UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 50549
Form 10-KSB
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _______ to ____________
Commission file number 1-14219
Transnational Financial Corporation
- --------------------------------------------------------------------------------
(Name of small business issuer in its charter)
California
- --------------------------------------------------------------------------------
(State or other jurisdiction of incorporation or organization)
94-2964195
- --------------------------------------------------------------------------------
(I.R.S. Employer identification No.)
401 Taraval Street, San Francisco 94116
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (415) 242-7800
Securities registered under Section 12(b) of the Exchange Act:
Title of each class
Common Stock
Securities registered under Section 12(g) of the Exchange Act: None
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports. Yes X No
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by referenced in Part III of this Form
10-KSB or any amendment to this Form 10-KSB [ ]
State issuer's revenues for its most recent fiscal year: $11,481,200
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity, as of March
25, 1999. $6,383,200
State the number shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 3,700,000
<PAGE>
Item 1. Business
General
The Company is a mortgage banker which originates, funds and sells
mortgage loans through retail and wholesale branch operations secured by
one-to-four family residential properties in the San Francisco Bay Area. Since
1985, when the Company was incorporated, the Company has been engaged in the
retail origination of mortgage loans. In 1995, the Company began a wholesale
division to close and fund loans originated by mortgage brokers as well as those
originated through the Company's retail division. The Company funds its
originations through warehouse lines of credit. The mortgage loans are
subsequently sold together with the mortgage loan servicing rights to secondary
markets. The total loan production volume for 1998 was $1.05 billion which was
an increase of 126% compared to 1997, and 1997 was a 78% increase compared to
1996. Wholesale originations accounted for 87% of the Company's loan production
volume for 1998. The Company maintains four offices, a retail office in San
Francisco and wholesale offices in San Francisco, San Jose, and Tustin
California.
The Company originates a variety of mortgage loan products. Conforming
mortgage loans are those that qualify for inclusion in guarantee programs
sponsored by Federal National Mortgage Association ("FNMA"). Non-conforming
mortgage loans are those that do not conform to FNMA requirements. The principal
deviation from such standards relates to the size of the mortgage loan although
some do not conform because of lower documentation standards where there is a
lower loan-to-value ratio. Those that exceed the present FNMA guidelines for the
San Francisco Bay area, mortgage loans larger than $240,000, are called Jumbo
loans, comprised 66% of the mortgage loans originated by the Company in 1998. In
times of declining interest rates, the Company's predominant products are fixed
rate mortgages for a term of 15 or 30 years. When interest rates are rising, the
Company's predominant products are adjustable rate mortgages. While the Company
originates some home equity financing through second mortgages and some lines of
credit using the home as a security, these products constitute a small portion
of the Company's business.
From its inception, the Company's marketing niche has been borrowers that
have high credit ratings and require large mortgage loans with low loan to value
ratios. As a consequence, the average loan size originated by the Company in
1998 was approximately $259,000. Due to the large loan size and operating
efficiencies, the Company has sustained an efficient use of capital while
maintaining service quality combined with competitively priced loans. The
Company generates revenues through gains on the sale of mortgage loans and
servicing rights to investors, interest generated on mortgage loans held or
warehoused from the time the mortgage loan is originated until the mortgage loan
is sold, hedging activities, and, in the case of retail brokerage operations,
origination fees.
The Company closed its initial public offering in June 1998. The purpose
of this offering was to increase the Company's liquid capital because the total
amount available in the Company's warehouse lines to fund closing of mortgage
loans pending resale is limited to a multiple of the Company's capital.
Following the completion of the offering, the Company entered into a warehouse
line of credit with Guaranty Federal Bank, F.S.B. which achieved the purpose of
the offering. See "Item 6. Management's Discussion and Analysis or Plan of
Operation."
Following the completion of the offering, the Company opened an office in
Tustin, California. The Company is considering further offices in Southern
California and other states.
The Wholesale Origination Division
In 1998, wholesale mortgage loans constituted 87% of the Company's
mortgage loan originations. Wholesale mortgage loan origination involves the
purchase of loan applications from mortgage brokers for a purchase price less
than what the Company receives when it sells the same mortgage loan to an
investor. The mortgage loan is processed, closed and funded by the Company. To
maintain competitive rates with specific profit margins, the Company prices
mortgage loans on a daily basis.
The Company's wholesale lending division, which was established in May
1995, operates from its executive offices in San Francisco and offices in San
Jose and Tustin, California. Currently, the Company obtains mortgage loan volume
through a network of more than 600 independent mortgage brokers and other
financial intermediaries who are all screened and approved by the Company. With
the exception of the Company's retail division, in 1998 no single source of
independent brokers accounted for more than 5% of the Company's total wholesale
mortgage originations.
2
<PAGE>
Mortgage brokers are qualified to participate in the Company's wholesale
program after the completion of an application process which includes the
Company checking and verifying references, resumes, licenses and financial
statements. New broker relationships are established through business
development staff. Approved mortgage brokers are monitored by the Company's
wholesale account representatives and on a yearly basis the broker's financial
statements are updated and re-verified.
Mortgage loans are processed and every mortgage loan is underwritten by
the Company's underwriters, all of whom have many years of experience. Only
those mortgage loan applications which meet the Company's underwriting criteria
are funded. The Company uses the Internal Revenue Service ("IRS") verification
of income program, a particular tool which specifies that brokers must include
in the submitted file an IRS form which the Company uses to confirm with the IRS
certain income data on the mortgage loan application. This mechanism helps
ensure the quality of mortgage loans funded. If the mortgage loan file does not
contain this IRS form, the application is automatically rejected.
Wholesale lending allows the Company to benefit from cost efficiencies
derived from not having to take a mortgage loan application, a labor intensive
function, thereby reducing mortgage loan processing time, while being able to
centralize support functions and reduce fixed operating costs. Wholesale lending
offers the Company economies of scale while building substantial loan volume.
The Retail Origination Division
The Company's retail division was established in 1985 and employs four
commissioned mortgage loan officers located in one office in San Francisco.
While the retail division advertises weekly in San Francisco newspapers, most of
the retail division's business is generated through customer referrals, and a
high percentage of mortgage loans originated by the retail division close.
Approximately 71% of the mortgage loans originated by the retail division
are sold to the Company's wholesale division. The retail division completes and
processes the mortgage loan applications and prepares and organizes necessary
mortgage loan documents. The retail division underwrites these mortgage loans to
conform to either agency guidelines or private investor guidelines. Mortgage
loans acquired by the wholesale division are underwritten again by the wholesale
division. During 1998 the mortgage loans originated by the retail division were
evenly divided between conforming and non-conforming (Jumbo) mortgage loans,
with the average mortgage loan size originated by the retail division being
$267,000 and the average loan-to-value ratio being 80%.
The Company's retail division collects origination fees and closing costs
from the borrower which make the gross revenues larger than the revenues
generated by the wholesale division. However, the additional fees must be split
with commissioned mortgage loan officers and cover the cost of processing the
mortgage loan and assume the fixed operating costs, of the retail office. The
primary financial benefit to the Company of the retail division is as a source
for loans for the wholesale division.
The following table shows mortgage loan production volume by division.:
<TABLE>
<CAPTION>
Twelve Months Ended
December 31,
1998 1997 1996 1995
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Retail Division
Volume $137,356 $77,768 $54,686 $53,380
Percentage of Total Volume 13% 16% 21% 58%
Wholesale Division
Volume 913,780 387,312 206,613 38,328
Percentage of Total Volume 87% 84% 79% 42%
Total Loan Production
Volume $1,051,136 $465,080 $261,299 $ 91,708
Number of Loans 4,053 1,822 998 363
Average Loan Size $259 $255 $261 $252
Volume Growth 126% 78% 185%
---- --- ----
</TABLE>
3
<PAGE>
Loan Production Administration
All mortgage loan applications must be underwritten and approved in
accordance with the Company's underwriting standards and criteria. Underwriting
standards used for conforming loans are those promulgated by FNMA. Nonconforming
(Jumbo) loans are underwritten subject to credit and appraisal standards
established by specific investors. The Company analyzes the borrower's credit
standing, financial resources and repayment ability as well as the risk of the
underlying collateral.
All mortgage loans must have a property appraisal provided by an
independent third party, fee-based appraiser. Nationally recognized credit
reporting agencies provide complete reports of the borrower's credit history
including bankruptcies and delinquencies.
A given borrower may qualify for a mortgage loan through five mortgage
loan documentation programs: full documentation, limited documentation,
alternative documentation, no ratio loan documentation and no income/no asset
verification. Under the full documentation program, the borrower's assets,
income and employment are all verified by written or verbal confirmation. Under
the limited documentation program, more emphasis is placed on the ability to pay
and the property value. Under the alternative documentation program, income and
assets are confirmed by reviewing supporting documentation. Under the no ratio
loan documentation program, no income ratios are calculated. Under the no
income/no asset program, the value of the loan collateral is as critical as the
borrower's credit history. Each program places a heavy emphasis on credit scores
and differing loan to value ratios.
The Company's underwriting department consists of 11 underwriters who each
average 11 years of experience and who maintain the consistent quality of
mortgage loans expected by secondary market investors. The Company generally
takes five to ten days to underwrite a mortgage loan from the initial date of
the application. Upon completion of the underwriting process, the mortgage loan
is closed by a title agency chosen by the borrower.
The Company performs a pre-funding audit on all mortgage loans which
includes a verification of certain mortgage loan documentation to determine the
integrity of the data and a review for compliance with underwriting guidelines.
Post-funding audits are performed to monitor and evaluate the Company's
origination policies and procedures. Ten percent of all mortgage loans closed
are sampled and are subjected to a full quality control review including re-
underwriting the mortgage loan. Management receives a monthly report on any
deficiencies found in the randomly sampled mortgage loans. Management of the
Company believes that its use of the IRS Verification of Income program
increases significantly the quality of its originators.
