SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Quarterly Period ended SEPTEMBER 30, 1998.
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Transition Period from _________ to _________.
Commission File Number 0-8909
-----------------------
HOMEGOLD FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
South Carolina 57-0513287
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
P. O. Box 17526
Greenville, South Carolina 29606
(Address of principal executive offices)
864-235-8056
(Registrant's telephone number, including area code)
EMERGENT GROUP, INC.
(Registrant's former name, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such report), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No _____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Title of each Class: Outstanding at October 31, 1998
- ---------------------------------- --------------------------------
Common Stock, par value $0.05 per share 9,733,374
1
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
Form 10-Q
Quarter Ended SEPTEMBER 30, 1998
INDEX
-----
PART I. FINANCIAL INFORMATION Page
- ------ --------------------- ----
Item 1. Financial Statements for HomeGold Financial, Inc.
Consolidated Balance Sheets as of
September 30, 1998 and December 31, 1997 4
Consolidated Statements of Operations
for the nine months ended September 30, 1998
and 1997 and for the three months 6
ended September 30, 1998 and 1997
Consolidated Statements of Cash Flows
for the nine months ended September 30, 1998
and 1997 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 25
PART II. OTHER INFORMATION
- -------- -----------------
Item 1. Legal Proceedings 49
Item 2. Changes in Securities 49
Item 3. Defaults Upon Senior Securities 49
Item 4. Submission of Matters to a Vote of Security Holders 49
Item 5. Other Information 49
Item 6. Exhibits and Reports on Form 8-K 49
2
<PAGE>
PART I. FINANCIAL INFORMATION
3
<PAGE>
PART I. FINANCIAL INFORMATION
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------ ------------
(In thousands)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 25,833 $ 7,561
Loans receivable:
Loans receivable held for investment 91,647 100,379
Loans receivable held for sale 197,890 197,236
------------ ------------
Total loans receivable 289,537 297,615
Less allowance for credit losses on loans (9,799) (6,528)
Less allowance for mark-to-market on loans (5,300) --
Less deferred loan fees (6,215) (4,316)
Plus deferred loan costs 1,791 1,658
------------ ------------
Net loans receivable 270,014 288,429
Other receivables:
Accrued interest receivable 4,358 4,407
Other receivables 7,622 10,680
------------ ------------
Total other receivables 11,980 15,087
Residual receivables, net 63,175 63,202
Property and equipment, net 22,999 18,080
Real estate and personal property acquired through
foreclosure 5,194 3,295
Excess of cost over net assets of acquired businesses,
net of accumulated
amortization of $1,602 in 1998 and $978 in 1997 2,250 2,874
Debt origination costs 5,839 4,767
Deferred income tax asset, net 4,151 4,151
Servicing asset 1,021 1,468
Other assets 4,728 7,238
------------ ------------
Total assets $ 417,184 $ 416,152
============ ============
</TABLE>
See Notes to Unaudited Financial Statements
4
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------ ------------
(In thousands)
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Revolving warehouse lines of credit $ 147,990 $ 77,605
Investor savings:
Notes payable to investors 120,246 115,368
Subordinated debentures 17,810 18,947
------------ ------------
Total investor savings 138,056 134,315
Senior unsecured debt 108,250 125,000
Accounts payable and accrued liabilities 9,970 6,517
Remittances payable 5,421 4,591
Accrued interest payable 1,757 4,750
------------ ------------
Total other liabilities 17,148 15,858
------------ ------------
Total liabilities 411,444 352,778
Minority interest 57 --
Commitments and contingencies
Shareholders' equity:
Common stock, par value $.05 per share - authorized
100,000,000 shares, issued and outstanding 9,733,374
shares in 1998 and 9,686,477 shares in 1997 487 484
Capital in excess of par value 38,821 38,609
Retained earnings (deficit) (33,625) 24,281
------------ ------------
Total shareholders' equity 5,683 63,374
------------ ------------
Total liabilities and shareholders' equity $ 417,184 $ 416,152
============ ============
</TABLE>
See Notes to Unaudited Financial Statements
5
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
<TABLE>
<CAPTION>
For the Nine Months Ended For the Three Months Ended
September 30, September 30,
------------------------- --------------------------
1998 1997 1998 1997
------------ ----------- ------------ -----------
(In thousands, except share data)
<S> <C> <C> <C> <C>
REVENUES:
Interest income $ 29,552 $ 25,866 $ 10,362 $ 10,842
Servicing income 10,198 6,005 2,597 2,920
Gain on sale of loans:
Cash gain on sale of loans 13,036 8,773 2,925 1,477
Non-cash gain (loss) on sale of loans 2,785 24,008 (396) 13,197
Loan costs (5,197) -- (2,267) --
Loan fee income 15,288 22,067 5,529 8,852
------------ ----------- ------------ -----------
Total net gain on sale of loans 25,912 54,848 5,791 23,526
Other revenues 3,510 761 1,092 328
------------ ----------- ------------ -----------
Total revenues 69,172 87,480 19,842 37,616
------------ ----------- ------------ -----------
EXPENSES:
Interest 28,335 16,735 9,950 6,953
Provision for credit losses 10,579 7,087 3,639 2,415
Fair value write-down of residual receivables 14,230 -- 5,320 --
Salaries, wages and employee benefits 46,864 32,585 12,488 13,825
Business development costs 8,488 4,940 1,953 1,961
Other general and administrative expense 22,204 18,167 7,671 8,192
------------ ----------- ------------ -----------
Total expenses 130,700 79,514 41,021 33,346
------------ ----------- ------------ -----------
Income (loss) before income taxes, minority
interest, and extraordinary item (61,528) 7,966 (21,179) 4,270
Provision (benefit) for income taxes 4,109 (1,975) 865 (350)
------------ ----------- ------------ -----------
Income (loss) before minority interest and
extraordinary item (65,637) 9,941 (22,044) 4,620
Minority interest in earnings (loss) of subsidiaries 13 (156) 11 --
------------ ----------- ------------ -----------
Income before extraordinary item (65,624) 9,785 (22,033) 4,620
Extraordinary item-gain on extinguishment of debt,
net of $0 tax 7,724 -- 7,724 --
------------ ----------- ------------ -----------
Net income (loss) $ (57,900) $ 9,785 $ (14,309) $ 4,620
============ =========== ============ ===========
Basic earnings (loss) per share of common stock:
Income (loss) before extraordinary item $ (6.76) $ 1.05 $ (2.26) $ 0.48
Extraordinary item, net of taxes .79 -- .79 --
------------ ----------- ------------ -----------
Net income (loss) $ (5.97) $ 1.05 $ (1.47) $ 0.48
============ =========== ============ ===========
Basic weighted average shares outstanding 9,714,506 9,314,104 9,733,097 9,651,566
============= ============ ============= ============
Diluted earnings (loss) per share of common stock:
Income (loss) before extraordinary item $ (6.76) $ 1.03 $ (2.26) $ 0.47
Extraordinary item, net of tax .79 -- .79 --
------------ ----------- ------------ -----------
Net income (loss) $ (5.97) $ 1.03 $ (1.47) $ 0.47
============ =========== ============ ===========
Diluted weighted average shares outstanding 9,714,506 9,501,372 9,733,097 9,861,816
============ =========== ============ ===========
</TABLE>
See Notes to Unaudited Financial Statements
6
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
<TABLE>
<CAPTION>
For the Nine Months Ended
September 30,
---------------------------------
1998 1997
-------------- --------------
(In thousands)
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ (57,900) $ 9,785
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 2,771 1,922
Benefit for deferred income taxes -- (2,971)
Provision for credit losses 10,579 7,087
Gain on retirement of senior
unsecured debt (7,724) --
Fair value writedown of residual
receivables 14,230 --
Mark to market adjustment on loans
held for sale 5,300 --
Loans originated with intent to sel (672,604) (808,165)
Proceeds from loans sold 548,713 393,458
Proceeds from securitization of loans 92,316 332,156
Other 2,305 2,648
Changes in operating assets and
liabilities decreasing cash (7,446) (37,165)
------------- ------------
Net cash used in operating activities $ (69,460) $ (101,245)
-------------- ------------
INVESTING ACTIVITIES:
Loans originated for investment
purposes $ (123,748) $ (102,189)
Principal collections on loans not sold 149,492 91,121
Proceeds from sale of real estate and
personal property acquired through
foreclosure 4,325 4,850
Purchase of property and equipment (9,134) (5,935)
Other 1,488 (326)
------------ ------------
Net cash provided by (used in) investing
activities $ 22,423 $ (12,479)
------------ ------------
FINANCING ACTIVITIES:
Advances on revolving warehouse lines
of credit $ 333,230 $ 817,222
Payments on revolving warehouse lines
of credit (262,846) (841,363)
Proceeds from issuance of senior
unsecured debt -- 120,630
Retirement of senior unsecured debt (9,026) --
Net increase in notes payable to
investors 4,878 12,907
Net increase (decrease) in subordinated
debentures (1,137) 3,146
Proceeds from issuance of additional
common stock 215 1,148
Other (5) --
----------- ------------
Net cash provided by financing
activities $ 65,309 $ 113,690
------------ -------------
Net increase in cash and cash
equivalents $ 18,272 $ (34)
CASH AND CASH EQUIVALENTS:
Beginning of period 7,561 1,276
============= =============
End of period $ 25,833 $ 1,242
============= ==============
</TABLE>
See Notes to Unaudited Financial Statements
7
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
NOTE 1--BASIS OF PREPARATION
The accompanying consolidated financial statements are prepared in
accordance with the Securities and Exchange Commission's rules regarding interim
financial statements, and therefore do not contain all disclosures required by
generally accepted accounting principles for annual financial statements.
Reference should be made to the financial statements included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1997, including the
footnotes thereto. Certain previously reported amounts have been reclassified to
conform to current year presentation. Such reclassifications had no effect on
net income or shareholders' equity as previously reported.
The consolidated balance sheet as of September 30, 1998, and the
consolidated statements of operations for the nine-month and three-month periods
ended September 30, 1998 and 1997, and the consolidated statements of cash flows
for the nine-month periods ended September 30, 1998 and 1997, are unaudited and
in the opinion of management contain all known adjustments, which consist of
only normal recurring adjustments necessary to present fairly the financial
position, results of operations, and cash flows of the Company.
KPMG Peat Marwick LLP previously examined and reported on the Company's
financial statements for the year ended December 31, 1997, from which the
consolidated balance sheet as of that date is derived. On September 21, 1998,
the Company's audit committee selected Elliott, Davis & Company LLP to serve as
the Company's auditors for the fiscal year ended December 31, 1998.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company's historic accounting policy provided that the estimated lower
of cost or market analysis for loans held for sale be assessed on a disaggregate
basis based solely on the type of loan (e.g. mortgage, commercial and auto).
Beginning in 1998, the Company elected to further disaggregate the mortgage loan
portfolio for purposes of estimating the lower of cost or market assessment by
evaluating loans secured by first liens separately from loans secured by second
liens.
NOTE 3--CASH FLOW INFORMATION
For the nine-month periods ended September 30, 1998 and 1997, the Company
paid interest of $31.3 million and $15.8 million, respectively.
For the nine-month periods ended September 30, 1998 and 1997, the Company
paid income taxes of $2.3 million and $1.1 million, respectively.
For the nine-month periods ended September 30, 1998 and 1997, the Company
foreclosed on property in the amount of $6.7 million and $8.8 million,
respectively.
NOTE 4--CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments readily convertible to
cash or having a maturity of three months or less to be cash equivalents.
The Company maintains its primary checking accounts with three principal
banks and makes overnight investments in reverse repurchase agreements with
those banks. The amounts maintained in the checking accounts are insured by the
Federal Deposit Insurance Corporation ("FDIC") up to $100,000. At September 30,
1998, the amounts maintained in overnight investments in reverse repurchase
agreements, which are not insured by the FDIC, totaled approximately $23.3
million. The investments were secured by U.S. Government securities pledged by
the banks.
8
<PAGE>
NOTE 5 --ADOPTION OF NEW ACCOUNTING STANDARDS
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income". This Statement establishes standards for
reporting comprehensive income and its components in a full set of general
purpose financial statements. The objective of the Statement is to report a
measure of all changes in equity of an enterprise that result from transactions
and other economic events during the period other than transactions with owners.
Comprehensive income is divided into net income and other comprehensive income.
Adoption of this Statement did not change total shareholders' equity as
previously reported. Net income and comprehensive income are the same for the
nine-month and three-month periods ended September 30, 1998 and 1997.
NOTE 6--INCOME TAXES
A reconciliation of the provision for Federal and State income taxes and
the amount computed by applying the statutory Federal income tax rate to income
before income taxes and minority interest are as follows:
<TABLE>
<CAPTION>
Nine months ended Three Months Ended
September 30, September 30,
----------------------- ----------------------
1998 1997 1998 1997
----------- ---------- ---------- ----------
(In thousands) (In thousands)
<S> <C> <C> <C> <C>
Statutory Federal rate of 34% applied to pre-tax income
(loss) before minority interest and extraordinary item $ (20,920) $ 2,708 $ (7,201) $ 1,451
State income taxes, net of Federal income tax benefit 253 168 28 87
Change in the beginning of period balance of the valuation
allowance for deferred tax assets allocated to income
tax expense 21,925 (4,806) 5,514 (1,747)
Defeasance gain 2,626 -- 2,626 --
Nondeductible expenses 76 63 21 29
Amortization of excess cost over net assets of acquired
businesses 44 50 12 17
Other, net 105 (158) (135) (187)
---------- --------- ---------- ---------
$ 4,109 $ (1,975) $ 865 $ (350)
========== ========== ========== ==========
</TABLE>
Provision for income taxes from continuing operations is comprised of
the following:
<TABLE>
<CAPTION>
Nine months ended Three Months Ended
September 30, September 30,
----------------------- ----------------------
1998 1997 1998 1997
----------- ---------- ---------- ----------
(In thousands) (In thousands)
<S> <C> <C> <C> <C>
Current:
- --------
Federal $ 3,725 $ 394 $ 822 $ 134
State and local 384 602 43 29
---------- ---------- ---------- ----------
4,109 996 865 163
Deferred:
- --------
Federal -- (2,625) -- (617)
State and local -- (346) -- 104
---------- ---------- ---------- ----------
-- (2,971) -- (513)
Total:
- ------
Federal 3,725 (2,231) 822 (483)
State and local 384 256 43 133
---------- ---------- ---------- ----------
$ 4,109 $ (1,975) $ 865 $ (350)
========== ========== ========== ==========
</TABLE>
9
<PAGE>
Deferred income taxes reflect the net tax effects of (a) temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes, and (b)
operating loss carryforwards. The tax effects of significant items comprising
the Company's net deferred tax asset are as follows:
September 30, December 31,
------------- -------------
1998 1997
------------- -------------
(In thousands)
Deferred tax liabilities:
Differences between book and tax basis of
property $ (1,058) $ (796)
Difference between book and tax basis of the
residual receivables associated with the
Company's investment in its affiliated
Real Estate Investment Trust (REIT) (2,110) (3,849)
Deferred loan costs (628) (608)
Other (175) (90)
------------ ------------
Total gross deferred tax liabilities (3,971) (5,343)
------------ ------------
Deferred tax assets:
Differences between book and tax basis of
deposit base intangibles 172 216
Differences between book and tax basis of REMIC
residual receivable 4,925 --
Allowance for credit losses 4,716 3,525
AMT credit carryforward -- 608
Operating loss carryforward 17,383 4,171
Deferred loan fees 1,604 --
Unrealized gain on loans to be sold 1,128 909
Other 119 65
------------ ------------
Total gross deferred tax assets 30,047 9,494
Less valuation allowance (21,925) --
Less gross deferred tax liabilities (3,971) (5,343)
------------ ------------
Net deferred tax asset $ 4,151 $ 4,151
============= =============
The valuation allowance for deferred tax assets at January 1, 1997 was
$7.5 million. The increase (decrease) in the valuation allowance for the nine
months ended September 30, 1998 and the year ended December 31, 1997 was $21.9
million and ($7.5) million, respectively. The valuation allowance at September
30, 1998 relates primarily to net operating loss ("NOL") carryforwards. The
decision to record the valuation allowance in 1998 was based on changes in 1998
earnings projections. Current projections are for a taxable loss in 1998. The
ability to fully utilize all of the NOL's expiring in 1999 is reduced by the
Company's anticipated current year loss and the inability to use current period
earnings classified as "excess inclusion" to offset prior NOL's. Earnings of
approximately $9.5 million in the nine months ended September 30, 1998 and $4.0
million in 1997 were classified as excess inclusion and were not able to be
offset with prior year NOL's. Management believes that it is more likely than
not that the results of future operations and tax planning strategies available
to the Company will generate sufficient taxable income to realize the net
deferred tax asset. Management continues to evaluate this each quarter, and may
take additional reserves against this asset if deemed necessary in the future.
As of September 30, 1998, the Company has available Federal NOL's expiring
as follows (in thousands):
1999 $ 5,456
2000 3,297
2001 1,911
2002 and after 40,435
-----------
$ 51,099
===========
There are no known significant pending assessments from taxing authorities
regarding taxation issues at the Company or its subsidiaries. No additional
incremental taxes result from the gain on extinguishment of debt.
10
<PAGE>
NOTE 7--WAREHOUSE LINES OF CREDIT
The Company's mortgage lending subsidiaries are parties to a $200 million
revolving warehouse line of credit, which matures on June 30, 2001. This line of
credit contains a requirement to maintain a minimum specified amount of investor
savings notes to be held by Carolina Investors, Inc., a requirement for audited
financial statements from a national auditing firm, and limitations on certain
intercompany transactions. This line of credit prohibits HomeGold, Inc., and in
certain circumstances Carolina Investors, Inc., from paying dividends or making
distributions to the Company in excess of 50% of such subsidiaries' cumulative
net income as determined for the most recent four consecutive completed fiscal
quarters on a cumulative rolling basis or if an event of default exists at the
time of, or after giving effect to, the dividend or distribution. It also
restricts the ability of HomeGold, Inc., and in certain circumstances Carolina
Investors, Inc., to make loans or advances to the Company. The Company
anticipates reducing the maximum available line of credit by $50 to $100 million
upon completion of the sale of the Small Business Loan Division. With the
Company's strategy of monthly whole loan sales, it does not anticipate needing a
line of credit in excess of this capacity, and will be able to reduce its unused
line fees by lowering the facility amount. At September 30, 1998, the Company
had excess availability under the mortgage loan revolving warehouse line of
credit of $3.3 million based on the eligible borrowing base and related advance
rates under the terms of the agreement. While the Company believes it is in
compliance with the covenants of its debt agreement, it is currently in
discussions with its lender regarding whether or not its auditors, Elliott,
Davis & Company qualifies as a national auditing firm, and whether or not any
provisions were violated when the Company repurchased some of its Senior Notes.
