10-K 1 form10k-12312001.txt FOR YEAR ENDING 12-31-2001 UNITED STATES 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, 2001 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO --------------- ------------------ COMMISSION FILE NO. 000-08909 HOMEGOLD FINANCIAL, INC. ------------------------ (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) SOUTH CAROLINA 57-0513287 -------------- ---------- (STATE OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYER ORGANIZATION) IDENTIFICATION NO.) 1021 BRIARGATE CIRCLE, COLUMBIA, SOUTH CAROLINA 29210 ----------------------------------------------- ----- (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) 803-365-2500 ------------ REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE SECURITIES REGISTERED UNDER SECTION 12(B) OF THE ACT: NAME OF EACH EXCHANGE ON TITLE OF EACH CLASS WHICH REGISTERED ------------------- ------------------------- None None SECURITIES REGISTERED UNDER SECTION 12(G) OF THE ACT: TITLE OF EACH CLASS Common Stock, par value $.001 per share Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |_| As of March 28, 2002, the aggregate market value of voting stock held by non-affiliates of registrant was approximately $6.3 million. As of March 28, 2002, 16,912,594 shares of the Registrant's common stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE The Company's Proxy Statement for the Annual Meeting of Shareholders scheduled for June 4, 2002 to be filed not later than 120 days after December 31, 2001 is incorporated by reference into Part III hereof. PART I ITEM 1. BUSINESS GENERAL HomeGold Financial, Inc., together with its subsidiaries (collectively, "HGFN" or "the Company"), is a specialty finance company primarily engaged in the business of originating and selling conforming and sub-prime first and second-lien residential mortgage loan products ("Mortgage Loans") and issuing notes payable and subordinated debentures to investors through its subsidiary, Carolina Investors, Inc. ("CII"). The Company commenced its lending operations in 1991 with the acquisition of CII, a small South Carolina mortgage lender, which had been in business since 1963. Since such acquisition, the Company has significantly expanded its lending operations. During the years 2001, 2000, and 1999, the Company originated $647.9 million, $597.0 million, and $234.0 million of loans, respectively. HomeGold Financial, Inc.'s major operating subsidiaries are HomeGold, Inc. ("HGI") and CII. On April 28, 2000, the shareholders of HomeGold Financial, Inc. approved a merger agreement with HomeSense Financial Corp. and affiliated companies (collectively "HomeSense"), a privately owned business, located in Lexington, South Carolina. The merger was consumated on May 9, 2000, and is described below under the heading "Merger with HomeSense Financial Corp." In August, 2000, the Company closed its wholesale loan origination operations. In the first seven months of 2000 and in the year ended December 31, 1999, loan originations generated by the wholesale brokers represented approximately 33% and 46.9%, respectively, of the Company's total production. In general, these wholesale loans produced much smaller margins compared to loans originated through the Company's retail origination channels. The Company may re-enter the wholesale mortgage business in the future depending on market conditions and other factors. MERGER WITH HOMESENSE FINANCIAL CORP. On May 9, 2000, HomeSense was merged into HGI, a wholly owned subsidiary of HGFN pursuant to a merger agreement approved by HGFN's shareholders on April 28, 2000. HomeSense was a privately owned specialized mortgage company headquartered in Lexington, South Carolina that originated and sold mortgage loans in the sub-prime mortgage industry. Its principal loan product was a debt consolidation loan, generally collateralized by a first lien on the borrower's home. HomeSense originated its loan volume through a direct retail branch network of eight offices, as well as through centrally-provided telemarketing leads, direct mail, and television advertising. HomeGold, Inc. has continued the business of HomeSense after the merger. In the merger, HGFN issued 6,780,944 shares of its common stock (approximately 40% of post-merger shares outstanding) valued at $1.04 per share plus an additional 10 million shares of Series A Non-convertible Preferred Stock, par value $1 per share, for 100% of the outstanding stock of HomeSense. Most of this merger consideration was issued to HomeSense's primary shareholder Ronald J. Sheppard. Mr. Sheppard is now Chief Executive Officer and a director of HGFN, and a director of both HGI and CII. The merger was accounted for under the purchase method of accounting prescribed by generally accepted accounting principles. The transaction resulted in $19.0 million of goodwill. After the merger was consummated, certain differences arose between the parties to the merger regarding the warranties and representations in the merger agreement. These differences were resolved in February 2001 by an agreement between Mr. Sheppard and HGFN pursuant to which Mr. Sheppard agreed to remain a guarantor with respect to certain indebtedness HGI assumed from HomeSense in the merger and pursuant to which options for HGFN stock issued to Mr. Sheppard in the merger were cancelled. In addition, a mutual indemnity agreement between HGFN and Mr. Sheppard was cancelled. 2 The amounts are based upon certain assumptions and estimates, and do not reflect any benefit from economies that might be achieved from combined operations. The pro forma results do not necessarily represent results that would have occurred if the acquisition had taken place on the basis assumed above, nor are they indicative of the results of future combined operations. CRITICAL ACCOUNTING POLICIES The Company has adopted various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of the Company's financial statements. The significant accounting policies of the Company are described in the footnotes to the consolidated financial statements. Certain accounting policies involve significant judgments and assumptions by Management which have a material impact on the carrying value of certain assets and liabilities; Management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by Management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by Management, actual results could differ from these judgments and estimates which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company. The Company believes the allowance for loan losses, assumptions related to residual receivables, valuation of real estate, impairment on property and equipment and the valuation allowance on deferred taxes are the critical accounting policies that require the most significant judgments and estimates used in preparation of its consolidated financial statements. Refer to Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") under applicable sections for detailed descriptions of the Company's estimation process and methodologies related to these specific accounting policies. Going concern, a defined term in professional accounting standards, is a basic underlying assumption for most accounting methods and indicates the Company will fulfill its operational objectives and commitments. As noted in the MD&A and in Note 2 to the Company's Consolidated Financial Statements, and based upon the reasons listed therein, there is substantial doubt as to the Company's ability to continue as a going concern. Refer to Note 2 to the Company's Consolidated Financial Statements for a detailed description of this issue and management's intentions related to it. MORTGAGE LOAN PRODUCTS OVERVIEW The Company provides Mortgage Loan products primarily to owners of single family residences who use the loan proceeds for such purposes as refinancing, debt consolidation, home improvements and educational expenditures. A majority of the Mortgage Loans are made to sub-prime borrowers. These borrowers generally have limited access to credit, or are considered credit-impaired by conventional lenders such as thrift institutions and commercial banks. These conventional lending sources generally impose stringent and inflexible loan underwriting guidelines, as compared to the Company, to approve and fund loans. Loan applications of sub-prime borrowers are generally characterized by one or more of the following: (1) limited or unfavorable credit history, including bankruptcy, (2) problems with employment history, (3) insufficient debt coverage, (4) self-employment or (5) inadequate collateral. During 2001, the Company began originating conforming loans to customers with one or more of the following: (1) favorable credit history, (2) steady income, (3) sufficient debt coverage or (4) adequate collateral. These borrowers are able to obtain financing from many sources and therefore are mostly price sensitive. 3 The Company has developed a comprehensive credit analysis system for its loan originations, which is designed to ensure that credit standards are maintained and consistent underwriting procedures are followed. The Company believes that its customers require or seek a high degree of personalized service and swift response to their loan applications. Also, the Company believes that most of its customers generally focus more on the amount of the monthly payment than the interest rate charged. Furthermore, because the Company's customers are generally credit-impaired for one or more reasons, the customers are typically not in a position to obtain better rates from traditional lending institutions. In 2001, 90% of the Mortgage Loans the Company originated were secured by first-liens. These first-lien Mortgage Loans had an average principal balance of approximately $108,000, a weighted average interest rate of approximately 8.92% and an average loan-to value ("LTV") ratio of 79.7%. Approximately 10% of the Mortgage Loans originated by the Company in 2001 were secured by a second-lien Mortgage Loan, some of which were to the same borrower as the first-lien Mortgage Loan. First and second mortgage combinations resulted in combined LTV ratios that averaged 109% on these loans and may be as high as 125% under the Company's guidelines. Such second-lien Mortgage Loans originated during 2001 had an average principal balance of approximately $41,000 and a weighted average interest rate of approximately 12.17%. In order to reduce the Company's credit risk, second-lien Mortgage Loans with a combined LTV ratio greater than 100% are generally pre-approved and pre-underwritten by a third party and generally sold without recourse on a whole loan basis with certain representations and warranties. Second-lien Mortgage Loans with a combined LTV ratio less than 100% are underwritten by the Company. These loans are generally sold on a whole loan basis without recourse. No assurance can be given that any second-lien Mortgage Loans can be sold. To the extent that the loans are not sold, the Company retains the risk of loss. At December 31, 2001 and 2000, the Company had retained $5.7 million and $17.1 million, respectively, of second-lien mortgage loans on its balance sheet. During 2001, the Company included certain second mortgages in its securitization. The Company may choose to include second mortgage products in future securitizations. The Company has invested significantly in technology and the training of personnel to improve and expand its underwriting, servicing, and collection functions. The Company believes its current operations are capable of supporting increases in both loan origination volume and securitization servicing capacity with only modest increases in fixed expenses. MORTGAGE LOAN ORIGINATION The Company reaches targeted customers for its Mortgage Loan products on a retail basis using a combination of direct mail, telemarketing, and television advertising. Responses are directed through the Company's loan centers in Greenville and Lexington, South Carolina; Cincinnati, Ohio; Tempe, Arizona; San Antonio, Texas; and Philadelphia, Pennsylvania. The Company is licensed to operate its mortgage lending operations in 45 states and the District of Columbia. 4 The following table sets forth mortgage loan originations by channel for the period indicated:
LOAN ORIGINATIONS BY CHANNEL YEAR ENDED DECEMBER 31, 2001 --------------------------------------- 1ST MORTGAGE 2ND MORTGAGE LOANS LOANS TOTAL ------------- ------------- ----- (DOLLARS IN THOUSANDS) Retail - Nonconforming Loan originations...................... $450,996 $ 62,242 $513,238 Average principal balance per loan..... 107 41 89 Weighted average initial LTV ratio.... 81.75% 108.91% 72.37% Weighted average coupon rate.......... 9.44% 12.17% 9.77% Retail - Conforming Loan originations...................... $134,672 -- $134,672 Average principal balance per loan..... 110 -- 110 Weighted average initial LTV ratio..... 72.86% -- 72.86% Weighted average coupon rate........... 7.17% -- 7.17% Total Loan originations...................... $585,668 $ 62,242 $647,910 Average principal balance per loan..... 108 41 93 Weighted average initial LTV ratio..... 79.70% 108.91% 74.85% Weighted average coupon rate........... 8.92% 12.17% 9.23%
RETAIL OPERATION. The Company has focused a significant portion of its resources in developing its retail loan products and in developing its related delivery systems. In January 2001, the Company began originating conforming loans in an effort to maximize profits in a declining interest rate environment. Offering both conforming and nonconforming products allows the Company to more efficiently utilize its financing sources by creating a larger target market across the United States. In 2001, retail Mortgage Loan originations represented 100% of the Company's total loan originations compared to 67% and 53% in 2000 and 1999, respectively. Retail Mortgage Loan originations during 2001, 2000, and 1999, totaled $647.9 million, $399.2 million, and $124.2 million, respectively. The Company believes that its retail operation has significant long-term profit potential because it expects that the origination and other fees (typically paid to the broker-originators) will more than offset the infrastructure expenses associated with operating a retail operation once planned efficiency levels are reached. The Company also believes that the retail operation allows more Company control over the underwriting process and its borrower relationship. Unlike many of its competitors (particularly sub-prime mortgage lenders that began operations as traditional finance companies), the Company markets its retail lending operations in large part using direct mail, telemarketing, and television advertising methods. Compared to a traditional "bricks and mortar" retail approach in which loans are originated out of local, walk-in retail offices, the Company believes that this strategy allows it to target different areas of the country more quickly, depending on the economic, demographic, and other characteristics that may exist at a particular point in time. The Company also believes that this strategy avoids the expense typically associated with multiple physical locations. As of December 31, 2001, the Company has six central origination production locations in order to take advantage of multiple labor pools and time zones for more efficient telephone marketing. WHOLESALE LENDING OPERATION. In August 2000, the Company closed its wholesale mortgage origination division. Although wholesale originations made up a substantial portion of the Company's total origination volume, the margins derived from wholesale production were much smaller than those derived from retail production. All of the Mortgage Loans originated on a wholesale basis by the Company were originated through mortgage brokers with whom the Company had developed continuing relationships. As a wholesale originator of Mortgage Loans, the Company funded the Mortgage Loans at closing. In the first seven months of 2000, wholesale Mortgage Loan originations represented 33% of the Company's total Mortgage Loan originations, compared to 47% in 1999. 5 GEOGRAPHIC DIVERSIFICATION. Since the Company commenced its retail mortgage operations in 1996, it has significantly expanded its geographic presence. During 2001, 2000, and 1999, Mortgage Loan originations by state were as shown below:
STATE 2001 % 2000 % 1999 % ----- ---------- ---- --------- ---- -------- ----- (DOLLARS IN THOUSANDS) California......... $69,109 10.7% $ 8,650 1.4% $ -- --% New Jersey......... 56,715 8.8 22,916 3.8 -- -- South Carolina..... 53,321 8.2 74,320 12.5 25,180 10.8 Virginia.......... 48,377 7.5 32,193 5.4 13,851 5.9 Georgia ........... 41,741 6.4 45,138 7.6 10,751 4.6 Florida ........... 32,945 5.1 30,306 5.1 10,487 4.5 Alabama ........... 31,297 4.8 45,713 7.7 -- -- Michigan........... 29,899 4.6 18,593 3.1 10,392 4.4 Tennessee.......... 24,173 3.7 30,240 5.1 12,163 5.2 Pennsylvania....... 20,580 3.2 14,380 2.4 13,616 5.8 Mississippi........ 18,693 2.9 30,684 5.1 5,214 2.2 Louisiana.......... 15,925 2.5 20,623 3.5 12,239 5.2 Arkansas........... 16,088 2.5 -- -- -- -- Colorado........... 16,192 2.5 -- -- -- -- Ohio . ........... 14,781 2.3 19,616 3.3 10,960 4.7 North Carolina..... 14,520 2.2 46,135 7.7 33,945 14.6 Missouri........... 14,491 2.2 12,747 2.1 7,932 3.4 Washington......... 13,788 2.1 10,252 1.7 -- -- West Virginia...... 10,102 1.6 14,771 2.5 -- -- Indiana ........... 10,143 1.6 10,647 1.8 3,465 1.5 Maryland........... 9,785 1.5 12,715 2.1 -- -- Illinois........... 9,479 1.5 9,080 1.5 9,178 3.9 Minnesota.......... 9,160 1.4 -- -- -- -- New Hampshire...... 8,364 1.3 -- -- -- -- New Mexico......... 6,872 1.1 7,701 1.3 -- -- Wisconsin.......... 6,833 1.1 -- -- -- -- All other states... 44,537 6.7 79,245 13.3 54,632 23.3 -------- ------ --------- ------ -------- ---- Total......... $647,910 100.0% $596,665 100.0% $234,005 100.0% ======== ====== ======== ====== ======== ======
LOAN UNDERWRITING In the application and approval process associated with the Company's retail Mortgage Loan operations, a loan officer finds potential borrowers through leads generated by the Company's marketing efforts. After obtaining an initial loan application, additional information is compiled and gathered and forwarded to the underwriting department for approval. The underwriting department generally completes its review within one business day after procurement of all necessary documentation. Upon approval by the underwriting department, the loan is generally forwarded by the loan closing department to an attorney or title company for closing. Creditworthiness is assessed through a variety of means, including calculating debt to income ratios, examining the applicant's credit history through credit reporting bureaus, verifying an applicant's employment status and income, and checking the applicant's payment history with respect to any first-lien mortgage on the property. The Company uses several procedures to verify information obtained from an applicant. In order to verify an applicant's employment status and income, the Company generally obtains such verification from the applicant's employer. The Company requires self-employed borrowers to provide a copy of their tax return. The Company generally requires an independent appraisal on all loans. Loans in excess of $350,000 generally require two independent appraisals. The Company generally requires title insurance for all real estate loans. The Company also generally requires real estate improvements to be fully insured as to fire and other commonly insurable risks and regularly monitors its loans to ensure that insurance is maintained for the period of the loan. The following table provides a general overview of the Company's principal underwriting criteria for first Mortgage Loans, set forth according to internal product types: 6
INTERNAL PRODUCT TYPE--FIRST MORTGAGES --------------------------------------------------------------------------------- AA A A- B C Existing mortgage No 30 day Maximum of Maximum of Maximum of Maximum of four (maximum historical late one two 30 day late three 30 day 30 day late delinquencies) payments 30 day late payments in late payments in the in the last payment last 12 months; payments in the last 12 months; 24 in last 12 and last 12 months; maximum of one months months; one 60 day maximum of 60 day late and late payment in one 60 day in payment one 60 day the last 24 the last 24 in the last 12 late months months months; maximum payment of one in the last 90 day late payment 24 months in the last 24 months Other credit history Maximum Maximum of Maximum of one Maximum of one 30, 60, and 90+ (maximum historical of two one 60 day 60 day late 90 day late day late payments delinquencies) 30 day late payment payment acceptable, late payment in the last in the last provided that payments in the last 24 months, 24 months the borrower has at in the last 24 months, with minimal least minimal 24 months with minimal 30 day favorable credit 30 day late late payments in history payments the last 24 in months the last 24 months Bankruptcy filings None in past None in past None in past None in past None in past 3 years 3 years 2 years 3 years year Maximum debt service 45% 45% 45% 45% 50% to income ratio(1) Maximum LTV ratio: Owner occupied 100% 100% 90% 85% 80% Non-owner occupied 80% 75% 75% 70% 65% (1)Maximum debt service to income ratio may increase by 5% in each category (except AA loans) if disposable income meets certain thresholds.
7 The following table provides a general overview of the Company's principal underwriting criteria for second Mortgage Loans, set forth according to internal product types:
INTERNAL PRODUCT TYPE--SECOND MORTGAGES ---------------------------------------------------------------------------- 125% PIGGYBACK LESS CLTV THAN PIGGYBACK GREATER PREAPPROVAL PERSONAL HOME OR EQUAL TO $15,000 THAN $15,000 REQUIRED LOAN ------------------- ----------------- ----------- ------------- Existing mortgage (maximum No 30 day late Maximum of one 30 No 30 day late Maximum of one 30 historical delinquencies) payments in last 12 day late payment payments in last 12 day late payment months; Maximum of in last 12 months months in last 12 months two 30 day late payments in months 13 through 24 Other credit history (maximum Maximum of three 30 Maximum of two 30 N/A Maximum of two historical delinquencies) day late payments day late payments 30 day late payments in last 12 months; in last 12 months, in last 12 months, Maximum of five 30 unless credit unless credit score day late payments score is is greater than 650 in months 13 greater than 650 through 24; Maximum of one 60 day late payment Bankruptcy filings None None in past None in past None in past three years seven years three years Maximum debt service to 45% 45% 45% 45% income ratio(1) Maximum LTV ratio 100% 100% 125% 100%
(1) Maximum debt service to income ratio may increase by 5% on second mortgages greater than $15,000 when the Company also owns the first mortgage and on personal home loans if disposable income meets certain thresholds. The following tables provide information regarding the Company's first and second-lien Mortgage Loan originations by credit classification for the years ended December 31, 2001 and 2000:
LOAN ORIGINATIONS BY CREDIT CLASSIFICATION YEAR ENDED DECEMBER 31, 2001 (DOLLARS IN THOUSANDS) INTERNAL LOAN CLASSIFICATION ------------------------------------------------------ AAA/AA/A/A- B C TOTALS ------------- -------- ------- ---------- First-Lien Mortgage Loans Amount........................... $ 441,802 $111,708 $32,158 $585,668 Percentage....................... 75.44% 19.07% 5.49% 100.00% Weighted average coupon.......... 8.42 10.1 11.1 8.88 Weighted average LTV ratio....... 81.54 80.33 79.28 81.05 Second-Lien Mortgage Loans Amount........................... $ 23,074 $38,717 $ 451 $62,242 Percentage....................... 37.07% 62.20% 0.73% 100.00% Weighted average coupon.......... 11.75 11.99 11.35 11.89 Weighted average LTV ratio....... 116.89 112.02 118.84 113.85
8
LOAN ORIGINATIONS BY CREDIT CLASSIFICATION YEAR ENDED DECEMBER 31, 2000 (DOLLARS IN THOUSANDS) INTERNAL LOAN CLASSIFICATION ------------------------------------------------- AA/A/A- B C TOTALS --------- -------- ------- -------- First-Lien Mortgage Loans Amount........................... $ 265,070 $155,804 $67,151 $488,025 Percentage....................... 54.31% 31.93% 13.76% 100.00% Weighted average coupon.......... 9.56 9.9 10.7 9.79 Weighted average LTV ratio....... 82.18 80.17 78.2 81.03 Second-Lien Mortgage Loans Amount........................... $ 82,364 $20,436 $5,840 $108,640 Percentage....................... 75.81% 18.81% 5.38% 100.00% Weighted average coupon.......... 13.06 12.65 11.90 12.95 Weighted average LTV ratio....... 116.02 105.6 107.23 113.04
Loan officers are trained to structure loans that meet the applicant's needs, while satisfying the Company's lending criteria. If an applicant does not meet the lending criteria, the loan officer may offer to make a smaller loan, or request that the borrower obtain a co-borrower or guarantor, in order to bring the application within the Company's lending parameters. The amount the Company will lend to a particular borrower is determined by a number of factors, including the borrower's creditworthiness, the value of the borrower's equity in the real estate, and the ratio of such equity to the home's appraised value. In connection with its Mortgage Loan products, the Company collects nonrefundable loan fees and various other fees, depending on state law, such as fees for credit reports, lien searches, title insurance and recordings, and appraisal fees. In connection with the servicing of the loans, the Company may receive late fees and insufficient funds fees, where permitted by applicable law. SALE AND SECURITIZATION OF MORTGAGE LOANS The Company sells a significant portion of the loans it originates, primarily through two methods, whole loan cash sales and securitization. Whole loan cash sales represent loans generally packaged in pools of $1.0 million to $5.0 million. Historically, the Company has sold its Mortgage Loans "servicing released" (i.e., without retention of the servicing rights and associated revenues) and on a non-recourse basis, with certain representations and warranties. The Company is required to repurchase any loan if it is subsequently determined that any representation and warranty made with respect to such loan was untrue. In 1997, the Company began securitizing Mortgage Loans. Under this method, the Company sells Mortgage Loans it purchased or originated to a trust for cash. The trust sells asset-backed bonds secured by the loans to investors. The Company records certain assets and income based upon the difference between all principal and interest received from the loans sold and the following factors (i) all principal and interest required to be passed through to the asset-backed bond investors, (ii) all excess contractual servicing fees, (iii) other recurring fees and (iv) an estimate of losses on the loans (collectively, the "Excess Cash Flow"). At the time of the securitization, the Company estimates these amounts based upon a declining principal balance of the underlying loans, adjusted by an estimated prepayment and loss rate, and capitalizes these amounts using a discount rate that market participants would use for similar financial instruments. These capitalized assets are recorded as a residual receivable. The Company believes the assumptions it has used in past securitizations are appropriate and reasonable. 9 The following table sets forth for the periods indicated, Mortgage Loans securitized and Mortgage Loans sold on a whole loan basis and Mortgage Loans originated:
YEAR ENDED DECEMBER 31, ---------------------------------- 2001 2000 1999 -------- --------- -------- (DOLLARS IN THOUSANDS) Mortgage Loans securitized........................................... $ 9,994 $64,330 $ 59,630 Mortgage Loans sold.................................................. 629,546 517,295 220,382 -------- ------- -------- Total Mortgage Loans sold or securitized............................. $639,540 $581,625 $ 280,012 ======== ========== ========= Total Mortgage Loans originations.................................... $647,910 $596,665 $234,005 Mortgage Loans sold or securitized as a % of total Mortgage Loan originations ..................................................... 99% 97% 120%
During 2001, 2000, and 1999, the weighted average premiums (discount) on the whole loan sales of mortgage loans were 2.64%, 1.93%, and 2.03%, respectively. For the years ended December 31, 2001, 2000, and 1999, gains recognized by the Company in connection with the whole loan sales of Mortgage Loans were $12.8 million, $9.8 million, and $6.2 million, respectively. In 1999 average premiums were impacted by industry difficulties that occurred in the fourth quarter of 1998. In the fourth quarter of 1998, the industry, which had been securitizing much of its loans during 1997 and most of 1998, began offering most of its loans to investors in the whole loan sale market. This shift occurred because securitization became less attractive as the corporate interest rate spreads required by investors increased. Prior to the fourth quarter of 1998, the Company generally was able to recognize higher premiums from securitizations compared to whole loan sale. However, cash flow is impacted more positively in the short term by whole loan sales, compared to securitizations. In 1999, the Company completed a securitization transaction in the second quarter. The Company securitized $59.6 million of loans for a weighted average premium of 2.88%. This securitization consisted of seasoned first and second Mortgage Loans, resulting in a lower than average premium. However, the securitization of seasoned loans resulted in additional liquidity of $33.0 million for the Company. Certain loans included in that securitization were ineligible for inclusion in the borrowing base under the Company's warehouse line of credit. In 2000, the company completed two securitizations totaling $64.3 million of loans. These securitizations consisted primarily of first and second mortgages, and resulted in additional liquidity in 2000 of $47.1 million. Both 2000 securitizations consisted primarily of Mortgage Loans not eligible for inclusion in the borrowing base under the Company's warehouse lines of credit and not readily marketable for the secondary market. In 2001, the company completed one securitization totaling $10.0 million of loans. This securitization consisted primarily of first and second mortgages, and resulted in additional liquidity in 2001 of $6.5 million. The 2001 securitization consisted primarily of Mortgage Loans not eligible for inclusion in the borrowing base under the Company's warehouse lines of credit and not readily marketable for the secondary market. The Company sold its servicing rights under the 2001 and 2000 securitizations because the price paid by the independent third party servicer resulted in a higher realized gain than if the servicing rights not been sold. Consequently, the residual interests related to these two pools are not subject to the Company's normal quarterly evaluation of assumptions and estimates as compared to actual performance. These residual interests represent the Company's estimate of market value. Market value determination includes an estimate of credit losses, based on anticipated performance of the securitized loans in the portfolio. During 2001, the Company increased the valuation reserve $7.1 million for anticipated future losses related to these pools. This valuation adjustment is included in the fair market value adjustment on residual receivables in the accompanying consolidated statement of operations. Management reviews the allowance on an ongoing basis and believes the valuation reserve is sufficient to cover future losses. 10 MORTGAGE LOAN SERVICING, DELINQUENCIES AND COLLECTIONS SERVICING The Company maintains a centralized portfolio management department located in Columbia, South Carolina which services Mortgage Loans. Servicing includes depositing cash received and posting payments to accounts for principal and interest, remitting funds to the Trustee, imaging documents, collection activities on past due accounts, management of loss mitigation activities and foreclosure and sale of properties, ensuring that insurance is in place, monitoring payment of real estate property taxes, customer service and retention activities and warehouse funding management. The Company does not escrow funds for purposes of insurance and taxes. However, it has the right to purchase insurance and pay taxes, which, if paid by the Company, are charged back to the borrower. The Company serves as master servicer for all of the Mortgage Loan securitizations which it has to date except the 2001 and 2000 securitizations. In connection with such securitizations, the Company's servicing operation was reviewed by the rating agencies which rated the bonds issued in connection with such securitizations. Because the Company did not retain servicing rights on the 2001 and 2000 securitizations, completed only one securitization during 1999, and sold the majority of loans originated on a "servicing released" basis, the servicing portfolio has declined from $408.5 million at December 31, 1999, to $264.9 million at December 31, 2001. DELINQUENCIES AND COLLECTIONS Collection efforts generally begin when a Mortgage Loan is over eight days past due, unless the account has previous unpaid late fees, in which case collection efforts generally begin when an account is over one day past due. At that time, the Company generally contacts the borrower by telephone to determine the reason for the delinquency and attempts to bring the account current. Typically, after an account becomes 15 days past due, the Company sends a reminder letter to the borrower, and then sends subsequent letters at 30 days past due, 41 days past due, and 55 days past due. In general, at 41 days past due, the Company sends a right-to-cure letter. After 90 days, the Company sends a five day demand letter and turns the account over to an attorney. In addition to written notices, the Company attempts to maintain telephone contact with the borrower at various times throughout the delinquency period. If the status of the account continues to deteriorate, the Company's loss mitigation unit works on a dual track along with the foreclosure unit to try to save the borrowers from a foreclosure action, while at the same time, trying to keep the foreclosure timelines as short as possible. In limited circumstances, when a borrower is experiencing difficulty in making timely payments, Mortgage Loan Operations may temporarily adjust the borrower's payment schedule. The determination of how to work out a delinquent loan is based upon a number of factors, including the borrower's payment history and the reason for the current inability to make timely payments. When a loan is 150 days past due, generally, it is placed on nonaccrual status and the Company initiates foreclosure proceedings. In connection with such foreclosure, the Company reviews the loan and the facts surrounding its delinquency, and may reappraise the underlying property. Regulations and practices regarding foreclosure and the rights of the mortgagor in default vary greatly from state to state. If deemed appropriate, the Company will bid in its loan amount at the foreclosure sale or accept a deed in lieu of foreclosure. The residential real estate owned portfolio, which is carried at the lower of carrying value or appraised fair market value less estimated cost to sell, totaled $0.6 million, $1.3 million, and $7.7 million at December 31, 2001, 2000, and 1999, respectively. 11 The following table sets forth for the periods indicated information relating to the delinquency and loss experience of the Company with respect to its securitized Mortgage Loans serviced:
YEAR ENDED DECEMBER 31, ------------------------------------ 2001 2000 1999 ---------- ---------- -------- (DOLLARS IN THOUSANDS) Total serviced Mortgage Loans (period end)(1)................ $264,902 $335,881 $408,529 Serviced Mortgage Loans (period end)(2)...................... 264,902 335,881 408,529 Average serviced Mortgage Loans(2)........................... 291,507 407,786 488,057 Delinquency (period end) 30-59 days past due: Principal balance....................................... $ 5,173 $ 6,622 $16,461 % of serviced Mortgage Loans(2)......................... 1.95% 2.0% 4.03% 60-89 days past due: Principal balance....................................... $ 1,514 $ 2,647 $ 5,325 % of serviced Mortgage Loans(2)......................... 0.6% 0.8% 1.30% 90 days or more past due: Principal balance....................................... $13,243 $16,014 $28,997 % of serviced Mortgage Loans(2)......................... 5.0% 4.8% 7.10% Total delinquencies: Principal balance....................................... $19,930 $25,283 $50,783 % of serviced Mortgage Loans(2)......................... 7.5% 7.5% 12.43% Real estate owned (period end)............................... $ 603 $ 1,281 $ 7,673 Net charge-offs.............................................. 33 1,990 3,686 % of net charge-offs to average serviced Mortgage Loans...... .01% .49% 0.75%
(1) Includes loans subserviced for others, where the Company has no credit risk. (2) Does not include loans subserviced for others, where the Company has no credit risk. Since substantially all of the Company's loans are to sub-prime borrowers who have limited access to credit or who may be considered credit-impaired by conventional lending standards, the percentage of the Company's loans past due is expected to be higher than a financial institution that provides loans to prime borrowers. COMPETITION The financial services industry, including the markets in which the Company operates, is highly competitive. Competition is based on the type of loan, interest rates, and service. Traditional competitors in the financial services industry include commercial banks, credit unions, thrift institutions, credit card issuers, consumer and commercial finance companies, and leasing companies, many of which have considerably greater financial and marketing resources than the Company. Moreover, major brokerage firms, insurance companies, retailers and bank holding companies have formed substantial national financial services networks. The Company believes that it competes effectively in its markets by providing competitive rates and efficient, complete services. The Company faces significant competition in connection with its Mortgage Loan products, principally from national companies which focus their efforts on making mortgage loans to non-prime borrowers. Many of these companies have considerably greater financial and marketing resources than the Company. Although these large national companies compete in the mortgage loan industry, this industry, as a whole, is highly fragmented and no one company has a significant share of the total mortgage loan market. 12 REGULATION The Company's operations are subject to extensive local, state and federal regulations including, but not limited to, the following federal statutes and regulations promulgated thereunder: Title 1 of the Consumer Credit Protection Act of 1968, as amended (including certain provisions thereof commonly known as the "Truth-in-Lending Act" or "TILA"), the Equal Credit Opportunity Act of 1974, as amended ("ECOA"), the Home Mortgage Disclosure Act, the Fair Credit Reporting Act of 1970, as amended ("FCRA"), the Fair Debt Collection Practices Act, as amended, the Real Estate Settlement Procedures Act ("RESPA") and the National Housing Act, as amended. In addition, the Company is subject to state laws and regulations, including those with respect to the amount of interest and other charges which lenders can collect on loans (e.g., usury laws). Mortgage lending laws generally require lenders to be licensed, and place limitations on the amount, duration and charges for various categories of loans, require adequate disclosure of certain contract terms and place limitations on certain collection practices and creditor remedies. Many states have usury laws that limit interest rates, although the limits generally are considerably higher than current interest rates charged by the Company. State regulatory authorities may conduct audits of the books, records and practices of the Company's operations. The Company is licensed to do business in each state in which it does business and in which such licensing is required and believes it is in compliance in all material respects with these regulations. The Company's Mortgage Loan origination activities are subject to TILA. TILA contains disclosure requirements designed to provide consumers with uniform, understandable information with respect to the terms and conditions of loans and credit transactions in order to give them the ability to compare credit terms. TILA also guarantees consumers a three-day right to cancel certain credit transactions, including any refinanced mortgage or junior Mortgage Loan on a consumer's primary residence. The Company believes that it is in substantial compliance in all material respects with TILA. The Company is also required to comply with the ECOA, which, in part, prohibits creditors from discriminating against applicants on the basis of race, religion, national origin, sex, age or marital status. ECOA restricts creditors from obtaining certain types of information from loan applicants. It also requires certain disclosures by the lender regarding consumer rights and requires lenders to advise applicants who are turned down for credit of the reasons therefor. In instances where a loan applicant is denied credit, or the rate or charge for a loan is increased as a result of information obtained from a consumer credit agency, another statute, the FCRA, requires the lender to supply the applicant with the name, address and phone number of the reporting agency. RESPA was enacted to provide consumers with more effective advance disclosures about the nature and costs of the settlement process, and to eliminate kickbacks or referral fees that raised the costs of settlement services. RESPA applies to virtually all mortgages on residential real property that is designed principally for occupancy of one to four families. Specific disclosures mandated by RESPA include, without limitation, estimates of closing costs, transfers of servicing, affiliated business arrangements and other settlement information. In the opinion of management, existing statutes and regulations have not had a materially adverse effect on the business done by the Company. However, it is not possible to forecast the nature of future legislation, regulations, judicial decisions, orders or interpretations, nor their impact upon the future business, financial condition or prospects of the Company. The Company believes that it is in substantial compliance with state and federal laws and regulations governing its lending activities. However, there can be no assurance that the Company will not inadvertently violate one or more of such laws and regulations. Such violations may result in actions for damages, claims for refunds of payments made, certain fines and penalties, injunctions against certain practices, and the potential forfeiture of rights to repayment of loans. Further adverse changes in the laws or regulations to which the Company's business is subject, or in the interpretation thereof, could have a material adverse effect on the Company's business. EMPLOYEES At December 31, 2001, the Company employed a total of 728 full-time equivalent employees. 13 ITEM 2. PROPERTIES The Company's headquarters is located at 1021 Briargate Circle, Suite B, Columbia, South Carolina and is leased by the Company. At December 31, 2001, the Company owned five offices and leased 13 offices. None of the leases, considered separately or collectively, are believed to be material to the Company's operations. The Company believes that its leased and owned locations are suitable and adequate for their intended purposes. The Company's properties located at 113 Reed Avenue, Lexington, SC, and 3901 Pelham Road, Greenville, SC, secure the Company's warehouse lines. ITEM 3. LEGAL PROCEEDINGS From time to time, the Company is involved in litigation in the ordinary course of its business. As a result of legal defenses and insurance arrangements, the Company does not believe that any such litigation, if decided unfavorably to the Company, would have a material adverse effect on its business or assets, with the exception of the litigation noted below. On August 20, 1999, Janice Tomlin, Isaiah Tomlin, and Constance Wiggins filed a purported class action lawsuit ("Tomlin action") in New Hanover County, North Carolina Superior Court. That suit has been transferred to North Carolina Business Court. The suit was filed against the Company's affiliate, HGI, and others alleging a variety of statutory and common law claims arising out of Mortgage Loans they obtained through Chase Mortgage Brokers ("Chase"). On February 22, 2000, Michael and Kimberly Chasten filed a similar action in Duplin County, North Carolina Superior Court. On April 13, 2000 Reginald Troy filed a similar action in New Hanover County, North Carolina Superior Court. The plaintiffs in all of these cases are seeking unspecified monetary damages which fall into three basic categories: (1) refund of all fees charged by Chase in connection with the Mortgage Loans; (2) forfeiture of all profits realized from the sale of the Mortgage Loans in the secondary market; and (3) refund of two times the past interest paid on the Mortgage Loans, and forfeiture of future interest. The complaints in all of these cases allege participation by HGI in an arrangement with Chase under which Chase allegedly failed to make necessary disclosures to the borrowers, and charged excessive and duplicative fees to the borrowers, and under which Chase allegedly received undisclosed premiums. On February 1, 2002, the Court granted to the plaintiffs in the Tomlin action their motion for class certification. HGI intends to vigorously contest these cases. Because these matters are in their early stages, it is not possible to evaluate the likelihood of an unfavorable outcome or estimate the amount of potential loss. Management believes that if any of these causes of action is determined adversely, the effect on the financial condition of the Company could be materially adverse. 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 2001 year. 14 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock presently is traded on the National Association of Stock Dealers (NASD) Over the Counter Bulletin Board (OTCBB) under the symbol "HGFN". Until April 20, 2000, the common stock was traded on the NASDAQ National Market System (NNM). These prices reflect inter-dealer prices without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions. The following table sets forth the high and low bid prices of the common stock for the periods indicated, as reported on the OTCBB, and prior to April 20, 2000, the high and low sales price on the NNM. HIGH LOW Year Ended December 31, 2000 First Quarter................... $1.75 $1.00 Second Quarter.................. $1.15 $0.25 Third Quarter................... $0.94 $0.38 Fourth Quarter.................. $0.72 $0.22 Year Ended December 31, 2001 First Quarter................... $0.69 $0.28 Second Quarter.................. $0.50 $0.30 Third Quarter................... $0.47 $0.26 Fourth Quarter.................. $0.50 $0.26 On March 28, 2002, the closing price for the Company's common stock was $0.67. As of March 28, 2002, the Company had 16,912,594 outstanding shares of common stock held by 387 stockholders of record. No dividends on common stock were paid or declared during 2001 or 2000, and no dividends are expected to be paid on the common stock for the foreseeable future. The credit facility between the Company's subsidiary HGI and Household Commercial Financial Services, Inc. contains a covenant that prohibits the Company from paying dividends or making distributions with respect to its capital stock other than dividends payable solely in its capital stock and dividends required to be paid with respect to the Company's Series A Non-Convertible Preferred Stock pursuant to the terms and provisions thereof. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" which discussion is incorporated herein by reference. 15 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth historical selected financial information of the Company as of the dates and for the periods indicated. The statement of operations data, cash flow data, and balance sheet data are derived from the audited financial statements of the Company. The data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Consolidated Financial Statements and Notes thereto included elsewhere in this Report.
