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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report: December 19, 1996
RAC FINANCIAL GROUP, INC.
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(Exact name of registrant as specified in its charter)
Nevada 0-27550 75-2561052
(State or other jurisdiction of (Commission File Number) (IRS Employer
incorporation or organization) Identification No.)
1250 West Mockingbird Lane
Dallas, Texas 75247
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 636-6006.
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ITEM 5. OTHER EVENTS.
OWNERSHIP OF THE COMMON STOCK AND OTHER SECURITIES OF RAC FINANCIAL GROUP,
INC. (THE "COMPANY") INVOLVES CERTAIN RISKS. HOLDERS OF THE COMPANY'S
SECURITIES AND PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING
RISK FACTORS IN EVALUATING AN INVESTMENT IN THE COMPANY'S SECURITIES.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY. As a result of the Company's increasing volume of loan
originations and purchases, and its expanding securitization activities, the
Company has operated, and expects to continue to operate, on a negative
operating cash flow basis, which is expected to increase as the volume of the
Company's loan purchases and originations increases and its securitization
program grows. The Company's primary operating cash requirements include the
funding of (i) loan originations and loan purchases, (ii) reserve accounts,
overcollateralization requirements, fees and expenses incurred in connection
with its securitization program, (iii) tax payments due on the Company's
taxable net income, (iv) television, radio and direct mail advertising and
other marketing expenses, and (v) administrative and other operating expenses.
The Company typically has funded its cash requirements from borrowings
under its warehouse facilities. There can be no assurance that, as the
Company's existing lending arrangements mature, the Company will have access
to the financing necessary for its operations and its growth plans or that
such financing will be available to the Company on favorable terms. To the
extent the Company is unable to renew existing warehouse facilities or
arrange additional or new warehouse lines of credit, the Company may have to
curtail loan origination and purchasing activities, which could have a
material adverse effect on the Company's results of operations and financial
condition.
NEED FOR ADDITIONAL FINANCING. The Company requires substantial capital to
fund its operations. Consequently, the Company's operations and its ability
to grow are affected by the availability of financing and the terms thereof.
Based on the rate of growth of the Company's originations in the recent past,
the Company anticipates that it will need to arrange additional warehouse
lines of credit or other financing sources from time to time over the
foreseeable future in order to maintain its historical growth rates. There
can be no assurance that the Company will be successful in consummating such
financing transactions in the future or on terms the Company would consider
to be favorable. If the Company is unable to arrange new warehouse lines of
credit or other financing sources, the Company may have to curtail its loan
origination and purchasing activities, which could have a material adverse
effect on the Company's results of operations and financial condition.
DEPENDENCE ON SECURITIZATION TRANSACTIONS. Since the beginning of fiscal
1995, the Company has utilized a securitization program that involves the
periodic pooling and sale of its strategic loans (i.e., uninsured home
improvement and uninsured debt consolidation loans ("Conventional Loans") and
partially insured Title I home improvement loans ("Title I Loans")). The
securitization proceeds have historically been used to repay borrowings under
warehouse facilities, thereby making such warehouse facilities available to
finance the origination and purchase of additional strategic loans. There can
be no assurance that, as the Company's volume of loans originated or
purchased increases and other new products available for securitization
increases, the Company will be able to securitize its loan production
efficiently. In addition, the securitization market for many types of assets
is relatively undeveloped and may be more susceptible to market fluctuations
or other adverse changes than more developed capital markets. Securitization
transactions may be affected by a number of factors, some of which are beyond
the Company's control, including, among other things, conditions in the
securities markets in general, conditions in the asset-backed securitization
market and the conformity of loan pools to rating agency requirements and to
the extent that monoline insurance is used, the requirements of such
insurers. Adverse changes in the secondary market could impair the Company's
ability to originate, purchase and sell loans on a favorable or timely basis.
In addition, the Company's securitizations typically utilize credit
enhancements in the form of financial guaranty insurance policies in order to
achieve better credit ratings. Failure to obtain acceptable rating agency
ratings or insurance company credit enhancements could decrease the
efficiency or affect the timing of future securitizations. The Company
intends to continue public or private securitizations of its loan pools on a
quarterly basis. Any delay in the sale of a loan pool beyond a quarter-end
would substantially reduce and may eliminate the Gain on Sale (as hereafter
defined) in the given quarter and would likely result in losses for such
quarter being reported by the Company. If the Company were unable to
securitize loans due to changes in the secondary market or the unavailability
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of credit enhancements, the Company's growth would be materially impaired and
the Company's results of operations and financial condition would be
materially adversely affected.
