<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
---------------------- --------------------------
Commission file number 000-23887
ROCK FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2603955
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
30600 TELEGRAPH ROAD, FOURTH FLOOR
BINGHAM FARMS, MICHIGAN
48025
(Address of principal executive offices)
(Zip Code)
(248) 540-8000
(Registrant's telephone number, including area code)
- - --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Number of common shares outstanding as of November 13, 1998: 13,644,000
Page 1 of 32 pages
<PAGE> 2
ROCK FINANCIAL CORPORATION
Table of Contents
<TABLE>
<CAPTION>
Page
Number
------
<S> <C>
PART I--FINANCIAL INFORMATION...............................................................................3
ITEM 1. FINANCIAL STATEMENTS......................................................................3
BALANCE SHEETS............................................................................3
STATEMENTS OF INCOME......................................................................4
STATEMENT OF SHAREHOLDERS'EQUITY..........................................................5
STATEMENTS OF CASH FLOWS..................................................................6
NOTES TO FINANCIAL STATEMENTS.............................................................7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS....................................................................10
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...............................30
PART II--OTHER INFORMATION.................................................................................31
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.........................................................31
SIGNATURES.................................................................................................32
</TABLE>
Page 2 of 32 pages
<PAGE> 3
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ROCK FINANCIAL CORPORATION
BALANCE SHEETS
DECEMBER 31, 1997 AND SEPTEMBER 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
December 31, September 30,
1997 1998
---- ----
ASSETS
<S> <C> <C>
Cash and cash equivalents............................................... $ 11,946,992 $ 34,384,364
Mortgage loans held for sale............................................ 121,343,814 104,222,524
Mortgage loans held for investment (net of allowance for
losses of $270,000 and $467,255 at December 31,
1997 and September 30, 1998, respectively)......................... 810,293 1,678,954
Real estate owned....................................................... 158,271 181,651
Shareholders' advances.................................................. 1,626,519 --
Property and equipment (net of accumulated depreciation of
$3,429,862 and $5,023,206 at December 31, 1997 and
September 30, 1998, respectively).................................. 7,010,537 9,986,960
Deferred income taxes................................................... -- 1,684,088
Other assets............................................................ 1,532,471 1,660,540
------------ ------------
Total assets............................................................ $144,428,897 $153,799,081
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Warehouse line of credit........................................... $ 79,293,856 $ 53,550,433
Reverse repurchase agreement....................................... 18,161,423 2,750,916
Notes payable...................................................... 1,944,445 -
Drafts payable..................................................... 21,875,184 45,270,882
Accounts payable................................................... 3,255,503 4,703,781
Accrued expenses and other liabilities............................. 4,790,350 11,834,996
------------ ------------
Total liabilities.............................................. 129,320,761 118,111,008
------------ ------------
Shareholders' equity:
Common shares, $.01 par value. Authorized 50,000,000
shares; issued and outstanding 10,000,000 shares
and 13,829,500 shares at December 31, 1997 and
September 30, 1998, respectively............................... 100,000 138,295
Additional paid-in capital......................................... 1,423,750 26,764,790
Retained earnings.................................................. 13,584,386 8,784,988
------------ ------------
Total shareholders' equity..................................... 15,108,136 35,688,073
------------ ------------
Total liabilities and shareholders' equity.............................. $144,428,897 $153,799,081
============ ============
</TABLE>
Page 3 of 32 pages
<PAGE> 4
ROCK FINANCIAL CORPORATION
STATEMENTS OF INCOME
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998
(UNAUDITED)
<TABLE>
<CAPTION>
For the Three-Month For the Nine-Month
Periods Ended September 30, Periods Ended September 30,
--------------------------- ---------------------------
1997 1998 1997 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Interest income................................. $ 2,443,524 $ 2,964,168 $ 5,236,214 9,191,880
Interest expense................................ 1,515,464 1,481,819 3,448,595 5,101,646
----------- ----------- ----------- -----------
Net interest margin......................... 928,060 1,482,349 1,787,619 4,090,234
Provision for credit losses..................... 100,000 139,863 100,000 389,573
----------- ----------- ----------- -----------
Net interest margin after provision for
credit losses........................... 828,060 1,342,486 1,687,619 3,700,661
Loan fees and gains on sale of mortgages........ 12,154,899 21,761,051 30,221,950 60,400,881
Net gain on sale of marketable securities....... 1,587,268 -- 2,254,242 --
Other income.................................... 44,081 614 144,496 18,349
----------- ----------- ----------- -----------
14,614,308 23,104,151 34,308,307 64,119,891
----------- ----------- ----------- -----------
Expenses:
Salaries, commissions and employee benefits..... 7,348,889 10,085,776 17,714,764 28,282,016
General and administrative expenses............. 2,206,717 3,452,014 5,251,588 9,549,769
Marketing expenses.............................. 1,547,910 3,396,356 3,098,128 9,856,834
Depreciation and amortization................... 345,522 541,654 738,389 1,593,704
----------- ----------- ----------- -----------
11,449,038 17,475,800 26,802,869 49,282,323
----------- ----------- ----------- -----------
Income before income taxes............................. 3,165,270 5,628,351 7,505,438 14,837,568
Income taxes due to quarterly earnings................. -- 1,501,016 -- 2,624,540
Income tax benefit due to conversion of "S" Corp. -- -- -- (950,939)
----------- ----------- ----------- -----------
Net income $ 3,165,270 $ 4,127,335 $ 7,505,438 $13,163,967
=========== =========== =========== ===========
Pro forma information (note 5):
Income before income taxes...................... 3,165,270 5,628,351 7,505,438 14,837,568
Provision for pro forma income taxes............ 1,107,845 1,969,923 2,626,903 5,193,149
----------- ----------- ----------- -----------
Pro forma net income............................ 2,057,426 $ 3,658,428 $ 4,878,535 $ 9,644,419
=========== =========== =========== ===========
Pro forma earnings per share:
Basic ........................................ $ 0.15 $ 0.26 $ 0.35 $ 0.70
=========== =========== =========== ===========
Diluted ........................................ $ 0.14 $ 0.25 $ 0.34 $ 0.66
=========== =========== =========== ===========
Dividends declared per share........................... -- $ 0.02 -- $ 0.04
=========== =========== =========== ===========
Pro forma weighted average number of shares outstanding:
Basic ........................................ 13,829,500 13,829,500 13,829,500 13,829,500
=========== =========== =========== ===========
Diluted ........................................ 14,516,904 14,516,904 14,520,594 14,520,594
=========== =========== =========== ===========
</TABLE>
Page 4 of 32 pages
<PAGE> 5
ROCK FINANCIAL CORPORATION
STATEMENT OF SHAREHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
ADDITIONAL TOTAL
COMMON PAID-IN RETAINED SHAREHOLDERS'
SHARES CAPITAL EARNINGS EQUITY
------ ------- -------- ------
<S> <C> <C> <C> <C>
Balance January 1, 1998................................ $100,000 $ 1,423,750 $ 13,584,386 $ 15,108,136
S corporation shareholder distribution................. (5,380,500) (5,380,500)
Proceeds from initial public offering.................. 38,295 32,551,455 32,589,750
Distribution to S corporation shareholders
in connection with conversion to a
C corporation................................... (7,570,415) (12,029,585) (19,600,000)
Cash dividends to C corporation shareholders........... (553,280) (553,280)
Tax benefit from the exercise of non-qualified
stock options................................... 360,000 360,000
Net income ........................................ 13,163,967 13,163,967
-------- ----------- ------------ ------------
Balance September 30, 1998 $138,295 $26,764,790 $ 8,784,988 35,688,073
======== =========== ============ ============
</TABLE>
Page 5 of 32 pages
<PAGE> 6
ROCK FINANCIAL CORPORATION
STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998
(UNAUDITED)
<TABLE>
<Caption
For the Nine-Month
Periods Ended September 30,
---------------------------
1997 1998
-------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net income............................................... $ 7,505,438 $ 13,163,967
------------- ---------------
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization........................ 738,390 1,593,704
Provision for credit losses.......................... 100,000 389,573
Net gain on sales of marketable securities........... (2,254,242) --
Mortgage loans held for sale - originations.......... (824,312,003) (1,541,037,088)
Mortgage loans held for sale - sales................. 819,985,023 1,558,158,378
Change in assets and liabilities:....................
Deferred income taxes........................... -- (1,684,088)
Other assets.................................... (1,136,197) (128,069)
Drafts payable.................................. 7,429,715 23,395,698
Accounts payable................................ (249,055) 1,448,278
Accrued expenses and other liabilities.......... 3,141,403 7,404,646
------------- ---------------
Total adjustments........................... 3,443,033 49,541,032
------------- ---------------
Net cash provided by operating activities... 10,948,471 62,704,999
------------- ---------------
Cash flows from investing activities:
Proceeds from sale of marketable securities.............. 8,586,853 --
Purchase of marketable securities........................ (4,106,842) --
Net increase in real estate owned and loans
held for investment.................................. -- (1,281,614)
Purchase of property and equipment....................... (4,008,917) (4,570,127)
Shareholder repayments................................... 607,642 1,626,519
------------- ---------------
Net cash provided by (used in) investing
activities.................................... 1,078,736 (4,225,222)
------------- ---------------
Cash flows from financing activities:
Net payments under warehouse
line of credit....................................... (24,214,813) (25,743,423)
Net payments under reverse repurchase
agreement............................................ 15,604,151 (15,410,507)
Net (payments) borrowings under notes payable............ 1,961,111 (1,944,445)
Net proceeds from initial public offering................ -- 31,045,350
Proceeds from exercised options.......................... -- 1,544,400
Cash dividends........................................... -- (553,280)
S Corporation distributions.............................. (7,056,403) (24,980,500)
------------- ---------------
Net cash used in financing activities........... (13,705,954) (36,042,405)
------------- ---------------
Net increase (decrease) in cash and cash equivalents.......... (1,678,747) 22,437,372
Cash and cash equivalents, beginning of period................ 3,288,751 11,946,992
------------- ---------------
Cash and cash equivalents, end of period...................... $ 1,610,004 $ 34,384,364
============= ===============
Supplemental disclosure of cash flow information:
Cash paid during the period for interest................. $ 3,221,851 $ 5,059,170
============= ===============
Transfers of loans from held for sale to held
for investment....................................... $ -- $ 989,338
============= ===============
Transfers of loans from held for investment to
real estate owned.................................... $ -- $ 45,880
============= ===============
</TABLE>
Page 6 of 32 pages
<PAGE> 7
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. FINANCIAL STATEMENT PRESENTATION:
The accompanying unaudited interim financial statements of Rock
Financial Corporation (the "Company") have been prepared pursuant to
the rules and regulations of the Securities and Exchange Commission.
