SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
[ X ] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended SEPTEMBER 30, 2000.
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from _________ to _________.
Commission File Number 0-8909
-----------------------
HOMEGOLD FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
South Carolina 57-0513287
(State or Other Jurisdiction of I.R.S. Employer
Incorporation or Organization) Identification No.)
3901 Pelham Road
Greenville, South Carolina 29615
(Address of Principal Executive Offices)
864-289-5000
(Registrant's Telephone Number, Including Area Code)
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 the number of shares outstanding of each of the issuer's classes of
stock, as of the latest practicable date.
Title of each Class: Outstanding at October 31, 2000
--------------------------------------------- --------------------------------
Series A Non-convertible Preferred Stock, par
value $1.00 per share 10,000,000
Common Stock, par value $0.001 per share 16,810,149
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
Form 10-Q
Quarter Ended SEPTEMBER 30, 2000
<TABLE>
<CAPTION>
INDEX
PART I. FINANCIAL INFORMATION Page
------ --------------------- ----
<S> <C> <C>
Item 1. Financial Statements for HomeGold Financial, Inc.
Consolidated Balance Sheets
as of September 30, 2000 and December 31, 1999 3
Consolidated Statements of Operations
for the Nine Months Ended September 30, 2000 and 1999
and for the Three Months Ended September 30, 2000 and 1999 4
Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2000 and 1999 5
Consolidated Statements of Shareholders' Equity
for the Nine Months Ended September 30, 2000 and 1999 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 19
Item 3. Disclosures About Market Risk 30
PART II. OTHER INFORMATION
-------- -----------------
Item 1. Legal Proceedings 31
Item 2. Changes in Securities 31
Item 3. Defaults Upon Senior Securities 31
Item 4. Submission of Matters to a Vote of Security Holders 31
Item 5. Other Information 31
Item 6. Exhibits and Reports on Form 8-K 32
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS FOR HOMEGOLD FINANCIAL, INC.
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
-------------- -------------
(In thousands)
ASSETS (Unaudited) (Audited)
<S> <C> <C>
Cash and cash equivalents $ 9,921 $ 26,009
Restricted cash 6,069 5,314
Loans receivable 69,450 62,958
Less allowance for credit losses on loans (4,246) (6,344)
-------------- -------------
Net loans receivable 65,204 56,614
Income taxes receivable 341 461
Accrued interest receivable 1,822 1,423
Other receivables 10,558 8,059
Residual receivable, net 61,477 47,770
Property and equipment, net 22,134 17,160
Real estate and personal property acquired through foreclosure 1,769 7,673
Excess of cost over net assets of acquired businesses, net of accumulated
amortization of $1,389 in 2000 and $748 in 1999 20,443 1,566
Debt origination costs, net 442 1,658
Deferred income tax asset, net 22,000 12,000
Servicing asset 732 867
Other assets 3,050 2,163
-------------- -------------
Total assets $ 225,962 $ 188,737
=============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Revolving warehouse lines of credit $ 37,632 17,808
Other borrowings 3,661 --
Investor savings:
Notes payable to investors 141,776 127,065
Subordinated debentures 19,054 17,710
-------------- -------------
Total investor savings 160,830 144,775
Senior unsecured debt 11,214 12,134
Other liabilities:
Accounts payable and accrued liabilities 7,022 4,120
Remittances payable 892 1,078
Income taxes payable 458 120
Accrued interest payable 1,640 845
-------------- -------------
Total other liabilities 10,012 6,163
-------------- -------------
Total liabilities 223,349 180,880
Minority interest 6 13
Shareholders' equity:
Preferred stock, par value $1.00 per share- authorized 20,000,000 shares, issued
and outstanding 10,000,000 shares at September 30, 2000 and 0 shares at
December 31, 1999 10,000 --
Common stock, par value $.001 per share at September 30, 2000 and 0.05 at
December 31, 1999- authorized 100,000,000 shares, issued and outstanding 16,810,149
shares at September 30, 2000 and 10,149,629 shares at December 31, 1999 17 507
Capital in excess of par value 46,643 39,028
Note receivable from shareholder (5,908) --
Retained earnings (deficit) (48,145) (31,691)
-------------- -------------
Total shareholders' equity 2,607 7,844
Total liabilities and shareholders' equity $ 225,962 $ 188,737
=============== =============
</TABLE>
See Notes to Unaudited Consolidated Financial Statements, which are an
integral part of these statements.
3
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
<TABLE>
<CAPTION>
For the Nine Months Ended For the Three Months Ended
September 30, September 30,
--------------------------------- ------------------------------
2000 1999 2000 1999
------------- ------------ ------------ -------------
(In thousands, except share data)
<S> <C> <C> <C> <C>
REVENUES:
Interest income $ 9,390 $ 6,727 $ 3,784 $ 1,771
Servicing income 6,127 7,616 1,907 2,606
Gain on sale of loans 8,498 4,459 3,554 70
Loan fees, net 12,977 3,089 6,926 716
------------- ------------ ------------- -------------
Total revenue from loans and investments 36,992 21,891 16,171 5,163
Other revenues 1,512 1,159 573 409
------------- ------------ ------------- -------------
Total revenues 38,504 23,050 16,744 5,572
------------- ------------ ------------- -------------
EXPENSES:
Interest 14,564 12,765 5,680 3,778
Provision for credit losses 2,292 1,323 650 1,672
Cost on real estate owned and defaulted loans 2,841 2,140 914 729
Fair value write-down of residual receivable 2,143 1,631 509 856
Salaries, wages and employee benefits 21,337 15,860 8,469 4,957
Business development costs 6,012 3,757 2,136 1,330
Other general and administrative expenses 15,830 9,716 6,528 2,920
------------- ------------ ------------- -------------
Total expenses 65,019 47,192 24,886 16,242
------------- ------------ ------------- -------------
Loss before income taxes, minority interest and
extraordinary item (26,515) (24,142) (8,142) (10,670)
Provision for (benefit from) income taxes (9,485) 675 (9,820) 55
------------- ------------ ------------- -------------
Income (loss) before minority interest and
extraordinary item (17,030) (24,817) 1,678 (10,725)
Minority interest in loss of subsidiaries (3) (7) (2) (3)
------------- ------------ ------------- -------------
Income (loss) before extraordinary item (17,033) (24,824) 1,676 (10,728)
Extraordinary item-gain on extinguishment of debt,
net of $0 tax 579 29,370 261 8,143
------------- ------------ ------------- -------------
Net income (loss) $ (16,454) $ 4,546 1,937 $ (2,585)
============= ============ ============= =============
Basic and diluted earnings (loss) per share of
common stock:
Income (loss) before extraordinary item $ (1.25) $ (2.49) 0.10 $ (1.07)
Extraordinary item, net of taxes 0.04 2.94 0.02 0.81
------------- ------------ ------------- -------------
Net income (loss) $ (1.21) $ 0.45 0.12 $ (0.26)
============= ============ ============= =============
Basic and diluted weighted average shares outstanding 13,651,181 9,983,479 16,805,023 10,070,150
============= ============ ============= =============
</TABLE>
See Notes to Unaudited Consolidated Financial Statements, which are an
integral part of these statements.
4
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
<TABLE>
<CAPTION>
For the Nine Months Ended
September 30,
-----------------------------------
2000 1999
--------------- ----------------
(In thousands)
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ (16,454) $ 4,546
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 2,709 2,065
Provision for credit losses on loans 2,292 1,323
Gain on retirement of senior unsecured debt (579) (29,370)
Loss on real estate acquired through 1,380 355
foreclosure
Fair value write-down of residual receivable 2,143 1,631
Loans originated with intent to sell (441,223) (181,944)
Proceeds from loans sold 374,971 163,332
Proceeds from securitization of loans 44,588 59,630
Other (10,300) 993
Net changes in operating assets and (27,015) (10,267)
liabilities
-------------- ---------------
Net cash provided by (used in) operating activities $ (67,488) $ 12,294
-------------- ---------------
INVESTING ACTIVITIES:
Loans originated or purchased for investment purposes $ (409) $ (1,815)
Principal collections on loans not sold 40,948 16,332
Proceeds from sale of real estate and personal property
acquired through foreclosure 9,710 6,637
Proceeds from sale of property and equipment 45 199
Purchase of property and equipment (147) (549)
Loan to shareholder (5,908) --
Other (2,867) (6,686)
-------------- ---------------
Net cash provided by investing activities $ 41,372 $ 14,118
-------------- ---------------
FINANCING ACTIVITIES:
Advances on revolving warehouse lines of credit $ 557,878 $ 210,023
Payments on revolving warehouse lines of credit (563,637) (223,437)
Retirement of senior unsecured debt (341) (44,871)
Net increase (decrease) in notes payable to investors (7,510) 6,294
Net increase (decrease) in subordinated debentures 23,565 2,178
Proceeds from issuance of common stock 73 179
-------------- ---------------
Net cash provided by (used in) financing activities $ 10,028 $ (49,634)
-------------- ---------------
Net decrease in cash and cash equivalents $ (16,088) $ (23,222)
CASH AND CASH EQUIVALENTS:
Beginning of period 26,009 36,913
-------------- ---------------
End of period $ 9,921 $ 13,691
============== ===============
</TABLE>
See Notes to Unaudited Consolidated Financial Statements, which are an
integral part of these statements.
5
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For The Nine Months Ended September 30, 2000 and 1999
<TABLE>
<CAPTION>
Common Stock Note
--------------------- Capital in Receivable Retained Total
Shares Excess of Preferred from Earnings Shareholders'
Issued Amount Par Value Stock Shareholder (Deficit) Equity
----------- -------- ---------- --------- ----------- --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
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 shares issued (332) -- -- -- -- -- --
Net income -- -- -- -- -- 1,815 1,815
------------ ------ -------- ------- -------- ---------- ---------
Balance at December 31, 1999 10,149,629 507 39,028 -- -- (31,691) 7,844
Change in par from $0.05 to $0.001 -- (490) 490 -- -- -- --
Shares issued:
Employee Stock Purchase Plan 46,606 1 35 -- -- -- 36
Officer/Director Compensation 61,540 3 45 -- -- -- 48
Share Cancellation (228,570) (11) (11)
Shares issued in HomeSense Merger 6,780,944 7 7,045 -- -- -- 7,052
Shares issued in HomeSense Merger -- -- -- 10,000 -- -- 10,000
Note Receivable from Shareholder -- -- -- -- (5,908) -- (5,908)
Net income -- -- -- -- (16,454) (16,454)
------------ ------ -------- ------- -------- ---------- ---------
Balance at September 30, 2000 16,810,149 $ 17 $46,643 $10,000 $(5,908) $(48,145) $ 2,607
============ ====== ======== ======= ======== ========== =========
</TABLE>
See Notes to Unaudited Consolidated Financial Statements, which are an
integral part of these statements.
