SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES ACT
OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999.
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
COMMISSION FILE NUMBER 000-23775
APPROVED FINANCIAL CORP.
(Exact Name of Registrant as Specified in its Charter)
VIRGINIA 52-0792752
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
3420 HOLLAND ROAD, SUITE 107, VIRGINIA BEACH, VIRGINIA 23452
(Address of Principal Executive Office) (Zip Code)
757-430-1400
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant is
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___ .
The number of shares outstanding of the registrant's $1.00 par value common
stock, as of November 1, 1999: 5,482,114 shares.
<PAGE>
APPROVED FINANCIAL CORP.
INDEX
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements
Consolidated Balance Sheets as of
September 30, 1999 and December 31, 1998 2
Consolidated Statements of Income (Loss) and Comprehensive
Income (Loss) for the three months ended September 30,
1999 and 1998. 3
Consolidated Statements of Income (Loss) and Comprehensive Income
(Loss) for the nine months ended September 30, 1999
and 1998 4
Consolidated Statements of Cash Flows for
the nine months ended September 30, 1999
and 1998. 5
Notes to Consolidated Financial Statements 7
Consolidating Balance Sheet as of September 30, 1999 9
Consolidating Statements of Income (Loss) for the
nine months ended September 30, 1999 10
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 34
Item 2. Changes in Securities 34
Item 3. Defaults Upon Senior Securities 34
Item 4. Submission of Matters to a Vote of Security Holders 34
Item 5. Other Information 34
Item 6. Exhibits and Reports on Form 8-K 34
<PAGE>
PART I. FINANCIAL INFORMATION
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1999 AND DECEMBER 31, 1998
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
ASSETS (Unaudited) 1998
1999
---------------- ------------------
<S> <C>
Cash $ 6,668 $ 6,269
Mortgage loans held for sale, net 41,345 105,044
Real estate owned, net 2,238 1,707
Investments 2,531 3,472
Income taxes receivable 4,337 2,023
Deferred tax asset 1,140 3,330
Premises and equipment, net 4,693 5,579
Goodwill, net 3,936 4,554
Other assets 2,215 4,140
---------------- ------------------
Total assets $ 69,103 $ 136,118
================ ==================
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 13,885 $ 72,546
Mortgage payable 331 1,210
Notes payable-related parties 3,556 3,628
Certificate of indebtedness 2,325 2,414
Certificates of deposits 30,326 29,728
Loan proceeds payable 0 2,565
Accrued and other liabilities 3,429 4,760
---------------- ------------------
Total liabilities 53,852 116,851
---------------- ------------------
Shareholders' equity:
Preferred stock series A, $10 par value;
Noncumulative, voting:
Authorized shares - 100
Issued and outstanding shares - 90 1 1
Common stock $1.00 par value in 1999 and 1998:
Authorized shares - 40,000,000
Issued and outstanding shares - 5,482,114
in 1999 and 1998 5,482 5,482
Accumulated other comprehensive income (loss) (38) 30
Additional paid in capital 552 552
Retained earnings 9,254 13,202
---------------- ------------------
Total equity 15,251 19,267
---------------- ------------------
Total liabilities and equity $ 69,103 $ 136,118
================ ==================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
2
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND
COMPREHENSIVE INCOME (LOSS)
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
1999 1998
--------------- -----------------
<S> <C>
Revenue:
Gain on sale of loans $ 2,920 $ 7,060
Interest income 1,695 2,305
Gain on sale of securities 0 996
Other fees and income 1,971 1,810
--------------- -----------------
6,586 12,171
--------------- -----------------
Expenses:
Compensation and related benefits 4,189 5,879
General and administrative 3,023 2,839
Loan production expense 460 976
Interest expense 1,039 1,477
Provision for loan and foreclosed property losses 179 718
--------------- -----------------
8,890 11,889
--------------- -----------------
Income/(loss) before income taxes (2,304) 282
Provision for (benefit from) income taxes (901) 121
--------------- -----------------
Net income/(loss) $ (1,403) $ 161
Other comprehensive income, net of tax:
Unrealized losses on securities:
Unrealized holding loss arising during period (12) (5,153)
--------------- -----------------
Comprehensive loss $ (1,415) $ (4,992)
=============== =================
Net income/(loss) per share:
Basic and Diluted $ (0.26) $ 0.03
=============== =================
Weighted average number of shares outstanding:
Basic 5,482,114 5,512,114
=============== =================
Diluted 5,482,114 5,515,702
=============== =================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
3
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND
COMPREHENSIVE INCOME (LOSS)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
1999 1998
--------------- -----------------
<S> <C>
Revenue:
Gain on sale of loans $ 10,443 $ 25,593
Interest income 6,333 7,559
Gain on sale of securities 0 996
Other fees and income 6,370 4,971
--------------- -----------------
23,146 39,119
--------------- -----------------
Expenses:
Compensation and related benefits 13,579 17,878
General and administrative 8,974 8,671
Loan production expense 1,491 2,844
Interest expense 3,934 4,561
Provision for loan and foreclosed property losses 1,423 1,556
--------------- -----------------
29,401 35,510
--------------- -----------------
Income/(loss) before income taxes (6,255) 3,609
Provision for (benefit from) income taxes (2,307) 1,501
--------------- -----------------
Net income/(loss) $ (3,948) $ 2,108
Other comprehensive income, net of tax:
Unrealized losses on securities:
Unrealized holding loss arising during period (68) (5,879)
--------------- -----------------
Comprehensive loss $ (4,016) $ (3,771)
=============== =================
Net income/(loss) per share:
Basic and Diluted $ (0.72) $ .38
=============== =================
Weighted average number of shares outstanding:
Basic 5,482,114 5,510,404
=============== =================
Diluted 5,482,114 5,513,744
=============== =================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
4
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
1999 1998
----------------- ----------------
<S> <C>
Operating activities
Net income/(loss) $ (3,948) $ 2,108
Adjustments to reconcile net income/(loss)
to net cash provided by operating activities:
Depreciation of premises and equipment 685 515
Amortization of goodwill 345 292
Provision for loan losses 1,227 1,657
Provision for losses on real estate owned 196 (101)
Loss (gain) on sale of securities 8 (994)
Loss on sale of real estate owned 393 580
Gain on sale of loans (10,443) (25,961)
Proceeds from sale and prepayments of loans 226,796 366,741
Originations - Loans held for sale (156,462) (340,435)
Changes in assets and liabilities:
Loan sale receivable (279) (3)
Other assets 2,205 (2,065)
Accrued and other liabilities (1,056) (1,786)
Income tax payable (2,314) (2,689)
Deferred tax asset 2,225 1,110
Loan proceeds payable (2,565) 2,214
--------------- ----------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 57,013 1,183
Cash flows from investing activities:
Purchase of securities (125) 0
Sales of ARM Portfolio shares 4,692 0
Sales of securities 0 3,919
Purchase of premises and equipment (1,210) (733)
Sales of premises and equipment 1,410 41
Sales of real estate owned 1,850 3,771
Real estate owned capital improvements (408) (234)
Recoveries on loans charged off 19 150
Purchases of ARM Portfolio shares (3,594) (2,035)
Purchases of FHLB stock (146) (96)
---------------- ----------------
NET CASH PROVIDED BY INVESTING ACTIVITIES 2,488 4,783
</TABLE>
5
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(IN THOUSANDS)
(Unaudited)
<TABLE>
<CAPTION>
1999 1998
----------------- ----------------
<S> <C>
Cash flows from financing activities:
Borrowings - warehouse 134,511 300,437
Repayments of borrowings - warehouse (193,171) (312,135)
Proceeds from FHLB advances 0 380
Principal payments on mortgages payable (879) (61)
Net increase (decrease) in:
Notes payable (72) 60
Certificates of indebtedness (89) (18)
Certificates of deposit 598 8,428
----------------- ----------------
NET CASH USED BY FINANCING ACTIVITIES (59,102) (2,909)
----------------- ----------------
NET INCREASE IN CASH 399 3,057
CASH AT BEGINNING OF PERIOD 6,269 11,869
----------------- ----------------
CASH AT END OF PERIOD $ 6,668 $ 14,926
================= ================
Supplemental cash flow information:
Cash paid for interest $ 4,190 $ 5,068
Cash paid for income taxes 0 3,080
Supplemental non-cash information:
Loan balances transferred to real estate owned $ 2,978 $ 3,618
Exchange of stock for acquisition of Armada Residential
Mortgage LLC 0 669
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
6
<PAGE>
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999, AND 1998
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
ORGANIZATION: Approved Financial Corp., a Virginia corporation ("Approved"), and
its subsidiaries (collectively, the "Company") operate primarily in the consumer
finance business of originating, servicing and selling mortgage loans secured
primarily by first and second liens on one-to-four family residential
properties. The Company sources mortgage loans through two origination channels;
a network of mortgage brokers who refer mortgage customers to the Company
("broker" or "wholesale") and an internal sales staff that originate mortgages
directly with the borrower ("retail" or "direct"). Approved has three
wholly-owned subsidiaries through which it originates residential mortgages,
Approved Federal Savings Bank (the "Savings Bank"), a federally chartered thrift
institution with broker operations in eight states and ten retail offices at
September 30, 1999, Approved Residential Mortgage, Inc. ("ARMI") with three
retail locations at September 30, 1999, and MOFC d/b/a ConsumerOne Financial
("ConsumerOne") with one retail office in Michigan on September 30, 1999.