The Company's small business lending subsidiaries have various revolving
warehouse lines of credit providing them with an aggregate line of credit of $70
million, of which $60 million matures on December 29, 2000 and $10 million in
November of 1998. These lines of credit require, among other things, minimum
tangible net worth ratios, maximum ratios of total liabilities to tangible net
worth and minimum interest coverage ratios, and contain limitations on the
amount of capital expenditures in any fiscal year and restrictions on the
payment of dividends. These required financial ratios are calculated on the
Small Business Loan Division's financial statements. These agreements contain no
consolidated financial statement covenants. Most of these lines of credit
contain provisions prohibiting the small business lending subsidiaries party to
those credit facilities from paying dividends, or making distributions to the
Company (unless such provisions are waived by the lender). Reedy River Ventures
Limited Partnership's line of credit restricts its ability to make loans to the
Company, but prevents it from paying dividends or making distributions to the
Company only if an event of default exists or is cured by such dividend or
distribution or if the Company ceases to guarantee the line of credit. At
September 30, 1998, the Company had excess availability under the small business
revolving warehouse lines of credit of $8.0 million based on the eligible
borrowing base and related advance rates under the terms of the agreement. The
small business lending subsidiaries' revolving warehouse lines of credit will be
paid off upon completion of the sale of these business units.
NOTE 8--EXTRAORDINARY ITEM - GAIN ON EXTINGUISHMENT OF DEBT
In the third quarter of 1998, the Company purchased $16.8 million face
amount of its Senior Notes due 2004 ("Senior Notes") in the market for a
purchase price of $8.5 million or 50.7% of face value. A proportionate share of
the unamortized debt origination costs relating to the issuance of the Senior
Notes was charged against this gain, to record a net gain of $7.7 million. The
Company may, from time to time, purchase more of its Senior Notes depending on
its cash needs, market conditions, and other factors.
NOTE 9--SALE OF SUBSIDIARIES
The Company completed the sale of substantially all of the assets of its
Auto Loan Division for book value on March 19, 1998, to TranSouth Financial
Corporation, a subsidiary of Associates Financial Services Company, Inc. This
sale provided the Company with cash proceeds of approximately $20.4 million. No
significant gain or loss was recognized on this transaction. The Company no
longer originates auto loans. Prior to the sale of the auto loan division, it
recorded a net loss of approximately $110,000 for the period ended March 19,
1998.
On August 21, 1998, the Company completed the sale of its small branch
network retail mortgage origination company, Sterling Lending Corporation, to
First National Security Corporation of Beaumont, Texas. The sale resulted in
cash proceeds of $400,000 to HomeGold Financial, Inc. and a note receivable for
$1.1 million, payable over 5 years at 7% interest. There was no significant gain
or loss recorded as a result of this sale. For the three months ended September
30, 1998 and 1997, Sterling Lending Corporation recorded a net loss of $1.5
million and $1.2 million, respectively. For the nine months ended September 30,
1998 and 1997, Sterling Lending Corporation recorded a net loss of $3.4 million
and $3.6 million, respectively.
11
<PAGE>
NOTE 10--SUBSEQUENT EVENTS
On October 2, 1998, the Company entered into a definitive agreement to
sell the majority of the assets of its small business lending units, including
the 7(a) SBA lending unit, its 504 SBA lending unit, and its SBIC mezzanine
lending unit, to Transamerica Business Credit Corporation. On November 13, 1998,
the Company completed the sale. Total "initial" sales proceeds from this sale
were $96 million based on the September 30 balance sheet. After repayment of the
related warehouse lines of credit, escrowing $5 million holdback in the purchase
price, and paying transaction costs, the Company received "initial" net cash
proceeds of approximately $45 million. The Company may also receive additional
proceeds within 30 days to adjust the "initial" purchase price, which was based
on the September 30, 1998 balance sheet, to the "final" purchase price, which is
based on the balance sheet as of the closing date, November 13, 1998. These
additional proceeds may be approximately $7 million. The gain to be realized in
the fourth quarter of 1998 is expected to be approximately $18 million net of
related costs. For the three months ended September 30, 1998 and 1997, these
small business division subsidiaries recorded a net loss of $2.0 million and
$100,000, respectively. For the nine months ended September 30, 1998 and 1997,
these small business division subsidiaries recorded a net loss of $2.8 million
and $1.4 million net gain, respectively.
On November 5, 1998, the Company entered into a definitive agreement to
sell the majority of its asset-based lending unit to Emergent Asset Based
Lending LLC, a Maryland Limited Liability Company. This transaction will
complete the disposition of all non-mortgage related activities of the Company.
A loss of approximately two to three million dollars is anticipated on the
disposition of the asset-based lending unit. For the three months ended
September 30, 1998 and 1997, the asset-based lending subsidiary recorded net
losses of $100,000 and $500,000, respectively. For both the nine months ended
September 30, 1998 and 1997, the asset-based lending subsidiary recorded net
losses of $1.0 million.
12
<PAGE>
Summary statements of financial condition and operations broken out by
ongoing operations and by operations to-be-sold as of September 30, 1998 are as
follows:
<TABLE>
<CAPTION>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING BALANCE SHEETS
September 30, 1998
(Unaudited)
(In thousands)
Small
Continuing Business
Mortgage Operations To Consolidated
Operations Be Sold (1) Eliminations Total
---------- ------------- ------------ ------------
ASSETS
-------
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 24,103 $ 1,730 $ -- $ 25,833
Loans receivable:
Loans receivable held for investment 53,531 38,116 -- 91,647
Loans receivable held for sale 149,031 48,859 -- 197,890
---------- ----------- ---------- ----------
Total loans receivable 202,562 86,975 -- 289,537
Less allowance for credit losses on loans (7,131) (2,668) -- (9,799)
Less allowance for mark-to-market on loans (5,300) -- -- (5,300)
Less deferred loan fees (4,336) (1,605) -- (5,941)
Plus deferred loan costs 1,654 137 -- 1,791
---------- ----------- ---------- ----------
Net loans receivable 187,449 82,565 -- 270,014
Accrued interest receivable and other
receivables 10,150 2,718 (888) 11,980
Intercompany receivables and investment in
subsidiaries 125,671 -- (125,671) --
Residual receivables, net 45,329 17,846 -- 63,175
Net property and equipment 21,575 1,424 -- 22,999
Real estate and personal property acquired
through foreclosure 4,375 819 -- 5,194
Net excess of cost over net assets of
acquired businesses 1,682 1,501 (933) 2,250
Net debt origination costs 5,656 183 -- 5,839
Deferred income tax asset 3,128 1,165 (142) 4,151
Servicing asset 1,021 -- -- 1,021
Other assets 3,535 1,193 -- 4,728
---------- ----------- ---------- ----------
Total assets $ 433,674 $ 111,144 $ (127,634) $ 417,184
========== =========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Revolving warehouse lines of credit $ 89,581 $ 58,409 $ -- $ 147,990
Investor savings 138,056 -- -- 138,056
Senior unsecured debt 108,250 -- -- 108,250
Other liabilities 12,978 5,200 (1,030) 17,148
---------- ----------- ---------- ---------
Total liabilities 348,865 63,609 (1,030) 411,444
Minority interest 57 -- -- 57
Intercompany debt 33,308 17,640 (50,948) --
Shareholders' equity 51,444 29,895 (75,656) 5,683
---------- ----------- ---------- ---------
Total liabilities and shareholders' equity $ 433,674 $ 111,144 $ (127,634) $ 417,184
=========== ============ =========== ==========
</TABLE>
(1) Represents the Company's Small Business Loan Division, including its
7(a) SBA lending unit, its 504 SBA lending unit, its SBIC mezzanine
lending unit, and its asset-based lending unit. A substantial
majority of these assets are expected to be sold by the end of the
year.
13
<PAGE>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING STATEMENTS OF OPERATIONS
Nine months ended September 30, 1998
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Continuing Sold Sold Small Business
Mortgage Mortgage Auto Operations Consolidated
Operations Operations (1) Operations (2) To Be Sold (3) Total
---------- ---------- ------------ ------------- ------------
<S> <C> <C> <C> <C> <C>
REVENUES:
Interest income $ 21,693 $ 10 $ 1,102 $ 6,747 $ 29,552
Servicing income 7,736 -- -- 2,462 10,198
Gain on sale of loans:
Cash gain on sale of loans 8,836 780 -- 3,420 13,036
Non-cash gain (loss) on sale
of loans 1,902 635 -- 248 2,785
Loan costs (5,197) -- -- -- (5,197)
Loan fee income 13,105 1520 7 656 15,288
---------- ---------- ------------ ----------- -----------
Total gain on sale of loans 18,646 2,935 7 4,324 25,912
Other revenues 2,249 217 58 986 3,510
---------- ---------- ------------ ----------- -----------
Total revenues 50,324 3,162 1,167 14,519 69,172
EXPENSES:
Interest 24,108 125 287 3,815 28,335
Provision for credit losses 8,086 -- 554 1,939 10,579
Fair value write-down of residual
receivables 12,428 -- -- 1,802 14,230
General and administrative expense 59,414 6,460 440 11,242 77,556
---------- ------------ ----------- ----------- ------------
Total expenses 104,036 6,585 1,281 18,798 130,700
---------- ------------ ------------ ----------- -----------
Loss before income taxes, minority
interest, and extraordinary item (53,712) (3,423) (114) (4,279) (61,528)
Provision (benefit) for income
taxes 4,650 (46) (4) (491) 4,109
---------- ---------- ------------ ----------- -----------
Loss before minority interest and
extraordinary item (58,362) (3,377) (110) (3,788) (65,637)
Minority interest in loss of
subsidiaries 13 -- -- -- 13
---------- ---------- ------------ ----------- -----------
Loss before extraordinary item (58,349) (3,377) (110) (3,788) (65,624)
Extraordinary item-gain on
extinguishment of debt 7,724 -- -- -- 7,724
---------- ---------- ------------ ----------- -----------
Net loss $ (50,625) $ (3,377) $ (110) $ (3,788) $ (57,900)
============ =========== ============ =========== ===========
</TABLE>
(1) Represents Sterling Lending Corporation, a retail mortgage lending
subsidiary which was sold in August 1998.
(2) Substantially all of the assets of the Company's Auto Loan Division
were sold in March 1998. The Company operated its Auto Loan Division
through two subsidiaries - The Loan Pro$, Inc. and Premier Financial
Services, Inc.
(3) Represents the Company's Small Business Loan Division, including its
7(a) SBA lending unit, its 504 SBA lending unit, its SBIC mezzanine
lending unit and its asset-based lending unit. A substantial majority
of these assets are expected to be sold by the end of the year.
14
<PAGE>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING STATEMENTS OF OPERATIONS
Three months ended September 30, 1998
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Continuing Sold Sold Small Business
Mortgage Mortgage Auto Operations Consolidated
Operations Operations (1) Operations (2) To Be Sold (3) Total
---------- ---------- ------------ ------------- ------------
<S> <C> <C> <C> <C> <C>
REVENUES:
Interest income $ 7,595 $ -- $ -- $ 2,767 $ 10,362
Servicing income 1,750 -- -- 847 2,597
Gain on sale of loans:
Cash gain on sale of loans 2,159 (575) -- 1,341 2,925
Non-cash gain (loss) on sale of loans (1,005) 635 -- (26) (396)
Loan costs (2,267) -- (2,267)
Loan fee income 5,215 46 -- 268 5,529
---------- ---------- ----------- ------------ ------------
Total gain on sale of loans 4,102 106 -- 1,583 5,791
Other revenues 885 24 -- 183 1,092
---------- ---------- ----------- ------------ ------------
Total revenues 14,332 130 -- 5,380 19,842
EXPENSES:
Interest 8,363 13 -- 1,574 9,950
Provision for credit losses 2,864 -- -- 775 3,639
Fair value write-down of residual
receivables 4,078 -- -- 1,242 5,320
General and administrative expense 16,699 1,588 -- 3,825 22,112
---------- --------- ------------ ------------ -----------
Total expenses 32,004 1,601 -- 7,416 41,021
---------- ---------- ----------- ------------ ------------
Loss before income taxes, minority
interest, and extraordinary item (17,672) (1,471) -- (2,036) (21,179)
Provision (benefit)for income taxes 833 5 -- 27 865
---------- ---------- ----------- ------------ -------------
Loss before minority interest and
extraordinary item (18,505) (1,476) -- (2,063) (22,044)
Minority interest in loss of
subsidiaries 11 -- -- -- 11
---------- ---------- ----------- ------------ ------------
Loss before extraordinary item (18,494) (1,476) -- (2,063) (22,033)
Extraordinary item-gain on extinguishment
of debt 7,724 -- -- -- 7,724
---------- ---------- ----------- ------------ ------------
Net loss $ (10,770) (1,476) -- (2,063) (14,309)
============ =========== =========== ============ ============
</TABLE>
(1) Represents Sterling Lending Corporation, a retail mortgage lending
subsidiary which was sold in August 1998.
(2) Substantially all of the assets of the Company's Auto Loan Division were
sold in March 1998. The Company operated its Auto Loan Division through two
subsidiaries - The Loan Pro$, Inc. and Premier Financial Services, Inc.
(3) Represents the Company's Small Business Loan Division, including its 7(a)
SBA lending unit, its 504 SBA lending unit, its SBIC mezzanine lending unit
and its asset-based lending unit. A substantial majority of these assets
are expected to be sold by the end of the year.
NOTE 11--SENIOR UNSECURED DEBT AND SUBSIDIARY GUARANTORS
In September 1997, the Company sold $125.0 million in aggregate principal
amount of Senior Notes due 2004 ("Senior Notes"). The Senior Notes constitute
unsecured indebtedness of the Company. The Senior Notes mature on September 15,
2004, with interest payable semi-annually at 10.75%. The Senior Notes will be
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. In the third quarter of 1998, the Company
purchased $16.8 million face amount of its Senior Notes in an open market
transaction at a purchase price of $8.5 million or 50.7% of face value. The
Company may, from time to time, purchase more of its Senior Notes depending on
its cash needs, market conditions, and other factors. The indenture pertaining
to the Senior Notes contains various restrictive covenants including limitations
on, among other things, the incurrence of certain types of additional
indebtedness, the payment of dividends and certain other payments, the ability
of the Company's subsidiaries to incur further limitations on their ability to
pay dividends or make other payments to the Company, liens, asset sales, the
issuance of preferred stock by the Company's subsidiaries and transactions with
affiliates. At September 30, 1998, management believes the Company was in
compliance with such restrictive covenants. The Senior Notes 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 the Company's subsidiary Carolina Investors, Inc. ("CII"), the Subsidiary
Guarantees rank pari passu in right of payment with all existing and future
unsubordinated indebtedness of the
15
<PAGE>
Subsidiary Guarantors and senior in right of payment to all existing and future
subordinated indebtedness of such Guarantors. All existing debt of all
subsidiaries other than CII are currently considered to be subordinated to the
Senior Notes. The Guarantee by CII is equal in priority to CII's notes payable
to investors and is senior to CII's subordinated debentures.
The following tables present consolidating condensed financial data of the
combined subsidiaries of the Company. The Company believes that providing the
condensed consolidating information is of material interest to investors in the
Senior Notes and has not presented separate financial statements for each of the
wholly-owned Subsidiary Guarantors, because it was deemed that such financial
statements would not provide investors with any material additional information
At September 30, 1998, the Company did not have any subsidiaries which were not
owned 100% by the Company.
Investments in subsidiaries are accounted for by the Parent and Subsidiary
Guarantors on the equity method for the purposes of the consolidating financial
data. Earnings of subsidiaries are therefore reflected in the parent's and
Subsidiary Guarantor's investment accounts and earnings. The principal
elimination entries eliminate investments in subsidiaries and intercompany
balances and transactions. Certain sums in the following tables reflect
immaterial rounding differences.
The Subsidiary Guarantors at September 30, 1998 consist of the following
wholly owned subsidiaries of the Company:
HomeGold, Inc.(f/k/a Emergent Mortgage Corp.)
Emergent Mortgage Corp. of Tennessee
Carolina Investors, Inc.
Emergent Business Capital, Inc.
Emergent Commercial Mortgage, Inc.
Emergent Business Capital Asset Based Lending, Inc.(f/k/a Emergent
Financial Corp.)
Emergent Business Capital Equity Group, Inc. (f/k/a Emergent Equity
Advisors, Inc.)
Emergent Insurance Agency Corp.
As of September 30, 1998, the Subsidiary Guarantors conduct all of the
Company's operations other than the investment of certain residual receivables
through its special purpose bankruptcy-remote securitization subsidiaries and
its mezzanine lending operations, which are performed through Reedy River
Ventures Limited Partnership, a small business investment company. Prior to
March 1998, The Loan Pro$, Inc. and Premier Financial Services, Inc. (the
Company's Auto Loan Division subsidiaries) were guarantors of this indebtedness,
but their guarantees terminated when substantially all of the assets of the Auto
Loan Division were sold to TranSouth Financial Corporation, a subsidiary of
Associates Financial Services Company, Inc., in March 1998.
Prior to August 21, 1998, Sterling Lending Corporation (an 80% owned
subsidiary of the Company) and Sterling Lending Insurance Agency, Inc. (a 100%
owned subsidiary of Sterling Lending Corporation) were also guarantors of this
indebtedness, but their guarantees terminated when they were sold to First
National Security Corporation of Beaumont, Texas, in August 1998. Therefore the
operations of Sterling Lending (a non-wholly-owned guarantor subsidiary) are
included in the consolidated statements of operations for the respective periods
prior to August 21, 1998.
