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As filed with the Securities and Exchange Commission on September 16, 1996.
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1996
[ ] 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
AAMES FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 95-4340340
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3731 WILSHIRE BOULEVARD, 10TH FLOOR
LOS ANGELES, CALIFORNIA 90010
(Address of principal executive offices, including ZIP Code)
(213) 351-6100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each Class
COMMON STOCK, PAR VALUE $0.001
PREFERRED STOCK PURCHASE RIGHTS
10.50% SENIOR NOTES DUE 2002
Securities registered pursuant to Section 12(g) of the Act:
Title of each Class
None
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 .
--- ---
Indicated 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 August 30, 1996, there were outstanding 15,829,824 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 ($47.25 per share) of the Registrant's Common Stock on the New York Stock
Exchange was $747,959,184. For purposes of this computation, it has been assumed
that the shares beneficially held by directors and 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
1996 Annual Meeting of Stockholders 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"), founded in 1954, is
a consumer finance company engaged in the business of originating, purchasing,
selling and servicing home equity mortgage loans secured by single family
residences. The Company's principal market is credit-impaired borrowers who have
significant equity in their homes but whose borrowing needs are not being met by
traditional financial institutions due to credit exceptions or other factors.
The Company focuses its efforts on collateral lending and believes that it
originates and purchases a greater proportion of lower credit grade loans ("C-"
and "D" loans) than most other lenders to credit-impaired borrowers. These lower
credit grade loans are characterized by lower combined loan-to-value ratios and
higher average interest rates than higher credit grade loans ("A-," "B" and "C"
loans). The Company believes lower credit-quality borrowers represent an
underserved niche of the home equity loan market and present an opportunity to
earn a superior return for the risks assumed. Although the Company has
historically experienced delinquency rates that are higher than those prevailing
in its industry, management believes the Company's historical loan losses are
generally lower than those experienced by most other lenders to credit-impaired
borrowers because of the lower combined loan-to-value ratios on the Company's
lower credit grade loans. The mortgage loans originated and purchased by the
Company are generally used by borrowers to consolidate indebtedness or to
finance other consumer needs rather than to purchase homes. Consequently, the
Company believes that it is not as dependent as traditional mortgage bankers on
levels of home sales or refinancing activity prevailing in its markets.
The Company originates and purchases loans through three
production channels. The Company has historically originated its loans through
its retail loan office network. In 1994, the Company diversified its production
channels to include a wholesale correspondent program which consisted initially
of purchasing loans from other mortgage bankers and financial institutions
underwritten in accordance with the Company's guidelines. In fiscal 1996, this
program was expanded to include the purchase of loans in bulk from other
mortgage bankers and financial institutions. On August 28, 1996, the Company
acquired One Stop Mortgage, Inc. ("One Stop"), which further diversified the
Company's production channels to include the originations and purchase of
mortgage loans from a network of independent mortgage brokers. While the Company
intends to continue focusing on its traditional niche in the "C-" and "D" credit
grade loans, the Company also intends to continue to diversify the loans it
originates and purchases through its three production channels to include more
"A-," "B" and "C" credit grade loans. The Company underwrites every loan it
originates and re-underwrites and reviews appraisals on all loans it purchases.
See "-- Mortgage Loan Production -- Underwriting."
Substantially all of the mortgage loans originated and purchased
by the Company are sold in the secondary market through public securitizations
in order to enhance profitability, maximize liquidity and reduce the Company's
exposure to fluctuations in interest rates. In a securitization, the Company
recognizes a gain on the sale of loans securitized upon the closing of the
securitization, but does not receive the excess servicing, which is payable over
the actual life of the loans securitized. The excess servicing represents, over
the estimated life of the loans, the excess of the weighted average interest
rate on the pool of loans sold over the sum of the investor pass-through rate,
normal servicing fee and the monoline insurance fee. The net present value of
that excess (determined based on certain prepayment and loss assumptions) less
transaction expenses is recorded as excess servicing gain or loss at the time of
the closing of the securitization. The Company securitized and sold in the
secondary market $107 million, $317 million and $791 million of loans in the
years ended June 30, 1994, 1995 and 1996, respectively. Each of the Company's
securitizations has been credit-enhanced by insurance provided by a monoline
insurance company to receive ratings of "Aaa" by Moody's Investors Service and
"AAA" from Standard & Poor's.
The Company retains the servicing rights (collecting loan
payments and handling borrower defaults) to substantially all of the loans it
originates or purchases. At June 30, 1996, the Company had a servicing portfolio
of $1.25 billion, 27% of which was serviced by subservicers. In fiscal 1996, the
Company serviced directly all
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loans in its servicing portfolio which were secured by mortgaged properties
located in Arizona, California, Colorado, Nevada, Oregon, Utah and Washington.
Loans secured by properties located in other states were serviced through one or
more subservicers which were paid a fee per loan and a participation in certain
other fees paid by the borrowers. The Company will implement in fiscal 1997 a
new servicing system which will provide the Company the capability to service in
house all loans originated or purchased by it regardless of the state in which
the mortgaged property is located. See "-- Loan Servicing."
BUSINESS STRATEGY
The Company's strategy is to continue to build on its position as
a leading lender to credit-impaired borrowers. The expansion of the Company's
business over the last three years has been driven by the growth in the volume
of loans originated and purchased by the Company and by the Company's ability to
continue to access the capital markets to facilitate the sale of these loans
through securitizations. The Company intends to pursue its growth strategy by
(i) continuing to expand its retail loan office network, wholesale correspondent
program, and independent broker network, (ii) increasing its servicing portfolio
and servicing capabilities; (iii) continuing to enhance its corporate and
operating infrastructure and (iv) diversifying its funding sources. An important
long-term goal of the Company's business strategy is to continue to build its
excess servicing receivable, mortgage servicing rights and residual assets
("Excess Spread Receivables"). The Company believes that its investments in
these assets yield attractive cash on cash returns. In addition, the Company
believes its cash flow profile will change over time as the rate of loan
production growth moderates and as the size of its servicing portfolio and its
Excess Spread Receivables increases. In particular, the Company intends to
employ the following strategies:
Geographic Diversification. The Company plans to continue the
geographic expansion of its loan production. During fiscal 1996, the Company
expanded its retail loan office network into the Midwest and East and continued
to expand its wholesale correspondent network. The Company intends to continue
focusing on its expansion in the Midwest and East and to expand its loan
purchasing capabilities by building new relationships with loan correspondents
and, with the acquisition of One Stop, independent mortgage brokers nationwide
with the goal of increasing market share in these areas.
Diversification of Loan Production Channels. At the beginning of
fiscal 1994, the Company originated virtually all of its mortgage loans through
its retail loan office network. Since that time, the Company has been pursuing a
strategy of diversifying its loan production. The Company has developed a
wholesale correspondent program and has recently added a network of independent
brokers as a production source when it acquired One Stop. The Company intends to
increase production through each of these channels and to diversify the loans it
originates and purchases to include more "A-," "B" and "C" credit grade loans.
Increase Servicing Portfolio; Increase Margins and Develop
Subservicing Capabilities. The Company plans to build the size of its servicing
portfolio to provide a stable, and ultimately a significant, source of recurring
revenue. On June 30, 1996, the Company's servicing portfolio was $1.25 billion,
up 105% from $609 million at the end of the prior year. The Company expects to
increase the size of its loan servicing portfolio by continuing to increase loan
originations and purchases and completing new securitizations. To service this
greater volume and to provide the Company with the capability of servicing its
entire portfolio, the Company is investing in a new servicing system which is
expected to be on line prior to the end of fiscal 1997. This new operation is
expected to increase margins in the Company's servicing operations and to
provide the Company with the capability of subservicing for other mortgage
bankers, a potential new revenue source.
Continue to Enhance Corporate and Operational Management and
Infrastructure. From June 30, 1994 to June 30, 1996, the Company's revenues and
net income grew 255% and 485%, respectively, and its employee base grew from 303
employees at June 30, 1994 to 672 employees at June 30, 1996. To support this
significantly larger operation, the Company has invested in additional corporate
and operating management and infrastructure. The Company has also expanded its
telemarketing operations, including a predictive dialer system which is expected
to be fully operational in fall 1996.
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Continue to Diversify Funding Sources. The Company intends to
continue to expand and diversify its funding sources by adding additional
warehouse and residual financing facilities and seeking to increase the advance
rates on existing and new facilities. In addition, the Company intends to obtain
higher credit ratings by improving its financial condition and operating
results. The Company believes that higher credit ratings, as well as obtaining
higher advance rates on warehouse and residual facilities, should improve the
Company's cash flow over time. In particular, higher credit ratings could
facilitate the Company's use of letters of credit in lieu of cash in
overcollateralization accounts, and the Company's obtaining debt financing at a
lower cost. In addition, the Company intends to improve its liquidity by
exploring alternatives, including: (i) whole loan sales, (ii) monetization of
the excess servicing receivable asset (including sale of interest-only strips),
and (iii) use of senior/subordinated securitization structures which may be more
cash flow efficient than buying monoline insurance. The Company also believes it
will improve its cash flow by improving the efficiency of its servicing
operations and realizing overall operating leverage over time as cash expenses
grow at a slower rate than cash receipts.