6
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BASIS OF PREPARATION
HomeGold Financial, Inc. (referred to herein sometimes as the "Company"
and "HGFN") states that the accompanying consolidated financial statements are
prepared in accordance with the Securities and Exchange Commission's rules
regarding interim financial statements, and therefore do not contain all
disclosures required by generally accepted accounting principles for annual
financial statements. Reference should be made to the consolidated financial
statements included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1999, including the footnotes thereto. Certain previously
reported amounts have been reclassified to conform to current year presentation.
Such reclassifications had no effect on net operations or shareholders' equity
as reported prior to its adoption.
The consolidated balance sheet as of September 30, 2000, and the
consolidated statements of operations for the nine-month and three-month periods
ended September 30, 2000 and 1999, and the consolidated statements of cash flows
for the nine-month periods ended September 30, 2000 and 1999, are unaudited and
in the opinion of management contain all known adjustments, which consist of
only normal recurring adjustments necessary to present fairly the financial
position, results of operations, and cash flows of the Company. 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.
NOTE 2--MERGER WITH HOMESENSE FINANCIAL CORP.
On April 28, 2000, the shareholders of HomeGold Financial, Inc.
approved a merger agreement with HomeSense Financial Corp. and affiliated
companies (collectively "HomeSense"), a privately owned business, located in
Lexington, 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. HomeSense originates its loan volume
through a direct retail branch network of eight offices, as well as through
centrally provided telemarketing leads, direct mail, and television advertising.
As of May 9, 2000, the effective date of the merger, HGFN issued
6,780,944 shares of its common stock (approximately 40% of post-merger shares
outstanding) valued at $1.04 per share plus an additional 10 million shares of
Series A Non-convertible Preferred Stock (par value $1 per share) for 100% of
the outstanding stock of HomeSense. The merger was accounted for under the
purchase method of accounting prescribed by generally accepted accounting
principles. The transaction resulted in $19.5 million of goodwill, which is
being amortized on a straight line basis over 15 years. The results of
operations of HomeSense are included in the accompanying financial statements
from the date of the acquisition.
The following summarized unaudited pro forma financial information
assumes the acquisition had occurred on January 1 of each year:
<TABLE>
<CAPTION>
For the Nine Months Ended
September 30,
------------------------------------
2000 1999
---------------- ----------------
(In thousands)
<S> <C> <C>
Revenue $ 48,426 $ 33,636
Income before extraordinary items (17,751) (25,301)
Net income (16,648) 4,320
Earnings per share (0.99) 0.26
</TABLE>
The amounts are based upon certain assumptions and estimates, and do
not reflect any benefit from economies that might be achieved from combined
operations. The pro forma results do not necessarily represent results that
would have occurred if the acquisition had taken place on the basis assumed
above, nor are they indicative of the results of future combined operations.
7
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3--CASH FLOW INFORMATION
For the nine-month periods ended September 30, 2000 and 1999, the
Company paid interest of $13.8 million and $15.5 million, respectively.
For the nine-month periods ended September 30, 2000 and 1999, the
Company paid income taxes of $177,000 and $1.0 million, respectively.
For the nine-month periods ended September 30, 2000 and 1999, the
Company foreclosed on property in the amount of $2.3 million and $3.3 million,
respectively.
During the nine months ended September 30, 2000 in connection with the
HomeSense merger the following non cash items were recorded:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
Loans receivable $ 29,244
Property and equipment, net 5,800
Goodwill 19,500
Revolving warehouse lines of credit 29,244
Preferred stock 10,000
Common stock 7
Capital in excess of par value 7,045
</TABLE>
NOTE 4--CASH, CASH EQUIVALENTS AND RESTRICTED CASH
The Company maintains its primary checking accounts with one principal
bank and makes overnight investments in reverse repurchase agreements with that
bank, as well as other short-term investments in a money manager fund of the
bank. The amounts maintained in the checking accounts are insured by the Federal
Deposit Insurance Corporation ("FDIC") up to $100,000. At September 30, 2000,
the amounts maintained in overnight investments in reverse repurchase agreements
and other short-term investments, which are not insured by the FDIC, totaled
approximately $9.8 million. The investments were secured by U.S. Government
securities pledged by the banks.
The Company considers all highly liquid investments readily convertible
to cash or having an original maturity of three months or less to be cash
equivalents.
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. Additional
restricted cash is maintained as part of the Company's primary checking account
relationship with one principal bank.
NOTE 5--RESIDUAL RECEIVABLES AND SALES AND SECURITIZATIONS 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.
8
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. Total mortgage loans
securitized in the first nine months of 2000 and 1999 were $64.5 million and
$59.6 million, respectively.
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. Certain loans included in that securitization were
ineligible for inclusion in the borrowing base under the Company's warehouse
line of credit.
During 2000, the Company completed two securitization transactions. The
first transaction occurred in the second quarter of the year involving $41.6
million of loans securitized substantially at par value. The second transaction
occurred in the third quarter of the year and included $22.9 million of loans.
This transaction carried a weighted average premium of 1.16%. Both 2000
securitizations consisted primarily of mortgage loans not eligible for inclusion
in the borrowing base under the Company's warehouse lines of credit and not
readily marketable for the secondary market.
In August 2000, the Company exceeded the twelve month rolling loss
trigger in the 1998 securitization pool which resulted in approximately $173,000
of cash flow being retained by the trustee that would have been paid to the
Company. At which time the Company returns performance of this pool below the
required trigger, the return of cash flow back to the Company will continue.
While the Company has not yet exceeded any other triggers, it has had
to continually monitor the performance of the pools for which it services.
Should any trigger threshold be exceeded, certain cash flows would be retained
by the trustee as defined in the securitization agreements as increased
overcollateralization.
NOTE 6--WAREHOUSE LINES OF CREDIT AND OTHER BORROWINGS
Prior to the Company's merger with HomeSense, the Company had a $100
million revolving warehouse line of credit with CIT Group/Business Credit, Inc.
("CIT") to fund its mortgage loan originations. The credit facility bears
interest at prime rate plus 0.75% and matures on June 30, 2001. The credit
facility contains certain covenants, including, but not limited to, covenants
that require a minimum availability of $10.0 million on the line of credit and
covenants that impose limitations on the Company and its subsidiaries with
respect to declaring or paying dividends, minimum CII Notes outstanding, and
loans and advances by HGI and CII to the Company. As of the effective date of
and in connection with the Company's merger with HomeSense, the terms of the CIT
line of credit were modified to reduce the maximum commitment to $50 million.
The agreement stipulates incremental decreases in the maximum commitment, based
on certain criteria, to $25 million at December 31, 2000. At September 30, 2000,
the maximum commitment was $38 million. The maturity date, rates of interest,
advance rates, and collateral requirements remain unchanged. 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 $10.0 million
minimum availability requirements would have allowed a maximum borrowing level
based on eligible collateral of $5.1 million at September 30, 2000 and $18.9
million at December 31, 1999. After considering outstanding borrowings under the
line of credit of $4.9 million and $17.8 million, respectively, the Company had
$200,000 and $1.1 million, respectively, of immediate availability under this
agreement on September 30, 2000 and December 31, 1999, based on its existing
borrowing base.
In connection with the merger, the Company entered into a new $40
million revolving warehouse line of credit with Household Commercial Financial
Services, Inc. Subsequent to the merger, the maximum commitment was increased to
$50 million. The line bears interest at the prime rate plus 0.25% and is
collateralized by mortgage loan receivables. The agreement requires, among other
matters, minimum net worth of the Company of $10,000,000 commencing August 31,
2000, a leverage ratio of less than 35 to 1, and positive consolidated net
income for each quarter beginning on or after July 1, 2000. The revolving credit
agreement had an original maturity date of April 30, 2001. The revolving credit
agreement was subsequently amended under an amendment and forbearance agreement
whereby the lender agreed to forebear from exercising its rights on account of
existing events of default and whereby the maturity date was amended to January
25, 2001. The advance rate was also amended to 97% from 100% for all loans made
after October 23, 2000. 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 would have allowed a maximum borrowing
9
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
level based on eligible collateral of $21.8 million at September 30, 2000. After
considering outstanding borrowings under the line of credit of $21.8 million,
the Company had no immediate availability under this agreement at September 30,
2000.
Prior to the merger, HomeSense had a $25 million revolving purchase
facility with Residential Mortgage Services of Texas ("RMST"). This agreement
was amended at the time of the merger to extend to the merged entity. The
agreement is structured as a purchase of the mortgages by RMST, subject to a
limited right of RMST to require the repurchase of defective mortgages by the
Company. The facility bears interest at the prime rate plus 0.75%. At September
30, 2000, the Company had outstanding purchased mortgages of $10.9 million on
the facility. The Company received a notice of termination of the facility on
September 19, 2000. The termination notice reduces the commitment amount in five
phases leading to full termination of the facility on December 31, 2000. At
September 30, 2000, the maximum commitment was $15.0 million.
The Company believes that no event of default has occurred on its
warehouse lines of credit for which it has not obtained a waiver or forbearance.
The Company assumed an operating line of credit of $1,860,000 with
Branch Banking & Trust Company ("BB&T") in connection with the merger. The line
is secured by a $1.0 million certificate of deposit held by the bank. Monthly
principal and interest payments are payable for twenty-four months beginning
July 5, 2000. The line bears interest at LIBOR plus 2.5%.
