-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, C++rRm+THwIFRJiviMAaUSJ0wG8yTI8ty80p2H5jEbCX8GoyvpV6yBmx3gOKTzoa BPFKP+QLRW2OeGjBdQa9og== 0000950144-97-003152.txt : 19970329 0000950144-97-003152.hdr.sgml : 19970329 ACCESSION NUMBER: 0000950144-97-003152 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970328 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: EMERGENT GROUP INC CENTRAL INDEX KEY: 0000277028 STANDARD INDUSTRIAL CLASSIFICATION: PERSONAL CREDIT INSTITUTIONS [6141] IRS NUMBER: 570513287 STATE OF INCORPORATION: SC FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-08909 FILM NUMBER: 97566863 BUSINESS ADDRESS: STREET 1: 15 SOUTH MAIN ST STE 750 CITY: GREENVILLE STATE: SC ZIP: 29601 BUSINESS PHONE: 8642358056 MAIL ADDRESS: STREET 1: 15 SOUTH MAIN ST STE 750 CITY: GREENVILLE STATE: SC ZIP: 29601 FORMER COMPANY: FORMER CONFORMED NAME: NRUC CORP DATE OF NAME CHANGE: 19911002 FORMER COMPANY: FORMER CONFORMED NAME: NATIONAL RAILWAY UTILIZATION CORP DATE OF NAME CHANGE: 19840813 10-K 1 EMERGENT GROUP, INC 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 ------------------ FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31,1996 COMMISSION FILE NO. 0-8909 --------------------- EMERGENT GROUP, INC. (Exact name of registrant as specified in its charter) SOUTH CAROLINA 57-0513287 ------------------------------ ------------------------ (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 15 SOUTH MAIN STREET SUITE 750 GREENVILLE, SOUTH CAROLINA 29601 - ---------------------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code 864-235-8056 SECURITIES REGISTERED UNDER SECTION 12(B) OF THE ACT: Name of Each Exchange on which registered ----------------------------------------------- NONE SECURITIES REGISTERED UNDER SECTION 12(G) OF THE ACT: Title of Each Class ----------------------------------------------- Common Stock, par value $.05 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. [ ] As of March 14, 1997, the aggregate market value of voting stock held by non-affiliates of registrant was approximately $104,083,349. As of March 14, 1997, the shares outstanding of the issuer's class of common stock were as follows: 9,144,430. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Company's Definitive Proxy Statement for the Annual Meeting of Shareholders scheduled for May 27, 1997 are incorporated by reference into Part III hereof. Portions of the Company's Annual Report to the shareholders for the year ended December 31, 1996, are incorporated by reference into Part II hereof. 2 PART I ITEM 1. BUSINESS Emergent Group, Inc. (the "Company") is a diversified financial services company headquartered in Greenville, South Carolina which originates, services and sells residential mortgage loans ("Mortgage Loans"), commercial loans to small businesses ("Small Business Loans"), and pre-owned automobile loans ("Auto Loans"). The Company also serves as investment manager for a venture capital fund and a mezzanine level fund which originates loans to certain small businesses in which the fund retains stock purchase warrants. The Company makes substantially all of its loans to borrowers who have limited access to credit or who may be considered credit impaired by conventional lending standards ("non-prime borrowers"). The Company commenced its lending operations in 1991 and has experienced significant loan growth over the past several years. During 1994, 1995, and 1996, the Company originated $150.0 million, $249.5 million and $415.1 million in loans, respectively. Of the Company's loan originations in 1996, $328.6 million were Mortgage Loans, $68.2 million were Small Business Loans and $18.3 million were Auto Loans. For the years ended December 31, 1994, 1995, and 1996, the Company's pre-tax income from continuing operations was $2.4 million, $4.9 million, and $10.5 million, respectively. The Company's Mortgage Loan operation (the "Mortgage Loan Division") makes Mortgage Loans primarily to owners of single family residences who use the loan proceeds for such purposes as debt consolidation, home improvements and educational expenditures. The majority of the Company's Mortgage Loans generally have initial principal balances ranging from $25,000 to $100,000 and fixed rates of interest ranging from 9% to 16% per annum. The Mortgage Loan Division has experienced significant growth over the past several years. During 1994, 1995, and 1996, Mortgage Loan originations totaled $99.4 million, $192.8 million, and $328.6 million, respectively. To date, a majority of the Mortgage Loans were sold on a non-recourse basis to institutional investors, with customary representations and warranties. However, in 1997 the Company plans to begin Securitizing a substantial portion of its Mortgage Loans. Because the Company has not securitized any Mortgage Loans to date, no assurance can be given that this forward-looking statement can be accomplished. The Mortgage Loan Division originates Mortgage Loans on both a retail basis through regional offices and a wholesale basis through independent mortgage brokers and mortgage bankers (collectively, the "Mortgage Bankers"). The Company's retail lending operations were established in the second quarter of 1996, and currently operate through eight offices. Through its retail offices, the Company targets Mortgage Loan borrowers through a variety of marketing methods, but to date has achieved its best results in connection with its direct mail campaigns. The Company also originates Mortgage Loans on a wholesale basis through approximately 330 Mortgage Bankers in approximately 12 states. The Company has established strategic alliance agreements with certain Mortgage Bankers (the "Strategic Alliance Mortgage Bankers"), which require the Strategic Alliance Mortgage Bankers to sell to the Company all of their loans up to specified levels which meet the Company's underwriting criteria, in exchange for delegated underwriting, administrative support and expedited funding. The Company has a minority equity interest in certain of the Strategic Alliance Mortgage Bankers. The Company believes that its use of retail and wholesale origination and strategic alliances is a unique strategy which enables the Company to penetrate the non-prime mortgage loan market through multiple channels. 2 3 The Company's Small Business Loan operation (the "Small Business Loan Division") makes loans to small businesses primarily for the acquisition or refinancing of property, plant and equipment and working capital. During 1994, 1995, and 1996, Small Business Loan originations totaled $43.1 million, $39.6 million, and $68.2 million, respectively. A substantial portion of the Company's Small Business Loans are loans ("SBA Loans") which are partially guaranteed by the U.S. Small Business Administration (the "SBA"). The SBA Loans are secured by real or personal property and have initial principal balances ranging from $250,000 to $1.5 million and variable interest rates limited to a maximum of 2.75% over the prime rate. The SBA guarantees approximately 75% of the original principal amount of the SBA Loans, up to a maximum guarantee amount of $750,000. The Company sells participations representing the SBA-guaranteed portion of its SBA Loans (the "SBA Loan Participations") in the secondary market. In connection with such sales the Company receives, in addition to excess servicing revenue, cash premiums of approximately 10% of the guaranteed portion being sold. SBA Loans are originated directly by the Company's loan officers in its eight branch offices, and are primarily generated through referral sources such as commercial loan and real estate brokers ("Commercial Loan Brokers") located in its market area. The Small Business Loan Division also provides working capital loans secured by accounts receivable, inventory and equipment to small- to medium -sized businesses in the southeastern United States ("Asset-based Small Business Loans"). The Company began its asset-based lending operation in April 1996 in Atlanta, GA. The Company's Auto Loan operation (the "Auto Loan Division") makes loans to non-prime borrowers for the purchase of used automobiles. Substantially all of the Auto Loans are made directly by the Company to purchasers of automobiles who are referred to the Company by automobile dealers ("Dealers"). The Auto Loans generally have initial principal balances ranging from $3,000 to $10,000, terms ranging from 24 to 48 months, and fixed interest rates from 18% to 46% per annum. The Auto Loan Division operates through eight locations and originates Auto Loans in connection with approximately 200 Dealers. During 1994, 1995, and 1996, Auto Loan originations totaled $7.5 million, $17.1 million, and $18.3 million, respectively. FORWARD-LOOKING INFORMATION Certain statements throughout this document that reflect projections or expectations of future financial or economic performance of the Company, and statements of the Company's plans and objectives for future operations are "forward-looking" statements, including in particular statements regarding additional office expansion plans, geographic expansion plans, establishment of additional strategic alliances as well as other forward-looking statements. No assurance can be given that actual results or events will not differ materially from those projected, estimated, assumed, or anticipated in any such forward-looking statements. Important factors that could result in such differences are many and include: the Company generally lends to "sub-prime" borrowers which have higher incidents of default. The Company's projections could be adversely affected if defaults exceed expected levels. The Company's retail operations are relatively new. Whether the Company meets its overall earnings and growth projections will be materially affected by the Company's ability to "ramp up" its retail operations and achieve profitability. The Company's ability to meet growth and/or earnings projections could also be adversely affected by one or more of the following: the termination or nonrenewal of strategic alliance agreements with Mortgage Bankers or other significant Mortgage Banker relationships; a general economic downturn, which could stunt loan growth or result in increased delinquencies; the loss of funding sources, which are necessary to fund loan demand at profitable margins; the loss of the ability to sell loans, which could require the Company to obtain additional funding sources; the failure to open additional offices as scheduled; the loss of all or part of the NOL; restrictions in federal programs through 3 4 which it originates loans or other regulatory changes, which could affect profitability or risk associated with certain loans; and the loss of key executives on which the Company is materially dependent. GENERAL BACKGROUND The Company currently has three primary divisions consisting of its Mortgage Loan Division, its Small Business Loan Division, and its Auto Loan Division. Prior to the current management obtaining control of the Company in December 1990, the Company was primarily engaged in its transportation segment operations. Under previous management, the Company incurred significant losses. In 1991, current management implemented a strategic plan to acquire profitable businesses. Pursuant to such strategy, the Company acquired Carolina Investors, Inc. ("CII"), Premier Financial Services, Inc. ("Premier"), Emergent Business Capital, Inc. ("EBC") and The Loan Pro$, Inc. ("Loan Pro$") in 1991 and Young Generations, Inc. ("YGI") in 1993. In 1994, the Company made a strategic decision to divest all non-financial operations and to focus exclusively on the financial services industry. In accordance with such strategy, the Company completed the divestiture of its apparel segment consisting solely of YGI, and transportation segment operations in 1995. BUSINESS STRATEGY The Company's business strategy is to be a diversified financial services company that meets the credit needs of borrowers in what the Company believes to be under-served credit markets. The key elements of the Company's business strategy are as follows: - - Emphasis on Profitability Rather than Asset Growth. The Company will continue to focus principally on increasing earnings and equity, rather than increasing total assets. The Company believes that it can maximize its return on assets and equity by maintaining a "high velocity" capital strategy, whereby a substantial majority of loans are made and sold or securitized within 90 days of origination. Recycling its capital in this manner enables the Company to recognize gains on the sale of its loans and quickly redeploy its capital, as well as reduce its interest rate risk and borrowing costs. - - Decentralized Loan Approval. The Company believes that one of the most important factors to customers is the length of time between the lender's initial contact with the customer and the disbursement of loan proceeds. Accordingly, the Company emphasizes minimizing the length of time involved in the lending process, without sacrificing credit quality. It attempts to accomplish this goal, in part, by fostering an entrepreneurial, decentralized management culture and by maintaining up-to-date Management Information Systems for loan production, asset quality management and servicing. In the Mortgage Loan Division, the Company has an expedited review process with respect to loans submitted by the Strategic Alliance Mortgage Bankers. The Company also utilizes a decentralized approval process with respect to its retail Mortgage Loan operations which generally results in the lending decision being made within one business day. Also, in the Small Business Loan Division, the Company uses its "Preferred Lender" status, as well as specially-trained officers who handle only loans partially guaranteed by the SBA, to shorten the loan approval process. Furthermore, the Small Business Loan Division maintains relatively autonomous regional offices which generally have significant underwriting capabilities and credit authority. Because of the increased risk of decentralized credit approval, the Company just recently hired a National Credit Manager to provide close guidance and supervision over the underwriting related activities of its Small Business Loan Division regional offices to ensure uniform credit decisions consistent with corporate policies. - - Proactive Underwriting Process. The Company takes a proactive approach to its loan underwriting process. Because the Company's borrowers are generally non-prime borrowers, standardized credit scoring and underwriting criteria are not always meaningful in assessing a borrower's creditworthiness. Consequently, 4 5 the Company attempts to analyze each application independently and to craft a loan package which meets the needs of the borrower while providing the Company with adequate security. Underwriting adjustments often suggested by Company underwriters include requiring a guarantor or co-borrower with better credit history and/or additional disposable income, lowering the loan-to-value ratio, increasing the interest rate, securing additional collateral and lowering the loan amount. - - Uniform Credit Guidelines and Procedures. The Company attempts to mitigate the risks often associated with non-prime borrowers by utilizing uniform guidelines and procedures for evaluating credit applications in connection with its loan originations. This is designed to complement the Company's decentralized management strategy by ensuring consistent credit quality. The Company's guidelines and procedures relate to such matters as the borrower's stability of residence, employment history, credit history, capacity to pay, total income, discretionary income and debt ratios, as well as the value of the collateral. With respect to its Small Business Loans, the Company's guidelines and procedures also emphasize factors pertaining to the business of the borrower, such as business plans, historical and projected financial statements, strength of management, and value of the collateral. - - Corporate Monitoring and Supervision of Operations. The Company has in place corporate policies designed to monitor and ensure continued quality of credit underwriting and servicing and to evaluate management in each of the Mortgage, Small Business and Auto Loan Divisions. Such policies include on-site audits of loan files and underwriting and servicing procedures at each branch office as well as ongoing evaluation of general portfolio credit and performance quality, the effectiveness of business development efforts and branch office profitability. The Company's Management Information Systems provide management with reports on a regular basis which contain operational information from each of the Mortgage, Small Business and Auto Loan Divisions, including the volume of loan originations, delinquency experience and foreclosure and repossession activities. GROWTH STRATEGY The Company's growth strategy is to continue to expand its lending operations, while emphasizing profitability and return on equity, rather than asset growth. Many of the statements in this section are forward-looking statements and no assurance can be given that actual results or events will not differ materially from those projected, estimated, assured, or anticipated in any such forward-looking statements. The key elements in the Company's growth strategy are as follows: - - Retail Mortgage Lending. The Company expects to increase its Mortgage Loan originations through the continued expansion of its retail mortgage lending operations. The Company began its retail mortgage lending operations with the opening of an office in Indianapolis, IN in April 1996, and currently operates through this Indianapolis office, as well as offices in Baton Rouge and New Orleans, LA, Atlanta, GA, Greenville, SC, Jackson, MS, Jacksonville, FL, and Phoenix, AZ. The Company expects that Mortgage Loan volume associated with its retail lending operation will continue to experience growth in the future. In addition, the Company's retail originations are generally more profitable than wholesale originations through mortgage bankers because the Company earns loan origination fees to cover its production costs, and retains all of the gain on sale of the loans. The Company believes that the combination of its retail and wholesale strategies will increase the Company's penetration of the non-prime market. - - Wholesale Mortgage Lending. The Company plans to increase its wholesale mortgage lending originations by expanding its operations geographically and by adding additional account executives and independent Mortgage Bankers. Prior to 1994, the wholesale lending operations were conducted exclusively in South Carolina. In 1994, the Company launched its expansion strategy by entering the North Carolina market, and since that time has expanded into approximately ten additional states. The Company intends to continue 5 6 this geographic expansion as well as further penetrate existing markets. The Company plans to expand the number of account executives and affiliated mortgage brokers during 1997. - - New Strategic Alliances in the Mortgage Loan Division. The Company plans to establish additional strategic alliances with Mortgage Bankers during 1997. The Company offers additional services to these Strategic Alliance Mortgage Bankers, such as providing capital through arrangements similar to warehouse lending and additional MIS and accounting services, which are designed to increase their loan originations. The Company does not expect to have contractual arrangements regarding future loan originations with any Mortgage Bankers except for the Mortgage Bankers with whom the Company has strategic alliance agreements. The Company has a minority equity interest, generally ranging from 5% to 10%, in certain of the Strategic Alliance Mortgage Bankers, which is designed to enhance the Company's growth potential. - - Small Business Lending. The Company plans to expand its Small Business Loan operations by opening additional offices and by utilizing its "Preferred Lender" status to minimize its response time and maximize its loan production. The Company has been designated as a "Preferred Lender" by the SBA, which gives the Company the authority to approve a loan and to obligate the SBA to partially guarantee the loan without submitting an application to the SBA for credit review. Preferred Lender status also enables the Company to more easily enter additional SBA districts. The Company also expects to increase its Small Business Loan originations through expansion of its asset-based lending operation, which began in April 1996. This asset-based lending operation currently operates through offices in Atlanta, GA, Denver, CO, and New Orleans, LA. Additional Offices. The Company plans to increase its penetration of existing markets and expand geographically by opening additional offices. In 1996, the Company opened four Mortgage Loan offices, four Small Business Loan offices, and one Auto Loan office. In the future, the Company will continue to target for expansion areas which have favorable demographics or where the Company has identified qualified individuals who are available to effectively manage additional locations. No new Auto Loan offices are planned for 1997. The Company's ability to meet these growth projections could also be adversely affected by one or more of the following, among other factors: the termination or nonrenewal of strategic alliance agreements with Mortgage Bankers or other significant Mortgage Banker relationships; a general economic downturn, which could stunt loan growth or result in increased delinquencies; the failure to open additional offices as scheduled; the inability to procure employees to staff additional offices; and restrictions in federal programs through which it originates loans or other regulatory changes, which could affect profitability or risk associated with certain loans. The following table shows the Company's originations (based on note amount of loans closed) for the periods indicated: ORIGINATIONS BY LOAN TYPE (IN THOUSANDS)
For the Years Ended December 31, -------------------------------- 1992 1993 1994 1995 1996 ---------- ---------- ---------- ---------- ---------- Mortgage Division Loans $ 29,146 $ 20,536 $ 99,373 $ 192,800 $ 328,649 Small Business Division Loans 25,376 37,867 43,123 39,560 68,210 Auto Division Loans 2,760 5,230 7,547 17,148 18,287 ---------- ---------- ----------- ------------ ----------- Total $ 57,282 $ 63,633 $ 150,043 $ 249,508 $ 415,146 ========== ========== =========== ============ ===========
6 7 The Company has funded the majority of its lending activities from the cash flow generated from operations and through borrowings pursuant to its existing credit facilities (the "Credit Facilities"), by selling senior subordinated notes and subordinated debentures to residents of South Carolina (the "Debentures") and by selling a substantial portion of the loans it originates. The Company has historically sold a substantial majority of its Mortgage Loan production on a whole loan basis with servicing released, non-recourse with customary representations and warranties, while it has retained servicing for its Small Business Loans and Auto Loans. The following table shows the Company's total serviced loans receivable at the end of each of the last five years: TOTAL SERVICED LOANS BY LOAN TYPE (IN THOUSANDS)
December 31, ---------------------------------------------------- 1992 1993 1994 1995 1996 ---- ---- ---- ---- ---- Mortgage Division Loans $42,459 $ 42,335 $ 60,151 $ 88,165 $146,231 Small Business Division Loans 21,682 58,552 88,809 108,696 140,809 Auto Division Loans 4,348 6,011 8,483 17,673 22,033 ------- -------- -------- -------- -------- Total $68,489 $106,898 $157,443 $214,534 $309,073 ======= ======== ======== ======== ========
MORTGAGE LOAN DIVISION OVERVIEW The Company's mortgage lending activities consist primarily of originating, selling, and servicing Mortgage Loans which are secured by owner-occupied, single-family residential properties. Substantially all of the Company's Mortgage Loans are made to refinance existing mortgages and for debt consolidation, home improvements, educational expenses and a variety of other purposes. The Mortgage Loans generally are secured by a first lien, have principal balances ranging from $25,000 to $100,000, and bear fixed interest rates generally ranging in 1996 from 9% to 16% per annum. Most Mortgage Loans provide for equal monthly payments over their terms, which generally range from 15 to 30 years. Substantially all of the Mortgage Loans are made to non-prime borrowers. These borrowers generally have limited access to credit or are considered to be credit-impaired by conventional lenders such as thrift institutions and commercial banks. These conventional lending sources generally impose stringent and inflexible loan underwriting guidelines and generally require a longer period of time, as compared to the Company, to approve and fund loans. The Company believes that its customers require or seek a high degree of personalized service and swift response to their loan applications. Furthermore, the Company believes that its customers generally focus more on the amount of the monthly payment, rather than the interest rate charged. Consequently, the Company's customers many times are willing to pay higher interest rates, assuming the amount of the monthly payment is otherwise acceptable. Furthermore, because the Company's customers are generally credit-impaired for one or more reasons, the customers are not in a position to obtain better rates from traditional lending institutions. The Mortgage Loan Division has experienced significant growth over the past several years. For the years ended December 31, 1994, 1995, and 1996, Mortgage Loan originations totaled $99.4 million, $192.8 million, and $328.6 million, respectively. 7 8 In 1995, the Company diversified its Mortgage Loan products to include high loan-to-value second mortgage loans ("HLTV Loans"), which have loan-to-values in excess of 80%, but less than 125%. HLTV Loans typically have principal amounts ranging from $5,000 to $75,000 and in 1996, had a weighted average interest rate of approximately 15% per annum. The Company sells its HLTV Loans on a nonrecourse basis in the secondary market with customary representations and warranties. The Company's credit guidelines for this product meet the underwriting criteria of the purchasing investor. During 1995 and 1996, the Company originated $9.0 million and $36.6 million, respectively, of HLTV Loans. Industry Although several different estimates exist regarding the size of the non-prime mortgage industry, the Company believes that the non-prime mortgage market is approximately $100 billion per year. The Company believes that the non-prime mortgage industry is highly fragmented, with no single lender having a significant portion of the market. However, many of the providers of financing to the non-prime mortgage industry are publicly-traded specialty finance companies. Generally, non-prime borrowers may be considered credit-impaired because their loan application is characterized by one or more of the following: (1) inadequate collateral; (2) insufficient debt coverage; (3) problems with employment history; (4) limited or unfavorable credit history; or (5) self-employment. Under the Company's underwriting guidelines, Mortgage Loans are classified into five categories: AA, A, B, C and D. These categories are further divided into subcategories, depending on various underwriting criteria. These underwriting standards are under continual review and are subject to revision by Company management. The majority of the Company's borrowers do not fit exclusively into one category. Rather, such borrowers generally have some characteristics of one or more classifications. Accordingly, there is a significant degree of subjectivity in determining which rates and other loan terms will be offered. For the year ending December 31, 1996, approximately 53% of the Company's Mortgage Loan originations were classified as "AA" or "A" loans, 33% were "B" loans, 12% were "C" loans and 2% were "D" loans. Mortgage Loan Origination The Company originates Mortgage Loans both on a retail and wholesale basis. Retail Mortgage Loans are originated by persons employed by the Company, while wholesale Mortgage Loans are generally originated through Mortgage Bankers. The Company utilizes two principal strategies in the retail mortgage lending area, one of which utilizes a regional approach to origination, underwriting, processing and funding and a second which utilizes a centralized approach to underwriting, funding and processing, but a decentralized, state-by-state approach to origination. The Company began its regional approach to retail mortgage lending in April 1996 by hiring an experienced team of originators to establish its Indianapolis, IN office under its tradename, "HomeGold." The Company has created a marketing plan which utilizes the HomeGold tradename in direct mail, radio, inbound and outbound telephone, and television marketing efforts, and is designed to create national brand awareness and capitalize on the fragmentation which currently exists in the marketplace. The Company also opened retail lending operations which utilize this strategy in Phoenix, AZ and Greenville, SC during the 8 9 fourth quarter of 1996 and the first quarter of 1997, respectively. From May through December 1996, HomeGold originated $67.6 million in Mortgage Loans. The second, decentralized origination approach is conducted through Sterling Lending Corporation, an 80% owned indirect subsidiary of the Company, which has offices in Baton Rouge and New Orleans, LA, Atlanta, GA, Jackson, MS, and Jacksonville, FL. The Company's Baton Rouge office is a loan processing and underwriting center for the loans originated through the other offices. Prior to 1996, all of the Mortgage Loans were originated on a wholesale basis by the Company through Mortgage Bankers. As a wholesale originator of Mortgage Loans, the Company funds the Mortgage Loans at closing, although the Mortgage Loans may be closed in either the Company's name or in the name of the Mortgage Banker with the Company taking an assignment of the Mortgage Banker's interest. During 1994, 1995, and 1996, the Company originated loans through approximately 65, 120, and 330 Mortgage Bankers, respectively. Of the approximately 120 and 330 Mortgage Bankers who were responsible for origination of Mortgage Loans in 1995 and 1996, the Strategic Alliance Mortgage Bankers accounted for approximately $145 million, or 75%, of the Company's Mortgage Loans originated in 1995 and approximately $190.7 million, or 58%, of the Company's Mortgage Loans originated in 1996. In December 1996, the Company's largest Strategic Alliance Mortgage Banker accounted for 18.1% of the Company's total Mortgage loan production for the month. In July 1996, the former vice president and regional sales manager for a national finance company assumed management of the Company's wholesale lending operation. Monthly wholesale Mortgage Loan production has grown from $3.5 million in January 1996 to $12.5 million in December 1996 for total production of $69.1 million for 1996. In 1994, the Company began seeking to enter into strategic alliance agreements with Mortgage Bankers that were believed by the Company to be able to consistently generate large volumes of quality mortgage loans. These strategic alliance agreements require that the Strategic Alliance Mortgage Bankers must first offer the Company the right to purchase all of their loans which meet the Company's underwriting criteria before offering such loans to other parties. The Strategic Alliance Mortgage Bankers are accorded additional services, information and authority by the Company, including the provision of capital through arrangements similar to warehouse lending and the provision of additional MIS and accounting services. These strategic alliance agreements have terms ranging from three to five years and are scheduled to terminate beginning in August 1999. The Company believes that these strategic alliances are an important factor in providing a higher level of customer service. At December 31, 1996 the Company had contracts with four Strategic Alliance Mortgage Bankers, and has added two additional Strategic Alliance Mortgage Bankers in the first quarter of 1997. The Company has a minority equity interest in certain of the Strategic Alliance Mortgage Bankers, which is designed to enhance the Company's growth potential. On June 1, 1996, First Greensboro Home Equity, Inc. ("First Greensboro") terminated its strategic alliance agreement with the Company in connection with the pending purchase of First Greensboro by a third party financial institution. In addition, AmeriFund Group, Inc. ("Amerifund") terminated its strategic alliance agreement with the Company in October 1996. As a result of the termination of these strategic alliance agreements, the Company's Mortgage Loan originations were materially less than would otherwise have been the case; however, the Company received termination fees of approximately $7.3 million from these two companies in 1996. By the fourth quarter of 1996, all of the monthly production from these two sources had been replaced through alternate sources, including the Company's retail production and the expansion of its wholesale operations. 9 10 At December 31, 1996, the Company had Mortgage Loan commitments outstanding of $83.8 million, of which 11% related to its retail loan originations, 86% related to its wholesale loan originations and 3% related to its loan originations through its Strategic Alliance Mortgage Bankers. Application and Approval Process In the application and approval process associated with the Company's retail Mortgage Loan operations, a Company loan officer in a retail loan origination office obtains an initial loan application, which is processed throughout the underwriting department associated with the particular loan origination office. The Company loan officer is responsible for securing all necessary underwriting information associated with such application. 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 forwarded to an attorney or title company for closing. The application and approval process for wholesale Mortgage Loans depends upon the specific Mortgage Bankers involved in the origination process. Loans originated through the Strategic Alliance Mortgage Bankers are initially evaluated and underwritten by the loan officers of the Strategic Alliance Mortgage Bankers, who are required to follow the Company's underwriting guidelines. After the Strategic Alliance Mortgage Bankers have gathered the necessary underwriting information and evaluated and approved the application, then the summary loan information and a funding request is forwarded to the Company and the Strategic Alliance Mortgage Banker forwards the loan package to an attorney or title company for closing. In the origination process, the Strategic Alliance Mortgage Banker makes standard representations and warranties with respect to the Mortgage Loan, as well as a representation that the Mortgage Loan meets the Company's underwriting criteria. The loan package is reviewed by the Company generally within two weeks of closing, and the Company may require the Strategic Alliance Mortgage Banker to repurchase the loan if there is a violation of the representations and warranties, or if the loan does not meet the Company's underwriting criteria. With respect to loans originated through Mortgage Bankers other than the Strategic Alliance Mortgage Bankers, the necessary underwriting information is gathered by both the Mortgage Banker and the Mortgage Loan Division's credit department. After review and evaluation, an officer in the credit department makes the final credit decision before funding. The Company attempts to grant approvals of loans quickly to borrowers meeting the Company's underwriting criteria. 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, request additional collateral, or request that the borrower obtain a co-borrower or a guarantor. Mortgage Loans are generally originated in amounts ranging from $10,000 to $100,000. The maximum amount is $350,000, but loans generally do not exceed $200,000. In limited instances, Mortgage Loans are made in excess of this limit, but only upon senior management approval. Creditworthiness is assessed through a variety of means, including calculating standard debt to income ratios, examining the applicant's credit history through standard credit reporting bureaus, verifying an applicant's employment status and income, and checking the applicant's payment history with respect to the first mortgage, if any, on the property. In the case of owner-occupied property, the loan amount generally may not exceed 90% of the appraised value of the property, less any balance outstanding on any existing mortgages. In non-owner-occupied properties, the loan amount generally may not exceed 75% of the appraised value of the property, less any balance outstanding on any existing mortgages. The Company also makes loans which have loan-to-value ratios greater than 90%. However, such loans are generally made only to borrowers deemed by the 10 11 Company to have a higher degree of creditworthiness (e.g., superior credit history, stable, high-income employment and low gross debt ratios), when compared to its typical borrowers. It is the Company's current policy that such loans do not exceed $350,000. Approximately 90% of the Company's Mortgage Loans are secured by owner-occupied property. The Company requires an independent appraisal on all loans. The Company generally requires title insurance for all real estate loans. The Company generally requires real estate improvements to be fully insured as to fire and other commonly insured-against risks and regularly monitors its loans to ensure that insurance is maintained for the period of the loan. In connection with Mortgage Loans, the Company collects nonrefundable underwriting fees, late charges and various other fees, depending on state law. Other fees charged, where allowable, include those related to credit reports, lien searches, title insurance and recordings, prepayment fees and appraisal fees. Sale of Mortgage Loans The Company began selling Mortgage Loans in 1994 and for the years ended December 31, 1995 and 1996, the Company sold $127.6 million and $284.8 million of Mortgage Loans, respectively. The Mortgage Loans to be sold are generally packaged in whole loan pools of approximately $20 million and offered to several potential purchasers for the purpose of obtaining bids. After obtaining bids, the pool is generally sold to the highest bidder. Historically, the Mortgage Loans have been sold servicing released and on a non-recourse basis, with customary representation and warranties. The sale of these loans to the secondary market as well as the product development and compliance with underwriting standards is managed by the centralized secondary marketing department in Greenville, SC. In connection with the sale of Mortgage Loans, the Mortgage Loan Division receives cash premiums generally ranging from 4% to 8% of the principal amount of the Mortgage Loan being sold, depending on prevailing interest rates and the term of the loan. During 1995 and 1996, the weighted average premiums on the Mortgage Loans sold were 7.04% and 5.86%, respectively. For the years ended December 31, 1995 and 1996, cash gains recognized by the Company in connection with the sale of Mortgage Loans were $6.0 million and $18.3 million, respectively. The amount for 1996 includes $7,337,000 in termination fees relating to the termination of two of the Company's Strategic Alliance Mortgage Bankers. The termination fees represent a recoupment of previously shared premiums with those partners. Purchasers of Mortgage Loan pools are typically large financial institutions, many of which purchase the Mortgage Loans for inclusion in larger pools of loans, which, in turn, are sold to institutional investors. The Company plans to begin securitizing the majority of its Mortgage Loans in 1997, although no assurances exist that the Company can accomplish this plan. Mortgage Loan Servicing The Company services the Mortgage Loans that are not sold, but historically has not retained the servicing on Mortgage Loans sold. However, in the future, the Company may retain servicing on Mortgage Loans sold and securitized. Servicing includes collecting payments from borrowers, accounting for principal and interest, contacting delinquent borrowers, ensuring that insurance is in place, monitoring payment of real estate property taxes, and supervising foreclosures and bankruptcies in the event of unremedied defaults. The Company has increased its servicing capabilities and staffing significantly during 1996 in anticipation of increased origination growth. A centralized quality control department reviews each Mortgage Loan subsequent to funding to maintain consistency and compliance with documentation and legal standards. 11 12 Delinquencies and Collections Collection efforts generally begin when an account is over five days past due. At that time, the Company attempts to contact the borrower to determine the reason for the delinquency and obtain the payment from the borrower. If the status of the account continues to deteriorate, the Company undertakes an analysis to determine the appropriate action. In limited circumstances, when a borrower is experiencing difficulty in making timely payments, the Company may temporarily adjust the borrower's payment schedule without changing the loan's delinquency status. Payment extensions or rollovers are only permitted in limited instances with the approval of departmental management. 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 90 days past due in accordance with its original terms, it is placed on non-accrual status and foreclosure proceedings are generally initiated. The amount of other real estate owned which was acquired through foreclosure relating to the Mortgage Loan Division was $3.1 million and $3.0 million at December 31, 1995 and 1996, respectively. The value is determined based upon the lower of carrying value or appraised value less estimated costs to sell. The following table illustrates the Company's delinquency and charge-off experience with respect to Mortgage Loans: MORTGAGE LOAN DELINQUENCIES AND CHARGE-OFFS (DOLLARS IN THOUSANDS)
AT AND FOR THE YEARS ENDED DECEMBER 31, --------------------------------------- 1993 1994 1995 1996 -------- -------- -------- -------- Serviced Mortgage Loan delinquencies: 30-59 days past due 8.09% 7.96% 7.75% 3.04% 60-89 days past due 2.05 2.87 1.80 1.05 Over 90 days past due 13.40 6.83 4.93 3.17 Serviced Mortgage Loans Charged-off, net, as a % of average serviced Mortgage Loans: 1.05 2.96 1.04 .81 Serviced Mortgage Loans charged-off, net $ 446 $ 1,518 $ 771 $ 792 Serviced Mortgage Loans 42,335 60,151 88,165 146,231 Average Serviced Mortgage Loans 42,397 51,243 74,158 97,281 Outstanding Mortgage Loans (Balance Sheet) 42,335 60,151 88,165 146,231
