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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 2000
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________________ TO ________________
COMMISSION FILE NUMBER 0-19604
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AAMES FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 95-4340340
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation)
350 S. GRAND AVENUE, LOS
ANGELES, CALIFORNIA 90071
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (323) 210-5000
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
COMMON STOCK, PAR VALUE $0.001 NEW YORK STOCK EXCHANGE
PREFERRED STOCK PURCHASE RIGHTS NEW YORK STOCK EXCHANGE
10.50% SENIOR NOTES DUE 2002 NEW YORK STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /
At September 27, 2000, there were outstanding 6,235,226 shares of the Common
Stock of Registrant, and the aggregate market value of the shares held on that
date by non-affiliates of the Registrant, based on the closing price ($1.5625
per share) of the Registrant's Common Stock on the New York Stock Exchange was
$9,183,973.00. For purposes of this computation, it has been assumed that the
shares beneficially held by directors and executive officers of Registrant were
"held by affiliates"; this assumption is not to be deemed to be an admission by
such persons that they are affiliates of Registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's Proxy Statement relating to its 2000 Annual Meeting
of Stockholders or an amendment to this Form 10-K are incorporated by reference
in Items 10, 11, 12 and 13 of Part III of this Annual Report.
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PART I
ITEM 1. BUSINESS
GENERAL
Aames Financial Corporation (the "Company") is a consumer finance company
primarily engaged, through its subsidiaries, in the business of originating,
purchasing, selling and servicing home equity mortgage loans secured by single
family residences. Upon its formation in 1991, the Company acquired Aames Home
Loan, a home equity lender making loans in California since it was founded in
1954. In 1995, the Company expanded its retail presence outside of California
and began purchasing loans from correspondents. In August 1996, the Company
acquired its broker production channel through the acquisition of One Stop
Mortgage, Inc. In 1999, the Company consolidated its loan production channels
into one company, and the retail and broker production channels (including the
former One Stop) now operate under the name "Aames Home Loan."
The Company's principal market is borrowers whose financing needs are not
being met by traditional mortgage lenders for a variety of reasons, including
the need for specialized loan products or credit histories that may limit such
borrowers' access to credit. The Company believes these borrowers continue to
represent an underserved niche of the home equity loan market and present an
opportunity to earn a superior return for the risk assumed. The residential
mortgage loans originated and purchased by the Company, which include fixed and
adjustable rate loans, are generally used by borrowers to consolidate
indebtedness or to finance other consumer needs, and to a lesser extent, to
purchase homes.
The Company originates loans nationally through its core retail and broker
production channels. The Company also purchases loans through correspondents,
which it has materially decreased since fiscal 1998. During the years ended
June 30, 2000, 1999 and 1998, the Company originated $2.0 billion, $2.0 billion
and $1.7 billion, respectively, of mortgage loans and purchased $32.7 million,
$241.5 million and $646.3 million of mortgage loans from correspondents. The
Company underwrites and appraises every loan it originates and generally reviews
appraisals and re-underwrites all loans it purchases. See--"Mortgage Loan
Production."
As a fundamental part of its business and financing strategy, the Company
sells its loans to third party investors in the secondary market as market
conditions allow. The Company maximizes opportunities in its loan disposition
transactions by disposing of its loan production through a combination of
securitizations and whole loan sales, depending on market conditions,
profitability and cash flows. During the years ended June 30, 2000, 1999 and
1998, the Company sold $2.2 billion, $1.9 billion and $2.5 billion,
respectively, of loans. See "--Loan Disposition."
The Company generally retains the servicing on the loans it securitizes. At
June 30, 2000, 1999 and 1998, the Company's servicing portfolio was
$3.6 billion, $3.8 billion and $4.1 billion, respectively. Loans serviced
in-house at June 30, 2000, 1999 and 1998 were $3.3 billion, $3.4 billion and
$3.9 billion, respectively, or 92.6%, 89.2% and $95.0%, respectively.
The Company continues to focus on its core business strategy, which consists
of: (i) continuing to focus on its core loan production units; (ii) increasing
its servicing portfolio and servicing capabilities; and (iii) diversifying its
funding sources to become self-financing (i.e., the ability to obtain sufficient
lines of credit to provide financing for assets created by the Company and the
reduction of reliance on the public equity and debt markets). In particular, the
Company intends to employ the following strategies:
FOCUS ON CORE LOAN PRODUCTION. The Company intends to evaluate expansion
opportunities in its retail, including internet, and broker operations by
improving market penetration in existing locations and evaluating other
potential locations and by building new relationships with independent mortgage
2
brokers, with the goal of increasing market share in these areas. The Company
regularly reviews its loan offerings and introduces new loan products to further
meet the needs of its customers and increase its core loan production volume.
INCREASE SERVICING PORTFOLIO AND INCREASE MARGINS. The Company plans to
continue to build the size of its servicing portfolio to provide a stable and
significant source of recurring revenue. The Company expects to increase slowly
the size of its loan servicing portfolio by continuing to increase loan
originations and selling a portion of its loan production through new
securitizations.
CONTINUE TO DIVERSIFY FUNDING SOURCES AND BECOME SELF-FINANCING. The
Company intends to continue to expand and diversify its funding sources by
adding additional warehouse or repurchase facilities, disposing of a portion of
its loan production for cash in the whole loan market, and developing new
sources for working capital.
The strategies discussed above contain forward-looking statements. Such
statements are based on current expectations and are subject to risks,
uncertainties and assumptions, including those discussed under "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Risk Factors." Should one or more of these risks or uncertainties
materialize, or should underlying assumptions prove incorrect, actual results
may vary materially from those anticipated, estimated or projected. Thus, no
assurance can be given that the Company will be able to accomplish the above
strategies.
RECENT EVENTS
The Company lost $122.4 million during the fiscal year ended June 30, 2000.
The $122.4 million loss resulted from the Company's $82.5 million write down to
its residual interests and mortgage servicing rights and a $39.9 million net
operating loss. Of the $82.5 million write down, $77.5 million related to the
reduction to the fair value of the Company's residual interests reflecting the
Company's assessment of recent credit loss experience in its securitized pools
and the impact of recent interest rate increases which reduced excess spread in
such pools . The Company also wrote down the carrying value of its mortgage
servicing rights by $5.0 million during fiscal 2000 to reflect increased costs
incurred by the Company due in part to subservicing arrangements. The
$39.9 million net operating loss during the fiscal year is attributable
primarily to the Company's reliance on the whole loan sale market as its sole
loan disposition strategy during the March and June quarters, and the delay in
realizing the benefits of the Company's recently implemented expense management
efforts.
In June and July 2000, the Company completed an investment of $50.0 million
from Specialty Finance Partners ("SFP"), the Company's largest stockholder which
is controlled by Capital Z Financial Services Fund, II, L.P., a Bermuda
partnership (together with SFP, "Capital Z"), issuing 58.8 million shares of
Series D Preferred Stock for a price per share equal to $0.85 per share, and
warrants to purchase an additional 5.0 million shares of Series D Preferred
Stock at $0.85 per share.
On August 31, 2000, the Company entered into a Residual Forward Sale
Facility (the "Residual Facility") with Capital Z Investments, L.P., a Bermuda
partnership ("CZI"), an affiliate of Capital Z, pursuant to which the Company
may sell, on a forward flow basis, up to $75.0 million of residual interests
created in future securitizations through the earliest of (i) September 30,
2002, (ii) the full utilization of the $75.0 million amount of the Residual
Facility, or (iii) a termination event, as defined in the Residual Facility. The
Company believes that the Residual Facility will assist the Company by
strengthening its ability to include securitizations in its loan disposition
strategy through reducing the negative cash flow aspects of securitizations and
by providing another source of cash to the Company through periodically
converting residual interests into cash.
On August 31, 2000, the Company renewed a $250.0 million committed warehouse
facility and increased the borrowing limit thereunder by $50.0 million to
$300.0 million. As previously reported, on
3
April 28, 2000, the Company renewed a $300.0 million committed repurchase
facility, decreasing the borrowing limit thereunder by $100.0 million to
$200.0 million. With these recent renewals, the Company has current borrowing
capacity under committed revolving warehouse and repurchase facilities of
$665.0 million (excluding a $35.0 million non-revolving subline). All of the
Company's revolving warehouse and repurchase facilities contain provisions
requiring the Company to meet certain periodic financial covenants. In addition,
under the Company's 1999 securitization trusts, the monoline insurance company
providing credit enhancement requires the Company to maintain a specified net
worth and level of cash liquidity in order to continue to service the loans in
the trust. The Company met all of its financial covenants under its revolving
warehouse and repurchase facilities and its securitization trusts at June 30,
2000.
On September 21, 2000, the Company completed a securitization of
$460.0 million of mortgage loans and sold its residual interest through the
Residual Facility for cash. Although the Company generally retains the servicing
on the loans it securities, the Company sold its servicing rights and the rights
to prepayment penalties under the securitization because the gain realized on
sale was higher than what the Company would have realized had the mortgage
servicing rights and the rights to prepayment fees been retained, and the gain
was for cash.
As previously reported, the Company's existing revolving warehouse and
repurchase facilities do not provide for the funding of mortgage loans at
closing; instead, the Company uses working capital to close mortgage loans.
After the mortgage loans are closed, the Company pledges them under one of its
revolving warehouse or repurchase facilities to replenish working capital. The
Company is currently seeking a new revolving warehouse or repurchase facility to
fund mortgage loans at closing. As a result of the recent $50.0 million
investment, and the $460.0 million securitization, the residual sale under the
Residual Facility and the sale of servicing rights and the rights to prepayment
penalties completed September 21, 2000, the Company believes it has sufficient
cash to fund at closing its current loan production.
As a result of the recent investment by Capital Z, the Company intends to
make a distribution to the holders of the Company's Common Stock, and Series C
Convertible Preferred Stock, in the form of a dividend of nontransferable
subscription rights to purchase shares of Series D Preferred Stock for $0.85 per
share (the "Rights Offering"). Capital Z has agreed that neither they nor any of
their affiliates (including SFP) will participate in the Rights Offering.
Consequently, the number of shares offered in the Rights Offering to
stockholders not affiliated with Capital Z (the "Nonaffiliated Stockholders")
will be approximately 19.8 million shares of Series D Preferred Stock. The
Company expects to complete the Rights Offering during the quarter ending
December 31, 2000.
