UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the fiscal year ended December 31,1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the transition period from _____________________ to
_______________________
Commission File No. 0-8909
HOMEGOLD FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
South Carolina 57-0513287
- ------------------------------------------------ ----------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
3901 Pelham Road, Greenville, South Carolina 29615
- ----------------------------------------------------- ----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code
864-289-5000
Securities registered under Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on which registered
- ------------------------------ ---------------------------------------------
None None
Securities registered under Section 12(g) of the Act:
Title of Each Class
- --------------------------------------------------------------------------------
Common Stock, par value $.05
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of February 28, 2000, the aggregate market value of voting stock held by
non-affiliates of registrant was approximately $11.1 million.
As of February 28, 2000, 10,171,416 shares of the Registrant's common stock were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Company's Proxy Statement for the Annual Meeting of Shareholders scheduled
for April 28, 2000 to be filed not later than 120 days after December 31, 1999
is incorporated by reference into Part III hereof.
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
HomeGold Financial, Inc. (f/k/a Emergent Group, Inc.) and its
subsidiaries (collectively, "HGFN" or "the Company") is a specialty finance
company primarily engaged in the business of originating, purchasing, selling,
securitizing and servicing sub-prime first and second-lien residential mortgage
loan products ("Mortgage Loans"). Prior to November 1998, the Company also
engaged in the business of originating, selling, securitizing and servicing
small-business loan products partially guaranteed by the United States Small
Business Administration ("SBA") and small-business loans collateralized by
accounts receivable and inventory and mezzanine loans (collectively,
"Small-Business Loans"). Prior to March 1998, the Company also engaged, to a
lesser extent, in making auto loans ("Auto Loans"). The Company makes
substantially all of its loans to non-prime borrowers who have limited access to
credit or who may be considered credit-impaired under conventional lending
standards.
The Company commenced its lending operations in 1991 with the
acquisition of Carolina Investors, Inc. ("CII"), a small South Carolina mortgage
lender, which had been in business since 1963. Since such acquisition, the
Company has significantly expanded its lending operations. During the years
1999, 1998, and 1997, the Company originated $234.0 million, $785.3 million, and
$1.2 billion in loans, respectively. HomeGold Financial, Inc.'s major operating
subsidiaries are HomeGold, Inc. and Carolina Investors, Inc.
In February 2000, HomeGold Financial, Inc. entered into a
merger agreement with HomeSense Financial Corporation and affiliated companies
(collectively "HomeSense"), a privately owned business, located in Columbia,
South Carolina. HomeSense is a specialized mortgage company that originates and
sells mortgage loans in the sub-prime mortgage industry, whose principal loan
product is a debt consolidation loan, generally collateralized by a first lien
on the borrower's home. The merger is subject to shareholder approval. The
Company expects to obtain shareholder approval and complete the transaction in
April. The merger will be accounted for under the purchase method of accounting
prescribed by generally accepted accounting principles.
HGFN will issue 6,780,944 million shares of its common stock
(40% of post-merger shares outstanding) in addition to approximately $11 million
of non-convertible preferred stock for 100% of the outstanding stock of
HomeSense. HomeSense originated an average of approximately $42 million per
month in mortgage loans in the fourth quarter 1999, with a mix of approximately
62% through its direct retail origination channels and 38% through its wholesale
origination network. HomeSense originates its retail loan volume through both a
direct retail branch network of nine offices, as well as through
centrally-provided telemarketing leads, direct mail, and television advertising.
MORTGAGE LOAN PRODUCTS
OVERVIEW
The Company provides Mortgage Loan products primarily to
owners of single family residences who use the loan proceeds for such purposes
as refinancing, debt consolidation, home improvements and educational
expenditures. The Company believes the non-prime mortgage market is highly
fragmented.
Substantially all of the Mortgage Loans are made to non-prime
borrowers. These borrowers generally have limited access to credit, or are
considered credit-impaired by conventional lenders such as thrift institutions
and commercial banks. These conventional lending sources generally impose
stringent and inflexible loan underwriting guidelines, as compared to the
Company, to approve and fund loans. Loan applications of non-prime borrowers are
generally characterized by one or more of the following: (1) limited or
unfavorable credit history, including bankruptcy, (2) problems with employment
history, (3) insufficient debt coverage, (4) self-employment or (5) inadequate
collateral.
The Company has developed a comprehensive credit analysis
system for its loan originations, which is designed to ensure that credit
standards are maintained and consistent underwriting procedures are followed.
2
<PAGE>
The Company believes that its customers require or seek a high
degree of personalized service and swift response to their loan applications.
Also, the Company believes that its customers generally focus more on the amount
of the monthly payment than the interest rate charged. Furthermore, because the
Company's customers are generally credit-impaired for one or more reasons, the
customers are typically not in a position to obtain better rates from
traditional lending institutions.
In 1999, approximately 53.1%, or $124.2 million, of the
Company's Mortgage Loans were originated through the Company's retail operation
with the remainder being originated by wholesale brokers. In 1999, 74.8% of the
Mortgage Loans the Company originated were secured by first-liens. These
first-lien Mortgage Loans had an average principal balance of approximately
$78,000, a weighted average interest rate of approximately 10.36% and an average
loan-to value ("LTV") ratio of 82.3%.
Approximately 24.8% of the Mortgage Loans originated by the
Company were secured by a second-lien Mortgage Loan, some of which were to the
same borrower as the first-lien mortgage loan. First and second mortgage
combinations resulted in combined LTV ratios that averaged 112.1% on these loans
and may have been as high as 125% under the Company's guidelines. Such
second-lien Mortgage Loans originated during 1999 had an average principal
balance of approximately $31,000 and a weighted average interest rate of
approximately 14.32%.
In order to reduce the Company's credit risk, second-lien
Mortgage Loans with a combined LTV ratio greater than 100% are generally
pre-approved and pre-underwritten by a third party and generally sold without
recourse on a whole loan basis with certain representations and warranties.
Second-lien Mortgage Loans with a combined LTV ratio less than 100% are
underwritten by the Company. These loans are generally sold on a whole loan
basis without recourse. However, no assurance can be given that the second-lien
mortgage loans can be sold. To the extent that the loans are not sold, the
Company retains the risk of loss. At December 31, 1999 and 1998, the Company had
retained $9.5 million and $19.0 million, respectively, of second-lien mortgage
loans on its balance sheet. During 1999, the Company included certain second
mortgages in its second quarter securitization. The Company may choose to
include second mortgage products in future securitizations.
The Company has invested significantly in technology and the
training of personnel to improve and expand its underwriting, servicing, and
collection functions. The Company believes its current operations are capable of
supporting increases in both loan origination volume and securitization
servicing capacity with only modest increases in fixed expenses.
MORTGAGE LOAN ORIGINATION
The Company originates its Mortgage Loan products on a retail
basis using direct mail marketing techniques. Responses are directed through the
Company's call center in Greenville, South Carolina. Mortgage loans are
originated on a wholesale basis through approximately 700 independent mortgage
brokers and mortgage bankers (collectively, the "Mortgage Brokers"). The Company
conducts its mortgage lending operations in 44 states.
The Company believes that its use of retail and wholesale
origination is an effective diversification strategy that enables it to
penetrate the non-prime mortgage loan market through multiple channels.
3
<PAGE>
The following table sets forth mortgage loan originations by channel for the
period indicated:
<TABLE>
<CAPTION>
LOAN ORIGINATIONS BY CHANNEL
YEAR ENDED DECEMBER 31, 1999
---------------------------------------------------------
1ST MORTGAGE 2ND MORTGAGE
LOANS LOANS TOTAL
----------------- ----------------- ---------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Retail
Loan originations $ 85,206 $ 38,976 $ 124,182
Average principal balance per loan $ 76 $ 34 $ 55
Weighted average initial LTV ratio 82.8% 113.4% 92.4%
Weighted average coupon rate 10.05% 14.26% 11.37%
Wholesale
Loan originations $ 90,422 $ 19,401 $ 109,823
Average principal balance per loan $ 79 $ 26 $ 58
Weighted average initial LTV ratio 81.9% 109.8% 86.8%
Weighted average coupon rate 10.66% 14.44% 11.33%
Total
Loan originations $ 175,628 $ 58,377 $ 234,005
Average principal balance per loan $ 78 $ 31 $ 56
Weighted average initial LTV ratio 82.29% 112.17% 89.8%
Weighted average coupon rate 10.36% 14.32% 11.35%
</TABLE>
RETAIL OPERATION. Since 1996, the Company has focused a
significant portion of its resources in developing its retail loan products and
in developing its related delivery systems. In 1999, retail Mortgage Loan
originations represented 53.1% of the Company's total Mortgage Loan originations
compared to 56% and 52% in 1998 and 1997, respectively. Retail Mortgage Loan
originations during 1999, 1998, and 1997 totaled $124.2 million, $371.1 million,
and $562.7 million, respectively. The Company has experienced a decrease in
retail mortgage originations in both of the last two years. This decrease was
the result of management turnover in the retail division, closing of three
regional operating centers, and a focus on assessing the efficiency and
effectiveness of the retail origination process, in an effort to improve both
the quality and volume of loans originated in the retail channel. The Company
believes that its retail operation has significant long-term profit potential
because it expects that the origination and other fees (typically paid to the
broker-originators) will more than offset the infrastructure expenses associated
with operating a retail operation once planned efficiency levels are reached.
The Company also believes that the retail operation allows more Company control
over the underwriting process and its borrower relationship. The retail
operation also reduces reliance on wholesale sources, while building brand
recognition.
Unlike many of its competitors (particularly non-prime
mortgage lenders that began operations as traditional finance companies), the
Company markets its retail lending operations in large part through direct mail
and telemarketing methods. Compared to a traditional "bricks and mortar" retail
approach in which loans are originated out of local, walk-in retail offices, the
Company believes that this strategy allows it to target different areas of the
country more quickly, depending on the economic, business and other
characteristics that may exist at a particular point in time. The Company also
believes that this strategy avoids the expense typically associated with "bricks
and mortar" operations. The Company currently has one central operating center
consisting of originators, underwriters, and loan processors. The Company
utilized multiple, regional operating centers in Greenville, Indianapolis,
Phoenix, and Houston in previous years. These regional operating centers were
consolidated into the Greenville retail operation in November of 1998.
WHOLESALE LENDING OPERATION. All of the Mortgage Loans
originated on a wholesale basis by the Company are originated through mortgage
brokers with whom the Company seeks to develop and maintain continuing
relationships. As a wholesale originator of Mortgage Loans, the Company funds
the Mortgage Loans at closing. During 1997, the Company conducted its wholesale
loan operations through approximately 1,000 mortgage brokers. In 1999 and 1998,
the Company conducted its wholesale loan operations through approximately 700
mortgage brokers. In 1999, wholesale Mortgage Loan originations represented
46.9% of the Company's total Mortgage Loan originations compared to 44% and 48%
in 1998 and 1997, respectively. Wholesale Mortgage Loan originations during
1999, 1998, and 1997, totaled $109.8 million, $288.3 million, and $520.1
million, respectively.
4
<PAGE>
The Company believes that its wholesale lending operation will
continue to constitute an important part of its business strategy and that the
wholesale operation, when coupled with retail origination channels, will
maximize the Company's potential growth and penetration of the non-prime
mortgage loan market. This is because there are a large number of independent
mortgage brokers who require outside funding of their loans. The wholesale
strategy of funding individual loans from brokers at par (or at a slight premium
based on yield spreads) rather than at the premiums typically associated with
bulk purchases, provides more favorable cash flow for the Company.
Total wholesale originations have decreased in each of the
last two years. The Company attributes this reduction to the high employee
turnover rates experienced, and tightening of underwriting guidelines. In 1999,
average origination volume per person has remained relatively stable, but as
turnover rates have stabilized and additional account executives have been
hired, total volume for the division has increased. In addition, during 1999 an
inside sales group was established. The focus of the inside sales group is to
work with mortgage brokers working in areas not served by an account executive,
and to provide customer service to brokers in an effort to expedite underwriting
and approval processes. As a result, the wholesale lending operation was able to
improve total production each quarter over the previous quarter throughout 1999.
GEOGRAPHIC DIVERSIFICATION. Since the Company commenced its
retail mortgage operations in 1996, it has significantly expanded its geographic
presence. During 1999, 1998, and 1997, Mortgage Loan originations by state were
as shown below:
<TABLE>
<CAPTION>
State 1999 % 1998 % 1997 %
-------------------- ----------- -------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
North Carolina $ 33,945 14.6% $ 108,714 16.4% $ 198,485 18.4%
South Carolina 25,180 10.8 87,435 13.3 147,663 13.6
Virginia 13,851 5.9 28,836 4.4 50,556 4.7
Pennsylvania 13,616 5.8 28,425 4.3 275 --
Louisiana 12,239 5.2 33,238 5.0 53,917 5.0
Tennessee 12,163 5.2 30,538 4.6 55,872 5.2
Ohio 10,960 4.7 19,643 3.0 328 --
Georgia 10,751 4.6 34,725 5.3 80,012 7.4
Florida 10,487 4.5 43,698 6.6 101,612 9.4
Michigan 10,392 4.4 29,461 4.5 61,836 5.7
Illinois 9,178 3.9 28,479 4.3 1,466 0.1
Missouri 7,932 3.4 22,864 3.5 2,594 0.2
Mississippi 5,214 2.2 19,523 3.0 13,579 1.3
Indiana 3,465 1.5 20,700 3.1 51,046 4.7
All other states 54,632 23.3 123,165 18.7 263,575 24.3
----------- -------- ----------- -------- ----------- --------
Total $ 234,005 100.0% $ 659,444 100.0% $ 1,082,816 100.0%
=========== ======== =========== ======== =========== ========
</TABLE>
LOAN UNDERWRITING
In the application and approval process associated with the
Company's retail Mortgage Loan operations, a Company loan officer finds
potential borrowers through leads generated by direct mail marketing techniques
and calling campaigns. After obtaining an initial loan application, additional
information is compiled and gathered by loan processors, who then forward the
file to the underwriting department for approval. The underwriting department
generally completes its review within one business day after procurement of all
necessary documentation. Upon approval by the underwriting department, the loan
is generally forwarded by the loan closing department to an attorney or title
company for closing.
For loans originated through mortgage brokers, the application
and necessary underwriting information is generally gathered by the mortgage
broker and forwarded to the Company's underwriting department for approval
before the loan is closed and funded.
Creditworthiness is assessed through a variety of means,
including calculating debt to income ratios, examining the applicant's credit
history through credit reporting bureaus, verifying an applicant's employment
status and income, and checking the applicant's payment history with respect to
any first-lien mortgage on the property. The Company uses several procedures to
verify information obtained from an applicant. In order to verify an applicant's
employment status and income, the Company generally obtains such verification
from the applicant's employer. The Company requires self-employed borrowers to
provide a copy of their tax return.
The Company generally requires an independent appraisal on all
loans. Loans in excess of $350,000 generally require two independent appraisals.
The Company generally requires title insurance for all real estate loans. The
Company also generally requires real estate improvements to be fully insured as
to fire and other commonly insurable
5
<PAGE>
risks and regularly monitors its loans to ensure that insurance is maintained
for the period of the loan.
During December 1999, the Company instituted a different
approach to the assignment of credit grades to loans, relying heavily on FICO
scores. (See 1998 Form 10-K for previous guidelines.) A FICO score is a
numerical assessment of an individual's creditworthiness, generated by a
proprietary computer model developed by Fair, Isaac and Co., and utilized by all
three primary credit-reporting agencies. In general, and assuming that the
applicant's current mortgage is included on the credit report and that the
report shows sufficient depth of credit to provide a usable score, the frequency
of mortgage or other delinquencies is no longer counted, and credit grades are
assigned according to the table set forth below. However, if the mortgage is not
included on the credit report, the number of late payments in the last 12 months
determines the credit grade. That credit grade can be adjusted up or down one
grade by the FICO score.
<TABLE>
<CAPTION>
Product Type - First Mortgages
- --------------------------------------------------------------------------------------------------------------------------
FICO Score Credit Grade Mortgage Lates (12 Months)
- ------------------------------------------ -------------------------------- ---------------------------------------
<S> <C> <C>
710+ AAA 0
680-709 AA 0
640-679 A 1
610-639 A- 2
580-609 B+ 3
550-579 B 3
520-549 C 4 (or 1 60-day late)
500-519 D Mortgage cannot be 120 days past due
A FICO score is considered valid only if it contains a
mortgage reporting for at least 12 months plus one other "bona fide" trade line,
or three "bona fide" trade lines. A "bona fide" trade line is one which either
(i.) has a high balance or available credit of $1,000 and has been open and
reported on the credit report for at least 24 months, or (ii.) is an installment
debt of at least $5,000 which has been reported for 12 months. Any applicant
whose credit report does not contain an acceptable depth of credit is graded no
higher than "C".
The maximum debt-to-income ratio ("DTI") on all loans is 50%,
provided, however, that on grades B+ through D a DTI of up to 55% will be
permitted where the borrower possesses sufficient disposable income. The maximum
loan-to-value ratio ("LTV") on all first mortgages is 85%, except that "C" grade
mortgages are limited to 80% and D grade mortgages are limited to 70%. A similar
change has been made with respect to second-lien mortgages with combined
loan-to-value ratios ("CLTV") of up to 100%. In that case, however, in addition
to the use of FICO scores, a separate Bankruptcy Score is applied. This is
another numerical score provided by a proprietary Fair, Isaac computer model,
which attempts to predict the likelihood of a bankruptcy filing by the borrower.
Unlike FICO scores, in Bankruptcy Scores, a lower score is better. The following
table shows the FICO and Bankruptcy Score requirement for high-CLTV second lien
mortgages:
<CAPTION>
Product Type - Second Mortgages
----------------------------------------------------------------------------------------------------------
FICO Score Credit Grade Maximum CLTV Minimum Bankruptcy Score
----------------------- --------------------- -------------------- ------------------------------
<S> <C> <C> <C>
710+ AAA 100% 900
680-709 AA 100% 900
640-679 A 100% 900
610-639 A- 100% 800
580-609 B+ 100% 700
550-579 B 90% 600
-----------------------
In general, the maximum DTI on second mortgages is 50%.
</TABLE>
6
<PAGE>
The following tables provide information regarding the
Company's first and second-lien Mortgage Loan originations by credit
classification for the years ended December 31, 1999 and 1998:
<TABLE>
<CAPTION>
LOAN ORIGINATIONS BY CREDIT CLASSIFICATION
YEAR ENDED DECEMBER 31, 1999
(DOLLARS IN THOUSANDS)
INTERNAL LOAN CLASSIFICATION
-----------------------------------------------------------------------------------
AAA/AA/A/A- B C D TOTALS
------------ ------------ ------------ ----------- -------------
FIRST-LIEN MORTGAGE LOANS
<S> <C> <C> <C> <C> <C>
Amount $ 149,516 $ 12,446 $ 10,071 $ 2,898 $ 174,931
Percentage 85.5% 7.1% 5.7% 1.7% 100.0%
Weighted average coupon 10.1 11.3 12.0 11.9 10.4
Weighted average LTV ratio 85.2 78.8 75.0 74.4 82.3
SECOND-LIEN MORTGAGE LOANS
Amount $ 57,079 $ 580 $ 120 $ 159 $ 57,938
Percentage 98.5% 1.0% 0.2% 0.3% 100.0%
Weighted average coupon 13.9 14.2 14.1 14.8 14.3
Weighted average LTV ratio 110.2 84.8 81.1 90.0 112.2
<CAPTION>
LOAN ORIGINATIONS BY CREDIT CLASSIFICATION
YEAR ENDED DECEMBER 31, 1998
(DOLLARS IN THOUSANDS)
INTERNAL LOAN CLASSIFICATION
-----------------------------------------------------------------------------------
AA/A/A- B C D TOTALS
------------ ------------ ------------ ------------ -------------
FIRST-LIEN MORTGAGE LOANS
<S> <C> <C> <C> <C> <C>
Amount $ 369,153 $ 76,776 $ 44,226 $ 12,298 $ 502,453
Percentage 73.5% 15.3% 8.8% 2.4% 100.0%
Weighted average coupon 10.0 11.1 12.0 13.8 10.4
Weighted average LTV ratio 83.7 79.9 76.0 68.5 82.1
SECOND-LIEN MORTGAGE LOANS
Amount $ 138,166 $ 14,102 $ 4,321 $ 402 $ 156,991
Percentage 88.0% 9.0% 2.7% .3% 100.0%
Weighted average coupon 14.2 14.3 14.2 14.6 14.2
Weighted average LTV ratio 102.6 92.0 84.5 80.8 101.1
</TABLE>
Loan officers are trained to structure loans that meet the
applicant's needs, while satisfying the Company's lending criteria. If an
applicant does not meet the lending criteria, the loan officer may offer to make
a smaller loan, or request that the borrower obtain a co-borrower or guarantor,
in order to bring the application within the Company's lending parameters. The
amount the Company will lend to a particular borrower is determined by a number
of factors, including the borrower's creditworthiness, the value of the
borrower's equity in the real estate, and the ratio of such equity to the home's
appraised value.
In connection with its Mortgage Loan products, the Company
collects nonrefundable loan fees and various other fees, depending on state law,
such as fees for credit reports, lien searches, title insurance and recordings,
and appraisal fees. In connection with the servicing of the loans, the Company
may receive late fees and insufficient funds fees, where permitted by applicable
law.
SALE AND SECURITIZATION OF MORTGAGE LOANS
The Company sells a significant portion of the loans it
originates, primarily through two methods, whole loan cash sales and
securitization.
Whole loan cash sales are where loans are generally packaged
in pools of $1.0 million to $5.0 million. Historically, the Company has sold its
Mortgage Loans "servicing released" (i.e., without retention of the servicing
rights and associated revenues) and on a non-recourse basis, with certain
representations and warranties. The Company is required to repurchase any loan
if it is subsequently determined that any representation and warranty made with
respect to such loan was untrue.
In 1997, the Company began securitizing mortgage loans. Under
this method, the Company sells Mortgage Loans it purchased or originated to a
trust for cash. The trust sells asset-backed bonds secured by the loans to
investors. The Company records certain assets and income based upon the
difference between all principal and interest
7
<PAGE>
received from the loans sold and the following factors (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 as a residual receivable. The Company believes
the assumptions it has used in past securitizations are appropriate and
reasonable.
The following table sets forth for the periods indicated,
Mortgage Loans securitized and Mortgage Loans sold on a whole loan basis and
Mortgage Loans originated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1999 1998 1997
---------------- ---------------- -----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Mortgage loans securitized $ 59,630 $ 90,352 $ 487,563
Mortgage loans sold 220,382 625,480 435,333
------------ ------------- -------------
Total Mortgage loans sold or securitized $ 280,012 $ 715,832 $ 922,896
============ ============= =============
Total Mortgage loans originations $ 234,005 $ 659,444 $ 1,082,816
Mortgage loans sold or securitized as a % of Total
Mortgage loan originations 120% 108% 85%
</TABLE>
In connection with the cash sale of Mortgage Loans prior to
1998, the Company received premiums ranging from 2% to 6% of the principal
amount of the Mortgage Loans being sold, depending on prevailing interest rates
and the terms of the loans. During 1999, 1998, and 1997, the weighted average
premiums (discount) on the whole loan cash sales of mortgage loans were 2.03%,
(.40)%, and 2.75%, respectively. For the years ended December 31, 1999, 1998,
and 1997, gains (losses) recognized by the Company in connection with the whole
loan cash sales of Mortgage Loans were $4.5 million, $(2.5) million, and $11.1
million, respectively. In 1999 average premiums were impacted by industry
difficulties that occurred in the fourth quarter of 1998. In the fourth quarter
of 1998, the industry, which had been securitizing much of its loans during 1997
and most of 1998, began offering most of its loans to investors in the whole
loan sale market. This shift occurred because securitization became less
attractive as the corporate interest rate spreads required by investors
increased. A surplus in the market affected premiums paid, and continued to
affect premiums into 1999. However, in general throughout 1999, excluding
discount sales of second mortgages, premiums received have improved. In January
1999, average net premiums received were 1.19%. By December 1999, average net
premiums received were 3.43%.
Prior to the fourth quarter of 1998, the Company generally was
able to recognize higher premiums from securitizations compared to whole loan
sale. However, cash flow is impacted more positively in the short term by whole
loan sales, compared to securitizations.
In 1999, the Company completed a securitization transaction in
the second quarter. The Company securitized $59.6 million of loans for a
weighted average premium of 2.88%. This securitization consisted of seasoned
first and second mortgage loans, resulting in a lower than average premium.
However, the securitization of seasoned loans resulted in additional liquidity
of $33.0 million for the Company. Certain loans included in that securitization
were ineligible for inclusion in the borrowing base under the Company's
warehouse line of credit.
For the year ended December 31, 1999, gains recognized into
income by the Company in connection with the securitization of Mortgage Loans
were $1.7 million. The gains recognized into income, resulting from
securitization transactions, can 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. See " Loan Sales and Securitizations" under Management's
Discussion and Analysis of Financial Condition and Results of Operations.
8
<PAGE>
During the last two quarters of the year, the Company sold its
loans on a whole-loan, servicing released basis. The Company makes
securitization decisions based on a number of factors including conditions in
the secondary market, the aggregate size and weighted average coupon of loans
available to sell, fixed costs associated with securitization transactions, and
liquidity needs. During 1999, investors' attitudes improved, and opportunities
for securitization transactions increased. The Company believes that it will
continue to securitize, as well as whole loan sell, in 2000.
MORTGAGE LOAN SERVICING, DELINQUENCIES AND COLLECTIONS
SERVICING
The Company maintains a centralized portfolio management
department located in Greenville, South Carolina which services Mortgage Loans.
Prior to 1997, the Company did not retain the servicing on Mortgage Loans sold.
Beginning in March 1997, the Company began retaining servicing for Mortgage
Loans it securitized. Servicing includes depositing cash received and posting
payments to accounts for principal and interest, remitting funds to the Trustee,
imaging documents, collection activities on past due accounts, management of
loss mitigation activities and foreclosure and sale of properties, ensuring that
insurance is in place, monitoring payment of real estate property taxes,
customer service and retention activities and warehouse funding management. The
Company does not escrow funds for purposes of insurance and taxes. However, it
has the right to purchase insurance and pay taxes, which, if paid by the
Company, are charged back to the borrower.
The Company serves as master servicer for all of the Mortgage
Loan securitizations which it has effected to date. In connection with such
securitizations, the Company's servicing operation was reviewed by the rating
agencies which rated the bonds issued in connection with such securitizations.
Because the Company completed only one securitization in each
of the years 1999 and 1998, and sold the majority of loans originated on a
"servicing released" basis, the servicing portfolio has declined from $768.6
million at December 31, 1997, to $408.5 million at December 31, 1999. Consistent
with the Company's strategy to match staffing levels with servicing volume,
staffing levels declined through 1999.
DELINQUENCIES AND COLLECTIONS
Collection efforts generally begin when a Mortgage Loan is
over eight days past due, unless the account has previous unpaid late fees, in
which case collection efforts generally begin when an account is over one day
past due. At that time, the Company generally contacts the borrower by telephone
to determine the reason for the delinquency and attempts to bring the account
current. Typically, after an account becomes 15 days past due, the Company sends
a reminder letter to the borrower, and then sends subsequent letters at 30 days
past due, 41 days past due, and 55 days past due. In general, at 41 days past
due, the Company sends a right-to-cure letter. After 90 days, the Company sends
a five day demand letter and turns the account over to an attorney. In addition
to written notices, the Company attempts to maintain telephone contact with the
borrower at various times throughout the delinquency period. If the status of
the account continues to deteriorate, the Company's loss mitigation unit works
on a dual track along with the foreclosure unit to try to save the borrowers
from a foreclosure action, while at the same time, trying to keep the
foreclosure timelines as short as possible. In limited circumstances, when a
borrower is experiencing difficulty in making timely payments, the Mortgage Loan
Operations may temporarily adjust the borrower's payment schedule. The
determination of how to work out a delinquent loan is based upon a number of
factors, including the borrower's payment history and the reason for the current
inability to make timely payments.
The Company utilizes a proprietary Real RewardsTM program
designed to counsel its borrowers on budgeting concepts, to assist them in their
personal financial planning, to help them avoid costly foreclosure action and to
educate them on the advantages and the importance of maintaining good credit.
The Company stresses to the borrowers the importance of their home, and why they
should make the mortgage payment ahead of other creditors in the event of tight
cash flow.
9
<PAGE>
When a loan is 90 days past due, generally, it is placed on
non-accrual status and the Company initiates foreclosure proceedings. In
connection with such foreclosure, the Company reviews the loan and the facts
surrounding its delinquency, and may reappraise the underlying property.