The Company also assumed a mortgage note of $2.0 million with Bank of
America, N.A. in connection with the merger. The note was scheduled to mature on
November 2, 2000. The Company has received a commitment from Bank of America to
extend the loan maturity date to March 2, 2001. The note bears interest at the
prime rate plus 1.5%. The note is secured by a mortgage on the Company's
building in Lexington, South Carolina, as well as a parcel of real estate
investment property.
NOTE 7--SENIOR UNSECURED DEBT AND SUBSIDIARY GUARANTORS
In September 1997, the Company sold $125.0 million in aggregate
principal amount of Senior Notes. The Senior Notes constitute unsecured
indebtedness of the Company. The Senior Notes mature on September 15, 2004, with
interest payable semi-annually at 10.75%. The Senior Notes will be redeemable at
the option of the Company, in whole or in part, on or after September 15, 2001,
at predetermined redemption prices plus accrued and unpaid interest to the date
of redemption. In the nine months ended September 30, 2000 and the year ended
December 31, 1999, the Company purchased $920,000 and $74.5 million,
respectively, in aggregate principal amount of its Senior Notes in open market
transactions. The Company recognized extraordinary gains from extinguishment of
debt of $579,000 for the purchases made during the nine months ended September
30, 2000 and $29.5 million for its purchases during the year ended December 31,
1999. The Company recorded an extraordinary gain on extinguishment of debt of
$261,000 in the third quarter of 2000, and $8.1 million in the third quarter of
1999. Remaining Senior Notes outstanding as of September 30, 2000 totaled $11.2
million.
The Company may, from time to time, purchase more of its Senior Notes
depending on its cash needs, market conditions, and other factors. The indenture
pertaining to the Senior Notes contains various restrictive covenants including
limitations on, among other things, the incurrence of certain types of
additional indebtedness, the payment of dividends and certain other payments,
the ability of the Company's subsidiaries to incur further limitations on their
ability to pay dividends or make other payments to the Company, liens, asset
sales, the issuance of preferred stock by the Company's subsidiaries and
transactions with affiliates. At September 30, 2000, 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 below. 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. No existing debt of any of the
existing subsidiaries, other than the CII subordinated debentures, is 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.
10
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company has included consolidating condensed financial data of the
combined subsidiaries of the Company in these financial statements. 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 both September 30, 2000 and December 31,
1999, all of the Subsidiary Guarantors were wholly-owned by the Company.
The Subsidiary Guarantors of the Company's Senior Notes at September
30, 2000 consist of the following wholly-owned subsidiaries of the Company:
HomeGold, Inc.
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 company 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 September 30, 2000 and 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 securitization
subsidiaries.
11
<PAGE>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING BALANCE SHEETS
September 30, 2000
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Combined
Wholly-Owned Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Eliminations Consolidated
---------- ------------ -------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents $ 204 9,716 1 -- $ 9,921
Restricted cash 5,069 1,000 -- -- 6,069
Loans receivable:
Loans receivable -- 69,450 -- -- 69,450
Notes receivable from other affiliates 7,686 54,807 11,767 (74,260) --
---------- ------------ -------------- ------------ ------------
Total loans receivable 7,686 124,257 11,767 (74,260) 69,450
Less allowance for credit losses on loans -- (4,246) -- -- (4,246)
---------- ------------ -------------- ------------ ------------
Net loans receivable 7,686 120,011 11,767 (74,260) 65,204
Income tax receivable -- 341 -- -- 341
Accrued interest receivable 79 1,743 -- -- 1,822
Other receivables -- 10,558 -- -- 10,558
Investment in subsidiaries 40,304 43,439 -- (83,743) --
Residual receivable, net 1,000 20,271 40,206 -- 61,477
Property and equipment, net -- 22,134 -- -- 22,134
Real estate and personal property acquired
through foreclosure -- 1,769 -- -- 1,769
Excess of cost over net assets of acquired
businesses, net 36 20,407 -- -- 20,443
Deferred income tax asset, net 1,810 20,190 -- -- 22,000
Other assets 236 3,988 -- -- 4,224
---------- ------------ -------------- ------------ ------------
Total assets $ 56,424 $ 275,567 $ 51,974 $ (158,003) $ 225,962
========== ============ ============== ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Revolving warehouse lines of credit and other
borrowings $ -- $ 41,293 $ -- $ -- $ 41,293
Investor savings:
Notes payable to investors -- 141,776 -- -- 141,776
Subordinated debentures -- 19,054 -- -- 19,054
---------- ------------ -------------- ------------ ------------
Total investor savings -- 160,830 -- -- 160,830
Senior unsecured debt 11,214 -- -- -- 11,214
Other liabilities:
Accounts payable and accrued liabilities -- 7,022 -- -- 7,022
Remittances payable -- 892 -- -- 892
Income taxes payable -- 458 -- -- 458
Accrued interest payable 27 1,613 -- -- 1,640
Due to (from) affiliates -- 23,155 8,528 (31,683) --
---------- ------------ -------------- ------------ ------------
Total other liabilities 27 33,140 8,528 (31,683) 10,012
Subordinated debt to affiliates 42,576 -- -- (42,576) --
---------- ------------ -------------- ------------ ------------
Total liabilities 53,817 235,263 8,528 (74,259) 223,349
Minority interest -- (1) 7 -- 6
Shareholders' equity:
Common stock 17 1,000 2 (1,002) 17
Preferred stock 10,000 -- -- -- 10,000
Capital in excess of par value 46,643 141,902 48,807 (190,709) 46,643
Note receivable from shareholder (5,908) (5,908) -- 5,908 (5,908)
Retained earnings (deficit) (48,145) (96,689) (5,370) 102,059 (48,145)
---------- ------------ -------------- ------------ ------------
Total shareholders' equity 2,607 40,305 43,439 (83,744) 2,607
---------- ------------ -------------- ------------ ------------
Total liabilities and shareholders' equity $ 56,424 275,567 51,974 (158,003) $ 225,962
========== ============ ============== ============ ============
</TABLE>
12
<PAGE>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING BALANCE SHEETS
December 31, 1999
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Combined
Wholly-Owned Combined
Parent Guarantor Non-Guarantor
Company Subsidiaries Subsidiaries Eliminations Consolidated
---------- ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents $ 202 $ 25,806 $ 1 $ -- $ 26,009
Restricted cash 5,314 -- -- -- 5,314
Loans receivable:
Loans receivable -- 62,958 -- -- 62,958
Notes receivable from affiliates 7,097 36,229 4,584 (47,910) --
---------- ----------- ----------- ------------ ------------
Total loans receivable 7,097 99,187 4,584 (47,910) 62,958
Less allowance for credit losses on loans -- (6,344) -- -- (6,344)
---------- ----------- ----------- ------------ ------------
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
Investment in subsidiaries 31,487 -- -- (31,487) --
Residual receivable, net -- 4,545 43,225 -- 47,770
Property and equipment, net -- 17,160 -- -- 17,160
Real estate and personal property acquired -- 7,673 -- -- 7,673
through foreclosure
Excess of cost over net assets of acquired 38 1,528 -- -- 1,566
businesses, net
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>
13
<PAGE>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING STATEMENTS OF OPERATIONS
Nine Months Ended September 30, 2000
(Unaudited) (In thousands)
<TABLE>
<CAPTION>
Combined Combined
Wholly-Owned Non-
Parent Guarantor Guarantor
Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- ------------- ------------ ----------- -----------
REVENUES:
<S> <C> <C> <C> <C> <C>
Interest income $ 866 $ 11,835 $ -- $ (3,311) $ 9,390
Servicing income -- 641 5,486 -- 6,127
Gain on sale of loans -- 8,498 -- -- 8,498
Loan fees, net -- 12,977 -- -- 12,977
----------- ------------- ------------ ----------- -----------
Total revenue from loans and investments 866 33,951 5,486 (3,311) 36,992
Other revenues -- 1,556 -- (44) 1,512
----------- ------------- ------------ ----------- -----------
Total revenues 866 35,507 5,486 (3,355) 38,504
EXPENSES:
Interest 3,721 14,154 -- (3,311) 14,564
Provision for credit losses -- 2,292 -- -- 2,292
Costs on REO and defaulted loans -- 2,841 -- -- 2,841
Fair market write-down of residual receivable -- 2,019 124 -- 2,143
Salaries, wages and employee benefits -- 21,337 -- -- 21,337
Business development costs -- 6,012 -- -- 6,012
Restructuring charges -- 2,375 -- -- 2,375
Other general and administrative expenses 150 13,349 -- (44) 13,455
----------- ------------- ------------ ----------- -----------
Total expenses 3,871 64,379 124 (3,355) 65,019
----------- ------------- ------------ ----------- -----------
Income (loss) before income taxes, minority
interest, and equity in undistributed earnings
(loss) of subsidiaries (3,005) (28,872) 5,362 -- (26,515)
Earnings (loss) of subsidiaries (12,328) 5,842 -- 6,486 --
----------- ------------- ------------ ----------- -----------
Income (loss) before income taxes, minority
interest and extraordinary item (15,333) (23,030) 5,362 6,486 (26,515)
Provision (benefit) for income taxes 1,700 (11,185) -- -- (9,485)
-------- ---------- --------- -------- --------
Income (loss) before minority interest and
extraordinary item (17,033) (11,845) 5,362 6,486 (17,030)
Minority interest in loss of subsidiaries -- -- (3) -- (3)
----------- ------------- ------------ ----------- -----------
Net income before extraordinary item (17,033) (11,845) 5,359 6,486 (17,033)
Extraordianary item - gain on extinquishment of debt 579 -- -- -- 579
----------- ------------- ------------ ----------- -----------
Net income (loss) $ (16,454) $ (11,845) $ 5,359 $ 6,486 $ (16,454)
=========== ============= ============ =========== ===========
