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, 1999
[ ] 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 Network, Inc.
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(Name of small business issuer in its charter)
California
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(State or other jurisdiction of incorporation or organization)
94-2964195
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(I.R.S. Employer identification No.)
401 Taraval Street, San Francisco 94116
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(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: $10,967,322
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
27, 2000. $1,436,804
State the number shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 4,279,310
<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. The Company's operations are
primarily focused in the San Francisco Bay Area, but beginning in late 1998 the
Company expanded out of the San Francisco Bay Area to Tustin California and in
1999 expanded to Phoenix. 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 operates in one business segment - mortgage banking. On
July 30, 1999, the Company acquired LRS, Inc, a mortgage broker and banker
located in Campbell, California.
The Company funds its originations through warehouse lines of credit. The
mortgage loans are subsequently sold together with the mortgage loan servicing
rights to investors in the secondary mortgage market. The total mortgage loan
production volume for 1999, including that of LRS, Inc. for the entire year, was
$973 million, a decrease of about seven percent from the Company's prior year.
Without the acquisition of LRS, Inc., the Company's mortgage loan production
volume would have been $803 million, a decrease of about 24%. This decline
contrasts with the increase from 1998 of 126% compared to 1997, and the 78%
increase from 1996 to 1997. Wholesale originations, including that of LRS, Inc.,
accounted for 80% of the Company's loan production volume for 1999. The Company
maintains retail offices in San Francisco and Campbell, and wholesale offices in
San Francisco, Campbell, and Tustin, California as well as Phoenix, Arizona.
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 FNMA guidelines for the San
Francisco Bay area, presently mortgage loans larger than $252,700, are called
Jumbo loans and comprised 68% of the mortgage loans originated by the Company in
1999. 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, adjustable rate mortgages make up a larger percentage of the Company's
mortgage loans. 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
1999 was approximately $257,000. 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. In December 1999, the Company changed its warehouse lender to
Residential Funding Corporation to achieve a lower cost of borrowing. See "Item
6. Management's Discussion and Analysis or Plan of Operation."
The Wholesale Origination Division
In 1999, wholesale mortgage loans constituted 80% 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.
<PAGE>
The Company's wholesale lending division, which was established in May
1995, operates from its executive offices in San Francisco and offices in
Campbell and Tustin, California as well as Phoenix, Arizona. Currently, the
Company obtains mortgage loan volume through a network of more than 1200
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 1999 no single source of independent brokers accounted for more
than 5% of the Company's total wholesale mortgage originations.
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.
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 currently
employs 33 commissioned loan officers in its Campbell, California office and
three commissioned mortgage loan officers located in an 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.
In 1999 approximately 55% of the mortgage loans originated by the retail
division were 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 1999 the number of mortgage loans
originated by the retail division were almost equally divided between conforming
and non-conforming (Jumbo) mortgage loans, with the average mortgage loan size
originated by the retail division being $270,000 and the average loan-to-value
ratio being approximately 80%.
The Company's retail division collects origination fees and closing costs
from the borrower which add to the gross 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 of loans for the wholesale
division and of loan fees to improve profit margins.
3
<PAGE>
The following table shows mortgage loan production volume by division.:
<TABLE>
<CAPTION>
Twelve Months Ended
December 31,
1999 1998 1997 1996 1995
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Retail Division
Volume $192,981(1) $137,356 $77,768 $54,686 $53,380
Percentage of Total Volume 20% 13% 16% 21% 58%
Wholesale Division
Volume 780,247(2) 913,780 387,312 206,613 38,328
Percentage of Total Volume 80% 87% 84% 79% 42%
Total Loan Production
Volume $973,228(3) $1,051,136 $465,080 $261,299 $ 91,708
Number of Loans 3,780 4,053 1,822 998 363
Average Loan Size $257 $259 $255 $261 $252
Volume Growth -7% 126% 78% 185%
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</TABLE>
(1) Includes $115 million in retail mortgage loan production from LRS, Inc.
from the date of acquisition. If this production had been excluded,
retail mortgage loan production would have been $78 million.
(2) Includes $55 million in wholesale mortgage loan production from LRS,
Inc. during fiscal year 1999. If this production had been excluded,
wholesale mortgage loan production would have been $725 million.
(3) If LRS, Inc.'s mortgage loan production had been excluded for the 1999
fiscal year, total mortgage loan production would have been $803
million or a decrease of 24% from the previous fiscal year
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.
Non-conforming (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 10 underwriters who each
average five 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.
4
<PAGE>
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 sale of the mortgage loan. To protect
against 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. and at the end of 1999 replaced this line with one
from Residential Funding Corporation. The lending limit under the Guaranty
Federal Bank line was $100 million until September when it was reduced to $65
million. The line with Residential Funding Corporation has a $50 million limit
and charges LIBOR plus 1.5%. In March 2000, the Company requested to reduce the
lending limit to $35 million to better match the Company's current funding
needs.
The company maintains a Loan Participation and Custodian Agreement with
Gateway Bank for $15 million and has entered into a $10 million Quick Sale
Master Loan Participation and Custodian Agreement, also with Gateway Bank. These
agreements permit the Company to sell mortgage loans thereunder pending resale
to the Company's investors. The interest rate charged for these lines is prime
rate less 1.125%.
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. As of December 31, 1999, the Company was in compliance with all
covenants except the minimum tangible net worth requirement. The Company has
obtained a waiver of non-compliance.
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, mortgage brokers, 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.
5
<PAGE>
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 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 in November 1999
obtained 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 results of operations and
financial condition.
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 March 1, 2000, the Company had 93 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 leases 13,200 square feet of office space in San Francisco
with a monthly rental of approximately $22,000. The term of the lease is for
five years commencing the date of the Company's occupancy which occurred in July
1999. This office space is used for corporate administrative offices and for
conducting wholesale and retail mortgage lending operations in San Francisco.
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.
The Company has additional offices in San Jose and Tustin, California and
in Phoenix, Arizona.