Regulations and practices regarding foreclosure and the rights of the mortgagor
in default vary greatly from state to state. If deemed appropriate, the Company
will bid in its loan amount at the foreclosure sale or accept a deed in lieu of
foreclosure. The residential real estate owned portfolio, which is carried at
the lower of carrying value or appraised fair market value less estimated cost
to sell, totaled $7.7 million, $5.9 million, and $2.5 million at December 31,
1999, 1998, and 1997, respectively.
The following table sets forth for the periods indicated
information relating to the delinquency and loss experience of the Company with
respect to its Mortgage Loans serviced:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1999 1998 1997
------------- ------------- -------------
(Dollars in Thousands)
<S> <C> <C> <C>
Total serviced Mortgage Loans (period end) (1) $ 408,529 $ 550,304 $ 768,556
Serviced Mortgage Loans (period end) (2) 408,529 550,304 700,248
Average serviced Mortgage Loans (2) 488,057 743,362 411,549
Delinquency (period end)
30-59 days past due:
Principal balance $ 16,461 $ 28,174 $ 25,424
% of serviced Mortgage Loans (2) 4.03% 5.12% 3.63%
60-89 days past due:
Principal balance $ 5,325 $ 8,647 $ 9,383
% of serviced Mortgage Loans (2) 1.30% 1.57% 1.34%
90 days or more past due:
Principal balance $ 28,997 $ 38,109 $ 21,233
% of serviced Mortgage Loans (2) 7.10% 6.93% 3.03%
Total delinquencies:
Principal balance $ 50,783 $ 74,930 $ 56,040
% of serviced Mortgage Loans (2) 12.43% 13.62% 8.00%
Real estate owned (period end) 7,673 $ 5,881 $ 2,522
Net charge-offs 3,686 6,842 1,305
% of net charge-offs to average serviced Mortgage Loans 0.75% 0.92% 0.32%
</TABLE>
(1) Includes loans subserviced for others, where the Company has no credit risk.
(2) Does not include loans subserviced for others, where the Company has no
credit risk.
Since substantially all of the Company's loans are to
non-prime borrowers who have limited access to credit or who may be considered
credit-impaired by conventional lending standards, the percentage of the
Company's loans past due is expected to be higher than a financial institution
that provides loans to prime borrowers.
SMALL BUSINESS LOAN PRODUCTS
The Company sold substantially all of the assets of the small
business loan operations to TransAmerica Small Business Capital, Inc.
("TransAmerica") in the fourth quarter of 1998. The Company maintains a $5.3
million investment account with a trustee relating to representations and
warranties in connection with the sale of the small business loan unit. Both the
Company and TransAmerica must agree for funds to be released to either party
from the escrow account. On February 26, 1999, the Company received notification
from TransAmerica that pursuant to the asset purchase agreement dated October 2,
1998, a loan for approximately $1.1 million was allegedly not made by the
Company in accordance with stated representations. TransAmerica is seeking to
recover the loan amount from the Company's $5.3 million that is being maintained
by the trustee. The Company has made a Demand for Arbitration, which is the
method agreed upon in the terms of the sale agreement for resolving disputes.
The Company does not expect settlement of the claim to have a material effect on
the Company's operations. The Company no longer offers the small business loan
products.
The small business loan unit originations during 1998 and 1997
totaled $122.9 million and $81.0 million, respectively. This unit sold $141.0
million and $41.2 million of loans during 1998 and 1997, respectively. This unit
also securitized $1.8 million and $24.3 million of loans in 1998 and 1997,
respectively. The Small Business Loan Unit realized net income in 1998 and 1997
of $11.0 million and $5.0 million, respectively. Included in the 1998 net income
was a $19.0 million pre-tax gain on sale of the Small Business Loan Unit's net
assets.
10
<PAGE>
AUTO LOAN PRODUCTS
The Company sold substantially all of the assets of the auto
loan unit on March 19, 1998 for $20.4 million, the approximate book value of the
assets. The Company no longer offers auto loans as one of its financial
products.
Prior to the sale of the auto loan assets in 1998 and in 1997,
the auto loan unit recorded net losses of $110,000 and $1.9 million,
respectively.
COMPETITION
The financial services industry, including the markets in
which the Company operates, is highly competitive. Competition is based on the
type of loan, interest rates, and service. Traditional competitors in the
financial services industry include commercial banks, credit unions, thrift
institutions, credit card issuers, consumer and commercial finance companies,
and leasing companies, many of which have considerably greater financial and
marketing resources than the Company. Moreover, major brokerage firms, insurance
companies, retailers and bank holding companies have formed substantial national
financial services networks. The Company believes that it competes effectively
in its markets by providing competitive rates and efficient, complete services.
The Company faces significant competition in connection with
its Mortgage Loan products, principally from national companies which focus
their efforts on making mortgage loans to non-prime borrowers. Many of these
companies have considerably greater financial and marketing resources than the
Company. Although these large national companies compete in the mortgage loan
industry, this industry, as a whole, is highly fragmented and no one company has
a significant share of the total mortgage loan market. The Company attempts to
maintain its competitiveness by servicing its retail mortgage loans and by
maintaining and developing its strong relationships with mortgage brokers. If
the Company is not successful in these regards, the Company's operations could
be materially and adversely affected. See "Mortgage Loan Products -- Mortgage
Loan Origination."
REGULATION
The Company's operations are subject to extensive local, state
and federal regulations including, but not limited to, the following federal
statutes and regulations promulgated thereunder: Title 1 of the Consumer Credit
Protection Act of 1968, as amended (including certain provisions thereof
commonly known as the "Truth-in-Lending Act" or "TILA"), the Equal Credit
Opportunity Act of 1974, as amended ("ECOA"), the Home Mortgage Disclosure Act,
the Fair Credit Reporting Act of 1970, as amended ("FCRA"), the Fair Debt
Collection Practices Act, as amended, the Real Estate Settlement Procedures Act
("RESPA") and the National Housing Act, as amended. In addition, the Company is
subject to state laws and regulations, including those with respect to the
amount of interest and other charges which lenders can collect on loans (e.g.,
usury laws).
Mortgage lending laws generally require lenders to be
licensed, and place limitations on the amount, duration and charges for various
categories of loans, require adequate disclosure of certain contract terms and
place limitations on certain collection practices and creditor remedies. Many
states have usury laws that limit interest rates, although the limits generally
are considerably higher than current interest rates charged by the Company.
State regulatory authorities may conduct audits of the books, records and
practices of the Company's operations. The Company is licensed to do business in
each state in which it does business and in which such licensing is required and
believes it is in compliance in all material respects with these regulations.
The Company's Mortgage Loan origination activities are subject
to TILA. TILA contains disclosure requirements designed to provide consumers
with uniform, understandable information with respect to the terms and
conditions of loans and credit transactions in order to give them the ability to
compare credit terms. TILA also guarantees consumers a three-day right to cancel
certain credit transactions, including any refinanced mortgage or junior
mortgage loan on a consumer's primary residence. The Company believes that it is
in substantial compliance in all material respects with TILA.
11
<PAGE>
The Company is also required to comply with the ECOA, which,
in part, prohibits creditors from discriminating against applicants on the basis
of race, color, religion, national origin, sex, age or marital status. ECOA
restricts creditors from obtaining certain types of information from loan
applicants. It also requires certain disclosures by the lender regarding
consumer rights and requires lenders to advise applicants who are turned down
for credit of the reasons therefor. In instances where a loan applicant is
denied credit, or the rate or charge for a loan is increased as a result of
information obtained from a consumer credit agency, another statute, the FCRA,
requires the lender to supply the applicant with the name, address and phone
number of the reporting agency. RESPA was enacted to provide consumers with more
effective advance disclosures about the nature and costs of the settlement
process, and to eliminate kickbacks or referral fees that raised the costs of
settlement services. RESPA applies to virtually all mortgages on residential
real property that is designed principally for occupancy of one to four
families. Specific disclosures mandated by RESPA include, without limitation,
estimates of closing costs, transfers of servicing, affiliated business
arrangements and other settlement information.
In the opinion of management, existing statutes and
regulations have not had a materially adverse effect on the business done by the
Company. However, it is not possible to forecast the nature of future
legislation, regulations, judicial decisions, orders or interpretations, nor
their impact upon the future business, financial condition or prospects of the
Company.
The Company believes that it is in substantial compliance with
state and federal laws and regulations governing its lending activities.
However, there can be no assurance that the Company will not inadvertently
violate one or more of such laws and regulations. Such violations may result in
actions for damages, claims for refunds of payments made, certain fines and
penalties, injunctions against certain practices, and the potential forfeiture
of rights to repayment of loans. Further adverse changes in the laws or
regulations to which the Company's business is subject, or in the interpretation
thereof, could have a material adverse effect on the Company's business.
EMPLOYEES
At December 31, 1999, the Company employed a total of 387
full-time equivalent employees. Although the Company has experienced staffing
reductions during 1999, it believes that relations with the remaining employees
are good.
ITEM 2. PROPERTIES
The Company's headquarters are located at 3901 Pelham Road,
Greenville, South Carolina and are owned by the Company. At December 31, 1999,
the Company owned one office and leased twelve offices. None of the leases,
considered separately or collectively, are believed to be material to the
Company's operations. The Company believes that its leased and owned locations
are suitable and adequate for their intended purposes.
ITEM 3. LEGAL PROCEEDINGS
On February 26, 1999, the Company received notification from
TransAmerica Small Business Capital, Inc. ("TransAmerica") that pursuant to the
asset purchase agreement dated October 2, 1998, a loan for approximately $1.1
million was allegedly not made by the Company in accordance with stated
representations. TransAmerica has filed an action in the Circuit Court of Cook
County, Illinois seeking to recover the loan amount from the Company's $5.3
million that is being maintained by the trustee. This action is stayed at this
time, and is before the American Arbitration Association, following the
Company's successful motion to compel arbitration. TransAmerica has appealed the
order compelling arbitration to the Appellate Court of Illinois, First District.
As a part of the agreement to sell Sterling Lending ("SLC") in
1998, the Company guaranteed certain leases of office space used by SLC. In
1999, SLC filed for bankruptcy protection and due to the financial situation of
SLC, the Company has been asked to perform under certain of the guarantees. The
Company is resolving each lease through active negotiations with the landlords,
and management feels that the resolution of these leases will not be material to
the financial statements of the Company.
12
<PAGE>
On August 20, 1999, Janice Tomlin, Isaiah Tomlin, and
Constance Wiggins filed a purported class action lawsuit in New Hanover County,
North Carolina Superior Court. The suit was filed against a subsidiary of the
Company and others alleging a variety of statutory and common law claims arising
out of mortgage loans they obtained through Chase Mortgage Brokers ("Chase").
The plaintiffs are seeking unspecified monetary damages. As to the Company's
subsidiary, the complaint alleges participation by the Company's subsidiary in
an arrangement with Chase under which Chase allegedly charged excessive fees and
interest to the consumers, and under which Chase allegedly received undisclosed
premiums. There has been no class certification, and the Company intends to
contest the case vigorously. Because this matter is in its early stages, it is
not possible to evaluate the likelihood of an unfavorable outcome or estimate
the amount of potential loss.
The Company and its subsidiaries are, from time to time,
parties to various legal actions arising in the normal course of business.
Management believes that there is no proceeding threatened or pending against
the Company or any of its subsidiaries that, if determined adversely, would have
a materially adverse effect on the operations, profitability or financial
condition of the Company or any of its subsidiaries.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
No matter was submitted to a vote of security holders during
the fourth quarter of the Company's 1999 fiscal year.
13
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
The Company's common stock presently is traded on the NASDAQ
National Market under the symbol "HGFN". Continued listing on the NASDAQ
National Market requires compliance with certain criteria. In the event the
Company fails to comply with this criteria, its securities may be listed on "The
Nasdaq SmallCap Market" pursuant to the maintenance criteria. In the event the
Company is unable to comply with the listing requirements of The Nasdaq SmallCap
Market, its securities may be delisted from The NASDAQ Stock Market. Based on
the Company's current financial conditions, the Company currently meets the
financial conditions that are outlined for continued listing. However, no
assurance can be given that the Company's future operating results will meet the
criteria for continued listing on the NASDAQ market.
According to Rule 4450 of the NASD Manual, the following quantitative
maintenance criteria (Maintenance Standard 1) must be met for continued
listing:
(1) There are at least 750,000 publicly held shares.
(2) The market value of publicly held shares is at least $5 million.
(3) The issuer of the security has net tangible assets of at least $4 million.
(4) The issuer has a minimum of 400 round lot shareholders.
(5) The minimum bid price per share of $1.
The following table sets forth the high and low closing sale prices of the
common stock for the periods indicated, as reported by NASDAQ.
High Low
------------- -------------
YEAR ENDED DECEMBER 31, 1998
First Quarter $14.50 $7.50
Second Quarter $ 9.50 $3.25
Third Quarter $ 5.25 $2.00
Fourth Quarter $ 1.81 $0.44
YEAR ENDED DECEMBER 31, 1999
First Quarter $ 2.22 $0.34
Second Quarter $ 1.94 $1.06
Third Quarter $ 1.50 $0.97
Fourth Quarter $ 1.25 $0.63
On February 28, 2000, the closing price for the Company's
common stock was $1.09375. As of February 28, 2000, the Company had 10,171,416
outstanding shares of common stock held by 850 stockholders of record.
No dividends on common stock were paid or declared during 1999
or 1998, and no dividends are expected to be paid on the common stock for the
foreseeable future. The Indenture pertaining to the Company's 10-3/4% Senior
Notes places certain restrictions on the Company's ability to pay dividends, and
the Credit Facility to which the Company's subsidiaries HomeGold, Inc. and
Carolina Investors, Inc. are parties restricts the ability of these subsidiaries
to pay dividends and make loans and advances to the Company. See "Management's
Discussion and Analysis of Financial Conditions and Results of
Operations--Liquidity and Capital Resources" which discussion is incorporated
herein by reference.
14
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth historical selected financial
information of the Company as of the dates and for the periods indicated. The
statement of income data, cash flow data, and balance sheet data are derived
from the audited financial statements of the Company. The data set forth below
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Company's Consolidated
Financial Statements and Notes thereto included elsewhere in this Report.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1999 1998 1997 1996 1995
----------- ------------ ----------- ------------ ------------
(Dollars in thousands)
STATEMENT OF INCOME DATA:
<S> <C> <C> <C> <C> <C>
Interest income $ 8,286 $ 35,075 $ 34,008 $ 17,908 $ 15,193
Servicing income 9,813 12,239 8,514 3,274 446
Gain on sale of loans:
Gross gain on sale of loans 6,216 9,472 52,828 23,815 9,169
Loan fee, net 3,313 11,745 30,207 4,150 586
---------- ---------- ---------- --------- ---------
Total gain on sale of loans 9,529 21,217 83,035 27,965 9,755
Gain on sale of subsidiaries' net assets (1) -- 18,964 -- -- --
Other revenues 1,609 4,230 1,399 1,241 884
---------- ---------- ---------- --------- ---------
Total revenues 29,237 91,725 126,956 50,388 26,278
Interest expense 16,338 35,968 25,133 11,021 8,527
Provision for credit losses 3,339 11,906 10,030 5,416 2,480
Costs on real estate owned and defaulted loans 3,018 2,665 876 380 195
Fair value adjustment on residual receivable 3,327 13,638 -- -- --
Restructuring charges (2) -- 6,838 -- -- --
General and administrative expenses 38,286 93,701 83,408 23,110 10,224
---------- ---------- ---------- --------- ---------
Total expenses 64,308 164,716 119,447 39,927 21,426
---------- ---------- ---------- --------- ---------
Income (loss) from continuing operations before
Income taxes, minority interest and
extraordinary item (35,071) (72,991) 7,509 10,461 4,852
Provision (benefit) for income taxes (7,394) 3,017 (3,900) 718 190
---------- ---------- ---------- --------- ---------
Income (loss) from continuing operations before
Minority interest and extraordinary item (27,677) (76,008) 11,409 9,743 4,662
Minority interest in (earnings) loss of subsidiaries (8) 47 (156) 352 (81)
---------- ---------- ---------- --------- ---------
Income (loss) from continuing operations before
Extraordinary item (27,685) (75,961) 11,253 10,095 4,581
Income (loss) from discontinued operations (3) -- -- -- -- (3,924)
Extraordinary item-gain on extinguishment of debt,
net of $0 tax (4) 29,500 18,216 -- -- --
---------- ---------- ---------- --------- ---------
Net income (loss) $ 1,815 $ (57,745) $ 11,253 $ 10,095 $ 657
========== ========== ========== ========= =========
DILUTED EARNINGS PER SHARE:
Continuing operations (2.78) (7.81) 1.17 1.42 0.69
Discontinued operations -- -- -- -- (0.59)
Extraordinary item 2.96 1.87 -- -- --
---------- ---------- ---------- --------- ---------
Net income (loss) per share $ 0.18 $ (5.94) $ 1.17 1.42 $ 0.10
========== ========== ========== ========= =========
CASH FLOW DATA:
Cash flow due to operating cash income and expenses (18,993) (62,775) (26,652) 14,174 6,849
Cash provided by (used in)loans held for sale and other 26,210 147,055 (119,637) (92,652) (17,025)
---------- ---------- ---------- --------- ---------
Net cash provided by (used in) operating activities $ 7,217 $ 84,280 $ (146,289) (78,478) $ (10,176)
========== ========== ========== ========= =========
BALANCE SHEET DATA:
Total gross loans receivable $ 63,242 $ 124,740 $ 297,615 189,532 $ 126,458
Total residual assets, net 47,770 43,857 63,202 13,215 3,831
Total assets 188,737 257,208 416,152 224,149 144,931
Total debt 174,717 239,276 336,920 169,596 129,950
Total shareholders' equity $ 7,844 $ 5,801 $ 63,374 $ 46,635 $ 9,885
- -----------------------------------
(1) See Footnote 12. Sale of Subsidiary and Subsidiary's Assets in Notes to
Consolidated Financial Statements.
(2) See Footnote 14. Restructuring Charge in Notes to Consolidated Financial
Statements.
(3) The Company discontinued its apparel segment in 1995.
(4) See Footnote 17. Extraordinary Item-Gain on Extinguishment of Debt in
Notes to Consolidated Financial Statements.
</TABLE>
15
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
This discussion should be read in conjunction with the
Consolidated Financial Statements and Notes of the Company appearing elsewhere
in this report.
FORWARD - LOOKING INFORMATION
From time to time, the Company makes oral and written
statements that may constitute "forward-looking statements" (rather than
historical facts) as defined in the Private Securities Litigation Reform Act of
1995 (the "Act") or by the SEC in its rules, regulations and releases, including
Section 27A of the Securities Exchange Act of 1933, as amended, and Section 21E
of the Securities Exchange Act of 1934, as amended. The Company desires to take
advantage of the "safe harbor" provisions in the Act for forward-looking
statements made from time to time, including, but not limited to, the
forward-looking statements made in this Annual Report on Form 10-K (the "Annual
Report"), as well as those made in other filings with the SEC, its Annual Report
to Shareholders, and other financial discussion and analysis by management that
reflect projections or future financial or economic performance of the Company.
Such forward-looking statements are based on management's current plans and
expectations and are subject to risks and uncertainties that could cause actual
results to differ materially from those described in the forward-looking
statements. In the preparation of this Annual Report, where such forward-looking
statements appear, the Company has sought to accompany such statements with
meaningful cautionary statements identifying important factors that could cause
actual results to differ materially from those described in the forward-looking
statements. Such factors include, but are not limited to: lower origination
volume due to market conditions, inability to achieve desired efficiency levels,
higher losses due to economic downturn or lower real estate values, loss of key
employees, adverse consequences of changes in interest rate environment,
deterioration of creditworthiness of borrowers and risk of default, general
economic conditions in the Company's markets, including inflation, recession,
interest rates and other economic factors, loss of funding sources, loss of
ability to sell loans, general lending risks, dependence on Federal programs,
impact of competition, regulation of lending activities, changes in the
regulatory environment, lower than anticipated premiums on loan sales, lower
than anticipated origination fees, adverse impact of lawsuits, faster than
anticipated prepayments on loans, losses due to breach of representation or
warranties under previous agreements, and other detrimental developments.
The preceding list of risks and uncertainties, however, is not
intended to be exhaustive, and should be read in conjunction with other
cautionary statements made herein, including, but not limited to, risks
identified from time to time in the Company's SEC reports, registration
statements and public announcements.
GENERAL
The Company is headquartered in Greenville, South Carolina,
and primarily engages in the business of originating, purchasing, selling,
securitizing and servicing mortgage loan products to sub-prime customers. Prior
to the sale of the Company's auto loan portfolio in March 1998, the Company also
originated, securitized and serviced auto loans. Prior to the sale of
substantially all of the assets of the small business loan unit in the fourth
quarter of 1998, the Company made loans to small businesses primarily for the
acquisition or refinancing of real estate or property, plant and equipment,
working capital, and debt consolidation. The Company commenced its lending
operations in 1991 through the acquisition of Carolina Investors, Inc., a small
mortgage lending company, which had been in operation since 1963.
In the last few years, the Company has undergone significant
changes. In 1997, the Company decided to focus primarily on the Company's larger
direct mail retail mortgage operation and its mortgage brokerage business. This
resulted in the sale of the auto loan operations in early 1998, the sale of the
small retail origination subsidiary, Sterling Lending Corp. ("SLC") in August
1998, and the sale of substantially all of the assets of the small business loan
operations in November 1998. Beginning in the fourth quarter of 1997, the
Company began restructuring its retail Mortgage Loan distribution channel.
Having assessed market conditions, management made strategic decisions to
streamline retail mortgage lending operations. Retail lending operations located
in Indianapolis, Indiana, Phoenix, Arizona, and Houston, Texas were consolidated
in November 1998 into the Greenville retail operating center located at the
Company headquarters in Greenville, South Carolina.
16
<PAGE>
The impact of the above restructuring resulted in the
elimination of 204 positions or approximately 28% of the Company's work force.
The Company incurred a $6.8 million restructuring charge in the fourth quarter
of 1998 as a result of this decision. However, management feels these charges
have been beneficial by creating efficiencies through consolidation of
operations and implementation of strategic directives, and better alignment of
expenses with current levels of production.
In 1999, management has focused on improving processes,
especially in the retail origination channel. The changes that have been
implemented are designed to improve production levels without increasing costs.
One of the focal points of these changes is the time between application and
funded loan. Management has streamlined the application, information gathering,
and underwriting processes to reduce the processing time, and reduce the loss of
customers to competitors. The Company's primary objective in 2000 will continue
to be to increase loan originations while preserving liquidity, and to work
towards achieving profitability from operations.
As a part of the Company's strategy to maintain high levels of
liquidity, the Company made a decision to reduce the size of the loan portfolio.
Many of the loans in the portfolio were ineligible for the full advance rate
under the Company's warehouse line of credit. The sale of those loans created
excess liquidity that was used in 1999 to repurchase $74.5 million face value of
its senior unsecured debt for a purchase price of $45.0 million and realize an
extraordinary gain of $29.5 million (net of tax) on the extinguishment of this
debt. The Company may, from time to time, continue to acquire its senior debt.
$12.1 million of the original $125.0 million Senior Notes remain at December 31,
1999.
As a result of higher customer loan prepayments than
anticipated on both the portfolio and the securitized loan pools and the
decision to reduce the loan portfolio by whole loan selling loans, the Company's
serviced mortgage loan portfolio declined from $550.3 million at the end of 1998
to $418.9 million (including $10.4 million small business loans) at the end of
1999.
The combination of the above factors resulted in the Company
having $26.0 million of cash and overnight investments on hand at December 31,
1999. The Company also had additional availability under its warehouse line of
credit at the end of 1999 of $1.1 million. The Company will continue its effort
to closely monitor its liquidity position while maximizing opportunities for
achieving profitability in 2000.
17
<PAGE>
The following table sets forth certain data relating to the
Company's various loan products at and for the periods indicated:
<TABLE>
<CAPTION>
AT AND FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------------
1999 1998 1997
------------ ----------- -------------
(DOLLARS IN THOUSANDS)
MORTGAGE LOANS:
<S> <C> <C> <C>
Mortgage loans originated $ 234,005 $ 659,444 $ 1,176,800
Mortgage loans sold 220,382 623,675 435,333
Mortgage loans securitized 59,630 92,173 487,563
Total mortgage loans owned (period end) 63,242 117,685 231,145
Total serviced mortgage loans (period end) 408,529 550,304 768,556
Total serviced unguaranteed mortgage loans (period end) (1) 408,529 550,304 700,248
Average mortgage loans owned (2) 72,711 245,915 215,790
Average serviced mortgage loans (2) 478,386 744,221 443,318
Average serviced unguaranteed mortgage loans (1) 478,386 743,362 411,549
Average interest earned (2) 8.67% 10.34% 10.92%
SMALL BUSINESS LOANS:
Small business loans originated $ -- $ 122,902 $ 81,018
Small business loans sold -- 141,041 41,232
Small business loans securitized -- 1,827 24,286
Total small business loans owned (period end) 10,388 7,054 45,186
Total serviced small business loans (period end) 10,388 7,054 198,876
Total serviced unguaranteed small business loans (period
end) (3) 10,388 7,054 78,822
Average small business loans owned (2) 9,671 59,598 38,427
Average serviced small business loans (2) 9,671 202,446 165,053
Average serviced unguaranteed small business loans (2) (3) 9,671 82,270 61,420
Average interest earned (2) 6.37 % 14.28% 15.89%
AUTO LOANS:
Auto loans originated $ -- $ 2,982 $ 15,703
Auto loans sold -- 20,898 --
Auto loans securitized -- -- --
Total auto loans owned (period end) -- -- 21,284
Total serviced auto loans (period end) -- -- 21,284
Average auto loans owned (2) -- 5,340 17,104
Average serviced auto loans (2) -- 5,340 22,267
Average interest earned (2) -- % 21.28% 24.05%
TOTAL LOANS:
Total loans originated $ 234,005 $ 785,328 $ 1,273,521
Total loans sold 220,382 785,614 476,565
Total loans securitized 59,630 94,000 511,849
Total loans receivable (period end) 73,630 124,739 297,615
Total serviced loans (period end) 418,917 557,358 988,716
Total serviced unguaranteed loans (period end) (1)(3) 418,917 557,358 800,354
Average loans owned 82,382 310,853 271,321
Average serviced loans 488,057 952,007 630,638
Average serviced unguaranteed loans 488,057 830,972 495,236
Average interest earned 8.40% 11.28% 12.53%
</TABLE>
- ---------------------------------
(1) Excludes loans serviced for others with no credit risk to the Company.
(2) Averages are computed based on the daily averages except for monthly
averages for Mortgage Loans in 1997.
(3) Excludes guaranteed portion of SBA Loans.
18
<PAGE>
RESULTS OF OPERATIONS
For the periods indicated, the following table sets forth
certain information derived from the Company's Consolidated Financial Statements
expressed as a percentage of total revenues.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------
1999 1998 1997
----------- ----------- ----------
<S> <C> <C> <C>
Interest income 28.3% 38.2% 26.8%
Servicing income 33.6 13.3 6.7
Gross gain on sale of loans 21.3 10.4 41.6
Loan fee income, net 11.3 12.8 23.8
Gain on sale of subsidiaries' net asset -- 20.7 --
Other revenues 5.5 4.6 1.1
----------- ----------- ----------
Total revenues 100.0% 100.0% 100.0%
=========== =========== ==========
Interest expense 55.9% 39.2% 19.8%
Provision for credit losses 11.4 13.0 7.9
Costs on real estate owned and defaulted loans 10.3 2.9 0.7
Fair value adjustment on residual receivables 11.4 14.9 --
Salaries, wages and employee benefits 69.0 61.7 37.8
Business development costs 16.4 11.8 5.9
Restructuring charges -- 7.5 --
Other general and administrative expenses 45.6 28.7 22.0
----------- ----------- ----------
Income (loss) before income taxes, minority interest and extraordinary item (120.0) (79.7) 5.9
Provision (benefit) for income taxes (25.3) 3.3 (3.1)
Minority interest in (earnings) loss of subsidiary -- .01 (0.1)
Extraordinary item 100.9 19.9 --
----------- ----------- ----------
Net income (loss) 6.2% (63.0)% 8.9%
=========== =========== ==========
</TABLE>
YEAR ENDED DECEMBER 31, 1999, COMPARED TO YEAR ENDED DECEMBER 31, 1998
The Company recognized net income of $1.8 million for the year
ended December 31, 1999 as compared to a net loss of $57.7 million for the year
ended December 31, 1998. Included in net income for 1999 and 1998 is $29.5
million and $18.2 million, respectively of extraordinary gain on extinguishment
of debt. In 1999, the Company realigned its processes and its expense structure
to correspond with a lower loan production level.
