10QSB 1 a4291753.txt HARBOURTON FINANCIAL CORPORATION U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-QSB -- QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002 TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ TO __________ Commission File Number 0-17832 Harbourton Financial Corporation --------------------------------------- (Exact name of small business issuer as specified in its charter) Delaware 54-1208450 ------------------ ---------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 8180 Greensboro Drive, McLean, VA 22102 --------------------------------- --------- (Address of principal executive offices) (Zip Code) (703) 883-9757 ----------------------------- (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No --- The number of shares outstanding of the issuer's common stock, $.01 par value, as of November 13, 2002, was 15,184,164 Transitional Small Business Disclosure Format Yes No x ---- -----
Harbourton Financial Corporation Form 10-QSB Page Index Number Part I Item 1. Financial Statements (unaudited) Condensed Consolidated Balance Sheets (unaudited) 3 Condensed Consolidated Statements of Operations (unaudited) 4 Condensed Consolidated Statements of Comprehensive Income (unaudited) 5 Condensed Consolidated Statements of Shareholders' Equity (unaudited) 6 Condensed Consolidated Statements of Cash Flows (unaudited) 7 Notes to Condensed Consolidated Financial Statements 8 Segment Reporting 11 Item 2. Management's Discussion and Analysis 13 Item 3. Disclosure Controls and Procedures 20 Part II Other Information 21 Item 1. Legal Proceedings. 21 Item 2. Changes in Securities and Use of Proceeds 21 Item 3. Defaults Upon Senior Securities 21 Item 4. Submission of Matters to a Vote of Security Holders 21 Item 5. Other Information. 21 Item 6. Exhibits and Reports on Form 8-K. 21 Signatures 22 Certifications 23
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Harbourton Financial Corporation and Subsidiaries Condensed Consolidated Balance Sheets (unaudited) September 30, 2002 December 31, 2001 --------------------------------------------------------------------------------------------------------- Assets: Cash and cash equivalents $1,302,198 $1,199,924 Loans receivable, net 16,752,823 13,426,318 Purchased receivables, net 1,441,732 1,518,454 Investment in real estate 8,478,901 - Deferred income taxes, net 3,269,034 3,151,157 HMIC deferred state income tax 85,473 - Furniture, fixtures and equipment, net 191,358 191,277 Other assets 389,796 167,740 -------------------------------------------------- Total assets $31,911,315 $19,654,870 ================================================== Liabilities and shareholders' equity: Liabilities: Notes payable $12,763,880 $1,725,000 Convertible subordinated notes 266,000 266,000 Accounts payable and accrued expenses 494,419 448,236 Income taxes payable - 5,622 -------------------------------------------------- Total liabilities 13,524,299 2,444,858 -------------------------------------------------- Shareholders' equity: Preferred stock, no par value, authorized 2,000,000 shares, no shares issued or outstanding - - Common stock, $.01 par value, authorized 20,000,000 shares; 15,184,164 issued and outstanding 151,841 151,841 Additional paid-in-capital 24,612,674 24,612,674 Accumulated deficit (6,377,499) (7,550,519) Accumulated other comprehensive loss- unrealized loss on investment securities - (3,984) -------------------------------------------------- Total shareholders' equity 18,387,016 17,210,012 -------------------------------------------------- Total liabilities and shareholders' equity $31,911,315 $19,654,870 ================================================== See Notes to Condensed Consolidated Financial Statements
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Harbourton Financial Corporation and Subsidiaries Condensed Consolidated Statements of Operations (unaudited) Three Months Nine Months Ended September 30, Ended September 30, 2002 2001 2002 2001 ------------------------------------------------------------------------------------------------------------------ Revenue ------- Interest, discounts, and loan fees $970,801 $701,952 $2,309,964 $1,784,761 Interest expense (141,456) (49,257) (307,407) (101,930) ------------------------------------------------------------ Net interest income before provision for loan losses 829,345 652,695 2,002,557 1,682,831 Provision for loan losses (43,900) - (91,100) - ------------------------------------------------------------ Net interest income 785,445 652,695 1,911,457 1,682,831 Fees and other income 363,547 199,760 1,107,999 841,642 Profit participations 68,699 81,817 167,394 178,995 Gain on sale of loans 689,449 - 1,053,333 - Other income 2,766 151,264 8,612 401,014 ------------------------------------------------------------ Total net revenues 1,909,906 1,085,536 4,248,795 3,104,482 ------------------------------------------------------------ Expenses ---------- Compensation 953,147 291,775 2,259,316 897,903 General and administrative 282,079 101,633 737,976 279,805 Professional fees 85,825 151,948 223,999 261,248 Depreciation 18,009 9,984 63,455 30,024 ------------------------------------------------------------ Total expenses 1,339,060 555,340 3,284,746 1,468,980 Income before income taxes 570,846 530,196 964,049 1,635,502 Income tax benefit (31,198) (15,000) (208,972) (78,484) ------------------------------------------------------------ Net income $602,044 $545,196 $1,173,021 $1,713,986 ============================================================ Income per common share $.04 $.04 $.08 $.11 ============================================================ Weighted average shares outstanding 15,184,164 15,184,164 15,184,164 15,184,164 ============================================================ See Notes to Condensed Consolidated Financial Statements
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Harbourton Corporation and Subsidiaries Condensed Consolidated Statements of Comprehensive Income (unaudited) Three Months Nine Months Ended September 30, Ended September 30, 2002 2001 2002 2001 -------------------------------------------------------------------------------------------- Net income $602,044 $545,196 $1,173,021 $1,713,986 Other comprehensive income: Unrealized loss on securities available for sale - (788) - (59,921) ------------------------------------------------------------ Comprehensive income $602,044 $544,408 $1,173,021 $1,654,065 ============================================================ See Notes to Condensed Consolidated Financial Statements