Mortgage Loan Sales
The Company originates and purchases all of its mortgage loans with the
intent to sell the mortgage loans, without retaining any interest therein, and
the related servicing rights into the secondary market. The mortgage loans are
sold without recourse primarily to institutional investors, national banks and
mortgage lenders. At any given time there are several investors that have
contacted the Company and seek to purchase mortgage loans or enter into programs
to purchase mortgage loans. As part of the sale, the Company provides
representations and warranties which are customary to the industry and cover
such things as compliance with program standards, laws and regulations as well
as the accuracy of the information. In the event of a breach of these
representations and warranties, the Company may be required to repurchase these
mortgage loans and/or may be liable for certain damages. Normally, any
repurchased mortgage loan can be corrected and resold back to the original
investor.
The Company holds the originated or purchased mortgage loan for sale from
the time that the mortgage loan application is submitted by the borrower until
the time the mortgage loan is sold to an investor. During that time, the
interest rate on the mortgage loan might be higher or lower than the market rate
at which price the Company can sell the mortgage loan to an investor. Therefore,
a market gain or loss results on the salfe of the mortgage loan. To protect
against
4
<PAGE>
interest rate changes on mortgage loans that are in the warehouse (mortgage
loans that have closed but not sold) and pipeline loans (loans which are not yet
closed but on which an interest rate has been set) the Company often commits to
deliver mortgage loans at a specific price for future delivery to investors
through the use of commitments on a "best efforts" basis where the Company has
no obligation to sell a mortgage loan to an investor unless and until the
mortgage loan closes.
The Company has a hedging program in place which is administered for the
Company by Tuttle & Co. using a managed account. The Company is able to take
advantage of the hedging firm's reporting services, pipeline management, mark to
market, commitment and position reporting. At any one time the Company hedges
approximately 75% of the value of loans warehoused or in the pipeline.
Individual mortgage loans are grouped by note rate, loan type and length of time
in the pipeline. These are then matched based on duration with the appropriate
hedging instrument which reduces risk until the mortgage loan is closed and
delivered to the investor. Hedging gains and losses are recorded at settlement.
Funding of Mortgage Loans
The Company needs substantial cash flow to facilitate the funding and
closing of the originated and purchased loans. These funds are provided on a
short-term basis by financial institutions that specialize in providing lines of
credit known as warehouse lines. Following the close of the Company's public
offering in June, 1998, the Company entered into a warehouse line of credit with
Guaranty Federal Bank, F.S.B., replacing existing warehouse lines of credit.
The amount of the warehouse line provided by a lender is based on the
Company's net worth. Often a warehouse lender applies a leverage factor of
between ten to twelve. Guaranty Federal Bank's warehouse line of credit provides
a basic lending amount of $105 million with an additional gestation line, that
is, the ability to sell mortgage loans subject to their purchase by a third
party that has previously agreed to purchase the mortgage loans. An additional
gestation line of $30 million is provided by Greenwich Capital. These facilities
replaced several warehouse agreements which provided funding capabilities in the
aggregate of $18 million with an additional bulge facility of $44 million. The
warehouse bank receives $35 per loan from the Company plus interest at the
London Interbank Offered Rates ("LIBOR") plus approximately 1.5% per annum on
the unpaid principal balance of the loan for the time the loan is in the
warehouse. This interest rate represents a reduction of approximately 2.5% from
the prior warehouse agreements. As a result of the new warehouse line of credit
and during the period between funding the loan and its sale to investors, the
Company often makes a small percentage on the difference between the amount the
Company pays the warehouse lender and the amount received from the borrower.
Previously the Company lost as much as two to two and one half percent on each
loan it funds (the difference between the rate charged by the warehouse bank and
the note rate on the loan). LIBOR is the British Bankers' Association average of
interbank offered rates for dollar deposits in the London market based on
quotations at 16 major banks and act as a base lending rate similar to the prime
rate.
The Company submits the mortgage loan to the warehouse bank for funding
along with the investor commitment, if any, to purchase the loan. The warehouse
agreement has various financial and operational covenants with which the Company
must comply.
Competition
The Company faces strong competition in originating, purchasing and
selling mortgage loans and the related mortgage servicing rights. The Company's
competition is principally from savings and loan associations, other mortgage
companies, commercial banks and, to a lesser degree, credit unions and insurance
companies, depending upon the type of mortgage loan product offered. Many of
these institutions have greater financial and other resources than the Company
and maintain a significant number of branch offices in the area in which the
Company conducts operations. Increased competition for mortgage loans from other
lenders may result in a decrease in the volume of mortgage loans originated and
purchased by the Company. If the Company is unable to compete effectively, its
business, results of operations and financial condition could be materially and
adversely affected.
The Company depends primarily on mortgage brokers who are not obligated by
contract to originate or deliver new mortgage loans to the Company. Mortgage
brokers compete on the basis of customer service, range of loan
5
<PAGE>
products offered and pricing. Although the Company emphasizes pricing to
brokers, it strives to offer brokers a variety of competitive products and
efficient mortgage loan processing and closing.
Legislation and Regulation
Federal, state and local authorities regulate and examine the origination,
processing, underwriting, selling and servicing of mortgage loans. The Company
is an approved seller/servicer of mortgage loans for FNMA and is in the process
of obtaining Federal Home Loan Mortgage Corporation approval. In addition, the
Company is an approved mortgagee by the United States Department of Housing and
Urban Development ("HUD") and is qualified to originate mortgage loans insured
by Federal Housing Authority ("FHA") or guaranteed by the Veterans
Administration ("VA"). Among other consequences, the failure to comply with HUD
or FNMA regulations could prevent the Company from reselling its mortgage loans
or prevent its ability to enter into the servicing of mortgage loans should it
choose to do so. Such failure could also result in demands for indemnification
or mortgage loan repurchase, certain rights of rescission for mortgage loans,
class action law suits and administrative enforcement actions, any of which
could have a material adverse effect on the Company's business results of
operations and financial conditions.
Federal, state and local governmental authorities also regulate the
Company's activities as a lender. The TILA and Regulation Z promulgated
thereunder contain certain requirements designed to provide consumers with
uniform, understandable information with respect to the terms and conditions of
mortgage loans and credit transactions. The Equal Credit Opportunity Act
prohibits creditors from discriminating against applicants on the basis of race,
color, sex, age or marital status, among other restrictions and requirements. In
instances where the applicant is denied credit, or the rate or charge for a
mortgage loan increases as a result of information obtained from a consumer
credit agency, the Fair Credit Reporting Act of 1970 requires the lender to
supply the applicant with a name and address of the reporting agency. The Real
Estate Settlement Procedures Act and the Debt Collection Practices Act subject
the Company to filing an annual report with the Department of Housing and Urban
Development.
There can be no assurance that the Company will maintain compliance with
these requirements in the future without additional expenses, or that more
restrictive local, state or federal laws, rules and regulations will not be
adopted or that existing laws and regulations will not be interpreted in a more
restrictive manner, which would make compliance more difficult and more
expensive for the Company.
Employees
As of February 1, 1999, the Company had 83 employees, all of whom worked
on a full-time basis. None of the Company's employees is represented by a union.
The Company considers its relations with its employees to be excellent.
Item 2. Description of Property.
The Company has offices in three separate locations in San Francisco which
occupy approximately 11,000 square feet of commercial office space. The Company
has additional offices in San Jose and Tustin, California. All of the space is
leased, and presently the Company's monthly rental for office space is
approximately $27,000.
In June 1998 the Company entered into a lease for 6,200 square feet of
office space in San Francisco with a monthly rental of approximately $10,000.
The term of the lease is for five years commencing the date of the Company's
occupancy which occurred in mid August. This new office space is used for
corporate administrative offices and for conducting wholesale mortgage lending
operations. The Company believes that the wholesale and retail offices are
adequate for the foreseeable future. The Company maintains adequate casualty
insurance on all its property.
Item 3. Legal Proceedings.
The Company is involved in legal proceedings arising in the ordinary
course of business. The ultimate outcome of these proceedings can not be
determined because of the uncertainties that exist. In the opinion of
management, the disposition of matters that are pending or asserted will not
have a materially adverse effect on the financial position of the Company.
Item 4. Submission of Matters to a Vote of Security Holders.
None
6
<PAGE>
PART II
Item 5. Market for Common Equity and Related Stockholder Matters.
The Company's Common Stock is listed on the American Stock Exchange and is
traded under the symbol TFN.
The Company completed its initial public offering in June 1998 after the
Securities and Exchange Commission declared its registration statement effective
on June 24, 1998. The following table summarizes the shares offered and sold in
the offering:
<TABLE>
<CAPTION>
Seller Shares Offered Aggregate Price Shares Sold Aggregate Price
<S> <C> <C> <C> <C>
The Company 1,200,000 $9,000,000 1,200,000 $ 9,000,000
Kristul Family LLC 180,000 1,350,000 138,790 1,040,795
----------- ------------ ---------- -------------
Total 1,380,000 $10,350,000 1,338,790 $10,040,795
</TABLE>
After deducting the offering expenses, the Company realized $7,419,719 net
proceeds from the offering. At closing, the Company repaid $1,000,000 in
subordinated debt. The Company utilized the balance, $6,419,719 to enter into a
new warehouse line of credit to increase its borrowing capacity to fund an
additional mortgage volume of mortgage loans. In August, 1998, the Company
entered into a warehouse facility with Guaranty Federal Bank, F.S.B. whereby the
Company obtained a line of credit of $75,000,000. This line of credit has been
subsequently increased to $105,000,000 and the Company has entered into an
additional "Gestation" line of credit with Greenwich Capital in the amount of
$30,000,000. See "Item 6. Management's Discussion and Analysis or Plan of
Operation."
The following table sets forth certain information regarding the proceeds
of the offering:
Gross Proceeds to the Company $9,000,000
Underwriting Discounts and Commissions 900,000
Nonaccountable underwriter expense allowance 180,000
Other expenses 500,281
------------
Total Expenses 1,580,281
Net proceeds to the Company $7,419,719
The net proceeds to the Company set forth above is $62,781 less than that
indicated in the Company's prospectus.
The following table sets forth the high and low sales price, as reported
by the American Stock Exchange, of the Company's Common Stock commencing June
24, 1998:
1998 High Low
Second quarter 7.625 6.75
Third quarter 8.87 4.125
Fourth quarter 5.87 3.375
As of March 10, 1999, there were approximately 650 shareholders of record
of the Company's Common Stock.