Approved has a fourth wholly owned subsidiary, Approved Financial Solutions
("AFS"), through which it offers life insurance products to its mortgage
customers. The Savings Bank at September 30, 1999, had a wholly owned
subsidiary, Global Title Company ("Global Title"), which was licensed as a title
insurance agency. Global Title did not produce material revenues during the
nine-month period ended September 30, 1999. During the fourth quarter of 1999,
ownership of Global Title was transferred to AFS in order to consolidate the
companies insurance operations.
PRINCIPLES OF ACCOUNTING AND CONSOLIDATION: The consolidated financial
statements of the Company include the accounts of Approved and its wholly owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated.
NOTE 2. BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the interim periods are not necessarily
indicative of financial results for the full year. These unaudited consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 1998.
NOTE 3. NEW ACCOUNTING PRONOUNCEMENTS:
In June 1998, SFAS No. 133, as amended by SFAS No. 137, "ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" was issued, effective for fiscal
year ends beginning after June 15, 2000. This statement establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that entities recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. If certain conditions are
met, a derivative may be specifically designed as (a) a hedge of the exposure to
changes in the fair value of a recognized asset or liability or an unrecognized
firm commitment, (b) a hedge of the exposure to variable cash flows of a
forecasted transaction, or (c) a hedge of the foreign currency exposure of a net
investment in a foreign operation, an unrecognized firm commitment, an
7
<PAGE>
available-for-sale security, or a foreign-currency-denominated forecasted
transaction. The Company is currently evaluating the effect this statement will
have on the financial statements.
In October 1998, SFAS No. 134, "ACCOUNTING FOR MORTGAGE-BACKED SECURITIES
RETAINED AFTER THE SECURITIZATION OF MORTGAGE LOANS HELD FOR SALE BY A MORTGAGE
BANKING ENTERPRISE" was issued, effective for the first fiscal quarter beginning
after December 15, 1998. The new statement requires that after an entity that is
engaged in mortgage banking activities has securitized mortgage loans that are
held for sale, it must classify the resulting retained mortgage-backed
securities or other retained interests based on its ability and intent to sell
or hold those investments. Any retained mortgage-backed securities that are
committed for sale before or during the securitization process must be
classified as trading. This statement does not have any impact on the Company's
financial statements since the company has never securitized loans.
NOTE 4. SALE OF BUILDING:
The Company sold the administrative and executive office building located at
3386 Holland Road, Virginia Beach, Virginia. The sales price was $1,081,250,
which resulted in a break-even transaction for the Company. The Company had a
mortgage note payable on this property in the amount of $751,674 at the time of
sale. The closing date for this transaction was March 26, 1999. The Company also
entered into a lease agreement with the purchaser to lease back 15,574 square
feet of the premises for an initial term commencing from the closing date to
September 30, 1999, with the option to renew the lease for three additional one
month terms. The Company renewed this lease for a three month term ending
December 31,1999. The lease payment is $15,000 per month.
NOTE 5. PURCHASE OF LAND:
The Company purchased 7.77 acres of land from the City of Virginia Beach
Development Authority on March 11, 1999 on which it originally planned to
construct a new administrative and executive office building to consolidate the
Virginia Beach locations. The purchase price of the land was approximately
$642,000. Subsequently, another building located in the same office park
development that accommodates the Company's space requirements became available
for purchase and was acquired by the Company. (See Note 6)
NOTE 6. PURCHASE OF BUILDING:
On October 15, 1999 the Company entered into an agreement to purchase an office
building in Virginia Beach, Virginia to be used as the Company's new
administrative and executive office building. The purchase price of the building
was $2,250,000. The Company financed this transaction through a non-affiliated
Virginia Beach lender with a mortgage note in the amount of $2,025,000.
8
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATING BALANCE SHEET
SEPTEMBER 30, 1999
($ IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS APPROVED MOFC,
APPROVED APPROVED FEDERAL INC. D/B/A
FINANCIAL RESIDENTIAL SAVINGS *GLOBAL CONSUMER ONE
CONSOLIDATED ELIMINATIONS CORP. MORTGAGE BANK TITLE FINANCIAL
------------- ------------- ----------- ----------- ---------- ---------- -----------
<S> <C>
Cash $ 6,668 $ 1,470 $ 422 $ 4,757 $ 52 $ (33)
Mortgage loans held for 41,345 1,493 9,927 28,519 0 1,406
sale, net
Real estate owned, net 2,238 296 1,925 0 0 17
Investments 2,531 (6,856) 6,972 0 2,415 0 0
Income taxes receivable 4,337 (4,235) 8,572 0 0 0 0
Deferred tax asset 1,140 282 342 402 0 114
Premises and equipment,
net 4,693 3,236 618 209 0 630
Goodwill, net 3,936 886 0 105 0 2,945
Due from affiliates 0 (2,395) 1,448 36 911 0 0
Other assets 2,215 1,108 356 581 13 157
------------- ------------- ----------- ----------- ---------- ---------- -----------
Total assets $ 69,103 $ (13,486) $ 25,763 $ 13,626 $ 37,899 $ 65 $ 5,236
============= ============= =========== =========== ========== ========== ===========
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 13,885 $ 1,999 $ 9,554 0 0 $ 2,332
Mortgage payable 331 331 0 0 0 0
Notes payable-related 3,556 3,556 0 0 0 0
parties
Certificates of indebtedness 2,325 2,325 0 0 0 0
Certificates of deposits 30,326 0 0 30,326 0 0
Due to affiliates 0 (2,395) 46 1,044 1,296 4 5
Accrued and other 3,429 2,255 343 261 18 552
liabilities
Income taxes payable 0 (4,235) 0 4,078 0 0 157
------------- ------------- ----------- ----------- ---------- ---------- -----------
Total liabilities $ 53,852 $ (6,630) $ 10,512 $ 15,019 $ 31,883 $ 22 $ 3,046
------------- ------------- ----------- ----------- ---------- ---------- -----------
Shareholder's equity:
Preferred stock-
series A 1 1 0 0 0 0
Common stock 5,482 (299) 5,482 250 32 16 1
Unrealized gain on
securities (38) 15 (38) 0 (15) 0 0
Additional paid in
capital 552 (6,837) 552 491 3,056 0 3,290
Retained earnings 9,254 265 9,254 (2,134) 2,943 27 (1,101)
------------- ------------- ----------- ----------- ---------- ---------- -----------
Total equity 15,251 (6,856) 15,251 (1,393) 6,016 43 2,190
------------- ------------- ----------- ----------- ---------- ---------- -----------
Total liabilities
and equity $ 69,103 $ (13,486) $ 25,763 $ 13,626 $ 37,899 $ 65 $ 5,236
============= ============= =========== =========== ========== ========== ===========
</TABLE>
* Global Title was a wholly owned subsidiary of Approved Federal Savings Bank as
of September 30, 1999.
9
<PAGE>
APPROVED FINANCIAL CORP.
CONSOLIDATING STATEMENTS OF INCOME/(LOSS)
FOR THE NINE MONTHS ENDING SEPTEMBER 30, 1999
($ IN THOUSANDS)
<TABLE>
<CAPTION>
MOFC, INC.
APPROVED D/B/A
APPROVED APPROVED FEDERAL CONSUMER
FINANCIAL RESIDENTIAL SAVINGS *GLOBAL ONE
CONSOLIDATED ELIMINATIONS CORP. MORTGAGE BANK TITLE FINANCIAL
------------- ------------- ----------- ----------- ------------ ------------ -----------
<S> <C>
REVENUE:
Gain on sale of loans $ 10,443 $ 216 $ 3,983 $ 4,838 $ 0 $ 1,406
Interest income 6,333 420 2,758 2,882 1 272
Other fees and income 6,370 (31) 3,114 2,108 27 1,152
------------- ------------- ----------- ----------- ------------ ------------ -----------
23,146 605 9,855 9,828 28 2,830
------------- ------------- ----------- ----------- ------------ ------------ -----------
EXPENSES:
Compensation and related 13,579 3,464 5,725 3,255 1 1,134
General and administrative 8,974 1,499 2,819 3,196 1 1,459
Loan production expense 1,491 49 765 550 4 123
Interest expense 3,934 1,248 1,310 1,293 0 83
Provision for loan/REO 1,423 (763) 2,127 62 0 (3)
losses
------------- ------------- ----------- ----------- ------------ ------------ -----------
29,401 5,497 12,746 8,356 6 2,796
------------- ------------- ----------- ----------- ------------ ------------ -----------
Income before income taxes (6,255) (4,892) (2,891) 1,472 22 34
Provision for income taxes (2,307) (4,004) 1,145 527 9 16
------------- ------------- ----------- ----------- ------------ ------------ -----------
Net income/(loss) $ (3,948) $ (888) $ (4,036) $ 945 $ 13 $ 18
============= ============= =========== =========== ============ ============ ===========
</TABLE>
* Global Title was a wholly owned subsidiary of Approved Federal Savings Bank as
of September 30, 1999.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
The following commentary discusses major components of the Company's business
and presents an overview of the Company's consolidated results of operations for
the three and nine month periods ended September 30, 1999 and 1998 and its
consolidated financial position at September 30, 1999 and December 31, 1998. 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, availability of adequate
capital funding, loan delinquency, default and loss rates, general economic
environment, market forces affecting the value of the loans originated by the
Company and the price of the Company's common stock, and other risks as
disclosed in the Company's filing on Form 10-K for the year ended December 31,
1998. This discussion should be reviewed in conjunction with the consolidated
financial statements and accompanying notes and other statistical information
presented in the Company's 1998 audited financial statements.