The Company was notified in writing by the New York Stock Exchange (the
"NYSE") on September 12, 2000 (the "NYSE Notice") that the average closing price
per share of the Company's Common Stock was below the NYSE's minimum stock price
requirement of $1.00 per share as of the thirty trading-day period ended
July 19, 2000. Pursuant to the NYSE Notice, the Company has until December 29,
2000 to raise the thirty day average closing price of the Common Stock above
$1.00 per share or the NYSE will suspend the Company's listing and apply to the
Securities and Exchange Commission ("SEC") for delisting. The closing price of
the Common Stock on September 27, 2000 was $1.5625 per share and the average
closing price for the thirty trading-day period ended September 27, 2000 was
$1.45 per share. There can be no assurance that the thirty day average closing
price of the Common Stock will remain above $1.00 per share or that the Common
Stock will not be delisted by the NYSE. If the Common Stock were delisted by the
NYSE, it would seriously impair the ability of Common stockholders to trade
their shares.
4
MORTGAGE LOAN PRODUCTION
The Company's principal loan product is a non-conforming home equity loan
with a fixed principal amount and term to maturity which is typically secured by
a first or second mortgage on the borrower's residence with either a fixed or
adjustable interest rate. Non-conforming home equity loans are loans made to
homeowners whose borrowing needs may not be met by traditional financial
institutions due to credit exceptions or other factors and generally cannot be
directly marketed to agencies such as Fannie Mae and Freddie Mac. During the
year ended June 30, 2000, the Company originated its residential loans through
its primary retail and broker channels, and to a lesser extent, purchased closed
loans.
The following table presents certain information about the Company's loan
production at or during the periods indicated:
YEAR ENDED JUNE 30,
--------------------------------------------
2000 1999 1998
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(DOLLARS IN THOUSANDS)
Retail loans(1):
Total dollar amount................................ $ 783,700 $ 770,000 $ 636,100
Number of loans.................................... 11,226 12,214 11,531
Average loan amount................................ 70 63 55
Average initial combined loan to value............. 73% 72% 70%
Weighted average interest rate(3).................. 10.0% 9.5% 10.3%
Number of retail loan offices at period end........ 100 101 103
Broker loans(2):
Total dollar amount................................ $1,262,900 $1,182,100(3) $1,101,200(3)
Number of loans.................................... 13,838 14,006 12,763
Average loan amount................................ 91 84 86
Average initial combined loan to value............. 78% 76% 75%
Weighted average interest rate(3).................. 10.3% 9.9% 9.8%
Number of broker loan offices at period end........ 7 35 52
Correspondent program:
Total dollar amount................................ $ 32,700 $ 241,500 $ 646,300
Number of loans.................................... 289 2,219 6,252
Average loan amount................................ 113 109 103
Average initial combined loan to value............. 81% 80% 79%
Weighted average interest rate(3).................. 10.2% 10.0% 10.2%
Total loans:
Total dollar amount................................ $2,079,300 $2,193,600 $2,383,600
Number of loans.................................... 25,353 28,439 30,546
Average loan amount................................ 82 77 78
Average initial combined loan to value............. 76% 75% 75%
Weighted average interest rate(3).................. 10.2% 9.8% 10.1%
- ------------------------------
(1) During the quarter ended December 31, 1999, the Company commenced
originating loans through the internet, through an affiliation with certain
internet lending sites. The numbers for fiscal year 2000 includes 82 loans
with a total dollar amount of $5.9 million in loans originated through the
internet.
(2) During the quarter ended June 30, 2000, the Company's broker channel
commenced originating loans through telemarketing and the internet, through
an affiliation with certain internet lending sites. The numbers for fiscal
year 2000 includes 241 loans with a total dollar amount of $24.9 million in
loans originated through these sources.
(3) Calculated with respect to the interest rate at the time the loan was
originated or purchased by the Company.
(4) Includes commercial loans. In late fiscal 1997, the Company began
originating small commercial loans on a limited basis. In January 1999, the
Company discontinued its commercial loan operation.
5
Total loan production during the fiscal year ended June 30, 2000 of
$2.1 billion was down from the $2.2 billion reported for the fiscal year ended
June 30, 1999 and the $2.4 billion reported for the fiscal year ended June 30,
1998; however, core retail and broker production was $2.0 billion for fiscal
2000, and $2.0 billion for fiscal 1999 and $1.7 billion for fiscal 1998. Loan
origination volume from the Company's broker channel increased to $1.3 billion
during fiscal 2000 from $1.2 billion in production reported during fiscal 1999
and $1.1 billion reported for fiscal 1998. During fiscal 2000, the Company's
retail channel production increased to $783.7 million from $770.0 million during
fiscal 1999 and $636.1 million during fiscal 1998. Correspondent production
during fiscal 2000 declined to $32.7 million from $241.5 million during fiscal
1999 and $646.3 million during fiscal 1998, reflecting the Company's previously
reported decision to decrease its reliance on this channel.
RETAIL LOAN CHANNEL. The Company originates home equity mortgage loans
through its network of retail loan offices and through the internet. At
June 30, 2000, the Company had 100 offices serving borrowers nationally. During
the coming year, the Company intends to evaluate opportunities for further
retail office expansion. The Company selects areas in which to introduce or
expand its retail presence on the basis of selected demographic statistics,
marketing analyses and other criteria developed by the Company.
The Company generates applications for loans through its retail loan office
network principally through a direct response marketing program, which relies
primarily on the use of direct mailings to homeowners, telemarketing and
yellow-page listings. In the past, the Company has also used television and
radio advertising. The Company generates customer leads for the retail network
in two ways: produced by the Company based upon Company derived models and
commercially developed customer lists, the ("centralized marketing approach")
and generated by the local branch by the loan officers who are familiar with the
local area (the "decentralized marketing approach"). Prior to fiscal year 1999,
the Company relied exclusively on the centralized marketing approach and added
the decentralized marketing approach in fiscal year 1999 in order to increase
its retail loan production and further penetrate the non-conforming home equity
market. The Company believes that its marketing efforts campaigns establish name
recognition and serve to distinguish the Company from its competitors. The
Company continually monitors the sources of its applications to determine the
most effective methods and manner of marketing.
The Company's direct mail invites prospective borrowers to call the Company
to apply for a loan. Direct mail is often followed up by telephone calls to
potential customers. All contact with the customer is handled through the local
branch. On the basis of an initial screening conducted at the time of the call,
the Company's loan officer at the local retail loan office makes a preliminary
determination of whether the customer and the property meet the Company's
lending criteria. If so, the loan officer assists the applicant in completing
the loan application, arranges for an appraisal, orders a credit report from an
independent, nationally recognized credit reporting agency and performs various
other tasks in connection with the completion of the loan package. The loan
officer may complete the application over the telephone, or schedule an
appointment in the retail loan office most conveniently located to the customer
or in the customer's home, depending on the customer's needs. The loan package
is then underwritten for loan approval. If the loan package is approved, the
loan is funded by the Company. The Company's loan officers are trained to
structure loans that meet the applicant's needs while satisfying the Company's
lending guidelines.
In November of 1999, the Company sought to increase its retail loan
production and further penetrate the non-conforming home equity market through
loan originations through the internet. The Company obtains leads through
several commercially available internet sites as well as through its own
internet web site "Aames.net". Retail internet loan originations totaled
$5.9 million, or 0.8% of retail production for fiscal year 2000. The Company
expects retail internet production to generate an increasing dollar amount and
percentage of retail loan production in the coming quarters.
6
INDEPENDENT MORTGAGE BROKER CHANNEL. At June 30, 2000, the Company operated
7 regional offices and had approximately 8,100 approved mortgage brokers. During
fiscal 2000, the Company originated loans through approximately 4,700 brokers,
no one of which accounted for more than 3% of total broker originations. All
broker loans originated by the Company are underwritten in accordance with the
Company's underwriting guidelines. Once approved, the loan is funded by the
Company directly.
The broker's role is to identify the applicant, assist in completing the
loan application form, gather necessary information and documents and serve as
the Company's liaison with the borrower through the lending process. The Company
reviews and underwrites the applications submitted by the broker, approves or
denies the application, sets the interest rate and other terms of the loan and,
upon acceptance by the borrower and satisfaction of all conditions imposed by
the Company, funds the loan. Because brokers conduct their own marketing and
employ their own personnel to complete loan applications and maintain contact
with borrowers, originating loans through its broker network allows the Company
to increase its loan volume without incurring the higher marketing and employee
costs associated with increased retail originations.
Because mortgage brokers generally submit loan files to several prospective
lenders simultaneously, consistent underwriting, quick response times and
personal service are critical to successfully producing loans through
independent mortgage brokers. To meet these requirements, the Company strives to
provide quick response time to the loan application (generally within
24 hours). In addition, loan consultants and loan processors, including
underwriters, are available in the Company's regional offices to answer
questions, assist in the loan application process and facilitate ultimate
funding of the loan.
In the fourth quarter of fiscal year 2000, the Company sought to use
telemarketing and the internet to increase its broker loan production and
further penetrate the non-conforming home equity broker market through its
"Broker Direct" program. Through Broker Direct, the Company makes out bound
telemarketing calls to brokers who are not currently doing business with the
Company or are outside the geographic areas served by the loan officers. Through
"Broker Direct", the Company obtains leads through a commercially available
internet site as well as through its own internet web site "Aamesdirect.com".
"Broker Direct" loan origination totaled $24.0 million for telemarketing
generated leads, and $875,000 for internet generated leads for fiscal year ended
June 30, 2000. The Company expects "Broker Direct" to generate an increasing
dollar amount and percentage of broker loan production in the coming quarters.
CORRESPONDENT CHANNEL. The Company purchases a limited amount of closed
loans from mortgage bankers and other financial institutions on a continuous or
"flow" basis. The Company believes that its flow correspondent program enables
the Company to supplement its core loan production on a cost effective basis.
Prior to fiscal 1999, the Company purchased a significant dollar amount of
correspondent loans in bulk purchases, but eliminated bulk purchases and
decreased its reliance on correspondent production in fiscal 1999, shifting its
focus on core retail and broker production.
UNDERWRITING. The Company underwrites every residential loan it originates
and generally re-underwrites each loan it purchases. The Company's underwriting
guidelines are designed to assess the borrower's creditworthiness and the
adequacy of the real property as collateral for the loan. The borrower's
creditworthiness is assessed by examination of a number of factors, including
calculation of debt-to-income ratios, which is the sum of the borrower's monthly
debt payments divided by the borrowers's monthly income before taxes and other
payroll deductions, an examination of the borrower's credit history and credit
score through standard credit reporting bureaus, and by evaluating the
borrower's payment history with respect to existing mortgages, if any, on the
property.