RECENT DEVELOPMENTS
One Stop Acquisition. On August 28, 1996, the Company acquired
One Stop, a residential mortgage lender specializing in originating and
purchasing home equity mortgage loans made to credit-impaired borrowers from a
network of independent mortgage brokers. At August 31, 1996, One Stop operated
in 26 states out of 24 offices. The acquisition is part of the Company's
strategy to diversify its mortgage loan production sources and to expand the
geographic scope of its operations. The acquisition was accomplished through the
merger of a wholly-owned subsidiary of the Company into One Stop, in a tax-free
exchange accounted for as a pooling-of-interests.
Under the terms of the acquisition, each outstanding share of One
Stop Common Stock was converted into the right to receive 16,479.4 shares of the
Company's Common Stock. The Company issued 2.3 million shares of its Common
Stock, representing approximately 14.7% of its issued and outstanding shares
(after giving effect to the acquisition), 102,750 shares of which have been
placed in escrow pursuant to an escrow agreement as security for the
indemnification obligations of One Stop and its principal stockholder, to be
released on August 28, 1997. The Company has agreed to use its best efforts to
file certain registration statements under the Securities Act covering
approximately 1.0 million of the shares of its Common Stock issued in connection
with the acquisition. Additionally, the Company assumed options granted to key
employees to purchase approximately 375,000 shares.
For the three month period ended July 31, 1996, One Stop's loan
originations and purchases totaled approximately $126 million. Neil Kornswiet,
the founder of One Stop, will continue as President, Chief Executive Officer and
Chairman of the Board of Directors of One Stop (which will be operated as a
separate subsidiary under the name, "One Stop Mortgage, Inc.") under a five year
employment contract. Mr. Kornswiet will also serve as Executive Vice President
of the Company and will serve on its Board of Directors.
Recent Financings. Since June 30, 1996, the Company has entered
into or renewed warehouse financing facilities, bringing its aggregate
warehousing capacity under all of its warehouse credit facilities at September
10, 1996 to $675 million, and has entered into a $50.0 million credit facility
secured by certain excess servicing receivables.
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 mortgage on the borrower's residence with either a
fixed or adjustable 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 that cannot be
marketed to agencies such as Ginnie Mae, Fannie Mae and Freddie Mac. In
addition, the Company offers junior mortgages and other products in order to
meet a wide variety of borrower needs. In fiscal 1996, the Company obtained its
loans through two primary channels: its retail loan office network, through
which loans are originated by the Company out of its 50 retail loan offices
located in 17 states, and its wholesale correspondent program, through which
loans are purchased from mortgage bankers and other financial institutions. With
the acquisition of One Stop
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on August 28, 1996, the Company expanded its loan production channels to include
a network of independent mortgage brokers, from which loans are submitted to One
Stop for funding or purchase.
The following table illustrates the sources of the Company's loan
production, excluding loans originated or purchased by One Stop during fiscal
1996 in the aggregate amount of $320 million:
FISCAL YEARS ENDED JUNE 30,
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1994 1995 1996
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(IN THOUSANDS)
Retail loans:
Total dollar amount $130,200 $148,200 $220,900
Number of loans 3,373 3,734 4,792
Average loan amount $ 36.6 $ 39.7 $ 46.0
Average initial combined loan to value 52% 55% 60%
Weighted average interest rate 10.3% 11.8% 11.0%
Wholesale correspondent program:
Total dollar amount $ 19,700 $206,800 $628,200
Number of loans 265 2,314 7,166
Average loan amount $ 74.3 $ 89.4 $ 87.7
Average initial combined loan to value NM 65% 66%
Weighted average interest rate NM 11.4% 11.7%
Total loans:
Total dollar amount $149,900 $355,000 $849,100
Number of loans 3,638 6,048 11,958
Average loan amount $ 41.2 $ 58.7 $ 71.0
Average initial combined loan to value 52% 61% 64%
Weighted average interest rate 10.3% 11.6% 11.5%
Retail Loan Office Network. The Company originates home equity
mortgage loans through its network of retail loan offices which, at August 31,
1996, consisted of 50 retail loan offices located in 17 states. The Company is
aggressively pursuing a strategy of expanding its retail loan office network
beyond the 36 offices located in California and the other Western states. Of the
Company's 50 retail loan offices, seven are located in the Midwest and seven are
located along the East Coast. The Company believes that it has significant
additional expansion opportunities in these and other areas.
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. Typically, new office
locations have become profitable within 90 days of opening.
The Company's expansion of its retail loan office network has
resulted in significant increases in retail loan production over the last three
fiscal years. The Company originated $130 million, $148 million and $221 million
of mortgage loans through this network in fiscal 1994, 1995 and 1996,
respectively.
The Company generates applications for loans through its retail
loan office network principally through a multimedia advertising program, which
includes the use of direct mailings to homeowners, radio and television
advertising, yellow-page listings, and telemarketing. The Company believes that
its advertising campaigns establish
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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 advertising.
The Company's advertising invites prospective borrowers to call
its headquarters office through the Company's toll-free telephone numbers. On
the basis of an initial screening conducted at the time of the call, the
Company's customer service representative makes a preliminary determination of
whether the customer and the property meet the Company's lending criteria,
schedules an appointment with an appraiser and refers the customer to the most
conveniently located retail loan office.
The Company's loan officer at the local retail loan office
assists the applicant in completing the loan application, 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 package is then forwarded to the Company's headquarters office for review
by underwriters and 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. If an applicant does not meet the guidelines for the loan applied
for, a different loan that may also serve the applicant's needs is usually
suggested.
Through its retail loan office network, the Company also takes
applications from prospective borrowers who respond to the Company's advertising
but fall outside the Company's target market. These loans may be brokered to
other institutional lenders or to private investors. In these cases, the Company
receives brokerage commissions on loans actually funded.
Wholesale Correspondent Program. The Company purchases closed
loans from mortgage bankers and other financial institutions on a continuous or
"flow" basis, and through bulk purchases. In fiscal 1996, 74% of the Company's
loan production came from these sources. The Company believes that its wholesale
correspondent program represents a cost effective means to increasing loan
production. Although the Company purchases mortgage loans from a variety of
sources, one correspondent represented approximately 32% of total mortgage loans
purchased in fiscal 1996.
Independent Broker Network. On August 28, 1996, the Company
acquired One Stop, and thereby expanded its mortgage loan production sources to
include a network of independent mortgage brokers. Under this program, the
independent mortgage broker identifies the potential applicant, assists the
applicant in completing the loan application and submits the application with
the other documents constituting the completed loan package to One Stop for
underwriting and loan approval. Prior to its acquisition by the Company, a
substantial portion of the loans originated or purchased by One Stop were "A-,"
"B," or "C" loans. Beginning in September 1996, One Stop intends to increase the
percentage of "C-" and "D" loans originated and purchased by it. All loans
originated by One Stop will be underwritten in accordance with the Company's
underwriting guidelines. Once approved, the loan is funded or purchased by One
Stop directly.
Consistent underwriting, quick response times and personal
service are critical to successfully producing loans through independent
mortgage brokers. To meet these requirements, One Stop operates out of 24
offices to service the needs of the independent brokers and loan applicants. One
Stop strives to provide quick response time to the loan application (generally
within 24 hours). In addition, loan consultants and loan processors are
available in the offices to answer questions, assist in the loan application
process and facilitate ultimate funding of the loan.
Underwriting. The Company underwrites every loan it originates
and re-underwrites each loan it purchases, in each case, either utilizing its
staff consisting at August 31, 1996 of 157 full-time appraisers, or a Company-
qualified contract appraiser. The Company's underwriting guidelines are designed
to assess the adequacy of the real property as collateral for the loan and the
borrower's creditworthiness. 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 ratio (the "combined loan-to-value ratio") of all
mortgages existing on the property (including the loan applied for) bear to the
appraised value of the property at the time of origination. As a lender that
specializes in loans made to credit-impaired borrowers, the Company ordinarily
makes home equity mortgage loans to borrowers with credit histories
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or other factors that would typically disqualify them from consideration for a
loan from traditional financial institutions. Consequently, the Company's
underwriting guidelines generally require substantially 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. 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 normal monthly
expenses divided by the borrowers's monthly income before taxes and other
payroll deductions, an examination of the borrower's credit history through
standard credit reporting bureaus, and by evaluating the borrower's payment
history with respect to existing mortgages, if any, on the property.
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. On an exception basis, and approval of the Company's underwriters,
home equity mortgage loans may be made that do not conform to the Company's
guidelines but only with the approval of a senior underwriter or by an executive
officer of the Company. The Company regularly reviews its underwriting
guidelines and makes changes when appropriate to respond to market conditions,
because of the poor performance of loans representing a particular loan product
or to respond to changes in laws or regulations. In September 1996, the Company
changed its underwriting guidelines to eliminate one loan purchase product known
as the "no documentation - salaried employee" loan product in the "C-" and "D"
credit grades because of what management believed to be the higher than average
delinquency rates experienced on such loans, raised the combined loan-to-value
ratios of its "A-" credit grade loans to conform to market conditions and
lowered the combined loan-to-value ratios for its "C-" and "D" credit grade
loans made in certain judicial foreclosure states in recognition of the greater
length of time it takes in such states to complete the foreclosure process.