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Harbourton Financial Corporation and Subsidiaries Condensed Consolidated Statements of Shareholders' Equity (unaudited) Retained Accumulated Additional Earnings Other Common Paid-in- (Accumulated Comprehensive Stock Capital Deficit) Income Total ------------------------------------------------------------------------------------------------------------------------ Balance-December 31, 2000 $151,841 $24,612,674 ($9,704,848) $56,000 $15,115,667 Unrealized loss on investment securities - - - (59,921) (59,921) Net income - - 1,713,986 - 1,713,986 ------------------------------------------------------------------------------- Balance- September 30, 2001 151,841 24,612,674 (7,990,862) (3,921) 16,769,732 Unrealized loss on investment securities - - - (63) (63) Net income - - 440,342 - 440,342 ------------------------------------------------------------------------------- Balance - December 31, 2001 151,841 24,612,674 (7,550,520) (3,984) 17,210,011 Permanent impairment of securities - - - 3,984 3,984 Net income - - 1,173,021 - - 1,173,021 ------------------------------------------------------------------------------- Balance - September 30, 2002 $151,841 $24,612,674 $(6,377,499) $ - $18,387,016 ===============================================================================
See Notes to Condensed Consolidated Financial Statements 6
Harbourton Financial Corporation and Subsidiaries Condensed Consolidated Statements of Cash Flows (unaudited) Nine months ended September 30 2002 2001 ------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $1,173,021 $1,713,986 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 63,455 30,024 Reduction of deferred tax valuation allowance (7,549) (67,941) Provision for loan losses 91,100 - Loans originated for sale (42,563,661) - Loans Sold 36,591,857 Permanent impairment of securities 3,984 - Increase in warehouse line of credit 6,221,361 - Changes in operating assets and liabilities: Other receivables (136,599) (25,334) Accounts payable and accrued expenses (44,912) (347,319) HMIC deferred state income tax (85,473) - Deferred income taxes (117,877) (78,484) ---------------------------------------------------- Net cash provided by operating activities 1,188,707 1,224,932 ---------------------------------------------------- Cash flows from investing activities: Originations of receivables, net (5,845,875) (1,326,191) Recoveries of charged off assets, net 5,460 - Purchase of furniture, fixtures and equipment (63,537) (4,886) ---------------------------------------------------- Net cash used in investing activities (5,903,952) (1,331,077) ---------------------------------------------------- Cash flows from financing activities: Proceeds from notes payable, net 4,817,519 260,000 ---------------------------------------------------- Net cash provided by financing activities 4,817,519 260,000 ---------------------------------------------------- Net increase in cash 102,274 153,855 Cash, beginning of period 1,199,924 447,184 ---------------------------------------------------- Cash, end of period $1,302,198 $601,039 ==================================================== Supplemental disclosure of cash flow information: Cash paid for interest $307,407 $109,419 ---------------------------------------------------- Unrealized loss on securities available for sale - $(59,921) ---------------------------------------------------- Assignment to real estate from previously impaired loan: Investment in real estate $8,478,901 - ---------------------------------------------------- Non-recourse bank loan $5,573,556 - ---------------------------------------------------- See Notes to Consolidated Financial Statements
7 Harbourton Financial Corporation and Subsidiaries Notes to Condensed Consolidated Financial Statements General. The consolidated financial statements of Harbourton Financial Corporation (f/k/a Allstate Financial Corporation, prior to its name change on May 1, 2001) and subsidiaries ("Harbourton" or the "Company") included herein are unaudited for the periods ended September 30, 2002 and 2001; however, they reflect all adjustments (consisting only of normal recurring accruals) which, in the opinion of management, are necessary to present fairly the results for the periods presented. The December 31, 2001 balance sheet has been derived from audited financial information. Harbourton Mortgage Investment Corporation ("HMIC"), a wholly owned subsidiary of Harbourton, began mortgage operations on January 2, 2002. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The Company belie ves that the disclosures are adequate to make the information presented not misleading. The results of operations for the three and nine months ended September 30, 2002 are not necessarily indicative of the results of operations to be expected for the remainder of the year. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in Harbourton Financial Corporation's Annual Report on Form 10-KSB for the year ended December 31, 2001. Receivables: At September 30, 2002 and December 31, 2001, loans receivable, net, comprises the following:
Loans receivable, net September 30, 2002 December 31, 2001 ----------------------------------------------------------------------------------- Loans receivable, gross $22,782,291 $51,824,734 Loans held for sale, gross 5,971,803 - Portion sold to participants (10,265,972) (36,577,307) Deferred interest and fees (1,103,557) (1,192,984) Amount allocated from purchase of minority interest - (7,549) Allowance for loan losses (631,742) (620,576) -------------------------------------------- Loans receivable, net $16,752,823 $13,426,318 ============================================
At September 30, 2002 and December 31, 2001, purchased receivables, net, is as follows:
Purchased receivables, net September 30, 2002 December 31, 2001 ----------------------------------------------------------------------------------- Life insurance policies $2,642,462 $2,814,868 Valuation allowance (1,240,876) (1,336,560) -------------------------------------------- Life insurance policies, net 1,401,586 1,478,308 Litigation claims, net 40,146 40,146 -------------------------------------------- Purchased receivables, net $1,441,732 $1,518,454 ============================================
