CRA
also requires the OTS to assess a savings association's record of helping to
meet the credit needs of its community and to take the assessment into
consideration when evaluating applications for mergers, applications and other
transactions. The OTS may assign a rating of "outstanding," "satisfactory,"
"needs to improve," or "substantial noncompliance." A less than satisfactory CRA
rating may be the basis for denying such applications. The OTS has not conducted
a CRA review of the Savings Bank since the Company acquired the Savings Bank on
September 11, 1996. However, management believes the OTS will have a favorable
view of the Savings Bank's recent CRA record.
Under the CRA and implementing OTS regulations, a savings association
has a continuing and affirmative obligation to help meet the credit needs of its
local communities, including low- and moderate-income neighborhoods, consistent
with the safe and sound operation of the institution. Until July 1, 1997, the
OTS implementing regulations required the board of directors of each savings
association to adopt a CRA statement for each delineated local community that,
among other things, describes its efforts to help meet community credit needs
and the specific types of credit that the institution is willing to extend.
Under new standards, the OTS will assign a CRA rating based on a Lending Test,
Investment Test and Service Test keyed to, respectively, the number of loans,
the number of investments, and the level of availability of retail banking
services in a savings association's assessment area. The Lending Test will be
the primary component of the assigned composite rating. An "outstanding" rating
on the Lending Test automatically will result in at least a "satisfactory"
rating in the composite, but an institution cannot receive a "satisfactory" or
better rating on the composite if it does not receive at least a "low
satisfactory" rating on the Lending Test. Alternatively, a savings association
may elect to be assessed by complying with a strategic plan approved by the OTS.
Evaluation under the new rules is mandatory after June 30, 1997; however, a
savings association could elect to be evaluated under the new rules beginning on
January 1, 1996, although the Savings Bank did not elect to do so. Data
collection requirements became effective January 1, 1996.
Safety and Soundness. Other regulations which were recently adopted or
are currently proposed to be adopted pursuant to recent legislation include: (i)
real estate lending standards for insured institutions, which provide guidelines
concerning loan-to-value ratios for various types of real estate loans; (ii)
revisions to the risk-based capital rules to account for interest rate risk,
concentration of credit risk and the risks posed by "non-traditional
activities;" (iii) rules requiring depository institutions to develop and
implement internal procedures to evaluate and control credit and settlement
exposure to their correspondent banks; and (iv) rules addressing various "safety
and soundness" issues, including operations and managerial standards, standards
for asset quality, earnings and stock valuations, and compensation standards for
the officers, directors, employees and principal stockholders of the insured
institution.
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Legislative Risk
Members of Congress and government officials from time to time have
suggested the elimination of the mortgage interest deduction for federal income
tax purposes, either entirely or in part, based on borrower income, type of loan
or principal amount. Because many of the Company's loans are made to borrowers
for the purpose of consolidating consumer debt or financing other consumer
needs, the competitive advantages of tax deductible interest, when compared with
alternative sources of financing, could be eliminated or seriously impaired by
such government action. Accordingly, the reduction or elimination of these tax
benefits could have a material adverse effect on the demand for loans of the
kind offered by the Company.
Environmental Factors
To date, the Company has not been required to perform any investigation
or clean up activities, nor has it been subject to any environmental claims.
There can be no assurance, however, that this will remain the case in the
future. In the ordinary course of its business, the Company from time to time
forecloses on properties securing loans. Although the Company primarily lends to
owners of residential properties, there is a risk that the Company could be
required to investigate and clean up hazardous or toxic substances or chemical
releases at such properties after acquisition by the Company, and could be held
liable to a governmental entity or to third parties for property damage,
personal injury, and investigation and cleanup costs incurred by such parties in
connection with the contamination. The costs of investigation, remediation or
removal of such substances may be substantial, and the presence of such
substances, or the failure to properly remediate such property, may adversely
affect the owner's ability to sell or rent such property or to borrow using such
property as collateral. Persons who arrange for the disposal or treatment of
hazardous or toxic substances also may be liable for the costs of removal or
remediation of such substances at the disposal or treatment facility, whether or
not the facility is owned or operated by such person. In addition, the owner or
former owners of a contaminated site may be subject to common law claims by
third parties based on damages and costs resulting from environmental
contamination emanating from such property.
In the course of its business, the Company may acquire properties as a
result of foreclosure. There is a risk that hazardous or toxic waste could be
found on such properties. In such event, the Company could be held responsible
for the cost of cleaning up or removing such waste, and such cost could exceed
the value of the underlying properties.
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Dependence on Key Personnel
The Company's growth and development to date have been largely
dependent upon the services of Allen D. Wykle, Chairman of the Board, President
and Chief Executive Officer, Neil W. Phelan, Executive Vice President in charge
of the broker lending division, and Barry C. Diggins, a key member of the retail
lending management team. The loss of Mr. Wykle's, Mr. Phelan's or Mr. Diggins'
services for any reason could have a material adverse effect on the Company.
Certain of the Company's principal credit agreements contain a provision which
permit the lender to accelerate the Company's obligations in the event that Mr.
Wykle were to leave the Company for any reason and not be replaced with an
executive acceptable to such lender.
Control by Certain Shareholders
As of March 15, 1998, Allen D. Wykle, Chairman of the Board, President
and Chief Executive Officer and Leon H. Perlin, Director, beneficially own an
aggregate of 50.1% of the outstanding shares of Common Stock of the Company.
Accordingly, such persons, if they were to act in concert, would have majority
control of the Company, with the ability to approve certain fundamental
corporate transactions and the election of the entire Board of Directors.
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ITEM 2 - PROPERTIES
Properties
The Company's executive and administrative offices are located at 3420
Holland Road, Virginia Beach, Virginia. The building consists of approximately
15,000 square feet and is owned by the Company. In June 1997, the Company
purchased a building adjacent to its headquarters to accommodate its growth
plans. The second building consists of approximately 20,000 square feet. The
Company occupies approximately 17,000 square feet in this building, and the
remainder is leased to third-party tenants. The two buildings are subject to
total mortgage debt of $1,216,000 as of December 31, 1997.
As of December 31, 1997 the Company had leases for regional broker
lending offices, retail lending offices, and the Savings Bank's administrative
office. These facilities aggregate approximately 57,000 square feet and are
leased under terms which vary as to duration. In general, the leases expire
between January 1998 and October 2002, and provide rent escalations tied to
either increases in the lessor's operating expenses or fluctuations in the
consumer price index in the relevant geographic area.
The Company anticipates that it may need to obtain additional space to
accommodate its growth plans for 1998.
ITEM 3 - LEGAL PROCEEDINGS
The Company is a party to various routine legal proceedings arising out
of the ordinary course of its business. Management believes that none of these
actions, individually or in the aggregate, will have a material adverse effect
on the results of operations or financial condition of the Company.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS
None.
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PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
Market Price of and Cash Dividends on the Company's Common Equity
The following table shows the quarterly high, low and closing prices of
the Company's common stock for 1997, 1996 and the second six months of 1995 and
cash dividends paid per share. Stock prices for the first six months of 1995 are
not available. All stock price and dividend data has been adjusted to reflect
two-for-one stock splits which occurred on August 30, 1996 and December 16,
1996, and a 100% stock dividend which occurred on November 21, 1997.
Stock Prices
-------------------------------- Cash
High Low Close Dividends
------ ------ ------ ---------
1997:
Fourth Quarter $17.00 $12.75 $14.75 $ --
Third Quarter 17.00 8.00 15.00 --
Second Quarter 10.00 6.00 8.25 --
First Quarter 13.50 8.50 9.75 --
1996:
Fourth Quarter 11.50 8.00 8.50 .01
Third Quarter 9.13 3.75 9.00 .01
Second Quarter 4.75 2.13 3.88 .01
First Quarter 2.25 2.06 2.19 .01
1995:
Fourth Quarter 2.14 1.84 2.14 .01
Third Quarter 1.78 1.46 1.71 .01
The Company did not pay any cash dividends on its Common Stock in 1997.
The Company intends to retain all of its earnings to finance its operations and
does not anticipate paying cash dividends for the foreseeable future. Any
decision made by the Board of Directors to declare dividends in the future will
depend on the Company's future earnings, capital requirements, financial
condition and other factors deemed relevant by the Board.
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Absence of Active Public Trading Market and Volatility of Stock Price
The Company's Common Stock is traded on the National Quotation Bureau,
Inc. OTC Bulletin Board under the symbol "APFN." Historically, there has been a
limited market for the Company's Common Stock. As a result, the prices reported
for the Company's Common Stock reflect the relative lack of liquidity and may
not be reliable indicators of market value. There can be no assurance that an
active public trading market for the Company's Common Stock will be created in
the future.
The Company intends to file an application with the National
Association of Securities Dealers in Washington, D.C. to request a listing on
the NASDAQ National Market.
The market price of the Common Stock may experience fluctuations that
are unrelated to the operating performance of the Company. In particular, the
price of the Common Stock may be affected by general market price movements as
well as developments specifically related to the residential mortgage lending
industry such as, among other things, interest rate movements, delinquencies,
loan payment speeds, and loss trends.
Transfer Agent and Registrar
The Transfer Agent for the Company's Common Stock is First Union
National Bank, 230 South Tryon Street, 11th Floor, Charlotte, North Carolina
28288-1153.
Recent Sales of Unregistered Securities
In connection with the offering of 225,000 new shares of Common Stock
in the State of Virginia, pursuant to Section 3(a)(11) of the Securities Act of
1933 and Rule 147 issued thereunder, the Company in 1992 also issued warrants to
its existing eleven shareholders, also in Virginia, to purchase 47,601 shares of
Common Stock for $7.50 per share. The warrants were convertible for a five year
period expiring April 20, 1997. Nine of the eleven shareholders exercised the
warrants prior to their expiration. Taking into account all prior stock splits,
362,968 shares were issued at $0.935 per share for an aggregate price of
$339,375.
Of the 362,968 shares issued, 305,712 were purchased by the two largest
shareholders of the Company: Allen D. Wykle, President and Chief Executive
Officer, and Leon H. Perlin. Both are directors. Three other shareholders who
purchased shares upon the exercise of the warrants were also directors, and one
shareholder was the spouse of a director. Most were accredited investors at the
time of exercise. The Company relied on a private exemption from registration
under Section 4(2) of the Securities Act of 1933, and the regulations issued
thereunder. The stock bears a restrictive legend, is subject to an
administrative stop, may not be resold without an opinion of the Company's legal
counsel, and is subject to the resale requirements of Rule 144.
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Since December 1994, the Company had conducted a portion of its retail
lending business through Armada Residential Mortgage, LLC ("Armada LLC"), which
was owned 1% by the Company, 82% by ARMI and 17% by Armada LLC's senior officer.
In connection with terminating Armada LLC, in September 1997 the Company agreed
to issue 106,146 shares of its Common Stock to purchase the senior officer's
ownership interest in Armada LLC. The Company issued 2,000 shares to the senior
officer on October 10, 1997 and 104,146 shares on January 5, 1998. The senior
officer terminated his employment with Armada LLC and became an employee of
ARMI. He also became a Director of the Company. The Company also agreed to issue
6,780 shares to a key employee of Armada LLC. The Company issued 1,000 shares to
the key employee on October 10, 1997 and 13,560 shares on January 5, 1998. The
key employee terminated his employment with Armada LLC and became an employee of
ARMI. The stock bears a restrictive legend, is subject to an administrative
stop, may not be resold without an opinion of the Company's legal counsel, and
is subject to the resale requirements of Rule 144. No broker or general
solicitation was involved. The Company relied on an exemption from registration
under Section 4(2) of the Securities Act of 1933, and the regulations issued
thereunder, and Rule 701. The share figures have been adjusted for the 100%
stock dividend, which occurred on November 21, 1997.
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ITEM 6 - SELECTED FINANCIAL DATA
The historical consolidated financial data for the five years ended
December 31, 1997 were derived from the consolidated financial statements of the
Company included elsewhere herein. The historical consolidated financial data
are not necessarily indicative of the results of operations for any future
period. This information should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the historical consolidated financial statements and notes thereto included
elsewhere herein. Unless otherwise indicated, all financial data has been
adjusted to reflect two-for-one stock splits which occurred on August 30, 1996
and December 16, 1996, and a 100% stock dividend which occurred on November 21,
1997.
52
<PAGE>
APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
Years Ended
December 31 1997 1996 1995 1994 1993
- ----------- -------- -------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Revenue:
Gain on sale of loans $ 33,501 $ 17,955 $ 7,298 $ 2,184 $ 2,641
Interest income 10,935 4,520 3,065 2,556 3,338
Gain on sale of securities 2,796 - - - -
Other fees and income 4,934 2,407 1,535 639 227
-------- -------- ------- ------- -------
Total revenue 52,166 24,882 11,898 5,379 6,206
-------- -------- ------- ------- -------
Expenses:
Compensation (1) 16,447 8,017 3,880 1,452 1,040
General and administrative 14,188 6,853 3,050 1,337 1,122
Interest expense 6,157 3,121 2,194 1,700 1,781
Provision for loan and
foreclosed property losses 1,676 1,308 731 191 426
-------- -------- ------- ------- -------
Total expenses 38,468 19,299 9,855 4,680 4,369
-------- -------- ------- ------- -------
Income before income taxes 13,698 5,583 2,043 699 1,837
Income taxes 5,638 2,259 876 328 761
-------- -------- ------- ------- -------
Net income $ 8,060 $ 3,324 $ 1,167 $ 371 $ 1,076
======== ======= ======= ======== =======
Net income per share (diluted) (2) $ 1.51 $ 0.63 $ 0.23 $ 0.07 $ 0.21
======== ======= ======= ======== =======
Cash dividends per share (2) $ - $ 0.04 $ 0.04 $ 0.04 $ 0.04
======== ======= ======= ======== =======
Weighted average number
of shares outstanding (diluted) 5,345,957 5,281,103 5,062,809 5,035,350 5,077,440
========= ========= ========= ========= =========
</TABLE>
- -------------
(1) This document reclassifies "minority interests in consolidated
subsidiaries" as "compensation."
(2) All per-share data has been adjusted to reflect two-for-one stock splits
which occurred on August 30, 1996 and December 16, 1996, and a 100% stock
dividend which occurred on November 21, 1997.
53
<PAGE>
APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Years Ended
December 31 1997 1996 1995 1994 1993
- ----------- -------- -------- -------- -------- --------
SELECTED BALANCES AT YEAR END
<S> <C> <C> <C> <C> <C>
Loans receivable, net $ 80,696 $ 45,423 $ 28,430 $ 18,021 $ 16,216
Securities 15,201 20,140 - - -
Total assets 118,125 75,143 34,485 23,109 21,663
Revolving warehouse loans 52,488 32,030 19,566 7,727 5,790
FDIC-insured deposits 17,815 1,576 - - -
Subordinated debt 9,080 9,183 6,905 8,546 9,561
Total liabilities (1) 93,070 53,934 28,250 17,465 16,291
Shareholders' equity 25,055 21,209 6,236 5,645 5,372
SELECTED LOAN DATA
Loans originated $468,955 $258,833 $111,505 $ 43,079 $ 56,972
Loans sold 420,498 228,918 83,328 34,409 56,909
Amount of loans serviced
at year-end 83,512 48,785 29,249 18,482 16,434
Loans delinquent 31 days or
more as percent of
loans at year-end 5.50% 6.61% 8.88% 7.03% 12.07%
SELECTED RATIOS
Return on average assets 7.68% 7.32% 4.06% 1.67% 4.61%
Return on average
shareholders' equity 32.69% 36.44% 19.86% 6.80% 21.83%
Shareholders' equity
to assets 21.21% 28.22% 18.08% 24.43% 24.80%
Book value per share (2) $ 4.64 $ 4.21 $ 1.28 $ 1.09 $ 1.06
</TABLE>
- -------------
(1) Includes minority interests in subsidiaries.
(2) All per-share data has been adjusted to reflect two-for-one stock splits
which occurred on August 30, 1996 and December 16, 1996, and a 100% stock
dividend which occurred on November 21, 1997.
54
<PAGE>
ITEM 7. 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 each year in the three-year period ended December 31, 1997 and
its consolidated financial position at December 31, 1997, 1996 and 1995. 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. This
discussion should be reviewed in conjunction with the consolidated financial
statements and accompanying notes and other statistical information presented in
the Company's 1997 audited financial statements.
Results of Operations for the Years Ended December 31, 1997, 1996 and 1995
Net Income. The Company's net income for 1997 was $8,060,000 compared
to net income of $3,324,000 in 1996 and $1,167,000 in 1995. On a per share basis
(diluted), income for 1997 was $1.51, compared to $0.63 for 1996 and $0.23 for
1995.
The per-share figures have been adjusted to reflect two-for-one stock
splits of the Company's common stock, which occurred on August 30, 1996 and
December 16, 1996, and a 100% stock dividend which occurred on November 21,
1997.
The following table shows changes in net income per share (diluted):
1997 1996 1995
Versus 1996 Versus 1995 Versus 1994
----------- ----------- -----------
Net income per share for 1996,
1995 and 1994, respectively $ .63 $ .23 $ .07
Increase (decrease) attributable to:
Gains on sale of loans 2.79 2.10 1.02
Net interest income .62 .11 --
Other income .98 .18 .17
Compensation expense (1.53) (.81) (.48)
Other expenses (1.39) (.86) (.45)
Income taxes (.62) (.28) (.10)
Average shares outstanding .03 (.04) --
----- ----- -----
Net increase .88 .40 .16
----- ----- -----
Net income per share for 1997,
1996 and 1995, respectively $1.51 $ .63 $ .23
===== ===== =====
55
<PAGE>
The return on average assets was 7.68% in 1997, compared to 7.32% in
1996 and 4.06% in 1995. Return on average shareholders' equity was 32.69% in
1997, compared to 36.44% in 1996 and 19.86% in 1995.