All appraisals in connection with loans originated by the Company
through its retail loan office network are performed by Company appraisers. The
Company's 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. Loans purchased as part of the
Company's wholesale correspondent program are reviewed by Company appraisers or
Company-qualified contract appraisers, to assure that they meet the Company's
standards. All of the Company's appraisers are full-time employees of the
Company and compensated by salary and a bonus that is not dependent on
completion of loan transactions.
The Company requires title insurance coverage issued on an ALTA
form of title insurance on all 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.
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 office network and its wholesale
correspondent program or loans presented or purchased from its independent
broker network 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.
Credit Grades. The Company believes that it originates a greater
proportion of lower credit quality loans ("C-" and "D" loans) than other lenders
who lend to credit-impaired borrowers and as a result has historically
experienced delinquency rates that are higher than those generally prevailing in
its industry. However, the Company has not historically experienced significant
loan losses because its loan portfolio has been characterized by relatively low
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combined loan-to-value ratios. The weighted average initial combined
loan-to-value ratio of loans in its servicing portfolio at June 30, 1994, 1995
and 1996 was 56%, 59% and 63%, respectively. The increase in weighted average
combined loan-to-value ratios at June 30, 1996 reflected a changing mix in the
mortgage loans in the servicing portfolio to include a greater proportion of
first mortgages and higher credit grade loans.
The following chart generally outlines certain parameters of the
credit grades of the Company's underwriting guidelines at September 10, 1996:
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"A-" CREDIT "B" CREDIT "C" CREDIT "C-" CREDIT "D" CREDIT
GRADE GRADE GRADE GRADE GRADE
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GENERAL Has good Pays the Marginal credit Marginal credit Designed to
REPAYMENT credit but majority of history which history not provide a
might have accounts on is offset by offset by other borrower with
some minor time but has other positive positive poor credit
delinquency. some 30- attributes. attributes. history an
and/or 60-day opportunity to
delinquency. correct past
credit
problems
through lower
monthly
payments.
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EXISTING Current at Current at Cannot exceed Must be paid Must be paid
MORTGAGE application application four 30-day in full from from loan
LOANS time and a time and a delinquencies loan proceeds proceeds.
maximum of maximum of or one 60-day and no more Rating not a
two 30-day four 30-day or multiple 30- than 119 days factor.
delinquencies delinquencies day delinquent.
in the past 12 in the past 12 delinquencies
months. months. in the past 12
months.
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NON-MORTGAGE Major credit Major credit Major credit Major and Major credit
CREDIT and installment and installment and installment minor credit delinquency is
debt should be debt can debt can delinquency is acceptable.
current but exhibit some exhibit some acceptable, but
may exhibit minor 30- minor 60- must
some minor and/or 60-day and/or 90-day demonstrate
30-day delinquency. delinquency. some payment
delinquency. regularity.
Minor credit Minor credit
Minor credit may exhibit up may exhibit
may exhibit to 90-day more serious
some minor delinquency. delinquency.
delinquency.
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BANKRUPTCY Charge-offs, Discharged Discharged Discharged Current
FILINGS judgments, more than two more than two prior to bankruptcy
liens, and years with years with closing. must be paid
former reestablished reestablished through loan.
bankruptcies credit. credit.
are
unacceptable.
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DEBT SERVICE- Generally not Generally not Generally not Generally not Generally not
TO-INCOME to exceed to exceed to exceed to exceed to exceed
RATIO 45%. 50%. 50%. 55%. 60%.
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MAXIMUM Generally 85% Generally 80% Generally 70% Generally 65% Generally 65%
LOAN-TO- 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
VALUE RATIO: family family family family family
dwelling dwelling dwelling dwelling. dwelling.
NON- residence; 70% residence; 65% residence; 65%
OWNER for a for a for a
OCCUPIED condominium. condominium. condominium.
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NON- Generally 70% Generally 65% Generally 65% N/A N/A
OWNER for a 1 to 2 for a 1 to 2 for a 1 to 2
OCCUPIED family family family
dwelling; 65% dwelling; 60% dwelling; 60%
for a 3 to 4 for a 3 to 4 for a 3 to 4
family. family. family.
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The following tables present certain information on the Company's
loan originations through its retail loan office network and loan purchases
through its wholesale correspondent program during fiscal 1995 and fiscal 1996:
Loan Originations and Purchases in Fiscal 1995
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Weighted
Average
Dollar Amount of % of Weighted Average Interest
Credit Grade Loan Total Loan-to-Value Rate
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A- 111,808,000 31% 63% 10.6%
B 55,338,000 16% 65% 11.1%
C 70,515,000 20% 59% 11.7%
C- 53,635,000 15% 62% 12.2%
D 63,629,000 18% 58% 13.3%
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TOTAL $ 354,925,000 100%
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Loan Originations and Purchases in Fiscal 1996
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Weighted
Average
Dollar Amount of % of Weighted Average Interest
Credit Grade Loan Total Loan-to-Value Rate
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A- $ 224,943,000 26% 68% 10.2%
B 143,700,000 17% 68% 10.6%
C 139,329,000 16% 63% 11.5%
C- 106,067,000 12% 63% 12.1%
D 235,018,000 27% 61% 13.1%
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TOTAL $ 849,057,000 100%
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SECURITIZATION OF LOANS
The primary funding strategy of the Company is to securitize and
sell mortgage loans originated or purchased by the Company. Securitization is a
cost competitive source of capital compared to other debt financing sources
available to the Company. Through June 30, 1996, the Company had completed 17
securitizations totaling $1.3 billion. The Company's operations have been
restructured in recent years specifically for the purpose of efficiently
originating, purchasing, underwriting and servicing loans for securitization in
order to meet the requirements of rating agencies, credit enhancers and
investors. The Company generally seeks to complete a securitization once each
quarter. The Company applies the net proceeds of the securitization to pay down
its warehouse facilities in order to make these facilities available for future
funding of mortgage loans.
In a securitization, the Company sells the loans that it has
purchased or originated to a real estate mortgage investment conduit ("REMIC")
for a cash purchase price and an interest in the loans securitized (in the form
of "excess servicing"). The cash purchase price is raised through an offering of
senior pass-through certificates by the trust. Following the securitization, the
purchasers of the senior certificates receive the principal collected and the
investor pass-through interest rate on the certificate balance, while the
Company receives the excess servicing. The excess servicing is typically a
certificated security in the form of a residual certificate, which generally
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represents the excess servicing on the loans. The excess servicing represents,
over the estimated life of the loans, the excess of the weighted average
interest rate on the pool of loans sold over the sum of the investor pass
through rate, normal servicing fee and the monoline insurance fee. The net
present value of that excess (determined based on certain prepayment and loss
assumptions) less transaction expenses is recorded as excess servicing gain or
loss at the time of the closing of the securitization.
The purchasers of the senior certificates receive a
credit-enhanced security. The Company's securitizations have been enhanced
generally through two sources: (i) subordination of an amount of excess
servicing retained by the Company and (ii) an insurance policy provided by an
AAA/Aaa-rated monoline insurance company. As a result, each offering of senior
certificates receives ratings of AAA from Standard & Poor's and Aaa from Moody's
Investors Service.
Each pooling and servicing agreement that the Company has entered
into in connection with its securitizations requires either the establishment of
a reserve account that may initially be funded by cash deposited by the Company
or the overcollateralization of the REMIC trust. The Company's interest in each
overcollateralization amount and reserve account is reflected on the Company's
Consolidated Financial Statements as "residual assets." If payment defaults
exceed the amount of the overcollateralization or the reserve account, as
applicable, the monoline insurance company policy will pay any further losses
experienced by holders of the senior interests in the related REMIC trust. To
date, there have been no claims on any monoline insurance company policy
obtained in any of the Company's securitizations.
In connection with its securitizations, the Company typically
enters into an agreement pursuant to which it agrees to sell loans to the trust
in the future at an agreed-upon price (the "pre-funding"). The pre-funding locks
in the price agreed upon with investors on the pricing date (typically five
business days prior to the closing date of the securitization) for a period of
generally 30 days. In a pre-funding arrangement, the Company typically delivers
approximately 75% of the loans sold at the closing and the remainder generally
within 30 days after the closing.
LOAN SERVICING
Servicing includes collecting and remitting loan payments,
accounting for principal and interest, contacting delinquent borrowers, handling
borrower defaults and liquidating foreclosed properties. The Company retains the
servicing rights to substantially all of the loans it originates or purchases.