Accordingly, such financial statements do not include all of the
information and footnotes normally included in the Company's annual
financial statements prepared in accordance with generally accepted
accounting principles, although the Company believes that the
disclosures are adequate to make the information presented not
misleading.
The accompanying unaudited interim financial statements reflect
all adjustments which are, in the opinion of management, necessary to a
fair statement of the results for the interim periods presented. All
such adjustments are of a normal recurring nature, except those not
material to the Company's financial condition or results of operations.
Operating results for the three- and nine-month periods ended September
30, 1998 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1998. The unaudited interim
financial statements should be read in conjunction with the audited
financial statements and footnotes to such financial statements for the
year ended December 31, 1997 included in the Company's Registration
Statement on Form S-1 (file no. 333-46885), effective May 1, 1998.
2. MORTGAGE LOANS HELD FOR SALE AND HELD FOR INVESTMENT:
The following summarizes mortgage loans held for sale by type at
December 31, 1997 and September 30, 1998:
<TABLE>
<CAPTION>
December 31, September 30,
1997 1998
---- ----
<S> <C> <C>
Prime loans held for sale..................................... $ 74,049,209 $ 81,407,873
Sub-prime loans held for sale................................. 38,372,558 18,626,042
High LTV loans held for sale.................................. 9,194,343 4,219,635
------------ ------------
121,616,110 104,253,550
Net deferred loan origination fees............................ (272,296) (31,026)
------------ ------------
Mortgage loans held for sale.............................. $121,343,814 $104,222,524
</TABLE>
Mortgage loans held for investment at December 31, 1997 is
presented net of an allowance for credit losses of $270,000, which was
established in 1997 through a provision of $300,000 offset by
charge-offs of $30,000. Mortgage loans held for investment at September
30, 1998 is presented net of an allowance for credit losses of $467,255
which included a provision of $389,573 in the first nine months of
1998, offset by charge-offs of $192,317.
Page 7 of 32 pages
<PAGE> 8
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS, CONTINUED
As of December 31, 1997 and September 30, 1998, there were no\
loans held for sale that were greater than 90 days past due. As of
December 31, 1997, there were approximately $72,000 of loans held for
investment that were greater than 90 days past due, $25,000 of which
was classified as nonaccrual. As of September 30, 1998, there were
approximately $728,000 of loans held for investment that were greater
than 90 days past due, all of which were classified as nonaccrual. The
increase in "nonaccrual" loans is due to holding on to Sub-Prime Home
Equity Loans for longer periods of time so that "bulk sales" of
Sub-Prime Home Equity Loans can be accomplished. The "bulk sale"
metholodogy exposes the Company to delinquencies and loans that could
go into default.
3. INITIAL PUBLIC OFFERING AND RELATED MATTERS:
On May 6, 1998, the Company completed its initial public offering
(the "Offering") of 3,829,500 Common Shares, including 330,000 Common
Shares sold by selling shareholders and 3,499,500 newly-issued Common
Shares sold by the Company, at a price of $10.00 per share, for gross
proceeds to the Company of $34,995,000, not including the $1,544,400
received by the Company upon exercise by the selling shareholders of
options to purchase 330,000 common shares at $4.68 per share. These
options were exercised by the selling shareholders to acquire the
common shares they sold in the Offering. The estimated net proceeds to
the Company from the sale of shares offered by it in the Offering,
after deducting the underwriting discount and the estimated expenses of
the Offering, were approximately $31,045,350. The Offering was
underwritten by a group of underwriters for which Bear, Stearns & Co.
Inc., Prudential Securities Incorporated and Roney & Co. served as
representatives. The December 31, 1997 balance sheet includes
approximately $55,000 of capitalized costs directly associated with the
Offering.
The Company's September 30, 1998 balance sheet reflects the
following in connection with the Offering: (1) the distribution from
retained earnings of a $25.0 million dividend (including the $5.4
million tax distribution to existing shareholders on April 10, 1998) to
the Company's then existing shareholders, effective immediately before
the closing of the Offering and payable out of the proceeds of the
Offering, equal to the entire amount of the Company's income taxed or
taxable to the existing shareholders while the Company was an S
corporation, but not yet distributed to them (the "Shareholder
Distribution Amount"), (2) the establishment of a deferred tax asset of
$1.8 million along with the creation of a current income tax liability
of approximately $0.9 million in connection with the termination of the
Company's S corporation status as of May 6, 1998, (3) the repayment by
one of the Company's shareholders of the entire outstanding balance of
shareholder advances (approximately $1.6 million) with his share of the
Shareholder Distribution Amount, and the Company's use of that cash to
repay a portion of the amounts outstanding under its warehouse line of
credit, (4) the receipt by the Company of approximately $1.5 million
upon exercise by certain of the Company's option holders of 330,000
options at $4.68 a share to acquire the Common Shares they sold in the
Offering and the Company's application of the net proceeds therefrom to
repay a portion of the
Page 8 of 32 pages
<PAGE> 9
amounts outstanding under its warehouse line of credit, and (5) the
sale of the Common Shares offered by the Company in the Offering and
the application of the net proceeds therefrom to fund the Shareholder
Distribution Amount and repay a portion of the amounts outstanding
under its warehouse line of credit. Due to the payment of the estimated
accumulated Subchapter S corporate earnings paid to the shareholders in
the Shareholder Distribution Amount of $25.0 million, the Company does
not expect to have any undistributed "S" corporation earnings. The
principal component of the Company's deferred tax asset is related to
the temporary differences between tax and book accounting for
recognition of gains on sales of mortgage loans. The amount of the
deferred tax asset initially recorded was based on the amount of such
temporary differences at May 6, 1998, the date of revocation of the
Company's S corporation status.
For a description of the pro forma provision for income tax, see
note 5.
4. RELATED PARTY TRANSACTIONS:
On May 6, 1998, the Company's short-term advances to a
shareholder were repaid in full out of the proceeds of the Shareholder
Distribution Amount.
5. UNAUDITED PRO FORMA FINANCIAL INFORMATION:
The pro forma financial information has been presented to show
what the significant effects on the historical results of operations
might have been had the Company not been treated as an S corporation
for income tax purposes as of the beginning of the earliest period
presented. The presentation of pro forma net income represents the
historical results of operations adjusted to recognize federal and
state income taxes as if the Company had been taxed as a C corporation
rather than an S corporation for all of the periods presented, using a
pro forma combined federal and state income tax rate of approximately
35.0%.
Pro forma basic earnings per share has been computed by dividing
pro forma net income by the 13,829,500 average shares assumed to be
outstanding including the 3,499,500 shares sold by the Company in the
Offering and the 330,000 shares sold by certain existing shareholders
in the Offering (after exercising options to purchase those shares from
the Company). Pro forma diluted earnings per share for the period
ending September 30, 1998, has been computed by dividing pro forma net
income by the 14,520,594 average shares assumed to be outstanding,
including the 3,499,500 shares sold by the Company in the Offering and
the 330,000 shares to be sold by certain existing shareholders in the
Offering (after exercising options to purchase those shares from the
Company) as well as the number of common stock equivalent shares
assumed to be outstanding upon exercise of the Company's stock options
existing as of September 30, 1998, using the treasury stock method and
the $9.86 per share weighted average market price of the Company's
common shares for the period ended September 30, 1998, as reported by
The Nasdaq Stock Market.
Page 9 of 32 pages
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
With the exception of historical information, certain of the
matters discussed in this Management's Discussion and Analysis of
Financial Condition and Results of Operations are forward-looking
statements that involve risks and uncertainties and actual results
could differ materially from those discussed. The words and phrases
"should be," "will be," "predicted," "believe," "expect," "anticipate"
and similar expressions identify forward-looking statements. These
forward-looking statements reflect the Company's current views in
respect to future events in financial performance, but are subject to
many risks, uncertainties and factors relating to the Company's
operations and business environment which may cause its actual results
to differ materially from historical results or any future results
expressed or implied by such forward-looking statements. Such risks and
uncertainties include the factors described under the caption "Risk
Factors" and elsewhere in the Company's Registration Statement on Form
S-1 (file no. 333-46885) effective May 1, 1998 and elsewhere in this
Report.
GENERAL
The Company is a specialty finance company marketing conventional
and sub-prime debt consolidation and home financing loans, secured
primarily by first or second mortgages on one-to four-family,
owner-occupied residences. The Company originates loans through 28
stores and branches, one marketing center and one call center. Founded
in 1985 by its current Chief Executive Officer and Chairman of the
Board, Daniel Gilbert, the Company originates 100% of its loans through
its retail operations, marketing its loans directly to consumers.
The Company had operated through three major divisions, but
currently operates through two major divisions. The Company decided, in
the third quarter, to stop originating home equity second mortgage
loans to individuals with good credit histories but little or no equity
in their homes ("High LTV Loans") due to concerns of liquidity that
resulted from a dimishing base of purchasers of these loans and to take
advantage of the high demand for Conventional Loans. Therefore, the
sales force from this division was shifted to handle this high demand
for Conventional Loans resulting from the lower interest rate
environment. The Company originates Sub-Prime Home Equity Loans to
individuals with impaired credit characteristics, high levels of debt
service to income, unfavorable past credit experience, limited credit
history, limited employment history or unverifiable income through its
Fresh Start(R) division, created in 1994. Since its inception in 1985,
the Company has originated Conventional Loans that generally conform to
FNMA or Freddie Mac underwriting standards, or that generally meet such
standards except for maximum loan size guidelines, through its
Conventional Mortgage Lending division. In addition, the Company began
to increase its government insured lending operations in 1997,
primarily making mortgage loans that meet the underwriting standards
for FHA insurance, but currently the Company does not view government
insured lending as a major business segment.
Page 10 of 32 pages
<PAGE> 11
TERMINATION OF S CORPORATIoN STATUS AND INCOME TAXES
Simultaneously with the closing of the Company's initial public
offering on May 6, 1998 (the "Offering"), the Company ceased to be
taxed as an S corporation under the Internal Revenue Code of 1986, as
amended (the "Code"). In connection with the termination of its S
corporation status, the Company paid the Shareholder Distribution
Amount out of the net proceeds of the Offering to the Company's
shareholders existing immediately before the closing of the Offering
(the "Existing Shareholders"). The Shareholder Distribution Amount
(including the approximately $5.4 million tax distribution to existing
shareholders on April 10, 1998) was approximately $25.0 million, and is
subject to adjustment upon final determination of the amount of taxable
income through May 5, 1998.
