<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 MARCH 31, 1999
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 May 10, 1999: 14,776,254
<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..........11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.....................................26
PART II--OTHER INFORMATION.......................................................................................28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...............................................................28
SIGNATURES.......................................................................................................29
</TABLE>
<PAGE> 3
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ROCK FINANCIAL CORPORATION
BALANCE SHEETS
DECEMBER 31, 1998 AND MARCH 31, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
December 31, March 31,
1998 1999
------------- -------------
<S> <C> <C>
ASSETS
Cash and cash equivalents............................................... $30,081,524 $35,943,156
Mortgage loans held for sale............................................ 155,631,112 79,035,216
Mortgage loans held for investment (net of allowance for
losses of $634,851 and $1,194,900 at December 31,
1998 and March 31, 1999, respectively)............................. 3,766,171 3,370,224
Real estate owned....................................................... 49,989 222,989
Shareholders' advances.................................................. 994,372 --
Property and equipment (net of accumulated depreciation of
$5,400,480 and $5,794,494 at December 31, 1998 and
March 31, 1999, respectively)...................................... 10,775,733 9,828,307
Deferred income taxes................................................... 1,945,000 1,500,000
Other assets............................................................ 1,193,552 1,546,465
------------- -------------
Total assets............................................................ $204,437,453 $131,446,357
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Warehouse line of credit........................................... $98,008,105 $33,277,161
Reverse repurchase agreement....................................... 11,521,065 2,675,073
Drafts payable..................................................... 44,021,087 40,654,912
Accounts payable................................................... 4,680,275 4,200,574
Accrued expenses and other liabilities............................. 8,171,773 6,878,692
----------- ---------
Total liabilities.............................................. 166,402,305 87,686,412
----------- ----------
Shareholders' equity:
Common shares, $.01 par value. Authorized 50,000,000
shares; issued and outstanding 13,590,500 shares
and 14,302,770 shares at December 31, 1998 and
March 31, 1999, respectively................................... 135,905 143,028
Additional paid-in capital......................................... 26,297,782 29,632,435
Retained earnings.................................................. 11,601,461 13,984,482
----------- ----------
Total shareholders' equity..................................... 38,035,148 43,759,945
----------- ----------
Total liabilities and shareholders' equity.............................. $204,437,453 $131,446,357
============ ============
</TABLE>
Page 3 of 29 pages
<PAGE> 4
ROCK FINANCIAL CORPORATION
STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 31, 1998 AND 1999
(Unaudited)
<TABLE>
<CAPTION>
For the Three-Month
Periods Ended March 31,
--------------------------------------
1998 1999
------------ ----------
<S> <C> <C>
Revenue:
Interest income................................................ $3,099,267 $3,026,124
Interest expense............................................... 1,737,637 1,418,938
---------- ------------
Net interest margin........................................ 1,361,630 1,607,186
Provision for credit losses.................................... 114,470 570,546
---------- ------------
Net interest margin after provision for credit losses...... 1,247,160 1,036,640
Loan fees and gains on sale of mortgages....................... 17,663,331 19,016,292
Other income................................................... 10,420 14,820
---------- ------------
18,920,911 20,067,752
---------- ------------
Expenses:
Salaries, commissions and employee benefits.................... 8,494,324 9,476,247
General and administrative expenses............................ 2,881,938 3,423,360
Marketing expenses............................................. 2,899,706 2,374,294
Depreciation and amortization.................................. 542,655 637,184
---------- ------------
14,818,623 15,911,085
---------- ------------
Income before income taxes..................................... 4,102,288 4,156,667
Income taxes................................................... -- 1,497,000
---------- ------------
Net income................................................. $4,102,288 $2,659,667
========== ============
Pro forma information (note 5):
Income before income taxes..................................... 4,102,288 --
Provision for pro forma income taxes........................... 1,476,824 --
---------- ------------
Pro forma net income........................................... $2,625,464 $2,659,667
========== ============
Earnings per share (1999)/pro forma earnings per share:
Basic.......................................................... $0.19 $0.19
===== =====
Diluted........................................................ $0.18 $0.18
===== =====
Dividends declared per share........................................ $ -- $0.02
===== =====
Weighted average number of shares outstanding (1999)/
pro forma weighted average number of
shares outstanding:
Basic.......................................................... 13,829,500 13,790,537
========== ============
Diluted........................................................ 14,911,994 14,795,713
========== ============
</TABLE>
Page 4 of 29 pages
<PAGE> 5
ROCK FINANCIAL CORPORATION
STATEMENT OF SHAREHOLDERS' EQUITY
THREE MONTHS ENDED MARCH 31, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
ADDITIONAL TOTAL
COMMON PAID-IN RETAINED SHAREHOLDERS'
SHARES CAPITAL EARNINGS EQUITY
-------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Balance January 1, 1999................................ $135,905 $26,297,782 $11,601,461 $38,035,148
Net income ............................................ 2,659,667 2,659,667
Cash dividends ($.02 per share)........................ (276,646) (276,646)
Tax benefit from the exercise of non-qualified
stock options................................... 1,200,000 1,200,000
Stock options exercised................................ 7,123 2,134,653 2,141,776
-------- ----------- ----------- -----------
Balance March 31, 1999................................. $143,028 $29,632,435 $13,984,482 $43,759,945
======== =========== =========== ===========
</TABLE>
Page 5 of 29 pages
<PAGE> 6
ROCK FINANCIAL CORPORATION
STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 1998 AND 1999
(UNAUDITED)
<TABLE>
<CAPTION>
For the Three-Month
Periods Ended March 31,
--------------------------------
1998 1999
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income .............................................. $ 4,102,288 $ 2,659,667
------------- -------------
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ....................... 542,655 637,184
Provision for credit losses ......................... 114,470 570,546
Mortgage loans held for sale - originations ......... (459,741,771) (605,589,469)
Mortgage loans held for sale - sales ................ 457,879,559 682,185,365
Change in assets and liabilities:
Deferred income taxes .......................... -- 445,000
Other assets ................................... (336,374) (352,913)
Drafts payable ................................. 13,514,497 (3,366,175)
Accounts payable ............................... 921,007 (479,701)
Accrued expenses and other liabilities ......... 1,004,874 (419,400)
------------- -------------
Total adjustments .......................... 13,898,917 73,630,437
------------- -------------
Net cash provided by operating activities... 18,001,205 76,290,104
------------- -------------
Cash flows provided by (used in) investing activities:
Net increase in real estate owned and loans
held for investment ................................. (553,504) (347,599)
Purchase of property and equipment ...................... (2,403,876) (563,438)
Repayments of shareholders' advances .................... -- 994,372
------------- -------------
Net cash provided by (used in)
investing activities ....................... (2,937,380) 83,335
------------- -------------
Cash flows from financing activities:
Net payments under warehouse line of credit ............. (10,548,139) (64,730,944)
Net payments under reverse repurchase agreement ......... (13,451,056) (8,845,993)
Net payments under notes payable ........................ (16,667) --
Proceeds from exercised options ......................... -- 3,341,776
Cash dividends .......................................... -- (276,646)
------------- -------------
Net cash used in financing activities ...... (24,015,862) (70,511,807)
------------- -------------
Net increase (decrease) in cash and cash equivalents ......... (8,952,037) 5,861,632
Cash and cash equivalents, beginning of period ............... 11,946,992 30,081,524
------------- -------------
Cash and cash equivalents, end of period ..................... $ 2,994,955 $ 35,943,156
============= =============
Supplemental disclosure of cash flow information:
Cash paid during the period for interest ................ $ 1,651,630 $ 1,926,564
============= =============
Transfers of loans from held for sale to held
for investment ...................................... $ 478,085 $ 164,102
============= =============
Transfers of loans from held for investment to
real estate owned ................................... $ 45,880 $ 173,000
============= =============
</TABLE>
Page 6 of 29 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 present a fair
statement of the results of operations 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-month period ended March 31, 1999 are not necessarily indicative
of the results that may be expected for the year ending December 31, 1999. 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, 1998 included in the Company's Annual Report on Form
10-K (file no. 000-23887) for the year ended December 31, 1998.