SMALL BUSINESS LOAN DIVISION Overview The Company formed EBC in December 1991 for the purpose of acquiring substantially all of the assets, including a license to originate loans partially guaranteed by the SBA, of an inactive SBA lender. EBC is one of approximately 12 non-bank entities in the United States possessing and actively using a license to make SBA Loans. Substantially all of the Company's SBA Loans are made under Section 7(a) 12 13 ("Section 7(a) Loans") of the Small Business Act of 1953, as amended (the "Small Business Act"). However, the Company, through a subsidiary, began originating loans in 1995 pursuant to Section 504 ("Section 504 Loans") of the Small Business Act (the "Section 504 Loan Program"). During 1994, 1995, 1996, the Company originated $43.1 million, $39.6 million and $68.2 million, respectively, in Small Business Loans, of which 100%, 92%, and 82%, respectively, were Section 7(a) Loans. Based on a recent trade association report, management believes that during the SBA's fiscal year ended September 30, 1996, the Company was the seventh largest SBA lender in the nation based on principal amount of Section 7(a) Loans approved by the SBA. During 1996, the Company originated no new Section 504 Loans, but continued to fund $2.1 million of Section 504 Loans closed in 1995. The Company expects to continue to focus its SBA lending efforts on Section 7(a) Loans, although future regulatory changes could alter such decision. The Small Business Loan Division operates through a total of eight offices. The Company's SBA operations are divided into four regions: (1) the Southeastern Region, which is headquartered in Greenville, SC; (2) the Gulf Coast Region, which is headquartered in Panama City, FL; (3) the Rocky Mountain Region, which is headquartered in Denver, CO; and (4) the Southwestern Region, which is headquartered in Dallas, TX. The Small Business Loan Division also originates asset-based loans to small- to medium-sized businesses in the Southeastern United States ("Asset-based Small Business Loans"). These Asset-based Small Business Loans are structured as revolving credit lines for working capital purposes and are generally secured by a first lien on accounts receivable, inventory and equipment. This asset-based lending operation was begun by the Company in April 1996 in Atlanta, GA, and it currently originates loans through offices in Atlanta, GA, Denver, CO, and New Orleans, LA. In 1996, loans originated (based on note amount of loans closed) by this asset-based lending operation totaled approximately $12.6 million. The Small Business Loan Division also serves as investment manager for a venture capital fund, Palmetto Seed Capital Fund Limited Partnership ("Palmetto"), and a mezzanine level fund, Reedy River Ventures, L.P. ("RRV") (the "Managed Funds"). Palmetto provides venture capital to start-up and early stage companies headquartered within the state of South Carolina. RRV, a licensed Small Business Investment Company under the Small Business Investment Act of 1958, provides loans to later stage companies accompanied by warrants to buy equity in the borrower at nominal prices. The Company has no capital invested in Palmetto, and has a $1 million investment in RRV. The Company receives fees for managing the two funds. Small Business Loan Customers The Company's Small Business Loan customers are commercial businesses which are generally considered to be non-prime borrowers insofar as they generally do not have access to traditional bank financing. Such financing may be unavailable because of a variety of factors, including inadequate collateral, insufficient debt coverage, lack of management experience or an unfavorable credit history. The Company's SBA Loans are made only to potential borrowers who meet defined criteria of the SBA as to the definition of a "small business." These criteria differ based upon the industry in which the potential borrower operates. The portion of the loan guaranteed by the SBA, the term of the loan and the range of interest rates charged are also defined by the SBA. The Company underwrites SBA loans using these SBA criteria, as well as by assessing the available collateral, personal guarantees, and earnings and cash flow of the small business and other factors on a case by case basis. 13 14 SBA Loan Program Participation Section 7(a) Loan Program. Section 7(a) Loans are term loans made to commercial businesses which qualify under SBA regulations as "small businesses." These loans are primarily for the acquisition or refinancing of property, plant and equipment, working capital or debt consolidation. The SBA administers three levels of lender participation in its Section 7(a) Loan program. Under the first level of lender participation, known as the Guaranteed Participant Program, the lender gathers and processes data from applicants and forwards it, along with its request for the SBA's guaranty, to the local SBA office. The SBA then completes an independent analysis and makes its decision on the loan applications. Under the second level of lender participation, known as the Certified Lender Program, the lender (the "Certified Lender") gathers and processes the application and makes its request to the SBA, as in the Guaranteed Participant Program procedure. The SBA then performs a review of the lender's credit analysis on an expedited basis, which review is generally completed within three working days. The SBA requires that lenders originate loans meeting certain portfolio quality and volume criteria before authorizing lenders to participate as Certified Lenders. Authorization is granted by the SBA on a district-by-district basis. Under the third level of lender participation, known as the Preferred Lender Program, the lender has the authority to approve a loan and to obligate the SBA to guarantee the loan without submitting an application to the SBA for credit review. However, the lender (the "Preferred Lender") is required to secure confirmation from the SBA that the loan and applicant is eligible. Such confirmation generally takes less than 24 hours. The standards established for participants in the Preferred Lender Program, the SBA's highest designation, are more stringent than those for participants in the Certified Lender Program and involve meeting additional portfolio quality and volume requirements. The Company has been designated a Preferred Lender by the SBA in 42 of the 65 SBA districts. These districts are all of the SBA districts in which the Company is deemed to be an "active" lender by the SBA. Virtually all of the Company's SBA Loans are made in these districts. The SBA may suspend or revoke Preferred Lender status for reasons such as loan performance unacceptable to the SBA, failure to make the required number of loans under the expedited procedures, or violations of applicable statutes, regulations or published SBA policies and procedures. The SBA performs periodic audits of its non-bank licensed lenders to ensure compliance with its policies and procedures. Section 504 Program. The Section 504 Program differs from the Section 7(a) Loan program in both structure and size of loans. Section 504 loans generally range in principal amount from $1.0 million to $2.5 million and are made in connection with a state chartered Certified Development Corporation ("CDC"). Section 504 Loans are generally commercial development-related loans. Upon complete funding of the loan, a significant portion of the total loan (generally approximately 55%) is repaid by the CDC as the second lien holder. This repayment is funded by the SBA through the purchase of a fixed rate debenture issued by the CDC. This purchased portion of the loan is subordinated to the first mortgage loan held by the Company. Consequently, the Company has a loan which has a very favorable loan-to-value ratio. The approval process for Section 504 Loans is similar to the first level of lender participation with respect to the Section 7(a) Loan program except that the CDC presents the loan to the SBA (after it has been approved by the Company and the CDC). Upon presentation, the SBA completes its independent analysis of the loan and makes its credit decision. SBA turnaround time on such applications can vary greatly, depending on its backlog of loan applications. 14 15 SBA Guarantees Under the Preferred Lender Program, the SBA guarantees up to 80% on loans of $100,000 or less, and up to 75% on loans in excess of $100,000. However, the SBA's maximum guaranty per borrower under most SBA Loans is $750,000. In the event of a default by a borrower on an SBA Loan, if the SBA establishes that any resulting loss is attributable to a failure by the Company to comply with the SBA policies and procedures in connection with the origination, servicing, documentation or funding of the loan, the SBA may seek recovery of funds from the Company. With respect to SBA Loan Participations which have been sold, the SBA first will honor its guarantee and then seek compensation from the Company in the event that a loss is deemed to be attributable to such failure to comply with SBA policies and procedures. To date, the SBA has notified the Company as to the potential for partial impairment of guarantee on two of its loans. The Company believes it is adequately reserved in relation to these potential impairments. Small Business Loan Origination In the past five years, the Company's SBA Loan origination offices have made loans in 26 states and the District of Columbia. The Company's SBA Loans generally range in size from $100,000 to $1.5 million. Average loan size for originations during 1996 was $679,000. The SBA Loans generally have a variable rate of interest which is limited to a maximum of 2.75% over the lowest prime lending rate published in The Wall Street Journal adjusted on the first day of each calendar quarter. The Company's Asset-based Small Business Loans have variable rates of interest which range generally from 2.0% to 3.0% above the prime lending rate. However, these Asset-based Small Business Loans also provide for servicing and other processing fees, which cause the effective rate associated with such loans to be approximately 26% for the loans originated to date. Although the Company originates Small Business Loans through direct contact between its loan officers and potential borrowers, a substantial portion of the Company's Small Business Loans are generated by loan referral sources, such as commercial loan brokers who generally are paid referral fees. The Company does not have any contractual agreements with any of these brokers obligating them to refer loans to the Company. In 1996, the Company originated Small Business Loans in connection with approximately 45 commercial loan brokers, and no referral source accounted for more than 16% of the Company's Small Business Loans. The Company attempts to maintain strong relationships with commercial realtors, commercial loan brokers, commercial banks, attorneys, accountants and other potential loan referral sources. The majority of the Company's SBA Loan originations have been for the acquisition or refinance of real property, plant and equipment, working capital or debt consolidation. A number of SBA Loans were made to business franchises in connection with the acquisition of national franchises. These loans are generally secured by all assets of the borrower, including any real property. The Asset-based Small Business Loans are generally secured by a first lien on accounts receivable, inventory and equipment. In connection with the SBA Loans, the Company obtains the personal guarantee of the primary principals involved in the business, which is often secured by real property. All SBA Loans originated by the Company are evidenced by variable rate notes which adjust quarterly, require payment monthly and are scheduled to amortize fully over their stated term. SBA Loans originated by the Company have terms ranging from seven to 25 years depending upon the use of proceeds, with an original weighted average term of approximately 18 years. Generally, loans are made up to a seven year term for working capital, 10 year term for equipment and 25 year term for real estate. 15 16 Applicants for SBA Loans are generally required to provide historical financial statements for three years and/or projected statements of operations for two years. They are also generally required to provide proof of equity, personal guarantees and assignments of affiliated leases and life insurance. Credit reports are generally obtained from independent credit reporting agencies for all applicants. These reports are reviewed by the SBA lending operation's credit officers. Independent appraisals are generally required on real estate pledged as collateral. Asset-based Small Business Loans are evidenced by variable-rate, revolving credit notes, which are payable upon demand. However, the Company generally commits to make the credit facility available for a period of one to two years, provided that certain covenants and conditions are met. Applicants for Asset-based Small Business Loans are generally required to provide cash flow projections, and inventory and accounts receivable aging and turn-over information. Such aging and turnover information is provided to the Company on a daily basis. All loans made by the Small Business Loan Division generally must be approved by a designated regional officer and one other loan officer. All SBA Loans in excess of the assigned regional authority and all of the loans in excess of $1.0 million must be approved by the President and Executive Vice President of the SBA lending operation. After approval of such officers, the loan application is produced and forwarded to the appropriate SBA office. If an SBA Loan is being made in a district where the Small Business Loan Division is certified as a Preferred Lender, no prior credit approval of the SBA is required before the loan transaction can be consummated. However, if the SBA Loan is being made in a district where the Small Business Loan Division is not certified as a Preferred Lender, the loan cannot be made until the SBA office approves the loan, issues an authorization letter and assigns a loan number. At December 31, 1996, the Company had Small Business Loan commitments outstanding of $45.7 million, of which 73% related to Section 7(a) SBA Loans, 14% related to Section 504 SBA Loans, and 13% related to Asset-based Small Business Loans. Multiple Disbursements of Small Business Loans The Company funds certain of its SBA Loans on a multiple disbursement basis. In particular, when part of the use of proceeds of a loan is for the construction or improvement of real property, the loan may require multiple disbursements over a lengthy period of time. At December 31, 1996, the Company had $16.7 million of outstanding SBA Loans in various stages of multiple disbursements, of which $8.3 million had been disbursed. The length of time necessary to complete the disbursement process for multiple disbursement loans is generally six to twelve months. The Asset-based Small Business Loans are revolving notes. Advances and repayments are made daily based on the borrower's available cash position and borrowing base of available collateral. At December 31, 1996, the Company had asset-based notes receivable totaling $11.8 million, of which $6.8 million were outstanding. SBA Loan Sales The Company sells participations representing the SBA-guaranteed portion of its SBA Loans. Upon final disbursement of the proceeds of each SBA Loan, the Company obtains bids in the secondary market for the SBA Loan Participation associated with that SBA Loan. The SBA Loan Participation is generally sold to the highest bidder. The Company retains the unguaranteed portion of the loan and the servicing rights to the entire loan. The Small Business Loan Division sells the SBA Loan Participations generally to financial institutions or other institutional investors. Purchasers of the SBA Loan Participations 16 17 share ratably with the Small Business Loan Division (holding the unguaranteed portion) with respect to all principal collected from the borrowers with respect to the SBA Loans. SBA lenders are required to pay a fee of 50 basis points per annum to the SBA on the outstanding balance of the guaranteed portion of all loans. During the years ended December 31, 1994, 1995 and 1996, Small Business Loans sold (excluding securitized loans) totaled $31.2 million, $25.4 million and $33.1 million, respectively. In connection with the sale of SBA Loan Participations, the Small Business Loan Division receives, in addition to excess servicing revenue, cash premiums typically of approximately 10% of the guaranteed portion being sold. During 1994, 1995, and 1996, the weighted average premiums on the SBA Loan Participations sold, together with the additional servicing revenue, aggregated 11.79%, 13.75% and 14.17%, respectively, of the SBA Loan Participations sold. For the years ended December 31, 1994, 1995 and 1996 gains recognized by the Company in connection with the sale of SBA Loan Participations were $4.0 million, $3.9 million and $5.5 million, respectively. In June 1995 and November 1996, the Company securitized $17,063,000 and $17,500,000 respectively, of the unguaranteed portions of its SBA Loans. The securitizations were effected through a grantor trust (the "Trust"), the ownership of which was represented by Class A and Class B certificates. The Class A certificates were purchased by investors, while the Company retained the Class B certificates. These certificates give the holders thereof the right to receive payments and other recoveries attributable to the unguaranteed portion of the SBA Loans held by the Trust. The Class B Certificates issued in June 1995 and November 1996 represent 10% and 9%, respectively, of the principal amount of the SBA Loans transferred in the securitization and are subordinate in payment and all other respects to the Class A Certificates. Accordingly, in the event that payments received by the Trust are not sufficient to pay certain expenses of the Trust and the required principal and interest payments due on the Class A Certificates, the Company, as holder of the Class B Certificates, would not be entitled to receive principal or interest payments due thereon. The securitization transaction completed in November 1996 included a pre-funding account of $4,649,000, for which additional loans could be placed into the Trust prior to January 31, 1997. On January 23, 1997, loans totaling $4,626,000 were placed into the Trust, for which the Company received proceeds of $4,210,000 and a retained interest in Class B certificates of $416,000. The Company serves as master servicer for the Trust and, accordingly, forwards payments received on account of the SBA Loans held by the Trust to the trustee, which in turn, pays the holders of the certificates in accordance with the terms of and priorities set forth in the securitization documents. The transfer of the SBA Loans to the Trust constitutes a sale of the underlying SBA Loans. However, the Company has the obligation to repurchase the SBA Loans from the Trust in the event that certain representations made with respect to the transferred SBA Loans are breached or in the event of certain defaults by the Company, as master servicer. The Class A certificates issued in June 1995 and November 1996 received a rating of Aaa and Aa2, respectively, from Moody's Investors Service, Inc. The Class B Certificates were not rated for either transaction. In connection with the securitizations, the SBA Loan Division received funds substantially equal to the Class A certificates' percentage of the total principal amount of the SBA Loans transferred to the Trust. The Company intends to continue to pursue securitization transactions in the future. Legislation is currently pending which will allow Banks to securitize SBA Loans and may require a minimum level of retained interest to be held by SBA Lenders. Loan Servicing The Company services substantially all the Small Business Loans it originates. Servicing includes collecting payments from borrowers and remitting payments with respect to the SBA Loan 17 18 Participations to Colson Services, remitting payments to the trustee for securitized SBA loans, preparing servicers certificates and remittance reports, accounting for principal and interest, contacting delinquent borrowers and supervising foreclosures. Delinquency and Collection When a Small Business Loan becomes delinquent, the Company contacts the borrower to determine the circumstances of the delinquency and attempts to maintain close contact with the borrower until the loan is brought current or is liquidated. Depending on the circumstances, the Company may grant a deferral of payments, typically up to 90 days, to assist the borrower if the Company believes it will benefit the long-term viability of the borrower. When an SBA Loan becomes 60 days past due, the Company is required to notify the SBA of such delinquency. Generally, after a loan becomes 90 days delinquent, the Company places the loan on non-accrual status, delivers a default notice and begins the legal process of foreclosure and liquidation, upon notification to and approval by the SBA. Any loss after foreclosure and liquidation is allocated pro rata between the guaranteed and the unguaranteed portions of the SBA Loan. The asset-based lending operation monitors its borrowers daily for availability under the lines of credit. Loans are placed on a watch list if the borrower is experiencing tight cash flow and poor profitability. Loans are placed on non-accrual status if collection of the interest is deemed to be doubtful. In the event of a default, the Company makes an assessment of the borrower's financial condition and nature of the default to determine further action. If repayment of the loan is considered doubtful, a demand letter is sent and the Company begins the process to take control of the collateral. None of the other real estate owned at December 31, 1995 and 1996, which was acquired through foreclosure, related to the Small Business Loan Division. The value is determined based on the lower of carrying value or appraised value less estimated cost to sell. The following table illustrates the Company's delinquency and charge-off experience with respect to Small Business Loans: SMALL BUSINESS LOAN DELINQUENCIES AND CHARGE-OFFS (DOLLARS IN THOUSANDS)
AT AND FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------------ 1993 1994 1995 1996 -------- -------- -------- -------- Serviced Unguaranteed Small Business Loan delinquencies: 30-59 days past due 1.10% 1.17% 2.97% 3.37% 60-89 days past due -- -- 4.47 .89 Over 90 days past due .09 -- 2.53 3.67 Serviced Unguaranteed Small Business Loans charged off, net, as a % of average Serviced Small Business Loans .05 .21 1.43 2.71 Serviced Unguaranteed Small Business Loans charged off, net $ 4 $ 31 $ 311 $ 932 Serviced Unguaranteed Small Business Loans 11,238 18,771 24,867 44,017 Average Serviced Unguaranteed Small Business Loans 7,635 15,004 21,819 34,442 Total Serviced Small Business Loans 58,552 88,809 108,696 140,809 Outstanding Small Business Loans (Balance Sheet) 17,933 26,764 20,620 29,386
18 19 AUTO LOAN DIVISION Overview The Company's Auto Loan Division originates loans directly to non-prime borrowers for the purchase of pre-owned automobiles. Substantially all of the Auto Loans are made directly by the Company through referrals from dealers located in South Carolina. Less than 25% of the Auto Loans originated in 1996 were "indirect" loans purchased from dealers, all of which were located in South Carolina. Of the dealers which referred loans to the Company in 1996, the Company estimates approximately half of such dealers were franchised dealers and approximately half were independent dealers. The non-prime consumer automobile market is comprised of borrowers who generally do not have access to other conventional sources of automobile credit because they do not meet the credit standards imposed by other lenders. As a result of its borrowers' credit status, the Company charges relatively high rates of interest to such consumers, which in 1996 ranged from 18% to 46% (with a weighted average rate of 27.3%). By contrast, banks, thrift institutions, and financing subsidiaries of manufacturers and retailers generally impose more stringent, objective credit requirements and generally charge lower interest rates based on the prevailing interest rate environments at the time of origination. The Company began originating Auto Loans with its acquisition of 80% of the common stock of Loan Pro$ in 1991. At the time of acquisition, Loan Pro$ had $1.8 million in loans outstanding and operated through one location. The Company also acquired Premier in 1991. At the time of acquisition, Premier had approximately $3 million in loans, which were principally personal property loans, and operated through three locations. During 1993, the Company decided to terminate Premier's unsecured personal property loan operation and focus its lending efforts on secured automobile lending. The Company currently operates its Auto Loan Division through eight locations, and at December 31, 1996, had a total of $22.0 million of serviced Auto Loans outstanding, substantially all of which were made in connection with the purchase of automobiles. During 1994, 1995 and 1996, the Auto Loan originations totaled $7.5 million, $17.1 million and $18.3 million, respectively. The Company does not utilize a category rating system with respect to its Auto Loans. Rather, such loans are underwritten independently based on criteria such as the age and wholesale value of the automobile, the borrower's past credit history and the availability of cosigners and/or guarantors for the loan. The interest rates charged on Auto Loans are determined by the loan officer after reviewing the potential borrower's credit history. Direct Auto Loans and Related Products The majority of the Company's Auto Loans are made directly by the Company to consumers in connection with purchases of preowned automobiles. This is in contrast to "indirect lending," where lenders purchase loans from dealers that have already been originated by such dealers. The Auto Loans are generally fixed rate loans, with interest rates ranging from 18% to 46% per annum, depending on the model year of the automobile being financed and the creditworthiness of the borrower. At December 31, 1996, the Auto Loans had a weighted average interest rate of 27.3%. The amount financed on Auto Loans generally ranges from $3,000 to $10,000 (with an average initial principal balance in 1996 of approximately $5,000), and the repayment terms generally range from 24 to 48 months, depending upon the amount financed. The maximum interest rate which may be charged by the Company is regulated by state law. The age of the vehicles financed generally ranges from four to six years. The Company's underwriting guidelines generally provide that the amount of the Auto Loan may not exceed 110% of National Auto Dealers Association ("NADA") wholesale value of the vehicle being financed. 19 20 In connection with its Auto Loans, the Company offers credit life and accident and health insurance products for which it receives commissions. These insurance products are sold by branch managers who are licensed representatives of an unaffiliated insurance company. During 1996, insurance was sold in connection with approximately 50% of the total number of Auto Loans originated. During 1996, the Company recognized $217,000 in commissions in connection with the sale of insurance products. Relationships with Dealers Substantially all of the Company's Auto Loans are originated by referrals from dealers located in or around the localities served by the Company. In a typical situation, the dealer will bring a customer who wishes to purchase an automobile, along with the automobile, to an Auto Loan Division branch location. In dealing with the Company, dealers become familiar with the Company's lending policies and procedures and develop the ability to screen potential applicants for credit who are unlikely to be approved by the Company. The Company attempts to establish and maintain its relationships with dealers by making prompt credit determinations and by offering quality, consistent and dependable service. During 1996, the Company originated Auto Loans in connection with approximately 200 dealers. In 1996, no single dealer accounted for a material portion of the Company's Auto Loans. The Company has no formal agreements with any dealers under its direct lending program. Direct Auto Lending Procedures The Company's credit review process requires the completion of a standardized credit application with information on the applicant's background, employment and credit history. The Company obtains a credit report on the applicant from an independent reporting service and obtains verification of the applicant's employment and wages from his or her employer. The Company does not use a "scoring" system or other inflexible, standardized credit criteria. Nevertheless, the Company estimates that approximately 50% of all applicants are denied credit by the Company, generally because of their credit histories or because their income levels will not, in the Company's judgment, support the amount of credit sought. The Company considers refinancing of its existing loans on a case-by-case basis. The Company generally does not refinance delinquent loans unless its determines that refinancing is not likely to increase the credit risk. Indirect Lending Operations In 1995, the Company began an indirect automobile lending program. Under this program, certain approved dealerships are provided underwriting criteria and guidelines by the Company. The dealerships close and fund the loans to the borrowers. The manager of the Company's local office is then given an opportunity to purchase the loan from the dealer based on the office manger's credit decision and verification procedures. Loans are purchased from the dealer at a discount from the principal amount of the loan. This discount, which is not refundable to the dealer, averaged 7% in 1996. Less than 25% of the Auto Loans originated in 1996 were generated under this indirect lending program. Auto Loan Sales In March 1996, the Company securitized $16,107,000 of its Auto Loans. The securitization was effected through a grantor trust (the "Trust"), the ownership of which was represented by Class A and Class B certificates. The Class A certificates were purchased by investors, while the Company retained the Class B certificates. These certificates give the holders thereof the right to receive payments and other recoveries attributable to the Auto Loans held by the Trust. The Class B Certificates represent 10% of the principal amount of the Auto Loans transferred in the securitization and are subordinate in payment and all other respects to the Class A Certificates. Accordingly, in the event that payments received by the Trust are not 20 21 sufficient to pay certain expenses of the Trust and the required principal and interest payments due on the Class A Certificates, the Company, as holder of the Class B Certificates, would not be entitled to receive principal or interest payments due thereon. The Company serves as master servicer for the Trust and, accordingly, forwards payments received on account of the Auto Loans held by the Trust to the trustee, which in turn, pays the holders of the certificates in accordance with the terms of and priorities set forth in the securitization documents. Because the transfer of the Auto Loans to the Trust constitutes a sale of the underlying Auto Loans, no liability is created on the Company's Consolidated Financial Statements. However, the Company has the obligation to repurchase the Auto Loans from the Trust in the event that certain representations made with respect to the transferred Auto Loans are breached or in the event of certain defaults by the Company, as master servicer. The Class A certificates received a rating of Aaa and AAA from Moody's Investors Service, Inc. and Standard and Poor's, respectively. The Class B certificates were not rated. In connection with the securitizations, the Auto Loan Division received funds substantially equal to the Class A certificates' percentage of the total principal amount of the Auto Loans transferred to the Trust. The Company has no plans for another securitization of its Auto Loans at this time. Servicing, Collection and Delinquencies The Company's borrowers are expected to remit their monthly payments using the payment coupon book provided to them at the time the credit is extended. Consequently, the Company does not issue monthly statements to borrowers. If a payment is not received within five days after its due date, the Company telephones the borrower, and attempts to maintain weekly contact thereafter until the loan is brought current. If a payment is not received within 11 days after its due date, the borrower is sent a right to cure letter. In certain instances, the automobile is picked up and stored by the Company after the right to cure letter has been received and the cure period has expired. After 30 days, the branch manager contacts the borrower. After 45-60 days, at the discretion of the branch manager, the Company generally repossesses the automobile. In certain instances, borrowers are permitted to recover their repossessed vehicles if they cure defaults under their loan. Repossessed automobiles are usually offered for sale by the Company through independent dealers. If such efforts are unsuccessful, the automobiles are sold at public auction. The time between repossession and public sale generally ranges from one to six months. The amount of repossessed automobiles held by the Company at December 31, 1995 and 1996 was $675,000 and $1,761,000, respectively. The value is determined based on the lower of carrying value or the NADA wholesale value. The following table illustrates the Company's delinquency and charge-off experience with respect to Auto Loans: AUTO LOAN DELINQUENCIES AND CHARGE-OFFS (DOLLARS IN THOUSANDS)
AT AND FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------------- 1993 1994 1995 1996 -------- -------- -------- -------- Serviced Auto Loan delinquencies: 30-59 days past due 2.80% 2.29% 9.39% 11.30% 60-89 days past due 1.02 .79 2.68 3.90 Over 90 days past due 5.69 .64 .77 1.90 Serviced Auto Loans charged off, net, as a % of average serviced Auto Loans 5.03 2.53 3.68 9.65 Serviced Auto Loans charged off, net $ 260 $ 183 $ 481 $ 2,053 Serviced Auto Loans 6,011 8,483 17,673 22,033 Average serviced Auto Loans 5,179 7,247 13,078 21,277 Outstanding Auto Loans (Balance Sheet) 6,011 8,483 17,673 13,915
21 22 LOANS RECEIVABLE/LOAN SALES The Company's loans receivable held for investment at December 31, 1994, 1995, and 1996 totaled $91.7 million, $103.9 million and $89.5 million, respectively. Consistent with the Company's "high velocity" capital strategy, the Company has sold a substantial majority of the loans it has originated through whole Mortgage Loan sales, sales of SBA Loan participation's and through the securitization of approximately $17.1 million and $17.5 million of the unguaranteed portion of SBA Loans in June 1995 and November 1996, respectively, and $16.1 million of Auto Loans in March 1996. Mortgage Loans The Company retains in its portfolio the Mortgage Loans originated in South Carolina, which are originated pursuant to the same underwriting criteria as the Company's other Mortgage Loans. The Company has historically retained these Mortgage Loans in its portfolio for several reasons. The interest income provided by these Mortgage Loans has created a positive interest margin when matched against the interest expense associated with the Debentures (which are short-term obligations constituting a low cost source of funds for the Company). Furthermore, these Mortgage Loans provide a relatively stable, recurring source of cash flow. Finally, these Mortgage Loans provide the Company with an existing source of loans which may be sold should the Company determine that they were needed to complete a pool of Mortgage Loans then being marketed for sale. Beginning in 1994, the Company began selling its Mortgage Loans originated outside of South Carolina. For the years ended December 31, 1995 and 1996, the Company sold $127.6 million and $284.8 million, respectively, of Mortgage Loans. The Mortgage Loans which are sold are generally packaged in pools of approximately $20 million and sold through a bidding process. Purchasers of Mortgage Loan pools are typically large financial institutions. See "Mortgage Loan Division-Sale of Mortgage Loans." To date, the Company has not securitized Mortgage Loans, principally because the Company was more familiar with the whole loan sale process, which was a profitable and economical means of converting such loans to cash. However, based on its experience with the securitizations of the Small Business and Auto Loans, the Company believes that securitization of Mortgage Loans is potentially more profitable than whole loan sales and expects to pursue Mortgage Loan securitizations beginning in 1997. Small Business Loans and Auto Loans The Company sells all of its SBA Loan Participations in the secondary market, and in connection with such sales, has received cash premiums, in addition to servicing revenue, of approximately 10%. For the years ended December 31, 1994, 1995 and 1996, SBA Loan Participations sold totaled $31.2 million, $25.4 million, and $33.1 million, respectively. Prior to June 1995, the Company retained the unguaranteed portion of its SBA Loans in its loan portfolio, principally because these loans were profitable investments and because there was not a ready market into which these loans could be sold. However, in June 1995 and in November 1996, the Company completed the securitization of approximately $17.1 and $17.5 million of the unguaranteed portion of SBA Loans. The Company expects to continue to pursue additional securitizations of its Small Business Loans in the future. Historically, the Company has also retained in its loan portfolio all of its Auto Loans, principally because these loans were profitable investments and because there was not a ready market into which these loans could be sold. However, in March 1996, the Company completed the securitization of approximately $16.1 million of Auto Loans. The Company may securitize additional Auto Loans in the future if loan volume and market conditions are deemed favorable, but currently has no plans to do so. 22 23 The Company did not securitize Small Business or Auto Loans prior to 1995, principally because it did not have the critical volume of Small Business Loans or Auto Loans necessary to comprise a profitable securitization. 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, substantial national financial services networks have been formed by major brokerage firms, insurance companies, retailers and bank holding companies. The Company believes that it competes effectively by providing competitive rates, and efficient, complete services. The Company faces significant competition in connection with its Mortgage Loan operation, principally from national companies which focus their efforts on making mortgage loans to non-prime borrowers. These competitors include The Money Store, Inc., Ford Consumer Finance Company, Associates First Capital Corporation, Cityscape Financial Corp., Aames Financial Corporation, Southern Pacific Funding Corporation, United Companies Financial Corporation, and ContiFinancial Corporation. Each of these companies has considerably greater financial and marketing resources than the Company. Although these large national companies compete in the mortgage loan industry, the industry, as a whole, is highly fragmented and no one company has a large percentage of the total mortgage loan market. The Company attempts to maintain its competitiveness by establishing strong relationships with Mortgage Bankers and establishment of retail operations through direct mail marketing efforts. Although the Company believes that it has been successful in this regard, in the event that the Company's competitors are able to weaken the relationships between the Company and its Mortgage Bankers, including the Strategic Alliance Mortgage Bankers, the Company's operations would be materially and adversely affected. The Company faces significant competition in all markets in which it makes Small Business Loans. The Company's major competitors vary from region to region. However, its primary competitors are small independent banks and large companies such as The Money Store, AT&T Capital Corporation and Heller First Capital. Because SBA Loan interest rates and terms offered by lenders are relatively uniform, the Company believes that the principal source of competition in making SBA Loans relates to the quality of service provided by the lender and the relationships established with the borrower. In addition, the Company believes that it is important to maintain good relations with the commercial loan referral sources, who are a significant source of SBA Loan originations. The consumer finance business, and the Auto Loan business in particular, is highly competitive. Because the Company's Auto Loan business is limited to a particular area of the consumer finance industry and because the Company's customer base consists of individuals who generally do not have access to other traditional sources of consumer credit, the Company usually does not compete directly with banks, savings and loan associations, financing subsidiaries of manufacturers and retailers of automobiles, and other traditional consumer financing sources with respect to Auto Loans. However, in each market where the Company operates, there are generally a number of other non-prime lenders that compete for the Auto Loans, including local finance companies. Certain of these non-prime lenders are larger and have greater resources than the Company. These companies include First Merchants Acceptance Corporation and Regional Acceptance Corporation. Furthermore, the Company believes that conventional lenders are increasingly seeking to operate in the non-prime consumer market. Such additional competition could have a material adverse effect on the Company and its ability to attract customers. The Company believes that 23 24 the principal basis for competition in the Auto Loan business are the monthly payment amount, the speed of the credit determination process and the general level of service provided to the Dealers. Accordingly, the Company believes that it is important that it maintain good relationships with its associated Dealers. REGULATION General 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: the Small Business Act, the Small Business Investment Act of 1958, as amended (the "SIB"), 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 (the "ECOA"), the Fair Credit Reporting Act of 1970, as amended (the "FCRA"), the Fair Debt Collection Practices Act, as amended, the Real Estate Settlement Procedures Act (the "RESPA") and the National Housing Act, as amended. In addition, the Company is subject to state laws and regulations with respect to the amount of interest and other charges which lenders can collect on loans (e.g. usury laws). Although most states do not regulate commercial loans, a few states do require licensing of lenders, limitations on interest rates and other charges, adequate disclosure of certain contract terms and limitations on certain collection practices and creditor remedies. Authorities in those states that regulate the Company's SBA Loan activities may conduct audits of the books, records and practices of the Company. 