As an S corporation, the Company's income, whether or not
distributed, was taxed at the shareholder level for federal and state
tax purposes. As a result of the termination of its S corporation
status, the Company is subject to federal and state income taxation and
recorded a $1.8 million deferred tax asset on its balance sheet in the
second quarter of 1998. The amount of the deferred tax asset is based
on timing differences between tax and book accounting relating
principally to marking loans to market for tax purposes. The pro forma
provision for income taxes in the interim statements of income show
results as if the Company had been subject to federal and state
taxation at the tax rates effective for the periods presented.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998
VERSUS THREE MONTHS ENDED SEPTEMBER 30, 1997
The following table sets forth the revenues and expenses and net
income for the Company for the three months ended September 30, 1997
and 1998:
<TABLE>
<CAPTION>
Three Months Ended September 30,
--------------------------------
1997 1998
---- ----
(In thousands)
<S> <C> <C>
Total revenue before gains on sale
of marketable securities.................. $ 13,027 $ 23,104
Net gain on sale of marketable
securities................................ 1,587 --
------------- -------------
Total revenue............................... 14,614 23,104
Total expenses.............................. (11,449) (17,476)
------------- -------------
Income before income taxes.................. 3,165 5,628
Income taxes due to quarterly earnings...... -- 1,501
------------- -------------
Net income.................................. $ 3,165 $ 4,127
============= =============
</TABLE>
Page 11 of 32 pages
<PAGE> 12
The Company's total revenues increased to $23.1 million in the
third quarter of 1998 from $14.6 million in the third quarter of 1997,
an increase of $8.5 million, or 58.1%. The increase in revenues is
primarily due to (i) an increase of $212.5 million, or 98.0%, in the
volume of Conventional Loans sold by the Company in the third quarter
of 1998 compared to the third quarter of 1997, (ii) an increase of
$50.7 million, or 92.0%, in the volume of Sub-Prime Home Equity Loans
sold by the Company in the third quarter of 1998 compared to the third
quarter of 1997, (iii) an increase of $8.2 million, or 226.6%, in the
volume of government insured loans sold in the third quarter of 1998
compared to the third quarter of 1997, (iv) a 34.8% increase in margins
earned on loan fees and gains on sale of Conventional Loans, and (v) a
12.0% increase in margins earned on loan fees and gain on sale of
government insured loans, partially offset by (i) a decrease of $6.0
million, or 33.3%, in the volume of High LTV Loans sold in the third
quarter of 1998 as compared to the third quarter of 1997, (ii) a 21.3%
decrease in margins earned on loan fees and gains on sale of High LTV
Loans, and (iii) an 18.0% decrease in margins earned on loan fees and
gains on sale of Sub-Prime Home Equity Loans in the third quarter of
1998 compared to the third quarter of 1997.
During the third quarter of 1998, the Company disbursed $571.9
million of loans, an increase of $247.9 million, or 76.5%, from the
$324.0 million of loans disbursed in the third quarter of 1997. The
Company's loans held for sale increased by $12.6 million in the third
quarter of 1998, compared to $30.1 million in the third quarter of
1997. The increase was due to the Company selling $559.3 million in
loans while disbursing $571.9 million in loans in the third quarter of
1998. The increase in loans held for sale in the third quarter of 1998
included increases of $14.0 million in Conventional Loans and $1.2
million in government insured loans, and a decrease of $2.6 million in
Sub-Prime Home Equity Loans. The increase in loans held for sale in the
third quarter of 1997 included increases of $18.9 million in
Conventional Loans, $6.1 million in Sub-Prime Home Equity Loans and
$5.1 million in High LTV Loans.
Total expenses increased from $11.4 million in the third quarter
of 1997 to $17.5 million in the third quarter of 1998, an increase of
$6.0 million, or 52.6%, primarily due to increased commissions,
increased occupancy costs for new stores and branches, increases in
marketing and advertising expenses associated with these new store
openings, and increases in general and administrative expenses that
fluctuate with increases in volumes of loans closed and numbers of
employees. There are no new branch or store openings planned for the
fourth quarter of 1998, branch openings are being planned for the first
quarter of 1999.
The 18 branches and stores along with the marketing center that
have opened since July 1, 1997 contributed significantly less to the
Company's revenues and net income in the third quarter of 1998 than
stores that have been in operation for more than fifteen months. Eight
of the 18 stores and branches operated at a net loss aggregating
approximately $0.3 million in the third quarter of 1998. The Company
believes that its new stores generally mature over a twelve- to
eighteen-month time period.
Page 12 of 32 pages
<PAGE> 13
The following table sets forth information regarding the components of
the Company's revenues for the three months ended September 30, 1997 and 1998:
<TABLE>
<CAPTION>
Three Months
Ended September 30,
-------------------
1997 1998
---- ----
(in thousands)
<S> <C> <C>
Interest income........................................................ $ 2,443 $ 2,964
Interest expense....................................................... (1,515) (1,482)
------- -------
Net interest margin............................................... 928 1,482
Provision for credit losses............................................ 100 140
------- -------
Net interest margin after provision for credit losses............. 828 1,342
Loan fees and gains on sale of mortgages............................... 12,155 21,761
Net gain on sale of marketable securities.............................. 1,587 --
Other income........................................................... 44 1
------- -------
Total revenue..................................................... $14,614 $23,104
======= =======
</TABLE>
Net interest margin increased to $1.5 million in the third
quarter of 1998 from $0.9 million in the third quarter of 1997, an
increase of $0.6 million, or 59.7%. The increase was primarily due to
(i) the increase in the dollar volume of loans closed by the Company,
(ii) an increase in the portion of loans sold on a "bulk" or assignment
of trade basis, rather than on a "flow" basis, resulting in an increase
in the length of time loans were held before sale, which allowed the
Company to take advantage of the positive net interest margin, (iii) a
decrease in the weighted average interest rates charged on the
Company's borrowing facilities (from 7.03% in the third quarter of 1997
to 6.78% in the third quarter of 1998), and (iv) the Company's
increased use of internally-generated cash to fund its loans.
The Company may be required to repurchase or substitute loans in
the event of a breach of representations and warranties, including any
fraud or any misrepresentation made during the loan origination
process. In addition, by increasing net interest margin by holding
loans for longer periods of time, the Company is subject to a higher
risk of delinquencies and resulting foreclosure losses. The Company
recorded a provision for credit losses of approximately $100,000 in the
third quarter of 1997 and recorded a provision for credit losses of
approximately $140,000 in the third quarter of 1998 for future
repurchase or substitution requirements relating to loans sold before
September 30, 1997 and 1998, respectively, and credit risk for loans
held for sale and investment. During the third quarters of 1997 and
1998, no loans were reclassified as real estate owned. There were no
charges against the reserve in the third quarter of 1997 and charges of
approximately $34,000 were recorded in the third quarter of 1998.
Loan fees and gains on sale of mortgages increased to $21.8
million in the third quarter of 1998 from $12.2 million in the third
quarter of 1997, an increase of $9.6 million, or 79.0%. This increase
is primarily due to the increase in sales of loans described above
along with the
Page 13 of 32 pages
<PAGE> 14
changes in the margins earned on loan fees and gains on sale of loans
described above. The increase in margins earned on loan fees and gains
on sale of Conventional Loans was primarily the result of changes in
sales methodologies. The decrease in loan fees and gains on sale of
High LTV loans was due to originations expanding beyond the State of
Michigan, resulting in originations in states that impose limitations
on the loan fees paid by the borrower. The decrease in the margins
earned on the loan fees and gains on sale of Sub-Prime Home Equity
Loans was due to more loans sold on a "flow" rather than "bulk sales"
basis in 1998 and, to a lesser extent, a 6.5% decrease in "bulk sale"
prices. The change in sales execution was primarily the result of the
product guidelines available from "flow" purchasers which were more
liberal as to loan-to-value ratios and allowable credit criteria. The
guidelines of these "flow" purchasers, changed to be more in line with
the Company's stringent criteria. It is, therefore, anticipated that
more of the fourth quarter origination will be of the Company's bulk
product. Management expects that prices for Sub-Prime Home Equity Loans
product in the fourth quarter of 1998 may be lower on average than
those of the third quarter of 1998.
The increase in loan fees and gains on sale of mortgages was
partially offset by an increase in the Company's estimated prepayment
recapture reserve in the third quarter of 1998. Some Sub-Prime Loan
sales require the Company to return a portion of the premium received
by the Company on the sale of the loan if the loan is prepaid by the
customer within the first year after sale. The Company records a
provision for this risk separate from the provision for credit losses
based on its evaluation of the terms of its sale contracts and its
assumptions concerning prepayments. The Company increased its reserve,
and decreased its loan fees and gains on sale of mortgages, by
approximately $0.3 million, for this risk in the third quarter of 1998,
compared to an increase of approximately $0.2 million, in the third
quarter of 1997.
Net gain on sale of marketable securities was approximately $1.6
million in the third quarter of 1997. Before the end of 1997, the
Company had invested some of its excess cash in marketable securities.
During 1997, the Company sold its remaining portfolio of marketable
securities held for sale. No such marketable securities were held by
the Company at December 31, 1997 or at September 30, 1998, and,
therefore, the gains and losses on sales will not continue in the
future.
The following table sets forth information regarding the
components of the Company's expenses for the three months ended
September 30, 1997 and 1998:
<TABLE>
<CAPTION>
Three Months
Ended September 30,
-------------------
1997 1998
---- ----
(in thousands)
<S> <C> <C>
Salaries, commissions and employee benefits............................ $ 7,349 $10,086
General and administrative expenses.................................... 2,207 3,452
Marketing expenses..................................................... 1,548 3,396
Depreciation and amortization.......................................... 345 542
------- -------
Total expenses.................................................... $11,449 $17,476
======= =======
</TABLE>
Page 14 of 32 pages
<PAGE> 15
Salaries, commissions and employee benefits increased from $7.3
million in the third quarter of 1997 to $10.1 million in the third
quarter of 1998, an increase of $2.8 million, or 37.2%. The increase
was primarily attributable to increased commissions due to increased
closings, the Company hiring additional personnel in order to
accommodate increased levels of loan closings and to staff additional
branch openings, along with increased compensation for new management
team members. The Company employed 622 persons as of September 30,
1997, compared to 747 persons as of September 30, 1998, a 20.1%
increase. These expenses are expected to continue to increase in 1998
in connection with the expansion of existing operations.
General and administrative expenses consist primarily of
occupancy costs, professional services, office expenses, automobile and
delivery expenses and other expenses, many of which vary with the
volume of loan closings. General and administrative expenses increased
from $2.2 million in the third quarter of 1997 to $3.5 million in the
third quarter of 1998, an increase of $1.3 million, or 56.4%. The
increase was primarily attributable to an increase in occupancy
expenses, office expenses, and automobile and delivery expenses as a
result of opening 18 new branches and stores since July 1, 1997. The
expenses are expected to vary according to the volume of loan closings
in 1998.
