Document/Exhibit Description Pages Size
1: S-1 Registration Statement (General Form) 218 823K
2: EX-3.2 Articles of Incorporation/Organization or By-Laws 15 52K
3: EX-4.1 Instrument Defining the Rights of Security Holders 45 233K
4: EX-5.1 Opinion re: Legality 2 13K
9: EX-10.11 Material Contract 14 47K
5: EX-10.3 Material Contract 2 11K
6: EX-10.5 Material Contract 14 45K
7: EX-10.7 Material Contract 15 50K
8: EX-10.9 Material Contract 15 50K
10: EX-12 Statement re: Computation of Ratios 2± 11K
11: EX-21 Subsidiaries of the Registrant 1 9K
12: EX-23.1 Consent of Experts or Counsel 1 7K
13: EX-24 Power of Attorney 2± 11K
14: EX-25 Statement re: Eligibility of Trustee 3 14K
15: EX-99.1 Miscellaneous Exhibit 5 21K
As filed with the Securities and Exchange Commission on ___ __, 2000
Registration No. ___________
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM S-1
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
APPROVED FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
Virginia 52-0792752
-------- ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
APPROVED FINANCIAL CORP.
1716 Corporate Landing Parkway
Virginia Beach Virginia 23454
1-757-430-1400
(Address, including zip code, and telephone number, including area code,of
registrant's principal executive offices)
Allen D. Wykle
Chairman, President, Chief Executive Officer
Approved Financial Corp.
1716 Corporate Landing Parkway
Virginia Beach Virginia 23454
1-757-430-1400
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
Copies to:
Ronald M. Gates, Esquire
Payne, Gates, Farthing and Radd, P.C.
1515 Dominion Tower
999 Waterside Drive
Norfolk, Virginia 23510
1-757-640-1500
Approximate date of commencement of proposed sale to the public: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [X]
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registrations statement number of the earlier effective registration statement
for the same offering.[ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
The registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that the Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Securities and Exchange Commission, acting
pursuant to said Section 8(a) may determine.
CALCULATION OF REGISTRATION FEES
[Enlarge/Download Table]
Title of each class of Amount to be Proposed maximum Proposed maximum Amount of
securities to be registered registered offering per unit* aggregate offering price registration fee
----------------------------------------------------------------------------------------------------------------------------------
Subordinated Debt Securities $50,000,000 100% $50,000,000 $13,200
----------------------------------------------------------------------------------------------------------------------------------
* estimated solely for determination of the registration fee.
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[LOGO]
APPROVED FINANCIAL CORP.
$50,000,000 of Subordinated Debt Securities
Approved Financial Corp. is offering the subordinated Certificates of
Investment and the adjustable-rate, subordinated Money Market Accounts. We may
offer Certificates of Investment with maturities of three months to 120 months.
The Money Market Accounts have no stated maturity. For a more detailed
description of these securities, see "Highlights of Terms of the Debt
Securities" and "Description of the Debt Securities Offered and the Indenture."
We will provide the interest rates currently being offered on the debt
securities in a supplement to this prospectus. You should read this prospectus
and the rate supplement carefully before you invest.
Throughout this document and all supplements thereto, the use of the words
"we", "us" and "our" refers to Approved Financial Corp. and its subsidiaries and
reflects the opinion of its management.
We will receive all of the proceeds from the sale of the debt securities
which we estimate will total approximately $48,868,800 after paying expenses.
These debt securities are not certificates of deposit or other obligations
of, or guaranteed by a depository institution. The payment of principal and
interest on these Securities is not guaranteed or insured by the FDIC or any
governmental or private insurance fund, or any other entity.
These debt securities are our unsecured obligations. We will not contribute
funds to a separate account such as a sinking fund to repay the debt represented
by these securities upon maturity.
There is no public trading market for these securities and it is unlikely
that an active trading market will develop or be sustained.
An investment in these securities involves risks and uncertainties. These
securities are unsecured obligations, which are subordinated to our senior debt
and the debt of our subsidiaries. You should consider carefully the risk factors
and the other information set forth in this prospectus before you decide to
purchase these securities. See "Risk Factors" beginning on page __.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or passed on the
adequacy or accuracy of this prospectus. Any representation to the contrary is a
criminal offense.
The date of this prospectus is ____________, 2000
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TABLE OF CONTENTS
[Enlarge/Download Table]
Page
Prospectus Summary.............................................................. 5
Risk factors.................................................................... 14
Ratio of Earnings To Fixed Charges............................................. 23
Use of Proceeds................................................................. 23
Plan of Distribution............................................................ 24
Description of The Debt Securities Offered and The Indenture.................... 26
Interest of Named Experts and Counsel........................................... 40
Business........................................................................ 40
Property ....................................................................... 83
Legal Proceedings .............................................................. 84
Directors and Executive Officers................................................ 85
Executive Compensation ......................................................... 88
Principal Shareholders.......................................................... 99
Certain Relationships and related Transactions.................................. 101
Selected financial Data......................................................... 103
Management's Discussion and Analysis of Financial Condition and Results of
Operations...................................................................... 106
Nine Month Periods Ended September 30, 2000 compared to 1999
Years Ended December 31, 1999 compared to 1998
Years Ended December 31, 1998 compared to 1997
Quantitative and Qualitative Disclosures about Market Risks..................... 149
Interest Rate Risk.............................................................. 151
Asset Quality................................................................... 153
Changes in and Disagreements with Accountants................................... 154
Legal Matters................................................................... 154
Experts......................................................................... 154
Where You Can Find More Information............................................. 154
Index To Consolidated Financial Statements...................................... F-1
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PROSPECTUS SUMMARY
This summary includes an overview of the material terms of the offering,
which are discussed in detail in this prospectus. It does not contain all of the
information that is necessary to make an informed investment decision. To fully
understand the offering, you should read the entire prospectus carefully,
including the "Risk Factors" on page 14 and the consolidated financial
statements and the related notes before you decide to purchase these securities.
General Information Regarding Our Business
Approved Financial Corp. is headquartered in Virginia Beach, Virginia at
1716 Corporate Landing Parkway and our telephone number is 757-430-1400. We are
a specialty financial services company with subsidiaries operating throughout
the United States.
Our Primary Business
Origination, service and sale of:
o Fixed rate and adjustable rate mortgage loans which are secured primarily by
first, and to a lesser extent by second mortgages on one-to-four family
residential properties and which generally do not satisfy the eligibility
requirements of Fannie Mae, Freddie Mac or similar buyers, which are referred
to in this document as non-conforming or subprime loans, but who exhibit both
the ability and willingness to repay the loan.
o Fixed rate and adjustable rate mortgage loans which are secured by first
mortgages on one-to-four family residential properties, most of which satisfy
the eligibility requirements of Federal Housing Administration ("FHA"),
Fannie Mae and Freddie Mac, which are referred to in this document as
government (FHA) and conforming loans.
Primary Loan Origination Channels consist of:
o Mortgage customer referrals from a network of mortgage brokers ("Broker
Division")
o Mortgage loans originated directly with the consumer through our retail
branch network of offices ("Retail Division")
History of Corporate Structure
o Approved Financial Corp., which holds a Virginia industrial loan association
charter was incorporated in 1952 as a subsidiary of Government Employees
Insurance Co. ("GEICO").
o Approved Financial Corp. was acquired in September 1984 by, among others,
several members of current management and the board of directors and
currently operates primarily through three wholly owned subsidiaries.
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o In 1993, we formed our first wholly owned subsidiary, Approved Residential
Mortgage Inc. ("ARMI") to facilitate operations outside of the state of
Virginia.
o In September 1996 we acquired another wholly owned subsidiary Approved
Federal Savings Bank (the "Bank"), a federally chartered thrift institution.
The Bank is subject to the supervision, regulation and examination of the
Office of Thrift Supervision (the "OTS") and the Federal Deposit Insurance
Corporation ("FDIC"). We are a registered Bank Holding Company under the
Federal Home Owner's Loan Act ("HOLA") because of our ownership of the Bank.
As such, we are subject to the regulation, supervision and examination of the
OTS. The Bank is also subject to the regulations of the Board of Governors of
the Federal Reserve System governing reserves required to be maintained
against deposits.
o During 1998, we formed our third active subsidiary, Approved Financial
Solutions, through which we offer various ancillary products such as Debt
Free Solutions and Mortgage Acceleration Program, both of which are programs
designed to assist consumers in accelerating the repayment of their
outstanding consumer and mortgage debt.
o Our title insurance division was restructured during the year 2000 as a
wholly owned subsidiary, Global Title of Maryland, Inc. We offer title
insurance to our customers in the states where we hold license.
Overview of the Offering
Background. We have historically offered similar subordinated debt and notes
to investors through an intrastate exemption from registration of those
securities. Since we now operate in several states, we cannot offer subordinated
debt and notes to new investors under this exemption. Thus, our ability to
access this type of corporate funding which we have utilized for many years is
very limited. Therefore, by means of this prospectus we can offer a new class of
similar subordinated debt securities to existing and new investors.
The Offering. We are offering up to $50 million of subordinated
Certificates of Investment Securities and adjustable rate subordinated Money
Market Account Securities referred to in this prospectus as debt securities. In
connection with this offering of debt securities, we have entered into an
agreement called an indenture with US Bank Trust, a national banking association
who will act as the trustee. The indenture provides detailed information
regarding the term of debt securities and what happens in the event we fail to
make a payment. The trustee monitors our compliance with the terms of the
indenture and takes actions to protect the rights of holders of the debt
securities if we do not comply with these terms. There is no minimum amount of
debt securities that must be sold in the offering. We may withdraw or cancel the
6
offering at any time. In the event of a withdrawal or cancellation, the debt
securities previously sold will remain outstanding until maturity or redemption
by us with notice and pending orders will be irrevocable. See "Plan of
Distribution" and "Description of the Debt Securities Offered and the
Indenture".
Unsecured Obligations. The debt securities are not insured, guaranteed or
secured by the FDIC or other government agencies or by any lien on any of our
assets. We do not intend to contribute funds to a separate fund, such as a
sinking fund, to provide funds to repay the debt securities upon maturity. Our
sources of funds for the repayment of principal at maturity and the ongoing
payment of interest on these debt securities include revenues from operations,
including the sale of loans available for sale, working capital, and cash
generated from additional debt financing. See "Risk Factors - Since we do not
set aside funds to repay the debt securities offered and you must rely on our
revenues from operations and other sources for repayment, if our sources of
repayment are not adequate, you could lose all or a part of your investment."
Subordinated Obligations. The debt securities are second in right of
repayment, or subordinated, to our senior debt and debt of our subsidiaries,
other than the senior debt. There is no limitation on the amount of senior debt
or subsidiary debt we may incur. See "Description of the Debt Securities Offered
and the Indenture" for a description of what constitutes senior debt and debt of
our subsidiaries.
Parity Debt. Upon liquidation or dissolution, our indebtedness, other than
the senior debt, will have rights equal to those of the debt securities being
offered. As of September 30, 2000, we had $4.8 million of indebtedness, which
will rank equally in right of payment with the debt securities. See "Description
of the Debt Securities Offered and the Indenture."
Orders. Your order is irrevocable upon submission to us. However, we may
reject your order in whole or in part, for any reason. If we do not accept your
order, we will promptly refund the funds you paid with your order to you without
deduction of any costs and without interest. See "Plan of Distribution."
Transaction Statements. Upon acceptance of an order, the purchaser will
receive an initial transaction statement, which shows the purchaser's ownership.
Purchasers may not transfer rights of ownership in the security by the
endorsement and delivery of the statement to another purchaser. See "Provisions
Relating to All Securities" for information on how to transfer this debt
security.
Overview of Terms of Debt Securities. For an overview of the debt
securities, see "Highlights of Terms of Debt Securities Offered" and
"Description of the Debt Securities Offered and Indenture" appearing in this
prospectus.
7
Use of Proceeds. Assuming that we sell all of the $50 million of debt
securities offered according to our initial plan of distribution, we will
receive net proceeds of approximately $48.9 million after paying expenses which
we estimate to be approximately $1.1 million. Proceeds from the sale of the
securities offered in this prospectus will be used for general corporate
purposes, including the purchase of assets from, investments in and extensions
of credit to, our subsidiaries and affiliates, which will use the proceeds for
general corporate purposes including capital liquidity requirements. (See also
"Use of Proceeds").
Commissions. We will not pay commissions to our employees assisting in the
sale of these securities. We do not presently intend to use registered broker-
dealers to assist with the sale of the debt securities. If we elect to use
broker-dealers on a best efforts basis in connection with future sales of the
Certificates of Investment or Money Market Accounts, we anticipate that we will
pay a commission that will represent a percentage of the sales price to those
brokers and we may reimburse those brokers for costs and expenses related to
those sales. If we use brokers, expenses of the offering will increase and the
proceeds we receive will be less than currently estimated.
8
HIGHLIGHTS OF TERMS OF THE DEBT SECURITIES OFFERED
[Enlarge/Download Table]
Types of Security Offered Certificate of Investment (Unsecured, Money Market Account
subordinated subordinated, fixed term subordinated (Unsecured, adjustable rate,
debt security) subordinated debt security)
Denomination of Initial Minimum purchase: $5,000 per security Minimum purchase: $5,000 per security
Purchase and Additional or any amount in excess of $5,000 or any amount in excess of $5,000.
purchases (Minimum purchase for self-directed (Minimum purchase for self-directed IRA
IRA accounts $2,000) accounts $2,000)
Annual Interest Rate Fixed upon issuance. The interest Depending on the balance in your Money
rate will vary according to the term Market Account at the end of each day,
chosen and as offered in pricing different interest rates and annual
supplements to the prospectus. percentage yields may apply. We will
adjust the interest rate paid from time
to time in our sole discretion, however
interest rates for each one-week period
commencing on Sunday will be at least
equal to the rate of the Thirteen Week
U.S. Treasury Bills auctioned the
immediately preceding Monday less one
percent. No interest will be paid for
any day on which the principal balance
is below $5,000 (unless your account is
a self-directed IRA). We will provide
written notice to security holders 14
days prior to a reduction in the
interest rate on the account.
9
[Enlarge/Download Table]
Types of Security Offered Certificate of Investment (Unsecured, Money Market Account
subordinated subordinated, fixed term subordinated (Unsecured, adjustable rate,
debt security) subordinated debt security)
Payment of Interest Interest in Certificates of Interest in Money Market Accounts will
Investment with maturities of less be compounded daily, credited to
than one year will be compounded accounts monthly and paid at redemption.
daily and paid at maturity. Interest
on Certificates of Investment with
maturities of one year or greater
will be compounded daily and, at the
election of the holder, paid at
monthly, quarterly, semi-annually or
annually.
10
[Enlarge/Download Table]
Types of Security Offered Certificate of Investment (Unsecured, Money Market Account
subordinated subordinated, fixed term subordinated (Unsecured, adjustable rate,
debt security) subordinated debt security)
Redemption by Holder Certificates of Investment with May be redeemed by the holder upon
remaining maturities of less than one written notice to us with payment to be
year are not redeemable prior to made within 10 business days of our
maturity. Certificates of Investment receipt of such notice from the holder.
with remaining maturities of one year Redemptions must be at least $500
or greater may be redeemed by the except for redemption to close an
holder, who is a natural person, account.
following his/her total permanent
disability (as described under the
heading "Description of the Debt
Securities Offered and the Indenture
-Provisions Relating to Certificates
of Investment"), or by the holder's
estate after his/her death, at the
principal amount plus accrued
interest. Any holder who is not a
natural person, such as a trust,
partnership or corporation, will have
no right to cause redemption prior to
maturity (for joint, Holders, see
"Description of the Debt Securities
Offered and the Indenture Provisions
Relating to Certificate of
Investments")
Redemption by Us Redeemable upon 90 days written Redeemable upon 30 days written notice
notice to the holder. to the holder.
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[Enlarge/Download Table]
Types of Security Offered Certificate of Investment (Unsecured, Money Market Account
subordinated subordinated, fixed term subordinated (Unsecured, adjustable rate,
debt security) subordinated debt security)
Form Issued/ Book-entry form and non-negotiable. A Book-entry form and non-negotiable. A
Transferability transaction statement will be issued transaction statement will be issued
not an individual promissory note not an individual promissory note
(except for custodial accounts for (except for custodial accounts for
self-directed IRAs). Not transferable self-directed IRAs). Not transferable
without our prior written consent. without our prior written consent.
Maturity Certificates of Investment are No fixed maturity.
offered with terms to maturity of
three (3)to 120 months, the term of
each note is established at the time
of purchase.
Automatic Extension The Certificates of Investment will Not applicable.
be automatically extended for a
period equal to the original term
unless: (i) we notify the holder at
least seven days prior to the
maturity date that an extension will
not be provided; or (ii) the holder
gives us notice of redemption within
seven days after the maturity date.
Certificates of Investment to be
extended will be extended at a fixed
rate equal to the rate then being
offered on newly issued Certificates
of Investment of like term and
denomination.
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[Enlarge/Download Table]
Types of Security Offered Certificate of Investment (Unsecured, Money Market Account
subordinated subordinated, fixed term subordinated (Unsecured, adjustable rate,
debt security) subordinated debt security)
Periodic Statements Quarterly statements will be mailed Monthly statements detailing the
to each holder no later than the balance and interest rate paid on each
tenth business day following the end account will be mailed to each holder
of each quarter detailing the current no later than the tenth business day
balance, the dollar amount and rate following the end of each month.
of interest credited or paid and
other transactions if any occurring
over the past quarter.
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RISK FACTORS
Before you invest in our debt securities, you should be aware that there
are various risks, including those described in this section. You should also be
aware of the risk factors described in other sections of this prospectus
including the sections titled; "BUSINESS", "MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS", "INTEREST RATE RISK" AND
"QUANTITATIVE AND QUALITATIVE DISCUSSION ABOUT MARKET RISK". You should consider
carefully these risk factors together with all of the other information included
in this prospectus and the applicable prospectus rate supplement before you
decide to purchase any debt securities offered by this prospectus.
NEITHER THE FDIC NOR ANY OTHER GOVERNMENTAL OR PRIVATE AGENCY INSURES THE DEBT
SECURITIES OFFERED BY THIS PROSPECTUS.
The securities offered in this prospectus are not secured by any of our
assets. Neither the FDIC nor any other governmental or private agency insures
the debt securities offered by this prospectus. The holder of the debt
securities is dependent solely upon sources such as our earnings, proceeds from
the sale of available for sale loans, our working capital and other sources of
funds, including proceeds from the continuing sale of subordinated debt for
repayment of principal at maturity and the ongoing payment of interest on the
debt securities. Therefore, if you invest in any of the securities, you are
relying solely on these sources of funds for repayment of principal and interest
and you could lose your entire investment including unpaid accrued interest.
THESE SECURITIES ARE SUBORDINATED TO OTHER INDEBTEDNESS, ARE NOT ASSIGNABLE, ARE
NOT RATED, ARE NOT BACKED BY A SINKING FUND AND HAVE LIMITED LIQUIDITY BEFORE
MATURITY
The debt securities offered by this prospectus including interest are
subordinated, or second in right of repayment, to our senior debt and the debt
of our subsidiaries. As of September 30, 2000, there was $51.2 million of senior
debt and subsidiary debt outstanding. There is no limitation on the amount of
senior debt we can incur. Senior debt includes any indebtedness (whether
outstanding on the date of this prospectus or created later) incurred in
connection with our (including our subsidiaries) borrowings from a bank, trust
company, insurance company, or from any other lender. These borrowings do not
have to be specifically designated as "senior debt." If we were to become
insolvent, our senior debt would have to be paid in full prior to payment of
these subordinated debt securities in our liquidation. In addition, any
indebtedness of our subsidiaries, other than the senior debt, will have rights
upon liquidation or dissolution of the particular subsidiary prior to payment
being made to the holders of the debt securities. There may not be adequate
funds remaining to pay the principal and interest on the debt securities. See
"Description of the Debt Securities Offered and the Indenture -- Provisions
Relating to All Securities."
14
These securities are not rated by any type of rating agency and do not
reflect the characteristics commonly associated with other corporate debt
holding an investment grade rating. We do not contribute funds to a separate
account, commonly known as a sinking fund, to make interest or principal
payments on the securities. Because funds are not set aside periodically for the
repayment of these debt securities over their term, holders of these debt
securities must rely on our revenues from operations and other sources for
repayment. To the extent revenues from operations are not sufficient to repay
the debt, holders may lose all or a part of their investment. See "Description
of the Debt Securities Offered and the Indenture" and "Business , General."
Your ability to liquidate your investment is limited because of transfer
restrictions and the lack of a trading market for the debt securities.
The debt securities offered by this prospectus may not be transferred
without our prior written consent. There is no established trading market for
the debt securities. Due to the non-transferable nature of the debt securities
and the lack of a market for the sale of the debt securities, even if we
permitted a transfer, investors would be unable to liquidate their investment.
See "Description of the Debt Securities Offered and the Indenture."
Since no specific allocation of the proceeds has been determined as of the
date of this Prospectus, we will have broad discretion in determining how the
proceeds of the offering will be used. As a result, we could use the funds in a
manner contrary to the best interest of investors. See "Use of Proceeds."
RISK FROM NEGATIVE CASH FLOW AND RECENT LOSS FROM OPERATIONS
Since we have historically experienced negative cash flows from our
operations and expect to do so in the foreseeable future, our ability to repay
the Certificates of Investment could be impaired.
We have historically experienced negative cash flow from operations
primarily due to our loan sale strategy of accumulating an inventory of loans
over time for sale in bulk on a whole loan basis. During this accumulation
period costs and expenses are incurred, however, the gain on the sale of loans
is not recognized until the loans are sold, which may occur in a subsequent
period. Negative cash flow from operations is expected to continue and if our
loans cannot be profitably sold for cash in a timely manner, it could impair our
ability to make principal and interest payments due under the terms of the
securities.
We were profitable each year from acquisition in 1984 through the year
ended December 31, 1998. However, triggered by adverse conditions in the
secondary marketplace for whole loan sales (see "Risks Associated with Loan
sales through Securitization"), we reported a net loss from operations for the
year ended December 31, 1999 and for the nine months ended September 30, 2000,
and we anticipate a net loss for the year ending December 31, 2000. Beginning in
15
July of 1998, we initiated and continue to implement major cost reduction
initiatives and corporate restructuring plans that are designed for a return to
profitability. We expect that we will continue to be challenged by a reduction
in premiums received on non-conforming mortgage loans sold in the secondary
market compared to premiums realized in recent years reducing our revenue per
loan and by new competition, a limited availability of capital, and the
possibility of a rise in loan delinquency and the associated loss rates. If we
do not achieve our goals for a return to profitability, we may not be able to
repay principal and interest on these securities and you could loose all of your
investment.
RISKS ASSOCIATED WITH NON-CONFORMING LOAN ORIGINATION, SERVICING AND SALE
We market a significant portion of our loans to borrowers who are either
unable or unwilling to obtain financing from traditional sources, such as
commercial banks. Loans made to these borrowers may entail a higher risk of
delinquency and loss than loans made to borrowers who use traditional financing
sources. Historically, we have experienced a higher rate of delinquencies on
loans made to these credit-impaired borrowers as compared to delinquency rates
experienced by banks on loans to conforming borrowers. While we sell the
majority of our loans on a service released, no recourse basis and use
underwriting standards and collection procedures designed to mitigate the higher
credit risk associated with lending to these borrowers, our standards and
procedures may not offer adequate protection against risks of default. Higher
than anticipated delinquencies, foreclosures or losses in our serviced loans,
would reduce our profits, which could restrict our ability to repay the notes
upon maturity. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
Beginning in late 1998, adverse changes in the securitization market
impaired our ability to originate and sell loans on a favorable and/or timely
basis. This was due to our dependence on investors for our whole loan sales that
relied on securitization as their primary source of funding. As a part of our
restructuring plans initialed in 1998, we have diversified our base of investors
for loan sales over the past two years and continue to procure new investors on
an ongoing basis.
While we have and continue to explore securitization structures as possible
alternative loan sale strategy, we have not sold loans through securitization in
the past and have no current plans to do so in the future. Selling our loans
through a securitization program would be a significant departure from our
current business operations. However, subject to changes in the secondary
marketplace, it is possible that in the future we may adopt plans to sell a
portion of the loans we originate through a securitization program and retain
the rights to service the loans. However, whether or not we adopt this loan sale
strategy in the future, adverse changes in the securitization market could
impair our ability to originate and sell loans on a favorable and/or timely
basis. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations".
16
For our ongoing operations, we depend upon frequent financings, including
the sale of unsecured subordinated debt securities, warehouse credit facilities
and other forms of indebtedness. If we are unable to renew or obtain adequate
funding under a warehouse credit facility, or other borrowings, the lack of
adequate funds would restrict our ability to repay the notes upon maturity. To
the extent that we are not successful in maintaining or replacing existing and
new subordinated debt securities upon maturity, we may have to limit our loan
origination volume or sell loans earlier than intended for lower prices than
under normal circumstances and restructure our operations. Limiting our
originations or earlier sales of loans could reduce our operating revenues
relative to operating expenses and impair our ability to repay the principal and
interest on the subordinated debt securities. "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
Any substantial impairment in the size, pricing or availability of the
secondary market for our loans could result in our inability to continue to
originate loans and repay the principal and interest on the subordinated debt
securities. "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
OUR ABILITY TO ATTAIN IMPROVED OPERATING RESULTS DEPENDS UPON A VARIETY OF
FACTORS OUTSIDE OUR CONTROL, INCLUDING:
o changes in interest rates,
o conditions in the secondary marketplace for our loans including whole
loan investors and the asset-backed securities markets,
o economic conditions in our origination market areas,
o competition, and
o regulatory restrictions
o residential real estate values
o the demand for and general levels of consumer debt
See also: "BUSINES - Competition" "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Impact of Inflation and Changing
Price Changes"
A CHANGE IN MARKET INTEREST RATES MAY RESULT IN A REDUCTION IN OUR PROFITS AND
IMPAIR OUR ABILITY TO REPAY THE NOTES.
Rapid changes, either upward or downward, in interest rates may adversely
affect our profits. Any future rise in interest rates may:
o reduce customer demand for our products;
o increase our cost of funds;
o reduce the spread between the rate of interest we receive on loans and
the interest rates we must pay under our outstanding credit facilities
and debt securities;
o reduce our revenue realized from loan sales; and
17
o limit our access to borrowings in the capital markets.
We are subject to risks associated with changes in interest rates to the
extent that we have issued fixed rate senior and subordinated debt securities
with scheduled maturities of one to ten years. At September 30, 2000, we had
$4.8 million of subordinated debt securities with scheduled maturities greater
than one year, which is not subject to early redemption at our option. If market
interest rates decrease in the future, the rates paid on our long term
subordinated debt could exceed the current market rates earned by us on our new
loan originations, which could result in a reduction in our profitability and
could impair our ability to repay the notes. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Interest Rate Risk
Management."
IF WE ARE UNABLE TO SUCCESSFULLY IMPLEMENT OUR BUSINESS STRATEGY, OUR REVENUES
MAY DECREASE WHICH COULD IMPAIR OUR ABILITY TO REPAY THE NOTES.
Our business strategy seeks to increase revenues from current operations
relative to expenses, add new sources of revenues, increase our loan volume
through further development of existing markets while maintaining our customary
origination fees and to maintain an acceptable spread between loan interest
rates and the interest rates we pay for capital. Implementation of this strategy
will depend in large part on our ability to:
o open or expand offices in markets with a sufficient
concentration of borrowers who meet our underwriting criteria;
o obtain adequate financing on favorable terms;
o profitably sell our loans in the secondary market on an attractive and
timely basis;
o hire, train and retain skilled employees;
o reduce our operating costs and enhance operating efficiency through
technology
o successfully implement our marketing campaigns; and
o expand in the face of increasing competition from other lenders.
o successfully enter new lines of business under consideration including
but not limited to Small Business Administration lending
Our inability to achieve any or all of these factors could impair our
ability to implement our business strategy and successfully leverage our fixed
costs which could result in a reduction in our revenues and impair our ability
to repay the notes.
COMPETITION FROM OTHER LENDERS COULD ADVERSELY AFFECT OUR PROFITABILITY AND OUR
ABILITY TO REPAY THE NOTES.
The lending markets in which we operate are highly competitive. Some
competing lenders have substantially greater resources, greater experience,
lower cost of funds, and a more established market presence than us. If our
competitors increase their marketing efforts to include our market niche of
borrowers, we may be forced to reduce the rates and fees we currently charge in
order to maintain and expand our market share. Any reduction in our rates or
fees could have an adverse impact on our profitability and our ability to repay
18
the notes. Our profitability and the profitability of other similar lenders may
attract additional competitors into this market. (See "Business - Competition")
AN ECONOMIC DOWNTURN IN OUR PRIMARY GEOGRAPHIC ORIGINATION MARKETS COULD RESULT
IN LOWER REVENUES, WHICH WOULD REDUCE THE FUNDS AVAILABLE TO REPAY THE NOTES.
We currently originate loans primarily in the eastern half of the United
States. The concentration of loans in a specific geographic region subjects us
to the risk resulting from a downturn in these economies which could result in
reduced revenues which would reduce the funds available to repay the notes. (See
"Geographical Concentration of Operations" under Business section)
Although we sell substantially all of the loans we originate on a whole
loan, service released basis, `buy sell' agreements with our investors require
that we replace or repurchase loans which do not conform to the representations
and warranties made by us at the time of sale. Claims by borrowers or investors
could result in reduced revenues, which would reduce the funds available to
repay the notes.
In the ordinary course of our business, we are subject to claims made
against us by borrowers and private investors arising from, among other things:
o losses that are claimed to have been incurred as a result of
alleged breaches of fiduciary obligations, misrepresentation, error
and omission by our employees, officers and agents (including our
appraisers);
o incomplete documentation; and
o failure to comply with various laws and regulations applicable to our
business.
Although no material claims or legal actions are currently assessed against
us, any claims asserted in the future may result in legal expenses, liability,
and reduced revenues.
LOSS OF KEY MEMBERS OF OUR MANAGEMENT TEAM COULD DISRUPT OUR OPERATIONS AND
RESULT IN REDUCED REVENUES, WHICH COULD REDUCE THE FUNDS AVAILABLE TO REPAY THE
NOTES.
The success of our operations depends on the continued employment of our
senior level management. If key members of the senior level management were for
some reason unable to perform their duties or were to leave us for any reason,
we may not be able to find capable replacements in a timely manner, which could
disrupt operations and result in reduced revenues. Any reduction in revenues
could reduce the funds available to repay the notes.
19
ENVIRONMENTAL LAWS AND REGULATIONS MAY RESTRICT OUR ABILITY TO FORECLOSE ON
LOANS SECURED BY REAL ESTATE OR INCREASE COSTS ASSOCIATED WITH THOSE LOANS,
WHICH COULD REDUCE OUR REVENUES AND THE FUNDS AVAILABLE TO REPAY THE NOTES.
(See also under `Business', `Environmental Risk Factors')
REGULATIONS THAT APPLY TO OUR BANKING SUBSIDIARY, THROUGH WHICH WE CONDUCT MOST
OF OUR BUSINESS OPERATIONS, IMPOSE CAPITAL AND OTHER REQUIREMENTS THAT WE MUST
MAINTAIN AND COMPLY WITH AND WHICH IMPOSE LIMITATIONS ON THE ABILITY OF THESE
SUBSIDIARIES TO MAKE LOANS OR PAY DIVIDENDS TO US; THESE REGULATIONS MAY MAKE IT
MORE DIFFICULT FOR US TO REPAY INDEBTEDNESS(See also: "BUSINESS - Regulation,
OTS Regulation of Approved Financial Corp. and Regulation of the Bank)
We conduct most of our business operations through our subsidiaries,
including Approved Federal Savings Bank. State and federal regulation of our
banking institution impose capital requirements that these subsidiaries must
maintain and impose limitations on the ability of these subsidiaries to make
loans or pay dividends to us. Among the applicable regulations are the
following:
o Banking regulations impose minimum capital requirements that our banking
subsidiary must maintain. From time to time we may need to contribute capital
in the form of cash to our bank subsidiary to ensure its continued regulatory
compliance and ability to conduct its business operations.
o Banking regulations limit the amount of dividends that our bank subsidiary
may pay to us.
o Sections 23A and 23B of the Federal Reserve Act restrict the ability of our
bank subsidiary to transfer funds to us and our affiliates in the form of
loans, extensions of credit, investments or purchases of assets. These
regulations also require generally that transactions between our bank
subsidiary and us be on terms no less favorable to the bank subsidiary than
comparable transactions with unrelated third parties. Similarly, transfers of
funds in any twelve-month period by our bank subsidiary to us or to any
single affiliate may not exceed 10% of the depository subsidiary's capital
and surplus, and transfers to all affiliates in any twelve-month period may
not exceed 20% of its capital and surplus.
o We must comply with collateral requirements when obtaining loans or other
extensions of credit from our affiliated banking institution.
Our need to provide cash to our banking subsidiary from time to time to
meet capital requirements and our limited ability to obtain funds from this
subsidiary may limit the amount of cash we may have available at any time and
could make it more difficult for us to make payments on the securities offered
in this prospectus.
20
YOUR RIGHT TO RECEIVE PAYMENT ON THE SECURITIES IS JUNIOR TO THE RIGHTS OF
DEPOSITORS AND OTHER CREDITORS OF OUR SUBSIDIARIES TO BE PAID MONEY OWED TO THEM
Our right to receive any distribution of assets from any of our
subsidiaries if they liquidate their assets or undergo reorganization or other
similar transaction is junior to the claims of creditors of the subsidiary.
Consequently, unless we are recognized as a creditor of the subsidiary, the
securities will be effectively junior in right of repayment to all of the
existing and future liabilities of our subsidiaries. At December 31, 1999 and at
September 30, 2000, our subsidiaries had total liabilities, excluding
liabilities owed to us, of approximately $ 45.8 million and $75.1 million,
respectively. The indenture does not limit the amount of secured or unsecured
debt that we or any of our subsidiaries may incur.
THE BANKING AND FINANCE INDUSTRIES ARE SUBJECT TO SUBSTANTIAL REGULATION WHICH
MAY INCREASE OUR COST OF DOING BUSINESS; OUR FAILURE TO COMPLY WITH THESE
REGULATIONS COULD ADVERSELY AFFECT OUR OPERATIONS
Extensive federal and state regulations affect our banking and finance
businesses in general, and our banking subsidiary in particular. Our lending and
servicing activities must adhere to various federal and state laws, including
but not limited to:
o the Truth-in-Lending Act;
o the Equal Credit Opportunity Act;
o the Home Mortgage Disclosure Act;
o the Community Reinvestment Act;
o the Electronic Funds Transfer Act;
o the Home Ownership and Equity Protection Act;
o the Real Estate Settlement Procedures Act; and
o the Fair Credit Reporting Act.
In addition, various legislative proposals and initiatives relating to the
banking and finance businesses have been or will be introduced in Congress.
Recently an FDIC discussion draft proposal has been made public regarding
requirements for subprime lenders. Under the proposal, regulatory capital
required to be held for certain loan classes included in the institution's
portfolio could be increased. The ultimate resolution of this proposal is
uncertain at this time. However, we believe that the Bank can remain in
compliance with its capital requirements. Other federal legislative proposals
and initiatives that could impact us and our businesses include financial
privacy initiatives that would restrict the permissible use of customer-specific
21
financial and other credit information and statutory changes to the Real Estate
Settlement Procedures Act, the Truth-in-Lending Act and the Home Ownership
Equity Protection Act ("HOEPA"). Additionally, The Federal Home Loan
Bank("FHLB") Board recently distributed a new policy to its members entitled
"Policies to Promote Responsible Lending". The policy restricts the general
characteristics, such as rates and fees, associated with the origination of
mortgage loans that a member institution, such as our Bank, can pledge as
collateral for advances of credit from the FHLB. Also, the OTS recently issued a
draft proposal concerning its oversight of savings and loan holding companies.
If the proposal is adopted we will be required to provide 30 days notice to the
OTS before undertaking certain significant new business activities that would
result in an increase in our debt at the holding company level or a reduction in
our capital or in relation to certain asset acquisitions. The draft proposal
indicates that this is for the purpose of allowing time for the OTS to access
the potential impact that such activity will have on our risk profile and on the
risk profile of our Bank. The ultimate resolution of this OTS proposal is
uncertain at this time.
Additionally, a number of states are considering, and others likely will
consider, legislative and regulatory initiatives related to subprime mortgage
lending and financial privacy. If any of these proposals were to become law,
they could negatively impact our profitability or the manner in which we conduct
our business.
Various states regulate the subsidiaries through which we conduct our home
equity lending businesses and require licensing of those subsidiaries as
mortgage bankers, mortgage brokers, and originators, sellers and servicers of
mortgage loans. The Office of Thrift Supervision regulates our subsidiary,
Approved Federal Savings Bank. Federal and state regulatory authorities also
periodically conduct examinations of us with respect to originating, processing,
underwriting, selling and servicing our loans. Failure to comply with these
statutory and regulatory requirements can lead to, among other remedies,
termination or suspension of licenses, certain rights of rescission for mortgage
loans, class action lawsuits and administrative enforcement actions.
We have implemented procedures to comply with these requirements and we
believe that we comply in all material respects with applicable local, state and
federal laws, rules and regulations. However, if more restrictive laws, rules
and regulations are adopted in the future, compliance could become more
difficult or expensive. We are also subject to Federal Reserve Board regulations
related to residential mortgage lending and servicing and the Department of
Housing and Urban Development regulation and reporting requirements. Failure to
comply with these requirements can lead to, among other remedies, termination or
suspension of licenses, rights of rescission for mortgage loans, class action
lawsuits and administrative enforcement actions.
Federal and state government agencies have recently begun to consider, and
in some instances have adopted, legislation to restrict lenders' ability to
22
charge rates and fees in connection with sub-prime residential mortgage loans
and loans to borrowers with credit problem. Such legislation also imposes
various loan term restrictions, e.g., limits on balloon loan features.
Frequently referred to generally as "predatory lending" legislation, this
legislation may limit our ability to impose fees, charge interest rates on
consumer loans to those borrowers with problem credit and may impose additional
regulatory restrictions on our business.
Additionally, financial institutions that currently, as well as those who
may in the future, provide us with credit facilities periodically perform due
diligence reviews in respect to our origination, processing, underwriting,
selling and servicing of home equity loans and conventional first mortgage
loans. In addition, these credit facilities contain restrictive covenants with
which we must comply. Since the debt securities offered by this prospectus are
unsecured and second in right of repayment to our senior debt borrowed from
these institutional lenders, in the event of insolvency, subordinated debt
holders would be repaid only if funds remain after the repayment of our senior
debt.
RATIO OF EARNINGS TO FIXED CHARGES
The following table shows our ratio of earnings to fixed charges for the
periods indicated:
[Enlarge/Download Table]
------------------------------------------------------------------------------------------------------------------------
Table: Ratio of Earnings to Fixed Charges
------------------------------------------------------------------------------------------------------------------------
(UNAUDITED) Year Ended December 31 Nine Months
$ IN 1,000 Ended
------------------------------------------------------------------------------------------------------------------------
Year 1995 1996 1997 1998 1999 9/30/00
------------------------------------------------------------------------------------------------------------------------
Earnings $4,251 $8,724 $19,921 $7,334 -$ 7,365 $ 367
------------------------------------------------------------------------------------------------------------------------
Fixed Charges $2,142 $3,014 $ 6,223 $6,382 $ 5,306 $ 3,128
------------------------------------------------------------------------------------------------------------------------
Earnings/Fixed 1.98X 2.89X 3.20X 1.15X * *
Charges
------------------------------------------------------------------------------------------------------------------------
* Earnings are inadequate to cover fixed charges by $12,671 for the year ended
December 31, 1999 and $2,761 for the nine months ended September 30, 2000.
USE OF PROCEEDS
The amount of securities that we offer from time to time and the precise
amounts and timing of the applications of the proceeds will depend upon market
conditions as well as our funding requirements and those of our subsidiaries and
affiliates.
We estimate that the resulting proceeds from the sale of the debt
securities according to our initial plan of distribution will be approximately
$48.9 million net of estimated offering expenses if we sell all of the
securities that we offer by this prospectus (See also "Plan of Distribution").
23
The proceeds will be used for general corporate purposes, which may include, but
are not limited to:
o financing the future growth of our loan portfolios and capital
expenditures;
o paying general operating expenses including interest expense;
o purchasing assets from, making investments in and extending credit to, our
subsidiary companies. Our subsidiaries may use the proceeds for
general corporate purposes, including but not limited to use as capital
for regulatory capital ratio requirements;
o repayment of warehouse credit facilities and any other senior or
subordinated indebtedness, including but not limited to notes to related
parties; o funding the startup of new business divisions both in current
and new lines of business; o financing of possible acquisitions of related
businesses or assets, or strategic relationships with other companies
although none are currently contemplated; o investing in other securities
or repurchasing our common stock from time to time;
In addition, the precise amounts and timing of the application of such
proceeds depends upon many factors, including, but not limited to, the amount of
any such proceeds, actual funding requirements and the availability of other
sources of funding. Until the proceeds are used, we may invest the proceeds,
depending on our cash flow requirements, in short and long-term investments,
including, but not limited to:
o treasury bills,
o commercial paper,
o certificates of deposit,
o securities issued by U.S. government agencies,
o money market funds; and
o repurchase agreements.
Our investment policies permit significant flexibility as to the types of
such investments that we may make. We may also maintain daily unsettled balances
with broker-dealers.
PLAN OF DISTRIBUTION
Except as otherwise indicated in a prospectus supplement, we will sell
these securities directly, without an underwriter or selling agent, and the
securities will be sold by our employees who, under Rule 3a4-1(a) of the
Exchange Act of 1934, are deemed not to be brokers. In accordance with the
provisions of Rule 3a4-1(a), our employees who sell securities will not be
compensated by commission, will not be associated with any broker or dealer and
will limit their activities so that, among other things, they do not engage in
oral
24
solicitations of, and comply with certain specified limitations when responding
to inquiries from, potential purchasers.
We may distribute the securities offered in this prospectus in one or more
transactions: (1) at a fixed price or prices, which may be changed; (2) at
market prices prevailing at the time of sale; (3) at prices related to the
prevailing market prices; or (4) at negotiated prices.
We do not plan to use a broker-dealer or an agent for the purpose of
soliciting the sale of these securities. However, if we were to do so in the
future, the member broker-dealer or agent, which may be deemed to be an
underwriter as that term is defined in the Securities Act, involved in the offer
or sale of the securities offered in this prospectus and any commissions payable
by us to that member broker-dealer or agent will be disclosed in the applicable
prospectus supplement. Unless otherwise indicated in the prospectus supplement,
any member broker-dealer or agent will be acting on a reasonable efforts basis.
We may also agree to indemnify the broker-dealer or agent against specific
liabilities, including liabilities under the Securities Act and to reimburse the
broker-dealer or agent for its costs and expenses, up to a maximum to be
determined, based upon the total dollar value of the securities sold.
We may reject any order, in whole or in part, for any reason. Your order is
irrevocable upon receipt by us. In the event your order is not accepted, we will
promptly refund your funds, without deduction of any costs and without interest.
We expect that orders will be refunded within 48 hours after receipt. Once your
order has been accepted, the applicable order funds will be promptly deposited
in our account. You will receive by mail a receipt confirming your investment as
soon as practical after acceptance of your order. No minimum number of debt
securities must be sold in the offering. You will not know at the time of
submitting an order for purchase of subordinated debt securities whether we will
be successful in completing the sale of any or all of the debt securities being
offered. We reserve the right to withdraw or cancel the offering at any time. In
the event of a withdrawal or cancellation, orders previously received will be
irrevocable and no funds will be refunded.
We may from time to time offer investment incentives to investors. These
incentives could take the form of merchandise travel, accommodations, or other
goods or services that would be awarded to investors who satisfy total
investment, length of investment or other criteria. There are no specific
incentive programs in place on the date of this prospectus. Any specific
incentive program would be disclosed in a prospectus supplement. Investors must
consider that they will recognize income for income tax purposes based upon the
value of any incentive received.
We estimate our expenses involved in this offering, excluding the costs
associated with any agent or broker-dealer that may be contracted to sell these
securities in the future, and assuming the full offering amount of $50 million
is sold, to be approximately $1,133,200.
25
DESCRIPTION OF THE DEBT SECURITIES OFFERED AND THE INDENTURE
General
The debt securities represent our unsecured debt obligations. In connection
with this offering of debt securities, we have entered into an agreement, called
an indenture, with US Bank Trust, a national banking association. The terms of
the debt securities include those stated in the indenture and those made part of
the indenture by reference to the Trust Indenture Act of 1939, in effect on the
date the indenture is qualified under that act. The debt securities are subject
to all terms and conditions of the indenture and Trust Indenture Act. We refer
you to the indenture and the Trust Indenture Act for a complete understanding of
the debt securities. The following includes a summary of some provisions of the
indenture, and a copy of the indenture is available from us upon request. This
summary does not purport to be complete and is qualified in its entirety by
reference to the indenture, including the definitions in the indenture of some
of the terms used below.
Subordination. The debt securities will be subordinated in right of payment
to, or subordinate to, the prior payment in full of all senior debt further
described in our prospectus, whether outstanding on the date of the indenture or
incurred following the date of the indenture. There is no limit on the amount of
senior debt we may incur. The stock we hold in our subsidiaries, as well as any
of our other assets, is available to repay the debt securities in the event of
default. In the event of our default and liquidation of our subsidiaries to
repay the note holders, we must pay or make provisions for the payment of
creditors of the subsidiaries from the assets of the subsidiaries before the
remaining assets of the subsidiaries can be used to repay the holders of the
debt securities. See "-- Provisions Relating to All Securities --
Subordination."
Unsecured without a Sinking Fund. These debt securities are not secured by
any collateral or lien. These debt securities do not contain provisions for a
sinking fund or similar fund providing for payments on the debt securities. See
"Risk Factors -- Since we do not set aside funds to repay the debt securities
offered and you must rely on our revenues from operations and other sources for
repayment, if our sources of repayment are not adequate, you could lose all or a
part of your investment."
Debt securities will consist of Certificates of Investment and Money Market
Accounts and may be purchased in the minimum amount of $5,000 or any amount in
excess of $5,000, subject to the exception for self-directed IRA accounts (See:
"Self-Directed IRA Accounts") . You may not cumulate separate purchases to
satisfy the minimum denomination requirement.
Provisions Relating to Certificates of Investment
Maturity. We are offering Certificates of Investment with terms ranging
from three (3) to 120 months. You will select the term of each Certificate of
Investment upon your order.
26
Book Entry. Upon acceptance of an order, we will credit our book-entry
registration and transfer system to the account of the purchaser of the
Certificate of Investment with the principal amount of such security owned of
record by such purchaser, which record holder is referred to as the holder or
registered holder in this document and in the indenture. This shall represent
the sole method of recording the ownership and transfer of ownership interests
in such securities except for custodial accounts for self-directed IRAs. Also
upon acceptance of an order, we will send each holder a transaction statement,
which will indicate our acceptance of the order. The laws of some jurisdictions
require that purchasers of securities take physical delivery of those securities
in definitive form. Since these securities are issued in book entry form only,
these legal requirements may impair the holder's ability to transfer the record
ownership of the Certificate of Investment. Book entry shall represent the sole
method of recording ownership and transfer of ownership of Certificates of
Investment except for custodial accounts for self-directed IRAs (See: "Self-
Directed IRA Accounts")
The holders of Certificates of Investment issued in a book-entry form will
not receive or be entitled to receive physical delivery of a note or certificate
evidencing such indebtedness. The holders of the accounts we establish upon the
purchase or transfer of Certificates of Investment shall be deemed to be the
owners of the Certificates of Investment under the indenture. The holder of the
Certificates of Investment must rely upon the procedures established by the
trustee to exercise any rights of a holder of Certificates of Investment under
the indenture. We will provide the trustee with information regarding the
establishment of new accounts and the transfer of existing accounts on a
quarterly basis.
We will provide the trustee with information, as requested, regarding the
total amount of any principal and/or interest due to holders with regard to the
Certificates of Investment on any interest payment date or upon redemption. On
each interest payment date, we will credit interest due on each account. We will
determine the interest payments to be made to the book entry accounts and
maintain, supervise and review any records relating to book entry beneficial
interests in the notes.
Book entry notations in the accounts evidencing ownership of the
Certificates of Investment are exchangeable for actual notes in denominations of
$5,000 and any amount in excess of $5,000 and are fully registered in those
names as we direct only if:
o we, at our option, advise the trustee in writing of our election to
terminate the book-entry system, or
o after the occurrence of an event of default under the indenture,
holders of the Certificates of Investment aggregating more than 50% of
the aggregate outstanding amount of the Certificates of Investment
advise the trustee in writing that the continuation of a book-entry
system is no longer in the best interest of the holders of
Certificates of Investment and the trustee notifies all registered
holders of these securities, of the occurrence of any such event and
27
the availability of definitive notes to holders of these securities
requesting such notes.
Subject to the exceptions described above, the book-entry interests in
these securities shall not otherwise be exchangeable for fully registered
Certificates of Investment.
Interest. The interest rate payable on a Certificate of Investment will be
determined based upon the maturity date, term and other criteria established by
us at the time of your investment. Prevailing rates and terms will be set forth
in a supplement to this prospectus. We will establish the interest rates payable
on the Certificates of Investment from time to time based on market conditions
and our financial requirements. We constantly re-evaluate our interest rates
based upon this analysis. Once determined, the rate of interest payable on a
Certificate of Investment will remain fixed for the term that the Certificate of
Investment is outstanding.
We will compute interest on Certificates of Investment on the basis of an
actual calendar year and interest will compound daily. We will pay interest on
Certificates of Investment with terms of less than twelve months at maturity.
Holders of Certificates of Investment with terms of twelve months or greater may
elect to have interest paid monthly, quarterly, semiannually, annually or at
maturity. The holder may change this election one time during the term of the
Certificate of Investment. Holders must request to change the election in
writing to us. No specific change in election form is required. Any interest not
otherwise paid on an interest payment date will be paid at maturity.