6
<PAGE>
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
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 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
1999
First quarter 6.50 4.0625
Second quarter 7.250 3.1875
Third quarter 4.9375 2.50
Fourth quarter 2.75 1.875
As of March 27, 2000, there were approximately 671 shareholders of record
of the Company's Common Stock.
On July 30, 1999, the Company issued 579,310 shares of Common Stock in
connection with the acquisition of LRS, Inc. This transaction was exempt from
registration under the Securities Act pursuant to Section 4(2) thereunder as
transactions not involving a public offering.
In March of 1998 the Company agreed to issue, upon termination of the
Company's status as an S corporation, to its counsel 12,500 shares of Common
Stock in consideration of legal services rendered to the Company and to issue
18,750 shares of Common Stock, upon the same conditions, to a financial advisor
to the Company. These transactions were exempt from registration under the
Securities Act pursuant to Section 4(2) thereunder as transactions not involving
a public offering.
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.
General
Similar to the mortgage banking industry's experience, the Company's loan
performance and profit performance are largely affected by interest rates.
Mortgage rates run parallel with the direction of yields on 30 year United
States Treasury bonds ("Treasuries"). Throughout 1998 interest rates on
Treasuries declined but increased throughout 1999. In January 1998, interest
rates on Treasuries were approximately 5.85% and at the end of 1998 were
approximately 5.16% after reaching a low of approximately 4.70% in October 1998.
From approximately 5.16% in January 1999, interest rates on Treasuries increased
to approximately 6.00% at the end of June 1999. This trend continued in the
second half of 1999 with the yield on Treasuries reaching almost 6.50% at the
end of December 1999.
7
<PAGE>
Higher interest rates increase the cost of home ownership resulting in
diminished demand for mortgage loans, whether the purpose of the mortgage loan
was for the purchase of a home, refinancing of a home to obtain a lower rate or
longer term, home improvement, debt consolidation, or obtaining cash. The
mortgage loan financing that does occur usually takes the form of roll over
mortgages loans, that is, mortgage loans that have interest rates that
frequently change and, consequently, lower interest rates than that charged on
longer term fixed interest rate mortgage loans.
As a consequence, the Company saw its volume of mortgage loans generally
increase throughout 1998, reaching its peak in February 1999 and started to
decline in the second quarter of 1999. The following tables set forth the
wholesale and retail production for the indicated periods.
Mortgage Loan Volume
For the Twelve Months Ended
<TABLE>
<CAPTION>
December 31, 1999
-----------------------------------------------------------------------------------------------
First Quarter Second Quarter Third Quarter Fourth Quarter TOTAL
<S> <C> <C> <C> <C> <C>
Wholesale $269,810,903 $185,189,710 $165,426,612 $159,819,500 $780,246,725
Retail 27,053,889 21,097,932 75,457,636 69,371,902 192,981,359
------------- ------------- ------------- ------------- -------------
TOTAL $296,864,792 $206,287,642 $240,884,248 $229,917,452 $973,228,084
</TABLE>
Mortgage Loan Volume
For the Twelve Months Ended
<TABLE>
<CAPTION>
December 31, 1998
-----------------------------------------------------------------------------------------------
First Quarter Second Quarter Third Quarter Fourth Quarter TOTAL
<S> <C> <C> <C> <C> <C>
Wholesale $166,206,275 $217,989,563 $224,641,555 $304,942,607 $913,780,000
Retail 28,328,830 28,711,820 31,625,000 48,690,350 137,356,000
------------- ------------- ------------- ------------- --------------
TOTAL $194,535,105 $246,701,383 $256,266,555 $353,632,957 $1,051,136,000
</TABLE>
During the second quarter of 1999 the Company opened additional mortgage
loan production offices in Phoenix, Houston and Reno but subsequently closed the
Reno office and Houston offices. At the end of July 1999, the Company acquired
LRS, Inc., the holding company for a wholesale and retail mortgage company based
in Silicon Valley. The new offices and the acquisition of LRS, Inc. were meant
to expand the production base.
Year Ended December 31, 1999 compared to Year Ended December 31, 1998
The Company incurred a pretax loss of $2,929,918 for the year ended
December 31, 1999, compared to a pre tax profit of $1,741,828 for the year ended
December 31, 1998. Revenues decreased to $10,967,322 in 1999 from $11,481,200 in
1998, a decline of about 4.5% in revenues.
The increase in interest rates decreased the volume of mortgage loan
production. Excluding the volume contributed by LRS, Inc., TFN's mortgage loan
volume would have declined approximately 24% rather than the seven percent it
actually declined. Retail mortgage loan volume would have declined approximately
48% and wholesale mortgage loan production would have declined approximately
21%. This decrease is largely attributable to a decline in the volume of
refinancing.
When interest rates rise, management believes that competitors become more
aggressive in pricing. The effect is a decrease to the margins on mortgage loans
sold by the Company. Between the time the mortgage loan is funded through the
Company's warehouse line and the mortgage loan is sold, the interest rate
received by the Company on such mortgage loans is often less than the interest
rate the Company pays. Accordingly, the Company paid more in interest in the
fourth quarter of 1999 than the Company received, a situation which had not
occurred since the second quarter of 1998.
8
<PAGE>
Finally, management believes that its geographic concentration in the San
Francisco Bay Area has harmed the Company's revenues. While sharply rising
prices in that area have increased the cost of a home, there are not many
houses, in the opinion of management, being built. Because many potential
borrowers pre-qualify for a mortgage loan prior to purchasing a home, management
believes that between 50% and 60% of mortgage loans that are approved fail to
close because of the unavailability of housing to purchase or because the
borrower submits applications to multiple lenders and chooses to close
elsewhere. The cost to the Company to open offices in other geographic areas
such as Reno, Phoenix and Houston have adversely affected the Company's
profitability.
With the acquisition of LRS, Inc. in the third quarter of 1999, the
Company began to derive a much larger percentage of its revenue form retail
mortgage lending which generates higher revenues than wholesale mortgage
banking. Retail mortgage lending also increased expenses which is categorized
under salaries and benefits due to commissions paid to retail loans originators.
