10-K 1 0001.txt HOME GOLD UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2000 or [_] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______________ to__________________ Commission File No. 000-08909 HOMEGOLD FINANCIAL, INC. (Exact name of registrant as specified in its charter) South Carolina 57-0513287 ------------------------------------ --------------------------------------- (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 3901 Pelham Road, Greenville, South Carolina 29615 ---------------------------------------------- ----------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code 864-289-5000 Securities registered under Section 12(b) of the Act: Title of Each Class Name of Each Exchange on which registered --------------------------------- --------------------------------------------- None None Securities registered under Section 12(g) of the Act: Title of Each Class -------------------------------------------------------------------------------- Series A Non-convertible Preferred Stock, par value $1.00 per share Common Stock, par value $.001 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] As of March 31, 2001, the aggregate market value of voting stock held by non-affiliates of registrant was approximately $5.8 million. As of March 31, 2001, 16,810,149 shares of the Registrant's common stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE The Company's Proxy Statement for the Annual Meeting of Shareholders scheduled for July 11, 2001 to be filed not later than 120 days after December 31, 2000 is incorporated by reference into Part III hereof. PART I Item 1. BUSINESS GENERAL HomeGold Financial, Inc. , together with its subsidiaries (collectively, "HGFN" or "the Company"), is a specialty finance company primarily engaged in the business of originating, selling, and servicing sub-prime first and second-lien residential mortgage loan products ("Mortgage Loans"). Prior to November 1998, the Company also engaged in the business of originating, selling, securitizing and servicing small-business loan products partially guaranteed by the United States Small Business Administration ("SBA") and small-business loans collateralized by accounts receivable and inventory and mezzanine loans (collectively, "Small-Business Loans"). Prior to March 1998, the Company also engaged, to a lesser extent, in making auto loans ("Auto Loans"). The Company commenced its lending operations in 1991 with the acquisition of Carolina Investors, Inc. ("CII"), a small South Carolina mortgage lender, which had been in business since 1963. Since such acquisition, the Company has significantly expanded its lending operations. During the years 2000, 1999, and 1998, the Company originated $597.0 million, $234.0 million, and $785.3 million of loans, respectively. HomeGold Financial, Inc.'s major operating subsidiaries are HomeGold, Inc. and Carolina Investors, Inc. On April 28, 2000, the shareholders of HomeGold Financial, Inc. approved a merger agreement with HomeSense Financial Corp. and affiliated companies (collectively "HomeSense"), a privately owned business, located in Lexington, South Carolina. The merger was consumated on May 9th 2000, and is described below under the heading "Merger with HomeSense Financial Corp." In August, 2000, the Company closed its wholesale loan origination operations. In the first seven months of 2000 and in the year ended December 31, 1999, loan originations generated by the wholesale brokers represented approximately 33% and 46.9%, respectively, of the Company's total production. However, wholesale loans produced much smaller margins compared to loans originated through the Company's retail origination channels. In addition, the availability of warehouse funding for higher-margin retail production was limited by the volume of wholesale production being funded on the warehouse lines. MERGER with HOMESENSE FINANCIAL CORP. On May 9, 2000, HomeSense Financial Corporation and certain of its affiliated companies ("HomeSense") were merged into HomeGold, Inc., a wholly owned subsidiary of HGFN pursuant to a merger agreement approved by HGFN's shareholders on April 28, 2000. HomeSense was a privately owned specialized mortgage company headquartered in Lexington, South Carolina that originated and sold mortgage loans in the sub-prime mortgage industry. Its principal loan product was a debt consolidation loan, generally collateralized by a first lien on the borrower's home. HomeSense originated its loan volume through a direct retail branch network of eight offices, as well as through centrally-provided telemarketing lead, direct mail, and television advertising. HomeGold, Inc. has continued the business of HomeSense after the merger. In the merger, HGFN issued 6,780,944 shares of its common stock (approximately 40% of post-merger shares outstanding) valued at $1.04 per share plus an additional 10 million shares of Series A Non-convertible Preferred Stock, par value $1 per share, for 100% of the outstanding stock of HomeSense. Most of this merger consideration was issued to HomeSense's primary shareholder Ronald J. Sheppard. Mr. Sheppard is now the chief executive officer and a director of HGFN, and a director of both HomeGold, Inc. and the Company. The merger was accounted for under the purchase method of accounting prescribed by generally accepted accounting principles. The transaction resulted in $19.0 million of goodwill, which is being amortized, on a straight-line basis over 15 years. After the merger was consummated, certain differences arose between the parties to the merger regarding the warranties and representations in the merger agreement. These differences were resolved in February 2001 by an agreement between Mr. Sheppard and HGFN pursuant to which Mr. Sheppard agreed to remain a guarantor with respect to certain indebtedness HomeGold, Inc. assumed from HomeSense in the merger and pursuant to which options for HGFN stock issued to Mr. Sheppard in the merger were cancelled. In addition, a mutual indemnity agreement between HGFN and Mr. Sheppard was cancelled. 2 The following summarized unaudited pro forma financial information for the combined companies assumes the acquisition had occurred on January 1 of each year: For the Years Ended December 31, ------------------------------------ 2000 1999 ---------------- ---------------- (In thousands) Revenue $ 57,477 $ 53,045 Income before extraordinary items (30,585) (29,574) Net income (30,006) 4,320 Earnings per share (1.41) (0.01) The amounts are based upon certain assumptions and estimates, and do not reflect any benefit from economies that might be achieved from combined operations. The pro forma results do not necessarily represent results that would have occurred if the acquisition had taken place on the basis assumed above, nor are they indicative of the results of future combined operations. MORTGAGE LOAN PRODUCTS OVERVIEW The Company provides Mortgage Loan products primarily to owners of single family residences who use the loan proceeds for such purposes as refinancing, debt consolidation, home improvements and educational expenditures. The Company believes the sub-prime mortgage market is highly fragmented. Substantially all of the Mortgage Loans are made to sub-prime borrowers. These borrowers generally have limited access to credit, or are considered credit-impaired by conventional lenders such as thrift institutions and commercial banks. These conventional lending sources generally impose stringent and inflexible loan underwriting guidelines, as compared to the Company, to approve and fund loans. Loan applications of sub-prime borrowers are generally characterized by one or more of the following: (1) limited or unfavorable credit history, including bankruptcy, (2) problems with employment history, (3) insufficient debt coverage, (4) self-employment or (5) inadequate collateral. The Company has developed a comprehensive credit analysis system for its loan originations, which is designed to ensure that credit standards are maintained and consistent underwriting procedures are followed. The Company believes that its customers require or seek a high degree of personalized service and swift response to their loan applications. Also, the Company believes that its customers generally focus more on the amount of the monthly payment than the interest rate charged. Furthermore, because the Company's customers are generally credit-impaired for one or more reasons, the customers are typically not in a position to obtain better rates from traditional lending institutions. In 2000, 82% of the Mortgage Loans the Company originated were secured by first-liens. These first-lien Mortgage Loans had an average principal balance of approximately $82,000, a weighted average interest rate of approximately 9.81% and an average loan-to value ("LTV") ratio of 81%. Approximately 18% of the Mortgage Loans originated by the Company in 2000 were secured by a second-lien Mortgage Loan, some of which were to the same borrower as the first-lien mortgage loan. First and second mortgage combinations resulted in combined LTV ratios that averaged 113% on these loans and may be as high as 125% under the Company's guidelines. Such second-lien Mortgage Loans originated during 2000 had an average principal balance of approximately $31,000 and a weighted average interest rate of approximately 12.97%. In order to reduce the Company's credit risk, second-lien Mortgage Loans with a combined LTV ratio greater than 100% are generally pre-approved and pre-underwritten by a third party and generally sold without recourse on a whole loan basis with certain representations and warranties. Second-lien Mortgage Loans with a combined LTV ratio less than 100% are underwritten by the Company. These loans are generally sold on a whole loan basis without recourse. No assurance can be given that any second-lien mortgage loans can be sold. To the extent that the loans are not sold, the Company retains the risk of loss. At December 31, 2000 and 1999, the Company had retained $17.1 million and $9.5 million, respectively, of second-lien mortgage loans on its balance sheet. During 2000, the Company included certain second mortgages in its securitization. The Company may choose to include second mortgage products in future securitizations. 3 The Company has invested significantly in technology and the training of personnel to improve and expand its underwriting, servicing, and collection functions. The Company believes its current operations are capable of supporting increases in both loan origination volume and securitization servicing capacity with only modest increases in fixed expenses. MORTGAGE LOAN ORIGINATION The Company reaches targeted customers for its Mortgage Loan products on a retail basis using a combination of direct mail, telemarketing, and television advertising. Responses are directed through the Company's call centers in Greenville and Lexington, South Carolina and Cincinnati, Ohio. The Company conducts its mortgage lending operations in 46 states. The following table sets forth mortgage loan originations by channel for the period indicated: Loan Originations by Channel
Year Ended December 31, 2000 --------------------------------------------------------- 1ST Mortgage 2ND Mortgage Loans Loans Total ----------------- ----------------- --------------- (Dollars in thousands) Retail Loan originations $ 316,740 $ 82,490 $ 399,230 Average principal balance per loan $ 84 $ 36 $ 66 Weighted average initial LTV ratio 81.93 % 116.6 % 72.22 % Weighted average coupon rate 9.95 % 13.41 % 10.66 % Wholesale Loan originations $ 174,359 $ 23,076 $ 197,435 Average principal balance per loan $ 77 $ 21 $ 56 Weighted average initial LTV ratio 79.35 % 102.47 % 72.95 % Weighted average coupon rate 9.54 % 11.35 % 9.74 % Total Loan originations $ 491,099 $ 105,566 $ 596,665 Average principal balance per loan $ 82 $ 31 $ 63 Weighted average initial LTV ratio 81.01 % 113.21 % 72.5 % Weighted average coupon rate 9.81 % 12.97 % 10.36 %
RETAIL OPERATION. Since 1996, the Company has focused a significant portion of its resources in developing its retail loan products and in developing its related delivery systems. In August 2000 the Company closed its wholesale mortgage origination division, focusing its production efforts on retail originations. Focusing on retail production allows the Company to more efficiently utilize its financing sources for higher-margin Mortgage Loan products. In 2000, retail Mortgage Loan originations represented 67% of the Company's total Mortgage Loan originations compared to 53% and 56% in 1999 and 1998, respectively. Retail Mortgage Loan originations during 2000, 1999, and 1998, totaled $399.2 million, $124.2 million, and $371.1 million, respectively. The Company believes that its retail operation has significant long-term profit potential because it expects that the origination and other fees (typically paid to the broker-originators) will more than offset the infrastructure expenses associated with operating a retail operation once planned efficiency levels are reached. The Company also believes that the retail operation allows more Company control over the underwriting process and its borrower relationship. The retail operation also reduces reliance on wholesale sources, while building brand recognition. Unlike many of its competitors (particularly sub-prime mortgage lenders that began operations as traditional finance companies), the Company markets its retail lending operations in large part using direct mail, telemarketing, and television advertising methods. Compared to a traditional "bricks and mortar" retail approach in which loans are originated out of local, walk-in retail offices, the Company believes that this strategy allows it to target different areas of the country more quickly, depending on the economic, demographic, and other characteristics that may exist at a particular point in time. The Company also believes that this strategy avoids the expense typically associated with multiple physical locations. The Company currently has three central origination production locations in order to take advantage of multiple labor pools and time zones for more efficient telephone marketing. 4 WHOLESALE LENDING OPERATION. As noted above, in August 2000, the Company closed its wholesale mortgage origination division. Although wholesale originations made up a substantial portion of the Company's total origination volume, the margins derived from wholesale production were much smaller than those derived from retail production. Total wholesale originations had decreased in each of the prior two years. The Company attributes this reduction to the high employee turnover rates and tightening of underwriting guidelines. All of the Mortgage Loans originated on a wholesale basis by the Company were originated through mortgage brokers with whom the Company had developed continuing relationships. As a wholesale originator of Mortgage Loans, the Company funded the Mortgage Loans at closing. In the first seven months of 2000, wholesale Mortgage Loan originations represented 33% of the Company's total Mortgage Loan originations, compared to 47% and 44% in 1999 and 1998, respectively. Wholesale Mortgage Loan originations during 2000, 1999, and 1998 totaled $197.4 million, $109.8 million, and $288.3 million, respectively. GEOGRAPHIC DIVERSIFICATION. Since the Company commenced its retail mortgage operations in 1996, it has significantly expanded its geographic presence. During 2000, 1999, and 1998, Mortgage Loan originations by state were as shown below:
(Dollars in thousands) State 2000 % 1999 % 1998 % -------------------- ----------- -------- ----------- -------- ----------- -------- South Carolina $ 74,320 12.5 % $ 25,180 10.8 % $ 87,435 13.3 % North Carolina 46,135 7.7 33,945 14.6 108,714 16.4 Alabama 45,713 7.7 -- -- -- -- Georgia 45,138 7.6 10,751 4.6 34,725 5.3 Virginia 32,193 5.4 13,851 5.9 28,836 4.4 Mississippi 30,684 5.1 5,214 2.2 19,523 3.0 Florida 30,306 5.1 10,487 4.5 43,698 6.6 Tennessee 30,240 5.1 12,163 5.2 30,538 4.6 New Jersey 22,916 3.8 -- -- -- -- Louisiana 20,623 3.5 12,239 5.2 33,238 5.0 Ohio 19,616 3.3 10,960 4.7 19,643 3.0 Michigan 18,593 3.1 10,392 4.4 29,461 4.5 West Virginia 14,771 2.5 -- -- -- -- Pennsylvania 14,380 2.4 13,616 5.8 28,425 4.3 Arizona 13,132 2.2 -- -- -- -- Missouri 12,747 2.1 7,932 3.4 22,864 3.5 Maryland 12,715 2.1 -- -- -- -- Indiana 10,647 1.8 3,465 1.5 20,700 3.1 Washington 10,252 1.7 -- -- -- -- Illinois 9,080 1.5 9,178 3.9 28,479 4.3 Kentucky 8,776 1.5 -- -- -- -- California 8,650 1.4 -- -- -- -- New Mexico 7,701 1.3 -- -- -- -- Maine 6,045 1.0 -- -- -- -- All other states 51,292 8.6 54,632 23.3 123,165 18.7 ----------- -------- ----------- -------- ----------- -------- Total $ 596,665 100.0 % $ 234,005 100.0 % $ 659,444 100.0 % =========== ======== =========== ======== =========== ========
LOAN UNDERWRITING In the application and approval process associated with the Company's retail Mortgage Loan operations, a loan officer finds potential borrowers through leads generated by the Company's marketing efforts. After obtaining an initial loan application, additional information is compiled and gathered and forwarded to the underwriting department for approval. The underwriting department generally completes its review within one business day after procurement of all necessary documentation. Upon approval by the underwriting department, the loan is generally forwarded by the loan closing department to an attorney or title company for closing. 5 Creditworthiness is assessed through a variety of means, including calculating debt to income ratios, examining the applicant's credit history through credit reporting bureaus, verifying an applicant's employment status and income, and checking the applicant's payment history with respect to any first-lien mortgage on the property. The Company uses several procedures to verify information obtained from an applicant. In order to verify an applicant's employment status and income, the Company generally obtains such verification from the applicant's employer. The Company requires self-employed borrowers to provide a copy of their tax return. The Company generally requires an independent appraisal on all loans. Loans in excess of $350,000 generally require two independent appraisals. The Company generally requires title insurance for all real estate loans. The Company also generally requires real estate improvements to be fully insured as to fire and other commonly insurable risks and regularly monitors its loans to ensure that insurance is maintained for the period of the loan. The following table provides a general overview of the Company's principal underwriting criteria for first Mortgage Loans, set forth according to internal product types:
Internal Product Type - First Mortgages -------------- -------------- -------------- -------------- -------------- -------------- AA A A- B C D -------------- -------------- -------------- -------------- -------------- -------------- Existing mortgage No 30 day Maximum of Maximum of Maximum of Maximum of Cannot be in (maximum historical late one 30 day two 30 day three 30 day four 30 day foreclosure delinquencies) payments in late payment late late late the last 24 in last 12 payments in payments in payments in months months; and last 12 the last 12 the last 12 one 60 day months; and months; months; late payment one 60 day maximum of maximum of in the last late payment one 60 day one 60 day 24 months in the last late payment late payment 24 months in the last in the last 24 months 12 months; maximum of one 90 day late payment in the last 24 months Other credit history Maximum of Maximum of Maximum of Maximum of 30, 60, and No criteria (maximum historical two 30 day one 60 day one 60 day one 90 day 90+ day late delinquencies) late late payment late payment late payment payments payments in in the last in the last in the last acceptable, the last 24 24 months, 24 months, 24 months provided months with minimal with minimal that the 30 day late 30 day late borrower has payments in payments in at least the last 24 the last 24 minimal months months favorable credit history Bankruptcy filings None in past None in past None in past None in past None in past No criteria 3 years 3 years 3 years 2 years year Maximum debt service to income ratio (1) 45% 45% 45% 45% 50% 50% Maximum LTV ratio: Owner occupied 100% 100% 90% 85% 80% 70% Non-owner occupied 80% 75% 75% 70% 65% No product
---------- (1) Maximum debt service to income ratio may increase by 5% in each category (except AA loans) if disposable income meets certain thresholds. 6 The following table provides a general overview of the Company's principal underwriting criteria for second Mortgage Loans, set forth according to internal product types:
Internal Product Type - Second Mortgages --------------------- -------------------- ------------------------ --------------- Piggyback Less Than Piggyback Greater 125% CLTV Preapproval Personal Home or Equal to $15,000 Than $15,000 Required Loan --------------------- -------------------- ------------------------ --------------- Existing mortgage No 30 day late Maximum of one 30 No 30 day late Maximum of (maximum historical payments in last 12 day late payment payments in last 12 one 30 day delinquencies) months; Maximum of in last 12 months months late payment two 30 day late in last 12 payments in months months 13 through 24 Other credit history Maximum of three 30 Maximum of two 30 N/A Maximum of (maximum historical day late payments day late payments two 30 day delinquencies) in last 12 months; in last 12 months, late payments Maximum of five 30 unless credit in last 12 day late payments score is greater months, in months 13 than 650 unless credit through 24; Maximum score is of one 60 day late greater than payment 650 Bankruptcy filings None None in past three None in past seven None in past years years three years Maximum debt service to income ratio (1) 45% 45% 45% 45% Maximum LTV ratio 100% 100% 125% 100%
---------- (1) Maximum debt service to income ratio may increase by 5% on Piggybacks greater than $15,000 and on Personal home loans if disposable income meets certain thresholds. 7 The following tables provide information regarding the Company's first and second-lien Mortgage Loan originations by credit classification for the years ended December 31, 2000 and 1999: Loan Originations by Credit Classification Year Ended December 31, 2000 (Dollars in Thousands)
Internal Loan Classification ------------------------------------------------------------------------------- AAA/AA/A/A- B C D Totals ------------ ------------ ------------ ----------- ------------- First-Lien Mortgage Loans Amount $ 265,070 $ 155,804 $ 52,458 $ 14,693 $ 488,025 Percentage 54.31 % 31.93 % 10.75 % 3.01 % 100.0 % Weighted average coupon 9.56 9.9 10.5 10.11 9.79 Weighted average LTV ratio 82.18 80.17 78.6 77.66 81.03 Second-Lien Mortgage Loans Amount $ 82,364 $ 20,436 $ 3,668 $ 2,172 $ 108,640 Percentage 75.81 % 18.81 % 3.37 % 1.99 % 100.0 % Weighted average coupon 13.06 12.65 11.72 12.01 12.95 Weighted average LTV ratio 116.02 105.6 108.00 106.46 113.04
Loan Originations by Credit Classification Year Ended December 31, 1999 (Dollars in Thousands) Internal Loan Classification ------------------------------------------------------------------------------- AA/A/A- B C D Totals ------------ ------------ ------------ ------------ ------------- First-Lien Mortgage Loans Amount $ 149,516 $ 12,446 $ 10,071 $ 2,898 $ 174,931 Percentage 85.5 % 7.1 % 5.7 % 1.7 % 100.0 % Weighted average coupon 10.1 11.3 12.0 11.9 10.4 Weighted average LTV ratio 85.2 78.8 75.0 74.4 82.3 Second-Lien Mortgage Loans Amount $ 57,079 $ 580 $ 120 $ 159 $ 57,938 Percentage 98.5 % 1.0 % 0.2 % 0.3 % 100.0 % Weighted average coupon 13.9 14.2 14.1 14.8 14.3 Weighted average LTV ratio 110.2 84.8 81.1 90.0 112.2
Loan officers are trained to structure loans that meet the applicant's needs, while satisfying the Company's lending criteria. If an applicant does not meet the lending criteria, the loan officer may offer to make a smaller loan, or request that the borrower obtain a co-borrower or guarantor, in order to bring the application within the Company's lending parameters. The amount the Company will lend to a particular borrower is determined by a number of factors, including the borrower's creditworthiness, the value of the borrower's equity in the real estate, and the ratio of such equity to the home's appraised value. In connection with its Mortgage Loan products, the Company collects nonrefundable loan fees and various other fees, depending on state law, such as fees for credit reports, lien searches, title insurance and recordings, and appraisal fees. In connection with the servicing of the loans, the Company may receive late fees and insufficient funds fees, where permitted by applicable law. SALE AND SECURITIZATION OF MORTGAGE LOANS The Company sells a significant portion of the loans it originates, primarily through two methods, whole loan cash sales and securitization. Whole loan cash sales represent loans generally packaged in pools of $1.0 million to $5.0 million. Historically, the Company has sold its Mortgage Loans "servicing released" (i.e., without retention of the servicing rights and associated revenues) and on a non-recourse basis, with certain representations and warranties. The Company is required to repurchase any loan if it is subsequently determined that any representation and warranty made with respect to such loan was untrue. 8 In 1997, the Company began securitizing mortgage loans. Under this method, the Company sells Mortgage Loans it purchased or originated to a trust for cash. The trust sells asset-backed bonds secured by the loans to investors. The Company records certain assets and income based upon the difference between all principal and interest received from the loans sold and the following factors (i) all principal and interest required to be passed through to the asset-backed bond investors, (ii) all excess contractual servicing fees, (iii) other recurring fees and (iv) an estimate of losses on the loans (collectively, the "Excess Cash Flow"). At the time of the securitization, the Company estimates these amounts based upon a declining principal balance of the underlying loans, adjusted by an estimated prepayment and loss rate, and capitalizes these amounts using a discount rate that market participants would use for similar financial instruments. These capitalized assets are recorded as a residual receivable. The Company believes the assumptions it has used in past securitizations are appropriate and reasonable. The following table sets forth for the periods indicated, Mortgage Loans securitized and Mortgage Loans sold on a whole loan basis and Mortgage Loans originated:
Year Ended December 31, ---------------------------------------------------------- 2000 1999 1998 ---------------- ---------------- ----------------- (Dollars in thousands) Mortgage loans securitized $ 64,330 $ 59,630 $ 90,352 Mortgage loans sold 517,295 220,382 625,480 ------------ ------------- ------------- Total Mortgage loans sold or securitized $ 581,625 $ 280,012 $ 715,832 ============ ============= ============= Total Mortgage loans originations $ 596,665 $ 234,005 $ 659,444 Mortgage loans sold or securitized as a % of Total Mortgage loan originations 97 % 120 % 108 %
In connection with the sale of Mortgage Loans prior to 1998, the Company received premiums ranging from 2% to 6% of the principal amount of the Mortgage Loans being sold, depending on prevailing interest rates and the terms of the loans. During 2000, 1999, and 1998, the weighted average premiums (discount) on the whole loan sales of mortgage loans were 1.93%, 2.03%, and (.40)%, respectively. For the years ended December 31, 2000, 1999, and 1998, gains recognized by the Company in connection with the whole loan sales of Mortgage Loans were $9.8 million, $6.2 million, and $9.5 million, respectively. In 1999 average premiums were impacted by industry difficulties that occurred in the fourth quarter of 1998. In the fourth quarter of 1998, the industry, which had been securitizing much of its loans during 1997 and most of 1998, began offering most of its loans to investors in the whole loan sale market. This shift occurred because securitization became less attractive as the corporate interest rate spreads required by investors increased. Prior to the fourth quarter of 1998, the Company generally was able to recognize higher premiums from securitizations compared to whole loan sale. However, cash flow is impacted more positively in the short term by whole loan sales, compared to securitizations. In 1999, the Company completed a securitization transaction in the second quarter. The Company securitized $59.6 million of loans for a weighted average premium of 2.88%. This securitization consisted of seasoned first and second mortgage loans, resulting in a lower than average premium. However, the securitization of seasoned loans resulted in additional liquidity of $33.0 million for the Company. Certain loans included in that securitization were ineligible for inclusion in the borrowing base under the Company's warehouse line of credit. In 2000, the company completed two securitizations totaling $64.3 million of loans. These securitizations consisted primarily of first and second mortgages, and resulted in additional liquidity in 2000 of $50.5 million. Both 2000 securitizations consisted primarily of mortgage loans not eligible for inclusion in the borrowing base under the Company's warehouse lines of credit and not readily marketable for the secondary market. During 2000, the Company primarily sold its loans on a whole-loan, servicing released basis, although it did complete two securitization transactions during the year. The Company makes securitization decisions based on a number of factors including conditions in the secondary market, the aggregate size and weighted average coupon of loans available to sell, fixed costs associated with securitization transactions, and liquidity needs. The Company believes that it will continue to securitize, as well as whole loan sell, in 2001. 9 MORTGAGE LOAN SERVICING, DELINQUENCIES AND COLLECTIONS SERVICING The Company maintains a centralized portfolio management department located in Greenville, South Carolina which services Mortgage Loans. Servicing includes depositing cash received and posting payments to accounts for principal and interest, remitting funds to the Trustee, imaging documents, collection activities on past due accounts, management of loss mitigation activities and foreclosure and sale of properties, ensuring that insurance is in place, monitoring payment of real estate property taxes, customer service and retention activities and warehouse funding management. The Company does not escrow funds for purposes of insurance and taxes. However, it has the right to purchase insurance and pay taxes, which, if paid by the Company, are charged back to the borrower. The Company serves as master servicer for all of the mortgage loan securitizations which it has to date except the 2000 securitizations. In connection with such securitizations, the Company's servicing operation was reviewed by the rating agencies which rated the bonds issued in connection with such securitizations. Because the Company did not retain servicing rights on the 2000 securitizations, completed only one securitization during 1999, and sold the majority of loans originated on a "servicing released" basis, the servicing portfolio has declined from $550.3 million at December 31, 1998, to $283.6 million at December 31, 2000. DELINQUENCIES AND COLLECTIONS Collection efforts generally begin when a Mortgage Loan is over eight days past due, unless the account has previous unpaid late fees, in which case collection efforts generally begin when an account is over one day past due. At that time, the Company generally contacts the borrower by telephone to determine the reason for the delinquency and attempts to bring the account current. Typically, after an account becomes 15 days past due, the Company sends a reminder letter to the borrower, and then sends subsequent letters at 30 days past due, 41 days past due, and 55 days past due. In general, at 41 days past due, the Company sends a right-to-cure letter. After 90 days, the Company sends a five day demand letter and turns the account over to an attorney. In addition to written notices, the Company attempts to maintain telephone contact with the borrower at various times throughout the delinquency period. If the status of the account continues to deteriorate, the Company's loss mitigation unit works on a dual track along with the foreclosure unit to try to save the borrowers from a foreclosure action, while at the same time, trying to keep the foreclosure timelines as short as possible. In limited circumstances, when a borrower is experiencing difficulty in making timely payments, the Mortgage Loan Operations may temporarily adjust the borrower's payment schedule. The determination of how to work out a delinquent loan is based upon a number of factors, including the borrower's payment history and the reason for the current inability to make timely payments. When a loan is 150 days past due, generally, it is placed on non-accrual status and the Company initiates foreclosure proceedings. In connection with such foreclosure, the Company reviews the loan and the facts surrounding its delinquency, and may reappraise the underlying property. Regulations and practices regarding foreclosure and the rights of the mortgagor in default vary greatly from state to state. If deemed appropriate, the Company will bid in its loan amount at the foreclosure sale or accept a deed in lieu of foreclosure. The residential real estate owned portfolio, which is carried at the lower of carrying value or appraised fair market value less estimated cost to sell, totaled $1.3 million, $7.7 million, and $5.9 million at December 31, 2000, 1999, and 1998, respectively. 10 The following table sets forth for the periods indicated information relating to the delinquency and loss experience of the Company with respect to its Securitized Mortgage Loans serviced:
Year Ended December 31, ------------------------------------------------ 2000 1999 1998 ------------- ------------- ------------- (Dollars in Thousands) Total serviced Mortgage Loans (period end) (1) $ 335,881 $ 408,529 $ 550,304 Serviced Mortgage Loans (period end) (2) 335,881 408,529 550,304 Average serviced Mortgage Loans (2) 407,786 488,057 743,362 Delinquency (period end) 30-59 days past due: Principal balance $ 6,622 $ 16,461 $ 28,174 % of serviced Mortgage Loans (2) 2.0 % 4.03 % 5.12 % 60-89 days past due: Principal balance $ 2,647 $ 5,325 $ 8,647 % of serviced Mortgage Loans (2) 0.8 % 1.30 % 1.57 % 90 days or more past due: Principal balance $ 16,014 $ 28,997 $ 38,109 % of serviced Mortgage Loans (2) 4.8 % 7.10 % 6.93 % Total delinquencies: Principal balance $ 25,283 $ 50,783 $ 74,930 % of serviced Mortgage Loans (2) 7.5 % 12.43 % 13.62 % Real estate owned (period end) $ 1,281 $ 7,673 $ 5,881 Net charge-offs 1,990 3,686 6,842 % of net charge-offs to average serviced Mortgage Loans .49 % 0.75 % 0.92 %
(1) Includes loans subserviced for others, where the Company has no credit risk. (2) Does not include loans subserviced for others, where the Company has no credit risk. Since substantially all of the Company's loans are to sub-prime borrowers who have limited access to credit or who may be considered credit- impaired by conventional lending standards, the percentage of the Company's loans past due is expected to be higher than a financial institution that provides loans to prime borrowers. SMALL BUSINESS LOAN PRODUCTS The Company sold substantially all of the assets of the small business loan operations to TransAmerica Small Business Capital, Inc. ("TransAmerica") in the fourth quarter of 1998 and the Company no longer offers the small business loan products. The Small Business Loan Unit realized net income in 1998 of $11.0 million. Included in the 1998 net income was a $19.0 million pre-tax gain on sale of the Small Business Loan Unit's net assets. AUTO LOAN PRODUCTS The Company sold substantially all of the assets of the auto loan unit on March 19, 1998 for $20.4 million, the approximate book value of the assets. The Company no longer offers auto loans as one of its financial products. Prior to the sale of the auto loan assets in 1998, the auto loan unit recorded a net loss of $110,000. COMPETITION The financial services industry, including the markets in which the Company operates, is highly competitive. Competition is based on the type of loan, interest rates, and service. Traditional competitors in the financial services industry include commercial banks, credit unions, thrift institutions, credit card issuers, consumer and commercial finance companies, and leasing companies, many of which have considerably greater financial and marketing resources than the Company. Moreover, major brokerage firms, insurance companies, retailers and bank holding companies have formed substantial national financial services networks. The Company believes that it competes effectively in its markets by providing competitive rates and efficient, complete services. 11 The Company faces significant competition in connection with its Mortgage Loan products, principally from national companies which focus their efforts on making mortgage loans to non-prime borrowers. Many of these companies have considerably greater financial and marketing resources than the Company. Although these large national companies compete in the mortgage loan industry, this industry, as a whole, is highly fragmented and no one company has a significant share of the total mortgage loan market. REGULATION The Company's operations are subject to extensive local, state and federal regulations including, but not limited to, the following federal statutes and regulations promulgated thereunder: Title 1 of the Consumer Credit Protection Act of 1968, as amended (including certain provisions thereof commonly known as the "Truth-in-Lending Act" or "TILA"), the Equal Credit Opportunity Act of 1974, as amended ("ECOA"), the Home Mortgage Disclosure Act, the Fair Credit Reporting Act of 1970, as amended ("FCRA"), the Fair Debt Collection Practices Act, as amended, the Real Estate Settlement Procedures Act ("RESPA") and the National Housing Act, as amended. In addition, the Company is subject to state laws and regulations, including those with respect to the amount of interest and other charges which lenders can collect on loans (e.g., usury laws). Mortgage lending laws generally require lenders to be licensed, and place limitations on the amount, duration and charges for various categories of loans, require adequate disclosure of certain contract terms and place limitations on certain collection practices and creditor remedies. Many states have usury laws that limit interest rates, although the limits generally are considerably higher than current interest rates charged by the Company. State regulatory authorities may conduct audits of the books, records and practices of the Company's operations. The Company is licensed to do business in each state in which it does business and in which such licensing is required and believes it is in compliance in all material respects with these regulations. The Company's Mortgage Loan origination activities are subject to TILA. TILA contains disclosure requirements designed to provide consumers with uniform, understandable information with respect to the terms and conditions of loans and credit transactions in order to give them the ability to compare credit terms. TILA also guarantees consumers a three-day right to cancel certain credit transactions, including any refinanced mortgage or junior mortgage loan on a consumer's primary residence. The Company believes that it is in substantial compliance in all material respects with TILA. The Company is also required to comply with the ECOA, which, in part, prohibits creditors from discriminating against applicants on the basis of race, color, religion, national origin, sex, age or marital status. ECOA restricts creditors from obtaining certain types of information from loan applicants. It also requires certain disclosures by the lender regarding consumer rights and requires lenders to advise applicants who are turned down for credit of the reasons therefor. In instances where a loan applicant is denied credit, or the rate or charge for a loan is increased as a result of information obtained from a consumer credit agency, another statute, the FCRA, requires the lender to supply the applicant with the name, address and phone number of the reporting agency. RESPA was enacted to provide consumers with more effective advance disclosures about the nature and costs of the settlement process, and to eliminate kickbacks or referral fees that raised the costs of settlement services. RESPA applies to virtually all mortgages on residential real property that is designed principally for occupancy of one to four families. Specific disclosures mandated by RESPA include, without limitation, estimates of closing costs, transfers of servicing, affiliated business arrangements and other settlement information. In the opinion of management, existing statutes and regulations have not had a materially adverse effect on the business done by the Company. However, it is not possible to forecast the nature of future legislation, regulations, judicial decisions, orders or interpretations, nor their impact upon the future business, financial condition or prospects of the Company. The Company believes that it is in substantial compliance with state and federal laws and regulations governing its lending activities. However, there can be no assurance that the Company will not inadvertently violate one or more of such laws and regulations. Such violations may result in actions for damages, claims for refunds of payments made, certain fines and penalties, injunctions against certain practices, and the potential forfeiture of rights to repayment of loans. Further adverse changes in the laws or regulations to which the Company's business is subject, or in the interpretation thereof, could have a material adverse effect on the Company's business. 12 EMPLOYEES At December 31, 2000, the Company employed a total of 693 full-time equivalent employees. Item 2. PROPERTIES The Company's headquarters are located at 3901 Pelham Road, Greenville, South Carolina and are owned by the Company. At December 31, 2000, the Company owned five offices and leased ten offices. None of the leases, considered separately or collectively, are believed to be material to the Company's operations. The Company believes that its leased and owned locations are suitable and adequate for their intended purposes. Item 3. LEGAL PROCEEDINGS On April 4, 2000, the Company received notice of a suit filed against it by Danka Funding Company, LLC ("Danka") in New Jersey Superior Court. In the suit, Danka seeks recovery of $356,000 allegedly due under copier equipment leases. It is not possible to evaluate the likelihood or amount of an unfavorable outcome at this stage. On August 20, 1999, Janice Tomlin, Isaiah Tomlin, and Constance Wiggins filed a purported class action lawsuit in New Hanover County, North Carolina Superior Court. That suit has been transferred to North Carolina Business Court. The suit was filed against the Company's affiliate HomeGold, Inc. and others alleging a variety of statutory and common law claims arising out of mortgage loans they obtained through Chase Mortgage Brokers ("Chase"). On February 22, 2000, Michael and Kimberly Chasten filed a similar action in Duplin County, North Carolina Superior Court. That suit has been removed to the United States District Court for the Eastern District of North Carolina. On March 21, 2000, Rosa and Royal Utley filed a similar suit in New Hanover County, North Carolina Superior Court. On April 13, 2000 Reginald Troy filed a similar action in New Hanover County, North Carolina Superior Court. That suit has been removed to the United States District Court for the Eastern District of North Carolina. The plaintiffs in all of these cases are seeking unspecified monetary damages. As to HomeGold, Inc., the complaints in these four cases allege participation by HomeGold, Inc. in an arrangement with Chase under which Chase allegedly charged excessive fees and interest to the consumers, and under which Chase allegedly received undisclosed premiums. There has been no class certified in any of the cases, and HomeGold Inc. has contested, and will continue to contest each case vigorously. The Company and its subsidiaries are, from time to time, parties to various legal actions arising in the normal course of business. Management believes that there is no proceeding threatened or pending against the Company or any of its subsidiaries that, if determined adversely, would have a materially adverse effect on the operations, profitability or financial condition of the Company or any of its subsidiaries. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the fourth quarter of the Company's 2000 fiscal year. 13 PART II Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock presently is traded on the National Association of Stock Dealers (NASD) Over the Counter Bulletin Board (OTCBB) under the symbol "HGFN". Until April 20, 2000, the common stock was traded on the NASDAQ National Merchant System (NNM). The following table sets forth the high and low bid prices of the common stock for the periods indicated, as reported on the OTCBB, and prior to April 20, 2000, the high and low sales price on the NNM. High Low ------------- ------------- Year Ended December 31, 1999 First Quarter $ 2.22 $ 0.34 Second Quarter $ 1.94 $ 1.06 Third Quarter $ 1.50 $ 0.97 Fourth Quarter $ 1.25 $ 0.63 Year Ended December 31, 2000 First Quarter $ 1.75 $ 1.00 Second Quarter $ 1.15 $ 0.25 Third Quarter $ 0.94 $ 0.38 Fourth Quarter $ 0.72 $ 0.22 On March 31, 2001, the closing price for the Company's common stock was $0.344. As of March 31, 2001, the Company had 16,810,149 outstanding shares of common stock held by 392 stockholders of record. No dividends on common stock were paid or declared during 2000 or 1999, and no dividends are expected to be paid on the common stock for the foreseeable future. The Indenture pertaining to the Company's 10-3/4% Senior Notes places certain restrictions on the Company's ability to pay dividends. See "Management's Discussion and Analysis of Financial Conditions and Results of Operations--Liquidity and Capital Resources" which discussion is incorporated herein by reference. 14 Item 6. SELECTED FINANCIAL DATA The following table sets forth historical selected financial information of the Company as of the dates and for the periods indicated. The statement of income data, cash flow data, and balance sheet data are derived from the audited financial statements of the Company. The data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Consolidated Financial Statements and Notes thereto included elsewhere in this Report.