The assets of Emergent Business Capital, Inc., Emergent Commercial
Mortgage, Inc., Emergent Business Capital Equity Group, Inc. and Reedy River
Ventures Limited Partnership were sold to Transamerica Business Credit
Corporation in the fourth quarter 1998. Accordingly, the guarantees of these
companies were terminated upon consummation of that sale.
The assets of Emergent Business Capital Asset Based Lending, Inc. are also
planned to be sold in the fourth quarter 1998. Accordingly, the guaranty of this
company will be terminated upon consummation of the sale of substantially all of
the assets of this subsidiary.
16
<PAGE>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING BALANCE SHEETS
September 30, 1998
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Combined Combined
Wholly- Non Wholly- Combined
Owned Owned Non-
Parent Guarantor Guarantor Guarantor
Company Subsidiaries Subsidiaries Subsidiaries Eliminations Consolidated
-------- ------------ -------------- ------------ ------------- ------------
ASSETS
------
<S> <C> <C> <C> <C> <C> <C>
Cash and cash equivalents $ 673 25,113 $ -- 47 $ -- $ 25,833
Loans receivable:
Loans receivable held for investment 1,461 80,186 -- 10,000 -- 91,647
Loans receivable held for sale -- 197,890 -- -- -- 197,890
Notes receivable from affiliates 37,226 9,324 -- 7,707 (54,257) --
-------- -------- --------- ------- -------- ---------
Total loans receivable 38,687 287,400 -- 17,707 (54,257) 289,537
Less allowance for credit losses on loans (181) (9,618) -- -- -- (9,799)
Less mark-to-market reserves (5,300) (5,300)
Less deferred loan fees (96) (5,866) -- (253) -- (6,215)
Plus deferred loan costs -- 1,791 -- -- -- 1,791
-------- -------- --------- ------- --------- ---------
Net loans receivable 38,410 268,407 -- 17,454 (54,257) 270,014
Other Receivables:
Accrued interest receivable 30 4,259 -- 69 -- 4,358
Income tax receivable 692 196 -- -- (888) --
Other receivables 93 7,529 -- -- -- 7,622
-------- -------- --------- ------- --------- ---------
Total other receivables 815 11,984 -- 69 (888) 11,980
Investment in subsidiaries 71,414 -- -- -- (71,414) --
Residual receivables, net -- 41,916 -- 21,259 -- 63,175
Net property and equipment 1,608 21,391 -- -- -- 22,999
Real estate and personal property acquired
through foreclosure 52 5,142 -- -- -- 5,194
Net excess of cost over net assets of
acquired businesses 41 2,811 -- 331 (933) 2,250
Deferred income tax asset 2,234 2,059 -- -- (142) 4,151
Other assets 3,848 7,158 -- 582 -- 11,588
-------- -------- --------- -------- --------- ---------
Total assets $ 119,095 $385,981 $ -- $39,742 $ (127,634) $ 417,184
======== ======== ========= ======== ========= ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Revolving warehouse lines of credit $ -- $141,012 $ -- $ 6,978 $ -- $ 147,990
Investor savings:
Notes payable to investors -- 120,246 -- -- -- 120,246
Subordinated debentures -- 17,810 -- -- -- 17,810
-------- -------- --------- -------- --------- ---------
Total investor savings -- 138,056 -- -- -- 138,056
Senior unsecured debt 108,250 -- -- -- -- 108,250
Accounts payable and accrued
liabilities 4,644 6,169 -- 45 (888) 9,970
Deferred income tax payable -- 142 -- -- (142) --
Remittances payable -- 5,421 -- -- -- 5,421
Accrued interest payable 518 1,239 -- -- -- 1,757
Due to affiliates -- --
-------- -------- --------- -------- --------- ---------
Total other liabilities 5,162 12,971 -- 45 (1,030) 17,148
Subordinated debt to EGI -- 50,772 -- 176 (50,948) --
-------- -------- --------- -------- --------- ---------
Total liabilities 113,412 333,952 -- 16,058 (51,978) 411,444
Minority interest -- -- -- 57 -- 57
Shareholders' equity:
Common stock 487 4,083 -- 11 (4,094) 487
Preferred stock -- -- -- -- -- --
Capital in excess of par value 38,821 63,020 -- 24,958 (87,978) 38,821
Retained earnings (deficit) (33,625) (15,074) -- (1,342) 16,416 (33,625)
------ -------- --------- ------- ------- -------
Total shareholders' equity 5,683 52,029 -- 23,627 (75,656) 5,683
-------- -------- --------- -------- --------- ---------
Total liabilities and shareholders'
equity $ 119,095 385,981 $ -- 39,742 $ (127,634) $ 417,184
======== ========== ========= ========= =========== ==========
</TABLE>
17
<PAGE>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING BALANCE SHEETS
December 31, 1997
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Combined Combined
Wholly- Non Wholly- Combined
Owned Owned Non-
Parent Guarantor Guarantor Guarantor
Company Subsidiaries Subsidiaries Subsidiaries Eliminations Consolidated
-------- ------------ -------------- ------------ ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
-------
Cash and cash equivalents $ 713 6,411 $ 263 174 $ -- $ 7,561
Loans receivable:
Loans receivable held for
investment -- 93,129 -- 7,250 -- 100,379
Loans receivable held for sale -- 187,911 9,325 -- -- 197,236
Notes receivable from
affiliates 71,854 31,851 -- 25 (103,730) --
------- -------- --------- -------- --------- ---------
Total loans receivable 71,854 312,891 9,325 7,275 (103,730) 297,615
Less allowance for credit
losses on loans -- (6,528) -- -- -- (6,528)
Less deferred loan fees -- (3,556) (568) (192) -- (4,316)
Plus deferred loan costs -- 1,458 200 -- -- 1,658
-------- ------- -------- -------- --------- ---------
Net loans receivable 71,854 304,265 8,957 7,083 (103,730) 288,429
Other Receivables:
Accrued interest receivable -- 4,250 63 94 -- 4,407
Income tax 614 -- -- -- -- 614
Other receivables 3,064 6,802 496 -- (296) 10,066
------- -------- --------- -------- --------- ---------
Total other receivables 3,678 11,052 559 94 (296) 15,087
Investment in subsidiaries 107,989 -- -- -- (107,989) --
Residual receivables, net -- 43,579 -- 19,623 -- 63,202
Net property and equipment 1,666 15,086 1,328 -- -- 18,080
Real estate and personal property
acquired through foreclosure -- 3,295 -- -- -- 3,295
Net excess of cost over net
assets of acquired businesses 42 3,426 -- 342 (936) 2,874
Deferred tax 4,588 2,117 -- -- (2,554) 4,151
Other assets 4,822 8,207 207 237 -- 13,473
------- -------- --------- -------- --------- ---------
Total assets $ 195,352 397,438 $ 11,314 27,553 $ (215,505 $ 416,152
======== ======== ========= ======= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Liabilities:
Revolving warehouse lines of
credit $ -- $ 77,605 $ -- -- $ -- $ 77,605
Investor savings:
Notes payable to investors -- 115,368 -- -- -- 115,368
Subordinated debentures -- 18,947 -- -- -- 18,947
-------- -------- --------- -------- --------- ---------
Total investor savings -- 134,315 -- -- -- 134,315
Senior unsecured debt 125,000 -- -- -- -- 125,000
Accounts payable and accrued
liabilities 312 7,408 760 22 (1,985) 6,517
Remittances payable -- 4,591 -- -- -- 4,591
Accrued interest payable 3,645 1,105 -- -- -- 4,750
Due to affiliates 3,021 -- -- 7,057 (10,078) --
-------- -------- --------- -------- --------- ---------
Total other liabilities 6,978 13,104 760 7,079 (12,063) 15,858
Subordinated debt to affiliates -- 63,969 9,544 16,829 (90,342) --
-------- -------- --------- -------- -------- ---------
Total liabilities 131,978 288,993 10,304 23,908 (102,405) 352,778
Shareholders' equity:
Common stock 484 4,259 -- 10 (4,269) 484
Preferred stock -- 4,621 5,700 -- (10,321) --
Capital in excess of par value 38,609 64,570 -- 3,102 (67,672) 38,609
Retained earnings (deficit) 24,281 34,995 (4,690) 533 (30,838) 24,281
------ -------- ------- -------- ------- ---------
Total shareholders' equity 63,374 108,445 1,010 3,645 (113,100) 63,374
------- -------- ------- -------- -------- ---------
Total liabilities and shareholders'
equity $ 195,352 $ 397,438 $ 11,314 27,553 $ (215,505) $ 416,152
========= ======== ====== ======= ======= =======
</TABLE>
18
<PAGE>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING STATEMENTS OF OPERATIONS
Nine months ended September 30, 1998
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Combined
Combined Non Wholly- Combined
Wholly-Owned Owned Non-
Parent Guarantor Guarantor Guarantor
Company Subsidiaries Subsidiaries Subsidiaries Eliminations Consolidated
---------- --------- ------------ ------------ --------- -----------
<S> <C> <C> <C> <C> <C> <C>
REVENUES:
Interest income $ 5,645 $ 29,145 $ 10 $ 1,024 $ (6,272) $ 29,552
Servicing income -- 9,193 -- 2,277 (1,272) 10,198
Gain on sale of loans:
Cash gain on sale of loans -- 12,256 780 -- -- 13,036
Non-cash gain on sale of loans -- 2,150 635 -- -- 2,785
Loan costs -- (5,197) -- -- -- (5,197)
Loan fee income -- 13,684 1,520 84 -- 15,288
--------- --------- --------- --------- --------- -----------
Total gain on sale of loans -- 22,893 2,935 84 -- 25,912
Other revenues 5 3,284 217 489 (485) 3,510
--------- --------- --------- --------- --------- -----------
Total revenues 5,650 64,515 3,162 3,874 (8,029) 69,172
--------- --------- --------- --------- --------- -----------
EXPENSES:
Interest 11,207 23,412 125 331 (6,740) 28,335
Provision for credit losses 20 10,559 -- -- -- 10,579
Fair value write-down of residual receivables -- 10,263 -- 3,967 -- 14,230
Salaries, wages and employee benefits 2,635 40,590 3,639 -- -- 46,864
Business development costs 2 8,217 269 -- -- 8,488
Other general and administrative expense (1,911) 21,382 2,552 202 (21) 22,204
--------- --------- ------- ------- ---------
Total expenses 11,953 114,423 6,585 4,500 (6,761) 130,700
--------- --------- --------- --------- --------- -----------
Income(loss) before income taxes, minority
interest, equity in undistributed
earnings of subsidiaries, and extraordinary
item (6,303) (49,908) (3,423) (626) (1,268) (61,528)
Equity in undistributed earnings of
subsidiaries
(57,442) (507) -- -- 57,949 --
--------- --------- --------- --------- --------- -----------
Income(loss) before income taxes, minority
interest, and extraordinary item (63,745) (50,415) (3,423) (626) 56,681 (61,528)
Provision (benefit) for income taxes 1,879 2,276 (46) -- -- 4,109
--------- ------- ------- ---------- ---------- ---------
Income(loss) before minority interest and
extraordinary item (65,624) (52,691) (3,377) (626) 56,681 (65,637)
Minority interest in (earnings) loss
of subsidiaries -- 11 -- 2 -- 13
--------- --------- --------- --------- --------- -----------
Income(loss) before extraordinary iterm (65,624) (52,680) (3,377) (624) 56,681 (65,624)
Extraordinary item-gain on extinguishment of
debt, net of $0 tax 7,724 -- -- -- -- 7,724
--------- --------- --------- --------- --------- -----------
Net income (loss) $ (57,900) $ (52,680) $ (3,377) $ (624) $ 56,681 $ (57,900)
========= ========= ========= ========= ========= ===========
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING STATEMENTS OF OPERATIONS
Nine months ended September 30, 1997
(Unaudited)
(In thousands)
Combined
Combined Non Wholly- Combined
Wholly-Owned Owned Non-
Parent Guarantor Guarantor Guarantor
Company Subsidiaries Subsidiaries Subsidiaries Eliminations Consolidated
---------- --------- ------------ ------------ --------- -----------
<S> <C> <C> <C> <C> <C> <C>
REVENUES:
Interest income $ 309 $ 27,420 $ -- $ 184 $ (2,047) $ 25,866
Servicing income -- 6,005 -- -- -- 6,005
Gain on sale of loans:
Cash gain on sale of loans -- 8,773 -- -- -- 8,773
Non-cash gain on sale of loans -- 23,509 499 -- -- 24,008
Loan fee income -- 20,860 1,177 30 -- 22,067
-------- -------- -------- -------- -------- --------
Total gain on sale of loans -- 53,142 1,676 -- -- 54,848
Other revenues 190 433 137 19 (18) 761
-------- -------- -------- -------- -------- --------
Total revenues 499 87,000 1,813 233 (2,065) 87,480
EXPENSES:
Interest 694 17,944 62 82 (2,047) 16,735
Provision for credit losses -- 7,087 -- -- -- 7,087
Salaries, wages and employee benefits 2,800 27,093 2,692 -- -- 32,585
Business development costs -- 4,738 202 -- -- 4,940
Other general and administrative expense (2,636) 18,338 2,432 51 (18) 18,167
-------- -------- -------- -------- -------- --------
Total expenses 858 75,200 5,388 133 (2,065) 79,514
-------- -------- -------- -------- -------- --------
Income(loss) before income taxes, minority
interest, and equity in undistributed earnings
of subsidiaries (359) 11,800 (3,575) 100 -- 7,966
Equity in undistributed earnings of
subsidiaries 9,530 -- -- -- (9,530) --
-------- -------- -------- -------- -------- --------
Income(loss) before income taxes and minority
interest 9,171 11,800 (3,575) 100 (9,530) 7,966
Provision(benefit) for income taxes (597) (1,378) -- -- -- (1,975)
-------- -------- -------- -------- --------
Income (loss) before minority interest 9,768 13,178 (3,575) 100 (9,530) 9,941
Minority interest in (earnings) loss of
subsidiaries 17 (173) -- -- -- (156)
-------- -------- -------- -------- -------- --------
Net income (loss) $ 9,785 $ 13,005 $ (3,575) $ 100 $ (9,530) $ 9,785
======== ======== ======== ======== ======== ========
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998
(Unaudited)
(In thousands)
Combined Combined Non
Wholly-Owned Wholly-Owned
Guarantor Guarantor
Parent Company Subsidiaries Subsidiaries
----------------- ------------------ -----------------
REVENUES:
<S> <C> <C> <C>
Interest income $ 1,815 $ 10,076 $ --
Servicing income -- 2,197 --
Gain on sale of loans:
Cash gain on sale of loans -- 2,865 60
Non-cash gain on sale of loans -- (396) --
Loan cost -- (2,267) --
Loan fee income -- 5,464 46
------------- -------------- ------------
Total gain on sale of loans -- 5,666 106
Other revenues (2,778) 1,224 24
------------- -------------- ------------
Total revenues (963) 19,163 130
------------- -------------- ------------
EXPENSES:
Interest 3,851 8,100 13
Provision for credit losses (6) 3,645 --
Fair value write-down of residual receivables -- 4,008 --
Salaries, wages and employee benefits 733 10,874 881
Business development costs -- 1,942 11
Other general and administrative expense (3,840) 7,958 696
------------- -------------- ------------
Total expenses 738 36,527 1,601
------------- -------------- ------------
Income (loss) before income taxes, minority interest,
equity in undistributed earnings of subsidiaries, and
extraordinary item (1,701) (17,364) (1,471)
Equity in undistributed earnings of subsidiaries (21,311) -- --
------------- -------------- ------------
Income (loss) before income taxes, minority interest, (23,012) (17,364) (1,471)
and extraordinary item
Provision (benefit) for income taxes (979) 1,839 5
------------- -------------- -----------
Income (loss) before minority interest and extraordinary (22,033) (19,203) (1,476)
item
Minority interest in (earnings) loss of subsidiaries -- 11 --
------------- -------------- -----------
Income (loss) before extraordinary item (22,033) (19,192) (1,476)
Extraordinary item-gain on extinguishment of debt,
net of $0 tax 7,724 -- --
------------- -------------- -----------
NET INCOME (LOSS) $ (14,309) $ (19,192) $ (1,476)
============== ============== ===========
<CAPTION>
Combined
Non-Guarantor
Subsidiaries Eliminations Consolidated
----------------- ----------------- ----------------
REVENUES:
<S> <C> <C> <C>
Interest income $ 447 $ (1,976) $ 10,362
Servicing income 400 -- 2,597
Gain on sale of loans:
Cash gain on sale of loans -- -- 2,925
Non-cash gain on sale of loans -- -- (396)
Loan cost -- -- (2,267)
Loan fee income 19 -- 5,529
------------- ------------ ------------
Total gain on sale of loans 19 -- 5,791
Other revenues -- 2,622 1,092
------------- ------------ ------------
Total revenues 866 646 19,842
------------- ------------ ------------
EXPENSES:
Interest 119 (2,133) 9,950
Provision for credit losses -- -- 3,639
Fair value write-down of residual receivables 1,312 -- 5,320
Salaries, wages and employee benefits -- -- 12,488
Business development costs -- -- 1,953
Other general and administrative expense 78 2,779 7,671
------------- ------------ ------------
Total expenses 1,509 646 41,021
------------- ------------ ------------
Income (loss) before income taxes, minority interest,
equity in undistributed earnings of subsidiaries, and (643) -- (21,179)
extraordinary item -- 21,311 --
Equity in undistributed earnings of subsidiaries ------------- ------------ ------------
(643) 21,311 (21,179)
Income (loss) before income taxes, minority interest,
and extraordinary item -- -- 865
------------- ------------ ------------
Provision (benefit) for income taxes (643) 21,311 (22,044)
-- -- 11
Income (loss) before minority interest and extraordinary ------------ ------------ ------------
item (643) 21,311 (22,033)
Minority interest in (earnings) loss of subsidiaries
-- -- 7,724
Income (loss) before extraordinary item ----------- ------------ ------------
Extraordinary item-gain on extinguishment of debt,
net of $0 tax
$ (643) $ 21,311 $ (14,309)
============ ============ =============
NET INCOME (LOSS)
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
HOMEGOLD FINANCIAL , INC.