Item 6. Management's Discussion and Analysis or Plan of Operation.
This annual report on Form 10-KSB contains certain "forward-looking
statements", including, without limitation, statements containing the words
"believes," "anticipates," "expects," "intends", "plans," "should," "seeks to,"
and similar words. People are cautioned that such forward-looking statements are
not guarantees of future performance and involve risks and uncertainties. Actual
results may differ materially from those in the forward-looking statements as a
result of various factors, including, but not limited to, interest rates,
economic conditions, competitive factors, changes in operating costs, and the
success of the Company's operating plans.
The following should be read in connection with the Company's financial
statements, related notes and other financial information included elsewhere in
this Prospectus.
7
<PAGE>
General
In May of 1995, the Company expanded its operations to include wholesale
mortgage banking in addition to its existing retail mortgage banking. See
"Business - The Wholesale Origination Division." The growth of the Company has
been driven since that time by the wholesale division.
The effect of the establishment of the Company's wholesale division has
been to place greater demand on the Company's financial resources as well as the
requirements for additional personnel.
Year Ended December 31, 1998 compared to Year Ended December 31, 1997
The Company's C corporation tax status pro forma net income increased to
$1,050,479 in 1998 from $508,772 in 1997.
Revenues in 1998 continued to increase from the prior year which is the
principal reason for the growth in pro forma net income. Revenues increased to
$11,481,200 from $4,481,233 or 156%. The Company was able to respond to general
demands for mortgage loans that resulted from lower interest rates throughout
1998.
Both wholesale and retail production grew strongly in 1998. Wholesale
mortgage loan production grew from $387,312,000 in 1997 to $913,780,000 in 1998,
an increase of 136%. Retail mortgage loan production grew from $77,768,000 in
1997 to $137,356,000 in 1998, an increase of 76.6%.
The increased volume of mortgage loans for 1998 aided the Company in
obtaining better pricing for the sale of its mortgage loans. The increase in
sales from mortgage loans, an increase of 172% in 1998 over 1997, was more than
the increase in mortgage loan production volumes, 126.0%. The Company's more
favorable pricing in 1998, however, was a somewhat offset in the fourth quarter
because diminished liquidity in the industry adversely affected the pricing of
sales of mortgage loans.
The Company's profitability was also affected by increased interest
expense and salaries in 1998. Prior to the Company's public offering, the
Company had been taxed as an "S" corporation. Consequently the Company's two
owners had elected to take no salaries and instead were compensated through
earnings of the Company. When the Company's basis for taxation changed to a "C"
corporation, both executives began to receive salaries. The Company also added
senior executives, to manage the increasing business base.
Year Ended December 31, 1997 compared to Year Ended December 31, 1996
The Company's pro forma net income increased in 1997 to $508,772 from
$243,774 in 1996. The increase is principally due to the Company's growth in
revenues attributable to its wholesale mortgage loan production. Revenues for
the 1997 fiscal year were $3,189,837 compared to revenues of $1,929,084 in
fiscal 1996. Wholesale mortgage loan production for 1997 was $387,311,770
compared to $206,613,000 for 1996. The average mortgage loan size for the
wholesale operations remained essentially unchanged between 1997 and 1996,
$264,196 and $278,079, respectively.
Although the dominant increase in the Company's revenues is attributable
to growing wholesale division, the Company's retail division also
contributed to its increase in revenues in 1997 over 1996. Retail mortgage loan
production increased to $77,768,000 in 1997 compared to $54,686,000 in 1996, an
increase of approximately 42%. The number of loans originated by the retail
division increased, however, by approximately 11% reflecting, in management's
opinion, increased housing costs in the San Francisco Bay area.
While revenues grew approximately 65% from 1996 to 1997, expenses grew
approximately 53%. The Company benefitted from operational efficiencies relating
to the growth of its wholesale division with salaries and benefits, general and
administrative expenses and occupancy expenses an aggregate of approximately
49.5%. However, the savings that arose from these efficiencies were reduced
because of increased interest costs, which increased to $279,093 in 1997 from
$146,860 in 1996, or approximately 90.0% attributable to the Company's larger
volume of mortgage loans.
Liquidity and Capital Resources
The Company's capital resources substantially are provided by its
warehouse lenders who fund mortgage loans pending resale of those mortgage loans
to investors. In August 1998 the Company entered into warehouse lines of credit
8
<PAGE>
which as of March 1, 1999, had $105,000,000 in lending capacity. In addition,
the Company had a $30,000,000 gestation line that enables the Company to sell
mortgage loans which investors have committed to purchase at a later date.
Balance outstanding at December 31, 1998 is $53.6 million.
The Company engages in hedging activities. The primary function of the
hedging is to protect the Company's mortgage position against adverse movements
in interest rates and thereby maintain the Company's net profit margins.
Protection is accomplished by committing to the forward sale of mortgage loans
with either a "best efforts" purchase, that is a purchase whereby the Company
commits to use its best efforts to supply a mortgage loan at a specified
interest rate, or a mandatory purchase by an investor where the interest rate on
the sale is not determined until an investor acquires the mortgage loan. Best
efforts transactions transfer the interest rate risk to the investor and
therefore require no hedging activity. Mortgage loans scheduled for a mandatory
sale, that is those mortgage loans that the Company does not have a commitment
to purchase the mortgage loan at a specified rate, are hedged according to the
hedging policy. The hedging policy is an analytical framework that accurately
and systematically quantifies exposure to interest rate risk. The foundation of
the Company's risk analysis for hedged mortgage loans is the Tuttle & Company
Risk Management model. The hedge involves the sale of the appropriate quantity
of mortgage-backed securities as mortgage loans are committed to by the Company.
The Company then purchases the same securities as mortgage loans are sold on a
mandatory basis. The risks involved include market risk on the unsold portion of
the mortgage loans and the interest rate risk between whole mortgage loan and
security pricing.
Year 2000
The Company recognizes the need to ensure its operations will not be adversely
impacted by Year 2000 software failures. Accordingly, over the next few years,
management may incur additional expenditures to modify its software to operate
correctly for the year 2000. While considered to be immaterial by management,
the Company has not yet quantified such costs, which will be expensed as
incurred. If the Company or other entities not affiliated with the Company do
not address this issue successfully, the Company's business could be materially
affected.
The Company depends upon the effective operations of the financial institutions
with which the Company deals as well as the United States financial system as
administered by the United States Federal Reserve Board. To the extent that
these institutions fail to have software that effectively deals with the Year
2000 issue, the Company's business could be materially affected.
Item 7. Financial Statements.
The response to this item is submitted as a separate section of this Form
10-KSB. See "Item 13. Exhibits and reports on Form 8-K."
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.
See Form 8-K filed on September 15, 1998.
PART III
Item 9. Directors, Executive Officers, Promoters and control Persons;
Compliance With Section 16(a) of the Exchange Act.
The following table sets forth certain information regarding the Company's
directors and executive officers.
Name Age Position
Joseph Kristul 51 Chief Executive Officer and Treasurer,
Director
Maria Kristul 51 President, Director
Chito F. Schnupp 48 Executive Vice President
Robert W. Bronson 42 Senior Vice President
Ronald W. Kiehn 57 Director of Operations
Eugene Kristul 28 Secretary, Director
Hilary Whitley 50 Director
Robert A. Shuey 44 Director
Robert A. Forrester 54 Director
Joseph Kristul founded the Company in 1985, has been a director and
officer since that time and has been responsible for the Company's overall
management since the Company's inception, emphasizing mortgage loan pricing,
funding, administration and sales. Beginning in 1995 Mr. Kristul created the
Company's wholesale division, developing the Company's base of brokers, which
deliver loan product, and implementing systems and controls on the quality of
the product delivered by brokers.
9
<PAGE>
Maria Kristul founded the Company in 1985, has been a director and officer
since 1991, and has been responsible for the Company's retail division since the
Company's inception. As well as personally originating approximately 60%, in
1998, of the retail division's production, Ms. Kristul oversees the retail
division's day to day operations including training and managing that divisions
sales and loan processing staff and its quality assurance.
Chito F. Schnupp joined the Company in February, 1999, and is manager of
the Company's loan administration operations. Ms. Schnupp was Vice President of
Secondary Marketing from October, 1988, to December, 1995 for Medallion/AccuBank
Mortgage. From March, 1996 to March ,1998 she was Vice President of Secondary
Marketing for First Franklin Financial Corporation and from March, 1998 through
January, 1999 she was Vice President of Operations for Crossland Mortgage.
Robert W. Bronson joined the Company effective April 1, 1998, and is the
Company's Senior Vice President of Secondary Marketing. In 1997 and 1998 Mr.
Bronson was an Account Manager for Tuttle & Co., a mortgage hedging consultant.
Prior to joining Tuttle & Co., Mr. Bronson was Vice President of Secondary
Marketing for WMC Mortgage Corp and that firm's predecessor, Weyerhaeuser
Mortgage Company where he was responsible for that firm's trading operations,
responsibilities he assumed in 1991. Mr. Bronson joined Weyerhaeuser Mortgage
Company in 1986, and prior to assuming responsibilities for that firm's trading
operations, Mr. Bronson held a variety of positions in the corporate finance
department.
Ronald W. Kiehn joined the Company in February of 1997 and is responsible
for administration of the Company's wholesale loan origination. For
approximately one year prior to joining the Company, Mr. Kiehn was a private
consultant to the mortgage banking industry emphasizing sales, marketing,
secondary marketing, underwriting and due diligence. From June of 1991 through
December of 1995, Mr. Kiehn was Vice President of Secondary Marketing for
Medallion Mortgage Company, and from 1986 through 1991, Mr. Kiehn held sales and
marketing positions as well as secondary marketing and loan administration
responsibilities for Mortgage Loans America.
Eugene Kristul has been engaged in the private practice of law since
December 1996. Eugene Kristul became a director in March 1998 and Secretary in
1996. Prior to becoming an attorney, Eugene Kristul was a law student.
Joseph and Maria Kristul are husband and wife. Eugene Kristul is their
son.