2. MORTGAGE LOANS HELD FOR SALE AND HELD FOR INVESTMENT:
The following summarizes mortgage loans held for sale by type at
December 31, 1998 and March 31, 1999:
<TABLE>
<CAPTION>
December 31, March 31,
1998 1999
------------ ------------
<S> <C> <C>
Prime loans held for sale ............ $124,182,099 $ 65,102,261
Sub-prime loans held for sale ........ 30,542,410 13,853,927
High LTV loans held for sale ......... 671,748 --
------------ ------------
155,396,257 78,956,188
Net deferred loan origination costs... 234,855 79,028
------------ ------------
Mortgage loans held for sale ..... $155,631,112 $ 79,035,216
============ ============
</TABLE>
Included in mortgage loans held for investment at December 31, 1998 and
March 31, 1999 is an allowance for credit losses of $634,851, and $1,194,900,
respectively. The activity for the three months ended March 31, 1999 includes a
provision of $570,546 offset by charge-offs of $10,497. The activity for the
year ended December 31, 1998 includes a provision of $567,738 offset by
charge-offs of $202,888.
Page 7 of 29 pages
<PAGE> 8
As of December 31, 1998 and March 31, 1999, there were no loans held
for sale that were greater than 90 days past due. As of December 31, 1998 and
March 31, 1999, there were approximately $753,000 and $1,214,000, respectively,
of loans held for investment that were greater than 90 days past due, the vast
majority of which is sub-prime loans.
3. RELATED PARTY TRANSACTIONS:
The Company's short-term advances to certain shareholders were repaid
in full on March 31, 1999.
4. EARNINGS PER SHARE:
Basic earnings per share are computed based on the weighted average
number of common shares outstanding during the period. Diluted earnings per
share are computed based on the weighted average number of common shares and
common share equivalents during the period.
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 36.0%.
Pro forma basic earnings per share for the period ended March 31, 1998
have 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 its initial public offering and the 330,000 shares sold by certain
existing shareholders in its initial public offering (after exercising options
to purchase those shares from the Company). Pro forma diluted earnings per share
for the period ended March 31, 1998 have been computed by dividing pro forma net
income by the 14,911,994 average shares assumed to be outstanding, including the
3,499,500 shares sold by the Company in its initial public offering and the
330,000 shares sold by certain existing shareholders in its initial public
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 March 31, 1998,
using the treasury stock method and the $10.00 initial public offering price for
the period ended March 31, 1998.
Page 8 of 29 pages
<PAGE> 9
6. SEGMENT REPORTING :
The Company adopted SFAS No. 131 in 1998 and was comprised of three
major operating divisions in 1998 and in the first quarter of 1999. The
following table shows the contribution to revenues and expenses and the loan
closings of each of the Company's divisions for the three months periods ended
March 31, 1998 and March 31, 1999. Other than loans, the Company's assets are
not specifically allocated to its three operating divisions and therefore, not
used by management for operating decisions with respect to the divisions. As a
result, total assets by division are not presented.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 1998
(IN THOUSANDS)
------------------------------------------------------------------
FRESH SPECIALTY
START CONVENTIONAL LENDING OTHER TOTAL
----------- ------------ --------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues ....... $ 9,256.1 $ 6,663.1 $ 2,753.8 $ 362.3 $ 19,035.3
Expenses ....... 5,903.4 3,807.2 1,841.1 3,381.4 14,933.1
----------- ------------ ----------- ------------ ------------
Net contribution $ 3,352.7 $ 2,855.9 $ 912.7 $ (3,019.1) $ 4,102.2
=========== ============ =========== ============ ============
Loan closings .. $ 80,495 $368,234 $ 23,203 $ 9,090 $ 481,022
=========== ============ =========== ============ ============
------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 1999
(IN THOUSANDS)
------------------------------------------------------------------
FRESH SPECIALTY
START CONVENTIONAL LENDING OTHER TOTAL
----------- ------------ ------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenues .......... $ 6,035.2 $ 13,452.0 $ 62.4 $ 1,088.7 $ 20,638.3
Expenses .......... 4,600.2 7,039.3 1.3 4,840.8 16,481.6
----------- ------------ --------- ----------- ------------
Net contribution... $ 1,435.0 $ 6,412.7 $ 61.1 $ (3,752.1) $ 4,156.7
=========== ============ ========= =========== ============
Loan closings ..... $ 55,005 $ 495,311 $ 0 $ 23,857 $ 574,173
=========== ============ ========= =========== ============
------------------------------------------------------------------
</TABLE>
Included in other revenue and expenses is the government division and
corporate overhead.
Before April 1, 1999, the Company operated through divisions based on
the major products it offered. As of April 1, 1999, the Company changed the way
it manages its business based on the distribution channels for its loan
products: the Web/Call Center division, the Branch network and the Strategic
Alliance Program. Beginning with the three months ending June 30, 1999, the
Company's results will be presented based on the newly defined divisions, with
comparable results for prior periods.
Page 9 of 29 pages
<PAGE> 10
7. BRANCH CLOSINGS
Management's evaluation of the performance of certain retail branches
during the fourth quarter of 1998 concluded that their continuing viability was
questionable. The branches' performance was creating both operating losses and a
"cash drain" on the resources of the Company. As of December 31, 1998 management
committed to a plan to close nine Fresh Start stores. In 1998, the combined loss
for the stores closed was $2.5 million, excluding the loss recognized for the
closing of such stores.