CONSOLIDATING STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1997
(Unaudited)
(In thousands)
Combined Combined Non
Wholly-Owned Wholly-Owned
Parent Guarantor Guarantor
Company Subsidiaries Subsidiaries
-------------- --------------------- ------------------
REVENUES:
<S> <C> <C> <C>
Interest income $ 270 $ 12,223 $ --
Servicing income -- 2,920 --
Gain on sale of loans:
Cash gain on sale of loans -- 1,477 --
Non-cash gain on sale of loans -- 12,890 307
Loan fee income -- 8,374 448
-------------- -------------------- ----------------
Total gain on sale of loans -- 21,741 755
Other revenues 148 108 71
-------------- -------------------- ----------------
Total revenues 418 37,992 826
EXPENSES:
Interest 482 8,200 24
Provision for credit losses -- 2,415 --
Salaries, wages and employee benefits 1,245 11,522 1,058
Business development costs -- 1,933 28
Other general and administrative expense (837) 8,126 870
-------------- -------------------- ----------------
Total expenses 890 32,196 1,980
-------------- -------------------- ----------------
Income before income taxes, minority interest, and
equity in undistributed earnings of subsidiaries (472) 5,796 (1,154)
Equity in undistributed earnings of subsidiaries 4,542 -- --
-------------- -------------------- ----------------
Income before income taxes and minority interest 4,070 5,796 (1,154)
Provision (benefit) for income taxes (550) 200 --
-------------- -------------------- ----------------
Income before minority interest 4,620 5,596 (1,154)
Minority interest in (earnings) loss of subsidiaries -- -- --
-------------- -------------------- ----------------
NET INCOME (LOSS) $ 4,620 $ 5,596 $ (1,154)
============== ===================== ==================
<CAPTION>
</TABLE>
<PAGE>
<TABLE>
Combined
Non-Guarantor
Subsidiaries Eliminations Consolidated
------------------ ----------------- ------------------
REVENUES:
<S> <C> <C> <C>
Interest income $ 184 $ (1,835) $ 10,842
Servicing income -- -- 2,920
Gain on sale of loans:
Cash gain on sale of loans -- -- 1,477
Non-cash gain on sale of loans -- -- 13,197
Loan fee income 30 -- 8,852
------------------ ----------------- -------------------
Total gain on sale of loans 30 -- 23,526
Other revenues 19 (18) 328
------------------ ----------------- -------------------
Total revenues 233 (1,853) 37,616
EXPENSES:
Interest 82 (1,835) 6,953
Provision for credit losses -- -- 2,415
Salaries, wages and employee benefits -- -- 13,825
Business development costs -- -- 1,961
Other general and administrative expense 51 (18) 8,192
------------------ ----------------- -------------------
Total expenses 133 (1,853) 33,346
------------------ ----------------- -------------------
Income before income taxes, minority interest, and
equity in undistributed earnings of subsidiaries 100 -- 4,270
Equity in undistributed earnings of subsidiaries -- (4,542) --
------------------ ----------------- -------------------
Income before income taxes and minority interest 100 (4,542) 4,270
Provision (benefit) for income taxes -- -- (350)
------------------ ----------------- -------------------
Income before minority interest 100 (4,542) 4,620
Minority interest in (earnings) loss of subsidiaries -- -- --
------------------ ----------------- -------------------
NET INCOME (LOSS) $ 100 $ (4,542) $ 4,620
================== ================= ===================
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATING STATEMENT OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1998
(Unaudited)
(Dollars in thousands)
Combined Combined Non
Wholly-Owned Wholly-Owned
Guarantor Guarantor
Parent Company Subsidiaries Subsidiaries
--------------- ----------------- -----------------
OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net income (loss) $ (57,900) $ (52,678) $ (3,377)
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Equity in undistributed earnings of subsidiaries 57,442 507 --
Depreciation and amortization 387 2,181 192
Provision for deferred income taxes 1,968 (1,647) (321)
Provision for credit losses 20 10,559 --
Gain on retirement of senior unsecured debt (7,724) -- --
Fair value write-down of residual receivable -- 11,506 --
Mark to market adjustment on loans held for sale -- 5,300 --
Loans originated with intent to sell -- (633,166) (39,438)
Principal proceeds from sold loans -- 499,949 48,764
Proceeds from securitization of loans -- 92,316 --
Other -- 2,248 --
Changes in operating assets and liabilities
increasing (decreasing) cash 5,522 (8,343) (29)
--------------- ----------------- -----------------
Net cash provided by (used in) operating activities (285) (71,268) 5,791
--------------- ----------------- -----------------
INVESTING ACTIVITIES:
Loans originated for investment purposes (1,568) (118,180) --
Principal collections on loans not sold 63 148,179 --
Additional investment in subsidiary -- -- --
Proceeds from sale of real estate and personal property
acquired through foreclosure 418 3,907 --
Purchase of property and equipment (359) (8,601) (174)
Other (233) 411 1,310
--------------- ----------------- -----------------
Net cash provided by (used in) investing activities (1,679) 25,716 1,136
--------------- ----------------- -----------------
FINANCING ACTIVITIES:
Advances on notes payable to banks -- 325,427 --
Payments on notes payable to banks -- (262,021) --
Retirement of senior unsecured debt (9,026) -- --
Net increase in notes payable to investors -- 4,878 --
Net (decrease) increase in subordinated debentures -- (1,137) --
Advances (to) from subsidiary 10,740 (2,874) (7,190)
Proceeds from issuance of additional common stock 215 -- --
Other (5) (19) --
--------------- ----------------- -----------------
Net cash provided by (used in) financing activities 1,924 64,254 (7,190)
--------------- ----------------- -----------------
Net increase (decrease) in cash and cash equivalents (40) 18,702 (263)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 713 6,411 263
--------------- ----------------- -----------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 673 $ 25,113 $ --
============== ================= =================
<CAPTION>
<PAGE>
Combined
Non-Guarantor
Subsidiaries Eliminations Consolidated
--------------- ---------------- -----------------
OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net income (loss) $ (624) $ 56,679 $ (57,900)
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Equity in undistributed earnings of subsidiaries -- (57,949) --
Depreciation and amortization 11 -- 2,771
Provision for deferred income taxes -- -- --
Provision for credit losses -- -- 10,579
Gain on retirement of senior unsecured debt -- -- (7,724)
Fair value write-down of residual receivable 2,724 -- 14,230
Mark to market adjustment on loans held for sale -- -- 5,300
Loans originated with intent to sell -- -- (672,604)
Principal proceeds from sold loans -- -- 548,713
Proceeds from securitization of loans -- -- 92,316
Other 57 -- 2,305
Changes in operating assets and liabilities
increasing (decreasing) cash (4,596) -- (7,446)
--------------- ---------------- -----------------
Net cash provided by (used in) operating activities (2,428) (1,270) (69,460)
--------------- ---------------- -----------------
INVESTING ACTIVITIES:
Loans originated for investment purposes (4,000) -- (123,748)
Principal collections on loans not sold 1,250 -- 149,492
Additional investment in subsidiary -- -- --
Proceeds from sale of real estate and personal property
acquired through foreclosure -- -- 4,325
Purchase of property and equipment -- -- (9,134)
Other -- -- 1,488
--------------- ---------------- -----------------
Net cash provided by (used in) investing activities (2,750) -- 22,423
--------------- ---------------- -----------------
FINANCING ACTIVITIES:
Advances on notes payable to banks 7,803 -- 333,230
Payments on notes payable to banks (825) -- (262,846)
Retirement of senior unsecured debt -- -- (9,026)
Net increase in notes payable to investors -- -- 4,878
Net (decrease) increase in subordinated debentures -- -- (1,137)
Advances (to) from subsidiary (676) -- --
Proceeds from issuance of additional common stock -- -- 215
Other (1,251) 1,270 (5)
--------------- ---------------- -----------------
Net cash provided by (used in) financing activities 5,051 1,270 65,309
--------------- ---------------- -----------------
Net increase (decrease) in cash and cash equivalents (127) -- 18,272
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 174 -- 7,561
--------------- ---------------- -----------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 47 $ -- $ 25,833
=============== ================ ================-
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATING STATEMENT OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1997
(Unaudited)
(Dollars in thousands)
Combined Combined Non
Wholly-Owned Wholly-Owned
Parent Guarantor Guarantor
Company Subsidiaries Subsidiaries
-------------- ---------------- ---------------
OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net income (loss) $ 9,785 $ 13,005 $ (3,574)
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Equity in undistributed earnings of subsidiaries (9,534) -- --
Depreciation and amortization 198 1,415 309
Provision for deferred income taxes (657) (2,313) (1)
Provision for credit losses -- 7,087 --
Loans originated with intent to sell -- (781,825) (26,340)
Principal proceeds from sold loans -- 367,118 26,340
Proceeds from securitization of loans -- 332,156 --
Other -- 2,584 --
Changes in operating assets and liabilities
increasing (decreasing) cash 1,251 (38,566) 197
-------------- ---------------- ---------------
Net cash provided by (used in) operating activities 1,043 (99,339) (3,069)
-------------- ---------------- ---------------
INVESTING ACTIVITIES:
Loans originated for investment purposes -- (100,939) --
Principal collections on loans not sold -- 91,121 --
Additional investment in subsidiary (38,031) -- --
Proceeds from sale of real estate and personal property
acquired through foreclosure -- 4,850 --
Purchase of property and equipment (1,134) (3,613) (1,188)
Other 163 (489) --
-------------- ---------------- ---------------
Net cash provided by (used in) investing activities (39,002) (9,070) (1,188)
-------------- ---------------- ---------------
FINANCING ACTIVITIES:
Advances on notes payable to banks -- 817,222 --
Payments on notes payable to banks -- (841,363) --
Net increase in notes payable to investors -- 12,907 --
Net increase in subordinated debentures -- 3,146 --
Proceeds from issuance of senior unsecured debt 120,630 -- --
Advances (to) from subsidiary (83,987) 82,654 (4)
Proceeds from issuance of additional common stock 1,148 33,831 4,200
-------------- ---------------- ---------------
Net cash provided by (used in) financing activities 37,791 108,397 4,196
-------------- ---------------- ---------------
Net increase (decrease) in cash and cash equivalents (168) (12) (61)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 192 958 126
-------------- ---------------- ---------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 24 $ 946 $ 65
============== =============== ===============
<PAGE>
<CAPTION>
Combined
Non-Guarantor
Subsidiaries Eliminations Consolidated
----------------- ----------------- ----------------
OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net income (loss) $ 100 $ (9,531) $ 9,785
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Equity in undistributed earnings of subsidiaries -- 9,534 --
Depreciation and amortization 3 (3) 1,922
Provision for deferred income taxes -- -- (2,971)
Provision for credit losses -- -- 7,087
Loans originated with intent to sell -- -- (808,165)
Principal proceeds from sold loans -- -- 393,458
Proceeds from securitization of loans -- -- 332,156
Other 64 -- 2,648
Changes in operating assets and liabilities
increasing (decreasing) cash (47) -- (37,165)
----------------- ----------------- ----------------
Net cash provided by (used in) operating activities 120 -- (101,245)
----------------- ----------------- ----------------
INVESTING ACTIVITIES:
Loans originated for investment purposes (1,250) -- (102,189)
Principal collections on loans not sold -- -- 91,121
Additional investment in subsidiary -- 38,031 --
Proceeds from sale of real estate and personal property
acquired through foreclosure -- -- 4,850
Purchase of property and equipment -- -- (5,935)
Other -- -- (326)
----------------- ----------------- ----------------
Net cash provided by (used in) investing activities (1,250) 38,031 (12,479)
----------------- ----------------- ----------------
FINANCING ACTIVITIES:
Advances on notes payable to banks -- -- 817,222
Payments on notes payable to banks -- -- (841,363)
Net increase in notes payable to investors -- -- 12,907
Net increase in subordinated debentures -- -- 3,146
Proceeds from issuance of senior unsecured debt -- -- 120,630
Advances (to) from subsidiary 1,337 -- --
Proceeds from issuance of additional common stock -- (38,031) 1,148
----------------- ----------------- ----------------
Net cash provided by (used in) financing activities 1,337 (38,031) 113,690
----------------- ----------------- ----------------
Net increase (decrease) in cash and cash equivalents 207 -- (34)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR -- -- 1,276
----------------- ----------------- ----------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 207 $ -- $ 1,242
================= ================= =================
</TABLE>
24
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The discussion should be read in conjunction with the HomeGold
Financial, Inc. and Subsidiaries (the "Company") Consolidated Financial
Statements and Notes appearing elsewhere in this report.
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,
lower premiums on loan sales, 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 residential mortgage loans (through its "Mortgage Loan
Division") and small business loans (through its "Small Business Loan Division")
to sub-prime customers. Prior to March 1998, the Company also originated,
securitized and serviced auto loans (through its "Auto Loan Division").
Substantially all of the assets of the Auto Loan Division were sold in the first
quarter of 1998.
The Company commenced its lending operations in 1991 through the
acquisition of Carolina Investors, Inc. ("CII"), a small mortgage lending
company, which has been in operation since 1963. Since 1996, the Company has
been focused principally on expanding its Mortgage Loan Division and Small
Business Loan Division.
In the fourth quarter of 1997, the Company began restructuring its
Mortgage Loan Division. Because of this restructuring and other factors,
mortgage loan origination volume decreased an aggregate of approximately 22.9%
in the first three quarters of 1998 as compared to the fourth quarter of 1997.
Loan origination volume in October continued to decline compared to the third
quarter. The Company anticipates that loan volume will probably continue to
decline for the remainder of the fourth quarter and will only resume modest
growth in the first quarter of 1999. However, no assurance can be given that the
anticipated volume level will be obtained. The Company's general and
administrative overhead structure in the first nine months of 1998 was high in
relationship to production.
Having assessed market conditions, management has made strategic
decisions to streamline retail mortgage lending operations. Management plans to
discontinue retail lending operations in retail centers outside of Greenville,
South Carolina. Retail lending operations located in Indianapolis, Indiana,
Phoenix, Arizona, and Houston, Texas will be consolidated in November 1998 into
the Greenville retail operating center located at the company headquarters in
Greenville, South Carolina.
In addition, management has chosen not to solicit additional
candidates for partners under the Company's Strategic Alliance production
channel. The Strategic Alliance agreements generally require that the Strategic
Alliance Mortgage Bankers must first offer to the Company the right to purchase
all of their loans which meet the Company's underwriting criteria up to certain
limitations and conditions, obligating the Company to purchase such loans. The
Strategic Alliance operations will be combined with Wholesale lending operations
on an ongoing operational basis as existing partner agreements are fulfilled.
The Wholesale lending operations purchase loans from independent mortgage
bankers.
The impact of the above restructuring (primarily the branch
closings) resulted in the elimination of 225 positions or approximately 33% of
the Mortgage Loan Division work force. The Company anticipates incurring certain
restructuring charges in the fourth quarter as a result of this decision.
Management feels these charges will be beneficial by creating efficiencies
through consolidation of operations and implementation of future strategic
directives, and better aligning expenses with current levels of production.
25
<PAGE>
Existing economic conditions have also impacted programs and
products currently being offered and supported by the Company. The Company has
suspended the yield spread programs which were implemented in the third quarter
1998 through the Wholesale/Broker production channel as management feels the
profitability of such programs has diminished given current financial market
conditions. The Company is also proactively reviewing and evaluating the
economic viability of additional products to support the diverse sub-prime
customer.
In order to concentrate on the larger retail mortgage operation
("HomeGold"), the Company has also sold its smaller retail mortgage origination
subsidiary, Sterling Lending Corporation ("SLC"). This subsidiary was started in
June 1996 and has originated only a small percentage of total retail loans. In
August 1998, the Company sold the stock of Sterling Lending Corporation for $1.5
million, with $400,000 paid in cash at closing and $1.1 million paid in the form
of a promissory note.
The Company also sold substantially all of the assets of its Auto
Loan Division for book value on March 19, 1998. This sale provided the Company
with cash proceeds of approximately $20.4 million. No significant gain or loss
was recognized on this transaction. The Company no longer originates auto loans.
Prior to the sale of the Auto Loan Division, it recorded a net loss of
approximately $110,000 for the period ended March 19, 1998.
On October 2, 1998, the Company entered into a definitive agreement
to sell the majority of the assets of its small business lending units,
including the 7(a) SBA lending unit, its 504 SBA lending unit, and its SBIC
mezzanine lending unit, to Transamerica Business Credit Corporation. On November
13, 1998, the Company completed the sale. Total "initial" sales proceeds from
this sale were $96 million based on the September 30 balance sheet. After
repayment of the related warehouse lines of credit, escrowing $5 million
holdback in the purchase price, and paying transaction costs, the Company
received "initial" net cash proceeds of approximately $45 million. The Company
may also receive additional proceeds within 30 days to adjust the "initial"
purchase price, which was based on the September 30, 1998 balance sheet, to the
"final" purchase price, which is based on the balance sheet as of the closing
date, November 13, 1998. These additional proceeds may be approximately $7
million. The gain to be realized in the fourth quarter of 1998 is expected to be
approximately $18 million net of related costs. For the three months ended
September 30, 1998 and 1997, these small business division subsidiaries recorded
a net loss of $2.0 million and $100,000, respectively. For the nine months ended
September 30, 1998 and 1997, these small business division subsidiaries recorded
a net loss of $2.8 million and $1.4 million net gain, respectively.
On November 5, 1998, the Company entered into a definitive agreement
to sell the majority of its asset-based lending unit to Emergent Asset Based
Lending LLC, a Maryland Limited Liability Company. This transaction will
complete the disposition of all non-mortgage related activities of the Company.