Marketing expenses increased from $1.5 million in the third
quarter of 1997 to $3.4 million in the third quarter of 1998, an
increase of $1.9 million, or 119.4%. The increase was primarily
attributable to the Company's greater marketing of Sub-Prime Home
Equity Loans, both in existing markets and in new markets in an attempt
to generate higher levels of loan closings, as well as the marketing
costs associated with the Company's High LTV Loans. The increase is
primarily the result of the Company's increase in its Sub-Prime Home
Equity Loan business, which required greater marketing related to new
store openings, and ongoing marketing. Management expects these
expenses to fluctuate depending on the amounts of marketing needed to
generate the volumes of loan closings to support the expansion of
existing operations into new geographic markets.
Depreciation and amortization expenses increased from $0.3
million in the third quarter of 1997 to $0.5 million in the third
quarter of 1998, an increase of $0.2 million, or 56.8%. The increase
was primarily attributable to the Company's purchases of additional
equipment and leasehold improvements during 1997 and 1998 for new
stores and branches. The expenses are expected to continue to increase
in 1998 as a result of the expansion of existing operations.
Effective May 6, 1998, the Company's tax status changed from that
of an S corporation to that of a C corporation. As a C corporation, the
Company became subject to federal and state income taxation in the
second quarter of 1998. As an S corporation, the Company's taxable
income is included in the individual returns of the shareholders. As a
result, the Company's income taxes due to earnings for the second and
third quarters of 1998 represent income taxes provided based on the
Company's estimated allocation of income before income taxes between
the S corporation and the C corporation as required under IRS
regulations. The Company recognized tax expense of approximately $1.5
million for the quarter ended September 30, 1998. The "effective" tax
rate is lower than the tax rate that the Company
Page 15 of 32 pages
<PAGE> 16
would have incurred had this allocation between the S Corporation
and C Corporation not occurred.
NINE MONTHS ENDED SEPTEMBER 30, 1998
VERSUS NINE MONTHS ENDED SEPTEMBER 30, 1997
The following table sets forth the revenues and expenses and net
income for the Company for the nine months ended September 30, 1997 and
1998:
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1997 1998
---- ----
(In thousands)
<S> <C> <C>
Total revenue before gains and losses
on sale of marketable securities.......... $ 32,054 $ 64,120
Net gain on sale of marketable securities... 2,254 --
----------- -----------
Total revenue............................... 34,308 64,120
Total expenses.............................. (26,803) (49,282)
----------- -----------
Income before income taxes.................. 7,505 14,838
Income taxes due to quarterly earnings...... -- 2,625
Income tax benefit due to conversion
of "S" corp............................... -- (951)
----------- -----------
Net income.................................. $ 7,505 $ 13,164
=========== ===========
</TABLE>
The Company's total revenues increased to $64.1 million in the
first nine months of 1998 from $34.3 million in the first nine months
of 1997, an increase of $29.8 million, or 86.9%. The increase in
revenues is primarily due to (i) an increase of $549.1 million, or
88.3%, in the volume of Conventional Loans sold by the Company in the
first nine months of 1998 compared to the first nine months of 1997,
(ii) an increase of $141.2 million, or 89.6%, in the volume of
Sub-Prime Home Equity Loans sold by the Company in the first nine
months of 1998 compared to the first nine months of 1997, (iii) an
increase of $20.3 million, or 190.7%, in the volume of government
insured loans sold in the first nine months of 1998 compared to the
first nine months of 1997, (iv) an increase of $27.5 million, or 93.0%,
in the volume of High LTV Loans sold by the Company in the first nine
months of 1998 compared to the first nine months of 1997, (v) a 23.6%
increase in margins earned on loan fees and gains on sale of
Conventional Loans, and (vi) a 14.1% increase in margins earned on loan
fees and gains on sale of government insured loans, partially offset by
(i) a 16.7% decrease in margins earned on loan fees and gains on sale
of High LTV Loans, and (ii) a 3.7% decrease in margins earned on loan
fees and gains on sale of Sub-Prime Home Equity Loans in the first nine
months of 1998 compared to the first nine months of 1997.
The Company's loans held for sale decreased by $17.4 million in
the first nine months of 1998, compared to a $5.0 million increase in
the first nine months of 1997. The decrease was due to the Company
selling $1.558 billion in loans while disbursing $1.541 billion in
loans in the nine-month period ended September 30, 1998. The increase
in loans held for sale in the first nine months of 1998 included
increases of $5.4 million in Conventional Loans and
Page 16 of 32 pages
<PAGE> 17
decreases of $18.0 million in Sub-Prime Home Equity Loans and
$4.8 million in High LTV Loans. The increase in loans held for sale in
the first nine months of 1997 included increases of $17.6 million in
Sub-Prime Home Equity Loans, $8.4 million in High LTV Loans and
decreases of $21.0 million in Conventional Loans.
During the first nine months of 1998, the Company closed $1.6
billion of loans (16,434 loans), an increase of $740.6 million, or
88.5%, from the $836.7 million of loans (8,608 loans) closed in the
first nine months of 1997.
Total expenses increased from $26.8 million in the first nine
months of 1997 to $49.3 million in the first nine months of 1998, an
increase of $22.5 million, or 83.9%, primarily due to increased
commissions, increased occupancy costs for new stores and branches,
increases in marketing and advertising expenses associated with these
new store openings, and increases in general and administrative
expenses that fluctuate with increases in volumes of loans closed and
numbers of employees.
The 14 branches and stores along with the one marketing center
that have opened since October 1, 1997 (including four stores in the
fourth quarter of 1997, six stores in January 1998, three branches in
the second quarter of 1998 and one branch in the third quarter of
1998), contributed significantly less to the Company's revenues and net
income in the first nine months of 1998 than stores that have been in
operation for at least twelve months. Eight of the 14 stores and
branches that opened since October 1, 1997 operated at a net loss
aggregating approximately $2.1 million in the first nine months of
1998. The Company believes that its new stores generally mature over a
twelve- to eighteen-month time period.
The following table sets forth information regarding the
components of the Company's revenues for the nine months ended
September 30, 1997 and 1998:
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
-------------------
1997 1998
---- ----
(in thousands)
<S> <C> <C>
Interest income........................................................ $ 5,236 $ 9,192
Interest expense....................................................... (3,448) (5,102)
------- -------
Net interest margin............................................... 1,788 4,090
Provision for credit losses............................................ (100) (389)
------- -------
Net interest margin after provision for credit losses............. 1,688 3,701
Loan fees and gains on sale of mortgages............................... 30,222 60,401
Net gain on sale of marketable securities.............................. 2,254 --
Other income........................................................... 144 18
------- -------
Total revenue..................................................... $34,308 $64,120
======= =======
</TABLE>
Net interest margin increased to $4.1 million in the first nine
months of 1998 from $1.8 million in the first nine months of 1997, an
increase of $2.3 million, or 128.8%. The increase was primarily due to
(i) the increase in the dollar volume of loans closed by the Company,
Page 17 of 32 pages
<PAGE> 18
(ii) an increase in the portion of loans sold on a "bulk" or
assignment of trade basis, rather than on a "flow" basis, resulting in
an increase in the length of time loans were held before sale, which
allowed the Company to take advantage of the positive net interest
margin, (iii) a decrease in the weighted average interest rates charged
on the Company's borrowing facilities (from 7.22% in the first nine
months of 1997 to 6.84% in the first nine months of 1998), and (iv) the
Company's increased use of internally-generated cash to fund its loans.
The Company recorded a provision for credit losses of approximately
$100,000 in the first nine months of 1997 and recorded a provision for
credit losses of approximately $390,000 in the first nine months of
1998 for future repurchase or substitution requirements relating to
loans sold before September 30, 1997 and 1998, respectively, and credit
risk for loans held for sale and investment. During the first nine
months of 1997 and 1998, zero and 2 loans, respectively, were
reclassified as real estate owned. There were no charges against the
reserve in the first nine months of 1997 and charges of approximately
$192,000 were recorded in the first nine months of 1998.
Loan fees and gains on sale of mortgages increased to $60.4
million in the first nine months of 1998 from $30.2 million in the
first nine months of 1997, an increase of $30.2 million, or 99.9%. The
increase is primarily due to the increase in loan sales along with the
increases and decreases in the margins earned on loan fees and gain on
sale of loans described above. [See Results of Operation for Three
Months Ended.] Additionally affecting loan fees and gains on sale of
mortgages was an increase in the Company's recapture reserve in the
first nine months of 1998. The Company increased its reserve, and
decreased its loan fees and gains on sale of mortgages, by
approximately $972,000 for this risk in the first nine months of 1998,
compared to an increase of approximately $538,000 in the first nine
months of 1997. The balance in the prepayment recapture reserve was
approximately $1.3 million at September 30, 1998 as compared to $0.7
million at September 30, 1997.
Net gain on sale of marketable securities was approximately $2.3
million in the first nine months of 1997. Before the end of 1997, the
Company had invested some of its excess cash in marketable securities.
During 1997, the Company sold its remaining portfolio of marketable
securities held for sale. No such marketable securities were held by
the Company at December 31, 1997 or at September 30, 1998, and,
therefore, the gains on sales will not continue in the future.
The following table sets forth information regarding the
components of the Company's expenses for the nine months ended
September 30, 1997 and 1998:
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
-------------------
1997 1998
---- ----
(in thousands)
<S> <C> <C>
Salaries, commissions and employee benefits............................ $17,715 $28,282
General and administrative expenses.................................... 5,252 9,550
Marketing expenses..................................................... 3,098 9,857
Depreciation and amortization.......................................... 738 1,593
------- -------
Total expenses....................................................... $26,803 $49,282
======= =======
</TABLE>
Page 18 of 32 pages
<PAGE> 19
Salaries, commissions and employee benefits increased from $17.7
million in the first nine months of 1997 to $28.3 million in the first
nine months of 1998, an increase of $10.6 million, or 59.7%. The
increase was primarily attributable to increased commissions due to
increased closings, the Company hiring additional personnel in order to
accommodate increased levels of loan closings and to staff additional
branch openings, along with increased compensation for new management
team members.
General and administrative expenses consist primarily of
occupancy costs, professional services, office expenses, automobile and
delivery expenses and other expenses, many of which vary with the
volume of loan closings. General and administrative expenses increased
from $5.3 million in the first nine months of 1997 to $9.5 million in
the first nine months of 1998, an increase of $4.2 million, or 81.8%.