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 is also required to comply with certain portions of the ECOA which are applicable to commercial loans, including SBA Loans. 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. Mortgage Loans Mortgage lending laws generally require licensing of the lender, limitations on the amount, duration and charges for various categories of loans, adequate disclosure of certain contract terms and limitations on certain collection practices and creditor remedies. Many states have usury laws which limit interest rates, although the limits generally are considerably higher than current interest rates being 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. 24 25 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, 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 and address of the reporting agency. Under RESPA, disclosures to certain borrowers are required to be made within prescribed time frames. Good faith estimates of applicable closing costs are also required. The Company believes that it is in substantial compliance in all material respects with ECOA. Small Business Loans The SBA Loans made by the Small Business Loan Division are governed by federal statutes (the Small Business Act and SBA regulations) and may be subject to regulation by certain states. These federal statutes and regulations specify the types of loans and loan amounts which are eligible for the SBA's guaranty as well as the servicing requirements imposed on the lender to maintain SBA guarantees. The Company is also required to comply with certain portions of ECOA which are applicable to commercial loans, including SBA Loans. The Company must comply with ECOA's prohibition against discrimination on the basis of race, color, sex, age or marital status and with the portion of Regulation B under the ECOA that requires lenders to advise loan applicants of the reasons their credit request was declined or subject to other adverse action. The Company believes it is in substantial compliance in all material respects with ECOA. The SBA is proposing to modify its rules regarding the financing and securitization of the unguaranteed portion of loans guaranteed under Section 7(a) of the Small Business Act. Present regulations provide these options only to non-depository lenders. These proposed rules would permit both depository and non-depository lenders to pledge or securitize the unguaranteed portions of SBA Loans. Under the proposal, participating lenders which undertake securitizations would be required to retain the equivalent of at least 5% interest in each loan. The proposed rules would also increase the amount of required minimum equity for Small Business Lending Companies by 8% of the retained tranche, unless the lender puts up a 5% cash reserve. The proposed regulations will reduce the economic benefits of securitization to the Company, and could also impact liquidity of the Company and availability of funding. However, management believes that securitization of its SBA Loans will still be economical, and that it will have sufficient availability of funding. However, many uncertainties could impact the outcome of this forward-looking statement, and no assurance can be made that actual results will not differ materially. The Company's Asset-based Small Business Loans are generally not regulated except to the extent set forth above in "Regulation-General." 25 26 Auto Loans The Company's Auto Loan business is subject to extensive supervision and regulation under state and federal laws and regulations, which, among other things, require that the Company obtain and maintain certain licenses and qualifications, regulate the interest rates, fees and other charges the Company is allowed to charge, limit or prescribe certain other terms of the Company's loans, require specified disclosures to consumers, govern the sale and terms of insurance products offered by the Company and the insurers for which it acts as agent, and define the Company's rights to repossess and sell collateral. The Company's Auto Loan business is currently limited to South Carolina and is therefore subject to certain South Carolina laws and regulations, including the South Carolina Consumer Protection Code (the "SC Code"). With respect to their direct lending activities, Premier and Loan Pro$ are each licensed under the SC Code as a "supervised lender" (a lender making consumer loans at interest rates in excess of 12% per annum), subject to regulation by the Consumer Finance Division of the State Board of Financial Institutions and by the South Carolina Department of Consumer Affairs. These state regulatory agencies audit the Company's local offices from time to time, and each state agency performs an annual compliance audit of the Company's operations. The SC Code and the regulations thereunder generally do not limit the finance charges that may be contracted for with respect to loans having a cash advance exceeding $600, but require supervised lenders to file schedules showing maximum finance charges for each category and amount of supervised loans. Such schedules must express finance charges in terms of annual percentage rates determined in accordance with TILA, and must be conspicuously posted in each location where loans are originated in the format and with certain notices set forth in regulations promulgated under the SC Code. The SC Code and regulations thereunder also, among other things, limit or regulate closing costs, insurance premiums, delinquency, deferral, refinancing, consolidation and conversion fees and other additional charges which may by assessed in connection with consumer loans, prescribe certain disclosures and notices to borrowers and cosigners, prescribe maximum repayment terms for loans of $1,000 or less, define and limit creditors' remedies on default, and prescribe certain record-keeping and reporting procedures and requirements, and regulate other aspects of consumer finance transactions, including permitted collateral, application of payments, limits on scheduled balloon payments, rebates on repayments, certain terms, disclosures and formalities in the loan contract, and other matters. The SC Code contains provisions similar to the foregoing which are applicable to consumer credit sale transactions in which a consumer's purchase of goods or services is financed by the seller or by the seller's assignment of the retail installment sale contract to another lender. These provisions are applicable to the Company's indirect financing of automobile purchases. The SC Code provides that the seller effecting the credit sales, and does not impose on the assignee any obligation of the seller with respect to events occurring before the assignment. However, upon the assignment, the Company is subject to the provisions governing credit sales. The Company believes that it and the dealers from which it accepts assignment of consumer loans are in substantial compliance with the provisions of the SC Code governing credit sales. The Company's Auto Loan business is also subject to extensive federal regulations in connection with its consumer loans, including TILA, ECOA and FCRA and the regulations thereunder, and certain rules of the Federal Trade Commission. These laws and regulations are referenced above under " - Regulation - - Mortgage Loans." The Company's Auto Loan business is also subject to the rules of the Federal Trade Commission, which limit the types of property a creditor may accept as collateral to secure a consumer loan and provide for the preservation of the consumer's claims and defenses when a consumer obligation is 26 27 assigned to a subsequent holder. The Company believes that it is in substantial compliance in all material respects with TILA, ECOA, FCRA and the Federal Trade Commission rules. EMPLOYEES At December 31, 1996, the Company employed a total of 477 full-time equivalent employees. The Company believes that its relations with its employees are good. ITEM 2. PROPERTIES The Company's headquarters are located at 15 South Main Street, Suite 750, Greenville, South Carolina and are leased. The Company owns three locations and leases 23 locations. None of the leases or properties owned is 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. The Company would expect to lease or purchase any properties necessary for any expansion. ITEM 3. LEGAL PROCEEDINGS 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 1996 fiscal year. 27 28 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Information about the market for the Company's Common Stock and related security holder matters on page 46 of the Company's Annual Report to the Shareholders for the year ended December 31, 1996 is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA Selected financial data included on page 1 of the Company's Annual Report to Shareholders for the year ended December 31, 1996 is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 9 through 18 in the Company's Annual Report to the Shareholders for the year ended December 31, 1996, is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements and notes to consolidated financial statements of the Company and its subsidiaries included on pages 21 through 45 in the Company's Annual Report to the Shareholders for the year ended December 31, 1996 are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On August 26, 1996, the Company decided to dismiss Elliott Davis & Company, L.L.P. ("ED&C") and to engage KPMG Peat Marwick LLP ("KPMG") as the Company's independent auditors for the 1996 fiscal year. ED&C has served as the Company's principal accountants since 1993. The change in auditors resulted from the Company's decision that it was in the Company's best interest to utilize a national accounting firm, with its attendant size, experience, and expertise. In connection with its audits for the past two fiscal years and for the interim period through August 26, 1996, there have been no disagreements between the Company and ED&C on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of the auditors, would have caused it to make reference to the subject matter of the disagreement in connection with its report. Moreover, ED&C reports as principal auditor of the financial statements of the Company for the past two fiscal years did not contain an adverse opinion or a disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles. The Audit Committee of the Board of Directors and the Board of Directors of the Company have approved this change of accounting firms. ED&C has furnished to the Company a letter addressed to the Commission stating that it agrees with the above statements. A copy of that letter dated September 5, 1996, is filed as Exhibit 16.1. 28 29 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 is included in the Company's Definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 27, 1997 and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 is included in the Company's Definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 27, 1997 and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 is included in the Company's Definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 27, 1997 and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 is included in the Company's Definitive Proxy Statement for the Annual Meeting of the Shareholders scheduled to be held May 27, 1997, and is incorporated herein by reference. 29 30 PART IV ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K (a) Listing of Exhibits 3.1-- Amended and Restated Articles of Incorporation dated September 20, 1978: Incorporated by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-1, Commission File No. 2-62723 (the "1978 Registration Statement"). 3.2-- Articles of Amendment as filed with the Secretary of State of South Carolina on June 5, 1984: Incorporated by reference to Item 6(a) of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1984, Commission File No. 0-8909. 3.3-- Articles of Amendment as filed with the Secretary of State of South Carolina on December 27, 1985: Incorporated by reference to Current Report on Form 8-K dated January 2, 1986, Commission File No. 0-8909. 3.4-- Articles of Amendment as filed with the Secretary of State of South Carolina on August 23, 1991: Incorporated herein by reference to Quarterly Report on Form 10-Q for the quarter ended September 30, 1991, Commission File No. 0-8909. 3.5-- Restated by-laws: Incorporated by reference to Exhibit 3.2 of the 1978 Registration Statement. 3.6-- Amendment to Bylaws: Incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended September 30, 1991, Commission File No. 0-8909). 3.7-- Form of Warrant: Incorporated herein by reference to the Company's Report on Form 10-K for the year ended December 31, 1985, File No. 0-8909. 3.8-- Articles of Amendment as filed with the Secretary of State of South Carolina on April 19, 1996: Incorporated by reference to Exhibit 3.1 in the Quarterly Report on Form 10-Q for the quarter ended March 31, 1996, Commission File No. 0-8909. 3.9-- Articles of Amendment as filed with the Secretary of State of South Carolina on May 26, 1989: Incorporated by reference to Exhibit 4.8 of the Company's registration statement on Form S-8, Commission File No. 333-07923. 3.10-- Articles of Amendment as filed with the Secretary of State of South Carolina on June 14, 1995: Incorporated by reference to Exhibit 4.9 of the Company's registration statement on Form S-8, Commission File No. 333-07923. 4.1-- See Exhibits 3.1 through 3.7. 10.1-- Emergent Group, 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. 0-8909. 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-- Loan and Security Agreement dated December 19, 1995 between BankAmerica Business Credit, Inc. and The Loan Pro$, Inc., and Premier Financial Services, Inc.: Incorporated by reference to Exhibit 10.5 of the Company's Registration Statement on Form S-1, Commission File No. 333-01. 10.6-- Loan and Security Agreement, as amended by Amendment No. 1 dated April 10, 1995 between BankAmerica Business Credit, Inc. and Premier Financial Services, Inc.: Incorporated by reference to Exhibit 10.6 of the Company's Registration Statement on Form S-1, Commission File No. 333-01393. 10.7-- Loan and Security Agreement, as amended by Amendment Nos. 1, 2 and 3 dated December 29,1993 between NationsBank of Georgia and Emergent Business Capital, as amended: Incorporated by reference to Exhibit 10.7 of the Company's Registration Statement on Form S-1, Commission File No. 333-01393. 10.8-- Loan and Security Agreement dated October 10, 1995 between NationsBank of Georgia and Emergent Commercial Mortgage, as amended: Incorporated by reference to Exhibit 10.8 of the Company's Registration Statement on Form S-1, Commission File No. 333-01393. 30 31 10.9-- Mortgage Loan Warehousing Agreement dated November 22, 1994 between First Union National Bank of North Carolina and Carolina Investors, Inc. as amended by Amendments No. 1, 2, 3, and 4: Incorporated by reference to Exhibit 10.9 of the Company's Registration Statement on Form S-1, Commission File No. 333-01393. 10.10-- Mortgage Loan Warehousing Agreement dated March 6, 1996 between First Union National Bank of North Carolina and Emergent Mortgage Corp., as amended: Incorporated by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. Commission File No. 0-8909. 10.11-- The Pooling and Servicing Agreement dated as of June 29, 1995 between Emergent Business Capital, nc. as Seller and Servicer, and First Union National Bank of North Carolina, as Trustee: Incorporated by reference to Exhibit 28.1 to the Company's Current Report on Form 8-K dated June 29, 1995, Commission File No. 0-8909. 10.12-- Certificate Purchase Agreement between the Placement Agent, as initial purchaser, and the Company: Incorporated by reference to Exhibit 28.1 to the Company's Current Report on Form 8-K dated June 29, 1995, Commission File No. 0-8909. 10.13-- Loan and Security Agreement dated May 31, 1996, between NationsBank, N.A. (South) and Emergent Financial Corporation. Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996. 10.14-- Amendment No. 1 to Loan and Security agreement dated October 10, 1995, between NationsBank of Georgia, N.A. and Emergent Commercial Mortgage, Inc. Incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996. 10.15-- Amendment Number 4 to Loan and Security Agreement dated December 29, 1993, between NationsBank of Georgia and Emergent Business Capital, Inc. Incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996. 10.16-- Amendment No. 5 to Loan and Security Agreement dated December 29, 1993 between NationsBank of Georgia and Emergent Business Capital, Inc. Incorporated by reference to Exhibit 10.16 to the Company's Registration Statement on Form S-1, Commission File No. 333-01393. 10.17-- Amendment No. 2 to Loan and Security Agreement dated October 10, 1995, between NationsBank of Georgia, N.A. and Emergent Commercial Mortgage, Inc. Incorporated by reference to Exhibit 10.17 to the Company's Registration Statement on Form S-1, Commission File No. 333-01393. 10.18-- Amendment Nos. 5, 6, and 7 to Mortgage Loan Warehousing Agreement dated March 6, 1996 between First Union National Bank of North Carolina and Carolina Investors, Inc. Incorporated by reference to Exhibit 10.18 to the Company's Registration Statement on Form S-1, Commission File No. 333-01393. 10.19-- Amendent Nos. 3 and 4 to Mortgage Loan Warehousing Agreement dated February 4, 1997, and March 5, 1997, respectively, between First Union National Bank of North Carolina and Emergent Mortgage Corp. 10.20-- Interim Warehouse and Security Agreement dated March 4, 1997, between Prudential Securities Credit Corporation and Emergent Mortgage Corp. 10.21-- Emergent Group, 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. 11.1-- Statement re. computation of earnings per share. 13.0-- The Company's Annual Report to Shareholders for the fiscal year ended December 31, 1996. (Only those portions specifically incorporated by reference into this report shall be "filed" with the Securities and Exchange Commission). 16.1-- Letter of Elliott, Davis & Company, L.L.P. dated September 5, 1996. Incorporated by reference to Exhibit 16.1 to the Company's Current Report on Form 8-K dated August 26, 1996, Commission File No. 0-8909. 21.0-- Listing of subsidiaries. 23.1-- Report of Independent Auditors (Elliott, Davis & Company, L.L.P.) for each of the two years in the period ended December 31, 1995. 23.2-- Consent of KPMG Peat Marwick LLP to include report of Independent Auditors for the year ended December 31, 1996, in the: (1) Company's registration statement on Form S-8 dated July 11, 1996, for the Emergent Group, Inc. 1995 Employee and Officer Stock Option Plan, Commission File No. 333- 07923; (2) Company's registration statement on Form S-8 dated July 11, 1996, for the Emergent Group, Inc. Restricted Stock Agreement Plan, Commission File No. 333-07927; (3) Company's registration 31 32 statement on Form S-8 dated July 11, 1996, for the Emergent Group, Inc. 1995 Director Stock Option Plan, Commission File No. 333-07925; and (4) Company's registration statement on Form S-8 dated February 14, 1997, for the Emergent Group, Inc. Employee Stock Purchase Plan, Commission File No. 333-20179. 27.1-- Financial Data Schedule (For SEC Use Only). (b) Reports on Form 8-K filed in the fourth quarter of 1996: None 32 33 CORPORATE PROFILE ================================================================================ Emergent Group, Inc. is a diversified financial services company which originates and services residential mortgage loans, small business loans, and pre-owned automobile loans. During 1994, 1995 and 1996, loan originations were $150 million, $250 million and $415 million respectively. Of the Company's loan originations in 1996, $329 million were Mortgage Loans, $68 million were Small Business Loans and $18 million were Auto Loans. For the years ended December 31, 1994, 1995 and 1996 pre-tax income from continuing operations was $2.4 million, $4.9 million and $10.5 million respectively. Strategically the similarities of our businesses are more important than their differences. Each business has the ability to meet critical requirements in consumer and commercial markets. Key components of the Company's business strategy include: - Emphasis on Profitability Rather than Asset Growth - High Velocity Asset Turnover - Conservative Financial Structure - Decentralized Operations - Multi-Channel Loan Originations - Corporate Financial Controls, Servicing and Quality Monitoring [CHART] 1996 BUSINESS MIX BY LOAN ORIGINATIONS The Rhino acts as our corporate symbol. He reminds us to take charge of our lives, and business. He is determined to find success, no matter how difficult. Our corporate pledge is to serve our industry and customers with the single mindedness and determination of the hard charging rhino. 33 34 SELECTED FINANCIAL HIGHLIGHTS EMERGENT GROUP, INC. AND SUBSIDIARIES (Dollars in thousands except per share amounts)
Year Ended December 31, 1992 1993 1994 1995 1996 - --------------------------------------------------------------------------------------------------------------------- REVENUE $ 9,008 $ 12,046 $ 18,195 $ 26,278 $ 50,388 INCOME (LOSS)FROM CONTINUING OPERATIONS (249) 824 1,792 4,581 10,095 INCOME (LOSS) FROM DISCONTINUED OPERATIONS 685 260 546 (3,924) -- NET INCOME 436 1,197 2,338 657 10,095 INCOME (LOSS)PER SHARE FROM CONTINUING OPERATIONS (.04) .13 .27 .69 1.42 NET INCOME PER SHARE .08 .18 .35 .10 1.42 ===================================================================================================================== SHAREHOLDERS' EQUITY $ 5,057 $ 7,362 $ 9,700 $ 9,885 $ 46,635 - --------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 70,359 $ 84,279 $ 109,448 $ 144,931 $ 224,149 - --------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES $ 65,302 $ 76,917 $ 99,748 $ 135,046 $ 177,514 (including minority interest) - ---------------------------------------------------------------------------------------------------------------------
34 35 TO OUR SHAREHOLDERS ================================================================================ EMERGENT GROUP, INC. Dear Fellow Shareholders: This past year was a rewarding and exciting one for our Company. Pre-tax income from continuing operations increased 116% from $4.9 million to $10.5 million. Revenues increased 92%, to $50.4 million. Emergent's profits are driven primarily by loan originations which went from $250 million in 1995 to $415 million in 1996, an increase of 66%. [CHART] [CHART] One highlight was the successful completion of a common stock offering in November. As part of a 3,000,000 share offering, the Company sold 2,519,031 shares at $11.50 with the remainder being sold by existing shareholders, none of which were sold by management. This raised $26.4 million (net of offering expenses) for the Company. Our 1996 year-end shareholders' equity stands at $46.6 million, with a year-end equity to assets ratio of 20.8%. The Company is now well capitalized to implement its expansion plans for 1997. To further management's focus on increasing shareholder value, we adopted a financial planning and evaluation system, Economic Value Added ("EVA") EVA accounts for the cost of equity capital used, thereby requiring management to seek returns greater than this cost. By the end of 1997, we will have implemented EVA throughout the Company's operations. This should help to ensure better alignment of capital allocation and investment, business unit evaluation, and incentive compensation to fundamental long-term changes in shareholder value. The Company's Management Information Systems area received significantly greater attention during 1996. In 1997 we expect to complete additional upgrades of our loan processing and servicing software. The Mortgage Loan Division continued its rapid expansion. The Company initiated retail loan originations in April with the opening of an Indianapolis, Indiana office which operates under the name HomeGold(TM). Retail loan production offices were also opened in Phoenix, Arizona and Greenville, South Carolina. A second distinct retail operation was also initiated, operating under the name Sterling Lending Corporation. It has a loan processing office in Baton Rouge, Louisiana with origination offices in New Orleans, Louisiana; Atlanta, Georgia; Jacksonville, Florida and Jackson, Mississippi. The Company has also continued the expansion of its wholesale mortgage division through three regions. Total mortgage loan originations were $329 million, a 70% increase over 1995 originations. A new customer service program was added for our mortgage loan customers. Non-prime borrowers have typically experienced debt payment problems usually related to the excessive use of unsecured debt, primarily credit cards. The Mortgage Loan Division's servicing department has a group dedicated to assisting borrowers in improving their credit status which is done through helping to educate them with better planning, spending discipline, and emphasis on reducing the use of personal debt. This Real Rewards(TM) program includes interest rate reduction rewards for borrowers who have maintained a good payment history. It is hoped that this will be of value to our customers in reducing financial stress, and also be of value to us as we anticipate reduced portfolio delinquencies, lower foreclosure rates and the creation of a marketing advantage. 35 36 =============================================================================== The Small Business Loan Division added two new loan products to complement our U.S. Small Business Administration 7(a) term loan program. One product provides working capital for small businesses through a revolving line of credit secured primarily by accounts receivable and inventory. The second product is mezzanine loans which we began making in February 1996 through one of the funds we manage, and in which we have a $1 million equity investment. These are subordinated term loans to small businesses with warrants to purchase stock. The target borrowers are small businesses which normally have positive cash flow from operations but require capital to expand. The Auto Loan Division had a disappointing year. Delinquencies increased which required larger loan loss provisions. Expansion has been curtailed so that the offices can concentrate on collection activity and asset quality rather than origination growth. OPERATIONS STRATEGY Our operations strategy continues to include significant market expansion of our two core divisions. Mortgage Loan Division 1. Continued channels of diversified loan originations, including wholesale and retail production. Wholesale includes loans which are made through mortgage brokers and strategic alliance partners. In selected cases, we obtain minority ownership positions with our strategic alliance partners. 2. Regional underwriting backed by a centralized system of quality control checks. 3. Rapid asset turnover through whole loan sales and securitizations. 4. Emphasis on loan servicing to maintain good collection experiences and to counsel borrowers, as appropriate, on how to improve their financial affairs. Small Business Loan Division 1. Geographic expansion of office locations. 2. Consideration of additional product related opportunities. 3. Joint marketing of multiple products to a larger referral base. FINANCIAL STRATEGY Our financial strategy is focused on increasing shareholder value. Our primary objective is to concentrate on products with significant margin and to maintain an aggressive asset turnover rate, to minimize increasing the level of assets while growing equity. [CHART] [CHART] 36 37 ================================================================================ To better prepare for continued growth, the Company made three key management changes in 1996. Robert Davis, formerly Chief Financial Officer, was elected Vice President Administration with responsibilities for human resources and shareholder relations. This was a critical appointment that will help ensure both competitive employee programs and quality communication with our shareholders. Kevin Mast was promoted to Vice President, Chief Financial Officer and Treasurer. Kevin has been instrumental in developing our accounting and financial control systems and is the driving force behind our loan securitizations. Additionally, we have added Sam Couvillion as Chief Operating Officer, Small Business Loan Division. Sam comes to us with a solid commercial banking background which will be valuable as we continue the rapid expansion of this division. We all share a common vision of profitable growth based on real value service to our customers. CLOSING We are thankful to all our shareholders, associates and customers who make our progress possible. Emergent has a wonderful "can do" culture with a high sense of ethics. We pride ourselves on doing what we say we will do. Our Board continues to be a great source of wisdom and guidance. As significant shareholders, they have a focused view on management's responsibility to shareholders. Our friend and fellow director, Jake Martin, is retiring from the Board this year. Jake made a special contribution to Emergent when we first started. Jake was president of a company which was a significant shareholder in the Company when we acquired control in 1991. He pledged to hold onto this stock and support our efforts to give us time to get started. For that, and all of his valued advise, we will always be thankful. At the request of the Board of Directors, Mr. Martin has agreed to serve as Director Emeritus. We are optimistic about 1997 and future years. The mortgage market is large, growing and consolidating. We also have a great opportunity to increase market share. The small business lending market is also dynamic. Continuing consolidation of commercial banks creates opportunities for smaller, more specialized lenders. Thanks again to all our old and new shareholders for your support. We pledge our best efforts to continually earn and retain your trust. Sincerely, John M. Sterling, Jr. Keith B. Giddens Chairman of the Board President and Chief Operating Officer and Chief Executive Officer 37 38 EMERGENT GROUP TODAY =============================================================================== EMERGENT GROUP, INC. AND SUBSIDIARIES MORTGAGE LOAN DIVISION The Mortgage Loan Division experienced excellent revenue growth in 1996, up over 130% from 1995. The primary contributor to the growth was an increase in loan originations. Originations are derived from two distribution channels which consist of retail (point of sale directly to the borrower) and wholesale (point of sale to a mortgage broker along with Strategic Alliance having the point of sale to a mortgage banker with delegated credit underwriting). The sub-prime mortgage market exceeds $100 billion in annual originations. There is significant competition; however, the market is highly fragmented and not dominated by any one competitor. Sub-prime borrowers are typically credit impaired and are unable to receive loans from traditional mortgage lenders. In general, a large portion of the borrowers have overextended themselves with unsecured debt. However, the equity in their homes may be utilized to consolidate their debt and reduce their monthly expenses with lower interest rates and extended terms. At the retail level, originations are dominated by thousands of small local brokers. Emergent therefore has approached this market with a multi-faceted distribution strategy. The two retail production channels operate under the names HomeGold(TM) and Sterling Lending Corporation. They approach their market with a different marketing and sales strategy. Retail loan production began in April with the opening of the first HomeGold(TM) production office in Indianapolis, Indiana and is currently operating out of three regional centers. Sterling Lending later opened its first retail office in Baton Rouge, Louisiana and is currently operating out of five offices. In the fourth quarter the retail channel represented 43% of total Mortgage Loan Division originations. There are plans to open additional loan offices for both retail production channels during 1997. The wholesale loan distribution channel has expanded from two states at the start of the year to twelve states at year end. The number of approved mortgage brokers increased over the same time frame from 172 to 330. There are presently three regions for the wholesale group with plans for an additional region to be established later in 1997. The strategic alliance part of the wholesale channel lost its largest loan producer in 1996 due to that firm's sale to a commercial bank holding company. However, the Company has expanded the channel coverage with two strategic alliance partners signed in the fourth quarter of 1996, bringing the total number of strategic alliance partners to five. Additional strategic alliance partners are being added in 1997. The Company has minority ownership positions in four of its strategic alliance partners. The Mortgage Loan Division centralized its servicing and portfolio management departments during the fourth quarter. These departments have also been expanded nearly four-fold over the past year to meet the increased processing and servicing requirements resulting from the increased loan originations. Significant changes in the quality control and compliance related areas of the Mortgage Loan Division have been made over the past year. Included among these changes is a quality control secondary marketing group which reunderwrites mortgage loan production and ensures the underwriting standards and policies of the Company are properly administered. The Company is anticipating completion of its first mortgage loan securitization during the first quarter of 1997. Emergent has adopted the slogan "The Power to Be Debt Free" as a theme, encouraging borrowers to become less dependent on high interest rate personal and credit debt. Servicing and counseling departments have begun training and assisting borrowers with their personal financial matters. This is a genuine concern which the Company feels is unique within the market. Operating under Real Rewards(TM) this part of servicing is believed by management to be a competitive advantage. MORTGAGE LOAN PRODUCTION MIX (IN MILLIONS [GRAPH] MORTGAGE LOANS ORIGINATED (IN MILLIONS) [GRAPH] MORTGAGE LOANS SERVICED (IN MILLIONS AT YEAR END) [GRAPH] 38 39 EMERGENT GROUP TODAY ================================================================================ EMERGENT GROUP, INC. AND SUBSIDIARIES SMALL BUSINESS LOAN DIVISION The Small Business Loan Division had an excellent year with substantially increased operating results. Additionally, an asset-based lending group was started which allows for a broader product offering and incremental business opportunities. The primary contributor of the strong operating results was increased volume of originations under the U.S. Small Business Administration ("SBA") 7(a) term loan program. Emergent Business Capital, Inc. ("EBC") is the Company's Small Business Lending Company subsidiary. It has a grandfathered Small Business Lending Company license which permits it, as a non-bank, to make SBA loans. Industry sources reported that in terms of dollar volume of loan approvals, EBC was the seventh largest SBA lender, as of the SBA fiscal year ended September 30, 1996. Typically, loans up to $1,500,000 are made to small businesses with the Company obtaining a guaranty from the SBA for the lower of 75% or $750,000. After closing and full loan disbursement, the guaranteed portion of the loan is sold into an active secondary market. The non-guaranteed portions are retained until a critical mass is obtained at which time they are pooled and sold through a loan securitization. In November, the Company completed its second SBA loan securitization totalling $17.5 million. Only two other lenders have successfully securitized the unguaranteed portion of SBA loans. Securitization permits the Company to redeploy its capital while maintaining the profitable loan servicing. SBA loans are generally long term floating rate obligations secured by fixed assets of an eligible small business. The borrower base is a diversified mix of businesses including industries such as hospitality, restaurant, convenience stores, manufacturing, and distribution. Regional loan production offices are located in Dallas, Texas; Panama City, Florida; Denver, Colorado; and Greenville, South Carolina. Loan servicing functions have been centralized in Greenville. New regions contemplated for 1997 include the Upper Midwest and New Jersey/Pennsylvania markets. In July, Emergent Financial Corp., an asset-based lending group, was started in Atlanta, Georgia. Emergent Financial Corp. offers short-term working capital loans for small businesses, usually secured by accounts receivable and inventory. Loan sizes typically range from $100,000 to $1 million. Further geographic and market expansion is planned for this unit. The Small Business Loan Division also serves as investment manager for a venture capital partnership; Palmetto Seed Capital Fund Limited Partnership ("Palmetto") and a mezzanine level partnership fund, Reedy River Ventures, L.P. ("RRV"). Palmetto provides equity capital for early stage companies headquartered in South Carolina. RRV provides loans to later stage companies accompanied by warrants to purchase equity. The Company has no capital invested in Palmetto and has a $1 million investment in RRV. The Company receives fees for managing the two funds. Each of the Small Business Loan Division's products are targeted to businesses that have limited access to traditional sources of credit. This non-traditional credit market is highly fragmented and growing. The Company has an outstanding opportunity to profitably expand its commercial business by marketing all three products to key referral sources and by taking advantage of the fragmented nature of this industry. SMALL BUSINESS LOANS ORIGINATED (IN MILLIONS) [GRAPH] SBA LOANS ORIGINATED AND NET INCREASE IN ASSET-BASED LOANS SMALL BUSINESS LOANS SERVICED (IN MILLIONS, AT YEAR-END) [GRAPH] (SBA AND ASSET-BASED LOANS) 39 40 EMERGENT GROUP TODAY =============================================================================== EMERGENT GROUP, INC. AND SUBSIDIARIES AUTO LOAN DIVISION The Auto Loan Division finances pre-owned automobile purchases through eight offices in South Carolina. Substantially all of the loans are made directly to borrowers through dealer referrals. In March the Company securitized $16.1 million of auto loans. This division experienced slower growth and higher than anticipated charge-offs in 1996. This is generally reflective of the recent trends that have occurred within the sub-prime automobile finance industry as a whole. The Company has implemented changes in its underwriting standards, loan pricing and corporate controls to better access risks and improve the asset quality. At this time, the Company has no plans to expand the Auto Loan Division. AUTO LOANS ORIGINATED (IN MILLIONS [GRAPH] AUTO LOANS SERVICED (IN MILLIONS, AT YEAR-END) [GRAPH] 40 41 EMERGENT GROUP, INC. AND SUBSIDIARIES REPORT ON CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1995, AND 1996 42 EMERGENT GROUP, INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1995, AND 1996 CONTENTS
Page ---- Independent Auditors' Report ........................................... 2 Audited Consolidated Financial Statements Consolidated Balance Sheets ................................... 3 Consolidated Statements of Income ............................. 5 Consolidated Statements of Shareholders' Equity ............... 6 Consolidated Statements of Cash Flows ......................... 7 Notes to Consolidated Financial Statements .................... 9
-1- 43 INDEPENDENT AUDITORS' REPORT Shareholders and Board of Directors EMERGENT GROUP, INC. AND SUBSIDIARIES Greenville, South Carolina We have audited the accompanying consolidated balance sheet of EMERGENT GROUP, INC. AND SUBSIDIARIES as of December 31, 1996, and the related consolidated statements of income, shareholders' equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. The consolidated financial statements of EMERGENT GROUP, INC. AND SUBSIDIARIES as of and for the two years ended December 31, 1995, were audited by other auditors whose report dated January 31, 1996, expressed an unqualified opinion on those statements. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of EMERGENT GROUP, INC. AND SUBSIDIARIES as of December 31, 1996, and the consolidated results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. January 30, 1997 -2- 44 EMERGENT GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands)
DECEMBER 31, ------------------------ 1995 1996 ---------- ---------- ASSETS Cash and cash equivalents $ 1,260 $ 1,276 Restricted cash 912 5,319 Loans receivable: Loans receivable 103,865 89,469 Mortgage loans held for sale 22,593 100,063 ---------- ---------- Total loans receivable 126,458 189,532 Less allowance for credit losses on loans (1,874) (3,084) Less unearned discount, dealer reserves, and deferrals, net of deferred loan costs (610) (1,419) ---------- ---------- Net loans receivable 123,974 185,029 Other receivables: Excess servicing receivable, net of allowance for loss of $848 in 1996 2,054 4,315 Accrued interest receivable 1,571 2,087 Other receivables 1,626 4,459 ---------- ---------- Total other receivables 5,251 10,861 Investment in asset-backed securities, net of allowance for loss of $773 in 1995 and $354 in 1996 865 3,581 Net property and equipment 3,370 7,177 Excess of cost over net assets of acquired businesses, net of accumulated amortization of $597 in 1995 and $781 in 1996 2,865 2,722 Real estate and personal property acquired through foreclosure 3,742 4,720 Other assets 2,692 3,464 ---------- ---------- TOTAL ASSETS $ 144,931 $ 224,149 ========== ==========
-3- 45 EMERGENT GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (CONTINUED) (In thousands, except share data) LIABILITIES AND SHAREHOLDERS' EQUITY DECEMBER 31, ------------------------ 1995 1996 ---------- ---------- Liabilities: Notes payable to banks $ 31,633 $ 55,494 Subordinated investor savings: Notes payable to investors 82,132 97,987 Subordinated debentures 16,185 16,115 ---------- ---------- Total subordinated investor savings 98,317 114,102 Accounts payable and accrued liabilities 3,090 3,958 Remittances payable 1,188 3,519 Accrued interest payable 622 597 ---------- ---------- Total other liabilities 4,900 8,074 ---------- ---------- Total liabilities 134,850 177,670 Minority interest 196 (156) Commitments and contingencies Shareholders' equity: Common stock, par value $.05 a share - authorized 4,000,000 shares in 1995 and 30,000,000 shares in 1996, issued and outstanding 121,000 shares in 1995 and 9,141,131 shares in 1996 6 457 Class A common stock, par value $.05 a share - authorized 6,666,667 shares in 1995 and - 0 - in 1996; issued and outstanding 6,276,474 shares in 1995 and - 0 - shares in 1996 314 -- Capital in excess of par value 6,632 33,150 Retained earnings 2,933 13,028 ---------- ---------- Total shareholders' equity 9,885 46,635 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 144,931 $ 224,149 ========== ==========