We reserve the right to vary from time to time, at our discretion, the
interest rates we offer on the Certificates of Investment based on numerous
factors other than length of term to maturity. These factors may include, but
are not limited to: the desire to attract new investors; Certificates of
Investment in excess of specified principal amounts; Certificates of Investment
purchased for Self-directed IRA accounts; rollover investments; and Certificates
of Investment beneficially owned by persons residing in particular geographic
localities. We may make a decision to vary interest rates in the future based on
our fund raising objectives including, but not limited to, the attraction of new
investors in particular regions, the encouragement of the rollover of
Certificates of Investment by current holders, circumstances in the financial
markets and the economy, additional costs which we may incur in selling
Certificates of Investment in a particular jurisdiction which may at the time be
relevant to our operations and other factors.
Automatic Extension. The term of the Certificate of Investment will
automatically extend for a term identical to the term of the original
Certificate of Investment unless:
o We notify the holder at least seven days prior to the maturity date of
our intention not to extend the Certificate of Investment; or
28
o The holder elects to redeem the Certificate of Investment within seven
days after the maturity date.
Until either, the holder or we terminate or redeem the Certificate of
Investment, they will continue to renew in this manner. Each renewed Certificate
of Investment will continue in all its provisions, including provisions relating
to payment, except that the interest rate payable during any renewed term will
be the interest rate on similar Certificates of Investment being offered as of
the renewal date. If similar Certificates of Investment are not being offered,
the interest rate upon renewal will be the rate specified by us on or before the
maturity date, or the then current rate of the Certificate of Investment if no
rate is specified. If we notify the holder of our intention to repay a
Certificate of Investment at maturity, no interest will accrue after the date of
maturity. Otherwise, if a holder requests repayment within seven days after its
maturity date, we will pay interest during the period after its maturity date
and prior to repayment at the lower of:
o the lowest interest rate then being offered by us on a Certificate of
Investment or Money Market Account to the general public; or
o the rate we paid on the Certificate of Investment immediately prior to
its maturity.
As a courtesy, we provide a request for repayment form with the notice. Use
of the form by a holder is not a condition of repayment. Holder may also request
repayment by writing to us.
Optional Renewal Programs. From time to time, we may offer, in our sole
discretion, some Certificate of Investment holders the ability to extend the
maturity of an existing Certificate of Investment. This extension option if and
when offered will not be subject to the 90-day notice of redemption described in
this prospectus. If the holder elects to extend, then we will send a
confirmation statement in accordance with the terms and interest rate prevailing
at the extension date.
Place and Method of Payment. We will pay principal and interest on the
Certificates of Investment at our principal executive office or at another place
that we designate for that purpose. However, we may choose to make payments by
check or draft mailed to the persons entitled to the payments at their addresses
appearing in the register, which is maintained for that purpose.
Redemption by Us. We have the right to redeem any Certificate of Investment
at any time, prior to its stated maturity, upon 90 days written notice to the
holder. The holder has no right to require us to prepay any Certificate of
Investment prior to its maturity date as originally stated or as it may be
extended, except as indicated below.
29
Redemption by the Holder upon Death or Total Permanent Disability.
Certificates of Investment with remaining maturities of one year or greater may
be redeemed at the election of the holder, who is a natural person, following
his/her total permanent disability, as established to our satisfaction, or by
his/her estate following his/her death. The redemption price, in the event of
such a death or disability, will be the principal amount of the Certificate of
Investment, plus interest accrued and not previously paid, to the date of
redemption. If spouses are joint registered holders of an Certificate of
Investment, the election to redeem will apply when either registered holder dies
or becomes subject to a total permanent disability. In other cases of
Certificates of Investment jointly held by persons who are not legally married,
the election to redeem upon the death of one joint holder will not apply. If
person who is not a natural person such as a trust, partnership, corporation or
other similar entity, holds the Certificate of Investment, then the redemption
upon death or disability does not apply.
We may modify the foregoing policy on redemption after death or disability
in the future. However, no modification will affect the right of redemption
applicable to any outstanding Certificate of Investment.
For the purpose of determining the right of a holder to demand early
repayment of an Certificate of Investment, total permanent disability means a
determination by a physician chosen by us that the holder, who was gainfully
employed on a full time basis at the time of purchase, is unable to work on a
full time basis, at least forty hours per week, during the succeeding twenty-
four months.
Quarterly Statements. We will provide holders of the Certificates of
Investment with or statements, which will indicate, among other things, the
current account balance, including interest paid or accrued. These statements
will be mailed not later than the tenth business day following the end of each
calendar quarter.
Provisions Relating to Money Market Accounts
Maturity. The Money Market Accounts have no stated maturity and are
redeemable at any time in minimum amounts of $500, or a lesser amount available
to close an account, at the option of the holder. (See "Redemptions by the
Holder of Money Market Accounts.")
Book-Entry System. Upon acceptance of an order, we will credit to our book-
entry registration and transfer system, the principal amount of the Money Market
Accounts owned of record by that purchaser to the account of the purchaser of
the Money Market Account which record holder is referred to as the holder or
registered holder in this document and in the indenture. This shall represent
the sole method of recording the ownership and transfer of ownership interests
in such securities except for custodial accounts for self-directed IRAs. Upon
acceptance of the purchaser's order, we will send each purchaser a transaction
statement, which will indicate our acceptance of the order. The laws of some
jurisdictions require that purchasers of securities take physical delivery of
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those securities in definitive form. Since these securities are issued in book
entry form only, these legal requirements may impair the holder's ability to
transfer the record ownership of the Money Market Accounts. Book entry shall
represent the sole method of recording ownership and transfer of ownership in
Money Market Accounts except for custodial accounts for self-directed IRAs (See:
"Self-Directed IRA Accounts")
The registered holders of Money Market Accounts issued in a book-entry only
form will not receive or be entitled to receive physical delivery of a note or
certificate. The registered holders of the accounts we establish upon the
purchase or transfer of Money Market Accounts will be deemed to be the owners of
the Money Market Accounts under the indenture. Each person holding a book entry
interest in the Money Market Accounts must rely upon the procedures established
by the trustee to exercise any rights of a holder of the Money Market Accounts
under the indenture. We will provide the trustee with information regarding the
establishment of new accounts and the transfer of existing accounts on a
quarterly basis.
We will make the information regarding the total amount of any principal
and/or interest, which we will pay in the form of additional securities, due to
registered holders with regard to the Money Market Accounts on any interest
payment date or upon redemption available to the trustee upon the trustee's
request. On each interest payment date, we will credit each account, the
interest due. We will determine the interest payments to be made to the book-
entry accounts and will maintain, supervise and review any records relating to
book-entry beneficial interests in Money Market Accounts.
Book-entry interests in the accounts evidencing ownership of the Money
Market Accounts are exchangeable for actual notes in denominations of $5,000 and
any amount in excess of $5,000 and are fully registered in the names of the
accounts as we direct only if:
o we, at our option, advise the trustee in writing of our election to
terminate the book-entry system, or
o after the occurrence of an event of default under the indenture,
holders of the Money Market Accounts aggregating more than 50% of the
aggregate outstanding amount of the Money Market Accounts advise the
trustee in writing that the continuation of a book-entry system is no
longer in the best interests of the holders of Money Market Accounts
and the trustee notifies all registered holders of the Money Market
Accounts, of the occurrence of any such event and the availability of
definitive notes to holders of these securities requesting the notes.
The book-entry interests in the Money Market Accounts are not otherwise
exchangeable for fully registered securities.
31
Interest. We will adjust the interest rates payable on the Money Market
Accounts from time to time in our sole discretion provided that the rate for
each one-week period commencing on Sunday will be at least equal to the rate of
the Thirteen Week U.S. Treasury Bills auctioned the immediately preceding Monday
less one percent. No interest will be paid for any day on which the principal
balance is below $5,000, subject to the exception for self-directed IRA
accounts(See: "Self-Directed IRA Accounts").We will provide written notice to
all holders of the Money Market Accounts 14 days prior to any decrease in the
interest rate. The notice will set forth the new interest rate to be paid and
the effective date of the change. We reserve the right to increase the interest
rate paid on the Money Market Accounts at any time without prior notice to the
holders of the Money Market Accounts. Investors may inquire about the current
interest rate on the outstanding Money Market Accounts by calling us at [new
toll free number to be inserted].
Interest accrues daily and is credited monthly on the last day of each
calendar month. Interest accrued during each monthly period will not be paid by
check but will be added to the note holder's principal balance of the account in
the form of additional securities. Interest will continue to accrue on the
principal balance of each security through the date of redemption. If a holder
redeems the security in full, the principal balance of the account (including
accrued interest) will be paid by check as soon as practicable.
Subject to the limitations set forth in this prospectus, we may vary, at
our discretion, the interest rates we offer on the Money Market Accounts based
on numerous factors. These factors may include, but are not limited to: the
desire to attract new investors; Money Market Accounts in excess of specified
principal amounts; Money Market Accounts purchased for self-directed IRA and/or
Keogh accounts; and Money Market Accounts beneficially owned by persons residing
in particular geographic localities. As of the date of this prospectus, we are
not offering Money Market Accounts at varying rates to different investors.
However, we may make a decision to vary interest rates in the future based on
our fund raising objectives including, but not limited to, the attraction of new
investors in particular regions, circumstances in the financial markets and the
economy, any additional costs which may be incurred by us in selling Money
Market Accounts in a particular jurisdiction which may at the time be relevant
to our operations and other factors.
Redemption by the Holder of Money Market Accounts. The holder of the Money
Market Accounts may redeem the security at any time in minimum amounts of $500
(or any amount to close an account) upon not less than 10 business days written
notice to us.
Redemption by Us. We have the right to redeem a Money Market Account at any
time upon 30 days written notice to the holder of the note.
Place and Method of Payment Upon Redemption. We will make payments upon the
redemption of the Money Market Accounts at our principal executive office, or at
another place that we may designate for that purpose. However, we may, at our
32
option, make payments by check or draft mailed to the persons entitled to the
payments at their addresses appearing in the register, which we maintain for
that purpose.
Monthly Statements. We will provide holders of the Money Market Accounts
with monthly statements, which will indicate, among other things, the current
account balance (including interest credited and withdrawals made, if any) and
the interest rate paid on those Money Market Accounts as of the month end
preceding the issuance of the statement. The statements will be mailed not later
than the tenth business day following the end of each month. We will provide
additional statements as the holders of these securities may reasonably request
from time to time. We may require holders requesting additional statements to
pay all charges incurred by us in providing the additional statements.
Provisions Relating to All Securities
Form and Denominations/Transfers. The debt securities are not negotiable
debt instruments and, subject to some exceptions, will be issued only in book-
entry form. Upon the submission of an order, we will issue a transaction
statement reflecting the ownership of a debt security to each purchaser upon our
acceptance of the order. The transaction statement is not a negotiable
instrument, and purchasers cannot transfer record ownership without our prior
written consent. Each holder of a debt security will receive a periodic
statement indicating any transactions in the holder's account, as well as
interest credited. Owners may transfer ownership of the debt securities on our
register only by written notice to us signed by the owners or the owners' duly
authorized representatives on a form we supply and with our written consent
(which we will not unreasonably withhold). We may also, in our discretion,
require an opinion from the holder's counsel that the proposed transfer will not
violate any applicable securities laws and/or a signature guarantee in
connection with the transfer. Upon transfer of a debt security, we will provide
the new owner of the security with a transaction statement, which will evidence
the transfer of the account on our records.
Interest Accrual Date. Interest on the debt securities will accrue from the
date of purchase. The date of purchase will be for accepted orders, the date we
receive funds, if the funds are received prior to 3:00 p.m. on a business day,
or the next business day if the funds are received on a non-business day or
after 3:00 p.m. on a business day. For this purpose, our business days are
Monday through Friday, except for legal holidays in the State of Virginia.
Right of Set-off. Subject to the provisions of applicable law, if the
holder of a Certificate of Investment or a Money Market Account is a borrower or
guarantor on a loan, lease or other obligation owned by us or one of our direct
or indirect subsidiaries or affiliates, and that obligation becomes delinquent
or otherwise in default, we may have the right to set-off principal and interest
payments due on the Certificate of Investment or Money Market Account against
all sums due by the holder to our subsidiary or affiliate pursuant to the set-
off terms contained in the loan, lease, other indebtedness or the guarantee. If
33
we elect to exercise our right of set-off, the Certificate of Investment or
Money Market Account will automatically be deemed redeemed as of the date of
set-off without regard to any notice period otherwise applicable to any
redemption by us.
Subordination. The indebtedness evidenced by the debt securities, and any
interest, are subordinated to all of our senior debt. The term senior debt is
defined for this purpose to include any indebtedness (whether outstanding on the
date of this prospectus or created later) incurred by us in connection with
borrowings by us (including our subsidiaries) from a bank, trust company,
insurance company, or from any other institutional lender, whether the
indebtedness is or is not specifically designated by us as being "senior debt"
in its defining instruments. The debt securities are not guaranteed by any of
our subsidiaries. Accordingly, in the event of a liquidation or dissolution of
one of our subsidiaries, the law requires that we pay or make provisions for
payment of the creditors of that subsidiary from the assets of that subsidiary
prior to distributing any remaining assets to us as a shareholder of that
subsidiary. Therefore, in the event of liquidation or dissolution of a
subsidiary, creditors of that subsidiary will receive payment of their claims
prior to any payment to the holders of the debt securities. As of September 30,
2000, $51.2 million of senior debt and subsidiary debt were outstanding, and as
of December 31, 1999, $82.9 million of senior debt and subsidiary debt were
outstanding. The provisions of indenture do not limit the amount of senior debt
or subsidiary debt we can incur. Any of our indebtedness, other than that
described as senior debt and the debt of the subsidiaries, will have rights upon
liquidation or dissolution of us which ranks equally in right of payment to the
debt securities being offered. As of September 30, 2000, we had $4.8 million,
and as of December 31, 1999, we had $5.1 million of debt outstanding, which
ranks equally in right of payment to the debt securities offered.
For a discussion of the lack of insurance or guarantees to support the
repayment of the debt securities, see "Risk Factors".
In the event of any liquidation, dissolution or any other winding up of us,
or of any receivership, insolvency, bankruptcy, readjustment, reorganization or
similar proceeding under the U.S. Bankruptcy Code or any other applicable
federal or state law relating to bankruptcy or insolvency, or during the
continuation of any event of default (as described below), no payment may be
made on the notes until all senior debt has been paid. If any of the above
events occurs, holders of senior debt may also submit claims on behalf of
holders of the notes and retain the proceeds for their own benefit until they
have been fully paid, and any excess will be turned over to the holders of the
debt securities. If any distribution is nonetheless made to holders of the debt
securities, the money or property distributed to them must be paid over to the
holders of the senior debt to the extent necessary to pay senior debt in full.
See "Risk Factors -- Since the debt securities are unsecured and second in right
of repayment to our senior debt borrowed from institutional lenders, in the
event of insolvency, debt holders would be repaid only if funds remain after the
repayment of our senior debt."
34
Events of Default. The indenture provides that each of the following
constitute an event of default:
o default for 30 days in the payment of interest when due on the debt
securities (whether or not prohibited by the subordination provisions
of the indenture);
o default in payment of principal when due on the debt securities
(whether or not prohibited by the subordination provisions of the
indenture) and continuation of the default for 30 days;
o our failure to observe or perform any covenant, condition or agreement
with respect to the liquidation, consolidation or merger or other
disposition of substantially all of our assets (after notice and
provided such default is not cured within 60 days after receipt of
notice);
o our failure for 60 days after notice to comply with other agreements
described in the indenture or the debt securities; and
o specific events of bankruptcy or insolvency with respect to us.
If any event of default occurs and continues, the trustee or the holders of
at least a majority in principal amount of the then outstanding notes may
declare the unpaid principal of and any accrued interest on the debt securities
to be due and payable immediately. However, so long as we have any outstanding
senior debt, a declaration of this kind will not become effective until the
earlier of:
o the day, which is five business days after the receipt by
representatives of senior debt of such written notice of acceleration
or
o the date of acceleration of any senior debt.
In the case of an event of default arising from specific events of
bankruptcy or insolvency, with respect to us, all outstanding debt securities
will become due and payable without further action or notice. Holders of the
notes may not enforce the indenture or the debt securities except as provided in
the indenture. Subject to these limitations, holders of a majority in principal
amount of the then outstanding notes may direct the trustee in its exercise of
any trust or power. The trustee may withhold from holders of the notes notice of
any continuing default or event of default (except a default or event of default
relating to the payment of principal or interest) if the trustee determines that
withholding notice is in the interest of the holders.
The holders of a majority in aggregate principal amount of the debt
securities then outstanding, by notice to the trustee, may, on behalf of the
holders of all of the notes, waive any existing default or event of default and
35
its consequences under the indenture, except a continuing default or event of
default in the payment of interest on or the principal of the notes.
We are required to deliver to the trustee annually a statement regarding
compliance with the indenture, and we are required upon becoming aware of any
default or event of default, to deliver to the trustee a statement specifying
such default or event of default.
Amendment, Supplement and Waiver. Except as provided in this prospectus, we
may amend or supplement the indenture or the terms of the debt securities may be
amended or supplemented with the consent of the holders of at least a majority
in principal amount of the debt securities then outstanding. The holders of a
majority in principal amount of the then outstanding notes, may waive any
existing default or compliance with any provision of the indenture or the debt
securities.
Without the consent of each holder of the Certificates of Investment
affected, an amendment or waiver may not (with respect to any Certificates of
Investment held by a nonconsenting holder of Certificate of Investments):
o reduce the principal amount of any Certificate of Investment whose
holder must consent to an amendment, supplement or waiver;
o reduce the principal of, or change the fixed maturity of, any security
or alter the redemption provisions or the price at which we shall
offer to repurchase the Certificate of Investment;
o reduce the rate of, or change the time for payment of interest,
including default interest, on any subordinated security;
o waive a default or event of default in the payment of
interest, principal or premium, if any, or redemption payment with
respect to the Certificates of Investment(except a rescission of
acceleration of the Certificates of Investment by the holders of at
least a majority in aggregate principal amount of the Certificates of
Investment and a waiver of the payment default that resulted from such
acceleration);
o make any subordinated security payable in money other than that stated
in the security confirmation;
o make any change in the provisions of the indenture relating to waivers
of past defaults or the rights of holders of Certificates of
Investment to receive payments of principal or interest on the
subordinated securities;
o make any change to the subordination provisions of the indenture that
adversely affects holders;
36
o modify or eliminate holders' redemption rights (provided that no
modification or elimination is permitted as to any securities issued
with such right); or
o make any change in the foregoing amendment and waiver
provisions.
Without the consent of each holder of the Money Market Accounts affected,
an amendment or waiver may not (with respect to any Money Market Accounts held
by a nonconsenting holder of Money Market Accounts):
o reduce the principal amount of Money Market Accounts whose holders
must consent to an amendment, supplement or waiver (other than as a
result of withdrawals made by the holder of the note);
o reduce the principal of any Money Market Account(other than as a
result of withdrawals made by the holder of the note) or alter the
redemption provisions of the Money Market Account or the price at
which we shall offer to repurchase the Money Market Account;
o reduce the rate of interest on the Money Market Accounts, other than
the rate adjustments provided for pursuant to the terms of the Money
Market Accounts or change the time for payment of interest, including
default interest, on any Money Market Account;
o waive a default or event of default in the payment of
interest, principal or premium, if any, or redemption payment with
respect to the Money Market Accounts (except a rescission of
acceleration of the Money Market Accounts by the holders of at least a
majority in aggregate principal amount of the Money Market Accounts
and a waiver of the payment default that resulted from such
acceleration);
o make any Money Market Account payable in money other than that stated
in the Money Market Accounts;
o make any change in the provisions of the indenture relating to waivers
of past defaults or the rights of holders of Money Market Accounts to
receive payments of principal or interest on the Money Market
Accounts;
o make any change to the subordination provisions of the indenture that
adversely affects holders of Money Market Accounts;
o modify or eliminate redemption right of holders of the money market
notes; or
o make any change in the foregoing amendment and waiver
provisions.
37
However, without the consent of any holder of the debt securities, we
and/or the trustee may amend or supplement the indenture or the debt securities:
o to cure any ambiguity, defect or inconsistency; to provide for
assumption of our obligations to holders of the debt securities in the
case of a merger or consolidation;
o to provide for additional certificates or certificated
securities;
o to make any change that would provide any additional rights or
benefits to the holders of the notes or that does not adversely affect
the legal rights under the indenture of any such holder, including an
increase in the aggregate dollar amount of debt securities, which may
be outstanding under the indenture;
o to modify our policy to permit redemptions of the Certificates of
Investment upon the death or total permanent disability of any holder
of the Certificates of Investment(but such modification shall not
adversely affect any then outstanding security); or
o to comply with requirements of the SEC in order to effect or maintain
the qualification of the indenture under the Trust Indenture Act.
The Trustee. The indenture imposes restrictions on the trustee, should it
become one of our creditors, regarding payments of claims, property received and
proceeds on the sale of property received as security or otherwise. The trustee
will be permitted to engage in other transactions with us.
Subject to exceptions described in the indenture, the holders of a majority
in principal amount of the then outstanding debt securities will have the right
to direct the time, method and place of conducting any proceeding for exercising
any remedy available to the trustee. The indenture provides that in case an
event of default specified in the indenture occurs and is not cured, the trustee
will be required, in the exercise of its power, to use the degree of care of a
reasonable person in the conduct of his own affairs. Subject to those
provisions, the trustee will be under no obligation to exercise any of its
rights or powers under the indenture at the request of any holder of notes,
unless the holder has offered the trustee security and indemnity satisfactory to
it against any loss, liability or expense.
Reports to Trustee. We will provide the trustee with quarterly reports,
which will contain the information reasonably requested, by the trustee. These
quarterly reports will include information regarding the outstanding balance,
38
interest credited, withdrawals made and interest rate paid related to each
account we maintain during the preceding quarterly period.
No Personal Liability of Directors, Officers, Employees and Stockholders.
No director, officer, employee, incorporator or stockholder of ours, will have
any liability for any obligations of ours under the notes, the indenture or for
any claim based on, in respect to, or by reason of, these obligations or their
creation. Each holder of the debt securities waives and releases these persons
from any liability. The waiver and release are part of the consideration for
issuance of the debt securities. We have been advised that the waiver may not be
effective to waive liabilities under the federal securities laws and that the
SEC views these waivers as against public policy.
Service Charges. We reserve the right to assess service charges for
replacing lost or stolen Certificates of Investment(for which an affidavit from
the holder will be required), changing the registration of any security to
reflect a change in name of the holder, or a transfer (whether by operation of
law or otherwise) of a security by the holder to another person.
Interest Withholding. With respect to those investors who do not provide us
with a fully executed Form W-8 or Form W-9, we will withhold 31% of any interest
paid for United States taxes. Otherwise, we will not withhold interest, except
on debt securities held by foreign business entities. It is our policy that no
sale will be made to anyone refusing to provide a fully executed Form W-8 or
Form W-9.
Additional Securities. We may offer from time to time additional classes of
securities with terms and conditions different from the debt securities being
offered. We will amend or supplement this prospectus if and when we decide to
offer to the public any additional class of security under this prospectus.
Variations by State. We reserve the right to offer different securities and
to vary the terms and conditions of the offer (including, but not limited to,
different interest rates, additional interest payments and service charges for
all notes) depending upon the state where the purchaser resides.
Self-directed IRA Accounts. The minimum initial investment and minimum
balance for Certificates of Investment and Money Market Accounts registered in
the name of a custodian for the benefit of an individual's self-directed IRA is
$2,000. A certificate representing ownership of the securities will be issued to
the custodian of the IRA for benefit of the IRA owner. Request for transfer of
ownership from an IRA custodial account to a non-IRA account will be subject to
the procedures described above in the section titled `Form and
Denominations/Transfers' and upon transfer the new owner of the security will be
issued a transaction statement, which will evidence the transfer of the account
to the new owner in book entry form.
39
INTEREST OF NAMED EXPERTS AND COUNSEL
None.
BUSINESS
Forward Looking Statements
Some of the information in this prospectus may contain forward-looking
statements. These forward-looking statements regarding our business and
prospects are based upon numerous assumptions about future conditions, which may
ultimately prove to be inaccurate. Actual events and results may materially
differ from anticipated results described in those statements. Forward-looking
statements involve risks and uncertainties described under "Risk Factors",
"Business", "Management's Discussion And Analysis Of Financial Condition And
Results Of Operations", "Interest Rate Risk" And "Quantitative And Qualitative
Discussion About Market Risk" Sections, as well as other portions of the
prospectus, which could cause actual results to differ materially from
historical earnings and those presently anticipated. When considering forward-
looking statements, you should keep these risk factors in mind as well as the
other cautionary statements in this prospectus. You should not place undue
reliance on any forward-looking statement.
Certain statements in this prospectus which are not merely historical facts
are forward-looking statements within the meaning of the Private Securities
Litigation Act of 1995 concerning Approved Financial Corp. and our subsidiaries
concerning future loan production volume, revenues from loan sales,
restructuring and expense reduction initiatives, ability to profitably
participate in any present or future line of business or operation are forward-
looking statements. You can identify these statements by words or phrases such
as "will likely result," "may," "are expected to," "will continue to," "is
anticipated," "estimate," "projected," "intends to" or other similar words.
There are a number of important factors that could cause our actual results to
differ materially from those indicated in such forward-looking statements. Those
factors include, but are not limited to our ability to implement restructuring
and expense reduction plans, our ability to retain experienced personnel, any
changes in residential real estate values, changes in industry competition,
general economic conditions, changes in interest rates, changes in the demand
for non-conforming or conforming mortgage loans, our availability of affordable
funding sources for capital liquidity, changes in loan prepayment speeds,
delinquency and default and loss rates, changes in regulatory issues concerning
mortgage companies, federal banks, or insurance companies, changes in GAAP
accounting standards effecting our financial statements, and any changes which
influence any market for profitable sales of all of our products and services
including mortgage loans.
40
General
Primary Business. Approved Financial Corp. is a Virginia-chartered
financial institution, principally involved in originating, purchasing,
servicing and selling loans secured primarily by conforming and non-conforming
first and junior liens on owner-occupied, one-to-four-family residential
properties. We offer both fixed-rate and adjustable-rate loans for debt
consolidation, home improvements, purchase and other purposes. Historically,
our specialty was lending to the "non-conforming" borrower who does not meet
traditional "conforming" or government agency credit qualification guidelines,
but who exhibits both the ability and willingness to repay the loan. The needs
of these individuals are generally not being served by traditional financial
institutions due to such individuals' impaired credit profiles often resulting
from personal issues such as divorce, family illness or death and a temporary
loss of employment due to corporate downsizing as well as other factors.
Operating under current management for the past sixteen years, we have helped
non-conforming mortgage customers satisfy their financial needs and in many
cases has helped them improve their credit profile. Through our retail division
we also originate, service and sell traditional conforming mortgage products and
government mortgage products such as VA and FHA.
We utilize broker and retail channels to originate loans. At the broker
level, an extensive network of independent mortgage brokers generates referrals.
This loan source has been a successful and profitable mainstay of the business
for many years. We began making residential mortgage loans through retail
offices during the fourth quarter of 1994. In 1999, the dollar volume in the
broker lending division accounted for 32.5% of total originations and the retail
lending division accounted for 67.5% of total originations. For the nine-month
period ended September 30, 2000 the broker lending division accounted for 46.8%
of total originations and the retail lending division accounted for 53.1% of
total originations. Our current initiatives focus on increasing future
origination volume in a cost-effective manner through the broker and retail
channels.
Once loan applications are received from the broker and retail networks,
the underwriting process is completed and the loans are funded, we typically
package the loans and sell them on a whole loan basis to institutional investors
consisting primarily of larger financial institutions. We sell conforming loans
to large financial institutions and to government and quasi-government agencies.
The proceeds from these sales release funds for additional lending.
We historically have derived our income primarily from the premiums
received on whole loan sales to institutional investors, net warehouse interest
earned on loans held for sale, net interest income on loans held for yield,
origination and other fees received as part of the loan application process and
to a lesser extent from ancillary fees associated with the portfolio of loans
serviced and from our other financial services offered through Approved
Financial Solutions. In future periods, we may generate revenue from loans sold
through alternative loan sale strategies such as securitization, from other
types of consumer finance lending and from the sale of other financial products
and services.
41
Corporate History. Incorporated in 1952 as a subsidiary of Government
Employees Insurance Co. ("GEICO"), Approved Financial Corp. was acquired in
September 1984 by, among others, several members of current management. We are
headquartered in Virginia Beach, Virginia, and hold a Virginia industrial loan
association charter and are therefore subject to the supervision, regulation and
examination of the Virginia State Corporation Commission's Bureau of Financial
Institutions.
As of September 30, 2000, Approved Financial Corp. had four primary
operating subsidiaries:
o Approved Federal Savings Bank ("Bank")
o Approved Residential Mortgage, Inc. ("ARMI")
o Approved Financial Solutions ("AFS").
o Global Title of Maryland, Inc.
Bank. In September 1996 we acquired Approved Federal Savings Bank(the
"Bank"), a federally chartered institution. The Bank is subject to the
supervision, regulation and examination of the Office of Thrift Supervision (the
"OTS") and the Federal Deposit Insurance Corporation ("FDIC"). We are a
registered savings and loan holding company under the federal Home Owner's Loan
Act ("HOLA") because of our ownership of the Bank. As such, we are subject to
the regulation, supervision and examination of the OTS. The Bank is also subject
to the regulations of the Board of Governors of the Federal Reserve System
governing reserves required to be maintained against deposits.
The principal business activity of the Bank, also headquartered in Virginia
Beach, is attracting deposits and originating, investing in and selling loans
primarily secured by first and junior mortgage liens on single-family dwellings,
including condominium units. To a lesser extent the Bank from time to time
originates consumer loans to credit worthy customers. The Bank also invests in
certain U.S. Government and agency obligations and other investments permitted
by applicable laws and regulations. The operating results of the Bank are
highly dependent on net interest income, the difference between interest income
earned on loans and investments and the cost of deposits and borrowed funds. The
Bank's charter provides for ease of entry into new markets, with reduced legal
costs. By taking advantage of the flexible provisions of the charter, the Bank
is able to make real estate-secured loans in many states without the expense and
time involved in the licensing process for non-bank mortgage companies. The Bank
originates loans utilizing a network of mortgage brokers for loan referrals and
through retail mortgage lending offices. The Bank has contracted us to provide
the processing, underwriting and closing procedures for Bank operations. We have
agreed to purchase all nonconforming mortgage loans made by the Bank. We have
sold in the secondary market most of the loans purchased from the Bank.
Deposit accounts of the Bank up to $100,000 are insured by the Association
Insurance Fund, administered by the FDIC. The Bank is a member of the Federal
Home Loan Bank (the "FHLB") of Atlanta. Therefore, the Bank and we are subject
42
to the supervision, regulation and examination of the OTS and the FDIC. The
Bank is also subject to the regulations of the Board of Governors of the Federal
Reserve System governing reserves required to be maintained against deposits.
However, the Bank and the FDIC do not insure the Securities being offered by
this prospectus.
Approved Residential Mortgage, Inc. ("ARMI") was formed in April 1993.
Initially ARMI originated loans through broker referrals. In 1994 ARMI opened
its first retail operation. Currently, ARMI's primary business activity is to
originate non-conforming residential mortgage loans on a retail basis.
Approved Financial Solutions, Inc. ("AFS") was formed in November of 1998
for the initial purpose of offering life insurance to our loan customers. To
date, life insurance sales have not represented a material source of revenue and
are not anticipated to do so in the near future. AFS offers ancillary financial
products such as Mortgage Acceleration Program ("MAP") and Debt Free Solutions
Program. (See: "Business Strategy (v) Expand product and financial service
offerings")
Global Title of Maryland, Inc. To facilitate the restructure of our title
insurance division, this subsidiary was formed during the first part of the year
2000 and offers title insurance products to our customers in the states where we
hold licenses.
Inactive Subsidiary. A fifth wholly owned subsidiary, MOFC, Inc. d/b/a/
ConsumerOne Financial ("ConsumerOne"), located in Birmingham, Michigan was
acquired in December of 1998. The operations of ConsumerOne were transferred to
the Bank during 2000 and currently operate as a retail loan origination branch
of the Bank and serves as a disaster "hot" site for us.
43
Business Strategy
Our current corporate business strategies include but are not limited to the
following;
(i) Maintain quality loan underwriting and servicing standards.
(ii) Maintain strict cost controls and reduce expenses through the continued
application of new technologies.
(iii) Increase revenues by expanding the level of profitable volume from retail
branches, through strategic alliances and from broker referrals.
(iv) Diversify loan sale strategies and investors with a commitment to prudent
management of cash flow.
(v) Expand product and financial service offerings.
(vi) Build on the opportunities available through the Bank.
(vii) Leverage the marketing and advertising division with new applications.
(i) Maintain Quality Loan Underwriting and Servicing Standards. Our
underwriting and servicing staff have experience in the non-conforming, home
equity loan industry. We believe that the experience of our underwriting and
servicing staff provides us with the infrastructure and skills necessary to
maintain our commitment to solid underwriting standards during periods of rapid
growth as well as through times of unprecedented competition, which the mortgage
industry has experienced over recent years.
(ii) Maintain strict cost controls and reduce expenses through the
continued application of new technologies. During 1999 we implemented several
cost cutting campaigns, one of which centralized all marketing and advertising
efforts in the Virginia Beach headquarters location. Additionally, during
December of 1999 we combined the home office staff of three Virginia Beach
locations into its new headquarters building. This move facilitates greater
operating efficiencies and improved internal communication. Another campaign
introduced in October of 1999, was the conversion to a new systems platform. The
benefits anticipated from this conversion include but are not limited to, a
significant reduction in the amount of multiple data entry, the transfer of
documents electronically ("e-docs"), real-time management reporting, remote
location interactive training for users and greatly enhanced data integrity and
quality control.
(iii) Increase revenues by expanding the level of profitable volume from
retail branches, through strategic alliances, from broker referrals and through
utilization of the internet.
Retail. We intend to expand our loan origination volume from its retail
branch network by building larger sales staffs in each location and retaining
highly seasoned mortgage professionals as branch managers and as corporate sales
trainers.
Strategic Alliances. We look to strengthen our retail loan production
capabilities not only through internal growth, but also from time to time
through the development of strategic alliances with other mortgage companies. We
44
believe that these relationships can accelerate the pace of growth in a cost-
effective manner with minimal initial investment or long-term financial
commitment. These candidates must exhibit management styles compatible with our
management team and with business strategies that complement our own. We adheres
to the belief that "people" are more important than "location" in the lending
business, therefore we seek qualified individuals with proven track records for
management positions and or strategic relationships in lieu of targeting a
geographic area and then looking for an appropriate candidate.
Broker Referrals. Our wholesale division sales efforts are conducted
through account executives with extensive experience in the non-conforming
mortgage business located in several states. To augment these sales efforts we
are currently exploring an effective structure to facilitate an inside sales
staff who will solicit broker referral business from the home office in Virginia
Beach. We launched, during September of 2000, and are currently developing a new
wholesale division, located in Huntington Beach, California, to service the
western portion of the United States.
Internet Applications. We are currently launching a business-to-business
web-based platform to facilitate more efficient and cost-effective service to
our broker network and to our off site wholesale and retail sales staff. This
password secured application allows off site loan origination personnel to
access their loan files in process, retrieving underwriting status and
outstanding stipulations needed. We feel that business-to-business applications
present immediate value to us. We launched a website
http://www.approvedfinancialsolutions.com during 2000 related to our new
financial services products (see (v) Broaden Product Offerings in this section).
(iv) Diversify loan sale strategies and investors with a commitment to
prudent management of cash flow. We historically have sold our loans on a whole
loan basis receiving cash at the time of sale. Beginning in the second half of
1998, many of our investors that utilized the securitization market as their
primary loan sale strategy experienced significant difficulty with capital and
liquidity issues. Since 1998, the secondary market place has experienced
unprecedented turmoil as a result of the liquidity issues faced by many in the
non-conforming mortgage industry, the result of which explains the drop in our
average non-conforming loan sale premiums received from 5.4% in 1998 to 3.1% in
1999, excluding seasoned loan sales. In order to reduce our dependence on any
individual investor, we initiated a campaign to diversify our investor base by
increasing the number of relationships and the types of investors to whom we
sell loans. We have been successful in obtaining new investors having reduced
the percentage of loans sold to a single investor from 66% in 1997 to 30% in
1998 and down to 16% in 1999. We continue to aggressively pursue expansion of
our investor base for loan sales.
Alternative or complementary loan sale strategies, such as asset-backed
securitization, may be utilized in the future in addition to whole loan sales.
However, any new strategy will be adopted only after prudent economic analysis
has been performed to determine the long-term effects that such a strategy would
have on our profitability, capital base and liquidity.
45
(v) Broaden Product Offerings. We frequently review our traditional non-
conforming pricing and loan offerings for competitiveness relative to the
origination and secondary markets. We introduce new loan products to meet the
needs of its brokers and borrowers and to expand its market share to new
customers who are not traditionally part of our market.
a. Conforming Division: In order to facilitate the funding of conforming loans
in-house in lieu of funding these loans through other lenders, a strategic
alliance was formed with a Virginia Beach based conforming lender in March
1999 which facilitates the funding of conforming, VA and FHA loans in-house.
b. Title Insurance Division: Over the past year, we restructured our title
insurance operation and retained an individual with many years of experience
in the title insurance business to run the operation. This division is
licensed in the states of Maryland and Virginia and is in the licensing
process in other states where we have a strong retail presence.
c. During late 1999 and 2000, we developed various ancillary financial products
and services, such as a Mortgage Acceleration Program and Debt Free
Solutions program. Both of these programs are designed to assist consumers
in accelerating the repayment of their outstanding consumer and mortgage
debt. Marketing strategies for these products are presently being assessed
for cost effectiveness and estimated success in generating profitable sales
of these new products. A website http://www.approvedfinancialsolutions.com
is operational for illustration of the benefits offered by these products
and it is expected to be part of the future marketing strategy.
(vi) Building on Our Investment in the Bank. The Bank's ability to raise
FDIC-insured deposits and to obtain Federal Home Loan Bank advances to finance
its activities is a significant benefit to us by providing a lower cost source
of funds. The Bank facilitates ease of entry into new states by way of the
charter, which exempts many expensive and time consuming licensing procedures.
The Bank as a federal thrift charter provides many additional opportunities that
we have not yet developed, such as Small Business Administration (SBA) and Small
Business Investment Corporation (SBIC) and Trust activities. We plan to explore
these areas in the future.
46
(vii) Leverage the marketing and advertising division with new
applications. A targeted advertising and marketing division is centralized in
the Virginia Beach facility, using outbound and inbound telemarketing, direct
mail, newspaper advertising and various other mediums to obtain potential
customers leads for the retail branches. We centralized all of our advertising
and marketing activities in order to better measure the effectiveness of various
advertising campaigns, achieve economies of scale, ensure the quality of its
marketing efforts, and to secure compliance with various regulations associated
with these activities. We leverage this operation by generating leads for sale
to other companies and for additional internal marketing campaigns unrelated to
individual mortgage lead generation.
Our Borrowers and Our Loan Products
Our primary products are fixed-rate and adjustable-rate mortgage loans for
purposes such as debt consolidation, home improvements and home purchase,
serving both conforming and non-conforming borrowers. These loans secured
primarily by first and junior liens on owner-occupied, one-to-four-family
residential properties.
Prior to the establishment of a conforming origination division in March
1999, we catered solely to individuals who do not meet the strict qualification
guidelines established by most conforming lending programs. These customers
historically have experienced limited access to credit, but their financial
needs are nonetheless real. By consolidating their debts with a mortgage loan
from us, these customers can often save several hundred dollars per month in
cash flow, amounts that can make a significant difference in a customer's
financial situation and quality of life. Personal circumstances including
divorce, family illnesses or deaths and temporary job loss due to layoffs and
corporate downsizing will often impair an applicant's credit record. Among our
specialties is the ability to identify and assist this type of borrower in the
establishment of improved credit. In this segment of the mortgage loan
business, the interest rate or origination costs charged on loans is not the
overriding concern of customers but rather the size of their monthly payment.
Therefore, these customers are less rate-sensitive than conforming loan
customers and therefore lenders compete more often by flexibility in
underwriting criteria and through the quality and speed of service.
Loans made to such credit-impaired borrowers generally entail a higher
frequency of delinquency and loan losses than those for more creditworthy
borrowers. The severity of loan losses is normally related to the loan to value
ratios associated with a mortgage loan. In order to compensate us for the
increased credit risks associated with its non-conforming borrowers, higher
interest rates and origination fees or points are charged for these loans
compared to higher credit quality conforming real estate loans. No assurance can
be given that our underwriting policies and collection procedures will
substantially reduce such risks. In the event that warehoused loans or
portfolio loans held and serviced by the us experience higher than anticipated
delinquency, foreclosure, loss or prepayment speed rates, our results of
47
operation or financial condition would be adversely affected.
Most of the loans we make are used by the borrowers for debt consolidation,
property improvement, home purchase and other purposes. Borrowers may gain the
income tax advantages of real estate-secured debt by paying off higher-rate
credit cards on which interest payments are generally not tax-deductible. We
offer fixed and adjustable rate mortgages, however, most of the loans carry
fixed interest rates with 20- to 30-year terms and provide for a prepayment
penalty. The average size of non-conforming loans that we funded in-house during
the nine-month period ended September 30, 2000 was $70,109 and was $63,000
during the year ended 1999. The average size of non-conforming loans that we
originated, including retail loans funded through other lenders ("brokered
loans") during the nine-month period ended September 30, 2000 was $69,542 and
was $71,000 during the year ended 1999. The average size of conforming loans
that we funded during the nine-month period ended September 30, 2000 was
$102,410 and was $101,000 during the year ended 1999.
There is an active secondary market for most types of mortgage loans that
we originate. The majority of our loans are sold to other mortgage companies,
finance companies and other financial institutions including federally chartered
banking institutions. The loans are sold for cash on a whole loan, servicing-
released basis. Consistent with industry practices, the loans are sold with
certain representations and warranties. However, we may adopt alternative or
complimentary loan sale strategies in the future. We plan to make additional
investments in technology to further streamline our operating procedures,
enhance productivity, reduce expenses and provide for future expansion. However,
we expect that we would have to invest in additional capabilities if we enter
the securitization business.
We have the ability to originate loans through the Bank that are not
secured by real estate collateral, including consumer installment debt. If
offered, these products will be underwritten based on the borrower's credit
worthiness. As is the case with its other loan products, our intention would be
to sell these loans in the secondary market, to limit its exposure to future
losses. To date, the amount of non-real estate secured loans originated by us
have not been material.
Broker Loan Originations. We originate non-conforming residential mortgage
loans through a network of independent mortgage brokers who offer our products
to their clients. During 1999, loans originated from this source declined both
in the absolute dollar amount of loans originated and as a percentage of total
loan volume. Loans originated from mortgage broker referrals declined to $126.9
million or 32.5% of the total loan volume compared to $203.9 or 39.0% of 1998
loan volume. The loan volume originated from this source during the nine-months
ended September 30, 2000 was $99.4 million, representing 46.8% of total loan
volume as compared to $80.2 million and 28.4% for the same period in 1999.
In cultivating this broker network, we stress superior service, efficiency,
flexibility and professionalism. Due to concentrated size and centrally-
48
organized operations, we normally offer one business day turnaround on
underwriting decisions and can close loans in as few as two business days with
appropriate documentation provided to the underwriting and processing
department. A wide variety of loan products have been designed to assist
brokers in supporting a broader spectrum of borrowers. A team of regional sales
managers and account executives assist mortgage brokers in the field. The
majority of the loans are underwritten at our Virginia Beach, Virginia
headquarters.
We plan to continue to develop the broker sales force with ongoing training
programs. Additionally, we are building an inside sales division to augment the
efforts of the account executives in the field.
In late September 2000, we launched a new wholesale division located in
Huntington Beach, California to service the western portion of the United
States. This new division is under development with the goal of increasing
broker referred loan originations and to further the geographic diversification
of our mortgage production volume.
Retail Loan Originations. During 1999 loans originated from the retail
division totaled $263.9 or 67.5% of total volume for the year compared to $318.1
or 60.9% during 1998. During the nine months ended September 30, 2000, loans
originated from the retail division totaled $112.6 million or 53.1% of total
volume compared to $202.1 million or 71.6% for the same period in 1999.
We initiated retail loan origination in December 1994. As a result of the
drastic changes that occurred in the mortgage industry beginning in the fourth
quarter of 1998, revenues from premiums received on whole-loan sales dropped
materially from 5.3% during the third quarter of 1998 to 3.1% in the fourth
quarter of 1999. As a result, the smaller retail branch structure, which
comprised many of the locations in 1998, no longer represented a profitable
business model and had to be eliminated. We found it necessary to dramatically
restructure our retail operations. At the end of 1998, we had 26 retail branches
compared to 11 offices at December 31, 1999, a reduction of 58 percent.
The new retail branch strategy encompasses a "super branch" structure with
larger sales staffs, greater loan volume per location and highly seasoned
mortgage professionals serving as branch managers. As illustration, while the
number of retail sales offices decreased by 58% from year end 1998 to 1999, the
dollar volume of loans originated from this source declined by only 17%. We
intend to expand its loan origination volume from its retail branch network by
continuing this super branch strategy with continuous product and sales training
for loan officers.
To support the retail sales efforts, integrated marketing programs have
been designed to generate new business. Retail customer demand is generated
through targeted outbound telemarketing, direct mail and multimedia advertising,
which generate inbound telemarketing leads. (See "Marketing")
49
Strategic Alliances. In order to increase volume and to diversify our
sources of loan originations, we seek to enter into strategic alliances with
selected mortgage originators as opportunities occur. We have no predefined
structure of such alliances because we anticipate that each will provide unique
opportunities.
During 2000, we made an agreement with the management of a smaller mortgage
operation located in New Jersey. We formed a new retail branch that is run by
management of the prior company, hired the loan origination employees of this
operation, assumed the operating expenses for its loan origination staff and
provided the branch with services such as underwriting, closing, quality
control, secondary marketing, human resource, legal and payroll.
Underwriting Guidelines
We underwrite non-conforming, conforming conventional and government
mortgage loans. Underwriting Criteria for all mortgage loans reflects the
underwriting criteria of our whole-loan investors. Historically, the majority of
mortgage loans funded by us have been non-conforming loans. We began funding
conforming conventional and government mortgages in the second half of 1999.
Non-Conforming Mortgage Loans. Historically, we have focused on the non-
conforming mortgage business. The following is a general description of the non-
conforming underwriting guidelines that we currently use with respect to
mortgage loans we originate. We revise such guidelines from time to time in
connection with changing economic and market conditions. We may make exceptions
to these guidelines for special types of loans, we rely on the judgment of the
underwriting staff in making these exceptions. Also, we will substitute
underwriting guidelines of other lenders to which we anticipate selling such
loans under an established buy-sell agreement.
Loan applications received from retail offices and brokers are classified
according to certain characteristics including available collateral, loan size,
debt ratio, loan-to-value ratio and the credit history of the applicant. Loan
applicants with less favorable credit ratings generally are offered loans with
higher interest rates and lower loan-to-value ratios than applicants with more
favorable credit ratings. Our underwriting standards are designed to provide a
program for all qualified applicants in an amount and for a period of time
consistent with each applicant's demonstrated willingness and ability to repay.
Our underwriters make determinations on loans without regard to sex, marital
status, race, color, religion, age or national origin. Each application is
evaluated on its individual merits, applying the guidelines set forth below, to
ensure that each application is considered on an equitable basis.
A current credit report by an independent and nationally recognized credit
reporting agency reflecting the applicant's complete credit history is required.
The credit report will disclose whether any instances of adverse credit appear
on the applicant's record. Such information might include delinquencies,
repossessions, judgments, foreclosures, bankruptcies and similar instances of
50
adverse credit that can be discovered by a search of public records. An
applicant's recent credit performance weighs heavily in our evaluation of risk.
A lack of credit history will not necessarily preclude a loan if the borrower
has sufficient equity in the property. Slow payments on the borrower's credit
report must be satisfactorily explained and will normally reduce the amount of
the loan for which the applicant can be approved.
The underwriting department is headquartered in our Virginia Beach,
Virginia office. We have underwriters located in the broker operations centers
in Florida and California. Our loan application and approval process generally
is conducted via facsimile submission of the credit application to our
underwriters. An underwriter reviews the applicant's employment history and
financial status as contained in the loan application, current bureau reports
and the real estate property characteristics as presented on the application in
order to determine if the loan is acceptable under our underwriting guidelines.
Based on this review, the underwriter assigns a preliminary rating to the
application. The proposed terms of the loan are then communicated to the retail
loan officer or broker responsible for the application who in turn discusses the
proposal with the loan applicant. When a potential borrower applies for a loan
through a branch office, the underwriter may discuss the proposal directly with
the applicant. We endeavor to respond with preliminary proposed loan terms, and
in most cases do respond, to the broker or borrower within one business day from
when the application is received. If the applicant accepts the proposed terms,
the underwriter will contact the broker or the loan applicant to gather
additional information necessary for the closing and funding of the loan.
All loan applicants must have an appraisal of their collateral property
prior to closing the loan. We require loan officers and brokers to use licensed
appraisers that are listed on or qualify for our approved appraiser list. We
approve appraisers based upon a review of sample appraisals, professional
experience, education, membership in related professional organizations, client
recommendations and review of the appraiser's experience with the particular
types of properties that typically secure our loans.
The decision to provide a loan to an applicant is based upon the value of
the underlying collateral, the applicant's creditworthiness and the our
evaluation of the applicant's willingness and ability to repay the loan. A
number of factors determine a loan applicant's creditworthiness, including debt
ratios (the borrower's monthly expenses for debts, including fixed monthly
expenses for housing, taxes and installment debt, as a percentage of gross
monthly income), payment history on existing mortgages, customer's history of
bankruptcy, the credit score of the applicant provided from services accepted by
the various investor's who buy our loans and the combined loan-to-value ratio
for all existing mortgages on a property.