An assessment of the adequacy of the real property as collateral for the
loan is primarily based upon an appraisal of the property and a calculation of
the ratios of the loan applied for (the "LTV") and of all mortgages existing on
the property (including the loan applied for) (the "combined loan-to-value
ratio") or "CLTV" to the appraised value of the property at the time of
origination. As a
7
lender that specializes in loans made to credit impaired borrowers, the Company
makes home equity mortgage loans to borrowers with credit histories or other
factors that would typically disqualify them from consideration for a loan from
traditional financial institutions. Consequently, the Company's underwriting
guidelines for such credit-impaired borrowers generally require lower combined
loan-to-value ratios than would typically be the case if the borrower could
qualify for a loan from a traditional financial institution.
Appraisers determine a property's value by reference to the sales prices of
comparable properties recently sold, adjusted to reflect the condition of the
property as determined through inspection. Appraisals on loans purchased as part
of the Company's correspondent program are reviewed by Company appraisers or
Company-qualified contract appraisers to assure that they meet the Company's
standards.
The underwriting of a mortgage loan to be originated or purchased by the
Company includes a review of the completed loan package, which includes the loan
application, a current appraisal, a preliminary title report and a credit
report. All loan applications and all closed loans offered to the Company for
purchase must be approved by the Company in accordance with its underwriting
criteria. The Company regularly reviews its underwriting guidelines and makes
changes when appropriate to respond to market conditions, the performance of
loans representing a particular loan product or changes in laws or regulations.
The Company requires title insurance coverage issued on an American Land
Title Association (or similar) form of title insurance on all residential
properties securing mortgage loans it originates or purchases. The loan
originator and its assignees are generally named as the insured. Title insurance
policies indicate the lien position of the mortgage loan and protect the Company
against loss if the title or lien position is not as indicated. The applicant is
also required to maintain hazard and, in certain instances, flood insurance, in
an amount sufficient to cover the new loan and any senior mortgage, subject to
the maximum amount available under the National Flood Insurance Program.
The Company has two general underwriting programs through which it
implements the above:
- the "traditional" underwriting program, under which the borrower's
mortgage credit and consumer credit are each scored and weighted to
determine the overall credit grade of the borrower with the borrower then
being assigned an "A" through "D" credit grade, and
- a credit score/LTV based underwriting program (referred to as the "SNAP
program"), under which the borrower's credit score as reported by various
reporting agencies and the LTV of the loan are used to determine whether
the borrower qualifies for the loan requested and the appropriate pricing
for that loan. Loans under this program are converted to "traditional"
underwriting credit scores for reporting purposes.
"TRADITIONAL" UNDERWRITING PROGRAM. The Company assigns a credit grade (A,
A-, B, C, C- and D) to each loan it originates or purchases depending on the
risk profile of the loan, with the higher credit grades exhibiting a lower risk
profile and the lower credit grades exhibiting increasingly higher risk
profiles. Generally, the higher credit grade loans have higher loan-to-value
ratios and carry a lower
8
interest rate. The following chart generally outlines certain parameters of the
credit grades of the Company's traditional underwriting program at
September 15, 2000:
"A" CREDIT "A-" CREDIT "B" CREDIT "C" CREDIT "C-" CREDIT "D" CREDIT
GRADE GRADE GRADE GRADE GRADE GRADE
-------------- -------------- -------------- -------------- -------------- --------------
GENERAL REPAYMENT Has good Has good Generally good Marginal Marginal Designed to
credit. credit but mortgage pay credit history credit history provide a
might have history but which is not offset by borrower with
some minor may have offset by other positive poor credit
delinquency. marginal other positive attributes. history an
consumer attributes. opportunity to
credit correct past
history. credit
problems.
EXISTING MORTGAGE No lates in No more than No more than Can have No more than Greater than
LOANS past 12 59 days late 89 days late multiple 149 days 150 days
months. at closing and at closing and 30-day lates delinquent in delinquent in
a maximum of a maximum of and two 60-day the past 12 the past 12
two 30-day four 30-day lates or one months. Can months.
lates in the lates in the 90-day late in have multiple
past 12 past 12 months the past 12 90-day lates
months. or one 60-day months; or one 120 day
late and two currently not late in the
30-day lates. more than 119 past 12
days late at months.
closing.
CONSUMER CREDIT Consumer Consumer Consumer Consumer Consumer Consumer
credit is good credit is good credit must be credit is fair credit is poor credit is poor
in the last 12 in the last 12 satisfactory in the last 12 in the last 12 in the last 12
months. Less months. Less in the last 12 months. The months with months. The
than 25% of than 35% of months. Less majority of currently majority of
credit report credit report than 40% of the credit is delinquent the credit is
items items credit report not currently accounts. Less derogatory
derogatory derogatory items delinquent. than 60% of (more than
with no 60-day with no 90-day derogatory. Less than 50% credit report 60%).
or more lates. or more lates. Generally, of credit items Percentage of
Generally, Generally, requires a report items derogatory. derogatory
requires a requires a minimum credit derogatory. Generally, items not a
minimum credit minimum credit score of 560. Generally, requires a factor.
score of 600. score of 580. requires a minimum credit Generally,
minimum credit score of 500. requires a
score of 530. minimum credit
score of 500.
BANKRUPTCY 2 years since 2 years since 1 year since Bankruptcy Bankruptcy Current
discharge or discharge or discharge with filing 12 filed within bankruptcy
dismissal with dismissal with reestablished months old, last 12 months must be paid
reestablished reestablished "B" credit or discharged or and discharged through loan.
"A" credit. "A-" credit. 18 months dismissed or dismissed
since prior to prior to
discharge application. application.
without
reestablished
credit.
DEBT SERVICE- Generally not Generally not Generally not Generally not Generally not Generally not
TO-INCOME RATIO to exceed 45%. to exceed 45%. to exceed 50%. to exceed 55%. to exceed 60%. to exceed 60%.
9
"A" CREDIT "A-" CREDIT "B" CREDIT "C" CREDIT "C-" CREDIT "D" CREDIT
GRADE GRADE GRADE GRADE GRADE GRADE
-------------- -------------- -------------- -------------- -------------- --------------
MAXIMUM LOAN-TO-
VALUE RATIO:
OWNER OCCUPIED Generally 90% Generally 90% Generally 80% Generally 75% Generally 70% Generally 65%
for a 1 to 4 for a 1 to 4 for a 1 to 4 for a 1 to 4 for a 1 to 4 for a 1 to 4
family family family family family family
dwelling. dwelling. dwelling. dwelling. dwelling. dwelling.
NON-OWNER OCCUPIED Generally 80% Generally 70% Generally 65% Generally 65% Generally 65% Generally 60%
for a 1 to 4 for a 1 to 4 for a 1 to 2 for a 1 to 4 for a 1 to 4 for a 1 to 4
family family family family family family
dwelling. dwelling. dwelling. dwelling. dwelling. dwelling.
"SNAP" UNDERWRITING PROGRAM. The SNAP program was developed by the Company
to enhance its ability to risk-base price its loan products, to increase
uniformity of creditworthiness within each credit "band" and to reduce
subjectivity and simplify the underwriting process in order to improve
efficiency and service levels to its customers.
The SNAP program uses the credit score (as defined below) of the primary
borrower (i.e., the borrower with the majority of total income) to determine
program eligibility and then to determine the maximum LTV and interest rate for
which the borrower may qualify. Generally, the minimum acceptable credit score
under the SNAP program is 500.
In most cases, the payment history of the borrower under the existing
mortgage loan is also taken into consideration. Borrowers with lower credit
scores generally qualify for lower maximum LTVs and are charged higher interest
rates than borrowers with higher credit scores. "Credit Scores" are discussed
below.
Under the SNAP program, a verification of the borrower's mortgage payment
history under his existing mortgage loan over the most recent 12 months is
required in all cases where the primary borrower's credit score is less than 600
(or less than 640 if the loan amount is less than $100,000). The maximum LTV
allowed and the interest rate for the loan indicated by the SNAP program may be
adjusted based on the borrower's past mortgage payment history. Under the SNAP
program, a poor mortgage payment history will result in a lower maximum LTV and
a higher interest rate (comparable to the maximum LTV and interest rate for a
borrower with a lower credit score) in order to reflect the increased risk of
default indicated by the mortgage payment history. The LTV and credit score
adjustments are set forth in the chart below.
ADJUSTED CREDIT SCORE AND MAXIMUM LTV
BASED UPON MORTGAGE LATES IN PREVIOUS MONTHS
----------------------------------------------------------------------------------------
ACTUAL CREDIT 4X30 AND 0X60; 12X30 AND 2X60;
SCORE 2X30 2X30 AND 1X60 12X30 AND 1X90 12X60 AND 1X120 1X150
- ----- -------- ----------------- ----------------- ----------------- -----------------
700+................. 600 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
680.................. 600 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
660.................. 600 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
640.................. 600 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
620.................. 600 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
600.................. 600 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
580.................. 580 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
560.................. 560 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
540.................. 540 540 540 520; 70%max LTV 500; 65%max LTV
520.................. 520 520 520 520; 70%max LTV 500; 65%max LTV
500.................. 500 500 500 500 500
For example, under the SNAP program, in the case of a borrower with a credit
score of 640 who has had not more than one 30-day late payment on his existing
mortgage loan during the previous
10
12 months (i.e., 1x30) and who otherwise qualifies for a maximum LTV of 90%, the
borrower's actual credit score of 640 would be used for purposes of qualifying
for the loan and determining the applicable interest rate and the 90% maximum
LTV allowed would not be adjusted downward. However, under the SNAP program, if
the borrower with the 640 credit score had two 30-day late payments in the
previous 12 months (i.e., 2x30), the credit score used for purposes of
qualifying and determining pricing, would fall to 600--and the maximum LTV
allowed would be 80%. In addition, the interest rate for that loan would be
determined as if the borrower's credit score were 600 (instead of the actual
credit score of 640). If that same borrower had a mortgage delinquency of 2x30
and 1x60 or 4x30 and 0x60 during the previous 12 months, then the maximum LTV
allowed would be 80% and the loan would be priced as if the credit score was
560. If that borrower had a mortgage delinquency of 12x30 and 2x60 or 12x30 and
1x60 and 1x90 for the previous 12 months, then the maximum LTV falls to 75% and
the loan would be priced as if the credit score was 550. If that borrower had a
mortgage delinquency of 12x90, or 12x60 and 1x90 and 1x120 for the previous
12 months, then the maximum LTV decreases to 70% and the credit score used for
pricing falls to 520. If that borrower had a mortgage delinquency of 1x150 or
more for the previous 12 months, then the maximum LTV falls to 65% and the loan
would be priced as if the credit score were 500.