A loss of approximately two to three million dollars is anticipated on the
disposition of the asset-based lending unit. For the three months ended
September 30, 1998 and 1997, the asset-based lending subsidiary recorded net
losses of $100,000 and $500,000, respectively. For both the nine months ended
September 30, 1998 and 1997, the asset-based lending subsidiary recorded net
losses of $1.0 million.
MARKET CONDITIONS
As a result of higher than anticipated prepayments on securitized
loan pools and concerns about the credit worthiness of several issuers,
corporate spreads within the industry have widened significantly in the last
half of the third quarter. These conditions have negatively impacted the
securitization and whole loan sale markets. As spreads have widened,
securitization, as a means of financing, has become less attractive. As a
result, more issuers are turning to the whole loan sale market. As this whole
loan product flows into the market, whole loan sale premiums have eroded, which
has, in turn, adversely impacted issuer's profitability.
26
<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 NINE AT AND FOR THE YEARS ENDED
MONTHS ENDED SEPTEMBER 30, DECEMBER 31,
------------------------------------------ ---------------------
1998 1997 1997
-------------------- ----------------- --------------------
<S> <C> <C> <C>
(DOLLARS IN THOUSANDS)
MORTGAGE LOANS:
Mortgage loans originated:
Retail $ 339,106 $ 403,393 $ 562,709
Broker wholesale 259,333 371,064 520,107
-------------------- ----------------- --------------------
Total mortgage loans originated 598,439 774,457 1,082,816
Mortgage loans sold 485,687 326,043 435,333
Mortgage loans securitized 90,489 329,861 487,563
Total mortgage loans owned (4) 202,201 204,225 231,145
Total serviced mortgage loans (4) 673,672 625,796 768,556
Total serviced unguaranteed mortgage
loans (1)(4) 673,672 527,256 700,248
Average mortgage loans owned (2) 268,818 234,722 215,790
Average serviced mortgage loans (2) 785,824 348,532 443,318
Average serviced unguaranteed
mortgage loans (1)(2) 784,675 336,600 411,549
Average interest earned (2) 10.74 % 10.74 % 10.92 %
SMALL BUSINESS LOANS:
Small business loans originated $ 101,082 $ 55,949 $ 81,018
Small business loans sold 42,935 27,383 41,232
Small business loans securitized 1,827 4,626 24,286
Total small business loans owned (4) 86,975 54,912 45,186
Total serviced small business loans (4) 255,221 187,500 198,876
Total serviced unguaranteed small business
loans (3)(4) 108,636 73,624 78,822
Average small business loans owned (2) 63,578 34,065 38,427
Average serviced small business loans (2) 227,431 157,867 165,053
Average serviced unguaranteed small
business loans (2) (3) 93,729 58,820 61,420
Average interest earned (2) 14.15 % 15.44 % 15.89 %
AUTO LOANS:
Auto loans originated $ 2,983 $ 12,260 $ 15,703
Auto loans sold 20,578 -- --
Auto loans securitized -- -- --
Total auto loans owned (4) 361 18,389 21,284
Total serviced auto loans (4) 361 22,078 21,284
Average auto loans owned (2) 6,927 16,576 17,104
Average serviced auto loans (2) 6,927 22,426 22,267
Average interest earned (2) 21.22 % 24.05 % 24.05 %
TOTAL LOANS:
Total loans receivable (4) $ 289,537 $ 277,526 $ 297,615
Total serviced loans (4) 929,254 835,374 988,716
Total serviced unguaranteed loans (1)(3)(4) 782,669 622,958 800,354
<CAPTION>
<PAGE>
AT AND FOR THE YEARS ENDED
DECEMBER 31,
---------------------------------------------
1996 1995
----------------- ------------------
MORTGAGE LOANS:
Mortgage loans originated:
Retail $ 68,842 $ --
Broker wholesale 259,807 192,800
----------------- ------------------
Total mortgage loans originated 328,649 192,800
Mortgage loans sold 284,794 127,632
Mortgage loans securitized -- --
Total mortgage loans owned (4) 146,231 88,165
Total serviced mortgage loans (4) 146,231 88,165
Total serviced unguaranteed mortgage
loans (1)(4) 146,231 88,165
Average mortgage loans owned (2) 97,281 74,158
Average serviced mortgage loans (2) 97,281 74,158
Average serviced unguaranteed
mortgage loans (1)(2) 97,281 74,158
Average interest earned (2) 11.97 % 12.10 %
SMALL BUSINESS LOANS:
Small business loans originated $ 68,210 $ 39,560
Small business loans sold 33,060 25,423
Small business loans securitized 12,851 17,063
Total small business loans owned (4) 29,385 20,620
Total serviced small business loans (4) 140,809 108,696
Total serviced unguaranteed small business
loans (3)(4) 44,017 24,867
Average small business loans owned (2) 26,700 23,692
Average serviced small business loans (2) 125,723 98,753
Average serviced unguaranteed small
business loans (2) (3) 34,442 21,819
Average interest earned (2) 12.61 % 10.39 %
AUTO LOANS:
Auto loans originated $ 18,287 $ 17,148
Auto loans sold -- --
Auto loans securitized 16,107 --
Total auto loans owned (4) 13,916 17,673
Total serviced auto loans (4) 22,033 17,673
Average auto loans owned (2) 11,917 13,078
Average serviced auto loans (2) 21,277 13,078
Average interest earned (2) 23.57 % 27.40 %
TOTAL LOANS:
Total loans receivable (4) $ 189,532 $ 126,458
Total serviced loans (4) 309,073 214,534
Total serviced unguaranteed loans (1)(3)(4) 212,281 130,705
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Excludes loans serviced for others with no credit risk to the
Company.
(2) Averages are daily averages for all periods, except 1995 averages,
which are computed using beginning and ending balances.
(3) Excludes guaranteed portion of SBA Loans.
(4) Period end.
27
<PAGE>
OPERATING CASH FLOW
As a result of selling its loans for cash in the whole loan market
and as a result of selling more loans in the third quarter of 1998 than were
originated in the same three months, the Company experienced a positive cash
flow from operating activities in the third quarter of 1998. Although the
Company's goal is to achieve a positive cash flow each quarter, no assurance can
be given that this objective will be obtained due to the higher level of cash
required to fund the loans purchased and originated. Currently, the Company's
primary operating cash uses include the funding of (i) loan originations and
purchases pending their securitization or sale, (ii) interest expense on CII
investor savings notes ("CII Notes"), senior unsecured debt and its revolving
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, (iii)
interest 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 residual receivables.
The Company overcollateralizes loans as a credit enhancement on the
mortgage securitization transactions. This requirement creates negative cash
flows in the year of securitization. The Company has determined to conduct its
whole loan sales so as to improve liquidity. Accordingly, the Company did not
securitize any mortgage loans in the second or third quarters of 1998 and has
also determined to continue selling all loans on a whole-loan cash basis for the
remainder of 1998, rather than securitizing such loans. 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. However, in the third quarter
1998, the Company implemented a correspondent-based loan origination strategy as
a way to increase its wholesale production.
<PAGE>
The table below summarizes cash flows provided by and used in
operating activities by quarter in 1998 and for the fourth quarter 1997, and the
year ended December 31, 1997:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, 1998 3RD QTR 2ND QTR
1998 1998
-------------------------- -------------------- -----------------
(IN THOUSANDS)
<S> <C> <C> <C>
OPERATING CASH INCOME:
Servicing fees received and
excess cash flow from
securitization trusts $ 10,297 $ 5,426 $ 2,143
Interest received 29,603 9,369 10,867
Cash gain on sale of loans 13,035 5,056 4,530
Cash loan origination fees
received 17,185 7,343 5,959
Securitization hedge gains 38 -- --
Other cash income 3,832 1,267 1,016
----------------- --------------------- ---------------------
Total operating cash income 73,990 28,461 24,515
OPERATING CASH EXPENSES:
Securitization costs (851) -- --
Securitization hedge losses -- -- --
Cash operating expenses (79,725) (26,090) (24,882)
Interest paid (31,328) (12,559) (7,230)
Taxes paid (2,287) (820) (1,280)
----------------- --------------------- ---------------------
Total operating cash expenses (114,191) (39,469) (33,392)
CASH DEFICIT DUE TO OPERATING
CASH INCOME AND EXPENSES (40,201) (11,008) (8,877)
CASH REVENUES TO CASH EXPENSES
RATIO 65% 72% 73%
OTHER CASH FLOWS:
Cash provided by (used in) other
payables and receivables 2,466 1,827 (9,817)
Cash used provided by (used in)
loans held for sale (31,725) 19,333 14,982
----------------- --------------------- ---------------------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES $ (69,460) $ 10,152 $ (3,712)
================ ===================== =====================
<PAGE>
<CAPTION>
1ST QTR YEAR ENDED 4TH QTR
1998 1997 1997
----------------- ----------------- --------------------
<S> <C> <C> <C>
OPERATING CASH INCOME:
Servicing fees received and
excess cash flow from
securitization trusts $ 2,728 $ 3,687 $ 651
Interest received 9,367 31,716 8,042
Cash gain on sale of loans 3,449 14,153 2,306
Cash loan origination fees
received 3,883 31,843 7,277
Securitization hedge gains 38 -- --
Other cash income 1,549 1,875 1,046
-------------- -------------- ------------------
Total operating cash income 21,014 83,274 19,322
OPERATING CASH EXPENSES:
Securitization costs (851) (3,646) (1,236)
Securitization hedge losses -- (2,125) (129)
Cash operating expenses (28,753) (81,594) (27,086)
Interest paid (11,539) (20,980) (5,186)
Taxes paid (187) (1,581) (469)
-------------- -------------- ------------------
Total operating cash expenses (41,330) (109,926) (34,106)
CASH DEFICIT DUE TO OPERATING
CASH INCOME AND EXPENSES (20,316) (26,652) (14,784)
CASH REVENUES TO CASH EXPENSES
RATIO 51% 76% 57%
OTHER CASH FLOWS:
Cash provided by (used in) other
payables and receivables 10,456 (5,355) 335
Cash used provided by (used in)
loans held for sale (66,040) (114,282) (30,595)
-------------- -------------- ------------------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES $ (75,900) $ (146,289) $ (45,044)
============== =============== ==================
</TABLE>
Certain previously reported amounts have been reclassified to conform to current
year presentation.
28
<PAGE>
REVENUES
The principal components of the Company's revenues 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;
and (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 NINE MONTHS FOR THE THREE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------------------- ---------------------------
1998 1997 1998 1997
-------------- -------------------- ------------- ----------
<S> <C> <C> <C> <C>
Interest income 42.7 % 29.6 % 52.2 % 28.8 %
Servicing fee income 14.7 6.8 13.1 7.8
Cash gain on sale of loans 18.8 10.0 14.7 3.9
Non-cash gain on sale of loans 4.0 27.5 (2.0) 35.1
Loan costs (7.5) -- (11.4) --
Loan fee income 22.1 25.6 27.9 23.5
Other revenues 5.2 0.5 5.5 0.9
--------- --------- ------- --------
Total revenues 100.0 % 100.0 % 100.0 % 100.0 %
======== ========= ======= ========
Interest expense 41.0 % 19.1 % 50.1 % 18.5 %
Provision for credit losses 15.3 8.1 18.3 6.4
Fair value write-down of residual receivables 20.6 -- 26.8 --
Salaries, wages and employee benefits 67.8 37.3 62.9 36.8
Business development costs 12.3 5.6 9.9 5.2
Other general and administrative expenses 32.0 20.8 38.7 21.8
Income (loss) before income taxes, minority
interest and extraordinary item (89.0) 9.1 (106.7) 11.3
Provision (benefit) for income taxes 5.9 (2.3) 4.4 (1.0)
Minority interest in earnings (loss) of subsidiaries 0.1 (0.2) 0.1 --
Extraordinary item-gain on extinguishment of debt 11.1 -- 38.9 --
--------- --------- ------- --------
Net income (loss) (83.7) % 11.2 % (72.1) % 12.3 %
========= ========== ======== ========
</TABLE>
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1998, COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1997
The Company recognized a net loss of $57.9 million for the nine
months ended September 30, 1998 as compared to net income of $9.8 million for
the nine months ended September 30, 1997. This net loss was mainly due to the
Company's loan production volume being below capacity levels in relation to the
general and administrative expense structure and several unusual items in the
first three quarters of 1998, which negatively impacted net income. These
unusual items included, a $14.2 million write-down in the value of its residual
receivables due to faster than anticipated prepayment speeds on its
securitization pools, and a $5.0 million loss on sale of lower quality second
mortgage loans originated in 1997 and reserved in the first quarter of 1998. In
addition, in the third quarter of 1998 a $5.3 million loss from a write-down on
mortgage loans included in the held for sale portfolio was taken as a result of
adjusting the portfolio carrying value to the estimated market value at
September 30, 1998 based on current market conditions.
Total revenues decreased $18.3 million, or 21%, to $69.2 million for
the nine months ended September 30, 1998 from $87.5 million for the nine months
ended September 30, 1997. The lower level of revenues resulted principally from
lower than anticipated mortgage loan originations and decreases in non-cash gain
on sale of loans as the Company did not complete a mortgage securitization in
the second or third quarters of 1998. No mortgage loan securitizations are
currently planned for the remainder of 1998, as the Company plans to sell its
loans on a whole-loan, servicing-released basis for cash premiums. The decrease
in non-cash gain on sale was partly offset by higher interest income and
servicing income.
Interest income increased $4.1 million, or 16%, to $30.0 million for
the nine months ended September 30, 1998 from $25.9 million for the nine months
ended September 30, 1997. Interest income earned by the Mortgage Loan Division
(including intercompany interest income) increased $1.6 million, or 7.73%, to
$22.3 million for the nine months ended September 30, 1998 from $20.7 million
for the nine months ended September 30, 1997. This increase was due principally
to the growth in the average outstanding customer loan portfolio in the Mortgage
Loan Division, which increased $34.1 million, or 14.52%, to $268.8 million for
the nine months ended September 30, 1998 from $234.7 million for the nine months
ended September 30, 1997. The Mortgage Loan Division increases
29
<PAGE>
were primarily related to the first six months of 1998. In the third quarter of
1998, the Company began reducing the amount of loans held for sale. The Company
plans to continue to reduce the amount of loans held for sale during the
remainder of 1998 through whole-loan sales. The average interest rate earned by
the Mortgage Loan Division adjusted for intercompany income for the nine months
ended September 30, 1998 and 1997 was virtually unchanged at 10.7%. Interest
income earned by the Small Business Loan Division increased $2.8 million, or
71.8%, to $6.7 million for the nine months ended September 30, 1998 from $3.9
million for the nine months ended September 30, 1997. This increase was due
principally to the growth in the average outstanding loan portfolio in the Small
Business Loan Division, which increased $29.5 million, or 86.5%, to $63.6
million for the nine months ended September 30, 1998 from $34.1 million for the
nine months ended September 30, 1997, reflecting the increased loan origination
levels generated by that Division, and the fact that the Company retains the
asset-based loans and mezzanine loans for investment purposes, rather than
selling or securitizing these loans. Average interest earned by the Small
Business Loan Division for the nine months ended September 30, 1998 was 14.15%
as compared to 15.4% for the nine months ended September 30, 1997.
Servicing income increased $4.2 million, or 70.0%, to $10.2 million
for the nine months ended September 30, 1998 from $6.0 million for the nine
months ended September 30, 1997. This increase was due principally to the
securitization of mortgage loans throughout 1997 and in the first quarter of
1998, for which the Company retained servicing rights. Prior to 1997, the
Mortgage Loan Division did not securitize its loans, therefore the serviced
portfolio was just beginning to grow during 1997. The average serviced loan
portfolio for the Mortgage Loan Division increased $449.2 million, or 133.5%, to
$785.8 million for the nine months ended September 30, 1998 from $336.6 million
for the nine months ended September 30, 1997.
Cash gain on sale of loans increased $4.2 million, or 47.7%, to
$13.0 million for the nine months ended September 30, 1998 from $8.8 million for
the nine months ended September 30, 1997. The increase resulted principally from
increased sales of mortgage loans in the first three quarters of 1998 due to the
fact that the Company chose not to do a mortgage securitization in the second
and third quarters of 1998. Mortgage Loans sold increased $159.7 million, or
49.0%, to $485.7 million for the nine months ended September 30, 1998 from
$326.0 million for the nine months ended September 30, 1997. The weighted
average gain on sale of Mortgage Loans was 2.7% for both the nine-month periods
ended September 30, 1998 and 1997.
Non-cash gain on sale of loans decreased $21.2 million, or 88.3%, to
$2.8 million for the nine months ended September 30, 1998 from $24.0 million for
the nine months ended September 30, 1997. The decrease in non-cash gain on sale
of loans was due principally to the Company's decision not to do a mortgage
securitization in the second and third quarters of 1998, in addition to a $5.3
million write-down in 1998 related to the lower of cost or market accounting for
mortgage loans held for sale. The Mortgage Loan Division securitized $92.2
million in loans for the nine months ended September 30, 1998 and recognized a
weighted average non-cash gain on sale as a percentage of loans securitized of
8.8%, net of expenses. Included in non-cash gain on sale is a loss of $5.3
million relating to a write-down on mortgage loans. The Mortgage Loan Division
securitized $329.9 million in loans for the nine months ended September 30, 1997
and recognized a weighted average non-cash gain on sale as a percentage of loans
securitized of 7.3%, net of expenses. The non-cash gain as a percentage of loans
securitized was higher for the nine months ended September 30, 1998 as the
result of reduced overcollateralization requirements on the 1998 first quarter
securitization transaction compared to the Company's initial mortgage loan
securitization completed in the first quarter of 1997.
Beginning in the fourth quarter of 1997, when the Company began to
increase the loan portfolio and not to sell a substantial portion of all loans
that were originated, the Company became subject to Statement of Financial
Standards 91 that does not apply to mortgage bankers. This accounting standard
requires that the cost to originate loans be capitalized and not shown as a
period cost, but be amortized over the life of the loans. Any unamortized costs
are recognized at the time the loan is sold. During the nine months ended
September 30, 1998, the Company capitalized $5.3 million of general and
administrative expenses and recognized $5.2 million of cost as part of the gain
on sale transaction at the time the loans were sold.