Activity in the allowance for loan losses accounts for the three and nine months ending September 30, 2002 was as follows:
Allowance for Loan Losses Three Months Ended Nine Months Ended September 30, September 30, 2002 2001 2002 2001 -------------------------------------------------------------------------------------------- Beginning Balance $586,762 $618,526 $620,576 $540,227 Provision for loan losses 43,900 - 91,100 - Charge-offs - - (85,394) (19,182) Recoveries 1,080 1,189 5,460 98,670 --------------------------------------------------------------- Ending Balance $631,742 $619,715 $631,742 $619,715 ===============================================================
Impaired loans are measured based on the present value of expected future cash flows discounted at a rate determined by management, or, as a practical expedient, the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Changes in the present value of impaired loans are recognized as bad debt expense in the same manner in which impairment was initially recognized or as a reduction in the amount of bad-debt expense that otherwise would be reported. Information regarding impaired loans at September 30, 2002 and December 31, 2001 is as follows:
Impaired Loans September 30, 2002 December 31, 2001 ---------------------------------------------------------------------------------------- Number of impaired loans 1 - 1 Total recorded investment in impaired loans, net of deferred income 1 - $2,194,723 Recorded investment in impaired loans for which there is a related allowance - $2,194,723 Related allowance for impaired loans - $620,576
1 During the quarter ended September 30, 2002, one impaired loan with a net balance of $825,380 was transferred to investment in real estate. Credit Concentrations. For the nine months ended September 30, 2002, the total revenue from the three largest borrowers, each of which accounted for 10% or more of the Company's total revenues (net of non-recurring items), was 65.6% of the Company's total revenues, compared to revenues from two borrowers, each accounting for over 10% of the Company's total revenue, representing 42.1% of the total in the same period in 2001. At September 30, 2002, the total loan balances of the two largest borrowers, each accounting for more than 10% of the Company's outstanding loan balance net of deferred income and participations sold, accounted for 29.7% of the Company's total receivables, while at December 31, 2001, four such borrowers accounted for 47.7%. 9 Investment in Real Estate: The addition to investment in real estate of $8.5 million resulted from the assignment of ownership for two of our previously impaired loans. The Company recorded this investment on a gross basis, which includes $5.6 million of senior bank debt that is non-recourse to Harbourton, with the remainder representing our equity in the projects. At September 30, 2002 and December 31, 2001, investment in real estate, net, comprises the following:
Investment in Real Estate September 30, 2002 December 31, 2001 ------------------------------------------------------------------------------------------------ Investment in real estate $8,478,901 $- Less: Non recourse senior debt1 (5,573,556) - ----------------------------------------------------- Total net investment in real estate $2,905,345 $- =====================================================
1 Represents senior debt from a non-affiliated entity, without recourse to the Company. Stock Options. The Company maintains one stock option plan, the 2000 Stock Option Plan ("2000 Plan"), under which either qualified or non-qualified options may be issued. The Company continues to account for stock options under APB No. 25, "Accounting for Stock Issued to Employees", and provides the additional disclosures as required by SFAS No. 123, "Accounting for Stock Based Compensation". As of September 30, 2002, the Company reserved 1,200,000 shares of authorized but unissued shares of common stock for issuance under its 2000 Plan. During the nine months ended September 30, 2002, a total of 45,000 non-qualified stock options were issued to three non-employee directors under the 2000 Stock Option Plan. The options were granted with an initial strike price equal to $1.13, which equated to the book value of the Company on December 31, 2001. This amount exceeded the market value of the common shares throughout the nine-month period ended September 30, 2002. The options have a strike price that increases by 5% per annum, beginning March 31, 2003, have a term of seven years (expiring March 31, 2009), and all options vested immediately upon issuance. On May 2, 2001, senior executives of the Company were granted 400,000 stock options. The exercise price of these options was $1.00 per share through December 31, 2001 and thereafter increasing by 5% per annum. The options vest by December 31, 2003 and expire on December 31, 2008. The table below summarizes the option activity for the 2000 Plan for the nine months ended September 30, 2002:
Stock Options Weighted Option Number of Options Price Per Share -------------------------------------------------------------------------------------- Outstanding at January 1, 2002 400,000 $1.00 Granted 45,000 $1.13 -------------------------------------------------- Outstanding at September 30, 2002 445,000 $1.01 ================================================== Exercisable at September 30, 2002 245,000 $1.02 ==================================================
