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TMFZ - great Q1 results 200% plus!!!!!
Form 10-Q for TMSF HOLDINGS INC
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23-May-2005
Quarterly Report
ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and Notes thereto appearing elsewhere in this quarterly report on Form 10-Q.
This quarterly report may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements with regard to descriptions of our plans or objectives for future operations, products or services, and forecasts of our revenues, earnings or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include the words "believe," "expect," "anticipate," "intend," "plan," "estimate," or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could," or "may."
Forward-looking statements, by their nature, are subject to risks and uncertainties. A number of factors - many of which are beyond our control - could cause actual conditions, events or results to differ significantly from those described in the forward-looking statements and reported results should not be considered an indication of our future performance. Some of these risk factors, include, among others certain credit, market, operational, liquidity and interest rate risks associated with our business and operations, changes in business and economic conditions, accounting estimates and judgments and legislation including the Sarbanes-Oxley Act of 2002. These risk factors are not exhaustive, and additional factors that could have an adverse effect on our business and financial performance are set forth under "Risk Factors" and elsewhere in this quarterly report.
Forward-looking statements speak only as of the date they are made. We do not undertake to update forward-looking statements to reflect circumstances or events that occur after the date forward-looking statements are made.
General
We are a financial holding company that through our wholly owned subsidiary, The Mortgage Store Financial, Inc. is engaged in nationwide mortgage banking to originate, finance, and sell conforming and non-conforming mortgage loans secured by single-family residences.
We originate our loans primarily through independent mortgage brokers across the United States and, to a lesser extent, through our direct sales force in our retail offices. We primarily sell our loans in whole loan transactions and currently do not retain any interest in the servicing of the loans.
Revenue Model
Our operations generate revenues in three ways:
?Income from sales of loans. We generate income from selling the loans we originate for a premium to originate. This accounts for a substantial percentage of our revenues.
?Mortgage interest income. We earn mortgage interest income on loans held for sale from the time we originate the loan until the time we sell the loan. This income is partially offset by our borrowing costs under our warehouse borrowing facilities.
?Commission fee income. To a lesser extent we generate commission fee income from our retail origination and lending activities.
Financial Highlights
Our operations consist primarily of originating loans that we pool and sell in the secondary markets. We analyze and group our loans together to maximize our profit from the sale of each class of mortgages. To date all of our loan sales are structured as whole loan sales where we dispose of our entire interest in the loans and produce immediate cash revenues. However, in the future we may determine that other strategies such as securitization or retaining servicing rights may be more profitable and we may begin to engage in those activities.
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Net Income. For the three months ended March 31, 2005 we had operating income of $4,925,329 and income before provision for income tax of $4,943,988. The net income available to common shareholders after provision for income tax was $2,970,762 or $0.20 per share and $0.19 per share diluted.
Loan originations. For the three months ended March 31, 2005 we funded $348.6 million of mortgage loans compared to $145.5 million for 2004. Purchase money mortgages accounted for 69.6% of our originations during the three months ended March 31, 2005 compared to 55.9% for the same period in 2004. Our wholesale channel, which originates loans through independent mortgage brokers, originated $308.9 million in loans during the quarter-ended March 31, 2005 and $113.6 million for the comparable period in 2004.
We continued to expand our geographical reach and increased our originations throughout the country. During the three months ended March 31, 2005 we had loan originations in 32 states with California accounting for 62.6% of our total origination volume, compared to 91.4% in 2004. During the three months ended March 31, 2004 originations from 31 states outside of California accounted for 37.4% of total funding.
Whole loan sales - cash income from sale. For the three months ended March 31, 2005, we sold $339.4 million of loans (excluding loans funded under our Early Purchase facility) compared to $113.8 million during comparable period in 2004. Our revenue from sales of loans was $15.7 million during three months ended March 31, 2005 compared to $6.2 million for the same period in 2004. In spite of rising interest rates and flattening yield curve we continued to benefit from the higher premiums which we received from sales of Alt-A type mortgage loans during the three months ended March 31, 2005. The weighted average premium collected from sales of loans in this period was 3.22% compared to 3.50% in 2004. During the three months ended March 31, 2005 the rebate or yield spread premium paid to the loan originators was 0.75% compared to 0.63% for the same period in 2004.
As of March 31, 2005, we had loan origination financing facilities with three financial institutions for a total funding capacity of $270 million. This included an Early Purchase facility with a maximum concentration amount of $150 million. This facility was subsequently increased to $250 million in May 2005. The cost of borrowing on these lines are a variable rate equal to 1 month LIBOR plus a margin between 1.50% and 3.25%. The cost of borrowing on loans that are aged over 90 days would increase to 4.00%.