Origination of Mortgage Loans. The following table shows the loan
originations in dollars and units for the Company's broker and retail units in
1997, 1996 and 1995:
(Dollars in thousands)
Years Ended
December 31 1997 1996 1995
- ----------- -------- -------- --------
Dollar Volume of Loan Originations:
Broker $256,417 $162,887 $ 61,378
Retail 212,538 95,946 50,127
-------- -------- --------
Total $468,955 $258,833 $111,505
======== ======== ========
Number of Loans Originated:
Broker 4,399 2,670 1,023
Retail 4,022 1,683 835
-------- -------- --------
Total 8,421 4,353 1,858
======== ======== ========
The increases in the dollar volume of loan originations of 81.2% in 1997, 132.2%
in 1996 and 158.8% in 1995 reflect strong growth in both broker and retail
lending operations.
The Company's broker lending division originated $256,417,000 of
residential mortgage loans during 1997, compared to $162,887,000 in 1996 and
$61,378,000 in 1995. The 57.4% increase in originations in 1997 compared to 1996
and the 165.4% increase in 1996 compared to 1995 were due to additional broker
account representatives, and back-office capabilities. On a unit basis, the
Company originated 4,399 loans in its broker operation in 1997, compared to
2,670 loans in 1996 and 1,023 in 1995.
The Company's retail lending division originated $212,538,000 of
residential mortgage loans in 1997, compared to $95,946,000 in 1996 and
$50,127,000 in 1995. The 121.5% increase in 1997 compared to 1996 and the 91.4%
increase in 1996 compared to 1995 is attributed to additional retail loan
offices and back-office capabilities. On a unit basis, the Company originated
4,022 loans in its retail operation in 1997, compared to 1,683 loans in 1996 and
835 in 1995.
In addition to originating residential mortgage loans, the Company also
purchases loans to obtain geographic diversity and yields not obtainable in the
Company's normal lending areas. However, purchases during 1997, 1996 and 1995
were minimal.
56
<PAGE>
The following tables summarize mortgage loan originations, by state,
for the years ended December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
(In thousands)
Years Ended
December 31 1997 1996 1995
- ----------- -------------------- -------------------- -------------------
Dollars Percent Dollars Percent Dollars Percent
-------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Broker Division:
Maryland $ 29,997 6.4% $ 9,609 3.7% $ 10,626 9.5%
North and South Carolina 33,420 7.1 33,568 13.0 1,477 1.3
Georgia 59,792 12.8 54,488 21.1 26,831 24.1
Florida 61,897 13.2 36,711 14.2 18,101 16.2
Ohio 32,578 6.9 3,314 1.3 -- --
Virginia 5,415 1.2 9,405 3.6 2,320 2.1
Illinois 12,781 2.7 8,631 3.3 -- --
Indiana 9,131 1.9 2,761 1.1 2,023 1.8
Tennessee 7,826 1.7 886 0.3 -- --
Michigan 3,680 0.8 3,514 1.4 -- --
-------- ----- -------- ----- -------- -----
Total Broker Division $256,417 54.7% $162,887 63.0% $ 61,378 55.0%
======== ===== ======== ===== ======== =====
Retail Division:
Maryland $ 66,954 14.4% $ 45,089 17.3% $ 30,444 27.4%
North and South Carolina 57,618 12.3 12,353 4.8 2,020 1.8
Georgia 12,886 2.7 25,599 9.9 13,862 12.4
Florida 4,141 0.9 -- -- -- --
Ohio 12,666 2.7 61 -- -- --
Virginia 34,442 7.3 11,108 4.3 3,801 3.4
Illinois 4,877 1.0 -- -- -- --
Delaware 16,056 3.4 1,736 0.7 -- --
Indiana 2,813 0.6 -- -- -- --
Kentucky 85 -- -- -- -- --
-------- ----- -------- ----- -------- -----
Total Retail Division $212,538 45.3% $ 95,946 37.0% $ 50,127 45.0%
======== ===== ======== ===== ======== =====
Total originations:
Maryland $ 96,951 20.8% $ 54,698 21.0% $ 41,070 36.9%
North and South Carolina 91,038 19.4 45,921 17.8 3,497 3.1
Georgia 72,678 15.5 80,087 31.0 40,693 36.5
Florida 66,038 14.1 36,711 14.2 18,101 16.2
Ohio 45,144 9.6 3,375 1.3 -- --
Virginia 39,857 8.5 20,513 7.9 6,121 5.5
Illinois 17,658 3.7 8,631 3.3 -- --
Delaware 16,056 3.4 1,736 0.7 -- --
Indiana 11,944 2.5 2,761 1.1 2,023 1.8
Tennessee 7,826 1.7 886 0.3 -- --
Michigan 3,680 0.8 3,514 1.4 -- --
Kentucky 85 -- -- -- -- --
-------- ----- -------- ----- -------- -----
Total originations $468,955 100.0% $258,833 100.0% $111,505 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
57
<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 $420,498,000 of mortgage loans during 1997, compared
to $228,918,000 in 1996 and $83,328,000 in 1995. Sales volume increased by 83.7%
in 1997, by 174.7% in 1996 and by 142.2% in 1995. The magnitudes of the
period-to-period changes in loan sales are consistent with and reflect the
percentage changes in mortgage loan originations in those periods.
For 1997, gain on the sale of loans was $33,501,000, which compares
with $17,955,000 and $7,298,000 in 1996 and 1995, respectively. The year-to-year
increases in the gain on loan sales were the direct result of increased loan
originations, which enabled the Company to sell more loans.
The weighted-average premium realized by the Company on its loan sales
increased to 6.39% in 1997, compared to 6.34% in 1996 and 6.15% in 1995. These
premiums do not include loan fees collected by the Company at the time the loans
are closed and 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 in 1997 was $8,198,000, compared to
$3,935,000 in 1996 and $3,180,000 in 1995. The increases of 104.4% and 25.8% in
1997 and 1996, respectively, are the result of the Company originating and
selling more loans generated by the retail lending division. The Company's
retail originations increased by $116,592,000, or 121.5%, in 1997 and increased
by $45,819,000, or 91.4%, in 1996. The Company's retail loan sales in 1997
comprised 48.5% of total loan sales, with an average loan origination fee income
earned of 4.2%. For 1996, the Company's retail loan sales were 35.0% of total
loan sales with an average loan fee income earned of 4.9%. Total recapture
premium and fees associated with selling loans represented approximately 35
basis points of loans sold in 1997 compared with 30 basis points in 1996.
58
<PAGE>
A substantial portion of the Company's loan sales during the three-year
period ended December 31, 1997 were to Industry 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 December 31,
1997. The Company sold IMC 3,791 loans totaling $235,228,000 in 1997, compared
to 1,536 loans totaling $100,095,000 in 1996 and 504 loans totaling $37,993,000
in 1995. The loans sold to IMC represented 55.9%, 43.7% and 45.6% of the dollar
volume of the Company's loan sales in 1997, 1996 and 1995, 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.
Interest Income and Expense. Interest income in 1997 was $10,935,000,
compared with $4,520,000 and $3,065,000 in 1996 and 1995, respectively. The
141.9% increase in interest income in 1997 was primarily due to a higher average
balance of loans held for sale resulting from the increase in loan originations.
The average holding period in 1997 for mortgage loans in inventory remained
consistent with the average 1996 holding period.
Interest expense in 1997 was $6,157,000, compared with $3,121,000 and
$2,194,000 in 1996 and 1995 respectively. The year-to-year increases in interest
expense were the direct result of increased borrowings under the Company's
warehouse lines of credit, which were used to fund the increase in loan
origination volume.
The Company's net interest income for 1997 was $4,778,000, compared to
$1,399,000 in 1996 and $871,000 in 1995. Net interest income increased by
$3,379,000 or 141.5% in 1997 compared to 1996, and increased by $528,000 or
60.7% in 1996 compared to 1995.
The Company's net earnings are highly 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.
The following tables reflect the average yields earned and rates paid
by the Company during 1997 and 1996. 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.
59
<PAGE>
<TABLE>
<CAPTION>
(In thousands)
1997 1996
----------------------------- -----------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1) $ 74,116 $10,662 14.39% $ 36,519 $ 4,464 12.22%
Cash and other interest-
earning assets 4,240 273 6.44 1,107 56 5.06
-------- ------- ----- -------- ------- -----
73,356 10,935 13.96 37,626 4,520 12.01
------- ----- ------- -----
Non-interest-earning assets:
Allowance for loan losses (1,231) (754)
Investment in IMC 17,376 2,438
Premises and equipment, net 3,372 1,671
Other 7,112 4,423
-------- --------
Total assets $ 104,985 $ 45,404
========= ========
Interest-bearing liabilities:
Revolving warehouse lines $ 59,681 4,834 8.10 $ 25,810 2,373 9.19
FDIC-insured deposits 6,076 357 5.88 470 21 4.47
Other interest-bearing
liabilities 10,307 966 9.37 8,690 727 8.37
-------- ------- ----- -------- ------- -----
76,064 6,157 8.09 39,970 3,121 8.92
------- ----- ------- -----
Non-interest-bearing liabilities 4,264 1,314
-------- --------
Total liabilities 80,328 36,284
Shareholders' equity 24,657 9,120
-------- --------
Total liabilities and equity $ 104,985 $ 45,404
========= ========
Average dollar difference between
interest-earning assets and interest-
bearing liabilities $ 2,292 $ 2,656
======== ========
Net interest income $ 4,778 $ 1,399
======= =======
Interest rate spread (2) 5.87% 3.09%
===== =====
Net annualized yield on average
interest-earning assets 6.10% 3.72%
===== =====
</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.
60
<PAGE>
The Company's net interest income is affected by changes in both
average interest rates and the average volumes of interest-earning assets and
interest-bearing liabilities. Total interest income increased by $6,415,000 in
1997 compared to 1996. Total interest expense increased by $3,036,000 in 1997
compared to 1996. The 1997 increases in both interest income and interest
expense are due primarily to increases in average interest-earning assets and
interest-bearing liabilities.
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 $3,379,000
increase in net interest income in 1997 was the net result of a growing balance
sheet positively affected by lower rates on borrowed funds.
1997 Versus 1996
Increase (Decrease) Due to
-----------------------------------
(in thousands) Volume Rate Total
------ ---- -------
Total interest-earning assets
Loans receivable $ 5,289 $ 909 $ 6,198
Cash and other
interest-earning assets 198 19 217
------- ------- -------
5,487 928 6,415
------- ------- -------
Total interest-bearing liabilities
Revolving warehouse loans 2,706 (245) 2,461
FDIC-insured deposits 327 9 336
Other 145 94 239
------- ------- -------
3,178 (142) 3,036
------- ------- -------
Net interest income $ 2,309 $ 1,070 $ 3,379
======= ======= =======
61
<PAGE>
Provision for Loan Losses. The Company provided $1,534,000 during 1997
as additions to the allowance for loan losses, compared to $1,145,000 in 1996
and $629,000 in 1995.
The following table presents the activity in the Company's allowance
for loan losses and selected loan loss data for 1997, 1996 and 1995:
<TABLE>
<CAPTION>
(In thousands)
Years Ended
December 31 1997 1996 1995
- ----------- -------- -------- --------
<S> <C> <C> <C>
Balance at beginning of year $ 924 $ 594 $ 567
Provision charged to expense 1,534 1,145 629
Acquisition of the Savings Bank -- 20 --
Loans charged off (953) (863) (662)
Recoveries of loans previously charged off 182 28 60
-------- -------- --------
Balance at end of year $ 1,687 $ 924 $ 594
======== ======== ========
Loans receivable at year-end, gross
of allowance for losses $ 82,383 $ 46,347 $ 29,024
Ratio of allowance for loan losses to gross
loans receivable at year-end 2.05% 1.99% 2.05%
</TABLE>
The Company's acquisition of the Savings Bank in September 1996
included $2,531,000 of mortgage loans subject to a $20,000 allowance for loan
losses.
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.
62
<PAGE>
Provision for Foreclosed Property Losses. The Company provided $142,000
during 1997 as additions to the allowance for foreclosed property losses,
compared to $163,000 in 1996 and $101,000 in 1995.
Sales of real estate owned yielded net losses of $666,000 in 1997,
$192,000 in 1996 and $129,000 in 1995.
The following table presents the activity in the Company's allowance
for foreclosed property losses and selected real estate owned data for 1997,
1996 and 1995:
<TABLE>
<CAPTION>
(In thousands)
Years Ended
December 31 1997 1996 1995
- ----------- ------ ------ ------
<S> <C> <C> <C>
Balance at beginning of year $ 529 $ 366 $ 265
Provision charged to expense 142 163 101
------ ------ ------
Balance at end of year $ 671 $ 529 $ 366
====== ====== ======
Real estate owned at year-end, gross
of allowance for losses $3,038 $2,606 $1,509
Ratio of allowance for foreclosed property losses
to gross real estate owned at year-end 22.09% 20.30% 24.25%
</TABLE>
While the Company's management believes that its present allowance for
foreclosed property losses is adequate, future adjustments may be necessary.
63
<PAGE>
Income from the IMC Partnership and IMC Mortgage Company. The Company
was an original limited partner in Industry Mortgage Company, L.P. (the "IMC
Partnership"), a non-conforming residential mortgage company based in Tampa,
Florida. The Company's initial ownership interest represented approximately
9.09% of the IMC Partnership and was accounted for under the equity method of
accounting. Therefore, the Company recognized the portion of the IMC
Partnership's net income equal to its ownership percentage in the IMC
Partnership. In 1996, the Company recognized $480,000 of income from its
investment in the IMC Partnership, compared to $596,000 in 1995.
The IMC Partnership converted to a corporation, IMC Mortgage Company
("IMC"), immediately before its initial public offering on June 24, 1996. The
limited partners received common stock of IMC in exchange for their IMC
Partnership interests as of June 24, 1996. The Company was issued 1,199,768
shares of IMC common stock at that time. Shares of IMC common stock are traded
on the NASDAQ National Exchange under the trading symbol "IMCC." However, the
shares received by the Company have not been registered with the Securities and
Exchange Commission ("SEC") under the Securities Act of 1933. Sales of IMC stock
by the Company are subject to SEC Rule 144 and a lock-up agreement. The lock-up
agreement limits sales of IMC stock by the Company to approximately 96,000
shares per month between August 1997 and August 1998. The share figures above
reflect a two-for-one split of IMC shares on February 13, 1997.
Following the partnership's conversion to corporate form, the Company's
investment in IMC is accounted for as an investment security available for sale
under the provisions of Statement of Financial Accounting Standards ("SFAS") No.
115, "Accounting for Certain Investments in Debt and Equity Securities." Such
securities are reported on a fair value basis, with unrealized gains and losses
excluded from earnings but reported as a separate component of stockholders'
equity, net of any deferred tax provision. As of December 31, 1997, the Company
owned 975,592 shares of IMC stock. The Company's stock position represented
approximately 3.2% of IMC's outstanding stock at that date. The market value of
the Company's investment in IMC was $11,585,000 and the unrealized holding gain,
net of deferred income taxes, was $6,854,000. During 1997, the Company sold
233,241 shares of IMC stock for $3,729,000, which resulted in a pre-tax gain of
$2,796,000. The Company is likely to experience volatility in its capital
account in future periods because of market price fluctuations of this
investment security.
64
<PAGE>
Other Income. In addition to interest on the loan portfolio and gains
from the sale of loans, the Company derives income from broker fees, document
preparation fees, underwriting service fees, prepayment penalties, late charge
fees for delinquent loan payments and rental income on office space. For 1997,
other income totaled $4,934,000, compared to $1,927,000 in 1996 and $939,000 in
1995. The increases of $3,007,000, or 56.0%, in 1997 and $988,000, or 105.2%, in
1996 were due to several factors.
Underwriting service and document preparation fees increased by
$2,000,000 in 1997 and by $885,000 in 1996 as a direct result of additional loan
origination volume. These fees are charged to a borrower at the time a loan is
closed. The unit volume of loan closings increased by 4,034 loans to 8,421 in
1997, and increased by 2,529 loans to 4,387 in 1996.
The Company brokers to various lenders loans that do not meet the its
underwriting guidelines. Broker fee income increased by $543,000 to $992,000 in
1997 and increased by $320,000 to $449,000 in 1996.
Increases in prepayment penalty and late charge income are attributed
to the Company's larger loan portfolio.
Compensation Expenses. The largest component of expenses is
compensation expense. Compensation expense in 1997 increased by $8,430,000 to
$16,447,000, and 1996 compensation expense increased by $4,137,000 to
$8,017,000. The increases of 105.2% in 1997 and 106.6% in 1996 were directly
attributable to the addition of new employees. The Company had 552 full-time
equivalent employees at December 31, 1997 (443 full-time and 217 part-time
employees), compared to 287 at December 31, 1996 and 84 at December 31, 1995.
