<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] Quarterly report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the quarterly period ended March 31, 1998.
[_] Transition report under Section 13 or 15(d) of the Exchange Act
For the transition period from ___________ to __________.
Commission File Number: 0-9774
HOMECAPITAL INVESTMENT CORPORATION
(Exact Name of Small Business Issuer as Specified in its Charter)
NEVADA 95-3614463
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
6836 AUSTIN CENTER BLVD.
SUITE 280
AUSTIN, TEXAS 78731
(Address of Principal Executive Offices)
(512) 427-5200
(Issuer's Telephone Number, Including Area Code)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [_]
As of April 30, 1998, there were 8,295,525 shares of common stock of the
issuer outstanding.
Transitional Small Business Disclosure Format (check one): Yes [_] No [X]
The Exhibit Index appears on page 30.
<PAGE>
HOMECAPITAL INVESTMENT CORPORATION
Index to Form 10-QSB
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements
Consolidated Balance Sheet
As of March 31, 1998 (Unaudited) 3
Consolidated Statements of Operations
For the Six Months Ended March 31, 1998
and 1997 (Unaudited) 4
Consolidated Statements of Operations
For the Three Months Ended March 31, 1998
and 1997 (Unaudited) 5
Consolidated Statements of Cash Flows
For the Six Months Ended March 31, 1998
and 1997 (Unaudited) 6
Notes to Financial Statements 7
Item 2. Management's Discussion and Analysis or
Plan of Operation. 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Changes in Securities and Use of Proceeds 28
Item 3. Defaults Upon Senior Securities 28
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 6. Exhibits and Reports on Form 8-K. 30
SIGNATURES 31
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<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
March 31, 1998
(Unaudited)
ASSETS
Cash $ 4,202
Cash deposits, restricted 1,429,010
Loans held for sale, net 14,794,245
Interest-only strip receivables 10,066,775
Retained interest in securitized assets 1,358,544
Income taxes refundable 1,241,295
Prepaid expenses and other assets 1,182,292
Furniture, fixtures and equipment, net 1,572,978
------------
Total assets $ 31,649,341
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Bank overdraft $ 1,318,008
Note payable 8,345
Revolving lines of credit 25,694,461
Capital lease obligations 217,283
Accrued expenses and other liabilities 6,305,471
Allowance for credit losses on loans sold 1,969,315
Deferred tax liabilities 1,237,173
------------
Total liabilities 36,750,056
------------
Commitments and contingencies
Stockholders' deficit:
Preferred stock, $.01 par value; 10,000,000 shares
authorized; 1,431,335 shares of cumulative convertible
Series A stock issued and outstanding(liquidation value
of $2,147,003) 14,313
Common stock, $.01 par value; 100,000,000 shares
authorized; 8,295,525 shares issued and
outstanding 82,955
Additional paid-in capital 6,296,399
Accumulated deficit (11,438,882)
Notes receivable for stock issued (55,500)
------------
Total stockholders' deficit (5,100,715)
------------
Total liabilities and stockholders' deficit $ 31,649,341
============
The accompanying notes are an integral part of the consolidated financial
statements.
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<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Six Months Ended March 31, 1998 and 1997
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
------------ ------------
Revenues:
<S> <C> <C>
Gain on sale of loans and mortgage-backed securities $ 7,623,246 $ 8,618,767
Net unrealized gain (loss) on valuation of investment
securities (1,224,794) 427,975
Interest - loans 1,750,710 694,416
Interest - investments 1,652,799 539,959
Loan servicing income - 422,482
Other income 313,060 98,714
------------ ------------
Total revenues 10,115,021 10,802,313
------------ ------------
Costs and Expenses:
Salaries and employee benefits 5,675,268 1,872,781
Servicing costs 878,486 179,909
Loan costs 1,680,227 808,550
General and administrative 5,258,280 1,313,174
Occupancy 480,865 258,483
Interest 1,997,851 532,049
Nonrecurring charge--write off on interest-
only strip receivable 13,857,307 -
------------ ------------
Total costs and expenses 29,828,284 4,964,945
------------ ------------
Income (loss) before income taxes (19,713,263) 5,837,368
Provision (benefit) for income taxes (2,308,909) 2,048,512
------------ ------------
Net income (loss) $(17,404,354) $ 3,788,856
============ ============
Income (loss) per common share:
Basic:
Earnings (loss) per common share $ (2.12) $ .46
============ ============
Weighted average number of common shares
outstanding 8,257,973 7,899,547
============ ============
Diluted:
Earnings (loss) per common share $ (2.12) $ .38
============ ============
Weighted average number of common shares
outstanding 8,257,973 9,989,979
============ ============
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
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<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended March 31, 1998 and 1997
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
------------ ------------
Revenues:
<S> <C> <C>
Gain on sale of loans and mortgage-backed securities $ 2,661,633 $ 3,831,648
Net unrealized gain (loss) on valuation of investment
securities (3,707,095) 427,975
Interest - loans 880,276 329,973
Interest - investments 735,245 538,723
Other income 147,243 61,643
------------ ------------
Total revenues 717,302 5,189,962
------------ ------------
Costs and Expenses:
Salaries and employee benefits 2,530,377 1,092,831
Servicing costs 462,218 -
Loan costs 786,650 467,723
General and administrative 3,712,677 815,549
Occupancy 284,277 147,158
Interest 904,659 288,573
Nonrecurring charge--write off on interest-
only strip receivable 13,857,307 -
------------ ------------
Total costs and expenses 22,538,165 2,811,834
------------ ------------
Income (loss) before income taxes (21,820,863) 2,378,128
Provision (benefit) for income taxes (3,109,797) 833,435
------------ ------------
Net (loss) income $(18,711,066) $ 1,544,693
============ ============
Income (loss) per common share:
Basic:
Earnings (loss) per common share $ (2.27) $ .18
============ ============
Weighted average number of common shares
outstanding 8,279,133 8,168,254
============ ============
Diluted:
Earnings (loss) per common share $ (2.27) $ .15
============ ============
Weighted average number of common shares
outstanding 8,279,133 10,310,027
============ ============
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
-5-
<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended March 31, 1998 and 1997
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
------------ ------------
Cash flows from operating activities:
<S> <C> <C>
Net income (loss) $(17,404,354) $ 3,788,856
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 294,022 348,484
Deferred tax (benefit) provision (1,067,614) (71,285)
Provision for credit losses 1,050,000 342,805
Issuance of warrants and options 162,690 -
Gain on sales of loans and mortgage-backed securities (7,623,246) (8,618,767)
Unrealized loss (gain) from valuation of trading
account securities 1,224,794 (427,975)
Loss on impairment of interest-only strip receivables 12,076,207 -
Proceeds from sales of loans and mortgage-backed securities 118,131,255 75,397,612
Purchase and origination of loans (96,120,707) (75,476,991)
Change in operating assets and liabilities:
Decrease in cash deposits, restricted 194,772 110,682
Decrease (increase) in accrued interest receivable 220,848 (53,256)
Decrease (increase) in prepaid and other assets 925,444 (624,333)
Increase in accrued expenses and other liabilities 1,221,583 1,090,891
------------ ------------
Net cash provided by (used in) operating activities 13,285,694 (4,193,277)
------------ ------------
Cash flows from investing activities:
Purchase of furniture, fixtures and equipment (447,617) (392,185)
Payments received on interest-only strip receivables 2,750,994 -
------------ ------------
Net cash provided by (used in) investing activities 2,303,377 (392,185)
------------ ------------
Cash flows from financing activities:
Increase (decrease) in revolving lines of credit (8,698,122) 3,926,408
Decrease in payable under securities loan agreements (7,673,000) -
Payments on note payable (41,655) (49,998)
Proceeds from exercise of Series A warrants - 1,911,919
Proceeds from exercise of other warrants - 92,700
Bank overdraft 774,486 -
Additions (payments) on capital lease obligations 176,830 (6,714)
Preferred stock dividends (127,610) (134,629)
------------ ------------
Net cash provided by (used in) financing activities (15,589,071) 5,379,686
------------ ------------
Increase in cash - 1,154,224
Cash, beginning of period 4,202 343,484
------------ ------------
Cash, end of period $ 4,202 $ 1,479,708
============ ============
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
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<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS
THE COMPANY AND SUBSIDIARY
The consolidated financial statements include the accounts of HomeCapital
Investment Corporation, a public holding company, ("HomeCapital"),
incorporated in the state of Nevada on October 8, 1980, and its wholly-
owned subsidiary, HomeOwners Mortgage & Equity, Inc. ("Home", collectively,
the "Company").
