UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K/A
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the fiscal year ended December 31,1997
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the transition period from _____________________ to
_______________________
Commission File No. 0-8909
EMERGENT GROUP, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
<S> <C>
South Carolina 57-0513287
- ------------------------------------------------------------------- ------------------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
</TABLE>
15 South Main Street Suite 750 Greenville, South Carolina 29601
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 864-235-8056
Securities registered under Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on which registered
- --------------------------------- ------------------------------------------
None None
Securities registered under Section 12(g) of the Act:
Title of Each Class
- --------------------------------------------------------------------------------
Common Stock, par value $.05
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of March 20, 1998, the aggregate market value of voting stock held by
non-affiliates of registrant was approximately $61,362,134.
As of March 20, 1998, 9,708,083 shares of the Registrant's common stock were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Company's Proxy Statement for the Annual Meeting of Shareholders scheduled
for June 10, 1998 to be filed not later than 120 days after December 31, 1997 is
incorporated by reference into Part III hereof.
<PAGE>
Item 7 set forth replaces in its entirety Item 7 set forth in the Company's
10-K filing on April 15, 1998.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The discussion should be read in conjunction with the
Consolidated Financial Statements and notes of the Company appearing elsewhere
in this report. As used herein, "Discontinued Operations" refers to the
Company's former transportation and apparel operations. Unless otherwise noted,
the discussion contained herein relates to the continuing operations of the
Company, which solely consist of its Financial Services operations.
FORWARD - LOOKING INFORMATION
Certain statements in the financial discussion and analysis by
management that reflect projections or expectations of future financial or
economic performance of the Company, and statements of the Company's plans and
objectives for future operations are "forward-looking" statements. No assurance
can be given that actual results or events will not differ materially from those
projected, estimated, assumed or anticipated in any such forward-looking
statements. Important factors that could result in such differences are many and
include: lower origination volume due to market conditions, higher losses due to
economic downturn or lower real estate values, loss of key employees, adverse
consequences of changes in interest rate environment, deterioration of
creditworthiness of borrowers and risk of default, general economic conditions
in the Company's markets, including inflation, recession, interest rates and
other economic factors, loss of funding sources, loss of ability to sell loans,
general lending risks, dependence on Federal programs, impact of competition,
regulation of lending activities, and changes in the regulatory environment.
GENERAL
The Company is a diversified financial services company
headquartered in Greenville, South Carolina, which originates, purchases, sells,
securitizes and services mortgage and small business loans to sub-prime
customers. Prior to March 1998, the Company also originated, securitized and
serviced auto loans. The Auto Loan Division was sold in the first quarter of
1998 in order to narrow the Company's financial services focus. The Company
commenced its lending operations in 1991 through the acquisition of Carolina
Investors, Inc. ("CII"), a small mortgage lending company, which had been in
operation since 1963. Since acquisition through December 31, 1997, the Company
has experienced a compounded annual growth rate of 84% in loan originations.
Since 1996, the Company has been focused principally on expanding its mortgage
loan division and small business loan division. During the fourth quarter of
1997, the Company opened its fourth retail mortgage regional operating center
and expanded its existing retail mortgage operating centers, in order to
increase capacity. As a result of this expansion, the Company will continue to
incur significant expansion and start-up costs in the first quarter of 1998.
Additionally in the fourth quarter of 1997, the Company restructured its
Mortgage Loan Division. Because of this restructuring, the Company anticipates
that loan origination volume will be lower in the first quarter of 1998
compared to the last few quarters of 1997.
Due to the anticipated higher cost levels and lower volumes,
the Company expects to incur a significant loss in the first quarter of 1998.
While the above changes will have a negative impact on earnings in the first
quarter of 1998, the long-term benefits of these changes are expected to
outweigh this negative impact. In order to concentrate effort on the larger
retail mortgage operation ("Homegold(R)"), the Company has determined to pursue
the divestiture of its smaller retail mortgage origination subsidiary, Sterling
Lending Corp. ("SLC"). This subsidiary was started in June 1996 and has
originated
2
<PAGE>
only a small percentage of total retail loans. This company's first-year
start-up cost resulted in a pre-tax loss of approximately $3.7 million in 1997.
A primary focus of the Company in 1997, in addition to growing
its retail mortgage loan origination business, was to increase its serviced loan
portfolio. The Company's total serviced loans receivable increased to $988.7
million at December 31, 1997, from $309.1 million at December 31, 1996. The
increase in the serviced mortgage loan portfolio has resulted from both the
Company's decision to enter the retail loan origination business and the
increase in both the loan volume from existing and new Mortgage Bankers. Small
Business Loans have increased due to the opening of additional offices, an
increase in the number of commercial loan brokers, which refer loans to the
Small Business Loan Division, and new product offerings. Auto Loans increased
during all such periods, prior to 1997, principally as a result of an increase
in the number of loan production offices and successful efforts at establishing
additional dealer relationships. Beginning in September 1996, the Company
curtailed the expansion of its Auto Loan operations and, since that time, the
Company has experienced a decline in Auto Loan originations. The Company no
longer originates Auto Loans.
3
<PAGE>
The following table sets forth certain data relating to the
Company's loans at and for the periods indicated:
<TABLE>
<CAPTION>
AT AND FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
MORTGAGE LOANS:
Mortgage loans originated $ 1,082,816 $ 328,649 $ 192,800
Mortgage loans sold 435,333 284,794 127,632
Mortgage loans securitized 487,563 -- --
Total mortgage loans owned (period end) 231,145 146,231 88,165
Total serviced mortgage loans (period end) 768,556 146,231 88,165
Total serviced unguaranteed mortgage
loans (period end) (1) 700,248 146,231 88,165
Average mortgage loans owned (2) 215,790 97,281 74,158
Average serviced mortgage loans (2) 443,318 97,281 74,158
Average serviced unguaranteed
mortgage loans (1) 411,549 97,281 74,158
Average interest earned (2) 10.92 % 11.97 % 12.10 %
SMALL BUSINESS LOANS:
Small business loans originated $ 81,018 $ 68,210 $ 39,560
Small business loans sold 41,232 33,060 25,423
Small business loans securitized 24,286 12,851 17,063
Total small business loans owned (period 45,186 29,385 20,620
end)
Total serviced small business loans
(period end) 198,876 140,809 108,696
Total serviced unguaranteed small
business loans (period end) (3) 78,822 44,017 24,867
Average small business loans owned (2) 38,427 26,700 23,692
Average serviced small business loans (2) 165,053 125,723 98,753
Average serviced unguaranteed small
business loans (2) (3) 61,420 34,442 21,819
Average interest earned (2) 15.89 % 12.61 % 10.39 %
AUTO LOANS:
Auto loans originated $ 15,703 $ 18,287 $ 17,148
Auto loans securitized -- 16,107 --
Total auto loans owned (period end) 21,284 13,916 17,673
Total serviced auto loans (period end) 21,284 22,033 17,673
Average auto loans owned (2) 17,104 11,917 13,078
Average serviced auto loans (2) 22,267 21,277 13,078
Average interest earned (2) 24.05 % 23.57 % 27.40 %
TOTAL LOANS:
Total loans receivable (period end) $ 297,615 $ 189,532 $ 126,458
Total serviced loans (period end) 988,716 309,073 214,534
Total serviced unguaranteed loans
(period end) (1)(3) 800,354 212,281 130,705
</TABLE>
- --------------------------------------------------------------------------------
(1) Excludes loans serviced for others with no credit risk to the Company.
(2) Averages are computed using beginning and ending balances for the
period presented, except that the 1996 and 1997 averages are calculated
based on the daily averages for Small Business Loan Division and Auto Loan
Division and monthly averages for Mortgage Loan Division (rather than the
beginning and ending balances).
(3) Excludes guaranteed portion of SBA Loans.