</TABLE>
Nine Months Ended September 30, 1999
(Unaudited) (In thousands)
<TABLE>
<CAPTION>
Combined Combined
Wholly-Owned Non-
Parent Guarantor Guarantor
Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- ------------- ------------ ----------- -----------
REVENUES:
<S> <C> <C> <C> <C> <C>
Interest income $ 3,260 $ 6,519 $ -- $ (3,052) $ 6,727
Servicing income -- 3,794 3,822 -- 7,616
Gain on sale of loans -- 4,459 -- -- 4,459
Loan fees, net -- 3,089 -- -- 3,089
----------- ------------- ------------ ----------- -----------
Total revenue from loans and investments 3,260 17,861 3,822 (3,052) 21,891
Other revenues 8 1,141 10 -- 1,159
----------- ------------- ------------ ----------- -----------
Total revenues 3,268 19,002 3,832 (3,052) 23,050
EXPENSES:
Interest 4,022 11,795 -- (3,052) 12,765
Provision for credit losses -- 1,323 -- -- 1,323
Fair market write-down of residual receivable -- 1,362 269 -- 1,631
Salaries, wages and employee benefits -- 15,860 -- -- 15,860
Business development costs -- 3,757 -- -- 3,757
Other general and administrative expenses 356 11,499 1 -- 11,856
----------- ---------- ------------ ----------- -----------
Total expenses 4,378 45,596 270 (3,052) 47,192
----------- ------------- ------------ ----------- -----------
Income (loss) before income taxes, minority
interest, and equity in undistributed earnings
(loss) of subsidiaries (1,110) (26,594) 3,562 -- (24,142)
Earnings (loss) of subsidiaries (23,714) -- -- 23,714 --
----------- ------------- ------------ ----------- -----------
Income (loss) before income taxes, minority
interest and extraordinary item (24,824) (26,594) 3,562 23,714 (24,142)
Provision (benefit) for income taxes -- 675 -- -- 675
----------- ------------- ------------ ----------- -----------
Income (loss) before minority interest and
extraordinary item (24,824) (27,269) 3,562 23,714 (24,817)
Minority interest in loss of subsidiaries -- (7) -- -- (7)
----------- ------------- ------------ ----------- -----------
Net income before extraordinary item (24,824) (27,276) 3,562 23,714 (24,824)
Extraordianary item - gain on extinquishment of debt 29,370 -- -- -- 29,370
----------- ------------- ------------ ----------- -----------
Net income (loss) $ 4,546 $ (27,276) $ 3,562 $ 23,714 $ 4,546
=========== ============= ============ =========== ===========
</TABLE>
14
<PAGE>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING STATEMENTS OF OPERATIONS
Three Months Ended September 30, 2000
(Unaudited) (In thousands)
<TABLE>
<CAPTION>
Combined Combined
Wholly-Owned Non-
Parent Guarantor Guarantor
Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- ------------- ------------ ------------ ------------
REVENUES:
<S> <C> <C> <C> <C> <C>
Interest income $ 266 $ 4,489 $ -- $ (971) $ 3,784
Servicing income -- (71) 1,978 -- 1,907
Gain on sale of loans -- 3,554 -- -- 3,554
Loan fees, net -- 6,926 -- -- 6,926
---------- ------------ ----------- ----------- -----------
Total revenue from loans and investments 266 14,898 1,978 (971) 16,171
Other revenues -- 588 -- (15) 573
---------- ------------ ----------- ----------- -----------
Total revenues 266 15,486 1,978 (986) 16,744
EXPENSES:
Interest 1,082 5,569 -- (971) 5,680
Provision for credit losses -- 650 -- -- 650
Cost on REO and defaulted loans -- 914 -- -- 914
Fair market write-down of residual receivable -- 1,938 (1,429) -- 509
Salaries, wages and employee benefits -- 8,469 -- -- 8,469
Business development costs -- 2,360 -- -- 2,360
Other general and administrative expenses 34 6,285 -- (15) 6,304
---------- ------------ ----------- ----------- -----------
Total expenses $ 1,116 $ 26,185 $ (1,429) $ (986) $ 24,886
---------- ------------ ----------- ----------- -----------
Income (loss) before income taxes, minority
interest, and equity in undistributed earnings
(loss) of subsidiaries (850) (10,699) 3,407 -- (8,142)
Earnings (loss) of subsidiaries 4,226 5,842 -- (10,068) --
---------- ------------ ----------- ----------- -----------
Income (loss) before income taxes, minority
interest and extraordinary item 3,376 (4,857) 3,407 (10,068) (8,142)
Provision (benefit) for income taxes 1,700 (11,520) -- -- (9,820)
---------- ------------ ----------- ----------- -----------
Income (loss) before minority interest and
extraordinary item 1,676 6,663 3,407 (10,068) 1,678
Minority interest in loss of subsidiaries -- 1 (3) -- (2)
---------- ------------ ----------- ----------- -----------
Income before extraordinary item 1,676 6,664 3,404 (10,068) 1,676
Extraordinary item - gain on extinquishment of debt 261 -- -- -- 261
---------- ------------ ----------- ----------- -----------
Net income (loss) $ 1,937 $ 6,664 $ 3,404 $ (10,068) $ 1,937
========== ============= ============ ============ ============
</TABLE>
Three Months Ended September 30, 1999
(Unaudited) (In thousands)
<TABLE>
<CAPTION>
Combined Combined
Wholly-Owned Non-
Parent Guarantor Guarantor
Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- ------------- ------------ ------------ ------------
REVENUES:
<S> <C> <C> <C> <C> <C>
Interest income $ 236 $ 1,711 $ -- $ (176) $ 1,771
Servicing income -- 374 2,232 -- 2,606
Gain on sale of loans -- 70 -- -- 70
Loan fees, net -- 716 -- -- 716
----------- ------------- ------------ ------------ ------------
Total revenue from loans and investments 236 2,871 2,232 (176) 5,163
Other revenues -- 264 8 137 409
----------- ------------- ------------ ------------ ------------
Total revenues 236 3,135 2,240 (39) 5,572
EXPENSES:
Interest 746 3,208 -- (176) 3,778
Provision for credit losses -- 1,672 -- -- 1,672
Fair market write-down of residual receivable -- 995 (139) -- 856
Salaries, wages and employee benefits -- 4,957 -- -- 4,957
Business development costs -- 1,330 -- -- 1,330
Other general and administrative expenses 57 3,455 -- 137 3,649
----------- ------------- ------------ ------------ ------------
Total expenses 803 15,617 (139) (39) 16,242
----------- ------------- ------------ ------------ ------------
Income (loss) before income taxes, minority
interest, and equity in undistributed
earnings (loss) of subsidiaries (567) (12,482) 2,379 -- (10,670)
Earnings (loss) of subsidiaries (10,161) 1,178 (1,178) 10,161 --
----------- ------------- ------------ ------------ ------------
Income (loss) before income taxes, minority
interest and extraordinary item (10,728) (11,304) 1,201 10,161 (10,670)
Provision (benefit) for income taxes -- 55 -- -- 55
----------- ------------- ------------ ------------ -------------
Income (loss) before minority interest and
extraordinary item (10,728) (11,359) 1,261 10,161 (10,725)
Minority interest in loss of subsidiaries -- (3) -- -- (3)
----------- ------------- ------------ ------------ ------------
Income before extraordinary item (10,728) (11,362) 1,201 10,161 (10,728)
Extraordinary item - gain on extinquishment of debt 8,143 -- -- -- 8,143
----------- ------------- -- --------- -- --------- -- ---------
Net income (loss) $ (2,585) $ (11,362) $ 1,201 $ 10,161 $ (2,585)
=========== ============= ============ ============ ============
</TABLE>
15
<PAGE>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING STATEMENT OF CASH FLOWS
Nine Months Ended September 30, 2000
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Combined
Wholly- Combined
Owned Non-
Parent Guarantor Guarantor
Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- ------------ ----------- ------------ ------------
OPERATING ACTIVITIES:
<S> <C> <C> <C> <C> <C>
Net income (loss) $ (16,454) $ (11,845) $ 5,359 $ 6,486 (16,454)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Equity in undistributed earnings of
subsidiaries 12,328 (5,842) -- (6,486) --
Depreciation and amortization -- 2,709 -- -- 2,709
Provision for credit losses -- 2,292 -- -- 2,292
Gain on retirement of senior unsecured debt 579 (1,158) -- -- (579)
Loss on sale of real estate acquired through
foreclosure -- 1,380 -- -- 1,380
Fair value write-down of residual receivable -- 2,143 -- -- 2,143
Loans originated with intent to sell -- (441,223) -- -- (441,223)
Proceeds from sold loans -- 374,971 -- -- 374,971
Proceeds from securitization of loans -- 44,588 -- -- 44,588
Other -- (10,300) -- -- (10,300)
Changes in operating assets and liabilities
increasing (decreasing) cash (81) (29,953) 3,019 -- (27,015)
----------- ------------ ----------- ------------ ------------
Net cash provided by (used in) operating
activities (1,928) (72,238) 8,378 -- (67,488)
----------- ------------ ----------- ------------ ------------
INVESTING ACTIVITIES:
Loans originated for investment purposes -- (220) -- -- (220)
Loans purchased for investment purposes -- (189) -- -- (189)
Principal collections on loans not sold -- 40,948 -- -- 40,948
Proceeds from sale of real estate and personal
property acquired through foreclosure -- 9,710 -- -- 9,710
Proceeds from sale of property and equipment -- 45 -- -- 45
Purchase of property and equipment -- (147) -- -- (147)
Loans to shareholders (5,908) -- -- -- (5,908)
Other -- (2,867) -- -- (2,867)
----------- ------------ ----------- ------------ ------------
Net cash provided by in investing activities (4,000) 39,572 -- -- 35,572
----------- ------------ ----------- ------------ ------------
FINANCING ACTIVITIES:
Advances on warehouse lines of credit -- 557,878 -- -- 557,878
Payments on warehouse lines of credit -- (563,637) -- -- (563,637)
Retirement of senior unsecured debt (341) -- -- -- (341)
Net increase in notes payable to investors -- (7,510) -- -- (7,510)
Net increase in subordinated debentures -- 23,565 -- -- 23,565
Advances (to) from subsidiary 9,879 (1,508) (8,371) -- --
Proceeds from issuance of additional common stock -- 73 -- -- 73
Other -- 7 (7) -- --
----------- ------------ ----------- ------------ ------------
Net cash provided by (used in) financing
activities 9,538 8,868 (8,378) -- 10,028
----------- ------------ ----------- ------------ ------------
Net increase (decrease) in cash and cash
equivalents 2 (16,090) -- -- (16,088)
CASH AND CASH EQUIVALENTS:
BEGINNING OF PERIOD 202 25,806 1 -- 26,009
----------- ------------ ----------- ------------ ------------
END OF PERIOD $ 204 $ 9,716 $ 1 $ -- 9,921
=========== ============ =========== ============ ============
</TABLE>
16
<PAGE>
HOMEGOLD FINANCIAL, INC.