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30,
1999 COMPARED TO THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 1998.
NET INCOME
The Company's net loss for the three and nine months ended September 30, 1999
was $1.4 and $3.9 million compared to net income of $0.2 and $2.1 million for
the three and nine month periods ended September 30, 1998. On a per share basis
(diluted), income (loss) for the three and nine months ended September 30, 1999
was $ (0.26) and $ (0.72) compared to $0.03 and $0.38 for the three and nine
months ended September 30, 1998.
11
<PAGE>
ORIGINATION OF MORTGAGE LOANS
The following table shows the loan originations in dollars and units for the
Company's broker and retail divisions for the three and nine months ended
September 30, 1999 and 1998. During the second quarter of 1999, the Company
initiated in-house funding of conforming mortgages originated by the retail
division. Additionally, the retail branches originate mortgages that are funded
through other lenders ("Brokered Loans"). Brokered Loans consist primarily of
non-conforming mortgages that do not meet the Company's underwriting criteria
and conforming loans. The Company did not fund conforming loans in-house during
1998.
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
Sept. 30, Sept. 30,
(dollars in thousands) 1999 1998 1999 1998
--------------------- --------------------
<S> <C>
Dollar Volume of Loans Originated:
Broker $22,912 $ 56,224 $ 80,222 $161,307
Retail - Brokered Loans 37,017 23,524 125,873 59,954
Retail - funded in-house non-conforming 15,526 56,259 57,675 179,128
Retail - funded in-house conforming
and government 11,114 0 18,565 0
--------------------- --------------------
Total $86,569 $136,007 $282,335 $400,389
===================== ====================
Number of Loans Originated:
Broker 409 876 1,336 2,780
Retail - Brokered Loans 453 288 1,495 711
Retail - funded in-house non-conforming 248 962 893 3,232
Retail - funded in-house conforming
and government 114 0 193 0
--------------------- --------------------
Total 1,224 2,126 3,917 6,723
===================== ====================
</TABLE>
The decrease of 36.3% and 29.5% in dollar volume of loans, originated during the
three and nine months ended September 30, 1999, compared to the same period in
1998 was due primarily to increased competition in the non-conforming mortgage
industry.
Loans originated through the Company's retail offices (including Brokered
Loans), decreased 20.2% and 15.5% to $63.7 million and $202.1 million for the
three and nine month periods ended September 30, 1999, compared to $79.8 million
and $239.1 million during the same periods in 1998. The decrease was primarily
the result of decrease in the number of retail loan origination centers from 26
at September 30, 1998 to 14 as of September 30, 1999.
The volume of loans originated through referrals from the Company's network of
mortgage brokers decreased 59.2% and 50.3% to $22.9 million and $80.2 million
for the three and nine months ended September 30, 1999, compared to $56.2
million and $161.3 million for the three and nine months ended September 30,
1998. The Company did not offer conforming and government loan products through
the broker division, therefore the refinance boom for conforming mortgages
created by the low interest rate environment contributed to the decrease in loan
volume from this division. However, the continuation of strong competition in
the non-conforming mortgage industry was the primary reason for the decrease in
loans from this source.
12
<PAGE>
GAIN ON SALE OF LOANS
The largest component of the Company's net income is gain on sale of loans.
There is an active secondary market for most types of mortgage loans originated
by the Company. The majority of the loans originated by the Company are sold to
other financial institutions on a whole loan service-released basis. The Company
receives cash at the time loans are sold. The loans are sold on a non-recourse
basis, except for normal representations and warranties, which is consistent
with industry practices. By selling loans in the secondary mortgage market, the
Company is able to obtain funds that may be used for additional lending,
investment and business purposes. Gains from the sale of loans is comprised of
several components, as follows: (a) the difference between the sales price and
the net carrying value of the loan; plus (b) loan origination fee income
collected at loan closing and deferred until the loan is sold; less (c)
recapture premiums and loan selling costs.
Non-conforming loan sales totaled $58.5 and $192.8 million including loans owned
by the Company in excess of 180 days ("seasoned loans") for the three and nine
months ended September 30, 1999, compared to $100.7 and $331.9 million including
seasoned loans for the same period in 1998. The decrease was caused primarily by
the decrease in loan origination volume.
During the three month period ended September 30, 1999, the Company sold $10.9
million of seasoned loans, at a weighted average discount to par value of 7%.
The loss was fully reserved for in prior periods. For the three and nine month
periods ended September 30, 1998, the Company sold $2.3 million and $12.0
million of seasoned loans, at a weighted average discount to par value of 21%
and 10.5% respectively. These losses were recorded as charge offs during the
1998 periods.
Conforming and government loan sales were $11.0 million and $16.4 million for
the three and nine months ended September 30, 1999. The company did not
originate conforming or government loans during the same periods ended in 1998.
The combined gain on the sale of loans was $2.9 and $10.4 million for the three
and nine months ended September 30, 1999, which compares with $7.1 and $25.6
million for the same period in 1998. The decrease for the three and nine months
ended September 30, 1999, was the direct result of a decrease in the
weighted-average premium paid by investors for the Company's loans, the addition
of conforming and government loan sales that normally carry lower loan sale
premiums and a lower volume of loans sold. Gain on the sale of mortgage loans
represented 44.3% and 45.1% of total revenue during the three and nine months
ended September 30, 1999, compared to 58.0% and 65.4% of total revenue for the
same period in 1998.
The weighted-average premium realized by the Company on its non-conforming loan
sales decreased to 3.04% and 3.16% (excluding seasoned loan sales), during the
three and nine months ended September 30, 1999, from 5.29% and 5.73% (excluding
seasoned loan sales) for the same period in 1998. The decrease in premium
percentage was caused by material changes in the secondary market conditions for
non-conforming mortgage loans. The weighted-average premium realized by the
Company on its conforming and government loan sales was 1.88% and 1.91% during
the three and nine months ended September 30, 1999.
The Company has never used securitization as a loan sale strategy. However, the
whole-loan sale marketplace for non-conforming mortgage loans was impacted by
changes that affected companies who previously used securitization to sell
loans. Excessive competition during 1997 and 1998 and a coinciding reduction in
interest rates in general caused an increase in the prepayment speeds for
non-conforming loans. The valuation method applied to interest-only and residual
assets ("Assets"), the capitalized assets created from securitization, include
an assumption for average prepayment speed in order to determine the average
13
<PAGE>
life of a loan pool. The increased prepayment speeds experienced in the industry
were greater than the assumptions previously used by many securitization issuers
and led to an impairment of Asset values for several companies in the industry.
Additionally, in September 1998, a flight to quality among fixed income
investors negatively impacted the pricing spreads for mortgage-backed
securitizations compared to earlier periods and negatively impacted the
associated economics to the issuers. Consequently, many of these companies have
and continue to report material losses, experience reductions in liquidity
sources and have diverted to whole loan sale strategies in order to generate
cash. This shift materially decreased the demand and increased the supply of
non-conforming mortgage loans in the secondary marketplace, which resulted in
significantly lower premiums on non-conforming whole-loan mortgage sales.
In addition, the recent market pricing spreads between the pass through rates on
securitized mortgage pools and the yield on the associated treasury rates have
widened significantly which has reduced the economic returns available to the
Company's loan investors who are currently accessing the securitization market
as a means of financing. Therefore, the loan sale premiums that these companies
paid to the Company in the three and nine months ended September 30, 1999 were
lower than premiums received in the three and nine month periods of 1998.
Furthermore, the loan sale premium percentage has decreased due to a decrease in
the Weighted Average Coupon ("WAC") on the Company's loan originations, which
was primarily the result of a lower interest rate market and a shift in the
Company's origination profile to a higher credit grade customer. These premiums
do not include loan origination fees collected by the Company at the time the
loans are closed, which are included in the computation of gain on sale when the
loans are sold.