4
<PAGE>
OPERATING CASH FLOW
The Company expects to continue to operate on a negative cash
flow basis due to the level of cash required to fund the increases in the volume
of loans purchased and originated. Currently, the Company's primary operating
cash uses include the funding of (i) Mortgage Loan originations and purchases
pending their securitization or sale, (ii) interest expense on CII investor
savings notes ("CII Notes"), senior unsecured debt and its warehouse credit
facilities ("Credit Facilities"), (iii) fees, expenses, overcollateralization
and tax payments incurred in connection with the securitization program and (iv)
ongoing administrative and other operating expenses. The Company's primary
operating sources of cash are (i) cash gains from sale of SBA loan
participations and whole-loan mortgage loan sales. (ii) cash payments of
contractual and ancillary servicing revenues received by the Company in its
capacity as servicer for securitized and subserviced loans, (
nterest
income on loans receivable and certain cash balances, (iv) fee income received
in connection with its retail mortgage loan originations, and (v) excess cash
flow received in each period with respect to interest-only and residual
certifica
Creating negative cash flow is the requirement to provide
overcollateralization of loans as credit enhancement on the mortgage
securitization transactions. This will continue to negatively impact the
Company's cash flow as additional mortgage securitizations are completed in the
future, unless the Company decides to alter its securitization structures or
sell its residual interests in the securitization trusts. The Company reduces
the negative cash flow impact from the overcollateralization of loans included
in securitizations by continuing to sell whole loans on a cash basis. Cash flow
is also enhanced by the generation of loan fees in its retail mortgage loan
operation and the utilization of a wholesale loan origination strategy whereby
loans are generally funded at par, rather than at the significant premiums
typically associated with a correspondent-based strategy.
The table below summarizes cash flows provided by and used in
operating activities:
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------
1997 1996 1995
------------- ------------- ---------------
(IN THOUSANDS)
<S> <C>
OPERATING CASH INCOME:
Servicing fees received and excess cash flow from
securitization trusts $ 12,498 $ 3,782 $ 1,259
Interest received 31,716 17,392 14,549
Cash gain on sale of loans 14,153 20,862 8,987
Cash loan origination fees received 31,843 4,714 --
Other cash income 1,875 1,266 491
------------- ------------- ---------------
Total operating cash income 92,085 48,016 25,286
OPERATING CASH EXPENSES:
Securitization costs (3,646) (849) (266)
Securitization hedge losses (2,125) -- --
Cash operating expenses (81,594) (21,625) (9,480)
Interest paid (20,980) (11,046) (8,424)
Taxes paid (1,581) (322) (267)
------------- ------------- ---------------
Total operating cash expenses (109,926) (33,842) (18,437)
CASH FLOW (DEFICIT) DUE TO OPERATING CASH INCOME AND
EXPENSES (17,841) 14,174 6,849
5
<PAGE>
Years Ended December 31,
-------------------------------------------------
1997 1996 1995
------------- ------------- ---------------
(IN THOUSANDS)
OTHER CASH FLOWS:
Cash used in other payables and receivables $ (4,978) $ (5,959) $ (4,850)
Cash used in loans held for sale (114,282) (86,770) (13,767)
Net cash provided by operating activities of
discontinued operations -- 77 1,592
------------- ------------- ---------------
NET CASH USED IN OPERATING ACTIVITIES $ (137,101) $ (78,478) $ (10,176)
============= ============= ===============
</TABLE>
PROFITABILITY
The principal components of the Company's profitability are
(i) interest, fees and servicing revenues earned on its serviced loans
receivable reduced by interest paid on borrowed funds associated with such
serviced loans receivable; (ii) gains resulting from the sale and securitization
of its loans, including loan origination fees recognized.
For the periods indicated, the following table sets forth
certain information derived from the Company's Consolidated Financial Statements
expressed as a percentage of total revenues.
<TABLE>
<CAPTION>
For the Year Ended December 31,
----------------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Interest income 26.8 % 35.5 % 57.8 %
Servicing income 6.7 6.5 1.7
Cash gain on sale of loans 11.1 41.4 30.3
Non-cash gain on sale of loans 30.5 5.9 4.6
Loan fee income 23.8 8.2 2.2
Other revenues 1.1 2.5 3.4
========== ========== ==========
Total revenues 100.0 % 100.0 % 100.0 %
========== ========== ==========
Interest expense 19.8 % 21.9 % 32.5 %
Provision for credit losses 7.9 10.7 9.4
Business development costs 5.9 3.2 2.5
Other general and administrative expenses 60.5 43.4 37.1
Income from continuing operations before income taxes 5.9 20.8 18.5
Income tax expense (benefit) (3.1) 1.4 0.8
Minority interest (0.1) 0.7 (0.3)
Income (loss) from discontinued operations -- -- (14.9)
---------- ---------- ----------
Net income 8.9 % 20.1 % 2.5 %
========== ========== ==========
The Company's net income, as a percentage of revenues,
decreased substantially in 1997 from 1996 as a result of increased expenses
associated with the start-up of three new retail mortgage regional operating
centers for HomeGold(R), expansion of Sterling Lending Corp. retail mortgage
branches to 13, expansion of portfolio management department to handle
anticipated increases to the Company's serviced portfolio, and expansion of
broker wholesale operations. These significant start-up costs were expensed
during 1997 and accordingly, have substantially reduced current operating profit
margins. For the fourth quarter of 1997, income from continuing operations
decreased to a loss of $457,000 from income of $4.3 million in the third
quarter. The profit margin worsened as a result of approximately $500,000
additional reserves taken in the Auto Loan Division (which was sold in March
1998), write-off of approximately $3.0 million for potential loss on a
receivable from a former strategic alliance partner, approximately $500,000) of
additional costs for the Small Business Loan Division as a result of continued
expansion of that business, and approximately $5.3 million in increased costs
for the Mortgage Loan Division. Approximately $2.6 million of these increased
costs was due to the new Houston Regional Operating Center for HomeGold(R) which
was opened on October 1, 1997. Approximately $1.0 million of the increased costs
was due to increased personnel and expansion of the broker wholesale operations,
which is being increased from 4 regions to 7 regions. The remaining increased
costs for the Mortgage Loan Division in the fourth quarter 1997 was due to
additional expansion in the other three HomeGold(R) Regional Operating Centers,
additional corporate infrastructure for MIS and Training, and continued
enhancements and expansion of the portfolio management department. These
expansions were partially performed in anticipation of meeting increased
origination estimates. Origination volume, however, levelled-off in the fourth
quarter of 1997 ($308.4 million in the fourth quarter as compared to $300.2
million in the third quarter), which combined with the continued expansion,
contributed to the decreased operating margins. The Company anticipates its
efficiency ratios for loans originated per originator to decrease in the first
quarter of 1998 as a result of the Company's reorganization and personnel
changes, and accordingly will continue to have higher costs relative to revenue
during the first part of 1998. Management plans to improve these efficiency
ratios, both through evaluating and improving loans originated per originator as
well as to cut operating costs where possible to improve operating efficiencies
by the end of 1998.
</TABLE>
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997, COMPARED TO YEAR ENDED DECEMBER 31, 1996
Total revenues increased $76.6 million, or 152%, to $127.0
million in 1997 from $50.4 million in 1996. The higher level of revenues
resulted principally from increases in interest income, servicing income, and
gain on sale of loans.
6
<PAGE>
Interest income increased $16.1 million, or 90%, to $34.0
million in 1997 from $17.9 million in 1996. This growth resulted primarily from
the growth experienced by the Mortgage Loan Division. Interest income earned by
the Mortgage Loan Division increased $12.6 million, or 92%, to $26.3 million in
1997 from $13.7 million in 1996. This increase was due principally to the growth
in the average outstanding loan portfolio in the Mortgage Loan Division, which
increased $143.0 million, or 147%, to $240.3 million in 1997 from $97.3 million
in 1996, reflecting the increased loan origination levels generated by that
Division.
Servicing income increased $5.2 million, or 158%, to $8.5
million in 1997 from $3.3 million in 1996. This increase was due principally to
the securitization of Mortgage Loans in 1997, for which the Company retained
servicing rights. Prior to 1997, the Mortgage Loan Division did not securitize
its loans. The Mortgage Loan Division securitized $487.6 million in loans in
1997. The average serviced loan portfolio for the Mortgage Loan Division
increased $343.5 million, or 353%, to $440.8 million from $97.3 million.
Cash gain on sale of loans decreased $6.7 million, or 32%, to
$14.2 million in 1997 from $20.9 million in 1996. The decrease resulted
principally from decreased premiums on sales of Mortgage Loans. The weighted
average gain on sale of Mortgage Loans decreased 3.3%, or 54%, to 2.8% in 1997
from 6.1% in 1996. This decrease in premiums is due primarily to the product
sold in 1997 compared to 1996. In 1996, the majority of loans sold was first
mortgage loans. In 1997, most first mortgage loans originated were securitized,
while second mortgage loans were whole-loan sold. Mortgage Loans sold increased
$150.5 million, or 53%, to $435.3 million in 1997 from $284.8 million in 1996.