Loan fees decreased $6.8 million, or 30.8%, to $15.3 million for the
nine months ended September 30, 1998 from $22.1 million for the nine months
ended September 30, 1997. Loan fees received as a percentage of retail
production for the nine months ended September 30, 1998 were 4.65% as compared
to 4.96% for the nine months ended September 30, 1997. 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 $2.7 million to $3.5 million for the nine
months ended September 30, 1998 from $761,000 for the nine months ended
September 30, 1997. Other revenues are comprised principally of insurance
commissions, underwriting fees and management fees. The increase of other
revenues resulted principally from the
30
<PAGE>
increased value of securities owned relating to the commercial mezzanine lending
operation in the amount of approximately $500,000 and higher underwriting fees
received in 1998 on brokered loans.
Total expenses increased $51.2 million, or 64.4%, to $130.7 million
for the nine months ended September 30, 1998 from $79.5 million for the nine
months ended September 30, 1997. Total expenses are comprised of interest
expense, provision for credit losses, fair value write-down of residual
receivables, salaries, wages and employee benefits, business development costs,
and other general and administrative expenses. The increased expenses are due
largely to the Company's increased Mortgage Loan retail origination operations
during 1997 with the opening of the Greenville office in the first quarter and
the opening of the Houston office in the fourth quarter. However, management has
reduced general and administrative expenses during 1998 from an average of $9.9
million per month in the first quarter of 1998, to $8.6 million per month in the
second quarter of 1998, to $7.4 in the third quarter of 1998. Management expects
fourth quarter general and administrative expenses before anticipated
restructuring charges and expenses on sold business units to be lower than the
third quarter, mainly as a result of the sale of selected business units.
Expenses should be further reduced in the first quarter 1999 after the personnel
reductions and restructuring initiated in November becomes fully implemented.
Interest expense increased $11.6 million, or 69.5%, to $28.3 million
for the nine months ended September 30, 1998 from $16.7 million for the nine
months ended September 30, 1997. The increase in interest expense was due
principally to additional borrowings by the Mortgage Loan Division associated
with an increase in the Company's average loan portfolio, the offering of the
Company's Senior Notes and the higher borrowing levels that were required to
fund the Company's operating loss in 1998. In September 1997, the Company
completed the $125.0 million offering of the Company's Senior Notes with
interest payable at 10.75%. For the nine months ended September 30, 1998, the
Company incurred interest expense of approximately $10.5 million related to the
Senior Notes. Interest expense in the Mortgage Loan Division increased to $19.8
million for the nine months ended September 30, 1998 from $14.7 million for the
nine months ended September 30, 1997. 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, decreased to $262.4 million for the nine months ended September 30,
1998 from $272.1 million for the nine months ended September 30, 1997. The
decrease in borrowing by the Mortgage Division resulted from increased
intercompany borrowing associated with the offering of the Company's Senior
Notes.
Provision for credit losses increased $3.5 million, or 49.3%, to
$10.6 million for the nine months ended September 30, 1998 from $7.1 million for
the nine months ended September 30, 1997. 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, including delinquent loans purchased out of the mortgage
securitizations, which totaled $6.1 million for the nine months ended September
30, 1998.
As the result of higher than anticipated prepayments, the Company,
in the second quarter of 1998, modified the estimated prepayment speeds on all
of its mortgage loan securitization transactions to peak at 25 constant
prepayment rate ("CPR") up from the previous prepayment speeds of 20 CPR and
modified the estimated prepayment speeds on its 1995-1 small business loan
securitization transaction to peak at 25 CPR, up from the previous prepayment
speeds of 15 CPR. This resulted in a write-down of residual receivables of $8.9
million in the second quarter 1998. No such write-down was necessary in the
first nine months of 1997. Due to actual loan prepayments remaining at higher
levels than anticipated in the third quarter 1998, the Company modified the
estimated prepayment speeds on all of its mortgage loan securitization
transactions to peak at 30 CPR, up from the previous prepayment speeds of 25 CPR
estimated at the end of the second quarter. This, along with higher prepayments
in the small business loan securitizations, resulted in the recognition of a
write-down of residual receivables of $5.3 million in the third quarter 1998.
General and administrative expense increased $21.9 million, or
39.3%, to $77.6 million for the nine months ended September 30, 1998 from $55.7
million for the nine months ended September 30, 1997. This is a result primarily
from the increased personnel costs in the Mortgage Loan Division due to the
expansion in 1997 and early 1998 of the portfolio management, underwriting,
processing, and closing departments, and the increased expenses associated with
the opening of retail regional operating centers in Greenville (first quarter of
1997) and Houston (fourth quarter of 1997). Salaries, wages and employee
benefits increased $4.7 million, or 14.42%, to $37.3 million for the nine months
ended September 30, 1998 from $32.6 million for the nine months ended September
30, 1997. The higher general and administrative expenses were also the result of
expenditures associated with an anticipated higher level of production volume
planned for in 1998, which has not occurred. The Company's volume continues to
lag behind expectations.
The Company has recorded current income tax expense of $4.1 million
for the nine months ended September 30, 1998, even though overall the Company
generated a pre-tax loss for the nine months ended
31
<PAGE>
September 30, 1998. The Company has not recorded a deferred tax benefit related
to the current loss due to management's assessment of the recoverability of the
related deferred tax asset. The current tax is due on income called "excess
inclusion income." Excess inclusion income is a result of the Company
securitizing loans in pools to third party investors. These transactions
generate income for the Company that is included in the overall loss. However,
according to IRS regulations, a portion of that income is subject to federal tax
in the current period regardless of other current period losses or NOL
carryovers otherwise available to offset regular taxable income. The excess
inclusion income approximates the net interest the Company receives on the loans
in the pools after the bondholders are paid their share of the interest less the
sum of the daily accruals, an amount allowed for tax purposes as a reasonable
economic return on the retained ownership interest.
THREE MONTHS ENDED SEPTEMBER 30, 1998, COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997
The Company recognized a net loss of $14.3 million for the three
months ended September 30, 1998 as compared to net income of $4.6 million for
the three months ended September 30, 1997. This net loss was mainly due to the
Company's loan production volume being below capacity levels in relation to
general and administrative expense structure, and several non-recurring or
unusual items in the third quarter of 1998, that negatively impacted net income.
These non-recurring or unusual items included, among other things, a $5.3
million write-down in the value of its residual receivables due to faster than
anticipated prepayment speeds on its securitization pools and a $4.0 million
loss resulting from the mark-to-market adjustment on the Company's loans due to
anticipated price compression in the whole loan sale market as a result of the
turmoil being experienced by the industry.
Total revenues decreased $17.8 million, or 47.3%, to $19.8 million
for the three months ended September 30, 1998 from $37.6 million for the three
months ended September 30, 1997. The lower level of revenues resulted
principally from lower than anticipated mortgage loan originations and lower
non-cash gain on sale of loans as a result of no loan securitization transaction
being completed in the third quarter of 1998. No mortgage loan securitizations
are currently planned for the remainder of 1998, as the Company plans to sell
its loans on a whole-loan servicing-released basis for cash premiums.
Interest income decreased $480,000, or 4.44%, to $10.3 million for
the three months ended September 30, 1998 from $10.8 million for the three
months ended September 30, 1997. Interest income earned by the Mortgage Loan
Division decreased $600,000, or 7.14%, to $7.8 million for the three months
ended September 30, 1998 from $8.4 million for the three months ended September
30, 1997. This decline was due principally to the reduction in the average
outstanding loan portfolio in the Mortgage Loan Division, which decreased $3.1
million, or 1.52%, to $201.1 million for the three months ended September 30,
1998 from $204.2 million for the three months ended September 30, 1997. The
Company plans to reduce the amount of loans held for sale during the remainder
of 1998 through whole-loan sales. The average interest rate earned by the
Mortgage Loan Division for the three months ended September 30, 1998 was 11.2%
as compared to 13.5% for the three months ended September 30, 1997. Interest
income earned by the Small Business Loan Division increased $1.0 million, or
55.56%, to $2.8 million for the three months ended September 30, 1998 from $1.8
million for the three months ended September 30, 1997. This increase was due
principally to the growth in the average outstanding loan portfolio in the Small
Business Loan Division, which increased $32.1 million, or 58.47%, to $87.0
million for the three months ended September 30, 1998 from $54.9 million for the
three months ended September 30, 1997, reflecting the increased loan origination
levels generated by that Division, and the fact that the Company retains the
asset-based loans and mezzanine loans for investment purposes, rather than
selling or securitizing these loans. The average interest rate earned by the
Small Business Loan Division for the three months ended September 30, 1998 was
17.4% as compared to 21.7% for the three months ended September 30, 1997.
Servicing income decreased $323,000, or 11.14%, to $2.6 million for
the three months ended September 30, 1998 from $2.9 million for the three months
ended September 30, 1997. The decrease was due primarily from the increased
amortization of the residual assets that resulted from the anticipated shorter
lives of the related assets.
Cash gain on sale of loans increased $1.4 million, or 93.33%, to
$2.9 million for the three months ended September 30, 1998 from $1.5 million for
the three months ended September 30, 1997. The increase resulted principally
from increased mortgage loan sales. Mortgage loans sold increased $24.6 million,
or 14.68%, to $192.2 million for the three months ended September 30, 1998 from
$167.6 million for the three months ended September 30, 1997. The weighted
average gain on sale of mortgage loans increased to 0.82% for the three months
ended September 30, 1998 from 0.44% for the three months ended September 30,
1997.
Non-cash gain (loss) on sale of loans decreased $13.6 million to a
negative $396,000 for the three months ended September 30, 1998 from $13.2
million for the three months ended September 30, 1997. The decrease in non-cash
gain on sale of loans was due to the Company's decision not to complete a
mortgage securitization in the third quarter of 1998 and an additional $396,000
mark-to-market write-down. The Mortgage Loan Division
32
<PAGE>
securitized $131.1 million in loans in the second quarter of 1997 and recognized
a weighted average non-cash gain on sale as a percentage of loans securitized of
10.1%, net of expenses.
Beginning in the fourth quarter of 1997, when the Company began to
increase the loan portfolio and not to sell a substantial portion of all loans
that were originated, the Company became subject to Statement of Financial
Standards 91 that does not apply to mortgage bankers. This accounting standard
requires that the cost to originate loans be capitalized and not shown as a
period cost, but be amortized over the life of the loans. Any unamortized costs
are recognized at the time the loan is sold. During the three months ended
September 30, 1998, the Company capitalized $1.8 million of general and
administrative expenses and at the time the loans were sold, recognized $2.3
million of cost as part of the gain on sale transaction.
Loan fees decreased $3.4 million to $5.5 million for the three
months ended September 30, 1998 from $8.9 million for the three months ended
September 30, 1997. Loan fees received as a percentage of retail production for
the three months ended September 30, 1998 were 4.46% as compared to 4.73% for
the three months ended September 30, 1997. 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 $764,000 to $1.1 million for the three
months ended September 30, 1998 from $328,000 for the three months ended
September 30, 1997. Other revenues are comprised principally of insurance
commissions, underwriting fees and management fees. The increase of other
revenues resulted principally from higher underwriting fees received in 1998 on
brokered loans.
Total expenses increased $7.7 million, or 23.1%, to $41.0 million
for the three months ended September 30, 1998 from $33.3 million for the three
months ended September 30, 1997. Total expenses are comprised of interest
expense, provision for credit losses, fair value write-down of residual
receivables, salaries, wages and employee benefits, business development, and
other general and administrative expenses. The increased expenses are due
largely to the Company's increased Mortgage Loan retail origination operations
with the addition of the Houston Regional Operating Center in the fourth quarter
1997. However, management has reduced general and administrative expenses during
1998 from an average of $9.9 million per month in the first quarter of 1998, to
$8.6 million per month in the second quarter of 1998, to $7.4 million in the
third quarter of 1998. Management expects fourth quarter general and
administrative expenses before anticipated restructuring charges and expenses on
sold business units to be lower than the third quarter, mainly as a result of
the sale of selected business units.
Interest expense increased $3.0 million, or 43.48%, to $10.0 million
for the three months ended September 30, 1998 from $7.0 million for the three
months ended September 30, 1997. The increase in interest expense was due
principally to the higher interest cost on the Company's Senior Notes and the
higher borrowing level that were required to fund the Company's operating loss
in 1998. In September 1997, the Company completed the $125.0 million offering of
the Company's Senior Notes with interest payable at 10.75%. For the three months
ended September 30, 1998, the Company incurred interest expense of $3.4 million
related to the Senior Notes. Interest expense in the Mortgage Loan Division
increased to $6.6 million for the three months ended September 30, 1998 from
$5.8 million for the three months ended September 30, 1997. Average borrowings
attributable to the Mortgage Loan Division, both under its revolving warehouse
credit facilities and in connection with the sales of notes payable to investors
and subordinated debentures, increased $500,000 or 0.2%, to $227.6 million for
the three months ended September 30, 1998 from $227.1 million for the three
months ended September 30, 1997.
Provision for credit losses increased $1.2 million, or 50%, to $3.6
million for the three months ended September 30, 1998 from $2.4 million for the
three months ended September 30, 1997. 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, including delinquent loans purchased out of the mortgage
securitizations, which totaled $2.6 million for the three months ended September
30, 1998.
As a result of actual loan prepayments remaining at higher levels
than anticipated in the third quarter 1998, the Company modified the estimated
prepayment speeds on all of its mortgage loan securitization transactions to
peak at 30 CPR, up from the previous prepayment speeds of 25 CPR estimated at
the end of the second quarter. This, along with higher prepayments in the small
business loan securitizations, resulted in the recognition of a write-down of
residual receivables of $5.3 million in the third quarter 1998.
General and administrative expense decreased $1.9 million, or 7.9%,
to $22.1 million for the three months ended September 30, 1998 from $24.0
million for the three months ended September 30, 1997. This resulted primarily
from the decreased personnel costs in the Mortgage Loan Division. During 1997,
the Company experienced additional general and administrative expense each
quarter as the Company expanded. However, when
33
<PAGE>
production volume declined in the fourth quarter of 1997 and continued to
decline in the first quarter of 1998, the Company began a strategic plan in 1998
to reduce the general and administrative expense to be more in line with
anticipated production levels. Salaries, wages and employee benefits decreased
$1.3 million, or 9.42%, to $12.5 million for the three months ended September
30, 1998 from $13.8 million for the three months ended September 30, 1997. The
Company's volume continues to lag behind expectations.
The Company has recorded current income tax expense of $865,000 for
the three months ended September 30, 1998, even though overall the Company
generated a pre-tax loss for the three months ended September 30, 1998. The
current tax is due on income called "excess inclusion income." Excess inclusion
income is a result of the Company securitizing loans in pools to third party
investors. These transactions generate income for the Company that is included
in the overall loss. However, according to IRS regulations, a portion of that
income is subject to federal tax in the current period regardless of other
current period losses or NOL carryovers otherwise available to offset regular
taxable income. The excess inclusion income approximates the net interest the
Company receives on the loans in the pools after the bondholders are paid their
share of the interest less the sum of the daily accruals, an amount allowed for
tax purposes as a reasonable economic return on the retained ownership interest.
FINANCIAL CONDITION
Net loans receivable decreased $18.4 million to $270.0 million at
September 30, 1998 from $288.4 million at December 31, 1997. The residual
receivables were $63.2 million at September 30, 1998, and at December 31, 1997.
This resulted primarily from the amortization of the residual asset and the
write-downs as a result of higher than anticipated prepayments approximating the
amount of retention of the residual interest certificates in the Company's
mortgage loan securitization completed in the first quarter of 1998.
The primary reason for the $3.1 million reduction in other
receivables is that the Company had a $3.0 million receivable at December 31,
1998 related to "unwinding" the Automobile Division securitization that was
received in January 1998.
Net property and equipment increased by $4.9 million to $23.0
million at September 30, 1998, from $18.1 million at December 31, 1997. This
relates primarily to the cost to renovate the new corporate office building, and
approximately $1.6 million of computer software cost that was classified as
other assets at December 31, 1997 since the software had not been implemented in
1997. Also included in other assets at December 31, 1997 was $1.1 million of
pre-funded payroll expense. Due to the holidays, the cash required for the first
payroll in 1998 was pre-funded.
Real estate and personal property acquired in foreclosure increased
$1.9 million while debt origination costs increased $1.9 million. The primary
reason for the higher debt origination costs relates to the $2.0 million fee on
the Mortgage Division's $200.0 million line of credit that was obtained on June
30, 1998.
The primary source of funding the Company's receivables comes from
borrowings issued under various credit arrangements (including the Credit
Facilities, CII Notes, and the Company's Senior Notes). At September 30, 1998,
the Company had debt outstanding under revolving warehouse lines of credit to
banks of $148.0 million, which compares with $77.6 million at December 31, 1997,
for an increase of $70.4 million. During the second quarter of 1998, the Company
obtained a three-year $200 million revolving warehouse line of credit that was
used to replace a warehouse line of credit with another financial institution
that matured on June 30, 1998. At September 30, 1998, the Company had $138.1
million of CII Notes outstanding, which compares with $134.3 million at December
31, 1997, for an increase of $3.8 million.
In the third quarter of 1998, the Company purchased $16.8 million
face amount of its Senior Notes for a purchase price of $8.5 million. The
Company may, from time to time, purchase more of its Senior Notes depending on
the Company's cash available, market conditions, and other factors.
Total shareholders' equity at September 30, 1998 was $5.7 million,
which compares to $63.4 million at December 31, 1997, a decrease of $57.7
million. This decrease resulted principally from a net loss of $57.9 million for
the nine months ended September 30, 1998.
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
34
<PAGE>
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.
In securitization transactions, the residual receivables bear the
risk of default for the entire pool of securitized loans to the extent of such
certificates' value. Accordingly, the value of the residual receivables 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.
SUMMARY OF ALLOWANCE FOR CREDIT LOSSES ON OWNED PORTFOLIO
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.