The Company defers recognizing income from the loan origination fees it receives
at the time a loan is closed. These fees are deferred and recognized over the
lives of the related loans as an adjustment of the loan's yield using the
level-yield method. Deferred income pertaining to loans held for sale is taken
into income at the time of sale of the loan. Origination fee income is primarily
derived from the Company's retail lending division. Origination fee income
included in the gain on sale of loans for the three and nine months ended
September 30, 1999 was $1.3 and $4.6 million, compared to $2.1 and $8.1 million
in the three and nine months ended September 30, 1998. The decrease is the
result of a decrease in the volume of loans sold, which were generated by the
Company's retail division. The Company's retail loan sales during the three and
nine months ended September 30, 1999 comprised 57.4% and 48.1% of total loan
sales, with average loan origination fee income earned of 4.40% and 4.58%,
(including conforming loans). Excluding conforming loans the average loan
origination fee income earned was 4.80% and 4.60% for the three and nine months
ended September 30, 1999. For the same period in 1998, the Company's retail loan
sales were 51.0% and 51.7% of total loan sales with average origination fee
income earned of 4.3% and 4.9%. Fees associated with selling loans were
approximately 11 and 12 basis points of the dollar volume of loans sold for the
three and nine months ended September 30, 1999 compared to 20 basis points for
the three and nine months ended September 30, 1998.
The Company also defers recognition of the expense it incurs, from the payment
of fees to mortgage brokers, for services rendered on loan originations. These
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. The remaining
balance of expenses associated with fees paid to brokers is recognized when the
loan is sold. Average fees paid to mortgage brokers for the three and nine
months ended September 30, 1999 were 0.36% and 0.33%, compared to 0.68% and
0.60% for the same periods ended September 30, 1998.
14
<PAGE>
INTEREST INCOME AND EXPENSE
The Company's net interest income is dependent on the difference, or "spread",
between the interest income it receives from its loans and its cost of funds,
consisting principally of the interest expense paid on the warehouse lines of
credit, the Savings Bank's deposit accounts and other borrowings.
Interest income for the three and nine months ended September 30, 1999 was $1.7
million and $6.3 million compared with $2.3 and $7.6 million for the same period
ended in 1998. The decrease in interest income for the three and nine months
ended September 30, 1999 was primarily due to a lower average yield on the loans
held for sale.
Interest expense for the three and nine months ended September 30, 1999 was $1.0
and $3.9 million compared with $1.5 and $4.6 million for the three and nine
months ended September 30, 1998. The decrease in interest expense for the three
and nine months ended September 30, 1999, was the direct result of a decrease in
the average balance of interest-bearing liabilities.
Changes in the average yield received on the Company's loan portfolio may not
coincide with changes in interest rates the Company must pay on its revolving
warehouse loans, the Savings Bank's FDIC-insured deposits, and other borrowings.
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.
15
<PAGE>
The following tables reflect the average yield earned and rates paid by the
Company during the nine months ended September 30, 1999 and 1998. 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.
<TABLE>
<CAPTION>
(IN THOUSANDS) September 30, 1999 September 30, 1998
-------------------------------------------- -------------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------------ ---------- ------------- ----------- ---------- -------------
<S> <C>
Interest-earning assets:
Loans receivable (1) $ 73,958 $ 6,019 10.85% $ 78,549 $ 7,160 12.19%
Cash and other interest-
earning assets 8,627 314 4.86 7,686 399 6.94
------------ ---------- ------------- ----------- ---------- -------------
82,585 6,333 10.23% 86,235 7,559 11.72
------------ ---------- ------------- ----------- ---------- -------------
Non-interest-earning assets:
Allowance for loan losses (2,867) (1,561)
Investment in IMC 87 11,102
Premises and equipment, net 5,130 4,712
Other 13,709 16,914
------------ -----------
Total assets $ 98,644 $117,402
============ ===========
Interest-bearing liabilities:
Revolving warehouse lines $ 40,029 $ 2,132 7.10% $ 54,011 $ 2,843 7.04%
FDIC - insured deposits 30,314 1,279 5.62 20,946 933 5.96
Other interest-bearing
liabilities 7,347 523 9.49 11,404 785 9.20
------------ ---------- ------------- -----------
---------- -------------
77,690 3,934 6.75 86,361 4,561 7.06
---------- ------------- ---------- -------------
Non-interest-bearing liabilities 4,038 4,594
------------ -----------
Total liabilities 81,728 90,955
Shareholders' equity 16,916 26,447
------------ -----------
Total liabilities and equity $ 98,644 $117,402
============ ===========
Average dollar difference between
interest-earning assets and
interest-bearing
liabilities $ 4,895 $ (126)
============ ===========
Net interest income $ 2,399 $ 2,998
========== ==========
Interest rate spread (2) 3.48% 4.66%
============= =============
Net annualized yield on average
interest-earning assets 3.87% 4.65%
============= =============
</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.
16
<PAGE>
The following table shows the change in net interest income which can be
attributed to rate (change in rate multiplied by old volume) and volume (change
in volume multiplied by old rate) for the nine months ended September 30, 1999,
compared to the nine months ended September 30, 1998, and for the nine months
ended September 30, 1998, compared to the nine months ended September 30, 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 decrease
of $599,000 in net interest income for the nine months ended September 30, 1999
compared to the nine months ended September 30, 1998 was primarily the result of
a decrease in the average yield on interest-earning assets.
($ IN THOUSANDS)
<TABLE>
<CAPTION>
1999 Versus 1998 1998 Versus 1997
Increase (Decrease) due to: Increase (Decrease) due to:
Volume Rate Total Volume Rate Total
------------ ----------- ----------- ----------- ----------- ------------
<S> <C>
Interest-earning assets:
Loans receivable $ (403) $(738) $(1,141) $1,407 $ (1,942) $ (535)
Cash and other interest-
Earning assets 59 (144) (85) 229 20 249
------------ ----------- ----------- ----------- ----------- ------------
(344) (882) (1,226) 1,636 (1,922) (286)
------------ ----------- ----------- ----------- ----------- ------------
Interest-bearing liabilities:
Revolving warehouse lines (745) 34 (711) (257) (352) (609)
FDIC-insured deposits 392 (46) 346 796 14 810
Other interest-
Bearing liabilities (290) 28 (262) 81 (7) 74
----------- ----------- ------------
------------ ----------- -----------
(643) 16 (627) 620 (345) 275
------------ ----------- ----------- ----------- ----------- ------------
Net interest income (expense) $ 299 $(898) $ (599) $1,016 $ (1,577) $ (561)
============ =========== =========== =========== =========== ============
</TABLE>
OTHER INCOME
In addition to net interest income (expense), and gain on the sale of loans, the
Company derives income from origination fees earned on Brokered Loans generated
by the Company's retail offices. Also, other fees earned on the loans funded by
the Company, such as underwriting service fees, fees earned from loan prepayment
penalties, and late charge fees for delinquent loan payments are classified as
other income. Other income for the three and nine months ended September 30,
1999 was $2.0 and $6.4 million compared with $1.8 and $5.0 million for the same
period ended in 1998. The increase in other income for the three and nine months
ended September 30, 1999 was primarily due to an increase in brokered loan fee
income. Brokered Loan fees were $1.6 and $5.1 million for the three and nine
months ended September 30, 1999, compared to $1.1 and $2.8 million for the three
and nine months ended September 30, 1998. The underwriting fee income decreased
for the three and nine months ended September 30, 1999 compared to the same
period a year earlier due to the lower unit volume of in-house loans closed.
17
<PAGE>
COMPREHENSIVE INCOME
The Company has other comprehensive income (loss) in the form of unrealized
holding gains (losses) on securities held for sale. For the three and nine
months ended September 30, 1999, other comprehensive loss was $1.4 and $4.0
million compared to other comprehensive loss of $5.0 and $3.8 million for the
three and nine months ended September 30, 1998. The loss for the three and nine
months ended September 30, 1999 and September 30, 1998 was related to a decrease
in the market price of IMC Mortgage Company common stock. The Company owned
435,634 shares of IMC Mortgage Company common stock on September 30, 1999.