RISKS ASSOCIATED WITH LOANS HELD FOR SALE. In order to increase its
interest income and, therefore, reduce the amount of cash used in the
Company's operating activities, in the third quarter of fiscal 1996 the
Company began to implement a strategy of maintaining a significant quantity
of loans on its balance sheet as "loans held for sale, net." During fiscal
1994 and 1995, loans were held an average of one month before their sale. In
fiscal 1996, this average holding period increased to two months. The Company
expects this holding period to increase to 180 days during fiscal 1997, and
it could exceed one year thereafter.
The interest rate on loans originated and purchased by the Company are
fixed at the time the Company issues a loan commitment. In addition, the
interest rates on the Company's loans are fixed, and the Company's loan
financing facilities all bear floating interest rates. See "Sensitivity to
Interest Rates." Accordingly, the Company's strategy to increase the dollar
amount of loans held for sale and the length of time such loans are held will
significantly increase the Company's exposure to interest rate fluctuations
and the risks that such fluctuations will result in greater interest expense
under warehouse facilities and reduced Gain on Sale resulting from a reduced
spread between the interest rates charged to borrowers and the interest rate
paid to investors in securitizations. Moreover, in order to manage this
increased risk the Company will have to increase its hedging activities, and
there can be no assurance that such hedging activities will be successful in
managing the risk or will not themselves have a material adverse effect on
the Company's financial condition or results of operations. As a result,
there can be no assurance that this strategy will not have a material adverse
effect on the Company's financial condition or results of operations.
SENSITIVITY TO INTEREST RATES
The Company's profitability may be directly affected by fluctuations in
interest rates. While the Company monitors interest rates and employs a
strategy designed to hedge some of the risks associated with changes in
interest rates, no assurance can be given that the Company's results of
operations and financial condition will not be adversely affected during
periods of fluctuations in interest rates. The Company's interest rate
hedging strategy currently includes purchasing put contracts on treasury
securities, selling short treasury securities and maintaining a pre-funding
strategy with respect to its securitizations. Since the interest rates on the
Company's indebtedness used to fund and acquire loans are variable and the
rates charged on loans the Company originates and purchases are fixed,
increases in the interest rates after loans are originated and prior to their
sale could have a material adverse effect on the Company's results of
operations and financial condition. In addition, increases in interest rates
prior to sale of the loans may reduce the Gain on Sale earned by the Company.
The ultimate sale of the Company's loans will fix the spread between the
interest rates paid by borrowers and the interest rates paid to investors in
securitization transactions (the "Excess Servicing Spread") with respect to
such loans, although increases in interest rates may narrow the potential
spread that existed at the time the loans were originated or purchased by the
Company. A significant, sustained rise in interest rates could curtail the
Company's growth opportunities by decreasing the demand for loans at such
rates and increasing market pressure to reduce origination fees or servicing
spreads. The Company has begun to implement a strategy of maintaining a
significant quantity of loans on its balance sheet, thus increasing the
length of time that loans are held for sale and materially increasing its
interest rate risk.
The Company's investment in the Excess Servicing Receivable is also
sensitive to interest rates. A decrease in interest rates could cause an
increase in the rate at which outstanding loans are prepaid, thereby reducing
the period of time during which the Company receives the Excess Servicing
Spread and other servicing income with respect to such prepaid loans, thereby
possibly resulting in accelerated amortization of the Excess Servicing
Receivable. Although an increase in interest rates may decrease prepayments,
such increase may not offset the higher interest costs of financing the
Excess Servicing Receivable.