The following table sets forth certain information regarding the Company's
servicing portfolio for the periods indicated:
FISCAL YEARS ENDED JUNE 30,
----------------------------------------------------------------------
1994 1995 1996
--------------------- -------------------- ------------------
(IN THOUSANDS)
Loans added to the servicing portfolio........... $ 213,900 $ 354,900 $ 849,100
Servicing portfolio (period end)................. 381,800 608,700 1,250,400
Loan service revenue (1)......................... 6,099 8,246 18,185
- -------------------------
(1) For a description of loan service revenue, see Note 1 of Notes to
Consolidated Financial Statements.
In fiscal 1996 the Company directly serviced all loans in its
servicing portfolio which were secured by mortgaged properties located in
Arizona, California, Colorado, Nevada, Oregon, Utah and Washington. Loans
secured by properties located in other states were serviced through one or more
subservicers which were paid a fee per loan and a participation in certain other
fees paid by the borrowers. The Company is in the process of implementing a new
servicing system which will provide the Company the capability to service
in-house all loans originated or purchased by it regardless of the state in
which the mortgaged property is located. This new servicing system is expected
to be implemented in fiscal 1997. The Company's new servicing system will also
provide the Company the capability of subservicing on behalf of other mortgage
lenders. The Company intends to offer this service in fiscal 1998. The Company
believes that the successful implementation of its new servicing system will
provide it with improved margins on its servicing and potentially a new source
of servicing revenue.
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The pooling and servicing agreements between the Company and the
REMIC trusts established in connection with securitizations typically require
the Company advance interest (but not principal) on delinquent loans to the
holders of the senior interests in the related REMIC trust to the extent the
Company deems such advances of interest to be ultimately recoverable. No
advances are made for interest if the Company deems that the advances are not
ultimately recoverable and no advances are made for payments of principal.
Realized losses on the loans are paid out of the related reserve account or paid
out of principal and interest payments on overcollateralized amounts as
applicable, and if necessary, from the related monoline insurance company
policy.
The pooling and servicing agreements also typically provide that
the Company may be terminated as servicer by the monoline insurance company
which insures the senior interests in the related REMIC trust (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
pooling and servicing agreement, the rate of over 90-day delinquency (including
properties acquired on foreclosure and not sold) exceeding specified limits,
losses on foreclosure exceeding certain limits, any payment being made by the
monoline insurance company under its policy, and certain events of bankruptcy or
insolvency. Serviced loans subject to such agreements represented approximately
84% (by dollar volume) of the Company's servicing portfolio at June 30, 1996. At
June 30, 1996, four REMIC trusts representing approximately 23% (by dollar
volume) of the Company's servicing portfolio exceeded the foregoing delinquency
rate, although the servicing rights of the Company have not been terminated. See
"Item 7. Management's Discussion and Analysis of Financial Condition -- Risk
Factors -- Delinquencies; Negative Impact on Cash Flow; Right to Terminate
Normal Servicing."
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 and assumption charges paid by the
borrower, as well as other miscellaneous fees for performing various loan
servicing functions. The Company also generally receives any prepayment fees
paid by borrowers.
The Company's servicing portfolio is subject to reduction by
normal monthly payments, by prepayment and by foreclosure. It is the Company's
strategy to build and retain its servicing portfolio. In general, revenue from
the Company's loan servicing portfolio may be adversely affected as interest
rates decline and loan prepayments increase. This effect has historically been
partially offset by increases in prepayment fee income received from borrowers.
In some states in which the Company currently operates, prepayment fees may be
limited or prohibited by applicable law. In addition, the Company's ability to
collect prepayment fees under certain circumstances will be restricted in future
periods under federal regulations which went into effect in 1995. See
"--Regulation."
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The following table illustrates the mix of credit grades in the
Company's servicing portfolio as of June 30, 1996:
- ---------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted
Dollar Amount of Average Average
Credit Grade Loan % of Total Loan-to-Value Interest Rate
- ---------------------------------------------------------------------------------------------------------------------------------
A- $ 308,901,000 25 % 66 % 10.4 %
B 185,892,000 15 % 67 % 10.8 %
C 192,051,000 15 % 62 % 11.6 %
C- 144,565,000 12 % 62 % 12.1 %
D 291,592,000 23 % 60 % 12.9 %
Other 127,406,000 10 % 55 % 12.2 %
-----
---------------------------
Total $ 1,250,407,000 100 %
- ---------------------------------------------------------------------------------------------------------------------------------
COLLECTIONS, DELINQUENCIES AND FORECLOSURES
The Company sends borrowers a monthly billing statement 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 "C-" and "D" credit grades, collection efforts
begin approximately six days after the due date.) If the loan remains unpaid,
the Company will contact 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 shortly after
the due date of the next subsequently scheduled installment, providing 30 days'
notice of impending foreclosure action. During the 30-day notice period,
collection efforts continue. However, 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 60 days delinquent.
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.
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. After the reinstatement
period has expired without the default having been cured, the borrower or junior
lienholder no longer has the right to reinstate the loan and must pay the loan
in full to prevent the scheduled foreclosure sale.
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
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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 for an amount equal to the principal amount outstanding under
the loan, accrued and unpaid interest 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 following table sets forth delinquency and foreclosure
experience of loans originated and/or purchased included in the Company's
servicing portfolio for the periods indicated:
FISCAL YEARS ENDED JUNE 30,
------------------------------------------------------
1994 1995 1996
---------------- ---------------- --------------
Percentage of dollar amount of delinquent loans to loans
serviced (period end) (1) (2) (3)
One Month................................................... 3.8% 3.9% 4.9%
Two Months.................................................. 1.6% 1.5% 1.8%
Three or More Months:
Not foreclosed (3) (4).................................... 6.7% 5.0% 8.0%
Foreclosed ............................................... 3.6% 1.5% 1.0%
---------------- ---------------- --------------
Total............................................. 15.7% 11.9% 15.7%
================ ================ ==============
Percentage of dollar amount of loans foreclosed to loans
serviced (period end) (2)........................................................ 3.0% 1.2% 1.2%
Number of loans foreclosed......................................................... 215 159 221
Principal amount at time of foreclosure of foreclosed loans (in thousands)......... $ 11,528 $ 6,675 $ 14,349
Net losses on foreclosed loans included in pools (in thousands).................... $ 0 $ 92 $ 922
- ----------------------
(1) Delinquent loans are loans for which more than one payment is due.
(2) The delinquency and foreclosure percentages are calculated on the basis
of the total dollar amount of mortgage loans originated or purchased by
the Company and, in each case, serviced by the Company, or the Company
and any subservicers, as applicable, as of the end of the periods
indicated.
(3) At June 30, 1996, the dollar volume of loans delinquent more than 90
days in the Company's four REMIC trusts formed during the period from
December 1994 to September 1995 exceeded the permitted limit in the
related pooling and servicing agreements. The higher delinquency rates
could result in the termination of the Company's normal servicing
rights with respect to the loans in these trusts, although to date no
servicing rights have been terminated, negatively affect the Company's
cash flows and adversely influence the Company's assumptions underlying
the excess servicing gain (see "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Delinquencies; Negative Impact on Cash Flow; Right to
Terminate Normal Servicing").
(4) Represents loans which are in foreclosure but as to which foreclosure
proceedings have not concluded.
The Company's servicing portfolio has grown over the periods
presented. However, 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.
COMPETITION
In addition to competing with other consumer finance lenders,
mortgage bankers and mortgage brokers, the Company competes with financial
institutions that have substantially greater financial resources than the
Company. Although some traditional financial institutions are aggressively
promoting and pricing home equity loans and attempting to increase the
percentage of their portfolios consisting of consumer real estate loans, the
Company does not believe that these trends have had a material impact on its
competitive position. The Company competes by emphasizing customer service on a
timely basis to attract borrowers whose needs are not generally met by
traditional financial institutions and by placing a greater emphasis on the
equity value of the property securing the loan. Nevertheless, there can be no
assurance that the Company will not face increased competition from such
institutions.
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Further, a number of the Company's competitors have recently increased their
access to the capital markets, which helps foster their growth and therefore
increases competition.
REGULATION
The operations of the Company are subject to extensive
regulation, supervision and licensing by federal, state and local government
authorities. Regulated matters include, without limitation, loan origination,
credit activities, maximum interest rates and finance and other charges,
disclosure to customers, the terms of secured transactions, the collection,
repossession and claims-handling procedures utilized by the Company, multiple
qualification and licensing requirements for doing business in various
jurisdictions and other trade practices.
The Company's loan origination activities are subject to the laws
and regulations in each of the states in which those activities are conducted.
The Company's activities as a lender are also subject to various federal laws
including, among others, the Truth in Lending Act ("TILA"), the Real Estate
Settlement Procedures Act, the Equal Credit Opportunity Act of 1974, as amended
("ECOA"), the Home Mortgage Disclosure Act and the Fair Credit Reporting Act of
1970, as amended ("FCRA").
The TILA and Regulation Z promulgated thereunder contain
disclosure requirements designed to provide consumers with uniform,
understandable information with respect to the terms and conditions of loans and
credit transactions in order to give them the ability to compare credit terms.