CREDIT SCORES. "Credit scores" are obtained by many lenders in connection
with mortgage loan applications to help assess a borrower's creditworthiness.
Credit scores are obtained from credit reports provided by various credit
reporting organizations, each of which may employ differing computer models and
methodologies. The credit score is designed to assess a borrower's credit
history at a single point, using objective information currently on file for the
borrower at a particular credit reporting organization. Information utilized to
create a credit score may include, among other things, payment history,
delinquencies on accounts, level of outstanding indebtedness, length of credit
history, types of credit, and bankruptcy experience. Credit scores range from
approximately 400 to approximately 800, with higher scores indicating an
individual with a more favorable credit history compared to an individual with a
lower score. However, a credit score purports only to be a measurement of the
relative degree of risk a borrower represents to a lender, that is, a borrower
with a higher score is statistically expected to be less likely to default in
payment than a borrower with a lower score. In addition, it should be noted that
credit scores were developed to indicate a level of default probability over a
two-year period, which does not correspond to the life of a mortgage loan.
Furthermore, credit scores were not developed specifically for use in connection
with mortgage loans, but for consumer loans in general, and assess only the
borrower's past credit history. Therefore, a credit score does not take into
consideration the differences between mortgage loans and consumer loans
generally or the specific characteristics of the related mortgage loan
including, for example, the LTV or CLTV, the collateral for the mortgage loan,
or the debt to income ratio. There can be no assurance that the credit scores of
the mortgagors will be an accurate predictor of the likelihood of repayment of
the related mortgage loans.
The tables on the following page present certain information about the
Company's loan production through its retail, broker and correspondent channels
during the years ended June 30, 2000, 1999 and 1998:
11
LOAN ORIGINATIONS AND PURCHASES DURING THE YEAR ENDED JUNE 30, 2000
TRADITIONAL UNDERWRITING PROGRAM AND "SNAP" UNDERWRITING PROGRAM
WEIGHTED
DOLLAR AMOUNT % OF COMBINED WEIGHTED AVERAGE
CREDIT GRADE(2) OF LOAN TOTAL LOAN-TO-VALUE INTEREST RATE(1)
- --------------- -------------- -------- ------------- ----------------
A......................... $ 772,412,000 37% 79% 9.6%
A-........................ 499,408,000 24 77 9.8
B......................... 508,467,000 24 76 10.4
C......................... 197,119,000 9 63 11.5
C-........................ 43,310,000 2 68 12.6
D......................... 58,562,000 3 61 13.8
-------------- --- --- ----
Total..................... $2,079,278,000 100% 76% 10.2 %
============== === === ====
LOAN ORIGINATIONS AND PURCHASES DURING THE YEAR ENDED JUNE 30, 1999
TRADITIONAL UNDERWRITING PROGRAM ONLY
WEIGHTED
DOLLAR AMOUNT % OF COMBINED WEIGHTED AVERAGE
CREDIT GRADE OF LOAN TOTAL LOAN-TO-VALUE INTEREST RATE(1)
- ------------ -------------- -------- ------------- ----------------
A........................... $ 707,644,000 32% 79% 9.1%
A-.......................... 729,237,000 33 77 9.4
B........................... 475,370,000 22 75 10.1
C........................... 119,730,000 5 68 11.1
C-.......................... 37,990,000 2 65 12.3
D........................... 123,665,000 6 62 12.9
-------------- --- -- ----
Total....................... $2,193,636,000 100% 75% 9.8%
============== === == ====
LOAN ORIGINATIONS AND PURCHASES DURING THE YEAR ENDED JUNE 30, 1998
TRADITIONAL UNDERWRITING PROGRAM ONLY
WEIGHTED
AVERAGE
DOLLAR AMOUNT % OF COMBINED WEIGHTED AVERAGE
CREDIT GRADE OF LOAN TOTAL LOAN-TO-VALUE INTEREST RATE(1)
- ------------ -------------- -------- ------------- ----------------
A........................... $ 651,303,000 27% 77% 9.3%
A-.......................... 835,834,000 35 78 9.7
B........................... 560,710,000 24 74 10.2
C........................... 159,652,000 7 67 11.2
C-.......................... 45,378,000 2 65 12.2
D........................... 130,761,000 5 61 13.2
-------------- --- -- ----
Total....................... $2,383,638,000 100% 75% 10.1%
============== === == ====
- ------------------------
(1) Calculated with respect to the interest rate at the time the loan is
originated or purchased by the Company, as applicable.
(2) Loans underwritten under the "SNAP" underwriting program are assigned a
credit grade that the Company believes correlates to the credit grades in
the "Traditional" underwriting program.
12
QUALITY CONTROL. The Company's quality control program is intended to
(i) monitor and improve the overall quality of loan production generated by the
Company's retail loan channel, independent mortgage broker channel and
correspondent channel and (ii) identify and communicate to management existing
or potential underwriting and loan packaging problems or areas of concern. The
quality control file review examines compliance with the Company's underwriting
guidelines and federal and state regulations. This is accomplished by focusing
on: (i) the accuracy of all credit and legal information; (ii) a collateral
analysis which may include a desk or field re-appraisal of the property and
review of the original appraisal; (iii) employment and/or income verification;
and (iv) legal document review to ensure that the necessary documents are in
place.
LOAN DISPOSITION
As a fundamental part of its business and financing strategy, the Company
sells loans to third party investors in the secondary markets as market
conditions allow. The Company maximizes opportunities in its loan disposition
transactions by selling its loan production through a combination of
securitizations and whole loan sales, depending on market conditions,
profitability and cash flows. The Company generally realizes higher gain on sale
on securitization than it does on whole loan sales for cash. However, the
upfront overcollateralization and servicing advance obligations required on
retaining the servicing in securitizations are cash flow negative to the Company
in the early years of the securitization. These negative cash flow
considerations along with conditions in the securitization market precluded the
Company from securitizing mortgage loans in the second half of the year ended
June 30, 2000. The Company believes that the Residual Facility will assist the
Company by strengthening its ability to include securitizations in its loan
disposition strategy through reducing the negative cash flow aspects of
securitization and by providing another source of cash to the Company through
periodically converting residual interests into cash.
The higher gain on sale in securitizations transactions is attributable to
the excess servicing spread and mortgage servicing rights associated with
retaining a residual interest and the servicing on the mortgage loans in the
securitization, respectively, net of transactional costs. Generally, in a
securitization, the underlying securities are over-collateralized by the Company
depositing a combination of mortgage loans with a principal balance exceeding
the principal balance of the securities, and cash into the securitization, which
requires a cash outflow. In whole loan sales with servicing released, the gain
on sale is generally lower than gains realized in securitizations, but the
Company receives the gain in the form of cash.
The Company generally seeks to dispose of substantially all of its
production within 90 days. The Company applies the net proceeds of the loan
dispositions, whether through securitizations or whole loan sales, to pay down
its warehouse and repurchase facilities in order to make these facilities
available for future funding of mortgage loans.
The following table sets forth certain information regarding the Company's
securitizations and whole loan sales during the periods presented (in
thousands):
YEAR ENDED JUNE 30,
------------------------------------
2000 1999 1998
---------- ---------- ----------
Loans pooled and sold in
securitizations........................ $ 803,557 $ 649,999 $2,034,300
Whole loan sales......................... 1,419,199 1,236,050 416,390
---------- ---------- ----------
Total loans securitized and sold....... $2,222,756 $1,886,049 $2,450,690
========== ========== ==========
Each agreement that the Company has entered into in connection with its
securitizations requires either the overcollateralization of the trust or the
establishment of a reserve account that may initially be funded by cash
deposited by the Company. If losses exceed the amount of the
overcollateralization or the reserve account, as applicable, the
credit-enhancement aspects of the trust are triggered. In a securitization
credit-enhanced by a monoline insurance policy, any further losses experienced
by holders
13
of the senior interests in the related trust will be paid under such policy. To
date, there have been no claims on any monoline insurance policy obtained in any
of the Company's securitizations. In a senior/ subordinated structure, losses in
excess of the overcollateralization amount generally are allocated first to the
holders of the subordinated interests and then to the holders of the senior
interests of the trust. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources--The Securitization and Sale of Mortgage Loans."
LOAN SERVICING
Servicing includes collecting and remitting loan payments, accounting for
principal and interest, contacting delinquent borrowers, managing borrower
defaults and liquidating foreclosed properties. It is the Company's strategy to
build and retain its core servicing portfolio. The Company believes that the
business of loan servicing provides a more consistent revenue stream and is less
cyclical than the business of loan origination and disposition. The Company
generally retains the servicing rights to the residential loans it securitizes.
However, in the securitization completed by the Company on September 21, 2000,
the Company sold its servicing rights, together with the rights to prepayment
penalties because the gain realized on sale was higher than what the Company
would have realized had the mortgage servicing rights and the rights to
prepayment fees been retained, and the gain was for cash. Moreover, the Company
does not generally retain servicing on loans it sells in whole loan sales for
cash. The Company's servicing portfolio is subject to reduction by normal
monthly principal amortization, by voluntary prepayment and by foreclosure. The
following table sets forth certain information regarding the Company's servicing
portfolio for the periods indicated:
YEAR ENDED JUNE 30,
------------------------------------------
2000 1999 1998
---------- ---------- ----------
(IN THOUSANDS)
Servicing portfolio (period end)....... $3,560,000(1) $3,841,000(2) $4,147,000(3)
Serviced in-house...................... 3,296,000 3,428,000 3,941,000
Loan service revenue................... 15,654 23,329 10,634
- ------------------------
(1) Includes $280.2 million of loans subserviced for others on an interim basis
and approximately 265.4 million of loans subserviced by others.
(2) Includes $84.0 million of loans subserviced for others on an interim basis
and approximately $413.0 million of loans subserviced by others.
(3) Includes $82.0 million of loans subserviced for others on an interim basis.