The increase was primarily attributable to an increase in occupancy
costs, office expenses, and automobile and delivery expenses as a
result of opening 14 new Fresh Start(R) and Conventional stores along
with one marketing center since the fourth quarter of 1997. The
expenses are expected to vary according to the volume of loan closings
in 1998.
Marketing expenses increased from $3.1 million in the first nine
months of 1997 to $9.9 million in the first nine months of 1998, an
increase of $6.8 million, or 218.2%. The increase was primarily
attributable to the Company's greater marketing of Sub-Prime Home
Equity Loans, both in existing markets and in new markets to generate
higher levels of loan closings, as well as the marketing costs
associated with the Company's High LTV Loans. The increase is primarily
the result of the Company's increase in its Sub-Prime Home Equity Loan
business, which required greater marketing related to new store
openings, and ongoing marketing. The expenses are expected to fluctuate
depending on the amounts of marketing necessary to generate the volume
of loan closings to support the expansion of existing operations into
new geographic markets.
Depreciation and amortization expenses increased from $0.7
million in the first nine months of 1997 to $1.6 million in the first
nine months of 1998, an increase of $0.9 million, or 115.8%. The
increase was primarily attributable to the Company's purchases of
additional equipment and leasehold improvements during 1997 and 1998
for new stores. These expenses are expected to continue to increase in
1998 as a result of the expansion of existing operations.
Effective May 6, 1998, the Company's tax status changed from that
of an S corporation to that of a C corporation. As a C corporation, the
Company became subject to federal and state income taxation in the
second quarter of 1998. As an S corporation, the Company's taxable
income is included in the individual returns of the shareholders. As a
result, the Company's income taxes due to quarterly earnings for the
first nine months of 1998 represents income taxes provided based on the
Company's estimated allocation of income before income taxes between
the S corporation and the C corporation as required under IRS
regulations.
In addition, in connection with the change in the Company's tax
status, the Company recognized a net income tax benefit due to
conversion of the S corporation of approximately
Page 19 of 32 pages
<PAGE> 20
$0.9 million during the first nine months of 1998. Upon
conversion to a C corporation, the Company recorded a net deferred tax
asset of approximately $1.8 million, and recognized a corresponding
deferred income tax benefit, which was somewhat offset by the Company's
recognition of a current income tax liability of approximately $0.9
million associated with the allocation of the Company's taxable income
between the S corporation and the C corporation. Additionally, the
Company recognized the $2.6 million of current tax expense relating to
the earnings subject to tax attributing to operating as a C Corporation
for the period ended September 30, 1998.
Page 20 of 32 pages
<PAGE> 21
SEGMENT ANALYSIS
The Company's recent growth may have a distortive impact on some
of the Company's ratios and financial statistics and may make
period-to-period comparisons difficult. In light of the Company's
growth, historical earnings and other financial statistics may be of
little relevance in predicting future performance. Additionally, the
sensitivity of Conventional Loans to interest rates and the effect of
interest rates on the volume of loan production will impact period to
period comparisons.
Management expects segment contributions to vary from period to
period. In order to demonstrate the effect that varying factors have on
loan production, revenue and profits, management has elected to show
the results of its divisions. The following table shows the
contribution to revenues and expenses and the loan closings of each of
the Company's divisions for the three and nine month periods ended
September 30, 1997 and 1998:
<TABLE>
<CAPTION>
For the Three-Month For the Nine-Month
Periods Ended September 30, Periods Ended September 30,
--------------------------- ---------------------------
1997 1998 1997 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
FRESH START(R):
Revenue..................... $ 6,678.5 $ 10,640.0 $ 16,613.1 $ 30,481.7
Expenses.................... (4,520.6) (6,821.9) (10,033.2) (20,088.4)
-------------- -------------- -------------- --------------
Division contribution..... 2,157.9 3,818.1 6,579.9 10,393.3
-------------- -------------- -------------- --------------
SPECIALTY LENDING:
Revenue..................... 2,293.9 1,251.8 3,640.5 6,256.3
Expenses.................... (1,221.3) (1,367.7) (2,003.7) (4,827.7)
-------------- -------------- -------------- --------------
Division contribution..... 1,072.6 (115.9) 1,636.8 1,428.6
-------------- --------------- -------------- --------------
CONVENTIONAL MORTGAGE LENDING:
Revenue..................... 3,938.0 10,738.4 11,282.9 26,252.2
Expenses.................... (2,869.3) (5,475.2) (7,258.7) (14,012.1)
-------------- -------------- -------------- --------------
Division contribution..... 1,068.7 5,263.2 4,024.2 12,240.1
-------------- -------------- -------------- --------------
OTHER REVENUE................. 1,703.9 474.0 2,771.8 1,129.7
OTHER EXPENSES................ (2,837.8) (3,811.0) (7,507.3) (10,354.2)
-------------- -------------- -------------- --------------
Pre-tax income.............. 3,165.3 5,628.4 7,505.4 14,837.5
PROVISION FOR PRO FORMA
INCOME TAX.................. 1,107.9 1,970.0 2,626.9 5,193.1
-------------- -------------- -------------- --------------
PRO FORMA NET INCOME.......... $ 2,057.4 $ 3,658.4 $ 4,878.5 $ 9,644.4
============== ============== ============== ==============
</TABLE>
Page 21 of 32 pages
<PAGE> 22
<TABLE>
<CAPTION>
For the Three-Month For the Nine-Month
Periods Ended September 30, Periods Ended September 30,
--------------------------- ---------------------------
1997 1998 1997 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
LOAN CLOSINGS:
Fresh Start(R)............. $ 72,790 $ 102,074 $ 178,501 $ 284,374
Specialty Lending........... 23,273 12,059 36,966 51,628
Conventional Mortgage
Lending................... 232,050 456,690 609,826 1,208,980
Other....................... 4,490 13,222 11,383 32,274
-------------- -------------- -------------- --------------
Total Loan Closings....... $ 332,603 $ 584,045 $ 36,676 $ 1,577,256
============== ============== ============== ==============
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1998
VERSUS THREE MONTHS ENDED SEPTEMBER 30, 1997
Although revenues increased in the third quarter of 1998 compared
to the third quarter of 1997, the contribution by segment differed from
quarter to quarter. In the third quarter of 1998, the Conventional
Mortgage Lending division contributed $10.7 million, or 46.5%, of
revenues, compared to $3.9 million, or 26.9%, in the third quarter of
1997. The Fresh Start(R) division contributed $10.6 million, or 46.0%,
of revenues in the third quarter of 1998, compared to $6.7 million, or
45.7%, in the third quarter of 1997. The Specialty Lending division
contributed $1.3 million, or 5.4%, of revenues in the third quarter of
1998 compared to $2.3 million, or 15.7%, of revenues in the third
quarter of 1997. The Company's pro forma net income increased from $2.1
million in the third quarter of 1997 to $3.7 million in the third
quarter of 1998, an increase of $1.6 million, or 77.8%.
FRESH START(R): The Fresh Start(R) division generated $10.6
million in revenue in the third quarter of 1998 versus $6.7 million of
revenue in the third quarter of 1997. The 59.3% increase in revenue is
mainly attributable to a 92.0% increase in sales of Sub-Prime Home
Equity Loans in the third quarter of 1998 compared to the third quarter
of 1997. The greater loan sales are primarily attributable to (i) an
increase in Sub-Prime Home Equity Loan closings as a result of more
stores open in the third quarter of 1998 than in the third quarter of
1997, and (ii) the sale of $2.6 million more Sub-Prime Home Equity
Loans in the third quarter of 1998 than were disbursed. Stores that
were open before January 1, 1997 closed an average of $9.9 million of
Sub-Prime Home Equity Loans during the third quarter of 1998 compared
to $11.8 million in the third quarter of 1997. The Company moved some
higher producing loan officers to new stores either as new store
managers or to help develop those stores' local presence. Management
expects that the personnel relocations will result in short-term
decreases in loan closings at the mature stores from which these new
store managers were moved, but believes that these moves will generally
enable the new stores to mature and reach full productivity more
quickly. Additionally, the increase in revenue due to more loan sales
was partially offset by a decrease in margins earned on loan fees and
gain on sale of mortgages of 18.0% due to the reasons previously
mentioned [See Results of Operations].
Direct expenses of the Fresh Start(R) division were $6.8 million
on closings of $102.1 million (6.7%) in the third quarter of 1998
compared to $4.5 million on closings of $72.8 million (6.2%) in the
third quarter of 1997. The 50.9% increase in expenses is partially
attributable to the 40.2% increase in the volume of closed Sub-Prime
Home Equity Loans and the opening of 13 new stores and one marketing
center since July 1, 1997. Eight of the 13 new stores generated a net
operating loss of $0.4 million in the third quarter of 1998. The
increase in expenses as a percentage of closings is also attributable
to marketing expenses of $1.9 million (1.9% of closings) in the third
quarter of 1998 compared to $0.9 million (1.2% of closings) in the
third quarter of 1997. The increase was incurred primarily to expose
the Fresh Start(R) brand in the expanded markets from new store
openings.
SPECIALTY LENDING: The Specialty Lending division commenced its
High LTV loan operations in the second quarter of 1997. The Specialty
Lending division generated $1.3 million in revenue in the third quarter
of 1998 versus $2.3 million of revenue in the third quarter of 1997.
The 45.4% decrease in revenue is mainly attributable to a $6.0 million
or 33.3% decrease in sales of High LTV Loans in the third quarter of
1998 compared to the third quarter of 1997, along with a 21.3% decrease
in margins earned on average loan fees and gains on sale of High LTV
Loans. The Company, during the third quarter, opted to take advantage
of the potential business available in Conventional Loans, due to low
interest rates, by switching the remaining sales force from High LTV
Loans to Conventional Loans. Management intends to continue this
practice, thereby offsetting the loss of High LTV revenues with more
revenues earned through
Page 22 of 32 pages
<PAGE> 23
Conventional Loans. Therefore, management anticipates that the only
revenues to be recognized in the fourth quarter for High LTV Loans will
be those earned on closing out the existing pipeline of applications.
Management believes this demonstrates the flexibility of the Call
Center platform to shift to the products that are in the most demand.
The decrease in average loan fees and gains on sale of High LTV Loans
is mainly attributable to the expansion of originations into other
states, as previously described.
Direct expenses of the Specialty Lending division were $1.4
million on closings of $12.1 million (11.3%) in the third quarter of
1998 compared to $1.2 million on closings of $23.3 million (5.2%) in
the third quarter of 1997. The 118.0% increase in expenses as a
percentage of closings is primarily attributable to increased marketing
expenses and lower originations as the Company refocused on
Conventional Loan originations, 7.2% of closings in the third quarter
of 1998 compared to 1.6% in the third quarter of 1997.