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Accounting for Our Loan Sales
When we sell our mortgage loans in whole loan sale transactions, we dispose of our entire interest in the loans. We recognize revenue at the time of the sale of loans. The revenue consists of pricing premiums from sales less cost of financing origination of loans. The lender and retail origination fees are also recognized at the time we sell the loans. Lender fees and origination fees that are payable to third party brokers and which are paid by borrowers on mortgage loans held for sale are deferred as a balance sheet item and are recaptured as revenue in the statements of operations when the related loans are sold.
In July 2004, we entered into an early purchase agreement with one of our warehouse lenders where certain qualifying loans are purchased by the same institution immediately upon funding, with the Company retaining the right to service and resell the loans to a take-out investor for a period of 90 days. Loan originations under provisions of this facility are recognized as sales of loans and are not reflected on our balance sheet. For loans that we originate through this facility, we recognize the origination fee and other lender fees at the time of funding and all corresponding commissions and fees are recognized immediately.
We separately record mortgage interest income on loans we hold from the date of origination to the date of sale.
Critical Accounting Policies
The preparation of our financial statements requires us to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although we base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, our management exercises significant judgment in the final determination of our estimates. Actual results may differ from these estimates.
Pursuant to our critical accounting policies the following reflect significant judgments by management:
?Accounting for income taxes
?Income from sales of loans
?Gain on sale
?Provisions for losses
?Interest rate risk, derivatives and hedging
Accounting for income taxes.
As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations.
Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. The net deferred tax liability and asset as of March 31, 2004 was $102,709 and $439,701, respectively.
Income from Sales of Loans
To date our income from sales of mortgage loans has consisted primarily of cash gain that resulted from whole loan sales. To date, we have sold all of our loans on a servicing released basis. Currently, we do not retain servicing rights. However, in the future we may decide to retain the right to service any of the loans that we have sold, in which case we may also record non-cash sales related to the value of those servicing rights.
Gain on Sale
Gains or losses resulting from our loan sales are recorded at the time of sale. At the closing of a sale we remove the mortgage loans held for sale and related warehouse debt from our books and record the net gain or loss to our income statement.
Accordingly, our financial results are significantly impacted by the timing of our loan sales. If we hold a significant pool of loans at the end of a reporting period, those loans will remain on our balance sheet, along with the related debt used to fund the loans. The revenue that we generate from those loans will not be recorded until the subsequent reporting period when we sell the loans.
A number of factors influence the timing of our loan sales and our targeted disposition strategy, including the current market demand for our loans, liquidity needs, and our strategic objectives. We have, from time to time, delayed the sale of loans to a later period, and may do so again in the future.
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Under term of an Early Purchase agreement with a financial institution, we sell certain qualifying loans to the financial institution immediately upon origination. We retain the right to service the loans, which will be sold to a Takeout investor within 90 days . We recognize revenue from this transaction to the extent of difference between the price at which loans are acquired by the institution and the funding amount. We recognize additional revenue (loss) equal to the difference between Take-out investor's price and the acquisition price by the institution at the time that the institution releases its interest to the Take-out investor . Although this transaction is treated as a sale and loans are not held on our balance sheet, we may face losses due to changes in the value of servicing rights for such notes.
Provisions for Losses
We may make market valuation adjustments on certain non-performing loans, other loans we hold for sale and real estate owned. These adjustments are based upon our estimate of expected losses and are based upon the value that we could reasonably expect to obtain from a sale. An allowance for losses on loans held for sale, loans sold which we are obligated to repurchase, and real estate owned is recorded in an amount sufficient to maintain adequate coverage for probable losses on such loans. As of March 31, 2005, the reserve for losses on loans held for sale, loans sold which we are obligated to repurchase, and real estate owned was $127,500, $775,600, and $50,000, respectively. Our estimate of expected losses could increase or decrease if our actual loss experience or repurchase activity is different than originally estimated, or if economic factors change the value we could reasonably expect to obtain from a sale. In particular, if actual losses increase or if values reasonably expected to be obtained from a sale decrease, the provision for losses would increase. Any increase in the provision for losses could adversely affect our results of operations.
Interest Rate Risk, Derivatives and Hedging We face two primary types of interest rate risk: during the period from approval of a loan application through loan funding, and on our loans held for sale from the time of funding to the date of sale. Interest rate risk exists during the period from approval of a loan application through loan funding and from the time of funding to the date of sale because the premium earned on the sale of these loans is partially contingent upon the then-current market rate of interest for loans as compared to the contractual interest rate of the loans. In the past we have attempted to minimize such risk through forward commitments and other such strategies.