Total revenues decreased $62.5 million, or 68.1%, to $29.2
million for the year ended December 31, 1999 from $91.7 million for the year
ended December 31, 1998. 1998 amounts include revenues from operations that were
sold in 1998. 1998 revenue from the mortgage operations, net of a sold
subsidiary, is a more comparable figure, at $52.6 million for 1998. The lower
level of revenues resulted principally from lower mortgage loan production
levels and lower gains on sale of loans. The lower gains on sale of loans were a
result of a combination of lower volumes of loans sold and lower overall
premiums.
Interest income decreased $26.8 million, or 76.4%, to $8.3
million for the year ended December 31, 1999 from $35.1 million for the year
ended December 31, 1998. The decrease in interest income resulted primarily from
a $228.5 million, or 73.5%, decrease in average loan balance to $82.4 million in
1999 from $310.9 million in 1998. The decrease in the average loan balance
resulted from a $64.8 million decrease in the Company's mortgage loan portfolio,
the sale of the small-business loan portfolio and the sale of the auto loan
portfolio. This decrease was compounded by a reduction in the average yield of
290 basis points. The yield in 1999 was 8.40% compared to 11.28% in 1998 due
primarily to loans on non-accrual status. The decrease in the average yield is
also due to the changes in the types of loans in the Company's portfolio.
Weighted average mortgage rates declined 167 basis points from 10.34% in 1998 to
8.67% in 1999.
Servicing income decreased $2.4 million, or 19.8%, to $9.8
million for the year ended December 31, 1999 from $12.2 million for the year
ended December 31, 1998. This decrease was due principally to the sale of the
assets of the small business loan unit in November 1998. The average serviced
mortgage loan portfolio decreased $269.1 million, or 36.1%, to $475.1 million
for the year ended December 31, 1999 from $744.2 million for the year ended
December 31, 1998.
19
<PAGE>
Gross gain on sale of loans declined $3.3 million, or 34.4%,
to $6.2 million for the year ended December 31, 1999, from $9.5 million for the
year ended December 31, 1998 due to lower gain on sale from securitization
transactions. The securitization transaction completed in May 1999 were older
seasoned loans which included some second mortgage loans. As a result, higher
estimated losses are anticipated on this pool. Cash gain on sale of loans
increased $3.1 million, or 233.2%, to $4.5 million for the year ended December
31, 1999 from $1.3 million for the year ended December 31, 1998. The increase
resulted principally from the Company's decision to focus on liquidity and
whole-loan sales in late 1998 and in 1999.
Loans sold decreased $498.9 million, or 64.1%, to $280.0
million for the year ended December 31, 1999 from $778.9 million for the year
ended December 31, 1998. The decrease in loans sold resulted from lower
originations of mortgage loans held for sale and from the sale of Sterling
Lending and the small business loan units in 1998. The weighted average cash
gain on sale of loans was 2.03% and 0.2% for the years ended December 31, 1999
and 1998, respectively.
Non-cash gain on sale of loans decreased $6.4 million, or
78.6%, to $1.7 million for the year ended December 31, 1999 from $8.1 million
for the year ended December 31, 1998. The decrease in non-cash gain on sale of
loans was due principally to the Company's decision to sell most of its 1999
originations servicing-released and to securitize seasoned first and second
mortgage loans. The Company securitized $59.6 million in loans for the year
ended December 31, 1999 and recognized a weighted average non-cash gain on sale
as a percentage of loans securitized of 2.88%, net of expenses. The Company
securitized $92.3 million in loans for the year ended December 31, 1998 and
recognized a weighted average non-cash gain on sale as a percentage of loans
securitized of 8.81%, net of expenses.
Loan fees decreased $8.4 million, or 71.8%, to $3.3 million
for the year ended December 31, 1999 from $11.7 million for the year ended
December 31, 1998. Loan fees received as a percentage of retail production for
the year ended December 31, 1999 were 4.01% as compared to 4.65% for the year
ended December 31, 1998. 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.
In 1998, the Company realized a net $19.0 million gain on sale
of subsidiaries' net assets. The Company completed the sale of substantially all
of the assets of its auto loan unit for book value on March 19, 1998. No
significant gain or loss was recognized on this transaction. On August 21, 1998,
the Company completed the sale of its small branch network retail mortgage
origination unit, Sterling Lending Corporation. There was no significant gain or
loss recorded as a result of this sale. On November 13, 1998, the Company sold
the majority of the assets of its small business lending units. The gain
realized in 1998 was approximately $19.7 million net of related costs. On
December 2, 1998, the Company sold the majority of its asset-based lending unit.
This transaction completed the disposition of all non-mortgage-related
activities of the Company. The sale resulted in a pre-tax loss of $755,000.
Other revenues decreased $2.6 million to $1.6 million for the
year ended December 31, 1999 from $4.2 million for the year ended December 31,
1998. In 1998, other revenues were comprised principally of insurance
commissions, underwriting fees, late charges, warrant valuations, and management
fees received in connection with the mezzanine lending operation. In 1999, other
revenues consist primarily of prepayment penalty income, underwriting fees, late
charges, and nonrecurring income from rental of the Company's computer systems
by a former subsidiary.
Total expenses decreased $100.4 million, or 61.0%, to $64.3
million for the year ended December 31, 1999 from $164.7 million for the year
ended December 31, 1998. Total expenses are comprised of interest expense,
provision for credit losses, costs on real estate owned and defaulted loans,
fair value adjustment of residual receivables, salaries, wages and employee
benefits, business development costs, and other general and administrative
expenses. The decreased expenses in 1999 are the result of sales of subsidiaries
in 1998 and of management's efforts to redesign processes and increase
efficiency and effectiveness of its operations. Certain personnel reductions in
the fourth quarter of 1998 and in 1999 have decreased personnel costs from $56.9
million for 1998 to $20.4 million in 1999.
Interest expense decreased $19.6 million, or 54.6%, to $16.3
million for the year ended December 31, 1999 from $36.0 million for the year
ended December 31, 1998. The decrease in interest expense was due principally to
lower levels of borrowings associated with the decrease in the Company's average
mortgage loan portfolio, and the retirement of $74.5 million of the Company's
Senior Notes due 2004 ("Senior Notes"). For the years ended December 31, 1999
and 1998, the Company incurred interest expense of approximately $4.4 million
and $13.5 million, respectively related to the Senior Notes. For the years ended
December 31, 1999 and 1998, the Company incurred interest expense of $2.0
million and $12.8 million, respectively, related to warehouse lines of credit.
20
<PAGE>
Provision for credit losses decreased $8.6 million, or 72.0%,
to $3.3 million for the year ended December 31, 1999 from $11.9 million for the
year ended December 31, 1998. The decrease in the provision was associated with
lower levels of loans held for investment. However, additional provision was
required in 1999 to increase specific reserves for possible losses with regard
to particular loans, including delinquent loans relating to the small business
loan operations which were not sold.
Costs on real estate and defaulted loans increased $353,000,
or 13.2%, to $3.0 million for the year ended December 31, 1999 from $2.7 million
for 1998. This increase is due to higher levels of real estate acquired through
foreclosure in 1999 over 1998. These higher levels of real estate are related to
seasoning of the retained portfolio and repurchases from securitized pools.
Management feels that loans made in 1997 which were not underwritten in
accordance with Company guidelines increased the Company's foreclosures. As
these loans are foreclosed or sold, management expects these costs to return to
lower levels.
In 1998, due to higher than anticipated prepayments, the
Company modified the estimated prepayment speeds on all of its mortgage loan
securitization transactions to peak at a 30 constant prepayment rate ("CPR") up
from the previous prepayment speeds of 20 CPR. This resulted in a write-down of
residual receivables of $13.6 million in 1998. No such write-down was necessary
in 1999. The peak CPR was adjusted to 28 during 1999 to reflect the recent trend
in slower prepayment speeds.
In November 1998, the Company decided to close three retail
loan origination centers and to consolidate all operations into one location.
This decision resulted in a restructuring charge of $6.8 million. The
restructuring charge related to the write-down of fixed assets to net realizable
value on assets no longer used by the Company was $3.6 million, the estimated
costs of employee relocation costs and employee severance was approximately $1.4
million, and the estimated net lease cost on facilities no longer being used was
$1.8 million. No such charge was required in 1999, and management feels that the
reserves at December 31, 1999 continue to be adequate.
Total general and administrative expense decreased $55.4
million, or 59.1%, to $38.3 million for the year ended December 31, 1999, from
$93.7 million for the year ended December 31, 1998. This resulted primarily
because salaries, wages and employee benefits decreased $36.4 million, or 64.4%,
to $20.2 million in 1999, from $56.6 million in 1998, and business development
costs decreased $6.0 million to $4.8 million in 1999 from $10.8 million in 1998.
The decreased costs resulted from the closure of retail operations centers
outside Greenville in late 1998. The lower business development costs related to
changes in the Company's direct mail campaigns in an effort to re-focus mailings
to consumers more closely matching the profile of the Company's customer base.
The Company has recorded current income tax expense of
$455,000 for the year ended December 31, 1999, even though overall the Company
generated a pre-tax loss for the year ended December 31, 1999. 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.
The Company has recorded a deferred tax benefit in the amount
of $7.8 million related to the current loss based on management's assessment of
the recoverability of the related deferred tax asset. Management has performed
an analysis of the recoverability of the asset based on projected conditions,
and determined that it is more likely than not that the Company will be able to
realize this benefit prior to the expiration of the net operating loss
carryforwards.
YEAR ENDED DECEMBER 31, 1998, COMPARED TO YEAR ENDED DECEMBER 31, 1997
The Company recognized a net loss of $57.7 million for the
year ended December 31, 1998 as compared to net income of $11.3 million for the
year ended December 31, 1997. This net loss was primarily due to the Company's
loan production volume being below capacity levels in relation to the general
and administrative expense structure. Included in the $57.7 million net loss are
several unusual items that included a $13.6 million write-down in the value of
its residual receivables due to faster than anticipated prepayment speeds on its
securitization pools, a $6.8 million restructuring charge, a gain on sale of
subsidiaries' net assets of $19.0 million, and an $18.2 million gain on
extinguishment of debt.
Total revenues decreased $35.2 million, or 27.8%, to $91.7
million for the year ended December 31, 1998 from $127.0 million for the year
ended December 31, 1997. The lower level of revenues resulted principally from
21
<PAGE>
lower than anticipated mortgage loan originations and decreases in gain on sale
of loans. The decrease in gain on sale of loans was partly offset by higher
interest income and servicing income, and gain on sale of subsidiaries' net
assets.
Interest income increased $1.1 million, or 3.1%, to $35.1
million for the year ended December 31, 1998 from $34.0 million for the year
ended December 31, 1997. The increase in interest income resulted primarily from
a $39.5 million, or 14.6%, increase in average loan balance to $310.9 million in
1998 from $271.3 million in 1997. This increase was partly offset by a reduction
in the average yield of 125 basis points. The yield in 1998 was 11.28% compared
to 12.53% in 1997. The increase in the average loan balance resulted from a
$30.2 million increase in the Company's mortgage loan portfolio, a $21.2 million
increase in the small-business loan portfolio and a $11.9 million reduction in
the auto loan portfolio. The increase in the average mortgage portfolio related
primarily to growth in the portfolio in the first six months of 1998. In the
third quarter of 1998, the Company began reducing the amount of mortgage loans
held in its portfolio. The reduction in the yield earned resulted from both a
change in the mix of the Company's total portfolio, more mortgage and small
business and less auto, combined with lower mortgage and commercial rates.
Weighted average mortgage rates declined 58 basis points from 10.92% in 1997 to
10.34% in 1998. Weighted average commercial rates declined 161 basis points from
15.89% in 1997 to 14.28 % in 1998.
Servicing income increased $3.7 million, or 43.8%, to $12.2
million for the year ended December 31, 1998 from $8.5 million for the year
ended December 31, 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, all mortgage loans sold
were sold servicing released, therefore the mortgage serviced portfolio was just
beginning to grow during 1997. The average serviced mortgage loan portfolio
increased $300.9 million, or 40.4%, to $744.2 million for the year ended
December 31, 1998 from $443.3 million for the year ended December 31, 1997.
Gross gain on sale of loans declined $43.4 million, or 82.1%,
to $9.5 million for the year ended December 31, 1998, from $52.8 million for the
year ended December 31, 1997. Cash gain on sale of loans decreased $12.8
million, or 90.5%, to $1.3 million for the year ended December 31, 1998 from
$14.2 million for the year ended December 31, 1997. The decrease resulted
principally from lower premiums and discounts on sales of mortgage loans.
The Company believes the significant change in the premiums
(discounts) received in 1998 resulted primarily from two factors. First, the
Company sold at a discount substantially all of the second lien mortgage loans
it held, that were not underwritten in accordance with Company guidelines. In an
effort to increase loan production, former employees approved loans that did not
meet Company guidelines. Second, the Company received significantly lower
premiums on loan sales in the third and fourth quarters of 1998 because of a
market surplus in the supply of loans in the resale market. The Company believes
this surplus, in turn, resulted from the decision of issuers of securitized loan
pools to sell their loan products in the whole loan cash market when
securitization, as a means of financing, became less attractive. Securitization
became less attractive as the corporate interest rate spreads required by
investors increased in the latter half of 1998. Investors required higher
spreads because of concerns related to higher than anticipated prepayments on
securitized loan pools and concerns about the credit worthiness of several
issuers.
Loans sold increased $309.0 million, or 39.3%, to $785.6
million for the year ended December 31, 1998 from $476.6 million for the year
ended December 31, 1997. The increase in loans sold resulted from the Company's
decision to increase its liquidity by reducing its loan portfolio. The weighted
average cash gain on sale of Loans was 0.2% and 2.7% for the years ended
December 31, 1998 and 1997, respectively.
Non-cash gain on sale of loans decreased $30.5 million, or
79.0%, to $8.1 million for the year ended December 31, 1998 from $38.7 million
for the year ended December 31, 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 last three quarters of 1998. The Company securitized $92.3
million in loans for the year ended December 31, 1998 and recognized a weighted
average non-cash gain on sale as a percentage of loans securitized of 8.81%, net
of expenses. The Company securitized $511.8 million in loans for the year ended
December 31, 1997 and recognized a weighted average non-cash gain on sale as a
percentage of loans securitized of 7.59%, net of expenses.
Loan fees decreased $18.5 million, or 61.1%, to $11.7 million
for the year ended December 31, 1998 from $30.2 million for the year ended
December 31, 1997. Loan fees received as a percentage of retail production for
the year ended December 31, 1998 were 4.65% as compared to 4.82% for the year
ended December 31, 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.
In 1998, the Company realized a net $19.0 million gain on sale
of subsidiaries' net assets. The Company completed the sale of substantially all
of the assets of its auto loan unit for book value on March 19, 1998. No
significant gain or loss was recognized on this transaction. On August 21, 1998,
the Company completed the sale of its small branch network retail mortgage
origination unit, Sterling Lending Corporation. There was no significant gain or
loss recorded as a result of this sale. On November 13, 1998, the Company sold
the majority of the assets of its small
22
<PAGE>
business lending units. The gain realized in 1998 was approximately $19.7
million net of related costs. On December 2, 1998, the Company sold the majority
of its asset-based lending unit. This transaction completed the disposition of
all non-mortgage-related activities of the Company. The sale resulted in a
pre-tax loss of $755,000.
Other revenues increased $2.8 million to $4.2 million for the
year ended December 31, 1998 from $1.4 million for the year ended December 31,
1997. Other revenues are comprised principally of insurance commissions,
underwriting fees, late charges, warrant valuations, and management fees
received in connection with the mezzanine lending operation. The increase of
other revenues resulted principally from the increased value of securities owned
relating to the commercial mezzanine lending operation in the amount of
approximately $500,000 and higher underwriting fees and late charge fees
received in 1998.
Total expenses increased $45.3 million, or 37.9%, to $164.7
million for the year ended December 31, 1998 from $119.4 million for the year
ended December 31, 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, and to $6.3 in the fourth
quarter of 1998 (excluding $6.8 million restructuring charge).
Interest expense increased $10.8 million, or 43.1%, to $36.0
million for the year ended December 31, 1998 from $25.1 million for the year
ended December 31, 1997. The increase in interest expense was due principally to
additional borrowings associated with the increase in the Company's average
mortgage and small-business loan portfolio, the offering of the Company's Senior
Notes due 2004 ("Senior Notes") in September 1997, and the higher borrowing
levels that were required to fund the Company's operating loss in 1998. For the
year ended December 31, 1998 and 1997, the Company incurred interest expense of
approximately $13.5 million and $5.1 million, respectively related to the Senior
Notes.
Provision for credit losses increased $1.9 million, or 18.7%,
to $11.9 million for the year ended December 31, 1998 from $10.0 million for the
year ended December 31, 1997. The increase in 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 $10.0 million for the year ended
December 31, 1998.
Cost on real estate and defaulted loans increased $1.8 million
in 1998 to $2.7 million from $876,000 in 1997. These costs are mainly associated
with loans made in 1997 outside Company guidelines by former employees. These
costs include carrying costs prior to the sale of the foreclosed property and
net gains and losses on sale.
As the result of higher than anticipated prepayments in 1998,
the Company modified the estimated prepayment speeds on all of its mortgage loan
securitization transactions to peak at 30 constant prepayment rate ("CPR") up
from the previous prepayment speeds of 20 CPR. This resulted in a write-down of
residual receivables of $13.6 million in 1998. No such write-down was necessary
in 1997.
In November 1998, the Company decided to close three retail
loan origination centers and to consolidate all operations into one location.
This decision resulted in a restructuring charge of $6.8 million. The
restructuring charge related to the write-down of fixed assets to net realizable
value on assets no longer used by the Company was $3.6 million, the estimated
costs of employee relocation costs and employee severance was approximately $1.4
million, and the estimated net lease cost on facilities no longer being used was
$1.8 million.
23
<PAGE>
Total general and administrative expense increased $10.3
million, or 11.0%, to $93.7 million for the year ended December 31, 1998, from
$83.4 million for the year ended December 31, 1997. This resulted primarily
because salaries, wages and employee benefits increased $8.5 million, or 17.8%,
to $56.6 million in 1998, from $48.0 million in 1997, and business development
costs increased $3.3 million to $10.8 million in 1998 from $7.5 million in 1997.
The increased personnel costs resulted from the expansion of the mortgage retail
product distribution channels in 1997 and early 1998 in 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). The
higher business development costs also related to the retail lending expansion.
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 did not occur.
The Company has recorded current income tax expense of $3.0
million for the year ended December 31, 1998, even though overall the Company
generated a pre-tax loss for the year ended December 31, 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.
FINANCIAL CONDITION
Net loans receivable decreased $60.3 million to $56.6 million
at December 31, 1999 from $116.9 million at December 31, 1998. The reduction in
net loans receivable resulted primarily from the Company's decision to increase
liquidity and reduce debt by selling and securitizing residential mortgage
loans.
The residual receivables were $47.8 million at December 31,
1999, and $43.9 million at December 31, 1998. This increase resulted primarily
from the amount of the residual interest certificates in the Company's Mortgage
Loan securitization completed in the second quarter of 1999, partially offset by
the amortization of the residual asset.
Net property and equipment decreased by $2.5 million to $17.2
million at December 31, 1999, from $19.7 million at December 31, 1998. Most of
the decrease can be attributed to depreciation expense incurred during the year.
Real estate and personal property acquired in foreclosure
increased $1.8 million to $7.7 million at December 31, 1999, from $5.9 million
at December 31, 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 December 31, 1999,
the Company had debt outstanding under revolving warehouse lines of credit to
banks of $17.8 million, which compares with $16.7 million at December 31, 1998,
for an increase of $1.1 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. This line of credit was subsequently reduced to
$100.0 million to reflect the Company's reduced loan volume levels. At December
31, 1999, the Company had $144.8 million of CII Notes and subordinated
debentures outstanding, which compares with $135.9 million at December 31, 1998,
for an increase of $8.9 million.
The aggregate principal amount of outstanding Senior Notes was
$12.1 million at December 31, 1999 compared to $86.6 million on December 31,
1998. In 1999, the Company purchased $74.5 million face amount of its Senior
Notes for a purchase price of $45.0 million. The Company may, from time to time,
purchase more of its Senior Notes depending on the Company's cash availability,
market conditions, and other factors.
Total shareholders' equity at December 31, 1999 was $7.8
million, which compares to $5.8 million at December 31, 1998, an increase of
$2.0 million. This increase resulted principally from the net income recognized
in 1999 of $1.8 million.
24
<PAGE>
ALLOWANCE FOR CREDIT LOSSES AND CREDIT LOSS EXPERIENCE
The Company is exposed to the risk of loan delinquencies and
defaults with respect to loans retained in its portfolio. With respect to loans
to be sold on a non-recourse basis, the Company is at risk for loan
delinquencies and defaults on such loans while they are held by the Company
pending such sale. To provide for credit losses, the Company charges against
current earnings an amount necessary to maintain the allowance for credit losses
at levels expected to cover inherent losses in loans receivable.
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>
SUMMARY OF ALLOWANCE FOR CREDIT LOSSES ON OWNED PORTFOLIO
AT AND FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------
1999 1998 1997
----------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
Allowance for credit losses at beginning of period $ 6,659 $ 6,528 $ 3,084
Net charge-offs (3,654) (8,791) (5,166)
Provision charged to expense 3,339 11,905 10,030
Write-down of allowance due to sale of receivables -- (2,983) (1,420)
----------- ----------- ------------
Allowance for credit losses at the end of the period $ 6,344 $ 6,659 $ 6,528
=========== =========== ============
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.
The table below summarizes certain information with respect to
the Company's allowance for losses on the securitization residual assets for
each of the periods indicated.
<CAPTION>
SUMMARY OF EMBEDDED ALLOWANCE FOR LOSSES ON SECURITIZATION RESIDUAL ASSETS
AT AND FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------
1999 1998 1997
--------------- ------------- --------------
(IN THOUSANDS)
RESIDUAL SECURITIES:
<S> <C> <C> <C>
Allowance for losses at beginning of period $ 7,165 $ 14,255 $ 1,202
Net charge-offs (1,661) (147) (1,645)
Anticipated losses net against gain 1,266 2,242 13,278
Allowance transferred from (to) owned portfolio -- -- 1,420
Mark-to-market adjustment 406 (6,228) --
Sale of small business residual assets -- (2,957) --
------------ ---------- ----------
Allowance for losses at end of period $ 7,176 $ 7,165 $ 14,255
============ ========== ==========
</TABLE>
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.
25
<PAGE>
The table below summarizes the Company's allowance for credit
losses with respect to the Company's total combined serviced portfolio
(including both owned and securitized loan pools) for each of the periods
indicated.
<TABLE>
<CAPTION>
SUMMARY OF ALLOWANCE FOR CREDIT LOSSES ON COMBINED SERVICED PORTFOLIO
AT AND FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------
1999 1998 1997
--------------- ------------- --------------
(IN THOUSANDS)
Allowance for credit losses at beginning of period $ 13,824 $ 20,783 $ 4,286
Net charge-offs (5,315) (8,938) (6,811)
Provision charged to expense 3,339 11,905 10,030
Provision netted against gain on securitizations 1,266 2,242 13,278
Mark-to-market adjustment 406 (6,228) --
Sale of small business residual assets -- (2,957) --
Write-down of allowance due to sale of receivables -- (2,983) --
------------ ---------- ----------
Allowance for credit losses at the end of the period $ 13,520 $ 13,824 $ 20,783
============ ========== ==========
The total allowance for credit losses as shown on the balance sheet is
as follows:
Allowance for credit losses on loans $ 6,344 $ 6,659 $ 6,528
Allowance for credit losses on residual receivables 7,176 7,165 14,255
------------ ---------- ----------
Total allowance for credit losses $ 13,520 $ 13,824 $ 20,783
============ ========== ==========
The following table sets forth the Company's allowance for
credit losses on the combined 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.
<CAPTION>
AT AND FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------
1999 1998 1997
---------------------------------------
ALLOWANCE FOR CREDIT LOSSES AS A % OF COMBINED SERVICED LOANS (1):
<S> <C> <C> <C>
Mortgage loans 2.5% 2.1% 2.0%
Small business loans 32.2 32.6 6.8
Auto loans -- -- 7.6
Total allowance for credit losses as a % of serviced loans 3.2 2.5 2.6
NET CHARGE-OFFS AS A % OF AVERAGE COMBINED SERVICED LOANS (2):
Mortgage loans 0.8 0.9 0.3
Small business loans -- 1.6 2.7
Auto loans -- 15.0 17.2
Total net charge-offs as a % of total serviced loans 0.8 1.1 1.4
LOANS RECEIVABLE PAST DUE 30 DAYS OR MORE AS A % OF COMBINED SERVICED LOANS (1):
Mortgage loans 12.4 13.6 8.0
Small business loans 55.3 -- 4.2
Auto loans -- -- 9.4
Total loans receivable past due 30 days or more as a % of total serviced loans 13.5 13.4 7.7
TOTAL ALLOWANCE FOR CREDIT LOSSES AS A % OF COMBINED SERVICED LOANS PAST DUE 90 DAYS OR
MORE (1) 23.9% 35.3% 94.3%
</TABLE>
------------------
(1) For purposes of these calculations, combined serviced loans represents all
loans for which the Company bears credit risk, and includes all portfolio
Mortgage Loans and Auto Loans, all securitized loans, and the Small Business
Loans, but excludes the guaranteed portion of the SBA Loans and Mortgage
Loans serviced without credit risk.
(2) Average serviced loans have been determined by using beginning and ending
balances for the period presented.
Management closely monitors delinquencies to measure the
quality of its loan portfolio and securitized loans and the potential for credit
losses. Accrual of interest is discontinued and reversed when a loan is over 90
days past due, when the collateral is determined to be inadequate, or when
foreclosure proceedings begin. 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.
26
<PAGE>
Management monitors securitized pool delinquencies using a static pool
analysis by month by pool balance. Current year results are not necessarily
indicative of future performance. The following sets forth the static pool
analysis for delinquencies by month in the Company's securitized mortgage loan
pools.