CONSOLIDATING STATEMENT OF CASH FLOWS
Nine Months Ended September 30, 1999
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Combined
Wholly- Combined
Owned Non-
Parent Guarantor Guarantor
Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- ----------- ------------- ------------ -------------
OPERATING ACTIVITIES:
<S> <C> <C> <C> <C> <C>
Net income (loss) $ 4,546 (27,276) $ 3,562 $ 23,714 $ 4,546
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Equity in undistributed earnings of
subsidiaries 23,714 -- -- (23,714) --
Depreciation and amortization 1 2,064 -- -- 2,065
Provision for credit losses -- 1,323 -- -- 1,323
Gain on retirement of senior unsecured debt (29,370) -- -- -- (29,370)
Loss on sale of real estate acquired through
foreclosure -- 355 -- -- 355
Fair value write-down of residual receivable -- 1,631 -- -- 1,631
Loans originated with intent to sell -- (181,944) -- -- (181,944)
Proceeds from sold loans -- 163,332 -- -- 163,332
Proceeds from securitization of loans -- 59,630 -- -- 59,630
Other -- 993 -- -- 993
Changes in operating assets and liabilities
increasing (decreasing) cash (1,263) 22,936 (31,940) -- (10,267)
----------- ----------- ------------- ------------ -------------
Net cash provided by (used in) operating
activities (2,372) 43,044 (28,378) -- 12,294
----------- ----------- ------------- ------------ -------------
INVESTING ACTIVITIES:
Loans originated for investment purposes -- (1,815) -- -- (1,815)
Principal collections on loans not sold -- 16,332 -- -- 16,332
Proceeds from sale of real estate acquired
through foreclosure -- 6,637 -- -- 6,637
Proceeds from sale of property and equipment -- 199 -- -- 199
Purchase of property and equipment -- (549) -- -- (549)
Other -- (6,686) -- -- (6,686)
----------- ----------- ------------- ------------ -------------
Net cash provided by in investing activities -- 14,118 -- -- 14,118
----------- ----------- ------------- ------------ -------------
FINANCING ACTIVITIES:
Advances on warehouse lines of credit -- 210,023 -- -- 210,023
Payments on warehouse lines of credit -- (223,437) -- -- (223,437)
Retirement of senior unsecured debt (44,871) -- -- -- (44,871)
Net increase in notes payable to investors -- 6,294 -- -- 6,294
Net increase in subordinated debentures -- 2,178 -- -- 2,178
Advances (to) from subsidiary 46,973 (76,083) 29,110 -- --
Proceeds from issuance of additional common stock 179 (2) 2 -- 179
Other -- 3,235 (3,235) -- --
----------- ----------- ------------- ------------ -------------
Net cash provided by (used in) financing
activities 2,281 (77,792) 26,877 -- (49,634)
----------- ----------- ------------- ------------ -------------
Net decrease in cash and cash equivalents (91) (20,630) (2,501) -- (23,222)
CASH AND CASH EQUIVALENTS:
BEGINNING OF PERIOD 196 34,215 2,502 -- 36,913
----------- ----------- ------------- ------------ -------------
END OF PERIOD $ 105 13,585 $ 1 $ -- $ 13,691
=========== =========== ============= ============ =============
</TABLE>
17
<PAGE>
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8--CONTINGENCIES
On February 26, 1999, the Company received notification from
Transamerica Small Business Capital, Inc. ("Transamerica") claiming that a loan
in the original principal amount of $1.1 million sold by the Company to
Transamerica pursuant to an asset purchase agreement dated October 2, 1998 was
not made by the Company's subsidiary 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 funds held in escrow in
connection with the transaction with Transamerica. On June 5, 2000 Transamerica
allowed the release from escrow to the Company of $450,000, and the balance of
the escrow account, reflected on the balance sheet as restricted cash, is
$5,068,723 as of September 30, 2000. On June 21, 2000, Transamerica amended its
complaint to add another loan, claiming damage of "not less than $200,000," and
allegations concerning servicing fee income claiming damage of "not less than
$116,000." The Company intends to defend itself vigorously and seek the release
of escrowed funds.
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. That suit has been transferred to North Carolina Business 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"). On February 22, 2000, Michael
and Kimberly Chasten filed a similar action in Duplin County, North Carolina
Superior Court. That suit has been removed to the United States District Court
for the Southern District of North Carolina. On March 21, 2000, Rosa and Royal
Utley filled a similar suit in New Hanover County, North Carolina Superior
Court. On April 13, 2000 Reginald Troy filed a similar action in New Hanover
County, North Carolina Superior Court. That suit has been removed to the United
States District Court for the Southern District of North Carolina. The
plaintiffs in all of these cases are seeking unspecified monetary damages. As to
the Company's subsidiary, the complaints in these four cases allege
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 in any of the cases, and the Company intends to contest each
case vigorously.
On April 4, 2000, the Company received notice of a suit filed against
it by Danka Funding Company, LLC ("Danka") in New Jersey Superior Court. In the
suit, Danka seeks recovery of $356,000 allegedly due under copier equipment
leases. It is not possible to evaluate the likelihood or amount of an
unfavorable outcome at this stage.
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.
NOTE 9--SUBSEQUENT EVENT
On November 3, 2000, the Company entered into a $10 million warehouse
line of credit agreement with PCFS Financial Services. The line bears interest
at a rate of prime plus 1.75%, and is due upon demand at the discretion of PCFS
Financial Services. The Company expects to begin using this facility
mid-November. The line of credit will be collateralized by mortgage loan
receivables.
18
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The discussion should be read in conjunction with the HomeGold
Financial, Inc. and Subsidiaries (the "Company") Unaudited Consolidated
Financial Statements and Notes 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 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
Form 10-Q, as well as those made in other filings with the SEC, 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. Such risks
and uncertainties include, but are not limited to: lower origination volume due
to market conditions, inability to renew or replace existing credit facilities
to fund loan originations, inability to achieve desired efficiency levels,
higher losses due to economic downturn or lower real estate values, loss of key
employees, negative cash flows and capital needs, delinquencies and losses in
securitization trusts, right to terminate mortgage servicing and related
negative impact on cash flow, 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, 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. The
Company commenced its lending operations in 1991 through the acquisition of CII,
a small mortgage lending company, which had been in operation since 1963.
Market Conditions
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. While the Company faces significant competition in connection with
its mortgage loan products, it believes that it competes effectively in its
markets by providing competitive rates and efficient, complete services.
Merger with HomeSense Financial Corp.
On April 28, 2000, the shareholders of HomeGold Financial, Inc.
approved a merger agreement with HomeSense Financial Corp. and affiliated
companies (collectively "HomeSense"), a privately owned business, located in
Lexington, 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. HomeSense originates its loan volume
through a direct retail branch network of eight offices, as well as through
centrally provided telemarketing leads, direct mail, and television advertising.
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As of May 9, 2000, the effective date of the merger, HGFN issued
6,780,944 shares of its common stock (40% of post-merger shares outstanding)
valued at $1.04 per share plus an additional 10 million shares of Series A
Non-convertible Preferred Stock (par value $1 per share) for 100% of the
outstanding stock of HomeSense. The merger was accounted for under the purchase
method of accounting prescribed by generally accepted accounting principles. The
transaction resulted in $19.5 million of goodwill, which is being amortized on a
straight line basis over 15 years. The results of operations of HomeSense are
included in the accompanying financial statements from the date of the
acquisition.
The following summarized unaudited pro forma financial information
assumes the acquisition had occurred on January 1 of each year:
<TABLE>
<CAPTION>
For the Nine Months Ended
September 30,
------------------------------------
2000 1999
---------------- ----------------
(In thousands)
<S> <C> <C>
Revenue $ 48,426 $ 33,636
Income before extraordinary items (17,751) (25,301)
Net income (16,648) 4,320
Earnings per share (0.99) 0.26
</TABLE>
The amounts are based upon certain assumptions and estimates, and do
not reflect any benefit from economies that might be achieved from combined
operations. The pro forma results do not necessarily represent results that
would have occurred if the acquisition had taken place on the basis assumed
above, nor are they indicative of the results of future combined operations.
Results of Operations
Nine months ended September 30, 2000, compared to nine months ended September
30, 1999
The Company recognized a net loss of $16.5 million for the nine months
ended September 30, 2000 ("the 2000 period") as compared to net income of $4.5
million for the nine months ended September 30, 1999 ("the 1999 period").
Included in the net loss and net income figures for the 2000 and 1999 periods
were extraordinary gains on the extinguishment of debt of $579,000 and $29.4
million, respectively. Excluding extraordinary gains, the net losses for the
2000 and 1999 periods were $17.0 million and $24.8 million, respectively. In
addition, two other nonrecurring items were recorded during the 2000 period
which had an affect on net income: the Company recorded a deferred tax benefit
of $10.0 million, and the Company recorded $2.4 million in restructuring
expenses related to the HomeSense merger.
Total revenues for the 2000 period increased $15.5 million (67.0%)
compared to the nine months ended September 30, 1999. The increase in total
revenues is comprised of a $9.9 million (320.1%) increase in net loan fees, a
$4.0 million (90.6%) increase in gain on sale of loans, and a $2.7 million
(39.6%) increase in interest income, partially offset by a $1.5 million (19.6%)
decrease in servicing income.
The increase in net loan fees is primarily attributable to a $257.9
million (140.3%) increase in production and an increase in average loan
origination fees charged, to 3.3% from 2.9%. The overall increase in production
is attributable to the merger, combining the production capacity of HomeGold
with that of HomeSense. The increase in average origination fees charged
occurred because of a shift in the mix of wholesale and retail production,
resulting from the Company's decision to end wholesale production operations as
of August 1, 2000. During the 1999 period, wholesale production accounted for
45.0% of the Company's total production, and during the 2000 period, wholesale
production accounted for 42.2% of the Company's total production.