COMPENSATION AND RELATED EXPENSES
The largest component of expenses is compensation and related benefits expense,
which decreased by $1.7 and $4.3 million to $4.2 and $13.6 million for the three
and nine-month periods ended September 30, 1999 compared to the same period in
1998. The 28.7% and 24.0% decreases were directly attributable to a decrease in
the number of employees. During the three and nine months ended September 30,
1999 the company had an average full time equivalent employee count of 335 and
412 compared to 575 and 574 full time equivalent employee count during the three
and nine month periods ended September 30, 1998. The Company had 332 full time
equivalent employees as of September 30, 1999. The reduction in employees was
part of the Company's cost reduction initiative.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses for the three and nine month periods ended
September 30, 1999 increased by $0.2 million to $3.0 million, and $0.3 million
to $9.0 million, compared to the three and nine month periods ended September
30, 1998. The increase is attributed to increases in advertising expense, rent
expense and depreciation expense. For the three and nine months ended September
30, 1999 these three expense items increased $0.7 million and $1.6 million
compared to the same period ended September 30, 1998. The increase in
advertising was caused by the Company's formation of a centralized advertising
and marketing department in order to consolidate its generation of new customer
leads. The sale lease back of the building that houses the advertising and
marketing department in Virginia Beach caused the increase in rent. Also, the
Company continues to pay rent on a majority of offices that it has closed. The
Company is currently attempting to sublease these locations. The increase in
depreciation expense was caused by the acquisition of ConsumerOne Financial,
which has depreciable equipment of $1.0 million. Expenses in all other general
and administrative categories decreased by $0.5 million and $1.3 million during
the three and nine months ended September 30, 1999, compared to the three and
nine months ended September 30, 1998. These expenses were part of the Company's
cost reduction initiative.
LOAN PRODUCTION EXPENSE
The largest component of loan production expense is fees paid by the Company to
mortgage brokers for services rendered in the preparation of loan packages.
Average fees paid to mortgage brokers for the three and nine months ended
September 30, 1999 were 0.36% and 0.33%, compared to 0.68% and 0.60% for the
same periods ended September 30, 1998. Other items that comprise loan production
expenses are appraisals, credit reports, leads research and telemarketing
expenses. Loan production expenses for the three and nine months ended September
30, 1999 were $0.5 and $1.5 million compared to $1.0 and $2.8 million for the
three and nine months ended September 30, 1998. The decrease was primarily the
result of a decrease in services rendered fees paid to mortgage brokers.
18
<PAGE>
PROVISION FOR LOAN LOSSES
The following table presents the activity in the Company's allowance for loan
losses and selected loan loss data for the nine months ended September 30, 1999
and the year ended December 31, 1998:
(IN THOUSANDS)
1999 1998
--------- --------
Balance at beginning of year $ 2,590 $ 1,687
Provision charged to expense 1,227 3,064
Acquisition of MOFC, Inc. 0 49
Loans charged off (2,362) (2,372)
Recoveries of loans previously charged off 19 162
----------- --------
Balance at end of period $ 1,474 $ 2,590
=========== =======
Loans receivable at period-end, gross
of allowance for losses $ 42,819 $ 107,634
Ratio of allowance for loan losses to gross
loans receivable at period-end 3.44% 2.41%
The Company increased its provision for loan losses $0.1 million for the three
months ended September 30, 1999 and added $1.2 million, during the nine months
ended September 30, 1999 to the allowance for loan losses. This compares to
additions of $0.9 and $1.7 million for the three and nine months ended September
30, 1998. The decrease was primarily the result of the composition of loans held
for sale and the recent secondary market environment for whole loan sales. All
losses ("charge offs" or "write downs") and recoveries realized on loans
previously charged off, are accounted for in the allowance for loan losses.
The allowance is established at a level that management considers adequate
relative to the composition of the current portfolio of loans held for sale.
Management considers characteristics of the Company's current loan portfolio
such as credit quality, the weighted average coupon, the weighted average loan
to value ratio, the age of the loan portfolio and the portfolio's delinquency
status in the determination of an appropriate allowance. Other criteria such as
covenants associated with the Company's credit facilities, trends in the demand
and loan sale pricing for non-conforming mortgage loans in the secondary market
and general economic conditions, including interest rates, are also considered
when establishing the allowance. Adjustments to the reserve for loan losses may
be made in future periods due to changes in the factors mentioned above and any
additional factors that may effect anticipated loan loss levels in the future.
19
<PAGE>
PROVISION FOR FORECLOSED PROPERTY LOSSES
The provision for foreclosed property losses increased by $0.03 and $0.2 million
for the three and nine months ended September 30, 1999, compared to a decrease
of $0.2 and an increase of $0.1 million for the three and nine months ended
September 30, 1998.
Sales of real estate owned yielded net losses of $148,000 and $393,000 for the
three and nine months ended September 30, 1999 versus $186,000 and $580,000 for
the three and nine months ended September 30, 1998.
The following table presents the activity in the Company's allowance for
foreclosed property losses and selected real estate owned data for the nine
months ended September 30, 1999 and the year ended December 31, 1998:
(IN THOUSANDS)
Nine Months Year Ended
Ended December 31,
Sept. 30, 1999 1998
---------------- -----------------
Balance at beginning of year $ 503 $ 671
Provision charged to (reducing) expense 197 (168)
---------------- -----------------
Balance at end of period $ 700 $ 503
================ =================
Real estate owned at period-end, gross
Of allowance for losses $ 2,938 $ 2,211
Ratio of allowance for foreclosed
property losses
To gross real estate owned at period-end 23.83% 22.75%
The Company maintains a reserve on its real estate owned ("REO") based upon
management's assessment of appraised values at the time of foreclosure. The
increase in the provision for foreclosed property losses relates to an increase
in the dollar amount of outstanding REO at September 30, 1999 when compared to
December 31, 1998. While the Company's management believes that its present
allowance for foreclosed property losses is adequate, future adjustments may be
necessary.
20
<PAGE>
FINANCIAL CONDITION AT SEPTEMBER 30, 1999 AND DECEMBER 31, 1998
ASSETS
The total assets of the Company were $69.1 million at September 30, 1999,
compared to total assets of $136.1 million at December 31, 1998. The decrease
was primarily due to a decrease in net mortgage loans receivable.
Cash and cash equivalents increased by $0.4 million to $6.7 million at September
30, 1999, from $6.3 million at December 31, 1998. The principal reason for the
increase for the period ending September 30, 1999 was the receipt of proceeds
from loan sales in the final week of September 1999. These proceeds were used to
fund new loans in the first week of October 1999.
Net mortgage loans receivable decreased by $63.7 million to $41.3 million at
September 30, 1999. The 60.6% decrease in 1999 is primarily due to the Company
selling more loans than were originated in-house during the first nine months of
1999.
Real estate owned ("REO") increased by $0.5 million to $2.2 million at September
30, 1999. The 31.1% increase in REO resulted from the sale of $2.2 million in
REO properties and additions of $3.0 million to REO during the nine months ended
September 30, 1999.
Investments decreased by $0.9 million to $2.5 million at September 30, 1999.
Investments consist primarily of an Asset Management Fund, Inc. Adjustable Rate
Mortgage Portfolio and FHLB stock owned by the Savings Bank. The 27.1% decrease
in Investments in 1999 is primarily due to the sale of shares in the Asset
Management Fund, Inc. Adjustable Rate Mortgage Portfolio. Also, included in
Investments is a $0.13 million investment pursuant to the Company's joint
venture with a conforming mortgage company located in Virginia Beach.
Premises and equipment decreased by $0.9 million to $4.7 million at September
30, 1999. The primary reason for the 1999 decrease was the sale of one of the
Company's office buildings in Virginia Beach for $1.1 million. This decrease was
offset by the $0.6 million acquisition of 7.77 acres of land designated for the
future location of the Company's administrative and executive headquarters. In
addition, the disposition of equipment located in the retail branches recently
closed by the Company contributed to the decrease.
Goodwill (net) decreased by $0.6 million to $3.9 million at September 30, 1999.
The 1999 decrease is due to amortization of the intangible asset as well as the
reversal of $0.3 million in goodwill attributed to the 1998 acquisition of an
Atlanta Georgia based loan origination office. The goodwill was reversed because
the Atlanta office did not reach its profit goal on an earnout provision.
The income tax receivable increased by $2.3 million to $4.3 million at September
30, 1999. The 114.4% increase can be attributed to the Company's before tax net
loss of $6.3 million for the first nine months of 1999.
The deferred tax asset decreased by $2.2 million to $1.1 million at September
30, 1999. The change was the result of a combination of a reduction of the state
tax rate from 8.75% in 1998 to 7.0% in 1999 and the elimination of unearned loan
fees (FAS 91) as a timing difference in the calculation of the Company's tax
provision.
Other assets decreased by $1.9 million to $2.2 million at September 30, 1999.
Other assets consist of accrued interest receivable, prepaid assets, Brokered
Loan fees receivable, deposits, and various other assets. Accrued interest
21
<PAGE>
receivable decreased by $0.5 million, which was due to a lower average balance
of loans held for sale at September 30, 1999. In addition, prepaid assets
decreased by $0.6 million. Other receivables decreased by $0.4 million and the
remainder of the decrease is due to a lower Brokered Loan fee receivable for the
first nine months of 1999 in comparison with 1998.
LIABILITIES
Outstanding balances for the Company's revolving warehouse lines of credit
decreased by $58.7 million to $13.9 million at September 30, 1999. The 80.9%
decrease in 1999 was primarily attributable to the decrease in loans receivable.