<TABLE>
<CAPTION>
CURRENT PRINCIPAL BALANCE
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
MONTHS FROM POOL INCEPTION 1997-1 1997-2 1997-3 1997-4 1998-1 1999-1
- --------------------------------------------------------------------------------------------------------------------------------
1 $ 77,435,632 $ 120,860,326 $ 130,917,899 $ 118,585,860 $ 62,726,105 $ 59,219,199
2 $ 77,405,312 $ 120,119,653 $ 169,093,916 $ 118,061,792 $ 62,300,302 $ 57,977,700
3 $ 76,709,417 $ 119,364,510 $ 168,182,957 $ 148,291,454 $ 61,609,815 $ 57,201,142
4 $ 75,889,160 $ 118,965,905 $ 166,783,489 $ 146,880,279 $ 60,768,433 $ 56,168,578
5 $ 75,395,969 $ 117,238,693 $ 165,608,534 $ 145,775,696 $ 59,347,948 $ 55,351,358
6 $ 74,630,019 $ 115,870,168 $ 164,084,260 $ 144,465,651 $ 58,739,309 $ 54,561,477
7 $ 73,149,957 $ 113,537,447 $ 161,880,416 $ 143,048,555 $ 57,829,352 $ 53,610,555
8 $ 72,261,386 $ 112,100,397 $ 158,220,175 $ 140,482,698 $ 56,918,186 $ 52,592,079
9 $ 71,342,842 $ 110,468,401 $ 155,854,981 $ 137,318,432 $ 55,894,240
10 $ 70,195,198 $ 107,887,242 $ 153,193,421 $ 134,991,772 $ 54,887,268
11 $ 68,981,147 $ 105,138,088 $ 148,382,102 $ 131,582,081 $ 53,817,889
12 $ 67,149,553 $ 102,142,062 $ 144,556,568 $ 129,029,429 $ 52,813,707
13 $ 65,705,603 $ 98,876,084 $ 140,265,621 $ 125,457,545 $ 51,834,618
14 $ 63,210,889 $ 95,394,444 $ 136,583,138 $ 121,706,895 $ 50,355,268
15 $ 60,052,314 $ 92,501,939 $ 133,252,925 $ 118,983,067 $ 49,261,441
16 $ 58,133,496 $ 89,402,897 $ 129,792,748 $ 116,012,173 $ 48,013,883
17 $ 56,900,372 $ 83,793,933 $ 127,118,396 $ 112,424,165 $ 46,682,595
18 $ 55,154,969 $ 81,637,626 $ 124,262,781 $ 109,695,150 $ 45,808,180
19 $ 50,852,179 $ 79,392,938 $ 119,512,141 $ 107,288,894 $ 44,422,122
20 $ 49,702,926 $ 77,843,648 $ 116,408,786 $ 104,842,028 $ 43,821,316
21 $ 48,629,373 $ 76,319,392 $ 113,506,699 $ 101,806,498 $ 42,973,221
22 $ 45,780,152 $ 74,512,970 $ 108,064,086 $ 98,013,963 $ 41,901,327
23 $ 44,612,888 $ 71,644,155 $ 104,734,353 $ 95,627,417
24 $ 43,845,616 $ 69,074,182 $ 101,605,131 $ 92,702,818
25 $ 42,879,623 $ 66,456,654 $ 98,057,107 $ 89,450,634
26 $ 40,453,030 $ 63,909,211 $ 94,776,180
27 $ 38,939,475 $ 61,789,775 $ 91,621,984
28 $ 38,094,550 $ 59,776,201 $ 88,960,343
29 $ 37,287,522 $ 56,901,545
30 $ 36,315,115 $ 55,673,168
31 $ 35,921,142 $ 54,358,523
32 $ 34,976,083
33 $ 33,841,626
34 $ 33,114,404
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
DELINQUENCIES > 30 DAYS PAST DUE
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
MONTHS FROM POOL INCEPTION 1997-1 1997-2 1997-3 1997-4 1998-1 1999-1
- ---------------------------------------------------------------------------------------------------------------------------------
1 $ 0 $ 515,954 $ 609,201 $ 402,972 $ 44,600 $ 1,466,076
2 $ 1,499,056 $ 1,631,017 $ 2,042,757 $ 2,132,028 $ 1,223,964 $ 3,134,425
3 $ 1,931,761 $ 3,930,423 $ 4,498,266 $ 5,049,035 $ 2,013,525 $ 2,438,937
4 $ 3,760,774 $ 5,399,569 $ 8,546,414 $ 7,290,097 $ 3,872,888 $ 2,434,471
5 $ 5,220,385 $ 7,293,856 $ 12,337,604 $ 10,290,987 $ 3,825,651 $ 2,662,519
6 $ 5,849,574 $ 9,790,732 $ 13,432,454 $ 13,459,369 $ 5,199,587 $ 2,804,957
7 $ 6,777,962 $ 11,933,526 $ 15,076,729 $ 12,443,357 $ 6,248,301 $ 3,115,273
8 $ 8,078,783 $ 12,484,893 $ 17,745,496 $ 13,861,088 $ 5,983,226 $ 3,351,500
9 $ 8,528,559 $ 12,471,739 $ 18,099,411 $ 16,777,959 $ 6,591,674
10 $ 10,008,415 $ 11,304,455 $ 16,680,011 $ 19,050,239 $ 6,317,098
11 $ 10,728,125 $ 12,630,402 $ 18,929,917 $ 18,524,292 $ 5,701,474
12 $ 9,257,295 $ 14,540,910 $ 21,295,026 $ 18,470,254 $ 5,950,145
13 $ 9,578,031 $ 12,933,959 $ 22,303,472 $ 18,645,129 $ 5,705,994
14 $ 10,757,672 $ 12,674,148 $ 21,746,520 $ 17,059,730 $ 5,287,678
15 $ 9,401,614 $ 14,212,157 $ 23,240,338 $ 15,698,435 $ 6,297,465
16 $ 8,127,303 $ 14,386,886 $ 22,031,312 $ 16,318,099 $ 6,255,440
17 $ 8,227,263 $ 11,723,546 $ 19,672,481 $ 15,292,242 $ 6,342,927
18 $ 8,708,963 $ 11,171,133 $ 18,472,732 $ 15,132,124 $ 7,150,420
19 $ 7,349,210 $ 12,018,899 $ 18,243,184 $ 15,706,290 $ 6,380,174
20 $ 7,217,783 $ 11,810,332 $ 18,119,731 $ 16,301,760 $ 6,080,991
21 $ 7,120,727 $ 11,040,206 $ 18,038,082 $ 15,464,631 $ 6,103,461
22 $ 6,661,879 $ 10,286,947 $ 16,452,727 $ 14,333,343 $ 6,165,388
23 $ 6,511,325 $ 10,414,360 $ 16,055,129 $ 15,895,532
24 $ 6,250,278 $ 8,906,082 $ 15,924,085 $ 14,232,856
25 $ 6,276,717 $ 9,514,340 $ 15,482,673 $ 13,162,282
26 $ 5,442,995 $ 8,806,693 $ 15,438,560
27 $ 4,900,780 $ 8,262,250 $ 14,301,848
28 $ 6,106,097 $ 8,642,371 $ 13,359,698
29 $ 4,982,511 $ 6,969,409
30 $ 5,346,769 $ 7,939,953
31 $ 5,756,594 $ 7,790,662
32 $ 4,972,092
33 $ 4,995,142
34 $ 4,944,931
</TABLE>
Included in the principal balances and delinquency amounts at
December 31, 1999 is $4.7 million of real estate acquired through foreclosure.
28
<PAGE>
<TABLE>
<CAPTION>
DELINQUENCIES > 30 DAYS PAST DUE AS A PERCENT OF CURRENT BALANCE
- ---------------------------------------------------------------------------------------------------------------------
MONTHS FROM POOL INCEPTION 1997-1 1997-2 1997-3 1997-4 1998-1 1999-1 AVERAGE
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1 0.00% 0.43% 0.47% 0.34% 0.07% 2.48% 0.63%
2 1.94% 1.36% 1.21% 1.81% 1.96% 5.41% 2.28%
3 2.52% 3.29% 2.67% 3.40% 3.27% 4.26% 3.24%
4 4.96% 4.54% 5.12% 4.96% 6.37% 4.33% 5.05%
5 6.92% 6.22% 7.45% 7.06% 6.45% 4.81% 6.49%
6 7.84% 8.45% 8.19% 9.32% 8.85% 5.14% 7.96%
7 9.27% 10.51% 9.31% 8.70% 10.80% 5.81% 9.07%
8 11.18% 11.14% 11.22% 9.87% 10.51% 6.37% 10.05%
9 11.95% 11.29% 11.61% 12.22% 11.79% 11.77%
10 14.26% 10.48% 10.89% 14.11% 11.51% 12.25%
11 15.55% 12.01% 12.76% 14.08% 10.59% 13.00%
12 13.79% 14.24% 14.73% 14.31% 11.27% 13.67%
13 14.58% 13.08% 15.90% 14.86% 11.01% 13.89%
14 17.02% 13.29% 15.92% 14.02% 10.50% 14.15%
15 15.66% 15.36% 17.44% 13.19% 12.78% 14.89%
16 13.98% 16.09% 16.97% 14.07% 13.03% 14.83%
17 14.46% 13.99% 15.48% 13.60% 13.59% 14.22%
18 15.79% 13.68% 14.87% 13.79% 15.61% 14.75%
19 14.45% 15.14% 15.26% 14.64% 14.36% 14.77%
20 14.52% 15.17% 15.57% 15.55% 13.88% 14.94%
21 14.64% 14.47% 15.89% 15.19% 14.20% 14.88%
22 14.55% 13.81% 15.22% 14.62% 14.71% 14.58%
23 14.60% 14.54% 15.33% 16.62% 15.27%
24 14.26% 12.89% 15.67% 15.35% 14.54%
25 14.64% 14.32% 15.79% 14.71% 14.86%
26 13.46% 13.78% 16.29% 14.51%
27 12.59% 13.37% 15.61% 13.86%
28 16.03% 14.46% 15.02% 15.17%
29 13.36% 12.25% 12.81%
30 14.72% 14.26% 14.49%
31 16.03% 14.33% 15.18%
32 14.22% 14.22%
33 14.76% 14.76%
34 14.93% 14.93%
ACTUAL HISTORICAL LIFE TO
DATE PREPAYMENT SPEED 22.3% 24.1% 22.4 % 20.6% 18.7 % 15.9% 18.9 %
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's business requires continued access to short and
long-term sources of debt financing and equity capital. As a result of selling
its loans for cash in the whole loan market and as a result of selling more
loans in 1999 than were originated in 1999, the Company experienced a positive
cash flow from operating activities in 1999. Although the Company's goal is to
achieve a positive cash flow each quarter, no assurance can be given that this
objective will be attained 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,
senior unsecured debt and its revolving warehouse credit facilities ("Credit
Facilities"), (iii) fees, expenses, overcollateralization, servicer advances 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 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 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.
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.
29
<PAGE>
The Company overcollateralizes loans as a credit enhancement
on the mortgage loan securitization transactions. This requirement creates
negative cash flows in the year of securitization. The Company decided to
securitize only seasoned first and second mortgages in the second quarter of
1999, and to conduct whole loan sales for the remainder of the year. Currently
the Company plans to conduct a combination of securitizations and whole loan
sales throughout 2000. This strategy is designed to maximize liquidity and
profitability. 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. In 1999, the Company began paying, on a limited basis, some yield
spread premiums as a way to increase its wholesale production.
<TABLE>
<CAPTION>
The table below summarizes cash flows provided by and used in operating activities:
YEARS ENDED DECEMBER 31,
---------------------------------------------------
1999 1998 1997
-------------- -------------- --------------
(IN THOUSANDS)
OPERATING CASH INCOME:
<S> <C> <C> <C>
Servicing fees received and excess cash flow from securitization
trusts $ 15,622 $ 16,548 $ 3,687
Interest received 9,475 36,127 31,716
Cash gain on sale of loans 6,477 1,343 14,153
Cash loan origination fees received 4,841 18,255 31,843
Other cash income 1,609 5,388 1,875
----------- ----------- ----------
Total operating cash income 38,024 77,661 83,274
OPERATING CASH EXPENSES:
Securitization costs (593) (851) (3,646)
Securitization hedge losses -- -- (2,125)
Cash operating expenses (37,456) (99,551) (81,594)
Interest paid (18,691) (37,519) (20,980)
Taxes paid (278) (2,515) (1,581)
----------- ----------- ----------
Total operating cash expenses (57,018) (140,436) (109,926)
CASH FLOW (DEFICIT) DUE TO OPERATING CASH INCOME AND EXPENSES (18,994) (62,775) (26,652)
OTHER CASH FLOWS:
Cash used in other payables and receivables (7,741) (12,541) (5,355)
Cash provided by (used in) loans held for sale 33,951 123,674 (114,282)
Cash provided from sale of residual receivables -- 16,958 --
Cash gain on sale of subsidiary assets -- 18,964 --
----------- ----------- ----------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES $ 7,216 $ 84,280 $ (146,289)
=========== =========== ==========
</TABLE>
Cash and cash equivalents were $26.0 million at December 31,
1999, $36.9 million at December 31, 1998, and $7.6 million at December 31, 1997.
Cash provided by operating activities was $7.2 million for the year ended
December 31, 1999, compared to $84.3 million for the year ended December 31,
1998. Cash provided by investing activities was $16.7 million for the year ended
December 31, 1999, compared to cash provided in investing activities of $24.3
million for the year ended December 31, 1998, and cash used in financing
activities was $34.8 million for the year ended December 31, 1999, compared to
cash used by financing activities of $79.3 million for the year ended December
31, 1998. The decrease in cash provided by operations was due principally to a
greater amount of loans sold and securitized than originations in 1999. Cash
provided by investing activities was primarily from the principal collections on
loans not sold. The decrease in cash provided by financing activities was due
principally to retirement of $74.5 million face amount of the Senior Notes for a
purchase price of $45.0 million.
At December 31, 1999, the Company had a $100.0 million
warehouse line of credit with CIT Group/Business Credit, Inc. ("CIT") to fund
its Mortgage Loan originations. Based on the borrowing base limitations
contained in the credit facility, at December 31, 1999, the Company had
aggregate outstanding borrowings of $17.8 million and aggregate borrowing
availability of $11.1 million. The credit facility requires a minimum
availability of $10.0 million, leaving excess availability of $1.1 million at
December 31, 1999. The credit facility bears interest at Prime + 0.75% and
matures on June 30, 2001. The credit facility contains certain covenants,
including, but not limited to, covenants that impose limitations on the Company
and its subsidiaries with respect to declaring or paying dividends and minimum
CII Notes outstanding and loans and advances by HomeGold, Inc. and CII to the
Company. The Company believes that it is currently in compliance with the loan
covenants.
30
<PAGE>
During 1997, the Company sold $125.0 million aggregate
principal amount of Senior Notes due 2004. The Senior Notes due 2004 constitute
unsecured indebtedness of the Company. The Senior Notes due 2004 are redeemable
at the option of the Company, in whole or in part, on or after September 15,
2001, at predetermined redemption prices plus accrued and unpaid interest to the
date of redemption. This agreement requires, among other matters, restrictions
on the payment of dividends. At December 31, 1999, management believes the
Company was in compliance with such restrictive covenants. The Senior Notes due
2004 are fully and unconditionally guaranteed (the "Subsidiary Guarantees")
jointly and severally on an unsecured basis (each, a "Guarantee") by certain of
the Company's subsidiaries (the "Subsidiary Guarantors"). With the exception of
the Guarantee by CII, the Subsidiary Guarantees rank PARI PASSU in right of
payment with all existing and future unsubordinated indebtedness of the
Subsidiary Guarantors and senior in right of payment to all existing and future
subordinated indebtedness of such Guarantors. The Guarantee by CII is equal in
priority to CII's notes payable to investors and is senior to CII's subordinated
debentures. The Company purchased $74.5 million face amount of its senior notes
in 1999 and $38.4 million in 1998. At December 31, 1999 and 1998, 12.1 million
and $86.4 million, respectively, in aggregate principal amount of Senior Notes
were outstanding.
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 believed to be exempt from Federal registration under the Federal intrastate
exemption. CII believes it conducts its operations so as to qualify for the safe
harbor provisions of Rule 147 promulgated pursuant to the Securities Exchange
Act of 1933, as amended (the "Securities Act"). At December 31, 1999, CII had an
aggregate of $127.1 million of investor notes outstanding bearing a weighted
average interest rate of 7.6%, and an aggregate of $17.7 million of subordinated
debentures bearing a weighted average interest rate of 5.0%. The investor notes
and subordinated debentures are subordinate in priority to the credit facility.
Maturities of the CII Notes and debentures generally range from one to two
years.
Shareholders' equity increased in 1999 by $2.0 million to $7.8
million at December 31, 1999, from $5.8 million at December 31, 1998. During
1998, stockholders equity decreased $57.6 million to $5.8 million at December
31, 1998, from $63.4 million at December 31, 1997. The principal reason for the
change to shareholders' equity is the net income (loss) recognized for the year.
The Company's primary objective in 2000 will be to increase
profitability and increase loan originations while insuring adequate levels of
liquidity. The Company anticipates incurring operating losses into 2000. The
Company continually evaluates the need to establish other sources of capital and
will pursue those it considers appropriate based upon its needs and market
conditions. The Company currently does not anticipate incurring any significant
capital expenditures in 2000.
LOAN SALES AND SECURITIZATIONS
The Company sells or securitizes substantially all of its
loans. The Company sells 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, principally to secure the additional cash flow
associated with the premiums paid in connection with such sales and to eliminate
the credit risk associated with the second lien mortgage loans. However, no
assurance can be given that the second lien mortgage loans can be sold. To the
extent that the loans are not sold, the Company retains the risk of loss. At
December 31, 1999 and 1998, the Company had retained $9.5 million and $19.0
million, respectively, of second lien mortgage loans on its balance sheet.
During 1999, 1998, and 1997, the Company sold $220.4 million, $623.7 million,
and $435.3 million, respectively, of Mortgage Loans. In 1998 and 1997, the
Company sold $141.0 million, and $41.2 million, respectively, of the guaranteed
portions of SBA 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 securitizations, the Company has retained
interest-only residual certificates representing residual interests in the
trusts. These subordinate residual securities totaled $47.8 million, net of
allowances, at December 31, 1999.
31
<PAGE>
The first, second and third securitizations of 1997 and the
1998 securitization are structured as real estate mortgage investment conduits
("REMIC's"). The fourth quarter 1997 securitization utilized a real estate
investment trust ("REIT"). This allows sales treatment for financial reporting
purposes, but debt treatment for tax purposes. Accordingly, this structure
eliminates current taxes payable on the book gain, while maintaining the
structural efficiency of tranching, previously only available through a REMIC
transaction. Additionally, under this structure, the Company has distributed
.46% ownership in the REIT to a certain class of current and former employees,
with an initial value of approximately $62,000. The 1999 securitization is an
"Owners' Trust", another structure which allows sales treatment for financial
reporting purposes, but debt treatment for tax purposes.
The Company has been securitizing mortgage loans since 1997.
In a securitization transaction, the Company sells Mortgage Loans it purchased
or originated to a trust for cash. The trust sells asset-backed bonds secured by
the loans to investors. The Company records certain assets and income based upon
the difference between all principal and interest received from the loans sold
and the following factors (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 as
a residual receivable. The Company believes the assumptions it has used in past
securitizations are appropriate and reasonable.
In connection with its 1999-1 securitization transaction,
HomeGold agreed to cross-collateralize its residual interests in that
transaction and in its 1997-1, 1997-2, and 1997-3 securitizations for the
benefit of Financial Security Assurance, Inc., the bond issuer for all of those
transactions. Under the terms of that cross-collateralization agreement, in the
event HomeGold is in breach of its obligations under any one or more of those
securitization trusts or if certain cumulative loss or delinquency triggers are
met, the excess cash flow on all four residual interests will be captured by the
Collateral Agent, who will distribute those monies to FSA or as otherwise
specified in the agreement. The total amount that may be retained by the
Collateral Agent is capped at $15 million. This agreement terminates upon the
termination of all of the related securitization trusts.
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) 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. For all of the mortgage loan securitizations completed to
date, the servicing asset recorded represents a 10 basis point strip of cash
flows from the stipulated servicing percentage.
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 December 31, 1999:
<TABLE>
<CAPTION>
1997-1 1997-2 1997-3 1997-4 1998-1 1999-1
------------ ------------ ------------ -----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding balance of loans securitized $33,114,404 $54,358,523 $88,960,343 $89,450,634 $41,901,327 $52,592,079
Average stated principal balance 57,490 55,525 62,692 62,465 62,260 46,583
Weighted average coupon on loans 10.83% 10.64% 11.06% 10.97% 10.81% 11.03%
Weighted average remaining term to stated
maturity 174 mths 174 mths 176 mths 180 mths 189 mths 202 mths
Weighted average LTV 77% 72% 75% 75% 75% 71%
Percentage of first mortgage loans 100% 100% 100% 100% 100% 84.22%
Weighted average pass-through rate to
bondholders 7.59% 7.16% 7.05% 6.79% 6.61% 6.84%
Assumed annual losses 0.60% 0.60% 0.60% 0.60% 0.60% 0.87%
Remaining ramp period for losses 0 mths 0 mths 0 mths 0 mths 0 mths 8 mths
Assumed cumulative losses as a % of UPB 1.90% 1.87% 1.79% 1.80% 1.79% 2.34%
Annual servicing fee 0.50% 0.50% 0.50% 0.50% 0.50% 0.56%
Servicing asset 0.10% 0.10% 0.10% 0.10% 0.10% 0.10%
Discount rate applied to cash flow after
overcollateralization 12% 12% 12% 12% 12% 12%
Prepayment speed:
Initial CPR (1) 0 CPR 0 CPR 0 CPR 0 CPR 0 CPR 24 HEP
Peak CPR (1) 28 CPR 28 CPR 28 CPR 28 CPR 28 CPR 24 HEP
Tail CPR (1) 26/24 CPR 26/24 CPR 26/24 CPR 26/24 CPR 26/24 CPR 24 HEP
CPR ramp period (1) 12 mths 12 mths 12 mths 12 mths 12 mths 24 HEP
CPR peak period (1) 24 mths 24 mths 24 mths 24 mths 24 mths 24 HEP
CPR tail begins (1) 37/49 mths 37/49mths 37/49 mths 37/49 mths 37/49 mths 24 HEP
Annual wrap fee and trustee fee 0.285% 0.205% 0.195% 0.187% 0.185% 0.265%
Initial overcollateralization required (2) 3.25% -- -- -- -- 9.5%
Final overcollateralization required (2) 6.5% 3.75% 3.75% 3.75% 3.75% 13.5%
</TABLE>
(1) CPR represents an industry standard of calculating prepayment speeds and
refers to Constant Prepayment Rate. For its first five securitization pools,
the Company uses a curve based on various CPR levels throughout the pool's
life,
32
<PAGE>
based on its estimate of prepayment performance, as outlined in the table
above. For the 1999-1 transaction the Company uses a 24 HEP (Home Equity
Prepayment) curve. This curve, developed by Prudential Securities, ramps to
the terminal CPR (in this case, 24%) over ten months and then remains
constant for the life of the pool.
(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 such that the senior certificates have received 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 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 gains recognized into income resulting from securitization
transactions vary depending on the assumptions used, the specific
characteristics of the underlying loan pools, and the structure of the
transaction. The Company believes the assumptions it has used are appropriate
and reasonable.
The Company assesses the carrying value of its residual
receivables and servicing assets for impairment at the end of each month. 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. If actual loan prepayments or
defaults exceed the Company's estimates, the carrying value of the Company's
residual receivables and/or servicing assets may be decreased through a charge
against earnings in the period management recognizes the disparity. Conversely,
if actual loan prepayments or defaults are better than the Company's estimates,
the carrying value of the Company's residual receivables and/or servicing assets
may be increased, with additional earnings recognized in the period management
recognizes the disparity.
At December 31, 1999 key economic assumptions and the
sensitivity of the current fair value of residual cash flows to immediate 5
percent and 10 percent adverse changes in assumed economics is as follows
(dollars in thousands).
Loans
--------------
Carrying amount/fair value of retained interests $ 47,770
Weighted-average life (in years) 3.03
Prepayment speed assumption (annual rate) 24% - 30%
Impact on fair value of 5% adverse change $ 664
Impact on fair value of 10% adverse change $ 1,295
Expected credit losses (annual rate) 0.60%
Impact on fair value of 5% adverse change $ 273
Impact on fair value of 10% adverse change $ 547
Residual cash flows discount rate (annual) 12.0%
Impact on fair value of 5% adverse change $ 748
Impact on fair value of 10% adverse change $ 1,473
33
<PAGE>
These sensitivities are hypothetical and should be viewed with
caution. As the figures indicate, any change in fair value based on a 5 percent
variation in assumptions cannot be extrapolated because the relationship of the
change in assumption to the change in fair value is not linear. Also, in this
table, the effect of a variation in a particular assumption on the fair value of
the retained interest is calculated independent from any change in another
assumption; in reality, changes in one factor may result in changes in another,
which might magnify or counteract the sensitivities.
TAX CONSIDERATIONS
As a result of operating losses incurred by the Company, the
Company has net operating losses ("NOL") that can be used to offset future
earnings. 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 its maximum cumulative change of control during the relevant
three-year period was less than 50%.
During 1999 the Company recorded a deferred tax benefit in the amount
of $7.8 million, bringing the total deferred tax asset to $12.0 million. The
Company adjusted its reserve against the deferred tax asset in the fourth
quarter 1999 based on its forecasted results prepared in December 1999. The
amount of the deferred tax asset is deemed appropriate by management based on
its belief that it is more likely than not that it will realize the benefit of
this deferred tax asset, given the levels of historical taxable income and
current projections for future taxable income over the periods in which the
deferred tax assets would be realized. The Company had a federal NOL of
approximately $63.4 million at December 31, 1999.
HEDGING ACTIVITIES
The Company's profitability may be directly affected by
fluctuations in interest rates. While the Company monitors interest rates it
may, from time to time, employ a strategy designed to hedge some of the risks
associated with changes in interest rates, however, 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 includes shorting interest rate futures
and treasury forwards, and entering into interest-rate lock agreements. Since
the interest rates on the Company's warehouse line of credit used to fund and
acquire loans is 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 sale or securitization of loans earned by the
Company.
ACCOUNTING CONSIDERATIONS
In June 1998, the Financial Accounting Standards Board (FASB)
issued SFAS 133, Accounting for Derivative Instrument and Hedging Activities.
All derivatives are to be measured at fair value and recognized in the balance
sheet as assets or liabilities. This statement's effective date was delayed by
the issuance of SFAS 137, Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of SFAS 133, and is effective for
fiscal years and quarters beginning after June 15, 2000. The Company does not
expect that the adoption of SFAS 137 will have a material impact on the
presentation of the Company's financial results or financial position.
Accounting standards that have been issued by the FASB that
will not require adoption until a future date and will impact the preparation of
the financial statements will not have a material effect upon adoption.
34
<PAGE>
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-lien mortgage loan products. Generally, first-lien mortgage
production increases relative to second-lien mortgage production in response to
low interest rates and second-lien mortgage production increases relative to
first-lien 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 and 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 line of credit.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk reflects the risk of economic loss resulting from
adverse changes in market price and interest rates. This risk of loss can be
reflected in diminished current market values and/or reduced potential net
interest income in future periods.
The Company's market risk arises primarily from interest rate
risk inherent in its lending, its holding of residual receivables and its
investor savings activities. The structure of the Company's loan and investor
savings portfolios is such that a significant rise or decline in interest rates
may adversely impact net market values and net interest income. The Company does
not maintain a trading account nor is the Company subject to currency exchange
risk or commodity price risk. Responsibility for monitoring interest rate risk
rests with senior management. Senior management regularly reviews the Company's
interest rate risk position and adopts balance sheet strategies that are
intended to optimize operating earnings while maintaining market risk within
acceptable guidelines. To estimate the impact that changes in interest rates
would have on the Company's earnings, management uses Simulation Analysis.
Simulation Analysis is performed using a computer-based
asset/liability model which incorporates current portfolio balances and rates,
contractual maturities, repricing opportunities and assumptions about
prepayments, future interest rates and future volumes. To measure the
sensitivity of the Company's earnings, the result of multiple simulations, which
assume changes in interest rates, are compared to the "base case" simulation,
which assumes no changes in interest rates. The sensitivity of earnings is
expressed as a percentage change in comparison to the "base case" simulation.
The model assumes an immediate parallel shift in interest rates. The Company's
interest rate risk position based on simulation results as of December 31, 1999
is as follows:
Basis point change in interest rates (100) 100
Projected percentage change in net income 4.5% (6.9)%
As a result of the Company's interest rate position, a 100
basis point immediate increase in interest rates would have a negative impact on
projected net loss of $1.4 million and $652,000, computed as of December 31,
1999 and December 31, 1998, respectively. A significant portion of this impact
relates to a reduction in the anticipated sale premiums on loans being held for
sale as well as higher interest expense on the warehouse line of credit. The
estimated impact at December 31, 1999 compared to December 31, 1998 is due
partially to more variable rate debt and less fixed rate debt outstanding, as a
result of the repurchase of Senior Notes in 1999.
35
<PAGE>
An immediate reduction of 100 basis points in market rates
would result in a positive (negative) impact on projected net loss of $893,000
and ($2.4) million as of December 31, 1999 and December 31, 1998, respectively.
The most significant reason for the negative impact of an interest rate drop
estimated at December 31, 1998 is the assumption that prepayment speeds on the
securitization pools would increase from a constant prepayment rate ("CPR") of
30 to a CPR of 35 if market interest rates declined by 100 basis points. This
impact would be partially offset by higher gains from the sale of loans, which
is the primary reason for the positive impact on projected earnings at December
31, 1999 under the same interest rate scenario. The Company no longer believes,
in the absence of other external factors, that it would experience an increase
in prepayment speeds if market rates declined by 100 basis points due to the
"burn-out" principal. In other words, since the borrowers have already had
several opportunities to refinance because rates have been 100 basis points
lower in the last twelve months, but have not, the likelihood of the remaining
borrowers prepaying given further interest rate reductions is diminished. A
portion of the impact results from the Company's assumption that it would not
experience a significant benefit from a reduction in the rates paid on investor
notes. The model assumes only a 25 basis points reduction on investor notes
assuming a 100 basis points reduction in market rates. The rates offered on the
investor notes have not historically moved with changes in market rates.
While the Company monitors interest rates and may, from time
to time, employ 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.
As of December 31, 1999, the Company did not hedge its loans
held for whole-loan sales. The Company's strategy during 1999 was to sell a
substantial portion of the current month's production that is designated for
whole-loan sales in the following month and the remaining loans in the
subsequent month. However, for 2000, the Company may begin securitizing a
portion of its loan production on a quarterly basis. Because 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 may reduce the gain on loan sales earned by the Company. There were no
significant open hedging positions at year-end.