The increase in interest income resulted primarily from an $11.5
million (13.1%) increase in average loans receivable outstanding. The increase
in average loans receivable outstanding relates primarily to the increase in
mortgage loan production mentioned above. In addition, the Company experienced
an approximate 230 basis point increase in the average yield on loans receivable
outstanding.
The increase in gains on sale of loans resulted from an increase in the
volume of loan sales, partially offset by a reduction in the average premium
obtained in the 2000 period compared to the 1999 period. In the 2000 period, the
Company had mortgage whole loan sales of $375.0 million at an average premium of
2.3% compared to mortgage whole loan sales of $163.3 million at an average
premium of 2.7% in the 1999 period. The higher sales were primarily a result of
increased loan production. The Company believes the reduction in premiums
received is primarily due to changes in market conditions.
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<PAGE>
The decline in servicing income was primarily due to a decrease in
average serviced loan portfolio. The reduction in the average mortgage loans
serviced in the 2000 period compared to the 1999 period resulted primarily from
repayments of loans in the securitized pools as well as amortization of the
residual assets.
Total expenses for the 2000 period, excluding the restructuring costs,
increased $15.4 million (32.7%) compared to the nine months ended September 30,
1999. The increase in total expenses was primarily comprised of an $11.4 million
(39.0%) increase in general and administrative expenses, a $2.2 million (42.8%)
increase in costs related to the securitization pools, real estate owned, and
portfolio credit losses, and a $1.8 million (14.1%) increase in interest
expense.
In general and administrative expenses, personnel costs increased $5.5
million (34.5%), business development costs increased $2.3 million (60.0%), and
other general and administrative costs increased $3.7 million (38.2%). The
increase in personnel costs resulted primarily from the combination of employees
resulting from the merger. The number of employees increased from 406 at
September 30, 1999 to 715 at September 30, 2000. Likewise, the increase in
business development costs and other general and administrative costs are
primarily attributable to the additional costs related to the merged company.
The increase in costs related to the securitization pools, real estate
owned, and portfolio credit losses include a $969,000 (73.2%) increase in the
provision for credit losses, a $701,000 (32.8%) increase in costs on owned real
estate and defaulted loans, and a $512,000 (31.4%) increase in the fair value
adjustment on residual receivables. The increase in the provision for credit
losses resulted from higher levels of loans held for investment, along with
management's decision in early 2000 to record additional reserves against
amounts paid on behalf of borrowers for taxes, insurance, and attorney's fees,
partially offset by a lower loan delinquency rate. The increase in costs on
owned real estate and defaulted loans is due to higher levels of real estate
acquired through foreclosure in the 2000 period over the 1999 period. These
higher levels are related to seasoning of the retained portfolio and repurchases
from securitized pools. Changes in valuation assumptions were required in the
first nine months of 2000, primarily related to the assumed loss rates in the
1997 pools. The change in assumed loss rates, due to lower than expected actual
losses, resulted in an increase in fair value of the residual receivable.
However, this increase was offset by actual losses on foreclosed properties in
all the securitization pools, causing the write-down of the overall residual
receivable.
The increase in interest expense is the result of additional borrowings
associated with the increase in the Company's average loan portfolio and the
cost of borrowings that were required to fund the Company's operating losses,
the combination of which was partially offset by a decrease in interest costs
related to the reduction of outstanding senior unsecured notes resulting from
the Company's repurchase of notes throughout 1999 and 2000.
The Company has recorded current tax expense of $515,000 and $675,000
for the 2000 and 1999 periods, respectively, although the Company generated a
pre-tax loss before extraordinary item for both periods. The Company has also
recorded a $10 million deferred tax benefit as a result of the Company's latest
assessment of the recoverability of the related deferred tax asset. The current
tax expense results from "excess inclusion income." Excess inclusion income is a
result of the Company's securitizing loans in pools to third party investors
using a REMIC structure. These transactions generate income for the Company that
is included in the overall loss from operations. However, according to IRS
regulations, a portion of that income is subject to federal tax in the current
period regardless of other 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 extraordinary gain on the extinguishment of
debt (discussed below) is net of $0 tax since the gain was offset against prior
NOL's and did not result in any incremental increase in current income tax
expense. The latest securitizations were structured utilizing alternative
structures that do not generate excess inclusion income.
During the 1999 period, the Company recorded a $29.4 million
extraordinary gain on the extinguishment of debt related to the purchase of
$74.2 million of its Senior Notes. The purchase price of the Senior Notes was
$42.7 million, or a weighted average of 57.5% of face value. A proportionate
share of the unamortized debt origination cost ($2.1 million) relating to the
issuance of the Senior Notes was charged against this gain. The extraordinary
gain on the extinguishment of debt for the 2000 period was $579,000, resulting
from a minor purchase of the Company's Senior Notes. At September 30, 2000, the
Company had $11.2 million of Senior Notes outstanding.
21
<PAGE>
Three months ended September 30, 2000 compared to three months ended September
30, 1999
The Company recognized net income of $1.9 million for the three months
ended September 30, 2000 ("the 2000 period") as compared to a net loss of $2.6
million for the three months ended September 30, 1999 ("the 1999 period").
Included in the net income and net loss figures for the 2000 and 1999 periods
were extraordinary gains of $261,000 and $8.1 million on the extinguishment of
debt, respectively. Excluding extraordinary gains, the net income for the 2000
period was $1.7 million and the net loss for the 1999 period was $10.7 million.
In addition, two other nonrecurring items were recorded during the 2000 period
which had an affect on net income: the Company recorded a deferred tax benefit
of $10.0 million, and the Company recorded $99,000 in restructuring expenses
related to the merger.
Total revenues increased $11.2 million (200.5%) for the 2000 period
compared to the 1999 period. The increase in total revenues was comprised of a
$6.2 million (867.3%) increase in net loan fees, a $3.5 million (4,977.1%)
increase in gain on sale of loans, and a $2.0 million (113.7%) increase in
interest income, partially offset by a $699,000 (26.8%) decrease in servicing
income.
The increase in net loan fees is primarily attributable to a $90.2
million (139.1%) increase in production and an increase in average loan
origination fees charged, to 4.38% from 2.18%. The overall increase in
production is attributable to the merger, combining the production capacity of
HomeGold with that of HomeSense. The increase in average origination fees
charged occurred because of a shift in the mix of wholesale and retail
production, resulting from the Company's decision to end wholesale production
operations as of August 1, 2000. During the 1999 period, wholesale production
accounted for 48.8% of the Company's total production, and during the 2000
period, wholesale production accounted for only 19.7% of the Company's total
production.
The increase in gain on sale of loans is attributable to the unusually
low loan sales related to production in the 1999 period compared to normal loan
sales related to production in the 2000 period.
The increase in interest income resulted primarily from a $42.5 million
(70.4%) increase in average loans receivable outstanding. The increase in
average loans receivable outstanding relates primarily to the increase in
mortgage loan production mentioned above. In addition, the Company experienced
an approximate 390 basis point increase in average yield.
The decline in servicing income was primarily due to a decrease in
average serviced loan portfolio. The reduction in the average mortgage loans
serviced in the 2000 period compared to the 1999 period resulted primarily from
repayments of loans in the securitized pools as well as amortization of the
residual assets.
Total expenses for the 2000 period, excluding the restructuring costs,
increased $8.6 million (53.1%) compared to the 1999 period. The increase in
total expenses was primarily comprised of a $7.8 million (115.9%) increase in
general and administrative expenses and a $1.9 million (50.3%) increase in
interest expense. These increases were partially offset by a $1.2 million
(36.4%) decrease in costs related to the securitization pools, real estate
owned, and provision for credit losses.
In general and administrative expenses, personnel costs increased $3.5
million (70.8%), business development costs increased $806,000 (60.6%), and
other general and administrative costs increased $3.5 million (120.1%). The
increase in personnel costs resulted primarily from the combination of employees
resulting from the merger. The number of employees increased from 406 at
September 30, 1999 to 715 at September 30, 2000. Likewise, the increase in
business development costs and other general and administrative costs are
primarily attributable to the additional costs related to the merged company.
The decrease in costs related to the securitization pools, real estate
owned, and portfolio credit losses include a $1.0 million (61.1%) decrease in
the provision for credit losses and a $347,000 (40.5%) decrease in the fair
value adjustment on residual receivables, partially offset by a $185,000 (25.4%)
increase in costs on owned real estate and defaulted loans. The decrease in the
provision for credit losses resulted from a non-recurring adjustment of the
reserve for credit losses to anticipated levels, partially offset by higher
levels of loans held for investment, along with management's decision in early
2000 to record additional reserves against amounts paid on behalf of borrowers
for taxes, insurance, and attorney's fees, partially offset by a lower loan
delinquency rate. The decrease in the fair value write-down of the residual
receivables was due to a change in valuation assumptions related to the assumed
loss rates in the 1997 pools. The impact of this change increased the valuation
of the residual assets by $895,000. The increase in costs on owned real estate
and defaulted loans is due to higher levels of real estate acquired through
foreclosure in the 2000 period over the 1999 period. These higher levels are
related to seasoning of the retained portfolio and repurchases from securitized
pools.
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<PAGE>
The increase in interest expense is the result of additional borrowings
associated with the increase in the Company's average loan portfolio and the
cost of borrowings that were required to fund the Company's operating losses,
the combination of which was partially offset by a decrease in interest costs
related to the reduction of outstanding senior unsecured notes resulting from
the Company's repurchase of notes throughout 1999 and 2000.
The Company has recorded current tax expense of $180,000 and $55,000
for the 2000 and 1999 periods, respectively, although the Company generated a
pre-tax loss before extraordinary item for both periods. The Company has also
recorded a $10 million deferred tax benefit as a result of the Company's latest
assessment of the recoverability of the related deferred tax asset. The current
tax expense results from "excess inclusion income." Excess inclusion income is a
result of the Company's securitizing loans in pools to third party investors
using a REMIC structure. These transactions generate income for the Company that
is included in the overall loss from operations. However, according to IRS
regulations, a portion of that income is subject to federal tax in the current
period regardless of other 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 extraordinary gain on the extinguishment of
debt (discussed below) is net of $0 tax since the gain was offset against prior
NOL's and did not result in any incremental increase in current income tax
expense. The latest securitizations were structured utilizing alternative
structures that do not generate excess inclusion income.