DESCRIPTION OF OPERATIONS
The Company, through wholesale and retail sources, originates and purchases
home improvement loans, and other second lien mortgage loans ("Loans") and
disposes of such Loans through direct sale, securitization or conversion to
Mortgage-backed securities. The Company is an approved lender under the
Department of Housing and Urban Development ("HUD") Federal Housing
Administration ("FHA") Title I Program, which provides FHA insurance
against losses on eligible property improvement and manufactured housing
loans ("Title I Loans"). As a FHA approved lender, the Company is subject
to regulation and examination by HUD. Under the program, the FHA insures
90% of the principal balance of each Title I Loan and certain interest
costs, subject to the amount of insurance available in the Company's
reserve account maintained by the FHA. The Company also holds approval
from HUD under the FHA Title II Program; however the Company had not
originated any Loans pursuant to that Program as of March 31, 1998.
NONRECURRING EVENTS
On March 24, 1998, the Company was notified by officials of the Federal
National Mortgage Association ("Fannie Mae") that Fannie Mae was
terminating the Mortgage Selling and Servicing Contract for FHA Title I
Loans with Home. Additionally, Fannie Mae also terminated its short-term
warehouse facilities and its securities repurchase facilities with Home
related to financing of Title I Loans and Mortgage-backed securities and
demanded the repurchase by Home of certain loans, including multifamily
loans previously sold to Fannie Mae that Fannie Mae now considers to be
ineligible under the contract. As part of the contract termination, the
right to service the portfolio of Title I Loans and Mortgage-backed
securities and receive the excess interest flow from these assets serviced
was terminated by Fannie Mae, and Fannie Mae assumed control over the
servicing and the related cash flow.
The carrying value of this asset, which is included in the balance sheet
caption, Interest-only strip receivable, had a balance of approximately
$12,356,000 at February 28, 1998, the month-end immediately preceding the
date of termination by Fannie Mae. At March 31, 1998, the Company has
determined that the asset has been permanently impaired and has charged the
write-off of the asset against operations for the three and six month
periods ended March 31, 1998. See Note 5.
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<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS, CONTINUED
The Company began selling substantially all of its Title I Loan production
to Fannie Mae in June 1996, and, thereafter, substantially all of the Title
I Loan production of Home was sold to Fannie Mae on a whole loan basis or
swapped with Fannie Mae for Mortgage-backed securities, and the whole loans
and Mortgage-backed securities were financed by Fannie Mae. The actions
taken by Fannie Mae have had a materially adverse effect upon the Company,
including the substantial suspension of business, the write-off of a
material portion of Interest-only strip receivables in the amount of
$13,857,307, and default by Home under the various financing agreements
with lending institutions.
As a result, the going concern value of Home and the Company has been
materially impaired, and it is highly unlikely that the Company will be
able to continue operations. On May 4, 1998, Home filed a voluntary
petition for relief under Chapter 11 of the United States Bankruptcy Code.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ADJUSTMENTS TO INTERIM FINANCIAL STATEMENTS
The interim financial statements of the Company at March 31, 1998 and for
the three and six month periods ended March 31, 1998 and 1997, reflect all
adjustments (consisting of normal recurring adjustments and adjustments for
the events described in Note 1), which, in the opinion of management, are
necessary to present fairly the results of operations and financial
position. The results of operations of any interim period are not
necessarily indicative of the results of operations for a full year.
CREDIT CONCENTRATIONS
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash, Loans held for
sale, Mortgage-backed securities, Retained interest, and Interest-only
strip receivables. Concentration of credit risk and mitigating factors
regarding Loans, Mortgage-backed securities, Retained interest, and
Interest-only strip receivables are described in the Notes to the Financial
Statements included in the annual report of the Company on Form 10-KSB for
the year ended September 30, 1997.
The Company places its cash in various major financial institutions thereby
limiting the exposure of the Company's cash to concentrations of credit
risk. See Note 11.
The Company is party to financial instruments with off-balance sheet credit
risk in the normal course of business. These financial instruments include
commitments to extend credit to borrowers and commitments to purchase loans
from others. As of March 31, 1998, the Company had outstanding commitments
to extend credit or purchase loans in the amounts of approximately
$25,700,000, exclusive of the repurchase obligations claimed by Fannie Mae
as described in Note 1. As a result of actions
-8-
<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
taken by Fannie Mae as more fully described in Note 1, the Company will not
be able to fulfill its commitments to fund outstanding loan commitments.
Credit concentrations of the Company's loans serviced which give rise to
Interest-only strip receivables are discussed in Note 11. See Note 1 for a
description of the effect of the Fannie Mae contract termination on
Interest-only strip receivables.
EARNINGS PER SHARE
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share." SFAS
No. 128 specifies the computation, presentation, and disclosure
requirements for earnings per share. SFAS No. 128 is effective for periods
ending after December 15, 1997, thus the Company adopted SFAS No. 128 at
December 31, 1997. Previously reported earnings per share have been
restated to conform to SFAS No. 128.
The computation of basic earnings per share is based on the weighted
average number of common shares outstanding during the period. Net
earnings used in the computation of basic earnings per share are reduced by
preferred stock dividend requirements. Diluted earnings per share assumes
conversion of the Company's 1,431,335 outstanding shares of Preferred
Stock, Series A, and the exercise of outstanding stock options and stock
warrants, except when the effect is antidilutive.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
RISKS AND UNCERTAINTIES
The Company's Interest-only strip receivables are based upon estimates of
future cash flows, which consider assumptions as to rates of prepayment and
defaults of Title I Loans. There is a reasonable possibility that changes
in the value of the Interest-only strip receivables could occur in the
short-term and that the changes could be material to the Company's
financial statements. See Note 1 for a description of the effect of the
Fannie Mae contract termination on Interest-only strip receivables.
-9-
<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
3. LOANS HELD FOR SALE
Loans held for sale consisted of the following at March 31, 1988:
Title I Loans $ 12,771,375
Conventional loans 1,883,306
Other 7,235
Capitalized loan origination fees and
costs, net 382,329
------------
15,044,245
Allowance for credit losses (250,000)
------------
Total $ 14,794,245
============
As of March 31, 1998, substantially all of the Title I Loans held for sale
were financed under warehouse loan facilities with the Company's financial
institutional lender or with Fannie Mae. Immediately prior to the March
24, 1998, contract termination by Fannie Mae, the Title I Loans had an
estimated fair value of 105 to 107 of par value. As a result of the
actions taken by Fannie Mae and the corresponding adverse effect on the
investor marketplace, the fair value of the Title I Loans has been
impaired. It is uncertain whether the Company will realize the carrying
value of Loans subsequent to March 31, 1998.
4. ALLOWANCE FOR CREDIT LOSSES
Combined changes in the allowance for credit losses for Loans held for sale
and Loans sold consisted of the following for the three months ended March
31, 1998:
Balance at beginning of period $ 1,769,315
Provisions for credit losses 450,000
------------
Balance at end of period $ 2,219,315
============
Components of the allowance at March 31:
Allowance for credit losses on Loans held for sale $ 250,000
Allowance for credit losses on Loans sold 1,969,315
------------
$ 2,219,315
============
As more fully described in Note 1, Fannie Mae has requested that Home
repurchase an unspecified amount of Title I Loans. Since the repurchase
request is unspecified and the Company is unable to estimate the amount of
repurchase obligation, if any, no amount has been provided in the
accompanying statements of operations for the three or six months ended
March 31, 1998.
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<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
4. ALLOWANCE FOR CREDIT LOSSES, CONTINUED
The allowance for credit losses may not be adequate based upon the events
surrounding the Fannie Mae contract termination and the lack of senior
management personnel. See Note 12.
