News Column

PSM HOLDINGS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

February 19, 2014

Management's Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of the Company's balance sheets and statements of income. This section should be read in conjunction with our Annual Report on Form 10-K for the year ended June 30, 2013, and our interim financial statements and accompanying notes to these financial statements filed with this report.

Overview



PSM Holdings, Inc. (the "Company" or "PSMH") originates mortgage loans funded either directly off our warehouse lines of credit or through brokering transactions to other third parties. Approximately 90% of our mortgage origination volume is banked off of our current warehouse lines. We have relationships with multiple investors who purchase the loans funded on our warehouse lines. All of our lending activities are conducted by our subsidiary, PrimeSource Mortgage, Inc. ("PSMI").

Historically, a significant portion of the Company's business has been referral based and purchase orientated (versus refinance). The Company does not directly participate in the secondary markets and further does not maintain a servicing portfolio. Approximately 75% of total loan applications are generated from business contacts and previous client referrals. Realtor referrals and other lead sources like Costco account for the balance of loan applications.

The Company has retail offices located around the United States from which it derives revenue from the loan origination volume from these offices. The Company is able to leverage the Company's warehouse lines of credit relationships with related parties in order to provide it the funding capacity to support anticipated growth. PSMI is licensed in 23 states and operates out of approximately 37 offices around the country.

Current Environment



Regulatory changes from Federal and State authorities have placed a significant amount of pressure on mortgage companies across the United States. The regulatory changes have applied operational pressure for deeper and more disciplined internal processes, limitations on loan officer compensation and increased compliance requirements all making it difficult for small to mid market mortgage firms to operate profitably as independent businesses. This dynamic has spurred consolidation in the industry as many firms feel the need to join larger more established platforms. This industry shift has left the remaining mortgage businesses forced to either make the financial investments in their business to operate in today's environment or become part of a more stable, mature operation that is better suited to compete in a contracting market.

Further, since the middle of June 2013, interest rates on mortgages have experienced a significant increase and industry wide volumes have decreased significantly. The increase in rates has directly impacted the refinance business and has led to the market for purchase business being extremely competitive. In addition to the reduced volumes, most of the industry has experienced declining origination margins. The Company cannot predict with certainty that margins and or origination volumes will return to the levels experienced prior to June of 2013.

The following table represents a production matrix reflecting our past production by number of Loans Closed and Dollar Volume:

Six Months Ended December 31, Number of Loans Closed Dollar Production

2012 2,063 $357,054,108 2013 1,326 $236,023,566 25

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Strategy For Growth



Over the last year, the Company has embarked on a strategy to become a national lending platform that it anticipates other small to medium sized brokers and lenders will want to join as they face challenges due to the changing regulatory environment and mounting competitive pressures on their businesses. Quite simply, the Company wants to be the destination they think of first when they are considering a move. The Company has taken steps to prepare its platform in order to support anticipated growth. Specifically, it has completed a capital raise, hired additional experienced management, strengthened and improved corporate governance, obtained additional state licensing in key markets, implemented programs where its stock is an attractive currency for recruiting and implemented reporting metrics and management analysis tools help management better manage the business. Further, The Company continues to evaluate additional opportunities to monetize origination volume by participating in such things as service release premium and gain on sale in the secondary markets.

The Company is one of nine approved lenders designated as preferred mortgage lenders on the Costco Mortgage Services Platform (the "MSP") that began in January 2010, and is operated and managed by First Choice Bank. The PrimeSource office in Newport Beach, CA has loan originators dedicated to servicing this platform. The Company intends to significantly increase the number of states it is obtaining Costco leads in during the calendar year 2014. Management believes it has committed the appropriate resources in terms of monetary and human capital to position the Company as a leading lender on this platform.

As a result of the market consolidation in the mortgage banking industry, the Company continues to recruit and onboard new entities, as well as work with existing offices to increase their loan originators, locations and production. During the six months ended December 31, 2013, we added a total of 9 locations through onboarding of other mortgage operations (Kansas, California and Utah). We will continue to recruit loan originators and existing mortgage banking or broker operations as we believe our current infrastructure can support a significant scaling of our operations without the need for additional resources or capital.