AT AND FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------ 2001 2000 1999 1998 1997 --------- -------- -------- ------- ------- (DOLLARS IN THOUSANDS) STATEMENT OF OPERATIONS DATA: Interest income.............................................. $8,009 $12,192 $8,286 $35,075 $ 34,008 Servicing income............................................. 4,268 7,397 9,813 12,239 8,514 Gain on sale of loans: Gross gain on sale of loans................................ 12,807 9,801 6,216 9,472 52,828 Loan fees, net............................................. 22,013 16,430 3,313 11,745 30,207 --------- -------- ------ --------- ------- Total gain on sale of loans.............................. 34,820 26,231 9,529 21,217 83,035 Gain on sale of subsidiaries' net assets(1).................. -- -- -- 18,964 -- Other revenues............................................... 1,267 1,735 1,609 4,230 1,399 --------- -------- ------ --------- -------- Total revenues........................................... 48,364 47,555 29,237 91,725 126,956 Interest expense............................................. 20,609 19,448 16,338 35,968 25,133 Provision for credit losses.................................. 2,883 3,159 3,339 11,906 10,030 Costs on real estate owned and defaulted loans............... 1,419 3,451 3,018 2,665 876 Fair market value adjustment on residual receivable.......... 10,490 2,279 3,327 13,638 -- Restructuring charges(2)..................................... 873 1,469 -- 6,838 -- General and administrative expenses.......................... 65,183 57,592 38,286 93,701 83,408 --------- -------- ------- --------- -------- Total expenses........................................... 101,457 87,398 64,308 164,716 119,447 --------- -------- ------- --------- -------- Income (loss) from operations before income taxes, minority interest and (53,093) (39,843) (35,071) (72,991) 7,509 extraordinary item......................................... Provision (benefit) for income taxes (3)..................... 22,524 (9,456) (7,394) 3,017 (3,900) --------- -------- ------- --------- -------- Income (loss) from operations before minority interest and extraordinary items ....................................... (75,617) (30,387) (27,677) (76,008) 11,409 Minority interest in (earnings) loss of subsidiaries......... (4) (4) (8) 47 (156) --------- -------- ------- --------- -------- Income (loss) from operations before extraordinary item...... (75,621) (30,391) (27,685) (75,961) 11,253 Extraordinary item-gain on extinguishment of debt, Net of 2,022 579 29,500 18,216 -- $0 tax (4)..................................................--------- -------- ------ --------- -------- Net income (loss)........................................ $ (73,599) $(29,812) $1,815 $ (57,745) $ 11,253 ========= ======== ====== ========= ======== Diluted Earnings Per Share: Operations................................................. (4.48) (2.10) (2.78) (7.81) 1.17 Extraordinary item......................................... .12 .04 2.96 1.87 -- --------- -------- ------ --------- -------- Net income (loss) per share.............................. $ (4.36) $ (2.06) $ 0.18 $ (5.94) $ 1.17 ========= ======= ====== ======= ======== CASH FLOW DATA: Cash flow due to operating cash income and expenses.......... (26,872) (20,873) (18,994) (62,775) (26,652) Cash provided by (used in) loans held for sale and other..... (10,120) (41,848) 26,210 147,055 (119,637) -------- -------- -------- --------- Net cash provided by (used in) operating activities...... $ (36,992) $(62,721) $7,216 $84,280 $(146,289) ========= ======== ======= ======= ========= BALANCE SHEET DATA: Total gross loans receivable................................. $51,805 $58,483 $ 63,242 $ 124,740 $297,615 Total residual assets, net................................... 49,270 58,877 47,770 43,857 63,202 Total assets................................................. 187,482 202,021 188,737 257,208 416,152 Total liabilities............................................ 271,608 212,844 180,880 239,276 336,920 Total shareholders' equity (deficit)......................... $ (84,126) $(10,828) $7,844 $ 5,801 $ 63,374
(1) In 1998, the Company disposed of all nonmortgage related activities and realized a net gain. (2) See Footnote 14. Restructuring Charge in Notes to Consolidated Financial Statements. (3) See Footnote 16. Income Taxes to Consolidated Financial Statements. (4) See Footnote 17. Extraordinary Item-Gain on Extinguishment of Debt in Notes to Consolidated Financial Statements. 16 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion should be read in conjunction with the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements of the Company appearing elsewhere in this report. FORWARD-LOOKING INFORMATION From time to time, the Company makes oral and written statements that may constitute "forward-looking statements" (rather than historical facts) as defined in the Private Securities Litigation Reform Act of 1995 (the "Act") or by the SEC in its rules, regulations and releases, including Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. This report contains such statements. The Company desires to take advantage of the "safe harbor" provisions in the Act for forward-looking statements made from time to time, including, but not limited to, the forward-looking statements made in this Form 10-K, as well as those made in other filings with the SEC, and other financial discussion and analysis by Management that reflect projections of future financial or economic performance of the Company. The words "expect," "estimate," "anticipate," "predict," "believe," and similar expressions and variations thereof are intended to identify forward-looking statements. Such statements appear in a number of places in this filing and include statements regarding the intent, belief, or current expectations of the Company, its directors, or officers with respect to Management's current plans and expectations and are subject to risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Such risks and uncertainties include, but are not limited to: lower origination volume due to market conditions, inability to achieve desired efficiency levels, higher losses due to economic downturn or lower real estate values, loss of key employees, negative cash flows and capital needs, delinquencies and losses in securitization trusts, right to terminate mortgage servicing and related negative impact on cash flow, adverse consequences of changes in the interest rate environment, deterioration of creditworthiness of borrowers and risk of default, general economic conditions in the Company's markets, including inflation, recession, interest rates and other economic factors, loss of funding sources, loss of ability to sell loans, general lending risks, impact of competition, regulation of lending activities, changes in the regulatory environment, lower than anticipated premiums on loan sales, lower than anticipated origination fees, adverse impact of lawsuits, faster than anticipated prepayments on loans, losses due to breach of representation or warranties under previous agreements and other detrimental developments. The preceding list of risks and uncertainties, however, is not intended to be exhaustive. Because actual results may differ materially from those projected in this Report for the reasons, among others, listed above, the stockholders and bondholders of the Company are cautioned not to put undue reliance on such forward-looking statements. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the factors referred to above and the other documents the Company files from time to time with the Securities and Exchange Commission, including the quarterly reports on Form 10-Q filed by the Company during fiscal 2001 and any current reports on Form 8-K filed by the Company. The preceding list of risks and uncertainties, however, is not intended to be exhaustive, and should be read in conjunction with other cautionary statements made herein, including, but not limited to, risks identified from time to time in the Company's SEC reports, registration statements and public announcements. GENERAL The Company is headquartered in Columbia, South Carolina, and engages primarily in the business of originating, selling, and servicing conforming and nonconforming mortgage loan products and issuing notes payable and subordinated debentures to investors through its subsidiary, CII. The Company commenced its lending operations in 1991 through the acquisition of CII, a small mortgage lending company, which had been in operation since 1963. In the three years prior to the acquisition by merger of HomeSense as described below, the Company had already undergone significant changes. In late 1997, the Company decided to focus primarily on its mortgage operations, resulting in the sales of its auto loan operations in early 1998, its small 17 retail origination subsidiary, Sterling Lending Corp. ("SLC") in August 1998, and substantially all of the assets of its small business loan operations in November 1998. MERGER WITH HOMESENSE FINANCIAL CORP. On May 9, 2000, HomeSense was merged into HGI, a wholly owned subsidiary of HGFN pursuant to a merger agreement approved by HGFN's shareholders on April 28, 2000. HomeSense was a privately owned specialized mortgage company headquartered in Lexington, South Carolina that originated and sold Mortgage Loans in the sub-prime mortgage industry. Its principal loan product was a debt consolidation loan, generally collateralized by a first lien on the borrower's home. HomeSense originated its loan volume through a direct retail branch network of eight offices, as well as through centrally-provided telemarketing lead, direct mail, and television advertising. HGI has continued the business of HomeSense after the merger. In the merger, HGFN issued 6,780,944 shares of its common stock (approximately 40% of post-merger shares outstanding) valued at $1.04 per share plus an additional 10 million shares of Series A Non-convertible Preferred Stock, par value $1 per share, for 100% of the outstanding stock of HomeSense. Most of this merger consideration was issued to HomeSense's primary shareholder Ronald J. Sheppard. Mr. Sheppard is now Chief Executive Officer and a director of HGFN, and a director of both HGI and CII. The merger was accounted for under the purchase method of accounting prescribed by generally accepted accounting principles. The transaction resulted in $19.0 million of goodwill, which is being amortized, on a straight-line basis over 15 years. After the merger was consummated, certain differences arose between the parties to the merger regarding the warranties and representations in the merger agreement. These differences were resolved in February 2001 by an agreement between Mr. Sheppard and HGFN pursuant to which Mr. Sheppard agreed to remain a guarantor with respect to certain indebtedness HGI assumed from HomeSense in the merger and pursuant to which options for HGFN stock issued to Mr. Sheppard in the merger were cancelled. In addition, a mutual indemnity agreement between HGFN and Mr. Sheppard was cancelled. The following summarized unaudited pro forma financial information for the combined companies assumes the merger had occurred on January 1 of each year: FOR THE YEARS ENDED DECEMBER 31, ------------------------ 2000 1999 ------- -------- (IN THOUSANDS) Revenue ..................................... $57,477 $53,045 Income before extraordinary items............ (30,585) (29,574) Net income................................... (30,006) 4,320 Earnings per share........................... (1.41) (0.01) The amounts are based upon certain assumptions and estimates, and do not reflect any benefit from economies that might be achieved from combined operations. The pro forma results do not necessarily represent results that would have occurred if the acquisition had taken place on the basis assumed above, nor are they indicative of the results of future combined operations. DISCONTINUATION OF WHOLESALE MORTGAGE DIVISION In August, 2000, Management closed the Company's wholesale mortgage origination division. The decision to exit the wholesale business arose primarily from Management's desire to narrow its focus to the Company's more profitable retail loan origination efforts. The closure of the wholesale division resulted in a decrease in low-margin origination volume, enabling the Company to terminate its relationship under a particularly burdensome agreement with its primary warehouse lender. Further benefits have been realized through more focused and efficient usage of marketing resources and a sizable reduction in overhead costs related to the closed division. 18 The following table sets forth certain data relating to the Company's various loan products at and for the periods indicated:
AT AND FOR THE YEARS ENDED DECEMBER 31, --------------------------------------- 2001 2000 1999 --------------- ----------- ---------- (DOLLARS IN THOUSANDS) Mortgage Loans: Mortgage loans originated............................................ $ 647,910 $ 596,665 $234,005 Mortgage loans sold.................................................. 629,546 517,295 220,382 Mortgage loans securitized........................................... 9,994 64,330 59,630 Total Mortgage Loans owned (period end).............................. 43,487 49,321 63,242 Total serviced Mortgage Loans (period end)........................... 256,584 326,719 408,529 Total serviced unguaranteed Mortgage Loans (period end)(1)........... 256,584 326,719 408,529 Average Mortgage Loans owned(2)...................................... 43,300 67,452 72,711 Average serviced Mortgage Loans(2)................................... 283,134 318,019 478,386 Average serviced unguaranteed Mortgage Loans(1)...................... 283,134 318,019 478,386 Average interest earned(2)........................................... 10.13% 10.79% 8.67% Small Business Loans: Total small business loans owned (period end)........................ 8,318 9,162 10,388 Total serviced small business loans (period end)..................... 8,318 9,162 10,388 Total serviced unguaranteed small business loans (period end)(3)..... 8,318 9,162 10,388 Average small business loans owned(2)................................ 8,373 10,557 9,671 Average serviced small business loans(2)............................. 8,373 10,557 9,671 Average serviced unguaranteed small business loans(2)(3)............. 8,373 10,557 9,671 Average interest earned(2)........................................... 6.85% 7.68% 6.37% Total Loans: Total loans originated............................................... $ 647,910 $ 596,665 $234,005 Total loans sold..................................................... 629,546 517,295 220,382 Total loans securitized.............................................. 9,994 64,330 59,630 Total loans receivable (period end).................................. 51,805 58,483 73,630 Total serviced loans (period end).................................... 264,902 335,881 418,917 Total serviced unguaranteed loans (period end)(1)(3)................. 264,902 335,881 418,917 Average loans owned.................................................. 51,673 78,009 82,382 Average serviced loans............................................... 291,507 328,576 488,057 Average serviced unguaranteed loans.................................. 291,507 328,576 488,057 Average interest earned.............................................. 8.49% 10.69% 8.40%
(1) Excludes loans serviced for others with no credit risk to the Company. (2) Averages are computed based on the daily averages. (3) Excludes guaranteed portion of SBA Loans. 19 RESULTS OF OPERATIONS For the periods indicated, the following table sets forth certain information derived from the Company's Consolidated Financial Statements expressed as a percentage of total revenues.
FOR THE YEARS ENDED DECEMBER 31, ----------------------------- 2001 2000 1999 --------- ------ -------- Interest income................................................................ 16.6% 25.6% 28.3% Servicing income............................................................... 8.9 15.6 33.6 Gross gain on sale of loans.................................................... 26.4 20.6 21.3 Loan fee income, net........................................................... 45.5 34.6 11.3 Other revenues................................................................. 2.6 3.6 5.5 ----- ----- ----- Total revenues............................................................ 100.0% 100.0% 100.0% ===== ===== ===== Interest expense............................................................... 42.6% 40.9% 55.9% Provision for credit losses.................................................... 6.0 6.6 11.4 Costs on real estate owned and defaulted loans................................. 2.9 7.3 10.3 Fair market value adjustment on residual receivables........................... 21.7 4.8 11.4 Salaries, wages and employee benefits.......................................... 77.7 61.2 69.0 Business development costs..................................................... 18.9 18.1 16.4 Restructuring charges.......................................................... 1.8 3.1 -- Other general and administrative expenses...................................... 38.1 41.8 45.6 ----- ----- ----- Income (loss) before income taxes, minority interest and extraordinary item.... (109.7) (83.8) (120.0) Provision (benefit) for income taxes........................................... 46.6 (19.9) (25.3) Minority interest in (earnings) loss of subsidiary............................. -- -- -- Extraordinary item............................................................. 4.2 1.2 100.9 ----- ----- ----- Net income (loss)......................................................... (152.1)% (62.7)% 6.2% ===== ===== =====
YEAR ENDED DECEMBER 31, 2001, COMPARED TO YEAR ENDED DECEMBER 31, 2000 The Company recognized a net loss of $73.6 million for the year ended December 31, 2001 ("2001"), as compared to a net loss of $29.8 million for the year ended December 31, 2000 ("2000"). The primary reasons for the $43.8 million additional losses for 2001 were a decrease in income tax benefits of $32.0 million and an increase of $7.1 million in the allowance for losses on residual receivables. Included in the net loss for 2001 and 2000 were $2.0 million and $579,000, respectively, of extraordinary gain on extinguishment of debt. The Company's net losses before extraordinary gains were $75.6 million and $30.4 million in 2001 and 2000, respectively. Total revenues increased $809,000 (1.7%), to $48.4 million in 2001 from $47.6 million in 2000. The increase in total revenues is comprised of a $5.6 million (34.0%) increase in loan fee income and a $3.0 million (30.7%) increase in gain on sale of loans, partially offset by a $4.2 million (34.3%) decrease in interest income, a $3.1 million (42.3%) decrease in servicing income and a $0.5 million (27.0%) decrease in other revenues. The increase in net loan fees is primarily attributable to a $73.5 million increase in mortgage origination production and an increase in average loan origination fees charged, to 4.01% in 2001 from 2.75% in 2000. The overall increase in production is attributable to a full year of production of the combined HGI and HomeSense companies in 2001 compared to eight months of production in 2000 following the HGI-HomeSense merger. The increase in average origination fees charged occurred because of a shift in the mix of wholesale and retail production, resulting from the Company's decision to end wholesale production operations as of August 1, 2000. During 2000, wholesale production accounted for only 33.1% of the Company's total production. There was no wholesale production in 2001. 20 The decrease in interest income resulted primarily from an $26.3 million (33.6%) decrease in average loans receivable outstanding. The decrease in average loans receivable outstanding relates primarily to the increase in mortgage loan sales and to the fact that the loans were sold quicker; therefore, the Company did not earn interest for as long a period on average for each mortgage loan in 2001 than in 2000. In addition, the Company experienced an approximate 66 basis point decrease in the average yield on loans receivable outstanding. The average serviced mortgage loan portfolio decreased $37.1 million, or 13%, to $291.5 million in 2001 from $328.6 million in 2000. Gross gain on sale of loans increased $3.0 million, or 30.7%, to $12.8 million in 2001, from $9.8 million in 2000 due primarily to an increase in loans sold. Loans sold increased $66.7 million, or 11.5%, to $648.3 million for 2001 from $581.6 million for 2000. The increase in loans sold resulted from higher originations of mortgage loans held for sale and the Company's decision to focus on liquidity and whole-loan sales. The weighted average gross gain on sale of loans was 2.64% and 1.75% for 2001 and 2000, respectively. In 2001 and 2000, other revenues consist primarily of prepayment penalty income, underwriting fees, and late charges. Total expenses increased $14.1 million, or 16.1%, to $101.5 million in 2001 from $87.4 million in 2000. The increase in total expenses is comprised of an $8.5 million (29.1%) increase in personnel expenses, an $8.2 million (360.3%) increase in the fair value adjustment of residual receivables, a $1.2 million (6.0%) increase in interest expense and a $0.5 million (6.4%) increase in business development costs, partially offset by a $2.0 million (58.9%) decrease in costs on real estate owned and defaulted loans, a $1.4 million (7.3%) decrease in other general and administrative expenses, a 0.6 million (40.6%) decrease in restructuring charges, and a $0.3 million (8.8%) decrease in the provision for credit losses. The $8.2 million increase in fair value adjustment of residual receivables resulted from a $7.1 million increase in the allowance for losses on residual receivables based on anticipated performance of the underlying securitized loan portfolio. The increase in personnel costs resulted primarily from the addition of employees during 2001. The number of employees increased from 693 at December 31, 2000 to 728 at December 31, 2001. Part of the increase is due to the opening of additional production centers in 2001 and higher incentives due to increased mortgage loan originations. The increase in interest expense was due principally to higher levels of borrowings associated with the increase in the Company's average mortgage loan portfolio. For 2001 and 2000, the Company incurred interest expense of $15.2 million and $11.7 million, respectively, related to investor notes and subordinated debentures. This increase was offset by the decrease related to the interest expense on the warehouse lines of credit and the reduction in the Company's senior unsecured debt. The Company funded more loans using its own cash in 2001; therefore, the warehouse lines of credit created lower interest charges. For 2001 and 2000, such expenses were $4.2 million and $6.4 million, respectively, related to warehouse lines of credit and $1.1 million and $1.3 million, respectively, on the senior unsecured debt. The increase in business development costs was a result of the Company increasing its marketing efforts to increase its loan production. The decrease in costs on real estate and defaulted loans is due to the company selling a majority of the prior year real estate owned. The decrease in other general and administrative expenses was comprised primarily of a $.4 million decrease in repairs and maintenance type expenses as well as several other expense categories. The Company placed tighter controls on its expenditures in the second half of 2001, thereby reducing expenses. Restructuring charges decreased $0.6 million (40.6%) in 2001. These costs were related to the relocation of the corporate headquarters from Greenville, S.C. to Lexington, S.C. in May of 2001. During 2000, the Company incurred restructuring charges related to the merger and to the decision to close its wholesale loan origination division. These charges included the estimated costs of employee relocation costs and employee severance, and the estimated net lease cost on facilities no longer being used. 21 The decrease in the provision for credit losses was associated with lower levels of loans held for investment and a lower loan delinquency rate. The decrease was partially offset by Management's decision in late 2001 to record additional reserves against amounts paid on behalf of borrowers for taxes, insurance, and attorney's fees. The Company has recorded current income tax expense of $524,000 for 2001, related to its "excess inclusion income." Excess inclusion income is a result of the Company's securitizing loans in pools to third party investors. These transactions generate income for the Company that is included in the overall loss. However, according to IRS regulations, a portion of that income is subject to federal tax in the current period regardless of other current period losses or NOL carryovers otherwise available to offset regular taxable income. The excess inclusion income approximates the net interest the Company receives on the loans in the pools after the bondholders are paid their share of the interest less the sum of the daily accruals, an amount allowed for tax purposes as a reasonable economic return on the retained ownership interest. The loss for the year includes a $22 million increase in the Company's deferred tax asset valuation allowance. Although the Company expects to utilize its net operating loss carryforwards, a valuation allowance was established in accordance with Statement of Financial Accounting Standards No. 109. This adjustment was a non-cash transaction and had no effect on the Company's working capital. YEAR ENDED DECEMBER 31, 2000, COMPARED TO YEAR ENDED DECEMBER 31, 1999 The Company recognized a net loss of $29.8 million for the year ended December 31, 2000 ("2000"), as compared to net income of $1.8 million for the year ended December 31, 1999 ("1999"). Included in net income for 2000 and 1999 were $579,000 and $29.5 million, respectively, of extraordinary gain on extinguishment of debt. Excluding extraordinary gains, the Company's net losses were $30.4 million and $27.7 million in 2000 and 1999, respectively. Total revenues increased $18.3 million (62.7%), to $47.6 million in 2000 from $29.2 million in 1999. The increase in total revenues is comprised of a $13.1 million (395.9%) increase in loan fee income, a $3.9 million (47.1%) increase in interest income, a $3.6 million (57.7%) increase in gain on sale of loans, and a $126,000 (7.8%) increase in other income, partially offset by a $2.4 million (24.6%) decrease in servicing fee income. The increase in net loan fees is primarily attributable to a $362.7 million increase in mortgage origination production and an increase in average loan origination fees charged, to 2.75% in 2000 from 1.42% in 1999. The overall increase in production is attributable to the merger, combining the production capacity of HGI with that of HomeSense. The increase in average origination fees charged occurred because of a shift in the mix of wholesale and retail production, resulting from the Company's decision to end wholesale production operations as of August 1, 2000. During 1999, wholesale production accounted for 46.9% of the Company's total production, and during 2000, wholesale production accounted for only 33.1% of the Company's total production. The increase in interest income resulted primarily from an $5.3 million (8%) increase in average loans receivable outstanding. The increase in average loans receivable outstanding relates primarily to the increase in Mortgage Loan production mentioned above. In addition, the Company experienced an approximate 212 basis point increase in the average yield on loans receivable outstanding. The decrease in servicing fee income was due in part to the sale on a servicing-released basis of $64.3 million in Mortgage Loans during 2000. The average serviced mortgage loan portfolio decreased $149.8 million, or 31%, to $328.6 million in 2000 from $479.4 million in 1999. Gross gain on sale of loans increased $3.6 million, or 57.7%, to $9.8 million in 2000, from $6.2 million in 1999 due primarily to an increase in loans sold. Loans sold increased $279.2 million, or 99.7%, to $581.6 million for 2000 from $280.0 million for 1999. The increase in loans sold resulted from higher originations of mortgage loans held for sale and the Company's decision to focus on liquidity and whole-loan sales in late 1999 and 2000. The weighted average gross gain on sale of loans was 1.75% and 2.22% for 2000 and 1999, respectively. In 2000 and 1999, other revenues consist primarily of prepayment penalty income, underwriting fees, and late charges. In 1999, other revenues also included nonrecurring income from rental of the Company's computer systems by a former subsidiary. 22 Total expenses increased $23.1 million, or 35.9%, to $87.4 million in 2000 from $64.3 million in 1999. The increase in total expenses is comprised of an $8.8 million (43.0%) increase in personnel expenses, a $6.7 million (51.3%) increase in other general and administrative expenses, a $3.8 million (79.3%) increase in business development costs, a $3.1 million (19.0%) increase in interest expense, and a $433,000 (14.4%) increase in costs on real estate owned and defaulted loans, partially offset by a $1.0 million (31.5%) decrease in the fair value adjustment of residual receivables and a $180,000 (5.4%) decrease in the provision for credit losses. During 2000, the Company also reported $1.5 million in non-recurring restructuring charges related to the merger and the dissolution of the wholesale division. While total expenses increased substantially as a result of the merger and increased retail production, the Company significantly reduced the combined expenses of the merged companies by taking advantage of economies of scale, eliminating many redundant positions, and closing the wholesale division. The increase in personnel costs resulted primarily from the addition of employees during the merger. The number of employees increased from 387 at December 31, 1999 to 693 at December 31, 2000. Immediately after the merger, the Company employed 790 people. Significant personnel reductions came at the time of the closure of the wholesale division, with additional cuts occurring from the date of the merger through year end. The increase in other general and administrative expenses was comprised primarily of a $2.7 million increase in loan origination costs resulting from increased production volume generated by the merger, an $870,000 increase in amortization expense resulting from the addition of substantial goodwill arising from the merger, and merger-related increases in telephone costs ($671,000), equipment rentals ($227,000), office rent ($499,000), ($906,000) of additional amortization from the write-off of the debt origination of a former credit facility with CIT, and several other expense categories. The increase in business development costs was necessary to support additional production capacity after the merger. Such costs decreased when measured as a percentage of production, to 1.4% in 2000 from 2.1% in 1999. The increase in interest expense was due principally to higher levels of borrowings associated with the increase in the Company's average Mortgage Loan portfolio. For 2000 and 1999, the Company incurred interest expense of $6.4 million and $2.0 million, respectively, related to warehouse lines of credit and $11.7 million and $9.9 million, respectively, related to investor notes and subordinated debentures. These increases were partially offset by a decrease related to the reduction in the Company's senior unsecured debt. For 2000 and 1999, such expenses were $1.3 million and $4.4 million, respectively. The increase in costs on real estate and defaulted loans is due to the company aggressively liquidating its real estate acquired through foreclosure in 2000. Changes in valuation assumptions for the Company's residual receivables from securitizations were adjusted in 2000, primarily related to the assumed loss rates in the 1997 pools. The change in assumed loss rates, due to lower than expected actual losses, resulted in an increase in fair value of the residual receivable. However, this increase was offset by actual losses on foreclosed properties in all the securitization pools, causing the write-down of the overall residual receivable. The decrease in the provision for credit losses was associated with lower levels of loans held for investment and a lower loan delinquency rate. The decrease was partially offset by Management's decision in early 2000 to record additional reserves against amounts paid on behalf of borrowers for taxes, insurance, and attorney's fees. During 2000, the Company incurred restructuring charges related to the merger and to the decision to close its wholesale loan origination division. These charges included the estimated costs of employee relocation costs and employee severance, and the estimated net lease cost on facilities no longer being used. The Company has recorded current income tax expense of $544,000 for 2000, related to its "excess inclusion income." Excess inclusion income is a result of the Company's securitizing loans in pools to third party investors. These transactions generate income for the Company that is included in the overall loss. However, according to IRS regulations, a portion of that income is subject to federal tax in the current period regardless of other current period losses or NOL carryovers otherwise available to offset regular taxable income. The 23 excess inclusion income approximates the net interest the Company receives on the loans in the pools after the bondholders are paid their share of the interest less the sum of the daily accruals, an amount allowed for tax purposes as a reasonable economic return on the retained ownership interest. The Company has recorded a deferred tax benefit of $10 million in 2000 related to historical losses based on management's assessment of the realization of the related deferred tax asset. Management performed an analysis of the recoverability of the asset based on projected conditions at the close of 2000, and determined that it is more likely than not that the Company will be able to realize this benefit prior to the expiration of the net operating loss carryforwards. FINANCIAL CONDITION Net loans receivable decreased $7.0 million to $44.7 million at December 31, 2001 from $51.7 million at December 31, 2000. The reduction in net loans receivable resulted primarily from the Company's decision to increase liquidity and reduce debt by selling and securitizing residential mortgage loans, partially offset by an increase in overall production. The residual receivables were $49.3 million at December 31, 2001, and $58.9 million at December 31, 2000. This decrease resulted primarily from a $7.1 million increase in the reserve for potential losses. Real estate and personal property acquired in foreclosure decreased to $0.6 million at December 31, 2001, from $1.3 million at December 31, 2000. This decrease resulted from the sale of foreclosed properties, partially offset by additional foreclosures on mortgage loans within the period. The loss for the year includes a $22 million increase in the valuation reserve for the deferred tax asset. Although the Company expects to utilize its operating loss carryforwards, the valuation allowance was established in accordance with Statement of Financial Accounting Standards No. 109. This adjustment was a non-cash transaction and had no effect on the Company's working capital. Total net operating loss carryforwards are now $143.8 million. Approximately $143.0 million does not begin to expire until 2007 and beyond. The primary source of funding the Company's receivables comes from borrowings issued under various credit arrangements (including the Credit Facilities, CII Notes, and the Company's Senior Notes). At December 31, 2001, the Company had debt outstanding under revolving warehouse lines of credit and other obligations to banks of $25.6 million, which compares with $29.3 million at December 31, 2000, for a decrease of $3.7 million. At December 31, 2001, the Company had $231.1 million of CII Notes and subordinated debentures outstanding, which compares with $165.2 million at December 31, 2000, for an increase of $65.9 million. The aggregate principal amount of outstanding Senior Notes was $6.3 million at December 31, 2001 compared to $11.2 million on December 31, 2000. In 2001, the Company purchased $5.0 million face amount of its Senior Notes for a purchase price of $3.0 million. The Company's repurchase of Senior Notes in 2001 was accomplished through a tender offer and a solicitation of consents of holders of the Senior Notes to the deletion of most of the restrictive covenants, certain events of default and related definitions from the Senior Notes Indenture. The Company received sufficient consents to amend the Indenture, consequently, as of November 2001 most of the restrictive covenants in the original Indenture no longer exist. The Company may, from time to time, purchase more of its Senior Notes depending on the Company's cash availability, market conditions, and other factors. The Company had a total shareholders' deficit at December 31, 2001 of $84.1 million, which compares to a deficit of $10.8 million at December 31, 2000, a decrease of $73.3 million. This decrease resulted principally from the net loss recognized in 2001. The credit facility between the Company's subsidiary HGI and Household Commercial Financial Services, Inc. contains a covenant that prohibits the Company from paying dividends or making distributions with respect to its capital stock other than dividends payable solely in its capital stock and dividends required to be paid with respect to the Company's Series A Non-Convertible Preferred Stock pursuant to the terms and provisions thereof. 24 ALLOWANCE FOR CREDIT LOSSES AND CREDIT LOSS EXPERIENCE The Company is exposed to the risk of loan delinquencies and defaults with respect to loans retained in its portfolio. With respect to loans to be sold on a non-recourse basis, the Company is at risk for loan delinquencies and defaults on such loans while they are held by the Company pending such sale. To provide for credit losses, the Company charges against current earnings an amount necessary to maintain the allowance for credit losses at levels expected to cover inherent losses in loans receivable. The table below summarizes certain information with respect to the Company's allowance for credit losses on the owned portfolio for each of the periods indicated.
