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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
for the Fiscal Year Ended June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ________ to __________
Commission file number 0-19604
AAMES FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 95-4340340
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(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation)
350 S. GRAND AVENUE, LOS ANGELES, CALIFORNIA 90071
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (323) 210-5000
Securities registered pursuant to Section 12(b) of the Act:
Title of each Class Name of each exchange on which registered
COMMON STOCK, PAR VALUE $0.001 NEW YORK STOCK EXCHANGE
PREFERRED STOCK PURCHASE RIGHTS NEW YORK STOCK EXCHANGE
10.50% SENIOR NOTES DUE 2002 NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.[ ]
At August 18, 1999, there were outstanding 31,016,964 shares of the
Common Stock of Registrant, and the aggregate market value of the shares held on
that date by non-affiliates of the Registrant, based on the closing price
($1.4375 per share) of the Registrant's Common Stock on the New York Stock
Exchange was $41,869,205.75. For purposes of this computation, it has been
assumed that the shares beneficially held by directors and executive officers of
Registrant were "held by affiliates"; this assumption is not to be deemed to be
an admission by such persons that they are affiliates of Registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's Proxy Statement relating to its 1999 Annual
Meeting of Stockholders or an amendment to this Form 10-K are incorporated by
reference in Items 10, 11, 12 and 13 of Part III of this Annual Report.
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PART I
ITEM 1. BUSINESS
GENERAL
Aames Financial Corporation (the "Company") is a consumer finance
company primarily engaged, through its subsidiaries, in the business of
originating, purchasing, selling and servicing home equity mortgage loans
secured by single family residences. Upon its formation in 1991, the Company
acquired Aames Home Loan, a home equity lender founded in 1954. In August 1996,
the Company acquired One Stop Mortgage, Inc. ("One Stop") which originates
mortgage loans primarily through a broker network. In August 1999, One Stop
began operating under the name "Aames Home Loan."
On December 23, 1998 as amended February 10, 1999, June 9, 1999 and July
16, 1999, the Company entered into a Preferred Stock Purchase Agreement (the
"Preferred Stock Purchase Agreement") with Capital Z Financial Services Fund,
II, L.P., a Bermuda limited partnership ("Capital Z"), pursuant to which Capital
Z has agreed to make an equity investment of up to $126.5 million in the Company
(the "Investment"). The Investment is to be made as follows: (i) on February 10,
1999 (the "Initial Closing"), Capital Z (through a partnership majority-owned by
Capital Z) and certain other investors designated by Capital Z purchased 26,704
shares of the Series B Convertible Preferred Stock of the Company and 49,796
shares of the Series C Convertible Preferred Stock of the Company for $1,000 per
share, or an aggregate purchase price of $76.5 million; (ii) on August 3, 1999,
Capital Z (through a partnership majority-owned by Capital Z) purchased an
additional 25,000 shares of Series C Convertible Preferred Stock of the Company
for $1,000 per share, or an aggregate purchase price of $25 million (the
"Additional Investment'); (iii) subject to receiving stockholder approval of
amendments to the Company's Certificate of Incorporation to increase the
authorized common and preferred stock and effect a 1,000-for-1 forward stock
split of the outstanding preferred stock (the "Recapitalization") at a meeting
of stockholders scheduled for September 13, 1999, the Company will offer in a
public offering to the holders of the common stock of the Company
non-transferable subscription rights (the "Rights Offering") to purchase up to
approximately 31 million shares of Series C Convertible Preferred Stock for
$1.00 per share, and (iv) if less than 25 million shares of Series C Convertible
Preferred Stock is purchased by the stockholders, Capital Z has agreed to
purchase the difference (up to 25 million additional shares of Series C
Convertible Preferred Stock) for $1.00 per share (the "Standby Commitment").
The Company's principal market is borrowers whose financing needs are
not being met by traditional mortgage lenders for a variety of reasons,
including the need for specialized loan products or credit histories that may
limit such borrowers' access to credit. The Company believes these borrowers
continue to represent an underserved niche of the home equity loan market and
present an opportunity to earn a superior return for the risk assumed. The
residential mortgage loans originated and purchased by the Company, which
include fixed and adjustable rate loans, are generally used by borrowers to
consolidate indebtedness or to finance other consumer needs rather than to
purchase homes.
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The Company originates and purchases loans nationally through three
production channels retail, broker and correspondent. For the year ended June
30, 1999, the Company originated and purchased $2.19 billion of mortgage loans.
The Company underwrites and appraises every loan it originates and generally
reviews appraisals and re-underwrites all loans it purchases.
As a fundamental part of its business and financing strategy, the
Company sells its loans to third party investors in the secondary market as
market conditions allow. The Company maximizes opportunities in its loan
disposition transactions by disposing of its loan production through a
combination of securitizations and whole loan sales, depending on market
conditions, profitability and cash flows. The Company sold $1.89 billion, $2.45
billion and $2.27 billion of loans in the fiscal years ended June 30, 1999, 1998
and 1997, respectively. Of the total amount of loans sold during the fiscal
years ended June 30, 1999, 1998 and 1997, $650 million, $2.03 billion and $2.26
billion were sold in securitizations, respectively. During those same fiscal
years, the Company sold $1.24 billion, $416 million and $7.5 million,
respectively, in whole loan sales for cash. The Company did not complete a
securitization during the quarters ended December 31, 1998, March 31, 1999 and
June 30, 1999 due to adverse market conditions for asset-backed securitizations.
In August 1999, the Company completed a mortgage loans securitization of $400
million. See "- Loan Disposition."
The Company retains the servicing on the loans it originates or
purchases and securitizes. In April 1999, the Company entered into a
sub-servicing arrangement with a loan servicing company with respect to $388
million of loans primarily to reduce the burden on its cash resources caused by
its obligation to advance interest on delinquent loans in its servicing
portfolio.
BUSINESS STRATEGY
Fiscal 1999's results reflect the impact on the Company of the global
economic crises that existed early in the year and the continuing effects of
those crises on the credit, capital and asset-backed markets. From October
through the Initial Closing, the Company was dependent on one $300 million
warehouse line to fund its loan production. In conjunction with the Initial
Closing, the Company obtained an additional $400 million in committed warehouse
and repurchase facilities and an additional $100 million in an uncommitted
facility. The limited warehouse capacity during the second and part of the third
fiscal quarters severely constrained the Company's loan production capability.
Further, the public equity and debt markets on which the Company had
historically relied to satisfy its cash flow needs were not available during the
whole of the fiscal year. Additionally, the asset-backed markets on which the
Company had historically and primarily relied for its loan disposition strategy
remained weak, and inaccessible to, or impracticable for, the Company,
throughout the last three fiscal quarters. The Company, therefore, relied solely
on whole loan sales for cash during that period. The gains recorded for whole
loan sales are generally lower than the gains recorded for securitizations.
However, this difference in gain was exacerbated during the year by the
over-supply of whole loan product as other home equity lenders who had
traditionally securitized their production also sold loans in the whole loan
market. The gain on sale from the securitization completed during the first
fiscal quarter was significantly reduced due to a loss on the Company's hedge
position which was not offset by enhanced securitization execution. These
negative market conditions adversely affected the prepayment, loss and discount
rate assumptions applied by the Company in estimating the value of its
interest-only strips.
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The application of these revised assumptions resulted in the Company recording a
$194 million net loss in valuation of its interest-only strips during the second
fiscal quarter of 1999 (the "Write-Down").
For the three years prior to fiscal 1998, the Company's significant
year-over-year growth was driven primarily by the increases in the volume of
loans purchased in the bulk correspondent business facilitated by the sale of
the Company's loan production in securitization transactions. These business
strategies significantly contributed to the Company's operating on a negative
cash flow basis which was funded by the Company regularly accessing the public
equity and debt markets. In the fourth quarter of fiscal 1997, primarily as a
reaction to the uncertainties in those capital markets, the Company decided to
reduce its bulk loan purchases and focus on the less cash intensive core retail
and broker loan production units and its servicing divisions. Fiscal 1998's
results reflect these strategic decisions in the record levels of retail and
broker loan production, increased expenses for retail and broker loan office
expansion and increased expenses to accommodate the significant increase in the
Company's in-house servicing portfolio.
The Company believes that the Investment by Capital Z and its current
warehouse capacity permits the Company to resume its growth strategy. This
growth strategy consists of: (i) continuing to focus on its core loan production
units; (ii) increasing its servicing portfolio and servicing capabilities; and
(iii) diversifying its funding sources to become self-financing (i.e., the
ability to obtain sufficient lines of credit to provide financing for assets
created by the Company and the reduction of reliance on the public equity and
debt markets). In particular, the Company intends to employ the following
strategies:
Focus on Core Loan Production. The Company intends to evaluate expansion
opportunities in its retail and broker operations and to expand its loan
purchasing capabilities by building new relationships with independent mortgage
brokers, with the goal of increasing market share in these areas. The Company
regularly reviews its loan offerings and introduces new loan products to further
meet the needs of its customers and increase its core loan production volume.
However, no assurance as to the Company's ability to accomplish these goals can
be given.
Increase Servicing Portfolio; Increase Margins and Develop Subservicing
Capabilities. The Company plans to continue to build the size of its servicing
portfolio to provide a stable and significant source of recurring revenue. At
June 30, 1999, the Company's servicing portfolio was $3.84 billion. The Company
expects to increase the size of its loan servicing portfolio by continuing to
increase loan originations and purchases, completing new securitizations and
subservicing on behalf of third parties. However, no assurance as to the
Company's ability to accomplish these goals can be given.
Continue to Diversify Funding Sources and Become Self-Financing. The
Company intends to continue to expand and diversify its funding sources by
adding additional warehouse or repurchase facilities, disposing of a portion of
its loan production for cash in the whole loan market, and developing new
sources for working capital. However, no assurance as to the Company's ability
to accomplish these goals can be given.