Results of Operations Three and Six Months Ended December 31, 2013

The Company reported a net loss of $(1,215,969) and $(2,741,631) for the three and six months ended December 31, 2013 compared to a net income of $212,000 and $444,482 for the comparable periods in the prior year. The decrease in income was a direct result of lower production volumes, decreased revenue and increases in both fixed and variable compensation. The Company has taken certain measures to more closely align costs with the current and anticipated productions levels and has transitioned much of the Company's volume to it's fully delegated platform which offers additional ways in which the Company can earn revenue on each loan transaction. Additionally, the Company continues to actively recruit new operations and loan officers to its platform in an effort to increase production and revenue.

Revenues



Total revenues decreased by $(2,176,046) or 36.4% to $3,797,928 for the three months ended December 31, 2013, as compared to $5,973,974 for the three months ended December 31, 2012. Our total revenues decreased by $(4,266,496) or 36.1% to $7,562,275 for the six months ended December 31, 2013 compared to $11,828,771 for the six months ended December 31, 2012. For the current six-month period, our origination volumes decreased by 121,030,542 compared to the prior year. Additionally, as the entire market experienced reduced origination volumes, competitive pricing pressure increased which directly reduced yield spreads in the current period. The Company believes these competitive pressures and depressed origination volume are likely to continue through the first few calendar quarters of 2014. We anticipate that our recruitment of additional operations in key markets across the country will help offset the declines we are currently experiencing. However, there is no assurance that we will be successful in these efforts and our operating results may continue to decline.

Operating Expenses

Total operating expenses decreased by $(769,446) or 13.3% to $5,014,364 for the three months ended December 31, 2013 as compared to $5,783,810 for the prior year period. For the six months ended December 31, 2013, operating expenses amounted to $10,305,420, a reduction of $1,098,634 or 9.6% from the prior six months in which operating expenses amounted to $11,404,054. Our largest single operating cost is compensation, both in terms of fixed salaries and wages and commissions paid on closed loans. During both the three and six month periods ending December 31, 2013, salaries and commissions as a percentage of revenue increased significantly to 92.2% and 92.1% compared to 66.0% and 64.8% for the three and six month periods ended December 31, 2012, respectively. This increase as a percentage of total revenue is directly associated with the newer rules surrounding loan originator compensation in which the loan originators get paid a fixed fee per loan regardless of the profitability of that loan. In the current periods, the competitive landscape was such that overall margins on closed loans were lower yet compensation paid on those loans was unchanged compared to the prior year. We are aggressively looking at modifications to our current compensation structure that would more closely align our compensation and overhead to the future expected origination volume and to industry norms.

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Depreciation and amortization expense increased by $15,023 to $76,624 for the three months ended December 31, 2013, and increased by $24,110 to $146,683 for the six months ended December 31, 2013. This is attributed to a higher balance of fixed assets compared to the prior period.

Non-operating Income (Expense)

Total non-operating income was $467 and $1,514 for the three months and six months ending December 31, 2013 as compared to non-operating income of $21,836 and $19,765 in the same periods in the prior year. Non-operating income and expense in both periods represented interest income and interest expense with some insurance proceeds in the prior year.

Liquidity and Capital Resources

Cash and cash equivalents totaled $1,071,379 as of December 31, 2013. In addition, cash of $500,000 is restricted as collateral against various state licensing bonds. As shown in the accompanying consolidated financial statements, the Company recorded a net loss of $(2,741,631) for the six months ended December 31, 2013, compared to a net income of $444,482 for the comparable period in the prior fiscal year. Current assets exceeded current liabilities by $557,262 at December 31, 2013. The Company incurred a significant reduction in working capital in the recently completed quarter and is implementing various cost reduction initiatives to conserve working cash balances. Additionally, the Company is aggressively recruiting additional mortgage operations to join the platform and increase origination volume and profitability. During the current quarter, the Company closed its first loans as a full correspondent lender. This means that the Company performed all of the back office functions beyond the origination, essentially delivering a closed loan to the ultimate investor. In addition to California, the Company has been funding loans from the New Jersey offices on this platform since October and intends to roll out the platform company wide in February. Operating as a full lender delivering closed loans to investors could increase profitability and improve the ability to recruit additional operations currently operating in a similar manner. There are no assurances that the Company will be successful in rolling out the fully delegated platform throughout the entire Company, or that the Company will be able to successfully recruit additional profitable mortgage operations to join the platform. If the Company is unsuccessful in these initiatives, revenue and profitability may continue to decline and there may not be enough capital to continue to implement growth plans. Further, the Company may be required to raise additional operating capital which would require the issuance of additional equity securities which would dilute our current shareholders. There are no assurances the Company will be successful in raising additional capital and as such, the business could fail.