5. INTEREST-ONLY STRIP RECEIVABLE
The activity in Interest-only strip receivables is summarized as follows
for the three month period ended March 31, 1998:
Balance, January 1, 1998 $ 27,405,521
Additions -
Payment received, net of amortization (1,649,832)
Unrealized losses on trading securities (3,707,095)
Write-down for impairment (11,981,819)
------------
Balance, March 31, 1998 $ 10,066,775
============
The components of Interest-only strip receivables at March 31, 1998, are
classified as follows:
Available for sale securities $ 237,340
Trading securities 9,829,435
------------
Total $ 10,066,775
============
Net loss for the three month period ended March 31, 1998 includes a pre-tax
charge of $11,981,819 relating to an impairment loss on Interest-only strip
receivables. In addition to the impairment loss, the valuation allowance
for securities available for sale was reversed, and a loss of $1,875,488
was also charged to operations for the three months ended March 31, 1998.
In total, the impairment loss was $13,857,307. The impairment loss on
Interest-only strip receivables resulted from the termination by Fannie Mae
of its contract with Home. Interest-only strip receivables classified as
trading securities were reevaluated as of March 31, 1998, in connection
with the Fannie Mae contract termination and in connection with the effect
upon the Company of its inability to continue operations in the normal
course of business. As a result, the fair value of these assets was
reduced by $3,707,095, with the amount included in the caption Net
unrealized loss on valuation of investment securities, in the Consolidated
Statements of Operations.
The serviced Loan portfolio, which includes Loans sold to investors on a
servicing retained basis and Loans retained by the Company, aggregated
approximately $61,131,000 at March 31, 1998. The aggregate amount of
serviced loan portfolio is exclusive of approximately $218,300,000 in loans
serviced for Fannie Mae prior to March 24, 1998. The serviced Loan
portfolio at March 31, 1998, represents only loans held for sale by the
Company and loans sold to another investor prior to June 1996.
-11-
<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
6. REVOLVING LINES OF CREDIT
The Company finances certain of its Loans held for sale through a
$20,000,000 revolving line of credit agreement, which matures June 30,
1998, and had an outstanding balance of $4,748,619 at March 31, 1998. The
Company receives funding for approximately 98% of the principal on each
Loan it originates or purchases through the warehouse line. The
outstanding principal is collateralized by the original notes and mortgages
and repaid upon their sale. Interest accrues at 300 basis points over the
federal funds rate (5.59% at March 31, 1998) and is due monthly. The
agreement stipulates that the bank will hold the original notes and
mortgages for all loans funded under the line as collateral. Upon sale of
the loans, the purchaser funds the bank directly and the collateral is
released.
The Company also has a working capital line of credit (servicing
collateralized), which matures June 30, 1998, and had an outstanding
balance of $15,020,468 at March 31,1998. The agreement requires interest
only payments monthly. At March 31, 1998, the interest rates on the two
components of the working capital line ranged from 9.44% (30 day LIBOR plus
375 basis points) to 10.19% (30 day LIBOR plus 450 basis points). The
weighted average interest rate for this facility at March 31, 1998, was
9.74%.
Under terms of the working capital line of credit, the bank determines at
its sole discretion the collateral value as of the end of each fiscal
quarter using information provided by an outside consulting firm. As of
December 31, 1997, the lender determined, based upon such information, that
a principal repayment of approximately $940,000 was required under terms of
its credit agreement. The lender agreed to be repaid an initial payment of
$300,000, which was made on February 12, 1998, and the balance was due on
or before March 31, 1998. The balance of the required principal repayment
of $640,000 due on March 31, 1998, was not made. Furthermore, the outside
consulting firm did not prepare a determination of collateral value for the
lender as of March 31, 1998. However, the Company, using methodology
similar to that of the outside consulting firm, prepared an estimate of the
value of the collateral, which was determined to be $11,187,979. The
estimated collateral value excludes any amount previously assigned to the
Interest-only strip receivable, classified as available for sale
securities, relating to the Fannie Mae loan serviced portfolio. By
terminating the Mortgage Selling and Servicing Contract and assuming
control over the servicing portfolio, Fannie Mae effectively eliminated a
material portion of the collateral of the lender. See Note 5.
In connection with both borrowings, the Company has agreed to certain
covenants, including without limitation, tangible net worth, adjusted
tangible net worth, leverage ratios, and liquidity. The Company is
permitted to pay dividends as long as the financial ratios are maintained.
As of March 31, 1998, the Company was in violation of substantially all
financial covenants. Furthermore, the Company was in default under both
borrowings at March 31, 1998. As a result of the default, no additional
advances are available under either facility, and the amounts outstanding
under the credit facilities are due and payable.
-12-
<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
6. REVOLVING LINES OF CREDIT, CONTINUED
As part of the arrangement to exchange Title I Loans for Fannie Mae
Mortgage-backed securities, Fannie Mae had provided short-term warehouse
funding to Home, on an uncommitted basis, for its Title I Loans and
Mortgage-backed securities exchanged for such Loans. Generally, the
funding facilities require repayment with a cost of funds based on 30 day
LIBOR rate, plus 30 basis points to 90 basis points, depending upon whether
the funding is provided for Title I Loans or Mortgage-backed securities.
All financing arrangements with Fannie Mae have been terminated as of March
24, 1998. Amounts outstanding at March 31, 1998, are due and payable.
The composition of the revolving lines of credit was as follows at March
31, 1998:
Payable to financial institution, warehouse line $ 4,748,619
Payable to Fannie Mae, funding facilities 5,925,374
Payable to financial institution, working capital line 15,020,468
------------
$ 25,694,461
============
7. PREFERRED STOCK
On June 18, 1996, the Company issued 1,500,000 shares of Preferred Stock,
Series A, par value $.01 per share ("Series A Preferred Stock), for the
purchase price of $1.50 per share or an aggregate of $2,250,000. Cash
dividends on the Series A Preferred Stock have been paid only on the first
full four quarters following the issuance of the Series A Preferred Stock.
At March 31, 1998, dividends in the amount of $201,877 are in arrears and
payable.
During the three month period ended March 31, 1988, 26,998 shares of Series
A Preferred Stock were converted to Common Stock.
8. INCOME TAXES
The provision (benefit) for income taxes for the three months ended March
31, 1998 and 1997 is comprised of the following:
1998 1997
------------ ----------
Current:
Federal $ (1,180,000) $ 763,546
State (180,480) 31,087
------------ ----------
(1,360,480) 794,633
Deferred (benefit) provision (1,749,317) 38,802
------------ ----------
Provision (benefit) for income taxes $ (3,109,797) $ 833,435
============ ==========
-13-
<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
8. INCOME TAXES, CONTINUED
The components of deferred tax assets and liabilities were as follows at
March 31:
<TABLE>
<CAPTION> 1998
---------------
<S> <C>
Deferred tax liabilities:
Unrealized gains $ (2,216,163)
Depreciation and amortization (55,283)
---------------
Total deferred tax liabilities (2,271,446)
---------------
Deferred tax assets:
Net operating loss carryforward 5,017,524
Allowance for credit losses 754,054
Deferred compensation 206,989
Unrealized gains -
---------------
Total deferred tax assets 5,978,567
Valuation allowance (4,944,294)
---------------
1,034,273
---------------
Net deferred tax assets (liabilities) $ (1,237,173)
===============
The reconciliation between the income tax provision (benefit) and the income tax expense using the federal statutory rate is as
follows for the three month periods ended March 31:
1998 1997
------------- ---------
Federal tax (benefit) at statutory rate of 34% $ (7,419,093) $ 808,564
State income tax refund, net of federal tax expense (119,117) 21,591
Expenses not deductible for tax purposes 6,692 3,280
Effect of net operating loss carryforward 4,421,721 -
------------- ---------
Total income tax provision (benefit) $ (3,109,797) $ 833,435
============= =========
9. GAIN ON SALE OF LOANS
Gain on sale of Loans and the related cost is as follows for the three
month periods ended March 31:
1998 1997
------------ ------------
Gain on sale of Loans and Mortgage-backed securities:
Cash $ 2,583,487 $ 1,456,121
Interest-only strip gain - 3,864,442
------------ ------------
2,583,487 5,320,563
Premiums, net (1,575,490) (1,488,915)
Origination fees 1,662,331 -
Transaction costs (8,695) -
------------ ------------
Gain on sale of Loans and Mortgage-backed securities $ 2,661,633 $ 3,831,648
============ ============
</TABLE>
-14-
<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
9. GAIN ON SALE OF LOANS, CONTINUED
During the three month period ended March 31, 1998, the Company sold $32.4
million of Fannie Mae Mortgage-backed securities with an average interest
rate of approximately 12.17% for total sales proceeds of approximately
$36.2 million.
