<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 15, 1997
REGISTRATION NO. 333-
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------------------
CONTIFINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 13-3852588
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</TABLE>
--------------------------
277 PARK AVENUE
NEW YORK, NEW YORK 10172
(212) 207-2800
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
------------------------------
ALAN L. LANGUS, ESQ.
CHIEF COUNSEL
CONTIFINANCIAL CORPORATION
277 PARK AVENUE
NEW YORK, NEW YORK 10172
(212) 207-2822
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------------------
COPIES TO:
<TABLE>
<S> <C> <C>
DOUGLAS L. GETTER, ESQ. MATTHEW NIMETZ, ESQ. NORMAN D. SLONAKER, ESQ.
DEWEY BALLANTINE PAUL, WEISS, RIFKIND, WHARTON & GARRISON BROWN & WOOD LLP
1301 AVENUE OF THE AMERICAS 1285 AVENUE OF THE AMERICAS ONE WORLD TRADE CENTER
NEW YORK, NEW YORK 10019-6092 NEW YORK, NEW YORK 10019-6064 NEW YORK, NEW YORK 10048-0557
(212) 259-8000 (212) 373-3000 (212) 839-5300
</TABLE>
--------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box: / /
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box: / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering: / / __________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: / / __________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: /X/
--------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED MAXIMUM
PROPOSED MAXIMUM AGGREGATE AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE OFFERING REGISTRATION
SECURITIES TO BE REGISTERED REGISTERED(1)(2) PER SHARE(3) PRICE(1)(3) FEE(4)
<S> <C> <C> <C> <C>
Common Stock, par value $0.01 per share..... 3,220,000 shares $36.97 $119,043,400 $36,073.76
</TABLE>
(1) Includes 420,000 shares to cover over-allotments, if any, and an
indeterminate number of shares which may be delivered pursuant to stock
splits, combinations, dividends, recapitalizations or other adjustments.
(2) In accordance with Rule 429, the Prospectus included herein is a combined
prospectus which also relates to the Registrant's Registration Statement on
Form S-3 (Registration No. 333-21839) (the "Prior Registration Statement").
The remaining amount of Common Stock eligible to be sold under the Prior
Registration Statement (2,972,642 shares) shall be carried forward to this
Registration Statement.
(3) Estimated solely for purposes of determining the registration fee pursuant
to Rule 457 under the Securities Act of 1933.
(4) $2,771.16 of such Registration Fee is paid pursuant to this Registration
Statement. The remaining $33,302.60 of the Registration Fee is attributable
to the Common Stock carried forward from the Prior Registration Statement,
for which a Registration Fee in the amount of $66,605.21 was paid at the
time of registration.
--------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
PURSUANT TO RULE 429 UNDER THE SECURITIES ACT OF 1933, THIS REGISTRATION
STATEMENT ALSO RELATES TO THE REGISTRANT'S PRIOR REGISTRATION STATEMENT
(REGISTRATION NO. 333-21839).
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED AUGUST 15, 1997
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>
PROSPECTUS
2,800,000 SHARES
CONTIFINANCIAL CORPORATION
COMMON STOCK
--------------
This Prospectus relates to 2,800,000 shares of common stock, $0.01 par value
(the "Common Stock"), of ContiFinancial Corporation, a Delaware corporation (the
"Company"), which may be delivered by Merrill Lynch & Co., Inc. ("ML & Co.")
upon payment and discharge of the Structured Yield Product Exchangeable for
Stock-SM-, % STRYPES-SM- Due , 2000 of ML & Co. (each, a "STRYPES") at
maturity, subject to ML & Co.'s right to deliver an amount in cash with an equal
value. ML & Co. has granted the Underwriter of the STRYPES (as defined herein)an
option for 30 days to purchase additional STRYPES, solely to cover
over-allotments, if any. Such additional STRYPES may be paid and discharged by
ML & Co. at their maturity by delivery of up to an additional 420,000 shares of
Common Stock to which this Prospectus also relates.
All of the shares of Common Stock covered hereby are beneficially owned by
Continental Grain Company, a New York corporation ("Continental Grain"), which
may deliver such Common Stock to a wholly owned subsidiary of ML & Co. (the "ML
& Co. Subsidiary"), pursuant to a forward purchase contract (the "Forward
Contract") among Continental Grain, ML & Co. and the ML & Co. Subsidiary. In
lieu of delivering shares of Common Stock, Continental Grain has the right to
satisfy its obligations under the Forward Contract by delivering cash with an
equal value. Such right, if exercised by Continental Grain, must be exercised
with respect to all shares of Common Stock deliverable pursuant to the Forward
Contract. The Company will not receive any of the proceeds from the sale of the
STRYPES or as a result of the distribution of the Common Stock in connection
therewith.
The STRYPES are offered by a separate prospectus of ML & Co. (the "STRYPES
Prospectus"). This Prospectus relates only to the Common Stock covered hereby
and does not relate to the STRYPES. THE COMPANY TAKES NO RESPONSIBILITY FOR ANY
INFORMATION INCLUDED IN OR OMITTED FROM THE STRYPES PROSPECTUS. THE STRYPES
PROSPECTUS DOES NOT CONSTITUTE A PART OF THIS PROSPECTUS, NOR IS IT INCORPORATED
BY REFERENCE HEREIN. Because the STRYPES are a separate security issued by ML &
Co. for which the Company has no responsibility, an investment in the STRYPES
may have materially different characteristics from a direct investment in the
Common Stock.
SEE "RISK FACTORS," BEGINNING ON PAGE 9 OF THIS PROSPECTUS, FOR A DISCUSSION
OF CERTAIN FACTORS RELEVANT TO AN INVESTMENT IN THE COMMON STOCK.
The Common Stock is traded on the New York Stock Exchange ("NYSE") under the
trading symbol "CFN." On , 1997, the last reported sale price of the
Common Stock on the NYSE was $ per share. See "Price Range of Common Stock."
-------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
-------------------
- -SM- Service mark of Merrill Lynch & Co., Inc.
The date of this Prospectus is , 1997.
<PAGE>
Certain persons participating in the offering of the STRYPES may engage in
transactions that stabilize, maintain, or otherwise affect the price of the
Common Stock. Such transactions may include stabilizing the purchase of STRYPES
to cover short positions. Such transactions may be effected on the NYSE, in the
over-the-counter market or otherwise. Stabilizing, if commenced, may be
discontinued at any time. For a description of these activities, see "Plan of
Distribution."
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Reports, proxy statements
and other information filed by the Company with the Commission can be inspected
and copied at the public reference facilities maintained by the Commission at
Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
Commission's regional offices located at Suite 1300, Seven World Trade Center,
New York, New York 10048, and Suite 1400, CitiCorp Center, 500 West Madison
Street, Chicago, Illinois 60661. Copies of such materials can be obtained from
the Public Reference Section of the Commission at Room 1024, 450 Fifth Street,
N.W., Washington, D.C. 20549, at prescribed rates and electronically through the
Commission's Electronic Data Gathering, Analysis and Retrieval System at the
Commission's web site (http:\\www.sec.gov). Such materials can also be inspected
at the New York Stock Exchange, 20 Broad Street, New York, New York 10005.
The Company has filed with the Commission a Registration Statement on Form
S-3 under the Securities Act of 1933, as amended (the "Securities Act"), with
respect to the Common Stock offered hereby. This Prospectus does not contain all
of the information set forth in the Registration Statement and the exhibits and
schedules thereto. For further information with respect to the Company and the
Common Stock, reference is hereby made to such Registration Statement and the
exhibits and schedules thereto. Statements contained in this Prospectus as to
the contents of any contract or other documents are not necessarily complete
and, in each instance, reference is made to the copy of such contract or
document filed as an exhibit to the Registration Statement, each such statement
being qualified in all respects by such reference. The Registration Statement,
including exhibits thereto, may be inspected and copied at the offices of the
Commission, or obtained at prescribed rates from the Public Reference Section of
the Commission, at the addresses set forth above.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The Company's Annual Report on Form 10-K for the fiscal year ended March 31,
1997 and the Company's Quarterly Report on Form 10-Q for the quarter ended June
30, 1997, filed with the Commission, are hereby incorporated by reference in
this Prospectus, and attached hereto as Annex A and Annex B, respectively,
except as superseded or modified herein.
All documents filed with the Commission pursuant to Section 13(a), 13(c), 14
or 15(d) of the Exchange Act, after the date of this Prospectus and prior to the
termination of the offering shall be deemed to be incorporated by reference into
this Prospectus and to be a part hereof from the date of filing of such
documents. Any statement contained in any document incorporated or deemed to be
incorporated by reference herein shall be deemed to be modified or superseded
for purposes of this Prospectus to the extent that a statement contained herein
or in any other subsequently filed document which also is or is deemed to be
incorporated by reference herein modifies or supersedes such statement. Any such
statement so modified or superseded shall not be deemed, except as modified or
superseded, to constitute a part of this Prospectus.
The Company will provide without charge to each person, including any
beneficial owner, to whom this Prospectus is delivered, upon written or oral
request of such person, a copy of any and all of the documents that have been or
may be incorporated by reference herein (other than exhibits to such documents
which are not specifically incorporated by reference into such documents). Such
requests should be directed to ContiFinancial Corporation, 277 Park Avenue, New
York, New York 10172, Attention: Chief Counsel or by telephone at (212)
207-2800.
2
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHOULD BE READ IN
CONJUNCTION WITH, THE MORE DETAILED INFORMATION AND FINANCIAL STATEMENTS
APPEARING ELSEWHERE IN THIS PROSPECTUS OR INCORPORATED HEREIN BY REFERENCE.
UNLESS THE CONTEXT INDICATES OTHERWISE, ALL REFERENCES IN THIS PROSPECTUS TO THE
COMPANY INCLUDE CONTIFINANCIAL CORPORATION AND ITS SUBSIDIARIES AND ALL
REFERENCES TO THE NUMBER OF SHARES OF COMMON STOCK AND PER SHARE AMOUNTS ASSUME
THAT OUTSTANDING EMPLOYEE AND DIRECTOR STOCK OPTIONS ARE NOT EXERCISED. FOR THE
DEFINITION OF CERTAIN CAPITALIZED TERMS USED IN THIS PROSPECTUS, SEE "GLOSSARY."
CERTAIN STATEMENTS IN THIS PROSPECTUS (INCLUDING THIS PROSPECTUS SUMMARY) MAY
CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995 (THE "REFORM ACT"). SEE "SPECIAL NOTE
REGARDING FORWARD-LOOKING STATEMENTS."
THE COMPANY
The Company engages in the consumer and commercial finance business by
originating and servicing primarily home equity loans and providing financing
and asset securitization structuring and placement services to originators of a
broad range of loans, leases, receivables and other assets. Securitization
provides significant benefits, including greater operating leverage and reduced
costs of funds, in the financing of assets such as non-conforming home equity
loans, equipment leases, home improvement loans, franchisee loans,
commercial/multi-family loans, non-prime and sub-prime auto loans and leases and
timeshare loans. For the three months ended June 30, 1997 and the year ended
March 31, 1997, the Company originated or purchased approximately $1.4 billion
and $3.9 billion, respectively, of home equity loans through its subsidiary,
ContiMortgage Corporation ("ContiMortgage"), and the Home Equity Companies
(defined below). During the three months ended June 30, 1997 and the year ended
March 31, 1997, the Company securitized or sold approximately $1.3 billion and
$3.6 billion, respectively, of home equity loans. For the same periods, the
Company securitized or sold approximately $200 million and $700 million,
respectively, of commercial real estate loans, and approximately $200 million
and $600 million, respectively, of other loans and assets for its Strategic
Alliance clients. In addition, during the three months ended June 30, 1997 and
the year ended March 31, 1997, the Company securitized or sold $45.9 million and
$43.5 million, respectively, of non-prime auto loans originated by its
subsidiary, Triad Financial Corporation ("Triad").
Through ContiMortgage and the Home Equity Companies, the Company is a
leading originator, purchaser, seller and servicer of home equity loans made to
borrowers whose borrowing needs may not be met by traditional financial
institutions due to credit exceptions or other factors. Loans are made to
borrowers primarily for debt consolidation, home improvements, education or
refinancing and are primarily secured by first mortgages on one- to four-family
residential properties. ContiMortgage is devoting substantial resources and
capital to: (i) increasing its market penetration across the United States; (ii)
expanding its broker loan network to complement its existing wholesale loan
network; (iii) adding new loan products, such as adjustable rate mortgages; (iv)
expanding and diversifying its origination sources; and (v) investing in
information services and collection technologies.
There are two distinct factors that drive the expansion of the Company's
home equity loan business-- growth in volume of loans and access to the capital
markets to facilitate the most efficient sale of these loans through
securitization. The Company believes it has a competitive advantage because the
management of ContiMortgage is able to focus exclusively on expanding the volume
of loans originated or purchased, enhancing loan underwriting efficiencies and
building its servicing portfolio, while relying upon the professional staff of
its subsidiaries, ContiTrade Services L.L.C. ("ContiTrade") and ContiFinancial
Services Corporation ("ContiFinancial Services") to focus exclusively on
providing warehouse financing, hedging and securitization structuring and
placement services. This specific industry expertise enables the Company to
minimize its financing costs and interest rate exposure and to maximize the
proceeds and profits from its securitizations and its growing servicing
portfolio. From April 1991 through June 30, 1997, ContiMortgage completed 28
AAA/Aaa-rated "real estate mortgage investment conduit" ("REMIC")
securitizations totalling approximately $8.8 billion. As of June 30, 1997,
ContiMortgage had a servicing portfolio of approximately $7.3 billion.
3
<PAGE>
During the year ended March 31, 1997, the Company moved towards achieving
its strategic objectives of expanding and diversifying its loan origination
methodology by acquiring three retail home equity loan originators. In November
1996, the Company purchased 100% of the outstanding stock of California Lending
Group, Inc. d/b/a United Lending Group ("ULG"), a West coast-based home equity
lender specializing in retail originations using direct mail and telemarketing
throughout the United States, and Royal Mortgage Partners, L.P., d/b/a Royal
MortgageBanc ("Royal"), a California-based wholesale and retail originator of
home equity loans. In December 1996, the Company purchased Resource One Consumer
Discount Company, Inc. ("Resource One"), a Pennsylvania-based home equity lender
specializing in retail origination through direct mail, television,
telemarketing, referrals and other sources to generate loan inquiries directly
from borrowers throughout the eastern and mid-western states. Collectively,
ContiMortgage, ContiWest (defined below), ULG, Royal and Resource One are
referred to as the "Home Equity Companies." In each case the companies acquired
were either former Strategic Alliance clients (as discussed below) or former
ContiMortgage loan origination sources.
As part of the Company's strategic growth plan, the Company determined that
the acquisition of originators and servicers of under-served asset classes other
than home equity loans would provide diversity. The Company's growth strategy is
to acquire only originators and servicers which operate in asset classes in
which the Company has significant securitization experience and which have
strong and experienced management. Consequently, in June 1997, the Company
purchased 35% of the common stock of GateCapital, L.L.C. ("GateCapital"), a
California-based commercial real estate lender, 33% of the common stock of First
Security Commercial Mortgage, L.P. ("First Security Mortgage"), a Midwest-based
commercial mortgage lender specializing in originations through retail, broker
and correspondent channels throughout the United States, and 49% of the common
stock of First Security Commercial Mortgage Servicing, L.L.C. ("First Security
Servicing", and together with First Security Mortgage, "First Security"), a
Midwest-based commercial mortgage servicer.
The Company, through ContiTrade, provides financing and asset securitization
structuring expertise, and, through ContiFinancial Services, provides placement
services. In this area, ContiTrade's management and execution of ContiMortgage's
financing, hedging and securitization needs has served as a model for the
Company's strategic alliances with originators of a broad range of consumer and
commercial loans and other assets ("Strategic Alliances"). The Company offers
Strategic Alliance clients complete balance sheet liability management,
including warehouse financing, interest rate hedging services and the
structuring and placement of asset portfolios in the form of asset-backed
securities. This allows the management of its Strategic Alliance clients to
focus on expanding and improving asset origination and servicing.
ContiFinancial Corporation is a Delaware corporation incorporated on
September 29, 1995. The principal executive offices of the Company are located
at 277 Park Avenue, New York, New York 10172 and its telephone number is (212)
207-2800.
BUSINESS STRATEGY
The Company's strategy is to continue its strong growth in the consumer and
commercial finance business through geographic expansion of its home equity loan
business, diversification of origination capabilities, Strategic Alliance
activities, selected acquisition opportunities ("Strategic Acquisitions") and
investments in origination, servicing and collection information systems and
technology. The Company seeks to become the most efficient low cost provider of
non-conforming home equity loans underwritten in accordance with sound criteria
which perform with excellent delinquency, default and loss experience relative
to the industry. Further, where prudent and appropriate, the Company will
diversify into business lines which are otherwise under-served by the market
presently and which can benefit from the lower cost of funds and the discipline
provided through securitization as well as from the Company's approach to growth
in originations, servicing and collections as successfully applied to
ContiMortgage.
The Company is implementing its home equity loan growth strategy through the
use of ContiMortgage as an origination, underwriting, servicing and sales
platform. ContiMortgage's centralized underwriting, servicing and collections
are utilized by ContiMortgage's regional offices as well as the Company's home
equity lending subsidiaries to channel home equity loan products from the
wholesale and small
4
<PAGE>
broker markets. Direct retail production through branch systems has been
implemented by the acquisition of Royal and Resource One which combined have 36
branch offices located throughout the west, the mid-west and the northeast
United States. ULG, another recent acquisition, originates home equity loans and
home improvement loans nationally through direct mail and telemarketing. The
full implementation of this growth strategy, through the completion of
additional Strategic Alliances and Strategic Acquisitions, will allow the
Company to build its market share by building a broad national penetration of
all origination channels of the home equity market in the United States.
The Company's strategy with respect to Strategic Alliance activities is to
replicate its success with ContiMortgage by: (i) targeting classes of consumer
and commercial loans, leases and receivables that have the potential to be
financed more efficiently through securitization; (ii) identifying and
establishing Strategic Alliances with originators of these assets that have
experienced management teams, sophisticated systems and a proven track record of
originating, underwriting, servicing and collecting consumer and commercial
loans, leases and receivables; and (iii) securing from these originators a
consistent flow of securitizable assets. The Company currently has 11 active
Strategic Alliances. In addition, the Company may, from time to time, make an
equity or subordinated debt investment in a Strategic Alliance client.
In addition to substantial loan, lease, and receivable originations from
Strategic Alliance clients, the Company originated approximately $1.2 billion in
commercial mortgage loans since fiscal 1995. The Company plans to expand its
market share in multi-family, healthcare, and self-storage facilities and
broaden its array of loan products in the commercial mortgage market sector.
As a key part of its growth strategy to diversify into asset classes that
can benefit from securitization, the Company has formed five Strategic Alliances
with originators of non-prime and sub-prime auto loans since fiscal 1995.
Management believes that this market benefits significantly from securitization
through reduced cost of funds, and the discipline which the regular
securitization process brings to the origination, underwriting, servicing, and
collection of auto loans and leases. Consequently, after closely monitoring the
performance and development of its Strategic Alliances in this industry, the
Company has acquired 56.0% of the outstanding common stock of Triad, a former
Strategic Alliance client. The Company's strategy is to apply to Triad the same
disciplined approach to underwriting, credit grading, servicing and collections
as has been applied to ContiMortgage. The Company believes that its strategy
with respect to Triad, combined with prudent growth, will create a significant
market presence in the non-prime automobile finance industry.
The Company's strategy with respect to Strategic Acquisitions is an
extension of its Strategic Alliance strategy, which the Company believes
provides it with a unique capability to analyze and select acquisition
opportunities. Specifically, the Company has targeted the acquisition of
companies with which it has significant experience as either a Strategic
Alliance or as a broker/loan originator which has been selling home equity loans
to ContiMortgage and which will enhance the Company's geographic diversification
or method of origination. This focused approach on existing relationships, using
considerable static pool data and analysis (loan characteristics, demographics,
delinquencies, losses and prepayments), allows the Company to better judge: (i)
the management team; (ii) the quality of the origination and underwriting; (iii)
the ability to pass rating agency and/or financial guarantor scrutiny; and (iv)
product consistency. The Company has sought to align itself with management
teams which have consistently delivered product and which have demonstrated
performance histories consistent with the Company's emphasis on quality
originations rather than volume.
The Strategic Acquisitions are deliberately structured to motivate the
respective management teams to achieve goals consistent with those of the
Company, with an emphasis on operating efficiencies and immediate accretion to
earnings per share. The Company's Strategic Acquisitions to date have all
included the following characteristics: (i) a purchase price providing for a
modest upfront payment; (ii) subsequent installments based upon profit
performance (i.e., net income, not volume); and (iii) management long-term
incentives with attractive upside if successful in achieving agreed upon goals.
5
<PAGE>
THE OFFERING
This Prospectus relates to 2,800,000 shares of Common Stock which may be
delivered by ML & Co. upon payment and discharge of the STRYPES at maturity,
subject to ML & Co.'s right to deliver an amount in cash with an equal value. ML
& Co. has granted the Underwriter of the STRYPES an option for 30 days to
purchase additional STRYPES, solely to cover over-allotments, if any. Such
additional STRYPES may be paid and discharged by ML & Co. at their maturity by
delivery of up to an additional 420,000 shares of Common Stock to which this
Prospectus also relates.
All of the shares of Common Stock covered hereby are beneficially owned by
Continental Grain, which may deliver such Common Stock to the ML & Co.
Subsidiary pursuant to the Forward Contract. The Company will not receive any of
the proceeds from the sale of the STRYPES or as a result of the distribution of
such Common Stock.
The STRYPES are offered only by the STRYPES Prospectus. This Prospectus
relates only to the Common Stock covered hereby and does not relate to the
STRYPES. THE COMPANY TAKES NO RESPONSIBILITY FOR ANY INFORMATION INCLUDED IN OR
OMITTED FROM THE STRYPES PROSPECTUS. THE STRYPES PROSPECTUS DOES NOT CONSTITUTE
A PART OF THIS PROSPECTUS, NOR IS IT INCORPORATED BY REFERENCE HEREIN. Because
the STRYPES are a separate security issued by ML & Co., for which the Company
has no responsibility, an investment in the STRYPES may have materially
different characteristics from an investment in the Common Stock.
RELATIONSHIP WITH CONTINENTAL GRAIN
Prior to the Company's initial public offering of 7,130,000 shares of its
Common Stock on February 14, 1996 (the "IPO"), the Company was a wholly owned
subsidiary of Continental Grain. Continental Grain is a privately held,
multinational agribusiness company.
Continental Grain currently owns approximately 75% of the Company's
outstanding Common Stock. Upon subsequent satisfaction of the Forward Contract,
assuming Continental Grain delivers to the ML & Co. Subsidiary the maximum
number of shares of Common Stock subject thereto, Continental Grain would own
approximately 70% of the outstanding Common Stock (or approximately 69% of the
outstanding Common Stock if the over-allotment option granted to the Underwriter
of the STRYPES is exercised in full).
As a result of its ownership interest, Continental Grain has voting control
on all matters submitted to stockholders, including the election of directors
and the approval of extraordinary corporate transactions. Except to the extent
that Continental Grain may deliver shares of Common Stock to satisfy its
obligations under the Forward Contract, Continental Grain has advised the
Company that its current intention is to continue to hold all of the shares of
Common Stock beneficially owned by it. However, there can be no assurance that
Continental Grain will not sell all or a portion of its holdings at some future
date.
RISK FACTORS
Prior to making an investment decision, prospective investors should
carefully consider all the information set forth in this Prospectus and, in
particular, should evaluate the factors set forth in "Risk Factors."
6
<PAGE>
SUMMARY FINANCIAL INFORMATION
(DOLLAR AMOUNTS EXPRESSED IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS
THREE MONTHS ENDED ENDED
JUNE 30, MARCH 31,
------------------------- ----------
<S> <C> <C> <C>
1997 1996 1997
---------- ---------- ----------
INCOME STATEMENT DATA:
Gross income:
Gain on sale of receivables........... $ 64,340 $ 31,166 $ 210,861
Interest.............................. 49,679 28,515 161,402
Net servicing income.................. 15,973 9,073 46,340
Other income (loss)................... 4,031 1,009 9,227
---------- ---------- ----------
Total gross income.................. 134,023 69,763 427,830
---------- ---------- ----------
Expenses:
Compensation and benefits............. 30,234 12,408 82,170
Interest.............................. 35,863 19,662 120,636
Provision for loan losses............. 1,311 219 3,043
General and administrative............ 21,070 4,779 44,940
---------- ---------- ----------
Total expenses...................... 88,478 37,068 250,789
---------- ---------- ----------
Income before income tax expense and
minority interest....................... 45,545 32,695 177,041
Income tax expense........................ 18,641 13,262 71,341
Minority interest of subsidiary........... 31 -- (304)
---------- ---------- ----------
Net income................................ $ 26,873 $ 19,433 $ 106,004
---------- ---------- ----------
---------- ---------- ----------
Primary and fully dilutive earnings per
common share (pro forma at March 31,
1996 only).............................. $ 0.59 $ 0.44 $ 2.40
<CAPTION>
<S> <C> <C> <C> <C>
1996 1995 1994 1993
---------- ---------- ---------- ----------
INCOME STATEMENT DATA:
Gross income:
Gain on sale of receivables........... $ 146,529 $ 67,512 $ 49,671 $ 18,587
Interest.............................. 91,737 42,929 20,707 11,385
Net servicing income.................. 29,298 9,304 3,989 1,842
Other income (loss)................... 4,252 2,252 162 (147)
---------- ---------- ---------- ----------
Total gross income.................. 271,816 121,997 74,529 31,667
---------- ---------- ---------- ----------
Expenses:
Compensation and benefits............. 52,203 23,812 14,674 6,870
Interest.............................. 74,770 29,635 12,124 6,529
Provision for loan losses............. 285 1,935 4,499 2,018
General and administrative............ 18,022 9,627 7,946 4,101
---------- ---------- ---------- ----------
Total expenses...................... 145,280 65,009 39,243 19,518
---------- ---------- ---------- ----------
Income before income tax expense and
minority interest....................... 126,536 56,988 35,286 12,149
Income tax expense........................ 49,096 22,168 13,726 4,640
Minority interest of subsidiary........... 3,310 8,728 5,076 1,600
---------- ---------- ---------- ----------
Net income................................ $ 74,130 $ 26,092 $ 16,484 $ 5,909
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Primary and fully dilutive earnings per
common share (pro forma at March 31,
1996 only).............................. $ 2.00
</TABLE>
<TABLE>
<CAPTION>
AS OF JUNE 30,
-------------------- AS OF MARCH 31,
1997 1996 1997
--------- --------- ---------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Excess spread receivables (interest-only and residual certificates).... $ 516,707 $ 223,802 $ 445,005
Receivables held for sale.............................................. 695,045 364,159 625,545
Total assets........................................................... 2,106,534 891,672 1,545,798
Long-term debt......................................................... 498,823 -- 498,817
Total liabilities...................................................... 1,566,480 575,864 1,136,726
Minority interest of subsidiary........................................ 1,319 -- 1,288
Stockholders' equity................................................... 538,735 315,808 407,784
</TABLE>
<TABLE>
<CAPTION>
YEARS
THREE MONTHS ENDED ENDED
JUNE 30, MARCH 31,
------------------------- ----------
<S> <C> <C> <C>
1997 1996 1997
---------- ---------- ----------
OPERATING DATA:
Face value of home equity loans serviced
(at period end)....................... $7,269,361 $4,256,948 $6,423,376
Home equity loan originations........... 1,392,231 678,128 3,906,798
Securitization and sales volume:
ContiMortgage and ContiWest......... $1,265,000 $ 692,954 $3,642,554
Commercial real estate.............. 158,816 193,916 742,259
Triad............................... 45,881 -- 43,530
Strategic alliances................. 174,200 106,559 568,401
---------- ---------- ----------
Total securitization and sales
volume.......................... $1,643,897 $ 993,429 $4,996,744
---------- ---------- ----------
---------- ---------- ----------
LOAN LOSS DATA (A):
Delinquency rate (at period end) (b).... 3.68% 4.05% 3.24%
Default rate (at period end) (c)........ 5.05% 3.98% 4.70%
Net losses as a percentage of average
amount outstanding.................... 0.07%(d) 0.05%(d) 0.26%
<CAPTION>
<S> <C> <C> <C> <C>
1996 1995 1994 1993
---------- ---------- ---------- ----------
OPERATING DATA:
Face value of home equity loans serviced
(at period end)....................... $3,863,575 $2,192,190 $1,105,393 $ 484,857
Home equity loan originations........... 2,311,471 1,328,158 786,754 282,072
Securitization and sales volume:
ContiMortgage and ContiWest......... $2,030,270 $1,292,691 $ 772,324 $ 272,544
Commercial real estate.............. 185,980 89,000 -- --
Triad............................... -- -- -- --
Strategic alliances................. 1,776,700 906,000 418,000 426,000
---------- ---------- ---------- ----------
Total securitization and sales
volume.......................... $3,992,950 $2,287,691 $1,190,324 $ 698,544
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
LOAN LOSS DATA (A):
Delinquency rate (at period end) (b).... 2.51% 1.64% 0.97% 1.20%
Default rate (at period end) (c)........ 3.54% 1.16% 0.81% 1.70%
Net losses as a percentage of average
amount outstanding.................... 0.13% 0.08% 0.15% 0.26%
</TABLE>
(FOOTNOTES ON FOLLOWING PAGE)
7
<PAGE>
- ------------------------------
(a) Loan loss data represents data for the home equity loan servicing portfolio
of ContiMortgage only. See "Business--Home Equity Loan Origination and
Servicing" in the Company's Annual Report on Form 10-K for the fiscal year
ended March 31, 1997, incorporated herein by reference and attached hereto
as Annex A.
(b) The delinquency percentage represents, as a percentage of the aggregate
principal balance of loans in ContiMortgage's servicing portfolio as of the
relevant date, the outstanding principal balance of home equity loans for
which payments are contractually past due, exclusive of home equity loans in
foreclosure, bankruptcy, real estate owned or forbearance.
(c) The default percentage represents, as a percentage of the aggregate
principal balance of loans in the Company's portfolio as of the relevant
date, the dollar value of delinquent payments on home equity loans in
foreclosure, bankruptcy, real estate owned or forbearance.
(d) This percentage is based on data for the three months ended June 30, 1997
and 1996 and is not necessarily indicative of an annualized percentage.
8
<PAGE>
RISK FACTORS
PRIOR TO MAKING AN INVESTMENT DECISION, PROSPECTIVE INVESTORS SHOULD
CAREFULLY CONSIDER ALL INFORMATION SET FORTH IN THIS PROSPECTUS AND, IN
PARTICULAR, SHOULD EVALUATE THE FACTORS DESCRIBED BELOW.
ECONOMIC CONDITIONS
GENERAL
The risks associated with the Company's business become more acute in any
economic slowdown or recession. Periods of economic slowdown or recession may be
accompanied by decreased demand for consumer and commercial credit and declining
real estate and other asset values. In the mortgage business, 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 loans
previously made by the Company, thereby weakening collateral coverage and
increasing the possibility of a loss in the event of a default. Delinquencies,
foreclosures and losses generally increase during economic slowdowns or
recessions. Because of the Company's focus on credit-impaired borrowers in the
home equity loan market and certain other markets, the actual rates of
delinquencies, foreclosures and losses on such loans could be higher under
adverse economic conditions than those experienced in such markets in general.
In addition, in an economic slowdown or recession, the Company's servicing costs
will increase. Any sustained period of increased delinquencies, foreclosures,
losses or increased costs could adversely affect the Company's ability to sell
loans or other assets through securitization and could increase the cost of
selling loans or other assets through securitization, which could adversely
affect the Company's financial condition and results of operations.
INTEREST RATES
Profitability may be directly affected by the level of and fluctuations in
interest rates which affect the Company's ability to earn a spread between
interest received on its loans and the costs of its liabilities. While the
Company monitors the interest rate environment and employs a hedging strategy
designed to mitigate the impact of changes in interest rates, there can be no
assurance that the profitability of the Company would not be adversely affected
during any period of changes in interest rates. During periods of increasing
interest rates, the Company generally experiences market pressure to reduce
servicing spreads. In addition, an increase in interest rates may decrease the
demand for consumer or commercial credit. A substantial and sustained increase
in interest rates could, among other things: (i) adversely affect the ability of
the Company to purchase or originate loans or other assets; (ii) reduce the
average size of loans underwritten by the Company; and (iii) reduce the gains
recognized by the Company upon their securitization and sale. A decline in
interest rates could decrease the size of the Company's loan servicing portfolio
by increasing the level of loan prepayments, thereby shortening the life and
impairing the value of the Excess Spread Receivable (defined below). Fluctuating
interest rates also may affect the net interest income earned by the Company
resulting from the difference between the yield to the Company on loans held
pending sale and the cost of funds obtained by the Company to finance such
loans. In addition, inverse or flattened interest yield curves could have an
adverse impact on the profitability of the Company because the loans or assets
pooled and sold by the Company are priced based on long-term interest rates
while the senior interests in the related REMIC, owner trust or grantor trust
are priced on the basis of intermediate term United States Treasury rates.
NEGATIVE CASHFLOWS AND CAPITAL NEEDS
In a securitization, the Company recognizes a gain on sale for the loans or
assets securitized upon the closing of the securitization, but does not receive
the cash representing such gain until it receives the Excess Spread (defined
below), which is payable over the actual life of the loan or other assets
securitized. The Company incurs significant expenses in connection with a
securitization and incurs both current and
9
<PAGE>
deferred tax liabilities as a result of the gain on sale. Net cash used in
operating activities for the three months ended June 30, 1997 and fiscal 1997,
1996 and 1995 was $109.2 million, $153.2 million, $300.5 million and $35.3
million, respectively. Therefore, the Company requires continued access to
short- and long-term external sources of cash to fund its operations.
The Company has operated, and expects to continue to operate, on the
negative cash flow basis described above, which is expected to increase as the
volume of the Company's loan and asset purchases and originations increases and
its securitization program grows. The Company's primary cash requirements are
expected to include the funding of: (i) mortgage, loan and lease originations
and purchases pending their pooling and sale; (ii) the points and other expenses
paid in connection with the acquisition of wholesale loans; (iii) fees and
expenses incurred in connection with its securitization program; (iv)
overcollateralization or reserve account requirements in connection with loans
and leases pooled and sold; (v) ongoing administrative and other operating
expenses; (vi) payments related to its tax obligations; (vii) interest and
principal payments under the Senior Notes (defined below) and the Credit
Facility (defined below) and the costs of the Company's Purchase and Sale
Facilities and the Repurchase Agreement; and (viii) Strategic Acquisitions and
investments in Strategic Alliance clients. The Company's primary sources of
liquidity in the future are expected to be existing cash, sales of the loans,
leases and other assets through securitization, the sale of loans under the
Purchase and Sale Facilities and the Repurchase Agreement, the sale of Excess
Spread Receivables, cash servicing income, net interest income, draws under the
Credit Facility and further issuances of debt (subject to the covenants of the
Company's existing debt). See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
In anticipation of growth in the Company's future operations, additional
financing sources will be required. The Company currently has commitments for
financing through the Credit Facility however, there can be no assurance that
the Company will be successful in consummating additional financing transactions
in the future on terms that the Company would consider to be favorable.
Furthermore, no assurance can be given that Continental Grain will provide any
financing if the Company is unable to obtain third party financing or that the
terms of the Continental Grain Debt Agreements (defined below) will permit the
Company to obtain such financing.
DEPENDENCE ON SECURITIZATION PROGRAM
Since 1991, the Company has pooled and sold substantially all loans or other
assets which it originates or purchases through securitization. Accordingly,
adverse changes in the securitization market could impair the Company's ability
to originate, purchase and sell loans or other assets on a favorable or timely
basis. Any such impairment could have a material adverse effect upon the
Company's business and results of operations. 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. Finally, any delay in the sale of a loan or other asset pool
would postpone the recognition of gain on such loans until their sale. Such
delays could cause the Company's earnings to fluctuate from quarter to quarter.
In addition, in order to gain access to the securitization market for home
equity loans and certain other classes of assets, the Company has primarily
relied on four monoline insurance companies to provide guarantees on outstanding
senior interests in the related REMIC, owner trust or grantor trust to enable it
to obtain an AAA/Aaa rating for such interests. An unwillingness of the monoline
insurance companies to guarantee the senior interests in the Company's home
equity loan or other asset pools could have a material adverse effect on the
Company's financial position and results of operations.
10
<PAGE>
DEPENDENCE ON PURCHASE AND SALE FACILITIES AND THE REPURCHASE AGREEMENT
In order to fund new loan and asset originations and purchases, the Company
is dependent upon its ability to sell loans and other assets through its
subsidiaries under the Purchase and Sale Facilities and the Repurchase Agreement
(defined below) with certain financial institutions. The "Purchase and Sale
Facilities" allow the Company to sell, with limited recourse, interests in
designated pools of loans and other assets, subject to various repurchase
options. A portion of the purchase price for any assets (up to 10%) is generally
deposited into an account held by the financial institution on behalf of the
Company, against which the financial institution may set off any losses incurred
in the resale of such assets. Unless waived, each Purchase and Sale Facility
will terminate upon the occurrence of certain events, which include: (i) failure
of the Company to perform under the terms and covenants of the Purchase and Sale
Facility (including payment obligations), to make true representations and
warranties regarding the assets sold and certain other matters, to make material
scheduled payments under all indebtedness or to perform under any other
agreement with the financial institution; (ii) any material adverse change in
the financial condition of the Company; and (iii) certain bankruptcy events of
the Company. The Company has guaranteed its subsidiaries' obligations under the
Purchase and Sale Facilities.
On March 31, 1997, the Company entered into a funding agreement under an
agreement to repurchase (the "Repurchase Agreement"). The Repurchase Agreement
allows the Company to sell receivables held for sale to a financial institution
under an agreement that the Company will repurchase the asset, generally within
30 to 90 days. This agreement has a one year renewable term which expires
January 1998.
As of June 30, 1997, the Company had $2.6 billion of committed and an
additional $1.1 billion of uncommitted capacity under the Purchase and Sale
Facilities and the Repurchase Agreement and had utilized $1.0 billion of such
capacity. The Company utilized the Purchase and Sale Facilities and the
Repurchase Agreement to sell and repurchase assets totaling $2.6 billion, $7.4
billion, $5.7 billion and $2.5 billion in the three months ended June 30, 1997
and fiscal 1997, 1996, and 1995, respectively. The Company's need for capacity
under the Purchase and Sale Facilities and the Repurchase Agreement or from
other third party financing will increase as its volume of loan origination and
purchasing grows.
Although the Company expects to be able to obtain replacement financing or
asset purchase commitments when the Company's current Purchase and Sale
Facilities and the Repurchase Agreement expire or additional financing or asset
purchase commitments when such agreements become fully utilized, there can be no
assurance that such financing will be obtainable on as favorable terms, if at
all. To the extent that the Company is unable to arrange any third party or
other financing, the Company's loan origination and purchasing activities would
be adversely affected, which could have a material adverse effect on the
Company's operations, financial results and cash position.
EFFECT OF CERTAIN DEBT OBLIGATIONS ON THE COMPANY
EFFECT OF THE NOTES
In August 1996, the Company issued $300 million aggregate principal amount
of 8 3/8% Senior Notes, due 2003 (the "8 3/8% Senior Notes"), and, in March
1997, the Company issued $200 million aggregate principal amount of 7 1/2%
Senior Notes, due 2002 (the "7 1/2% Senior Notes," and together with the 8 3/8
Senior Notes, the "Senior Notes"). The indentures pursuant to which the Senior
Notes were issued (the "Indentures") place certain restrictions on the Company
which may limit the Company's operating flexibility. Such restrictions include
the following: (i) limitations on indebtedness; (ii) limitations on liens; (iii)
limitations on restricted payments such as dividends, repurchases of the
Company's stock and repurchase of subordinated obligations and minority
investments; (iv) limitations on restrictions on distributions from
subsidiaries; (v) limitations on sales of assets and subsidiary stock; and (vi)
limitations on merger and consolidation. Upon receiving investment grade ratings
from Moody's Investors Service, Inc. and Standard & Poor's Ratings Services with
respect to the Senior Notes, all restrictions described
11
<PAGE>
above, other than the limitations on liens, will be suspended. No assurance can
be given that the Senior Notes will receive investment grade ratings at any time
in the future.
In addition, upon a "change of control," the holders of the Senior Notes may
cause the Company to repurchase the Senior Notes. A "change of control" as
defined in the Indentures includes the occurrence of: (i) the acquisition of 35%
of the outstanding Common Stock by a person other than Continental Grain or its
shareholders at a time when Continental Grain or its shareholders own less than
such amount owned by such greater than 35% shareholder; (ii) a change in the
composition of a majority of the Board of Directors during any two consecutive
years; and (iii) certain mergers and consolidations or sale of all or
substantially all of the assets of the Company.
The occurrence of an event of default under the Indentures or a "change of
control" could have a material adverse effect upon the Company. See "Description
of Certain Indebtedness and Financing Arrangements."
EFFECT OF CREDIT FACILITY
The Company's $200 million unsecured revolving credit facility (the "Credit
Facility") contains a number of restrictive covenants including: (i) limitations
on indebtedness; (ii) limitations on liens; (iii) minimum net worth
requirements; (iv) limitations on restrictions on distributions from
subsidiaries; (v) limitations on sales of assets and subsidiary stock; and (vi)
limitations on merger and consolidations. The Credit Facility also includes a
monthly asset coverage test to determine availability under the Credit Facility.
Currently the Company has full use of the Credit Facility based on this test.
See "Description of Certain Indebtedness and Financing Arrangements."
EFFECT OF CONTINENTAL GRAIN'S DEBT AGREEMENTS
Continental Grain's debt agreements with its lenders and certain guarantees
provided by Continental Grain for the benefit of the Company (the "Continental
Grain Debt Agreements") place certain restrictions on Continental Grain and the
Company which will limit the Company's operating flexibility. Certain of the
Continental Grain Debt Agreements require the consent of the lenders in
connection with any equity financing by the Company. In order to comply with the
other financial covenants applicable to Continental Grain and its subsidiaries
under the Continental Grain Debt Agreements, Continental Grain will place
limitations upon the Company's ability to incur debt, to sell its assets, to
incur liens, to make acquisitions, investments and capital expenditures, to
incur off-balance sheet contingent obligations, to reduce its working capital,
to pay dividends and to otherwise expand the Company's business in a manner that
would be possible in the absence of such restrictions. The presence of such
financial covenants in the Continental Grain Debt Agreements could present
situations involving potential conflicts of interest for those members of the
board of directors of the Company who also owe fiduciary duties to Continental
Grain by virtue of their positions as officers or directors of Continental
Grain. There can be no assurance that such conflicts of interest will be
resolved in favor of the Company. Although it is Continental Grain's intention
to seek to exclude the Company from the application of all or many of the
covenants of Continental Grain's future debt agreements, there can be no
assurance that the future debt agreements of Continental Grain will not continue
to impose substantial limitations upon the Company.
EXCESS SPREAD RECEIVABLES
As a fundamental part of its business and financing strategy, the Company
sells substantially all of its loans or other assets through securitization. In
a securitization, the Company sells loans or other assets that it has originated
or purchased to a trust for a cash purchase price and an interest in the loans
or other assets securitized in the form of the Excess Spread. The cash purchase
price is raised through an offering of pass-through certificates by the trust.
Following the securitization, the purchasers of the pass-through certificates
receive the principal collected and the investor pass-through interest rate on
the certificate
12
<PAGE>
balance, while the Company receives the Excess Spread. The Excess Spread
generally represents, over the life of the loans or other assets, the excess of
the weighted average coupon on each pool of loans or other assets sold over the
sum of the pass-through interest rate plus a normal servicing fee, a trustee
fee, an insurance fee and an estimate of annual future credit losses related to
the loans or other assets securitized.
The primary component of the Company's gross income is recognized as gain on
sale of loans or other assets, which represents the present value of the Excess
Spread, less origination and underwriting costs. The present value of the Excess
Spread is the Excess Spread receivable (the "Excess Spread Receivable"). The
Company recognizes the gain on sale of loans or other assets in the fiscal year
in which such loans or other assets are sold, although cash (representing the
Excess Spread and servicing fees) is received by the Company over the life of
the loans or other assets. Concurrent with recognizing such gain on sale, the
Company records the Excess Spread Receivable as an asset on its consolidated
balance sheet.
In 1994, the Company adopted Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115"), which requires fair value accounting for these
securities. In accordance with the provisions of SFAS 115, the Company
classifies subordinated classes of REMICs, owner trusts and grantor trusts as
"trading securities" and, as such, they are recorded at fair value with the
resultant unrealized gain or loss recorded in the results of operations in the
period of the change in fair value. The Company determines fair value on a
quarterly basis based on a discounted cash flow analysis. The cash flows are
estimated as the excess of the weighted average coupon on each pool of consumer
and commercial loans, leases and receivables (collectively, the "Receivables")
sold over the sum of the pass-through interest rates plus a normal servicing
fee, a trustee fee, an insurance fee and an estimate of annual future credit
losses related to the Receivables securitized, over the life of the Receivables.
These cash flows are projected over the life of the Receivables using
prepayment, default, and interest rate assumptions that the Company believes
market participants would use for similar financial instruments subject to
prepayment, credit and interest rate risk and are discounted using an interest
rate that the Company believes a purchaser unrelated to the seller of such a
financial instrument would demand. Higher than anticipated rates of loan
prepayments or credit losses on the loans or other assets underlying the Excess
Spread Receivables would require the Company to write down the value of the
Excess Spread Receivables, which could have a material adverse impact on the
Company's financial position and results of operations.
At June 30, 1997, the Company's consolidated balance sheet reflected Excess
Spread Receivables of $516.7 million. While the Company has consummated
contingent recourse sales of Excess Spread Receivables from time to time, there
is no liquid market for such Excess Spread Receivables. In fiscal 1995, the
Company, through its subsidiaries, began to sell certain Excess Spread
Receivables. In connection with such sales, the Company retains negotiated
levels of recourse obligations in the event the purchaser does not realize
expected cash flows from the Excess Spread Receivables that have been sold.
Continental Grain has guaranteed, for a fee, the Company's performance
obligations under such sales, but is under no obligation to provide such
guarantees for future transactions. If Continental Grain does not provide such
guarantees in the future, the Company's ability to raise cash by entering into
future sales of its Excess Spread Receivables with retained recourse could be
impaired. The Company's recourse obligations under the sales transactions could
result in losses in the event cash flow from the Excess Spread Receivables that
have been sold is significantly less than was anticipated at the time of the
related sale. The Company, as well as Continental Grain, has guaranteed its
subsidiaries' performance obligations under each such sale. There were no cash
proceeds from such sales for the three months ended June 30, 1997, and the cash
proceeds from such sales in fiscal 1997 and 1996 aggregated $96.5 million and
$54.5 million, respectively. Of the Company's $516.7 million of Excess Spread
Receivables at June 30, 1997, $104.5 million represented the fair value of
subordinated retained interests in Excess Spread Receivables which the Company
sold pursuant to contingent recourse sales. Since subordinated retained
interests are designed to absorb changes in both the residual interest and the
recourse sale amount, their value may be more adversely impacted than unsold
Excess Spread Receivables under certain circumstances.
13
<PAGE>
In addition, for the three months ended June 30, 1997 and for fiscal years
1997, 1996 and 1995, the Company sold without recourse $13.3 million, $70.0
million, $53.5 million and $26.3 million, respectively, of interest-only
certificates which the Company generated from its securitization activities.
These sales represent an important source of liquidity for the Company. Any
impairment of the Company's ability to sell these interest-only certificates
would require the Company to obtain the liquidity from other sources and thus
could have a materially adverse impact on the Company's financial position or
results of operations.