At and for the Years Ended December 31, 2000 1999 1998 1997 1996 ------------- ------------ ----------- -------------- ------------ (Dollars in thousands) Statement of Income Data: Interest income $ 12,192 $ 8,286 $ 35,075 $ 34,008 $ 17,908 Servicing income 7,397 9,813 12,239 8,514 3,274 Gain on sale of loans: Gross gain on sale of loans 9,801 6,216 9,472 52,828 23,815 Loan fees, net 16,430 3,313 11,745 30,207 4,150 ------------- ------------- ------------- ------------- ------------ Total gain on sale of loans 26,231 9,529 21,217 83,035 27,965 Gain on sale of subsidiaries' net assets (1) -- -- 18,964 -- -- Other revenues 1,735 1,609 4,230 1,399 1,241 ------------- ------------- ------------- ------------- ------------ Total revenues 47,555 29,237 91,725 126,956 50,388 Interest expense 19,448 16,338 35,968 25,133 11,021 Provision for credit losses 3,159 3,339 11,906 10,030 5,416 Costs on real estate owned and defaulted loans 3,451 3,018 2,665 876 380 Fair market value adjustment on residual receivable 2,279 3,327 13,638 -- -- Restructuring charges (2) 1,469 -- 6,838 -- -- General and administrative expenses 57,592 38,286 93,701 83,408 23,110 ------------- ------------- ------------- ------------- ------------ Total expenses 87,398 64,308 164,716 119,447 39,927 ------------- ------------- ------------- ------------- ------------ Income (loss) from operations before Income taxes, minority interest and extraordinary item (39,843) (35,071) (72,991) 7,509 10,461 Provision (benefit) for income taxes (9,456) (7,394) 3,017 (3,900) 718 ------------- ------------- ------------- ------------- ------------ Income (loss) from operations before Minority interest and extraordinary item (30,387) (27,677) (76,008) 11,409 9,743 Minority interest in (earnings) loss of subsidiaries (4) (8) 47 (156) 352 ------------- ------------- ------------- ------------- ------------ Income (loss) from operations before Extraordinary item (30,391) (27,685) (75,961) 11,253 10,095 Extraordinary item-gain on extinguishment of debt, Net of $0 tax (3) 579 29,500 18,216 -- -- ------------- ------------- ------------- ------------- ------------ Net income (loss) $ (29,812) $ 1,815 $ (57,745) $ 11,253 $ 10,095 ============= ============= ============= ============= ============ Diluted Earnings Per Share: Operations (2.10) (2.78) (7.81) 1.17 1.42 Extraordinary item .04 2.96 1.87 -- -- ------------- ------------- ------------- ------------- ------------ Net income (loss) per share $ (2.06) $ 0.18 $ (5.94) $ 1.17 $ 1.42 ============= ============= ============= ============= ============ Cash Flow Data: Cash flow due to operating cash income and expenses (20,873) (18,994) (62,775) (26,652) 14,174 Cash provided by (used in) loans held for sale and other (41,848) 26,210 147,055 (119,637) (92,652) ------------- ------------- ------------- ------------- ------------ Net cash provided by (used in) operating activities $ (62,721) $ 7,216 $ 84,280 $ (146,289) $ (78,478) ============= ============= ============= ============= ============ Balance Sheet Data: Total gross loans receivable $ 58,483 $ 63,242 $ 124,740 $ 297,615 $ 189,532 Total residual assets, net 58,877 47,770 43,857 63,202 13,215 Total assets 202,021 188,737 257,208 416,152 224,149 Total debt 212,845 180,880 239,276 336,920 169,596 Total shareholders' equity (deficit) $ (10,828) $ 7,844 $ 5,801 $ 63,374 $ 46,635
---------- (1) See Footnote 12. Sale of Subsidiary and Subsidiary's Assets in Notes to Consolidated Financial Statements. (2) See Footnote 14. Restructuring Charge in Notes to Consolidated Financial Statements. (3) See Footnote 17. Extraordinary Item-Gain on Extinguishment of Debt in Notes to Consolidated Financial Statements. 15 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion should be read in conjunction with the Consolidated Financial Statements and Notes of the Company appearing elsewhere in this report. Forward - Looking Information From time to time, the Company makes oral and written statements that may constitute "forward-looking statements" (rather than historical facts) as defined in the Private Securities Litigation Reform Act of 1995 (the "Act") or by the SEC in its rules, regulations and releases, including Section 27A of the Securities Exchange Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company desires to take advantage of the "safe harbor" provisions in the Act for forward-looking statements made from time to time, including, but not limited to, the forward-looking statements made in this Annual Report on Form 10-K (the "Annual Report"), as well as those made in other filings with the SEC, its Annual Report to Shareholders, and other financial discussion and analysis by management that reflect projections or future financial or economic performance of the Company. Such forward-looking statements are based on management's current plans and expectations and are subject to risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. In the preparation of this Annual Report, where such forward-looking statements appear, the Company has sought to accompany such statements with meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those described in the forward-looking statements. Such factors include, but are not limited to: lower origination volume due to market conditions, inability to achieve desired efficiency levels, higher losses due to economic downturn or lower real estate values, loss of key employees, adverse consequences of changes in the interest rate environment, deterioration of creditworthiness of borrowers and risk of default, general economic conditions in the Company's markets, including inflation, recession, interest rates and other economic factors, loss of funding sources, loss of ability to sell loans, general lending risks, impact of competition, regulation of lending activities, changes in the regulatory environment, lower than anticipated premiums on loan sales, lower than anticipated origination fees, adverse impact of lawsuits, faster than anticipated prepayments on loans, losses due to breach of representation or warranties under previous agreements, and other detrimental developments. The preceding list of risks and uncertainties, however, is not intended to be exhaustive, and should be read in conjunction with other cautionary statements made herein, including, but not limited to, risks identified from time to time in the Company's SEC reports, registration statements and public announcements. General The Company is headquartered in Greenville, South Carolina, and primarily engages in the business of originating, selling, and servicing non-conforming mortgage loan products. The Company commenced its lending operations in 1991 through the acquisition of Carolina Investors, Inc., a small mortgage lending company, which had been in operation since 1963. In the three years prior to the acquisition by merger of HomeSense Financial Corp. and certain of its affiliates as described below, the Company had already undergone significant changes. In late 1997, the Company decided to focus primarily on its mortgage operations, resulting in the sales of its auto loan operations in early 1998, its small retail origination subsidiary, Sterling Lending Corp. ("SLC") in August 1998, and substantially all of the assets of its small business loan operations in November 1998. Merger with HomeSense Financial Corp. On May 9, 2000, HomeSense Financial Corporation and certain of its affiliated companies ("HomeSense") were merged into HomeGold, Inc., a wholly owned subsidiary of HGFN pursuant to a merger agreement approved by HGFN's shareholders on April 28, 2000. 16 HomeSense was a privately owned specialized mortgage company headquartered in Lexington, South Carolina that originated and sold mortgage loans in the sub-prime mortgage industry. Its principal loan product was a debt consolidation loan, generally collateralized by a first lien on the borrower's home. HomeSense originated its loan volume through a direct retail branch network of eight offices, as well as through centrally-provided telemarketing lead, direct mail, and television advertising. HomeGold, Inc. has continued the business of HomeSense after the merger. In the merger, HGFN issued 6,780,944 shares of its common stock (approximately 40% of post-merger shares outstanding) valued at $1.04 per share plus an additional 10 million shares of Series A Non-convertible Preferred Stock, par value $1 per share, for 100% of the outstanding stock of HomeSense. Most of this merger consideration was issued to HomeSense's primary shareholder Ronald J. Sheppard. Mr. Sheppard is now the chief executive officer and a director of HGFN, and a director of both HomeGold, Inc. and the Company. The merger was accounted for under the purchase method of accounting prescribed by generally accepted accounting principles. The transaction resulted in $19.0 million of goodwill, which is being amortized, on a straight-line basis over 15 years. After the merger was consummated, certain differences arose between the parties to the merger regarding the warranties and representations in the merger agreement. These differences were resolved in February 2001 by an agreement between Mr. Sheppard and HGFN pursuant to which Mr. Sheppard agreed to remain a guarantor with respect to certain indebtedness HomeGold, Inc. assumed from HomeSense in the merger and pursuant to which options for HGFN stock issued to Mr. Sheppard in the merger were cancelled. In addition, a mutual indemnity agreement between HGFN and Mr. Sheppard was cancelled. The following summarized unaudited pro forma financial information for the combined companies assumes the acquisition had occurred on January 1 of each year: For the Years Ended December 31, ------------------------------------ 2000 1999 ---------------- ---------------- (In thousands) Revenue $ 57,477 $ 53,045 Income before extraordinary items (30,585) (29,574) Net income (30,006) 4,320 Earnings per share (1.41) (0.01) The amounts are based upon certain assumptions and estimates, and do not reflect any benefit from economies that might be achieved from combined operations. The pro forma results do not necessarily represent results that would have occurred if the acquisition had taken place on the basis assumed above, nor are they indicative of the results of future combined operations. Discontinuation of Wholesale Mortgage Division In August, 2000, management closed the Company's wholesale mortgage origination divisions. The decision to exit the wholesale business arose primarily from management's desire to narrow its focus to the Company's more profitable retail loan origination efforts. The closure of the wholesale division resulted in a decrease in low-margin origination volume, enabling the Company to terminate its relationship under a particularly burdensome agreement with its primary warehouse lender. Further benefits have been realized through more focused and efficient usage of marketing resources and a sizable reduction in overhead costs related to the closed division. 17
The following table sets forth certain data relating to the Company's various loan products at and for the periods indicated: At and For the Years Ended December 31, ------------------------------------------------------ 2000 1999 1998 ------------ ----------- ------------- (Dollars in thousands) Mortgage Loans: Mortgage loans originated $ 596,665 $ 234,005 $ 659,444 Mortgage loans sold 517,295 220,382 623,675 Mortgage loans securitized 64,330 59,630 92,173 Total mortgage loans owned (period end) 52,225 63,242 117,685 Total serviced mortgage loans (period end) 335,881 408,529 550,304 Total serviced unguaranteed mortgage loans (period end) (1) 335,881 408,529 550,304 Average mortgage loans owned (2) 78,009 72,711 245,915 Average serviced mortgage loans (2) 328,576 478,386 744,221 Average serviced unguaranteed mortgage loans (1) 328,576 478,386 743,362 Average interest earned (2) 10.79 % 8.67 % 10.34 % Small Business Loans: Small business loans originated $ -- $ -- $ 122,902 Small business loans sold -- -- 141,041 Small business loans securitized -- -- 1,827 Total small business loans owned (period end) 9,162 10,388 7,054 Total serviced small business loans (period end) 9,162 10,388 7,054 Total serviced unguaranteed small business loans (period end)(3) 9,162 10,388 7,054 Average small business loans owned (2) 10,557 9,671 59,598 Average serviced small business loans (2) 10,557 9,671 202,446 Average serviced unguaranteed small business loans (2)(3) 10,557 9,671 82,270 Average interest earned (2) 7.68 % 6.37 % 14.28 % Auto Loans: Auto loans originated $ -- $ -- $ 2,982 Auto loans sold -- -- 20,898 Auto loans securitized -- -- -- Total auto loans owned (period end) -- -- -- Total serviced auto loans (period end) -- -- -- Average auto loans owned (2) -- -- 5,340 Average serviced auto loans (2) -- -- 5,340 Average interest earned (2) -- % -- % 21.28 % Total Loans: Total loans originated $ 596,665 $ 234,005 $ 785,328 Total loans sold 517,295 220,382 785,614 Total loans securitized 65,330 59,630 94,000 Total loans receivable (period end) 61,387 73,630 124,739 Total serviced loans (period end) 345,043 418,917 557,358 Total serviced unguaranteed loans (period end) (1)(3) 345,043 418,917 557,358 Average loans owned 88,566 82,382 310,853 Average serviced loans 339,133 488,057 952,007 Average serviced unguaranteed loans 339,133 488,057 830,972 Average interest earned 10.69 % 8.40 % 11.28 %
-------------------------------------------------------------------------------- (1) Excludes loans serviced for others with no credit risk to the Company. (2) Averages are computed based on the daily averages except for monthly averages for Mortgage Loans in 1998. (3) Excludes guaranteed portion of SBA Loans. 18 Results of Operations For the periods indicated, the following table sets forth certain information derived from the Company's Consolidated Financial Statements expressed as a percentage of total revenues.
For the Years Ended December 31, ---------------------------------------- 2000 1999 1998 ----------- ----------- ---------- Interest income 25.6 % 28.3 % 38.2 % Servicing income 15.6 33.6 13.3 Gross gain on sale of loans 20.6 21.3 10.4 Loan fee income, net 34.6 11.3 12.8 Gain on sale of subsidiaries' net asset -- -- 20.7 Other revenues 3.6 5.5 4.6 ----------- ----------- ---------- Total revenues 100.0 % 100.0 % 100.0 % =========== =========== ========== Interest expense 40.9 % 55.9 % 39.2 % Provision for credit losses 6.6 11.4 13.0 Costs on real estate owned and defaulted loans 7.3 10.3 2.9 Fair market value adjustment on residual receivables 4.8 11.4 14.9 Salaries, wages and employee benefits 61.2 69.0 61.7 Business development costs 18.1 16.4 11.8 Restructuring charges 3.1 -- 7.5 Other general and administrative expenses 41.8 45.6 28.7 ----------- ----------- ---------- Income (loss) before income taxes, minority interest and extraordinary item (83.8) (120.0) (79.7) Provision (benefit) for income taxes (19.9) (25.3) 3.3 Minority interest in (earnings) loss of subsidiary -- -- 0.1 Extraordinary item 1.2 100.9 19.9 ----------- ----------- ---------- Net income (loss) (62.7) % 6.2 % (63.0) % =========== =========== ==========
Year Ended December 31, 2000, Compared to Year Ended December 31, 1999 The Company recognized a net loss of $29.8 million for the year ended December 31, 2000 ("2000"), as compared to a net income of $1.8 million for the year ended December 31, 1999 ("1999"). Included in net income for 2000 and 1999 were $579,000 and $29.5 million, respectively, of extraordinary gain on extinguishment of debt. Excluding extraordinary gains, the Company's net losses were $30.4 million and $27.7 million in 2000 and 1999, respectively. Total revenues increased $18.3 million (62.7%), to $47.6 million in 2000 from $29.2 million in 1999. The increase in total revenues is comprised of a $13.1 million (395.9%) increase in loan fee income, a $3.9 million (47.1%) increase in interest income, a $3.6 million (57.7%) increase in gain on sale of loans, and a $126,000 (7.8%) increase in other income, partially offset by a $2.4 million (24.6%) decrease in servicing fee income. The increase in net loan fees is primarily attributable to a $362.7 million increase in mortgage origination production and an increase in average loan origination fees charged, to 2.75% in 2000 from 1.42% in 1999. The overall increase in production is attributable to the merger, combining the production capacity of HomeGold with that of HomeSense. The increase in average origination fees charged occurred because of a shift in the mix of wholesale and retail production, resulting from the Company's decision to end wholesale production operations as of August 1, 2000. During 1999, wholesale production accounted for 46.9% of the Company's total production, and during 2000, wholesale production accounted for only 33.1% of the Company's total production. The increase in interest income resulted primarily from an $5.3 million (8%) increase in average loans receivable outstanding. The increase in average loans receivable outstanding relates primarily to the increase in mortgage loan production mentioned above. In addition, the Company experienced an approximate 212 basis point increase in the average yield on loans receivable outstanding. The decrease in servicing fee income was due in part to the sale on a servicing-released basis of $64.3 million in mortgage loans during 2000. The average serviced mortgage loan portfolio decreased $149.8 million, or 31%, to $328.6 million in 2000 from $479.4 million in 1999. 19 Gross gain on sale of loans increased $3.6 million, or 57.7%, to $9.8 million in 2000, from $6.2 million in 1999 due primarily to an increase in loans sold. Loans sold increased $279.2 million, or 99.7%, to $581.6 million for 2000 from $280.0 million for 1999. The increase in loans sold resulted from higher originations of mortgage loans held for sale and the Company's decision to focus on liquidity and whole-loan sales in late 1999 and 2000. The weighted average gross gain on sale of loans was 1.75% and 2.22% for 2000 and 1999, respectively. In 2000 and 1999, other revenues consist primarily of prepayment penalty income, underwriting fees, and late charges. In 1999, other revenues also included nonrecurring income from rental of the Company's computer systems by a former subsidiary. Total expenses increased $23.1 million, or 35.9%, to $87.4 million in 2000 from $64.3 million in 1999. The increase in total expenses is comprised of an $8.8 million (43.0%) increase in personnel expenses, a $6.7 million (51.3%) increase in other general and administrative expenses, a $3.8 million (79.3%) increase in business development costs, a $3.1 million (19.0%) increase in interest expense, and a $433,000 (14.4%) increase in costs on real estate owned and defaulted loans, partially offset by a $1.0 million (31.5%) decrease in the fair value adjustment of residual receivables and a $180,000 (5.4%) decrease in the provision for credit losses. During 2000, the Company also reported $1.5 million in non-recurring restructuring charges related to the merger and the dissolution of the wholesale division. While total expenses increased substantially as a result of the merger and increased retail production, the Company significantly reduced the combined expenses of the merged companies by taking advantage of economies of scale, eliminating many redundant positions, and closing the wholesale division. The increase in personnel costs resulted primarily from the addition of employees during the merger. The number of employees increased from 387 at December 31, 1999 to 693 at December 31, 2000. Immediately after the merger, the Company employed 790 people. Significant personnel reductions came at the time of the closure of the wholesale division, with additional cuts occurring from the date of the merger through year end. The increase in other general and administrative expenses was comprised primarily of a $2.7 million increase in loan origination costs resulting from increased production volume generated by the merger, an $870,000 increase in amortization expense resulting from the addition of substantial goodwill arising from the merger, and merger-related increases in telephone costs ($671,000), equipment rentals ($227,000), office rent ($499,000), ($906,000) of additional amortization from the write-off of the CIT debt origination, and several other expense categories. The increase in business development costs was necessary to support additional production capacity after the merger. Such costs decreased when measured as a percentage of production, to 1.4% in 2000 from 2.1% in 1999. The increase in interest expense was due principally to higher levels of borrowings associated with the increase in the Company's average mortgage loan portfolio. For 2000 and 1999, the Company incurred interest expense of $6.4 million and $2.0 million, respectively, related to warehouse lines of credit and $11.7 million and $9.9 million, respectively, related to investor notes and subordinated debentures. These increases were partially offset by a decrease related to the reduction in the Company's senior unsecured debt. For 2000 and 1999, such expenses were $1.3 million and $4.4 million, respectively. The increase in costs on real estate and defaulted loans is due to the company aggressively liquidating its real estate acquired through foreclosure in 2000. Changes in valuation assumptions for the Company's residual receivables from securitizations were adjusted in 2000, primarily related to the assumed loss rates in the 1997 pools. The change in assumed loss rates, due to lower than expected actual losses, resulted in an increase in fair value of the residual receivable. However, this increase was offset by actual losses on foreclosed properties in all the securitization pools, causing the write-down of the overall residual receivable. The decrease in the provision for credit losses was associated with lower levels of loans held for investment and a lower loan delinquency rate. The decrease was partially offset by management's decision in early 2000 to record additional reserves against amounts paid on behalf of borrowers for taxes, insurance, and attorney's fees. During 2000, the Company incurred restructuring charges related to the merger and to the decision to close its wholesale loan origination division. These charges included the estimated costs of employee relocation costs and employee severance, and the estimated net lease cost on facilities no longer being used. 20 The Company has recorded current income tax expense of $544,000 for 2000, related to its "excess inclusion income." Excess inclusion income is a result of the Company's securitizing loans in pools to third party investors. These transactions generate income for the Company that is included in the overall loss. However, according to IRS regulations, a portion of that income is subject to federal tax in the current period regardless of other current period losses or NOL carryovers otherwise available to offset regular taxable income. The excess inclusion income approximates the net interest the Company receives on the loans in the pools after the bondholders are paid their share of the interest less the sum of the daily accruals, an amount allowed for tax purposes as a reasonable economic return on the retained ownership interest. The Company has recorded a deferred tax benefit of $10 million in 2000 related to historical losses based on management's assessment of the realization of the related deferred tax asset. Management has performed an analysis of the recoverability of the asset based on projected conditions, and has determined that it is more likely than not that the Company will be able to realize this benefit prior to the expiration of the net operating loss carryforwards. Year Ended December 31, 1999, Compared to Year Ended December 31, 1998 The Company recognized net income of $1.8 million for the year ended December 31, 1999 as compared to a net loss of $57.7 million for the year ended December 31, 1998. Included in net income for 1999 and 1998 is $29.5 million and $18.2 million, respectively of extraordinary gain on extinguishment of debt. In 1999, the Company realigned its processes and its expense structure to correspond with a lower loan production level. Total revenues decreased $62.5 million, or 68.1%, to $29.2 million for the year ended December 31, 1999 from $91.7 million for the year ended December 31, 1998. 1998 amounts include revenues from small business and auto loan operations that were sold in 1998. 1998 revenue from the mortgage operations, net of a subsidiary also sold in 1998, is a more comparable figure, at $52.6 million for 1998. The lower level of mortgage loan revenues resulted principally from lower mortgage loan production levels and lower gains on sale of loans. The lower gains on sale of loans were a result of a combination of lower volumes of loans sold and lower overall premiums. Interest income decreased $26.8 million, or 76.4%, to $8.3 million for the year ended December 31, 1999 from $35.1 million for the year ended December 31, 1998. The decrease in interest income resulted primarily from a $228.5 million, or 73.5%, decrease in average loan balance to $82.4 million in 1999 from $310.9 million in 1998. The decrease in the average loan balance resulted from a $64.8 million decrease in the Company's mortgage loan portfolio, the sale of the small-business loan portfolio and the sale of the auto loan portfolio. This decrease was compounded by a reduction in the average yield of 290 basis points. The average yield in 1999 was 8.40% compared to 11.28% in 1998 due primarily to loans on non-accrual status. The decrease in the average yield is also due to the changes in the types of loans in the Company's portfolio. Weighted average mortgage rates declined 167 basis points from 10.34% in 1998 to 8.67% in 1999. Servicing income decreased $2.4 million, or 19.8%, to $9.8 million for the year ended December 31, 1999 from $12.2 million for the year ended December 31, 1998. This decrease was due principally to the sale of the assets of the small business loan unit in November 1998. The average serviced mortgage loan portfolio decreased $269.1 million, or 36.1%, to $475.1 million for the year ended December 31, 1999 from $744.2 million for the year ended December 31, 1998. Gross gain on sale of loans declined $3.3 million, or 34.4%, to $6.2 million for the year ended December 31, 1999, from $9.5 million for the year ended December 31, 1998 due to lower gain on sale from securitization transactions. The securitization transaction completed in May 1999 involved older seasoned loans which included some second mortgage loans. As a result, higher estimated losses are anticipated on this pool. Cash gain on sale of loans increased $3.1 million, or 233.2%, to $4.5 million for the year ended December 31, 1999 from $1.3 million for the year ended December 31, 1998. The increase resulted principally from the Company's decision to focus on liquidity and whole-loan sales in late 1998 and in 1999. Loans sold decreased $498.9 million, or 64.1%, to $280.0 million for the year ended December 31, 1999 from $778.9 million for the year ended December 31, 1998. The decrease in loans sold resulted from lower originations of mortgage loans held for sale and from the sale of Sterling Lending and the small business loan units in 1998. The weighted average cash gain on sale of loans was 2.03% and 0.2% for the years ended December 31, 1999 and 1998, respectively. 21 Non-cash gain on sale of loans decreased $6.4 million, or 78.6%, to $1.7 million for the year ended December 31, 1999 from $8.1 million for the year ended December 31, 1998. The decrease in non-cash gain on sale of loans was due principally to the Company's decision to sell most of its 1999 originations servicing-released and to securitize seasoned first and second mortgage loans. The Company securitized $59.6 million in loans for the year ended December 31, 1999 and recognized a weighted average non-cash gain on sale as a percentage of loans securitized of 2.88%, net of expenses. The Company securitized $92.3 million in loans for the year ended December 31, 1998 and recognized a weighted average non-cash gain on sale as a percentage of loans securitized of 8.81%, net of expenses. Loan fees decreased $8.4 million, or 71.8%, to $3.3 million for the year ended December 31, 1999 from $11.7 million for the year ended December 31, 1998. Loan fees received as a percentage of retail production for the year ended December 31, 1999 were 4.01% as compared to 4.65% for the year ended December 31, 1998. Loan fees are deferred and recognized as interest income over the life of the loan. All unamortized loan fees, net of origination costs, are realized as part of the gain on sale of loans when the loans are sold or securitized. In 1998, the Company realized a net $19.0 million gain on sale of subsidiaries' net assets. The Company completed the sale of substantially all of the assets of its auto loan unit for book value on March 19, 1998. No significant gain or loss was recognized on this transaction. On August 21, 1998, the Company completed the sale of its small branch network retail mortgage origination unit, Sterling Lending Corporation. There was no significant gain or loss recorded as a result of this sale. On November 13, 1998, the Company sold the majority of the assets of its small business lending units. The gain realized in 1998 was approximately $19.7 million net of related costs. On December 2, 1998, the Company sold the majority of its asset-based lending unit. This transaction completed the disposition of all non-mortgage-related activities of the Company. The sale resulted in a pre-tax loss of $755,000. Other revenues decreased $2.6 million to $1.6 million for the year ended December 31, 1999 from $4.2 million for the year ended December 31, 1998. In 1998, other revenues were comprised principally of insurance commissions, underwriting fees, late charges, warrant valuations, and management fees received in connection with the mezzanine lending operation. In 1999, other revenues consist primarily of prepayment penalty income, underwriting fees, late charges, and nonrecurring income from rental of the Company's computer systems by a former subsidiary. Total expenses decreased $100.4 million, or 61.0%, to $64.3 million for the year ended December 31, 1999 from $164.7 million for the year ended December 31, 1998. Total expenses are comprised of interest expense, provision for credit losses, costs on real estate owned and defaulted loans, fair value adjustment of residual receivables, salaries, wages and employee benefits, business development costs, and other general and administrative expenses. Certain personnel reductions in the fourth quarter of 1998 and in 1999 have decreased personnel costs from $56.9 million for 1998 to $20.4 million in 1999. Interest expense decreased $19.6 million, or 54.6%, to $16.3 million for the year ended December 31, 1999 from $36.0 million for the year ended December 31, 1998. The decrease in interest expense was due principally to lower levels of borrowings associated with the decrease in the Company's average mortgage loan portfolio, and the retirement of $74.5 million of the Company's Senior Notes due 2004 ("Senior Notes"). For the years ended December 31, 1999 and 1998, the Company incurred interest expense of approximately $4.4 million and $13.5 million, respectively related to the Senior Notes. For the years ended December 31, 1999 and 1998, the Company incurred interest expense of $2.0 million and $12.8 million, respectively, related to warehouse lines of credit. Provision for credit losses decreased $8.6 million, or 72.0%, to $3.3 million for the year ended December 31, 1999 from $11.9 million for the year ended December 31, 1998. The decrease in the provision was associated with lower levels of loans held for investment. However, additional provision was required in 1999 to increase specific reserves for possible losses with regard to particular loans, including delinquent loans relating to the small business loan operations which were not sold. Costs on real estate and defaulted loans increased $353,000, or 13.2%, to $3.0 million for the year ended December 31, 1999 from $2.7 million for 1998. This increase is due to higher levels of real estate acquired through foreclosure in 1999 over 1998. These higher levels of real estate are related to seasoning of the retained portfolio and repurchases from securitized pools. Management feels that loans made in 1997 which were not underwritten in accordance with Company guidelines increased the Company's foreclosures. As these loans are foreclosed or sold, management expects these costs to return to lower levels. 22 In 1998, due to higher than anticipated prepayments, the Company modified the estimated prepayment speeds on all of its mortgage loan securitization transactions to peak at a 30 constant prepayment rate ("CPR") up from the previous prepayment speeds of 20 CPR. This resulted in a write-down of residual receivables of $13.6 million in 1998. No such write-down was necessary in 1999. The peak CPR was adjusted to 28 during 1999 to reflect the recent trend in slower prepayment speeds. (See Loan and Securitizations section) In November 1998, the Company decided to close three retail loan origination centers and to consolidate all operations into one location. This decision resulted in a restructuring charge of $6.8 million. The restructuring charge related to the write-down of fixed assets to net realizable value on assets no longer used by the Company was $3.6 million, the estimated costs of employee relocation costs and employee severance was approximately $1.4 million, and the estimated net lease cost on facilities no longer being used was $1.8 million. No such charge was required in 1999, and management feels that the reserves at December 31, 1999 continue to be adequate. Total general and administrative expense decreased $55.4 million, or 59.1%, to $38.3 million for the year ended December 31, 1999, from $93.7 million for the year ended December 31, 1998. This resulted primarily because salaries, wages and employee benefits decreased $36.4 million, or 64.4%, to $20.2 million in 1999, from $56.6 million in 1998, and business development costs decreased $6.0 million to $4.8 million in 1999 from $10.8 million in 1998. The decreased costs resulted from the closure of retail operations centers outside Greenville in late 1998. The lower business development costs related to changes in the Company's direct mail campaigns in an effort to re-focus mailings to consumers more closely matching the profile of the Company's customer base. The Company has recorded current income tax expense of $455,000 for the year ended December 31, 1999, even though overall the Company generated a pre-tax loss for the year ended December 31, 1999. The current tax is due on income called "excess inclusion income." Excess inclusion income is a result of the Company securitizing loans in pools to third party investors. These transactions generate income for the Company that is included in the overall loss. However, according to IRS regulations, a portion of that income is subject to federal tax in the current period regardless of other current period losses or NOL carryovers otherwise available to offset regular taxable income. The excess inclusion income approximates the net interest the Company receives on the loans in the pools after the bondholders are paid their share of the interest less the sum of the daily accruals, an amount allowed for tax purposes as a reasonable economic return on the retained ownership interest. The Company has recorded a deferred tax benefit in the amount of $7.8 million related to the current loss based on management's assessment of the recoverability of the related deferred tax asset. Management has performed an analysis of the recoverability of the asset based on projected conditions, and determined that it is more likely than not that the Company will be able to realize this benefit prior to the expiration of the net operating loss carryforwards. Financial Condition Net loans receivable decreased $4.9 million to $51.7 million at December 31, 2000 from $56.6 million at December 31, 1999. The reduction in net loans receivable resulted primarily from the Company's decision to increase liquidity and reduce debt by selling and securitizing residential mortgage loans, partially offset by an increase in overall production. The residual receivables were $58.9 million at December 31, 2000, and $47.8 million at December 31, 1999. This increase resulted primarily from net residual assets of $14.2 million retained on the 2000 securitization transactions competed in June and September and an $895,000 increase in value resulting from a change in the assumed loss rates of the 1997 pools, due to lower than expected actual losses. These increases were partially offset by the amortization of the residual assetS. Net property and equipment increased by $4.3 million to $21.4 million at December 31, 2000, from $17.2 million at December 31, 1999, which is attributable to the merger with HomeSense, partially offset by depreciation expense incurred during the year. Real estate and personal property acquired in foreclosure decreased to $1.3 million at December 31, 2000, from $7.7 million at December 31, 1999. This decrease resulted from the sale of foreclosed properties, partially offset by additional foreclosures on mortgage loans within the period. 23 The net deferred income tax asset increased from $12 million at December 31, 1999 to $22 million at December 31, 2000. The increase is the result of the Company's latest assessment of the recoverability of the net operating loss carryforwards based upon recent changes in its management team, business strategy, opportunities in the marketplace, and projected conditions. Total net operating loss carryforwards are now $103.6 million. Approximately $101.7 million does not begin to expire until 2006 and beyond. The primary source of funding the Company's receivables comes from borrowings issued under various credit arrangements (including the Credit Facilities, CII Notes, and the Company's Senior Notes). At December 31, 2000, the Company had debt outstanding under revolving warehouse lines of credit and other obligations to banks of $29.3 million, which compares with $17.8 million at December 31, 1999, for an increase of $11.5 million. At December 31, 2000, the Company had $165.2 million of CII Notes and subordinated debentures outstanding, which compares with $144.8 million at December 31, 1999, for an increase of $20.4 million. The aggregate principal amount of outstanding Senior Notes was $11.2 million at December 31, 2000 compared to $12.1 million on December 31, 1999. In 2000, the Company purchased $920,000 face amount of its Senior Notes for a purchase price of $341,000. The Company may, from time to time, purchase more of its Senior Notes depending on the Company's cash availability, market conditions, and other factors. The Company showed a deficit in total shareholders' equity at December 31, 2000 of $10.8 million, which compares to positive equity of $7.8 million at December 31, 1999, a decrease of $18.7 million. This decrease resulted principally from the net loss recognized in 2000, partially offset by the issuance of stock in conjunction with the merger. Allowance for Credit Losses and Credit Loss Experience The Company is exposed to the risk of loan delinquencies and defaults with respect to loans retained in its portfolio. With respect to loans to be sold on a non-recourse basis, the Company is at risk for loan delinquencies and defaults on such loans while they are held by the Company pending such sale. To provide for credit losses, the Company charges against current earnings an amount necessary to maintain the allowance for credit losses at levels expected to cover inherent losses in loans receivable. The table below summarizes certain information with respect to the Company's allowance for credit losses on the owned portfolio for each of the periods indicated. Summary of Allowance for Credit Losses on Owned Portfolio