Hilary Whitley became a director of the Company in April of 1998 and is
the founder of Financial Capital Resources, Inc., which was formed in 1988 and
specializes in client representation principally relating to financial matters
within the mortgage banking industry. Prior to founding Financial Capital
Resources, Ms. Whitley focused her career of over fifteen years on financial
management, eight of which were directly involved with mortgage banking with an
emphasis on mergers and acquisitions, business and strategic planning. Ms.
Whitley has held the position of Chief Financial Officer for several companies
and was previously in public accounting with the predecessor of KPMG Peat
Marwick LLP.
Robert A. Shuey, III, has been a director of the Company since August
1998. Mr. Shuey is Chief Executive Officer of EuroMed, Inc., the parent company
of Redstone Securities, Inc. From August 1997 to December 1998 he acted as
Managing Director of Capital Markets for Tejas Securities Group, Inc. From
September 1996 to July 1997, he acted as Managing Director Corporate Finance for
National Securities Corporation; from April 1995 to August 1996, he acted as
Managing Director Corporate Finance for LaJolla Securities Corporation; from
January 1993 to March 1995 he acted as Managing Director Corporate Finance for
Dillon-Gage Securities, Inc. Mr. Shuey is a member of the Board of Directors of
EuroMed, Inc., AutoBond Corporation, Westower, Inc. and Bioshield Technologies,
Inc.
Robert A. Forrester became a director of the Company in March, 1999. Mr.
Forrester is an attorney and has practiced in his own firm since April 1989. Mr.
Forrester is a member of the State Bars of Texas and California.
Committees of the Board of Directors
The Company's Board of Directors has established an Audit Committee and a
Compensation Committee whose members are Ms. Whitley and Mr. Shuey. The duties
of the audit Committee are to recommend to the entire Board of Directors the
selection of independent certified public accountants to perform an audit of the
financial statements of the Company, to review the activities and report of the
independent certified public accountants, and to report the results os such
review to the entire Board of Directors. The audit Committee also monitors the
internal controls of the Company. The duties of the Compensation Committee are
to provide a general review of the Company's Compensation and benefit plans to
ensure that they meet corporate objectives and to administer or oversee the
Company's Stock Option Plan and other benefit plans. In addition, the
Compensation Committee reviews the compensation of officers of the Company and
the recommendations of the Chief
10
<PAGE>
Executive Officer on (i) compensation of all employees of the Company and (ii)
adopting and changing major Company compensation policies and practices. Except
with respect to the administration of the Stock Option Plan, the Compensation
Committee will report its recommendations to the entire Board of Directors for
approval.
Section 16(a) Beneficial Ownership Reporting Compliance.
The Company became a reporting Company on June 24, 1998. The initial Form
3's for Joseph Kristul, Maria Kristul, Eugene Kristul, Hilary Whitley, Robert W.
Bronson, and Ronald W. Kiehn were filed on September 4, 1998. The initial Form 3
for Robert A. Shuey, who became a director on August 14, 1998, was filed on
February 5, 1999.
On July 1, 1998 and July 27, 1998, the Kristul Family LLC, of which Joseph
and Maria Kristul are beneficial owners, sold 50,000 and 88,790 shares,
respectively. The sales price per share in these transactions was $7.50 or a
total of $1,040,925 and the transactions were reported on September 18, 1998. On
December 16, and December 21, 1998, Ms. Whitley purchased 9.900 shares for $4.50
and 1,100 shares for $4.0625, respectively. These purchases were reported on
February 5, 1999.
Item 10. Executive Compensation.
The following table sets forth the compensation paid to the Company's
Chief Executive Officer and the only other executive officer who earned more
than $100,000 in 1998 (the "Named Executive Officers") for services rendered to
the Company in all capacities for the fiscal years ended December 31, 1998.
Summary Compensation Table
<TABLE>
<CAPTION>
Name and Annual Compensation All Other
Principal Position Fiscal Year Salary Bonus Compensation
- ------------------ ----------- ------ ----- ------------
<S> <C> <C> <C> <C> <C>
Joseph Kristul (1) 1998 $166,667 57,661 $389,605
Chief Executive Officer 1997 $12,000 - $256,536
Maria Kristul (1) 1998 $296,887 - $389,605
President 1997 $12,000 - $256,537
Ron Kiehn(2) 1998 $113,639 - -
Vice President
- ----------------
</TABLE>
(1) All Other Compensation represent distributions made to Joseph and
Maria Kristul in connection with the Company's status as an S
corporation.
(2) In 1998 the Company granted to Mr. Kiehn the right to acquire
15,000 shares of Common Stock of which Mr. Kiehn presently has the
right to acquire 6,000 of such shares. The exercise price is $7.50
and the option expires in 2008.
Employment Agreements
The Company has employment agreements with five people, Joseph Kristul,
Maria Kristul, Robert W. Bronson, Ronald W. Kiehn and Chito Schnupp. Joseph and
Maria Kristul's agreements end December 31, 1999 and may be renewed for an
additional one year term. Beginning May 1, 1998, Mr. Kristul will receive a
salary of $250,000 per year with an bonus equal to 10% of the Company's pretax
profits up to a maximum bonus of $150,000. Beginning January 1, 1999, Maria
Kristul will receive an annual salary of $300,000.
Ms. Schnupp's agreement's term ends on December 31, 1999. The agreement
calls for a base salary of $132,000 per year, plus a signing bonus of $33,000.
Ms Schnupp has been awarded options to acquire 15,000 shares for $7.50 under the
Company's stock option plan.
Mr. Bronson's agreement's term ends on March 31, 1999 and may be renewed
for an additional one year term. In addition to a signing bonus of $5,000, Mr.
Bronson's agreement calls for an annual salary of $100,000 plus a bonus of
$50,000 provided the Company's trading operations and the increase in margins,
as defined, result in an increased profit of $1,000,000.
Mr. Kiehn's agreement's term ends on May 1, 1999 and may be renewed for an
additional one year term. Mr. Kiehn's base salary is $92,000 per year plus $250
per month car expenses.
11
<PAGE>
Each of the above employment agreements provide that the executive is
entitled to benefits that the Company's Board of Directors or its Compensation
Committee may determine. In defined circumstances, the agreements also provide
severance payments of up to two times the executive's annual base salary upon
termination and immediate vesting of any stock options.
Stock Option Plan
The 1998 Stock Option Plan (the "Stock Option Plan") provides for the
grant to employees, officers, directors, and consultants to the Company or any
parent, subsidiary or affiliate of the Company of up to 300,000 shares of the
Company's Common Stock, subject to adjustment in the event of any subdivision,
combination, or reclassification of shares. The Stock Option Plan will terminate
in 2008. The Stock Option Plan provides for the grant of incentive stock options
("ISO's") within the meaning of Section 422 of the Internal Revenue Code of
1986, as amended, and non-qualified options at the discretion of the Board of
Directors or a committee of the Board of Directors (the "Committee"). The
exercise price of any option will not be less than the fair market value of the
shares at the time the option is granted. The options granted are exercisable
within the times or upon the events determined by the Board or Committee set
forth in the grant, but no option is exercisable beyond ten years from the date
of the grant. The Board of Directors or Committee administering the Stock Option
Plan will determine whether each option is to be an ISO or non-qualified stock
option, the number of shares, the exercise price, the period during which the
option may be exercised, and any other terms and conditions of the option. The
holder of an option may pay the option price in (1) cash, (2) check, (3) other
mature shares of the Company, (4) any combination of the foregoing methods of
payment, or (5) other consideration or method of payment for the issuance of
shares as may be permitted under applicable law. The options are nontransferable
except by will or by the laws of descent and distribution. Upon dissolution,
liquidation, merger, sale of stock or sale of substantially all assets,
outstanding options, notwithstanding the terms of the grant, will become
exercisable in full at least 10 days prior to the transaction. The Stock Option
Plan is subject to amendment or termination at any time and from time to time,
subject to certain limitations.
The plan is administered by the Compensation Committee of the Board of
Directors.
In April of 1998 the Company agreed to grant options for 15,000 shares
each to Messrs. Bronson, and Kiehn, exercisable at the initial public offering
price of $7.50. Furthermore, the Company has granted to Ms. Schnupp options to
acquire 15,000 shares at $7.50. Ms. Kristul has been granted options to acquire
30,000 shares of Common Stock plus an additional 20,000 shares of Common Stock
if the Company's San Francisco retail division produces $150,000,000 in mortgage
loans in 1999. For each additional $10,000,000 in mortgage loan production from
the San Francisco retail division above $150,000,000, the Company will grant Ms.
Kristul options to acquire an additional 5,000 shares. The exercise price of
each of these options if $7.50 per share.
The following sets forth certain information regarding compensation of
directors paid for services in 1998 and those appointed to serve as directors
other than named executive officers:
<TABLE>
<CAPTION>
Number of
Annual Consulting Securities
Retainer Meeting Fees/Other Number of Underlying
Name Fees Fees Fees Shares Options
<S> <C> <C> <C> <C>
Eugene Kristul 22,000
Hilary Whitley 7,000 120,461 18,750 60,000(1)
Robert A. Shuey 7,000 60,000(1)
Robert A. Forrester 121,264 12,500 60,000(1)
</TABLE>
(1) The exercise price of all such options is $7.50. Of the 60,000 shares
of Common Stock indicated for each of Ms. Whitley and Messrs. Shuey and
Forrester, 40,000 are exercisable upon a change of control in the
Company.
12
<PAGE>
Non-employee directors of the Company receive $1,000 per month for each
month the director served. The director also receives $500 per meeting attended
and related travel expenses.
Item 11. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth certain information regarding the
beneficial ownership as of March 15, 1999, of the Common stock by (a) each
person known by the Company to be a beneficial owner of more than 5% of the
outstanding shares of Common Stock and by each Selling Shareholder, (b) each
director of the Company, (c) each Named Executive Officer, and (d) as directors
and executive officers of the Company as a group. Unless otherwise noted, each
beneficial owner named below has sole investment and voting power with respect
to the Common Stock shown below as beneficially owned by him.