Although the Company intends to continue to pursue opportunities to sell
Excess Spread Receivables, no assurance can be given that such opportunities
will be available in the future or that all or any portion of Excess Spread
Receivables could in fact be sold at their stated value on the balance sheet, if
at all. The Indentures, the Credit Facility, and the Continental Grain Debt
Agreements place certain limitations on the Company's ability to incur
indebtedness secured by its Excess Spread Receivables. Although the Company may
seek in the future to negotiate such financing within the terms of such
limitations, there can be no assurance that the Company will be able to identify
sources of such financing or whether the terms of any such financing, if
available, would be on terms the Company would consider favorable.
FINANCING EXCESS SPREAD RECEIVABLES FOR STRATEGIC ALLIANCE CLIENTS
The Company finances the Excess Spread Receivables of certain Strategic
Alliance clients through loans secured by such Excess Spread Receivables or by a
pledge of the stock of the special purpose corporation holding such Excess
Spread Receivables. In a similar manner, the Company also finances the related
Excess Spread, subsequent to the related securitization, of certain Strategic
Alliance clients. As of June 30, 1997 and March 31, 1997, the total committed
amount of such financings was $54.1 million and $64.1 million, respectively, and
the amount outstanding in connection with such financings was $39.5 million and
$35.6 million, respectively. The financed Excess Spread Receivables are
generated through securitizations of home equity and home improvement loans.
While all financed Excess Spread Receivables were issued in securitizations
which yielded securities rated investment grade by nationally recognized
statistical rating organizations, and all are financed at a discount to fair
value determined after application of discounts for expected loss, prepayment
and interest rate factors, the Strategic Alliance clients are often companies
with limited operating histories and capital and have not been rated or have a
non-investment grade credit rating. The value of the financed Excess Spread
Receivables or Excess Spread is dependent on, among other things, the ability of
the Strategic Alliance client to service its securitized assets in accordance
with the specifications of the related pooling and servicing agreements. If a
Strategic Alliance client was unable to meet its obligations under the pooling
and servicing agreement pertaining to the financed Excess Spread Receivables,
the value of such Excess Spread Receivables could decline to less than the
amount of the loan it secures. In such cases, the Company would suffer losses.
COMPETITION
The home equity loan market is highly competitive. The Company faces
competition from other consumer finance lenders, mortgage lenders, mortgage
brokers, commercial banks, mortgage banks, large securities firms, smaller
boutique securities firms, credit unions, thrift institutions, credit card
issuers and finance companies. Many of these competitors are substantially
larger and have more capital and other resources than the Company. Competition
can take many forms, including convenience in obtaining a loan, customer
service, marketing and distribution channels, terms provided and interest rates
charged to borrowers. Heightened competition could contribute to higher
prepayments. In addition, the current level of gains realized by the Company and
its competitors on the sale of their home equity loans could attract additional
competitors into this market with the possible effect of lowering gains that may
be realized on the Company's future loan sales.
For the three months ended June 30, 1997, 84% of the total home equity loans
purchased and originated by ContiMortgage and the Home Equity Companies were
wholesale loans. Although the
14
<PAGE>
Company has recently diversified its origination capabilities with the
acquisition of home equity companies with retail capabilities, wholesale loans
are expected to remain a significant part of the Company's home equity loan
production program. As a purchaser of wholesale loans, the Company is exposed to
fluctuations in the volume and cost of wholesale loans resulting from
competition from other purchasers of such loans, market conditions and other
factors.
CONTINGENT RISKS
Although the Company sells substantially all loans or other assets which it
originates or purchases, the Company retains some degree of risk on
substantially all loans or other assets sold. During the period of time that
loans or other assets are held pending sale, the Company is subject to the
various business risks associated with the lending business including the risk
of borrower default, the risk of foreclosure and the risk that an increase in
interest rates would result in a decline in the value of loans or other assets.
The Company continues to be subject to the risks of default and foreclosure
following the sale of the loans or other assets through securitization to the
extent that actual losses exceed the loss assumption made by the Company in
valuing the Excess Spread received from its securitizations. The documents
governing the Company's securitization program require (i) the Company to
establish deposit accounts or (ii) the related trust to build
overcollateralization levels by retaining Excess Spread distributions or
applying Excess Spread distributions to reduce the principal balances of the
senior interests issued by the trust. These actions serve as credit enhancement
for the related trust and are therefore available to fund losses realized on
loans or other assets held by such trust. At June 30, 1997, credit-enhancement
amounts (in the form of deposit accounts and overcollateralization levels)
aggregated approximately $177.8 million. In addition, documents governing the
Company's securitization programs require the Company to commit to repurchase or
replace loans or other assets which do not conform to the representations and
warranties made by the Company at the time of sale. When borrowers are
delinquent in making monthly payments on loans included in a REMIC, owner trust
or grantor trust, the Company is required, if it is the servicer of such loans,
to advance amounts equal to the delinquent interest on such loans to the extent
that the Company deems such advances ultimately recoverable. These advances may
require funding from the Company's capital resources but have priority of
repayment out of the trust from the succeeding month's payments on loans in the
trust. The Company also has contingent risk with respect to financing through
its Purchase and Sale Facilities and the sale of Excess Spread Receivables. See
"--Negative Cashflows and Capital Needs-- Dependence on Purchase and Sale
Facilities" and "--Excess Spread Receivables."
CONCENTRATION OF OPERATIONS
For the three months ended June 30, 1997, approximately 39% (by dollar
volume) of the home equity loans originated by the Company were secured by
properties located in six states (Michigan, Ohio, Illinois, New York, New Jersey
and Pennsylvania). Although the Company has expanded its mortgage origination
network outside these states, the Company's origination business is likely to
remain concentrated in these states for the near future. In addition, a
substantial majority of the loans in the existing securitization pools are
secured by properties located in these states. Consequently, the Company's
results of operations and financial condition are dependent upon general trends
in the economy and the residential real estate market in these states.
RIGHT TO TERMINATE SERVICING
At June 30, 1997 and March 31, 1997, approximately 86% and 84% (by dollar
volume), respectively, of the Company's servicing portfolio consisted of loans
securitized by the Company and sold to REMICs. The Company's form of pooling and
servicing agreement for each of these trusts provides that the monoline
insurance company insuring the senior interests in the related REMIC may
terminate the Company's servicing rights if, among other things, the number of
loans included in the REMIC which are delinquent for 90 days or more (including
properties acquired upon foreclosure and not sold) exceeds 10% of the
15
<PAGE>
aggregate number of the loans included in such trust in four consecutive months.
As of June 30, 1997, the delinquency rates with respect to five of the Company's
28 sponsored pools had exceeded this rate, and although there can be no
assurance that the Company will not have its servicing rights terminated, the
Company presently does not expect such a termination will occur. There can be no
assurance that delinquency rates with respect to other Company-sponsored pools
will not exceed this rate in the future or, if exceeded, that the servicing
rights would not be terminated.
ENVIRONMENTAL LIABILITIES
In the course of its business, the Company has acquired, and may in the
future acquire, properties securing loans that are in default. There is a risk
that hazardous substances or waste, contaminants, pollutants or source thereof
could be discovered on such properties after acquisition by the Company. In such
event, the Company might be required to remove such substances from the affected
properties at its sole cost and expense. There can be no assurances that the
cost of such removal would not substantially exceed the value of the affected
properties or the loans secured by the properties or that the Company would have
adequate remedies against the prior owner or other responsible parties, or that
the Company would not find it difficult or impossible to sell the affected
properties either prior to or following any such removal.
GOVERNMENT REGULATION
The home equity loan and financing operations of the Company are subject to
regulation by federal, state and local government authorities, as well as to
various laws and judicial and administrative decisions, that impose requirements
and restrictions affecting, among other things, the Company's loan originations,
credit activities, maximum interest rates, finance and other charges,
disclosures to customers, the terms of secured transactions, collection,
repossession and claims-handling procedures, multiple qualification and
licensing requirements for doing business in various jurisdictions and other
trade practices. Although the Company believes that it is in compliance in all
material respects with applicable local, state and federal laws, rules and
regulations, there can be no assurance that more restrictive laws, rules and
regulations will not be adopted in the future that could make compliance much
more difficult or expensive, restrict the Company's ability to originate,
purchase or sell loans, further limit or restrict the amount of interest and
other charges earned on loans originated or purchased by the Company, further
limit or restrict the terms of loan agreements, or otherwise adversely affect
the business of the Company. In addition, changes in government sponsored loan
programs, such as the Title I home improvement loan program, could adversely
affect the business of the Company.
As part of the Company's financing and asset securitization business,
ContiFinancial Services is required to register as a broker-dealer with certain
Federal and state securities regulatory agencies and is a member of the National
Association of Securities Dealers, Inc. (the "NASD"). As a registered broker-
dealer, ContiFinancial Services is subject to certain minimum net capital rules
and certain other requirements. Any changes in such requirements or the loss of
the broker-dealer license of ContiFinancial Services, for any reason, could have
a material adverse effect on the Company.
INVESTMENT COMPANY ACT CONSIDERATIONS
The Company believes that it is not an investment company as defined in the
Investment Company Act of 1940, as amended (the "Investment Company Act"). Among
other things, under the Investment Company Act, an investment company is
prohibited from engaging in certain activities, is restricted from entering into
certain transactions with affiliated persons and interested persons, is governed
by certain laws that limit the issuance of debt securities, preferred stock,
warrants and rights to subscribe or purchase a security and is subject to
certain restrictions on the payment of dividends, the making of loans and the
purchase and redemption of its securities.
16
<PAGE>
The Company intends to continue its business and to conduct its operations
so as not to become regulated as an investment company under the Investment
Company Act. The Company's business strategy includes acquiring equity or debt
interests in Strategic Alliance clients and investing in loans, other assets and
Excess Spread Receivables. In order to avoid becoming an investment company, the
Company will have to limit certain types of its investments or its activities.
If the Company were to become an investment company for any reason, the Company
could be required either (i) to change significantly the manner in which it
conducts its operations to avoid being required to register as an investment
company or (ii) to register as an investment company, either of which could have
a material adverse effect on the Company and the market prices for the Common
Stock.
CONTROL OF THE COMPANY
Continental Grain currently owns approximately 75% of the Company's
outstanding Common Stock. Upon satisfaction of the Forward Contract, assuming
Continental Grain delivers to the ML & Co. Subsidiary the maximum number of
shares of Common Stock subject thereto, and assuming no other sales of the
Company's Common Stock by Continental Grain, Continental Grain would own
approximately 70% of the outstanding Common Stock (or approximately 69% of the
outstanding Common Stock if the over-allotment option granted to the Underwriter
of the STRYPES is exercised in full). As a result, upon satisfaction of the
Forward Contract (even assuming the maximum number of shares of Common Stock are
delivered thereunder), Continental Grain will continue to be able to elect all
of the directors of the Company and to determine the outcome of any matter
submitted to a vote of the Company's stockholders for approval. Except to the
extent that it may deliver shares of Common Stock in satisfaction of its
obligations under the Forward Contract, Continental Grain has advised the
Company that its current intention is to continue to hold all shares of Common
Stock beneficially owned by it. However, there can be no assurance that
Continental Grain will not decide to sell all or a portion of its holdings at
some future date.
SHARES AVAILABLE FOR FUTURE SALE
Sales of a substantial number of shares of Common Stock in the public market
could adversely affect the prevailing market price of the Common Stock and could
impair the Company's future ability to raise capital through an offering of its
equity securities. As of July 31, 1997, the Company had 47,623,984 shares of
Common Stock outstanding, of which approximately 10,444,386 shares are freely
tradable. All other shares are "restricted shares" for purposes of the
Securities Act. The Company and Continental Grain are parties to an agreement
which provides Continental Grain with certain registration rights.
The Company has filed a registration statement covering the sale of up to
4,487,895 shares of Common Stock reserved for issuance under the 1995 Long-Term
Stock Incentive Plan (the "1995 Stock Plan") and the Directors Retainer Fee Plan
(the "Directors Plan"). Under the 1995 Stock Plan, the Company granted certain
employees of the Company awards of 1,330,532 shares of "restricted" Common Stock
and nonqualified stock options representing the right to acquire 2,445,412
shares of Common Stock, which will vest in full by March 31, 2000. Under the
Directors Plan, a director who is not an employee of the Company or an affiliate
may elect to receive payment of all or any portion of the annual cash retainer
and meeting fees either currently, in cash or shares of Common Stock, or may
elect to defer receipt of any such payment. The aggregate number of shares
authorized for issuance under the Directors Plan is 50,000. Generally, upon
vesting, the shares of Common Stock representing such restricted stock or stock
options will be freely tradeable.
17
<PAGE>
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is traded publicly on the NYSE under the symbol
"CFN." The table below sets forth the quarterly intra-day high and low sales
prices of the Common Stock as reported by the NYSE during the calendar quarters
indicated.
<TABLE>
<CAPTION>
PRICE RANGE
-----------------
<S> <C> <C> <C> <C>
HIGH LOW
------ ------
1996
- -----------------------------------------------------------------------------
First Quarter (from February 9, 1996)...................................... $ 31 1/2 $ 25 1/8
Second Quarter............................................................. 33 28
Third Quarter.............................................................. 30 3/8 22 3/4
Fourth Quarter............................................................. 39 1/4 28 5/8
1997
- -----------------------------------------------------------------------------
First Quarter.............................................................. 39 3/8 31
Second Quarter............................................................. 37 26 3/8
Third Quarter (through August 14, 1997).................................... 40 1/2 34 3/8
</TABLE>
As of August 11, 1997, there were approximately 80 holders of record of the
Common Stock including Cede & Co., a nominee of The Depository Trust Company,
which holds shares of Common Stock on behalf of an indeterminate number of
beneficial holders. On , 1997, the last price reported on the NYSE for
the Common Stock was $ per share.
DIVIDEND POLICY
The Company has no current intention to pay cash dividends on its Common
Stock. As a holding company, the ability of the Company to pay dividends is
dependent upon the receipt of dividends or other payments from its subsidiaries.
Any future determination as to the payment of dividends will be at the
discretion of the Company's Board of Directors and will depend upon the
Company's operating results, financial condition and capital requirements,
contractual restrictions, general business conditions and such other factors as
the Company's Board of Directors deems relevant. Furthermore, covenants in the
Indentures, the Credit Facility and the Continental Grain Debt Agreements
restrict the payment of dividends by the Company. There can be no assurance that
the Company will have earnings sufficient to pay a dividend on its Common Stock
or that, even if there are sufficient earnings, dividends will be permitted
under applicable law. See "Risk Factors -- Effect of Certain Debt Obligations on
the Company."
18
<PAGE>
CAPITALIZATION
The following table sets forth the consolidated capitalization of the
Company as of June 30, 1997. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources,"
"Description of Certain Indebtedness and Financing Arrangements" and the
Consolidated Financial Statements incorporated herein by reference.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
--------------------
<S> <C>
(DOLLARS IN
THOUSANDS)
CURRENT PORTION OF LONG-TERM DEBT:
Capitalized leases........................................................................ $ 274
-----------
-----------
LONG-TERM DEBT:
Capitalized leases........................................................................ $ 286
8 3/8% Senior Notes Due 2003 (a).......................................................... 299,218
7 1/2% Senior Notes Due 2002 (a).......................................................... 199,319
-----------
Total long-term debt.................................................................. 498,823
-----------
STOCKHOLDERS' EQUITY:
Preferred stock ($0.01 par value) 25,000,000 shares authorized; none issued and
outstanding............................................................................. --
Common stock ($0.01 par value) 250,000,000 shares authorized; 47,623,984 shares issued and
outstanding............................................................................. 476
Paid-in capital........................................................................... 397,984
Treasury stock............................................................................ (368)
Retained earnings......................................................................... 155,525
Deferred compensation..................................................................... (14,882)
-----------
Total stockholders' equity.............................................................. 538,735
-----------
Total capitalization.................................................................. $ 1,037,558
-----------
-----------
</TABLE>
- ------------------------
(a) See "Description of Certain Indebtedness and Financing Arrangements."
19
<PAGE>
SELECTED FINANCIAL DATA
(DOLLAR AMOUNTS EXPRESSED IN THOUSANDS, EXCEPT PER SHARE DATA)
The historical financial data set forth below for fiscal year 1993 has not
been separately audited but has been derived from Continental Grain audited
financial statements which are not included herein. The historical financial
data set forth below for fiscal years 1997, 1996, 1995 and 1994 have been
derived from, and should be read in conjunction with, the audited Consolidated
Financial Statements of the Company, of which fiscal years 1997, 1996 and 1995
are included in the Company's Annual Report on Form 10-K for the fiscal year
ended March 31, 1997, incorporated by reference herein and attached hereto as
Annex A. The historical financial data set forth below for the three months
ended June 30, 1997 and 1996 have been derived from, and should be read in
conjunction with, the unaudited Consolidated Financial Statements of the Company
included in the Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1997, incorporated by reference herein and attached hereto as Annex B.
In the opinion of the Company, such unaudited financial statements reflect all
adjustments, consisting only of normal recurring accruals, necessary for a fair
presentation of the results for such periods. Results for the three months ended
June 30, 1997 are not necessarily indicative of results for the full year and
are subject to year end adjustments.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30, YEARS ENDED MARCH 31,
-------------------- -----------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1997 1996 1997 1996 1995 1994 1993
--------- --------- --------- --------- --------- --------- ---------
INCOME STATEMENT DATA:
Gross income:
Gain on sale of receivables.......... $ 64,340 $ 31,166 $ 210,861 $ 146,529 $ 67,512 $ 49,671 $ 18,587
Interest............................. 49,679 28,515 161,402 91,737 42,929 20,707 11,385
Net servicing income................. 15,973 9,073 46,340 29,298 9,304 3,989 1,842
Other income (loss).................. 4,031 1,009 9,227 4,252 2,252 162 (147)
--------- --------- --------- --------- --------- --------- ---------
Total gross income................. 134,023 69,763 427,830 271,816 121,997 74,529 31,667
--------- --------- --------- --------- --------- --------- ---------
Expenses:
Compensation and benefits............ 30,234 12,408 82,170 52,203 23,812 14,674 6,870
Interest............................. 35,863 19,662 120,636 74,770 29,635 12,124 6,529
Provision for loan losses............ 1,311 219 3,043 285 1,935 4,499 2,018
General and administrative........... 21,070 4,779 44,940 18,022 9,627 7,946 4,101
--------- --------- --------- --------- --------- --------- ---------
Total expenses..................... 88,478 37,068 250,789 145,280 65,009 39,243 19,518
--------- --------- --------- --------- --------- --------- ---------
Income before income tax expense and
minority interest.................... 45,545 32,695 177,041 126,536 56,988 35,286 12,149
Income tax expense..................... 18,641 13,262 71,341 49,096 22,168 13,726 4,640
Minority interest of subsidiary........ 31 -- (304) 3,310 8,728 5,076 1,600
--------- --------- --------- --------- --------- --------- ---------
Net income............................. $ 26,873 $ 19,433 $ 106,004 $ 74,130 $ 26,092 $ 16,484 $ 5,909
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Primary and fully dilutive earnings per
common share (pro forma at March 31,
1996 only)........................... $ 0.59 $ 0.44 $ 2.40 $ 2.00
</TABLE>
<TABLE>
<CAPTION>
AS OF JUNE 30,
-------------------- AS OF MARCH 31,
1997 1996 1997
--------- --------- ---------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Excess spread receivables (interest-only and residual certificates)...... $ 516,707 $ 223,802 $ 445,005
Receivables held for sale................................................ 695,045 364,159 625,545
Total assets............................................................. 2,106,534 891,672 1,545,798
Long term debt........................................................... 498,823 -- 498,817
Total liabilities........................................................ 1,566,480 575,864 1,136,726
Minority interest of subsidiary.......................................... 1,319 -- 1,288
Stockholders' equity..................................................... 538,735 315,808 407,784
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30, YEARS ENDED MARCH 31,
-------------------- -----------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1997 1996 1997 1996 1995 1994 1993
--------- --------- --------- --------- --------- --------- ---------
OPERATING DATA:
Face value of home equity loans
serviced (at period end).......... $7,269,361 $4,256,948 $6,423,376 $3,863,575 $2,192,190 $1,105,393 $ 484,857
Home equity loan originations....... 1,392,231 678,128 3,906,798 2,311,471 1,328,158 786,754 282,072
Securitization and sales volume:
ContiMortgage and ContiWest....... $1,265,000 $ 692,954 $3,642,554 $2,030,270 $1,292,691 $ 772,324 $ 272,544
Commercial real estate............ 158,816 193,916 742,259 185,980 89,000 -- --
Triad............................. 45,881 -- 43,530 -- -- -- --
Strategic alliances............... 174,200 106,559 568,401 1,776,700 906,000 418,000 426,000
--------- --------- --------- --------- --------- --------- ---------
Total securitization and sales
volume........................ $1,643,897 $ 993,429 $4,996,744 $3,992,950 $2,287,691 $1,190,324 $ 698,544
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
LOAN LOSS DATA (A):
Delinquency rate (at period end)
(b)............................... 3.68% 4.05% 3.24% 2.51% 1.64% 0.97% 1.20%
Default rate (at period end) (c).... 5.05% 3.98% 4.70% 3.54% 1.16% 0.81% 1.70%
Net losses as a percentage of
average amount outstanding........ 0.07%(d) 0.05%(d) 0.26% 0.13% 0.08% 0.15% 0.26%
</TABLE>
- ------------------------------
(a) Loan loss data represents data for the home equity loan servicing portfolio
of ContiMortgage only. See "Business--Home Equity Loan Origination and
Servicing" in the Company's Annual Report on Form 10-K for this fiscal year
ended March 31, 1997, incorporated herein by reference and attached hereto
as Annex A.
(b) The delinquency percentage represents, as a percentage of the aggregate
principal balance of loans in ContiMortgage's servicing portfolio as of the
relevant date, the outstanding principal balance of home equity loans for
which payments are contractually past due, exclusive of home equity loans in
foreclosure, bankruptcy, real estate owned or forbearance.
(c) The default percentage represents, as a percentage of the aggregate
principal balance of loans in the Company's portfolio as of the relevant
date, the dollar value of delinquent payments on home equity loans in
foreclosure, bankruptcy, real estate owned or forbearance.
(d) This percentage is based on data for the three months ended June 30, 1997
and 1996 and is not necessarily indicative of an annualized percentage.
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion should be read in conjunction with "Selected Financial Data"
and the Company's Consolidated Financial Statements and the notes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year ended
March 31, 1997 and Quarterly Report on Form 10-Q for the quarter ended June 30,
1997, incorporated by reference herein and attached hereto as Annex A and Annex
B, respectively.
GENERAL
The Company is engaged in the consumer and commercial finance business by
originating and servicing home equity loans and providing financing and asset
securitization expertise to originators of a broad range of loans, leases and
receivables. Through ContiMortgage, the Company is a leading originator,
purchaser, seller and servicer of home equity loans made to borrowers whose
borrowing needs may not be met by traditional financial institutions due to
credit exceptions or other factors. The Company has Strategic Alliances with
various originators of a broad range of consumer and commercial loans and other
assets. Through ContiTrade the Company provides financing and asset
securitization structuring expertise, and through ContiFinancial Services, an
NASD registered broker/dealer, the Company provides placement services. In
September 1996, the Company established ContiWest Corporation, a Nevada
corporation ("ContiWest"), to administer and underwrite a portion of the
Company's origination portfolio.
The Company's Strategic Alliance clients are originators of consumer and
commercial loans, leases and receivables. The Company provides financing and
asset securitization execution and expertise to the Strategic Alliance client
while the client provides a consistent flow of securitizable assets to the
Company. In certain Strategic Alliances, the Company receives interests
("Strategic Alliance Equity Interests") in the Strategic Alliance client. The
realization of value on such Strategic Alliance Equity Interests is subject to
many factors, including the future growth and profitability of the Strategic
Alliance clients and the completion of initial public offerings or sale of such
Strategic Alliance clients.
In the third quarter of fiscal 1997, the Company acquired three home equity
companies and one auto finance company to implement growth strategies of
expanding into the western United States, diversifying into retail origination
and owning other asset origination platforms with which the Company has
significant securitization experience. The four new loan origination
subsidiaries, ULG, Royal, Triad, and Resource One, collectively called the
"Acquisitions", are discussed below:
- On November 8, 1996, the Company purchased 100% of the outstanding stock
of ULG, a West coast-based home equity lender specializing in retail
originations via direct mail and telemarketing throughout the United
States.
- On November 15, 1996, the Company, through its subsidiary ContiMortgage,
purchased 100% of Royal. Royal is a California-headquartered wholesale and
retail originator of fixed and adjustable rate home equity loans.
- On November 21, 1996, the Company acquired a 53.5% equity interest in
Triad and an additional 2.5% in January 1997, a California-based non-prime
auto finance company. The Company has the right and obligation to acquire
the remaining common stock of Triad from existing shareholders.
- On December 16, 1996, the Company, through its subsidiary ContiMortgage,
purchased 100% of the outstanding stock of Resource One. Resource One,
headquartered in Langhorne, Pennsylvania, is a retail branch home equity
loan originator that utilizes direct mail, television, telemarketing,
referrals and other sources to generate loan inquiries directly from
borrowers.
In each case, the companies acquired were former Strategic Alliance clients
or ContiMortgage loan origination sources.
22
<PAGE>
The Acquisitions have been accounted for as purchases, and the results of
operations have been included with the Company's results of operations since the
effective acquisition dates. The cumulative purchase price was approximately
$38.0 million, which includes deferred payments of approximately $5.0 million,
resulting in approximately $35.0 million of cost in excess of equity which will
be amortized on a straight-line basis over a 25 year useful life. Certain of the
Acquisitions' terms contain payments which are contingent upon future earnings
or employment of key management. Such contingent payments will be recorded as
purchase price or compensation as is appropriate for the nature of the payments.
The Company has a right and obligation to purchase the remaining 44% of the
common stock of Triad over the next four and one-half years. The purchase price
will be based upon the future earnings of Triad and will be recorded when
determinable. The excess of the purchase price over the fair value of the net
assets acquired will be recorded as an increase in cost in excess of equity. The
Acquisitions are not material to the financial position or results of operations
of the Company.
CERTAIN ACCOUNTING CONSIDERATIONS
As a fundamental part of its business and financing strategy, the Company
sells substantially all of its loans or other assets through securitization in
the form of REMICs, owner trusts or grantor trusts. In a securitization, the
Company sells loans or other assets that it has originated or purchased to a
trust for a cash purchase price and an interest in the loans or other assets
securitized in the form of the Excess Spread. The cash purchase price is raised
through an offering of pass-through certificates by the trust. Following the
securitization, the purchasers of the pass-through certificates receive the
principal collected and the investor pass-through interest rate on the
certificate balance, while the Company receives the excess spread. The Excess
Spread represents, over the life of the loans or other assets, the excess of the
weighted average coupon on each pool of loans or other assets sold over the sum
of the pass-through interest rate plus a normal servicing fee, a trustee fee, an
insurance fee and an estimate of annual future credit losses related to the
loans or other assets securitized. These cash flows are projected over the life
of the loans or other assets using prepayment, default, and interest rate
assumptions that market participants would use for similar financial instruments
subject to prepayment, credit and interest rate risk and are discounted using an
interest rate that a purchaser unrelated to the seller of such a financial
instrument would demand. The majority of the Company's gross income is
recognized as gain on sale of the Excess Spread Receivable, less origination and
underwriting costs. The Excess Spread Receivable is either a contractual right
or a certificated security generally in the form of an interest-only or residual
certificate. The majority of the Company's Excess Spread Receivable at March 31,
1997 and 1996 is interest-only and residual certificates. Consequently, the
Company's consolidated balance sheets designate Excess Spread Receivable as
"interest-only and residual certificates."
The Company recognizes the gain on sale of loans or other assets in the
fiscal year in which such loans or other assets are sold, although cash
(representing the Excess Spread and servicing fees) is received by the Company
over the life of the loans or other assets. Concurrent with recognizing such
gain on sale, the Company records the Excess Spread Receivable as an asset on
its consolidated balance sheets. The Excess Spread Receivable is reduced as cash
distributions are received from the securitization.
Due to the fact that the gain recognized in the year of sale is equal to the
present value of the estimated future cash flows from the Excess Spread, the
amount of cash actually received over the lives of the loans or other assets
normally exceeds the gain previously recognized at the time the loans or other
assets were sold, and therefore interest income is recognized over the life of
the loans or other assets securitized. In periods subsequent to the sale, the
Company may recognize an increase in fair value of Excess Spread Receivable as
gain on sale of receivables to the extent that estimates of the loan pools'
future remaining lives exceed those originally projected. This estimate of
extended life is performed by reviewing past prepayment experience and
estimating future prepayment experience by considering numerous factors which
include current market assumptions, the interest rate environment and economic
factors. If actual prepayments with respect to sold loans occur faster or credit
experience is worse than
23
<PAGE>
projected at the time such loans were sold, the carrying value of the Excess
Spread Receivable may have to be written down through a charge to earnings in
the period of adjustment.
Additionally, upon sale or securitization of servicing retained mortgages,
the Company capitalizes the cost associated with the right to service mortgage
loans based on its relative fair value. 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 in proportion to
and over the period of estimated net future servicing fee income. The Company
periodically reviews capitalized servicing fees receivable for valuation
impairment. This review is performed on a disaggregated basis for the
predominant risk characteristics of the underlying loans which are loan type,
loan-to-value ratio and credit quality. The Company generally makes loans to
credit impaired borrowers whose borrowing needs may not be met by traditional
financial institutions due to credit exceptions. The Company has found that
credit impaired borrowers are payment sensitive rather than interest rate
sensitive. As such the Company does not consider interest rates a predominant
risk characteristic for purposes of valuation impairment. Impairment is
recognized in a valuation allowance for each disaggregated stratum in the period
of impairment.
On January 1, 1997, the Company adopted the Financial Accounting Standards
Board's ("FASB") SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities" ("SFAS 125") which addresses
the accounting for transfers of financial assets in which the transferor has
some continuing involvement either with the assets transferred or with the
transferee. A transfer of financial assets in which the transferor surrenders
control over those assets is accounted for as a sale to the extent that
consideration other than beneficial interest in the transferred assets is
received in exchange. SFAS 125 requires that liabilities and derivatives
incurred or obtained by transferors as part of a transfer of financial assets be
initially measured at fair value, if practicable. In addition, SFAS 125 requires
that servicing assets and liabilities be subsequently measured by the
amortization over their estimated life and assessment of asset impairment be
based on such assets' fair value. SFAS 125 is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
December 31, 1996, and is to be applied prospectively. The adoption of this
standard did not have a material impact on the Company's results of operations.
However, certain of the assets that the Company had sold under the Purchase and
Sale Facilities subsequent to January 1, 1997 did not qualify for sale treatment
under SFAS 125, and as a result, $251.5 million of such assets were included as
trade receivables sold under agreements to repurchase on the Company's
consolidated balance sheets. SFAS 125 does not in any way effect the ability of
the Company to finance these assets. The Company expects to replace the Purchase
and Sale Facilities with repurchase agreements for those asset types which do
not qualify for sale treatment.
FINANCIAL CONDITION
AT JUNE 30, 1997
Securities purchased under agreements to resell increased $280.6 million
from $224.0 million at March 31, 1997 to $504.6 million at June 30, 1997.
Receivables held for sale and loans and other assets sold with recourse under
the Company's Purchase and Sale Facilities and the Repurchase Agreement are
hedged, in part, through the use of United States Treasury securities and
futures contracts to reduce exposure to interest rate fluctuations. Securities
purchased under agreements to resell are part of this hedging strategy. This
increase was primarily due to the increase in the Company's securitization
volume and the related receivables held for sale account.
Interest-only and residual certificates increased $71.7 million from $445.0
million at March 31, 1997 to $516.7 million at June 30, 1997. This increase
represents $81.2 million recorded during fiscal 1997 relating to new
securitizations and recorded interest income of $11.2 million partially offset
by $7.2 million of sales and $13.5 million of collections.
24
<PAGE>
Capitalized servicing fees receivable increased $5.7 million from $29.4
million at March 31, 1997 to $35.1 million at June 30, 1997. This balance
reflects the capitalization of $7.8 million of servicing rights and $1.1 million
of prepayment premiums paid partially offset by amortization of $3.2 million.
Trade receivables, net increased $135.6 million from $709.2 million at March
31, 1997 to $844.8 million at June 30, 1997. This increase was due to an
increase in receivables held for sale from $625.5 million as of March 31, 1997
to $695.0 million at June 30, 1997, and an increase in other receivables from
$87.4 million at March 31, 1997 to $152.6 million at June 30, 1997. The increase
in receivables held for sale of $69.5 million was due to the investment of the
net cash proceeds available from the Company's 1997 Equity Offering (defined
below) and the timing of securitizations.
The increase in other receivables of $65.2 million from March 31, 1997 to
June 30, 1997, was primarily due to an increase in short-term receivables
associated with the timing of securitization transactions of $48.7 million.
Additional changes to other receivables were an increase in servicing advances
of $6.0 million and an increase in financed interest-only and residual
certificates of $3.9 million.
Premises and equipment, net increased $1.1 million from $7.8 million at
March 31, 1997 to $8.9 million at June 30, 1997. The increase is primarily due
to increased purchases related to the expansion of ContiMortgage's offices.
Cost in excess of equity acquired decreased $0.3 million from $48.2 million
at March 31, 1997 to $47.9 million at June 30, 1997. The decrease was due to the
amortization of the cost in excess of equity acquired which was recorded upon
the purchase of the Acquisitions made by the Company during the third quarter of
fiscal 1997.
Other assets increased $6.2 million from $30.7 million at March 31, 1997 to
$36.9 million at June 30, 1997. Other assets represents prepaid expenses, margin
and other deposits, deferred bond issuance costs, equity investments in
unconsolidated subsidiaries and other investments. This increase is primarily
due to an increase of approximately $5.6 million for equity investments in
unconsolidated subsidiaries.
Accounts payable and accrued expenses increased $6.2 million from $87.8
million at March 31, 1997 to $94.0 million at June 30, 1997. The balance
increased primarily due to an increase in accrued taxes payable of $27.0
million, and accrued interest payable of $10.0 million offset by a decrease in
accrued incentive amounts of $27.1 million and accrued securitization expenses
of $4.0 million. See due to affiliates discussion below for a discussion of
accrued taxes payable. The increase in accrued interest payable and the
decreases in accrued incentive amounts and accrued securitization expenses were
due to timing differences relating to the payments of these liabilities.
Securities sold but not yet purchased increased $271.8 million from $225.1
million at March 31, 1997 to $496.9 million at June 30, 1997. Receivables held
for sale and loans and other assets sold, with recourse, under the Company's
Purchase and Sale Facilities and the Repurchase Agreement are hedged, in part,
through the use of United States Treasury securities and futures contracts to
reduce exposure to interest rate fluctuations. Securities sold but not yet
purchased are part of this hedging strategy. This increase was primarily due to
the increase in the Company's securitization volume and the related receivables
held for sale account.
Trade receivables sold under agreements to repurchase increased $54.5
million from $251.5 million at March 31, 1997 to $306.0 million at June 30,
1997. This increase is due to the increase in receivables held for sale during
the three months ended June 30, 1997.
Due to affiliates decreased $20.3 million from $36.4 million at March 31,
1997 to $16.1 million at June 30, 1997. The decrease is primarily due to the
effect of the 1997 Equity Offering (defined below) which reduced Continental
Grain's ownership of the Company from approximately 81% to approximately 75%.
When the Company was 81% owned by Continental Grain, the Company's Federal
income taxes were prepared on a consolidated basis with Continental Grain and
such liabilities were paid through the
25
<PAGE>
due to affiliates account. Since Continental Grain's ownership percentage has
been reduced to approximately 75%, taxes are now accrued and paid directly by
the Company.
Short-term borrowed funds represents borrowings from the Credit Facility. At
June 30, 1997 and March 31, 1997, $130.0 million and $25.0 million of drawings
under this line were outstanding, respectively. These borrowings were used for
general corporate purposes. For further discussion see "Liquidity and Capital
Resources."
There were no material changes in long-term debt from March 31, 1997 to June
30, 1997.
Other liabilities increased $12.4 million from $12.1 million at March 31,
1997 to $24.5 million at June 30, 1997. The increase is primarily due to a net
increase in deferred compensation payable of $10.6 million under the terms of
incentive plans and an increase in deferred income of $1.8 million.
Stockholders' equity increased $130.9 million from $407.8 million at March
31, 1997 to $538.7 million at June 30, 1997. The increase was due to the 1997
Equity Offering with net proceeds of $100.8 million, net income of $26.9
million, the amortization of deferred compensation and a deferred compensation
tax adjustment of $3.0 million and the exercise of stock options of $0.2
million.
AT MARCH 31, 1997
Securities purchased under agreements to resell increased $44.1 million from
$179.9 million at March 31, 1996 to $224.0 million at March 31, 1997. The
Company hedges, in part, its interest rate exposure on its receivables held for
sale and loans and other assets sold, with recourse, under its Purchase and Sale
Facilities, through the use of United States Treasury securities and futures
contracts. Securities purchased under agreements to resell are part of this
hedging strategy. The increase in securities purchased under agreements to
resell was due primarily to the increase in the Company's securitization volume
in fiscal 1997 as compared to fiscal 1996.
Interest-only and residual certificates increased $151.8 million from $293.2
million at March 31, 1996 to $445.0 million at March 31, 1997. Excluding $15.2
million of interest-only and residual certificates relating to the Acquisitions,
the March 31, 1997 balance increased by $136.6 million from March 31, 1996. This
increase represents $251.1 million recorded during fiscal 1997 relating to new
securitizations and recorded interest income of $33.7 million partially offset
by $96.5 million of sales and $51.7 million of collections.
Capitalized servicing fees receivable increased $17.7 million from $11.7
million at March 31, 1996 to $29.4 million at March 31, 1997. This balance
reflects the capitalization of $24.0 million of servicing rights and $1.4
million of prepayment premiums paid partially offset by amortization of $7.7
million.
Trade receivables, net increased $356.9 million from $352.3 million at March
31, 1996 to $709.2 million at March 31, 1997. Excluding $51.3 million of trade
receivables, net relating to the Acquisitions, the March 31, 1997 balance
increased by $305.6 million from March 31, 1996. This increase was primarily due
to an increase in receivables held for sale from $303.7 million as of March 31,
1996 to $574.3 million at March 31, 1997, and partially due to the increase in
other receivables from $50.5 million at March 31,1996 to $85.7 million at March
31, 1997. The increase in receivables held for sale was primarily due to the
adoption of SFAS 125 on January 1, 1997. As of March 31, 1997, $251.5 million of
receivables held for sale under the Purchase and Sale Facilities were
categorized as financing under SFAS 125 and classified as "Trade receivables
sold under agreements to repurchase". In addition to the SFAS 125
classification, there was an additional increase of $19.1 million of receivables
held for sale due to an overall increase in securitization volume from fiscal
1996 to fiscal 1997.
The increase in other receivables of $35.2 million from fiscal 1996 to
fiscal 1997 was primarily due to an increase in servicing advances of $16.8
million and an increase in short-term receivables of $17.2 million. The increase
in servicing advances was due to advances made by ContiMortgage on loans in the
26
<PAGE>
servicing system. ContiMortgage, as servicer, is contractually liable to pay the
REMIC for certain delinquencies and then collects the past due amounts from the
borrower. This increase is because of an overall dollar increase in
delinquencies from fiscal 1996 to fiscal 1997. The increase in short-term
receivables is due to timing differences in receiving loan payments from third
party intermediaries.
Premises and equipment, net increased $3.8 million from $3.9 million at
March 31, 1996 to $7.7 million at March 31, 1997. Excluding $3.4 million of
premises and equipment relating to the Acquisitions, the March 31, 1997 balance
decreased by $0.4 million from March 31, 1996. This decrease was primarily as a
result of office equipment acquisitions which were more than offset by the
normal periodic depreciation of owned equipment.
Cost in excess of equity increased $33.6 million from $14.6 million at March
31, 1996 to $48.2 million at March 31, 1997. The increase was primarily due to
the costs in excess of equity recorded upon the Acquisitions made by the Company
during the third quarter of fiscal 1997.
Other assets increased $26.8 million from $3.9 million at March 31, 1996 to
$30.7 million at March 31, 1997. Excluding the effects of the Acquisitions,
other assets at March 31, 1997 increased by $24.4 million from March 31, 1996.
Other assets represents prepaid expenses, margin and other deposits, deferred
bond issuance costs and other investments. This increase is primarily due to an
increase of approximately $12.0 million of deferred issuance costs on the 8 3/8%
and 7 1/2% Senior Notes, $3.7 million of prepaid shelf registration and
servicing fees and an increase of $4.3 million in escrow deposits.
Accounts payable and accrued expenses increased $14.3 million from $73.5
million at March 31, 1996 to $87.8 million at March 31, 1997. Excluding $6.6
million of accounts payable and accrued expenses relating to the Acquisitions,
the March 31, 1997 balance increased by $7.7 million from March 31, 1996. The
balance increased primarily due to an increase in accrued taxes payable of $14.6
million, incentive accruals of approximately $5.5 million, accruals for
securitization obligations of $4.1 million, accrued interest payable of $3.1
million, accrued pension and health care costs of approximately $1.5 million
offset by a decrease in accrued amounts payable under the Company's Purchase and
Sale Facilities of approximately $20.8 million. The increases in accrued taxes
payable, and accruals for securitization obligations were due to increased
securitization volume, producing higher net income in fiscal 1997. The increase
in incentive accruals in fiscal 1997 as compared to fiscal 1996 was due to the
deferral of payments. The increase in accrued pension and healthcare costs was
due to an increase in the number of employees (excluding the Acquisitions) to
703 in fiscal 1997 as compared to 455 employees in fiscal 1996. The decrease in
accrued amounts payable under the Company's Purchase and Sale Facilities was due
to a timing difference in the amounts payable under these obligations.
Securities sold but not yet purchased increased $44.4 million from $180.7
million at March 31, 1996 to $225.1 million at March 31, 1997. The Company
hedges, in part, its interest rate exposure on its receivables held for sale and
loans and other assets sold with recourse under its Purchase and Sale Facilities
through the use of United States Treasury securities and futures contracts.
Securities sold but not yet purchased are part of this hedging strategy. This
increase was due primarily to the increase in the Company's securitization
volume in fiscal 1997 from fiscal 1996.
Payables to affiliates decreased $301.3 million from $337.7 million at March
31, 1996 to $36.4 million at March 31, 1997. In connection with the IPO,
Continental Grain provided financing with three notes totaling $324.0 million.
These notes were refinanced principally with the net proceeds of the Senior
Notes. The remaining balance of payables to affiliates at March 31, 1997
represents amounts due under a services agreement and a tax sharing agreement
with Continental Grain.
Short-term borrowed funds represents borrowings from the Credit Facility. At
March 31, 1997, $25.0 million of drawings under this line were outstanding.
On August 14, 1996, the Company issued the 8 3/8% Senior Notes and on March
12, 1997, the Company issued the 7 1/2% Senior Notes, resulting in $498.5
million of the balance sheet increase in long-term debt
27
<PAGE>
from March 31, 1996. The Senior Notes were issued at a discount which is being
amortized over the life of the Senior Notes. The remaining $0.3 million of
long-term debt represents amounts payable under a long term capitalized lease.
Other liabilities increased $6.3 million from $5.8 million at March 31, 1996
to $12.1 million at March 31, 1997. Excluding the effects of the Acquisitions,
other liabilities at March 31, 1997 increased by $5.9 million from March 31,
1996. The increase is primarily due to the accrual of contingent payments
relating to the Acquisitions.
Stockholders' equity increased $113.0 million from $294.8 million at March
31, 1996 to $407.8 million at March 31, 1997 due to net income of $106.0
million, the amortization of deferred compensation of $6.7 million and the
exercise of stock options of $0.3 million. Excluding the effect of the
Acquisitions, stockholders' equity at March 31, 1997 increased by $109.4 million
from March 31, 1996.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1997 COMPARED TO THREE MONTHS ENDED JUNE 30, 1996
The Company's total gross income increased from $69.8 million for the three
months ended June 30, 1996 to $134.0 million for the three months ended June 30,
1997, representing a 92% increase. During the first quarter of fiscal 1998,
gross income increased by $37.0 million, or 53%, exclusive of the Acquisitions.
Net income increased from $19.4 million for the three months ended June 30, 1996
to $26.9 million for the three months ended June 30, 1997, representing a 38%
increase. Net income for the three months ended June 30, 1997 increased by $4.2
million, or 22%, exclusive of the Acquisitions.
On a percentage basis, the following table sets forth the composition of the
Company's results as a percentage of total gross income for the periods
indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
----------------------
1997 1996
---------- ----------
<S> <C> <C>
Gross income
Gain on sale of receivables..................................... 48.00% 44.67%
Interest........................................................ 37.07 40.87
Net servicing income............................................ 11.92 13.01
Other income.................................................... 3.01 1.45
---------- ----------
Total gross income............................................ 100.00% 100.00%
---------- ----------
Expenses
Compensation and benefits....................................... 22.56% 17.79%
Interest........................................................ 26.76 28.18
Provision for loan losses....................................... 0.98 0.31
General and administrative...................................... 15.72 6.85
---------- ----------
Total expenses................................................ 66.02% 53.13%
---------- ----------
Income before income taxes and minority interest.................. 33.98% 46.87%
Income taxes...................................................... 13.91 19.01
---------- ----------
Income before minority interest................................... 20.07% 27.86%
Minority interest of subsidiary................................... 0.02 0.00
---------- ----------
Net income.................................................... 20.05% 27.86%
---------- ----------
---------- ----------
</TABLE>
The Company's move into retail origination has resulted in a change in the
profile of the income statement. Retail origination expenses focus heavily on
compensation and benefits and general and administrative expenses, whereas with
wholesale originators, such ContiMortgage, costs of origination in
28
<PAGE>
the form of origination points are netted against gain on sale of receivables.
As retail origination grows, the Company anticipates a related increase in
operating expenses, largely offset by higher income from origination points and
other cash income included in gain on sale results.
INCOME. The increase in total gross income was due to a greater volume of
loans originated as a result of the expansion of the Company's wholesale and
broker home equity loan origination sources and the move into retail
originations.
The following table sets forth information regarding the components of the
Company's total gross income in each of the three month periods ended June 30:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED JUNE 30,
----------------------
1997 1996
---------- ----------
(IN THOUSANDS)
<S> <C> <C>
Gain on sale of receivables....................................... $ 64,340 $ 31,166
Interest.......................................................... 49,679 28,515
Net servicing income.............................................. 15,973 9,073
Other income...................................................... 4,031 1,009
---------- ----------
Total gross income.............................................. $ 134,023 $ 69,763
---------- ----------
---------- ----------
</TABLE>
Gain on sale of receivables was the primary component of total gross income,
comprising 48% and 45% of total gross income in the three months ended June 30,
1997 and 1996, respectively. Gain on sale of receivables increased $33.2
million, or 106%, in the three months ended June 30, 1997 as compared to the
corresponding period in 1996. During the first quarter of fiscal 1998, gain on
sale of receivables increased by $8.9 million or 29%, exclusive of the
Acquisitions.
Gain on sale of receivables represents income primarily from the structuring
and sale of pools of home equity loans originated by ContiMortgage, the retail
origination companies and Strategic Alliance clients of the Company in REMICs,
owner trusts and grantor trusts. In addition, gains on sale of receivables are
earned upon whole loan sales and upon securitization of commercial and
multi-family loans, home improvement loans, franchisee loans, prime and
non-prime auto loans and equipment leases which are sold into REMICs and whole
loan and other trust structures.
The increase in income earned from gain on sale of receivables was due to an
increased volume of loans and leases structured partially offset by a decreased
gain on sale percentage. The Company structured and sold $1.4 billion of
mortgages, loans and leases, exclusive of the Acquisitions, in the three months
ended June 30, 1997, an increase of $0.6 billion from the three months ended
June 30, 1996, which contributed $16.3 million of the increase in gain on sale
of receivables.