As part of our interest rate management process, we may use derivative financial instruments such as options and futures. The use of derivatives is intended to mitigate volatility of earnings associated with fluctuations in the gain on sale of loans due to changes in the current market rate of interest. We do not intend to use derivatives to speculate on interest rates. For derivative financial instruments designated as hedge instruments, we will evaluate the effectiveness of these hedges against the mortgage loans being hedged to ensure that there remains a highly effective correlation in the hedge relationship. To hedge the adverse effect of interest rate changes on the fair value of mortgage loans held for sale we will use derivatives as fair value hedges under SFAS No. 133. Once the hedge relationship is established, the realized and unrealized changes in fair value of both the hedge instrument and mortgage loans will be recognized in the period in which the changes occur. The net amount recorded in our consolidated statements of operations will be referred to as hedge ineffectiveness. Any change in the fair value of mortgage loans recognized as a result of hedge accounting will be reversed at the time we sell the mortgage loans. This will result in a correspondingly higher or lower gain on sale revenue at such time. For derivative financial instruments not designated as hedge instruments, realized and unrealized changes in fair value will be recognized in the period in which the changes occur or when such instruments are settled.
Since the composition of our loan originations has shifted from fixed term loans to short term adjustable rate mortgages which are less sensitive to interest rate risk, a hedging position with securities that match the characteristics of short term ARMs was determined to be less cost effective.
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Results of operations for the three months ended March 31, 2005 compared to the same period in 2004
The following table sets forth our results of operations for the three months ended March 31, for the years indicated
2005 2004
(unaudited) (unaudited)
Revenue
Income from sales of loans $15,673,881 $6,196,081
Mortgage interest income 3,420,680 1,049,650
Commission fee income 59,649 84,833
Escrow service income - 74,671
Total revenue 19,154,210 7,405,235
Cost of sales
Commission expense 4,898,396 2,063,451
Warehouse interest expense 2,766,444 707,436
Other closing expenses 507,319 311,473
Reserve for loans to be repurchased 524,822 100,000
Total cost of sales 8,696,981 3,182,360
Gross profit 10,457,229 4,222,875
Operating expenses
Salaries and wages 3,529,421 1,425,335
Occupancy 244,910 81,286
General and administrative 1,757,568 981,480
Total expenses 5,531,900 2,488,101
Income from operations 4,925,329 1,734,774
Other income
Other income 18,659 16,673
Income from REO - 78,280
Total other income 18,659 94,953
Income before tax 4,943,988 1,829,727
Provision for income tax 1,973,226 781,600
Net income $2,970,762 $1,048,127
Loan income
Total revenue. Total revenue increased 158.7% to $19.2 million for the three months ended March 31, 2005 from $7.4 million for the three months ended March 31, 2004. This increase was due to increases in income from sales of loans to $15.7 million and mortgage interest income of $3.4 million for the three months ended March 31, 2005 compared to $6.2 million and $1.0 million, respectively, for the same period in 2004.
Income from sales of mortgage loans. Income from sales of loans for the three months ended March 31, 2005 increased 153.0% to $15.7 million from $6.2 million for the same period in 2004 due to higher volume of whole loan sales. Total whole loan sales increased 198.2% to $339.4 million for the three months ended March 31, 2005 compared to $113.8 million for the same period in 2004. This increase was due to increased loan originations during the three months ended March 31, 2005 compared to the same period in 2004. However, the weighted average premium for whole loan sales for the three months ended March 31, 2005 was 3.22% compared to 3.50% for comparable period in 2004.
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The slightly lower weighted average premium we received from sales of loans in the three months ended March 31, 2005 reflects the rise of short term interest rates and the narrowing of the spread between short and long term rates.
Interest income on loans held for sale. Mortgage interest income increased 225.9% to $3.4 million for the three months ended March 31, 2005 from $1.0 million for the comparable period in 2004. The increase in interest income was due to an increase in the volume of loans originated in 2005 compared to 2004 as well as higher coupon rates.
Commission fee income. To a lesser extent, we earn commission fees on loans that we broker out to other lenders. The mortgage origination fees earned by us for retail loans are recognized at the time of sale of those mortgage loans and are included in the income from sale of loans. Commission fee income for three months ended March 31, 2005 was $60,000 compared to 85,000 in 2004.
Escrow fee income. We discontinued our escrow division in 2004. Income from escrow and other fees for the three months ended March 31, 2004 was $75,000. There was no comparable income for the same period in 2005
Cost of loan origination and sale of mortgage
Commission Expense. Commission expense for mortgage loans sold during three months ended March 31, 2005 increased 137.4% to $4.9 million from $2.1 million in the three months ended March 31, 2004. This increase was due to an increased volume of loan originations. Commission expense, which is primarily a pricing rebate paid by the company and origination fee deducted from borrower's fund at origination, are recognized at the time of sale to correspond with the recognition of income for the same loan. The commissions paid for loans which are held for sale are included in the value of loans held for sale on our balance sheet. As of March 31, 2005, we paid $1.1 million in commissions for loans held for sale.