During the 1999 period, the Company recorded a $8.1 million
extraordinary gain on the extinguishment of debt related to the purchase of
$25.0 million of its Senior Notes. The purchase price of the Senior Notes was
$16.1 million, or a weighted average of 64.7% of face value. A proportionate
share of the unamortized debt origination cost ($0.7 million) relating to the
issuance of the Senior Notes was charged against this gain. The extraordinary
gain on the extinguishment of debt for the 2000 period was $261,000, resulting
from a minor purchase of the Company's Senior Notes. At September 30, 2000, the
Company had $11.2 million of Senior Notes outstanding.
Financial Condition
Net loans receivable increased to $65.2 million at September 30, 2000
from $56.6 million at December 31, 1999. The increase in net loans receivable
resulted primarily from increased production due to the merger. Average monthly
loan production in 2000 to date is $49.1 million compared to average monthly
loan production of $20.4 million in 1999.
The residual receivables were $61.5 million at September 30, 2000,
compared to $47.8 million at December 31, 1999. This increase resulted primarily
from net residual assets of $16.0 million retained on the 2000 securitization
transactions completed in June and September and an $895,000 increase in value
resulting from a change in the assumed loss rates of the 1997 pools, due to
lower than expected actual losses. These increases were partially offset by the
amortization of the other residual assets from prior securitizations.
Net property and equipment increased to $22.1 million at September 30,
2000, from $17.2 million at December 31, 1999, an increase of $5.6 million,
which is attributable to the merger with HomeSense. Real estate and personal
property acquired in foreclosure decreased to $1.8 million at September 30,
2000, from $7.7 million at December 31, 1999. This decrease resulted from the
sale of foreclosed properties, partially offset by additional foreclosures on
mortgage loans within the period.
As a result of the merger, net excess of cost over net assets of
acquired businesses increased to $20.4 million at September 30, 2000, from $1.6
million at December 31, 1999.
The net deferred income tax asset increased from $12.0 million at
December 31, 1999 to $22.0 million at September 30, 2000. The increase is the
result of the Company's latest assessment of the recoverability of the net
operating loss carryforwards based upon recent changes in its management team,
business strategy, opportunities in the marketplace and projected conditions.
Total net operating loss carryforwards are now $92.9 million. Approximately
$87.7 million does not begin to expire until 2006 and beyond.
The primary sources for funding the Company's receivables comes from
borrowings issued under various credit arrangements (including the warehouse
lines of credit, CII notes payable to investors and subordinated debentures, and
the Company's Senior Notes) and the sale or securitization of loans. At
September 30, 2000, the Company had $41.3 million outstanding under revolving
warehouse lines of credit and other obligations to banks, compared with $17.8
million at December 31, 1999. At September 30, 2000, the Company had $160.8
million of CII notes payable to investors and subordinated debentures
outstanding, compared with $144.8 million at December 31, 1999.
23
<PAGE>
The aggregate principal amount of outstanding Senior Notes was $11.2
million at September 30, 2000, compared to $12.1 million on December 31, 1999.
In the nine months ended September 30, 2000, the Company purchased $920,000 of
its Senior Notes for a purchase price of $341,000. 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 September 30, 2000 was $2.6 million,
compared to $7.8 million at December 31, 1999. This decrease is attributable to
the net loss of $16.4 million for the nine months ended September 30, 2000 and
the classification in shareholders' equity of a $5.8 million note receivable
from a shareholder, arising from the merger. This decrease is partially offset
by an increase in preferred stock and paid-in capital in excess of par value,
also arising from the merger.
In connection with the merger with HomeSense, which was effective May
9, 2000, the Company issued 6,780,944 shares of its common stock in addition to
10 million shares of Series A Non-convertible Preferred Stock (par value $1 per
share), which increased the Company's shareholders' equity by approximately
$17.1 million.
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 and,
in certain cases, where the terms of sale include a warranty against first
payment defaults. 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 percentage of total serviced mortgage loans past due 30 days or
more declined to 8.50% at September 30, 2000 compared to 12.43% at December 31,
1999. The Company incurred net charge-offs on retained loans of $1.8 million in
the nine months ended September 30, 2000 compared to $2.2 million in net
charge-offs on retained loans in the nine months ended September 30, 1999.
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.
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 either over 150
days past due, or the loan is over 90 days past due and the loan-to-value ratio
is greater than 90%, 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.
The Company's allowance for loan loss as a percentage of gross loans
was 6.1% at September 30, 2000 and 10.0% at December 31, 1999. The Company
considers its allowance for credit losses at September 30, 2000 to be adequate
in view of the Company's ability to sell a significant portion of its loans,
improving loss experience and the secured nature of most of the Company's
outstanding loans.
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 increases in loan
production and incurred operating expenses in excess of operating income, the
Company experienced a $67.5 million net use of cash from operating activities in
the first nine months of 2000. 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 its revolving warehouse credit
facilities ("Credit Facilities"), senior unsecured debt and CII investor savings
notes, (iii) fees, expenses, overcollateralization and tax payments incurred in
connection with the securitization program and (iv) ongoing general and
administrative and other operating expenses. The Company's primary operating
sources of cash are (i) cash proceeds of whole-loan mortgage loan sales, (ii)
cash payments for 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, (v) excess cash flow
received in each period with respect to residual receivables and (vi) borrowings
under warehouse lines of credit.
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<PAGE>
The Company believes that additional sources of funds are needed, including
warehouse lines of credit, to meet its future liquidity requirements. No
assurance can be given that these additional sources of funds can be attained.
Cash and cash equivalents were $9.9 million at September 30, 2000, and
$26.0 million at December 31, 1999. Cash used by operating activities was $67.5
million for the nine months ended September 30, 2000, compared to cash provided
by operating activities of $12.3 million for the nine months ended September 30,
1999. Cash provided by investing activities was $41.4 million for the nine
months ended September 30, 2000 compared to $14.1 million for the nine months
ended September 30, 1999. Cash provided by financing activities was $10.0
million for the nine months ended September 30, 2000 compared to cash used in
financing activities of $49.6 million for the nine months ended September 30,
1999. The increase in cash used by operating activities was principally due to
operating losses incurred for the nine month period ended September 30, 2000
when compared to the same period of 1999. Cash provided by investing activities
in both the nine months ended September 30, 2000 and 1999, resulted primarily
from principal collections on loans not sold. The cash provided in financing
activities in the nine months ended September 30, 2000, resulted primarily an
increase of $23.6 million of subordinated debentures on the Company's revolving
warehouse lines of credit.
Prior to the Company's merger with HomeSense, the Company had a $100
million revolving warehouse line of credit with CIT Group/Business Credit, Inc.
("CIT") to fund its mortgage loan originations. The credit facility bears
interest at prime rate plus 0.75% and matures on June 30, 2001. The credit
facility contains certain covenants, including, but not limited to, covenants
that require a minimum availability of $10.0 million on the line of credit and
covenants that impose limitations on the Company and its subsidiaries with
respect to declaring or paying dividends, minimum CII Notes outstanding, and
loans and advances by HGI and CII to the Company. As of the effective date of
and in connection with the Company's merger with HomeSense, the terms of the CIT
line of credit were modified to reduce the maximum commitment to $50 million.
The agreement stipulates incremental decreases in the maximum commitment, based
on certain criteria, to $25 million at December 31, 2000. At September 30, 2000,
the maximum commitment was $38 million. The maturity date, rates of interest,
advance rates, and collateral requirements remain unchanged. 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 $10.0 million
minimum availability requirements would have allowed a maximum borrowing level
based on eligible collateral of $5.1 million at September 30, 2000 and $18.9
million at December 31, 1999. After considering outstanding borrowings under the
line of credit of $4.9 million and $17.8 million, respectively, the Company had
$200,000 and $1.1 million, respectively, of immediate availability under this
agreement on September 30, 2000 and December 31, 1999, based on its existing
borrowing base.
In connection with the merger, the Company entered into a new $40
million revolving warehouse line of credit with Household Commercial Financial
Services, Inc. Subsequent to the merger, the maximum commitment was increased to
$50 million. The line bears interest at the prime rate plus 0.25% and is
collateralized by mortgage loan receivables. The agreement requires, among other
matters, minimum net worth of the Company of $10,000,000 commencing August 31,
2000, a leverage ratio of less than 35 to 1, and positive consolidated net
income for each quarter beginning on or after July 1, 2000. The revolving credit
agreement had an original maturity date of April 30, 2001. The revolving credit
agreement was subsequently amended under an amendment and forbearance agreement
whereby the lender agreed to forebear from exercising its rights on account of
existing events of default and whereby the maturity date was amended to January
25, 2001. The advance rate was also amended to 97% from 100% for all loans made
after October 23, 2000. 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 would have allowed a maximum borrowing level based on eligible
collateral of $21.8 million at September 30, 2000. After considering outstanding
borrowings under the line of credit of $21.8 million, the Company had no
immediate availability under this agreement at September 30, 2000.
Prior to the merger, HomeSense had a $25 million revolving purchase
facility with Residential Mortgage Services of Texas ("RMST"). This agreement
was amended at the time of the merger to extend to the merged entity. The
agreement is structured as a purchase of the mortgages by RMST, subject to a
limited right of RMST to require the repurchase of defective mortgages by the
Company. The facility bears interest at the prime rate plus 0.75%. At September
30, 2000, the Company had outstanding purchased mortgages of $10.9 million on
the facility. The Company received a notice of termination of the facility on
September 19, 2000. The termination notice reduces the commitment amount in five
phases leading to full termination of the facility on December 31, 2000. At
September 30, 2000, the maximum commitment was $15.0 million.
The Company believes that no event of default has occurred on its
warehouse lines of credit for which it has not obtained a waiver or forbearance.
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<PAGE>
On November 3, 2000, the Company entered into a $10 million warehouse
line of credit agreement with PCFS Financial Services. The lender has indicated
that future increases in the commitment amount will be considered based upon
satisfactory performance of the line of credit
The Company is currently pursuing warehouse credit facilities to
replace the expiring facilities discussed above. In the event these efforts
ultimately prove unsuccessful, the Company's operations could be materially and
adversely affected.