<TABLE>
<CAPTION>
AT AND FOR THE AT AND FOR THE
NINE MONTHS THREE MONTHS AT AND FOR THE YEARS ENDED
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, DECEMBER 31,
----------------- ----------------- ---------------------------------------------
1998 1997 1996 1995
--------------------------------------- ---------------- --------------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Allowance for credit losses at
beginning of period $ 6,528 $ 8,385 $ 3,084 $ 1,874 $ 1,730
Net charge-offs (6,060) (2,225) (5,166) (2,494) (1,563)
Provision charged to expense 10,578 3,639 10,030 5,416 2,480
Reversal of allowance on auto
loans sold (1,247) -- -- -- --
Securitization transfers -- -- (1,420) (1,712) (773)
-------------- --------------- ------------- ------------- ------------
Allowance for credit losses at
end of the period $ 9,799 $ 9,799 $ 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.
SUMMARY OF EMBEDDED ALLOWANCE FOR LOSSES ON RESIDUAL RECEIVABLES
The table below summarizes certain information with respect to the
Company's allowance for losses that is embedded in the residual receivables for
each of the periods indicated.
<TABLE>
<CAPTION>
AT AND FOR THE AT AND FOR THE
NINE MONTHS THREE MONTHS AT AND FOR THE YEARS ENDED
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, DECEMBER 31,
------------------- ------------------- ------------------------------------------
1998 1997 1996 1995
---------------------------------------- ---------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
RESIDUAL RECEIVABLES:
Allowance for losses at beginning of period $ 14,255 $ 12,861 $ 1,202 $ 773 $ --
Net charge-offs (638) (624) (1,645) (1,283) --
Change in anticipated losses embedded in
securitization gain model (3,091) (1,711) 13,278 -- --
Allowance transferred from owned portfolio -- -- 1,420 1,712 773
----------- ---------- ----------- ---------- ---------
Allowance for losses at the end of the period $ 10,526 $ 10,526 $ 14,255 $ 1,202 $ 773
=========== ========== =========== ========== =========
</TABLE>
35
<PAGE>
SUMMARY OF ALLOWANCE FOR CREDIT LOSSES ON SERVICED PORTFOLIO
The table below summarizes the Company's allowance for credit losses
with respect to the Company's total serviced portfolio (including both owned and
securitized loan pools) for each of the periods indicated.
<TABLE>
<CAPTION>
AT AND FOR THE
AT AND FOR THE THREE MONTHS
NINE MONTHS ENDED ENDED AT AND FOR THE YEARS ENDED
SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31,
--------------------------------- -------------------------------------
1998 1997 1996 1995
--------------------------------- --------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Allowance for credit losses at beginning of period $ 20,783 $ 21,246 $ 4,286 $ 2,647 $ 1,730
Reversal of allowance on auto loans sold (1,247) -- -- -- --
Net charge-offs (6,698) (3,041) (6,811) (3,777) (1,563)
Provision charged to expense 10,578 3,831 10,030 5,416 2,480
Change in anticipated losses embedded in
Securitization gain model (3,091) (1,711) 13,278 -- --
---------- ----------- ----------- --------- ---------
Allowance for credit losses at the end of the period $ 20,325 $ 20,325 $ 20,783 $ 4,286 $ 2,647
========== =========== ============ ========= =========
Allowance as a % of total serviced portfolio 2.60% 2.60% 2.60% 2.02% 2.03%
Annualized net charge-offs as a % of average serviced
Portfolio 1.01% 1.46% 1.38% 2.47% 1.43%
Thetotal allowance for credit losses as shown on the
Balance sheet is as follows:
Allowance for credit losses on loans $ 9,799 $ 9,799 $ 6,528 $ 3,084 $ 1,874
Allowance for credit losses on residual receivables 10,526 10,526 14,255 1,202 773
========== =========== ========== ======== =========
Total allowance for credit losses $ 20,325 $ 20,325 $ 20,783 $ 4,286 $ 2,647
========== =========== ========== ======== =========
</TABLE>
36
<PAGE>
The following table sets forth the Company's allowance for credit
losses on the serviced 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 AT AND FOR THE
NINE MONTHS THREE MONTHS
ENDED SEPTEMBER ENDED SEPTEMBER AT AND FOR THE YEARS ENDED
30, 30, DECEMBER 31,
--------------- --------- -------------------------------
1998 1998 1997 1996 1995
----------- ------- ------ ------ ------
<S> <C> <C> <C> <C> <C>
ALLOWANCE FOR CREDIT LOSSES AS A % OF SERVICED LOANS (1):
Mortgage Loan Division 2.16% 2.16% 1.98% 0.80% 0.93%
Small Business Loan Division 5.18 5.18 6.76 3.84 4.50
Auto Loan Division -- -- 7.58 6.45 4.03
Total allowance for credit losses
as a % of serviced loans 2.60 2.60 2.60 2.02 2.03
NET CHARGE-OFFS AS A % OF AVERAGE SERVICED LOANS (2):
Mortgage Loan Division 0.78 1.11 0.32 0.81 1.04
Small Business Loan Division 1.91 3.85 2.74 2.71 1.43
Auto Loan Division 10.57 -- 17.17 9.65 3.68
Total net charge-offs as a % of total
serviced loans 1.01 1.46 1.38 2.47 1.43
LOANS RECEIVABLE PAST DUE 30 DAYS OR MORE AS A % OF
SERVICED LOANS (1):
Mortgage Loan Division 14.86 14.86 8.00 7.26 14.43
Small Business Loan Division 4.00 4.00 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 13.34 13.34 7.66 8.41 13.31
TOTAL ALLOWANCE FOR CREDIT LOSSES AS A % OF SERVICED
LOANS PAST DUE 90 DAYS OR MORE (1) 41.15 41.15 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 are daily averages for all periods, except 1995
averages, which are computed using beginning and ending balances.
Management closely monitors delinquencies to measure the quality of
its loan portfolio 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.
37
<PAGE>
The following sets forth delinquencies as a percentage of the total
serviced portfolio for the periods indicated.
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30, MARCH 31, DECEMBER 31, DECEMBER 31,
1998 1998 1998 1997 1996
------------- ----------- ------------- ----------- ---------------
(Dollars in thousands)
--------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Loans past due 30-59 days $ 37,965 $ 34,702 $ 34,115 $ 29,174 $ 8,412
As a % of total serviced portfolio 4.86% 4.07% 3.73 % 3.65% 3.96%
Loans past due 60-89 days $ 16,941 $ 13,076 $ 11,527 $ 10,009 $ 2,789
As a % of total serviced portfolio 2.16% 1.53% 1.26 % 1.25% 1.31%
Loans past due 90+ days $ 49,508 $ 38,556 $ 31,934 $ 22,147 $ 6,662
As a % of total serviced portfolio 6.32% 4.52% 3.49 % 2.76% 3.14%
Total loans past due $104,414 $ 86,334 $ 77,576 $ 61,330 $ 17,863
As a % of total serviced portfolio 13.34% 10.12% 8.48 % 7.66% 8.41%
</TABLE>
Management monitors securitized pool delinquencies using a static
pool analysis by month by pool balance. Delinquencies generally increase during
the first one to two years. Current year results are not necessarily indicative
of future performance. The following three tables set 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 1998-1
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1 $ 77,435,632 $ 120,860,326 $ 130,917,899 $ 118,585,860 $ 62,726,105
2 77,045,312 120,119,653 169,093,916 118,061,792 62,300,302
3 76,709,417 119,364,510 168,182,957 148,291,146 61,609,815
4 75,889,160 118,965,905 166,783,489 146,880,279 60,768,433
5 75,395,969 117,236,893 165,608,534 145,775,696 59,347,948
6 74,630,019 115,870,168 164,084,260 144,465,651 58,739,309
7 73,149,957 113,537,447 161,880,416 143,048,555 57,829,352
8 72,261,386 112,100,397 158,220,175 140,482,698
9 71,342,842 110,468,401 155,854,981 137,318,432
10 70,195,198 107,887,242 153,193,421 134,991,772
11 68,981,147 105,138,088 148,382,102
12 67,149,553 102,142,062 144,556,568
13 65,705,603 98,876,084 140,265,621
14 63,210,889 95,394,444
15 60,052,314 92,501,939
16 58,133,496 89,402,897
17 56,900,372
18 55,154,969
19 50,852,179
</TABLE>
38
<PAGE>
<TABLE>
<CAPTION>
DELINQUENCIES > 30 DAYS PAST DUE (1)
- -------------------------------------------------------------------------------------------------------------------------------
MONTHS FROM
POOL INCEPTION 1997-1 1997-2 1997-3 1997-4 1998-1
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1 $ -- $ 515,954 $ 609,201 $ 402,972 $ 44,600
2 1,499,056 1,631,017 2,042,757 2,132,028 1,223,964
3 858,311 3,930,423 4,498,266 5,049,035 2,013,525
4 3,760,775 5,399,570 8,546,414 7,290,097 3,872,739
5 5,220,385 7,293,855 12,337,604 10,290,987 3,825,651
6 5,849,574 9,790,731 13,432,454 13,459,369 5,199,587
7 6,777,961 11,933,526 15,076,729 12,375,957 6,248,301
8 8,078,783 12,484,893 17,687,496 13,861,088
9 8,475,207 12,471,739 17,881,539 16,777,959
10 9,911,115 11,222,005 16,148,887 19,050,239
11 10,630,824 12,421,169 18,929,917
12 9,169,743 14,055,100 21,295,026
13 9,372,949 12,095,456 22,303,472
14 10,605,203 12,674,148
15 9,401,614 14,212,157
16 7,957,382 14,386,886
17 8,227,263
18 8,708,963
19 7,349,210
</TABLE>
<TABLE>
<CAPTION>
DELINQUENCIES > 30 DAYS PAST DUE (1) AS A PERCENT OF CURRENT BALANCE
- ------------------------------------------------------------------------------------------------------------------------------------
MONTHS FROM
POOL INCEPTION 1997-1 1997-2 1997-3 1997-4 1998-1 AVERAGE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1 0.00% 0.43% 0.47% 0.34% 0.07% 0.26%
2 1.94% 1.36% 1.21% 1.81% 1.96% 1.66%
3 1.12% 3.29% 2.67% 3.40% 3.27% 2.75%
4 4.96% 4.54% 5.12% 4.96% 6.37% 5.19%
5 6.92% 6.22% 7.45% 7.06% 6.45% 6.82%
6 7.84% 8.45% 8.19% 9.32% 8.85% 8.53%
7 9.27% 10.51% 9.31% 8.70% 10.80% 9.72%
8 11.18% 11.14% 11.22% 9.87% 10.85%
9 11.88% 11.29% 11.61% 12.22% 11.75%
10 14.12% 10.40% 10.89% 14.11% 12.38%
11 15.41% 11.81% 12.76% 13.33%
12 13.66% 14.24% 14.73% 14.21%
13 14.27% 13.08% 15.90% 14.42%
14 16.78% 13.29% 15.04%
15 15.66% 15.36% 15.51%
16 13.98% 16.09% 15.04%
17 14.46% 14.46%
18 15.79% 15.79%
19 14.45% 14.45%
</TABLE>
(1) Includes real estate foreclosures held for sale, and loans in process
of foreclosure.
38
<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 20,655,808
7 15,292,515 17,128,785 19,881,542
10 14,816,770 16,850,017 19,548,717
13 14,147,481 15,768,712
16 13,214,217 15,411,337
19 11,685,931 14,669,588
22 11,367,569 13,889,117
25 10,932,915
28 10,043,467
31 9,263,383
34 8,597,644
37 7,607,622
40 6,819,078
</TABLE>
<TABLE>
<CAPTION>
DELINQUENCIES > 30 DAYS PAST DUE
---------------------------------------------------------------------------------------------------------------
MONTHS FROM
POOL INCEPTION 1995-1 1996-1 1997-1
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1 388,110 69,463 474,946
4 1,504,537 320,625 366,470
7 1,230,648 2,275,021 366,951
10 1,160,321 1,602,343 941,122
13 1,399,070 1,058,535
16 1,198,855 396,230
19 999,427 1,324,533
22 791,103 1,277,199
25 582,389
28 349,993
31 383,049
34 388,510
37 220,728
40 660,797
</TABLE>
<TABLE>
<CAPTION>
DELINQUENCIES > 30 DAYS PAST DUE AS A % OF CURRENT BALANCE
----------------------------------------------------------------------------------------------------------------------------
MONTHS FROM
POOL INCEPTION 1995-1 1996-1 1997-1 AVERAGE
----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1 2.32% 0.54% 2.42% 1.76%
4 9.23% 1.86% 1.77% 4.29%
7 8.05% 13.28% 1.85% 7.72%
10 7.83% 9.51% 4.81% 7.38%
13 9.89% 6.71% 8.30%
16 9.07% 2.57% 5.82%
19 8.55% 9.03% 8.79%
22 6.96% 9.20% 8.08%
25 5.33% 5.33%
28 3.48% 3.48%
31 4.14% 4.14%
34 4.52% 4.52%
37 2.90% 2.90%
40 9.69% 9.69%
Actual Historical Cumulative
Prepayment Speed 15 CPR 12 CPR 9 CPR
</TABLE>
40
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's business requires continued access to short- and
long-term sources of debt financing and equity capital. The ability to access
these sources has been suppressed recently as capital markets have moved toward
a more risk adverse environment. 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 traditional sources of liquidity are proceeds from the sales of
the loans it originates and purchases, proceeds from the sale of CII Notes,
borrowings under the Credit Facilities, principal and interest received from
borrowers, loan fees received from borrowers, and receipt of excess spread on
securitization transactions. In addition to traditional sources of liquidity,
the Company anticipates receiving $96 million in the fourth quarter from the
sale of the majority of the assets of the Small Business Loan Division, before
paying transaction costs and escrowing $5 million in holdbacks in the purchase
price. Approximately $41 million will be used to reduce credit lines employed by
the Small Business Loan Division. Remaining funds in the amount of approximately
$45 million will be an additional source of funds for mortgage lending
operations. The Company may also receive additional proceeds within 30 days to
adjust the "initial" purchase price, which was based on the September 30, 1998
balance sheet, to the "final" purchase price, which is based on the balance
sheet as of the closing date, November 13, 1998. These additional proceeds may
be approximately $7 million. 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 decreased to $5.7 million at September 30, 1998
from $63.4 million at December 31, 1997. This decrease resulted from the net
losses incurred by the Company in the first nine months of 1998.
Cash and cash equivalents were $25.8 million at September 30, 1998
and $7.6 million at December 31, 1997. Cash used in operating activities
decreased to $69.5 million for the nine months ended September 30, 1998, from
$101.2 million for the nine months ended September 30, 1997. Cash provided by
investing activities increased to $22.4 million for the nine months ended
September 30, 1998, from cash used in investing activities of $12.5 million for
the nine months ended September 30, 1997. Cash provided by financing activities
decreased to $65.3 million for the nine months ended September 30, 1998,
compared to cash provided by financing activities of $113.7 million for the nine
months ended September 30, 1997. The decrease in cash used in operations was due
principally to the increase in whole-loan sales during the first three quarters
of 1998 as compared to the first three quarters of 1997, offset somewhat by the
significant net loss for the nine months ended September 30, 1998, as compared
to net income for the nine months ended September 30, 1997. The increase in cash
provided by investing activities was principally due to increased collections on
loans not sold. The decrease in cash provided by financing activities was due to
receiving $120.6 million in proceeds from issuance of senior unsecured debt in
September of 1997 partly offset by a $70.4 million net increase in warehouse
lines in 1998 versus a net decrease of $24.1 million in 1997.
At September 30, 1998, the Company's credit facilities ("Credit
Facilities") were comprised principally of a revolving warehouse credit facility
of $200 million (the "Mortgage Loan Division Facility") and warehouse credit
facilities of $70.0 million for the Small Business Loan Division (the "Small
Business Loan Division Facility"). The Mortgage Loan Division Facility was
obtained on June 30, 1998, and was used to replace a warehouse line of credit
with another financial institution that matured on June 30, 1998. Based on the
borrowing base limitations contained in the Credit Facilities, at September 30,
1998, the Company had aggregate outstanding borrowings of $89.6 million and
aggregate borrowing availability of $3.3 million under the Mortgage Loan
Division Facility and aggregate outstanding borrowings of $58.4 million and
aggregate borrowing availability of $8.0 million under the Small Business Loan
Division Facility. Total Company borrowings and availability at September 30,
1998 under the Credit Facilities were $148.0 million and $11.3 million,
respectively. The Mortgage Loan Division Facility bears interest at prime plus
0.50% with an option to convert to LIBOR plus 2.50% and matures on June 30,
2001. The Small Business Loan Division Facility bears interest at the prime rate
and matures on December 29, 2000.
The Mortgage Loan Division Facility contains a requirement to
maintain a minimum specified amount of investor savings notes to be held by
Carolina Investors, Inc, a requirement for audited financial statements from a
national auditing firm, and limitations on certain intercompany transactions.
While the Company believes it is in compliance with the covenants of its debt
agreement, it is currently in discussions with its bank regarding whether or not
its auditors, Elliott, Davis & Company qualifies as a national auditing firm,
and whether or not any provisions were violated when the Company repurchased
some of its Senior Notes. The Small Business Loan Division Facility contains a
number of financial covenants, including, but not limited to, covenants with
respect to certain debt to equity, tangible net worth, and interest coverage
ratios. These required financial ratios are calculated on the Small Business
Loan Division financial statements. The agreements contain no consolidated
financial statement covenants. 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
and certain other distributions (including dividends and distributions from the
subsidiaries to the Company), making
41
<PAGE>
intercompany loans, making payments with respect to certain subordinated debt,
and making certain changes to its equity capital structure. The Mortgage Loan
Division Facility prohibits HomeGold, Inc., and in certain circumstances
Carolina Investors, Inc., from paying dividends or making distributions to the
Company in excess of 50% of such subsidiaries' cumulative net income as
determined for the most recent four consecutive completed fiscal quarters on a
cumulative rolling basis or if an event of default exists at the time of, or
after giving effect to, the dividend or distribution. The majority of the credit
facilities in the Small Business Loan Credit Facility contain provisions
prohibiting subsidiaries of the Company party to the included credit facilities
from paying dividends, or making distributions to the Company (unless such
provisions are waived by the lender). At September 30, 1998, management believes
the Company was in compliance with such restrictive covenants.