At and For the Year Ended December 31, ------------------------------------------ 2000 1999 1998 ----------- ----------- ------------ (In thousands) Allowance for credit losses at beginning of period $ 6,344 $ 6,659 $ 6,528 Net charge-offs (1,990) (3,654) (8,792) Provision charged to expense 3,159 3,339 11,906 Allowance related to loans sold (2,861) -- (2,983) ----------- ----------- ------------ Allowance for credit losses at the end of the period $ 4,652 $ 6,344 $ 6,659 =========== =========== ============
The Company considers its allowance for credit losses to be adequate in view of the Company's loss experience and the secured nature of most of the Company's outstanding loans. Although management considers the allowance appropriate and adequate to cover inherent losses in the loan portfolio, management's judgment is based upon a number of assumptions about future events, which are believed to be reasonable, but which may or may not prove valid. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for credit losses or that additional increases in the allowance for possible credit losses will not be required. 24 The table below summarizes certain information with respect to the Company's allowance for losses on the securitization residual assets for each of the periods indicated. Summary of Embedded Allowance for Losses on Securitization Residual Assets
At and For the Year Ended December 31, ------------------------------------------------- 2000 1999 1998 -------------- ------------- -------------- (In thousands) Residual securities: Allowance for losses at beginning of period $ 7,176 $ 7,165 $ 14,255 Net charge-offs (3,577) (1,661) (147) Anticipated losses net against gain 1,559 1,266 2,242 Mark-to-market adjustment 489 406 (6,228) Sale of small business residual assets -- -- (2,957) ------------- ------------ ------------ Allowance for losses at end of period $ 5,647 $ 7,176 $ 7,165 ============= ============ ============
The value of the residual receivables retained by the Company would be impaired to the extent losses on the securitized loans exceed the amount estimated when determining the residual cash flows. The table below summarizes the Company's allowance for credit losses with respect to the Company's total combined serviced portfolio (including both owned and securitized loan pools) for each of the periods indicated. Summary of Allowance for Credit Losses on Combined Serviced Portfolio
At and For the Year Ended December 31, ------------------------------------------------- 2000 1999 1998 -------------- ------------- -------------- (In thousands) Allowance for credit losses at beginning of period $ 13,520 $ 13,824 $ 20,783 Net charge-offs (5,567) (5,315) (8,938) Provision charged to expense 3,159 3,339 11,905 Provision netted against gain on securitizations 1,559 1,266 2,242 Mark-to-market adjustment 489 406 (6,228) Sale of small business residual assets -- -- (2,957) Allowance related to loans sold (2,861) -- (2,983) -------------- ------------ ------------ Allowance for credit losses at the end of the period $ 10,299 $ 13,520 $ 13,824 ============== ============ ============ The total allowance for credit losses as shown on the balance sheet is as follows: Allowance for credit losses on loans $ 4,652 $ 6,344 $ 6,659 Allowance for credit losses on residual receivables 5,647 7,176 7,165 -------------- ------------ ------------ Total allowance for credit losses $ 10,299 $ 13,520 $ 13,824 ============== ============ ============
25 The following table sets forth the Company's allowance for credit losses on the combined serviced portfolio at the end of the periods indicated, the credit loss experience over the periods indicated, and delinquent loan information at the dates indicated for loans receivable at least 30 days past due.
At and For the Year Ended December 31, -------------------------------------- 2000 1999 1998 -------------------------------------- Allowance for Credit Losses as a % of Combined Serviced Loans (1): Mortgage loans 1.88 % 2.5 % 2.1 % Small business loans 43.5 32.2 32.6 Auto loans -- -- -- Total allowance for credit losses as a % of serviced loans 3.1 3.2 2.5 Net Charge-offs as a % of Average Combined Serviced Loans (2): Mortgage loans 0.6 0.8 0.9 Small business loans -- -- 1.6 Auto loans -- -- 15.0 Total net charge-offs as a % of total serviced loans 0.6 0.8 1.1 Loans Receivable Past Due 30 Days or More as a % of Combined Serviced Loans (1): Mortgage loans 7.5 12.4 13.6 Small business loans 33.4 55.3 -- Auto loans -- -- -- Total loans receivable past due 30 days or more as a % of total serviced loans 7.3 13.5 13.4 Total Allowance for Credit Losses as a % of Combined Serviced Loans Past Due 90 Days or More (1) 29.0 % 23.9 % 35.3 %
---------- (1) For purposes of these calculations, combined serviced loans represents all loans for which the Company bears credit risk, and includes all portfolio Mortgage Loans and Auto Loans, all securitized loans, and the Small Business Loans, but excludes the guaranteed portion of the SBA Loans and Mortgage Loans serviced without credit risk. (2) Average serviced loans have been determined by using beginning and ending balances for the period presented. Management closely monitors delinquencies to measure the quality of its loan portfolio and securitized loans and the potential for credit losses. Accrual of interest is discontinued and reversed when a loan is over 150 days past due, when the collateral is determined to be inadequate, or when foreclosure proceedings begin. Collection efforts on charged-off loans continue until the obligation is satisfied or until it is determined that such obligation is not collectible or the cost of continued collection efforts would exceed the potential recovery. Recoveries of previously charged-off loans are credited to the allowance for credit losses. 26 Management monitors securitized pool delinquencies using a static pool analysis by month by pool balance. Current year results are not necessarily indicative of future performance. The following sets forth the static pool analysis for delinquencies by month in the Company's securitized mortgage loan pools.
Current Principal Balance -------------------------------------------------------------------------------------------------------------------------------- Months from Pool Inception 1997-1 1997-2 1997-3 1997-4 1998-1 1999-1 -------------------------------------------------------------------------------------------------------------------------------- 1 $ 77,435,632 $ 120,860,326 $ 130,917,899 $ 118,585,860 $ 62,726,105 $ 59,219,199 2 $ 77,405,312 $ 120,119,653 $ 169,093,916 $ 118,061,792 $ 62,300,302 $ 57,977,700 3 $ 76,709,417 $ 119,364,510 $ 168,182,957 $ 148,291,454 $ 61,609,815 $ 57,201,142 4 $ 75,889,160 $ 118,965,905 $ 166,783,489 $ 146,880,279 $ 60,768,433 $ 56,168,578 5 $ 75,395,969 $ 117,238,693 $ 165,608,534 $ 145,775,696 $ 59,347,948 $ 55,351,358 6 $ 74,630,019 $ 115,870,168 $ 164,084,260 $ 144,465,651 $ 58,739,309 $ 54,561,477 7 $ 73,149,957 $ 113,537,447 $ 161,880,416 $ 143,048,555 $ 57,829,352 $ 53,610,555 8 $ 72,261,386 $ 112,100,397 $ 158,220,175 $ 140,482,698 $ 56,918,186 $ 52,592,079 9 $ 71,342,842 $ 110,468,401 $ 155,854,981 $ 137,318,432 $ 55,894,240 $ 51,544,836 10 $ 70,195,198 $ 107,887,242 $ 153,193,421 $ 134,991,772 $ 54,887,268 $ 50,557,441 11 $ 68,981,147 $ 105,138,088 $ 148,382,102 $ 131,582,081 $ 53,817,889 $ 49,432,647 12 $ 67,149,553 $ 102,142,062 $ 144,556,568 $ 129,029,429 $ 52,813,707 $ 48,605,367 13 $ 65,705,603 $ 98,876,084 $ 140,265,621 $ 125,457,545 $ 51,834,618 $ 47,558,170 14 $ 63,210,889 $ 95,394,444 $ 136,583,138 $ 121,706,895 $ 50,355,268 $ 46,337,600 15 $ 60,052,314 $ 92,501,939 $ 133,252,925 $ 118,983,067 $ 49,261,441 $ 45,710,455 16 $ 58,133,496 $ 89,402,897 $ 129,792,748 $ 116,012,173 $ 48,013,883 $ 45,288,892 17 $ 56,900,372 $ 83,793,933 $ 127,118,396 $ 112,424,165 $ 46,682,595 $ 44,736,648 18 $ 55,154,969 $ 81,637,626 $ 124,262,781 $ 109,695,150 $ 45,808,180 $ 44,334,435 19 $ 50,852,179 $ 79,392,938 $ 119,512,141 $ 107,288,894 $ 44,422,122 $ 43,964,717 20 $ 49,702,926 $ 77,843,648 $ 116,408,786 $ 104,842,028 $ 43,821,316 $ 43,417,008 21 $ 48,629,373 $ 76,319,392 $ 113,506,699 $ 101,806,498 $ 42,973,221 22 $ 45,780,152 $ 74,512,970 $ 108,064,086 $ 98,013,963 $ 41,901,327 23 $ 44,612,888 $ 71,644,155 $ 104,734,353 $ 95,627,417 $ 41,054,409 24 $ 43,845,616 $ 69,074,182 $ 101,605,131 $ 92,702,818 $ 39,983,743 25 $ 42,879,623 $ 66,456,654 $ 98,057,107 $ 89,450,634 $ 38,501,039 26 $ 40,453,030 $ 63,909,211 $ 94,776,180 $ 87,745,088 $ 37,990,490 27 $ 38,939,475 $ 61,789,775 $ 91,621,984 $ 85,848,197 $ 37,156,755 28 $ 38,094,550 $ 59,776,201 $ 88,960,343 $ 83,961,093 $ 36,185,661 29 $ 37,287,522 $ 56,901,545 $ 87,513,930 $ 81,180,064 $ 35,520,835 30 $ 36,315,115 $ 55,673,168 $ 84,993,550 $ 79,358,028 $ 34,757,751 31 $ 35,921,142 $ 54,358,523 $ 82,761,581 $ 77,639,662 $ 33,935,509 32 $ 34,976,083 $ 53,498,302 $ 81,263,821 $ 76,476,892 $ 33,413,263 33 $ 33,841,626 $ 52,449,253 $ 79,413,800 $ 74,771,334 $ 32,816,210 34 $ 33,114,404 $ 50,659,884 $ 77,515,749 $ 73,827,440 $ 32,271,294 35 $ 32,042,753 $ 49,557,700 $ 75,640,670 $ 71,857,595 36 $ 31,308,902 $ 48,739,883 $ 74,138,736 $ 70,570,042 37 $ 30,544,226 $ 47,409,883 $ 73,172,980 $ 68,966,966 38 $ 30,042,212 $ 46,964,391 $ 72,502,513 39 $ 29,441,691 $ 46,032,969 $ 71,078,320 40 $ 28,874,422 $ 45,160,626 $ 69,847,023 41 $ 28,026,177 $ 44,409,740 42 $ 27,865,131 $ 43,860,257 43 $ 27,319,610 $ 43,340,538 44 $ 26,768,456 45 $ 26,284,168 46 $ 25,754,675
27
Delinquencies > 30 days Past Due --------------------------------------------------------------------------------------------------------------------------------- Months from Pool Inception 1997-1 1997-2 1997-3 1997-4 1998-1 1999-1 --------------------------------------------------------------------------------------------------------------------------------- 1 $ 0 $ 515,954 $ 609,201 $ 402,972 $ 44,600 $ 1,466,076 2 $ 1,499,056 $ 1,631,017 $ 2,042,757 $ 2,132,028 $ 1,223,964 $ 3,134,425 3 $ 1,931,761 $ 3,930,423 $ 4,498,266 $ 5,049,035 $ 2,013,525 $ 2,438,937 4 $ 3,760,774 $ 5,399,569 $ 8,546,414 $ 7,290,097 $ 3,872,888 $ 2,434,471 5 $ 5,220,385 $ 7,293,856 $ 12,337,604 $ 10,290,987 $ 3,825,651 $ 2,662,519 6 $ 5,849,574 $ 9,790,732 $ 13,432,454 $ 13,459,369 $ 5,199,587 $ 2,804,957 7 $ 6,777,962 $ 11,933,526 $ 15,076,729 $ 12,443,357 $ 6,248,301 $ 3,115,273 8 $ 8,078,783 $ 12,484,893 $ 17,745,496 $ 13,861,088 $ 5,983,226 $ 3,351,500 9 $ 8,528,559 $ 12,471,739 $ 18,099,411 $ 16,777,959 $ 6,591,674 $ 3,512,716 10 $ 10,008,415 $ 11,304,455 $ 16,680,011 $ 19,050,239 $ 6,317,098 $ 3,579,689 11 $ 10,728,125 $ 12,630,402 $ 18,929,917 $ 18,524,292 $ 5,701,474 $ 2,689,907 12 $ 9,257,295 $ 14,540,910 $ 21,295,026 $ 18,470,254 $ 5,950,145 $ 3,084,083 13 $ 9,578,031 $ 12,933,959 $ 22,303,472 $ 18,645,129 $ 5,705,994 $ 3,360,592 14 $ 10,757,672 $ 12,674,148 $ 21,746,520 $ 17,059,730 $ 5,287,678 $ 3,540,638 15 $ 9,401,614 $ 14,212,157 $ 23,240,338 $ 15,698,435 $ 6,297,465 $ 3,390,079 16 $ 8,127,303 $ 14,386,886 $ 22,031,312 $ 16,318,099 $ 6,255,440 $ 4,398,425 17 $ 8,227,263 $ 11,723,546 $ 19,672,481 $ 15,292,242 $ 6,342,927 $ 3,841,679 18 $ 8,708,963 $ 11,171,133 $ 18,472,732 $ 15,132,124 $ 7,150,420 $ 3,757,618 19 $ 7,349,210 $ 12,018,899 $ 18,243,184 $ 15,706,290 $ 6,380,174 $ 4,546,107 20 $ 7,217,783 $ 11,810,332 $ 18,119,731 $ 16,301,760 $ 6,080,991 $ 3.954,210 21 $ 7,120,727 $ 11,040,206 $ 18,038,082 $ 15,464,631 $ 6,103,461 22 $ 6,661,879 $ 10,286,947 $ 16,452,727 $ 14,333,343 $ 6,165,388 23 $ 6,511,325 $ 10,414,360 $ 16,055,129 $ 15,895,532 $ 5,571,022 24 $ 6,250,278 $ 8,906,082 $ 15,924,085 $ 14,232,856 $ 5,290,607 25 $ 6,276,717 $ 9,514,340 $ 15,482,673 $ 13,162,282 $ 4,817,659 26 $ 5,442,995 $ 8,806,693 $ 15,438,560 $ 12,180,657 $ 5,597,356 27 $ 4,900,780 $ 8,262,250 $ 14,301,848 $ 12,737,934 $ 4,386,742 28 $ 6,106,097 $ 8,642,371 $ 13,359,698 $ 11,694,987 $ 4,583,117 29 $ 4,982,511 $ 6,969,409 $ 13,659,548 $ 11,460,244 $ 4,045,655 30 $ 5,346,769 $ 7,939,953 $ 11,918,981 $ 10,909,001 $ 3,980,150 31 $ 5,756,594 $ 7,790,662 $ 10,833,705 $ 9,815,183 $ 4,018,994 32 $ 4,972,092 $ 6,957,167 $ 10,924,836 $ 9,618,960 $ 3,613,024 33 $ 4,995,142 $ 6,445,310 $ 10,766,050 $ 9,552,132 $ 3,496,246 34 $ 4,944,931 $ 6,168,132 $ 8,884,739 $ 9,027,820 $ 3,172,976 35 $ 3,900,531 $ 5,871,698 $ 8,549,661 $ 8,351,543 36 $ 3,884,396 $ 6,401,739 $ 9,144,434 $ 8,958,424 37 $ 3,242,843 $ 5,254,138 $ 8,807,168 $ 8,464,824 38 $ 3,266,679 $ 4,385,425 $ 8,035,129 39 $ 3,322,549 $ 4,646,624 $ 8,446,342 40 $ 2,622,995 $ 3,906,395 $ 8,315,750 41 $ 2,956,319 $ 3,886,438 42 $ 3,227,518 $ 3,885,226 43 $ 3,076,141 $ 3,706,334 44 $ 2,727,918 45 $ 2,644,450 46 $ 2,550,625
The principal balances and delinquency amounts include $4.9 million and $4.7 million of real estate acquired through foreclosure at December 31, 2000 and 1999, respectively. 28
Delinquencies > 30 days Past Due As a Percent of Current Balance --------------------------------------------------------------------------------------------------------------------- Months from Pool Inception 1997-1 1997-2 1997-3 1997-4 1998-1 1999-1 Average --------------------------------------------------------------------------------------------------------------------- 1 0.00 % 0.43 % 0.47 % 0.34 % 0.07 % 2.48 % 0.63 % 2 1.94 % 1.36 % 1.21 % 1.81 % 1.96 % 5.41 % 2.28 % 3 2.52 % 3.29 % 2.67 % 3.40 % 3.27 % 4.26 % 3.24 % 4 4.96 % 4.54 % 5.12 % 4.96 % 6.37 % 4.33 % 5.05 % 5 6.92 % 6.22 % 7.45 % 7.06 % 6.45 % 4.81 % 6.49 % 6 7.84 % 8.45 % 8.19 % 9.32 % 8.85 % 5.14 % 7.96 % 7 9.27 % 10.51 % 9.31 % 8.70 % 10.80 % 5.81 % 9.07 % 8 11.18 % 11.14 % 11.22 % 9.87 % 10.51 % 6.37 % 10.05 % 9 11.95 % 11.29 % 11.61 % 12.22 % 11.79 % 6.81 % 10.95 % 10 14.26 % 10.48 % 10.89 % 14.11 % 11.51 % 7.08 % 11.39 % 11 15.55 % 12.01 % 12.76 % 14.08 % 10.59 % 5.44 % 11.74 % 12 13.79 % 14.24 % 14.73 % 14.31 % 11.27 % 6.35 % 12.45 % 13 14.58 % 13.08 % 15.90 % 14.86 % 11.01 % 7.07 % 12.75 % 14 17.02 % 13.29 % 15.92 % 14.02 % 10.50 % 7.64 % 13.07 % 15 15.66 % 15.36 % 17.44 % 13.19 % 12.78 % 7.42 % 13.64 % 16 13.98 % 16.09 % 16.97 % 14.07 % 13.03 % 9.71 % 13.98 % 17 14.46 % 13.99 % 15.48 % 13.60 % 13.59 % 8.59 % 13.29 % 18 15.79 % 13.68 % 14.87 % 13.79 % 15.61 % 8.48 % 13.70 % 19 14.45 % 15.14 % 15.26 % 14.64 % 14.36 % 10.34 % 14.03 % 20 14.52 % 15.17 % 15.57 % 15.55 % 13.88 % 9.11 % 13.97 % 21 14.64 % 14.47 % 15.89 % 15.19 % 14.20 % 12.40 % 22 14.55 % 13.81 % 15.22 % 14.62 % 14.71 % 12.15 % 23 14.60 % 14.54 % 15.33 % 16.62 % 13.57 % 12.44 % 24 14.26 % 12.89 % 15.67 % 15.35 % 13.23 % 11.90 % 25 14.64 % 14.32 % 15.79 % 14.71 % 12.51 % 12.00 % 26 13.46 % 13.78 % 16.29 % 13.88 % 14.73 % 12.02 % 27 12.59 % 13.37 % 15.61 % 14.84 % 11.81 % 11.37 % 28 16.03 % 14.46 % 15.02 % 13.93 % 12.67 % 12.02 % 29 13.36 % 12.25 % 15.61 % 14.12 % 11.39 % 11.12 % 30 14.72 % 14.26 % 14.02 % 13.75 % 11.45 % 11.37 % 31 16.03 % 14.33 % 13.09 % 12.64 % 11.84 % 11.32 % 32 14.22 % 13.00 % 13.44 % 12.58 % 10.81 % 10.68 % 33 14.76 % 12.29 % 13.56 % 12.78 % 10.65 % 10.67 % 34 14.93 % 12.18 % 11.46 % 12.23 % 9.83 % 10.11 % 35 12.17 % 11.85 % 11.30 % 11.62 % 7.82 % 36 12.41 % 13.13 % 12.33 % 12.69 % 8.43 % 37 10.62 % 11.08 % 12.04 % 12.27 % 7.67 % 38 10.87 % 9.34 % 11.08 % 5.22 % 39 11.29 % 10.09 % 11.88 % 5.54 % 40 9.08 % 8.65 % 11.91 % 4.94 % 41 10.55 % 8.75 % 3.22 % 42 11.58 % 8.86 % 3.41 % 43 11.26 % 8.55 % 3.30 % 44 10.19 % 1.70 % 45 10.06 % 1.68 % 46 9.90 % 1.65 % Actual Historical Life to Date Prepayment Speed 22.3 % 24.1 % 22.4 % 20.6 % 18.7 % 15.9 % 18.9 % The following presents delinquencies, net credit losses, and securitized financial assets managed by the Company. Total Principal Principal Amount of Loans Amount of Loans 60 Days or More Past Due Net Credit Losses --------------------------------------------------------------------------------- 2000 1999 2000 1999 2000 1999 --------------------------------------------------------------------------------- Residential mortgage loans $ 342,081 $ 423,619 $ 24,964 $ 34,322 $ 5,400 $ 5,421 Less: Loans securitized 283,598 360,377 18,661 29,144 3,410 1,767 --------------------------------------------------------------------------------- Loans held in portfolio $ 58,483 $ 63,242 $ 6,303 $ 5,178 $ 1,990 $ 3,654 ================================================================================= Liquidity and Capital Resources
29 The Company's business requires continued access to short and long-term sources of debt financing and equity capital. Primarily as a result of selling fewer loans in 2000 than were originated in 2000, and as a result of its operating loss, the Company experienced a negative cash flow from operating activities in 2000 of $62.7 million. At December 31, 2000, the Company had deficit shareholders' equity of $10.8 million. Although the Company's goal is to achieve a positive cash flow each quarter, no assurance can be given that this objective will be attained due to the higher level of cash required to fund the loans purchased and originated. Currently, the Company's primary operating cash uses include the funding of (i) loan originations and purchases pending their securitization or sale, (ii) interest expense on CII investor savings notes, senior unsecured debt and its revolving warehouse credit and purchase facilities ("Credit Facilities"), (iii) fees, expenses, overcollateralization, servicer advances and tax payments incurred in connection with the securitization program and (iv) ongoing administrative and other operating expenses. The Company's primary operating sources of cash are (i) cash gains from whole-loan mortgage loan sales, (ii) cash payments of contractual and ancillary servicing revenues received by the Company in its capacity as servicer for securitized loans, (iii) interest income on loans receivable and certain cash balances, (iv) fee income received in connection with its retail mortgage loan originations, and (v) excess cash flow received in each period with respect to residual receivables. The Company overcollateralizes loans as a credit enhancement on the mortgage loan securitization transactions. This requirement creates negative cash flows in the year of securitization. The Company decided to securitize only seasoned first and second mortgages in 2000, and conducted whole loan sales for the majority of the mortgages. Currently the Company plans to conduct a combination of securitizations and whole loan sales throughout 2001. This strategy is designed to maximize liquidity and profitability. Cash flow is also enhanced by the generation of loan fees in its retail mortgage loan operation. The table below summarizes cash flows provided by and used in operating activities:
For the Years Ended December 31, --------------------------------------------------- 2000 1999 1998 -------------- -------------- -------------- (In thousands) Operating Cash Income: Servicing fees received and excess cash flow from securitization trusts $ 11,594 $ 15,622 $ 16,548 Interest received 11,799 9,475 36,127 Cash gain on sale of loans 9,801 6,477 1,343 Cash loan origination fees received 19,480 4,841 18,255 Other cash income 1,354 1,609 5,388 ------------- ------------- ------------- Total operating cash income 54,028 38,024 77,661 Operating Cash Expenses: Securitization costs -- (593) (851) Cash operating expenses (56,831) (37,456) (99,551) Interest paid (17,895) (18,691) (37,519) Taxes paid (175) (278) (2,515) ------------- ------------- ------------- Total operating cash expenses (74,901) (57,018) (140,436) Cash flow (deficit) due to operating cash income and expenses (20,873) (18,994) (62,775) Other Cash Flows: Cash used in other payables and receivables (33,671) (7,741) (12,541) Cash provided by (used in) loans held for sale (8,177) 33,951 123,674 Cash provided from sale of residual receivables -- -- 16,958 Cash gain on sale of subsidiary assets -- -- 18,964 ------------- ------------- ------------- Net cash provided by (used in) operating activities $ (62,721) $ 7,216 $ 84,280 ============= ============= =============
Cash and cash equivalents were $3.7 million at December 31, 2000, $26.0 million at December 31, 1999, and $36.9 million at December 31, 1998. Cash used in operating activities was $62.7 million for the year ended December 31, 2000, compared to cash provided by operating activities of $7.2 million for the year ended December 31, 1999. Cash provided by investing activities was $44.8 million for the year ended December 31, 2000, compared to cash provided by investing activities of $16.7 million for the year ended December 31, 1999, and cash used in financing activities was $4.4 million for the year ended December 31, 2000, compared to cash used by financing activities of $34.8 million for the year ended December 31, 1999. The decrease in cash provided by operations was due principally to a lower number of loans sold and securitized than originations in 2000, along with the operating loss. Cash provided by investing activities was primarily from the principal collections on loans not sold and proceeds from the sale of owned real estate. The increase in cash provided by financing activities was due principally to retirement in 1999 of $74.5 million face amount of the Senior Notes for a purchase price of $45.0 million. 30 In connection with the merger with HomeSense, the Company entered into a new $40 million revolving warehouse line of credit with Household Commercial Financial Services, Inc. Subsequent to the merger, the maximum commitment was increased to $50 million. The line bears interest at the prime rate plus 0.25% and is collateralized by mortgage loan receivables. The agreement requires, among other matters, minimum net worth of the Company of $10,000,000 commencing August 31, 2000, a leverage ratio of less than 35 to 1, and positive consolidated net income for each quarter beginning on or after July 1, 2000. The Company is currently in default with these covenants. Amendments were subsequently executed whereby the lender agreed to forebear from exercising its rights on account of existing events of default, the maturity date was extended to April 30, 2001, and the advance rate was changed to 97% from 100% for all loans made after October 23, 2000. Availability under the credit agreement is determined based on eligible collateral as defined in the agreement, for which the Company has forwarded to the bank the required loan files and documentation. At December 31, 2000, the balance of funded loans on the line was $2.6 million. Prior to the merger, HomeSense had a $25 million revolving purchase facility with Residential Mortgage Services of Texas ("RMST"). This agreement was amended at the time of the merger to extend to the merged entity. The agreement is structured as a purchase of the mortgages by RMST, subject to a limited right of RMST to require the repurchase of defective mortgages by the Company. The facility bears interest at the prime rate plus 0.75%. Under a termination agreement between RMST and the Company, the maximum commitment at December 31, 2000 was $15 million, and the outstanding balance on that date was $11.4 million. An additional provision of the termination agreement required the Company to assign a $3.5 million certificate of deposit to RMST as security for the outstanding balance on the line. As of March 31, 2001, the agreement with RMST was terminated, and RMST's right to the certificate of deposit was relinquished, and no balance remained outstanding. On November 3, 2000, the Company entered into a $10 million revolving warehouse line of credit with The Provident Bank ("Provident"). Interest on the line varies on a loan by loan basis and ranges from the prime rate plus 1.5% to the prime rate plus 3.5%, depending on the grade and age of the mortgage funded. The agreement allows for a rate reduction from the base rates if certain monthly funded volume targets are met. For the month of December, 2000, the Company achieved the targeted funded volume for the first stage rate reduction of .15% from the initial base rates. The agreement contains no covenants related to the financial condition or results of operations of the Company. The agreement allows Provident to retain the servicing rights to any loans funded on the line of credit. Availability under the credit agreement is determined based on eligible collateral as defined in the agreement, for which the Company has forwarded to the bank the required loan files and documentation. The line of credit matures on October 31, 2001. At December 31, 2000, the balance of funded loans on the line was $6.6 million, and these loans were all sub-serviced by Provident. On December 20, 2000, the Company entered into an oral short term repurchase arrangement with New Freedom Mortgage Corporation ("New Freedom") as an interim funding source while a long-term warehouse agreement was being negotiated. Under the arrangement, New Freedom agreed to fund both new mortgage production and certain mortgages originally funded by the Company. The advance rates on fundings range from 80% to 88% of the principal amount, depending on the type and source of the mortgage. New Freedom receives a fee from 1.5% up to 2.5% of the note amount based on the length of time credit is provided for each loan funded. In addition, New Freedom receives the interest accrued on the loan during the period it remains on the line. At December 31, 2000, the outstanding balance on the line was $6.3 million. The arrangement was terminated in February, 2001, after the execution of a new long-term warehouse agreement with another lender. During December 2000, the Company terminated its revolving warehouse line of credit agreement with CIT Group/Business Credit, Inc. ("CIT"). At December 31, 1999, the Company had $1.1 million of immediate availability under the CIT agreement, based on its borrowing base on that date. Upon termination of the agreement, the company has no further obligations thereunder. At December 31, 2000, the Company believes that no event of default has occurred on its warehouse lines of credit for which it has not obtained a waiver or forbearance. On January 11, 2001, the Company entered into a $15 million master repurchase agreement with Imperial Warehouse Finance, Inc. Advance rates on fundings range from 85% to 88% of the principal amount, depending on the type and source of the mortgage. The facility bears interest at prime rate plus 1.00%. The agreement requires a collateral deposit of $2.5 million be in place for the life of the line. The agreement also requires that the Company have net operating income for any period after January 2001. The Company is currently in default with the agreement. Management is currently negotiating a waiver and/or modification of the terms of the agreement. Management believes they will be successful in obtaining a modified agreement, or waiver at a minimum, although there can be no assurance that a new agreement will be reached. 31 During 1997, the Company sold $125.0 million in aggregate principal amount of 10 3/4% Senior Notes due 2004. The Senior Notes due 2004 constitute unsecured indebtedness of the Company. The Senior Notes due 2004 are redeemable at the option of the Company, in whole or in part, on or after September 15, 2001, at predetermined redemption prices plus accrued and unpaid interest to the date of redemption. This agreement requires, among other matters, restrictions on the payment of dividends. At December 31, 2000, management believes the Company was in compliance with such restrictive covenants. The Senior Notes due 2004 are fully and unconditionally guaranteed (the "Subsidiary Guarantees") jointly and severally on an unsecured basis (each, a "Guarantee") by certain of the Company's subsidiaries (the "Subsidiary Guarantors"). With the exception of the Guarantee by CII, the Subsidiary Guarantees rank on par with the right of payment with all existing and future unsubordinated indebtedness of the Subsidiary Guarantors and senior in right of payment to all existing and future subordinated indebtedness of such Guarantors. The Guarantee by CII is equal in priority to CII's notes payable to investors and is senior to CII's subordinated debentures. The Company purchased $920,000, $74.5 million, and $38.4 million in face amount of its senior notes in 2000, 1999, and 1998, respectively. At December 31, 2000 and 1999, $11.2 million and $12.1 million, respectively, in aggregate principal amount of Senior Notes were outstanding. CII engages in the sale of CII Notes to investors. The CII Notes are comprised of senior notes and subordinated debentures bearing fixed rates of interest which are sold by CII only to South Carolina residents. The offering of the CII Notes is registered under South Carolina securities law and is believed to be exempt from Federal registration under the Federal intrastate exemption. CII believes it conducts its operations so as to qualify for the safe harbor provisions of Rule 147 promulgated pursuant to the Securities Exchange Act of 1933, as amended (the "Securities Act"). At December 31, 2000, CII had an aggregate of $146.1 million of investor notes outstanding bearing a weighted average interest rate of 7.92%, and an aggregate of $19.1 million of subordinated debentures bearing a weighted average interest rate of 6.00%. The investor notes and subordinated debentures are subordinate in priority to the credit facility. Maturities of the CII Notes and debentures generally range from one to two years. Shareholders' equity decreased in 2000 by $18.7 million to ($10.8 million) at December 31, 2000, from $7.8 million at December 31, 1999. During 1999, stockholders equity increased $2.0 million from $5.8 million at December 31, 1998. The principal reason for the change to shareholders' equity is the net income (loss) recognized in the respective years. HGFN has incurred operating losses of $39.8 million, $35.1 million, and $73.0 million for the years ended December 31, 2000, 1999, and 1998, respectively and has deficit shareholder's equity of $10.8 million at December 31, 2000. The management of HGFN has implemented plans to reverse these negative trends by implementing operating changes which include, but are not limited to, the following: - Continually offering and reviewing loan products to meet customer demands while also meeting the needs of purchasers of loans originated. - Hiring, retaining, and motivating loan officers and employees. - Geographic expansion of loan origination operations. - Maintaining and increasing warehouse lines of credit to fund loan originations. - Reducing non-core operating and general overhead. - Negotiating with potential buyers the sale of non-core lines of business and assets The Company's primary objective in 2001 will be to increase profitability and increase loan originations while insuring adequate levels of liquidity. The Company anticipates incurring operating losses into 2001. The Company continually evaluates the need to establish other sources of capital and will pursue those it considers appropriate based upon its needs and market conditions. The Company currently does not anticipate incurring any significant capital expenditures in 2001. Loan Sales and Securitizations The Company sells or securitizes substantially all of its loans. The Company sells on a whole loan basis a significant amount of its Mortgage Loans (servicing released), including substantially all of its Mortgage Loans secured by second liens, principally to secure the additional cash flow associated with the premiums paid in connection with such sales and to eliminate the credit risk associated with the second lien mortgage loans. However, no assurance can be given that the second lien mortgage loans can be sold. To the extent that the loans are not sold, the Company retains the risk of loss. At December 31, 2000 and 1999, the Company had retained $17.1 million and $9.5 million, respectively, of second lien mortgage loans on its balance sheet. During 2000, 1999, and 1998, the Company sold $517.3 million, $220.4 million, and $623.7 million, respectively, of Mortgage Loans. In 1998, the Company sold $141.0 million of the guaranteed portions of SBA Loans. Although securitizations provide liquidity, the Company has utilized securitizations principally to provide a lower cost of funds and reduce interest rate risk, while building servicing revenues by increasing the serviced portfolio. In connection with its securitizations, the Company has retained interest-only residual certificates representing residual interests in the trusts. These subordinate residual securities totaled $47.8 million, net of allowances, at December 31, 1999. 