SUMMARY OF ALLOWANCE FOR CREDIT LOSSES ON OWNED PORTFOLIO AT AND FOR THE YEAR ENDED DECEMBER 31, 2001 2000 1999 --- ------- --------------- (IN THOUSANDS) Allowance for credit losses at beginning of period..... $ 4,652 $6,344 $6,659 Net charge-offs........................................ (1,684) (3,654) (1,990) Provision charged to expense........................... 2,883 3,159 3,339 Allowance related to loans sold........................ -- (2,861) -- ------- ------- ------ Allowance for credit losses at the end of the period... $ 5,851 $4,652 $6,344 ======= ====== ======
The Company considers its allowance for credit losses to be adequate in view of the Company's loss experience and the secured nature of most of the Company's outstanding loans. Although Management considers the allowance appropriate and adequate to cover inherent losses in the loan portfolio, Management's judgment is based upon a number of assumptions about future events, which are believed to be reasonable, but which may or may not prove valid. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for credit losses or that additional increases in the allowance for possible credit losses will not be required. The table below summarizes certain information with respect to the Company's allowance for losses on the securitization residual assets for each of the periods indicated.
SUMMARY OF EMBEDDED ALLOWANCE FOR LOSSES ON SECURITIZATION RESIDUAL ASSETS AT AND FOR THE YEAR ENDED DECEMBER 31, --------------------------- 2001 2000 1999 --------- --------- ------- (IN THOUSANDS) Residual securities: Allowance for losses at beginning of period..... $ 5,647 $7,176 $7,165 Net charge-offs................................. (3,240) (3,577) (1,661) Anticipated losses net against gain............. 6,261 1,559 1,267 Mark-to-market adjustment....................... 2,481 489 405 ------- ------ ------ Allowance for losses at end of period........... $11,149 $5,647 $7,176 ======= ====== ======
The value of the residual receivables retained by the Company would be impaired to the extent losses on the securitized loans exceed the amount estimated when determining the residual cash flows. 25 The table below summarizes the Company's allowance for credit losses with respect to the Company's total combined serviced portfolio (including both owned and securitized loan pools) for each of the periods indicated.
SUMMARY OF ALLOWANCE FOR CREDIT LOSSES ON COMBINED SERVICED PORTFOLIO AT AND FOR THE YEAR ENDED DECEMBER 31, ----------------------------- 2001 2000 1999 ------ ------- ------- (IN THOUSANDS) Allowance for credit losses at beginning of period..... $10,299 $13,520 $13,824 Net charge-offs........................................ (4,924) (5,567) (5,315) Provision charged to expense........................... 2,883 3,159 3,339 Provision netted against gain on securitizations....... 6,261 1,559 1,266 Mark-to-market adjustment.............................. 2,481 489 406 Sale of small business residual assets................. -- -- -- Allowance related to loans sold........................ -- (2,861) -- ------- ------- ------- Allowance for credit losses at the end of the period... $17,000 $10,299 $13,520 ======= ======= =======
The total allowance for credit losses as shown on the balance sheet is as follows:
Allowance for credit losses on loans.................. $ 5,851 $ 4,652 $ 6,344 Allowance for credit losses on residual receivables.... 11,149 5,647 7,176 ------- ------- ------- Total allowance for credit losses...................... $17,000 $10,299 $13,520 ======= ======= =======
The following table sets forth the Company's allowance for credit losses on the combined serviced portfolio at the end of the periods indicated, the credit loss experience over the periods indicated, and delinquent loan information at the dates indicated for loans receivable at least 30 days past due.
AT AND FOR THE YEAR ENDED DECEMBER 31, ---------------------- 2001 2000 1999 ------ ------ ----- Allowance for Credit Losses as a % of Combined Serviced Loans(1): Mortgage Loans....................................................................... 3.1% 1.88% 2.5% Small business loans................................................................. 53.9 43.5 32.2 Total allowance for credit losses as a % of serviced loans...................... 4.6 3.1 3.2 Net Charge-offs as a % of Average Combined Serviced Loans(2): Mortgage Loans....................................................................... 0.1 0.6 0.8 Total net charge-offs as a % of total serviced loans............................ 0.1 0.6 0.8 Loans Receivable Past Due 30 Days or More as a % of Combined Serviced Loans(1): Mortgage Loans....................................................................... 7.5 7.5 12.4 Small business loans................................................................. 84.3 33.4 55.3 Total loans receivable past due 30 days or more as a % of total serviced loans........................................................................ 10.2 7.3 13.5 Total Allowance for Credit Losses as a % of Combined Serviced Loans Past Due 90 Days or More(1)........................................................................ 62.3% 29.0% 23.9%
(1) For purposes of these calculations, combined serviced loans represents all loans for which the Company bears credit risk, and includes all portfolio Mortgage Loans and securitized loans, and the Small Business Loans. (2) Average serviced loans have been determined by using beginning and ending balances for the period presented. Management closely monitors delinquencies to measure the quality of its loan portfolio and securitized loans and the potential for credit losses. Accrual of interest is discontinued and reversed when a loan is over 150 days past due, when the collateral is determined to be inadequate, or when foreclosure proceedings begin. Collection efforts on charged-off loans continue until the obligation is satisfied or until it is determined that such obligation is not collectible or the cost of continued collection efforts would exceed the potential recovery. Recoveries of previously charged-off loans are credited to the allowance for credit losses. 26 Management monitors securitized pool delinquencies using a static pool analysis by month by pool balance. Current year results are not necessarily indicative of future performance. The following sets forth the static pool analysis for delinquencies by month in the Company's securitized mortgage loan pools.
CURRENT PRINCIPAL BALANCE --------------------------------------------------------------------------------------- MONTHS FROM POOL INCEPTION 1997-1 1997-2 1997-3 1997-4 1998-1 1999-1 ---------------- --------- -------- -------- -------- -------- -------- 1 $77,435,632 $120,860,326 $130,917,899 $118,585,860 $62,726,105 $59,219,199 2 $77,405,312 $120,119,653 $169,093,916 $118,061,792 $62,300,302 $57,977,700 3 $76,709,417 $119,364,510 $168,182,957 $148,291,454 $61,609,815 $57,201,142 4 $75,889,160 $118,965,905 $166,783,489 $146,880,279 $60,768,433 $56,168,578 5 $75,395,969 $117,238,693 $165,608,534 $145,775,696 $59,347,948 $55,351,358 6 $74,630,019 $115,870,168 $164,084,260 $144,465,651 $58,739,309 $54,561,477 7 $73,149,957 $113,537,447 $161,880,416 $143,048,555 $57,829,352 $53,610,555 8 $72,261,386 $112,100,397 $158,220,175 $140,482,698 $56,918,186 $52,592,079 9 $71,342,842 $110,468,401 $155,854,981 $137,318,432 $55,894,240 $51,544,836 10 $70,195,198 $107,887,242 $153,193,421 $134,991,772 $54,887,268 $50,557,441 11 $68,981,147 $105,138,088 $148,382,102 $131,582,081 $53,817,889 $49,432,647 12 $67,149,553 $102,142,062 $144,556,568 $129,029,429 $52,813,707 $48,605,367 13 $65,705,603 $98,876,084 $140,265,621 $125,457,545 $51,834,618 $47,558,170 14 $63,210,889 $95,394,444 $136,583,138 $121,706,895 $50,355,268 $46,337,600 15 $60,052,314 $92,501,939 $133,252,925 $118,983,067 $49,261,441 $45,710,455 16 $58,133,496 $89,402,897 $129,792,748 $116,012,173 $48,013,883 $45,288,892 17 $56,900,372 $83,793,933 $127,118,396 $112,424,165 $46,682,595 $44,736,648 18 $55,154,969 $81,637,626 $124,262,781 $109,695,150 $45,808,180 $44,334,435 19 $50,852,179 $79,392,938 $119,512,141 $107,288,894 $44,422,122 $43,964,717 20 $49,702,926 $77,843,648 $116,408,786 $104,842,028 $43,821,316 $43,417,008 21 $48,629,373 $76,319,392 $113,506,699 $101,806,498 $42,973,221 $42,912,170 22 $45,780,152 $74,512,970 $108,064,086 $98,013,963 $41,901,327 $42,230,852 23 $44,612,888 $71,644,155 $104,734,353 $95,627,417 $41,054,409 $41,640,761 24 $43,845,616 $69,074,182 $101,605,131 $92,702,818 $39,983,743 $40,798,143 25 $42,879,623 $66,456,654 $98,057,107 $89,450,634 $38,501,039 $39,901,234 26 $40,453,030 $63,909,211 $94,776,180 $87,745,088 $37,990,490 $39,022,122 27 $38,939,475 $61,789,775 $91,621,984 $85,848,197 $37,156,755 $38,899,651 28 $38,094,550 $59,776,201 $88,960,343 $83,961,093 $36,185,661 $37,285,192 29 $37,287,522 $56,901,545 $87,513,930 $81,180,064 $35,520,835 $36,519,531 30 $36,315,115 $55,673,168 $84,993,550 $79,358,028 $34,757,751 $35,492,829 31 $35,921,142 $54,358,523 $82,761,581 $77,639,662 $33,935,509 $34,188,399 32 $34,976,083 $53,498,302 $81,263,821 $76,476,892 $33,413,263 $33,581,860 33 $33,841,626 $52,449,253 $79,413,800 $74,771,334 $32,816,210 34 $33,114,404 $50,659,884 $77,515,749 $73,827,440 $32,271,294 35 $32,042,753 $49,557,700 $75,640,670 $71,857,595 $31,663,893 36 $31,308,902 $48,739,883 $74,138,736 $70,570,042 $31,339,108 37 $30,544,226 $47,409,883 $73,172,980 $68,966,966 $30,363,309 38 $30,042,212 $46,964,391 $72,502,513 $67,729,913 $29,701,033 39 $29,441,691 $46,032,969 $71,078,320 $66,954,372 $28,841,968 40 $28,874,422 $45,160,626 $69,847,023 $65,136,094 $28,398,206 41 $28,026,177 $44,409,740 $68,779,193 $62,971,633 $27,910,951 42 $27,865,131 $43,860,257 $67,685,042 $61,308,651 $26,743,877 43 $27,319,610 $43,340,538 $66,026,900 $59,659,276 $26,271,331 44 $26,768,456 $42,143,412 $65,031,394 $58,310,522 $26,126,570 45 $26,284,168 $41,276,998 $63,069,395 $57,202,981 $25,780,934 46 $25,754,675 $39,882,153 $62,254,811 $55,271,863 $24,935,521 47 $25,534,819 $38,924,169 $60,530,303 $54,233,011 48 $24,907,316 $38,002,769 $59,143,112 $53,465,915 49 $24,310,283 $37,512,446 $57,779,250 $51,569,640 50 $23,555,774 $36,704,664 $56,468,763 51 $23,311,839 $35,643,925 $55,354,478 52 $22,533,303 $34,715,449 $53,998,455 53 $22,185,519 $33,974,185 54 $21,755,311 $33,076,394 55 $20,982,547 $32,219,346 56 $20,436,365 57 $20,148,565 58 $19,532,318
27
DELINQUENCIES > 30 DAYS PAST DUE MONTHS FROM POOL ----------------------------------------------------------------------------------- INCEPTION 1997-1 1997-2 1997-3 1997-4 1998-1 1999-1 ---------------- ---------- ---------- ------------ ----------- ----------- ----------- 1 $ 0 $ 515,954 $ 609,201 $ 402,972 $ 44,600 $1,466,076 2 $1,499,056 $1,631,017 $2,042,757 $2,132,028 $1,223,964 $3,134,425 3 $1,931,761 $3,930,423 $4,498,266 $5,049,035 $2,013,525 $2,438,937 4 $3,760,774 $5,399,569 $8,546,414 $7,290,097 $3,872,888 $2,434,471 5 $5,220,385 $7,293,856 $12,337,604 $10,290,987 $3,825,651 $2,662,519 6 $5,849,574 $9,790,732 $13,432,454 $13,459,369 $5,199,587 $2,804,957 7 $6,777,962 $11,933,526 $15,076,729 $12,443,357 $6,248,301 $3,115,273 8 $8,078,783 $12,484,893 $17,745,496 $13,861,088 $5,983,226 $3,351,500 9 $8,528,559 $12,471,739 $18,099,411 $16,777,959 $6,591,674 $3,512,716 10 $10,008,415 $11,304,455 $16,680,011 $19,050,239 $6,317,098 $3,579,689 11 $10,728,125 $12,630,402 $18,929,917 $18,524,292 $5,701,474 $2,689,907 12 $9,257,295 $14,540,910 $21,295,026 $18,470,254 $5,950,145 $3,084,083 13 $9,578,031 $12,933,959 $22,303,472 $18,645,129 $5,705,994 $3,360,592 14 $10,757,672 $12,674,148 $21,746,520 $17,059,730 $5,287,678 $3,540,638 15 $9,401,614 $14,212,157 $23,240,338 $15,698,435 $6,297,465 $3,390,079 16 $8,127,303 $14,386,886 $22,031,312 $16,318,099 $6,255,440 $4,398,425 17 $8,227,263 $11,723,546 $19,672,481 $15,292,242 $6,342,927 $3,841,679 18 $8,708,963 $11,171,133 $18,472,732 $15,132,124 $7,150,420 $3,757,618 19 $7,349,210 $12,018,899 $18,243,184 $15,706,290 $6,380,174 $4,546,107 20 $7,217,783 $11,810,332 $18,119,731 $16,301,760 $6,080,991 $3.954,210 21 $7,120,727 $11,040,206 $18,038,082 $15,464,631 $6,103,461 $4,575,889 22 $6,661,879 $10,286,947 $16,452,727 $14,333,343 $6,165,388 $4,478,405 23 $6,511,325 $10,414,360 $16,055,129 $15,895,532 $5,571,022 $4,133,536 24 $6,250,278 $8,906,082 $15,924,085 $14,232,856 $5,290,607 $4,078,963 25 $6,276,717 $9,514,340 $15,482,673 $13,162,282 $4,817,659 $4,683,557 26 $5,442,995 $8,806,693 $15,438,560 $12,180,657 $5,597,356 $4,306,053 27 $4,900,780 $8,262,250 $14,301,848 $12,737,934 $4,386,742 $4,549,594 28 $6,106,097 $8,642,371 $13,359,698 $11,694,987 $4,583,117 $5,084,297 29 $4,982,511 $6,969,409 $13,659,548 $11,460,244 $4,045,655 $3,194,561 30 $5,346,769 $7,939,953 $11,918,981 $10,909,001 $3,980,150 $4,467,069 31 $5,756,594 $7,790,662 $10,833,705 $9,815,183 $4,018,994 $3,768,465 32 $4,972,092 $6,957,167 $10,924,836 $9,618,960 $3,613,024 $3,692,501 33 $4,995,142 $6,445,310 $10,766,050 $9,552,132 $3,496,246 34 $4,944,931 $6,168,132 $8,884,739 $9,027,820 $3,172,976 35 $3,900,531 $5,871,698 $8,549,661 $8,351,543 $3,197,470 36 $3,884,396 $6,401,739 $9,144,434 $8,958,424 $3,368,240 37 $3,242,843 $5,254,138 $8,807,168 $8,464,824 $2,877,919 38 $3,266,679 $4,385,425 $8,035,129 $7,679,669 $2,993,149 39 $3,322,549 $4,646,624 $8,446,342 $7,964,987 $2,922,684 40 $2,622,995 $3,906,395 $8,315,750 $8,530,220 $3,295,930 41 $2,956,319 $3,886,438 $7,997,811 $8,054,070 $3,174,244 42 $3,227,518 $3,885,226 $7,933,292 $7,615,093 $3,792,083 43 $3,076,141 $3,706,334 $6,919,987 $7,159,379 $3,194,561 44 $2,727,918 $3,766,097 $6,322,597 $7,125,239 $3,382,609 45 $2,644,450 $3,804,501 $6,668,240 $6,854,808 $3,131,746 46 $2,550,625 $3,402,198 $6,764,444 $7,506,828 $3,074,022 47 $2,409,035 $3,769,390 $6,361,953 $7,697,719 48 $2,455,749 $2,922,138 $7,590,742 $6,913,025 49 $2,129,385 $3,454,020 $7,228,286 $6,912,510 50 $2,508,661 $3,109,449 $7,088,821 51 $2,547,403 $3,740,080 $7,031,727 52 $2,769,567 $3,241,154 $6,304,962 53 $2,741,242 $3,248,915 54 $3,132,623 $3,526,856 55 $2,131,077 $3,222,200 56 $1,963,250 57 $1,922,310 58 $2,201,229
The principal balances and delinquency amounts include $5.4 million and $4.9 million of real estate acquired through foreclosure at December 31, 2001 and 2000, respectively. 28
MONTHS FROM POOL INCEPTION DELINQUENCIES > 30 DAYS PAST DUE AS A PERCENT OF CURRENT BALANCE -------------------------- ----------------------------------------------------------------- 1997-1 1997-2 1997-3 1997-4 1998-1 1999-1 AVERAGE -------- ------ ------ ------ ------ ------ ------- 1 0.00% 0.43% 0.47% 0.34% 0.07% 2.48% 0.63% 2 1.94% 1.36% 1.21% 1.81% 1.96% 5.41% 2.28% 3 2.52% 3.29% 2.67% 3.40% 3.27% 4.26% 3.24% 4 4.96% 4.54% 5.12% 4.96% 6.37% 4.33% 5.05% 5 6.92% 6.22% 7.45% 7.06% 6.45% 4.81% 6.49% 6 7.84% 8.45% 8.19% 9.32% 8.85% 5.14% 7.96% 7 9.27% 10.51% 9.31% 8.70% 10.80% 5.81% 9.07% 8 11.18% 11.14% 11.22% 9.87% 10.51% 6.37% 10.05% 9 11.95% 11.29% 11.61% 12.22% 11.79% 6.81% 10.95% 10 14.26% 10.48% 10.89% 14.11% 11.51% 7.08% 11.39% 11 15.55% 12.01% 12.76% 14.08% 10.59% 5.44% 11.74% 12 13.79% 14.24% 14.73% 14.31% 11.27% 6.35% 12.45% 13 14.58% 13.08% 15.90% 14.86% 11.01% 7.07% 12.75% 14 17.02% 13.29% 15.92% 14.02% 10.50% 7.64% 13.07% 15 15.66% 15.36% 17.44% 13.19% 12.78% 7.42% 13.64% 16 13.98% 16.09% 16.97% 14.07% 13.03% 9.71% 13.98% 17 14.46% 13.99% 15.48% 13.60% 13.59% 8.59% 13.29% 18 15.79% 13.68% 14.87% 13.79% 15.61% 8.48% 13.70% 19 14.45% 15.14% 15.26% 14.64% 14.36% 10.34% 14.03% 20 14.52% 15.17% 15.57% 15.55% 13.88% 9.11% 13.97% 21 14.64% 14.47% 15.89% 15.19% 14.20% 10.66% 12.40% 22 14.55% 13.81% 15.22% 14.62% 14.71% 10.60% 13.92% 23 14.60% 14.54% 15.33% 16.62% 13.57% 9.93% 14.10% 24 14.26% 12.89% 15.67% 15.35% 13.23% 10.00% 13.57% 25 14.64% 14.32% 15.79% 14.71% 12.51% 11.74% 13.95% 26 13.46% 13.78% 16.29% 13.88% 14.73% 11.03% 13.86% 27 12.59% 13.37% 15.61% 14.84% 11.81% 11.70% 13.32% 28 16.03% 14.46% 15.02% 13.93% 12.67% 13.64% 14.29% 29 13.36% 12.25% 15.61% 14.12% 11.39% 8.75% 12.58% 30 14.72% 14.26% 14.02% 13.75% 11.45% 12.59% 13.47% 31 16.03% 14.33% 13.09% 12.64% 11.84% 11.02% 13.16% 32 14.22% 13.00% 13.44% 12.58% 10.81% 11.00% 12.51% 33 14.76% 12.29% 13.56% 12.78% 10.65% 10.67% 34 14.93% 12.18% 11.46% 12.23% 9.83% 10.11% 35 12.17% 11.85% 11.30% 11.62% 10.10% 9.51% 36 12.41% 13.13% 12.33% 12.69% 10.75% 10.22% 37 10.62% 11.08% 12.04% 12.27% 9.48% 9.25% 38 10.87% 9.34% 11.08% 11.34% 10.08% 8.79% 39 11.29% 10.09% 11.88% 11.90% 10.13% 9.22% 40 9.08% 8.65% 11.91% 13.10% 11.61% 9.06% 41 10.55% 8.75% 11.63% 12.79% 11.37% 9.18% 42 11.58% 8.86% 11.72% 12.42% 14.18% 9.79% 43 11.26% 8.55% 10.48% 12.00% 12.16% 9.08% 44 10.19% 8.94% 9.72% 12.22% 12.95% 9.00% 45 10.06% 9.22% 10.57% 11.98% 12.15% 9.00% 46 9.90% 8.53% 10.87% 13.58% 12.33% 9.20% 47 9.43% 9.68% 10.51% 14.19% 7.30% 48 9.86% 7.69% 12.83% 12.93% 7.22% 49 8.76% 9.21% 12.51% 13.40% 7.31% 50 10.65% 8.47% 12.55% 5.28% 51 10.93% 10.49% 12.70% 5.69% 52 12.29% 9.34% 11.68% 5.55% 53 12.36% 9.56% 3.65% 54 14.40% 10.66% 4.18% 55 10.16% 10.00% 3.36% 56 9.61% 1.60% 57 9.54% 1.59% 58 11.27% 1.88% Actual Historical Life to Date Prepayment Speed 22.3% 24.1% 22.4% 20.6% 18.7% 15.9% 18.9%
29 LIQUIDITY AND CAPITAL RESOURCES The Company's business requires continued access to short and long-term sources of debt financing and equity capital. Primarily as a result of selling fewer loans in 2001 than were originated in 2001, and as a result of its operating loss, the Company experienced a negative cash flow from operating activities in 2001 of $37.0 million. At December 31, 2001, the Company had a shareholders' deficit of $84.1 million. Although the Company's goal is to achieve a positive cash flow each quarter, no assurance can be given that this objective will be attained due to the higher level of cash required to fund the loans purchased and originated. Currently, the Company's primary operating cash uses include the funding of (i) loan originations and purchases pending their securitization or sale, (ii) interest expense on CII investor savings notes, senior unsecured debt and its revolving warehouse credit and purchase facilities ("Credit Facilities"), (iii) fees, expenses, overcollateralization, servicer advances and tax payments incurred in connection with the securitization program and (iv) ongoing administrative and other operating expenses. The Company's primary operating sources of cash are (i) cash gains from whole-loan mortgage loan sales, (ii) cash payments of contractual and ancillary servicing revenues received by the Company in its capacity as servicer for securitized loans, (iii) interest income on loans receivable and certain cash balances, (iv) fee income received in connection with its retail mortgage loan originations, (v) excess cash flow received in each period with respect to residual receivables, (vi) cash borrowed under its credit facilities, and (vii) proceeds from CII Notes and Debentures. The Company overcollateralizes loans as a credit enhancement on the mortgage loan securitization transactions. This requirement creates negative cash flows in the year of securitization. The Company decided to securitize seasoned first and second mortgages in 2001 and 2000, and conducted whole loan sales for the majority of the mortgages. Currently the Company plans to conduct a combination of securitizations and whole loan sales throughout 2002. This strategy is designed to maximize liquidity and profitability. Cash flow is also enhanced by the generation of loan fees in its retail mortgage loan operation. The table below summarizes cash flows provided by and used in operating activities:
FOR THE YEARS ENDED DECEMBER 31, --------------------------------- 2001 2000 1999 ----------- -------------- ------ (IN THOUSANDS) Operating Cash Income: Servicing fees received and excess cash flow from securitization trusts........................................................... $14,459 $11,594 $15,622 Interest received................................................... 7,839 11,799 9,475 Cash gain on sale of loans.......................................... 12,807 9,801 6,477 Cash loan origination fees received................................. 27,143 19,480 4,841 Other cash income................................................... 735 1,354 1,609 ------------------------------------- Total operating cash income.................................... 62,983 54,028 38,024 Operating Cash Expenses: Securitization costs................................................ -- -- (593) Cash operating expenses............................................. (69,305) (56,831) (37,456) Interest paid....................................................... (20,863) (17,895) (18,691) Taxes refunds / (paid).............................................. 158 (175) (278) ------------------------------------- Total operating cash expenses.................................. (90,010) (74,901) (57,018) Cash (deficit) due to operating cash income and expenses............ (27,027) (20,873) (18,994) Other Cash Flows: Cash used in other payables and receivables......................... (14,779) (33,671) (7,741) Cash provided by (used in) loans held for sale...................... 4,814 (8,177) 33,951 ------------------------------------- Net cash provided by (used in) operating activities............ $ (36,992) $ (62,721) $7,216 =====================================
Cash and cash equivalents were $26.4 million at December 31, 2001, $3.7 million at December 31, 2000, and $26.0 million at December 31, 1999. Cash used in operating activities was $37.0 million for the year ended December 31, 2001, compared to cash used in operating activities of $62.7 million for the year ended December 31, 2000. Cash provided by investing activities was $0.1 million for the year ended December 31, 2001, compared to cash provided by investing activities of $44.8 million for the year ended December 31, 2000, and cash provided by financing activities was $59.6 million for the year ended December 31, 2001, compared to cash used by financing activities of $4.4 million for the year ended December 31, 2000. The decrease in cash used in operations was due 30 principally to a higher number of loans originated than sold and securitized in 2001, along with the operating loss being reduced. Cash used in investing activities was primarily from the purchase of additional equipment for the new production centers opened in 2001. The increase in cash provided by financing activities was due principally to the increase in CII deposits by its investors. HGI has a $15 million revolving warehouse line of credit with Household Commercial Financial Services ("Household"). The facility bears interest at the prime rate plus .25%, requires a $1.5 million collateral deposit, and is due on demand. All of the Company's subsidiaries are guarantors under the agreement. During 2000 and 2001, amendment and forbearance agreements were executed whereby the lender agreed to forebear from exercising its rights on account of existing events of default. The outstanding balance under the Household line of credit was $4.3 million at December 31, 2001. The Company secured its guaranty of the Household facility with a mortgage on the former Company headquarters located at 3901 Pelham Road in Greenville, S.C. The lender may terminate its forbearance on thirty days notice. Based on the outstanding borrowings under the line of credit of $4.3 million, the Company had $10.7 million of immediate availability under this agreement at December 31, 2001. The credit facility contains a covenant that prohibits the Company from paying dividends or making distributions with respect to its capital stock other than dividends payable solely in its capital stock and dividends required to be paid with respect to the Company's Series A Non-Convertible Preferred Stock pursuant to the terms and provisions thereof. HGI has a $15 million revolving warehouse line of credit with The Provident Bank ("Provident"). Interest on the line varies on a loan by loan basis and ranges from the prime rate plus 1.5% to the prime rate plus 3.5%, depending on the grade and age of the mortgage funded. The agreement allows for a rate reduction from the base rates if certain monthly funded volume targets are met. The agreement requires a $2 million collateral deposit. Provident holds a security interest in the Company's Reed Avenue property, formerly occupied by HGI, in Lexington, South Carolina. The line of credit terminates on October 31, 2002. At December 31, 2001, the balance of funded loans on the line was $8.3 million, and these loans were all sub-serviced by Provident. HGI has a $25 million warehouse line of credit with Impac Mortgage Acceptance Corp. ("Impac"). The facility bears interest at the prime rate plus 1.5%, requires a $2.5 million collateral deposit, and may be terminated by Impac without notice. Advance rates on fundings range from 96% to 100% of the principal amount, depending on the type and source of the mortgage. The outstanding balance under the Impac line of credit was $12.3 million at December 31, 2001. The Company has guaranteed the obligations of HGI under the Impac credit agreement. At December 31, 2001, the balance of funded loans on the line was $12.3 million. All of the Company's warehouse lines contain provisions whereby the lender can terminate their agreement without cause with certain notice requirements. The Company's management believes all current warehouse relationships will remain in place until maturity; however, there is no assurance that one or more of the lenders will not terminate their agreements prior to maturity, or that additional lines will be negotiated at maturity. Either occurrence would adversely affect the Company's ability to originate loans. During 1997, the Company sold $125.0 million in aggregate principal amount of 10 3/4% Senior Notes due 2004. The Senior Notes due 2004 constitute unsecured indebtedness of the Company. The Senior Notes due 2004 are redeemable at the option of the Company, in whole or in part, on or after September 15, 2001, at predetermined redemption prices plus accrued and unpaid interest to the date of redemption. The Senior Notes due 2004 are fully and unconditionally guaranteed (the "Subsidiary Guarantees") jointly and severally on an unsecured basis (each, a "Guarantee") by certain of the Company's subsidiaries (the "Subsidiary Guarantors"). With the exception of the Guarantee by CII, the Subsidiary Guarantees rank on par with the right of payment with all existing and future unsubordinated indebtedness of the Subsidiary Guarantors and senior in right of payment to all existing and future subordinated indebtedness of such Guarantors. The Guarantee by CII is equal in priority to CII's notes payable to investors and is senior to CII's subordinated debentures. The Company purchased $5.0 million, $0.9 million, and $74.5 million in face amount of its senior notes in 2001, 2000, and 1999, respectively. At December 31, 2001 and 2000, $6.2 million and $11.2 million, respectively, in aggregate principal amount of Senior Notes were outstanding. The Company's repurchase of Senior Notes in 2001 was accomplished through a tender offer and a solicitation of consents of holders of the Senior Notes to the deletion of most of the restrictive covenants, certain 31 events of default and related definitions from the Senior Notes Indenture. The Company received sufficient consents to amend the original Indenture, consequently, as of November 2001, most of the restrictive covenants in the original Indenture no longer exist. CII engages in the sale of CII Notes to investors. The CII Notes are comprised of senior notes and subordinated debentures bearing fixed rates of interest which are sold by CII only to South Carolina residents. The offering of the CII Notes is registered under South Carolina securities law and is believed to be exempt from Federal registration under the Federal intrastate exemption. CII believes it conducts its operations so as to qualify for the safe harbor provisions of Rule 147 promulgated pursuant to the Securities Exchange Act of 1933, as amended (the "Securities Act"). At December 31, 2001, CII had an aggregate of $200.9 million of investor notes outstanding bearing a weighted average interest rate of 8.17%, and an aggregate of $30.1 million of subordinated debentures bearing a weighted average interest rate of 6.00%. The investor notes and subordinated debentures are subordinate in priority to the warehouse lines. Maturities of the CII Notes and debentures generally range from one to two years. Shareholders' equity decreased in 2001 by $73.6 million to a $84.1 million deficit at December 31, 2001, from a $10.8 million deficit at December 31, 2000. During 2000, stockholders equity decreased $18.7 million from $7.8 million at December 31, 1999. The principal reason for the change to shareholders' equity is the net income (loss) recognized in the respective years. GOING CONCERN HGFN has sustained substantial operating losses in recent years and has a shareholders' deficit of $84.1 million at December 31, 2001. These losses began in 1998 when the subprime lending industry suffered a significant downturn. This was primarily due to global shifts in the capital markets which reduced by over 80% the margin available on the resale of loans in the secondary markets. More than 60% of the Company's stand-alone, publicly-traded competitors were forced out of business. These losses continued through 1999. In May 2000, HomeSense merged into a subsidiary of HGFN and, under new management, HGFN rededicated itself to making the subprime lending operation profitable. Although the losses have continued through 2001, the new manangement team of HGFN has taken steps to reverse these negative trends by implementing operating changes which include, but are not limited to, the following: o Opening seven additional production facilities since first quarter 2000; o Strengthening the depth of experienced production center managers; o Increasing the number of loan officers from 135 to 240 since early 2001; o Initiating a "conforming loan" product in early 2001 to utilize higher credit leads which were previously wasted; o Overhauling the marketing plan to produce lower cost, higher efficiency leads and to utilize recycled leads as a major component of the overall marketing efforts; o Reducing the costs of originating loans by requiring payment for appraisals at the time the appraisal is performed and by negotiating reduced prices for credit bureau reports; o Modifying incentive compensation plans for production associates to focus efforts on more profitable production; o Improving ability to fund higher volumes of loan originations by increasing warehouse lines of credit and utilizing available cash to fund loan originations; o Negotiating joint ventures to realize revenue from title-related fees on current production; and o Reducing non-core operating and general overhead. In addition, HGFN has considered the divestiture of its retail mortgage origination division. Recent independent valuations have valued the division at between $135 million and $170 million. HGFN management may pursue potential acquirers for the division, but will continue to operate and grow the division until and if it is sold. The recurring losses and deficit equity of HGFN raise substantial doubt about the Company's ability to continue as a going concern. Management of the Company believes the actions discussed above will provide the opportunity for the Company to continue as a going concern. 32 LOAN SALES AND SECURITIZATIONS The Company sells or securitizes substantially all of its loans. The Company sells on a whole loan basis a significant amount of its Mortgage Loans (servicing released), including substantially all of its Mortgage Loans secured by second liens, principally to secure the additional cash flow associated with the premiums paid in connection with such sales and to eliminate the credit risk associated with the second lien Mortgage Loans. However, no assurance can be given that the second lien Mortgage Loans can be sold. To the extent that the loans are not sold, the Company retains the risk of loss. At December 31, 2001 and 2000, the Company had retained $5.7 million and $17.1 million, respectively, of second lien Mortgage Loans on its balance sheet. During 2001, 2000, and 1999, the Company sold $629.5 million, $517.3 million, and $220.4 million, respectively, of Mortgage Loans. Although securitizations provide liquidity, the Company has utilized securitizations principally to provide a lower cost of funds and reduce interest rate risk, while building servicing revenues by increasing the serviced portfolio. In connection with its securitizations, the Company has retained interest-only residual certificates representing residual interests in the trusts. These subordinate residual securities totaled $49.3 million, net of allowances, at December 31, 2001. The first, second and third securitizations of 1997 and the 1998 securitization are structured as real estate mortgage investment conduits ("REMIC's"). The fourth quarter 1997 securitization utilized a real estate investment trust ("REIT"). This allows sales treatment for financial reporting purposes, but debt treatment for tax purposes. Accordingly, this structure eliminates current taxes payable on the book gain, while maintaining the structural efficiency of tranching, previously only available through a REMIC transaction. Additionally, under this structure, the Company has distributed .46% ownership in the REIT to a certain class of current and former employees, with an initial value of approximately $62,000. The 2000 and 2001 securitizations are "Owners' Trusts", another structure which allows sales treatment for financial reporting purposes, but debt treatment for tax purposes. The Company has been securitizing mortgage loans since 1997. In a securitization transaction, the Company sells Mortgage Loans it purchased or originated to a trust for cash. The trust sells asset-backed bonds secured by the loans to investors. The Company records certain assets and income based upon the difference between all principal and interest received from the loans sold and the following factors (i) all principal and interest required to be passed through to the asset-backed bond investors, (ii) all excess contractual servicing fees, (iii) other recurring fees and (iv) an estimate of losses on the loans (collectively, the "Excess Cash Flow"). At the time of the securitization, the Company estimates these amounts based upon a declining principal balance of the underlying loans, adjusted by an estimated prepayment and loss rate, and capitalizes these amounts using a discount rate that market participants would use for similar financial instruments. These capitalized assets are recorded as a residual receivable. The Company believes the assumptions it has used in past securitizations are appropriate and reasonable. In connection with its 1999 securitization transaction, HGFN agreed to cross-collateralize its residual interests in that transaction and its first three 1997 securitization transactions. The cross-collateralization is for the benefit of Financial Security Assurance, Inc. ("FSA") the bond insurer for all of the transactions. Under the terms of the cross-collateralization agreement, in the event HGFN is in breach of its obligations under any one or more of the securitization trusts, or if certain cumulative loss or delinquency triggers are met, the excess cash flow on all four residual interests will be captured by the Collateral Agent. The Collateral Agent will distribute these monies to FSA or as otherwise specified in the agreement. The total amount which may be retained by the Collateral Agent is capped at $15.0 million. This agreement terminates upon the termination of all of the related securitization trusts. In August 2000, the Company exceeded the twelve-month rolling loss trigger in the 1998 securitization pool which resulted in the monthly cash flow of this pool (approximately $70,000 per month) being retained by the trustee rather than being paid to the Company. In December of 2001, the performance of this pool returned to a point below the required trigger, and cash flow back to the Company resumed. In September 2001, the Company exceeded the three-month average delinquency trigger in the 1997-1 securitization pool which resulted in the monthly cash flow of this pool (approximately $60,000 per month) being retained by the trustee rather than being paid to the Company. In December of 2001 the performance of this pool returned to a point below the required trigger, and cash flow back to the Company resumed. 