The gain on sale percentage, computed as the ratio of gain on sale gross
income divided by the dollar volume of loans securitized, decreased by 87 basis
points from 3.69% for the three months ended June 30, 1996 to 2.82% for the
three months ended June 30, 1997. The primary reasons for the decline were
twofold: (1) origination costs or premiums paid for loans increased by 74 basis
points, reducing the Excess Spread component of the gain on sale calculation;
and (2) the average life on ContiMortgage securitizations declined by 0.3 years
in the first quarter of fiscal 1998 compared to the corresponding period in
fiscal 1997 due to an increase in prepayment speed assumptions used by the
Company in valuing the Excess Spread Receivable. Securities sold were executed
at more favorable investor yields and efficient securitization structures in the
three months ended June 30, 1997, than in the comparable period in 1996,
generating a 30 basis point increase in Excess Spread, partially offsetting the
declines in Excess Spread and average life. These changes resulted in a $7.4
million decline in gain on sale of receivables.
The combination of the $16.3 million increase due to increased volume and
the $7.4 million decrease due to a decline in ContiMortgage Excess Spread
resulted in a net increase in gain on sale of receivables from the three months
ended June 30, 1996 to the corresponding period in 1997 of $8.9 million.
29
<PAGE>
Interest income increased $21.2 million, or 74%, for the three months ended
June 30, 1997, from the corresponding period in 1996. Interest income increased
by $19.1 million, or 67%, exclusive of the Acquisitions. Interest income
represents interest earned on loans originated or purchased by the Company
during the period from their origination or purchase until the actual sale of
the loans, as well as the recognition of the increased value of the discounted
Excess Spread Receivables over time. The interest earned on loans originated and
purchased contributed $15.1 million to the increase between the three months
ended June 30, 1996 and 1997. The increase in interest earned on loans
originated and purchased was primarily due to a $646.4 million increase in the
average balance of loans originated and purchased but not yet securitized during
the periods. The recognition of the increased value of the discounted Excess
Spread Receivables over time accounted for $4.0 million of the increase in
interest income which was due to the increase in the average investment in
Excess Spread Receivables in the three months ended June 30, 1997 as compared to
the corresponding period in 1996.
Net servicing income increased $6.9 million, or 76%, for the three months
ended June 30, 1997 compared to the corresponding period in 1996 due to the
increase in the size of the servicing portfolio and the volume of loan sales and
securitizations. Net servicing income increased by $6.4 million, or 70%,
exclusive of the Acquisitions. The Company's loan servicing portfolio increased
$3.0 billion from $4.3 billion to $7.3 billion at June 30, 1996 as compared to
June 30, 1997, contributing to a $2.6 million increase in net servicing income
between the three months ending June 30, 1996 and 1997. Additionally, net
servicing income increased by $3.8 million in the first quarter of fiscal 1998
as compared to the first quarter of fiscal 1997 due to capitalized servicing
income associated with the 83% increase in the ContiMortgage and ContiWest home
equity loan sales and securitizations for the three months ended June 30, 1997
as compared to the corresponding period in 1996.
Other income increased $3.0 million, or 300%, for the three month period
ended June 30, 1997 compared to the corresponding period in 1996. Other income
increased by $2.6 million, or 254%, exclusive of the Acquisitions. Other income
consists primarily of "purchase premium refunds" on warehouse advances and for
the three months ended June 30, 1997, miscellaneous income. "Purchase premium
refunds" are received from certain origination sources related to loans that
prepay within a contractually set time period. Upon origination of a loan, the
Company will pay a wholesale originator a purchase premium for the loan or pools
of loans. The Company negotiates agreements with wholesale originators that
stipulate that a portion of such purchase premium will be repaid if individual
loans are repaid within a contractually set time period. The income from
"purchase premium refunds" increased by approximately $0.9 million due to the
increase in ContiMortgage origination volume. The miscellaneous income received
during the three months ended June 30, 1997 consisted of $1.1 million of income
received in connection with the termination of a Strategic Alliance agreement.
EXPENSES. Total expenses for the three months ended June 30, 1997 increased
$51.4 million or 139% from the corresponding period in 1996. Total expenses
increased by $28.0 million, or 75%, exclusive of the Acquisitions. This increase
in total expenses was due to the increase in number of employees, and costs
associated with increased loan volume.
The following table sets forth the components of the Company's expenses for
the three months ended June 30, 1997 and 1996:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
--------------------
1997 1996
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Compensation and benefits........................................... $ 30,234 $ 12,408
Interest............................................................ 35,863 19,662
Provision for loan losses........................................... 1,311 219
General and administrative.......................................... 21,070 4,779
--------- ---------
Total expenses.................................................. $ 88,478 $ 37,068
--------- ---------
--------- ---------
</TABLE>
30
<PAGE>
Compensation and benefits expense increased $17.8 million, or 144%, for the
three months ended June 30, 1997 compared to the corresponding period in 1996.
Of this increase in compensation and benefits, $12.3 million was due to the
addition of 974 employees from the Acquisitions. Compensation and benefits
expense increased by $5.5 million, or 44%, exclusive of the Acquisitions. This
increase was primarily due to the addition of new personnel. On June 30, 1997,
the Company had 770 employees, exclusive of the Acquisitions, as compared to 515
employees on June 30, 1996, a 50% increase, which primarily contributed to a
$5.9 million increase in salary and benefits partially offset by a $0.4 million
decrease in total incentive compensation. Incentive compensation is calculated
under provisions of certain formula based plans. Total incentive compensation
decreased due to changes in certain components of these formula based plans.
Interest expense increased $16.2 million, or 82%, to $35.9 million for the
three months ended June 30, 1997 as compared to $19.7 million for the
corresponding period in 1996. Interest expense increased by $15.9 million, or
81%, to $35.6 million exclusive of the Acquisitions. This increase was primarily
a result of an increase in long-term or short-term borrowings, trade receivables
sold under agreements to repurchase and sales under the Company's Purchase and
Sale Facilities. Average borrowings increased by $0.9 billion for the three
months ended June 30, 1997, as compared to the corresponding period in 1996.
Provision for loan losses increased to $1.3 million for the three months
ended June 30, 1997 as compared to $0.2 million for the three months ended June
30, 1996. Provision for loan losses remained comparable exclusive of the
Acquisitions. Provision for loan losses is recorded in sufficient amounts to
maintain an allowance at a level considered adequate to cover anticipated losses
resulting from liquidation of receivables held for sale and receivables sold
with limited recourse under the Purchase and Sale Facilities, prior to
securitization.
General and administrative expenses increased $16.3 million, or 341%, for
the three months ended June 30, 1997 compared to the corresponding period in
1996. Of this increase in general and administrative expenses, $9.7 million was
attributable to the retail origination operations of the Acquisitions. General
and administrative expenses increased by $6.6 million, or 139%, exclusive of the
Acquisitions. Part of the increase was due to a $1.7 million increase in costs
associated with underwriting, originating and servicing higher loan volumes. In
the three months ended June 30, 1997, origination volume increased 72% as
compared to the three months ended June 30, 1996 exclusive of the Acquisitions.
The remaining increase in general and administrative expenses of approximately
$2.8 million was primarily due to the increase in the number of employees to 770
on June 30, 1997, exclusive of employees from the Acquisitions, from 515 on June
30, 1996.
INCOME TAXES. The Company's provision for income taxes was $18.6 million
and $13.3 million for the three months ended June 30, 1997 and 1996,
respectively. The increase in taxes of 40% for the three months ended June 30,
1997 compared to the corresponding period in 1996 was related to the increase in
income before taxes and minority interest over the same period. The effective
tax rate for each of the three month periods remained consistent at 41%.
YEAR ENDED MARCH 31, 1997 COMPARED TO YEAR ENDED MARCH 31, 1996 AND YEAR ENDED
MARCH 31, 1995
The Company's total gross income increased $156.0 million or 57% to $427.8
million in fiscal 1997 as compared to $271.8 million of total gross income in
fiscal 1996, which in turn increased $149.8 million or 123% from total gross
income of $122.0 million for fiscal 1995. Excluding the effects of the
Acquisitions, fiscal 1997 gross income increased by $123.9 million from fiscal
1996. The Company's total expenses as a percentage of total gross income
increased to 59% in fiscal 1997 from 53% in fiscal 1996 and fiscal 1995. As a
result, net income for fiscal 1997 increased $79.9 million or 306% to $106.0
million compared to net income of $26.1 million in fiscal 1995. Excluding the
Acquisitions during the third quarter of fiscal 1997, net income increased by
$76.3 million from fiscal 1995.
31
<PAGE>
On a percentage basis, the following table sets forth the composition of the
Company's results as a percentage of total gross income for the periods
indicated:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
----------------------------------
<S> <C> <C> <C>
1997 1996 1995
---------- ---------- ----------
Gross income
Gain on sale of receivables................................................ 49.28% 53.91% 55.34%
Interest................................................................... 37.73 33.75 35.19
Net servicing income....................................................... 10.83 10.78 7.63
Other income............................................................... 2.16 1.56 1.84
---------- ---------- ----------
Total gross income..................................................... 100.00% 100.00% 100.00%
---------- ---------- ----------
Expenses
Compensation and benefits.................................................. 19.21% 19.21% 19.52%
Interest................................................................... 28.20 27.51 24.29
Provision for loan losses.................................................. 0.71 0.10 1.59
General and administrative................................................. 10.50 6.63 7.89
---------- ---------- ----------
Total expenses......................................................... 58.62% 53.45% 53.29%
---------- ---------- ----------
Income before income taxes and minority interest............................. 41.38% 46.55% 46.71%
Income taxes................................................................. 16.67 18.06 18.17
Minority Interest............................................................ (0.07) 1.22 7.15
---------- ---------- ----------
Net income............................................................. 24.78% 27.27% 21.39%
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
INCOME. The increase in total gross income was due to a greater volume of
loans originated as a result of the expansion of the Company's wholesale and
broker origination sources. The following table sets forth information regarding
the components of the Company's total gross income in each of the last three
fiscal years ending on March 31:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
----------------------------------
<S> <C> <C> <C>
1997 1996 1995
---------- ---------- ----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Gain on sale of receivables.................................................. $ 210,861 $ 146,529 $ 67,512
Interest..................................................................... 161,402 91,737 42,929
Net servicing income......................................................... 46,340 29,298 9,304
Other income................................................................. 9,227 4,252 2,252
---------- ---------- ----------
Total gross income........................................................... $ 427,830 $ 271,816 $ 121,997
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
Gain on sale of receivables was the primary component of total gross income,
comprising 49%, 54% and 55% of total gross income in fiscal 1997, 1996 and 1995,
respectively. Gain on sale of receivables increased $64.3 million or 44% in
fiscal 1997 as compared to fiscal 1996, which in turn increased by $79.0 million
or 117% from fiscal 1995. Excluding $26.5 million of gain on sale of receivables
relating to the Acquisitions, the fiscal 1997 balance increased by $37.8 million
or 26% from fiscal 1996. Gain on sale of receivables as a percentage of total
gross income was lower in fiscal 1997 due to an increased outstanding balance of
interest earning assets resulting in increased interest income.
Gain on sale of receivables represents income primarily from the structuring
and sale of pools of home equity loans originated by ContiMortgage and Strategic
Alliance clients of the Company in REMICs, owner trusts and grantor trusts. In
addition, gains on sale of receivables are earned upon whole loan sales and upon
securitization of commercial and multi-family loans, self-storage facilities,
Title I home improvement loans, franchisee loans, auto loans and equipment
leases which are sold into REMICs and whole loan and other trust structures.
32
<PAGE>
The increase in income earned from gain on sale of receivables was due to an
increased volume of loans, leases and other assets structured and sold and an
increased gain on sale percentage. Excluding contributions from the
Acquisitions, the Company structured and sold $4.9 billion of mortgages, loans
and leases in fiscal 1997, an increase of $0.9 billion from fiscal 1996, which
contributed $32.7 million of the increase in gain on sale of receivables. The
Company also structured and sold $4.0 billion of mortgages, loans and leases in
fiscal 1996, an increase of $1.7 million from fiscal 1995, which contributed
$62.6 million of the increase in gain on sale of receivables.
The gain on sale percentage represents the differential between the interest
rate earned on underlying securitized loans, leases or other assets and the
pass-through rate paid to the securitization investors during the estimated life
of the loans, leases or other assets. The increase in the gain on sale
percentage was primarily due to the type of assets securitized and changes in
the yield curve. The larger gain on sale percentage in fiscal 1997 as compared
to fiscal 1996 was partially due to an increased proportion of ContiMortgage
securitizations which yield higher gain on sale percentages than securitizations
and placements for Strategic Alliance clients. In fiscal 1997, ContiMortgage
securitizations represented 75% of total volume as compared to 51% for fiscal
1996 and 57% for fiscal 1995. This contributed to a gain of 13 basis points in
Excess Spread or a $5.1 million increase in gain on sale of receivables in
fiscal 1997 as compared to fiscal 1996. The combination of the $32.7 million
increase due to increased volume and the $5.1 million increase due to an
increase in the percentage of ContiMortgage assets securitized resulted in a
total increase in gain on sale of receivables from fiscal 1996 to fiscal 1997 of
$37.8 million.
In fiscal 1996 as compared to fiscal 1995, the relationship between interest
rates and maturity caused an increase in the gain on sale percentage. As the
Company originates and sells loans and leases based on the interpolated United
States Treasury interest rate plus a negotiated additional interest spread, the
gain on sale of receivables is affected by unequal movements in interest rates
at various maturities. The interpolated United States Treasury interest rate is
based on the Company's estimate of the average life of the pool of loans or
leases. In fiscal 1996 as compared to fiscal 1995, the yield curve steepened
which contributed an additional 72 basis points to Excess Spread or $16.4
million of the increase in gain on sale of receivables. The combination of the
$16.4 million increase due to the yield curve and the $62.6 million increase due
to increased volume resulted in a total increase in gain on sale of receivables
from fiscal 1995 to fiscal 1996 of $79.0 million. The gain on sale as a
percentage of loans securitized and sold for fiscal 1997, 1996 and 1995 was
4.2%, 3.7% and 3.0%, respectively.
Interest income increased $69.7 million or 76% in fiscal 1997 from fiscal
1996 and $48.8 million or 114% in fiscal 1996 from fiscal 1995. Excluding the
effects of the Acquisitions, fiscal 1997 interest income increased by $65.9
million, or 72% from fiscal 1996. Interest income represents interest earned on
loans originated or purchased by the Company during the period from origination
or purchase until the actual sale of the loans, as well as the recognition of
the increased value of the discounted Excess Spread Receivables over time. The
interest earned on loans originated and purchased contributed $50.1 million to
the increase between fiscal 1996 and fiscal 1997 and $35.5 million to the
increase between fiscal 1995 and fiscal 1996. The increase in interest earned on
loans originated and purchased was due primarily to the increase in the average
balance of loans originated and purchased but not yet securitized during the
periods, an increase of $715.6 million in fiscal 1997 as compared to fiscal 1996
and an increase of $591.5 million in fiscal 1996 as compared to fiscal 1995. The
recognition of the increased value of the discounted Excess Spread Receivables
over time, due to an increase in interest-only and residual certificates, as
previously discussed, accounted for $12.8 million of the increase in interest
income between fiscal 1996 and fiscal 1997 and $13.3 million of the increase
between fiscal 1995 and fiscal 1996.
Net servicing income increased $17.0 million or 58% in fiscal 1997 compared
to fiscal 1996 and $20.0 million or 215% in fiscal 1996 compared to fiscal 1995
due to the increase in the size of the servicing portfolio, the volume of loan
sales and securitizations and, in fiscal 1996, a change in accounting
principles. Excluding the effects of the Acquisitions, fiscal 1997 net servicing
income increased by $16.5 million, or 56% from fiscal 1996. The Company's home
equity loan servicing portfolio increased $2.5 billion or 66% to $6.4 billion at
March 31, 1997 from March 31, 1996 and $1.7 billion or 76% to $3.9 billion at
March 31,
33
<PAGE>
1996 from March 31, 1995. The growth of the servicing portfolio contributed
$11.9 million of the increase between fiscal 1996 and fiscal 1997, and $8.3
million of the increase between fiscal 1995 and fiscal 1996. Additionally, net
servicing income increased by $4.6 million in fiscal 1997 as compared to fiscal
1996 due to capitalized servicing income associated with the 79% increase in the
ContiMortgage home equity loan sales and securitizations during the same period.
In fiscal 1996 as compared to fiscal 1995 the capitalization of servicing fees
increased servicing income by $11.7 million as servicing fees were not
capitalized in fiscal 1995.
Other income increased $4.9 million or 114% to $9.2 million in fiscal 1997
as compared to fiscal 1996 and increased $2.0 million or 87% to $4.3 million in
fiscal 1996 as compared to fiscal 1995. Excluding the effects of the
Acquisitions, fiscal 1997 other income increased by $3.7 million or 86% from
fiscal 1996. Other income consists primarily of "purchase premium refunds" and
for fiscal 1997, warrant income. "Purchase premium refunds" are received from
certain origination sources related to loans that prepay within a contractually
set time period. Upon origination of a loan, the Company will pay a wholesale
originator a purchase premium for the loan or pools of loans. The Company
negotiates agreements with wholesale originators that provide that a portion of
such purchase premium will be repaid if individual loans are repaid within a
contractually set time period. The income from "purchase premium refunds"
increased due to the increase in ContiMortgage origination volume. The fiscal
1997 warrant income received consists of $2.7 million of income from the sale of
stock warrants in a Strategic Alliance company.
EXPENSES. Total expenses for fiscal 1997 increased $105.5 million or 73%
from fiscal 1996 which in turn increased $80.3 million or 123% from fiscal 1995.
Excluding the effects of the Acquisitions, fiscal 1997 total expenses increased
by $77.0 million or 53% from fiscal 1996. These increases in total expenses were
due to the increase in number of employees and costs associated with increased
mortgage volume and increased interest costs from financing larger balances of
securitizable loans.
The following table sets forth the components of the Company's expenses for
each of the last three fiscal years.
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
---------------------------------
<S> <C> <C> <C>
1997 1996 1995
---------- ---------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Compensation and benefits.................................. $ 82,170 $ 52,203 $ 23,812
Interest................................................... 120,636 74,770 29,635
Provision for loan losses.................................. 3,043 285 1,935
General and administrative................................. 44,940 18,022 9,627
---------- ---------- ---------
Total expenses............................................. $ 250,789 $ 145,280 $ 65,009
---------- ---------- ---------
---------- ---------- ---------
</TABLE>
Compensation and benefits increased $30.0 million or 57% in fiscal 1997
compared to fiscal 1996 and increased $28.4 million or 119% in fiscal 1996 as
compared to fiscal 1995. Excluding $16.1 million of compensation and benefits
relating to the Acquisitions, fiscal 1997 compensation and benefits expense
increased by $13.9 million or 27% from fiscal 1996. The increase was primarily
due to the addition of new personnel, changes in and accruals under incentive
compensation plans, vesting of restricted common stock and commissions paid to
certain employees based upon volume of loan originations. On March 31, 1997, the
Company had 1,562 employees, 859 from the Acquisitions, as compared to 455
employees on March 31, 1996 and 234 employees on March 31, 1995. This increase
primarily contributed to a $14.0 million increase in compensation costs in
fiscal 1997 compared to fiscal 1996, excluding the Acquisitions, and a $6.4
million increase in compensation costs in fiscal 1996 as compared to fiscal
1995. The fiscal 1997 accrual for incentive compensation was $23.2 million as
compared to $28.0 million in fiscal 1996 and $12.4 million in fiscal 1995, which
contributed to a $4.8 million decrease in compensation costs in fiscal 1997
compared to fiscal 1996 and a $15.6 million increase in fiscal 1996 compared to
fiscal 1995. In connection with the IPO, shares of "restricted" common stock
were granted to certain key employees. The "restricted" common stock granted,
subject to the employee's continued employment with the Company,
34
<PAGE>
generally vests between February 14, 1996 and March 31, 2000. The expense
related to the vesting of "restricted" common stock increased by $1.7 million to
$6.7 million during fiscal 1997 from fiscal 1996 restricted stock expense of
$5.0 million. The commissions paid to certain ContiMortgage employees increased
$3.0 million and $1.4 million from fiscal 1996 to fiscal 1997 and fiscal 1995 to
fiscal 1996, respectively, associated with increased ContiMortgage origination
volume. Compensation and related expenses represents 19% of total gross income
for fiscal 1997 and 1996 and 20% of total gross income for fiscal 1995.
Interest expense increased $45.9 million or 61% in fiscal 1997 as compared
to fiscal 1996 and increased $45.1 million or 152% in fiscal 1996 as compared to
fiscal 1995. Excluding the effects of the Acquisitions, fiscal 1997 interest
expense increased by $45.3 million or 61% from fiscal 1996. This increase was
primarily a result of interest expense associated with the issuance of the
Senior Notes, the costs of the sale, with limited recourse, of certain Excess
Spread Receivables, increased expenses from the Purchase and Sale Facilities and
an overall increase in the cost of borrowing offset by decreased borrowing from
Continental Grain. The average borrowings from Continental Grain, Purchase and
Sale Facilities, the Senior Notes and Excess Spread Receivables sold with
limited recourse, increased by $621.3 million in fiscal 1997 as compared to
fiscal 1996, resulting in a $43.5 million increase in interest expense, while
such average increased $627.4 million in fiscal 1996, as compared to fiscal 1995
resulting in a $43.0 million increase in interest expense. The increase in
interest rates contributed $1.8 million to the increase in interest expense
between fiscal 1997 as compared to fiscal 1996 and the increase in interest
rates contributed $2.1 million in fiscal 1996 as compared to fiscal 1995.
Provision for loan losses increased to $3.0 million in fiscal 1997 as
compared to $0.3 million in fiscal 1996 and $1.9 million in fiscal 1995.
Excluding $2.4 million of provision for loan losses relating to the
Acquisitions, the fiscal 1997 balance increased by $0.3 million from fiscal
1996. Provision for loan losses is recorded in sufficient amounts to maintain an
allowance at a level considered adequate to cover anticipated losses resulting
from liquidation of receivables held for sale and receivables sold with limited
recourse under Purchase and Sale Facilities, prior to sale or securitization.
The increase in fiscal 1997 as compared to fiscal 1996 and the decrease in
fiscal 1996 as compared to fiscal 1995 resulted from a determination of adequate
reserves in light of actual loss experience during the period.
General and administrative expenses increased $26.9 million or 149% in
fiscal 1997 compared to fiscal 1996 and $8.4 million or 87% in fiscal 1996
compared to fiscal 1995. Excluding $9.4 million of general and administrative
expenses relating to the Acquisitions, the fiscal 1997 balance increased by
$17.5 million, or 97% from fiscal 1996. The increases were partially a result of
a $7.1 million and a $3.7 million increase in costs associated with
underwriting, originating and servicing higher loan volumes in fiscal 1997 as
compared to fiscal 1996 and fiscal 1996 as compared to fiscal 1995,
respectively. In fiscal 1997, the origination volume increased 69% as compared
to fiscal 1996 and 74% in fiscal 1996 as compared to fiscal 1995. Expenses
related to the implementation of collection technology accounted for
approximately $1.3 million of the increase in fiscal 1997 as compared to fiscal
1996. The remaining increases were primarily due to an increase in general and
administrative expenses related to the increase in the number of employees by
248, excluding employees of the Acquisitions, from fiscal 1996 to fiscal 1997
and the increase of 221 employees from fiscal 1995 to fiscal 1996.
INCOME TAXES. The Company's provision for income taxes was $71.3 million,
$49.1 million and $22.2 million for fiscal 1997, fiscal 1996 and fiscal 1995,
respectively. The Company is included in the consolidated Federal income tax
return of Continental Grain. The increase in taxes over the three fiscal years
is directly related to the increase in income before taxes and minority interest
over the same period. The effective tax rate for each year remained relatively
consistent at 39% to 40%. Increases in the effective tax rate were due to
changes in the provision for state income taxes.
MINORITY INTEREST. In fiscal 1996 and fiscal 1995, minority interest
represents the portion of income before taxes and minority interest due to the
20% minority shareholders of ContiMortgage. Minority interest decreased $5.4
million or 62% in fiscal 1996 compared to fiscal 1995. This decrease in minority
35
<PAGE>
interest was directly related to the change in the Company's ownership
percentage of ContiMortgage. On June 19, 1995, ContiTrade Services Corporation
("ContiTrade Services") effectively acquired control of the remaining 20%
minority interest in ContiMortgage, which became a wholly-owned subsidiary of
the Company. Accordingly, the fiscal 1996 results of operations include
approximately three months of minority interest of $3.3 million, while the
comparable period of fiscal 1995 reflected 12 months of minority interest of
$8.7 million.
In fiscal 1997, minority interest represents the portion of loss before
taxes and minority interest due to the 44% minority shareholders of Triad. In
the third and fourth quarters of fiscal 1997, the Company acquired 56% of the
common stock of Triad. Minority interest was ($0.3) million for the period ended
March 31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
In a securitization, the Company recognizes a gain on the sale of loans or
assets securitized upon the closing of the securitization, but does not receive
the majority of the cash representing such gain until it receives the Excess
Spread, which is payable over the actual life of the loan or other assets
securitized. This negative cash flow has been partially offset by the Company's
move into retail origination which resulted in an increase in the cash received
through origination points and other cash income included in the gain on sale
results. The Company incurs significant expenses in connection with a
securitization and incurs both current and deferred tax liabilities as a result
of the gain on sale. Therefore, the Company requires continued access to short
and long term external sources of cash to fund its operations. The Company's
primary cash requirements are expected to include the funding of: (i) mortgage,
loan and lease originations and purchases pending their pooling and sale; (ii)
the points and expenses paid in connection with the acquisition of wholesale
loans; (iii) fees and expenses incurred in connection with its securitization
program; (iv) over collateralization or reserve account requirements in
connection with loans and leases pooled and sold; (v) ongoing administrative and
other operating expenses; (vi) payments related to its tax obligations; (vii)
interest and principal payments under the Senior Notes; (viii) the costs of the
Purchase and Sale Facilities and the Repurchase Agreement; (ix) interest
payments under the unsecured revolving credit facility; and (x) the cost of any
new acquisitions that the Company may pursue.
As a result of its growing securitization program, the Company has operated,
and expects to continue to operate, on a negative cash flow basis, which is
expected to increase as the volume of its loan and asset purchases and
originations increases and its securitization program grows. During the three
months ended June 30, 1997 and 1996 and the fiscal years ended March 31, 1997,
1996 and 1995, the Company securitized and sold in the secondary market $1.6
billion, $1.0 billion, $5.0 billion, $4.0 billion and $2.3 billion of loans,
respectively. The Company used $109.2 million, $1.9 million, $153.2 million,
$300.5 million and $35.3 million of cash in operations during the three months
ended June 30, 1997 and 1996 and the fiscal years ended March 31, 1997, 1996 and
1995, respectively.
During the life of the REMICs, owner trusts or grantor trusts, the Company
subordinates to the rights of holders of senior interests a portion of the
Excess Spread otherwise due to the Company as a credit enhancement to support
the sale of senior interests. The terms of the REMICs, owner trusts and grantor
trusts generally require that the Excess Spread otherwise payable to the Company
during the early months of the trusts be used to increase the cash reserve
account, or to repay the senior interests in order to increase over
collateralization to specified maximums. The value of such "deposit" accounts is
included in the value of Excess Spread Receivables and the related gain on sale
of receivables, net of necessary reserves for credit losses, if applicable.
In addition, increased use of securitization transactions as a funding
source by the Company has resulted in a significant increase in the amount of
gain on sale of receivables recognized by the Company. During the three months
ended June 30, 1997 and 1996 and the fiscal years ended March 31, 1997, 1996 and
1995, the Company recognized gain on sale of receivables in the amounts of $64.3
million, $31.2 million, $210.9 million, $146.5 million, and $67.5 million,
respectively. The recognition of gain on sale of
36
<PAGE>
receivables will have a negative impact on the cash flows of the Company to the
extent the Company is required to pay state and Federal income taxes on these
amounts in the period recognized, notwithstanding that the Company does not
receive the cash representing the gain until later periods as the related loans
are repaid or otherwise collected.
The Company's primary sources of liquidity are sales of loans, leases and
other assets through securitization, the sale of loans, leases and other assets
under the Purchase and Sale Facilities and the Repurchase Agreement, the
issuance of shares of Common Stock, the issuance of long-term debt and the
Credit Facility. While the Company sells Excess Spread Receivables from time to
time, there is no liquid market for such Excess Spread Receivables.
The Company had $2.6 billion and $2.3 billion of committed sale capacity
under its Purchase and Sale Facilities and the Repurchase Agreement with various
financial institutions as of June 30, 1997 and March 31, 1997, respectively. The
Purchase and Sale Facilities allow the Company to sell, with limited recourse,
interests in designated pools of loans and other assets. The Repurchase
Agreement allows the Company to sell receivables held for sale to a financial
institution under an agreement that the Company will repurchase the assets.
These facilities generally have one year renewable terms (one Purchase and Sale
Facility has a two-year term), all of which will expire between October 1997 and
June 1998. On June 30, 1997 and March 31, 1997, the Company utilized $995.5
million and $590.7 million, respectively, of the capacity under these
facilities. The Company currently anticipates that it will be able to renew
these facilities when they expire and to obtain additional facilities.
The Company sells Excess Spread Receivables, with limited recourse, to
provide cash to fund the Company's securitization program. These sales
aggregated $50.0 million in fiscal 1995, $54.5 million in fiscal 1996 and $96.5
million in fiscal 1997. At June 30, 1997 and March 31, 1997, $132.2 million and
$144.9 million, respectively, of these sales were outstanding. Under the
recourse provisions of the agreements, the Company is responsible for losses
incurred by the purchaser within an agreed-upon range. The Company's performance
obligations in these transactions are guaranteed by Continental Grain for an
agreed-upon fee. Although the Company intends to continue to pursue
opportunities to sell Excess Spread Receivables, no assurance can be given that
such opportunities will be available in the future.
In order to fund the Company's growth prior to the IPO, Continental Grain
provided the Company with intercompany financing ("Intercompany Debt"). To
refinance the Intercompany Debt, simultaneously with the completion of the IPO,
Continental Grain purchased from the Company a $125 million five-year note
issued under an indenture (the "Indenture Note"), a $74 million four-year note
(the "Four Year Note") and a $125 million term note (the "Term Note") for $324
million in aggregate (collectively, the "Notes").
On August 14, 1996, the Company issued the 8 3/8% Senior Notes. Interest on
these notes is payable semiannually on February 15 and August 15 commencing
February 15, 1997. The 8 3/8% Senior Notes are redeemable as a whole or in part,
at the option of the Company, at any time or from time to time, at a redemption
price equal to the greater of (i) 100% of their principal amount and (ii) the
sum of the present values of the remaining scheduled payments of principal and
interest thereon discounted to the date of redemption on a semiannual basis at
the treasury yield plus 50 basis points, plus in each case, accrued interest to
the date of redemption. Proceeds to the Company, net of underwriting fees,
market discount and other costs were $287.7 million. Of this amount, $125.0
million was used by the Company to repay in full the Term Note payable to
Continental Grain and the remaining funds were used for general corporate
purposes, including funding loan originations and purchases, supporting
securitization transactions and other working capital needs.
On January 8, 1997, the Company entered into the Credit Facility. The
three-year facility has several interest rate pricing alternatives, including
those based on LIBOR and federal funds rates. The Credit Facility will be used
for general corporate and liquidity purposes. At June 30, 1997, $130.0 million
of drawings under the Credit Facility were outstanding.
37
<PAGE>
On March 12, 1997, the Company issued the 7 1/2% Senior Notes. Proceeds to
the Company, net of underwriting fees, market discount and other costs were
$197.7 million. Interest on these notes is payable semi-annually on March 15 and
September 15 commencing September 15 ,1997. This amount, together with other
funds of the Company, were used to repay in full the Indenture Note and the Four
Year Note payable to Continental Grain which constituted all of the remaining
financing indebtedness due to Continental Grain.
On June 4, 1997, the Company completed a primary offering of 2,800,000
shares of common stock and an additional 420,000 shares were purchased by the
underwriters to cover over-allotments (the "1997 Equity Offering"). The net
proceeds of the 1997 Equity Offering to the Company were $100.8 million.
The net proceeds from the issuance of the Senior Notes and the 1997 Equity
Offering, were used by the Company to repay the Notes and for general corporate
purposes, including funding loan originations and purchases, supporting
securitization transactions (including the retention of Excess Spread
Receivables), other working capital needs and to make certain strategic
acquisitions. Sales of the loans, leases and other assets through
securitizations, the sale of loans under the Purchase and Sale Facilities and
the Repurchase Agreement, the sale of Excess Spread Receivables and the 1997
Equity Offering, together with cash on hand, are expected to be sufficient to
fund the Company's liquidity requirements for at least the next 12 months if the
Company's future operations are consistent with management's current growth
expectations. The Company currently has commitments for financing through the
Credit Facility, however, there can be no assurance that the Company will be
successful in consummating any such financing transactions in the future on
terms that the Company would consider to be favorable. Furthermore, no assurance
can be given that Continental Grain will provide such financing if the Company
is unable to obtain third party financing or that the terms of the Continental
Grain Debt Agreements will permit the Company to obtain such financing. See
"Risk Factors--Negative Cashflows, and Capital Needs."
During fiscal 1995 and during fiscal 1996, prior to the close of the IPO,
the Company paid cash dividends to Continental Grain of $30 million and $0.3
million, respectively. The Company has no current intention to pay cash
dividends on its Common Stock. As a holding company, the ability of the Company
to pay dividends is dependent upon the receipt of dividends or other payments
from its subsidiaries. Any future determination as to the payment of dividends
will be at the discretion of the Company's Board of Directors and will depend
upon the Company's operating results, financial condition and capital
requirements, contractual restrictions, general business conditions and such
other factors as the Company's Board of Directors deems relevant. Furthermore,
covenants in the Indentures, the Credit Facility and the Continental Grain Debt
Agreements restrict the payment of dividends by the Company. There can be no
assurance that the Company will have earnings sufficient to pay a dividend on
its Common Stock or that, even if there are sufficient earnings, dividends will
be permitted under applicable law.
EFFECTS OF ACCOUNTING PRONOUNCEMENTS
See the Company's Annual Report on Form 10-K for the fiscal year ended March
31, 1997 and Quarterly Report on Form 10-Q for the quarter ended June 30, 1997,
incorporated by reference herein and attached hereto as Annex A and Annex B,
respectively.
38
<PAGE>
BUSINESS
See the Company's Annual Report on Form 10-K for the fiscal year ended March
31, 1997, incorporated herein by reference and attached hereto as Annex A.
REGULATION
See the Company's Annual Report on Form 10-K for the fiscal year ended March
31, 1997, incorporated herein by reference and attached hereto as Annex A.
39
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The directors and executive officers of the Company and their respective
ages and positions are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------------------- --- -----------------------------------------------
<S> <C> <C>
James E. Moore................................. 50 President, Chief Executive Officer and Director
Robert A. Major................................ 50 Executive Vice President of the Company and
President and Chief Executive Officer of
ContiMortgage
Glenn S. Goldman............................... 35 Executive Vice President of the Company and
Co-President of ContiFinancial Services
Scott M. Mannes................................ 38 Executive Vice President of the Company and
Co-President of ContiFinancial Services
Peter Abeles................................... 42 Senior Vice President of the Company and
Managing Director of ContiFinancial Services
Robert J. Babjak............................... 54 Senior Vice President of the Company and
Executive Vice President and Chief Operating
Officer of ContiMortgage
A. John Banu................................... 42 Senior Vice President of the Company and Senior
Managing Director of ContiFinancial Services
Daniel J. Egan................................. 42 Senior Vice President of the Company and Senior
Vice President and Chief Financial Officer of
ContiMortgage
Michael J. Festo............................... 45 Senior Vice President, Human Resources
Alan L. Langus................................. 50 Senior Vice President, Chief Counsel and
Secretary
Jerome M. Perelson............................. 58 Senior Vice President of the Company and
Managing Director and Chief Credit Officer of
ContiFinancial Services
Daniel J. Willett.............................. 47 Senior Vice President and Chief Financial
Officer of the Company and Managing Director of
ContiFinancial Services
Debra J. Huddleston............................ 41 Vice President--Internal Audit
Susan E. O'Donovan............................. 36 Vice President and Controller
James J. Bigham................................ 59 Director and Chairman of the Board
Paul J. Fribourg............................... 43 Director
John W. Spiegel................................ 56 Director
Donald L. Staheli.............................. 65 Director
John P. Tierney................................ 65 Director
Lawrence G. Weppler............................ 52 Director
Michael J. Zimmerman........................... 46 Director
</TABLE>
JAMES E. MOORE. Mr. Moore has been President, Chief Executive Officer and a
Director of the Company since October 1995. He has been President and Managing
Director of ContiFinancial Services since 1988 and Chairman of ContiMortgage
since 1990. Mr. Moore joined ContiFinancial Services in 1983 as an investment
banker. He is also a Director of Student Loan Marketing Association (a non-bank
finance company).
40
<PAGE>
ROBERT A. MAJOR. Mr. Major has been Executive Vice President of the Company
since October 1995, President and a Director of ContiMortgage since July 1995
and Chief Executive Officer of ContiMortgage since June 1996. Prior to becoming
Chief Executive Officer, Mr. Major was the Chief Operating Officer, a position
he had held since July 1995. From February 1993 to July 1995, Mr. Major was
Chief Operating Officer for NationsCredit Corporation (a diversified financial
services company). From April 1990 to February 1993, Mr. Major was Chief
Executive Officer of Chrysler First (a consumer finance company acquired by
NationsBank Corporation in February 1993).
GLENN S. GOLDMAN. Mr. Goldman has been Executive Vice President of the
Company since July 1997, prior to which he had been Senior Vice President since
October 1995. He joined ContiFinancial Services in April 1990 and was appointed
Managing Director of ContiFinancial Services in August 1992 after holding the
position of Vice President, Corporate Finance. From 1986 to 1990, Mr. Goldman
was an Assistant Vice President of Merrill Lynch & Company. He was appointed
Co-President of ContiFinancial Services in July 1997.
SCOTT M. MANNES. Mr. Mannes has been Executive Vice President of the
Company since July 1997, prior to which he had been Senior Vice President since
October 1995. He joined ContiFinancial Services in September 1990 and was
appointed Managing Director of ContiFinancial Services in August 1992 after
holding the position of Vice President, Corporate Finance. Prior to joining
ContiFinancial Services, Mr. Mannes was associated with the Financial Guarantee
Insurance Company. He was appointed Co-President of ContiFinancial Services in
July 1997.
PETER ABELES. Mr. Abeles has been Senior Vice President of the Company
since October 1995. He joined ContiFinancial Services in 1989 and was appointed
Managing Director of ContiFinancial Services in August 1992 after serving as
Vice President, Corporate Finance from October 1989 to August 1992.
ROBERT J. BABJAK. Mr. Babjak has been Senior Vice President of the Company
since October 1995. He was appointed Executive Vice President and Chief
Operating Officer of ContiMortgage in June 1996 prior to which he was Senior
Vice President, Chief Credit Officer, a position he had held since October 1995
when he was also appointed as a Director of ContiMortgage. Prior to October 1995
he was Vice President, Chief Credit Officer of ContiMortgage, a position he had
held since April 1992. Mr. Babjak joined ContiMortgage in June 1991 as Chief
Credit Officer. From 1989 to June 1991, Mr. Babjak was a Senior Loan Officer of
Mutual Mortgages Services, Inc.
A. JOHN BANU. Mr. Banu has been Senior Vice President of the Company since
October 1995. He joined ContiFinancial Services in 1984 as Vice President, Debt
Placement and was appointed Managing Director of ContiFinancial Services in
August 1992 and Senior Managing Director in July 1997.
DANIEL J. EGAN. Mr. Egan has been Senior Vice President of the Company
since October 1995. He was appointed Senior Vice President and Chief Financial
Officer of ContiMortgage in 1995, prior to which he was Vice President, Chief
Financial Officer of ContiMortgage, a position he had held since April 1991.
From October 1990 to April 1991, Mr. Egan was Controller of ContiMortgage.
MICHAEL J. FESTO. Mr. Festo has been Senior Vice President, Human Resources
of the Company since September 1996, prior to which he held the position of Vice
President, Human Resources of the Company from October 1995. He was appointed
Vice President, Human Resources of ContiTrade Services Corporation in July 1990.
Mr. Festo held a number of staff and executive human resources positions within
Continental Grain since joining Continental Grain in 1974.
ALAN L. LANGUS. Mr. Langus has been Senior Vice President, Chief Counsel
and Secretary of the Company since September 1996, prior to which he held the
position of Vice President, Chief Counsel and Secretary of the Company from
October 1995. He was Vice President and Chief Counsel of ContiTrade Services
Corporation between December 1989 and October 1995.
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JEROME M. PERELSON. Mr. Perelson has been Senior Vice President of the
Company since February 1997 prior to which he held the position of Senior Vice
President and Chief Financial Officer of the Company from October 1995. He has
been Managing Director and Chief Credit Officer of ContiFinancial Services since
September 1995. Mr. Perelson joined Continental Grain in 1971. He was appointed
Managing Director and Chief Credit Officer of ContiTrade Services Corporation in
August 1989 and President in November 1993, after serving as Corporate Deputy
Treasurer of Continental Grain.
DANIEL J. WILLETT. Mr. Willett has been Senior Vice President and Chief
Financial Officer of the Company since February 1997. He was also a Director of
the Company from October 1995 until January 1997. He has been a Managing
Director of ContiFinancial Services since February 1997. Mr. Willett also was a
Vice President and Treasurer of Continental Grain from March 1990 to January
1997.
DEBRA J. HUDDLESTON. Ms. Huddleston has been Vice President--Internal Audit
of the Company since May 1997. She was appointed Vice President--Internal Audit
of ContiMortgage in July 1992. Prior to that, Ms. Huddleston also held the
position of Controller--Government Securities and Foreign Exchange Division of
Continental Grain since 1991.
SUSAN E. O'DONOVAN. Ms. O'Donovan has been Vice President and Controller of
the Company since October 1995. She joined ContiFinancial Services as Controller
in April 1991. From August 1983 until March 1991, Ms. O'Donovan was an auditor
at Price Waterhouse LLP.
JAMES J. BIGHAM. Mr. Bigham has been a Director of the Company since
October 1995. He also has been a Director, Executive Vice President and Chief
Financial Officer of Continental Grain since August 1989 and a Director of
ContiMortgage since 1990.
PAUL J. FRIBOURG. Mr. Fribourg has been a Director of the Company since
October 1995. He has been President and Chief Operating Officer of Continental
Grain since June 1994. From April 1990 to June 1994, Mr. Fribourg served as
Executive Vice President of the Bulk Commodities Group of Continental Grain. Mr.
Fribourg is the son of Michel Fribourg.
JOHN W. SPIEGEL. Mr. Spiegel has been a Director of the Company and
Chairman of the Audit Committee since February 1996. Mr. Spiegel has been
Executive Vice President and Chief Financial Officer of SunTrust Banks, Inc.
since 1985 and Treasurer of Trust Company of Georgia since 1978. Mr. Spiegel
also is currently a member of the Boards of Directors of Rock-Tenn Company (a
manufacturer of paperboard products) and Student Loan Marketing Association (a
non-bank finance company).
DONALD L. STAHELI. Mr. Staheli has been a Director of the Company since
October 1995 and Chairman of the Compensation Committee since February 1996. He
has been Chairman of the Board of Directors of Continental Grain since June 1994
and Chief Executive Officer of Continental Grain since 1988. From 1988 until
June 1994, Mr. Staheli served as President and a Director of Continental Grain.
Mr. Staheli serves as a Director of Prudential Life Insurance Company of America
and Bankers Trust Company. Since October 21, 1996, Mr. Staheli has served as a
member of the Supervisory Board of Directors of Frensenius Medical Care A.G.
JOHN P. TIERNEY. Mr. Tierney has been a Director of the Company and
Chairman of the Independent Directors' Committee since February 1996. From 1987
until his retirement in December 1994, Mr. Tierney was the Chairman of the Board
and Chief Executive Officer of Chrysler Financial Corporation (a non-bank
finance company). Mr. Tierney serves as a Director of RCSB Financial, Inc. (the
holding company for Rochester Community Savings Bank, a consumer banking and
lending company).
LAWRENCE G. WEPPLER. Mr. Weppler has been a Director of the Company since
October 1995. He also has been Vice President and General Counsel-Corporate of
Continental Grain since April 1993. From 1980 to April 1993, Mr. Weppler served
as Deputy General Counsel of Continental Grain.
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MICHAEL J. ZIMMERMAN. Mr. Zimmerman has been a Director of the Company
since February 1997. He also was a Senior Vice President-Investments and
Strategy of Continental Grain since May 1996. From January 1985 to April 1996,
Mr. Zimmerman was a managing director at Salomon Brothers. Mr. Zimmerman is also
currently a member of the Board of Directors of U.S. Can Corporation (a
manufacturing company).
The Company has compensated its officers and directors in part through the
issuance of restricted Common Stock and the granting of stock options. The
directors and executive officers as a group (20 persons total) own 2,423,703
shares of Common Stock, or 5% of the total outstanding Common Stock.
DESCRIPTION OF CERTAIN INDEBTEDNESS AND FINANCING ARRANGEMENTS
CERTAIN INDEBTEDNESS
NOTES
In August 1996, the Company issued the 8 3/8% Senior Notes, and, in March
1997, the Company issued the 7 1/2% Senior Notes. The Indentures contain a
number of significant restrictive covenants including: (i) limitations on
indebtedness; (ii) limitations on liens; (iii) limitations on restricted
payments such as dividends, repurchases of the Company's stock and repurchase of
subordinated obligations; (iv) limitations on restrictions on distributions from
subsidiaries; (v) limitations on sales of assets and subsidiary stock; and (vi)
limitations on merger and consolidation. Upon receiving investment grade ratings
from Moody's Investors Service, Inc. and Standard & Poor's Ratings Services with
respect to the Senior Notes, except for the limitations on liens, all other
restrictions described above will be suspended. No assurance can be given that
the Company will receive an investment grade rating at any time in the future.
The Indentures also contain customary events of default relating to the Company
and its subsidiaries. The Senior Notes are redeemable at the option of the
holders of the Senior Notes upon the occurrence of a "change of control." A
"change of control" as defined in the Indentures includes the occurrence of: (i)
the acquisition of 35% of the outstanding Common Stock by a person other than
Continental Grain or its shareholders at a time when Continental Grain or its
shareholders own less than such amount owned by such greater than 35%
shareholder; (ii) a change in the composition of a majority of the Board of
Directors during any two consecutive years; and (iii) certain mergers and
consolidations or sale of all or substantially all of the assets of the Company.
CREDIT FACILITY
In January 1997, the Company entered into the Credit Facility, a $200
million unsecured revolving credit facility lead-managed by Credit Suisse and
Dresdner Bank, with participation by a group of twelve other major U.S. and
foreign banks. The Company has the option of several interest rate pricing
alternatives under this three-year facility, including those based on LIBOR and
the federal funds rates. The Credit Facility also contains a number of
restrictive covenants including: (i) limitations on indebtedness; (ii)
limitations on liens; (iii) minimum net worth requirements; (iv) limitations on
restrictions on distributions from subsidiaries; (v) limitations on sales of
assets and subsidiary stock; and (vi) limitations on merger and consolidations.
The Credit Facility also includes a monthly asset coverage test to determine
availability under the Credit Facility. Currently the Company has full use of
the facility based on this test.
FINANCING ARRANGEMENTS
The Company had $2.6 billion of committed sale capacity under its Purchase
and Sale Facilities and Repurchase Agreements with various financial
institutions as of June 30, 1997. The Purchase and Sale Facilities allow the
Company to sell, with limited recourse, interests in designated pools of loans
and other assets. On March 31, 1997, the Company entered into the Repurchase
Agreement. The Repurchase Agreement allows the Company to sell receivables held
for sale to a financial institution under an agreement that the Company will
repurchase the assets. These facilities generally have one year renewable
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terms (one of the Company's seven Purchase and Sale Facilities has a two-year
term), all of which will expire between October 1997 and July 1998. On June 30,
1997, the Company utilized $995.5 million of the capacity under the Purchase and
Sale Facilities and Repurchase Agreements. The Company currently anticipates
that it will be able to renew these facilities when they expire and to obtain
additional facilities.