32 The first, second and third securitizations of 1997 and the 1998 securitization are structured as real estate mortgage investment conduits ("REMIC's"). The fourth quarter 1997 securitization utilized a real estate investment trust ("REIT"). This allows sales treatment for financial reporting purposes, but debt treatment for tax purposes. Accordingly, this structure eliminates current taxes payable on the book gain, while maintaining the structural efficiency of tranching, previously only available through a REMIC transaction. Additionally, under this structure, the Company has distributed .46% ownership in the REIT to a certain class of current and former employees, with an initial value of approximately $62,000. The 2000 securitization are "Owners' Trusts", another structure which allows sales treatment for financial reporting purposes, but debt treatment for tax purposes. The Company has been securitizing mortgage loans since 1997. In a securitization transaction, the Company sells Mortgage Loans it purchased or originated to a trust for cash. The trust sells asset-backed bonds secured by the loans to investors. The Company records certain assets and income based upon the difference between all principal and interest received from the loans sold and the following factors (i) all principal and interest required to be passed through to the asset-backed bond investors, (ii) all excess contractual servicing fees, (iii) other recurring fees and (iv) an estimate of losses on the loans (collectively, the "Excess Cash Flow"). At the time of the securitization, the Company estimates these amounts based upon a declining principal balance of the underlying loans, adjusted by an estimated prepayment and loss rate, and capitalizes these amounts using a discount rate that market participants would use for similar financial instruments. These capitalized assets are recorded as a residual receivable. The Company believes the assumptions it has used in past securitizations are appropriate and reasonable. In connection with its 1999-1 securitization transaction, HomeGold agreed to cross-collateralize its residual interests in that transaction and in its 1997-1, 1997-2, and 1997-3 securitizations for the benefit of Financial Security Assurance, Inc., the bond issuer for all of those transactions. Under the terms of that cross-collateralization agreement, in the event HomeGold is in breach of its obligations under any one or more of those securitization trusts or if certain cumulative loss or delinquency triggers are met, the excess cash flow on all four residual interests will be captured by the Collateral Agent, who will distribute those monies to FSA or as otherwise specified in the agreement. The total amount that may be retained by the Collateral Agent is capped at $15 million. This agreement terminates upon the termination of all of the related securitization trusts. The Company sold its servicing rights under the 2000 securitizations because the price paid by the independent third party servicer resulted in a higher realized gain than if the servicing rights not been sold. Consequently, the residual interests of $14.5 million owned by the Company are not subject to the Company's normal quarterly evaluation of assumptions and estimates as compared to actual performance. These residual interests represent the Company's estimate of market value. Market value determination includes an estimate of credit losses, based on anticipated performance of the securitized loans in the portfolio. The original certificate balances for the 2000 securitizations totaled $64,330,194. The 2000-4 trust had an original certificate balance of $41,473,722 with the Company's share of the original certificate balances being $12,047,487. The 2000-5 trust had an original certificate balance of $22,856,471 with the Company's share of the original certificate balances being $5,142,707. The average stated principal balances are $54,734 and $47,105 for pools 2000-4 and 2000-5, respectively. The annual servicing fees are 0.58% and 0.50% for 2000-4 and 2000-5, respectively, and the trustee fee is .050%. At December 31, 2000, the 2000-4 trust had outstanding principal balances of $37,711,512 with the Company's certificate share being $11,872,993. The 2000-5 trust had outstanding principal balances of $21,809,445 with the Company's certificate share being $5,142,707. Interest income is allocated to the bondholders based on the certificate balances. At December 31, 2000, the weighted average pass through rate to bondholders is 11.74% and 11.89% for 2000-4 and 2000-5, respectively. The Company will not receive its share of principal distribution until three years from the time of the transaction. After three years, principal distribution will be received if the portfolios meet certain performance requirements. Although the Company is a certificate holder, its share of the principal balance is reduced by all losses incurred by the pools. The assumed cumulative losses as a percent of the unpaid principal balance at December 31, 2000 are 4.95% and 3.9% for the 2000-4 and 2000-5 pools. These assumed loss rates are used in estimating the market value of the Company's residual interest. 33 The Company retains the right to service loans it securitizes except for the 2000 securitization. Fees for servicing loans are based on a stipulated percentage (generally 0.50% per annum) of the unpaid principal balance of the associated loans. Other than the 2000 securitization, the Company has recognized a servicing asset in addition to its gain on sale of loans. The servicing asset is calculated as the present value of the expected future net servicing income in excess of adequate compensation for a substitute servicer, based on common industry assumptions and the Company's historical experience. These factors include default and prepayment speeds. For all of the mortgage loan securitizations completed to date, the servicing asset recorded represents a 10 basis point strip of cash flows from the stipulated servicing percentage. The following sets forth facts and assumptions used by the Company in arriving at the valuation of the residual receivables relating to its Mortgage Loan securitization pools it services as of December 31, 2000:
1997-1 1997-2 1997-3 1997-4 1998-1 1999-1 ------------------------------------------------------------------------------------ Outstanding balance of loans securitized $25,754,675 $43,340,538 $69,847,023 $68,966,966 $32,271,294 $43,417,008 Average stated principal balance 55,988 53,179 61,323 60,817 59,984 46,386 Weighted average coupon on loans 10.83% 10.64% 11.03% 10.88% 10.76% 10.91% Weighted average remaining term to stated maturity 164 mths 163 mths 168 mths 171 mths 181 mths 194 mths Weighted average LTV 75% 70% 74% 74% 74% 71% Percentage of first mortgage loans 100% 100% 100% 100% 100% 86.91% Weighted average pass-through rate to 7.66% 7.21% 7.10% 6.86% 6.70% 6.84% bondholders Assumed annual losses 0.18% 0.18% 0.26% 0.36% 0.39% 0.56% Remaining ramp period for losses 0 mths 0 mths 0 mths 0 mths 0 mths 0 mths Assumed cumulative losses as a % of UPB 1.44% 1.78% 2.50% 2.84% 3.25% 1.17% Annual servicing fee 0.50% 0.50% 0.50% 0.50% 0.50% 0.56% Servicing asset 0.10% 0.10% 0.10% 0.10% 0.10% 0.10% Discount rate applied to cash flow after collateralization 12% 12% 12% 12% 12% 12% Prepayment speed: Initial CPR (1) 0 CPR 0 CPR 0 CPR 0 CPR 0 CPR 24 HEP Peak CPR (1) 28 CPR 28 CPR 28 CPR 28 CPR 28 CPR 24 HEP Tail CPR (1) 26/24 CPR 26/24 CPR 26/24 CPR 26/24 CPR 26/24 CPR 24 HEP CPR ramp period (1) 12 mths 12 mths 12 mths 12 mths 12 mths 24 HEP CPR peak period (1) 24 mths 24 mths 24 mths 24 mths 24 mths 24 HEP CPR tail begins (1) 37/49 mths 37/49mths 37/49 mths 37/49 mths 37/49 mths 24 HEP Annual wrap fee and trustee fee 0.285% 0.205% 0.195% 0.185% 0.185% 0.265% Initial overcollateralization required (2) 3.25% -- -- -- -- 9.5% Final overcollateralization required (2) 6.5% 3.75% 3.75% 3.75% 3.75% 13.5%
(1) CPR represents an industry standard of calculating prepayment speeds and refers to Constant Prepayment Rate. For its first five securitization pools, the Company uses a curve based on various CPR levels throughout the pool's life, based on its estimate of prepayment performance, as outlined in the table above. For the 1999-1 transaction the Company uses a 24 HEP (Home Equity Prepayment) curve. This curve, developed by Prudential Securities, ramps to the terminal CPR (in this case, 24%) over ten months and then remains constant for the life of the pool. (2) Based on percentage of original principal balance, subject to step-down provisions after 30 months. Each of the Company's Mortgage Loan securitizations have been credit-enhanced by an insurance policy provided through a monoline insurance company such that the senior certificates have received ratings of "Aaa" from Moody's Investors Services, Inc. ("Moody's") and "AAA" from Standard & Poor's Ratings Group, a division of The McGraw-Hill Companies, Inc. ("Standard & Poor's"). The Company expects to begin receiving excess cash flow on its Mortgage Loan securitizations approximately 16 months from the date of securitization, although this time period may be shorter or longer depending upon the securitization structure and performance of the loans securitized. Prior to such time, the monoline insurer requires a reserve provision to be created within the securitization trust which uses Excess Cash Flow to retire the securitization bond debt until the spread between the outstanding principal balance of the loans in the securitization trust and the securitization bond debt equals a specified percentage (depending on the structure of the securitization) of the initial securitization principal balance (the "overcollateralization limit"). Once this overcollateralization limit is met, excess cash flows are distributed to the Company. The Company begins to receive regular monthly servicing fees in the month following securitization. The gains recognized into income resulting from securitization transactions vary depending on the assumptions used, the specific characteristics of the underlying loan pools, and the structure of the transaction. The Company believes the assumptions it has used are appropriate and reasonable. 34 The Company assesses the carrying value of its residual receivables and servicing assets for impairment at the end of each month. There can be no assurance that the Company's estimates used to determine the gain on sale of loans, residual receivables, and servicing assets valuations will remain appropriate for the life of each securitization. If actual loan prepayments or defaults exceed the Company's estimates, the carrying value of the Company's residual receivables and/or servicing assets may be decreased through a charge against earnings in the period management recognizes the disparity. Conversely, if actual loan prepayments or defaults are better than the Company's estimates, the carrying value of the Company's residual receivables and/or servicing assets may be increased, with additional earnings recognized in the period management recognizes the disparity. At December 31, 2000 key economic assumptions and the sensitivity of the current fair value of residual cash flows to immediate 5 percent and 10 percent adverse changes in assumed economics is as follows (dollars in thousands).
Loans (In Thousands) ----------------- Carrying amount/fair value of retained interests $ 58,877 Weighted-average life (in years) 4.24 Prepayment speed assumption (annual rate) 24% - 30% Impact on fair value of 5% adverse change $ 607 Impact on fair value of 10% adverse change $ 1,216 Expected credit losses (annual rate) 0.35 % Impact on fair value of 5% adverse change $ 390 Impact on fair value of 10% adverse change $ 780 Residual cash flows discount rate (annual) 12.0 % Impact on fair value of 5% adverse change $ 638 Impact on fair value of 10% adverse change $ 1,256
These sensitivities are hypothetical and should be viewed with caution. As the figures indicate, any change in fair value based on a 5 percent variation in assumptions cannot be extrapolated because the relationship of the change in assumption to the change in fair value is not linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated independent from any change in another assumption; in reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. Tax Considerations As a result of operating losses incurred by the Company, the Company has net operating losses ("NOL") that can be used to offset future earnings. Federal tax laws provide that net operating loss carryforwards are restricted or eliminated upon certain changes of control. Applicable federal tax laws provide that a 50% "change of control," which is calculated over a rolling three-year period, would cause the loss of substantially all of the NOL. The Company believes its maximum cumulative change of control during the relevant three-year period was less than 50%. During 2000 the Company recorded a deferred tax benefit in the amount of $10.0 million, bringing the total deferred tax asset to $22.0 million. The Company adjusted its reserve against the deferred tax asset in the fourth quarter 2000 based on its forecasted results prepared in December 2000 and operational changes implemented by changes made by management in 2000 due to the merger. The amount of the deferred tax asset is deemed appropriate by management based on its belief that it is more likely than not that it will realize the benefit of this deferred tax asset, given the levels of historical taxable income and current projections for future taxable income over the periods in which the deferred tax assets would be realized. The Company had a federal NOL of approximately $103 million at December 31, 2000. 35 Hedging Activities The Company's profitability may be directly affected by fluctuations in interest rates. While the Company monitors interest rates it may, from time to time, employ a strategy designed to hedge some of the risks associated with changes in interest rates, however, no assurance can be given that the Company's results of operations and financial condition will not be adversely affected during periods of fluctuations in interest rates. The Company's interest rate hedging strategy includes shorting interest rate futures and treasury forwards, and entering into interest-rate lock agreements. Since the interest rates on the Company's warehouse line of credit used to fund and acquire loans is variable and the rates charged on loans the Company originates are fixed, increases in the interest rates after loans are originated and prior to their sale could have a material adverse effect on the Company's results of operations and financial condition. The ultimate sale of the Company's loans generally will fix the spread between the interest rates paid by borrowers and the interest rates paid to investors in securitization transactions with respect to such loans, although increases in interest rates may narrow the potential spread that existed at the time the loans were originated by the Company. Without hedging these loans, increases in interest rates prior to sale of the loans may reduce the gain on sale or securitization of loans earned by the Company. Accounting Considerations In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." All derivatives are to be measured at fair market value and recognized in the balance sheet as assets and liabilities. SFAS No. 137, "Accounting for Certain Derivative Instruments and Certain Hedging Activities" was issued in June 2000 and amends the accounting and reporting standards of SFAS No. 133 for certain derivative instruments and hedging activities. The two statements are to be adopted concurrently and are effective for fiscal years and quarters beginning after June 15, 2000. The adoption of SFAS No. 133 and SFAS No. 137 did not have a material impact on the presentation of the Company's financial results or financial position. In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of FASB No. 125." It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures but carries over most of FASB No. 125's provisions without reconsideration. SFAS No. 140 is effective for all transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001. Retroactive and early adoption is prohibited. This statement is effective for disclosures related to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of provisions of SFAS No. 140 is not expected to be material to the Company. In the November 2000 meeting, the Emerging Issues Task Force (EITF) reached a consensus on EITF 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets." The issue deals with how interest income and impairment should be recognized for retained interests in securitizations. If upon evaluation, the holder determines that it is probable that there is a change in estimated cash flows (in both timing and estimates of projected cash flows) , the amount of accretable yield should be recalculated and if that change in estimated cash flows is an adverse change, an other-than-temporary impairment should be considered to have occurred. The effective date of this EITF is March 15, 2001. The Company does not know if there is any impact of this EITF on its residual assets or if the impact could be material. The Company anticipates implementing EITF 99-20 in the first quarter of 2001. The FASB reached a tentative decision related to accounting treatment for goodwill in its Business Combinations and Intangible Assets - Accounting for Goodwill project and related exposure draft. In this exposure draft, the FASB has determined that goodwill will no longer be amortized. Goodwill of a reporting unit should be tested for impairment when events or circumstances occur indicating that an impairment might exist. The FASB is expected to issue this accounting standard in 2001. The Company does not know the impact, if any, on its financial statements or its financial position related to this proposed guidance. Impact of Inflation Inflation affects the Company most significantly in the area of loan originations and can have a substantial effect on interest rates. Interest rates normally increase during periods of high inflation and decrease during periods of low inflation. Profitability may be directly affected by the level and fluctuation in interest rates which affect the Company's ability to earn a spread between interest received on its loans and the costs of its borrowings. The profitability of the Company is likely to be adversely affected during any period of unexpected or rapid changes in interest rates. A substantial and sustained increase in interest rates could adversely affect the ability of the Company to originate and purchase loans and affect the mix of first and second-lien mortgage loan products. Generally, first-lien mortgage production increases relative to second-lien mortgage production in response to low interest rates and second-lien mortgage production increases relative to first-lien mortgage production during periods of high interest rates. A significant decline in interest rates could decrease the size of the Company's loan servicing portfolio by increasing the level of loan prepayments. Additionally, to the extent servicing rights and residual receivables have been capitalized on the books of the Company, higher than anticipated rates of loan prepayments or losses could require the Company to write down the value of such servicing rights and residual receivables, adversely impacting earnings. Fluctuating interest rates may also affect the net interest income earned by the Company resulting from the difference between the yield to the Company on loans held pending sales and the interest paid by the Company for funds borrowed under the Company's warehouse line of credit. The Company's Chief Financial Officer, Rhonda Johnson, resigned effective Monday, March 26, 2001 to pursue other opportunities. She will serve as a consultant to the Company. Forrestt E. Ferrell, the Company's President will serve as the Company's interim Chief Financial Officer. 36 Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods. The Company's market risk arises primarily from interest rate risk inherent in its lending, its holding of residual receivables and its investor savings activities. The structure of the Company's loan and investor savings portfolios is such that a significant rise or decline in interest rates may adversely impact net market values and net interest income. The Company does not maintain a trading account nor is the Company subject to currency exchange risk or commodity price risk. Responsibility for monitoring interest rate risk rests with senior management. Senior management regularly reviews the Company's interest rate risk position and adopts balance sheet strategies that are intended to optimize operating earnings while maintaining market risk within acceptable guidelines. To estimate the impact that changes in interest rates would have on the Company's earnings, management uses Simulation Analysis. Simulation Analysis is performed using a computer-based asset/liability model which incorporates current portfolio balances and rates, contractual maturities, repricing opportunities and assumptions about prepayments, future interest rates and future volumes. To measure the sensitivity of the Company's earnings, the result of multiple simulations, which assume changes in interest rates, are compared to the "base case" simulation, which assumes no changes in interest rates. The model assumes an immediate parallel shift in interest rates. As a result of the Company's interest rate position, a 100 basis point immediate increase in interest rates would have a negative impact on projected net loss of $3.3 million and $1.4 million, computed as of December 31, 2000 and 1999, respectively. A significant portion of this impact relates to a reduction in the anticipated sale premiums on loans being held for sale as well as higher interest expense on the warehouse line of credit, partially offset by an increase in interest earned on short term investments. An immediate reduction of 100 basis points in market rates would result in a positive impact on projected net loss of $2.1 million and $893,000 as of December 31, 2000 and December 31, 1999, respectively. This impact is related to higher gains from the sale of loans, which is the primary reason for the positive impact on projected earnings at December 31, 1999 under the same interest rate scenario, and a decrease in interest paid on warehouse lines of credit, partially offset by the assumption that prepayment speeds on the securitization pools would increase approximately ten percent if market interest rates declined by 100 basis points.. The Company no longer believes, in the absence of other external factors, that it would experience an increase in prepayment speeds if market rates declined by 100 basis points due to the "burn-out" principal. In other words, since the borrowers have already had several opportunities to refinance because rates have been 100 basis points lower in the last twelve months, but have not, the likelihood of the remaining borrowers prepaying given further interest rate reductions is diminished. The Company assumes that it would not experience a significant benefit from a reduction in the rates paid on investor notes. The rates offered on the investor notes have not historically moved with changes in market rates. While the Company monitors interest rates and may, from time to time, employ a strategy designed to hedge some of the risks associated with changes in interest rates, no assurance can be given that the Company's results of operations and financial condition will not be adversely affected during periods of fluctuations in interest rates. As of December 31, 2000, the Company did not hedge its loans held for whole-loan sales. The Company's strategy during 2000 was to sell a substantial portion of the current month's production that is designated for whole-loan sales in the following month and securitizing a portion of its loan production on a quarterly basis. Because the interest rates on the Company's warehouse lines of credit used to fund and acquire loans are variable and the rates charged on loans the Company originates are fixed, increases in the interest rates after loans are originated and prior to their sale may reduce the gain on loan sales earned by the Company. There were no significant open hedging positions at year-end. 37 On loans originated for inclusion in securitized pools, the Company may employ a strategy designed to hedge some of the risks associated with changes in interest rates. The Company's interest rate hedging strategy, includes shorting interest rate futures and treasury forwards, and entering into interest-rate lock agreements relating to loans pending a securitization transaction. The ultimate sale of the Company's loans included in a securitized transaction generally will fix the spread between the interest rates paid by borrowers and the interest rates paid to investors in securitization transactions with respect to such loans, although increases in interest rates may narrow the potential spread that existed at the time the loans were originated by the Company. However, a significant reduction in market rates could accelerate the prepayment speed on loans held in the various securitized mortgage pools. An acceleration of prepayment on loans held in the securitized pools would have a negative impact on the carrying value of the residual assets. There were no significant open hedging positions at year end. Projected percentage changes in operating results brought about by changes in interest rates could be material relative to the Company's operating results. If simulation results indicate earnings sensitivity in excess of management's acceptable limits, management will seek to identify on-balance sheet and/or off-balance sheet strategies to bring earnings sensitivity within target guidelines. Management will continue to monitor the Company's interest rate risk position to manage the possible adverse impact on earnings caused by changes in interest rates. These analyses do not consider the effects of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management would likely take actions to further mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no changes in the Company's financial structure. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Financial Statements and Supplementary Data are set forth herein commencing on page F-1 of this Report. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 38 PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report. Item 11. EXECUTIVE COMPENSATION The information required by Item 11 is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report. 39 PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Documents filed as part of Report. 1. FINANCIAL STATEMENTS FOR HOMEGOLD FINANCIAL, INC.: The Financial Statements are listed in the index to Consolidated Financial Statements on page F-1 of this Report. 2. FINANCIAL STATEMENT SCHEDULES: Not applicable. 3. EXHIBITS: The exhibits are listed on the Exhibit Index attached hereto. (b) Reports on Form 8-K. None. 40 SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HOMEGOLD FINANCIAL, INC. ------------------------------------- Registrant April 16, 2001 /s/ John M. Sterling, Jr. ------------------------------------- ------------------------------------- (Date) John M. Sterling, Jr., Chairman of the Board of Directors Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ J. Robert Philpott, Jr. /s/ Tecumseh Hooper, Jr. ------------------------------------- ------------------------------------- J. Robert Philpott, Jr. Tecumseh Hooper, Jr. Director Director /s/ Ronald J. Sheppard /s/ Clarence B. Bauknight ------------------------------------- ------------------------------------- Ronald J. Sheppard Clarence B. Bauknight Chief Executive Officer Director /s/ John M. Sterling, Jr. /s/ Porter B. Rose ------------------------------------- ------------------------------------- John M. Sterling, Jr., Chairman of Porter B. Rose the Board of Directors Director /s/ Forrestt E. Ferrell /s/ Jan Sirota ------------------------------------- ------------------------------------- Forrestt E. Ferrell, President and Jan Sirota Director Director April 16, 2001 ------------------------------------- (Date) 41 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS Contents Independent Auditors' Report ..............................................F-2 Audited Consolidated Financial Statements Consolidated Balance Sheets.......................................F-3 Consolidated Statements of Operations.............................F-5 Consolidated Statements of Shareholders' Equity (Deficit).........F-6 Consolidated Statements of Cash Flows.............................F-7 Notes to Consolidated Financial Statements .......................F-8 F-1 INDEPENDENT AUDITORS' REPORT ---------------------------- Shareholders and Board of Directors HomeGold Financial, Inc. and Subsidiaries Greenville, South Carolina We have audited the accompanying consolidated balance sheets of HomeGold Financial, Inc. and Subsidiaries as of December 31, 2000 and 1999 and the related consolidated statements of operations, shareholders' equity (deficit), and cash flows for each of the years in the three year period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HomeGold Financial, Inc. and Subsidiaries as of December 31, 2000 and 1999 and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. Elliott, Davis & Company, L.L.P. Greenville, South Carolina March 21, 2001 F-2 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, ------------------------------ 2000 1999 -------------- ------------ ASSETS (In thousands, except share data) ------ Cash and cash equivalents $ 3,691 $ 26,009 Restricted cash 5,066 5,314 Loans receivable 58,483 63,242 Less allowance for credit losses (4,652) (6,344) Less deferred loan fees (2,339) (730) Plus deferred loan costs 207 446 -------------- ------------ Net loans receivable 51,699 56,614 Income taxes receivable 318 461 Accrued interest receivable 1,817 1,423 Other receivables 11,497 8,059 Residual receivables, net 58,877 47,770 Property and equipment, net 21,430 17,160 Real estate owned (REO) and personal property acquired through foreclosure 1,281 7,673 Goodwill, net of accumulated amortization of $1,712 in 2000 and $748 in 1999 19,623 1,566 Debt origination costs 221 1,658 Deferred income tax asset, net 22,000 12,000 Servicing asset 703 867 Other assets 3,798 2,163 -------------- ------------ Total assets $ 202,021 $ 188,737 ============== ============
See Notes to Consolidated Financial Statements, which are an integral part of these statements. F-3 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, -------------------------------- 2000 1999 --------------- ------------- LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) (In thousands, except share data) ---------------------------------------------- Liabilities: Revolving warehouse lines of credit $ 26,951 $ 17,808 Notes payable to banks 2,352 -- Investor savings: Notes payable to investors 146,087 127,065 Subordinated debentures 19,117 17,710 --------------- ------------- Total investor savings 165,204 144,775 Senior unsecured debt 11,214 12,134 Accounts payable and accrued liabilities 4,637 4,120 Remittances payable 1,201 1,078 Income taxes payable 347 120 Accrued interest payable 938 845 --------------- ------------- Total other liabilities 7,123 6,163 --------------- ------------- Total liabilities 212,844 180,880 Minority interest 5 13 Commitments and contingencies, Notes 2, 5, 8, 10, 11, 22 and 26 Shareholders' equity (Deficit): Preferred stock , par value $1.00 per share, authorized 20,000,000 shares, issued and outstanding 10,000,000 shares at December 31, 2000 and 0 shares at December 31, 1999 10,000 -- Common stock, par value $.001 per share at December 31, 2000 and $.05 at December 31, 1999, authorized 100,000,000 shares, issued and outstanding 16,810,149 shares at December 31, 2000 and 10,149,629 shares at December 31, 1999 17 507 Capital in excess of par value 46,643 39,028 Note receivable from shareholder (5,985) -- Accumulated deficit (61,503) (31,691) --------------- ------------- Total shareholders' equity (deficit) (10,828) 7,844 --------------- ------------- Total liabilities and shareholders' equity (deficit) $ 202,021 $ 188,737 =============== =============
See Notes to Consolidated Financial Statements, which are an integral part of these statements. F-4 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, -------------------------------------------------------- 2000 1999 1998 ----------------- --------------- --------------- (In thousands, except share data) REVENUES: Interest income $ 12,192 $ 8,286 $ 35,075 Servicing income 7,397 9,813 12,239 Gain on sale of loans: Gross gain on sale of loans 9,801 6,216 9,472 Loan fees, net 16,430 3,313 11,745 ----------------- --------------- --------------- Total gain on sale of loans 26,231 9,529 21,217 Gain on sale of subsidiaries' net assets -- -- 18,964 Other revenues 1,735 1,609 4,230 ----------------- --------------- --------------- Total revenues 47,555 29,237 91,725 ----------------- --------------- --------------- EXPENSES: Interest 19,448 16,338 35,968 Provision for credit losses 3,159 3,339 11,906 Costs on real estate owned and defaulted loans 3,451 3,018 2,665 Fair market value adjustment on residual receivables 2,279 3,327 13,638 Salaries, wages and employee benefits 29,116 20,359 56,925 Business development costs 8,615 4,804 10,818 Restructuring charges 1,469 -- 6,838 Other general and administrative expense 19,861 13,123 25,958 ----------------- --------------- --------------- Total expenses 87,398 64,308 164,716 ----------------- --------------- --------------- Loss before income taxes, minority interest and extraordinary item (39,843) (35,071) (72,991) Provision (benefit) for income taxes (9,456) (7,394) 3,017 ----------------- --------------- --------------- Loss before minority interest and extraordinary item (30,387) (27,677) (76,008) Minority interest in (earnings) loss of subsidiaries (4) (8) 47 ----------------- --------------- --------------- Loss before extraordinary item (30,391) (27,685) (75,961) Extraordinary item--gain on extinguishment of debt, net of $0 tax 579 29,500 18,216 ----------------- --------------- --------------- Net income (loss) $ (29,812) $ 1,815 $ (57,745) ================= =============== =============== Basic earnings (loss) per share of common stock: Loss before extraordinary item $ (2.10) $ (2.78) $ (7.81) Extraordinary item, net of taxes .04 2.96 1.87 ----------------- --------------- --------------- Net income (loss) $ (2.06) $ .18 $ (5.94) ================= =============== =============== Basic weighted average shares outstanding 14,445,238 9,961,077 9,719,262 ================= =============== =============== Diluted earnings (loss) per share of common stock: Loss before extraordinary item $ (2.10) $ (2.78) $ (7.81) Extraordinary item, net of tax .04 2.96 1.87 ----------------- --------------- --------------- Net income (loss) $ (2.06) $ .18 $ (5.94) ================= =============== =============== Diluted weighted average shares outstanding 14,445,238 9,961,077 9,719,262 ================= =============== ===============
See Notes to Consolidated Financial Statements, which are an integral part of these statements. F-5 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For The Years Ended December 31, 2000, 1999, and 1998