10 Income Taxes. The Company adjusts the valuation allowance for the deferred tax asset based on the projected profitability of the Company. In November of 2000, the Company acquired Harbourton Financial Corp., which had demonstrated profitable operations. At that time, the Company determined that a portion of the valuation allowance for the deferred tax asset was not required because of projected future profitability. The Company reviews its valuation allowance and projected future profitability on a periodic basis and records appropriate adjustments to the allowance. Adjustments were made to the valuation allowance in the three-month periods ended September 30, 2002 and 2001 as set forth below. The Company's net operating loss ("NOL") at December 31, 2001 amounted to $19,389,268. The Company's use of the NOL's prior to the expirations of their carry forward periods may be limited by the provisions of Section 382 of the Internal Revenue Code of 1986 ("the Code"), if it is determined that the Company h as undergone a change of ownership, as defined by the section. The Company's Certificate of Incorporation contains a provision whereby the transfer of any of the Company's corporate securities to any person, entity or group who directly or indirectly owns, or would own after giving effect to the proposed transfer, more than 4.9% of the outstanding shares of any class of the Company's corporate securities will be void, unless the transfer receives the prior approval of at least two-thirds of the Board of Directors of the Company. The purpose of this provision is to minimize the likelihood of an inadvertent change of ownership of the Company. Activity in the net deferred income taxes account for the three months ended September 30, 2002 and 2001 and the nine months ended September 30, 2002 was as follows:
Deferred Income Taxes Three months ended Nine months ended September 30, September 30, 2002 2001 2002 --------------------------------------------------------------------------------------- Beginning Balance $3,248,293 $3,126,714 $3,151,157 Reduction in valuation allowance (20,741) (78,484) (117,877) -------------------------------------------------------- Ending Balance $3,269,034 $3,205,198 $3,269,034 ========================================================
Segment Reporting Reportable segments include the mezzanine/first trust lending and the mortgage banking activities. The following information presents results as if the mezzanine/first trust lending and mortgage banking segments were operated on a stand alone basis; however, the results do not reflect a full allocation of costs based on the current management structure of the entities and thus the results may not be comparable to like information from other companies. 11 The following summary financial data provides information for the Company's principal segments for the three and nine-month periods ended September 30, 2002.
Mezzanine / First Harbourton Trust Lending Mortgage Banking Segment Eliminations Financial Corporation ------------------------------------------------------------------------------------------------------------------------ Three months ended September 30, 2002 ------------------------------------------------------------------------------------------------------ Net interest income $788 $(3) $- $785 Fees and other income 435 - - 435 Gain on sale of loans - 690 - 690 -------------------------------------------------------------------------------- Total net revenues 1,223 687 - 1,910 Total non interest expense 562 777 - 1,339 Income tax expense (benefit) (22) (38) 29 (31) -------------------------------------------------------------------------------- Net income (loss) $683 $(52) ($ 29) $602 ================================================================================ Nine months ended September 30, 2002 ------------------------------------------------------------------------------------------------------------------------ Net interest income $1,882 $29 $- $1,911 Fees and other income 1,282 3 - 1,285 Gain on sale of loans - 1,053 - 1,053 -------------------------------------------------------------------------------- Total net revenues 3,164 1,085 - 4,249 Total non interest expense 1,350 1,935 - 3,285 Income tax benefit (benefit) (118) (348) 257 (209) -------------------------------------------------------------------------------- Net income (loss) $1,932 ($ 502) ($ 257) $1,173 ================================================================================
12 Item 2. Management's Discussion and Analysis This Form 10-QSB may contain certain "forward-looking statements" relating to the Company (defined in the notes to the financial statements above, and also referred to herein as "we," "our," or "us") that represent our current expectations or beliefs, including, but not limited to, statements concerning our operations, performance, financial condition and growth. For this purpose, any statements contained in this Form 10-QSB that are not statements of historical fact may be deemed forward-looking statements. Without limiting the generality of the foregoing, words such as "may", "will", "expect", "believe", "anticipate", "intend", "could", "estimate", or "continue", or the negatives or other variations thereof, or comparable terminology are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainties, such as credit losses, dependence on management and key personnel, seasonality and variability of quarterly results, our ability to continue ou r growth strategy, competition, and regulatory restrictions relating to potential new activities, certain of which are beyond our control. Should one or more of these risks or uncertainties materialize or should the underlying assumptions prove incorrect, actual outcomes and results could differ materially from those indicated in the forward-looking statements. General Description. Harbourton Financial Corporation, f/k/a Allstate Financial Corporation, was formed in 1982 as a Virginia corporation. On August 28, 2000, we changed our state of incorporation to Delaware and, on November 30, 2000, acquired Harbourton Financial Corp. ("Old Harbourton") by merger. On May 1, 2001, the name of the company was changed to Harbourton Financial Corporation to better reflect our business plan, which is to provide financing to the residential building and development community, through products that were previously offered by Old Harbourton. On October 5, 2001, Harbourton Mortgage Investment Corporation ("HMIC") was incorporated as a wholly owned subsidiary to purchase and originate both conforming and non-conforming mortgage loans and to subsequently sell these loans to investors in the secondary mortgage market. HMIC began mortgage operations on January 2, 2002 and is expected to operate nationwide. At September 30, 2002, HMIC was licensed to operate in 11 states. HMIC acts as a loan broker and sells all of its production