See Notes to Consolidated Financial Statements which are an integral part of these statements. -4- 46 EMERGENT GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------- 1994 1995 1996 ----------- ----------- ----------- (IN THOUSANDS, EXCEPT SHARE DATA) REVENUES: Interest income $ 10,691 $ 15,193 $ 17,908 Servicing income 212 446 3,274 Gain on sale of loans 6,450 9,169 23,815 Management fees 320 570 514 Loan fee income 276 586 4,150 Other revenues 246 314 727 ----------- ----------- ----------- Total revenues 18,195 26,278 50,388 ----------- ----------- ----------- EXPENSES: Interest 5,879 8,527 11,021 Provision for credit losses 2,510 2,480 5,416 Salaries, wages and employee benefits 4,001 5,691 13,663 Business development costs 626 653 1,603 Other general and administrative expense 2,732 4,075 8,224 ----------- ----------- ----------- Total expenses 15,748 21,426 39,927 ----------- ----------- ----------- Income from continuing operations before income taxes and minority interest 2,447 4,852 10,461 Provision for income taxes 609 190 718 ----------- ----------- ----------- Income from continuing operations before minority interest 1,838 4,662 9,743 Minority interest in (earnings) loss of subsidiaries (46) (81) 352 ----------- ----------- ----------- Income from continuing operations 1,792 4,581 10,095 Discontinued transportation and apparel manufacturing segments: Gain (loss) from operations, net of income tax (2,022) (1,573) -- Gain (loss) on disposal of segments, net of income tax 2,568 (2,351) -- ----------- ----------- ----------- 546 (3,924) -- ----------- ----------- ----------- NET INCOME $ 2,338 $ 657 $ 10,095 =========== =========== =========== Earnings (loss) per share of common stock: Continuing operations $ 0.27 $ 0.69 $ 1.42 Discontinued operations 0.08 (0.59) -- ----------- ----------- ----------- EARNINGS PER SHARE $ 0.35 $ 0.10 $ 1.42 =========== =========== =========== Weighted average shares outstanding 6,688,734 6,668,192 7,099,874 =========== =========== ===========
See Notes to Consolidated Financial Statements which are an integral part of these statements. -5- 47 EMERGENT GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994, 1995, AND 1996
Class A Common Stock Common Stock ------------------------- ------------------------- Shares Issued Amount Shares Issued Amount ------------- -------- ------------- -------- (In thousands, except share data) Balance at December 31, 1993 200,575 $ 10 9,803,438 $ 490 Net income -- -- -- -- ---------- ---------- ---------- ---------- Balance at December 31, 1994 200,575 10 9,803,438 490 Shares issued, formerly held by subsidiary -- -- 24,700 1 Shares purchased through tender offer (19,377) (1) (467,288) (23) Shares retired through reverse stock split (121,204) (6) (6,242,275) (312) Shares issued on exercise of stock options 506 -- 19,662 1 Two for one stock split in the form of a stock dividend 60,500 3 3,138,237 157 Net income -- -- -- -- ---------- ---------- ---------- ---------- Balance at December 31, 1995 121,000 6 6,276,474 314 Shares issued on exercise of stock options 2,026 -- 110,668 5 Conversion of Class A Common Stock to Common Stock 6,387,142 319 (6,387,142) (319) Shares issued on exercise of stock warrants 111,932 6 -- -- Issuance of Common Stock 2,519,031 126 -- -- Net income -- -- -- -- ---------- ---------- ---------- ---------- Balance at December 31, 1996 9,141,131 $ 457 -- $ -- ========== ========== ========== ========== Capital in Excess of Retained par Value Earnings Total ---------- ---------- ---------- Balance at December 31, 1993 $ 6,924 $ (62) $ 7,362 Net income -- 2,338 2,338 ---------- ---------- ---------- Balance at December 31, 1994 6,924 2,276 9,700 Shares issued, formerly held by subsidiary 15 -- 16 Shares purchased through tender offer (535) -- (559) Shares retired through reverse stock split 309 -- (9) Shares issued on exercise of stock options 79 -- 80 Two for one stock split in the form of a stock dividend (160) -- -- Net income -- 657 657 ---------- ---------- ---------- Balance at December 31, 1995 6,632 2,933 9,885 Shares issued on exercise of stock options 156 -- 161 Conversion of Class A Common Stock to Common Stock -- -- -- Shares issued on exercise of stock warrants 288 -- 294 Issuance of Common Stock 26,074 -- 26,200 Net income -- 10,095 10,095 ---------- ---------- ---------- Balance at December 31, 1996 $ 33,150 $ 13,028 $ 46,635 ========== ========== ==========
See Notes to Consolidated Financial Statements which are an integral part of these statements. -6- 48 EMERGENT GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, --------------------------------------- 1994 1995 1996 ----------- ----------- ----------- (IN THOUSANDS) OPERATING ACTIVITIES: Net income $ 2,338 $ 657 $ 10,095 Adjustments to reconcile net income to net cash provided by (used in) operating activities Depreciation and amortization 783 938 1,334 Provision for deferred income taxes 343 41 (141) Provision for credit losses 2,510 2,480 5,416 Loss on sale of investments 66 -- -- Loss on disposal of property and equipment 5 44 26 Net (increase) decrease in deferred loan costs -- (171) 145 Net increase (decrease) in unearned discount and other deferrals 453 (853) 665 Loans originated with intent to sell (73,709) (173,985) (368,650) Principal proceeds from loans sold 85,693 144,861 271,858 Proceeds from securitization of loans -- 15,357 30,128 Payments to securitization certificate holders for credit losses -- -- (1,155) Minority interest in earnings (loss) of subsidiaries 7 81 (352) Changes in operating assets and liabilities increasing (decreasing) cash: Restricted cash -- (912) (4,407) Excess servicing receivable (1,460) (183) (3,109) Accrued interest receivable (193) (644) (516) Other assets (101) (964) (4,114) Remittance due loan participants 295 505 2,331 Accrued interest payable 30 103 (24) Other liabilities 913 877 865 Net cash provided by (used in) operating activities of discontinued operations (1,253) 1,592 77 ----------- ----------- ----------- Net cash provided by (used in) operating activities $ 16,720 $ (10,176) $ (59,528) ----------- ----------- -----------
-7- 49 EMERGENT GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------- 1994 1995 1996 ----------- ----------- ----------- (IN THOUSANDS) INVESTING ACTIVITIES: Loans originated for investment purposes $ (74,937) $ (74,363) $ (68,123) Principal collections on loans not sold 31,786 50,329 61,868 Principal collections on asset-backed securities -- 177 933 Additional investment in subsidiary -- (359) -- Purchase of investments -- (1,000) (135) Increase in note receivable from former subsidiary -- (200) -- Reduction in goodwill of subsidiary 85 -- -- Proceeds from sale of short-term investments 581 614 -- Proceeds from sale of real estate and personal property acquired through foreclosure 1,128 3,401 3,383 Proceeds from sale of property and equipment -- -- 160 Purchase of property and equipment (479) (1,732) (4,894) Rent received on real estate acquired through foreclosure 87 85 381 Improvements and related costs incurred on real estate acquired through foreclosure (477) (205) (330) Net cash provided by investing activities of discontinued operations 806 31 -- ----------- ----------- ----------- Net cash used in investing activities (41,420) (23,222) (6,757) ----------- ----------- ----------- FINANCING ACTIVITIES: Advances on notes payable to banks 104,622 179,381 509,118 Payments on notes payable to banks (91,839) (164,989) (485,257) Net increase in notes payable to investors 13,496 25,635 15,855 Net (decrease) in subordinated debentures (5,826) (4,812) (70) Payments on long-term debt and capital leases (280) (279) -- Cash paid for stock purchased in tender offer -- (568) -- Proceeds from issuance of additional common stock -- 52 26,655 Other (155) (40) -- ----------- ----------- ----------- Net cash provided by financing activities 20,018 34,380 66,301 ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents (4,682) 982 16 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 4,960 278 1,260 ----------- ----------- ----------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 278 $ 1,260 $ 1,276 =========== =========== ===========
See Notes to Consolidated Financial Statements which are an integral part of these statements. -8- 50 EMERGENT GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SIGNIFICANT ACCOUNTING POLICIES CONSOLIDATION The consolidated financial statements include the accounts of the Company and its subsidiaries, each of which is wholly-owned except The Loan Pro$, Inc. ("Loan Pro$") and Sterling Lending Corporation ("Sterling Lending") which are each 80% owned. All significant intercompany items and transactions have been eliminated in consolidation. The Company and its subsidiaries are primarily engaged in the business of originating, selling and servicing first and second residential mortgage loans, commercial loans partially guaranteed by the United States Small Business Administration ("SBA"), commercial loans collateralized by accounts receivable and inventory, and loans collateralized by pre-owned automobiles. The funds for these loans are obtained principally through the utilization of various lines of credit with banks and the issuance of notes payable and subordinated debentures to investors. Substantially all of the Company's loans are made to non-prime borrowers. These borrowers generally have limited access to credit or are otherwise considered to be credit impaired by conventional lenders. 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, anticipated prepayments on loans sold with servicing retained, valuation of real estate owned, and determination of the allowance for credit losses. Minority interest represents minority shareholders' proportionate share of the equity and earnings of Loan Pro$ and Sterling Lending. 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. -9- 51 AMORTIZATION The excess of cost over related net assets of businesses acquired is amortized using the straight-line method principally over 25 years. On a periodic basis, the Company reviews goodwill for events or changes in circumstances that may indicate that the carrying amount of goodwill may not be recoverable. The Company utilizes estimated future cash flows of the purchased subsidiary in determining any impairment on the excess of cost over the related net assets. INCOME TAXES The Company and its subsidiaries file a consolidated Federal income tax return. The Company uses Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes, which requires accounting for income taxes using the asset and liability method. Under the asset and liability method of Statement 109, 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 enacted 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, amortization of intangibles and allowances for credit losses. STATEMENT OF CASH FLOWS The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The Company foreclosed on, or repossessed, property used to collateralize loans receivable in the amount of $3,362,000 in 1994, $3,955,000 in 1995, and $4,452,000 in 1996. The Company sold real estate held for sale by issuing loans to the buyers in the amount of $611,000 in 1994, $689,000 in 1995, and $40,000 in 1996. The Company paid income taxes of $214,000 in 1994, $267,000 in 1995, and $322,000 in 1996. The Company paid interest of $5,967,000 in 1994, $8,397,000 in 1995, and $11,046,000 in 1996. ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses is based on management's ongoing evaluation of the serviced 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 current economic conditions, prior loan loss experience, the composition of the serviced loan portfolio, and management's estimate of anticipated credit losses, including obligations relating to loans securitized. 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 possible losses in the serviced 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. -10- 52 ACCOUNTING FOR IMPAIRED LOANS When an impaired loan is identified by the portfolio management department of the Company to have risk characteristics that are unique to an individual borrower, the Company assesses a specific allowance on a loan-by-loan basis each month. The general allowance is calculated on a monthly basis using historical statistics. Effective January 1, 1995, the Company adopted SFAS 114, Accounting by Creditors for Impairment of a Loan. SFAS 114 requires that the allowance for credit losses for impaired loans (as defined) be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The adoption of SFAS 114 had no effect on net income or shareholders' equity. The Company's policy is to evaluate impaired loans based on the fair value of the collateral, since all loans originated by the Company are collateral dependent. Interest income from impaired loans is recorded using the cash collection method. REAL ESTATE AND PERSONAL PROPERTY ACQUIRED THROUGH FORECLOSURE Real estate and personal property acquired through foreclosure represent properties foreclosed upon or repossessed in the normal course of business and is valued at the lower of cost or fair value, less selling costs. Costs related to the development and improvement of the properties are capitalized whereas those costs relating to holding the properties are charged to expense. 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 1994, 1995, or 1996. INTEREST INCOME Interest income on loans receivable is recognized using the interest method. Accrual of interest is discontinued when a loan is over 90 days past due and the collateral is determined to be inadequate or when foreclosure proceedings begin. Loan fees and insurance commissions are amortized into income over the life of the loan, using the interest method for loans originated for investment purposes. Loan fees and insurance commissions are recognized into income on the note date for loans originated with intent to sell. GAIN ON SALE OF LOANS Mortgage loans consist principally of first and second residential mortgages and are stated at the principal amount outstanding, if held for investment purposes. Non-refundable loan fees and direct costs associated with the origination or purchase of loans are deferred and netted against outstanding loan balances. Mortgage loans held for sale are carried at the lower of aggregate cost or market. Mortgage loans are sold servicing released and on a non-recourse basis, with customary representations and warranties. In connection with the sale of mortgage loans, the Company receives cash premiums generally ranging from 4% to 8% of the principal amount of the mortgage loan being sold. -11- 53 Under the terms of the Company's strategic alliance mortgage banker agreements, the Company provides funding and secondary marketing activities for its strategic alliance partners ("Strategic Alliance Partner"). In exchange, the Strategic Alliance Partners agree to provide the Company with all of their mortgage loan production that meets the Company's underwriting criteria. The premiums earned on the secondary market are then split between the Company and its Strategic Alliance Partner. The terms of these agreements range from 3 to 5 years. In the event the Strategic Alliance Partner terminates the agreement early, the contract provides for a termination fee equal to, at a minimum, all of the premium income shared by the Strategic Alliance Partner over the last twelve months. This termination fee is considered to be a recoupment of previously shared premiums, and accordingly is included in gain on sale of loans in the Statements of Income. For the year ended December 31, 1996, two Strategic Alliance Partners terminated their agreements early. Accordingly, the Company has recognized $7,337,000 in gain on sale of loans in 1996 relating to these terminations. Loans sold through securitizations with servicing retained are sold at or near par with the Company retaining a participation in the cash flows. Excess servicing receivable is calculated using prepayments, default, and interest rate assumptions that market participants would use for similar instruments. The Company sells participations representing the SBA-guaranteed portion of all of its SBA Loans (the "SBA Loan Participations") in the secondary market. In connection with such sales, the Company receives excess servicing revenue and typically receives a cash premium of approximately 10% related to the guaranteed portion being sold. In accordance with Emerging Issues Task Force ("EITF") 88-11, a portion of the cash premium received from the sale of the guaranteed portion of the SBA loan is deferred as an unearned discount against the remaining unguaranteed portion of the loan based on the relative fair values of those portions to the total loan and the remainder is recognized as income at the time of the sale. The resulting unearned discount is accreted into interest income over the life of the loan using the interest method. The excess servicing receivable recognized at the time of sale does not exceed that amount which would be received if it were sold in the marketplace. The excess servicing receivable is written down to the present value of the remaining estimated future cash flows exceeding normal servicing fees at each balance sheet date using the same discount rate used in the original calculation. The Company's normal servicing fees from its securitization transactions are recognized over the life of the related transaction. ADVERTISING EXPENSE Advertising, promotional, and other business development costs are generally expensed as incurred. External costs incurred in producing media advertising are expensed the first time the advertising takes place. External costs relating to direct mailing costs are expensed in the period in which the direct mailings are sent. Advertising, promotional, and other business development costs of $626,000, $653,000, and $1,603,000 were included in the Company's results of operations for 1994, 1995, and 1996, respectively. STARTUP COSTS One-time, non-recurring, and incremental out-of-pocket expenditures directly related to and incurred during the startup phase of geographic expansions are expensed as incurred rather than deferred and amortized over future periods. Startup costs of $94,000, $250,000, and $3,017,000 were included in the Company's results of operations for 1994, 1995, and 1996, respectively. -12- 54 REMITTANCES PAYABLE AND SERVICING FEE INCOME The Company retains the servicing rights on SBA guaranteed loan participations sold in the secondary market, for which it earns monthly a minimum of 1% of the outstanding principal balance. The Company receives the payments from the borrowers and records the portion relating to the sold participation as a liability. The participation portion is remitted to Colson Services Corp., the exclusive Fiscal and Transfer Agent for the guaranteed portion of SBA loans sold in the secondary market, by the 3rd business day of the following month. The Company also retains the servicing rights on its securitization transactions. The Company receives the payments from the borrowers and records a liability until the funds are remitted to the Trustee. MANAGEMENT FEES The Company serves as investment manager for a venture capital fund and a mezzanine level fund for which it receives management fees. The Company recognizes the management fees on the accrual basis. EXCESS SERVICING RECEIVABLE An excess servicing receivable is recognized on loan sales in which a servicing fee in excess of the normal servicing fee is retained. The amount is determined based on the difference between the actual sales price and the estimated sales price that would have been obtained if a normal servicing fee rate had been specified. The excess servicing receivable is amortized on a loan by loan basis against servicing income over the life of the loan using the interest method. (Note 4) BORROWER COMMITMENT DEPOSITS The Company generally receives a commitment deposit from its applicants for SBA loans prior to closing. The commitment deposits are recorded as a liability when received, and are reduced for any direct expenses incurred and paid to a third party in making the loan. Any deposit in excess of these direct expenses is refunded to the borrower at the time of, or subsequent to, the loan closing. Borrower commitment deposits are included in accrued liabilities. EARNINGS PER SHARE The Company's shareholders approved a one-for-three reverse split of the Company's Common and Class A Common Stock in June 1995. Effective January 29, 1996, the Company declared a two-for-one stock split effected in the form of a 100% stock dividend on the Common Stock and Class A Common Stock. The weighted average number of shares of Common and Class A Common Stock have been restated for all periods presented to reflect these stock splits. In 1996, the Company's shareholders approved the conversion of all Class A Common Stock to Common Stock on a one-for-one basis. Accordingly, at December 31, 1996, there was no Class A Common Stock outstanding. Earnings per share are based on the weighted average number of common shares outstanding during the year, adjusted for the assumed conversion of dilutive stock options and warrants. In computing the per share effect of assumed conversion, funds which would have been received from the exercise of options and warrants are considered to have been used to purchase common shares at current market prices, and the resulting net additional common shares are included in the calculation of average common shares outstanding. -13- 55 Earnings per share is computed on the weighted average number of shares of Common Stock and Class A Common Stock and common stock equivalents outstanding during each year. 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. 2. CASH AND CASH EQUIVALENTS AND RESTRICTED CASH The Company maintains its primary checking accounts with three principal banks and maintains overnight investments in reverse repurchase agreements with those same banks. The amounts maintained in the checking accounts are insured by the Federal Deposit Insurance Corporation ("FDIC") up to $100,000. At December 31, 1995 and 1996, the amounts maintained in the overnight investments in reverse repurchase agreements, which are not insured by the FDIC, totaled $791,000 and $282,000, respectively. These investments were collateralized by U. S. Government securities pledged by the banks. The Company also maintains cash collateral and collection accounts with a trustee in connection with its securitizations. These accounts are shown as restricted cash, and are invested in overnight investments or short-term U.S. Treasury securities. 3. LOANS RECEIVABLE AND MORTGAGE LOANS HELD FOR SALE The following is a summary of loans receivable by type of loan, including mortgage loans held for sale:
December 31, ------------------------ 1995 1996 ---------- ---------- (in thousands) Mortgage Loans: First mortgage residential property $ 72,995 $ 107,246 Second mortgage residential property 6,683 28,090 Real estate loans on rental property 3,867 894 Construction loans 2,934 5,038 ---------- ---------- Total mortgage loans 86,479 141,268 ---------- ---------- Commercial Loans: Guaranteed portion of SBA loans 11,045 9,662 Unguaranteed portion of SBA loans 7,110 10,503 Commercial loans secured by real estate 1,782 2,253 Asset-based commercial lending -- 6,967 ---------- ---------- Total commercial loans 19,937 29,385 ---------- ---------- Automobile loans 17,673 13,915 Other loans 2,369 4,964 ---------- ---------- Total loans receivable $ 126,458 $ 189,532 ========== ==========
-14- 56 Notes receivable from related parties of $363,000 and $1,069,000 at December 31, 1995 and 1996, respectively, are included in the above table. Notes receivable from related parties included advances of $261,000 in 1995 and $736,000 in 1996 and repayments of $67,000 in 1995 and $30,000 in 1996. First mortgage residential loans generally have contractual maturities of 12 to 360 months with an average interest rate at December 31, 1995 and 1996 of approximately 12%. Second mortgage residential loans generally have contractual maturities of 12 to 360 months with an average interest rate at December 31, 1995 and 1996 of approximately 15%. Construction loans generally have contractual maturities of 12 months with an average interest rate at December 31, 1995 and 1996 of approximately 12%. SBA loans range in maturity from 7 years to 25 years depending on the use of proceeds. Interest rates on SBA loans are variable, adjusted on the first day of each calendar quarter and are generally prime plus 2.75%. The average interest rate at December 31, 1995 and 1996 for SBA loans was 10% and 10.5%, respectively. Asset-based commercial loans generally are due on demand and have average interest rates of approximately 24%. Automobile loans have maturities generally not exceeding 60 months with fixed interest rates averaging 28% in 1995 and 27% in 1996. At December 31, 1995 and 1996, approximately $3,950,000 (net of an allowance for impaired loans of $73,000) and $3,334,000 (net of an allowance for impaired loans of $576,000), respectively, of loans receivable were impaired. Impaired loans are considered to be those loans for which it is probable that the Company will be unable to collect all amounts due according to original contractual terms of the loan agreement, based on current information and events. Loans sold and serviced for others at December 31, 1995 and 1996 were approximately $88,077,000 and $119,541,000, respectively, and are not included in assets in the accompanying balance sheets. At December 31, 1995 and 1996, mortgage loans totaling $9,890,000 and $56,901,000, respectively, had been sold but not settled, and accordingly are included in the accompanying balance sheet in mortgage loans held for sale. At December 31, 1995 and 1996, guaranteed portions of SBA loans totaling $5,400,000 and $4,387,000, respectively, had been sold but not settled, and accordingly are included in the accompanying balance sheet in loans receivable. The Company's portfolio of commercial loans receivable is diversified by industry type. At December 31, 1996, the Company's serviced commercial loan portfolio consisted of loans to small businesses in the following industries (in thousands): Limited service lodging $ 40,861 29.02% Retail trade 33,573 23.84% Services 23,869 16.95% Manufacturing 19,478 13.83% Wholesale distribution 10,527 7.48% Other 12,501 8.88% ======== ======== $140,809 100.00% ======== ========
-15- 57 The Company's serviced loan portfolio at December 31, 1996, consisted of loans to borrowers in the following states (in thousands):
Mortgage Commercial Auto Total Percent ----------- ----------- ----------- ----------- ----------- South Carolina $ 64,763 $ 24,169 $ 21,480 $ 110,412 35.72% North Carolina 29,279 5,399 195 34,873 11.28% Florida 4,410 24,415 39 28,864 9.34% Colorado 2,201 18,039 2 20,242 6.55% Indiana 7,210 -- 4 7,214 2.33% Louisiana 5,088 3,608 8 8,704 2.82% Kansas -- 18,682 -- 18,682 6.04% Georgia 8,217 18,040 129 26,386 8.54% Texas 42 5,353 13 5,408 1.75% Michigan 8,840 -- 2 8,842 2.86% Tennessee 6,143 -- 34 6,177 2.00% Other 10,038 23,104 127 33,269 10.77% =========== =========== =========== =========== =========== Total $ 146,231 $ 140,809 $ 22,033 $ 309,073 100.00% =========== =========== =========== =========== ===========
An analysis of the allowance for credit losses is as follows:
Years Ended December 31, ----------------------------------------- 1994 1995 1996 ----------- ----------- ----------- (in thousands) Balance at beginning of year $ 952 $ 1,730 $ 2,647 Provision for credit losses 2,510 2,480 5,416 Net charge offs (1,732) (1,563) (3,777) ----------- ----------- ----------- Balance at end of year $ 1,730 $ 2,647 $ 4,286 =========== =========== ===========
The total allowance for credit losses and recourse obligations as shown on the balance sheet is as follows:
December 31, ------------------------ 1995 1996 ---------- ---------- (in thousands) Allowance for credit losses on loans 1,874 3,084 Allowance for losses on excess servicing receivable -- 848 Allowance for losses on asset-backed securities 773 354 ---------- ---------- Total allowance for credit losses $ 2,647 $ 4,286 ========== ==========
As of December 31, 1994, 1995, and 1996, loans totaling $1,433,000, $5,145,000, and $4,922,000, respectively, were on non-accrual status. The associated interest income not recognized on these non-accrual loans was approximately $45,000 during 1994, $164,000 during 1995, and $593,000 during 1996. -16- 58 4. EXCESS SERVICING RECEIVABLE The activity in the excess servicing receivable is summarized as follows:
Years Ended December 31, ------------------------ 1994 1995 1996 ---- ---- ---- (in thousands) Gross balance, beginning of year $ 412 $1,872 $2,054 Additional gain on sale of loans 1,942 1,095 4,770 Amortization against servicing revenues (482) (913) (1,661) ------ ------ ------ Gross balance, end of year 1,872 2,054 5,163 Less allowance for losses on excess servicing receivable -- -- (848) ------ ----- ------ Excess servicing receivable, net $1,872 $2,054 $4,315 ====== ====== ======
The weighted average interest rate inherent in the carrying value of the excess servicing receivable is 10% at December 31, 1996. During 1994, the Company changed its estimated normal servicing rate for its SBA loans to more closely reflect the industry standard in accordance with Emerging Issues Task Force Consensus 94-9. The effect of this change was to increase 1994 income by approximately $490,000. The carrying value of the excess servicing receivable approximates fair value. The allowance represents potential credit losses in the securitized pool which may be incurred by the Company as a result of its investment being subordinate to the interests of the Class A certificate holders. 5. INVESTMENT IN ASSET-BACKED SECURITIES In June 1995 and November 1996, the Company securitized $17,063,000 and $12,851,000, respectively, of the unguaranteed portions of its SBA loans. In March of 1996, the Company securitized $16,107,000 of its auto loans. The securitizations were effected through a grantor trust (the "Trust"), the ownership of which was represented by Class A and Class B certificates. The Class A certificates were purchased by investors, while the Company retained the Class B certificates. The Company classifies its Class B certificates as trading securities under SFAS 115, and they are carried at fair market value. These certificates are carried on the balance sheet as asset-backed securities in the net amount of $865,000 and $3,581,000 at December 31, 1995, and 1996, respectively. This amount is net of an allowance for credit losses of $773,000 and $354,000 at December 31, 1995, and 1996, respectively. The allowance represents potential credit losses in the securitized pool which may be incurred by the Company as a result of its investment being subordinate to the interests of the Class A certificate holders. These certificates give the holders thereof the right to receive payments and other recoveries attributable to the unguaranteed portion of SBA loans and auto loans held by the respective Trust. The Class B certificates represent approximately 9% and 10%, respectively, of the principal amount of the SBA and auto loans transferred in the securitizations and are subordinate in payment and all other respects to the Class A certificates. In the event that payments received by the Trusts are not sufficient to pay certain expenses of the Trusts and the required principal and interest payments due on the Class A certificates, the Company, as holder of the Class B certificates, would not be entitled to receive principal or interest payments due thereon. Although securitizations provide liquidity, the Company has utilized securitizations principally to provide a lower cost of funds and to reduce interest rate risk. -17- 59 The Company serves as master servicer for both of the Trusts and, accordingly, forwards payments received on account of the SBA loans held by the Trust to the trustee, which, in turn, pays the holders of the certificates in accordance with the terms of and priorities set forth in the securitization documents. Because the transfers of the loans to the Trusts constituted sales of the underlying loans, no liability was created on the Company's Consolidated Financial Statements. However, the Company has the obligation to repurchase individual loans from the Trusts in the event that certain representations made with respect to that transferred loan is breached or in the event of certain defaults by the Company, as master servicer. To date the Company has not been required to repurchase any SBA or auto loans from the Trusts under this provision. The Class A certificates for the first SBA loan securitization and the auto loan securitization received a rating of AAA from Moody's Investors Service, Inc. In addition, the Class A certificates for the auto loan securitization received a rating of AAA from Standard and Poor's ratings group, and were guaranteed by Financial Security Assurance, Inc. The Class A certificates for the second SBA loan securitization received a rating of Aa2 from Moody's Investors Service, Inc. The Class B certificates were not rated for any of the securitization transactions. In connection with the SBA and auto loan securitizations, the Company received cash proceeds, net of securitization costs, of $15,357,000 and $30,128,000 in 1995 and 1996, respectively. The 1996 SBA securitization transaction included a prefunding account of approximately $4,649,000, for which additional loans can be placed into the Trust prior to January 31, 1997. On January 23, 1997, loans totaling $4,626,000 were placed into the Trust, for which the Company received proceeds of $4,626,000 and a retained interest in Class B certificates of $416,000. 6. PROPERTY AND EQUIPMENT The following is a summary of property and equipment:
December 31, ------------ 1995 1996 ---- ---- (in thousands) Land $ 228 $ 279 Buildings and leasehold improvements 1,162 1,279 Equipment 264 4,345 Furniture and fixtures 2,673 2,766 Vehicles -- 206 ------ ------ Total property and equipment 4,327 8,875 Less accumulated depreciation (957) (1,698) ------ ------ Net property and equipment $3,370 $7,177 ====== ======
Depreciation expense was $694,000, $769,000, and $901,000 in 1994, 1995, and 1996, respectively. 7. REAL ESTATE AND PERSONAL PROPERTY ACQUIRED THROUGH FORECLOSURE An analysis of real estate and personal property acquired through foreclosure is as follows:
December 31, ------------ 1995 1996 ---- ---- (in thousands) Balance at beginning of year $3,603 $3,742 Loan foreclosures and improvements 4,160 4,782 Dispositions, net (4,021) (3,804) ------ ------ Balance at end of year $3,742 $4,720 ====== ======
-18- 60 8. NOTES PAYABLE TO BANKS Notes payable to banks are summarized as follows:
December 31, -------------------------- 1995 1996 ---- ---- (in thousands) A. Notes payable under revolving credit agreements, with interest at the bank's prime rate (8.25% at December 31, 1996) maturing March 31, 1997 $ 6,892 $46,774 B. Notes payable under lines of credit, with interest at the bank's prime rate plus 3/4% ( 9.00% at December 31, 1996) maturing in December 1997 9,911 -- C. Notes payable under lines of credit, with interest at the bank's prime rate (8.25% at December 31, 1996) maturing December 29, 1998 14,830 8,720 ------- ------- $31,633 $55,494 ======= =======
A. Under the terms of revolving credit agreements, the mortgage lending subsidiaries of the Company may borrow up to a maximum of $90,000,000 with interest at the bank's prime rate payable monthly. The note is collateralized by loans receivable. The agreements require, among other matters, a specified debt to net worth ratio, a minimum tangible net worth and limitations on the payment of dividends. Management believes the Company is in substantial compliance with such restrictive covenants. The revolving credit agreements mature on April 4, 1997. At December 31, 1996, $14,232,000 was available under these lines of credit. B. Under the terms of the lines of credit, the automobile lending subsidiaries of the Company may borrow up to a maximum of $26,000,000 with interest at the bank's prime rate plus three-quarters of one percent payable monthly. The notes are collateralized by loans receivable. The terms of the agreements state that advances under the lines of credit cannot exceed 85% of the aggregate unpaid principal balance of outstanding notes receivable, which are no more than sixty days past due. This advance rate is reduced based on delinquency and loss levels exceeding certain target levels and at December 31, 1996, the advance rate on the $20,000,000 line of credit for one of the automobile lending subsidiaries was reduced to 71%, while the advance rate remained 85% on the $6,000,000 line of credit for the other automobile lending subsidiary. The agreements require, among other matters, minimum debt to tangible net worth ratios, minimum interest coverage ratios, minimum loss reserves, maximum debt to borrowing base restrictions, and restrictions on the payment of dividends. At December 31, 1996, one of the Company's automobile lending subsidiaries exceeded the maximum delinquency levels permitted under the $20,000,000 agreement. In addition the Company's automobile lending subsidiaries were also in violation of the minimum interest coverage ratio. The Bank has provided a waiver to the Company's automobile lending subsidiaries for the above violations. At December 31, 1996, no amounts were owed under these lines of credit, and $9,778,403 was available under these lines of credit. These agreements mature in December 1997. -19- 61 C. Under the terms of the lines of credit, the commercial lending subsidiaries of the Company may borrow up to a maximum of $40,000,000 with interest at the bank's prime rate. The lines are limited to 100% of the outstanding balance of the guaranteed portion of SBA 7(a) loans, 80% of the outstanding balance of the unguaranteed portion of SBA 7(a) loans, 80% of asset-based loans, and 50% of SBA 504 loans as defined in the loan agreements. The agreements require, among other matters, minimum tangible net worth ratios, maximum ratios of total liabilities to tangible net worth, minimum interest coverage ratios, limitations on the amount of capital expenditures in any fiscal year, and restrictions on the payment of dividends. At December 31, 1996, management believes these subsidiaries were in substantial compliance with such restrictive covenants and $13,662,000 was available under these lines of credit. These agreements mature in December, 1998. Annual aggregate maturities of notes payable at December 31, 1996 are as follows (in thousands): 1997 $46,774 1998 8,720 ------- $55,494
9. SUBORDINATED INVESTOR SAVINGS Subordinated investor savings are summarized as follows:
December 31, 1995 1996 (in thousands) A. Notes payable to investors $82,132 $ 97,987 B. Subordinated debentures 16,185 16,115 ------- -------- $98,317 $114,102 ======= ========
A) Notes payable to investors are issued by a subsidiary company, Carolina Investors, Inc. ("CII"), in any denomination greater than $10,000 and are registered under the South Carolina Uniform Securities Act. The notes mature from one to three years from date of issuance. Interest is payable monthly, quarterly or at maturity at the option of the investors. Interest rates on the notes are fixed until maturity and range from 7% to 9% at December 31, 1995, and 5% to 9% at December 31, 1996. The notes are subordinated to all bank debt, and are senior to the subordinated debentures. B) 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 normally mature in one year from date of issuance and have an interest rate ranging from 5% to 6% quarterly. The debentures are subordinated to all bank debt and notes payable to investors. At December 31, 1995 and 1996, notes payable to investors and subordinated debentures include an aggregate of approximately $17,080,000 and $21,039,000, respectively, of individual investments exceeding $100,000. -20- 62 The investor savings at December 31, 1996 mature as follows: (in thousands) -------------- 1997 $110,441 1998 3,648 1999 13 -------- $114,102 ========
10. LEASES The Company leases various property and equipment, office space and automobiles under operating leases. The following is a schedule by year of future minimum rental payments for all operating leases that have initial or remaining noncancellable terms in excess of one year (in thousands):
1997 $1,689 1998 1,433 1999 1,144 2000 892 2001 615 2002 15 ----- $5,788 ======