CONVENTIONAL MORTGAGE LENDING: The Conventional Mortgage Lending
division generated $10.7 million in revenue in the third quarter of
1998 versus $3.9 million of revenue in the third quarter of 1997. The
172.7% increase in revenue is mainly attributable to (i) a 98.0%
increase in sales of Conventional Loans in the third quarter of 1998
compared to the third quarter of 1997, and (ii) a 34.8% increase in the
margins earned on loan fees and gains on sale of Conventional
Loans in the third quarter of 1998 compared to the third quarter of
1997. The greater loan sales are primarily attributable to an increase
in Conventional Loan closings as a result of (i) a more favorable
interest rate environment, (ii) the hiring of additional loan officers,
(iii) to some extent, the significant efficiencies gained through the
implementation of automated underwriting systems and other proprietary
technology, along with (iv) the opening of additional branches during
the second and third quarters of 1998. Management believes that
an increase in interest rates or a prolonged period of consistently low
interest rates could reduce the volume of Conventional Loans closed by
the division as a result of a decrease in refinancing of existing
mortgages by consumers. The increase in the margins earned on
loan fees and gains on sale of Conventional Loans was the result of
changes in sales methodologies, as previously described in the "Results
of Operations" section.
Direct expenses of the Conventional Mortgage Lending division
were $5.5 million on closings of $456.7 million (1.2%) in the third
quarter of 1998 compared to $2.9 million on closings of $232.1 million
(1.2%) in the third quarter of 1997. The 90.8% increase in expenses
quarter over quarter is primarily attributable to the 98.0% increase in
the volume of closed Conventional Loans. Management believes that an
increase in interest rates or a prolonged period of consistently low
interest rates could reduce the volume of Conventional Loans closed by
the division and, therefore, increase its per loan cost to originate
Conventional Loans, reducing its profitability.
OTHER REVENUE: Most of the other revenue in the third quarter of
1997 consisted of the $1.6 million gain on the sale of marketable
securities. The remaining other revenue in the third quarter of 1997
and almost all of the third quarter of 1998 consisted of the activity
of government insured lending, including the gain on sale of government
insured loans.
Page 23 of 32 pages
<PAGE> 24
OTHER EXPENSES: Other expenses include expenses not directly
allocable to a particular division, such as the costs associated with
the Company's legal, marketing, accounting, information systems,
facilities management, servicing and general and administrative support
teams. The direct expenses of government insured lending are also
reflected within these expenses. The majority of the increase of $1.0
million in expenses from $2.8 million in the third quarter of 1997 to
$3.8 million for the third quarter of 1998 is due to increased costs of
growth in technology support for the front-end origination system and
branch network.
NINE MONTHS ENDED SEPTEMBER 30, 1998
VERSUS NINE MONTHS ENDED SEPTEMBER 30, 1997
Although revenues increased in the first nine months of 1998
compared to the first nine months of 1997, the contribution by segment
differed from period to period. In the first nine months of 1998, the
Conventional Mortgage Lending division contributed $26.3 million, or
40.9%, of revenues, compared to $11.3 million, or 32.9%, in the first
nine months of 1997. The Fresh Start(R) division contributed $30.5
million, or 47.5%, of revenues in the first nine months of 1998,
compared to $16.6 million, or 48.4%, in the first nine months of 1997.
The Specialty Lending division contributed $6.3 million, or 9.8%, of
revenues in the first nine months of 1998 compared to $3.6 million, or
10.6%, of revenues in the first nine months of 1997. The Company's pro
forma net income increased from $4.9 million in the first nine months
of 1997 to $9.6 million in the first nine months of 1998, an increase
of $4.7 million, or 97.7%.
FRESH START(R): The Fresh Start(R) division generated $30.5
million in revenue in the first nine months of 1998 versus $16.6
million of revenue in the first nine months of 1997. The 83.5% increase
in revenue is mainly attributable to a 89.6% increase in sales of
Sub-Prime Home Equity Loans in the first nine months of 1998 compared
to the first nine months of 1997, and to the division beginning to sell
loans by bulk sales in the second quarter of 1997, which generate
higher premiums than sales of individual loans. The greater loan sales
are primarily attributable to (i) an increase in Sub-Prime Home Equity
Loan closings as a result of more stores open in the first nine months
of 1998 than in the first nine months of 1997, and (ii) the sale of
$18.0 million more Sub-Prime Home Equity Loans in the first nine months
of 1998 than were disbursed, somewhat offset by (iii) a 3.7% decrease
in margins earned on loan fees and gains on sale of mortgages. Stores
that were open before January 1, 1997 closed an average of $30.1
million of Sub-Prime Home Equity Loans during the first nine months of
1998 compared to $31.6 million in the first nine months of 1997.
Direct expenses of the Fresh Start(R) division were $20.1
million on closings of $284.4 million (7.1%) in the first nine months
of 1998 compared to $10.0 million on closings of $178.5 million (5.6%)
in the first nine months of 1997. Management believes that the increase
in expenses as a percentage of closings is primarily due to (i) the
continuing absorption of the direct start-up expenses, net of revenue,
of some new stores opened in 1997 and the five new stores opened in
January 1998, and (ii) an approximate $3.7 million increase (to 2.0% of
closings in the first nine months of 1998 from 1.0% of closings in the
first nine months of
Page 24 of 32 pages
<PAGE> 25
1997) in advertising to support the branch expansion into new
markets in order to "brand" the Fresh Start(R) product in these new
territories. A new store opening requires the Company to incur monthly
expenses in excess of revenues generated by the new store until enough
loans are closed for the store to reach break even. The Company expects
these stores to contribute significantly less to its revenues and net
income and more to its expenses for the twelve month period ending
December 31, 1998, and possibly the first quarter of 1999. The new
store expenses, net of revenue, were approximately $1.7 million through
the nine months ended September 30, 1998.
SPECIALTY LENDING: The Specialty Lending division generated $6.3
million in revenue in the first nine months of 1998 versus $3.6 million
of revenue in the first nine months of 1997. The 71.9% increase in
revenue is mainly attributable to a 93.0% increase in sales of High LTV
Loans in the first nine months of 1998 compared to the first nine
months of 1997, partially offset by a 16.7% decrease in the margins
earned on loan fees and gains on sales of High LTV Loans in the
first nine months of 1998 compared to the first nine months of 1997.
Management believes that the higher loan sales are primarily
attributable to (i) an increase in High LTV Loan closings as a result
of the expansion of the Company's call center operations into
additional states, partially offset by the conscious decision to shift
part of the Company's Specialty Lending division's sales force to
handle the high demand for Conventional Loans during the first nine
months of 1998, as previously discussed, and (ii) the sale of $4.8
million more High LTV Loans in the first nine months of 1998 than were
disbursed.
Direct expenses of the Specialty Lending division were $4.8
million on closings of $51.6 million (9.4%) in the first nine months of
1998 compared to $2.0 million on closings of $37.0 million (5.4%) in
the first nine months of 1997. The 74.1% increase in expenses as a
percentage of closings is primarily attributable to marketing expenses
of only $0.5 million for the nine month period ended September 30, 1997
versus $2.8 million for the nine month period ended September 30, 1998.
CONVENTIONAL MORTGAGE LENDING: The Conventional Mortgage Lending
division generated $26.3 million in revenue in the first nine months of
1998 versus $11.3 million of revenue in the first nine months of 1997.
The 132.7% increase in revenue is mainly attributable to (i) a 88.3%
increase in sales of Conventional Loans in the first nine months of
1998 compared to the first nine months of 1997, and (ii) a 23.6%
increase in the margins earned on loan fees and gains on sale of
Conventional Loans in the first nine months of 1998 compared to the
first nine months of 1997. The greater loan sales are primarily
attributable to an increase in Conventional Loan closings as a result
of a more favorable interest rate environment, which caused a
significant increase in loan refinancings, and, to some extent, the
significant efficiencies gained through the implementation of automated
underwriting systems and other proprietary technology. Management
believes that an increase in interest rates or a prolonged period of
consistently low interest rates could reduce the volume of Conventional
Loans closed by the division as a result of a decrease in refinancing
of existing mortgages by consumers.
Page 25 of 32 pages
<PAGE> 26
Direct expenses of the Conventional Mortgage Lending division
were $14.0 million on closings of $1,209 million (1.2%) in the first
nine months of 1998 compared to $7.3 million on closings of $609.8
million (1.2%) in the first nine months of 1997. The 93.0% increase in
expenses is primarily attributable to the 98.3% increase in the volume
of closed Conventional Loans. The Company believes its consistent
expense ratio resulted from increased incentive compensation which was
substantially offset by economies of scale resulting from greater loan
volume and, to some extent, efficiencies resulting from the
implementation of automated underwriting systems and other proprietary
technology. Management believes that an increase in interest rates or a
prolonged period of consistently low interest rates could reduce the
volume of Conventional Loans closed by the division and, therefore,
increase its per loan cost to originate Conventional Loans, reducing
its profitability.
LIQUIDITY AND CAPITAL RESOURCES
The following table sets forth information concerning the
Company's financial condition as of December 31, 1997 and September 30,
1998:
<TABLE>
<CAPTION>
December 31, September 30,
1997 1998
---- ----
(In thousands)
<S> <C> <C>
Cash and cash equivalents............................................... $ 11,947 $ 34,384
Mortgage loans held for sale............................................ 121,344 104,223
Property and equipment, net............................................. 7,011 9,987
Other assets............................................................ 4,127 5,205
-------------- --------------
Total assets........................................................ $ 144,429 $ 153,799
============== ==============
Warehouse borrowings.................................................... $ 97,455 $ 56,301
Drafts payable.......................................................... 21,875 45,271
Other liabilities....................................................... 9,991 16,539
Shareholders' equity.................................................... 15,108 35,688
-------------- --------------
Total liabilities and shareholders' equity.......................... $ 144,429 $ 153,799
============== =============
</TABLE>
On May 6, 1998, the Company completed its Offering of 3,829,500
Common Shares, including 330,000 Common Shares sold by selling
shareholders and 3,499,500 newly-issued Common Shares sold by the
Company, at a price of $10.00 per share, for gross proceeds to the
Company of $34,995,000, not including the $1,544,400 received by the
Company upon exercise by the selling shareholders of options to
purchase 330,000 Common Shares at $4.68 per share. These options were
exercised by the selling shareholders to acquire the Common Shares they
sold in the Offering. The net proceeds to the Company from the sale of
shares offered by it in the Offering, after deducting the underwriting
discount and the expenses of the Offering, were approximately
$31,045,350. The Offering was underwritten by a group of underwriters
for which Bear, Stearns & Co. Inc., Prudential Securities Incorporated
and Roney & Co. served as representatives. The December 31, 1997
balance sheet includes approximately $55,000 of capitalized costs
directly associated with the Offering.
