NEW CENTURY FINANCIAL CORP - 10-K Annual Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2001

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 000-22633

NEW CENTURY FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction incorporation or organization)		33-0683629 (I. R. S. Employer Identification Number)

18400 Von Karman, Suite 1000, Irvine, California (Address of principal executive offices)		92612 (Zip Code)

Registrant’s telephone number, including area code: (949) 440-7030

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.01 par value

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 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. ¨

The aggregate market value of Common Stock held by non-affiliates of the Registrant on February 14, 2002 was approximately $126 million based on the closing sales price for the Common Stock on such date of $14.14 as reported on the Nasdaq National Market.

As of February 14, 2002, the Registrant had 20,635,981 shares of Common Stock outstanding.

PART III incorporates information by reference from the Registrant’s definitive Proxy Statement for its 2002 Annual Meeting of Stockholders to be filed with the Commission within 120 days of December 31, 2001.

PART I

Item 1. Business

General

We are a leading nationwide specialty mortgage banking company that originates, purchases and sells residential mortgage loans secured primarily by first mortgages on single-family residences. We offer mortgage products that focus on borrowers who generally do not satisfy the credit, documentation or other underwriting standards prescribed by conventional mortgage lenders and loan buyers, such as Fannie Mae and Freddie Mac. We originate and purchase loans on the basis of the borrower’s ability to repay the mortgage loan, the borrower’s historical pattern of debt repayment and the amount of equity in the borrower’s property (as measured by the borrower’s loan-to-value ratio, or LTV). We have been originating and purchasing these types of loans since 1996 and believe we have developed a comprehensive and sophisticated process of credit evaluation and risk-based pricing that allows us to effectively manage the potentially higher risks associated with this segment of the mortgage industry.

Our borrowers generally have considerable equity in the properties securing their loans, but have impaired or limited credit profiles or higher debt-to-income ratios than traditional mortgage lenders allow. Our borrowers also include individuals who, due to self-employment or other circumstances, have difficulty verifying their income through conventional methods, and who prefer the prompt and personalized service we provide.

We originate and purchase approximately 80% of our loans through our wholesale network of 9,900 independent mortgage brokers, and the remainder through our retail network of 65 branch offices located in 25 states, our central retail unit and through our anyloan.com website. Although a significant percentage of our loans are originated in California, we are authorized to do business in all 50 states and regularly originate and purchase loans throughout the country. Wholesale originations and purchases are through independent mortgage brokers who provide loans through the Wholesale Division of our subsidiary, New Century Mortgage Corporation, as well as its subsidiary, Worth Funding. Retail originations occur through our network of branch offices, through our Central Retail Division and through our subsidiary, The Anyloan Company’s strategic alliances with mortgage companies and other financial institutions.

Historically, our loan sales strategy focused on a balanced combination of securitizations and whole loan sales in order to achieve our goal of enhancing profits while managing cash flows. However, our previous securitizations required us to make significant investments of cash at the time of securitization, and were not expected to generate significant cash flow to us for an extended period. In fiscal 2000, we changed our loan sales strategy to selling our loans in a way so as to optimize cash revenue and improve liquidity. To effect this strategy, we sold loans through whole loan sale transactions and cash flow-positive securitizations. Whole loan sale transactions enable us to generate current cash flow, protect against the potential volatility of the securitization market and reduce the risks inherent in retaining residual interests. Recent changes in market conditions have also allowed us to generate cash revenues from securitizations. In our 2001 securitizations, we employed a structure that allowed us to receive initial cash proceeds similar to those received through whole loan sales completed during this same period. For our 2001 sales transactions, 84.0% were whole loan sales while the remainder were cash flow-positive securitizations. We expect to continue to employ a combination of whole loan sales and cash flow-positive securitizations in order to maximize our operating flexibility and to maintain multiple loan sales channels.