33 In December 2001, the Company exceeded the twelve-month rolling loss trigger in the 1999 securitization pool which resulted in the monthly cash flow of this pool (approximately $80,000 per month) being retained by the trustee rather than being paid to the Company. If the Company returns performance of this pool to a point below the required trigger, the return of cash flow back to the Company will resume. The Company sold its servicing rights under the 2001 and 2000 securitizations because the price paid by the independent third party servicer resulted in a higher realized gain than if the servicing rights had not been sold. Consequently, the residual interests related to these two pools are not subject to the Company's normal quarterly evaluation of assumptions and estimates as compared to actual performance. These residual interests represent the Company's estimate of market value. Market value determination includes an estimate of credit losses, based on anticipated performance of the securitized loans in the portfolio. During 2001, the Company increased the valuation reserve $7.1 million for anticipated future losses related to these pools. This valuation adjustment is included in the fair market value adjustment on residual receivables in the accompanying consolidated statement of operations. Management reviews the allowance on an ongoing basis and believes the valuation reserve is sufficient to cover future losses. The original certificate balance of the 2001-5 securitization trust totaled $9,994,196. The Company's share of the original certificate balances was $3,498,196. The average stated principal balance is $52,273 for the 2001-5 pool. The annual servicing fee is 0.50% for the 2001-5, and the trustee fee is 0.05%. The original certificate balances for the 2000 securitizations totaled $64,330,194. The 2000-4 trust had an original certificate balance of $41,473,722 with the Company's share of the original certificate balances being $12,047,487. The 2000-5 trust had an original certificate balance of $22,856,471 with the Company's share of the original certificate balances being $5,142,707. The average stated principal balances are $54,734 and $47,105 for pools 2000-4 and 2000-5, respectively. The annual servicing fees are 0.58% and 0.50% for 2000-4 and 2000-5, respectively, and the trustee fee is .05%. Interest income is allocated to the bondholders based on the certificate balances. At December 31, 2001, the weighted average pass through rate to bondholders is 9.75%, 11.13%, and 11.84% for the 2001-5, 2000-4, and 2000-5 pools respectively. The Company will not receive its share of principal distribution until three years from the time of the transaction. After three years, principal distribution will be received if the portfolios meet certain performance requirements. Although the Company is a certificate holder, its share of the principal balance is reduced by all losses incurred by the pools. The estimated cumulative losses as a percent of the unpaid principal balance at December 31, 2001 are 10.5%, 19%, and 10% for the 2001-5, 2000-4, and 2000-5 pools. These estimated loss rates are used in estimating the market value of the Company's residual interest. At December 31, 2001, the 2001-5 trust had an outstanding principal balance of $8,905,216 with the Company's certificate share being $2,560,921, net of a reserve of $937,274. The 2000-4 trust had outstanding principal balances of $29,546,745 with the Company's certificate share being $4,269,805, net of a reserve of $5,613,000. The 2000-5 trust had outstanding principal balances of $17,811,931 with the Company's certificate share being $2,793,234, net of a reserve of $1,839,725. The Company retains the right to service loans it securitizes except for the 2000 and 2001 securitizations. Fees for servicing loans are based on a stipulated percentage (generally 0.50% per annum) of the unpaid principal balance of the associated loans. Other than the 2000 and 2001 securitizations, the Company has recognized a servicing asset in addition to its gain on sale of loans. The servicing asset is calculated as the present value of the expected future net servicing income in excess of adequate compensation for a substitute servicer, based on common industry assumptions and the Company's historical experience. These factors include default and prepayment speeds. For all of the mortgage loan securitizations completed to date, the servicing asset recorded represents a 10 basis point strip of cash flows from the stipulated servicing percentage. The following sets forth facts and assumptions used by the Company in arriving at the valuation of the residual receivables relating to its Mortgage Loan securitization pools it services as of December 31, 2001: 34
1997-1 1997-2 1997-3 1997-4 1998-1 1999-1 ------------------------------------------------------------------------------------ Outstanding balance of loans securitized (1) $19,532,318 $32,219,346 $53,998,455 $51,569,640 $24,935,521 $33,581,860 Average stated principal balance 54,408 50,186 60,333 58,535 58,125 43,898 Weighted average coupon on loans 10.76% 10.62% 11.01% 10.79% 10.73% 10.90% Weighted average remaining term to stated 157 mths 153 mths 158 mths 162 mths 180 mths 183 mths maturity Weighted average LTV 74% 69% 73% 73% 73% 69% Percentage of first mortgage loans 100% 100% 100% 100% 100% 81.22% Weighted average pass-through rate to 7.66% 7.21% 7.10% 6.76% 6.70% 6.84% bondholders Assumed annual losses 0.20% 0.18% 0.26% 0.36% 0.39% 0.49% Remaining ramp period for losses 0 Mths 0 Mths 0 Mths 0 Mths 0 Mths 0 Mths Assumed cumulative losses as a % of UPB 1.90% 1.87% 1.79% 1.80% 1.79% 2.34% Annual servicing fee 0.50% 0.50% 0.50% 0.50% 0.50% 0.56% Servicing asset 0.10% 0.10% 0.10% 0.10% 0.10% 0.10% Discount rate applied to cash flow after Over collateralization 12% 12% 12% 12% 12% 12% Prepayment speed: Initial CPR (2) 0 CPR 0 CPR 0 CPR 0 CPR 0 CPR 22 HEP Peak CPR (2) 26 CPR 26 CPR 26 CPR 26 CPR 26 CPR 22 HEP Tail CPR (2) 24/22 CPR 24/22 CPR 24/22 CPR 24/22 CPR 24/22 CPR 22 HEP CPR ramp period (2) 12 mths 12 mths 12 mths 12 mths 12 mths 22 HEP CPR peak period (2) 24 mths 24 mths 24 mths 24 mths 24 mths 22 HEP CPR tail begins (2) 37/49 mths 37/49mths 37/49 mths 37/49 mths 37/49 mths 22 HEP Annual wrap fee and trustee fee 0.285% 0.205% 0.195% 0.185% 0.185% 0.265% Initial overcollateralization required (3) 3.25% -- -- -- -- 9.5% Final overcollateralization required (3) 6.5% 3.75% 3.75% 3.75% 3.75% 13.5%
(1) The aggregate amount securitized is $215,837,139 including $5,478,073 of real estate acquired through foreclosure. (2) CPR represents an industry standard of calculating prepayment speeds and refers to Constant Prepayment Rate. For its first five securitization pools, the Company uses a curve based on various CPR levels throughout the pool's life, based on its estimate of prepayment performance, as outlined in the table above. For the 1999-1 transaction the Company uses a 22 HEP (Home Equity Prepayment) curve. This curve, developed by Prudential Securities, ramps to the terminal CPR (in this case, 22%) over ten months and then remains constant for the life of the pool. (3) Based on percentage of original principal balance, subject to step-down provisions after 30 months. Each of the Company's Mortgage Loan securitizations have been credit-enhanced by an insurance policy provided through a monoline insurance company such that the senior certificates have received ratings of "Aaa" from Moody's Investors Services, Inc. ("Moody's") and "AAA" from Standard & Poor's Ratings Group, a division of The McGraw-Hill Companies, Inc. ("Standard & Poor's"). The Company expects to begin receiving Excess Cash Flow on its Mortgage Loan securitizations approximately 16 months from the date of securitization, although this time period may be shorter or longer depending upon the securitization structure and performance of the loans securitized. Prior to such time, the monoline insurer requires a reserve provision to be created within the securitization trust which uses Excess Cash Flow to retire the securitization bond debt until the spread between the outstanding principal balance of the loans in the securitization trust and the securitization bond debt equals a specified percentage (depending on the structure of the securitization) of the initial securitization principal balance (the "overcollateralization limit"). Once this overcollateralization limit is met, excess cash flows are distributed to the Company. The Company begins to receive regular monthly servicing fees in the month following securitization. The gains recognized into income resulting from securitization transactions vary depending on the assumptions used, the specific characteristics of the underlying loan pools, and the structure of the transaction. The Company believes the assumptions it has used are appropriate and reasonable. The Company assesses the carrying value of its residual receivables and servicing assets for impairment at the end of each month. There can be no assurance that the Company's estimates used to determine the gain on sale of loans, residual receivables, and servicing assets valuations will remain appropriate for the life of each securitization. If actual loan prepayments or defaults exceed the Company's estimates, the carrying value of the Company's residual receivables and/or servicing assets may be decreased through a charge against earnings in the period management recognizes the disparity. Conversely, if actual loan prepayments or defaults are better than the Company's estimates, the carrying value of the Company's residual receivables and/or servicing assets may be increased, with additional earnings recognized in the period management recognizes the disparity. 35 At December 31, 2001 key economic assumptions and the sensitivity of the current fair value of residual cash flows to immediate 5 percent and 10 percent adverse changes in assumed economics is as follows: LOANS ----- (DOLLARS IN THOUSANDS) Carrying amount/fair value of retained interests............ $ 39,646 Weighted-average life (in years)............................ 4.167 Prepayment speed assumption (annual rate)................... 20% - 22% Impact on fair value of 5% adverse change......... $ 224 Impact on fair value of 10% adverse change........ $ 448 Expected credit losses (annual rate)........................ 39.8% Impact on fair value of 5% adverse change......... $ 45 Impact on fair value of 10% adverse change........ $ 91 Residual cash flows discount rate (annual).................. 12% Impact on fair value of 5% adverse change......... $ 441 Impact on fair value of 10% adverse change........ $ 883 These sensitivities are hypothetical and should be viewed with caution. As the figures indicate, any change in fair value based on a 5 percent variation in assumptions cannot be extrapolated because the relationship of the change in assumption to the change in fair value is not linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated independent from any change in another assumption; in reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. TAX CONSIDERATIONS As a result of operating losses incurred by the Company, the Company has net operating losses ("NOL") that can be used to offset future earnings. Federal tax laws provide that NOL carryforwards are restricted or eliminated upon certain changes of control. Applicable federal tax laws provide that a 50% "change of control," which is calculated over a rolling three-year period, would cause the loss of substantially all of the NOL. The Company believes its maximum cumulative change of control during the relevant three-year period was less than 50%. The loss for the year includes a $22 million increase in the valuation allowance for its deferred tax asset. Although the Company expects to utilize its NOL carryforwards, the valuation allowance was established in accordance with Statement of Financial Accounting Standards No. 109. This adjustment was a non-cash transaction and had no effect on the Company's working capital. Total NOL carryforwards are now $143.8 million. Approximately $143.0 million does not begin to expire until 2007 and beyond. HEDGING ACTIVITIES The Company's profitability may be directly affected by fluctuations in interest rates. While the Company monitors interest rates it may, from time to time, employ a strategy designed to hedge some of the risks associated with changes in interest rates, however, no assurance can be given that the Company's results of operations and financial condition will not be adversely affected during periods of fluctuations in interest rates. The Company's interest rate hedging strategy includes shorting interest rate futures and treasury forwards, and entering into interest-rate lock agreements. Since the interest rates on the Company's warehouse line of credit used to fund and acquire loans is variable and the rates charged on loans the Company originates are fixed, increases in the interest rates after loans are originated and prior to their sale could have a material adverse effect on the Company's results of operations and financial condition. The ultimate sale of the Company's loans generally will fix the spread between the interest rates paid by borrowers and the interest rates paid to investors in securitization transactions with respect to such loans, although 36 increases in interest rates may narrow the potential spread that existed at the time the loans were originated by the Company. Without hedging these loans, increases in interest rates prior to sale of the loans may reduce the gain on sale or securitization of loans earned by the Company. There were no open hedging positions on December 31, 2001. ACCOUNTING CONSIDERATIONS In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" which is effective for all fiscal quarters of fiscal years beginning after June 15, 2000, as amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133". This SFAS statement establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. Since the Company has no significant hedging positions outstanding, the implementation of this standard had no material impact on its financial statements. In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of SFAS No. 125." It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures but carries over most of SFAS No. 125's provisions without reconsideration. SFAS No. 140 is effective for all transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001. Retroactive and early adoption is prohibited. This statement is effective for disclosures related to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of provisions of SFAS No. 140 was not material to the Company. In the November 2000 meeting, the Emerging Issues Task Force (EITF) reached a consensus on EITF No. 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets". The issue deals with how interest income and impairment should be recognized for retained interests in securitizations. If upon evaluation, the holder determines that it is probable that there is a change in estimated cash flows (in both timing and estimates of projected cash flows), the amount of accretable yield should be recalculated and if that change in estimated cash flows is an adverse change, an other-then-temporary impairment should be considered to have occurred. The effective date of this EITF is March 15, 2001. The Company believes a permanent impairment has occurred in certain of its securitized assets as of December 31, 2001. (See Note 5.) In June 2001, the FASB issued SFAS No. 141, "Business Combinations". This FASB addresses accounting and reporting for all business combinations and defines the purchase method as the only acceptable method. This statement is effective for all business combinations initiated after June 30, 2001. During 2001, the Company did not participate in any business combinations. In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets". This SFAS addresses how goodwill and other intangible assets should be accounted for at their acquisition (except for those acquired in a business combination) and after they have been initially recognized in the financial statements. The statement is effective for all fiscal years beginning after December 15, 2001. The Company has not completed its evaluation of the effect this statement will have on the financial position of the Company. In July 2001, The SEC issued Staff Accounting Bulletin ("SAB") No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues". This SAB clearly defines the required development, documentation and application of a systematic methodology for determining allowances for loan and lease losses in accordance with accounting principles generally accepted in the United States of America. The Company believes that it is in compliance with SAB No. 102 as of December 31, 2001. Additional accounting standards that have been issued or proposed by the FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. 37 IMPACT OF INFLATION Inflation affects the Company most significantly in the area of loan originations and can have a substantial effect on interest rates. Interest rates normally increase during periods of high inflation and decrease during periods of low inflation. Profitability may be directly affected by the level and fluctuation in interest rates which affect the Company's ability to earn a spread between interest received on its loans and the costs of its borrowings. The profitability of the Company is likely to be adversely affected during any period of unexpected or rapid changes in interest rates. A substantial and sustained increase in interest rates could adversely affect the ability of the Company to originate and purchase loans and affect the mix of first and second-lien Mortgage Loan products. Generally, first-lien mortgage production increases relative to second-lien mortgage production in response to low interest rates and second-lien mortgage production increases relative to first-lien mortgage production during periods of high interest rates. A significant decline in interest rates could decrease the size of the Company's loan servicing portfolio by increasing the level of loan prepayments. Additionally, to the extent servicing rights and residual receivables have been capitalized on the books of the Company, higher than anticipated rates of loan prepayments or losses could require the Company to write down the value of such servicing rights and residual receivables, adversely impacting earnings. Fluctuating interest rates may also affect the net interest income earned by the Company resulting from the difference between the yield to the Company on loans held pending sales and the interest paid by the Company for funds borrowed under the Company's warehouse lines of credit. 38 ITEM 7. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods. The Company's market risk arises primarily from interest rate risk inherent in its mortgage lending, its holding of residual receivables, and its investor savings activities. The structure of the Company's loan and investor savings portfolios is such that a significant rise or decline in interest rates may adversely affect net market values and net interest income. The Company does not maintain a trading account, nor is the Company subject to currency exchange risk or commodity price risk. Responsibility for monitoring interest rate risk rests with senior management. Senior management regularly reviews the Company's interest rate risk position and adopts balance sheet strategies that are intended to optimize operating earnings while maintaining market risk within acceptable guidelines. While the Company monitors interest rates and may, from time to time, employ a strategy designed to hedge some of the risks associated with changes in interest rates, no assurance can be given that the Company's results of operations and financial condition will not be adversely affected during periods of fluctuations in interest rates. There were no significant open hedging positions at December 31, 2001. The majority of the loans originated are sold through loan sale strategies in an attempt to limit exposure to interest rate risk as well as generate cash revenues. The Company's strategy for 2002 is to sell a substantial portion of the current month's production in the following month. Interest rates on the Company's loan funding warehouse lines of credit are variable and the rates charged on loans originated are fixed. Therefore, increases in the interest rates after loans are originated and prior to their sale may reduce the gain on loan sales earned by the Company. The residual receivables originating from prior securitizations do not have a direct interest rate risk. The sale of loans in a securitized transaction generally fixes the spread between the interest rates paid by borrowers and the interest rates paid to investors. However, a significant reduction in market rates could accelerate the prepayment speed on loans held in the various securitized mortgage pools. An acceleration of prepayment on loans held in the securitized pools would have a negative impact on the carrying value of the residual assets. The Company no longer believes, in the absence of other external factors, that it would experience an increase in prepayment speeds if market rates declined due to the "burn-out" principal. In other words, since the borrowers have already had several opportunities to refinance because rates have been at historical lows in the last twelve months, but have yet to do so, the likelihood of the remaining borrowers prepaying given further interest rate reductions is diminished. The Company assumes that it would not experience a significant benefit from a reduction in the rates paid on investor savings portfolios. The rates offered on the investor portfolios have not historically moved with changes in market rates. The Company used "Simulation Analysis" in 1999 and 2000 to measure the interest rate sensitivity of earnings. This type of analysis assumes a base line interest rate with parallel shift changes in the market interest rates. For 2001, Management has elected to use "Gap Position" to monitor the timing differences between interest earning assets and interest bearing liabilities. This approach is a static representation of the Company's balance sheet items that are most likely to be affected by a change in interest rates. Management believes the "Gap Position" analysis provides a more detailed breakdown of the Company's interest rate risk. The "Gap Position" also adds a time dimension to the balance sheet items that are sensitive to market rate. Both the "Simulation Analysis" and Gap Position" methods are provided below. As a result of the Company's interest rate position, a 100 basis point immediate increase in interest rates would have had a negative impact on projected net loss of approximately $942,000 and $3.3 million, computed for the year ending December 31, 2001, and the year ending December 31, 2000, respectively. A significant portion of this impact relates to a reduction in the anticipated sale premiums on loans being held for sale as well as higher interest expense on the warehouse line of credit, partially offset by an increase in interest earned on short term investments. 39 An immediate reduction of 100 basis points in market rates would result in a positive impact on projected net loss of approximately $817,000 and $2.1 million for the year ending December 31, 2001, and the year ending December 31, 2000, respectively. This impact is related to higher gains from the sale of loans, which is the primary reason for the positive impact on projected earnings under the same interest rate scenario, and a decrease in interest paid on warehouse lines of credit, partially offset by the assumption that prepayment speeds on the securitization pools would increase approximately ten percent if market interest rates declined by 100 basis points. The Company no longer believes, in the absence of other external factors, that it would experience an increase in prepayment speeds if market rates declined by 100 basis points due to the "burn-out" principal. In other words, since the borrowers have already had several opportunities to refinance because rates have been 100 basis points lower in the last twelve months, but have not, the likelihood of the remaining borrowers prepaying given further interest rate reductions is diminished. The Company assumes that it would not experience a significant benefit from a reduction in the rates paid on investor notes. The rates offered on the investor notes have not historically moved with changes in market rates Although it is the intent of the Company to sell new loans within one month of origination, we have used the contractually scheduled maturity dates of loans for purposes of this analysis in an effort to more conservatively display the interest rate risk of the Company. Profitability could be affected by changes in market interest rates. If the Company were to hold a significant portion of its funded loans long-term, profitability would be adversely affected as interest rates rise and positively affected as interest rates decline because our loans earn a fixed rate of interest while our funding sources bear variable interest. The Company's practice of selling loans as soon as possible after origination limits the interest rate risk. If the Company's ability to sell loans on a timely basis is impaired, the interest rate risk will increase. The gap table below shows the one-year gap was a negative 54.38% of total assets at December 31, 2001. The Company expects to remain in a negative gap position as presented in the table because the contractual maturities of loans originated in the mortgage industry are always greater than one year and we have shorter-term contractual obligations with our investor savings relationships. The fact that we sell most of our loans within one year reduces the actual exposure of this interest rate risk. Also, the one- and two-year contractual relationships with our investor savings products have historically rolled over into another one- or two-year product at the time of maturity. The Company expects to maintain all or most of the investor savings relationships for periods significantly longer than two years. 40
GAP POSITION ANALYSIS DECEMBER 31, 2001 THREE TO FOUR MORE THAN PRINCIPAL BALANCES OF BALANCE SHEET TOTAL ONE YEAR OR TWO YEARS YEARS FOUR YEARS ITEMS LESS --------------------------------------- ---------------- --------------------------------- ---------------------------------- Interest Earning Assets: Loans held for sale (1) $ 51,805 $ - $ - $ - $ 51,805 Average Interest Rate 9.23% 9.23% Cash and other $ 26,352 $ 26,352 $ - $ - $ - Average Interest Rate 2.37% 2.37% Residual receivable (2) $ 60,419 $ 28,296 $ 4,154 $ 24,471 $ 3,498 Average Interest Rate 7.80% 7.80% 6.30% 5.00% 3.70% ---------------- -------------- ----------------- ---------------- --------------- Total interest earning assets $ 138,576 $ 54,648 $ 4,154 $ 24,471 $ 55,303 ============== ================= ================ =============== Allowance for credit losses $ (5,851) Deferred loan fees $ (1,215) Allowance for loss on residual receivable $ (11,149) Property and equipment, net $ 19,941 Other $ 47,180 ---------------- Total assets $ 187,482 ================ Interest Bearing Liabilities: Revolving warehouse lines of credit $ 24,933 $ 24,933 $ - $ - $ - Average Interest Rate 6.75% 6.75% Investor savings debentures $ 231,103 $ 139,174 $ 91,929 $ - $ - Average Interest Rate 8.12% 7.46% 8.23% Senior unsecured debt - bonds $ 6,250 $ - $ 6,250 $ - $ - 10.75% 10.75% 10.75% ---------------- -------------- ----------------- ---------------- --------------- Total interest bearing liabilities $ 262,286 $ 164,107 $ 98,179 $ - $ - ============== ================= ================ =============== Non-interest bearing liabilities $ 9,322 ---------------- Total Liabilities $ 271,608 Shareholder's Deficit $ (84,126) ---------------- Total Liabilities and Shareholder's $ 187,482 Deficit ================ Maturity / repricing gap $ (109,459) $ (94,025) $ 24,471 $ 55,303 ============== ================= ================ =============== Cumulative gap $ (109,459) $ (203,484) $ (179,013) $ (123,710) ============== ================= ================ =============== As percent of total assets -54.38% -108.54% -95.48% -65.99% Ratio of cumulative interest earning assets 0.33 0.22 0.32 0.53 To cumulative interest bearing liabilities
(1) Loans shown gross of allowance for loan losses, net of premiums / discounts. (2) Residual receivable shown gross of allowance for loss in receivable. 41 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS CONTENTS Independent Auditors' Report.................................... Audited Consolidated Financial Statements Consolidated Balance Sheets.................................. Consolidated Statements of Operations........................ Consolidated Statements of Shareholders' Deficit............. Consolidated Statements of Cash Flows........................ Notes to Consolidated Financial Statements................... 42 INDEPENDENT AUDITORS' REPORT Shareholders and Board of Directors HomeGold Financial, Inc. and Subsidiaries Greenville, South Carolina We have audited the accompanying consolidated balance sheets of HomeGold Financial, Inc. and Subsidiaries as of December 31, 2001 and 2000 and the related consolidated statements of operations, shareholders' deficit, and cash flows for each of the years in the three-year period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HomeGold Financial, Inc. and Subsidiaries as of December 31, 2001 and 2000 and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 of the consolidated financial statements, the Company has recurring operating losses and has a shareholders' deficit of approximately $84 million at December 31, 2001. These factors raise substantial doubt about the Company's ability to continue as a going concern. The plans of Management in regard to these matters are also described in Note 2. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. ELLIOTT DAVIS, LLC Greenville, South Carolina April 8, 2002 43
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, ------------------ 2001 2000 --------- ------- (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS Cash and cash equivalents.................................................................... $ 26,352 $ 3,691 Restricted cash.............................................................................. 7,345 5,066 Loans receivable............................................................................. 51,805 58,483 Less allowance for credit losses......................................................... (5,851) (4,652) Less deferred loan fees.................................................................. (1,215) (2,339) Plus deferred loan costs................................................................. -- 207 --------- --------- Net loans receivable................................................................... 44,739 51,699 Income taxes receivable...................................................................... 596 318 Accrued interest receivable.................................................................. 1,987 1,817 Other receivables............................................................................ 9,608 11,497 Residual receivables, net.................................................................... 49,270 58,877 Property and equipment, net.................................................................. 19,941 21,430 Real estate owned (REO) and personal property acquired through foreclosure................... 603 1,281 Goodwill, net of accumulated amortization of $3,110 in 2001 and $1,712 in 2000............... 18,225 19,623 Debt origination costs....................................................................... 90 221 Deferred income tax asset, net............................................................... -- 22,000 Servicing asset.............................................................................. 563 703 Prepaid advertising and other assets......................................................... 8,163 3,798 --------- --------- TOTAL ASSETS................................................................................ $ 187,482 $ 202,021 ========= ========= LIABILITIES AND SHAREHOLDERS' DEFICIT LIABILITIES: Revolving warehouse lines of credit........................................................ $24,933 $26,951 Notes payable to banks..................................................................... 688 2,352 Investor savings: Notes payable to investors............................................................... 200,978 146,087 Subordinated debentures.................................................................. 30,125 19,117 --------- --------- Total investor savings................................................................. 231,103 165,204 Senior unsecured debt...................................................................... 6,250 11,214 Accounts payable and accrued liabilities................................................... 6,210 4,637 Remittances payable........................................................................ 1,186 1,201 Income taxes payable....................................................................... 555 347 Accrued interest payable................................................................... 683 938 --------- --------- Total other liabilities................................................................ 8,634 7,123 --------- --------- Total liabilities............................................................................ 271,608 212,844 MINORITY INTEREST............................................................................ -- 5 COMMITMENTS AND CONTINGENCIES, Notes 2, 3, 5, 9, 11, 12, 22 and 26 SHAREHOLDERS' DEFICIT: Preferred stock, par value $1.00 per share, authorized 20,000,000 shares, issued and outstanding 10,000,000 shares .......................................................... 10,000 10,000 Common stock, par value $.001 per share, authorized 100,000,000 shares, issued and outstanding 16,912,594 shares at December 31, 2001 and 16,810,149 shares at December 31, 2000....................................................................... 17 17 Capital in excess of par value............................................................. 46,659 46,643 Note receivable from shareholder........................................................... (5,700) (5,985) Accumulated deficit........................................................................ (135,102) (61,503) --------- --------- Total shareholders' deficit............................................................ (84,126) (10,828) --------- --------- TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT.................................................. $187,482 $ 202,021 ========= ========= See Notes to Consolidated Financial Statements, which are an integral part of these statements.