Common Stock --------------------------- Note Capital in Receivable Excess of Preferred From Shares Issued Amount Par Value Stock Shareholder --------------- ---------- -------------- ------------ -------------- (In thousands, except share data) Balance at December 31, 1997 9,686,477 $ 484 $ 38,609 $ -- $ -- Shares issued: Exercise of stock options 9,467 -- 21 -- -- Employee Stock Purchase Plan 37,430 2 191 -- -- Dividends paid -- -- -- -- -- Net loss -- -- -- -- -- --------------- ---------- -------------- ------------ -------------- Balance at December 31, 1998 9,733,374 486 38,821 -- -- Shares issued: Exercise of stock options 3,200 -- 3 -- -- Employee Stock Purchase Plan 102,604 5 39 -- -- Officer/Director Compensation 310,783 16 165 -- -- Other (332) -- -- -- -- Net income -- -- -- -- -- --------------- ---------- -------------- ------------ -------------- Balance at December 31, 1999 10,149,629 507 39,028 -- -- Change in par from $0.05 to $0.001 -- (490) 490 Shares issued: Employee Stock Purchase Plan 46,606 1 35 -- -- Officer/Director Compensation 61,540 3 45 -- -- Share Cancellation (228,570) (11) -- -- -- Shares issued in HomeSense Merger 6,780,944 7 7,045 -- -- Shares issued in HomeSense Merger -- -- -- 10,000 -- Note Receivable from Shareholder -- -- -- -- (5,985) Net loss -- -- -- -- -- --------------- ---------- -------------- ------------ -------------- Balance at December 31, 2000 16,810,149 $ 17 $ 46,643 $ 10,000 $ (5,985) =============== ========== ============== ============ ==============
Retained Earnings Total (Accumulated) Shareholders' (Deficit) Equity (Deficit) ------------- ---------------- Balance at December 31, 1997 $ 24,281 $ 63,374 Shares issued: Exercise of stock options -- 21 Employee Stock Purchase Plan -- 193 Dividends Paid (42) (42) Net income (loss) (57,745) (57,745) ----------- ----------- Balance at December 31, 1998 (33,506) 5,801 Shares issued: Exercise of stock options -- 3 Employee Stock Purchase Plan -- 44 Officer/Director Compensation -- 181 Other -- -- Net income 1,815 1,815 ----------- ----------- Balance at December 31, 1999 (31,691) 7,844 Change in par from $.05 to $0.001 Shares issued: Employee Stock Purchase Plan -- 36 Officer/Director Compensation -- 48 Share cancellation -- (11) Shares issued in HomeSense merger -- 7,052 Shares issued in HomeSense merger -- 10,000 Note receivable from Shareholder -- (5,985) Net income (29,812) (29,812) ----------- ----------- Balance at December 31, 2000 $ (61,503) $ (10,828) =========== ===========
See Notes to Consolidated Financial Statements, which are an integral part of these statements. F-6 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, ------------------------------------------------------------ 2000 1999 1998 ----------------- ----------------- ---------------- (In thousands) OPERATING ACTIVITIES: Net income (loss) $ (29,812) $ 1,815 $ (57,745) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 4,714 2,692 3,626 Fair market value adjustment on residual receivables 2,279 3,327 13,638 Benefit for deferred income taxes (10,000) (7,849) -- Provision for credit losses on loans 3,159 3,339 11,906 Provision for losses on real estate owned 952 2,665 696 Gain on retirement of senior unsecured debt (579) (29,500) (18,216) Net decrease in deferred loan costs 239 442 770 Net increase (decrease) in unearned discount and other deferred loan fees 1,609 (1,341) (2,245) Loans originated with intent to sell (567,421) (244,086) (747,442) Proceeds from loans sold 508,690 220,410 778,948 Proceeds from securitization of loans 50,554 59,630 92,316 Restructuring charges -- -- 5,760 Other 652 731 994 Changes in operating assets and liabilities increasing (decreasing) cash (27,757) (5,059) 1,274 ----------------- ----------------- ---------------- Net cash provided by (used in) operating activities (62,721) 7,216 84,280 ----------------- ----------------- ---------------- INVESTING ACTIVITIES: Loans originated (345) (762) (156,617) Principal collections on loans not sold 41,266 19,718 192,176 Loans purchased for investment purposes (3,167) (1,413) -- Purchase of REO and loans from securitization trusts (2,978) (10,476) (9,980) Proceeds from sale of real estate owned and personal property acquired through foreclosure 10,067 9,774 7,593 Proceeds from sale of property and equipment 54 235 2,808 Purchase of property and equipment (164) (532) (11,701) Other 111 167 48 ----------------- ----------------- ---------------- Net cash provided by investing activities 44,844 16,711 24,327 ----------------- ----------------- ---------------- FINANCING ACTIVITIES: Advances on warehouse lines of credit 702,518 292,020 1,416,500 Payments on warehouse lines of credit (722,618) (290,948) (1,477,369) Payments on notes to banks (501) -- -- Net increase in notes payable to investors 19,022 8,479 3,218 Net increase (decrease) in subordinated debentures 1,406 405 (1,643) Retirement of senior unsecured debt (341) (45,016) (20,134) Proceeds from issuance of common stock 73 229 214 Note receivable from shareholder (4,000) -- -- Other -- -- (41) ----------------- ----------------- ---------------- Net cash used in financing activities (4,441) (34,831) (79,255) ----------------- ----------------- ---------------- Net increase (decrease) in cash and cash equivalents (22,318) (10,904) 29,352 CASH AND CASH EQUIVALENTS: Beginning of the year 26,009 36,913 7,561 ----------------- ----------------- ---------------- End of the year $ 3,691 $ 26,009 $ 36,913 ================= ================= ================
See Notes to Consolidated Financial Statements, which are an integral part of these statements. F-7 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Significant Accounting Policies and Business Activities Business HomeGold Financial, Inc. and its subsidiaries ("HGFN" or "the Company") are primarily engaged in the business of originating, selling, securitizing and servicing first and second-lien residential mortgage loan products. The funds for these loans are obtained principally through the utilization of various bank warehouse lines of credit, proceeds from securitization of loans, and the issuance of notes payable and subordinated debentures to investors. Substantially all of the Company's loans are made to sub-prime borrowers. These borrowers generally have limited access to credit or are otherwise considered to be credit impaired by conventional lenders. In August, 2000, management closed the Company's wholesale mortgage origination divisions. The decision to exit the wholesale business arose primarily from management's desire to narrow its focus to the Company's more profitable retail loan origination efforts. The closure of the wholesale division resulted in a decrease in low-margin origination volume, enabling the Company to terminate its relationship under an agreement with its primary warehouse lender. Further benefits have been realized through more focused and efficient usage of marketing resources and a sizable reduction in overhead costs related to the closed division. On April 28, 2000, the shareholders of HomeGold Financial, Inc. approved a merger agreement with HomeSense Financial Corp. and affiliated companies (collectively "HomeSense"), a privately owned business, located in Lexington, South Carolina. HomeSense is a specialized mortgage company that originates and sells mortgage loans in the sub-prime mortgage industry, whose principal loan product is a debt consolidation loan, generally collateralized by a first lien on the borrower's home. HomeSense originates its loan volume through a direct retail branch network of eight offices, as well as through centrally provided telemarketing leads, direct mail, and television advertising. As of May 9, 2000, the effective date of the merger, HGFN issued 6,780,944 shares of its common stock (approximately 40% of post-merger shares outstanding) valued at $1.04 per share plus an additional 10 million shares of Series A Non-convertible Preferred Stock (par value $1 per share) for 100% of the outstanding stock of HomeSense. The merger was accounted for under the purchase method of accounting prescribed by generally accepted accounting principles. The transaction resulted in $19.0 million of goodwill, which is being amortized on a straight line basis over 15 years. The results of operations of HomeSense are included in the accompanying financial statements from the date of the acquisition. Preferred Stock Rights The following summarized unaudited pro forma financial information assumes the acquisition had occurred on January 1 of each year: For the Years Ended December 31, ------------------------------------ 2000 1999 ---------------- ---------------- (In thousands) Revenue $ 57,477 $ 53,045 Loss before extraordinary items (30,585) (29,574) Net income (loss) (30,006) 4,320 Basic loss per share of common stock (1.41) (0.01) The amounts are based upon certain assumptions and estimates, and do not reflect any benefit from economies that might be achieved from combined operations. The pro forma results do not necessarily represent results that would have occurred if the acquisition had taken place on the basis assumed above, nor are they indicative of the results of future combined operations. F-8 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Significant Accounting Policies and Business Activities (Continued) Consolidation and Estimates The consolidated financial statements include the accounts of the Company and its subsidiaries. All subsidiaries at December 31, 2000 were wholly-owned except for one special purpose corporation that is 99.54% owned. Included in the consolidated financial statements of operations in 1998 are the operations of the various subsidiaries that were sold during 1998. All significant intercompany items and transactions have been eliminated in consolidation. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates. These estimates include, among other things, valuation of real estate owned, assumptions used to value residual receivables and determination of the allowance for credit losses. Residual Receivables and Sales and Securitization of Loans In 1997, the Company began securitizing mortgage loans, whereby it sells the loans that it originates or purchases to a trust for cash, and records certain assets and income based upon the difference between all principal and interest received from the loans sold and (i) all principal and interest required to be passed through to the asset-backed bond investors, (ii) all excess contractual servicing fees, (iii) other recurring fees and (iv) an estimate of losses on the loans (collectively, the "Excess Cash Flow"). At the time of the securitization, the Company estimates these amounts based upon a declining principal balance of the underlying loans, adjusted by an estimated prepayment and loss rate, and capitalizes these amounts using a discount rate that market participants would use for similar financial instruments. These capitalized assets are recorded as a residual receivable. The Company believes the assumptions it has used to value the residual receivable are appropriate and reasonable. At each reporting period, the Company assesses the fair value of these residual assets based on the present value of future cash flows expected under management's current best estimates of the key assumptions-credit losses, prepayment speed, forward yield curves, and discount rates commensurate with the risks involved and adjusts the recorded amounts to their estimated fair value. Total mortgage loans securitized in 2000, 1999, and 1998 were $64.3 million, $59.6 million, and $90.4 million, respectively. The Company also sells on a whole loan basis a significant portion of its loans (servicing released), including substantially all of its mortgage loans secured by second mortgage liens principally to secure the additional cash flow associated with the premiums paid in connection with such sales and to eliminate the credit risk associated with the second lien mortgage loans. The Company makes securitization decisions based on a number of factors including conditions in the secondary market, the aggregate size and weighted average coupon of loans available to sell, fixed costs associated with securitization transactions, and liquidity needs. The Company believes that it will continue to securitize, as well as whole loan sell, in 2001. Cash and Cash Equivalents The Company maintains its primary checking accounts with one principal bank and makes overnight investments in reverse repurchase agreements with that bank. The amounts maintained in the checking accounts are insured by the Federal Deposit Insurance Corporation ("FDIC") up to $100,000. At December 31, 2000, 1999, and 1998, the amounts maintained in the overnight investments in reverse repurchase agreements, which are not insured by the FDIC, totaled $2.4 million, $25.4 million, and $31.6 million, respectively. These investments were collateralized by U. S. Government securities pledged by the banks. The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. F-9 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Significant Accounting Policies and Business Activities (Continued) Restricted Cash The Company maintains an investment bank account that it considers the minimum balance requirement as restricted cash. The purpose of this account is overdraft protection and required as part of its primary banking relationship. Also, the Company assigned a $3.5 million certificate of deposit to a warehouse lender to secure the Company's borrowings under a revolving warehouse credit agreement (see Note 8). This certificate of deposit is included as restricted cash in the financial statements. Loans Receivable and Interest Income Loans receivable in 2000 and 1999 consist primarily of first and second lien residential mortgage loans. In prior years, it also included SBA loans, asset- based small-business loans, and automobile loans. During 1998, the Company sold the majority of its small-business and auto loans. The Company presently is not originating these types of loans. Non-refundable loan fees and direct costs associated with the origination or purchase of loans are deferred and netted against outstanding loan balances. Interest income on loans receivable is recognized on the accrual basis as earned. Fees received, net of direct costs incurred, for the origination of loans are recognized into income at the time the loan is repaid or sold. Accrual of interest is discontinued and reversed when a loan is either over 150 days past due or the loan is over 90 days past due with a loan to value percentage greater than 90%. Loans receivable held for sale are carried at the lower of aggregate cost or market. There was no allowance for market losses on loans receivable held for sale required at December 31, 2000 or 1999. Allowance for Credit Losses The allowance for credit losses is based on management's ongoing evaluation of the loan portfolio and reflects an amount that, in management's opinion, is adequate to absorb inherent losses in the existing portfolio. In evaluating the portfolio, management takes into consideration numerous factors including delinquencies, current economic conditions, prior loan loss experience, the composition of the serviced loan portfolio, and management's estimate of anticipated credit losses. Loans, including those deemed impaired, are charged against the allowance at such time as they are determined to be uncollectible. Subsequent recoveries are credited to the allowance. Management considers the year-end allowance appropriate and adequate to cover inherent losses in the loan portfolio; however, management's judgment is based upon a number of assumptions about future events, which are believed to be reasonable. Actual results could differ from these estimates. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for credit losses or that additional increases in the allowance for credit losses will not be required. Accounting for Impaired Loans The Company accounts for impaired loans in accordance with Statement of Financial Accounting Standards (SFAS) No. 114 "Accounting by Creditors for Impairment of a Loan". This standard requires that all creditors value loans at the loan's fair market value if it is probable that the creditor will be unable to collect all amounts due according to the terms of the loan agreement. Fair value may be determined based upon the present value of expected cash flows, market price of the loan, if available, or value of underlying collateral. Expected cash flows are required to be discounted at the loan's effective interest rate. SFAS No. 114 was amended by SFAS No. 118 to allow a creditor to use existing methods for recognizing interest income on an impaired loan and by requiring additional disclosures about how a creditor recognizes interest income on an impaired loan F-10 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Significant Accounting Policies and Business Activities (Continued) Accounting for Impaired Loans (Continued) Under SFAS No. 114, as amended by SFAS No. 118, when the ultimate collectibility of an impaired loan's principal is in doubt, wholly or partially, all cash receipts are applied to principal. When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to principal and then to interest income. Once the reported principal balance has been reduced to zero, future cash receipts are applied to interest income, to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amount previously charged off. A loan is also considered impaired if its terms are modified in a troubled debt restructuring. For these accruing impaired loans, cash receipts are typically applied to principal and interest receivable in accordance with the terms of the restructured loan agreement. Interest income is recognized on these loans using the accrual method of accounting. The Company assesses a specific allowance on mortgage loans, by reviewing on a loan-by-loan basis each month, all loans over 150 days past due or any loans that are in bankruptcy. Real Estate Owned and Personal Property Acquired Through Foreclosure Real estate owned and personal property acquired through foreclosure represents properties that have been acquired through actual foreclosures or deeds received in lieu of loan payments. These assets are recorded at the lower of the carrying value of the loans or the estimated fair value of the related real estate, net of estimated selling costs. The excess carrying value, if any, of the loan over the estimated fair value of the asset is charged to the allowance for credit losses upon transfer. Costs relating to the development and improvement of the properties are capitalized whereas those costs relating to holding the property are charged to expense. Property and Equipment Property and equipment are stated at cost. Depreciation is computed principally using the straight-line method over the estimated useful lives of the assets. Estimated lives are 15 to 40 years for buildings and improvements, 3 to 7 years for furniture, fixtures and equipment, and the lease period for leasehold improvements. Additions to property and equipment and major replacements or improvements are capitalized at cost. Maintenance, repairs and minor replacements are expensed when incurred. Impairment of Long-Lived Assets Long-lived assets and identifiable intangibles held and used by the Company are reviewed for impairment whenever management believes events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. No impairment loss was recognized for continuing operations in 2000 or 1999. In November 1998, the Company decided to close three retail loan centers and to consolidate all operations into one location. This decision resulted in a restructuring charge of $6.8 million. The restructuring charge relates to the write-down of fixed assets to net realizable value on assets no longer used by the Company and the estimated net lease cost on facilities no longer being used. F-11 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Significant Accounting Policies and Business Activities (Continued) Goodwill The excess of cost over related net assets of businesses acquired is amortized using the straight-line method principally over 15 years. During 2000, approximately $19.0 million was attributed to goodwill from the purchase of HomeSense. On a periodic basis, the Company reviews goodwill for events or changes in circumstances that may indicate that the carrying amount of goodwill may not be recoverable. The Company utilizes estimated future cash flows of the purchased subsidiary compared to the value of goodwill booked in determining any impairment on the excess of cost over the related net assets. Debt Origination Costs The Company capitalizes costs incurred to obtain warehouse lines of credit and senior unsecured debt. These costs are amortized as an addition to interest expense over the terms in the loan agreements. The Company also reduces the debt origination costs by the unamortized portion of the senior unsecured debt that is purchased on the open market. These amounts have been netted against the gain on extinguishment of debt. Also, during 2000, the Company expensed the remaining debt origination costs that existed from the expired CIT warehouse line of credit agreement (See note 15). Remittances Payable The Company retains the servicing rights on certain of its mortgage securitization transactions. The Company receives the payments from the borrowers and records a liability until the funds are remitted to the Trustee. Investor Savings The Company issues notes payable and subordinated debentures through a subsidiary company, CII. The notes are fixed rate securities registered under the South Carolina Uniform Securities Act ("the Act"), and mature from one to two years from the date of issuance. The Company pays interest on the notes monthly, quarterly, or at maturity at the option of the investor. The Company also issues subordinated debentures under the Act, which mature one year from date of issuance and have an interest rate of 6.0%. See Note 10. Senior Debt The Company sold $125.0 million in aggregate principal amount of senior unsecured notes in 1997. The notes pay interest semi-annually at 10.75%, and mature September 15, 2004. Income Taxes The Company and its subsidiaries file a consolidated Federal income tax return. The Company accounts for income taxes using an asset and liability approach as required by SFAS No. 109 "Accounting for Income Taxes". Under this approach, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred income taxes arise principally from depreciation, unrealized gains on loans held for sale, certain securitization transactions, amortization of intangibles, allowances for credit losses, and net operating loss carryforwards. Management establishes on a quarterly basis a valuation allowance for deferred assets. Management believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the net deferred tax assets. F-12 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Significant Accounting Policies and Business Activities (Continued) Advertising Expense Advertising, promotional, and other business development costs are generally expensed as incurred except as noted herein. External costs incurred in producing media advertising are expensed the first time the advertising takes place. In 1997, the Company began using a direct mail marketing approach for its retail mortgage business. External costs related to direct mailings are capitalized in accordance with Statement of Position 93-7 and amortized over a three-month period. Total expenses recognized in 2000, 1999 and 1998 for direct mailings were approximately $8.4 million, $4.4 million and $8.8 million, respectively. The total amounts capitalized into other assets on the balance sheet at December 31, 2000 and 1999 were approximately $1,841,000 and $934,000 respectively. Interest Rate Risk Management The Company's operations may be directly affected by fluctuations in interest rates. While the Company monitors interest rates and may, from time to time, employ a strategy designed to hedge some of the risks associated with changes in interest rates, no assurance can be given that the Company's results of operations and financial condition will not be adversely affected during periods of fluctuations in interest rates. The Company currently does not hedge its loans held for sale. The Company's present strategy is to sell a substantial portion of the current months' production that is designated for whole-loan sales in the following month and the remaining loans in the subsequent month. Because the interest rates on the Company's warehouse lines of credit used to fund and acquire loans are variable and the rates charged on loans the Company originates are fixed, increases in the interest rates after loans are originated and prior to their sale may reduce the gain on loan sales earned by the Company. There were no significant open hedging positions at December 31, 2000 or 1999. Earnings (Loss) Per Share of Common Stock Earnings (loss) per share of common stock ("EPS") is computed in accordance with SFAS No. 128, "Earnings per Share". Basic EPS includes no dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution of securities that could share in the earnings of the Company. Common stock equivalents included in the diluted EPS computation consist of stock options, which are computed using the treasury stock method. In 2000 and 1999, due to the Company's net operating loss, the common stock equivalents were not included in the diluted EPS calculation since their inclusion would be antidilutive. Segment Reporting During 1998, the Company adopted the provisions of SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information". This Statement establishes standards for the method that public entities use to report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about product and services, geographical areas, and major customers. The Company believes that it operates as one segment. Reclassifications Certain previously reported amounts have been reclassified to conform to current year presentation. Such reclassifications had no effect on net income or shareholders' equity as previously reported. F-13 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Significant Accounting Policies and Business Activities (Continued) Accounting Considerations In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." All derivatives are to be measured at fair market value and recognized in the balance sheet as assets and liabilities. SFAS No. 137, "Accounting for Certain Derivative Instruments and Certain Hedging Activities" was issued in June 2000 and amends the accounting and reporting standards of SFAS No. 133 for certain derivative instruments and hedging activities. The two statements are to be adopted concurrently and are effective for fiscal years and quarters beginning after June 15, 2000. The adoption of SFAS No. 133 and SFAS No. 137 did not have a material impact on the presentation of the Company's financial results or financial position. Effective January 1, 1999, the Company adopted the provisions of SFAS No. 134 "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise". This Statement conforms the subsequent accounting for securities retained after the securitization of mortgage loans by a mortgage banking enterprise with the subsequent accounting for securities retained after the securitization of other types of assets by a non-mortgage banking enterprise. The adoption of this Statement did not change total Stockholders' Equity as previously reported. In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of FASB No. 125." It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures but carries over most of FASB No. 125's provisions without reconsideration. SFAS No. 140 is effective for all transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001. Retroactive and early adoption is prohibited. This statement is effective for disclosures related to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of provisions of SFAS No. 140 is not expected to be material to the Company. In the November 2000 meeting, the Emerging Issues Task Force (EITF) reached a consensus on EITF 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets." The issue deals with how interest income and impairment should be recognized for retained interests in securitizations. If upon evaluation, the holder determines that it is probable that there is a change in estimated cash flows (in both timing and estimates of projected cash flows) , the amount of accretable yield should be recalculated and if that change in estimated cash flows is an adverse change, an other-than-temporary impairment should be considered to have occurred. The effective date of this EITF is March 15, 2001. The Company does not know if there is any impact of this EITF on its residual assets or if the impact could be material. The Company anticipates implementing EITF 99-20 in the first quarter of 2001. The FASB reached a tentative decision related to accounting treatment for goodwill in its Business Combinations and Intangible Assets -Accounting for Goodwill project and related exposure draft. In this exposure draft, the FASB has determined that goodwill will no longer be amortized. Goodwill of a reporting unit should be tested for impairment when events or circumstances occur indicating that an impairment might exist. The FASB is expected to issue this accounting standard in 2001. The Company does not know the impact, if any, on its financial statements or its financial position related to this proposed guidance. Note 2. Loans Receivable The following is a summary of loans receivable by type of loan:
December 31, ----------------------------------------- 2000 1999 ------------------- ------------------ (In thousands) Mortgage Loans: First mortgage residential property $ 31,918 $ 41,848 Second mortgage residential property 17,117 9,256 Real estate loans on rental property 216 1,121 ----------------- ------------------ Total mortgage loans 49,251 52,225 ----------------- ------------------ Small-business loans 9,162 10,388 Other loans 70 629 ----------------- ------------------ Total loans receivable $ 58,483 $ 63,242 ================= ==================
F-14 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 2. Loans Receivable (Continued) Included in loans receivable are $45.3 million and $46.9 million at December 31, 2000 and 1999, respectively that are being held for sale. Included in loans receivable are loans from related parties of $70,000 and $121,000 at December 31, 2000 and 1999, respectively. Notes receivable from related parties included advances of $0 in 2000 and $12,000 in 1999. Repayments from related parties were $5,837 and $13,176 in 2000 and 1999, respectively. In 2000 and 1999, the Company had notes from parties at the beginning of the year who were no longer considered related parties as of December 31 due to termination of employment status. First mortgage residential loans generally have contractual maturities of 12 to 360 months with an average interest rate at December 31, 2000 and 1999 of approximately 10.7% and 10.9%, respectively. Second mortgage residential loans have contractual maturities of 12 to 360 months with an average interest rate at December 31, 2000 and 1999 of approximately 13.3% and 14.3%, respectively. Loans sold and serviced for others at December 31, 2000 and 1999 were approximately $283.6 million and $355.7 million, respectively, and are not included in assets in the accompanying balance sheets. At December 31, 2000, the Company's serviced for others mortgage loan portfolio by type of collateral is summarized as follows (in thousands): First mortgage residential property $ 269,730 95.1% Second mortgage residential property 5,673 2.0 Real estate loans on rental property 8,195 2.9 ---------------- ------------- $ 283,598 100.0% ================ ============= The Company services loans in 46 states. South Carolina, North Carolina, Florida, Georgia and Louisiana serviced loans represent approximately 16.3%, 15.4%, 9.6%, 7.8% and 6.2%, respectively, of the Company's total serviced loan portfolio at December 31, 2000. No other state represents more than 6% of total serviced loans. An analysis of the allowance for credit losses is as follows:
Years Ended December 31, ------------------------------------------------------ 2000 1999 1998 ---------------- -------------- --------------- (In thousands) Balance at beginning of year $ 6,344 $ 6,659 $ 6,528 Provision for credit losses 3,159 3,339 11,906 Net charge offs (1,990) (3,654) (8,792) Allowance related to loans sold (2,861) -- (2,983) -------------- -------------- --------------- Balance at end of year $ 4,652 $ 6,344 $ 6,659 ============== ============== ===============
As of December 31, 2000, 1999, and 1998, loans totaling $9.6 million, $10.8 million, and $7.9 million, respectively, were on non-accrual status. The associated interest income not recognized on these non-accrual loans was approximately $868,000, $825,000, and $2.0 million during the years ended December 31, 2000, 1999 and 1998, respectively. F-15 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 2. Loans Receivable (Continued) The following presents delinquencies, net credit losses, and securitized financial assets managed by the Company.
Total Principal Principal Amount of Loans Amount of Loans 60 Days or More Past Due Net Credit Losses --------------------------------------------------------------------------------- 2000 1999 2000 1999 2000 1999 --------------------------------------------------------------------------------- Residential mortgage loans $ 342,081 $ 423,619 $ 24,964 $ 34,322 $ 5,400 $ 5,421 Less: Loans securitized 283,598 360,377 18,661 29,144 3,410 1,767 --------------------------------------------------------------------------------- Loans held in portfolio $ 58,483 $ 63,242 $ 6,303 $ 5,178 $ 1,990 $ 3,654 =================================================================================
Note 3. Other Receivables The following is a summary of other receivables: December 31, ---------------------------------------- 2000 1999 ------------------ ------------------ (In thousands) Fees earned not collected $ 3,503 $ 3,277 Advanced funds to trust (1) 1,894 2,035 Receivable from mortgage trust (2) 1,251 975 Loan sale receivable 4,801 -- Fees receivable reserve (3) (953) -- Note receivable 75 1,006 Other 926 766 ---------------- ----------------- $ 11,497 $ 8,059 ================ ================= -------------- (1) Trust agreements require the Company to advance interest on delinquent customer accounts. (2) Excess distribution from mortgage trust received in January 2001 and 2000, respectively. (3) Reserve for potential future uncollectable servicing fees F-16 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 4. Residual Receivables In connection with its mortgage loan securitizations and SBA loan securitizations and sales, the Company retained residual interests in the trusts. During 1998, the Company's residual interests relating to its SBA loan securitizations were sold. These subordinate residual assets totaled $58.9 million and $47.8 million, net of allowances, at December 31, 2000 and 1999 respectively. The following summarizes activity in the residual receivables:
Year Ended Year Ended Year Ended December 31, December 31, December 31, 2000 1999 1998 (In Thousands) (In Thousands) (In Thousands) ---------------------------------------------------------------- Gross balance at beginning of year $ 54,946 $ 51,022 $ 77,457 Gain on sale of loans -- 9,641 12,322 Residual from securitization of loans 17,244 -- -- Return of Over collateralization (1,767) -- -- Increase of future discounted cash flows, net -- -- 14,289 Mark to market value adjustment 4,859 19 (19,366) Amortization of original residual asset value (10,758) (5,736) (15,920) Sale of small-business commercial residual receivable -- -- (14,845) Other -- -- (2,915) ---------------------------------------------------------------- Gross balance, end of year 64,524 54,946 51,022 Less allowance for losses on residual receivable (5,647) (7,176) (7,165) ---------------------------------------------------------------- Balance at end of year $ 58,877 $ 47,770 $ 43,857 ================================================================
An analysis of the allowance for losses, which is embedded in the residual receivables, is as follows:
Years Ended December 31, ----------------------------------------------------- 2000 1999 1998 ----------------- --------------- ------------- (In thousands) Balance at beginning of year $ 7,176 $ 7,165 $ 14,255 Anticipated losses netted against gain 1,559 1,267 2,242 Mark to market adjustment 489 405 (5,728) Sale of small-business commercial residual asset -- -- (2,957) Net charge offs (3,577) (1,661) (647) --------------- -------------- ------------- Balance at end of year $ 5,647 $ 7,176 $ 7,165 =============== ============== =============
The table below summarizes certain cash flows received and paid to the securitization trusts (in thousands).