See "Risk Factors--Negative Cashflows and Capital Needs--Dependence on
Purchase and Sale Facilities" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."
SHARES ELIGIBLE FOR FUTURE SALE
As of July 31, 1997, the Company had 47,623,984 shares of Common Stock
outstanding, of which the approximately 10,444,886 shares are freely tradeable.
All other shares will be "restricted shares" for purposes of the Securities Act,
subject to the volume and other limitations set forth in Rule 144 promulgated
under the Securities Act. The Company and Continental Grain are parties to an
agreement which provides Continental Grain with certain registration rights. The
Company has filed a registration statement covering the sale of up to 4,487,895
shares of Common Stock reserved for issuance under the 1995 Stock Plan and the
Directors Plan. Under the 1995 Stock Plan, the Company granted certain employees
of the Company awards of 1,330,532 shares of "restricted" Common Stock and
nonqualified stock options representing the right to acquire 2,445,412 shares of
Common Stock, which will vest in full by March 31, 2000. Upon vesting, the
shares of Common Stock representing such restricted stock or stock options will
be freely tradeable, except for any such shares beneficially owned by an
"affiliate" of the Company, as such term is defined in the Securities Act (the
sale of which will be subject to timing, volume, manner of sale and other
restrictions under Rule 144).
In general, under Rule 144, if one year has elapsed since the later of the
date of acquisition of restricted shares from the Company or any affiliate of
the Company, a non-affiliate acquiror or subsequent holder thereof is entitled
to sell within any three-month period a number of shares that does not exceed
the greater of 1% of the then outstanding shares of the Company's Common Stock
(476,240 shares as of July 31, 1997) or the average weekly trading volume of the
Company's Common Stock on all exchanges and/or reported through the automated
quotation system of a registered securities association during the four calendar
weeks preceding the date on which notice of the sale is filed with the
Commission. Sales under Rule 144 are also subject to certain manner of sales
provisions, notice requirements and the availability of current public
information about the Company. If two years have elapsed since the later of the
date of acquisition of restricted shares from the Company or from any affiliate
of the Company, and the acquiror or subsequent holder thereof is deemed not to
have been an affiliate of the Company at any time during the 90 days preceding a
sale, such person would be entitled to sell such shares in the public market
under Rule 144(k) without regard to the volume limitations, manner of sale
provisions, public information requirements or notice requirements.
DESCRIPTION OF CAPITAL STOCK
GENERAL
The authorized capital stock of the Company consists of 250,000,000 shares
of Common Stock, par value $0.01 per share and 25,000,000 shares of preferred
stock, par value $0.01 per share (the "Preferred Stock"). As of July 31, 1997,
the Company had 47,623,984 shares of Common Stock outstanding and 2,686,783
shares of Common Stock issuable upon exercise of employee stock options. The
following summary description of the capital stock of the Company is qualified
in its entirety by reference to the Restated Certificate of Incorporation and
the By-laws of the Company, copies of which are incorporated by reference
herein.
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COMMON STOCK
Subject to the rights of the holders of any Preferred Stock which may be
outstanding, each holder of Common Stock on the applicable record date is
entitled to receive such dividends as may be declared by the Board of Directors
out of funds legally available therefor, and, in the event of liquidation, to
share pro rata in any distribution of the Company's assets after payment or
providing for the payment of liabilities and the liquidation preference of any
outstanding Preferred Stock. Each holder of Common Stock is entitled to one vote
for each share held of record on the applicable record date on all matters
presented to a vote of stockholders, including the election of directors.
Holders of Common Stock have no cumulative voting rights or preemptive rights to
purchase or subscribe for any stock or other securities and there are no
conversion rights or redemption or sinking fund provisions with respect to such
stock. All outstanding shares of Common Stock are, and the shares of Common
Stock offered hereby will be when issued, fully paid and nonassessable.
The Common Stock is listed on the NYSE under the symbol "CFN."
The transfer agent and registrar for the Common Stock is First Chicago Trust
Company of New York.
PREFERRED STOCK
The Company's Board of Directors is authorized to issue up to 25,000,000
shares of Preferred Stock from time to time in one or more classes or series and
with such voting powers, full or limited, or without voting powers, and with
such designations, preferences and relative, participating, optional or other
special rights, and the qualifications, limitations or restrictions thereof, as
the Board of Directors may be permitted to fix under the laws of the State of
Delaware as in effect at the time such class or series is created.
The authorized but unissued shares of Common Stock and Preferred Stock are
available for future issuance without stockholder approval. These additional
shares may be utilized for a variety of corporate purposes, including future
public offerings to raise additional capital, corporate acquisitions and
employee benefit plans. The existence of authorized but unissued and unreserved
Common Stock and Preferred Stock may enable the Board of Directors to issue
shares to persons friendly to current management which could render more
difficult or discourage an attempt to obtain control of the Company by means of
a proxy contest, tender offer, merger, or otherwise, and thereby protect the
continuity of the Company's management.
DIRECTOR'S LIABILITY
The Company has included in its Restated Certificate of Incorporation
provisions to eliminate the personal liability of its directors for monetary
damages resulting from breaches of their fiduciary duty. This provision does not
eliminate liability for breaches of the duty of loyalty, acts or omissions not
in good faith or which involve intentional misconduct or a knowing violation of
law, violations under Section 174 of the Delaware General Corporation Law (the
"Delaware Law") concerning the unlawful payment of dividends or stock
redemptions or repurchases or for any transaction from which the director
derived an improper personal benefit. These provisions will not limit the
liability of the Company's directors under the Federal securities laws. The
Company believes that these provisions are necessary to attract and retain
qualified persons as directors and officers.
SECTION 203 OF THE DELAWARE LAW
The Company is subject to Section 203 of the Delaware Law. Section 203
prohibits publicly held Delaware corporations from engaging in a "business
combination" with an "interested stockholder" for a period of three years
following the date of the transaction in which the person or entity became an
interested stockholder, unless (i) prior to such date, either the business
combination or the transaction
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which resulted in the stockholder becoming an interested stockholder is approved
by the Board of Directors of the corporation, (ii) upon the consummation of the
transaction which resulted in the stockholder becoming an interested
stockholder, the interested stockholder owned at least 85% of the outstanding
voting stock of the corporation (excluding for this purpose certain shares owned
by persons who are directors and also officers of the corporation and by certain
employee benefit plans) or (iii) on or after such date the business combination
is approved by the Board of Directors of the corporation and by the affirmative
vote (and not by written consent) of at least 66% of the outstanding voting
stock which is not owned by the interested stockholder. For the purposes of
Section 203, a "business combination" is broadly defined to include mergers,
asset sales and other transactions resulting in the financial benefit to the
"interested stockholder." An interested stockholder is a person who together
with affiliates and associates, owns (or within the immediately preceding three
years did own) 15% or more of the corporation's voting stock.
CERTIFICATE AND BY-LAW PROVISIONS
Certain provisions of the Restated Certificate of Incorporation and By-laws
of the Company summarized in the following paragraphs may be deemed to have an
anti-takeover effect and may delay, defer or prevent a tender offer or takeover
attempt that a stockholder might consider in its best interest, including those
attempts that might result in a premium over the market price for the shares
held by stockholders.
CLASSIFIED BOARD OF DIRECTORS. The Restated Certificate of Incorporation
provides for the Board of Directors to be divided into three classes of
directors serving staggered three-year terms. As a result, approximately
one-third of the Board of Directors will be elected each year. Moreover, under
Delaware Law, in the case of a corporation having a classified board,
stockholders may remove a director only for cause. This provision, when coupled
with the provision of the Restated Certificate of Incorporation authorizing only
the Board of Directors to fill vacant directorships, will preclude a stockholder
from removing incumbent directors without cause and simultaneously gaining
control of the Board of Directors by filling the vacancies created by such
removal with its own nominees.
SPECIAL MEETING OF STOCKHOLDERS. The Restated Certificate of Incorporation
and By-laws provide that special meetings of stockholders of the Company may be
called only by the Board of Directors, the Chairman of the Board of Directors or
the Chief Executive Officer. This provision will make it more difficult for
stockholders to take actions opposed by the Board of Directors.
STOCKHOLDER ACTION BY WRITTEN CONSENT. The Restated Certificate of
Incorporation and By-laws provide that no action required or permitted to be
taken at any annual or special meeting of the stockholders of the Company may be
taken without a meeting, and the power of stockholders of the Company to consent
in writing, without a meeting, to the taking of any action is specifically
denied.
ADVANCE NOTICE REQUIREMENTS FOR STOCKHOLDER PROPOSALS AND DIRECTOR
NOMINATIONS. The By-laws provide that stockholders seeking to bring business
before an annual meeting of stockholders, or to nominate candidates for election
as directors at an annual or special meeting of stockholders, must provide
timely notice thereof in writing. To be timely, a stockholder's notice must be
delivered to or mailed and received at the principal executive offices of the
Company not less than 30 days nor more than 60 days prior to the meeting;
provided, however, that in the event that less than 40 days' notice or prior
public disclosure of the date of the meeting is given or made to stockholders,
notice by the stockholder to be timely must be received no later than the close
of business on the 10th day following the day on which such notice of the date
of the meeting was mailed or such public disclosure was made. The By-laws also
specify certain requirements for a stockholder's notice to be in proper written
form. In addition, no business may be transacted at any special meeting of the
Board of Directors other than (i) such business stated in a notice of meeting or
waiver of notice (approved by the Company) or (ii) such business as is related
to the purpose of such meeting and which is properly brought before the meeting
by or at the direction of the Board of Directors. These provisions may preclude
some stockholders from bringing matters before the
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stockholders at an annual or special meeting or from making nominations for
directors at an annual or special meeting.
PLAN OF DISTRIBUTION
The Company is advised that under the terms of the STRYPES, ML & Co. is
obligated to pay and discharge the STRYPES at maturity by delivering to the
holders thereof a specified number of shares of Common Stock (and/or, pursuant
to certain antidilution provisions of the STRYPES, cash, securities and other
property), subject to ML & Co.'s right to deliver an amount in cash with an
equal value. The Company is advised that pursuant to the terms of the Forward
Contract, Continental Grain is obligated to deliver to the ML & Co. Subsidiary
immediately prior to maturity of the STRYPES that number of shares of Common
Stock (and/or cash, securities and other property) equal to the number (or
amount) required by ML & Co. to pay and discharge all of the STRYPES at
maturity, subject to Continental Grain's right to satisfy its obligation under
the Forward Contract by delivery of an amount in cash with an equal value. The
Company is advised that, under the Forward Contract, ML & Co. has agreed to pay
and discharge the STRYPES at maturity by delivering to the holders thereof the
form of consideration that the ML & Co. Subsidiary receives from Continental
Grain. The Company is not a party to the Forward Contract, has no obligations
thereunder or with respect to the STRYPES, which are securities of ML & Co. and
are not securities of the Company, and takes no responsibility for the foregoing
information, which is set forth in greater detail in the STRYPES Prospectus.
The Company and certain members of management of the Company have agreed not
to offer, sell, contract to sell or otherwise dispose of, directly or
indirectly, or file or cause to be filed a registration statement under the
Securities Act with respect to, any shares of Common Stock, securities
convertible into, exchangeable for or repayable with such shares or rights or
warrants to acquire such shares, for a period of 90 days after the date of this
Prospectus without the prior written consent of Merrill Lynch, Pierce, Fenner &
Smith Incorporated (the "Underwriter of the STRYPES"), except that the Company
may, without such consent, grant options, issue shares of Common Stock upon the
exercise of outstanding options, or otherwise issue shares of Common Stock
pursuant to its employee benefit plans. The Company is advised that Continental
Grain has agreed not to offer, sell, contract to sell or otherwise dispose of,
directly or indirectly, or cause to be filed a registration statement under the
Securities Act with respect to, any shares of Common Stock, securities
convertible into, exchangeable for or repayable with such shares or rights or
warrants to acquire such shares, for a period of 90 days after the date of this
Prospectus without the prior written consent of the Underwriter of the STRYPES.
The Company has agreed to indemnify ML & Co. and the Underwriter of the
STRYPES against certain liabilities, including liabilities under the Securities
Act, with respect to the information in this Prospectus (including the documents
incorporated by reference herein) other than information furnished to the
Company in writing by ML & Co. or the Underwriter of the STRYPES expressly for
use herein.
Until the distribution of the STRYPES is completed, rules of the Commission
may limit the ability of the Underwriter of the STRYPES to bid for and purchase
the STRYPES or shares of the Common Stock. As an exception to these rules, the
Underwriter of the STRYPES is permitted to engage in certain transactions that
stabilize the price of the STRYPES or the Common Stock. Such transactions
consist of bids or purchases for the purpose of pegging, fixing or maintaining
the price of the STRYPES or the Common Stock.
If the Underwriter of the STRYPES creates a short position in the STRYPES in
connection with the Offering, I.E., if it sells more STRYPES than are set forth
on the cover page of the STRYPES Prospectus, the Underwriter of the STRYPES may
reduce that short position by purchasing STRYPES in the open market. The
Underwriter of the STRYPES may also elect to reduce any short position by
exercising all or part of the over-allotment option described on the cover of
this Prospectus.
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In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases.
Neither ML & Co. nor the Underwriter of the STRYPES makes any representation
or prediction as to the direction or magnitude of any effect that the
transactions described above may have on the price of the STRYPES or the Common
Stock. In addition, neither ML & Co. nor the Underwriter of the STRYPES makes
any representation that the Underwriter of the STRYPES will engage in such
transactions or that such transactions, once commenced, will not be discontinued
without notice.
LEGAL MATTERS
The validity of the Common Stock offered hereby and certain other legal
matters in connection with the Offering will be passed upon for the Company by
Dewey Ballantine, New York, New York. From time to time, Dewey Ballantine has
provided legal services for the Underwriter of the STRYPES.
EXPERTS
The Consolidated Financial Statements included in the Company's Annual
Report on Form 10-K for the fiscal year ended March 31, 1997, incorporated by
reference herein and attached hereto as Annex A, have been audited by Arthur
Andersen LLP, independent public accountants, as indicated in their report with
respect thereto, and are incorporated herein in reliance upon the authority of
said firm as experts in giving said report.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements under the headings "Prospectus Summary" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
elsewhere in this Prospectus, and under the heading "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in the Company's
Annual Report on Form 10-K for the fiscal year ended March 31, 1997 and
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, attached
hereto as Annex A and Annex B, respectively, constitute "forward-looking
statements" within the meaning of the Reform Act. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors,
which may cause the actual results, performances or achievements of the Company
to be materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. There are many
important factors that could cause the Company's actual results to differ
materially from those indicated in the forward-looking statements. Such factors
include, but are not limited to, general economic conditions, including interest
rate risk, prepayment, delinquency and default rates, changes (legislative and
otherwise) in the asset securitization industry, demand for the Company's
services, the impact of certain covenants in loan agreements of the Company and
Continental Grain, the degree to which the Company is leveraged, the Company's
needs for financing, and other risks identified in this Prospectus and in the
Company's other filings with the Commission.
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GLOSSARY
<TABLE>
<CAPTION>
Adjustable Rate Mortgages or
ARMs....................... Mortgages with a variable interest rate which typically
adjust off LIBOR or United States Treasury rates.
<S> <C>
"A", "B", "C" and "D" Credit
Grades..................... A grading system used in the finance industry to reflect a
borrower's overall credit quality. The grade assigned by a
lender to each borrower is a function of the borrower's
historical payment performance on his or her outstanding
consumer debt. Such debt may include credit cards and
automobile loans. The Company establishes the prices it will
pay for loans based on the borrower's credit profile,
prevailing market conditions and other factors.
Commercial/Multi-family
Loans...................... Loans secured by commercial properties including
multi-family dwellings, self-storage facilities, assisted
living and other health-related facilities, and retail and
industrial buildings.
Conduits..................... Stand-alone securitization vehicles where the originator(s),
underwriter(s), servicer(s) and seller(s) may all be
different parties coming together to generate loans or other
assets to be serviced and securitized. Conduits allow
smaller originators to sell their assets into a single
securitizable pool, thus benefitting from economies of scale
and the ability to share the fixed transaction costs
associated with securitization.
Debt-to-Income Ratio......... The ratio of a borrower's monthly debt service requirements
to his or her monthly income.
Equipment Leases............. Leases of assets primarily to commercial users. Leased
assets may include office equipment and medical equipment.
Excess Spread................ In a securitization, generally, the excess of the weighted
average coupon on each pool of loans or other assets sold
over the sum of the investor pass-through rate plus a normal
servicing fee, a trustee fee, an insurance fee, if any, and
an estimate of annual future credit losses related to the
loans or other assets sold over the life of the loans or
other assets. The Excess Spread is either a contractual
right or a certificated security.
Excess Spread Receivable..... The present value of the Excess Spread. When the Company
completes a securitization, it recognizes a gain on sale of
the loans or other assets sold equal to the amount of the
Excess Spread Receivable less the origination and
underwriting costs in the related securitization and records
the Excess Spread Receivable as an asset on its balance
sheet. On the Company's consolidated balance sheet, the
Excess Spread Receivable is reduced as cash distributions
are received over the actual life of the loans or other
assets securitized. The Excess Spread Receivable represent
interest-only and residual certificates.
Franchisee Loans............. Loans to franchisees of national restaurant chains or other
service chains. The loans are secured by fixtures, equipment
and cash flows.
</TABLE>
i
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Gain on Sale of
Receivables................ The gross income from the structuring and sale of loans and
other assets into REMICs, owner trusts and grantor trusts.
Gain on sale of receivables represents the Excess Spread
Receivables less cost of originating and structuring the
loans and other assets.
Ginnie Mae ("GNMA"),
Fannie Mae ("FNMA"),
Freddie Mac ("FHLMC")...... Government National Mortgage Association, Federal National
Mortgage Association and Federal Home Loan Mortgage
Corporation.
Home Equity Loans............ Loans made to borrowers typically for debt consolidation,
home improvements, education or refinancing and secured by a
first or second mortgage on one- to four-family residential
properties.
Interest-only Certificate.... Represents Excess Spread Receivables which represent the
right to receive interest payments on a securitization
trust's underlying assets and is subject to changes in value
due to changes in prepayment rates. Generally, the
Interest-Only Certificate is senior to the Residual
Certificate(s).
LIBOR........................ London interbank offered rate.
Non-conforming Home Equity
Loans...................... Home equity loans made to borrowers whose financing needs
cannot be met by traditional financial institutions due to
credit exceptions or other factors and cannot be marketed to
agencies such as Ginnie Mae, Fannie Mae and Freddie Mac.
Non-prime Auto Loans and
Leases..................... Automobile loans or leases secured by new or used
automobiles made generally to "B" or "C" Credit Grade
borrowers.
Overcollateralization........ The amount by which the outstanding principal balance of
assets which have been securitized exceeds the outstanding
principal balance of the certificates issued by the related
trust. The surplus principal of the assets is available to
absorb losses. The amount of overcollateralization required
for a securitization is specified for each issuance.
Overcollateralization is developed by applying Excess Spread
as an accelerated payment of principal on the certificates.
Once the required level of overcollateralization is reached,
and for so long as such level is maintained, the Excess
Spread flows through to the Company.
Purchase and Sale
Facilities................. Agreements pursuant to which the Company sells certain of
its qualifying securitizable assets with limited recourse to
certain financial institutions subject to various repurchase
options.
Purchase Premium Refunds..... That portion of the premium paid by the Company to a
wholesale originator upon purchase of a loan which is
required to be repaid by the originator if the loan prepays
before a contractually set time.
REMIC........................ Real estate mortgage investment conduit.
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REMICs, Owner Trusts and
Grantor Trusts............. Trusts formed to purchase securitizable assets, issue
pass-through certificates and make distributions to
investors. Such trusts are organized in accordance with the
Internal Revenue Code so as to not be subject to corporate
tax at the entity level.
Reserve Account.............. A reserve account serves the same purpose as
Overcollateralization. However, instead of applying Excess
Spread as a payment of principal on the certificates, it is
accumulated in an account until a required amount is
reached. Funds from this account are available to cover
losses realized on loans or other assets held by a trust.
Residual Certificates........ Represent Excess Spread Receivables which are subject to
change in value due to prepayment rates and credit losses.
The Residual Certificates are subordinate certificates and
are in a first loss position.
Securitization............... The sale by the Company of loans or other assets it has
originated or purchased to a trust (or other special purpose
entity). Concurrently, the trust issues securities (usually
pass-through certificates) to investors in a private
placement or a public offering. The Company is paid a
purchase price consisting of cash from the proceeds of the
sale of the securities and an interest in the loans or other
assets securitized generally in the form of Interest-only
Certificates and/or Residual Certificates (i.e., the Excess
Spread Receivable).
Strategic Alliance........... A relationship between the Company and an originator of
consumer and commercial loans, leases and receivables. In
the relationship, the Company provides financing and asset
securitization expertise (including warehouse financing,
interest rate hedging services and the structuring and
placement of the asset portfolio in the form of asset-backed
securities) to the asset originator and the asset originator
provides a consistent flow of securitizable assets to the
Company. In certain of its Strategic Alliances, the Company
may receive warrants or warrant-like equity participations
in Strategic Alliance clients or may otherwise seek to make
equity investments in its Strategic Alliance clients.
Strategic Alliance Equity
Interests.................. Warrants, warrant-like equity participations or other equity
investments in Strategic Alliance clients.
Sub-prime Auto Loans and
Leases..................... Automobile loans or leases made generally to "C-" or "D"
Credit Grade borrowers.
Timeshare Loans.............. Loans made to purchase a real property interest in specific
units at vacation resort properties. Typically, the
borrowers' rights to use and occupy the real property are
subject to limitations.
Title I Home Improvement
Loans...................... Loans to homeowners, a portion of which is guaranteed by the
U.S. government, for the purpose of certain pre-qualified
home improvements.
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Warehouse Financing.......... Secured loan facilities or purchase commitments provided to
asset originators to facilitate the accumulation of
securitizable assets prior to securitization. Commitments
are typically for one year or less and are designed to fund
only securitizable assets.
Wholesale Loans.............. Loans purchased by the Company in bulk sales from mortgage
bankers and commercial banks.
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
1-14074
(Commission File Number)
CONTIFINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
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DELAWARE 13-3852588
(State of other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
277 PARK AVENUE 10172
NEW YORK, NEW YORK (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (212) 207-2800
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK NEW YORK STOCK EXCHANGE
(Title of each Class) (Name of each exchange on which registered)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
(Title of Class)
Indicate by check mark whether 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. ______
As of June 9, 1997 the aggregate market value of the voting stock held by
non-affiliates of the registrant was $356,431,735.
The Company had 47,623,984 shares of common stock outstanding as of June 9,
1997.
Document incorporated by reference:
The information required by Part III, Items 10,11,12 and 13, is incorporated
by reference to ContiFinancial Corporation's proxy statement which will be filed
with the Securities and Exchange Commission not more than 120 days after March
31, 1997.
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CONTIFINANCIAL CORPORATION
TABLE OF CONTENTS
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PART I.
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PAGE
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Item 1. Business.................................................................... 3
Item 2. Properties.................................................................. 22
Item 3. Legal Proceedings........................................................... 22
Item 4. Submission of Matters to a Vote of Security Holders......................... 22
<CAPTION>
PART II.
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Item 5. Market for Registrant's Common Equity and Related Stockholder Matters....... 23
Item 6. Selected Financial Data..................................................... 24
Item 7. Management's Discussion and Analysis of Financial Condition and Results of 26
Operations..................................................................
Item 8. Financial Statements and Supplementary Data................................. 38
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial 63
Disclosure..................................................................
<CAPTION>
PART III.
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Item 10. Directors and Executive Officers of the Registrant.......................... 64
Item 11. Executive Compensation...................................................... 64
Item 12. Security Ownership of Certain Beneficial Owners and Management.............. 64
Item 13. Certain Relationships and Related Transactions.............................. 64
<CAPTION>
PART IV.
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Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............. 64
Signatures.................................................................. 66
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PART I
ITEM 1. BUSINESS.
GENERAL
ContiFinancial Corporation together with its subsidiaries, (collectively,
the "Company" or "ContiFinancial"), engages in the consumer and commercial
finance business by originating and servicing primarily home equity loans and
providing financing and asset securitization structuring and placement services
to originators of a broad range of loans, leases, receivables and other assets.
Securitization provides significant benefits, including greater operating
leverage and reduced costs of funds, in the financing of assets, such as
non-conforming home equity loans, equipment leases, home improvement loans,
franchisee loans, commercial/multi-family loans, non-prime and sub-prime auto
loans and leases, and timeshare loans. For the years ended March 31, 1997 and
1996, the Company originated or purchased $3.9 billion and $2.3 billion,
respectively, of home equity loans through its subsidiary, ContiMortgage
Corporation ("ContiMortgage") of which $3.6 billion and $2.0 billion,
respectively, of these loans were securitized or sold. For the same periods, the
Company securitized or sold $0.7 billion and $0.2 billion of commercial real
estate loans, respectively, and $0.6 billion and $1.8 billion, respectively, of
loans and other assets for its clients. In addition, during the year ended March
31, 1997, the Company securitized and sold $43.5 million of auto loans
originated by its subsidiary Triad Financial Corporation ("Triad").
Through ContiMortgage, acquired in 1990, the Company is a leading
originator, purchaser, seller and servicer of home equity loans made to
borrowers whose borrowing needs may not be met by traditional financial
institutions due to credit exceptions or other factors. Loans are made to
borrowers primarily for debt consolidation, home improvements, education or
refinancing and are primarily secured by first mortgages on one- to four-family
residential properties. ContiMortgage has devoted substantial resources and
capital to (i) increasing its market penetration across the United States, (ii)
expanding its broker loan network to complement its existing wholesale loan
network, (iii) adding new loan products, and (iv) investing in information
services and collection technologies.
There are two distinct factors that drive the expansion of the Company's
home equity loan business -- growth in volume of loans and access to the capital
markets to facilitate the most efficient sale of these loans through
securitization. The Company believes it has a competitive advantage because the
management of ContiMortgage is able to focus exclusively on expanding the volume
of loans originated or purchased, enhancing loan underwriting efficiencies and
building its servicing portfolio, while relying upon the professional staff of
ContiTrade Services L.L.C. ("ContiTrade") and ContiFinancial Services
Corporation ("ContiFinancial Services") to focus exclusively on providing
warehouse financing, hedging and securitization structuring and placement
services. This specific industry expertise enables the Company to minimize its
financing costs and interest rate exposure and maximize the proceeds and profits
from its securitizations and its growing servicing portfolio. From March 1991
through March 31, 1997, ContiMortgage has completed 27 AAA/Aaa-rated Real Estate
Mortgage Investment Conduit ("REMIC") securitizations totaling $7.6 billion. As
of March 31, 1997, ContiMortgage had a servicing portfolio of $6.4 billion.
During 1997, the Company moved towards achieving its strategic objectives of
expanding and diversifying its loan origination methodology and product mix by
acquiring three retail home equity loan originators. In November 1996, the
Company purchased 100% of the outstanding stock of California Lending Group,
Inc. d/b/a United Lending Group, Inc. ("ULG"), a west coast-based home equity
lender specializing in retail originations through direct mail and telemarketing
throughout the United States, and Royal Mortgage Partners, L.P., d/b/a Royal
MortgageBanc ("Royal"), a California-based wholesale and retail originator of
home equity loans. In December 1996, the Company purchased Resource One Consumer
Discount Company, Inc. ("Resource One"), a Pennsylvania-based home equity lender
specializing in retail origination through direct mail, television,
telemarketing, referrals and other sources to generate loan inquires directly
from borrowers throughout the eastern and mid-western states. Collectively,
ContiMortgage, ContiWest (defined below), ULG, Royal and Resource One are
referred to as the
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"Home Equity Companies". In each case the companies acquired were former
Strategic Alliances (as discussed below) or ContiMortgage loan origination
sources.
During the year ended March 31, 1997, the Company organized ContiWest
Corporation ("ContiWest"), a Nevada corporation, to better administer and
underwrite the Company's origination portfolio.
As part of the Company's strategic growth plan, the Company determined that
the acquisition of originators and servicers of under-served securitizable asset
classes other than home equity loans would provide diversity. The Company's
growth strategy dictated that such acquisitions would only be made in asset
classes in which the Company had significant securitization experience and the
acquisition candidate had strong and experienced management. Consequently, in
November 1996, the Company purchased 53.5% of the common stock of Triad, a
corporation which the Company had previously had a Strategic Alliance (as
discussed below) relationship. The Company purchased an additional 2.5% in
January 1997 and has the right and obligation to purchase the remaining 44.0%
over the next 4.5 years. Triad is a California-based auto finance company
specializing in the origination of non-prime auto finance contracts for new and
used vehicles. Non-prime auto loans and leases are originated to primarily "B"
and "C" credit grade borrowers as opposed to sub-prime auto loans which are
usually issued on a discount basis to "C-" and "D" credit grade borrowers.
The Company, through its subsidiary ContiTrade, provides financing and asset
securitization structuring expertise and through its subsidiary ContiFinancial
Services, provides placement services. In this area, ContiTrade's management and
execution of ContiMortgage's financing, hedging and securitization needs has
served as a model for the Company's strategic alliances with originators of a
broad range of consumer and commercial loans and other assets ("Strategic
Alliances"). The Company's strategy is to replicate its success with
ContiMortgage by (i) targeting classes of consumer and commercial loans, leases,
receivables and other assets, which have the potential to be financed more
efficiently through securitization, (ii) identifying and establishing Strategic
Alliances with originators of these assets that have experienced management
teams, sophisticated systems and a proven track record of originating,
underwriting, servicing and collecting consumer and commercial loans, leases,
receivables and other assets, and (iii) securing from these originators a
consistent flow of securitizable assets. The Company offers Strategic Alliance
clients complete balance sheet liability management, including warehouse
financing, interest rate hedging services and the structuring and placement of
asset portfolios in the form of asset-backed securities. This allows the
management of its Strategic Alliance clients to focus on expanding and improving
asset origination and servicing.
The Company earns fees for the financing and asset securitization services
provided to its Strategic Alliance clients. In addition, in order to support its
Strategic Alliance clients and to further enhance its returns, the Company may
take what it believes are manageable risk positions in its Strategic Alliances
by purchasing whole loans (and issuing asset-backed securities and thus
recognizing gain on sale) and providing financing of the subordinated classes of
securitizations owned by its clients. In certain of its Strategic Alliances, the
Company may receive warrants or warrant-like equity participations in Strategic
Alliance clients or may otherwise seek to make equity investments in its
Strategic Alliance clients (collectively, "Strategic Alliance Equity
Interests"). The Company believes that its Strategic Alliance strategy results
in the Company being less transaction oriented and more focused on increasing
the long-term value of its Strategic Alliance clients.
The Company's successful execution of its Strategic Alliance strategy to
date has resulted in the addition of the following new business lines and
securitization volume from 1991 through March 31, 1997: 28 home equity loan
securitizations representing $2.3 billion (for clients other than
ContiMortgage), 19 equipment lease securitizations for $1.5 billion, five
adjustable rate mortgage securitizations for $642 million, seven Title I home
improvement loan securitizations for $245 million, six franchisee loan
securitizations for $312 million, seven commercial/multi-family whole loan
portfolio sales for $1.0 billion,
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five non-prime and sub-prime auto securitizations for $292 million and one small
business loan securitization for $20 million. The Company currently has nine
active Strategic Alliances, three specialize in commercial loans and leases, two
specialize in home equity loans, two focus on auto loans and the remainder focus
on other asset classes.
HOME EQUITY LOAN ORIGINATION AND SERVICING
Through ContiMortgage, the Company is a leading originator, purchaser,
seller and servicer of non-conventional home equity loans. ContiMortgage's home
equity loan production has increased from $161.5 million for the year ended
March 31, 1992 (its first full year of operations under the Company) to $3.9
billion for the year ended March 31, 1997, representing a 90% annual compound
growth rate.
In September 1996, the Company organized ContiWest to better administer and
underwrite the Company's origination portfolio.
The Company's home equity strategy is to continue its strong growth through
geographic expansion, diversification of origination sources and investments in
origination, servicing and collection information technology. One means of
implementing this strategy was through the acquisitions of ULG, Royal and
Resource One, as well as the organization of ContiWest. Royal and Resource One
provide a retail branch network throughout the west, the mid-west and the
northeast United States which complements ContiMortgage's and ContiWest's
wholesale and small broker origination sources. ULG originates home equity loans
and home improvement loans nationally through direct mail and telemarketing.
The source and geographic expansion that ULG, Royal and Resource One provide
allows the Company to channel its home equity loan products to ContiMortgage
which has been designated as the servicing and sales platform for the Company.
The full implementation of this home equity growth strategy, through the
completion of additional Strategic Alliances and strategic acquisitions, will
allow the Company to build its market share by building a broad national
penetration of all origination channels of the home equity market in the United
States.
LOAN PRODUCTION
ORIGINATION. ContiMortgage's and ContiWest'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. Currently, over 90% of originations are secured by a first lien
mortgage. Non-conforming home equity loans are home equity loans made to
borrowers whose borrowing needs may not be met by traditional financial
institutions due to credit exceptions or other factors and that cannot be
marketed to agencies, such as Ginnie Mae, Fannie Mae and Freddie Mac. The
Company originates or purchases loans through ContiMortgage's headquarters in
Horsham, Pennsylvania, ContiWest's headquarters in Las Vegas, Nevada and five
regional offices nationwide. ContiMortgage obtains its loans through two primary
sources in 48 states: wholesale, which represents loans purchased from mortgage
bankers and commercial banks; and broker, which represents loans referred by
brokers.
For fiscal year 1997, wholesale purchases accounted for approximately 78% of
ContiMortgage's and ContiWest's loan production. The Company believes that
wholesale loan sourcing provides a cost effective means of growing and
sustaining origination volumes. Because wholesale sources underwrite loans to
ContiMortgage's underwriting guidelines and fund those loans in their own name,
wholesale sources deliver pre-approved loan packages to ContiMortgage and
ContiWest typically in excess of $1.0 million in size. As a result, the general
and administrative expenses of the Company associated with wholesale loan
purchases are significantly less than when loans are purchased or originated on
a loan-by-loan basis. For fiscal 1997, ContiMortgage and ContiWest purchased
loans from approximately 160 wholesale sources with no one source accounting for
more than 10% and the top five wholesale sources accounting for 19% of total
wholesale loan production.
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Towards achieving its strategic objective of expanding and diversifying its
sources of home equity loan production, the Company recently acquired three home
equity lenders involved in retail home equity loan production. In November 1996,
the Company purchased ULG, a west coast-based home equity lender specializing in
retail origination via direct mail and telemarketing throughout the United Sates
and Royal, a California-based wholesale and retail originator of home equity
loans. In December 1996, the Company purchased Resource One, a
Pennsylvania-based home equity lender specializing in retail origination via
direct mail, television, telemarketing, referrals and other sources throughout
the eastern and mid-western states. The Company will securitize most of the home
equity loans originated by these new subsidiaries through ContiMortgage. The
Company believes these operations will contribute significantly to the Company's
home equity loan production growth in the future.
UNDERWRITING. All home equity loans are underwritten to the Company's
mortgage underwriting guidelines. The underwriting process is intended to assess
both the prospective borrower's ability to repay the loan and the adequacy of
the real property security as collateral for the loan. In the underwriting
process, a credit package is submitted to the Company which includes a current
appraisal from an independent appraiser, a property inspection, a credit report
and a verification of employment. On a case-by-case basis, after review and
approval by the Company's underwriters, home equity loans may be made which vary
from the underwriting guidelines. However, any variations from guidelines must
be approved by a senior underwriter or by an executive officer of ContiMortgage
or ContiWest.
The Company generally purchases or originates loans which either fully
amortize over a period not to exceed 360 months or provide for amortization over
a 360-month schedule with a "balloon" payment required at the maturity date,
which will not be less than five years after origination. The loan amounts
generally range from a minimum of $10,000 to a maximum of $350,000, unless a
higher amount is specifically approved. Management estimates that the current
average home equity loan purchased or originated by ContiMortgage is
approximately $64,000. ContiMortgage and ContiWest primarily purchase or
originate non-purchase money first or second mortgage loans although
ContiMortgage and ContiWest have programs for origination of certain purchase
money first mortgages.
The homes used for collateral to secure the loans may be either residential
(mostly primary residences, but also second and vacation homes) or
investor-owned one- to four- family homes, condominiums or townhouses.
Generally, each home must have a minimum appraised value of $35,000. Mobile
housing or agricultural land are not accepted as collateral. In addition,
mixed-use loans secured by owner-occupied properties, including one- to
four-family and small multifamily residences, are made where the proceeds may be
used for business purposes.
Each property proposed as security for a loan must be appraised not more
than six months prior to the date of such loan. The combined loan-to-value ratio
("CLTV") of the first and second mortgages generally may not exceed 85%. If a
prior mortgage exists, the Company first reviews the first mortgage history. If
it contains open end, advance or negative amortization provisions, the maximum
potential first mortgage balance is used in calculating the CLTV ratio which
determines the maximum loan amount. The Company does not purchase or originate
loans where the first mortgage contains a shared appreciation clause.
The Company also requires a credit report by an independent credit reporting
agency which describes the applicant's credit history. The credit report should
reflect all delinquencies of 30 days or more, repossessions, judgments,
foreclosures, garnishments, bankruptcies, divorce actions and similar adverse
credit events that can be discovered by a search of public records. Written
verification is obtained on any first mortgage balance, its status and whether
local taxes, interest, insurance and assessments are included in the applicant's
monthly payment on the first mortgage. All taxes and assessments not included in
the monthly payment must be verified as current.
Each loan applicant is required to secure property insurance in an amount
sufficient to cover the new loan and any prior mortgage. If the sum of the
outstanding first mortgage, if any, and the home equity loan exceeds replacement
value, insurance at least equal to replacement value may be accepted.
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QUALITY CONTROL. The purpose of the Company's quality control program is:
(i) to monitor and improve the overall quality of loan production generated by
ContiMortgage's regional offices, ContiWest and wholesale sources; and (ii) to
identify and communicate to management, existing and/or potential underwriting
and loan file packaging problems or areas of concern. Each month, the following
sample of funded loans are examined: (i) a 10% random sample of all funded
loans, (ii) a 1-3% random sample of loans underwritten at the maximum LTV ratio
for such risk class of loans, (iii) a 1-3% random sample of loans with a
debt-to-income ratio greater than 50%, (iv) a minimum of the first five loans
from any new origination source, and (v) loans selected in accordance with such
other criteria as may be determined by management. The quality control file
review examines compliance with underwriting guidelines and federal and state
regulations. This is accomplished through a focus on (i) accuracy of all credit
and legal information, (ii) collateral analysis including re-appraisals of
property (field or desk) and review of original appraisal, (iii) employment and
income verification and (iv) legal document review to ensure that the
appropriate documents are in place.
LOAN SECURITIZATION
GENERAL. The primary funding strategy of the Company is to securitize loans
purchased or originated. The Company's origination sources: ContiMortgage,
ContiWest, ULG, Royal and Resource One (collectively, the "Home Equity
Companies") benefit from the reduced cost of funds and greater leverage provided
through securitization. Through March 31, 1997, ContiMortgage has completed 27
AAA/Aaa-rated REMIC securitizations totaling $7.6 billion. Management has
structured the operations and processes of the Home Equity Companies
specifically for the purpose of efficiently originating, underwriting, and
servicing (ContiMortgage only) loans for securitization in order to meet the
requirements of rating agencies, credit enhancers and AAA/Aaa-rated REMIC
pass-through investors. The Company generally seeks to enter the public home
equity securitization market on a quarterly basis.
In a securitization, the Company sells the loans that it has originated or
purchased to a REMIC, owner trust or grantor trust, for a cash purchase price
and an interest in the loans or other assets securitized (in the form of the
excess spread). The cash purchase price is raised through an offering of
pass-through certificates by the trust. Following the securitization, the
purchasers of the pass-through certificates receive the principal collected or
allocated and the investor pass-through interest rate on the certificate
balance, while the Company receives the Excess Spread. The Excess Spread
represents, over the life of the loans or other assets, the excess of the
weighted average coupon on each pool of loans or other assets sold over the sum
of the pass-through interest rate plus a normal servicing fee, a trustee fee, an
insurance fee and an estimate of annual future credit losses related to the
loans or other assets securitized (the "Excess Spread"). The majority of the
Company's gross income is recognized as gain on sale of loans or other assets,
which represents the present value of the Excess Spread, less origination and
underwriting costs. The present value of the Excess Spread is the Excess Spread
receivable (the "Excess Spread Receivable"). The Excess Spread Receivable is
either a contractual right or a certificated security generally in the form of
an interest-only or residual certificate. The majority of the Company's Excess
Spread Receivable at March 31, 1997 and 1996 is interest-only or residual
certificates. Consequently, the Company's Consolidated Balance Sheets designate
Excess Spread Receivable as "interest-only and residual certificates."
The purchasers of the pass-through certificates receive a credit-enhanced
security. Credit enhancement is generally achieved by the Company's
subordination of their Excess Spread in the form of over collateralization or
spread account structured in two forms: (i) subordination of subsidiary classes
of bonds to senior classes; or (ii) an insurance policy provided by an
AA/Aaa-rated monoline insurance company. As a result, each offering of the
senior REMIC pass-through certificates has received ratings of AAA from Standard
& Poor's Ratings Group and Fitch Investor Services, L.P. and Aaa from Moody's
Investors Service.
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The pooling and servicing agreements that govern the distribution of cash
flows from the loans included in the REMIC trusts require either: (i) the
establishment of a reserve account that may be funded by cash or a letter of
credit deposited by the Company, or (ii) the over collateralization of the REMIC
trust, which is intended to result in receipts and collections on the loans
exceeding the amounts required to be distributed to the holders of the senior
REMIC pass-through certificates. If payment defaults exceed the amount in the
reserve account or the amount of over collateralization, as applicable, the
monoline insurance company policy will pay any further losses experienced by
holders of the senior interests in the related REMIC trust or a subordinate
class will bear the loss. To date, there have been no calls on any monoline
insurance company policy obtained in any of the Company's securitizations.
HEDGING. A fixed rate loan inventory held for sale will have a smaller
Excess Spread if interest rates rise before the loans are sold. Conversely,
falling rates expand the Excess Spread. As such, the Company actively hedges
interest rate exposure through the use of United States Treasury securities and
futures contracts.
WHOLE LOAN SALES. From time to time, the Company will sell loans on a whole
loan or loan participation basis when and where pricing is more attractive than
that available through securitization. For the year ended March 31, 1997,
ContiMortgage and ContiWest sold $452.6 million of home equity loans in whole
loan sales or loan participations. Because cash is received when the loans are
sold, the full gain on sale is recorded at the time of sale.
LOAN SERVICING
OVERVIEW. The Company generally retains the right to service the home
equity loans it originates or purchases. Servicing includes collecting payments
from borrowers, remitting payments to investors who have purchased the loans,
investor reporting, accounting for principal and interest, contacting delinquent
borrowers, conducting foreclosure proceedings and disposing of foreclosed
properties. As of March 31, 1997, ContiMortgage serviced 104,568 loans in 48
states with an outstanding balance of $6.4 billion, up 66% from March 31, 1996.
ContiMortgage has developed a sophisticated computer-based mortgage
servicing operation that it believes enables it to provide effective and
efficient processing of home equity loans. The key elements of any servicing
operation are the quality and experience of the staff and the effectiveness of
the computer software.
The servicing system is an on-line real time system. It provides
payment-processing and cashiering functions, automated payoff statements,
on-line collections, hazard insurance and tax monitoring and a full range of
investor-reporting requirements. The monthly investor-reporting package includes
a trial balance, accrued interest report, remittance report, and delinquency
reports.
ContiMortgage is a Fannie Mae and Freddie Mac approved seller/servicer. As
such, ContiMortgage is subject to a thorough due diligence of its policies,
procedures, and business, and is qualified to underwrite, sell and service loans
on behalf of both Fannie Mae and Freddie Mac. This designation is typically a
prerequisite for loan securitization.
As of March 31, 1997, ContiMortgage's $6.4 billion servicing portfolio was
earning a servicing fee of approximately 50 basis points per annum.
The pooling and servicing agreements which govern the distribution of cash
flows within the REMIC trusts generally require that ContiMortgage, as servicer,
advance interest (but not principal) on any delinquent loans to the holders of
the senior interests in the related REMIC trust until satisfaction of the note,
liquidation of the mortgaged property or charge-off of the loan to the extent
ContiMortgage deems such advances of interest to be ultimately recoverable. To
the extent there are any realized losses on loans, such losses are paid out of
the related reserve account, out of principal and interest payments on over
collateralized amounts or, if necessary, from the related monoline insurance
company policy.
A-8
<PAGE>
COLLECTIONS. The ContiMortgage collection department is organized into
three divisions (two collection divisions and one default division), each led by
a collection supervisor. The collection divisions are comprised of six teams,
consisting of one team leader and seven loan counselors whose responsibilities
include contacting first payment defaults that are one to ten days delinquent
and post 30-day delinquent accounts with balances over $100,000. In March 1996,
each collection division was restructured to include an auto-dial team of
collectors to handle pre 30-day delinquent accounts. In addition, there is a
loss mitigation team which generally contacts mortgagors who are three payments
in arrears to determine if a special forbearance repayment agreement can be
arranged or if foreclosure action needs to be initiated. In certain cases,
delinquent loans are forwarded to the default division for legal action by a
foreclosure or bankruptcy team. If a property is acquired through foreclosure,
the Company will market the property for liquidation of the asset and recovery.
Generally, collection activity will commence once a loan has not been paid
within five days of the due date. Once a loan becomes 30 days past due, a
collection supervisor generally analyzes the account to determine the
appropriate course of action. On or about the 45th day of delinquency, each
property is typically inspected. The inspection indicates if the property is
occupied or vacant, the general condition of the property, whether the condition
is deteriorating, and a recommendation for securing, repair or maintenance.
Borrowers usually will be contacted by telephone at least five times and also by
written correspondence before the loan becomes more than 60 days delinquent.
Collection activity on accounts 60 days or more delinquent typically emphasize
curing the delinquency, including the use of formal forbearance, refinance and
voluntary liquidation and other means directed at completely curing the
delinquency. In most cases, accounts that cannot be cured by reasonable means
will be moved to foreclosure as soon as all legal documentation permits.
Depending upon the circumstances surrounding the delinquent account, a
temporary suspension of payments or a repayment plan to return the account to an
up-to-date status may be authorized by the collection supervisor. In any event,
it is the Company's policy to work with the delinquent customer to resolve the
past due balance before legal action is initiated.
Mortgaged properties securing loans that are more than 60 days delinquent,
including loans in foreclosure, are typically inspected on a monthly basis. In
most cases, the cost of these inspections will be advanced by ContiMortgage and
charged to the individual escrow accounts of the borrowers. The Company expects
that the cost of inspections generally will be recovered through reinstatement,
liquidation or payoff. The collection supervisor generally reviews each
inspection report and takes whatever corrective action is necessary. The cost to
secure, winterize or maintain a property are typically charged to the borrower's
escrow account. If and when a property moves to foreclosure status, a
foreclosure coordinator will review all previous inspection reports, evaluate
the lien and equity position and obtain any additional information as necessary.
The ultimate decision to foreclose, after all necessary information is obtained,
is made by an officer of ContiMortgage.
Foreclosure regulations and practices and the rights of the owner in default
vary from state to state, but generally procedures may be initiated if: (i) the
loan is 90 days or more delinquent; (ii) a notice of default on a senior lien is
received; or (iii) ContiMortgage discovers circumstances indicating potential
loss exposure.
A-9
<PAGE>
CREDIT QUALITY OF HOME EQUITY LOAN SERVICING PORTFOLIO.