The Company's corporate office staff increased by 122.3% in 1997, with a
corresponding increase in base salaries of approximately $1,700,000. The broker
division increased its staffing by 63.6% and the increase in base salaries
associated with the new employees was approximately $500,000. The Company opened
twelve retail lending offices in 1997, and the retail lending staff increased by
100.7%, resulting in a base salary increase in the retail division of
approximately $3,000,000. Commission and bonus expense in 1997 increased by
approximately $2,500,000 due to increased production. Finally, additional 1997
costs due to merit and cost of living increases were approximately $700,000.
General and Administrative Expenses. General and administrative
expenses in 1997 increased by $7,335,000 to $14,188,000, and 1996 general and
administrative expenses increased by $3,803,000 to $6,853,000. The increases of
107.0% in 1997 and 124.7% in 1996 were attributed to the growth of the Company.
The Company opened nine retail offices in 1997. In addition, seven offices
opened in 1996 operated for a full year in 1997. The total general and
administrative expenses associated with the new retail offices was $1,800,000 in
1997. For offices open for all of 1997 and 1996, general and administrative
expenses increased by $900,000 to $2,100,000 in 1997, as a result of a 32.0%
loan production volume increase in those offices. General and administrative
expenses related to the Company's corporate office staff increased by $3,000,000
to $5,600,000 in 1997, as the Company increased corporate staff expenditures to
support the increased loan volume. These expenses included increases in
utilities, postage, office supplies, travel & entertainment, depreciation on
office equipment, and professional fees.
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<PAGE>
The broker division began paying fees to brokers in 1997 for services
rendered in the preparation of loan packages. The total expense associated with
those fees was $1,426,000 in 1997.
Minority Interest in Net Income of Subsidiary. Contained in the
consolidated statements of income for 1996 and1995 were minority interests in
earnings of a subsidiary. This portion of the subsidiary's earnings was an
element of compensation paid to an officer of the Company. In 1997, the Company
has recharacterized this item as compensation expense. See the discussion under
Item 11, "Executive Compensation."
Income Taxes. Income tax expense for 1997 was $5,638,000, resulting in
an effective tax rate of 41.2%. By comparison, the Company had income tax
expense of $2,259,000 for an effective tax rate of 40.5% in 1996 and an income
tax expense of $876,000 for an effective tax rate of 42.9% in 1995.
The effective tax rates differ from the statutory federal rates due
primarily to state income taxes and certain nondeductible expenses.
66
<PAGE>
Financial Condition at December 31, 1997, 1996 and 1995
Assets. The total assets of the Company were $118,125,000 at December
31, 1997, compared to total assets of $75,143,000 at December 31, 1996 and
$34,485,000 at December 31, 1995.
The 57.2% increase in assets in 1997 is primarily attributable to the
increase in loans receivable. The 117.9% increase in assets during 1996 is
primarily attributable to the increase in loans receivable, the increase in the
carrying value of the company's ownership interest in IMC, and the Company's
purchase of the Savings Bank, while the 49.2% increase in assets in 1995 is
primarily attributable to the increase in loans receivable.
The primary uses of funds by the Company is funding of loan
originations and the expenses associated with loan production. Net mortgage
loans receivable increased by $35,273,000 to $80,696,000 at December 31, 1997,
and increased by $16,993,000 to $45,423,000 at December 31, 1996. The 77.7%
increase in 1997 and the 59.8% increase in 1996 reflect the Company's growth
during the past two years. The Company generally sells loans within sixty days
after origination. The Company's loan originations in the final two months of
1997 were 58.2% higher than loan originations in the final two months of 1996,
which resulted in the higher balance of loans on hand and awaiting sale at
December 31, 1997 compared to December 31, 1996.
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 $11,585,000 at December 31, 1997 and $20,096,000
at December 31, 1996. At December 31, 1995, the Company's investment in the IMC
Partnership was carried at a cost of $713,000.
Cash and cash equivalents increased by $8,429,000 to $11,869,000 at
December 31, 1997, and increased by $2,656,000 to $3,440,000 at December 31,
1996. The principal reason for the 1997 increase was the receipt of proceeds
from loan sales in the final week of 1997. These proceeds were used to fund new
loans in the first week of 1998.
The purchase of the Savings Bank resulted in a $2,950,000 increase in
cash and a $1,724,000 increase in other assets at December 31, 1996. The Company
acquired 87.3% of the common stock of the Savings Bank on September 11, 1996.
The remaining 12.7% of the Savings Bank's stock was acquired in 1997. The
Company paid a premium of $150,000 over the Savings Bank's book value.
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Premises and equipment increased by $2,306,000 to $4,530,000 at
December 31, 1997, and increased by $813,000 to $2,224,000 at December 31, 1996.
The primary reason for the 1997 increase was the purchase of a new office
building. In addition, the increases in 1997 and 1996 were due to expansion of
the Company's retail lending network, increases in the office support staff, and
the associated investments in technology, equipment and improvements.
Real estate owned increased by $290,000 to $2,367,000 at December 31,
1997, and increased by $935,000 to $2,077,000 at December 31, 1996. The 14.0%
increase in real estate owned in 1997 and the 81.9% increase in 1996 were the
result of higher average loans held for sale because of the increase in loan
originations.
Other assets increased by $1,623,000 to $3,462,000 at December 31,
1997, and increased by $1,247,000 to $1,839,000 at December 31, 1996. The 1997
increase is primarily the result of $700,000 of goodwill associated with the
purchase of the 17% increase in Armada Residential Mortgage LLC. Also, prepaid
assets increased by $800,000 in 1997 and by $15,000 in 1996. Prepaid assets
include syndicated bank fees, insurance, taxes and rent. Accrued interest
receivable increased by $200,000 in 1997 and by $100,000 in 1996. The increases
in accrued interest receivable were the result of higher average loans held for
sale due to the increases in loan originations in those years.
Liabilities. Revolving warehouse loans increased by $20,458,000 to
$52,488,000 at December 31, 1997, and increased by $12,464,000 to $32,030,000 at
December 31, 1996. The 63.9% increase in 1997 and the 63.7% increase in 1996
were primarily attributable to the increases in loans receivable.
The Company draws on its revolving warehouse lines of credit as needed
to fund loan production. As of December 31, 1997, the Company had issued loan
funding checks totaling $6,364,000 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 January 1998 and most were funded with cash on hand or new warehouse line
draws.
The Savings Bank's deposits totaled $17,815,000 at December 31, 1997,
compared to $1,576,000 at December 31, 1996 and $1,379,000 at the September 11,
1996 acquisition date. The Savings Bank substantially increased its deposits in
1997 in order to fund loans. During the period from September 11, 1996 to
December 31, 1996, the Savings Bank did not actively solicit new deposits, as it
was closing down its Annandale, Virginia-based loan production operations and
was making its transition to Virginia Beach, Virginia. Of the certificate
accounts as of December 31, 1997, a total of $13,268,000 was scheduled to mature
in the twelve-month period ending December 31, 1998.
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On December 16, 1997, the Savings Bank borrowed $1,000,000 from the
FHLB, and this amount was outstanding at December 31, 1997. The Savings Bank
held $50,000 of FHLB stock at December 31, 1997. Management expects to utilize
FHLB advances as the Savings Bank builds a portfolio of loans.
Mortgage loans payable increased by $738,000 to $1,126,000 at December
31, 1997, and decreased by $46,000 to $478,000 at December 31, 1996. The
Company's executive and administrative offices are located in Virginia Beach,
Virginia. In June 1997 the Company purchased a second building adjacent to its
headquarters to accommodate its growth plans. The new building was purchased
with a mortgage debt of $800,000. The Company made total principal payments of
$62,000 and $46,000 on its mortgage loans in 1997 and 1996, respectively. The
weighted-average rate of the mortgage loans at December 31, 1997 was 8.40%.
Promissory notes and certificates of indebtedness totaled $9,080,000 at
December 31, 1997, compared to $9,182,000 at December 31, 1996 and $6,905,000 at
December 31, 1995. The Company has utilized promissory notes and certificates of
indebtedness to help funds 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%, with a weighted-average rate
of 9.59% at December 31, 1997. 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%, with a weighted-average rate of 9.46% at
December 31, 1997. The Company is not currently soliciting new promissory notes
or certificates of indebtedness. The 1996 net increase of $2,277,000 is
primarily due to the issuance of a $1,500,000 promissory note issued to a single
investor.
Accrued and other liabilities increased by $636,000 to $2,837,000 at
December 31, 1997, and increased by $266,000 to $985,000 at December 31, 1996.
This category includes accounts payable, accrued interest payable, deferred
income, accrued bonuses, and other payables. The increases of 64.6% in 1997 and
37.0% in 1996 were associated with the increases in the Company's loan
origination volume.
Shareholders' Equity. Total shareholders' equity at December 31, 1997
was $25,055,000 at December 31, 1997, compared to $21,209,000 at December 31,
1996. The $3,846,000 increase in 1997 was primarily due to net income of
$8,060,000 and the reduction of $4,547,000 in the unrealized gain on securities.
The $14,973,000 increase in 1996 was primarily due to net income of $3,324,000
and the unrealized gain on securities of $11,401,000.
Also during 1997, the Company issued 176,836 split-adjusted shares of
common stock upon the exercise of stock warrants for $332,000. During 1996, the
Company paid cash dividends of $199,000, sold 44,000 shares of common stock for
proceeds of $440,000, and issued 9,296 split-adjusted shares of common stock
upon the exercise of stock warrants for $9,000.
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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. For the years ended December 31, 1997 and 1996, the
Company used cash from operating activities of $31,212,000 and $15,041,000,
respectively. 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
years ended December 31, 1997 and 1996, the Company received cash from financing
activities of $38,666,000 and $17,289,000, respectively.
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 December 31, 1997 were 74.5%,
compared to 60.4% of assets at December 31, 1996.
Warehouse and Other Credit Facilities. On December 10, 1997, the
Company obtained a $100,000,000 warehouse line of credit from a commercial bank
syndicate. 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. This line of credit
replaced three existing lines of credit. 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 December 31, 1997, $46,734,000 was
outstanding under this facility.
Also on December 10, 1997, the Company obtained 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 December 31, 1997, $5,754,000 was outstanding under this facility.
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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
$17,815,000 at December 31, 1997, compared to $1,576,000 at December 31, 1996.
The Savings Bank substantially increased its deposits in 1997 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.
The Company has utilized promissory notes and certificates of
indebtedness to help funds its operations. Promissory notes and certificates of
indebtedness totaled $9,080,000 at December 31, 1997, compared to $9,182,000 at
December 31, 1996. 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 $11,869,000 at December
31, 1997. 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. Management expects that the
Company and the industry will be challenged by competition and rising
delinquencies.
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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 withdrawable savings and borrowings due in one year or
less is 5.0%. Penalties are assessed for noncompliance. In 1997 and 1996, 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 December 31, 1997, the Savings
Bank's book value under generally accepted accounting principles ("GAAP") was
$3,242,000. 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 December
31, 1997, 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 $ 3,242 $ 3,242 $ 3,242
Add: unrealized loss on securities 2 2 2
Nonallowable asset: goodwill (132) (132) (132)
Additional capital item: general allowance -- -- 73
------- ------- -------
Regulatory capital - computed 3,112 3,112 3,185
Minimum capital requirement 336 895 1,249
------- ------- -------
Excess regulatory capital $ 2,776 $ 2,217 $ 1,936
======= ======= =======
Ratios:
Regulatory capital - computed 13.91% 13.91% 20.40%
Minimum capital requirement 1.50 4.00 8.00
------- ------- -------
Excess regulatory capital 12.41% 9.91% 12.40%
======= ======= =======
</TABLE>
Management believes that the Savings Bank can remain in compliance with
its capital requirements.
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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.
New Accounting Standards
In October 1995, SFAS No. 123, "Accounting for Stock Based
Compensation," was issued, effective for fiscal years beginning after December
15, 1995. The standard encourages, but does not require, companies to recognize
compensation expense for grants of stock, stock options, and other equity
instruments to employees based on the new fair value accounting rules. The
Company is currently following Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees" and related Interpretations in
accounting for employee equity instruments. Prospectively, the Company has
determined that it will not adopt SFAS 123 for expense recognition purposes. The
Company will continue to follow the provisions of APB 25 and make the pro forma
disclosures as required by SFAS 123. Pro forma disclosures are not required for
awards issued prior to December 15, 1994. The statement did not have a material
impact on results of operations or financial position.
In June 1996, SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities" was issued. This statement
supercedes SFAS No. 122, "Accounting for Mortgage Servicing Rights" and requires
that after a transfer of financial assets, an entity recognizes the financial
and servicing assets it controls and the liabilities it has incurred,
derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. This Statement is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after December 31, 1996. The Company adopted this statement on January
1, 1997 and has determined that this statement did not have a material effect on
the results of operations or financial position for the year ended December 31,
1997.
Effective December 31, 1997, the Company adopted SFAS No. 128,
"Earnings per Share," which superseded APB Opinion No. 15, "Earnings per Share."
This new statement requires that "basic earnings per share" be computed by
dividing income available to common shareholders by the weighted-average number
of common shares outstanding for the period. "Diluted earnings per share," if
different, reflects potential dilution if stock options or other contracts would
result in the issue or exercise of additional shares of common stock that shared
in the earnings. "Basic earnings per share" and "diluted earnings per share"
will replace "primary earnings per share" and "fully diluted earnings per
share," respectively, as described under APB Opinion No. 15, and must be
reported on the income statement. There was no material change in the earnings
per share amounts as a result of adopting this new standard.
In June 1997, 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 Company is currently evaluating the effect this statement will
have on the financial statements.
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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.
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. In
addition, certain loans must be "seasoned" for periods of six to twelve months
before they can be sold. 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. To offset the effects of interest rate fluctuations on the value
of its fixed rate mortgage loans held for sale, the Company in certain cases
will enter into Treasury security lock contracts, which function similar to
short sales of U.S. Treasury securities. Prior to entering into a hedge
transaction, the Company performs an analysis of its loans, taking into account
such factors as interest rates and maturities, to determine the proportion of
contracts to sell so that the risk value of the loans will be most effectively
hedged. The Company in 1997 used one of the commercial banks in its syndicated
bank group to arrange hedge contracts.
If the value of a hedge decreases, offsetting an increase in the value
of the hedged loans, the Company, upon settlement with its counter-party, will
pay the hedge loss in cash and realize the corresponding increase in the value
of the loans. Conversely, if the value of a hedge increases, offsetting a
decrease in the value of the hedged loans, the Company will receive the hedge
gain in cash at settlement.
The Company's management believes that its current hedging strategy
using Treasury rate lock contracts is an effective way to manage interest rate
risk on fixed rate loans prior to sale.
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.
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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.
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ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements, the report thereon, the
notes thereon and the supplementary data commencing on page F-1 of this report,
which financial statements, report, notes and data are incorporated by
reference.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
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<PAGE>
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS
Directors and Executive Officers
The directors and executive officers of the Company are as follows:
Position(s) and Offices Presently
Name Age Held with the Company
--------------- --- ---------------------------------
Allen D. Wykle 51 Chairman of the Board, President and
Chief Executive Officer, and member
of Executive and Compensation
Committees
Leon H. Perlin 69 Director, member of the Executive,
Audit, Compensation and Option
Committees
Oscar S. Warner 80 Director, member of the Audit,
Compensation and Option Committees
Arthur Peregoff 78 Director
Stanley W. Broaddus 48 Director, Vice President and
Secretary, and member of the
Executive Committee
Robert M. Salter 49 Director, member of the Compensation
and Option Committees
Jean S. Schwindt 42 Director, member of the Executive
and Audit Committees
Neil W. Phelan 40 Director, Executive Vice President
Barry C. Diggins 34 Director, President of a retail
lending division of ARMI
Eric S. Yeakel 33 Treasurer and Chief Financial
Officer
Gregory W. Gleason 45 President, Approved Federal Savings
Bank
Except for Allen D. Wykle, who is a director of IMC, none of the
directors of the Company hold other directorships in a company, or have any been
nominated to become a director in a company, with a class of securities
registered pursuant to Section 12 of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), or subject to the requirements of Section 15(d) of
the Exchange Act, or any company registered as an investment company under the
Investment Company Act of 1940.
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<PAGE>
The following table sets forth the principal occupations and business
experience for the directors and executive officers. The date shown for first
election as a director in the information below represents the year in which the
director was first elected to the Board of Directors of the Company. Unless
otherwise indicated, the business experience and principal occupations shown for
each director or executive officer has extended for five or more years.
Allen D. Wykle, 51, has been a director since 1984.
Mr. Wykle has served as Chairman of the Board, President and Chief
Executive Officer of the Company since September 1984.
Leon H. Perlin, 69, has been a director since 1984.
Mr. Perlin has served as President and Chief Executive Officer of Leon
H. Perlin Company, Inc., a commercial construction concern, for over
30 years.
Oscar S. Warner, 80, has been a director since 1984.
Mr. Warner has been retired for the past five years. Previously, he
was owner and operator of Oscar Warner Corporation, an import company.
Arthur Peregoff, 78, has been a director since 1985.
Mr. Peregoff has served as Chief Executive Officer of Globe Iron
Construction Company, Inc., a commercial construction company, for
over 25 years.
Stanley W. Broaddus, 48, has been a director since 1985.
Mr. Broaddus has served as Secretary and Vice President of the Company
since April 1987. Previous experience includes fourteen years as
Regional Sales Manager with the building products unit of Atlantic
Richfield Co.
Robert M. Salter, 49, has been a director since 1989.
Mr. Salter has served as President of Salter and Hall, P.C. since
1979. Mr. Salter is a Certified Public Accountant and a Certified
Financial Planner.