Non-cash gain on sale of loans increased $35.7 million to
$38.7 million in 1997 from $3.0 million in 1996. The increase in non-cash gain
on sale of loans was due principally to the securitization of Mortgage Loans in
1997, which was not done prior to 1997. The Mortgage Loan Division securitized
$487.6 million in loans in 1997 and recognized a weighted average non-cash gain
on sale as a percentage of loans securitized of 7.4%, net of expenses. All
non-cash gain on sale of loans in 1996 related to the Small Business Loan
Division.
Loan fees increased $26.0 million to $30.2 million in 1997
from $4.2 million in 1996. The higher loan fees was due principally to the
increase in retail loan originations in the Mortgage Loan Division. The Company
receives substantially higher fees on loans it originates through its retail
operations than it receives on loans purchased. Retail loan originations
increased $493.9 million, or 718%, to $562.7 million in 1997 from $68.8 million
in 1996. Loan fees are deferred and recognized as interest income over the life
of the loan. All unamortized loan fees, net of origination costs, are realized
as part of the gain on sale of loans when the loans are sold or securitized.
Other revenues increased $158,000, or 13%, to $1.4 million in
1997 from $1.2 million in 1996. Other revenues are comprised principally of
insurance commissions and management fees. The increase of other revenues
resulted principally from the increase in the Company's loan originations.
Total expenses increased $79.5 million, or 199%, to $119.4
million in 1997 from $39.9 million in 1996. Total expenses are comprised of
provision for credit losses, interest expense, business development, and other
general and administrative expenses.
7
<PAGE>
Interest expense increased $14.1 million, or 128%, to $25.1
million in 1997 from $11.0 million in 1996. The increase in interest expense was
due principally to increased borrowings by the Mortgage Loan Division associated
with increased loan originations and the offering of the Company's Senior Notes
due 2004. Interest expense in the Mortgage Loan Division increased $10.1 million
in 1997 from 1996. Average borrowings attributable to the Mortgage Loan
Division, both under its warehouse credit facilities and in connection with the
sales of notes payable to investors and subordinated debentures, increased
$134.6 million, or 105%, to $262.3 million at December 31, 1997 from $127.7
million at December 31, 1996. In September 1997, the Company also completed the
$125.0 million offering of the Company's Senior Notes due 2004 with interest
payable at 10.75%.
Provision for credit losses increased $4.6 million, or 85%, to
$10.0 million in 1997 from $5.4 million in 1996. The provision was made to
maintain the general reserves for credit losses associated with loans held for
investment, as well as to increase specific reserves for possible losses with
regard to particular loans.
General and administrative expense increased $60.8 million, or
259%, to $84.3 million in 1997 from $23.5 million in 1996. This is a result
primarily from the increased personnel costs in the Mortgage Loan Division due
to the continued expansion in the portfolio management, underwriting,
processing, and closing departments, and the increased expenses associated with
the opening of retail lending offices in Greenville and Houston in 1997. General
and administrative expenses increased to 13.4% of average serviced loans in 1997
from 9.6% in 1996, principally as a result of the higher costs associated with
the retail mortgage origination facilities. Retail production increased 717% in
1997.
Net income increased $1.2 million, or 12%, to $11.3 million in
1997 from $10.1 million in 1996. The improvement in income was due principally
to the increased growth and profitability of the Small Business Loan Division
and a $3.9 million tax benefit recorded in 1997 due to the recognition of the
deferred tax benefit associated with the net operating loss carryforward.
YEAR ENDED DECEMBER 31, 1996, COMPARED TO YEAR ENDED DECEMBER 31, 1995
Total revenues increased $24.1 million, or 92%, to $50.4
million in 1996 from $26.3 million in 1995. The increase in revenues resulted
principally from increases in interest and servicing revenue and gain on sale of
loans.
Interest income increased $2.7 million, or 18%, to $17.9
million in 1996 from $15.2 million in 1995. This increase was due principally to
the growth in the serviced loan portfolio in the Mortgage Loan Division.
Interest income earned by the Mortgage Loan Division increased $4.6 million or
51%, to $13.7 million in 1996 from $9.1 million in 1995.
Servicing income increased $2.9 million, or 640%, to $3.3
million in 1996 from $446,000 in 1995. This increase was due to the
securitizations of Small Business Loans and Auto Loans in 1996, for which the
Company retains servicing rights.
8
<PAGE>
Cash gain on sale of loans increased $12.9 million, or 161%,
to $20.9 million in 1996 from $8.0 million in 1995. The increase resulted
principally from increased sales of Mortgage Loans and Small Business Loans
associated with the increased loan originations. Mortgage Loans sold increased
$157.2 million, or 123%, to $284.8 million in 1996 from $127.6 million in 1995.
Small Business Loans sold increased $7.7 million, or 30%, to $33.1 million in
1996 from $25.4 million in 1995. Additionally, the Company received a recoupment
of previously shared premiums of $7.3 million in connection with the settlement
with First Greensboro Home Equity, Inc. and Amerifund Group, Inc., two strategic
alliance partners who terminated their agreements with the Company in 1996.
Non-cash gain on sale of loans increased $1.8 million, or
150%, to $3.0 million in 1996 from $1.2 million in 1995. The increase resulted
principally from the increase in total loans securitized. In 1995, $17.1 million
of Small Business Loans were securitized. In 1996, $29.0 million of Small
Business and Auto Loans were securitized.
Loan fees increased $3.6 million, or 616%, to $4.2 million in
1996 from $586,000 in 1995. The increase in loan fees was due principally to the
increase in loan originations in the Mortgage Loan Division.
Other revenues increased $357,000, or 40%, to $1.2 million in
1996 from $884,000 in 1995. Other revenues are comprised principally of
insurance commissions and management fees. The increase of other revenues
resulted principally from the increase in the Company's loan originations.
Total expenses increased $18.5 million, or 86%, to $39.9
million in 1996 from $21.4 million in 1995. Total expenses are comprised of
interest expense, provision for credit losses and general and administrative
expenses.
Interest expense increased $2.5 million, or 29%, to $11.0
million in 1996 from $8.5 million in 1995. The increase was due principally to
increased borrowings by the Mortgage and Small Business Loan Divisions
associated with increased loan originations. Borrowings attributable to the
Mortgage Loan Division, both under its warehouse credit facilities and in
connection with the sales of notes payable to investors and subordinated
debentures, increased $55.7 million, or 53%, to $160.9 million at December 31,
1996 from $105.2 million at December 31, 1995. Interest expense in the Mortgage
Loan Division increased $2.4 million in 1996 from 1995. Total borrowings
attributable to the Small Business Loan Division decreased $6.1 million, or 41%,
to $8.7 million at December 31, 1996 from $14.8 at December 31, 1995. This
decrease in debt resulted principally from cash received from the securitization
completed in November 1996, which was used to pay down outstanding debt.
Interest expense in the Small Business Loan Division increased $198,000 in 1996
from 1995. There were no borrowings outstanding in the Auto Loan Division as of
December 31, 1996, down from $9.9 million at December 31, 1995. This decrease
resulted principally from cash received from the securitization transaction
completed in March 1996 and from the Company's public offering completed in
November 1996. The offering was used to pay outstanding debt. Interest expense
in the Auto Loan Division decreased $220,000 in 1996 from 1995.
Provision for credit losses increased $2.9 million, or 116%,
to $5.4 million in 1996 from $2.5 million in 1995. The provision was made to
maintain the general reserves for
9
<PAGE>
credit losses associated with loan originations, as well as to increase specific
reserves for possible losses with particular loans.
General and administrative expense increased $13.1 million, or
126%, to $23.5 million in 1996 from $10.4 million in 1995. This is a result of
increased personnel costs in the Mortgage Loan Division due to the continued
expansion in the portfolio management and underwriting departments, and the
increased expenses associated with the opening of retail lending offices in
Indianapolis, Baton Rouge, New Orleans, and Phoenix. General and administrative
expenses increased to 9.62% in 1996 from 5.63% of average serviced loans in
1995, principally as a result of the costs associated with the retail mortgage
origination facilities, for which the related production was sold on a
non-recourse, servicing-released basis, with customary representations and
warranties. Accordingly, costs have been increased relative to the serviced
portfolio.