Recent Operational Highlights

We have implemented several strategic initiatives that have reduced our risk profile and significantly improved our operating performance and financial results. These initiatives allowed us to achieve our goal of positive cash flow from operations for 2001. These key initiatives include:

•

Transition to Cash Flow-Positive Loan Sales Strategy. As part of our strategy to improve cash flows, beginning in the first quarter of 2000, we transitioned from securitizing the majority of our loans to

selling the majority of production for cash in whole loan sales and, beginning in 2001, cash flow-positive securitizations. To that end, during the year ended December 31, 2001, we completed whole loan sales of $4.7 billion and two securitizations totaling $898 million, with accompanying net interest margin securities, or NIMS. The net cash proceeds from the securitizations and accompanying NIMS resulted in cash proceeds in amounts similar to whole loan sales. This transition increased our cash revenues and reduced our need for additional capital or borrowings in order to fund operations. We plan to continue to execute loan sales strategies that optimize cash revenues and liquidity.

•

Restructured and Reduced Debt. In March 2001, we restructured nearly all of our residual financing, which eliminated our exposure to margin calls on that debt. In addition, during 2001, we repaid $96.9 million in residual financing and extended the maturity of our subordinated debt to December 31, 2003, which allowed us to more closely match our payment obligations with the projected cash flows from our residual interests. We expect to repay all outstanding residual financing by the end of the third quarter of 2002.

•

Reduction of Loan Acquisition Costs. We reduced our loan acquisition costs to 2.27% of loan production for the quarter ended December 31, 2001 from 2.69% for the quarter ended December 31, 2000. Loan acquisition costs are the fees paid to wholesale brokers and correspondents, plus direct loan origination costs (including commissions and corporate overhead costs), less the sum of points and fees received from borrowers, divided by total production volume. We achieved this reduction in our loan acquisition costs through a combination of: (i) decreasing corporate overhead and commission expense; (ii) reducing marketing costs; (iii) consolidating operations; (iv) managing premiums paid to wholesale brokers and correspondent lenders; (v) closing unprofitable branches; and (vi) increasing our loan origination volume.

•

Sale of Servicing Rights. In March 2001, we sold to Ocwen Federal Bank FSB, one of the country’s highest rated special servicers, for $19.7 million, the servicing rights on $4.8 billion of our servicing portfolio which was comprised of 25 separate asset-backed securities. Ocwen also reimbursed us for our outstanding servicing advance receivables and assumed responsibility for all future servicing advance obligations on the purchased securities. We used the sale proceeds to: (i) repay the portion of our warehouse line of credit that was secured by servicing advances; (ii) repay the outstanding balance of $22.5 million under our working capital line of credit with U.S. Bank; and (iii) increase our liquidity.

•

Raised Capital. In July 2001, we completed a private placement managed by Friedman, Billings, Ramsey, Inc. of 1.44 million shares of common stock. We received approximately $14 million of new capital after all costs and expenses. In October 2001, we completed a follow-on public offering with Friedman, Billings, Ramsey, Inc. as lead underwriter and Jefferies and Company, Inc. and Advest, Inc. as co-underwriters. Due to a strong demand for the shares, the offering was increased from 3.0 to 3.5 million shares at $11.00 per share, including the sale of 300,000 shares by certain selling stockholders. The underwriters elected to exercise their option to purchase an additional 525,000 shares from us to cover over-allotments. We received approximately $38 million of new capital after deducting offering expenses. We intend to use the net proceeds for general corporate purposes, including an increase in our capital base to support expansion of credit facilities and additional growth.

•

Improved Underwriting Controls. We implemented a process designed to monitor and adjust our underwriting guidelines to originate loans that are widely accepted by loan buyers. We also took steps to further reduce documentation errors, better identify borrower misrepresentation and reduce early payment default with the goal of decreasing the number of loans sold at a discount.

•

Management Reorganization. During the first quarter of 2001, we announced several senior management changes designed to improve accountability and increase the efficiency of our operations. Most notably, Brad Morrice, our Vice Chairman and President, assumed the additional role of Chief Operating Officer and also became the sole Chairman and Chief Executive Officer of our subsidiary, New Century Mortgage.

Growth and Operating Strategies

The following are our growth and operating strategies:

•

Increase Loan Originations. We plan to pursue geographic expansion of our wholesale business, particularly into the Northeast and Mid-Atlantic areas of the country. Our Wholesale Division can expand quickly into new markets with limited investment in infrastructure. For retail expansion, we will continue our practice of reviewing demographic information about potential markets and opening branches in markets that we conclude can support a retail branch. We plan to continue to deploy new marketing and technology initiatives and expand our product line and sales personnel in an effort to increase our existing market penetration.