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<PAGE>
Jean S. Schwindt, 42, has been a director since 1992.
Ms. Schwindt has been Vice President and Director of Investor
Relations and Strategic Planning for IMC Mortgage Company since March
1996. From April 1989 to March 1996 she served as Senior Vice
President/Director and Secretary of Anderson and Strudwick, Inc., a
member of the New York Stock Exchange. Ms. Schwindt is a Chartered
Financial Analyst and is a Registered Investment Advisor affiliated
with the firm of Mills Value Adviser, Inc. since January 1995.
Neil W. Phelan, 40, has been a director since 1997.
Mr. Phelan is Executive Vice President and has been with the Company
since April 1995. He manages the Company's wholesale lending unit,
Approved Residential Mortgage. Immediately prior to joining the
Company, Mr. Phelan served on the senior management team of ITT
Financial Services for 17 years.
Barry C. Diggins, 34, has been a director since 1997.
Mr. Diggins oversees a large portion of the Company's retail lending
unit, Armada Residential Mortgage. Mr. Diggins has been with the
Company since October 1994. He was Regional Marketing Director of ITT
Financial Services from September 1985 to October 1994.
Eric S. Yeakel, 33, is Treasurer and Chief Financial Officer.
Mr. Yeakel has been with the Company since June 1994. He served as
Assistant Controller with Office Warehouse, Inc. from October 1989 to
August 1992. Mr. Yeakel is a Certified Public Accountant who worked
with Ernst & Young from July 1987 to October 1989.
Gregory W. Gleason, 45, is President of Approved Federal Savings Bank.
Mr. Gleason joined the Company in November 1996 with more than 20
years of savings institution management. Mr. Gleason was Senior Vice
President with Virginia First Savings Bank from February 1984 through
June 1996, and was on the management team of BankAtlantic from May
1977 to January 1984.
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<PAGE>
Board of Directors
The Company has nine directors as of December 1, 1997. The directors
held an organizational meeting following the Annual Meeting of the Company's
Stockholders on July 25, 1997. At the organizational meeting, the Board of
Directors ratified the Company's Amended and Restated Articles of Incorporation,
which provides that the Board of Directors shall consist of at least five
directors. The Company's Amended and Restated Bylaws, also ratified by the Board
at its meeting of July 25, 1997, provides that the number of Directors shall be
no less than five and not more than fifteen, as shall be fixed for the ensuing
year by the shareholders at the annual election. The Directors are elected by
the shareholders at the Annual Meeting for a term of one year and until his
successor is duly elected and qualified. A Director may be removed at any time,
with or without cause, at a special meeting of shareholders called for that
purpose, by a vote of a majority of the shares of stock represented and entitled
to vote at such meeting. At any such meeting, a successor to such Director may
be elected for his unexpired term. In the event of any vacancy caused by death,
resignation, retirement, disqualification or removal from office of a Director,
or by failure of the shareholders to elect a successor to a Director who has
been removed, or otherwise, the Board of Directors may fill such vacancy by vote
of a majority of all the Directors then in office, though less than a quorum.
Directors so elected shall serve for the unexpired term of their predecessors,
and until their successor is duly elected and qualified, unless sooner
displaced.
Meetings of the Board of Directors are held regularly, and there is
also an organizational meeting following the conclusion of the Annual Meeting of
Shareholders. The Board of Directors held nine meetings in 1996 and four
meetings in 1997. For 1996 and 1997, none of the Company's directors attended
fewer than 75% of the aggregate of the total number of meetings of the Board of
Directors and the total number of meetings of committees on which the respective
directors served.
Committees of the Board of Directors. The Board of Directors has four
committees: the Executive Committee, the Audit Committee, the Compensation
Committee and the Option Committee.
The Executive Committee consists of Mr. Wykle, as Chairman, Mr. Perlin,
Ms. Schwindt and Mr. Broaddus. The Executive Committee acts for the Board when
the Board is not in session.
The Audit Committee consists of Ms. Schwindt, as Chairman, Mr. Perlin
and Mr. Warner. The Audit Commitee makes recommendations concerning the
engagements of independent public accountants, reviews with the independent
public accountants the plans and results of the audit engagement, approves
professional services provided by the independent public accountants, reviews
the independence of the independent public accountants, considers the range of
audit and non-audit fees and reviews the adequacy of the Company's internal
accounting controls. It also reviews and accepts the reports of the Company's
regulatory examiners.
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<PAGE>
The Compensation Committee, which determines the compensation of the
Company's senior management, and reviews and sets guidelines for compensation
for all employees, consists of Mr. Warner, Chairman, Mr. Wykle, Mr. Perlin and
Mr. Salter. Mr. Wykle abstains from voting on his own compensation.
The Option Committee, which administers the Company's stock option
plans and grants options under those plans, consists of Mr. Warner, Chairman,
Mr. Perlin and Mr. Salter.
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ITEM 11 - EXECUTIVE COMPENSATION
Summary of Cash and Other Compensation
The following table sets forth the compensation paid to the Company's
Chief Executive Officer and the three most highly-compensated Executive Officers
other than the Chief Executive Officer whose 1997 compensation exceeded $100,000
(collectively, the "Named Executive Officers") during the three years ended
December 31, 1997:
Summary Compensation Table
Annual Compensation (1)
----------------------------
All Other
Name and Principal Position Year Salary Bonus Compensation (2)
- --------------------------- ---- -------- -------- ----------------
Allen D. Wykle 1997 $421,218 $575,000 $ 4,750
President and Chief 1996 300,000 400,000 4,750
Executive Officer 1995 200,000 -- 49,062
Barry C. Diggins (3) 1997 132,638 209,564 6,821
Retail Lending 1996 75,000 175,092 --
1995 75,000 64,415 --
Neil W. Phelan 1997 110,000 75,000 3,383
Executive Vice President, 1996 100,000 75,000 1,500
Marketing and Broker Lending 1995 75,000 -- 10,000
Stanley W. Broaddus 1997 85,000 100,000 2,437
Secretary and 1996 85,000 45,000 2,100
Vice President 1995 58,000 -- 6,072
- -----------------------
(1) All benefits that might be considered of a personal nature did not exceed
the lesser of $50,000 or 10% of total annual salary and bonus for the
officer named in the table.
(2) Amounts reflect the Company's matching contribution under its 401(k)
retirement plan. The table also includes contributions to the Company's
non-qualified retirement plan of $47,000 in 1995 for Mr. Wykle and $5,000
in 1995 for Mr. Broaddus. The table also reflects $10,000 paid to reimburse
Mr. Phelan in 1995 for moving expenses.
(3) Mr. Diggins was paid an annualized base salary of $75,000 in 1996 and 1995.
In addition, Mr. Diggins was paid an incentive based on the earnings of the
retail lending division. His incentive amounts were $209,564 in 1997,
$175,092 in 1996 and $64,415 in 1995.
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Stock Option/Stock Appreciation Right Grants in the Last Year
The Company did not grant any stock options or stock appreciation
rights in 1996, other than the stock appreciation rights issued to Ms. Schwindt.
See "Board of Directors - Directors' Compensation."
On January 27, 1997, the Company issued options to key employees to
purchase up to 9,200 shares of the Company's common stock. The employees have a
ten-year period to exercise the options at an exercise price of $9.75 per share.
The number of shares and exercise price for these options have been adjusted for
the 100% stock dividend on November 21, 1997.
The following table contains information regarding options to purchase
the Company's common stock granted to three Named Executive Officers. Mr.
Diggins did not receive an option grant. No stock appreciation rights were
granted to Named Executive Officers during 1997 or 1996.
<TABLE>
<CAPTION>
Individual Grant Potential Realizable
----------------------------------- Value at Assumed
Number of Percent of Annual Rates of Stock
Securities Total Options Price Appreciation for
Underlying Granted to Per Share Option Term (2)
Options Employees Exercise Expiration -------------------------------
Name Granted in Year Price (1) Date 0% 5% 10%
- ------------------- --------- --------- --------- --------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Allen D. Wykle 1,000 10.9% $9.75 1-27-2007 $ - $ 6,132 $15,538
Neil W. Phelan 1,000 10.9% $9.75 1-27-2007 - 6,132 15,538
Stanley W. Broaddus 1,000 10.9% $9.75 1-27-2007 - 6,132 15,538
</TABLE>
- -------------------
(1) These shares are based on $9.75, the closing price of Common Stock on
January 26, 1997 (as adjusted for the 100% stock dividend on November 21,
1997). The exercise price may be paid in cash, in shares of Common Stock
valued at fair market value on the date of exercise or pursuant to a
cash-less exercise involving the same-day sale of the purchased shares.
(2) The 5% and 10% assumed annual rates of compounded stock price appreciation
are permitted by rules of the Securities and Exchange Commission. There can
be no assurance provided to any executive officer or any other holder of
the Company's securities that the actual stock price appreciation over the
10-year option term will be at the assumed 5% and 10% levels or at any
other defined level. Unless the market price of the Common Stock
appreciates over the option term, no value will be realized from the option
grants to executive officers.
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Aggregate Option Exercises and Period-End Values
The following table sets forth information concerning the value of
unexercised options held by three of the Company's Named Executive Officers at
March 1, 1998. No options of stock appreciation rights were exercised during
1996 or 1997, and no stock appreciation rights were outstanding at December 31,
1997.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money
Options at Options at
Fiscal Year End Fiscal Year End (1)
---------------------------- ---------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
-------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Allen D. Wykle - 1,000 - -
Neil W. Phelan - 1,000 - -
Stanley W. Broaddus - 1,000 - -
</TABLE>
- -----------------------
(1) Based on the closing price of $14.75 per share, for the Common Stock
on December 29, 1997.
1996 Incentive Stock Option Plan
On June 28, 1996, the Company adopted the 1996 Incentive Stock Option
Plan (the "Incentive Plan"), pursuant to which key employees of the Company are
eligible for awards of stock options. The following sections summarize some of
the principle features of the Incentive Plan.
Purpose. The Board of Directors believes that long-term incentive
compensation is one of the fundamental components of compensation for the
Company's key employees and that stock options under the Incentive Plan will
play an important role in encouraging employees to have a greater financial
investment in the Company. The Board of Directors believes that the Incentive
Plan will help promote long-term growth and profitability by further aligning
stockholder and employee interests.
The purpose of the Incentive Plan is to promote the interests of the
Company and its shareholders by affording participants an opportunity to acquire
a proprietary interest in the Company and by providing participants with
long-term financial incentives for outstanding performance. Under the terms of
the Incentive Plan, the Option Committee has a great deal of flexibility in the
types and amounts of awards that can be made and the terms and conditions
applicable to those awards.
Description of the Incentive Plan. The aggregate number of shares of
Common Stock that are available for grants under the Incentive Plan is 126,000
shares, as adjusted for the two-for-one stock split on December 16, 1996 and the
100% stock dividend on November 21, 1997. All shares allocated to awards under
the Incentive Plan that are cancelled or forfeited are available for subsequent
awards.
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<PAGE>
Administration. The Incentive Plan is administered by the Option
Committee. The members of the Option Committee are not eligible to receive
awards under the Incentive Plan. The Option Committee has the full power to: (a)
designate the key employees to receive awards from time to time; (b) determine
the sizes and types of awards; (c) determine the terms and provisions of awards
as it deems appropriate; (d) construe and interpret the Incentive Plan and
establish, amend or waive rules and regulations relating to the administration
of the Incentive Plan; (e) amend the terms and provisions of any outstanding
award to the extent such terms and provisions are within the discretion of the
Option Committee; and (f) make all other decisions and determinations necessary
or advisable for the administration of the Incentive Plan. All determinations
and decisions made by the Option Committee pursuant to the Incentive Plan are
final, conclusive and binding.
Eligible Participants. Only "key employees" of the Company and its
subsidiaries are eligible to participate in the Incentive Plan. An employee who
is a director is eligible for an award unless he or she is a member of the
Option Committee. The selection of the key employees is entirely within the
discretion of the Option Committee. The concept of a "key employee" is, however,
somewhat flexible and it is anticipated that such factors as the duties and
responsibilities of employees, the value of their services, their present and
potential contributions to the success of the Company and other relevant factors
will be considered. Accordingly, the number of persons who ultimately may be
eligible to participate in the Incentive Plan cannot presently be determined.
Option Price of Stock. The Incentive Plan provides for the grant of
options to purchase shares of Common Stock at option prices to be determined by
the Option Committee as of the date of grant. The option price may not be less
than the fair market value (or in the case of a 10% stockholder not less than
110% of the fair market value) of the shares of Common Stock on the date of
grant. For such purpose "fair market value" means the average of the bid and
asked price per share of the Common Stock as reported by the NASDAQ Stock Market
or the OTC Bulletin Board, whichever is applicable at the time, on the date on
which the fair market value is determined or, if Common Stock is not traded on
such exchange or system on such date, then on the immediately preceding date on
which Common Stock was traded on such exchange or system. Each grant of options
is to be evidenced by an option agreement which is to specify the option price,
the term of the option, the number of shares subject to the option and such
other provisions as the Committee may determine.
Exercise of Options. The shares subject to an option may be purchased
as follows: none in the first year after the grant of option; one-third in each
of the second, third and fourth years. Options granted under the Incentive Plan
will expire not more than ten years (or in the case of a 10% stockholder not
more than five years) from the date of grant.
Awards of Options. Awards of options under the Incentive Plan are to be
determined by the Option Committee at its discretion. Notwithstanding the
foregoing, the Option Committee may not grant options to any participant that,
in the aggregate, are first exercisable during any one calendar year to the
extent that the aggregate fair market value of the shares subject to such
options, at the time of grant, exceeds $100,000.
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<PAGE>
Payments for shares issued pursuant to the exercise of any option may
be made either in cash or by tendering shares of Common Stock of the Company
with a fair market value at the date of the exercise equal to the portion of the
exercise price which is not paid in cash.
No Rights as Stockholder. A participant granted an option under the
Incentive Plan will have no rights as a stockholder of the Company with respect
to the shares subject to such option except to the extent shares are actually
issued.
Non-transferability. Options may not be sold, transferred, pledged or
assigned, except as otherwise provided by law or in an option agreement. The
Option Committee may impose restrictions on the transfer of shares acquired
pursuant to the exercise of options as it may deem advisable.
Termination of Employment. Except for termination for cause, death or
disability, options terminate three months after the employment terminates or on
such earlier date as the participant's option agreement specifies. In the event
of termination for cause as defined in the Incentive Plan, the option terminates
upon termination (subject to the Option Committee's right to reinstate for 30
days). In the event of death, the option will terminate six months after death,
and in the event of disability one year after disability (unless the option
period in the participant's option agreement expires earlier).
Amendment and Termination of the Incentive Plan. The Board of Directors
may alter, amend, discontinue, suspend or terminate the Incentive Plan at any
time in whole or in part. Notwithstanding the foregoing, stockholder approval is
required for any change to the material terms of the Incentive Plan and no
amendment or modification of the Incentive Plan may materially and adversely
affect any award previously granted without the consent of the participant.
401(k) Retirement Plan
On January 1, 1995, the Company implemented a 401(k) Retirement Plan
(the "401(k) Plan"). The 401(k) Plan is a defined contribution plan covering all
employees who have completed at least one year of service. The 401(k) Plan is
subject to the provisions of the Employee Retirement Income Security Act of
1974. The Company contributes an amount equal to 50% of a participant's payroll
savings contribution up to 6% of a participant's annual compensation. The
Company's contributions to the 401(k) Plan in 1997 and 1996 were $115,000 and
$33,000, respectively.
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<PAGE>
Employment Agreements
The Company has employment agreements with three executive officers.
Neil W. Phelan. The Employment Agreement which commenced April 1, 1995
was for a two year initial term and will automatically renew for additional
one-year terms absent six months written notice by either party prior to the end
of a term of nonrenewal. He currently receives an annual salary of $110,000. It
provides for a bonus of up to 75% of base compensation depending on specified
pre-tax net profit goals. He also is entitled to all group employee benefits and
a car allowance.
The Employment Agreement provides for termination "for cause" as
defined in the Agreement. Under the Employment Agreement he has agreed not to
compete with the Company for a period of two years after termination within a
prescribed geographic area and not to solicit or employ Company employees for
two years after termination. These restrictive covenants apply upon termination
by Mr. Phelan or termination for cause by the Company.
Stanley W. Broaddus. The Employment Agreement which commenced January
1, 1997 was for a one year initial term and will automatically renew for
additional one-year terms absent ninety day written notice by either party prior
to the end of a term of nonrenewal. It provides for an annual salary of $85,000
with an annual 6% increase during the initial term. He is entitled to a Company
car and all group employee benefits. He is entitled to a quarterly bonus based
on 1 1/2% of net profits after taxes not to exceed $100,000. He is also entitled
to one year's annual salary in the event that following a change in control of
the Company (i.e. Mr. Wykle and Mr. Perlin own less than 51% of the voting
stock) Allen D. Wykle is no longer employed and the Company terminates him
without cause.
The Employment Agreement provides for termination "for cause" as
defined in the Agreement with notice and for termination upon 90 days prior
written notice without cause.
Under the Employment Agreement he has agreed not to compete with the
company for a period of one (1) year after termination within a prescribed
geographic area and not to solicit or employ Company employees for two (2) years
after termination. These restrictive covenants apply upon termination by either
party, with or without cause and upon expiration of the Agreement.