Net income increased $5.5 million, or 120%, to $10.1 million
in 1996 from $4.6 million in 1995. The improvement in income was due principally
to the increased growth and profitability of the Mortgage Loan Division,
although the Small Business Loan Division's profitability also increased
significantly in 1996 from 1995.
FINANCIAL CONDITION
Net loans receivable increased $103.4 million to $288.4
million at December 31, 1997 from $185.0 million at December 31, 1996. The
increase in investment in asset-backed securities of $12.8 million was due
primarily to the overcollateralization associated with the retention of the
residual interest certificates in the Company's mortgage loan securitizations
completed in each quarter of 1997. The interest only strip security increased by
$40.1 million to $44.4 million at December 31, 1997, from $4.3 million at
December 31, 1996. This increase resulted primarily from the estimated present
value of the excess cash flow on mortgage loans sold with servicing retained of
$44.1 million, offset by amortization of $4.0 million.
Net property, plant and equipment increased by $10.9 million
to $18.1 million at December 31, 1997, from $7.2 million at December 31, 1996.
The Company purchased additional computer equipment to provide system
improvements and equipment supporting electronic document generation, storage,
and retrieval. The Company purchased a 100,000 square foot building for
approximately $4.5 million in late 1997 in Greenville, South Carolina to
facilitate the growth in the Mortgage Loan Division. The Company also purchased
additional furniture and office equipment in connection with the continued
expansion in the portfolio management, underwriting, processing, and closing
departments, and the opening of retail lending offices in Greenville and
Houston.
Other assets increased by $14.1 million to $17.6 million at
December 31, 1997 from $3.5 million at December 31, 1996. The increase results
primarily from $4.4 million in debt origination costs incurred in the offering
of the Company's Senior Notes due 2004, the recording of a deferred tax asset of
approximately $4.2 million, the capitalization of approximately $1.9 million in
direct mail advertising costs, and approximately $1.6 million of capitalized
costs associated with the implementation of a new loan origination and
processing system.
The primary source of funding the Company's receivables comes
from borrowings issued under various credit arrangements (including the Credit
Facilities, CII Notes,
10
<PAGE>
and the Company's Senior Notes due 2004). At December 31, 1997, the Company had
debt outstanding under warehouse lines of credit to banks of $77.6 million,
which compares with $55.5 million at December 31, 1996, for an increase of $22.1
million. During September 1997, the Company issued $125.0 million of Senior
Notes due 2004. At December 31, 1997, the Company had $134.3 million of CII
Notes outstanding, which compares with $114.1 million at December 31, 1996, for
an increase of $20.2 million.
Total stockholders' equity at December 31, 1997 was $63.4
million, which compares to $46.6 million at December 31, 1996, an increase of
$16.8 million. This increase resulted principally from net income of $11.3
million for the year ended December 31, 1997 and the issuance of stock in the
amount of $5.2 million related to the acquisition of the remaining 87% of Reedy
River Ventures that the Company did not previously own.
DISCONTINUED OPERATIONS
TRANSPORTATION SEGMENT
In connection with the Company's strategic plan to focus its
business efforts on the financial services segment, the Company divested its
transportation segment operations during 1994 and 1995. As a result, the
transportation segment has been classified as discontinued operations, and
accordingly, the Company's Consolidated Financial Statements and the Notes
related thereto segregate continuing and discontinued operations. The
transportation segment had a loss of $320,000 in 1995. Operating revenues for
the transportation segment were $390,000 in 1995. These revenues were due
principally to the progressive sale of assets associated with the transportation
segment. The Company does not believe that there are material liabilities,
contingent or otherwise, with respect to its transportation segment.
APPAREL SEGMENT
In connection with the Company's strategic plan to focus its
business efforts on the financial services segment, the Company sold all of the
outstanding stock of Young Generations, Inc. (a former Company subsidiary, which
manufactures children's apparel) ("YGI") in exchange for a non-recourse note in
September 1995, thereby divesting its apparel segment operations. In connection
with the sale of YGI, the Company wrote off all amounts due the Company from YGI
as intercompany debt and amounts due to the Company from the purchasers of the
YGI stock, which amounts totaled $3.9 million, net of income taxes of $156,000.
The Company remains contingently liable for its guarantee of certain bank loans
and certain trade accounts payable, which at December 31, 1997 totaled
approximately $150,000 and were secured by substantially all of YGI's assets. In
1997 and 1996, the Company loaned additional amounts to YGI, $800,000 of which
remained outstanding at December 31, 1997. As a result of the sale of YGI, the
operating results of the apparel segment have been classified as discontinued
operations. The Company does not anticipate loaning any more money to YGI in the
future. The Company may incur additional charges to future earnings as a result
of these guarantees and loans to YGI, if YGI is unable to repay the
indebtedness.
The apparel segment had a net loss of $1.3 million in 1995.
The apparel segment had revenues of $7.3 million in 1995.
11
<PAGE>
ALLOWANCE FOR CREDIT LOSSES AND CREDIT LOSS EXPERIENCE
The Company is exposed to the risk of loan delinquencies and
defaults with respect to loans retained in its portfolio. With respect to loans
to be sold on a non-recourse basis, the Company is at risk for loan
delinquencies and defaults on such loans while they are held by the Company
pending such sale. To provide for credit losses, the Company charges against
current earnings an amount necessary to maintain the allowance for credit losses
at levels expected to cover inherent losses in loans held for investment.
The table below summarizes certain information with respect to
the Company's allowance for credit losses on the owned portfolio for each of the
periods indicated.
SUMMARY OF ALLOWANCE FOR CREDIT LOSSES ON OWNED PORTFOLIO
<TABLE>
<CAPTION>
At and For the Year Ended December 31,
------------------------------------------
1997 1996 1995
----------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
Allowance for credit losses at beginning of period $ 3,084 $ 1,874 $ 1,730
Net charge-offs (5,166) (2,494) (1,563)
Provision charged to expense 10,030 5,416 2,480
Securitization transfers (1,420) (1,712) (773)
----------- ----------- ------------
Allowance for credit losses at the end of the period $ 6,528 $ 3,084 $ 1,874
=========== =========== ============
</TABLE>
The Company considers its allowance for credit losses to be
adequate in view of the Company's loss experience and the secured nature of most
of the Company's outstanding loans. Although management considers the allowance
appropriate and adequate to cover inherent losses in the loan portfolio,
management's judgment is based upon a number of assumptions about future events,
which are believed to be reasonable, but which may or may not prove valid. Thus,
there can be no assurance that charge-offs in future periods will not exceed the
allowance for credit losses or that additional increases in the allowance for
possible credit losses will not be required.
In securitization transactions, the interest-only, subordinate
and/or residual certificates bear the risk of default for the entire pool of
securitized loans to the extent of such certificates' value. Accordingly, the
value of the interest-only, subordinate and/or residual certificates retained by
the Company would be impaired to the extent losses on the securitized loans
exceed the amount estimated when determining the residual cash flows.
12
<PAGE>
The table below summarizes certain information with respect to
the Company's allowance for losses on the securitization residual assets for
each of the periods indicated.
SUMMARY OF EMBEDDED ALLOWANCE FOR LOSSES ON SECURITIZATION RESIDUAL ASSETS
<TABLE>
<CAPTION>
At and For the Year Ended December 31,
------------------------------------------
1997 1996 1995
------------ ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
INTEREST-ONLY STRIP SECURITIES:
Allowance for losses at beginning of period $ 848 $ -- $ --
Net charge-offs (1,533) (1,155) --
Anticipated losses net against gain 13,278 -- --
Allowance transferred from owned portfolio 1,662 2,003 --
------------ ----------- -----------
Allowance for losses at the end of the period $ 14,255 $ 848 $ --
============ =========== ===========
ASSET-BACKED SECURITIES:
Allowance for losses at beginning of period $ 354 $ 773 --
Net charge-offs (112) (128) --
Transfer from (to) owned portfolio (242) (291) 773
------------ ----------- -----------
Allowance for losses at end of year $ -- $ 354 $ 773
============ =========== ===========
</TABLE>
The table below summarizes the Company's allowance for credit
losses with respect to the Company's total managed portfolio (including both
owned and securitized loan pools) for each of the periods indicated.