•

Develop Strategic Alliance Program. We are developing a strategic alliance program to provide our products to customers of banks, thrifts and other financial institutions and mortgage companies who do not offer such products. We hired a team of individuals during 2001 with extensive experience developing such alliances. We began originating loans under this program in December 2001.

•

Continue to Emphasize Cash Flow-Positive Operations. We plan to continue to focus our secondary marketing on sales strategies that will optimize revenues and cash flow. We also intend to continue to utilize securitization structures that generate cash in excess of origination costs, as well as selected sales of servicing rights.

•

Optimize Net Interest Income. Our current levels of cash, capital and financing sources allow us to hold loans for a longer period of time prior to sale or securitization. We earn net interest income on loans held for sale as a result of the spread between the interest rate that we pay on our warehouse and aggregation lines and the interest rate we receive on our loans. As a result, by optimizing the number of days that we hold the loans prior to sale, we will optimize the amount of interest income that we earn.

•

Reduce Loans Sold at a Discount. We are devoting significant efforts to reduce the losses that result from loans we sell at a discount to par value. Loans are typically sold at a discount when (i) there are documentation deficiencies, (ii) the loans have characteristics that are outside the guidelines of whole loan buyers, or (iii) the borrower defaults on the first payment. In order to accomplish these objectives, we appointed a corporate level Chief Credit Officer, improved the analytics used in evaluating discount loans and eliminated products resulting in disproportionately high levels of discount loans. While loans sold at a discount increased for the year ended December 31, 2001 compared to 2000, they decreased during 2001, from over $190 million in the first half of 2001 to $46 million in the second half.

•

Continue to Manage Loan Acquisition Costs. We continue to focus our efforts on reducing our loan acquisition costs by improving efficiencies and increasing loan origination volume. In the fourth quarter of 2001, our loan acquisition cost was 2.27% of loan originations. While we continue to focus on reducing operating expenses, we are not expecting further decreases in this measure during the first few quarters of 2002, due to the fact that the percentage of production from Wholesale continues to grow and Wholesale has slightly higher loan acquisition costs. In addition, we plan to invest in the technology, training and other infrastructure necessary to support future growth, improve loan quality and set the stage for future cost reductions.

•

Pay Off Residual Financing. As of December 31, 2001, we owed approximately $79.9 million in residual financing to Salomon Smith Barney. This financing matures on December 31, 2002. However, we expect to repay all outstanding residual financing by the end of the third quarter of 2002. Upon the full repayment of the residual financing, we will be able to retain all of the cash flow from the residual interests. This will reduce the interest expense that we incur and, as a result, enhance our operating results.

•

Re-establish Servicing Platform. We intend to re-establish our servicing operations in 2002. To that end, we have hired our former Senior Vice President of Servicing who is in turn recruiting an experienced team of managers. We believe that establishing in-house servicing capability will enhance our value as a full-service mortgage banking franchise, and that it will provide an additional source of revenue and

profits. During the period we are rebuilding servicing, we intend to continue to use Ocwen to service our new originations. We also expect to continue to sell to Ocwen a significant volume of servicing rights in 2002. We anticipate that we will begin boarding some production on our servicing platform in the fourth quarter of 2002.

Strengths and Competitive Advantages

We believe that we have several strengths and competitive advantages that will allow us to compete effectively in our business, including:

•

Management Experience and Depth. The members of our senior management team have on average over 18 years of experience in the consumer finance sector.

•

High Quality Customer Service. We strive to make the origination process easy for our borrowers and brokers by providing prompt responses, consistent and clear procedures and an emphasis on ease of use.

•

Strong Secondary Market Relationships. We have developed relationships with a variety of large institutional loan buyers, including Salomon Smith Barney, CSFB, Morgan Stanley and Deutsche Bank, who consistently bid on and buy large loan pools from us.

•

Advanced Technology for Credit Evaluation. The implementation of our proprietary credit grading and pricing engines has allowed us to produce a more consistent and predictable portfolio of loans.

•

Award-Winning Website. E-Qual, our Wholesale Division’s website won the 2000 Website of the Year Award from Mortgage Technology Magazine. The site’s features make the loan process easier for our brokers which in turn helps to solidify our relationships with them.