TILA also guarantees consumers a three-day right to cancel certain credit
transactions including loans of the type originated by the Company. Management
of the Company believes that it is in compliance with TILA in all material
respects.
In September 1994, the Riegle Community Development and
Regulatory Improvement Act of 1994 (the "Riegle Act") was enacted. Among other
things, the Riegle Act made certain amendments to TILA. The TILA Amendments,
which became effective in October 1995, generally apply to mortgage loans with
(i) total points and fees upon origination in excess of the greater of eight
percent of the loan amount or $400 or (ii) an annual percentage rate of more
than ten percentage points higher than comparably maturing U.S. treasury
securities. Loans covered by the TILA Amendments are known as "Section 32
loans."
The TILA Amendments impose additional disclosure requirements on
lenders originating Section 32 loans and prohibit lenders from originating
Section 32 loans that are underwritten solely on the basis of the borrower's
home equity without regard to the borrower's ability to repay the loan. In
accordance with TILA Amendments, the Company applies underwriting criteria that
take into consideration the borrower's ability to repay to all Section 32 loans.
The TILA Amendments also prohibit lenders from including
prepayment fee clauses in Section 32 loans to borrowers with a debt-to-income
ratio in excess of 50%. In addition, a lender that refinances a Section 32 loan
previously made by such lender will not be able to enforce any prepayment
penalty clause contained in such refinanced loan. The Company reported $1.9
million, $2.0 million and $3.2 million in prepayment fee revenue in fiscal 1994,
1995 and 1996, respectively. The Company will continue to collect prepayment
fees on loans originated prior to the effectiveness of the TILA Amendments and
on non-Section 32 loans as well as on Section 32 loans in permitted
circumstances following the effectiveness of the TILA Amendments. The TILA
Amendments impose other restrictions on Section 32 loans, including restrictions
on balloon payments and negative amortization features, which the Company does
not believe will have a material impact on its operations.
The Company is also required to comply with the ECOA, which
prohibits creditors from discriminating against applicants on the basis of race,
color, sex, age or marital status. Regulation B promulgated under ECOA restricts
creditors from obtaining certain types of information from loan applicants. It
also requires certain disclosures by the lender regarding consumer rights and
requires lenders to advise applicants of the reasons for any credit denial. In
instances where the applicant is denied credit or the rate or charge for a loan
increases as a result of information obtained from a consumer credit agency,
another statute, the FRCA requires the lender to supply the applicant with a
name and address of the reporting agency. The Company is also subject to the
Real Estate
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Settlement Procedures Act and is required to file an annual report with the
Department of Housing and Urban Development pursuant to the Home Mortgage
Disclosure Act.
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.
The laws, rules and regulations applicable to the Company are
subject to regular modification and change. There are currently proposed various
laws, rules and regulations which, if adopted, could impact the Company. There
can be no assurance that these proposed laws, rules and regulations, or other
such laws, rules or regulations, will not be adopted in the future which could
make compliance much more difficult or expensive, restrict the Company's ability
to originate, purchase, broker or sell loans, further limit or restrict the
amount of commissions, interest and other charges earned on loans originated or
sold by the Company, or otherwise adversely affect the business or prospects of
the Company.
EMPLOYEES
At June 30, 1996, the Company employed 672 persons. The Company
has satisfactory relations with its employees.
ITEM 2. PROPERTIES
The executive and administrative offices of the Company are
located at 3731 Wilshire Boulevard, Los Angeles, California, and consist of
approximately 101,000 square feet. The lease on these premises extends through
July 31, 2000. The Company intends to relocate its corporate executive offices
to Downtown Los Angeles in May 1997 under a lease that will expire in May 2007
and intends to sublease its current facility for the remainder of the term of
its lease. The executive and administrative offices of One Stop are located at
200 Baker Street, Costa Mesa, California, and consist of approximately 19,544
square feet. The lease on these premises extends through November 8, 1998.
The Company and One Stop also lease space for their loan offices.
These facilities aggregate approximately 135,000 square feet and are leased
under terms which vary as to duration. In general, the leases expire between
1996 and 2001, 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.
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 1996
to a vote of the security holders of the Company.
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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 New York Stock Exchange (NYSE). Prior to that time, the
Company's Common Stock was quoted on the NASDAQ National Market System. The
following table sets forth the range of high and low sale prices per share for
the periods indicated.
CASH
HIGH LOW DIVIDEND
------------------- ----------------- -------------------
FISCAL 1996
Fourth Quarter 37 24 1/8 $ .05
Third Quarter 25 1/8 16 1/4 .05
Second Quarter 24 1/2 16 1/8 .05
First Quarter 19 1/2 11 1/2 .05
FISCAL 1995
Fourth Quarter 12.5 7.25 $ .05
Third Quarter 8.75 5.25 .05
Second Quarter 6 5.25 .05
First Quarter $ 6.25 $ 5.25 .05
At September 15, 1996, the Company had 68 stockholders of record,
and the Company believes that it had in excess of 2,000 beneficial owners of its
Common Stock. Since its initial public offering on December 3, 1991, the Company
has consistently paid quarterly cash dividends on its Common Stock. The Company
declared and subsequently paid an aggregate of $.20 per share in dividends for
the year ended June 30, 1996, representing approximately 8.7% of its net income
for the period. The Board of Directors of the Company periodically reviews the
Company's dividend policy in light of the earnings, cash position and capital
needs of the Company, general business conditions and other relevant factors. In
addition, the Company's ability to pay dividends is limited under various bank
and other credit agreements.
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ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data for the Company for the
five year period ended June 30, 1996 have been derived from the Consolidated
Financial Statements of the Company which have been audited by Price Waterhouse
LLP, independent accountants. The selected consolidated financial data should be
read in conjunction with the Consolidated Financial Statements and Notes thereto
and other financial information included herein. Results of operations of the
Company for the year ended June 30, 1996, reflect the Company's adoption of SFAS
No. 122. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations." The selected consolidated financial data
for the Company for the year ended June 30, 1996 does not give pro forma effect
to the acquisition of One Stop. See "Item 1. Business--Recent Developments."
Fiscal Year Ended June 30,
-----------------------------------------------------------------------
1992 1993 1994 1995 1996
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
STATEMENT OF INCOME DATA:
Revenue:
Excess servicing gain ................................. $ 1,583 $ 3,486 $ 8,101 $ 22,954 $ 78,274
Commissions ........................................... 13,166 18,686 16,432 15,799 19,880
Loan service .......................................... 3,346 4,377 6,099 8,246 18,185
Fees and other ........................................ 3,397 4,762 5,595 7,940 12,069
----------- ----------- ----------- ----------- -----------
Total revenue ....................................... 21,492 31,311 36,227 54,939 128,408
Total expenses ........................................ 17,466 22,955 27,244 37,788 74,877
----------- ----------- ----------- ----------- -----------
Income before income taxes ............................ 4,026 8,356 8,983 17,151 53,531
Provision for income taxes (1) ........................ 1,112 3,353 3,684 7,117 22,483
----------- ----------- ----------- ----------- -----------
Net income ............................................ $ 2,914 $ 5,003 $ 5,299 $ 10,034 $ 31,048
=========== =========== =========== =========== ===========
Net income per share (fully diluted) .................. $ 0.51 $ 0.75 $ 0.61 $ 1.11 $ 2.09
=========== =========== =========== =========== ===========
Weighted average number of shares outstanding
(in thousands) (fully diluted) ...................... 5,717 6,623 8,751 9,021 15,465
CASH FLOW DATA:
(Used in) provided by operating activities ............ $ 3,115 $ (1,490) $ (13,857) $ (43,375) $ (122,233)
(Used in) investing activities ........................ (568) (489) (870) (988 (4,597)
Provided by (used in) financing activities ............ 7,515 (1,522) 22,855 48,209 124,687
Net increase (decrease) in cash and cash equivalents .. 10,062 (3,501) 8,128 3,846 (2,143)
RATIOS AND OTHER DATA:
Return on average common equity ....................... NM 36% 18% 27% 33%
Return on average managed receivables (2) ............. 1.5% 2.1% 1.6% 2.0% 3.3%
Loans originated or purchased:
Retail loans ...................................... $ 90,600 $ 122,200 $ 130,200 $ 148,200 $ 220,900
Wholesale loan correspondent ...................... 0 0 19,700 206,800 628,200
----------- ----------- ----------- ----------- -----------
Total (3) ..................................... 90,600 122,200 149,900 355,000 849,100
=========== =========== =========== =========== ===========
Loans pooled and sold in the secondary market ......... $ 11,000 $ 52,500 $ 106,800 $ 316,600 $ 791,300
Loans serviced (period end) ........................... $ 204,600 $ 262,100 $ 381,800 $ 608,700 1,250,400
Weighted average commission rate on retail loan
origination (4) ..................................... 13.0% 14.0% 12.0% 9.4% 7.7%
Weighted average interest rate (4) .................... 12.7% 11.2% 10.2% 11.6% 11.0%
Weighted average initial combined loan-to-value
ratio (4)(5):
Retail loans ........................................ 53% 51% 52% 55% 60%
Wholesale loan correspondents ....................... NM NM NM 65.0% 66.0%
Number of retail loan offices (period end) ............ 21 24 27 32 48
ASSET QUALITY DATA:
Delinquent loans to loans serviced
(period end) (6)(7) ................................... 18% 16% 16% 12% 16%
Number of loans foreclosed ............................ 69 137 215 159 221
Dollar amount of loans foreclosed as a percentage of
average loans serviced .............................. 1.2% 2.4% 3.0% 1.2% 1.2%
Net losses as a percentage of average amount
outstanding ......................................... NM NM NM .02% .10%
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At June 30,
--------------------------------------------------------------
1992 1993 1994 1995 1996
--------- ---------- ---------- ---------- ---------
BALANCE SHEET DATA:
Cash and cash equivalents...............................$ 11,886 $ 8,385 $ 16,513 $ 20,359 $ 18,216
Excess Spread Receivable (8)............................ 2,544 7,555 18,780 56,960 184,691
Total assets............................................ 18,927 21,307 53,344 114,623 293,997
--------- ---------- ---------- ---------- ---------
10.5% Senior Notes due 2002............................. -- -- -- 23,000 23,000
5.5% Convertible Subordinated Debentures due 2006....... -- -- -- -- 115,000
Other long-term debt.................................... 1,177 944 1,104 144 45
Total long-term debt................................ 1,177 944 1,104 23,144 138,045
Stockholders' equity.................................... 12,136 15,850 31,669 80,047 110,170
(1) Prior to December 1991, the Company was operated as an S
Corporation for federal tax purposes and consequently was not
responsible for federal income taxes.