SUMMARY OF ALLOWANCE FOR CREDIT LOSSES ON MANAGED PORTFOLIO
<TABLE>
<CAPTION>
At and For the Year Ended December 31,
------------------------------------------
1997 1996 1995
----------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
Allowance for credit losses at beginning of period $ 4,286 $ 2,647 $ 1,730
Net charge-offs (6,811) (3,777) (1,563)
Provision charged to expense 10,030 5,416 2,480
Provision netted against gain on securitizations 13,278 -- --
----------- ----------- ------------
Allowance for credit losses at the end of the period $ 20,783 $ 4,286 $ 2,647
=========== =========== ============
Allowance as a % of total managed portfolio 2.60% 2.02% 2.03%
Net charge-offs as a % of average managed portfolio 1.38% 2.47% 1.43%
The total allowance for credit losses as shown on the balance sheet
is as follows:
Allowance for credit losses on loans $ 6,528 $ 3,084 $ 1,874
Allowance for credit losses on asset-backed securities -- 354 773
Allowance for credit losses on interest-only strip
security 14,255 848 --
----------- ----------- ------------
Total allowance for credit losses $ 20,783 $ 4,286 $ 2,647
=========== =========== ============
</TABLE>
13
<PAGE>
Management closely monitors delinquencies to measure the
quality of its loan portfolio and securitized loans and the potential for credit
losses. The Company's policy is to generally place a loan on non-accrual status
after it becomes 90 days past due, if collection in full is questionable.
Collection efforts on charged-off loans continue until the obligation is
satisfied or until it is determined that such obligation is not collectible or
the cost of continued collection efforts would exceed the potential recovery.
Recoveries of previously charged-off loans are credited to the allowance for
credit losses.
Management monitors securitized pool delinquencies using a
static pool analysis by month by pool balance. Since these pools are new, it is
anticipated that the delinquencies will ramp up during the first one to two
years. Current year results are not necessarily indicative of future
performance. The following sets forth the static pool analysis for delinquencies
by month in the Mortgage Loan Division's securitized pools.
<TABLE>
<CAPTION>
CURRENT PRINCIPAL BALANCE
----------------------------------------------------------------------------------
MONTHS FROM POOL INCEPTION 1997-1 1997-2 1997-3 1997-4
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1 77,435,632 120,860,326 130,917,899 118,585,860
2 77,045,312 120,119,653 169,093,916
3 76,709,417 119,364,510 168,182,957
4 75,889,160 118,965,905 166,783,489
5 75,395,969 117,236,893
6 74,630,019 115,870,168
7 73,149,957 113,537,447
8 72,261,386
9 71,342,842
10 70,195,198
DELINQUENCIES > 30 DAYS PAST DUE
----------------------------------------------------------------------------------
MONTHS FROM POOL INCEPTION 1997-1 1997-2 1997-3 1997-4
----------------------------------------------------------------------------------
1 -- 515,954 609,201 402,972
2 1,499,056 1,631,017 2,042,757
3 858,311 3,930,423 4,498,266
4 3,760,775 5,399,570 8,546,414
5 5,220,385 7,293,855
6 5,849,574 9,790,731
7 6,777,961 11,933,526
8 8,078,783
9 8,475,207
10 9,911,115
DELINQUENCIES > 30 DAYS PAST DUE AS A PERCENT OF CURRENT BALANCE
--------------------------------------------------------------------------------------------------
MONTHS FROM POOL INCEPTION 1997-1 1997-2 1997-3 1997-4 AVERAGE
--------------------------------------------------------------------------------------------------
1 0.00% 0.43% 0.47% 0.34% 0.31%
2 1.94% 1.36% 1.21% 1.50%
3 1.12% 3.29% 2.67% 2.36%
4 4.96% 4.54% 5.12% 4.87%
5 6.92% 6.22% 6.57%
6 7.84% 8.45% 8.14%
7 9.27% 10.51% 9.89%
8 11.18% 11.18%
9 11.88% 11.88%
10 14.12% 14.12%
ACTUAL HISTORICAL
PREPAYMENT SPEED 11 CPR 9 CPR 5 CPR N/A
</TABLE>
14
<PAGE>
The following sets forth the static pool analysis for
delinquencies by quarter in the Small Business Loan Division's securitized
pools.
<TABLE>
<CAPTION>
CURRENT PRINCIPAL BALANCE
----------------------------------------------------------------------------
MONTHS FROM
POOL INCEPTION 1995-1 1996-1 1997-1
----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1 16,728,904 12,835,117 19,635,971
4 16,293,396 17,198,763
7 15,292,515 17,128,785
10 14,816,770 16,850,017
13 14,147,481 15,768,712
16 13,214,217
19 11,685,931
22 11,367,569
25 10,932,915
28 10,043,467
31 9,263,383
<PAGE>
DELINQUENCIES > 30 DAYS
----------------------------------------------------------------------------
MONTHS FROM
POOL INCEPTION 1995-1 1996-1 1997-1
----------------------------------------------------------------------------
1 388,110 69,463 474,946
4 1,504,537 320,625
7 1,230,648 2,275,021
10 1,160,321 1,602,343
13 1,399,070 1,058,535
16 1,198,855
19 999,427
22 791,103
25 582,389
28 349,993
31 383,049
DELINQUENCIES > 30 DAYS AS A % OF CURRENT BALANCE
------------------------------------------------------------------------------------------
MONTHS FROM
POOL INCEPTION 1995-1 1996-1 1997-1 AVERAGE
------------------------------------------------------------------------------------------
1 2.32% 0.54% 2.42% 1.76%
4 9.23% 1.86% 5.55%
7 8.05% 13.28% 10.66%
10 7.83% 9.51% 8.67%
13 9.89% 6.71% 8.30%
16 9.07% 9.07%
19 8.55% 8.55%
22 6.96% 6.96%
25 5.33% 5.33%
28 3.48% 3.48%
31 4.14% 4.14%
ACTUAL HISTORICAL
PREPAYMENT SPEED 13 CPR 8 CPR N/A
</TABLE>
15
<PAGE>
The following table sets forth the Company's allowance for
credit losses on the managed portfolio at the end of the periods indicated, the
credit loss experience over the periods indicated, and delinquent loan
information at the dates indicated for loans receivable at least 30 days past
due.
<TABLE>
<CAPTION>
At and For the Year Ended December 31,
--------------------------------------
1997 1996 1995
---------- --------- ---------
<S> <C> <C> <C>
ALLOWANCE FOR CREDIT LOSSES AS A % OF SERVICED LOANS (1):
Mortgage Loan Division 1.98% 0.80% 0.93%
Small Business Loan Division 6.76 3.84 4.50
Auto Loan Division 7.58 6.45 4.03
Total allowance for credit losses as a % of serviced 2.60 2.02 2.03
loans
NET CHARGE-OFFS AS A % OF AVERAGE SERVICED LOANS (2):
Mortgage Loan Division 0.32 0.81 1.04
Small Business Loan Division 2.74 2.71 1.43
Auto Loan Division 17.17 9.65 3.68
Total net charge-offs as a % of total serviced loans 1.38 2.47 1.43
LOANS RECEIVABLE PAST DUE 30 DAYS OR MORE AS A % OF SERVICED LOANS (1):
Mortgage Loan Division 8.00 7.26 14.43
Small Business Loan Division 4.17 7.92 9.69
Auto Loan Division 9.41 17.09 12.83
Total loans receivable past due 30 days or more as a
% of total serviced loans 7.66 8.41 13.31
TOTAL ALLOWANCE FOR CREDIT LOSSES AS A % OF SERVICED LOANS PAST DUE
90 DAYS OR MORE (1) 94.33% 88.71% 73.21%
</TABLE>
(1) For purposes of these calculations, serviced loans represents all
loans for which the Company bears credit risk, and includes all
portfolio Mortgage Loans and Auto Loans, all securitized loans, and
the Small Business Loans, but excludes the guaranteed portion of the
SBA Loans and Mortgage Loans serviced without credit risk.
(2) Average serviced loans have been determined by using beginning and
ending balances for the period presented except that the 1996 and
1997 averages are calculated based on the daily averages for Small
Business Loan Division and Auto Loan Division and monthly averages
for the Mortgage Loan Division (rather than the beginning and ending
balances).