•

Significant Cash Flows from Residuals. Our residual interests provide significant cash flows that we expect will allow us to repay our long-term debt aggressively. Once the debt has been repaid, we expect that the continued cash flow from residual interests will provide significant growth and operating capital in the future.

Product Types

We offer both fixed-rate and adjustable-rate loans, or ARMs. We also offer loans with an interest rate that is initially fixed for a period of time and that subsequently converts to an adjustable-rate. Most of the ARMs that we originate are offered at a low initial interest rate, sometimes referred to as a “start rate.” At each interest rate adjustment date, we adjust the rate, subject to certain limitations on the amount of any single adjustment and a cap on the aggregate of all adjustments.

In addition, our products are available at different interest rates and with different origination and application points and fees depending on the particular borrower’s risk classification (see “Business—Underwriting Standards”). Borrowers may choose to increase or decrease their interest rate through the payment of different levels of origination fees. Many of our fixed-rate borrowers, in particular, choose to “buy down” their interest rate through the payment of additional origination fees. Our maximum loan amounts are generally $500,000 with a loan-to-value ratio of up to 80%. We do, however, offer larger loans with lower loan-to-value ratios on a case-by-case basis. We also offer products that permit a loan-to-value ratio of up to 95% for selected borrowers with a risk classification of “A+” or of up to 90% for selected borrowers with a risk classification of “A-”. We have also introduced our “Prime Alternative” product designed to appeal to borrowers of higher credit quality.

Loans originated or purchased by us during 2001 had an average loan amount of approximately $138,000 and an average loan-to-value ratio of approximately 78.7%. If permitted by applicable law and agreed to by the borrower, our loans may also include a prepayment charge that is triggered by the loan’s full or substantial prepayment early in the loan term. Approximately 84.2% of the loans we originated or purchased during 2001 included some form of prepayment charge.

Loan Originations and Purchases

We originate and purchase loans through the New Century Mortgage Wholesale Division, Retail Branch Operations Division, Central Retail Division, and through Worth Funding, a wholly-owned subsidiary of New Century Mortgage. In late 2001, we began originating loans through The Anyloan Company, another subsidiary of New Century Financial Corporation. These divisions originate and purchase loans as follows:

•

The Wholesale Division originates and purchases loans through a network of independent mortgage brokers and correspondents solicited by our account executives. These account executives provide on-site customer service to the broker to facilitate the funding of the loan.

•

Worth Funding originates and purchases loans by soliciting and servicing brokers through its centralized telemarketing approach, operating from a central office where all decisions can be made promptly.

•

The Retail Branch Operations Division originates loans direct to the consumer through 65 retail branch offices located in 25 states.

•

The Central Retail Division originates loans nationwide through one central office. Leads are generated through radio, direct mail, telemarketing, and the Internet.

•

The Anyloan Company originates loans by developing alliances with mortgage companies and other financial institutions that do not offer our products.

Characteristics of the loans we originated and purchased during 2001 include:

•

66.3% were to borrowers within our three highest credit grades even though our underwriting guidelines include six levels of credit risk classifications;

•

93.2% were secured by the primary residences of our borrowers;

•

99.3% were secured by first mortgages and the remainder were secured by second mortgages; and

•

82.9% were refinances of existing loans, while the remaining 17.1% represented loans for a borrower’s purchase of a residential property.

Wholesale and Worth Funding

During 2001, our wholesale originations and purchases totaled $5.1 billion, or 81.2% of our total loan production, including $439.4 million, or 7.0%, which was originated through Worth Funding. As of December 31, 2001, the Wholesale Division operated through five regional operating centers located in Southern California, Northern California, Schaumburg, Illinois, Greenwood Village, Colorado, and Tampa, Florida. The Wholesale Division also operated through 31 additional sales offices located in Alabama, California, Florida, Georgia, Idaho, Indiana, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Missouri (2), Nevada, New Mexico, Ohio (3), Oregon, Rhode Island, South Carolina, Tennessee, Texas (2), Utah, Virginia, Washington (2), West Virgina and Wisconsin (2). As of December 31, 2001, the Wholesale Division employed 209 account executives.

As of December 31, 2001, approximately 9,900 mortgage brokers were approved by us to submit loans. We originated loans through approximately 6,000 brokers during 2001. During this period, our ten largest producing brokers originated 5.7% of our wholesale production.