(2) Represents net income divided by the average servicing
portfolio for the fiscal year.
(3) Does not include loans originated or purchased by One Stop during
fiscal 1996 in the aggregate amount of $320 million.
(4) Computed on loans originated or purchased, as the case may be,
during the period.
(5) The weighted average combined loan-to-value ratio of a loan
secured by a first mortgage is determined by dividing the amount
of the loan by the appraised value of the mortgaged property at
origination. The weighted average combined loan-to-value ratio of
loans secured by a junior mortgage is determined by taking the
sum of the loans secured by the junior and all senior mortgages
and dividing by the appraised value of the mortgaged property at
origination.
(6) Does not include loans for which only the servicing rights were
purchased by the Company. Delinquent loans are loans for which
more than one payment is past due.
(7) At June 30, 1996, the dollar volume of loans delinquent more than
90 days in the Company's four real estate mortgage investment
conduit ("REMIC") trusts formed during the period from December
1994 to September 1995 exceeded the permitted limit in the
related pooling and servicing agreements. The higher delinquency
rates could result in the termination of the Company's normal
servicing rights with respect to the loans in these trusts,
although to date no servicing rights have been terminated,
negatively affects the Company's cash flows and influence the
Company's assumptions underlying the excess servicing gain (see
"Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Risk Factors --
Delinquencies; Negative Impact on Cash Flow; Termination of
Normal Servicing").
(8) Represents the sum of excess servicing receivable and residual
assets, and at June 30, 1996, mortgage servicing rights. See Note
1 of Notes to Consolidated Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with
Item 6. Selected Financial Data and Item 8. Financial Statements and
Supplementary Data.
OVERVIEW
The Company, founded in 1954, is a consumer finance company
engaged in the business of originating, purchasing, selling and servicing home
equity mortgage loans secured by single family residences. The Company's
principal market is credit-impaired borrowers who have significant equity in
their homes but whose borrowing needs are not being met by traditional financial
institutions due to credit exceptions or other factors. The Company focuses its
efforts on collateral lending and believes that it originates a greater
proportion of lower credit grade loans ("C-" and "D" loans) than most other
lenders to credit-impaired borrowers. These lower credit grade loans are
characterized by lower combined loan-to-value ratios and higher average interest
rates than the higher credit grade loans ("A-," "B" and "C" loans). The Company
believes lower credit-quality borrowers represent an underserved niche of the
home equity loan market and present an opportunity to earn a superior return for
the risks assumed. Although the Company has historically experienced delinquency
rates that are higher than those prevailing in its industry, management believes
the Company's historical loan losses are generally lower than those experienced
by most other lenders to credit-impaired borrowers because of the lower combined
loan-to-value ratios on the Company's lower credit grade loans. The mortgage
loans originated and purchased by the Company are generally used by borrowers to
consolidate indebtedness or to finance other consumer needs rather than to
purchase homes.
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Consequently, the Company believes that it is not as dependent as traditional
mortgage bankers on levels of home sales or refinancing activity prevailing in
its markets.
The Company originates and purchases loans through three
production channels. The Company has historically originated its loans through
its retail loan office network. In 1994, the Company diversified its production
channels to include a wholesale correspondent program which consisted initially
of purchasing loans from other mortgage bankers and financial institutions
underwritten in accordance with the Company's guidelines. In fiscal 1996, this
program was expanded to include the purchase of loans in bulk from mortgage
bankers and other financial institutions. On August 28, 1996, the Company
acquired One Stop which further diversified the Company's production channels to
include the origination and purchase of mortgage loans from a network of
independent mortgage brokers. While the Company intends to continue focusing on
its traditional niche in the "C-" and "D" credit grade loans, the Company also
intends to continue to diversify loan originations and purchases through its
three production channels to include more "A-," "B" and "C" credit grade loans.
The Company underwrites every loan it originates and re-underwrites and reviews
appraisals on all loans it purchases. See "Item 1. Business - - Mortgage Loan
Production -- Underwriting."
The Company has experienced significant growth in the last
three years. Management believes that this growth is primarily attributable to
(i) the Company's geographic expansion of its retail loan office network from 21
offices in California at July 1, 1993 to 50 offices located in 17 states at
August 31, 1996, (ii) the commencement of the Company's wholesale correspondent
program in fiscal 1994, which was expanded in fiscal 1996 to include purchases
of loans in bulk, (iii) the Company's ability to complete increasingly large
mortgage loan securitizations on a quarterly basis, (iv) the Company's increased
access to warehouse and other credit facilities over this period, and (v) the
Company's ability to effect additional debt and equity financings over this
period, which in the aggregate raised net proceeds of approximately $134 million
and $52.4 million, respectively. The Company has managed its growth by employing
experienced senior management, regularly monitoring its underwriting guidelines
and strengthening quality control procedures.
The acquisition of One Stop was accomplished through the
merger of a wholly-owned subsidiary of the Company into One Stop, in a tax-free
exchange accounted for as a pooling-of-interests, in which the Company issued
approximately 2.3 million shares of its Common Stock and assumed options granted
to key employees to purchase approximately 375,000 shares of its Common Stock.
Under the pooling rules, the historical financial results of the Company will be
restated to reflect the combination and will reflect the historical losses of
One Stop. Further, under the pooling rules, the costs incurred by the Company
and One Stop in consummating the acquisition will be expensed during the first
quarter of fiscal 1997. See "-- One-time Charges."
ONE-TIME CHARGES
Because of several one-time charges, the Company expects to
incur a net loss for the quarter ended September 30, 1996. As a result of, and
subsequent to, the acquisition of One Stop, One Stop's credit facilities with an
investment bank were terminated and, as a consequence, the Company will accrue a
pre-tax write-off of approximately $23 million (approximately $15 million on an
after-tax basis) in prepaid financing costs capitalized by One Stop,
representing the fair market value of a warrant for 25% of the equity of One
Stop granted to an investment bank in connection with entering into those credit
facilities. However, the $15 million charge will be less than the additions to
the Company's consolidated stockholders' equity of $23.3 million resulting from
the acquisition of One Stop. Further, because the acquisition of One Stop is to
be accounted for as a pooling-of-interests, all merger costs, which are expected
to aggregate approximately $2 million, will be expensed in the first quarter of
fiscal 1997. In addition, in August 1996, the Company entered into a lease for
new corporate offices, prior to the expiration of the lease for its existing
headquarters. As a consequence, the Company will incur a pre-tax charge of
approximately $2 million in the first quarter of fiscal 1997.