The following table illustrates ContiMortgage's delinquency and charge-off
experience with respect to its home equity loan portfolio:
Delinquency and Default Experience of
ContiMortgage's Servicing Portfolio
of Home Equity Loans
<TABLE>
<CAPTION>
AT MARCH 31,
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
-------------- -------------- -------------- -------------- ------------
<CAPTION>
PRINCIPAL PRINCIPAL PRINCIPAL PRINCIPAL PRINCIPAL
BALANCE BALANCE BALANCE BALANCE BALANCE
-------------- -------------- -------------- -------------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Portfolio............. $ 6,423,376 $ 3,863,575 $ 2,192,190 $ 1,105,393 $ 484,857
Delinquency percentage
(1)
30-59 days.......... 2.18% 1.81% 0.83% 0.51% 0.49%
60-89 days.......... 0.68% 0.47% 0.36% 0.19% 0.27%
90 days and over.... 0.38% 0.23% 0.45% 0.27% 0.44%
Total delinquency... 3.24% 2.51% 1.64% 0.97% 1.20%
Total delinquency
amount............ $ 208,084 $ 97,082 $ 35,980 $ 10,036 $ 5,794
Default percentage (2)
Foreclosure......... 2.90% 2.42% 0.46% 0.53% 0.83%
Bankruptcy.......... 1.15% 0.74% 0.41% 0.23% 0.69%
Real estate owned... 0.52% 0.13% 0.09% 0.05% 0.18%
Forbearance......... 0.13% 0.25% 0.20% N/A N/A
Total default....... 4.70% 3.54% 1.16% 0.81% 1.70%
Total default
amount............ $ 302,164 $ 136,796 $ 25,486 $ 9,615 $ 8,263
</TABLE>
- ------------------------
(1) The delinquency percentages represent the percent of the portfolio balance
of home equity loans for which payments are contractually past due,
exclusive of home equity loans in foreclosure, bankruptcy, real estate owned
or forbearance.
(2) The default percentages represent the percent of the portfolio balance of
home equity loans in foreclosure, bankruptcy, real estate owned or
forbearance.The following table illustrates ContiMortgage's loan loss
experience with respect to its home equity loan portfolio:
A-10
<PAGE>
The following table illustrates ContiMortgage's loan loss experience with
respect to its home equity loan portfolio.
Loan Loss Experience on
ContiMortgage's Servicing Portfolio
of Home Equity Loans
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
----------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
------------ ------------ ------------ ---------- ----------
Average amount outstanding (1)................. $ 4,845,304 $ 2,858,790 $ 1,663,865 $ 745,351 $ 396,910
Net losses (2)............................... $ 12,767 $ 3,781 $ 1,313 $ 1,108 $ 1,076
Net losses after recoveries (3).............. $ 12,719 $ 3,686 $ 1,308 $ 1,108 $ 1,036
Net losses as a percentage of average........
amount outstanding......................... 0.26% 0.13% 0.08% 0.15% 0.26%
</TABLE>
- ------------------------
(1) The average of the aggregate principal balances of the home equity loans
outstanding on the last business day of each month during the year.
(2) Actual losses incurred on liquidated properties for each respective period.
Losses include all principal, foreclosure costs and all accrued interest.
(3) Net losses after recoveries from deficiency judgments (net of expenses).
In fiscal 1994, the Company made a strategic decision to increase its mix of
higher yielding, lower loan-to-value B, C, and D grade loans. The ratings are
those employed by the Company in its grading system, which the Company believes
is similar to grading systems used in the non-conforming home equity loan
industry. As a result of this strategic decision, delinquency levels have
increased as anticipated and are expected to continue to increase as the loan
mix shifts toward more B, C and D loans and such types of loans in the portfolio
become more seasoned. The Company believes that this increase in delinquency
levels is more than offset by the higher yields associated with B, C and D loans
and the lower loan-to-value ratios which provide a larger equity cushion against
loss in the event of foreclosure.
A-11
<PAGE>
The following chart generally outlines certain parameters of the credit
grades of ContiMortgage's and ContiWest's current underwriting guidelines:
DESCRIPTION OF CREDIT GRADES
<TABLE>
<CAPTION>
"A" CREDIT GRADE "B" CREDIT GRADE "C" CREDIT GRADE "D" CREDIT GRADE
--------------------- --------------------- --------------------- ---------------------
<S> <C> <C> <C> <C>
GENERAL REPAYMENT Has good credit but Pays the majority of Marginal credit Designed to provide a
might have some minor accounts on time but history which is borrower with poor
delinquency. has some 30-and/or offset by other credit history an
60-day delinquency. positive attributes. opportunity to
correct past credit
problems through
lower monthly
payments.
EXISTING MORTGAGE Current at Current at Cannot exceed four Must be paid in full
LOANS application time and application time and 30-day delinquencies from loan proceeds
a maximum of two a maximum of three or one 60-day and no more than 119
30-day delinquencies 30-day delinquencies delinquency in the days' delinquency.
in the past 12 in the past 12 past 12 months.
months. months.
NON-MORTGAGE CREDIT Major credit and Major credit and Major credit and Major and minor
installment debt installment debt can installment can credit delinquency is
should be current but exhibit some minor exhibit some minor acceptable, but must
may exhibit some 30-and/or 60-day 30-and/or 90-day demonstrate some
minor 30-day delinquency. Minor delinquency. Minor payment regularity.
delinquency. Minor credit may exhibit up credit may exhibit
credit may exhibit to 90-day more serious
some minor delinquency. delinquency.
delinquency.
BANKRUPTCY FILINGS Charge-offs, Discharged more than Discharged more than Discharged prior to
judgments, liens, and two years with two years with closing.
former bankruptcies reestablished credit. reestablished credit.
are unacceptable.
DEBT Generally not to Generally not to Generally not to Generally not to
SERVICE-TO-INCOME exceed 45%. exceed 45%. exceed 45%. exceed 50%.
RATIO
MAXIMUM LOAN-TO-VALUE
RATIO:
Owner Occupied Generally 80% (or Generally 80% (or Generally 75% (or Generally 65% (or
90%) for a 1 to 4 85%) for a 1 to 4 85%) for a 1 to 4 70%) for a 1 to 4
family dwelling family dwelling family dwelling family dwelling
residence; 70% for a residence; 65% for a residence; 65% for a residence.
condominium. condominium. condominium.
Non-Owner Occupied Generally 70% for a 1 Generally 65% for a 1 Generally 65% for a 1 N/A
to 2 family dwelling, to 2 family dwelling, to 2 family dwelling,
65% for a 3 to 4 60% for a 3 to 4 65% for a 3 to 4
family. family. family.
</TABLE>
FINANCING AND ASSET SECURITIZATION SERVICES
GENERAL
The Company provides financing and asset securitization execution and
expertise to originators of a broad range of consumer and commercial loans,
leases, receivables and other assets. Through the activities of its other two
principal operating entities--ContiTrade and ContiFinancial Services--the
Company focuses on providing financing and asset securitization services to its
subsidiaries and Strategic Alliance clients. ContiTrade provides financing and
structuring of asset-backed securities. ContiFinancial Services, a
A-12
<PAGE>
National Association of Securities Dealers, Inc. ("NASD") member and
broker/dealer, privately places or underwrites offerings of asset-backed
securities on behalf of the Company and its finance company clients.
STRATEGY
Understanding the cash flow and credit characteristics associated with each
of the asset classes with which it works, ensuring that each pool of assets is
securitizable prior to funding and controlling its own warehouse take-out risk
through its placement capabilities, allows the Company to assume controlled
risks, support new business, and introduce more securitizable assets to the
institutional marketplace. The Company's strategy is to replicate its success
with ContiMortgage by (i) targeting classes of consumer and commercial loans,
leases, receivables or other assets, which have the potential to be financed
more efficiently through securitization, (ii) identifying and establishing
Strategic Alliances with originators of these assets that have experienced
management teams, sophisticated systems and a proven track record of
originating, underwriting, servicing and collecting consumer and commercial
loans, leases, receivables and other assets and (iii) securing from these
originators a consistent flow of securitizable assets. The Company offers
Strategic Alliance clients complete balance sheet liability management,
including warehouse financing, interest rate hedging services and the
structuring and placement of asset portfolios in the form of asset-backed
securities. This allows the management of its Strategic Alliance clients to
focus on expanding and improving asset origination and servicing.
The Company earns fees for the financing and asset securitization services
provided to its Strategic Alliance clients. In addition, in order to support its
Strategic Alliance clients and to further enhance its returns, the Company may
take what it believes are manageable risk positions in its Strategic Alliances
by purchasing whole loans (and issuing asset-backed securities and thus
recognizing gain on sale) and providing financing of the Excess Spread
Receivables owned by its clients. In certain of its Strategic Alliances, the
Company may receive Strategic Alliance Equity Interests. The Company believes
that its Strategic Alliance strategy results in the Company being less
transaction oriented and more focused on increasing the long-term value of its
Strategic Alliance clients. Because of the extensive time and resources that the
Company commits to a Strategic Alliance, the Company only seeks to develop and
maintain a limited number of Strategic Alliance clients in each of its business
lines.
TARGETING OPPORTUNITIES
As described above, the Company seeks to identify consumer and commercial
loans, leases, receivables or other assets which have the potential to be more
efficiently financed through securitization and to form Strategic Alliances with
the originators of such assets. Identifying such assets involves a thorough
analysis and due diligence of: (i) the asset (loan, lease, or receivable), (ii)
the management team of the potential Strategic Alliance client, and (iii) the
servicing systems of the potential Strategic Alliance client. The credit review
process of the Company seeks to determine whether or not a new asset is
securitizable to investment grade and whether there exists a ready and
interested investor base for the new product.
The due diligence process and the results thereof are outlined in a risk
memorandum. The preparation of the risk memorandum is an intensive process,
managed by the Company's Chief Credit Officer, and focuses on four areas: (i)
background on company, management, asset and industry, (ii) risks and mitigating
factors, (iii) projected profitability, and (iv) balance sheet and cash impact.
Once the risk memorandum is completed, the decision to securitize a new class of
assets with a new client is subject to approval by a credit committee made up of
senior executive officers of the Company. After the credit process is completed
for a new client, each subsequent securitization transaction by that client will
be subject to an abridged credit review process.
A-13
<PAGE>
CLIENT SERVICES
The Company provides warehouse financing, whole loan purchasing, hedging,
credit enhancement and Excess Spread Receivables financing services to the
Company's subsidiaries and the Company's Strategic Alliance clients.
WAREHOUSE FINANCING. The Company makes financing available to its
securitization clients through secured loans or purchase commitments to
facilitate the accumulation of securitizable assets prior to securitization
("warehouse financing"). As of March 31, 1997, through ContiTrade, the Company
had committed $1.6 billion of financing to its third party clients, of which
$566 million was drawn down. Warehouse financing commitments are typically for a
term of one year or less and are generally designed to fund only securitizable
assets. Assets from a particular client typically remain in the warehouse for a
period of 30 to 120 days at which point they are securitized and sold to
institutional investors, in most cases, through ContiFinancial Services, the
Company's NASD registered broker/dealer. The Company utilizes its asset purchase
and sale facilities with certain financial institutions ("Purchase and Sale
Facilities") and a funding agreement under an agreement to repurchase
("Repurchase Agreement") to finance this warehouse financing.
WHOLE LOAN PURCHASING. The Company seeks opportunities to purchase assets
for sale into securitized trusts and to recognize gain on sale. The Company's
Strategic Alliance clients often seek to raise additional cash to cover the
expenses and the negative cash flow associated with securitization. Therefore,
whole loan pools of assets may be purchased by the Company from a Strategic
Alliance client and then securitized under the Company's name or the name of its
Strategic Alliance client. The Company will typically invest its capital in the
transaction through the purchase of loans at a premium and the assumption of
certain costs of securitization.
CONDUITS. The Company also executes its loan purchase strategy through loan
conduits. Conduits are stand-alone securitization vehicles where the
originator(s), underwriter(s), servicer(s), and seller(s) may all be different
parties coming together to generate loans to be serviced and securitized.
Conduits allow smaller originators to sell their product into a single
securitizable pool, thus benefiting from the economies of scale and the ability
to share the fixed transaction costs associated with securitization. The Company
has established a conduit for commercial/multi-family mortgages
("ContiMAP-Registered Trademark-"). The Company's role is to provide capital
through warehouse financing and/or the purchase of loans at a premium and to
ensure that the loans are underwritten to the conduit's underwriting guidelines
and are thus securitizable. In addition, the Company also manages the ultimate
sale or securitization of the loans originated through
ContiMAP-Registered Trademark-. The Company had previously also operated an
adjustable rate mortgage conduit which was closed in fiscal 1997 due to the
strategic acquisition of Royal, previously the major participant of the conduit.
HEDGING. As certain assets are accumulated for securitization, they are
exposed to fluctuations in interest rates. This is because the securitization of
each asset class is priced to the investor utilizing the United States Treasury
security with a maturity most closely matching the assets' average lives.
Therefore, at the client's discretion, the Company will hedge the specific
United States Treasury security in the cash market.
CREDIT ENHANCEMENT. To the extent that the securitization of a particular
asset class requires credit enhancement in addition to the Excess Spread, the
Company will consider providing that additional support in the form of (i) an
initial deposit to be reimbursed from the cash flow of the assets securitized or
(ii) the purchase of a mezzanine security.
EXCESS SPREAD RECEIVABLES FINANCING. In certain cases, the Company finances
a client's Excess Spread Receivables in order to provide the client with cash to
cover the expenses and negative cash flow associated with securitization. The
financing is typically in the form of a secured loan. The Company commits to
provide such financing only to its Strategic Alliance clients. In each case, in
return for the financing, the
A-14
<PAGE>
Company will receive ownership participations either in the Strategic Alliance
clients or in the portfolio of loans securitized. As of March 31, 1997, the
total committed amount of such financing was $64.1 million and the amount
outstanding of such financing was $35.6 million.
CONTIFINANCIAL SERVICES
PLACEMENT OF ASSET-BACKED SECURITIES. Securitization, or structured
finance, expertise is the foundation upon which the Company has built its
business and executes its strategy. Since 1991 through March 31, 1997, the
Company has structured or placed over $13.9 billion of securitized assets
representing over 105 transactions both for ContiMortgage and other clients.
ContiFinancial Services' placement capabilities accomplish two objectives:
(i) generating fee income, and (ii) providing a controlled exit strategy for
assets financed by allowing the Company and its Strategic Alliance clients to
manage more effectively when and how transactions are brought to market. While
ContiFinancial Services' placement capabilities have been primarily focused on
private placements, to the extent opportunities exist in the public market,
ContiFinancial Services will bid out the public underwriting business to other
investment banks and manage the process on behalf of itself and its clients. The
Company has filed a shelf registration statement with the Securities and
Exchange Commission (the "Commission") for up to $5.0 billion in certain
asset-backed securities.
If the Company is successful in a Strategic Alliance (earning fees for
warehousing, gain on sale for whole loan purchases and sales, and fees for the
placement of asset-backed securities) while its client experiences significant
growth and profitability, the Strategic Alliance client will ultimately need the
services of a larger full service investment bank. The Company's strategy,
however, contemplates this evolution through: (i) continuing to purchase whole
loans from the Strategic Alliance client, (ii) creating new loan conduits, (iii)
recognizing the value of any Strategic Alliance Equity Interests, and, most
importantly, (iv) continuing to develop new securitizable assets and Strategic
Alliances.
PURCHASE AND SALE FACILITIES AND REPURCHASE AGREEMENT
As of March 31, 1997, the Company had $2.3 billion of committed and an
additional $1.1 billion of uncommitted sale capacity under its Purchase and Sale
Facilities. The Purchase and Sale Facilities allow the Company to sell, with
limited recourse, interest in designated pools of loans and other assets. The
Company utilized the facilities to sell assets totaling $7.4 billion, $5.7
billion and $2.5 billion, in the fiscal years 1997, 1996 and 1995, respectively.
As of March 31, 1997 the Company had utilized $842.5 million of the sale
capacity under the Purchase and Sale Facilities.
Due to the implementation of the Financial Accounting Standards Board's
Statement of Financial Accounting Standards No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishment of Liabilities" on January
1, 1997 (see Management Discussion and Analysis of Financial Conditions and
Results of Operations--Certain Accounting Considerations), certain of the assets
that the Company has sold under the Purchase and Sale Facilities subsequent to
January 1, 1997 did not qualify for sale treatment under the new accounting
principles and as a result $251.5 million of such assets were included as Trade
Receivables sold under agreements to repurchase (under the Repurchase Agreement)
on the Company's consolidated balance sheets. The new accounting principle does
not in any way effect the ability of the Company to finance these assets. The
Company expects to replace the Purchase and Sale Facilities with Repurchase
Agreements for those asset types which do not qualify for sale treatment.
ASSET CLASSES
Since 1991, the Company has expanded the scope of its products to include
equipment leases, franchisee loans, commercial/multi-family loans, non-prime and
sub-prime auto loans and leases, and timeshare loans.
A-15
<PAGE>
The following table illustrates the Company's securitization volume
(excluding ContiMortgage whole loan sales) and the addition of its new asset
classes:
The Company's Securitization Volume
by Asset Classes
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31, TOTAL BY
----------------------------------------------------- ASSET
1997 1996 1995 1994 1993 CLASS
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Home equity loans
ContiMortgage......................................... $ 3,454 $ 2,030 $ 1,293 $ 772 $ 273 $ 7,822
Other................................................. 250 755 340 60 148 1,553
--------- --------- --------- --------- --------- ---------
Total............................................... $ 3,704 $ 2,785 $ 1,633 $ 832 $ 421 $ 9,375
ARMs.................................................... -- 505 101 36 -- 642
Equipment leasing....................................... 250 190 179 178 278 1,075
Title I home improvement loans.......................... -- -- 149 96 -- 245
Franchisee loans........................................ 21 145 98 48 -- 312
Commercial/multi-family loans (1)....................... 742 186 89 -- -- 1,017
Non-prime and sub-prime auto loans and leases........... 91 162 39 -- -- 292
Small business loans.................................... -- 20 -- -- -- 20
--------- --------- --------- --------- --------- ---------
Total securitization volume............................. $ 4,808 $ 3,993 $ 2,288 $ 1,190 $ 699 $ 12,978
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
</TABLE>
- ------------------------
(1) Includes two whole-loan sales.
HOME EQUITY LOANS. The home equity loan product is the flagship business
for the Company. Having set the standard for the securitization of home equity
loans at the inception of the market in 1988, the Company leveraged its
financing capabilities and structured finance expertise by acquiring
ContiMortgage in 1990 and establishing Strategic Alliances with other clients in
the home equity loan industry. In addition to providing its financing, hedging
and securitization services to ContiMortgage, resulting in 27 securitizations
for $7.6 billion from March 1991 through March 31, 1997, the Company also
provided its services to other clients, resulting in 28 securitizations for $2.3
billion from 1991 through March 31, 1997.
In the home equity loan market, the Company's Strategic Alliance
relationships vary in terms of products and services offered. Certain of these
Strategic Alliances include the provision of warehouse financing and hedging in
return for a committed flow of securitizable product for which it earns
placement fees and gains on sale. Other Strategic Alliances include the
provision of warehouse financing and hedging in return for a guaranteed flow of
securitizable product as well as minority ownership in the form of Strategic
Alliance Equity Interests.
As part of its strategy of working closely with its Strategic Alliances and
utilizing that relationship as a basis for monitoring growth and asset
performance, the Company acquired ULG , a former Strategic Alliance.
COMMERCIAL/MULTI-FAMILY LOANS. In 1993, the Company established a
commercial real estate conduit, ContiMAP-Registered Trademark-, to satisfy a
need in the marketplace for the financing of $0.5 to $25 million loans secured
by
A-16
<PAGE>
commercial properties, such as multi-family dwellings, self storage facilities,
assisted living and other health related facilities, retail and industrial
buildings.
ContiMAP-Registered Trademark- purchases commercial real estate loans
suitable for securitization and sale into the capital markets. The Company
manages the aggregation and underwriting of the loans through correspondent
relationships with established lending companies. The Company's strategy is to
grow ContiMAP-Registered Trademark- by continuing to add additional qualified
commercial lenders and by continuing to enhance its product offerings.
TITLE I CONVENTIONAL HOME IMPROVEMENT LOANS. Home improvement loans
represent loans to homeowners, a portion of which may be guaranteed by the U.S.
Government in the case of Title I home improvement loans for the purpose of
certain pre-qualified home improvements. The Company decided to pursue this
business line, which was a natural extension of its home equity loan business,
because of its highly fragmented nature and higher cost of funds through which
these assets are typically being financed.
The Company executed securitizations, in the form of conduits where it
financed and placed Title I and conventional home improvement loans on behalf of
conduit participants and through a Strategic Alliance with one of the conduit
participants. The Company's strategy is to facilitate the growth of its
Strategic Alliance client through securitizations, expanding its presence
nationwide, building economies of scale and helping to create a low cost, high
volume producer in an otherwise fragmented industry.
The Company, through its newly acquired subsidiary, ULG, also originates
Title I and conventional home improvement loans through retail origination
channels. ULG currently obtains home improvement loan inquiries through a direct
mail and telemarketing approach, reaching borrowers not contacted by the
Company's Strategic Alliance clients.
ADJUSTABLE RATE MORTGAGES. The Company established its Adjustable Rate
Mortgage Conduit ("ARM Conduit") in 1994 in order to: (i) leverage its expertise
in the closely related fixed-rate home equity loan market and the relationships
it developed in building that business; (ii) establish a more significant
presence in the western United States which is primarily an ARM market; and
(iii) offer its Strategic Alliance clients an outlet for a new product to offer
their borrowers. The Company's ARM Conduit allowed smaller originators to sell
their loan product into a single securitizable pool and to benefit from the
economies of scale not otherwise available to them on a stand-alone basis. In
fiscal 1997, the Company acquired Royal, the largest contributor to the ARM
conduit and discontinued the conduit.
EQUIPMENT LEASING. The equipment leasing industry is a highly fragmented
industry which leases a wide array of equipment to predominately commercial
users. The typical leasing company provides a specialized service to a
relatively specific asset class (e.g. office equipment or medical equipment).
The Company has financed various assets for several equipment lease company
clients ranging from $300 fax machines to $3 million MRI machines. While these
relationships historically have been transaction oriented, the Company is
actively pursuing Strategic Alliance opportunities to leverage its capabilities,
product and market knowledge and establish a long-term, equity participation.
FRANCHISEE LOANS. Franchisee loans represent loans to franchisees of top
tier national restaurant chains and other franchise chains. In the Company's
securitization of franchisee loans, the underwriting process focuses on the
franchisee borrower's ability to generate cash flow from the particular
restaurant as opposed to more traditional financing, which is based upon hard
collateral values or the credit rating of the franchisor.
In 1993, the Company identified this niche opportunity and developed this
business line in conjunction with a Strategic Alliance client. The Company
believes that its warehouse financing, hedging, structured finance and placement
capabilities combined with its unique approach to underwriting and credit
analysis, will provide it with a competitive advantage.
A-17
<PAGE>
NON-PRIME AND SUB-PRIME AUTO LOANS AND LEASES. Non-prime and sub-prime
automobile lending represents loans to credit-impaired borrowers. Like the home
equity loan market, the Company believes that prudent loan underwriting and
pricing, coupled with strong servicing and collections, mitigates the risk of
the non-prime and sub-prime credit borrower. Non-prime auto loans and leases are
originated to primarily "B" and "C" credit grade borrowers as opposed to
sub-prime auto loans which are usually issued on a discount basis to "C-" and
"D" credit grade borrowers.
Since fiscal 1995, the Company has formed five Strategic Alliances with
originators of non-prime and sub-prime auto loans. Management believes that this
market benefits significantly from securitization through reduced cost of funds,
and the discipline which the regular securitization process brings to the
origination, underwriting, servicing, collection and monitoring of non-prime and
sub-prime auto loans. Consequently, given the Company's experience in this
industry, and having closely monitored the development of its Strategic
Alliances, in November 1996, the Company purchased 53.5% of the common stock of
Triad, a California-based auto finance company specializing in origination of
non-prime auto finance contracts for used and new vehicles. As of March 31,
1997, Triad has relationships with approximately 1,600 dealerships in 15 states,
with California representing approximately 50% of loan originations. As with
ContiMortgage, Triad utilizes centralized origination, underwriting and
servicing techniques. In January 1997, the Company purchased an additional 2.5%
of the common stock of Triad. ContiFinancial has a right and obligation to
purchase the remaining 44% of the common stock of Triad over the next 4.5 years.
The Company believes that significant opportunities still exist in the
non-prime and sub-prime auto loan and lease market due to: (i) the higher cost
of funds through which these assets are typically being financed; (ii) the
discipline which the regular securitization process brings to the origination,
underwriting, servicing, collection and monitoring of auto loans and leases;
(iii) consolidation in the industry; and (iv) the Company's ability to identify
strong management teams and provide its unique mix of products and services.
TIMESHARE LOANS. Timeshare loans are made to borrowers for the purchase of
a real property interest in specific units at vacation resort properties. A
number of major corporations have become involved in the industry in recent
years, and through their advertising and marketing efforts, are increasing the
public's awareness of the benefits of timesharing. Because timeshare financing
is still a relatively new and fragmented industry, the Company believes that it
provides significant growth potential to the extent that: (i) the credit
analysis and cash flow characteristics are similar to traditional home equity
loans; and that (ii) the lower cost of funds and greater operating leverage from
securitization can be applied successfully.
WARRANTS AND STOCK OWNERSHIP
In certain of its Strategic Alliances, the Company may receive Strategic
Alliance Equity Interests. All Strategic Alliance Equity Interests existing
prior to the consummation of the Company's initial public offering, (the "IPO")
were retained by the Company's parent company, Continental Grain Company
("Continental Grain"), and therefore, these assets are not reflected in the
Company's Consolidated Financial Statements included herein. The Company
currently holds Strategic Alliance Equity Interests acquired after the IPO.
Based on its prior experience, the Company does not anticipate that any
Strategic Alliance Equity Interest that it holds or may acquire in the future
will have any effect on the Company's financial position or results of
operations until the business of the Strategic Alliance client matures, which
typically takes several years. However, in fiscal 1997, the Company received
$2.7 million of warrant income from the sale of stock warrants in a Strategic
Alliance company. In addition, the Company may, from time to time, make a direct
cash equity or subordinated debt investment in a Strategic Alliance client.
A-18
<PAGE>
REGULATION
GENERAL. The Company's businesses are subject to extensive regulation in
the United States at both the Federal and state level. In the Company's home
equity loan and financing businesses, regulated matters include loan
origination, credit activities, maximum interest rates and finance and other
charges, disclosure to customers, the terms of secured transactions, the
collection, repossession and claims-handling procedures utilized by the Company,
multiple qualification and licensing requirements for doing business in various
jurisdictions and other trade practices. As part of the Company's financing and
asset securitization business, ContiFinancial Services is required to register
as a broker/dealer with certain Federal and state securities regulatory agencies
and is a member of the NASD.
TRUTH IN LENDING. The Truth in Lending Act ("TILA") and Regulation Z
promulgated thereunder contain disclosure requirements designed to provide
consumers with uniform, understandable information with respect to the terms and
conditions of loans and credit transactions in order to give them the ability to
compare credit terms. TILA also guarantees consumers a three day right to cancel
certain credit transactions including loans of the type originated by the
Company. Management of the Company believes that it is in compliance with TILA
in all material respects. If the Company were found not to be in compliance with
TILA, aggrieved borrowers could have the right to rescind their mortgage loan
transactions and to demand the return of finance charges paid to the Company.
In September 1994, the Riegle Community Development and Regulatory
Improvement Act of 1994 (the "Riegle Act") was enacted. Among other things, the
Riegle Act makes certain amendments to TILA. The Riegle Act generally applies to
mortgage loans (other than mortgage loans to finance the acquisition or initial
construction of a dwelling) with (i) total points and fees upon origination
exceeding eight percent of the loan amount (as adjusted for changes in the
Consumer Price Index) or (ii) an annual percentage rate of more than ten
percentage points higher than comparably maturing United States Treasury
securities ("Covered Loans"). The Company estimates that approximately 10% of
the loans originated or purchased by the Company are Covered Loans.
The Riegle Act imposes additional disclosure requirements on lenders
originating Covered Loans and prohibits lenders from originating Covered Loans
that are underwritten solely on the basis of the borrower's home equity without
regard to the borrower's ability to repay the loan. The Company is currently
applying underwriting criteria to all Covered Loans that take into consideration
the borrower's ability to repay.
The Riegle Act also prohibits lenders from including prepayment fee clauses
in Covered Loans to borrowers with a debt-to-income ratio in excess of 50% or
Covered Loans used to refinance existing loans originated by the same lender.
The Company will continue to collect prepayment fees on loans originated prior
to the October 1995 effectiveness of the Riegle Act and on non-Covered Loans as
well as on Covered Loans in permitted circumstances. The Riegle Act imposes
other restrictions on Covered Loans, including restrictions on balloon payments
and negative amortization features, which the Company does not believe will have
a material impact on its operations.
OTHER LENDING LAWS. The Company is also required to comply with the Equal
Credit Opportunity Act of 1974, as amended ("ECOA"), which prohibits creditors
from discriminating against applicants on the basis of race, color, sex, age or
marital status. Regulation B promulgated under ECOA restricts creditors from
obtaining certain types of information from loan applicants. It also requires
certain disclosures by the lender regarding consumer rights and requires lenders
to advise applicants of the reasons for any credit denial. In instances where
the applicant is denied credit or the rate or charge for loans increases as a
result of information obtained from a consumer credit agency, another statute,
the Fair Credit Reporting Act of 1970, as amended, requires lenders to supply
the applicant with the name and address of the reporting agency. The Company is
also subject to the Real Estate Settlement Procedures Act of 1974, as amended,
and is required to file an annual report with the Department of Housing and
Urban Development pursuant to the Home Mortgage Disclosure Act.
A-19
<PAGE>
In addition, the Company is subject to various other federal and state laws,
rules and regulations governing, among other things, the licensing of, and
procedures which must be followed by, mortgage lenders and servicers, and
disclosures which must be made to consumer borrowers. Failure to comply with
such laws may result in civil and criminal liability and may, in some cases,
give consumer borrowers the right to rescind their mortgage loan transactions
and to demand the return of finance charges paid to the Company.
In addition, certain of the loans purchased by the Company, such as Title I
home improvement loans, are insured by an agency of the federal government. Such
loans are subject to extensive government regulation.
ENVIRONMENTAL LIABILITY. In the course of its business, the Company may
acquire properties securing loans that are in default. 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.
BROKER/DEALER. In the Company's capital management services business,
ContiFinancial Services acts as a placement agent and underwriter for public and
private offerings of asset-backed securities. As a result, ContiFinancial
Services is registered as a broker/dealer with the Securities and Exchange
Commission, the State of California and the State of New York and is a member of
the NASD. ContiFinancial Services is subject to regulation by the Commission,
the NASD and state securities administrators in matters relating to the conduct
of its securities business, including record keeping and reporting requirements,
supervision and licensing of employees and obligations to customers. Additional
legislation and regulations, including those relating to the activities of
affiliates of broker/dealers, changes in rules promulgated by the Commission or
other regulatory authorities, and the NASD, changes in the interpretation or
enforcement of existing laws and rules and changes in the special exemption of
ContiFinancial Services may adversely affect the manner of operation and
profitability of the Company.
As a registered broker/dealer, ContiFinancial Services is subject to the
Commission's net capital rules. These rules, which specify minimum net capital
requirements for registered broker/dealers, are designed to assure that
broker/dealers maintain adequate regulatory capital in relation to their
liabilities and the size of their customer business and have the effect of
requiring that at least a substantial portion of their assets be kept in cash or
highly liquid investments. Because it acts primarily as a private placement
agent in asset-backed securities offerings, ContiFinancial Services operates
under a less restrictive net capital standard. To the extent that the Company
elects to expand its public underwriting capacity, it would be required to
substantially increase the net capital of ContiFinancial Services. Under such
circumstances, there can be no assurance that the Company will have the capital
necessary to increase such net capital.
FUTURE LAWS. Because each of the Company's businesses is highly regulated,
the laws, rules and regulations applicable to the Company are subject to regular
modification and change. There are currently proposed various laws, rules and
regulations which, if adopted, could impact the Company. There can be no
assurance that these proposed laws, rules and regulations, or other such laws,
rules or regulations will not be adopted in the future which could make
compliance much more difficult or expensive, restrict the Company's ability to
originate, broker, purchase or sell loans, further limit or restrict the amount
of commissions, interest and other charges earned on loans originated, brokered,
purchased or sold by the Company, or otherwise adversely affect the business or
prospects of the Company.
COMPETITION
The home equity loan market is highly competitive. The Company faces
competition from other consumer finance lenders, mortgage lenders, mortgage
brokers, commercial banks, mortgage banks, large securities firms, smaller
boutique securities firms, credit unions, thrift institutions, credit card
issuers and finance companies. Many of these competitors are substantially
larger and have more capital and other
A-20
<PAGE>
resources than the Company. Competition can take many forms, including
convenience in obtaining a loan, customer service, marketing and distribution
channels, terms provided and interest rates charged to borrowers. Heightened
competition could contribute to higher prepayments. In addition, the current
level of gains realized by the Company and its competitors on the sale of their
home equity loans could attract additional competitors into this market with the
possible effect of lowering gains that may be realized on the Company's future
loan sales. The principal competitive factors influencing the Company's business
are its professional staff, its reputation in the marketplace, its existing
client relationships, the ability to commit capital to client transactions and
its mix of market capabilities.
Currently, some traditional financial institutions are aggressively
promoting and pricing home equity loans. The Company does not believe that this
trend has had a material impact on its competitive position because the
Company's success is tied to its emphasis on timely customer service, on
attracting borrowers whose needs are not met by traditional financial
institutions and on the equity value of the property securing various types of
loans. Nevertheless, there can be no assurance that the Company will not face
increased competition from traditional financial institutions attempting to
enter into the Company's market.
In fiscal 1997, 78% of the total home equity loans purchased and originated
by ContiMortgage and ContiWest were wholesale loans. Wholesale loans are
expected to remain a significant part of the Company's home equity loan
production program. As a purchaser of wholesale loans, the Company is exposed to
fluctuations in the volume and cost of wholesale loans resulting from
competition from other purchasers of such loans, market conditions and other
factors.
In its financing and asset securitization business, the Company faces
significant competition from large securities firms, smaller boutique securities
firms, commercial banks, mortgage banks, credit unions, thrift institutions,
credit card issuers and finance companies. Many of the Company's competitors are
substantially larger and have more capital and other resources than the Company.
EMPLOYEES
At March 31, 1997, the Company had 1,562 employees. None of the Company's
employees are represented by a labor union. The Company believes that its
relations with its employees are good.
A-21
<PAGE>
ITEM 2. PROPERTIES.
The Company's principal executive offices are located at 277 Park Avenue,
New York, New York, 10172 and are occupied under a sublease with Continental
Grain. The lease on this premises extends through February 28, 2000.
ContiMortgage's current headquarters in Horsham, Pennsylvania, and regional
offices located in Phoenix, Arizona; Orange and Pleasanton, California; Atlanta,
Georgia; Oak Brook, Illinois and Horsham, Pennsylvania are operated under leases
with third parties that expire through April 2001.
ContiMortgage is currently redeveloping a manufacturing facility in Hatboro,
Pennsylvania as its new headquarters. The facility will operate under a lease
with a third party that extends twelve years from the facility's anticipated
completion at the end of calendar 1997.
ContiFinancial Services and ContiTrade occupy office space in Santa Monica,
California under a lease with a third party that expires in September 1999.
ContiWest occupies office space in Las Vegas, Nevada under a lease with a third
party that expires in January 2000. ULG, Resource One, Royal and Triad have
various offices throughout the United States and operate under various leases
with third parties that expire through July 2003.
The Company believes that its present facilities are adequate for its
current needs.
ITEM 3. LEGAL PROCEEDINGS.
In May 1997, a class action suit was filed in the Court of Common Pleas of
the State of South Carolina naming ContiMortgage as a defendant. On June 6,
1997, the case was removed to the United States District Court in the District
of South Carolina Florence Division. The complaint alleges violations of a state
notification law by the originator of certain home equity loans purchased by
ContiMortgage. Such law requires the originator to notify, ascertain and comply
with the preferences of borrowers as to the legal counsel employed to represent
such borrowers and as to the insurance agent to furnish the required insurance
in connection with the mortgage. The Company is currently investigating the
allegations. The suit has not yet been certified as a class action. The Company
does not believe the lawsuit will have a material adverse effect on the
consolidated financial position or results of operations of the Company.
In addition, the Company has been named as a defendant in various legal
actions arising from the conduct of its normal business activities. Although the
amount of any liability that could arise with respect to these actions cannot be
accurately predicted, in the opinion of the Company, any such liability will not
have a material adverse effect on the consolidated financial position or results
of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
A-22
<PAGE>
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
On February 9, 1996, the Company's common stock began trading under the
symbol "CFN" on the New York Stock Exchange. The following table sets forth, for
the period indicated, the high and low closing sale price per share of the
Company's common stock:
<TABLE>
<CAPTION>
SALES PRICE
--------------------
<S> <C> <C>
HIGH LOW
--------- ---------
Fiscal Year Ended March 31, 1996:
Fourth Quarter........................................................ $ 31.25 $ 25.50
Fiscal Year Ended March 31, 1997:
First Quarter......................................................... $ 33.00 $ 28.50
Second Quarter........................................................ $ 30.25 $ 23.25
Third Quarter......................................................... $ 39.25 $ 28.875
Fourth Quarter........................................................ $ 39.375 $ 31.00
</TABLE>
As of June 9, 1997, the Company had 83 stockholders of record, and
approximately 4,550 beneficial owners of its common stock.
During fiscal 1995 and during fiscal 1996, prior to the close of its IPO on
February 14, 1996, the Company paid cash dividends to Continental Grain of $30
million and $0.3 million, respectively. The Company has no current intention to
pay cash dividends on its Common Stock. As a holding company, the ability of the
Company to pay dividends is dependent upon the receipt of dividends or other
payments from its subsidiaries. Any future determination as to the payment of
dividends will be at the discretion of the Company's Board of Directors and will
depend upon the Company's operating results, financial condition and capital
requirements, contractual restrictions, general business conditions and such
other factors as the Company's Board of Directors deems relevant. Furthermore,
covenants in the Company's and Continental Grain Company's loan agreements
restrict the payment of dividends by the Company. There can be no assurance that
the Company will have earnings sufficient to pay a dividend on its Common Stock
or that, even if there are sufficient earnings, dividends will be permitted
under applicable law.
A-23
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
SELECTED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
------------- ------------- --------- --------- ---------
INCOME STATEMENT DATA:
Gain on sale of receivables............................ $ 210,861 $ 146,529 $ 67,512 $ 49,671 $ 18,587
Interest............................................... 161,402 91,737 42,929 20,707 11,385
Net servicing income................................... 46,340 29,298 9,304 3,989 1,842
Other income........................................... 9,227 4,252 2,252 162 (147)
------------- ------------- --------- --------- ---------
Total gross income................................. 427,830 271,816 121,997 74,529 31,667
------------- ------------- --------- --------- ---------
Expenses
Compensation and benefits.............................. 82,170 52,203 23,812 14,674 6,870
Interest............................................... 120,636 74,770 29,635 12,124 6,529
Provision for loan losses.............................. 3,043 285 1,935 4,499 2,018
General and administrative............................. 44,940 18,022 9,627 7,946 4,101
------------- ------------- --------- --------- ---------
Total expenses..................................... 250,789 145,280 65,009 39,243 19,518
------------- ------------- --------- --------- ---------
Income before income taxes and minority interest....... 177,041 126,536 56,988 35,286 12,149
Income taxes........................................... 71,341 49,096 22,168 13,726 4,640
Minority interest of subsidiary........................ (304) 3,310 8,728 5,076 1,600
------------- ------------- --------- --------- ---------
Net income............................................. $ 106,004 $ 74,130 $ 26,092 $ 16,484 $ 5,909
------------- ------------- --------- --------- ---------
------------- ------------- --------- --------- ---------
Primary and fully diluted earnings per common share
(pro forma at March 31, 1996) (1).................... $ 2.40 $ 2.00
------------- -------------
------------- -------------
Fully diluted weighted average number of shares
outstanding (pro forma at March 31, 1996) (1)........ 44,152,343 37,050,165
------------- -------------
------------- -------------
Primary weighted average number of shares outstanding
(pro forma at March 31, 1996) (1).................... 44,090,095 36,995,631
------------- -------------
------------- -------------
</TABLE>
During fiscal 1995 and 1996, the Company paid cash dividends to Continental
Grain of $30,000 and $305, respectively.
<TABLE>
<CAPTION>
AS OF MARCH 31,
---------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
------------- ------------- ---------- ---------- ---------
BALANCE SHEET DATA:
Interest-only and residual certificates......... $ 445,005 $ 293,218 $ 143,031 $ 94,491 $ 51,270
Total assets.................................... 1,545,798 892,540 327,742 217,856 76,526
Payables to affiliates.......................... 36,367 337,734 114,907 49,846 12,463
Long term debt.................................. 498,817 -- -- -- --
Total liabilities............................... 1,136,726 597,721 243,579 138,513 18,743
Minority interest of subsidiary................. 1,288 -- 16,248 7,520 2,444
Stockholders' equity............................ 407,784 294,819 67,915 71,823 55,339
</TABLE>
- ------------------------
(1) Because of the Company's reorganization that occurred in December 1995 and
changes in capital structure, per share data for the years ended March 31,
1995, 1994 and 1993 are not meaningful.
A-24
<PAGE>
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
------------- ------------- ------------ ------------ ------------
OTHER DATA:
ContiMortgage loan originations.......... $ 3,906,798 $ 2,311,471 $ 1,328,158 $ 786,754 $ 282,072
Number of loans serviced (at year end)... 104,568 65,121 38,740 20,146 11,093
Face value of loans serviced (at year
end)................................... $ 6,423,376 $ 3,863,575 $ 2,192,190 $ 1,105,393 $ 484,857
Securitization and sales volume:
ContiMortgage--Securitization............ $ 3,454,259 $ 2,030,000 $ 1,258,919 $ 733,182 $ 194,668
--Whole loan................ 188,295 270 33,772 39,142 77,876
Commercial real estate
--Securitization............ 742,259 149,980 -- -- --
--Whole loan................ -- 36,000 89,000 -- --
Triad.................................... 43,530 -- -- -- --
Strategic alliances...................... 568,401 1,776,700 906,000 418,000 426,000
------------- ------------- ------------ ------------ ------------
Total securitization and sales volume.... $ 4,996,744 $ 3,992,950 $ 2,287,691 $ 1,190,324 $ 698,544
------------- ------------- ------------ ------------ ------------
------------- ------------- ------------ ------------ ------------
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
ContiMortgage
DELINQUENCY AND LOAN LOSS DATA (1):
Delinquency rate (at end of year)................................. 3.24% 2.51% 1.64% 0.97% 1.20%
Default rate (at end of year)..................................... 4.70% 3.54% 1.16% 0.81% 1.70%
Net losses as a percentage of average amount outstanding.......... 0.26% 0.13% 0.08% 0.15% 0.26%
</TABLE>
<TABLE>
<CAPTION>
Triad
YEAR ENDED
MARCH 31,
1997
-----------
DELINQUENCY AND LOAN LOSS DATA :
<S> <C>
Portfolio................................................................... $71,648
Delinquency rate (at end of year)........................................... 1.17%
Net losses as a percentage of average amount outstanding (November 1, 1996
through March 31, 1997)................................................... 0.60%
</TABLE>
- ------------------------
(1) Includes home equity loans originated by Royal MortgageBanc, Resource One
and United Lending Group, and serviced by ContiMortgage.
A-25
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This discussion should be read in conjunction with "Selected Financial Data"
and the Company's Consolidated Financial Statements and the Notes thereto.
Certain statements under this caption constitute "forward-looking statements"
under federal securities laws. See "Forward-looking Statements."
GENERAL
The Company is engaged in the consumer and commercial finance business by
originating and servicing home equity loans and providing financing and asset
securitization expertise to originators of a broad range of loans, leases and
receivables. Through ContiMortgage Corporation ("ContiMortgage"), the Company is
a leading originator, purchaser, seller and servicer of home equity loans made
to borrowers whose borrowing needs may not be met by traditional financial
institutions due to credit exceptions or other factors. The Company has
strategic alliances with various originators of a broad range of consumer and
commercial loans and other assets ("Strategic Alliances"). Through ContiTrade
Services L.L.C. ("ContiTrade") the Company provides financing and asset
securitization structuring expertise, and through ContiFinancial Services
Corporation ("ContiFinancial Services"), an NASD registered broker/ dealer, the
Company provides placement services. In September 1996, the Company established
ContiWest Corporation, a Nevada corporation, to administer and underwrite a
portion of the Company's origination portfolio.
The Company's Strategic Alliance clients are originators of consumer and
commercial loans, leases and receivables. The Company provides financing and
asset securitization execution and expertise to the Strategic Alliance client
while the client provides a consistent flow of securitizable assets to the
Company. In certain Strategic Alliances, the Company receives interests
("Strategic Alliance Equity Interests") in the Strategic Alliance client. The
realization of value on such Strategic Alliance Equity Interests is subject to
many factors, including the future growth and profitability of the Strategic
Alliance clients and the completion of initial public offerings or sale of such
Strategic Alliance clients.
In the third quarter of fiscal 1997, the Company acquired three home equity
companies and one auto finance company to implement growth strategies of
expanding into the western United States, diversifying into retail origination
and owning other asset origination platforms with which the Company has
significant securitization experience. The four new loan origination
subsidiaries, California Lending Group, Inc. d/b/a United Lending Group, Inc.
("ULG"), Royal Mortgage Partners, L.P., d/b/a Royal MortgageBanc ("Royal"),
Triad Financial Corporation ("Triad"), and Resource One Consumer Discount
Company, Inc. ("Resource One"), collectively called the "Acquisitions", are
discussed below:
- On November 8, 1996, the Company purchased 100% of the outstanding stock
of ULG, a west coast-based home equity lender specializing in retail
originations via direct mail and telemarketing throughout the United
States.
- On November 15, 1996, the Company, through its subsidiary ContiMortgage,
purchased 100% of Royal. Royal is a California-headquartered wholesale and
retail originator of fixed and adjustable rate home equity loans.
- On November 21, 1996, the Company acquired a 53.5% equity interest in
Triad and an additional 2.5% in January 1997, a California-based non-prime
auto finance company. The Company has the right and obligation to acquire
the remaining common stock of Triad from existing shareholders.
- On December 16, 1996, the Company, through its subsidiary ContiMortgage,
purchased 100% of the outstanding stock of Resource One. Resource One,
headquartered in Langhorne, Pennsylvania, is a retail branch home equity
loan originator that utilizes direct mail, television, telemarketing,
referrals and other sources to generate loan inquiries directly from
borrowers.
A-26
<PAGE>
In each case, the companies acquired were former Strategic Alliances or
ContiMortgate loan origination sources.
The Acquisitions have been accounted for as purchases, and the results of
operations have been included with the Company's results of operations since the
effective acquisition dates. The cumulative purchase price was approximately
$38.0 million, which includes deferred payments of approximately $5.0 million,
resulting in approximately $35.0 million of cost in excess of equity which will
be amortized on a straight-line basis over a 25 year useful life. Certain
acquisition's terms contain payments which are contingent upon future earnings
or employment of key management. Such contingent payments will be recorded as
purchase price or compensation as is appropriate for the nature of the payments.
The Company has a right and obligation to purchase the remaining 44% of the
common stock of Triad over the next 4.5 years. The purchase price will be based
upon the future earnings of Triad and will be recorded when determinable. The
excess of the purchase price over the fair value of the net assets acquired will
be recorded as an increase in cost in excess of equity. The Acquisitions are not
material to the financial position or results of operations of the Company.