In wholesale originations, the broker’s role is to identify the applicant, assist in completing the loan application form, gather necessary information and documents and serve as our liaison with the borrower through the lending process. We review and underwrite the application submitted by the broker, approve or deny the application, set the interest rate and other terms of the loan and, upon acceptance by the borrower and satisfaction of all conditions imposed by us, fund 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 the Wholesale Division allows us to increase loan volume without incurring the higher marketing, labor and other overhead costs associated with increased retail originations.

Mortgage brokers generally submit loan applications to an account executive in one of our sales offices. The sales office then forwards the application to the closest regional operating center where the loan is logged in for regulatory compliance purposes, underwritten and, in most cases, conditionally approved or denied within 24 hours of receipt. Because mortgage brokers generally submit individual loan files to several prospective lenders simultaneously, we attempt to respond to each application as quickly as possible. If approved, we issue a “conditional approval” to the broker with a list of specific conditions that have to be met (for example, credit verifications and independent third–party appraisals) and additional documents to be supplied prior to the funding of the loan. An account manager and the account executive who originated the loan work directly with the submitting mortgage broker to collect the requested information and to meet the underwriting conditions and other requirements. In most cases, we fund loans within 30 days after approval of the application.

The Wholesale Division also purchases closed loans on an individual or “flow” basis from independent mortgage brokers and financial institutions. We review an application for approval from each lender that seeks to sell us a closed loan. We analyze the mortgage broker’s underwriting guidelines and financial condition, including its licenses and financial statements. We require each mortgage broker to enter into a purchase and sale agreement with customary representations and warranties regarding the loans such mortgage broker will sell to us. These representations and warranties are comparable to those given by us, through our subsidiary, NC Capital, to our loan purchasers.

The following table sets forth selected information relating to loan originations through the Wholesale Division and Worth Funding during the periods shown:

	For the Quarters Ended
	March 31, 2001			June 30, 2001			September 30, 2001			December 31, 2001
Principal balance (in thousands)	$	807,954		$	1,103,235		$	1,493,309		$	1,663,968
Average principal balance per loan (in thousands)	$	140		$	143		$	150		$	153
Combined weighted average initial loan-to-value ratio		78.4	%		78.8	%		79.2	%		79.2	%
Percent of first mortgage loans		98.7			99.5			100.0			100.0
Property securing loans:
Owner occupied		92.1			91.7			93.1			93.3
Non-owner occupied		7.9			8.3			6.9			6.7
Weighted average interest rate:
Fixed-rate		10.5			9.7			9.4			8.7
ARMs		9.9			9.6			9.3			9.1
Margin—ARMs		6.5			6.6			6.6			6.7

Retail Branch Operations Division, Central Retail Division and The Anyloan Company.

During 2001, the Retail Branch Operations Division originated $868.4 million in loans, or 13.9% of our total loan production. As of December 31, 2001, the Retail Branch Operations Division employed 288 retail loan officers. These employees were located in 65 sales offices in Arizona (3), California (18), Colorado, Florida (4), Georgia, Hawaii, Illinois (2), Kentucky, Louisiana, Massachusetts, Michigan, Minnesota (2), Missouri (2), Montana, Nevada (2), New Jersey, New Mexico, Ohio (3), Oklahoma, Oregon (2), Pennsylvania (2), Texas (8), Utah, Virginia (2), and Washington (3).

During 2001, the Central Retail Division originated $307.3 million, or 4.9%, of our total loan production. As of December 31, 2001, the Central Retail Division employed 82 loan officers at its offices in Irvine, California.

During 2001, The Anyloan Company, which began its lending activities in November 2001, originated $846,000 in loans. As of December 31, 2001, The Anyloan Company employed 4 loan officers at its offices in Irvine, California.

By creating a direct relationship with the borrower, retail lending provides a more sustainable loan origination franchise and greater control over the lending process. Loan origination fees contribute to profitability and cash flow and offset the higher costs of retail lending.