Total rental expense was approximately $974,000 in 1994, $901,000 in 1995 and $843,000 in 1996. 11. MANAGEMENT AGREEMENTS The Company manages a venture capital fund and a mezzanine level fund. The Company receives management fees equal to two and one-half percent of the total assets under management in each fund with a current aggregate minimum management fee of $445,000 annually. The Company received management fees of $320,000, $570,000, and $514,000 from the managed funds during 1994, 1995, and 1996 respectively. The Company may also receive incentive management fees of 15% and 20%, respectively, from the managed funds of the net portfolio profits of each managed fund, as defined. The Company is a General Partner of one of the Venture Funds and, during 1995, made a $1,000,000 investment into the partnership. This partnership has significant common principals with the Company. 12. SHAREHOLDERS' EQUITY The Company has one class of capital stock: Common Stock. On May 21, 1981, the shareholders approved a 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 shares are available for grant under this stock option plan, and there are 89,342 unexercised options outstanding at December 31, 1996, of which 8,672 are exercisable. -21- 63 On June 9, 1995, the shareholders approved a stock option plan under which the Board of Directors may issue 566,668 shares of common stock. Under the terms of the plan, the Company may grant options to key employees to purchase up to a total of 566,668 shares of its $.05 par value common stock. The option price is the fair market value at date of grant. Prices for incentive stock options granted to employees who own 10% or more of the Company's stock are at 110% of market value at date of grant. The options expire five to 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 152,667 common stock options at December 31, 1996, and there are 391,636 unexercised options outstanding at December 31, 1996, of which 88,303 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. 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 26,673 common stock options at December 31, 1996, and there are 6,660 unexercised options outstanding at December 31, 1996, of which 1,998 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 which 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, 1996, there were 10,500 options granted under this plan. 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. The Company offered to buy from the shareholders up to 1,000,000 shares of common stock for the period March 31, through May 8, 1995 at a price of $1.15 per share. As a result of this offer, the Company purchased 486,665.34 shares of common stock at an aggregate cost of approximately $560,000. On June 9, 1995 the shareholders of the Company approved a one-for-three reverse split of the Common Stock. The certificates for previously issued common stock were canceled and were forfeited by the holder in order for the holder to receive replacement certificates for the after reverse split shares. The shareholders also authorized the increase of post reverse split authorized shares of common stock to 4,000,000 shares. The Company issued to all shareholders certificates for one-third of their common shares as of June 9, 1995, upon the shareholder presenting their existing shares. No fractional shares were issued as a result of the one-for-three reverse stock split. All fractional shares were redeemed at an equivalent price of $1.25 per share. The Articles of Incorporation of the Company were amended by vote of the shareholders at the Annual Meeting of Shareholders on April 18, 1996. The Class A Common Stock, $0.05 par value, was converted to common stock on a one-for-one basis effective April 19, 1996. All authorized but unissued shares of Class A Common Stock were canceled. The number of authorized shares of common stock was increased from 4,000,000 to 30,000,000 shares. -22- 64 The Company filed a registration statement with the Securities and Exchange Commission on September 20, 1996, for the issuance of 3,000,000 shares of common stock of which 2,119,031 shares were offered by the Company and 880,969 shares were offered by certain selling shareholders. No officers or directors of the Company sold any shares in connection with the offering. The offering was effective on November 8, 1996, as the Company's common stock was listed on the NASDAQ Stock Market's National Market under the trading symbol, "EMER." On December 11, 1996, the underwriters of the public offering exercised the option to purchase an additional 400,000 shares of common stock in accordance with the terms of the registration statements. Total gross proceeds of approximately $28,969,000 were raised as a result of the issuance of stock, which was offset by approximately $2,769,000 in costs and expenses relating to the transaction. Activity in stock options is as follows:
Years Ended December 31, ------------------------ 1994 1995 1996 ---- ---- ---- Options outstanding, beginning of year 133,333 140,000 339,000 Issued at: Date of Grant $1.0825 per share 2-17-94 40,000 -- -- $l.32 per share 1-13-95 -- 80,006 -- $4.625 per share 10-31-95 -- 124,000 -- $5.09 per share 10-31-95 -- 32,000 -- $9.435 per share 12-18-95 -- 2,664 -- $10.38 per share 12-18-95 -- 666 -- $12.25 per share 11-11-96 -- -- 258,000 $11.25 per share 12-15-96 -- -- 3,330 ------ ------ ------ Total Granted 40,000 239,336 261,330 Exercised: Expired or canceled (33,333) -- -- $1.0825 per share -- (29,800) (74,197) $1.32 per share -- (1,336) (29,335) $4.625 per share -- (3,200) (9,160) $5.09 per share -- (6,000) -- ------- ------- ------- Total exercised, expired or cancelled (33,333) 40,336 112,692 ------- ------- ------- Options outstanding, end of year 140,000 339,000 487,638 ======= ======= ======= Exercisable, end of year 56,000 83,532 98,973 ======= ======= ======= Available for grant, end of year 82,667 440,671 179,340 ======= ======= =======
At December 31, 1995, 121,742 warrants were outstanding; 111,932 of these warrants were exercised during 1996 for $2.625 per share. The remaining warrants expired as of December 31, 1996. No warrants are outstanding at December 31, 1996. -23- 65 The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation cost has been recognized for the stock option plans. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date for awards in 1995 and 1996 consistent with the provisions of SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
1995 1996 ----------------------------------------- (In thousands, except per share data) Net income - as reported $657 $10,095 Net income - pro forma 616 9,875 Earnings per share - as reported 0.10 1.42 Earnings per share - pro forma .09 1.39
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: dividend yield of 0%, expected volatility of 45.0%; risk-free interest rate of approximately 6.3%, and expected lives of 3 years. The proforma amounts disclosed above may not be representative of the effects on reported net income for future periods. The Company plans to implement an Employee Stock Purchase Plan ("ESPP") in 1997. The ESPP will allow eligible employees the right to purchase common stock on a semi-annual basis at 85% of the lower of the market price at the beginning or ending of each six-month offering period. The ESPP will operate on a calendar basis beginning February 1, 1997. A liability will be recorded for ESPP withholdings not yet applied towards the purchase of common stock. The Company's Board of Directors has approved the reservation of 200,000 shares to be issued under the ESPP, subject to shareholder approval at the Company's annual meeting on May 22, 1997. 13. SALE OF SUBSIDIARY In connection with the Company's strategic plan to focus its business efforts on financial services, the Company divested its apparel segment operations, which was comprised solely of the operations of Young Generations, Inc. ("YGI"). On September 30, 1995, the Company sold all of the outstanding stock (the "stock sale") of YGI to fifteen individuals (the "Buyers"), who were members of YGI's management team. As a result, the loss on the sale of the stock and operating results of the apparel segment have been classified as discontinued operations. The results of operations for 1994 have been restated to exclude the Apparel Manufacturing segment from continuing operations. The Company sold the stock for $600,000 under a non-recourse promissory note from the buyers. As a result of the sale, the Company wrote-off all amounts due from YGI resulting in a charge of $3,580,300, net of income taxes of $67,700, reported as a loss from discontinued operations. The Company remains contingently liable for the guaranty of certain bank loans and trade accounts payable which existed prior to the stock sale which do not exceed $396,000. Management does not anticipate any significant charges to future earnings as a result of these guarantees. -24- 66 The apparel segment, which consists solely of the operations of YGI, had net losses of $31,000 in 1994 and $1.3 million for the nine months ended September 30, 1995. The net loss in 1994 was decreased by the receipt of $1.25 million in life insurance proceeds due to the death of YGI's president. YGI had revenues of $12.2 million in 1994 and $7.3 million for the nine months ended September 30, 1995. 14. DISCONTINUED OPERATIONS The Company's operations in the Apparel and Transportation segments were discontinued during 1995. The sale of the apparel segment is discussed further in Note 13. In July 1994 the Company sold an operating railroad for $940,000. In connection with this sale, the Company received $20,000 cash, and a note receivable of $920,000, payable in semi-annual payments over five years, with an interest rate of 10%. In November 1994, the Company assigned the rights to boxcars in a lease with a Class I railroad for $1,174,000 cash. The Company sold additional railcars in June 1995 for $111,000 cash. At December 31, 1995, the Company had remaining net assets in the transportation segment of $77,000, the majority of which the Company sold during 1996. The results of operations for 1994 have been restated to exclude these segments from continuing operations. Revenues applicable to the discontinued operations were:
Years Ended December 31, --------------------------------- 1994 1995 1996 ---- ---- ---- (in thousands) Apparel manufacturing $12,140 $7,263 $-- Transportation 1,407 390 --
Income from operations and gain (loss) on disposal attributable to the discontinued segments is reported net of income tax expense of:
Years Ended December 31, --------------------------------- 1994 1995 1996 ---- ---- ---- (in thousands) Apparel manufacturing $(158) $ (22) $-- Transportation 306 (53) --
Net assets of discontinued operations were comprised of the following:
December 31, -------------------- 1995 1996 ---- ---- (in thousands) Assets: Property and equipment, net $153 $ -- Other assets 80 -- ---- ---- 233 -- Liabilities: Other liabilities 156 -- ---- ---- Net assets of discontinued operations $ 77 $ --
-25- 67 Gain (loss) from operations, net of income tax, consists of the following:
Years Ended December 31, ---------------------------------- 1994 1995 1996 ---- ---- ---- (in thousands) Apparel manufacturing segment $(1,949) $(1,253) $ -- Transportation segment (73) (320) -- ------- ------- ---- $(2,022) $(1,573) $ -- ======= ======= ====
Gain (loss) on disposal of segments, net of income taxes, consists of the following:
Years Ended December 31, ---------------------------------- 1994 1995 1996 ---- ---- ---- (in thousands) Apparel manufacturing segment $ -- $(2,324) $ -- Transportation segment 2,568 (27) -- ------ ------- ---- $2,568 $(2,351) $ -- ====== ======= ====
15. INCOME TAXES Total income tax expense was allocated as follows:
Years Ended December 31, ---------------------------------- 1994 1995 1996 ---- ---- ---- (in thousands) Income from continuing operations $609 $ 190 $718 Discontinued operations 148 (75) -- ---- ----- ---- $757 $(115) $718 ==== ===== ====
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 and minority interest are as follows:
Years Ended December 31, ------------------------ 1994 1995 1996 ---- ---- ---- (in thousands) Statutory Federal rate of 34% applied to pre-tax income from continuing operations before minority interest $832 $1,650 $ 3,557 State income taxes, net of federal income tax benefit 311 3 350 Change in the beginning of the year balance of the valuation allowance for deferred tax assets allocated to income tax expense (630) (1,566) (3,229) Alternative Minimum Tax on proceeds from life insurance 25 -- -- Nondeductible expenses 3 5 17 Amortization of excess cost over net assets of acquired businesses 69 62 64 Other, net (1) 36 (41) ---- ------ ------- $609 $ 190 $ 718 ==== ====== =======
-26- 68 Provision (benefit) for income taxes from continuing operations is comprised of the following:
Years Ended December 31, ------------------------ 1994 1995 1996 ---- ---- ---- (in thousands) Current Federal $117 $100 $199 State and local 149 49 660 ---- ---- ---- 266 149 859 Deferred Federal 242 27 (11) State and local 101 14 (130) ---- ---- ---- 343 41 (141) Total Federal 359 127 188 State and local 250 63 530 ---- ---- ---- $609 $190 $718 ==== ==== ====
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 carryforwards. The tax effects of significant items comprising the Company's net deferred tax asset are as follows:
December 31, -------------- 1995 1996 ---- ---- Deferred tax liabilities: (in thousands) Differences between book and tax basis of property $ (269) $ (372) ------- ------ Deferred tax assets: Differences between book and tax basis of deposit base intangibles 165 205 Allowance for credit losses 1,202 1,672 Write-off of notes receivable 1,386 -- AMT credit carryforward 367 568 Operating loss carryforward 7,700 4,590 Unrealized gain on loans to be sold 382 1,182 ------- ------ Total gross deferred tax assets 11,202 8,217 Less valuation allowance (10,737) (7,508) ------- ------ Net deferred tax asset $ 196 $ 337 ======= ======
-27- 69 The valuation allowance consists of Alternative Minimum Tax Credit carryforwards, net operating loss carryforwards, and deductible temporary differences primarily for Federal income tax purposes. Management believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize net deferred tax assets. As of December 31, 1996, the Company has available Federal net operating loss ("NOL") carryforwards of approximately $13,500,000 expiring in 1997 through 2001. There are no known significant pending assessments from taxing authorities regarding taxation issues at the Company or its subsidiaries. 16. OPERATIONS AND INDUSTRY SEGMENTS The Financial Services segment was active in 1994, 1995 and 1996 in originating selling and servicing first and second mortgage loans, commercial loans, and pre-owned automobile loans. The Apparel Manufacturing segment was active in 1994 in the design, manufacture and marketing of dresses for children. The Company sold YGI, the sole component of the segment as of September 30, 1995 and as a result, the Apparel Manufacturing segment is shown on the statements of income as discontinued operations. The Transportation segment was active in 1994 in boxcar leasing, short-line railroad operations and railcar repair shop operations. The Company sold Peninsula Terminal Company in July 1994 and assigned the rights to boxcars in the lease with a Class I railroad in November 1994. The Company sold additional railcars in 1995 and as a result, the Transportation segment is shown on the statements of income as discontinued operations. The Company's customers include investors within the State of South Carolina, first and second residential mortgage borrowers throughout the United States, commercial borrowers throughout the United States and preowned automobile borrowers principally in South Carolina. -28- 70 17. SUPPLEMENTAL QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The quarterly results of operations for the year ended December 31, 1996, are as follows:
Quarter Ended ------------------------------------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, 1996 1996 1996 1996 -------------- ----------------- ------------------ ----------------- (in thousands, except share data) REVENUES: Interest income $ 4,324 $ 4,051 $ 4,219 $ 5,314 Servicing income 536 1,027 924 787 Gain on sale of loans 3,018 4,450 7,870 8,478 Loan fee and other income 404 498 1,557 2,931 --------------- ----------------- ---------------- -------------- Total Revenues 8,282 10,026 14,570 17,510 EXPENSES: Interest 2,741 2,837 2,603 2,840 Provision for credit losses 911 621 1,569 2,315 General and administrative 3,227 4,395 6,058 9,811 --------------- ----------------- ---------------- -------------- Total expenses 6,879 7,853 10,230 14,966 --------------- ----------------- ---------------- -------------- Income before income taxes 1,403 2,173 4,340 2,544 Provision for income taxes (42) (77) (129) (470) Minority interest in earnings of subsidiaries (12) (10) 90 285 --------------- ----------------- ---------------- -------------- Net income $ 1,349 $ 2,086 $ 4,301 $ 2,359 =============== ================= ================ ============== Earnings per share $ .20 $ .31 $ .63 $ .29 =============== ================= ================ ============== Weighted average shares outstanding 6,735,996 6,785,457 6,777,439 8,100,302 =============== ================= ================ ==============
The quarterly results of operations for the year ended December 31, 1995, are as follows:
Quarter Ended ----------------------------------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, 1995 1995 1995 1995 --------------- ------------- ------------------ --- ----------------- (in thousands, except share data) REVENUES: Interest and servicing income $ 3,368 $ 3,939 $ 3,909 $ 4,423 Gain on sale of loans 1,220 3,135 2,224 2,590 Loan fee and other income 234 458 526 252 --------------- ----------------- ---------------- -------------- Total revenues 4,822 7,532 6,659 7,265 EXPENSES: Interest 1,727 2,053 2,161 2,586 Provision for credit losses 489 751 380 860 General and administrative 2,109 2,405 2,620 3,285 --------------- ----------------- ---------------- -------------- Total expenses 4,325 5,209 5,161 6,731 --------------- ----------------- ---------------- -------------- Income before income taxes 497 2,323 1,498 534 Provision for income taxes (4) (89) (87) (10) Minority interest in earnings of subsidiaries (8) (23) (35) (15) --------------- ----------------- ---------------- -------------- Income from continuing operations 485 2,211 1,376 509 Discontinued transportation and apparel manufacturing segments (316) (435) (2,728) (445) --------------- ----------------- ---------------- -------------- Net income (loss) $ 169 $ 1,776 $ (1,352) $ 64 =============== ================= ================ ============== Earnings (loss) per share: Continuing operations $ .07 $ .33 $ .21 $ .08 Discontinued operations (.05) (.06) (.41) (.07) --------------- ----------------- ---------------- -------------- Earnings (loss) per share $ .02 $ .27 $ (.20) $ .01 =============== ================= ================ ============== Weighted average shares outstanding 6,699,266 6,690,608 6,705,140 6,705,140 =============== ================= ================ ==============
-29- 71 18. TRANSACTIONS WITH RELATED PARTIES The Company engaged in the following related party transactions: The Company obtains legal services from a firm, certain members of which, when considered in the aggregate, may be deemed to beneficially own 596,351 shares of the Company's capital stock. Total charges for these services were $118,000 in 1994, $234,000 in 1995, and $756,000 in 1996. Approximately $17,000 in 1994, $0 in 1995 and $47,000 in 1996 of accounts payable are payable to this law firm. The Company provided management services to a mezzanine level small business investment company partnership fund with significant common shareholders for which it received fees of $35,000 in 1994, $250,000 in 1995, and $175,000 in 1996. Notes payable to investors and subordinated debentures include amounts due to officers, directors and key employees of approximately $791,000, $873,000, and $694,000 at December 31, 1994, 1995, and 1996, respectively. The Company also has notes receivable from related parties. (Note 3) 19. 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 provides for employee and Company contributions, subject to certain limitations. Company matching contributions are 35% of employee contributions to a maximum of 6% of compensation for each employee. The Company plans to increase its matching contribution to 50% in 1997. The Company's contributions under the plan totaled approximately $95,000 in 1994, $76,000 in 1995, and $60,000 in 1996. In 1997, the plan was amended to allow employees who have completed 30 days of service to participate in the plan, and the matching contribution was changed to 50%. 20. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1996, the FASB issued SFAS 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." FASB's objective is to develop consistent accounting standards for those transactions, including determining when financial assets should be considered sold and derecognized from the statement of financial position and when related revenues and expenses should be recognized. The approach focuses on analyzing the components of financial asset transfers and requires each party to a transfer to recognize the financial assets it controls and liabilities it has incurred and derecognize assets when control over them has been relinquished. The statement is not expected to have a significant impact on the accounting practices of the Company and is generally effective for transactions entered into after December 31, 1996. The Company will apply the new rules prospectively to transactions beginning in the first quarter of 1997. 21. CONTINGENCIES AND LOAN COMMITMENTS The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These instruments expose the Company to credit risk in excess of the amount recognized in the balance sheet. -30- 72 The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Total credit exposure at December 31, 1996 related to these items is summarized below:
Contract Amount ----------------- (in thousands) Loan commitments: Approved loan commitments $ 111,361 Unadvanced portion of loans 18,070 ----------------- Total loan commitments $ 129,431 =================
Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management's credit evaluation of the counterparty. Collateral held is primarily residential property. Interest rates on loan commitments are a combination of fixed and variable. Commitments outstanding at December 31, 1996 consist of adjustable rate commercial loans and fixed rate residential mortgage loans of $45,680,000 and $83,751,000, respectively, at rates ranging from 8% to 18%. Commitments to originate loans generally expire within 30 days to 60 days. From time to time, the Company or its subsidiaries are defendants in legal actions involving claims arising in the normal course of its business. The Company believes that, as a result of its legal defenses and insurance arrangements, none of these actions, if decided adversely, would have a material effect on the business, financial condition, results of operations or cash flows of the Company taken as a whole. 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, 1996, the Company had no outstanding forward commitment contracts. The Company has accrued $51,000 for a former operating location to record the potential liability for environmental contamination at this site. The Company believes that the total cost for this environmental liability will not exceed the amount accrued. 22. 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. -31- 73 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 SHORT-TERM INVESTMENTS For these short-term instruments, the carrying amount is a reasonable estimate of fair value. RECEIVABLES For residential mortgage loans, commercial loans and automobile loans fair value is estimated using the market prices received on recent sales or securitizations of these loans in the secondary market. MORTGAGE LOANS HELD FOR SALE Fair value for mortgage loans held for sale is determined using the anticipated price to be derived from the sale of the mortgage loans in the secondary market. EXCESS SERVICING RECEIVABLE Fair value of the excess servicing receivable is determined based on the discounted present value of the remaining excess estimated future cash flows using estimated prepayment and default rates and discount rates anticipated in similar instruments. INVESTMENT IN ASSET-BACKED SECURITIES Fair value of the investment in asset-backed securities approximates the carrying amount. Fair value is determined based on the discounted present value of the remaining estimated future cash flows attributable to the related investment in asset-backed securities using estimated prepayment and default rates and discount rates anticipated in similar instruments. INVESTOR SAVINGS Due to their short-term maturity, usually one year, the fair value of the notes due investors and subordinated debentures is the current carrying amount. 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. 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. -32- 74 COMMON STOCK =============================================================================== EMERGENT GROUP, INC. AND SUBSIDIARIES Traded -- The Company's Common stock is traded on the NASDAQ National Market. The Company is included in the National Association of Securities Dealers, Inc. (NASD) Automated Quotation System. At March 14, 1997, the closing price was $14.50 for the Company's Common Stock. These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily reflect actual transactions.
HIGH AND LOW BID PRICES - ------------------------------------------------------------------------------- COMMON BID COMMON BID ----------- ---------- QUARTER ENDED HIGH LOW QUARTER ENDED HIGH LOW - ----------------------- --------- ------ ------------------- ------ ------ First Quarter 1995 $1.13 $0.56 First Quarter 1996 $9.00 $4.00 Second Quarter 1995 $1.88 $0.75 Second Quarter 1996 $12.50 $9.00 Third Quarter 1995 $5.50 $1.75 Third Quarter 1996 $12.00 $7.50 Fourth Quarter 1995 $6.50 $2.00 Fourth Quarter 1996 $14.50 $10.50
OUTSTANDING - 9,144,430 shares Common as of March 14, 1997 SHAREHOLDERS OF RECORD - 860 Common as of March 14, 1997 DIVIDENDS - No dividends were paid or declared during 1996 or 1995 No cash dividends are expected to be paid on the Common Stock for the forseeable future TRANSFER AGENT AND REGISTRAR: First Union Bank of North Carolina 301 South Tryon Street, M-12 Charlotte, North Carolina 28288 34 75 GENERAL INFORMATION ============================================================================= EMERGENT GROUP, INC. BOARD OF DIRECTORS JOHN M. STERLING, JR. - Chief Executive Officer and Chairman of the Board of Emergent Group, Inc. KEITH B. GIDDENS - President and Chief Operating Officer of Emergent Group, Inc. ROBERT S. DAVIS - Vice President -Administration of Emergent Group, Inc. CLARENCE B. BAUKNIGHT - Chairman of the Board of Enterprise Computer Systems, Inc. TECUMSEH HOOPER, JR. - President, Mid-South Region of IKON Office Solutions, Inc. JACOB H. MARTIN - Retired, former Chairman of Standard Car Truck Company BUCK MICKEL - Chairman of the Board and Chief Executive Officer of RSI Holdings, Inc. PORTER B. ROSE - President of Liberty Insurance Services, Inc. and Liberty Investment Group, Inc.; Chairman of Liberty Capital Advisors, Inc. and Liberty Properties Group, Inc. SEC FORM 10-K Upon written request the Company will provide, without charge, a copy of its 1996 Annual Report to Shareholders on Form 10-K as filed with the Securities and Exchange Commission (including financial statements and schedules but excluding exhibits). Requests for this document should be directed to Robert S. Davis, Vice President - Administration, Emergent Group, Inc., P.O. Box 17526, Greenville, SC 29606. INDEPENDENT AUDITORS KPMG Peat Marwick LLP Greenville, South Carolina GENERAL COUNSEL Wyche, Burgess, Freeman & Parham, P.A. Greenville, South Carolina 35 76 ANNUAL MEETING =============================================================================== EMERGENT GROUP, INC. ANNUAL MEETING The 1997 meeting of holders of Emergent Group, Inc. Common Stock is scheduled to be held on Tuesday, May 27, 1997 at 9:00 a.m. at the Hyatt Regency Hotel, 220 North Main Street, Greenville South Carolina. EXECUTIVE OFFICERS John M. Sterling, Jr. Chairman and Chief Executive Officer Keith B. Giddens President and Chief Operating Officer Kevin J. Mast Vice President, Chief Financial Officer and Treasurer Robert S. Davis Vice President - Administration C. Thomas Wyche Secretary DIVISIONAL OFFICERS Dennis W. Canupp Chief Operating Officer, Mortgage Loan Division Samuel J. Couvillion Chief Operating Officer, Small Business Loan Division 36 77 The estimated fair values of the Company's financial instruments at December 31 were as follows:
1995 1996 --------------------------- -------------------------- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE --------------------------- -------------------------- (IN THOUSANDS) (IN THOUSANDS) Financial Assets: Cash and cash equivalents $ 1,260 $ 1,260 $ 1,276 $ 1,276 Restricted cash 912 912 5,319 5,319 Loans receivable, net 103,865 107,520 84,966 89,493 Mortgage loans held for sale 22,593 23,526 100,063 104,066 Excess servicing receivable, net 2,054 2,054 4,315 4,700 Investment in asset-backed securities, net 865 865 3,581 3,935 Financial Liabilities: Notes payable to banks and other $ 31,633 $ 31,633 $ 55,494 $ 55,494 Notes due to investors 82,132 82,132 97,987 97,987 Subordinated debentures 16,185 16,185 16,115 16,115 Commitments to extend credit 84,157 89,711 129,431 136,628
-33- 78 ANNUAL REPORT ON FORM 10-K LIST OF FINANCIAL STATEMENTS CERTAIN EXHIBITS YEAR ENDED DECEMBER 31, 1996 EMERGENT GROUP, INC. GREENVILLE, SOUTH CAROLINA 35 79 Form 10-K Emergent Group, Inc. and Subsidiaries List of Financial Statements The following consolidated financial statements of Registration and subsidiaries included in the Company's Annual Report to the Shareholders for the year ended December 31, 1996 are incorporated herein by reference in item 8: Consolidated Financial Statements of Emergent Group, Inc., and subsidiaries: Report of Independent Auditors for the year ended December 31, 1996 Report of Independent Auditors for each of the two years in the period ended December 31, 1995 Consolidated Balance Sheets - December 31, 1995 and 1996 Consolidated Statement of Income - Years ended December 31, 1994, 1995, and 1996 Consolidated Statement of Shareholders' Equity - Years ended December 31, 1994, 1995 and 1996 Consolidated Statements of Cash Flows - Years ended December 31, 1994, 1995, and 1996 Notes to Consolidated Financial Statements 36 80 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. EMERGENT GROUP, INC. ------------------------------------- Registrant March 24, 1997 \s\ John M. Sterling, Jr. - ----------------------------- -------------------------------------- (Date) John M. Sterling, Jr. Board of Directors and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. \s\ Robert S. Davis \s\ Tecumseh Hooper, Jr. - ---------------------------------- ------------------------------------- Robert S. Davis Tecumseh Hooper, Jr. Vice President-Administration Director Director \s\ John M. Sterling, Jr. \s\ Clarence B. Bauknight - ---------------------------------- ------------------------------------- John M. Sterling, Jr. Clarence B. Bauknight Chairman of the Board of Directors Director and Chief Executive Officer \s\ Buck Mickel \s\ Porter B. Rose - ---------------------------------- ------------------------------------- Buck Mickel Porter B. Rose Director Director \s\ Jacob H. Martin \s\ Keith B. Giddens - ---------------------------------- ------------------------------------- Jacob H. Martin Keith B. Giddens Director President and Chief Operating Officer Director March 24, 1997 \s\ Kevin J. Mast - --------------------------------- ------------------------------------- (Date) Kevin J. Mast Vice President, Chief Financial Officer and Treasurer 37 EX-10.19 2 AMENDMENT NOS 3&4 TO MORTGAGE LOAN WAREHOUSING AGM 1 EXHIBIT 10.19 THIRD AMENDMENT TO MORTGAGE LOAN WAREHOUSING AGREEMENT THIRD AMENDMENT TO MORTGAGE LOAN WAREHOUSING AGREEMENT (the "Amendment"), dated as of February 4, 1997 by and among EMERGENT MORTGAGE CORP. ("Borrower"), CAROLINA INVESTORS, INC. and EMERGENT GROUP, INC. (each, jointly and severally, a "Guarantor" and, collectively, the "Guarantors"), FIRST UNION NATIONAL BANK OF NORTH CAROLINA, COMERICA BANK, FIRST NATIONAL BANK OF BOSTON, BANK UNITED and BANK ONE TEXAS, N.A. (collectively, the "Lenders"); and FIRST UNION NATIONAL BANK OF NORTH CAROLINA, as administrative agent for the Lenders (in such capacity, the "Administrative Agent"). STATEMENT OF PURPOSE WHEREAS, the Borrower, the Lenders and the Administrative Agent are parties to a Mortgage Loan Warehousing Agreement dated as of March 6, 1996, as amended by that certain First Amendment to Mortgage Loan Warehousing Agreement dated as of April 3, 1996 and by that certain Second Amendment to Mortgage Loan Warehousing Agreement dated as of September 11, 1996 and as modified by that certain letter agreement dated as of November 30, 1996 (as so amended and modified, the "Credit Agreement"); and WHEREAS, the parties hereto wish to amend the Credit Agreement as set forth below; and WHEREAS, subject to and upon the terms and conditions herein set forth, the Lenders and the Administrative Agent are willing to continue to make available to the Borrower the credit facilities provided for in the Credit Agreement; and WHEREAS, a specific condition to the willingness of the Lenders and the Administrative Agent to continue to make available to the Borrower the credit facilities provided for in the Credit Agreement, is the reaffirmation by each of the Guarantors of the Guaranty to which such Guarantor is a party; and WHEREAS, each of the Guarantors will derive a material benefit from the continued availability to the Borrower of the credit facilities provided for in the Credit Agreement and therefore each of the Guarantors is willing to reaffirm the Guaranty to which such Guarantor is a party; NOW, THEREFORE, in consideration of the premises and agreements contained herein, and for good and valuable consideration, the receipt and sufficiency of which are acknowledged by the parties hereto, the parties hereto hereby agree as follows: 1. All capitalized terms used herein and not otherwise defined shall have the respective meanings provided to such terms in the Credit Agreement, as amended hereby. 2 2. Amendment to the Credit Agreement. a. The definition of the term "Maturity Date" contained in Paragraph 11 of the Credit Agreement is hereby amended by deleting the phrase "the 364th day following the date of this Agreement" therefrom and substituting the date "April 4, 1997" in lieu thereof. 3. This Amendment shall become effective as of the date hereof, provided that the Administrative Agent shall have received by such date the following items: a. A copy of this Amendment executed by the Borrower, each of the Guarantors, each of the Lenders, and the Administrative Agent (whether such parties shall have signed the same or different copies); b. A certificate of even date herewith signed by the President or any Vice President of the Borrower and attested to by the Secretary or any Assistant Secretary of the Borrower certifying that (i) the Articles, Bylaws and resolutions of the Borrower previously delivered to the Administrative Agent remain in full force and effect except as provided therein, (ii) the Borrower remains in good standing, (iii) all representations and warranties of the Borrower previously made to the Lenders remain true, complete and accurate, and (iv) no Event of Default or Potential Default has occurred and is continuing; and c. Resolutions of the Borrower and of each of the Guarantors authorizing the execution of this Amendment. 4. This Amendment is limited and, except as set forth herein, shall not constitute a modification, acceptance or waiver of any other provision of the Credit Agreement, or any other document or instrument entered into in connection therewith. 5. This Amendment may be executed in any number of counterparts by the different parties hereto on separate counterparts, each of which counterparts when executed and delivered shall be an original, but all of which together shall constitute one and the same instrument. A complete set of counterparts shall be lodged with the Borrower and the Administrative Agent. 6. This Amendment and the rights and obligations of the parties hereunder shall be construed in accordance with and governed by the laws of the State of North Carolina. 7. From and after the date hereof, all references in the Credit Agreement, and any other document or instrument entered into in connection therewith, to the Credit Agreement shall be deemed to be references to the Credit Agreement as amended hereby. 8. The Guarantors join in the execution and delivery of this Amendment to acknowledge and consent to the terms hereof and hereby reaffirm their obligations under the 3 Guaranties and agree that the Guaranties shall remain in full force and effect with respect to the Obligations. 9. THE LENDERS, THE ADMINISTRATIVE AGENT, THE GUARANTORS AND THE BORROWER EACH HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, THE RIGHT ANY OF THEM MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, OR ARISING OUT OF, UNDER OR IN CONNECTION WITH THIS AMENDMENT AND ANY AGREEMENT CONTEMPLATED TO BE EXECUTED IN CONJUNCTION HEREWITH, OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER VERBAL OR WRITTEN) OR ACTIONS OF ANY PARTY RELATING HERETO OR THERETO. THIS PROVISION IS A MATERIAL INDUCEMENT FOR THE LENDERS AND THE ADMINISTRATIVE AGENT TO ENTER INTO THIS AMENDMENT. 4 IN WITNESS WHEREOF, each of the parties hereto has caused a counterpart of this Amendment to be duly executed and delivered as of the date first above written. EMERGENT MORTGAGE CORP., a South Carolina corporation By: /s/ Kevin J. Mast ----------------------------------------------- Name: Kevin J. Mast --------------------------------------------- Title: Vice President & Treasurer -------------------------------------------- FIRST UNION NATIONAL BANK OF NORTH CAROLINA, a national banking association, as Administrative Agent and as a Lender By: /s/ R. Steven Hall ----------------------------------------------- Name: R. Steven Hall --------------------------------------------- Title: Vice President -------------------------------------------- COMERICA BANK, a Michigan banking corporation By: /s/ N. Donald Heath ----------------------------------------------- Name: N. Donald Heath --------------------------------------------- Title: Vice President -------------------------------------------- FIRST NATIONAL BANK OF BOSTON, a national banking association By: /s/ Gunther Fritze ----------------------------------------------- Name: Gunther Fritze --------------------------------------------- Title: Vice President -------------------------------------------- BANK UNITED, a federal savings bank By: /s/ John D. West ----------------------------------------------- Name: John D. West --------------------------------------------- Title: Regional Director -------------------------------------------- 5 BANK ONE TEXAS, N.A., a national banking association By: /s/ Mark L. Freeman ----------------------------------------------- Name: Mark L. Freeman --------------------------------------------- Title: Vice President -------------------------------------------- CAROLINA INVESTORS, INC., a South Carolina corporation, as a Guarantor By: /s/ Kevin J. Mast ----------------------------------------------- Name: Kevin J. Mast --------------------------------------------- Title: Vice President & Treasurer -------------------------------------------- EMERGENT GROUP, INC., a South Carolina corporation, as a Guarantor By: /s/ Kevin J. Mast ----------------------------------------------- Name: Kevin J. Mast --------------------------------------------- Title: Vice President, Treasurer & CFO -------------------------------------------- 6 FOURTH AMENDMENT TO MORTGAGE LOAN WAREHOUSING AGREEMENT FOURTH AMENDMENT TO MORTGAGE LOAN WAREHOUSING AGREEMENT (the "Amendment"), dated as of March 5, 1997 by and among EMERGENT MORTGAGE CORP. ("Borrower"), CAROLINA INVESTORS, INC. and EMERGENT GROUP, INC. (each, jointly and severally, a "Guarantor" and, collectively, the "Guarantors"), FIRST UNION NATIONAL BANK OF NORTH CAROLINA, COMERICA BANK, FIRST NATIONAL BANK OF BOSTON, BANK UNITED and BANK ONE TEXAS, N.A. (collectively, the "Lenders"); and FIRST UNION NATIONAL BANK OF NORTH CAROLINA, as administrative agent for the Lenders (in such capacity, the "Administrative Agent"). STATEMENT OF PURPOSE WHEREAS, the Borrower, the Lenders and the Administrative Agent are parties to a Mortgage Loan Warehousing Agreement dated as of March 6, 1996, as amended by that certain First Amendment to Mortgage Loan Warehousing Agreement dated as of April 3, 1996 and by that certain Second Amendment to Mortgage Loan Warehousing Agreement dated as of September 11, 1996, as modified by that certain letter agreement dated as of November 30, 1996, and as amended by that certain Third Amendment to Mortgage Loan Warehousing Agreement dated as of February 4, 1997 (as so amended and modified, the "Credit Agreement"); and WHEREAS, the parties hereto wish to amend the Credit Agreement as set forth below; and WHEREAS, subject to and upon the terms and conditions herein set forth, the Lenders and the Administrative Agent are willing to continue to make available to the Borrower the credit facilities provided for in the Credit Agreement; and WHEREAS, a specific condition to the willingness of the Lenders and the Administrative Agent to continue to make available to the Borrower the credit facilities provided for in the Credit Agreement, is the reaffirmation by each of the Guarantors of the Guaranty to which such Guarantor is a party; and WHEREAS, each of the Guarantors will derive a material benefit from the continued availability to the Borrower of the credit facilities provided for in the Credit Agreement and therefore each of the Guarantors is willing to reaffirm the Guaranty to which such Guarantor is a party; NOW, THEREFORE, in consideration of the premises and agreements contained herein, and for good and valuable consideration, the receipt and sufficiency of which are acknowledged by the parties hereto, the parties hereto hereby agree as follows: 7 1. All capitalized terms used herein and not otherwise defined shall have the respective meanings provided to such terms in the Credit Agreement, as amended hereby. 2. Amendment to the Credit Agreement. a. The definition of the term "Aggregate Facility Commitment" contained in Paragraph 11 of the Credit Agreement is hereby amended by deleting the amount "$70,000,000" therefrom and substituting the amount "$120,000,000" in lieu thereof. b. The Commitment Schedule attached as Schedule III to the Credit Agreement is hereby deleted in its entirety and the Commitment Schedule attached as EXHIBIT A hereto is hereby substituted in lieu thereof. 3. The Borrower hereby represents and warrants as of the date hereof that (i) its parent corporation, Emergent Group, Inc., contributed $5,000,000 in paid-in-capital to the Borrower during the month of February 1997; (ii) as of the date hereof, said paid-in-capital has not been withdrawn or distributed and has been retained in full; and (iii) no portion of said paid-in-capital shall be withdrawn, distributed or otherwise disbursed so long as any Obligations remain outstanding. 4. This Amendment shall become effective as of the date hereof, provided that the Administrative Agent shall have received by such date the following items: a. A copy of this Amendment executed by the Borrower, each of the Guarantors, each of the Lenders, and the Administrative Agent (whether such parties shall have signed the same or different copies); b. A certificate of even date herewith signed by the President or any Vice President of the Borrower and attested to by the Secretary or any Assistant Secretary of the Borrower certifying that (i) the Articles, Bylaws and resolutions of the Borrower previously delivered to the Administrative Agent remain in full force and effect except as provided therein, (ii) the Borrower remains in good standing, (iii) all representations and warranties of the Borrower previously made to the Lenders remain true, complete and accurate, and (iv) no Event of Default or Potential Default has occurred and is continuing; and c. Resolutions of the Borrower and of each of the Guarantors authorizing the execution of this Amendment. 5. This Amendment is limited and, except as set forth herein, shall not constitute a modification, acceptance or waiver of any other provision of the Credit Agreement, or any other document or instrument entered into in connection therewith. 8 6. This Amendment may be executed in any number of counterparts by the different parties hereto on separate counterparts, each of which counterparts when executed and delivered shall be an original, but all of which together shall constitute one and the same instrument. A complete set of counterparts shall be lodged with the Borrower and the Administrative Agent. 7. This Amendment and the rights and obligations of the parties hereunder shall be construed in accordance with and governed by the laws of the State of North Carolina. 8. From and after the date hereof, all references in the Credit Agreement, and any other document or instrument entered into in connection therewith, to the Credit Agreement shall be deemed to be references to the Credit Agreement as amended hereby. 9. The Guarantors join in the execution and delivery of this Amendment to acknowledge and consent to the terms hereof and hereby reaffirm their obligations under the Guaranties and agree that the Guaranties shall remain in full force and effect with respect to the Obligations. 10. THE LENDERS, THE ADMINISTRATIVE AGENT, THE GUARANTORS AND THE BORROWER EACH HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, THE RIGHT ANY OF THEM MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, OR ARISING OUT OF, UNDER OR IN CONNECTION WITH THIS AMENDMENT AND ANY AGREEMENT CONTEMPLATED TO BE EXECUTED IN CONJUNCTION HEREWITH, OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER VERBAL OR WRITTEN) OR ACTIONS OF ANY PARTY RELATING HERETO OR THERETO. THIS PROVISION IS A MATERIAL INDUCEMENT FOR THE LENDERS AND THE ADMINISTRATIVE AGENT TO ENTER INTO THIS AMENDMENT. 9 IN WITNESS WHEREOF, each of the parties hereto has caused a counterpart of this Amendment to be duly executed and delivered as of the date first above written. EMERGENT MORTGAGE CORP., a South Carolina corporation By: /s/ Kevin J. Mast ----------------------------------------------- Name: Kevin J. Mast --------------------------------------------- Title: Vice President & Treasurer -------------------------------------------- FIRST UNION NATIONAL BANK OF NORTH CAROLINA, a national banking association, as Administrative Agent and as a Lender By: /s/ R. Steven Hall ----------------------------------------------- Name: R. Steven Hall --------------------------------------------- Title: Vice President -------------------------------------------- COMERICA BANK, a Michigan banking corporation By: /s/ N. Donald Heath ----------------------------------------------- Name: N. Donald Heath --------------------------------------------- Title: Vice President -------------------------------------------- FIRST NATIONAL BANK OF BOSTON, a national banking association By: /s/ Paul Chemelinski ----------------------------------------------- Name: Paul Chemelinski --------------------------------------------- Title: Vice President -------------------------------------------- BANK UNITED, a federal savings bank By: /s/ John D. West ----------------------------------------------- Name: John D. West --------------------------------------------- Title: Regional Director -------------------------------------------- 10 BANK ONE TEXAS, N.A., a national banking association By: /s/ Mark Freeman ----------------------------------------------- Name: Mark Freeman --------------------------------------------- Title: Vice President -------------------------------------------- CAROLINA INVESTORS, INC., a South Carolina corporation, as a Guarantor By: /s/ Kevin J. Mast ----------------------------------------------- Name: Kevin J. Mast --------------------------------------------- Title: Vice President & Treasurer -------------------------------------------- EMERGENT GROUP, INC., a South Carolina corporation, as a Guarantor By: /s/ Kevin J. Mast ----------------------------------------------- Name: Kevin J. Mast --------------------------------------------- Title: Vice President, CFO & Treasurer -------------------------------------------- 11 EXHIBIT A T0 FOURTH AMENDMENT TO MORTGAGE LOAN WAREHOUSING AGREEMENT DATED AS OF MARCH 5, 1997 LISTING EMERGENT MORTGAGE CORP. AS BORROWER COMMITMENT SCHEDULE -------------------