On loans originated for inclusion in securitized pools, the
Company may employ a strategy designed to hedge some of the risks associated
with changes in interest rates. The Company's interest rate hedging strategy,
includes shorting interest rate futures and treasury forwards, and entering into
interest-rate lock agreements relating to loans pending a securitization
transaction. The ultimate sale of the Company's loans included in a securitized
transaction 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. However, a significant reduction in market rates
could accelerate the prepayment speed on loans held in the various securitized
mortgage pools. An acceleration of prepayment on loans held in the securitized
pools would have a negative impact on the carrying value of the residual assets.
There were no significant open hedging positions at year end.
Projected percentage changes in operating results brought
about by changes in interest rates could be material relative to the Company's
operating results. If simulation results indicate earnings sensitivity in excess
of management's acceptable limits, management will seek to identify on-balance
sheet and/or off-balance sheet strategies to bring earnings sensitivity within
target guidelines. Management will continue to monitor the Company's interest
rate risk position to manage the possible adverse impact on earnings caused by
changes in interest rates.
These analyses do not consider the effects of the reduced
level of overall economic activity that could exist in such an environment.
Further, in the event of a change of such magnitude, management would likely
take actions to further mitigate its exposure to the change. However, due to the
uncertainty of the specific actions that would be taken and their possible
effects, the sensitivity analysis assumes no changes in the Company's financial
structure.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements and Supplementary Data are set forth
herein commencing on page F-1 of this Report.
36
<PAGE>
HOMEGOLD FINANCIAL, INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
<PAGE>
HOMEGOLD FINANCIAL, INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
<TABLE>
<CAPTION>
<S> <C>
Independent Auditors' Report ............................................................................F-2
Audited Consolidated Financial Statements
Consolidated Balance Sheets.....................................................................F-3
Consolidated Statements of Operations...........................................................F-5
Consolidated Statements of Shareholders' Equity.................................................F-6
Consolidated Statements of Cash Flows...........................................................F-7
Notes to Consolidated Financial Statements .....................................................F-8
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
Shareholders and Board of Directors
HOMEGOLD FINANCIAL, INC.
AND SUBSIDIARIES
Greenville, South Carolina
We have audited the accompanying consolidated balance sheets of
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES as of December 31, 1999 and 1998 and
the related consolidated statements of operations, shareholders' equity, and
cash flows for the years then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits. The
consolidated financial statements of HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
for the year ended December 31, 1997, were audited by other auditors whose
report dated February 27, 1998, expressed an unqualified opinion on those
statements.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES as of December 31, 1999 and 1998 and
the results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
Elliott, Davis & Company, L.L.P.
Greenville, South Carolina
February 11, 2000
F-2
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1999 1998
-------------- -------------
ASSETS (In thousands)
------
<S> <C> <C>
Cash and cash equivalents $ 26,009 $ 36,913
Restricted cash 5,314 5,100
Loans receivable 63,242 124,740
Less allowance for credit losses (6,344) (6,659)
Less deferred loan fees (730) (2,071)
Plus deferred loan costs 446 888
-------------- -------------
Net loans receivable 56,614 116,898
Income taxes receivable 461 900
Accrued interest receivable 1,423 2,613
Other receivables 8,059 12,028
Residual receivables, net 47,770 43,857
Property and equipment, net 17,160 19,665
Real estate acquired through foreclosure 7,673 5,881
Excess of cost over net assets of acquired businesses, net of accumulated
amortization of $748 in 1999 and $654 in 1998 1,566 1,660
Debt origination costs 1,658 4,681
Deferred income tax asset, net 12,000 4,151
Servicing asset 867 940
Other assets 2,163 1,921
------------- ------------
TOTAL ASSETS $ 188,737 $ 257,208
============== =============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF
THESE STATEMENTS.
F-3
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------------------------------------------- --------------------------------
1999 1998
--------------- -------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY (In thousands)
------------------------------------
Liabilities:
Revolving warehouse lines of credit $ 17,808 $ 16,736
Investor savings:
Notes payable to investors 127,065 118,586
Subordinated debentures 17,710 17,304
--------------- -------------
Total investor savings 144,775 135,890
Senior unsecured debt 12,134 86,650
Accounts payable and accrued liabilities 4,120 6,656
Remittances payable 1,078 1,871
Income taxes payable 120 382
Accrued interest payable 845 3,199
--------------- -------------
Total other liabilities 6,163 12,108
--------------- -------------
Total liabilities 180,880 251,384
Minority interest 13 23
Commitments and contingencies, Notes 12, 22
Shareholders' equity:
Common stock, par value $.05 per share - authorized 100,000,000 shares; issued
and outstanding 10,149,629 shares in 1999 and 9,733,374 shares in 1998 507 486
Capital in excess of par value 39,028 38,821
Retained deficit (31,691) (33,506)
--------------- -------------
Total shareholders' equity 7,844 5,801
--------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 188,737 $ 257,208
=============== =============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF
THESE STATEMENTS.
F-4
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------
1999 1998 1997
----------------- --------------- ---------------
(In thousands, except share data)
<S> <C> <C> <C>
REVENUES:
Interest income $ 8,286 $ 35,075 $ 34,008
Servicing income 9,813 12,239 8,514
Gain on sale of loans:
Gross gain on sale of loans 6,216 9,472 52,828
Loan fees, net 3,313 11,745 30,207
----------------- --------------- ---------------
Total gain on sale of loans 9,529 21,217 83,035
Gain on sale of subsidiaries' net assets -- 18,964 --
Other revenues 1,609 4,230 1,399
----------------- --------------- ---------------
Total revenues 29,237 91,725 126,956
----------------- --------------- ---------------
EXPENSES:
Interest 16,338 35,968 25,133
Provision for credit losses 3,339 11,906 10,030
Costs on real estate owned and defaulted loans 3,018 2,665 876
Fair market value adjustment on residual receivables 3,327 13,638 --
Salaries, wages and employee benefits 20,359 56,925 48,044
Business development costs 4,804 10,818 7,486
Restructuring charges -- 6,838 --
Other general and administrative expense 13,123 25,958 27,878
----------------- --------------- ---------------
Total expenses 64,308 164,716 119,447
----------------- --------------- ---------------
Income (loss) before income taxes, minority interest and
extraordinary item (35,071) (72,991) 7,509
Provision (benefit) for income taxes (7,394) 3,017 (3,900)
----------------- --------------- ---------------
Income (loss) before minority interest and extraordinary item (27,677) (76,008) 11,409
Minority interest in (earnings) loss of subsidiaries (8) 47 (156)
----------------- --------------- ---------------
Income (loss) before extraordinary item (27,685) (75,961) 11,253
Extraordinary item--gain on extinguishment of debt, net of $0 tax 29,500 18,216 --
----------------- --------------- ---------------
NET INCOME (LOSS) $ 1,815 $ (57,745) $ 11,253
================= =============== ===============
BASIC EARNINGS (LOSS) PER SHARE OF COMMON STOCK:
Income (loss) before extraordinary item $ (2.78) $ (7.81) $ 1.20
Extraordinary item, net of taxes 2.96 1.87 --
----------------- --------------- ---------------
Net income (loss) .18 (5.94) 1.20
================= =============== ===============
Basic weighted average shares outstanding 9,961,077 9,719,262 9,406,221
================= =============== ===============
DILUTED EARNINGS (LOSS) PER SHARE OF COMMON STOCK:
Income (loss) before extraordinary item $ (2.78) $ (7.81) $ 1.17
Extraordinary item, net of taxes 2.96 1.87 --
----------------- --------------- ---------------
Net income (loss) .18 (5.94) 1.17
================= =============== ===============
Diluted weighted average shares outstanding 9,961,077 9,719,262 9,598,811
================= =============== ===============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL
PART OF THESE STATEMENTS.
F-5
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
<TABLE>
<CAPTION>
Common Stock
-----------------------------
Capital in Retained Total
Excess of Earnings Shareholders'
Shares Issued Amount Par Value (Deficit) Equity
--------------- ------------ ------------ ------------ -----------------
(In thousands, except share data)
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1996 9,141,131 $ 457 $ 33,150 $ 13,028 $ 46,635
Shares issued:
Exercise of stock options 40,667 2 227 -- 229
Exercise of restricted stock options 2,900 -- -- -- --
Employee Stock Purchase Plan 7,534 -- 67 -- 67
Purchase of Reedy River Ventures LP 494,195 25 5,164 -- 5,189
Other shares issued 50 -- 1 -- 1
Net income -- -- -- 11,253 11,253
--------------- ------------ ------------ ------------ -----------------
Balance at December 31, 1997 9,686,477 484 38,609 24,281 63,374
Shares issued:
Exercise of stock options 9,467 -- 21 -- 21
Employee Stock Purchase Plan 37,430 2 191 -- 193
Dividends Paid -- -- -- (42) (42)
Net loss -- -- -- (57,745) (57,745)
--------------- ------------ ------------ ------------ -----------------
Balance at December 31, 1998 9,733,374 486 38,821 (33,506) 5,801
Shares issued:
Exercise of stock options 3,200 -- 3 -- 3
Employee Stock Purchase Plan 102,604 5 39 -- 44
Officer/Director Compensation 310,783 16 165 -- 181
Other (332) -- -- -- --
Net income -- -- -- 1,815 1,815
--------------- ------------ ------------ ------------ -----------------
BALANCE AT DECEMBER 31, 1999 10,149,629 $ 507 $ 39,028 $ (31,691) $ 7,844
=============== ============ ============ ============ =================
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF
THESE STATEMENTS.
F-6
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------------------
1999 1998 1997
---------------- ---------------- ----------------
(In thousands)
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 1,815 $ (57,745) $ 11,253
Less: Extraordinary gain on extinguishment of debt (29,500) (18,216) --
------------- ------------- -------------
Income (loss) from continuing operations (27,685) (75,961) 11,253
Adjustments to reconcile net income (loss) from continuing
operations to net cash provided by (used in) operating
activities:
Depreciation and amortization 2,692 3,626 2,691
Fair market value adjustment on residual receivables 3,327 13,638
Benefit for deferred income taxes (7,849) -- (3,813)
Provision for credit losses on loans 3,339 11,906 10,030
Provision for losses on real estate owned 2,665 696 --
Net (increase) decrease in deferred loan costs 442 770 (1,573)
Net increase (decrease) in unearned discount and
other deferrals (1,341) (2,245) 2,812
Loans originated with intent to sell (244,086) (747,442) (1,140,333)
Proceeds from loans sold 220,410 778,948 517,803
Proceeds from securitization of loans 59,630 92,316 509,781
Restructuring charge -- 5,760 --
Other 731 994 (902)
Changes in operating assets and liabilities
increasing (decreasing) cash (5,059) 1,274 (54,038)
------------- ------------- -------------
Net cash provided by (used in) operating
activities 7,216 84,280 (146,289)
------------- ------------- -------------
INVESTING ACTIVITIES:
Loans originated (762) (156,617) (133,188)
Principal collections on loans not sold 19,718 192,176 128,552
Loans purchased for investment purposes (1,413) -- --
Purchase of REO and loans from securitization trusts (10,476) (9,980) --
Proceeds from sale of real estate and personal property
acquired through foreclosure 9,774 7,593 6,652
Proceeds from sale of property and equipment 235 2,808 29
Purchase of property and equipment (532) (11,701) (13,222)
Other 167 48 (411)
------------- ------------- -------------
Net cash provided by (used in) investing activities 16,711 24,327 (11,588)
------------- ------------- -------------
FINANCING ACTIVITIES:
Advances on warehouse lines of credit 292,020 1,416,500 1,139,815
Payments on warehouse lines of credit (290,948) (1,477,369) (1,117,704)
Net increase in notes payable to investors 8,479 3,218 17,381
Net increase (decrease) in subordinated debentures 405 (1,643) 2,832
Net proceeds from issuance of senior unsecured debt -- -- 120,578
Retirement of senior unsecured debt (45,016) (20,134) --
Proceeds from issuance of common stock 229 214 1,260
Other -- (41) --
------------- ------------- -------------
Net cash provided by (used in) financing activities (34,831) (79,255) 164,162
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents (10,904) 29,352 6,285
CASH AND CASH EQUIVALENTS:
BEGINNING OF YEAR 36,913 7,561 1,276
---------------- ---------------- ---------------
END OF YEAR $ 26,009 $ 36,913 $ 7,561
================ ================ ===============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF
THESE STATEMENTS.
F-7
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
HomeGold Financial, Inc. and its subsidiaries ("HGFN" or "the Company") are
primarily engaged in the business of originating, selling, securitizing and
servicing first and second-lien residential mortgage loan products. Prior to
November 1998, the Company also engaged in the business of originating, selling,
securitizing and servicing commercial loan products partially guaranteed by the
United States Small Business Administration ("SBA") and commercial loans
collateralized by accounts receivable and inventory and mezzanine loans.
The funds for these loans are obtained principally through the utilization of
various bank warehouse lines of credit, proceeds from securitization of loans,
and the issuance of senior unsecured debt, notes payable and subordinated
debentures to investors. Substantially all of the Company's loans are made to
non-prime borrowers. These borrowers generally have limited access to credit or
are otherwise considered to be credit impaired by conventional lenders.
CONSOLIDATION AND ESTIMATES
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All subsidiaries at December 31, 1999 were wholly-owned except
for one special purpose corporation that is 99.54% owned. Included in the
consolidated financial statements of operations in 1998 and 1997 are the
operations of the various subsidiaries that were sold during 1998. All
significant intercompany items and transactions have been eliminated in
consolidation.
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles. In preparing the consolidated
financial statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as of the date of the
balance sheet and revenues and expenses for the period. Actual results could
differ from those estimates. These estimates include, among other things,
valuation of real estate owned, assumptions used to value residual receivables
and determination of the allowance for credit losses.
ADOPTION OF NEW ACCOUNTING POLICIES
In the first quarter of 1999, the Company adopted FASB Statement of Financial
Accounting Standards ("SFAS") No. 134 "ACCOUNTING FOR MORTGAGE-BACKED SECURITIES
RETAINED AFTER THE SECURITIZATION OF MORTGAGE LOANS HELD FOR SALE BY A MORTGAGE
BANKING ENTERPRISE". 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 non-mortgage banking
enterprise. The adoption of this standard did not have a material effect on the
Company's financial statements.
RESIDUAL RECEIVABLES AND SALES AND SECURITIZATION OF LOANS
In 1997, the Company began securitizing mortgage loans, whereby it 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 as
a residual receivable. The Company believes the assumptions it has used to value
the residual receivable are appropriate and reasonable. At each reporting
period, the Company assesses the fair value of these residual assets based on
the present value of future cash flows expected under management's current best
estimates of the key assumptions-credit losses, prepayment speed, forward yield
curves, and discount rates commensurate with the risks involved and adjusts the
recorded amounts to their estimated fair value. Total mortgage loans securitized
in 1999 and 1998 were $59.6 million and $90.4 million, respectively.
F-8
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RESIDUAL RECEIVABLES AND SALES AND SECURITIZATION OF LOANS (CONTINUED)
The Company also sells on a whole loan basis a significant portion of its loans
(servicing released), including substantially all of its mortgage loans secured
by second mortgage liens 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.
Historically, the Company generally has been able to recognize higher premiums
from securitizations compared to whole loan sales. However, cash flow is
impacted more positively in the short term by whole loan sales, compared to
securitizations.
In 1999, the Company completed a securitization transaction in the second
quarter. The Company securitized $59.6 million of loans for a weighted average
premium of 2.88%. This securitization consisted of seasoned first and second
lien mortgage loans, resulting in a lower than average premium. However, the
securitization of seasoned loans resulted in additional liquidity of $33.0
million for the Company. Certain loans included in that securitization were
ineligible for inclusion in the borrowing base under the Company's warehouse
line of credit.
During the last two quarters of the year, the Company sold its loans on a
whole-loan, servicing released basis. The Company makes securitization decisions
based on a number of factors including conditions in the secondary market, the
aggregate size and weighted average coupon of loans available to sell, fixed
costs associated with securitization transactions, and liquidity needs. The
Company believes that it will continue to securitize, as well as whole loan
sell, in 2000.
CASH AND CASH EQUIVALENTS
The Company maintains its primary checking accounts with three principal banks
and maintains overnight investments in reverse repurchase agreements with those
same banks. The amounts maintained in the checking accounts are insured by the
Federal Deposit Insurance Corporation ("FDIC") up to $100,000. At December 31,
1999, 1998 and 1997, the amounts maintained in the overnight investments in
reverse repurchase agreements, which are not insured by the FDIC, totaled $25.4
million, $31.6 million, and $5.3 million, respectively. These investments were
collateralized by U. S. Government securities pledged by the banks.
The Company considers all highly liquid investments with original maturities of
three months or less to be cash equivalents.
RESTRICTED CASH
The Company maintains an investment account with a trustee relating to
representations and warranties in connection with the sale of the small-business
loan unit. This account is shown as restricted cash, and is invested in
overnight investments or short-term U.S. Treasury securities.
LOANS RECEIVABLE AND INTEREST INCOME
Loans receivable in 1999 consist primarily of first and second lien residential
mortgage loans, and asset-based small-business loans. In prior years, it also
included SBA loans and automobile loans. During 1998, the Company sold the
majority of its small-business and auto loans. The Company presently is not
originating these types of loans. Non-refundable loan fees and direct costs
associated with the origination or purchase of loans are deferred and netted
against outstanding loan balances.
F-9
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LOANS RECEIVABLE AND INTEREST INCOME (CONTINUED)
Interest income on loans receivable is recognized on the accrual basis as
earned. Fees received, net of direct costs incurred, for the origination of
loans and insurance commissions, are deferred and amortized into interest income
over the contractual life of the loan using the interest method. Any unamortized
amounts are recognized into income at the time the loan is repaid or sold.
Accrual of interest is discontinued and reversed when a loan is either over 90
days past due, or the collateral is determined to be inadequate, or when
foreclosure proceedings begin.
Loans receivable held for sale are carried at the lower of aggregate cost or
market. There was no allowance for market losses on loans receivable held for
sale at December 31, 1999 or 1998.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is based on management's ongoing evaluation of
the loan portfolio and reflects an amount that, in management's opinion, is
adequate to absorb inherent losses in the existing portfolio. In evaluating the
portfolio, management takes into consideration numerous factors including
delinquencies, current economic conditions, prior loan loss experience, the
composition of the serviced loan portfolio, and management's estimate of
anticipated credit losses. Loans, including those deemed impaired, are charged
against the allowance at such time as they are determined to be uncollectible.
Subsequent recoveries are credited to the allowance. Management considers the
year-end allowance appropriate and adequate to cover inherent losses in the loan
portfolio; however, management's judgment is based upon a number of assumptions
about future events, which are believed to be reasonable. Actual results could
differ from these estimates. 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 credit losses will not be required.
ACCOUNTING FOR IMPAIRED LOANS
The Company accounts for impaired loans in accordance with SFAS No. 114
"ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN". This standard requires that
all creditors value loans at the loan's fair market value if it is probable that
the creditor will be unable to collect all amounts due according to the terms of
the loan agreement. Fair value may be determined based upon the present value of
expected cash flows, market price of the loan, if available, or value of
underlying collateral. Expected cash flows are required to be discounted at the
loan's effective interest rate. SFAS No. 114 was amended by SFAS No. 118 to
allow a creditor to use existing methods for recognizing interest income on an
impaired loan and by requiring additional disclosures about how a creditor
recognizes interest income on an impaired loan.
Under SFAS No. 114, as amended by SFAS No. 118, when the ultimate collectibility
of an impaired loan's principal is in doubt, wholly or partially, all cash
receipts are applied to principal. When this doubt does not exist, cash receipts
are applied under the contractual terms of the loan agreement first to principal
and then to interest income. Once the reported principal balance has been
reduced to zero, future cash receipts are applied to interest income, to the
extent that any interest has been foregone. Further cash receipts are recorded
as recoveries of any amount previously charged off.
A loan is also considered impaired if its terms are modified in a troubled debt
restructuring. For these accruing impaired loans, cash receipts are typically
applied to principal and interest receivable in accordance with the terms of the
restructured loan agreement. Interest income is recognized on these loans using
the accrual method of accounting. The Company assesses a specific allowance on
mortgage loans, by reviewing on a loan-by-loan basis each month, all loans over
90 days past due or any loans that are in bankruptcy.
F-10
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REAL ESTATE ACQUIRED THROUGH FORECLOSURE
Real estate acquired through foreclosure represents properties that have been
acquired through actual foreclosures or deeds received in lieu of loan payments.
These assets are recorded at the lower of the carrying value of the loans or the
estimated fair value of the related real estate, net of estimated selling costs.
The excess carrying value, if any, of the loan over the estimated fair value of
the asset is charged to the allowance for credit losses upon transfer. Costs
relating to the development and improvement of the properties are capitalized
whereas those costs relating to holding the property are charged to expense.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed principally
using the straight-line method over the estimated useful lives of the assets.
Estimated lives are 15 to 40 years for buildings and improvements, 3 to 7 years
for furniture, fixtures and equipment, and the lease period for leasehold
improvements. Additions to property and equipment and major replacements or
improvements are capitalized at cost. Maintenance, repairs and minor
replacements are expensed when incurred.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets and identifiable intangibles held and used by the Company are
reviewed for impairment whenever management believes events or changes in
circumstances indicate that the carrying amount of an asset may not be fully
recoverable. No impairment loss was recognized for continuing operations in 1997
or 1999.
In November 1998, the Company decided to close three retail loan centers and to
consolidate all operations into one location. This decision resulted in a
restructuring charge of $6.8 million. The restructuring charge relates to the
write-down of fixed assets to net realizable value on assets no longer used by
the Company and the estimated net lease cost on facilities no longer being used.
GOODWILL
The excess of cost over related net assets of businesses acquired is amortized
using the straight-line method principally over 25 years. On a periodic basis,
the Company reviews goodwill for events or changes in circumstances that may
indicate that the carrying amount of goodwill may not be recoverable. The
Company utilizes estimated future cash flows of the purchased subsidiary
compared to the value of goodwill booked in determining any impairment on the
excess of cost over the related net assets.
DEBT ORIGINATION COSTS
The Company capitalizes costs incurred to obtain warehouse lines of credit and
senior unsecured debt. These costs are amortized as an addition to interest
expense over the terms in the loan agreements. The Company also reduces the debt
origination costs by the unamortized portion of the senior unsecured debt that
is purchased. These amounts have been netted against the gain on extinguishment
of debt.
REMITTANCES PAYABLE
The Company retains the servicing rights on its mortgage securitization
transactions. The Company receives the payments from the borrowers and records a
liability until the funds are remitted to the Trustee.
F-11
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVESTOR SAVINGS
The Company issues notes payable and subordinated debentures through a
subsidiary company, CII. The notes are fixed rate securities registered under
the South Carolina Uniform Securities Act ("the Act"), and mature from one to
three years from the date of issuance. The Company pays interest on the notes
monthly, quarterly, or at maturity at the option of the investor. The Company
also issues subordinated debentures under the Act, which mature one year from
date of issuance and have an interest rate of 5.0%. See Note 10.
SENIOR DEBT
The Company sold $125.0 million in aggregate principal amount of senior
unsecured notes in 1997. The notes pay interest semi-annually at 10.75%, and
mature September 15, 2004.
INCOME TAXES
The Company and its subsidiaries file a consolidated Federal income tax return.
The Company accounts for income taxes using the asset and liability method.
Under the asset and liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. Deferred income
taxes arise principally from depreciation, unrealized gains on loans held for
sale, certain securitization transactions, amortization of intangibles,
allowances for credit losses, and net operating loss carryforwards. Management
establishes on a quarterly basis a valuation allowance for deferred assets.
Management believes that it is more likely than not that the results of future
operations will generate sufficient taxable income to realize net deferred tax
assets.
ADVERTISING EXPENSE
Advertising, promotional, and other business development costs are generally
expensed as incurred except as noted herein. External costs incurred in
producing media advertising are expensed the first time the advertising takes
place. In 1997, the Company began using a direct mail marketing approach for its
retail mortgage business. External costs related to direct mailings are
capitalized in accordance with Statement of Position 93-7 and amortized over a
three-month period. Total expenses recognized in 1999, 1998 and 1997 for direct
mailings were approximately $4.4 million, $8.8 million and $5.9 million,
respectively. The total amounts capitalized into other assets on the balance
sheet at December 31, 1999 and 1998 were approximately $934,000 and $842,000,
respectively.
INTEREST RATE RISK MANAGEMENT
The Company's operations may be directly affected by fluctuations in interest
rates. While the Company monitors interest rates and may, from time to time,
employ 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 currently does not hedge its
loans held for whole-loan sales. The Company's present strategy is to sell a
substantial portion of the current months' production that is designated for
whole-loan sales in the following month and the remaining loans in the
subsequent month. Because 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 may reduce the gain on loan sales
earned by the Company. There were no significant open hedging positions at
year-end. On loans originated for inclusion in securitized pools, the Company
generally employs a strategy designed to hedge some of the risks associated with
changes in interest rates. The Company's interest rate hedging strategy,
includes shorting interest rate futures and treasury forwards, and entering into
interest-rate lock agreements relating to loans pending a securitization
transaction. The
F-12
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INTEREST RATE RISK MANAGEMENT (CONTINUED)
ultimate sale of the Company's loans included in a securitized transaction
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.
EARNINGS PER SHARE
Earnings per share ("EPS") are computed in accordance with SFAS No. 128,
"EARNINGS PER SHARE". Basic EPS includes no dilution and is computed by dividing
net income by the weighted average number of common shares outstanding for the
period. Diluted EPS reflects the potential dilution of securities that could
share in the earnings of the Company. Common stock equivalents included in the
diluted EPS computation consist of stock options, which are computed using the
treasury stock method. In 1999 and 1998, due to the Company's net operating
loss, the common stock equivalents were not included in the diluted EPS
calculation since their inclusion would be antidilutive. In 1997 common stock
equivalent shares included in diluted EPS totaled 192,590 equivalent shares.
SEGMENT REPORTING
During 1998, the Company adopted the provisions of SFAS No. 131 "DISCLOSURES
ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION". This Statement
establishes standards for the method that public entities use to report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about product and services, geographical areas, and
major customers. The Company believes that it operates as one segment.
RECLASSIFICATIONS
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.
ACCOUNTING CONSIDERATIONS
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS 133,
"ACCOUNTING FOR DERIVATIVE INSTRUMENT AND HEDGING ACTIVITIES". All derivatives
are to be measured at fair value and recognized in the balance sheet as assets
or liabilities. This statement's effective date was delayed by the issuance of
SFAS 137, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES -
DEFERRAL OF THE EFFECTIVE DATE OF SFAS 133", and is effective for fiscal years
and quarters beginning after June 15, 2000. The Company does not expect that the
adoption of SFAS 137 will have a material impact on the presentation of the
Company's financial results or financial position.
Accounting standards that have been issued by the FASB that will not require
adoption until a future date and will impact the preparation of the financial
statements will not have a material effect upon adoption.
F-13
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SUBSEQUENT EVENT (UNAUDITED)
On January 31, 2000, HomeGold Financial, Inc. entered into a Letter of Intent to
merge with HomeSense Financial Corp., a privately owned company, located in
Columbia, South Carolina. HomeSense is a specialized mortgage company that
originates and sells mortgage loans in the sub-prime mortgage industry, whose
principal loan product is a debt consolidation loan, generally collateralized by
a first lien on the borrower's home. The merger is subject to completion of a
Definitive Merger Agreement and shareholder approval. The Company expects to
sign a Definitive Merger Agreement in the next few weeks and obtain shareholder
approval in April.
NOTE 3. LOANS RECEIVABLE
The following is a summary of loans receivable by type of loan:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------
1999 1998
------------------- ------------------
(In thousands)
<S> <C> <C>
Mortgage Loans:
First mortgage residential property $ 41,848 $ 92,696
Second mortgage residential property 9,256 18,992
Real estate loans on rental property 1,121 1,285
Construction loans -- 2,932
------------------- ------------------
Total mortgage loans 52,225 115,905
------------------- ------------------
Small-business loans 10,388 7,054
Other loans 629 1,781
----------------- ------------------
Total loans receivable $ 63,242 $ 124,740
================= ==================
</TABLE>
Included in loans receivable are $46.9 million and $74.1 million at December 31,
1999 and 1998, respectively that are being held for sale.
Included in loans receivable are loans from related parties of $121,000 and
$168,000 at December 31, 1999 and 1998, respectively. Notes receivable from
related parties included advances of $12,000 in 1999 and $160,000 in 1998.