Page 26 of 32 pages
<PAGE> 27
Cash and cash equivalents increased in the first nine months of
1998 primarily due to the proceeds of the Company's Offering and cash
generated from operations offset by cash used to pay the Shareholder
Distribution Amount. This cash is normally used to pay down warehouse
borrowings. In order to demonstrate the availability of this liquidity,
the Company withdrew its cash from its warehouse lines at September 30,
1998 for one day. Mortgage loans held for sale decreased due to more
loans being sold than were closed in the first nine months of 1998. See
"Results of Operations." Property and equipment increased due to new
Fresh Start(R) stores and Conventional Mortgage Lending branch
openings. Other assets at September 30, 1998 include approximately $1.7
million of loans held for investment, net of approximately $0.5 million
of allowances for losses on these loans, approximately $0.2 million of
real estate owned as a result of foreclosures, approximately $1.7
million of deferred income taxes, and approximately $1.6 million of
miscellaneous assets.
The combination of warehouse borrowings and drafts payable
decreased due to the decrease in volumes of mortgage loans held for
sale. See "Results of Operations." The increase in other liabilities is
due to increased trade payables relating to increases in the volume of
loans closed and financing for equipment acquisitions, increases to
accrued expenses for accrued payroll, and a significant increase due to
accrued income taxes reflecting the change to a C Corporation.
Shareholders' equity reflects the increase due to the receipt of
approximately $31.0 million in net proceeds from the Company's Offering
that closed on May 6, 1998 and approximately $1.5 million in proceeds
from the exercise of stock options by selling shareholders in the
Offering, and net income, less distributions to shareholders of the
Shareholder Distribution Amount, other distributions to pay tax
liabilities they incur as a result of the Company's status as an S
corporation until May 6, 1998 and cash dividends paid to C corporation
shareholders.
Net cash provided by operating activities during the first nine
months of 1998 was approximately $62.7 million, compared to
approximately $10.9 million in the first nine months of 1997. Cash was
provided primarily by (i) the Company's net income for the first nine
months of 1998 (approximately $13.5 million before depreciation and
amortization, provision for credit losses, deferred income taxes and
net gain on sales of marketable securities in 1998, compared to
approximately $6.1 million in 1997), (ii) a decrease in mortgage loans
held for sale (approximately $17.1 million in 1998, compared to an
increase of approximately $4.3 million in 1997), (iii) an increase in
drafts payable, which represent funds advanced for loan closings that
have not yet been drawn against the warehouse line of credit
(approximately $23.4 million in 1998, compared to approximately $7.4
million in 1997), (iv) a decrease in other assets (approximately $0.1
million in 1998 compared to $1.1 million in 1997), and (v) an increase
in accounts payable and accrued expenses and other liabilities,
primarily as a result of the increase in loan closings and the number
of stores and branches opened during 1998 (approximately $8.5 million
in 1998, compared to approximately $2.8 million in 1997).
These sources of cash were partially offset primarily by cash
used during the first nine months of 1998 to purchase equipment for new
stores (approximately $4.6 million in 1998, compared to approximately
$4.0 million in 1997), and for real estate owned and loans held for
investment (approximately $1.3 million in 1998, compared to zero in
1997). The Company
Page 27 of 32 pages
<PAGE> 28
also used cash to pay the Shareholder Distribution Amount
(approximately $19.6 million), to pay a tax distribution to existing
shareholders in April 1998 (approximately $5.4 million), to decrease
borrowings under the Company's warehouse financing facilities
(approximately $41.2 million in 1998, compared to approximately $8.6
million in the first nine months of 1997), to repay all notes payable
(approximately $1.9 million in 1998, compared to borrowings of
approximately $2.0 million in the first nine months of 1997), and to
pay dividends to shareholders (approximately $0.6 million). These uses
of cash were financed primarily by cash generated by operations and the
proceeds of its Offering, the repayment of shareholder advances, and
the proceeds of option exercises. During the first nine months of 1997,
the use of cash was partially financed by the sale of marketable
securities (approximately $4.5 million) and the repayment of
shareholder advances.
The Company has $400 million of warehouse financing facilities,
an increase from $190 million of warehouse financing facilities as of
September 30, 1997. The Company's warehouse line of credit currently
provides for up to $150 million principal amount of demand loans
secured by loans held for sale and other assets of the Company. Loans
under the warehouse line of credit bear interest at rates that vary
depending on the type of underlying loan, and the loans are subject to
sublimits, advance rates and warehouse terms that vary depending on the
type of underlying loan. The effective weighted average interest rate
for this arrangement in the first nine months of 1998 was 7.04%. As of
November 10, 1998, the Company had borrowed $146.5 million under this
facility and had a maximum of $3.5 million available for additional
borrowings. As of November 11, 1998, the Company expanded this
warehouse facility to $200 million.
In addition to the $150 million warehouse line of credit, the
Company's reverse repurchase arrangement provides that the lender, an
affiliate of one of the representatives of the underwriters in the
Company's Offering, will purchase from the Company at par, subject to
the Company's agreement to repurchase on a daily basis, up to $200
million of fully-amortizing, first or junior lien residential mortgage
loans and home equity loans that comply with the Company's origination
guidelines and conform to whole and bulk loan sale requirements. This
agreement is not a committed facility and the lender may elect to
discontinue the repurchase agreement at any time. The term of any
financing under the repurchase agreement matures and may be renewed on
a daily basis. In any event, the arrangement terminates in March 1999.
The effective weighted average interest rate to the Company of this
arrangement in the first nine months of 1998 was 6.8%. The Company uses
this facility as a supplemental borrowing facility to fund loans closed
by the Company until they are sold. As of November 10, 1998, the
Company had financed $24.5 million of loans under this facility and an
additional $175.5 million was available for future financings.
The net proceeds of the Offering, together with cash flows from
operations, are expected to be sufficient to fund the Company's
liquidity requirements for the next 12 months, if the Company's future
operations are consistent with management's expectations. The Company,
however, expects that eventually it will need to arrange for additional
sources of capital through the issuance of debt, equity or additional
bank borrowings. The Company has no commitments for any such additional
financings, and there can be no assurance that the
Page 28 of 32 pages
<PAGE> 29
Company will be able to obtain any such additional financing at
the times required and on terms and conditions acceptable to the
Company. In such event, the Company's growth and operations could be
curtailed. If the Company begins to securitize its assets or
significantly increases its retained mortgage servicing rights, the
Company's liquidity could be materially adversely affected.
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("Statement 133"). Statement 133 establishes accounting and
reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities. Statement 133 requires companies to record derivatives on
the balance sheet as assets or liabilities, measured at fair value.
Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the
derivative and whether it qualifies for hedge accounting. Statement 133
is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. Upon initial application, hedging relationships must be
designated anew and documented pursuant to the provisions of Statement
133. Statement 133 may not be applied retroactively to financial
statements for prior periods. Management has not yet evaluated the
impact of the implementation of this statement at this time.
YEAR 2000 COMPLIANCE
The Company does not expect the cost of making its computer
systems Year 2000 compliant will be material to its financial condition
or results of operation. Most of the Company's computer hardware and
software is less than two years old, it believes that its exposure to
Year 2000 related hardware and software problems is lower than if it
used older equipment and software and the identification and resolution
of any problems discovered. The Company, together with its independent
network consultant has completed the evaluation of its hardware and
software, and has begun the process of purchasing the hardware and
software necessary to replace what was determined to be non-compliant.
The Company also plans to explore the strategies of its vendors to
discover and resolve any Year 2000 problems. The Company is already
participating with its loan servicing vendor in its Year 2000
evaluation process. Based on the responses of its vendors to date, the
Company does not expect any material disruption in its operations as a
result of Year 2000 compliance failure. The Company has budgeted
$250,000 for software and hardware replacement of which $ 120,000 had
been spent as of September 30, 1998. The Company expects to complete
this process during the first six months of 1999. The Company has not
yet prepared a contingency plan in the event of a Year 2000 related
failure of its computer hardware or software.
Page 29 of 32 pages
<PAGE> 30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Not Applicable.
Page 30 of 32 pages
<PAGE> 31
PART II--OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.1 Amendment No. 3 to Second Amended and Restated
Mortgage Warehousing Agreement
10.2 Amendment No. 4 to Second Amended and Restated
Mortgage Warehousing Agreement
27.1 Financial Data Schedule.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by the Registrant
during the quarter for which this report is filed.
Page 31 of 32 pages
<PAGE> 32
SIGNATURES
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.
ROCK FINANCIAL CORPORATION
(Registrant)
Date: November 16, 1998 By: /s/ DANIEL GILBERT
-----------------------------------
DANIEL GILBERT
Its: Chairman of the Board
and Chief Executive
Officer
(Duly Authorized Officer)
Date: November 16, 1998 By: /s/ FRANK E. PLENSKOFSKI
-----------------------------------
FRANK E. PLENSKOFSKI
Its: Chief Financial Officer
(Principal Accounting Officer)
Page 32 of 32 pages
<PAGE> 33
EXHIBIT INDEX
Exhibit Description
- - ------- -----------
10.1 Amendment No. 3 to Second Amended and Restated Mortgage
Warehousing Agreement
10.2 Amendment No. 4 to Second Amended and Restated Mortgage
Warehousing Agreement
27.1 Financial data schedule.
<PAGE> 1
EXHIBIT 10.1
AMENDMENT NO. 3 TO
SECOND AMENDED AND RESTATED MORTGAGE WAREHOUSING AGREEMENT
THIS AMENDMENT ("Amendment") is dated as of July 13, 1998, by and
among Comerica Bank, a Michigan banking corporation ("Comerica"), Corestates
Bank, N.A., a national banking association ("CBNA"), Residential Funding
Corporation, a Delaware corporation ("RFC") and National City Bank of Kentucky,
a national banking association ("NCBank") (collectively, Comerica, CBNA, RFC and
NCBank are referred to as "Lenders"), Comerica Bank, as Agent for Lenders (in
such capacity, "Agent"), and Rock Financial Corporation, a Michigan corporation
("Borrower");
RECITALS:
A. Borrower, Agent and Lenders entered into a certain Second
Amended and Restated Mortgage Warehousing Agreement dated
November 13, 1997, as amended by Amendment No. 1 dated
January 30, 1998 and by Amendment No. 2 dated April 2, 1998 (as
amended, the "Agreement").
B. Borrower, Agent and Leaders desire to further amend the
Agreement as hereinafter set forth.