The Company draws on its revolving warehouse lines of credit as needed to fund
loan production. As of September 30, 1999, the Company had issued loan funding
checks totaling $0.1 million which had not cleared the Company's checking
account and for which the Company had not drawn funds from its warehouse lines.
These checks cleared the Company's bank accounts in the first few business days
of October 1999 and most were funded with cash on hand or new warehouse line
draws.
The Savings Bank's deposits totaled $30.3 million at September 30, 1999,
compared to $29.7 million at December 31, 1998. Of the certificate accounts as
of September 30, 1999, a total of $17.6 million was scheduled to mature in the
twelve-month period ending September 30, 2000.
Promissory notes and certificates of indebtedness totaled $5.9 million at
September 30, 1999 compared to $6.0 million at December 31, 1998. The Company
has utilized promissory notes and certificates of indebtedness to help fund its
operations since 1984. These borrowings are subordinated to the Company's
warehouse lines of credit. Promissory notes outstanding carry terms of one to
five years and interest rates between 8.00% and 10.25%, with a weighted-average
rate of 10.19% at September 30, 1999. Certificates of indebtedness are uninsured
deposits authorized for financial institutions chartered as a Virginia
Industrial Loan Association. The certificates of indebtedness carry terms of one
to five years and interest rates between 6.75% and 10.00%, with a
weighted-average rate of 9.69% at September 30, 1999. The promissory notes and
certificates of indebtedness with remaining terms exceeding twelve months as of
September 30, 1999 totaled $2.7 million.
Mortgage loans payable decreased by $0.9 million to $0.3 million at September
30, 1999. The decrease is due to the sale of one of the Company's headquarters
buildings for which the Company was carrying a mortgage note payable of $0.8
million.
Accrued and other liabilities decreased by $1.3 million to $3.4 million at
September 30, 1999. This category includes accounts payable, accrued interest
payable, deferred income, accrued bonuses, and other payables. The decrease in
the first nine months of 1999 is primarily attributable to payment of year end
accrued payables, the cancellation of capitalized lease obligations, as well as
the elimination of the $.3 million investment payable attributed to the 1998
acquisition of the Atlanta, Georgia based loan origination office.
SHAREHOLDERS' EQUITY
Total shareholders' equity at September 30, 1999 was $15.3 million compared to
$19.3 million at December 31, 1998. The $4.0 million decrease in the first nine
months of 1999 was due to the $3.9 million loss for the first nine months of
1999.
22
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations require access to short and long-term sources of cash.
The Company's primary sources of cash flow result from the sale of loans through
whole loan sales, loan origination fees, processing, underwriting and other fees
associated with loan origination and servicing, net interest income, and
borrowings under its warehouse facilities, certificates of indebtedness issued
by Approved Financial Corp. and certificates of deposit issued by the Savings
Bank 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 historically operated, and expects
to operate in the future on a negative cash flow basis from operations due to
the fact that originations normally exceed loan sales. During the nine months
ended September 30, 1999 and 1998, the Company was provided cash from operating
activities of $57.0 million and $1.2 million, respectively, due to the fact that
the Company sold a greater volume of loans than it originated during the
periods. The net cash provided by 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 nine months
ended September 30, 1999 and 1998, the Company used cash from financing
activities of $59.1 million and $2.9 million, 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) were 73.0% of assets at September 30, 1999 compared to
82.3% at December 31, 1998.
WHOLE LOAN SALE PROGRAM
The Company's most important source of liquidity and capital resources is the
ability to profitably sell conforming and non-conforming loans in the secondary
market. The market value of the loans funded by the Company is dependent on a
number of factors, including but not limited to loan delinquency and default
rates, the original term and current age of the loan, the interest rate and loan
to value ratio, whether or not the loan has a prepayment penalty, the credit
grade of the loan, the credit score of the borrower, the geographic location of
the real estate, the type of property, the supply and demand for conforming and
non-conforming loans in the secondary market, general economic and market
conditions, market interest rates and governmental regulations. Adverse changes
in these conditions may affect the Company's ability to sell mortgages in the
secondary market for acceptable prices, which is essential to the continuation
of the Company's mortgage origination operations.
SAVINGS BANK SOURCES OF CAPITAL
The Savings Bank's deposits totaled $30.3 million at September 30, 1999,
compared to $29.7 million at December 31, 1998. The Savings Bank currently
utilizes funds from the deposits and a $10 million line of credit with the FHLB
of Atlanta to fund first lien and junior lien mortgage loans. The Company plans
to increase the use of credit facilities and funding opportunities available to
the Savings Bank.
23
<PAGE>
WAREHOUSE AND OTHER CREDIT FACILITIES
On December 8, 1997, the Company obtained a $100.0 million warehouse line of
credit from a commercial bank syndicate. The syndicate's lead bank is Chase Bank
of Texas. Other banks in the syndicate are BankBoston, National City Bank,
Comerica Bank and Compass Bank. The line is secured by loans originated by the
Company and bears interest at a rate of 1.5% over the one-month LIBOR rate. The
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 September 30, 1999, $8.3 million was outstanding under this
facility. Since the utilization of the credit line has been very low in 1999,
the Company negotiated, with the syndicate bank group, a reduction in the size
of the warehouse credit facility to $50.0 million effective on November 1, 1999.
The line is scheduled to expire on December 7, 1999 and is subject to renewal of
which there can be no assurance.
Also on December 8, 1997, the Company obtained a $25.0 million seasoned loan
line of credit from certain members of the 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. There is not a time limit as to the number of days from
origination for the loans pledged to secure this line of credit. As of September
30, 1999, $5.6 million was outstanding under this facility. Since the
utilization of the seasoned credit line has been very low in 1999, the Company
negotiated, with the syndicate bank group, a reduction in the size of the
seasoned loan credit facility to $10.0 million. The reduction was effective on
October 1, 1999. All other terms remained the same. The line expires on December
7, 1999 and will not be renewed.
The Company is currently negotiating with Chase Bank of Texas for a new and
smaller credit facility upon termination of the existing syndicated facilities.
The Company is also negotiating with another bank for a new credit facility for
$40 million. There can be no assurance that the Company will be successful in
securing these or other lines of credit.
OTHER CAPITAL RESOURCES
Promissory notes and certificates of indebtedness have been a source of capital
for the Company since current management acquired the Company in 1984.
Promissory notes and certificates of indebtedness totaled $5.9 million at
September 30, 1999 compared to $6.0 million at December 31, 1998. These
borrowings are subordinated to the Company's warehouse lines of credit.
The Company had cash and cash equivalents of $6.7 million at September 30, 1999.
The Company has sufficient resources to fund its current operations. Alternative
sources for future liquidity and capital resource needs may include the issuance
of debt or equity securities, increase in Saving Bank deposits and new lines of
credit. Each alternative source of liquidity and capital resources will be
evaluated with consideration for maximizing shareholder value, regulatory
requirements, the terms and covenants associated with the alternative capital
source. Management expects that the Company and the industry will continue to be
challenged by a limited availability of capital, a reduction in premiums
received on non-conforming mortgage loans sold in the secondary market compared
to premiums realized in recent years, new competition and a rise in loan
delinquency and the associated loss rates.
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
24
<PAGE>
levels. At present, the required ratio of liquid assets to savings and
borrowings, which can be withdrawn and are due in one year or less is 4.0%.
Penalties are assessed for noncompliance. In 1998 and in the first nine months
of 1999, 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 September 30, 1999, the Savings Bank's book value under generally accepted
accounting principles ("GAAP") was $6.0 million. OTS Regulations require that
savings institutions maintain the following capital levels: (1) tangible capital
of at least 1.5% of total adjusted assets, (2) core capital of 4.0% of total
adjusted assets, and (3) overall risk-based capital of 8.0% of total
risk-weighted assets. As of September 30, 1999, 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>
GAAP capital $ 6,017 $ 6,017 $ 6,017
Add: unrealized loss on securities 15 15 15
Nonallowable asset: goodwill (106) (106) (106)
Additional capital item: general allowance 0 0 327
----------------- -------------- ---------------
Regulatory capital - computed 5,926 5,926 6,253
Minimum capital requirement 567 1,513 2,089
----------------- -------------- ---------------
Excess regulatory capital $ 5,359 $ 4,413 $ 4,164
================= ============== ===============
Ratios:
Regulatory capital - computed 15.67% 15.67% 23.94%
Minimum capital requirement 1.50% 4.00% 8.00%
----------------- -------------- ---------------
Excess regulatory capital 14.17% 11.67% 15.94%
================= ============== ===============
</TABLE>
Management believes that the Savings Bank can remain in compliance with its
capital requirements.
The Company is not aware of any other trends, events or uncertainties other than
those discussed in the section "Gain on Sale of Loans" which will have or that
are likely to have a material effect on the Company's or the Savings Bank's
liquidity, capital resources or operations. The Company is not aware of any
current recommendations by regulatory authorities, which if they were
implemented would have such an effect.