87
<PAGE>
Barry C. Diggins. The Employment Agreement which commenced September
15, 1997 was for a two year initial term and will automatically renew for
additional one-year terms absent 90 day written notice by either party prior to
the end of a term of nonrenewal. It provides for an annual salary of $130,000
with an annual 6% increase during the initial term. It provides for a bonus of
up to 100% of annual salary if he makes a specified "Profit Target" (net after
tax profits) for offices under his supervision. If he meets at least 75% of the
Profit Target, he earns a bonus computed by multiplying the percentage of the
Profit Target reached times 100% of salary. In addition he is entitled to
incentive compensation of 5% of annual after tax net profit attributable to the
offices supervised by him. Any such incentive compensation in excess of $150,000
per year may within the discretion of the Company be converted to nonstatutory
stock options. He is also entitled to 5% of gross written life insurance
premiums as well as the group benefits of other employees.
The Employment Agreement provides for termination "for cause" as
defined in the Agreement. If he terminates his employment or it is terminated
for cause as defined in the Agreement or either party elects not to renew at the
end of any term with the required notice, the contract ceases, and no further
compensation or benefits are paid. If the Employment Agreement is terminated by
the Company without cause during the initial term, then in lieu of any other
damages or compensation is entitled to severance pay in the amount equal to
$300,000 multiplied by a percentage equal to the number of days left at
termination in the initial term divided by 730. If terminated without cause in a
renewal term, the severance pay shall be equal to the base compensation for that
renewal term multiplied by a percentage equal to the number of days remaining in
the renewal term at termination divided by 365.
Under the Employment Agreement he has agreed not to compete with the
company for a period of one year after termination within a prescribed
geographic area and not to solicit or employ Company employees for two years
after termination. These restrictive covenants apply upon termination by either
party, with or without cause and upon expiration of the Agreement.
88
<PAGE>
Directors' Compensation.
Directors who are compensated as employees of the Company receive no
additional compensation for service as directors.
Each director who is not an employee of the Company receives an annual
retainer of $9,000, payable in cash in quarterly installments of $2,250. All
directors receive reimbursement of reasonable out-of-pocket expenses incurred in
connection with meetings of the Board of Directors. For 1997, the outside
directors were paid an additional $5,000 for their services.
During 1996, the Board of Directors approved the grant of stock
appreciation rights ("SARs") to Ms. Schwindt. The SARs are for a period of three
years and entitle the holder to the appreciated value of 16,000 shares of common
stock, which represents the difference between the grant price and the fair
market value of the shares at the time of exercise. The grant price is $2.63.
The compensation expense associated with issuance of the SARs was approximately
$94,000 during 1996.
Compensation Committee Interlocks and Insider Participation. No
interlocking relationships exist between the Company's Board of Directors or
officers responsible for compensation decisions and the board of directors or
compensation committee of any company, nor has any such interlocking
relationship existed in the past.
89
<PAGE>
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
Security Ownership of Certain Beneficial Owners
Persons who were beneficial owners of 5% or more of the issued and
outstanding Common Stock of the Company as of March 15, 1998 are shown in the
following table. Beneficial ownership includes shares, if any, held in the name
of the spouse, minor children or other relatives of the nominee living in such
person's home, as well as shares, if any, held in the name of another person
under an arrangement whereby the director or executive officer can vest title in
himself at once or at some future time.
Name and Address Amount and Nature Percent of
of Beneficial Owner Beneficial Ownership Common Stock
-------------------------- -------------------- ------------
Allen D. Wykle (1)(2) 1,822,357 33.06%
1062 Normandy Trace Road
Tampa, Florida 33602
Leon H. Perlin (3) 938,256 17.02
3360 South Ocean Boulevard
Apartment 5H2
Palm Beach, Florida 33480
JAM Partners, L.P. (4)
One Fifth Avenue
New York, New York 10003 290,800 5.28
- ---------------------
(1) Mr. Wykle's shares exclude 4,000 shares registered to his adult children
and his grandchildren, as to which Mr. Wykle disclaims beneficial
ownership. Also includes beneficial ownership of 333 shares issuable upon
the exercise of stock options exercisable within 60 days of March 15, 1998,
and excludes 667 shares subject to stock options that cannot be exercised
within 60 days of March 15, 1998.
(2) Mr. Wykle and Mr. Stanley W. Broaddus are Co-Trustees of the Company's
Profit-Sharing Plan, which owns 39,680 of the Company's Common Stock. They
share voting power. Mr. Wykle's ownership interest is 65%. Mr. Broaddus'
share is 15%. All of the 39,680 shares owned by the Profit-Sharing Plan are
included under Mr. Wykle's shares for the purposes of this disclosure,
except for the 15% owned by Mr. Broaddus. Mr. Wykle disclaims beneficial
ownership of all but the 65% he owns in the Profit-Sharing Plan.
(3) Mr. Perlin's shares include 594,000 shares owned by his wife.
(4) JAM Partners, L.P. is a Delaware limited partnership. It is an investment
partnership managed by Jacobs Asset Management LLC. The General Partner is
JAM Managers, LLC. The capital of JAM Partners, L.P. at January 1, 1998 was
approximately $35,500,000. JAM Partners, L.P.'s shares include 260,000 it
owns directly. Also included are 20,000 shares owned directly by Sy Jacobs
and 10,800 shares owned directly by Bernard Sucher and his wife. Mr. Jacobs
and Mr. Sucher are general partners in JAM Managers LLC.
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<PAGE>
Security Ownership of Directors and Executive Officers
The following table sets forth information as of March 15, 1998
regarding the number of shares of Common Stock beneficially owned by all
directors and executive officers:
Common Stock Percentage of
Name Beneficially Owned Class
---- ------------------ -----
Directors:
Allen D. Wykle (1)(2)(6) 1,822,357 33.06%
Leon H. Perlin (3) 938,256 17.02
Oscar S. Warner (4) 64,000 1.16
Arthur Peregoff (5) 81,800 1.48
Stanley W. Broaddus (1)(6) 133,805 2.31
Robert M. Salter 4,464 *
Jean S. Schwindt (7) 62,400 1.13
Neil W. Phelan (1) 10,453 *
Barry C. Diggins 111,034 2.01
Executive officers who are
not directors:
Eric S. Yeakel (1) 333 *
Gregory W. Gleason 1,000 *
All present executive
officers and directors
as a group (11 persons) (1) 3,229,902 55.58%
- ---------------------
* Owns less than 1% of class.
(1) Includes beneficial ownership of 333 shares issuable upon the exercise of
stock options exercisable within 60 days of March 15, 1998, and excludes
667 shares subject to stock options that cannot be exercised within 60 days
of March 15, 1998.
(2) Mr. Wykle's shares excludes 4,000 shares registered to his adult children
and his grandchildren, as to which Mr. Wykle disclaims beneficial
ownership.
(3) Mr. Perlin's shares include 594,000 shares owned by his wife.
(4) Mr. Warner's shares include 4,000 shares owned by his wife, and excludes
30,000 shares registered to his adult children and his grandchildren, as to
which Mr. Warner disclaims beneficial ownership.
(5) Mr. Peregoff's shares are held jointly with his wife. The shares exclude
4,648 shares registered to Mr. Pergoff's adult children and his
grandchildren, as to which Mr. Peregoff disclaims beneficial ownership.
(6) Mr. Wykle and Mr. Broaddus are Co-Trustees of the Company's Profit-Sharing
Plan, which owns 39,680 of the Company's Common Stock. They share voting
power. Mr. Wykle's ownership interest is 65%. Mr. Broaddus' share is 15%.
All of the 39,680 shares owned by the Profit-Sharing Plan are included
under Mr. Wykle's shares for the purposes of this disclosure, except for
the 5,952 shares owned by Mr. Broaddus. Mr. Wykle disclaims beneficial
ownership of all but the 65% he owns in the Profit-Sharing Plan
(7) Ms. Schwindt also has stock appreciation rights on 16,000 shares. Excluded
are 8,000 shares owned by her parents to which Ms. Schwindt disclaims
beneficial ownership.
(8) Mr. Diggins' shares include 4,888 shares owned jointly with his wife.
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ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company has maintained business relationships and engaged in
certain transactions with affiliated companies and the parties as described
below. It is the policy of the Company to engage in transactions with related
parties only on terms that, in the opinion of the Company, are no less favorable
to the Company than could be obtained from unrelated parties and each of the
transactions described below conforms to that policy.
Agreement with IMC Mortgage Company
The Company has an agreement for the sale of mortgage loans to IMC
Mortgage Company ("IMC"). During 1997 and 1996, the Company sold 55.9% and
43.7%, respectively, of its loans to IMC. The Company's contract with IMC
requires the Company to sell a minimum of $2.0 million of loans to IMC each
month. These loan sale transactions are subject to prevailing secondary market
terms for pools of non-conforming mortgage loans. Historically, these
transactions have resulted in the payment of a cash premium from IMC to the
Company. From time to time, various other purchasers purchase more than 10% of
the Company's loan production. While there are several other major purchasers of
non-conforming mortgage loans as large or larger than IMC, the Company maintains
a good working relationship with IMC. IMC offers to buy a wide range of the
Company's loan products at competitive prices. However, there can be no
assurance that IMC will be in a position to continue to purchase the Company's
loan production at margins favorable to the Company. The Company owned
approximately 3.2% of the outstanding common stock of IMC at December 31, 1997.
The Company has had since January 1996 a warehouse financing facility under
which IMC agreed to lend the Company $8,000,000 secured by the Company's
mortgage loans. Borrowings under the facility bore interest at a rate of LIBOR
plus 1.75%. There was no outstanding balance on this line at December 31, 1997.
The line was due to expire on January 29, 1998 and was subject to renewal.
However, the Company terminated this credit line and replaced it with a new
credit line agreement with another party, effective December 10, 1997. 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.
Agreement with Mills Value Adviser, Inc.
The Company entered into an investment management agreement on March
28, 1996, with Mills Value Adviser, Inc. ("MVAI"), a registered investment
advisor. Under the agreement, MVAI manages a portion of the Company's
non-qualified Profit-Sharing Plan. The Plan's trustees retain all proxy voting
rights for securities managed by MVAI. During 1997, the Company paid $3,436 in
advisory fees to MVAI. Jean S. Schwindt, a member of the Company's Board of
Directors and Executive Committee, is a portfolio manager for MVAI.
92
<PAGE>
Termination of Armada Residential Mortgage, LLC
Since December 1994, the Company had conducted a portion of its retail
lending business through Armada Residential Mortgage, LLC ("Armada LLC"), which
was owned 1% by the Company, 82% by ARMI and 17% by Armada LLC's senior officer.
In connection with terminating Armada LLC in September 1997, the Company agreed
to issue 106,146 shares of its Common Stock to purchase the senior officer's
ownership interest in Armada LLC. The senior officer terminated his employment
with Armada LLC and became an employee of ARMI. He also a Director of the
Company. The shares have been adjusted for the 100% stock dividend on November
21, 1997.
Indebtedness of Management
The Company and the Savings Bank have no outstanding extensions of
credit to members of the Board of Directors or management at December 31, 1997.
On June 30, 1994, the Company made a loan to Director Leon H. Perlin. The
original principal balance on the loan was $300,000 and the loan bore an
interest rate of 9.50% . Mr. Perlin paid the loan off in full on September 2,
1997. During 1997, the Company made a loan to Stanley W. Broaddus consisting of
three promissory notes totaling $165,000. These notes bore interest rates
ranging from 9% to 12%. All notes were paid off in full on August 29, 1997.
Promissory Notes
The Company has, from time to time, issued promissory notes to assist
in cash flow. The notes are callable on 30 days notice from the holder and may
be prepaid by the Company. The notes are usually issued to Directors, officers
or shareholders. As of December 31, 1997, the following Directors and Executive
Officers were holders of promissory notes in the amounts and interest rates
specified below:
Allen D. Wykle $539,220 10.00%
Stanley W. Broaddus 231,830 9.00
Stanley W. Broaddus 75,378 8.25
Leon H. Perlin 257,891 9.00
Oscar S. Warner 54,124 8.00
Arthur Peregoff 397,236 9.00
93
<PAGE>
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K
Audited Financial Statements
The following 1997 Consolidated Financial Statements of Approved
Financial Corp. and Subsidiaries are included:
- Report of Independent Public Accountants...................F - 2
- Consolidated Balance Sheets................................F - 3
- Consolidated Statements of Income..........................F - 4
- Consolidated Statements of Shareholders' Equity........F - 5 - F - 6
- Consolidated Statements of Cash Flows..................F - 7 - F - 8
- Notes to Consolidated Financial Statements.............F - 9 - F - 34
94
<PAGE>
Exhibit Index
Exhibit
Number Description
- ------ -----------
3.1 Amended and Restated Articles of Incorporation of the Company
(Incorporated by Reference to Appendix A of the Form 10 Registration
Statement Filed February 11, 1998)
3.2 Bylaws of the Company (Incorporated by Reference to Appendix B of the
Form 10 Registration Statement Filed February 11, 1998)
10.1 Approved Financial Corp. Incentive Stock Option Plan (Incorporated by
Reference to Appendix C of the Form 10 Registration Statement Filed
February 11, 1998)
10.2 Employment Agreement between the Company and Neil W. Phelan
(Incorporated by Reference to Appendix D of the Form 10 Registration
Statement Filed February 11, 1998)
10.3 Employment Agreement between the Company and Stanley W. Broaddus
(Incorporated by Reference to Appendix E of the Form 10 Registration
Statement Filed February 11, 1998)
10.4 Employment Agreement between the Company and Barry C. Diggins
(Incorporated by Reference to Appendix F of the Form 10 Registration
Statement Filed February 11, 1998)
10.5 Purchase Agreement of Barry C. Diggins' Interest in Armada Residential
Mortgage, LLC, and related Nonqualified Stock Option Agreement
(Incorporated by Reference to Appendix G of the Form 10 Registration
Statement Filed February 11, 1998)
10.6 Employment Agreement between the Company and Eric S. Yeakel
(Incorporated by Reference to Appendix H of the Form 10 Registration
Statement Filed February 11, 1998)
10.7 Mills Value Adviser, Inc, Investment Management Agreement/Contract with
the Company (Incorporated by Reference to Appendix I of the Form 10
Registration Statement Filed February 11, 1998)
10.8 Share Purchase Agreement for Purchase of Controlling Interest in
Approved Federal Savings Bank (Formerly First Security Federal Savings
Bank, Inc.) (Incorporated by Reference to Appendix J of the Form 10
Registration Statement Filed February 11, 1998)
95
<PAGE>
Exhibit
Number Description
- ------ -----------
10.9 Stock Appreciation Rights Agreement with Jean S. Schwindt (Incorporated
by Reference to Appendix K of the Form 10 Registration Statement Filed
February 11, 1998)
10.10 Asset Purchase Agreement with Funding Center of Georgia, Inc.
(Incorporated by Reference to Appendix L of the Form 10 Registration
Statement Filed February 11, 1998)
10.11 Gregory J. Witherspoon Registration Rights Agreement (Incorporated by
Reference to Appendix M of the Form 10 Registration Statement Filed
February 11, 1998)
21 Subsidiaries of the Company (Appendix N)
27 Financial Data Schedule
96
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Registration Statement
to be signed on its behalf by the undersigned, thereunto duly authorized.
APPROVED FINANCIAL CORP.
(Registrant)
Date: March 27, 1998 By: /s/ Eric S. Yeakel
------------------------
Eric S. Yeakel
Treasurer and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Date: March 27, 1998 By: /s/ Allen D. Wykle
------------------------
Allen D. Wykle
Chairman of the Board of Directors
President, and Chief Executive Officer
Date: March 27, 1998 By: /s/ Eric S. Yeakel
------------------------
Eric S. Yeakel
Treasurer and
Chief Financial Officer
Date: March 27, 1998 By: /s/ Leon H. Perlin
------------------------
Leon H. Perlin
Director
Date: March 27, 1998 By: /s/ Oscar S. Warner
-------------------------
Oscar S. Warner
Director
Date: March 27, 1998 By: /s/ Arthur Peregoff
-------------------------
Arthur Peregoff
Director
Date: March 27, 1998 By: /s/ Stanley W. Broaddus
-----------------------------
Stanley W. Broaddus
Director, Vice President
and Secretary
97
<PAGE>
Date: March 27, 1998 By: /s/ Robert M. Salter
--------------------------
Robert M. Slater
Director
Date: March 27, 1998 By: /s/ Jean S. Schwindt
--------------------------
Jean S. Schwindt
Director
Date: March 27, 1998 By: /s/ Neil W. Phelan
------------------------
Neil W. Phelan
Director, Executive Vice President
Date: March 27, 1998 By: /s/ Barry C. Diggins
--------------------------
Barry C. Diggins
Director, President of a retail
lending division of ARMI
Date: March 27, 1998 By: /s/ Gregory W. Gleason
----------------------------
Gregory W. Gleason
President, Approved Federal
Savings Bank
98
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Pages
-----
Report of Independent Accountants................................ F - 2
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1997 and 1996.. F - 3
Consolidated Statements of Income for the years ended
December 31, 1997, 1996 and 1995........................... F - 4
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1997, 1996 and 1995..................... F - 5 - F - 6
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995........................... F - 7 - F - 8
Notes to Consolidated Financial Statements.................... F - 9 - F - 34
F - 1
<PAGE>
Report of Independent Accountants
Board of Directors
Approved Financial Corp.