The following table sets forth the accrued loss on store closings
and the related subsequent activity during the quarter ended March 31, 1999:
<TABLE>
<CAPTION>
PROVISION COSTS RESERVE AT
ITEM RECORDED INCURRED MARCH 31, 1999
---- ------------------ ------------------ -----------------
<S> <C> <C> <C>
Write off of fixed assets.............. $ 900,000 $ 873,680 $ 26,320
Lease commitments...................... 1,000,000 309 999,691
Severance pay.......................... 100,000 98,514 1,486
---------------- ---------------- -----------------
Total.............................. $ 2,000,000 $ 972,503 $ 1,027,497
================ ================ =================
</TABLE>
The remaining reserve is expected to be utilized over the remaining life of the
lease obligations and/or lease termination payments.
8. SUBSEQUENT EVENTS
The Company signed a lease in April 1999 for a 110,000 square foot
facility that will house its new 400-seat Web/Call Center, including room for
approximately 200 loan officers, and its National Support Center. The new
facility will more than triple the size of the Company's current Web/Call
Center, which is nearing capacity. The move is expected to take place in October
1999. The Company estimates that the move will cost it approximately $5.5
million between equipment, new technology, leasehold improvements and moving
costs and accelerated depreciation in the second and third quarters of 1999,
$3.5 million of which the Company expects to capitalize, and that the new larger
facility will increase operating expenses by approximately $125,000 to $150,000
a month.
Page 10 of 29 pages
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
With the exception of historical information, some 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 "may," "will," "should," "believe," "expect,"
"anticipate," "estimate," "continue," "predict," and similar expressions
identify forward-looking statements. These forward-looking statements reflect
our current views with respect to future events in financial performance, but
are subject to many risks, uncertainties and factors relating to our operations
and business environment which may cause our 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) filed April 30, 1998 and
elsewhere in this Report.
GENERAL
We are a technology and service driven retail mortgage banking company
that markets conventional, government-insured, and sub-prime mortgage loans and
home equity lines of credit directly to consumers through the Internet
(www.RockLoans.com), our call center, 17 retail branches and our strategic
alliance program. We believe we are developing a growing brand identity, built
upon our technology, service, people and marketing. We believe we are unlike
most mortgage companies and loan middlemen that have Web sites on the Internet.
We process, underwrite and close the loan ourselves without referring the
customer to another company to perform these services and without charging
additional brokerage fees to our customers. We seek to provide "world class"
service to our customers, thereby encouraging them to return for future loans
and refer others to us for loans. We also focus on recruiting, developing and
motivating talented people to implement our business strategies. As of May 10,
1999, we had 729 employees, including 274 loan officers.
Until April 1, 1999, we operated through three major divisions based
on the major products we offered. Through our Conventional Mortgage Lending
division, we have originated Conventional Loans since our inception in 1985.
Through our Fresh Start division, created in 1994, we have also originated
Sub-Prime Loans. Through our Specialty Lending division, which commenced these
operations in March 1997, we originated High LTV Loans. We decided, in the third
quarter of 1998, to stop originating High LTV Loans because there were fewer
buyers of these loans and because we wanted to shift our resources to take
advantage of the high demand for Conventional Loans. We will continue to
evaluate the High LTV marketplace and do not currently plan to begin originating
High LTV Loans again unless and until the market for these loans changes. In
addition to our major divisions, we further increased our government-insured
lending operations in 1998, primarily making mortgage loans that meet the
underwriting standards for Federal Housing Administration ("FHA") insurance.
Page 11 of 29 pages
<PAGE> 12
As of April 1, 1999, we changed the way we manage our business, based
on the major distribution channels for our loan products: the Web/Call Center
division, the Branch network and the Strategic Alliance Program. Our Web/Call
Center division markets loans on-line through our Internet Web site,
RockLoans.com, which began originating loans in January 1999. Our Web/Call
Center division also markets loans through our call center located in our
National Support Center in Bingham Farms, Michigan. Our Branch network markets
loans through our network of 17 retail loan origination branches. Our Strategic
Alliance Program currently consists of one joint venture, a 70%-owned limited
liability company that originates residential mortgage products to Michigan
National Bank's customers through Michigan National Bank's 192 financial
centers, a call center and over the Internet. Michigan National Bank has
approximately 450,000 customers and owns the other 30% of the joint venture. The
joint venture began business in April 1999.
We expect 1999 to be a transition year for us, as we move from a brick
and mortar branch operation to one more based on Internet, Call Center and
Strategic Alliance mortgage lending channels. We expect that this transition
will adversely affect our short-term earnings. We believe that technology is
changing the way mortgages are originated. Consequently, we began to concentrate
more of our resources and marketing efforts on originating mortgages through two
new distribution channels, the Internet and our Strategic Alliance Program.
In the first quarter of 1999, margins on our Conventional Loans as well
as our Sub-Prime Loans declined slightly from fourth quarter 1998 levels.
Margins on our Conventional Loans as well as the volumes of our Conventional
Loan and Sub-Prime Loan originations have further declined so far in the second
quarter of 1999 from the first quarter levels. The declines are primarily due to
higher interest rates, lower refinancing loan volumes and our closing of 10
branches and one marketing center in 1999. We expect these trends to continue in
the second quarter and our second quarter earnings to be substantially below our
first quarter earnings. However, we expect our Internet (www.RockLoans.com),
Michigan National Bank strategic alliance and government-insured lending
business to grow substantially.
We also plan to make several moves that are intended to further our
long-term business and our transition from a brick and mortar branch operation
to one more based on Internet, Call Center and Strategic Alliance mortgage
lending channels. We expect that this transition will adversely affect our
short-term earnings. We have signed a lease for a 110,000 square foot facility
that will house our new 400-seat Web/Call Center, including room for
approximately 200 loan officers, and our National Support Center. The new
facility will more than triple the size of our current Web/Call Center, which is
nearing capacity. The move is expected to take place in October 1999. We
estimate that the move will cost us approximately $5.5 million between
equipment, new technology, leasehold improvements and moving costs and
accelerated depreciation in the second and third quarters of 1999, $3.5 million
of which we expect to capitalize, and that the new larger facility will increase
our operating expenses by approximately $125,000 to $150,000 a month.
Page 12 of 29 pages
<PAGE> 13
We also plan to launch a national advertising campaign in the third and
fourth quarter of 1999 to increase recognition for our "Rock Financial" and
"RockLoans.com" brand names. We expect this multi-million dollar effort to
include national television, radio and print advertising and, potentially,
on-line business development transactions with high traffic Web sites. We expect
this advertising campaign to increase incrementally as our processing and
closing infrastructure, capable of handling the expected loan volume increase
from this campaign, including the new Web/Call Center, is developed. Each of the
events described above, however, is expected to have an adverse effect on our
earnings, in the short-term.