CERTAIN ACCOUNTING CONSIDERATIONS
As a fundamental part of its business and financing strategy, the Company
sells substantially all of its loans or other assets through securitization in
the form of REMICs, owner trusts or grantor trusts. In a securitization, the
Company sells loans or other assets that it has originated or purchased to a
trust for a cash purchase price and an interest in the loans or other assets
securitized (in the form of the "excess spread"). The cash purchase price is
raised through an offering of pass-through certificates by the trust. Following
the securitization, the purchasers of the pass-through certificates receive the
principal collected and the investor pass-through interest rate on the
certificate balance, while the Company receives the excess spread. The excess
spread represents, over the life of the loans or other assets, the excess of the
weighted average coupon on each pool of loans or other assets sold over the sum
of the pass-through interest rate plus a normal servicing fee, a trustee fee, an
insurance fee and an estimate of annual future credit losses related to the
loans or other assets securitized (the "Excess Spread"). These cash flows are
projected over the life of the loans or other assets using prepayment, default,
and interest rate assumptions that market participants would use for similar
financial instruments subject to prepayment, credit and interest rate risk and
are discounted using an interest rate that a purchaser unrelated to the seller
of such a financial instrument would demand. The majority of the Company's gross
income is recognized as gain on sale of loans or other assets, which represents
the value of the Excess Spread less origination and underwriting costs. The
present value of the Excess Spread is the Excess Spread receivable (the "Excess
Spread Receivable"). The Excess Spread Receivable is either a contractual right
or a certificated security generally in the form of an interest-only or residual
certificate. The majority of the Company's Excess Spread Receivable at March 31,
1997 and 1996 is interest-only and residual certificates. Consequently, the
Company's consolidated balance sheets designate Excess Spread Receivable as
"interest-only and residual certificates."
The Company recognizes the gain on sale of loans or other assets in the
fiscal year in which such loans or other assets are sold, although cash
(representing the Excess Spread and servicing fees) is received by the Company
over the life of the loans or other assets. Concurrent with recognizing such
gain on sale, the Company records the Excess Spread Receivable as an asset on
its consolidated balance sheets. The Excess Spread Receivable is reduced as cash
distributions are received from the securitization.
Due to the fact that the gain recognized in the year of sale is equal to the
present value of the estimated future cash flows from the Excess Spread, the
amount of cash actually received over the lives of the loans or other assets
normally exceeds the gain previously recognized at the time the loans or other
assets were sold and therefore interest income is recognized over the life of
the loans or other assets securitized. In periods subsequent to the sale, the
Company may recognize an increase in fair value of Excess Spread Receivable as
gain on sale of receivables to the extent that estimates of the loan pools'
A-27
<PAGE>
future remaining lives exceed those originally projected. This estimate of
extended life is performed by reviewing past prepayment experience and
estimating future prepayment experience by considering numerous factors which
include current market assumptions, the interest rate environment and economic
factors. If actual prepayments with respect to sold loans occur faster or credit
experience is worse than projected at the time such loans were sold, the
carrying value of the Excess Spread Receivable may have to be written down
through a charge to earnings in the period of adjustment.
Additionally, upon sale or securitization of servicing retained mortgages,
the Company capitalizes the cost associated with the right to service mortgage
loans based on its relative fair value. 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 in proportion to
and over the period of estimated net future servicing fee income. The Company
periodically reviews capitalized servicing fees receivable for valuation
impairment. This review is performed on a disaggregated basis for the
predominant risk characteristics of the underlying loans which are loan type,
loan-to-value ratio and credit quality. The Company generally makes loans to
credit impaired borrowers whose borrowing needs may not be met by traditional
financial institutions due to credit exceptions. The Company has found that
credit impaired borrowers are payment sensitive rather than interest rate
sensitive. As such the Company does not consider interest rates a predominant
risk characteristic for purposes of valuation impairment. Impairment is
recognized in a valuation allowance for each disaggregated stratum in the period
of impairment.
On January 1, 1997, the Company adopted the Financial Accounting Standards
Board's ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities" ("SFAS 125") which addresses the accounting for transfers of
financial assets in which the transferor has some continuing involvement either
with the assets transferred or with the transferee. A transfer of financial
assets in which the transferor surrenders control over those assets is accounted
for as a sale to the extent that consideration other than beneficial interest in
the transferred assets is received in exchange. SFAS 125 requires that
liabilities and derivatives incurred or obtained by transferors as part of a
transfer of financial assets be initially measured at fair value, if
practicable. In addition, SFAS 125 requires that servicing assets and
liabilities be subsequently measured by the amortization over their estimated
life and assessment of asset impairment be based on such assets' fair value.
SFAS 125 is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996, and is to be
applied prospectively. The adoption of this standard did not have a material
impact on the Company's results of operations. However, certain of the assets
that the Company had sold under the Purchase and Sale Facilities subsequent to
January 1, 1997 did not qualify for sale treatment under SFAS 125 and as a
result $251.5 million of such assets were included as trade receivables sold
under agreements to repurchase on the Company's consolidated balance sheets.
SFAS 125 does not in any way effect the ability of the Company to finance these
assets. The Company expects to replace the Purchase and Sale Facilities with
repurchase agreements for those asset types which do not qualify for sale
treatment.
FINANCIAL CONDITION
MARCH 31, 1997
Securities purchased under agreements to resell increased $44.1 million from
$179.9 million at March 31, 1996 to $224.0 million at March 31, 1997. The
Company hedges, in part, its interest rate exposure on its receivables held for
sale and loans and other assets sold, with recourse, under its Purchase and Sale
Facilities, through the use of United States Treasury securities and futures
contracts. Securities purchased under agreements to resell are part of this
hedging strategy. This increase was due primarily to the increase in the
Company's securitization volume in fiscal 1997 as compared to fiscal 1996.
Interest-only and residual certificates increased $151.8 million from $293.2
million at March 31, 1996 to $445.0 million at March 31, 1997. Excluding $15.2
million of interest-only and residual certificates
A-28
<PAGE>
relating to the Acquisitions, the March 31, 1997 balance increased by $136.6
million from March 31, 1996. This increase represents $251.1 million recorded
during fiscal 1997 relating to new securitizations and recorded interest income
of $33.7 million partially offset by $96.5 million of sales and $51.7 million of
collections.
Capitalized servicing fees receivable increased $17.7 million from $11.7
million at March 31, 1996 to $29.4 million at March 31, 1997. This balance
reflects the capitalization of $24.0 million of servicing rights and $1.4
million of prepayment premiums paid partially offset by amortization of $7.7
million.
Trade receivables, net increased $356.9 million from $352.3 million at March
31, 1996 to $709.2 million at March 31, 1997. Excluding $51.3 million of trade
receivables, net relating to the Acquisitions, the March 31, 1997 balance
increased by $305.6 million from March 31, 1996. This increase was primarily due
to an increase in receivables held for sale from $303.7 million as of March 31,
1996 to $574.3 million at March 31, 1997, and partially due to the increase in
other receivables from $50.5 million at March 31,1996 to $85.7 million at March
31, 1997. The increase in receivables held for sale was primarily due to the
adoption of SFAS 125 on January 1, 1997. As of March 31, 1997, $251.5 million of
receivables held for sale under the Purchase and Sale Facilities were
categorized as financing under SFAS 125 and classified as "Trade receivables
sold under agreements to repurchase". In addition to the SFAS 125
classification, there was an additional increase of $19.1 million of receivables
held for sale due to an overall increase in securitization volume from fiscal
1996 to fiscal 1997.
The increase in other receivables of $35.2 million from fiscal 1996 to
fiscal 1997 was primarily due to an increase in servicing advances of $16.8
million and an increase in short-term receivables of $17.2 million. The increase
in servicing advances was due to advances made by ContiMortgage on loans in the
servicing system. ContiMortgage, as servicer, is contractually liable to pay the
REMIC for certain delinquencies and then collects the past due amounts from the
borrower. This increase is because of an overall dollar increase in
delinquencies from fiscal 1996 to fiscal 1997. The increase in short-term
receivables is due to timing differences in receiving loan payments from third
party intermediaries.
Premises and equipment, net increased $3.8 million from $3.9 million at
March 31, 1996 to $7.7 million at March 31, 1997. Excluding $3.4 million of
premises and equipment relating to the Acquisitions, the March 31, 1997 balance
decreased by $0.4 million from March 31, 1996. This decrease was primarily as a
result of office equipment acquisitions which were more than offset by the
normal periodic depreciation of owned equipment.
Cost in excess of equity increased $33.6 million from $14.6 million at March
31, 1996 to $48.2 million at March 31, 1997. The increase was primarily due to
the costs in excess of equity recorded upon the purchase of the Acquisitions
made by the Company during the third quarter of fiscal 1997.
Other assets increased $26.8 million from $3.9 million at March 31, 1996 to
$30.7 million at March 31, 1997. Excluding the effects of the Acquisitions,
March 31, 1997 other assets increased by $24.4 million from March 31, 1996.
Other assets represents prepaid expenses, margin and other deposits, deferred
bond issuance costs and other investments. This increase is primarily due to an
increase of approximately $12.0 million of deferred issuance costs on the 8 3/8%
and 7 1/2% Senior Notes (defined below), $3.7 million of prepaid shelf
registration and servicing fees and an increase of $4.3 million in escrow
deposits.
Accounts payable and accrued expenses increased $14.3 million from $73.5
million at March 31, 1996 to $87.8 million at March 31, 1997. Excluding $6.6
million of accounts payable and accrued expenses relating to the Acquisitions,
the March 31, 1997 balance increased by $7.7 million from March 31, 1996. The
balance increased primarily due to an increase in accrued taxes payable of $14.6
million, incentive accruals of approximately $5.5 million, accruals for
securitization obligations of $4.1 million, accrued interest payable of $3.1
million, accrued pension and health care costs of approximately $1.5 million
offset by a decrease in accrued amounts payable under the Company's Purchase and
Sale Facilities of approximately $20.8 million. The increases in accrued taxes
payable, and accruals for securitization obligations
A-29
<PAGE>
were due to increased securitization volume, producing higher net income in
fiscal 1997. The increase in incentive accruals in fiscal 1997 as compared to
fiscal 1996 was due to the deferral of payments. The increase in accrued pension
and healthcare costs was due to an increase in the number of employees
(excluding the Acquisitions) to 703 in fiscal 1997 as compared to 455 employees
in fiscal 1996. The decrease in accrued amounts payable under the Company's
Purchase and Sale Facilities was due to a timing difference in the amounts
payable under these obligations.
Securities sold but not yet purchased increased $44.4 million from $180.7
million at March 31, 1996 to $225.1 million at March 31, 1997. The Company
hedges, in part, its interest rate exposure on its receivables held for sale and
loans and other assets sold with recourse under its Purchase and Sale Facilities
through the use of United States Treasury securities and futures contracts.
Securities sold but not yet purchased are part of this hedging strategy. This
increase was due primarily to the increase in the Company's securitization
volume in fiscal 1997 from fiscal 1996.
Payables to affiliates decreased $301.3 million from $337.7 million at March
31, 1996 to $36.4 million at March 31, 1997. In connection with the Company's
IPO on February 14, 1996, Continental Grain Company ("Continental Grain")
provided financing with three notes totaling $324.0 million. These notes were
refinanced principally with the net proceeds of the Senior Notes, as defined
below. The remaining balance of Payables to affiliates at March 31, 1997
represents amounts due under a services agreement and a tax sharing agreement
with Continental Grain .
Short-term borrowed funds represents borrowings from a $200.0 million
unsecured revolving credit facility the Company entered into on January 8, 1997.
At March 31, 1997, $25.0 million of drawings under this line were outstanding.
On August 14, 1996, the Company issued the $300.0 million 8 3/8% unsecured
senior notes due 2003 (the "8 3/8% Senior Notes") and on March 12, 1997, the
Company issued the $200.0 million unsecured 7 1/2% senior notes due 2002 (the
"7 1/2% Senior Notes") (collectively the "Senior Notes"), resulting in $498.5
million of the balance sheet increase in Long-term debt from March 31, 1996. The
Senior Notes were issued at a discount which is being amortized over the life of
the Senior Notes. The remaining $0.3 million of long-term debt represents
amounts payable under a long term capitalized lease.
Other liabilities increased $6.3 million from $5.8 million at March 31, 1996
to $12.1 million at March 31, 1997. Excluding the effects of the Acquisitions,
March 31, 1997 other liabilities increased by $5.9 million from March 31, 1996.
The increase is primarily due to the accrual of contingent payments relating to
the Acquisitions.
Stockholders' equity increased $113.0 million from $294.8 million at March
31, 1996 to $407.8 million at March 31, 1997 due to net income of $106.0
million, the amortization of deferred compensation of $6.7 million and the
exercise of stock options of $0.3 million. Excluding the effect of the
Acquisitions, March 31, 1997, stockholders' equity increased by $109.4 million
from March 31, 1996.
RESULTS OF OPERATIONS
YEAR ENDED MARCH 31, 1997 COMPARED TO YEAR ENDED MARCH 31, 1996 AND YEAR ENDED
MARCH 31, 1995
The Company's total gross income increased $156.0 million or 57% to $427.8
million in fiscal 1997 as compared to $271.8 million of total gross income in
fiscal 1996 which in turn increased $149.8 million or 123% from total gross
income of $122.0 million for fiscal 1995. Excluding the effects of the
Acquisitions, fiscal 1997 gross income increased by $123.9 million from fiscal
1996. The Company's total expenses as a percentage of total gross income
increased to 59% in fiscal 1997 from 53% in fiscal 1996 and fiscal 1995. As a
result, net income for fiscal 1997 increased $79.9 million or 306% to $106.0
million compared to net income of $26.1 million in fiscal 1995. Excluding the
Acquisitions during the third quarter of fiscal 1997, net income increased by
$76.3 million from fiscal 1995.
A-30
<PAGE>
On a percentage basis, the following table sets forth the composition of the
Company's results as a percentage of total gross income for the periods
indicated:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-------------------------------
<S> <C> <C> <C>
1997 1996 1995
--------- --------- ---------
GROSS INCOME
Gain on sale of receivables........................................................ 49.28% 53.91% 55.34%
Interest........................................................................... 37.73% 33.75% 35.19%
Net servicing income............................................................... 10.83% 10.78% 7.63%
Other income....................................................................... 2.16% 1.56% 1.84%
--------- --------- ---------
Total gross income............................................................... 100.00% 100.00% 100.00%
--------- --------- ---------
EXPENSES
Compensation and benefits.......................................................... 19.21% 19.21% 19.52%
Interest........................................................................... 28.20% 27.51% 24.29%
Provision for loan losses.......................................................... 0.71% 0.10% 1.59%
General and administrative......................................................... 10.50% 6.63% 7.89%
--------- --------- ---------
Total expenses................................................................... 58.62% 53.45% 53.29%
--------- --------- ---------
Income before income taxes and minority interest..................................... 41.38% 46.55% 46.71%
Income taxes......................................................................... 16.67% 18.06% 18.17%
Minority interest.................................................................... -0.07% 1.22% 7.15%
--------- --------- ---------
Net income......................................................................... 24.78% 27.27% 21.39%
--------- --------- ---------
--------- --------- ---------
</TABLE>
INCOME. The increase in total gross income was due to a greater volume of
loans originated as a result of the expansion of the Company's wholesale and
broker origination sources. The following table sets forth information regarding
the components of the Company's total gross income in each of the last three
fiscal years ending on March 31:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
----------------------------------
<S> <C> <C> <C>
1997 1996 1995
---------- ---------- ----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Gain on sale of receivables.............................. $ 210,861 $ 146,529 $ 67,512
Interest................................................. 161,402 91,737 42,929
Net servicing income..................................... 46,340 29,298 9,304
Other income............................................. 9,227 4,252 2,252
---------- ---------- ----------
Total gross income....................................... $ 427,830 $ 271,816 $ 121,997
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
Gain on sale of receivables was the primary component of total gross income,
comprising 49%, 54% and 55% of total gross income in fiscal 1997, 1996 and 1995,
respectively. Gain on sale of receivables increased $64.3 million or 44% in
fiscal 1997 as compared to fiscal 1996 which in turn increased by $79.0 million
or 117% from fiscal 1995. Excluding $26.5 million of gain on sale of receivables
relating to the Acquisitions, the fiscal 1997 balance increased by $37.8 million
or 26% from fiscal 1996. Gain on sale of receivables as a percentage of total
gross income was lower in fiscal 1997 due to an increased outstanding balance of
interest earning assets resulting in increased interest income.
Gain on sale of receivables represents income primarily from the structuring
and sale of pools of home equity loans originated by ContiMortgage and Strategic
Alliance clients of the Company in REMICs, owner trusts and grantor trusts. In
addition, gains on sale of receivables are earned upon whole loan sales and upon
securitization of commercial and multi-family loans, self-storage facilities,
Title I home improvement loans, franchisee loans, auto loans and equipment
leases which are sold into REMICs and whole loan and other trust structures.
A-31
<PAGE>
The increase in income earned from gain on sale of receivables was due to an
increased volume of loans, leases and other assets structured and an increased
gain on sale percentage. Excluding contributions from the Acquisitions, the
Company structured and sold $4.9 billion of mortgages, loans and leases in
fiscal 1997, an increase of $0.9 billion from fiscal 1996, which contributed
$32.7 million of the increase in gain on sale of receivables, and structured and
sold $4.0 billion of mortgages, loans and leases in fiscal 1996, an increase of
$1.7 million from fiscal 1995, which contributed $62.6 million of the increase
in gain on sale of receivables.
The gain on sale percentage represents the differential between the interest
rate earned on underlying securitized loans, leases or other assets and the
pass-through rate paid to the securitization investors during the estimated life
of the loans, leases or other assets. The increase in the gain on sale
percentage was primarily due to the type of assets securitized and changes in
the yield curve. The larger gain on sale percentage in fiscal 1997 as compared
to fiscal 1996 was partially due to an increased proportion of ContiMortgage
securitizations which yield higher gain on sale percentages than securitizations
and placements for Strategic Alliance clients. In fiscal 1997, ContiMortgage
securitizations represented 75% of total volume as compared to 51% for fiscal
1996 and 57% for fiscal 1995. This contributed to a gain of 13 basis points in
Excess Spread or a $5.1 million increase in gain on sale of receivables in
fiscal 1997 as compared to fiscal 1996. The combination of the $32.7 million
increase due to increased volume and the $5.1 million increase due to an
increase in the percentage of ContiMortgage assets securitized resulted in a
total increase in gain on sale of receivables from fiscal 1996 to fiscal 1997 of
$37.8 million.
In fiscal 1996 as compared to fiscal 1995, the relationship between interest
rates and maturity caused an increase in the gain on sale percentage. As the
Company originates and sells loans and leases based on the interpolated United
States Treasury interest rate plus a negotiated additional interest spread, the
gain on sale of receivables is affected by unequal movements in interest rates
at various maturities. The interpolated Treasury interest rate is based on the
Company's estimate of the average life of the pool of loans or leases. In fiscal
1996 as compared to fiscal 1995, the yield curve steepened which contributed an
additional 72 basis points to Excess Spread or $16.4 million of the increase in
gain on sale of receivables. The combination of the $16.4 million increase due
to the yield curve and the $62.6 million increase due to increased volume
resulted in a total increase in gain on sale of receivables from fiscal 1995 to
fiscal 1996 of $79.0 million. The gain on sale as a percentage of loans
securitized and sold for fiscal 1997, 1996 and 1995 was 4.2%, 3.7% and 3.0%,
respectively.
Interest income increased $69.7 million or 76% in fiscal 1997 from fiscal
1996 and $48.8 million or 114% in fiscal 1996 from fiscal 1995. Excluding the
effects of the Acquisitions, fiscal 1997 interest income increased by $65.9
million, or 72% from fiscal 1996. Interest income represents interest earned on
loans originated or purchased by the Company during the period from origination
or purchase until the actual sale of the loans, as well as the recognition of
the increased value of the discounted Excess Spread Receivables over time. The
interest earned on loans originated and purchased contributed $50.1 million to
the increase between fiscal 1996 and fiscal 1997 and $35.5 million to the
increase between fiscal 1995 and fiscal 1996. The increase in interest earned on
loans originated and purchased was due primarily to the increase in the average
balance of loans originated and purchased but not yet securitized during the
periods, an increase of $715.6 million in fiscal 1997 as compared to fiscal 1996
and an increase of $591.5 million in fiscal 1996 as compared to fiscal 1995. The
recognition of the increased value of the discounted Excess Spread Receivables
over time, due to an increase in interest-only and residual certificates, as
previously discussed, accounted for $12.8 million of the increase in interest
income between fiscal 1996 and fiscal 1997 and $13.3 million of the increase
between fiscal 1995 and fiscal 1996.
Net servicing income increased $17.0 million or 58% in fiscal 1997 compared
to fiscal 1996 and $20.0 million or 215% in fiscal 1996 compared to fiscal 1995
due to the increase in the size of the servicing portfolio, the volume of loan
sales and securitizations and, in fiscal 1996, a change in accounting
principles. Excluding the effects of the Acquisitions, fiscal 1997 net servicing
income increased by $16.5 million, or 56% from fiscal 1996. The Company's home
equity loan servicing portfolio increased $2.5 billion or 66% to
A-32
<PAGE>
$6.4 billion at March 31, 1997 from March 31, 1996 and $1.7 billion or 76% to
$3.9 billion at March 31, 1996 from March 31, 1995 . The growth of the servicing
portfolio contributed $11.9 million of the increase between fiscal 1996 and
fiscal 1997, and $8.3 million of the increase between fiscal 1995 and fiscal
1996. Additionally, net servicing income increased by $4.6 million in fiscal
1997 as compared to fiscal 1996 due to capitalized servicing income associated
with the 79% increase in the ContiMortgage home equity loan sales and
securitizations during the same period. In fiscal 1996 as compared to fiscal
1995 the capitalization of servicing fees increased servicing income by $11.7
million as servicing fees were not capitalized in fiscal 1995.
Other income increased $4.9 million or 114% to $9.2 million in fiscal 1997
as compared to fiscal 1996 and increased $2.0 million or 87% to $4.3 million in
fiscal 1996 as compared to fiscal 1995. Excluding the effects of the
Acquisitions, fiscal 1997 other income increased by $3.7 million or 86% from
fiscal 1996. Other income consists primarily of "purchase premium refunds" and
for fiscal 1997, warrant income. "Purchase premium refunds" are received from
certain origination sources related to loans that prepay within a contractually
set time period. Upon origination of a loan, the Company will pay a wholesale
originator a purchase premium for the loan or pools of loans. The Company
negotiates agreements with wholesale originators that provide that a portion of
such purchase premium will be repaid if individual loans are repaid within a
contractually set time period. The income from "purchase premium refunds"
increased due to the increase in ContiMortgage origination volume. The fiscal
1997 warrant income received consists of $2.7 million of income from the sale of
stock warrants in a Strategic Alliance company.
EXPENSES. Total expenses for fiscal 1997 increased $105.5 million or 73%
from fiscal 1996 which in turn increased $80.3 million or 123% from fiscal 1995.
Excluding the effects of the Acquisitions, fiscal 1997 total expenses increased
by $77.0 million or 53% from fiscal 1996. These increases in total expenses were
due to the increase in number of employees and costs associated with increased
mortgage volume and increased interest costs from financing larger balances of
securitizable loans.
The following table sets forth the components of the Company's expenses for
each of the last three fiscal years.
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
---------------------------------
<S> <C> <C> <C>
1997 1996 1995
---------- ---------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Compensation and benefits.................................. $ 82,170 $ 52,203 $ 23,812
Interest................................................... 120,636 74,770 29,635
Provision for loan losses.................................. 3,043 285 1,935
General and administrative................................. 44,940 18,022 9,627
---------- ---------- ---------
Total expenses............................................. $ 250,789 $ 145,280 $ 65,009
---------- ---------- ---------
---------- ---------- ---------
</TABLE>
Compensation and benefits increased $30.0 million or 57% in fiscal 1997
compared to fiscal 1996 and increased $28.4 million or 119% in fiscal 1996 as
compared to fiscal 1995. Excluding $16.1 million of compensation and benefits
relating to the Acquisitions, fiscal 1997 compensation and benefits expense
increased by $13.9 million or 27% from fiscal 1996. The increase was primarily
due to the addition of new personnel, changes in and accruals under incentive
compensation plans, vesting of restricted common stock and commissions paid to
certain employees based upon volume of loan originations. On March 31, 1997, the
Company had 1,562 employees, 859 from the Acquisitions, as compared to 455
employees on March 31, 1996 and 234 employees on March 31, 1995. This increase
primarily contributed to a $14.0 million increase in compensation costs in
fiscal 1997 compared to fiscal 1996, excluding the Acquisitions, and a $6.4
million increase in compensation costs in fiscal 1996 as compared to fiscal
1995. The fiscal 1997 accrual for incentive compensation was $23.2 million as
compared to $28.0 million in fiscal 1996 and $12.4 million in fiscal 1995, which
contributed to a $4.8 million decrease in compensation costs in fiscal 1997
compared to fiscal 1996 and a $15.6 million increase in fiscal 1996 compared to
fiscal 1995. In connection
A-33
<PAGE>
with the IPO, shares of "restricted" common stock were granted to certain key
employees. The "restricted" common stock granted, subject to the employee's
continued employment with the Company, generally vests between February 14, 1996
and March 31, 2000. The expense related to the vesting of "restricted" common
stock increased by $1.7 million to $6.7 million during fiscal 1997 from fiscal
1996 restricted stock expense of $5.0 million. The commissions paid to certain
ContiMortgage employees increased $3.0 million and $1.4 million from fiscal 1996
to fiscal 1997 and fiscal 1995 to fiscal 1996, respectively, associated with
increased ContiMortgage origination volume. Compensation and related expenses
represents 19% of total gross income for fiscal 1997 and 1996 and 20% of total
gross income for fiscal 1995.
Interest expense increased $45.9 million or 61% in fiscal 1997 as compared
to fiscal 1996 and increased $45.1 million or 152% in fiscal 1996 as compared to
fiscal 1995. Excluding the effects of the Acquisitions, fiscal 1997 interest
expense increased by $45.3 million or 61% from fiscal 1996. This increase was
primarily a result of interest expense associated with the issuance of the
Senior Notes, the costs of the sale, with limited recourse, of certain Excess
Spread Receivables, increased expenses from the Purchase and Sale Facilities and
an overall increase in the cost of borrowing offset by decreased borrowing from
Continental Grain. The average borrowings from Continental Grain, Purchase and
Sale Facilities, the Senior Notes and Excess Spread Receivables sold with
limited recourse, increased by $621.3 million in fiscal 1997 as compared to
fiscal 1996, resulting in a $43.5 million increase in interest expense, while
such average increased $627.4 million in fiscal 1996, as compared to fiscal 1995
resulting in a $43.0 million increase in interest expense. The increase in
interest rates contributed $1.8 million to the increase in interest expense
between fiscal 1997 as compared to fiscal 1996 and the increase in interest
rates contributed $2.1 million in fiscal 1996 as compared to fiscal 1995.
Provision for loan losses increased to $3.0 million in fiscal 1997 as
compared to $0.3 million in fiscal 1996 and $1.9 million in fiscal 1995.
Excluding $2.4 million of provision for loan losses relating to the
Acquisitions, the fiscal 1997 balance increased by $0.3 million from fiscal
1996. Provision for loan losses is recorded in sufficient amounts to maintain an
allowance at a level considered adequate to cover anticipated losses resulting
from liquidation of receivables held for sale and receivables sold with limited
recourse under Purchase and Sale Facilities, prior to sale or securitization.
The increase in fiscal 1997 as compared to fiscal 1996 and the decrease in
fiscal 1996 as compared to fiscal 1995 resulted from a determination of adequate
reserves in light of actual loss experience during the period.
General and administrative expenses increased $26.9 million or 149% in
fiscal 1997 compared to fiscal 1996 and $8.4 million or 87% in fiscal 1996
compared to fiscal 1995. Excluding $9.4 million of general and administrative
expenses relating to the Acquisitions, the fiscal 1997 balance increased by
$17.5 million, or 97% from fiscal 1996. The increases were partially a result of
a $7.1 million and a $3.7 million increase in costs associated with
underwriting, originating and servicing higher loan volumes in fiscal 1997 as
compared to fiscal 1996 and fiscal 1996 as compared to fiscal 1995,
respectively. In fiscal 1997, the origination volume increased 69% as compared
to fiscal 1996 and 74% in fiscal 1996 as compared to fiscal 1995. Expenses
related to the implementation of collection technology accounted for
approximately $1.3 million of the increase in fiscal 1997 as compared to fiscal
1996. The remaining increases were primarily due to an increase in general and
administrative expenses related to the increase in the number of employees by
248, excluding employees of the Acquisitions, from fiscal 1996 to fiscal 1997
and the increase of 221 employees from fiscal 1995 to fiscal 1996.
INCOME TAXES. The Company's provision for income taxes was $71.3 million,
$49.1 million and $22.2 million for fiscal 1997, fiscal 1996 and fiscal 1995,
respectively. The Company is included in the consolidated Federal income tax
return of Continental Grain. The increase in taxes over the three fiscal years
is directly related to the increase in income before taxes and minority interest
over the same period. The effective tax rate for each year remained relatively
consistent at 39% to 40%. Increases in the effective tax rate were due to
changes in the provision for state income taxes.
A-34
<PAGE>
MINORITY INTEREST. In fiscal 1996 and fiscal 1995, minority interest
represents the portion of income before taxes and minority interest due to the
20% minority shareholders of ContiMortgage. Minority interest decreased $5.4
million or 62% in fiscal 1996 compared to fiscal 1995. This decrease in minority
interest was directly related to the change in the Company's ownership
percentage of ContiMortgage. On June 19, 1995, ContiTrade Services Corporation
("ContiTrade Services") effectively acquired control of the remaining 20%
minority interest in ContiMortgage, which became a wholly-owned subsidiary of
ContiFinancial Corporation. Accordingly, the fiscal 1996 results of operations
include approximately three months of minority interest of $3.3 million, while
the comparable period of fiscal 1995 reflected 12 months of minority interest of
$8.7 million.
In fiscal 1997, minority interest represents the portion of loss before
taxes and minority interest due to the 44% minority shareholders of Triad. In
the third and fourth quarters of fiscal 1997, the Company acquired 56% of the
common stock of Triad. Minority interest was ($0.3) million for the period ended
March 31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
In a securitization, the Company recognizes a gain on the sale of loans or
assets securitized upon the closing of the securitization, but does not receive
the cash representing such gain until it receives the Excess Spread, which is
payable over the actual life of the loan or other assets securitized. The
Company incurs significant expenses in connection with a securitization and
incurs both current and deferred tax liabilities as a result of the gain on
sale. Therefore, the Company requires continued access to short and long term
external sources of cash to fund its operations. The Company's primary cash
requirements are expected to include the funding of: (i) mortgage, loan and
lease originations and purchases pending their pooling and sale; (ii) the points
and expenses paid in connection with the acquisition of wholesale loans; (iii)
fees and expenses incurred in connection with its securitization program; (iv)
over collateralization or reserve account requirements in connection with loans
and leases pooled and sold; (v) ongoing administrative and other operating
expenses; (vi) payments related to its tax obligations under a Tax Sharing
Agreement with Continental Grain or to tax authorities; (vii) interest and
principal payments under the Senior Notes; (viii) the costs of the Purchase and
Sale Facilities; (ix) interest payments under the unsecured revolving credit
facility; and (x) the cost of any new acquisitions that the Company may pursue.
As a result of its growing securitization program, the Company has operated,
and expects to continue to operate, on a negative cash flow basis, which is
expected to increase as the volume of its loan and asset purchases and
originations increases and its securitization program grows. During fiscal 1995,
1996 and 1997, the Company securitized and sold in the secondary market $2.3
billion, $4.0 billion and $5.0 billion of loans, respectively. The Company used
$153.2 million, $300.5 million and $35.3 million of cash in operations during
fiscal 1997, 1996 and 1995, respectively.
During the life of the REMICs, owner trusts or grantor trusts, the Company
subordinates to the rights of holders of senior interests a portion of the
Excess Spread otherwise due to the Company as a credit enhancement to support
the sale of senior interests. The terms of the REMICs, owner trusts and grantor
trusts generally require that the Excess Spread otherwise payable to the Company
during the early months of the trusts be used to increase the cash reserve
account, or to repay the senior interests in order to increase over
collateralization to specified maximums. The value of such "deposit" accounts is
included in the value of Excess Spread Receivables and the related gain on sale
of receivables, net of necessary reserves for credit losses, if applicable.
In addition, increased use of securitization transactions as a funding
source by the Company has resulted in a significant increase in the amount of
gain on sale of receivables recognized by the Company. During fiscal 1995, 1996
and 1997, the Company recognized gain on sale of receivables in the amounts of
$67.5 million, $146.5 million, and $210.9 million, respectively. The recognition
of gain on sale of receivables will have a negative impact on the cash flows of
the Company to the extent the Company is
A-35
<PAGE>
required to pay state and Federal income taxes on these amounts in the period
recognized, notwithstanding that the Company does not receive the cash
representing the gain until later periods as the related loans are repaid or
otherwise collected.
The Company's primary sources of liquidity are sales of loans, leases and
other assets through securitization, the sale of loans, leases and other assets
under the Purchase and Sale Facilities and trade receivables sold under
agreements to repurchase, the sale of Excess Spread Receivables, the sale of the
Senior Notes and the unsecured revolving credit facility. While the Company
sells Excess Spread Receivables from time to time, there is no liquid market for
such Excess Spread Receivables.
The Company had $2.3 billion of committed sale capacity under its Purchase
and Sale Facilities with various financial institutions as of March 31, 1997.
The Purchase and Sale Facilities allow the Company to sell, with limited
recourse, interests in designated pools of loans and other assets. These
agreements generally have one year renewable terms (one Purchase and Sale
Facility has a two-year term), all of which will expire between May 1997 and
June 1998. On March 31, 1997, the Company utilized $590.7 million of the
capacity under these facilities. The Company currently anticipates that it will
be able to renew these facilities when they expire and to obtain additional
facilities.
On March 31, 1997, the Company entered into a funding agreement under an
agreement to repurchase ("Repurchase Agreement"). The Repurchase Agreement
allows the Company to sell receivables held for sale to a financial institution
under an agreement that the Company will repurchase the asset. This agreement
has a one year renewable term which expires January 1998. The Company currently
anticipates that it will be able to renew this facility when it expires and to
obtain additional facilities.
The Company sells Excess Spread Receivables, with limited recourse, to
provide cash to fund the Company's securitization program. These sales
aggregated $50.0 million in fiscal 1995, $54.5 million in fiscal 1996 and $96.5
million in fiscal 1997. At March 31, 1997, $144.9 million of these sales were
outstanding. Under the recourse provisions of the agreements, the Company is
responsible for losses incurred by the purchaser within an agreed-upon range.
The Company's performance obligations in these transactions are guaranteed by
Continental Grain for an agreed-upon fee. Although the Company intends to
continue to pursue opportunities to sell Excess Spread Receivables, no assurance
can be given that such opportunities will be available in the future.
In order to fund the Company's growth prior to the IPO, Continental Grain
provided the Company with intercompany financing ("Intercompany Debt"). To
refinance the Intercompany Debt, simultaneously with the completion of the IPO,
Continental Grain purchased from the Company a $125 million five-year note
issued under an indenture (the "Indenture Note"), a $74 million four-year note
(the "Four Year Note") and a $125 million term note (the "Term Note") for $324
million in aggregate (collectively, the "Notes").
On August 14, 1996, the Company issued the 8 3/8% Senior Notes maturing
August 15, 2003. Interest on these notes is payable semiannually on February 15
and August 15 commencing February 15, 1997. The 8 3/8% Senior Notes are
redeemable as a whole or in part, at the option of the Company, at any time or
from time to time, at a redemption price equal to the greater of (i) 100% of
their principal amount and (ii) the sum of the present values of the remaining
scheduled payments of principal and interest thereon discounted to the date of
redemption on a semiannual basis at the treasury yield plus 50 basis points,
plus in each case, accrued interest to the date of redemption. Proceeds to the
Company, net of underwriting fees, market discount and other costs were $287.7
million. Of this amount, $125.0 million was used by the Company to repay in full
the Term Note payable to Continental Grain and the remaining funds have been
used for general corporate purposes, including funding loan originations and
purchases, supporting securitization transactions and other working capital
needs.
A-36
<PAGE>
On January 8, 1997, the Company closed a $200 million unsecured revolving
credit facility. The three-year facility has several interest rate pricing
alternatives, including those based on LIBOR and federal funds rates. The
facility will be used for general corporate and liquidity purposes.
On March 12, 1997, the Company issued the 7 1/2% Senior Notes maturing March
15, 2002. Proceeds to the Company, net of underwriting fees, market discount and
other costs were $197.7 million. Interest on these notes is payable
semi-annually on March 15 and September 15 commencing September 15 ,1997. This
amount, together with other funds of the Company, were used to repay in full the
Indenture Note and the Four Year Note payable to Continental Grain which
constituted all of the remaining financing indebtedness due to Continental
Grain.
On June 4, 1997, the Company completed a primary offering of 2,800,000
shares of common stock and an additional 420,000 shares were purchased by the
underwriters for over allotments. The net proceeds of the offering to the
Company were $100.8 million.
The net proceeds from the IPO, the issuance of the 8 3/8% and the 7 1/2%
Senior Notes and the June 4, 1997 primary offering, were used by the Company for
general corporate purposes, including funding loan originations and purchases,
supporting securitization transactions (including the retention of Excess Spread
Receivables), other working capital needs and to make certain strategic
acquisitions. Sales of the loans, leases and other assets through
securitizations, the sale of loans under the Purchase and Sale Facilities, the
sale of Excess Spread Receivables and the June 4, 1997 primary offering of
2,800,000 shares of common stock, together with cash on hand, are expected to be
sufficient to fund the Company's liquidity requirements for at least the next 12
months if the Company's future operations are consistent with management's
current growth expectations. The Company has no commitments for additional
financing and there can be no assurance that the Company will be successful in
consummating any such financing transactions in the future on terms that the
Company would consider to be favorable. Furthermore, no assurance can be given
that Continental Grain will provide such financing if the Company is unable to
obtain third party financing or that the terms of the Continental Grain debt
agreements will permit the Company to obtain such financing.
During fiscal 1995 and during fiscal 1996, prior to the close of its IPO on
February 14, 1996, the Company paid cash dividends to Continental Grain of $30
million and $0.3 million, respectively. The Company has no current intention to
pay cash dividends on its Common Stock. As a holding company, the ability of the
Company to pay dividends is dependent upon the receipt of dividends or other
payments from its subsidiaries. Any future determination as to the payment of
dividends will be at the discretion of the Company's Board of Directors and will
depend upon the Company's operating results, financial condition and capital
requirements, contractual restrictions, general business conditions and such
other factors as the Company's Board of Directors deems relevant. Furthermore,
covenants in the Company's and Continental Grain's loan agreements restrict the
payment of dividends by the Company. There can be no assurance that the Company
will have earnings sufficient to pay a dividend on its Common Stock or that,
even if there are sufficient earnings, dividends will be permitted under
applicable law.
EFFECTS OF ACCOUNTING PRONOUNCEMENTS
On January 1, 1997, the Company adopted the SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities".
See "Certain Accounting Considerations" for discussion of the statement and its
impact on the Company's financial condition and results of operations.
In February 1997, the FASB issued SFAS No. 128 "Earnings Per Share ("EPS")"
("SFAS 128") which is effective in fiscal 1998, early application is not
permitted. SFAS 128 simplifies the standards for computing earnings per share.
It replaces the presentation of primary EPS with a presentation of basic EPS.
Basic EPS excludes dilution and is computed by dividing income available to
common stockholders by the weighted-average number of common shares outstanding
for the period. If SFAS 128 had been applied to fiscal 1997 results of
operations, the Company's basic EPS would have been $2.44 (pro forma) of
A-37
<PAGE>
earnings per common share based on net income of $106,004 and weighted-average
number of common shares of 43,361,253 (pro forma). Fully dilutive EPS remains
the same under SFAS 128 but will be referred to as diluted EPS.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Annual Report Form 10-K which are not
historical fact, may be deemed to be forward-looking statements under the
federal securities laws. There are many important factors that could cause the
Company's actual results to differ materially from those indicated in the
forward-looking statements. Such factors include, but are not limited to,
general economic conditions, interest rate risk, prepayment speeds, delinquency
and default rates, changes (legislative and otherwise) in the asset
securitization industry, demand for the Company's services, the impact of
certain covenants in loan agreements of the Company and Continental Grain, the
degree to which the Company is leveraged, its needs for financing, and other
risks identified in the Company's Securities and Exchange Commission filings. In
addition, it should be noted that past financial and operational performance of
the Company is not necessarily indicative of future financial and operational
performance.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
CONTIFINANCIAL CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Independent Public Accountants................................................................... 39
Consolidated Balance Sheets as of March 31, 1997 and 1996.................................................. 40
Consolidated Statements of Income for the years ended March 31, 1997, 1996 and 1995........................ 41
Consolidated Statements of Changes in Stockholders' Equity for the years ended March 31, 1997, 1996 and
1995..................................................................................................... 42
Consolidated Statements of Cash Flows for the years ended March 31, 1997, 1996 and 1995.................... 43
Notes to Consolidated Financial Statements................................................................. 44
</TABLE>
A-38
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of ContiFinancial Corporation:
We have audited the accompanying consolidated balance sheets of ContiFinancial
Corporation (a Delaware corporation) and subsidiaries as of March 31, 1997 and
1996, and the related consolidated statements of income, changes in
stockholders' equity and cash flows for each of the three years in the period
ended March 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of ContiFinancial Corporation as
of March 31, 1997 and 1996, and the results of its operations and its cash flows
for each of the three years in the period ended March 31, 1997, in conformity
with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
New York, New York
May 8, 1997 (except with respect
to the matter discussed in Note 14,
as to which the date is June 4, 1997)
A-39
<PAGE>
CONTIFINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 1997 AND 1996
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
MARCH 31,
------------------------
1997 1996
------------ ----------
<S> <C> <C>
ASSETS
Cash and cash equivalents............................................................... $ 51,200 $ 32,479
Restricted cash......................................................................... 464 620
Securities purchased under agreements to resell......................................... 223,962 179,875
Interest-only and residual certificates................................................. 445,005 293,218
Capitalized servicing fees receivable................................................... 29,353 11,689
Trade receivables:
Receivables held for sale............................................................. 625,545 303,679
Other receivables..................................................................... 87,353 50,470
Allowance for loan losses............................................................. (3,747) (1,824)
------------ ----------
Total trade receivables, net............................................................ 709,151 352,325
------------ ----------
Premises and equipment, net of accumulated depreciation of $4,298 and $2,497 as of March
31, 1997 and 1996, respectively....................................................... 7,789 3,906
Cost in excess of equity................................................................ 48,200 14,573
Other assets............................................................................ 30,674 3,855
------------ ----------
Total assets...................................................................... $ 1,545,798 $ 892,540
------------ ----------
------------ ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Accounts payable and accrued expenses................................................... $ 87,770 $ 73,459
Securities sold but not yet purchased................................................... 225,131 180,729
Trade receivables sold under agreements to repurchase................................... 251,539 --
Payables to affiliates:
Due to affiliates..................................................................... 36,367 13,734
Notes payable......................................................................... -- 324,000
------------ ----------
Total payables to affiliates............................................................ 36,367 337,734
------------ ----------
Short-term borrowed funds............................................................... 25,000 --
Long-term debt.......................................................................... 498,817 --
Other liabilities....................................................................... 12,102 5,799
------------ ----------
Total liabilities................................................................. 1,136,726 597,721
------------ ----------
Commitments and contingencies
Minority interest of subsidiary......................................................... 1,288 --
STOCKHOLDERS' EQUITY:
Preferred stock (par value $0.01 per share; 25,000,000 shares authorized; none issued
at March 31, 1997 and 1996)......................................................... -- --
Common stock (par value $0.01 per share; 250,000,000 shares authorized; 44,390,335 and
44,378,953 shares issued at March 31, 1997 and 1996, respectively).................. 444 444
Paid-in capital....................................................................... 295,029 294,701
Retained earnings..................................................................... 128,652 22,648
Treasury Stock (27,931 and 0 shares of common stock, at cost as of
March 31, 1997 and 1996, respectively).............................................. (586) --
Deferred compensation................................................................. (15,755) (22,974)
------------ ----------
Total stockholders' equity........................................................ 407,784 294,819
------------ ----------
Total liabilities and stockholders' equity........................................ $ 1,545,798 $ 892,540
------------ ----------
------------ ----------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
A-40
<PAGE>
CONTIFINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
--------------------------------------
<S> <C> <C> <C>
1997 1996 1995
------------ ------------ ----------
Gross income
Gain on sale of receivables............................................. $ 210,861 $ 146,529 $ 67,512
Interest................................................................ 161,402 91,737 42,929
Net servicing income.................................................... 46,340 29,298 9,304
Other income............................................................ 9,227 4,252 2,252
------------ ------------ ----------
Total gross income.................................................... 427,830 271,816 121,997
------------ ------------ ----------
Expenses
Compensation and benefits............................................... 82,170 52,203 23,812
Interest (includes $18,598, $22,635, and $10,234 for the years ended
March 31, 1997, 1996 and 1995, respectively, to affiliates)........... 120,636 74,770 29,635
Provision for loan losses............................................... 3,043 285 1,935
General and administrative.............................................. 44,940 18,022 9,627
------------ ------------ ----------
Total expenses........................................................ 250,789 145,280 65,009
------------ ------------ ----------
Income before income taxes and minority interest.......................... 177,041 126,536 56,988
Income taxes.............................................................. 71,341 49,096 22,168
------------ ------------ ----------
Income before minority interest........................................... 105,700 77,440 34,820
Minority interest of subsidiary........................................... (304) 3,310 8,728
------------ ------------ ----------
Net income............................................................ $ 106,004 $ 74,130 $ 26,092
------------ ------------ ----------
------------ ------------ ----------
Primary and fully diluted earnings per common share (pro forma at March
31, 1996)............................................................... $ 2.40 $ 2.00
------------ ------------
------------ ------------
Fully diluted weighted average number of shares outstanding (pro forma at
March 31, 1996)......................................................... 44,152,343 37,050,165
------------ ------------
------------ ------------
Primary weighted average number of shares outstanding (pro forma at March
31, 1996)............................................................... 44,090,095 36,995,631
------------ ------------
------------ ------------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
A-41
<PAGE>
CONTIFINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK
------------------------- TOTAL
NUMBER PAID-IN RETAINED TREASURY DEFERRED STOCKHOLDERS'
OF SHARES AMOUNT CAPITAL EARNINGS STOCK COMPENSATION EQUITY
------------ ----------- ---------- ----------- ----------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at March 31, 1995......... 3,100 $ 1 $ 34,000 $ 33,914 $ -- $ -- $ 67,915
Capital contribution.............. -- -- 10,000 -- -- -- 10,000
Net income for the period from
April 1, 1995 to February 8,
1996............................ -- -- -- 51,482 -- -- 51,482
Cash dividend paid................ -- -- -- (305) -- -- (305)
------------ ----- ---------- ----------- ----------- ------------- ------------
Balance at February 8, 1996....... 3,100 1 44,000 85,091 -- -- 129,092
Reorganization:
Transfer of stock............... (3,100) (1) -- -- -- -- (1)
Common stock issued............. 35,918,421 359 84,732 (85,091) -- -- --
Common stock issued in public
offering........................ 7,130,000 72 138,041 -- -- -- 138,113
Issuance of restricted stock...... 1,330,532 13 27,928 -- -- (27,941) --
Net income for the period from
February 9, 1996 to March 31,
1996............................ -- -- -- 22,648 -- -- 22,648
Amortization of deferred
compensation.................... -- -- -- -- -- 4,967 4,967
------------ ----- ---------- ----------- ----------- ------------- ------------
Balance at March 31, 1996......... 44,378,953 444 294,701 22,648 -- (22,974) 294,819
Net income........................ -- -- -- 106,004 -- -- 106,004
Exercise of options............... 11,382 -- 240 -- -- 240
Forfeiture of restricted stock.... -- -- -- -- (712) 712 --
Restricted stock awards........... -- -- 88 -- 126 (214) --
Amortization of deferred
compensation.................... -- -- -- -- -- 6,721 6,721
------------ ----- ---------- ----------- ----------- ------------- ------------
Balance at March 31, 1997......... 44,390,335 $ 444 $ 295,029 $ 128,652 $ (586) $ (15,755) $ 407,784
------------ ----- ---------- ----------- ----------- ------------- ------------
------------ ----- ---------- ----------- ----------- ------------- ------------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
A-42
<PAGE>
CONTIFINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
---------------------------------------------
<S> <C> <C> <C>
1997 1996 1995
-------------- -------------- -------------
Cash flows from operating activities:
Net income...................................................... $ 106,004 $ 74,130 $ 26,092
Adjustments to reconcile net income to net cash used in
operating activities:
Amortization of deferred compensation......................... 6,721 4,967 --
Depreciation and amortization................................. 4,536 1,690 555
Provision (benefit) for deferred taxes........................ 5,680 3,830 (3,080)
Provision for loan losses..................................... 3,043 285 1,935
Net changes in operating assets and liabilities:
Decrease in restricted cash................................... 156 140 164
Increase in interest-only and residual certificates........... (150,701) (150,187) (48,540)
Increase in capitalized servicing fees receivable............. (17,664) (11,689) --
Increase in receivables held for sale:
Originations and purchases.................................. (16,094,071) (12,532,051) (4,986,561)
Sales and principal repayments.............................. 15,774,222 12,304,078 4,951,227
Increase in other receivables................................. (34,858) (33,924) (8,499)
Increase in accounts payable and accrued expenses............. 7,908 31,356 24,207
Increase in trade receivables sold under agreements to
repurchase.................................................... 251,539 -- --
Increase (decrease) in securities purchased under agreements
to resell and securities sold but not yet purchased........... 315 3,887 (4,789)
(Increase) decrease in minority interest of subsidiary........ (325) 3,310 8,728
Other, net.................................................... (15,689) (279) 3,225
-------------- -------------- -------------
Net cash used in operating activities....................... (153,184) (300,457) (35,336)
-------------- -------------- -------------
Cash flows from investing activities:
Acquisitions of subsidiaries (net of cash acquired)............. (28,277) (34,600) --
Purchase of property and equipment.............................. (3,535) (2,643) (1,816)
-------------- -------------- -------------
Net cash used in investing activities......................... (31,812) (37,243) (1,816)
-------------- -------------- -------------
Cash flows from financing activities:
Net increase (decrease) in due to affiliates.................... 17,972 (94,451) 67,666
Net increase (decrease) in notes payable to affiliates.......... (324,000) 324,000 --
Increase in short-term borrowed funds........................... 25,000 -- --
Increase in long-term debt...................................... 498,423 -- --
Debt issuance costs............................................. (12,982) -- --
Other, net...................................................... (696) -- --
Net proceeds from initial public common stock offering.......... -- 138,113 --
Dividends paid.................................................. -- (305) (30,000)
-------------- -------------- -------------
Net cash provided by financing activities..................... 203,717 367,357 37,666
-------------- -------------- -------------
Net increase in cash and cash equivalents....................... 18,721 29,657 514
Cash and cash equivalents at beginning of year.................. 32,479 2,822 2,308
-------------- -------------- -------------
Cash and cash equivalents at end of year........................ $ 51,200 $ 32,479 $ 2,822
-------------- -------------- -------------
-------------- -------------- -------------
</TABLE>
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES:
For the year ended March 31, 1996, Continental Grain Company forgave
intercompany debt of $10,000 and such amount was capitalized as a capital
contribution.