in the secondary market. All loans are sold on a servicing released basis and thus, all gains on sale of loans are represented by cash proceeds from the sales. Gains on sales of mortgage loans are recognized on the date of sale based on the difference between the selling price of the loans and the carrying value of the loans sold. Related loan fees and direct costs associated with the origination of loans are deferred and income is recognized at the time the loans are sold. Liquidity and Capital Resources. Our requirement for capital is a function of the level of our generation of and investment in receivables. We fund our investment in receivables through loan participations, shareholders' equity, bank lines of credit, convertible subordinated notes, and internally generated funds. HMIC funds its mortgage banking operations through a warehouse line of credit and from equity contributed by Harbourton. Harbourton has and will provide additional equity to HMIC until it has established stabilized profitable operations. The Company sells participation interests in its loans in a structure designed to provide credit enhancement to participants as well as incentives for the Company to efficiently service and administer loans. The Company retains an interest in each loan, with repayment on a pro rata basis with the participant. Since the interest retained by the Company may become subordinate to that of the participant under certain circumstances of default, the Company assumes the risk of potential credit losses up to a maximum amount of the Company's retained interest in the loan. Each transaction is treated as an individual loan with no cross collateralization and no blanket subordination. Loan to value to the participant will range from 50% to 70% after giving consideration to the Company's subordinated interest. This structure provides the participant with an investment with reduced risk, and without the cost of origination and servicing. All loans and subsequent participations are structured to meet the requirements of applicable law and regulatory guidelines. The Company currently has participations with four sources including banks and a major non-bank financial services company. The Company may seek to establish relationships with new participants or increase the level of existing agreements. 13 On March 21, 2002, our bank approved an increase in Harbourton's secured line of credit from $3.0 million to $4.5 million, and an extension of the maturity to December 31, 2002. On September 30, 2002, there was $3.5 million available to the Company under its line of credit. HMIC has a $12.0 million warehouse line of credit available to originate mortgage loans, which is secured by the loans closed under the line, by the assets of HMIC and a loan guaranty by Harbourton. Effective October 28, 2002 HMIC's line of credit was increased to $25 million. When HMIC purchases or originates a new loan, approximately 94% to 97% of the loan amount is funded through the line of credit and the remainder from internal funds. When the loan is sold, the lender for the line of credit is repaid and HMIC receives the residual cash flow. On September 30, 2002, there was $6.2 million outstanding under the warehouse line of credit. Harbourton and HMIC were not in violation of any covenants of their respective lines of credit at September 30, 2002. Financial condition at September 30, 2002 and December 31, 2001. The financial results for HMIC, which started mortgage operations on January 2, 2002, are included in the consolidated results for the three-month and nine-months ending September 30, 2002. Total assets were $31.9 million at September 30, 2002 compared to $19.7 million at December 31, 2001. Total assets increased primarily due to the increase in the portfolio of loans held for sale by HMIC and the addition to investment in real estate of $8.5 million, resulting from the assignment of ownership for two of our previously impaired loans, by the borrowers on the loans. The Company recorded this investment on a gross basis, which includes $5.6 million of senior bank debt that is non-recourse to Harbourton, with the remainder representing our equity in the project. Our total loans receivable before the sale of participations ("Managed Loan Portfolio") was $22.8 million at September 30, 2002 and $51.8 million at December 31, 2001. The decrease reflects a reduction in the construction and mezzanine loans outstandi ng in which we have sold participations, the transfer of two loans (with a "net" balance of $2.9 million at September 30, 2002) to investment in real estate, offset by the increase in HMIC's portfolio of loans held for sale of $6.0 million. Participations sold as of September 30, 2002 and December 31, 2001 were $10.3 million and $36.6 million. Purchased receivables decreased by $77 thousand due to the collection of a receivable associated with one of the life insurance policies in our portfolio. We increased the balance of our deferred tax asset by $21 thousand in the third quarter of 2002, as a result of a reduction in the valuation allowance applied to the asset, which reflected our assessment of the Company's future earnings capacity. Other assets increased to $389 thousand from $168 thousand, primarily due to accrued profit and commitment fees. 14 The following table indicates the composition of our portfolio, net of deferred income, participations sold and allowance for losses, by loans receivable and purchased receivables, as of September 30, 2002 and December 31, 2001 (dollars in thousands and as a percentage of the total portfolio).
Composition of Receivable Portfolio September 30, 2002 December 31, 2001 Amount % of total Amount %f total -------------------------------------------------------------------------------------- Loans receivable $10,872 59.8% $13,426 90.3% Loans held for sale 5,881 32.3% - - Purchased receivables 1,442 7.9% 1,518 9.7% ----------------------------------------------- Total portfolio $18,195 100.0% $14,944 100.0% ===============================================
The following table indicates the composition of our retained loan portfolio, net of allowance for losses and deferred income, by loan product, as of September 30, 2002 and December 31, 2001 (dollars in thousands and as a percentage of the total portfolio).