Year Ended December 31 ------------------------------------------------ 2000 1999 1998 ------------------------------------------------ Proceeds from new securitizations $ 50,554 $ $59,630 $ $92,316 Proceeds from loan payment collections 159,780 155,818 168,496 Servicing fees received 1,792 1,882 2,410 Other cash flows received on retained interests 10,969 13,740 14,138 Purchases of delinquent or foreclosed assets 3,200 13,700 10,000 Servicing advances 5,999 9,033 9,693 Repayments of servicing advances 5,735 7,879 7,666
F-17 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 4. Residual Receivables (Continued) The Company expects to begin receiving Excess Cash Flow on its Mortgage Loan securitizations approximately 16 months from the date of securitization, although this time period may be shorter or longer depending upon the securitization structure and performance of the loans securitized. Prior to such time, the monoline insurer requires a reserve provision to be created within the securitization trust which uses Excess Cash Flow to retire the securitization bond debt until the spread between the outstanding principal balance of the loans in the securitization trust and the securitization bond debt equals a specified percentage (depending on the structure of the securitization) of the initial securitization principal balance (the "overcollateralization limit"). Once this overcollateralization limit is met, excess cash flows are distributed to the Company. The following sets forth facts and assumptions used by the Company in arriving at the valuation of the residual receivables relating to its Mortgage Loan securitization pools it services as of December 31, 2000:
1997-1 1997-2 1997-3 1997-4 1998-1 1999-1 ------------------------------------------------------------------------------------ Outstanding balance of loans securitized $25,754,675 $43,340,538 $69,847,023 $68,966,966 $32,271,294 $43,417,008 Average stated principal balance 55,988 53,179 61,323 60,817 59,984 46,386 Weighted average coupon on loans 10.83% 10.64% 11.03% 10.88% 10.76% 10.91% Weighted average remaining term to stated 164 mths 163 mths 168 mths 171 mths 181 mths 194 mths maturity Weighted average LTV 75% 70% 74% 74% 74% 71% Percentage of first mortgage loans 100% 100% 100% 100% 100% 86.91% Weighted average pass-through rate to 7.66% 7.21% 7.10% 6.86% 6.70% 6.84% bondholders Assumed annual losses 0.18% 0.18% 0.26% 0.36% 0.39% 0.56% Remaining ramp period for losses 0 mths 0 mths 0 mths 0 mths 0 mths 0 mths Assumed cumulative losses as a % of UPB 1.44% 1.78% 2.50% 2.84% 3.25% 1.17% Annual servicing fee 0.50% 0.50% 0.50% 0.50% 0.50% 0.56% Servicing asset 0.10% 0.10% 0.10% 0.10% 0.10% 0.10% Discount rate applied to cash flow after Overcollateralization 12% 12% 12% 12% 12% 12% Prepayment speed: Initial CPR (1) 0 CPR 0 CPR 0 CPR 0 CPR 0 CPR 24 HEP Peak CPR (1) 28 CPR 28 CPR 28 CPR 28 CPR 28 CPR 24 HEP Tail CPR (1) 26/24 CPR 26/24 CPR 26/24 CPR 26/24 CPR 26/24 CPR 24 HEP CPR ramp period (1) 12 mths 12 mths 12 mths 12 mths 12 mths 24 HEP CPR peak period (1) 24 mths 24 mths 24 mths 24 mths 24 mths 24 HEP CPR tail begins (1) 37/49 mths 37/49mths 37/49 mths 37/49 mths 37/49 mths 24 HEP Annual wrap fee and trustee fee 0.285% 0.205% 0.195% 0.185% 0.185% 0.265% Initial overcollateralization required (2) 3.25% -- -- -- -- 9.5% Final overcollateralization required (2) 6.5% 3.75% 3.75% 3.75% 3.75% 13.5%
(1) CPR represents an industry standard of calculating prepayment speeds and refers to Constant Prepayment Rate. For its first five securitization pools, the Company uses a curve based on various CPR levels throughout the pool's life, based on its estimate of prepayment performance, as outlined in the table above. For the 1999-1 transaction the Company uses a 24 HEP (Home Equity Prepayment) curve. This curve, developed by Prudential Securities, ramps to the terminal CPR (in this case, 24%) over ten months and then remains constant for the life of the pool. (2) Based on percentage of original principal balance, subject to step-down provisions after 30 months. Additionally, the Company obtained an independent valuation of the residual receivables it services at December 31, 2000. This independent valuation concurred with the carrying value of the residuals it services as of the valuation date. Each of the Company's Mortgage Loan securitizations have been credit-enhanced by an insurance policy provided through a monoline insurance company such that the senior certificates have received ratings of "Aaa" from Moody's Investors Services, Inc. ("Moody's") and "AAA" from Standard & Poor's Ratings Group, a division of The McGraw-Hill Companies, Inc. ("Standard & Poor's"). In 1999, the Company completed a securitization transaction in the second quarter. The Company securitized $59.6 million of loans for a weighted average premium of 2.88%. This securitization consisted of seasoned first and second lien mortgage loans, resulting in a lower than average premium. However, the securitization of seasoned loans resulted in additional liquidity of $33.0 million for the Company. Certain loans included in that securitization were ineligible for inclusion in the borrowing base under the Company's warehouse line of credit. F-18 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 4. Residual Receivables (Continued) In connection with its 1999 securitization transaction, HGFN agreed to cross-collateralize its residual interests in that transaction and its first three 1997 securitization transactions. The cross-collateralization is for the benefit of Financial Security Assurance, Inc. ("FSA") the bond insurer for all of the transactions. Under the terms of the cross-collateralization agreement, in the event HGFN is in breach of its obligations under any one or more of the securitization trusts, or if certain cumulative loss or delinquency triggers are met, the excess cash flow on all four residual interests will be captured by the Collateral Agent. The Collateral Agent will distribute these monies to FSA or as otherwise specified in the agreement. The total amount which may be retained by the Collateral Agent is capped at $15.0 million. This agreement terminates upon the termination of all of the related securitization trusts. In August 2000, the Company exceeded the twelve-month rolling loss trigger in the 1998 securitization pool which resulted in the monthly cash flow of this pool (approximately $70,000 per month) being retained by the trustee rather than being paid to the Company. If the Company returns performance of this pool to a point below the required trigger, the return of cash flow back to the Company will continue. The Company sold its servicing rights under the 2000 securitizations because the price paid by the independent third party servicer resulted in a higher realized gain than if the servicing rights not been sold. Consequently, the residual interests of $14.5 million owned by the Company are not subject to the Company's normal quarterly evaluation of assumptions and estimates as compared to actual performance. These residual interests represent the Company's estimate of market value. Market value determination includes an estimate of credit losses, based on anticipated performance of the securitized loans in the portfolio. The original certificate balances for the 2000 securitizations totaled $64,330,194. The 2000-4 trust had an original certificate balance of $41,473,722 with the Company's share of the original certificate balances being $12,047,487. The 2000-5 trust had an original certificate balance of $22,856,471 with the Company's share of the original certificate balances being $5,142,707. The average stated principal balances are $54,734 and $47,105 for pools 2000-4 and 2000-5, respectively. The annual servicing fees are 0.58% and 0.50% for 2000-4 and 2000-5, respectively, and the trustee fee is .050%. At December 31, 2000, the 2000-4 trust had outstanding principal balances of $37,711,512 with the Company's certificate share being $11,872,993. The 2000-5 trust had outstanding principal balances of $21,809,445 with the Company's certificate share being $5,142,707. Interest income is allocated to the bondholders based on the certificate balances. At December 31, 2000, the weighted average pass through rate to bondholders is 11.74% and 11.89% for 2000-4 and 2000-5, respectively. The Company will not receive their share of principal distribution until three years from the time of the transaction. After three years, principal distribution will be received if the portfolios meet certain performance requirements. Although the Company is a certificate holder, its share of the principal balance is reduced by all losses incurred by the pools. The assumed cumulative losses as a percent of the unpaid principal balance at December 31, 2000 are 4.95% and 3.9% for the 2000-4 and 2000-5 pools. These assumed loss rates are used in estimating the market value of the Company's residual interest. F-19 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 4. Residual Receivables (Continued) At December 31, 2000 key economic assumptions and the sensitivity of the current fair value of residual cash flows to immediate 5 percent and 10 percent adverse changes in assumed economics is as follows (dollars in thousands). Loans (In Thousands) ----------------- Carrying amount/fair value of retained interests $ 58,877 Weighted-average life (in years) 4.24 Prepayment speed assumption (annual rate) 24% - 30% Impact on fair value of 5% adverse change $ 607 Impact on fair value of 10% adverse change $ 1,216 Expected credit losses (annual rate) 0.35% Impact on fair value of 5% adverse change $ 390 Impact on fair value of 10% adverse change $ 780 Residual cash flows discount rate (annual) 12.0% Impact on fair value of 5% adverse change $ 638 Impact on fair value of 10% adverse change $ 1,256 These sensitivities are hypothetical and should be viewed with caution. As the figures indicate, any change in fair value based on a 5 percent variation in assumptions cannot be extrapolated because the relationship of the change in assumption to the change in fair value is not linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated independent from any change in another assumption; in reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. Note 5. Property and Equipment The following is a summary of property and equipment: December 31, --------------------------------------- 2000 1999 ------------------ ---------------- (In thousands) Land $ 1,919 $ 948 Buildings and leasehold improvements 13,871 11,545 Equipment and computers 9,431 10,126 Furniture and fixtures 4,304 4,470 Vehicles 542 191 Restructuring reserve -- (4,312) ---------------- ---------------- Total property and equipment 30,067 22,968 Less accumulated depreciation (8,637) (5,808) ---------------- ---------------- Net property and equipment $ 21,430 $ 17,160 ================ ================ The Company leases various property and equipment, office space and automobiles under operating leases. The Company's headquarters building collateralizes the warehouse line of credit. F-20 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5. Property and Equipment (Continued) In 1998, the Company recorded a $1.8 million non-cash restructuring charge related to future minimum rental payments for operating leased assets and facilities that are no longer used in the Company's normal course of business. During 2000 and 1999, rental payments on leased facilities no longer used by the company have been paid from and sublease rent receipts have been deposited into the reserve established in 1998. As of December 31, 2000, management feels that the reserve is adequate to absorb future costs estimated to be associated with the leased space. The following is a schedule of future minimum lease payments by year for all operating leases (in thousands): Future Minimum Lease Payments -------------------- 2001 $ 2,435 2002 1,229 2003 593 2004 176 2005 and thereafter 34 -- ----------------- $ 4,467 ==================== Total rental expense was approximately $2.7 million in 2000, $2.0 million in 1999, and $4.9 million in 1998. Note 6. Real Estate Owned and Personal Property Acquired through Foreclosure An analysis of real estate acquired through foreclosure is as follows:
Years Ended December 31, --------------------------------------------------- 2000 1999 1998 --------------------------------------------------- (In thousands) Balance at beginning of year $ 7,673 $ 5,881 $ 3,295 Loan foreclosures and improvements 5,414 14,827 11,777 Dispositions, net (10,854) (10,370) (8,495) Write-down of real estate acquired through foreclosure (952) (2,665) (696) ------------ ------------ ------------ Balance at end of year $ 1,281 $ 7,673 $ 5,881 ============ ============ ============
Note 7. Goodwill An analysis of goodwill is as follows: Years Ended December 31, ------------------------------------- 2000 1999 ---------------- ---------------- (In thousands) Balance at beginning of year $ 1,566 $ 1,660 HomeSense purchase (See Note 1) 19,021 -- Amortization expense (964) (94) ---------------- ---------------- Balance at end of year $ 19,623 $ 1,566 ================ ================ F-21 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 8. Warehouse Lines of Credit In connection with the merger with HomeSense, the Company entered into a new $40 million revolving warehouse line of credit with Household Commercial Financial Services, Inc. Subsequent to the merger, the maximum commitment was increased to $50 million. The line bears interest at the prime rate plus 0.25% and is collateralized by mortgage loan receivables. The agreement requires, among other matters, minimum net worth of the Company of $10,000,000 commencing August 31, 2000, a leverage ratio of less than 35 to 1, and positive consolidated net income for each quarter beginning on or after July 1, 2000. The Company is default on these covenants. Amendments were subsequently executed whereby the lender agreed to forebear from exercising its rights on account of existing events of default, the maturity date was extended to April 30, 2001, and the advance rate was changed to 97% from 100% for all loans made after October 23, 2000. Availability under the credit agreement is determined based on eligible collateral as defined in the agreement, for which the Company has forwarded to the bank the required loan files and documentation. At December 31, 2000, the balance of funded loans on the line was $2.6 million. Prior to the merger, HomeSense had a $25 million revolving purchase facility with Residential Mortgage Services of Texas ("RMST"). This agreement was amended at the time of the merger to extend to the merged entity. The agreement is structured as a purchase of the mortgages by RMST, subject to a limited right of RMST to require the repurchase of defective mortgages by the Company. The facility bears interest at the prime rate plus 0.75%. Under a termination agreement between RMST and the Company, the maximum commitment at December 31, 2000 was $15 million, and the outstanding balance on that date was $11.4 million. An additional provision of the termination agreement required the Company to assign a $3.5 million certificate of deposit to RMST as security for the outstanding balance on the line. As of March 31, 2001, the agreement with RMST was terminated, and RMST's right to the certificate of deposit was relinquished. On November 3, 2000, the Company entered into a $10 million revolving warehouse line of credit with The Provident Bank ("Provident"). Interest on the line varies on a loan by loan basis and ranges from the prime rate plus 1.5% to the prime rate plus 3.5%, depending on the grade and age of the mortgage funded. The agreement allows for a rate reduction from the base rates if certain monthly funded volume targets are met. For the month of December, 2000, the Company achieved the targeted funded volume for the first stage rate reduction of .15% from the initial base rates. The agreement contains no covenants related to the financial condition or results of operations of the Company. The agreement allows Provident to retain the servicing rights to any loans funded on the line of credit. Availability under the credit agreement is determined based on eligible collateral as defined in the agreement, for which the Company has forwarded to the bank the required loan files and documentation. The line of credit matures on October 31, 2001. At December 31, 2000, the balance of funded loans on the line was $6.6 million, and these loans were all sub-serviced by Provident. On December 20, 2000, the Company entered into a short term repurchase arrangement with New Freedom Mortgage Corporation ("New Freedom") as an interim funding source while a long-term warehouse agreement was being negotiated. Under the arrangement, New Freedom agreed to fund both new mortgage production and certain mortgages originally funded by the Company. The advance rates on fundings range from 80% to 88% of the principal amount, depending on the type and source of the mortgage. New Freedom receives a fee from 1.5% up to 2.5% of the note amount based on the length of time credit is provided for each loan funded. In addition, New Freedom receives the interest accrued on the loan during the period it remains on the line. At December 31, 2000, the outstanding balance on the line was $6.3 million. The arrangement was terminated in February 2001, after the execution of a new long-term warehouse agreement with another lender. During December 2000, the Company had terminated its revolving warehouse line of credit agreement with CIT Group/Business Credit, Inc. ("CIT"). At December 31, 1999, the Company had $1.1 million of immediate availability under the CIT agreement, based on its borrowing base on that date. Upon termination of the agreement, the company has no further obligations thereunder. At December 31, 2000, the Company believes that no event of default has occurred on its warehouse lines of credit for which it has not obtained a waiver or forbearance. F-22 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 8. Warehouse Lines of Credit (Continued) Unused Lines of Credit On January 11, 2001, the Company entered into a $15 million master repurchase agreement with Imperial Warehouse Finance, Inc. Advance rates on fundings range from 85% to 88% of the principal amount, depending on the type and source of the mortgage. The facility bears interest at prime rate plus 1.00%. The agreement requires a collateral deposit of $2.5 million be in place for the life of the line. The agreement also requires that the Company have net income for any period after January 2001. The Company is currently in default of the net income covenant. Management is currently negotiating a waiver and/or modification of the terms of the agreement. Management believes they will be successful in obtaining a modified agreement, or waiver at a minimum, although there can be no assurance that a new agreement will be reached. Note 9. Notes Payable to Banks The Company assumed a mortgage note of $1.9 million with Bank of America, N.A. in connection with the merger. The note was scheduled to mature on November 2, 2000. The maturity date was extended to March 2, 2001, at which time it was paid off. The note bore interest at the prime rate plus 1.5%, and was secured by a mortgage on the Company's building in Lexington, South Carolina, as well as a parcel of real estate investment property. The Company also assumed a note payable of $422,000 to Bank of America, N.A. related to the merger. The note bears interest at 8.25% through October 2019, and is collateralized by certain other property and equipment. The maturity schedule for theses notes is: Principal Year Payments ------------------------------------------- 2001 $ 1,946,152 2002 10,438 2003 11,333 2004 12,304 2005 13,358 2006 and beyond 358,539 ---------------- $ 2,352,124 ================ F-23 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10. Investor Savings Investor savings are summarized as follows: December 31, -------------------------------------- 2000 1999 ------------------ ---------------- (In thousands) Notes payable to investors $ 146,087 $ 127,065 Subordinated debentures 19,117 17,710 ---------------- ---------------- $ 4,652 $ 144,775 ================ ================ Notes payable to investors are issued by a subsidiary company, CII, in any denomination greater than $10,000 and are registered under the South Carolina Uniform Securities Act. The notes payable to investors are on par with the rights of the holders of the senior unsecured debt of HGFN. The notes mature from one to two years from date of issuance. Interest is payable monthly, quarterly or at maturity at the option of the investors. Interest rates on the notes are fixed until maturity and range from 5% to 9%. At December 31, 2000, and 1999, the weighted average rate was 7.92%, 7.55%, respectively. At December 31, 2000 and 1999, notes payable to investors include an aggregate of approximately $31.1 million and $26.9 million, respectively, of individual investments exceeding $100,000. The investor savings at December 31, 2000 mature as follows (in thousands): 2001 $ 92,469 2002 53,618 --------------- $ 146,087 =============== There were 5,704 and 4,853 accounts for the notes due to investors at December 31, 2000 and 1999, respectively. Subordinated debentures are issued by CII in any denomination greater than $100 and are registered under the South Carolina Uniform Securities Act. The subordinated debentures mature one year from date of issuance and have interest rates of 6%. The debentures are subordinated to all bank debt, notes due to investors, and the senior unsecured debt. There were 1,409 and 1,312 subordinated debenture accounts at December 31, 2000 and 1999, respectively. These notes and debentures are not secured by a pledge of any specific assets at CII, nor guaranteed by the Company. F-24 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 11. Senior Unsecured Debt and Subsidiary Guarantors In September 1997, the Company sold $125.0 million in aggregate principal amount of Senior Notes due 2004 ("Senior Notes"). The Senior Notes constitute unsecured indebtedness of the Company. The Senior Notes mature on September 15, 2004, with interest payable semi-annually at 10.75%. The Senior Notes will be redeemable at the option of the Company, in whole or in part, on or after September 15, 2001, at predetermined redemption prices plus accrued and unpaid interest to the date of redemption. In 1998, the Company purchased $38.4 million in aggregate principal amount of its Senior Notes in open market transactions for a combined purchase price of $18.9 million or 49.4% of face value. In 1999, the Company purchased $74.5 million in aggregate principal amount of the Senior Notes for a purchase price of $45.0 million. In 2000, the company purchased $920,000 in aggregate principal amount of the Senior Notes in open market for a purchase price of $341,000, and may, from time to time, purchase more of its Senior Notes depending on its cash needs, market conditions, and other factors. The indenture pertaining to the Senior Notes contains various restrictive covenants including limitations on, among other things, the incurrence of certain types of additional indebtedness, the payment of dividends and certain other payments, the ability of the Company's subsidiaries to incur further limitations on their ability to pay dividends or make other payments to the Company, liens, asset sales, the issuance of preferred stock by the Company's subsidiaries and transactions with affiliates. At December 31, 2000 and 1999, management believes the Company was in compliance with such restrictive covenants. The Senior Notes are fully and unconditionally guaranteed (the "Subsidiary Guarantees") jointly and severally on an unsecured basis (each, a "Guarantee") by certain of the Company's subsidiaries listed in Note 26 (the "Subsidiary Guarantors"). With the exception of the Guarantee by the Company's subsidiary CII, the Subsidiary Guarantees rank on par with the right of payment with all existing and future unsubordinated indebtedness of the Subsidiary Guarantors and senior in right of payment to all existing and future subordinated indebtedness of such Guarantors. All existing debt of all subsidiaries other than CII are currently considered to be subordinated to the Senior Notes. The Guarantee by CII is equal in priority to CII's notes payable to investors and is senior to CII's subordinated debentures. The Senior Notes outstanding at December 31, 2000 and 1999 were $11.2 million and $12.1 million, respectively. Included in Note 26 is consolidating condensed financial data of the combined subsidiaries of the Company. The Company believes that providing the condensed consolidating information is of material interest to investors in the Senior Notes and has not presented separate financial statements for each of the wholly-owned Subsidiary Guarantors, because it was deemed that such financial statements would not provide investors with any material additional information. At December 31, 2000 and 1999, all of the subsidiary guarantors were wholly-owned by the Company. Note 12. Sale of Subsidiary and Subsidiary's Assets The Company sold substantially all of the assets of the small business loan operations to TransAmerica Small Business Capital, Inc. ("TransAmerica") in the fourth quarter of 1998. The Company no longer offers the small business loan products. The Small Business Loan Unit realized net income in 1998 of $11.0 million. Included in the 1998 net income was a $19.0 million pre-tax gain on sale of the Small Business Loan Unit's net assets. The Company sold substantially all of the assets of the auto loan unit on March 19, 1998 for $20.4 million, the approximate book value of the assets. The Company no longer offers auto loans as one of its financial products. Prior to the sale of the auto loan assets in 1998, the auto loan unit recorded a net loss of $110,000. On December 2, 1998, the Company sold the majority of its asset-based lending operation to Emergent Asset Based Lending LLC, a Maryland Limited Liability Company. This transaction completed the disposition of all non-mortgage-related activities of the Company. The sale resulted in a pre-tax loss of $755,000. The Company received a note receivable of $2.2 million payable over two years at an interest rate of Prime plus 1%. F-25 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 13. Fair Market Value Adjustment on Residual Receivables As a result of higher than anticipated prepayments in 1998, the Company modified the estimated prepayment speeds on all of its mortgage loan securitization transactions to peak at 30 constant prepayment rate ("CPR") up from the previous prepayment speeds of 20 CPR. This resulted in a write-down of residual receivables of $13.6 million in 1998. No such write-down was necessary in 2000 or 1999. The Company refined its estimate and began using CPR's of 28 in 1999 based on a review of a longer period of actual experience. Changes in valuation assumptions made in 2000, primarily related to the assumed loss rates in the pools. The change in assumed loss rates, due to lower than expected actual losses, resulted in an increase in fair value of the residual receivable. However, this increase was offset by actual losses on foreclosed properties in all the securitization pools, causing the write-down of the overall residual receivable. Note 14. Restructuring Charges In November 1998, the Company decided to close three retail loan centers and to consolidate all operations into one location. This decision resulted in a restructuring charge of $6.8 million. The restructuring charge related to the write-down of fixed assets to net realizable value on assets no longer used by the Company was $3.6 million. The estimated net lease cost on facilities no longer being used was $1.8 million, and the estimated costs of employee relocation cost and employee severance was approximately $1.4 million. During 2000, the Company incurred restructuring charges of approximately $1.5 million to the merger, to the decision to close its wholesale loan origination division, and estimated costs of employee relocation and severance in connection with Merger and Subsequent wholesale division closings. Note 15. Other General and Administrative Expenses Other general and administrative expenses for the years ended December 31, 2000, 1999, and 1998 consist of the following:
Years Ended December 31, ------------------------------------------------------------- 2000 1999 1998 ------------------ ------------------ ----------------- (In thousands) Depreciation expense $ 2,732 $ 2,487 $ 3,337 Amortization expense 1,981 206 289 Legal and professional fees 2,369 2,013 3,125 Loan costs 2,879 1,608 3,972 Deferred loan costs (835) (2,251) (5,917) Travel and entertainment 802 729 3,362 Office rent and utilities 821 322 2,827 Telephone 1,599 928 4,228 Office supplies 612 501 2,015 Equipment and miscellaneous rental 2,123 1,896 2,285 Repairs and maintenance 1,264 1,124 966 Postage and handling charges 600 374 1,146 Other 2,914 3,186 4,323 ----------------- ----------------- ---------------- Total other general and administrative expenses $ 19,861 $ 13,123 $ 25,958 ================= ================= ================
F-26 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 16. Income Taxes A reconciliation of the provision for Federal and state income taxes and the amount computed by applying the statutory Federal income tax rate to income before income taxes, minority interest, and extraordinary item are as follows:
Years Ended December 31, ---------------------------------------------------- 2000 1999 1998 ---------------- --------------- ------------- (In thousands) Statutory Federal rate of 34% applied to pre-tax income from continuing operations before minority interest and extraordinary item $ (13,547) $ (11,924) $ (24,817) State income taxes, net of federal income tax benefit (1,593) (511) 279 Change in the valuation allowance for deferred tax assets allocated to income tax expense (10,000) (7,500) 21,672 Nondeductible expenses 19 23 91 Amortization of excess cost over net assets of acquired businesses 112 18 46 Effect of losses on tax provision 14,769 11,800 3,909 Tax on excess inclusion income from REMIC's 632 700 2,284 Other, net 152 -- (447) ------------- -------------- ------------ $ (9,456) $ (7,394) $ 3,017 ============= ============== ============ The extraordinary gain on the extinguishment of debt is net of $0 tax since the gain was offset against prior NOLs and did not result in any incremental increase in income tax expense. Provision (benefit) for income taxes from continuing operations is comprised of the following: Years Ended December 31, ---------------------------------------------------- 2000 1999 1998 ---------------- --------------- ------------- (In thousands) Current Federal $ 535 $ 403 $ 2,594 State and local 9 52 423 ------------- -------------- ------------ 544 455 3,017 Deferred Federal (8,942) (7,023) -- State and local (1,058) (826) -- ------------- -------------- ------------ (10,000) (7,849) -- Total Federal (8,407) (6,620) 2,594 State and local (1,049) (774) 423 ------------- -------------- ------------ $ (9,456) $ (7,394) $ 3,017 ============= ============== ============
F-27 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 16. Income Taxes (continued) Deferred income taxes reflect the net tax effects of (a) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and (b) operating loss and AMT credit carryforwards. The tax effects of significant items comprising the Company's net deferred tax asset are as follows:
December 31, --------------------------------- 2000 1999 --------------- ------------- (In thousands) Deferred tax liabilities: Differences between book and tax basis of property $ (745) $ (601) Differences between book and tax basis of investment in owner's trust (521) (546) Difference between book and tax basis of the residual receivables associated with the Company's investment in the Real Estate Investment Trust (1,185) (1,096) Deferred loan costs -- (100) Other (41) (9) -------------- ------------ Total gross deferred tax liabilities $ (2,492) $ (2,352) ============== ============ Deferred tax assets: Differences between book and tax basis of deposit base intangibles $ 214 $ 200 Differences between book and tax basis of REMIC residual receivables 1,687 2,303 Allowance for credit losses 3,335 3,501 AMT credit carryforward 19 19 Operating loss carryforward 30,145 21,535 Deferred loan fees -- 270 REO reserve 114 114 Restructuring reserve-leases 377 415 Other 406 167 -------------- ------------ Total gross deferred tax assets 36,297 28,524 Less valuation allowance (11,805) (14,172) Less gross deferred tax liabilities (2,492) (2,352) -------------- ------------ Net deferred tax asset $ 22,000 $ 12,000 ============== ============
The valuation allowance for deferred tax assets at December 31, 2000 was $11.8 million. The increase (decrease) in the valuation allowance for the year ended December 31, 2000 and 31, 1999 was ($10.0) million and $7.5 million, respectively. The valuation allowance at December 31, 2000 relates primarily to net operating loss ("NOL") carryforwards. The decision to decrease the valuation allowance in 2000 was based on 2001 earnings projections, and the operational changes implemented in 2000 as a result of the merger. The Company experienced a taxable loss for 2000. Management believes that it is more likely than not that future operations will generate sufficient taxable income to realize the net deferred tax asset. Management will evaluate this each quarter, and will make additional adjustments to reserves against this asset if deemed appropriate in the future. As of December 31, 2000, the Company has available Federal NOL carryforwards expiring as follows (in thousands): 2001 $ 1,911 2002-2005 -- 2006 and after 101,681 ------------ $ 103,592 ============ There are no known significant pending assessments from taxing authorities regarding taxation issues at the Company or its subsidiaries. F-28 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17. Extraordinary Item - Gain On Extinguishment of Debt The Company purchased $920,000, $74.5 million, and $38.4 million face amount of its Senior Notes in the market for a purchase price of $341,000, $45.0 million, and $18.9 million in 2000, 1999, and 1998, respectively. A proportionate share of the unamortized debt origination costs relating to the issuance of the Senior Notes was charged against this gain, to record a net gain of $579,000, $29.5 million, and $18.2 million in 2000, 1999, and 1998, respectively. The Company may, from time to time, purchase more of its Senior Notes depending on its cash needs, market conditions, and other factors. Note 18. Statement of Cash Flows The following information relates to the Statement of Cash Flows for the three years ended December 31, 2000, 1999, and 1998:
Years Ended December 31, ----------------------------------------------- 2000 1999 1998 ------------- ------------- ------------ (In thousands) Changes in operating assets and liabilities increasing (decreasing) cash: Restricted cash $ 248 $ (214) $ (5,100) Other receivables (6,300) 3,969 (2,657) Residual receivable (13,386) (7,240) 6,124 Accrued interest receivable (393) 1,189 1,794 Servicing asset 165 73 528 Other assets (1,218) 2,670 6,373 Remittance due to loan participants 122 (793) (2,720) Accrued interest payable 92 (2,354) (1,551) Income taxes payable 369 177 511 Other liabilities (7,456) (2,536) (2,028) ------------- ------------ ----------- $ (27,757) (5,059) $ 1,274 ============= ============ =========== During the year ended December 31, 2000 in connection with the HomeSense merger the following non-cash items were recorded: (In thousands) Loans receivable $ 29,244 Property and equipment, net 5,800 Goodwill 19,020 Revolving warehouse lines of credit 29,244 Notes payable 2,853 Other liabilities 4,915 Preferred stock 10,000 Common stock 7 Capital in excess of par value 7,045
The Company foreclosed on, or repossessed property used to collateralize loans receivable in the amount of $2.4 million, $4.3 million, and $12.1 million, in 2000, 1999, and 1998, respectively. The Company purchased $3.0 and $10.5 million of foreclosed property from the securitization trusts in 2000 and 1999, respectively. The company repurchased loans from the securitization trusts of $9.9 million in 1998. The Company paid income taxes of $175,000, $277,000 and $2.5 million, in 2000, 1999, and 1998, respectively. The Company paid interest of $17.9 million, $18.7 million, and $37.5 million, in 2000, 1999, and 1998, respectively. F-29 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 19. Stock Option Plans and Stock Warrants On May 21, 1981, the shareholders approved an employee stock option plan and on May 22, 1984, the shareholders approved an increase in the number of shares of common stock which may be granted from 250,000 to 500,000. Under the terms of the plan, the Company may grant options to key employees and directors to purchase up to a total of 500,000 shares of its $.05 par value common stock. The option price is the fair market value at date of grant. The options expire five years from date of grant, are not transferable other than on death, and are exercisable 20% on the date of grant and 20% per year on a cumulative basis for each year subsequent to the date of grant. No additional shares are available for grant under this stock option plan, and there are 24,000 unexercised options outstanding at December 31, 2000, of which 24,000 are exercisable. On June 9, 1995, the shareholders approved a stock option plan under which the Board of Directors may issue 566,667 shares of common stock. In May 1997, April 1998, March 1999, and in March 2000, the shareholders approved an additional 150,000, 350,000, 400,000 and 500,000 shares of common stock, respectively. Therefore, under the terms of the plan, the Company may grant options to key employees to purchase up to a total of 1,966,667 shares of its $.001 par value common stock. The option price is the fair market value at date of grant. Prices for incentive stock options granted to employees who own 10% or more of the Company's stock are at 110% of market value at date of grant. The options expire ten years from date of grant, are not transferable other than on death, and are exercisable 20% on the date of grant and 20% per year on a cumulative basis for each year subsequent to the date of grant. The remaining options available for grant under the plan consist of 230,207 common stock options at December 31, 2000, and there are 930,800 unexercised options outstanding at December 31, 2000, of which 460,000 are exercisable. Also on June 9, 1995, the shareholders approved a stock option plan under which each non-employee member of the Board of Directors receives options to purchase 666 shares of common stock each December 31 beginning in 1995 through 1999. Under the terms of the plan, the Company may grant options totaling 33,333 shares. The terms of the plan are identical to the employee stock option plan approved on June 9, 1995. The remaining options available for grant under this plan consist of 27,606 common stock options at December 31, 2000 and there are 5,328 unexercised options outstanding at December 31, 2000, of which 5,328 are exercisable. On April 18, 1996, the shareholders approved a restricted stock agreement plan to provide additional incentives to members of the Board of Directors of the Company who are not employees of the Company. Shares that may be issued pursuant to the Restricted Stock Agreements under the Plan shall not exceed 50,000 shares in the aggregate. The Plan provides that, on each grant date, each eligible director will automatically receive from the Company an Agreement to purchase for $.05 per share that number of shares having a fair market value equal to $12,000. For purposes of the Plan, the grant date is January 31 of each calendar year commencing with the 1996 calendar year. At December 31, 2000 and 1999, there were 14,500 agreements granted under this plan with 11,600 unexercised agreements outstanding, all of which are exercisable. Shares subject to a Restricted Stock Agreement are initially non-transferable and subject to forfeiture. Shares granted to a recipient become freely transferable and no longer subject to forfeiture at a rate of 20% of the total number of shares covered by such agreement on each of the five anniversaries of the grant date, beginning with the first anniversary of such grant. On April 28, 2000, the shareholders approved a stock option plan pursuant to the HomeSense merger agreement to compensate Mr. Ronald J. Sheppard, CEO. The agreement authorized 825,423 shares of Common Stock to issued at $1.75 per share to Mr. Sheppard. These options can be exercised, forfeited, and cancelled at a rate of .67 to 1 in direct proportion to any exercised, forfeited, or cancelled options that were in existence at the time of the agreement. The remaining options outstanding under this plan consist of 637,354 common stock options at December 31, 2000. In February 2001, these options were cancelled. In connection with the consummation of the Merger on May 9, 2000, the Company issued a warrant to purchase 250,000 shares of its common stock at an exercise price of $1.50 per share to Raymond James and Associates, Inc. in partial consideration for the delivery to the Company of a fairness opinion regarding the Merger. The warrant was exercisable on issuance, expires five years from the date of issuance and is transferable. The Company issued the warrant without registration under Section 4(2) of the Securities Act of 1933, as amended, as a transaction not involving a public offering. F-30 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 19. Stock Option Plans and Warrants (continued) Activity in stock options is as follows:
Years Ended December 31, ---------------------------------------------------- 2000 1999 1998 --------------- --------------- -------------- Options outstanding, beginning of year 1,268,160 973,003 483,971 Date of Grant Issued at: -------------------- ---------------------- 01/16/98 $8.00 per share -- -- 6,000 01/16/98 $9.00 per share -- -- 15,000 03/11/98 $9.75 per share -- -- 205,000 04/22/98 $8.75 per share -- -- 16,900 05/13/98 $6.75 per share -- -- 50,000 09/04/98 $2.44 per share -- -- 7,000 12/02/98 $0.9375 per share -- -- 404,000 02/26/99 $0.9375 per share (non-qualified) -- 25,000 -- 02/26/99 $1.32 per share (non-qualified) -- 1,334 -- 03/10/99 $1.22 per share -- 10,000 -- 07/23/99 $1.3125 per share -- 35,000 -- 08/20/99 $0.9375 per share (non-qualified) -- 10,000 -- 10/06/99 $1.03 per share -- 502,800 -- 02/10/00 $1.06 per share 35,000 -- -- 04/28/00 $4.625 per share (non-qualified) 14,400 -- -- 04/28/00 $12.25 per share (non-qualified) 40,000 -- -- 04/28/00 $9.75 per share (non-qualified) 30,000 -- -- 04/28/00 $0.9375 per share (non-qualified) 40,000 -- -- 04/28/00 $1.03 per share (non-qualified) 50,000 -- -- 05/01/00 $1.3125 per share (non-qualified) 35,000 -- -- 05/01/00 $1.03 per share (non-qualified) 20,000 -- -- 05/02/00 $9.75 per share (non-qualified) 10,000 -- -- 05/02/00 $0.9375 per share (non-qualified) 20,000 -- -- 05/02/00 $1.03 per share (non-qualified) 20,000 -- -- 05/09/00 $1.75 per share (non-qualified) 825,423 -- -- 05/22/00 $13.50 per share (non-qualified) 3,000 -- -- 05/22/00 $9.75 per share (non-qualified) 10,000 -- -- 05/22/00 $0.9375 per share (non-qualified) 35,400 -- -- 05/22/00 $1.03 per share (non-qualified) 22,000 -- -- 05/22/00 $4.625 per share (non-qualified) 6,400 -- -- 07/03/00 $4.625 per share (non-qualified) 12,800 -- -- 07/03/00 $12.25 per share (non-qualified) 25,000 -- -- 07/03/00 $9.75 per share (non-qualified) 5,000 -- -- 07/03/00 $6.75 per share (non-qualified) 50,000 -- -- 07/03/00 $0.9375 per share (non-qualified) 25,000 -- -- 07/03/00 $1.03 per share (non-qualified) 35,000 -- -- 07/03/00 $1.06 per share (non-qualified) 35,000 -- -- 08/15/00 $0.50 per share 535,000 -- -- 10/04/00 $0.50 per share (non-qualified) 20,000 -- -- 10/04/00 $1.03 per share (non-qualified) 15,000 -- -- 10/04/00 $0.9375 per share (non-qualified) 5,000 -- -- 11/28/00 $0.42 per share 30,000 -- -- ------------- --------------- -------------- Total Granted 2,009,423 584,134 37,000 ------------- --------------- --------------
F-31 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 19. Stock Option Plans and Warrants (Continued)
Years Ended December 31, ---------------------------------------------------- 2000 1999 1998 --------------- --------------- -------------- Expired, canceled or forfeited: $1.0825 per share (12,002) -- $1.32 per share (1,334) (9,335) (2,668) $4.625 per share (36,800) (34,840) (28,800) $10.38 per share (directors plan) -- (400) $12.25 per share (66,000) (46,000) (86,000) $11.25 per share (directors plan) -- (533) $13.50 per share (9,000) -- (1,000) $13.00 per share (10,000) -- $14.25 per share -- (5,000) $13.50 per share -- (15,000) $8.00 per share -- (6,000) $9.00 per share -- (15,000) $9.75 per share (81,000) (42,000) (45,000) $8.75 per share (16,900) -- $0.9375 per share (245,100) (114,700) -- $0.50 per share (20,000) $1.06 per share (35,000) $1.22 per share (4,000) $1.03 per share (370,800) $1.3125 per share (70,000) $2.44 per share (7,000) $6.75 per share (50,000) $1.75 per share (188,069) ------------- --------------- -------------- (1,184,103) (285,777) (205,401) Exercised: $1.0825 per share -- -- (6,667) $1.32 per share -- -- -- $4.625 per share -- -- (1,600) $5.09 per share -- -- (1,200) $10.380 per share (directors plan) -- -- -- $11.250 per share (directors plan) -- -- -- $0.9375 per share -- (3,200) -- ------------- --------------- -------------- -- (3,200) (9,467) ------------- --------------- -------------- Options outstanding, end of year 2,331,082 1,268,160 973,003 ============= =============== ============== Exercisable, end of year 734,728 525,129 340,818 ============= =============== ============== Available for grant, end of year 1,301,916 257,813 141,173 ============= =============== ==============
The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." As such, the stock-based compensation utilized by the Company has been accounted for under APB Opinion No. 25. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date for awards in 2000, 1999, and 1998 consistent with the provisions of SFAS No. 123, the Company's net income (loss) and earnings (loss) per share of common stock would have been reduced to the pro forma amounts indicated below: F-32 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 19. Stock Option Plans and Stock Warrants (Continued)
Years ended December 31, ------------------------------------------------------- 2000 1999 1998 ---------------- ------------------ ----------------- (In thousands, except per share data) Net income (loss) - as reported $ (29,812) $ 1,815 $ (57,745) Net income (loss) - pro forma (30,243) 1,160 (58,025) Diluted earnings (loss) per share of common stock - as reported (2.06) 0.18 (5.94) Diluted earnings (loss) per share of common stock - pro forma (2.09) 0.12 (5.97)
The fair value of each option grant is estimated on the date of grant using a Black-Scholes valuation model with the following weighted average assumptions used in 2000: dividend yield of 0%, expected volatility of 120%, risk-free interest rate of approximately 6.00%, and expected lives of 5 years. The weighted average assumptions used in 1999 were dividend yield of 0%, expected volatility of 254%, risk-free interest rate of 6.73% and expected lives of 5 years. The pro forma amounts disclosed above may not be representative of the effects on reported net income for future periods. The Company implemented an Employee Stock Purchase Plan ("ESPP") in 1997. The ESPP allows eligible employees the right to purchase common stock at the end of each of two six-month offering periods (January 1 through June 30 and July 1 through December 31). Eligible employees must work 20 or more hours per week and have been employed for a period of 1 year. The stock is purchased at 85% of the lower of the market price at the beginning or ending of each six-month offering period. A liability is recorded for ESPP withholdings not yet applied towards the purchase of common stock. During 2000, the Company's Board of Directors has authorized an additional 400,000 shares to be issued under the Espp. The total amount of authorized shares is 600,000 at December 31, 2000. Note 20. Transactions with Related Parties The Company engaged in the following related party transactions: The Company obtains legal services from Wyche, Burgess, Freeman & Parham, P.A., certain members of which, when considered in the aggregate, beneficially own 596,351 shares of the Company's capital stock. A partner of the firm also serves as secretary to the Company. Total charges for these services were approximately $276,000 in 2000, $228,000 in 1999, and $659,000 in 1998. Notes payable to investors and subordinated debentures include amounts due to officers, directors and key employees of approximately $690,000, $707,000, and $661,000 at December 31, 2000, 1999 and 1998, respectively. The Company also had notes receivable from related parties at December 31, 2000, 1999 and 1998 of approximately $110,000, $121,000, and $168,000, respectively. Note 21. Employee Retirement Plan The Company has a matched savings plan under Section 401(k) of the Internal Revenue Code covering employees meeting certain eligibility requirements. The plan allows employees who have completed 30 days of service to participate in the plan and provides for Company contributions, subject to certain limitations. Company matching contributions are 50% of employee contributions to a maximum of 6% of compensation for each employee. The Company's contributions under the plan totaled approximately $160,800 in 2000, $320,500 in 1999, and $879,000 in 1998. F-33 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 22. Commitments and Contingencies The Company may from time to time enter into forward commitments to sell residential first mortgage loans to reduce risk associated with originating and holding loans for sale. At December 31, 2000, the Company had no outstanding forward commitment contracts. On April 4, 2000, the Company received notice of a suit filed against it by Danka Funding Company, LLC ("Danka") in New Jersey Superior Court. In the suit, Danka seeks recovery of $356,000 allegedly due under copier equipment leases. It is not possible to evaluate the likelihood or amount of an unfavorable outcome at this stage. On August 20, 1999, Janice Tomlin, Isaiah Tomlin, and Constance Wiggins filed a purported class action lawsuit in New Hanover County, North Carolina Superior Court. That suit has been transferred to North Carolina Business Court. The suit was filed against the Company's affiliate HomeGold, Inc. and others alleging a variety of statutory and common law claims arising out of mortgage loans they obtained through Chase Mortgage Brokers ("Chase"). On February 22, 2000, Michael and Kimberly Chasten filed a similar action in Duplin County, North Carolina Superior Court. That suit has been removed to the United States District Court for the Eastern District of North Carolina. On March 21, 2000, Rosa and Royal Utley filed a similar suit in New Hanover County, North Carolina Superior Court. On April 13, 2000 Reginald Troy filed a similar action in New Hanover County, North Carolina Superior Court. That suit has been removed to the United States District Court for the Eastern District of North Carolina. The plaintiffs in all of these cases are seeking unspecified monetary damages. As to HomeGold, Inc., the complaints in these four cases allege participation by HomeGold, Inc. in an arrangement with Chase under which Chase allegedly charged excessive fees and interest to the consumers, and under which Chase allegedly received undisclosed premiums. There has been no class certified in any of the cases, and HomeGold Inc. has contested, and will continue to contest each case vigorously. The Company and its subsidiaries are, from time to time, parties to various legal actions arising in the normal course of business. Management believes that there is no proceeding threatened or pending against the Company or any of its subsidiaries that, if determined adversely, would have a materially adverse effect on the operations, profitability or financial condition of the Company or any of its subsidiaries. In May 2000, HGFN entered into a $40 million revolving warehouse line of credit with Household Commercial Financial Services, Inc. ("Household") which was subsequently increased to $50 million. All of HGFN's subsidiaries, including HGI, are guarantors under the agreement. In an amendment and forbearance agreement with its lender dated October 25, 2000, HomeGold, Inc. acknowledged that it was in default with respect to certain financial covenants under the warehouse line of credit, and the lender agreed to forebear exercising its rights and remedies without waiving any events of default. The lender has subsequently extended its forbearance, and the termination date of the warehouse, through the earlier of April 30, 2001 or the entry of HomeGold, Inc. and the lender into an amended credit agreement. The outstanding balance under this warehouse line as of March 27, 2001 was $23,921,412. HomeGold, Inc. management believes that they will obtain an amended agreement and be able to meet its obligations thereunder on April 30, 2001; however, there can be no assurance this will occur. Were HomeGold, Inc. to default on its obligations, guarantors could be required to perform under their guaranties and fulfill HomeGold, Inc.'s obligations under the warehouse, including the obligation to pay principal and accrued interest. HGI, together with certain other subsidiaries of HGFN (collectively, the "Subsidiary Guarantors"), has guaranteed HGFN's performance of its obligations under its 10-3/4% Senior Notes due 2004 (the "Senior Notes") and the indenture related thereto (the "Indenture"). The original aggregate principal amount of the Senior Notes was $125,000,000; however, as of December 31, 2000, HGFN has repurchased $113,786,000 of the Senior Notes leaving $11,214,000 in aggregate principal amount outstanding. HGFN has incurred operating losses of $39.8 million, $35.1 million, and $73.0 million for the years ended December 31, 2000, 1999, and 1998, respectively and has deficit shareholder's equity of $10.8 million at December 31, 2000. The management of HGFN has implemented plans to reverse these negative trends by implementing operating changes which include, but are not limited to, the following: - Continually offering and reviewing loan products to meet customer demands while also meeting the needs of purchasers of loans originated. - Hiring, retaining, and motivating loan officers and employees. - Geographic expansion of loan origination operations. - Maintaining and increasing warehouse lines of credit to fund loan originations. - Reducing non-core operating and general overhead. - Negotiating with potential buyers the sale of non-core lines of business and assets F-34 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 23. Supplemental Quarterly Results of Operations (Unaudited) The quarterly results of operations for the year ended December 31, 2000, are as follows:
Quarter Ended -------------------------------------------------------------------------- March 31, June 30, September 30, December 31, 2000 2000 2000 2000 --------------- --------------- ---------------- --------------- (in thousands, except share data) Revenues: Interest income $ 1,927 $ 3,679 $ 3,784 $ 2,802 Servicing income 2,004 2,216 1,907 1,270 Gain on sale of loans: Gross gain on sale of loans 1,854 3,090 3,554 1,303 Loan fees, net 432 5,620 6,926 3,452 --------------- --------------- ---------------- --------------- Total gain (loss) on sale 2,286 8,710 10,480 4,755 Other revenues 510 429 573 223 --------------- --------------- ---------------- --------------- Total revenues 6,727 15,034 16,744 9,050 Expenses: Interest 4,003 4,881 5,680 4,884 Provision for credit losses 990 652 650 867 Cost of real estate owned and defaulted loans 1,054 914 1,483 Fair market adjustment on residual receivables 1,080 555 509 135 Salaries, wages and employee benefits 4,912 7,955 8,469 7,780 Business development costs 1,841 1,811 2,136 2,827 Restructuring charges -- 1,369 99 1 Other general and administrative 2,813 6,218 6,429 4,401 --------------- --------------- ---------------- --------------- Total expenses 16,693 23,441 24,886 22,378 --------------- --------------- ---------------- --------------- Loss before income taxes, minority interest and extraordinary item (9,966) (8,407) (8,142) (13,328) Provision (benefit) for income taxes 145 190 (9,820) 29 Minority interest in (earnings) loss of subsidiaries (1) 1 (2) (2) --------------- --------------- ---------------- --------------- Income before extraordinary item (10,112) (8,596) 1,676 (13,359) Extraordinary item-gain on extinguishment of debt, net of $0 tax 226 92 261 0 --------------- --------------- ---------------- --------------- Net income (loss) $ (9,886) $ (8,504) $ 1,937 $ (13,359) =============== =============== ================ =============== Basic earnings (loss) per share of common stock: Loss before extraordinary item $ (0.99) $ (0.62) $ 0.10 $ (0.59) Extraordinary item, net of taxes 0.02 0.01 0.02 (0.01) --------------- --------------- ---------------- --------------- Net income (loss) $ (0.97) $ (0.61) $ 0.12 $ (0.60) =============== =============== ================ =============== Basic weighted average shares outstanding 10,170,698 13,943,164 16,805,023 16,810,149 =============== =============== ================ =============== Diluted earnings (loss) per share of common stock: Loss before extraordinary item $ (0.81) (0.63) (1.07) 0.41 Extraordinary item, net of tax 1.73 0.44 0.81 (2.94) --------------- --------------- ---------------- --------------- 0.92 (0.19) (0.26) (2.53) =============== =============== ================ =============== Diluted weighted average shares outstanding 10,170,698 13,943,164 16,805,023 16,810,149 =============== =============== ================ ===============
F-35 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 23. Supplemental Quarterly Results of Operations (Unaudited) (Continued) The quarterly results of operations for the year ended December 31, 1999, are as follows:
Quarter Ended ------------------------------------------------------------------------ March 31, June 30, September 30, December 31, 1999 1999 1999 1999 --------------- --------------- --------------- --------------- (in thousands, except share data) Revenues: Interest income $ 3,338 $ 1,618 $ 1,771 $ 1,559 Servicing income 2,402 2,608 2,606 2,197 Gain on sale of loans: Gross gain on sale of loans 1,173 3,216 70 1,757 Loan fees, net 957 1,416 716 224 --------------- --------------- ---------------- --------------- Total gain (loss) on sale 2,130 4,632 786 1,981 Other revenues 396 354 409 450 --------------- --------------- ---------------- --------------- Total revenues 8,266 9,212 5,572 6,187 Expenses: Interest 4,798 4,189 3,778 3,573 Provision for credit losses 81 (430) 1,672 2,016 Cost of real estate owned and defaulted loans 823 588 729 878 Fair market adjustment on residual receivables (53) 828 856 1,696 Salaries, wages and employee benefits 5,671 5,232 4,957 4,499 Business development costs 1,190 1,237 1,330 1,047 Other general and administrative 3,258 3,538 2,920 3,407 --------------- --------------- ---------------- --------------- Total expenses 15,768 15,182 16,242 17,116 --------------- --------------- ---------------- --------------- Loss before income taxes, minority interest and extraordinary item (7,502) (5,970) (10,670) (10,929) Provision (benefit) for income taxes 450 170 55 (8,069) Minority interest in (earnings) loss of subsidiaries 3 (7) (3) (1) --------------- --------------- ---------------- --------------- Income before extraordinary item (7,949) (6,147) (10,728) (2,861) Extraordinary item-gain on extinguishment of debt, net of $0 tax 16,946 4,281 8,143 130 --------------- --------------- ---------------- --------------- Net income (loss) $ 8,997 $ (1,866) $ (2,585) $ (2,731) =============== =============== ================ =============== Basic earnings (loss) per share of common stock: Loss before extraordinary item $ (0.81) $ (0.63) $ (1.07) $ (0.28) Extraordinary item, net of taxes 1.73 0.44 0.81 0.01 --------------- --------------- ---------------- --------------- Net income (loss) $ 0.92 $ (0.19) $ (0.26) $ (0.27) =============== =============== ================ =============== Basic weighted average shares outstanding 9,792,174 9,827,228 10,070,150 10,149,629 =============== =============== ================ =============== Diluted earnings (loss) per share of common stock: Loss before extraordinary item $ (0.81) (0.63) (1.07) (0.28) Extraordinary item, net of tax 1.73 0.44 0.81 0.01 --------------- --------------- ---------------- --------------- Net income (loss) 0.92 (0.19) (0.26) (0.27) =============== =============== ================ =============== Diluted weighted average shares outstanding 9,792,174 9,827,228 10,070,150 10,149,629 =============== =============== ================ ===============
F-36 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 24. Earnings (loss) per share of common stock The following table sets forth the computation of basic and fully diluted earnings per share.
For the Year Ended December 31, ----------------------------------------------------------- 2000 1999 1998 ------------------ ---------------- ----------------- (in thousands, except per share data) Numerator Net income (loss)-numerator for basic and fully diluted EPS $ (29,812) $ 1,815 $ (57,745) ================== ================ ================= Denominator Basic weighted average shares o/s-denominator for basic EPS 14,445,283 9,961,077 9,719,262 Effect of dilutive employee stock options -- -- -- ------------------ ---------------- ----------------- Fully diluted weighted average shares o/s-denominator for fully diluted EPS 14,445,283 9,961,077 9,719,262 ================== ================ ================= Basic earnings per common share $ (2.06) $ 0.18 $ (5.94) Fully diluted earnings per common share $ (2.06) $ 0.18 $ (5.94)
The computation of fully diluted EPS in 2000, 1999, and 1998, does not take into account the effect of any outstanding common stock equivalents since their inclusion would be antidilutive. The number of shares related to common stock equivalents that would have been included in 2000 and 1999 were 12,089 and 70,657, respectively. Note 25. Fair Value of Financial Instruments SFAS 107, "Disclosures about Fair Value of Financial Instruments" requires disclosure of fair value information whether or not recognized in the balance sheet, when it is practicable to estimate the fair value. SFAS 107 defines a financial instrument as cash, evidence of an ownership interest in an entity or contractual obligations which require the exchange of cash or financial instruments. Certain items are specifically excluded from the disclosure requirements, including the Company's common stock, property and equipment and other assets and liabilities. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and Cash Equivalents and Restricted Cash For these short-term instruments, the carrying amount is a reasonable estimate of fair value. Loans Receivable For certain homogeneous categories of loans, such as residential mortgages, fair value is estimated using the secondary market prices received on recent sales of these loans in the secondary market. Residual Receivable, Net The fair value of the residual receivable is calculated using prepayment, default and interest rate assumptions that the Company believes market participants would use for similar instruments at the time of sale. Projected performance is monitored on an ongoing basis. Accordingly, carrying value approximates fair value. F-37 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 25. Fair Value of Financial Instruments (Continued) Investor Savings Subordinated Investor Savings were $165.2 million and $144.8 million at December 31, 2000 and 1999, respectively. These instruments bear interest at rates ranging from 5%-9% and mature at various dates throughout 2001 and 2002. There is no active market for these instruments and it is not practicable to estimate fair value. Revolving Warehouse Lines and Notes Payable to Banks and Other The fair value of notes payable to banks and other approximates the carrying amount. Rates with similar terms and maturities currently available to the Company are used to estimate fair value of existing debt. Senior Unsecured Debt The fair value of senior unsecured debt is based on the market value of the publicly traded securities. Commitments to Extend Credit The fair value of commitments to extend credit is determined by using the anticipated market prices that the loans will generate in the secondary market. The estimated fair values of the Company's financial instruments at December 31 were as follows:
2000 1999 --------------------------------- --------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value --------------- -------------- -------------- --------------- (In thousands) Financial Assets: Cash and cash equivalents $ 3,691 $ 3,691 $ 26,009 $ 26,009 Restricted cash 5,066 5,066 5,314 5,314 Loans receivable, net 51,699 52,731 56,614 57,300 Residual receivable 58,877 58,877 47,770 47,770 Financial Liabilities: Revolving warehouse lines and notes payable to banks and other $ 29,304 $ 26,304 $ 17,808 $ 17,808 Senior unsecured debt 11,214 4,300 12,134 5,700 Commitments to extend credit -- -- 4,255 4,307
F-38 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 26. Consolidating Condensed Financial Data of the Combined Subsidiaries That Guaranteed Senior Debt The Subsidiary Guarantors of the Company's Senior Notes at December 31, 2000 consist of the following wholly owned subsidiaries of the Company: HomeGold, Inc. (f/k/a Emergent Mortgage Corp.) Emergent Mortgage Corp. of Tennessee Carolina Investors, Inc. Emergent Insurance Agency Corp. Emergent Business Capital Asset Based Lending, Inc. Investments in subsidiaries are accounted for by the Parent and Subsidiary Guarantors on the equity method for the purposes of the consolidating financial data. Earnings of subsidiaries are therefore reflected in the parent's and Subsidiary Guarantor's investment accounts and earnings. The principal elimination entries eliminate investments in subsidiaries and intercompany balances and transactions. Certain sums in the following tables may reflect immaterial rounding differences. As of December 31, 2000, the Subsidiary Guarantors conduct all of the Company's operations, other than the investment of certain residual receivables through its special purpose bankruptcy-remote securitization subsidiaries. Prior to March 1998, The Loan Pro$, Inc. and Premier Financial Services, Inc. (the Company's auto loan units) were guarantors of this indebtedness, but their guarantees terminated when substantially all of the assets of the auto loan units were sold to TranSouth Financial Corporation, a subsidiary of Associates Financial Services Company, Inc., in March 1998. Prior to August 21, 1998, Sterling Lending Corporation (an 80% owned subsidiary of the Company) and Sterling Lending Insurance Agency, Inc. (a 100% owned subsidiary of Sterling Lending Corporation) were also guarantors of this indebtedness, but their guarantees terminated when they were sold to First National Security Corporation of Beaumont, Texas, in August 1998. Therefore the operations of Sterling Lending (a non-wholly-owned guarantor subsidiary) are included in the consolidated statements of operations for the respective periods prior to August 21, 1998. The majority of the assets of Emergent Business Capital, Inc., Emergent Commercial Mortgage, Inc., Emergent Business Capital Equity Group, Inc. and Reedy River Ventures Limited Partnership were sold to Transamerica Business Credit Corporation on November 13, 1998. Accordingly, any guarantees of these companies were terminated upon consummation of that sale. A substantial majority of the assets of Emergent Business Capital Asset Based Lending, Inc. were sold to Emergent Asset-Based Lending LLC, an unaffiliated Maryland Limited Liability Company, on December 2, 1998. Since not all assets of this subsidiary were sold, the guaranty was not released. F-39 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING BALANCE SHEET
December 31, 2000 (Unaudited) (Dollars in thousands) Combined Wholly-Owned Combined Parent Guarantor Non-Guarantor ASSETS Company Subsidiaries Subsidiaries Eliminations Consolidated ------ ----------- ------------ ------------- ------------ ------------ Cash and cash equivalents $ 100 $ 3,590 $ 1 $ -- $ 3,691 Restricted cash 66 5,000 -- -- 5,066 Loans receivable: Loans receivable 1,087 57,396 -- -- 58,483 Notes receivable from affiliates 7,847 95,448 14,083 (117,378) -- ----------- ------------ ------------ ------------ ----------- Total loans receivable 8,934 152,844 14,083 (117,378) 58,483 Less allowance for credit losses on loans (250) (4,402) -- -- (4,652) Less deferred loan fees -- (2,339) -- -- (2,339) Plus deferred loan costs -- 207 -- -- 207 ----------- ------------ ------------ ------------ ----------- Net loans receivable 8,684 146,310 14,083 (117,378) 51,699 Other Receivables: Income tax -- 318 -- -- 318 Accrued interest receivable 80 1,737 -- -- 1,817 Other receivables -- 11,497 -- -- 11,497 ----------- ------------ ------------ ------------ ----------- Total other receivables 80 13,552 -- -- 13,632 Investment in subsidiaries 89,558 45,147 -- (134,705) -- Residual receivables, net -- 19,123 39,754 -- 58,877 Net property and equipment -- 21,430 -- -- 21,430 Real estate and personal property acquired through foreclosure -- 1,281 -- -- 1,281 Net excess of cost over net assets of acquired businesses 35 19,588 -- -- 19,623 Deferred income tax asset, net 1,810 20,190 -- -- 22,000 Other assets 1,220 3,502 -- -- 4,722 ----------- ------------ ------------ ------------ ----------- Total assets $ 101,554 $ 298,713 $ 53,837 $ (252,083) $ 202,021 =========== ============ ============ ============ =========== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Liabilities: Revolving warehouse lines of credit and notes payable to banks $ -- $ 29,304 $ -- $ -- $ 29,304 Investor savings: Notes payable to investors -- 146,087 -- -- 146,087 Subordinated debentures -- 19,117 -- -- 19,117 ----------- ------------ ------------ ------------ ----------- Total investor savings -- 165,204 -- -- 165,204 Senior unsecured debt 11,214 -- -- -- 11,214 Accounts payable and accrued liabilities -- 4,637 -- -- 4,637 Remittances payable -- 1,201 -- -- 1,201 Income taxes payable -- 347 -- -- 347 Accrued interest payable 328 610 -- -- 938 Due to (from) affiliates 100,840 7,852 8,686 (117,378) -- ----------- ------------ ------------ ------------ ----------- Total other liabilities 101,168 14,647 8,686 (117,378) 7,123 Subordinated debt to affiliates -- -- -- -- -- ----------- ------------ ------------ ------------ ----------- Total liabilities 112,382 209,155 8,686 (117,378) 212,844 Minority interest -- -- 5 (1) 5 Shareholders' equity: Common stock 17 1,000 2 (1,002) 17 Preferred stock 10,000 10,000 Capital in excess of par value 46,643 203,739 48,807 (252,546) 46,643 Note receivable from shareholder (5,985) (5,985) -- 5,985 (5,985) Retained earnings (deficit) (61,503) (109,196) (3,663) 112,859 (61,503) ----------- ------------ ------------ --------- ----------- Total shareholders' equity (10,828) 89,558 45,146 (134,704) (10,828) ----------- ------------ ------------ ------------ ----------- Total liabilities and shareholders' equity $ 101,554 $ 298,713 $ 53,837 $ (252,083) $ 202,021 =========== ============ ============ ============ ===========