10. STOCK OPTIONS
HomeCapital issued options to an employee in June 1993 to purchase 409,668
shares of Common Stock at $0.16 per share. The options, which are fully
exercisable as of March 31, 1998, expire in the year 2001. None of these
options have been exercised.
Effective March 21, 1996, the Board of Directors of HomeCapital adopted the
HomeCapital Investment Corporation 1996 Stock Option Plan, which was
ratified by stockholder vote on August 16, 1996. The 1996 Stock Option
Plan was amended in September 1997, to increase the number of shares
reserved for issuance under the Plan. The Stock Option Plan provides that
up to 1,000,000 shares of common stock may be issued upon exercise of
options granted under the Stock Option Plan, subject to adjustment to
reflect stock splits, stock dividends, mergers and similar transactions.
At March 31, 1998, options to purchase an aggregate of 879,500 shares of
common stock had been granted and are outstanding under the Stock Option
Plan, including options to purchase an aggregate of 404,500 shares of
common stock that were granted in October, 1997. Exercise prices per share
range from $3.50 to $11.00. No options have been exercised.
Under the 1996 Stock Option Plan, the Company may grant incentive and non-
qualified options to eligible participants that vest in accordance with a
vesting schedule, as determined in the sole discretion of the Compensation
Committee of the Company's Board of Directors. Options granted pursuant to
the 1996 Stock Option Plan are for a term of 10 years. All of the options
have an exercise price equal to or greater than the fair market value of
the common stock at grant date. The options granted vest ratably over a
period of three to five years beginning on the first anniversary of the
date of grant.
In addition to the employee stock options described above, HomeCapital
granted 250,000 stock options in fiscal 1997 to nonemployees rendering
financial advisory services to the Company. The options vested upon
issuance, have a five-year term, an exercise price of $8.125, and are
outstanding as of March 31, 1998. The fair value of the stock options of
$655,000 was determined under the Black-Scholes option-pricing model and
will be amortized into expense in equal monthly installments over a two-
year period. During the three month period ended March 31, 1998, a total
of $81,345 was charged to operations.
HomeCapital established the Non-Employee Director Compensation Plan
("Director Plan"). The Director Plan provides cash compensation and
options to purchase common stock of HomeCapital for persons who serve as
members of the Board of Directors of
-15-
<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
10. STOCK OPTIONS, CONTINUED
either or both of HomeCapital and Home ("Directors") and who are not
otherwise employed by HomeCapital or Home ("Participants"). The Director
Plan provides for an annual retainer of $10,000 payable each year
immediately following the annual election of a participant as a Director,
or upon the initial election of the Participant as a Director, if not at an
annual meeting of stockholders. Participants will also receive a fee of
$1,000 and reimbursement for accountable expenses in connection with each
meeting of the board of directors attended.
The Director Plan also provides for the granting of non-qualified stock
options to each Participant. The Director Plan authorized the issuance of
options to purchase 15,000 shares of common stock of HomeCapital to each
Participant as of the date of election to the Board of Directors and an
annual award of options to purchase 3,000 shares of common stock
immediately following the election of each Participant as a Director on the
date of the annual meeting of stockholders.
Options granted under the Director Plan have an exercise price equal to the
fair market value of the common stock on the date that the options are
granted. The Director Plan contains provisions for adjustment of the
number of shares available for options and subject to unexercised options
under the Director Plan in the event of stock splits, dividends payable in
common stock, business combinations or certain other events. The Board of
Directors has initially reserved up to 250,000 shares of common stock for
issuance under the Director Plan.
Each option granted under the Director Plan is exercisable as to 20% of the
shares subject to the option each year for five (5) consecutive years
following the date of grant. Unexercised options shall expire ten (10)
years after the date of grant, and within 180 days after termination of
service as a Director, disability or death of the Participant.
At March 31, 1998, 120,000 options have been granted under this Plan with
an exercise price of $8.375.
11. CONCENTRATIONS
For the three month periods ended March 31,1998 and 1997, Title I Loan
origination and production (exclusive of paydowns and repurchases) are
summarized as follows:
1998 1997
--------------------- --------------------
Source of Loan Production Amount % Amount %
------------------------- ------------ ------ ------------ ------
Correspondent Loans $ 22,168,153 88.4% $ 31,801,408 89.3%
Dealer Loans 23,500 0.1 1,750,588 4.9
Direct Loans 2,877,195 11.5 2,069,664 5.8
------------ ----- ------------ -----
Total Title I Loans $ 25,068,848 100% $ 35,621,660 100%
============ ===== ============= =====
-16-
<PAGE>
HOMECAPITAL INVESTMENT CORPORATION AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
11. CONCENTRATIONS, CONTINUED
The Company also originates coventional home improvement and other second
mortgage Loans through arrangements with other lenders on a pre-approved
basis. Total conventional loans originated for the three months ended
March 31, 1998 and 1997 were $13,527,022 and $1,045,335, respectively. At
March 31, 1998 and 1997, $1,883,306 and $134,589, respectively, of
conventional loans were held for sale under firm purchase commitments.
Prior to October 1995, the Company sold all of its loans held for sale on a
servicing released basis. In October 1995, the Company commenced selling
the majority of its loan production to its then warehouse lender an on a
servicing retained basis. Subsequently, the Company was approved as a
Seller/Servicer with Fannie Mae to sell Title I Loans to Fannie Mae, and in
June 1996, began selling the majority of its Title I Loans to Fannie Mae on
a servicing retained basis. In March 1997, the Company began exchanging
the majority of its Title I Loans for Fannie Mae Mortgage-backed
securities.
12. SUBSEQUENT EVENTS
In April 1998, four senior executives of the Company either were terminated
or resigned their position, including the President of HomeCapital and
Home. The Board of Directors appointed a committee to oversee the
remaining operations of the Company. Additionally, substantially all of
the employees have been laid off and all branch offices have been closed.
On May 4, 1998, Home filed for reorganization under Chapter 11 of the
United States Bankruptcy Code. Home is seeking to develop a plan of
reorganization and protect its assets in the best interest of its creditors
and HomeCapital stockholders.
-17-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
HomeCapital Investment Corporation, a Nevada corporation (the
"Company" or "Registrant"), is a holding company, which conducts its business
entirely through a wholly-owned subsidiary, HomeOwners Mortgage & Equity, Inc.,
a Delaware corporation ("Home"). All references herein to the Company include
Home, unless the context otherwise requires.
Home is a specialized consumer finance company organized in 1993 to
originate, purchase, sell and service home improvement loans and other second
mortgage loans secured by residential property. Home primarily finances Title I
home improvement loans ("Title I Loans") and conventional consumer and home
equity loans that may fund a variety of borrower needs ("Conventional Loans").
Loans originated or purchased by Home are financed through warehouse credit
lines and then sold to the Federal National Mortgage Association ("Fannie Mae"),
secondary market mortgage investors and other financial institutions or
exchanged for Fannie Mae Mortgage-backed securities. Home originates and
purchases its loans through two primary sources: wholesale (i.e., "Correspondent
Loans") and retail (i.e., "Direct Loans"). Home purchases Correspondent Loans
through a national network of mortgage company loan correspondents
("Correspondents"). Home originates Direct Loans by direct mail solicitation of
individual homeowners, through referrals from home improvement contractors,
located principally in the Southwestern and Western regions of the United
States, and through special marketing arrangements with home improvement supply
and installation firms ("Corporate Alliances") to provide loans to customers of
these firms.
NONRECURRING EVENTS
On March 24, 1998, the Company was notified by officials of the
Federal National Mortgage Association ("Fannie Mae") that Fannie Mae was
terminating the Mortgage Selling and Servicing Contract for FHA Title I Loans
with Home. Additionally, Fannie Mae also terminated its short-term warehouse
facilities and its securities repurchase facilities with Home related to
financing of Title I Loans and Mortgage-backed securities and demanded the
repurchase by Home of certain loans, including multifamily loans previously sold
to Fannie Mae that Fannie Mae now considers to be ineligible under the contract.
As part of the contract termination, the right to service the portfolio of Title
I Loans and Mortgage-backed securities and receive the excess interest flow from
these assets serviced was terminated by Fannie Mae, and Fannie Mae assumed
control over the servicing and the related cash flow.