Accordingly, the acquisition of LRS, Inc. contributed to the increase in
salaries and benefits.
The Company's expansion out of the San Francisco Bay Area also contributed
to the increase in salaries and benefits. Salaries and benefits increased to
$7,919,933 in the 1999 period compared $3,564,111 in the earlier period, an
increase of 122%.
The expansion also affected general and administrative expenses, and
office occupancy expenses. In addition, during the fall of 1998, the Company
expanded the amount of office space it leased in San Francisco.
The cost of being a publicly held company also contributed to the increase
to general and administrative expenses.
The revenues contributed by the new offices in 1999 did not offset startup
costs during the start-up period of the Company's new offices. Similarly,
production from these offices was not sufficient to compensate for the decline
in wholesale revenues resulting form increasing interest rates.
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.
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. Until termination on December 30, 1999, Guaranty Federal Bank
provided this facility and was then replaced by a facility from Residential
Funding Corporation. The capacity under the Guaranty Federal Bank line was $100
million until September 30, 1999, when it was reduced to $65 million. The
Company's present warehouse line with Residential Funding Corporation is for $35
million.
9
<PAGE>
The size of a warehouse line of credit is based on the Company's net worth
and cash resources. The Company's operating losses in 1999 have eroded this net
worth and cash position. The Company has taken steps, beginning in late 1999 to
stem these losses and stabilize the operations of the Company. These steps
include the closing of the Houston and Reno offices, downsizing the Tustin
office and reducing staffing to a more appropriate level. Management of the
Company believes that the results of these steps will significantly reduce or
eliminate these losses, even if interest rates fail to recover, although there
can be no assurance that these actions will be successful, particularly if
interest rates continue to increase or remain volatile.
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's mission critical systems responded to the century date
change. Accordingly, the Company's main operating systems are fully operational
in accurately processing customer information and transactions. The Company will
continue to monitor its systems and those of its vendors and suppliers over the
coming months.
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.
None.
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 52 Chief Executive Officer
and Treasurer, Director
Maria Kristul 52 President, Director
William A. Russell 47 Vice President, Director
Beth De George 48 Executive Vice President
Teresita Dee 57 Controller
Hilary Whitley 51 Director
Robert A. Shuey 45 Director
Robert A. Forrester 55 Director
Alex Rotzang 55 Director
J. Peter Gaskins 51 Director
10
<PAGE>
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.
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.
Joseph and Maria Kristul are husband and wife.
William A. Russell became a Vice President and Director of the Company
following the company's acquisition of LRS, Inc., a wholesale and retail
mortgage banking company that Mr. Russell founded with others in January of
1996, becoming LRS, Inc.'s president at its formation. Mr. Russell had formed R+
Financial, a mortgage banking firm in July 1992 which he served as president
until participating in the formation of LRS, Inc. in January 1996.
Beth De George joined the Company in November 1999 where she directs and
coordinates the day-to-day operating activities of the Company, including
customer service, credit policy, regulatory compliance, quality control, finance
and accounting, secondary marketing, and technology. In June 1997 she joined
Elliot Ames, Inc., a retail mortgage banking company. At Elliot Ames, Inc. she
was Executive Vice President and participated in the successful sale of that
entity. For three years prior to joining Elliot Ames, Inc. she owned and
operated her own mortgage banking company which was successfully sold to a
community bank. Ms. De George has over 20 years experience in all aspects of
residential mortgage banking, including sales, operations, finance, secondary
marketing, credit, training and technology.
Teresita Dee joined the Company in May 1999. From June 1998 until she
joined the Company, she performed accounting consulting services. From July 1997
to March 1998, Ms. Dee was Executive Vice President and Chief Financial Officer
for Mission National Bank, a publicly held commercial bank based in San
Francisco. Ms. Dee joined that bank in December 1993 and served as interim Chief
Executive Officer and as a Vice President prior to her promotion in July 1997.
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.
Alex Rotzang became a director in August, 1999. He is Chairman of NoreX
Pertroleum Limited, an international oil and gas company based in Cyprs and
Calgary, Canada. Mr. Rotzang formed NoreX Petroleum Limited in 1994 and has 23
years experience in the oil and gas industry.
J. Peter Gaskins became a director of the Company in January 2000. He has
over 25 years experience in capital management and investment banking and is
presently a strategic and financial consultant to private and small publicly
held companies. He provides private investment banking and consulting services
through Clarion Associates, Inc., a firm he founded in 1991. Recently he has
consulted with several e-commerce companies by assisting in the developing
marketing, operational and financial strategies, including management
compensation plans. He has also developed strategic planning for manufacturing
and capital management companies as they merge or reorganize. Prior to 1991 he
was Chief Executive Officer and President of NatWest Securities USA, the United
States institutional stock brokerage business for National Westminster,
Britain's largest commercial bank. Mr. Gaskins is an honors graduate in
statistics from Harvard College and received a Masters in Business
Administration from Harvard University.
11
<PAGE>
Committees of the Board of Directors
The Company's Board of Directors has established three active committee,
the Audit Committee, the Compensation Committee and a Primary Committee to
administer the 2000 Stock Inventive Plan. The Compensation Committee is composed
of Ms. Whitley and Mr. Shuey. The Audit Committee is composed of Ms. Whitley and
Messrs. Shuey and Rotzang. The Primary Committee is composed of Messrs. Gaskins
and Rotzang. 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 of 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
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.
The duties of the Primary Committee are set forth under the caption 2000
Stock Incentive Plan.
Section 16(a) Beneficial Ownership Reporting Compliance.
In May 1999, Ms Dee was named the Corporation's Controller and in November
1999 Ms. DeGeorge was named Executive Vice President. Each's Form 3 to be filed
in March 2000. In July 1999, Mr. Rotzang was named a director of the Company and
his Form 3 is anticipated to be filed in April 2000. On February 5, March 3 and
March 25, 1999, Mr. Kristul purchased 8,100, 2,000 and 2,000 shares,
respectively at a respective price of $6.125, $5.00 and $5.125. Shares purchased
were reported in May 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 1999 (the "Named Executive Officers") for services rendered to
the Company in all capacities for the fiscal years ended December 31, 1999.