The accompanying notes to consolidated financial statements are an integral part
of these statements.
A-43
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
1. BACKGROUND AND BASIS OF PRESENTATION
ContiFinancial Corporation ("ContiFinancial" or the "Company") was
incorporated as a Delaware corporation on September 29, 1995. The accompanying
consolidated financial statements include the accounts of the Company and its
direct wholly or majority owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
REORGANIZATION
Prior to February 14, 1996, the consolidated financial statements present
the financial condition and results of operations of the Company which includes
its directly wholly-owned subsidiaries: ContiSecurities Asset Funding Corp.
("CSAF"), ContiSecurities Asset Funding II, L.L.C. ("CSAF II"), ContiFunding
Corporation ("CFC"), ContiTrade Services L.L.C. ("CTS"), ContiMortgage
Corporation ("CMC") (all Delaware corporations or limited liability companies)
and ContiFinancial Services Corporation ("CSC"), a New York corporation.
On February 14, 1996, ContiFinancial closed an initial public offering in
the United States and internationally (the "IPO") of approximately 16% of its
common stock. In the reorganization that occurred in December 1995 (the
"Reorganization"), (i) ContiTrade Services Corporation ("CTSC") transferred
certain of its businesses (excluding its trade finance business) to CTS and the
common stock of its subsidiaries, CMC and CSC, and its interest-only and
residual certificates to Continental Grain Company ("Continental Grain") and
(ii) Continental Grain transferred all of the common stock of CMC, CSC, CSAF and
CFC, all of the members' interest held by it in CTS and CSAF II and the
transferred interest-only and residual certificates (See Note 7) to
ContiFinancial. As a result, ContiFinancial owns all of the common stock or
members' interests in CTS, CMC, CSC, CFC, CSAF and CSAF II (collectively, the
"Previous Companies"). Prior to the IPO, both ContiFinancial and the Previous
Companies (exclusive of CMC) were direct or indirect wholly-owned subsidiaries
of Continental Grain. As described in Note 6, on June 19, 1995, CTSC effectively
acquired control of the remaining 20% minority interest in CMC, which became a
wholly-owned subsidiary of CTSC.
As a result of the Reorganization, the Company issued 35,918,421 shares of
common stock to Continental Grain. Additionally, the Company converted $84,732
of the Previous Companies retained earnings to paid-in capital.
The consolidated financial statements for the periods prior to the IPO have
been combined to reflect the Reorganization accounted for similar to a pooling
of interests method. All material intercompany transactions have been eliminated
in the combination. The Consolidated Financial Statements include additional
charges and liabilities related to expenses incurred by Continental Grain for
the Previous Companies, which historically had not been allocated to the
Previous Companies. These charges include corporate service charges from
Continental Grain and income taxes (See Note 7.).
ACQUISITIONS
In fiscal 1997, the Company acquired 100% of three home equity companies,
California Lending Group, Inc., d/b/a United Lending Group, Inc. ("ULG"),
Resource One Consumer Discount Company, Inc. ("Resource One"), and Royal
Mortgage Partners, L.P., d/b/a Royal MortgageBanc ("Royal") and 56% of an auto
finance company, Triad Financial Corporation ("Triad"), collectively, the
"Acquisitions". In
A-44
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
1. BACKGROUND AND BASIS OF PRESENTATION (CONTINUED)
each case, the companies acquired were former Strategic Alliances or CMC loan
origination sources. The Acquisitions have been accounted for as purchases, and
the results of operations have been included with the Company's results of
operations since the effective acquisition date. ( See Note 6.).
OTHER
The Company organized ContiWest Corporation ("CWC"), a Nevada corporation,
in fiscal 1997 to administer and underwrite a portion of the Company's
origination portfolio. Other direct or indirect wholly-owned subsidiaries were
also organized in fiscal 1997.
2. NATURE OF BUSINESS
The Company engages in the consumer and commercial finance business by
originating and servicing home equity loans and providing financing and asset
securitization expertise to originators of a broad range of loans, leases and
receivables. Securitization provides significant benefits, including greater
operating leverage and reduced costs of funds, in the financing of assets, such
as non-conforming home equity loans, equipment leases, home improvement loans,
franchisee loans, commercial/multi-family loans, non-prime and sub-prime auto
loans and leases and timeshare loans. The Company considers this business to be
one operating segment.
Through CMC and CWC, the Company is an originator, purchaser and servicer of
home equity loans made to borrowers who may not otherwise qualify for
conventional loans. The loans are then sold to whole-loan investors or
securitized in the form of Real Estate Mortgage Investment Conduits ("REMICs"),
owner trusts or grantor trusts. All of the mortgages are sold on a servicing
retained basis. The outstanding principal balance in CMC's mortgage servicing
portfolio at March 31, 1997 and March 31, 1996 was $6,423,376 and $3,863,575,
respectively. Through CTS and CSC, the Company provides complete balance sheet
liability management, including warehouse financing, interest rate hedging
services and the structuring and placement of asset portfolios in the form of
asset-backed securities to CMC, the Acquisitions and other originators
("Strategic Alliances") of consumer and commercial loans, leases, receivables
and other assets (collectively, the "Receivables"). The Strategic Alliances
provide ContiFinancial with a consistent flow of securitizable Receivables. In
certain of the Strategic Alliances, CTSC receives warrants or warrant-like
equity participations ("Strategic Alliance Equity Interests") in the Strategic
Alliance client. The Strategic Alliance Equity Interests in existence prior to
the IPO are held by Continental Grain and as such are not reflected in
ContiFinancial's consolidated financial statements. Strategic Alliance Equity
Interests received from Strategic Alliance clients subsequent to the IPO have
been granted to ContiFinancial. If such Strategic Alliance Equity Interests
develop a readily determinable fair value, the Strategic Alliance Equity
Interests will be recorded at fair value. If such value is not determinable, the
Strategic Alliance Equity Interests will be recorded at cost adjusted for write
downs for impairments as appropriate.
The Company's business may be affected by many factors including real estate
and other asset values, the level of and fluctuations in interest rates, changes
in the securitization market and competition. In addition, the Company's
operations require continued access to short and long term sources of cash.
A-45
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of reserves and expenses during the
reporting period. Actual results could differ from these estimates.
INCOME RECOGNITION
Gain on sale of receivables is recognized upon delivery and acceptance of
loans, leases or receivables by whole-loan investors or upon the securitization
of the Receivables in the form of REMICs, owner trusts or grantor trusts, as
applicable. Gains from sales of whole-loans are calculated based upon the
difference between the net sales proceeds and the net carrying amount of the
loans sold. Gains on sales of Receivables from securitizations represent the
present value of the differential between the interest rate earned on the
Receivables sold and the pass-through rate paid to the securitization investors,
after considering the effects of estimated prepayments, defaults and other
costs, including normal servicing fees, less the costs of originating such
Receivables, and the gain or loss on certain transactions structured as an
economic hedge that are designed to minimize the risk of interest rate
fluctuations.
Interest income is recorded as earned. Interest income represents the
interest earned on the loans and leases during the warehousing period (the
period prior to their securitization) and the recognition of interest income on
the interest-only and residual certificates, which is the recognition of the
increased time value of the discounted interest-only and residual certificates
over time. Receivables are placed on non-accrual status when the loans become
sixty days past due. When a loan is classified as non-accrual, the accrual of
interest income ceases, and all interest income previously accrued and unpaid on
such loans is reversed.
INCOME TAXES
The Company is included in the consolidated Federal income tax return of
Continental Grain. The Company has a tax sharing arrangement with Continental
Grain whereby Federal income taxes are computed on a separate company basis.
Federal income taxes are settled through the due to affiliates accounts.
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes"
("SFAS 109"). SFAS 109 utilizes the balance sheet method and deferred taxes are
determined based on the estimated future tax effects of differences between the
financial statement and tax basis of assets and liabilities given the provision
of the enacted tax laws.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid debt instruments purchased with an
original maturity of no more than three months to be cash equivalents.
A-46
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RESTRICTED CASH
As of March 31, 1997 and 1996, the Company had restricted cash of $464 and
$620, respectively, related to the sale of mortgage loans with limited recourse
to a counterparty. The amount of cash required to be restricted is based on a
percentage of the outstanding balance of the loans sold.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL AND SECURITIES SOLD BUT NOT YET
PURCHASED
In order to hedge the interest rate risk on loan purchases and commitments,
the Company sells short United States Treasury securities which match the
duration of the Receivables and purchases the securities under agreements to
resell.
Securities sold but not yet purchased are recorded on a trade date basis and
are carried at their sale amount. The unrealized gain or loss on these
instruments is deferred and recognized upon securitization as an adjustment to
the carrying value of the hedged asset.
Securities purchased under agreements to resell are recorded on a trade date
basis and are carried at the amounts at which the securities will be
subsequently resold, plus accrued interest. The agreements mature through May
1997 and have interest rates ranging from 4.9% to 5.4%.
INTEREST-ONLY AND RESIDUAL CERTIFICATES
The Company purchases Receivables for the purpose of securitization and
sale. The Company securitizes the Receivables primarily into the form of a
REMIC. A REMIC is a multi-class security structure with certain tax advantages
which derives its monthly principal paydowns from a pool of underlying
mortgages. The senior classes of the REMICs are sold, with the subordinated
classes retained by the Company. The subordinated classes are in the form of
interest-only and residual certificates. These subordinated classes of REMICs
represent an interest in the REMIC, or in other minor cases an owner trust or a
grantor trust, as compared to the right to receive funds under the form of
retained or capitalized excess servicing assets.
In accordance with the provisions of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities", the Company classifies subordinated
classes of REMICs, owner trusts and grantor trusts as "trading securities" and,
as such, they are recorded at fair value with the resultant unrealized gain or
loss recorded in the results of operations in the period of the change in fair
value. The Company determines fair value based on a discounted cash flow
analysis. The cash flows are estimated as the excess of the weighted average
coupon on each pool of Receivables sold over the sum of the pass-through
interest rate plus a normal servicing fee, a trustee fee, an insurance fee and
an estimate of annual future credit losses related to the Receivables
securitized, over the life of the Receivables. These cash flows are projected
over the life of the Receivables using prepayment, default, and interest rate
assumptions that market participants would use for similar financial instruments
subject to prepayment, credit and interest rate risk and are discounted using an
interest rate that a purchaser unrelated to the seller of such a financial
instrument would demand. The fair valuation includes consideration of the
following characteristics: loan type, size, interest rate, date of origination,
term and geographic location. The Company also uses other available information
such as externally prepared reports on prepayment rates, interest rates,
A-47
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
collateral value, economic forecasts and historical default and prepayment rates
of the portfolio under review.
RECEIVABLES HELD FOR SALE/TRADE RECEIVABLES SOLD UNDER AGREEMENTS TO REPURCHASE
Receivables held for sale are mortgages, loans, leases and other assets the
Company plans to sell or securitize and other related assets including deposits
made with financial institutions. Receivables held for sale are stated at the
lower of cost, the origination costs plus accrued interest, or market. Market
value is determined by outstanding commitments from investors or current
investor yield requirements plus any deferred hedging gain less any deferred
hedging loss calculated on the aggregate loan basis. The carrying amount of
receivables held for sale is a reasonable estimate of fair value based on
current pricing of whole-loan transactions.
On January 1, 1997, the Company adopted SFAS No. 125 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
("SFAS 125") which addresses the accounting for transfers of financial assets in
which the transferor has some continuing involvement either with the assets
transferred or with the transferee. A transfer of financial assets in which the
transferor surrenders control over those assets is accounted for as a sale to
the extent that consideration other than beneficial interest in the transferred
assets is received in exchange. SFAS 125 requires that liabilities and
derivatives incurred or obtained by transferors as part of a transfer of
financial assets be initially measured at fair value, if practicable. In
addition, SFAS 125 requires that servicing assets and liabilities be
subsequently measured by the amortization over their estimated life and
assessment of asset impairment be based on such assets' fair value. SFAS 125 is
effective for transfers and servicing of financial assets and extinguishments of
liabilities occurring after December 31, 1996, and is to be applied
prospectively. The adoption of this standard did not have a material impact on
the Company's results of operations. However, certain of the assets that the
Company has sold under the Purchase and Sale Facilities subsequent to January 1,
1997 did not qualify for sale treatment under SFAS 125 and as a result are
accounted for on the balance sheet of the Company on a trade date basis and are
carried at their sale amount of $251,539 as of March 31, 1997. In the opinion of
management, SFAS 125 does not in any way effect the ability of the Company to
finance these assets.
CAPITALIZED SERVICING FEES RECEIVABLE
Effective April 1, 1995, the Company adopted SFAS No. 122 "Accounting for
Mortgage Servicing Rights" ("SFAS 122") which requires that upon sale or
securitization of servicing retained mortgages, companies capitalize the cost
associated with the right to service mortgage loans based on their relative fair
values. Effective January 1, 1997, SFAS 122 was superseded by SFAS 125, as
discussed above, with minor amendments. 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 in proportion to
and over the period of estimated net future servicing fee income.
Prior to the adoption of SFAS 122, income related to servicing rights
acquired through loan origination activities was recorded in the period the
loans were serviced. Under SFAS 122 and SFAS 125, the Company capitalized, at
fair value, $24,004 and $13,828 of such costs during the years ended March 31,
1997 and 1996, respectively. During the same periods, amortization of
capitalized servicing rights were $7,676 and $2,139, respectively. Also
increasing the capitalized servicing fees receivable were prepayment
A-48
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
premiums paid during the year ended March 31, 1997 of $1,336. At March 31, 1997
and 1996 the capitalized servicing rights approximated fair value. The Company
periodically reviews capitalized servicing fees receivable for valuation
impairment. This review is performed on a disaggregated basis for the
predominant risk characteristics of the underlying loans which are loan type,
loan-to-value ratio and credit quality. The Company generally makes loans to
credit impaired borrowers whose borrowing needs may not be met by traditional
financial institutions due to credit exceptions. The Company has found that
credit impaired borrowers are payment sensitive rather than interest rate
sensitive. As such the Company does not consider interest rates a predominant
risk characteristic for purposes of valuation impairment. Impairment is
recognized in a valuation allowance for each disaggregated stratum in the period
of impairment.
OTHER RECEIVABLES
Other receivables consist primarily of amounts relating to the origination
and execution of securitization transactions which include advances made to
Strategic Alliances to finance their purchase of interest-only and residual
certificates, servicing advances, short-term receivables, mortgage loan
advances, and accrued interest on loans and other receivables.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents an amount considered by management
to be adequate to cover estimated losses and valuation adjustments related to
the balance of mortgage and non-prime auto receivables held for sale and
mortgage receivables sold with limited recourse. The allowance for loan losses
is based upon periodic analysis of the portfolio, economic conditions and
trends, historical credit loss experience, borrowers' ability to repay and
collateral values. The Company's charge-off policy is based on a review of each
individual receivable.
PREMISES AND EQUIPMENT, NET OF ACCUMULATED DEPRECIATION
Property and equipment are carried at cost and depreciated on a
straight-line basis over the estimated useful lives of the assets. Leasehold
improvements are amortized over the lesser of the useful lives of the
improvements or term of the leases. The estimated useful lives of property and
equipment and leasehold improvements are between two to twelve years.
OTHER ASSETS
Other assets is comprised of prepaid expenses, margin and other deposits,
deferred bond issuance costs and other investments. Certain of these assets are
periodically reviewed for impairment.
STOCK BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123")
which is effective beginning in fiscal 1997. SFAS 123 allows companies either to
continue to account for stock-based employee compensation plans under existing
accounting standards or adopt a fair value based method of accounting for stock
options as
A-49
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
compensation expense over the service period (generally the vesting period) as
defined in the new standard. SFAS 123 requires that if a company continues to
account for stock options under Accounting Principles Board ("APB") Opinion No.
25, it must provide pro forma net income and earnings per share information "as
if " the new fair value approach had been adopted. The Company will continue to
account for stock based compensation under APB Opinion No. 25 and made the
required disclosures in fiscal 1997 (See Note 9.).
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the FASB issued SFAS No. 128 "Earnings Per Share ("EPS")"
("SFAS 128") which is effective in fiscal 1998, early application is not
permitted. SFAS 128 simplifies the standards for computing earnings per share.
It replaces the presentation of primary EPS with a presentation of basic EPS.
Basic EPS excludes dilution and is computed by dividing income available to
common stockholders by the weighted-average number of common shares outstanding
for the period. If SFAS 128 had been applied to fiscal 1997 results of
operations, the Company's basic EPS would have been $2.44 (pro forma) of
earnings per common share based on net income of $106,004 and weighted-average
number of common shares of 43,361,253 (pro forma). Fully dilutive EPS remains
the same under SFAS 128 but will be referred to as diluted EPS.
CONSOLIDATED STATEMENTS OF CASH FLOWS--SUPPLEMENTAL DISCLOSURES
Total interest paid was $119,223, $71,539, and $29,635 for the years ended
March 31, 1997, 1996, and 1995, respectively. Total income taxes paid were
$45,624, $896, and $441 for the years ended March 31, 1997, 1996 and 1995,
respectively. For the year ended March 31, 1997, federal income taxes were paid,
on a current basis, to Continental Grain in accordance with the provisions of
the tax sharing agreement (See Note 7.). As such, these amounts were included in
total income taxes paid for the year ended March 31, 1997. Prior to the IPO,
federal income taxes were included in due to affiliates, which was not repaid to
Continental Grain on a current basis, and as such were not included in total
income taxes paid for the years ended March 31, 1996 and 1995.
PRO FORMA EARNINGS PER COMMON SHARE AND EARNINGS PER COMMON SHARE
Due to the Reorganization and the issuance of common stock in the IPO, net
earnings per common share for the year ended March 31, 1996 have been computed
on a pro forma basis, assuming the Reorganization occurred at the beginning of
fiscal 1996, and includes the number of common shares issued by the Company in
the IPO from the date of issuance plus the effect of common stock equivalent
shares under the restricted stock awards and stock options plans (See Note 9.)
from that same date. Because of the Company's Reorganization and changes in
capital structure, per share data for the year ended March 31, 1995 is not
meaningful.
Net earnings per common share for the year ended March 31, 1997 have been
computed using the weighted average number of common shares outstanding during
the year, after giving effect of common stock equivalents issued under the "1995
Long-Term Stock Incentive Plan" (See Note 9.).
A-50
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATIONS
Certain reclassifications of prior years' amounts have been made to conform
to the current year presentation.
4. STOCKHOLDERS' EQUITY
The stockholders' equity as of March 31, 1995 reflects the combined common
stock, paid-in capital and retained earnings of the Previous Companies.
CMC is subject to minimum capital requirements imposed by the states in
which it operates, with the highest being $250. In addition, CMC is required by
the U.S. Department of Housing and Urban Development to maintain minimum capital
of $250 plus an amount based on the volume of Federal Housing Authority
business. Furthermore, CMC is required by the Federal National Mortgage
Association ("FNMA") to maintain minimum capital of $250 plus .20% of the
principal balance of the portfolio being serviced for FNMA.
CSC is registered as a broker/dealer with the Securities and Exchange
Commission and is subject to the SEC's Uniform Net Capital Rule 15c3-1, under
which the ratio of aggregate indebtedness to net capital, as those are defined,
may not exceed 15 to 1.
5. ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses and related additions and deductions to the
allowance for the years ended March 31, 1997,1996, and 1995, were as follows:
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS CHARGED DEDUCTIONS
BEGINNING OF ACQUIRED FROM TO COSTS AND AND BALANCE AT END
YEAR ENDED MARCH 31, YEAR ACQUISITIONS EXPENSES REVERSALS OF YEAR
- ------------------------------------ ------------- ------------- ----------------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
1997................................ $ 1,824 $ 1,547 $ 3,043 $ (2,667) $ 3,747
1996................................ 1,808 -- 285 (269) 1,824
1995................................ 2,401 -- 1,935 (2,528) 1,808
</TABLE>
The deductions in the allowance for loan losses for the years ended March
31, 1997, 1996, and 1995 relate to the reversal of reserves and net loan
charge-offs.
6. ACQUISITIONS
On June 19, 1995, CTSC effectively acquired control of the remaining 20%
minority interest of CMC for $34,600. The acquisition has been accounted for by
the purchase method of accounting. Associated cost in excess of equity is being
amortized over 25 years on a straight-line basis. The Company assesses the
future useful life of this asset whenever events or changes in circumstances
indicate that the current useful life has diminished. The Company considers the
future undiscounted cash flows of the acquired business in assessing the
recoverability of this asset. If the fair value of the estimated future
undiscounted cash flows from this business is lower than the carrying value of
this asset, and the decline is deemed to be other than temporary, the Company
will write down the asset to fair value.
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<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
6. ACQUISITIONS (CONTINUED)
The March 31, 1996 consolidated statement of income of the Company reflects
the entire results of the operations of CMC for the period from June 19, 1995 to
March 31, 1996.
The pro forma results of operations of the Company for the year ended March
31, 1996 would be as follows to reflect the acquisition of the minority interest
as if the acquisition occurred as of April 1, 1995: Gross income of $271,816,
Net income of $77,319 and pro forma primary and fully diluted earnings per
common share of $2.09.
On November 8, 1996, the Company purchased 100% of the outstanding stock of
ULG, a west coast-based home equity lender specializing in retail originations
via direct mail and telemarketing throughout the United States. On November 15,
1996, the Company, through its subsidiary CMC, purchased 100% of Royal, a
California-based wholesale and retail originator of fixed and adjustable rate
home equity loans. On November 21, 1996, the Company purchased 53.5% of the
common stock of Triad and an additional 2.5% of the common stock in January
1997. Triad is a California-based auto finance company specializing in
origination of non-prime auto finance contracts for used and new vehicles. On
December 16, 1996, the Company, through its subsidiary CMC, purchased 100% of
the outstanding stock of Resource One, a Pennsylvania-based home equity lender
specializing in retail origination via direct mail, television, and
telemarketing throughout the eastern and mid-western states. In each case the
companies acquired were former Strategic Alliances or CMC loan origination
sources. These transactions have been accounted for as purchases, and the
results of operations have been included with the Company's results of
operations since the effective acquisition dates. The cumulative purchase price
was approximately $38,000, which includes deferred payments of approximately
$5,000. As a result of the acquisitions, approximately $35,000 of cost in excess
of equity was recorded which will be amortized on a straight-line basis over a
25 year useful life. Certain acquisition's terms contain payments which are
contingent upon future earnings or employment of key management. Such contingent
payments will be recorded as purchase price or compensation as is appropriate
for the nature of the payments. The Company has a right and obligation to
purchase the remaining 44% of the common stock of Triad over the next 4.5 years.
The purchase price will be based upon the future earnings of Triad and will be
recorded, when determinable. The excess of the purchase price over the fair
value of the net assets acquired will be recorded as an increase in cost in
excess of equity. The Acquisitions are not material to the financial position or
results of operations of the Company.
7. RELATED PARTY TRANSACTIONS
NOTES PAYABLE
In connection with the IPO (See Note 1.), the Company entered into a note
purchase agreement with Continental Grain, pursuant to which Continental Grain
purchased from the Company a $125,000 five-year note issued under an indenture
(the "Indenture Note"), a $74,000 four-year note (the "Four Year Note") and a
$125,000 term note (the "Term Note") for $324,000 in the aggregate
(collectively, the "Notes"). As of March 12, 1997 the intercompany debt was paid
in full and the Company is no longer subject to the covenants of the
intercompany debt.
The Company is indirectly subject to the financial covenants of Continental
Grain's debt agreements which restrict dividends by less than wholly-owned
subsidiaries. If these covenants are still in place at the
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<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
7. RELATED PARTY TRANSACTIONS (CONTINUED)
time the Company decides to declare a dividend, a waiver from the related
lenders would have to be obtained.
DUE TO AFFILIATES
Prior to the IPO, Continental Grain provided interest bearing and
non-interest bearing funds to support operations of the Company. On February 14,
1996, this support of operations was replaced by the Notes. The interest bearing
funds ("Interest Bearing Funds") provided by Continental Grain were subject to
interest charges which represent Continental Grain's all inclusive weighted
average cost of short term funds (the "FMA Rate"). Interest expense incurred at
the FMA Rate was $19,584 and $10,234 for the years ended March 31, 1996 and
1995, respectively.
The average Interest Bearing Funds for the years ended March 31, 1996 and
1995, were $325,355 and $160,659, respectively. The weighted average interest
rates charged on the Interest Bearing Funds for the years ended March 31, 1996
and 1995 were 6.88% and 6.37%, respectively.
The March 31, 1997 and 1996 due to affiliates balance represents payments
due on the Services Agreement, the Tax Sharing Agreement, the Employee Benefits
Allocation Agreement and the Sublease Agreement, as defined below. The March 31,
1996 due to affiliates balance also included accrued interest due to Continental
Grain under the terms of the Notes.
AFFILIATE CHARGES
Continental Grain incurs certain general and administrative expenses that
support the Company's operations. Expenses directly attributable to the Company,
such as occupancy and communication charges, are directly charged to the
Company. Other general and administrative expenses indirectly charged relate to
support services such as treasury functions, tax services, human resource
management, information technology, internal audit functions, insurance
management, legal services, and others. The amount of such expenses was $1,749,
$1,907 and $2,848 for the years ended March 31, 1997, 1996 and 1995,
respectively.
The determination of expenses incurred by Continental Grain applicable to
the Company is based first, on identifying specific expenses that are directly
attributable to its operations and second, on estimating that portion of general
and administrative expenses of Continental Grain used to support the operations
of the Company based on the service hours attributable to the Company and the
asset base of the Company. Management believes that the method of allocation of
general and administrative expenses is reasonable.
On February 14, 1996, the Company entered into an agreement with Continental
Grain (the "Services Agreement") under which Continental Grain agrees to
continue to provide the Company certain corporate services, including treasury
administration, risk management, internal audit, Federal and state tax
(including payroll) administration, management information and communication
support services, public affairs, and facilities management through March 31,
1999 and from year-to-year thereafter.
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<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
7. RELATED PARTY TRANSACTIONS (CONTINUED)
INTEREST-ONLY AND RESIDUAL CERTIFICATES TRANSFER
On February 14, 1996, the Company entered into an agreement with Continental
Grain to transfer $60,701 of its interest-only and residual certificates at book
value to Continental Grain in order to reduce the amount of due to affiliates to
$324,000 on such date. Based upon management's valuation of these interest-only
and residual certificates and other sales transactions with unrelated third
parties, the Company believes that the book value of such interest-only and
residual certificates represented the fair value of such interest-only and
residual certificates .
TAX SHARING AGREEMENT
On February 14, 1996, Continental Grain and the Company entered into a tax
sharing agreement (the "Tax Sharing Agreement") which (i) defines their
respective rights and obligations with respect to Federal, state, local and all
other taxes for all taxable periods both prior to and after the IPO and (ii)
governs the conduct of all audits and other tax controversies relating to the
Company. Pursuant to the Tax Sharing Agreement, the Company will be charged or
credited, as the case may be, for its Federal income tax liability or refund
that would have been payable or received by the Company for such year, or
portion thereof, determined as if the Company had filed a separate Federal
income tax return computed in accordance with prevailing Federal income tax laws
and regulations as applied to the Company as if it were a separate taxpayer.
EMPLOYEE BENEFITS ALLOCATION AGREEMENT
On February 14, 1996, Continental Grain and the Company entered into an
employee benefits allocation agreement (the "Employee Benefits Allocation
Agreement") which permits the Company's employees to continue to participate in
the Continental Grain employee benefit plans. The cost of the Company's
employees' participation in these programs will be allocated to the Company
based on the actual cost of benefit accruals and an allocated cost of
administration of the plans and overhead (See Note 9.).
SUBLEASE AGREEMENT
On February 14, 1996, Continental Grain and the Company entered into a
sublease agreement with subsequent amendments (the "Sublease Agreement") for the
utilization of the facilities leased from Continental Grain. The Sublease
Agreement will require an annual payment of approximately $787 through the year
2000.
A-54
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
8. DEBT
In fiscal 1996, debt financing was provided by Continental Grain (See Note
7.). During fiscal 1997, this debt was retired and replaced with publicly issued
debt. Long-term debt at March 31, 1997 consists of the following:
<TABLE>
<CAPTION>
MARCH 31,
1997
----------
<S> <C>
8 3/8% Senior Notes, $300 million face amount, due 2003............................................... $ 299,194
7 1/2% Senior Notes, $200 million face amount, due 2002............................................... 199,288
Capitalized lease..................................................................................... 335
----------
Total long-term debt.................................................................................. $ 498,817
----------
----------
</TABLE>
On August 14, 1996, the Company issued $300 million of unsecured senior
notes (the "8 3/8% Senior Notes") due August 15, 2003. Proceeds to the Company,
net of underwriting fees, market discount and other costs were $287,742.
Interest on these notes is payable semi-annually on February 15 and August 15
commencing February 15, 1997. The 8 3/8% Senior Notes are redeemable as a whole
or in part, at the option of the Company, at any time or from time to time, at a
redemption price equal to the greater of (i) 100% of their principal amount or
(ii) the sum of the present values of the remaining scheduled payments of
principal and interest thereon discounted to the date of redemption on a
semiannual basis at the treasury yield plus 50 basis points, plus, in each case,
accrued interest to the date of redemption. Interest expense on the unsecured 8
3/8% Senior Notes was $15,484 for fiscal 1997.
On March 12, 1997, the Company issued $200 million of unsecured senior notes
(the "7 1/2% Senior Notes") due March 15, 2002 (together with the 8 3/8% Senior
Notes, the "Senior Notes"). Proceeds to the Company, net of underwriting fees,
market discount and other costs were $197,700. Interest on these notes is
payable semi-annually on March 15 and September 15 commencing September 15,
1997. Interest expense on the 7 1/2% Senior Notes was $756 for fiscal 1997.
The Company is required to comply with various operating and financial
covenants as set forth in the agreements governing the issuance of the Senior
Notes. Among other restrictions, the Company must comply with limitations on
indebtedness and restricted payments.
The Senior Notes are equal in right of payment with all existing and future
senior indebtedness of the Company and will be senior in right of payment to all
future subordinated indebtedness of the Company.
On January 8, 1997, the Company closed a $200 million unsecured revolving
credit facility (the "Short-Term Borrowing"). The three-year Short-Term
Borrowing has several interest rate pricing alternatives, including those based
on the London Interbank Offering Rate ("LIBOR") and federal funds rate. The
amount available under the Short-Term Borrowing is based on a formula based on
certain of the Company's consolidated assets. Interest expense on the Short-Term
Borrowing was $164 for fiscal 1997.
9. EMPLOYEE BENEFITS
The Company's employees are included in Continental Grain's employee
benefits programs, and the Company reimburses Continental Grain for the actual
cost of benefit accruals and an allocable cost of administration and overhead.
A-55
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
9. EMPLOYEE BENEFITS (CONTINUED)
Continental Grain has a number of noncontributory pension plans covering
substantially all United States employees. The pension plan covering salaried
employees provides benefits that are generally based on a percentage of the
employee's salary during the five years before retirement. Continental Grain's
funding policy for these plans is generally to make the minimum annual
contribution required by applicable regulations. Pension costs charged to the
Company by Continental Grain were $374, $118, and $91 for the years ended March
31, 1997, 1996 and 1995, respectively.
Post-retirement health care coverage under Continental Grain's Salaried
Health Care Plan is available on a cost sharing basis to retired employees. Life
insurance coverage is provided on a noncontributory basis to substantially all
retirees. Post-retirement health care costs charged to the Company by
Continental Grain were $419, $680 and $394 for the years ended March 31, 1997,
1996, and 1995, respectively. Effective April 1, 1996, Continental Grain
transferred the Company's portion of the accrual, as of such date, for
post-retirement health care costs. This accrual was determined on a stand alone
basis for the Company.
The Company has in effect an incentive compensation program which is a
formula plan based on pre-tax income targets. Incentive compensation for the
years ended March 31, 1997, 1996 and 1995 was $24,580, $27,986 and $12,400,
respectively.
Upon acquisition of ULG, the Company established a long term incentive plan
for certain key employees of ULG. The program is a formula plan based on
after-tax income. The Company recognized $200 in expense for this plan for the
year ended March 31, 1997.
1995 LONG-TERM STOCK INCENTIVE PLAN
On February 9, 1996, the Company adopted the 1995 Long-Term Stock Incentive
Plan (the "Stock Plan") pursuant to which the Company was authorized to grant
certain key employees 4,437,895 of options and restricted stock, in the common
stock of the Company. The aggregate equity interests in the Company available
under the Stock Plan is not to exceed 9% of all equity interests in the Company
as of the date the plan was adopted. In fiscal 1997 and fiscal 1996, the Company
granted stock options and restricted stock under the Stock Plan.
The Company applies APB Opinion No. 25 and the related interpretations in
accounting for the Stock Plan. In October 1995, the FASB issued SFAS 123. If
fully adopted, SFAS 123 changes the method for measurement and recognition of
stock-based compensation on plans similar to those of the Company. The Company
has adopted the disclosure requirements established by SFAS 123. Pro forma
disclosures as if the Company had adopted the cost recognition requirements
under SFAS 123 are presented below.
Stock options granted under the Stock Plan are nonqualified stock options
that: (1) are granted at prices which are equal to the market value of the stock
on the date of grant; (2) subject to a grantee's continued employment with the
Company, vest at various periods over a four year period; and (3) expire ten
years subsequent to the award.
A-56
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
9. EMPLOYEE BENEFITS (CONTINUED)
A summary of the status of the Company's stock options as of March 31, 1997
and 1996 and the changes during the year is presented below:
<TABLE>
<CAPTION>
MARCH 31,1997 MARCH 31, 1996
------------------------- -------------------------
<S> <C> <C> <C> <C>
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
---------- ------------- ---------- -------------
Outstanding at beginning of year.......................... 2,623,500 $ 21.11 -- $ --
Granted................................................... 50,000 35.63 2,623,500 21.11
Exercised................................................. (11,382) 21.11 -- --
Forfeited................................................. (177,388) 21.11 -- --
Outstanding at end of year................................ 2,484,730 $ 21.41 2,623,500 $ 21.11
Options exercisable at end of year........................ 491,946 $ 21.26 196,763 $ 21.11
</TABLE>
The fair value of each option granted during fiscal 1997 and fiscal 1996 is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions: (1) dividend yield of zero; (2) expected volatility
49.75%; (3) risk-free interest rate of 5.05% for 1996 and 6.32% for 1997 and;
(4) expected life of 3.5 years. The weighted average fair value of options
granted during 1997 and 1996 was $15.33 and $8.78, respectively.
Had compensation cost for the Company's fiscal 1997 and fiscal 1996 grants
for stock options been determined consistent with SFAS 123, the Company's pro
forma net income and pro forma net income per common share for fiscal 1997 and
fiscal 1996 would approximate the pro forma amounts below:
<TABLE>
<CAPTION>
MARCH 31, 1997 MARCH 31, 1996
------------------------ ------------------------
<S> <C> <C> <C> <C>
AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- ----------- ----------- -----------
Net income.................................................... $ 106,004 $ 99,730 $ 74,130 $ 72,217
Net income per common share:
Primary................................................... $ 2.40 $ 2.25 $ 2.00 $ 1.95
Fully diluted............................................. $ 2.40 $ 2.25 $ 2.00 $ 1.95
</TABLE>
The restricted stock granted under the Stock Plan is recorded as deferred
compensation in stockholders' equity. The deferred compensation is amortized
over the vesting period of the restricted stock. The restricted stock vests over
a 3 to 4 year period and is subject to the employee's continued employment with
the Company.
In connection with the restricted stock issuance, the Company recorded
compensation expense of $6,721 and $4,967 in fiscal 1997 and fiscal 1996,
respectively.
A-57
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
9. EMPLOYEE BENEFITS (CONTINUED)
A summary of the status of the Company's restricted stock as of March 31,
1997 and 1996 and the changes during the year is presented below:
<TABLE>
<CAPTION>
MARCH 31,1997 MARCH 31, 1996
----------------------- -----------------------
<S> <C> <C> <C> <C>
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES GRANT PRICE SHARES GRANT PRICE
---------- ----------- ---------- -----------
Outstanding at beginning of year.............................. 1,330,532 $ 21.00 -- $ --
Granted....................................................... 6,000 35.63 1,330,532 21.00
Forfeited..................................................... (33,929) 21.00 -- --
Vested and transferable....................................... (57,052) 21.00 -- --
Outstanding at end of year.................................... 1,245,551 $ 21.07 1,330,532 $ 21.00
</TABLE>
10. INCOME TAXES
Income taxes included in the consolidated statements of income represent the
following:
<TABLE>
<CAPTION>
CURRENT DEFERRED TOTAL
--------- --------- ---------
<S> <C> <C> <C>
Year ended March 31, 1997
Federal........................................................................ $ 54,137 $ 4,661 $ 58,798
State and local................................................................ 11,524 1,019 12,543
--------- --------- ---------
$ 65,661 $ 5,680 $ 71,341
--------- --------- ---------
--------- --------- ---------
Year ended March 31, 1996
Federal........................................................................ $ 38,762 $ 3,278 $ 42,040
State and local................................................................ 6,504 552 7,056
--------- --------- ---------
$ 45,266 $ 3,830 $ 49,096
--------- --------- ---------
--------- --------- ---------
Year ended March 31, 1995
Federal........................................................................ $ 21,354 $ (2,605) $ 18,749
State and local................................................................ 3,894 (475) 3,419
--------- --------- ---------
$ 25,248 $ (3,080) $ 22,168
--------- --------- ---------
--------- --------- ---------
</TABLE>
A-58
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
10. INCOME TAXES (CONTINUED)
The difference between the "expected" Federal tax rate and expense computed
by applying the statutory tax rate to income before provision for income taxes
and the effective tax rate and expense is as follows:
<TABLE>
<CAPTION>
MARCH 31,
MARCH 31, 1997 MARCH 31, 1996 1995
------------------------ ------------------------ ---------
<S> <C> <C> <C> <C> <C>
PERCENT OF PERCENT OF
PRE-TAX PRE-TAX
AMOUNT EARNINGS AMOUNT EARNINGS AMOUNT
--------- ------------- --------- ------------- ---------
Computed "expected" tax provision...................... $ 61,963 35.0% $ 44,288 35.0% $ 19,946
State and local taxes, net of related Federal
benefit.............................................. 8,055 4.6% 4,808 3.8% 2,222
Other.................................................. 1,323 0.7% -- -- --
--------- --- --------- --- ---------
Total................................................ $ 71,341 40.3% $ 49,096 38.8% $ 22,168
--------- --- --------- --- ---------
--------- --- --------- --- ---------
<CAPTION>
<S> <C>
PERCENT OF
PRE-TAX
EARNINGS
-------------
Computed "expected" tax provision...................... 35.0%
State and local taxes, net of related Federal
benefit.............................................. 3.9%
Other.................................................. --
---
Total................................................ 38.9%
---
---
</TABLE>
The effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are as follows:
<TABLE>
<CAPTION>
MARCH 31,
---------------------------------
<S> <C> <C> <C>
1997 1996 1995
---------- ---------- ---------
Deferred Tax Assets:
Provision for loan losses..................................................... $ 1,069 $ 982 $ 605
Deferred compensation......................................................... 4,835 -- --
Restricted stock awards....................................................... 301 1,927 --
Other......................................................................... 2,776 377 42
Deferred Tax Liabilities:
Net servicing income.......................................................... (11,081) (4,535) --
Interest-only and residual certificates....................................... (12,942) (9,813) (7,881)
Other......................................................................... (115) (18) (16)
---------- ---------- ---------
Net deferred tax liability...................................................... $ (15,157) $ (11,080) $ (7,250)
---------- ---------- ---------
---------- ---------- ---------
</TABLE>
11. COMMITMENTS AND CONTINGENCIES
In addition to utilizing facilities leased by Continental Grain, the
Company's operations are conducted from leased facilities located in various
areas of the United States. These leases have clauses which provide for
increases in rent in the event of increases in real estate taxes and maintenance
costs. Rental expense for the years ended March 31, 1997, 1996 and 1995 was
$3,470, $1,884, and $564, respectively. The Company
A-59
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
also has a capital lease on certain machinery and equipment included as part of
"Premises and equipment". The future minimum lease payments under the operating
and capital leases for the Company, are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
FISCAL YEAR LEASES LEASES
- ------------------------------------------------------------------------- ----------- -----------
<S> <C> <C>
1998..................................................................... $ 6,653 $ 362
1999..................................................................... 7,580 174
2000..................................................................... 7,222 121
2001..................................................................... 5,960 64
2002..................................................................... 5,159 18
Thereafter............................................................... 29,614 0
----------- -----
$ 62,188 $ 739
----------- -----
----------- -----
Less: amounts representing interest...................................... (104)
-----
Present value of net minimum lease payments.............................. 635
Less: current maturties.................................................. (300)
-----
Long-term obligation..................................................... $ 335
-----
-----
</TABLE>
LITIGATION
The Company is involved in certain 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.
12. FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET ACTIVITIES
SALES OF ASSETS WITH RECOURSE
During 1997, 1996 and 1995, the Company utilized agreements with financial
institutions (the "Purchasers") to sell, with limited recourse, interests in
designated pools of securitized and whole loans receivables. Under the
agreements, the Purchasers have given the Company a right of first refusal to
repurchase such receivables prior to third-party sales. Pursuant to the recourse
provisions of these agreements, the Company is responsible for losses incurred
by the Purchasers on third-party sales of the receivables up to either 5% or 10%
of the sale amounts. The agreements are guaranteed by the Company. The Company
monitors its exposure associated with these agreements and records recourse
provisions, as necessary, to address this potential exposure. During 1997, 1996
and 1995, the Company utilized these facilities to sell receivables totaling
approximately $7,350,000, $5,671,000 and $2,510,000, respectively. At March 31,
1997 and 1996, approximately $591,000 and $565,000, respectively, were
outstanding and offset against receivables held for sale.
During 1997, 1996, and 1995, the Company sold, with limited recourse, an
interest in certain interest-only and residual certificates for $96,545, $54,500
and $50,000, respectively. At March 31, 1997, 1996 and 1995, $144,926, $90,985
and $50,000, respectively, of these aforementioned sales were outstanding. Under
A-60
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
12. FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET ACTIVITIES (CONTINUED)
the recourse provisions of the agreements, the Company is responsible for losses
incurred by the purchaser within an agreed upon range. The agreements are
guaranteed by Continental Grain for an agreed upon fee.
FINANCIAL INSTRUMENTS
SFAS No. 105, "Disclosure of Information about Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk" and SFAS No. 119, "Disclosure about Derivative Financial Instruments and
Fair Value of Financial Instruments" require the disclosure of the notional
amount or contractual amounts of financial instruments.
The Company regularly securitizes and sells fixed and variable rate mortgage
loan receivables. As part of its interest rate risk management strategy, the
Company may choose to hedge its interest rate risk related to its mortgage
portfolio and purchase commitments by utilizing financial futures. The Company
classifies these futures as hedges of specific loan receivables and purchase
commitments. The gains and losses derived from these financial futures are
deferred and included in the carrying amounts of the related hedged items and
ultimately recognized in income. Deferred gains on the futures used to hedge the
anticipated transactions amounted to $2,821, $1,968 and $359 at March 31, 1997,
1996, and 1995, respectively.
The following table identifies the contract and market values of financial
instruments as of March 31, 1997, 1996 and 1995.
Futures Contracts:
<TABLE>
<CAPTION>
CONTRACT VALUE MARKET VALUE
SHORT SHORT
-------------- ------------
<S> <C> <C>
March 31, 1997.................................................. $ 364,900 $ 377,440
March 31, 1996.................................................. 219,800 231,739
March 31, 1995.................................................. 58,500 60,068
</TABLE>
MARKET RISK
In the normal course of business the Company enters into various contractual
commitments involving forward settlement. These include financial futures
contracts and short sales. Commitments involving forward settlement give rise to
market risk, which represents the potential loss that can be caused by a change
in the market value of a particular financial instrument.
The Company is also exposed to market interest rate risk. A decline in
interest rates will typically increase the amount of loan prepayments and
decrease the value of the interest-only and residual certificates and
capitalized servicing fees receivable. An increase in interest rates may
decrease the demand for consumer and commercial credit.