Operating Activities

Net cash used in operating activities for the six months ended December 31, 2013 was $(3,031,485) compared to net cash provided by operating activities of $676,533 for the six months ended December 31, 2012. In the current six-month period, the net loss of $(2,741,631) was the single largest contributing factor to the cash used by operating activities. Other significant items impacting cash used by operating activities were pay down of accrued liabilities in the amount of $(493,648), increase in prepaid expenses and employee advances of $(154,538) and $(51,579), respectively offset somewhat by collection of accounts receivable of $163,721 and an increase in accounts payable of $65,409. In the prior period, net income was $444,482. The other largest contributing factors to cash provided by operating activities were collection of accounts receivable of $227,597, a reduction in prepaid expenses of $180,376 and a pay down of accounts payable of $(325,186).

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Investing Activities



Net cash used in investing activities for the six months ended December 31, 2013, was $(218,394) resulting almost entirely from cash used to purchase property and equipment of $(207,053). For the six months ended December 31, 2012 net cash used in investing activities amounted to $(15,951) resulting from cash used for purchase of property and equipment amounting to $(22,195) offset somewhat by cash received on employee advances of $7,918. The company does not currently have material commitments for capital expenditures and does not anticipate entering into any such commitments during the next twelve months.

Financing Activities

Net cash used in financing activities for the six months ended December 31, 2013 was $(194,360) consisting of cash paid for preferred dividends amounting to $(171,000) and cash paid on short term financing of $(23,360). Net cash used in financing activities in the prior year period was $(100,000) consisting of a cash payment of $(100,000) on a loan from a related party.

As a result of the above activities, the Company experienced a net decrease in cash of $(3,444,239) for the six months ended December 31, 2013. The Company's ability to continue as a going concern is still dependent on its success in recruiting profitable and stable mortgage businesses, expanding the business of our existing branches, and reducing its current expense structure proportionate to the volumes the Company is currently experiencing and that are expected to continue for the foreseeable future.

Critical Accounting Policies and Estimates

Management's discussion and analysis of its financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The financial statements reflect the selection and application of accounting policies which require management to make estimates and judgments. (See Note 1 to the consolidated financial statements, "Summary of Significant Accounting Policies"). The Company believes that the following paragraphs reflect accounting policies that currently affect the Company's financial condition and results of operations:

Share Based Payment Plan

Under the 2012 Stock Incentive Plan, the Company can grant stock or options to employees, related parties, and unrelated contractors in connection with the performance of services provided to the Company by the awardees. The Company uses the fair value method to account for employee stock compensation costs and to account for share based payments to non-employees.

Revenue Recognition

Revenue is derived primarily from revenue earned from the origination of mortgage loans that are funded by third parties. Revenue is recognized as earned on the earlier of the settlement date or the funding date of the loan. In addition, the Company receives supplemental compensation from our warehouse line providers based on achieving certain production levels which we recognize as revenue when the loans are sold off the warehouse lines.

Recent Accounting Pronouncements

The Company has evaluated the possible effects on its financial statements of the accounting pronouncements and accounting standards that have been issued or proposed by FASB that do not require adoption until a future date, and that are not expected to have a material impact on the consolidated financial statements upon adoption.

Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, result of operations, liquidity, capital expenditures or capital resources.

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Source: Edgar Glimpses


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