14
The following table illustrates the mix of credit grades in the Company's
servicing portfolio as of June 30, 2000 (dollars in thousands):
WEIGHTED
AVERAGE
COMBINED WEIGHTED AVERAGE
DOLLAR AMOUNT % OF INITIAL ORIGINAL
CREDIT GRADE(1) OF LOAN TOTAL LOAN-TO-VALUE INTEREST RATE
- --------------- ------------- -------- ------------- ----------------
A............................. $ 808,000 23% 78% 9.6%
A-............................ 1,268,000 35 76 10.2
B............................. 840,000 23 74 10.9
C............................. 309,000 9 69 11.8
C-............................ 97,000 3 65 12.8
D............................. 234,000 7 62 13.7
Other (2)..................... 4,000 0 53 11.3
---------- --- --- ----
Total......................... $3,560,000 100% 74% 10.7%
========== === === ====
- ------------------------
(1) Loans underwritten under the "SNAP" Underwriting Program are assigned, for
loan servicing purposes, a credit grade that the Company believes correlates
to the credit grades in the "Traditional" underwriting program.
(2) Consists of older loans that were not assigned a credit grade at
origination.
At June 30, 2000, of the Company's $3.6 billion servicing portfolio, 92.6%
was serviced in-house compared to 89.2% of the Company's $3.8 billion servicing
portfolio serviced in-house at June 30, 1999 and 95.0% of the Company's
$4.1 billion servicing portfolio at June 30, 1998. During the year ended
June 30, 1999, in order to reduce its servicing advance obligations, the Company
entered into an arrangement with a loan servicing company whereby the servicing
company purchased certain cumulative advances and agreed to make future
servicing advances with respect to an aggregate of $388.0 million
($265.4 million at June 30, 2000) in principal amount of loans.
The agreements between the Company and the real estate mortgage investment
conduit ("REMIC") or owner trusts established in connection with securitizations
typically require the Company, in its role as servicer, to advance interest (but
not principal) on delinquent loans to the holders of the senior interests in the
related trusts. The agreements also require the Company to make certain
servicing advances (e.g., for property taxes or hazard insurance) unless the
Company determines that such advances would not be recoverable. Realized losses
on the loans are paid out of the related loss reserves established by the
Company at the time of securitization or paid out of principal and interest
payments or overcollateralized amounts as applicable, and if necessary, from the
related monoline insurance policy or the subordinated interests.
In the case of securitizations credit-enhanced by monoline insurance, the
agreements also typically provide that the Company may be terminated as servicer
by the monoline insurance company (or by the trustee with the consent of the
monoline insurance company) upon certain events of default, including the
Company's failure to perform its obligations under the servicing agreement, the
rate of over 90-day delinquency (including properties acquired by foreclosure
and not sold) exceeding specified limits, losses on liquidation of collateral
exceeding certain limits, any payment being made by the monoline insurance
company under its policy, and certain events of bankruptcy or insolvency. At
June 30, 2000, ten trusts representing approximately 18.0% (by dollar volume) of
the Company's servicing portfolio exceeded the specified delinquency rate. Nine
of the ten trusts representing approximately 17.6% (by dollar volume) of the
Company's servicing portfolio exceeded specified loss limits at June 30, 2000.
In addition, under the Company's 1999 Securitization Trusts, the Company is
appointed as a servicer on a term-to-term basis, and the monoline insurer has
the right not to renew
15
the term at any time. None of the servicing rights of the Company have been
terminated. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Risk Factors--Our Right to Service Loans
May be Terminated Because of the High Delinquencies and Losses on the Loans in
Our Servicing Portfolio." In the case of the Company's senior/subordinated
securitization transactions, holders of 51% of the certificates may terminate
the servicer upon certain events of default generally relating to certain levels
of loss experience, but not delinquency rates. No such events of default have
occurred to date in the Company's senior/subordinated securitizations.
The Company receives a servicing fee based on a percentage of the declining
principal balance of each loan serviced. Servicing fees are collected by the
Company out of the borrower's monthly payments. In addition, the Company, as
servicer, generally receives all late fees and assumption charges paid by the
borrower on loans serviced directly by the Company, as well as other
miscellaneous fees for performing various loan servicing functions. The Company
also generally receives any prepayment fees paid by borrowers. Under
arrangements entered into in fiscal 2000 and 1999 with an investment bank to
reduce the Company's servicing advances, the Company's right to receive fees,
charges and prepayment fees collected on loans in its securitization trusts has
been subordinated to the right of the investment bank to such fees to repay
advances previously made to those trusts. Under the Company's December 1999
Securitization Trusts, the Company's right to receive any prepayment penalties
collected on loans in the trust has been subordinated to the right to such
prepayment penalties as payment to trust as additional over collateralization.
The Company believes that continued technology and processing enhancements
will provide it with improved margins on its servicing. In general, revenue from
the Company's loan servicing portfolio may be adversely affected by competitive
market conditions that result in lower mortgage interest rates or accelerated
prepayment activity, subject to the receipt by the Company of prepayment fee
income. In some states in which the Company currently operates, prepayment fees
may be limited or prohibited by applicable law.
COLLECTIONS, DELINQUENCIES AND FORECLOSURES
The Company sends borrowers a monthly billing statement approximately ten
days prior to the monthly payment due date. Although borrowers generally make
loan payments within ten to fifteen days after the due date (the "grace
period"), if a borrower fails to pay the monthly payment within the grace
period, the Company commences collection efforts by notifying the borrower of
the delinquency. In the case of borrowers in the "B," "C," "C-" and "D" credit
grades, collection efforts begin immediately after the due date. The Company
continues contact with the borrower to determine the cause of the delinquency
and to obtain a commitment to cure the delinquency at the earliest possible
time.
As a general matter, if efforts to obtain payment have not been successful,
a pre-foreclosure notice will be sent to the borrower immediately after the due
date of the next subsequently scheduled installment (five days after the initial
due date for C- and D credit grades), providing 30 days' notice of impending
foreclosure action. During the 30-day notice period, collection efforts continue
and the Company evaluates various legal options and remedies to protect the
value of the loan, including arranging for extended prepayment terms, accepting
a deed-in-lieu of foreclosure, entering into a short sale (a sale for less than
the outstanding principal amount) or commencing foreclosure proceedings. If no
substantial progress has been made in collecting delinquent payments from the
borrower, foreclosure proceedings will begin. Generally, the Company will have
commenced foreclosure proceedings when a loan is 45 to 100 days delinquent,
depending upon credit grade, other credit considerations or borrower bankruptcy
status.
Servicing and collection practices change over time in accordance with,
among other things, the Company's business judgment, changes in portfolio
performance and applicable laws and regulations.
16
Loans originated or purchased by the Company are secured by mortgages, deeds
of trust, security deeds or deeds to secure debt, depending upon the prevailing
practice in the state in which the property securing the loan is located.
Depending on local law, foreclosure is effected by judicial action or
nonjudicial sale, and is subject to various notice and filing requirements. In
general, the borrower, or any person having a junior encumbrance on the real
estate, may cure a monetary default by paying the entire amount in arrears plus
other designated costs and expenses incurred in enforcing the obligation during
a statutorily prescribed reinstatement period. Generally, state law controls the
amount of foreclosure expenses and costs, including attorneys' fees, which may
be recovered by a lender, the minimum time required to foreclose and the
reinstatement or redemption rights of the borrower.
Although foreclosure sales are typically public sales, frequently no
third-party purchaser bids in excess of the lender's lien because of the
difficulty of determining the exact status of title to the property, the
possible deterioration of the property during the foreclosure proceedings and a
requirement that the purchaser pay for the property in cash or by cashier's
check. Thus, the Company often purchases the property from the trustee or
referee through a credit bid in an amount up to the principal amount outstanding
under the loan, accrued and unpaid interest, servicing advances and the expenses
of foreclosure. Depending upon market conditions, the ultimate proceeds of the
sale may not equal the Company's investment in the property.
The Company has historically experienced delinquency rates that are higher
than those prevailing in its industry due to its origination of lower credit
grade loans. During the year ended June 30, 1997, the Company started to focus
more on higher credit grade loans which should cause delinquencies in the
Company's servicing portfolio to decrease in the future. If the Company were to
sell 100% of its loans in the whole loan market on a servicing released basis,
the Company would not be adding new loans to the servicing portfolio. The
seasoning of the old portfolio without the addition of new loans might cause
delinquency rates to rise. The delinquency rate at June 30, 2000 was 13.6%
compared to 15.7% at June 30, 1999.
During the fiscal year ended June 30, 2000, losses on loan liquidations
increased to $96.1 million from $51.7 million in the prior year primarily due to
seasoning of the loans purchased in bulk and included in the Company's earlier
trusts. The Company has eliminated its bulk purchase program. Credit losses
incurred by the Company on liquidation were disproportionately higher for
correspondent loans purchased in bulk than experienced upon liquidations of
loans originated in the Company's core production channels. During the year
ended June 30, 2000, approximately 57.0% of losses on liquidation were from
losses on disposition of real estate collateral for bulk purchased correspondent
loans. In turn, bulk purchased correspondent loans comprised approximately 34.0%
of the Company's servicing portfolios when measured at July 1, 1999. The
seasoning of the bulk purchased portfolio may continue this trend in losses
during the current fiscal year. Further, the adverse market conditions that
existed during the fall of 1998 have resulted in the tightening in underwriting
guidelines by purchasers of whole loans and the insolvency of several large
subprime home equity lenders. These factors have had the effect of decreasing
the availability of credit to delinquent lower credit grade borrowers who in the
past had avoided default by refinancing. Management believes that continuance of
these factors will contribute to the Company's losses during the current fiscal
year.
Because foreclosures and losses typically occur months or years after a loan
is originated, data relating to delinquencies, foreclosures and losses as a
percentage of the current portfolio can understate the risk of future
delinquencies, losses or foreclosures.
17
The following table sets forth delinquency, foreclosure and loss information
relating to the Company's servicing portfolio as of or for the periods
indicated:
AT OR DURING THE YEAR ENDED JUNE 30,
------------------------------------------
2000 1999 1998
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Percentage of dollar amount of delinquent
loans to loans serviced (period
end)(1)(2)(3)(4)
One Month............................... 1.9% 2.4% 3.8%
Two Months.............................. 0.8 1.0 1.3
Three or More Months
Not foreclosed(5)..................... 9.0 10.3 9.0
Foreclosed(6)......................... 1.9 2.0 1.5
---------- ---------- ----------
Total............................... 13.6% 15.7% 15.6%
========== ========== ==========
Percentage of dollar amount of loans
foreclosed during the period to loans
serviced(4)(8).......................... 3.6% 2.9% 2.0%
Number of loans foreclosed during the
period.................................. 1,854 1,680 1,125
Principal amount of foreclosed loans
during the period....................... $ 135,629 $ 122,445 $ 84,613
Number of loans liquidated during the
period.................................. 2,749 1,518 812
Net losses on liquidations during the
period(7)............................... $ 96,119 $ 51,730 $ 26,488
Percentage of annualized losses to average
servicing portfolio(4)(8)............... 2.6% 1.2% .7%
Servicing portfolio at period end......... $3,560,000 $3,841,000 $4,147,000
- ------------------------------
(1) Delinquent loans are loans for which more than one payment is past due.