TERMINATION OF S CORPORATION STATUS AND INCOME TAXES
Simultaneously with the closing of our initial public offering on May
6, 1998 (the "Offering"), we ceased to be taxed as an S corporation under the
Internal Revenue Code. In connection with the termination of our S corporation
status, we paid an estimate of our income taxed or taxable to our shareholders
while we were an S Corporation, but not yet distributed to them ("Shareholder
Distribution Amount") out of the net proceeds of the Offering to our
shareholders existing immediately before the closing of the Offering (the
"Existing Shareholders"). The estimated Shareholder Distribution Amount,
including the approximately $5.4 million tax distribution to the Existing
Shareholders on April 10, 1998, was approximately $25.0 million. Based upon the
final results of 1998, the Existing Shareholders were required to pay us
approximately $800,000, representing the excess of amounts disbursed in May 1998
over the year-end estimate of the taxable income allocable to the Existing
Shareholders. The amount due to us was paid in full as of March 31, 1999.
As an S corporation, our income, whether or not distributed, was taxed
at the shareholder level for federal and state tax purposes. When we terminated
our S corporation status, we became subject to federal and state income taxation
and we recorded a $1.8 million deferred tax asset on our balance sheet along
with a current income tax liability of $0.9 million as of May 6, 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 statements of income
are intended to show results as if we had been subject to federal and state
taxation at the tax rates effective for the periods presented.
Page 13 of 29 pages
<PAGE> 14
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999
VERSUS THREE MONTHS ENDED MARCH 31, 1998
The following table sets forth our revenues, expenses and pre-tax
income for the three months ended March 31, 1998 and 1999:
<TABLE>
<CAPTION>
Three Months Ended March 31,
1998 1999
------------ -------------
(In thousands)
<S> <C> <C>
Total revenue............................... $ 18,921 $ 20,068
Total expenses.............................. (14,819) (15,911)
------------ -------------
Pre-tax income.............................. $ 4,102 $ 4,157
============ ============
</TABLE>
Our total revenues increased from $18.9 million in the first quarter of
1998 to $20.1 million in the first quarter of 1999, an increase of $1.2 million,
or 6.1%. The increase in revenues is primarily due to the following:
- an increase of $251.0 million, or 74.9%, in the volume of Conventional
Loans we sold in the first quarter of 1999 compared to the first
quarter of 1998;
- an increase of $14.9 million, or 189.6%, in the volume of
government-insured loans we sold in the first quarter of 1999 compared
to the first quarter of 1998;
- a 23.8% increase in margins earned on loan fees and gains on sale of
Conventional Loans in the first quarter of 1999 compared to the first
quarter of 1998; and
- an 8.8% increase in margins earned on loan fees and gain on sale of
government-insured loans in the first quarter of 1999 compared to the
first quarter of 1998;
partially offset by the following:
- a decrease of $24.2 million, or 97.9%, in the volume of High LTV Loans
we sold in the first quarter of 1999 compared to the first quarter of
1998;
- a decrease of $17.5 million, or 19.4%, in the volume of Sub-Prime Loans
we sold in the first quarter of 1999 compared to the first quarter of
1998;
- a 23.4% decrease in margins earned on loan fees and gains on sale of
Sub-Prime Loans in the first quarter of 1999 compared to the first
quarter of 1998.
In the first quarter of 1999, margins on our Conventional Loans as well
as our Sub Prime Loans declined slightly from the fourth quarter 1998 levels.
Margins on our Conventional Loans as well as the volumes of our Conventional
Loan and Sub-Prime Loan originations have further declined so far in the second
quarter of 1999 from the first quarter levels. The declines are primarily due to
higher interest rates, lower refinancing loan volumes and our closing of 10
branches and one marketing center in 1999. We expect these trends to continue in
the second quarter and our second quarter earnings to be substantially below our
first quarter earnings. However, we expect our Internet
Page 14 of 29 pages
<PAGE> 15
(www.RockLoans.com), Michigan National Bank strategic alliance and
government-insured lending business to grow substantially.
During the first quarter of 1999, we disbursed $605.6 million of loans,
an increase of $145.9 million, or 31.7%, from the $459.7 million of loans
disbursed in the first quarter of 1998. Our loans held for sale decreased by
$76.6 million in the first quarter of 1999, compared to an increase of $1.9
million in the first quarter of 1998. The decrease, which had a significant
positive effect on our profitability, was due to our selling $682.2 million in
loans while closing $605.6 million in loans in the first quarter of 1999. The
decrease in loans held for sale in the first quarter of 1999 included decreases
of $59.1 million in Conventional Loans and government-insured loans, $16.7
million in Sub-Prime Loans and $0.7 million in High LTV Loans. The increase in
loans held for sale in the first quarter of 1998 included an increase of $17.8
million in Conventional Loans, partially offset by decreases of $14.7 million in
Sub-Prime Loans and $1.4 million in High LTV Loans.
Total expenses increased from $14.8 million in the first quarter of
1998 to $15.9 million in the first quarter of 1999, an increase of $1.1 million,
or 7.4%, primarily due to increased commissions and increases in general and
administrative expenses that fluctuate with increases in volumes of loans closed
and numbers of employees, partially offset by reduced marketing and advertising
expenses, partly as a result of closing nine branches and a marketing center in
the first quarter of 1999.
The following table sets forth information regarding the components of
our revenues for the three months ended March 31, 1998 and 1999:
<TABLE>
<CAPTION>
Three Months
Ended March 31,
----------------------------
1998 1999
------- -------
(In thousands)
<S> <C> <C>
Interest income........................................................ $3,099 $3,026
Interest expense....................................................... (1,738) (1,419)
------- -------
Net interest margin............................................... 1,361 1,607
Provision for credit losses............................................ (114) (570)
------- -------
Net interest margin after provision for credit losses............. 1,247 1,037
Loan fees and gains on sale of mortgages............................... 17,663 19,016
Other income........................................................... 10 15
------- -------
Total revenue..................................................... $18,920 $20,068
======= =======
</TABLE>
Net interest margin before provision for credit losses increased from
$1.4 million in the first quarter of 1998 to $1.6 million in the first quarter
of 1999, an increase of $0.2 million, or 18.0%. The increase was primarily due
to the following:
- 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 us to take advantage of the positive net interest margin;
Page 15 of 29 pages
<PAGE> 16
- a decrease in the weighted average interest rates charged on our
borrowing facilities, from 7.00% in the first quarter of 1998 to
6.10% in the first quarter of 1999; and
- our increased use of cash generated from operations and our
initial public offering to fund our loans.
In the remainder of 1999, we intend to hold our loans for a shorter
period of time before selling them, which we expect will significantly decrease
our net interest margin.