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RESULTS OF OPERATIONS -- FISCAL YEARS 1994, 1995, AND 1996
The following table sets forth information regarding the
components of the Company's revenue in fiscal 1994, 1995 and 1996:
-------------------------------------------------------------------------------
1994 1995 1996
----------------------- ---------------------- -----------------------
Revenue:
Excess servicing gain $ 8,101 22.3% $ 22,954 41.7% $ 78,274 61.0%
Commissions 16,432 45.3% 15,799 28.8% 19,880 15.4%
Loan Service:
Servicing spread 2,778 7.7% 4,399 8.0% 12,666 9.9%
Prepayment fees 1,866 5.2% 1,974 3.6% 3,228 2.5%
Late charges and other servicing fees 1,455 4.0% 1,873 3.4% 2,291 1.8%
Fees and other:
Closing 1,626 4.5% 2,077 3.8% 2,512 2.0%
Appraisal 893 2.5% 988 1.8% 1,167 0.9%
Underwriting 833 2.3% 1,091 2.0% 1,600 1.2%
Interest income 771 2.1% 2,339 4.3% 5,850 4.6%
Other 1,472 4.1% 1,445 2.6% 940 0.7%
-------- ----- -------- ----- -------- -----
Total revenue $ 36,227 100% $ 54,939 100% $128,408 100%
======== ===== ======== ===== ======== =====
Expenses:
Compensation and related expenses 13,616 37.5% 17,610 32.2% 33,241 25.8%
Sales and advertising costs 7,891 21.7% 9,906 18.1% 18,362 14.2%
General and administrative expenses 5,415 14.9% 7,067 12.9% 13,926 10.7%
Interest expense 322 0.9% 3,205 5.8% 9,348 7.3%
-------- ----- -------- ----- -------- -----
Total expenses 27,244 75% 37,788 69% 74,877 58%
-------- ----- -------- ----- -------- -----
Income before income taxes 8,983 24.8% 17,151 31.2% 53,531 41.7%
Income taxes 3,684 10.2% 7,117 12.9% 22,483 17.5%
-------- ----- -------- ----- -------- -----
Net income $ 5,299 14.6% $ 10,034 18.3% $ 31,048 24.2%
======== ===== ======== ===== ======== =====
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REVENUE
Total revenue for fiscal 1996 increased $73.5 million, or
134%, over total revenue for fiscal 1995 which, in turn, increased $18.7
million, or 52%, over total revenue in fiscal 1994. These increases in total
revenue were primarily the result of higher excess servicing gain and loan
service revenue resulting from increased volumes of mortgage loans originated
and purchased by the Company and securitized and sold. The Company originated
and purchased $150 million, $355 million and $849 million of mortgage loans
during fiscal 1994, 1995 and 1996, respectively.
In a securitization, the Company recognizes a gain on the sale
of loans securitized upon the closing of the securitization, but does not
receive the excess servicing, which is payable over the actual life of the loans
securitized. The excess servicing represents, over the estimated life of the
loans, the excess of the weighted average interest rate on the pool of loans
sold over the sum of the investor pass-through rate, normal servicing fee and
the monoline insurance fee. The net present value of that excess (determined
based on certain prepayment and loss assumptions) less transaction expenses is
recorded as excess servicing gain or loss at the time of the closing of the
securitization. Excess servicing gain increased by $55.3 million, or 241%, in
fiscal 1996 compared to fiscal 1995 and $14.9 million, or 183%, in fiscal 1995
compared to fiscal 1994. These increases resulted primarily from the greater
size of the mortgage loan pools securitized and sold by the Company in the
secondary market and, in fiscal 1996, increased servicing spreads and the
recognition of mortgage servicing rights pursuant to SFAS 122 in the amount of
$11.8 million (see "--Certain Accounting Considerations"). The Company
securitized and sold $107 million, $317 million and $791 million of loans in the
secondary market during fiscal 1994, 1995, and 1996, respectively. The weighted
average servicing spread on loans securitized and sold during these periods was
3.91%, 3.91% and 4.93% for fiscal 1994, 1995 and 1996, respectively. The higher
weighted average servicing spread in 1996 reflected a decrease in pass-through
rates to investors and a change in product mix. In the future, the Company
expects to realize a lower percentage of excess servicing gain on the sale of
loans as a result of changes in assumptions to reflect the changing composition
of the Company's loan product mix and other factors.
Commissions earned on loan originations continue to be a
significant component of total revenue, although to a lesser degree than in
prior years, comprising 45%, 29% and 15% of total revenue in fiscal 1994, 1995
and 1996 respectively. Commissions increased $4.1 million, or 26%, in fiscal
1996 compared to fiscal 1995, and decreased $633,000, or 3.9%, in fiscal year
1995 compared to fiscal 1994. Commission revenue is primarily a function of the
volume of mortgage loans originated by the Company through its retail loan
office network and the weighted average commission rate charged on such loans.
The increase in commissions in fiscal year 1996 was a result of increased
origination volume, offsetting a decline in weighted average commission rate.
The decrease in commissions in fiscal year 1995 was due to a reduction in the
weighted average commission rate, partially offset by an increase in the dollar
amount of loans originated. The weighted average commission rate was 11.6 %,
9.4% and 7.7% during fiscal 1994, 1995 and 1996, respectively. The lower
weighted average commission rate in 1996 reflected competitive factors, and
the increase of higher credit grade loans originated through the Company's
retail loan office network. Commissions do not include $722,000 and $1.0
million of commissions on loans which were held for sale as of June 30, 1995
and 1996, respectively.
Loan service revenue increased $9.9 million, or 121%, in
fiscal 1996 compared to fiscal 1995 and $2.1 million, or 35%, in fiscal 1995
compared to fiscal 1994. Loan service revenue consists of net servicing spread
earned on the principal balances of the loans in the Company's loan servicing
portfolio, prepayment fees, late charges and other fees retained by the Company
in connection with the servicing of loans. The increases in fiscal 1996 and 1995
were due primarily to the greater size of the portfolio of loans serviced in
each of these periods. The Company's loan servicing portfolio increased to $1.25
billion at June 30, 1996, up 105% from the June 30, 1995 balance of $609 million
which, in turn, increased 59% over the June 30, 1994 balance.
Fees and other revenue increased by $4.1 million, or 52%, in
fiscal 1996 compared to fiscal 1995 and increased $2.3 million, or 42%, in
fiscal 1995 compared to fiscal 1994. Fees and other revenue consist of fees
received by the Company through its retail loan office network in the form of
closing, appraisal, underwriting and other fees, plus interest income. The
dollar amount of these fees increased in each of the years presented due to the
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larger number of mortgage loans originated through the Company's retail loan
office network during the respective periods. Interest income increased in
fiscal 1996 and 1995 due to interest earned on larger amounts of loans held by
the Company during the period from origination or purchase of the loans until
the date sold by the Company.
EXPENSES
Compensation and related expenses increased $15.6 million, or
89%, in fiscal 1996 compared to fiscal 1995 as a result of increased
compensation paid to senior management ($4.2 million) as well as the addition of
new personnel. For primarily the same reasons, compensation and related expenses
increased by $4.0 million, or 29%, in fiscal 1995 as compared to fiscal 1994.
Compensation and related expenses as a percentage of total revenues were 38%,
32% and 26% for fiscal 1994, 1995 and 1996, respectively. The Company
anticipates that compensation expense will increase in fiscal 1997 as a result
of a full year's compensation to be paid to members of senior management who
joined the Company in the latter half of fiscal 1996, as well as the addition in
fiscal 1997 of One Stop's senior management and other personnel.
Sales and advertising costs increased $8.5 million, or 85%, in
fiscal 1996 compared to fiscal 1995 and $2.0 million, or 26%, in fiscal 1995
compared to fiscal 1994, due primarily to the Company's nationwide expansion of
its retail loan office network. Sales and advertising costs as a percentage of
total revenue were 22%, 18% and 14% for fiscal 1994, 1995, and 1996,
respectively.
General and administrative expenses increased $6.9 million, or
97%, in fiscal 1996 compared to fiscal 1995 and decreased to 11% from 13% of
revenue for the same periods. General and administrative expenses increased by
$1.7 million, or 31%, in fiscal 1995 compared to fiscal 1994, a decrease to 13%
from 15% of revenue for the same periods. The dollar increases were primarily
the result of occupancy and communications costs related to the expansion of the
Company's retail loan office network (an increase of $3.7 million in 1996 when
compared to 1995 and $592,000 in 1995 when compared with 1994), and equipment
rental expense (an increase of $956,000 in 1996 when compared to 1995 and
$10,000 in 1995 when compared with 1994). The increase in equipment rental
expense in 1996 was primarily attributable to an airplane lease entered into in
February 1996.
Interest expense increased to $9.3 million in fiscal 1996
compared to $3.2 million in fiscal 1995 and $322,000 in fiscal 1994 primarily as
a result of increased borrowings under various financing arrangements used to
fund the origination and purchase of mortgage loans prior to their
securitization and sale in the secondary market. Interest expense is expected to
increase in future periods due to the Company's continued reliance on
warehousing arrangements to fund increased originations and purchases of loans
pending their securitization, and as a result of the Company's sale in the third
quarter of fiscal 1996 of $115 million of its 5.5% Convertible Subordinated
Debentures due 2006.
INCOME TAXES
The Company's provision for income taxes increased to $22.5
million in fiscal 1996 from $7.1 million in fiscal 1995 and $3.7 million in
fiscal 1994 primarily as a result of increased pre-tax income.
FINANCIAL CONDITION
Loans held for sale. Prior to securitization, the Company
holds mortgage loans in its portfolio. Due to the increased volume of loan
originations and purchases, the Company's portfolio of loans held for sale
increased to $67.3 million at June 30, 1996 from $24.1 million at June 30, 1995.
Accounts receivable. Accounts receivable representing
servicing fees and advances, increased by $2.5 million from $6.1 million at June
30, 1995 to $8.6 million at June 30, 1996. This increase was primarily due to
the increased size of the servicing portfolio.