Warehouse interest expense. Warehouse interest expense represents the interest incurred on all financing associated with use of our warehouse credit facilities during the time our loans are on the line prior to their sale. Interest expense increased 291.1% to $2.8 million for the three months ended March 31, 2005 from $707,400 for the same period in 2004. The increase in interest expense was due to the increase in our volume of borrowing and higher interest rates. Our daily average warehouse borrowing increased 146.0% from $48.0 million in 2004 to $118.1 million in 2005. The weighted average number of days we held loans before sale was 61 and 39 days respectively for the three months ended March 31, 2005 and 2004. The interest rate for our warehouse financing as of March 31, 2005 was a variable rate equal to 1 month LIBOR plus a margin ranging between 1.50% and 4.00%.
Reserve for impairment of mortgage loans. As of March 31, 2005, we had requests to repurchase loans due to early payment defaults in an aggregate amount of $7,311,598 compared to $856,500 for March 31, 2004. At March 31, 2005 we had a $775,600 reserve for impairment of mortgage loans to be repurchased in addition to $127,500 for impairment of mortgage loans held for sale compared to a total of $100,000 in the comparable period in 2004. The increase in the reserve is the result of higher repurchase demands, which resulted from the significant increase in overall loan origination since March 31, 2004
Other closing expenses. Other closing expenses related to closing of loans, including credit check expenses, appraisal and appraisal review fees and closing expenses, increased 62.9% to $507,300 for the three months ended March 31, 2005 from $311,500 for the comparable period in 2004. This increase reflects the additional cost related to increased volume of loan origination offset by improved pricing for services used in loan origination.
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Operating expenses
Total operating expenses. Total operating expenses increased 121.9% to $5.5 million for the three months ended March 31, 2005 compared to $2.5 million for the three months ended March 31, 2004. The increase was the result of higher salaries, wages, and benefits expense, and increases in other variable operating expenses associated with growth in mortgage loan volume and in the number of employees.
Salaries and wages. Salaries and wages increased 147.6% to $3.5 million for the three months ended March 31, 2005 from $1.4 million for the three months ended March 31, 2004. The increase was due to growth in the number of our employees, as well as higher commission and bonus expenses related to loan production. The total number of employees at March 31, 2005 was 352 including 103 commission based employees in our retail and wholesale divisions compared to 124 total employees at March 31, 2004.
Occupancy. Occupancy expense increased 201.3% to $244,900 for the three months ended March 31, 2005 from $81,300 for the three months ended March 31, 2004. The increase resulted from increase in office space due to expansion and a larger number of employees.
General and administrative. General and administrative expenses increased 77.9% to $1.7 million for the three months ended March 31, 2005 from $981,500 for the three months ended March 31, 2004. This increase was due to an increase in mortgage loan origination volume, increased marketing expenses, and an increase in the number of employees.
Loss from real estate owned. While we sell all of our loans for a cash price with servicing rights released, under terms of our agreements with various purchasers, we make certain representations and warranties to the purchaser, which we are obligated to satisfy or correct even after completion of the sale transaction. For example we agree to repurchase loans where borrowers default on their payments within 90 days from date of transfer of servicing.
At March 31, 2005 we had two properties that were classified as REO with an aggregate balance of $704,821 compared to $448,444 at March 31, 2004. A provision for loss in the amount of $50,000 was made for one of the properties held as REO at March 31, 2005. No provision was made at March 31, 2004.
At March 31, 2005, there were 42 loans with an aggregate value of $7.3 million, which we have been requested to repurchase as a result of early payment defaults, breaches in the term of agreements, or violation of mortgage banker's requirements. We have made a provision for losses on these amounts of $775,600 at March 31, 2005.
Provision for income tax. Provision for income tax increased to $2.0 million for the three months ended March 31, 2005 from $781,600 for three months ended March 31, 2004. This increase was a result of the increase in our income before taxes to $4.9 million for the three months ended March 31, 2005 from $1.8 million for the three months ended March 31, 2004.
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Liquidity and capital resources
As a mortgage banking company, our primary cash requirements include the funding of (1) mortgage loan originations, including principal, as well as origination costs such as commissions and broker premiums, (2) interest expense on and repayment of principal on warehouse credit facilities, (3) operational expenses, and (4) tax payments. We fund these cash requirements with cash received from
(1) borrowings under warehouse credit facilities, (2) loan sales, (3) mortgage interest collections on loans held for sale, (4) points and fees collected from the origination of loans, and (5) private sales of equity and debt securities.
We use warehouse credit facilities to finance a significant portion of our loan originations. It is our intention to utilize the maximum allowable leverage ratio, defined as our total liabilities divided by our stockholders' equity, for our warehouse financing.
Our liquidity strategy is to maintain sufficient and diversified warehouse credit facilities to finance our mortgage loan originations, to maintain strong relationships with a diverse group of whole loan purchasers, and to establish the ability to execute our own securitizations. This provides us with the ability to finance our growing origination operations and to maximize our realization of the value of loans we originate.