CREDIT RISK ASSOCIATED WITH BORROWERS
Many of the Company's borrowers are consumers who have limited access to
consumer financing for a variety of reasons, including insufficient home
equity value and, in the case of borrowers under the Title I credit insurance
program (the "Title I Program") administered by the Federal Housing
Administration (the "FHA"), unfavorable past credit
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experience. The Company is subject to various risks associated with these
borrowers, including, but not limited to, the risk that borrowers will not
satisfy their debt service payments, including payments of interest and
principal, and that the realizable value of the property securing such loans
will not be sufficient to repay the borrower's obligation to the Company. The
risks associated with the Company's business increase during an economic
downturn or recession. Such periods may be accompanied by decreased demand
for consumer credit and declining real estate values. Any material decline in
real estate values reduces the ability of borrowers to use home equity to
support borrowings and increases the loan-to-value ratios of the Company's
existing loans, thereby weakening collateral values and increasing the
possibility of a loss in the event of default. Furthermore, the rates of
delinquencies and foreclosures and the frequency and severity of losses
generally increase during economic downturns or recessions. Because the
Company lends to borrowers who may be credit-impaired, the actual rates of
delinquencies, foreclosures and losses on such loans could be higher under
adverse economic conditions than those currently experienced in the consumer
finance industry in general. While the Company is experiencing declining
delinquency rates on the strategic loans serviced by the Company (the
"Serviced Loan Portfolio") as a whole, delinquency rates have followed
historical trends on a pool-by-pool basis, which trends assume increased
rates of delinquencies over time. However, there can be no assurance that
delinquency rates will not increase beyond historical trends. In addition, in
an economic downturn or recession, the Company's servicing costs will
increase. Any sustained period of such increased losses could have a material
adverse effect on the Company's results of operations and financial condition.
CREDIT RISK ASSOCIATED WITH HIGH LTV LOANS
Although the Company's strategic loans are typically secured by real
estate, because of the relatively high loan-to-value ratios ("LTVs") of most
of the Company's loans, in most cases the collateral of such loans will not
be sufficient to cover the principal amount of the loans in the event of
default. The Company relies principally on the creditworthiness of the
borrower and to a lesser extent on the underlying collateral for repayment of
the Company's Conventional Loans, and FHA co-insurance with respect to Title
I Loans. Consequently, many of the Company's loans equal or exceed the value
of the mortgaged properties, in some instances involving LTVs of up to 125%.
With respect to many of the Company's loans, LTV determinations are based
upon the borrowers' representations as to the value of the underlying
property; accordingly, there can be no assurance that such represented values
accurately reflect prevailing market prices. With respect to any default, the
Company currently evaluates the cost effectiveness of foreclosing on the
collateral. To the extent that borrowers with high LTVs default on their loan
obligations, the Company is less likely to use foreclosure as a means to
mitigate its losses. Under these circumstances, losses would be applied to
the Company's allowances for possible credit losses on loans sold and held
for sale, except to the extent that Title I Program insurance is available.
Such absorption, if in excess of the Company's allowance for such losses,
could have a material adverse effect on the Company's financial condition and
results of operations, if such losses required the Company to record
additional provisions for losses on loans sold.
EXCESS SERVICING RECEIVABLE RISKS
ILLIQUIDITY OF THE EXCESS SERVICING RECEIVABLE. The Company's "Gain on
Sale," with respect to securitizations, is equal to the present value of the
Company's portion of the expected future excess cash flow to be received on
the loans sold through securitization transactions, in excess of
securitization costs and net premiums paid, net of sharing, but not net of
the Company's provision for possible credit losses. When the Company's loans
are pooled and sold in securitization transactions, the Company recognizes
Gain on Sale, which constitutes a substantial majority of the Company's
revenues. The Company records an asset corresponding to its Gain on Sale (the
"Excess Servicing Receivable") on its balance sheet in an initial amount
equal to the present value of the Excess Servicing Spread it expects to
collect over the life of the securitized loans sold. The Company is not aware
of an active market for this kind of receivable, and no assurance can be
given that the receivable could in fact be sold at its stated value on the
balance sheet, if at all.
In addition, the Gain on Sale is recognized in the period during which
loans are sold, while cash payments are received by the Company pursuant to
its pooling and servicing agreements and servicing fees are paid to the
Company by the securitization trustees over the lives of the securitized
loans. This difference in the timing of cash flows could cause a cash
shortfall, which may have a material adverse effect on the Company's
financial condition and results of operations.