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The strategies discussed above contain forward-looking statements. Such
statements are based on current expectations and are subject to risks,
uncertainties and assumptions, including those discussed under "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Risk Factors." Should one or more of these risks or uncertainties
materialize, or should underlying assumptions prove incorrect, actual results
may vary materially from those anticipated, estimated or projected. Thus, no
assurance can be given that the Company will be able to accomplish the above
strategies.
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 interest rate. Non-conforming home equity loans are loans made to
homeowners whose borrowing needs may not be met by traditional financial
institutions due to credit exceptions or other factors and that generally cannot
be marketed to agencies such as the Federal National Mortgage Association
("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"). In addition,
the Company offers junior mortgages and other products in order to meet a wide
variety of borrower needs. In fiscal 1999, the Company obtained its residential
loans through three primary channels: retail, broker and correspondent.
The following table illustrates the sources of the Company's loan
production during the periods indicated:
FISCAL YEARS ENDED JUNE 30,
1999 1998 1997
---- ---- ----
(DOLLARS IN THOUSANDS)
Retail loans:
Total dollar amount.............................. $770,000 636,100 436,900
Number of loans................................. 12,214 11,531 8,565
Average loan amount............................ 63 55 51
Average initial combined loan to value........... 72% 70 67
Weighted average interest rate(1)................ 9.5% 10.3 10.5
Broker loans(2):
Total dollar amount.............................. $1,182,100 1,101,200 741,000
Number of loans.................................. 14,006 12,763 8,985
Average loan amount.............................. 84 86 83
Average initial combined loan to value........ 76% 75 71
Weighted average interest rate(1)................ 9.9% 9.8 10.0
Correspondent program:
Total dollar amount.............................. $ 241,500 646,300 1,170,000
Number of loans.................................. 2,219 6,252 12,500
Average loan amount.............................. 109 103 94
Average initial combined loan to value........... 80% 79 71
Weighted average interest rate(1)................ 10.0% 10.2 11.0
Total loans:
Total dollar amount.............................. $2,193,600 2,383,600 2,347,900
Number of loans.................................. 28,439 30,546 30,050
Average loan amount.............................. 77 78 78
Average initial combined loan to value........... 75% 75 70
Weighted average interest rate(1)................ 9.8% 10.1 10.6
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(1) Calculated with respect to the interest rate at the time the loan is
originated or purchased by the Company.
(2) Includes commercial loans. In late fiscal 1997, the Company began
originating small commercial loans on a limited basis. In January 1999,
the Company discontinued its commercial loan operation.
Retail Loan Office Network. The Company originates home equity mortgage
loans through its network of retail loan offices. At June 30, 1999, the Company
had 101 offices serving borrowers in 37 states. Prior to fiscal year 1994, the
Company's retail offices were located only in California. Commencing fiscal
1996, the Company aggressively pursued a strategy of expanding its retail loan
office network nationwide. The Company's retail office network increased by 16
offices and 53 offices in fiscal 1997 and 1998, respectively. However, primarily
due to market conditions, during fiscal 1999, the Company closed 20 retail
offices. The Company's network of retail loan offices includes two different
retail operations - a centralized network which operates under the name "Aames
Home Loan" and uses a centralized marketing approach, and a decentralized
network which now operates under the name "Aames Funding Corporation" and uses a
decentralized marketing approach at the branch level. During the current fiscal
year, the Company intends to evaluate opportunities for further retail office
expansion.
The Company selects areas in which to introduce or expand its retail
presence on the basis of selected demographic statistics, marketing analyses and
other criteria developed by the Company.
The Company's expansion of its retail loan office network during fiscal
1997 and 1998 resulted in significant increases in retail loan production over
those fiscal years. The Company originated $636 million and $437 million of
mortgage loans through this network in fiscal 1998 and 1997, respectively.
Despite the adverse market conditions that existed during most of the year,
retail production increased to $770 million during fiscal 1999. Most of the
increase resulted from the Company's decentralized retail network which
commenced operations in March 1998.
The Company generates applications for loans through its retail loan
office network principally through a multimedia advertising program, which
relies primarily on the use of direct mailings to homeowners, yellow-page
listings and telemarketing. In the past, the Company has also used television
and radio advertising. The Company believes that its advertising campaigns
establish name recognition and serve to distinguish the Company from its
competitors. The Company continually monitors the sources of its applications to
determine the most effective methods and manner of advertising.
The Company's advertising invites prospective borrowers to call the
Company to apply for a loan. On the basis of an initial screening conducted at
the time of the call, the Company makes a preliminary determination of whether
the customer and the property meet the Company's lending criteria, and schedules
an appointment with a loan officer in the retail loan office most conveniently
located to the customer or in the customer's home.
The Company's loan officer at the local retail loan office assists the
applicant in completing the loan application, arranges for an appraisal, orders
a credit report from an independent, nationally recognized credit reporting
agency and performs various other tasks in connection with the completion of the
loan package. The loan package is then underwritten for loan approval. If the
loan package is
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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.
Centralized Retail Network. The Company's direct mail advertising for
the centralized retail network is produced by the Company and distributed to
prospective borrowers based upon Company derived models and commercially
developed customer lists. The direct mail invites prospective borrowers to call
its headquarters office through the Company's toll-free telephone numbers, where
the customer is prequalified and scheduled for an appointment with a loan
officer in the retail loan office most conveniently located to the customer or
in the customer's home. If the customer cannot schedule an appointment or is
located in an area without a retail office, the customer is referred to a loan
officer who takes the loan application by telephone. The loan package is then
forwarded to the Company's headquarters office for review by underwriters and
for loan approval. At June 30, 1999, the Company had 80 centralized retail
offices serving borrowers in 32 states. During the years ended June 30, 1999,
1998, and 1997, $639 million, $635 million and $437 million in loans were
originated through this network, respectively.
Decentralized Retail Direct Network. In March 1998, the Company
established a separate decentralized retail production unit to enable the
Company to further penetrate the non-conforming home equity loan market. The
Company's advertising for the decentralized retail network is generated by the
local branch by the loan officers who are familiar with the local area. Direct
mail is often followed up by telephone calls to potential customers. All contact
with the customer is handled through the local branch. At June 30, 1999, the
Company had 21 decentralized retail offices serving borrowers in 13 states.
During the years ended June 30, 1999 and 1998, $131 million and $1.5 million in
loans were originated through this network, respectively.
Independent Mortgage Broker Network. Through its independent mortgage
broker network, the Company funded $1.18 billion, $1.10 billion and $741 million
in residential loans during the fiscal years ended June 30, 1999, 1998 and 1997,
respectively. At June 30, 1999, the Company operated 35 broker offices in 28
states and had approximately 7,100 approved mortgage brokers. During fiscal
1999, the Company originated loans through approximately 4,200 brokers, no one
of which accounted for more than 3% of total broker originations. All broker
loans originated by the Company are underwritten in accordance with the
Company's underwriting guidelines. Once approved, the loan is funded by the
Company directly.
The broker's role is to identify the applicant, assist in completing the
loan application form, gather necessary information and documents and serve as
the Company's liaison with the borrower through the lending process. The Company
reviews and underwrites the applications submitted by the broker, approves or
denies the application, sets the interest rate and other terms of the loan and,
upon acceptance by the borrower and satisfaction of all conditions imposed by
the Company, funds the loan. Because brokers conduct their own marketing and
employ their own personnel to complete loan applications and maintain contact
with borrowers, originating loans through its broker network allows the Company
to increase its loan volume without incurring the higher marketing costs
associated with increased retail originations.
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Because mortgage brokers generally submit loan files to several
prospective lenders simultaneously, consistent underwriting, quick response
times and personal service are critical to successfully producing loans through
independent mortgage brokers. To meet these requirements, the Company strives to
provide quick response time to the loan application (generally within 24 hours).
In addition, loan consultants and loan processors, including underwriters, are
available in the Company's broker offices to answer questions, assist in the
loan application process and facilitate ultimate funding of the loan.
Correspondent Channel. The Company purchases closed loans from mortgage
bankers and other financial institutions on a continuous or "flow" basis, and
through mini-bulk purchases. During the fiscal years ended June 30, 1999, 1998
and 1997, $241 million, $646 million and $1.17 billion in loans were purchased
through the correspondent channel. The Company believes that its flow and
mini-bulk correspondent program represents a cost effective means of increasing
loan production. In the fourth quarter of fiscal 1997, primarily as a reaction
to the uncertainties in the public equity and debt markets, the Company decided
to emphasize its mini-bulk and flow purchases, rather than its bulk loan
purchases. This strategic decision eliminated bulk purchases in fiscal 1999 and
decreased the amount of bulk loans purchased in fiscal 1998 compared to fiscal
1997. Additionally, the Company's limited warehouse capacity during the second
and part of the third fiscal quarters constrained its ability to purchase loans
and contributed to the decline in fiscal 1999.
Underwriting. The Company underwrites every residential loan it
originates and generally re-underwrites each loan it purchases. The Company's
underwriting guidelines are designed to assess the 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) 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 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 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 monthly debt payments
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. The Company regularly reviews its underwriting guidelines and makes
changes when appropriate to
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respond to market conditions, the performance of loans representing a particular
loan product or changes in laws or regulations.
Appraisers determine a property's value by reference to the sales prices
of comparable properties recently sold, adjusted to reflect the condition of the
property as determined through inspection. Appraisals on loans purchased as part
of the Company's correspondent program are reviewed by Company appraisers or
Company-qualified contract appraisers to assure that they meet the Company's
standards.