Summary Compensation Table
<TABLE>
<CAPTION>
Name and Annual Compensation All Other
Principal Position Fiscal Year Salary Bonus Compensation
<S> <C> <C> <C> <C>
Joseph Kristul (1) 1999 $250,000 0 0
Chief Executive Officer 1998 $166,667 $57,661 $389,605
1997 $12,000 - $256,536
Maria Kristul (1) 1999 $300,000 $47,516 0
President 1998 $296,887 - $389,605
1997 $12,000 - $256,537
</TABLE>
----------------
(1) All Other Compensation represent distributions made to Joseph and Maria
Kristul in connection with the Company's status as an S corporation.
12
<PAGE>
Employment Agreements
In July 1999, in connection with the acquisition of LRS, Inc., William J.
Russell and the Company entered into a three year employment agreement. During
the term of the agreement, the Company agreed to pay Mr. Russell a salary of
$180,000 per year. In addition, Mr. Russell and another are entitled to
participate in an earn out of the LRS, Inc. profits, as defined, the total earn
out amounting to 50% of the LRS, Inc.'s pretax profits.
Stock Option Plans
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 500,000 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 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"). On February 29, 2000 the Board of Directors
terminated this plan and adopted the 2000 incentive Stock Plan.
Ms. Kristul has been granted options to acquire 30,000 shares of Common
Stock and Ms. Dee has been granted an option to acquire 10,000 shares of Common
Stock. All of the options granted to Ms. Kristul and Ms. Dee have an exercise
price of $7.50.
On February 29, 2000, effective March 1, 2000, the Company's Board of
Directors adopted the 2000 Stock Incentive Plan for the grant to employees,
officers, directors and consultants to the Company, parent or subsidiary of the
Company of up to 750,000 shares of the Company's Common Stock, subject to
adjustment in the event of any subdivision, combination or reclassification of
shares. Beginning with calendar year 2001, the number of shares authorized under
the plan shall automatically increase by an amount equal to 4% of the total
number of shares of Common Stock outstanding on the last trading day of December
of the immediately preceding calendar year. However, in no event shall any such
annual increase exceed 400,000 shares. No one person may receive options for
more than 150,000 shares in the aggregate per year.
There are five programs under the 2000 Stock Incentive Plan under which
(I) eligible persons may be granted options to purchase Common Stock for
incentive stock options within the meaning of Section 422 of the Internal
Revenue Code of 1986, as amended. (ii) eligible employees may have a portion of
their base salary invested in special option grants; (iii) eligible persons may
be issued shares of Common Stock directly, either through immediate purchase of
shares or as a bonus; (iv) non-employee directors shall receive option grants at
designated intervals over the period of continued board service; and (v)
non-employee board members may have their annual retainer fee otherwise payable
in cash applied to a special option grant.
The Company plans to submit to its stockholders this plan for approval at
the Company's Annual Meeting of Stockholders to be held in 2000.
Director Remuneration
The following sets forth certain information regarding compensation of
directors paid for services in 1999 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(1)
<S> <C> <C> <C> <C>
Hilary Whitley $14,500 $228,050 0 60,000(2)
Robert A. Shuey $12,000 0 0 60,000(2)
Robert A. Forrester $12,000 $62,647 0 60,000(2)
</TABLE>
<PAGE>
(1) Excludes 15,000 shares options automatically granted effective March 1,
2000 to each director pursuant to the 2000 Stock Incentive Plan.
(2) 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.
13
<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, 2000, 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.
<TABLE>
<CAPTION>
Name and Address of Number of Percent Beneficial Owner
Shares Owned Owned
<S> <C> <C>
Kristul Family LLC(1)(2) 2,329,960 53.2%
401 Taraval Street
San Francisco, CA 94116
Joseph Kristul(1)(2) 2,357,060 53.8
401 Taraval Street
San Francisco, CA 94116
Maria Kristul(1)(2)(3) 2,357,060 54.5
401 Taraval Street
San Francisco, CA 94116
Beth De George 7,500 0.2
401 Taraval Street
San Francisco, CA 94116
Teresita Dee(4) 10,000 0.2
401 Taraval Street
San Francisco, CA 94116
Hilary Whitley(5) 73,300 2.1
5445 Mariner Street
Suite 107
Tampa FL 33609
Robert A. Shuey(5) 20,100 0.9
8214 Westchester
Suite 500
Dallas, TX 75225
Robert A. Forrester(5) 32,500 1.2
1215 Executive Drive West
Suite 102
Richardson, TX 75081
William Russell 347,586 7.9
1725 Bascom Ave., Suite 100
Campbell, CA 95008
Teri Saldivar 231,724 5.3
1725 Bascom Ave., Suite 100
Campbell, CA 95008
All Executive Officers and
Directors as a group (11 persons)(3)(4)(5) 3,069,770 72.4%
- -------------------
</TABLE>
14
<PAGE>
(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.
(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 Company's 1998 Stock Option Plan.
(4) Includes 10,000 shares Ms. Dee has the right to acquire pursuant to the
Company's 1998 Stock Option Plan.
(5) 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. Excludes 15,000 shares granted pursuant to the
Company's 2000 Stock Incentive 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.
In connection with consulting services rendered to the Company in 1998 by
Financial Capital Resources, Inc., an affiliate of Ms. Whitley's, 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. In 1999, the Company paid Financial Capital Resources and Ms.
Whitley a total of $228,050.
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. In 1999 Mr. Forrester was paid $62,647 for legal services rendered
to the Company.
15
<PAGE>
Item 13. Exhibits and Reports on Form 8-K.
(a) Financial Statements
The following financial statements are included herewith:
Page
Report of Independent Certified Public Accountants 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
(a) Reports on Form 8-K
None
(a) 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)
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>
TRANSNATIONAL FINANCIAL NETWORK, INC.
Financial Statements as of and for the Years
Ended December 31, 1999 and 1998 and
Independent Auditors' Report
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Transnational Financial Network, Inc.