Name and Address of Number of Percent
Beneficial Owner Shares Owned Owned
Kristul Family LLC(1)(2) 2,329,960 60.8
401 Taraval Street
San Francisco, CA 94116
Joseph Kristul(1)(2) 2,340,060 61.1
401 Taraval Street
San Francisco, CA 94116
Maria Kristul(1)(2)(3) 2,370,060 61.9
401 Taraval Street
San Francisco, CA 94116
Eugene Kristul(4) 20,000 0.5
401 Taraval Street
San Francisco, CA 94116
Hilary Whitley(4) 57,900 1.5
5445 Mariner
Suite 107
Tampa FL 33609
Robert A. Shuey(4) 20,100 0.5
8214 Westchester
Suite 500
Dallas, TX 75225
Robert A. Forrester(4) 32,500 0.8
1215 Executive Drive West
Suite 102
Richardson, TX 75081
Ronald W. Kiehn(5) 6,000 0.2
All Executive Officers and
Directors as a group (11 persons)(3)(4)(5) 2,528,360 66.0%
- -------------------
(1) Joseph Kristul is a managing member of the Kristul Family LLC and
the beneficial owner of 42.5% of the shares held by the Kristul
Family LLC and is jointly with Maria Kristul the beneficiary of a
trust that is a member owning 15% of the Kristul Family LLC.
13
<PAGE>
(2) Maria Kristul is a managing member of the Kristul Family LLC and
the beneficial owner of 42.5% of the shares held by the Kristul
Family LLC and is jointly with Joseph Kristul the beneficiary of a
trust that is a member owning 15% of the Kristul Family LLC.
(3) Includes 30,000 shares that Mrs. Kristul has the right to acquire
for $7.50 per share pursuant to the Stock Option Plan.
(4) Includes 20,000 shares of Common Stock Ms. Whitley and Messrs.
Shuey, Eugene Kristul and Forrester each have the right to acquire
pursuant to a non-qualified option.
(5) Includes 6,000 shares Mr. Kiehn has the right to acquire pursuant
to the Company's Stock Option Plan and 21,000 shares executive
officers and directors have the right to acquire as a group
pursuant to the Stock Option Plan.
Item 12. Certain Relationships and Related Transactions
Joseph and Maria Kristul each personally guaranteed the Company's
warehouse lines of credit with Warehouse Lending Corporation of America and PNC
Mortgage Bank, National Association. After the close of the Company's public
offering in June, 1998, the Company entered into a new warehouse line of credit
with Guaranty Federal Savings Bank, F.S.B. Thereafter the Company did not renew
the previous agreements, and the Kristuls no longer guaranty any of the
Company's indebtedness.
In 1997 and 1996, certain of the Company's certificates of deposit were
pledged to Wells Fargo Bank, N.A., for the personal indebtedness of Joseph and
Maria Kristul. In March 1998, Wells Fargo released this security interest.
In March 1998, the Company entered into a subordinated debt agreement with
InSouth Bank under which all of the Company's stock at the time, or 2,468,750
shares, was pledged to secure the indebtedness of $1,000,000. Upon completion of
the Company's public offering the subordinated debt was repaid and the Kristul's
pledge and personal guarantees released.
The Company has agreed to indemnify Joseph and Maria Kristul for taxes
owing by the Company for which Joseph and Maria Kristul are obligated upon the
termination of the Company's status as an S corporation.
Eugene Kristul receives a monthly retainer of $2,000 for legal services
rendered to the Company.
For the year ended December 31, 1997, the Company paid to Financial
Capital Resources, Inc., an affiliate of Ms. Whitley's, $5,600 for consulting
services. In connection with consulting services rendered to the Company in 1998
by Financial Capital Resources, Inc., the Company paid to Financial Capital
Resources, Inc. $120,461 and issued 18,750 shares of Common Stock in connection
with services rendered for the Company's initial public offering.
Effective December 31, 1997, the Company entered into a promissory note
payable to the Company by Joseph and Maria Kristul which matured March 31, 1998
bearing interest at 6.5% per annum. This note has been repaid as of March 31,
1998.
In 1998 the Company issued to Mr. Forrester 12,500 shares of Common Stock
in connection with services rendered for the Company's initial public offering
and paid Mr. Forrester $121,264 in connection with legal services rendered to
the Company.
14
<PAGE>
Item 13. Exhibits and Reports on Form 8-K.
(a) Financial Statements
The following financial statements are included herewith:
Page
----
Independent Auditors' Report 1
Balance Sheets 2
Statements of Income 3
Statements of Shareholders' Equity 4
Statements of Cash Flows 5
Notes to Financial Statements 6
Report of Independent Certified Public Accountants
(b) Reports on Form 8-K
None
(c) Exhibits
Exhibit 1.1 Form of Underwriting Agreement. (Incorporated by
reference from a similarly numbered exhibit filed with
the Company's Registration Statement No. 333-50657)
Exhibit 1.2 Form of Underwriters' Warrant Agreement (Incorporated
by reference from a similarly numbered exhibit filed
with the Company's Registration Statement No.
333-50657)
Exhibit 3.1 Restated Articles of Incorporation (Incorporated by
reference from a similarly numbered exhibit filed with
the Company's Registration Statement No. 333-50657)
Exhibit 3.2 Bylaws (Incorporated by reference from a similarly
numbered exhibit filed with the Company's Registration
Statement No. 333-50657)
Exhibit 10.1 Employment Agreement of Joseph Kristul (Incorporated
by reference from a similarly numbered exhibit filed
with the Company's Registration Statement No.
333-50657)
Exhibit 10.2 Employment Agreement of Maria Kristul (Incorporated by
reference from a similarly numbered exhibit filed with
the Company's Registration Statement No. 333-50657)
Exhibit 10.3 Employment Agreement of Robert W. Bronson
(Incorporated by reference from a similarly numbered
exhibit filed with the Company's Registration
Statement No. 333-50657)
Exhibit 10.4 Employment Agreement of Matt Heidari (Incorporated by
reference from a similarly numbered exhibit filed with
the Company's Registration Statement No. 333-50657)
Exhibit 10.5 Employment of Ronald W. Kiehn (Incorporated by
reference from a similarly numbered exhibit filed with
the Company's Registration Statement No. 333-50657)
Exhibit 10.6 1998 Stock Option Plan (Incorporated by reference from
a similarly numbered exhibit filed with the Company's
Registration Statement No. 333-50657)
Exhibit 10.7 Agreement between the Registrant and Warehouse Lending
Corporation of America (Incorporated by reference from
a similarly numbered exhibit filed with the Company's
Registration Statement No. 333-50657)
Exhibit 10.8 Agreement between the Registrant and PNC Mortgage
Bank, National Association (Incorporated by reference
from a similarly numbered exhibit filed with the
Company's Registration Statement No. 333-50657)
15
<PAGE>
Exhibit 10.9 Letter agreement between the Company and Financial
Capital Resources (Incorporated by reference from a
similarly numbered exhibit filed with the Company's
Registration Statement No. 333-50657)
Exhibit 27.1 Financial Data Schedule
16
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
of Transnational Financial Corporation
We have audited the accompanying balance sheet of Transnational Financial
Corporation as of December 31, 1998, and the related statement of income,
shareholders' equity and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The financial statements of Transnational Financial Corporation for
the year ended December 31, 1997 were audited by other auditors whose report,
dated June 4, 1998, expressed an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 1998, and the
results of its operations and its cash flows for the year then ended in
conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
San Francisco, California
March 23, 1999
<PAGE>
TRANSNATIONAL FINANCIAL CORPORATION
BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 1998 1997
<S> <C> <C>
Cash $ 990,115 $ 482,558
Certificates of deposit - 272,298
Mortgage loans held for sale 62,540,846 50,288,714
Accrued interest receivable 45,524 181,763
Notes receivable 135,819 135,819
Notes receivable, shareholders - 250,000
Investment in real estate 195,308 199,944
Property and equipment 271,441 103,267
Other assets 287,342 61,420
-------------- ---------------
TOTAL ASSETS $ 64,466,395 $ 51,975,783
============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Warehouse notes payable $ 53,587,740 $ 50,154,791
Accrued interest payable 462,487 202,118
Real estate mortgage 143,975 146,755
Accounts payable and accrued expenses 1,026,378 133,480
Distributions payable to S Corporation shareholders 65,742 -
-------------- ---------------
TOTAL LIABILITIES $ 55,286,322 $ 50,637,144
-------------- ---------------
SHAREHOLDERS' EQUITY:
Preferred stock, no par value; 2,000,000 shares
authorized; no shares issued or outstanding - -
Common stock, no par value; 10,000,000 shares
authorized; 3,700,000 and 2,468,750 shares issued and
outstanding at December 31, 1998 and 1997, respectively 8,453,059 1,002,090
Retained earnings 727,014 336,549
-------------- ---------------
TOTAL SHAREHOLDERS' EQUITY 9,180,073 1,338,639
-------------- ---------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 64,466,395 $ 51,975,783
============== ===============
</TABLE>
See accompanying notes to financial statements.
-2-
<PAGE>
TRANSNATIONAL FINANCIAL CORPORATION
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
REVENUE:
<S> <C> <C>
Gain on sale of mortgage loans $ 6,097,762 $ 2,230,309
Production income 1,534,525 943,182
Interest income 3,830,839 1,291,396
Other 18,074 16,346
-------------- ------------
Total revenue 11,481,200 4,481,233
-------------- --------------
EXPENSES:
Interest expense 4,268,931 1,570,489
Salaries and benefits 3,539,838 1,262,790
General and administrative 1,717,027 674,962
Occupancy 213,576 125,020
-------------- --------------
Total expenses 9,739,372 3,633,261
-------------- --------------
INCOME BEFORE INCOME TAXES 1,741,828 847,972
INCOME TAX EXPENSE 572,153 13,000
-------------- --------------
NET INCOME $ 1,169,675 $ 834,972
============== ==============
NET INCOME PER SHARE:
Basic and diluted $0.37 $0.33
PRO FORMA (unaudited)
Historical income before income taxes $ 1,741,828 $ 847,972
Pro forma income tax expense 691,349 339,200
-------------- --------------
Pro forma net income 1,050,479 508,772
============== ==============
PRO FORMA EARNINGS PER SHARE (unaudited)
Basic and diluted $0.34 $0.20
</TABLE>
See accompanying notes to financial statements.