The carrying value of this asset, which is included in the Balance
Sheet caption Interest-only strip receivable, had a balance of approximately
$12,356,000, at February 28, 1998, the month-end immediately preceding the date
of termination by Fannie Mae. At March 31, 1998, the Company has determined
that the asset has been permanently impaired and has charged the write-off of
the asset against operations for the three and six month periods ended March 31,
1998.
The Company began selling substantially all of its Title I Loan
production to Fannie Mae in June 1996, and, thereafter, substantially all of the
Title I Loan production of Home was sold to Fannie Mae on a whole loan basis or
swapped with Fannie Mae for Mortgage-backed securities, and the whole loans and
Mortgage-backed securities were financed by Fannie Mae. The actions taken by
Fannie Mae have had a materially adverse effect upon the Company, including the
substantial suspension of business, the write-off of a material portion of
Interest-
-18-
<PAGE>
only strip receivables in the amount of $13,857,307, and default by Home under
the various financing agreements with lending institutions.
As a result, the going concern value of Home and the Company has been
materially impaired, and it is highly unlikely that the Company will be able to
continue operations. During April 1998, all senior executives of the Company
and substantially all of the employees have been laid off or resigned and all
branch offices have been closed. On May 4, 1998, Home filed a voluntary
petition for relief under Chapter 11 of the United States Bankruptcy Code.
RESULTS OF OPERATIONS
SIX MONTHS ENDED MARCH 31, 1998 ("1998 PERIOD"), COMPARED TO SIX MONTHS ENDED
MARCH 31, 1997 ("1997 PERIOD"):
The continuing operations and growth of the Company have been
suspended as a result of recent actions by Fannie Mae and the resulting
consequences described above and herein. The discussion which follows is
qualified in its entirety by these events, some of the effects of which have not
yet been determined.
The Company produced $98.8 million of loans during the 1998 period
compared to $75.5 million of loans during the 1997 period, an increase of 31%.
This change is primarily a result of an increase in the number of active
Correspondents and increases in the level of Direct Loan originations and
Conventional Loan originations in the Phoenix direct marketing office. Of the
$98.8 million of loans produced in the 1998 period, $65.9 million were Title I
Loans and $32.9 were Conventional Loans.
The following table sets forth certain data regarding loans originated
and purchased by the Company during the six month periods ended March 31, 1998
and 1997:
Six Month Period Ended March 31,
1998 1997
--------------------------------------------
Principal amount of loans:
Correspondents Title I $ 59,872,568 62% $ 63,547,512 84%
Dealers - Title I 32,500 - 4,394,927 6%
Direct Title I 5,863,290 6 6,030,052 8%
Conventional 30,352,349 32 1,522,864 2%
------------ ------ ------------ -----
Total $ 96,120,707 100% $ 75,495,355 100%
============ ====== ============ =====
Total revenues decreased 6.4% to $10.1 million for the 1998 period
from $10.8 million for the 1997 period. The increase was primarily the result
of the change in the manner in which the Company disposes of its loans and the
effect of the Fannie Mae contract termination. Included in revenues for the
1998 period is $3,707,095 representing the net unrealized gain on valuation of
investment securities.
The following table sets forth the gain on sale data for the 1998
period and the 1997 period:
-19-
<PAGE>
Six Month Period Ended March 31,
1998 1997
------------ -------------
Gain on sale of Loans and Mortgage-
backed securities:
Cash $ 3,242,917 $ 1,782,252
Interest-only strip gain 4,764,249 9,524,001
------------ -------------
Subtotal 8,007,166 11,306,253
Premiums, net (4,108,213) (2,782,069)
Origination fees 3,757,402 103,280
Transaction costs (33,109) (8,697)
------------ -------------
Gain on sale of Loans and Mortgage-
backed securities $ 7,623,246 $ 8,618,767
============ =============
Gain on sale of loans and Mortgage-backed securities decreased 11.6%
to $7.6 million during the 1998 period from $8.6 million during the 1997 period.
The decrease in gain on sale of loans and Mortgage-backed securities was
primarily attributable to the change in the disposition strategy for such loans.
During the 1998 period, the Company has primarily disposed of its Title I Loans
through either whole loan sales on a cash basis to Fannie Mae or the exchange or
swap of loans for Fannie Mae Mortgage-backed securities and the subsequent
securitization of those securities. In each case the Company has retained an
excess interest spread that exceeds the estimated cost of servicing the loans
and has recorded an Interest-only strip receivable attributable to this excess
interest spread. The estimated fair value from the creation of this asset is
recorded as a component of the total gain on sale in the Consolidated Statement
of Operations. During the 1998 period the Company originated $30,352,349 in
conventional second mortgage loans, which generated in excess of $3.9 million in
fee income. The conventional second mortgage loans are generally sold to
investors on a servicing released basis.
In May 1997, the Company began retaining the Fannie Mae Mortgage-
backed securities created from the exchange or swap of its Title I Loans. The
Company previously retained Mortgage-backed securities in anticipation of
resecuritizing through the issuance of asset backed securities. Following the
resecuritization of these Fannie Mae Mortgage-backed securities, the Company
would retain the residual interest and would have been entitled to the excess of
the cash flow from these Mortgage-backed securities over the payments on the
asset backed securities issued to prospective investors.
However, as a result of the termination of the Mortgage Selling and
Servicing Contract by Fannie Mae, the ability of the Company to originate and
sell Title I Loans has been adversely affected, and the Interest-only strip
receivable attributable to loans sold to Fannie Mae has been usurped. Fannie
Mae has declined to purchase any Title I Loans or to convert existing Title I
Loans into Mortgage-backed securities. The Company does not have any feasible
alternative disposition method for Title I Loans.
Interest income-loans increased 152% to $1,750,710 during the 1998
period from $694,416 during the 1997 period. The increase was primarily the
result of the increase in the amount of Mortgage-backed securities and loans
held for sale.
-20-
<PAGE>
As a result of the adoption of SFAS No. 125, amounts previously
reported as loan servicing income were reported as Interest-investments
beginning January 1, 1997. The investment interest income reflects the accrued
income associated with the Interest-only strip receivables and the interest
income associated with Mortgage-backed securities. Interest-investments
increased to $1,652,799 in the 1998 period primarily due to the increase in
Interest-only strip receivables and Mortgage-backed securities.
The provision for credit losses increased from $550,000 in the 1997
period to $1,050,000 in the 1998 period primarily in relation to the overall
increase in loan production during the 1998 period and the increase in loan
delinquency rates, first payment defaults during the 1998 period and the
estimated loss on loans held for sale at March 31, 1998. The provision for
credit losses is based upon periodic analysis of the portfolio, economic
conditions and trends, historical credit loss experience, the borrowers' ability
to repay, collateral values, and estimated FHA insurance recoveries on loans
originated and sold. Upon sale of loans by Home to investors, including the
exchange by Home of Title I Loans to Fannie Mae for Mortgage-backed securities,
the purchasing investor assumes all credit risk, except for first payment
default, fraud, a breach of customary loan representations and warranties and
certain other limited exceptions. If Home changes, or secondary market
conditions cause Home to change, its loan disposition strategy in a manner that
increases its credit risk, then the provision for credit losses as a percentage
of loans originated can be expected to increase. For example, future changes to
its loan disposition strategy that may subsequently increase Home's credit risk
could include the following possibilities: Home may elect or may be required to
retain the risk of loss on the uninsured portion of Title I Loans exchanged for
Fannie Mae Mortgage-backed securities; Home may securitize its loans other than
through the exchange of loans for Fannie Mae Mortgage-backed securities; or Home
may retain its loans in portfolio for a longer period prior to their
securitization.
As a result of the termination of the Mortgage Selling and Servicing
Contract by Fannie Mae on March 24, 1998, the Company's access to servicing
information for the Fannie Mae Title I Loan portfolio was suspended and no
delinquency information with respect to the Fannie Mae portfolio as of March 31,
1998, was provided to the Company. The most recent available delinquency
information was as of February 28, 1998. Therefore, the most recent information
presented below for the total Title I Loan serviced portfolio is as of February
28, 1998.