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EXCESS SERVICING RECEIVABLE MAY BE OVERSTATED; PROVISION FOR CREDIT LOSSES
MAY BE UNDERSTATED. The calculation of Gain on Sale and the valuation of the
Excess Servicing Receivable are based on certain management estimates
relating to the appropriate discount rate and anticipated average lives of
the loans sold. In order to determine the present value of this excess cash
flow, the Company currently applies an estimated market discount rate of
between 10% and 11% to the expected pro forma gross cash flow calculated
utilizing the weighted average maturity of the securitized loans, and
currently applies a risk free discount rate of 6.5% to the anticipated losses
attendant to this pro forma cash flow stream. Accordingly, the overall
effective current average discount rate utilized on the cash flows, net of
expected credit losses is approximately 12.5%. Although the Company records
the Excess Servicing Receivable and the related reserve on a gross basis, for
purposes of evaluation and comparison, the Company calculates an average net
discount rate for the net Excess Servicing Receivable. This is calculated by
subtracting the present value of the anticipated losses attributable to loans
being securitized and sold from the present value of the expected stream of
payments to derive the present value of the net Excess Servicing Receivable.
The Company then determines the average discount rate that equates the
expected payments, net of expected losses, to the value of the Excess
Servicing Receivable, which, with respect to its 1996-4 securitization
(November 15, 1996), is approximately 12.5%. To estimate the anticipated
average lives of the loans sold in securitization transactions, management
estimates prepayment, default and interest rates on a pool-by-pool basis. If
actual experience varies from management estimates at the time loans are
sold, the Company may be required to write down the remaining Excess
Servicing Receivable through a charge to earnings in the period of adjustment.
Prepayment rates and default rates may be affected by a variety of
economic and other factors, including prevailing interest rates and the
availability of alternative financing, most of which are not within the
Company's control. A decrease in prevailing interest rates could cause
prepayments to increase, thereby requiring a writedown of the Excess
Servicing Receivable. Even if actual prepayment rates occur more slowly and
default rates are lower than management's original estimates, the Excess
Servicing Receivable would not increase.
Furthermore, management's estimates of prepayment rates and default rates
are based, in part, on the historical performance of the Company's Title I
Loans. The Company is originating an increasing proportion of Conventional
Loans, while historical performance data is based primarily on Title I Loans.
In addition, a significant portion of the Company's securitized loans sold
were very recently originated or were acquired in bulk purchases. No
assurance can be given that these loans, as with any new loan, will perform
in the future in accordance with the Company's historical experience. In
addition, when the Company introduces new loan products it may have little or
no historical experience on which it can base its estimates, and thus its
estimates may be less reliable. During the fiscal year ended September 30,
1996, the Company increased its provision for credit losses, $2.5 million of
which was taken because the default rate for a pool of loans acquired by the
Company through a bulk purchase of home improvement and debt consolidation
loans ("Bulk Loans") included in the 1995-2 securitization exceeded the
estimates made at the time of the securitization and the adjustment was in
conformity with the Company's current estimation methodology. There can be no
assurance that the Company will not be required in the future to write down
its Excess Servicing Receivable in excess of its provision for credit losses.
Any such writedown could have a material adverse effect on the Company's
financial condition and results of operations.
FINANCING OF THE EXCESS SERVICING RECEIVABLE. The Company retains
significant amounts of Excess Servicing Receivable on its balance sheet. The
Company currently does not hedge this asset. The Company finances its Excess
Servicing Receivable with term-line borrowings under an existing term
facility (the "Term Line") with Residential Funding Corporation (the
"Warehouse Lender"). These borrowings bear interest at a floating rate. The
Company, however, cannot reprice its Excess Servicing Receivable on its
balance sheet, which has an expected average life of four to six years.