Assessment of the applicant's demonstrated willingness and ability to pay
is one of the principal elements in distinguishing our lending specialty from
methods employed by traditional lenders. All lenders utilize debt ratios and
51
loan-to-value ratios in the approval process. Many lenders rely on software
packages to score an applicant for loan approval and fund the loan after
auditing the data provided by the borrower. We primarily rely upon experienced
non-conforming mortgage loan underwriters to scrutinize an applicant's credit
profile and to evaluate whether an impaired credit history is a result of
previous adverse circumstances or a continuing inability or unwillingness to
meet credit obligations in a timely manner. Personal circumstances including
divorce, family illnesses or deaths and temporary job loss due to layoffs and
corporate downsizing will often impair an applicant's credit record.
Upon completion of the underwriting and processing functions, the loan is
closed through a closing attorney or agent approved by us. The closing attorney
or agent is responsible for completing the loan transaction in accordance with
applicable law and our operating procedures.
We require title insurance coverage issued by an approved ALTA title
insurance company of all property securing mortgage loans we originate or
purchase. We and our assignees are generally named as the insured. Title
insurance policies indicate the lien position of the mortgage loan and protect
us against loss if the title or lien position is not as indicated. The
applicant is also required to secure hazard and, in certain instances, flood
insurance in an amount sufficient to cover the building securing the loan for
the entire term of the loan, for an amount that is at least equal to the
outstanding principal balance of the loan or the maximum limit of coverage
available under applicable law, whichever is less. Evidence of adequate
homeowner's insurance naming us as an additional insured is required on all
loans.
We have general classifications with respect to the credit profiles of
loans based on certain characteristics of the applicant in conjunction with
other loan characteristics such as the loan size in dollars relative to the
appraised property value ("loan-to-value ratio" or "LTV"). Within the mortgage
industry, classifications for non-conforming loans are extremely objective in
nature and vary greatly between lenders. Over time gradual adjustments to the
criteria defining loan classifications may occur throughout the industry as the
performance, in terms of delinquency and default rates, of aged pools of loans
are analyzed relative to the borrower and loan characteristics of the associated
loan pools.
Our classifications place each loan application into one of three letter
ratings "A" through "C," with sub-ratings within those categories. Ratings are
based upon a number of factors including the applicant's credit history, the
loan size relative to the value of the property and the applicant's employment
history and current status. We also rely on the judgment of its underwriting
staff, which may make exceptions to the general criteria and upgrade a rating
due to compensating factors considered appropriate to the underwriting staff.
Terms of loans made by us, as well as the maximum loan-to-value ratio and debt
service-to-income coverage (calculated by dividing fixed monthly debt payments
by gross monthly income), vary depending upon the classification of the
application. Applicants falling into a lower credit classification will
52
generally pay higher rates and loan origination fees than those in higher credit
classifications in order to compensate the lender for assuming greater credit
risk.
Subject to adjustments to the general classification criteria from time to
time and the underwriting staff judgment of compensating factors that merit
exceptions, the general criteria currently used by us in classifying loan
applicants are set forth below:
"A" Risk. Under the "A" risk category, a loan applicant must have
generally repaid installment or revolving debt according to its terms.
o Existing mortgage loans: A maximum of two (case-by-case exceptions are
made provided the credit score is greater than 599) 30-day late
payment(s) within the last 12 months being acceptable.
o Non-mortgage credit: minor derogatory items are allowed, but a letter of
explanation is required.
o Bankruptcy filings: must have been discharged more than two years prior
to closing with credit re-established.
o Maximum loan-to-value ratio: up to 100% for attached and detached single
family residence, 90% for a loan secured by a two-to-four family
residence; and 85% for a loan secured by a non-owner occupied single
family residence and 80% on a loan secured by a two-to-four family
residence.
o Debt service-to-income ratio: 60% or less.
"B" Risk. Under the "B" risk category, a loan applicant must have
generally repaid installment or revolving debt according to its terms.
o Existing mortgage loans: Maximum of two (case-by-case exceptions are
allowed provided the credit score is greater than 550) 60-day late
payments within the last 12 months being acceptable.
o Non-mortgage credit: some prior defaults may have occurred, but major
credit paid or installment debt paid as agreed may offset some
delinquency; any open charge-offs, judgments or liens may be left open
at underwriters discretion.
o Bankruptcy filings: must have been discharged more than two years prior
to closing with credit re-established.
o Maximum loan-to-value ratio: up to 90% for attached and detached single
family residence, 90% for a loan secured by a two-to-four family
residence; and 70% for a loan secured by a non-owner occupied single
family residence and 70% on a loan secured by a two-to-four family
residence.
53
o Debt service-to-income ratio: 55% or less
"C" Risk. Under the "C" risk category, a loan applicant may have
experienced significant credit problems in the past.
o Existing mortgage loans: must be brought current from loan proceeds;
applicant is allowed up to 119 days late payment 12 months. Foreclosures
and Notices of Default are not allowed within the last 12 months.
o Non-mortgage credit: significant prior delinquencies may have occurred.
o Bankruptcy filings: must have been discharged.
o Maximum loan-to-value ratio: up to 80% for detached single-family
residence, 70% for a loan secured by a two-to-four family residence;
non-owner occupied loans are not eligible.
o Debt service-to-income ratio: generally 50% or less.
We use the foregoing categories and characteristics only as guidelines. On
a case-by-case basis, the underwriting staff may determine that the prospective
borrower warrants a risk category upgrade, a debt service-to-income ratio
exception, a pricing exception, a loan-to-value exception or an exception from
certain requirements of a particular risk category. An upgrade or exception may
generally be allowed if the application reflects certain compensating factors,
among others: low loan-to-value ratio; stable employment or length of occupancy
at the applicant's current residence. For example, a higher debt ratio may be
acceptable with a lower loan-to-value ratio. An upgrade or exception may also
be allowed if the applicant places a down payment in escrow equal to at least
20% of the purchase price of the mortgaged property, or if the new loan reduces
the applicant's monthly aggregate debt load. Accordingly, we may classify in a
more favorable risk category certain mortgage loans that, in the absence of such
compensating factors, would satisfy only the criteria of a less favorable risk
category. The foregoing examples of compensating factors are not exclusive.
The underwriting staff has discretion to make exceptions to the criteria and to
upgrade ratings on case-by-case basis.
54
Conforming Conventional Mortgage Loans. Conforming conventional mortgages
are investment quality loans meeting underwriting criteria as required by
financial institutions such as the Federal National Mortgage Association (Fannie
Mae), and Federal Home Loan Mortgage Corporation (Freddie Mac). Our
conventional underwriting guidelines adhere to general standards set forth by
the ultimate investors for these loans including but not limited to, Countrywide
Mortgage, Fleet Financial, Freddie Mac and Fannie Mae. We are an approved
Fannie Mae and Freddie Mac Seller/Servicer, and have delegated underwriting
authority with most of our investors.
Our underwriting analysis is accomplished with aid of Desktop Underwriter
(Fannie Mae) and Loan Prospector (Freddie Mac). Through the use of these
Automated Underwriting Systems (AUS) upon input of loan data a three-repository
credit report is pulled and a response is received to either approve the loan or
to refer it to a human underwriter for further evaluation. It is the
underwriter's key responsibility to assess the accuracy of the information input
into the AUS and to determine if the value of the collateral is acceptable. The
majority of our offered conventional conforming programs encompass a minimum
credit score of 620. However, any cases that a credit score fall under the
"industry standard" of 620, we send the application to the investor for
approval.
In the event the loan has been referred to a human underwriter for
traditional underwriting, the AUS has recognized that significant layering of
risk may be associated with the application. Our underwriters will closely
scrutinize the findings given by the AUS to determine if erroneous information
was reported by one or all of the credit agencies that may have prohibited an
acceptable rating. If credit has been determined to be acceptable by our
underwriters by reviewing a credit explanation and/or other supporting
information, the loan application is sent to our investor for their approval.
We offer a vast array of conventional expanded criteria and conventional
non-conforming programs, most of which are underwritten through the investor
specific automated underwriting systems. The availability of these programs
varies from time to time and may include, but are not limited to, "Jumbo"
products, high LTV Rate/Term & Cash-out loans, stated income and/or asset loans,
high LTV investor and 2nd home properties, home equity lines of credit (HELOC's)
and closed end seconds.
Our conforming loan division requires Private Mortgage Insurance on all 1st
Lien programs exceeding an 80% LTV. The insurance can be accomplished by our
direct-delegated authority with several mortgage insurance companies, or through
various lender paid insurance options that may include pricing adjustments.
Government Mortgage Loans. We offer FHA Title II first mortgage loans, and
will be soon offering FHA Title I subordinate lien mortgages, in many areas of
the country. We have FHA Direct Endorsement underwriters, allowing all credit
and collateral decisions to be made in-house. We approve FHA loans which are of
investment quality and which meet the requirements of the Government National
55
Mortgage Association (Ginnie Mae) standards for sale on the secondary mortgage
market. FHA Mortgage Insurance endorsement is obtained directly by us through
direct submission to HUD Area Offices.
The underwriters approve loan applications in direct accordance to
established FHA written standards, but recognize that FHA loans require
extensive analysis. As per FHA's encouragement, the many aspects of a loan must
to be evaluated before making an underwriting decision. While a poor credit
history is, in and of itself, sufficient reason to reject a loan application, no
minimum credit score has been established and applicants with tarnished credit
histories are given the opportunity to explain any adverse credit and to present
supporting documentation that may establish that the situation was beyond their
control and may assist an applicant in successfully obtaining an FHA insured
mortgage. FHA establishes certain debt-to-income ratio requirements, however
these ratios may be exceeded if underwriting determines that certain FHA-
established compensating factors exist. Overall, each case tends to be unique
and the totality of the loan package must be evaluated before a credit decision
can be rendered.
FHA has approved the use of Fannie Mae's Desktop Underwriter (DU) and
Freddie Mac's Loan Prospector (LP) for evaluating loan applications. We utilize
these AUS tools, but take a firm stance on evaluating the totality of each loan
application not approved through an AUS. We offer owner-occupied fixed and
adjustable rate loans for purchase and for FHA streamline, rate/term, and cash-
out refinances. Non-owner occupied loans are limited to FHA streamline
refinances.
We offer first mortgage loans guaranteed by the Veterans Administration
(VA) in many regions of the country to qualified active duty/retired/reservist
military personnel. We employ "VA Automatic" underwriters, allowing credit
decisions for nearly all VA loan applications to be made in-house. We have also
obtained VA LAPP authority (Lenders Appraisal Processing Program), which allows
our underwriters to review VA appraisals without prior endorsement from the VA.
All loans are underwritten in strict accordance to VA guidelines and we perform
all submissions for Loan Guaranty. We underwrite VA loans to ensure conformance
to Government National Mortgage Association (Ginnie Mae) standards in order to
facilitate the sale of loans in the secondary mortgage market.
Underwriting standards are similar to that of FHA. DU and LP have been
approved for evaluating VA loan applications, and we follow the same
underwriting practices based on AUS findings as we do for FHA loans. We offer
owner-occupied fixed-rate VA purchase loans, Interest Rate Reduction Refinancing
Loans (IRRRL), and cash-out refinance loans. Non-owner occupied loans are
limited to VA IRRRL.
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Mortgage Loan Servicing
We have been servicing our portfolio and warehouse loans since 1984. Since
January 1, 1997, the Bank's portfolio of loans held for sale and for investment
has been serviced by us under a contractual arrangement.
Our loan servicing operation has two functions: collection and customer
service for borrowers. The customer service department monitors loans,
addresses customer inquiries and collects current loan payments due from
borrowers. The collection department furnishes reports and enforces the rights
of the holder or owner of the loan, including recovery of delinquent payments,
institution of loan foreclosure proceedings and liquidation of the underlying
collateral.
The accounting department is responsible for posting all payments to the
borrower's loan accounts. This provides a "separation" in duties between
payments and the servicing operation personnel whose performance is measured by
factors such as delinquency and loss levels.
We close loans throughout the month. Most of our loans require a first
payment thirty to forty-five days after funding. Accordingly, our servicing
portfolio consists of loans with payments due at varying times each month.
Our collection policy is designed to identify payment problems sufficiently
early to permit us to address delinquency problems quickly and, when necessary,
to act to preserve equity before a property goes to foreclosure. We believe
that these policies, combined with the experience level of independent
appraisers engaged by us, help to reduce the incidence of charge-offs on a first
or second mortgage loan.
Collection procedures commence upon identification of a past due account by
our automated servicing system. Five days before the first payment is due on
every loan, the borrower is contacted by telephone to welcome the borrower, to
remind the borrower of the payment date and to answer any questions the borrower
may have. If the first payment due is delinquent, a collector will immediately
telephone to remind the borrower of the payment. Five days after any payment is
due, a written notice of delinquency is sent to the borrower and follow up calls
are made. A second written notice is sent on the fifteenth day after payment is
due and our collectors make follow up calls. During the delinquency period, the
collector will continue to frequently contact the borrower. Our collectors have
computer access to telephone numbers, payment histories, loan information and
all past collection notes. All collection activity, including the date
collection letters were sent and detailed notes on the substance of each
collection telephone call, is entered into a permanent collection history for
each account. Notice of our intent to start foreclosure proceedings is sent at
thirty days past due. Further guidance with respect to the collection and
foreclosure process is derived through frequent communication with senior
management.
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Our loan servicing software also tracks and maintains homeowners' insurance
information. Expiration reports are generated weekly listing all policies
scheduled to expire within 30 days. When policies lapse, a letter is issued
advising the borrower of the lapse and that we will obtain force-placed
insurance at the borrower's expense. We also have an insurance policy in place
that provides coverage automatically for us in the event an employee fails to
obtain force-placed insurance.
At the time the foreclosure process begins through the time of liquidation
of real estate owned ("REO") the account is handled by the foreclosure and REO
team, which is coordinated by the collection department manager who directs
items to our resources both internal and external as appropriate. The Chief
Financial Officer or Chief Executive Officer must approve the major steps in
this procedure. There are occasions when foreclosures and charge-off occurs.
Prior to a foreclosure sale, we perform a foreclosure analysis with respect to
the mortgaged property to determine the value of the mortgaged property and the
bid that we will make at the foreclosure sale. This analysis includes: (i) a
current valuation of the property obtained through a drive-by appraisal
conducted by an independent appraiser; (ii) an estimate of the sales price of
the mortgaged property by sending two local realtors to inspect the property;
(iii) an evaluation of the amount owed, if any, to a senior mortgagee and for
real estate taxes; and (iv) an analysis of the marketing time, required repairs
and other costs, such as for real estate broker and legal fees, that will be
incurred in connection with the foreclosure sale.
All foreclosures are assigned to outside counsel located in the same state
as the secured property. Bankruptcies filed by borrowers are also assigned to
appropriate local counsel who is required to provide monthly reports on each
loan file.
At the present time we do not service mortgage loans for other investors.
However, in future periods we may securitize loans and retain the servicing
component on those securities or we may provide interim servicing for investors
who acquire the loans and contract us to service the loans on their behalf. In
this event, we would need to enhance our servicing capabilities. If we were to
adopt a securitization loan sale strategy, we may engage one or more companies
to sub-service a portion of the loans securitized.
Marketing
Marketing to Broker Networks. Marketing to brokers is conducted through
our staff of account executives ("AE"), which establish and maintain
relationships with a network of mortgage brokers that refer loans to us. During
the first nine months of 2000, loans made through the broker networks amounted
to 46.8% of total originations or $99.4 million compared to $80.2 million or
28.4% during the same period in 1999. Loans made through the broker networks
amounted to 32.4% of total originations or $127 million in 1999, compared to 39%
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or $204 million of total loan originations in 1998. (See the table on page 120
for divisional loan originations by state.)
The AE's provide various levels of information, assistance and training to
the mortgage brokers regarding our products and non-traditional prospecting
strategies, and are principally responsible for maintaining our relationships
with our clients. AE's endeavor to increase the volume of loan originations
from brokers located within the geographic territory assigned to them. The AE's
and the their sales managers visit brokers offices and attend trade shows. The
AE's also provide feedback to us relating to the current marketplace relative to
products and pricing offered by competitors and new market entrants, all of
which assist us in refining its programs in order to offer competitive products.
The AE's are compensated with a base salary and commissions based on the volume
of loans that are originated as a result of their efforts.
In late September of 2000, we launched a new wholesale division located in
Huntington Beach, California. The goal of this new operation is to develop a
broker referral network in the western portion of the United States that will
add new sources of loan volume for us while augmenting our geographical
diversification of mortgage origination business. Additionally, to augment the
sales efforts performed by the outside AEs in the field, we are currently
developing a sales staff to facilitate inside telemarketing solicitation of
broker referral business.
Marketing of Retail Lending Products. We market our direct consumer
lending services through a sales staff of loan officers in our branch offices
located in several states. Loans made through the retail lending division
amounted to $112.6 million or 53.1% of total originations during the nine-month
period ended September 30, 2000 compared to $202.1 million or 71.6% for the same
period in 1999. Retail loan originations represented $263.9 million or 68% of
total originations in 1999, compared to $318.1 million or 61% of total loan
originations in 1998. (See the table on page 120 for divisional loan
originations by state.)
Over the past two years several small retail branch locations were either
consolidated or closed reducing the number of locations from 29 at December 31,
1998 to 15 at March 30, 1999 and 10 as of September 30, 2000. We continue to
monitor financial and operational performance of branches on a monthly basis in
order to restructure or close down those branches not attaining established
goals.
The retail lending division is now structured as highly focused super sales
centers with a larger average number of loan officers per branch than in recent
years and with more seasoned managers. While the total number of retail branches
decreased by 58% from 26 at December 1998 to 11 as of December 1999, the dollar
value of loans originated by the retail division during 1999 decreased by only
17%.
To generate customer leads for the retail loan officers, we use targeted
outbound and inbound telemarketing centralized in the Virginia Beach
headquarters. An automatic dialer telemarketing system is used for targeted lead
59
generation campaigns for each retail branch. This centralized system allows us
to efficiently purchase and use lists of potential leads and to maintain the
required "do not call" list of names. The campaigns are rotated to provide the
appropriate number of leads to each branch based on the number of loan officers.
Our inbound call center that receives inquiries from various forms of
advertising and marketing campaigns initiated from the home office in the
geographic locations surrounding retail branch locations provides a solid source
of leads to the sales staff. The more experienced telemarketing agents are
cross-trained to work both inbound and outbound calls, which provides for more
flexibility with new campaigns and efficient use of the staff.
In the event that a potential retail customer's loan application does not
fall within our underwriting guidelines, the underwriter may authorize the
application for submission to another lending institution. If the loan is
approved and funded, we act in the capacity of a mortgage broker, receiving fee
income ("brokered loans"). Brokered loans are primarily non-conforming mortgages
that do not meet our underwriting guidelines. While less profitable, this type
of retail loan production allows us to accommodate loan customers during
competitive periods while adhering to solid underwriting standards. In October
of 1999, we instituted strict controls to ensure that only loans not meeting our
underwriting criteria are brokered to other lenders. As a result, brokered loans
as a percent of total retail loan origination decreased to approximately 33%
during the nine month period ended September 30, 2000 down from an average of
63% for the nine months ended September 30, 1999.
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Our Sources of Funds and Liquidity
[Enlarge/Download Table]
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SUMMARY
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As of Date: September 30, 2000 December 31, 1999
Warehouse Credit Lines $80 million $55 million
FHLB credit line $15 million $15 million
FDIC Bank Deposits $42 million $55 million
Subordinated $ 5 million $ 5 million
Stockholder's Equity $ 9 million $11 million
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At September 30, 2000, we had combined warehouse lines of credit of $95
million, including a $15.0 million line of credit available to the Bank from the
Federal Home Loan Bank ("FHLB"), with an outstanding balance of $3.1 million.
Additionally, we had subordinated debt outstanding of $4.8 million, FDIC insured
certificates of deposit outstanding of $42.0 million and consolidated
stockholder's equity of $9.2 million.
On July 21, 2000, we obtained a $40.0 million line of credit from Bank
United. The credit line can be used for prime and sub-prime mortgage loans and
is secured by loans originated by us. The line bears interest at a rate of
2.00% and 2.75% over the one-month LIBOR rate for prime and sub-prime loans
respectively. We may receive warehouse credit advances of 98%, 97%, and 90% for
prime, sub-prime, and high LTV loans (loans with LTV's greater than 90%),
respectively, of the collateral value amount on pledged mortgage loans for a
period of 90 days after advance of funds on each loan. If an investor has not
purchased a loan within 90 days of such advance, the interest rate on the loan
increases to 3.75% over the one-month LIBOR and we have an additional 30 days to
sell the loan or purchase the loan back from the warehouse. The aged loan sub
limit is $2.0 million. As of September 30, 2000 there were $3.2 million
borrowings outstanding under this facility. The line of credit is scheduled to
expire on July 21, 2001. The line of credit is subject to financial covenants
for a current ratio, tangible net worth and a leverage ratio. As of September
30, 2000 we were in compliance with all financial covenants.
On November 10, 1999, we obtained a $20.0 million sub-prime line of credit
from Regions Bank. The line is secured by loans originated by us and bears
interest at a rate of 3.25% over the one-month LIBOR rate. We may receive
warehouse credit advances of 100% of the net loan value amount on pledged
mortgage loans for a period of 90 days after origination. As of September 30,
2000 there were no borrowings outstanding under this facility. The line of
credit is scheduled to expire on November 10, 2001. The line of credit is
subject to financial covenants for a current ratio, tangible net worth and a
leverage ratio. As of September 30, 2000 we were in compliance with all
financial covenants.
On November 10, 1999, we obtained a $20.0 million conforming loan line of
credit from Regions Bank. The line is secured by loans originated by us and
bears interest ranging from 2.25% to 2.75% over the one-month LIBOR rate based
upon the monthly advance levels. We may receive warehouse credit advances of
100% of the net loan value amount on pledged mortgage loans for a period of 90
61
days after origination. As of September 30, 2000 there were no borrowings
outstanding under this facility. The line of credit is scheduled to expire on
November 10, 2001. The line of credit is subject to financial covenants for a
current ratio, tangible net worth and a leverage ratio. As of September 30, 2000
we were in compliance with all financial covenants.
Bank Sources of Funds
Certificates of Deposits. The Bank had $39.0 million FDIC insured
certificates of deposits outstanding at September 30, 2000. The Bank had $55.3
million FDIC insured certificates of deposits outstanding at December 31, 1999.
The Bank also had $3.0 million in money market deposits through an arrangement
with a local NYSE member broker/dealer at September 30, 2000. The bank did not
have any money market deposits at December 31, 1999.
The primary source of deposits for the Bank has been brokered certificates
of deposit obtained through national investment banking firms, which, pursuant
to agreements with the Bank, solicit funds from their customers for deposit with
the Bank ("brokered deposits"). Such deposits amounted to $15.2 million or 39%
and $25.0 million, or 45.21%, of the Bank's deposits at September 30, 2000 and
December 31, 1999, respectively. The Bank solicits deposits via a computer
bulletin board where the rates of many other banks and institutions are
advertised. At September 30, 2000 and December 31, 1999, the Bank had deposits
from this source of $ 39.0 million or 92.9% and $55.3 million or 100% of total
deposits, respectively. The fees paid to deposit brokers are amortized using the
interest method and included in interest expense on certificates of deposit.
We believe that the Bank's effective cost of brokered and other wholesale
deposits is more attractive than deposits obtained on a retail basis from branch
offices after the general and administrative expense associated with the
maintenance of branch offices is taken into account. Moreover, brokered and
other wholesale deposits generally give the Bank more flexibility than retail
sources of funds in structuring the maturities of its deposits and in matching
liabilities with comparable maturing assets. At September 30, 2000, $32.5
million of the Bank's certificates of deposit were scheduled to mature within
one year (83.3% of total deposits). At December 31, 1999, $44.9 million of the
Bank's certificates of deposit were scheduled to mature within one year (81.2%
of total deposits).
Although we believe that the Bank's brokered and other wholesale deposits
are advantageous in certain respects, such funding sources, when compared to
retail deposits attracted through a branch network, are generally more sensitive
to changes in interest rates and volatility in the capital markets and are more
likely to be compared by the investor to competing instruments. In addition,
such funding sources may be more sensitive to significant changes in the
financial condition of the Bank. There are also various regulatory limitations
on the ability of all but well-capitalized insured financial institutions to
obtain brokered deposits; see "Regulation of the Bank - Brokered Deposits."
62
These limitations currently are not applicable because the Bank is a well-
capitalized financial institution under applicable laws and regulations. There
can be no assurances, however, that the Bank will not become subject to such
limitations in the future. In addition, our reliance on wholesale deposits
effects our ability to rollover deposits as they mature due to the fact that in
general the wholesale customer is highly interest rate-sensitive. However, we
are of the opinion that we will be able to readily obtain funding from the
wholesale deposit market in future periods at the then current competitive
interest rates being offered by other institutions.
As a result of the Bank's reliance on brokered and other wholesale
deposits, significant changes in the prevailing interest rate environment, in
the availability of alternative investments for individual and institutional
investors or in the Bank's financial condition, among other factors, could
affect the Bank's liquidity and results of operations much more significantly
than might be the case with an institution that obtained a greater portion of
its funds from retail or core deposits attracted through a branch network. (See
page F-34 of the audited financial statements for a table that sets forth
various interest rate categories for the certificates of deposit of the Bank.)
Borrowings. The Bank is able to obtain advances from the FHLB of Atlanta
upon the security of certain of its residential first mortgage loans, and other
assets, including FHLB stock, provided certain standards related to the
creditworthiness of the Bank have been met and subject to new restrictions on
collateral characteristics described in this section. FHLB advances are
available to member institutions such as the Bank for investment and lending
activities and other general business purposes. FHLB advances are made pursuant
to several different credit programs, each of which has its own interest rate,
which may be fixed or adjustable, and which has its own range of maturities.
FHLB members are required to hold shares of the capital stock of the regional
FHLB in which they are a member in an amount at least equal to the greater of 1%
of the member's home mortgage loans or 5% of the member's advances from the
FHLB.
At September 30, 2000 the Bank had a line of credit with the FHLB for $15
million. During the nine month period ended September 30,2000, the Bank had
advances of $1.0 million from the FHLB and paid down principal on advances of
$5.6 million. During the year ended December 31, 1999, the Bank had advances of
$13.0 million from the FHLB and paid down principal on advances of $8.4 million.
For the year ended December 31, 1998, the Bank had advances of $1.0 million and
paid down principal on advances of $2.0 million. The Bank held $407,000 and
$146,000 of the FHLB stock at December 31, 1999 and December 31, 1998,
respectively. We expect the Bank to utilize FHLB advances as the Bank builds a
portfolio of loans.
The Federal Home Loan Bank ("FHLB") Board of Atlanta announced to its
member institutions on November 27, 2000 the adoption of "Policies to Promote
Responsible Lending". The policy restricts the general characteristics of
mortgage loans or the mortgage loans backing mortgage backed securities that a
63
member institution, such as our Bank, can pledge as collateral for advances of
credit from the FHLB. In general collateral pledged cannot (i) meet the interest
requirements of high cost mortgages under the HOEPA of 1994 (ii) Include
prepaid, single premium credit insurance (iii) include points and fees,
excluding discount points, in excess of 5% (iv) include prepayment penalty if
the interest rate at time of origination is 300 basis points higher than
conventional rates.
64
Taxation
General. We currently file, and expect to continue to file, a consolidated
federal income tax return based on a calendar year. Consolidated returns have
the effect of eliminating inter-company transactions, including dividends, from
the computation of taxable income.
Our income is subject to tax in most of the states in which we make loans.
Our taxable income in most states is determined based on certain apportionment
factors.
Alternative Minimum Tax. In addition to the regular corporate income tax,
corporations, including qualifying institutions, can be subject to an
alternative minimum tax. The 20% tax is computed on Alternative Minimum Taxable
Income ("AMTI") and applies if it exceeds the regular tax liability. AMTI is
equal to regular taxable income with certain adjustments. For taxable years
beginning after 1989, AMTI includes an adjustment for 75% of the excess of
"adjusted current earnings" over regular taxable income. Net operating loss
carry backs and carry forwards are permitted to offset only 90% of AMTI.
Alternative minimum tax paid can be credited against regular tax due in later
years. We are not currently subject to the AMT.
Employees
As of December 31, 1999, we had, including our subsidiaries, a total of 295
full-time employees and 13 part-time employees or 301.5 full time equivalent
employees. As of September 30, 2000 we had, including our subsidiaries, a total
of 195 full-time employees and 9 part-time employees or 199.5 full time
equivalent employees. None of our employees are covered by a collective
bargaining agreement. We consider the relations with our employees to be good.
Service Marks
We have four service marks that have become federally registered. They are
"Armada" which became registered on July 23, 1996, "Approved Residential
Mortgage" which became registered on May 15, 1995, "Approved Financial Corp."
which became registered July 21, 1998 and "ConsumerOne Financial" which became
registered on December 18, 1998.
Effect and Risk of Adverse Economic Conditions
Our business may be adversely affected by periods of economic slowdown or
recession, which may be accompanied by decreased demand for consumer credit and
declining real estate values. Any material decline in real estate values reduces
the ability of borrowers to use home equity to support borrowings and increases
the loan-to-value ratios of loans previously made by us, thereby weakening
collateral coverage and increasing the possibility of a loss in the event of
default. In addition, delinquencies, foreclosures and losses generally increase
during economic slowdowns or recessions.
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Risk from Concentration of Operations in Certain States
During 1999, 90.3% of the aggregate principal balance of the loans we
originated was secured by properties located in eight states (Florida, Georgia,
South Carolina, North Carolina, Virginia, Maryland, Michigan, and Ohio). During
the first nine months of 2000 96.1% of the aggregate principal balance of the
loans we originated were secured by properties located in ten states (Maryland,
Virginia, Florida, Ohio, North Carolina, Pennsylvania, Michigan, New Jersey,
Georgia and South Carolina). Although we are currently attempting to expand our
wholesale operation into the western portion of the United States, if this
effort is not successful, our origination business is likely to remain
concentrated in these states in the foreseeable future. Consequently, our
results of operation and financial condition are dependent upon general trends
in the economy and the residential real estate markets in those states.
Future Risks Associated with Loan Sales through Securitizations
In future periods, we may sell a portion of the loans we originate through
a securitization program and retain the rights to service the loans. The sale
of loans through a securitization program would be a significant departure from
our previous business operations. While we have explored securitization as a
possible alternative loan sale strategy, no affirmative decision has been made
to adopt such a program nor has any specific time frame in the future for such a
program been established.
Adverse changes in the securitization market could impair our ability to
originate and sell loans through securitization on a favorable or timely basis.
Any such impairment could have a material adverse effect upon our results of
operation and financial condition. Furthermore, our quarterly operating results
in future periods may fluctuate significantly as a result of the timing and
level of securitizations. If securitizations do not close when expected, our
results of operation may be adversely affected for that period. Whether or not
we adopt this loan sale strategy in the future, adverse changes in the
securitization market could impair our ability to originate and sell loans to
other financial institutions that utilize the securitization market.
Contingent Risks
In the ordinary course of its business, we are subject to claims made
against us by borrowers and private investors arising from, among other things,
losses that are claimed to have been incurred as a result of alleged breaches of
fiduciary obligations, misrepresentations, errors and omissions of our
employees, officers, and agents(including our appraisers), incomplete
documentation and failures by us to comply with various laws and regulations
applicable to our business. We are not aware of any material claims.
66
Although we sell substantially all loans that we originate and purchase on
a non-recourse, service released basis, during the period of time that loans are
held pending sale, we are subject to the various business risks associated with
lending, including the risk of borrower default, loan foreclosure and loss, and
the risk that an increase in interest rates or a change in secondary market
conditions for any reason would result in a decline in the value of loans in the
secondary market.
Risk from Competition
We face intense competition from other mortgage banking companies, banks,
credit unions, thrift institutions, credit card issuers, finance companies and
other financial institution. Many of these competitors in the financial
services business are substantially larger and have more capital and financial
resources than us. Also, the larger national finance companies, banks, quasi-
governmental agencies and other originators of conforming mortgage loans have
been adapting their conforming origination programs to expand into the non-
conforming loan business and are targeting our prime customer base. There can
be no assurance that we will not face increased competition and erosion of
operating margins from such institutions in the future.
Competition can take on many forms, including convenience in obtaining a
loan, service, loan pricing terms such as the loan to value ratio, origination
fees and interest rate, marketing and distribution channels and competition for
employees through compensation plans and benefit packages.
The quantity and quality of our competition may also be affected by
fluctuations in interest rates and general economic conditions. During periods
of rising rates, competitors that "locked in" low borrowing costs may have a
competitive advantage. During periods of declining interest rates, competitors
may solicit our borrowers to refinance their mortgage loans. During an economic
slowdown or recession, our borrowers may have new financial difficulties and may
be receptive to offers by our competitors.
We use mortgage brokers as a source of origination of new loans. Our
competitors also seek to establish relationships with the brokers with whom we
do business. Our future results may become more exposed to fluctuations in the
volume and costs of our wholesale loans (loans sourced from mortgage brokers)
resulting from competition from other originators of such loans, market
conditions and other factors.
Regulation
Our business is subject to extensive regulation, supervision and licensing
by federal, state and local government authorities and is subject to various
laws and judicial and administrative decisions imposing requirements and
restrictions on part or all of its operations. Regulated matters include loan
origination, credit activities, maximum interest rates and finance and other
67
charges, disclosure to customers, the terms of secured transactions, the
collection, repossession and claims-handling procedures utilized by us, multiple
qualification and licensing requirements for doing business in various
jurisdictions and other trade practices. The following discussion and other
references to and descriptions of the regulation of financial institutions
contained in this document constitute brief summaries of the regulations as
currently in effect. This discussion is not intended to constitute a complete
statement of all the legal restrictions and requirements applicable to us and
the Bank and all such descriptions are qualified in their entirety by reference
to applicable statutes, regulations and other regulatory pronouncements. (see
also: "Regulatory Capital Requirements")
Our consumer lending activities are subject to the federal Truth-in-Lending
Act ("TILA") and Regulation Z (including the Home Ownership and Equity
Protection Act of 1994 "HOEPA"); the federal Equal Credit Opportunity Act and
Regulation B, as amended (the "ECOA"); the Home Mortgage Disclosure Act and the
Fair Credit Reporting Act of 1970, as amended ("FCRA"); the federal Real Estate
Settlement Procedures Act ("RESPA") and Regulation X; the federal Home Mortgage
Disclosure Act; and the federal Fair Debt Collection Practices Act. We are also
subject to state statutes and regulations affecting our activities.
TILA and Regulation Z promulgated thereunder contain disclosure
requirements designed to provide consumers with uniform, understandable
information with respect to the terms and conditions of loans and credit
transactions in order to give them the ability to compare credit terms. TILA
also guarantees consumers a three-day right to cancel certain credit
transactions including loans of the type we originate. We believe that we are
in compliance with TILA in all material respects.
In September 1994, the Riegle Community Development and Regulatory
Improvement Act of 1994 (the "Riegle Act") was enacted. Among other things, the
Riegle Act made certain amendments to TILA. The TILA Amendments, which became
effective in October 1995, generally apply to mortgage loans with (i) total
points and fees upon origination in excess of the greater of eight percent of
the loan amount or $465 or (ii) an annual percentage rate of more than ten
percentage points higher than comparable maturing U.S. Treasury securities.
Loans covered by the TILA Amendments are known as "Section 32 Loans."
The TILA Amendments impose additional disclosure requirements on lenders
originating Section 32 Loans and prohibit lenders from originating Section 32
Loans that are underwritten solely on the basis of the borrower's home equity
without regard to the borrower's ability to repay the loan. In accordance with
TILA Amendments, we apply underwriting criteria that take into consideration the
borrower's ability to repay all Section 32 Loans.
The TILA Amendments also prohibit lenders from including prepayment fee
clauses in Section 32 loans to borrowers with a debt-to-income ratio in excess
of 50%. In addition, a lender that refinances a Section 32 Loan previously made
68
by such lender will not be able to enforce any prepayment penalty clause
contained in such refinanced loan. We will continue to collect prepayment fees
on loans originated prior to the effectiveness of the TILA Amendments and on
non-Section 32 Loans as well as on Section 32 Loans in permitted circumstances
following the effectiveness of the TILA Amendments. The TILA Amendments impose
other restrictions on Section 32 Loans, including restrictions on balloon
payments and negative amortization features, which we believe will not have a
material impact on its operations.
We are also required to comply with the ECOA, which prohibits creditors
from discriminating against applicants on the basis of race, color, sex, age or
marital status. Regulation B promulgated under ECOA restricts creditors from
obtaining certain types of information from loan applicants. It also requires
certain disclosures by the lender regarding consumer rights and requires lenders
to advise applicants of the reasons for any credit denial. In instances where
the applicant is denied credit or the rate or charge for a loan increase as a
result of information obtained from a consumer credit agency, another statute,
the FCRA requires the lender to supply the applicant with a name and address of
the reporting agency. We are also subject to the Real Estate Settlement
Procedures Act and are required to file an annual report with the Department of
Housing and Urban Development pursuant to the Home Mortgage Disclosure Act.
We are also subject to the rules and regulations of, and examinations by,
the U.S. Department of Housing and Urban Development and state regulatory
authorities with respect to originating, processing, underwriting, selling and
servicing loans. These rules and regulations, among other things, impose
licensing obligations on us, establish eligibility criteria for mortgage loans,
prohibit discrimination, provide for inspections and appraisals of properties,
require credit reports on loan applicants, regulate assessment, collection,
foreclosure and claims handling, investment and interest payments on escrow
balances and payment features, and mandate certain loan amounts.
Failure to comply with these requirements can lead to loss of approved
status, termination or suspension of servicing contracts without compensation to
the servicer, demands for indemnification or mortgage loan repurchases, certain
rights of rescission for mortgage loans, class action lawsuits and
administrative enforcement actions. There can be no assurance that we will
maintain compliance with these requirements in the future without additional
expenses, or that more restrictive federal, state or local laws, rules and
regulations will not be adopted that would make compliance more difficult for
us. We believe that we are in compliance in all material respects with
applicable federal and state laws and regulations.
Additionally, we are subject to the regulations enforced by, and the
reporting requirements of, the Equal Employment Opportunity Commission ("EEOC").
In addition, we are subject to various other federal and state laws regulating
the issuance and sale of securities, relationships with entities regulated by
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the Employee Retirement Income Security Act of 1974, as amended, and other
aspects of our business.
The laws, rules and regulations applicable to us are subject to regular
modification and change. There are currently proposed various laws, rules and
regulations, which, if adopted, could impact us. There can be no assurance that
these proposed laws, rules and regulations, or other such laws, rules or
regulations, will not be adopted in the future which could make compliance much
more difficult or expensive, restrict our ability to originate, purchase, broker
or sell loans, further limit or restrict the amount of commissions, interest and
other charges earned on loans we originate or sell, or otherwise adversely
affect the business or prospects.
The previously described laws and regulations are subject to legislative,
administrative and judicial interpretation. Some of these laws and regulations
have recently been enacted.
Some of these laws and regulations are rarely challenged in or interpreted
by the courts. Infrequent interpretations of these laws and regulations or an
insignificant number of interpretations of recently enacted regulations can make
it difficult for us to know what is permitted conduct under these laws and
regulations. Any ambiguity under the laws and regulations to which we are
subject may lead to regulatory investigations or enforcement actions and private
causes of action, such as class action lawsuits, with respect to our compliance
with the applicable laws and regulations.
Federal and state government agencies have recently begun to consider, and
in some instances have adopted, legislation to restrict lenders' ability to
originate certain non-conforming and subprime loans and to charge rates and fees
in connection with certain non-conforming and subprime residential mortgage
loans made to borrowers with problem credit histories. Such legislation also
imposes various loan term restrictions, e.g., limits on balloon loan features.
Frequently referred to generally as "predatory lending" legislation, such
legislation may limit our ability to impose fees, charge interest rates on
consumer loans to those borrowers with problem credit and may impose additional
regulatory restrictions on the mortgage industry of which we are a participant.
The Gramm-Leach-Bliley Act, which was signed into law at the end of 1999,
contains comprehensive consumer financial privacy restrictions. The various
federal enforcement agencies, including the Federal Trade Commission, have
issued final regulations to implement this act; however, compliance with the new
regulations is voluntary until July 1, 2001. These restrictions fall into two
basic categories. First, a financial institution must provide various notices to
consumers about an institution's privacy policies and practices. Second, this
act gives consumers the right to prevent the financial institution from
disclosing non-public personal information about the consumer to non-affiliated
third parties, with exceptions. We continue to develop and refine the
appropriate disclosures and internal procedures to assure compliance with these
new requirements.
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Although we believe that we have implemented systems and procedures to make
sure that we comply with all regulatory requirements, if more restrictive laws,
rules and regulations are enacted or more restrictive judicial and
administrative interpretations of those laws are issued, compliance with the
laws could become more expensive or difficult for us to operate. Failure to
comply with the laws described above, as well as new legislation affecting us
may result in civil and criminal liability.
OTS Regulation of Approved Financial Corp.
General. We are a registered savings and loan holding company under the
federal Home Owner's Loan Act ("HOLA") because of our ownership of the Bank. As
such, we are subject to the regulation, supervision and examination of the OTS.
Activities Restriction. Currently there are no restrictions on the
activities of a savings and loan holding company, such as us, which holds only
one subsidiary institution. However, if the Director of the OTS determines that
there is reasonable cause to believe that the continuation by a savings holding
company of an activity constitutes a serious risk to the financial safety,
soundness or stability of its subsidiary institution, the Director may impose
such restrictions as deemed necessary to address such risk, including the
limitation of: (i) payment of dividends by the institution; (ii) transactions
between the institution and its affiliates; and (iii) any activities of the
institution that might create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the institution. Notwithstanding
the above rules as to the permissible business activities of unitary savings and
loan holding companies, if the institution subsidiary of such a holding company
fails to meet a qualified thrift lender ("QTL") test set forth in OTS
regulations, then such unitary holding company shall become subject to the
activities and regulations applicable to multiple savings and loan holding
companies and, unless the institution qualifies as a QTL within one year
thereafter, shall register as, and become subject to the restriction applicable
to, a bank holding company. See "Regulation of the Bank - Qualified Thrift
Lender Test." However, on October 25, 2000, the OTS issued a draft proposal
seeking public comment concerning its oversight of savings and loan holding
companies. If the proposal is adopted as proposed in the draft we will be
required to provide 30 days notice to the OTS before undertaking certain
significant new business activities that would result in an increase in our debt
at the holding company level or a reduction in our capital or in relation to
certain asset acquisitions. The draft proposal indicates that this is for the
purpose of allowing time for the OTS to access the potential impact that such
activity will have on our risk profile and on the risk profile of our Bank. The
ultimate resolution of this OTS proposal is uncertain at this time.
If we were to acquire control of another institution other than through
merger or other business combination with the Bank, we would become a multiple
savings and loan holding company. Except where such acquisition is pursuant to
the authority to approve emergency thrift acquisition and where each subsidiary
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institution meets the QTL test, as set forth below, our activities (other than
the Bank) would thereafter be subject to further restrictions. Among other
things, no multiple savings and loan holding company or subsidiary thereof which
is not a institution generally shall commence or continue for a limited period
of time after becoming a multiple savings and loan holding company or subsidiary
thereof any business activity, other than: (i) furnishing or performing
management services for a subsidiary institution; (ii) conducting an insurance
agency or escrow business; (iii) holding, managing, or liquidating assets owned
by or acquired from a subsidiary institution; (iv) holding or managing
properties used or occupied by a subsidiary institution; (v) acting as trustee
under deeds of trust; (vi) those activities authorized by regulation as of March
5, 1987 to be engaged in by multiple savings and loan holding companies; or
(vii) unless the Director of the OTS by regulation prohibits or limits such
activities for savings and loan holding companies, those activities authorized
by the Federal Reserve Board as permissible for bank holding companies. Those
activities described in clause (vii) above also must be approved by the
Directors of the OTS prior to being engaged in by a multiple savings and loan
holding company.
Restrictions on Acquisitions. Except under limited circumstances, savings
and loan holding companies are prohibited from acquiring, without prior approval
of the Director of the OTS, (i) control of any other institution or savings and
loan holding company or substantially all the assets thereof or (ii) more than
5% of the voting shares of a institution or holding company thereof which is not
a subsidiary. Except with the proper approval of the Director of the OTS, no
director or officer of a savings and loan holding company or person owning or
controlling by proxy or otherwise more than 25% of such company's stock, may
acquire control of any institution, other than a subsidiary institution, or of
any other savings and loan holding company.
The Director of the OTS may approve acquisitions resulting in the formation
of a multiple savings and loan holding company which controls institutions in
more than one state only if (i) the multiple savings and loan holding company
involved controls an institution which operated a home or branch office located
in the state of the institution to be acquired as of March 5, 1987; (ii) the
acquirer is authorized to acquire control of the institution pursuant to the
emergency acquisition provision of the Federal Deposit Insurance Act ("FDIA");
or (iii) the statutes of the state in which the institution to be acquired is
located specifically permit institutions to be acquired by state-chartered
institutions located in the state where the acquiring entity is located (or by a
holding company that controls such state-chartered institutions).
Restrictions on Transactions with Affiliates. Transactions between us (or
any of our non-bank subsidiaries)and the Bank are subject to various
restrictions, which are described under "Regulation of the Bank- Affiliate
Transactions."
Also, the OTS recently issued a draft proposal concerning its oversight of
savings and loan holding companies. If the proposal is adopted we will be
72
required to provide 30 days notice to the OTS before undertaking certain
significant new business activities that would result in an increase in our debt
at the holding company level or a reduction in our capital or in relation to
certain asset acquisitions. The draft proposal indicates that this is for the
purpose of allowing time for the OTS to access the potential impact that such
activity will have on our risk profile and on the risk profile of our Bank. The
ultimate resolution of this OTS proposal is uncertain at this time.
Regulation of the Bank
General. The Bank is a federally chartered bank organized under the HOLA.
As such, the Bank is subject to regulation, supervision and examination by the
OTS. The deposit accounts of the Bank are insured up to applicable limits by
the SAIF administered by the FDIC and, as a result, the Bank also is subject to
regulation, supervision and examination by the FDIC. The Bank is also subject to
the regulations of the Board of Governors of the Federal Reserve System
governing reserves required to be maintained against deposits. The Bank is a
member of the FHLB of Atlanta.
The business and affairs of the Bank are regulated in a variety of ways.
Regulations apply to, among other things, insurance of deposit accounts, capital
ratios, payment of dividends, liquidity requirements, the nature and amount of
the investments that the Bank may make, transactions with affiliates, community
and consumer lending laws, internal policies and controls, reporting by and
examination of the Bank and changes in control of the Bank.
Insurance of Accounts. Deposit accounts of the Bank up to $100,000 are
insured by the Association Insurance Fund (the "SAIF"),administered by the FDIC.
Pursuant to legislation enacted in September 1996, a fee was paid by all SAIF
insured institutions at the rate of $0.657 per $100 of deposits held by such
institutions at March 31, 1995. The money collected capitalized the SAIF reserve
to the level of 1.25% of insured deposits as required by law. In 1996, the Bank
paid $23,000 for this assessment.
This legislation also provided for the merger, subject to certain
conditions, of the SAIF into the Bank Insurance Fund ("BIF") by 1999. The
BIF/SAIF legislation provided for a merger of BIF and SAIF on January 1, 1999,
but only if no insured institution was an association. Associations would have
had to change charters in order to achieve a merger of the two insurance funds.
This provision has now expired. Though the statutory date for a funds merger
has passed, the Congress could, at any time, without condition, permit FDIC to
merge the funds.
The legislation also required BIF-insured institutions to share in the
payment of interest on the bonds issued by a specially created government entity
("FICO"), the proceeds of which were applied toward resolution of the thrift
industry crisis in the 1980s. Beginning on January 1, 1997, in addition to the
insurance premium that is paid by SAIF-insured institutions to maintain the SAIF
73
reserve at its required level pursuant to the current risk classification
system, SAIF-insured institutions paid deposit insurance premiums at the annual
rate of 6.4 basis points of their insured deposits and BIF-insured institutions
paid deposit insurance premiums at the annual rate of 1.3 basis points of their
insured deposits towards the payment of interest on the FICO bonds. Assessments
paid for the period starting January 1, 2000 will be assessed the same FICO rate
for both BIF and SAIF insured deposits. The new rate paid by the Bank and a BIF
insured institution with the same risk classification is 2.12 basis points.
Under the current risk classification system, institutions are assigned on one
of three capital groups which are based solely on the level of an institution's
capital - "well capitalized," "adequately capitalized" and "undercapitalized" -
which are defined in the same manner as the regulations establishing the prompt
corrective action system under Section 38 of the FDIA, as discussed below.
These three groups are then divided into three subgroups, which are based on
supervisory evaluations by the institution's primary federal regulator,
resulting in nine assessment classifications. Assessment rates currently range
from zero basis points for well capitalized, healthy institutions to 27 basis
points for undercapitalized institutions with substantial supervisory concerns.
The re-capitalization of the SAIF is expected to result in lower deposit
insurance premiums in the future for most SAIF-insured financial institutions,
including the Bank.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. We are not aware of any existing circumstances, which would result in
termination of the Bank's deposit insurance.
Regulatory Capital Requirements. Federally insured savings associations are
required to maintain minimum levels of regulatory capital. These standards
generally must be as stringent as the comparable capital requirements imposed on
national banks. The OTS also is authorized to impose capital requirements in
excess of these standards on individual associations on a case-by-case basis.
At December 31, 1999, the Bank's regulatory capital exceeded applicable
requirements for categorization as "well-capitalized."
Federally-insured savings associations are subject to three capital
requirements: a tangible capital requirement, a core or leverage capital
requirement and a risk-based capital requirement. All savings associations
currently are required to maintain tangible capital of at least 1.5% of adjusted
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total assets (as defined in the regulations), core capital equal to 3% of
adjusted total assets and total capital (a combination of core and supplementary
capital) equal to 8% of risk-weighted assets (as defined in the regulations).
A FDIC discussion draft proposal has been made public regarding
requirements for subprime lenders, which could increase the Bank's regulatory
capital requirements for certain loan classes included in the institution's
portfolio. The ultimate resolution of this proposal is uncertain at this time.