The Company requires title insurance coverage issued on an American Land
Title Association (or similar) form of title insurance on all residential
properties securing mortgage loans it originates or purchases. The loan
originator and its assignees are generally named as the insured. Title insurance
policies indicate the lien position of the mortgage loan and protect the Company
against loss if the title or lien position is not as indicated. The applicant is
also required to maintain hazard and, in certain instances, flood insurance, in
an amount sufficient to cover the new loan and any senior mortgage, subject to
the maximum amount available under the National Flood Insurance Program.
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 networks, independent mortgage broker network and
correspondent program 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 assigns a credit grade (A, A-, B, C, C- and
D) to each loan it originates or purchases depending on the risk profile of the
loan, with the higher credit grades exhibiting a lower risk profile and the
lower credit grades exhibiting increasingly higher risk profiles. Generally, the
higher credit grade loans have higher loan-to-value ratios and carry a lower
interest rate. The following chart generally outlines certain parameters of the
credit grades of the Company's underwriting guidelines for its residential loans
at August 12, 1999:
"A" CREDIT "A-" CREDIT "B" CREDIT "C" CREDIT "C-" CREDIT "D" CREDIT
GRADE GRADE GRADE GRADE GRADE GRADE
---------- ---------- ---------- ---------- ----------- ----------
GENERAL Has good Has good credit Generally good Marginal credit Marginal credit Designed to
REPAYMENT credit. but might have mortgage pay history which is history not offset provide a borrower
some minor history but may offset by other by other positive with poor credit
delinquency. have marginal positive attributes. history an
consumer credit attributes. opportunity to
history. correct past credit
problems.
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"A" CREDIT "A-" CREDIT "B" CREDIT "C" CREDIT "C-" CREDIT "D" CREDIT
GRADE GRADE GRADE GRADE GRADE GRADE
---------- ----------- ---------- ---------- ----------- ----------
EXISTING No lates in No more than 59 No more than 89 Can have No more than Greater than
MORTGAGE past 12 months. days late at days late at multiple 30-day 149 days 150 days
LOANS closing and a closing and a lates and two delinquent in delinquent in
maximum of maximum of 60-day lates the past 12 the past 12
two 30-day lates four 30-day lates or one 90-day months. Can months.
in the past 12 in the past 12 late in the past have multiple
months. months or one 12 months; 90-day lates
60-day late currently not or one 120 day
and two 30-day more than 119 late in the past
lates. days late at 12 months.
closing.
CONSUMER Consumer credit Consumer credit Consumer credit Consumer credit Consumer credit Consumer credit
CREDIT is good in the is good in the must be is fair in the last is poor in the is poor in the
last 12 months. last 12 months. satisfactory in 12 months. The last 12 months last 12 months.
Less than 25% Less than 35% the last 12 majority of the with currently The majority of
of credit report of credit report months. Less credit is not delinquent the credit is
items derogatory items derogatory than 40% of currently accounts. Less derogatory (more
with no 60-day with no 90-day credit report delinquent. Less than 60% of than 60%).
or more lates. or more lates. items derogatory. than 50% of credit report Percentage of
credit report items derogatory. derogatory items
items derogatory not a factor.
BANKRUPTCY 2 years since 2 years since 1 year since Bankruptcy Bankruptcy Current
discharge or discharge or discharge with filing 12 months filed within bankruptcy
dismissal with dismissal with reestablished old, discharged last 12 months must be paid
reestablished reestablished "B" credit or 18 or dismissed and discharged through loan.
"A" credit. "A-" credit. months since prior to or dismissed
discharge application. prior
without to
reestablished application.
credit.
DEBT SERVICE- Generally not to Generally not to Generally not to Generally not to Generally not Generally not to
TO-INCOME exceed 45%. exceed 45%. exceed 50%. exceed 55%. to exceed 60%. exceed 60%.
RATIO
MAXIMUM
LOAN-TO-VALUE
RATIO:
OWNER
OCCUPIED Generally 90% Generally 90% Generally 80% Generally 75% Generally 70% Generally 65%
for a 1 to 4 for a 1 to 4 for a 1 to 4 for a 1 to 4 for a 1 to 4 for a 1 to 4
family dwelling. family dwelling. family dwelling. family dwelling. family dwelling. family dwelling.
NON-OWNER Generally 80% Generally 70% Generally 65% Generally 65% Generally 65% Generally 60%
OCCUPIED for a 1 to 4 for a 1 to 4 for a 1 to 2 for a 1 to 4 for a 1 to 4 for a 1 to 4
family dwelling. family dwelling. family dwelling. family dwelling. family dwelling. family dwelling.
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The following tables present certain information about the Company's
loan production through its retail loan office networks, independent mortgage
broker network and correspondent program during fiscal 1999, 1998 and 1997:
LOAN ORIGINATIONS AND PURCHASES IN FISCAL 1999
WEIGHTED
WEIGHTED AVERAGE
DOLLAR AMOUNT % OF COMBINED INTEREST
CREDIT GRADE OF LOAN TOTAL LOAN-TO-VALUE RATE(1)
A $ 707,644,000 32% 79% 9.1%
A- 729,237,000 33 77 9.4
B 475,370,000 22 75 10.1
C 119,730,000 5 68 11.1
C- 37,990,000 2 65 12.3
D 123,665,000 6 62 12.9
-------------- ------- ----- -------
Total $2,193,636,000 100% 75% 9.8%
============== ------- ===== =======
LOAN ORIGINATIONS AND PURCHASES IN FISCAL 1998
WEIGHTED
WEIGHTED AVERAGE AVERAGE
DOLLAR AMOUNT % OF COMBINED INTEREST
CREDIT GRADE OF LOAN TOTAL LOAN-TO-VALUE RATE(1)
A $ 651,303,000 27% 77% 9.3%
A- 835,834,000 35 78 9.7
B 560,710,000 24 74 10.2
C 159,652,000 7 67 11.2
C- 45,378,000 2 65 12.2
D 130,761,000 5 61 13.2
-------------- ------- ----- -------
Total $2,383,638,000 100% 75% 10.1%
============== ------- ===== =======
LOAN ORIGINATIONS AND PURCHASES IN FISCAL 1997
WEIGHTED
WEIGHTED AVERAGE AVERAGE
DOLLAR AMOUNT % OF COMBINED INTEREST
CREDIT GRADE OF LOAN TOTAL LOAN-TO-VALUE RATE(1)
A $ 327,574,000 14% 72% 9.2%
A- 758,842,000 32 73 9.8
B 573,125,000 24 72 10.3
C 277,002,000 12 67 11.2
C- 112,209,000 5 65 12.0
D 299,186,000 13 62 13.4
-------------- ------- ----- -------
Total $2,347,938,000 100% 70% 10.6%
============== ------- ===== =======
--------------
(1)Calculated with respect to the interest rate at the time the loan is
originated or purchased by the Company, as applicable.
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LOAN DISPOSITION
The Company sells loans to third party investors in the secondary market
as market conditions allow. The Company maximizes opportunities in its loan
disposition transactions by selling its loan production through a combination
of securitizations and whole loan sales, depending on market conditions,
profitability and cash flows. As discussed in "- Business Strategy," during the
1999 fiscal year, the Company relied primarily on whole loan sales to dispose
of its loans. The Company generally seeks to dispose of substantially all of
its production within 90 days. The Company applies the net proceeds of the loan
dispositions, whether through securitizations or whole loan sales, to pay down
its warehouse and repurchase facilities in order to make these facilities
available for future funding of mortgage loans.
The Company sold $1.89 billion, $2.45 billion and $2.27 billion of loans
in the fiscal years ended June 30, 1999, 1998 and 1997, respectively. Of the
total amount of loans sold during the fiscal years ended June 30, 1999, 1998
and 1997, $650 million, $2.03 billion and $2.26 billion were sold in
securitizations, respectively. During those same fiscal years, the Company sold
$1.24 billion, $416 million and $7.5 million, respectively, in whole loan sales
for cash. The Company did not complete a securitization during the quarters
ended December 31, 1998, March 31, 1999 and June 30, 1999. In August 1999, the
Company completed a securitization of $400 million of mortgage loans. See "-
Loan Disposition."
Each agreement that the Company has entered into in connection with its
securitizations requires either the overcollateralization of the trust or the
establishment of a reserve account that may initially be funded by cash
deposited by the Company. If losses exceed the amount of the
overcollateralization or the reserve account, as applicable, the
credit-enhancement aspects of the trust are triggered. In a securitization
credit-enhanced by a monoline insurance policy, any further losses experienced
by holders of the senior interests in the related trust will be paid under such
policy. To date, there have been no claims on any monoline insurance policy
obtained in any of the Company's securitizations. In a senior/subordinated
structure, losses in excess of the overcollateralization amount generally are
allocated first to the holders of the subordinated interests and then to the
holders of the senior interests of the trust. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Capital Resources -- Loan Sales" and "- Risk Factors -- Our Right to Service
Loans May be Terminated Because of the High Delinquencies and Losses on the
Loans in Our Servicing Portfolio."
In a whole loan sale for cash, the Company generally enters into an
agreement to sell the loans for cash on a servicing released basis. After the
sale, the Company retains no interest in the underlying loans.
LOAN SERVICING
Servicing includes collecting and remitting loan payments, accounting
for principal and interest, contacting delinquent borrowers, managing borrower
defaults and liquidating foreclosed properties. The Company retains the
servicing rights to the residential loans it originates or
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purchases and securitizes. In its whole loan sale strategy, the Company
evaluates the feasibility of selling loans on a servicing retained or servicing
released basis. To date, all of the Company's whole loan sales have been done
on a servicing released basis. The following table sets forth certain
information regarding the Company's servicing portfolio for the periods
indicated:
FISCAL YEARS ENDED JUNE 30,
1999 1998 1997
---- ---- ----
(IN THOUSANDS)
Servicing portfolio (period end) ................... $3,841,000(1) 4,147,000(2) 3,174,000
Serviced in-house .................................. 3,428,000(1) 3,941,000(2) 1,506,000
Loan service revenue .............................. 49,900 51,642 31,131
- --------------------
(1) Includes $84 million in loans subserviced for others on an interim basis
and approximately $413 million subserviced by others.