<TABLE>
<CAPTION>
1997 1998
---------------------------------- --------------------------
Delinquency Data: March 31 June 30 September 30 December 31 February 28
-------- ------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C>
Delinquencies in Serviced Loan
Portfolio (At period end):
31-60 days.......................... 2.89% 3.26% 5.52% 6.67% 5.51%
61-90 days.......................... 1.22 1.36 2.58 3.13 2.63
91 days and over.................... 1.71 2.00 4.67 8.14 8.86
----- ----- ------ ------ ------
Total 5.82% 6.62% 12.77% 17.94% 17.00%
===== ===== ====== ====== ======
Serviced Loan Portfolio at period
end (dollars in thousands) $158,259 $186,889 $234,748 $268,351 $280,298
</TABLE>
The above delinquency data excludes loans that were pending the
submission of claims for reimbursement under the FHA Title I program, which at
February 28, 1998 included 597 loans with a principal balance of $13,250,211.
The Company calculates its delinquency rates by dividing the amount of
delinquent loans included in the loan servicing portfolio by the aggregate
-21-
<PAGE>
outstanding principal of the loans in the servicing portfolio. The calculation
excludes the pending FHA claims from the numerator and denominator.
The Title I Loan portfolio serviced by the Company remaining at March
31, 1998, consists only of loans held for sale by the Company and loans
previously sold to an investor other than Fannie Mae.
At March 31, 1998, the delinquency experience of the Company's
remaining Title I Loan serviced portfolio is as follows:
Delinquency Data:
Delinquencies in Serviced Loan
Portfolio (At period end):
31-60 days........................... 4.45%
61-90 days........................... 2.20
91 days and over..................... 11.34
------
Total 17.99%
======
Serviced Loan Portfolio at period
end (dollars in thousands) $61,131
The above delinquency data excludes loans that were pending the
submission of claims for reimbursement under the FHA Title I program, which at
March 31, 1998, included 333 loans with a principal balance of $7,362,382. The
Company calculates its delinquency rates by dividing the amount of delinquent
loans included in the loan servicing portfolio by the aggregate outstanding
principal of the loans in the servicing portfolio. The calculation excludes the
pending claims from the numerator and denominator.
Since the initiation of Title I Loan servicing in October 1995, the
Company has subcontracted with non-affiliated companies to provide all servicing
related activities, such as payment collection and processing, investor
reporting, FHA claims filing administration, and workmanship complaint
monitoring.
During fiscal 1997 the Company experienced an increase in the
delinquencies of its serviced loan portfolio, while such loan portfolio was
increasing. In particular, there was a significant increase in the
delinquencies at the end of the fourth quarter of fiscal 1997 in comparison to
the third quarter of fiscal 1997. Accordingly, the Company considered various
options to improve the servicing of its loan portfolio, including the
delinquency performance, and decided to assume the FHA claims filing
administration and workmanship complaint monitoring activities in house. A
loan-servicing department of the Company was established for these activities.
In addition, the Company decided to engage a collection agency to separately
perform the delinquent collection services for all loans that are five days
or more delinquent, and during August 1997 the Company transferred these
collection services from its then existing subservicer to the collection agency.
Management believes that the complexity of transferring these collection
services from the then existing subservicer to the collection agency, including
the transfer of relevant computer data for borrowers, contributed to an increase
in delinquencies during the fourth quarter of fiscal 1997. In addition,
management believes that the separation of the normal payment collection and
processing functions from the delinquent collection functions also contributed
to an increase in delinquencies during the fourth quarter of fiscal 1997.
-22-
<PAGE>
During the three month period ended December 31, 1997, the Company
reevaluated the separation of the payment processing and delinquency collection
functions and concluded that a new subservicer should be located to perform both
these functions to improve the delinquency performance of the loan portfolio.
Effective December 1, 1997, the Company transferred a majority of its serviced
loan portfolio to a new subservicer to perform these loan-servicing functions.
The Company believes that the transitions related to the transfer of the
collection functions and the subsequent servicing transfer to a new subservicer
have contributed to the increasing delinquencies that have occurred during the
fourth quarter of fiscal 1997 and first quarter of fiscal 1998.
The Company entered into an incentive servicing fee arrangement with
Litton Loan Servicing, Inc. for collection and processing of loans serviced by
the Company. Litton has significant experience in collecting delinquent loans,
as well as a sophisticated and automated collection process, and earns
additional fees, if delinquencies in the Company's servicing portfolio are
reduced below specified levels. As a consequence of this arrangement, the
Company expected that an improvement in collection results should begin to occur
during the second quarter of fiscal 1998. Loan delinquencies continued to
increase during the first quarter of fiscal 1998, and a continued period of high
delinquencies was anticipated during the transition period in which the new
subservicer was implementing its collection procedures and practices with
respect to the Company's servicing portfolio.
As expected, the delinquency rate declined approximately 100 basis
points from December 31, 1997, to February 28, 1998, the most recent date
information was available to the Company. No comprehensive loan delinquency
information was available at March 31, 1998.
In connection with the termination of the Selling and Servicing
Contract by Fannie Mae, the right of Home to service loans previously sold to
Fannie Mae was terminated. However, Litton Loan Servicing, Inc., was retained
by Fannie Mae to continue servicing the Title I Loan portfolio. The Company no
longer exercises any control or supervision over the servicing function with
respect to such loans.
Because delinquencies and losses typically occur months or years after
a loan is originated, data relating to delinquencies and losses as a percentage
of the current portfolio can understate the risk of future delinquencies, losses
or defaults. There is no assurance that the delinquency, default and loss
experience with respect to any of the loans serviced will be comparable to the
experience reflected above for assets originated and serviced by Home. The rate
of delinquencies, defaults and losses with respect to the loans will also be
affected by, among other things, interest rate fluctuations and national and
regional economic conditions.
Salaries and employee benefits increased 203% to $5,675,268 for the
1998 period from $1,872,781 for the 1997 period, primarily as a result of an
increase in the pay rates of employees, the increase in hiring of professionals
required for growth, and the increase in commissioned sales personnel in the
Phoenix direct marketing office. Commissioned sales personnel costs accounted
for a significant share of the increase in salaries and employment benefits for
the 1998 period.
Servicing costs consists primarily of the costs related to servicing
the portfolio of Loans sold on a servicing retained basis. The servicing
function is performed by a non-affiliate of the Company at a negotiated fee.
Servicing costs increased 388% from $ 179,909 in the 1997
-23-
<PAGE>
period to $878,486 in the 1998 period. The increase was a result of increased
loans serviced from $158,200,000 at March 31, 1997 to 280,298,000 at February
28, 1998, a 77% increase.
Loan costs, consisting primarily of costs for credit reports, flood
reports, title reports, inspection fees, and the provision for credit losses,
increased 108% to $1,680,227 for the 1998 period from $808,550 for the 1997
period due primarily to the provision for credit losses of $1,050,000, as well
as the increase in loan production of $20.6 million from the 1997 period to
1998.
Total general and administrative expenses increased 300% to $5,258,280
for the 1998 period from $1,313,174 for the 1997 period. The increase was
primarily as a result of increases in legal and professional fees, postage and
courier costs, telecommunication costs, stationary and office supplies expenses,
travel costs, advertising expenses, and depreciation expense. The increase in
these costs was primarily attributable to the increased volume of loan
originations, loans serviced, the overall increase in the number of personnel,
and the effect of the Fannie contract termination.
Occupancy costs increased to $480,865 in the 1998 period from $258,483
in the 1997 period, or 86%, due primarily to the expansion of lease space at the
corporate offices, and the expansion of the office space related to the direct
mail solicitation operations.
Interest expense increased 276% to $1,997,851 for the 1998 period from
$532,049 for the 1997 period. The increase was the direct result of increased
loan originations, the corresponding increase in the average outstanding balance
of the warehouse credit lines, and the financing of the Interest-only strip
receivables and Mortgage-backed securities.
The benefit for income taxes in the 1998 period was $2,308,909 as
compared to a provision for income taxes $2,048,512 for the 1997 period. For
the six month period ended March 31, 1998, the Company had a loss before income
taxes of $19.7 million as compared to income before income taxes of $5.8 million
for the six month period ended March 31, 1997.
The effective income tax benefit for the 1998 period was 11.7%. This
percentage differs from the federal statutory rate of 34% due primarily to the
effect of the net operating loss carryforward.