For purposes of the regulation, tangible capital is core capital less all
intangibles other than qualifying purchased mortgage-servicing rights, of which
the Bank had none at December 31, 1999. Core capital includes common
stockholders' equity, non-cumulative perpetual preferred stock and related
surplus,minority interest in the equity accounts of fully consolidated
subsidiaries and certain nonwithdrawable accounts and pledged deposits. Core
capital generally is reduced by the amount of a savings association's intangible
assets, other than qualifying mortgage-servicing rights.
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital included does not exceed the savings association's core capital.
Supplementary capital consists of certain capital instruments that do not
qualify as core capital, including subordinated debt, which meets specified
requirements, and general valuation loan, and lease loss allowances up to a
maximum of 1.25% of risk-weighted assets. In determining the required amount of
risk-based capital, total assets, including certain off-balance sheet items, are
multiplied by a risk weight based on the risks inherent in the type of assets.
The risk weights assigned by the OTS for principal categories of assets
currently range from 0% to 100%, depending on the type of asset.
OTS policy imposes a limitation on the amount of net deferred tax assets
under SFAS No. 109 that may be included in regulatory capital. (Net deferred
tax assets represent deferred tax assets, reduced by any valuation allowances,
in excess of deferred tax liabilities.) Application of the limit depends on the
possible sources of taxable income available to an institution to realize
deferred tax assets. Deferred tax assets that can be realized from the
following are generally not limited: taxes paid in prior carry back years and
future reversals of existing taxable temporary differences. To the extent that
the realization of deferred tax assets depends on an institution's future
taxable income (exclusive of reversing temporary differences and carry
forwards), or its tax-planning strategies, such deferred tax assets are limited
for regulatory capital purposes to the lesser of the amount that can be realized
within one year of the quarter-end report date or 10% of core capital. The
foregoing considerations did not affect the calculation of the Bank's regulatory
capital at December 31, 1999.
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In August 1993, the OTS adopted a final rule incorporating an interest-rate
risk component into the risk-based capital regulation. Under the rule, an
institution with a greater than "normal" level of interest rate risk will be
subject to a deduction of its inherent rate risk component from total capital
for purposes of calculating the risk-based capital requirement. As a result,
such an institution will be required to maintain additional capital in order to
comply with the risk-based capital requirement. Although the final rule was
originally scheduled to be effective as of January 1994, the OTS has indicated
that it will delay invoking its interest rate risk rule requiring institutions
with above normal interest rate risk exposure to adjust their regulatory capital
requirement until appeal procedures are implemented and evaluated. The OTS has
not yet established an effective date for the capital deduction. We do not
believe that the OTS' adoption of an interest rate risk component to the risk-
based capital requirement will adversely affect the Bank if it becomes effective
in its current form.
In April 1991, the OTS proposed to modify the 3% of adjusted total assets
core capital requirement in the same manner as was done by the Comptroller of
the Currency for national banks. Under the OTS proposal, only associations
rated composite 1 under the CAMEL rating system will be permitted to operate at
the regulatory minimum core capital ratio of 3%. For all other associations,
the minimum core capital ratio will be 3% plus at least an additional 100 to 200
basis points, which will increase the 4% core capital ratio requirement to 5% of
adjusted total assets or more. In determining the amount of additional capital,
the OTS will assess both the quality of risk management systems and the level of
overall risk in each individual association through the supervisory process on a
case-by-case basis.
Prompt Corrective Action. Federal law provides the federal banking
regulators with broad power to take "prompt corrective action" to resolve the
problems of undercapitalized institutions. The extent of the regulators' powers
depends on whether the institution in question is "well capitalized,"
"adequately capitalized," "under-capitalized," "significantly undercapitalized"
or "critically undercapitalized." Under regulations adopted by the federal
banking regulators, an institution shall be deemed to be (i) "well capitalized"
if it has a total risk-based capital ratio of 10.0% or more, has a Tier I risk-
based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0%
or more and is not subject to specified requirements to meet and maintain a
specific capital level for any capital measure; (ii) "adequately capitalized" if
it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based
capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or
more (3.0% under certain circumstances) and does not meet the definition of
"well capitalized," (iii) "undercapitalized" if it has a total risk-based
capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is
less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0%
under certain circumstances), (iv) "significantly undercapitalized" if it has a
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total risk-based capital ratio that is less than 6.0%, a Tier I risk-based
capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is
less than 3.0%, and (v) "critically undercapitalized" if it has a ratio of
tangible equity to adjusted total assets that is equal to or less than 2.0%.
The regulations also permit the appropriate federal banking regulator to
downgrade an institution to the next lower category (provided that a
significantly undercapitalized institution may not be downgraded to critically
undercapitalized) if the regulator determines (i) after notice and opportunity
for hearing or response, that the institution is an unsafe or unsound condition
or (ii) that the institution has received (and not corrected) a less-than-
satisfactory rating for any of the categories of asset quality, management,
earnings or liquidity in its most recent exam. At December 31, 1999, the Bank
was a "well capitalized" institution, as defined under the prompt corrective
action regulations of the OTS.
Depending upon the capital category to which an institution is assigned,
the regulators' corrective powers, many of which are mandatory in certain
circumstances, include prohibition on capital distributions; prohibition on
payment of management fees to controlling persons; requiring the submission of a
capital restoration plan; placing limits on asset growth; limiting acquisitions,
branching or new lines of business; requiring the institution to issue
additional capital stock (including additional voting stock) or to be acquired;
restricting transactions with affiliates; restricting the interest rates that
the institution may pay on deposits; ordering a new election of directors of the
institution; requiring that senior executive officers or directors be dismissed;
prohibiting the institution from accepting deposits from correspondent banks;
requiring the institution to divest certain subsidiaries; prohibiting the
payment of principal or interest on subordinated debt; and, ultimately,
appointing a receiver for the institution.
Qualified Thrift Lender Test. All associations are required to meet the
QTL test set forth in the HOLA and regulations to avoid certain restrictions on
their operations. A association that does not meet the QTL test set forth in
the HOLA and implementing regulations must either convert to a bank charter or
comply with the following restrictions on its operations: (i) the association
may not engage in any new activity or make any new investment, directly or
indirectly, unless such activity or investment is permissible for a national
bank; (ii) the branching powers of the association shall be restricted to those
of a national bank; (iii) the association shall not be eligible to obtain any
advances from its FHLB; and (iv) payment of dividends by the association shall
be subject to the rules regarding payment of dividends by a national bank. Upon
the expiration of three years from the date the association ceases to be a QTL,
it must cease any activity and not retain any investment not permissible for a
national bank and immediately repay any outstanding FHLB advances (subject to
safety and soundness considerations). The Bank met the QTL test throughout
1999.
Restrictions on Capital Distributions. The OTS has promulgated a regulation
governing capital distributions by associations, which include cash dividends,
stock redemption's or repurchases, cash-out mergers, interest payments on
certain convertible debt and other transactions charged to the capital account
of association as a capital distribution. Generally, the regulation creates
three tiers of associations based on regulatory capital, with the top two tiers
77
providing a safe harbor for specified levels of capital distributions from
associations so long as such associations notify the OTS and receive no
objection to the distribution from the OTS. Associations that do not qualify
for the safe harbor provided for the top two tiers of associations are required
to obtain prior OTS approval before making any capital distributions.
Tier 1 associations may make the highest amount of capital distributions,
and are defined as associations that before and after the proposed distribution
meet or exceed their fully phased-in regulatory capital requirements. Tier 1
associations may make capital distributions during any calendar year equal to
the greater of (i) 100% of net income for the calendar year-to-date plus 50% of
its "surplus capital ratio" at the beginning of the calendar year and (ii) 75%
of its net income over the most recent four-quarter period. The "surplus capital
ratio" is defined to mean the percentage by which the association's ratio of
total capital to assets exceeds the ratio of its "fully phased-in capital
requirement" to assets, and "fully phased-in capital requirement" is defined to
mean an association's capital requirement under the statutory and regulatory
standards applicable on December 31, 1994, as modified to reflect any applicable
individual minimum capital requirement imposed upon the association. At December
31, 1999, the Bank was a Tier 1 association under the OTS capital distribution
regulation.
In December 1994, the OTS published a notice of proposed rulemaking to
amend its capital distribution regulation. Under the proposal, the three tiered
approach contained in existing regulations would be replaced and institutions
would be permitted to make capital distributions that would not result in their
capital being reduced below the level required to remain "adequately
capitalized," as defined above under "Prompt Corrective Action."
On April 1, 1999 the OTS has adopted regulations changing the notification
requirements on capital distributions. The updated regulation provides that an
OTS-regulated institution will not have to file a capital distribution notice
with the OTS upon meeting certain conditions. These conditions include that the
institution has a composite 1 or 2 CAMELS rating; a compliance rating of 1 or 2;
a Community Reinvestment Act rating of at least "satisfactory"; is not otherwise
in troubled condition; limits capital distribution plans for the calendar year
to no more than the sum of it's current retained net income and the preceding
two years; remains well-capitalized after the capital distribution; and will not
use the proposed capital distribution to reduce or retire stock or debt
instruments. An institution that fails to meet any of the required conditions
must submit a full application to the OTS.
Loan-to-One Borrower. Under applicable laws and regulations the amount of
loans and extensions of credit which may be extended by an institution such as
the Bank to any one borrower, including related entities, generally may not
exceed the greater of $500,000 or 15% of the unimpaired capital and unimpaired
surplus of the institution. Loans in an amount equal to an additional 10% of
unimpaired capital and unimpaired surplus also may be made to a borrower if the
78
loans are fully secured by readily available marketable securities. An
institution's "unimpaired capital and unimpaired surplus" includes, among other
things, the amount of its core capital and supplementary capital included in its
total capital under OTS regulations.
At December 31, 1999, the Bank's unimpaired capital and surplus amounted to
$6,356,000 resulting in a general loans-to-one borrower limitation of $953,000
under applicable laws and regulations. At September 30, 2000, the Bank's
unimpaired capital and surplus amounted to $9,304,000 resulting in a general
loans-to-one borrower limitation of $1,396,000
Brokered Deposits. Under applicable laws and regulations, an insured
depository institution may be restricted in obtaining, directly or indirectly,
funds by or through any "deposit broker," as defined, for deposit into one or
more deposit accounts at the institution. The term "deposit broker" generally
includes any person engaged in the business of placing deposits, or facilitating
the placement of deposits, of third parties with insured depository institutions
or the business of placing deposits with insured depository institutions for the
purpose of selling interest in those deposits to third parties. In addition,
the term "deposit broker" includes any insured depository institution, and any
employee of any insured depository institution, which engages, directly or
indirectly, in the solicitation of deposits by offering rates of interest (with
respect to such deposits) which are significantly higher than the prevailing
rates of interest on deposits offered by other insured depository institutions
have the same type of charter in such depository institution's normal market
area. As a result of the definition of "deposit broker," all of the Bank's
brokered deposits, as well as possibly its deposits obtained through customers
of regional and local investment banking firms and the deposits obtained from
the Bank's direct solicitation efforts of institutional investors and high net
worth individuals, are potentially subject to the restrictions described below.
Under FDIC regulations, well-capitalized institutions are subject to no brokered
deposit limitations, while adequately-capitalized institutions are able to
accept, renew or roll over brokered deposits only (i) with a waiver from the
FDIC and (ii) subject to the limitation that they do not pay an effective yield
on any such deposit which exceeds by more than (a) 75 basis points the effective
yield paid on deposits of comparable size and maturity in such institution's
normal market area for deposits accepted in its normal market area or (b) by
120% for retail deposits and 130% for wholesale deposits, respectively, of the
current yield on comparable maturity U.S. Treasury obligations for deposits
accepted outside the institution's normal market area. Undercapitalized
institutions are not permitted to accept brokered deposits and may not solicit
deposits by offering any effective yield that exceeds by more than 75 basis
points, the prevailing effective yields on insured deposits of comparable
maturity in the institution's normal market area or in the market area in which
such deposits are being solicited. At December 31, 1999, the Bank was a well-
capitalized institution, which was not subject to restrictions on brokered
deposits. See "Business - Bank Sources of Funds - Deposits."
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Liquidity Requirements. All savings associations are required to maintain
an average daily balance of liquid assets, which include specified short-term
assets and certain long-term assets, equal to a certain percentage of the sum of
its average daily balance of net deposit accounts and borrowings payable in one
year or less, which can be withdrawn. The liquidity requirement may vary from
time to time (between 3% and 10%) depending upon economic conditions and flows
of all savings associations. At the present time, the required liquid asset
ratio is 4%. Historically, the Bank has operated in compliance with these
requirements.
Affiliate Transactions. Under federal law and regulation, transactions
between a savings association and its affiliates are subject to quantitative and
qualitative restrictions. Affiliates of a savings association include, among
other entities, companies that control, are controlled by or are under common
control with the association. As a result, we and our non-bank subsidiaries are
affiliates of the Bank.
Savings associations are restricted in their ability to engage in "covered
transactions" with their affiliates. In addition, covered transactions between a
savings association and an affiliate, as well as certain other transactions with
or benefiting an affiliate, must be on terms and conditions at least as
favorable to the association as those prevailing at the time for comparable
transactions with non-affiliated companies. Associations are required to make
and retain detailed records of transactions with affiliates.
Notwithstanding the foregoing, a savings association is not permitted to
make a loan or extension of credit to any affiliate unless the affiliate is
engaged only in activities the Federal Reserve Board has determined to be
permissible for bank holding companies. Savings associations also are prohibited
from purchasing or investing in securities issued by an affiliate, other than
shares of a subsidiary of the savings association.
Savings associations are also subject to various limitations and reporting
requirements on loans to insiders. These limitations require, among other
things, that all loans or extensions of credit to insiders (generally executive
officers, directors or 10% stockholders of the institution) or their "related
interest" be made on substantially the same terms (including interest rates and
collateral) as, and follow credit underwriting procedures that are not less
stringent than, those prevailing for comparable transactions with the general
public and not involve more than the normal risk of repayment or present other
unfavorable features.
Community Investment and Consumer Protection Laws. In connection with its
lending activities, the Bank is subject to the same federal and state laws
applicable to us in general, laws designed to protect borrowers and promote
lending to various sectors of the economy and population. In addition, the Bank
is subject to the federal Community Reinvestment Act ("CRA"). The CRA requires
each bank or association to identify the communities it serves and the types of
credit or other financial services the bank or association is prepared to extend
80
to those communities. The CRA also requires the OTS to assess a association's
record of helping to meet the credit needs of its community and to take the
assessment into consideration when evaluating applications for mergers,
applications and other transactions. The OTS may assign a rating of
"outstanding," "satisfactory," "needs to improve," or "substantial
noncompliance." A less than satisfactory CRA rating may be the basis for denying
such applications. The OTS conducted a CRA review of the Bank on April 27, 1998
at which time the Bank received a "satisfactory record of meeting community
credit needs" rating. We believe the OTS will continue to have a favorable view
of the Bank's CRA record.
Under the CRA and implementing OTS regulations, an association has a
continuing and affirmative obligation to help meet the credit needs of its local
communities, including low- and moderate-income neighborhoods, consistent with
the safe and sound operation of the institution. Until July 1, 1997, the OTS
implementing regulations required the board of directors, of each association,
to adopt a CRA statement for each delineated local community that, among other
things, describes its efforts to help meet community credit needs and the
specific types of credit that the institution is willing to extend. Under new
standards, the OTS will assign a CRA rating based on a Lending Test, Investment
Test and Service Test keyed to, respectively, the number of loans, the number of
investments, and the level of availability of retail banking services in a
association's assessment area. The Lending Test will be the primary component
of the assigned composite rating. An "outstanding" rating on the Lending Test
automatically will result in at least a "satisfactory" rating in the composite,
but an institution cannot receive a "satisfactory" or better rating on the
composite if it does not receive at least a "low satisfactory" rating on the
Lending Test. Alternatively, a association may elect to be assessed by
complying with a strategic plan approved by the OTS. Evaluation under the new
rules is mandatory after June 30, 1997; however, a association could elect to
be evaluated under the new rules beginning on January 1, 1996, although the
Bank did not elect to do so. Data collection requirements became effective
January 1, 1996.
Safety and Soundness. Other regulations which were recently adopted or are
currently proposed to be adopted pursuant to recent legislation include: (i)
real estate lending standards for insured institutions, which provide guidelines
concerning loan-to-value ratios for various types of real estate loans; (ii)
revisions to the risk-based capital rules to account for interest rate risk,
concentration of credit risk and the risks posed by "non-traditional
activities;" (iii) rules requiring depository institutions to develop and
implement internal procedures to evaluate and control credit and settlement
exposure to their correspondent banks; and (iv) rules addressing various "safety
and soundness" issues, including operations and managerial standards, standards
for asset quality, earnings and stock valuations, and compensation standards for
the officers, directors, employees and principal stockholders of the insured
institution.
Collateral Restrictions of the Federal Home Loan Bank. The Federal Home
Loan Bank ("FHLB") Board of Atlanta announced to its member institutions on
November 27, 2000 the adoption of "Policies to Promote Responsible Lending". The
policy restricts the general characteristics of mortgage loans or the mortgage
81
loans backing mortgage backed securities that a member institution, such as our
Bank, can pledge as collateral for advances of credit from the FHLB. In general
collateral pledged cannot (i) meet the interest requirements of high cost
mortgages under the HOEPA of 1994 (ii) Include prepaid, single premium credit
insurance (iii) include points and fees, excluding discount points, in excess of
5% (iv) include prepayment penalty if the interest rate at time of origination
is 300 basis points higher than conventional rates.
Legislative Risk (See: "Regulation" and "OTS Regulation of Approved Financial
Corp.")
Members of Congress and government officials from time to time have
suggested the elimination of the mortgage interest deduction for federal income
tax purposes, either entirely or in part, based on borrower income, type of loan
or principal amount. Because many of our loans are made to borrowers for the
purpose of consolidating consumer debt or financing other consumer needs, the
competitive advantages of tax-deductible interest, when compared with
alternative sources of financing, could be eliminated or seriously impaired by
such government action. Accordingly, the reduction or elimination of these tax
benefits could have a material adverse effect on the demand for loans of the
kind offered by us. (See also: "Regulatory Capital Requirements")
Environmental Risk Factors
To date, we have not been required to perform any investigation or clean up
activities, nor have we been subject to any environmental claims. There can be
no assurance, however, that this will remain the case in the future. In the
ordinary course of our business, we from time to time foreclose on properties
securing loans. Although we primarily lend to owners of residential properties,
there is a risk that we could be required to investigate and clean up hazardous
or toxic substances or chemical releases at such properties after acquisition by
us, and could be held liable to a governmental entity or to third parties for
property damage, personal injury, and investigation and cleanup costs incurred
by such parties in connection with the contamination. The costs of
investigation, correction of or removal of such substances may be substantial,
and the presence of such substances, or the failure to properly correct such
property, may adversely affect the owner's ability to sell or rent such property
or to borrow using such property as collateral. Persons who arrange for the
disposal or treatment of hazardous or toxic substances also may be liable for
the costs of removal or correction of such substances at the disposal or
treatment facility, whether or not the facility is owned or operated by such
person. In addition, the owner or former owners of a contaminated site may be
subject to common law claims by third parties based on damages and costs
resulting from environmental contamination emanating from such property.
In the course of our business, we may acquire properties as a result of
foreclosure. There is a risk that hazardous or toxic waste could be found on
82
such properties. In such event, we could be held responsible for the cost of
cleaning up or removing such waste, and such cost could exceed the value of the
underlying properties.
Dependence on Key Personnel
Our growth and development to date have been largely dependent upon the
services of Allen D. Wykle, Chairman of the Board, President and Chief Executive
Officer. The loss of Mr. Wykle's services for any reason could have a material
adverse effect on us. Certain of our principal credit agreements contain a
provision which permit the lender to accelerate the our obligations in the event
that Mr. Wykle, Mr. Yeakel or Ms. Schwindt leave us for any reason and are not
replaced with an executive acceptable to such lender. The dependence on these
individuals is a risk factor for the holder's of subordinated debt securities as
well as investors in senior debt and our common stock.
Control by Certain Shareholders
As of September 30, 2000, Allen D. Wykle, Chairman of the Board, President
and Chief Executive Officer and Leon H. Perlin, Director, beneficially own an
aggregate of 50.5% of the outstanding shares of Common Stock of Approved
Financial Corp. Accordingly, a risk factor exist in the fact that if they were
to act in concert, they would have voting control with the ability to approve
certain fundamental corporate transactions and the election of the entire Board
of Directors.
PROPERTIES
Our executive and administrative offices are located at 1716 Corporate
Landing Parkway, Virginia Beach, Virginia, 23454. We purchased and moved to this
new location on December 6, 1999. The building consists of approximately 30,985
square feet.
We continue to own our prior executive and administrative offices located
at 3420 Holland Road, Virginia Beach, Virginia 23451. This building is currently
listed for sale. The two buildings are subject to total mortgage debt of
$2,341,000 as of December 31, 1999 and of $2,272,000 as of September 30, 2000.
In February 1999, we sold the office building purchased in June 1997, which
was adjacent to our prior headquarters located on Holland Road. (See Note 22 of
audited financial statements for information regarding the sale of this office
building.)
As of September 30, 2000 we had leases for one regional broker lending
office, retail lending offices, and the administrative office for the Bank.
These facilities are leased under terms that vary as to duration and in general,
the leases expire between 2000 and 2004, and provide rent escalations tied to
either increases in the operating expenses of the lessor or fluctuations in the
83
consumer price index in the relevant geographic area. Lease expense was
$2,027,000, $1,394,000, and $966,000 in 1999, 1998 and 1997, respectively. Lease
expense was $572,000 for the nine-month period ended September 30, 2000.
Total minimum lease payments under non-cancelable operating leases with
remaining terms in excess of one year as of December 31, 1999 were as follows
(in thousands):
[Download Table]
2000 $ 724
2001 344
2002 152
2003 64
2004 48
------
Total 2000-2004 $1,332
======
Total minimum lease payments under non-cancelable operating leases with
remaining terms in excess of one year as of September 30, 2000 were as follows
(in thousands):
[Download Table]
2001 $379
2002 263
2003 76
2004 48
-----
Total 2001-2004 $766
=====
We anticipate that in the normal course of business we will lease
additional office space as we open new loan origination locations or assumes
leases associated with any future acquisitions or strategic alliances.
LEGAL PROCEEDINGS
We are a party to various routine legal proceedings arising out of the
ordinary course of our business. We believe that none of these actions,
individually or in the aggregate, will have a material adverse effect on our
results of operations or financial condition.
84
DIRECTORS AND EXECUTIVE OFFICERS
The following provides background information with respect to the Directors
and Executive Officers. See "Security Ownership of Certain Beneficial Owners and
Management" for information regarding such persons' holdings of Approved
Financial Corp. Common Stock.
(*) Indicates Executive Officers
Class I Directors
(Term expiring at the annual meeting of shareholders to be held in 2001 or until
their successor is duly elected and qualified)
(*) Allen D. Wykle (54) Chairman, President and CEO. Mr. Wykle, in addition to
being an initial investor, organized and headed the initial management team that
acquired the Approved Financial Corp. from Government Employees Insurance
Corporation (GEICO) in September of 1984. He has served as Chairman of the
Board, President and Chief Executive Officer since September 1984. Mr. Wykle
served as a Director of IMC Mortgage Company from April 1996 until June 1998.
Mr. Wykle was owner, President and Chief Executive Officer of Best Homes of
Tidewater, Inc., a residential construction and remodeling company in Virginia,
from 1972 to 1986.
Leon H. Perlin (72) Mr. Perlin was an initial investor and has been a
Director since 1984. Mr. Perlin has served as President and Chief Executive
Officer of Leon H. Perlin Company, Inc., a commercial construction concern, for
over 30 years.
Oscar S. Warner (83) Mr. Warner was an initial investor in 1984 and has been a
Director and Shareholder since 1984. Mr. Warner has been retired for the past
six years. Previously, he was owner and operator of Oscar Warner Corporation, an
import company.
Class II Directors -Term expiring at the annual meeting of shareholders to be
held in 2003 or until their successor is duly elected and qualified)
Arthur Peregoff (81) Mr. Peregoff was an initial investor and has been a
Director since 1985. Mr. Peregoff has served as Chief Executive Officer of Globe
Iron Construction Company, Inc., a commercial construction company, for over 25
years.
(*) Stanley W. Broaddus (50) Vice President and Secretary. Mr. Broaddus was an
initial investor and has been a Director since 1985. Mr. Broaddus has served as
Vice President and Secretary since April 1987. Previous experience includes
fourteen years as Regional Sales Manager with the building products unit of
Atlantic Richfield Co.
(*) Jean S. Schwindt (45) Executive Vice President. Ms. Schwindt has been a
Director since 1992 and became Executive Vice President in June 1998 she served
as Vice President and Director of Investor Relations and Strategic Planning for
85
IMC Mortgage Company from March 1996 until June 1998. Ms. Schwindt has served on
the Board of Directors of IMC Mortgage Company ("IMC") since April 11, 2000.
From April 1989 to March 1996 she served on the Board of Directors and as Senior
Vice President/Secretary of Anderson and Strudwick, Inc., a member of the New
York Stock Exchange. Ms. Schwindt, a Chartered Financial Analyst and a
Registered Investment Advisor, has been affiliated with the firm of Mills Value
Advisers, Inc. since January 1995.
Class III Directors
Each Class III Director is serving a Three-Year Term Expiring at the Annual
Meeting of Shareholders held in 2002 or until their successor is duly elected
and qualified
Robert M. Salter (52) Mr. Salter was an initial investor and has been a Director
since 1989. Beginning January 1, 2000, he became a partner with Goodman and
Company LLP, which is a certified public accounting and consulting firm. From
1979 through 1999 he was President of the accounting firm of Salter and Hall,
P.C. Mr. Salter is a Certified Public Accountant and a Certified Financial
Planner.
(*) Neil W. Phelan, (43) Executive Vice President. Mr. Phelan is Executive Vice
President and has been associated with us since April 1995. He has been a
Director since 1997. His primary responsibility with us is the management of
certain wholesale lending operations. Immediately prior to joining us, Mr.
Phelan served on the senior management team of ITT Financial Services for 17
years.
Barry C. Diggins (37) Mr. Diggins, a director since 1997, is president of Fresh
Start Financial Services located in Maryland. From October 1994 through July
2000, Mr. Diggins served as Executive Vice President of Approved Financial Corp.
Before joining us in 1984, Mr. Diggins was Regional Marketing Director of ITT
Financial Services from September 1985 to October 1994.
Gregory J. Witherspoon (54) Mr. Witherspoon has been a Director since 1998. He
is president of Witherspoon Consulting, a company that provides consulting
services to the financial services industry. He also serves as managing director
of Amusement Industry Consultants, LLC. He served as a Director of Aames
Financial Corporation from 1991 to March 1998, as Chief Financial Officer from
1987 until 1997,after which, he served as Executive Vice President for Strategic
Planning. He is a Certified Public Accountant. Mr. Witherspoon previously served
on the Board of Directors of Approved from July 1996 until January 1997.
Executive Officers Not Serving on The Board Of Directors
Our Executive Officers as of the date of this prospectus who are not also
Directors are identified below, together with information regarding the business
experience of such officers. Each Executive Officer is elected by the Board of
Directors and serves at the pleasure of the Board.
86
(*) Eric S. Yeakel (36) Treasurer and Chief Financial Officer. Mr. Yeakel has
been with us since June 1994. He was a full time graduate student from
September 1992 until receiving a Masters in Business Administration in 1994. He
served as Assistant Controller with Office Warehouse, Inc. from October 1989 to
August 1992. Mr. Yeakel is a Certified Public Accountant who worked with Ernst
& Young from July 1987 to October 1989.
(*) Gregory W. Gleason (49) President of Approved Federal Savings Bank. Mr.
Gleason joined the Bank in November 1996 with more than 20 years of savings
institution management. Mr. Gleason was Senior Vice President with Virginia
First Savings Bank from February 1984 through June 1996, and was on the
management team of BankAtlantic from May 1977 to January 1984.
87
EXECUTIVE COMPENSATION
Summary of Cash and Other Compensation
The following table sets forth the compensation paid to our Chief Executive
Officer and the most highly compensated Executive Officers other than the Chief
Executive Officer. (collectively, the "Named Executive Officers") during the
three years ended December 31, 1999:
Summary Compensation Table
[Enlarge/Download Table]
Annual Compensation (1) Long-term Compensation
-------------------------------------------------------------
Securities All Other
Name and Principal Year Salary Bonus underlying Compensation
Position Options(2)
------ --------- -------- ------------- ---------------
Allen D. Wykle (3,4) 1999 $418,368 $ - - $ 5,000
President and Chief 1998 418,368 - 20,000 4,750
Executive Officer 1997 421,218 575,000 1,000 4,750
Barry C. Diggins (3,5) 1999 $200,000 $ 39,000 - $ 5,000
Executive Vice President 1998 171,186 67,142 7,500 4,963
Director 1997 132,638 209,564 - -
Jean S. Schwindt (6) 1999 $160,000 $ - - $ 4,800
Executive Vice President 1998 86,667 - 12,500 2,250
Director 1997 - - - 14,500
Neil W. Phelan (3,7) 1999 $143,000 $ - - $ 3,960
Executive Vice President, 1998 130,000 - 8,500 3,383
Director 1997 110,000 150,000 1,000 3,383
Eric S. Yeakel(3,8) 1999 $120,000 $ - - $ 3,600
Chief Financial Officer and 1998 102,500 - 13,000 2,213
Treasurer 1997 75,910 42,171 1,000 -
Greg Gleason (3,9) 1999 $110,000 $ - - $ 3,300
President Approved Federal 1998 111,000 - 1,350 3,330
Savings Bank 1997 103,424 - - -
Stanley W. Broaddus (3,10) 1999 $ 95,000 $ - - $ 2,850
Secretary, Vice President 1998 95,000 29,216 7,000 2,437
Director 1997 85,000 100,000 1,000 2,437
1) All benefits that might be considered of a personal nature are omitted
according to SEC rules if they did not exceed the lesser of $50,000 or 10%
of total annual salary and bonus for the officer.
2) Options are granted from the 1996 Incentive Option Plan.
3) Other compensation amounts reflect our matching contribution under our
401(k) retirement plan.
4) Options granted to Mr. Wykle in 1997 carry an exercise price of $9.75 per
share and those granted in 1998 carry an exercise price of $4 per share.
88
5) Mr. Diggins was paid incentive compensation based on the earnings of the
retail lending division. His incentive amounts were $27,642 in 1998 and
$209,564 in 1997. The salary for 1998 reflects $33,386, which was paid in
1999 as retroactive salary for the period July to December of 1998. In 1999
Mr. Diggins received $40,670 in retro pay. The $39,000 bonus paid in 1999
represents payment for 1998 retail branch incentive bonus. The 7,500
options granted to him in 1998 carry an exercise price of $4 per share. Mr.
Diggins resigned employment with us effective July 28, 2000 and therefore,
according to the option plan document, his options, which were unexercised
expired 30 days from this date.
6) Other compensation for 1997 and 1998 represents fees earned as an outside
Director. Stock options related to 12,500 shares that were granted in 1998
carry an exercise price of $4 per share. Stock Appreciation Rights
concerning 16,000 shares of common stock were issued in 1996 at a price
$2.63 and expire in 2003.
7) Options granted to Mr. Phelan in 1997 carry an exercise price of $4.00 per
share, 8,500 options granted in 1998 carry an exercise price of $4 per
share. Mr. Phelan's bonus of $150,000 earned in 1997 was paid in 1998.
8) Options granted to Mr. Yeakel in 1997 carry an exercise price of $9.75, 500
options granted in 1998 carry an exercise price of $13.50 and 12,500
options granted in 1998 carry an exercise price of $4 per share. A portion
of the bonus earned and reflected in 1998 was paid in 1999.
9) Options granted to Mr. Gleason in 1998 carry an exercise price of $4 per
share.
10) Options granted to Mr. Broaddus in 1997 carry an exercise price of $4.00
per share and options granted to him in 1998 carry an exercise price of $4
per share.
STOCK OPTION/STOCK APPRECIATION RIGHT GRANTS IN THE LAST YEAR
In June of 1999, we granted common stock options to employees to purchase 14,600
shares of common stock at $4.00 per share. In November of 1999, we granted
common stock options to employees to purchase 6,825 share of common stock at
$4.00 per share. All grants are from the 1996 Incentive Stock Option Plan and
have a term of ten years and a vesting schedule of three years.
No new stock options or stock appreciation rights were granted to Named
Executive Officers during 1999. However, during 1999, 1,000 stock options
granted to Mr. Phelan in 1997 with an exercise price of $9.75 per share were
repriced to an exercise price of $4.00 per share and 3,000 stock options granted
to him in 1998 at an exercise price of $13.75 per share were repriced to an
exercise price of $4.00 per share. Additionally, 1,000 shares issued to Stanley
Broaddus in 1997 at an exercise price of $9.75 per share were repriced to an
exercise price of $ 4.00 per share. The table below reflects the repricing for
the Named Executive Officers.
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[Enlarge/Download Table]
Individual Grants
-----------------
Potential Realizable
Value at Assumed
Number of Percent of Annual Rates of Stock
Securities Total Options Per Share Prices Price Appreciation for
Underlying Repriced to ------------------ Option Term (1)
Options Employees Option Market ----------------------
Name Repriced in 1999 Exercise at Repricing Expiration 5% 10%
---- -------- ------- -------- ------------ ---------- --- ---
Neil W. Phelan 1,000 11% $4.00 $2.75 1/26/07 $ 0 $1,359
Neil W. Phelan 3,000 33% 4.00 2.75 4/7/08 189 5,685
Stanley W. Broaddus 1,000 11% 4.00 2.75 1/26/07 0 1,359
(1) The 5% and 10% assumed annual rates of compounded stock price appreciation
are permitted by rules of the Securities and Exchange Commission. There
can be no assurance provided to any Executive Officer or any other holder
that the actual stock price appreciation over the 10-year option term will
be at the assumed 5% and 10% levels or at any other defined level. Unless
the market price of the Common Stock appreciates over the option term, no
value will be realized from the option grants to Executive Officers.
90
Aggregate Option /Stock Appreciation Rights ("SAR") Exercises
and Period-End Values
The following table sets forth information concerning the December 31, 1999
value of unexercised options/SARs held by our Named Executive Officers as of
November 3, 2000.
[Download Table]
Number of Securities Value of Unexercised
Underlying Unexercised In-the-money options
Options as Fiscal Year End at Fiscal Year End (1)
-------------------------- ----------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
Allen Wykle 7,667 13,333 0 0
Eric Yeakel 5,500 8,500 0 0
Jean Schwindt (2) 20,167 8,333 0 0
Neil Phelan 4,833 4,667 0 0
Stanley Broaddus 3,333 4,667 0 0
Greg Gleason 450 900 0 0
(1) Value of Unexercised Options is calculated using the price of Approved
Common Stock on 12/31/99 of $0.875 per share less the exercise prices of
$4.00, $9.75 & $13.50 per share, multiplied by the number of shares
represented by the options. There were no common stock options issued and
outstanding to Executive Officers with an exercise price lower than the
year end common stock market price ("in the money options") on December 31,
1999 and thus having a value based on this formula at 12/31/99.
(2) Includes 16,000 exercisable SARs with a price of $2.63 per share.
91
EMPLOYMENT AGREEMENTS
As of December 1st, 2000 we have employment agreements with five Executive
Officers, Messrs. Wykle, Yeakel, Broaddus, Phelan and Ms. Schwindt. We had an
Employment Agreement with Barry Diggins, prior to termination of his full time
employment with us effective July 28, 2000. (See:"Class III Directors")
Mr. Wykle has not received an increase in base salary or total compensation
since 1998 and he voluntarily commenced a reduction in salary effective July 1,
2000. Mr. Broaddus voluntarily forgave an increase in base salary or bonus
compensation due to him under the terms of his employment agreement during 2000.
Mr. Yeakel and Ms. Schwindt voluntarily forgave the increase in base salary due
to them in January 2000 under the terms of their employment agreements and
reduced their base salaries effective July 1, 2000. Mr. Phelan received the ten
percent increase in base salary due to him under his employment agreement
effective January 2000, however, he voluntarily reduced his total compensation
effective July 1, 2000.
Allen D. Wykle
Chairman, President and Chief Executive Officer
Prior to November of 2000,Allen D. Wykle had no formal employment agreement
with us and the Compensation Committee of the Board of Directors determined his
base salary and bonus. Mr. Wykle entered into an employment agreement with us on
December 1, 2000.
TERM, RENEWAL AND CHANGE IN CONTROL. The initial term of this agreement
shall be from December 1, 2000 until December 31, 2001. After December 31, 2001,
this Agreement will be renewable on a year to year basis. Either party must give
one hundred and eighty (180) days written notice if this Agreement is not going
to be renewed after December 31, 2001. Upon failure to give such notice, this
Agreement will automatically renew for an additional year on the same terms.
This notice requirement shall continue for all subsequent renewal periods. In
the event of a Change of Control (i.e. (i) a reduction in the percentage of our
common stock owned and controlled by Allen D. Wykle of 50% or greater, or (ii)
the cessation of Allen D. Wykle's full time employment with us as Chairman of
the Board, President or Chief Executive Officer) and during the calendar year in
which the Change of Control occurred he is notified of nonrenewal of this
Employment Agreement 180 or more days before the end of the then current
calendar year term then that term shall be extended for six (6) months i.e.
until June 30 of the following calendar year, thereby allowing Employee at least
one full year of remaining employment. If the notice of nonrenewal is given with
less than 180 days remaining before the end of the then current calendar year
term the then current term will not be extended because the then current term
will automatically renew for another year (due to failure to give 180 days
notice) thereby assuring him of at least one full year of continued employment.
92
SALARY: The agreement provides for an initial base salary at an annual rate
of $418,368 and provides for increases of 3% or 10% per year effective as of
January for any renewal term. The yearly salary increase is 10% if our net
income after tax increases by 10% or greater from the prior year increases by 3%
if our net income after tax does not increase by a minimum of 10%. Mr. Wykle
voluntarily reduced his current base salary by 10% to $376,531 due to our
current financial condition. He is entitled to transportation and all standard
group employee benefits.
BONUS: The bonus plan under the agreement provides for a bonus beginning in
the year 2001 of up to a maximum of 100% of the annual salary for each year. The
bonus is based on the annual return on equity ("ROE") percentage per share in
excess of a base annual ROE of 20% (after accrual for bonuses.) A bonus is
payable 50% in cash or stock at our discretion and 50% in cash or stock at the
employee's discretion.
Bonus Example.
--------------
o If ROE per share for a year is 30%
o Then he will be entitled to a bonus equal to 33% of his base salary
(30%-20%)/20% = 50%
o If his Base Salary is $418,368
o Then his bonus would be $418,368 * 50% = $209,184
NON-COMPETE: Under the Employment Agreement he has agreed not to compete
with us for a period of one year after termination within a prescribed
geographic area and not to solicit or employ our employees for two years after
termination. These restrictive covenants apply upon termination by either party,
with or without cause and upon expiration of the Agreement.
COMPENSATION AFTER TERMINATION. If he dies, becomes permanently disabled,
terminates his employment or is terminated for cause as defined in the
Agreement, this contract shall cease, and no further compensation or benefits in
any form shall be paid Employee. If this Agreement is terminated by us without
cause, then he shall be entitled to the compensation and benefits which he would
have received but for the termination without cause.
Neil W. Phelan
Executive Vice President
TERM: The Employment Agreement that commenced January 1, 1998 for a three-
year initial term, was amended in November of 2000 for a term ending December
31, 2001. The agreement automatically renews for additional one-year terms
absent three months written notice of non-renewal by either party prior to end
of a term.
SALARY & OTHER BENEFITS: Mr. Phelan's annual salary for 1999 was $143,000.
His pre-amended Employment Agreement provided for a 10% increase in base salary
to and annualized rate of $157,300, which he received for the six months ended
June 30, 2000. For the third and fourth quarters of 2000,his base salary was
reduced to an annualized rate of $150,000. His amended agreement provides for a
base
93
salary at an annualized rate of $135,000 for the first quarter of 2001 and
reducing to an annualized rate of $125,000 for the remainder of the term of the
agreement. He also is entitled to all standard group employee benefits. Mr.
Phelan received a car allowance of $700 per month in 1999 and $750 per month
during the first six months of 2000.Mr. Phelan voluntarily discontinued receipt
of a car allowance effective July 1, 2000.
BONUS: Mr. Phelan's amended agreement provides for a bonus plan consisting
of two parts, (1) an override bonus on production of certain account executives
and (2) participation in the senior management bonus.
Override Bonus: Mr. Phelan will earn a 5 basis points commission for monthly
loan origination volume produced by new wholesale account executives hired after
October 1, 2000 who are directly managed by Mr. Phelan. To qualify in the
calculation of this bonus the individual sales person must produce a minimum of
$750,000 per month in loan volume.
Senior Management Bonus: The senior management bonus provides for a bonus of
up to a maximum of 100% of the annual salary for each year. The bonus is based
on the annual return on equity ("ROE") percentage per share in excess of a base
annual ROE of 20% (after accrual for bonuses.) A bonus is payable 50% in cash or
stock at our discretion and 50% in cash or stock at the employee's discretion.
Bonus Example.
--------------
o If ROE per share for a year is 30%
o Then he will be entitled to a bonus equal to 50% of his base salary
(30%-20%)/20% = 50%
o If his Base Salary is $125,000
o Then his bonus would be $125,000 * 50% = $41,250
NON-SOLICITATION: Under the Employment Agreement Mr. Phelan has agreed not
to solicit our employees for two years after termination. This restrictive
covenant applies upon termination for any reason by Mr. Phelan or termination
for cause by us.
Stanley W. Broaddus.
Vice President and Secretary
TERM: The Employment Agreement which commenced January 1, 1997 was for a one
year initial term and automatically renews on January 1, of each subsequent year
for additional one-year terms absent ninety day written notice by either party
prior to the end of a renewed term. The agreement was amended December 1, 2000.
SALARY & OTHER BENEFITS: His current base annual salary is $95,000. He is
entitled to a car and all standard group employee benefits.
BONUS: The bonus plan under the agreement beginning in 2001 provides for a
bonus of up to a maximum of 100% of the annual salary for each year. The bonus
is
94
based on the annual return on equity ("ROE") percentage per share in excess of a
base annual ROE of 20% (after accrual for bonuses.) A bonus is payable 50% in
cash or stock at our discretion and 50% in cash or stock at the employee's
discretion.
Bonus Example.
--------------
o If ROE per share for a year is 30%
o Then he will be entitled to a bonus equal to 50% of his base salary
(30%-20%)/20% = 50%
o If his Base Salary is $95,000
o Then his bonus would be $95,000 * 50% = $47,250
TERMINATION & NON-COMPETE: The Employment Agreement provides for termination
"for cause" as defined in the Agreement with notice and for termination upon 90
days prior written notice without cause. Under the Employment Agreement he has
agreed not to compete with us for a period of one (1) year after termination
within a prescribed geographic area and not to solicit or employ our employees
for two (2) years after termination. These restrictive covenants apply upon
termination by either party, with or without cause and upon expiration of the
Agreement. He is also entitled to one year's annual salary in the event that we
experience a change in control, which results in Allen D. Wykle no longer being
employed by us and if we terminate Mr. Broaddus without cause.
Jean S. Schwindt
Executive Vice President
TERM, RENEWAL AND CHANGE IN CONTROL. The employment agreement with Ms.
Schwindt dated July1, 1998 and amended December 1, 2000 was for an initial
termfrom July 1, 1998 through December 31, 1998. On January 1, 1999 it
automatically renewed for a three (3) year term with each year running from
January 1st through December 31st. After December 31, 2001, this Agreement will
be renewable on a year to year basis. Either party must give one hundred and
eighty (180) days written notice if this Agreement is not going to be renewed
after December 31, 2001. Upon failure to give such notice, this Agreement will
automatically renew for an additional year on the same terms. This notice
requirement shall continue for all subsequent renewal periods. In the event of
a Change of Control (i.e. (i) a reduction in the percentage of our common stock
owned and controlled by Allen D. Wykle of 50% or greater, or (ii) the cessation
of Allen D. Wykle's full time employment with us as Chairman of the Board,
President or Chief Executive Officer) and during the calendar year in which the
Change of Control occurred she is notified of nonrenewal of this Employment
Agreement 180 or more days before the end of the then current calendar year term
then that term shall be extended for six (6) months i.e. until June 30 of the
following calendar year, thereby allowing her at least one full year of
95
remaining employment. If the notice of nonrenewal is given with less than 180
days remaining before the end of the then current calendar year term the then
current term will not be extended because the then current term will
automatically renew for another year (due to failure to give 180 days notice)
thereby assuring her of at least one full year of continued employment.
SALARY: It provides for an initial base salary at an annual rate of $160,000,
and provides for increases of 6% or 10% per year effective as of January 2000
and January 2001 and any renewal terms. Her yearly salary increase is 10% if our
net income after tax increases by 10% or greater from the prior year and
increases by 6% if our net income after tax does not increase by a minimum of
10%.
The Employment Agreement with Ms. Schwindt, as described above, provides for a
base salary during the year 2000 of $169,600. However, as contribution to our
expense reduction program, she voluntarily forgave her 6% salary increase due
January of 2000 and reduced her current annualized base salary to $144,000, a
reduction of 15% from the amount provided in the agreement. .
BONUS: The bonus plan under the agreement beginning in 2001 provides for a bonus
of up to a maximum of 100% of the annual salary for each year. The bonus is
based on the annual return on equity ("ROE") percentage per share in excess of a
base annual ROE of 20% (after accrual for bonuses.) A bonus is payable 50% in
cash or stock at our discretion and 50% in cash or stock at the employee's
discretion.
Bonus Example.
--------------
o If ROE per share for a year is 30%
o Then she will be entitled to a bonus equal to 50% of her base salary
(30%-20%)/20% = 50%
o If her Base Salary is $160,000
o Then her bonus would be $160,000 * 50% = $80,000
NON-COMPETE: Under the Employment Agreement she has agreed not to compete with
us for a period of one year after termination within a prescribed geographic
area and not to solicit or employ our employees for two years after termination.
These restrictive covenants apply upon termination by either party, with or
without cause and upon expiration of the Agreement.
COMPENSATION AFTER TERMINATION. If she dies, becomes permanently disabled,
terminates her employment or is terminated for cause as defined in the
Agreement, this contract shall cease, and no further compensation or benefits in
any form shall be paid to her. If this Agreement is terminated by us without
cause, then she shall be entitled to the compensation and benefits which she
would have received but for the termination without cause.
Eric S. Yeakel
Chief Financial Officer and Treasurer
TERM, RENEWAL AND CHANGE IN CONTROL. The initial term of the employment
agreement with Mr. Yeakel was from July 1, 1998 through December 31, 1998. On
January 1, 1999 it automatically renewed for a three (3) year term with each
96
year running from January 1st through December 31st. After December 31, 2001,
this Agreement will be renewable on a year to year basis. Either party must
give one hundred and eighty (180) days written notice if this Agreement is not
going to be renewed after December 31, 2001. Upon failure to give such notice,
this Agreement will automatically renew for an additional year on the same
terms. This notice requirement shall continue for all subsequent renewal
periods. In the event of a Change of Control (i.e. (i) a reduction in the
percentage of our common stock owned and controlled by Allen D. Wykle of 50% or
greater, or (ii) the cessation of Allen D. Wykle's full time employment with us
as Chairman of the Board, President or Chief Executive Officer) and during the
calendar year in which the Change of Control occurred he is notified of
nonrenewal of this Employment Agreement 180 or more days before the end of the
then current calendar year term then that term shall be extended for six (6)
months i.e. until June 30 of the following calendar year, thereby allowing him
at least one full year of remaining employment. If the notice of nonrenewal is
given with less than 180 days remaining before the end of the then current
calendar year term the then current term will not be extended because the then
current term will automatically renew for another year (due to failure to give
180 days notice) thereby assuring him of at least one full year of continued
employment.
SALARY: It provides for an initial base salary at an annual rate of $120,000,
and provides for increases of 6% or 10% per year effective as of January 2000
and January 2001 and any renewal terms. The yearly salary increase is 10% if our
net income after tax increases by 10% or greater from the prior year. His yearly
salary increases by 6% if our net income after tax does not increase by a
minimum of 10%.
The Employment Agreement with Mr. Yeakel, as described above, provides for a
base salary during the year 2000 of $127,200. However, as contribution to our
expense reduction program, he voluntarily forgave his 6% salary increase due
January of 2000 and reduced his current annualized base salary to $108,000, a
reduction of 15% from the amount provided in the agreement.
BONUS: The bonus plan under the agreement beginning in 2001 provides for a bonus
of up to a maximum of 100% of the annual salary for each year. The bonus is
based on the annual return on equity ("ROE") percentage per share in excess of a
base annual ROE of 20% (after accrual for bonuses.) A bonus is payable 50% in
cash or stock at our discretion and 50% in cash or stock at the employee's
discretion.
Bonus Example.
--------------
o If ROE per share for a year is 30%
o Then he will be entitled to a bonus equal to 50% of his base salary
(30%-20%)/20% = 50%
o If his Base Salary is $120,000
o Then his bonus would be $120,000 * 50% = $60,000
97
NON-COMPETE: Under the Employment Agreement he has agreed not to compete with us
for a period of one year after termination within a prescribed geographic area
and not to solicit or employ our employees for two years after termination.
These restrictive covenants apply upon termination by either party, with or
without cause and upon expiration of the Agreement.
COMPENSATION AFTER TERMINATION. If he dies, becomes permanently disabled,
terminates his employment or is terminated for cause as defined in the
Agreement, this contract shall cease, and no further compensation or benefits in
any form shall be paid to him. If this Agreement is terminated by us without
cause, then he shall be entitled to the compensation and benefits which he would
have received but for the termination without cause.
DIRECTORS' COMPENSATION
Employee Directors
Directors who are employees receive no additional compensation for service as
Directors while employed by us.
Outside Directors
Each Director who is not an employee receives an annual retainer of $9,000,
payable in cash in quarterly installments of $2,250. All Directors receive
reimbursement of reasonable out-of-pocket expenses incurred in connection with
meetings of the Board of Directors.