The following table sets forth selected information relating to loan originations through the Retail Branch Operations Division, Central Retail Division and The Anyloan Company during the periods shown:

	For the Quarters Ended
	March 31, 2001			June 30, 2001			September 30, 2001			December 31, 2001
Principal balance (in thousands)	$	218,579		$	280,684		$	322,220		$	355,022
Average principal balance per loan (in thousands)	$	95		$	104		$	113		$	117
Combined weighted average initial loan-to-value ratio		76.1	%		78.2	%		77.7	%		77.9	%
Percent of first mortgage loans		95.2			96.9			98.4			99.2
Property securing loans:
Owner occupied		96.6			96.7			97.2			97.0
Non-owner occupied		3.4			3.3			2.8			3.0
Weighted average interest rate:
Fixed-rate		10.8			10.6			9.9			9.1
ARMs		10.1			9.6			9.5			9.2
Margins—ARMs		6.4			6.5			6.7			6.6

Marketing

Wholesale Division and Worth Funding Marketing

The marketing strategy of the Wholesale Division of New Century Mortgage and of Worth Funding focuses on the sales efforts of their account executives, and on providing prompt, consistent service to brokers and their customers. These efforts are supplemented with direct mail and fax programs to brokers, advertisements in trade publications, in-house production of collateral sales material, seminar sponsorships, tradeshow attendance, periodic sales contests and the Wholesale Division’s e-commerce website.

Retail Branch Marketing

The Retail Branch Operations Division of New Century Mortgage relies primarily on targeted direct mail and outbound telemarketing to attract borrowers. New Century Mortgage’s direct mail programs are managed by a centralized staff who create a targeted mailing list for each branch market and oversee the completion of mailings by a third party mailing vendor. All calls or written inquiries from potential borrowers that result from the mailings are tracked centrally and then forwarded to each branch location and handled by branch loan officers. This division’s website (www.newcenturymortgage.com) is used in the direct mail program to provide information to prospective borrowers and to allow them to complete an application online. Under the Central Telemarketing Program, the telemarketing staff solicits prospective borrowers, makes a preliminary evaluation of the applicant’s credit and the value of the collateral property and refers qualified leads to loan officers in the retail branch closest to the customer.

Central Retail Marketing

The Central Retail Division of New Century Mortgage engages in a variety of direct response advertising, such as purchased leads from aggregators, radio advertising, direct mail, search engine placement, banner ads, e-mail campaigns and links to related websites. The Central Retail Division also markets to the current customer base of New Century Mortgage through direct mail and outbound telemarketing. In addition, this division maintains a comprehensive database on all customers with whom it has had contact and markets to these potential customers in an effort to convert them to application.

Financing Loan Originations and Loans Held for Sale

We require access to credit facilities in order to originate and purchase mortgage loans and to hold them pending their sale or securitization. In particular, we rely on a $300 million syndicated warehouse credit facility led by U.S. Bank and a $200 million warehouse and aggregation facility with CDC Mortgage Capital to fund our originations and purchases. We also rely on aggregation financing facilities totaling $1.2 billion with Salomon Brothers Realty Corp. and Morgan Stanley Dean Witter Mortgage Capital to finance the loans pending their sale or securitization. See “—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

Underwriting Standards

We originate or purchase our mortgage loans in accordance with the underwriting guidelines described below. The loans we originate or purchase generally do not satisfy conventional underwriting standards, such as those utilized by Fannie Mae or Freddie Mac. Therefore, our loans are likely to have higher delinquency and foreclosure rates than portfolios of mortgage loans underwritten to conventional Fannie Mae and Freddie Mac standards.

Our underwriting guidelines take into account the applicant’s credit history and capacity to repay the proposed loan as well as the secured property’s value and adequacy as collateral for the loan. Each applicant completes an application that includes information on the applicant’s liabilities, income, credit history, employment history and personal information. Based on review of the loan application and other data from the applicant against our underwriting guidelines, we determine the loan terms, including the interest rate and maximum loan-to-value ratio.

Credit History

Our underwriting guidelines require a credit report on each applicant from a credit reporting company. In evaluating an applicant’s credit history, we utilize credit bureau risk scores, or a FICO score, which is a statistical ranking of likely future credit performance developed by Fair, Isaac & Company and the three national credit data repositories—Equifax, TransUnion and Experian.