We have audited the accompanying balance sheets of Transnational Financial
Network, Inc. as of December 31, 1999 and 1998, and the related statements of
operations, shareholders' equity and cash flows for the years 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 audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 1999 and
1998, and the results of its operations and its cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States of America.
/s/ DELOITTE & TOUCHE LLP
San Francisco, California
February 18, 2000
<PAGE>
TRANSNATIONAL FINANCIAL NETWORK, INC.
BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
ASSETS
<S> <C> <C>
Cash $ 862,257 $ 990,115
Mortgage loans held for sale 2,009,092 62,254,412
Accrued interest receivable 40,126 45,524
Investment in Loan Link LLC 300,000
Receivable from Loan Link LLC 200,000
Notes receivable 135,819 135,819
Investment in real estate 190,671 195,308
Goodwill 3,758,827
Property and equipment, net 577,079 271,441
Other assets 988,930 573,776
------------- -----------
TOTAL ASSETS $ 9,062,801 $ 64,466,395
================= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Warehouse notes payable $ $ 53,587,740
Accrued interest payable 164,278 462,487
Real estate mortgage 140,283 143,975
Due to shareholders 22,043
Accounts payable and accrued expenses 80,392 1,026,378
Distributions payable to S Corporation shareholders 65,742
------------- -------------
Total liabilities 406,996 55,286,322
-------------------------------------
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; 4,279,310 and 3,700,000 shares issued and
outstanding at December 31, 1999 and 1998, respectively 10,558,709 8,453,059
Retained (deficit) earnings (1,902,904) 727,014
------------- -------------
Total shareholders' equity 8,655,805 9,180,073
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 9,062,801 $ 64,466,395
================== ===============
</TABLE>
See notes to financial statements.
- 2 -
<PAGE>
TRANSNATIONAL FINANCIAL NETWORK, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1999 AND 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
REVENUE:
<S> <C> <C>
Gain on sale of mortgage loans $ 3,868,928 $ 3,886,286
Production income 4,322,840 3,746,001
Interest income 2,716,999 3,830,839
Other 58,555 18,074
---------------- ------------------
Total revenue 10,967,322 11,481,200
---------------- ----------------
EXPENSES:
Interest expense 2,514,823 4,268,931
Salaries and benefits 7,919,933 3,564,111
General and administrative 2,854,982 1,692,754
Occupancy 607,502 213,576
---------------- ----------------
Total expenses 13,897,240 9,739,372
---------------- ----------------
INCOME (LOSS) BEFORE INCOME TAXES (2,929,918) 1,741,828
INCOME TAX (BENEFIT) EXPENSE (300,000) 572,153
---------------- ----------------
NET (LOSS) INCOME $ (2,629,918) $ 1,169,675
================ ================
NET (LOSS) INCOME PER SHARE:
Basic and diluted $ (0.67) $ 0.37
PRO FORMA (unaudited) (Note 3):
Historical income before income taxes $ 1,741,828
Pro forma income tax expense 691,349
----------------
Pro forma net income 1,050,479
================
PRO FORMA EARNINGS PER SHARE (unaudited):
Basic and diluted $ 0.34
</TABLE>
See notes to financial statements.
- 3 -
<PAGE>
TRANSNATIONAL FINANCIAL NETWORK, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1999 AND 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Common Stock Retained
----------------------------------------- (Deficit)
Shares Amount Earnings Total
<S> <C> <C> <C> <C>
BALANCE, January 1, 1998 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
Issuance of stock for
acquisition 579,310 2,082,500 2,082,500
Issuance of common stock warrants
for services performed 23,150 23,150
Net loss (2,629,918) (2,629,918)
---------------- ---------------- -------------- -------------
BALANCE, December 31, 1999 4,279,310 $ 10,558,709 $ (1,902,904) $ 8,655,805
================ ================= ============== =============
</TABLE>
See notes to financial statements.
- 4 -
<PAGE>
TRANSNATIONAL FINANCIAL NETWORK, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999 AND 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net income $(2,629,918) $ 1,169,675
Adjustments to reconcile net income to net cash used for operating activities:
Gain on sale of mortgage loans (3,868,928) (3,886,286)
Provision for loan losses 92,845 (122,238)
Depreciation and amortization 407,257 41,344
Issuance of common stock warrants for service performed 23,150
Mortgage loans originated for sale (770,798,238) (915,991,697)
Proceeds from sales of mortgage loans 846,347,958 907,923,676
Deferred income tax (benefit) expense (134,184) 134,184
Net effect of changes in:
Accrued interest receivable 5,398 136,239
Other assets 408,573 (401,509)
Accrued interest payable (298,209) 260,369
Accounts payable and accrued expenses (1,365,003) 758,714
------------- -----------
Net cash provided by (used in) operating activities 68,190,701 (9,977,529)
------------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (357,222) (204,882)
Acquisition of LRS, Inc., net of cash acquired (1,886,490)
Investment in Loan Link LLC (300,000)
Receivable from Loan Link LLC (200,000)
------------- -----------
Net cash used in investing activities (2,743,712) (204,882)
------------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowing on warehouse notes payable 996,632,246 953,513,302
Payments on warehouse notes payable (1,062,137,659) (950,080,353)
Distribution to S Corporation shareholders (65,742) (713,468)
Payments on real estate mortgage (3,692) (2,780)
Net proceeds from issuance of common stock 7,450,969
Receipt of notes receivable, shareholders 250,000
Borrowings on note payable, subordinated 1,000,000
Payment of note payable, subordinated (1,000,000)
------------- -----------
Net cash (used in) provided by financing activities (65,574,847) 10,417,670
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (127,858) 235,259
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 990,115 754,856
------------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR $862,257 $ 990,115
============= ===============
CASH PAID DURING THE YEAR FOR:
Interest $ 2,244,453 $ 3,887,139
Income taxes $ 526,221 $ 191,819
SUPPLEMENTAL SCHEDULE OF NONCASH
FINANCING ACTIVITIES:
Common stock issued for acquisition of LRS, Inc., net $ 2,100,000 $
Distribution to S Corporation shareholders declared but unpaid $ $ 65,742
</TABLE>
See notes to financial statements.