44
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, ------------------------------------ 2001 2000 1999 ------------ ---------- ------------ (IN THOUSANDS, EXCEPT SHARE DATA) REVENUES: Interest income.................................................. $ 8,009 $ 12,192 $ 8,286 Servicing income................................................. 4,268 7,397 9,813 Gain on sale of loans: Gross gain on sale of loans.................................... 12,807 9,801 6,216 Loan fees, net................................................. 22,013 16,430 3,313 ------------ ---------- -------- Total gain on sale of loans............................... 34,820 26,231 9,529 Other revenues................................................... 1,267 1,735 1,609 ------------ ---------- -------- Total revenues............................................ 48,364 47,555 29,237 ------------ ---------- -------- EXPENSES: Interest . ..................................................... 20,609 19,448 16,338 Provision for credit losses...................................... 2,883 3,159 3,339 Costs on real estate owned and defaulted loans................... 1,419 3,451 3,018 Fair market value adjustment on residual receivables............. 10,490 2,279 3,327 Salaries, wages and employee benefits............................ 37,595 29,116 20,359 Business development costs....................................... 9,169 8,615 4,804 Restructuring charges............................................ 873 1,469 -- Other general and administrative expense......................... 18,419 19,861 13,123 ------------ ---------- -------- Total expenses............................................ 101,457 87,398 64,308 ------------ ---------- -------- Loss before income taxes, minority interest and extraordinary item..................................... (53,093) (39,843) (35,071) Provision (benefit) for income taxes................................ 22,524 (9,456) (7,394) ------------- ---------- --------- Loss before minority interest and extraordinary item...... (75,617) (30,387) (27,677) Minority interest in (earnings) loss of subsidiaries................ (4) (4) (8) ------------- ----------- --------- Loss before extraordinary item............................ (75,621) (30,391) (27,685) Extraordinary item--gain on extinguishment of debt, net of $0 tax.... 2,022 579 29,500 ------------ ---------- --------- Net income (loss)......................................... $ (73,599) $ (29,812) $ 1,815 ============ ========== ========= BASIC EARNINGS (LOSS) PER SHARE OF COMMON STOCK: Loss before extraordinary item................................... $ (4.48) $ (2.10) $ (2.78) Extraordinary item, net of taxes................................. .12 .04 2.96 ------------ ---------- -------- Net income (loss)................................................ $ (4.36) $ (2.06) $ .18 ============ ========== ======== Basic weighted average shares outstanding........................... 16,882,919 14,445,238 9,961,077 ============ ========== ========= DILUTED EARNINGS (LOSS) PER SHARE OF COMMON STOCK: Loss before extraordinary item................................... $ (4.48) $ (2.10) $ (2.78) Extraordinary item, net of tax................................... .12 .04 2.96 ------------ ---------- --------- Net income (loss)................................................ $ (4.36) $ (2.06) $ .18 ============ ========== ========= Diluted weighted average shares outstanding......................... 16,882,919 14,445,238 9,961,077 ============ ========== ========= See Notes to Consolidated Financial Statements, which are an integral part of these statements.
45
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT FOR THE YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 COMMON STOCK CAPITAL IN NOTE TOTAL ------------------- EXCESS OF RECEIVABLE SHAREHOLDERS' SHARES PAR PREFERRED FROM ACCUMULATED EQUITY ISSUED AMOUNT VALUE STOCK SHAREHOLDER DEFICIT (DEFICIT) ------ ------ ---------- --------- ----------- ----------- ------------ (IN THOUSANDS, EXCEPT SHARE DATA) BALANCE AT DECEMBER 31, 1998........ 9,733,374 $ 486 $ 38,821 $ -- $ -- $ (33,506) $ 5,801 Shares issued: Exercise of stock options....... 3,200 -- 3 -- -- -- 3 Employee Stock Purchase Plan.... 102,604 5 39 -- -- -- 44 Officer/Director Compensation... 310,783 16 165 -- -- -- 181 Other........................... (332) -- -- -- -- -- -- Net income...................... -- -- -- -- -- 1,815 1,815 ----------- ------- -------- ------ ------ ----------- --------- BALANCE AT DECEMBER 31, 1999........ 10,149,629 507 39,028 -- -- (31,691) 7,844 Change in par from $0.05 to $0.001 -- (490) 490 -- -- -- -- Shares issued: Employee Stock Purchase Plan.... 46,606 1 35 -- -- -- 36 Officer/Director Compensation... 61,540 3 45 -- -- -- 48 Share Cancellation.............. (228,570) (11) -- -- -- -- (11) Shares issued in HomeSense Merger 6,780,944 7 7,045 -- -- -- 7,052 Shares issued in HomeSense Merger -- -- -- 10,000 -- -- 10,000 Note Receivable from Shareholder.... -- -- -- -- (5,985) -- (5,985) Net loss............................ -- -- -- -- -- (29,812) (29,812) -------- ------ -------- ------- ------- ---------- --------- BALANCE AT DECEMBER 31, 2000........ 16,810,149 17 46,643 10,000 (5,985) (61,503) (10,828) Shares issued: Employee Stock Purchase Plan.... 102,445 -- 16 -- -- -- 16 Payment on Note Receivable from -- -- -- -- 285 -- 285 Shareholder......................... Net loss............................ -- -- -- -- -- (73,599) (73,599) ---------- ---- ------ --------- -------- ----------- --------- BALANCE AT DECEMBER 31, 2001........ 16,912,594 $ 17 $ 46,659 $ 10,000 $ (5,700) $ (135,102) $ (84,126) ========== ======= ======== ========= ======== =========== ========= See Notes to Consolidated Financial Statements, which are an integral part of these statements.
46
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, ----------------------------------- 2001 2000 1999 -------- --------- -------- (IN THOUSANDS) OPERATING ACTIVITIES: Net income (loss)......................................................... $ (73,599) $ (29,812) $ 1,815 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization........................................... 3,897 4,714 2,692 Fair market value adjustment on residual receivables.................... 10,490 2,279 3,327 Provision (benefit) for deferred income taxes........................... 22,000 (10,000) (7,849) Provision for credit losses on loans.................................... 2,883 3,159 3,339 Provision for losses on real estate owned............................... 638 952 2,665 Gain on retirement of senior unsecured debt............................. (2,022) (579) (29,500) Net decrease in deferred loan costs..................................... 479 239 442 Net increase (decrease) in unearned discount and other deferred loan fees............................................................ (1,396) 1,609 (1,341) Loans originated with intent to sell.................................... (644,795) (567,421) (244,086) Proceeds from loans sold................................................ 643,950 508,690 220,410 Proceeds from securitization of loans................................... 6,399 50,554 59,630 Other . .............................................................. (2,041) 652 731 Changes in operating assets and liabilities decreasing cash ................................................................ (3,875) (27,757) (5,059) ---------- --------- ------- Net cash provided by (used in) operating activities................ (36,992) (62,721) 7,216 ---------- --------- ------- INVESTING ACTIVITIES: Loans originated.......................................................... (6,890) (345) (762) Principal collections on loans not sold................................... 8,014 41,266 19,718 Loans purchased for investment purposes................................... -- (3,167) (1,413) Purchase of REO and loans from securitization trusts...................... -- (2,978) (10,476) Proceeds from sale of real estate owned and personal property acquired through foreclosure..................................................... 1,440 10,067 9,774 Proceeds from sale of property and equipment.............................. 732 54 235 Purchase of property and equipment........................................ (3,219) (164) (532) Other . ................................................................ -- 111 167 ---------- --------- -------- Net cash provided by investing activities.......................... 77 44,844 16,711 ---------- --------- -------- FINANCING ACTIVITIES: Advances on warehouse lines of credit..................................... 610,368 702,518 292,020 Payments on warehouse lines of credit..................................... (612,386) (722,618) (290,948) Payments on notes to banks................................................ (1,664) (501) -- Net increase in notes payable to investors................................ 54,891 19,022 8,479 Net increase in subordinated debentures................................... 11,008 1,406 405 Retirement of senior unsecured debt....................................... (2,942) (341) (45,016) Proceeds from issuance of common stock.................................... 16 73 229 Note receivable from shareholder.......................................... 285 (4,000) -- ---------- --------- -------- Net cash provided by (used in) financing activities................ 59,576 (4,441) (34,831) ---------- --------- --------- Net increase (decrease) in cash and cash equivalents............... 22,661 (22,318) (10,904) CASH AND CASH EQUIVALENTS: Beginning of the year..................................................... 3,691 26,009 36,913 ---------- --------- -------- End of the year........................................................... $ 26,352 $ 3,691 $ 26,009 ========== ========= ======== See Notes to Consolidated Financial Statements, which are an integral part of these statements.
47 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS ACTIVITIES BUSINESS HomeGold Financial, Inc. and its subsidiaries ("HGFN" or "the Company") are primarily engaged in the business of originating, selling, securitizing and servicing first and second-lien residential mortgage loan products and issuing notes payable and subordinated debentures to investors through its subsidiary, Carolina Investors, Inc. ("CII"). The funds for these loans are obtained principally through the utilization of various bank warehouse lines of credit, proceeds from securitization of loans, and the issuance of notes payable and subordinated debentures to investors. Substantially all of the Company's loans are made to sub-prime borrowers. These borrowers generally have limited access to credit or are otherwise considered to be credit impaired by conventional lenders. In August, 2000, management closed the Company's wholesale mortgage origination divisions. The decision to exit the wholesale business arose primarily from management's desire to narrow its focus to the Company's more profitable retail loan origination efforts. The closure of the wholesale division resulted in a decrease in low-margin origination volume, enabling the Company to terminate its relationship under an agreement with its primary warehouse lender. Further benefits have been realized through more focused and efficient usage of marketing resources and a sizable reduction in overhead costs related to the closed division. On April 28, 2000, the shareholders of HGFN approved a merger agreement between HomeGold, Inc. ("HGI") and HomeSense Financial Corp. and affiliated companies (collectively "HomeSense"), a privately owned business, located in Lexington, South Carolina. HomeSense was a specialized mortgage company that originated and sold mortgage loans in the sub-prime mortgage industry, whose principal loan product was a debt consolidation loan, generally collateralized by a first lien on the borrower's home. HomeSense originated its loan volume through a direct retail branch network of eight offices, as well as through centrally provided telemarketing leads, direct mail, and television advertising. As of May 9, 2000, the effective date of the merger, HGFN issued 6,780,944 shares of its common stock (approximately 40% of post-merger shares outstanding) valued at $1.04 per share plus an additional 10 million shares of Series A Non-convertible Preferred Stock (par value $1 per share) for 100% of the outstanding stock of HomeSense. The merger was accounted for under the purchase method of accounting prescribed by generally accepted accounting principles. The transaction resulted in $19.0 million of goodwill. The results of operations of HomeSense are included in the accompanying financial statements from the date of the acquisition. PREFERRED STOCK The Series "A" Non-convertible Preferred Stock was issued with a $1.00 par value in conjunction with the HomeSense merger and 10,000,000 shares are currently outstanding. Currently, no dividends are paid or accumulating on this stock. At the time the preferred stock was designated and issued, the Senior Debt agreement restricted the payments of any dividends. At any point in the future when the Senior Debt no longer exists an annual dividend of $0.08 per share may be paid on a quarterly basis. Upon any form of liquidation by HGFN, a distribution of $1.00 per share will have priority over HGFN Common Stock. There are no voting rights associated with the Preferred Stock and the Preferred Stock is not convertible to HomeGold Common Stock or any other securities. 48 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following summarized unaudited pro forma financial information assumes the merger had occurred on January 1 of each year: FOR THE YEARS ENDED DECEMBER 31, ------------------- 2000 1999 -------- -------- (IN THOUSANDS) Revenue................................... $57,477 $53,045 Loss before extraordinary items........... (30,585) (29,574) Net income (loss)......................... (30,006) 4,320 Basic loss per share of common stock...... (1.41) (0.01) The amounts are based upon certain assumptions and estimates, and do not reflect any benefit from economies that might be achieved from combined operations. The pro forma results do not necessarily represent results that would have occurred if the acquisition had taken place on the basis assumed above, nor are they indicative of the results of future combined operations. CONSOLIDATION AND ESTIMATES The consolidated financial statements include the accounts of the Company and its subsidiaries. All subsidiaries at December 31, 2001 were wholly-owned except for one special purpose corporation that is 99.54% owned. All significant intercompany items and transactions have been eliminated in consolidation. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates. These estimates include, among other things, valuation of real estate owned, assumptions used to value residual receivables, and determination of the allowance for credit losses and valuation allowances on deferred tax assets. RESIDUAL RECEIVABLES AND SALES AND SECURITIZATIONS OF LOANS In 1997, the Company began securitizing mortgage loans, whereby it sells the loans that it originates or purchases to a trust for cash, and records certain assets and income based upon the difference between all principal and interest received from the loans sold and (i) all principal and interest required to be passed through to the asset-backed bond investors, (ii) all excess contractual servicing fees, (iii) other recurring fees and (iv) an estimate of losses on the loans (collectively, the "Excess Cash Flow"). At the time of the securitization, the Company estimates these amounts based upon a declining principal balance of the underlying loans, adjusted by an estimated prepayment and loss rate, and capitalizes these amounts using a discount rate that market participants would use for similar financial instruments. These capitalized assets are recorded as a residual receivable. The Company believes the assumptions it has used to value the residual receivable are appropriate and reasonable. At each reporting period, the Company assesses the fair value of these residual assets based on the present value of future cash flows expected under management's current best estimates of the key assumptions-credit losses, prepayment speed, forward yield curves, and discount rates commensurate with the risks involved and adjusts the recorded amounts to their estimated fair value. Total mortgage loans securitized in 2001, 2000, and 1999 were $10.0 million, $64.3 million and $59.6 million, respectively. The Company also sells on a whole loan basis a significant portion of its loans (servicing released), including substantially all of its mortgage loans secured by second mortgage liens principally to secure the additional cash flow associated with the premiums paid in connection with such sales and to eliminate the credit risk associated with the second lien mortgage loans. 49 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company makes securitization decisions based on a number of factors including conditions in the secondary market, the aggregate size and weighted average coupon of loans available to sell, fixed costs associated with securitization transactions, and liquidity needs. The Company believes that it will continue to securitize, as well as whole loan sell, in 2002. CASH AND CASH EQUIVALENTS The Company maintains its primary checking accounts with one principal bank and makes overnight investments in reverse repurchase agreements with that bank. The amounts maintained in the checking accounts are insured by the Federal Deposit Insurance Corporation ("FDIC") up to $100,000. At December 31, 2001, 2000, and 1999, the amounts maintained in the overnight investments in reverse repurchase agreements, which are not insured by the FDIC, totaled $24.9 million, $2.4 million and $25.4 million, respectively. These investments were collateralized by U. S. Government securities pledged by the banks. The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. RESTRICTED CASH The Company maintains an investment bank account that it considers the minimum balance requirement as restricted cash. The purpose of this account is overdraft protection and required as part of its primary banking relationship. Also, the Company assigned $6.3 million of certificates of deposit to its warehouse lenders to secure the Company's borrowings under a revolving warehouse credit agreement (see Note 9) and $1.0 million of certificates of deposit to secure the lease for two new office locations. These certificates of deposit are included as restricted cash in the financial statements. LOANS RECEIVABLE AND INTEREST INCOME Loans receivable in 2001 and 2000 consist primarily of first and second lien residential mortgage loans. Non-refundable loan fees and direct costs associated with the origination or purchase of loans are deferred and netted against outstanding loan balances. Interest income on loans receivable is recognized on the accrual basis as earned. Fees received, net of direct costs incurred, for the origination of loans are recognized into income at the time the loan is repaid or sold. Accrual of interest is discontinued and reversed when a loan is either over 150 days past due or the loan is over 90 days past due with a loan to value percentage greater than 90%. Loans receivable held for sale are carried at the lower of aggregate cost or market. There was no allowance for market losses on loans receivable held for sale required at December 31, 2001 or 2000. ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses is based on management's ongoing evaluation of the loan portfolio and reflects an amount that, in management's opinion, is adequate to absorb inherent losses in the existing portfolio. In 50 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS evaluating the portfolio, management takes into consideration numerous factors including delinquencies, current economic conditions, prior loan loss experience, the composition of the serviced loan portfolio, and management's estimate of anticipated credit losses. Loans, including those deemed impaired, are charged against the allowance at such time as they are determined to be uncollectible. Subsequent recoveries are credited to the allowance. Management considers the year-end allowance appropriate and adequate to cover inherent losses in the loan portfolio; however, management's judgment is based upon a number of assumptions about future events, which are believed to be reasonable. Actual results could differ from these estimates. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for credit losses or that additional increases in the allowance for credit losses will not be required. ACCOUNTING FOR IMPAIRED LOANS The Company accounts for impaired loans in accordance with Statement of Financial Accounting Standards (SFAS) No. 114 "Accounting by Creditors for Impairment of a Loan". This standard requires that all creditors value loans at the loan's fair market value if it is probable that the creditor will be unable to collect all amounts due according to the terms of the loan agreement. Fair value may be determined based upon the present value of expected cash flows, market price of the loan, if available, or value of underlying collateral. Expected cash flows are required to be discounted at the loan's effective interest rate. SFAS No. 114 was amended by SFAS No. 118 "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures - an amendment of FASB Statement No. 114" to allow a creditor to use existing methods for recognizing interest income on an impaired loan and by requiring additional disclosures about how a creditor recognizes interest income on an impaired loan. Under SFAS No. 114, as amended by SFAS No. 118, when the ultimate collectibility of an impaired loan's principal is in doubt, wholly or partially, all cash receipts are applied to principal. When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to principal and then to interest income. Once the reported principal balance has been reduced to zero, future cash receipts are applied to interest income, to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amount previously charged off. A loan is also considered impaired if its terms are modified in a troubled debt restructuring. For these accruing impaired loans, cash receipts are typically applied to principal and interest receivable in accordance with the terms of the restructured loan agreement. Interest income is recognized on these loans using the accrual method of accounting. The Company assesses a specific allowance on mortgage loans, by reviewing on a loan-by-loan basis each month, all loans over 150 days past due or any loans that are in bankruptcy. REAL ESTATE OWNED AND PERSONAL PROPERTY ACQUIRED THROUGH FORECLOSURE Real estate owned and personal property acquired through foreclosure represents properties that have been acquired through actual foreclosures or deeds received in lieu of loan payments. These assets are recorded at the lower of the carrying value of the loans or the estimated fair value of the related real estate, net of estimated selling costs. The excess carrying value, if any, of the loan over the estimated fair value of the asset is charged to the allowance for credit losses upon transfer. Costs relating to the development and improvement of the properties are capitalized whereas those costs relating to holding the property are charged to expense. PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is computed principally using the straight-line method over the estimated useful lives of the assets. Estimated lives are 15 to 40 years for buildings and improvements, 3 to 7 years for furniture, fixtures and equipment, and the lease period for leasehold improvements. Additions to property 51 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS and equipment and major replacements or improvements are capitalized at cost. Maintenance, repairs and minor replacements are expensed when incurred. IMPAIRMENT OF LONG-LIVED ASSETS Long-lived assets and identifiable intangibles held and used by the Company are reviewed for impairment whenever management believes events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. GOODWILL The excess of cost over related net assets of businesses acquired is amortized using the straight-line method principally over 15 years. During 2000, approximately $19.0 million was attributed to goodwill from the purchase of HomeSense. On a periodic basis, the Company reviews goodwill for events or changes in circumstances that may indicate that the carrying amount of goodwill may not be recoverable. DEBT ORIGINATION COSTS The Company capitalizes costs incurred to obtain warehouse lines of credit and senior unsecured debt. These costs are amortized as an addition to interest expense over the terms in the loan agreements. The Company also reduces the debt origination costs by the unamortized portion of the senior unsecured debt that is purchased on the open market. These amounts have been netted against the gain on extinguishment of debt. REMITTANCES PAYABLE The Company retains the servicing rights on certain of its mortgage securitization transactions. The Company receives the payments from the borrowers and records a liability until the funds are remitted to the Trustee. INVESTOR SAVINGS The Company issues notes payable and subordinated debentures through a subsidiary company, CII. The notes are fixed rate securities registered under the South Carolina Uniform Securities Act ("the Act"), and mature from one to two years from the date of issuance. The Company pays interest on the notes monthly, quarterly, or at maturity at the option of the investor. The Company also issues subordinated debentures under the Act, which mature one year from date of issuance and have an interest rate of 6.0%. See Note 11. SENIOR DEBT The Company sold $125.0 million in aggregate principal amount of senior unsecured notes in 1997. The notes pay interest semi-annually at 10.75%, and mature September 15, 2004. 52 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS INCOME TAXES The Company and its subsidiaries file a consolidated Federal income tax return. The Company accounts for income taxes using an asset and liability approach as required by SFAS No. 109 "Accounting for Income Taxes". Under this approach, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred income taxes arise principally from depreciation, unrealized gains on loans held for sale, certain securitization transactions, amortization of intangibles, allowances for credit losses, and net operating loss carryforwards. Management establishes on a quarterly basis a valuation allowance for deferred assets. ADVERTISING EXPENSE Advertising, promotional, and other business development costs are generally expensed as incurred except as noted herein. External costs incurred in producing media advertising are expensed the first time the advertising takes place. In 1997, the Company began using a direct mail marketing approach for its retail mortgage business. External costs related to direct mailings are capitalized in accordance with Statement of Position 93-7 and amortized over a twelve-month period. Total expenses recognized in 2001, 2000 and 1999 for direct mailings were approximately $9.2 million, $8.4 million and $4.4 million, respectively. The total amounts recorded as prepaid expenses on the balance sheet at December 31, 2001 and 2000 were approximately $6.6 million and $1.8 million, respectively. INTEREST RATE RISK MANAGEMENT The Company's operations may be directly affected by fluctuations in interest rates. While the Company monitors interest rates and may, from time to time, employ a strategy designed to hedge some of the risks associated with changes in interest rates, no assurance can be given that the Company's results of operations and financial condition will not be adversely affected during periods of fluctuations in interest rates. The Company currently does not hedge its loans held for sale. The Company's present strategy is to sell a substantial portion of the current months' production that is designated for whole-loan sales in the following month and the remaining loans in the subsequent month. Because the interest rates on the Company's warehouse lines of credit used to fund and acquire loans are variable and the rates charged on loans the Company originates are fixed, increases in the interest rates after loans are originated and prior to their sale may reduce the gain on loan sales earned by the Company. There were no significant open hedging positions at December 31, 2001 or 2000. EARNINGS (LOSS) PER SHARE OF COMMON STOCK Earnings (loss) per share of common stock ("EPS") is computed in accordance with SFAS No. 128, "Earnings per Share". Basic EPS includes no dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution of securities that could share in the earnings of the Company. Common stock equivalents included in the diluted EPS computation consist stock options, which are computed using the treasury stock method. In 2001 and 2000, due to the Company's net operating loss, the common stock equivalents were not included in the diluted EPS calculation since their inclusion would be antidilutive. 53 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEGMENT REPORTING Management believes the Company operates as one segment. RECLASSIFICATIONS Certain previously reported amounts have been reclassified to conform to current year presentation. Such reclassifications had no effect on net income or shareholders' equity as previously reported. ACCOUNTING CONSIDERATIONS In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" which is effective for all fiscal quarters of fiscal years beginning after June 15, 2000, as amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133". This SFAS statement establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. Since the Company has no significant hedging positions outstanding, the implementation of this standard had no material impact on its financial statements. In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of SFAS No. 125." It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures but carries over most of SFAS No. 125's provisions without reconsideration. SFAS No. 140 is effective for all transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001. Retroactive and early adoption is prohibited. This statement is effective for disclosures related to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of provisions of SFAS No. 140 was not material to the Company. In the November 2000 meeting, the Emerging Issues Task Force (EITF) reached a consensus on EITF No. 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets". The issue deals with how interest income and impairment should be recognized for retained interests in securitizations. If upon evaluation, the holder determines that it is probable that there is a change in estimated cash flows (in both timing and estimates of projected cash flows), the amount of accretable yield should be recalculated and if that change in estimated cash flows is an adverse change, an other-then-temporary impairment should be considered to have occurred. The effective date of this EITF is March 15, 2001. The Company believes a permanent impairment has occurred in certain of its securitized assets as of December 31, 2001. (See Note 5.) In June 2001, the FASB issued SFAS No. 141, "Business Combinations". This FASB addresses accounting and reporting for all business combinations and defines the purchase method as the only acceptable method. This statement is effective for all business combinations initiated after June 30, 2001. During 2001, the Company did not participate in any business combinations. In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets". This SFAS addresses how goodwill and other intangible assets should be accounted for at their acquisition (except for those acquired in a business combination) and after they have been initially recognized in the financial statements. The statement is effective for all fiscal years beginning after December 15, 2001. The Company has not completed its evaluation of the effect this statement will have on the financial position of the Company. 54 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In July 2001, The SEC issued Staff Accounting Bulletin ("SAB") No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues". This SAB clearly defines the required development, documentation and application of a systematic methodology for determining allowances for loan and lease losses in accordance with accounting principles generally accepted in the United States of America. The Company believes that it is in compliance with SAB No. 102 as of December 31, 2001. Additional accounting standards that have been issued or proposed by the FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. NOTE 2. GOING CONCERN The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. Going concern, a defined term in professional accounting standards, is a basic underlying assumption for most accounting methods (in particular, accrual based financials such as these) and indicates the Company will fulfill its operational objectives and commitments. HGFN has sustained substantial operating losses in recent years (including a $53.1 million loss from operations in 2001) and has a shareholders' deficit of $84.1 million at December 31, 2001. These losses began in 1998 when the subprime lending industry suffered a significant downturn. This was primarily due to global shifts in the capital markets which reduced by over 80% the margin available on the resale of loans in the secondary markets. More than 60% of the Company's stand-alone, publicly-traded competitors were forced out of business. These losses continued through 1999. In May 2000, HomeSense merged into a subsidiary of HGFN and, under new management, HGFN rededicated itself to making the subprime lending operation profitable. Although the losses have continued through 2001, the new manangement team of HGFN has taken steps to reverse these negative trends by implementing operating changes which include, but are not limited to, the following: o Opening seven additional production facilities since first quarter 2000; o Strengthening the depth of experienced production center managers; o Increasing the number of loan officers from 135 to 240 since early 2001; o Initiating a "conforming loan" product in early 2001 to utilize higher credit leads which were previously wasted; o Overhauling the marketing plan to produce lower cost, higher efficiency leads and to utilize recycled leads as a major component of the overall marketing efforts; o Reducing the costs of originating loans by requiring payment for appraisals at the time the appraisal is performed and by negotiating reduced prices for credit bureau reports; o Modifying incentive compensation plans for production associates to focus efforts on more profitable production; o Improving ability to fund higher volumes of loan originations by increasing warehouse lines of credit and utilizing available cash to fund loan originations; o Negotiating joint ventures to realize revenue from title-related fees on current production; and o Reducing non-core operating and general overhead. In addition, HGFN has considered the divestiture of its retail mortgage origination division. Recent independent valuations have valued the division at between $135 million and $170 million. HGFN management may pursue potential acquirers for the division, but will continue to operate and grow the division until and if it is sold. The recurring operating losses and deficit equity of HGFN raise substantial doubt about the Company's ability to continue as a going concern. Management of the Company believes the actions discussed above will provide the opportunity for the Company to continue as a going concern. 55 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 3. LOANS RECEIVABLE The following is a summary of loans receivable by type of loan: DECEMBER 31, ------------------- 2001 2000 ---------- ------- (IN THOUSANDS) Mortgage Loans: First mortgage residential property...... $37,588 $31,918 Second mortgage residential property..... 5,666 17,117 Real estate loans on rental property..... 150 216 ------- ------- Total mortgage loans................ 43,404 49,251 ------- ------- Small-business loans.......................... 8,318 9,162 Other loans .................................. 83 70 ------- ------- Total loans receivable.............. $51,805 $58,483 ======= ======= Included in loans receivable are $34.6 million and $45.3 million at December 31, 2001 and 2000, respectively that are being held for sale. Included in loans receivable are loans from related parties of $101,000 and $111,000 December 31, 2001 and 2000, respectively. Notes receivable from related parties included advances of $41,500 and $23,811 in 2001 and 2000, respectively. Repayments from related parties were $23,678 and $6,690 in 2001 and 2000, respectively. In 2001 and 2000, the Company had notes from parties at the beginning of the year who were no longer considered related parties as of December 31 due to termination of employment status. First mortgage residential loans generally have contractual maturities of 12 to 360 months with an average interest rate at December 31, 2001 and 2000 of approximately 8.4% and 10.7%, respectively. Second mortgage residential loans have contractual maturities of 12 to 360 months with an average interest rate at December 31, 2001 and 2000 of approximately 14.5% and 13.3%, respectively. Loans sold and serviced for others at December 31, 2001 and 2000 were approximately $215.8 million and $283.6 million, respectively, and are not included in assets in the accompanying balance sheets. At December 31, 2001, the Company's serviced for others mortgage loan portfolio by type of collateral is summarized as follows (in thousands): First mortgage residential property............. $205,243 95.1 % Second mortgage residential property............ 4,435 2.1 Real estate loans on rental property............ 6,159 2.8 -------- ------ $215,837 100.0 % The Company services loans in 45 states and the District of Columbia. South Carolina, North Carolina, Florida, Georgia and Louisiana serviced loans represent approximately 17.5%, 16.4%, 9.2%, 7.6% and 6.0%, respectively, of the Company's total serviced loan portfolio at December 31, 2001. No other state represents more than 6% of total serviced loans. 56 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS An analysis of the allowance for credit losses is as follows: YEARS ENDED DECEMBER 31, ------------------------------ 2001 2000 1999 --------- --------- ------- (IN THOUSANDS) Balance at beginning of year........ $ 4,652 $ 6,344 $6,659 Provision for credit losses......... 2,883 3,159 3,339 Net charge offs..................... (1,684) (1,990) (3,654) Allowance related to loans sold..... -- (2,861) -- --------- ------- ------ Balance at end of year.............. $ 5,851 $ 4,652 $6,344 ======= ======= ====== As of December 31, 2001, 2000, and 1999, loans totaling $11.1 million, $9.6 million and $10.8 million, respectively, were on non-accrual status. The associated interest income not recognized on these non-accrual loans was approximately $1.0 million, $868,000 and $825,000 during the years ended December 31, 2001, 2000 and 1999, respectively. NOTE 4. OTHER RECEIVABLES The following is a summary of other receivables: DECEMBER 31, ------------------ 2001 2000 --------- ------- (IN THOUSANDS) Fees earned not collected............. $ 3,152 $ 3,503 Advanced funds to trust(1)............ 2,573 1,894 Receivable from mortgage trust(2)..... 535 1,251 Loan sale receivable.................. 3,328 4,801 Fees receivable reserve(3)............ (1,173) (953) Note receivable....................... 75 75 Other................................. 1,118 926 ------- ------- $ 9,608 $11,497 ======= ======= (1) Trust agreements require the Company to advance interest on delinquent customer accounts. (2) Excess distribution from mortgage trust received in January 2001 and 2002, respectively. (3) Reserve for potential future uncollectable servicing fees. NOTE 5. RESIDUAL RECEIVABLES In connection with its mortgage loan securitizations, the Company retained residual interests in the trusts. These subordinate residual assets totaled $49.3 million and $58.9 million, net of allowances, at December 31, 2001 and 2000, respectively. 57 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following summarizes activity in the residual receivables:
YEARS ENDED DECEMBER 31, ------------------------------------- 2001 2000 1999 -------- --------- --------- (IN THOUSANDS) Gross balance at beginning of year........................ $ 64,524 $ 54,946 $ 51,022 Gain on sale of loans..................................... -- -- 9,641 Residual from securitization of loans..................... 3,594 17,244 -- Return of overcollateralization........................... (1,461) (1,767) -- Net amortization of original residual asset value and mark to market adjustment.............................. (6,238) (5,899) (5,717) --------- -------- -------- Gross balance, end of year................................ 60,419 64,524 54,946 Less allowance for losses on residual receivable.......... (11,149) (5,647) (7,176) --------- -------- -------- Balance at end of year.................................... $ 49,270 $ 58,877 $ 47,770 ========= ======== ========
An analysis of the allowance for losses, which is embedded in the residual receivables, is as follows:
YEARS ENDED DECEMBER 31, ----------------------------- 2001 2000 1999 -------- --------- ------- (IN THOUSANDS) Balance at beginning of year......................... $ 5,647 $ 7,176 $7,165 Anticipated losses netted against gain............... 6,261 1,559 1,267 Mark to market adjustment............................ 2,481 489 405 Net charge offs...................................... (3,240) (3,577) (1,661) -------- ------- ------ Balance at end of year............................... $ 11,149 $ 5,647 $7,176 ======== ======= ======
The table below summarizes certain cash flows received and paid to or (from) the securitization trusts.