In the past, we have financed our operations through increased warehouse . . .
Form 10-Q for TMSF HOLDINGS INC
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23-May-2005
Quarterly Report
ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and Notes thereto appearing elsewhere in this quarterly report on Form 10-Q.
This quarterly report may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements with regard to descriptions of our plans or objectives for future operations, products or services, and forecasts of our revenues, earnings or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include the words "believe," "expect," "anticipate," "intend," "plan," "estimate," or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could," or "may."
Forward-looking statements, by their nature, are subject to risks and uncertainties. A number of factors - many of which are beyond our control - could cause actual conditions, events or results to differ significantly from those described in the forward-looking statements and reported results should not be considered an indication of our future performance. Some of these risk factors, include, among others certain credit, market, operational, liquidity and interest rate risks associated with our business and operations, changes in business and economic conditions, accounting estimates and judgments and legislation including the Sarbanes-Oxley Act of 2002. These risk factors are not exhaustive, and additional factors that could have an adverse effect on our business and financial performance are set forth under "Risk Factors" and elsewhere in this quarterly report.
Forward-looking statements speak only as of the date they are made. We do not undertake to update forward-looking statements to reflect circumstances or events that occur after the date forward-looking statements are made.
General
We are a financial holding company that through our wholly owned subsidiary, The Mortgage Store Financial, Inc. is engaged in nationwide mortgage banking to originate, finance, and sell conforming and non-conforming mortgage loans secured by single-family residences.
We originate our loans primarily through independent mortgage brokers across the United States and, to a lesser extent, through our direct sales force in our retail offices. We primarily sell our loans in whole loan transactions and currently do not retain any interest in the servicing of the loans.
Revenue Model
Our operations generate revenues in three ways:
?Income from sales of loans. We generate income from selling the loans we originate for a premium to originate. This accounts for a substantial percentage of our revenues.
?Mortgage interest income. We earn mortgage interest income on loans held for sale from the time we originate the loan until the time we sell the loan. This income is partially offset by our borrowing costs under our warehouse borrowing facilities.
?Commission fee income. To a lesser extent we generate commission fee income from our retail origination and lending activities.
Financial Highlights
Our operations consist primarily of originating loans that we pool and sell in the secondary markets. We analyze and group our loans together to maximize our profit from the sale of each class of mortgages. To date all of our loan sales are structured as whole loan sales where we dispose of our entire interest in the loans and produce immediate cash revenues. However, in the future we may determine that other strategies such as securitization or retaining servicing rights may be more profitable and we may begin to engage in those activities.
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Net Income. For the three months ended March 31, 2005 we had operating income of $4,925,329 and income before provision for income tax of $4,943,988. The net income available to common shareholders after provision for income tax was $2,970,762 or $0.20 per share and $0.19 per share diluted.
Loan originations. For the three months ended March 31, 2005 we funded $348.6 million of mortgage loans compared to $145.5 million for 2004. Purchase money mortgages accounted for 69.6% of our originations during the three months ended March 31, 2005 compared to 55.9% for the same period in 2004. Our wholesale channel, which originates loans through independent mortgage brokers, originated $308.9 million in loans during the quarter-ended March 31, 2005 and $113.6 million for the comparable period in 2004.
We continued to expand our geographical reach and increased our originations throughout the country. During the three months ended March 31, 2005 we had loan originations in 32 states with California accounting for 62.6% of our total origination volume, compared to 91.4% in 2004. During the three months ended March 31, 2004 originations from 31 states outside of California accounted for 37.4% of total funding.
Whole loan sales - cash income from sale. For the three months ended March 31, 2005, we sold $339.4 million of loans (excluding loans funded under our Early Purchase facility) compared to $113.8 million during comparable period in 2004. Our revenue from sales of loans was $15.7 million during three months ended March 31, 2005 compared to $6.2 million for the same period in 2004. In spite of rising interest rates and flattening yield curve we continued to benefit from the higher premiums which we received from sales of Alt-A type mortgage loans during the three months ended March 31, 2005. The weighted average premium collected from sales of loans in this period was 3.22% compared to 3.50% in 2004. During the three months ended March 31, 2005 the rebate or yield spread premium paid to the loan originators was 0.75% compared to 0.63% for the same period in 2004.
As of March 31, 2005, we had loan origination financing facilities with three financial institutions for a total funding capacity of $270 million. This included an Early Purchase facility with a maximum concentration amount of $150 million. This facility was subsequently increased to $250 million in May 2005. The cost of borrowing on these lines are a variable rate equal to 1 month LIBOR plus a margin between 1.50% and 3.25%. The cost of borrowing on loans that are aged over 90 days would increase to 4.00%.