Loans Receivable, Net of Deferred Income, by Loan Product -------------------------------------------------------------------------------------- September 30, 2002 December 31, 2001 Amount % of total Amount % of total -------------------------------------------------------------------------------------- Mezzanine $9,155 52.7 % $7,126 48.6 % Loans held for sale 5,972 34.4% - -% Acquisition, development and construction 1,710 9.8% 6,582 44.9% Asset-based 443 2.5% 857 5.8% Other 105 .6% 110 0.7% ---------------------------------------------- Loans receivable $17,385 100.0% $14,675 100.0 % ============================================== Allowance for credit receivable (632) (621) ----------- ----------- Loans Receivable, net $16,753 $14,054 =========== ===========
Notes payable increased to $12.8 million at September 30, 2002, from $1.73 million at December 31, 2001. The following table provides information on notes payable at the dates indicated.
Notes Payable September 30, December 31, 2001 2002 ----------------------------------------------------------------------------------------- Harbourton Line of Credit $1,000 $1,725 HMIC Warehouse Line of Credit 6,190 - Development loan secured by Investment in Real Estate 1 5,574 - -------------------------------------- Total $12,764 $1,725 ======================================
1 Non-recourse to Harbourton 15 During the quarter ended September 30, 2002, HMIC purchased $23,691,332 of mortgage loans and sold $23,904,544 in the secondary market as follows:
HMIC - Purchased mortgage loans (dollars in thousands) ----------------------------------------------------------------------------------------- Three Months ended Nine Months ended September 30, 2002 September 30, 2002 State Amount Per Cent Amount Per Cent ----------------------------------------------------------------------------------------- California $20,404 86.1% $36,249 85.2 % Florida 1,043 4.4% 2,979 7.0% Arizona 702 3.0% 1,674 3.9% Nevada 642 2.7% 761 1.8% Oregon 557 2.4% 557 1.3% Idaho 208 .9% 208 .5% Washington 136 .5% 136 .3% ---------------------------------------------------------------- $23,692 100.0 % $42,564 100.0 % ---------------------------------------------------------------- Loan type ----------------------------------------------------------------------------------------- First trust $21,503 90.8% $38,847 91.3% Second trust 2,189 9.2% 3,717 8.7% ---------------------------------------------------------------- $23,692 100.0 % $42,564 100.0 % ----------------------------------------------------------------
Three and nine months ended September 30, 2002, compared to the three and nine months ended September 30, 2001. During the three and nine months ended September 30, 2002, the consolidated results were significantly impacted by inclusion of HMIC's revenues and expenses. HMIC began operations on January 2, 2002 as a start-up mortgage banking operation, and incurred operating expenses necessary to establish the personnel and operations to support future growth in the volume of originations and purchases of mortgage loans. It has continued to grow the volume of loans it purchases and the subsequent sales of these loans in the secondary market. 16 The following table provides the components of revenue, expense and net income for the three-month periods ending September 30, 2002 and 2001, respectively.
Three months ended September 30 ------------------------------------------------------------------- (dollars in thousands, and as a percentage of total revenues). 2002 2001 Increase (Decrease) ------------------ -------------------- ------------------------- Revenues % of % of Amount Revenue Amount Revenue Amount % ----------------------------------------------------------------------------------------------------------------------- Interest, discounts, and loan fees $970 50.8% $702 64.6% $268 38.2% Interest expense (141) (7.4%) (49) (4.5%) (92) 187.8% ------------------------------------------------------------------- Net interest income before provision for loan losses 829 43.4% 653 60.1% 176 27.0% Provision for loan losses (44) (2.3%) - -% (44) - ------------------------------------------------------------------- Net interest income 785 41.1% 653 60.1% 132 20.2% Fees and other income 364 19.0% 200 18.4% 164 82.0% Profit participations 69 3.6% 82 7.6% (13) (15.9%) Gain on sale of loans 689 36.1% - -% 689 - Other income 3 .2% 151 13.9% (148) (98.0%) ------------------------------------------------------------------- Total net revenues 1,910 100% 1,086 100% 824 75.9% Expenses ------------------------------------------------------------ Compensation and fringe benefits 953 49.9% 292 26.9% 661 226.4% General and administrative 282 14.8% 101 9.3% 181 178.2% Professional fees 86 4.5% 152 14.0% (66) (43.4%) Depreciation 18 .9% 11 1.0% 7 80.0% ------------------------------------------------------------------- Total expenses 1,339 70.1% 556 51.2% $783 (141.1%) Income before income taxes 571 29.9% 530 48.8% 41 7.7% Income tax benefit (31) (1.6%) (15) (1.4%) 16 106.7% ------------------------------------------------------------------- Net income $602 31.5% $545 50.2% $57 10.5% ===================================================================