(2) Includes $82 million in loans subserviced for others on an interim
basis.
The Company believes that continued technology and processing
enhancements will provide it with improved margins on its servicing. The
Company anticipates that during fiscal 2000 it will begin subservicing for
third parties which will provide a new source of servicing revenue. However, no
assurance can be given that the Company will be successful in its attempts to
generate subservicing business.
The agreements between the Company and the real estate mortgage
investment conduit ("REMIC") or owner trusts established in connection with
securitizations typically require the Company to advance interest (but not
principal) on delinquent loans to the holders of the senior interests in the
related trust. The agreements also require the Company to make certain
servicing advances (e.g., for property taxes or hazard insurance) unless the
Company determines that such advances would not be recoverable. Realized losses
on the loans are paid out of the related loss reserves established by the
Company at the time of securitization or paid out of principal and interest
payments on overcollateralized amounts as applicable, and if necessary, from
the related monoline insurance policy or the subordinated interests.
In the case of securitizations credit-enhanced by monoline insurance,
the agreements also typically provide that the Company may be terminated as
servicer by the monoline insurance company (or by the trustee with the consent
of the monoline insurance company) upon certain events of default, including
the Company's failure to perform its obligations under the servicing agreement,
the rate of over 90-day delinquency (including properties acquired by
foreclosure and not sold) exceeding specified limits, losses on liquidation of
collateral exceeding certain limits, any payment being made by the monoline
insurance company under its policy, and certain events of bankruptcy or
insolvency. At June 30, 1999, ten trusts representing approximately 20% (by
dollar volume) of the Company's servicing portfolio exceeded the specified
delinquency rate. Four of the ten trusts representing approximately 16% (by
dollar volume) of the Company's servicing portfolio exceeded specified loss
limits at June 30, 1999. None of the servicing rights of the Company have been
terminated. Additionally, during July 1999, one additional trust exceeded the
specified delinquency
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level and one of the four trusts that exceeded its loss limit was cured. See
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations - Risk Factors -- Our Right to Service Loans May be
Terminated Because of the High Delinquencies and Losses on the Loans in Our
Servicing Portfolio." In the case of the Company's senior/subordinated
securitization transactions, holders of 51% of the certificates may terminate
the servicer upon certain events of default generally relating to certain
levels of loss experience, but not delinquency rates. No such events of default
have occurred to date in the Company's senior/subordinated securitizations.
The Company receives a servicing fee based on a percentage of the
declining principal balance of each loan serviced. Servicing fees are collected
by the Company out of the borrower's monthly payments. In addition, the
Company, as servicer, generally receives all late fees and assumption charges
paid by the borrower on loans serviced directly by the Company, as well as
other miscellaneous fees for performing various loan servicing functions. The
Company also generally receives any prepayment fees paid by borrowers. Under an
arrangement entered into in June 1999, the Company's right to receive the fees
and charges collected on loans in pre-1999 securitization trusts has been
subordinated to the right to such fees and charges as payment to the investment
bank which has agreed to make a significant portion of future advances on loans
included in those trusts. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations - Capital Resources."
The Company's servicing portfolio is subject to reduction by normal
monthly principal amortization, by prepayment and by foreclosure. It is the
Company's strategy to build and retain its core servicing portfolio.
In general, revenue from the Company's loan servicing portfolio may be
adversely affected by competitive market conditions that result in lower
mortgage interest rates or accelerated prepayment activity, subject to the
receipt by the Company of prepayment fee income. In some states in which the
Company currently operates, prepayment fees may be limited or prohibited by
applicable law.
The following table illustrates the mix of credit grades in the
Company's servicing portfolio as of June 30, 1999:
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WEIGHTED WEIGHTED
AVERAGE AVERAGE
COMBINED ORIGINAL
DOLLAR AMOUNT INITIAL INTEREST
CREDIT GRADE OF LOAN % OF TOTAL LOAN-TO-VALUE RATE
A $ 680,204,000 18% 78% 9.3%
A- 1,515,062,000 40 76 9.9
B 885,208,000 23 74 10.6
C 303,425,000 8 67 11.6
C- 118,865,000 3 64 12.5
D 324,909,000 8 62 13.4
Other 13,618,000 - 58 10.8
--------------- -------- ----------- --------
Total $3,841,291,000 100% 73% 10.5%
=============== ======== =========== =======
COLLECTIONS, DELINQUENCIES AND FORECLOSURES
The Company sends borrowers a monthly billing statement approximately
ten days prior to the monthly payment due date. Although borrowers generally
make loan payments within ten to fifteen days after the due date (the "grace
period"), if a borrower fails to pay the monthly payment within the grace
period, the Company commences collection efforts by notifying the borrower of
the delinquency. In the case of borrowers in the "B," "C," "C-" and "D" credit
grades, collection efforts begin immediately after the due date. The Company
continues contact with the borrower to determine the cause of the delinquency
and to obtain a commitment to cure the delinquency at the earliest possible
time.
As a general matter, if efforts to obtain payment have not been
successful, a pre-foreclosure notice will be sent to the borrower immediately
after the due date of the next subsequently scheduled installment (five days
after the initial due date for C- and D credit grades), providing 30 days'
notice of impending foreclosure action. During the 30-day notice period,
collection efforts continue and the Company evaluates various legal options and
remedies to protect the value of the loan, including arranging for extended
prepayment terms, accepting a deed-in-lieu of foreclosure, entering into a
short sale (a sale for less than the outstanding principal amount) or
commencing foreclosure proceedings. If no substantial progress has been made in
collecting delinquent payments from the borrower, foreclosure proceedings will
begin. Generally, the Company will have commenced foreclosure proceedings when
a loan is 45 to 100 days delinquent, depending upon credit grade, other credit
considerations or borrower bankruptcy status.
Servicing and collection practices change over time in accordance with,
among other things, the Company's business judgment, changes in portfolio
performance and applicable laws and regulations.
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
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borrower, or any person having a junior encumbrance on the real estate, may
cure a monetary default by paying the entire amount in arrears plus other
designated costs and expenses incurred in enforcing the obligation during a
statutorily prescribed reinstatement period. Generally, state law controls the
amount of foreclosure expenses and costs, including attorneys' fees, which may
be recovered by a lender, the minimum time required to foreclose and the
reinstatement or redemption rights of the borrower.
Although foreclosure sales are typically public sales, frequently no
third-party purchaser bids in excess of the lender's lien because of the
difficulty of determining the exact status of title to the property, the
possible deterioration of the property during the foreclosure proceedings and a
requirement that the purchaser pay for the property in cash or by cashier's
check. Thus, the Company often purchases the property from the trustee or
referee through a credit bid in an amount up to the principal amount
outstanding under the loan, accrued and unpaid interest, servicing advances and
the expenses of foreclosure. Depending upon market conditions, the ultimate
proceeds of the sale may not equal the Company's investment in the property.
The Company has historically experienced delinquency rates that are
higher than those prevailing in its industry due to its origination of lower
credit grade loans. At the end of calendar year 1996, the Company started to
focus more on higher credit grade loans which should cause delinquencies in the
Company's servicing portfolio to decrease in the future. If the Company were to
sell 100% of its loans in the whole loan market on a servicing released basis,
the Company would not be adding new loans to the servicing portfolio. The
seasoning of the old portfolio without the addition of new loans could cause
delinquency rates to rise. The delinquency rate at June 30, 1999 was 15.7%
compared to 15.6% at June 30, 1998.
During the fiscal year ended June 30, 1999, losses increased to $52
million from $26 million in the prior year primarily due to the seasoning of
the lower credit grade loans purchased in bulk and included in the Company's
earlier trusts. The Company has eliminated its bulk purchase program. The
seasoning of the lower credit grade bulk portfolio may continue to contribute
to an increase in losses over time. Further, the adverse market conditions that
existed during the fall of 1998 resulted in the tightening in underwriting
guidelines by purchasers of whole loans and the insolvency of several large
subprime home equity lenders. These factors have had the effect of decreasing
the availability of credit to delinquent lower credit grade borrowers who in
the past had avoided default by refinancing. Management believes that this will
increase the Company's level of losses in future periods.
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The following table sets forth delinquency, foreclosure and loss
information relating to the Company's servicing portfolio as of or for the
periods indicated:
AS OF OR FOR THE FISCAL YEARS ENDED JUNE 30,
1999 1998 1997
------------- ------------- -------------
(Dollars in thousands)
Percentage of dollar amount of delinquent
loans to loans serviced (period end)(1)(2)(3)(4)
One Month ................................... 2.4% 3.8 4.3
Two Months .................................. 1.0 1.3 1.9
Three or More Months
Not foreclosed (5) ........................ 10.3 9.0 8.1
Foreclosed (6) ............................ 2.0 1.5 1.0
------------- ------------- -------------
Total ..................................... 15.7% 15.6 15.3
============= ============= =============
Percentage of dollar amount of loans foreclosed
during the period to loans serviced (2)(4) .... 3.0% 2.0 1.5
Number of loans foreclosed
during the period(7) ........................ 1,613 1,125 560
Principal amount of foreclosed loans
during the period(7) ........................ $ 117,015 84,613 48,029
Net losses on liquidations
during the period(8) ........................ $ 51,730 26,488 5,470
Percentage of losses to average servicing
portfolio (4) ............................... 1.31% .72 .24
Servicing portfolio at period end ............. $ 3,841,300 4,147,000 3,174,000
(1) Delinquent loans are loans for which more than one payment is past due.
(2) The delinquency and foreclosure percentages are calculated on the basis
of the total dollar amount of mortgage loans originated or purchased by
the Company and, in each case, serviced by the Company and any
subservicers as of the end of the periods indicated.