Repayments from related parties were $13,000 and $28,000 in 1999 and 1998,
respectively. In 1999 and 1998, the Company had notes from parties at the
beginning of the year who were no longer considered related parties as of
December 31 due to termination of employment status.
First mortgage residential loans generally have contractual maturities of 12 to
360 months with an average interest rate at December 31, 1999 and 1998 of
approximately 10.9% and 10.6%, respectively.
Second mortgage residential loans have contractual maturities of 12 to 360
months with an average interest rate at December 31, 1999 and 1998 of
approximately 14.3% and 14.0%, respectively.
Loans sold and serviced for others at December 31, 1999 and 1998 were
approximately $355.7 million and $432.6 million, respectively, and are not
included in assets in the accompanying balance sheets.
F-14
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3. LOANS RECEIVABLE (CONTINUED)
At December 31, 1999, the Company's serviced for others mortgage loan portfolio
by type of collateral is summarized as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C> <C>
First mortgage residential property $ 338,107 95.1 %
Second mortgage residential property 7,826 2.2
Real estate loans on rental property 9,742 2.7
--------------- -------
$ 355,675 100.0 %
=============== =======
</TABLE>
The Company services loans in 44 states. South Carolina, North Carolina, Florida
and Georgia serviced loans represent approximately 18%, 15%, 9% and 7%,
respectively, of the Company's total serviced loan portfolio at December 31,
1999. No other state represents more than 6% of total serviced loans.
An analysis of the allowance for credit losses is as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------
1999 1998 1997
---------------- -------------- ---------------
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 6,659 $ 6,528 $ 3,084
Provision for credit losses 3,339 11,906 10,030
Net charge offs (3,654) (8,792) (5,166)
Allowance related to loans sold -- (2,983) --
Securitization transfers -- -- (1,420)
---------------- -------------- ---------------
Balance at end of year $ 6,344 $ 6,659 $ 6,528
============== ============== ===============
</TABLE>
As of December 31, 1999, 1998, and 1997, loans totaling $10.8 million, $7.9
million, and $8.9 million, respectively, were on non-accrual status. The
associated interest income not recognized on these non-accrual loans was
approximately $825,000, $2.0 million, and $809,000, during the years ended
December 31, 1999, 1998 and 1997, respectively.
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These instruments expose the Company to credit risk in excess of the amount
recognized in the balance sheet. The Company's exposure to credit loss in the
event of nonperformance by the other party to the financial instrument for
commitments to extend credit is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments. Total
credit exposure at December 31, 1999 related to these items is summarized below:
Contract Amount
----------------------
(In thousands)
----------------------
Loan commitments $ 4,255
======================
Loan commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract. Loan
commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained upon
extension of credit is based on management's credit evaluation of the customer.
Collateral held is primarily residential property. Interest rates on loan
commitments are generally fixed rates.
F-15
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4. OTHER RECEIVABLES
The following is a summary of other receivables:
<TABLE>
<CAPTION>
December 31,
----------------------------------------
1999 1998
------------------ ------------------
(In thousands)
<S> <C> <C>
Fees Earned Not Collected $ 3,277 $ 1,909
Advanced funds to trust (2) 2,035 1,820
Receivable from mortgage trust (3) 975 1,394
Final purchase price adjustment on sale of assets to Transamerica (1) -- 4,339
Note receivable 1,006 --
Other 766 2,566
---------------- -----------------
$ 8,059 $ 12,028
================ =================
</TABLE>
- --------------
(1) Received in January 1999.
(2) Trust agreements require the Company to advance interest on delinquent
customer accounts.
(3) Excess distribution from mortgage trust received in January 2000 and 1999,
respectively.
NOTE 5. RESIDUAL RECEIVABLES
In connection with its mortgage loan securitizations and SBA loan
securitizations and sales, the Company retained residual interests in the
trusts. During 1998, the Company's residual interests relating to its SBA loan
securitizations were sold.
Residual assets totaling $47.8 million and $43.9 million at December 31, 1999
and 1998, respectively, resulted from mortgage loan securitizations.
The following summarizes activity in the residual receivable:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------
1999 1998 1997
----- ----------- --- ----------- -- -----------
(In thousands)
------------------------------------------------------
<S> <C> <C> <C>
Gross balance, beginning of year $ 51,022 $ 77,457 $ 14,417
Gain on sale of loans 9,641 12,322 57,516
Increase in the discounted value of future cash flows, net -- 14,289 10,311
Mark to market value adjustment 19 (19,366) --
Amortization of original residual asset value (5,736) (15,920) (3,984)
Sale of small-business commercial residual receivable -- (14,845) --
Other -- (2,915) (803)
Gross balance, end of year 54,946 51,022 77,457
Less allowance for losses on residual receivable (7,176) (7,165) (14,255)
--------------- --------------- --------------
Balance at end of year $ 47,770 $ 43,857 $ 63,202
=============== =============== ==============
</TABLE>
F-16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. RESIDUAL RECEIVABLES (CONTINUED)
An analysis of the allowance for losses, which is embedded in the interest-only
strip security, is as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------------
1999 1998 1997
----------------- --------------- -------------
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 7,165 $ 14,255 $ 1,202
Anticipated losses netted against gain 1,267 2,242 13,278
Mark to market adjustment 405 (5,728) --
Sale of small-business commercial residual asset -- (2,957) --
Net charge offs (1,661) (647) (1,645)
Transfer from allowance for loan loss -- -- 1,420
----------------- --------------- -------------
Balance at end of year $ 7,176 $ 7,165 $ 14,255
=============== ============== ==============
</TABLE>
The allowance represents management's estimate of losses to be incurred over the
life of the securitized pool.
The Company sold $59.6 million of mortgage loans in one securitization
transaction in 1999, $90.5 million of mortgage loans in one securitization
transaction in 1998, and $487.6 million of mortgage loans in four securitization
transactions in 1997. The company also sold $1.8 million small business loans in
one securitization transaction in 1998 and $24.3 million in two securitization
transactions in 1997.
The Company received net cash proceeds from the securitizations of $59.6
million, $92.3 million, and $509.8 million in 1999, 1998, and 1997,
respectively. The Company recorded a gain on sale of these loans of $1.7
million, $8.1 million, and $44.2 million in 1999, 1998, and 1997, respectively.
In all securitizations entered into during the three years ended December 31,
1999, the Company retained servicing responsibilities and subordinated
interests. The Company receives annual servicing fees approximating 50 basis
points of the outstanding balance, and rights to future cash flows arising after
the investors in the securitization trust received the return for which they are
contracted. As a result of the sale of the assets in both the auto and small
business loan units, the Company has no future rights related to the auto or
small business loan securitizations. The investors and their securitization
trusts have no recourse to the Company's other assets for failure of debtors to
pay when due. Most of the Company's retained interests are generally restricted,
however, until investors have been fully paid and subordinate to investor's
interests. The value of the Company's portion of the securitization is subject
to substantial credit, prepayment, and interest rate risk on the transferred
financial assets.
The Company received cash proceeds from servicing fees and excess cash flow on
the Company's retained interest in securitized loans of $15.6 million, $16.5
million, and $3.7 million in 1999, 1998, and 1997, respectively.
The various securitized loan trusts have delinquency percentage and loan
charge-off percentage covenants that if exceeded would significantly delay the
timing of when the Company receives the excess cash generated by the trust. The
excess cash results from the customer loan rates exceeding the rates paid to the
investors. The securitization agreements allow the Company to repurchase
delinquent or foreclosed assets. The Company purchased from the securitized loan
trusts approximately $13.7 million and $10.0 million of delinquent or foreclosed
assets in 1999 and 1998, respectively. As of December 31, 1999, 1998 and 1997
the Company was in compliance with the securitization agreement covenants.
In connection with its 1999 securitization transaction, the Company agreed to
cross-collateralize its residual interests in that transaction and its first
three 1997 securitization transactions. The cross-collateralization is for the
benefit of Financial Security Assurance, Inc. ("FSA") the bond insurer for all
of the transactions. Under the terms of the cross-collateralization agreement,
in the event the Company is in breach of its obligations under any one or more
of the securitization trusts, or if certain cumulative loss or delinquency
triggers are met, the excess cash flow on all four residual interests will be
captured by the Collateral Agent. The Collateral Agent will distribute these
monies to FSA or as otherwise specified in the agreement. The total amount which
may be retained by the Collateral Agent is capped at $15.0 million. This
agreement terminates upon the termination of all of the related securitization
trusts.
F-17
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. PROPERTY AND EQUIPMENT
The following is a summary of property and equipment:
December 31,
----------------------------
1999 1998
-------- --------
(In thousands)
Land $ 948 $ 948
Buildings and leasehold improvements 11,545 11,276
Equipment and computers 10,126 11,395
Furniture and fixtures 4,470 5,089
Vehicles 191 195
Restructuring reserve (4,312) (5,411)
-------- --------
Total property and equipment 22,968 23,492
Less accumulated depreciation (5,808) (3,827)
-------- --------
Net property and equipment $ 17,160 $ 19,665
======== ========
Depreciation expense was $2.5 million, $3.3 million, and $2.2 million in 1999,
1998, and 1997, respectively.
The Company leases various property and equipment, office space and automobiles
under operating leases. The Company's headquarters building collateralizes the
warehouse line of credit.
In 1998, the Company recorded a $1.8 million non-cash restructuring charge
related to future minimum rental payments for operating leased assets and
facilities that are no longer used in the Company's normal course of business.
During 1999, rental payments on leased facilities no longer used by the company
have been paid from and sublease rent receipts have been deposited into the
reserve established in 1998. As of December 31, 1999, management feels that the
reserve is adequate to absorb future costs estimated to be associated with the
leased space. No additional expense was recorded in 1999.
The following is a schedule of future minimum cash rental payments and future
minimum operating lease expense by year for all operating leases that have
initial or remaining noncancelable terms (in thousands):
Future Cash Future Lease
Payment Expense
---------------- ----------------
2000 $ 1,985 $ 1,491
2001 773 394
2002 523 217
2003 267 68
2004 and thereafter -- --
---------------- ----------------
$ 3,548 $ 2,170
================ ================
Total rental expense was approximately $2.0 million in 1999, $4.9 million in
1998, and $2.8 million in 1997.
F-18
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. REAL ESTATE ACQUIRED THROUGH FORECLOSURE
An analysis of real estate acquired through foreclosure is as follows:
<TABLE>
<CAPTION>
December 31,
----------------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 5,881 $ 3,295 $ 4,720
Loan foreclosures and improvements 14,827 11,777 5,888
Dispositions, net (10,370) (8,495) (7,313)
Write-down of real estate acquired through foreclosure (2,665) (696) --
-------- -------- --------
Balance at end of year $ 7,673 $ 5,881 $ 3,295
======== ======== ========
</TABLE>
NOTE 8. EXCESS OF COST OVER NET ASSETS OF ACQUIRED BUSINESSES
An analysis of excess of cost over net assets of acquired business is as
follows:
December 31,
------------------------
1999 1998
------- -------
(In thousands)
Balance at beginning of year $ 1,660 $ 2,874
Amortization expense (94) (172)
Sale of intangible asset -- (1,042)
------- -------
Balance at end of year $ 1,566 $ 1,660
======= =======
NOTE 9. WAREHOUSE LINES OF CREDIT
Under the terms of the revolving credit agreement, HomeGold, Inc. ("HGI"), a
wholly-owned subsidiary of HGFN, or Carolina Investors, Inc. ("CII"), a
wholly-owned subsidiary of HGFN, may borrow up to a maximum of $100 million with
interest at the Prime Rate plus 0.75%. The note is collateralized by mortgage
loan receivables and by a commercial building owned by CII. The agreement
requires, among other matters, minimum availability of $10 million on the line
of credit, and a requirement that CII maintain a minimum of $100 million in
aggregate outstanding principal amount of notes due to investors. It also
restricts the ability of HGI and, in certain circumstances, Carolina Investors,
Inc., to pay dividends or make loans or advances to HGFN. Management believes
the Company is in compliance with such restrictive covenants at December 31,
1999. The revolving credit agreement matures on June 30, 2001. Availability
under the credit agreement is determined based on eligible collateral as defined
under the agreement, for which the Company has forwarded to the bank the
required loan files and documentation. The borrowing base adjusted for the $10
million minimum availability requirements would have allowed a maximum borrowing
level based on eligible collateral of $18.9 million at December 31, 1999. HGI
had outstanding borrowings of $17.8 million, and CII had no outstanding
borrowings at December 31, 1999. Therefore, $1.1 million was available under
this agreement on December 31, 1999. $21.0 million was available under the
agreement at December 31, 1998.
The warehouse lines of credit to the small business lending subsidiaries were
paid off and terminated at the time that the majority of their respective assets
and liabilities were sold.
F-19
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. INVESTOR SAVINGS
Investor savings are summarized as follows:
December 31,
-----------------------
1999 1998
-------- --------
(In thousands)
Notes payable to investors $127,065 $118,586
Subordinated debentures 17,710 17,304
-------- --------
$144,775 $135,890
======== ========
Notes payable to investors are issued by a subsidiary company, CII, in any
denomination greater than $10,000 and are registered under the South Carolina
Uniform Securities Act. The notes payable to investors are PARI PASSU with the
senior unsecured debt of HGFN. The notes mature from one to three years from
date of issuance. Interest is payable monthly, quarterly or at maturity at the
option of the investors. Interest rates on the notes are fixed until maturity
and range from 5% to 9%. At December 31, 1999, and 1998, the weighted average
rate was 7.55%, 7.38%, respectively.
Subordinated debentures are issued by CII in any denomination greater than $100
and are registered under the South Carolina Uniform Securities Act. The
subordinated debentures mature one year from date of issuance and have interest
rates of 5%.
The notes and debentures are subordinated to all bank debt, notes payable to
investors, and senior unsecured debt. These notes and debentures are not secured
by a pledge of any specific assets at CII, nor guaranteed by the Company.
At December 31, 1999, 1998, and 1997, notes payable to investors include an
aggregate of approximately $27.0 million, $27.4 million, and $26.3 million,
respectively, of individual investments exceeding $100,000.
The investor savings at December 31, 1999 mature as follows (in thousands):
2000 $ 75,381
2001 51,684
---------------
$ 127,065
===============
F-20
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 1998, the Company purchased $38.4 million in aggregate
principal amount of its Senior Notes in open market transactions for a combined
purchase price of $18.9 million or 49.4% of face value. In 1999, the Company
purchased $74.5 million in aggregate principal amount of the Senior Notes for a
purchase price of $45.0 million, and 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 December 31, 1999
and 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 listed in Note 26 (the
"Subsidiary Guarantors"). With the exception of the Guarantee by the Company's
subsidiary 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. 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 Senior Notes
outstanding at December 31, 1999 and 1998 were $12.1 million and $86.7 million,
respectively.
Included in Note 26 are 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 December 31, 1999 and 1998, all of the subsidiary guarantors were
wholly-owned by the Company.
NOTE 12. SALE OF SUBSIDIARY AND SUBSIDIARY'S ASSETS
As part of the Company's effort to focus on its larger retail lending operation
that operates primarily through direct mail and telemarketing methods, the
Company chose to sell its small branch network retail origination company. This
company historically had originated its mortgage loan products through a
traditional "brick and mortar" retail approach. The Company also chose to sell
substantially all of the assets related to the auto and small-business units.
The Company also decided to no longer offer these financial products.
The Company completed the sale of substantially all of the assets related to its
auto loan operation 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 asset sale, this product line
recorded a net loss of approximately $110,000 for the period ended March 19,
1998. The auto loan operations recorded losses of $1.9 million for the year
ended December 31, 1997.
F-21
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12. SALE OF SUBSIDIARY AND SUBSIDIARY'S ASSETS (CONTINUED)
On August 21, 1998, the Company completed the sale of its small branch network
retail mortgage origination company, Sterling Lending Corporation ("SLC"), to
First National Security Corporation ("FNSC") 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 period in
1998 prior to the sale of Sterling Lending, and for the year ended December 31,
1997, Sterling Lending recorded losses of $3.4 million and $3.8 million,
respectively. During 1999, FNSC made three quarterly interest payments as
scheduled. However, in the fourth quarter the Company was notified that Sterling
Lending Corp. filed for bankruptcy protection under Chapter 11. As a result, the
Company has taken a charge of approximately $900,000 in order to value the note
at its estimated net realizable value at December 31, 1999. In addition, as a
part of the sale agreement, the Company guaranteed certain leases of office
space used by SLC. Due to the financial situation of SLC, the Company has been
asked to perform under certain of the guarantees. The Company is resolving each
lease through active negotiations with the landlords, and management feels that
the resolution of these leases will not be material to the financial statements
of the Company.
On November 13, 1998, the Company sold 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 ("Transamerica"). Total sales proceeds from this sale were $100.3
million. After repayment of the related warehouse lines of credit, escrowing a
$5.0 million holdback of the purchase price, and paying transaction costs, the
Company received net cash proceeds of approximately $49.3 million. The gain
realized in 1998 was approximately $19.7 million net of related costs. The
Company recorded in 1998, income (including the pre-tax $19.0 million gain on
sale of net assets) of $14.4 million on these operating units that were sold.
For the year ended December 31, 1997, income from the operations of these sold
units were $6.7 million. The Company maintains a $5.0 million account (plus
interest earned for a total of $5.3 million) with a trustee relating to
representations and warranties in connection with the sale of the small business
loan unit. Both the Company and Transamerica must agree for funds to be released
to either party from the escrow account. On February 26, 1999, the Company
received notification from Transamerica that pursuant to the asset purchase
agreement dated October 2, 1998, that a loan for approximately $1.1 million was
allegedly not made by the Company in accordance with stated representations.
Transamerica is seeking to recover the loan amount from the Company's $5.3
million escrow account, and thus has not agreed to allow the Company to make a
scheduled distribution from the account. The Company disagrees with the
assertions of Transamerica, and has made a Demand for Arbitration, which is the
agreed upon method in the terms of the sale agreement for resolving disputes.
The Company does not expect settlement of the claim to have a material effect on
the Company's operations.
On December 2, 1998, the Company sold the majority of its asset-based lending
operation to Emergent Asset Based Lending LLC, a Maryland Limited Liability
Company. This transaction completed the disposition of all non-mortgage-related
activities of the Company. The sale resulted in a pre-tax loss of $755,000. The
Company received a note receivable of $2.2 million payable over two years at an
interest rate of Prime plus 1%. The Company recorded in 1998 a net loss
(including the pre-tax $755,000 loss on the sale of assets) of $3.4 million on
this operating unit that was sold. For the year ended December 31, 1997, there
was a loss from operations of $1.7 million.
NOTE 13. FAIR MARKET VALUE ADJUSTMENT ON RESIDUAL RECEIVABLES
As a result of higher than anticipated prepayments in 1998, the Company modified
the estimated prepayment speeds on all of its mortgage loan securitization
transactions to peak at 30 constant prepayment rate ("CPR") up from the previous
prepayment speeds of 20 CPR. This resulted in a write-down of residual
receivables of $13.6 million in 1998. No such write-down was necessary in 1997
or 1999. The Company refined its estimate and began using CPR's of 28 in 1999
based on a review of a longer period of actual experience.
F-22
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14. RESTRUCTURING CHARGES
In November 1998, the Company decided to close three retail loan centers and to
consolidate all operations into one location. This decision resulted in a
restructuring charge of $6.8 million. The restructuring charge related to the
write-down of fixed assets to net realizable value on assets no longer used by
the Company was $3.6 million. The estimated net lease cost on facilities no
longer being used was $1.8 million, and the estimated costs of employee
relocation cost and employee severance was approximately $1.4 million.
NOTE 15. OTHER GENERAL AND ADMINISTRATIVE EXPENSES
Other general and administrative expenses for the years ended December 31, 1999,
1998, and 1997 consist of the following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------
1999 1998 1997
------------------ ------------------ -----------------
(In thousands)
<S> <C> <C> <C>
Depreciation expense $ 2,487 $ 3,337 $ 2,220
Amortization expense 206 289 471
Legal and professional fees 2,013 3,125 6,749
Loan costs 1,608 3,972 2,657
Deferred loan costs (2,251) (5,917) (1,658)
Travel and entertainment 729 3,362 3,493
Office rent and utilities 322 2,827 2,206
Telephone 928 4,228 3,411
Office supplies 501 2,015 2,322
Equipment and miscellaneous rental 1,896 2,285 611
Repairs and maintenance 1,124 966 413
Postage and handling charges 374 1,146 1,136
Other 3,186 4,323 3,847
------------------ ------------------ -----------------
TOTAL OTHER GENERAL AND ADMINISTRATIVE EXPENSES $ 13,123 $ 25,958 $ 27,878
================== ================== =================
</TABLE>
NOTE 16. 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, minority interest, and extraordinary item are as
follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------
1999 1998 1997
------------- -------------- ------------
(In thousands)
<S> <C> <C> <C>
Statutory Federal rate of 34% applied to pre-tax income
from continuing operations before minority interest
and extraordinary item $ (11,924) $ (24,817) $ 2,553
State income taxes, net of federal income tax benefit (511) 279 (16)
Change in the valuation allowance for deferred tax assets allocated
to income tax expense (7,500) 21,672 (7,508)
Nondeductible expenses 23 91 107
Amortization of excess cost over net assets of acquired businesses 18 46 66
Effect of losses on tax provision 11,800 3,909 --
Tax on excess inclusion income from REMIC's 700 2,284 457
Other, net -- (447) 441
------------- -------------- ------------
$ (7,394) $ 3,017 $ (3,900)
============= ============== ============
</TABLE>
F-23
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 16. INCOME TAXES (CONTINUED)
The extraordinary gain on the extinguishment of debt is net of $0 tax since the
gain was offset against prior NOLs and did not result in any incremental
increase in income tax expense.
Provision (benefit) for income taxes from continuing operations is comprised of
the following:
Years Ended December 31,
-------------------------------------
1999 1998 1997
------- ------- -------
(In thousands)
Current
Federal $ 403 $ 2,594 $ 289
State and local 52 423 (376)
------- ------- -------
455 3,017 (87)
Deferred
Federal (7,023) -- (4,165)
State and local (826) -- 352
------- ------- -------
(7,849) -- (3,813)
Total
Federal (6,620) 2,594 (3,876)
State and local (774) 423 (24)
------- ------- -------
$(7,394) $ 3,017 $(3,900)
======= ======= =======
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
and AMT credit carryforwards. The tax effects of significant items comprising
the Company's net deferred tax asset are as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------
1999 1998
-------- --------
(In thousands)
<S> <C> <C>
Deferred tax liabilities:
Differences between book and tax basis of property $ (601) $ (1,011)
Differences between book and tax basis of investment in owner's trust (546) --
Difference between book and tax basis of the residual receivables associated
with the Company's investment in the Real Estate Investment Trust (1,096) (1,513)
Deferred loan costs (100) (333)
Other (9) (11)
-------- --------
Total gross deferred tax liabilities $ (2,352) $ (2,868)
======== ========
Deferred tax assets:
Differences between book and tax basis of deposit base intangibles $ 200 $ 178
Differences between book and tax basis of REMIC residual receivables 2,303 5,318
Allowance for credit losses 3,501 3,582
AMT credit carryforward 19 58
Operating loss carryforward 21,535 17,871
Deferred loan fees 270 780
REO reserve 114 114
Restructuring reserve-leases 415 640
Other 167 150
-------- --------
Total gross deferred tax assets 28,524 28,691
Less valuation allowance (14,172) (21,672)
Less gross deferred tax liabilities (2,352) (2,868)
-------- --------
Net deferred tax asset $ 12,000 $ 4,151
======== ========
</TABLE>
F-24
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 16. INCOME TAXES (CONTINUED)
The valuation allowance for deferred tax assets at December 31, 1999 was $14.2
million. The increase (decrease) in the valuation allowance for the year ended
December 31, 1999 and the year ended December 31, 1998 was ($7.5) million and
$21.7 million, respectively. The valuation allowance at December 31, 1999
relates primarily to net operating losses ("NOL") carryforwards. The decision to
reduce the valuation allowance in 1999 was based on improvements in 1999
production and 2000 loss projections. The Company experienced a taxable loss for
1999. The ability to fully utilize all of the NOL's expiring in 2000 is reduced
by the Company's current year loss and the inability to use current period
earnings classified as "excess inclusion" to offset prior NOL's. Earnings of
approximately $1.8 million for the year ended December 31, 1999 and $6.0 million
in 1998 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 make
additional adjustments to reserves against this asset if deemed appropriate in
the future.
As of December 31, 1999, the Company has available Federal NOL carryforwards
expiring as follows (in thousands):
2000 $ 3,297
2001 1,911
2002 and after 58,128
---------------
$ 63,336
===============
There are no known significant pending assessments from taxing authorities
regarding taxation issues at the Company or its subsidiaries.
NOTE 17. EXTRAORDINARY ITEM - GAIN ON EXTINGUISHMENT OF DEBT
The Company purchased $74.5 and $38.4 million face amount of its Senior Notes in
the market for a purchase price of $45.0 and $18.9 million in 1999 and 1998,
respectively. 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 $29.5 million and $18.2 million in 1999 and 1998,
respectively. The Company may, from time to time, purchase more of its Senior
Notes depending on its cash needs, market conditions, and other factors.
NOTE 18. STATEMENT OF CASH FLOWS
The following information relates to the Statement of Cash Flows for the three
years ended December 31, 1999, 1998, and 1997:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Changes in operating assets and liabilities increasing (decreasing) cash:
Restricted cash $ (214) $ (5,100) $ --
Other receivables 3,969 (2,657) (5,223)
Residual receivable (7,240) 6,124 (46,318)
Accrued interest receivable 1,189 1,794 (2,292)
Servicing asset 73 528 (1,468)
Other assets 2,670 6,373 (5,378)
Remittance due to loan participants (793) (2,720) 1,072
Accrued interest payable (2,354) (1,551) 4,153
Income taxes payable 177 511 (1,666)
Other liabilities (2,536) (2,028) 3,082
-------- -------- --------
$ (5,059) $ 1,274 $(54,038)
======== ======== ========
</TABLE>
F-25
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 18. STATEMENT OF CASH FLOWS (CONTINUED)
The Company foreclosed on, or repossessed property used to collateralize loans
receivable in the amount of $4.3 million, $12.1 million, and $5.4 million, in
1999, 1998, and 1997, respectively. The Company purchased $10.5 million of
foreclosed property from the securitization trusts in 1999. The company
repurchased loans from the securitization trusts of $9.9 million in 1998. The
Company did not repurchase from the trusts in 1997.
The Company paid income taxes of $277,000, $2.5 million, and $1.6 million, in
1999, 1998, and 1997, respectively. The Company paid interest of $18.7 million,
$37.5 million, and $21.0 million, in 1999, 1998, and 1997, respectively.
NOTE 19. STOCK OPTION PLANS
On May 21, 1981, the shareholders approved an employee stock option plan and on
May 22, 1984, the shareholders approved an increase in the number of shares of
common stock which may be granted from 250,000 to 500,000. Under the terms of
the plan, the Company may grant options to key employees and directors to
purchase up to a total of 500,000 shares of its $.05 par value common stock. The
option price is the fair market value at date of grant. The options expire five
years from date of grant, are not transferable other than on death, and are
exercisable 20% on the date of grant and 20% per year on a cumulative basis for
each year subsequent to the date of grant. No additional shares are available
for grant under this stock option plan, and there are 24,000 unexercised options
outstanding at December 31, 1999, of which 24,000 are exercisable.
On June 9, 1995, the shareholders approved a stock option plan under which the
Board of Directors may issue 566,667 shares of common stock. In May 1997, April
1998, and in March 1999, the shareholders approved an additional 150,000,
350,000, and 400,000 shares of common stock, respectively. Therefore, under the
terms of the plan, the Company may grant options to key employees to purchase up
to a total of 1,066,667 shares of its $.05 par value common stock. The option
price is the fair market value at date of grant. Prices for incentive stock
options granted to employees who own 10% or more of the Company's stock are at
110% of market value at date of grant. The options expire ten years from date of
grant, are not transferable other than on death, and are exercisable 20% on the
date of grant and 20% per year on a cumulative basis for each year subsequent to
the date of grant. The remaining options available for grant under the plan
consist of 230,207 common stock options at December 31, 1999, and there are
1,202,500 unexercised options outstanding at December 31, 1999, of which 460,000
are exercisable.
Also on June 9, 1995, the shareholders approved a stock option plan under which
each non-employee member of the Board of Directors receives options to purchase
666 shares of common stock each December 31 beginning in 1995 through 1999.
Under the terms of the plan, the Company may grant options totaling 33,333
shares. The terms of the plan are identical to the employee stock option plan
approved on June 9, 1995. The remaining options available for grant under this
plan consist of 27,606 common stock options at December 31, 1999, and there are
5,328 unexercised options outstanding at December 31, 1999, of which 4,795 are
exercisable.