Buyers of our loans may require us 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, the
longer we hold our loans, the higher our risk of delinquencies and resulting
foreclosure losses. To compensate for those risks we recorded a provision for
credit losses of approximately $114,000 in the first quarter of 1998 and
recorded a provision for credit losses of approximately $571,000 in the first
quarter of 1999, partly for future repurchase or substitution requirements
relating to loans sold before March 31, 1998 and 1999, respectively, and credit
risk for loans held for sale and investment. The increase was primarily due to
the significant increase in the volume of loans held for investment that were
past due. During the fourth quarter of 1998 and the first quarter of 1999, the
secondary market Sub-Prime Loan buyers changed their underwriting standards,
making it more difficult for us to sell our loans. As a result, we held these
loans for a longer period of time than normal, more of them became delinquent
and we transferred the delinquent loans from loans held for sale to loans held
for investment. We have reserved approximately half of the amount of these
remaining delinquent loans as of March 31, 1999. In the second quarter of 1999,
we entered into an agreement with a loan buyer for our Sub-Prime Loans and we
are now underwriting our loans to that buyer's standards. During the first
quarters of 1998 and 1999, two loans and one loan, respectively, were
reclassified as real estate owned, resulting in charges of approximately $1,000
and $11,000, respectively, against the reserve.
Loan fees and gains on sale of mortgages increased from $17.7 million
in the first quarter of 1998 to $19.0 million in the first quarter of 1999, an
increase of $1.3 million, or 7.7%. This increase is primarily due to the
increase in sales of loans described above along with the changes in the margins
earned on loan fees and gains on sale of loans described above. See "Segment
Analysis" for a description of changes in sales volume. The increase in margins
earned on loan fees and gains on sale of Conventional Loans and
government-insured loans, when comparing the first quarter of 1999 to the first
quarter of 1998, was primarily the result of a favorable interest rate
environment, which reduced the need for rate competitiveness, along with changes
in sales methods. In the second quarter of 1999, margins earned on loan fees and
gains on sale of Conventional Loans have declined so far because of an increase
in interest rates and an increased need for rate competitiveness. We also expect
that Conventional Loan closings will decline in the second quarter of 1999
compared to the first quarter of 1999 due, in part, to increases in mortgage
interest rates in 1999. The decrease in margins earned on loan fees and gains on
sale of Sub-Prime Loans was due to the turmoil in the industry, which created a
surplus of Sub-Prime Loans available for sale thereby driving
Page 16 of 29 pages
<PAGE> 17
down the prices of these loans. We expect both loan closings and revenue to
decline from Sub-Prime Loans in the second quarter of 1999, principally due to
the branch closings in the first quarter of 1999.
The increase in loan fees and gains on sale of mortgages was partially
offset by an increase in our recapture reserve in the first quarter of 1999.
Some Sub-Prime Loan sales require us to return a portion of the premium we
received on the sale of the loan if the loan is prepaid by the customer within
the first year after sale. We record a provision for this risk separate from the
provision for credit losses based on our evaluation of the terms of our sale
contracts and our assumptions concerning prepayments. We increased our reserve,
and decreased our loan fees and gains on sale of mortgages, by approximately
$.01 million, for this risk in the first quarter of 1999, compared to an
increase of approximately $0.2 million, in the first quarter of 1998.
The following table sets forth information regarding the components of
our expenses for the three months ended March 31, 1998 and 1999:
<TABLE>
<CAPTION>
Three Months
Ended March 31,
----------------------------
1998 1999
------- -------
(In thousands)
<S> <C> <C>
Salaries, commissions and employee benefits............................ $8,494 $9,476
General and administrative expenses.................................... 2,882 3,424
Marketing expenses..................................................... 2,900 2,374
Depreciation and amortization.......................................... 543 637
------- -------
Total expenses.................................................... $14,819 $15,911
======= =======
</TABLE>
Salaries, commissions and employee benefits increased from $8.5 million
in the first quarter of 1998 to $9.5 million in the first quarter of 1999, an
increase of $1.0 million, or 11.6%. The increase was primarily attributable to
higher commissions due to increased closings and increased compensation for new
management team members, partially offset by an increase in the portion of
Conventional Loans originated, which have lower commission rates than our other
products. These expenses are expected to continue to increase in 1999 in
connection with our expansion of existing operations, along with our continued
development of our Internet presence and strategic alliance.
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 $2.9 million in the first quarter of
1998 to $3.4 million in the first quarter of 1999, an increase of $0.5 million,
or 18.8%. The increase was primarily attributable to an increase in occupancy
expenses, office expenses, and automobile and delivery expenses and expenses
related to technology, support and other personnel hired in connection with our
new Web site. These expenses are expected to vary according to the volume of
loan closings in 1999, except
Page 17 of 29 pages
<PAGE> 18
for occupancy expenses, which are expected to increase in connection with our
move to a new Web/Call Center and National Support Center, which management
expects to occur in the fourth quarter of 1999.
Marketing expenses decreased from $2.9 million in the first quarter of
1998 to $2.4 million in the first quarter of 1999, a decrease of $0.5 million,
or 18.1%. The decrease was primarily attributable to our closing nine branches
and one marketing center in the first quarter of 1999 and our discontinued
origination of High LTV Loans in the third quarter of 1998. We expect these
expenses to increase later in 1999 in connection with the expansion of existing
operations, along with the continuation of development of our Internet presence
and strategic alliances.
Depreciation and amortization expenses increased from $0.5 million in
the first quarter of 1998 to $0.6 million in the first quarter of 1999, an
increase of $0.1 million, or 17.4%. The increase was primarily attributable to
our purchases of additional equipment and leasehold improvements during 1998 and
1999 for our new Web center and existing branches. The expenses are expected to
continue to increase in 1999 as a result of the expansion of existing
operations, expansion of our Web center, and the relocation of our Web/Call
Center and National Support Center.
We did not have any income taxes due to earnings for the first quarter
of 1998 due to our S corporation status at that time. We recognized income tax
expense of approximately $1.5 million for the quarter ended March 31, 1999 as a
result of our conversion to a C corporation in 1998.
SEGMENT ANALYSIS
Our recent growth may distort some of our ratios and financial
statistics and may make period-to-period comparisons difficult. In light of our
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 and margins will affect period to period comparisons.