During 1996, which was before Ms. Schwindt became an employee, the Board of
Directors granted stock appreciation rights ("SARs") to Ms. Schwindt. The SARs,
with an initial term of three years, entitle the holder to the appreciated value
of 16,000 shares of common stock. The appreciated value is the difference
between the grant price and the fair market value of the shares at the time of
exercise. The grant price is $2.63. At the Board meeting held on February 21,
1999, the Board extended the term of the SARs granted to Ms. Schwindt for three
years from the initial expiration date in 1999.
Mr. Witherspoon was issued 4,500 non-qualified options with an exercise price
of $4 per share. The options vest over a period of ten years and under certain
circumstances may vest in less than 10 years. These options are payment for on-
going consulting services in addition to normal board duties.
98
SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of November 17, 2000
regarding the number of shares of Common Stock beneficially owned by all
Directors, Executive Officers, and 5 % Shareholders. Beneficial ownership
includes shares, if any, held in the name of the spouse, minor children or other
relatives of the nominee living in such person's home, as well as shares, if
any, held in the name of another person under an arrangement whereby the
Director, Executive Officer or 5% Shareholder can vest title in himself within
sixty days of November 17, 2000.
[Download Table]
Common Stock
Percentage of
Name Beneficially Owned Class
------------------------------------- ------------------ -------------
Allen D. Wykle (1)(2)(3)
1716 Corporate Landing Parkway
Virginia Beach, VA 23454 1,846,357 33.6%
Leon H. Perlin (4)
3360 South Ocean Boulevard
Apartment 5H2
Palm Beach, FL 33480 929,256 17.0
Gregory J. Witherspoon (1)
1601 Blue Jay Way
Los Angeles, CA 90069 232,800 4.2
Stanley W. Broaddus (1)(3)
1716 Corporate Landing Parkway
Virginia Beach, VA 23454 139,472 2.5
Barry C. Diggins (1,6)
8222 Glenmar Road
Ellicott City, MD 21043 108,034 2.0
Jean S. Schwindt (1,7)
1062 Normandy Trace Road
Tampa, FL 33602 85,983 1.6
Oscar S. Warner (8)
215 Brooke Avenue, Apt #905
Norfolk, VA 23510 66,000 1.2
Arthur Peregoff (9)
816 Oriole Drive
Virginia Beach, VA 23451 51,750 *
Neil W. Phelan (1)
1716 Corporate Landing Parkway
Virginia Beach, VA 23454 19,787 *
99
[Download Table]
Eric S. Yeakel (1)
1716 Corporate Landing Parkway
Virginia Beach, VA 23454 9,667 *
Gregory W. Gleason (1)
2380 Court Plaza Drive, Suite 200
Virginia Beach, VA 23456 5,300 *
Robert M. Salter
Pavilion Center Suite 300
Virginia Beach, VA 23451 464 *
All present Executive
Officers, Directors & Nominees
as a group (12 persons)
(1,2,3,4,6,7,8,9) 3,476,253 63.1
---------------------
* Owns less than 1% of class.
(1) For Mr. Wykle includes beneficial ownership of 14,333 shares that may be
issued upon the exercise of stock options exercisable within 60 days of
November 3, 2000, and excludes shares subject to stock options that cannot
be exercised within 60 days of November 3, 2000. For Mr. Witherspoon,
includes beneficial ownership of 3,000 shares subject to non-qualified
stock options that may be exercised within 60 days of November 3, 2000, and
excludes 1,500 shares subject to non-qualified stock options that cannot be
exercised within 60 days of November 3, 2000. For Ms. Schwindt includes
beneficial ownership of 8,333 shares that may be issued upon the exercise
of stock options exercisable within 60 days of November 3, 2000, excluded
are 4,167 shares subject to stock options that cannot be exercised within
60 days from November 3, 2000. For Mr. Phelan included is the beneficial
ownership of 6,667 shares which may be issued upon the exercise of stock
options exercisable within 60 days of November 3, 2000, and excludes 2,833
shares subject to stock options that cannot be exercised within 60 days of
November 3, 2000. For Mr. Yeakel included is the beneficial ownership of
9,667 shares that may be issued upon the exercise of stock options
exercisable within 60 days of November 3, 2000, and excludes 4,333 shares
subject to stock options that cannot be exercised within 60 days of
November 3, 2000. For Mr. Broaddus includes beneficial ownership of 5,667
shares that may be issued upon the exercise of stock options exercisable
within 60 days of November 3, 2000, and excludes 2,333 shares subject to
stock options that cannot be exercised within 60 days of November 3, 2000.
For Mr. Gleason, includes beneficial ownership of 900 shares that may be
issued upon the exercise of stock options exercisable within 60 days of
November 3, 2000, excluded are 350 share subject to stock options that
cannot be exercised within 60 days of November 3, 2000.
(2) Excludes 7,000 shares registered to his adult children and his
grandchildren, as to which Mr. Wykle disclaims beneficial ownership.
(3) Mr. Wykle and Mr. Broaddus are Co-Trustees of our profit-sharing Plan
("Plan"), which owns 39,680 of our common stock. They share voting power.
100
Mr. Wykle's ownership interest in the Plan is 65% and Mr. Broaddus' share
is 15%. Included under Mr. Wykle's shares for the purposes of this
disclosure are 33,728 Plan shares, which exclude the 5,952 shares (15% of
the Plan shares), which are included under Mr. Broaddus's ownership. Mr.
Wykle claims voting rights but disclaims beneficial ownership of all but
the 65% he owns in the Plan.
(4) Includes 594,000 shares owned by Mr. Perlin's wife.
(5) Includes 1,888 shares owned jointly by Mr. Diggins' and his wife.
(6) Excluded are stock appreciation rights for 16,000 shares at $2.63 per
share. Excluded are 8,000 shares owned by her parents, to which Ms.
Schwindt disclaims beneficial ownership.
(7) Excludes 68,600 shares registered to Mr. Warner's adult children and his
grandchildren, to which he disclaims beneficial ownership.
(8) Mr. Peregoff's shares are held jointly with his wife. Excludes 33,848
shares registered to Mr. Peregoff's adult children and his grandchildren,
to which he disclaims beneficial ownership.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We maintain business relationships and engage in certain transactions with
affiliated companies and the parties as described below. It is our policy to
engage in transactions with related parties only on terms that, in our opinion,
are no less favorable than could be obtained from unrelated parties and each of
the transactions described below conforms to that policy.
Indebtedness of Management
We had no outstanding extensions of credit to members of the Board of
Directors or management at September 30, 2000 or at December 31, 1999.
Promissory Notes
From time to time, we issued promissory notes to assist in cash flow. The
notes are callable on 30 days notice from the holder and may be prepaid by us.
The notes are usually issued to Directors, Officers or Shareholders. As of
December 31, 1999, the following Directors and Executive Officers were holders
of promissory notes in the amounts and interest rates specified below:
Allen D. Wykle 674,648 10.00%
Stanley W. Broaddus 315,316 10.00
Stanley W. Broaddus 188,227 8.00
Leon H. Perlin 8,999 8.00
Leon H. Perlin 245,953 9.00
Oscar S. Warner 46,000 8.00
Oscar S. Warner 65,789 8.75
Arthur Peregoff 400,000 10.00
As of September 30, 2000, the following Directors and Executive Officers
were holders of promissory notes in the amounts and interest rates specified
below:
101
Allen D. Wykle $714,803 10.00%
Stanley W. Broaddus 445,271 10.00
Leon H. Perlin 8,939 8.00
Leon H. Perlin 244,122 9.00
Oscar S. Warner 46,000 8.00
Oscar S. Warner 70,234 8.75
Arthur Peregoff 400,000 10.00
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SELECTED CONSOLIDATED FINANCIAL DATA
You should consider our consolidated financial information set forth below
together with the more detailed consolidated financial statements, including the
related notes and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" included elsewhere in this prospectus. Unless
otherwise indicated, all financial data has been adjusted to reflect two-for-one
stock splits which occurred on August 30, 1996 and December 16, 1996, and a 100%
stock dividend that occurred on November 21, 1997.
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APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
[Enlarge/Download Table]
Nine Months Ended Years Ended December 31,
------------------------ -------------------------------------------------------------------
9/30/00 9/30/99 1999 1998 1997 1996 1995
----------------------- -------------------------------------------------------------------
Revenue:
Gain on sale of $ 8,708 $ 10,443 $ 13,202 $ 29,703 $ 33,501 $ 17,955 $ 7,298
loans
Interest income 4,054 6,333 7,698 10,308 10,935 4,520 3,065
Gain on sale of
securities - - - 1,750 2,796 - -
Other fees and
income 3,564 6,370 7,834 7,042 4,934 2,407 1,535
--------------------------- -------------------------------------------------------------------
Total revenue 16,326 23,146 28,734 48,803 52,166 24,882 11,898
--------------------------- -------------------------------------------------------------------
Expenses:
Compensation 8,985 13,579 17,765 23,397 16,447 8,017 3,880
General and
administrative 6,598 10,072 14,427 15,306 14,188 6,853 3,050
Write down of
goodwill - - 1,131 - - - -
Loss on
sale/disposal
of fixed assets - - 796 - - - -
Loss on write off
of securities - - 73 - - - -
Interest expense 2,961 3,934 4,957 6,252 6,157 3,121 2,194
Provision for
loan and
foreclosed
property losses 543 1,816 2,256 2,896 1,676 1,308 731
--------------------------- -------------------------------------------------------------------
Total expenses 19,087 29,401 41,405 47,851 38,468 19,299 9,855
--------------------------- -------------------------------------------------------------------
Income (loss)
before income
taxes (2,761) (6,255) (12,671) 952 13,698 5,583 2,043
Income taxes (681) (2,307) (4,749) 473 5,638 2,259 876
--------------------------- -------------------------------------------------------------------
Net Income (loss) (2,080) $ (3,948) $ (7,922) $ 479 $ 8,060 $ 3,324 $ 1,167
=========================== ===================================================================
Net income (loss)
per share
(diluted) $ (.38) $ (.72) ($ 1.45) $ 0.09 $ 1.51 $ 0.63 $ 0.23
=========================== ===================================================================
Cash dividends per
share $ - $ - $ - $ - $ - $ 0.04 $ 0.04
============================ ====================================================================
Dividend payout
ratio - - - - - 6.35% 17.39%
============================ ====================================================================
Weighted average
number
of shares
outstanding
(diluted) 5,482,114 5,482,114 5,482,114 5,511,372 5,345,957 5,281,103 5,062,809
============================ ===================================================================
Ratio of earnings
to fixed charges 0.117 -0.58 -1.388 1.149 3.201 2.894 1.985
=========================== ===================================================================
(In thousands, except share and per share data)
104
APPROVED FINANCIAL CORP.
SELECTED FINANCIAL STATISTICS
(In thousands, except per share data)
[Enlarge/Download Table]
As of Sept.30 Years Ended December 31
----------------------------------------------------------------------------------
2000 1999 1998 1997 1996 1995
----------------------------------------------------------------------------------
SELECTED BALANCES AT YEAR END
Loans held for sale, net 29,150 $ 62,765 $105,044 $ 76,766 $ 44,371 $ 22,210
Loans held for yield, net 6,292 4,006 4,224 3,930 1,052 6,220
Securities 2,923 2,640 3,472 15,201 20,140 -
Total assets 63,422 98,600 136,118 118,125 75,143 34,485
Revolving warehouse loans 3,151 17,465 72,546 52,488 32,030 19,566
FDIC-insured deposits 42,008 55,339 29,728 17,815 1,576 -
Subordinated debt 4,811 5,081 6,042 9,080 9,183 6,905
Total liabilities 54,207 87,301 116,851 93,070 53,934 28,250
Shareholders' equity 9,215 11,299 19,267 25,055 21,209 6,236
SELECTED LOAN DATA
Loans originated (1) $212,095 $390,816 $522,045 $468,955 $258,833 $111,505
Loans sold 202,110 265,873 389,589 420,498 228,918 83,328
Amount of loans serviced 37,050 69,054 109,500 83,512 48,785 29,249
at year-end
Loans delinquent 31 days 9.17% 4.50% 5.42% 5.50% 6.61% 8.88%
or more as percent of
loans at year-end
SELECTED RATIOS
Return on average assets (2.91%) (8.45%) 0.40% 7.68% 7.32% 4.06%
Return on average (19.64%) (49.01%) 1.93% 32.69% 36.44% 19.86%
Shareholders' equity
Shareholders' equity 14.53% 11.46% 14.15% 21.21% 28.22% 18.08%
to assets
Book value per share $ 1.68 $ 2.07 $ 3.51 $ 4.64 $ 4.21 $ 1.28
_____________
(1) Includes $151.3 million and $92.3 million retail loans brokered to other
lenders in 1999 and 1998 respectively.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following financial review and analysis of the financial condition and
results of operations, for the nine months ended September 30, 2000 and 1999 and
the fiscal years ended December 31, 1999, 1998 and 1997 should be read in
conjunction with the consolidated financial statements and the accompanying
notes to the consolidated financial statements, and other detailed information
appearing in this document.
General
Approved Financial Corp. is a diversified financial services company with
subsidiaries operating throughout the United States. We are a Virginia-chartered
financial institution, principally involved in originating, purchasing,
servicing and selling loans secured primarily by first and junior liens on
owner-occupied, one- to four-family residential properties. We offer both fixed-
rate and adjustable-rate loans for debt consolidation, home improvements and
other purposes serving both conforming and non-conforming borrowers.
Our specialty is mortgage lending to the "non-conforming" borrower who does
not meet traditional "conforming" or government agency credit qualification
guidelines, but who exhibits both the ability and willingness to repay the loan.
These borrowers include credit impaired borrowers, often resulting from personal
issues such as divorce, family illness or death and a temporary loss of
employment due to corporate downsizing as well as other factors, and other
borrowers who would qualify for loans from traditional sources but who are
attracted to our loan products due to our personalized service and timely
response to loan applications. Operating under current management for the past
sixteen years, we have helped non-conforming mortgage customers satisfy their
financial needs and in many cases has helped them improve their credit profile.
Through our retail division we also originate, service and sell traditional
conforming mortgage products and government mortgage products such as VA and
FHA.
We continue to explore a variety of opportunities to broaden product
offerings, increase revenues and reduce operating expenses. To achieve these
goals, we may consider various technologies and electronic commerce initiatives,
strategic relationships with other financial institutions or related companies,
entering into new lines of business such as the origination and servicing of
loans insured by the Small Business Administration. We cannot assure you that we
will engage in any of the activities listed above or the impact of those
activities on our financial condition or results of operations.
A recent focus by state and federal banking regulatory agencies, state
attorneys general offices, the Federal Trade Commission, the U.S. Department of
Justice and the U.S. Department of Housing and Urban Development relates to
predatory lending practices by companies in our industry. Sanctions have been
106
imposed on selected industry competitors for practices including but not limited
to charging borrowers excess fees, imposing higher interest rates than the
borrower's credit risk warrants and failing to disclose the material terms of
loans to the borrowers. We have reviewed its lending policies in light of these
actions against other lenders and we believe that we are in compliance with all
lending related guidelines. To date, no sanctions or recommendations from
governmental regulatory agencies regarding our practices related to predatory
lending have been imposed. We are unable to predict whether state or federal
regulatory authorities will require changes in our lending practices in the
future or the impact of those changes on our profitability. See "Regulation".
Our business strategy is dependent upon our ability to identify and
emphasize lending related activities that will provide us with the most economic
value. The implementation of this strategy will depend in large part on a
variety of factors outside of our control, including, but not limited to, our
ability to obtain adequate financing on favorable terms, retain qualified
employees to implement our plans, profitably sell our loans on a regular basis
and to expand in the face of increasing competition. Our failure with respect to
any of these factors could impair our ability to successfully implement our
strategy, which would adversely affect our results of operations and financial
condition.
Results of Operations
Results of Operations for the nine months ended September 30, 2000 compared
to the nine months ended September 30, 1999.
Net Loss
The net loss decreased by 47% for the nine months ended September 30, 2000
to $2.1 million compared to a net loss of $3.9 million for the nine month period
ended September 30, 1999. On a per share basis, the net loss for the nine month
period ended September 30, 2000 was $0.38 compared to a net loss of $0.72 for
the nine month period ended September 30, 1999.
Origination of Mortgage Loans
The following table shows the loan originations in dollars and units for
our broker and retail divisions for the nine months ended September 30, 2000 and
1999. During the second quarter of 1999, we initiated in-house funding of
conforming and government mortgages originated by the retail division.
Additionally, the retail branches originate mortgages that are funded through
other lenders ("brokered loans"). Brokered loans consist primarily of non-
conforming mortgages that do not meet our underwriting criteria and conforming
loans.
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[Enlarge/Download Table]
Nine Months Ended
(dollars in thousands) September 30,
2000 1999
--------------------------------
Dollar Volume of Loans Originated:
Broker $ 99,449 $ 80,222
Retail - funded through other lenders 36,835 125,873
Retail - funded in-house non-conforming 40,910 57,675
Retail - funded in-house conforming and government 34,901 18,565
--------------------------------
Total $212,095 $ 282,335
================================
Number of Loans Originated:
Broker 1,384 1,336
Retail - funded through other lenders 546 1,495
Retail - funded in-house non-conforming 618 893
Retail - funded in-house conforming and government 339 193
--------------------------------
Total 2,887 3,917
================================
The dollar volume of loans, originated during the nine months ended
September 30, 2000, decreased 24.9% when compared to the same period in 1999.
The decrease in loan originations was primarily the result of the reduction in
the number of retail loan origination centers from 15 at September 30, 1999 to
10 at September 30, 2000.
The 33.3% decrease in retail loan origination center resulted in a 44.3%
decrease in our retail loan volume for the nine month period ended September 30,
2000 when compared to the same period in 1999. Brokered loans generated by the
retail division were $36.8 million during the nine month period ended September
30, 2000, which was a 70.7% decrease compared to $125.9 million during the same
period in 1999. The decrease was the result of our initiative to close more in-
house loans.
The volume of loans originated through broker referrals from our network of
mortgage brokers increased 24.0% to $99.4 million for the nine month period
ended September 30, 2000, compared to $80.2 million for the nine month period
ended September 30, 1999. The increase was primarily the result of an expanded
product line and the streamlining of our service to brokers. Average fees paid
to mortgage brokers for loans originated during the nine months ended September
30, 2000 was 46 basis points compared to 33 basis points for the nine months
ended September 30, 1999.
Gain on Sale of Loans
The largest component of our net income is gain on sale of loans. There is
an active secondary market for most types of mortgage loans originated. The
majority of the loans originated are sold to other financial institutions. We
receive cash at the time loans are sold. The loans are sold service-released on
a non-recourse basis, except for normal representations and warranties, which is
consistent with industry practices. By selling loans in the secondary mortgage
market, we are able to obtain funds that may be used for additional lending and
investment purposes. Gain on sale of loans is comprised of several components,
as follows: (a) the difference between the sales price and the net carrying
value of the loan; plus (b) loan origination fee income collected at loan
closing and deferred until the loan is sold; less (c) loan sale recapture
premiums and loan selling costs.
108
Nonconforming loan sales totaled $168.3 million including loans owned in
excess of 180 days ("seasoned loans") for the nine month period ended September
30, 2000, compared to $192.8 million for the same period in 1999.
During the nine month period ended September 30, 2000, we sold $2.9 million
of seasoned loans, at a weighted average discount to par value of 18.4%. The
loss was fully reserved for in prior periods. For the nine month period ended
September 30, 1999, we sold $10.9 million of seasoned loans, at a weighted
average discount to par value of 7.0%.
Conforming and government loan sales were $33.8 million for the nine month
period ended September 30, 2000, compared to $16.5 million for the nine month
period ended September 30, 1999. We began originating conforming loans in May
1999.
The combined gain on the sale of loans was $8.7 million for the nine month
period ended September 30, 2000, which compares with $10.4 million for the same
period in 1999. The decrease for the nine month period ended September 30, 2000,
was primarily the result of fewer loans being sold when compared to the same
period ended September 30, 1999. Gain on the sale of mortgage loans represented
53.3% of total revenue for the nine months ended September 30, 2000, compared to
45.1% of total revenue for the same period in 1999. This was primarily a result
of our initiative to decrease brokered loans, revenues from which are reported
in other income, and to increase the percentage of retail loan originations
funded in-house, revenues from which are reported in gain on sale of loans.
The weighted-average premium, realized on its non-conforming loan sales was
3.05% (excluding seasoned loans), during the nine month period ended September
30, 2000, compared to 3.14% for the same period in 1999. The weighted-average
premium realized on its conforming and government loans sales was 1.27% during
the nine month period ended September 30, 2000, compared to 1.91% for the nine
month period ended September 30, 1999.
We have never used securitization as a loan sale strategy. However, the
whole-loan sale marketplace for non-conforming mortgage loans was impacted by
changes that affected companies who previously used this loan sale strategy.
Excessive competition during 1998 and 1999 and a coinciding reduction in
interest rates in general caused an increase in the prepayment speeds for non-
conforming loans. The valuation method applied to interest-only and residual
assets ("Assets"), the capitalized assets created from securitization, include
an assumption for average prepayment speed in order to determine the average
life of a loan pool and an assumption for loan losses. The increased prepayment
speeds as well as the magnitude of loan losses experienced in the industry were
greater than the assumptions previously used by many securitization issuers and
have resulted in an impairment or write down of Asset values for several
companies in the industry. Additionally, in September of 1998, due to the
Russian crisis, and again in the fourth quarter of 1999, due to Y2K concerns, a
flight to quality among fixed income investors negatively impacted the pricing
spreads for mortgage-backed securitizations compared to earlier periods and
negatively impacted the associated economics to the issuers. Consequently, many
of these companies have experienced terminal liquidity problems and others have
diverted
109
to whole loan sale strategies in order to generate cash. This shift has
materially decreased the demand for and increased the supply of non-conforming
mortgage loans in the secondary marketplace, which resulted in significantly
lower premiums on non-conforming whole-loan mortgage sales beginning in the
fourth quarter of 1998 and continuing throughout the third quarter 2000 when
compared to earlier periods.
Furthermore, the loan sale premium percentage has decreased due to a
decrease in the Weighted Average Coupon ("WAC") on loan originations, which was
primarily the result of a shift in our origination profile to a higher credit
grade customer. These premiums do not include loan origination fees collected at
the time the loans are closed, which are included in the computation of gain on
sale when the loans are sold.
We defer recognizing income from the loan origination fees we receive at
the time a loan is closed. These fees are recognized over the lives of the
related loans as an adjustment of the loan's yield using the level-yield method.
Deferred income pertaining to loans held for sale is taken into income at the
time of sale of the loan. Origination fee income is primarily derived from our
retail lending division. Origination fee income included in the gain on sale of
loans for the nine month period ended September 30, 2000 was $3.7 million,
compared to $4.6 million for the nine month period ended September 30, 1999. The
decrease is the result of a decrease in the volume of loans sold, which were
generated by our retail division. Our non-conforming retail loan sales for the
nine month period ended September 30, 2000 comprised 31.7% of total non-
conforming loan sales, with average loan origination fee income earned of 4.73%.
For the nine months ended September 30, 1999, non-conforming retail loan sales
were 43.6% of total non-conforming loan sales with average origination fee
income of 4.60%. Average origination fee income from conforming and government
loans was 3.38% for the nine months ended September 30, 2000 compared to 4.46%
for the nine months ended September 30, 1999. Fees associated with selling loans
were approximately 22 basis points for the nine months ended September 30, 2000
compared to 11 basis points for the nine months ended September 30, 1999.
We also defer recognition of the expense incurred, from the payment of fees
to mortgage brokers, for services rendered on loan originations. These costs are
deferred and recognized over the lives of the related loans as an adjustment of
the loan's yield using the level-yield method. The remaining balance of expenses
associated with fees paid to brokers is recognized when the loan is sold.
Interest Income and Expense
Interest income for the nine months ended September 30, 2000 was $4.1
million compared with $6.3 million for the same period ended in 1999. The
decrease in interest income for the nine months ended September 30, 2000 was due
to a lower average balance of loans held for sale.
110
Interest expense for the nine months ended September 30, 2000 was $3.0
million compared with $3.9 million for the nine months ended September 30, 1999.
The decrease in interest expense for the nine months ended September 30, 2000,
was the direct result of a decrease in the average balance of interest-bearing
liabilities.
Changes in the average yield received on the loan portfolio may not
coincide with changes in interest rates we must pay on revolving warehouse
loans, the Bank's FDIC-insured deposits, and other borrowings. As a result, in
times of rising interest rates, decreases in the difference between the yield
received on loans and other investments and the rate paid on borrowings and the
Bank's deposits usually occur.
111
The following tables reflect the average yields earned and rates paid
during the nine-month periods ended September 30, 2000 and 1999. In computing
the average yields and rates, the accretion of loan fees is considered an
adjustment to yield. Information is based on average month-end balances during
the indicated periods.
[Enlarge/Download Table]
(In thousands) September 30, 2000 September 30, 1999
-----------------------------------------------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
-----------------------------------------------------------------------------
Interest-earning assets:
Loan receivable (1) $44,934 $3,586 10.64% $73,958 $6,019 10.85%
Cash and other interest-
earning assets 12,481 468 5.00 8,627 314 4.86
-------- ------- ------ ------- ------ -----
57,415 4,054 9.42% 82,585 6,333 10.23%
-------- ------- ------ ------ -----
Non-interest-earning assets:
Allowance for loan losses (1,227) (2,867)
Investment in IMC 0 87
Premises and equipment, net 5,844 5,130
Other 9,516 13,709
---------- -------------
Total assets $71,548 $98,644
========== =============
Interest-bearing liabilities:
Revolving warehouse lines $ 4,885 265 7.24% $40,029 2,132 7.10%
FDIC - insured deposits 45,888 2,042 5.93 30,314 1,279 5.62
Other interest-bearing
liabilities 8,240 653 10.57 7,347 523 9.49
-------- ------- ------ ------- ------ -----
59,013 2,960 6.69% 77,690 3,934 6.75%
------- ------ ------ -----
Non-interest-bearing liabilities 1,946 4,038
-------- -------
Total liabilities 60,959 81,728
Shareholders' equity 10,589 16,916
-------- --------
Total liabilities and equity $71,548 $98,644
======== ========
Average dollar difference between
Interest-earning assets and
interest-bearing liabilities $(1,598) $ 4,895
======== ========
Net interest income $1,094 $2,399
======= ======
Interest rate spread (2) 2.73% 3.48%
==== =====
Net annualized yield on average
Interest-earning assets 2.54% 3.87%
==== =====
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
(2) Average yield on total interest-earning assets less average rate paid on
total interest-bearing liabilities.
112
The following table shows the change in net interest income, which can be
attributed to rate (change in rate multiplied by old volume) and volume (change
in volume multiplied by old rate) for the nine months ended September 30, 2000
compared to the nine months ended September 30, 1999, and for the nine months
ended September 30, 1999, compared to the nine months ended September 30, 1998.
The changes in net interest income due to both volume and rate changes have been
allocated to volume and rate in proportion to the relationship of absolute
dollar amounts of the change of each. The table demonstrates that the decrease
of $1.3 million in net interest income for the nine months ended September 30,
2000 compared to the nine months ended September 30, 1999 was primarily the
result of a decrease in the average balance on interest-earning assets.
($ In thousands)
[Enlarge/Download Table]
2000 Versus 1999 1999 Versus 1998
Increase (Decrease) due to: Increase (Decrease) due to:
Volume Rate Total Volume Rate Total
------------- ------------ ------------ ------------ ----------- ------------
Interest-earning assets:
Loans receivable $(2,318) $(115) $(2,433) $(403) $(738) $(1,141)
Cash and other interest-
earning assets 144 10 154 59 (144) (85)
------------- ------------ ------------ ------------ ----------- ------------
(2,174) (105) (2,279) (344) (882) (1,226)
------------- ------------ ------------ ------------ ----------- ------------
Interest-bearing liabilities:
Revolving warehouse lines (1,907) 40 (1,867) (745) 34 (711)
FDIC-insured deposits 690 73 763 392 (46) 346
Other interest-
bearing liabilities 67 63 130 (290) 28 (262)
------------- ------------ ------------ ------------ ----------- ------------
(1,150) 176 (974) (643) 16 (627)
------------- ------------ ------------ ------------ ----------- ------------
Net interest income (expense) $(1,024) $(281) $(1,305) $ 299 $(898) $ (599)
============= ============ ============ ============ =========== ============
Other Income
In addition to net interest income (expense), and gain on sale of loans, we
derive income from origination fees earned on brokered loans generated by our
retail offices and other fees earned on the loans funded such as underwriting
service fees, prepayment penalties, and late charge fees for delinquent loan
payments. Revenues associated with the financial products marketed by Approved
Financial Solutions, while not material during the first nine months of 2000,
are also recorded in other income. For the nine month period ended September
30, 2000, other income totaled $3.6 million compared to $6.4 million for the
113
same period in 1999. The decrease was primarily the result of the decrease in
brokered loan fees, which was the result of a decrease in brokered loan volume.
Brokered loan fees were $1.9 million for the nine month period ended September
30, 2000, compared to $5.1 million for the nine months ended September 30, 1999.
Comprehensive Loss
For the nine months ended September 30, 2000 we had other comprehensive
losses of $2,000 in the form of unrealized holding gains/losses on an Asset
Management Fund investment. For the nine month period ended September 30, 1999,
we had other comprehensive losses of $68,000 in the form of unrealized holding
losses on securities held for sale. This loss related to a decrease in the
market price of IMC Mortgage Company common stock.
Compensation and Related Expenses
The largest component of expenses is compensation and related expenses,
which decreased by $4.6 million to $9.0 million for the nine month period ended
September 30, 2000 from 1999. The decrease was directly attributable to a
decrease in the number of employees and lower commissions expense caused by the
decrease in loan volume. For the nine month period ended September 30, 2000,
salary expense decreased by $2.7 million when compared to the same period in
1999. Also the payroll and related benefits decreased by $0.9 million for the
nine month period ended September 30, 2000 when compared to the same period in
1999. The decrease was caused by a lower average number of employees, which was
attributed to our cost cutting initiative. For the nine month period ended
September 30, 2000, the average full time equivalent employee count was 249.5
compared to 412 for the nine month period ended September 30, 1999. For the nine
month period ended September 30, 2000 the commissions to loan officers decreased
by $1.0 million when compared to the same period ended September 30, 1999. The
decrease was primarily due to lower loan volume.
General and Administrative Expenses
General and administrative expenses are comprised of various expenses such
as rent, postage, printing, general insurance, travel & entertainment,
telephone, utilities, depreciation, professional fees and other miscellaneous
expenses. General and administrative expenses for the nine month period ended
September 30, 2000 decreased by $2.6 million to $4.7 million, compared to the
nine month period ended September 30, 1999. The decrease was the result of a
reduction in retail loan origination offices, a decline in our employee count,
and our cost cutting initiative.
Loan Production Expense
Loan production expenses are comprised of expenses for appraisals, credit
reports, and payment of fees to mortgage brokers, for services rendered on loan
originations, and verification of mortgages. Loan production expenses for the
114
nine month period ended September 30, 2000 were $0.9 million compared to $1.5
million for the nine month period ended September 30, 1999. The decrease was
primarily the result of decreases in appraisal and credit report expenses, which
resulted from lower loan volume. We also eliminated payments to outside
consultants for research of customer leads due to the creation of the
centralized advertising and marketing departments. The expenses for those leads
were classified in loan production expenses for the nine month period ended
September 30, 1999.
Advertising Expense
We have a centralized telemarketing and advertising department in Virginia
Beach, Virginia. Advertising expenses are comprised of newspaper advertising,
yellow page advertising, postage & printing associated with mailers, the
purchase of telemarketing lists, and marketing supplies for trade shows.
Advertising expenses for the nine month period ended September 30, 2000 were
$1.0 million compared to $1.3 million for the nine month period ended September
30, 1999. The decrease was the result of the reduction in retail loan
origination offices.
Provision for Loan Losses
The following table presents the activity in the allowance for loan losses
and selected loan loss data for the nine months ended September 30, 2000 and the
year ended December 31, 1999:
(In thousands)
[Download Table]
2000 1999
Balance at beginning of year $ 1,382 $ 2,590
Provision (benefit) charged to expense 126 2,042
Loans charged off (844) (3,286)
Recoveries of loans previously charged off 447 36
----------- ------------
Balance at end of period $ 1,111 $ 1,382
=========== ============
Loans receivable at the end of period, gross $37,050 $69,054
of allowance for losses
Ratio of allowance for loan losses to gross 3.00% 2.00%
loans receivable at the end of period
We increased our provision for loan losses by $0.1 during the nine months
ended September 30, 2000 to the allowance for loan losses, compared to an
increase of $1.2 million, during the nine months ended September 30, 1999. For
the nine month period ended September 30, 2000, there was an increase in the
provision based upon the composition of loans held for sale. The large increase
in the provision during the first nine months of 1999 was a result of changes in
the secondary market environment for whole loan sales, which changed the
composition of loans held for sale. All losses ("charge offs" or "write downs")
and recoveries realized on loans previously charged off, are accounted for in
the allowance for loan losses.
115
The allowance is established at a level that we consider adequate relative
to the composition of the current portfolio of loans held for sale. We consider
characteristics of our current loan portfolio such as credit quality, the
weighted average coupon, the weighted average loan to value ratio, the age of
the loan portfolio and the portfolio's delinquency status in the determination
of an appropriate allowance. Other criteria such as covenants associated with
our credit facilities, trends in the demand for and pricing for loans sold in
the secondary market for non-conforming mortgages and general economic
conditions, including interest rates, are also considered when establishing the
allowance. Adjustments to the reserve for loan losses may be made in future
periods due to changes in the factors mentioned above and any additional factors
that may effect anticipated loss levels in the future.
Provision for Foreclosed Property Losses
We increased our provision for foreclosed property losses by $0.4 million
for the nine months ended September 30, 2000, compared to an increase of $0.2
million for the nine months ended September 30, 1999.
Sales of real estate owned yielded net losses of $670,000 for the nine
months ended September 30, 2000 versus $393,000 for the nine months ended
September 30, 1999.
116
The following table presents the activity in the allowance for foreclosed
property losses and selected real estate owned data for the nine months ended
September 30, 2000 and for the year ended December 1999:
(In thousands)
[Download Table]
2000 1999
-------- ---------
Balance at beginning of year $ 718 $ 503
Provision charged to expense 417 863
Loss on sale of foreclosures (670) (648)
-------- ---------
Balance at end of period $ 465 $ 718
======== =========
Real estate owned at the end of period, gross $1,882 $2,992
of allowance for losses
Ratio of allowance for foreclosed property losses 24.71% 24.00%
to gross real estate owned at the end of period
We maintain a reserve on our real estate owned ("REO") based upon
management's assessment of appraised values at the time of foreclosure. The
increase in the provision for foreclosed property losses relates to losses on
real estate owned sales for the nine month period ended September 30, 2000 and
1999. While we believe that our present allowance for foreclosed property losses
is adequate, future adjustments may be necessary.
117
Results of Operations for the Year Ended December 31, 1999 compared to the Year
Ended December 31, 1998.
Net Income (loss)
The net loss for 1999 was $7.9 million compared to net income of $0.5
million in 1998. On a per share basis (diluted), loss for 1999 was ($1.45)
compared to $0.09 income for 1998. The return on average assets was (8.45%) in
1999, compared to 0.40% in 1998. Return on average shareholders' equity was
(49.01%) in 1999, compared to 1.93% in 1998.
Origination of Mortgage Loans
The following table shows the loan originations in dollars and units for
our broker and retail divisions in 1999 and 1998. During the second quarter of
1999, we initiated in-house funding of conforming and government mortgages
originated by the retail division. Additionally, the retail branches originate
mortgages that are funded through other lenders ("brokered loans"). Brokered
loans consist primarily of non-conforming mortgages that do not meet our
underwriting criteria and conforming loans. We did not fund conforming loans in-
house during 1998.
[Download Table]
Year Ended December 31
($ in millions) 1999 1998
------------------------------------------------------------------
DOLLAR OF LOANS ORIGINATED
Broker Referrals $126.9 $203.9
Retail - brokered loans 151.7 92.3
Retail - funded in-house non-conforming 78.5 225.8
Retail - funded in-house conforming and 33.7 0
government
------------------------------------------------------------------
Total Retail 263.9 318.1
------------------------------------------------------------------
Total $390.8 $522.0
------------------------------------------------------------------
NUMBER OF LOANS ORIGINATED
Broker Referrals 2,029 3,484
Retail - brokered loans 1,809 1,099
Retail - funded in-house non-conforming 1,219 3,882
Retail - funded in-house conforming and 333 0
government
------------------------------------------------------------------
Total Retail 3,361 4,981
------------------------------------------------------------------
Total 5,390 8,465
------------------------------------------------------------------
118
The decrease of 44.4% in dollar volume of loans, excluding $151.7 million
in brokered loans, originated during the year ended December 31, 1999, compared
to the same period in 1998 was due primarily to increased competition in the
non-conforming mortgage industry.
Loans originated through our retail offices, excluding $151.7 million in
brokered loans, decreased 50.3% to $112.2 million, compared to $225.8 million
during the same period in 1998. The decrease was primarily the result of
increased pricing competition in the non-conforming mortgage area and a decrease
in the number of retail loan origination centers from 26 at December 31, 1998 to
11 at December 31, 1999.
Brokered loans generated by the retail division were $151.7 million during
the year ended December 31, 1999 which was a 64.4% increase compared to $92.3
million during the same period in 1998. The increase was primarily the result of
pricing competition in the non-conforming mortgage market.
The volume of loans originated through broker referrals from our network of
mortgage brokers decreased 37.8% to $126.9 million for the year ended December
31, 1999, compared to $203.9 million for the year ended December 31, 1998. The
pricing competition in the non-conforming mortgage industry was the primary
reason for the decrease in loans from this source. Also, since we did not offer
conforming and government loan products through the broker division, the
refinance boom for conforming mortgages created by the low interest rate
environment contributed to the decrease in loan volume from this division.
119
The following table summarizes the mortgage loan origination activity, including
brokered loans, by state, for the years ended December 31, 1999, 1998, and 1997.
[Enlarge/Download Table]
Years Ended
December 31 1999 1998 1997
---------------------------- ---------------------------- ----------------------------
(In thousands) Dollars Percent Dollars Percent Dollars Percent
-------------- ---------- ------------- ----------- ------------- ----------
Broker Division
Florida $ 41,415 10.6% $ 53,874 10.3% $ 61,897 13.2%
North Carolina 21,718 5.6 25,315 4.9 28,957 6.1
Virginia 13,520 3.5 11,698 2.2 5,415 1.2
Pennsylvania 12,723 3.3 43 0.0 - -
Ohio 11,406 2.9 22,233 4.3 32,478 6.9
Maryland 11,215 2.9 35,690 6.8 29,997 6.4
Georgia 6,408 1.6 34,617 6.7 59,792 12.8
South Carolina 2,677 .7 9,444 1.8 4,463 1.0
Kentucky 2,097 .5 361 0.1 - -
Tennessee 1,896 .5 6,391 1.2 7,826 1.7
Illinois 1,172 .3 3,059 0.6 12,781 2.7
Indiana 619 .1 72 0.0 9,131 1.9
Michigan 0 0 1,115 0.2 3,680 0.8
-------------- ---------- ------------- ----------- ------------- ----------
Total Broker Division $126,866 32.5% $203,912 39.1% $256,417 54.7%
============== ========== ============= =========== ============= ==========
Retail Division:
Maryland $ 68,986 17.7% $ 66,911 12.8% $ 66,954 14.4%
Virginia 51,407 13.3 52,856 10.1 34,442 7.3
Michigan 50,090 12.8 4,001 0.8 0 0
Georgia 21,596 5.5 58,558 11.2 12,886 2.7
South Carolina 20,482 5.2 21,682 4.1 18,611 4.0
Ohio 18,754 4.8 23,301 4.5 12,666 2.7
North Carolina 11,517 2.9 49,912 9.6 39,007 8.3
Colorado 7,540 1.9 0 0 0 0
Delaware 5,619 1.4 15,905 3.0 16,056 3.4
Kentucky 3,886 1.0 14,368 2.8 85 -
Florida 1,592 .4 6,374 1.2 4,141 0.9
New Jersey 1,546 .4 0 0 0 0
Texas 844 .2 0 0 0 0
Pennsylvania 91 0 0 0 0 0
Illinois 0 0 2,065 0.4 4,877 1.0
Indiana 0 0 2,200 0.4 2,813 0.6
-------------- ---------- ------------- ----------- ------------- ----------
Total Retail Division $263,950 67.5% $318,133 60.9% $212,538 45.3%
============== ========== ============= =========== ============= ==========
Total Originations:
Maryland $ 80,201 20.5% $102,601 19.7% $ 96,951 20.8%
Virginia 64,927 16.6 64,554 12.4 39,857 8.5
Michigan 50,090 12.8 5,116 1.0 3,680 0.8
Florida 43,007 11.1 60,248 11.5 66,038 14.1
North Carolina 33,235 8.5 75,227 14.4 67,964 14.5
Ohio 30,160 7.7 45,534 8.7 45,144 9.6
Georgia 28,004 7.2 93,175 17.9 72,678 15.5
South Carolina 23,159 5.9 31,126 6.0 23,074 4.9
Pennsylvania 12,814 3.3 43 0.0 0 0
Colorado 7,540 1.9 0 0 0 0
Kentucky 5,983 1.5 14,729 2.8 85 0
Delaware 5,619 1.4 15,905 3.0 16,056 3.4
Tennessee 1,896 .5 6,391 1.2 7,826 1.7
New Jersey 1,546 .4 0 0 0 0
Illinois 1,172 .3 5,124 1.0 17,658 3.7
Texas 844 .2 0 0 0 0
Indiana 619 .2 2,272 0.4 11,944 2.5
-------------- ---------- ------------- ----------- ------------- ----------
Total Originations $390,816 100.% $522,045 100.0% $468,955 100.0%
============== ========== ============= =========== ============= ==========
120
Gain on Sale of Loans
The largest component of net income is gain on sale of loans. There is an
active secondary market for most types of mortgage loans originated. The
majority of the loans originated are sold to other financial institutions. We
receive cash at the time loans are sold. The loans are sold service-released on
a non-recourse basis, except for normal representations and warranties, which is
consistent with industry practices. By selling loans in the secondary mortgage
market, we are able to obtain funds that may be used for additional lending and
investment purposes. Gain on sale of loans is comprised of several components,
as follows: (a) the difference between the sales price and the net carrying
value of the loan; plus (b) loan origination fee income collected at loan
closing and deferred until the loan is sold; less (c) loan sale recapture
premiums and loan selling costs.
Non-conforming loan sales totaled $235.5 million including loans owned in
excess of 180 days ("seasoned loans") for the year ended December 31, 1999,
compared to $389.6 million including seasoned loans for the same period in 1998.
The decrease was caused primarily by the decrease in loan origination volume.
For the year ended December 31, 1999, we sold $15.4 million of seasoned
loans, at a weighted average discount to par value of 7.8%. The loss was fully
reserved for in prior periods. For year ended December 31, 1998, we sold $12.0
million of seasoned loans, at a weighted average discount to par value of 10.5%.
These losses were recorded as charge offs during 1998.
Conforming and government loan sales were $30.3 million for the year ended
December 31, 1999. We did not fund conforming or government loans during the
same period ended in 1998.
The combined gain on the sale of loans was $13.2 million for the year ended
December 31, 1999, which compares with $29.7 million for the same period in
1998. The decrease for the year ended December 31, 1999, was the direct result
of a decrease in the weighted-average premium paid by investors for non-
conforming mortgage loans, the addition of conforming and government loan sales
that normally carry lower loan sale premiums and a lower volume of loans sold.
Gain on the sale of mortgage loans represented 46.3% of total revenue for the
year ended December 31, 1999, compared to 60.9% of total revenue for the same
period in 1998.
The weighted-average premium realized on non-conforming loan sales
decreased to 3.1% (excluding seasoned loan sales), during the year ended
December 31, 1999, from 5.4% (excluding seasoned loan sales) for the same period
in 1998. The decrease in premium percentage was caused by material changes in
the secondary market conditions for non-conforming mortgage loans. The weighted-
average premium realized on conforming and government loans sales was 1.85%
during the year ended December 31, 1999.
We have never used securitization as a loan sale strategy. However, the
whole-loan sale marketplace for non-conforming mortgage loans was impacted by
changes
121
that affected companies who previously used securitizations to sell loans.
Excessive competition during 1998 and 1999 and a coinciding reduction in
interest rates in general caused an increase in the prepayment speeds for non-
conforming loans. The valuation method applied to interest-only and residual
assets ("Assets"), the capitalized assets created from securitization, include
an assumption for average prepayment speed in order to determine the average
life of a loan pool. The increased prepayment speeds experienced in the industry
were greater than the assumptions previously used by many securitization issuers
and led to an impairment of Asset values for several companies in the industry.
Additionally, in September of 1998, due to the Russian crisis, and again in the
fourth quarter of 1999, due to Y2K concerns, a flight to quality among fixed
income investors negatively impacted the pricing spreads for mortgage-backed
securitizations compared to earlier periods and negatively impacted the
associated economics to the issuers. Consequently, many of these companies have
experienced terminal liquidity problems. and others have diverted to whole loan
sale strategies in order to generate cash. This shift has materially decreased
the demand for and increased the supply of non-conforming mortgage loans in the
secondary marketplace, which resulted in significantly lower premiums on non-
conforming whole-loan mortgage sales beginning in the fourth quarter of 1998 and
continuing throughout 1999 when compared to earlier periods.
Furthermore, the loan sale premium percentage has decreased due to a
decrease in the Weighted Average Coupon ("WAC") on loan originations, which was
primarily the result of a lower interest rate market and a shift in our
origination profile to a higher credit grade customer. These premiums do not
include loan origination fees collected at the time the loans are closed, which
are included in the computation of gain on sale when the loans are sold.
We defer recognizing income from the loan origination fees we receive at
the time a loan is closed. These fees are recognized over the lives of the
related loans as an adjustment of the loan's yield using the level-yield method.
Deferred income pertaining to loans held for sale is taken into income at the
time of sale of the loan. Origination fee income is primarily derived from our
retail lending division. Origination fee income included in the gain on sale of
loans for the year ended December 31, 1999 was $6.1 million, compared to $10.4
million for the year ended December 31, 1998. The decrease is the result of a
decrease in the volume of loans sold, which were generated by our retail
division. Our retail loan sales for the year ended December 31, 1999 comprised
53.4% of total loan sales, with average loan origination fee income earned of
4.62%, including conforming loans. Excluding conforming loans the average loan
origination fee income earned was 4.83% for the year ended December 31, 1999.
For the year ended December 31, 1998 retail loan sales were 55.5% of total loan
sales with average origination fee income of 5.0%. Fees associated with selling
loans were approximately 10 basis points for the year ended December 31, 1999
compared to 20 basis points for the year ended December 31, 1998.
122
We also defer recognition of the expense incurred, from the payment of fees
to mortgage brokers, for services rendered on loan originations. These costs are
deferred and recognized over the lives of the related loans as an adjustment of
the loan's yield using the level-yield method. The remaining balance of expenses
associated with fees paid to brokers is recognized when the loan is sold.
Average fees paid to mortgage brokers for the year ended December 31, 1999 was
41 basis points compared to 39 basis points in 1998.
Interest Income and Expense
Net interest income is dependent on the difference, or "spread", between
the interest income we receive from our loans and our cost of funds, consisting
principally of the interest expense paid on the warehouse lines of credit, the
Bank's deposit accounts and other borrowings.
Interest income for the year ended December 31, 1999 was $7.7 million
compared with $10.3 million for the same period ended in 1998. The decrease in
interest income for the year ended December 31, 1999 was due to a lower
weighted-average coupon associated with the balance of loans held for sale and
a lower average balance of loans held for sale.
Interest expense for the year ended December 31, 1999 was $5.0 million
compared with $6.3 million for the year ended December 31, 1998. The decrease in
interest expense for the year ended December 31, 1999, was the direct result of
a decrease in the average balance of interest-bearing liabilities and a lower
weighted average coupon associated with interest bearing liabilities.
Changes in the average yield received on the loan portfolio may not
coincide with changes in interest rates we must pay on revolving warehouse
loans, the Bank's FDIC-insured deposits, and other borrowings. As a result, in
times of rising interest rates, decreases in the difference between the yield
received on loans and other investments and the rate paid on borrowings and the
Bank's deposits usually occur.
123
The following tables reflect the average yields earned and rates paid during
1999 and 1998. In computing the average yields and rates, the accretion of loan
fees is considered an adjustment to yield. Information is based on average
month-end balances during the indicated periods.
[Enlarge/Download Table]
(In thousands) 1999 1998
-------------------------------------------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
-------------------------------------------------------------------------
Interest-earning assets:
Loan receivable (1) $67,665 $7,246 10.7% $ 83,522 $ 9,761 11.69%
Cash and other
interest-earning assets 9,227 452 4.90 12,754 547 4.28
--------- ------- ----- -------- ------- ------
76,892 7,698 10.0% 96,276 10,308 10.71%
--------- ------- ----- -------- ------- ------
Non-interest-earning assets:
Allowance for loan losses (2,481) (1,789)
Investment in IMC 71 8,136
Premises and equipment,
net 5,375 4,770
Other 13,941 11,875
--------- -------------
Total assets $93,798 $ 119,26
========= =============
Interest-bearing liabilities:
Revolving warehouse lines 33,380 2,405 7.20% $ 49,810 3,888 7.80%
FDIC- insured deposits 32,365 1,835 5.67 22,858 1,361 5.96
Other interest-bearing 7,792 717 9.20 10,677 1,003 9.39
--------- ------- ----- -------- ------- ------
Liabilities 73,537 4,957 6.74% 83,345 6,252 7.50%
--------- ------- ----- -------- ------- ------
Non-interest-bearing
liabilities 4,096 11,126
--------- -------------
Total liabilities 77,633 94,471
Shareholders' equity 16,165 24,797
--------- -------------
Total liabilities and
equity $93,798 $119,268
========= =============
Average dollar difference
between Interest-earning
assets and interest-
Bearing liabilities $ 3,354 $ 12,931
========= =============
Net interest income $2,741 $ 4,056
======== ========
Interest rate spread (2) 3.27% 3.21%
===== ======
Net annualized yield on
average Interest-earning
assets 3.57% 4.21%
===== ====
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
(2) Average yield on total interest-earning assets less average rate paid on
total interest-bearing liabilities.