- 5 -
<PAGE>
TRANSNATIONAL FINANCIAL NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
1. DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations - Transnational Financial Network, Inc. (the
"Company") conducts real estate mortgage banking activities through five
wholesale branches and two retail branches located in Northern and
Southern California, Houston, Texas and Phoenix, Arizona. 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 Network'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 consist of amounts on deposit with major
financial institutions.
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.
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. Certain loans
are sold under gestation lines in which a gestation bank assumes the risks
and rewards of ownership. Accordingly, the income effect on such loan
sales has been recorded in the accompanying statements of operations and
the resulting cash to be received from the sale is recorded as an asset in
the accompanying balance sheets.
- 6 -
<PAGE>
Investment in Loan Link LLC - At December 31, 1999, the Company's
investment in Loan Link LLC consists of 900,000 shares of Loan Link LLC's
class B nonvoting common shares, which are recorded at cost.
Property and equipment is stated at cost and is depreciated using straight
line depreciation over the estimated useful lives of the assets, which
range from three to seven years. Leasehold improvements are amortized over
the term of the respective lease.
Goodwill - Goodwill is being amortized by charges to income on a
straight-line basis over 10 years. Goodwill amortization for 1999 and 1998
was $185,598 and $0, respectively, and is included in general and
administrative expenses in the accompanying statements of operations.
Production income consists of fees paid to the Company for both retail and
wholesale lending 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.
Income Taxes - 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. Future tax benefits
attributable to temporary differences are reduced by a valuation allowance
for any benefits that, in the opinion of management, are not likely to be
realized.
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.
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 all loans, and 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.
- 7 -
<PAGE>
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 operations 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 its 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.
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 the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. 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.
Segment Information - The Company operates as a single business segment -
mortgage banking.
New Accounting Pronouncements - In June 1998, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 133, Accounting For Derivative
Instruments and Hedging Activities. The statement establishes accounting
and reporting standards for derivative instruments and hedging activities.
In June 1999 FASB issued SFAS No. 137, Accounting for Derivative
Instruments and Hedging Activities - Deferral of the Effective Date of
FASB Statement No. 133, which amended SFAS No. 133 to be effective for the
fiscal quarters of fiscal years beginning after June 15, 2000. The Company
is in the process of determining the impact of SFAS No. 133 on the
Company's financial statements.
- 8 -
<PAGE>
Reclassifications - Certain amounts in the 1998 financial statements have
been reclassified to conform with the 1999 presentation.
2. ACQUISITION
On July 30, 1999, the Company acquired all of the issued and outstanding
stock of LRS, Inc., a Silicon Valley based mortgage banking company. The
transaction was accounted for under the purchase method of accounting. The
operations of LRS, Inc. from July 1, 1999 to December 31, 1999 are
included in the accompanying statements of operations. Under the terms of
the agreement, the Company paid $1.5 million in cash and issued 579,310
shares of Common Stock at a closing share price of $3.625 per share as of
July 30, 1999. In addition, the Company must pay certain earn-out amounts
based on pretax income, as defined, to the former stockholders of LRS,
Inc. up to a total of $3.2 million over the four-year period beginning
August 1, 1999 and ending July 31, 2003. In connection with the
acquisition, goodwill of $3,944,425 was recorded and is being amortized
using the straight-line method over 10 years.
The following Unaudited Pro Forma Combined Summary of Operations presents
a pro forma combined summary of operations of the Company and LRS, Inc.
for the years ended December 31, 1999 and 1998, and it is presented as if
the acquisition had been effective on January 1, 1998. This pro forma
combined historical summary of operations was adjusted for the
amortization of purchase accounting adjustments.
The Unaudited Pro Forma Combined Summary of Operations data is intended
for informational purposes only and is not necessarily indicative of the
future results of operations of the Company, or the results of operations
that would have actually occurred had the merger been in effect for the
periods presented.
Unaudited ProForma Combined Summary of Operations (the Company and LRS,
Inc.):
Year Ended
December 31,
--------------------------
1999 1998
GROSS REVENUE $ 17,662,216 $ 27,719,072
NET (LOSS) INCOME $ (2,527,595) $ 2,898,685
NET (LOSS) INCOME PER SHARE -
Basic and diluted $ (0,59) $ 0.78
WEIGHTED AVERAGE
SHARES OUTSTANDING
Basic and diluted 4,279,310 3,703,968
3. 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>
4. 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.
December 31,
-------------------------------------
1999 1998
Mortgage loans $ 2,008,612 $ 60,853,346
Deferred fees, net of costs 480 1,401,066
------------- -------------
Total $ 2,009,092 $ 62,254,412
================ ===============
Substantially all mortgage loans held for sale are pledged as collateral
against borrowings on the Company's warehouse facility. The lenders
release the collateral at the time a mortgage loan is sold and payment is
received.
The total of mortgage loans held for sale is increased by the Company's
interest on loans sold to gestation.
5. NOTES RECEIVABLE
Notes receivable represents principal advances to individuals at fixed
interest rates of 6% and 8%. Principal and interest are due in 2000.
Accrued interest related to these notes totaled $40,126 and $45,524 at
December 31, 1999 and 1998, respectively.
6. INVESTMENT IN REAL ESTATE AND REAL ESTATE MORTGAGE
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 $21,829 and $17,192 at December 31, 1999 and 1998,
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, 1999) 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:
1999 1998
Furniture, fixtures and equipment $ 911,028 $ 326,442
Leasehold improvements 68,162 40,130
Total 979,190 366,572
Accumulated depreciation and amortization (402,111) (95,131)
-------------- --------------
Net $ 577,079 $ 271,441
============== ============
Depreciation and amortization expense on premises and on equipment was
$221,659 and $36,708 for 1999 and 1998, respectively.
8. WAREHOUSE NOTES PAYABLE
During 1999, the Company maintained two revolving warehouse lines of
credit with similar terms, primarily to fund mortgage loan originations.