YEARS ENDED DECEMBER 31, (IN THOUSANDS) ------------------------------ 2001 2000 1999 -------- -------- --------- Payments for new securitizations................... $ (6,467) $ (50,554) $ (59,630) Proceeds from loan payment collections............. 85,793 159,780 155,818 Servicing fees received............................ 1,194 1,792 1,882 Other cash flows received on retained interests.... 13,373 10,969 13,740 Purchases of delinquent or foreclosed assets....... -- 3,200 13,700 Servicing advances................................. 5,168 5,999 9,033 Repayments of servicing advances................... (4,817) (5,735) (7,879)
58 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following sets forth facts and assumptions used by the Company in arriving at the valuation of the residual receivables relating to its Mortgage Loan securitization pools it services as of December 31, 2001:
1997-1 1997-2 1997-3 1997-4 1998-1 1999-1 ------------------------------------------------------------------------------------ Outstanding balance of loans securitized (1) $19,532,318 $32,219,346 $53,998,455 $51,569,640 $24,935,521 $33,581,860 Average stated principal balance 54,408 50,186 60,333 58,535 58,125 43,898 Weighted average coupon on loans 10.76% 10.62% 11.01% 10.79% 10.73% 10.90% Weighted average remaining term to stated 157 mths 153 mths 158 mths 162 mths 180 mths 183 mths maturity Weighted average LTV 74% 69% 73% 73% 73% 69% Percentage of first mortgage loans 100% 100% 100% 100% 100% 81.22% Weighted average pass-through rate to 7.66% 7.21% 7.10% 6.76% 6.70% 6.84% bondholders Assumed annual losses 0.20% 0.18% 0.26% 0.36% 0.39% 0.49% Remaining ramp period for losses 0 Mths 0 Mths 0 Mths 0 Mths 0 Mths 0 Mths Assumed cumulative losses as a % of UPB 1.90% 1.87% 1.79% 1.80% 1.79% 2.34% Annual servicing fee 0.50% 0.50% 0.50% 0.50% 0.50% 0.56% Servicing asset 0.10% 0.10% 0.10% 0.10% 0.10% 0.10% Discount rate applied to cash flow after Over collateralization 12% 12% 12% 12% 12% 12% Prepayment speed: Initial CPR (2) 0 CPR 0 CPR 0 CPR 0 CPR 0 CPR 22 HEP Peak CPR (2) 26 CPR 26 CPR 26 CPR 26 CPR 26 CPR 22 HEP Tail CPR (2) 24/22 CPR 24/22 CPR 24/22 CPR 24/22 CPR 24/22 CPR 22 HEP CPR ramp period (2) 12 mths 12 mths 12 mths 12 mths 12 mths 22 HEP CPR peak period (2) 24 mths 24 mths 24 mths 24 mths 24 mths 22 HEP CPR tail begins (2) 37/49 mths 37/49mths 37/49 mths 37/49 mths 37/49 mths 22 HEP Annual wrap fee and trustee fee 0.285% 0.205% 0.195% 0.185% 0.185% 0.265% Initial overcollateralization required (3) 3.25% -- -- -- -- 9.5% Final overcollateralization required (3) 6.5% 3.75% 3.75% 3.75% 3.75% 13.5%
(1) The aggregate amount securitized is $215,837,139 including $5,478,073 of real estate acquired through foreclosure. (2) CPR represents an industry standard of calculating prepayment speeds and refers to Constant Prepayment Rate. For its first five securitization pools, the Company uses a curve based on various CPR levels throughout the pool's life, based on its estimate of prepayment performance, as outlined in the table above. For the 1999-1 transaction the Company uses a 22 HEP (Home Equity Prepayment) curve. This curve, developed by Prudential Securities, ramps to the terminal CPR (in this case, 22%) over ten months and then remains constant for the life of the pool. (3) Based on percentage of original principal balance, subject to step-down provisions after 30 months. The Company obtained an independent valuation of the residual receivables it services at December 31, 2001. This independent valuation supported the carrying value of the residuals it services as of the valuation date. Each of the Company's Mortgage Loan securitizations discussed above have been credit-enhanced by an insurance policy provided through a monoline insurance company such that the senior certificates have received ratings of "Aaa" from Moody's Investors Services, Inc. ("Moody's") and "AAA" from Standard & Poor's Ratings Group, a division of The McGraw-Hill Companies, Inc. ("Standard & Poor's"). The Company expects to begin receiving Excess Cash Flow on its mortgage loan securitizations approximately 16 months from the date of securitization, although this time period may be shorter or longer depending upon the securitization structure and performance of the loans securitized. Prior to such time, the monoline insurer requires a reserve provision to be created within the securitization trust which uses Excess Cash Flow to retire the securitization bond debt until the spread between the outstanding principal balance of the loans in the securitization trust and the securitization bond debt equals a specified percentage (depending on the structure of the securitization) of the initial securitization principal balance (the "overcollateralization limit"). Once this overcollateralization limit is met, Excess Cash Flows are distributed to the Company. In 1999, the Company completed a securitization transaction in the second quarter. The Company securitized $59.6 million of loans for a weighted average premium of 2.88%. This securitization consisted of seasoned first and second lien mortgage loans, resulting in a lower than average premium. However, the securitization of seasoned loans resulted in additional liquidity of $33.0 million for the Company. Certain loans included in that securitization were ineligible for inclusion in the borrowing base under the Company's warehouse line of credit. 59 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In connection with its 1999 securitization transaction, HGFN agreed to cross-collateralize its residual interests in that transaction and its first three 1997 securitization transactions. The cross-collateralization is for the benefit of Financial Security Assurance, Inc. ("FSA") the bond insurer for all of the transactions. Under the terms of the cross-collateralization agreement, in the event HGFN is in breach of its obligations under any one or more of the securitization trusts, or if certain cumulative loss or delinquency triggers are met, the Excess Cash Flow on all four residual interests will be captured by the Collateral Agent. The Collateral Agent will distribute these monies to FSA or as otherwise specified in the agreement. The total amount which may be retained by the Collateral Agent is capped at $15.0 million. This agreement terminates upon the termination of all of the related securitization trusts. In 2000, the company completed two securitizations totaling $64.3 million of loans. These securitizations consisted primarily of first and second mortgages, and resulted in additional liquidity in 2000 of $47.1 million. Both 2000 securitizations consisted primarily of mortgage loans not eligible for inclusion in the borrowing base under the Company's warehouse lines of credit and not readily marketable for the secondary market. In 2001, the company completed one securitization totaling $10.0 million of loans. This securitization consisted primarily of first and second mortgages, and resulted in additional liquidity in 2001 of $6.5 million. The 2001 securitization consisted primarily of mortgage loans not eligible for inclusion in the borrowing base under the Company's warehouse lines of credit and not readily marketable for the secondary market. In August 2000, the Company exceeded the twelve-month rolling loss trigger in the 1998 securitization pool which resulted in the monthly cash flow of this pool (approximately $70,000 per month) being retained by the trustee rather than being paid to the Company. In December of 2001, the performance of this pool returned to a point below the required trigger, and cash flow back to the Company resumed. In September 2001, the Company exceeded the three-month average delinquency trigger in the 1997-1 securitization pool which resulted in the monthly cash flow of this pool (approximately $60,000 per month) being retained by the trustee rather than being paid to the Company. In December of 2001, the performance of this pool returned to a point below the required trigger, and cash flow back to the Company resumed. In December 2001, the Company exceeded the twelve-month rolling loss trigger in the 1999 securitization pool which resulted in the monthly cash flow of this pool (approximately $80,000 per month) being retained by the trustee rather than being paid to the Company. If the Company returns performance of this pool to a point below the required trigger, the return of cash flow back to the Company will resume. The Company sold its servicing rights under the 2001 and 2000 securitizations because the price paid by the independent third party servicer resulted in a higher realized gain than if the servicing rights not been sold. Consequently, the residual interests related to these two pools are not subject to the Company's normal quarterly evaluation of assumptions and estimates as compared to actual performance. These residual interests represent the Company's estimate of market value. Market value determination includes an estimate of credit losses, based on anticipated performance of the securitized loans in the portfolio. During 2001, the Company increased the valuation reserve $7.1 million for anticipated future losses related to these pools. This valuation adjustment is included in the fair market value adjustment on residual receivables in the accompanying consolidated statement of operations. Management reviews the allowance on an ongoing basis and believes the valuation reserve is sufficient to cover future losses. The original certificate balance of the 2001-5 securitization trust totaled $9,994,196. The Company's share of the original certificate balances was $3,498,196. The average stated principal balance is $52,273 for the 2001-5 pool. The annual servicing fee is 0.50% for the 2001-5, and the trustee fee is 0.05%. The original certificate balances for the 2000 securitizations totaled $64,330,194. The 2000-4 trust had an original certificate balance of $41,473,722 with the Company's share of the original certificate balances being $12,047,487. The 2000-5 trust had an original certificate balance of $22,856,471 with the Company's share of the 60 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS original certificate balances being $5,142,707. The average stated principal balances are $54,734 and $47,105 for pools 2000-4 and 2000-5, respectively. The annual servicing fees are 0.58% and 0.50% for 2000-4 and 2000-5, respectively, and the trustee fee is .05%. At December 31, 2001, the 2001-5 trust had an outstanding principal balance of $8,905,216 with the Company's certificate share being $2,560,921, net of a reserve of $937,274. The 2000-4 trust had outstanding principal balances of $29,546,745 with the Company's certificate share being $4,269,805, net of a reserve of $5,613,000. The 2000-5 trust had outstanding principal balances of $17,811,931 with the Company's certificate share being $2,793,234, net of a reserve of $1,839,725. Interest income is allocated to the bondholders based on the certificate balances. At December 31, 2001, the weighted average pass through rate to bondholders is 9.75%, 11.13%, and 11.84% for the 2001-5, 2000-4, and 2000-5 pools respectively. The Company will not receive its share of principal distribution until three years from the time of the transaction. After three years, principal distribution will be received if the portfolios meet certain performance requirements. Although the Company is a certificate holder, its share of the principal balance is reduced by all losses incurred by the pools. The estimated cumulative losses as a percent of the unpaid principal balance at December 31, 2001 are 10.5%, 19%, and 10% for the 2001-5, 2000-4, and 2000-5 pools. These estimated loss rates are used in estimating the market value of the Company's residual interest At December 31, 2001 key economic assumptions and the sensitivity of the current fair value of residual cash flows to immediate 5 percent and 10 percent adverse changes in assumed economics is as follows (dollars in thousands). LOANS ------------- (DOLLARS IN THOUSANDS) Carrying amount/fair value of retained interests..... $39,646 Weighted-average life (in years)..................... 4.167 Prepayment speed assumption (annual rate)............ 20% - 22% Impact on fair value of 5% adverse change....... $224 Impact on fair value of 10% adverse change...... $448 Expected credit losses (annual rate)................. 39.8% Impact on fair value of 5% adverse change....... $45 Impact on fair value of 10% adverse change...... $91 Residual cash flows discount rate (annual)........... 12% Impact on fair value of 5% adverse change....... $441 Impact on fair value of 10% adverse change...... $883 These sensitivities are hypothetical and should be viewed with caution. As the figures indicate, any change in fair value based on a 5 percent variation in assumptions cannot be extrapolated because the relationship of the change in assumption to the change in fair value is not linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated independent from any change in another assumption; in reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. 61 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6. PROPERTY AND EQUIPMENT The following is a summary of property and equipment: DECEMBER 31, -------------------- 2001 2000 --------- ------- (IN THOUSANDS) Land ..................................... $1,593 $1,919 Buildings and leasehold improvements....... 14,395 13,871 Equipment and computers.................... 10,591 9,431 Furniture and fixtures..................... 4,596 4,304 Vehicles................................... 1,082 542 -------- ------- Total property and equipment.......... 32,257 30,067 Reserve for impairment..................... (1,500) -- Less accumulated depreciation.............. (10,816) (8,637) -------- ------- Net property and equipment............ $19,941 $21,430 ======= ======= In January, 2002, the former headquarters of HGFN located at 3901 Pelham Road, Greenville, S.C. was vacated. The Company is currently marketing this building for lease or sale. Management has concluded that a likely impairment has occurred. Accordingly, the reserve as noted above has been established to reflect this impairment. The Company leases various property and equipment, office space and automobiles under operating leases. The Company's former headquarters building collateralizes the warehouse line of credit. The following is a schedule of future minimum lease payments by year for all operating leases: FUTURE MINIMUM YEAR LEASE PAYMENTS (IN THOUSANDS) 2002 $2,310 2003 1,617 2004 1,334 2005 573 2006 and beyond 308 ----- ------ $6,142 ====== Total rental expense was approximately $3.0 million in 2001, $2.7 million in 2000, and $2.0 million in 1999. NOTE 7. REAL ESTATE OWNED AND PERSONAL PROPERTY ACQUIRED THROUGH FORECLOSURE An analysis of real estate acquired through foreclosure is as follows:
YEARS ENDED DECEMBER 31, ------------------------------- 2001 2000 1999 -------- --------- -------- (IN THOUSANDS) Balance at beginning of year............................... $ 1,281 $ 7,673 $ 5,881 Loan foreclosures and improvements......................... 1,746 5,414 14,827 Dispositions, net.......................................... (1,786) (10,854) (10,370) Write-down of real estate acquired through foreclosure..... (638) (952) (2,665) ------- ------- ------- Balance at end of year..................................... $ 603 $ 1,281 $ 7,673 ======= ======= =======
62 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 8. GOODWILL An analysis of goodwill is as follows: YEARS ENDED DECEMBER 31, ------------------------ 2001 2000 --------- ---------- (IN THOUSANDS) Gross balance at beginning of year.... $ 21,335 $ 2,314 HomeSense purchase (See Note 1)....... -- 19,021 Accumulated amortization.............. (3,110) (1,712) -------- -------- Balance at end of year................ $ 18,225 $ 19,623 ======== ======== Goodwill amortization expense for the years ended December 31, 2001, 2000, and 1999 was approximately $1,398,000, $964,000, and $94,000, respectively. NOTE 9. WAREHOUSE LINES OF CREDIT The Company has a $15 million revolving warehouse line of credit with Household Commercial Financial Services ("Household"). The facility bears interest at the prime rate plus .25%, requires a $1.5 million collateral deposit, and is due on demand. All of the Company's subsidiaries are guarantors under the agreement. During 2000 and 2001, amendments and forbearance agreements were executed whereby the lender agreed to forebear from exercising its rights on account of existing events of default. The outstanding balance under the Household line of credit was $4.3 million at December 31, 2001. The Company secured its guaranty of the Household facility with a mortgage on the former Company headquarters located at 3901 Pelham Road in Greenville, S.C. The lender Company may terminate its forbearance with thirty days notice. As of March 15, 2002, the Company remained in default with respect to the same financial covenants. As of the date hereof the lender has not given notice of termination of forbearance. The Company's subsidiary, HomeGold, Inc. ("HGI"), has a $15 million revolving warehouse line of credit with The Provident Bank ("Provident"). Interest on the line varies on a loan by loan basis and ranges from the prime rate plus 1.5% to the prime rate plus 3.5%, depending on the grade and age of the mortgage funded. The agreement allows for a rate reduction from the base rates if certain monthly funded volume targets are met. The agreement requires a $2 million collateral deposit. Provident holds a first mortgage on the Company's Reed Avenue property, formerly occupied by HGI, in Lexington, South Carolina. The line of credit terminates on October 31, 2002. The outstanding balance under the Provident line of credit was $8.3 million at December 31, 2001. HGI has a $25 million warehouse line of credit with Impac Mortgage Acceptance Corp. ("Impac"). The facility bears interest at the prime rate plus 1.5%, requires a $2.5 million collateral deposit, and may be terminated by Impac without notice. Advance rates on fundings range from 96% to 100% of the principal amount, depending on the type and source of the mortgage. The outstanding balance under the Impac line of credit was $12.3 million at December 31, 2001. The Company and its subsidiary, CII, have guaranteed the obligations of HGI under the Impac credit agreement. All of the Company's warehouse lines contain provisions whereby the lender can terminate their agreement without cause with certain notice requirements. The Company's management believes all current warehouse relationships will remain in place until maturity; however, there is no assurance that one or more of the lenders will not terminate their agreements prior to maturity, or that additional lines will be negotiated at maturity. Either occurrence would adversely affect the Company's ability to originate loans. 63 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 10. NOTES PAYABLE TO BANKS The Company assumed a mortgage note of $1.9 million with Bank of America, N.A. in connection with the merger. The note was scheduled to mature on November 2, 2000. The maturity date was extended to March 2, 2001, at which time it was paid off. The note bore interest at the prime rate plus 1.5%, and was secured by a mortgage on the Company's building in Lexington, South Carolina, as well as a parcel of real estate investment property. Notes payable to banks at December 31, 2001, consists of a note payable to Wachovia Bank, N.A. which bears interest at 7.75% through July, 2016 and is collateralized by certain property and equipment. The maturity schedule for these notes is: PRINCIPAL YEAR PAYMENTS -------------- -------------- (IN THOUSANDS) 2002 $ 26 2003 29 2004 31 2005 33 2006 36 2007and beyond 533 ---- $688 ==== NOTE 11. INVESTOR SAVINGS Investor savings are summarized as follows: DECEMBER 31, ------------------- 2001 2000 --------- -------- (IN THOUSANDS) Notes payable to investors........... $200,978 $146,087 Subordinated debentures.............. 30,125 19,117 -------- -------- $231,103 $165,204 ======== ======== Notes payable to investors are issued by a subsidiary company, CII, in any denomination greater than $10,000 and are registered under the South Carolina Uniform Securities Act. The notes payable to investors are on par with the rights of the holders of the senior unsecured debt of HGFN. The notes mature from one to two years from date of issuance. Interest is payable monthly, quarterly or at maturity at the option of the investors. Interest rates on the notes are fixed until maturity and range from 5% to 9%. At December 31, 2001, and 2000, the weighted average rate was 8.17% and 7.92%, respectively. At December 31, 2001 and 2000, notes payable to investors include an aggregate of approximately $49.1 million and $31.1 million, respectively, of individual investments exceeding $100,000. The investor savings at December 31, 2001 mature as follows (in thousands): 2002 $111,570 2003 89,408 -------- $200,978 ======== There were 7,448 and 5,704 accounts for the notes due to investors at December 31, 2001 and 2000, respectively. 64 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Subordinated debentures are issued by CII in any denomination greater than $100 and are registered under the South Carolina Uniform Securities Act. The subordinated debentures mature one year from date of issuance and have interest rates of 6%. The debentures are subordinated to all bank debt, notes due to investors, and the senior unsecured debt. There were 2,113 and 1,409 subordinated debenture accounts at December 31, 2001 and 2000, respectively. These notes and debentures are not secured by a pledge of any specific assets at CII, nor guaranteed by the Company. NOTE 12. SENIOR UNSECURED DEBT AND SUBSIDIARY GUARANTORS In September 1997, the Company sold $125.0 million in aggregate principal amount of Senior Notes due 2004 ("Senior Notes"). The Senior Notes constitute unsecured indebtedness of the Company. The Senior Notes mature on September 15, 2004, with interest payable semi-annually at 10.75%. The Senior Notes will be redeemable at the option of the Company, in whole or in part, on or after September 15, 2004, at predetermined redemption prices plus accrued and unpaid interest to the date of redemption. In 1998, the Company purchased $38.4 million in aggregate principal amount of its Senior Notes in open market transactions for a combined purchase price of $18.9 million or 49.4% of face value. In 1999, the Company purchased $74.5 million in aggregate principal amount of the Senior Notes for a purchase price of $45.0 million or 60.4% of face value. In 2000, the company purchased $920,000 in aggregate principal amount of the Senior Notes in open market for a purchase price of $341,000 or 37.1% of face value. In 2001, the company purchased $5.0 million in aggregate principal amount of the Senior Notes in open market for a purchase price of $3.0 million or 66.3% of face value, and may, from time to time, purchase more of its Senior Notes depending on its cash needs, market conditions, and other factors. The indenture pertaining to the Senior Notes originally contained various restrictive covenants including limitations on, among other things, the incurrence of certain types of additional indebtedness, the payment of dividends and certain other payments, the ability of the Company's subsidiaries to incur further limitations on their ability to pay dividends or make other payments to the Company, liens, asset sales, the issuance of preferred stock by the Company's subsidiaries and transactions with affiliates. The Company's repurchase of Senior Notes in 2001 was accomplished through a tender offer and a solicitation of consents of holders of the Senior Notes to the deletion of most of the restrictive covenants, certain events of default and related definitions from the Senior Notes Indenture. The Company received sufficient consents to so amend the Indenture, consequently, as of November 2001 most of the restrictive covenants in the original Indenture no longer exist. The Senior Notes are fully and unconditionally guaranteed (the "Subsidiary Guarantees") jointly and severally on an unsecured basis (each, a "Guarantee") by certain of the Company's subsidiaries listed in Note 26 (the "Subsidiary Guarantors"). With the exception of the Guarantee by the Company's subsidiary CII, the Subsidiary Guarantees rank on par with the right of payment with all existing and future unsubordinated indebtedness of the Subsidiary Guarantors and senior in right of payment to all existing and future subordinated indebtedness of such Guarantors. All existing debt of all susidiaries other than CII are currently considered to be subordinated to the Senior Notes. The Guarantee by CII is equal in priority to CII's notes payable to investors and is senior to CII's subordinated debentures. The Senior Notes outstanding at December 31, 2001 and 2000 were $ 6.2 million and $11.2 million, respectively. Included in Note 26 is consolidating condensed financial data of the combined subsidiaries of the Company. The Company believes that providing the condensed consolidating information is of material interest to investors in the Senior Notes and has not presented separate financial statements for each of the wholly-owned Subsidiary Guarantors, because it was deemed that such financial statements would not provide investors with any material additional information. At December 31, 2001 and 2000, all of the subsidiary guarantors were wholly-owned by the Company. 65 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 13. ADOPTION OF SHAREHOLDER RIGHTS PLAN On January 10, 2002 the Board of Directors of the Company declared for each outstanding share of Common Stock of the Company a Shareholder Right to be effective January 29, 2002 to stockholders of record at the close of business on January 9, 2002. Each Right entitles the registered holder of shares of Common Stock to receive on up to two successive occasions: (i) from the Company, one share of Common Stock, automatically with no further action by the holder or the Company, simultaneously upon the first acquisition on or after the effective date by a person of beneficial ownership of shares of Common Stock which, together with any Common Stock already owned by such person, would result in such person then owning 5% or more of the outstanding Common Stock; and (ii) from the Company, one share of Common Stock, automatically with no further action by the holder or the Company, simultaneously upon the second acquisition on or after the effective date by a person of beneficial ownership of shares of Common Stock which, together with any Common Stock already owned by such person, would result in such person then owning 5% or more of the outstanding Common Stock on a date after the date of the acquisition referred to in clause (i) above. The description and terms of the Rights are set forth in a Shareholder Rights Agreement between the Company and First Union National Bank, as Rights Agent. The purpose of the Rights is to protect the Company's net operating loss carry-forwards ("NOLs"). As of December 31, 2001, the Company had NOLs of approximately $144 million. Under the Internal Revenue Code and rules promulgated by the Internal Revenue Service, the Company can "carry forward" these losses in certain circumstances to offset future earnings and thus reduce its federal income tax liability (subject to certain requirements and restrictions). The Company believes that it will be able to carry forward a substantial portion of its NOLs in certain circumstances and so believes these NOLs constitute a substantial asset of the Company. If the Company experiences an "Ownership Change" as defined in Section 382 of the Internal Revenue Code during a three year period, its ability to use the NOLs could be substantially limited or lost altogether. The acquisition of HomeSense Financial Corp. and its affiliates by the Company on May 9, 2000, came close to constituting an Ownership Change. The Company believes that if a new stockholder were to acquire beneficial ownership of 5% or more of the Company's Common Stock or an existing "5% stockholder" were to increase its ownership before May 9, 2003, an Ownership Change could occur and the Company could lose part or all of its NOLs. The Board of Directors of the Company has issued the Rights to protect the NOLs which in turn will protect shareholder value. The Rights will be attached to all outstanding shares of Common Stock, and no separate Right Certificates will be distributed. The Rights will be triggered initially by the acquisition by a person or group of affiliated or associated persons (other than certain exempt persons) of beneficial ownership of such number of shares of Common Stock as, taken with any Common Stock already owned by such person or group, equals or exceeds 5% of the outstanding shares of Common Stock (each such acquirer, an "Acquiring Person"). The Rights may be triggered a second time in the event another Acquiring Person acquires Common Stock. Rights that are beneficially owned by an Acquiring Person become null and void at the time of the acquisition. The Rights will expire at the close of business on May 9, 2003 unless previously redeemed by the Company. NOTE 14. RESTRUCTURING CHARGES During 2000, the Company incurred restructuring charges of approximately $1.5 million related to the merger, to the decision to close its wholesale loan origination division, and estimated costs of employee relocation and severance in connection with the merger and subsequent wholesale division closing. During 2001, the Company incurred restructuring charges of approximately $873,000 primarily due to the relocation of the corporate headquarters from Greenville, S.C. to Lexington, S.C. 66 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 15. OTHER GENERAL AND ADMINISTRATIVE EXPENSES Other general and administrative expenses for the years ended December 31, 2001, 2000, and 1999 consist of the following:
YEARS ENDED DECEMBER 31, ----------------------------- 2001 2000 1999 ---------- ---------- ------- (IN THOUSANDS) Depreciation expense.................................... $2,462 $2,732 $2,487 Amortization expense.................................... 1,435 1,981 206 Legal and professional fees............................. 2,268 2,369 2,013 Travel and entertainment................................ 959 802 729 Office rent and utilities............................... 1,276 821 322 Telephone............................................... 2,079 1,599 928 Office supplies......................................... 1,006 612 501 Equipment and miscellaneous rental...................... 2,081 2,123 1,896 Repairs and maintenance................................. 860 1,264 1,124 Postage and handling charges............................ 798 600 374 Other................................................... 3,195 4,958 2,543 ------- ------- ------- Total other general and administrative expenses.... $18,419 $19,861 $13,123 ======= ======= =======
NOTE 16. INCOME TAXES A reconciliation of the provision for federal and state income taxes and the amount computed by applying the statutory Federal income tax rate to income before income taxes, minority interest, and extraordinary item are as follows:
YEARS ENDED DECEMBER 31, ----------------------------------- 2001 2000 1999 ---------- ---------- ---------- (IN THOUSANDS) Statutory Federal rate of 34% applied to pre-tax income from continuing operations before minority interest and extraordinary item............... $(18,052) $(13,547) $(11,924) State income taxes, net of federal income tax benefit....................... (2,125) (1,593) (511) Change in the valuation allowance for deferred tax assets allocated to income tax expense....................................................... 22,000 (10,000) (7,500) Nondeductible expenses...................................................... 483 19 23 Amortization of excess cost over net assets of acquired businesses.......... -- 112 18 Effect of losses on tax provision........................................... 19,715 14,769 11,800 Tax on excess inclusion income from REMICs.................................. 503 632 700 Other, net.................................................................. -- 152 -- ------- ------- ------- $22,524 $(9,456) $(7,394) ======= ======= =======
The extraordinary gain on the extinguishment of debt is net of $0 tax since the gain was offset against prior NOLs and did not result in any incremental increase in income tax expense. 67 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Provision (benefit) for income taxes from continuing operations is comprised of the following: YEARS ENDED DECEMBER 31, 2001 2000 1999 ---------- --------- ------ (IN THOUSANDS) Current Federal............ $ 469 $ 535 $ 403 State and local.... 55 9 52 ------- ------- ------- 524 544 455 Deferred Federal............ 19,684 (8,942) (7,023) State and local.... 2,316 (1,058) (826) ------- ------- ------- 22,000 (10,000) (7,849) Total Federal............ 20,153 (8,407) (6,620) State and local.... 2,371 (1,049) (774) ------- ------- ------- $22,524 $(9,456) $(7,394) ======= ======= ======= Deferred income taxes reflect the net tax effects of (a) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and (b) operating loss and AMT credit carryforwards. The tax effects of significant items comprising the Company's net deferred tax assets and liabilities are as follows:
DECEMBER 31, ---------------------- 2001 2000 -------- -------- (IN THOUSANDS) Deferred tax liabilities: Differences between book and tax basis of property............... $ (662) $ (745) Differences between book and tax basis of investment in owner's trust.................................................. (210) (521) Difference between book and tax basis of the residual receivables associated with the Company's investment in the Real Estate Investment Trust............................... (258) (1,185) Other ........................................................... -- (41) -------- -------- Total gross deferred tax liabilities........................ $ (1,130) $ (2,492) ======== ======== Deferred tax assets: Differences between book and tax basis of deposit base intangibles.................................................... $ 274 $ 214 Differences between book and tax basis of REMIC residual receivables.................................................... 2,448 1,687 Allowance for credit losses...................................... 2,300 3,335 AMT credit carryforward.......................................... 19 19 Operating loss carryforward...................................... 54,653 30,145 Deferred loan fees............................................... 462 -- REO reserve...................................................... 1,045 114 Restructuring reserve-leases..................................... 267 377 Other ........................................................... 96 406 -------- -------- Total gross deferred tax assets............................. 61,564 36,297 Less valuation allowance.................................... (60,434) (11,805) Less gross deferred tax liabilities......................... (1,130) (2,492) -------- -------- Net deferred tax assets.......................................... $ -- $ 22,000 ======== ========
68 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Due to recurring operating losses, Management has adjusted its valuation allowance for deferred tax assets at December 31, 2001 to $60.4 million. The increase (decrease) in the valuation allowance for the year ended December 31, 2001 and December 31, 2000 was $48.6 million and ($10.0) million, respectively. The valuation allowance at December 31, 2001 relates primarily to NOL carryforwards. The recognition of a net deferred tax asset is dependent upon a "more likely than not" expectation of the realization of the deferred tax asset based on analysis of available evidence. Management has concluded that a valuation allowance is required to sufficiently reduce the deferred tax asset based upon their analysis. The analysis is performed on a quarterly basis using the "more likely than not" criteria to determine the amount, if any, of the deferred tax asset to be realized. As of December 31, 2001, the Company has available federal NOL carryforwards expiring as follows (in thousands): 2002-2005 $ -- 2006 and beyond 143,827 -------- $143,827 ======== There are no known significant pending assessments from taxing authorities regarding taxation issues at the Company or its subsidiaries. NOTE 17. EXTRAORDINARY ITEM--GAIN ON EXTINGUISHMENT OF DEBT The Company purchased $5.0 million, $920,000 and $74.5 million face amount of its Senior Notes in the market for a purchase price of $3.0 million, $341,000 and $45.0 million in 2001, 2000, and 1999, respectively. A proportionate share of the unamortized debt origination costs relating to the issuance of the Senior Notes was charged against this gain, to record a net gain of $2.0 million, $579,000 and $29.5 million in 2001, 2000, and 1999, respectively. The Company may, from time to time, purchase more of its Senior Notes depending on its cash needs, market conditions, and other factors. NOTE 18. STATEMENT OF CASH FLOWS The following information relates to the Statement of Cash Flows for the three years ended December 31, 2001, 2000, and 1999:
YEARS ENDED DECEMBER 31, ----------------------------- 2001 2000 1999 ----------- --------- ------- (IN THOUSANDS) Changes in operating assets and liabilities increasing (decreasing) cash: Restricted cash....................................................... $(2,279) $ 248 $(214) Other receivables..................................................... 1,889 (6,300) 3,969 Residual receivable................................................... (3,594) (13,386) (7,240) Accrued interest receivable........................................... (170) (393) 1,189 Servicing asset....................................................... 140 165 73 Other assets.......................................................... (4,365) (1,218) 2,670 Remittance due to loan participants................................... (15) 122 (793) Accrued interest payable.............................................. (255) 92 (2,354) Income taxes payable.................................................. 208 369 177 Other liabilities..................................................... 4,566 (7,456) (2,536) ------- -------- ------- $(3,875) $(27,757) $(5,059) ======= ======== =======
69 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS During the year ended December 31, 2000 in connection with the HomeSense merger the following non-cash items were recorded: (IN THOUSANDS) Loans receivable ........................................... $29,244 Property and equipment, net................................. 5,800 Goodwill ................................................... 19,020 Revolving warehouse lines of credit......................... 29,244 Notes payable .............................................. 2,853 Other liabilities .......................................... 4,915 Preferred stock ............................................ 10,000 Common stock ............................................... 7 Capital in excess of par value.............................. 7,045 The Company foreclosed on, or repossessed property used to collateralize loans receivable in the amount of $1.7 million, $2.4 million and $4.3 million, in 2001, 2000, and 1999, respectively. The Company purchased $0 and $3.0 million of foreclosed property from the securitization trusts in 2001 and 2000, respectively. The Company paid income taxes of $722,000, $175,000 and $277,000, in 2001, 2000, and 1999, respectively. The Company paid interest of $19.4 million, $17.9 million and $18.7 million, in 2001, 2000, and 1999, respectively. NOTE 19. STOCK OPTION PLANS AND STOCK WARRANTS On May 21, 1981, the shareholders approved an employee stock option plan and on May 22, 1984, the shareholders approved an increase in the number of shares of common stock which may be granted from 250,000 to 500,000. Under the terms of the plan, the Company may grant options to key employees and directors to purchase up to a total of 500,000 shares of its common stock. The option price is the fair market value at date of grant. The options expire five years from date of grant, are not transferable other than on death, and are exercisable 20% on the date of grant and 20% per year on a cumulative basis for each year subsequent to the date of grant. No additional shares are available for grant under this stock option plan, and there are 24,000 unexercised options outstanding at December 31, 2001, of which 24,000 are exercisable. On June 9, 1995, the shareholders approved a stock option plan under which the Board of Directors may issue 566,667 shares of common stock. In May 1997, June 1998, May 1999, and in April 2000, the shareholders approved an additional 150,000, 350,000, 400,000 and 500,000 shares of common stock, respectively. Therefore, under the terms of the plan, the Company may grant options to key employees to purchase up to a total of 1,966,667 shares of its common stock. The option price for all options granted has been 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 fair market value at date of grant. The options expire ten years from date of grant, are not transferable other than on death, and are exercisable 20% on the date of grant and 20% per year on a cumulative basis for each year subsequent to the date of grant. The remaining options available for grant under the plan consist of 230,207 common stock options at December 31, 2001, and there are 930,800 unexercised options outstanding at December 31, 2001, of which 460,000 are exercisable. Also on June 9, 1995, the shareholders approved a stock option plan under which each non-employee member of the Board of Directors receives options to purchase 666 shares of common stock each December 15 beginning in 1995 through 2005. Under the terms of the plan, the Company may grant options totaling 33,333 shares. The terms of the plan are identical to the employee stock option plan approved on June 9, 1995. At December 31, 2001 there are 5,328 unexercised options outstanding of which 5,328 are exercisable. 70 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On April 18, 1996, the shareholders approved a restricted stock agreement plan to provide additional incentives to members of the Board of Directors of the Company who are not employees of the Company. Shares that may be issued pursuant to the Restricted Stock Agreements under the Plan shall not exceed 50,000 shares in the aggregate. The Plan provides that, on each grant date, each eligible director will automatically receive from the Company an Agreement to purchase for $.05 per share that number of shares having a fair market value equal to $12,000. For purposes of the Plan, the grant date is January 31 of each calendar year commencing with the 1996 calendar year. At December 31, 2001 and 2000, there were agreements covering 14,500 shares granted under this plan with agreements covering 11,600 shares unexercised and outstanding, all of which are exercisable. Shares subject to a Restricted Stock Agreement are initially non-transferable and subject to forfeiture. Shares granted to a recipient become freely transferable and no longer subject to forfeiture at a rate of 20% of the total number of shares covered by such agreement on each of the five anniversaries of the grant date, beginning with the first anniversary of such grant. On April 28, 2000, the shareholders approved a stock option agreement pursuant to the HomeSense merger agreement to compensate Mr. Ronald J. Sheppard, CEO. The agreement authorized 825,423 shares of Common Stock to be issued at $1.75 per share to Mr. Sheppard. These options were to be exercised, forfeited, and cancelled at a rate of .67 to 1 in direct proportion to any exercised, forfeited, or cancelled options that were in existence at the time of the agreement. In February 2001, these options were cancelled. In connection with the consummation of the Merger on May 9, 2000, the Company issued a warrant to purchase 250,000 shares of its common stock at an exercise price of $1.50 per share to Raymond James and Associates, Inc. in partial consideration for the delivery to the Company of a fairness opinion regarding the Merger. The warrant was exercisable on issuance, expires five years from the date of issuance and is transferable. The Company issued the warrant without registration under Section 4(2) of the Securities Act of 1933, as amended, as a transaction not involving a public offering. The Company implemented an Employee Stock Purchase Plan ("ESPP") in 1997. The ESPP allows eligible employees the right to purchase common stock at the end of each of two six-month offering periods (January 1 through June 30 and July 1 through December 31). To be eligible, employees must work 20 or more hours per week and have been employed for a period of 1 year. The stock is purchased at 85% of the lower of the market price at the beginning or ending of each six-month offering period. A liability is recorded for ESPP withholdings not yet applied towards the purchase of common stock. In April 2000, the Company's shareholders approved an amendment to the ESPP increasing the number of shares authorized for issue under the plan by 400,000. The total amount of authorized shares is 600,000 at December 31, 2001. The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation". As such, the stock-based compensation utilized by the Company has been accounted for under APB Opinion No. 25. 71 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Activity in stock options is as follows:
YEARS ENDED DECEMBER 31, 2001 2000 1999 ----------- ---------- -------- Options outstanding, beginning of year . 2,093,480 1,268,160 973,003 DATE OF GRANT ISSUED AT: 02/26/99 $0.9375 per share (non-qualified) -- -- 25,000 02/26/99 $1.32 per share (non-qualified) -- -- 1,334 03/10/99 $1.22 per share -- -- 10,000 07/23/99 $1.3125 per share -- -- 35,000 08/20/99 $0.9375 per share (non-qualified) -- -- 10,000 10/06/99 $1.03 per share -- -- 502,800 02/10/00 $1.06 per share -- 35,000 -- 04/28/00 $4.625 per share (non-qualified) -- 14,400 -- 04/28/00 $12.25 per share (non-qualified) -- 40,000 -- 04/28/00 $9.75 per share (non-qualified) -- 30,000 -- 04/28/00 $0.9375 per share (non-qualified) -- 40,000 -- 04/28/00 $1.03 per share (non-qualified) -- 50,000 -- 05/01/00 $1.3125 per share (non-qualified) -- 35,000 -- 05/01/00 $1.03 per share (non-qualified) -- 20,000 -- 05/02/00 $9.75 per share (non-qualified) -- 10,000 -- 05/02/00 $0.9375 per share (non-qualified) -- 20,000 -- 05/02/00 $1.03 per share (non-qualified) -- 20,000 -- 05/09/00 $1.75 per share (non-qualified) -- 825,423 -- 05/22/00 $13.50 per share (non-qualified) -- 3,000 -- 05/22/00 $9.75 per share (non-qualified) -- 10,000 -- 05/22/00 $0.9375 per share (non-qualified) -- 35,400 -- 05/22/00 $1.03 per share (non-qualified) -- 22,000 -- 05/22/00 $4.625 per share (non-qualified) -- 6,400 -- 07/03/00 $4.625 per share (non-qualified) -- 12,800 -- 07/03/00 $12.25 per share (non-qualified) -- 25,000 -- 07/03/00 $9.75 per share (non-qualified) -- 5,000 -- 07/03/00 $6.75 per share (non-qualified) -- 50,000 -- 07/03/00 $0.9375 per share (non-qualified) -- 25,000 -- 07/03/00 $1.03 per share (non-qualified) -- 35,000 -- 07/03/00 $1.06 per share (non-qualified) -- 35,000 -- 08/15/00 $0.50 per share -- 535,000 -- 10/04/00 $0.50 per share (non-qualified) -- 20,000 -- 10/04/00 $1.03 per share (non-qualified) -- 15,000 -- 10/04/00 $0.9375 per share (non-qualified) -- 5,000 -- 11/28/00 $0.42 per share 30,000 09/05/01 $0.35 per share -- -- -- 610,000 -- -- --------- --------- ------- Total Granted...... 610,000 2,009,423 584,134 ========= ========= =======
72
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, -------------------------------------- 2001 2000 1999 ----------- ------------ ---------- Expired, canceled or forfeited: $1.0825 per share.................... -- -- (12,002) $1.32 per share...................... -- (1,334) (9,335) $4.625 per share..................... (33,600) (36,800) (34,840) $10.38 per share (directors plan).... -- -- $12.25 per share..................... (65,000) (66,000) (46,000) $11.25 per share (directors plan).... -- -- -- $13.50 per share..................... -- (9,000) -- $13.00 per share..................... -- -- (10,000) $9.75 per share...................... (50,000) (81,000) (42,000) $8.75 per share...................... -- -- (16,900) $0.9375 per share.................... (121,400) (245,100) (114,700) $0.50 per share...................... (145,000) (20,000) -- $1.06 per share...................... (35,000) (35,000) -- $1.22 per share...................... -- (4,000) -- $1.03 per share...................... (199,000) (370,800) -- $1.3125 per share.................... -- (70,000) -- $2.44 per share...................... -- (7,000) -- $6.75 per share...................... (50,000) (50,000) -- $1.75 per share...................... (637,354) (188,069) -- $0.50 per share...................... (10,000) -- -- ------------ ----------- ----------- (1,346,354) (1,184,103) (285,777) Exercised: $0.9375 per share.................... -- -- (3,200) ------------ ----------- ----------- -- -- (3,200) ------------ ----------- ----------- Options outstanding, end of year........ 1,357,126 2,093,480 1,268,160 ============ =========== =========== Exercisable, end of year................ 248,328 734,728 525,129 ============ =========== =========== Available for grant, end of year........ 671,939 761,008 257,813 ============ =========== ===========
Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date for awards in 2001, 2000, and 1999 consistent with the provisions of SFAS No. 123, the Company's net income (loss) and earnings (loss) per share of common stock would have been reduced to the pro forma amounts indicated below:
YEARS ENDED DECEMBER 31, -------------------------------- 2001 2000 1999 ----------- -------- ----------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net income (loss)--as reported.................................... $(73,599) $(29,812) $1,815 Net income (loss)--pro forma . ................................... (73,914) (30,243) 1,160 Diluted earnings (loss) per share of common stock--as reported.... (4.36) (2.06) 0.18 Diluted earnings (loss) per share of common stock--pro forma ..... (4.38) (2.09) 0.12
The fair value of each option grant is estimated on the date of grant using a Black-Scholes valuation model with the following weighted average assumptions used in 2000 and 2001: dividend yield of 0%, expected volatility ranges from 75% to 120%, risk-free interest rate of approximately 6.00%, and expected lives of ten years. The weighted average assumptions used in 1999 were dividend yield of 0%, expected volatility of 254%, risk-free interest rate of 6.73% and expected lives of five years. The pro forma amounts disclosed above may not be representative of the effects on reported net income for future periods. 73 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 20. TRANSACTIONS WITH RELATED PARTIES The Company engaged in the following related party transactions: The Company obtains legal services from Wyche, Burgess, Freeman & Parham, P.A., certain members of which, when considered in the aggregate, beneficially own 414,586 shares of the Company's capital stock. A partner of the firm also serves as secretary to the Company. Total charges for these services were approximately $214,000 in 2001, $276,000 in 2000 and $228,000 in 1999. Notes payable to investors and subordinated debentures include amounts due to officers, directors and key employees of approximately $1,062,000, $690,000 and $707,000 at December 31, 2001, 2000 and 1999, respectively. The Company also had notes receivable from related parties at December 31, 2001, 2000 and 1999 of approximately $101,000, $111,000 and $121,000, respectively. NOTE 21. EMPLOYEE RETIREMENT PLAN The Company has a matched savings plan under Section 401(k) of the Internal Revenue Code covering employees meeting certain eligibility requirements. The plan allows employees who have completed 30 days of service to participate in the plan and provides for Company contributions, subject to certain limitations. Company matching contributions are 50% of employee contributions to a maximum of 6% of compensation for each employee. The Company's contributions under the plan totaled approximately $353,800 in 2001, $160,800 in 2000 and $320,500 in 1999. The Company discovered errors in the calculation and remittance of deferral and matching contributions from 1997 through 2001. These errors resulted in an estimated net understatement of contributions of approximately $112,600. Management is in the process of correcting the errors pursuant to the Internal Revenues Service's Employment Plans Compliance Resolution System. NOTE 22. COMMITMENTS AND CONTINGENCIES The Company may from time to time enter into forward commitments to sell residential first mortgage loans to reduce risk associated with originating and holding loans for sale. At December 31, 2001, the Company had no outstanding forward commitment contracts. From time to time, the Company is involved in litigation in the ordinary course of its business. As a result of legal defenses and insurance arrangements, the Company does not believe that any such litigation, if decided unfavorably to the Company, would have a material adverse effect on its business or assets, with the exception of the litigation noted below. On August 20, 1999, Janice Tomlin, Isaiah Tomlin, and Constance Wiggins filed a purported class action lawsuit ("Tomlin action") in New Hanover County, North Carolina Superior Court. That suit has been transferred to North Carolina Business Court. The suit was filed against the Company's subsidiary, HGI, and others alleging a variety of statutory and common law claims arising out of mortgage loans they obtained through Chase Mortgage Brokers ("Chase"). On February 22, 2000, Michael and Kimberly Chasten filed a similar action in Duplin County, North Carolina Superior Court. On April 13, 2000 Reginald Troy filed a similar action in New Hanover County, North Carolina Superior Court. The plaintiffs in all of these cases are seeking unspecified monetary damages which fall into three basic categories: (1) refund of all fees charged by Chase in connection with the mortgage loans; (2) forfeiture of all profits realized from the sale of the mortgage loans in the secondary market; and (3) refund of two times the past interest paid on the mortgage loans, and forfeiture of future interest. The complaints in all of these cases allege participation by HGI in an arrangement with Chase under which Chase allegedly failed to make necessary disclosures to the borrowers, and charged excessive and duplicative fees to the borrowers, and under which Chase allegedly received undisclosed premiums. On February 1, 2002, the Court granted to the plaintiffs in the Tomlin action their motion for class certification. HGI intends to vigorously contest these cases. Because these matters are in their early stages, it is not possible to evaluate the likelihood of an unfavorable outcome or estimate 74 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS the amount of potential loss. Management believes that if any of these causes of action is determined adversely, the effect on the financial condition of the Company could be materially adverse. During 2000 and 2001, the Company was in default with respect to certain financial covenants under the Company's revolving warehouse line of credit with Household. In November, 2001, an amendment and forbearance agreement was executed whereby the line of credit was reduced from $40 million to $15 million, a collateral deposit of $1.5 million was required, and the lender agreed to forebear from exercising its rights resulting from the default. The lender retained the right to terminate its forbearance with notice of 30 days. As of March 15, 2002, the Company remained in default with respect to the same financial covenants. As of the date hereof the lender has not given notice of termination of forbearance. HGI, together with certain other subsidiaries of HGFN (collectively, the "Subsidiary Guarantors"), has guaranteed HGFN's performance of its obligations under its 10-3/4% Senior Notes due 2004 (the "Senior Notes") and the indenture related thereto (the "Indenture"). The original aggregate principal amount of the Senior Notes was $125,000,000; however, as of December 31, 2000, HGFN has repurchased $118,750,000 of the Senior Notes leaving $6,250,000 in aggregate principal amount outstanding. 75
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 23. SUPPLEMENTAL QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The quarterly results of operations for the year ended December 31, 2001, are as follows: QUARTER ENDED ------------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, 2001 2001 2001 2001 ----------- --------- ------------- ------------ (IN THOUSANDS, EXCEPT SHARE DATA) Revenues: Interest income...................................... $2,053 $2,280 $2,468 $1,208 Servicing income..................................... 1,116 1,405 822 925 Gain on sale of loans: Gross gain on sale of loans..................... 1,993 3,546 2,850 4,418 Loan fees, net.................................. 6,069 8,829 7,461 (346) ----- ----- ----- ----- Total gain (loss) on sale.................. 8,062 12,375 10,311 4,072 Other revenues....................................... 154 644 94 375 ------ ------ ------ ------ Total revenues............................. 11,385 16,704 13,695 6,580 ------ ------ ------ ------ Expenses: Interest ........................................... 4,985 4,830 5,329 5,465 Provision for credit losses.......................... -- -- 192 2,691 Cost of real estate owned and defaulted 531 664 71 153 loans ........................................ Fair market adjustment on residual -- -- -- 10,490 receivables....................................... Salaries, wages and employee benefits................ 7,185 9,262 9,349 11,799 Business development costs........................... 2,683 3,040 (2,472) 5,918 Restructuring charges................................ -- 1,241 (345) (23) Other general and administrative..................... 5,807 4,815 6,270 1,527 -------- -------- ------- -------- Total expenses............................. 21,191 23,852 18,394 38,020 -------- -------- ------- -------- Loss before income taxes, minority interest and (9,806) (7,148) (4,699) (31,440) extraordinary item................................ Provision (benefit) for income taxes................. 190 139 127 22,068 Minority interest in (earnings) loss of subsidiaries...................................... (1) 1 (3) (1) ------- -------- ------ ------- Income before extraordinary item..................... (9,997) (7,286) (4,829) (53,509) Extraordinary item-gain (loss) on extinguishment of 52 101 2,077 (208) debt, net of $0 tax............................... ------- -------- ------- ------- Net income (loss).......................... $(9,945) $ (7,185) $(2,752) $(53,717) ======= ======== ====== ======== Basic earnings (loss) per share of common stock: Loss before extraordinary item.................. $ (0.59) $ (0.43) $(0.29) $ (3.17) Extraordinary item, net of taxes................ 0.00 0.01 0.12 (0.01) ------- ------- ------- ------- Net income (loss).......................... $ (0.59) $ (0.42) $ (0.17) $ (3.18) ======= ======= ======= ======= Basic weighted average shares outstanding . . . . . . . . . . . 16,848,359 16,878,784 16,897,507 16,906,198 ========== ========== ========== ============ Diluted earnings (loss) per share of common stock: Loss before extraordinary item.................. $ (0.59) $ (0.43) $ (0.29) $ (3.17) Extraordinary item, net of taxes................ 0.00 0.01 0.12 (0.01) ------- ------- -------- ------- Net income (loss).......................... $ (0.59) $ (0.42) $ (0.17) $ (3.18) ======= ======= ======== ======= Diluted weighted average shares outstanding . . . . . . . . . . . 16,848,359 16,878,784 16,897,507 16,906,198 ========== ========== ========== ============
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HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The quarterly results of operations for the year ended December 31, 2000, are as follows: QUARTER ENDED ------------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, 2000 2000 2000 2000 ----------- --------- ------------- ------------ (IN THOUSANDS, EXCEPT SHARE DATA) Revenues: Interest income...................................... $ 1,927 $ 3,679 $ 3,784 $ 2,802 Servicing income..................................... 2,004 2,216 1,907 1,270 Gain on sale of loans: Gross gain on sale of loans..................... 1,854 3,090 3,554 1,303 Loan fees, net.................................. 432 5,620 6,926 3,452 --------- ------- -------- ------- Total gain (loss) on sale.................. 2,286 8,710 10,480 4,755 Other revenues....................................... 510 429 573 223 --------- ------- -------- ------- Total revenues............................. 6,727 15,034 16,744 9,050 Expenses: Interest ............................................ 4,003 4,881 5,680 4,884 Provision for credit losses.......................... 990 652 650 867 Cost of real estate owned and defaulted loans ............................................ 1,054 -- 914 1,483 Fair market adjustment on residual receivables....................................... 1,080 555 509 135 Salaries, wages and employee benefits................ 4,912 7,955 8,469 7,780 Business development costs........................... 1,841 1,811 2,136 2,827 Restructuring charges................................ -- 1,369 99 1 Other general and administrative..................... 2,813 6,218 6,429 4,401 --------- ------- ------- ------- Total expenses............................. 16,693 23,441 24,886 22,378 --------- ------- ------- ------- Loss before income taxes, minority interest and extraordinary item................................ (9,966) (8,407) (8,142) (13,328) Provision (benefit) for income taxes................. 145 190 (9,820) 29 Minority interest in (earnings) loss of subsidiaries...................................... (1) 1 (2) (2) --------- ------- ------- ------- Income before extraordinary item..................... (10,112) (8,596) 1,676 (13,359) Extraordinary item-gain on extinguishment of debt, net of $0 tax............................... 226 92 261 -- --------- ------- ------- ------- Net income (loss).......................... $ (9,886) $(8,504) $ 1,937 $ (13,359) ========= ======= ======== ========= Basic earnings (loss) per share of common stock: Loss before extraordinary item.................. $ (0.99) $ (0.62) $ 0.10 $ (0.59) Extraordinary item, net of taxes................ 0.02 0.01 0.02 (0.01) --------- ------- -------- --------- Net income (loss).......................... $ (0.97) $ (0.61) $ 0.12 $ (0.60) ======== ======= ======== ========= Basic weighted average shares outstanding............ 10,170,698 13,943,164 16,805,023 16,810,149 ========== ========== ========== ========== Diluted earnings (loss) per share of common stock: Loss before extraordinary item.................. $ (0.99) $ (0.62) $ 0.10 $ (0.59) Extraordinary item, net of tax.................. 0.02 0.01 0.02 (0.01) ---------- ------- -------- -------- Net income (loss) ......................... $ (0.97) $ (0.61) $ 0.12 $ (0.60) ========== ======= ======== ======== Diluted weighted average shares outstanding.......... 10,170,698 13,943,164 16,805,023 16,810,149 ========== ========== ========== ==========
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HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 24. EARNINGS (LOSS) PER SHARE OF COMMON STOCK The following table sets forth the computation of basic and fully diluted earnings per share. FOR THE YEAR ENDED DECEMBER 31, ------------------------------------------- 2001 2000 1999 ------------- ---------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Numerator Net income (loss)-numerator for basic and fully diluted EPS................................................................ $ (73,599) $ (29,812) $ 1,815 ========= ========= ======= Denominator Basic weighted average shares o/s-denominator for basic EPS........... 16,882,919 14,445,283 9,961,077 Effect of dilutive employee stock options............................. -- -- -- ---------- ---------- --------- Fully diluted weighted average shares o/s-denominator for fully Diluted EPS........................................................ 16,882,919 14,445,283 9,961,077 ========== ========== ========= Basic earnings per common share....................................... $ (4.36) $ (2.06) $ 0.18 Fully diluted earnings per common share............................... $ (4.36) $ (2.06) $ 0.18
The computation of fully diluted EPS in 2001, 2000, and 1999, does not take into account the effect of any outstanding common stock equivalents since their inclusion would be antidilutive. The number of shares related to common stock equivalents that would have been included in both 2001 and 2000 were 12,089 shares. NOTE 25. FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS 107, "Disclosures about Fair Value of Financial Instruments" requires disclosure of fair value information whether or not recognized in the balance sheet, when it is practicable to estimate the fair value. SFAS 107 defines a financial instrument as cash, evidence of an ownership interest in an entity or contractual obligations which require the exchange of cash or financial instruments. Certain items are specifically excluded from the disclosure requirements, including the Company's common stock, property and equipment and other assets and liabilities. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: CASH AND CASH EQUIVALENTS AND RESTRICTED CASH For these short-term instruments, the carrying amount is a reasonable estimate of fair value. LOANS RECEIVABLE For certain homogeneous categories of loans, such as residential mortgages, fair value is estimated using the secondary market prices received on recent sales of these loans in the secondary market. RESIDUAL RECEIVABLE, NET The fair value of the residual receivable is calculated using prepayment, default and interest rate assumptions that the Company believes market participants would use for similar instruments at the time of sale. Projected performance is monitored on an ongoing basis. Accordingly, carrying value approximates fair value. 78 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS INVESTOR SAVINGS Subordinated Investor Savings were $231.1 and $165.2 million at December 31, 2001 and 2000, respectively. These instruments bear interest at rates ranging from 5% - 9% and mature at various dates throughout 2002 and 2003. There is no active market for these instruments and it is not practicable to estimate fair value. REVOLVING WAREHOUSE LINES AND NOTES PAYABLE TO BANKS AND OTHER The fair value of notes payable to banks and other approximates the carrying amount. Rates with similar terms and maturities currently available to the Company are used to estimate fair value of existing debt. SENIOR UNSECURED DEBT The fair value of senior unsecured debt is based on the market value of the publicly traded securities. COMMITMENTS TO EXTEND CREDIT The fair value of commitments to extend credit is determined by using the anticipated market prices that the loans will generate in the secondary market. The estimated fair values of the Company's financial instruments at December 31 were as follows:
2001 2000 ------ ---- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE -------- ----- -------- ----- (IN THOUSANDS) Financial Assets: Cash and cash equivalents................................. $26,352 $26,352 $3,691 $3,691 Restricted cash........................................... 7,345 7,345 5,066 5,066 Loans receivable, net..................................... 44,739 44,739 51,699 52,731 Residual receivable....................................... 49,270 49,270 58,877 58,877 Financial Liabilities: Revolving warehouse lines and notes payable to banks and other ............................................. $25,621 $25,621 $29,304 $26,304 Senior unsecured debt..................................... 6,250 2,813 11,214 4,300 Commitments to extend credit.............................. -- -- -- --
NOTE 26. CONSOLIDATING CONDENSED FINANCIAL DATA OF THE COMBINED SUBSIDIARIES THAT GUARANTEED SENIOR DEBT The Subsidiary Guarantors of the Company's Senior Notes at December 31, 2001 consist of the following wholly owned subsidiaries of the Company: HomeGold, Inc. (f/k/a Emergent Mortgage Corp.) Emergent Mortgage Corp. of Tennessee Carolina Investors, Inc. Emergent Insurance Agency Corp. Emergent Business Capital Asset Based Lending, Inc. 79 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Investments in subsidiaries are accounted for by the Parent and Subsidiary Guarantors on the equity method for the purposes of the consolidating financial data. Earnings of subsidiaries are therefore reflected in the parent's and Subsidiary Guarantor's investment accounts and earnings. The principal elimination entries eliminate investments in subsidiaries and intercompany balances and transactions. Certain sums in the following tables may reflect immaterial rounding differences. As of December 31, 2001, the Subsidiary Guarantors conduct all of the Company's operations, other than the investment of certain residual receivables through its special purpose bankruptcy-remote securitization subsidiaries. A substantial majority of the assets of Emergent Business Capital Asset Based Lending, Inc. were sold to Emergent Asset-Based Lending LLC, an unaffiliated Maryland Limited Liability Company, on December 2, 1998. Since not all assets of this subsidiary were sold, the guaranty was not released. 80
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATING BALANCE SHEET DECEMBER 31, 2001 (UNAUDITED) (DOLLARS IN THOUSANDS) COMBINED WHOLLY-OWNED COMBINED PARENT GUARANTOR NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------- ------------ ------------ ASSETS Cash and cash equivalents......................... $ 1 $ 26,350 $ 1 $ -- $ 26,352 Restricted cash................................... 66 7,279 -- -- 7,345 Loans receivable: Loans receivable.............................. 1,029 50,776 -- -- 51,805 Notes receivable from affiliates.............. 6,026 126,995 18,887 (151,908) -- --------- ----------- ----------- ----------- ----------- Total loans receivable...................... 7,055 177,771 18,887 (151,908) 51,805 Less allowance for credit losses on loans..... (250) (5,601) -- -- (5,851) Less deferred loan fees....................... -- (1,215) -- -- (1,215) Plus deferred loan costs...................... -- -- -- -- -- ------- ----------- ---------- ----------- ----------- Net loans receivable........................ 6,805 170,955 18,887 (151,908) 44,739 Other Receivables: Income tax.................................... -- 596 -- -- 596 Accrued interest receivable................... 199 1,788 -- -- 1,987 Other receivables............................. -- 9,608 -- -- 9,608 ------- ----------- ---------- ----------- ----------- Total other receivables..................... 199 11,992 -- -- 12,191 Investment in subsidiaries........................ 51,653 45,418 -- (97,071) -- Residual receivables, net......................... -- 13,406 35,864 -- 49,270 Net property and equipment........................ -- 19,941 -- -- 19,941 Real estate and personal property acquired through Foreclosure..................................... -- 603 -- -- 603 Net excess of cost over net assets of acquired 33 18,192 -- -- 18,225 businesses........................................ Deferred income tax asset, net.................... -- -- -- -- -- Other assets...................................... 90 8,726 -- -- 8,816 ------- ---------- ---------- ---------- ----------- TOTAL ASSETS................................ $58,847 $ 322,862 $ 54,752 $ (248,979) $ 187,482 ======= ========== ========== ========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES: Revolving warehouse lines of credit and notes payable $ -- $ 25,621 $ -- $ -- $ 25,621 to banks..................................... Investor savings: Notes payable to investors.................... -- 200,978 -- -- 200,978 Subordinated debentures....................... -- 30,125 -- -- 30,125 -------- ---------- ---------- ---------- ---------- Total investor savings...................... -- 231,103 -- -- 231,103 Senior unsecured debt............................. 6,250 -- -- -- 6,250 Accounts payable and accrued liabilities.......... 6 6,204 -- -- 6,210 Remittances payable............................... -- 1,186 -- -- 1,186 Income taxes payable.............................. -- 555 -- -- 555 Accrued interest payable.......................... 170 513 -- -- 683 Due to (from) affiliates.......................... 142,947 6,027 9,334 (158,308) -- --------- ---------- ---------- ---------- ---------- Total other liabilities..................... 143,123 14,485 9,334 (158,308) 8,634 Subordinated debt to affiliates................... -- -- -- -- -- --------- ---------- ---------- ---------- ---------- Total liabilities........................... 149,373 271,209 9,334 (158,308) 271,608 MINORITY INTEREST................................. -- -- -- -- -- SHAREHOLDERS' EQUITY: Common stock.................................. 17 1,000 2 (1,002) 17 Preferred stock............................... 10,000 10,000 Capital in excess of par value................ 46,659 235,215 48,807 (284,022) 46,659 Note receivable from shareholder.................. (5,700) (5,700) -- 5,700 (5,700) Retained earnings (deficit)....................... (141,502) (178,862) (3,391) 188,653 (135,102) --------- ---------- ---------- ---------- ---------- Total shareholders' equity.................. (90,526) 51,653 45,418 (90,671) (84,126) --------- ---------- ---------- ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $ 58,847 $ 322,862 $ 54,752 $ (248,979) $ 187,482 ======== ========== ========== ========== =========