On April 18, 1996, the shareholders approved a restricted stock agreement plan
to provide additional incentives to members of the Board of Directors of the
Company who are not employees of the Company. Shares that may be issued pursuant
to the Restricted Stock Agreements under the Plan shall not exceed 50,000 shares
in the aggregate. The Plan provides that, on each grant date, each eligible
director will automatically receive from the Company an Agreement to purchase
for $.05 per share that number of shares having a fair market value equal to
$12,000. For purposes of the Plan, the grant date is January 31 of each calendar
year commencing with the 1996 calendar year. At December 31, 1999 and 1998,
there were 14,500 agreements granted under this plan with 11,600 unexercised
agreements outstanding, all of which are exercisable. Shares subject to a
Restricted Stock Agreement are initially non-transferable and subject to
forfeiture. Shares granted to a recipient become freely transferable and no
longer subject to forfeiture at a rate of 20% of the total number of shares
covered by such agreement on each of the five anniversaries of the grant date,
beginning with the first anniversary of such grant.
F-26
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 19. STOCK OPTION PLANS (CONTINUED)
Activity in stock options is as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------
1999 1998 1997
------------- --------------- --------------
Options outstanding, beginning of year 973,003 483,971 487,638
Date of Grant Issued at:
- -------------------- ----------------------
<S> <C> <C> <C> <C>
02/11/97 $13.50 per share -- -- 1,000
05/02/97 $13.00 per share -- -- 10,000
08/06/97 $14.25 per share -- -- 5,000
09/22/97 $13.50 per share -- -- 21,000
01/16/98 $8.00 per share -- 6,000 --
01/16/98 $9.00 per share -- 15,000 --
03/11/98 $9.75 per share -- 205,000 --
04/22/98 $8.75 per share -- 16,900 --
05/13/98 $6.75 per share -- 50,000 --
09/04/98 $2.44 per share -- 7,000 --
12/02/98 $0.9375 per share -- 404,000 --
02/26/99 $0.9375 per share (non-qualified) 25,000 -- --
02/26/99 $1.32 per share (non-qualified) 1,334 -- --
03/10/99 $1.22 per share 10,000 -- --
07/23/99 $1.3125 per share 35,000 -- --
08/20/99 $0.9375 per share (non-qualified) 10,000 -- --
10/06/99 $1.03 per share 502,800 -- --
------------- --------------- --------------
Total Granted 584,134 703,900 37,000
------------- --------------- --------------
</TABLE>
F-27
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 19. STOCK OPTION PLANS (CONTINUED)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
1999 1998 1997
--------------- --------------- --------------
<S> <C> <C> <C>
Expired, canceled or forfeited:
$1.0825 per share (12,002) -- --
$1.32 per share (9,335) (2,668) --
$4.625 per share (34,840) (28,800) --
$10.38 per share (directors plan) -- (400) --
$12.25 per share (46,000) (86,000) --
$11.25 per share (directors plan) -- (533) --
$13.50 per share -- (1,000) --
$13.00 per share (10,000) -- --
$14.25 per share -- (5,000) --
$13.50 per share -- (15,000) --
$8.00 per share -- (6,000) --
$9.00 per share -- (15,000) --
$9.75 per share (42,000) (45,000) --
$8.75 per share (16,900) -- --
$0.9375 per share (114,700) -- --
------------- --------------- --------------
(285,777) (205,401) --
Exercised:
$1.0825 per share -- (6,667) (17,336)
$1.32 per share -- -- (13,332)
$4.625 per share -- (1,600) (9,600)
$5.09 per share -- (1,200) --
$10.380 per share (directors plan) -- -- (266)
$11.250 per share (directors plan) -- -- (133)
$0.9375 per share (3,200) -- --
------------- --------------- --------------
(3,200) (9,467) (40,667)
------------- --------------- --------------
Options outstanding, end of year 1,268,160 973,003 483,971
============= =============== ==============
Exercisable, end of year 525,129 340,818 193,839
============= =============== ==============
Available for grant, end of year 257,813 141,173 292,340
============= =============== ==============
</TABLE>
The above table does not include the restricted stock rights for 14,500 shares
issued in 1996 and 1997 of which rights for 11,600 shares are unexercised.
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"ACCOUNTING FOR STOCK-BASED Compensation." As such, the stock-based compensation
utilized by the Company has been accounted for under APB Opinion No. 25.
Had compensation cost for the Company's stock option plans been determined based
on the fair value at the grant date for awards in 1999, 1998, and 1997
consistent with the provisions of SFAS No. 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
1999 1998 1997
---------------- -------------- --------------
(In thousands, except per share data)
<S> <C> <C> <C>
Net income (loss) - as reported $ 1,815 $ (57,745) $ 11,253
Net income (loss) - pro forma 1,160 (58,025) 10,969
Diluted earnings (loss) per share - as reported 0.18 (5.94) 1.17
Diluted earnings (loss) per share - pro forma 0.12 (5.97) 1.14
</TABLE>
F-28
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 19. STOCK OPTION PLANS (CONTINUED)
The fair value of each option grant is estimated on the date of grant using a
Black-Scholes valuation model with the following weighted average assumptions
used in 1999 : dividend yield of 0%, expected volatility of 254.0%, risk-free
interest rate of approximately 6.73%, and expected lives of 8 years. The
weighted average assumptions used in 1998 were dividend yield of 0%, expected
volatility of 142%, risk-free interest rate of 4.64% and expected lives of 5
years. The weighted average assumption used in 1997 were dividend yield of 0%,
expected volatility of 64%, risk-free interest rate of 5.70% and expected lives
of 3 years. The pro forma amounts disclosed above may not be representative of
the effects on reported net income for future periods.
The Company implemented an Employee Stock Purchase Plan ("ESPP") in 1997. The
ESPP allows eligible employees the right to purchase common stock at the end of
each of two six-month offering periods (January 1 through June 30 and July 1
through December 31). Eligible employees must work 20 or more hours per week and
have been employed for a period of 1 year. The stock is purchased at 85% of the
lower of the market price at the beginning or ending of each six-month offering
period. A liability is recorded for ESPP withholdings not yet applied towards
the purchase of common stock. The Company's Board of Directors has authorized
200,000 shares to be issued under the Espp.
NOTE 20. TRANSACTIONS WITH RELATED PARTIES
The Company engaged in the following related party transactions:
The Company obtains legal services from Wyche, Burgess, Freeman & Parham, P.A.,
certain members of which, when considered in the aggregate, beneficially own
596,351 shares of the Company's capital stock. A partner of the firm also serves
as secretary to the Company. Total charges for these services were approximately
$228,000 in 1999, $659,000 in 1998, and $308,000 in 1997.
Notes payable to investors and subordinated debentures include amounts due to
officers, directors and key employees of approximately $707,000, $661,000, and
$660,000 at December 31, 1999, 1998 and 1997, respectively. The Company also had
notes receivable from related parties at December 31, 1999, 1998 and 1997 of
approximately $121,000, $168,000, and $509,000, respectively.
NOTE 21. EMPLOYEE RETIREMENT PLAN
The Company has a matched savings plan under Section 401(k) of the Internal
Revenue Code covering employees meeting certain eligibility requirements. The
plan allows employees who have completed 30 days of service to participate in
the plan and provides for Company contributions, subject to certain limitations.
Company matching contributions are 50% of employee contributions to a maximum of
6% of compensation for each employee. The Company's contributions under the plan
totaled approximately $320,500 in 1999, $879,000 in 1998, and $761,000 in 1997.
NOTE 22. COMMITMENTS AND CONTINGENCIES
The Company may from time to time enter into forward commitments to sell
residential first mortgage loans to reduce risk associated with originating and
holding loans for sale. At December 31, 1999, the Company had no outstanding
forward commitment contracts.
From time to time, the Company or its subsidiaries are defendants in legal
actions involving claims arising in the normal course of its business. The
Company believes that, as a result of its legal defenses and insurance
arrangements, none of these actions, if decided adversely, would have a material
effect on the business, financial condition, results of operations or cash flows
of the Company taken as a whole.
F-29
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 23. SUPPLEMENTAL QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The quarterly results of operations for the year ended December 31, 1999, are as
follows:
<TABLE>
<CAPTION>
Quarter Ended
------------------------------------------------------------
March 31, June 30, September 30, December 31,
1999 1999 1999 1999
------------ ------------ ------------ ------------
(in thousands, except share data)
<S> <C> <C> <C> <C>
REVENUES:
Interest income $ 3,338 $ 1,618 $ 1,771 $ 1,559
Servicing income 2,402 2,608 2,606 2,197
Gain on sale of loans:
Gross gain on sale of loans 1,173 3,216 70 1,757
Loan fees, net 957 1,416 716 224
------------ ------------ ------------ ------------
Total gain (loss) on sale 2,130 4,632 786 1,981
Other revenues 396 354 409 450
------------ ------------ ------------ ------------
Total revenues 8,266 9,212 5,572 6,187
EXPENSES:
Interest 4,798 4,189 3,778 3,573
Provision for credit losses 81 (430) 1,672 2,016
Cost of real estate owned and defaulted loans 823 588 729 878
Fair market adjustment on residual receivables (53) 828 856 1,696
Salaries, wages and employee benefits 5,671 5,232 4,957 4,499
Business development costs 1,190 1,237 1,330 1,047
Other general and administrative 3,258 3,538 2,920 3,407
------------ ------------ ------------ ------------
Total expenses 15,768 15,182 16,242 17,116
------------ ------------ ------------ ------------
Loss before income taxes, minority interest and
extraordinary item (7,502) (5,970) (10,670) (10,929)
Provision (benefit) for income taxes 450 170 55 (8,069)
Minority interest in (earnings) loss of subsidiaries 3 (7) (3) (1)
------------ ------------ ------------ ------------
Income before extraordinary item (7,949) (6,147) (10,728) (2,861)
Extraordinary item-gain on extinguishment of debt,
net of $0 tax 16,946 4,281 8,143 130
------------ ------------ ------------ ------------
Net income (loss) $ 8,997 $ (1,866) $ (2,585) $ (2,731)
============ ============ ============ ============
Basic earnings (loss) per share of common stock:
Loss before extraordinary item $ (0.81) $ (0.63) $ (1.07) $ (0.28)
Extraordinary item, net of taxes 1.73 0.44 0.81 0.01
------------ ------------ ------------ ------------
Net income (loss) $ 0.92 $ (0.19) $ (0.26) $ (0.27)
============ ============ ============ ============
Basic weighted average shares outstanding 9,792,174 9,827,228 10,070,150 10,149,629
============ ============ ============ ============
Diluted earnings (loss) per share of common stock:
Loss before extraordinary item $ (0.81) (0.63) (1.07) (0.28)
Extraordinary item, net of tax 1.73 0.44 0.81 0.01
------------ ------------ ------------ ------------
Net income (loss) 0.92 (0.19) (0.26) (0.27)
============ ============ ============ ============
Diluted weighted average shares outstanding 9,792,174 9,827,228 10,070,150 10,149,629
============ ============ ============ ============
</TABLE>
F-30
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 23. SUPPLEMENTAL QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (CONTINUED)
The quarterly results of operations for the year ended December 31, 1998, are as
follows:
<TABLE>
<CAPTION>
Quarter Ended
------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
1998 1998 1998 1998
--------------- ---------------- -------------- --------------
(in thousands, except share data)
REVENUES:
<S> <C> <C> <C> <C>
Interest income $ 8,673 $ 10,516 $ 10,364 $ 5,522
Servicing income 4,222 3,379 2,597 2,041
Gain on sale of loans:
Gross gain (loss) on sale of loans 6,517 6,775 2,529 (6,349)
Loan fees, net 3,602 3,228 3,261 1,654
--------------- ---------------- -------------- --------------
Total gain (loss) on sale 10,119 10,003 5,790 (4,695)
Gain on sale of subsidiaries-net assets -- -- -- 18,964
Other revenues 1,540 879 1,092 719
--------------- ---------------- -------------- --------------
Total revenues 24,554 24,777 19,843 22,551
EXPENSES:
Interest 8,432 9,953 9,950 7,633
Provision for credit losses 4,829 2,111 3,639 1,327
Cost of real estate owned and defaulted loans 123 275 1,299 968
Fair market adjustment on residual receivables 1,580 7,330 5,320 (592)
Salaries, wages and employee benefits 18,435 16,198 12,544 9,748
Business development costs 3,479 3,055 1,954 2,330
Restructuring charges -- -- -- 6,838
Other general and administrative 7,616 6,263 6,315 5,764
--------------- ---------------- -------------- --------------
Total expenses 44,494 45,185 41,021 34,016
--------------- ---------------- -------------- --------------
Loss before income taxes, minority interest and
extraordinary item (19,940) (20,408) (21,178) (11,465)
Provision (benefit) for income taxes 679 2,565 866 (1,093)
Minority interest in (earnings) loss of subsidiaries 4 (2) 11 34
--------------- ---------------- -------------- --------------
Income before extraordinary item (20,615) (22,975) (22,033) (10,338)
Extraordinary item-gain on extinguishment of debt,
net of $0 tax -- -- 7,724 10,492
--------------- ---------------- -------------- --------------
Net income (loss) $ (20,615) $ (22,975) $ (14,309) $ 154
=============== ================ ============== ==============
Basic earnings (loss) per share of common stock:
Loss before extraordinary item $ (2.12) $ (2.37) $ (2.26) $ (1.06)
Extraordinary item, net of taxes -- -- .79 1.08
--------------- ---------------- -------------- --------------
Net income (loss) $ (2.12) $ (2.37) $ (1.47) $ .02
=============== ================ ============== ==============
Basic weighted average shares outstanding 9,701,993 9,708,083 9,733,099 9,733,374
=============== ================ ============== ==============
Diluted earnings (loss) per share of common stock:
Loss before extraordinary item $ (2.12) $ (2.37) $ (2.26) $ (1.06)
Extraordinary item, net of tax -- -- .79 1.08
--------------- ---------------- -------------- --------------
Net income (loss) $ (2.12) $ (2.37) $ (1.47) $ .02
=============== ================ ============== ==============
Diluted weighted average shares outstanding 9,701,993 9,708,083 9,733,099 9,733,374
=============== ================ ============== ==============
</TABLE>
F-31
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 24. EARNINGS PER SHARE
The following table sets forth the computation of basic and fully diluted
earnings per share.
<TABLE>
<CAPTION>
For the Year Ended December 31,
-----------------------------------------------------------
1999 1998 1997
------------------ ---------------- -----------------
(in thousands, except per share data)
<S> <C> <C> <C>
Numerator
Net income (loss)-numerator for basic and fully diluted EPS $ 1,815 $ (57,745) $ 11,253
Denominator
Basic weighted average shares o/s-denominator for basic EPS 9,961,077 9,719,262 9,406,221
Effect of dilutive employee stock options -- -- 192,590
------------------ ---------------- -----------------
Fully diluted weighted average shares o/s-denominator for
fully diluted EPS 9,961,077 9,719,262 9,598,811
================== ================ =================
Basic earnings per common share $ 0.18 $ (5.94) $ 1.20
Fully diluted earnings per common share $ 0.18 $ (5.94) $ 1.17
</TABLE>
The computation of fully diluted EPS in 1999 and 1998 does not take into account
the effect of any outstanding common stock equivalents since their inclusion
would be antidilutive. The number of shares related to common stock equivalents
that would have been included in 1999 and 1998 were 70,657 and 77,983,
respectively.
NOTE 25. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS 107, "Disclosures about Fair Value of Financial Instruments" requires
disclosure of fair value information whether or not recognized in the balance
sheet, when it is practicable to estimate the fair value. SFAS 107 defines a
financial instrument as cash, evidence of an ownership interest in an entity or
contractual obligations which require the exchange of cash or financial
instruments. Certain items are specifically excluded from the disclosure
requirements, including the Company's common stock, property and equipment and
other assets and liabilities.
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Cash and Cash Equivalents and Restricted Cash
For these short-term instruments, the carrying amount is a reasonable estimate
of fair value.
Loans Receivable
For residential mortgage loans, small business loans and auto loans, fair value
is estimated using the market prices received on recent sales or securitizations
of these loans in the secondary market.
Residual Receivable, Net
The fair value of the residual receivable is calculated using prepayment,
default and interest rate assumptions that the Company believes market
participants would use for similar instruments at the time of sale. Projected
performance is monitored on an ongoing basis.
Investor Savings
Due to their short-term maturity, usually one year, the fair value of the notes
due investors and subordinated debentures is the current carrying amount.
F-32
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 25. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Notes Payable to Banks and Other
The fair value of notes payable to banks and other approximates the carrying
amount. Rates with similar terms and maturities currently available to the
Company are used to estimate fair value of existing debt.
Senior Unsecured Debt
The fair value of senior unsecured debt is based on the market value of the
publicly traded securities.
Commitments to Extend Credit
The fair value of commitments to extend credit is determined by using the
anticipated market prices that the loans will generate in the secondary market.
The estimated fair values of the Company's financial instruments at December 31
were as follows:
<TABLE>
<CAPTION>
1999 1998
--------------------------------- ---------------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
--------------- -------------- -------------- ---------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Financial Assets:
Cash and cash equivalents $ 26,009 $ 26,009 $ 36,913 $ 36,913
Restricted cash 5,314 5,314 5,100 5,100
Loans receivable 56,614 57,300 116,898 120,000
Residual receivable 47,770 47,770 43,857 43,857
Financial Liabilities:
Notes payable to banks and other $ 17,808 $ 17,808 $ 16,736 $ 16,736
Investor savings:
Notes due to investors 127,065 127,065 118,586 118,586
Subordinated debentures 17,710 17,710 17,304 17,304
Senior unsecured debt 12,134 5,700 86,650 43,000
Commitments to extend credit 4,255 4,307 5,619 5,800
</TABLE>
F-33
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 26. CONSOLIDATING CONDENSED FINANCIAL DATA OF THE COMBINED SUBSIDIARIES
THAT GUARANTEED SENIOR DEBT
The Subsidiary Guarantors of the Company's Senior Notes at December 31, 1999
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 Insurance Agency Corp.
Emergent Business Capital Asset Based Lending, Inc.
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 may reflect
immaterial rounding differences.
As of December 31, 1999, 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. Prior to
March 1998, The Loan Pro$, Inc. and Premier Financial Services, Inc. (the
Company's auto loan units) were guarantors of this indebtedness, but their
guarantees terminated when substantially all of the assets of the auto loan
units 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 majority of 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 on November 13, 1998. Accordingly, any guarantees of these
companies were terminated upon consummation of that sale.
A substantial majority of the assets of Emergent Business Capital Asset Based
Lending, Inc. were sold to Emergent Asset-Based Lending LLC, an unaffiliated
Maryland Limited Liability Company, on December 2, 1998. Since not all assets of
this subsidiary were sold, the guaranty was not released.
F-34
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING BALANCE SHEETS
DECEMBER 31, 1999
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Combined
Wholly-Owned Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Eliminations Consolidated
---------- ------------ ------------ ------------ ------------
ASSETS
------
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents $ 202 $ 25,806 $ 1 $ -- 26,009
Restricted cash 5,314 -- -- -- 5,314
Loans receivable:
Loans receivable -- 63,242 -- -- 63,242
Notes receivable from affiliates 7,097 36,229 4,584 (47,910) --
---------- ------------ ----------- ------------ ------------
Total loans receivable 7,097 99,471 4,584 (47,910) 63,242
Less allowance for credit losses on loans -- (6,344) -- -- (6,344)
Less deferred loan fees -- (730) -- -- (730)
Plus deferred loan costs -- 446 -- -- 446
---------- ------------ ----------- ------------ ------------
Net loans receivable 7,097 92,843 4,584 (47,910) 56,614
Other Receivables:
Income tax -- 461 -- -- 461
Accrued interest receivable 36 1,387 -- -- 1,423
Other receivables 1,006 7,053 -- -- 8,059
---------- ------------ ----------- ------------ ------------
Total other receivables 1,042 8,901 -- -- 9,943
Investment in subsidiaries 31,487 -- -- (31,487) --
Residual receivables, net -- 4,545 43,225 -- 47,770
Net property and equipment -- 17,160 -- -- 17,160
Real estate and personal property acquired through
foreclosure -- 7,673 -- -- 7,673
Net excess of cost over net assets of acquired
businesses 38 1,528 -- -- 1,566
Deferred income tax asset, net 3,510 8,490 -- -- 12,000
Other assets 304 4,384 -- -- 4,688
---------- ------------ ----------- ------------ ------------
TOTAL ASSETS $ 48,994 $ 171,330 $ 47,810 $ (79,397) $ 188,737
========== ============ =========== ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Liabilities:
Revolving warehouse lines of credit $ -- $ 17,808 $ -- $ -- $ 17,808
Investor savings:
Notes payable to investors -- 127,065 -- -- 127,065
Subordinated debentures -- 17,710 -- -- 17,710
---------- ------------ ----------- ------------ ------------
Total investor savings -- 144,775 -- -- 144,775
Senior unsecured debt 12,134 -- -- -- 12,134
Accounts payable and accrued liabilities -- 4,120 -- -- 4,120
Remittances payable -- 1,078 -- -- 1,078
Income taxes payable -- 120 -- -- 120
Accrued interest payable 384 461 -- -- 845
Due to (from) affiliates 28,632 -- 7,597 (36,229) --
---------- ------------ ----------- ------------ ------------
Total other liabilities 29,016 5,779 7,597 (36,229) 6,163
Subordinated debt to affiliates -- 11,681 -- (11,681) --
---------- ------------ ----------- ------------ ------------
Total liabilities 41,150 180,043 7,597 (47,910) 180,880
Minority interest -- (1) 14 -- 13
Shareholders' equity:
Common stock 507 998 2 (1,000) 507
Capital in excess of par value 39,028 66,043 48,807 (114,850) 39,028
Retained earnings (deficit) (31,691) (75,753) (8,610) 84,363 (31,691)
---------- ------------ ----------- ------------ ------------
Total shareholders' equity 7,844 (8,712) 40,199 (31,487) 7,844
---------- ------------ ----------- ------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 48,994 $ 171,330 $ 47,810 $ (79,397) 188,737
========== ============ =========== ============ ============
</TABLE>
F-35
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING BALANCE SHEETS
DECEMBER 31, 1998
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Combined
Combined Non
Wholly-Owned Wholly-Owned Combined
Parent Guarantor Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Subsidiaries Eliminations Consolidated
---------- ----------- ------------ ------------ ------------ ------------
ASSETS
------
<S> <C> <C> <C> <C> <C> <C>
Cash and cash equivalents $ 196 $ 34,215 $ -- $ 2,502 $ -- $ 36,913
Restricted cash 5,100 -- -- -- -- 5,100
Loans receivable:
Loans receivable -- 124,740 -- -- -- 124,740
Notes receivable from affiliates 48,876 -- -- 3 (48,879) --
---------- ----------- ------------ ------------ ------------ ------------
Total loans receivable 48,876 124,740 -- 3 (48,879) 124,740
Less allowance for credit losses on loans -- (6,659) -- -- -- (6,659)
Less deferred loan fees -- (2,071) -- -- -- (2,071)
Plus deferred loan costs -- 888 -- -- -- 888
---------- ----------- ------------ ------------ ------------ ------------
Net loans receivable 48,876 116,898 -- 3 (48,879) 116,898
Other Receivables:
Income tax -- 900 -- -- -- 900
Accrued interest receivable 21 2,592 -- -- -- 2,613
Other receivables 4 11,126 -- 898 -- 12,028
---------- ----------- ------------ ------------ ------------ ------------
Total other receivables 25 14,618 -- 898 -- 15,541
Investment in subsidiaries 35,550 -- -- -- (35,550) --
Residual receivables, net -- 31,752 -- 12,105 -- 43,857
Net property and equipment -- 19,665 -- -- -- 19,665
Real estate and personal property acquired
through foreclosure -- 5,881 -- -- -- 5,881
Net excess of cost over net assets of acquired
businesses 40 1,620 -- -- -- 1,660
Deferred income tax asset, net 3,510 641 -- -- -- 4,151
Other assets 2,696 4,846 -- -- -- 7,542
---------- ----------- ------------ ------------ ------------ ------------
TOTAL ASSETS $ 95,993 $ 230,136 $ -- $ 15,508 $ (84,429) $ 257,208
========== =========== ============ ============ ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Liabilities:
Revolving warehouse lines of credit $ -- $ 16,736 $ -- $ -- $ -- $ 16,736
Investor savings:
Notes payable to investors -- 118,586 -- -- -- 118,586
Subordinated debentures -- 17,304 -- -- -- 17,304
---------- ----------- ------------ ------------ ------------ ------------
Total investor savings -- 135,890 -- -- -- 135,890
Senior unsecured debt 86,650 -- -- -- -- 86,650
Accounts payable and accrued liabilities 624 6,032 -- -- -- 6,656
Remittances payable -- 1,871 -- -- -- 1,871
Income taxes payable 201 181 -- -- -- 382
Accrued interest payable 2,717 482 -- -- -- 3,199
Due to (from) affiliates -- (7,947) -- 7,947 -- --
---------- ----------- ------------ ------------ ------------ ------------
Total other liabilities 3,542 619 -- 7,947 -- 12,108
Subordinated debt to affiliates -- 48,879 -- -- (48,879) --
---------- ----------- ------------ ------------ ------------ ------------
Total liabilities 90,192 202,124 -- 7,947 (48,879) 251,384
Minority interest -- -- -- 23 -- 23
Shareholders' equity:
Common stock 486 4,091 -- 1 (4,092) 486
Capital in excess of par value 38,821 71,683 -- 17,675 (89,358) 38,821
Retained earnings (deficit) (33,506) (47,762) -- (10,138) 57,900 (33,506)
---------- ----------- ------------ ------------ ------------ ------------
Total shareholders' equity 5,801 28,012 -- 7,538 (35,550) 5,801
---------- ----------- ------------ ------------ ------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 95,993 $ 230,136 $ -- $ 15,508 $ (84,429) $ 257,208
========== =========== ============ ============ ============ ============
</TABLE>
F-36
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1999
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Combined Combined
Wholly-Owned Non-Guarantor
Parent Guarantor Subsidiaries
Company Subsidiaries Eliminations Consolidated
------------- ------------- ----------- ------------- -------------
REVENUES:
<S> <C> <C> <C> <C> <C>
Interest income $ 3,523 $ 7,996 $ -- $ (3,233) $ 8,286
Servicing income -- 5,883 3,930 -- 9,813
Gain on sale of loans:
Gross gain on sale of loans -- 6,216 -- -- 6,216
Loan fees, net -- 3,313 -- -- 3,313
------------- ------------- ----------- ------------- -------------
Total gain on sale of loans -- 9,529 -- -- 9,529
Other revenues 8 1,774 -- (173) 1,609
------------- ------------- ----------- ------------- -------------
Total revenues 3,531 25,182 3,930 (3,406) 29,237
------------- ------------- ----------- ------------- -------------
EXPENSES:
Interest 4,376 15,195 -- (3,233) 16,338
Provision for credit losses -- 3,339 -- -- 3,339
Costs on REO and defaulted loans -- 3,018 -- -- 3,018
Fair value write-down of residual
receivables -- 2,556 771 -- 3,327
Salaries, wages and employee benefits -- 20,359 -- -- 20,359
Business development costs -- 4,804 -- -- 4,804
Restructuring charges -- -- -- -- --
Other general and administrative expense 377 12,918 1 (173) 13,123
------------- ------------- ----------- ------------- -------------
Total expenses 4,753 62,189 772 (3,406) 64,308
------------- ------------- ----------- ------------- -------------
Income (loss) before income taxes, minority