Therefore, the Company remains at risk that its financing sources may
increase the interest rates they charge the Company.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 125 ("FASB 125"), "Accounting
for Transfer and Servicing of Financial Assets and Extinguishment of
Liabilities." FASB 125 addresses the accounting for all types of
securitization transactions, securities lending and repurchase agreements,
collateralized borrowing arrangements and other transactions involving the
transfer of financial
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assets. FASB 125 distinguishes transfers of financial assets that are
sales from transfers that are secured borrowings. FASB 125 is generally
effective for transactions that occur after December 31, 1996, and it is
to be applied prospectively. FASB 125 will require the Company to allocate
the total cost of mortgage loans sold to the mortgage loans, retained
certificates and servicing rights. The Company will be required to assess the
retained certificates and servicing rights for impairment based upon the fair
value of those rights. The pronouncement also will require the Company to
provide additional disclosure about the retained certificates in its
securitizations and to account for these assets at fair value in accordance
with FASB 115. The Company has not completed its analysis of the impact FASB
125 may have on the Company's financial condition or results of operations.
The Company will apply the new rules prospectively beginning in the first
calendar quarter of 1997. There can be no assurance, however, that the
implementation by the Company of FASB 125 will not reduce the Company's Gain
on Sale of loans in the future or otherwise adversely affect the Company's
results of operations or financial condition.
ABILITY OF THE COMPANY TO CONTINUE GROWTH STRATEGY; POSSIBLE ADVERSE
CONSEQUENCES FROM RECENT GROWTH
The Company's total revenues and net income have increased dramatically
and rapidly since the Company's inception. The Company does not expect to
sustain these growth rates.
The Company's ability to continue its growth strategy depends on its
ability to increase the volume of loans it originates and purchases while
successfully managing its growth. This volume increase is, in part, dependent
on the Company's ability to procure, maintain and manage its increasingly
larger warehouse facilities and lines of credit. In addition to the Company's
financing needs, its ability to increase its volume of loans will depend on,
among other factors, its ability to (i) offer attractive products to
prospective borrowers, (ii) attract and retain qualified underwriting,
servicing and other personnel, (iii) market its products successfully,
especially its new loan products originated directly to qualified homeowners
("Direct Loans"), (iv) establish new relationships and maintain existing
relationships with independent correspondent lenders in states where the
Company is currently active and in additional states and (v) build national
brand name recognition. In addition, the Company has recently begun to focus
resources on the small loan consumer finance industry. There can be no
assurance that the Company will successfully enter or compete in this highly
competitive segment of the consumer finance industry.
In light of the Company's rapid growth, the historical performance of the
Company's operations, including its underwriting and servicing operations,
which were principally related to origination of Title I Loans, may be of
limited relevance in predicting future performance with respect to
Conventional Loans, especially debt consolidation loans or personal consumer
loans. Any credit or other problems associated with the large number of loans
originated in the recent past may not become apparent until sometime in the
future. Consequently, the Company's historical results of operations may be
of limited relevance to an investor seeking to predict the Company's future
performance. In addition, purchases of Bulk Loans require the Company to rely
to a certain extent on the underwriting practices of the seller of the Bulk
Loans. Although the Company has its own review process when purchasing Bulk
Loans, the Company occasionally must rely upon the underwriting standards of
the originator, which standards may not be as rigorous as the Company's.
The Company's ability to successfully manage its growth as it pursues its
growth strategy will be dependent upon, among other things, its ability to
(i) maintain appropriate procedures, policies and systems to ensure that the
Company's loans have an acceptable level of credit risk and loss, (ii)
satisfy its need for additional short-term and long-term financing, (iii)
manage the costs associated with expanding its infrastructure, including
systems, personnel and facilities, and (iv) continue operating in
competitive, economic, regulatory and judicial environments that are
conducive to the Company's business activities. The Company's requirement for
additional operating procedures, personnel and facilities is expected to
continue over the near term. The Company is absorbing the effects of the
implementation of new computer hardware and software to manage its business
operations, and it plans to continue to procure hardware and software that
require additional corresponding investments in training and education. The
Company's significant growth has placed substantial new and increased
pressures on the Company's personnel. There can be no assurance that the
addition of new operating procedures, personnel and facilities together with
the Company's enhanced information systems, will be sufficient to enable it
to meet its current operating needs. Changes in the Company's ability to
obtain or maintain any or all of these factors or to successfully manage its
growth strategy could have a material adverse effect on the Company's
operations, profitability and growth.