For the three months ended September 30, 2002, net income increased to $602 thousand from $545 thousand, an increase of $57 thousand or 10.5%, from the comparable quarter for 2001. Net interest income before provision for loan losses increased by $176 thousand or 27.0% during the quarter ended September 30, 2002, representing a higher volume of deferred income recognized during the period; however, the Company was impacted by the continued lower levels of interest rates in the market. Since the majority of the Company's loan receivables are adjustable and float at a premium to the prime rate, the overall yields to the Company declined in the period ended September 30, 2002 as compared to the comparable period in 2001. HMIC achieved a positive spread between the interest income received by it on the loans held in the warehouse line and the interest paid to leverage these loans prior to their sale in the secondary market. Interest expense increased significantly during the period to $141 thousand as compared to $49 thousand in the comparable period in 2001. The increase resulted principally from HMIC's increased level of loans in the held for sale portfolio, which was financed through its warehouse line of credit. 17 During the period, HMIC recognized $689 thousand of gain on sale of loans related to the sale of $23.9 million in loans to seven secondary market investors. This compares to $256 thousand of gain on sale and total sales of $9.9 million for the quarter ended June 30, 2002. The gain on sale of mortgage loans is recognized at the date of settlement and is based on the difference between the selling price of the loan and HMIC's carrying value of the loan. Nonrefundable fees and other direct costs are deferred at the time of loan origination or purchase and recognized at settlement of the loan sale. HMIC sells all loans servicing released and does not service any loans once the loan has been sold. Total net revenues increased to $1.91 million during the three months ended September 30, 2002, compared to $1.09 million during the comparable period in 2001, an increase of $824 thousand or 75.9%. Included in this amount was net revenues from HMIC of $ 690 thousand during the three month period in 2002. Other income in the current period declined to $3 thousand as compared to $151 thousand in the like period in 2001. The primary reason for the decline was that the Company had $138 thousand of income from the sale of intellectual property during the three months ended September 30, 2001, with no corresponding income in the comparable period for 2002. A provision for loan losses of $44 thousand was recorded by HMIC for the three months ended September 30, 2002. The Company did not record a provision for the three months ended September 30, 2001. HMIC will continue to monitor the sufficiency of its provision for loan losses based on the risk profile of the mortgage loans it acquires. Management believes the current level of reserves provides a satisfactory level of reserves for the current exposure of the portfolio of loans held for sale and the prior originations that have been sold in the secondary market for which there are varying levels of recourse to HMIC. For the three months ended September 30, 2002, total operating expenses increased by $783 thousand or 141.1% as compared to the same period in 2001. This increase was directly attributable to the $778 thousand of additional operating expenses for HMIC during the reporting period. HMIC was projected to report operating losses in the early phase of its start-up because of the necessity to retain the essential personnel and system support to provide the platform to successfully originate and purchase an increasing volume of mortgage loans. HMIC continues to apply for and obtain licenses to operate in a number of states. At September 30, 2002, HMIC was authorized to do business in 11 states. For the three month period ended September 30, 2002, compensation and fringe benefits increased to $953 thousand from $292 thousand, representing an increase of $661 thousand or 226.4% from the comparable period in 2001. Accounting for the largest component of the compensation expense increase was HMIC's compensation expense for the period of $551 thousand. At September 30, 2002, the Company had approximately 42 full time equivalent employees, with eight at the corporate level and 34 at HMIC. Management anticipates additional account executives will be added in future periods to HMIC to solicit new mortgage loan production with a corresponding increase in operational personnel. During the quarter ended September 30, 2002, general and administrative expenses increased to $282 thousand from $101 thousand, representing an increase of $180 thousand or 178.2%, as compared to the like period in 2001. The amount attributable to HMIC for the 2002 period was $208 thousand, principally related to occupancy expense, and operating expenses for telephone, stationery, licensing and equipment. HMIC has three offices, including a main executive office, a support and origination branch and a loan origination office all located in California. Professional fees decreased by $66 thousand, principally due to a reduction in legal expenses incurred for litigation of a lawsuit that was concluded in 2002. 18 The income tax benefit of $31 thousand for the three months ended September 30, 2002 as compared to $15 thousand in the like period of 2001, represented an increase of $16 thousand. Based on the Company's projected profitability, we determined that a portion of the valuation allowance for the deferred tax asset was not required and recorded a $21 thousand reduction to the allowance at September 30, 2002. For the three months ended September 30, 2002, HMIC recorded a state income tax benefit of $10 thousand predicated on management's expectations that HMIC will achieve profitability by early 2003. Nine month comparison The following table provides the components of revenue, expense and net income for the nine-month periods ending September 30, 2002 and, 2001, respectively.