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HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATING BALANCE SHEET DECEMBER 31, 2000 (UNAUDITED) (DOLLARS IN THOUSANDS) COMBINED WHOLLY-OWNED COMBINED PARENT GUARANTOR NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------- ------------ ------------ ASSETS Cash and cash equivalents......................... $ 100 $ 3,590 $ 1 $ -- $ 3,691 Restricted cash................................... 66 5,000 -- -- 5,066 Loans receivable: Loans receivable.............................. 1,087 57,396 -- -- 58,483 Notes receivable from affiliates.............. 7,847 95,448 14,083 (117,378) -- ------- --------- ------- -------- -------- Total loans receivable...................... 8,934 152,844 14,083 (117,378) 58,483 Less allowance for credit losses on loans..... (250) (4,402) -- -- (4,652) Less deferred loan fees....................... -- (2,339) -- -- (2,339) Plus deferred loan costs...................... -- 207 -- -- 207 ------- --------- ------- -------- -------- Net loans receivable........................ 8,684 146,310 14,083 (117,378) 51,699 Other Receivables: Income tax.................................... -- 318 -- -- 318 Accrued interest receivable................... 80 1,737 -- -- 1,817 Other receivables............................. -- 11,497 -- -- 11,497 -------- --------- ------- -------- -------- Total other receivables..................... 80 13,552 -- -- 13,632 Investment in subsidiaries........................ 89,558 45,147 -- (134,705) -- Residual receivables, net......................... -- 19,123 39,754 -- 58,877 Net property and equipment........................ -- 21,430 -- -- 21,430 Real estate and personal property acquired through -- 1,281 -- -- 1,281 Foreclosure..................................... Net excess of cost over net assets of acquired 35 19,588 -- -- 19,623 businesses........................................ Deferred income tax asset, net.................... 1,810 20,190 -- -- 22,000 Other assets...................................... 1,220 3,502 -- -- 4,722 --------- ---------- ---------- ---------- --------- TOTAL ASSETS................................ $ 101,553 $ 298,713 $ 53,838 $ (252,083) $ 202,021 ========= ========== ========== ========== ========= LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES: Revolving warehouse lines of credit and notes payable to banks ............................ $ -- $ 29,303 $ -- $ -- $ 29,303 Investor savings: Notes payable to investors.................... -- 146,087 -- -- 146,087 Subordinated debentures....................... -- 19,117 -- -- 19,117 -------- ---------- ---------- --------- --------- Total investor savings...................... -- 165,204 -- -- 165,204 Senior unsecured debt............................. 11,214 -- -- -- 11,214 Accounts payable and accrued liabilities.......... -- 4,637 -- -- 4,637 Remittances payable............................... -- 1,201 -- -- 1,201 Income taxes payable.............................. -- 347 -- -- 347 Accrued interest payable.......................... 328 610 -- -- 938 Due to (from) affiliates.......................... 100,840 7,852 8,686 (117,378) -- -------- ---------- ---------- --------- --------- Total other liabilities..................... 101,168 14,647 8,686 (117,378) 7,123 Subordinated debt to affiliates................... -- -- -- -- -- -------- ---------- ---------- --------- --------- Total liabilities........................... 112,382 209,154 8,686 (117,378) 212,844 MINORITY INTEREST................................. (1) 1 6 (1) 5 SHAREHOLDERS' EQUITY: Common stock.................................. 17 1,000 2 (1,002) 17 Preferred stock............................... 10,000 10,000 Capital in excess of par value................ 46,643 203,739 48,807 (252,546) 46,643 Note receivable from shareholder.................. (5,985) (5,985) -- 5,985 (5,985) Retained earnings (deficit)....................... (61,503) (109,196) (3,663) 112,859 (61,503) -------- ---------- ---------- --------- --------- Total shareholders' equity.................. (10,828) 89,558 45,146 (134,704) (10,828) -------- ------- ------- --------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $ 101,553 $ 298,713 $ 53,838 $ (252,083) $ 202,021 ========= ========== ========== ========== =========
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HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATING STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2001 (UNAUDITED) (DOLLARS IN THOUSANDS) COMBINED WHOLLY-OWNED COMBINED PARENT GUARANTOR NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED -------- ------------ ------------- ------------ ------------ REVENUES: Interest income.......................... $ 647 $ 19,477 $ -- $ (12,115) $ 8,009 Servicing income......................... -- 33,693 (29,425) -- 4,268 Gain on sale of loans: Gross gain on sale of loans............ -- 12,807 -- -- 12,807 Loan fees, net......................... -- 22,013 -- -- 22,013 ------- ---------- -------- ---------- -------- Total gain on sale of loans........ -- 34,820 -- -- 34,820 Other revenues............................... 6 1,433 -- (172) 1,267 ------- ---------- -------- ---------- -------- Total revenues..................... 653 89,423 (29,425) (12,287) 48,364 --------- ---------- -------- ---------- -------- EXPENSES: Interest . 12,744 19,980 -- (12,115) 20,609 Provision for credit losses.............. -- 9,283 -- (6,400) 2,883 Costs on REO and defaulted loans......... -- 1,419 -- -- 1,419 Fair value write-down of residual receivables -- 42,049 (31,559) -- 10,490 Salaries, wages and employee benefits.... -- 37,595 -- -- 37,595 Business development costs............... -- 9,169 -- -- 9,169 Restructuring charges.................... -- 873 -- -- 873 Other general and administrative expense. 264 18,327 -- (172) 18,419 --------- ---------- -------- ---------- --------- Total expenses..................... 13,008 138,695 (31,559) (18,687) 101,457 --------- ---------- -------- ---------- --------- Income (loss) before income taxes, minority Interest, equity in undistributed earnings (loss) of Subsidiaries, and extraordinary item ... (12,355) (49,272) 2,134 6,400 (53,093) Equity in undistributed earnings (loss) of Subsidiaries............................... (69,665) 2,132 -- 67,533 -- ---------- ---------- -------- ---------- --------- Income (loss) before income taxes, minority Interest, and extraordinary item........... (82,020) (47,140) 2,134 73,933 (53,093) Provision (benefit) for income taxes......... -- 22,524 -- -- 22,524 --------- ---------- -------- ---------- --------- Income (loss) before minority interest and Extraordinary item......................... (82,020) (69,664) 2,134 73,933 (75,617) Minority interest in earnings of subsidiaries (1) (1) (2) -- (4) --------- ---------- -------- ---------- ---------- Income (loss) before extraordinary item...... (82,021) (69,665) 2,132 73,933 (75,621) Extraordinary item-gain on extinguishment of debt, net of $0 tax ....................... 2,022 -- -- -- 2,022 --------- ---------- --------- --------- --------- Net income (loss)............................ $ (79,999) $ (69,665) $ 2,132 $ 73,933 $ (73,599) ========= ========== ========= ========= =========
83
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATING STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2000 (UNAUDITED) (DOLLARS IN THOUSANDS) COMBINED WHOLLY-OWNED COMBINED PARENT GUARANTOR NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------- ------------ ------------- ------------ ------------ REVENUES: Interest income.......................... $ 1,081 $ 14,584 $ -- $ (3,473) $ 12,192 Servicing income......................... -- 5,327 2,070 -- 7,397 Gain on sale of loans: Gross gain on sale of loans............ -- 9,801 -- -- 9,801 Loan fees, net......................... -- 16,430 -- -- 16,430 --------- ---------- -------- --------- --------- Total gain on sale of loans........ -- 26,231 -- -- 26,231 Other revenues............................... -- 1,792 -- (57) 1,735 --------- ---------- -------- --------- --------- Total revenues..................... 1,081 47,934 2,070 (3,530) 47,555 --------- ---------- -------- --------- --------- EXPENSES: Interest ................................ 4,038 18,883 -- (3,473) 19,448 Provision for credit losses.............. 719 2,440 -- -- 3,159 Costs on REO and defaulted loans......... -- 3,451 -- -- 3,451 Fair value write-down of residual receivables -- 7,850 (5,571) -- 2,279 Salaries, wages and employee benefits.... -- 29,116 -- -- 29,116 Business development costs............... -- 8,615 -- -- 8,615 Restructuring charges.................... -- 2,375 -- -- 2,375 Other general and administrative expense. 182 18,832 -- (59) 18,955 --------- ---------- -------- --------- --------- Total expenses..................... 4,939 91,562 (5,571) (3,532) 87,398 --------- ---------- -------- --------- --------- Income (loss) before income taxes, minority Interest, equity in undistributed earnings (Loss) of subsidiaries, and extraordinary item (3,858) (43,628) 7,641 2 (39,843) Equity in undistributed earnings (loss) of Subsidiaries............................... (24,833) (972) -- 25,805 -- --------- ---------- -------- --------- --------- Income (loss) before income taxes, minority Interest, and extraordinary item .......... (28,691) (44,600) 7,641 25,807 (39,843) Provision (benefit) for income taxes......... 1,700 (11,156) -- -- (9,456) --------- ---------- -------- --------- --------- Income (loss) before minority interest and Extraordinary item......................... (30,391) (33,444) 7,641 25,807 (30,387) Minority interest in earnings of subsidiaries -- 1 (4) (1) (4) --------- ---------- -------- --------- --------- Income (loss) before extraordinary item...... (30,391) (33,443) 7,637 25,806 (30,391) Extraordinary item-gain on extinguishment of debt, net of $0 tax ....................... 579 -- -- -- 579 --------- ---------- --------- --------- --------- Net income (loss)............................ $ (29,812) $ (33,443) $ 7,637 $ 25,806 $ (29,812) ========= ========== =========- =========- =========
84
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATING STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1999 (UNAUDITED) (DOLLARS IN THOUSANDS) COMBINED WHOLLY-OWNED COMBINED PARENT GUARANTOR NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------- ------------ ------------ REVENUES: Interest income.............................. $ 3,523 $ 7,996 $ -- $ (3,233) $ 8,286 Servicing income............................. -- 5,883 3,930 -- 9,813 Gain on sale of loans: Gross gain on sale of loans................ -- 6,216 -- -- 6,216 Loan fees, net............................. -- 3,313 -- -- 3,313 --------- --------- --------- --------- ------- Total gain on sale of loans........... -- 9,529 -- -- 9,529 Other revenues.................................. 8 1,774 (173) 1,609 --------- --------- --------- -------- ------- Total revenues........................ 3,531 25,182 3,930 (3,406) 29,237 --------- --------- --------- -------- ------- EXPENSES: Interest................................... 4,376 15,195 -- (3,233) 16,338 Provision for credit losses................ -- 3,339 -- -- 3,339 Costs on REO and defaulted loans........... -- 3,018 -- -- 3,018 Fair value write-down of residual receivables............................. -- 2,556 771 -- 3,327 Salaries, wages and employee benefits................................ -- 20,359 -- -- 20,359 Business development costs................. -- 4,804 -- -- 4,804 Restructuring charges...................... -- -- -- -- -- Other general and administrative expense................................. 377 12,918 1 (173) 13,123 --------- --------- -------- -------- -------- Total expenses........................ 4,753 62,189 772 (3,406) 64,308 --------- --------- -------- -------- -------- Income (loss) before income taxes, minority Interest, equity in undistributed earnings (loss) of subsidiaries, and extraordinary item......................................... (1,222) (37,007) 3,158 -- (35,071) Equity in undistributed earnings (loss) of Subsidiaries................................. (26,463) -- -- 26,463 -- --------- --------- -------- -------- -------- Income (loss) before income taxes, minority Interest, and extraordinary item............. (27,685) (37,007) 3,158 26,463 (35,071) Provision (benefit) for income taxes............ -- (7,394) -- -- (7,394) --------- --------- -------- -------- --------- Income (loss) before minority interest and Extraordinary item........................... (27,685) (29,613) 3,158 26,463 (27,677) Minority interest in earnings of Subsidiaries................................. -- (8) -- -- (8) --------- --------- -------- -------- -------- Income (loss) before extraordinary item......... (27,685) (29,621) 3,158 26,463 (27,685) Extraordinary item-gain on extinguishment of debt, net of $0 tax....................... 29,500 -- -- -- 29,500 --------- --------- -------- -------- -------- Net income (loss)............................... $ 1,815 $ (29,621) $ 3,158 $ 26,463 $ 1,815 ======= ========= ======== ======== ========
85
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATING STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31, 2001 (UNAUDITED) (DOLLARS IN THOUSANDS) COMBINED WHOLLY-OWNED COMBINED PARENT GUARANTOR NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED Operating Activities: Net income (loss)............................. $ (79,999) $ (69,665) $ 2,132 $ 73,933 $ (73,599) Extraordinary Gain on retirement of senior unsecured debt.............................. (2,022) -- -- -- (2,022) --------- ---------- ---------- --------- ---------- Income (loss) from continuing operations.......... (82,021) (69,665) 2,132 73,933 (75,621) Adjustments to reconcile net income (loss) to net Cash provided by (used in) operating activities: Equity in undistributed earnings of subsidiaries 69,665 (2,132) -- (67,533) -- Depreciation and amortization................. 2 3,895 -- -- 3,897 Fair market writedown of residual receivable. -- 10,490 -- -- 10,490 Provision (benefit) for deferred income taxes. (1,810) 23,810 -- -- 22,000 Provision for credit losses................... -- 2,883 -- -- 2,883 Provision for impairment on loans............. 6,400 -- -- (6,400) -- Provision for losses on real estate owned..... -- 638 -- -- 638 Minority interest in earnings of subsidiaries. -- (3) 3 -- -- Net decrease in deferred loan cost............ -- 479 -- -- 479 Net increase (decrease) in unearned discount and deferred loan fees.......................... -- (1,396) -- -- (1,396) Loans originated with intent to sell.......... -- (644,795) -- -- (644,795) Principal proceeds from sold loans............ -- 643,950 -- -- 643,950 Proceeds from securitization of loans......... -- 6,399 -- -- 6,399 Other ........................................ -- (2,041) -- -- (2,041) Changes in operating assets and liabilities increasing (decreasing) cash................ 853 (8,617) 3,889 (3,875) -------- ---------- ---------- --------- ---------- Net cash provided by (used in) operating activities.............................. (6,911) (36,105) 6,024 -- (36,992) Investing Activities: Loans originated for investment purposes...... 58 (6,948) -- -- (6,890) Principal collections on loans not sold....... -- 8,014 -- -- 8,014 Proceeds from sale of real estate and personal property acquired through foreclosure -- 1,440 -- -- 1,440 Proceeds from the sale of property and equipment -- 732 -- -- 732 Purchase of property and equipment............ -- (3,219) -- -- (3,219) -------- ---------- --------- --------- ----------- Net cash provided by (used in) investing activities.............................. 58 19 -- -- 77 Financing Activities: Advances on warehouse lines of credit......... -- 610,368 -- -- 610,368 Payments on warehouse lines of credit......... -- (612,386) -- -- (612,386) Retirement of senior unsecured debt........... (2,942) -- -- -- (2,942) Net increase (decrease) in notes payable to banks -- (1,664) -- -- (1,664) Net increase (decrease) in notes payable to investors ................................. -- 54,891 -- -- 54,891 Net increase (decrease) in subordinated debentures ................................ -- 11,008 -- -- 11,008 Advances (to) from subsidiary................. 9,695 (3,678) (6,017) -- -- Note receivable from shareholder.............. -- 285 -- -- 285 Proceeds from issuance of additional common stock -- 16 -- -- 16 Other ........................................ -- 7 (7) -- -- --------- --------- --------- --------- ----------- Net cash provided by (used in) financing activities.............................. 6,753 58,847 (6,024) -- 59,576 --------- --------- --------- --------- ----------- Net increase (decrease) in cash and cash equivalents............................. (100) 22,761 -- -- 22,661 Cash and Cash Equivalents, Beginning of Year...... 101 3,589 1 -- 3,691 -------- --------- --------- --------- ----------- Cash and Cash Equivalents, End of Year............ 1 26,350 1 -- 26,352 ======== ========= ========= ========= ===========
86
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATING STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31, 2000 (UNAUDITED) (DOLLARS IN THOUSANDS) COMBINED WHOLLY-OWNED COMBINED PARENT GUARANTOR NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED OPERATING ACTIVITIES: Net income (loss)............................. $ (29,812) $ (33,443) $ 7,637 $ 25,806 $ (29,812) Extraordinary Gain on retirement of senior unsecured debt .............................. (579) -- -- -- (579) --------- ---------- --------- --------- --------- Income (loss) from continuing operations.......... (30,391) (33,443) 7,637 25,806 (30,391) Adjustments to reconcile net income (loss) to net Cash provided by (used in) operating activities: Equity in undistributed earnings of subsidiaries 24,833 972 -- (25,805) -- Depreciation and amortization................. 3 4,711 -- -- 4,714 Fair market writedown of residual receivable. -- 2,279 -- -- 2,279 Benefit for deferred income taxes............. (1,700) (8,300) -- -- (10,000) Provision for credit losses................... 719 2,440 -- -- 3,159 Provision for losses on real estate owned..... -- 952 -- -- 952 Net decrease in deferred loan cost............ -- 239 -- -- 239 Net increase (decrease) in unearned discount and deferred loan fees........................... -- 1,609 -- -- 1,609 Loans originated with intent to sell.......... -- (567,421) -- -- (567,421) Principal proceeds from sold loans............ -- 508,690 -- -- 508,690 Proceeds from securitization of loans......... -- 50,554 -- -- 50,554 Other ........................................ -- 652 -- -- 652 Changes in operating assets and liabilities increasing (decreasing) cash................. 5,238 (36,467) 3,472 -- (27,757) --------- ----------- --------- --------- --------- Net cash provided by (used in) operating activities................................ (1,298) (72,533) 11,109 1 (62,721) INVESTING ACTIVITIES: Loans originated for investment purposes...... -- (345) -- -- (345) Loans purchased for investment purposes....... (1,087) (2,080) -- -- (3,167) Principal collections on loans not sold....... -- 41,266 -- -- 41,266 Purchase of REO and loans from securitization trusts....................................... -- (2,978) -- -- (2,978) Proceeds from sale of real estate and personal property acquired through foreclosure ....... -- 10,067 -- -- 10,067 Proceeds from the sale of property and equipment -- 54 -- -- 54 Purchase of property and equipment............ -- (164) -- -- (164) Other ........................................ -- 111 -- -- 111 -------- ----------- --------- --------- --------- Net cash provided by (used in) investing activities................................ (1,087) 45,931 -- -- 44,844 FINANCING ACTIVITIES: Advances on warehouse lines of credit......... -- 702,518 -- -- 702,518 Payments on warehouse lines of credit......... -- (722,618) -- -- (722,618) Retirement of senior unsecured debt........... (341) -- -- -- (341) Net increase (decrease) in notes payable to banks -- (501) (501) Net increase (decrease) in notes payable to investors -- 19,022 -- -- 19,022 Net increase (decrease) in subordinated debentures -- 1,406 -- -- 1,406 Advances (to) from subsidiary................. 2,551 8,546 (11,096) (1) -- Proceeds from issuance of additional common stock 73 -- -- -- 73 Note receivable from shareholder.............. -- (4,000) -- -- (4,000) Other ........................................ -- 13 (13) -- -- -------- ----------- --------- --------- --------- Net cash provided by (used in) financing activities................................ 2,283 4,386 (11,109) (1) (4,441) -------- ----------- --------- --------- --------- Net increase (decrease) in cash and cash equivalents............................... (102) (22,216) -- -- (22,318) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR...... 202 25,806 1 -- 26,009 -------- ----------- --------- --------- --------- CASH AND CASH EQUIVALENTS, END OF YEAR............ 100 3,590 1 -- 3,691 ======== =========== ========= ========= =========
87
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATING STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31, 1999 (UNAUDITED) (DOLLARS IN THOUSANDS) COMBINED WHOLLY-OWNED COMBINED PARENT GUARANTOR NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------ ------------ ------------ OPERATING ACTIVITIES: Net income (loss).............................. $ 1,815 $ (29,621) $ 3,158 $ 26,463 $ 1,815 Extraordinary Gain on retirement of senior unsecured debt .............................. (29,500) -- -- -- (29,500) -------- ---- ---- ---- -------- Income (loss) from continuing operations......... (27,685) (29,621) 3,158 26,463 (27,685) Adjustments to reconcile net income (loss) to net cash Provided by (used in) operating activities: Equity in undistributed earnings of subsidiaries..................................... 26,463 -- -- (26,463) -- Depreciation and amortization................ 2 2,690 -- -- 2,692 Fair market writedown of residual receivable. -- 3,327 -- -- 3,327 Benefit for deferred income taxes............ -- (7,849) -- -- (7,849) Provision for credit losses.................. -- 3,339 -- -- 3,339 Loss (gain) on real estate acquired through Foreclosure................................. -- 2,665 -- -- 2,665 Loans originated with intent to sell......... -- (244,086) -- -- (244,086) Principal proceeds from sold loans........... -- 220,410 -- -- 220,410 Proceeds from securitization of loans........ -- 59,630 -- -- 59,630 Other ....................................... -- (168) -- -- (168) Changes in operating assets and liabilities increasing (decreasing) cash ............... (1,999) 28,060 (31,120) -- (5,059) -------- ---------- ---------- -------- --------- Net cash provided by (used in) operating Activities............................... (3,219) 38,397 (27,962) -- 7,216 INVESTING ACTIVITIES: Loans originated for investment purposes....... -- (762) -- -- (762) Loans purchased for investment purposes........ -- (1,413) -- -- (1,413) Principal collections on loans not sold........ -- 19,718 -- -- 19,718 Purchase of REO and loans from securitization Trusts....................................... -- 21,530 (32,006) -- (10,476) Proceeds from sale of real estate and personal property -- 9,774 -- -- 9,774 Acquired through foreclosure................. Proceeds from the sale of property and equipment -- 235 -- -- 235 Purchase of property and equipment............. -- (532) -- -- (532) Other ......................................... -- 167 -- -- 167 --------- ---------- --------- -------- --------- Net cash provided by (used in) investing Activities............................... -- 48,717 (32,006) -- 16,711 FINANCING ACTIVITIES: Advances on warehouse lines of credit.......... -- 292,020 -- -- 292,020 Payments on warehouse lines of credit.......... -- (290,948) -- -- (290,948) Retirement of senior unsecured debt............ (45,016) -- -- -- (45,016) Net increase (decrease) in notes payable to investors ................................... -- 8,479 -- -- 8,479 Net increase (decrease) in subordinated debentures -- 405 -- -- 405 Advances (to) from subsidiary.................. 48,012 (38,006) (10,008) 2 -- Proceeds from issuance of additional common stock 229 -- 2 (2) 229 Other ......................................... -- (67,473) 67,473 -- -- --------- --------- --------- ------- --------- Net cash provided by (used in) financing Activities............................... 3,225 (95,523) 57,467 -- (34,831) --------- --------- --------- ------- --------- Net increase (decrease) in cash and cash Equivalents.............................. 6 (8,409) (2,501) -- (10,904) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR..... 196 34,215 2,502 -- 36,913 --------- --------- --------- ------- --------- CASH AND CASH EQUIVALENTS, END OF YEAR........... 202 25,806 1 -- 26,009 ========= ========= ========= ======= =========
88 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report. 89 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Documents filed as part of Report. 1. Financial Statements for Homegold Financial, Inc.: The Financial Statements are listed in the index to Consolidated Financial Statements on page 42 of this Report. 2. Financial Statement Schedules: Not applicable. 3. Exhibits: The exhibits are listed on the Exhibit Index attached hereto. (b) Reports on Form 8-K. None. 90 SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED. HOMEGOLD FINANCIAL, INC. Registrant /s/ RONALD J. SHEPPARD ---------------------------------------------- By: RONALD J. SHEPPARD CHIEF EXECUTIVE OFFICER Date: April 15, 2002 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. SIGNATURE TITLE Director ---------------------------------- J. ROBERT PHILPOTT, JR. /s/ RONALD J. SHEPPARD Chief Executive Officer ---------------------------------- RONALD J. SHEPPARD /s/ JOHN M. STERLING, JR. Chairman of the Board of ---------------------------------- Directors JOHN M. STERLING, JR. /s/ FORREST E. FERRELL President ---------------------------------- FORREST E. FERRELL Director ---------------------------------- TECUMSEH HOOPER, JR. /s/ TOBE C.B. CHILDERS Director ---------------------------------- TOBE C.B. CHILDERS /s/ KEVIN G. MARTIN Chief Financial Officer ---------------------------------- KEVIN G. MARTIN /s/ PAUL BANNINGER Director ---------------------------------- PAUL BANNINGER 91 EXHIBIT INDEX 2.1.1 Reorganization Agreement dated February 29, 2000 by and between HomeGold Financial, Inc. and HomeSense Financial Corp. and its Affiliated Companies set forth on Schedule 3.5 thereto: Incorporated by Reference to the Company's Definitive Proxy Statement filed on March 21, 2000 for the 2000 Annual Meeting of the Company's shareholders held on April 28, 2000, Commission File No. 000-08909 (Exhibit C). 2.1.2 Amendment No. 1 to Reorganization Agreement dated March 10, 2000: Incorporated by Reference to the Company's Definitive Proxy Statement filed on March 21, 2000 for the 2000 Annual Meeting of the Company's shareholders held on April 28, 2000, Commission File No. 000-08909 (Exhibit C). 2.1.3 Amendment No. 2 to Reorganization Agreement dated May 1, 2000: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 2.1). 2.1.4 Amendment No. 3 to Reorganization Agreement dated May 9, 2000: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 2.2). 3.1.1 Restated Articles of Incorporation as filed with the South Carolina Secretary of State on June 6, 1997: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 1998 for the quarter ended March 31, 1998, Commission File No. 000-08909 (Exhibit 3.1). 3.1.2 Articles of Amendment as filed with the South Carolina Secretary of State on June 24, 1998: Incorporated by Reference to the Company's Current Report on Form 8-K filed on July 7, 1998, Commission File No. 000-08909 (Exhibit 3.1). 3.1.3 Resignation of Registered Agent and Notice of Change of Registered Agent as filed with the South Carolina Secretary of State on July 15, 1998: Incorporated by reference to the Company's Annual Report on Form 10-K filed on March 2, 2000 for the year ended December 31, 1999, Commission File No. 000-08909 (Exhibit 3.1.3). 3.1.4 Articles of Amendment filed with the South Carolina Secretary of State on May 9, 2000 (i) reducing par value of common stock from $0.05 per share to $0.001 per share, (ii) eliminating cumulative voting with respect to election of directors and (iii) authorizing issuance of up to 20,000,000 shares of "blank check" preferred stock: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 3.1.1). 3.1.5 Articles of Amendment filed with the South Carolina Secretary of State on May 9, 2000 containing Certificate of Designation of Series A Non-convertible Preferred Stock of the Company: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 3.1.2). 3.2 Amended and Restated Bylaws dated March 12, 1997: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 1998 for the quarter ended March 31, 1998, Commission File No. 000-08909 (Exhibit 3.2). 4.1.1 Indenture Dated as of September 23, 1997 among Emergent Group, Inc. (n/k/a HomeGold Financial, Inc., the Company), the Subsidiary Guarantors Named Therein and Bankers Trust Company, as Trustee pertaining to the Company's 10.75% Senior Notes due 2004: Incorporated by Reference to the Company's Registration Statement on Form S-4 filed on November 13, 1997, Commission File No. 333-39339 (Exhibit 4.1). 4.1.2 Supplemental Indenture adding Emergent Insurance Agency, Inc. as Subsidiary Guarantor dated November 3, 1997: Incorporated by reference to the Company's Annual Report on Form 10-K filed on March 2, 2000 for the year ended December 31, 1999, Commission File No. 000-08909 (Exhibit 4.1.2). 4.1.3 Officers' Certificate and Opinion of Counsel dated March 18, 1998, and Notice to Trustee dated March 30, 1998, for release from Guarantees of The Loan Pro$, Inc. and Premier Financial Services, Inc.: Incorporated by reference to the Company's Annual Report on Form 10-K filed on March 2, 2000 for the year ended December 31, 1999, Commission File No. 000-08909 (Exhibit 4.1.3). 4.1.4 Officers' Certificate, Opinion of Counsel dated August 21, 1998, and Notice to Trustee dated September 10, 1998, for release from Guarantees of Sterling Lending Corporation and Sterling Lending Insurance Agency: Incorporated by reference to the Company's Annual Report on Form 10-K filed on March 2, 2000 for the year ended December 31, 1999, Commission File No. 000-08909 (Exhibit 4.1.4). 4.1.5 Supplemental Indenture #1, dated as of August 19, 1998: Incorporated by reference to the Company's Annual Report on Form 10-K filed on March 2, 2000 for the year ended December 31, 1999, Commission File No. 000-08909 (Exhibit 4.1.5). 4.1.6 Officers' Certificate, Opinion of Counsel and Notice to Trustee dated November 13, 1998, for release from Guarantees of Emergent Business Capital, Inc., Emergent Business Capital Equity Group, Inc.(f/k/a/ Emergent Equity Advisors, Inc.) and Emergent Commercial Mortgage, Inc.: Incorporated by reference to the Company's Annual Report on Form 10-K filed on March 2, 2000 for the year ended December 31, 1999, Commission File No. 000-08909 (Exhibit 4.1.6). 4.1.7 Supplemental Indenture #2, effective as of November 14, 2001 deleting certain covenants, events of default and definitions. 4.2 Registration Rights Agreement dated May 9, 2000 between the Company and the individuals listed on Schedule 1 thereto: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.10). 4.3 Form of Stock Restriction Agreement and schedule of parties thereto: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.11). See exhibits 3.1.1 through 3.2 above. 4.4 Shareholder Rights Agreement dated January 29,2002 by and between the Company and First Union National Bank as Rights Agent: Incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K filed on January 29, 2002, Commission File No. 000-08909. 10.1 HomeGold Financial, Inc. Stock Option Plan: Incorporated by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-1, Commission File No. 333-01393. 10.2 1995 Officer and Employee Stock Option Plan: Incorporated by reference to Exhibit 10.1 of the Company's 1995 Notice of Annual Meeting and Proxy Statement, Commission File No. 000-08909. 10.2.1 Amendment No. 1 to the 1995 Employee and Officer Stock Option Plan, dated May 27, 1997: Incorporated by reference to the Company's Registration Statement on Form S-8 filed with the Commission on July 10, 1998, Commission File No. 333-58861. 10.2.2 Amendment No. 2 to the 1995 Employee and Officer Stock Option Plan, dated June 10, 1998: Incorporated by reference to the Company's Registration Statement on Form S-8 filed with the Commission on July 10, 1998, Commission File No. 333-58861. 10.2.3 Amendment No. 3 to the 1995 Employee and Officer Stock Option Plan, dated June 10, 1999 Incorporated by reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.2.1). 10.2.4 Amendment No. 4 to the 1995 Employee and Officer Stock Option Plan, dated April 28, 2000: Incorporated by reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.2.2). 10.3 1995 Director Stock Option Plan: Incorporated by reference to an exhibit filed with the Company's 1995 Notice of Annual Meeting and Proxy Statement. 10.4 1995 Restricted Stock Agreement Plan: Incorporated by reference to Exhibit 10.4 of the Company's Registration Statement on Form S-1, Commission File No. 333-01393. 10.5.1 HomeGold Financial, Inc. Employee Stock Purchase Plan: Incorporated by reference to Exhibit 99.1 of the Company's registration statement on Form S-8, Commission File No. 333-20179. 10.5.2 Amendment No. 1 to the Employee Stock Purchase Plan, dated April 28, 2000: Incorporated by reference to the Company's Definitive Proxy Statement file on March 21, 2000 for the 2000 Annual Meeting of the Company's shareholders held on April 28, 2000, Commission File No. 000-08909. 10.6.1 Severance Agreement dated April 28, 2000 between the Company and Keith B. Giddens: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.5). 10.6.2 Severance Agreement dated May 12, 2000 between the Company and John W. Crisler: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.6). 10.6.3 Form of Severance Agreement between the Company and employees listed in the schedule therewith: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.7). 10.7 Employment Agreement dated May 9, 2000 between the Company and Ronald J. Sheppard: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.8). 10.8.1 Mutual Indemnity Agreement dated May 9, 2000 between Ronald J. Sheppard and the Company: Incorporated by reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.9). 10.8.2 Agreement dated January 30, 2001, by and between HomeGold Financial, Inc. and Ronald J. Sheppard: Incorporated by reference to the Company's Annual Report on Form 10-K filed on April 17, 2001, Commission File No. 000-08909. 10.9.1 Amended and Restated $40,000,000 Warehousing Line of Revolving Credit Agreement by and between HomeGold, Inc. and Household Commercial Financial Services, Inc. dated as of June 11, 2001: Incorporated by reference to the Company's Quarterly Report on Form 10-Q filed on August 14, 2001 for the quarter ended June 30, 2001, Commission File No. 000-08909 (Exhibit 10.16.10). 10.9.2 Consent and Reaffirmation Agreement dated June 11, 2001 relating thereto of Carolina Investors, Inc. and HomeGold Financial, Inc. 10.9.3 Security Agreement dated May 2, 2000 of HomeGold, Inc., the other entities listed on the signature pages thereto and Household Commercial Financial Services, Inc.: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.4.2). 10.9.4 Guaranty dated May 2, 2000 of HomeGold Financial, Inc. and certain of its subsidiaries: Incorporated by Reference to the Company's Quarterly Report on Form 10-Q filed on May 15, 2000 for the quarter ended March 31, 2000, Commission File No. 000-08909 (Exhibit 10.4.3). 10.9.5 Amended and Restated Forbearance Agreement between HomeGold, Inc. and Household Commercial Financial Services, Inc. dated November 30, 2001. 10.9.6 Mortgage and Security Agreement between Carolina Investors, Inc. and Household Commercial Financial Services, Inc. dated April 19, 2001. 10.10.1 Amended and Restated Warehouse Loan and Security Agreement between HomeGold, Inc. and The Provident Bank. 10.10.2 Servicing Agreement by and between The Provident Bank and HomeGold Financial, Inc. dated October 25, 2000: Incorporated by reference to the Company's Annual Report on Form 10-K filed on April 17, 2001, Commission File No. 000-08909 10.10.3 Mortgage of Real Estate from HomeGold, Inc. to the Provident Bank dated September 28, 2001. 10.11 Master Repurchase Agreement between Impac Warehouse Lending Group and HomeGold, Inc. dated July 6, 2001. 10.12.1 Assumption of Debt and Contribution to Capital Agreement effective December 31, 2000 by and between HomeGold Financial, Inc., HomeGold, Inc. and Carolina Investors, Inc.: Incorporated by reference to the Company's Annual Report on Form 10-K filed on April 17, 2001, Commission File No. 000-08909 10.12.2 Amended and Restated Revolving Promissory Note dated March 26, 2002 effective December 31, 2001, in principal amount of up to $175,000,000 by HomeGold Financial, Inc. to Carolina Investors, Inc. 10.12.3 Guaranty and Security Agreement effective December 31, 2000 by and between HomeGold, Inc. and Carolina Investors, Inc.: Incorporated by reference to the Company's Annual Report on Form 10-K filed on April 17, 2001, Commission File No. 000-08909 10.12.4 Secured Revolving Promissory Note dated January 2, 2001, in principal amount of up to $75,000,000 by HomeGold, Inc. to Carolina Investors, Inc.: Incorporated by reference to the Company's Annual Report on Form 10-K filed on April 17, 2001, Commission File No. 000-08909 10.12.5 Assumption of Debt and Contribution to Capital Agreement effective December 31, 2001 by and between HomeGold Financial, Inc., HomeGold, Inc. and Carolina Investors, Inc. 10.13 See exhibits 2.1.1 through 4.3 above. 21.0 Listing of subsidiaries. 23.1 Consent of Elliott Davis, LLC to include Report of Independent Auditors for the three years ended December 21, 2001.