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CONSOLIDATION OF OPERATIONS OF ACQUISITIONS
The Company has in the past relied on, and in the future expects to
continue to rely on, in part an acquisition strategy in order to grow its
business and to enter into new lines of business. The Company must
successfully integrate the management, marketing, products and systems
associated with its acquisitions if the Company is to make current or
prospective acquisitions financially successful. In addition, the Company's
recent strategy of acquiring personal consumer loan companies involves
introducing the Company's strategic loan products, which are very different
from the type of loans such companies now originate, into this origination
channel. Acquisitions may produce excess costs and may become significant
distractions to management if they are not timely integrated. There can be no
assurance that future acquisition opportunities will become available, that
such future acquisitions can be accomplished on favorable terms or that such
acquisitions, if any, will result in profitable operations in the future or
can be integrated successfully with the Company's existing business.
CONCENTRATION OF OPERATIONS IN CALIFORNIA
A significant portion of the Serviced Loan Portfolio is secured by
subordinate liens on residential properties located in California.
Consequently, the Company's results of operations and financial condition are
dependent upon general trends in the California economy and its residential
real estate market. California has experienced an economic slowdown or
recession over the last several years, which has been accompanied by a
sustained decline in the California real estate market. Such a decline may
adversely affect the values of properties securing the Company's loans, such
that the principal balances of such loans, together with any primary
financing on the mortgaged properties, may further increase LTVs, making the
Company's ability to recoup losses in the event of a borrower's default
extremely unlikely. In addition, California historically has been vulnerable
to certain risks of natural disasters, such as earthquakes and erosion-caused
mudslides, which are not typically covered by the standard hazard insurance
policies maintained by borrowers. Uninsured disasters may adversely impact
borrowers' ability to repay loans made by the Company, which could have a
material adverse effect on the Company's results of operations and financial
condition.
COMPETITION
The consumer finance market is highly competitive and fragmented. The
Company competes with a number of finance companies that provide financing to
individuals who may not qualify for traditional financing. To a lesser
extent, the Company competes, or will compete, with commercial banks, savings
and loan associations, credit unions, insurance companies and captive finance
arms of major manufacturing companies that currently tend to apply more
traditional lending criteria. In addition, in recent months, several
companies have announced loan programs that will compete directly with the
Company's loan products, particularly its Conventional Loans. Many of these
competitors or potential competitors are substantially larger and have
significantly greater capital and other resources than the Company. In fiscal
1995 and 1996, approximately 68.5% and 93.9%, respectively, of the Company's
loans originated were loans originated through correspondent lenders
("Correspondent Loans"), which are expected to remain a significant part of
the Company's loan production program for the foreseeable future. As a
purchaser of Correspondent Loans, the Company is exposed to fluctuations in
the volume and price of Correspondent Loans resulting from competition from
other purchasers of such loans, market conditions and other factors. In
addition, the Federal National Mortgage Association ("Fannie Mae") has
purchased and is expected to continue to purchase significant volumes of
Title I Loans on a whole-loan basis. Purchases by Fannie Mae could be made
from sources from which the Company also purchases loans. To the extent that
purchasers of loans, such as Fannie Mae, enter or increase their purchasing
activities in the markets in which the Company purchases loans, competitive
pressures may decrease the availability of loans or increase the price the
Company would have to pay for such loans, a phenomenon that has occurred with
respect to Title I Loans. In addition, increases in the number of companies
seeking to originate loans tends to lower the rates of interest the Company
can charge borrowers, thereby reducing the potential value of subsequently
earned Gains on Sales of loans. To the extent that any of these lenders or
Fannie Mae significantly expand their activities in the Company's market, or
to the extent that new competitors enter the market, the Company's results of
operations and financial condition could be materially adversely affected.
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CONCENTRATION OF CORRESPONDENT LENDERS
Approximately 79.8% and 48.6% of the loans purchased from correspondent
lenders by the Company during fiscal 1995 and 1996, respectively, were
originated through the Company's 10 largest independent correspondent
lenders. The Company believes that it is possible for its dependence on a
small number of independent correspondent lenders to continue for the
foreseeable future as the Company focuses extensively on originating Direct
Loans. Correspondent lenders are not contractually bound to sell loans to the
Company, and, therefore, are able to sell their loans to others or to
undertake securitization programs of their own. To the extent that the
Company is no longer able to purchase or originate loans from these
significant independent correspondent lenders, this could have a material
adverse effect on the Company's results of operations and financial condition.