F-40 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING BALANCE SHEETS December 31, 1999 (Unaudited) (Dollars in thousands)
Combined Wholly-Owned Combined Parent Guarantor Non-Guarantor ASSETS Company Subsidiaries Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ ------------ Cash and cash equivalents $ 202 $ 25,806 $ 1 $ -- $ 26,009 Restricted cash 5,314 -- -- -- 5,314 Loans receivable: Loans receivable -- 63,242 -- -- 63,242 Notes receivable from affiliates 7,097 36,229 4,584 (47,910) -- ---------- ------------ ----------- ------------ ------------ Total loans receivable 7,097 99,471 4,584 (47,910) 63,242 Less allowance for credit losses on loans -- (6,344) -- -- (6,344) Less deferred loan fees -- (730) -- -- (730) Plus deferred loan costs -- 446 -- -- 446 ---------- ------------ ----------- ------------ ------------ Net loans receivable 7,097 92,843 4,584 (47,910) 56,614 Other Receivables: Income tax -- 461 -- -- 461 Accrued interest receivable 36 1,387 -- -- 1,423 Other receivables 1,006 7,053 -- -- 8,059 ---------- ------------ ----------- ------------ ------------ Total other receivables 1,042 8,901 -- -- 9,943 Investment in subsidiaries 31,487 -- -- (31,487) -- Residual receivables, net -- 4,545 43,225 -- 47,770 Net property and equipment -- 17,160 -- -- 17,160 Real estate and personal property acquired through foreclosure -- 7,673 -- -- 7,673 Net excess of cost over net assets of acquired businesses 38 1,528 -- -- 1,566 Deferred income tax asset, net 3,510 8,490 -- -- 12,000 Other assets 304 4,384 -- -- 4,688 ---------- ------------ ----------- ------------ ------------ Total assets $ 48,994 $ 171,330 $ 47,810 $ (79,397) 188,737 ========== ============ =========== ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Liabilities: Revolving warehouse lines of credit $ -- $ 17,808 $ -- $ -- $ 17,808 Investor savings: Notes payable to investors -- 127,065 -- -- 127,065 Subordinated debentures -- 17,710 -- -- 17,710 ---------- ------------ ----------- ------------ ------------ Total investor savings -- 144,775 -- -- 144,775 Senior unsecured debt 12,134 -- -- -- 12,134 Accounts payable and accrued liabilities -- 4,120 -- -- 4,120 Remittances payable -- 1,078 -- -- 1,078 Income taxes payable -- 120 -- -- 120 Accrued interest payable 384 461 -- -- 845 Due to (from) affiliates 28,632 -- 7,597 (36,229) -- ---------- ------------ ----------- ------------ ------------ Total other liabilities 29,016 5,779 7,597 (36,229) 6,163 Subordinated debt to affiliates -- 11,681 -- (11,681) -- ---------- ------------ ----------- ------------ ------------ Total liabilities 41,150 180,043 7,597 (47,910) 180,880 Minority interest -- (1) 14 -- 13 Shareholders' equity: Common stock 507 998 2 (1,000) 507 Capital in excess of par value 39,028 66,043 48,807 (114,850) 39,028 Retained earnings (deficit) (31,691) (75,753) (8,610) 84,363 (31,691) ---------- ------------ ----------- ------------ ------------ -- -- -- -- -- Total shareholders' equity 7,844 (8,712) 40,199 (31,487) 7,844 ---------- ------------ ----------- ------------ ------------ Total liabilities and shareholders' equity $ 48,994 $ 171,330 $ 47,810 $ (79,397) $ 188,737 ========== ============ =========== ============ ============
F-41 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING STATEMENTS OF OPERATIONS Year Ended December 31, 2000 (Unaudited) (Dollars in thousands)
Combined Wholly-Owned Combined Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated ------------- ------------- ------------- ------------- ------------- REVENUES: Interest income $ 1,081 $ 14,584 $ -- $ (3,473) $ 12,192 Servicing income -- 5,327 2,070 -- 7,397 Gain on sale of loans: Gross gain on sale of loans -- 9,801 -- -- 9,801 Loan fees, net -- 16,430 -- -- 16,430 ------------- ------------- ----------- ------------- ------------- Total gain on sale of loans -- 26,231 -- -- 26,231 Other revenues -- 1,792 -- (57) 1,735 ------------- ------------- ----------- ------------- ------------- Total revenues 1,081 47,934 2,070 (3,530) 47,555 ------------- ------------- ----------- ------------- ------------- EXPENSES: Interest 4,038 18,883 -- (3,473) 19,448 Provision for credit losses 719 2,440 -- -- 3,159 Costs on REO and defaulted loans -- 3,451 -- -- 3,451 Fair value write-down of residual receivables -- 7,850 (5,571) -- 2,279 Salaries, wages and employee benefits -- 29,116 -- -- 29,116 Business development costs -- 8,615 -- -- 8,615 Restructuring charges -- 1,469 -- -- 2,375 Other general and administrative expense 182 19,738 -- (59) 18,955 ------------- ------------- ----------- ------------- ------------- Total expenses 4,939 91,562 (5,571) (3,532) 87,398 ------------- ------------- ----------- ------------- ------------- Income (loss) before income taxes, minority interest, equity in undistributed earnings (loss) of subsidiaries, and extraordinary item (3,858) (43,628) 7,641 2 (39,843) Equity in undistributed earnings (loss) of subsidiaries (24,833) (972) -- 25,805 -- ------------- ------------- ----------- ------------- ------------- Income (loss) before income taxes, minority interest, and extraordinary item (28,691) (44,600) 7,641 25,807 (39,843) Provision (benefit) for income taxes 1,700 (11,156) -- -- (9,456) ------------- ------------- ----------- ------------- ------------- Income (loss) before minority interest and extraordinary item (30,391) (33,444) 7,641 25,807 (30,387) Minority interest in earnings of subsidiaries -- -- (4) -- (4) ------------- ------------- ----------- ------------- ------------- Income (loss) before extraordinary item (30,391) (33,444) 7,637 25,807 (30,391) Extraordinary item-gain on extinguishment of debt, net of $0 tax 579 -- -- -- 579 ------------- ------------- ----------- ------------- ------------- Net income (loss) $ (29,812) $ (33,444) $ 7,637 $ 25,807 $ (29,812) ============= ============= =========== ============= =============
F-42 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING STATEMENTS OF OPERATIONS Year Ended December 31, 1999 (Unaudited) (Dollars in thousands)
Combined Wholly-Owned Combined Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated ------------- ------------- ------------- ------------- ------------- REVENUES: Interest income $ 3,523 $ 7,996 $ -- $ (3,233) $ 8,286 Servicing income -- 5,883 3,930 -- 9,813 Gain on sale of loans: Gross gain on sale of loans -- 6,216 -- -- 6,216 Loan fees, net -- 3,313 -- -- 3,313 ------------- ------------- ----------- ------------- ------------- Total gain on sale of loans -- 9,529 -- -- 9,529 Other revenues 8 1,774 -- (173) 1,609 ------------- ------------- ----------- ------------- ------------- Total revenues 3,531 25,182 3,930 (3,406) 29,237 ------------- ------------- ----------- ------------- ------------- EXPENSES: Interest 4,376 15,195 -- (3,233) 16,338 Provision for credit losses -- 3,339 -- -- 3,339 Costs on REO and defaulted loans -- 3,018 -- -- 3,018 Fair value write-down of residual receivables -- 2,556 771 -- 3,327 Salaries, wages and employee benefits -- 20,359 -- -- 20,359 Business development costs -- 4,804 -- -- 4,804 Restructuring charges -- -- -- -- -- Other general and administrative expense 377 12,918 1 (173) 13,123 ------------- ------------- ----------- ------------- ------------- Total expenses 4,753 62,189 772 (3,406) 64,308 ------------- ------------- ----------- ------------- ------------- Income (loss) before income taxes, minority interest, equity in undistributed earnings (loss) of subsidiaries, and extraordinary item (1,222) (37,007) 3,158 -- (35,071) Equity in undistributed earnings (loss) of subsidiaries (26,463) -- -- 26,463 -- ------------- ------------- ----------- ------------- ------------- Income (loss) before income taxes, minority interest, and extraordinary item (27,685) (37,007) 3,158 26,463 (35,071) Provision (benefit) for income taxes -- (7,394) -- -- (7,394) ------------- ------------- ----------- ------------- ------------- Income (loss) before minority interest and extraordinary item (27,685) (29,613) 3,158 26,463 (27,677) Minority interest in earnings of subsidiaries -- (8) -- -- (8) ------------- ------------- ----------- ------------- ------------- Income (loss) before extraordinary item (27,685) (29,621) 3,158 26,463 (27,685) Extraordinary item-gain on extinguishment of debt, net of $0 tax 29,500 -- -- -- 29,500 ------------- ------------- ----------- ------------- ------------- Net income (loss) $ 1,815 $ (29,621) $ 3,158 $ 26,463 $ 1,815 ============= ============= =========== ============= =============
F-43 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING STATEMENTS OF OPERATIONS Year Ended December 31, 1998 (Unaudited) (Dollars in thousands)
Combined Combined Non Wholly-Owned Wholly-Owned Combined Parent Guarantor Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Subsidiaries Eliminations Consolidated ------------- ------------- ------------ ------------- -------------- --------------- REVENUES: Interest income $ 8,109 $ 34,551 $ 10 $ 1,238 $ (8,833) $ 35,075 Servicing income -- 18,646 -- 2,734 (9,141) 12,239 Gain on sale of loans: Gross gain on sale of loans -- 8,057 1,415 -- -- 9,472 Loan fees, net -- 10,136 1,520 89 -- 11,745 ------------- ------------- ----------- ------------ ------------- --------------- Total gain on sale of loans -- 18,193 2,935 89 -- 21,217 Gain on sale of subsidiaries' net assets -- 18,964 -- -- -- 18,964 Other revenues 927 3,242 217 489 (645) 4,230 ------------- ------------- ----------- ------------ ------------- --------------- Total revenues 9,036 93,596 3,162 4,550 (18,619) 91,725 ------------- ------------- ----------- ------------ ------------- --------------- EXPENSES: Interest 14,479 30,420 125 402 (9,458) 35,968 Provision for credit losses 20 11,886 -- -- -- 11,906 Costs on real estate owned and defaulted loans -- 2,665 -- -- -- 2,665 Fair value write-down of residual receivables -- 9,902 -- 3,736 -- 13,638 Salaries, wages and employee benefits 3,176 49,769 3,639 -- -- 56,584 Business development costs 2 10,547 269 -- -- 10,818 Restructuring charges -- 6,838 -- -- -- 6,838 Other general and administrative expense (2,216) 25,730 2,552 256 (23) 26,299 ------------- ------------- ----------- ------------ ------------- --------------- Total expenses 15,461 147,757 6,585 4,394 (9,481) 164,716 ------------- ------------- ----------- ------------ ------------- --------------- Income (loss) before income taxes, minority interest, equity in undistributed earnings (loss) of subsidiaries, and extraordinary item (6,425) (54,161) (3,423) 156 (9,138) (72,991) Equity in undistributed earnings (loss) of subsidiaries (69,668) (10,138) -- -- 79,806 -- ------------- ------------- ----------- ------------ ------------- --------------- Income (loss) before income taxes, minority interest, and extraordinary item (76,093) (64,299) (3,423) 156 70,668 (72,991) Provision (benefit) for income taxes (132) 3,195 (46) -- -- 3,017 ------------- ------------- ----------- ------------ ------------- --------------- Income (loss) before minority interest and extraordinary item (75,961) (67,494) (3,377) 156 70,668 (76,008) Minority interest in earnings of subsidiaries -- -- -- 47 -- 47 ------------- ------------- ----------- ------------ ------------- --------------- Income (loss) before extraordinary item (75,961) (67,494) (3,377) 203 70,668 (75,961) Extraordinary item-gain on extinguishment of debt, net of $0 tax 18,216 -- -- -- -- 18,216 ------------- ------------- ----------- ------------ ------------- --------------- Net income (loss) $ (57,745) $ (67,494) $ (3,377) $ 203 $ 70,668 $ (57,745) ============= ============= =========== ============ ============= ===============
F-44 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING STATEMENT OF CASH FLOWS Year Ended December 31, 2000 (Unaudited) (Dollars in thousands)
Combined Wholly-Owned Combined Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated ----------- ------------ ------------- ------------ ------------- OPERATING ACTIVITIES: Net income (loss) $ (29,812) $ (33,444) $ 7,637 $ 25,807 $ (29,812) Extraordinary Gain on retirement of senior unsecured debt -- -- -- -- -- ----------- ------------ ------------ ------------ ------------ Income (loss) from continuing operations -- -- -- -- -- Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Equity in undistributed earnings of subsidiaries 24,833 972 -- (25,805) -- Depreciation and amortization 3 4,711 -- -- 4,714 Fair market writedown of residual receivable -- 2,279 -- -- 2,279 Benefit for deferred income taxes (1,700) (8,300) -- -- (10,000) Provision for credit losses 719 2,440 -- -- 3,159 Provision for losses on real estate owned -- 952 -- -- 952 Gain on retirement of senior unsecured debt (579) -- -- -- (579) Net decrease in deferred loan cost -- 239 -- -- 239 Net increase (decrease) in unearned 1,609 1,609 discount and deferred loan fees Loans originated with intent to sell (567,421) (567,421) Principal proceeds from sold loans 508,690 508,690 Proceeds from securitization of loans -- 50,554 -- -- 50,554 Other -- 652 -- -- 652 Changes in operating assets and liabilities increasing (decreasing) cash 5,238 (36,467) 3,472 -- (27,757) ----------- ------------ ------------ ------------ ------------ Net cash provided by (used in) operating activities (1,298) (72,534) 11,109 2 (62,721) INVESTING ACTIVITIES: Loans originated for investment purposes -- (345) -- -- (345) Loans purchased for investment purposes (1,087) (2,080) -- -- (3,167) Principal collections on loans not sold -- 41,266 -- -- 41,266 Purchase of REO and loans from securitization trusts -- (2,978) -- -- (2,978) Proceeds from sale of real estate and personal property acquired through foreclosure -- 10,067 -- -- 10,067 Proceeds from the sale of property and equipment -- 54 -- -- 54 Purchase of property and equipment -- (164) -- -- (164) Note receivable from shareholder (4,000) (4,000) 4,000 (4,000) Other -- 111 -- -- 111 ----------- ------------ ------------ ------------ ------------ Net cash provided by (used in) investing activities (7,072) 41,931 -- 4,000 40,844 FINANCING ACTIVITIES: Advances on warehouse lines of credit -- 702,518 -- -- 702,518 Payments on warehouse lines of credit -- (722,618) -- -- (722,618) Retirement of senior unsecured debt (341) -- -- -- (341) Net increase (decrease) in notes payable to banks (501) (501) Net increase (decrease) in notes payable to investors -- 19,022 -- -- 19,022 Net increase (decrease) in subordinated debentures -- 1,406 -- -- 1,406 Advances (to) from subsidiary 8,537 8,546 (11,096) (4,002) -- Proceeds from issuance of additional common stock 73 -- -- -- 73 Other -- 13 (13) -- -- ----------- ------------ ------------ ------------ ------------ Net cash provided by (used in) financing activities 8,269 8,386 (11,109) (4,002) (441) ----------- ------------ ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents (101) (22,217) -- -- (22,318) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 202 25,806 1 -- 26,009 ----------- ------------ ------------ ------------ ------------ CASH AND CASH EQUIVALENTS, END OF YEAR 101 3,589 1 -- 3,691 =========== ============ ============ ============ ============
F-45 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING STATEMENT OF CASH FLOWS Year Ended December 31, 1999 (Unaudited) (Dollars in thousands)
Combined Combined Wholly-Owned Non- Parent Guarantor Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated ----------- ------------ ------------ ------------ ------------- OPERATING ACTIVITIES: Net income (loss) $ 1,815 $ (29,621) $ 3,158 $ 26,463 $ 1,815 Extraordinary Gain on retirement of senior unsecured debt (29,500) -- -- -- (29,500) ----------- ------------ ------------ ------------ ------------- Income (loss) from continuing operations (27,685) (29,621) 3,158 26,463 (27,685) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Equity in undistributed earnings of subsidiaries 26,463 -- -- (26,463) -- Depreciation and amortization 2 2,690 -- -- 2,692 Fair market writedown of residual receivable -- 3,327 -- -- 3,327 Benefit for deferred income taxes -- (7,849) -- -- (7,849) Provision for credit losses -- 3,339 -- -- 3,339 Loss (gain) on real estate acquired through foreclosure -- 2,665 -- -- 2,665 Loans originated with intent to sell -- (244,086) -- -- (244,086) Principal proceeds from sold loans -- 220,410 -- -- 220,410 Proceeds from securitization of loans -- 59,630 -- -- 59,630 Other -- (168) -- -- (168) Changes in operating assets and liabilities increasing (decreasing) cash (1,999) 28,060 (31,120) -- (5,059) ----------- ------------ ------------ ------------ ------------- Net cash provided by (used in) operating activities (3,219) 38,397 (27,962) -- 7,216 INVESTING ACTIVITIES: Loans originated for investment purposes -- (762) -- -- (762) Loans purchased for investment purposes -- (1,413) -- -- (1,413) Principal collections on loans not sold -- 19,718 -- -- 19,718 Purchase of REO and loans from securitization trusts -- 21,530 (32,006) -- (10,476) Proceeds from sale of real estate and personal property acquired through foreclosure -- 9,774 -- -- 9,774 Proceeds from the sale of property and equipment -- 235 -- -- 235 Purchase of property and equipment -- (532) -- -- (532) Other -- 167 -- -- 167 ----------- ------------ ------------ ------------ ------------- Net cash provided by (used in) investing activities -- 48,717 (32,006) -- 16,711 FINANCING ACTIVITIES: Advances on warehouse lines of credit -- 292,020 -- -- 292,020 Payments on warehouse lines of credit -- (290,948) -- -- (290,948) Retirement of senior unsecured debt (45,016) -- -- -- (45,016) Net increase (decrease) in notes payable to investors -- 8,479 -- -- 8,479 Net increase (decrease) in subordinated debentures -- 405 -- -- 405 Advances (to) from subsidiary 48,012 (38,006) (10,008) 2 -- Proceeds from issuance of additional common stock 229 -- 2 (2) 229 Other -- (67,473) 67,473 -- -- ----------- ------------ ------------ ------------ ------------- Net cash provided by (used in) financing activities 3,225 (95,523) 57,467 -- (34,831) ----------- ------------ ------------ ------------ ------------- Net increase (decrease) in cash and cash equivalents 6 (8,409) (2,501) -- (10,904) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 196 34,215 2,502 -- 36,913 ----------- ------------ ------------ ------------ ------------- CASH AND CASH EQUIVALENTS, END OF YEAR 202 25,806 1 -- 26,009 =========== ============ ============ ============ =============
F-46 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING STATEMENT OF CASH FLOWS Year Ended December 31, 1998 (Unaudited) (Dollars in thousands)
Combined Combined Non Combined Wholly-Owned Wholly-Owned Non- Parent Guarantor Guarantor Guarantor Company Subsidiaries Subsidiaries Subsidiaries Eliminations Consolidated ----------- ------------ ------------ ------------ ------------- ------------- OPERATING ACTIVITIES: Net income (loss) $ (57,745) $ (67,494) $ (3,377) $ 203 $ 70,668 $ (57,745) Extraordinary Gain on retirement of senior (18,216) unsecured debt (18,216) -- -- -- -- ----------- ------------ ------------ ------------ ------------- ------------- Income (loss) from continuing operations (75,961) (67,494) (3,377) 203 70,668 75,961 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: -- Equity in undistributed earnings of subsidiaries 69,668 10,138 -- -- (79,806) -- Depreciation and amortization 430 2,992 192 12 -- 3,626 Fair market writedown of residual receivable -- 11,144 -- 2,494 -- 13,638 Provision (benefit) for deferred income taxes 692 (371) (321) -- -- -- Provision for credit losses 20 11,886 -- -- -- 11,906 Provision for losses on real estate owned -- 696 -- -- -- 696 Net (increase) decrease in deferred loan costs -- 770 -- -- -- 770 Net increase (decrease) in unearned discount and other deferrals -- (2,245) -- -- -- (2,245) Loans originated with intent to sell -- (708,004) (39,438) -- -- (747,442) Principal proceeds from sold loans 178 718,406 48,764 11,600 -- 778,948 Proceeds from securitization of loans -- 92,316 -- -- -- 92,316 Restructuring charge-fixed assets -- 3,593 -- -- -- 3,593 Other 44 1,142 -- (192) -- Changes in operating 994 assets and liabilities increasing (decreasing) cash 3,419 (5,612) (29) 5,663 -- 3,441 ----------- ------------ ------------ ------------ ------------- ------------- Net cash provided by (used in) operating activities (1,510) 69,357 5,791 19,780 (9,138) 84,280 INVESTING ACTIVITIES: Loans originated for investment purposes (468) (150,549) -- (5,600) -- (156,617) Principal collections on loans not sold 65 190,861 -- 1,250 -- 192,176 Proceeds from sale of real estate and personal property acquired through foreclosure 453 7,140 -- -- -- 7,593 Purchase of REO and loans from securitization trusts -- (9,980) -- -- -- (9,980) Proceeds from the sale of property and equipment (1,262) 4,070 -- -- -- 2,808 Purchase of property and equipment (64) (11,463) (174) -- -- (11,701) Other (748) (514) 1,310 -- -- 48 ----------- ------------ ------------ ------------ ------------- ------------- Net cash provided by (used in) investing activities (2,024) 29,565 1,136 (4,350) -- 24,327 FINANCING ACTIVITIES: Advances on notes payable to banks -- 1,406,847 -- 9,653 -- 1,416,500 Payments on notes payable to banks -- (1,467,716) -- (9,653) -- (1,477,369) Net increase in notes payable to investors -- 3,218 -- -- -- 3,218 Net (decrease) increase in subordinated debentures -- (1,643) -- -- -- (1,643) Retirement of senior unsecured debt (20,134) -- -- -- -- (20,134) Advances (to) from subsidiary 22,978 (11,824) (7,190) (13,102) 9,138 -- Proceeds from issuance of additional common stock 214 -- -- -- -- 214 Other (41) -- -- -- -- (41) ----------- ------------ ------------ ------------ ------------- ------------- Net cash provided by (used in) financing activities 3,017 (71,118) (7,190) (13,102) 9,138 (79,255) ----------- ------------ ------------ ------------ ------------- ------------- Net increase (decrease) in cash and cash equivalents (517) 27,804 (263) 2,328 -- 29,352 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 713 6,411 263 174 -- 7,561 ----------- ------------ ------------ ------------ ------------- ------------- CASH AND CASH EQUIVALENTS, END OF YEAR 196 34,215 -- 2,502 -- 36,913 =========== ============ ============ ============ ============= =============
F-47 EXHIBIT INDEX 2.1.1 Reorganization Agreement dated February 29, 2000 by and between HomeGold Financial, Inc. and HomeSense Financial Corp. and its Affiliated Companies set forth on Schedule 3.5 thereto: Incorporated by Reference to the Company's Definitive Proxy Statement filed on March 21, 2000 for the 2000 Annual Meeting of the Company's shareholders held on April 28, 2000, Commission File No. 000-08909 (Exhibit C). 2.1.2 Amendment No. 1 to Reorganization Agreement dated March 10, 2000: Incorporated by Reference to the Company's Definitive Proxy Statement filed on March 21, 2000 for the 2000 Annual Meeting of the Company's shareholders held on April 28, 2000, Commission File No. 000-08909 (Exhibit C). 2.1.3 Amendment No. 2 to Reorganization Agreement dated May 1, 2000: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 2.1). 2.1.4 Amendment No. 3 to Reorganization Agreement dated May 9, 2000: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 2.2). 3.1.1 Restated Articles of Incorporation as filed with the South Carolina Secretary of State on June 6, 1997: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 1998 for the quarter ended March 31, 1998, Commission File No. 000-08909 (Exhibit 3.1). 3.1.2 Articles of Amendment as filed with the South Carolina Secretary of State on June 24, 1998: Incorporated by Reference to the Company's Current Report on Form 8-K filed on July 7, 1998, Commission File No. 000-08909 (Exhibit 3.1). 3.1.3 Resignation of Registered Agent and Notice of Change of Registered Agent as filed with the South Carolina Secretary of State on July 15, 1998: Incorporated in Reference to the Company's Annual Report on Form 10-K filed on March 2, 2000 for the year ended December 31, 1999, Commission File No. 000-08909 (Exhibit 3.1.3). 3.1.4 Articles of Amendment filed with the South Carolina Secretary of State on May 9, 2000 (i) reducing par value of common stock from $0.05 per share to $0.001 per share, (ii) eliminating cumulative voting with respect to election of directors and (iii) authorizing issuance of up to 20,000,000 shares of "blank check" preferred stock: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 3.1.1). 3.1.5 Articles of Amendment filed with the South Carolina Secretary of State on May 9, 2000 containing Certificate of Designation of Series A Non-convertible Preferred Stock of the Company: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 3.1.2). 3.2 Amended and Restated Bylaws dated March 12, 1997: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 1998 for the quarter ended March 31, 1998, Commission File No. 000-08909 (Exhibit 3.2). 4.1.1 Indenture Dated as of September 23, 1997 among Emergent Group, Inc. (n/k/a HomeGold Financial, Inc., the Company), the Subsidiary Guarantors Named Therein and Bankers Trust Company, as Trustee pertaining to the Company's 10.75% Senior Notes due 2004: Incorporated by Reference to the Company's Registration Statement on Form S-4 filed on November 13, 1997, Commission File No. 333-39339 (Exhibit 4.1). 4.1.2 Supplemental Indenture adding Emergent Insurance Agency, Inc. as Subsidiary Guarantor dated November 3, 1997: Incorporated by reference to the Company's Annual Report on Form 10-K filed on March 2, 2000 for the year ended December 31, 1999, Commission File No. 000-08909 (Exhibit 4.1.2). 4.1.3 Officers' Certificate and Opinion of Counsel dated March 18, 1998, and Notice to Trustee dated March 30, 1998, for release from Guarantees of The Loan Pro$, Inc. and Premier Financial Services, Inc. : Incorporated by reference to the Company's Annual Report on Form 10-K filed on March 2, 2000 for the year ended December 31, 1999, Commission File No. 000-08909 (Exhibit 4.1.3). 4.1.4 Officers' Certificate, Opinion of Counsel dated August 21, 1998, and Notice to Trustee dated September 10, 1998, for release from Guarantees of Sterling Lending Corporation and Sterling Lending Insurance Agency: Incorporated by reference to the Company's Annual Report on Form 10-K filed on March 2, 2000 for the year ended December 31, 1999, Commission File No. 000-08909 (Exhibit 4.1.4). 4.1.5 Supplemental Indenture #1, dated as of August 19, 1998: Incorporated by reference to the Company's Annual Report on Form 10-K filed on March 2, 2000 for the year ended December 31, 1999, Commission File No. 000-08909 (Exhibit 4.1.5). 4.1.6 Officers' Certificate, Opinion of Counsel and Notice to Trustee dated November 13, 1998, for release from Guarantees of Emergent Business Capital, Inc., Emergent Business Capital Equity Group, Inc. (f/k/a/ Emergent Equity Advisors, Inc.) and Emergent Commercial Mortgage, Inc.: Incorporated by reference to the Company's Annual Report on Form 10-K filed on March 2, 2000 for the year ended December 31, 1999, Commission File No. 000-08909 (Exhibit 4.1.6). 4.2 Registration Rights Agreement dated May 9, 2000 between the Company and the individuals listed on Schedule 1 thereto: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.10). 4.3 Form of Stock Restriction Agreement and schedule of parties thereto: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.11). 4.4 See exhibits 3.1.1 through 3.2 above. 10.1 HomeGold Financial, Inc. Stock Option Plan: Incorporated by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-1, Commission File No. 333-01393. 10.2 1995 Officer and Employee Stock Option Plan: Incorporated by reference to Exhibit 10.1 of the Company's 1995 Notice of Annual Meeting and Proxy Statement, Commission File No. 000-08909. 10.2.1 Amendment No. 1 to the 1995 Employee and Officer Stock Option Plan, dated May 27, 1997: Incorporated by reference to the Company's Registration Statement on Form S-8 filed with the Commission on July 10, 1998, Commission File No. 333-58861. 10.2.2 Amendment No. 2 to the 1995 Employee and Officer Stock Option Plan, dated June 10, 1998: Incorporated by reference to the Company's Registration Statement on Form S-8 filed with the Commission on July 10, 1998, Commission File No. 333-58861. 10.2.3 Amendment No. 3 to the 1995 Employee and Officer Stock Option Plan, dated June 10, 1999 Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.2.1). 10.2.4 Amendment No. 4 to the 1995 Employee and Officer Stock Option Plan, dated April 28, 2000: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.2.2). 10.3 1995 Director Stock Option Plan: Incorporated by reference to an exhibit filed with the Company's 1995 Notice of Annual Meeting and Proxy Statement. 10.4 1995 Restricted Stock Agreement Plan: Incorporated by reference to Exhibit 10.4 of the Company's Registration Statement on Form S-1, Commission File No. 333-01393. 10.5.1 HomeGold Financial, Inc. Employee Stock Purchase Plan: Incorporated by reference to Exhibit 99.1 of the Company's registration statement on Form S-8, Commission File No. 333-20179. 10.5.2 Amendment No. 1 to the Employee Stock Purchase Plan, dated April 28, 2000: Incorporated by Reference to the Company's Definitive Proxy Statement file on March 21, 2000 for the 2000 Annual Meeting of the Company's shareholders held on April 28, 2000, Commission File No. 000-08909. 10.6.1 $40,000,000 Warehousing Line Revolving Credit Agreement by and between HomeGold, Inc. and Household Commercial Financial Services, Inc. dated as of May 2, 2000: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.4.1). 10.6.2 Security Agreement dated May 2, 2000 of HomeGold, Inc., the other entities listed on the signature pages thereto and Household Commercial Financial Services, Inc.: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.4.2). 10.6.3 Guaranty dated May 2, 2000 of HomeGold Financial, Inc. and certain of its subsidiaries: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.4.3). 10.6.4 First Amendment to Credit Agreement, Household Commercial Financial Services, Inc. dated May 30, 2000: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on November 14, 2000 for the quarter ended September 30, 2000, Commission File No. 000-08909 (Exhibit 10.12). 10.6.5 Second Amendment to Credit Agreement, Household Commercial Financial Services, Inc. dated September 20, 2000: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on November 14, 2000 for the quarter ended September 30, 2000, Commission File No. 000-08909 (Exhibit 10.13). 10.6.6 Third Amendment to Credit Agreement and Forbearance Agreement, Household Commercial Financial Services, Inc. dated October 25, 2000: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on November 14, 2000 for the quarter ended September 30, 2000, Commission File No. 000-08909 (Exhibit 10.14). 10.6.7 Extension Re: Forbearance Agreement dated January 25, 2001. 10.6.8 Second Extension Re: Forbearance Agreement dated February 25, 2001. 10.6.9 Third Extension Re: Forbearance Agreement dated March 30, 2001. 10.7.1 Severance Agreement dated April 28, 2000 between the Company and Keith B. Giddens: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.5). 10.7.2 Severance Agreement dated May 12, 2000 between the Company and John W. Crisler: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.6). 10.7.3 Form of Severance Agreement between the Company and employees listed in the schedule therewith: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.7). 10.8 Employment Agreement dated May 9, 2000 between the Company and Ronald J. Sheppard: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.8). 10.9.1 Mutual Indemnity Agreement dated May 9, 2000 between Ronald J. Sheppard and the Company: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.9). 10.9.2 Agreement dated January 30, 2001, by and between HomeGold Financial, Inc. and Ronald J. Sheppard. 10.10.1 Warehouse Loan and Security Agreement between HomeGold, Inc. and The Provident Bank dated November 3, 2000. 10.10.2 Servicing Agreement by and between The Provident Bank and HomeGold Financial, Inc. dated October 25, 2000. 10.11.1 Master Repurchase Agreement between Imperial Warehouse Finance, Inc. and HomeGold Financial, Inc. and HomeGold, Inc. dated January 11, 2001. 10.11.2 Seller's Warranties Agreement between Imperial Warehouse Finance, Inc. and HomeGold Financial, Inc. and HomeGold, Inc. dated January 11, 2001. 10.12 Mortgages Purchase Agreement dated October 13, 1999 by and between HomeSense Financial Corp. and Affiliates and HSA Residential Mortgage Services of Texas, Inc.; Letter dated May 1, 2000 from Residential Mortgage Services of Texas, Inc. to Mr. Ronald J. Sheppard, HomeSense Financial Corp., acknowledged and agreed to by HomeGold, Inc.; Letter dated July 31, 2000 from Residential Mortgage Services of Texas, Inc. to Mr. Ronald Sheppard, HomeGold and Affiliates; Letter dated August 16, 2000 from Residential Mortgage Services of Texas, Inc. to Mr. Ronald J. Sheppard, HomeSense Financial Corp. acknowledged and agreed to by HomeGold, Inc.; Letter dated September 19, 2000 from Residential Mortgage Services of Texas, Inc. to Mr. Ronald J. Sheppard, CEO, HomeGold Financial, Inc.; Letter dated September 29, 2000 from Residential Mortgage Services of Texas, Inc. to Mr. Larry Gosnell, CFO, HomeGold Financial; Assignment of Certificate of Deposit to Residential Mortgage Services of Texas, Inc. by HomeGold, Inc. dated December 14, 2000 10.13 Letter of Agreement between HomeGold, Inc. and New Freedom Mortgage Corporation dated December 20, 2000. 10.14.1 Assumption of Debt and Contribution to Capital Agreement effective December 31, 2000 by and between HomeGold Financial, Inc., HomeGold, Inc. and Carolina Investors, Inc. 10.14.2 Revolving Promissory Note dated December 31, 2000, in principal amount of up to $125,000,000 by HomeGold Financial, Inc. to Carolina Investors, Inc. 10.14.3 Guaranty and Security Agreement effective December 31, 2000 by and between HomeGold, Inc. and Carolina Investors, Inc. 10.14.4 Secured Revolving Promissory Note dated January 2, 2001, in principal amount of up to $75,000,000 by HomeGold, Inc. to Carolina Investors, Inc. 10.15 See exhibits 2.1.1 through 4.3 above. 21.0 Listing of subsidiaries. 23.1 Consent of Elliott, Davis & Company, L.L.P. to include report of Independent Auditors for the three years ended December 31, 2000.