Over the last several years, and more acutely in 1997, the
Company has expanded rapidly. The reduction to net charge-offs and loans past
due as a percentage of total serviced mortgage loans is due, in part, to the
increased origination volume. The Company anticipates that its total charge-offs
and delinquencies will generally be higher than they were at December 31, 1997
as the portfolio becomes more seasoned.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business requires continued access to short- and
long-term sources of debt financing and equity capital. The Company's cash
requirements arise from loan originations and purchases, repayments of debt upon
maturity, payments of operating and interest expenses, expansion activities and
capital expenditures. The Company's primary sources of liquidity are cash flow
from operations, sales of the loans it originates and purchases, proceeds from
the sale of CII Notes, borrowings under the Credit Facilities and proceeds from
16
<PAGE>
securitization of loans. While the Company believes that such sources of funds
will be adequate to meet its liquidity requirements, no assurance of such fact
may be given.
Shareholders' equity increased to $63.4 million at December
31, 1997 from $46.6 million at December 31, 1996, and from $9.9 million at
December 31, 1995. Each of these increases resulted principally from the
retention of income by the Company and, for 1997, the issuance of 494,000
additional shares of common stock at a value of $5.2 million related to the
acquisition of the 87% of RRV that the Company did not already own, and for
1996, a public stock offering with proceeds of $26.1 million.
Cash and cash equivalents were $7.6 million at December 31,
1997, $1.3 million at December 31, 1996, and $1.3 million at December 31, 1995.
Cash used in operating activities increased to $137.1 million for the year ended
December 31, 1997, from $78.5 million for the year ended ended December 31,
1996; cash used in investing activities increased to $20.8 million for the year
ended December 31, 1997, from cash provided by investing activities of $12.2
million for the year ended ended December 31, 1996; and cash provided by
financing activities increased to $164.2 million for the year ended December 31,
1997, from $66.3 million for the year ended ended December 31, 1996. The
increase in cash used in operations was due principally to the increase in loan
originations during 1997. Cash used in investing activities was principally for
the net increase in loans originated for investment purposes. The increase in
cash provided by financing activities was due principally to the receipt of
approximately $120.6 million in proceeds from the offering of the Company's
Senior Notes due 2004 completed in September of 1997. At December 31, 1997, the
Company's credit facilities ("Credit Facilities") were comprised principally of
credit facilities of $395.0 million for the mortgage loan division (the
"Mortgage Loan Division Facility") and credit facilities of $50.0 million for
the small business loan division (the "Small Business Loan Division Facility").
Based on the borrowing base limitations contained in the Credit Facilities, at
December 31, 1997, the Company had aggregate outstanding borrowings of $63.1
million and aggregate borrowing availability of $55.8 million under the Mortgage
Loan Division Facility and aggregate outstanding borrowings of $14.5 million and
aggregate borrowing availability of $13.0 million under the Small Business Loan
Division Facility. Total Company borrowings and availabilty at December 31, 1997
under the Credit Facilities were $77.6 million and $68.8 million, respectively.
The Mortgage Loan Division Facility and the Small Business Loan Division
Facility both bear interest at variable rates, ranging from Fed Funds plus
1.875% to the bank's prime rate. The Credit Facilities have original terms
ranging from three months to three years and are renewable upon the mutual
agreement of the Company and the respective lender.
The Credit Facilities contain a number of financial covenants,
including, but not limited to, covenants with respect to certain debt to equity
ratios, borrowing base calculations and minimum adjusted tangible net worth. The
Credit Facilities also contain certain other covenants, including, but not
limited to, covenants that impose limitations on the Company and its
subsidiaries with respect to declaring or paying dividends, making payments with
respect to certain subordinated debt, and making certain changes to its equity
capital structure. The Company believes that it is currently in substantial
compliance with the loan covenants. In instances where the Company is not in
compliance with such covenants, the Company has obtained a waiver of
noncompliance from the bank.
17
<PAGE>
During 1997, the Company sold $125.0 million aggregate
principal amount of Senior Notes due 2004. The Senior Notes due 2004 constitute
unsecured indebtedness of the Company. The Senior Notes due 2004 are redeemable
at the option of the Company, in whole or in part, on or after September 15,
2001, at predetermined redemption prices plus accrued and unpaid interest to the
date of redemption. This agreement requires, among other matters, a maximum
ratio of total liabilities to tangible net worth, limitations on the amount of
capital expenditures, and restrictions on the payment of dividends. At December
31, 1997, management believes the Company was in compliance with such
restrictive covenants. The Senior Notes due 2004 are fully and unconditionally
guaranteed (the "Subsidiary Guarantees") jointly and severally on an unsecured
basis (each, a "Guarantee") by certain of the Company's subsidiaries (the
"Subsidiary Guarantors"). With the exception of the Guarantee by CII, the
Subsidiary Guarantees rank PARI PASSU in right of payment with all existing and
future unsubordinated indebtedness of the Subsidiary Guarantors and senior in
right of payment to all existing and future subordinated indebtedness of such
Guarantors. The Guarantee by CII is equal in priority to CII's notes payable to
investors and is senior to CII's subordinated debentures.
CII engages in the sale of CII Notes to investors. The CII
Notes are comprised of senior notes and subordinated debentures bearing fixed
rates of interest which are sold by CII only to South Carolina residents. The
offering of the CII Notes is registered under South Carolina securities law and
is exempt from Federal registration under the Federal intrastate exemption. CII
conducts its operations so as to qualify for the safe harbor provisions of Rule
147 promulgated pursuant to the Securities Act of 1933, as amended (the
"Securities Act"). At December 31, 1997, CII had an aggregate of $115.4 million
of senior notes outstanding bearing a weighted average interest rate of 7.7%,
and an aggregate of $18.9 million of subordinated debentures bearing a weighted
average interest rate of 5.0%. The senior notes and subordinated debentures are
subordinate in priority to the Mortgage Loan Division Credit Facility. The
senior notes rank PARI PASSU with the senior unsecured debt of the Company.
Substantially all of the CII Notes have one year maturities.
The Company has enhanced its management information systems
during 1997, as well as incurring additional other capital expenditures,
including the purchase of a 100,000 square foot building in late 1997 in
Greenville, South Carolina to facilitate the growth in the Mortgage Loan
Division. The Company expects to incur additional capital expenditures in 1998
for improvements to this building, additional Management Information Systems
improvements, and other capital additions.
LOAN SALES AND SECURITIZATIONS
The Company sells or securitizes substantially all of its
loans. The Company sells on a whole loan basis a minority of its Mortgage Loans
(servicing released), including substantially all of its Mortgage Loans secured
by second liens and loans originated through Strategic Alliance Mortgage
Bankers, and all of its SBA Loan Participations (servicing retained),
principally to secure the additional cash flow associated with the premiums paid
in connection with such sales and to eliminate the credit risk associated with
the second lien mortgage loans. However, no assurance can be given that the
second mortgage loans can be successfully sold. To the extent that the loans are
not sold, the Company retains the risk of loss. At December 31, 1997 and 1996,
the Company had retained $69.8 million and $28.1 million, respectively, of
second mortgage loans on its balance sheet. During 1997, 1996 and 1995, the
Company sold $435.3 million, $284.8 million and $127.6 million, respectively, of
Mortgage Loans and $41.2 million, $33.1 million, and $25.4 million,
respectively, of SBA Loan Participations.
18
<PAGE>
On a quarterly basis in 1997, the Company securitized
substantial amounts of its Mortgage Loans, totaling $487.6 million. Since 1995,
the Company has securitized $54.2 million of loans representing the unguaranteed
portions of the SBA Loans and $16.1 million of Auto Loans. Although
securitizations provide liquidity, the Company has utilized securitizations
principally to provide a lower cost of funds and reduce interest rate risk,
while building servicing revenues by increasing the serviced portfolio. In
connection with its Mortgage Loan and SBA Loan securitizations, the Company has
retained subordinate certificates and interest-only and residual certificates
representing residual interests in the trusts. These subordinate and residual
interests totaled approximately $63.2 million, net of allowances, at December
31, 1997.