We have audited the accompanying consolidated balance sheets of Approved
Financial Corp. and Subsidiaries, as of December 31, 1997 and 1996, and the
related consolidated statements of income, shareholders' equity, and cash flows
for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Approved Financial
Corp. and Subsidiaries at December 31, 1997 and 1996, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997 in conformity with generally accepted
accounting principles.
/s/ Coopers & Lybrand, L.L.P.
Virginia Beach, Virginia
February 20, 1998
F - 2
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
ASSETS 1997 1996
-------- -------
<S> <C> <C>
Cash $ 11,869 $ 3,440
Mortgage loans, net 80,696 45,423
Real estate owned, net 2,367 2,077
Securities, available for sale 15,201 20,140
Premises and equipment, net 4,530 2,224
Other assets 3,462 1,839
-------- -------
Total assets $118,125 $75,143
======== =======
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loans $ 52,488 $32,030
Certificates of deposit 17,815 1,576
Federal Home Loan Bank advance 1,000 --
Mortgage loans payable 1,216 478
Notes payable - related parties 6,684 6,839
Certificates of indebtedness 2,396 2,343
Loan proceeds payable 6,364 2,147
Accrued and other liabilities 2,837 2,201
Income taxes payable 1,161 985
Deferred income tax liability 1,109 5,335
-------- -------
Total liabilities 93,070 53,934
-------- -------
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 in 1997 and $.25 in 1996:
Authorized 40,000,000 shares,
Issued and outstanding 5,395,408 shares in 1997
and 5,038,736 in 1996 5,395 630
Unrealized gain on securities available for sale,
net of deferred income taxes 6,854 11,401
Additional capital -- 1,485
Retained earnings 12,805 7,692
-------- -------
Total equity 25,055 21,209
-------- -------
Total liabilities and equity $118,125 $75,143
======== =======
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F - 3
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME
for the years ended December 31, 1997, 1996 and 1995
(Dollars in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
Revenue:
<S> <C> <C> <C>
Gain on sale of loans $33,501 $17,955 $ 7,298
Interest income 10,935 4,520 3,065
Income from limited partnership -- 480 596
Gain on sale of securities 2,796 -- --
Other fees and income 4,934 1,927 939
------- ------- -------
52,166 24,882 11,898
------- ------- -------
Expenses:
Compensation and related 16,447 8,017 3,880
General and administrative 14,188 6,853 3,050
Interest expense 6,157 3,121 2,194
Provision for loan and foreclosed property losses 1,676 1,308 731
------- ------- -------
38,468 19,299 9,855
------- ------- -------
Income before income taxes 13,698 5,583 2,043
Provision for income taxes 5,638 2,259 876
------- ------- -------
Net income $ 8,060 $ 3,324 $ 1,167
======= ======= =======
Net income per share:
Basic $ 1.52 $ 0.67 $ 0.24
======= ======= =======
Diluted $ 1.51 $ 0.63 $ 0.23
======= ======= =======
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F - 4
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
for the years ended December 31, 1997, 1996 and 1995
(Dollars in thousands)
Preferred Stock
Series A Common Stock
-------------- -------------------
Shares Amount Shares Amount
------ ------ ------ ------
Balance at December 31, 1994 90 $ 1 631,680 $ 632
Net income -- -- -- --
Repurchase of common stock -- -- (25,000) (25)
Transfer -- -- -- --
Dividends on common stock -- -- -- --
---- ------ ---------- -------
Balance at December 31, 1995 90 1 606,680 607
Net income -- -- -- --
Reissuance of common stock -- -- 22,000 22
2:1 stock split -- -- 628,680 --
2:1 stock split -- -- 1,257,360 --
Exercise of warrants -- -- 4,648 1
Change in net unrealized gain on
securities available for sale
(net of tax of $7,601,000) -- -- -- --
Dividends on common stock -- -- -- --
---- ------ ---------- -------
Balance at December 31, 1996 90 1 2,519,368 630
Net income -- -- -- --
Issuance of common stock -- -- 1,500 1
Exercise of warrants -- -- 176,836 44
Change in par value of stock -- -- -- 2,022
Stock dividend -- -- 2,697,704 2,698
Change in net unrealized gain on
securities available for sale
(net of tax of $3,033,000) -- -- -- --
---- ------ ---------- -------
Balance at December 31, 1997 90 $ 1 5,395,408 $ 5,395
==== ====== ========== =======
The accompanying notes are an integral part of the consolidated financial
statements.
F - 5
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY, CONTINUED
for the years ended December 31, 1997, 1996 and 1995
(Dollars in thousands)
<TABLE>
<CAPTION>
Unrealized
Gain on
Securities
Additional Available Retained
Capital for Sale Earnings Total
------- -------- -------- -----
<S> <C> <C> <C> <C>
Balance at December 31, 1994 $ 598 $ -- $ 4,284 $ 5,515
Net income -- -- 1,167 1,167
Repurchase of common stock (131) -- (94) (250)
Transfer 675 -- (675) --
Dividends on common stock -- -- (196) (196)
------- -------- -------- --------
Balance at December 31, 1995 1,142 -- 4,486 6,236
Net income -- -- 3,324 3,324
Reissuance of common stock 336 -- 82 440
2:1 stock split -- -- -- --
2:1 stock split -- -- -- --
Exercise of warrants 7 -- -- 8
Change in net unrealized gain on
securities available for sale
(net of tax of $7,601,000) -- 11,401 -- 11,401
Dividends on common stock -- -- (200) (200)
------- -------- -------- --------
Balance at December 31, 1996 1,485 11,401 7,692 21,209
Net income -- -- 8,060 8,060
Issuance of common stock -- -- -- 1
Exercise of warrants 288 -- -- 332
Change in par value of stock (1,773) -- (249) --
Stock dividend -- -- (2,698) --
Change in net unrealized gain on
securities available for sale
(net of tax of $3,033,000) -- (4,547) -- (4,547)
------- -------- -------- --------
Balance at December 31, 1997 $ -- $ 6,854 $ 12,805 $ 25,055
======= ======== ======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F - 6
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1997, 1996 and 1995
(In thousands)
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
Operating activities:
<S> <C> <C> <C>
Net income $ 8,060 $ 3,324 $ 1,167
Adjustments to reconcile net income to net
cash used in operating activities:
Depreciation and amortization 609 133 131
Provision for loan losses 1,534 1,145 629
Provision for losses on real estate owned 142 163 101
Loss on sale of real estate owned 654 192 129
Income from limited partnership -- (480) (596)
Gain on sale of securities (2,796) -- --
Gain on sale of loans (32,696) (17,954) (7,298)
Proceeds from sales and prepayments of loans 479,499 258,363 97,229
Loan originations (490,579) (258,826) (100,613)
Changes in operating assets and liabilities:
Other assets (1,012) (581) (1,113)
Accrued and other liabilities 6,773 (110) 400
Income taxes payable 177 443 332
Deferred income taxes (1,195) (852) --
--------- --------- ---------
Net cash used in operating activities (30,830) (15,040) (9,502)
Investing activities:
Purchases of securities (4,304) (1,000) --
Sales of securities 4,458 -- 428
Distributions from limited partnership -- 1,098 --
Proceeds from sales of real estate owned 3,735 1,501 352
Purchases of premises and equipment (3,113) (946) (506)
Sales of premises and equipment 199 -- --
Net cash paid for acquisition of Savings Bank (382) (244) --
--------- --------- ---------
Net cash provided by investing activities 593 409 274
</TABLE>
F - 7
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
for the years ended December 31, 1997, 1996 and 1995
(In thousands)
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
Financing activities:
<S> <C> <C> <C>
Proceeds from revolving warehouse loans $ 471,717 $ 262,854 $ 109,270
Principal payments on revolving warehouse loans (451,259) (248,243) (97,431)
Net increase in certificates of deposit 16,238 197 --
Proceeds from FHLB advances 1,000 -- --
Proceeds from mortgage loans payable 800 -- --
Principal payments on mortgage loans payable (62) (46) (145)
Net increase (decrease) in:
Notes payable - related parties (155) 1,966 (1,369)
Certificates of indebtedness 53 311 (272)
Issuance of common stock 2 440 --
Exercise of common stock warrants 332 8 --
Repurchase of common stock -- -- (250)
Cash dividends paid -- (200) (196)
--------- --------- ---------
Net cash provided by financing activities 38,666 17,287 9,607
--------- --------- ---------
Net increase in cash 8,429 2,656 379
Cash at beginning of year 3,440 784 405
--------- --------- ---------
Cash at end of year $ 11,869 $ 3,440 $ 784
========= ========= =========
Supplemental cash flow information:
Cash paid for interest $ 5,991 $ 3,070 $ 2,143
Cash paid for income taxes 5,461 2,880 1,264
Supplemental non-cash information:
Loan balances transferred to real estate owned $ 4,641 $ 3,245 $ (1,771)
Conversion of and recognition of unrealized gains
of partnership interest to common stock -- 19,001 --
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F - 8
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
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 22 retail
offices in ten states at the end of 1997. 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.
Use of estimates: The preparation of financial statements in conformity with
generally accepted accounting principles require management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and cash equivalents: Cash and cash equivalents consist of cash on deposit
at financial institutions and short-term investments that are considered cash
equivalents if they were purchased with an original maturity of three months or
less.
Loans held for sale: Loans, which are all held for sale, are carried at the
lower of aggregate cost or market value. Market value is determined by current
investor yield requirements.
Allowance for loan losses: The allowance for loan losses is maintained at a
level believed adequate by management to absorb potential losses in the loan
portfolio. Management's determination of the adequacy of the allowance is based
on an evaluation of current economic conditions, volume, growth, and other
relevant factors. The allowance is increased by provisions for loan losses
charged against income. Loan losses are charged against the allowance when
management believes collectibility is unlikely.
Origination fees: The Company accounts for origination fees on mortgage loans
held for sale in conformity with Statement of Financial Accounting Standards
("SFAS") No. 91, "Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases." The statement requires that
net origination fees be recognized over the life of the loan or upon the sale of
the loan, if earlier.
Hedging: To offset the effects of interest rate fluctuations on the value of its
fixed rate mortgage loans held for sale, the Company in certain cases will enter
into Treasury security lock contracts, which function similar to short sales of
U.S. Treasury securities. Gains or losses from these contracts are deferred and
recognized as an adjustment to gains on sale of loans when the loans are sold or
when the related hedge position is closed.
F - 9
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 1. Organization and Summary of Significant Accounting Policies, continued:
Real estate owned: Real estate owned is valued at the lower of cost or fair
market value, net of estimated disposal costs. Cost includes loan principal and
certain capitalized expenses. Any excess of cost over the estimated fair market
value at the time of acquisition is charged to the allowance for loan losses.
The estimated fair market value is reviewed periodically by management and any
write-downs are charged against current earnings using a valuation account which
has been netted against real estate owned in the financial statements. Income
from temporary rental of the properties is credited against the investment when
collected. Capital improvements are capitalized to the extent of net realizable
value. Additional carrying costs, including taxes, utilities and insurance, are
also capitalized to the property.
Premises and equipment: Premises, leasehold improvements and equipment are
stated at cost less accumulated depreciation and amortization. The buildings are
depreciated using the straight line method over thirty years. Leasehold
improvements are amortized over the lesser of the terms of the lease or the
estimated useful lives of the improvements. Depreciation of equipment is
computed using the straight line method over the estimated useful lives of three
to five years. Expenditures for betterments and major renewals are capitalized
and ordinary maintenance and repairs are charged to operations as incurred.
Securities: All investment securities are classified as available-for-sale and
reported at fair value, with unrealized gains and losses excluded from earnings
and reported as a separate component of shareholders' equity.
Realized gains and losses on sales of securities are computed using the specific
identification method.
The Company's investment in the stock of the Federal Home Loan Bank ("FHLB") of
Atlanta is stated at cost.
Income recognition: Gains on the sale of mortgage loans representing the
difference between the sales price and the net carrying value of the loan are
recognized when mortgage loans are sold and delivered to investors.
Interest on loans is credited to income based upon the principal amount
outstanding. Interest is accrued on loans until they become 31 days or more past
due.
Advertising costs: Advertising costs are expensed when incurred.
Income taxes: Taxes are provided on substantially all income and expense items
included in earnings, regardless of the period in which such items are
recognized for tax purposes. The Company uses an asset and liability approach
that requires the recognition of deferred tax assets and liabilities for the
estimated future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events other
than enactments of changes in the tax laws or rates.
F - 10
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 1. Organization and Summary of Significant Accounting Policies, continued:
Earnings per share: Effective December 31, 1997, the Company adopted SFAS No.
128, "Earnings Per Share," which supersedes Accounting Principles Board ("APB")
Opinion No. 15, "Earnings per Share." The new statement requires that "basic
earnings per share" be computed by dividing income available to common
shareholders by the weighted-average number of common shares outstanding for the
period. "Diluted earnings per share" reflects potential dilution if stock
options would result in the issue or exercise of additional shares of common
stock that shared in the earnings. "Basic earnings per share" and "diluted
earnings per share" replaced "primary earnings per share" and "fully diluted
earnings per share," respectively, as described under APB Opinion No. 15, and
are reported on the income statement.
The Company declared two-for-one stock splits effective August 30, 1996,
December 16, 1996 and November 21, 1997. The share and per share figures in this
report have been adjusted to reflect these splits.
New accounting pronouncements: In June 1997, 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 Company is currently evaluating the effect
this statement will have on the financial statements.
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.
Reclassifications: Certain reclassifications have been made to amounts
previously reported in 1996 and 1995 to conform with the 1997 presentation.
F - 11
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 2. Securities:
The cost basis and fair value of the Company's securities at December 31, 1997
and 1996 are as follows (in thousands):
1997 1996
------------------ ------------------
Cost Fair Cost Fair
Basis Value Basis Value
------- ------- ------- -------
IMC Mortgage Company common stock $ 162 $11,585 $ 1,095 $20,096
Adjustable rate mortgage mutual fund 3,569 3,566 -- --
FHLB stock 50 50 44 44
------- ------- ------- -------
$ 3,781 $15,201 $ 1,139 $20,140
======= ======= ======= =======
The Company's investment in IMC Mortgage Company ("IMC") common stock had gross
unrealized gains of $11,423,000 and $19,001,000 at December 31, 1997 and 1996,
respectively. The Company's investment in the adjustable rate mortgage mutual
fund had an unrealized loss of $2,000 at December 31, 1997.
The Company was an original limited partner in Industry Mortgage Company, L.P.
(the "IMC Partnership"), a non-conforming residential mortgage company based in
Tampa, Florida. The Company's initial ownership interest represented
approximately 9.09% of the IMC Partnership and was accounted for under the
equity method of accounting. Therefore, the Company recognized the portion of
the IMC Partnership's net income equal to its ownership percentage in the IMC
Partnership. In 1996 and 1995, the Company recognized income of $480,000 and
$596,000, respectively, from the IMC Partnership.
The IMC Partnership converted to a corporation, IMC, immediately before its
initial public offering on June 24, 1996. The limited partners received common
stock of IMC in exchange for their IMC Partnership interests as of June 24,
1996. The Company was issued 1,199,768 shares of IMC common stock at that time.
Following the partnership's conversion to corporate form, the Company's
investment in IMC is accounted for as an investment security available for sale
under SFAS No. 115. As of December 31, 1997, the Company owned 975,592 shares of
IMC stock. The Company's stock position represented approximately 3.2% of IMC's
outstanding stock at that date. During 1997, the Company sold 233,241 shares of
IMC stock for $3,729,000, which resulted in a pre-tax gain of $2,796,000. The
Company also received 9,065 shares of IMC common stock as an incentive award
relating to the volume of loans sold by the Company to IMC. All of the share
figures above reflect a two-for-one split of IMC shares on February 13, 1997.
Shares of IMC common stock are traded on the NASDAQ National Exchange under the
trading symbol "IMCC." However, the shares received by the Company have not been
registered with the Securities and Exchange Commission ("SEC") under the
Securities Act of 1933. Sales of IMC stock by the Company are subject to SEC
Rule 144 and a lock-up agreement. The lock-up agreement limits sales of IMC
stock by the Company to approximately 96,000 shares per month between August
1997 and August 1998.
F - 12
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 3. Mortgage Loans Held for Sale:
The Company holds first- and second-lien mortgage loans for future sale. The
loans are carried at the lower of cost or market. These mortgage loans have been
pledged as collateral for the warehouse financing. Loans at December 31, 1997
and 1996 were as follows (in thousands):
1997 1996
-------- --------
Mortgage loans held for sale $ 83,512 $ 47,217
Net deferred origination fees and hedging costs (1,129) (870)
Allowance for loan losses (1,687) (924)
-------- --------
Total mortgage loans, net $ 80,696 $ 45,423
======== ========
As of December 31, 1997, the Company had one open interest rate hedge position
of $15,000,000 under a contract expiring on March 2, 1998. The Company had a
deferred loss of $91,000 at December 31, 1997 related to this hedge position.
The Company sold to Industry Mortgage Company 3,791, 1,536, and 504 loans
totaling $235,228,000, $100,095,000, and $37,993,000 and recognized gains on the
sale of these loans of $16,153,000, $6,648,000, and $2,372,000 during the years
ended December 31, 1997, 1996 and 1995, respectively.
Included in loans at December 31, 1996 were $456,000 of loans to related
parties. Such loans included three demand loans to a shareholder collateralized
by certain notes payable to related parties of the Company, and a demand note
collateralized by Company stock. These related party loans bore interest at or
above market rates when the loans were originated and were made on substantially
the same terms as loans to other borrowers. The loans were paid in full before
December 31, 1997. Interest income on related party loans was $36,000, $36,000
and $38,000 in 1997, 1996 and 1995, respectively.