The following table shows the change in net interest income, which can be
attributed to rate (change in rate multiplied by old volume) and volume (change
in volume multiplied by old rate) for the year ended December 31, 1999 compared
to the year ended December 31, 1998. The changes in net interest income due to
both volume and rate changes have been allocated to volume and rate in
124
proportion to the relationship of absolute dollar amounts of the change of each.
The table demonstrates that the decrease of $1.3 million in net interest income
for the year ended December 31, 1999 compared to the year ended December 31,
1998 was primarily the result of a decrease in the average balance on interest-
earning assets.
($ In thousands)
[Download Table]
1999 Versus 1998
Increase (Decrease) due to:
Volume Rate Total
--------------- ------------- ------------
Interest-earning assets:
Loan receivable $(1,746) $(769) $(2,515)
Cash and other interest-
earning assets (196) 101 (95)
------------ --------- ---------
(1,942) (668) (2,610)
------------ --------- ---------
Interest-bearing liabilities:
Revolving warehouse lines (1,202) (281) (1,483)
FDIC-insured deposits 536 (62) 474
Other interest-
bearing liabilities (266) (20) (286)
------------ --------- ---------
(932) (363) (1,295)
------------ --------- ---------
Net interest income (expense) $(1,010) $(305) $(1,315)
============ ========= =========
Other Income
In addition to net interest income (expense), and gain on sale of loans, we
derive income from origination fees earned on brokered loans generated by our
retail offices and other fees earned on the loans funded, such as document
preparation fees, underwriting service fees, prepayment penalties, and late
charge fees for delinquent loan payments. Brokered loan fees were $6.1 million
for the year ended December 31, 1999, compared to $4.3 million for the year
ended December 31, 1998. For the year ended December 31, 1999, other income
totaled $7.8 million compared to $7.0 million for the same period in 1998. The
increase was primarily the result of the increase in brokered loan fees, which
was generated by an increase in brokered loan volume. The increase in brokered
loan fees was offset by a reduction in underwriting fee income due to a lower
volume of loans closed. Underwriting fee income was $1.3 million for the year
ended December 31, 1999 compared to $2.3 million for the year ended December 31,
1998.
125
Comprehensive Income
We have other comprehensive income (loss) in the form of unrealized holding
losses on securities available for sale. For the year ended December 31, 1999,
other comprehensive loss was $0.05 million compared to other comprehensive loss
of $6.8 million for the year ended December 31, 1998. The loss for the year
ended December 31, 1999 related to the decrease in the market price of the Asset
Management Fund, Inc. Adjustable Rate Mortgage Portfolio investment and in 1998
the loss was related to a decrease in the market price of IMC Mortgage Company
common stock.
Compensation and Related Expenses
The largest component of expenses is compensation and related expenses,
which decreased by $5.6 million to $17.8 million for the year ended December 31,
1999 from 1998. The decrease was directly attributable to a decrease in the
number of employees and lower commissions expense caused by the decrease in loan
volume. Salary expense decreased by $4.4 million and payroll related benefits
decreased by $0.5 million. The decrease was caused by a lower average number of
employees, which was attributed to the cost cutting initiative. For the year
ended December 31, 1999 the average full time equivalent employee count was 371
compared to 578 for the year ended December 31, 1998. Commissions to loan
officers decreased by $1.1 million due to lower loan volume.
General and Administrative Expenses
General and administrative expenses for the year ended December 31, 1999
increased by $0.8 million to $12.5 million, compared to the year ended December
31, 1998. The increase is attributed to increases in advertising expense, rent
expense and depreciation expense. For the year ended December 31, 1999 these
three expense items increased $3.3 million compared to the same period ended
December 31, 1998. The increase in advertising was caused by the formation of a
centralized advertising and marketing department in order to consolidate its
marketing. The sale lease back of the building that housed the advertising and
marketing department in Virginia Beach prior to relocation to the new corporate
office building in December of 1999 caused the increase in rent. Also, we
continue to pay rent on many retail offices that we closed while we are
attempting to sublease these locations. The increase in depreciation expense
was caused by the acquisition of ConsumerOne Financial, which has depreciable
equipment of $0.8 million. Expenses in all other general and administrative
categories decreased by $4.1 million during the year ended December 31, 1999,
compared to the year ended December 31, 1998. These expenses were part of a
cost reduction initiative.
Write down of Goodwill
Goodwill related to the 1998 purchase of MOFC, Inc. d/b/a ConsumerOne
Financial and the Funding Center of Georgia was written down during the year
ended December 31, 1999. The anticipated net income from these acquisitions was
not realized due to the decreasing margins in the nonconforming mortgage
industry,
126
therefore we reevaluated our intangible assets associated with the acquisitions.
The total write down for the year ended December 31, 1999 was $1.1 million.
Loss on Sale/Disposal of Fixed Assets
For the year ended December 31, 1999 we disposed of computers and equipment
no longer in service because of branch closings, which resulted in a loss of
$0.4 million. There was also an expense of $0.3 million regarding the charge
taken for previously capitalized legal and architectural costs related to
previous plans to construct a new corporate headquarters building in Virginia
Beach. These construction plans were cancelled when our current building became
available for purchase and was acquired in late 1999.
Loan Production Expense
The largest component of loan production expense is fees paid to mortgage
brokers for services rendered in the preparation of loan packages. Other items
that comprise loan production expenses are appraisals, credit reports, lead
research and telemarketing list expenses. Loan production expenses for the year
ended December 31, 1999 were $1.9 million compared to $3.6 million for the year
ended December 31, 1998. The decrease was primarily the result of a decrease in
services rendered fees of $1.2 million. Also, appraisal and credit report
expense decreased due to lower loan volume. We also eliminated payments to
outside consultants for research of customer leads due to the creation of the
centralized advertising and marketing departments.
127
Provision for Loan Losses
The following table presents the activity in the allowance for loan losses and
selected loan loss data for 1999 and 1998:
(In thousands)
[Download Table]
Years Ended
December 31 1999 1998
-------------- -------------
Balance at beginning of year $ 2,590 $ 1,687
Provision charged to expense 2,042 3,064
Acquisition of MOFC, Inc. 0 49
Loans charged off (3,286) (2,372)
Recoveries of loans previously charged off 36 162
-------------- -------------
Balance at end of year $ 1,382 $ 2,590
============== =============
Loans receivable at year-end, gross
of allowance for losses $69,054 $107,634
Ratio of allowance for loan losses to gross
loans receivable at year-end 2.00% 2.41%
We added $2.0 million during the year ended December 31, 1999 to the
allowance for loan losses, compared to an increase of $3.1 million for the year
ended December 31, 1998. The decrease in the provision was primarily the result
of a decrease in the balance of gross mortgage loans held for the respective
dates. All losses ("charge offs" or "write downs") and recoveries realized on
loans previously charged off, are accounted for in the allowance for loan
losses.
The allowance is established at a level that we consider adequate relative
to the composition of the current portfolio of loans held for sale. We consider
characteristics of the current loan portfolio such as credit quality, the
weighted average coupon, the weighted average loan to value ratio, the age of
the loan portfolio and the portfolio's delinquency status in the determination
of an appropriate allowance. Other criteria such as covenants associated with
our credit facilities, trends in the demand for and pricing for loans sold in
the secondary market for non-conforming mortgages and general economic
conditions, including interest rates, are also considered when establishing the
allowance. Adjustments to the reserve for loan losses may be made in future
periods due to changes in the factors mentioned above and any additional factors
that may effect anticipated loss levels in the future.
Provision for Foreclosed Property Losses
We increased our provision for foreclosed property losses by $215,000 for
the year ended December 31, 1999, compared to an decrease of $168,000 for the
year ended December 31, 1998.
128
Sales of real estate owned yielded net losses of $648,000 for the year ended
December 31, 1999 versus $660,000 for the year ended December 31, 1998.
The following table presents the activity in our allowance for foreclosed
property losses and selected real estate owned data for 1999 and 1998:
(In thousands)
[Enlarge/Download Table]
Years Ended
December 31 1999 1998
--------------- ---------------
Balance at beginning of year $ 503 $ 671
Provision charged to (reducing) expense 215 (168)
--------------- ---------------
Balance at end of year $ 718 $ 503
=============== ===============
Real estate owned at year-end, gross $2,992 $2,211
of allowance for losses
Ratio of allowance for foreclosed property losses 24.00% 22.80%
to gross real estate owned at year-end
We maintain a reserve on our real estate owned ("REO") based upon our
assessment of appraised values at the time of foreclosure. The increase in the
provision for foreclosed property losses relates to an increase in the dollar
amount of outstanding REO at December 31, 1999 when compared to December 31,
1998. While we believe that our present allowance for foreclosed property losses
is adequate, future adjustments may be necessary.
Income Taxes. The income tax benefit for 1999 was $4.7 million resulting from
net operating loss carrybacks with an effective tax rate of 38.62%. By
comparison, we had income tax expense of $0.5 million for an effective tax rate
of 39.78% in 1998.
The effective tax rates differ from the statutory federal rates due primarily to
state income taxes and certain nondeductible expenses.
129
Results of Operations for the Year Ended December 31, 1998 compared to the Year
Ended December 31, 1997.
Net Income
Net income for 1998 was $0.5 million compared to net income of $8.1 million
in 1997. On a per share basis (diluted), income for 1998 was $0.09, compared to
$1.51 for 1997. The return on average assets was 0.40% in 1998, compared to
7.68% in 1997. Return on average shareholders' equity was 1.93% in 1998,
compared to 32.69% in 1997.
Origination of Mortgage Loans
The following table shows loan originations in dollars and units for broker and
retail units in 1998 and 1997:
(Dollars in millions)
[Download Table]
Years Ended
December 31 1998 1997
----------- ---------------- ----------------
Broker $203.9 $256.4
Retail - funded through other lenders 92.3 NM
Retail - funded in-house 225.8 212.5
Total $522.0 $468.9
================ ================
Number of Loan Originated:
Broker 3,484 4,399
Retail - funded through other lenders 1,099 NM
Retail - funded in-house 3,882 4,022
---------------- ----------------
Total 8,465 8,421
================ ================
NM = Not Material
The decrease of 8.4% in dollar volume of loans, excluding $92.3 million in
brokered loans, originated during the year ended December 31, 1998, compared to
the same period in 1997 was due primarily to increased competition in the non-
conforming mortgage industry.
Loans originated through our retail offices, excluding $92.3 million in
brokered loans, increased 6.3% to $225.8 million, compared to $212.5 million
during the same period in 1997. The growth in retail origination's for the year
ended December 31, 1998 was due to an increase in retail office locations from
internal growth and due to the acquisition of FCGA.
Brokered loans generated by the retail division were $92.3 million during
the year ended December 31, 1998. Brokered loan volume originated during the
year ended December 31, 1997 was not material and therefore the dollar volumes
were not recorded.
The volume of loans originated through referrals from our network of
mortgage brokers decreased 20.5% to $203.9 million for the year ended December
31, 1998, compared to $256.4 million for the year ended December 31, 1997.
Contributing
130
to this decrease in volume from broker referrals is the refinance boom for
conforming mortgages created by the low interest rate environment, increased
competition in the non-conforming mortgage industry and our acquisition of FCGA.
Before we acquired FCGA in January 1998, FCGA was a mortgage broker organization
that referred loans to us.
Gain on Sale of Loans
The largest component of net income is gain on sale of loans. There is an
active secondary market for most types of mortgage loans originated. The
majority of the loans originated are sold to other financial institutions. We
receive cash at the time loans are sold. The loans are sold service-released on
a non-recourse basis, except for normal representations and warranties, which is
consistent with the industry practices. By selling loans in the secondary
mortgage market, we are able to obtain funds that may be used for additional
lending and investment purposes Gain on sale of loans is comprised of several
components, as follows: (a) the difference between the sales price and the net
carrying value of the loan; plus (b) loan origination fee income collected at
loan closing and deferred until the loan is sold; less (c) loan sale recapture
premiums and loan selling costs.
Loan sales totaled $389.6 million for the year ended December 31, 1998,
including the sale of approximately $12.0 million of loans owned for more than
180 days ("Seasoned Loans") at a discount to par value, as compared to $420.5
million for the same period in 1997. We sold $2.3 million of Seasoned Loans at a
21% discount to par value in July 1998 and $9.6 million of Seasoned Loans at an
8% discount to par value in June 1998.
Gain on sale of loans was $29.7 million for the year ended December 31,
1998, which compares with $33.5 million for the same period in 1997. These gains
exclude the sale of $12.0 million of Seasoned Loans at a discount in 1998. The
decrease for the year ended December 31, 1998, was the direct result of a
decrease in the weighted-average premium paid by investors for our loans. Gain
on the sale of mortgage loans represented 60.9% of total revenue during the year
ended December 31, 1998, compared to 64.2% of total revenue for the same period
in 1997.
The weighted average premium realized on loan sales decreased to 5.4%,
excluding the sale of $12.0 million Seasoned Loans at a discount to par, during
the year ended December 31, 1998, from 6.4% for the same period in 1997.
Including the discounted sale of $12.0 million of Seasoned Loans, the weighted
average premium realized by during the year ended December 31, 1998 decreased to
4.9% from 6.4% for the same period in 1997.
The decrease in premium percentage was caused by material changes in the
secondary market conditions for non-conforming mortgage loans. We have never
used securitization as a loan sale strategy. However, the whole-loan sale
marketplace for non-conforming mortgage loans was impacted by changes that
affected companies who previously used securitizations to sell loans. Excessive
competition during 1997 and 1998 and a coinciding reduction in interest rates in
general caused an increase in the prepayment speeds for non-conforming loans.
131
The valuation method applied to interest-only and residual assets ("Assets"),
the capitalized assets created from securitization, include an assumption for
average prepayment speed in order to determine the average life of a loan pool.
The increased prepayment speeds experienced in the industry were greater than
the assumptions previously used by many securitization issuers and led to an
impairment of Asset values for several companies in the industry. Additionally,
in September 1998, a flight to quality among fixed income investors negatively
impacted the pricing spreads for mortgage-backed securitizations compared to
earlier periods and negatively impacted the associated economics to the issuers.
Consequently, many of these companies have and continue to report material
losses, experienced reductions in liquidity sources and diverted to whole loan
sale strategies in order to generate cash. This shift materially decreased the
demand and increased the supply of non-conforming mortgage loans in the
secondary marketplace, which resulted in significantly lower premiums on non-
conforming whole-loan mortgage sales.
In addition, the premium percentage has decreased due to a decrease in the
Weighted Average Coupon ("WAC") on loan originations, which was primarily the
result of an increase in adjustable rate mortgage originations during 1998
compared to 1997. These premiums do not include loan origination fees collected
at the time the loans are closed, which are included in the computation of gain
on sale when the loans are sold.
We defer recognizing income from the loan origination fees we receive at the
time a loan is closed. These fees are deferred and recognized over the lives of
the related loans as an adjustment of the loan's yield using the level-yield
method. Deferred income pertaining to loans held for sale is taken into income
at the time of sale of the loan. Origination fee income is primarily derived
from our retail lending division. Origination fee income included in the gain
on sale of loans, excluding the sale of $12.0 million of Seasoned Loans at a
discount, for the year ended December 31, 1998 was $10.4 million, compared to
$8.6 million in the year ended December 31, 1997. The increase is the result of
selling more loans generated by its retail division. Retail loan sales during
the year ended December 31, 1998 comprised 55.5% of total loan sales, with
average loan origination fee income earned of 5.0%, excluding the Seasoned Loan
sale of $12.0 million at a discount. For the same period of 1997, our retail
loan sales were 48.5% of total loan sales with average origination fee income
earned of 4.2%. Fees associated with selling loans decreased to approximately
20 basis points of the dollar volume of loans sold for the year ended December
31, 1998 from 35 basis points for the year ended December 31, 1997.
We also defer recognition of the expense incurred, from the payment of fees
to mortgage brokers, for services rendered on loan originations. These fees are
deferred and recognized over the lives of the related loans as an adjustment of
the loan's yield using the level-yield method. Deferred expenses pertaining to
loans held for sale are taken into income at the time of the sale of the loan.
132
Interest Income and Expense
Net interest income is dependent on the difference, or "spread", between the
interest income we receive from our loans and our cost of funds, consisting
principally of the interest expense paid on the warehouse lines of credit, the
Bank's deposit accounts and other borrowings.
Interest income for the year ended December 31, 1998 was $10.3 million
compared with $10.9 million for the same period ended in 1997. The decrease in
interest income for the year ended December 31, 1998 was primarily due to a
lower weighted-average coupon associated with the balance of loans held for
sale.
Interest expense for the year ended December 31, 1998 was $6.3 million
compared with $6.2 million for the year ended December 31, 1997. The decrease in
interest expense for the year ended December 31, 1998, was the direct result of
an increase in the average balance of interest-bearing liabilities.
Changes in the average yield received on the loan portfolio may not coincide
with changes in interest rates we must pay on our revolving warehouse loans, the
Bank's FDIC-insured deposits, and other borrowings. As a result, in times of
rising interest rates, decreases in the difference between the yield received on
loans and other investments and the rate paid on borrowings and the Bank's
deposits usually occur.
133
The following tables reflect the average yield earned and rates paid during 1998
and 1997. In computing the average yields and rates, the accretion of loan fees
is considered an adjustment to yield. Information is based on average month-end
balances during the indicated periods.
(In thousands)
[Enlarge/Download Table]
1998 1997
------------------------------------------------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
---------- -------- -------- ------- -------- --------
Interest-earning assets:
Loans receivable (1) $ 83,522 $ 9,761 11.69% $ 74,116 $10,662 14.39%
Cash and other interest-
Earning assets 12,754 547 4.28 4,240 273 6.44
-------- ------- ----- -------- ------- -----
96,276 10,308 10.71 78,356 10,935 13.96
------- ----- ------- -----
Non-interest-earning assets:
Allowance for loan losses (1,789) (1,231)
Investment in IMC 8,136 17,376
Premises and equipment,
net 4,770 3,372
Other 11,875 7,112
---------- --------
Total assets $119,268 $104,985
========== ========
Interest-bearing liabilities:
Revolving warehouse lines $ 49,810 3,888 7.80 $ 59,681 4,834 8.10
FDIC-insured deposits 22,858 1,361 5.96 6,076 357 5.88
Other interest-bearing
Liabilities 10,677 1,003 9.39 10,307 966 9.37
-------- ------- ----- -------- ------- -----
83,345 6,252 7.50 76,064 6,157 8.09
------- ----- ------- -----
Non-interest-bearing liabilities 11,126 4,264
---------- --------
Total liabilities 94,471 80,328
Shareholders' equity 24,797 24,657
---------- --------
Total liabilities and equity $119,268 $104,985
========== ========
Average dollar difference between
Interest-earning assets and interest-Bearing
liabilities $ 12,931 $ 2,292
========== ========
Net interest income $ 4,056 $ 4,778
======== =======
Interest rate spread (2) 3.21% 5.87%
==== ====
Net annualized yield on average
Interest-earning assets 4.21% 6.10%
==== ====
_____________
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
(2) Average yield on total interest-earning assets less average rate paid on
total interest-bearing liabilities.
134
The following table shows the amounts of the changes in interest income and
expense which can be attributed to rate (change in rate multiplied by old
volume) and volume (change in volume multiplied by old rate) for the year ended
December 31, 1998 compared to the year ended December 31, 1997. The changes in
net interest income due to both volume and rate changes have been allocated to
volume and rate in proportion to the relationship of absolute dollar amounts of
the change of each. The table demonstrates that the decrease of $723,000 in net
interest income for the year ended December 31, 1998 compared to the year ended
December 31, 1997 was primarily result of a decrease in the average yield on
interest-earning assets
[Download Table]
1998 Versus 1997
Increase (Decrease) Due to
---------------------------------
(in thousands) Volume Rate Total
---------------------------------
Total interest-earning assets
Loans receivable $1,884 $(2,785) $ (901)
Cash and other 328 (55) 273
---------------------------------
Interest-earning assets 2,212 (2,840) (628)
---------------------------------
Total interest-bearing liabilities
Revolving warehouse loans (776) (170) (946)
FDIC-insured deposits 999 5 1,004
Other 35 2 37
---------------------------------
258 (163) 95
---------------------------------
Net interest income $1,954 $(2,677) $ (723)
=================================
Gain on Sale of Securities
We sold 558,400 shares of IMC stock for $1.9 million, which resulted in a
pre-tax gain of $1.8 million, during 1998. We sold 233,241 shares of IMC stock
for $3.7 million, which resulted in a pre-tax gain of $2.8 million, during 1997.
Other Income
In addition to net interest income (expense), and gain on the sale of loans,
we derive income from origination fees earned on brokered loans generated by our
retail offices and other fees earned on the loans funded, such as document
preparation fees, underwriting service fees, prepayment penalties, and late
charge fees for delinquent loan payments. Brokered loan fees were $4.3 million
for the year ended December 31, 1998, compared to $1.0 million for the year
ended December 31, 1997. For the year ended December 31, 1998, other income
totaled $7.0 million compared to $5.0 million for the same period in 1997. The
increase was primarily the result of the increase in brokered loan fees, which
was offset by a reduction in underwriting fee income due to a lower volume of
loans closed.
Comprehensive Income
We have comprehensive income (loss) in the form of unrealized holding gain
(loss) on securities held for sale. The shares of IMC Mortgage Company common
stock owned is the primary component of our security holdings (See Item 2
section "Assets"). For the year ended December 31, 1998, other comprehensive
135
loss was $6.8 million compared to comprehensive loss of $4.5 million for the
year ended December 31, 1997. The losses for the year ended December 31, 1998
and 1997, were related to a decrease in the market price of IMC Mortgage Company
common stock. We owned approximately 435,634 shares of IMC Mortgage Company
common stock on December 31, 1998.
Compensation and Related Expenses
The largest component of expenses is compensation and related expenses,
which increased by $4.9 million to $23.4 million for the year ended December 31,
1998, compared to the same period in 1997. The increase was directly
attributable to an increase in the number of employees. During the year ended
December 31, 1998, approximately 60% of the increase was attributed to staffing
needs for seven additional retail origination offices compared to the same
period in 1997. The remaining 40% of the increase in compensation and related
benefits expense for the year ended December 31, 1998, was due to a higher
number of employees in the corporate headquarters during the first six months of
1998. During the first six months of 1998, we had an increase of 68.1% in
corporate office staff compared to the same period in 1997, with a corresponding
increase in base salaries and benefits of approximately $2.0 million. However,
in July 1998, we initiated a plan to reduce the number of employees in the
corporate office. As of December 31, 1998, the home office had been reduced by
21% compared to March 31, 1998.
General and Administrative Expenses
General and administrative expenses for the year ended December 31, 1998
increased by $1.5 million to $11.7 million, compared to the year ended December
31, 1997. This increase is attributed to the addition of seven retail-lending
offices during the year ended December 31, 1998.
Loan Production Expense
The largest component of loan production expense is fees paid to mortgage
brokers for services rendered in the preparation of loan packages. Other items
that comprise loan production expenses are appraisals, credit reports, lead
research and telemarketing expenses. Loan production expenses for the year
ended December 31, 1998 were $3.6 million compared to $1.9 million for the year
ended December 31, 1997. The increase was primarily the result of an increase
in services rendered fees.
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Provision for Loan Losses
The following table presents the activity in the allowance for loan losses and
selected loan loss data for 1998 and 1997:
[Download Table]
(In thousands)
Years Ended
December 31 1998 1997
---------------- ---------------
Balance at beginning of year $ 1,687 $ 924
Provision charged to expense 3,064 1,534
Acquisition of MOFC, Inc. 49 -
Loans charged off (2,372) (953)
Recoveries of loans previously charged off 162 182
----------- ------------
Balance at end of year $ 2,590 $ 1,687
=========== ============
Loans receivable at year-end, gross $107,634 $82,383
of allowance for losses
Ratio of allowance for loan losses to gross 2.41% 2.05%
loans receivable at year-end
We added $3.1 million during the year ended December 31, 1998 to the
allowance for loan losses, compared to an increase of $1.5 million for the year
ended December 31, 1997. The increase was primarily the result of two Seasoned
Loan sales, of approximately $9.6 million, at 92% and $2.3 million, at 79%, of
the carrying value of the loans. Also contributing to the increase in the
provision for loan losses was an increase in the balance of gross mortgage loans
held for the respective dates. All losses ("charge offs" or "write downs") and
recoveries realized on loans previously charged off, are accounted for in the
allowance for loan losses.
The allowance is established at a level that we consider adequate relative
to the composition of the current portfolio of loans held for sale. We consider
characteristics of the current loan portfolio such as credit quality, the
weighted average coupon, the weighted average loan to value ratio, the age of
the loan portfolio and the portfolio's delinquency status in the determination
of an appropriate allowance. Other criteria such as covenants associated with
our credit facilities, trends in the demand and loan sale pricing for non-
conforming mortgage loans in the secondary market and general economic
conditions, including interest rates, are also considered when establishing the
allowance. Adjustments to the reserve for loan losses may be made in future
periods due to changes in the factors mentioned above and any additional factors
that may effect anticipated loss levels in the future.
Provision for Foreclosed Property Losses
We decreased our provision for foreclosed property losses by $168,000 for
the year ended December 31, 1998, compared to an increase of $142,000 for the
year ended December 31, 1997.
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Sales of real estate owned yielded net losses of $660,000 for the year ended
December 31, 1998 versus $654,000 for the year ended December 31, 1997.
The following table presents the activity in the allowance for foreclosed
property losses and selected real estate owned data for 1998 and 1997:
[Download Table]
(In thousands)
Years Ended
December 31 1998 1997
------------- -----------
Balance at beginning of year $ 671 $ 529
Provision charged to expense (168) 142
----------- -----------
Balance at end of year $ 503 $ 671
=========== ===========
Real estate owned at year-end, gross $2,211 $3,038
of allowance for losses
Ratio of allowance for foreclosed property losses 22.80% 22.09%
to gross real estate owned at year-end
We maintain a reserve on our real estate owned ("REO") based upon our
assessment of appraised values at the time of foreclosure. The decrease in the
provision for foreclosed property losses relates to a decrease in the dollar
amount of outstanding REO at December 31, 1998 when compared to December 31,
1997. While we believe that its present allowance for foreclosed property losses
is adequate, future adjustments may be necessary.
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Financial Condition at September 30, 2000 and December 31, 1999
Assets
The total assets were $63.4 million at September 30, 2000 compared to total
assets of $98.6 million at December 31, 1999.
Cash and cash equivalents increased by $1.9 million to $12.6 million at
September 30, 2000, from $10.7 million at December 31, 1999. The cash position
increased because the loan origination volume was less than anticipated for the
level of certificate of deposit borrowings.
Net mortgage loans receivable decreased by $31.3 million to $35.4 million at
September 30, 2000. The 46.9% decrease in 2000 is primarily due to selling more
loans than were originated in-house during the first nine months of 2000. We
generally sell loans within sixty days of origination.
Real estate owned ("REO") decreased by $0.9 million to $1.4 million at
September 30, 2000. The 37.7% decrease in REO resulted from the sale of $2.8
million in REO properties compared to additions of $1.8 million to REO during
the nine months ended September 30, 2000.
Investments increased by $0.3 million to $2.9 million at September 30, 2000.
Investments consist primarily of an Asset Management Fund, Inc. Adjustable Rate
Mortgage Portfolio and FHLB stock owned by the Bank. The 10.7% increase in
investments in the first nine months of 2000 is primarily due to the purchase of
shares of FHLB stock.
Premises and equipment decreased by $0.5 million to $5.6 million at
September 30, 2000. The decrease is due to the depreciation of these assets for
the first nine months of 2000.
Goodwill (net) decreased by $0.1 million to $1.0 million at September 30,
2000. The decrease is due to the amortization of the intangible asset for the
first nine months of 2000.
Income tax receivable decreased by $3.6 million to $2.0 million at September
30, 2000. The 64.1% decrease represents the receipt of a refund due on federal
taxes based upon actual tax return filing.
The deferred tax asset decreased by $0.6 million to $1.1 million at
September 30, 2000. The decrease related to the establishment of a $0.4 million
valuation allowance for future unrealizable benefits for the deferred tax asset.
The valuation allowance is based upon an assessment by management of future
taxable income and its relationship to realizability of deferred tax assets. The
remainder of the decrease relates to changes in timing differences of the
deferred tax asset.
Other assets decreased by $0.4 million to $1.3 million at September 30,
2000. Other assets consist of accrued interest receivable, prepaid assets,
brokered loan fees receivable, deposits, and various other assets. The majority
of the
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decrease was in accrued interest receivable, which was due to a lower average
loans held for sale at September 30, 2000.
Liabilities
Outstanding balances for our revolving warehouse loans decreased by $14.3
million to $3.1 million at September 30, 2000. The 82.0% decrease in the first
nine months of 2000 was primarily attributable to the decrease in loans
receivable.
The Bank's deposits totaled $39.0 million at September 30, 2000 compared to
$55.3 million at December 31, 1999. Of the certificate accounts on hand as of
September 30, 2000, a total of $32.5 million was scheduled to mature in the
twelve-month period ending September 30, 2001.
During the three and nine month periods ended September 30, 2000, we
received $3.0 million in money market deposits through an arrangement with a
local NYSE member broker/dealer. There were no money market deposits for the
three and nine-month periods ended September 30, 1999.
As of December 31, 1999, the Bank borrowed $4.6 million from the Federal
Home Loan Bank (FHLB) to fund loan production. There were no borrowings at
September 30, 2000.
Promissory notes and certificates of indebtedness totaled $4.8 million at
September 30, 2000 compared to $5.1 million at December 31, 1999. The 5.3%
decrease is primarily due to the redemption of maturing promissory notes and
certificates. In the first nine months of 2000 and for the year of 1999, we
were not soliciting new promissory notes or certificates of indebtedness. We
have utilized promissory notes and certificates of indebtedness, which are
subordinated to our warehouse lines of credit, to help fund its operations since
1984. Promissory notes outstanding carry terms of one to five years and
interest rates between 8.00% and 10.00%, with a weighted-average rate of 9.76%
at September 30, 2000. Certificates of indebtedness are uninsured deposits
authorized for financial institutions, which have Virginia industrial loan
association charters. The certificates of indebtedness carry terms of one to
five years and interest rates between 6.75% and 10.00%, with a weighted-average
rate of 9.28% at September 30, 2000.
Mortgage loans payable totaled $2.6 million at September 30, 2000 compared
to $2.3 million at December 31, 1999. The $0.2 million increase is a combination
of a $0.3 first mortgage payable on one of its REO properties as well as a
minimal decrease in mortgage loans payable due to the normal principal reduction
with payments made on the note payable.
Accrued and other liabilities decreased by $0.7 million to $1.7 million at
September 30, 2000. This category includes accounts payable, accrued interest
payable, deferred income, accrued bonuses, and other payables. The 30.8%
decrease is the result of various payments of year end accrued expenses.
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Shareholders' Equity
Total shareholders' equity at September 30, 2000 was $9.2 million compared
to $11.3 million at December 31, 1999. The $2.1 million decrease in 2000 was due
to the $2.1 million loss for the nine months ended September 30, 2000.
Liquidity and Capital Resources
Our operations require access to short and long-term sources of cash. Our
primary sources of cash flow result from the sale of loans through whole loan
sales, loan origination fees, processing, underwriting and other fees associated
with loan origination and servicing, revenues generated by Approved Financial
Solutions and Global Title of Md., Inc., net interest income, and borrowings
under our warehouse facilities, certificates of indebtedness issued by Approved
Financial Corp. and certificates of deposit issued by the Bank to meet working
capital needs. Our primary operating cash requirements include the funding of
mortgage loan originations pending their sale, operating expenses, income taxes
and capital expenditures.
Adequate credit facilities and other sources of funding, including the
ability to sell loans in the secondary market, are essential to our ability to
continue to originate loans. We have historically operated, and expect to
operate in the future on a negative cash flow basis from operations based upon
the timing of proceeds used to fund loan originations and the subsequent receipt
of cash from the sale of the loan. Loan sales normally occur 30 to 45 days after
proceeds are used to fund the loan. However, for the nine months ended September
30, 2000, we generated cash from operating activities of $32.8 million, due
largely to the fact that we sold a greater volume of loans than we funded during
the period. The net cash provided by operating activities was primarily used to
fund mortgage loan originations. For the nine months ended September 30, 1999 we
generated cash from operating activities of $57.0 million.
We finance our operating cash requirements primarily through warehouse and
other credit facilities, and the issuance of other debt. For the nine months
ended September 30, 2000, we paid down debt from financing activities of $32.3
million, this was primarily the result of proceeds from loan sales in excess of
new borrowings for funding loan originations. For the nine months ended
September 30, 1999, we paid down debt from financing activities of $59.1
million.
Our borrowings (revolving warehouse loans, FDIC-insured deposits, mortgage
loans on our office buildings, FHLB advances, subordinated debt and loan
proceeds payable) were 82.8% of assets at September 30, 2000 compared to 86.1%
at December 31, 1999.
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Whole Loan Sale Program
The most important source of liquidity and capital resources is the ability
to profitably sell conforming and non-conforming loans in the secondary market.
The market value of the loans funded is dependent on a number of factors,
including but not limited to loan delinquency and default rates, the original
term and current age of the loan, the interest rate and loan to value ratio,
whether or not the loan has a prepayment penalty, the credit grade of the loan,
the credit score of the borrower, the geographic location of the real estate,
the type of property and lien position, the supply and demand for conforming and
non-conforming loans in the secondary market, general economic and market
conditions, market interest rates and governmental regulations. Adverse changes
in these conditions may affect our ability to sell mortgages in the secondary
market for acceptable prices, which is essential to the continuation of our
mortgage origination operations.
Bank Sources of Capital
The Bank's deposits totaled $39.0 million at September 30, 2000 compared to
$55.3 million at December 31, 1999. The Bank currently utilizes funds from
deposits and a $15 million line of credit with the FHLB of Atlanta to fund first
lien and junior lien mortgage loans. We plan to increase the use of credit
facilities and funding opportunities available to the Bank.
Warehouse and Other Credit Facilities
In addition to our $15 million line of credit with the FHLB of Atlanta, we
have available funding from warehouse facilities with other non-affiliated
financial institutions.
On July 21, 2000, we obtained a $40.0 million line of credit from Bank
United. The credit line can be used for prime and sub-prime mortgage loans and
is secured by loans originated. The line bears interest at a rate of 2.00% and
2.75% over the one-month LIBOR rate for prime and sub-prime loans respectively.
We may receive warehouse credit advances of 98%, 97%, and 90% for prime, sub-
prime, and high LTV loans (loans with LTV's greater than 90%), respectively, of
the collateral value amount on pledged mortgage loans for a period of 90 days
after advance of funds on each loan. If an investor has not purchased a loan
within 90 days of such advance, the interest rate on the loan increases to 3.75%
over the one-month LIBOR and we have an additional 30 days to sell the loan or
purchase the loan back from the warehouse. The aged loan sub limit is $2.0
million. As of September 30, 2000, $3.2 million was outstanding under this
facility. The line of credit is scheduled to expire on July 21, 2001. The line
of credit is subject to financial covenants for a current ratio, tangible net
worth and a leverage ratio. As of September 30, 2000 we are in compliance with
all financial covenants.
On November 10, 1999, we obtained a $20.0 million sub-prime line of credit
from Regions Bank. The line is secured by loans originated and bears interest at
a rate of 3.25% over the one-month LIBOR rate. We may receive warehouse credit
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advances of 100% of the net loan value amount on pledged mortgage loans for a
period of 90 days after origination. As of September 30, 2000 there were no
borrowings outstanding under this facility. The line of credit is scheduled to
expire on November 10, 2001. The line of credit is subject to financial
covenants for a current ratio, tangible net worth and a leverage ratio. As of
September 30, 2000 we are in compliance with all financial covenants.
On November 10, 1999, we obtained a $20.0 million conforming loan line of
credit from Regions Bank. The line is secured by loans originated and bears
interest ranging from 2.25% to 2.75% over the one-month LIBOR rate based upon
the monthly advance levels. We may receive warehouse credit advances of 100% of
the net loan value amount on pledged mortgage loans for a period of 90 days
after origination. As of September 30, 2000 there were no borrowings outstanding
under this facility. The line of credit is scheduled to expire on November 10,
2001. The line of credit is subject to financial covenants for a current ratio,
tangible net worth and a leverage ratio. As of September 30, 2000 we are in
compliance with all financial covenants.
Effective on December 8, 1999, we obtained an amendment to the warehouse line
of credit agreement with Chase Bank of Texas. Since the utilization of the
credit line was very low in 1999, the amendment reduced the size of the
warehouse facility to $15.0 million, and all bank syndicate members other than
Chase were released from the commitment. The line is secured by loans originated
and bears interest at a rate of 1.75% over the one-month LIBOR rate. We may
receive warehouse credit advances of 95% of the original principal balances on
pledged mortgage loans for a maximum period of 180 days after origination. This
line expired on June 7, 2000 and will not be renewed.
Other Capital Resources
Promissory notes and certificates of indebtedness, have been a source of
capital since 1984 and are issued primarily according to an intrastate exemption
from security registration. Promissory notes and certificates of indebtedness
totaled $4.8 million at September 30, 2000 compared to $5.1 million at December
31, 1999. These borrowings are subordinated to our warehouse lines of credit. We
cannot issue subordinated debt to new investors under the exemption since the
state of Virginia is no longer our primary state of operation.
We had cash and cash equivalents of $12.6 million at September 30, 2000. We
have sufficient resources to fund our current operations. Alternative sources
for future liquidity and capital resource needs may include the issuance of debt
or equity securities, increase in Saving Bank deposits and new lines of credit.
Each alternative source of liquidity and capital resources will be evaluated
with consideration for maximizing shareholder value, regulatory requirements,
the terms and covenants associated with the alternative capital source. We
expect that we will continue to be challenged by a limited availability of
capital, a reduction in premiums received on non-conforming mortgage loans sold
143
in the secondary market compared to premiums realized in recent years, new
competition and a rise in loan delinquency and the associated loss rates.
Bank Regulatory Liquidity
Liquidity is the ability to meet present and future financial obligations,
either through the acquisition of additional liabilities or from the sale or
maturity of existing assets, with minimal loss. Regulations of the OTS require
thrift associations and/or banks to maintain liquid assets at certain levels. At
present, the required ratio of liquid assets to and borrowings, which can be
withdrawn and are due in one year or less is 4.0%. Penalties are assessed for
noncompliance. In 1999 and the first nine months of 2000, the Bank maintained
liquidity in excess of the required amount, and we anticipate that we will
continue to do so.
Bank Regulatory Capital
At September 30, 2000, the Bank's book value under generally accepted
accounting principles ("GAAP") was $9.4 million. OTS Regulations require that
institutions maintain the following capital levels: (1) tangible capital of at
least 1.5% of total adjusted assets, (2) core capital of 4.0% of total adjusted
assets, and (3) overall risk-based capital of 8.0% of total risk-weighted
assets. As of September 30, 2000, the Bank satisfied all of the regulatory
capital requirements, as shown in the following table reconciling the Bank's
GAAP capital to regulatory capital:
[Enlarge/Download Table]
Tangible Core Risk-Based
(In thousands) Capital Capital Capital
GAAP capital $9,304 $9,304 $9,304
Add: unrealized loss on securities 16 16 16
Nonallowable asset: goodwill (564) (564) (564)
Additional capital item: general allowance - - 230
------------ ---------- ---------
Regulatory capital - computed 8,756 8,756 8,986
Minimum capital requirement 779 2,077 3,034
------------ ---------- ---------
Excess regulatory capital $7,977 $6,679 $5,952
============ ========== =========
Ratios:
Regulatory capital - computed 16.87% 16.87% 23.69%
Minimum capital requirement 1.50% 4.00% 8.00%
------------ ---------- ----------
Excess regulatory capital 15.37% 12.87% 15.69%
============ ========== =========
Recently an FDIC discussion draft proposal has been made public regarding
requirements for subprime lenders. Under the proposal, regulatory capital
required to be held for certain loan classes included in the institution's
portfolio could be increased. The ultimate resolution of this proposal is
uncertain at this time. However, we believe that the Bank can remain in
compliance with its capital requirements.
144
We are not aware of any other trends, events or uncertainties other than
those discussed in this document, which will have or that are likely to have a
material effect on our or the Bank's liquidity, capital resources or operations.
We are not aware of any other current recommendations by regulatory authorities,
which if they were implemented would have such an effect.
Interest Rate Risk Management
We originate mortgage loans for sale as whole loans. We mitigate our
interest rate exposure, and the related need for hedging activity, by selling
most of the loans within sixty days of origination. However, we may choose to
hold certain loans for a longer period prior to sale in order to increase net
interest income. Currently loans held for investment by the Bank are primarily
composed of adjustable rate mortgages in order to minimize the Bank's interest
rate risk exposure. However, excluding the Bank's loans held for investment the
majority of loans held beyond the normal sixty-day holding period are fixed rate
instruments. Since most of our borrowings have variable interest rates, we have
exposure to interest rate risk. For example, if market interest rates were to
rise between the time we originate the loans and the time the loans are sold,
the original interest rate spread on the loans narrows, resulting in a loss in
value of the loans. To offset the effects of interest rate fluctuations on the
value of our fixed rate mortgage loans held for sale, we in certain cases, may
enter into Treasury security lock contracts, which function similar to short
sales of U.S. Treasury securities. If the value of an interest rate hedge
position decreases in value, offsetting an increase in the value of the hedged
loans, upon settlement with its counter-party, will pay the hedge loss in cash
and realize the corresponding increase in the value of the loans. Conversely, if
the value of a hedge position increases, offsetting a decrease in the value of
the hedged loans, we will receive the hedge gain in cash at settlement. We
believe that our current hedging strategy using Treasury rate lock contracts is
an effective way to manage interest rate risk on fixed rate loans prior to sale.
We may in the future enter into similar transactions with government and quasi-
government agency securities in relation to its origination and sale of
conforming mortgage loans or similar forward loan sale commitments concerning
non-conforming mortgages. Prior to entering into any type of hedge transaction
or forward loan sale commitment, we perform an analysis of the loan associated
with the transaction or commitment taking into account such factors as credit
quality of the loans, interest rate and term of the loans, as well as current
economic market trends, in order to determine the appropriate structure and/or
size of a hedge transaction or loan sale commitment that will limit our exposure
to interest rate risk. We had no hedge contracts or forward commitments
outstanding at September 30, 2000. We have not entered into any hedge contracts
since the fourth quarter of 1997. That commitment expired during the first
quarter of 1998.
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New Accounting Standards
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"
as amended by SFAS 137, is effective for fiscal year ends beginning after June
15, 2000. This statement establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. It requires that entities recognize all derivatives as either assets
or liabilities in the financial statements and measure those instruments at fair
value. If certain conditions are met, a derivative may be specifically designed
as (a) a hedge of the exposure to changes in the fair value of a recognized
asset or liability or an unrecognized firm commitment,(b) a hedge of the
exposure to variable cash flows of a forecasted transaction, or (c) a hedge of
the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a foreign-
currency-denominated forecasted transaction. This statement should not have any
material impact on the financial statements.
Securities and Exchange Commission Staff Accounting Bulletin 101 (SAB 101),
"Revenue Recognition in Financial Statements", as amended by SAB 101B, must be
adopted no later than the fourth calendar quarter of the year 2000. Adoption of
SAB101 is not expected to have any material impact on the recognition,
presentation, and disclosure of revenue.
In March 2000, the Financial Accounting Standards Board, (FASB) issued
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation - an interpretation of APB Opinion No. 25 (FIN 44), providing new
accounting rules for stock-based compensation under APB Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25). FIN 44 does not change FASB
Statement No. 123, Accounting for Stock-Based Compensation (FAS 123). The new
rules are significant and could result in compensation expense in several
situations in which no expense is typically recorded under current practice.
FIN 44 is generally effective for transactions occurring after July 1, 2000,
however, the accounting must be applied prospectively to certain transactions
consummated after December 15, 1998. We are not aware of any transactions that
will cause FIN 44 to have a material effect on our financial condition or
results of operations.
In September 2000, the FASB issued SFAS No. 140, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities, a
replacement of SFAS No. 125. It revises the standards for accounting for
securitizations and other transfers of financial assets and collateral and
requires certain disclosures, but it carries over most of provisions of SFAS No.
125 without reconsideration. The Statement requires a debtor to reclassify
financial assets pledged as collateral and report these assets separately in the
statement of financial position. It also requires a secured party to disclose
information, including fair value, about collateral that it has accepted and is
permitted by contract or custom to sell or repledge. The Statement includes
specific disclosure requirements for entities with securitized financial assets
and entities that securitize assets. This Statement is effective for transfers
and
146
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2000 and is effective for recognition and reclassification of
collateral and for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2000. We do not expect
that FAS 140 will have a material effect on financial condition or results of
operation.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented in this
document have been prepared in accordance with generally accepted accounting
principles, which require the measurement of the financial position and
operating results in terms of historical dollars, without considering changes in
the relative purchasing power of money over time due to inflation.
The majority of the assets are monetary in nature. As a result, interest
rates have a more significant impact on our performance than the effects of
general levels of inflation. Inflation affects us most significantly in the area
of residential real estate values and inflation's effect on interest rates. Real
estate values generally increase during periods of high inflation and are
stagnant during periods of low inflation. While, interest rates do not
necessarily move in the same direction or with the same magnitude as the prices
of goods and services, normally interest rates increase during periods of high
inflation and decrease during periods of low inflation.
Loan origination volume generally increases as residential real estate
values increase because homeowners have new home equity values against which
they can borrow. A large portion of our loan volume is related to refinancing
and debt consolidation mortgages, therefore, an increase in real estate values
enhances the marketplace for this type of loan origination. Conversely, as
residential real estate values decrease, the market for home equity and debt
consolidation loan origination decreases. Additionally, an increase or decrease
in residential real estate values may have a positive or negative effect,
respectively, on the liquidation of foreclosed property.
Because we sell a significant portion of the loans we originate, the effect
that inflation has on interest rates has a diminished effect on the results of
operations. However, we hold a portfolio of loans held for investment, the size
of which varies from time to time and this portfolio will be more sensitive to
the effects of inflation and changes in interest rates. Profitability may be
directly affected by the level and fluctuation of interest rates, which affect
our ability to earn a spread between interest received on its loans and the
costs of its borrowings. Our profitability is likely to be adversely affected
during any period of unexpected or rapid changes in interest rates. (See also:
"Interest Rate Risk Management").
147
A substantial and sustained increase in interest rates could adversely affect
our ability to originate and purchase loans and affect the mix of first and
junior lien mortgage loan products. Generally, first mortgage production
increases relative to junior lien mortgage production in response to low
interest rates and junior lien mortgage loan production increases relative to
first mortgage loan production during periods of high interest rates.
While we have no plans to adopt a Securitization loan sale strategy at this
time, if we were to do so in the future, then to the extent servicing rights and
interest-only and residual classes of certificates are capitalized on the books
from future loan sales through securitization, higher than anticipated rates of
loan prepayments or losses could require us to write down the value of such
servicing rights and interest-only and residual certificates, adversely
affecting earnings. A significant decline in interest rates could increase the
level of loan prepayments. Conversely, lower than anticipated rates of loan
prepayments or lower losses could allow us to increase the value of interest-
only and residual certificates, which could have a favorable effect on our
results of operations and financial condition.
148
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Management - Asset/Liability Management
Our primary market risk exposure is interest rate risk. Fluctuations in
interest rates will impact both the level of interest income and interest
expense and the market value of our interest-earning assets and interest-bearing
liabilities.
We strive to manage the maturity or repricing match between assets and
liabilities. The degree to which we are "mismatched" in our maturities is a
primary measure of interest rate risk. In periods of stable interest rates, net
interest income can be increased by financing higher yielding long-term mortgage
loan assets with lower cost short-term Bank deposits and borrowings. Although
such a strategy may increase profits in the short run, it increases the risk of
exposure to rising interest rates and can result in funding costs rising faster
than asset yields. We attempt to limit our interest rate risk by selling a
majority of the fixed rate mortgage loans that we originate.
Contractual principal repayments of loans do not necessarily reflect the
actual term of our loan portfolio. The average lives of mortgage loans are
substantially less than their contractual terms because of loan prepayments and
because of enforcement of due-on-sale clauses, which gives us the right to
declare a loan immediately due and payable in the event, among other things, the
borrower sells the real property subject to the mortgage and the loan is not
repaid. In addition, certain borrowers increase their equity in the security
property by making payments in excess of those required under the terms of the
mortgage.
The majority of the loans originated are sold through our loan sale
strategies in an attempt to limit its exposure to interest rate risk in addition
to generating cash revenues. We sold, during 1999 and the first nine months of
2000 approximately 98.1% of the total loans originated and funded in-house
during the year ended December 31, 1999. We expect to sell the majority of its
loan originations, other than loans specifically originated to hold for
investment and yield, during the same twelve-month period in which they are
funded in future periods. Also, we sold, during the first nine months in 2000,
approximately 92.8% of loans originated and funded in-house during the period
beginning January 1, 2000 and ending August 31, 2000. As a result, loans are
held on average for less than 12 months in our portfolio of Loans Held for Sale.
The "gap position", defined as the difference between interest-earning assets
and interest-bearing liabilities maturing or repricing in one year or less, was
negative at September 30, 2000, as anticipated, and is expected to remain
negative in future periods. We have no quantitative target range for past gap
positions, nor any anticipated ranges for future periods due to the fact that we
sell the majority of our loans within a twelve month period while the gap
position is a static illustration of the contractual repayment schedule for
loans.