(2) The delinquency and foreclosure percentages are calculated on the basis of
the total dollar amount of mortgage loans serviced by the Company and any
subservicers as of the end of the periods indicated.
(3) At June 30, 2000, the dollar volume of loans delinquent more than 90 days in
the Company's ten REMIC trusts exceeded the permitted limit in the related
pooling and servicing agreements. Nine of those trusts exceeded certain loss
limits. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Certain Accounting Considerations;" and
"--Risk Factors--Our Right to Service Loans May Be Terminated Because of the
High Delinquencies and Losses on the Loans in Our Servicing Portfolio".
(4) The servicing portfolio used in percentage calculations includes loans
subserviced for others by the Company on an interim basis of
$280.2 million, $84.0 million and $82.0 million at June 30, 2000, 1999, and
1998, respectively.
(5) Represents loans which are in foreclosure but as to which foreclosure
proceedings have not concluded.
(6) Represents properties acquired following a foreclosure sale and still
serviced by the Company at period end.
(7) Represents losses, net of gains, on properties sold through foreclosure or
other default management activities during the periods indicated.
(8) The percentage for periods subsequent to June 30, 1998 were calculated to
reflect the dollar volume of loans foreclosed or annualized losses, as the
case may be, to the average dollar amount of mortgage loans serviced by the
Company and any subservicer's during the related periods indicated.
18
COMPETITION
The Company faces intense competition in the business of originating,
purchasing and selling mortgage loans. The Company's competitors in the industry
include consumer finance companies, mortgage banking companies, investment
banks, commercial banks, credit unions, thrift institutions, credit card issuers
and insurance companies. Many of these competitors are substantially larger and
have considerably greater financial, technical and marketing resources than the
Company. In addition, the current level of gains realized by the Company and its
competitors on the sale of non-conforming loans could attract additional
competitors into this market. Competition among industry participants can take
many forms, including convenience in obtaining a loan, customer service,
marketing and distribution channels, amount and term of the loan, loan
origination fees and interest rates. Additional competition may lower the rates
the Company can charge borrowers and increase the price paid for purchased
loans, thereby potentially lowering gain on future loan sales and
securitizations. To the extent any of these competitors significantly expand
their activities in the Company's market, the Company could be materially
adversely affected. Fluctuations in interest rates and general economic
conditions may also affect competition. During periods of rising rates,
competitors that have locked in lower rates to potential borrowers may have a
competitive advantage. During periods of declining rates, competitors may
solicit the Company's customers to refinance their loans.
The Company believes its competitive strengths include: (i) emphasizing
customer service to attract borrowers; (ii) providing a high level of service to
brokers and their customers; (iii) offering competitive loan programs for
borrowers whose needs are not met by conventional mortgage lenders;
(iv) providing convenience to the customer through the Company's nationwide
network of retail and broker offices and the internet; and (v) emphasizing
customer service in its loan servicing division.
REGULATION
The Company's operations are subject to extensive regulation, supervision
and licensing by federal, state and local governmental authorities and are
subject to various laws and judicial and administrative decisions imposing
requirements and restrictions on part or all of its operations. The Company's
consumer lending activities are subject to the Federal Truth-in-Lending Act and
Regulation Z (including the Home Ownership and Equity Protection Act of 1994),
the Federal Equal Credit Opportunity Act, as amended, and Regulation B, the Fair
Credit Reporting Act of 1970, as amended, the Federal Real Estate Settlement
Procedures Act and Regulation X, the Home Mortgage Disclosure Act, the Federal
Debt Collection Practices Act and the National Housing Act of 1934, as well as
other federal and state statutes and regulations affecting the Company's
activities. The Company is also subject to the rules and regulations of, and
examinations by, state regulatory authorities with respect to originating,
processing, underwriting, selling, securitizing and servicing loans. These rules
and regulations, among other things, impose licensing obligations on the
Company, establish eligibility criteria for mortgage loans, prohibit
discrimination, govern inspections and appraisals of properties and credit
reports on loan applicants, regulate assessment, collection, foreclosure and
claims handling, investment and interest payments on escrow balances and payment
features, mandate certain disclosures and notices to borrowers and, in some
cases, fix maximum interest rates, fees and mortgage loan amounts. A significant
portion of the Company's mortgage loans are so-called "high cost mortgage loans"
where the borrower is charged points and fees or interest rates above certain
levels. Such high cost mortgage loans are subject to special disclosure
requirements and certain substantive prohibitions under the Home Ownership and
Equity Protection Act of 1994 and regulations thereunder, and certain state
laws. The federal regulations governing high cost mortgage loans establish
guidelines for determination of whether an individual loan is a high cost
mortgage loan. Such guidelines may be interpreted differently by different
lenders. Federal regulations on high cost mortgage loans make assignees of such
mortgage loans liable for violations of the regulations. As a result of the
increased regulation and scrutiny of high cost mortgage loans, certain lenders,
including certain purchasers of the
19
Company's loans, will not purchase high cost mortgage loans. In addition, there
has been recent class action litigation and regulatory actions by certain state
agencies against lenders for violations of high cost mortgage regulations. The
Company has not to date been subject to any material class action litigation or
regulatory action.
Failure to comply with these requirements can lead to loss of approved
status, certain rights of rescission for mortgage loans, individual and class
action lawsuits and administrative enforcement action. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations--Risk
Factors--If We are Unable to Comply with Mortgage Banking Rules and Regulations,
Our Ability to Make Mortgage Loans May be Restricted."
In the course of its business, the Company may acquire properties as a
result of foreclosure. There is a risk that hazardous or toxic waste could be
found on such properties. In such event, the Company could be held responsible
for the cost of cleaning up or removing such waste, and such cost could exceed
the value of the underlying properties.
The Company is also subject to various other federal and state laws
regulating the issuance and sale of securities, relationships with entities
regulated by the Employee Retirement Income Security Act of 1974, as amended,
and other aspects of its business.
EMPLOYEES
At June 30, 2000, the Company employed 1,476 persons. The Company has
satisfactory relations with its employees.
ITEM 2. PROPERTIES
The executive and administrative offices of the Company are located at 350
S. Grand Avenue, Los Angeles, California, and consist of approximately 178,000
square feet. The Company is attempting to sublet a significant amount of these
premises. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations--Fiscal Years 2000,
1999 and 1998--Expenses." The lease on these premises extends through
February 2012. The Company also leases approximately 39,000 square feet of
office space at its former headquarters location at 3731 Wilshire Boulevard, Los
Angeles, California, which it uses for its telemarketing operations and its
internet production related operations. This lease expires in December 2008. The
administrative offices of the Company's Irvine office are located at 3347
Michaelson Drive, Irvine, California, and consist of approximately 47,000 square
feet. The lease on these premises extends through July 31, 2003.
The Company also leases space for its retail branch and broker regional
offices. These facilities aggregate approximately 264,000 square feet and are
leased under terms which vary as to duration. In general, the leases expire
between 2000 and 2005, and provide for rent escalations tied to either increases
in the lessor's operating expenses or fluctuations in the consumer price index
in the relevant geographical area.
20
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in litigation arising in the normal course of
business. The Company believes that any liability with respect to such legal
actions, individually or in the aggregate, is not likely to be material to the
Company's consolidated financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of fiscal 2000 to a vote
of the security holders of the Company.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
In November 1995, the Company's common stock began trading under the symbol
AAM on the NYSE. The Company was notified in writing by the NYSE on
September 12, 2000 that the average closing price per share of the Company's
Common Stock was below the NYSE's minimum stock price requirement of $1.00 per
share as of the thirty trading-day period ended July 19, 2000. Pursuant to the
NYSE Notice, the Company has until December 29, 2000 to raise the thirty day
average closing price of the Common Stock above $1.00 per share or the NYSE will
suspend the Company's listing and apply to the Securities and Exchange
Commission ("SEC") for delisting. This was an extension of time from the NYSE
for the Company to meet the minimum stock price requirement. As previously
reported, the Company was originally notified in writing by the NYSE on
December 2, 1999 that the average price of the Company's Common Stock was below
the NYSE's minimum stock price requirement as of October 29, 1999. As previously
reported, on April 14, 2000, the Company effected a one for five reverse stock
split of the issued and outstanding shares of Common Stock and Series C
Preferred Stock, among other reasons, to increase the market price of each share
of Common Stock. The closing price of the Common Stock on September 27, 2000 was
$1.5625 per share and the average closing price for the thirty trading-day
period ended September 27, 2000 was $1.45 per share. There can be no assurance
that the thirty day average closing price of the Common Stock will remain above
$1.00 per share or that the Common Stock will not be delisted by the NYSE. If
the Common Stock were delisted by the NYSE, it would seriously impair the
ability of Common stockholders to trade their shares. The following table sets
forth the range of high and low sale prices and per share cash dividends
declared for the periods indicated.