At December 31, 1997 and 1996, the recorded investment in loans for which
impairment has been determined in accordance with SFAS No. 114 totaled
$2,500,000 and $1,200,000, respectively. The average recorded investment in
impaired loans for the years ended December 31, 1997 and 1996 was $780,000 and
$64,000, respectively. Interest income recognized related to these loans was
$94,000 and $13,000 during 1997 and 1996, respectively. Due to the homogeneous
nature and collateral for these loans, there is no corresponding valuation
allowance.
Nonaccrual loans were $4,511,000 and $3,042,000 at December 31, 1997 and 1996,
respectively. The amount of additional interest that would have been recorded
had these loans not been placed on nonaccrual status was approximately $154,000,
$91,000, and $69,000 in 1997, 1996 and 1995, respectively.
F - 13
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 3. Mortgage Loans Held for Sale, continued:
Changes in the allowance for loan losses for the years ended December 31, 1997,
1996 and 1995 were (in thousands):
1997 1996 1995
------- ------- -------
Balance at beginning of year $ 924 $ 594 $ 567
Acquisition of Savings Bank -- 20 --
Charge-offs (953) (863) (662)
Recoveries 182 28 60
Provision 1,534 1,145 629
------- ------- -------
Balance at end of year $ 1,687 $ 924 $ 594
======= ======= =======
Note 4. Real Estate Owned:
Real estate owned is valued at the lower of cost or fair market value, net of
estimated disposal costs.
Changes in the real estate owned valuation allowance for the years ended
December 31, 1997, 1996 and 1995 were (in thousands):
1997 1996 1995
------ ------ ------
Balance at beginning of year $ 529 $ 366 $ 265
Provision 142 163 101
------ ------ ------
Balance at end of year $ 671 $ 529 $ 366
====== ====== ======
F - 14
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 5. Premises and Equipment:
Premises and equipment at December 31, 1997 and 1996 were summarized as follows
(in thousands):
1997 1996
------ ------
Land $ 240 $ 240
Buildings and improvements 2,101 734
Furniture, fixtures and equipment 1,465 843
Computer software and equipment 1,613 778
Vehicles 225 222
------ ------
5,644 2,817
Less accumulated depreciation and amortization 1,114 593
------ ------
Premises and equipment, net $4,530 $2,224
====== ======
Depreciation and amortization expense on premises and equipment totaled
$609,000, $133,000 and $131,000 in 1997, 1996 and 1995, respectively.
Note 6. Leases:
The Company leases some of its office facilities and equipment under operating
leases which expire at various times through 2003. Lease expense was $955,000,
$317,000 and $142,000 in 1997, 1996 and 1995, respectively. Total minimum lease
payments under noncancelable operating leases with remaining terms in excess of
one year as of December 31, 1997 were as follows (in thousands):
1998 $ 1,173
1999 856
2000 433
2001 211
2002 113
Thereafter 16
-------
$ 2,802
=======
F - 15
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 7. Revolving Warehouse Facilities:
Amounts outstanding under revolving warehouse facilities at December 31, 1997
and 1996 were as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Syndicated warehouse facility with commercial bank
collateralized by mortgages/deeds of trust; expires
December 31, 1999, with interest at 1.50% over
applicable LIBOR rate (5.71875% at December 31, 1997);
total credit available $100,000,000. $ 46,734 $ -
Syndicated seasoned loan line of credit with commercial
banks collateralized by mortgages/deeds of trust,
expires December 31, 1999, with interest at 2.50% over
applicable LIBOR rate (5.71875% at December 31, 1997);
total credit available $25,000,000. 5,754 -
Warehouse facility with commercial bank collateralized by
mortgages/deeds of trust; expired December 10, 1997. - 14,999
Warehouse facility with commercial bank collateralized by
assets of the Company; expired March 3, 1997. - 13,516
Warehouse facility with investor collateralized by
mortgages/deeds of trust; expired December 10, 1997. - 3,515
-------- --------
$ 52,488 $ 32,030
======== ========
</TABLE>
On December 10, 1997, the Company obtained a $100,000,000 warehouse line of
credit from a commercial bank syndicate. The line is collateralized by loans
originated by the Company and bears interest at a rate of 1.5% over the
one-month LIBOR rate. This line of credit replaced three existing lines of
credit. 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. Also on December 10, 1997, the Company obtained 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.
F - 16
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 8. Deposits:
The following table sets forth various interest rate categories for the
FDIC-insured certificates of deposit of the Savings Bank as of December 31, 1997
and 1996:
(In thousands)
1997 1996
------------------ -----------------
Weighted Weighted
Average Average
Rate Amount Rate Amount
-------- ------ -------- ------
5.24% or less -- $ -- 5.18% $ 396
5.25 - 5.49% 5.30% 198 5.34 495
5.50 - 5.74 5.56 300 5.65 288
5.75 - 5.99 5.91 8,318 5.93 397
6.00 - 6.24 6.11 8,010 -- --
6.25 - 6.49 6.32 989 -- --
---- ------- ---- ------
6.01% $17,815 5.50% $1,576
==== ======= ==== ======
The following table sets forth the amount and maturities of the certificates of
deposit of the Savings Bank at December 31, 1997.
(In thousands)
<TABLE>
<CAPTION>
Six Over Six Months Over One Over
Months and Less than Year and Less Two
Or Less One Year Than Two Years Years Total
------- -------- -------------- ----- -----
<S> <C> <C> <C> <C> <C>
5.25 - 5.49% $ 99 $ 99 $ -- $ -- $ 198
5.50 - 5.74 300 -- -- -- 300
5.75 - 5.99 5,945 2,373 -- -- 8,318
6.00 - 6.24 99 4,353 3,558 -- 8,010
6.25 - 6.49 -- -- 791 198 989
------ ------ ------ ------- -------
$6,443 $6,825 $4,349 $ 198 $17,815
====== ====== ====== ======= =======
</TABLE>
At December 31, 1997, twenty four certificates of deposit totaling $2,400,000
were in amounts of $100,000.
F - 17
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 9. Federal Home Loan Bank Advances:
Advances from the Federal Home Loan Bank ("FHLB") of Atlanta are summarized
below by maturity date (in thousands):
1997 1996
-------- ------
Due in 1998 $ 1,000 $ -
======== ======
At December 31, 1997, the Savings Bank has pledged its FHLB stock and qualifying
residential mortgage loans with an aggregate balance of $1,670,000 as collateral
for such FHLB advances under a specific collateral agreement. Interest is
computed based on the lender's cost of overnight funds. The interest rate on
December 31, 1997 was 6.50%. Interest expense on FHLB advances totaled $3,000 in
1997; the Savings Bank did not borrow from the FHLB in 1996.
Note 10. Notes Payable - Related Parties:
Notes payable - related parties are amounts due to shareholders, officers and
others related to the Company. These notes are subordinate to the line of credit
and all other collateralized indebtedness of the Company. Interest expense on
notes payable - related parties was $666,000, $547,000 and $530,000 in 1997,
1996 and 1995, respectively. The interest rates on the notes range from 8.00% to
10.25% and the notes mature as follows (in thousands):
1998 $1,527
1999 3,287
2000 742
2001 429
2002 699
------
$6,684
======
F - 18
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 11. Certificates of Indebtedness:
Certificates of indebtedness are uninsured deposits authorized for financial
institutions such as the Company which have Virginia industrial loan association
charters. The certificates are loans from Virginia residents for periods of one
to five years and interest rates between 6.75% and 10.00%. Interest expense on
the certificates was $225,000, $139,000 and $258,000 in 1997, 1996 and 1995,
respectively.
Certificates of indebtedness maturities were as follows as of December 31, 1997
(in thousands):
1998 $ 523
1999 90
2000 709
2001 545
2002 529
------
$2,396
======
Note 12. Mortgage Loans Payable:
The Company has two mortgage loans payable to a commercial bank. The loans are
collateralized by two office buildings used by the Company for its corporate
headquarters. Payments on the loans are made in monthly installments. The
mortgage loans are summarized as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Mortgage loan with commercial bank collateralized by office
building; original amount of $590,000; monthly payments
of $7,186; matures May 2004; with interest at 7.99%. $ 428 $ 478
Mortgage loan with commercial bank collateralized by office
building; original amount $800,000; monthly payments of
$7,953; matures June 2012; with interest at 8.625%. 788 -
------- -------
$ 1,216 $ 478
======= =======
</TABLE>
Interest expense on mortgage loans payable was $73,000, $40,000 and $44,000 in
1997, 1996 and 1995, respectively.
F - 19
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 12. Mortgage Loans Payable, continued:
Aggregate maturities for mortgage loans payable are as follows as of December
31, 1997 (in thousands):
1998 $ 83
1999 90
2000 97
2001 105
2002 114
Thereafter 727
------
$1,216
======
Note 13. Shareholders' Equity:
Prior to its stock offering in 1992, the Company issued warrants to purchase
190,404 shares of common stock at $1.87 per share to its then existing
shareholders. During 1997 and 1996, 176,836 and 4,648 warrants were exercised
for $332,000 and $8,000, respectively. The remaining 8,920 warrants expired on
April 20, 1997.
The Company has 50,000 shares of Series B Preferred Stock authorized for future
issuance. The stock has a stated par value of $10 per share and is
noncumulative, nonvoting. There were no shares issued or outstanding at December
31, 1997 or 1996.
In 1995, the Company's Board of Directors approved a transfer of $675,000 from
retained earnings to additional capital. After the transfer, the Company cannot
make loans in excess of $350,000 under existing regulations.
During 1996, the Board of Directors approved the grant of stock appreciation
rights ("SARs") to one board member. The SARs expire in three years and upon
expiration of the 16,000 shares of common stock, the holder shall receive cash
in an amount equivalent to the difference between the grant price and the fair
market value of the shares at the time of expiration. The grant price is $2.63.
The compensation expense associated with issuance of the SARs was $100,000 and
$94,000 during 1997 and 1996, respectively.
On July 16, 1996, the Company declared a two-for-one split of its common stock,
payable August 15, 1996 to shareholders of record on August 29, 1996. On
November 11, 1996, the Company declared a two-for-one split of its common stock,
payable December 2, 1996 to shareholders of record on December 16, 1996.
In August 1997, the Company changed the par value of its stock to $1.00 per
share from $.25 per share.
On October 27, 1997, the Company declared a 100% stock dividend on its common
stock, payable November 14, 1997 to shareholders of record on November 7, 1997.
F - 20
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 14. Stock Options:
On June 28, 1996, the Company adopted the 1996 Incentive Stock Option Plan. The
Company's stock option plan provides primarily for the granting of nonqualified
stock options to certain key employees. Generally, options are granted at prices
equal to the market value of the Company's stock on the date of grant, vest over
a three-year period, and expire ten years from the date of the award.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" and related interpretations in accounting for its
stock option plans. SFAS No. 123, "Accounting for Stock-Based Compensation," was
issued in 1995 and, if fully adopted, changes the method of recognition of cost
on plans similar to those of the Company. The Company has adopted the
alternative disclosure established by SFAS No. 123. Therefore, pro forma
disclosures as if the Company adopted the cost recognition requirements under
SFAS No. 123 are presented below.
A summary of the Company's stock options as of December 31, 1997 and the changes
during the year is presented below:
Weighted
Average
Options Exercise
Outstanding Price
----------- -----
Balance, December 31, 1996 -- $ --
Granted 9,200 9.75
------- -----
Balance, December 31, 1997 9,200 $9.75
======= =====
Options available for future grant 116,800
=======
Weighted average fair value of
options granted during year $3.49
=====
The weighted-average remaining contractual life of options outstanding at
December 31, 1997 was 9.0 years.
F - 21
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 14. Stock Options, continued:
The fair value of each option granted during 1997 is estimated on the date of
grant using the Black-Scholes option-pricing model with the following
assumptions: dividend yield of zero; expected volatility of 34.12%; risk-free
interest rate of 6.00%; and expected life of four years.
Had compensation cost for the 1997 grants for stock-based compensation plans
been recorded by the Company, the Company's pro forma net income and pro forma
net income per common share for 1997 would have been as follows:
(In thousands, except per share amounts)
Year Ended December 31, 1997
-------------------------------
As Reported Pro Forma
----------- ---------
Net income $ 8,060 $ 8,041
Net income per common share - Basic 1.52 1.52
Net income per common share - Dilutive 1.51 1.51
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. There were no awards prior to 1997 and additional
awards in future years are anticipated.
F - 22
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 15. Earnings Per Share:
The Company's earnings per share have been calculated using SFAS No. 128,
"Earnings Per Share." The statement requires calculations of basic and diluted
earnings per share. These calculations are described in Note 1. The following
table shows the reconciling components between basic and diluted earnings per
share:
Weighted
Average Shares
Net Income Outstanding Earnings
(Numerator) (Denominator) Per Share
----------- ------------- ---------
For the Year Ended December 31, 1997
- ------------------------------------
Basic earnings per share $8,060,000 5,310,263 $1.52
Effect of dilutive securities:
Stock options -- 1,162 --
Common stock issued January 5,
1998 (See Note 25) -- 34,532 (.01)
---------- --------- -----
Diluted earnings per share $8,060,000 5,345,957 $1.51
========== ========= =====
For the Year Ended December 31, 1996
- ------------------------------------
Basic earnings per share $3,324,000 4,964,244 $0.67
Effect of dilutive securities:
Warrants -- 316,859 (.04)
---------- --------- -----
Diluted earnings per share $3,324,000 5,281,103 $0.63
========== ========= =====
For the Year Ended December 31, 1995
- ------------------------------------
Basic earnings per share $1,167,000 4,913,168 $0.24
Effect of dilutive securities:
Warrants -- 149,641 (.01)
---------- --------- -----
Diluted earnings per share $1,167,000 5,062,809 $0.23
========== ========= =====
F - 23
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 16. Income Taxes:
The components of income tax expense for the years ended December 31, 1997, 1996
and 1995 were as follows (in thousands):
1997 1996 1995
------- ------- -------
Current $ 6,963 $ 3,147 $ 1,629
Deferred (1,325) (888) (753)
------- ------- -------
$ 5,638 $ 2,259 $ 876
======= ======= =======
The provision for income taxes for financial reporting purposes differs from the
amount computed by applying the statutory federal tax rate to income before
taxes. The principal reasons for these differences for the years ended December
31, 1997, 1996 and 1995 were (in thousands):
1997 1996 1995
------ ------ ------
Provision for income taxes at
statutory federal rate $4,731 $1,898 $ 695
State income taxes, net of federal benefit 827 332 121
Nondeductible expenses 79 30 28
Other, net 1 (1) 32
------ ------ ------
$5,638 $2,259 $ 876
====== ====== ======
F - 24
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 16. Income Taxes, continued:
Significant components of the Company's deferred tax assets and liabilities at
December 31, 1997 and 1996 were:
1997 1996
------- -------
Deferred tax assets:
Allowance for loan and real estate owned losses $ 912 $ 580
Deferred loan fees 487 443
Mark to market on mortgage loans held for sale 1,790 964
Deferred income 52 68
Other 244 239
------- -------
Total deferred tax assets 3,485 2,294
Deferred tax liabilities:
Market value of securities 4,568 7,601
Other 26 28
------- -------
Total deferred tax liabilities 4,594 7,629
------- -------
Net deferred liability $(1,109) $(5,335)
======= =======
The Company believes that a valuation allowance with respect to the realization
of the gross total deferred tax assets is not necessary. Based on the Company's
historical earnings, future expectations of taxable income and potential net
operating loss carrybacks, management believes it is more likely than not that
the Company will realize the gross deferred tax assets existing at December 31,
1997. However, there can be no assurances that the Company will generate taxable
income in any future period.
Note 17. Retirement Plans:
The employees of the Company participate in a defined contribution profit
sharing plan administered by officers of the Company. Company contributions to
the plan are discretionary, as authorized by the Compensation Committee of the
Board of Directors. There were no contributions for 1997, 1996 and 1995.
Participants are also eligible to make voluntary contributions to the plan, at
the discretion of the administrator. There were no voluntary contributions to
the plan for the years ended December 31, 1997, 1996 and 1995.
F - 25
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 17. Retirement Plans, continued:
The Company has a nonqualified retirement plan for several key members of
management. The plan allows participants to defer compensation from the current
year. Company contributions to the plan are discretionary, as authorized by the
Compensation Committee. Contributions for the years ended December 31, 1997,
1996 and 1995 were $10,000, $0 and $56,000, respectively.
The Company sponsors a 401(k) Retirement Plan. The Plan is a defined
contribution plan covering all employees who have completed at least one year of
service. The Plan is subject to the provisions of the Employee Retirement Income
Security Act of 1974. The Company contributes an amount equal to 50% of a
participant's payroll savings contribution up to 6% of a participant's annual
compensation. The Company's contributions to the plan in 1997, 1996 and 1995
were $115,000, $33,000 and $15,000, respectively.
Note 18. Employment Agreements:
The Company has employment agreements with various officers and employees. The
agreements expire at various times throughout 1998. Among other things, the
agreements provide for severance benefits payable to the officers upon
termination of employment following a change of control in the Company.