Collateral Review

All mortgaged properties are appraised by qualified independent appraisers prior to the loan’s funding. The appraiser inspects and appraises the property and verifies that it is in acceptable condition. Following each appraisal, the appraiser prepares a report that includes a market value analysis based on recent sales of comparable homes in the area and, when deemed appropriate, replacement cost analysis based on the current cost of constructing a similar home. All appraisals are required to conform to the Uniform Standards of Professional Appraisal Practice adopted by the Appraisal Standards Board of the Appraisal Foundation and are generally on forms acceptable to Fannie Mae and Freddie Mac. Our underwriting guidelines require a review of the appraisal by one of our qualified employees or by a qualified review appraiser that we have retained. Our underwriting guidelines then require our underwriters to be satisfied that the value of the property being financed, as indicated by the appraisal, currently supports the outstanding loan balance.

Income Documentation

Our underwriting guidelines include three levels of income documentation requirements, referred to as the “full documentation,” “limited documentation” and “stated income documentation” programs. Under the full documentation program, applicants generally are required to submit two written forms of verification of stable income for at least twelve months. Under the limited documentation program, applicants are generally required to submit twelve consecutive monthly bank statements on their individual bank account. Under the stated income

documentation program, an applicant may be qualified based upon monthly income as stated on the mortgage loan application if the applicant meets certain criteria. All of these documentation programs require that, with respect to salaried employees, the applicant’s employment be verified by telephone. In the case of a purchase money loan, verification of the source of funds, if any, to be deposited by the applicant into escrow is required. Under each of these programs, we review the applicant’s source of income, calculate the amount of income from sources indicated on the loan application or similar documentation, review the applicant’s credit history, calculate the debt service-to-income ratio to determine the applicant’s ability to repay the loan, review the type and use of the property being financed, and review the property. Our underwriters use a qualifying rate that is equal to the initial interest rate on the loan, in determing the applicant’s ability to repay an adjustable-rate loan.

Underwriting Requirements

In general, the maximum loan amount for our mortgage loans is $500,000. Our underwriting guidelines permit loans on one-to-four-family residential properties to have:

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a loan-to-value ratio at origination of up to 95% with respect to non-conforming first liens;

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a combined loan-to-value ratio at origination of up to 100% with respect to non-conforming second liens; and

•

a combined loan-to-value ratio at origination of up to 100% with respect to conforming second liens.

The applicability of the above ratios depends on, among other things, the purpose of the mortgage loan, a borrower’s credit history, the borrower’s repayment ability and debt service-to-income ratio, and the type and use of the property. The loan-to-value of a mortgage loan that is secured by mortgaged properties acquired by a borrower under a “lease option purchase” is determined in one of two ways. If the “lease option price” was set less than twelve months prior to origination, the loan-to-value of the related mortgage loan is based on the lower of the appraised value at the time of origination of the mortgage loan or the sale price of the related mortgaged property. If the “lease option price” was set twelve months or more prior to origination, the loan-to-value of the related mortgage is based on the appraised value at the time of origination.

Our underwriting guidelines for first lien mortgage loans have the following categories and criteria for grading the potential likelihood that an applicant will satisfy the repayment obligations of a mortgage loan:

Summary of Principal Underwriting Guidelines (1)

Prime Alternative

A+ Risk

A- Risk

B Risk

C Risk

C- Risk

Existing mortgage history

Maximum one 30–day late payment w/in last 12 months.

Maximum one 30–day late payment and no 60-day late payments w/in last 12 mos.; must have an LTV of 95% or less.

Maximum three 30–day late payments and no 60–day late payments w/in last 12 mos.; must have an LTV of 90% or less.

Maximum one 60–day late payment within last 12 months; must be less than 90 days late at funding.

Maximum one 90–day late payment within last 12 months; must be less than 120 days late at funding.

Maximum of two 90–day late payments and one 120–day late payment w/in last 12 months; less than 150 days late at funding. No current Notice of Default.

Other credit

FICO score of 625 or higher.

4 accts w/30-day late payments or FICO score of 620 or higher; no more than $500 in open collection accounts or charge-offs w/in 12 mos. open after funding.

Past/Present 30–day late payments and 1 acct w/60 day late payment or FICO score of 590 or higher; no more than $1,000 in open collection accounts or charge–offs w/in 12 mos. open after funding.

Past/Present 30-day late payments and 2 accts w/90 day late payments and 4 accts w/60 day late payments or FICO score of 570 or higher; no more than $2,500 in open collection accts or charge-offs w/in 12 mos. open after funding.

Significant prior defaults acceptable; Generally, no more than $5,000 in open collection accounts or charge-offs w/in 12 mos. Open after funding; on a case by case basis.