(3) At June 30, 1999, the dollar volume of loans delinquent more than 90
days in the Company's 10 REMIC trusts formed in December 1992 and during
the period from March 1995 to March 1997 exceeded the permitted limit in
the related pooling and servicing agreements. Four of those trusts
exceeded certain loss limits. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - Capital
Resources;" and "- Risk Factors -- Our Right to Service Loans May Be
Terminated Because of the High Delinquencies and Losses on the Loans in
Our Servicing Portfolio".
(4) The servicing portfolio used in percentage calculations includes $84
million and $82 million of loans subserviced by the Company on an
interim basis at June 30, 1999 and 1998.
(5) Represents loans which are in foreclosure but as to which foreclosure
proceedings have not concluded.
(6) Represents properties acquired following a foreclosure sale and still
serviced by the Company at period end.
(7) The increase in the number of loans foreclosed and principal amount of
loans foreclosed in the periods presented is due to the larger and more
seasoned servicing portfolio.
(8) Represents losses net of gains on foreclosed properties sold during the
period indicated.
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.
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COMPETITION
The Company faces intense competition in the business of originating,
purchasing and selling mortgage loans. The Company's competitors in the
industry include other consumer finance companies, mortgage banking companies,
investment banks, commercial banks, credit unions, thrift institutions, credit
card issuers and insurance companies. Many of these competitors are
substantially larger and have considerably greater financial, technical and
marketing resources than the Company. In addition, many financial services
organizations that are much larger than the Company have formed national loan
origination networks or purchased home equity lenders offering loan products
directed at the target market of the Company. Competition among industry
participants can take many forms, including convenience in obtaining a loan,
customer service, marketing and distribution channels, amount and term of the
loan, loan origination fees and interest rates. In addition, the current level
of gains realized by the Company and its competitors on the sale of
non-conforming loans could attract additional competitors into this market.
Additional competition may lower the rates the Company can charge borrowers and
increase the price paid for purchased loans, thereby potentially lowering gain
on future loan sales and securitizations. To the extent any of these
competitors significantly expand their activities in the Company's market, the
Company could be materially adversely affected. Fluctuations in interest rates
and general economic conditions may also affect the Company's competition.
During periods of rising rates, competitors that have locked in lower rates to
potential borrowers may have a competitive advantage. During periods of
declining rates, competitors may solicit the Company's customers to refinance
their loans.
The Company believes its competitive strengths include: (i) emphasizing
customer service to attract borrowers; (ii) providing a high level of service
to brokers and their customers; (iii) offering competitive loan programs for
borrowers whose needs are not met by conventional mortgage lenders; (iv)
providing convenient locations for its retail and broker offices and national
geographic coverage in origination channels; and (v) emphasizing customer
service in its loan servicing division.
REGULATION
The Company's operations are subject to extensive regulation,
supervision and licensing by federal, state and local governmental authorities
and are subject to various laws and judicial and administrative decisions
imposing requirements and restrictions on part or all of its operations. The
Company's consumer lending activities are subject to the Federal
Truth-in-Lending Act and Regulation Z (including the Home Ownership and Equity
Protection Act of 1994), the Federal Equal Credit Opportunity Act, as amended,
and Regulation B, the Fair Credit Reporting Act of 1970, as amended, the
Federal Real Estate Settlement Procedures Act and Regulation X, the Home
Mortgage Disclosure Act, the Federal Debt Collection Practices Act and the
National Housing Act of 1934, as well as other federal and state statutes and
regulations affecting the Company's activities. The Company is also subject to
the rules and regulations of, and examinations by, state regulatory authorities
with respect to originating, processing, underwriting, selling, securitizing
and servicing loans. These rules and regulations, among other things, impose
licensing obligations on the Company, establish eligibility criteria for
mortgage loans, prohibit discrimination, govern inspections and appraisals of
properties and credit reports on loan applicants, regulate assessment,
collection,
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foreclosure and claims handling, investment and interest payments on escrow
balances and payment features, mandate certain disclosures and notices to
borrowers and, in some cases, fix maximum interest rates, fees and mortgage
loan amounts. A significant portion of the Company's mortgage loans are
so-called "high cost mortgage loans" where the borrower is charged points and
fees or interest rates above certain levels. Such high cost mortgage loans are
subject to special disclosure requirements and certain substantive prohibitions
under the Home Ownership and Equity Protection Act of 1994 and regulations
thereunder, and certain state laws. The federal regulations governing high cost
mortgage loans establish guidelines for determination of whether an individual
loan is a high cost mortgage loan. Such guidelines may be interpreted
differently by different lenders. Federal regulations on high cost mortgage
loans make assignees of such mortgage loans liable for violations of the
regulations. As a result of the increased regulation and scrutiny of high cost
mortgage loans, certain lenders, including certain purchasers of the Company's
loans, will not purchase high cost mortgage loans. In addition, there has been
recent class action litigation and regulatory actions by certain state agencies
against lenders for violations of high cost mortgage regulations. The Company
has not to date been subject to any such class action litigation or regulatory
action.
Failure to comply with these requirements can lead to loss of approved
status, certain rights of rescission for mortgage loans, individual and class
action lawsuits and administrative enforcement action. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Risk Factors -- If We are Unable to Comply with Mortgage Banking
Rules and Regulations, Our Ability to Make Mortgage Loans May be Restricted."
In the course of its business, the Company may acquire properties as a
result of foreclosure. There is a risk that hazardous or toxic waste could be
found on such properties. In such event, the Company could be held responsible
for the cost of cleaning up or removing such waste, and such cost could exceed
the value of the underlying properties.
The Company is also subject to various other federal and state laws
regulating the issuance and sale of securities, relationships with entities
regulated by the Employee Retirement Income Security Act of 1974, as amended,
and other aspects of its business.
EMPLOYEES
At June 30, 1999, the Company employed 1,305 persons. The Company has
satisfactory relations with its employees.
ITEM 2. PROPERTIES
The executive and administrative offices of the Company are located at
350 S. Grand Avenue, Los Angeles, California, and consist of approximately
178,000 square feet. The Company is attempting to sublet a significant amount
of these premises. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations - Expenses." The lease on these
premises extends through February 2012. The Company also continues to lease
space at its former
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headquarters location at 3731 Wilshire Boulevard, Los Angeles, California,
which it will use for its telemarketing operations and future expansion of
production related operations. This lease expires in December 2008. The
executive and administrative offices of the Company's Irvine office are located
at 3347 Michaelson Drive, Irvine, California, and consist of approximately
46,911 square feet. The lease on these premises extends through July 31, 2003.
The Company also leases space for its branch offices. These facilities
aggregate approximately 319,462 square feet and are leased under terms which
vary as to duration. In general, the leases expire between 1999 and 2004, 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 1999 to a
vote of the security holders of the Company.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
In November 1995, the Company's common stock began trading under the
symbol AAM on the New York Stock Exchange (NYSE). Prior to that time, the
Company's common stock traded on the NASDAQ National Market under the symbol
AAMS. The following table sets forth the range of high and low sale prices and
per share cash dividends declared for the periods indicated.
CASH
HIGH LOW DIVIDEND
FISCAL 1999*
First Quarter .............................. 13.375 6.063 .033
Second Quarter ............................. 4.813 1.250 --
Third Quarter .............................. 3.438 1.375 --
Fourth Quarter ............................. 2.000 1.313 --
FISCAL 1998*
First Quarter .............................. 23.250 15.875 .033
Second Quarter ............................. 17.125 10.625 .033
Third Quarter .............................. 15.250 11.438 .033
First Quarter ............................. 15.562 13.625 .033
* As reported by Bloomberg
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As of August 18, 1999, the Company had 338 stockholders of record. From
its initial public offering on December 3, 1991 and through the first fiscal
quarter of 1999, the Company consistently paid quarterly cash dividends on its
common stock. The Company accrued and subsequently paid an aggregate of $0.033
per common share in dividends for the fiscal year ended June 30, 1999. The
Company declared and subsequently paid an aggregate of $0.13 per share in
dividends for the fiscal year ended June 30, 1998, representing approximately
13.7% of its net income for the period. The Board of Directors of the Company
reviews the Company's dividend policy at least annually in light of the
earnings, cash position and capital needs of the Company, general business
conditions and other relevant factors. In November 1998, the Board of Directors
decided to suspend cash dividends on the common stock until the Company's
earnings and cash flows improved. Credit agreements generally limit the
Company's ability to pay dividends if such payment would result in an event of
default under the agreements or would otherwise cause a breach of a net worth
or liquidity covenants. The Company's Indenture relating to its 9.125% Senior
Notes due 2003 prohibits the payment of dividends if the aggregate amount of
such dividends since October 26, 1996 exceeds the sum of (a) 25% of the
Company's net income during that period (minus 100% of any deficit); (b) net
cash proceeds from any securities issuances; and (c) proceeds from the sale of
certain investments. The Company's Indenture of Trust relating to its 10.50%
Senior Notes due 2002 restricts the payment of dividends to an amount which
does not exceed (i) $2.0 million, plus (ii) 50% of the Company's aggregate net
income for each fiscal year after the year ended June 30, 1994 (minus 100% of
net losses for any fiscal year), plus (iii) 100% of the net proceeds received
by the Company on offerings of its equity securities after December 31, 1994.
Under the most restrictive of these limitations, the Company will be prohibited
from paying cash dividends on its capital stock for the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below with respect to
the Company for the five years ended June 30, 1999 have been derived from the
audited consolidated financial statements. The selected consolidated financial
data should be read in conjunction with the consolidated financial statements
and notes thereto and other financial information included herein. The selected
consolidated financial data gives effect to the acquisition of One Stop in
August 1996.