Upon completion of the sale of the assets of the small business loan
division, the $70.0 million Small Business Loan Division warehouse credit
facility will be paid in full and terminated. It is also anticipated that after
completing the sale of the Small Business Loan Division that the Mortgage Loan
Division revolving warehouse credit facility may be reduced by approximately
$50.0 million to $100.0 million.
During 1997, the Company sold $125.0 million aggregate principal
amount of Senior Notes. The Senior Notes constitute unsecured indebtedness of
the Company. The Senior Notes 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. The indenture
pertaining to the Senior Notes contains various restrictive covenants including
limitations on, among other things, the incurrence of certain types of
additional indebtedness, the payment of dividends and certain other payments,
the ability of the Company's subsidiaries to incur further limitations on their
ability to pay dividends or make other payments to the Company, liens, asset
sales, the issuance of preferred stock by the Company's subsidiaries and
transactions with affiliates. At September 30, 1998, management believes the
Company was in compliance with such restrictive covenants. The Senior Notes 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 senior notes and is senior to CII's subordinated debentures.
In the third quarter of 1998, the Company purchased $16.8 million
face amount of its Senior Notes for a purchase price of $8.5 million. The
Company may, from time to time, purchase more of its Senior Notes depending on
the Company's cash available, market conditions, and other factors.
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 September 30, 1998, CII had an aggregate of $120.3 million of senior
notes outstanding bearing a weighted average interest rate of 7.44%, and an
aggregate of $17.8 million of subordinated debentures bearing a weighted average
interest rate of 5.00%. The senior notes and subordinated debentures are
subordinate in priority to CII's obligations under the Mortgage Loan Division
Credit Facility. Substantially all of the CII Notes have one-year maturities.
LOAN SALES AND SECURITIZATIONS
The Company offers for sale or securitization substantially all of
its loans other than those loans designated as held for investment purposes. The
Company offers for sale on a whole loan basis a significant amount 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 these
loans can be successfully sold. To the extent that the loans are not sold, the
Company retains the risk of loss. At September 30, 1998 and December 31, 1997,
the Company had retained $44.4 million and $69.8 million, respectively, of
second mortgage loans on its balance sheet. These loans contain substantially
higher credit risk than Mortgage Loans secured by first liens. During the first
nine months of 1998 and 1997, the Company sold $485.7 million and $326.0
million, respectively, of Mortgage Loans and $42.9 million and $27.4 million,
respectively, of SBA Loan Participations.
42
<PAGE>
Beginning in 1997, on a quarterly basis, the Company securitized
substantial amounts of its Mortgage Loans, totaling $579.8 million through
September 30, 1998. The Company did not complete a mortgage securitization in
the second or third quarters of 1998 and is planning to continue to sell loans
on a whole-loan cash basis for the remainder of 1998 rather than engage in a
securitization transaction. Since 1995, the Company has securitized $56.0
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.
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 residual receivables, and are aggregated and
reported on the income statement as non-cash gain on sale of loans, after being
reduced (increased) by the costs of securitization and any hedge (gains) losses.
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.
43
<PAGE>
The following sets forth facts and assumptions used by the Company
in arriving at the valuation of the residual receivables relating to its
Mortgage Loan securitizations at September 30, 1998:
<TABLE>
<CAPTION>
1997-1 1997-2 1997-3 1997-4 1998-1
--------------- ------------- ---------------- -------------- -------------
<S> <C> <C> <C> <C> <C>
Loans remaining in securitization pool $50,852,179 $89,402,897 $140,265,621 $134,991,772 $57,829,352
Weighted average coupon on loans 10.84 10.75% 11.12% 11.04% 10.95%
Weighted average original term to
stated maturity 187 months 183 months 187 months 194 months 200 months
Weighted average loan-to-value 78.50% 73.94% 76.13% 75.99% 76.64%
Percentage of first mortgage loans 100.00% 100.00% 100.00% 100.00% 100.00%
Weighted average pass-through rate to
Bondholders 7.34 6.97 6.87 6.58 6.36
Estimated annual losses assumed 0.60 0.60 0.60 0.60 0.60
Estimated cumulative losses assumed as a
Percentage of unpaid balance 1.71% 1.69% 1.64% 1.54% 1.41%
Remaining ramp period for losses 0 months 0 months 0 months 3 months 6 months
Annual servicing fee 0.50 0.50 0.50 0.50 0.50
Servicing asset 0.10 0.10 0.10 0.10 0.10
Discount rate implicit in cash flow
before
overcollateralization 31.00 25.00 23.00 23.00 24.00
Discount rate applied to cash flow after
Overcollateralization 12.00 12.00 12.00 12.00 12.00
Prepayment speed assumptions:
Initial CPR (1) 0 CPR 0 CPR 0 CPR 0 CPR 0 CPR
Peak CPR (1) 30 CPR 30 CPR 30 CPR 30 CPR 30 CPR
Tail CPR (1) 28/26 CPR 28/26 CPR 28/26 CPR 28/26 CPR 28/26 CPR
CPR ramp period (1) 12 months 12 months 12 months 12 months 12 months
CPR peak period (1) 24 months 24 months 24 months 24 months 24 months
CPR tail begins from (1) 37/49 months 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% 0.185%
Initial overcollateralization required (2) 3.25 0.00 0.00 0.00 0.00
Final overcollateralization required (2) 6.50 3.75 3.75 3.75 3.75
</TABLE>
(1) CPR ("Constant Prepayment Rate") represents an industry standard of
calculating prepayment speeds. 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.
Approximately 2/3 of the loans in the Company's securitization
transactions have a "piggy-backed" second mortgage loan behind the
first mortgage loan, creating a high combined LTV for the customer.
However, the second mortgage loans are whole-loan sold, reducing the
Company's and the pool's loss exposure to only the LTV on the first
mortgage loan. Typically, high LTV loans are priced at a slower CPR
than traditional home equity loans and are expected to have less
prepayment volatility under changing interest-rate scenarios. However,
the Company has experienced higher prepayment speeds on its pools than
originally anticipated, and therefore has increased its prepayment
assumptions as outlined above.
(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 sell its
loans on a whole loan basis for the remainder of 1998 to provide improved cash
flow, and will evaluate its strategy of securitization versus whole loan sale on
a quarterly basis.
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.
Also, in recent months, the
44
<PAGE>
prepayment speeds on the Company's Mortgage Loan securitization pools have
increased above the assumptions used in valuing the residual receivables from
the securitizations. The Company modified the estimated prepayment speeds in the
second quarter of 1998 on all of its mortgage loan securitization transactions
to peak at 25 CPR, up from the previous prepayment speeds of 20 CPR. This
modification resulted in a $8.9 million write-down of the residual receivables
in the second quarter of 1998. Due to actual loan prepayments remaining at
higher levels than anticipated in the third quarter 1998, the Company modified
the estimated prepayment speeds on all of its mortgage loan securitization
transactions to peak at 30 CPR, up from the previous prepayment speeds of 25 CPR
estimated at the end of the second quarter. This, along with higher prepayments
in the small business loan securitizations, resulted in the recognition of a
write-down of residual receivables of $5.3 million in the third quarter 1998.
The Company assesses the carrying value of its residual receivables
and servicing assets for impairment each quarter. These assets are carried at
their estimated fair market value. During the nine months ended September 30,
1998, the Company wrote-down the valuation of its mortgage residual receivables
by $12.4 million as a result of higher than anticipated mortgage loan
prepayments for the nine months ended September 30, 1998. There can be no
assurance that the Company's estimates used to determine the gain on sale of
loans, residual receivables, and servicing assets valuations will remain
appropriate for the life of each securitization.
The following table shows actual prepayment speeds versus the
current projected prepayment speeds (assumptions used in the Company's
calculation of residual receivables and gain on sale) for each mortgage
securitization transaction.
<TABLE>
<CAPTION>
Actual CPR
--------------------------------------------------------------------------------------------
Month From Projected
Inception CPR 1997-1 1997-2 1997-3 1997-4 1998-1
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1 0.00% -0.36% 1.49% 0.00% 2.52% 3.81%
2 2.73% 4.30% 5.24% 3.16% 2.48% 6.17%
3 5.45% 3.48% 5.21% 4.58% 3.91% 10.90%
4 8.18% 10.58% 1.95% 7.88% 9.27% 13.62%
5 10.91% 5.90% 14.53% 6.43% 7.02% 23.84%
6 13.64% 9.95% 11.28% 8.81% 8.64% 10.66%
7 16.36% 19.95% 19.96% 13.36% 9.52% 16.03%
8 19.09% 12.06% 12.29% 22.53% 18.67%
9 21.82% 12.64% 14.28% 14.90% 23.16%
10 24.55% 16.14% 23.01% 17.06% 16.59%
11 27.27% 17.35% 24.97% 30.31%
12 30.00% 26.21% 27.69% 26.12%
13 30.00% 21.46% 30.72% 28.71%
14 30.00% 35.92% 33.37%
15 30.00% 44.87% 29.56%
16 30.00% 30.91% 32.13%
17 30.00% 21.06%
18 30.00% 29.85%
19 30.00% 62.10%
20 30.00%
21 30.00%
CUMULATIVE 20.83% 17.77% 14.85% 11.30% 12.42%
</TABLE>
45
<PAGE>
The following table sets forth facts and assumptions used by the
Company in arriving at the valuation of the residual receivables relating to its
unguaranteed SBA Loan securitizations at September 30, 1998:
<TABLE>
<CAPTION>
1995-1 1996-1 1997-1
------------ ------------- --------------
<S> <C> <C> <C>
Loans remaining in securitization pool $6,819,078 $12,575,013 $ 19,548,717
Weighted average spread over Wall
Street Journal Prime Rate 2.73% 2.67% 2.47%
Weighted average original term to stated
Maturity 180 months 247 months 258 months
Weighted average original loan-to-value 55% 63% 67%
Spread under prime rate to investor 1.35% 1.80% 2.00%
Estimated annual losses assumed 2.25% 1.25% 1.25%
Annual servicing fee 0.40% 0.40% 0.40%
Discount rate applied to cash flow
after spread account 10.50% 10.50% 10.50%
Prepayment speed assumptions:
Initial CPR 0 CPR 0 CPR 0 CPR
Peak CPR 25 CPR 12 CPR 12 CPR
Tail CPR 15 CPR 11 CPR 11 CPR
CPR ramp period from inception date 12 months 12 months 12 months
CPR peak period from inception date 36 months 36 months 36 months
CPR tail begins from inception date 37 months 37 months 37 months
Annual trustee fee $ 8,000 $ 8,000 $ 8,000
Initial spread account required 2% 2% 2%
Final spread account required 4% 4% 6%
Subordinate piece retained 10% 9% 10%
</TABLE>
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 reviews the assumption used in valuing the residual
assets quarterly and makes adjustments deemed necessary, based on current data
that is known to management.
ACCOUNTING CONSIDERATIONS
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
interim and annual financial statements. Statement No. 131 is not required to be
applied to interim financial statements in the initial year of its application.
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.
In June 1998, FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities" which is effective for all fiscal quarters
of fiscal years beginning after June 15, 1999. This Statement establishes
accounting and reporting standards for derivative instruments and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. The Company has not assessed the impact of this
standard.
In October 1998, FASB issued SFAS No. 134 "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise" which is effective for the first
fiscal quarter beginning after December 31, 1998. This statement conforms the
subsequent accounting for securities retained after the securitization of
mortgage loans by a mortgage banking enterprise with the subsequent accounting
for securities retained after the securitization of other types of assets by a
nonmortgage banking enterprise. The adoption of this standard is not expected to
have a material effect on the Company's financial statements.
46
<PAGE>
TAX CONSIDERATIONS--NET OPERATING LOSS ("NOL")
As a result of operating losses incurred by the Company, the Company
has 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. The Company believes that it has had a maximum
cumulative change of control of 33% during the relevant three-year period. The
Company had a federal NOL of approximately $51.1 million remaining at September
30, 1998.
HEDGING ACTIVITIES
The Company's profitability may be directly affected by fluctuations
in interest rates. While the Company monitors interest rates and from time to
time 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 relating to loans
pending a securitization transaction. The Company currently does not hedge its
loans held for whole-loan sales or its loans held for investment purposes. 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
generally 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 securitization and whole-loan sale transactions
earned by the Company. At September 30, 1998, the Company had only interest-rate
lock agreements outstanding relating to variable rate loan agreements.
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,
residual receivables 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 and residual receivables,
adversely impacting earnings. Fluctuating interest rates may also affect the net
interest income earned by the Company resulting from the 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 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.
47
<PAGE>
A risk assessment is being developed by the Year 2000 team as part
of the project. This assessment is expected to be completed by December 31,
1998. Although the Company has not 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,
financial condition, and liquidity. So far the Company has spent approximately
$100,000 addressing Year 2000 issues. Any additional funds necessary for the
remediation of Year 2000 problems is expected to come from operating funds. No
information technology projects have been deferred because of Year 2000 problems
or issues. 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.
The worst-case scenario for a Year 2000 problem for the Company
would be a situation in which the Company was unable to receive electronic
advances under its lines-of-credit for a period of more than a day or two. In
such a situation, the Company would be unable to make loans and would lose its
primary source of income. The harm such a problem could cause to the Company
would increase the longer such an interruption remained uncorrected. The Company
believes the odds of such a scenario occurring are very small. The Company does
not yet have contingency plans in the event it is unable to prevent this Year
2000 problems from arising. The Company will formulate such plans, if necessary,
following the completion of its risk assessment.
48
<PAGE>
PART II. OTHER INFORMATION
49
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
1. On April 27, 1998, Capital City Acceptance, Inc. ("Capital City")
filed an arbitration demand against the Company, its directors and
selected officers with the American Arbitration Association in
Charlotte, NC. This demand arises from Capital City's attempted
purchase of HomeGold's Auto Loan subsidiaries in January, 1998, and
subsequent failed purchase of the remaining assets of HomeGold's
Auto Loan Division (valued by HomeGold at less than $500,000) after
sale of substantially all of the assets of the Auto Loan Division to
an unrelated third party. Capital City asserts claims for breach of
contract, appropriation, slander, libel, and fraud in the inducement
and requests actual damages in the amount of $5.2 million,
injunctive relief, and punitive damages in an unspecified amount.
HomeGold has counterclaimed against Capital City and brought a
third-party claim against its principal, Robert A. Zander, for
conversion, fraud, breach of contract accompanied by a fraudulent
act, misappropriation of trade name, breach of contract, breach of
warranty, and defamation and is vigorously contesting Capital City's
claims.
2. Ikbal Gaibi-Rodriguez sued the Company, HomeGold, Inc., and
Carolina Investors, Inc. in U.S. District Court for the District of
Puerto Rico on a breach of contract claim, alleging that the
defendants failed to comply with the terms of a Confidentiality
Agreement, Development Agreement and Employment Agreement. The
plaintiff sought in excess of $26,000,000 in damages. Defendant's
motion to dismiss was granted in January 1998. Plaintiff appealed to
the U.S. Court of Appeals for the First Circuit, and the lower
court's decision was affirmed in October, 1998. The appeal period as
to that affirmation has not yet lapsed.
The Company may be involved in various claims from time to time that
result in the normal course of business. The Company is not aware of any other
claims that either individually or collectively could have a material adverse
effect on the Company.
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
10.5-- Definitive sale agreement dated October 2, 1998,
between Transamerica Business Credit Corporation
and HomeGold Financial, Inc. and certain
subsidiaries thereof, incorporated by reference to
8-K dated October 2, 1998.
27.1-- Financial Data Schedule.
50
<PAGE>
b) Reports on Form 8-K
1) On July 7, 1998, the Company filed a Form 8-K with
respect to the new $200 million mortgage loan
warehousing facility entered into on June 30, 1998.
2) On August 7, 1998, the Company filed a Form 8-K
announcing an agreement in principle to sell the
majority of its Small Business Loan Division.
3) On September 25, 1998, the Company filed a Form 8-K
with respect to a change in auditors for the Company.
4) On October 2, 1998, the Company filed a Form 8-K
announcing a definitive agreement was signed with
Transamerica Business Credit Corporation for the sale
of the majority of the Company's Small Business Loan
Division.
51
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOMEGOLD FINANCIAL, INC.
Date: November 16, 1998
By: \s\ Kevin J. Mast
----------------------------------------
Kevin J. Mast,
Vice President, Chief Financial Officer,
and Treasurer
52
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<CURRENCY> U.S. Dollars
<S> <C> <C>
<PERIOD-TYPE> 9-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998
<PERIOD-START> JAN-1-1998 JUL-1-1998
<PERIOD-END> SEP-30-1998 SEP-30-1998
<EXCHANGE-RATE> 1.00 1.00
<CASH> 25833 25833
<SECURITIES> 0 0
<RECEIVABLES> 279813 279813
<ALLOWANCES> 9799 9799
<INVENTORY> 0 0
<CURRENT-ASSETS> 0<F1> 0<F1>
<PP&E> 28466 28466
<DEPRECIATION> 5467 5467
<TOTAL-ASSETS> 417184 417184
<CURRENT-LIABILITIES> 0<F1> 0<F1>
<BONDS> 0 0
487 487
0 0
<COMMON> 0 0
<OTHER-SE> 38821 38821
<TOTAL-LIABILITY-AND-EQUITY> 417184 417184
<SALES> 0 0
<TOTAL-REVENUES> 69172 19842
<CGS> 0 0
<TOTAL-COSTS> 91786 27432
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 10579 3639
<INTEREST-EXPENSE> 28335 9950
<INCOME-PRETAX> (61528) (21179)
<INCOME-TAX> 4109 865
<INCOME-CONTINUING> (65624) (22033)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (57900) (14309)
<EPS-PRIMARY> (5.97) (1.47)
<EPS-DILUTED> (5.97) (1.47)
<FN>
FOOTNOTE(1) Unclassified Balance Sheet
</FN>
</TABLE>