As a result of the foregoing, net loss increased to $17.4 million
($2.12 per share) for the 1998 period from net income of $3.8 million ($.38
per share) for the 1997 period.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
The Company's financial condition, liquidity and capital resources
have been adversely affected by the recent events described above, including the
termination of the Mortgage Selling and Servicing Contract of Home by Fannie
Mae, the related termination by Fannie Mae of Home's Title I Loan financing,
disposition and servicing facilities, and the resulting Chapter 11 bankruptcy
proceedings of Home and cessation of loan operations. The following discussion
is qualified in its entirety by these events and consequences, some of which are
as yet undetermined.
The Company's operations require continued access to financing
sources. The Company's primary operating cash requirements arise from the cost
of loan originations and
-24-
<PAGE>
payments of operating expenses, interest and income taxes. Loan originations are
initially funded principally through the Company's warehouse lines of credit
pending the sale of loans in the secondary market or pending the securitization
of Mortgage-backed securities. Substantially all of the loans originated by the
Company are sold. For the period ended March 31, 1998, the Company sold for cash
all Mortgage-backed securities which were financed with Fannie Mae. Net cash
provided by the Company's operating activities for the six month period ended
March 31, 1998 was approximately $13.3 million as compared to net cash used for
the six month period ended March 31, 1998 of $4.2 million. The net cash from the
Company's operating activities resulted primarily from the proceeds from the
sale of loans and Mortgage-backed securities totaling $118.1 million and $75.4
million for the six month periods ended March 31, 1998 and 1997, respectively.
Adequate credit facilities and other sources of funding, including the
ability of the Company to sell loans or Mortgage-backed securities in the
secondary market, are essential for the continuation of the Company's loan
origination operations. At March 31, 1998, the Company had a $20 million
warehouse line of credit with a commercial bank (the "Warehouse Line"), which is
in default and through which no further advances may be made. The outstanding
balance of approximately $4.7 million under the Warehouse Line is due and
payable at March 31, 1998. The Warehouse Line bears interest at 300 basis
points over the federal funds rate and is collateralized by loans pledged under
the Warehouse Line. The agreement with the lender requires the Company to
maintain a minimum adjusted tangible net worth, along with other financial
covenants. The Company was in violation of substantially all financial
covenants as of March 31, 1998.
The Company also had a working capital line of credit with the same
lender which is also in default and through which no further advances may be
made. The outstanding balance of $15.0 million under the working capital line
of credit is due and payable at March 31, 1998. At March 31, 1998, the interest
rates on the two components of the working capital line ranged from 9.44% (30
day LIBOR plus 375 basis points) to 10.19% (30 day LIBOR plus 450 basis points).
The weighted average interest rate for this facility at March 31, 1998, was
9.74%.
Under the terms of the working capital line of credit, the lender
determines at its sole discretion the collateral value as of the end of each
fiscal quarter using information provided by an outside consulting firm. As of
December 31, 1997, the lender determined, based upon such information, that a
principal repayment of approximately $940,000 was required under terms of its
credit agreement. The lender agreed to be repaid with an initial payment of
$300,000, which was made on February 12, 1998, with payment of the balance due
on or before March 31, 1998. The balance of the required principal repayment of
$640,000 due on March 31, 1998, was not made. Furthermore, the outside
consulting firm did not prepare a determination of collateral value for the
lender as of March 31, 1998. However, the Company, using methodology similar to
that of the outside consulting firm, prepared an estimate of the value of the
collateral, which was determined to be $11,187,979. The estimated collateral
value excludes any amount previously assigned to the Interest-only strip
receivable, classified as available for sale securities, relating to the Fannie
Mae loan serviced portfolio. By terminating the Mortgage Selling and Servicing
Contract and assuming control over the servicing portfolio, Fannie Mae
effectively eliminated a material portion of the collateral of the lender.
In connection with both borrowings, Home has agreed to certain
covenants, including without limitation, tangible net worth, adjusted tangible
net worth, leverage ratios, and liquidity. The Company is permitted to pay
dividends as long as the financial ratios
-25-
<PAGE>
are maintained. As of March 31, 1998, the Company was in violation of
substantially all financial loan covenants and otherwise in default under its
credit agreements with the lender. As a result, no additional advances are
available under either facility.
In connection with the arrangement with Fannie Mae to exchange Title I
Loans for Mortgage-backed securities, Fannie Mae had provided, prior to March
24, 1998, short-term repurchase funding to Home, on an uncommitted basis, for
Title I Loans and Mortgage-backed securities exchanged for such loans.
Generally, the repurchase facilities with Fannie Mae required repayment with a
cost of funds based on a 30-day LIBOR rate plus 30 to 90 basis points, depending
upon whether the funding is provided for Title I Loans or Mortgage-backed
securities. Fannie Mae also had provided repurchase funding to the Company for
its Title I Loans that are held for sale and intended for sale to Fannie Mae.
At March 31, 1998, the principal amount of the Company's obligations under this
repurchase facility was approximately $5.9 million for Title I Loans delivered
and available for sale to Fannie Mae.
At March 31, 1998, the Company had a bank overdraft of $1.3 million.
The bank overdraft at March 31, 1998, underscores the need for the Company to
secure an additional warehouse facility for conventional second mortgage loans
and the need for additional capital for operating purposes.
During the six month period ended March 31, 1998, the Company
completed its second securitization of Fannie Mae Mortgage-backed securities.
HOME Securitization Trust I issued and sold $39,193,258 of Asset Backed Bonds,
Series 1997-2, at 7.261% directly to an investor. The bonds are collateralized
by $39,589,150 of Fannie Mae Mortgage-backed securities with an average pass-
through rate of 12.24%. The Company retained and recorded an interest-only
strip receivable from the securitization which entitles it to the excess spread
from the interest received on the Fannie Mae Mortgage-backed securities over the
interest paid on the Bonds, as well as a retained interest that entitles it to
any remaining balances in the Mortgage-backed securities after the Bonds are
paid in full. In addition, the Company recorded an Interest-only strip
receivable from the excess servicing fee interest spread from the Title I Loans
underlying these Mortgage-backed securities. Also during the six month period
ended March 31, 1998, the Company sold $32.4 million of Fannie Mae Mortgage-
backed securities with an average interest rate of approximately 12.17% for
total sales proceeds of approximately $36.2 million.
During the 1998 period, the Company provided approximately $2.3
million in funds from investing activities primarily through the cash flow
associated with the interest-only strips retained by the Company in connection
with loan dispositions; and during the same period the Company used $15.6
million in its financing activities for the repayment of repurchase facilities
which had financed the Mortgage-backed securities sold.
As a result of the Mortgage Selling and Servicing Contract termination
by Fannie Mae on March 24, 1998, and the default by the Company under all of its
financing facilities, the Company no longer has access to current or future
sources of funding. Without sources of funding to continue loan origination
operations and loan disposition strategies, the going concern value of the
Company has been materially impaired.
-26-
<PAGE>
SAFE HARBOR STATEMENT
Statements contained in this document other than historical
information are forward looking statements. These forward looking statements
involve risks and uncertainties, including but not limited to the following
risks: changes in the performance of the financial markets, in the demand for
and market acceptance of the Company's loan products, and in general economic
conditions, including interest rates; the presence of competitors with greater
financial resources and the impact of competitive products and pricing; the
effect of the Company's policies; and the continued availability to the Company
of adequate funding sources. Accordingly, actual results and transactions may
differ materially from those projected or anticipated in the forward looking
statements. Investors are also directed to risks discussed elsewhere in this
document and in other documents filed by the Company with the Securities and
Exchange Commission.
-27-
<PAGE>
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On May 14, 1998, Home, as debtor, filed a voluntary petition for
relief under Chapter 11 of the United States Bankruptcy Code in the United
States Bankruptcy Court for the Western District of Texas, Austin Division, Case
No. 98-115551-FM-11, In Re: HomeOwners Mortgage & Equity, Inc., d/b/a Home,
Inc., Debtor.
On April 9, 1998, a petition was filed against the Company and others
in Tejas Securities Group, Inc. and John Gorman vs. HomeCapital Investment
Corporation, John Ballard and Richard Sandy Watkins, Cause No 98-03712, in the
District Court of Travis County, Texas, 98th Judicial District, seeking damages
in connection with alleged common law fraud and negligence related to a research
report published by Tejas Securities Group, Inc. in June 1997. Although
discovery in the case has not been initiated, based upon information available
to date, the Company believes that the suit is without merit and expects to deny
and vigorously defend against the allegations.