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FISCAL YEAR ENDED JUNE 30,
1999 1998 1997 1996 1995
--------- ------- ------- ------- ------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF INCOME DATA:
Revenue:
Gain on sale of loans ........................... $ 44,855 120,828 135,421 71,255 15,870
Valuation (write-down) of interest-only strips .. (186,451) 19,495 (18,950) -- --
Commissions ..................................... 33,034 27,664 29,250 21,564 15,799
Loan service .................................... 49,900 51,642 31,131 20,394 8,791
Interest income and fees ........................ 42,509 46,860 37,679 15,215 7,940
----------- --------- --------- --------- -------
Total revenue including write-down ......... (16,153) 266,489 214,531 128,428 48,400
Total expenses .................................. 261,996 213,683 205,071 89,541 37,788
--------- --------- --------- --------- -------
Income (loss) before income taxes ............... (278,149) 52,806 9,460 38,887 10,612
Provision (benefit) for income taxes ............ (30,182) 25,243 7,982 17,814 4,828
--------- --------- --------- --------- -------
Net income (loss) .............................. $(247,967) 27,563 1,478 21,073 5,784
--------- --------- --------- --------- -------
Net income (loss) per share (diluted) ........... $ (8.00) 0.87 0.05 0.82 0.43
=========== ========= ========= ========= =======
Weighted average number of shares outstanding
(in thousands) (diluted) ........................ 31,000 35,749 28,371 27,248 13,532
=========== ========= ========= ========= =======
Cash dividends declared per common share ........ $ 0.03 .13 .13 .13 .13
=========== ========= ========= ========= =======
CASH FLOW DATA:
Used in operating activities ...................... $ (466,966) (49,661) (280,073) (241,073) (43,375)
Used in investing activities ...................... (5,229) (5,163) (8,864) (5,885) (988)
Provided by financing activities .................. 480,637 40,244 291,898 250,540 48,209
Net increase (decrease) in
cash and cash equivalents ........................ 8,442 (14,580) 2,961 3,582 3,846
RATIOS AND OTHER DATA:
Return on average common equity(1) ................. (149.3)% 10.1 18.6 21.5 10.8
Return on average managed receivables(2) ........... (5.9)% 0.8 0.1 2.1 1.2
Loans originated or purchased:
Broker network ................................ $ 1,182,100 1,101,200 741,000 319,800 --
Retail loans .................................. 770,000 636,100 436,900 220,900 148,200
Correspondent loans ........................... 241,500 646,300 1,170,000 628,200 206,800
----------- --------- --------- --------- -------
Total ...................................... 2,193,600 2,383,600 2,347,900 1,168,900 355,000
=========== ========= ========= ========= =======
Whole loans sold .................................... $ 1,236,050 416,390 7,500 202,200 --
Loans pooled and sold in securitizations ........... 649,999 2,034,300 2,262,700 791,300 316,600
Loans serviced at period end ....................... 3,841,300 4,147,100 3,174,000 1,370,000 608,700
Weighted average commission rate on
retail loan originations(3)........................ 4.1% 4.3 4.9 7.7 9.4
Weighted average interest rate(3) .................. 9.8 10.1 10.6 11.3 11.6
Weighted average initial combined
loan-to-value ratio(3)(4):
Retail loans .................................... 72 70 67 60 55
Broker network .................................. 76 75 71 68 --
Correspondent loans ............................. 80 79 71 66 65
At period end:
Number of retail loan offices ...................... 101 103 56 48 32
Number of One Stop branch offices .................. 35 52 37 25 --
AT JUNE 30,
---------------------------------------------------------------------
1999 1998 1997 1996 1995
--------- ------- ------- ------- -------
BALANCE SHEET DATA:
Cash and cash equivalents .......................... $ 20,764 12,322 26,902 23,941 20,359
Interest-only strips and mortgage servicing rights.. 353,255 522,632 360,892 167,740 50,421
Total assets ....................................... 1,021,097 815,187 717,595 401,524 108,084
--------- ------- ------- ------- -------
10.5% Senior Notes due 2002 ........................ 17,250 23,000 23,000 23,000 23,000
9.125% Senior Notes due 2003 ....................... 150,000 150,000 150,000 -- --
5.5% Convertible Subordinated Debentures due 2006... 113,970 113,990 113,990 115,000 --
Other long-term debt ............................... -- -- -- 45 144
--------- ------- ------- ------- -------
Total long-term debt ........................ 281,220 286,990 286,990 138,045 23,144
Stockholders' equity ............................... 145,556 304,051 239,755 120,461 75,797
(1) Excludes nonrecurring charges in the pre-tax amount of $32 million during
the year ended June 30, 1997.
(2) Represents net income divided by the average servicing portfolio during
the fiscal year presented.
(3) Computed on loans originated or purchased during the fiscal year
presented.
(4) The weighted average initial combined loan-to-value ratio is determined by
dividing the sum of all loans secured by the junior or senior mortgages on
the property by the appraised value at origination.
22
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
The following discussion should be read in conjunction with Item 6. Selected
Financial Data and Item 8. Financial Statements and Supplementary Data.
SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION
This Report contains statements that constitute "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act of
1934 and Section 27A of the Securities Act of 1933. The words "expect,"
"estimate," "anticipate," "predict," "believe," and similar expressions and
variations thereof are intended to identify forward-looking statements. Such
statements appear in a number of places in this filing and include statements
regarding the intent, belief or current expectations of the Company, its
directors or officers with respect to, among other things (a) market conditions
in the securitization, capital, credit and whole loan markets and their future
impact on the Company's operations, (b) trends affecting the Company's liquidity
position, including, but not limited to, its access to warehouse and other
credit facilities and its ability to effect whole loan sales, (c) the impact of
the various cash savings plans and other restructuring strategies being
considered by the Company, (d) the Company's on-going efforts in improving its
equity position, (e) trends affecting the Company's financial condition and
results of operations, (f) the Company's plans to address the Year 2000 problem
and (g) the Company's business and liquidity strategies. The stockholders of the
Company are cautioned not to put undue reliance on such forward-looking
statements. Such forward-looking statements are not guarantees of future
performance and involve risks and uncertainties. Actual results may differ
materially from those projected in this Report, for the reasons, among others,
discussed under the captions "Item 1. Business - Business Strategy" and "- Risk
Factors." The Company undertakes no obligation to publicly revise these
forward-looking statements to reflect events or circumstances that arise after
the date hereof. Readers should carefully review the factors referred to above
and the other documents the Company files from time to time with the Securities
and Exchange Commission, including the quarterly reports on Form 10-Q filed by
the Company during fiscal 2000 and any current reports on Form 8-K filed by the
Company.
OVERVIEW
Fiscal 1999's results reflect the impact on the Company of the global
economic crises that existed early in the year and the continuing effects of
those crises on the credit, capital and asset-backed markets. From October
through the Initial Closing, the Company was dependent on one $300 million
warehouse line to fund its loan production. In conjunction with the Initial
Closing, the Company obtained an additional $400 million in committed warehouse
and repurchase facilities and an additional $100 million in an uncommitted
facility. The limited warehouse capacity during the second and part of the third
fiscal quarters severely constrained the Company's loan production capability.
Further, the public equity and debt markets on which the Company had
historically relied
23
24
to satisfy its cash flow needs were not available during the whole of the fiscal
year. Additionally, the asset-backed markets on which the Company had
historically and primarily relied for its loan disposition strategy remained
weak, and inaccessible to, or impracticable for, the Company, throughout the
last three fiscal quarters. The Company, therefore, relied solely on whole loan
sales for cash during that period. The gains recorded for whole loan sales are
generally lower than the gains recorded for securitizations. However, this
difference in gain was exacerbated during the year by the over-supply of whole
loan product as other home equity lenders who had traditionally securitized
their production also sold loans in the whole loan market. The gain on sale from
the securitization completed during the first fiscal quarter was significantly
reduced due to a loss on the Company's hedge position which was not offset by
enhanced securitization execution. These negative market conditions adversely
affected the prepayment, loss and discount rate assumptions applied by the
Company in estimating the value of its interest-only strips. The application of
these revised assumptions resulted in the Company recording a $194 million net
loss in valuation of its interest-only strips during the second fiscal quarter
of 1999.
For the three years prior to fiscal 1998, the Company's significant year
over year growth was driven primarily by the increases in the volume of loans
purchased in the bulk correspondent business facilitated by the sale of the
Company's loan production in securitization transactions. The combination of
these business strategies significantly contributed to the Company's operating
on a negative cash flow basis which was funded by the Company regularly
accessing the public equity and debt markets. In the fourth quarter of fiscal
1997, primarily as a reaction to the uncertainties in those capital markets, the
Company decided to reduce its bulk loan purchases and focus on the less cash
intensive core retail and broker loan production units and its servicing
division. Fiscal 1998's results reflect these strategic decisions in the record
levels of retail and broker loan production, increased expenses due to expedited
retail and broker loan office expansion and increased expenses to accommodate
the significant increase in the Company's in-house servicing portfolio.
CERTAIN ACCOUNTING CONSIDERATIONS
In December 1998, the FASB staff issued, in question and answer format,
"A Guide to Implementation of Statement 125 on Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, Questions and
Answers, Second Edition" (the "Special Report"). The Special Report indicates
that two methods have arisen in practice for accounting for credit enhancements
relating to securitization. These methods are the cash-in method and the
cash-out method. The cash-in method treats credit enhancements (pledged loans or
cash) as belonging to the Company. As such, these assets are recorded at their
face value as of the time they are received by the trust. The cash-out method
treats credit enhancements as assets owned by the related securitization trust.
As such, these assets are treated as part of the interest-only strips and are
recorded at a discounted value for the period between when collected by the
trust and released to the Company. The Special Report indicates that if no true
market exists for credit enhancement assets, the cash-out method should be used
to measure the fair value of credit enhancements.