Nine months ended September 30 ------------------------------------------------------------------------------- (dollars in thousands, and as a percentage of total revenues) Revenues 2002 2001 Increase(Decrease) -------------------- -------------------- ------------------- --------------------------------- Amount % Amount % Amount % ------------------------------------------------------------------------------------------------------------- Interest, discounts, and loan fees $2,310 54.4% $1,785 57.5% $525 29.4% Interest expense (308) (7.3%) (102) (3.3%) (206) 202.0% ------------------------------------------------------------------------------- Net interest income before provision for loan losses 2,002 47.1% 1,683 54.2% 319 19.0% Provision for loan losses (91) (2.1%) - -% (91) - ------------------------------------------------------------------------------- Net interest income 1,911 45.0% 1,683 54.2% 228 13.6% Fees and other income 1,108 26.1% 842 27.1% 266 31.6% Profit participations 167 3.9% 179 5.8% (12) (6.7%) Gain on sale of loans 1,053 24.8% - -% 1,053 - Other income 9 .2% 401 12.9% (392) (97.8%) ------------------------------------------------------------------------------- Total net revenues 4,248 100% 3,105 100% 1,143 36.8% ------------------------------------------------------------------------------- Expenses ------------------------------ Compensation and fringe benefits 2,259 53.2% 898 28.9% 1,361 151.6% General and administrative 738 17.4% 280 9.0% 458 163.6% Interest expense 224 5.3% 261 8.4% (37) (14.2%) Depreciation 63 1.5% 30 1.0% 33 111.0% ------------------------------------------------------------------------------- Total expenses 3,284 77.3% 1,469 47.3% 1,815 123.6% Income before income taxes 964 22.7% 1,636 52.7% (672) (41.1%) Income tax benefit (209) (4.9%) (78) (2.5%) 131 (167.9%) ------------------------------------------------------------------------------- Net income $1,173 27.6% $1,714 55.2% ($541) 31.6% ===============================================================================
For the nine months ended September 30, 2002, net revenue increased to $4.2 million from $3.1 million in the comparable period of 2001, an increase of $1.1 million or 36.8%. The principal component of the increase was represented by the gain on sale of mortgage loans of $1.05 million by HMIC and there were no such gains during the 2001 period. Net interest income increased during the nine month period ended September 30, 2002 to $1.9 million, compared to $1.7 million in the comparable period of 2001. The increase is primarily attributable to the increased amount of deferred interest income earned and recognized during the period and net interest income generated from the HMIC portfolio of loans held for sale. Interest expense increased to $307 thousand in the current period as compared to $102 thousand for the nine months ended September 30, 2001. The $205 thousand increase is principally the result of the interest expense associated with HMIC's warehouse line of credit. Fees and other income increased to $1.1 million, an increase of $266 thousand as compared to $842 thousand in the nine-month period ended in 2001. 19 For the nine months ended September 30, 2002, total operating expenses were $3.3 million as compared to $1.5 million, an increase of $1.8 million or 123.6% as compared to the like period in 2001. This increase was directly attributable to the $1.9 million of additional operating expenses for HMIC during the reporting period. For the nine-month period ended September 30, 2002, compensation and fringe benefits increased to $2.3 million from $898 thousand, representing an increase of $1.4 million or 151.6% from the comparable period in 2001. Accounting for the largest component of the compensation expense increase was HMIC's compensation expense for the period of $1.4 million. During the nine month period ended September 30, 2002, general and administrative expenses increased to $738 thousand from $280 thousand, representing an increase of $458 thousand or 163.6%, as compared to the like period in 2001. The amount attributable to HMIC for the 2002 period was $526 thousand, principally related to occupancy expense, and operating expenses for telephone, stationery, licensing and equipment. The income tax benefit of $209 thousand for the nine months ended September 30, 2002 as compared to $78 thousand in the like period of 2001, represented an increase of $131 thousand. HMIC is subject to California state income taxes. For the nine months ended September 30, 2002, HMIC recorded a state income tax benefit of $92 thousand predicated on management's expectations that HMIC will achieve profitability by early 2003. Item 3. Disclosure Controls and Procedures Within 90 days prior to the date of this quarterly report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's chief executive officer and chief financial officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon that evaluation, the chief executive officer and chief financial officer concluded that the Company's disclosure controls and procedures are effective. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. Disclosure controls and procedures are the controls and other procedures of the Company that are designed to ensure that the information required to be disclosed by the Company in its reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in its reports filed under the Exchange Act is accumulated and communicated to the Company's management, including the chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. 20 Part II Other Information Item 1. Legal Proceedings. None, other than routine proceedings incidental to our business, and the Company does not believe that these proceedings will have a material adverse effect on the Company. Item 2. Changes in Securities and Use of Proceeds None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information. None Item 6. Exhibits and Reports on Form 8-K. None 21 Signatures In accordance with the requirements of the Securities Exchange Act of 1934, Harbourton Financial Corporation caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Harbourton Financial Corporation Date: November 14, 2002 /s/ J. Kenneth McLendon --------------------------------------------- J. Kenneth McLendon President and Chief Executive Officer Date: November 14, 2002 /s/ Paula M. Morgan --------------------------------------------- Paula M. Morgan Senior Vice President and Chief Financial Officer 22 Certifications CERTIFICATION PURSUANT TO RULE 13a-14 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, J. Kenneth McLendon, President and Chief Executive Officer of Harbourton Financial Corporation, certify that: 1. I have reviewed this quarterly report on Form 10-QSB of Harbourton Financial Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 23 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ J. Kenneth McLendon -------------------------------------- J. Kenneth McLendon President and Chief Executive Officer 24 CERTIFICATION PUR SUANT TO RULE 13a-14 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Paula M. Morgan, Senior Vice President and Chief Financial Officer of Harbourton Financial Corporation, certify that: 1. I have reviewed this quarterly report on Form 10-QSB of Harbourton Financial Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 25 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ Paula M. Morgan -------------------------------------- Paula M. Morgan Senior Vice President and Chief Financial Officer 26 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The undersigned executive officers of the registrant hereby certify that this Form 10-QSB fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that the information contained herein fairly presents, in all material aspects, the financial condition and results of operations of the registrant. Harbourton Financial Corporation Dated: November 14, 2002 By: /s/ J. Kenneth McLendon ------------------------------------------- J. Kenneth McLendon President and Chief Executive Officer By: /s/ Paula M. Morgan ------------------------------------------- Paula M. Morgan Senior Vice President and Chief Financial Officer 27