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Accounting for Our Loan Sales
When we sell our mortgage loans in whole loan sale transactions, we dispose of our entire interest in the loans. We recognize revenue at the time of the sale of loans. The revenue consists of pricing premiums from sales less cost of financing origination of loans. The lender and retail origination fees are also recognized at the time we sell the loans. Lender fees and origination fees that are payable to third party brokers and which are paid by borrowers on mortgage loans held for sale are deferred as a balance sheet item and are recaptured as revenue in the statements of operations when the related loans are sold.
In July 2004, we entered into an early purchase agreement with one of our warehouse lenders where certain qualifying loans are purchased by the same institution immediately upon funding, with the Company retaining the right to service and resell the loans to a take-out investor for a period of 90 days. Loan originations under provisions of this facility are recognized as sales of loans and are not reflected on our balance sheet. For loans that we originate through this facility, we recognize the origination fee and other lender fees at the time of funding and all corresponding commissions and fees are recognized immediately.
We separately record mortgage interest income on loans we hold from the date of origination to the date of sale.
Critical Accounting Policies
The preparation of our financial statements requires us to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although we base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, our management exercises significant judgment in the final determination of our estimates. Actual results may differ from these estimates.
Pursuant to our critical accounting policies the following reflect significant judgments by management:
?Accounting for income taxes
?Income from sales of loans
?Gain on sale
?Provisions for losses
?Interest rate risk, derivatives and hedging
Accounting for income taxes.
As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations.
Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. The net deferred tax liability and asset as of March 31, 2004 was $102,709 and $439,701, respectively.
Income from Sales of Loans
To date our income from sales of mortgage loans has consisted primarily of cash gain that resulted from whole loan sales. To date, we have sold all of our loans on a servicing released basis. Currently, we do not retain servicing rights. However, in the future we may decide to retain the right to service any of the loans that we have sold, in which case we may also record non-cash sales related to the value of those servicing rights.
Gain on Sale
Gains or losses resulting from our loan sales are recorded at the time of sale. At the closing of a sale we remove the mortgage loans held for sale and related warehouse debt from our books and record the net gain or loss to our income statement.
Accordingly, our financial results are significantly impacted by the timing of our loan sales. If we hold a significant pool of loans at the end of a reporting period, those loans will remain on our balance sheet, along with the related debt used to fund the loans. The revenue that we generate from those loans will not be recorded until the subsequent reporting period when we sell the loans.
A number of factors influence the timing of our loan sales and our targeted disposition strategy, including the current market demand for our loans, liquidity needs, and our strategic objectives. We have, from time to time, delayed the sale of loans to a later period, and may do so again in the future.
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Under term of an Early Purchase agreement with a financial institution, we sell certain qualifying loans to the financial institution immediately upon origination. We retain the right to service the loans, which will be sold to a Takeout investor within 90 days . We recognize revenue from this transaction to the extent of difference between the price at which loans are acquired by the institution and the funding amount. We recognize additional revenue (loss) equal to the difference between Take-out investor's price and the acquisition price by the institution at the time that the institution releases its interest to the Take-out investor . Although this transaction is treated as a sale and loans are not held on our balance sheet, we may face losses due to changes in the value of servicing rights for such notes.
Provisions for Losses
We may make market valuation adjustments on certain non-performing loans, other loans we hold for sale and real estate owned. These adjustments are based upon our estimate of expected losses and are based upon the value that we could reasonably expect to obtain from a sale. An allowance for losses on loans held for sale, loans sold which we are obligated to repurchase, and real estate owned is recorded in an amount sufficient to maintain adequate coverage for probable losses on such loans. As of March 31, 2005, the reserve for losses on loans held for sale, loans sold which we are obligated to repurchase, and real estate owned was $127,500, $775,600, and $50,000, respectively. Our estimate of expected losses could increase or decrease if our actual loss experience or repurchase activity is different than originally estimated, or if economic factors change the value we could reasonably expect to obtain from a sale. In particular, if actual losses increase or if values reasonably expected to be obtained from a sale decrease, the provision for losses would increase. Any increase in the provision for losses could adversely affect our results of operations.
Interest Rate Risk, Derivatives and Hedging We face two primary types of interest rate risk: during the period from approval of a loan application through loan funding, and on our loans held for sale from the time of funding to the date of sale. Interest rate risk exists during the period from approval of a loan application through loan funding and from the time of funding to the date of sale because the premium earned on the sale of these loans is partially contingent upon the then-current market rate of interest for loans as compared to the contractual interest rate of the loans. In the past we have attempted to minimize such risk through forward commitments and other such strategies.