HEDGING ACTIVITIES
The Company originates mortgage loans for sale as whole loans. The Company
mitigates its interest rate exposure by selling most of the loans within sixty
days of origination. However, the Company may choose to hold certain loans for a
longer period prior to sale in order to increase net interest income. Currently
loans held for investment by the Savings Bank are primarily composed of
adjustable rate mortgages in order to minimize the Savings Bank's interest rate
risk exposure. However, excluding the Savings Bank's loans held for investment
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
25
<PAGE>
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, may enter into
Treasury security lock contracts, which function similar to short sales of U.S.
Treasury securities. If the value of an interest rate hedge position decreases
in value, 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 position 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. The Company may in the future enter into similar
transactions with government and quasi-government agency securities in relation
to its origination and sale of conforming mortgage loans or similar forward loan
sale commitments concerning non-conforming mortgages. Prior to entering into any
type of hedge transaction or forward loan sale commitment, the Company performs
an analysis of the loan associated with the transaction or commitment taking
into account such factors as credit quality of the loans, interest rate and term
of the loans, as well as current economic market trends, in order to determine
the appropriate structure and/or size of a hedge transaction or loan sale
commitment that will to limit the Company's exposure to interest rate risk. The
Company had no hedge contracts or forward commitments outstanding at September
30, 1999. The Company has not entered into any hedge contracts since the fourth
quarter of 1997. That commitment expired during the first quarter of 1998.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and related data presented in this
document have been prepared in accordance with generally accepted accounting
principles, which require the measurement of the financial position and
operating results of the Company in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation.
Virtually all of the assets of the Company are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or with the same magnitude as the
prices of goods and services. Inflation affects the Company most significantly
in the area of loan originations and can have a substantial effect on interest
rates. Interest rates normally increase during periods of high inflation and
decrease during periods of low inflation.
The Company intends to sell a significant portion of the loans it originates
therefore, inflation and interest rates should have a diminishing effect on the
Company's results of operations. However, 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. Currently the Savings Bank's portfolio of loans held for investment
consists primarily of adjustable rate mortgages.
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
26
<PAGE>
decrease the size of the Company's future loan portfolio by increasing the level
of loan prepayments and it therefore 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. Additionally, to the
extent servicing rights and interest-only and residual assets are capitalized on
the Company's books in the future from 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 assets, if created in the future which
could have a favorable effect on the Company's results of operations and
financial condition.
YEAR 2000 ISSUES
The Year 2000 issue relates to the way computer systems and programs define and
handle calendar issues. Non-compliant systems could fail or make miscalculations
due to interpretations of dates that fall past the millennium. For example, the
year value "00" could be interpreted to mean the year "1900", rather than
"2000". Other systems not normally thought of as computer related may also
contain embedded hardware or software that may contain a date or time element.
Approved, similar to other financial service institutions, is sensitive and
subject to the potential impact of the Year 2000 issue.
Approved initiated a Year 2000 project in late 1997 under the direction of a
project leader, supervised by the Company's Board of Directors. Management has
placed a high priority on Year 2000 issues, in recognition of the business risk
inherent in non-compliance. The project is proceeding on schedule, with expected
completion by the middle of the fourth quarter 1999.
PROJECT. The Approved Year 2000 project generally follows suggested OTS and
FFIEC guidelines. The scope of the project includes: ensuring the compliance of
all systems and applications of significance, operating systems and hardware of
the Company's LAN and PC platforms; addressing issues related to other systems
not normally thought of as computer related, and addressing the compliance of
key business partners.
There are five (5) phases of the project: Awareness, Assessment, Renovation,
Validation and Implementation. During the Assessment phase, the Company
determined to concentrate physical upgrades to those computers representing
"current technologies". Older units may still be used in non-critical
applications, but would be phased out and replaced before the Year 2000. The
Assessment phase also identified several systems that are classified as
"mission-critical" and represent the Company's core business of mortgage
lending. Project efforts have focused on getting these systems to year 2000
compliance levels.
Approved has no internally generated programmed software to correct, as
substantially all of the software utilized by the Company is purchased or
licensed from external providers. The Company is currently completing the
Renovation phase of the project. Virtually all "mission-critical" applications
and hardware have been upgraded to Year 2000 compliance release levels.
The Company contracted for a new Human Resource and Payroll system, which is
certified by the vendor as being Year 2000 compliant. Installation of these
systems occurred in the fourth quarter 1998. All PC equipment located at
corporate headquarters, including hardware BIOS, and software, have been
upgraded to Year 2000 compliance release levels.
The final portion of the Renovation phase consists of field upgrades of systems
and software located in our branch offices, which was substantially complete as
of December 31, 1998.
The Company has initiated formal communications with significant outside vendors
and business partners to determine the extent to which the Company is vulnerable
to those third parties' failure to remedy their own Year 2000 issues. Approved
is requesting that third party vendors represent their products and services to
be Year 2000 compliant and that they have a program to test for that compliance.
27
<PAGE>
The majority of the Company's mission-critical systems are already certified by
their respective vendors to being Year 2000 compliant. Certified compliant
systems include mortgage loan origination and processing, closing, servicing,
secondary marketing, and account systems. All named systems are installed at
current release levels.
The majority of the Company's non-computer-related systems and equipment are
currently Year 2000 compliant, based primarily upon verbal and written
communication with vendors. Compilation of written documentation regarding this
compliance is virtually complete.
Validation of internal mission-critical applications has begun upon those
applications certified by their vendors as being fully Year 2000 compliant.
Validations of several of the Company's mission-critical systems have been
completed. Approved Financial has met the FFIEC milestone of having "internal
testing of mission-critical systems substantially complete" by the end of the
first quarter 1999.
Although the critical systems are expected to be compliant well before December
31, 1999, the Company is developing a contingency plan to address the possible
failure of critical systems. This plan will address the Company's strategy in
dealing with an unlikely event such as a system not performing as expected, or
if there is non-compliance by a major third party provider. The Company expects
to complete its contingency plan by the middle of the fourth quarter of 1999.
COSTS. The total cost associated with required modifications and testing to
become Year 2000 compliant has been budgeted at $200,000, and is not considered
material to the Company's financial position. Costs are expensed as incurred in
the current period. This estimate does not include Approved Financial's
potential share of Year 2000 costs that may be incurred by partnerships or
ventures in which the company may participate but is not the operator.
RISKS. The failure to correct a material Year 2000 problem could result in
interruption in, or failure of certain normal business activities or operations.
Such failures could materially and adversely affect the company's results of
operations, liquidity and financial position.
The Company's Year 2000 project has resulted in a significantly reduced level of
uncertainty about the Company's mission-critical systems and software. The
Company believes that the completion of the Year 2000 project as scheduled will
vastly reduce the possibility of significant interruptions of normal business
operations.
Due to the general uncertainty inherent in the Year 2000 problem, resulting in
part from the uncertainty of the Year 2000 readiness of third-party suppliers,
the Company is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact on the company's results of
operations, liquidity or financial condition.
All statements made herein relating to our year 2000 efforts are "Year 2000
Readiness Disclosures" made pursuant to the Year 2000 Information and Readiness
Disclosure Act, and to the extent applicable, are entitled to the protection of
such act.
28
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ASSET/LIABILITY MANAGEMENT
The Company's primary market risk exposure is interest rate risk. Fluctuations
in interest rates will impact both the level of interest income and interest
expense and the market value of the Company's interest-earning assets and
interest-bearing liabilities.
Management strives to manage the maturity or repricing match between assets and
liabilities. The degree to which the Company is "mismatched" in its maturities
is a primary measure of interest rate risk. In periods of stable interest rates,
net interest income can be increased by financing higher yielding long-term
mortgage loan assets with lower cost short-term Savings Bank deposits and
borrowings. Although such a strategy may increase profits in the short run, it
increases the risk of exposure to rising interest rates and can result in
funding costs rising faster than asset yields. The Company attempts to limit its
interest rate risk by selling a majority of the fixed rate mortgage loans that
it originates.
Contractual principal repayments of loans do not necessarily reflect the actual
term of the Company's loan portfolio. The average lives of mortgage loans are
substantially less than their contractual terms because of loan prepayments and
because of enforcement of due-on-sale clauses, which gives the Company the right
to declare a loan immediately due and payable in the event, among other things,
the borrower sells the real property subject to the mortgage and the loan is not
repaid. In addition, certain borrowers increase their equity in the security
property by making payments in excess of those required under the terms of the
mortgage.
The majority of the loans originated by the Company are sold through the
Company's loan sale strategies in an attempt to limit its exposure to interest
rate risk in addition to generating cash revenues. The Company sold, during 1998
and the first nine months in 1999, approximately 95.7% of the total loans
originated and funded in-house during the year ended December 31,1998. Also, the
Company sold, during the first nine months in 1999, approximately 90.7% of loans
originated and funded in-house during the period beginning January 1999 and
ending August 31, 1999. The Company expects to sell the majority of its loan
originations within the twelve-month period following the closing date of the
loan. On average, loans are held for less than 12 months in the Company's
portfolio of Loans Held for Sale. The "gap position", defined as the difference
between interest-earning assets and interest-bearing liabilities maturing or
repricing in one year or less, was negative at September 30, 1999, as
anticipated, and is expected to remain negative in future periods. The Company
has no quantitative target range for past gap positions, nor any anticipated
ranges for future periods due to the fact that the Company sells the majority of
its loans within a twelve month period while the gap position is a static
illustration of the contractual repayment schedule for loans.