Note 19. Acquisition:
Effective September 11, 1996, the Company purchased 87.3 percent of the common
stock (11,300 of the total 12,941 total issued and outstanding shares) of the
Savings Bank for $2,776,000. The Company acquired substantially all of the
remaining outstanding shares of the Savings Bank's stock in April 1997 for
$382,000. The total purchase price of $3,158,000 represented the Savings Bank's
book value at the acquisition date plus $150,000. The Company also incurred
$94,000 of capitalized legal and other costs in connection with the acquisition.
The transaction was accounted for under the purchase method of accounting and
the associated intangible of $150,000 is being amortized over a period of 10
years by the Savings Bank.
Prior to the acquisition, the Savings Bank was a privately owned, federally
chartered thrift institution located in Annandale, Virginia operating under the
name First Security Federal Savings Bank, Incorporated. At the acquisition date
the Savings Bank had assets of $5,490,000 consisting primarily of cash, loans
and other assets totaling $2,269,000, $2,511,000 and $710,000, respectively.
Total liabilities were $2,482,000 and consisted predominately of certificates of
deposits totaling $1,379,000. The primary focus of the Savings Bank was the
origination of conforming residential mortgage loans in Maryland, Washington,
D.C. and northern Virginia. The Savings Bank sold most of its loans to investors
without retention of the servicing rights. The Savings Bank's primary funding
source was the issuance of certificates of deposit insured up to $100,000 by the
Federal Deposit Insurance Corporation.
F - 26
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 19. Acquisition, continued:
The Company acquired the Savings Bank to complement its nonconforming
residential mortgage business. After the acquisition, the Company began the
process of winding down the Savings Bank's operations. The Company installed a
new management team at the Savings Bank, and has moved the institution to leased
space in Virginia Beach, Virginia. The long-term lease for the Annandale
operations center expired in February 1997 and was not renewed. As of November
1, 1996, the Savings Bank discontinued its mortgage banking operations and most
of the mortgage personnel were terminated. Estimated costs and related
expenditures to move the operations to Virginia Beach were approximately
$25,000. Mortgage loans in process but not closed as of that date were closed by
other lenders. The Savings Bank's management also terminated all lease
agreements for space used in the mortgage banking operations. The Savings Bank
offers conforming loan products elsewhere in Virginia and in other states. The
Savings Bank's growth will be funded primarily with insured customer deposits
and advances from the Federal Home Loan Bank of Atlanta collateralized by
mortgage loans held by the Savings Bank.
At December 31, 1996, the Savings Bank had total assets of $4,874,000,
consisting primarily of $2,950,000 of cash and $1,052,000 of mortgage loans
receivable. The Savings Bank had $1,847,000 of liabilities, consisting primarily
of $1,576,000 in FDIC-insured customer deposits. The Savings Bank incurred a
loss of $61,000 for the period from the date of acquisition by Approved through
December 31, 1996. The financial condition and results of operations since
acquisition of the Savings Bank are reflected in the consolidated financial
statements. On a pro forma basis, the net loss incurred by the Savings Bank for
the period January 1, 1996 through December 31, 1996 was approximately $646,000
(unaudited). As previously noted, on November 1, 1996, the Savings Bank
terminated its mortgage banking operations in Northern Virginia, and relocated
its mortgage banking operations to Virginia Beach, Virginia. Subsequent to
December 31, 1996 and the relocation of its mortgage banking operations, the
Savings Bank's results of operations have become profitable again (unaudited).
On January 27, 1997, the Board of Directors of the Savings Bank changed the name
of the institution to Approved Federal Savings Bank.
At December 31, 1997, the Savings Bank had total assets of $22,589,000 and total
liabilities of $19,347,000, and the Savings Bank had net income of $217,000 for
the year ended December 31, 1997.
F - 27
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 20. Regulatory Capital:
Savings institutions, such as the Savings Bank, must maintain specific capital
standards that are no less stringent than the capital standards applicable to
national banks. Regulations of the OTS currently maintain three capital
standards: a tangible capital requirement, a core capital requirement, and a
risk-based capital requirement.
The tangible capital standard requires the Savings Bank to maintain tangible
capital of not less than 1.5% of total adjusted assets. As it applies to the
Savings Bank, "tangible capital" means core capital (as defined below).
The core capital standard requires the Savings Bank to maintain "core capital"
of not less than 4.0%. Core capital includes the Savings Bank's common
shareholders' equity, adjusted for certain nonallowable assets.
The risk-based standard requires the Savings Bank to maintain capital equal to
8.0% of risk-weighted assets. The rules provide that the capital ratio
applicable to an asset will be adjusted to reflect the degree of credit risk
associated with such asset, and the asset base used for computing the capital
requirement includes off-balance sheet assets.
At December 31, 1997 and 1996, the Savings Bank was classified as a
"well-capitalized" institution (financial institutions that maintain total risk
based capital in excess of 10%) as determined by the OTS and satisfied all
regulatory capital requirements, as shown in the following table reconciling the
Bank's capital to regulatory capital (in thousands):
<TABLE>
<CAPTION>
Tangible Core Risk-Based
Capital Capital Capital
------- ------- -------
December 31, 1997
- -----------------
<S> <C> <C> <C>
GAAP capital $ 3,242 $ 3,242 $ 3,242
Add: unrealized loss on securities 2 2 2
Nonallowable asset: goodwill (132) (132) (132)
Additional capital item: general allowance -- -- 73
------- ------- -------
Regulatory capital - computed 3,112 3,112 3,185
Minimum capital requirement 336 895 1,249
------- ------- -------
Excess regulatory capital $ 2,776 $ 2,217 $ 1,936
======= ======= =======
Ratios:
Regulatory capital - computed 13.91% 13.91% 20.40%
Minimum capital requirement 1.50 4.00 8.00
------- ------- -------
Excess regulatory capital 12.41% 9.91% 12.40%
======= ======= =======
</TABLE>
F - 28
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 20. Regulatory Capital, continued:
<TABLE>
<CAPTION>
Tangible Core Risk-Based
Capital Capital Capital
------- ------- -------
December 31, 1996
- -----------------
<S> <C> <C> <C>
GAAP capital $ 3,027 $ 3,027 $ 3,027
Nonallowable asset: goodwill (146) (146) (146)
Additional capital item: general allowance -- -- 24
------- ------- -------
Regulatory capital - computed 2,881 2,881 2,905
Minimum capital requirement 71 189 156
------- ------- -------
Excess regulatory capital $ 2,810 $ 2,692 $ 2,749
======= ======= =======
Ratios:
Regulatory capital - computed 60.93% 60.93% 148.64%
Minimum capital requirement 1.50 4.00 8.00
------- ------- -------
Excess regulatory capital 59.43% 56.93% 140.64%
======= ======= =======
</TABLE>
The payment of cash dividends by the Savings Bank is subject to regulation by
the OTS. The OTS measures an institution's ability to make capital
distributions, which includes the payment of dividends, according to the
institution's capital position. For institutions, such as the Savings Bank, that
meet their fully phased-in capital requirements, the OTS has established "safe
harbor" amounts of capital distributions that institutions can make after
providing notice to the OTS, but without needing prior approval. Institutions
can distribute amounts in excess of the safe harbor amount without the prior
approval of the OTS. The Savings Bank did not pay cash dividends to Approved in
1997 or 1996.
Note 21. Impact of Deposit Insurance Funds Act of 1996:
The Savings Bank is a member of the Savings Association Insurance Fund ("SAIF").
On September 30, 1996, President Clinton signed into law the Deposit Insurance
Funds Act of 1996, which included provisions recapitalizing the SAIF, provides
for the eventual merger of the thrift fund with the Bank Insurance Fund ("BIF"),
and reallocates payment of the annual Financing Corp. ("FICO") bond obligation.
As part of the package, the Federal Deposit Insurance Corp. imposed a special
one-time assessment of 65.7 basis points to be applied against all
SAIF-assessable deposits as of March 31, 1995, which will bring the SAIF up to
the statutorily prescribed 1.25 percent designated reserve ratio. The special
assessment, which was paid in November 1996, was included as a $23,000 pretax
charge to the Savings Bank's operations in September 1996.
F - 29
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 21. Impact of Deposit Insurance Funds Act of 1996, continued:
Effective January 1, 1997, SAIF members have the same risk-based assessment
schedule as BIF members. The Savings Bank will effectively pay no assessment for
deposit insurance coverage beginning on January 1, 1997. However, all SAIF and
BIF institutions including the Savings Bank will be responsible for sharing the
cost of interest payments on the FICO bonds. The cost will be an annualized
charge of 1.3 basis points for BIF deposits and 6.4 basis points for SAIF
deposits. The 1997 cost of insurance payments for the Savings Bank was $2,000.
As a result of the Deposit Insurance Funds Act of 1996, the Secretary of the
Treasury is to review recommendations in 1997 for the establishment of a common
charter for banks and savings associations. Accordingly, the Savings Bank may be
required to convert its federal savings bank charter to either a national bank
charter, a state depository institution charter, or a newly designed charter.
The Savings Bank may also become regulated at the holding company level by the
Board of Governors of the Federal Reserve System ("Federal Reserve") rather than
by the OTS. Regulation by the Federal Reserve could subject the Savings Bank to
capital requirements that are not currently applicable to the Savings Bank as a
holding company under OTS regulation and may result in statutory limitations on
the type of business activities in which the Savings Bank may engage at the
holding company level, which business activities currently are not restricted.
The Savings Bank is unable to predict whether such initiatives will result in
enacted legislation requiring a charter change and if so whether the charter
change would significantly impact the Savings Bank's operations.
Note 22. 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 which 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 is in
the process of implementing 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
estimated cost of compliance is not considered material to the Company's
financial condition.
F - 30
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 23. Disclosures About Fair Value of Financial Instruments:
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments" requires
the Company to disclose the estimated fair value for each class of financial
instrument, whether or not recognized in the financial statements, for which it
is practical to estimate that value. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and the estimated future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. SFAS No. 107 excludes certain
financial instruments and all non-financial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts do not represent the
underlying value of the Company.
The following methods and assumptions were used to estimate the fair value of
the Company's financial instruments:
Cash and cash equivalents: The carrying amount of cash on hand and on deposit at
financial institutions is considered to be fair value.
Mortgage loans, net: The estimate of fair value is based on current pricing of
whole loan transactions that a purchaser unrelated to the seller would demand
for a similar loan. The fair value of mortgage loans held for sale approximated
$83,996,000 and $48,854,000 at December 31, 1997 and 1996, respectively.
Securities: Fair values are based on quoted market prices or dealer quotes.
Revolving warehouse lines: Collateralized borrowings consist of warehouse
finance facilities and term debt. The warehouse finance facilities have
maturities of less than one year and bear interest at market rates and,
therefore, the carrying value is a reasonable estimate of fair value.
Certificates of deposit: The fair values for certificates of deposit are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated contractual
maturities on such time deposits. The fair value of the certificates of deposit
approximated $17,828,000 and $1,573,000 at December 31, 1997 and 1996,
respectively.
Mortgage loans payable: The fair value of mortgage loans payable is based on the
discounted value of expected cash flows. The discount rates used are those
currently offered for mortgage loans with similar remaining contractual
maturities and terms. The fair value of the mortgage loans payable approximated
$1,190,000 and $440,000 at December 31, 1997 and 1996, respectively.
Other term debt: The carrying amount of outstanding term debt, which bear market
rates of interest, approximates its fair value.
F - 31
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 24. Minority Interests:
Minority interests are included in other liabilities as of December 31, 1996.
They relate to a 17 percent partnership interest in the joint venture Armada
Residential and the 12.7 percent interest of shareholders in the Savings Bank.
The balances were as follows as of December 31, 1996 (in thousands):
Armada Residential Mortgage, LLC $ 170
Approved Federal Savings Bank 461
-------
Total minority interests included in other liabilities $ 631
=======
Note 25. Termination of Armada LLC:
Since December 1994, the Company had conducted a portion of its retail lending
business through Armada Residential Mortgage, LLC ("Armada LLC"), which was
owned 1% by Approved, 82% by ARMI and 17% by Armada LLC's senior officer. In
connection with terminating Armada LLC, in September 1997 the Company agreed to
issue 106,146 split-adjusted shares of its Common Stock to purchase the senior
officer's ownership interest in Armada LLC. The Company issued 2,000 shares to
the senior officer on October 10, 1997 and 104,146 shares on January 5, 1998.
The senior officer terminated his employment with Armada LLC and became an
employee of ARMI. He also became a Director of the Company. The Company also
agreed to issue 13,560 split-adjusted shares to a key employee of Armada LLC.
The Company issued 1,000 shares to the key employee on October 10, 1997 and
12,560 shares on January 5, 1998. The key employee terminated his employment
with Armada LLC and became an employee of ARMI. As of December 31, 1997, Armada
LLC was liquidated and dissolved and no longer exists as a legal entity.
F - 32
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 26. Quarterly Financial Data (Unaudited):
The following is a summary of selected quarterly operating results for each of
the four quarters in 1997 and 1996:
(In thousands, except per share data)
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
1997:
Gain on sale of loans $7,252 $8,133 $8,656 $ 9,460
Net interest income 613 1,426 1,520 1,219
Provision for losses 281 417 435 543
Other income 788 772 4,366 1,815
Other expenses 5,807 7,068 8,255 9,516
------ ------ ------ -------
Income before income taxes 2,565 2,846 5,852 2,435
Provision for income taxes 1,026 1,171 2,416 1,025
------ ------ ------ -------
Net income $1,539 $1,675 $3,436 $ 1,410
====== ====== ====== =======
Basic net income per share $ 0.30 $ 0.32 $ 0.64 $ 0.26
====== ====== ====== =======
1996:
Gain on sale of loans $2,477 $3,881 $4,819 $ 6,778
Net interest income 437 268 320 374
Provision for losses 375 381 585 (33)
Other income 381 711 309 1,006
Other expenses 2,407 2,918 3,537 6,008
------ ------ ------ -------
Income before income taxes 513 1,561 1,326 2,183
Provision for income taxes 205 596 556 902
------ ------ ------ -------
Net income $ 308 $ 965 $ 770 $ 1,281
====== ====== ====== =======
Basic net income per share $ 0.06 $ 0.18 $ 0.15 $ 0.24
====== ====== ====== =======
F - 33
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1997, 1996 and 1995
Note 27. Subsequent Event:
Effective January 26, 1998, ARMI purchased substantially all of the assets of
Funding Center of Georgia, Inc. ("FCGI"), a Georgia corporation. FCGI is
originating approximately $4,500,000 in mortgage loans per month. All of the
employees of FCGI have become employees of ARMI, and the business will be
conducted under the assumed name of "Funding Center of Georgia." The purchase
price for FCGI'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 FCGI 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.
F - 34
Appendix N
APPROVED FINANCIAL CORP.
EXHIBIT 21 - SUBSIDIARIES OF THE COMPANY
100% OWNED SUBSIDIARIES OF APPROVED FINANCIAL CORP.:
- ----------------------------------------------------
Approved Residential Mortgage, Inc.
3420 Holland Road
Suite 107
Virginia Beach, Virginia 23452
State of incorporation: Virginia.
Names used in business: Approved Residential Mortgage, Inc.
Approved Residential Mortgage, Inc.
DBA Armada Residential
Mortgage, Inc.
Approved Federal Savings Bank
2380 Court Plaza Drive
Suite 200
Virginia Beach, Virginia 23456
State of incorporation: Federal savings bank charter.
Names used in business: Approved Federal Savings Bank.
100% OWNED SUBSIDIARIES OF APPROVED FEDERAL SAVINGS BANK:
- ---------------------------------------------------------
Global Title Insurance Agency, Inc.
2380 Court Plaza Drive
Suite 200
Virginia Beach, Virginia 23456
State of incorporation: Virginia.
Names used in business: Global Title Insurance Agency, Inc.
First Security Mortgage Bankers, Inc.
2380 Court Plaza Drive
Suite 200
Virginia Beach, Virginia 23456
State of incorporation: Virginia.
Names used in business: First Security Mortgage Bankers, Inc.
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED FINANCIAL STATEMENTS FOR THE TWELVE-MONTH PERIOD ENDED DECEMBER 31,
1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 7,855
<INT-BEARING-DEPOSITS> 377
<FED-FUNDS-SOLD> 3,637
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 15,151
<INVESTMENTS-CARRYING> 50
<INVESTMENTS-MARKET> 50
<LOANS> 82,383
<ALLOWANCE> 1,687
<TOTAL-ASSETS> 118,125
<DEPOSITS> 17,815
<SHORT-TERM> 52,488
<LIABILITIES-OTHER> 14,020
<LONG-TERM> 10,296
0
1
<COMMON> 25,054
<OTHER-SE> 0
<TOTAL-LIABILITIES-AND-EQUITY> 118,125
<INTEREST-LOAN> 10,699
<INTEREST-INVEST> 168
<INTEREST-OTHER> 68
<INTEREST-TOTAL> 10,935
<INTEREST-DEPOSIT> 357
<INTEREST-EXPENSE> 6,157
<INTEREST-INCOME-NET> 4,778
<LOAN-LOSSES> 1,534
<SECURITIES-GAINS> 2,796
<EXPENSE-OTHER> 30,777
<INCOME-PRETAX> 13,698
<INCOME-PRE-EXTRAORDINARY> 8,060
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,060
<EPS-PRIMARY> 1.52
<EPS-DILUTED> 1.51
<YIELD-ACTUAL> 6.10
<LOANS-NON> 4,527
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 924
<CHARGE-OFFS> 953
<RECOVERIES> 182
<ALLOWANCE-CLOSE> 1,687
<ALLOWANCE-DOMESTIC> 1,687
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