-3-
<PAGE>
TRANSNATIONAL FINANCIAL CORPORATION
STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Common Stock Retained
Shares Amount Earnings Total
<S> <C> <C> <C> <C>
BALANCE, December 31, 1996 2,468,750 $ 1,002,090 $ 14,650 $1,016,740
Distributions to previous S
Corporation shareholders (513,073) (513,073)
Net income 834,972 834,972
--------- --------- -------- ---------
BALANCE, December 31, 1997 2,468,750 1,002,090 336,549 1,338,639
Issuance of stock through initial
public offering 1,200,000 7,419,719 7,419,719
Issuance of stock for services
performed 31,250 31,250 31,250
Distributions to previous S
Corporation shareholders (779,210) (779,210)
Net income 1,169,675 1,169,675
--------- --------- -------- ---------
BALANCE, December 31, 1998 3,700,000 $ 8,453,059 $ 727,014 $9,180,073
========= ============= ============= ==========
</TABLE>
See accompanying notes to financial statements.
-4-
<PAGE>
TRANSNATIONAL FINANCIAL CORPORATION
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,169,675 $ 834,972
Adjustments to reconcile net income to net cash used for
operating activities:
Gain on sale of mortgage loans (6,097,762) (2,230,309)
Provision for loan losses (122,238) -
Depreciation and amortization 41,344 14,851
Mortgage loans originated for sale (913,780,221) (387,311,774)
Proceeds from sales of mortgage loans 907,923,676 358,864,030
Net effect of changes in:
Deferred loan fees (175,587) (115,000)
Accrued interest receivable 136,239 (152,110)
Other assets (225,922) 2,344
Deferred taxes payable 134,184 -
Accounts payable and accrued expenses 758,714 23,537
Accrued interest payable 260,369 158,769
---------------- ---------------
Net cash used by operating activities (9,977,529) (29,910,690)
---------------- ---------------
Cash flows from investing activities:
Purchase of property and equipment (204,882) (29,930)
---------------- ---------------
Net cash used by investing activities (204,882) (29,930)
----------------- ----------------
Cash flows from financing activities:
Borrowings on warehouse note payable 953,513,302 399,152,597
Payments on warehouse note payable (950,080,353) (368,442,507)
Net proceeds from issuance of common stock 7,450,969 -
Distribution to S Corporation shareholders (713,468) (513,073)
Issuance of note receivable, shareholders - (250,000)
Receipt of note receivable, shareholders 250,000 -
Real estate mortgage loan payments (2,780) (2,608)
Borrowings on note payable, subordinated 1,000,000 -
Payment of note payable, subordinated (1,000,000) -
---------------- ---------------
Net cash provided by financing activities 10,417,670 29,944,409
---------------- ---------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 235,259 3,789
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 754,856 751,067
---------------- ---------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 990,115 $ 754,856
=============== ==============
Cash paid during the year for:
Interest $ 3,887,139 $ 1,411,720
Income taxes $ 191,819 $ 14,396
Supplemental Schedule of Noncash Investing and Financing Activities:
Distribution to S Corporation shareholders declared but unpaid $ 65,742
</TABLE>
See accompanying notes to financial statements.
-5-
<PAGE>
TRANSNATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------
1. DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Nature of Operations - Transnational Financial Corporation (the
"Company") conducts real estate mortgage banking activities through
three wholesale branches and one retail branch located in Northern and
Southern California. The Company's revenues are derived primarily from
the origination and sale of conforming and non-conforming residential
real estate loans for placement in the secondary market.
General - The accounting and reporting policies of the Company conform
to generally accepted accounting principles and to prevailing practices
within the mortgage banking industry. The Company follows the accrual
method of accounting.
On March 17, 1998 the Company's Board of Directors amended the
Company's Articles of Incorporation to authorize up to 10,000,000
shares of common stock and up to 2,000,000 shares of preferred stock
and approved a 2,468.75 for 1 common stock split. All Common shares and
per share amounts in the accompanying financial statements have been
adjusted to give effect to the stock split. However, the accompanying
financial statements do not reflect the termination of Transnational
Financial Corporation's S corporation status until the termination
date, April 30, 1998.
Public Offering - On June 24, 1998, the Company sold 1,200,000 shares
of its common stock for net proceeds of $7,419,719.
The more significant accounting and reporting policies are discussed
below.
Cash and Cash Equivalents - Cash and cash equivalents consist of
amounts on deposit with major financial institutions and certificates
of deposit with a maturity of three months or less at date of purchase.
Certificates of Deposit - Certificates of deposit held by the Company
generally mature within 180 days. Certificates of deposit totaling
$272,298 were pledged as collateral for obligations of the shareholders
at December 31, 1997. As of December 31, 1998, the Company did not hold
any certificates of deposit.
Mortgage Loans Held for Sale - All mortgage loans originated are
intended for sale in the secondary market and are carried at the lower
of cost or estimated market value, as determined by quoted market
prices, in aggregate. All loans are sold servicing released. The real
property of the borrower is pledged as collateral for mortgage loans.
-6-
<PAGE>
Loan origination fees and certain direct origination costs are deferred
and amortized into income over the period the loan is held by the
Company (generally less than 45 days). Fees representing reimbursement
for the costs of specific services performed by third parties, such as
appraisals and credit reports, are recognized when the services have
been performed. Loan placement fees are recognized when all significant
services have been performed.
Gains or losses realized from mortgage loan sales are recognized at
time of settlement with investors based upon the difference between the
proceeds from sale and the carrying value of the mortgage loan sold,
net of commitment fees paid. The Company reflects the value paid for
servicing rights released in net gain from sales of mortgage loans.
Property and Equipment - Property and equipment is stated at cost and
is depreciated using straight line depreciation for books over the
estimated useful lives of the assets, which range from three to ten
years. Leasehold improvements are amortized over the term of the
respective lease.
Production Income - Production income consists of fees paid to the
Company by borrowers for the preparation, documentation and
underwriting of loans. These fees and related lending transaction costs
are deferred until the related loan is sold. Upon sale of the loan, the
deferred fees net of costs are recognized as production income, and
deferred costs are recognized in the applicable expense
classifications.
Income Taxes - The Company was a Subchapter S corporation through April
30, 1998 and therefore was not subject to Federal income tax.
Distributions were periodically made to cover the Federal and state tax
liability of the shareholders. The California Revenue and Taxation Code
also levies a corporate tax of 1.5% on taxable income for which a
provision has been provided. The Subchapter S corporation status was
terminated on April 30, 1998 and the Company became a C corporation for
tax purposes. The Company applies an asset and liability method in
accounting for deferred income taxes. Deferred tax assets and
liabilities are calculated by applying applicable tax laws to the
differences between the financial statement basis and the tax basis of
assets and liabilities. The effect on deferred taxes of a change in tax
rates is recognized in income in the period that includes the enactment
date.
Off-Balance-Sheet Financial Instruments - The Company is a party to
financial instruments with off-balance-sheet risk in the normal course
of business to meet the real estate mortgage financing needs of its
customers and to reduce its own exposure to fluctuations in interest
rates. These financial instruments include commitments to extend
credit, financial futures and forward delivery commitments to sell
mortgage-backed securities. These instruments involve, to varying
degrees, elements of credit, and interest-rate risk in excess of the
amount recognized in the financial statements. The contract or notional
amounts of those instruments reflect the extent of the Company's
involvement in particular classes of financial instruments. Such
financial instruments are accounted for using settlement accounting and
are recorded in the financial statements when they are funded or
settled. All derivative financial instruments are held or issued for
purposes other than trading.
-7-
<PAGE>
Commitments to extend credit
In response to marketplace demands, the Company routinely makes
commitments to extend credit for fixed rate and variable rate loans
with or without rate lock guarantees. When rate lock guarantees are
made to customers, the Company becomes subject to market risk for
changes in interest rates that occur between the rate lock date and
the date that a firm commitment to purchase the loan is made by a
secondary market investor. Generally, as interest rates increase,
the market value of the loan commitment goes down. The opposite
effect takes place when interest rates decrease. As described
below, the Company uses a combination of financial futures and
forward delivery commitments to manage this risk. Hedging of the
market risk is most successful when these instruments are matched,
resulting in the market values of the financial futures and forward
delivery commitments moving in an inverse relationship with the
market value changes of the Company's loan commitments. Commitments
to extend credit are agreements to lend to a customer as long as
the borrower satisfies the Company's underwriting standards.
Commitments generally have fixed expiration dates or other
termination clauses and may require a payment of a fee to the
Company. The Company's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for
commitments to extend credit is represented by the contractual
notional amount of those commitments. The Company uses the same
credit policies in making commitments to extend credit as it does
for on-balance-sheet instruments. Collateral is required for
substantially all loans, and normally consists of real property.
The Company's experience has been that substantially all loan
commitments are completed or terminated by the borrower within
three months. The Company funds these commitments from operating
capital and through short-term borrowings on various warehouse
lines of credit. Sale of loans to permanent investors provides
additional liquidity to the Company.
Financial futures
Mortgage Backed Securities futures contracts are entered into by
the Company as hedges against exposure to interest-rate risk and
are not for speculation purposes. Changes in the market value of
futures contracts are deferred while the contracts are open and
subsequently recognized in income or expense after the contract
closes and the related assets or liabilities are sold.
Forward delivery commitments
The Company uses mandatory forward sale delivery commitments to
sell whole loans. These commitments are also used as a hedge
against exposure to interest-rate risks resulting from rate locked
loan origination commitments and certain mortgage loans held for
sale. Gains or losses incurred in completing these commitments
offset corresponding gains and losses in the items hedged, and are
deferred and recognized in the statement of income when the
contract is closed and the related assets are sold. Credit risk on
these instruments arise when the Company's position in these
securities becomes positive (i.e. "in-the-money") and the Company
is a net creditor to the counterparty to the agreement. To manage
this risk, the Company only enters into these agreements with
major, well-known financial institutions.