CASH
HIGH LOW DIVIDEND
-------- -------- --------
Fiscal 2000*
First Quarter.................................. $ 9.063 $ 3.750 --
Second Quarter................................. 7.500 3.080 --
Third Quarter.................................. 4.688 2.500 --
Fourth Quarter................................. 3.125 0.813 --
Fiscal 1999*
First Quarter.................................. $66.875 $30.315 $0.17
Second Quarter................................. 24.065 6.250 --
Third Quarter.................................. 17.190 6.875 --
First Quarter.................................. 10.000 6.565 --
- ------------------------
* As reported by Bloomberg
As of September 27, 2000, the Company had 318 stockholders of record. No
common share dividends were accrued or paid in the year ended June 30, 2000. The
Company accrued and
21
subsequently paid an aggregate of $0.17 per common share in dividends for the
fiscal year ended June 30, 1999. The Company declared and subsequently paid an
aggregate of $0.66 per common share in dividends for the fiscal year ended
June 30, 1998, representing approximately 13.7% of its net income for the
period. The Board of Directors of the Company reviews the Company's dividend
policy at least annually in light of the earnings, cash position and capital
needs of the Company, general business conditions and other relevant factors. In
November 1998, the Board of Directors decided to suspend cash dividends on the
common stock until the Company's earnings and cash flows improved. Credit
agreements generally limit the Company's ability to pay dividends if such
payment would result in an event of default under the agreements or would
otherwise cause a breach of a net worth or liquidity covenants. The Company's
Indenture relating to its 9.125% Senior Notes due 2003 prohibits the payment of
dividends if the aggregate amount of such dividends since October 26, 1996
exceeds the sum of (a) 25% of the Company's net income during that period (minus
100% of any deficit); (b) net cash proceeds from any securities issuances; and
(c) proceeds from the sale of certain investments. The Company's Indenture of
Trust relating to its 10.50% Senior Notes due 2002 restricts the payment of
dividends to an amount which does not exceed (i) $2.0 million, plus (ii) 50% of
the Company's aggregate net income for each fiscal year after the year ended
June 30, 1994 (minus 100% of net losses for any fiscal year), plus (iii) 100% of
the net proceeds received by the Company on offerings of its equity securities
after December 31, 1994. Under the most restrictive of these limitations, the
Company will be prohibited from paying cash dividends on its capital stock for
the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below with respect to the
Company for the five years ended June 30, 2000 have been derived from the
audited consolidated financial statements. The selected consolidated financial
data should be read in conjunction with the consolidated financial
22
statements and notes thereto and other financial information included herein.
The selected consolidated financial data gives effect to the acquisition of One
Stop in August 1996.
YEAR ENDED JUNE 30,
--------------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenue:
Gain on sale of loans............................... $ 48,098 $ 44,855 $ 120,828 $ 135,421 $ 71,255
Valuation (write-down) of residual interests and
mortgage servicing rights......................... (82,490) (194,551) 19,495 (18,950) --
Origination fees.................................... 37,951 39,689 34,282 35,616 27,505
Loan servicing...................................... 15,654 23,329 10,634 14,096 9,863
Interest income..................................... 94,569 70,525 81,250 48,348 19,805
---------- ---------- ---------- ---------- ----------
Total revenue, including valuation (write-down) of
residual interests and mortgage servicing
rights.......................................... 113,782 (16,153) 266,489 214,531 128,428
Total expenses...................................... 232,785 261,996 213,683 205,071 89,541
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes................... (119,003) (278,149) 52,806 9,460 38,887
Provision (benefit) for income taxes................ 3,369 (30,182) 25,243 7,982 17,814
---------- ---------- ---------- ---------- ----------
Net income (loss)................................... $ (122,372) $ (247,967) $ 27,563 $ 1,478 $ 21,073
---------- ---------- ---------- ---------- ----------
Net income (loss) per common share (diluted)........ $ (21.02) $ (40.31) $ 4.36 $ 0.26 $ 4.08
========== ========== ========== ========== ==========
Weighted average number of common shares outstanding
(in thousands) (diluted).......................... 6,209 6,200 7,150 5,674 5,450
========== ========== ========== ========== ==========
Cash dividends paid per common share................ $ -- $ 0.17 $ 0.66 $ 0.65 $ 0.66
========== ========== ========== ========== ==========
CASH FLOW DATA:
Cash provided by (used in) operating activities....... $ 99,391 $ (466,966) $ (49,661) $ (280,073) $ (241,073)
Cash used in investing activities..................... (2,664) (5,229) (5,163) (8,864) (5,885)
Cash provided by (used in) financing activities....... (107,312) 480,637 40,244 291,898 250,540
Net increase (decrease) in cash and cash
equivalents......................................... (10,585) 8,442 (14,580) 2,961 3,582
OTHER DATA:
Loans originated or purchased:
Broker network...................................... $1,262,900 $1,182,100 $1,101,200 $ 741,000 $ 319,800
Retail loans........................................ 783,700 770,000 636,100 436,900 220,900
Correspondent loans................................. 32,700 241,500 646,300 1,170,000 628,200
---------- ---------- ---------- ---------- ----------
Total............................................. $2,079,300 2,193,600 2,383,600 2,347,900 1,168,900
========== ========== ========== ========== ==========
Whole loans sold...................................... $1,419,199 $1,236,050 $ 416,390 $ 7,500 $ 202,200
Loans pooled and sold in securitizations.............. 803,557 649,999 2,034,300 2,262,700 791,300
Loans serviced at period end.......................... 3,560,000 3,841,000 4,147,000 3,174,000 1,370,000
Weighted average points on retail loan
originations(1)..................................... 4.7% 4.8% 4.3% 4.9% 7.7%
Weighted average interest rate(1)..................... 10.2 9.8 10.1 10.6 11.3
Weighted average initial combined loan-to-value
ratio(1)(2):
Retail loans........................................ 73 72 70 67 60
Broker network...................................... 78 76 75 71 68
Correspondent loans................................. 81 80 79 71 66
At period end:
Number of retail branch offices..................... 100 101 103 56 48
Number of broker offices............................ 7 35 52 37 25
23
AT JUNE 30,
------------------------------------------------------
2000 1999 1998 1997 1996
-------- ---------- -------- -------- --------
BALANCE SHEET DATA:
Cash and cash equivalents...................... $ 10,179 $ 20,764 $ 12,322 $ 26,902 $ 23,941
Residual interests and mortgage servicing
rights....................................... 303,302 353,255 522,632 360,892 167,740
Total assets................................... 790,364 1,021,097 815,187 717,595 401,524
-------- ---------- -------- -------- --------
10.5% Senior Notes due 2002.................... 11,500 17,250 23,000 23,000 23,000
9.125% Senior Notes due 2003................... 150,000 150,000 150,000 150,000 --
5.5% Convertible Subordinated Debentures due
2006......................................... 113,970 113,970 113,990 113,990 115,000
Other long-term debt........................... -- -- -- -- 45
-------- ---------- -------- -------- --------
Total long-term debt......................... 275,470 281,220 286,990 286,990 138,045
Stockholders' equity........................... 74,478 145,556 304,051 239,755 120,461
- ------------------------
(1) Computed on loans originated or purchased during the fiscal year presented.
(2) The weighted average initial combined loan-to-value ratio is determined by
dividing the sum of all loans secured by the junior or senior mortgages on
the property by the appraised value at origination.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion should be read in conjunction with Item 6. Selected
Financial Data and Item 8. Financial Statements and Supplementary Data.
SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION
This Report contains statements that constitute "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934 and
Section 27A of the Securities Act of 1933. The words "expect," "estimate,"
"anticipate," "predict," "believe," and similar expressions and variations
thereof are intended to identify forward-looking statements. Such statements
appear in a number of places in this filing and include statements regarding the
intent, belief or current expectations of the Company, its directors or officers
with respect to, among other things (a) market conditions in the securitization,
capital, credit and whole loan markets and their future impact on the Company's
operations, (b) trends affecting the Company's liquidity position, including,
but not limited to, its access to warehouse, working capital and other credit
facilities and its ability to effect securitizations and whole loan sales,
(c) the impact of the various cash savings plans and other restructuring
strategies being considered by the Company, (d) the Company's on-going efforts
in improving its equity position, (e) trends affecting the Company's financial
condition and results of operations, and (f) the Company's business and
liquidity strategies. The stockholders of the Company are cautioned not to put
undue reliance on such forward-looking statements. Such forward-looking
statements are not guarantees of future performance and involve risks and
uncertainties. Actual results may differ materially from those projected in this
Report, for the reasons, among others, discussed under the captions "Item 1.
Business and Risk Factors." The Company undertakes no obligation to publicly
revise these forward-looking statements to reflect events or circumstances that
arise after the date hereof. Readers should carefully review the factors
referred to above and the other documents the Company files from time to time
with the Securities and Exchange Commission, including the quarterly reports on
Form 10-Q filed by the Company during fiscal 2001 and any current reports on
Form 8-K filed by the Company.
24
CERTAIN ACCOUNTING CONSIDERATIONS
ACCOUNTING FOR SECURITIZATIONS. The Company's loan disposition strategy
relies on a combination of securitization transactions and whole loan sales. The
following discusses certain accounting considerations which arise only in the
context of securitization transactions.
In a securitization, the Company conveys loans that it has originated or
purchased to a separate entity (such as a trust) in exchange for cash proceeds
and a residual interest in the trust. The cash proceeds are raised through an
offering of the pass-through certificates or bonds evidencing the right to
receive principal payments and interest on the certificate balance or on the
bonds. The non-cash gain on sale of loans represents the difference between the
proceeds (including premiums) from the sale, net of related transaction costs,
and the allocated carrying amount of the loans sold. The allocated carrying
amount is determined by allocating the original cost basis of the loans
(including premiums paid on loans purchased) between the portion sold and any
retained interests (residual interests), based on their relative fair values at
the date of transfer. The residual interests represents, over the estimated life
of the loans, the present value of the estimated cash flows. These cash flows
are determined by the excess of the weighted average coupon on each pool of
loans sold over the sum of the interest rate paid to investors, the contractual
servicing fee, a monoline insurance fee, if any, and an estimate for loan
losses. Each agreement that the Company has entered into in connection with its
securitizations requires either the overcollateralization of the trust or the
establishment of a reserve account that may initially be funded by cash
deposited by the Company.
The Company determines the present value of the cash flows at the time each
securitization transaction closes using certain estimates made by management at
the time the loans are sold. These estimates include: (i) future rate of
prepayment; (ii) credit losses; and (iii) discount rate used to calculate
present value. The future cash flows represent management's best estimate.
Management monitors the performance of the loans, and any changes in the
estimates are reflected in earnings. There can be no assurance of the accuracy
of management's estimates.
The residual interests are recorded at estimated fair value and are marked
to market through a charge (or credit) to earnings. On a quarterly basis, the
Company reviews the fair value of the residual interests by analyzing its
prepayment, credit loss and discount rate assumptions in relation to its actual
experience and current rates of prepayment and credit loss prevalent in the
industry. The Company may adjust the value of the residual interests or take a
charge to earnings related to the residual interests, as appropriate, to reflect
a valuation or write-down of its residual interests based upon the actual
performance of the Company's residual interests as compared to the Company's key
assumptions and estimates used to determine fair value. Although management
believes that the assumptions to estimate the fair values of its residual
interests are reasonable, there can be no assurance as to the accuracy of the
assumptions or estimates.