Lender Maximum Commitment Percentage Share - ------ ------------------ ---------------- First Union National Bank of North Carolina $ 28,000,000 23.34% Comerica Bank $ 17,000,000 14.17% First National Bank of Boston $ 25,000,000 20.83% Bank United $ 25,000,000 20.83% Bank One Texas, N.A. $ 25,000,000 20.83% - ---------------------------------------------------------------------------------------------- AGGREGATE FACILITY COMMITMENT $120,000,000 100%
EX-10.20 3 INTERIM WAREHOUSE & SECURITY AGREEMENT 1 EXHIBIT 10.20 EXECUTION COPY ================================================================================ INTERIM WAREHOUSE AND SECURITY AGREEMENT by and between PRUDENTIAL SECURITIES CREDIT CORPORATION, as Lender EMERGENT MORTGAGE CORP., as Borrower and EMERGENT GROUP, INC., as Guarantor Dated as of March 4, 1997 ================================================================================ 2 INTERIM WAREHOUSE AND SECURITY AGREEMENT INTERIM WAREHOUSE AND SECURITY AGREEMENT, dated as of March 4, 1997 (as amended or otherwise modified from time to time, this "Agreement") among PRUDENTIAL SECURITIES CREDIT CORPORATION, a Delaware corporation, having an office at 1220 N. Market Street, Wilmington, Delaware 19801 (the "Lender"), EMERGENT MORTGAGE CORP., a South Carolina corporation, having its principal office at 50 Datastream Plaza, Suite 201, Greenville, South Carolina 29605 (the "Borrower") and EMERGENT GROUP, INC., a South Carolina corporation, having its principal office at 15 South Main Street, Suite 750, Greenville, South Carolina 29606 (the "Guarantor"). WHEREAS, the Lender intends to lend and the Borrower intends to borrow up to a maximum of $50,000,000 (fifty million dollars) to fund the purchase or origination by the Borrower of fixed rate, first- and second-lien, 1-4 family mortgage loans; WHEREAS, the Guarantor owns 100% of the common stock of the Borrower and has agreed to guarantee repayment of the Loan and any interest on the terms specified herein to the Lender in the event that the Borrower does not repay the Loan; and WHEREAS, the Lender's affiliate, Prudential Securities Incorporated ("PSI") will act as the sole or lead manager on the mortgage-backed securities issuance (the "Securitization") to be sponsored by the Borrower (or by an affiliate thereof) and collateralized by the Pledged Mortgage Loans. An index to the location of the definitions of the defined terms used herein is set forth as Appendix I hereto. NOW, THEREFORE, in consideration of the premises and for other good and valuable consideration, the parties hereto hereby agree as follows: 1. The Loan and the Guarantee. A. Subject to the terms of this Agreement: 1. The Lender agrees to lend to the Borrower up to a maximum of $50,000,000 (such borrowing, the "Loan") to be made in one or more advances (each, an "Advance") (as any such amount may be increased, in the Lender's sole and unreviewable discretion, by means of a Credit Increase Confirmation and Note Amendment in the form of Exhibit C attached hereto (a " Credit Increase Confirmation")). Each Advance hereunder shall be made by the Lender in an amount not less than $500,000 and in the event the Borrower 3 requests more than 2 Advances in any calendar week, the borrower shall pay to the Lender a $1,000 advance fee for each subsequent Advance hereunder. The Borrower agrees that the Loan shall be used to warehouse fixed rate, first- and second-lien, 1-4 family residential mortgage loans that are to be included in the Securitization (the " Mortgage Loans"), as such Mortgage Loans are identified to the Lender in writing and in electronic form from time to time. All Mortgage Loans financed hereunder shall be closed loans; i.e., this facility shall not be used for "wet" or "table" fundings. The Lender may refuse to lend against any Mortgage Loan(s) which the Lender reasonably believes will not be eligible for inclusion in the securitized pool either (x) due to the characteristics of such Mortgage Loan or (y) due to the expected aggregate characteristics of the Mortgage Loans. 2. Each Advance shall be made on a date prior to the Maturity Date referred to below (each such date, a " Funding Date"); provided that: (i) not later than two business days prior to the proposed Funding Date for an Advance, the Borrower shall deliver to the Lender (i) a written notice in the form of Exhibit D hereto and (ii) an electronic disk or tape, in form satisfactory to the Lender, detailing certain specified characteristics of the Mortgage Loans proposed to be pledged in connection with such Advance (each such schedule, a " Mortgage Loan Schedule"); (ii) the representations, warranties and covenants of the Borrower set forth in this Agreement hereof shall be true and correct on and as of such Funding Date as if made on and as of such date; (iii) no Event of Default shall have occurred and be continuing or would exist after the making of the Advance on such Funding Date; (iv) the Borrower shall have delivered to the Custodian the Mortgage Files with respect to each Mortgage Loan being pledged on such Funding Date; (v) the Lender shall have received in connection with each Advance, a certificate from the Custodian to the effect that it has reviewed the Mortgage Files relating to the Mortgage Loans being pledged in connection with the Advance being made on such Funding Date and has found no material deficiencies in such Mortgage Files; (vi) the Lender shall have received, prior to the initial Advance, a legal opinion from counsel (which may be in-house counsel) to the Borrower in the form of Exhibit B attached hereto; (vii) to the extent described in Section 5(D) hereof, no notice described in said Section 5(D) shall have been received by the Lender or PSI; (viii) the Lender shall have completed, to its satisfaction, due diligence of the Borrower and the Mortgage Loans; 2 4 (ix) the Borrower shall have taken all necessary steps to grant the Lender a first priority security interest in the Collateral; and (x) all documentation relating to the Loan shall have been completed and be satisfactory in form and substance to the Lender, including this Agreement, the Custodial Agreement and the Secured Note. 3. The Loan shall accrue interest daily on its outstanding principal amount (determined by the Lender as of each Funding Date after having taken into account all Advances made as of such date), with interest calculated for the actual number of days elapsed, based on a 360-day year. The interest rate shall be (except as otherwise provided in Section 1(F) or Section 11(D) hereof) LIBOR plus 1.55%, and shall be reset on each business day. With respect to each Advance, interest shall initially accrue from the Funding Date to and including the last day of the calendar month in which such Funding Date occurs (or, if earlier, the day preceding the Maturity Date) and shall thereafter accrue from the first day of each successive calendar month to and including the last day of such calendar month (or, if earlier, the day preceding the Maturity Date) (each such period, an " Accrual Period"). Interest which accrues during each Accrual Period shall be payable in arrears on the first business day of the following month, with any outstanding interest due and payable in its entirety on the date of termination of this Agreement (including the Maturity Date). "LIBOR" shall mean, for each day, a fluctuating interest rate per annum equal to the London interbank offered rate for one-month U.S. dollar deposits that appear on the Telerate Screen LIBOR Page 3750 as of 11:00 a.m., London time. Any amounts pre-paid under this Agreement prior to the Maturity Date may be re-borrowed, subject to the terms and conditions of this Agreement, until the Maturity Date. B. The amount of each Advance shall not exceed the lesser of (such lesser amount, the "Advance Amount"): 1. 100% of the aggregate outstanding principal balance of the Mortgage Loans (calculated as of the related Cut-Off Date or, if the Borrower is using the proceeds of the Advance to purchase the related Mortgage Loans at their aggregate outstanding principal balance as of the settlement date for the purchase, then their aggregate outstanding principal balance as of such settlement date) proposed to be pledged to the Lender in connection with such Advance, minus, in the event that A Collateral Deficiency Situation exists as of the date of such Advance, the Restoration Amount as of the date of such Advance; and 2. the product of (x) the Market Value of the Mortgage Loans proposed to be pledged to the Lender in connection with such Advance and (y) .95, 3 5 minus, in the event that A Collateral Deficiency Situation exists as of the date of such Advance, the Restoration Amount as of the date of such Advance. For purposes of this Agreement: A Collateral Deficiency Situation means the situation existing as of any day on which (i) the outstanding principal amount of the Loan as of such day exceeds (ii) the lesser of (a) the product of (x) the Market Value of the Pledged Mortgage Loans (disregarding the Market Value of any Mortgage Loans proposed to be pledged to the Lender on such day and Mortgage Loans which are 31 or more days past due) and (y) 95% and (b) the outstanding principal balance of the Pledged Mortgage Loans (disregarding the outstanding principal balance of any Mortgage Loans to be pledged to the Lender on such date and Mortgage Loans which are 31 or more days past due). Cut-Off Date means, as of any date, the close of business on the date set forth in the related Mortgage Loan Schedule (as defined in the Custodial Agreement). In no event shall the Cut-Off Date precede by more than two weeks the date on which the related Mortgage Loan Schedule is delivered. Market Value means, as of any date and with respect to any Mortgage Loans, the whole-loan servicing- retained fair market value of such Mortgage Loans as of such date as determined by the Lender (or an affiliate thereof) in its sole discretion. Maturity Date means the earlier of (a) March 31, 1997 and (b) the date on which the Securitization occurs. The Maturity Date may be extended by the Lender, in the Lender's sole and unreviewable discretion, on any date by the execution and delivery of a Credit Increase Confirmation. Pledged Mortgage Loans means, as of any date of determination, any mortgage loans then held by the Custodian on behalf of the Lender to secure the Loan. Restoration Amount means, as of any date of determination, the amount, if any, by which (i) the outstanding principal amount of the Loan as of such date (including accrued interest) exceeds (ii) the lesser of (a) the product of (x) the Market Value of the Pledged Mortgage Loans (disregarding the Market Value of any Mortgage Loans proposed to be pledged to the Lender on such date and Mortgage Loans which are 31 or more days past due) and (y) .95 and (b) the outstanding principal balance of the Pledged Mortgage Loans (disregarding the outstanding principal balance of any Mortgage Loans to be pledged to the Lender on such date and Mortgage Loans which are 31 or more days past due). C. The Loan evidenced hereby shall mature on the Maturity Date and all amounts outstanding hereunder shall be due and payable on the Maturity Date. 4 6 D. The Loan is pre-payable at any time without premium or penalty, in whole or in part; provided, that Pledged Mortgage Loans may not be removed from this facility (including in connection with any prepayment of the Loan in part) with the result that, in the Lender's sole reasonable determination, the remaining Pledged Mortgage Loans, are, in the aggregate, materially inferior as collateral as compared to the pool of Pledged Mortgage Loans immediately prior to such removal. In addition, no Pledged Mortgage Loans may be removed from this facility with the result that A Collateral Deficiency Situation would then exist. Notwithstanding the foregoing, however, a Pledged Mortgage Loan, may in any event be removed from this facility if such Pledged Mortgage Loan has been paid in full by the mortgagor. If any Pledged Mortgage Loans are removed from this facility for reasons other than as contemplated herein, the Borrower shall pay to the Lender on the first business date following such removal a fee equal to .50% of the outstanding principal balance of such removed Pledged Mortgage Loan(s). If the Borrower intends to repay the Loan in whole or in substantial part from a source other than the proceeds of the Securitization, the Borrower shall give 2 business days' written notice to the Lender. E. If the Loan is not extended by means of a Credit Increase Confirmation, the Loan shall immediately and automatically become due and payable without any further action by the Lender on the then scheduled Maturity Date, and in the event of non-payment in full on such Maturity Date the Lender may exercise all rights and remedies available to it as the holder of a first perfected security interest under the Uniform Commercial Code of the State of New York (the "New York UCC"). F. If the Borrower awards a Securitization or whole-loan trade involving any Pledged Mortgage Loans to a group of managers (or to an investment banking house, agent, broker, or underwriter) which in PSI's reasonable determination does not give PSI a fair allotment of the securities issued in such Securitization, then the interest rate on the Loan shall increase to LIBOR plus 3.50%, which higher rate shall retroactively be applied as of the related Funding Date for all prior Advances or Pledged Mortgage Loans so involved. G. The Loan shall be evidenced by the secured promissory note of the Borrower in the form attached hereto as Exhibit A (the "Secured Note"). H. Upon the occurrence and continuance of an Event of Default and/or in the event that the Loan is extended beyond its then scheduled Maturity Date by means of a Credit Increase Confirmation, the factors set forth in the definitions of "Advance Amount," "A Collateral Deficiency Situation" and "Restoration Amount" may be revised downward, at the time of such extension in the case of a Credit Increase Confirmation, by the Lender in its sole discretion. I. The Guarantor, pursuant to the guarantee to be executed by the Guarantor in the form of Exhibit E attached hereto (the "Guarantee"), shall guaranty, at the time of A Collateral Deficiency Situation or upon the occurrence and continuance of an Event of Default, payment of one hundred percent (100%) of the Secured Obligations outstanding at such time (the "Guarantee Amount") and in furtherance thereof but subject to the Guarantee Amount, the Guarantor shall be obligated to pay (i) following the occurrence of A Collateral Deficiency Situation, the 5 7 Restoration Amount, if any, then due to the Lender and (ii) following the occurrence of an Event of Default, principal and interest outstanding on the Loan after the Lender has liquidated the Collateral. The Guarantee shall survive the termination of this Agreement and shall remain in full force and effect until the Guarantee Amount shall have been reduced to zero. 2. Reimbursement of Costs and Expenses. The Borrower shall reimburse the Lender for any of the Lender's reasonable out-of-pocket costs, including due diligence review costs and reasonable attorney's fees, incurred by the Lender in connection with the negotiation, execution and enforcement of this Agreement and the transactions contemplated hereby. The Borrower's agreement in this Section 2 shall survive the payment in full of the Note and the expiration or termination, as applicable, of this Agreement. 3. Mortgage Files and Custodian. The Borrower shall deliver to Bankers Trust Company of California, N.A. as custodian (the "Custodian") on behalf of the Lender, the documents and instruments listed in Section 2 of that certain Custodial Agreement dated as of March 4, 1997 (the "Custodial Agreement") among the Borrower and the Custodian. Such documents and instruments evidencing and relating to the Mortgage Loans (the "Mortgage Loan Files"), and all the Borrower's right, title and interest in, to and under such Mortgage Loans together with any proceeds thereof are hereinafter referred to as the "Collateral". The Borrower hereby pledges all of its right, title and interest in, to and under the Collateral to the Lender to secure the repayment of principal of and interest on the Loan and all other amounts owing by the Borrower or its Affiliates to the Lender hereunder or under any other agreement or arrangement (collectively, the "Secured Obligations"). 4. Representations, Warranties and Covenants. A. Each of the Borrower and the Guarantor (each, a "Party") represents, warrants and covenants to the Lender that: 1. It has been duly organized and is validly existing as a corporation in good standing under the laws of the State of South Carolina. 2. It is duly licensed as a "Licensee" or is otherwise qualified in each state in which it transacts business and is not in default of such state's applicable laws, rules and regulations. The Borrower has the requisite power and authority and legal right to own and grant a lien on all of its right, title and interest in and to the Collateral. Such Party has the requisite power and authority to execute and deliver, engage in the transactions contemplated by, and perform and observe the terms and conditions of, this Agreement, the Secured Note and the Guarantee, to the extent that it is a party to such documents. 3. At all times after the Custodian has received a Mortgage Loan from the Borrower and until payment in full of the Loan, such Party shall not knowingly and intentionally commit any act in violation of applicable laws, or regulations promulgated with respect thereto. 6 8 4. Such Party is solvent and is not in default under any material mortgage, borrowing agreement or other instrument or agreement pertaining to indebtedness for borrowed money, and neither the execution, delivery nor performance by such Party of this Agreement, the Guarantee or the Secured Note, to the extent it is a party to such documents, conflicts with any term or provision of the certificate of incorporation or by- laws of such Party or any law, rule, regulation, order, judgment, writ, injunction or decree applicable to such Party of any court, regulatory body, administrative agency or governmental body having jurisdiction over such Party and will not result in any violation of any such mortgage, instrument or agreement. 5. All financial statements and certificates of such Party, any Affiliate of such Party or any of its officers furnished to the Lender are true and complete and do not omit to disclose any material liabilities or other facts relevant to such Party's or such Affiliate's condition. As used in this Agreement, "Affiliate" means any person directly or indirectly controlling, controlled by, or under common control (within the definition of "control" set forth in the Securities and Exchange Act of 1934, as amended) with, the Borrower or the Guarantor. All such financial statements have been prepared in accordance with GAAP. No financial statement or other financial information as of a date later than that supplied to the Lender, has been furnished by such Party or any of its Affiliates to another lender of such Party or any of its Affiliates that has not been furnished to the Lender. 6. No consent, approval, authorization or order of, registration or filing with, or notice to any governmental authority or court is required under applicable law in connection with the execution, delivery and performance by such Party of this Agreement, the Guarantee and the Secured Note, to the extent it is a party to such documents. 7. There is no action, proceeding or investigation pending with respect to which such Party has received service of process or, to the best of such Party's knowledge threatened against it before any court, administrative agency or other tribunal (A) asserting the invalidity of this Agreement, the Guarantee or the Secured Note, (B) seeking to prevent the consummation of any of the transactions contemplated by this Agreement, the Guarantee or the Secured Note, or (C) which might materially and adversely affect the validity or collectibility of the Mortgage Loans or the performance by it of its obligations under, or the validity or enforceability of, this Agreement, the Guarantee or the Secured Note. 8. There has been no material adverse change in the business, operations, financial condition, assets, properties or prospects of such Party or any Affiliate since the date set forth in the financial statements supplied to the Lender. 9. This Agreement, the Guarantee and the Secured Note have been duly authorized, executed and delivered by such Party, to the extent it is a 7 9 party to such documents, all requisite corporate action having been taken, and each is valid, legal, binding and enforceable against such Party, to the extent it is a party to such documents, in accordance with its terms except as such enforcement may be affected by bankruptcy, by other insolvency laws or by general principles of equity. B. With respect to every Mortgage Loan delivered to the Custodian and pledged to the Lender hereunder, the Borrower represents and warrants to the Lender that: 1. Such Mortgage Loan and all accompanying documents are complete and authentic and all signatures thereon are genuine. 2. Such Mortgage Loan arose from a bona fide loan, complying in all material respects with all applicable State and Federal laws and regulations, to persons having legal capacity to contract and is not subject to any defense, set-off or counterclaim. 3. All amounts represented to be payable on such Mortgage Loan are, in fact, payable in accordance with the provisions of such Mortgage Loan. 4. No default has occurred in any provisions of such Mortgage Loan. 5. Any property subject to any security interest given in connection with such Mortgage Loan is not subject to any encumbrance other than a stated first mortgage. 6. The Borrower holds good and indefeasible title to, and is the sole owner of, such Mortgage Loan subject to no liens, charges, mortgages, participations, encumbrances or rights of others except, in the case of certain Mortgage Loans, a stated first mortgage. 7. Each Mortgage Loan conforms to the description thereof as set forth on the related Mortgage Loan Schedule delivered to the Custodian and the Lender. 8. All disclosures required by the Real Estate Settlement Procedures Act, by Regulation X promulgated thereunder and by Regulation Z of the Board of Governors of the Federal Reserve System promulgated pursuant to the statute commonly known as the Truth-in-Lending Act and the Notice of the Right of Recision required by said statute and regulation have been properly made and given. 9. The Mortgage Loans have characteristics which are substantially similar to those of other mortgage loans financed by the Borrower during the twelve-month period preceding the initial Funding Date and 8 10 mortgage loans included in securitizations involving credit enhancers of the type contemplated by the Securitization. 10. Each Mortgage Loan will be eligible for inclusion in a pool to be securitized and insured by a credit enhancer; the Lender may refuse to lend against any Mortgage Loan(s) which the Lender reasonably believes will not be eligible for inclusion in such a securitized, insured pool either (x) due to the characteristics of such Mortgage Loan or (y) due to the expected aggregate characteristics of the Mortgage Loans. 11. Each Mortgage Loan was originated or acquired pursuant to the Borrower's written underwriting guidelines (including any amendments thereto) heretofore provided to, and approved by, the Lender. 12. No Mortgage Loans are more than 31 days delinquent, no Mortgage Loans have experienced delinquencies of more than 31 days on two or more occasions and no Mortgage Loan has incurred a first payment delinquency beyond any contractual grace period. C. The Borrower hereby covenants with the Lender that at all times during the term of this facility: 1. The Borrower's stated net worth minus intangible assets and the amount of any receivable from any of its shareholders or Affiliates ("Tangible Net Worth") shall not be less than $10,000,000. 2. The Borrower's Tangible Net Worth plus subordinated debt maturing 180 days or more from the Maturity Date ("Subordinated Debt") shall not be less than $40,000,000. 3. The Borrower's leverage ratio shall not exceed 6:1, such ratio being the ratio of (x) the Borrower's total liabilities less Subordinated Debt to (y) the Borrower's Tangible Net Worth minus Subordinated Debt. 4. The Borrower will continue to maintain, for it and its subsidiaries, insurance coverage with respect to employee dishonesty, forgery or alteration, theft, disappearance and destruction, robbery and safe burglary, property (other than money and securities) and computer fraud in an aggregate amount of at least $1,000,000, which insurance shall name the Lender as a loss payee. 5. All subordinated debt of the Borrower must be subordinate to all obligations, including unsecured obligations, owed to the Lender or PSI. D. The Guarantor hereby covenants with the Lender that at all times during the term of this facility the Guarantor's Tangible Net Worth shall not be less than $40,000,000. 5. Mandatory Prepayment of Loan. 9 11 A. Upon discovery by the Borrower, the Guarantor or the Lender of any breach of any of the representations, warranties or covenants set forth herein, the party discovering such breach shall promptly give notice of such discovery to the others. B. The Lender has the right to require, in its unreviewable discretion, the Borrower to repay the Loan in part with respect to any Mortgage Loan (i) which breaches one or more of the representations and warranties listed in Section 4(B) preceding or (ii) which is determined by the Lender to be unacceptable for inclusion in such Securitization. C. If any Mortgage Loan, as indicated on any Supplemental Mortgage Loan Schedule delivered pursuant to Section 9(A) hereof, becomes more than 31 days delinquent, the Lender shall require the Borrower to prepay the Loan in the amount advanced with respect to such Mortgage Loan, or, with the Lender's consent, deliver a qualifying substitute mortgage loan in its place, having an aggregate principal balance equal to or greater than the delinquent Mortgage Loan. D. If the Borrower awards the Securitization or any whole-loan trade involving any Pledged Mortgage Loans to an investment banking house, agent or underwriter other than PSI, or to a group of managers which in PSI's reasonable determination does not give PSI a fair allotment of the securities issued in such Securitization then (x) the Lender may demand that the Borrower repay any portion of the Loan evidenced hereby relating to the dollar amount of the Mortgage Loans to be included in such Securitization or whole loan trade, in which PSI has not been selected for participation, for payment within five business days of the demand for repayment, (y) the Lender may refuse to make further Advances hereunder if such Advances would relate to Mortgage Loans to be included in such Securitization or whole-loan trade in which PSI has not been selected for participation and (z) the interest rate on the Loan shall increase as set forth in Section 1(F) hereof. The Borrower shall give immediate notice, by facsimile transmission, to the attention of Elizabeth Castagna at the Lender and Glen Stein at PSI (fax 212-778-7401) of any decision to award the lead manager role or to name any group of managers for any Securitization or whole-loan trade involving any Pledged Mortgage Loans. E. If, on any date other than a Funding Date, the Lender determines that A Collateral Deficiency Situation exists, the Lender shall so notify the Borrower, and the Borrower, within one business day, shall either (i) pay to the Lender the Restoration Amount or (ii) deliver to the Custodian on behalf of the Lender additional Mortgage Loans having an aggregate Market Value at least equal to the Restoration Amount. The provisions of Section 1(B) shall govern with regard to A Collateral Deficiency Situation as of a Funding Date. 6. Release of Mortgage Files following Payment of Loan. At the written request of the Borrower, the Lender agrees to cause the Mortgage Files to be released from the lien hereof upon payment in full of the Loan, or, if a partial payment of the Loan occurs, subject to the restrictions set forth in Section 1(D), the documents relating to a pro rata portion of the Pledged Mortgage Loans. 10 12 7. Servicing. The Borrower shall service the Mortgage Loans with the degree of skill and care consistent with that which the Borrower customarily exercises with respect to similar mortgage loans owned, managed, or serviced by it and all applicable industry standards. The Borrower shall (i) comply with all applicable Federal and State laws and regulations, (ii) maintain all State and Federal licenses and franchises necessary for it to perform its servicing responsibilities hereunder and (iii) not impair the rights of the Lender in any Mortgage Loans or for payment thereunder. The related annual servicing fee shall be 50 b.p.s. of the then outstanding balances of the Pledged Mortgage Loans. 8. No Oral Modifications; Successors and Assigns; Assignment of Collateral. No provisions of this Agreement shall be waived or modified except by a writing duly signed by the authorized agents of the Lender, the Guarantor and the Borrower. This Agreement shall be binding upon the successors and assigns of the parties hereto. The Borrower acknowledges and agrees that the Lender may re-pledge, enter into repurchase transactions, and otherwise re- hypothecate (including the granting of participation interests therein) the Collateral for the Loan, provided that no such act shall in any way (x) affect the Borrower's rights to the Collateral, (y) change the location of the Mortgage Loan documents, which shall remain with the Custodian or (z) grant to any other person any direct rights against the underlying mortgagors. 9. Reports. A. The Borrower shall provide the Lender with an electronic disk or tape (each, a "Supplemental Mortgage Loan Schedule") (i) on the date any additional Mortgage Loans are delivered pursuant to Section 5(E) and at the earliest of (a) two business days before each Funding Date or (b) one week (or with respect to the information required by clause (c) of the next sentence, one month) following the date that the last such schedule was provided and (ii) within two business days following any request by the Lender or any affiliate thereof for such a schedule. Such Supplemental Mortgage Loan Schedule shall be cumulative and will contain information concerning (a) the Mortgage Loans then held in the warehouse facility, (b) any Mortgage Loans proposed to be delivered to the facility on the next Funding Date or in connection with Collateral maintenance pursuant to Section 5(E) hereof and (c) the portfolio performance data with respect to all such Mortgage Loans, including, without limitation, any outstanding delinquencies, prepayments in whole or in part and any repurchases by the Borrower, and shall be in a format as may be agreed upon by the Borrower and the Lender from time to time. Each Supplemental Mortgage Loan Schedule shall contain the following information with respect to each Pledged Mortgage Loan: (i) the loan number and name of the Mortgagor; (ii) the address and zip code of the mortgaged property; (iii) the property type; (iv) the loan purpose; (v) the date of origination (date indicated on mortgage note) and the name of the originator if different from the Borrower; (vi) the original stated maturity date; (vii) the remaining term to maturity; (viii) the principal balance at origination; (ix) the first payment date; (x) the monthly payment in effect as of the Cut-off Date; (xi) the principal balance as of the Cut-off Date as used in determining the Cut-off Date principal balance; (xii) the loan-to-value ratio at origination and currently; (xiii) the combined loan-to-value ratio if the Mortgage Loan is a second mortgage; (xiv) the interest rate; (xv) the occupancy status; (xvi) the appraised value of the Mortgage 11 13 Property at origination and a more current appraised value, if any; (xvii) if such Mortgage Loan is a "balloon loan," the amortization terms; (xiii) the lien priority; (xix) the credit rating given such Mortgage Loan by the Borrower; (xx) the last scheduled payment made; (xxi) the servicing fee; (xxii) the escrow balance; (xxiii) the escrow payment; (xxiv) the number of 30, 60 and 90 day delinquencies in the past twelve months and (xxv) the debt-to-income ratio. A. Each of the Borrower and the Guarantor shall furnish to Lender (i) promptly, copies of any material and adverse notices (including, without limitation, notices of defaults, breaches, potential defaults or potential breaches) given to or received from its other lenders, and, in the event any such default or breach has been cured or waived, notice of such cure or waiver and (ii) immediately, notice of the occurrence of any "Event of Default" hereunder or of any situation which the Borrower, with the passage of time, reasonably expects to develop into an "Event of Default" hereunder. The Borrower shall further furnish to the Lender the following: (a) consolidated audited financial statements of the Borrower and its Affiliates, within 120 days of the Borrower's fiscal year end; (b) consolidated unaudited financial statements of the Borrower and its Affiliates for each of the Borrower's first three quarters of each fiscal year, within 45 days after quarter end; (c) unaudited monthly financial statements of the Borrower; (d) quarterly and annual consolidated financial statements of the Borrower and its Affiliates reflecting material intercompany adjustments within 5 business days of their completion; (e) copies of all SEC filings by the Borrower and its Affiliates, within five business days of their filing with the SEC; and (f) within three business days of the end of each calendar month a summary schedule of any Pledged Mortgage Loans experiencing delinquencies. B. The Guarantor shall furnish to Lender the following: (a) quarterly and annual consolidated financial statements of the Guarantor reflecting material intercompany adjustments within 5 business days of their completion; and (b) copies of all SEC filings by the Guarantor within five business days of their filing with the SEC; provided, however, that the Guarantor shall provide a copy of the annual SEC Form 10-K no later than 90 days of the Guarantor's fiscal year end and a copy of the quarterly SEC Form 10-Q no later than 45 days after quarter end. 12 14 All required financial statements, information and reports shall be prepared in accordance with U.S. GAAP, or, if applicable to SEC filings, SEC accounting regulations. C. In conjunction with the delivery of each of the financial statements to be delivered by the Borrower pursuant to Section 9(B), the Borrower shall deliver to the Lender an officer's certificate of the Borrower certifying that, as of the date of delivery of such financial statements, the Borrower is in compliance with all the terms of this Agreement including, without limitation, each of the covenants set forth in Section 4(C). D. The Borrower shall also provide to the Lender within 10 days of the end of each month as requested by the Lender, a breakdown of Mortgage Loans held by (x) Emergent Mortgage Corp. and (y) Carolina Investors Inc. 10. Events of Default. Each of the following shall constitute an "Event of Default" hereunder: A. Failure of the Borrower or the Guarantor to (i) make any payment of interest or principal or any other sum which has become due, whether by acceleration or otherwise, under the terms of the Secured Note, this Agreement, the Guarantee, any warehouse and security agreement or any other document evidencing or securing indebtedness of the Borrower to the Lender or to any affiliate of the Lender, or (ii) pay or deliver any Restoration Amount. B. Any "event of default" by the Borrower under any agreement relating to any indebtedness of the Borrower to any other lender. C. Assignment or attempted assignment by the Borrower or the Guarantor of this Agreement, the Secured Note or the Guarantee or any rights hereunder, without first obtaining the specific written consent of Lender, or the granting by the Borrower of any security interest, lien or other encumbrance on any Collateral to other than the Lender. D. The filing by the Borrower or the Guarantor of a petition for liquidation, reorganization, arrangement or adjudication as a bankrupt or similar relief under the bankruptcy, insolvency or similar laws of the United States or any state or territory thereof or of any foreign jurisdiction; the failure of the Borrower or the Guarantor to secure dismissal of any such petition filed against it within thirty (30) days of such filing; the making of any general assignment by the Borrower or the Guarantor for the benefit of creditors; the appointment of a receiver or trustee for the Borrower or the Guarantor, or for any part of the Borrower's or the Guarantor's assets; the institution by the Borrower or the Guarantor of any other type of insolvency proceeding (under the Bankruptcy Code or otherwise) or of any formal or informal proceeding, for the dissolution or liquidation of, settlement of claims against, or winding up of the affairs of, the Borrower or the Guarantor; the institution of any such proceeding against the Borrower or the Guarantor if the Borrower or the Guarantor shall fail to secure dismissal thereof within thirty (30) days thereafter; the consent by the Borrower or the Guarantor to any type of insolvency proceeding 13 15 against the Borrower or the Guarantor (under the Bankruptcy Code or otherwise); the occurrence of any event or existence of any condition which could be the ground, basis or cause for any proceeding or petition described in this Section 10. E. Any materially adverse change in the financial condition of the Borrower or the Guarantor or any of its Affiliates or the existence of any other condition which, in the Lender's sole determination, constitutes an impairment of the Borrower's or the Guarantor's ability to perform its obligations under this Agreement, the Guarantee or the Secured Note or the validity or collectibility of the Collateral. F. Failure by the Borrower to service the Mortgage Loans in substantial compliance with the servicing requirements set forth in Section 7 hereof. G. A breach by the Borrower or the Guarantor of any representation, warranty or covenant set forth herein or a use by the Borrower of the proceeds of the Loan for a purpose other than as set forth in Section 1(A) hereof. H. A "default" or other event under the terms of any agreement relating to any material indebtedness of the Borrower to any other lender of the Borrower which default or event causes or is reasonably likely to cause the acceleration of indebtedness under such other agreement or cause or permit any such other lender to terminate its commitment to lend to the Borrower. 