29
<PAGE>
The Company's one-year gap was a negative 17.24% of total assets at
September 30, 1999, as illustrated in the following table:
(IN THOUSANDS)
<TABLE>
<CAPTION>
One Year Two Three to More Than
Description Total Or Less Years Four Years Four Years
- --------------------------------------------- ------------- ------------ --------------- -------------
<S> <C>
Interest earning assets:
Loans receivable (1) $ 42,819 $ 13,935 $ 751 $ 1,796 $ 26,336
Cash and other 9,040 9,040
Interest-earning assets
----------- ------------- ------------ --------------- -------------
Interest-earning assets 51,859 22,975 751 1,796 26,336
------------- ------------ --------------- -------------
Allowance for loan losses (1,474)
Investment in IMC 34
Premises and equipment, net 4,693
Other 13,991
-----------
Total assets $ 69,103
===========
Interest-bearing liabilities:
Revolving warehouse lines 13,885 13,885
FDIC - insured deposits 30,326 17,643 6,843 4,456 1,384
Other interest-bearing 6,512 3,359 562 2,265 326
liabilities
----------- ------------- ------------ --------------- -------------
50,723 $ 34,887 $ 7,405 $ 6,721 $ 1,710
============= ============ =============== =============
Non-interest-bearing liabilities 3,129
-----------
Total liabilities 53,852
Shareholders' equity 15,251
-----------
Total liabilities and equity $ 69,103
===========
Maturity/repricing gap $(11,912) $ (6,654) $ (4,925) $ 24,626
============= ============ =============== =============
Cumulative gap $(11,912) $ (18,566) $ (23,491) $ 1,135
============= ============ =============== =============
As percent of total assets (17.24%) (26.87%) (33.99%) 1.64%
============= ============ =============== =============
Ratio of cumulative interest
earning assets to cumulative
interest earning liabilities .66x .56x .52x 1.02x
============= ============ =============== =============
</TABLE>
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
30
<PAGE>
INTEREST RATE RISK
The principal quantitative disclosure of the Company's market risks is the gap
table on page 29. The gap table shows that the Company's one-year gap was a
negative 17.24% of total assets at September 30, 1999. The Company primarily
originates fixed-rate, fixed-term mortgage loans for sale in the secondary
market. While most of these loans are sold within a month or two of origination,
for purposes of the gap table the loans are shown based on their contractual
scheduled maturities. As of September 30, 1999, 61.5% of the principal on the
loans was expected to be received more than four years from that date. However,
the Company's activities are financed with short-term loans and credit lines,
68.8% of which reprice within one year of September 30, 1999. The Company
attempts to limit its interest rate risk by selling a majority of the fixed rate
loans that it originates. If the Company's ability to sell such fixed-rate,
fixed-term mortgage loans on a timely basis were to be limited, the Company
could be subject to substantial interest rate risk.
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
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
portfolio by increasing the level of loan prepayments. Additionally, to the
extent that interest only, residual or mortgage servicing assets are capitalized
on the books of the Company in the future, 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 whole
loan sale of mortgage loans would generally be limited to those gains resulting
from the yield differential between the interest rate on the mortgage loan and
the interest 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 normally holds a portfolio of loans for a short period of time
immediately following the closing of the loan during which it earns 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. As with other investments,
the Savings Bank regularly monitors the appropriateness of the level of mortgage
loans in its portfolio.
31
<PAGE>
ASSET QUALITY
The following table summarizes all of the Company's delinquent loans at
September 30, 1999 and December 31, 1998:
(IN THOUSANDS)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
---------------- ----------------
<S> <C>
Delinquent 31 to 60 days $ 345 $ 697
Delinquent 61 to 90 days 1,125 1,115
Delinquent 91 to 120 days 265 1,460
Delinquent 121 days or more 2,555 2,658
---------------- ----------------
Total delinquent loans (1) $ 4,290 $ 5,930
================ ================
Total loans receivable outstanding (gross) (1) $ 43,543 $ 109,500
=============== ================
Delinquent loans as a percentage of
total loans outstanding:
Delinquent 31 to 60 days .79% .64%
Delinquent 61 to 90 days 2.58 1.02
Delinquent 91 to 120 days .61 1.33
Delinquent 121 days or more 5.87 2.43
---------------- ----------------
Total delinquent loans as a percentage
of total loans outstanding 9.85% 5.42%
================ ================
</TABLE>
- -------------
(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. Nonaccrual loans were $3.9 million and
$5.2 million at September 30, 1999 and December 31, 1998, respectively. The
amount of additional interest that would have been recorded had the loans not
been placed on non-accrual status was approximately $311,000 and $212,000 for
the nine months ended September 30, 1999 and for the year ended December 31,
1998, respectively. The amount of interest income on the nonaccrual loans, that
was included in net income for the nine months ended September 30, 1999 was
$138,000. The data for interest income on nonaccrual loans, that was included in
net income for the nine months ended September 30, 1998 was not available.
Loans delinquent 31 days or more as a percentage of total loans outstanding
increased to 9.85% at September 30, 1999 from 5.42% at December 31, 1998. The
increase was primarily a result of a decrease in the dollar amount of total
loans outstanding. The dollar amount of total loans outstanding decreased
because the amount of loans sold or prepaid was greater than the amount of loans
originated during the nine-month period ended September 30, 1999.
32
<PAGE>
At September 30, 1999 and December 31, 1998 the recorded investment in loans for
which impairment has been determined in accordance with SFAS 114 totaled $2.8
million and $4.1 million, respectively. The average recorded investment in
impaired loans for the nine months ended September 30, 1999 and the year ended
December 31, 1998 was approximately $3.9 million and $2.6 million, respectively.
SFAS 118 allows a creditor to use existing methods for recognizing interest
income on an impaired loan. Consistent with the Company's method for nonaccrual
loans, interest receipts for impaired loans are recognized as interest income or
are applied to principal when the ultimate collectibility of principal is in
doubt. Due to the homogenous nature and the collateral securing these loans,
there is no corresponding valuation allowance.
33
<PAGE>
PART II. OTHER INFORMATION
<PAGE>
Item 1. LEGAL PROCEEDINGS - The Company is party to various legal proceedings
arising out of the ordinary course of its business. Management believes that
none of these actions, individual or in the aggregate will have a material
adverse effect on the results of operations or financial condition of the
Company.
Item 2. CHANGES IN SECURITIES - None
Item 3. DEFAULTS UPON SENIOR SECURITIES - None
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - None
Item 5. OTHER INFORMATION - None
Item 6. EXHIBITS AND REPORTS ON FORM 8-K -
(a) Exhibits:
27 Financial Data Schedule
(b) Reports on Form 8-K:
No reports on Form 8-K have been filed during the
nine (9) months ending September 30, 1999.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: ______________________ APPROVED FINANCIAL CORP.
By: ________________________________
Allen D. Wykle,
Chairman, President, and
Chief Executive Officer
By: ________________________________
Eric S. Yeakel,
Its Treasurer and Chief
Financial Officer
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED FINANCIAL STATEMENTS FOR THE PERIOD ENDED SEPTEMBER 30, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 5,903
<INT-BEARING-DEPOSITS> 765
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 2,114
<INVESTMENTS-CARRYING> 417
<INVESTMENTS-MARKET> 417
<LOANS> 42,819
<ALLOWANCE> 1,474
<TOTAL-ASSETS> 69,103
<DEPOSITS> 30,326
<SHORT-TERM> 17,047
<LIABILITIES-OTHER> 3,760
<LONG-TERM> 2,719
0
1
<COMMON> 5,482
<OTHER-SE> 9,768
<TOTAL-LIABILITIES-AND-EQUITY> 69,103
<INTEREST-LOAN> 6,019
<INTEREST-INVEST> 314
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 6,333
<INTEREST-DEPOSIT> 1,279
<INTEREST-EXPENSE> 2,655
<INTEREST-INCOME-NET> 2,399
<LOAN-LOSSES> 1,227
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 28,174
<INCOME-PRETAX> (6,255)
<INCOME-PRE-EXTRAORDINARY> (6,255)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,948)
<EPS-BASIC> (0.72)
<EPS-DILUTED> (0.72)
<YIELD-ACTUAL> 3.87
<LOANS-NON> 4,290
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,590
<CHARGE-OFFS> 2,362
<RECOVERIES> 19
<ALLOWANCE-CLOSE> 1,474
<ALLOWANCE-DOMESTIC> 1,474
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