149
Our one-year gap was a negative 22.38% of total assets at September 30, 2000, as
illustrated in the following table:
[Enlarge/Download Table]
One Year Two Three to More Than Four
Description Total Or Less Years Four Years Years
Interest earning assets:
Loans held for sale (1) $30,131 $ 10,588 $ 669 $ 1,515 $17,359
Loans held for yield (1) 6,422 2,169 87 267 3,899
Cash and other
interest-earning assets 12,593 12,593
--------------- ---------- ---------- ------------ --------------
49,146 $ 25,350 $ 756 $ 1,782 $21,258
========== ========== ============ ==============
Allowance for loan losses (1,111)
Premises and equipment, net 5,580
Other 9,807
---------------
Total assets $63,422
===============
Interest-bearing liabilities:
Revolving warehouse lines $ 3,151 3,151
FDIC - insured deposits 39,041 32,508 3,860 2,673
FDIC - insured money market account 2,967 2,967
Other interest-bearing 7,494 920 711 2,680 3,183
liabilities
--------------- ---------- ---------- ------------ --------------
52,653 $ 39,546 $ 4,571 $ 5,353 $ 3,183
========== ========== ============ ==============
Non-interest-bearing liabilities 1,554
---------------
Total liabilities 54,207
Shareholders' equity 9,215
---------------
Total liabilities and equity $63,422
===============
Maturity/repricing gap $(14,196) $ (3,815) $ (3,571) $18,075
========== ========== ============ ==============
Cumulative gap $(14,196) $(18,011) $(21,582) $(3,507)
========== ========== ============ ==============
As percent of total assets (22.38)% (28.40)% (34.03)% (5.53)%
Ratio of cumulative interest earning 0.64 0.59 0.56 .93
Assets to cumulative interest earning
liabilities
=========================================================================================================================
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
150
Interest Rate Risk
The principal quantitative disclosure of our market risks is the above gap
table. The gap table shows that the one-year gap was a negative 22.38% of total
assets at September 30, 2000. We originate fixed-rate, fixed-term mortgage loans
for sale in the secondary market. While most of these loans are sold within a
month or two of origination, for purposes of the gap table the loans are shown
based on their contractual scheduled maturities. As of September 30, 2000, 58.2%
of the principal on the loans was expected to be received more than four years
from that date. However, our activities are financed with short-term loans and
credit lines, 75.1% of which reprice within one year of September 30, 2000. We
attempt to limit our interest rate risk by selling a majority of the fixed rate
loans that we originate. If our ability to sell such fixed-rate, fixed-term
mortgage loans on a timely basis were to be limited, we could be subject to
substantial interest rate risk.
Profitability may be directly affected by the level of, and fluctuations in
interest rates, which affect our ability to earn a spread between interest
received on our loans and the cost of borrowing. Our profitability is likely to
be adversely affected during any period of unexpected or rapid changes in
interest rates. For example, a substantial or sustained increase in interest
rates could adversely affect our ability to purchase and originate loans and
would reduce the value of loans held for sale. A significant decline in
interest rates could decrease the size of our loan servicing portfolio by
increasing the level of loan prepayments. Additionally, to the extent mortgage
loan servicing rights in future periods have been capitalized on our books,
higher than anticipated rates of loan prepayments or losses could require us to
write down the value of these assets, adversely affecting earnings.
In an environment of stable interest rates, our gains on the sale of
mortgage loans would generally be limited to those gains resulting from the
yield differential between mortgage loan interest rates and rates required by
secondary market purchasers. A loss from the sale of a loan may occur if
interest rates increase between the time we establish the interest rate on a
loan and the time the loan is sold. Fluctuating interest rates also may affect
the net interest income earned, resulting from the difference between the yield
to us on loans held pending sale and the interest paid for funds borrowed,
including our warehouse facilities, subordinated debt, and the Bank's FHLB
advances and FDIC-insured customer deposits. Because of the uncertainty of
future loan origination volume and the future level of interest rates, there can
be no assurance that we will realize gains on the sale of financial assets in
future periods.
The Bank is building a portfolio of loans to be held for net interest
income. The sale of fixed rate product is intended to protect the Bank from
precipitous changes in the general level of interest rates. The valuation of
adjustable rate mortgage loans is not as directly dependent on the level of
interest rates as is
151
the value of fixed rate loans. Decisions to hold or sell adjustable rate
mortgage loans are based on the need for such loans in the Bank's portfolio,
which is influenced by the level of market interest rates and the Bank's
asset/liability management strategy. As with other investments, the Bank
regularly monitors the appropriateness of the level of adjustable rate mortgage
loans in its portfolio and may decide from time to time to sell such loans and
reinvest the proceeds in other adjustable rate investments.
152
Asset Quality
The following table summarizes all of our delinquent loans at September 30, 2000
and December 31, 1999:
(in thousands)
[Download Table]
2000 1999
--------- ----------
Delinquent 31 to 60 days $ 960 $ 864
Delinquent 61 to 90 days 435 264
Delinquent 91 to 120 days 500 513
Delinquent 121 days or more 1,505 1,466
--------- ----------
Total delinquent loans (1) $ 3,400 $ 3,106
========= ==========
Total loans receivable outstanding, gross $37,050 $69,054
========= ==========
Delinquent loans as a percentage of
Total loans outstanding:
Delinquent 31 to 60 days 2.59% 1.25%
Delinquent 61 to 90 days 1.17 0.39
Delinquent 91 to 120 days 1.35 0.74
Delinquent 121 days or more 4.06 2.12
--------- ----------
Total delinquent loans as a percentage 9.17% 4.50%
of total loans outstanding
--------- ----------
Reserve as a % of delinquent loans 32.7% 44.5%
========= ==========
_____________
(1) Includes loans in foreclosure proceedings and delinquent loans to borrowers
in bankruptcy proceedings, but excludes real estate owned.
Interest on most loans is accrued until they become 31 days or more past
due. Interest on loans held for investment by the Bank is accrued until the
loans become 90 days or more past due. Non-accrual loans were $2.4 million and
$2.2 million at September 30, 2000 and December 31, 1999 respectively. The
amount of additional interest that would have been recorded had the loans not
been placed on non-accrual status was approximately $268,000 and $235,000 for
the nine months ended September 30, 2000 and the year ended December 31, 1999,
respectively. The amount of interest income on the non-accrual loans, that was
included in net income for the nine months ended September 30, 2000 and the
twelve months ended December 31, 1999 was $98,000 and $109,000, respectively.
Loans delinquent 31 days or more as a percentage of total loans outstanding
increased to 9.17% at September 30, 2000 from 4.50% at December 31, 1999. The
increase in the percentage of delinquent loans resulted primarily from a 46%
decrease in the size of the serviced loan portfolio and also from a management
conversion in the collections department.
At September 30, 2000 and December 31, 1999 the recorded investment in loans
for which impairment has been determined, which includes loans delinquent in
excess of 90 days, totaled $2.0 million and $2.0 million, respectively. The
average
153
recorded investment in impaired loans for the nine months ended September 30,
2000 and the year ended December 31, 1999 was approximately $1.4 million and
$3.5 million, respectively.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
None.
LEGAL MATTERS
Payne, Gates, Farthing and Radd P.C., a Virginia professional corporation,
Norfolk, Virginia, will deliver an opinion stating that the debt securities when
issued as contemplated by this prospectus will be binding obligations.
EXPERTS
The financial statements as of December 31, 1999 and 1998, and for each of
the three years in the period ended December 31,1999, included in this
prospectus have been so included in reliance on the report of
PriceWaterhouseCoopers, LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We filed a Registration Statement on Form S-1 (which, together with all
exhibits and schedules thereto, is referred to as the "registration statement")
with the SEC, with respect to the registration of the notes offered by this
prospectus, which contains additional information and documents. For further
information pertaining to our business, the debt securities offered by this
prospectus and related matters, you should review the registration statement,
including the exhibits filed as a part of the registration statement.
We file annual, quarterly and current reports, proxy statements and other
information with the SEC. So long as we are subject to the SEC's reporting
requirements, we will continue to furnish the reports and other required
information to the SEC. We will furnish all holders of the notes with copies of
our annual reports containing audited financial statements and an opinion
thereon expressed by our independent accountants and will make available copies
of quarterly reports for the first three quarters of each fiscal year containing
unaudited financial information.
You may read and copy any reports, statements and other information as
filed with the SEC by us at the SEC's public reference room at 450 Fifth Street,
N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further
information on the operations of the Public Reference Room. Our SEC filings are
also available on the SEC's Internet site (http://www.sec.gov).
154
Our common stock is traded on the Bulletin Board under the symbol "APFN."
All press releases and links to our SEC filings are available at
http://www.businesswire.com/cnn/apfn.shtml.
We will provide, at no cost, to each person to whom this prospectus is
delivered, upon written or oral request, copies of any of the information
incorporated by reference or included in the registration statement, which is
not included in this prospectus. Requests should be directed to:
Investor Relations Department
Approved Financial Corp.
1716 Corporate Landing Parkway
Virginia Beach, Virginia 23454
757-430-1400
155
APPROVED FINANCIAL CORP.
INDEX
[Download Table]
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets as of
September 30, 2000 and December 31, 1999 2
Consolidated Statements of Loss and Comprehensive
Loss for the three months ended September 30, 2000 3
and 1999.
Consolidated Statements of Loss and Comprehensive Loss for the
nine months ended September 30, 2000 and 1999. 4
Consolidated Statements of Cash Flows for
the nine months ended September 30, 2000
and 1999. 5
Notes to Consolidated Financial Statements 7
Consolidated Statements of Shareholders' Equity for the periods
ended September 30, 2000 and December 31, 1999 and 1998 12
F 1
APPROVED FINANCIAL CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, 2000 (Interim period) and December 31, 1999
(Dollars in thousands, except per share amounts)
ASSETS (Unaudited)
2000 1999
---------- --------
Cash $ 12,593 $10,656
Mortgage loans held for sale, net 29,150 62,765
Mortgage loans held for yield, net 6,292 4,006
Real estate owned, net 1,417 2,274
Investments available for sale 2,923 2,640
Income taxes receivable 2,027 5,644
Deferred tax asset 1,106 1,676
Premises and equipment, net 5,580 6,086
Goodwill, net 1,017 1,120
Other assets 1,317 1,733
---------- -------
Total assets $ 63,422 $98,600
========== =======
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 3,151 $17,465
FHLB bank advances - 4,648
Mortgage notes payable 2,556 2,341
Notes payable-related parties 2,855 2,993
Certificates of indebtedness 1,956 2,087
Certificates of deposits 39,041 55,339
FDIC - insured money market account 2,967 -
Accrued and other liabilities 1,681 2,428
---------- -------
Total liabilities 54,207 87,301
---------- -------
Commitments and contingencies - -
Shareholders' equity:
Preferred stock series A, $10 par value; 1 1
Noncumulative, voting:
Authorized shares - 100
Issued and outstanding shares - 90
Common stock, par value - $1.00 5,482 5,482
Authorized shares - 40,000,000
Issued and outstanding shares - 5,482,114
Accumulated other comprehensive loss (19) (16)
Additional capital 552 552
Retained earnings 3,199 5,280
---------- -------
Total shareholders' equity 9,215 11,299
---------- -------
Total liabilities and equity $ 63,422 $98,600
========== =======
The accompanying notes are an integral part of the condensed consolidated
financial statements.
F 2
APPROVED FINANCIAL CORP.
CONDENSED CONSOLIDATED INTERIM STATEMENTS OF LOSS AND COMPREHENSIVE LOSS
for the three months ended September 30, 2000 and 1999
(In thousands, except per share amounts)
(Unaudited)
2000 1999
-------- --------
Revenue:
Gain on sale of loans $ 2,280 $ 2,920
Interest income 1,154 1,695
Other fees and income 1,164 1,971
-------- --------
4,598 6,586
-------- --------
Expenses:
Compensation and related 2,763 4,189
General and administrative 1,379 2,290
Advertising expense 331 585
Loan production expense 267 460
Interest expense 880 1,039
Provision for loan and foreclosed property losses 396 327
-------- --------
6,016 8,890
-------- --------
Loss before income taxes (1,418) (2,304)
Benefit from income taxes (176) (901)
-------- --------
Net loss (1,242) (1,403)
Other comprehensive loss, net of tax:
Unrealized gain (losses) on securities:
Unrealized holding gain (loss) arising during period 3 (12)
-------- --------
Comprehensive loss $ (1,239) $ (1,415)
======== ========
Net loss per share:
Basic and Diluted $ (0.23) $ (0.26)
======== ========
Weighted average number of shares outstanding:
Basic and Diluted 5,482 5,482
======== ========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
F 3
APPROVED FINANCIAL CORP.
CONDENSED CONSOLIDATED INTERIM STATEMENTS OF LOSS AND COMPREHENSIVE LOSS
for the nine months ended September 30, 2000 and 1999
(In thousands, except per share amounts)
(Unaudited)
[Download Table]
2000 1999
------------ ------------
Revenue:
Gain on sale of loans $ 8,708 $ 10,443
Interest income 4,054 6,333
Other fees and income 3,564 6,370
------------ ------------
16,326 23,146
------------ ------------
Expenses:
Compensation and related 8,985 13,579
General and administrative 4,706 7,295
Advertising expense 985 1,286
Loan production expense 907 1,491
Interest expense 2,961 3,934
Provision for loan and foreclosed property losses 543 1,816
------------ ------------
19,087 29,401
------------ ------------
Loss before income taxes (2,761) (6,255)
Benefit from income taxes (681) (2,307)
------------ ------------
Net loss (2,080) (3,948)
Other comprehensive loss, net of tax:
Unrealized losses on securities:
Unrealized holding loss arising during period (2) (68)
------------ ------------
Comprehensive loss $ (2,082) $ (4,016)
============ ============
Net loss per share:
Basic and Diluted $ (0.38) $ (0.72)
============ ============
Weighted average number of shares outstanding:
Basic and Diluted 5,482 5,482
============ ============
The accompanying notes are an integral part of the condensed consolidated
financial statements.
F 4
APPROVED FINANCIAL CORP.
CONDENSED CONSOLIDATED INTERIM STATEMENTS OF CASH FLOWS
for the nine months ended September 30, 2000 and 1999
(In thousands)
(Unaudited)
[Enlarge/Download Table]
2000 1999
------------ ------------
Operating activities
Net loss $ (2,081) $ (3,948)
Adjustments to reconcile net loss
to net cash provided by operating activities:
Depreciation of premises and equipment 510 685
Amortization of goodwill 103 345
Provision for loan losses 126 1,227
Provision for losses on real estate owned 417 589
Loss on sale of ARM Portfolio shares - 8
Deferred tax benefit 569 2,225
Gain on sale of loans (8,708) (10,443)
Proceeds from sale and prepayments of loans 214,226 226,796
Originations of loans held for sale, net of allowance (175,664) (156,443)
for loan losses
Changes in assets and liabilities:
Loan sale receivable 3 (279)
Other assets 412 2,205
Accrued and other liabilities (847) (1,056)
Income tax payable 3,617 (2,314)
Loan proceeds payable 99 (2,565)
------------ ------------
Net cash provided by operating activities 32,782 57,032
Cash flows from investing activities:
Purchase of available for sale securities - (125)
Sales of available for sale securities 115 -
Sales of ARM fund shares - 4,692
Purchase of premises and equipment (185) (1,210)
Proceeds from sales of premises and equipment 181 1,410
Proceeds from sales of real estate owned 2,176 1,850
Real estate owned capital improvements (387) (408)
Purchases of ARM fund shares (101) (3,594)
Purchases of FHLB stock (297) (146)
------------ ------------
Net cash provided by investing activities 1,502 2,469
F 5
APPROVED FINANCIAL CORP.
CONDENSED CONSOLIDATED INTERIM STATEMENTS OF CASH FLOWS,
continued
for the nine months ended September 30, 2000 and 1999
(In thousands)
(Unaudited)
[Enlarge/Download Table]
2000 1999
--------- ----------
Cash flows from financing activities:
Borrowings - warehouse $ 41,268 $ 134,511
Repayments of borrowings - warehouse (55,581) (193,171)
Repayments of FHLB advances (4,648) -
Principal payments (borrowings) on mortgage notes payable 215 (879)
Net increase (decrease) in:
Notes payable (138) (72)
Certificates of indebtedness (132) (89)
Certificates of deposit (16,298) 598
FDIC - insured money market account 2,967 -
--------- ----------
Net cash used in financing activities (32,347) (59,102)
--------- ----------
Net increase in cash 1,937 399
Cash at beginning of period 10,656 6,269
--------- ----------
Cash at end of period $ 12,593 $ 6,668
========= ==========
Supplemental cash flow information:
Cash paid for interest $ 3,043 $ 4,190
Supplemental non-cash information:
Loan balances transferred to real estate owned $ 1,735 $ 2,978
The accompanying notes are an integral part of the condensed consolidated
financial statements.
F 6
APPROVED FINANCIAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
for the nine months ended September 30, 2000 and 1999
Note 1. Organization and Summary of Significant Accounting Policies:
Organization: Approved Financial Corp., a Virginia corporation ("Approved"),
and its subsidiaries (collectively, the "Company") operate primarily in the
consumer finance business of originating, servicing and selling mortgage loans
secured primarily by first and second liens on one-to-four family residential
properties. The Company sources mortgage loans through two origination channels;
a network of mortgage brokers who refer mortgage customers to us ("broker" or
"wholesale") and an internal sales staff that originate mortgages directly with
borrowers ("retail" and "direct"). Approved has two wholly owned subsidiaries
through which it originates residential mortgages: Approved Federal Savings Bank
(the "Bank"), a federally chartered thrift institution with broker operations in
seven states and nine retail offices as of September 30, 2000; and Approved
Residential Mortgage, Inc. ("ARMI") with one retail location at September 30,
2000. Approved has a third wholly owned subsidiary, Approved Financial Solutions
("AFS"), through which it offers other financial products such as Debt Free
Solutions, Mortgage Acceleration Program and insurance products to its mortgage
customers. On April 1, 2000 the Company, as part of its expense reduction
initiatives, transferred all assets of MOFC d/b/a ConsumerOne Financial
("ConsumerOne"), a wholly owned subsidiary of Approved, to Approved Federal
Savings Bank, also a wholly owned subsidiary of Approved.
Basis of Presentation:
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and nine month periods ended
September 30, 2000 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2000. For further information, refer
to the consolidated financial statements and footnotes thereto included in the
Company's annual report on Form 10-K for the year ended December 31, 1999.
Principles of accounting and consolidation: The consolidated financial
statements of the Company include the accounts of Approved and its wholly-owned
subsidiaries. All significant inter-company accounts and transactions have been
eliminated.
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.
F 7
APPROVED FINANCIAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
for the nine months ended September 30, 2000 and 1999
Note 1. Organization and Summary of Significant Accounting Policies,
continued:
Cash and cash equivalents: Cash and cash equivalents consist of cash on deposit
at financial institutions and short-term investments that are considered cash
equivalents if they were purchased with an original maturity of three months or
less.
Loans held for sale: Loans, which are all held for sale, are carried at the
lower of aggregate cost or fair value as estimated by management. The fair value
is determined by current investor yield requirements
Loans held for yield: Loans are stated at the amount of unpaid principal less
net deferred fees and an allowance for loan losses. Interest on loans is accrued
and credited to income based upon the principal amount outstanding. Fees
collected and costs incurred in connection with loan originations are deferred
and recognized over the term of the loan.
Allowance for loan losses: The allowance for loan losses is maintained at a
level believed adequate by management to absorb probable losses in the held for
yield loan portfolio. Management's determination of the adequacy of the
allowance is based on an evaluation of the current loan portfolio
characteristics including criteria such as delinquency, default and foreclosure
rates and trends, age of the loans, credit grade of borrowers, loan to value
ratios, current economic and secondary market conditions, current and
anticipated levels of loan volume, and other relevant factors. The allowance is
increased by provisions for loan losses charged against income. Loan losses are
charged against the allowance when management believes it is unlikely that the
loan is collectable.
The allowance for loan losses on loans held for sale is based upon the fair
market value of blocks of loans that are grouped by certain similar
characteristics based upon loan to value ratios, holding period of the loan,
etc. The allowance is increased by provisions for loan losses charged against
income.
Origination fees: Net origination fees are recognized over the life of the loan
or upon the sale of the loan, if earlier.
Real estate owned: Real estate owned is valued at the lower of cost or fair
market value, net of estimated disposal costs. Cost includes loan principal and
certain capitalized expenses. Any excess of cost over the estimated fair market
value at the time of acquisition is charged to the allowance for loan losses.
The estimated fair market value is reviewed periodically by management and any
write-downs are charged against current earnings using a valuation account,
which has been netted against real estate owned in the financial statements.
Income from temporary rental of the properties is credited against the
investment when collected. Capital improvements are capitalized to the extent of
net realizable value. Additional carrying costs, including taxes, utilities and
insurance, are also capitalized to the property, to the extent of net realizable
value.
F 8
APPROVED FINANCIAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
for the nine months ended September 30, 2000 and 1999
Note 1. Organization and Summary of Significant Accounting Policies,
continued:
Premises and equipment: Premises, leasehold improvements and equipment are
stated at cost less accumulated depreciation and amortization. The buildings are
depreciated using the straight line method over thirty years. Leasehold
improvements are amortized over the lesser of the terms of the lease or the
estimated useful lives of the improvements. Depreciation of equipment is
computed using the straight line method over the estimated useful lives of three
to five years. Expenditures for betterments and major renewals are capitalized
and ordinary maintenance and repairs are charged to operations as incurred.
Investments: The Company's investment in the stock of the Federal Home Loan Bank
("FHLB") of Atlanta is stated at cost.
All other investment securities, except the FHLB stock, are classified as
available-for-sale and reported at fair value, with unrealized gains and losses
excluded from earnings and reported as other comprehensive income in
shareholders' equity. Realized gains and losses on sales of securities are
computed using the specific identification method.
Loan originations and income recognition: The Company applies a financial-
components approach that focuses on control when accounting and reporting for
transfers and servicing of financial assets and extinguishments of liabilities.
Under that approach, after a transfer of financial assets, an entity recognizes
the financial and servicing assets it controls and the liabilities it has
incurred, derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. This approach provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings. Gains on the sale of mortgage loans,
representing the difference between the sales price and the net carrying value
of the loans, are recognized when mortgage loans are sold and delivered to
investors.
Interest on loans is credited to income based upon the principal amount
outstanding. Interest is accrued on loans until they become 31 days or more past
due.
Advertising costs: Advertising costs are expensed when incurred.
Income taxes: Taxes are provided on substantially all income and expense items
included in earnings, regardless of the period in which such items are
recognized for tax purposes. The Company uses an asset and liability approach
that requires the recognition of deferred tax assets and liabilities for the
estimated future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events other
than enactments of changes in the tax laws or rates. The Company established a
$0.4 million valuation allowance for future
F 9
APPROVED FINANCIAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
for the nine months ended September 30, 2000 and 1999
Note 1. Organization and Summary of Significant Accounting Policies,
continued:
unrealizable benefits for the deferred tax asset. The valuation allowance is
based upon an assessment by management of future taxable income and its
relationship to realizability of deferred tax assets.
Earnings per share: The Company computes "basic earnings per share" by dividing
income available to common shareholders by the weighted-average number of common
shares outstanding for the period. "Diluted earnings per share" reflects the
effect of all potential dilution of common shares from stock options and
warrants and convertible securities.
Comprehensive income: The Company classifies items of other comprehensive income
(loss) by their nature in a financial statement and displays the accumulated
balance of other comprehensive income (loss) separately from retained earnings
and additional capital in the equity section of the consolidated balance sheets.
The only item the Company has in Comprehensive Income (Loss) for the three and
nine month periods ended September 30, 2000 and 1999, is an unrealized holding
loss on securities, net of deferred taxes.
Goodwill recognition policy: Goodwill represents the excess of purchase price
and related costs over the value assigned to the net tangible assets of
businesses acquired. Goodwill is amortized on a straight-line basis over 10
years. Periodically, the company reviews the recoverability of goodwill. The
measurement of possible impairment is based primarily on the ability to recover
the balance of the goodwill from expected future operating cash flows on an
undiscounted basis. In management's opinion, no material impairment exists at
September 30, 2000.
Segments: A public business enterprise is required to report financial and
descriptive information about its reportable operating segments. Operating
segments are components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision-maker in deciding how to allocate and in assessing performance.
Generally, financial information is required to be reported on the basis that it
is used internally for evaluating segment performance and deciding how to
allocate resources to segments. The Company has evaluated this requirement and
determined it operates in one segment.
New accounting pronouncements:
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" as
amended by SFAS 137, is effective for fiscal year ends beginning after June 15,
2000. This statement establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. It requires that entities recognize all derivatives as either
assets or liabilities in the financial statements and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designed as (a) a hedge of the exposure to
F 10
APPROVED FINANCIAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
for the nine months ended September 30, 2000 and 1999
Note 1. New accounting pronouncements, continued:
changes in the fair value of a recognized asset or liability or an unrecognized
firm commitment, (b) a hedge of the exposure to variable cash flows of a
forecasted transaction, or (c) a hedge of the foreign currency exposure of a net
investment in a foreign operation, an unrecognized firm commitment, an
available-for-sale security, or a foreign-currency-denominated forecasted
transaction. This statement should not have any material impact on the financial
statements.
Securities and Exchange Commission Staff Accounting Bulletin 101 (SAB 101),
"Revenue Recognition in Financial Statements", as amended by SAB 101B, must be
adopted no later than the fourth calendar quarter of the year 2000. Adoption of
SAB101 is not expected to have any material impact on the recognition,
presentation, and disclosure of revenue.
In March 2000, the Financial Accounting Standards Board, (FASB) issued
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation - an interpretation of APB Opinion No. 25 (FIN 44), providing new
accounting rules for stock-based compensation under APB Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25). FIN 44 does not change FASB
Statement No. 123, Accounting for Stock-Based Compensation (FAS 123). The new
rules are significant and could result in compensation expense in several
situations in which no expense is typically recorded under current practice. FIN
44 is generally effective for transactions occurring after July 1, 2000,
however, the accounting must be applied prospectively to certain transactions
consummated after December 15, 1998. The Company is not aware of any
transactions that will cause FIN 44 to have a material effect on its financial
condition or results of operations.
In September 2000, the FASB issued SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, a replacement
of SFAS No. 125. It revises the standards for accounting for securitizations and
other transfers of financial assets and collateral and requires certain
disclosures, but it carries over most of provisions of SFAS No. 125 without
reconsideration. The Statement requires a debtor to reclassify financial assets
pledged as collateral and report these assets separately in the statement of
financial position. It also requires a secured party to disclose information,
including fair value, about collateral that it has accepted and is permitted by
contract or custom to sell or repledge. The Statement includes specific
disclosure requirements for entities with securitized financial assets and
entities that securitize assets. This Statement is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2000 and is effective for recognition and reclassification of
collateral and for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2000. The Company does not
expect that FAS 140 will have a material effect on financial condition or
results of operation.
F 11
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
for the periods ended September 30, 2000, December 31, 1999 and 1998
(Dollars in thousands)
[Enlarge/Download Table]
Preferred Stock
Series A Common Stock Accumulated Other
------------------- --------------------- Additional Comprehensive Retained
Shares Amount Shares Amount Capital Income (Loss) Earnings Total
--------- --------- ---------- ---------- ------------ ------------------- ---------- -----------
Balance at December 31, 1997 90 $ 1 5,395,408 $ 5,395 $ 0 $ 6,854 $ 12,805 $ 25,055
Net income 479 479
Issuance of common stock 116,706 117 552 669
Repurchase of common stock (30,000) (30) (82) (112)
Unrealized loss on
investments available
for sale, net of tax (6,824) (6,824)
--------- --------- ---------- ---------- ------------ ------------------- ---------- -----------
Balance at December 31, 1998 90 $ 1 5,482,114 $ 5,482 $ 552 $ 30 $ 13,202 $ 19,267
Net loss (7,922) (7,922)
Issuance of common stock
Unrealized loss on
investments available for
sale, net of tax (46) (46)
--------- --------- ---------- ---------- ------------ ------------------- ---------- -----------
Balance at December 31, 1999 90 $ 1 5,482,114 $ 5,482 $ 552 $ (16) $ 5,280 $ 11,299
Net loss
Issuance of common stock (2,081) (2,081)
Unrealized loss on (3) (3)
investments available for
sale, net of tax
--------- --------- ---------- ---------- ------------ ------------------- ---------- -----------
Balance at September 30, 2000 90 $ 1 5,482,114 $ 5,482 $ 552 $ (19) $ 3,199 $ 9,215
========= ========= ========== ========== ============ =================== ========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
F 12
APPROVED FINANCIAL CORP.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 1999, 1998 AND 1997
APPROVED FINANCIAL CORP.
[Download Table]
Contents Pages
-----
Report of Independent Accountants................................... F-13
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1999 and 1998........ F-15
Consolidated Statements of Income (Loss) and Comprehensive
Income (Loss) for the years ended December 31, 1999, 1998 and 1997.. F-16
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1999, 1998 and 1997.............................. F-17
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997.................................... F-18
Notes to Consolidated Financial Statements.......................... F-20
F 13
Report of Independent Accountants
To the Board of Directors of
Approved Financial Corp.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income (loss) and comprehensive income (loss), of
shareholders' equity and of cash flows present fairly, in all material respects,
the consolidated financial position of Approved Financial Corp. and Subsidiaries
(the "Company") at December 31, 1999 and 1998, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of the
statements in accordance with auditing standards generally accepted in the
United States, which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
Virginia Beach, Virginia
March 2, 2000
F 14
APPROVED FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
December 31, 1999 and 1998
(Dollars in thousands, except per share amounts)
ASSETS 1999 1998
---------- -----------
Cash $ 10,656 $ 6,269
Mortgage loans held for sale, net 62,765 100,820
Mortgage loans held for yield, net 4,006 4,224
Real estate owned, net 2,274 1,707
Investments 2,640 3,472
Income taxes receivable 5,644 2,023
Deferred tax asset 1,676 3,330
Premises and equipment, net 6,086 5,579
Goodwill, net 1,120 4,554
Other assets 1,733 4,140
---------- -----------
Total assets $ 98,600 $ 136,118
========== ===========
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 17,465 $ 72,546
FHLB bank advances 4,648 -
Mortgage notes payable 2,341 1,210
Notes payable-related parties 2,993 3,628
Certificate of indebtedness 2,087 2,414
Certificates of deposits 55,339 29,728
Accrued and other liabilities 2,428 7,325
---------- -----------
Total liabilities 87,301 116,851
---------- -----------
Commitments and contingencies - -
Shareholders' equity:
Preferred stock series A, $10 par value; 1 1
Noncumulative, voting:
Authorized shares - 100
Issued and outstanding shares - 90
Common stock, par value - $1.00 5,482 5,482
Authorized shares - 40,000,000
Issued and outstanding shares - 5,482,114
Accumulated other comprehensive income (loss) (16) 30
Additional capital 552 552
Retained earnings 5,280 13,202
---------- -----------
Total equity 11,299 19,267
---------- -----------
Total liabilities and equity $ 98,600 $ 136,118
========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
F 15
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
for the years ended December 31, 1999, 1998 and 1997
(In thousands, except per share amounts)
[Enlarge/Download Table]
1999 1998 1997
Revenue:
Gain on sale of loans $ 13,202 $ 29,703 $ 33,501
Interest income 7,698 10,308 10,935
Gain on sale of securities 0 1,750 2,796
Other fees and income 7,834 7,042 4,934
------------ ------------- -------------
28,734 48,803 52,166
------------ ------------- -------------
Expenses:
Compensation and related 17,765 23,397 18,535
General and administrative 12,497 11,713 10,205
Write down of goodwill 1,131 0 0
Loss on sale/disposal of fixed assets 796 0 0
Loss on write off of securities 73 0 0
Loan production expense 1,930 3,593 1,895
Interest expense 4,957 6,252 6,157
Provision for loan and foreclosed property 2,256 2,896 1,676
losses
------------ ------------- -------------
41,405 47,851 38,468
------------ ------------- -------------
Income (loss) before income taxes (12,671) 952 13,698
Provision for (benefit from) income taxes (4,749) 473 5,638
------------ ------------- -------------
Net income (loss) (7,922) 479 8,060
Other comprehensive income, net of tax:
Unrealized losses on securities:
Unrealized holding loss arising during period (46) (6,824) (4,547)
------------ ------------- -------------
Comprehensive income (loss) $ (7,968) $ (6,345) $ 3,513
============ ============= =============
Net income (loss) per share:
Basic $ (1.45) $ 0.09 $ 1.52
============ ============= =============
Diluted $ (1.45) $ 0.09 $ 1.51
============ ============= =============
The accompanying notes are an integral part of the consolidated financial
statements.
F 16
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
for the years ended December 31, 1999, 1998 and 1997
(Dollars in thousands)
[Enlarge/Download Table]
Preferred Stock Accumulated
Series A Common Stock Other
------------------- ------------------ Additional Comprehensive Retained
Shares Amount Shares Amount Capital Income (Loss) Earnings Total
-------- -------- -------- -------- ---------- ------------- -------- --------
Balance at December 31, 1996 90 $1 2,519,368 $ 630 $ 1,485 $11,401 $ 7,692 $21,209
Net income 8,060 8,060
Exercise of warrants 176,836 44 288 332
Change par value of 2,022 (1,773) (249) 0
stock
Issuance of common stock 1,500 1 1
Stock dividend 2,697,704 2,698 (2,698) 0
Unrealized loss on investments
available for sale, net of tax (4,547) (4,547)
-------- -------- --------- -------- ---------- ------------- -------- --------
Balance at December 31, 1997 90 $1 5,395,408 $5,395 $ 0 $ 6,854 $12,805 $25,055
Net income 479 479
Issuance of common stock 116,706 117 552 669
Repurchase common stock (30,000) (30) (82) (112)
Unrealized loss on investments
available for sale, net of tax (6,824) (6,824)
-------- -------- --------- -------- ---------- ------------- -------- --------
Balance at December 31, 1998 90 $1 5,482,114 $5,482 $ 552 $ 30 $13,202 $19,267
Net loss (7,922) (7,922)
Unrealized loss on investments
available for sale, net of tax (46) (46)
-------- -------- --------- -------- ---------- ------------- -------- --------
Balance at December 31, 1999 90 $1 5,482,114 $5,482 $ 552 $ (16) $ 5,280 $11,299
======== ======== ========= ======== ========== ============ ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F 17
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1999, 1998 and 1997
(In thousands)
[Enlarge/Download Table]
1999 1998 1997
------------ ---------- ----------
Operating activities
Net income (loss) $ (7,922) $ 479 $ 8,060
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation of premises and equipment 1,105 750 609
Amortization of goodwill 455 395 -
Provision for loan losses 2,042 3,064 1,534
Provision for losses on real estate owned 214 (168) 142
Deferred tax expense 1,706 112 (1,325)
(Gain) loss on sale of securities 81 (1,750) (2,796)
Loss on sale of real estate owned 648 660 654
Gain on sale of loans (13,202) (29,703) (32,696)
Loss on write down of goodwill 1,131 - -
Proceeds from sale and prepayments of loans 286,089 434,682 479,317
Change in deferred hedging loss - 91 -
Originations of loans held for sale, net (240,017) (429,555) (490,397)
Changes in assets and liabilities:
Loan sale receivable 25 (28) -
Other assets 2,384 (2,931) (882)
Accrued and other liabilities (450) (709) 6,773
Income tax payable (3,621) (3,184) 177
Loan proceeds payable (2,565) (3,799) -
----------- --------- ---------
Net cash provided by (used in) operating activities 28,103 (31,594) (30,830)
Cash flows from investing activities:
Purchase of securities (125) - (4,304)
Sales of securities - 1,844 4,458
Sales of ARM fund shares 4,619 4,957 -
Purchase of premises and equipment (1,706) (1,036) (2,313)
Sales of premises and equipment 1,322 29 199
Loss on sale/disposal of fixed assets 796 - -
Sales of real estate owned 2,587 4,440 3,735
Real estate owned capital improvements (648) (343) -
Purchases of ARM fund shares (3,623) (4,563) -
Purchases of FHLB stock (261) (96) -
Net cash paid for acquisitions - (1,395) (382)
----------- --------- ---------
Net cash provided by investing activities 2,961 3,837 1,393
F 18
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
for the years ended December 31, 1999, 1998 and 1997
(In thousands)
[Enlarge/Download Table]
1999 1998 1997
------------ ----------- -----------
Cash flows from financing activities:
Borrowings - warehouse $ 169,576 $ 380,182 $ 471,717
Repayments of borrowings - warehouse (224,657) (365,705) (451,259)
Proceeds from (repayments of) FHLB advances 4,648 (1,000) 1,000
Principal payments on mortgage notes payable (894) (83) (62)
Net increase (decrease) in:
Notes payable (635) (3,056) (155)
Certificates of indebtedness (326) 18 53
Certificates of deposit 25,611 11,914 16,238
Exercise of common stock warrants - - 332
Redemption of common stock - (113) -
Common stock shares issued - - 2
----------- --------- ---------
Net cash (used in) provided by financing activities (26,677) 22,157 37,866
----------- --------- ---------
Net increase (decrease) in cash 4,387 (5,600) 8,429
Cash at beginning of year 6,269 11,869 3,440
----------- --------- ---------
Cash at end of year $ 10,656 $ 6,269 $ 11,869
=========== ========= =========
Supplemental cash flow information:
Cash paid for interest $ 5,233 $ 6,231 $ 5,991
Cash paid for income taxes - 3,546 5,461
Supplemental non-cash information:
Loan balances transferred to real estate owned $ 4,019 $ 3,930 $ 4,641
Exchange of stock for acquisition of Armada
Residential Mortgage LLC - 669 -
Accrued expenses incurred in exchange for
goodwill in Connection with the ConsumerOne
acquisition - 1,575 -
Purchase of building in exchange for note $ 2,025 - $ 800
payable
The accompanying notes are an integral part of the consolidated financial
statements.
F 19
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 1. Organization and Summary of Significant Accounting Policies:
Organization: Approved Financial Corp., a Virginia corporation ("Approved"), and
its subsidiaries (collectively, the "Company") operate primarily in the consumer
finance business of originating, servicing and selling mortgage loans secured
primarily by first and second liens on one-to-four family residential
properties. The Company sources mortgage loans through two origination channels;
a network of mortgage brokers who refer mortgage customers to the Company
("broker" or "wholesale") and an internal sales staff that originate mortgages
directly with borrowers ("retail" and "direct"). Approved has three wholly owned
subsidiaries through which it originates residential mortgages: Approved Federal
Savings Bank (the "Bank") is a federally chartered thrift institution with
broker operations in seven states and nine retail offices as of December 31,
1999; Approved Residential Mortgage, Inc. ("ARMI") with one retail location at
December 31, 1999; and MOFC d/b/a ConsumerOne Financial ("ConsumerOne") with one
retail office in Michigan at December 31, 1999. Approved has a fourth wholly
owned subsidiary, Approved Financial Solutions ("AFS"), through which it offers
insurance products to its mortgage customers.
The Bank had a wholly owned subsidiary, Global Title Company ("Global Title"),
which was licensed as a title insurance agency. Global Title did not produce
material revenues during the twelve month period ended December 31, 1999. During
the fourth quarter of 1999, ownership of Global Title was transferred to AFS
from the bank in order to consolidate the Company's insurance operations.
Principles of accounting and consolidation: The consolidated financial
statements of the Company include the accounts of Approved and its wholly-owned
subsidiaries. All significant inter-company accounts and transactions have been
eliminated.
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.
F 20
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 1. Organization and Summary of Significant Accounting Policies, continued:
Cash and cash equivalents: Cash and cash equivalents consist of cash on deposit
at financial institutions and short-term investments that are considered cash
equivalents if they were purchased with an original maturity of three months or
less.
Loans held for sale: Loans, which are all held for sale, are carried at the
lower of aggregate cost or market value. Market value is determined by current
investor yield requirements.
Loans held for yield: Loans are stated at the amount of unpaid principal less
net deferred fees and an allowance for loan losses. Interest on loans is
accrued and credited to income based upon the principal amount outstanding.
Fees collected and costs incurred in connection with loan originations are
deferred and recognized over the term of the loan.
Allowance for loan losses: The allowance for loan losses is maintained at a
level believed adequate by management to absorb probable losses in the held for
yield loan portfolio. Management's determination of the adequacy of the
allowance is based on an evaluation of the current loan portfolio
characteristics including criteria such as delinquency, default and foreclosure
rates and trends, age of the loans, credit grade of borrowers, loan to value
ratios, current economic and secondary market conditions, current and
anticipated levels of loan volume, and other relevant factors. The allowance is
increased by provisions for loan losses charged against income. Loan losses are
charged against the allowance when management believes it is unlikely that the
loan is collectable.
The allowance for loan losses on loans held for sales is based upon the fair
market value of blocks of loans that are grouped by certain similar
characteristics based upon loans to value ratios, holding period of the loan,
etc. The allowance is increased by provisions for loan losses charged against
income.
F 21
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 1. Organization and Summary of Significant Accounting Policies, continued:
Origination fees: The Company accounts for origination fees on mortgage loans
held for sale in conformity with Statement of Financial Accounting Standards
("SFAS") No. 91, "Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases." The statement requires
that net origination fees be recognized over the life of the loan or upon the
sale of the loan, if earlier.
Hedging: To offset the effects of interest rate fluctuations on the value of
its fixed rate mortgage loans held for sale, the Company in certain cases will
enter into Treasury security lock contracts, which function similarly to short
sales of U.S. Treasury securities. Gains or losses from these contracts are
deferred and recognized as an adjustment to gains on sale of loans when the
loans are sold or when the related hedge position is closed.
Real estate owned: Real estate owned is valued at the lower of cost or fair
market value, net of estimated disposal costs. Cost includes loan principal and
certain capitalized expenses. Any excess of cost over the estimated fair market
value at the time of acquisition is charged to the allowance for loan losses.
The estimated fair market value is reviewed periodically by management and any
write-downs are charged against current earnings using a valuation account,
which has been netted against real estate owned in the financial statements.
Income from temporary rental of the properties is credited against the
investment when collected. Capital improvements are capitalized to the extent of
net realizable value. Additional carrying costs, including taxes, utilities and
insurance, are also capitalized to the property, to the extent of net realizable
value.
Premises and equipment: Premises, leasehold improvements and equipment are
stated at cost less accumulated depreciation and amortization. The buildings
are depreciated using the straight line method over thirty years. Leasehold
improvements are amortized over the lesser of the terms of the lease or the
estimated useful lives of the improvements. Depreciation of equipment is
computed using the straight line method over the estimated useful lives of three
to five years. Expenditures for betterments and major renewals are capitalized
and ordinary maintenance and repairs are charged to operations as incurred.
F 22
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 1. Organization and Summary of Significant Accounting Policies, continued:
Goodwill recognition policy: Goodwill represents the excess of purchase price
and related costs over the value assigned to the net tangible assets of
businesses acquired. Goodwill is amortized on a straight-line basis over 10
years. Periodically, the company reviews the recoverability of goodwill. The
measurement of possible impairment is based primarily on the ability to recover
the balance of the goodwill from expected future operating cash flows on an
undiscounted basis. In management's opinion, no material impairment exists at
December 31, 2000.
Investments: The Company's investment in the stock of the Federal Home Loan Bank
("FHLB") of Atlanta is stated at cost.
All other investment securities, except the FHLB stock, are classified as
available-for-sale and reported at fair value, with unrealized gains and losses
excluded from earnings and reported as other comprehensive income in
shareholders' equity.
Realized gains and losses on sales of securities are computed using the specific
identification method.
Loan originations and income recognition: The Company applies a financial-
components approach that focuses on control when accounting and reporting for
transfers and servicing of financial assets and extinguishments of liabilities.
Under that approach, after a transfer of financial assets, an entity recognizes
the financial and servicing assets it controls and the liabilities it has
incurred, derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. This approach provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings. Gains on the sale of mortgage loans,
representing the difference between the sales price and the net carrying value
of the loans, are recognized when mortgage loans are sold and delivered to
investors.
Interest on loans is credited to income based upon the principal amount
outstanding. Interest is accrued on loans until they become 31 days or more past
due.
Advertising costs: Advertising costs are expensed when incurred.
F 23
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 1. Organization and Summary of Significant Accounting Policies, continued:
Income taxes: Taxes are provided on substantially all income and expense items
included in earnings, regardless of the period in which such items are
recognized for tax purposes. The Company uses an asset and liability approach
that requires the recognition of deferred tax assets and liabilities for the
estimated future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events other
than enactments of changes in the tax laws or rates.
Earnings per share: The Company computes "basic earnings per share" by dividing
income available to common shareholders by the weighted-average number of common
shares outstanding for the period. "Diluted earnings per share" reflects the
effect of all potentially dilutive potential common shares such as stock options
and warrants and convertible securities.
The Company declared a 100% stock dividend effective November 21, 1997. The
share and per share figures in this report have been adjusted to reflect this
stock dividend.
Comprehensive Income: The Company classifies items of other comprehensive income
(loss) by their nature in a financial statement and displays the accumulated
balance of other comprehensive income (loss) separately from retained earnings
and additional capital in the equity section of the consolidated balance sheets.
The only item the Company has in Comprehensive Income (Loss) for the three years
ended December 31, 1999, is an unrealized holding loss on securities, net of
deferred taxes.
Segments: A public business enterprise is required to report financial and
descriptive information about its reportable operating segments. Operating
segments are components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision-maker in deciding how to allocate and in assessing performance.
Generally, financial information is required to be reported on the basis that it
is used internally for evaluating segment performance and deciding how to
allocate resources to segments. The Company has evaluated this requirement and
determined it operates in one segment.
F 24
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 1. Organization and Summary of Significant Accounting Policies, continued:
New accounting pronouncements:
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" as
amended by SFAS 137, is effective for fiscal year ends beginning after June 15,
2000. This statement establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. It requires that entities recognize all derivatives as either assets
or liabilities in the financial statements and measure those instruments at fair
value. If certain conditions are met, a derivative may be specifically designed
as (a) a hedge of the exposure to changes in the fair value of a recognized
asset or liability or an unrecognized firm commitment, (b) a hedge of the
exposure to variable cash flows of a forecasted transaction, or (c) a hedge of
the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a foreign-
currency-denominated forecasted transaction. This statement should not have any
material impact on the financial statements.
In October 1998, SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise," was issued, effective for the first fiscal quarter
beginning after December 15, 1998. The new statement requires that after an
entity that is engaged in mortgage banking activities has securitized mortgage
loans that are held for sale, it must classify the resulting retained mortgage-
backed securities or other retained interests based on its ability and intent to
sell or hold those investments. Any retained mortgage-backed securities that are
committed for sale before or during the securitization process must be
classified as trading. This statement does not have any impact on the Company's
financial statements since the Company has never securitized loans.
F 25
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 2. Investments:
The cost basis and fair value of the Company's investments at December 31, 1999
and 1998, are as follows (in thousands):
[Enlarge/Download Table]
1999 1998
--------------------- ----------------------
Cost Fair Cost Fair Value
Basis Value Basis
---------- --------- --------- -----------
Asset Management Fund, Inc. ARM Portfolio $ 2,134 $ 2,108 $ 3,219 $ 3,203
FHLB stock 407 407 146 146
IMC Mortgage Company common stock - - 73 123
Other investments 125 125 - -
---------- --------- --------- -----------
$ 2,666 $ 2,640 $ 3,438 $ 3,472
========== ========= ========= ===========
The Company's investment in IMC Mortgage Company ("IMC") common stock had gross
unrealized gains of $0 and $50,000 at December 31, 1999 and 1998, respectively.
The Company's investment in the adjustable rate mortgage mutual fund had
unrealized losses of $26,000 and $16,000 at December 31, 1999 and 1998,
respectively.
The Company was an original limited partner in Industry Mortgage Company, L.P.
(the "IMC Partnership"), a non-conforming residential mortgage company based in
Tampa, Florida. The Company's initial ownership interest represented
approximately 9.09% of the IMC partnership.
The IMC Partnership converted to a corporation, IMC, immediately before its
initial public offering on June 24, 1996. The limited partners received common
stock of IMC in exchange for their IMC Partnership interests as of June 24,
1996. The Company was issued 1,199,768 shares of IMC common stock at that time.
Following the partnership's conversion to corporate form, the Company's
investment in IMC is accounted for as an investment security available for sale
under SFAS No. 115. As of December 31, 1999, the Company owned 435,634 shares of
IMC stock; however, the stock has a minimal value. During 1998, the Company sold
558,400 shares of IMC stock for $1.9 million, which resulted in a pre-tax gain
of $1.8 million. During 1997, the Company sold 233,241 shares of IMC stock for
$3.7 million, which resulted in a pre-tax gain of $2.8 million. The Company also
received 27,507 shares of IMC common stock as an incentive award relating to the
volume of loans sold by the Company to IMC. All of the share figures above
reflect a two-for-one split of IMC shares on February 13, 1997.
F 26
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 3. Mortgage Loans Held for Sale:
The Company owns first and second mortgages, which are being held as inventory
for future sale. The loans are carried at the lower of cost or market. These
mortgage loans have been pledged as collateral for the warehouse financing.
Loans at December 31, 1999 and 1998, were as follows (in thousands):
[Download Table]
1999 1998
-------------- --------------
Mortgage loans held for sale $ 64,857 $ 105,115
Net deferred origination fees and hedging costs (869) (1,966)
Allowance for loan losses (1,223) (2,329)
-------------- --------------
Total mortgage loans, net $ 62,765 $ 100,820
============== ==============
As of December 31, 1999, 1998 and 1997, the recorded investment in loans for
which impairment has been determined in totaled $2.0 million, $4.1 million, and
$2.5 million, respectively. The average recorded investment in impaired loans
for the years ended December 31, 1999, 1998 and 1997 was $3.5 million, $2.6
million and $0.8 million, respectively. Interest income recognized related to
these loans was $89,000, $86,000 and $94,000 during 1999, 1998 and 1997,
respectively. Due to the homogenous nature and collateral for these loans, there
is no corresponding valuation allowance.
Nonaccrual loans were $2.2 million and $5.9 million at December 31, 1999 and
1998, respectively. The amount of additional interest that would have been
recorded had these loans not been placed on nonaccrual status was approximately
$152,000, $212,000, and $154,000 in 1999, 1998 and 1997, respectively.