The Company contracts with a hedge management firm to carry out their
hedge strategy and to account for these off-balance sheet financial
instruments. A market position consisting of financial futures and
forward delivery commitments has been established with characteristics
that are designed to offset the market risks, which exist with certain
mortgage loans held for sale and commitments to extend credit.
-8-
<PAGE>
Use of Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts on the balance sheets and disclosure of contingent assets and
liabilities at December 31, 1998 and 1997, and the statements of income
for the years then ended. Actual results could differ significantly
from those estimates.
Stock-Based Compensation - The Company accounts for stock-based awards
to employees using the intrinsic value method in accordance with
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees. The Company accounts for transactions for which
goods or services are consideration for stock-based awards to
non-employees based upon the fair value of the goods or services
received or the fair value of the stock options awarded, whichever is
more reliably measurable. In Note 10, the Company presents the required
pro forma disclosures of the effect of stock-based compensation on net
income and net income per share using the fair value method in
accordance with Statement of Financial Accounting Standards (SFAS) No.
123, Accounting for Stock-Based Compensation.
Comprehensive Income - On January 1, 1998, the Company adopted SFAS No.
130, Reporting Comprehensive Income. This Statement requires that all
items recognized under accounting standards as components of
comprehensive income be reported in an annual financial statement that
is displayed with the same prominence as other annual financial
statements. This Statement also requires that an entity classify items
of other comprehensive income by their nature in an annual financial
statement. Comprehensive income includes net income and other
comprehensive income. The Company does not have any sources of other
comprehensive income for the years ended December 31, 1998 or 1997.
Disclosures About Segments of an Enterprise - On January 1, 1998, the
Company adopted SFAS No. 131, Disclosures About Segments of an
Enterprise and Related Information, which establishes annual and
interim reporting standards for an enterprise's business segments and
related disclosures about its products, services, geographic areas, and
major customers. The adoption of this Statement did not impact the
Company's consolidated financial position, results of operations or
cash flows. Management evaluates the Company's performance as a whole
and does not allocate resources based on the performance of different
lending or transaction activities and reports its operations on the
basis of a single business segment.
New Accounting Pronouncements - In June 1998, the Financial Accounting
Standards Board issued SFAS No. 133, Accounting For Derivative
Instruments and Hedging Activities. The statement establishes
accounting and reporting standards for derivative instruments and
hedging activities. The statement is effective for all fiscal quarters
of fiscal years beginning after June 15, 1999. The Company is in the
process of determining the impact of SFAS No. 133 on the Company's
financial statements.
Reclassifications - Certain amounts in the 1997 financial statements
have been reclassified to conform with the current presentation.
2. PRO FORMA INFORMATION
The objective of the unaudited pro forma information on the
accompanying statements of income is to show what the significant
effects on the historical information might have been had the Company
not been treated as an S corporation for tax purposes prior to May 1,
1998, the effective date of the Company's conversion to a corporation.
-9-
<PAGE>
3. MORTGAGE LOANS HELD FOR SALE
The cost of mortgage loans held for sale is the outstanding principal
balance of the mortgage loan decreased by fees or discounts collected
and increased by fees and discounts paid, and certain direct costs.
Fees and costs incurred net of discounts collected are deferred and
recognized as adjustments to gain or loss when the related loan is
sold.
<TABLE>
<CAPTION>
December 31,
1998 1997
---- ----
<S> <C> <C>
Mortgage loans $ 62,231,336 $ 50,154,791
Deferred fees, net of costs 309,510 133,923
------------- -------------
$ 62,540,846 $ 50,288,714
============= =============
</TABLE>
Substantially all mortgage loans held for sale are pledged as
collateral against the Company's warehouse line of credit. The lenders
release the collateral at the time a mortgage loan is sold and payment
is received.
4. NOTES RECEIVABLE
Notes receivable represent unsecured principal advances to individuals,
at fixed interest rates of 6% and 8%, principal and interest are due in
full in 2000. The advances were issued with an original maturity of
five years. Notes receivable includes principal amounts due from
employees of $35,819. Accrued interest related to these notes totaled
$45,524 and $41,763 at December 31, 1998 and 1997, respectively.
5. NOTE RECEIVABLE, SHAREHOLDERS
On December 31, 1997, the Company entered into a promissory note
agreement with its shareholders. The $250,000 note was unsecured,
bearing interest at an annual rate of 6.5% and due on or before March
31, 1998. The note was paid in full during March 1998.
6. INVESTMENT IN REAL ESTATE
Investment in real estate consists of a residence in Santa Rosa,
California. The real estate was contributed to the Company during 1995
by the shareholders of the S Corporation and is subject to a mortgage
assumed by the Company. The real estate is recorded at the property's
estimated market value at the date of contribution. Accumulated
depreciation on the real estate totaled $17,192 and $12,556 at December
31, 1998 and 1997, respectively. The property is not currently listed
for sale and is being rented on a monthly basis. The mortgage is due on
November 30, 2019 bearing interest at the 11th District cost of funds
index plus 2.45% (7.33 % at December 31, 1998) and interest adjusts on
a monthly basis.
-10-
<PAGE>
7. PREMISES AND EQUIPMENT
Major classifications of premises and equipment at December 31 are
summarized as follows:
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Furniture, fixtures and equipment $ 326,442 $153,387
Leasehold improvements 40,130 8,303
---------- -----------
366,572 161,387
Accumulated depreciation and amortization (95,131) (58,423)
---------- ----------
$ 271,441 $ 103,267
========== ==========
</TABLE>
Building and equipment rental expense was approximately $237,364 for
the year ended December 31, 1998 and $125,020 for the year ended
December 31, 1997. Depreciation and amortization expense was $36,708
and $10,215 for the years ended December 31, 1998 and 1997,
respectively.
8. WAREHOUSE NOTES PAYABLE
The Company maintains a revolving warehouse line of credit, primarily
to fund mortgage loan originations. Advances are made on the warehouse
line for specific properties, which are pledged as collateral. Interest
accrues monthly on the warehouse line and is due at settlement when the
underlying loans are sold. All advances are expected to be repaid
within one year. At December 31, 1998, $53,587,740 is outstanding under
this line. The line includes $105 million revolving credit facility
with Guaranty Federal Bank, and an additional $30 million gestation
facility. Interest on outstanding advances is LIBOR + 1.5% (6.618 % at
December 31, 1998) for the revolving credit facility and LIBOR + 1.375%
(6.493 % at December 31, 1998) for gestation facility. The credit
facility expires August 9, 1999.
The Company also has a whole loan Purchase and Sales Agreement
(Gestation Repurchase Line) with Greenwich Capital for $30 million.
Interest on gestation loans is at LIBOR + 1% (6.118% at December 31,
1998) with an available balance of $1,781,050.
The Company must comply with covenants provided in its credit
agreements, including restrictions on the payment of dividends (25% of
net income), maintenance of certain financial ratios, maintaining
minimum amounts of tangible net worth ($8,000,000) and other
conditions. As of December 31, 1998, the company is in compliance with
all covenants.
-11-
<PAGE>
9. CREDIT FACILITIES
Subordinated Debt - In order to obtain additional capital, the Company
obtained a $1,000,000 short-term note from a bank, subordinated to
warehouse lenders. The note bore interest at the Prime Rate plus 2%,
and was due and paid in full on the closing of an initial public
offering of Company stock (June 24, 1998).
Loan Participation and Custodian Agreement - During January through
September 1998, the Company entered into a loan participation and
custodian agreement with a bank to fund the origination and sale of
mortgage loans. Under the terms of the agreement, the bank purchased
from the Company a 100% loan participation interest and the related
firm purchase commitment obtained from permanent investors. The Company
replaced this facility with the warehouse note facilities described in
Note 8.
10. STOCK BASED COMPENSATION
On April 20, 1998, the Company's Board of Directors approved the 1998
Stock Compensation Plan (the "1998 Plan"), which permits the granting
of options to employees, officers and directors of the Company and
non-employees. As of December 31, 1998, a total of 255,000 shares of
common stock were reserved for future grants of options under the 1998
Plan. No options shall be granted under the plan after April 2008.
Vesting of the options is established at the compensation committee's
discretion for each grant. Options granted to employees during 1998
have a life of 5 years, beginning after the completion of 12 months
service and vest at 20% per year. All other options granted during 1998
vest immediately and have a contractual life of 10 years.
A summary of stock options follows:
<TABLE>
<CAPTION>
Weighted
Average
Options Exercise Price
<S> <C> <C>
Outstanding at December 31, 1997 -
Options Granted 105,000 7.50
-----------
Outstanding at December 31, 1998 105,000
===========
</TABLE>
Information about stock options outstanding at December 31, 1998 is
summarized as follows:
<TABLE>
<CAPTION>
Weighted Weighted
Average Average
Average Exercise Exercise
Range of Remaining Price of Price of
Exercises Options Contractual Options Options Options
Prices Outstanding Life (Years) Outstanding Exercisable Exercisable
<S> <C> <C> <C> <C> <C> <C>
7.50 105,000 7.8 7.50 69,000 7.50
</TABLE>
-12-
<PAGE>
The Company applies APB Opinion 25 and related interpretations in
accounting for its stock option plan for grants to employees. The
company applies SFAS No. 123, Accounting for Stock Based Compensation
(SFAS No. 123) for grants to non-employees. Under the intrinsic value
method no compensation cost has been recognized for its stock option
grants. SFAS No. 123, requires disclosure of pro forma net income and
net income per share had the Company adopted the fair value method of
accounting for stock-based compensation. Had compensation cost for the
grants been determined based upon the fair value method, the Company's
net income and net income per share would have been adjusted to the pro
forma amounts indicated below.
<TABLE>
<CAPTION>
1998 1997
Net income:
<S> <C> <C>
As reported $1,169,675 $834,972
Pro forma $1,011,725 $834,972
Basic net income per common share:
As reported $0.37 $0.33
Pro forma $0.32 $0.33
Diluted net income per common:
As reported $0.37 $0.33
Pro forma $0.32 $0.33
</TABLE>
The fair value of the stock options granted during 1998 is estimated as
$157,950 on the date of grant using a binomial option-pricing model
with the following assumptions: $0.375 annual dividend, volatility of
21.89%, risk-free interest rate of 5.4%, assumed forfeiture rate of
zero, and an expected life of six years. The weighted average fair
value per share of options granted in 1998 was $1.50.