We expect segment contributions to vary from period to period. In order
to demonstrate the effect that varying factors have on loan production, revenue
and profits, we have elected to show the results of our former divisions. As
described above, effective April 1, 1999, we changed the way we manage our
business from a product line basis to a distribution channel basis. The
following table shows the contribution to revenues and expenses and the loan
closings of each of our former divisions for the three months ended March 31,
1998 and 1999:
Page 18 of 29 pages
<PAGE> 19
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
1998 1999
------------ ------------
(In thousands)
<S> <C> <C>
CONVENTIONAL MORTGAGE LENDING:
Revenue .................... $ 6,663.1 $ 13,452.0
Expenses ................... (3,807.2) (7,039.3)
------------ ------------
Division contribution .... 2,855.9 6,412.7
------------ ------------
FRESH START:
Revenue .................... 9,256.1 6,035.2
Expenses ................... (5,903.4) (4,600.2)
------------ ------------
Division contribution .... 3,352.7 1,435.0
------------ ------------
SPECIALTY LENDING:
Revenue .................... 2,753.8 62.4
Expenses ................... (1,841.1) (1.3)
------------ ------------
Division contribution .... 912.7 61.1
------------ ------------
OTHER REVENUE ................ 362.3 1,088.7
OTHER EXPENSES ............... (3,381.4) (4,840.8)
------------ ------------
PRE-TAX INCOME ............. 4,102.2 4,156.7
INCOME TAXES ................. -- 1,497.0
------------ ------------
NET INCOME ................... 4,102.2 2,659.7
PROVISION FOR PROFORMA
INCOME TAX ................. 1,476.8 --
------------ ------------
PROFORMA NET INCOME .......... $ 2,625.4 $ 2,659.7
============ ============
LOAN CLOSINGS:
Conventional Mortgage
Lending .................. $ 368,234 $ 495,311
Fresh Start ................. 80,495 55,005
Specialty Lending ........... 23,203 --
Other ....................... 9,090 23,857
------------ -------------
Total Loan Closings ...... $ 481,022 $ 574,173
============ =============
</TABLE>
THREE MONTHS ENDED MARCH 31, 1999
VERSUS THREE MONTHS ENDED MARCH 31, 1998
Although revenues increased in the first quarter of 1999 compared to
the first quarter of 1998, the contribution by segment differed from quarter to
quarter. In the first quarter of 1999, the Conventional Mortgage Lending
division contributed $13.5 million, or 65.2%, of
Page 19 of 29 pages
<PAGE> 20
revenues, compared to $6.7 million, or 35.2%, in the first quarter of 1998. The
Fresh Start division contributed $6.0 million, or 29.2%, of revenues in the
first quarter of 1999, compared to $9.3 million, or 49.0%, in the first quarter
of 1998. The Specialty Lending division contributed $.06 million, or 0.3%, of
revenues in the first quarter of 1999, compared to $2.8 million, or 14.6%, of
revenues in the first quarter of 1998.
CONVENTIONAL MORTGAGE LENDING: The Conventional Mortgage Lending
division generated $13.5 million in revenue in the first quarter of 1999 versus
$6.7 million of revenue in the first quarter of 1998. The 101.9% increase in
revenue is mainly attributable to a 74.9% increase in sales of Conventional
Loans in the first quarter of 1999 compared to the first quarter of 1998, and a
23.8% increase in the margins earned on loan fees and gains on sale of
Conventional Loans in the first quarter of 1999 compared to the first quarter of
1998. The greater loan sales are primarily attributable to the following:
- an increase in Conventional Loan closings as a result of a more
favorable interest rate environment, which caused a significant
increase in loan refinancings;
- the sale of $63.5 million more Conventional Loans in the first
quarter of 1999 than were disbursed, compared to $19.5 million
fewer in the first quarter of 1998;
- the significant efficiencies gained through the implementation of
automated underwriting systems and other technology; and
- the maturation of the additional branches opened during the second
and third quarters of 1998.
We believe 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. See "Results of Operations" for a description of changes
in margins. We expect that loan closings will decline in the second quarter of
1999 due, in part, to increases in mortgage interest rates in 1999, which may
cause revenues and/or period-end inventory to be less than those of the first
quarter of 1999.
Direct expenses of the Conventional Mortgage Lending division were $7.0
million on closings of $495.3 million (1.4%) in the first quarter of 1999
compared to $3.8 million on closings of $368.2 million (1.0%) in the first
quarter of 1998. The 84.9% increase in expenses is primarily attributable to the
34.5% increase in the volume of closed Conventional Loans and marketing and
occupancy expenses associated with our Web/Call Center.
FRESH START: The Fresh Start division generated $6.0 million in revenue
in the first quarter of 1999 versus $9.3 million of revenue in the first quarter
of 1998. The 34.8% decrease in revenue is mainly attributable to a 23.4%
decrease in margins earned on loan fees and gain on sale of Sub-Prime Loans in
the first quarter of 1999 and a 19.4% decrease in sales of Sub-Prime Loans in
the first quarter of 1999 compared to the first quarter of 1998. The lower loan
sales are primarily attributable to a 31.7% decrease in Sub-Prime Loan closings
as a result of our decision to shift some of our resources to handle the higher
demand for Conventional Loans and government-insured loans and our closing of
nine of our unprofitable branches in the first quarter of 1999. Also, branches
that were open before January 1, 1998 and remained open through March 31, 1999
closed an average of $31.4 million of Sub-Prime Loans during the first quarter
of 1999 compared to $52.8 million in the first quarter of 1998. These decreases
were partially offset by our sale of $16.7 million more Sub-Prime loans in the
first quarter of 1999 than were disbursed, compared to $13.6 million in the
first quarter of 1998. Due to the branch closings in the first and second
Page 20 of 29 pages
<PAGE> 21
quarters of 1999, we expect both closings and revenues from Sub-Prime Loans to
decline in the second quarter of 1999. See "Results of Operations" for changes
in margins.
Direct expenses of the Fresh Start division were $4.6 million on
closings of $55.0 million (8.4%) in the first quarter of 1999 compared to $5.9
million on closings of $80.5 million (7.3%) in the first quarter of 1998. We
believe that the increase in expenses as a percentage of closings is primarily
due to the effect of the decreased volume of closings on fixed costs. These
increases were partially offset by a lack of new branch expenses in the first
quarter of 1999, compared to significant new branch expenses in the first
quarter of 1998. The new branch expenses, net of revenue, were approximately
$1.2 million in the first quarter of 1998. As previously discussed, nine
branches were closed in the first quarter of 1999 due to their unprofitable
operations.
SPECIALTY LENDING: The Specialty Lending division generated $62,400 in
revenue in the first quarter of 1999 versus $2.8 million of revenue in the first
quarter of 1998. The 97.7% decrease in revenue is mainly attributable to our
conscious decision, in the third quarter of 1998, to shift all of our Specialty
Lending division's sales force to handle the high demand for Conventional Loans.
We sold $0.5 million more High LTV Loans than we disbursed in the first quarter
of 1999, compared to $1.5 million more in the first quarter of 1998.
Direct expenses of the Specialty Lending division were $1,300 in the
first quarter of 1999 compared to $1.8 million on closings of $23.2 million
(7.9%) in the first quarter of 1998. We do not expect to recognize any further
revenues or expenses for the Specialty Lending Division in 1999.
OTHER: Substantially all of the other revenue in the first quarter of
1999 and most of the other revenue in the first quarter of 1998 consisted of
loan fees and gains on sale relating to government-insured loans.