RATE OF PREPAYMENT. The estimated life of the securitized loans depends on
the assumed annual prepayment rate which is a function of estimated voluntary
(full and partial) and involuntary (liquidations) prepayments. The prepayment
rate represents management's expectations of future prepayment rates based on
prior and expected loan performance, the type of loans in the relevant pool
(fixed or adjustable rate), the production channel which produced the loan,
prevailing interest rates, the presence of prepayment penalties, the
loan-to-value ratios and the credit grades of the loans included in the
securitization and other industry data. The rate of prepayment may be affected
by a variety of economic and other factors.
CREDIT LOSSES. In determining the estimate for credit losses on loans
securitized, the Company uses assumptions that it believes are reasonable based
on information from its prior securitizations, the loan-to-value ratios and
credit grades of the loans included in the securitizations, loss and delinquency
information by origination channel, and information available from other market
participants such as investment bankers, credit providers and credit agencies.
On a quarterly basis, the Company re-evaluates its credit loss estimates.
25
DISCOUNT RATE. In order to determine the fair value of the cash flow from
the residual interests, the Company discounts the cash flows based upon rates
prevalent in the market.
The actual performance of the Company's residual interests as compared to
the key assumptions and estimates used to evaluate their carrying value resulted
in valuation adjustments to the residual interests of $77.5 million and
$188.6 million during the years ended June 30, 2000 and 1999, respectively.
The $77.5 million valuation adjustment recorded during the year ended
June 30, 2000 was comprised of unfavorable adjustments of $86.3 million taken in
light of higher than expected credit loss experience and $12.3 million due to
the effects of rising interest rates on excess spreads which were offset by a
favorable $21.1 million adjustment due to actual prepayment rate trends compared
to prepayment rate assumptions.
The $188.6 million valuation adjustment recorded during the year ended
June 30, 1999 was comprised of unfavorable adjustments of $62.1 million,
$67.2 million and $64.5 million made to the rate of prepayment, credit loss and
discount rate assumptions, respectively, offset by a positive valuation
adjustment of $5.2 million.
Certain historical data and key assumptions and estimates used by the
Company in its June 30, 2000 review of the residual interests were the
following:
Prepayments:
Actual weighted average annual prepayment rate, as a
percentage of outstanding principal balance of
securitized loans, during the year ended June 30, 2000... 30.9%
Estimated peak annual prepayment rates, as a percentage
of outstanding principal balance of securitized loans:
Fixed rate loans....................................... 22.3% to 29.5%
Adjustable rate loans.................................. 36.7% to 46.3%
Estimated weighted average life of securitized loans..... 3.1 years
Credit losses:
Actual credit losses to date, as a percentage of original
principal balances of securitized loans................ 2.6%
Future estimated prospective credit losses, as a
percentage of original principal balances of
securitized loans...................................... 2.0%
Total actual and estimated prospective credit losses, as
a percentage of original principal balance of
securitized loans...................................... 4.6%
Total actual credit losses to date and estimated
prospective credit losses (dollars in thousands)....... $323,634
Discount rate.............................................. 15.0%
Additionally, upon sale or securitization of servicing retained mortgages,
the Company capitalizes the fair value of mortgage servicing rights ("MSRs")
assets separate from the loan. The Company determines fair value based on the
present value of estimated net future cash flows related to servicing income.
The cost allocated to the servicing rights is amortized over the period of
estimated net future servicing fee income. The Company periodically reviews the
valuation of its MSR's. This review is performed on a desegregated basis for the
predominant risk characteristics of the underlying loans which are loan type and
origination date.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities." ("SFAS 133") SFAS No. 133 requires companies to record derivatives
on the balance sheet as assets and liabilities, measured at fair value. Gains
and losses resulting from changes in the values of those derivatives would be
accounted for in earnings. Depending on the use of the derivative and the
satisfaction of other requirements, special hedge accounting may apply. At
June 30, 2000, the Company had no freestanding derivative instruments in place
and had no material amounts of embedded derivative instruments. The Company
adopted SFAS 133 on July 1, 2000. Based upon the Company's application of SFAS
No. 133, its adoption had no materially adverse effect on the Company's
consolidated financial statements.
26
RESULTS OF OPERATIONS--FISCAL YEARS 2000, 1999 AND 1998
The following table sets forth information regarding the components of the
Company's revenue and expenses in fiscal 2000, 1999 and 1998:
2000 1999 1998
-------------------- -------------------- -------------------
$ % $ % $ %
--------- -------- --------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Revenue:
Gain on sale of loans......... $ 48,098 42.3 % $ 44,855 (277.7)% $120,828 45.3%
Valuation (write-down) of
residual interests and
mortgage servicing rights... (82,490) (72.5) (194,551) 1,204.4 19,495 7.3
Origination fees.............. 37,951 33.4 39,689 (245.7) 34,282 12.9
Loan servicing................ 15,654 13.8 23,329 (144.4) 10,634 4.0
Interest income............... 94,569 83.1 70,525 (436.6) 81,250 30.5
--------- ------ --------- -------- -------- -----
Total revenue, including
valuation (write-down) of
residual interests and
mortgage servicing
rights.................... 113,782 100.0 % (16,153) 100.0 % 266,489 100.0%
--------- ------ --------- -------- -------- -----
Expenses:
Compensation.................. 93,239 81.9 % 80,167 (496.3)% 94,820 35.6%
Production.................... 26,718 23.5 40,061 (248.0) 34,195 12.8
General and administrative.... 60,489 53.2 60,635 (375.4) 40,686 15.3
Interest...................... 52,339 46.0 44,089 (272.9) 43,982 16.5
Nonrecurring charges.......... -- -- 37,044 (229.3) -- --
--------- ------ --------- -------- -------- -----
Total expenses.............. 232,785 204.6 % 261,996 (1,622.0)% 213,683 80.2%
--------- ------ --------- -------- -------- -----
Income (loss) before income
taxes......................... (119,003) (104.6) (278,149) 1,722.0 52,806 19.8
Provision (benefit) for income
taxes......................... 3,369 3.0 (30,182) 186.8 25,243 9.5
--------- ------ --------- -------- -------- -----
Net income (loss)........... $(122,372) (107.6)% $(247,967) 1,535.2 % $ 27,563 10.3%
========= ====== ========= ======== ======== =====
REVENUE
GENERAL. Total revenue during the year ended June 30, 2000 was
$113.8 million, compared to $(16.2) million during the year ended June 30, 1999
and $266.5 million during the year ended June 30, 1998. Included in total
revenue during the years ended June 30, 2000 and 1999 were write-downs of
$82.5 million and $194.6 million, respectively, to the Company's residual
interests and mortgage servicing rights. Included in total revenue during the
year ended June 30, 1998 was a positive valuation adjustment to the Company's
residual interests of $19.5 million.
Excluding the write-downs of residual interests and mortgage servicing
rights, total revenue during the year ended June 30, 2000 increased $17.9
million to $196.3 million compared to $178.4 million, for the year ended
June 30, 1999. The $17.9 million increase in total revenue is attributable
primarily to an increase in gain on sale of loans and interest income, partially
offset by declines in origination fees and loan servicing revenue.
Excluding the $194.6 million write-down of residual interests and mortgage
servicing rights during the year ended June 30, 1999, total revenue of
$178.4 million declined $88.1 million from the $266.5 million reported during
the year ended June 30, 1998. The decline in total revenue during the year ended
June 30, 1999 from a year earlier was comprised of decreases in gain on sale of
loans and interest income, partially offset by increases in origination fees and
loan servicing revenues.
27
GAIN ON SALE OF LOANS. Gain on sale of loans during the year ended
June 30, 2000 was $48.1 million, an increase of $3.2 million, or 7.2%, from the
$44.9 million reported during the year ended June 30, 1999. The increase in gain
on sale of loans during the year end June 30, 2000 over the year ended June 30,
1999 was due to increases in the volume of loans sold in whole loan sales and
securitizations, and higher gains on whole loan sales in fiscal 2000 compared to
fiscal 1999, partially offset by lower gains recorded on securitizations during
the year ended June 30, 2000. During the year ended June 30, 2000, the Company
disposed of $1.4 billion and $803.6 million of loans in whole loan sales and
securitizations, respectively, compared to $1.2 billion of loans in whole loan
sales for cash and $650.0 million of loan dispositions in the form of
securitizations for the year ended June 30, 1999. Gain on sale of loans in
securitizations during the year ended June 30, 2000 were lower than historical
gains due to, among other things, market conditions at the time of the
securitizations, higher margins paid by the Company on the certificates issued
by the securitization trusts and the Company's adoption of revised gain rate
assumptions during the second half of the year ended June 30, 1999. However, the
gain on sale recognized on whole loan sales during the year ended June 30, 2000
were generally higher than the gains recognized during the year ended June 30,
1999 due primarily to improved market conditions during fiscal 2000, changes in
loan product mix and loan pricing and, to a lesser extent, to the volume of
whole loans sold during the year ended June 30, 2000 over that during fiscal
1999. Additionally, gain on sale of loans during the year ended June 30, 1999
was negatively impacted by conditions imposed by whole loan buyers due to the
onset of adverse market conditions in October 1998 and the Company's limited
warehouse capacity which necessitated the expedited sale of loans. As previously
reported, gain on sale during the year ended June 30, 1999 was adversely
effected by a $13.5 million hedge loss.
Gain on sale declined $76.0 million to $44.9 million during the year ended
June 30, 1999 from $120.8 million during the year ended June 30, 1998. The
decrease in gain on sale was due to the $564.6 million decline in loan
dispositions which totaled $1.9 billion in fiscal year 1999, and the higher
volume and percentage of whole loan sales for cash in fiscal 1999, and lower
volume and percentage of securitizations compared to the year ended June 30,
1998. Gains associated with whole loan sales for cash during the year ended
June 30, 1999 were substantially less than the gains associated with the
securitizations during the year ended June 30, 1998. As previously mentioned,
gain on sale during June 30, 1999 was also adversely effected by a
$13.5 million hedge loss.
Subsequent to June 30, 2000, the Company sold approximately $460.0 million
of loans held for sale in a securitization, and sold the residual interest
created in this securitization to an affiliate through the Residual Facility for
cash.
ORIGINATION FEES. Origination fee revenue is primarily comprised of points
charged on mortgage loans originated by the Company and, to a lesser extent,
other fees charged in the loan origination process. Origination fee revenue in
the form of points is primarily a function of the volume of