-13-
<PAGE>
11. INCOME TAXES
The company was a subchapter S Corporation through April 30, 1998 and
therefore was not subject to federal income tax. As of May 1, 1998, the
company became a corporation for tax purposes. The provision for income
taxes for the years ended December 31, was as follows:
1998
Currently payable:
Federal $ 331,580
State 106,389
-----------
Total 437,969
Deferred taxes (benefit):
Federal (89,870)
State (44,314)
Total (134,184)
-----------
Total $ 572,153
===========
The effective federal tax rate for the years ended December 31, differs
from the statutory tax rate as follows:
1998
Federal income tax at statutory rates 34.0%
State income taxes, net of federal
income tax benefit 5.4
S Corporation income (6.8)
Other 0.3
-----
Total 32.9%
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes. Significant components of the Company's net deferred tax
liability at December 31 are as follows:
1998
Deferred tax assets:
State taxes $ 49,121
----------
Deferred tax liabilities:
Fixed asset basis difference (27,147)
Deferred loan costs (138,784)
Prepaid rent (12,102)
Other (5,272)
Total deferred tax liabilities (183,305)
Net deferred tax liability (134,184)
-14-
<PAGE>
12. CAPITAL STOCK
On March 17, 1998, the Company's Board of Directors amended the
Company's Articles of Incorporation to authorize up to 10,000,000
shares of Common Stock and approved a 2,468.75 for 1 common stock
split, of the Company's outstanding Common Stock. All common shares and
per share amounts in the accompanying financial statements have been
adjusted to give effect to the stock split. In addition, the Company's
Board of Directors amended the Company's Articles of Incorporation to
authorize up to 2,000,000 shares of Preferred Stock. On May 1, 1998,
two individuals were granted, in total, 31,250 shares of Common Stock
for services rendered in connection with the Initial Public Offering of
the Company's stock.
13. NET INCOME PER SHARE
Basic net income per share is based on net income after dividends and
on the weighted average common shares outstanding. Diluted net income
is computed based on the weighted average number of common shares
outstanding adjusted for the common stock equivalents, which include
stock options. The following table presents a reconciliation of basic
and diluted net income per share for the years ended December 31, 1998
and 1997 in accordance with SFAS No. 128. For the years ended December
31, 1998 and 1997, the effect of including outstanding options in the
calculation of diluted earnings per share would be antidilutive. As a
result, the effect of those outstanding options has not been included
in the calculations.
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Calculation of Basic Net Income Per Share
Numerator - net income $ 1,169,675 $ 834,972
Denominator - weighted average common
shares outstanding 3,124,658 2,500,000
------------ -----------
Basic net income per share $0.37 $0.33
===== =====
Calculation of Diluted Net Income Per Share
Numerator - net income $ 1,169,675 $ 834,972
Denominator:
Weighted average common shares outstanding 3,124,658 2,500,000
Dilutive effect of outstanding options - -
------------ -----------
3,124,658 2,500,000
------------ -----------
Diluted net income per share $0.37 $0.33
===== =====
</TABLE>
-15-
<PAGE>
14. FINANCIAL INSTRUMENTS
The Company's mortgage banking activities consist of the origination
and sale of mortgage loans for placement in the secondary market. The
Company enters into commitments to extend credit, forward delivery
contracts to sell mortgage-backed securities and forward delivery
commitments for the sale of whole loans in the normal course of
business to manage interest rate risks. Deferred gains on open
positions of mortgage-backed securities delivered under the forward
sales contracts approximated $42,930, and offset losses in the
Company's loan commitments to borrowers.
The following disclosure of the estimated fair value of financial
instruments at December 31, 1998 is made in accordance with the
requirements of SFAS No. 107, Disclosures about Fair Value of Financial
Instruments. The estimated fair value amounts have been determined by
the Company using available market information and appropriate
valuation methodologies. However, considerable judgment is necessary to
interpret market data in the development of the estimates of fair
value. These estimates are not necessarily indicative of the amounts
the Company could realize in a current market exchange, and the use of
different market assumptions and/or estimation methodologies could
significantly affect the estimates.
<TABLE>
<CAPTION>
1998 1997
---- ----
Carrying Fair Carrying Fair
Value Value Value Value
<S> <C> <C> <C> <C>
Financial Assets:
Cash $ 1,065,349 $ 1,065,349 $ 482,558 $ 482,558
Certificates of deposit - - 272,298 272,298
Mortgage loans held for sale 62,499,178 62,800,000 50,288,714 50,700,000
Notes receivable 135,819 124,888 135,819 110,000
Notes receivable, shareholders - - 250,000 250,000
Financial Liabilities:
Warehouse notes payable 53,587,740 53,587,740 50,154,791 50,154,791
Real estate mortgage 143,973 143,973 146,755 146,755
Off-Balance-Sheet Instruments:
Commitments to extend credit $ 141,228 $ 300,000
Financial futures - (65,000)
Forward delivery commitments 42,930 5,000
</TABLE>
The notional amount of the Company's commitments to extend credit at
fixed interest rates were approximately $39,000,000 and $52,000,000 at
December 31, 1998 and 1997. The Company also made commitments to
deliver $44,000,000 and $25,500,000 in loans and in mortgage based
securities to various investors, all at fixed interest rates as of
December 31, 1998 and 1997.
The fair values presented above represent the Company's best estimate
of fair value using the methodologies discussed below:
Cash and equivalents and certificate of deposit - Due to the relatively
short period of time between the origination of theses instruments and
their expected realization, the carrying amount is estimated to
approximate market value.
-16-
<PAGE>
Mortgage loans held for sale - Fair values for mortgage loans covered
by investor commitments are based on commitment prices. Fair values for
uncommitted loans are based on management's assessment of current
prices offered for similar loans sold in conjunction with the Company's
own secondary market transactions, adjusted for differences in loan
characteristics. Management's determination of fair value includes
consideration of commitment prices which clearly represent market
conditions at the balance sheet date and market prices and yields
sought by the Company's permanent investors, or other public market
quotations for long-term mortgage loan rates.
Notes receivable and note receivable, shareholder- The fair value of
notes receivable is estimated by discounting the future cash flows
using current interest rates at which similar loans would be made to
borrowers.
Financial Liabilities - The fair value of financial liabilities is
believed to approximate the carrying amount because the terms of the
debt are similar to terms currently offered by lenders, or the interest
rates are variable base on current market rates.
Off-Balance-Sheet Instruments - The fair value of off-balance-sheet
instruments is determined by management's assessment of current prices
offered for similar loans sold in conjunction with the Company's own
secondary market transactions, adjusted for related mandatory forward
commitments and risks associated with borrowers ability to complete
their commitments. The Company also employs pricing models and various
other techniques to determine the fair value of their forward delivery
and futures contracts.
15. SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
Substantially all of the Company's business activity is with customers
located within California. The loans and commitments extended to these
customers are expected to be repaid from proceeds of the sale of these
loans in the secondary market and are secured by real estate. The
Company's access and rights to this collateral vary and are legally
documented to the extent practicable. Sales agreements with secondary
market investors include recourse provisions, which may require the
Company to repurchase the loans sold in the event of certain
conditions, including the default or delinquency of borrowers under the
terms of the loan agreements.
Recourse obligations arising pursuant to these agreements are recorded
at estimated fair value using the best information available in the
circumstances when the loans are sold. The Company has not been
required to repurchase any loans sold during the years ended December
31, 1998 and 1997.
The Company has a concentration of credit risk with respect to cash
deposited with commercial banks in excess of federally insured limits.
-17-
<PAGE>
16. COMMITMENTS AND CONTINGENCIES
Operating Leases - The Company has entered into various operating lease
agreements for the rental of office space. The following represents
aggregate future minimum lease payments under these agreements:
Year ending December 31,
1999 $ 286,923
2000 264,018
2001 143,298
2002 121,770
2003 91,328
----------
Total $ 907,337
==========
Litigation - The Company is involved in legal proceedings arising in
the ordinary course of business. The ultimate outcome of these
proceedings can not be determined because of the uncertainties that
exist. In the opinion of management, the disposition of matters that
are pending or asserted will not have a materially adverse effect on
the financial position, results of operations or cash flows of the
Company.
-18-
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Transnational Financial Corporation
We have audited the accompanying balance sheet of Transnational Financial
Corporation as of December 31, 1997 and the related statements of income,
shareholders' equity and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the accompanying financial statements present fairly, in all
material respects, the financial position of Transnational Financial Corporation
as of December 31, 1997, and the results of its operations and its cash flows
for the year then ended in conformity with generally accepted accounting
principles.
/s/ MOSS ADAMS LLP
San Francisco, California
June 4, 1998
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Transnational Financial Corporation
/s/ Joseph Kristul
---------------------------------
Joseph Kristul, Chief Executive Officer and Principal Financial Officer
Date: March 30, 1999
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
/s/ Joseph Kristul Director March 30, 1999
- --------------------------------------
Joseph Kristul
/s/ Maria Kristul Director March 30, 1999
- --------------------------------------
Maria Kristul
/s/ Eugene Kristul Director March 30, 1999
- --------------------------------------
Eugene Kristul
/s/ Hilary Whitley Director March 30, 1999
- --------------------------------------
Hilary Whitley
Director March 29, 1999
- --------------------------------------
Robert A. Shuey
/s/ Robert A. Forrester Director March 29, 1999
- --------------------------------------
Robert A. Forrester
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 990,115
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 63,712,304
<PP&E> 271,441
<DEPRECIATION> 95,131
<TOTAL-ASSETS> 64,466,395
<CURRENT-LIABILITIES> 55,142,347
<BONDS> 0
0
0
<COMMON> 8,453,059
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 64,466,395
<SALES> 11,481,200
<TOTAL-REVENUES> 11,481,200
<CGS> 0
<TOTAL-COSTS> 9,739,372
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 279,093
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,741,828
<INCOME-TAX> 691,349
<INCOME-CONTINUING> 1,050,479
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,169,675
<EPS-PRIMARY> 0.34
<EPS-DILUTED> 0.34
</TABLE>