11. Remedies Upon Default. A. Upon the happening of one or more Events of Default, the Lender may (x) refuse to make further Advances hereunder and (y) immediately declare the principal of the Secured Note then outstanding to be immediately due and payable, together with all interest thereon and fees and expenses accruing under this Agreement; provided that, upon the occurrence of the Event of Default referred to in Section 10(D), such amounts shall immediately and automatically become due and payable without any further action by any person or entity. Upon such declaration or such automatic acceleration, the balance then outstanding on the Secured Note shall become immediately due and payable without presentation, demand or further notice of any kind to the Borrower. A. Upon the happening of one or more Events of Default, the Lender shall have the right to obtain physical possession, and to commence an action to obtain physical possession, of all files of the Borrower relating to the Collateral and all documents relating to the Collateral which are then or may thereafter come in to the possession of the Borrower or any third party acting for the Borrower. The Lender shall be entitled to specific performance of all agreements of the Borrower and the Guarantor contained in this Agreement, the Secured Note or the Guarantee. The Borrower and the Lender hereby acknowledge that the Lender's right to obtain physical possession of the Collateral is deemed for all purposes to be equivalent to the rights of "seizure of property or maintenance or continuation of perfection of an interest in property" as specified under Bankruptcy Code Sections 362(b) and 546(b)(2). B. Upon the happening of one or more Events of Default, the Lender shall have the right to direct all servicers then servicing any Pledged Mortgage 14 16 Loans to remit all collections on the Pledged Mortgage Loans to the Lender, and if any such payments are received by the Borrower, the Borrower shall not commingle the amounts received with other funds of the Borrower and shall promptly pay them over to the Lender. The Lender shall also have the right to terminate the servicer and assign such servicing responsibilities to an established mortgage loan servicing institution. In addition, the Lender shall have the right to dispose of the Collateral as provided herein, or as provided in the other documents executed in connection herewith, or in any commercially reasonable manner, or as provided by law. Such disposition may be on either a servicing-released or a servicing-retained basis. The Lender shall be entitled to place the Mortgage Loans which it recovers after any default in a pool for issuance of mortgage-backed securities at the then-prevailing price for such securities and to sell such securities for such prevailing price in the open market as a commercially reasonable disposition of Collateral, subject to the applicable requirements of the New York UCC. The Lender shall also be entitled to sell any or all of such Mortgage Loans individually for the prevailing price as a commercially reasonable disposition of Collateral subject to the applicable requirements of the New York UCC. The specification in this Section of manners of disposition of collateral as being commercially reasonable shall not preclude the use of other commercially reasonable methods (as contemplated by the New York UCC) at the option of the Lender. C. Following the occurrence and during the continuance of an Event of Default, interest shall accrue on the Loan at a default interest rate of LIBOR plus 5%. 12. Indemnification. The Borrower agrees to hold the Lender harmless from and indemnifies the Lender against all liabilities, losses, damages, judgments, costs and expenses of any kind which may be imposed on, incurred by, or asserted against the Lender relating to or arising out of this Agreement, the Secured Note, any Securitization Agreement or any transaction contemplated hereby or thereby resulting from anything other than the Lender's gross negligence or willful misconduct. The Borrower also agrees to reimburse the Lender for all reasonable costs and expenses incurred in connection with (i) the preparation, negotiation and enforcement of this Agreement, the Secured Note and the Guarantee, including, without limitation, the reasonable fees and disbursements of counsel, and (ii) the Lender's due diligence in connection herewith. The Borrower's agreements in this Section shall survive the payment in full of the Secured Note and the expiration or termination of this Agreement. The Borrower hereby acknowledges that, notwithstanding the fact that the Secured Note is secured by the Collateral, the obligations of the Borrower under the Secured Note are recourse obligations of the Borrower. 13. Power of Attorney. The Borrower hereby authorizes the Lender, at the Borrower's expense, to file such financing statement or statements relating to the Collateral without the Borrower's signature thereon as the Lender at its option may deem appropriate, and appoints the Lender as the Borrower's attorney-in-fact to execute any such financing statement or statements in the Borrower's name and to perform all other acts which the Lender deems appropriate to perfect and continue the security interest granted hereby and to protect, preserve and realize upon the Collateral, including, but not limited to, the right to endorse notes, complete blanks in 15 17 documents, transfer servicing, and sign assignments on behalf of the Borrower as its attorney-in-fact. This power of attorney is coupled with an interest and is irrevocable without the Lender's consent. Notwithstanding the foregoing, the power of attorney hereby granted may be exercised only during the occurrence and continuance of any Event of Default hereunder. 14. Governing Law; Agreement Constitutes Security Agreement; Jurisdiction. This Agreement is intended by the parties hereto to be governed by the laws of the State of New York, and to constitute a security agreement within the meaning of the New York UCC. THE PARTIES HERETO AGREE THAT ANY ACTION OR PROCEEDING BROUGHT TO ENFORCE OR ARISING OUT OF THIS AGREEMENT OR THE SECURED NOTE SHALL BE COMMENCED IN THE SUPREME COURT OF THE STATE OF NEW YORK, OR IN THE DISTRICT COURT OF THE UNITED STATES FOR THE SOUTHERN DISTRICT OF NEW YORK. 15. Lender May Act Through Affiliates. The Lender may, from time to time, designate one or more affiliates for the purpose of performing any action hereunder. 16. Notices. All demands, notices and communications relating to this Agreement shall be in writing and shall be deemed to have been duly given if mailed, by registered or certified mail, return receipt requested, or by overnight courier, or, if by other means, when received by the other party or parties at the address shown below, or such other address as may hereafter be furnished to the other party or parties by like notice. Any such demand, notice or communication hereunder shall be deemed to have been received on the date delivered to or received at the premises of the addressee (as evidenced, in the case of registered or certified mail, by the date noted on the return receipt). If to the Borrower: Emergent Mortgage Corp. 15 South Main Street, Suite 750 Greenville, South Carolina 29606 Attention: Mr. Wade Hall Phone Number: 864-232-6197 Fax Number: 864-271-8374 with a copy to: William P. Crawford, Esq. Wyche, Burgess, Freeman & Parham, P.A. 44 E. Camperdown Way P.O. Box 728 Greenville, SC 29602 Phone Number: 864-242-8265 Fax Number: 864-242-8324 If to the Guarantor: 16 18 Emergent Group, Inc. 15 South Main Street, Suite 750 Greenville, South Carolina 29606 Attention: Mr. Kevin J. Mast Phone Number: 864-232-6197 Fax Number: 864-271-8374 If to the Lender: Prudential Securities Credit Corporation One Seaport Plaza, 27th Floor Treasury Department New York, New York 10292 Attention: Ms. Elizabeth Castagna Phone Number: 212-214-7772 Fax Number: 212-214-7572 with a copy to: Prudential Securities Incorporated One New York Plaza, 17th Floor New York, New York 10292 Attention: Mr. Glen Stein Phone Number: 212-778-2012 Fax Number: 212-778-7401 17. Severability. Any provision of this Agreement which is prohibited, unenforceable or not authorized in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition, unenforceability or non-authorization, without invalidating the remaining provisions hereof or affecting the validity, enforceability or legality of such provision in any other jurisdiction. 18. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original, and all such counterparts shall together constitute one and the same instrument. 17 19 IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. EMERGENT MORTGAGE CORP. By: /s/ Kevin J. Mast ------------------------------------- Name: Kevin J. Mast Title: Vice President & Treasurer EMERGENT GROUP, INC., as Guarantor By: /s/ Kevin J. Mast ------------------------------------- Name: Kevin J. Mast Title: Vice President, CFO & Treasurer PRUDENTIAL SECURITIES CREDIT CORPORATION By: /s/ George Morgan ------------------------------------- Name: George Morgan Title: Vice President 20 Appendix I The following capitalized terms are defined in the corresponding sections of the Agreement specified below: "Accrual Period" - Section 1(A)(3). "Advance" - Section 1(A)(1). "Advance Amount" - Section 1(B). "Affiliate" - Section 4(A)(5). "Agreement" - Introductory Clause. "Borrower" - Introductory Clause. "Collateral" - Section 3. "Collateral Deficiency Situation" - Section 1(B)(2). "Credit Increase Confirmation" - Section 1(A)(1). "Custodian" - Section 3. "Custodial Agreement" - Section 3. "Cut-Off Date" - Section 1(B)(2). "Designated Pooling and Servicing Agreement" - Section 4(B)(10). "Event of Default" - Section 10. "Funding Date" - Section 1(A)(2). "Guarantor" - Introductory Clause. "Lender" - Introductory Clause. "LIBOR" - Section 1(A)(3). "Loan" - Section 1(A)(1). "Market Value" - Section 1(B)(2). "Maturity Date" - Section 1(B)(2). "Mortgage Files" - Section 3. I-1 21 "Mortgage Loans" - Section 1(A)(1). "Mortgage Loan Schedule" - Section 1(A)(2). "New York UCC" - Section 1(E)(1). "Party" - Section 4(A). "Pledged Mortgage Loans" - Section 1(B)(2). "PSI" - Recitals. "Restoration Amount" - Section 1(B)(2). "Secured Note" - Section 1(G). "Secured Obligations" - Section 3. "Securitization" - Recitals. "Subordinated Debt" - Section 4(C). "Supplemental Mortgage Loan Schedule" - Section 9(A). "Tangible Net Worth" - Section 4(C). I-2 22 Exhibit A FORM OF SECURED NOTE Dated as of ____________, 199_ FOR VALUE RECEIVED, the undersigned, [BORROWER], a [corporation] organized under the laws of the State of __________, whose address is ________________________________ (the "Borrower"), promises to pay to the order of PRUDENTIAL SECURITIES CREDIT CORPORATION, a Delaware corporation, whose address is One New York Plaza, New York, New York 10292 (the "Lender") on or before the Maturity Date the amount then outstanding (including accrued interest) under that certain Interim Warehouse and Security Agreement dated as of March __, 1997 (the "Agreement"). Initially, the maximum principal amount which may be outstanding is $______________ (as such amount may be amended, in the Lender's sole discretion, from time to time, by a Credit Increase Confirmation). Capitalized terms used herein and not defined herein shall have their respective meanings as set forth in the Agreement. The holder of this Note is authorized to record the date and amount of each Advance and the date and amount of each repayment of principal thereof on the schedule to be maintained by the Lender (which schedule may be obtained upon Borrower's request), and any such recordation shall constitute prima facie evidence of the accuracy of the amount so recorded; provided that the failure of the holder hereof to make such recordation (or any error in such recordation) shall not affect the obligations of the Borrower hereunder or under the Agreement. MAXIMUM RATE OF INTEREST: It is intended that the rate of interest herein shall never exceed the maximum rate, if any, which may be legally charged on the Loan evidenced by this Note ("Maximum Rate"), and if the provisions for interest contained in this Note would result in a rate higher than the Maximum Rate, interest shall nevertheless be limited to the Maximum Rate and any amounts which may be paid toward interest in excess of the Maximum Rate shall be applied to the reduction of principal, or, at the option of the Lender, returned to the Borrower. DUE DATE: The Loan evidenced hereby not paid before the Maturity Date shall be due and payable on the Maturity Date. PLACE OF PAYMENT: All payments hereon shall be made, and all notices to the Lender required or authorized hereby shall be given, at the office of the Lender at the address designated in the heading of this Note, or to such other place as the Lender may from time to time direct by written notice to the Borrower. PAYMENT AND EXPENSES OF COLLECTION: All amounts payable hereunder are payable by wire transfer in immediately available funds to the account number specified by the Lender, in lawful money of the United States. Payments A-1 23 remitted by the Borrower via wire transfer initiated after 1:00 p.m. New York City time shall be deemed to be received on the next business day. The Borrower agrees to pay all costs of collection when incurred, including, without limiting the generality of the foregoing, reasonable attorneys' fees through appellate proceedings, and to perform and comply with each of the covenants, conditions, provisions and agreements contained in every instrument now evidencing or securing said indebtedness. SECURITY: This Note is issued pursuant to the Agreement and is secured by a pledge of the Collateral described therein. Notwithstanding the pledge of the Collateral, the Borrower hereby acknowledges, admits and agrees that the Borrower's obligations under this Note are recourse obligations of the Borrower to which the Borrower pledges its full faith and credit. DEFAULTS: Upon the happening of an Event of Default (as defined in the Agreement), the Lender shall have all rights and remedies set forth in the Agreement. The failure to exercise any of the rights and remedies set forth in the Agreement shall not constitute a waiver of the right to exercise the same or any other option at any subsequent time in respect of the same event or any other event. The acceptance by the Lender of any payment hereunder which is less than payment in full of all amounts due and payable at the time of such payment shall not constitute a waiver of the right to exercise any of the foregoing rights and remedies at that time or at any subsequent time or nullify any prior exercise of any such rights and remedies without the express consent of Lender, except as and to the extent otherwise provided by law. WAIVERS: The Borrower waives diligence, presentment, protest and demand and also notice of protest, demand, dishonor and nonpayments of this Note, and expressly agrees that this Note, or any payment hereunder, may be extended from time to time, and consents to the acceptance of further collateral, the release of any collateral for this Note, the release of any party primarily or secondarily liable hereon, and that it will not be necessary for the Lender, in order to enforce payment of this Note, to first institute or exhaust Lender's remedies against the Borrower or any other party liable hereon or against any collateral for this Note. None of the foregoing shall affect the liability of the Borrower. No extension of time for the payment of this Note, or an installment hereof, made by agreement by the Lender with any person now or hereafter liable for the payment of this Note, shall affect the liability under this Note of the Borrower, even if the Borrower is not a party to such agreement; provided, however, the Lender and the Borrower, by written agreement between them, may affect the liability of the Borrower. TERMINOLOGY: If more than one party joins in the execution of this Note, the covenants and agreements herein contained shall be the joint and several obligation of each and all of them and of their respective heirs, executors, administrators, successors and assigns, and relative words herein shall be read as if written in the plural when appropriate. Any reference herein to the Lender shall be deemed to include and apply to every subsequent holder of this Note. Words of A-2 24 masculine or neuter import shall be read as if written in the neuter or masculine or feminine when appropriate. AGREEMENT: Reference is made to the Agreement for provisions as to Advances, rates of interest, mandatory principal repayments, collateral and acceleration. If there is any conflict between the terms of this Note and the terms of the Agreement, the terms of the Agreement shall control. APPLICABLE LAW; JURISDICTION: This Note shall be governed by and construed under the laws of the State of New York, the laws of which the Borrower hereby expressly elects to apply to this Note. THE BORROWER AGREES THAT ANY ACTION OR PROCEEDING BROUGHT TO ENFORCE OR ARISING OUT OF THIS NOTE SHALL BE COMMENCED IN THE SUPREME COURT OF THE STATE OF NEW YORK, OR IN THE DISTRICT COURT OF THE UNITED STATES FOR THE SOUTHERN DISTRICT OF NEW YORK. [BORROWER] By ------------------------------- Name: Title: A-3 25 Exhibit B _____________, 199_ [Custodian] [Address] Prudential Securities Credit Corporation One New York Plaza New York, NY 10292-2015 Re: Interim Funding Arrangement for Mortgage Loans Gentlemen: I am the counsel to [Borrower], a _________ [corporation] (the "Borrower") and [Guarantor], a _________ [corporation] (the "Guarantor"). I have represented the Borrower and the Guarantor in connection with the execution and delivery of the following documents: A. Interim Warehouse and Security Agreement, dated as of ___________, 199_ (the "Interim Warehouse and Security Agreement"), between the Borrower, Guarantor and Prudential Securities Credit Corporation (the "Lender"); B. Secured Note executed as of ______________, 199_ by the Borrower in favor of the Lender (the "Note"); C. Guarantee executed as of ___________, 199__ (the "Guarantee") by the Guarantor; and D. Custodial Agreement, dated as of ______________, 199_ (the "Custodial Agreement"), among the Borrower and [Custodian] (the "Custodian"). Capitalized terms used herein, but not defined herein, shall have the meanings assigned to them in the Interim Warehouse and Security Agreement. B-1 26 I have examined executed copies of the Interim Warehouse and Security Agreement, the Note, the Guarantee and the Custodial Agreement. I have also examined originals or photostatic or certified copies of all such corporate records of the Borrower and the Guarantor and such certificates of public officials, certificates of corporate officers, and other documents, and such questions of law, as I have deemed appropriate and necessary as a basis for the opinions hereinafter expressed. In making my examination and rendering the opinions herein expressed, I have made the following assumptions: i) each party to each of the Interim Warehouse and Security Agreement and the Custodial Agreement (other than the Borrower and the Guarantor) has the power to enter into and perform all of its obligations thereunder, (ii) the due authorization, execution and delivery of each of the Interim Warehouse and Security Agreement and the Custodial Agreement by all parties thereto (other than the Borrower and the Guarantor), and (iii) the validity and binding effect on all parties thereto (other than the Borrower and the Guarantor) of each of the Interim Warehouse and Security Agreement and the Custodial Agreement. The opinions expressed below with respect to enforceability are subject to the following additional qualifications: 19 The effect of bankruptcy, insolvency, reorganization, moratorium, conservatorship, receivership, or other similar laws relating to or affecting the rights of creditors generally in the event of insolvency, reorganization, moratorium or receivership. 20 The application of general principles of equity, including, but not limited to, the right of specific performance (regardless of whether enforceability is considered in a proceeding in equity or at law). 21 The unenforceability of provisions to the effect that failure to exercise or delay in exercising rights or remedies will not operate as a waiver of any such rights or remedies, or to the effect that provisions therein may only be waived in writing to the extent that an oral agreement has been entered into modifying such provisions. I am licensed to practice law in the State of New York, and, each opinion hereinafter set forth is an opinion concerning only the law of the State of New York. All opinions expressed herein are based on laws, regulations and policy guidelines currently enforced and may be affected by future changes in law. Furthermore, no opinion is expressed herein regarding the applicable state Blue Sky, legal investment or real estate syndication laws. Based upon the foregoing, and subject to the last paragraph hereof, I am of the opinion that: 1. The Interim Warehouse and Security Agreement, the Note, the Guarantee and the Custodial Agreement each constitutes the valid, legal and binding agreement of the Borrower, and each is enforceable against the Borrower and the Guarantor, to the extent it is a party thereto, in accordance with its terms. B-2 27 2. The Borrower is licensed as a "Licensee" or is otherwise qualified to do business in each state in which it transacts business. 3. No consent, approval, authorization or order of, registration or filing with, or notice to, any governmental authority or court is required under federal laws or the laws of the State of New York [or the State of __________] for the execution, delivery and performance of the Interim Warehouse and Security Agreement, the Note, the Guarantee or the Custodial Agreement as applicable, by the Borrower and the Guarantor, except such of which as have been obtained. 4. The execution, delivery and performance by the Borrower and the Guarantor of the Interim Warehouse and Security Agreement, the Note, the Guarantee and the Custodial Agreement to the extent each is a party thereto, does not conflict with or result in a breach of, or constitute a default under (a) the Borrower's or the Guarantor's, respectively, articles of incorporation or bylaws or (b) any law, rule or regulation of the federal government or of the State of New York [or the State of _________]. 5. The execution, delivery and performance by the Borrower and the Guarantor of the Interim Warehouse and Security Agreement, the Note, the Guarantee and the Custodial Agreement to the extent each is a party thereto will not result in a default under any mortgage, borrowing agreement, or other instrument or agreement pertaining to indebtedness for borrowed money to which the Borrower or the Guarantor, respectively, is a party. 6. Upon the execution of the Interim Warehouse and Security Agreement, a valid security interest in the Mortgage Loans and the proceeds thereof is granted to the Lender, which security interest would be a valid, first-priority, perfected security interest with respect to such Mortgage Loans and the proceeds thereof upon delivery of the Mortgage Files to the Custodian. This Opinion is furnished by me as counsel to the Borrower and the Guarantor and is solely for the benefit of the addressees hereof; except that this Opinion may be relied upon by any holder in due course of the Note. Yours truly, B-3 28 Exhibit C FORM OF CREDIT INCREASE CONFIRMATION AND NOTE AMENDMENT Dated ________________ Reference is made to (x) the Interim Warehouse and Security Agreement, dated as of ______________, 199_ (the "Interim Warehouse Agreement") between Prudential Securities Credit Corporation (the "Lender"), [Borrower] (the "Borrower") and [Guarantor] (the "Guarantor"), (y) the Secured Note dated as of ____________, 199_ (the "Note") from the Borrower to the Lender and (z) the Guarantee dated as of ________, 199__ (the "Guarantee") by the Guarantor in favor of the Lender. Capitalized terms used and not otherwise defined herein shall have their respective meanings set forth in the Interim Warehouse Agreement. Section 1. - The maximum amount of the Loan referenced in the Interim Warehouse Agreement and in the Note and Guarantee shall be ___________________________. - The "Maturity Date" referenced in the Interim Warehouse Agreement and in the Note and Guarantee shall be ___________________________. - [Any other changes.] Section 2. As amended by Section 1 hereof all provisions of the Interim Warehouse Agreement, the Note and the Guarantee are reconfirmed as of the date hereof. Each of the Borrower and the Guarantor, in addition, hereby reconfirms and remakes as of the date hereof each and every of its representations, warranties and covenants set forth in the Interim Warehouse Agreement, the Note and the Guarantee. C-1 29 IN WITNESS WHEREOF, the parties hereto have executed this Amendment on the day and year first above written. [BORROWER] By: ---------------------------------------- Name: Title: [GUARANTOR] By: ---------------------------------------- Name: Title: PRUDENTIAL SECURITIES CREDIT CORPORATION By: ---------------------------------------- Name: Title: C-2 30 Approval as to Legality I, _____________, counsel to the Borrower and the Guarantor hereby confirm that: - I delivered, on _________, 199_, the opinion letter, a copy of which is attached hereto (the "Opinion Letter") relating to the Interim Warehouse Agreement, the Note and the Guarantee. - I have represented the Borrower and the Guarantor in connection with its execution and delivery of the Credit Increase Confirmation and Note Amendment (the "Confirmation") to which this Approval as to Legality is attached. - I hereby extend, as of the date hereof, the opinions set forth in the Opinion Letter to cover both the Confirmation itself as well as the transactions described on the Confirmation and confirm, as of the date hereof, and subject to any and all assumptions and qualifications set forth therein, the opinions set forth in the Opinion Letter. Yours truly, ---------------------------------------- [NAME] Dated: ___________, 199_ C-3 31 Exhibit D FORM OF FUNDING NOTICE -------------- ______________, 199_ Prudential Securities Credit Corporation One New York Plaza New York, NY 10292 Re: Interim Warehouse and Security Agreement, dated as of ________, 199_, between Prudential Securities Credit Corporation, [Borrower] and [Guarantor] (the "Agreement") Gentlemen: Pursuant to Section 1(A)(2) of the Agreement, this letter constitutes notice that the undersigned desires to obtain an Advance in the principal amount of $____________, constituting ___% of the aggregate outstanding principal balance of the Mortgage Loans shown on the attached Mortgage Loan Schedule, as of the Cut-Off Date shown thereon. This letter will further certify that: (1) the undersigned has no notice or knowledge of any Event of Default; (2) the representations and warranties in the Agreement relating to the Mortgage Loans shown on the attached Mortgage Loan Schedule are true and correct as of the date hereof; (3) each of the conditions precedents to an Advance listed in Section 1(A)(2) of the Agreement are true and correct as of the date hereof and shall be true and correct on the date of the Advance requested herein, before and after giving effect thereto. Capitalized terms used and not otherwise defined herein shall have their respective meanings set forth in the Agreement. [BORROWER] By: ---------------------------------- Name: Title: D-1 32 Exhibit E FORM OF GUARANTEE OF [GUARANTOR] FOR VALUE RECEIVED, [Guarantor], a [corporation] organized and existing under the laws of the State of _________ (the "Guarantor"), hereby guarantees, unconditionally, to the holder of that certain Secured Note dated _________, 199__ (herein called the "Note"), issued to Prudential Securities Credit Corporation (the "Lender") pursuant to the terms of the Interim Warehouse and Security Agreement, dated ________, 199__, among the Lender, [the Borrower] and the Guarantor (the "Agreement"), the due and punctual payment of (i) at the time of A Collateral Deficiency Situation or (ii) upon the occurrence and continuance of an Event of Default, one hundred percent (100%) of the Secured Obligations outstanding at such respective time (the "Guarantee Amount") and in furtherance thereof but subject to the Guarantee Amount, the Guarantor shall be obligated to pay (a) following the occurrence of A Collateral Deficiency Situation, the Restoration Amount, if any, then due to the Lender and (b) following the occurrence of an Event of Default, principal and interest outstanding on the Loan after the Lender has liquidated the Collateral, in either case, when and as the same shall become due and payable, whether at their respective due dates or on a declaration or otherwise, in accordance with the terms of the Note and of the Agreement; provided, however, that payment of interest on overdue installments of interest is hereby guaranteed only to the extent permitted by applicable law. In the event of a default by the Borrower in the payment of any such Guarantee Amount, the Guarantor agrees duly and punctually to pay the same without demand. Subject to the terms and limitations of this Guarantee: the Guarantor also guarantees all of the obligations of the Borrower under this Agreement, including the indemnification provisions thereof; the Guarantor hereby agrees that its respective obligations under this Guarantee and the Agreement shall be unconditional, irrespective of any invalidity, illegality, irregularity or unenforceability of the Note or the Agreement as regards the Borrower (other than by reason of lack of genuineness), or the absence of any action to enforce the same, the recovery of any judgment against the Borrower or any action to enforce the same or any circumstance which might otherwise constitute a legal or equitable discharge or defense of a guarantor; and the Guarantor hereby waives diligence, presentment, demand of payment, filing of claims with a court in the event of merger, amalgamation, insolvency or bankruptcy of the Borrower, any right to require a proceeding first against the Borrower, protest or notice with respect to the Note or the indebtedness evidenced thereby and all demands whatsoever, and covenants that this Guarantee will not be discharged except by payment in full of (a) the Secured Obligations or (b) the Guarantee Amount. The obligations of the Guarantor under this Guarantee shall be a continuing obligation and a fresh cause of action under this Guarantee shall be deemed to arise in respect of each default in the payment of principal of or interest on the Note. E-1 33 The Guarantor shall be subrogated to all rights of the holder of the Note against the Borrower in respect of any amount paid by the Guarantor pursuant to the provisions of this Guarantee; provided, however, that the Guarantor shall not be entitled to enforce, or to receive any payments arising out of or based upon such right of subrogation until the Secured Obligations shall have been paid in full. No remedy for the enforcement of the rights of the holder of the Note to receive payment of the principal of and/or interest on the Note, under the Note, the Agreement and hereunder, shall be exclusive of or dependent on any other remedy. This Guarantee has been given in accordance with the terms of the Agreement and is subject to all applicable provisions thereof and the same shall be deemed to be incorporated herein. The Guarantor hereby certifies and warrants that all acts, conditions and things required to be done and performed and to have happened prior to the creation and issuance of this Guarantee to constitute the same valid and legally binding obligation of the Guarantor enforceable in accordance with its terms (except as enforcement thereof may be limited by bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium and other similar laws relating to or affecting creditors' rights generally) have been done and performed and have happened in due and strict compliance with all applicable law. Capitalized terms used herein and not otherwise defined herein shall have the meaning ascribed to such terms in the Agreement. This Guarantee shall be construed in accordance with and governed by the laws of the State of New York. Executed as of _____________, 199__. [GUARANTOR] By: ----------------------------------- Name: Title: E-2 34 TABLE OF CONTENTS
PAGE ---- Section 1. The Loan and the Guarantee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Section 2. Reimbursement of Costs and Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Section 3. Mortgage Files and Custodian . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Section 4. Representations, Warranties and Covenants . . . . . . . . . . . . . . . . . . . . . . . . . 6 Section 5. Mandatory Prepayment of Loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Section 6. Release of Mortgage Files following Payment of Loan . . . . . . . . . . . . . . . . . . . . 10 Section 7. Servicing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Section 8. No Oral Modifications; Successors and Assigns; Assignment of Collateral . . . . . . . . . . 11 Section 9. Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Section 10. Events of Default . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Section 11. Remedies Upon Default . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Section 12. Indemnification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Section 13. Power of Attorney . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Section 14. Governing Law; Agreement Constitutes Security Agreement; Jurisdiction . . . . . . . . . . . 15 Section 15. Lender May Act Through Affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Section 16. Notices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Section 17. Severability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Section 18. Counterparts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Appendix I - Defined Terms Exhibit A - Form of Secured Note Exhibit B - Form of Legal Opinion Exhibit C - Form of Credit Increase Confirmation and Note Amendment Exhibit D - Form of Funding Notice Exhibit E - Form of Guarantee
i EX-11.1 4 COMPUTATION OF EARNINGS 1 EXHIBIT 11.1 ITEM 14 (c) EMERGENT GROUP, INC. COMPUTATION OF EARNINGS PER SHARE
For the Years Ended December 31, ---------------------------------------- 1994 1995 1996 ---- ---- ---- (In thousands, except per share data) Income (loss) Applicable to Common Stock Income from continuing operations $1,792 $4,581 $10,095 Income from discontinued operations $546 ($3,924) -- Cumulative effect of change in accounting method -- -- -- ----------------------------------------- Net Income $2,338 $657 410,095 ========================================= Primary Earnings Per Share Computation Weighted average number of shares outstanding during the year 6,669,343 6,464,582 6,852,420 Dilutive effect of Common Stock options and warrants based on the average market price 19,391 203,610 247,454 ----------------------------------------- 6,688,734 6,668,192 7,099,874 ========================================= Per share amounts: Income from continuing operations before cumulative effect of change in accounting method $0.27 $0.69 $1.42 Income from discontinued operations $0.08 ($0.59) -- ----------------------------------------- Income before cumulative effect of change in accounting method $0.35 $0.10 $1.42 Cumulative effect of change in accounting method -- -- -- ----------------------------------------- Net Income $0.35 $0.10 $1.42 ========================================= Fully Diluted Earnings Per Share Computation Weighted average number of shares outstanding during the year 6,669,343 6,464,582 6,852,420 Dilutive effect of Common Stock options and warrants based on the average market price 19,391 203,610 247,454 ----------------------------------------- 6,688,734 6,668,192 7,099,874 ========================================= Per share amounts: Income from continuing operations before cumulative effect of change in accounting method $0.27 $0.69 $1.42 Income from discontinued operations $0.08 ($0.59) $0.00 Income before cumulative effect of change in ----------------------------------------- accounting method $0.35 $0.10 $1.42 Cumulative effect of change in accounting method -- -- -- ----------------------------------------- Net Income $0.35 $0.10 $1.42 =========================================
EX-13 5 ANNUAL REPORT 1 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS This discussion is intended to further your understanding of the consolidated financial condition and results of operations of Emergent Group, Inc. (the "Company"). It should be read in conjunction with the Consolidated Financial Statements, notes, and tables of the Company appearing elsewhere in this report. As used herein, "Discontinued Operations" refers to the Company's former transportation and apparel operations. Unless otherwise noted, the discussion contained herein relates to the continuing operations of the Company, which consist of its Financial Services operations. See notes 13 and 14 to the Consolidated Financial Statements. FORWARD-LOOKING INFORMATION Certain statements in the financial discussion and analysis by management that reflect projections or expectations of future financial or economic performance of the Company, and statements of the Company's plans and objectives for future operations are "forward-looking" statements. No assurance can be given that actual results or events will not differ materially from those projected, estimated, assumed or anticipated in any such forward-looking statements. Important factors that could result in such differences are many and include: lower origination volume due to market conditions, higher losses due to economic downturn or lower real estate values, adverse consequences of changes in interest rate environment, uncreditworthiness of borrowers and risk of default, limited operating history of retail lending operations, termination of strategic alliance agreements and Mortgage Banker relationships, general economic conditions in the Company's markets, including inflation, recession, interest rates and other economic factors, loss of funding sources, loss of ability to sell loans, general lending risks, dependence on Federal programs, loss of operating loss carryforwards, impact of competition, regulation of lending activities, and changes in the regulatory environment and dependence on key executives. GENERAL The Company is a diversified financial services company headquartered in Greenville, South Carolina which originates, services and sells Mortgage Loans, Small Business Loans and Auto Loans. Prior to current management's acquisition of control of the Company in December 1990, the Company was primarily engaged in its Transportation operations. Under previous management, the Company incurred significant losses which resulted in net operating loss carryforwards (the "NOL"). In 1991, current management implemented a strategic plan to acquire profitable businesses. Pursuant to such strategy, the Company acquired Carolina investors, Inc. ("CII"), Premier Financial Services, Inc. ("Premier"), Emergent Business Capital, Inc. ("EBC"), The LoanPro$, Inc. ("Loan Pro$") in 1991 (all financial-related companies) and Young Generations, Inc. ("YGI") (an apparel manufacturer) in 1993. In 1994, the Company made a strategic decision to divest all nonfinancial operations and to focus exclusively on the financial services industry. In accordance with such strategy, the Company completed its divestiture of its apparel and transportation operations in 1995. 1 2 The Company's total serviced loans receivable increased from $157.4 million at December 31, 1994, to $214.5 million at December 31, 1995 and to $309.1 million at December 31, 1996. Mortgage Loans increased during all such periods principally as a result of the Company's retail Mortgage loan origination network established during 1996, and an increase in the number of Mortgage Bankers originating Mortgage Loan Division, as well as increased loan volume from existing Mortgage Bankers. The Mortgage Loan Division is expected to continue its growth in 1997 in both its retail and wholesale loan distribution channels as a result of increased personnel and resources devoted to this division. In 1995, the U. S. Small Business Administration ("SBA") adopted certain policies, such as the temporary implementation of a maximum SBA Loan amount of $500,000 and the temporary prohibition of the use of SBA Loan proceeds for certain financings (which temporary limitations were removed in October 1995). Consequently, Small Business Loan volume in 1995 was relatively unchanged from the 1994 level as a result of the negative market impact from these changes. Small Business Loan volume in 1996 increased due to the removal of the temporary governmental restrictions in the SBA program as well as increased marketing efforts, the hiring of additional loan officers, and increase in the number of commercial loan brokers which refer Small Business Loans to the Company and the opening of the Company's asset-based lending operation in Atlanta, Georgia in April 1996. The Company plans to grow its Small Business Loan Division in 1997 with the opening of two additional offices. Auto Loans increased during all such periods principally as a result of an increase in the number of loan production offices and successful efforts at establishing additional dealer relationships. No significant growth is anticipated in 1997 for the Auto Loan Division as the Company plans to focus on collections rather than expansion and asset growth. Approximately $125.3 million, or approximately 68% of the company's Mortgage Loans in 1995, were originated through First Greensboro Home Equity, Inc. ("First Greensboro"). In 1996, First Greensboro originated approximately $80.9 million or 24.6% of the Company's Mortgage Loans. On June 1, 1996, First Greensboro terminated its strategic alliance agreement with the Company. Consequently, the Company's Mortgage Loan originations were less than if First Greensboro had not terminated this agreement (which was scheduled to expire December 31, 1997). Although First Greensboro generated a large percentage of the Company's Mortgage Loan originations, the Company was able to replace such loan originations through (i) its other Strategic Alliance Mortgage Bankers, three of which entered into strategic alliance agreements with the Company subsequent to April 1996 and (ii) its direct retail lending operation, the planned implementation of which was accelerated as a result of the termination of the First Greensboro strategic alliance agreement. The Company's retail mortgage lending operations were established in the second quarter of 1996, and at December 31, 1996, operated through offices in Indianapolis, IN, Phoenix, AZ, Baton Rouge, LA, and New Orleans, LA. The Company opened additional retail lending operations in Greenville, SC, Atlanta, GA, Jackson, MS, and Jacksonville, FL during the first quarter of 1997, and plans to open additional new offices later in 1997. Through its retail offices, the Company targets Mortgage Loan borrowers through a variety of marketing methods. During December 1996, January 1997, and February 1997, retail originations totaled $18.9 million, $22.2 million, and $28.6 million, respectively. The Company expects continued growth in retail Mortgage Loan originations. 2 3 The following table sets forth certain data relating to the Company's loans at and for the period indicated:
AT AND FOR THE YEAR ENDED DECEMBER 31, -------------------------------------- 1993 1994 1995 1996 ---- ---- ---- ---- (DOLLARS IN THOUSANDS) MORTGAGE DIVISION LOANS: $ 20,536 $ 99,373 $ 192,800 $ 328,649 Mortgage Loans originated during year 42,335 60,151 88,165 146,232 Total Mortgage Loans owned (period end) 42,335 60,151 88,165 146,232 Total serviced Mortgage Loans (period end) 42,397 51,243 74,158 97,281 Average Mortgage Loans (1) 42,397 51,243 74,158 97,281 Average Serviced Mortgage Loans (1) 11.96% 12.37% 12.10% 11.97% Weighted averaged interest rate SMALL BUSINESS DIVISION LOANS: Small Business loans originated during year $ 37,867 $ 43,123 $ 39,560 $ 68,210 Total Small Business loans owned (period end) 17,933 26,764 20,620 29,385 Total serviced Small Business Loans (period end) 58,552 88,809 108,696 140,809 Average Small Business Loans (1) 13,956 22,348 23,692 26,700 Average serviced Small Business Loans (1) 40,117 73,681 98,753 125,723 Weighted average interest rate 7.65% 10.11% 10.39% 12.61% Weighted average servicing fee 1.11% .41% .59% 1.30% AUTO DIVISION LOANS: Auto Loans originated during year $ 5,230 $ 7,547 $ 17,148 $ 18,287 Total Auto Loans owned (period end) 6,011 8,483 17,673 13,915 Total serviced Auto Loans (period end) 6,011 8,483 17,673 22,033 Average Auto Loans (1) 5,179 7,247 13,078 11,917 Average serviced Auto Loans (1) 5,179 7,247 13,078 21,277 Weighted average interest rate 28.33% 28.28% 27.40% 23.57% Weighted average servicing fee -- -- -- 21.20% TOTAL LOANS: Total loans receivable owned (period end) $ 66,279 $ 95,398 $ 126,458 $ 189,532 Total serviced loans receivable (period end) 106,898 157,443 214,534 309,073 Total unguaranteed serviced loans (period end) 59,584 87,405 130,705 212,281
(1) Averages are computed using beginning and ending balances for the period presented, except that the 1996 averages are calculated based on the daily average (rather than the beginning and ending balances). 3 4 PROFITABILITY The principal components of the Company's profitability are (i) net interest and servicing revenues associated with the Company's loans receivable and serviced loans, which is the excess of interest and fees earned on its serviced loans receivable over interest expense paid on borrowed funds associated with such serviced loans receivable; (ii) gains resulting from the sale of its Mortgage Loans; and (iii) gains resulting from the sale of the SBA Loan participations and the related servicing revenue. 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 YEAR ENDED DECEMBER 31, ------------------------------- 1993 1994 1995 1996 ---- ---- ---- ---- Interest income 63.9% 58.8% 57.8% 35.5% Servicing fee income 2.4 1.1 1.7 6.5 Gain on sale of loans 30.0 35.4 34.9 47.3 Other revenues 3.7 4.7 5.6 10.7 ------ ------ ------ ------ Total revenues 100.0% 100.0% 100.0% 100.0% ====== ====== ====== ====== Interest expense 42.1% 32.3% 32.5% 21.9% General and administrative expenses 46.7 40.4 39.6 46.6 Provision for credit losses 5.7 13.8 9.4 10.7 ----- ----- ----- ----- Income from continuing operations before income taxes 5.5 13.5 18.5 20.8 Income tax expense (benefit) (1.6) 3.3 0.8 1.4 Minority interest (0.2) (0.3) (0.3) .7 Income (loss) from discontinued operations 2.1 3.0 (14.9) -- Cumulative effect of change in accounting principle 0.9 -- -- -- ----- ----- ----- ----- Net income 9.9% 12.9% 2.5% 20.1% ===== ===== ===== =====
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1996, COMPARED TO YEAR ENDED DECEMBER 31, 1995 Total revenues increased $24.1 million, or 92%, from $26.3 million in 1995 to $50.4 million in 1996. The increase in revenues resulted principally from increases in interest and servicing revenue and gain on sale of loans. Interest revenue increased $2.7 million, or 18%, from $15.2 million in 1995 to $17.9 million in 1996. This increase was due principally to the growth in the serviced loan portfolio in the Mortgage Loan Division. Interest revenue earned by the Mortgage Loan Division increased $4.6 million or 51%, from $9.1 million in 1995 to $13.7 million in 1996. 4 5 Servicing revenue increased $2.85 million, or 640% from $446,000 in 1994 to $3.3 million in 1996. This increase was due to the securitization of Small Business Loans and Auto Loans in 1996, for which the company retains servicing rights. Gain on sale of loans increased $14.6 million, or 159%, from $9.2 million in 1995 to $23.8 million in 1996. The increase resulted partially from increased sales of Mortgage Loans and Small Business Loans associated with the increased loan originations and the securitization of Small Business Loans in November 1996. Mortgage Loans sold increased $157.2 million, or 123% from $127.6 million in 1995 to $284.8 million in 1996. Small Business Loans sold increased $7.7 million, or 30%, from $25.4 million in 1995 to $33.1 million in 1996. Additionally, the Company received a recoupment of previously shared premiums of $7.3 million in connection with the settlement with First Greensboro Home Equity, Inc. and Amerifund Group, Inc., two strategic partners who terminated their agreements with the Company in 1996. Loan fees increased $3.6 million, or 616% from $586,000 in 1995 to $4.2 million in 1996. The increase in loan fees was due principally to the increase in loan originations in the Mortgage Loan Division. Management fees decreased $56,000, or 10% from $570,000 in 1995 to $514,0000 in 1996. These management fees were paid to the Company by the two funds managed by the Company. In 1995, the fees included additional income due to the success of one of the investments of one of the funds. Other revenues increased $413,000, or 131%, from $314,000 in 1995 to $727,000 in 1996. Other revenues are comprised principally of insurance commissions. The increase of other revenues resulted principally from the increase in the Company's loan originations. Total expenses increased $18.5 million, or 86%, from $21.4 million in 1995 to $39.9 million in 1996. Total expenses are comprised of interest expense, provision for credit losses and general and administrative expenses. Interest expense increased $2.5 million, or 29%, from $8.5 million in 1995 to $11.0 million in 1996. The increase was due principally to increased borrowings by the Mortgage and Small Business Loan Divisions associated with increased loan originations. Borrowings attributable to the Mortgage Loan Division, both under the Credit Facilities and in connection with the sales of notes payable to investors and subordinated debentures, increased $55.7 million, or 53%, from $105.2 million at December 31,1 995 to $160.9 million at December 31, 1996. Interest expense in the Mortgage Loan Division increased $2.4 million in 1996 from 1995. Total borrowings attributable to the Small Business Loan Division decreased $6.1 million, or 41%, from $14.8 at December 31, 1995 to $8.7 million at December 31, 1996. This decrease in debt resulted principally from cash received from the securitization completed in November 1996 which was used to pay down outstanding debt. Interest expense in the Small Business Loan Division increased $198,000 in 1996 from 1995. There were no borrowings outstanding in the Auto Loan Division as of December 31, 1996, down from $9.9 million at December 31, 1995. This decreased resulted principally from cash received from the securitization transaction completed in March 1996 and from the Company's public offering completed in November 1996. The offering was used to pay outstanding debt. Interest expense in the Auto Loan Division decreased $220,000 in 1996 from 1995. 5 6 Provision for credit losses increased $2.9 million, or 116%, from $2.5 million in 1995 to $5.4 million in 1996. The provision was made to maintain the general reserves for credit losses associated with loan originations, as well as to increase specific reserves for possible losses with particular loans. General and administrative expense increased $13.1 million, or 126%, from $10.4 million in 1995 to $23.5 million in 1996. This is a result of increased personnel costs in the Mortgage Loan Division due to the continued expansion in the servicing and underwriting departments, and the increased expenses associated with the opening of retail lending offices in Indianapolis, Baton Rouge, New Orleans, and Phoenix. General and administrative expenses increased from 5.63% of average serviced loans in 1995 to 9.62% in 1996, principally as a result of the costs associated with the retail mortgage origination facilities, for which the related production was sold on a non-recourse, servicing-released basis, with customary representations and warranties. Accordingly, costs have been increased relative to the serviced portfolio. Income from continuing operations increased $5.5 million, or 120%, from $4.6 million in 1995 to $10.1 million in 1996. The improvement in income was due principally to the increased growth and profitability of the Mortgage Loan Division, although the Small Business Loan Divison's profitability also increased significantly in 1996 from 1995. Year Ended December 31, 1995, Compared to Year Ended December 31, 1994 Total revenues increased $8.1 million, or 44%, from $18.2 million in 1994 to $26.3 million in 1995. The increase in revenues resulted principally from increases in interest and servicing revenue and gain on sale of loans due to increased loan originations, sales and serviced loan portfolio of the Mortgage Loan Division. Interest revenue increased $4.5 million, or 42%, from $10.7 million in 1994 to $15.2 million in 1995. This increase was due principally to the growth in the serviced loan portfolio in the Mortgage Loan Division. Interest revenue earned by the Mortgage Loan Division increased $2.8 million or 44%, from $6.3 million in 1994 to $9.1 million in 1995. Interest revenue earned by the Small Business Loan Division increased $200,000, or 9%, from $2.3 million in 1994 to $2.5 million in 1995. This increase resulted from continued growth in serviced SBA Loans, despite the temporary changes in the SBA policies which negatively impacted the Company's SBA Loan originations. Interest revenue earned by the Auto Loan Division increased $1.5 million, or 71%, from $2.1 million in 1994 to $3.6 million in 1995. The increase in interest and servicing revenue for the Auto Loan Division was due to the growth of its loan portfolio. Servicing revenue increased $234,000, or 110%, from $212,000 in 1995 to $446,000 in 1996. This increase was due to the securitization of loans in the Small Business Loan Division in June 1995 as well as the increase in the guaranteed portion of sold SBA Loans serviced by the Company as a result of increased loan originations. Gain on sale of loans increased $2.7 million, or 42%, from $6.5 million in 1994 to $9.2 million in 1995. Gain on sale of loans was generated from the sale of Mortgage Loans and SBA Loan Participations. The increase resulted principally from increased sales of Mortgage Loans associated with the increased loan originations of the Mortgage Loan Division. 6 7 Loan Fees increased $310,000, or 112% from $276,000 in 1994 to $586,000 in 1995. The increase in loan fees was due principally to the increase in loan origination fees charged in the Auto Loan Division. Management fees increased $250,000, or 78%, from $320,000 in 1994 to $570,000 in 1995. These management fees were paid to the Company by the two funds managed by the Company. In 1995, the fees included additional income due to the success of one of the investments of one of the funds. Other revenues increased $68,000, or 28%, from $246,000 in 1994 to $314,000 in 1995. Other revenues are comprised principally of insurance commissions. The increase in other revenues in other revenues resulted principally from the increase in the Company's loan originations. Total expenses increased $5.7 million, or 36%, from $15.7 million in 1994 to $21.4 million in 1995. Total expenses are comprised of interest expense, provision for credit losses and general and administrative expenses. Interest expense increased $2.6 million, or 44%, from $5.9 million in 1994 to $8.5 million in 1995. The increase was due principally to increased borrowings by the Mortgage and Auto Loan Divisions associated with increased loan originations. Total borrowings attributable to the Mortgage Loan Division, both under the Credit Facilities and in connection with the sale of investor savings debentures, increased $27.7 million, or 36%, from $77.5 million at December 31, 1994 to $105.2 million at December 31, 1995. Interest expense in the Mortgage Loan Division increased $1.6 million in 1995 from 1994. Total borrowings attributable to the Small Business Loan Division increased $400,000, or 3%, from $14.4 million at December 31, 1994 to $14.8 million at December 31, 1995. This increase in debt resulted principally from current year loan origination activity, partially offset by a reduction to outstanding debt due to the securitization transaction completed in June 1995. Interest expense in the Small Business Loan Division increased $553,000 in 1995 from 1994. Total borrowings attributable to the Auto Loan Division increased $7.0 million, or 241%, from $2.9 million at December 31, 1994 to $9.9 million at December 31, 1995. Interest expense in the Auto Loan Division increased $500,000 in 1995 from 1994. Provision for credit losses remained flat at $2.5 million in 1994 and in 1995. The provision was made to maintain the general reserves for credit losses associated with loan growth, as well as to increase specific reserves for possible losses associated with particular loans. In 1994, the majority of the provision resulted from the writedown to market value of certain foreclosed properties in the amount of $1.7 million. These foreclosed properties related principally to speculative construction loans made by CII prior to its acquisition by the Company. Speculative construction loans are no longer being made by the Company. General and administrative expense increased $3.0 million, or 40%, from $7.4 million in 1994 to $10.4 million in 1995 principally as a result of increased personnel costs of $1.7 million due primarily to the continued expansion in the servicing and underwriting areas, increased legal, audit, and professional fees of $504,000 as a result of the stock tender offer by the Company in February 1995 and costs associated with the one-for-three reverse stock split approved by the shareholders in June 1995, and increased expenses of $477,000 associated with the opening of three new loan production offices by the Auto Loan Division. General and administrative expense increased from 5.59% of average serviced loans in 1994 to 5.63% in 1995, principally as a result of the increase in the Mortgage Loan Division's servicing operations in anticipation of increased originations of Mortgage Loans, including Mortgage Loans which may be sold servicing retained. 7 8 Income from continuing operations increased $2.8 million, or 155% from $1.8 million in 1994 to $4.6 million in 1995. The improvement in income was due principally to increased growth and profitability of the Mortgage Loan Division. DISCONTINUED OPERATIONS In connection with the Company's strategic plan to focus its business efforts on financial services, the Company divested its apparel operations, which was comprised solely of the operations of Young Generations, Inc. ("YGI"). On September 30, 1995, the Company sold all of the outstanding stock of YGI to fifteen individuals, who were members of YGI's management team. As a result, the loss on the sale of the stock and operating results of the apparel operations have been classified in the accompanying financial statements as discontinued operations. The results of operations for 1994 and 1995 have been restated to exclude the apparel operations from continuing operations. The Company sold the stock for $600,000 under a non-recourse promissory note from the buyers. As a result of the sale, the Company wrote off all amounts due from YGI resulting in a charge of $3,580,300, net of income taxes of $67,700, reported as a loss from discontinued operations. The Company remains contingently liable for the guaranty of certain bank loans and trade accounts payable which existed prior to the stock sale which do not exceed $396,000. Management does not anticipate any significant charges to future earnings as a result of these guarantees. The Company's transportation operations were also discontinued during 1995. In July 1994, the Company sold an operating railroad for $940,000. In connection with this sale, the Company received $20,000 cash, and a note receivable of $920,000, payable in semi-annual payments over five years, with an interest rate of 10%. In November 1994, the Company assigned the rights to boxcars in a lease with a Class I railroad for $1,174,000 cash. The Company sold additional railcars in June 1995 for $111,000 cash. At December 31, 1995, the Company had remaining assets in its transportation operations of $77,000, the majority of which the Company sold during 1996. ALLOWANCE FOR CREDIT LOSSES AND CREDIT LOSS EXPERIENCE The Company is exposed to the risk of loan delinquencies and defaults, particularly 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 delinquencies and defaults on such loans while they are held by the Company pending such sale. Following the sale of such loans, the Company's loan delinquency and default risk with respect to such loans is limited to those circumstances in which it is required to repurchase such loans due to a breach of a representation or warranty in connection with the whole loan sale. This risk with respect to breaches of a representation or warranties also exists for loans sold through securitization. In addition, in securitization transactions the subordinate and/or residual certificates bear the risk of default for the entire pool of securitized loans to the extent of such certificates' value. Accordingly, the value of the subordinate and/or residual certificates retained by the Company would be impaired to the extent of losses on the securitized loans. 8 9 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 future losses of principal on its portfolio loans and its residual asset-backed certificates held as a result of its securitizations of loans (which represent all loans for which the Company bears credit risk). At December 31, 1996, the total allowance for credit losses for the Company was $4.3 million, including $1.2 million reserved for potential losses relating to the Company's securitized SBA and Auto Loans. This compares to an allowance for credit losses at December 31, 1994 and 1995 of $1.7 million and $2.6 million, respectively. The increase in the allowance resulted from increases in the general allowance due to the corresponding growth in the Company's serviced loans receivable, as well as to provide specific reserves for possible losses associated with particular loans. The allowance for credit losses is a composite of the allowance for credit losses of the Mortgage Loan Division, the Small Business Loan Division and the Auto Loan Division. In addition to general reserves established, each division may establish a specific reserve for a particular loan that is deemedd by management to be a potential problem loan where full recovery is questionable. The Company does not currently service any loans for which it does not have credit risk other than the guaranteed portion of its SBA Loans. However, the Company's credit risk on its securitized loans is limited to its investment in its residual asset-backed securities and its excess servicing receivable. The table below summarizes certain information with respect to the Company's allowance for credit losses and the compositiuon of charge-offs and recoveries for each of the periods indicated. SUMMARY OF ALLOWANCE FOR CREDIT LOSSES
AT AND FOR THE YEAR ENDED DECEMBER 31, ------------------------------------- 1994 1995 1996 ---- ---- ---- (DOLLARS IN THOUSANDS) Allowance for credit losses at beginning of period $ 952 $ 1,730 $ 2,647 Total loans charged off (1,808) (1,718) (4,223) Total loans recovered 76 155 446 ------- ------- ------- Net charge-offs (1,732) (1,563) (3,777) Provision charged to expense 2,510 2,480 5,416 ------- ------- ------- Allowance for credit losses at the end of the period $ 1,730 $ 2,647 $ 4,286 Shown on balance sheet as: ======= ======= ======= Allowance for credit losses on loans $ 1,730 $ 1,874 $ 3,084 Allowance for credit losses on asset-backed securities -- 773 354 Allowance for credit losses on excess servicing receivable -- -- 848 ------- ------- ------- Total allowance for credit losses $ 1,730 $ 2,647 $ 4,286 ======= ======= =======
9 10 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. Management considers the 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. Management closely monitors delinquency to measure the quality of its loan portfolio and securitized loans and the potential for credit losses. The Company's policy is to place a loan on non-accrual status after it becomes 90 days past due, or sooner if the interest is deemed uncollectible. Collection efforts on charged-off loans continue until the obligation is satisfied or until it is determined such obligation is not collectible or the cost of continued collection efforts will exceed the potential recovery. Recoveries of previously charged-off loans are credited to the allowance for credit losses. The following table sets forth the Company's allowance for credit losses 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 90 days past due.
AT AND FOR THE YEAR ENDED ------------------------- DECEMBER 31, 1994 1995 1996 ---- ---- ---- ALLOWANCE FOR CREDIT LOSSES AS A % OF UNGUARANTEED SERVICED LOANS: Mortgage Loan Division 1.23% 0.93% 0.80% Small Business Loan Division 3.91 4.50 3.84 Auto Loan Division 3.00 4.03 6.45 Total allowance for credit losses as a % of serviced loans 1.98 2.03 2.02 NET CHARGE-OFFS AS A % OF AVERAGE SERVICED LOANS: Mortgage Loan Division 2.96% 1.04% 0.81% Small Business Loan Division 0.21 1.43 2.71 Auto Loan Division 2.53 3.68 9.65 Total net charge-offs as a % of total serviced loans 2.36 1.43 2.47 LOANS RECEIVABLE PAST DUE 90 DAYS OR MORE AS A % OF SERVICED LOANS: Mortgage Loan Division 2.96% 3.67% 2.23% Small Business Loan Division -- 0.97 2.63 Auto Loan Division 0.64 0.77 1.90 Total loans receivable past due 90 days or more as a % of total serviced loans 2.10 2.77 2.28 TOTAL ALLOWANCE FOR CREDIT LOSSES AS A % OF SERVICED LOANS PAST DUE 90 DAYS OR MORE 94.20% 73.21% 88.71%
Net loans charged off increased from 1.43% of average unguaranteed serviced loans outstanding for the year ended December 31, 1995, to 2.47% for the year ended December 31, 1996. The increase in net loans charged off resulted from writedowns in the estimated fair market value of real estate acquired through 10 11 foreclosure, increased losses in the Small Business Loan Division due to the continued seasoning of the SBA Loan portfolio, and higher losses in the Auto Loan Division due to increased delinquencies, repossession activity, and personal bankruptcy filings by its borrowers. Net Mortgage Loans charged off in 1996 were $792,000 or 80 basis points of total serviced mortgage loans. Net Small Business Loans charged off in 1996 were $932,000 or 2.71% of unguaranteed serviced Small Business Loans. Net Auto Loans charged off in 1996 were $2.1 million, or 9.65% of total serviced Auto Loans. The allowance for loan losses in the serviced loan portfolio was increased from $2.6 million at December 31, 1995 to $4.3 million at December 31, 1996, which represents 2.03% and 2.02%, respectively, of the unguaranteed serviced loan portfolio outstanding. Total delinquencies over 30 days have decreased from 13.31% of total unguaranteed serviced loans at December 31, 1995, to 8.41% at December 31, 1996. Total delinquencies over 30 days as a percentage of total unguaranteed serviced loans have decreased from December 31, 1995 to December 31, 1996, for both the Mortgage Loan Division (from 14.43% to 7.26%) and the Small Business Loan Division (from 9.69% to 7.92%), but have increased for the Auto Loan Division (from 12.83% to 17.09%). Management anticipates that net charge-offs as a percentage of average serviced loans will be lower for 1997 compared to 1996 as a result of the increased writedowns in 1996 discussed above, which are not anticipated to be a recurring event. Further, the delinquencies for the Company have declined in the first two months of 1997. At February 28, 1997, total delinquencies over 30 days as a percentage of total unguaranteed serviced loans have decreased from 8.41% at December 31, 1996 to 6.15% at February 28, 1997. The improved delinquencies were across all three business lines, with Mortgage Loan Division delinquencies decreasing from 7.26% to 5.69%, Small Business Loan Division delinquencies decreasing from 7.92% to 5.57%, and Auto Loan Division delinquencies decreasing from 17.09% to 11.34%. Accordingly, charge-offs for 1997 are anticipated to improve also. However, anticipated charge-off levels represent forward-looking statements, and no assurance can be given that actual results will not differ materially. Factors which could cause charge-off levels to increase are many and include economic downturn, poor underwriting or quality control, and depressed real estate values. LIQUIDITY AND CAPITAL RESOURCES The Company's business requires continued access to short- and long-term sources of debt financing and equity capital. The Company's cash requirements arise from loan originations and purchases, repayments of debt upon maturity, payments of operating and interest expenses, expansion activities and capital expenditures. The Company's primary sources of liquidity are sales of the loans it originates and purchases, proceeds from the sale of investor savings debentures, borrowings under the Bredit Facilities, proceeds from securitizations of loans and cash flows from operations. While the Company believes that such sources of funds will be adequate to meet its liquidity requirements, no asurance of this may be given. Shareholder's equity increased from $9.7 million at December 31, 1994, to $9.9 million at December 31, 1995, and to $46.7 million at December 31, 1996. Each of these increases resulted principally from the retention of income by the Company and the public offering of additional common stock in November 1996 which raised $26.4 million. 11 12 Cash and cash equivalents remained stable at $1.3 million at December 31, 1995 and 1996. Cash used in operating activities increased from $10.1 million in 1995 to $59.6 million in 1996, cash used in investing activities decreased from $23.2 million in 1995 to $6.8 million in 1996; and cash provided by financing activities increased from $34.4 million in 1995 to $66.3 million in 1996. The increase in cash used in operations was due principally to loans held for sale which were originated, but not yet sold as of December 31, 1996. Cash used in investing activities was principally for the net increase in loans originated with the expectations of holding the loans until maturity. Cash provided by financing activities was due principally to the increase in borrowing, both under the lines of credit available to the Company (the "Credit Facilities") and through the sale of the investor savings debentures, as well as the proceeds from the issuance of additional common stock. At December 31, 1996, the Company's Credit Facilities were comprised of credit facilities of $90 million for the Mortgage Loan Division which had aggregate unused borrowing availability of $14.2 million (the "Mortgage Loan Division Facility"), credit facilities of $40 million for the Small Business Loan Division which had aggregate unused borrowing availability of $13.7 million (the "Small Business Loan Division Facility"), and credit facilities of $26 million for the Auto Loan Division which had aggregate unused borrowing availability of $9.8 million (the "Auto Loan Division Facility"). The Credit Facilities contain a number of financial covenants including but not limited to, maintenance of certain debt to equity ratios, maintenance of minimum book net worth, limitations on declaring or paying dividends, limitations on making payments with respect to certain subordinated debt, and limitations on making certain changes to its equity structure. The Company believes that it is currently in material compliance with these covenants. At December 31, 1996, one of the Company's automobile lending subsidiaries exceeded the maximum delinquency levels permitted under the $20,000,000 agreement. In addition, the Company's automobile lending subsidiaries were also in violation of the minimum interest coverage ratio. The lender for the Auto Loan Division Facility has provided a waiver to the Company's automobile lending subsidiaries for the above violations. At December 31, 1996, $46.8 million bearing interest at the lender's prime rate eas outstanding under the Mortgage Loan Division Facility, $8.7 million bearing interest at the lender's prime rate was outstanding under the Small Business Loan Division Facility, and there was no debt outstanding under the Auto Loan Division Facilities. The Credit Facilities have terms ranging from one to three years and are renewable upon the mutual agreement of the Company and the respective lender. Send Note 8 to the Consolidated Financial Statements for additional information. To date, the Company has sold the majority of its Mortgage Loans and the guaranteed portion of its SBA Loans. During 1995 and 1996, the Company sold $127.6 million and $284.8 million, respectively, of Mortgage Loans and $25.4 million and $33.1 million, respectively, of the guaranteed portion of the SBA Loans. In June 1995 and November 1996, the Company securitized approximately $17.1 million and $17.5 million, respectively of loans representing the unguaranteed portions of the SBA Loans, and in March 1996, the Company securitized $16.1 million of Auto Loans. Although securitizations provide liquidity, the Company has utilized securitizations principally to provide a lower cost of funds and reduce interest rate risk. In connection with each loan securitization, the Company has retained subordinated certificates representing interests in the transferred loans equal to approximately 10% of the loans transferred. The retained subordinated certificates totaled approximately $3.6 million, net of allowances, at December 31, 1996. 12 13 CII engages in the sale of investor savings debentures to residents of South Carolina. The debentures are comprised of senior notes and subordinated debentures bearing fixed rates of interest. The offering of the debentures is registered under South Carolina securities law and exempt from Federal registration under the Federal intrastate exemption. At December 31, 1996, CII had an aggregate of $98.0 million of senior notes outstanding and $16 million in subordinated debentures bearing a weighted average interest rate of 6%. Both senior notes and subordinated debentures are subordinate in priority to the Mortgage Loan Division Credit Facility. Substantially all of the debentures have one year maturities. The Company expects to continue offering the debentures. The Company plans to continue to enhance its Management Information Systems in 1997, as well as incur additional other capital expenditures. The Company believes its capital requirements during 1997 will be met from retained earnings, current earnings, and utilization of proceeds from the common stock offering in 1996, although additional capital may be required in the event that business expands significantly more than anticipated, or in the event of a material adverse change in the Company's operations. TAX CONSIDERATIONS As a result of the operating losses incurred by the Company under prior management, the Company generated the NOL. At December 31, 1996, the amount of the NOL remaining and available to the Company was approximately $13.5 million. As a result of the utilization of the NOL, the net income reported by the Company for the year ended December 31, 1995 and 1996, was approximately $1.2 million and $3.4 million, respectively, higher than if the NOL were not available to the Company. The NOL expires, to the extent that it is not utilized to offset income, in varying amounts annually through 2001. 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. No net deferred tax asset was recognized with respect to the NOL for the years ended December 31, 1994, 1995, and 1996. A valuation allowance equal to the tax effect of the NOL was applied to the NOL in each of the years ended December 31, 1995 and 1996. A valuation allowance of approximately $7.5 million was applied to the tax effect of the NOL for the year ended December 31, 1996 ACCOUNTING CONSIDERATIONS In connection with the Company's sale of SBA Loan participations and securitization transactions, the Company accounts for the servicing revenue in excess of that defined as "normal" servicing revenue as excess servicing receivable in accordance with Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 65. This asset is amortized against servicing revenue over the life of the loan to which it relates. In the event that the related loan is prepaid or the related borrower defaults on such loan, the balance of the excess servicing receivable is charged against servicing revenue in the period in which the prepayment or default occurs. 13 14 The Company complies with the provisions of Emerging Issues Task Force ("EITF") 88-11 dealing with income recognition on the sales of loans. EITF 88-11 requires that the amount of gain or loss recognized on the sale of a portion of a loan be based on the relative fair values of the loan portion sold and the loan portion retained. For the Company, EITF 88-11 primarily impacts the amount of gain recognized by the Company on the sale of the SBA Loan Participations. As result of the Company's accounting treatment described above, a portion of the cash premiums received are deferred and recognized as income over the remaining term of the retained unguaranteed portion of the loan. IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS AND REGULATORY POLICIES In June 1996, the FASB issued SFAS 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities." FASB's objective is to develop consistent accounting standards for such transactions, including determining when financial assets should be considered sold and removed from the statement of financial position, and when related revenues and expenses should be recognized. This approach focuses on analyzing the components of financial asset transfers and requires each party to a transfer to recognize the financial assets it controls and liabilities it has incurred and remove such assets from the statement of financial position when control over them has been relinquished. The statement is not expected to have a significant impact on the accounting practices of the Company and is generally effective for transactions entered into after December 31, 1996. In December 1996, the FASB issued SFAS 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125." The provisions relating to this statement are not applicable to the Company. INFLATION Unlike most industrial companies, the assets and liabilities of financial services companies such as the Company are primarily monetary in nature. Therefore, interest rates have a more significant effect on the Company's performance than do the general levels of inflation in the price of goods and services. While the Company's noninterest income and expense and the interest rates earned and paid are affected by the rate of inflation, the Company believes that the effects of inflation are generally manageable through asset/liability management. INTEREST RATE SENSITIVITY Asset/liability management is the process by which the Company monitors and controls the mix and maturities of its assets and liabilities. The essential purpose of asset/liability management is to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities. The Company's asset/liability management varies by division. In general, with respect to the Mortgage Loan Division, the Company sells a significant portion of its mortgage loan production on a monthly basis and commitments for mortgage loans do not extend beyond 45 days. In the event that the economic conditions necessitate a change in rate, such rate change is communicated to potential borrowers and the Company's published rates are adjusted. In addition, 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. The Company's Mortgage Loans bear interest at a fixed rate. The Company does not currently hedge its loan pipeline. The Mortgage Loans generally have maturities of 15 to 30 years while the 14 15 line of credit used to fund these loans has a one-year maturity and bears interest at a variable rate. Accordingly, the Company has duration risk and interest rate risk on its Mortgage Loans prior to sale or securitization. Beginning in the first quarter of 1997, the Company plans to begin securitizing a portion of its Mortgage Loan production on a quarterly basis, and accordingly will hold an inventory of loans in its portfolio for up to 90 days. This exposes the Company to increased interest rate risk during that holding period. Once the securitization is completed, the loans are sold, so the Company no longer bears any interest rate risk or duration risk for the loans after the securitization is completed. The Company currently has no plans to hedge its interest rate risk during the accumulation period prior to the completion of its securitization transactions, although it may decide to do so in the future. With respect to the Small Business Loan Division, the Company only originates variable rate loans, which adjust on the first day of each calendar quarter. The funding for these loans are variable rate, which adjust on the first day of each month. Therefore, interest rate risk exists for a maximum period of 60 days, due to the Small Business Loan Credit Facility having a variable rate which adjusts monthly. The SBA Loans generally have maturities from 7 to 25 years while the line of credit used to fund these loans has a much shorter maturity. Accordingly, the Company has duration risk on its SBA Loans prior to sale or securitization. The Company bears no interest rate risk or duration risk relating to its securitized SBA Loans or the sold guaranteed SBA Loan participations. With respect to the Auto Loan Division, the Company's spread is in excess of 15%. All of the Company's Auto Loans are fixed rate loans. The contractual terms of the loans are generally three to four years, but the actual life approximates 18 months after considering the estimated constant prepayment rate. Because the Company's funding for these loans are variable rate while the funded loans are fixed rate, the Company bears both interest rate risk and duration risk on its Auto Loans prior to securitization. The Company currently has no plans to hedge its interest rate risk, although it may decide to do so in the future. The Company believes that this interest rate spread provides adequate margin to allow for any potential increase in interest rates, given the relatively short term of these loans. Further, the Auto Loans securitized are sold, so the Company no longer bears any interest rate risk or duration risk relating to its securitized Auto Loans. The company's average interest rate and servicing fee earned for the years ended December 31, 1995 and 1996 were 13.94% and 15.52%, respectively, computed on a simple average monthly basis. The Company's average interest rate paid for the years ended December 31, 1995 and 1996 were 7.57% and 7.36%, respectively, which resulted in an average spread of 6.37% and 8.16%, respectively, between the rate at which the Company borrows and the rate at which it lends. 15 EX-21.0 6 LISTING OF SUBSIDIARIES 1 EXHIBIT 21.0 Subsidiary State of Incorporation - ----------------------------------- ----------------------- Emergent Mortgage Corp. South Carolina Emergent Commercial Mortgage Corporation South Carolina Carolina Investors, Inc. South Carolina Emergent Mortgage Corp. of Tennessee South Carolina Emergent Mortgage Holdings Corporation South Carolina Emergent Business Capital, Inc. South Carolina Emergent Business Capital Holdings, Corp. South Carolina Emergent Financial Corp. South Carolina Emergent Equity Advisors, Inc. South Carolina The Loan Pro$, Inc. South Carolina (80% owned) Premier Financial Services, Inc. South Carolina Emergent Auto Holdings Corp. South Carolina The Mississippian Railway, Inc. (Inactive) South Carolina Pickens Liquidation Corp. (Inactive) South Carolina (81% owned) Sterling Lending Corporation South Carolina (80% owned) Sterling Insurance Agency Louisiana 33 EX-23.1 7 REPORT OF INDEPENDENT AUDITORS 1 EXHIBIT 23.1 MEMBERS OF THE AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS GREENVILLE, S.C. GREENWOOD, S.C. ANDERSON, S.C. COLUMBIA, S.C. [EDC LOGO] ELLIOTT, DAVIS & COMPANY, L.L.P. CERTIFIED PUBLIC ACCOUNTANTS REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Shareholders and Board of Directors EMERGENT GROUP, INC. AND SUBSIDIARIES Greenville, South Carolina We have audited the accompanying consolidated balance sheet of EMERGENT GROUP, INC. AND SUBSIDIARIES as of December 31, 1995, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the two years in the period ended December 31, 1995. 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 generally accepted auditing standards. 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 consolidated financial position of EMERGENT GROUP, INC. AND SUBSIDIARIES as of December 31, 1995, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. /s/ Elliott, Davis & Company, L.L.P - ----------------------------------- ELLIOTT, DAVIS AND COMPANY, L.L.P. Greenville, South Carolina January 31, 1996 EX-23.2 8 CONSENT OF KPMG 1 Exhibit 23.2 INDEPENDENT AUDITORS' CONSENT The Board of Directors Emergent Group, Inc. We consent to incorporation by reference in the registration statements on Form S-8 (No. 333-07925) 1995 Director Stock Option Plan Stock Plan, (No. 333-07927) 1995 Restricted Stock Agreement Plan, (No. 333-07923) 1995 Officer and Employee Stock Option Plan and (No. 333-20179) Employee Stock Purchase Plan of Emergent Group, Inc. of our report dated January 30, 1997, relating to the consolidated balance sheets of Emergent Group, Inc. and subsidiaries (the "Company") as of December 31, 1996 and the related consolidated statements of income, shareholders' equity, and cash flows for the year ended December 31, 1996, which report appears in the December 31, 1996 Annual Report on Form 10-K of the Company. /s/ KPMG Peat Marwick LLP ---------------------------------- Greenville, South Carolina KPMG Peat Marwick LLP March 24, 1997 EX-27 9 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 6,595 3,581 200,393 3,084 0 0 8,875 1,698 224,149 0 0 0 0 457 46,178 224,149 0 50,388 0 23,490 0 5,416 11,021 10,461 718 9,743 0 0 0 10,095 1.42 1.42 UNCLASSIFIED BALANCE SHEET
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