Changes in the allowance for loan losses for the years ended December 31, 1999,
1998 and 1997 were (in thousands):
[Download Table]
1999 1998 1997
-------------- ------------ ------------
Balance at beginning of year $ 2,329 $ 1,614 $ 904
Acquisitions 0 49 0
Charge-offs (3,286) (2,372) (953)
Recoveries 36 162 182
Provision 2,144 2,876 1,481
-------------- ------------ ------------
Balance at end of year $ 1,223 $ 2,329 $ 1,614
============== ============ ============
F 27
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 4. Mortgage Loans Held for Yield:
The Savings Bank holds certain first-lien mortgage loans to obtain a favorable
interest margin. The loans are carried at cost. These loans are obtained either
by direct purchase from AFC or designated as held for yield when funded by the
Bank. Certain of these loans have been pledged as collateral for the FHLB
financing. Loans held for yield at December 31, 1999 and 1998 were as follows
(in thousands):
[Download Table]
1999 1998
----------- -----------
Mortgage loans held for yield $ 4,197 $ 4,385
Net deferred origination fees and hedging costs (32) 100
Allowance for loan losses (159) (261)
----------- -----------
Total mortgage loans, net $ 4,006 $ 4,224
=========== ===========
No mortgage loans held for yield were on nonaccrual status at December 31, 1999
or 1998.
Changes in the allowance for loan losses for the years ended December 31, 1999,
1998 and 1997 were (in thousands):
[Download Table]
1999 1998 1997
------------ ------------ ------------
Balance at beginning of year $ 261 $ 73 $ 20
Provision (102) 188 53
------------ ------------ ------------
Balance at end of year $ 159 $ 261 $ 73
============ ============ ============
F 28
APROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 5. Real Estate Owned:
Real estate owned is valued at the lower of cost or fair market value, net
of estimated disposal costs.
Changes in the real estate owned valuation allowance for the years ended
December 31, 1999, 1998 and 1997 were (in thousands):
1999 1998 1997
------- ------ -------
Balance at beginning of year $ 503 $ 671 $ 529
Provision 214 (168) 142
------- ------ -------
Balance at end of year $ 717 $ 503 $ 671
======= ====== =======
Note 6. Premises and Equipment:
Premises and equipment at December 31, 1999 and 1998, were summarized as
follows (in thousands):
1999 1998
--------- ---------
Land $ 1,413 $ 240
Building & Improvements 2,947 2,513
Office Equipment & Furniture 1,780 2,303
Computer Software/Equipment 1,766 2,346
Vehicles 223 235
--------- ---------
8,129 7,637
Less accumulated depreciation and amortization 2,043 2,058
--------- ---------
Premises and equipment, net $ 6,086 $ 5,579
========= =========
The Company has several capital leases for computer and other equipment
included in the premises and equipment table above. See Note 6 for further
discussion on capital leases.
F 29
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 7. Capital Leases:
Assets recorded under capital leases at December 31, 1999 and 1998, consist of
the following (in thousands):
1999 1998
--------- -----------
Computer equipment $ 154 $ 322
Furniture & equipment 224 302
Less: Accumulated amortization (176) (116)
--------- -----------
$ 202 $ 508
========= ===========
Amortization expense for the years ended December 31, 1999 and 1998,
approximated $167,000 and $116,000, respectively.
Future minimum rental commitments, including the bargain purchase option
exercisable at the end of the lease terms and the present value of the net
minimum lease payments as of December 31, 1999, are as follows (in thousands):
2000 $ 139
2001 85
2002 22
--------
246
Less - amount representing interest 31
--------
Present value of net minimum lease payments $ 215
========
The Company has the option to purchase these assets at an established price at
the end of the lease terms. The Company recognized approximately $49,000 and
$36,000 of interest expense related to the lease obligations for the years ended
December 31, 1999 and 1998, respectively.
F 30
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 8. Leases
The Company leases some of its office facilities and equipment under operating
leases, which expire at various times through 2004. Lease expense was $2.0
million, $1.4 million, and $1.0 million in 1999, 1998 and 1997, respectively.
Total minimum lease payments under non-cancelable operating leases with
remaining terms in excess of one year as of December 31, 1999, were as follows
(in thousands):
2000 $ 724
2001 344
2002 152
2003 64
2004 48
---------
$ 1,332
=========
F 31
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 9. Revolving Warehouse Facilities:
Amounts outstanding under revolving warehouse facilities at December 31,
1999 and 1998, were as follows (in thousands):
1999 1998
--------- ---------
Warehouse facility with commercial bank $ 12,142 $ 0
collateralized by mortgages/deeds of trust;
expires June 7, 2000, with interest at 1.75%
over applicable LIBOR rate (5.8225% at December
31, 1999); total credit available $15 million.
Warehouse facility with commercial bank 5,323 0
collateralized by mortgages/deeds of trust;
expires November 10, 2001, with interest at
3.25% over applicable LIBOR rate (5.8225% at
December 31, 1999); total credit available $20
million.
Syndicated warehouse facility with commercial 0 59,261
bank collateralized by mortgages/deeds of
trust; expired in 1999.
7,076
Syndicated seasoned loan line of credit with 0
commercial banks collateralized by
mortgages/deeds of trust; expired in 1999.
Subsidiaries warehouse facility with investor 0 6,209
collateralized by mortgages/deeds of trust;
expired in 1999.
--------- ---------
$ 17,465 $ 72,546
========= =========
F 32
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 9. Revolving Warehouse Facilities, continued:
On November 10, 1999, the Company obtained a $20.0 million subprime line of
credit from Regions Bank. The line is secured by loans originated by the Company
and bears interest at a rate of 3.25% over the one-month LIBOR rate. The Company
may receive warehouse credit advances of 100% of the net loan value amount on
pledged mortgage loans for a period of 90 days after origination. As of December
31, 1999, $5.3 million was outstanding under this facility. The line of credit
is scheduled to expire on November 10, 2001.
On November 10, 1999, the Company obtained a $20.0 million conforming loan line
of credit from Regions Bank. The line is secured by loans originated by the
Company and bears interest ranging from 2.25% to 2.75% over the one-month LIBOR
rate based upon the monthly advance levels. The Company may receive warehouse
credit advances of 100% of the net loan value amount on pledged mortgage loans
for a period of 90 days after origination. As of December 31, 1999, there were
no borrowings outstanding under this facility. The line of credit is scheduled
to expire on November 10, 2001.
Effective on December 8, 1999, the Company obtained an amendment to their
warehouse line of credit agreement with Chase Bank of Texas. Since the
utilization of the credit line has been very low in 1999, the amendment reduced
the size of the warehouse facility to $15.0 million, and all bank syndicate
members other than Chase were released from the commitment. The line is secured
by loans originated by the Company and bears interest at a rate of 1.75% over
the one-month LIBOR rate. The Company may receive warehouse credit advances of
95% of the original principal balances on pledged mortgage loans for a maximum
period of 180 days after origination. As of December 31, 1999, $12.1 million was
outstanding under this facility. The line is scheduled to expire on June 7,
2000, and will not be renewed.
F 33
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 10. Deposits:
The following table sets forth various interest rate categories for the FDIC-
insured certificates of deposit of the Bank as of December 31, 1999 and 1998 (in
thousands):
[Download Table]
1999 1998
------------------------------ ---------------------------
Weighted Weighted
Average Average
Rate Amount Rate Amount
--------------- ---------- ------------- ----------
5.24% or less 5.18% $ 793 5.18% $ 1,883
5.25 - 5.49% 5.36 8,813 5.34 5,651
5.50 - 5.74 5.61 1,389 5.65 2,179
5.75 - 5.99 5.89 7,733 5.86 12,789
6.00 - 6.24 6.18 14,152 6.12 6,039
6.25 - 6.49 6.37 19,391 6.40 1,187
6.50 - 6.74 6.65 3,068 - -
------------ --------- --------- ----------
6.07% $55,339 5.78% $29,728
============ ========= ========= ==========
The following table sets forth the amount and maturities of the certificates of
deposit of the Bank at December 31, 1999 (in thousands):
[Enlarge/Download Table]
Over Six Months Over One Year Over Two Years
Six Months or and Less than One and Less than
Less Year Two Years Total
--------------- ------------------- ---------------- ---------------- --------
5.24% or less $ 495 $ 199 $ 99 $ - $ 793
5.25 - 5.49% 2,670 1,984 2,475 1,684 8,813
5.50 - 5.74 397 100 297 595 1,389
5.75 - 5.99 2,978 1,983 1,883 889 7,733
6.00 - 6.24 8,436 4,328 198 1,190 14,152
6.25 - 6.49 6,533 11,867 892 99 19,391
6.50 - 6.74 - 2,969 99 - 3,068
------------- ------------------ --------------- ------------- -------
$21,509 $23,430 $5,943 $4,457 $55,339
============= ================== =============== ============= =======
At December 31, 1999, sixty-eight certificates of deposit totaling $27,159,000
were in amounts of $100,000 or greater.
F 34
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 11. Federal Home Loan Bank Advances:
At December 31, 1999, the Bank has pledged its FHLB stock and qualifying
residential mortgage loans with an aggregate balance of $3.6 million as
collateral for such FHLB advances under a specific collateral agreement with a
limit of $15.0 million at December 31, 1999. Interest is computed based on the
lender's cost of overnight funds. The interest rates on December 31, 1999 and
1998, were 4.55% and 5.10%, respectively. Interest expense on FHLB advances
totaled $36,000, $76,000 and $3,000 in 1999, 1998 and 1997, respectively.
Note 12. Notes Payable - Related Parties:
Notes payable - related parties are amounts due to shareholders, officers and
others related to the Company. These notes are subordinate to the line of credit
and all other collateralized indebtedness of the Company. Interest expense on
notes payable - related parties was $332,000, $554,000, and $666,000, in 1999,
1998 and 1997, respectively. The interest rates on the notes range from 8.00% to
10.25% and the notes mature as follows (in thousands):
2000 $ 748
2001 0
2002 96
2003 596
2004 1,553
---------
$2,993
=========
F 35
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 13. Certificates of Indebtedness:
Certificates of indebtedness are uninsured deposits authorized for financial
institutions such as the Company, which have Virginia industrial loan
association charters. The certificates of indebtedness are loans from Virginia
residents for periods of one to five years at interest rates between 6.75% and
10.00%. Interest expense on the certificates was $225,000, $224,000, and
$225,000 in 1999, 1998 and 1997, respectively.
Certificates of indebtedness maturities were as follows as of December 31, 1999
(in thousands):
2000 $ 760
2001 476
2002 552
2003 263
2004 36
---------
$2,087
=========
F 36
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 14. Mortgage Notes Payable:
The Company has two remaining mortgage notes payable to a commercial bank. The
notes are collateralized by two office buildings used by the Company for its
corporate headquarters. The mortgage notes are summarized as follows (in
thousands):
1999 1998
---------- ----------
Mortgage note with commercial bank
collateralized by office building; original
amount of $590,000; monthly payments of
$7,186; matures May 2004; with interest at
7.99% $ 316 $ 375
Mortgage note with commercial bank
collateralized by office building; original
amount $2,025,000; monthly payments of
$21,170; matures November 2019; with
interest at 8.625% 2,025 0
Mortgage note with commercial bank paid off
March 1999. 0 759
Mortgage note payable- foreclosed properties 0 76
---------- ----------
$ 2,341 $ 1,210
========== ==========
Interest expense on mortgage loans payable was $62,000, $99,000 and $73,000 in
1999, 1998 and 1997 respectively.
Aggregate maturities for mortgage payable are as follows as of December 31, 1999
(in thousands):
2000 $ 96
2001 112
2002 122
2003 132
2004 86
Thereafter 1,793
---------
$2,341
=========
F 37
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 15. Shareholders' Equity:
In January 1998, the Company issued 104,146 split-adjusted shares of its Common
Stock to purchase a senior officer's 17% ownership interest in Armada
Residential Mortgage, LLC ("Armada LLC") that was terminated in September 1997.
The senior officer terminated his employment with Armada LLC and became an
employee of Approved Residential Mortgage, Inc. ("ARMI"). The Company also
issued 12,560 split-adjusted shares to a key employee of Armada LLC.
In December 1998, the Company repurchased 30,000 shares of its Common Stock at
$3.75 per share. The Company's Board of Directors authorized this stock buy back
plan at its quarterly board meeting held on November 2, 1998. The Company was
authorized to repurchase up to 1 million shares of its Common Stock. As of
December 31, 1999, the Company is still authorized to purchase up to 1 million
shares.
Note 16. Stock Options:
On June 28, 1996, the Company adopted the 1996 Incentive Stock Option Plan. The
Company's stock option plan provides primarily for the granting of nonqualified
stock options to certain key employees. Generally, options are granted at prices
equal to the market value of the Company's stock on the date of grant, vest over
a three-year period, and expire ten years from the date of the award.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations in accounting for its
stock option plans. SFAS No. 123, "Accounting for Stock-Based Compensation," was
issued in 1995 and, if fully adopted, changes the method of recognition of cost
on plans similar to those of the Company. The Company has adopted the
alternative disclosure established by SFAS No. 123. Therefore, pro forma
disclosures as if the Company adopted the cost recognition requirements under
SFAS No. 123 are presented on the following table:
F 38
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 16. Stock Options, continued:
A summary of the Company's stock options, including weighted average exercise
price (Price) as of December 31, 1999, 1998 and 1997, and the changes during the
years is presented below:
[Enlarge/Download Table]
1999 1998
------------------------------------- --------------------------------------
Shares Price Shares Price
--------------- ------------------ --------------- -------------------
Outstanding at beginning of year 108,325 $ 5.19 9,200 $ 9.75
Granted 21,425 4.00 8,050 13.50
Granted - - 91,475 4.00
Repriced 9,150 4.00 - -
Cancelled 5,000 9.75 400 4.00
Cancelled 7,100 13.50 -
Cancelled 8,400 4.00 - -
--------------- ------------------ --------------- -------------------
Outstanding at end of year 118,400 $ 4.37 108,325 $ 5.19
=============== ================== =============== ===================
Options available for future grant 138,100 148,175
=============== ===============
Weighted-average fair value of
options granted during year $ 1.00 $ 1.20
================== ===================
1997
-------------------------------------
Shares Price
--------------- ------------------
Outstanding at beginning of year - -
Granted 9,200 $ 9.75
--------------- ------------------
Outstanding at end of year 9,200 $ 9.75
=============== ==================
Options available for future grant 242,800
===============
Weighted-average fair value of
options granted during year $ 3.49
==================
The weighted-average remaining contractual life of options granted at
December 31, 1999, 1998 and 1997 was 9 years, 8 years, and 7 years respectively.
F 39
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 16. Stock Options, continued:
The fair value of each option granted during 1999, 1998 and 1997 is estimated on
the date of grant using the Black-Scholes option-pricing model with the
following assumptions: dividend yield of zero; expected volatility of 48.99% in
1999, 34.48% in 1998 and 34.12% in 1997; risk-free interest rate of 5.75% for
options granted in June 1999, 5.99% for options granted in November 1999, risk-
free interest rate of 5.42% for options granted in January 1998, 4.54% for
options granted in November 1998, and 6.00% for options granted in 1997.
Had compensation cost for the 1999, 1998 and 1997 grants for stock-based
compensation plans been recorded by the Company, the Company's pro forma net
income (loss) and pro forma net income (loss) per common share for 1999, 1998
and 1997 would have been as follows:
(In thousands, except per share amounts)
[Enlarge/Download Table]
Year Ended Year Ended
December 31, 1999 December 31, 1998
-------------------------------------- ----------------------------------
As Reported Pro Forma As Reported Pro Forma
-------------------------------------- ----------------------------------
Net income (loss) $(7,922) $(7,939) $ 479 $ 371
Net income (loss) per
common share - Basic (1.45) (1.45) 0.09 0.07
Net income (loss) per
common share - Dilutive (1.45) (1.45) 0.09 0.07
Year Ended
December 31, 1997
------------------------------------------
As Reported Pro Forma
------------------------------------------
Net income $ 8,060 $ 8,041
Net income per common share - Basic 1.52 1.52
Net income per common share - Dilutive 1.51 1.51
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. There were no awards prior to 1997 and additional
awards in future years are anticipated.
F 40
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 17. Earnings Per Share:
The Company's earnings per share have been calculated in accordance with SFAS
No. 128, "Earnings Per Share." The statement requires calculations of basic and
diluted earnings per share. These calculations are described in Note 1. The
following table shows the reconciling components between basic and diluted
earnings per share:
[Enlarge/Download Table]
Weighted Average
Shares Earnings (Loss)
Net Income (Loss) Outstanding Per
(Numerator) (Denominator) Share
------------------------------------------------------------------------------
For the Year Ended December 31, 1999
Basic and dilutive earnings per share $(7,922,000) 5,482,114 $(1.45)
========================= ======================= ===================
For the Year Ended December 31, 1998
Basic earnings per share $ 479,000 5,465,034 $ 0.09
Effect of dilutive securities: - 46,338 -
Common stock issued
------------------------- ----------------------- -------------------
Diluted earnings per share $ 479,000 5,511,372 $ 0.09
========================= ======================= ===================
For the Year Ended December 31, 1997
Basic earnings per share $ 8,060,000 5,310,263 $ 1.52
Effect of dilutive securities:
Stock options - 1,162 -
Common stock payable - 34,532 (.01)
------------------------- ----------------------- -------------------
Diluted earnings per share $ 8,060,000 5,345,957 $ 1.51
========================= ======================= ===================
F 41
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 18. Income Taxes:
The components of income tax expense (benefit) for the years ended December 31,
1999, 1998 and 1997, were as follows (in thousands):
[Download Table]
1999 1998 1997
-------------------- ---------------------- -------------------
Current $(6,455) $ 361 $ 6,963
Deferred 1,706 112 (1,325)
-------------------- ---------------------- -------------------
$(4,749) $ 473 $ 5,638
==================== ====================== ===================
The provision for (benefit from) income taxes for financial reporting purposes
differs from the amount computed by applying the statutory federal tax rate of
34% to income before taxes. The principal reasons for these differences for the
years ended December 31, 1999, 1998 and 1997, were (in thousands):
[Enlarge/Download Table]
1999 1998 1997
----------------- ------------------ -----------------
Provision for (benefit from) income $(4,308) $ 339 $4,731
taxes at statutory
federal rate
State income taxes, net (585) 58 827
of federal benefit
Nondeductible expenses 37 71 79
Other, net 107 5 1
----------------- ------------------ -----------------
$(4,749) $ 473 $5,638
================= ================== =================
F 42
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 18. Income Taxes, continued:
Significant components of the Company's deferred tax assets and liabilities at
December 31, 1999 and 1998, were (in thousands):
[Enlarge/Download Table]
1999 1998
--------------------- ---------------------
Deferred tax assets: $ 811 $1,231
Allowance for loan and real estate
owned losses
Deferred loan fees - 847
Mark to market on mortgage loans 300 670
held for sale
Deferred income 8 1
Accrued premium recapture 193 229
Accrued expenses 89 196
Accrued 401(k) match 68 60
Accrued insurance expense 189 60
Other 18 79
--------------------- ---------------------
Total deferred tax assets 1,676 3,373
Deferred tax liabilities:
Unrealized appreciation of investments - 19
Other - 24
--------------------- ---------------------
Total deferred tax liabilities - 43
--------------------- ---------------------
Net deferred tax asset $1,676 $3,330
===================== =====================
The Company believes that a valuation allowance with respect to the realization
of the gross total deferred tax assets is not necessary. Based on the
management's expected improvements of sufficient taxable income and reversing
temporary differences, management believes it is likely that the Company will
realize the gross deferred tax assets existing at December 31, 1999. However,
there can be no assurances that the Company will generate taxable income in any
future period.
F 43
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 19. Retirement Plans:
The Company has a defined contribution profit sharing plan, which is
administered by officers of the Company. Company contributions to the plan are
discretionary, as authorized by the Board of Directors. There were no
contributions for 1999, 1998 and 1997. Participants are also eligible to make
voluntary contributions to the plan, at the discretion of the administrator.
There were no voluntary contributions to the plan for the years ended December
31, 1999, 1998 and 1997.
The Company has a nonqualified retirement plan for several key members of
management. The plan allows participants to defer compensation from the current
year. Company contributions to the plan are discretionary, as authorized by the
Board of Directors. Contributions for the years ended December 31, 1999, 1998
and 1997, were $0, $0, and $10,000, respectively.
The Company sponsors a 401(k) Retirement Plan. The Plan is a defined
contribution plan covering all employees who have completed at least one year of
service. The Plan is subject to the provisions of the Employee Retirement Income
Security Act of 1974. The Company contributes an amount equal to 50% of a
participant's payroll contribution up to 6% of a participant's annual
compensation. The Company's contributions to the plan for the years ended
December 31, 1999, 1998 and 1997, were $141,000, $162,000, and $115,000,
respectively.
Note 20. Employment Agreements:
The Company has employment agreements with various employees. The agreements
expire at various times from 1999 through 2001. Among other things, the
agreements provide for severance benefits payable to the officers upon
termination of employment following a change of control in the Company.
F 44
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 21. Regulatory Capital:
Financial institutions, such as the Bank, must maintain specific capital
standards that are no less stringent than the capital standards applicable to
national banks. Regulations of the OTS currently maintain three capital
standards: a tangible capital requirement, a core capital requirement, and a
risk-based capital requirement.
The tangible capital standard requires the Bank to maintain tangible capital of
not less than 1.5% of total adjusted assets. As it applies to the Bank,
"tangible capital" means core capital (as defined below).
The core capital standard requires the Bank to maintain "core capital" of not
less than 4.0%. Core capital includes the Bank's common shareholders' equity,
adjusted for certain non-allowable assets.
The risk-based standard requires the Bank to maintain capital equal to 8.0% of
risk-weighted assets. The rules provide that the capital ratio applicable to an
asset will be adjusted to reflect the degree of credit risk associated with such
asset, and the asset base used for computing the capital requirement includes
off-balance sheet assets.
At December 31, 1999 and 1998, the Bank was classified as a "well-capitalized"
institution (financial institutions that maintain total risk based capital in
excess of 10%) as determined by the OTS and satisfied all regulatory capital
requirements, as shown in the following table reconciling the Bank's capital to
regulatory capital (in thousands):
[Enlarge/Download Table]
Tangible Core Risk-Based
Capital Capital Capital
------------ ------------- -----------
December 31, 1999
GAAP capital $ 6,356 $ 6,356 $ 6,356
Add: unrealized loss on securities 16 16 16
Non-allowable asset: goodwill (101) (101) (101)
Additional capital item: general allowance - - 336
------------ ---------- ---------
Regulatory capital - computed 6,271 6,271 6,607
Minimum capital requirement 1,106 2,949 4,004
------------ ---------- ---------
Excess regulatory capital $ 5,165 $ 3,322 $ 2,603
============ ========== =========
Ratios:
Regulatory capital - computed 8.51% 8.51% 13.20%
Minimum capital requirement 1.50 4.00 8.00
------------ ---------- ---------
Excess regulatory capital 7.01% 4.51% 5.20%
============ ========== =========
F 45
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 21. Regulatory Capital, continued:
[Enlarge/Download Table]
Tangible Core Risk-Based
Capital Capital Capital
------------------ ---------------- ----------------
December 31, 1998
GAAP capital $ 5,058 $ 5,058 $ 5,058
Add: unrealized loss on securities 15 15 15
Non-allowable asset: goodwill (116) (116) (116)
Additional capital item: general allowance - - 276
------------------ ---------------- ----------------
Regulatory capital - computed 4,957 4,957 5,233
Minimum capital requirement 578 1,157 2,166
------------------ ---------------- ----------------
Excess regulatory capital $ 4,379 $ 3,800 $ 3,067
================== ================ ================
Ratios:
Regulatory capital - computed 12.86% 12.86% 19.33%
Minimum capital requirement 1.50 4.00 8.00
------------------ ---------------- ----------------
Excess regulatory capital 11.36% 8.86% 11.33%
================== ================ ================
The payment of cash dividends by the Bank is subject to regulation by the OTS.
The OTS measures an institution's ability to make capital distributions, which
includes the payment of dividends, according to the institution's capital
position. For institutions, such as the Bank, that meet their fully phased-in
capital requirements, the OTS has established "safe harbor" amounts of capital
distributions that institutions can make after providing notice to the OTS, but
without needing prior approval. Effective April 1, 1999, the OTS has adopted
regulations that provide that an OTS-regulated institution will not have to file
a capital distribution notice with OTS upon meeting certain conditions.
Institutions can distribute amounts in excess of the safe harbor amount without
the prior approval of the OTS. The Bank did not pay cash dividends to Approved
in 1999, 1998 or 1997.
Note 22. Disclosures About Fair Value of Financial Instruments:
SFAS No. 107, "Disclosures about Fair Values of Financial Instruments," requires
disclosure of fair value information about financial instruments, whether or not
recognized in the financial statements, for which it is practicable to estimate
that value. In cases where quoted market prices are not available, fair values
are based upon estimates using present value or other valuation techniques.
Those techniques are significantly affected
F 46
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 22. Disclosures About Fair Value of Financial Instruments, continued:
by the assumptions used, including the discount rate and the estimated future
cash flows. In that regard, the derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases, could not
be realized in immediate settlement of the instrument. SFAS No. 107 excludes
certain financial instruments and all non-financial instruments from its
disclosure requirements. Accordingly, the aggregate fair value amounts do not
represent the underlying value of the Company.
The following methods and assumptions were used to estimate the fair value of
the Company's financial instruments:
Cash and cash equivalents: The carrying amount of cash on hand and on deposit at
financial institutions is considered to be a reasonable estimate of fair market
value.
Securities: Fair values are based on quoted market prices or dealer quotes.
Mortgage loans: The estimate of fair value is based on current pricing of whole
loan transactions that a purchaser unrelated to the seller would demand for a
similar loan. The fair value of mortgage loans held for sale approximated
$69,623,000 and $109,637,000 at December 31, 1999 and 1998, respectively.
Interest receivable and interest payable: The carrying amount approximates fair
value.
Revolving warehouse lines: Collateralized borrowings consist of warehouse
finance facilities and term debt. The warehouse finance facilities have
maturities of less than one year and bear interest at market rates and,
therefore, the carrying value is a reasonable estimate of fair value.
Certificates of deposit: The fair values for certificates of deposit are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated contractual
maturities on such time deposits. The fair value of certificates of deposit
approximated $55,064,000 and $29,853,000 at December 31, 1999 and 1998,
respectively.
F 47
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Mortgage loans payable: The fair value of mortgage loans payable is based on the
discounted value of expected cash flows. The discount rates used are those
currently offered for mortgage loans with similar remaining contractual
maturities and terms. The fair value of the mortgage loans payable approximated
$1,765,000 and $1,058,000 at December 31, 1999 and 1998, respectively.
Other term debt: The carrying amount of outstanding term debt, which bears
market rates of interest, approximates its fair value.
Note 23. Sale of Building:
The Company sold the administrative and executive office building located at
3386 Holland Road, Virginia Beach, Virginia. The sale price was $1,081,250,
which resulted in a minimal gain for the Company. The Company had a mortgage
note payable on this property in the amount of $751,674 at the time of sale.
The closing date for this transaction was March 26, 1999. The Company has also
entered into a lease agreement with the purchaser to lease back 15,574 square
feet of the premises for an initial term commencing from the closing date to
September 30, 1999, with the option to renew the lease for three additional one
month terms. The Company renewed this lease for a three month term ending
December 31, 1999. The lease payment is $15,000 per month.
F 48
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 24. Purchase of Land:
The Company purchased 7.77 acres of land from the City of Virginia Beach
Development Authority on March 11, 1999, on which it originally planned to
construct a new administrative and executive office building to consolidate the
Virginia Beach locations. The purchase price of the land was approximately
$642,000. Subsequently, another building located in the same office park
development that accommodates the Company's space requirements became available
for purchase and was acquired by the Company (see Note 24).
Note 25. Purchase of Building:
On October 15, 1999, the Company entered into an agreement to purchase an office
building in Virginia Beach, Virginia, to be used as the Company's new
administrative and executive office building. The purchase price of the building
was $2,250,000. The Company financed this transaction through a non-affiliated
Virginia Beach lender with a mortgage note in the amount of $2,025,000.
Note 26. Significant Fourth Quarter Events:
In the fourth quarter 1999, the Company recorded a charge of $1.1 million for
the write-off of goodwill related to the 1998 acquisition of the Funding Center
of Georgia ("FCGA") and Mortgage One Financial Corp. ("MOFC, Inc."). The rapidly
changing and competitive environment, which has resulted in shrinking margins,
has prevented the Company from achieving operating profits at levels that
existed prior to the acquisitions. The Company evaluated goodwill by comparing
the unamortized goodwill with revised projected operating results. This resulted
in writing off all of the goodwill for the FCGA acquisition and writing the
MOFC, Inc. acquisition goodwill down to $575,000.
Also, in the fourth quarter of 1999, the Company recorded a charge of $0.4
million for the write-off of computers and equipment no longer in service
because of the branch closings in 1999. There was also an expense of $0.3
million regarding legal and architectural costs, which were previously
capitalized, for construction of a new corporate headquarters. Since the Company
purchased an office building for its corporate headquarters, plans to build a
corporate headquarters were cancelled, and therefore the capitalized costs were
expensed.
F 49
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 1999, 1998 and 1997
Note 26. Quarterly Financial Data (Unaudited):
The following is a summary of selected quarterly operating results for each of
the four quarters in 1999 and 1998:
(In thousands, except per share data)
[Enlarge/Download Table]
March 31 June 30 September 30 December 31
--------------- -------------- ---------------- ----------------
1999:
Gain on sale of loans $ 4,396 $ 3,127 $ 2,920 $ 2,759
Net interest income 1,013 731 656 341
Provision for losses 1,279 (33) 179 831
Other income 2,290 2,106 1,971 1,467
Other expenses 8,253 8,115 7,672 10,152
--------------- -------------- ---------------- ----------------
Income (loss) before income taxes (1,833) (2,118) (2,304) (6,416)
Provision for income taxes (598) (808) (901) (2,442)
--------------- -------------- ---------------- ----------------
Net income (loss) $ (1,235) $ (1,310) $ (1,403) $ (3,974)
=============== ============== ================ ================
Basic and diluted net income (loss) per share $ (.23) $ (.24) $ (.26) $ (.73)
=============== ============== ================ ================
1998:
Gain on sale of loans $ 9,754 $ 8,779 $ 7,060 $ 4,110
Net interest income 1,054 1,118 828 1,056
Provision for losses (111) 949 718 1,340
Other income 1,482 1,678 2,806 2,826
Other expenses 9,928 9,772 9,694 9,309
--------------- -------------- ---------------- ----------------
Income (loss) before income taxes 2,473 854 282 (2,657)
Provision for income taxes 1,038 341 121 (1,027)
--------------- -------------- ---------------- ----------------
Net income (loss) $ 1,435 $ 513 $ 161 $ (1,630)
=============== ============== ================ ================
Basic and diluted net income (loss) per share $ 0.26 $ 0.09 $ 0.03 $ (0.30)
=============== ============== ================ ================
F 50
You should rely only on the information contained in this prospectus. We
have authorized no one to provide you with different information. You should not
assume that the information in this prospectus is accurate as of any date other
than the date on the front of the prospectus. This prospectus is not an offer to
sell nor is it seeking an offer to buy the securities in any jurisdiction where
that offer or sale is not permitted. The information in this prospectus is
correct only as of the date of this prospectus, regardless of the time of the
delivery of this prospectus or any sale of securities.
APPROVED FINANCIAL CORP.
[LOGO]
$50,000,000
of
Subordinated Certificates of Investment
and Adjustable Rate Subordinated
Money Market Accounts
PROSPECTUS
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
The following table sets forth the estimated expenses to be incurred in
connection with the offering of the Debt Securities, other than underwriting
discounts and commissions, which Approved Financial Corp. does not anticipate
paying:
SEC Registration Fee ................................$13,200
Printing, Engraving and Mailing......................$30,000
Legal Fees and Expenses..............................$50,000
Accounting Fees and Expenses.........................$25,000
Blue Sky Fees and Expenses...........................$15,000
Miscellaneous....................................$1,0000,000
TOTAL $1,133,200
Item 14. Indemnification of Directors and Officers.
The Virginia Stock Corporation Act (the "Corporation Act") provides that
Articles of Incorporation may eliminate or limit the liability of Officers and
Directors or shareholders for money damages for any action taken or any failure
to take any action as an Officer or Director, except liability for (a) unlawful
misconduct or (b) a knowing violation of the criminal law or of any federal or
state law including, without limitation, any claim of unlawful insider trading
or manipulation of the market for any security. The effect of this provision is
to limit or eliminate our rights and our shareholders rights (through
shareholders' derivative suits on behalf of us) to recover money damages from an
officer or director for all actions or omissions as an officer or director
(including breaches resulting from negligent or grossly negligent behavior)
except in the situations described in clauses (a) and (b) above. This provision
does not limit or eliminate our rights or any shareholder's rights to seek non-
monetary relief, such as an injunction or rescission, in the event of a breach
of a director's duty of care. Our amended and restated Articles of
Incorporation do set forth such a provision eliminating director liability for
monetary damages.
Under the Corporation Act, indemnification is mandatory unless limited by
its Articles of Incorporation for Officers or Directors who entirely prevail in
the defense of any proceeding to which he was a party because of being an
Officer or Director, for reasonable expense incurred in connection with the
proceeding. In addition, we may, in our sole discretion, indemnify and advance
expenses, to the fullest extent allowed by the Corporation Act, to any person
who incurs liability or expense by reasons of such person acting as for us as an
II-1
officer, employee, or agent, except where indemnification is mandatory pursuant
to the Business Corporation Act, in which case we are required to indemnify to
the fullest extent required by the Corporation Act.
Our Amended and Restated Articles of Incorporation, subject to the
requirements of the Corporation Act, provide that all Directors and Officers
may, by action of the Board of Directors, be indemnified by the Corporation
against liabilities, fines, penalties and claims imposed upon or asserted
against him (including amounts paid in settlement) by reason of having been such
a Director or Officer, whether or not then continuing so to be, and against all
expenses (including counsel fees) reasonably incurred by him in connection
therewith, except in relation to matters as to which he shall have been finally
adjudged to be liable by reason of having been guilty of gross negligence or
willful misconduct in the performance of his duty as such Director or Officer.
In the event of any other judgment against such Director or Officer or in the
event of a settlement, the indemnification shall be made only if the Corporation
shall be advised, in case none of the persons involved shall be or have been a
Director of the Corporation, by the Board of Directors, and otherwise by
independent counsel to be appointed by the Board of Directors, that in its or
his opinion such Director or Officer was not guilty of gross negligence or
willful misconduct in the performance of his duty, and, in the event of a
settlement, that such settlement was, or if still to be made is, in the best
interest of the Corporation. If the determination is to be made by the Board of
Directors, we may rely, as to all questions of law, on the advice of independent
counsel.
ITEM 15 - RECENT SALES OF UNREGISTERED SECURITIES
To supplement cash flows, we have from time to time issued Promissory Notes
(the "Notes") to insiders, including, directors, executive officers,
shareholders and employees. Most holders of the Notes are accredited investors.
The Notes are callable on thirty days notice from the holder, and we can prepay
them. The Notes vary from several thousand dollars to $400,000. The Notes bear
interest at rates ranging from 8.00% to 10.00%. The Notes are privately
arranged without any broker or general solicitation. As of September 30, 2000,
the total outstanding balance of Notes originally issued in the past three years
was $2.9 million and eight persons held such Notes. We relied upon an exemption
under Section 4(2) of the Securities Act of 1933, and the regulations issued
thereunder.
In June 1995, we made an intrastate offering of Certificates of
Indebtedness (the "Certificates"). The Certificates were offered to Virginia
residents only with a minimum investment of $5,000 and terms to maturity of one
to five years from date of issue. As of September 30, 2000, the outstanding
balance of the Certificates, including renewal of maturing Certificates, issued
pursuant to that offering was $2.0 million. The Certificates are legended,
advising purchasers that they cannot be sold, transferred, conveyed or pledged
to any person or entity other than a Virginia resident without our consent. We
II-2
relied on an exemption from registration under Section 3(a)(11) of the
Securities Act of 1933 and Rule 147 issued thereunder.
ITEM 16.
EXHIBIT INDEX
[Download Table]
Exhibit Number Description
-----------------------------------------------------------------------------
3.1 Amended and Restated Articles of Incorporation of the Company
(Incorporated by Reference to Appendix A of the Form 10 Registration
Statement Filed February 11, 1998)
-----------------------------------------------------------------------------
3.2 Amended and Restated Bylaws of the Company
-----------------------------------------------------------------------------
4.1 Trust Indenture Agreement dated as of ___, 2000, by Approved
Financial Corp., a Virginia corporation (the "Company"), and US Bank
Trust, national association as trustee (the "Trustee").
-----------------------------------------------------------------------------
5.1 Legal Opinion from Payne, Gates Farthing and Radd, P.C.
-----------------------------------------------------------------------------
10.1 Approved Financial Corp. Incentive Stock Option Plan (Incorporated
by Reference to Appendix C of the Form 10 Registration Statement
Filed February 11, 1998)
-----------------------------------------------------------------------------
10.2 Employment Agreement between the Company and Neil W. Phelan
(Incorporated by Reference to Appendix D of the Form 10 Registration
Statement Filed February 11, 1998)
-----------------------------------------------------------------------------
10.3 Employment Agreement between the Company and Neil W. Phelan as
amended November 17, 2000.
-----------------------------------------------------------------------------
10.4 Employment Agreement between the Company and Stanley W. Broaddus
(Incorporated by Reference to Appendix E of the Form 10 Registration
Statement Filed February 11, 1998)
-----------------------------------------------------------------------------
10.5 Employment Agreement between the Company and Stanley W. Broaddus
dated December 1, 2000
-----------------------------------------------------------------------------
10.6 Employment Agreement between Company and Eric S. Yeakel dated
February 1999 (Incorporated by reference to exhibit 10.24 of Form
10K filed March 31, 1999.)
-----------------------------------------------------------------------------
10.7 Employment Agreement as amended between Company and Eric S. Yeakel
dated December 1, 2000
-----------------------------------------------------------------------------
10.8 Employment Agreement between the Company and Jean S. Schwindt dated
February 1999 (Incorporated by reference to exhibit 10.23 of Form
10K filed March 31, 1999.)
-----------------------------------------------------------------------------
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[Download Table]
10.9 Employment Agreement as amended between Company and Jean S. Schwindt
dated December 1, 2000.
------------------------------------------------------------------------------
10.10 Employment Contract between the Company and Barry Epstein dated
September 18, 2000 (Incorporated by reference to Exhibit 10 filed
with Form 10Q on September 14, 2000)
------------------------------------------------------------------------------
10.11 Employment Contract between the Company and Allen D. Wykle dated
December 1, 2000.
------------------------------------------------------------------------------
10.12 Mills Value Adviser, Inc, Investment Management Agreement/Contract
with the Company (Incorporated by Reference to Appendix I of the
Form 10 Registration Statement Filed February 11, 1998)
------------------------------------------------------------------------------
10.13 Share Purchase Agreement for Purchase of Controlling Interest in
Approved Federal Savings Bank (Formerly First Security Federal
Savings Bank, Inc.) (Incorporated by Reference to Appendix J of the
Form 10 Registration Statement Filed February 11, 1998)
Description
------------------------------------------------------------------------------
10.14 Purchase Agreement between the Company and MOFC, Inc., Incorporated
by reference to exhibit 10.14 of Form 10K filed March 30,2000)
------------------------------------------------------------------------------
10.16 Option Agreement between the Company and Allen D.
Wykle.(Incorporated by reference to exhibit 10.16 of Form 10K filed
March 30,2000)
------------------------------------------------------------------------------
10.17 Option Agreement between the Company and Eric S.
Yeakel.(Incorporated by reference to exhibit 10.26 of Form 10K filed
March 30,2000)
------------------------------------------------------------------------------
10.18 Option Agreement between the Company and Jean S. Schwindt.
(Incorporated by reference to exhibit 10.17 of Form 10K filed March
30,2000)
------------------------------------------------------------------------------
10.19 Option Agreement between the Company and Neil S.
Phelan.(Incorporated by reference to exhibit 10.19 of Form 10K filed
March 30,2000)
------------------------------------------------------------------------------
10.20 Option Agreement between the Company and Gregory
Gleason.(Incorporated by reference to exhibit 10.21 of Form 10K
filed March 30,2000)
------------------------------------------------------------------------------
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[Download Table]
10.21 Option Agreement between the Company and Stanley
Broaddus.(Incorporated by reference to exhibit 10.20 of Form 10K
filed March 30,2000)
------------------------------------------------------------------------------
10.22 Stock Appreciation Rights Agreement with Jean S. Schwindt
(Incorporated by Reference to Appendix K of the Form 10 Registration
Statement Filed February 11, 1998)
------------------------------------------------------------------------------
10.23 Amendment to Stock Appreciation Rights Agreement with Jean S.
Schwindt (Incorporated by reference to Exhibit 10.22 of Form 10K
filed on March 30,2000)
------------------------------------------------------------------------------
10.24 Gregory J. Witherspoon Registration Rights Agreement (Incorporated
by Reference to Appendix M of the Form 10 Registration Statement
Filed February 11, 1998)
------------------------------------------------------------------------------
12 Statement re computation of earnings to fixed ratios
------------------------------------------------------------------------------
21 Subsidiaries of the registrant
---------------------------------------------------------------------------------
23.1 Consent of PriceWaterhouseCoopers
---------------------------------------------------------------------------------
23.2 Consent of Payne Gates Farthing Radd (included in exhibit 5)
---------------------------------------------------------------------------------
24 Power of attorney
---------------------------------------------------------------------------------
25 FORM T-1. Statement of eligibility and qualification under the Trust
Indenture Act of 1939 of corporation designated to act as trustee.
---------------------------------------------------------------------------------
99.1 Form of Prospectus Supplement, Order Form and Other materials.
---------------------------------------------------------------------------------
Item 17. Undertakings.
(a) The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sells securities, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) To reflect in the prospectus any facts or events arising
after the effective date of the registration statement (or
the most recent post-effective amendment thereof) which,
individually or in the aggregate, represent a fundamental
change in the information set forth in the registration
II-5
statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar
value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form
of prospectus filed with the Commission pursuant to Rule
424(b) if, in the aggregate, the changes in volume and price
represent no more than a 20% change in the maximum aggregate
offering price set forth in the "calculation of Registration
Fee" table in the effective registration statement;
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration
statement or any material change to such information in the
registration statement;
(2) That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time
shall be the initial bona fide offering thereof;
(3) To remove form registration by means of a post-effective amendment
any of the securities that remain unsold at the termination of the
offering.
(c) Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment
by the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
(d) The undersigned registrant hereby undertakes that:
(1) For the purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as
part of this registration statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the registrant under
Rule 424(b)(1), or (4) or 497(h) under the Securities Act shall be
II-6
deemed to be part of this registration statement as of the time it
was declared effective.
(2) For the purposes of determining any liability under the Securities
Act, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of the
securities at that time shall be deemed to be the initial bona fide
offering thereof.
II-7
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements of filing on Form S-1 and has duly caused this registration
statement to be signed on its behalf by the undersigned, in the City of Virginia
Beach, Commonwealth of Virginia on December 13, 2000.
APPROVED FINANCIAL CORP.
By: /s/ Allen D. Wykle
-------------------------------------------- Date: December 1, 2000
Allen D. Wykle, Chairman, President and Chief Executive Officer
(Duly Authorized Officer)
In accordance with the requirements of the Securities Act of 1933, this
registration statement was signed by the following persons in the capacities and
on the dates stated.
[Enlarge/Download Table]
SIGNATURE CAPACITY DATE
--------------------------------------------------------------------------------------------------
/s/ Allen D. Wykle Chairman, President, Chief Executive December 1, 2000
------------------------------ Officer
Allen D. Wykle
/s/ Eric S. Yeakel Chief Financial Officer December 1, 2000
------------------------------ (Principal Financial and Accounting Officer)
Eric S. Yeakel
/s/ Jean S. Schwindt Executive Vice President and Director December 1, 2000
------------------------------
Jean S. Schwindt
/s/ Neil W. Phelan Executive Vice President and Director December 1, 2000
------------------------------
Neil W. Phelan
/s/ Stanley W. Broaddus Vice President, secretary and Director December 1, 2000
------------------------------
Stanley W. Broaddus
/s/ Leon H. Perlin Director December 1, 2000
------------------------------
Leon H. Perlin
/s/ Oscar S. Warner Director December 1, 2000
------------------------------
Oscar S. Warner
/s/ Arthur Peregoff Director December 1, 2000
------------------------------
Arthur Peregoff
/s/ Robert M. Salter Director December 1, 2000
------------------------------
Robert M. Salter
/s/ Gregory J. Witherspoon Director December 1, 2000
------------------------------
Gregory J. Witherspoon
/s/ Barry C. Diggins Director December 1, 2000
------------------------------
Barry C. Diggins
II-8
EXHIBIT INDEX
[Enlarge/Download Table]
Exhibit Number Description Page Number
---------------------------------------------------------------------------------------------------
3.1 Amended and Restated Articles of Incorporation of
the Company (Incorporated by Reference to Appendix A
of the Form 10 Registration Statement Filed February
11, 1998)
---------------------------------------------------------------------------------------
3.2 Amended and Restated Bylaws of the Company
---------------------------------------------------------------------------------------
4.1 Trust Indenture Agreement dated as of ___, 2000, by
Approved Financial Corp., a Virginia corporation
(the "Company"), and US Bank Trust, national
association as trustee (the "Trustee").
---------------------------------------------------------------------------------------
5.1 Legal Opinion from Payne, Gates Farthing and Radd,
P.C.
---------------------------------------------------------------------------------------
10.1 Approved Financial Corp. Incentive Stock Option Plan
(Incorporated by Reference to Appendix C of the Form
10 Registration Statement Filed February 11, 1998)
---------------------------------------------------------------------------------------
10.2 Employment Agreement between the Company and Neil W.
Phelan (Incorporated by Reference to Appendix D of
the Form 10 Registration Statement Filed February
11, 1998)
---------------------------------------------------------------------------------------
10.3 Employment Agreement between the Company and Neil W.
Phelan as amended November 17, 2000.
---------------------------------------------------------------------------------------
10.4 Employment Agreement between the Company and Stanley
W. Broaddus (Incorporated by Reference to Appendix E
of the Form 10 Registration Statement Filed February
11, 1998)
---------------------------------------------------------------------------------------
10.5 Employment Agreement between the Company and Stanley
W. Broaddus dated December 1, 2000
---------------------------------------------------------------------------------------
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[Enlarge/Download Table]
10.6 Employment Agreement between Company and Eric S.
Yeakel dated February 1999 (Incorporated by
reference to exhibit 10.24 of Form 10K filed March
31, 1999.)
---------------------------------------------------------------------------------------
10.7 Employment Agreement as amended between Company and
Eric S. Yeakel dated December 1, 2000.
---------------------------------------------------------------------------------------
10.8 Employment Agreement between the Company and Jean S.
Schwindt dated February 1999 (Incorporated by
reference to exhibit 10.23 of Form 10K filed March
31, 1999.)
---------------------------------------------------------------------------------------
10.9 Employment Agreement as amended between Company and
Jean S. Schwindt dated December 1, 2000.
---------------------------------------------------------------------------------------------------
10.10 Employment Contract between the Company and Barry
Epstein dated September 18, 2000 (Incorporated by
reference to Exhibit 10 filed with Form 10Q on
September 14, 2000)
----------------------------------------------------------------------------------------
10.11 Employment Contract between the Company and Allen D.
Wykle dated December 1, 2000.
----------------------------------------------------------------------------------------
10.12 Mills Value Adviser, Inc, Investment Management
Agreement/Contract with the Company (Incorporated by
Reference to Appendix I of the Form 10 Registration
Statement Filed February 11, 1998)
----------------------------------------------------------------------------------------
10.13 Share Purchase Agreement for Purchase of Controlling
Interest in Approved Federal Savings Bank (Formerly
First Security Federal
Savings Bank, Inc.) (Incorporated by Reference to
Appendix J of the Form 10 Registration Statement
Filed February 11, 1998)
Description
----------------------------------------------------------------------------------------
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[Enlarge/Download Table]
10.14 Purchase Agreement between the Company and MOFC,
Inc., Incorporated by reference to exhibit 10.14 of
Form 10K filed March 30,2000)
----------------------------------------------------------------------------------------
10.16 Option Agreement between the Company and Allen D.
Wykle.(Incorporated by reference to exhibit 10.16 of
Form 10K filed March 30,2000)
----------------------------------------------------------------------------------------
10.17 Option Agreement between the Company and Eric S.
Yeakel.(Incorporated by reference to exhibit 10.26
of Form 10K filed March 30,2000)
----------------------------------------------------------------------------------------
10.18 Option Agreement between the Company and Jean S.
Schwindt.(Incorporated by reference to exhibit 10.17
of Form 10K filed March 30,2000)
----------------------------------------------------------------------------------------
10.19 Option Agreement between the Company and Neil S.
Phelan.(Incorporated by reference to exhibit 10.19
of Form 10K filed March 30,2000)
----------------------------------------------------------------------------------------
10.20 Option Agreement between the Company and Gregory
Gleason.(Incorporated by reference to exhibit 10.21
of Form 10K filed March 30,2000)
----------------------------------------------------------------------------------------
10.21 Option Agreement between the Company and Stanley
Broaddus.(Incorporated by reference to exhibit 10.20
of Form 10K filed March 30,2000)
----------------------------------------------------------------------------------------
10.22 Stock Appreciation Rights Agreement with Jean S.
Schwindt (Incorporated by Reference to Appendix K
of the Form 10 Registration Statement Filed February
11, 1998)
----------------------------------------------------------------------------------------
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[Enlarge/Download Table]
10.23 Amendment to Stock Appreciation Rights Agreement
with Jean S. Schwindt (Incorporated by reference to
Exhibit 10.22 of Form 10K filed on March 30,2000)
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10.24 Gregory J. Witherspoon Registration Rights Agreement
(Incorporated by Reference to Appendix M of the Form
10 Registration Statement Filed February 11, 1998)
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12 Statement re computation of earnings to fixed ratios
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21 Subsidiaries of the registrant
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23.1 Consent of PriceWaterhouseCoopers
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23.2 Consent of Payne Gates Farthing Radd (included in
exhibit 5)
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24 Power of attorney
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25 FORM T-1. Statement of eligibility and qualification
under the Trust Indenture Act of 1939 of corporation
designated to act as trustee.
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99.1 Form of Prospectus Supplement, Order Form and Other
materials.
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II-12
Dates Referenced Herein and Documents Incorporated by Reference
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