As part of our interest rate management process, we may use derivative financial instruments such as options and futures. The use of derivatives is intended to mitigate volatility of earnings associated with fluctuations in the gain on sale of loans due to changes in the current market rate of interest. We do not intend to use derivatives to speculate on interest rates. For derivative financial instruments designated as hedge instruments, we will evaluate the effectiveness of these hedges against the mortgage loans being hedged to ensure that there remains a highly effective correlation in the hedge relationship. To hedge the adverse effect of interest rate changes on the fair value of mortgage loans held for sale we will use derivatives as fair value hedges under SFAS No. 133. Once the hedge relationship is established, the realized and unrealized changes in fair value of both the hedge instrument and mortgage loans will be recognized in the period in which the changes occur. The net amount recorded in our consolidated statements of operations will be referred to as hedge ineffectiveness. Any change in the fair value of mortgage loans recognized as a result of hedge accounting will be reversed at the time we sell the mortgage loans. This will result in a correspondingly higher or lower gain on sale revenue at such time. For derivative financial instruments not designated as hedge instruments, realized and unrealized changes in fair value will be recognized in the period in which the changes occur or when such instruments are settled.
Since the composition of our loan originations has shifted from fixed term loans to short term adjustable rate mortgages which are less sensitive to interest rate risk, a hedging position with securities that match the characteristics of short term ARMs was determined to be less cost effective.
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Results of operations for the three months ended March 31, 2005 compared to the same period in 2004
The following table sets forth our results of operations for the three months ended March 31, for the years indicated
2005 2004
(unaudited) (unaudited)
Revenue
Income from sales of loans $15,673,881 $6,196,081
Mortgage interest income 3,420,680 1,049,650
Commission fee income 59,649 84,833
Escrow service income - 74,671
Total revenue 19,154,210 7,405,235
Cost of sales
Commission expense 4,898,396 2,063,451
Warehouse interest expense 2,766,444 707,436
Other closing expenses 507,319 311,473
Reserve for loans to be repurchased 524,822 100,000
Total cost of sales 8,696,981 3,182,360
Gross profit 10,457,229 4,222,875
Operating expenses
Salaries and wages 3,529,421 1,425,335
Occupancy 244,910 81,286
General and administrative 1,757,568 981,480
Total expenses 5,531,900 2,488,101
Income from operations 4,925,329 1,734,774
Other income
Other income 18,659 16,673
Income from REO - 78,280
Total other income 18,659 94,953
Income before tax 4,943,988 1,829,727
Provision for income tax 1,973,226 781,600
Net income $2,970,762 $1,048,127
Loan income
Total revenue. Total revenue increased 158.7% to $19.2 million for the three months ended March 31, 2005 from $7.4 million for the three months ended March 31, 2004. This increase was due to increases in income from sales of loans to $15.7 million and mortgage interest income of $3.4 million for the three months ended March 31, 2005 compared to $6.2 million and $1.0 million, respectively, for the same period in 2004.
Income from sales of mortgage loans. Income from sales of loans for the three months ended March 31, 2005 increased 153.0% to $15.7 million from $6.2 million for the same period in 2004 due to higher volume of whole loan sales. Total whole loan sales increased 198.2% to $339.4 million for the three months ended March 31, 2005 compared to $113.8 million for the same period in 2004. This increase was due to increased loan originations during the three months ended March 31, 2005 compared to the same period in 2004. However, the weighted average premium for whole loan sales for the three months ended March 31, 2005 was 3.22% compared to 3.50% for comparable period in 2004.
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The slightly lower weighted average premium we received from sales of loans in the three months ended March 31, 2005 reflects the rise of short term interest rates and the narrowing of the spread between short and long term rates.
Interest income on loans held for sale. Mortgage interest income increased 225.9% to $3.4 million for the three months ended March 31, 2005 from $1.0 million for the comparable period in 2004. The increase in interest income was due to an increase in the volume of loans originated in 2005 compared to 2004 as well as higher coupon rates.
Commission fee income. To a lesser extent, we earn commission fees on loans that we broker out to other lenders. The mortgage origination fees earned by us for retail loans are recognized at the time of sale of those mortgage loans and are included in the income from sale of loans. Commission fee income for three months ended March 31, 2005 was $60,000 compared to 85,000 in 2004.
Escrow fee income. We discontinued our escrow division in 2004. Income from escrow and other fees for the three months ended March 31, 2004 was $75,000. There was no comparable income for the same period in 2005
Cost of loan origination and sale of mortgage
Commission Expense. Commission expense for mortgage loans sold during three months ended March 31, 2005 increased 137.4% to $4.9 million from $2.1 million in the three months ended March 31, 2004. This increase was due to an increased volume of loan originations. Commission expense, which is primarily a pricing rebate paid by the company and origination fee deducted from borrower's fund at origination, are recognized at the time of sale to correspond with the recognition of income for the same loan. The commissions paid for loans which are held for sale are included in the value of loans held for sale on our balance sheet. As of March 31, 2005, we paid $1.1 million in commissions for loans held for sale.