Restatement of Prior Period Results. The Company had historically used
the cash-in method to account for its interest-only strips. However, during the
three months ended December 31, 1998,
24
25
the Company retroactively changed its practice of measuring and accounting for
its interest-only strips to the cash-out method in response to the FASB's
Special Report and to public comments from the staff of the Securities and
Exchange Commission released on December 8, 1998.
Under the cash-in method previously used by the Company, the assumed
discount period for measuring the present value of the interest-only strips
ended when the cash flows were received by the securitization trust; and, the
initial deposits to overcollateralization accounts were recorded at face value.
Under the cash-out method now required by the FASB and Securities and Exchange
Commission, the assumed discount period for measuring the present value of the
interest-only strips ends when cash, including the return of any initial
deposits, is distributed to the Company on an unrestricted basis.
The change to the cash-out method results only in a difference in the
timing of revenue recognition from a securitization and has no effect on the
total cash flows of securitization transactions. While the total amount of
revenue recognized over the term of a securitization is the same under either
method, the cash-out method results in lower initial gains on the sale of loans
due to the longer discount period, and higher subsequent loan service revenue
resulting from the impact of discounting cash flows. See "- Revenue."
As a result, the Company's consolidated results of operations for all
prior periods have been restated.
The restatement resulted in the following changes to prior financial
information (Dollars in thousands, except per share amounts):
YEAR ENDED JUNE 30,
--------------------------------------------
1998 1997 1996 1995
-------- ------- ------- ------
Revenue:
Previous $286,110 238,578 141,840 54,939
As restated 266,489 214,531 128,428 48,400
Net income:
Previous 40,317 17,109 29,791 10,034
As restated 27,563 1,478 21,073 5,784
Earnings per share:
Basic:
Previous 1.41 0.65 1.37 0.74
As restated 0.97 0.06 0.97 0.43
Diluted:
Previous 1.23 0.60 1.14 0.74
As restated 0.87 0.05 0.82 0.43
Interest-only strips:
(end of period)
Previous 554,161 383,249 173,789 56,960
As restated 490,542 339,251 153,838 50,421
25
26
Year Ended June 30,
----------------------------------------
1998 1997 1996 1995
------- ------- ------- -------
Stockholders' equity:
(end of period)
Previous 345,403 268,354 133,429 80,047
As restated 304,051 239,755 120,461 75,797
Accounting for Securitizations. Although the Company's loan disposition
strategy relies on a combination of securitization transactions and whole loan
sales, the Company relied solely on whole loan sales during the quarters ended
December 31, 1998, March 31, 1999 and June 30, 1999. The following discusses
certain accounting considerations which arise only in the context of
securitization transactions.
In a securitization, the Company conveys loans that it has originated or
purchased to a separate entity (such as a trust or trust estate) in exchange for
cash proceeds and an interest in the loans securitized represented by the
non-cash gain on sale of loans. The cash proceeds are raised through an offering
of the pass-through certificates or bonds evidencing the right to receive
principal payments on the securitized loans and the interest rate on the
certificate balance or on the bonds. The non-cash gain on sale of loans
represents the difference between the proceeds (including premiums) from the
sale, net of related transaction costs, and the allocated carrying amount of the
loans sold. The allocated carrying amount is determined by allocating the
original amount of loans (including premiums paid on loans purchased) between
the portion sold and any retained interests (interest-only strip), based on
their relative fair values at the date of transfer. The interest-only strip
represents, over the estimated life of the loans, the present value of the
estimated cash flows. These cash flows are determined by the excess of the
weighted average coupon on each pool of loans sold over the sum of the interest
rate paid to investors, the contractual servicing fee (currently .50%), a
monoline insurance fee, if any, a back-up servicer fee, if any, and an estimate
for loan losses. In quarters where the Company engaged in a securitization
transaction, net gains or losses in valuation of interest-only strips and
mortgage servicing rights include the recognition of a gain or loss which
represents the initial difference between the allocated carrying amount and the
fair market value of the interest-only strip at the date of sale. Additionally,
increases or decreases in valuation of the interest-only strips are also
recognized as net gains or losses. Each agreement that the Company has entered
into in connection with its securitizations requires either the
overcollateralization of the trust or the establishment of a reserve account
that may initially be funded by cash deposited by the Company.
The Company determines the present value of the cash flows at the time
each securitization transaction closes using certain estimates made by
management at the time the loans are sold. These estimates include: (i) future
rate of prepayment; (ii) discount rate used to calculate present value; and
(iii) credit losses on loans sold. The future cash flows represent management's
best estimate. Management monitors the performance of the loans, and any changes
in the estimates are reflected in earnings. There can be no assurance of the
accuracy of management's estimates.
Rate of Prepayment. The estimated life of the securitized loans depends
on the assumed annual prepayment rate which is a function of estimated
voluntary (full and partial) and involuntary (liquidations)
prepayments. The prepayment rate represents management's expectations
of future prepayment rates based on prior and expected loan
performance, the type of loans in the relevant pool (fixed or
adjustable rate), the production channel which produced the loan,
prevailing interest rates, the presence of prepayment penalties, the
loan-to-
26
27
value ratios and the credit grades of the loans included in the
securitization and other industry data. The rate of prepayment may be
affected by a variety of economic and other factors.
Discount Rate. In order to determine the fair value of the cash flow
from the interest-only strips, the Company discounts the cash flows
based upon rates prevalent in the market.
Credit Losses. In determining the estimate for credit losses on loans
securitized, the Company uses assumptions that it believes are
reasonable based on information from its prior securitizations, the
loan-to-value ratios, credit grades of the loans included in the
current securitizations and other industry data.
The interest-only strips are recorded at estimated fair value and are
marked to market through a charge (or credit) to earnings. On a quarterly basis,
the Company reviews the fair value of the interest-only strips by analyzing its
prepayment, discount rate and loss assumptions in relation to its actual
experience and current rates of prepayment and loss prevalent in the industry
and may adjust or take a charge to earnings through an adjustment to net gain or
loss on valuation of interest-only strips.
In the quarterly review of its interest-only strip for the quarter ended
December 31, 1998, the Company determined that it should adjust each of its
assumptions (rate of prepayment, discount rate and credit loss) to reflect
current market conditions. This change in estimates resulted in the Write-Down
in the quarter ended December 31, 1998. The components of this adjustment were
as follows:
Rate of Prepayment. In its valuation analysis of prepayment speeds, the
Company considered the relationship between the rate paid on the certificates or
bonds issued in the securitization and the weighted average coupons on the
mortgages outstanding in each securitization pool from time to time.
Additionally, for the quarters up to and including September 30, 1998,
prepayment rates used by the Company were held constant, e.g. flat, over the
life of the pool. The estimates used by the Company for the quarters up to and
including September 30, 1998 were flat prepayment rates ranging from 26% for
fixed to 30.5% for adjustable and hybrid loan products. These rates represented
a weighted average loan life of approximately 2.6 to 3.8 years. During the
quarter ended December 31, 1998, the Company finalized the development of an
enhanced analytical model which more precisely reflected the performance of the
securitized loans. This analytical model enabled the Company to refine its
estimate of the prepayment rates associated with the performance of its
securitized loans. Additionally, data and information received from market
participants (credit and capital providers) assisted the Company in its
assessment of current market conditions which resulted in the Company applying a
more precise valuation estimate to its prepayment assumptions. The Company
incorporated this new information in developing its improved judgment as to
prepayment speeds and changed its estimate of prepayment rates from a flat
constant prepayment rate to a vectored rate, which more closely approximates the
performance of the securitized loans. These revised prepayment rates resulted in
a weighted average life of 2.86 years. The impact of the change in prepayment
speeds amounted to approximately $62 million, which was included in the
Write-Down recorded for the quarter ended December 31, 1998.
Discount Rate. For the quarters up to and including September 30, 1998,
the Company used the weighted average interest rates of the loans included in
the pool as the best estimate available as an appropriate discount rate to
determine fair value. As the market deteriorated in the quarter ended December
31, 1998, it became apparent that a change in discount rate would be required in
order for the estimate of fair value to be consistent with market conditions. To
determine the appropriate discount rate, the Company reviewed general market
conditions as reflected by market sales of senior tranche asset-backed
securities. Management believed that the pass-through rate on senior tranche
27
28
securities should be lower than the discount rate applied to the subordinate,
and higher risk, interest-only strips. However, the adversity of the market
during the quarter ended December 31, 1998 was so severe that, in some
instances, transactions of senior tranche asset-backed securities could not even
be completed. Accordingly, the Company incorporated this current market
information in developing its judgment as to the appropriate risk adjusted rate
of return in establishing its change in estimate of the discount rate to be used
in estimating the fair value of the interest-only strips. For the quarter ended
December 31, 1998, the Company increased its discount rate to 15% to reflect
current market conditions. The impact of this change in discount rate amounted
to approximately $65 million, which was included in the Write-Down recorded for
the quarter ended December 31, 1998.