Other expenses include expenses not directly allocable to a particular
division, such as the costs associated with our legal, marketing, accounting,
information services, facilities management, servicing, executive, human
resources, secondary marketing and general and administrative support teams. The
direct expenses of government-insured lending are also included in other
expenses. The majority of the $1.4 million increase in expenses, from $3.4
million in the first quarter of 1998 to $4.8 million for the first quarter of
1999, is due to increased costs of technology support for our front-end
origination system, branch network and Web center and increased costs associated
with increased government-insured lending loan volumes.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities in the first quarter of 1999
was approximately $76.3 million, compared to approximately $18.0 million in the
first quarter of 1998. Cash was provided primarily by the following:
Page 21 of 29 pages
<PAGE> 22
- - our net income in the first quarter of 1999, approximately $4.3 million
before depreciation and amortization, provision for credit losses, and
deferred income taxes in the first quarter of 1999, compared to
approximately $4.8 million in the first quarter of 1998; and
- - a decrease in mortgage loans held for sale, approximately $76.6 million in
the first quarter of 1999, compared to an approximately $1.9 million
increase in the first quarter of 1998.
These sources of cash were partially offset by the following:
- - a decrease in drafts payable, which represent funds advanced for loan
closings that have not yet been drawn against the warehouse line of credit,
approximately $3.4 million in the first quarter of 1999, compared to an
increase of approximately $13.5 million in the first quarter of 1998, as a
result of lower volumes of closed loans in the first quarter of 1999
compared to the fourth quarter of 1998; and
- - a decrease in accounts payable and accrued expenses and other liabilities
of approximately $0.9 million in the first quarter of 1999, compared to an
increase of approximately $1.9 million in the first quarter of 1998,
primarily as a result of the decrease in loan closings from the fourth
quarter of 1998 to the first quarter of 1999.
Net cash provided by investing activities during the first quarter of
1999 was approximately $0.1 million, compared to approximately $2.9 million used
in investing activities during the first quarter of 1998. Cash was provided
primarily by the repayment of approximately $1.0 million of shareholder advances
in the first quarter of 1999, partially offset by the approximately $0.6 million
of purchases of property and equipment in the first quarter of 1999, compared to
approximately $2.4 million in the first quarter of 1998, and the increase in
real estate owned and loans held for investment of approximately $0.3 million in
the first quarter of 1999, compared to approximately $0.6 million in the first
quarter of 1998.
Net cash used in financing activities during the first quarter of 1999
was approximately $70.5 million, compared to approximately $24.0 million during
the first quarter of 1998. Cash was used for the following:
- - repayments of borrowings under our warehouse line of credit, approximately
$64.7 million in the first quarter of 1999, compared to approximately $10.5
million in the first quarter of 1998;
- - repayments of borrowings under our reverse repurchase agreement,
approximately $8.8 million in the first quarter of 1999, compared to
approximately $13.5 million in the first quarter of 1998; and
- - payment of dividends to shareholders, approximately $0.3 million in the
first quarter of 1999.
These uses of cash were partially offset by the proceeds of the exercises of
stock options, approximately $3.3 million in the first quarter of 1999. We
normally use our cash to pay
Page 22 of 29 pages
<PAGE> 23
down our warehouse borrowings. In order to demonstrate the availability of this
liquidity, we borrowed additional cash under our warehouse line of credit at
March 31, 1999 for four days.
We have $400 million of warehouse financing facilities, an increase
from $350 million of warehouse financing facilities as of March 31, 1998. Our
warehouse line of credit currently provides for up to $200 million principal
amount of demand loans secured by loans held for sale and other of our assets.
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 quarter of 1999 was 6.28%. As of May 10, 1999, we had
borrowed $39.8 million under this facility and had a maximum of $36.2 million
available for additional borrowings and were in compliance with all associated
financial covenants. We would have $160.2 million of borrowing capacity
available if we had sufficient collateral.
In addition to the $200 million warehouse line of credit, our reverse
repurchase arrangement provides that the lender, an affiliate of one of the
representatives of the underwriters in our initial public offering, will
purchase from us at par up to $200 million of fully-amortizing, first or junior
lien residential mortgage loans and home equity loans that comply with our
origination guidelines and conform to whole and bulk loan sale requirements. The
lender's obligations are subject to our agreement to repurchase loans on a daily
basis. 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 2000. We intend to renew this
facility. The effective weighted average interest rate to us of this arrangement
in the first quarter of 1999 was 5.92%. We use this facility as a supplemental
borrowing facility to fund loans we close until they are sold. As of May 10,
1999, we had financed $1.0 million of loans under this facility and had no
additional borrowings available to draw against. We would have an additional
$199.0 million of borrowing capacity if we had sufficient collateral.
The net proceeds of our initial public offering, together with cash
flows from operations, are expected to be sufficient to fund our liquidity
requirements for the next 12 months, if our future operations are consistent
with our expectations. We, however, expect that eventually we will need to
arrange for additional sources of capital through the issuance of debt, equity
or additional bank borrowings. We have no commitments for any such additional
financing, and we cannot assure you that we will be able to obtain any such
additional financing at the times required and on terms and conditions
acceptable to us. In such event, our growth and operations could be curtailed.
If we begin to securitize our assets or significantly increase our retained
mortgage servicing rights, our liquidity could be materially adversely affected,
although we have no current intention to do either in the immediate future.
Page 23 of 29 pages
<PAGE> 24
NEW ACCOUNTING STANDARDS NET YET ADOPTED
In September 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 Statement 133.
YEAR 2000 -DISCLOSURE
STATE OF READINESS
We have developed a Year 2000 project plan that addresses both
technological and non-technological systems, including embedded systems for all
business units. We have designated a Year 2000 project team to lead the efforts
using a phased approach. We employ both internal and external resources to
identify, correct and test systems to achieve Year 2000 compliance. We are also
reviewing the Year 2000 readiness of third parties that provide services
essential to our operations.
The plan consists of nine phases. The initial phases of planning,
awareness, inventory, triage, detailed assessment and resolution are complete.
Test planning and testing have begun and are projected to be completed by June
30, 1999. The deployment phase includes the installation of compliant hardware
and software into the production environment. This phase has begun and many of
the mission critical systems have been upgraded or replaced with compliant
systems. We expect to compete this phase by September 1, 1999. We are
communicating with key third party suppliers and other business partners to
establish and monitor their levels of Year 2000 readiness. Our Year 2000 project
is subject to modification, and we may revise it periodically as we further
develop information. We believe we will complete our project without any
material adverse effects.
ESTIMATED COST
Our cost estimates are in the range of $250,000 to $500,000. As of
March 31, 1999, we have incurred approximately $222,000 of costs. We continually
review our cost estimates and adjust them, if appropriate. We do not expect our
Year 2000 project cost to have a material impact on our liquidity or capital
resources.
Page 24 of 29 pages
<PAGE> 25
RISKS OF OUR YEAR 2000 ISSUES
Based on current information, we believe the Year 2000 problem will not
have a material adverse effect on us, our business or our financial condition.