Advances are made on the warehouse lines for specific properties, which
are pledged as collateral. Interest is accrued monthly on the warehouse
lines and is due at settlement when the underlying loans are sold. All
advances are expected to be repaid within one year. The Company maintained
a $65 million ($100 million up to September 30, 1999) line with Guaranty
Federal Bank which terminated on December 30, 1999. On December 16, 1999,
the Company entered into a $50 million line of credit with Residential
Funding Corporation ("RFC") which was reduced to $35 million in February
2000. Interest on outstanding advances (none outstanding at December 31,
1999) is at LIBOR plus 1.5% (7.332% at December 31, 1999). The RFC line of
credit expires on August 31, 2000.
The Company maintains a Loan Participation and Custodian Agreement
(Gestation Repurchase Line) with Gateway Bank for $15 million dated
January 29, 1998. Interest on the December 30, 1999 Guaranty Federal loan
transfer is at the Prime Rate plus 0.625% (9.125% at December 31, 1999),
interest through January 31, 2000 is at the Prime Rate less 0.75% (7.750%
at December 31, 1999) and interest from February 1, 2000 to March 31, 2000
(the termination date) is at the Prime Rate less 1.375%. At December 31,
1999, no amounts were available on the Gestation Repurchase Line.
The Company also has entered into a $10 million QuickSale Master Loan
Participation and Custodian Agreement with Gateway Bank (QuickSale
Gestation Line), which allows the Company to sell mortgage loans
thereunder pending resale to the Company's investors. Interest on the line
is at the Prime Rate less 1.125% (7.375% at December 31, 1999). At
December 31, 1999, $5,703,969 was available on the line. The line
terminates only upon written notice from either party.
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% (6.832% at December 31, 1999) with an
available balance of $30 million. The line terminates only upon written
notice from either party.
The Company must comply with covenants included in its credit agreements,
including restrictions on the payment of dividends (50% of net income),
maintenance of certain financial ratios, maintaining minimum amounts of
tangible net worth ($5,000,000 as of December 31, 1999 and amended to
$3,000,000 in 2000) and other conditions. As of December 31, 1999, the
Company was in compliance with all covenants except the minimum tangible
net worth requirement. A waiver of noncompliance was obtained.
- 11 -
<PAGE>
9. CREDIT FACILITIES
Subordination Debt - In order to obtain additional capital in 1998, 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). Interest expense related to the note in
1998 was $30,131.
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, 1999 and 1998, a total of 164,500 and
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
1999 and 1998 have a life of 5 years and vest at 25% per year. During 1999
and 1998, the Company issued options to outside directors with a
contractual life of 10 years as follows: 80,000 options which vest
immediately and 160,000 options which vest only upon a change in control.
A summary of stock options follows:
Weighted
Average
Stock Exercise
Options Price
Outstanding at January 1, 1998 -
Options granted 225,000 $ 7.50
-------------
Outstanding at December 31, 1998 225,000 7.50
Options granted 155,500 7.50
Options forfeited (45,000) 7.50
-------------
Outstanding at December 31, 1999 335,500 7.50
=============
- 12 -
<PAGE>
Information about stock options outstanding at December 31, 1999 is
summarized as follows:
<TABLE>
<CAPTION>
Weighted Weighted
Average Average
Average Exercise Exercise
Range of Remaining Price of Price of
Exercise Options Contractual Options Options Options
Prices Outstanding Life (Years) Outstanding Exercisable Exercisable
<S> <C> <C> <C> <C> <C> <C>
$ 7.50 335,500 8.90 $7.50 110,000 $ 7.50
</TABLE>
The Company applies APB Opinion No. 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>
1999 1998
Net (loss) income:
<S> <C> <C>
As reported $ (2,629,918) $ 1,169,675
Pro forma $ (2,978,543) $ 1,011,725
Basic and diluted (loss) income per common share:
As reported $ (0.67) $ 0.37
Pro forma $ (0.75) $ 0.32
</TABLE>
The fair value of the stock options granted during 1999 and 1998,
respectively, is estimated as $500,180 and $157,950 on the date of grant
using a binomial option-pricing model with the following assumptions: $0
and $0.375 annual dividend, volatility of 58.50% and 21.89%, risk-free
interest rate of 6.5% and 5.4%, assumed forfeiture rate of zero, and an
average expected life of 9.2 to 6.0 years. The weighted average fair value
per share of options granted in 1999 and 1998 was $3.23 and $1.50,
respectively.
11. 401(K) PLANS
On January 1, 1999, the Company established a 401(K) and Profit Sharing
Plan (the "TFN Plan") for certain full-time employees. The Company
contributes a maximum of 2% of the employees' gross salary limited to the
amount of the employee's contribution. The Company contributed $29,908 to
the TFN Plan during 1999.
The Company also maintains a 401(k) Savings Plan ("the LRS Plan") which
covers certain previous employees of LRS, Inc. (see Note 2). Under the LRS
Plan, the Company matches 50% of employee contributions up to a maximum of
6% of gross salary. From August 1, 1999 (date of acquisition) through
December 31, 1999, the Company contributed $8,371 to the LRS Plan.
- 13 -
<PAGE>
12. 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. Income tax (benefit)
expense for the years ended December 31 were as follows:
1999 1998
Current:
Federal $ (150,952) $ 331,580
State (14,864) 106,389
-----------------------------
Total (165,816) 437,969
-----------------------------
Deferred:
Federal (89,870) 89,870
State (44,314) 44,314
----------------------------
Total (134,184) 134,184
----------------------------
Total $ (300,000) $ 572,153
=============== ============
The effective federal tax rate for the years ended December 31, differ
from the statutory tax rate as follows:
1999 1998
Federal income tax at statutory rates 34.0% 34.0%
Net operating loss carrybacks, net
of valuation allowance (26.6)
State income taxes, net of federal
income tax benefit 5.4
S Corporation income (6.8)
Other 2.8 0.3
----- -----
10.2% 32.9%
===== =====
- 14 -
<PAGE>
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:
1999 1998
Deferred tax assets:
Net operating loss carryforwards $ 623,195 $
Goodwill 37,883
Property and equipment 2,706
State taxes 272 49,121
Other 5,690
------------ -----------
Total deferred tax assets 669,746 49,121
Deferred tax liabilities:
Prepaid rent (14,690) (12,102)
Deferred loan costs (1,150) (138,784)
Property and equipment (27,147)
Other (5,272)
------------ -----------
Total deferred tax liabilities (15,840) (183,305)
-------------------------------
Net deferred tax asset (liability) before
valuation allowance 653,906 (134,184)
Valuation allowance (653,906)
------------ -----------
Net deferred tax liability $ - $ (134,184)
============ ===========
At December 31, 1999, the net deferred tax asset is fully reserved through
valuation allowances. Federal and state net operating loss carryforwards
of $535,767 and $87,428 expire in 2019 and 2004, respectively.