Credit Losses. For the quarter up to and including September 30, 1998,
the Company used a prospective cumulative loan loss estimate of 1.4% of the
balance of the loans in the securitization pools as an appropriate estimate to
determine fair value. This estimate was developed through a review of the credit
performance of securitized loans in the aggregate. In conjunction with its
previous quarterly review of loss estimates, the Company considered the level of
delinquency of securitized loans and the percentage of annualized losses to
securitized loans in the aggregate. As market conditions deteriorated in the
quarter ended December 31, 1998, the Company refined its estimate of credit
losses by expanding the factors it considered in developing its credit loss
estimates to include loss and delinquency information by channel, credit grade
and product, and information available from other market participants such as
investment bankers, credit providers and credit agencies. For the quarter ended
December 31, 1998, the percentage of losses to average servicing portfolio
amounted to 1.08%, a significant increase from the previous quarter's level of
.80%. The Company had seen levels spike to .96% in the quarter ended June 30,
1998 but then subside to the .80% previously noted. This trend was in line with
the Company's assumption that losses were being realized as the servicing
portfolio was transferred in-house from sub-servicers. Management believes the
increase in losses in the December 1998 quarter reflected general market
conditions rather than the continuing effects of the transfer of servicing
in-house. Publicly available information from investment banking firms and
credit agencies began to indicate a market expectation that credit losses within
the sub-prime home equity sector would rise. Those indications, in part, arise
from the impact of the adverse market conditions on severely delinquent
borrowers who, in a more favorable market, would avoid default by refinancing
with other lenders. In the current market, with competition lessening and
underwriting guidelines tightening, these borrowers are much more likely to
default. Accordingly, the Company increased its prospective cumulative loan loss
estimate to 2.7% (discounted back at 15%) of the balance of the loans in the
securitization pools at December 31, 1998. This change in credit loss estimate
resulted in a valuation adjustment of $67 million, which was included in the
Write-Down recorded for the quarter ended December 31, 1998.
Additionally, upon sale or securitization of servicing retained
mortgages, the Company capitalizes the fair value of mortgage servicing rights
("MSRs") assets separate from the loan. The Company determines fair value based
on the present value of estimated net future cash flows related to servicing
income. The cost allocated to the servicing rights is amortized over the period
of estimated net future servicing fee income. The Company periodically reviews
the valuation of capitalized servicing fees receivable. This review is performed
on a disaggregated basis for the predominant risk characteristics of the
underlying loans which are loan type and origination date.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." In July 1999, the FASB issued SFAS 137
which deferred the effective date of SFAS 133 to fiscal years beginning after
June 15, 2000. SFAS No. 133 requires companies to record derivatives on the
balance sheet as assets and liabilities, measured at fair value. Gains and
losses resulting from changes in the values of those derivatives would be
accounted for in earnings. Depending on the use of the derivative and the
satisfaction of other requirements, special hedge accounting may apply.
28
29
The Company has not determined the impact that adoption of their
standard will have on its future consolidated financial statements.
RESULTS OF OPERATIONS -- FISCAL YEARS 1999, 1998 AND 1997
The following table sets forth information regarding the components of
the Company's revenue and expenses in fiscal 1999, 1998 and 1997:
1999 1998 1997
---------------------- ------------------ --------------------
(Dollars in thousands)
Dollars Percentage Dollars Percentage Dollars Percentage
------- ---------- ------- ---------- ------- ----------
Percentage
Revenue:
Gain on sale of loan ........ $ 44,855 (277.7)% $ 120,828 45.3% $ 135,421 63.1%
Valuation (write-down) of
interest-only strips ...... (186,451) 1,154.3 19,495 7.3 (18,950) (8.8)
Commissions ................. 33,034 (204.5) 27,664 10.4 29,250 13.6
Loan Service:
Servicing spread .......... 27,798 (172.1) 32,392 12.2 21,592 10.1
Prepayment fees ........... 13,772 (85.3) 11,761 4.4 5,815 2.7
Late charges and
other servicing fees ..... 8,330 (51.6) 7,489 2.8 3,724 1.7
Interest income and fees:
Interest income ........... 35,853 (221.9) 40,110 15.1 31,160 14.5
Closing ................... 1,325 (8.2) 2,668 1.0 2,723 1.3
Appraisal ................. 2,822 (17.5) 2,617 1.0 1,854 0.9
Underwriting .............. 1,839 (11.4) 1,085 0.4 1,382 0.6
Other ..................... 670 (4.1) 380 0.1 560 0.3
--------- ------- --------- ----- --------- -----
Total revenue including
write-down .......... $ (16,153) 100.0% $ 266,489 100.0% $ 214,531 100.0%
========= ======= ========= ===== ========= =====
Expenses:
Compensation .............. $ 80,167 (496.3)% $ 94,820 35.6% $ 81,021 37.8%
Production ................ 40,061 (248.0) 34,195 12.8 27,229 12.7
General and
administrative .......... 60,635 (375.4) 40,686 15.3 31,716 14.8
Interest .................. 44,089 (272.9) 43,982 16.5 33,105 15.4
Nonrecurring charges ...... 37,044 (229.3) -- -- 32,000 14.9
--------- -------- --------- ----- --------- -----
Total expenses ........ $ 261,996 (1,622.0)% $ 213,683 80.2% $ 205,071 95.6%
========= ======== ========= ===== ========= =====
Income (loss) before
income taxes ................. (278,149) 1,722.0 52,806 19.8 9,460 4.4
Provision (benefit) for
income taxes ................. (30,182) 186.8 25,243 9.5 7,982 3.7
--------- -------- --------- ----- --------- -----
Net income (loss) ..... $(247,967) 1,535.2% $ 27,563 10.3% $ 1,478 0.7%
========= ======== ========= ===== ========= =====
REVENUE
Total revenue, including the effects of the Write-Down for fiscal 1999,
was $(16 million), as compared to $266 million in fiscal 1998. Fiscal 1998's
total revenue increased $52 million, or 24.2%, from total revenue of $214
million for fiscal 1997. Total revenues include the Write-Down, net of a
positive valuation adjustment of $5.2 million recorded in the quarter ended
September 30, 1998 in connection with the Company's securitization, a $19
million net unrealized gain and a $19 million net unrealized loss (see below) on
valuation of the Company's interest-only strips for the fiscal years ended June
30, 1999, 1998 and 1997, respectively. The Write-Down reflected the impact of
negative market conditions that existed in the quarter ended December 31,
29
30
1998 on the prepayment, loss and discount rate assumptions applied by the
Company in estimating the fair value of its interest-only strips. See "- Certain
Accounting Considerations -- Accounting for Securitizations."
Revenues for the fiscal year ended June 30, 1999 (excluding the
Write-Down) were $170 million, a 36% decrease from 1998. The decrease in total
revenue during fiscal year 1999 from the amount reported in fiscal year 1998
primarily reflects the Company's reliance on whole loan sales for cash during
the last three fiscal quarters of 1999. Gains associated with whole loans for
cash are generally lower than those recognized when such loans are securitized.
This disparity was exacerbated during the second fiscal quarter as a consequence
of the over-supply of product for sale in the marketplace due to weaknesses in
the asset-backed market during the same period, as well as the Company's limited
warehouse capacity during the quarter which necessitated the expedited sale of
loans. This continued during the March 31, 1999 quarter and part of the June 30,
1999 quarter as substantially all of the whole loan sales were closed under a
forward commitment entered into in the prior quarter when whole loan prices were
at their lowest level. During the quarter ended December 31, 1998, the Company
entered into the mandatory forward commitment to sell $500 million, subsequently
amended to $750 million, of loans. The commitment, which expired in May 1999,
reflected the lower whole loan prices that existed during the quarter. During
the fourth fiscal quarter of 1999, the Company entered into a new mandatory
forward commitment to sell loans. The pricing formula in the new commitment
reflects the improved market conditions in the fourth fiscal quarter. Terms of
the new forward commitment, which expires on May 16, 2000, include provisions
for the Company to sell a minimum of $500 million and a maximum of $1.50 billion
of loans to the purchaser on a servicing released basis. At June 30, 1999, the
Company had fulfilled approximately $80 million of loans held for sale under
this commitment.
Further contributing to the results for the fiscal year ended June 30,
1999 was the decrease in total loan production, from $2.38 billion during 1998
to $2.19 billion during 1999. The decrease in total revenue during the 1999
fiscal year also reflects the lower gains on sale resulting from hedge losses
and lower than historical spreads on the Company's $650 million securitization
closed in the quarter ended September 30, 1998. In addition, the Company did not
complete a securitization in the last three quarters of fiscal year 1999, and it
did not dispose of all loans produced in the whole loan market in anticipation
of the August 1999 securitization. This increase in loans held for sale further
reduced gain on sale revenue.
During the first fiscal quarter, the Company, as it had historically,
hedged its fixed rate pipeline by purchasing hedges against U.S. Treasuries. In
the past, changes in Treasury rates were generally reflected in the pass-through
rates of the fixed rate portion of the Company's securitization. During fiscal
1999's first quarter, unsettled market conditions resulted in a $15 million loss
on the Company's hedge position without an equivalent benefit from reductions in
the pass-through rate paid on certificates sold in the fixed rate portion of the
Company's securitization.
The increase in total revenue from the year ended June 30, 1997 to the
year ended June 30, 1998 was primarily due to an increase in net gain (loss) on
valuation of interest-only strips and the increase in loan service revenue,
offset by a decline in gain on sale of loans. The net loss on valuation of
interest-only strips during the year ended June 30, 1997 was due primarily to
the $28 million net unrealized loss on its interest-only strips recorded by the
Company in the fourth quarter of fiscal 1997. This unrealized loss was due
primarily to an increase in prepayment rates in certain of the Company's
adjustable rate loans in some of its earlier pools. Increased loan service
revenues during the year ended June 30, 1998 were a result of the continued
growth in the
30
31
Company's servicing portfolio and the successful transfer in-house of $1.47
billion of mortgage loans previously subserviced by others.
Gain on sale, net of gain or loss on valuation of interest-only strips
for the fiscal year ended 1999 was $(142 million), as compared to $140 million
for the fiscal year ended 1998. Net gain (loss) on valuation of interest-only
strips and mortgage servicing rights for the fiscal year ended June 30, 1999
primarily reflects the impact of the Write-Down recorded in the quarter ended
December 31, 1998. The Company determines the fair value of the interest-only
strips by applying certain assumptions as to prepayments, losses and discount
rate to the future cash flows from prior securitizations. The negative market
conditions that existed during the quarter, as well as the performance of the
Company's pools of securitized loans, caused