A new securitization structure was completed for the fourth
quarter Mortgage Loan securitization. This structure utilizes a real estate
investment trust ("REIT") and allows sales treatment for financial reporting
purposes, but debt treatment for tax purposes. Accordingly, this structure
eliminates current taxes payable on the book gain, while maintaining the
structural efficiency of tranching, previously only available through a real
estate mortgage investment conduit ("REMIC") transaction. Additionally, under
this structure, the Company has distributed .46% ownership in the REIT to a
certain class of employees, with an initial value of approximately $62,000.
In securitizations, the Company sells the loans that it
originates or purchases to a trust for cash, and records certain assets and
income based upon the difference between all principal and interest received
from the loans sold and (i) all principal and interest required to be passed
through to the asset-backed bond investors, (ii) all excess contractual
servicing fees, (iii) other recurring fees and (iv) an estimate of losses on the
loans (collectively, the "Excess Cash Flow"). At the time of the securitization,
the Company estimates these amounts based upon a declining principal balance of
the underlying loans, adjusted by an estimated prepayment and loss rate, and
capitalizes these amounts using a discount rate that market participants would
use for similar financial instruments. These capitalized assets are recorded on
the Company's balance sheet as interest-only and residual certificates (as
"Interest-Only Strip Securities," "Investment in Asset-backed Securities" and
"Restricted Cash"), and are aggregated and reported on the income statement as
gain on sale of loans, after being reduced (increased) by the costs of
securitization and any hedge losses (gains).
The Company retains the right to service loans it securitizes.
Fees for servicing loans are based on a stipulated percentage (generally 0.50%
per annum on mortgage loans and 0.40% per annum on SBA loans) of the unpaid
principal balance of the associated loans. On its mortgage loan securitizations,
the Company has recognized a servicing asset in addition to its gain on sale of
loans. The servicing asset is calculated as the present value of the expected
future net servicing income in excess of adequate compensation for a substitute
servicer based on common industry assumptions and the Company's historical
experience. These factors include default and prepayment speeds.
19
<PAGE>
The following sets forth facts and assumptions used by the
Company in arriving at the valuation of the interest-only strip securities and
asset-backed securities relating to its Mortgage Loan securitizations at
December 31, 1997:
<TABLE>
<CAPTION>
1ST QTR. 2ND QTR. 3RD QTR. 4TH QTR.
1997 1997 1997 1997
---------------- --------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Loans securitized $77,526,090 $121,214,000 $131,121,432 $157,779,083
Average stated principal balance 63,288 63,190 68,328 66,039
Weighted average coupon on loans 11.01% 10.80% 11.19% 11.20%
Weighted average original term to stated 209 months 200 months 200 months 202 months
maturity
Weighted average LTV 80.62 75.94 77.38 76.25
% of first mortgage loans 100.00 100.00 100.00 100.00
% secured by primary residence 98.60 98.80 96.19 97.04
Weighted average pass-through rate
to 7.40 7.06 6.99 6.86
bondholders
Spread of pass-through rate over comparable
Treasury rate 0.89 0.78 0.81 1.00
Estimated annual losses 0.60 0.60 0.60 0.60
Ramp period for losses 12 months 12 months 12 months 12 months
Cumulative losses as a % of original UPB 2.33 2.24 2.18 2.21
Annual servicing fee 0.50 0.50 0.50 0.50
Servicing asset 0.10 0.10 0.10 0.10
Discount rate implicit in cash flow
before overcollateralization 26.00 22.00 20.00 20.00
Discount rate applied to cash flow after
overcollateralization 12.00 12.00 12.00 12.00
Prepayment speed:
Initial CPR (1) 0 CPR 0 CPR 0 CPR 0 CPR
Peak CPR (1) 20 CPR 20 CPR 20 CPR 20 CPR
Tail CPR (1) 18/16 CPR 18/16 CPR 18/16 CPR 18/16 CPR
CPR ramp period (1) 12 months 12 months 12 months 12 months
CPR peak period (1) 24 months 24 months 24 months 24 months
CPR tail begins (1) 37/49 months 37/49 months 37/49 months 37/49 months
Annual wrap fee and trustee fee 0.285% 0.205% 0.195% 0.187%
Initial overcollateralization required (2) 3.25 0.00 0.00 0.00
Final overcollateralization required (2) 6.50 3.75 3.75 3.75
</TABLE>
(1) CPR represents an industry standard of calculating prepayment
speeds and refers to Constant Prepayment Rate. The Company uses
a curve based on various CPR levels throughout the pool's life,
based on its estimate of prepayment performance, as outlined in
the table above. Typically, high LTV loans (approximately 2/3 of
the loans in the Company's securitization transactions) are
priced at a slower CPR than traditional home equity loans (22 to
25 CPR) and are expected to have less prepayment volatility
under changing interest-rate scenarios.
(2) Based on percentage of original principal balance, subject to
step-down provisions after 30 months.
Each of the Company's Mortgage Loan securitizations have been
credit-enhanced by an insurance policy provided through a monoline insurance
company to receive ratings of "Aaa" from Moody's Investors Services, Inc.
("Moody's") and "AAA" from Standard & Poor's Ratings Group, a division of The
McGraw-Hill Companies, Inc. ("Standard & Poor's"). The Company plans to continue
to complete the quarterly securitization of a substantial portion of its
Mortgage Loans, principally because the Company believes that securitization is
potentially more profitable than whole loan sales and because the Company (as
servicer) wants to maintain the relationship with its loan customers. However,
the Company may alter this strategy based on cash flow requirements.
20
<PAGE>
The Company expects to begin receiving Excess Cash Flow on its
Mortgage Loan securitizations approximately 16 months from the date of
securitization, although this time period may be shorter or longer depending
upon the securitization structure and performance of the loans securitized.
Prior to such time, the monoline insurer requires a reserve provision to be
created within the securitization trust which uses Excess Cash Flow to retire
the securitization bond debt until the spread between the outstanding principal
balance of the loans in the securitization trust and the securitization bond
debt equals a specified percentage (depending on the structure of the
securitization) of the initial securitization principal balance (the
"overcollateralization limit"). Once this overcollateralization limit is met,
excess cash flows are distributed to the Company. The Company begins to receive
regular monthly servicing fees in the month following securitization.
The Company originally used 50 basis points annual losses on
its first three mortgage securitization transactions, but in the fourth quarter
of 1997, changed its loss assumption to 60 basis points per annum as a result of
projected higher than anticipated delinquencies within the securitization pools.
The Company also modified the estimated prepayment speeds on all of its mortgage
loan securitization transactions to peak at 20 CPR, up from the deals' pricing
speeds of 18 HEP on the first two deals and 17 HEP on the second two
securitizations. Actual prepayment speeds have been running below these
assumptions, and the trusts have experienced virtually no losses to date. The
impact in the fourth quarter of the changes in these assumptions was to reduce
fair value of these residual interests by approximately $1.0 million. These
changes were the result of the Company's attempt to refine the modeling of the
anticipated cash flows to better match expected future cash flows.
The following sets forth facts and assumptions used by the
Company in arriving at the valuation of the interest-only strip securities,
asset-backed securities and restricted cash relating to its unguaranteed SBA
Loan securitizations at December 31, 1997:
<TABLE>
<CAPTION>
JUNE NOVEMBER JANUARY DECEMBER
1995 1996 1997 1997
--------------- ----------------- --------------- ---------------
<S> <C> <C> <C> <C>
Loans securitized $ 17,063,377 $ 12,850,743 $ 4,626,031 $ 19,659,945
Average stated principal balance 65,377 152,985 210,274 225,976
Weighted average spread over Wall Street
Journal Prime Rate 2.71% 2.70% 2.66% 2.48%
Weighted average original term to stated
maturity 198 months 258 months 256 months 259 months
Weighted average LTV 55% 63% 62% 67%
Spread under prime rate 1.35% 1.80% 1.80% 2.00%
Estimated annual losses 2.25% 1.25% 1.25% 1.25%
Annual servicing fee 0.40% 0.40% 0.40% 0.40%
Discount rate applied to cash flow after
spread account 10.50% 10.50% 10.50% 10.50%
Prepayment speed:
Initial CPR 0 CPR 0 CPR 0 CPR 0 CPR
Peak CPR 15 CPR 12 CPR 12 CPR 12 CPR
Tail CPR 14 CPR 11 CPR 11 CPR 11 CPR
CPR ramp period 12 months 12 months 12 months 12 months
CPR peak period 36 months 36 months 36 months 36 months
CPR tail begins 37 months 37 months 37 months 37 months
Annual trustee fee $ 8,000 $ 8,000 $ 8,000 $ 8,000
Initial spread account required 2% 2% 2% 2%
Final spread account required 4% 4% 4% 6%
Subordinate piece retained 10% 9% 9% 10%
</TABLE>
21
<PAGE>
The gains recognized into income resulting from securitization
transactions vary depending on the assumptions used, the specific
characteristics of the underlying loan pools, and the structure of the
transaction. The Company believes the assumptions it has used are appropriate
and reasonable.