NOW THEREFORE, the parties hereto agree as follows:
1. The definition of "Overnight-based Rate" in Section 1.02 of the
Agreement is amended and restated to read in its entirety as follows:
"Overnight-based Rate means a per annum interest rate equal to
(i) in the case of Conforming Mortgage Loan Advances, 1.25% above the
Overnight Rate, (ii) in the case of Non-Conforming Mortgage Loan
Advances, 1.625% above the Overnight Rate, and (iii) in the case of
Second Mortgage Loan Advances, 2.5% above the Overnight Rate."
2. Section 6.15 of the Agreement is amended and restated to read in
its entirety as follows:
"6.15 Financial Covenants. To maintain at all times:
(i) Tangible Effective Net Worth in the minimum amount of
Twenty Million Dollars ($20,000,000).
(ii) a Leverage Ratio not to exceed 9.0 to 1.0.
(iii) a Current Ratio of not less than 1.5 to 1.0.
(iv) Working Capital of not less than Five Million
Dollars ($5,000,000).
<PAGE> 2
(v) a Securities Margin not to exceed .35."
3. Section 7.09 of the Agreement is amended and restated to read
in its entirety as follows:
"7.09 No Change in Management, Ownership or Control. Change in
any material respect its executive management, ownership or control of
its business operations. For purposes of this Section 7.09, if (i) Dan
Gilbert shall cease to own 35% or more of all issued and outstanding
classes of stock of Borrower, (ii) Dan Gilbert shall cease to be the
Chairman of the Board of Directors and Chief Executive Officer of
Borrower, or (iii) Steve Stone shall cease to be the President of
Borrower, then Borrower shall be in default of this Section 7.09."
4. Borrower hereby represents and warrants that, after giving
effect to the amendments contained herein, (a) execution, delivery and
performance of this Amendment, and any other documents and instruments required
under this Amendment, or the Agreement are within the Borrower's corporate
powers, have been duly authorized, are not in contravention of law or the terms
of Borrower's Articles of Incorporation or Bylaws, and do not require the
consent or approval of any governmental body, agency or authority, and this
Amendment and any other documents and instruments required under this Amendment
or the Agreement will be valid and binding in accordance with their terms; (b)
the continuing representations and warranties of Borrower set forth in Section 5
of the Agreement (Sections 5.01-5.16) are true and correct on and as of the date
herewith, with the same force and effect as if made on and as of the date
herewith; and (c) no Event of Default, or condition or event which, with the
giving of notice or the running of time, or both, would constitute an Event of
Default under the Agreement, has occurred and is continuing on or as of the date
hereof.
5. Except as expressly modified by this Amendment, all of the
terms and conditions of the Agreement shall remain in full force and effect.
6. This Amendment shall not become effective unless and until
Agent and the Lenders shall have received duly executed counterpart originals of
this Amendment.
7. Capitalized terms not defined herein shall have the meanings
ascribed to them in the Agreement.
8. This Amendment may be signed in any number of counterparts
and by different parties on separate counterparts, and each such counterpart
when executed and delivered shall constitute an original but all such
counterparts shall together constitute one and the same Amendment.
IN WITNESS WHEREOF, the parties have executed this Amendment as of
the date set forth above.
2
<PAGE> 1
AMENDMENT NO. 4 TO
SECOND AMENDED AND RESTATED
MORTGAGE WAREHOUSING AGREEMENT
------------------------------
THIS AMENDMENT ("Amendment") is dated as of November____, 1998, by and
among Comerica Bank, a Michigan banking corporation ("Comerica"), First Union
National Bank, successor by merger to Corestates Bank, N.A. ("FUNB"),
Residential Funding Corporation, a Delaware corporation ("RFC") and National
City Bank of Kentucky, a national banking association ("NCBank")(collectively,
Comerica, FUNB, RFC and NCBank are referred to as "Lenders"), Comerica Bank, as
Agent for Lenders (in such capacity, "Agent"), and Rock Financial Corporation, a
Michigan corporation("Borrower");
RECITALS:
A. Borrower, Agent and Lenders entered into a certain Second Amended and
Restated Mortgage Warehousing Agreement dated November 13, 1997, as
amended by Amendment No. 1 dated January 30, 1998, Amendment No. 2
dated April 2, 1998 and Amendment No. 3 dated July 13, 1998 (as
amended, the "Agreement").
B. Borrower, Agent and Lenders desire to further amend the Agreement as
hereinafter set forth.
NOW THEREFORE, the parties hereto agree as follows:
1. Any reference in the Agreement to "CBNA" is amended to read "FUNB".
2. Subparagraph (d)(i) of the definition of "Borrowing Base" in Section
1.02 of the Agreement is amended and restated to read in its entirety as
follows:
"(i)(A) with respect to all Second Mortgage Loans other than Title I
Second Mortgage Loans, High LTV Second Mortgage Loans and
Home Equity Second Mortgage Loans, ninety-five percent (95%)
of the lesser of (1) the principal amount of, or (2) the
Committed Purchase Price for, each such Second Mortgage
Loan, plus
(B) with respect to Title I Second Mortgage Loans, High LTV
Second Mortgage Loans and Home Equity Second Mortgage Loans,
the lesser of (1) ninety-five percent (95%) of the lesser of
(x) the outstanding principal amount of, or (y) the
Committed Purchase Price for, each such Second Mortgage
Loan, or (2) Ten Million Dollars ($10,000,000), or"
3. The following paragraph (x) is added to the definition of "Eligible
Mortgage Loan" in Section 1.02 of the Agreement:
<PAGE> 2
"(x) The proceeds of said Mortgage Loan have been fully disbursed and
the obligor thereon has no additional right to further borrowings
thereunder."
4. the definition of "Lenders' Allocation Amount" in Section 1.02 of the
Agreement is amended and restated in its entirety as follows:
"Lenders' Allocation Amount means $75,000,000 as to Comerica,
$50,000,000 as to RFC, $40,000,000 as to FUNB and $35,000,000 as to
NCBank."
5. The definition of "Maximum Loan Amount" in Section 1.02 of the
Agreement is amended and restated in its entirety as follows:
"Maximum Loan Amount means Two Hundred Million Dollars ($200,000,000),
subject to Section 12 hereof."
6. The reference to "paragraph (j)" in the second line of the definition
of "Second Mortgage Loan" in Section 1.02 of the Agreement is amended and
restated to read in its entirety as follows: "paragraph (j) and, in the case of
Home Equity Second Mortgage Loans, paragraph (x),".
7. Paragraph (d) of the definition of "Second Mortgage Loan" in Section
1.02 of the Agreement is amended and restated to read in its entirety as
follows:
"(d) The Mortgage Loan has a loan to value ratio which does not
exceed ninety percent (90%), or, in the case of a High LTV Second
Mortgage Loan only, one hundred twenty five percent (125%). As
used in this paragraph (d), "loan to value ratio" means the ratio
of the principal amount of such Mortgage Loan outstanding at the
origination thereof (or, in the case of a Home Equity Second
Mortgage Loan, the maximum principal amount which can be drawn
under such Mortgage Loan) plus the principal amount of the
indebtedness secured by the prior mortgage or deed of trust
outstanding at the origination thereof, divided by the appraised
value of the property encumbered thereby."
8. The following definition is added to Section 1.02 of the Agreement:
"Home Equity Second Mortgage Loan means a Second Mortgage Loan
(i) which is a revolving home equity line of credit commonly known as a
HELOC, (ii) which is covered by a Take-Out Commitment and as to which Agent
has received the Take-Out Commitment identifying the Investor and the
Committed Purchase Price, (iii) with respect to which the obligor (x) has
requested one (1) advance of the Second Mortgage Loan from the Borrower
which will be or has been funded by the Borrower at the closing of such
Mortgage Loan, and (y) has
2
<PAGE> 3
executed a blackout agreement prohibiting any further borrowings until the
Second Mortgage Loan is purchased by an Investor, and (iv) with respect to
which no advances of such Second Mortgage Loan have been made by the
Borrower after the initial advance at closing."
9. Exhibit E to the Agreement is amended and restated in its entirety by
Exhibit E attached hereto.
10. The Percentage Share, as defined in the Agreement, on the effective date
of this Amendment, shall be 37.5% for Comerica, 25% for RFC, 20% for FUNB and
17.5% for NCBank.
11. Borrower hereby represents and warrants that, after giving effect to the
amendments contained herein, (a) execution, delivery and performance of this
Amendment, and any other documents and instruments required under this
Amendment, or the Agreement are within the Borrower's corporate powers, have
been duly authorized, are not in contravention of law or the terms of Borrower's
Articles of Incorporation or Bylaws, and do not require the consent or approval
of any governmental body, agency or authority; and this Amendment and any other
documents and instruments required under this Amendment or the Agreement will be
valid and binding in accordance with their terms; (b) the continuing
representations and warranties of Borrower set forth in Section 5 of the
Agreement (Sections 5.01-5.16) are true and correct on and as of the date
herewith, with the same force and effect as if made on and as of the date
herewith; and (c) no Event of Default, or condition or event which, with the
giving of notice or the running of time, or both, would constitute an Event of
Default under the Agreement, has occurred and is continuing on or as of the date
hereof.
12. Except as expressly modified by this Amendment, all of the terms and
conditions of the Agreement shall remain in full force and effect.
13. This Amendment shall not become effective unless and until Agent and the
Lenders shall have received, in form and substance satisfactory to the Agent and
Lenders: (a) duly executed counterpart originals of this Amendment; and (b) duly
executed replacement Notes for the Lenders, which replacement Notes shall amend,
restate and supersede in their entirety all of the existing Notes.
14. Capitalized terms not defined herein shall have the meanings ascribed to
them in the Agreement.
15. This Amendment may be signed in any number of counterparts and by
different parties on separate counterparts, and each such counterpart when
executed and delivered shall constitute an original but all such counterparts
shall together constitute one and the same Amendment.
3
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF ROCK FINANCIAL CORPORATION AS OF, AND FOR THE NINE
MONTHS ENDED, SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS AND ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 34,384,364
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 104,222,524
<CURRENT-ASSETS> 0
<PP&E> 15,010,166
<DEPRECIATION> 5,023,206
<TOTAL-ASSETS> 153,799,081
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 138,295
<OTHER-SE> 35,549,778
<TOTAL-LIABILITY-AND-EQUITY> 153,799,081
<SALES> 0
<TOTAL-REVENUES> 64,119,891
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 389,573
<INTEREST-EXPENSE> 5,101,646
<INCOME-PRETAX> 14,837,568
<INCOME-TAX> 1,673,601
<INCOME-CONTINUING> 13,163,967
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,163,967
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