Significant prior defaults acceptable; collection accounts may remain open after funding.

Bankruptcy filings

Generally, no Chapter 7 or 13 Bankruptcy discharge in last 2 years or Notice of Default in last 2 years.

Generally, no Chapter 7 or 13 Bankruptcy discharge in last 2 years or Notice of Default in last 3 years.

Generally, no Bankruptcy filings in last 2 years or Notice of Default filings in last 3 years.

Generally, no Bankruptcy discharge in last 18 months or Notice of Default filings in last 2 years.

Generally, no Bankruptcy or Notice of Default filings in last 12 months.

Chapter 7 Bankruptcy discharge in last 12 mos. Chapter 13 Bankruptcy filing allowed in last 12 months and no current NOD.

(Continued)

	Prime Alternative	A+ Risk	A- Risk	B Risk	C Risk	C- Risk

Total debt service to income Ratio	Up to 50%	45% to 50%	50% to 55%	55% to 59%	55% to 59%	50% to 59%

Maximum loan-to-value ratio (“LTV”):(2)
Owner	90%	95%	90%	85%	75%	70%

Occupied:
single family; detached PUD, or 2- unit Owner	80%	85%	85%	75%	70%	65%

Occupied:
condo/three-to-four unit

Non–owner occupied	Not applicable	85%	80%	75%	70%	65%

(1)

The letter grades applied to each risk classification reflect our internal standards and do not necessarily correspond to the classifications used by other mortgage lenders.

(2)

The maximum LTV set forth in the table is for borrowers providing full documentation. The LTV is reduced 5% for stated income applications, if applicable. Additionally, if the borrower’s FICO score meets or exceeds the risk category and debt ratio guidelines, consumer credit may be disregarded.

Prime Alternative Program

In 2000, we introduced a “Prime Alternative Program” to attract higher quality “Alternative—A” types of borrowers. We assess the borrower’s mortgage repayment history, any incidents of bankruptcy, mortgage default, or major derogatory credit, and call for a minimum FICO score of 625, which is substantially higher than our “core” product requirements. This program is restricted to owner-occupied properties; single unit, two unit, condominiums or detached PUD’s. We have limitations on loan amount, loan-to-value ratio, income documentation type, and the amount of “cash out” allowed on refinances.

Mortgage Credit Only Program

In addition to the six risk grade categories described above, New Century Mortgage also has a Mortgage Credit Only program. This program uses the applicant’s mortgage payment history as the primary factor in qualifying the applicant’s ability to repay the loan. The Mortgage Credit Only program allows no more than three 30-day late payments and no 60-day late payments within the last 12 months on an existing mortgage loan and must be current at funding. An existing mortgage loan is not required to be current at the time the application is submitted. Derogatory credit report items are allowed as to non-mortgage credit. In order to qualify for a Mortgage Credit Only loan:

•

The borrower may not be a participant in our Stated Income Documentation program;

•

No bankruptcy or notice of default filings may have occurred during the preceding two years, unless the borrower’s bankruptcy has been discharged during the past two years and the borrower has re-established a credit history that otherwise complies with the credit parameters set forth above; and

•

The mortgaged property must be in at least average condition. A maximum loan-to-value of 85% is permitted for a mortgage loan on a single–family owner–occupied property. A maximum loan-to-value of 80% is permitted for a mortgage loan on a non-owner occupied property, second home, owner–occupied condominium, or two- to four-family residential property. The debt service-to-income ratio is generally limited to a maximum of 55%.

Home Saver Program

We have established a sub-category of our C- credit grade for borrowers faced with at least one of the following credit scenarios: (i) the borrower has an existing mortgage currently in foreclosure; (ii) the borrower is subject to a notice of default filing; or (iii) the borrower has had a serious mortgage delinquency for more than one 120 day period in the last 12 months or is more than 90 days late at the time of funding. This sub-category is known as our Home Saver Program. The Home Saver Program is available only to Full Documentation borrowers and permits a maximum loan-to-value of 65% and a maximum debt service-to-income ratio of 55%. The maximum loan is $300,000 and all derogatory credit report items must either be brought current or paid through the loan proceeds. A maximum of 3% of the loan proceeds may be paid to the borrower in cash. If the borrower i