LIMITED OPERATING HISTORY
The Company was formed in 1994 to combine the operations of FIRSTPLUS
Financial, Inc. ("FIRSTPLUS Financial") and SFA: State Financial Acceptance
Corporation ("SFAC"). The Combination involved the integration of the
operations of two companies that previously operated independently.
Consequently, the Company has a limited operating history under its new
corporate structure upon which prospective investors may base an evaluation
of its performance.
DELINQUENCIES; RIGHT TO TERMINATE SERVICING; NEGATIVE IMPACT ON CASH FLOWS
A significant portion of the Serviced Loan Portfolio consists of loans
securitized by the Company and sold to grantor or owner trusts. The Company's
form of pooling and servicing agreement with each of these trusts provides
that the trustee of the related trust may terminate the Company's servicing
rights if certain delinquency or loss standards are not met. To date, none of
the pools of securitized loans exceeded the foregoing delinquency standards
and no servicing rights have been terminated. However, there can be no
assurance that delinquency rates with respect to Company-sponsored
securitized loan pools will not exceed this rate in the future and, if
exceeded, that servicing rights will not be terminated, which would have a
material adverse effect on the Company's results of operations and financial
condition.
The Company's cash flow can also be adversely impacted by high delinquency
and default rates in its grantor and owner trusts. Generally, provisions in
the pooling and servicing agreement have the effect of requiring the over
collateralization account, which is funded primarily by the excess servicing
on the loans held in the trust, to be increased up to about two and one-half
times the level otherwise required when the delinquency and the default rates
exceed various specified limits.
DEPENDENCE ON TITLE I PROGRAM
A portion of the Company's business is dependent on the continuation of
the Title I Program, which is federally funded. The Title I Program provides
that qualifying loans are eligible for FHA insurance, although such insurance
is limited. From time to time, legislation has been introduced in both houses
of the United States Congress that would, among other things, abolish the
Department of Housing and Urban Development ("HUD"), reduce federal spending
for housing and community development activities and eliminate the Title I
Program. Other changes to HUD have been proposed, which, if adopted, could
affect the operation of the Title I Program. No assurance can be given that
the Title I Program will continue in existence or that HUD will continue to
receive sufficient funding for the operation of the Title I Program.
Discontinuation of or a significant reduction in the Title I Program or the
Company's authority to originate or purchase loans under the Title I Program
could have a material adverse effect on the Company's results of operations
and financial condition.
IMPACT OF REGULATION AND LITIGATION
The Company's business is subject to regulation and licensing under
various federal, state and local statutes and regulations requiring, among
other things, the licensing of lenders, adequate disclosure of loan terms and
limitations on the terms and interest rates of consumer loans, collection
policies, creditor remedies and other trade practices. An adverse change in
these laws or regulations could have an adverse effect on the Company by,
among other things, limiting
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the interest and fee income the Company may generate on existing and
additional loans, limiting the states in which the Company may operate or
restricting the Company's ability to realize on the collateral securing its
loans.
Members of Congress and government officials have from time to time
suggested the elimination of the mortgage interest deduction for federal
income tax purposes, either entirely or in part, based on borrower income,
type of loan or principal amount. Because many of the Company's loans are
made to borrowers for the purpose of consolidating consumer debt or financing
other consumer needs, the competitive advantages of tax deductible interest,
when compared with alternative sources of financing, could be eliminated or
seriously impaired by such government action. Accordingly, the reduction or
elimination of these tax benefits could have a material adverse effect on the
demand for loans of the kind offered by the Company, which could have a
material adverse effect on the Company's results of operations and financial
condition.
Industry participants are frequently named as defendants in litigation
involving alleged violations of federal and state consumer lending laws and
regulations, or other similar laws and regulations, as a result of the
consumer-oriented nature of the industry in which the Company operates and
uncertainties with respect to the application of various laws and regulations
in certain circumstances. If a significant judgment were rendered against the
Company in connection with any litigation, it could have a material adverse
effect on the Company's financial condition and results of operations.