The Company assesses the carrying value of its interest-only
strip securities and servicing assets for impairment. There can be no assurance
that the Company's estimates used to determine the gain on sale of loans,
interest-only strip securities, and servicing assets valuations will remain
appropriate for the life of each securitization. If actual loan prepayments or
defaults exceed the Company's estimates, the carrying value of the Company's
interest-only strip securities and/or servicing assets may be decreased through
a charge against earnings in the period management recognizes the disparity.
ACCOUNTING CONSIDERATIONS
In June 1997, FASB issued SFAS No. 130 "Reporting
Comprehensive Income" which is effective for annual and interim periods
beginning after December 15, 1997. This statement requires that all items that
are required to be recognized under accounting standards as comprehensive income
be reported in a financial statement that is displayed with the same prominence
as other financial statements. The adoption of this standard is not expected to
have a material effect on the Company's financial reporting.
In June 1997, FASB issued SFAS No. 131 "Disclosures about
Segments of an Enterprise and Related Information" which is effective for fiscal
years beginning after December 15, 1997. This statement establishes standards
for the method that public entities report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about product and services, geographical areas and major customers. The adoption
of this standard is not expected to have a material effect on the Company's
financial reporting.
TAX CONSIDERATIONS--THE NOL
As a result of the operating losses incurred by the Company
under prior management in its discontinued transportation segment operations,
the Company generated an NOL. Federal tax laws provide that net operating loss
carryforwards are restricted or eliminated upon certain changes of control.
Applicable federal tax laws provide that a 50% "change of control," which is
calculated over a rolling three-year period, would cause the loss of
substantially all of the NOL. Although the calculation of the "change of
control" is factually difficult to determine, the Company believes that it has
had a maximum cumulative change of control of 33% during the relevant three-year
period.
22
<PAGE>
During 1997, the Company eliminated its valuation allowance
against its deferred tax asset, resulting in a net deferred tax asset of $4.2
million at December 31, 1997. Management based the decision to eliminate the
valuation based on its belief that it is more likely than not that it will
realize the benefit of this deferred tax asset, given the levels of historical
taxable income and current projections for future taxable income over the
periods in which the deferred tax assets would be realized. This resulted in the
Company recognizing a deferred tax benefit for 1997 of $3.8 million. The Company
had a federal NOL of approximately $13.0 million remaining at December 31, 1997.
HEDGING ACTIVITIES
The Company's profitability may be directly affected by
fluctuations in interest rates. While the Company monitors interest rates and
employs a strategy designed to hedge some of the risks associated with changes
in interest rates, no assurance can be given that the Company's results of
operations and financial condition will not be adversely affected during periods
of fluctuations in interest rates. The Company's interest rate hedging strategy
currently includes shorting interest rate futures and treasury forwards, and
entering into interest-rate lock agreements. Since the interest rates on the
Company's warehouse lines of credit used to fund and acquire loans are variable
and the rates charged on loans the Company originates are fixed, increases in
the interest rates after loans are originated and prior to their sale could have
a material adverse effect on the Company's results of operations and financial
condition. The ultimate sale of the Company's loans will fix the spread between
the interest rates paid by borrowers and the interest rates paid to investors in
securitization transactions with respect to such loans, although increases in
interest rates may narrow the potential spread that existed at the time the
loans were originated by the Company. Without hedging these loans, increases in
interest rates prior to sale of the loans may reduce the gain on securitized
loan sales earned by the Company.
IMPACT OF INFLATION
Inflation affects the Company most significantly in the area
of loan originations and can have a substantial effect on interest rates.
Interest rates normally increase during periods of high inflation and decrease
during periods of low inflation. Profitability may be directly affected by the
level and fluctuation in interest rates which affect the Company's ability to
earn a spread between interest received on its loans and the costs of its
borrowings. The profitability of the Company is likely to be adversely affected
during any period of unexpected or rapid changes in interest rates. A
substantial and sustained increase in interest rates could adversely affect the
ability of the Company to originate and purchase loans and affect the mix of
first and second mortgage loan products. Generally, first mortgage production
increases relative to second mortgage production in response to low interest
rates and second mortgage production increases relative to first mortgage
production during periods of high interest rates. A significant decline in
interest rates could decrease the size of the Company's loan servicing portfolio
by increasing the level of loan prepayments. Additionally, to the extent
servicing rights, interest-only and residual classes of certificates have been
capitalized on the books of the Company, higher than anticipated rates of loan
prepayments or losses could require the Company to write down the value of such
servicing rights, interest-only and residual certificates, adversely impacting
earnings. Fluctuating interest rates may also affect the net interest income
earned by the Company resulting from the
23
<PAGE>
difference between the yield to the Company on loans held pending sales and the
interest paid by the Company for funds borrowed under the Company's warehouse
facilities.
YEAR 2000
A critical issue has emerged in the financial community and
for businesses in general regarding whether existing computer programs and
systems, many of which were designed to recognize only two digits in the date
field, can be modified in time to accommodate four digits in the date field as
is necessary to properly distinguish dates on and after January 1, 2000 from
dates between January 1, 1900 and December 31, 1999. The upcoming change in the
century is expected to cause many computer applications to create erroneous
results or fail completely if the problem is not corrected. The Company has
established a Year 2000 team to oversee the identification, correction,
reprogramming and testing of the systems and software applications used by the
Company and the companies with which it interacts electronically for Year 2000
compliance as well as to identify other possible risks associated with the Year
2000 problem. The Company has hired a Year 2000 coordinator to head this
project. The Company has completed a hardware, software and vendor interface
inventory to identify all components for testing. It is in the process of
replacing and modifying noncompliant systems of which it is aware. The Company
has sent letters to vendors to request information on Year 2000 compliance and
testing arrangements. A formal test plan is being refined and the Company
currently plans to test its systems prior to December 31, 1998. Testing of
internally developed software has begun.
A risk assessment is being developed by the Year 2000 team as
part of the project. This assessment is expected to be completed by July 1,
1998. Although the Company has not yet fully evaluated the cost of modifying and
replacing its systems aimed at achieving Year 2000 compliance, such costs are
not currently expected to be material to the Company's results of operations and
liquidity. The inability of the Company or the parties with whom it
electronically interacts to successfully address Year 2000 issues could result
in interruptions in the Company's business and have a material adverse effect on
its financial condition.
24
<PAGE>
The following sets forth the accurate signature page of the Company's 10-K
filed on April 15, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
EMERGENT GROUP, INC.
---------------------------------------
Registrant
April 13, 1998 \s\ John M. Sterling, Jr.
- ------------------------------ ---------------------------------------
(Date) John M. Sterling, Jr., Chairman of
the Board of Directors and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
<S> <C>
\s\ J. Robert Philpott, Jr. \s\ Tecumseh Hooper, Jr.
------------------------------------------ -----------------------------------------
J. Robert Philpott, Jr. Tecumseh Hooper, Jr.
Director Director
\s\ John M. Sterling, Jr. \s\ Clarence B. Bauknight
------------------------------------------ -----------------------------------------
John M. Sterling, Jr. Clarence B. Bauknight
Chairman of the Board of Directors Director
and Chief Executive Officer
\s\ Buck Mickel \s\ Porter B. Rose
------------------------------------------ -----------------------------------------
Buck Mickel Porter B. Rose
Director Director
\s\ Larry G. Blackwell \s\ Keith B. Giddens
------------------------------------------ -----------------------------------------
Larry G. Blackwell Keith B. Giddens
Director President and Chief Operating Officer
Director
April 13, 1998 \s\ Kevin J. Mast
------------------------------------------ -----------------------------------------
(Date) Kevin J. Mast
Vice President,
Chief Financial Officer and Treasurer
</TABLE>