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Excess servicing receivable. Excess servicing receivable,
increased $87.0 million from $42.0 million at June 30, 1995 to $129 million at
June 30, 1996 reflecting the increased size of the Company's securitizations
during 1996.
Mortgage servicing rights. The June 30, 1996 balance includes
$10.9 million of mortgage servicing rights capitalized in accordance with SFAS
No. 122. This balance reflects the capitalization under SFAS No. 122 of $11.8
million of servicing rights partially offset by amortization of $857,000 during
fiscal 1996. See "--Certain Accounting Considerations."
Residual assets. Residual assets represent the reserve
accounts and overcollateralization amounts required to be maintained in
connection with the securitization of loans. Residual assets include cash and
mortgage loans in excess of the principal amounts of the senior certificates of
the REMIC trusts. Residual assets increased $29.8 million from $14.9 million at
June 30, 1995 to $44.7 million at June 30, 1996.
Equipment and improvements. Primarily as a result of the
expansion of the Company's retail loan office network and the associated
investment in technology, equipment and improvements, net increased $3.5 million
from $2.1 million at June 30, 1995 to $5.6 million at June 30, 1996.
Prepaid and other assets. Prepaid and other assets increased
$4.6 million from $5.0 million at June 30, 1995 to $9.6 million at June 30,
1996. The increase was primarily related to prepaid financing costs incurred in
connection with the issuance of $115 million of 5.5% Convertible Subordinated
Debentures due 2006 in the third quarter of fiscal 1996 and, to a lesser extent,
to prepaid advertising costs.
Revolving warehouse arrangements. Amounts outstanding under
warehouse arrangements increased by $11.0 million from a zero balance at
June 30, 1995 to an $11.0 million balance at June 30, 1996 primarily as a
result of the larger amount of loans held for sale at such dates.
Borrowings. Notes payable increased by $115 million from $23.1
million at June 30, 1995 to $138 million at June 30, 1996 primarily as a result
of the issuance in the third quarter of fiscal 1996 of $115 million of 5.5%
Convertible Subordinated Debentures due 2006.
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LIQUIDITY
The table below summarizes cash flow generated by operating
activities:
FISCAL YEARS ENDED JUNE 30,
-----------------------------------------------
1994 1995 1996
-------------- ------------ -------------
(IN THOUSANDS)
OPERATING CASH INCOME:
Excess cash flows generated by securitization trusts.................. $ 3,482 $ 7,984 $ 29,932
Less cash required to be invested in residual assets (1).......... (4,228) (8,691) (29,794)
-------------- ------------ -------------
Net excess cash flow from securitization trusts................... (746) (707) 138
Other servicing fees.............................................. 5,310 4,664 6,049
Interest received................................................. 771 2,339 6,397
Commission income................................................. 16,432 15,799 19,880
Other cash income................................................. 4,825 5,601 5,372
-------------- ------------ -------------
Total Operating Cash Income....................................... 26,592 27,696 37,836
OPERATING CASH EXPENSES:
Securitization and loan acquisition costs......................... (1,589) (10,937) (37,317)
Cash operating expenses........................................... (26,779) (36,377) (69,304)
Taxes paid........................................................ (2,991) (5,196) (4,240)
Interest paid..................................................... 0 (805) (2,415)
Total Operating Cash Expenses..................................... (31,359) (53,315) (113,276)
Net Operating Cash Flow........................................... (4,767) (25,619) (75,440)
Cash (used in) provided by other payables and receivables......... 875 (3,765) (3,598)
Cash used in loans held for sale.................................. (9,965) (13,991) (43,195)
-------------- ------------ -------------
Net Cash used in Operating Activities............................. ($13,857) ($43,375) ($122,233)
============== ============ =============
CHANGE IN EXCESS SPREAD RECEIVABLES (2)............................... $ 11,225 $ 38,180 $ 127,731
NET CASH PROVIDED BY FINANCING ACTIVITIES............................. $ 22,855 $ 48,209 $ 124,687
- --------------------
(1) Cash required to fund initial and required overcollateralization
account balances.
(2) Represents the sum of excess servicing receivables and residual
assets, and at June 30, 1996, mortgage servicing rights. See
Note 1 to Notes to Consolidated Financial Statements.
The Company's operations require continued access to short-term
and long-term sources of cash. The Company's operating cash requirements include
the funding of: (i) mortgage loan originations and purchases prior to their
securitization and sale, (ii) fees and expenses incurred in connection with the
securitization and sale of loans, (iii) cash reserve account or
overcollateralization requirements in connection with the securitization and
sale of mortgage loans, (iv) tax payments due on recognition of excess servicing
gain, and (v) ongoing administrative and other operating expenses.
The Company has operated on a negative operating cash flow basis
and expects to continue to do so for as long as the Company's cash requirements
necessitated by the growth in volume of its securitization program continue to
grow at rates in excess of the cash generated by the Company from its
operations, including its servicing activities. Historically, the Company has
funded, and expects to continue to fund, these negative operating cash flows,
subject to limitations under the Company's existing credit facilities,
principally through borrowings from financial institutions, sales of equity
securities and sales of senior and subordinated notes, among other sources.
There can be no assurance that the Company will have access to the capital
markets in the future or that financing will be available to satisfy the
Company's operating and debt service requirements or to fund its future growth.
See "--Capital Resources" and "Item 1. Business--Business Strategy."
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26
New loan originations and purchases represent the Company's most
significant cash flow requirement. The Company pays a premium on loans purchased
through its wholesale correspondent program and on loans purchased from
independent mortgage brokers. The amount of cash used to pay premiums
approximated $33.7 million in 1996.
The Company securitized and sold in the secondary market $107 million, $317
million and $791 million of loans in fiscal 1994, 1995 and 1996, respectively.
In connection with securitization transactions completed during these periods,
the Company was required to provide credit enhancements in the form of reserve
accounts or overcollateralization amounts. In addition, during the life of the
related REMIC trusts, the Company subordinates a portion of the excess servicing
otherwise due it to the rights of holders of senior interests as a credit
enhancement to support the sale of the senior interests. In connection with
securitizations effected in fiscal 1994, 1995, and 1996, initial reserve
accounts or overcollateralization requirements were set at $2.2 million, $3.5
million, and $7.5 million, respectively. The terms of the REMIC trusts generally
require that all excess servicing otherwise payable to the Company during the
early months of the trusts be used to increase the cash reserve accounts, or to
repay the senior interests in order to increase overcollateralization to
specified maximums. The accumulated amounts of such cash reserve accounts and
overcollateralization amounts are reflected on the Company's balance sheet as
"residual assets." At June 30, 1996, the residual assets balance was $44.7
million.
In addition, the increasing use of securitization transactions as a funding
source by the Company has resulted in a significant increase in the amount of
excess servicing gain recognized by the Company. During fiscal 1994, 1995, and
1996, the Company recognized excess servicing gain in the amounts of $8.1
million, $23.0 million, and $78.3 million, respectively. The recognition of
excess servicing gain has a negative impact on the cash flow of the Company
since the Company is required to pay federal and state taxes on a portion of
these amounts in the period recognized although it does not receive the cash
representing the gain until later periods as the related service fees are
collected and applicable reserve or overcollateralization requirements are met.
The Company also incurs certain expenses in connection with
securitizations, including underwriting fees, credit enhancement fees, trustee
fees, hedging and other costs, which in fiscal 1996 approximated 1.0% of the
principal amount of the securitized mortgage loans.
CAPITAL RESOURCES
The Company finances it operating cash requirements primarily through (i)
warehouse and other credit facilities, (ii) the securitization and sale of
mortgage loans, and (iii) the issuance of debt and equity securities.
Warehouse and Other Credit Facilities. At August 31, 1996, the Company had
four warehouse and one other credit facility in place. There is a $150 million
warehouse and working capital line of credit from a syndicate of six commercial
banks that is secured by loans originated and purchased by the Company as well
as certain servicing receivables, which bears interest at the rate of 0.875%
over one-month LIBOR. This line currently expires on December 26, 1996 and is
subject to renewal. There are two additional warehouse lines of credit from two
investment banks that are secured by loans originated and purchased by the
Company. These lines of $150 million and $125 million bear interest at the rate
of 0.875% over one-month LIBOR and are subject to renewal periodically. The $150
million line expires on January 1, 1997 and the $125 million line expires on
September 30, 1996. The Company also has a $250 million warehouse line of credit
with another investment bank that is secured by loans originated and purchased
by One Stop. This line bears interest at the rate of 1.1% over one-month LIBOR
and expires on September 27, 1996. Finally, the Company has a $50.0 million
credit facility from an investment bank that is secured by certain excess
servicing receivables in certificated form. Until February 1997 this is a
revolving facility that bears interest at the rate of 2.5% over one-month LIBOR;
during the amortizing term thereafter until August 1999, it bears interest at
the rate of 4.5% over one-month LIBOR. Management expects, although there can be
no assurance, that the Compan