ITEM 2. CHANGES IN SECURITIES.
On February 26, 1998, the Company granted options to purchase an
aggregate of 18,000 shares of Common Stock of the Company under the Non-Employee
Director Compensation Plan ("Director Plan"). The options were granted to the
six non-employee directors of the Company and Home at an exercise price of $3.50
per share in accordance with the Director Plan. The options granted under the
Director Plan are not transferable, and shares of Common Stock issuable upon
exercise of the options are restricted against transfer in the absence of
registration or exemption from registration pursuant to the Securities Act of
1933 ("Act"). Issuance of the options was exempt from registration under the
Act pursuant to Sections 3(b), 4(2) and 4(6) of the Act, and Rules 505 and 506
of Regulation D promulgated under the Act.
During the three month period ended March 31, 1998, a total of 26,998
shares of Preferred Stock, Series A, were converted into an equal number of
shares of Common Stock. Accrued and unpaid dividends associated with the
Preferred Stock, Series A, through the conversion date were paid to each
converting stockholder. Shares of Common Stock issuable upon conversion of the
Preferred Stock, Series A, are restricted against transfer in the absence of
registration or exemption from registration pursuant to the Securities Act of
1933 ("Act"). Issuance of such shares was exempt from registration under the
Act pursuant to Sections 3(b), 4(2) and 4(6) of the Act, and Rules 505 and 506
of Regulation D promulgated under the Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
(a) As a result of termination of the Mortgage Selling and Servicing
Contract of Home by Fannie Mae on March 24, 1998, and related consequences,
including the Chapter 11 reorganization bankruptcy filing by Home on May 4,
1998, Home is in default in financial and other covenants under its warehouse
line of credit and working capital line of credit with the Company's principal
commercial lender. Fannie Mae has also asserted that Home is in default under
certain loan financing and repurchase arrangements with Fannie Mae.
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<PAGE>
(b) As a result of termination of the Mortgage Selling and Servicing
Contract of Home by Fannie Mae, certain holders of shares of the Preferred
Stock, Series A, of the Company have asserted that the Company is in default
under covenants of the Stock Purchase Agreement by which such shares were
acquired. Through March 31, 1998, accrued dividends on the Preferred Stock,
Series A, in the aggregate amount of $201,877 were in arrears in accordance with
the provisions governing the Preferred Stock, Series A.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The annual meeting of stockholders of the Company was duly called and
held on February 26, 1998 ("Annual Meeting"). In connection with the Annual
Meeting, the Company filed and distributed to its stockholders a Proxy Statement
pursuant to Section 14(a) of the Securities Exchange Act of 1934, as amended.
The following matters were voted upon at the Annual Meeting:
(a) The election of the following persons to serve on the Board of
Directors of the Company: John W. Ballard, E. Jeff Bomer, J. Rolfe Johnson,
Charles R. Leone, III, Larry D. Meyers, Peter A. Pyhrr and Walter W.
Stoepplewerth; and
(b) The ratification of the appointment of Coopers & Lybrand, L.L.P.,
as independent accountants and auditors of the Company for the 1998 fiscal year.
Each of the nominees was elected to the Board of Directors and the
appointment of the accountants was ratified by the necessary vote at the Annual
Meeting. The following table sets forth the number of votes cast for, against or
withheld, and abstentions and broker non-votes in the election of each director
and appointment of the accountants:
For Against Abstain/1/
Directors --------- ------- ---------
Mr. Ballard 8,690,591 - 825,498
Mr. Bomer 8,361,453 - 1,125,498
Mr. Johnson 8.690,659 - 825,498
Mr. Leone 8,390,659 - 1,154,704
Mr. Meyers 8,355,966 - 1,160,191
Mr. Pyhrr 8,361,453 - 1,154,704
Mr. Stoeppelwerth 8,361,453 - 1,154,704
Accountants 8,509,030 5,295 1,833
- ---------------
/1/ Votes withheld in Election of Directors; includes broker non-votes
-29-
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
Exhibit 11.1 Statement of Computation of Earnings per Share (Six
Months).
Exhibit 11.2 Statement of Computation of Earnings per Share (Three
Months).
Exhibit 27 Financial Data Schedule (Electronic Filing Only).
(b) Reports on Form 8-K: None.
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<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
HOMECAPITAL INVESTMENT CORPORATION
(Registrant)
Date: May 20, 1998 By: /s/ Rebecca F. Blanchard
------------------------------------------
Rebecca F. Blanchard
Treasurer and Principal Accounting Officer
-31-
<PAGE>
EXHIBIT 11.1
HOMECAPITAL INVESTMENT CORPORATION
EARNINGS PER SHARE
<TABLE>
<CAPTION>
SIX MONTH PERIOD ENDED MARCH 31,
1998 1997
------------ -----------
BASIC EARNINGS PER COMMON SHARE:
<S> <C> <C>
Net income (loss) $(17,404,354) $ 3,788,856
Less preferred stock dividends (130,749) (134,630)
------------ -----------
Net income (loss) for common shareholders $(17,535,103) $ 3,654,226
============ ===========
Weighted average shares outstanding during the period 8,257,973 7,899,547
============ ===========
Basic earnings (loss) per common share $ (2.12) $ 0.46
============ ===========
DILUTED EARNINGS PER COMMON SHARE:
Net income (loss) for common shareholders $(17,404,354) $ 3,788,856
============ ===========
Weighted average shares outstanding during the period 8,257,973 7,899,547
Common stock equivalents 453,578 590,432
Assume conversion of preferred stock 1,431,335 1,500,000
------------ -----------
Weighted average common shares outstanding 10,142,886 9,989,979
============ ===========
Diluted earnings (loss) per common share $ (1.72)(1) $ 0.38
============ ===========
(1) Basic per share data only, due to antidilutive effect of common stock equivalents.
</TABLE>
<PAGE>
EXHIBIT 11.2
HOMECAPITAL INVESTMENT CORPORATION
EARNINGS PER SHARE
<TABLE>
THREE MONTH PERIOD ENDED MARCH 31,
1998 1997
------------ ----------
BASIC EARNINGS PER COMMON SHARE:
<S> <C> <C>
Net income (loss) $(18,711,066) $1,544,693
Less preferred stock dividends (62,319) (66,575)
------------ ----------
Net income(loss) for common shareholders $(18,773,385) $1,478,118
============ ==========
Weighted average shares outstanding during the period 8,279,133 8,168,254
============ ==========
Basic earnings (loss) per common share $ (2.27) $ 0.18
============ ==========
DILUTED EARNINGS PER COMMON SHARE:
Net income (loss) for common shareholders $(18,711,066) $1,544,693
============ ==========
Weighted average shares outstanding during the period 8,279,133 8,168,254
Common stock equivalents 511,524 641,773
Assume conversion of preferred stock 1,431,335 1,500,000
============ ==========
Weighted average common shares outstanding 10,221,992 10,310,027
============ ==========
Diluted earnings (loss) per common share $ (1.83)(1) $ 0.15
============ ==========
(1) Basic per share data only, due to antidilutive effect of common stock equivalents.
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
CONSOLIDATED BALANCE SHEET AT MARCH 31, 1998 AND STATEMENTS OF OPERATIONS FOR
THE PERIODS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> MAR-31-1998
<CASH> 4,202
<SECURITIES> 11,425,319
<RECEIVABLES> 15,044,245
<ALLOWANCES> 250,000
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 2,290,004
<DEPRECIATION> 717,026
<TOTAL-ASSETS> 31,649,341
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
14,313
<COMMON> 82,955
<OTHER-SE> (5,197,983)
<TOTAL-LIABILITY-AND-EQUITY> 31,649,341
<SALES> 7,623,246
<TOTAL-REVENUES> 10,115,021
<CGS> 0
<TOTAL-COSTS> 29,828,284
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,050,000
<INTEREST-EXPENSE> 1,997,851
<INCOME-PRETAX> (19,713,263)
<INCOME-TAX> (2,308,909)
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (17,404,354)
<EPS-PRIMARY> (2.12)
<EPS-DILUTED> (2.12)
</TABLE>