13. 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.
On June 24, 1998, the Company issued to Tejas Securities Group, Inc., the
underwriter for the Company's public offering, warrants to purchase
120,000 shares of TFN's stock at $8.12 expiring June 24, 2003. The fair
value of these grants was deducted from the common stock offering
proceeds.
On November 4, 1998, the Company issued warrants to purchase 5,000 shares
of the Company's common stock at $7.50 per share to James Drewitz. The
warrants are exercisable through November 4, 2008. Salaries and benefits
expense related to the warrants was not significant.
- 15 -
<PAGE>
On October 15, 1999, the Company issued warrants to purchase 20,000 shares
of the Company's common stock at $2.45 per share to First Colonial
Securities Group, Inc. The warrants are exercisable through October 15,
2005 and were recorded as salaries and benefits expense in the statement
of operations.
14. NET (LOSS) INCOME PER SHARE
Basic net (loss) income per share is based on net (loss) income after
dividends and on the weighted average common shares outstanding. Diluted
net (loss) income is computed based on the weighted average number of
common shares outstanding adjusted for the common stock equivalents, which
include stock options and warrants. The following table presents a
reconciliation of basic and diluted net income per share for the years
ended December 31, 1999 and 1998 in accordance with SFAS No. 128. For the
years ended December 31, 1999 and 1998, the effect of including
outstanding options and warrants of 480,500 and 350,000, respectively, 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>
1999 1998
Basic and Diluted Net (Loss) Income Per Share
<S> <C> <C>
Net (loss) income $ (2,629,918) $ 1,169,675
Weighted average common
shares outstanding 3,946,202 3,124,658
---------------------------------
Basic net (loss) income per share $ (0.67) $ 0.37
=============== ============
</TABLE>
15. FAIR VALUE OF 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 $90,000, 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 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.
- 16 -
<PAGE>
<TABLE>
<CAPTION>
1999 1998
------------------------------ ---------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
Financial assets:
<S> <C> <C> <C> <C>
Cash $ 862,257 $ 862,257 $ 1,065,349 $ 1,065,349
Mortgage loans held for sale 2,009,092 2,010,787 62,499,178 62,800,000
Investment in Loan Link LLC 300,000 300,000
Receivable from Loan Link LLC 200,000 200,000
Notes receivable 135,819 129,380 135,819 124,888
Financial liabilities:
Warehouse notes payable 53,587,740 53,587,740
Real estate mortgage 140,283 140,283 143,975 143,975
Off-balance-sheet instruments:
Commitments to extend credit $ 165,250 141,228
Financial futures 72,380
Forward delivery commitments 93,093 42,930
</TABLE>
The notional amount of the Company's commitments to extend credit at fixed
interest rates were approximately $33,050,100 and $39,000,000 at December
31, 1999 and 1998. The Company also made commitments to deliver $7,750,000
and $44,000,000 in loans and in mortgage backed securities to various
investors, all at fixed interest rates as of December 31, 1999 and 1998.
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.
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.
Investment in Loan Link LLC - Management believes the carrying amount is a
reasonable estimate of fair value considering the early stage of Loan Link
LLC's development.
Receivable From Loan Link LLC - The carrying amount is a reasonable
estimate of fair value.
Notes Receivable - 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 based 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.
- 17 -
<PAGE>
16. SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
A significant portion 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, 1999 and
1998.
The Company has a concentration of credit risk with respect to cash
deposited with commercial banks in excess of federally insured limits.
17. 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:
2000 $ 683,785
2001 603,664
2002 417,457
2003 350,295
2004 177,283
---------------
Total $ 2,232,484
==============
Building and equipment rental expense was approximately $726,571 and
$237,364 for the years ended December 31, 1999 and 1998.
Litigation - The Company is involved in legal proceedings arising in the
ordinary course of business. The ultimate outcome of these proceedings
cannot 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>
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 29, 2000
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/ Jospeh Kristul Director March 29, 2000
- --------------------------------------------
Joseph Kristul
/s/ Maria Kristul Director March 29, 2000
- --------------------------------------------
Maria Kristul
Director March 29, 2000
- --------------------------------------------
Hilary Whitley
Director March 29, 2000
- --------------------------------------------
Robert A. Shuey
/s/ Robert A. Forrester Director March 29, 2000
- --------------------------------------------
Robert A. Forrester
/s/ William A. Russell Director March 29, 2000
- --------------------------------------------
William A. Russell
Director March 29, 2000
- --------------------------------------------
Alex Rotzang
/s/ J. Peter Gaskins Director March 29, 2000
- --------------------------------------------
J. Peter Gaskins
17
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 862,257
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,009,092
<PP&E> 979,190
<DEPRECIATION> 402,111
<TOTAL-ASSETS> 9,062,801
<CURRENT-LIABILITIES> 164,278
<BONDS> 0
0
0
<COMMON> 8,655,805
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 9,062,801
<SALES> 10,967,322
<TOTAL-REVENUES> 10,967,322
<CGS> 0
<TOTAL-COSTS> 13,897,240
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (2,929,918)
<INCOME-TAX> (300,000)
<INCOME-CONTINUING> (2,629,918)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (269,918)
<EPS-BASIC> (0.67)
<EPS-DILUTED> (0.67)
</TABLE>