The Company's loans under the Title I Program are eligible for FHA
insurance. The FHA insures 90% of such loans and certain interest costs,
provided that the Company has not depleted its loss reserve account
established with the FHA and the loans were properly originated according to
FHA regulations. The amount of insurance coverage in a lender's FHA loss
reserve account is equal to 10% of the original principal amount of all Title
I Loans originated and the amount of the reserves for purchased loans
reported for insurance coverage by the lender, less the amount of all
insurance claims approved for payment in connection with losses on such loans
and other adjustments. If at any time claims exceed the loss reserve balance,
the remaining Title I Loans will be uninsured. In addition, the Title I
Program sets loan origination guidelines that must be satisfied by the lender
in connection with the origination of Title I Loans in order for FHA to
insure those loans. The Company's failure to comply with such requirements
could result in denial of payment by FHA. There can be no assurance that
losses will not exceed the Company's loss reserve account or that the Company
will not be adversely affected by such defaults. The Company's Conventional
Loans are not insured.
CONCENTRATION OF VOTING CONTROL IN MANAGEMENT
Daniel T. Phillips, the Company's President, Chief Executive Officer and
Chairman of the Board, and Eric C. Green, the Company's Chief Financial
Officer, beneficially own or otherwise control a significant block of the
outstanding voting Common Stock. Therefore, Messrs. Phillips and Green are
able to exercise significant influence with respect to the election of the
entire Board of Directors of the Company and all matters submitted to
stockholders. Messrs. Phillips and Green are also able to significantly
influence the direction and future operations of the Company, including
decisions regarding the issuance of additional shares of Common Stock and
other securities. In addition, as long as Messrs. Phillips and Green
beneficially own or otherwise control a significant block of issued and
outstanding Common Stock of the Company, it will be difficult for third
parties to obtain control of the Company through purchases of Common Stock
not beneficially owned or otherwise controlled by Messrs. Phillips and Green.
DEPENDENCE ON KEY PERSONNEL
The Company is dependent upon the continued services of Daniel T. Phillips
or Eric C. Green and the Company's other executive officers. While the
Company believes that it could find replacements for its executive officers,
the loss of their services could have an adverse effect on the Company's
operations. Each of the Company's executive officers has entered into an
employment agreement with the Company.
EVENTS OF DEFAULT UNDER CERTAIN FINANCING FACILITIES
The loss of the services of Daniel T. Phillips as Chief Executive Officer
of the Company and Eric C. Green as Chief Financial Officer of the Company
would constitute an event of default under the credit facilities with the
Warehouse
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Lender, which in turn would result in defaults under other indebtedness.
Mr. Phillips and Mr. Green have entered into employment agreements with
the Company.
EFFECT OF CERTAIN ANTITAKEOVER PROVISIONS
Certain provisions of the Company's Amended and Restated Articles of
Incorporation (the "Articles of Incorporation") and Amended and Restated
Bylaws (the "Bylaws"), the Nevada General Corporation Law and the Indenture
for the 7.25% Convertible Subordinated Notes Due 2003 (the "Convertible
Notes") could delay or frustrate the removal of incumbent directors and could
make difficult a merger, tender offer or proxy contest involving the Company,
even if such events could be viewed as beneficial by the Company's
stockholders. For example, the Articles of Incorporation deny the right of
stockholders to amend the Bylaws and require advance notice of stockholder
proposals and nominations of directors. The Company is also subject to
provisions of the Nevada General Corporation Law that prohibit a publicly
held Nevada corporation from engaging in a broad range of business
combinations with a person who, together with affiliates and associates, owns
10% or more of the corporation's outstanding voting shares (an "interested
stockholder") for three years after the person became an interested
stockholder, unless the business combination is approved in a prescribed
manner. In addition, the Indenture for the Convertible Notes provides that in
the event of a change of control (as defined therein) holders of the
Convertible Notes have the right to require that the Company repurchase the
Notes in whole or in part.
SECURITIES TRADING; POSSIBLE VOLATILITY OF PRICES
The Common Stock is quoted on the Nasdaq National Market. The market price
for shares of Common Stock may be significantly affected by such factors as
quarter-to-quarter variations in the Company's results of operations, news
announcements or changes in general market or industry conditions.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: December 19, 1996
RAC FINANCIAL GROUP, INC.
By:/s/ Eric C. Green
---------------------------
Name: Eric C. Green
Title: Chief Financial Officer