The Company assumed an operating line of credit of $1,860,000 with
Branch Banking & Trust Company ("BB&T") in connection with the merger. The line
is secured by a $1.0 million certificate of deposit held by the bank. Monthly
principal and interest payments are payable for twenty-four months beginning
July 5, 2000. The line bears interest at LIBOR plus 2.5%.
The Company also assumed a mortgage note of $2.0 million with Bank of
America, N.A. in connection with the merger. The note was scheduled to mature on
November 2, 2000. The Company has received a commitment from Bank of America to
extend the loan maturity date to March 2, 2001. The note bears interest at the
prime rate plus 1.5%. The note is secured by a mortgage on the Company's
building in Lexington, South Carolina, as well as a parcel of real estate
investment property.
During 1997, the Company sold $125.0 million aggregate principal amount
of Senior Notes. The Senior Notes constitute unsecured indebtedness of the
Company. The Senior Notes are redeemable at the option of the Company, in whole
or in part, on or after September 15, 2001, at predetermined redemption prices
plus accrued and unpaid interest to the date of redemption. This agreement
contains, among other matters, restrictions on the payment of dividends. At
September 30, 2000, management believes the Company was in compliance with such
restrictive covenants. The Senior Notes are fully and unconditionally guaranteed
(the "Subsidiary Guarantees") jointly and severally on an unsecured basis (each,
a "Guarantee") by certain of the Company's subsidiaries (the "Subsidiary
Guarantors"). With the exception of the Guarantee by CII, the Subsidiary
Guarantees rank pari passu in right of payment with all existing and future
unsubordinated indebtedness of the Subsidiary Guarantors and senior in right of
payment to all existing and future subordinated indebtedness of such Guarantors.
The Guarantee by CII is equal in priority to CII's 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 $920,000 in the first nine
months of 2000. At September 30, 2000 and December 31, 1999, $11.2 million and
$12.1 million in aggregate principal amount of Senior Notes were outstanding,
respectively.
CII engages in the sale of CII notes to investors. The CII notes are
comprised of investor 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 Act of
1933, as amended (the "Securities Act"). At September 30, 2000 and at December
31, 1999, CII had an aggregate of $141.8 million and $127.1 million of investor
notes outstanding, respectively, and an aggregate of $19.1 million and $17.7
million, respectively, of subordinated debentures. The investor notes and
subordinated debentures are subordinate in priority to the credit facility.
Substantially all of the CII notes and debentures have original maturities of
one or two years.
Total shareholders' equity at September 30, 2000 was $2.6 million,
compared to $7.8 million at December 31, 1999. This decrease is attributable to
the net loss of $16.4 million for the nine months ended September 30, 2000 and
the classification in shareholders' equity of a $5.8 million note receivable
from a shareholder, arising from the merger. This decrease is partially offset
by an increase in preferred stock and paid-in capital in excess of par value,
also arising from the merger.
In connection with the merger with HomeSense, which was effective May
9, 2000, the Company issued 6,780,944 shares of its common stock in addition to
10 million shares of Series A Non-convertible Preferred Stock (par value $1 per
share), which increased the Company's shareholders' equity by approximately
$17.1 million.
The Company's primary objective in 2000 is to ensure adequate levels of
liquidity as the Company increases loan originations. The Company plans to
continue to generate cash through whole loan sales. These sales will generate
cash that can be used to fund operating losses, or to fund declines in investor
notes that could occur. The Company plans to operate more like a mortgage banker
that originates and either sells or securitizes loans, retaining only a small
portfolio of loans. Management believes that, based on its present level of
liquidity combined with its borrowing availability under the warehouse lines of
credit, additional sources of operating capital will be needed to support the
2000 operating plan. The Company continually evaluates the need to establish
other sources of capital, and will pursue those it considers appropriate based
upon its need and market conditions.
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Loan Sales and Securitizations
The Company sells or securitizes substantially all of its loans. The
Company sells its production on a whole loan basis (servicing released),
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 mortgage loans. However, no assurance can be given that the mortgage loans
can be sold. To the extent that the loans are not sold, the Company retains the
risk of loss. For the nine months ended September 30, 2000 and 1999, the Company
sold $375.0 million and $163.3 million of mortgage loans, respectively.
Securitization transactions were completed in the nine months ended
September 30, 2000 and 1999 totaling $64.5 million and $59.6 million
respectively. In connection with its securitizations, the Company has retained
interest-only residual certificates representing residual interests in the
trusts created by the securitization transactions. These subordinate residual
securities totaled $61.5 million and $47.8 million, net of allowances, at
September 30, 2000 and December 31, 1999, respectively.
In a mortgage loan securitization, 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 estimated prepayment and
loss rates, and capitalizes these amounts using a discount rate that market
participants would use for similar financial instruments. These capitalized
assets are recorded as residual receivables. The Company believes the
assumptions it has used in past securitizations, adjusted to current market
conditions, are appropriate and reasonable.
The Company generally retains the right to service the loans it
securitizes. However, the Company released servicing rights for the two
securitization transactions completed during 2000. 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.
The Company generally 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. 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.
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Accounting Considerations
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative
Instruments and Hedging Activities" which is effective for all fiscal quarters
of fiscal years beginning after June 15, 2000, as amended by SFAS 137. This SFAS
statement establishes accounting and reporting standards for derivative
instruments and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. Since the Company has no
significant hedging positions outstanding, management estimates that the
implementation of this standard will have no material impact on its financial
statements.
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.
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%.
The Company's net deferred tax asset of $22.0 million at September 30,
2000 reflects a gross deferred tax asset of $32.7 million with a related
valuation allowance of $10.7 million. The amount of the net 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 asset would be realized.
Should the Company deem that the realization of the benefit of the deferred tax
asset is unlikely, the asset would then be adjusted to its estimated net
realizable value. The Company had a federal NOL of approximately $87.7 million
at September 30, 2000. Approximately $90.5 million does not begin to expire
until 2006 and beyond.
The current tax expense results from "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 from operations. However, according to IRS
regulations, a portion of that income is subject to federal tax in the current
period regardless of other 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 extraordinary gain on the extinguishment of
debt (discussed below) 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.
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, 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. While no hedging strategy is
currently being utilized, the Company's interest rate hedging strategy may
include 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. There were no significant
open hedging positions at either September 30, 2000 or December 31, 1999.
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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 that 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.
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ITEM 3. 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 limits. To estimate the impact that changes in interest rates would
have on the Company's earnings, management uses simulation analysis.
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's strategy for 2000 is to sell its loans within one month
of production. 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 as of
September 30, 2000.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On February 26, 1999, the Company received notification
from Transamerica Small Business Capital, Inc.
("Transamerica") claiming that a loan in the original
principal amount of $1.1 million sold by the Company to
Transamerica pursuant to an asset purchase agreement dated
October 2, 1998 was not made by the Company's subsidiary
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 funds held in escrow in connection with the
transaction with Transamerica. On June 5, 2000
Transamerica allowed the release from escrow to the
Company of $450,000, and the balance of the escrow
account, reflected on the balance sheet as restricted
cash, is $5,068,723 as of September 30, 2000. On June 21,
2000, Transamerica amended its complaint to add another
loan, claiming damage of "not less than $200,000," and
allegations concerning servicing fee income claiming
damage of "not less than $116,000." The Company intends to
defend itself vigorously.
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. That
suit has been transferred to North Carolina Business
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"). On
February 22, 2000, Michael and Kimberly Chasten filed a
similar action in Duplin County, North Carolina Superior
Court. That suit has been removed to the United States
District Court for the Southern District of North
Carolina. On March 21, 2000, Rosa and Royal Utley filled a
similar suit in New Hanover County, North Carolina
Superior Court. On April 13, 2000 Reginald Troy filed a
similar action in New Hanover County, North Carolina
Superior Court. That suit has been removed to the United
States District Court for the Southern District of North
Carolina. The plaintiffs in all of these cases are seeking
unspecified monetary damages. As to the Company's
subsidiary, the complaints in these four cases allege
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 in any of the cases, and
the Company intends to contest each case vigorously.
On April 4, 2000, the Company received notice of a suit
filed against it by Danka Funding Company, LLC ("Danka")
in New Jersey Superior Court. In the suit, Danka seeks
recovery of $355,865.80 allegedly due under copier
equipment leases. It is not possible to evaluate the
likelihood of an unfavorable outcome at this early stage.
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 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
No event of default has occurred for which the Company has
not obtained a waiver or forbearance.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
Pursuant to the HomeSense merger agreement, various
representations, warranties and covenants were made by the
parties to the merger. Allegations have been made to the
effect that each of the parties to the merger has failed
in some respects to fully comply with its obligations
under the merger agreement. The Board of Directors is
investigating each of these
On September 29, 2000 Larry D. Gosnell was appointed Chief
Financial Officer of the Company and on November 14, 2000
Mr. Gosnell resigned from this position.
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allegations and will attempt to resolve such allegations
in a manner which is fair to the parties and in the best
interests of all of the shareholders of HomeGold.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
10.12 First Amendment to Credit Agreement,
Household Commercial Financial
Services, Inc., dated May 30, 2000.
10.13 Second Amendment to Credit Agreement,
Household Commercial Financial
Services, Inc., dated September 20,
2000.
10.14 Third Amendment to Credit Agreement
and Forbearance Agreement, Household
Commercial Financial Services, Inc.,
dated October 25, 2000.
27.1 Financial Data Schedule.
b) Reports on Form 8-K
The Company filed a report on Form 8-K dated July 13,
2000 to disclose the departure of the Company's Chief
Financial Officer and the appointment of the interim
Chief Financial Officer.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
<TABLE>
<CAPTION>
<S> <C>
HOMEGOLD FINANCIAL, INC.
Date: November 14, 2000
By: \s\ Ronald J. Sheppard
-------------------------------------------
Ronald J. Sheppard.
Chief Executive Officer
Date: November 14, 2000
By: \s\ William E. Long
-------------------------------------------
William E. Long
Executive Vice President
</TABLE>
33