We cannot predict the actual effect of the Year 2000 problem on us. Many
uncertainties exist as to whether broad-based or systemic economic failures may
occur.
YEAR 2000 CONTINGENCY PLANS
We are reviewing existing contingency plans for potential modifications
to address specific Year 2000 issues. Our key operational systems are being
reviewed and strengthened to address business continuity requirements. Business
continuity plans will include the development of back-up processes that would be
implemented in the event of system failures, for example, the ability to provide
government reporting manually versus electronically. The contingency planning
process will continue as modifications are made and as the status of third party
readiness becomes better known.
Page 25 of 29 pages
<PAGE> 26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate risk is the largest market risk affecting us. Interest
rate risk is the possibility that changes in interest rates will cause
unfavorable changes in our net income and in the value of our interest rate
sensitive assets, liabilities and commitments. As part of our risk management
programs, we purchase financial instruments and enter into financial agreements
with off-balance sheet risk in the normal course of business to manage our
exposure to interest rate risk with respect to our Conventional Loans and our
government-insured loans (together, "Prime Loans"), but not with respect to our
Sub-Prime Loans. We use these financial instruments for the explicit purpose of
managing interest rate risks to protect the value of our Prime Loans held for
sale and the Prime Loan commitment pipeline. We use financial instruments that
tend to decrease in value as interest rates decline and increase in value as
interest rates rise, which acts as an offset to the behavior of the underlying
Prime Loans held for sale and Prime Loan pipeline.
Management actively monitors and manages our exposure to interest rate
risk on Prime Loans, which is incurred in the normal course of business. The
committed and closed pipelines of Prime Loans, as well as the related forward
commitments and derivatives, are valued daily. We refer to the loans, pipeline,
commitments and derivatives together as the "hedge position". The hedge position
is "shocked" against a spectrum of interest rate scenarios to evaluate expected
net changes of the fair values of the hedge position in relation to the changes
in interest rates. We do not enter into instruments for trading purposes.
We evaluate interest rate risk exposure using both static shock and
option adjusted spread models to estimate changes to the fair value of the hedge
position. Both modeling techniques measure net changes in the fair value to the
underlying assets and commitments by determining the present value of the cash
flow of the underlying mortgage or debt instrument discounted at the interest
rate assumed to be required by an investor to yield a market rate of return.
Both modeling techniques measure changes in the fair value of derivatives
through Option Adjusted Spread calculations to determine the present value using
implied volatility, discount rates and expected life of the derivative. Both
models use assumptions regarding the amount of commitments that close, given an
incremental shift of +/- 100 basis points, in 12.5 basis point increments, to
the yield curve. The assumptions are based on our historical experience. Our
exposure is analyzed daily and reviewed at least monthly by the Secondary
Marketing Executive Committee, which includes in its membership our Director of
Secondary Marketing, our Chief Financial Officer and our Chairman of the Board,
President, and Chief Executive Officer.
Both modeling techniques described above were applied to the hedge
position as of March 31, 1999 over a spectrum of interest rate changes to
evaluate the change in the hedge position's fair value ("sensitivity analysis").
Using the results of the model producing the largest loss in fair value, the
sensitivity analysis reflected that an instantaneous 50 basis point increase in
interest rates at March 31, 1999 determined by management to reflect a
reasonably possible near-term change, would have reduced the fair value of the
hedge position 11 basis points from 2.61% to 2.50% and would have decreased
revenue by approximately $17,000 even though the model assumes that more loans
would have closed due to an increase in interest rates. A 50 basis point
Page 26 of 29 pages
<PAGE> 27
decrease in interest rates at March 31, 1999, determined by management to
reflect a reasonably possible near-term change, would have increased the fair
value of the hedge position 3 basis points from 2.61% to 2.64% and would have
decreased revenue by approximately $376,000 assuming that fewer loans would have
closed due to the decline in interest rates. Both 50 basis point moves are
assumed shifts in the entire yield curve. We do not believe that our spread
income would be materially affected by interest rate changes as the interest we
charge on our mortgage loans can change faster than the interest on our
indebtedness.
The table below provides information about our other financial
instruments that are sensitive to changes in interest rates, including debt
obligations and Sub-Prime Loans, as of March 31, 1999. For both debt obligations
and Sub-Prime Loans, the table presents principal cash flows and related
weighted average interest rates by expected maturity dates. Weighted average
variable rates are based on current rates as of March 31, 1999. The instruments'
actual cash flows are all denominated in U.S. dollars.
<TABLE>
<CAPTION>
MARCH 31, 1999
EXPECTED MATURITY DATE
(AMOUNTS IN THOUSANDS) 1999 2000-2003 THEREAFTER TOTAL FAIR VALUE
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ASSETS:
SUB-PRIME LOANS $13,854 $0 $0 $13,854 $13,854
WEIGHTED AVERAGE INTEREST RATE: 12.11% NA NA 12.11%
LIABILITIES:
WAREHOUSE LINE OF CREDIT $33,277 $0 $0 $33,277 $33,277
WEIGHTED AVERAGE INTEREST RATE: 6.28% NA NA 6.28%
REVERSE REPURCHASE ARRANGEMENT $2,675 $0 $0 $2,675 $2,675
WEIGHTED AVERAGE INTEREST RATE: 5.92% NA NA 5.92%
</TABLE>
Page 27 of 29 pages
<PAGE> 28
PART II--OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
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 28 of 29 pages
<PAGE> 29
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: May 14, 1999 By:/s/ DANIEL GILBERT
----------------------------------
DANIEL GILBERT
Its: Chairman of the Board,
President and Chief
Executive Officer
(Duly Authorized Officer)
Date: May 14, 1999 By:/s/ FRANK E. PLENSKOFSKI
----------------------------------
FRANK E. PLENSKOFSKI
Its: Chief Financial Officer
(Principal Financial and Chief
Accounting Officer)
Page 29 of 29 pages
<PAGE> 30
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Description
- ------- -----------
<S> <C>
27.1 Financial data schedule.
</TABLE>
<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 THREE
MONTHS ENDED, MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS AND ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 35,943,156
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 79,035,216
<CURRENT-ASSETS> 0
<PP&E> 15,622,801
<DEPRECIATION> 5,794,494
<TOTAL-ASSETS> 131,446,357
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 143,028
<OTHER-SE> 43,616,917
<TOTAL-LIABILITY-AND-EQUITY> 131,446,357
<SALES> 0
<TOTAL-REVENUES> 20,067,752
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 570,546
<INTEREST-EXPENSE> 1,418,938
<INCOME-PRETAX> 4,156,667
<INCOME-TAX> 1,497,000
<INCOME-CONTINUING> 2,659,667
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,659,667
<EPS-PRIMARY> 0.19
<EPS-DILUTED> 0.18
</TABLE>