Warehouse interest expense. Warehouse interest expense represents the interest incurred on all financing associated with use of our warehouse credit facilities during the time our loans are on the line prior to their sale. Interest expense increased 291.1% to $2.8 million for the three months ended March 31, 2005 from $707,400 for the same period in 2004. The increase in interest expense was due to the increase in our volume of borrowing and higher interest rates. Our daily average warehouse borrowing increased 146.0% from $48.0 million in 2004 to $118.1 million in 2005. The weighted average number of days we held loans before sale was 61 and 39 days respectively for the three months ended March 31, 2005 and 2004. The interest rate for our warehouse financing as of March 31, 2005 was a variable rate equal to 1 month LIBOR plus a margin ranging between 1.50% and 4.00%.
Reserve for impairment of mortgage loans. As of March 31, 2005, we had requests to repurchase loans due to early payment defaults in an aggregate amount of $7,311,598 compared to $856,500 for March 31, 2004. At March 31, 2005 we had a $775,600 reserve for impairment of mortgage loans to be repurchased in addition to $127,500 for impairment of mortgage loans held for sale compared to a total of $100,000 in the comparable period in 2004. The increase in the reserve is the result of higher repurchase demands, which resulted from the significant increase in overall loan origination since March 31, 2004
Other closing expenses. Other closing expenses related to closing of loans, including credit check expenses, appraisal and appraisal review fees and closing expenses, increased 62.9% to $507,300 for the three months ended March 31, 2005 from $311,500 for the comparable period in 2004. This increase reflects the additional cost related to increased volume of loan origination offset by improved pricing for services used in loan origination.
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Operating expenses
Total operating expenses. Total operating expenses increased 121.9% to $5.5 million for the three months ended March 31, 2005 compared to $2.5 million for the three months ended March 31, 2004. The increase was the result of higher salaries, wages, and benefits expense, and increases in other variable operating expenses associated with growth in mortgage loan volume and in the number of employees.
Salaries and wages. Salaries and wages increased 147.6% to $3.5 million for the three months ended March 31, 2005 from $1.4 million for the three months ended March 31, 2004. The increase was due to growth in the number of our employees, as well as higher commission and bonus expenses related to loan production. The total number of employees at March 31, 2005 was 352 including 103 commission based employees in our retail and wholesale divisions compared to 124 total employees at March 31, 2004.
Occupancy. Occupancy expense increased 201.3% to $244,900 for the three months ended March 31, 2005 from $81,300 for the three months ended March 31, 2004. The increase resulted from increase in office space due to expansion and a larger number of employees.
General and administrative. General and administrative expenses increased 77.9% to $1.7 million for the three months ended March 31, 2005 from $981,500 for the three months ended March 31, 2004. This increase was due to an increase in mortgage loan origination volume, increased marketing expenses, and an increase in the number of employees.
Loss from real estate owned. While we sell all of our loans for a cash price with servicing rights released, under terms of our agreements with various purchasers, we make certain representations and warranties to the purchaser, which we are obligated to satisfy or correct even after completion of the sale transaction. For example we agree to repurchase loans where borrowers default on their payments within 90 days from date of transfer of servicing.
At March 31, 2005 we had two properties that were classified as REO with an aggregate balance of $704,821 compared to $448,444 at March 31, 2004. A provision for loss in the amount of $50,000 was made for one of the properties held as REO at March 31, 2005. No provision was made at March 31, 2004.
At March 31, 2005, there were 42 loans with an aggregate value of $7.3 million, which we have been requested to repurchase as a result of early payment defaults, breaches in the term of agreements, or violation of mortgage banker's requirements. We have made a provision for losses on these amounts of $775,600 at March 31, 2005.
Provision for income tax. Provision for income tax increased to $2.0 million for the three months ended March 31, 2005 from $781,600 for three months ended March 31, 2004. This increase was a result of the increase in our income before taxes to $4.9 million for the three months ended March 31, 2005 from $1.8 million for the three months ended March 31, 2004.
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Liquidity and capital resources
As a mortgage banking company, our primary cash requirements include the funding of (1) mortgage loan originations, including principal, as well as origination costs such as commissions and broker premiums, (2) interest expense on and repayment of principal on warehouse credit facilities, (3) operational expenses, and (4) tax payments. We fund these cash requirements with cash received from
(1) borrowings under warehouse credit facilities, (2) loan sales, (3) mortgage interest collections on loans held for sale, (4) points and fees collected from the origination of loans, and (5) private sales of equity and debt securities.
We use warehouse credit facilities to finance a significant portion of our loan originations. It is our intention to utilize the maximum allowable leverage ratio, defined as our total liabilities divided by our stockholders' equity, for our warehouse financing.
Our liquidity strategy is to maintain sufficient and diversified warehouse credit facilities to finance our mortgage loan originations, to maintain strong relationships with a diverse group of whole loan purchasers, and to establish the ability to execute our own securitizations. This provides us with the ability to finance our growing origination operations and to maximize our realization of the value of loans we originate.
In the past, we have financed our operations through increased warehouse . . .
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