interest, equity in undistributed
earnings (loss) of subsidiaries, and
extraordinary item (1,222) (37,007) 3,158 -- (35,071)
Equity in undistributed earnings (loss)
of subsidiaries (26,463) -- -- 26,463 --
------------- ------------- ----------- ------------- -------------
Income (loss) before income taxes, minority
interest, and extraordinary item (27,685) (37,007) 3,158 26,463 (35,071)
Provision (benefit) for income taxes -- (7,394) -- -- (7,394)
------------- ------------- ----------- ------------- -------------
Income (loss) before minority interest and
extraordinary item (27,685) (29,613) 3,158 26,463 (27,677)
Minority interest in earnings of subsidiaries -- (8) -- -- (8)
------------- ------------- ----------- ------------- -------------
Income (loss) before extraordinary item (27,685) (29,621) 3,158 26,463 (27,685)
Extraordinary item-gain on extinguishment
of debt, net of $0 tax 29,500 -- -- -- 29,500
------------- ------------- ----------- ------------- -------------
NET INCOME (LOSS) $ 1,815 $ (29,621) $ 3,158 $ 26,463 $ 1,815
============= ============= =========== ============= =============
</TABLE>
F-37
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Combined
Combined Non
Wholly-Owned Wholly-Owned Combined
Parent Guarantor Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Subsidiaries Eliminations Consolidated
------------- ------------- ----------- ------------ ------------- ---------------
REVENUES:
<S> <C> <C> <C> <C> <C> <C>
Interest income $ 8,109 $ 34,551 $ 10 $ 1,238 $ (8,833) $ 35,075
Servicing income -- 18,646 -- 2,734 (9,141) 12,239
Gain on sale of loans:
Gross gain on sale of loans -- 8,057 1,415 -- -- 9,472
Loan fees, net -- 10,136 1,520 89 -- 11,745
------------- ------------- ----------- ------------ ------------- ---------------
Total gain on sale of loans -- 18,193 2,935 89 -- 21,217
Gain on sale of subsidiaries' net assets -- 18,964 -- -- -- 18,964
Other revenues 927 3,242 217 489 (645) 4,230
------------- ------------- ----------- ------------ ------------- ---------------
Total revenues 9,036 93,596 3,162 4,550 (18,619) 91,725
------------- ------------- ----------- ------------ ------------- ---------------
EXPENSES:
Interest 14,479 30,420 125 402 (9,458) 35,968
Provision for credit losses 20 11,886 -- -- -- 11,906
Costs on real estate owned and defaulted
loans -- 2,665 -- -- -- 2,665
Fair value write-down of residual receivables -- 9,902 -- 3,736 -- 13,638
Salaries, wages and employee benefits 3,176 49,769 3,639 -- -- 56,584
Business development costs 2 10,547 269 -- -- 10,818
Restructuring charges -- 6,838 -- -- -- 6,838
Other general and administrative expense (2,216) 25,730 2,552 256 (23) 26,299
------------- ------------- ----------- ------------ ------------- ---------------
Total expenses 15,461 147,757 6,585 4,394 (9,481) 164,716
------------- ------------- ----------- ------------ ------------- ---------------
Income (loss) before income taxes, minority
interest, equity in undistributed
earnings (loss) of subsidiaries,and
extraordinary item (6,425) (54,161) (3,423) 156 (9,138) (72,991)
Equity in undistributed earnings (loss)
of subsidiaries (69,668) (10,138) -- -- 79,806 --
------------- ------------- ----------- ------------ ------------- ---------------
Income (loss) before income taxes, minority
interest, and extraordinary item (76,093) (64,299) (3,423) 156 70,668 (72,991)
Provision (benefit) for income taxes (132) 3,195 (46) -- -- 3,017
------------- ------------- ----------- ------------ ------------- ---------------
Income (loss) before minority interest
and extraordinary item (75,961) (67,494) (3,377) 156 70,668 (76,008)
Minority interest in earnings of
subsidiaries -- -- -- 47 -- 47
------------- ------------- ----------- ------------ ------------- ---------------
Income (loss) before extraordinary item (75,961) (67,494) (3,377) 203 70,668 (75,961)
Extraordinary item-gain on extinguishment
of debt, net of $0 tax 18,216 -- -- -- -- 18,216
------------- ------------- ----------- ------------ ------------- ---------------
NET INCOME (LOSS) $ (57,745) $ (67,494) $ (3,377) $ 203 $ 70,668 $ (57,745)
============= ============= =========== ============ ============= ===============
</TABLE>
F-38
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Combined
Combined Non
Wholly-Owned Wholly-Owned Combined
Parent Guarantor Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Subsidiaries Eliminations Consolidated
---------- ------------ ------------ ------------ ------------ ------------
REVENUES:
<S> <C> <C> <C> <C> <C> <C>
Interest income $ 2,620 $ 33,753 $ 50 $ 423 $ (2,838) $ 34,008
Servicing income -- 8,514 -- -- -- 8,514
Gain on sale of loans:
Gross gain on sale of loans -- 51,409 1,419 -- -- 52,828
Loan fees, net -- 28,024 2,137 46 -- 30,207
---------- ------------ ------------ ------------ ------------ ------------
Total gain on sale of loans -- 79,433 3,556 46 -- 83,035
Other revenues 253 923 11 405 (193) 1,399
---------- ------------ ------------ ------------ ------------ ------------
Total revenues 2,873 122,623 3,617 874 (3,031) 126,956
EXPENSES:
Interest 4,436 23,308 193 203 (3,007) 25,133
Provision for credit losses -- 10,030 -- -- -- 10,030
Costs on real estate owned and defaulted loans -- 876 -- -- -- 876
Salaries, wages and employee benefits 4,421 40,032 3,591 -- -- 48,044
Business development costs 25 7,206 255 -- -- 7,486
Other general and administrative expense (5,026) 29,514 3,302 116 (28) 27,878
---------- ------------ ------------ ------------ ------------ ------------
Total expenses 3,856 110,966 7,341 319 (3,035) 119,447
---------- ------------ ------------ ------------ ------------ ------------
Income before income taxes, minority interest,
and equity in undistributed earnings of
subsidiaries (983) 11,657 (3,724) 555 4 7,509
Equity in undistributed earnings of subsidiaries 8,302 -- -- -- (8,302) --
---------- ------------ ------------ ------------ ------------ ------------
Income before income taxes and minority
interest 7,319 11,657 (3,724) 555 (8,298) 7,509
Provision (benefit) for income taxes (3,917) (106) 101 22 -- (3,900)
---------- ------------ ------------ ------------ ------------ ------------
Income before minority interest 11,236 11,763 (3,825) 533 (8,298) 11,409
Minority interest in (earnings) loss of
subsidiaries 17 (173) -- -- -- (156)
---------- ------------ ------------ ------------ ------------ ------------
NET INCOME $ 11,253 $ 11,590 $ (3,825) $ 533 $ (8,298) $ 11,253
========== ============ ============ ============ ============ ============
</TABLE>
F-39
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1999
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Combined
Wholly-Owned Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Eliminations Consolidated
---------- ------------ ------------ ------------ -------------
OPERATING ACTIVITIES:
<S> <C> <C> <C> <C> <C>
Net income (loss) $ 1,815 $ (29,621) $ 3,158 $ 26,463 $ 1,815
Extraordinary Gain on retirement of senior
unsecured debt (29,500) -- -- -- (29,500)
---------- ------------ ------------ ------------ -------------
Income (loss) from continuing operations (27,685) (29,621) 3,158 26,463 (27,685)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Equity in undistributed earnings of
subsidiaries 26,463 -- -- (26,463) --
Depreciation and amortization 2 2,690 -- -- 2,692
Fair market writedown of residual receivable -- 3,327 -- -- 3,327
Benefit for deferred income taxes -- (7,849) -- -- (7,849)
Provision for credit losses -- 3,339 -- -- 3,339
Loss (gain) on real estate acquired through
foreclosure -- 2,665 -- -- 2,665
Loans originated with intent to sell -- (244,086) -- -- (244,086)
Principal proceeds from sold loans -- 220,410 -- -- 220,410
Proceeds from securitization of loans -- 59,630 -- -- 59,630
Other -- (168) -- -- (168)
Changes in operating assets and liabilities
increasing (decreasing) cash (1,999) 28,060 (31,120) -- (5,059)
---------- ------------ ------------ ------------ -------------
Net cash provided by (used in)
operating activities (3,219) 38,397 (27,962) -- 7,216
INVESTING ACTIVITIES:
Loans originated for investment purposes -- (762) -- -- (762)
Loans purchased for investment purposes -- (1,413) -- -- (1,413)
Principal collections on loans not sold -- 19,718 -- -- 19,718
Purchase of REO and loans from securitization
trusts -- 21,530 (32,006) -- (10,476)
Proceeds from sale of real estate and personal
property acquired through foreclosure -- 9,774 -- -- 9,774
Proceeds from the sale of property and equipment -- 235 -- -- 235
Purchase of property and equipment -- (532) -- -- (532)
Other -- 167 -- -- 167
---------- ------------ ------------ ------------ -------------
Net cash provided by (used in) investing
activities -- 48,717 (32,006) -- 16,711
FINANCING ACTIVITIES:
Advances on warehouse lines of credit -- 292,020 -- -- 292,020
Payments on warehouse lines of credit -- (290,948) -- -- (290,948)
Retirement of senior unsecured debt (45,016) -- -- -- (45,016)
Net increase (decrease) in notes payable to
investors -- 8,479 -- -- 8,479
Net increase (decrease) in subordinated
debentures -- 405 -- -- 405
Advances (to) from subsidiary 48,012 (38,006) (10,008) 2 --
Proceeds from issuance of additional common
stock 229 -- 2 (2) 229
Other -- (67,473) 67,473 -- --
---------- ------------ ------------ ------------ -------------
Net cash provided by (used in) financing
activities 3,225 (95,523) 57,467 -- (34,831)
---------- ------------ ------------ ------------ -------------
Net increase (decrease) in cash and cash
equivalents 6 (8,409) (2,501) -- (10,904)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 196 34,215 2,502 -- 36,913
---------- ------------ ------------ ------------ -------------
CASH AND CASH EQUIVALENTS, END OF YEAR 202 25,806 1 -- 26,009
========== ============ ============ ============ =============
</TABLE>
F-40
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1998
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Combined
Combined Non
Wholly-Owned Wholly-Owned Combined
Parent Guarantor Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Subsidiaries Eliminations Consolidated
---------- ------------ ----------- ------------ ------------ ------------
OPERATING ACTIVITIES:
<S> <C> <C> <C> <C> <C> <C>
Net income (loss) $ (57,745) $ (67,494) $ (3,377) $ 203 $ 70,668 $ (57,745)
Extraordinary Gain on retirement of senior
unsecured debt (18,216) -- -- -- -- (18,216)
---------- ------------ ----------- ------------ ------------ ------------
Income (loss) from continuing operations (75,961) (67,494) (3,377) 203 70,668 (75,961)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Equity in undistributed earnings of
subsidiaries 69,668 10,138 -- -- (79,806) --
Depreciation and amortization 430 2,992 192 12 -- 3,626
Fair market writedown of residual receivable -- 11,144 -- 2,494 -- 13,638
Provision (benefit) for deferred income taxes 692 (371) (321) -- -- --
Provision for credit losses 20 11,886 -- -- -- 11,906
Provision for losses on real estate owned -- 696 -- -- -- 696
Net (increase) decrease in deferred loan costs -- 770 -- -- -- 770
Net increase (decrease) in unearned discount
and other deferrals -- (2,245) -- -- -- (2,245)
Loans originated with intent to sell -- (708,004) (39,438) -- -- (747,442)
Principal proceeds from sold loans 178 718,406 48,764 11,600 -- 778,948
Proceeds from securitization of loans -- 92,316 -- -- -- 92,316
Restructuring charge-fixed assets -- 3,593 -- -- -- 3,593
Other 44 1,142 -- (192) -- 994
Changes in operating assets and liabilities
increasing (decreasing) cash 3,419 (5,612) (29) 5,663 -- 3,441
---------- ------------ ----------- ------------ ------------ ------------
Net cash provided by (used in)
operating activities (1,510) 69,357 5,791 19,780 (9,138) 84,280
INVESTING ACTIVITIES:
Loans originated for investment purposes (468) (150,549) -- (5,600) -- (156,617)
Principal collections on loans not sold 65 190,861 -- 1,250 -- 192,176
Proceeds from sale of real estate and personal
property acquired through foreclosure 453 7,140 -- -- -- 7,593
Purchase of REO and loans from securitization
trusts -- (9,980) -- -- -- (9,980)
Proceeds from the sale of property and equipment (1,262) 4,070 -- -- -- 2,808
Purchase of property and equipment (64) (11,463) (174) -- -- (11,701)
Other (748) (514) 1,310 -- -- 48
---------- ------------ ----------- ------------ ------------ ------------
Net cash provided by (used in) investing
activities (2,024) 29,565 1,136 (4,350) -- 24,327
FINANCING ACTIVITIES:
Advances on notes payable to banks -- 1,406,847 -- 9,653 -- 1,416,500
Payments on notes payable to banks -- (1,467,716) -- (9,653) -- (1,477,369)
Net increase in notes payable to investors -- 3,218 -- -- -- 3,218
Net (decrease) increase in subordinated
debentures -- (1,643) -- -- -- (1,643)
Retirement of senior unsecured debt (20,134) -- -- -- -- (20,134)
Advances (to) from subsidiary 22,978 (11,824) (7,190) (13,102) 9,138 --
Proceeds from issuance of additional common
stock 214 -- -- -- -- 214
Other (41) -- -- -- -- (41)
---------- ------------ ----------- ------------ ------------ ------------
Net cash provided by (used in) financing
activities 3,017 (71,118) (7,190) (13,102) 9,138 (79,255)
---------- ------------ ----------- ------------ ------------ ------------
Net increase (decrease) in cash and cash
equivalents (517) 27,804 (263) 2,328 -- 29,352
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 713 6,411 263 174 -- 7,561
---------- ------------ ----------- ------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR 196 34,215 -- 2,502 -- 36,913
========== ============ =========== ============ ============ ============
</TABLE>
F-41
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1997
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Combined
Combined Non
Wholly-Owned Wholly-Owned Combined
Parent Guarantor Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Subsidiaries Eliminations Consolidated
----------- ----------- ------------ ----------- ------------ ------------
OPERATING ACTIVITIES:
<S> <C> <C> <C> <C> <C> <C>
Net income (loss) $ 11,253 $ 11,590 $ (3,825) $ 533 $ (8,298) $ 11,253
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Equity in undistributed earnings of
subsidiaries (8,302) -- -- -- 8,302 --
Depreciation and amortization 304 2,009 375 7 (4) 2,691
Provision for deferred income taxes (3,291) (853) 331 -- -- (3,813)
Provision for credit losses -- 10,030 -- -- -- 10,030
Net (increase) decrease in deferred costs (1,573) -- -- -- (1,573)
Net increase (decrease) in unearned discount
and deferrals 2,252 368 192 2,812
Loans originated with intent to sell -- (1,098,826) (41,507) -- -- (1,140,333)
Principal proceeds from sold loans -- 485,622 32,181 -- -- 517,803
Proceeds from securitization of loans -- 509,781 -- -- -- 509,781
Other 15 (917) -- -- -- (902)
Changes in operating assets and liabilities
increasing (decreasing) cash 3,375 (46,295) (202) (10,916) -- (54,038)
----------- ------------ ----------- ----------- ------------ ------------
Net cash provided by (used in)
operating activities 3,354 (127,180) (12,279) (10,184) -- (146,289)
INVESTING ACTIVITIES:
Loans originated for investment purposes -- (124,938) -- (8,250) -- (133,188)
Principal collections on loans not sold -- 127,552 -- 1,000 -- 128,552
Additional investment in subsidiary (54,168) 53,389 -- 779 -- --
Proceeds from sale of real estate and personal
property acquired through foreclosure -- 6,652 -- -- -- 6,652
Proceeds from sale of property and equipment 29 -- -- -- -- 29
Purchase of property and equipment (1,438) (10,591) (1,193) -- -- (13,222)
Other (40) (371) -- -- -- (411)
----------- ------------ ----------- ----------- ------------ ------------
Net cash provided by (used in) investing
activities (55,617) 51,693 (1,193) (6,471) -- (11,588)
FINANCING ACTIVITIES:
Advances on notes payable to banks -- 1,139,815 -- -- -- 1,139,815
Payments on notes payable to banks -- (1,117,704) -- -- -- (1,117,704)
Net increase in notes payable to investors -- 17,381 -- -- -- 17,381
Net (decrease) increase in subordinated
debentures -- 2,832 -- -- -- 2,832
Advances (to) from subsidiary (69,054) 38,616 13,609 16,829 -- --
Proceeds from issuance of senior unsecured debt 120,578 -- -- -- -- 120,578
Proceeds from issuance of additional common
stock 1,260 -- -- -- -- 1,260
----------- ------------ ----------- ----------- ------------ ------------
Net cash provided by financing activities 52,784 80,940 13,609 16,829 -- 164,162
----------- ------------ ----------- ----------- ------------ ------------
Net increase in cash and cash equivalents 521 5,453 137 174 -- 6,285
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 192 958 126 -- -- 1,276
----------- ------------ ----------- ----------- ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 713 $ 6,411 $ 263 $ 174 $ $ 7,561
=========== ============ =========== =========== ============ ============
</TABLE>
F-42
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
On September 21, 1998, the Company changed principal
accounting firms from KPMG Peat Marwick LLP to Elliott, Davis & Company, LLP.
The discussion of this change in the Company's certifying accountant is
incorporated by reference to the Company's current report on Form 8-K dated
September 25, 1998 and filed with the Commission on September 25, 1998
(Commission File No. 000-8909).
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is incorporated herein by
reference to the Company's proxy statement to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A, not later than 120 days after
the end of the fiscal year covered by this report.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by
reference to the Company's proxy statement to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A, not later than 120 days after
the end of the fiscal year covered by this report.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by
reference to the Company's proxy statement to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A, not later than 120 days after
the end of the fiscal year covered by this report.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by
reference to the Company's proxy statement to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A, not later than 120 days after
the end of the fiscal year covered by this report.
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of Report.
1. FINANCIAL STATEMENTS FOR HOMEGOLD FINANCIAL, INC.:
The Financial Statements are listed in the index to Consolidated
Financial Statements on page F-1 of this Report.
2. FINANCIAL STATEMENT SCHEDULES:
Not applicable.
3. EXHIBITS:
The exhibits are listed on the Exhibit Index attached hereto.
(b) Reports on Form 8-K.
None.
<PAGE>
EXHIBIT INDEX
3.1.1 Restated Articles of Incorporation as filed with the South Carolina
Secretary of State on June 6, 1997: Incorporated by Reference to the
Company's Quarterly Report on Form 10-Q filed on May 15, 1998 for the
quarter ended March 31, 1998, Commission File No. 000-08909 (Exhibit
3.1).
3.1.2 Articles of Amendment as filed with the South Carolina Secretary of
State on June 24, 1998: Incorporated by Reference to the Company's
Current Report on Form 8-K filed on July 7, 1998, Commission File No.
000-08909 (Exhibit 3.1).
3.1.3 Resignation of Registered Agent and Notice of Change of Registered
Agent as filed with the South Carolina Secretary of State on July 15,
1998.
3.2 Amended and Restated Bylaws dated March 12, 1997: Incorporated by
Reference to the Company's Quarterly Report on Form 10-Q filed on May
15, 1998 for the quarter ended March 31, 1998, Commission File No.
000-08909 (Exhibit 3.2).
4.1.1 Indenture Dated as of September 23, 1997 among Emergent Group, Inc.
(n/k/a HomeGold Financial, Inc., the Company), the Subsidiary
Guarantors Named Therein and Bankers Trust Company, as Trustee
pertaining to the Company's 10.75% Senior Notes due 2004: Incorporated
by Reference to the Company's Registration Statement on Form S-4 filed
on November 13, 1997, Commission File No. 333-39339 (Exhibit 4.1).
4.1.2 Supplemental Indenture adding Emergent Insurance Agency, Inc. as
Subsidiary Guarantor dated November 3, 1997.
4.1.3 Officers' Certificate and Opinion of Counsel dated March 18, 1998, and
Notice to Trustee dated March 30, 1998, for release from Guarantees of
The Loan Pro$, Inc. and Premier Financial Services, Inc.
4.1.4 Officers' Certificate, Opinion of Counsel dated August 21, 1998, and
Notice to Trustee dated September 10, 1998, for release from Guarantees
of Sterling Lending Corporation and Sterling Lending Insurance Agency.
4.1.5 Supplemental Indenture #1, dated as of August 19, 1998.
4.1.6 Officers' Certificate, Opinion of Counsel and Notice to Trustee dated
November 13, 1998, for release from Guarantees of Emergent Business
Capital, Inc., Emergent Business Capital Equity Group, Inc. (f/k/a/
Emergent Equity Advisors, Inc.) and Emergent Commercial Mortgage, Inc.
4.2 See Exhibits listed under 3 above.
10.1 HomeGold Financial, Inc. Stock Option Plan: Incorporated by reference
to Exhibit 10.1 of the Company's Registration Statement on Form S-1,
Commission File No. 333-01393.
10.2.1 1995 Officer and Employee Stock Option Plan: Incorporated by reference
to Exhibit 10.1 of the Company's 1995 Notice of Annual Meeting and
Proxy Statement, Commission File No. 000-08909.
10.2.2 Amendment No. 1 to the 1995 Employee and Officer Stock Option Plan,
dated May 27, 1997: Incorporated by reference to the Company's
Registration Statement on Form S-8 filed with the Commission on July
10, 1998, Commission File No. 333-58861.
10.2.3 Amendment No. 2 to the 1995 Employee and Officer Stock Option Plan,
dated June 10, 1998: Incorporated by reference to the Company's
Registration Statement on Form S-8 filed with the Commission on July
10, 1998, Commission File No. 333-58861.
10.3 1995 Director Stock Option Plan: Incorporated by reference to an
exhibit filed with the Company's 1995 Notice of Annual Meeting and
Proxy Statement.
10.4 1995 Restricted Stock Agreement Plan: Incorporated by reference to
Exhibit 10.4 of the Company's Registration Statement on Form S-1,
Commission File No. 333-01393.
10.5 HomeGold Financial, Inc. Employee Stock Purchase Plan: Incorporated by
reference to Exhibit 99.1 of the Company's registration statement on
Form S-8, Commission File No. 333-20179.
10.6.1 Mortgage Loan Warehousing Agreement dated June 30, 1998, by and among
HomeGold, Inc. and Carolina Investors, Inc., as Borrowers, the
Financial Institutions Party Thereto, as Lenders, and The CIT
Group/Business Credit, Inc. as Administrative Agent: Incorporated by
Reference to the Company's 8-K filed on July 7, 1998, Commission File
No. 000-08909 (Exhibit 10.1).
10.6.2 First Amendment to Mortgage Loan Warehousing Agreement dated August 24,
1998.
10.6.3 Second Amendment to Mortgage Loan Warehousing Agreement dated December
24, 1998.
10.7.1 Asset Purchase Agreement dated October 2, 1998, by and among
TransAmerica Business Credit Corporation and Certain Subsidiaries
thereof, the Sellers named therein HomeGold Financial, Inc.
Incorporated by reference to the Company's current report on Form 8-K
dated October 2, 1998, Commission File No. 000-08909.
10.7.2 Amendment dated November 12, 1998, by and among TBCC, TransAmerica
Growth Capital, Inc., TransAmerica Small Business Services, Inc., the
Sellers named therein and HomeGold Financial, Inc. to the Asset
Purchase Agreement dated October 7, 1998.
10.8 HomeSense Letter of Intent.
16.1 Letter of KPMG Peat Marwick dated September 25, 1998. Incorporated by
reference to Exhibit 16.1 to the Company's Current Report on Form 8-K
dated September 25, 1998, Commission File No. 000-08909.
21.0 Listing of subsidiaries.
23.1 Consent of Elliott, Davis & Company, L.L.P. to include report of
Independent Auditors for the two years ended December 31, 1999.
<PAGE>
23.2 Consent of KPMG Peat Marwick, LLP to include report of independent
auditors for the year ended December 31, 1997.
27.1 Financial Data Schedule (For SEC Use Only).
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<CAPTION>
<S> <C>
HOMEGOLD FINANCIAL, INC.
--------------------------------------------------------
Registrant
February 28, 2000 \s\ John M. Sterling, Jr.
- ------------------------------------------------------ --------------------------------------------------------
(Date) John M. Sterling, Jr., Chairman of the Board of
Directors and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
\s\ J. Robert Philpott, Jr. \s\ Tecumseh Hooper, Jr.
- ------------------------------------------------------ ---------------------------------------------------------
J. Robert Philpott, Jr. Tecumseh Hooper, Jr.
Director Director
\s\ John M. Sterling, Jr. \s\ Clarence B. Bauknight
- ------------------------------------------------------ --------------------------------------------------------
John M. Sterling, Jr., Chairman of the Board of Clarence B. Bauknight
Directors and Chief Executive Officer Director
\s\ Porter B. Rose
--------------------------------------------------------
Porter B. Rose
Director
\s\ Keith B. Giddens \s\ Kevin J. Mast
- ------------------------------------------------------ -------------------------------------------------------
Keith B. Giddens, President and Director Kevin J. Mast, Executive Vice President, Chief
Financial Officer and Treasurer
February 28, 2000
- ------------------------------------------------------
(Date)
</TABLE>
Exhibit 21.0
Subsidiary State of Incorporation
- --------------------------------------------------------- ----------------------
HomeGold, Inc. South Carolina
Emergent Mortgage Corp. of Tennessee (a subsidiary of
HomeGold, Inc.) South Carolina
Emergent Mortgage Holdings Corporation (a subsidiary of
Carolina Investors, Inc.) Delaware
Emergent Mortgage Holdings Corporation II (a subsidiary of
Carolina Investors, Inc.) Delaware
Emergent Residual Holdings Corporation (a subsidiary of
Emergent Mortgage Holdings Corporation II) Delaware
Emergent Insurance Agency Corporation South Carolina
Carolina Investors, Inc. South Carolina
HomeGold Realty, Inc. (a subsidiary of HomeGold, Inc.) South Carolina
Exhibit 23.1
INDEPENDENT AUDITOR'S CONSENT
The Board of Directors
HomeGold Financial, Inc.
We consent to incorporation by reference in the registration
statements on Form S-8 (No. 333-07925) 1995 Director Stock Option Plan
Stock Plan, (No. 333-07927) 1995 Restricted Stock Agreement Plan, (No.
333-07923) 1995 Officer and Employee Stock Option Plan and (No. 333-20179)
Employee Stock Purchase Plan of HomeGold Financial, Inc. of our report
dated February 18, 2000, relating to the consolidated balance sheet of
HomeGold Financial, Inc. and subsidiaries (the "Company") as of December
31, 1999 and 1998 and the related consolidated statements of income,
shareholders' equity, and cash flows for the two years then ended, which
report appears in the 1999 Annual Report on Form 10-K of the Company.
/s/ ELLIOTT, DAVIS & COMPANY, L.L.P.
------------------------------------
ELLIOTT, DAVIS & COMPANY, L.L.P.
Greenville, South Carolina
February 28, 2000
Exhibit 23.2
INDEPENDENT AUDITOR'S CONSENT
The Board of Directors
HomeGold Financial, Inc.
We consent to incorporation by reference in the registration
statements on Form S-8 (No. 333-07925) 1995 Director Stock Option Plan
Stock Plan, (No. 333-07927) 1995 Restricted Stock Agreement Plan, (No.
333-07923) 1995 Officer and Employee Stock Option Plan and (No. 333-20179)
Employee Stock Purchase Plan of HomeGold Financial, Inc. of our report
dated February 27, 1998, relating to the consolidated balance sheet of
HomeGold Financial, Inc. and subsidiaries (the "Company") as of December
31, 1997 and the related consolidated statements of income, shareholders'
equity, and cash flows for the year then ended, which report appears in the
1999 Annual Report on Form 10-K of the Company.
/s/ KPMG PEAT MARWICK, L.L.P.
-----------------------------
KPMG PEAT MARWICK, L.L.P.
Greenville, South Carolina
February 28, 2000
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
Exhibit 27.1
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES FOR THE TWELVE
MONTHS ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000277028
<NAME> HOMEGOLD FINANCIAL INC
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 26,009
<SECURITIES> 0
<RECEIVABLES> 63,242
<ALLOWANCES> (6,344)
<INVENTORY> 0
<CURRENT-ASSETS> 0<F1>
<PP&E> 20,413
<DEPRECIATION> (748)
<TOTAL-ASSETS> 188,737
<CURRENT-LIABILITIES> 0<F1>
<BONDS> 12,134
0
0
<COMMON> 507
<OTHER-SE> 7,337
<TOTAL-LIABILITY-AND-EQUITY> 188,737
<SALES> 0
<TOTAL-REVENUES> 29,237
<CGS> 0
<TOTAL-COSTS> 31,508
<OTHER-EXPENSES> 13,123
<LOSS-PROVISION> 3,339
<INTEREST-EXPENSE> 16,338
<INCOME-PRETAX> (35,071)
<INCOME-TAX> (27,677)
<INCOME-CONTINUING> (27,685)
<DISCONTINUED> 0
<EXTRAORDINARY> 29,500
<CHANGES> 0
<NET-INCOME> 1,815
<EPS-BASIC> .18
<EPS-DILUTED> .18
<FN>
*FOOTNOTE (1) Unclassified Balance Sheet.
</FN>
</TABLE>