Periods of economic slowdown or recession may be accompanied by decreased
demand for the market for Receivables or declines in real estate values. These
factors will influence the Company's ability to
A-61
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
12. FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET ACTIVITIES (CONTINUED)
obtain and securitize Receivables. During these periods the Company's cost of
servicing loans may increase as rates of delinquency and foreclosure increase.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments recorded at contractual amounts that
approximate market or fair value primarily consist of securities purchased under
agreements to resell, trade receivables, accounts payable and accrued expenses,
securities sold but not yet purchased and trade receivables sold under
agreements to repurchase. As these amounts are short term in nature and/or
generally bear market rates of interest, the carrying amounts of these
instruments are reasonable estimates of their fair values. The carrying amounts
of the Company's long-term debt approximate fair value when valued using
available quoted market prices.
CREDIT RISK
The Company is exposed to on-balance sheet credit risk related to its
Receivables and interest-only and residual certificates. The Company is exposed
to off-balance sheet credit risk related to loans which the Company has
committed to originate or buy and loans sold with limited recourse.
The Company utilizes securities purchased under agreements to resell as part
of its interest rate management strategy. These instruments expose the Company
to credit risk which is measured as the loss the Company would record if
counterparties failed to perform pursuant to terms of their contractual
obligations and the value of the collateral held, if any, was not adequate to
cover such losses. The Company's policy is to take possession of securities
purchased under agreements to resell. The Company monitors the market value of
the assets acquired to ensure their adequacy as compared to the amount at which
the securities will be resold. The Company may require the counterparty to
deposit additional collateral or reduce the loan balance when necessary. The
interest rate on these instruments depends upon, among other things, the
underlying collateral, the term of the agreement and the credit quality of the
counterparty. At March 31, 1997 and 1996, these instruments had a weighted
average interest rate of 5.1%, and 4.7%, respectively. The Company transacts
these resale agreements primarily with three institutional broker/dealers.
The Company is a party to financial instruments with off-balance sheet
credit risk in the normal course of business. These financial instruments
include commitments to extend credit to borrowers, commitments to purchase loans
from correspondents, and recourse provided on loans sold to investors in prior
years. The Company has a first or second lien position on all of its loans, and
the combined loan-to-value ratio ("CLTV") permitted by the Company's mortgage
underwriting guidelines generally may not exceed 85%. The CLTV represents the
combined first and second mortgage balances as a percentage of the appraised
value or the mortgaged property, with the appraised value determined by an
appraiser with appropriate professional designations. A title insurance policy
is required for all loans.
As of March 31, 1997 and 1996, the Company had outstanding commitments to
extend credit or purchase loans in the amount of $428,234 and $206,314,
respectively. As these amounts are short term in nature and/or generally bear
market rates of interest, the contractual amounts of these instruments are
reasonable estimates of their fair values.
A-62
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
12. FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET ACTIVITIES (CONTINUED)
Commitments to extend credit or to purchase a loan are granted for a period
of thirty days and are contingent upon the borrower and the borrower's
collateral satisfying the Company's underwriting guidelines. Since many of the
commitments are expected to expire without being exercised, the total commitment
amount does not necessarily represent future cash requirements or future credit
risk.
The Company monitors concentrations of credit risk associated with business
conducted with financial institutions and minimizes credit risk by avoiding a
concentration with any single financial institution. As of March 31, 1997, and
1996 the majority of loans with on-balance sheet and off-balance sheet risks
were collateralized by properties located in the Eastern United States.
WAREHOUSING EXPOSURE
The Company makes warehouse financing available to its securitization
clients to facilitate the accumulation of securitizable products prior to
securitization. As of March 31, 1997 and 1996, the Company had $1,567,600 and
$981,600 of committed warehousing available to its third party clients, of which
$566,029 and $425,378, respectively, was drawn down. Warehouse commitments are
typically for a term of one year or less and are designated to fund only
securitizable assets. Assets from a particular client remain in the warehouse
for a period of 90-120 days at which point they are securitized and sold to
institutional investors. As these amounts are short term in nature and/or
generally bear market rates of interest, the contractual amounts of these
instruments are reasonable estimates of their fair values.
13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following table presents the quarterly results of operations for the
year ended March 31, 1997:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------
<S> <C> <C> <C> <C>
JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31,
1996 1996 1996 1997
--------- ------------- ------------ ----------
Total gross income........................................... $ 69,763 $ 89,683 $ 121,332 $ 147,052
Net income................................................... 19,433 25,516 29,025 32,030
Primary and fully diluted earning per common share........... $ 0.44 $ 0.58 $ 0.66 $ 0.72
--------- ------------- ------------ ----------
--------- ------------- ------------ ----------
</TABLE>
14. SUBSEQUENT EVENT
On June 4, 1997 the Company completed a primary offering of 2,800,000 shares
of common stock and an additional 420,000 shares were purchased by the
underwriters for over allotments. The proceeds of the offering to the Company,
net of estimated expenses and underwriting discount, were $100,778. The proceeds
will be used for general corporate purposes, including strategic acquisitions,
funding loan originations and purchases, supporting securitization transactions,
and other working capital needs. The completion of the offering reduces
Continental Grain's ownership of the Company from approximately 81% to
approximately 75%.
The consummation of the public offering causes the vesting of certain
options granted. The additional vesting would cause options exercisable as of
March 31, 1997 to increase to 1,734,311.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
A-63
<PAGE>
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The Company incorporates by reference herein information in its proxy
statement which complies with the information called for by Item 10 of the Form
10-K. The proxy will be filed at a later date, that is not more than 120 days
after the end of the Company's 1997 fiscal year, with the Commission.
ITEM 11. EXECUTIVE COMPENSATION.
The Company incorporates by reference herein information in its proxy
statement which complies with the information called for by Item 11 of the Form
10-K. The proxy will be filed at a later date, that is not more than 120 days
after the end of the Company's 1997 fiscal year, with the Commission.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The Company incorporates by reference herein information in its proxy
statement which complies with the information called for by Item 12 of the Form
10-K. The proxy will be filed at a later date, that is not more than 120 days
after the end of the Company's 1997 fiscal year, with the Commission.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The Company incorporates by reference herein information in its proxy
statement which complies with the information called for by Item 13 of the Form
10-K. The proxy will be filed at a later date, that is not more than 120 days
after the end of the Company's 1997 fiscal year, with the Commission.
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Financial Statements, Financial Statement Schedules and Exhibits.
(1) Financial Statements
See Item 8. "Financial Statements and Supplementary Data."
(2) Financial Statement Schedules
No Financial statement schedules are included because of the absence of the
conditions under which they are required or because the information is included
in the financial statements or the notes thereto.
(3) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
3.1 Restated Certificate of Incorporation of the Company (1)
3.2 By-laws of the Company (1)
4.1 Indenture between the Company and the Trustee with form of Indenture Note (1)
4.2 Form of Term Note issued by the Company to Continental Grain (1)
4.3 Form of Four Year Note issued by The Company to Continental Grain (1)
10.1 Indemnification Agreement between the Company and Continental Grain (1)
10.2 Tax Sharing Agreement between the Company and Continental Grain (1)
10.3 Employee Benefit Allocation Agreement between the Company and Continental Grain (2)
10.4 Services Agreement between the Company and Continental Grain (1)
10.5 Note Purchase Agreement between the Company and Continental Grain (1)
</TABLE>
A-64
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
10.6 Common Stock Registration Rights Agreement between the Company and Continental
Grain (1)
10.7 Indenture Note Registration Rights Agreement between the Company and Continental
Grain (1)
10.8 Sublease Agreement between the Company and Continental Grain (1)
10.9 ContiFinancial Corporation 1995 Long-Term Stock Incentive Plan (1)
10.10 ContiFinancial Services Long-Term Incentive Compensation Plan (1)
10.11 1997 ContiFinancial Services Division Incentive Compensation Plan (1)
10.12 1997 ContiMortgage Corporation Incentive Compensation Plan (1)
10.13 Form of Stock Option Agreement (1)
10.14 Form of Restricted Stock Award Agreement (1)
10.15 Agreement of Lease between LC/N Keith Valley Limited Partnership I and ContiTrade Services Corporation
and amendments thereto (1)
10.16 ContiFinancial Corporation Directors Retainer Fee Plan (1)
10.17 Assignment and Transfer of Excess Spread Receivables between Continental Grain and certain subsidiaries
of the Company (1)
10.18 Secured Promissory Note (2)
11.1 Computation of the Company's pro forma earnings per common share
21.1 List of Subsidiaries of the Company
23.2 Consent of Arthur Andersen LLP (2)
24.1 Attorneys-In-Fact and Agents for James J. Bigham (2)
24.2 Attorneys-In-Fact and Agents for Paul J. Fribourg (2)
24.3 Attorneys-In-Fact and Agents for John W. Spiegel (2)
24.4 Attorneys-In-Fact and Agents for Donald L. Staheli (2)
24.5 Attorneys-In-Fact and Agents for John P. Tierney (2)
24.6 Attorneys-In-Fact and Agents for Lawrence G. Weppler (2)
24.7 Attorneys-In-Fact and Agents for Daniel J. Willett (2)
24.8 Attorneys-In-Fact and Agents for Michael J. Zimmerman
27.1 Financial Data Schedule
</TABLE>
- ------------------------
(1) Incorporated by reference to the exhibit of the same number from the
Company's Registration Statement on Form S-1, File No. 33-98016.
(2) Incorporated by reference to the exhibit of the same number from the
Company's Annual Report on Form 10-K for the fiscal year ended March 31,
1996, File No. 1-14074.
(b) Reports on Form 8-K.
None
(c) Exhibits.
See (a) (3) above.
(d) Financial Statement Schedules.
See (a) (2) above.
A-65
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of
1934, ContiFinancial Corporation has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CONTIFINANCIAL CORPORATION
By: /s/ JAMES E. MOORE
-----------------------------------------
James E. Moore
PRESIDENT, CHIEF EXECUTIVE OFFICER AND
DIRECTOR
Date: June 27, 1997
Pursuant to the requirements of the Securities Act of 1934, this Report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
President, Chief Executive
/s/ JAMES E. MOORE Officer and Director
- ------------------------------ (Principal Executive June 27, 1997
James E. Moore Officer)
Senior Vice President and
/s/ DANIEL J. WILLETT Chief Financial Officer
- ------------------------------ (Principal Financial June 27, 1997
Daniel J. Willett Officer)
Vice President and
/s/ SUSAN E. O'DONOVAN Controller
- ------------------------------ (Principal Accounting June 27, 1997
Susan E. O'donovan Officer)
* Director and Chairman of
- ------------------------------ the Board June 27, 1997
James J. Bigham
* Director
- ------------------------------ June 27, 1997
Paul J. Fribourg
* Director
- ------------------------------ June 27, 1997
John W. Spiegel
* Director
- ------------------------------ June 27, 1997
Donald L. Staheli
* Director
- ------------------------------ June 27, 1997
John P. Tierney
* Director
- ------------------------------ June 27, 1997
Lawrence G. Weppler
* Director
- ------------------------------ June 27, 1997
Michael J. Zimmerman
<TABLE>
<S> <C>
/s/ JAMES E. MOORE
------------------------------------------
James E. Moore
* ATTORNEY-IN-FACT
By:
</TABLE>
A-66
<PAGE>
ANNEX B
CONTIFINANCIAL CORPORATION'S
QUARTERLY REPORT ON
FORM 10-Q FOR THE QUARTER ENDED
JUNE 30, 1997
<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
1-14074
(Commission File Number)
CONTIFINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 13-3852588
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
277 PARK AVENUE 10172
NEW YORK, NEW YORK (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (212) 207-2800
</TABLE>
NO CHANGE
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether 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 _
The Company had 47,623,984 shares of common stock outstanding as of August
7, 1997.
B-1
<PAGE>
CONTIFINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 1997 AND MARCH 31, 1997
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30, MARCH 31,
1997 1997
------------ ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents............................................................. $ 111,146 $ 51,200
Restricted cash....................................................................... 464 464
Securities purchased under agreements to resell....................................... 504,572 223,962
Interest-only and residual certificates............................................... 516,707 445,005
Capitalized servicing fees receivable................................................. 35,079 29,353
Trade receivables:
Receivables held for sale........................................................... 695,045 625,545
Other receivables................................................................... 152,567 87,353
Allowance for loan losses........................................................... (2,768) (3,747)
------------ ------------
Total trade receivables, net.......................................................... 844,844 709,151
------------ ------------
Premises and equipment, net of accumulated depreciation of $5,112 and $4,298 as of
June 30, 1997 and March 31, 1997, respectively...................................... 8,920 7,789
Cost in excess of equity acquired..................................................... 47,909 48,200
Other assets.......................................................................... 36,893 30,674
------------ ------------
Total assets.................................................................... $ 2,106,534 $ 1,545,798
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Accounts payable and accrued expenses................................................. $ 94,031 $ 87,770
Securities sold but not yet purchased................................................. 496,897 225,131
Trade receivables sold under agreements to repurchase................................. 306,042 251,539
Due to affiliates..................................................................... 16,149 36,367
Short-term borrowed funds............................................................. 130,000 25,000
Long-term debt........................................................................ 498,823 498,817
Other liabilities..................................................................... 24,538 12,102
------------ ------------
Total liabilities............................................................... 1,566,480 1,136,726
------------ ------------
Commitments and contingencies
Minority interest of subsidiary....................................................... 1,319 1,288
STOCKHOLDERS' EQUITY:
Preferred stock (par value $0.01 per share; 25,000,000 shares authorized; none
issued at June 30, 1997 and March 31, 1997)....................................... -- --
Common stock (par value $0.01 per share; 250,000,000 shares authorized; 47,623,984
and 44,390,335 shares issued at June 30, 1997 and March 31, 1997, respectively)... 476 444
Paid-in capital..................................................................... 397,984 295,029
Retained earnings................................................................... 155,525 128,652
Treasury Stock (17,509 and 27,931 shares of common stock, at cost, as of June 30,
1997 and March 31, 1997, respectively)............................................ (368) (586)
Deferred Compensation............................................................... (14,882) (15,755)
------------ ------------
Total stockholders' equity...................................................... 538,735 407,784
------------ ------------
Total liabilities and stockholders' equity...................................... $ 2,106,534 $ 1,545,798
------------ ------------
------------ ------------
</TABLE>
The accompanying notes to the unaudited condensed consolidated financial
statements
are an integral part of these statements.
B-2
<PAGE>
CONTIFINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED JUNE 30, 1997 AND 1996
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED JUNE 30,
--------------------------
<S> <C> <C>
1997 1996
------------ ------------
Gross income
Gain on sale of receivables......................................................... $ 64,340 $ 31,166
Interest............................................................................ 49,679 28,515
Net servicing income................................................................ 15,973 9,073
Other income........................................................................ 4,031 1,009
------------ ------------
Total gross income................................................................ 134,023 69,763
------------ ------------
Expenses
Compensation and benefits........................................................... 30,234 12,408
Interest (includes $6,226 to affiliates for the three months ended June 30, 1996)... 35,863 19,662
Provision for loan losses........................................................... 1,311 219
General and administrative.......................................................... 21,070 4,779
------------ ------------
Total expenses.................................................................... 88,478 37,068
------------ ------------
Income before income taxes and minority interest...................................... 45,545 32,695
Income taxes.......................................................................... 18,641 13,262
------------ ------------
Income before minority interest....................................................... 26,904 19,433
Minority interest of subsidiary....................................................... 31 --
------------ ------------
Net income........................................................................ $ 26,873 $ 19,433
------------ ------------
------------ ------------
Primary and fully diluted earnings per common share................................... $ 0.59 $ 0.44
------------ ------------
------------ ------------
Fully diluted weighted average number of shares outstanding........................... 45,588,626 44,043,368
------------ ------------
------------ ------------
Primary weighted average number of shares outstanding................................. 45,425,103 43,898,281
------------ ------------
------------ ------------
</TABLE>
The accompanying notes to the unaudited condensed consolidated financial
statements
are an integral part of these statements.
B-3
<PAGE>
CONTIFINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED JUNE 30, 1997 AND 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED JUNE 30,
----------------------
<S> <C> <C>
1997 1996
----------- ---------
Net cash used in operating activities..................................................... $ (109,202) $ (1,948)
----------- ---------
Cash flows from investing activities:
Acquisition of unconsolidated subsidiaries.............................................. (5,603) --
Purchase of property and equipment...................................................... (1,945) (57)
----------- ---------
Cash used in investing activities..................................................... (7,548) (57)
----------- ---------
Cash flows from financing activities:
Net decrease in due to affiliates....................................................... (29,376) (5,555)
Increase in short-term borrowed funds................................................... 105,000 --
Proceeds from equity offering........................................................... 100,778 --
Proceeds from exercise of options....................................................... 288 --
Other, net.............................................................................. 6 --
----------- ---------
Net cash provided by (used in) financing activities................................... 176,696 (5,555)
----------- ---------
Net increase (decrease) in cash and cash equivalents...................................... 59,946 (7,560)
Cash and cash equivalents at beginning of period.......................................... 51,200 32,479
----------- ---------
Cash and cash equivalents at end of period................................................ $ 111,146 $ 24,919
----------- ---------
----------- ---------
</TABLE>
The accompanying notes to the unaudited condensed consolidated financial
statements
are an integral part of these statements.
B-4
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
(DOLLARS IN THOUSANDS)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
ContiFinancial Corporation and its consolidated subsidiaries (collectively,
"ContiFinancial" or the "Company") have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission and, in the opinion of
management, reflect all normal, recurring adjustments which are necessary for a
fair presentation of the financial position, results of operations, and cash
flows for each period shown. The results for interim periods are not necessarily
indicative of financial results for the full year. These unaudited condensed
consolidated financial statements should be read in conjunction with the audited
Consolidated Financial Statements and notes thereto included in the Company's
Annual Report on Form 10-K for the fiscal year ended March 31, 1997 (the "Annual
Report"). All significant intercompany accounts and transactions have been
eliminated in consolidation.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings
Per Share ("EPS")" ("SFAS 128") which is effective for both interim and annual
periods ending after December 15, 1997. SFAS 128 simplifies the standards for
computing earnings per share. It replaces the presentation of primary EPS with a
presentation of basic EPS. Basic EPS excludes dilution and is computed by
dividing income available to common stockholders by the weighted-average number
of common shares outstanding for the period. If SFAS 128 had been applied to the
results of operations for the three months ended June 30, 1997 and June 30, 1996
the Company's basic EPS would have been $0.60 (pro forma) and $0.45 (pro forma),
respectively, of earnings per common share based on net income of $26,873 and
$19,433, respectively, and weighted-average number of common shares of
44,757,322 (pro forma) and 43,248,001 (pro forma), respectively. Fully diluted
EPS remains the same under SFAS 128 but will be referred to as diluted EPS.
In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income"
("SFAS 130") which is effective for fiscal years beginning after December 15,
1997. SFAS 130 establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
SFAS 130 requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. The adoption of this standard is not expected to have an
impact on the Company's financial position or results of operations.
In June 1997, the FASB issued SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131") which is effective for
financial statements for periods beginning after December 15, 1997. SFAS 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. It also established standards
for related disclosures about products and services, geographic areas and major
customers. The adoption of this standard is not expected to have an impact on
the Company's financial position or results of operations.
B-5
<PAGE>
CONTIFINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1997
(DOLLARS IN THOUSANDS)
3. EQUITY
On June 4, 1997, the Company completed a primary offering of 2,800,000
shares of common stock and an additional 420,000 shares were purchased by the
underwriters for over-allotments. The proceeds of the offering to the Company,
net of estimated expenses and underwriting discount, were $100,778. The net
proceeds will be used for general corporate purposes including funding loan
originations and purchases, supporting securitization transactions (including
the retention of Excess Spread Receivables--as defined on page 9 herein), other
working capital needs and to make certain strategic acquisitions. The completion
of the offering reduces Continental Grain Company's ("Continental Grain")
ownership of the Company from approximately 81% to approximately 75%. The
consummation of the public offering caused the vesting of certain options
granted.
B-6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This discussion should be read in conjunction with the accompanying
unaudited condensed consolidated financial statements and notes thereto, and the
Company's audited Consolidated Financial Statements and notes thereto included
in the Company's Annual Report. Certain statements under this caption constitute
"forward-looking statements" under federal securities laws. See "Forward-looking
Statements."
GENERAL
The Company is engaged in the consumer and commercial finance business by
originating and servicing home equity loans and providing financing and asset
securitization expertise to originators of a broad range of loans, leases and
receivables. Through ContiMortgage Corporation ("ContiMortgage") and the retail
origination subsidiaries, the Company is a leading originator, purchaser, seller
and servicer of home equity loans made to borrowers whose borrowing needs may
not be met by traditional financial institutions due to credit exceptions or
other factors. The Company has strategic alliances with various originators of a
broad range of consumer and commercial loans and other assets ("Strategic
Alliances"). Through ContiTrade Services L.L.C. ("ContiTrade") the Company
provides financing and asset securitization structuring expertise, and through
ContiFinancial Services Corporation ("ContiFinancial Services"), an NASD
registered broker/dealer, the Company provides placement services. In September
1996, the Company established ContiWest Corporation, a Nevada corporation, to
administer and underwrite a portion of the Company's origination portfolio.
The Company's Strategic Alliance clients are originators of consumer and
commercial loans, leases and receivables. The Company provides financing and
asset securitization execution and expertise to the Strategic Alliance client
while the client provides a consistent flow of securitizable assets to the
Company. In certain Strategic Alliances, the Company receives interests
("Strategic Alliance Equity Interests") in the Strategic Alliance client. The
realization of value on such Strategic Alliance Equity Interests is subject to
many factors, including the future growth and profitability of the Strategic
Alliance clients and the completion of initial public offerings or sale of such
Strategic Alliance clients.
In the third quarter of fiscal 1997, the Company acquired three home equity
companies and one auto finance company to implement growth strategies of
expanding into the western United States, diversifying into retail origination
and owning other asset origination platforms with which the Company has
significant securitization experience. The four new loan origination
subsidiaries, California Lending Group, Inc. d/b/a United Lending Group ("ULG"),
Royal Mortgage Partners, L.P., d/b/a Royal MortgageBanc ("Royal"), Triad
Financial Corporation ("Triad"), and Resource One Consumer Discount Company,
Inc. ("Resource One"), are collectively called the "Acquisitions".
B-7
<PAGE>
The following table presents loan portfolio data relating to the three month
periods ended June 30, 1997 and 1996:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED JUNE 30,
-----------------------------
<S> <C> <C>
LOAN PORTFOLIO DATA 1997 1996
- ----------------------------------------------------------------------------------- ------------- --------------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
ContiMortgage serviced loan portfolio.............................................. $ 7,269,361 $ 4,256,948
Home equity loan originations:
Wholesale........................................................................ $ 1,166,218 $ 678,128
Retail........................................................................... 226,013 --
------------- --------------
Total home equity loan originations................................................ $ 1,392,231 $ 678,128
------------- --------------
------------- --------------
Commercial loan originations....................................................... $ 191,806 $ 65,425
Non-prime auto loan originations................................................... $ 38,056 $ --
Securitizations and sales:
ContiMortgage and ContiWest...................................................... $ 1,265,000 $ 692,954
Commercial real estate........................................................... 158,816 193,916
Triad............................................................................ 45,881 --
Strategic alliances.............................................................. 174,200 106,559
------------- --------------
Total securitizations and sales.................................................... $ 1,643,897 $ 993,429
------------- --------------
------------- --------------
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1997 MARCH 31, 1997
------------- --------------
<S> <C> <C>
ContiMortgage delinquency and loan loss data (1):
Delinquency rate................................................................. 3.68% 3.24%
Default rate..................................................................... 5.05% 4.70%
<CAPTION>
THREE MONTHS
ENDED JUNE 30,
-----------------------------
1997 1996
------------- --------------
<S> <C> <C>
Net losses as a percentage of average amount outstanding.......................... 0.074% 0.051%
</TABLE>
- ------------------------
(1) Includes home equity loans originated by Royal MortgageBanc, Resource One
and United Lending Group, and serviced by ContiMortgage.
The delinquency rate on ContiMortgage's servicing portfolio at June 30, 1997
was 3.68%. ContiMortgage's delinquencies increased 44 basis points from the
March 31, 1997 rate of 3.24%, of which 51 basis points were in the 30-59 day
period. Delinquencies have fluctuated between 3.02% and 4.18% for the past
twelve months. The default portfolio increased 35 basis points to 5.05% from the
March 31, 1997 default percentage of 4.70%. Included in the default total were
loans performing under bankruptcy plans and real estate owned, making up 0.75%
and 0.48% of the servicing portfolio, respectively, compared with 0.62% and
0.52%, respectively, as of March 31, 1997. The modest increase in the default
portfolio is due to the seasoning of ContiMortgage's portfolio.
Net loss for the first quarter of fiscal 1998 was $5.0 million, or 0.074% of
average serviced loans outstanding, as compared with 0.051% for the first
quarter of fiscal 1997. Net losses as a percentage of average serviced home
equity loans outstanding was 0.28% for the twelve months ended June 30, 1997, as
compared with 0.26% for the twelve months ended March 31, 1997.
B-8
<PAGE>
CERTAIN ACCOUNTING CONSIDERATIONS
For a discussion of recent accounting pronouncements, see Note 2 to the
unaudited condensed consolidated financial statements.
As a fundamental part of its business and financing strategy, the Company
sells substantially all of its loans or other assets through securitization in
the form of Real Estate Mortgage Investment Conduits ("REMIC"), owner trusts or
grantor trusts. In a securitization, the Company sells loans or other assets
that it has originated or purchased to a trust for a cash purchase price and an
interest in the loans or other assets securitized (in the form of the "excess
spread"). The cash purchase price is raised through an offering of pass-through
certificates by the trust. Following the securitization, the purchasers of the
pass-through certificates receive the principal collected or allocated and the
investor pass-through interest rate on the certificate balance, while the
Company receives the excess spread . The excess spread represents, over the life
of the loans or other assets, the excess of the weighted average coupon on each
pool of loans or other assets sold over the sum of the pass-through interest
rate plus a normal servicing fee, a trustee fee, an insurance fee, if
applicable, and an estimate of annual future credit losses related to the loans
or other assets securitized (the "Excess Spread"). These cash flows are
projected over the life of the loans or other assets using prepayment, default,
and interest rate assumptions that market participants would use for similar
financial instruments subject to prepayment, credit and interest rate risk and
are discounted using an interest rate that a purchaser unrelated to the seller
of such a financial instrument would demand. The majority of the Company's gross
income is recognized as gain on sale of loans or other assets, which represents
the value of the Excess Spread less origination and underwriting costs. The
present value of the Excess Spread is the Excess Spread receivable (the "Excess
Spread Receivable"). The Excess Spread Receivable is either a contractual right
or a certificated security generally in the form of an interest-only or residual
certificate. The majority of the Company's Excess Spread Receivable at June 30,
1997 and March 31, 1997, is interest-only and residual certificates.
Consequently, the Company's consolidated balance sheets designate Excess Spread
Receivable as "interest-only and residual certificates."
The Company recognizes the gain on sale of loans or other assets in the
fiscal year in which such loans or other assets are sold, although the majority
of the cash (representing the Excess Spread and servicing fees) is received by
the Company over the life of the loans or other assets. Concurrent with
recognizing such gain on sale, the Company records the Excess Spread Receivable
as an asset on its consolidated balance sheets. The Excess Spread Receivable is
reduced as cash distributions are received from the securitization.
Due to the fact that the gain recognized in the year of sale is equal to the
present value of the estimated future cash flows from the Excess Spread, the
amount of cash actually received over the lives of the loans or other assets
normally exceeds the gain previously recognized at the time the loans or other
assets were sold and therefore interest income is recognized over the life of
the loans or other assets securitized. In periods subsequent to the sale, the
Company may recognize an increase in fair value of Excess Spread Receivable as
gain on sale of receivables to the extent that estimates of the loan pools'
future remaining lives exceed those originally projected. This estimate of
extended life is performed by reviewing past prepayment experience and
estimating future prepayment experience by considering numerous factors which
include current market assumptions, the interest rate environment and economic
factors. If actual prepayments with respect to sold loans occur faster or credit
experience is worse than projected at the time such loans were sold, the
carrying value of the Excess Spread Receivable may have to be written down
through a charge to earnings in the period of adjustment.
Additionally, upon sale or securitization of servicing retained mortgages,
the Company capitalizes the cost associated with the right to service mortgage
loans based on its relative fair value. 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 in proportion to
and over the period of estimated net future servicing fee income. The Company
periodically reviews capitalized servicing fees
B-9
<PAGE>
receivable for valuation impairment. This review is performed on a disaggregated
basis for the predominant risk characteristics of the underlying loans which are
loan type, loan-to-value ratio and credit quality. The Company generally makes
loans to credit impaired borrowers whose borrowing needs may not be met by
traditional financial institutions due to credit exceptions. The Company has
found that credit impaired borrowers are payment sensitive rather than interest
rate sensitive. As such the Company does not consider interest rates a
predominant risk characteristic for purposes of valuation impairment. Impairment
is recognized in a valuation allowance for each disaggregated stratum in the
period of impairment.
FINANCIAL CONDITION
JUNE 30, 1997
Securities purchased under agreements to resell increased $280.6 million
from $224.0 million at March 31, 1997 to $504.6 million at June 30, 1997. The
Company maintains asset purchase and sale facilities with certain financial
institutions ("Purchase and Sale Facilities"). Receivables held for sale and
loans and other assets sold with recourse under its Purchase and Sale Facilities
are hedged, in part, through the use of United States treasury securities and
futures contracts to reduce exposure to interest rate fluctuations. Securities
purchased under agreements to resell are part of this hedging strategy. This
increase was primarily due to the increase in the Company's securitization
volume and the related receivables held for sale account.
Interest-only and residual certificates increased $71.7 million from $445.0
million at March 31, 1997 to $516.7 million at June 30, 1997. This increase
represents $81.2 million recorded during fiscal 1997 relating to new
securitizations and recorded interest income of $11.2 million partially offset
by $7.2 million of sales and $13.5 million of collections.
Capitalized servicing fees receivable increased $5.7 million from $29.4
million at March 31, 1997 to $35.1 million at June 30, 1997. This balance
reflects the capitalization of $7.8 million of servicing rights and $1.1 million
of prepayment premiums paid partially offset by amortization of $3.2 million.
Trade receivables, net increased $135.6 million from $709.2 million at March
31, 1997 to $844.8 million at June 30, 1997. This increase was due to an
increase in receivables held for sale from $625.5 million as of March 31, 1997
to $695.0 million at June 30, 1997, and an increase in other receivables from
$87.4 million at March 31, 1997 to $152.6 million at June 30, 1997. The increase
in receivables held for sale of $69.5 million was due to the investment of the
net cash proceeds available from the Company's June 4, 1997 primary offering of
common stock and the timing of securitizations.
The increase in other receivables of $65.2 million from March 31, 1997 to
June 30, 1997, was primarily due to an increase in short-term receivables
associated with the timing of securitization transactions of $48.7 million.
Additional changes to other receivables were an increase in servicing advances
of $6.0 million and an increase in financed interest-only and residual
certificates of $3.9 million.
Premises and equipment, net increased $1.1 million from $7.8 million at
March 31, 1997 to $8.9 million at June 30, 1997. The increase is primarily due
to increased purchases related to the expansion of ContiMortgage's offices.
Cost in excess of equity acquired decreased $0.3 million from $48.2 million
at March 31, 1997 to $47.9 million at June 30, 1997. The decrease was due to the
amortization of the cost in excess of equity acquired which was recorded upon
the purchase of the Acquisitions made by the Company during the third quarter of
fiscal 1997.
Other assets increased $6.2 million from $30.7 million at March 31, 1997 to
$36.9 million at June 30, 1997. Other assets represents prepaid expenses, margin
and other deposits, deferred bond issuance costs, equity investments in
unconsolidated subsidiaries and other investments. This increase is primarily
due to an increase of approximately $5.6 million for equity investments in
unconsolidated subsidiaries.
B-10
<PAGE>
Accounts payable and accrued expenses increased $6.2 million from $87.8
million at March 31, 1997 to $94.0 million at June 30, 1997. The balance
increased primarily due to an increase in accrued taxes payable of $27.0
million, and accrued interest payable of $10.0 million offset by a decrease in
accrued incentive amounts of $27.1 million and accrued securitization expenses
of $4.0 million. See due to affiliates discussion below for a discussion of
accrued taxes payable. The increase in accrued interest payable and the
decreases in accrued incentive amounts and accrued securitization expenses were
due to timing differences relating to the payments of these liabilities.
Securities sold but not yet purchased increased $271.8 million from $225.1
million at March 31, 1997 to $496.9 million at June 30, 1997. Receivables held
for sale and loans and other assets sold, with recourse, under the Company's
Purchase and Sale Facilities are hedged, in part, through the use of United
States Treasury securities and futures contracts to reduce exposure to interest
rate fluctuations. Securities sold but not yet purchased are part of this
hedging strategy. This increase was primarily due to the increase in the
Company's securitization volume and the related receivables held for sale
account.
Trade receivables sold under agreements to repurchase increased $54.5
million from $251.5 million at March 31, 1997 to $306.0 million at June 30,
1997. This increase is due to the increase in receivables held for sale during
the three months ended June 30, 1997.
Due to affiliates decreased $20.3 million from $36.4 million at March 31,
1997 to $16.1 million at June 30, 1997. The decrease is primarily due to the
effect of the June 4, 1997 primary stock offering which reduced Continental
Grain's ownership of the Company from approximately 81% to approximately 75%.
When the Company was 81% owned by Continental Grain, the Company's Federal
income taxes were prepared on a consolidated basis with Continental Grain and
such liabilities were paid through the due to affiliates account. Since
Continental Grain's ownership percentage has been reduced to approximately 75%,
taxes are now accrued and paid directly by the Company.
Short-term borrowed funds represents borrowings from a $200.0 million
unsecured revolving credit facility the Company entered into on January 8, 1997.
At June 30, 1997 and March 31, 1997, $130.0 million and $25.0 million of
drawings under this line were outstanding, respectively. These borrowings were
used for general corporate purposes. For further discussion see "Liquidity and
Capital Resources".
There were no material changes in long-term debt from March 31, 1997 to June
30, 1997.
Other liabilities increased $12.4 million from $12.1 million at March 31,
1997 to $24.5 million at June 30, 1997. The increase is primarily due to a net
increase in deferred compensation payable of $10.6 million under the terms of
incentive plans and an increase in deferred income of $1.8 million.
Stockholders' equity increased $130.9 million from $407.8 million at March
31, 1997 to $538.7 million at June 30, 1997. The increase was due to the June 4,
1997 completion of the primary offering of common stock with net proceeds of
$100.8 million, net income of $26.9 million, the amortization of deferred
compensation and a deferred compensation tax adjustment of $3.0 million and the
exercise of stock options of $0.2 million.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1997 COMPARED TO THREE MONTHS ENDED JUNE 30, 1996
The Company's total gross income increased from $69.8 million for the three
months ended June 30, 1996 to $134.0 million for the three months ended June 30,
1997, representing a 92% increase. During the first quarter of fiscal 1998,
gross income increased by $37.0 million, or 53%, exclusive of the Acquisitions.
Net income increased from $19.4 million for the three months ended June 30, 1996
to $26.9 million for the three months ended June 30, 1997, representing a 38%
increase. Net income for the three months ended June 30, 1997 increased by $4.2
million, or 22%, exclusive of the Acquisitions.
B-11
<PAGE>
On a percentage basis, the following table sets forth the composition of the
Company's results as a percentage of total gross income for the periods
indicated:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED JUNE 30,
--------------------
<S> <C> <C>
1997 1996
--------- ---------
Gross income
Gain on sale of receivables.................................................................. 48.00% 44.67%
Interest..................................................................................... 37.07% 40.87%
Net servicing income......................................................................... 11.92% 13.01%
Other income................................................................................. 3.01% 1.45%
--------- ---------
Total gross income......................................................................... 100.00% 100.00%
--------- ---------
Expenses
Compensation and benefits.................................................................... 22.56% 17.79%
Interest..................................................................................... 26.76% 28.18%
Provision for loan losses.................................................................... 0.98% 0.31%
General and administrative................................................................... 15.72% 6.85%
--------- ---------
Total expenses............................................................................. 66.02% 53.13%
--------- ---------
Income before income taxes and minority interest............................................... 33.98% 46.87%
Income taxes................................................................................... 13.91% 19.01%
--------- ---------
Income before minority interest................................................................ 20.07% 27.86%
Minority interest of subsidiary................................................................ 0.02% 0.00%
--------- ---------
Net income................................................................................. 20.05% 27.86%
--------- ---------
--------- ---------
</TABLE>
The Company's move into retail origination has resulted in a change in the
profile of the income statement. Retail origination expenses focus heavily on
compensation and benefits and general and administrative expenses, whereas with
wholesale originators, such as ContiMortgage, costs of origination in the form
of origination points are netted against gain on sale of receivables. As retail
origination grows, the Company anticipates a related increase in operating
expenses, largely offset by higher income from origination points and other cash
income included in gain on sale results.
INCOME. The increase in total gross income was due to a greater volume of
loans originated as a result of the expansion of the Company's wholesale and
broker home equity loan origination sources and the move into retail
originations.
B-12
<PAGE>
The following table sets forth information regarding the components of the
Company's total gross income in each of the three month periods ended June 30:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED JUNE 30,
---------------------
<S> <C> <C>
1997 1996
---------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
Gain on sale of receivables................................................................ $ 64,340 $ 31,166
Interest................................................................................... 49,679 28,515
Net servicing income....................................................................... 15,973 9,073
Other income............................................................................... 4,031 1,009
---------- ---------
Total gross income......................................................................... $ 134,023 $ 69,763
---------- ---------
---------- ---------
</TABLE>
Gain on sale of receivables was the primary component of total gross income,
comprising 48% and 45% of total gross income in the three months ended June 30,
1997 and 1996, respectively. Gain on sale of receivables increased $33.2
million, or 106%, in the three months ended June 30, 1997 as compared to the
corresponding period in 1996. During the first quarter of fiscal 1998, gain on
sale of receivables increased by $8.9 million or 29%, exclusive of the
Acquisitions.
Gain on sale of receivables represents income primarily from the structuring
and sale of pools of home equity loans originated by ContiMortgage, the retail
origination companies and Strategic Alliance clients of the Company in REMICs,
owner trusts and grantor trusts. In addition, gains on sale of receivables are
earned upon whole loan sales and upon securitization of commercial and
multi-family loans, home improvement loans, franchisee loans, prime and
non-prime auto loans and equipment leases which are sold into REMICs and whole
loan and other trust structures.
The increase in income earned from gain on sale of receivables was due to an
increased volume of loans and leases structured partially offset by a decreased
gain on sale percentage. The Company structured and sold $1.4 billion of
mortgages, loans and leases, exclusive of the Acquisitions, in the three months
ended June 30, 1997, an increase of $0.6 billion from the three months ended
June 30, 1996, which contributed $16.3 million of the increase in gain on sale
of receivables.
The gain on sale percentage, computed as the ratio of gain on sale gross
income divided by the dollar volume of loans securitized, decreased by 87 basis
points from 3.69% for the three months ended June 30, 1996 to 2.82% for the
three months ended June 30, 1997. The primary reasons for the decline were
twofold: (1) origination costs or premiums paid for loans increased by 74 basis
points, reducing the Excess Spread component of the gain on sale calculation;
and (2) the average life on ContiMortgage securitizations declined by 0.3 years
in the first quarter of fiscal 1998 compared to the corresponding period in
fiscal 1997 due to an increase in prepayment speed assumptions used by the
Company in valuing the Excess Spread Receivable. Securities sold were executed
at more favorable investor yields and efficient securitization structures in the
three months ended June 30, 1997, than in the comparable period in 1996,
generating a 30 basis point increase in Excess Spread, partially offsetting the
declines in Excess Spread and average life. These changes resulted in a $7.4
million decline in gain on sale of receivables.
The combination of the $16.3 million increase due to increased volume and
the $7.4 million decrease due to a decline in ContiMortgage Excess Spread
resulted in a net increase in gain on sale of receivables from the three months
ended June 30, 1996 to the corresponding period in 1997 of $8.9 million.
Interest income increased $21.2 million, or 74%, for the three months ended June
30, 1997 from the corresponding period in 1996. Interest income increased by
$19.1 million, or 67%, exclusive of the Acquisitions. Interest income represents
interest earned on loans originated or purchased by the Company during the
period from their origination or purchase until the actual sale of the loans, as
well as the recognition of the increased value of the discounted Excess Spread
Receivables over time. The interest earned on loans originated and purchased
contributed $15.1 million to the increase between the three months ended
B-13
<PAGE>
June 30, 1996 and 1997. The increase in interest earned on loans originated and
purchased was primarily due to a $646.4 million increase in the average balance
of loans originated and purchased but not yet securitized during the periods.
The recognition of the increased value of the discounted Excess Spread
Receivables over time accounted for $4.0 million of the increase in interest
income which was due to the increase in the average investment in Excess Spread
Receivables in the three months ended June 30, 1997 as compared to the
corresponding period in 1996.
Net servicing income increased $6.9 million, or 76%, for the three months
ended June 30, 1997 compared to the corresponding period in 1996 due to the
increase in the size of the servicing portfolio and the volume of loan sales and
securitizations. Net servicing income increased by $6.4 million, or 70%,
exclusive of the Acquisitions. The Company's loan servicing portfolio increased
$3.0 billion from $4.3 billion to $7.3 billion at June 30, 1996 as compared to
June 30, 1997, contributing to a $2.6 million increase in net servicing income
between the three months ending June 30, 1996 and 1997. Additionally, net
servicing income increased by $3.8 million in the first quarter of fiscal 1998
as compared to the first quarter of fiscal 1997 due to capitalized servicing
income associated with the 83% increase in the ContiMortgage and ContiWest home
equity loan sales and securitizations for the three months ended June 30, 1997
as compared to the corresponding period in 1996.
Other income increased $3.0 million, or 300%, for the three month period
ended June 30, 1997 compared to the corresponding period in 1996. Other income
increased by $2.6 million, or 254%, exclusive of the Acquisitions. Other income
consists primarily of "purchase premium refunds" on warehouse advances and for
the three months ended June 30, 1997, miscellaneous income. "Purchase premium
refunds" are received from certain origination sources related to loans that
prepay within a contractually set time period. Upon origination of a loan, the
Company will pay a wholesale originator a purchase premium for the loan or pools
of loans. The Company negotiates agreements with wholesale originators that
stipulate that a portion of such purchase premium will be repaid if individual
loans are repaid within a contractually set time period. The income from
"purchase premium refunds" increased by approximately $0.9 million due to the
increase in ContiMortgage origination volume. The miscellaneous income received
during the three months ended June 30, 1997 consists of $1.1 million of income
received in connection with the termination of a strategic alliance agreement.
EXPENSES. Total expenses for the three months ended June 30, 1997 increased
$51.4 million or 139% from the corresponding period in 1996. Total expenses
increased by $28.0 million, or 75%, exclusive of the Acquisitions. This increase
in total expenses was due to the increase in number of employees, and costs
associated with increased loan volume.
B-14
<PAGE>
The following table sets forth the components of the Company's expenses for
the three months ended June 30, 1997 and 1996:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED JUNE 30,
--------------------
<S> <C> <C>
1997 1996
--------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
Compensation and benefits............................................... $ 30,234 $ 12,408
Interest................................................................ 35,863 19,662
Provision for loan losses............................................... 1,311 219
General and administrative.............................................. 21,070 4,779
--------- ---------
Total expenses.................................................... $ 88,478 $ 37,068
--------- ---------
--------- ---------
</TABLE>
Compensation and benefits expense increased $17.8 million, or 144 %, for the
three months ended June 30, 1997 compared to the corresponding period in 1996.
Of this increase in compensation and benefits, $12.3 million was due to the
addition of 974 employees from the Acquisitions. Compensation and benefits
expense increased by $5.5 million, or 44%, exclusive of the Acquisitions. This
increase was primarily due to the addition of new personnel. On June 30, 1997,
the Company had 770 employees, exclusive of the Acquisitions, as compared to 515
employees on June 30, 1996, a 50% increase, which primarily contributed to a
$5.9 million increase in salary and benefits partially offset by a $0.4 million
decrease in total incentive compensation. Incentive compensation is calculated
under provisions of certain formula based plans. Total incentive compensation
decreased due to changes in certain components of these formula based plans.
Interest expense increased $16.2 million, or 82%, to $35.9 million for the
three months ended June 30, 1997 as compared to $19.7 million for the
corresponding period in 1996. Interest expense increased by $15.9 million, or
81%, to $35.6 million exclusive of the Acquisitions. This increase was primarily
a result of an increase in long-term and short-term borrowings, trade
receivables sold under agreements to repurchase and sales under the Company's
Purchase and Sale Facilities. Average borrowings increased by $0.9 billion for
the three months ended June 30, 1997, as compared to the corresponding period in
1996.
Provision for loan losses increased to $1.3 million for the three months
ended June 30, 1997 as compared to $0.2 million for the three months ended June
30, 1996. Provision for loan losses remained comparable exclusive of the
Acquisitions. Provision for loan losses is recorded in sufficient amounts to
maintain an allowance at a level considered adequate to cover anticipated losses
resulting from liquidation of receivables held for sale and receivables sold
with limited recourse under the Purchase and Sale Facilities, prior to
securitization.
General and administrative expenses increased $16.3 million or 341% for the
three months ended June 30, 1997 compared to the corresponding period in 1996.
Of this increase in general and administrative expenses, $9.7 million was
attributable to the retail origination operations of the Acquisitions. General
and administrative expenses increased by $6.6 million, or 139%, exclusive of the
Acquisitions. Part of the increase was due to a $1.7 million increase in costs
associated with underwriting, originating and servicing higher loan volumes. In
the three months ended June 30, 1997, origination volume increased 72% as
compared to the three months ended June 30, 1996 exclusive of the Acquisitions.
The remaining increase in general and administrative expenses of approximately
$2.8 million was primarily due to the increase in the number of employees to 770
on June 30, 1997, exclusive of employees from the Acquisitions, from 515 on June
30, 1996.
INCOME TAXES. The Company's provision for income taxes was $18.6 million
and $13.3 million for the three months ended June 30, 1997 and 1996,
respectively. The increase in taxes of 40% for the three months ended June 30,
1997 compared to the corresponding period in 1996 was related to the increase in
B-15
<PAGE>
income before taxes and minority interest over the same period. The effective
tax rate for each of the three month periods remained consistent at 41%.
LIQUIDITY AND CAPITAL RESOURCES
In a securitization, the Company recognizes a gain on the sale of loans or
assets securitized upon the closing of the securitization, but does not receive
the majority of the cash representing such gain until it receives the Excess
Spread, which is payable over the actual life of the loan or other assets
securitized. This negative cash flow has been partially offset by the Company's
move into retail origination which resulted in an increase in the cash received
from securitization through origination points and other cash income included in
the gain on sale results. The Company incurs significant expenses in connection
with a securitization and incurs both current and deferred tax liabilities as a
result of the gain on sale. Therefore, the Company requires continued access to
short and long term external sources of cash to fund its operations. The
Company's primary cash requirements are expected to include the funding of: (i)
mortgage, loan and lease originations and purchases pending their pooling and
sale; (ii) the points and expenses paid in connection with the acquisition of
wholesale loans; (iii) fees and expenses incurred in connection with its
securitization program; (iv) over collateralization or reserve account
requirements in connection with loans and leases pooled and sold; (v) ongoing
administrative and other operating expenses; (vi) payments related to tax
obligations; (vii) interest and principal payments under the Company's long-term
debt and short-term borrowed funds; (viii) the costs of the Purchase and Sale
Facilities and the funding agreement under an agreement to repurchase (the
"Repurchase Agreement"); and (ix) the cost of any new acquisitions that the
Company may pursue and deferred purchase price commitments on existing
acquisitions.
As a result of its growing securitization program, the Company has operated,
and expects to continue to operate, on a negative cash flow basis. The Company
securitized and sold in the secondary market $1.6 billion of loans in the three
months ended June 30, 1997 compared to $1.0 billion in the three months ended
June 30, 1996. The Company used $109.2 million of cash in operations during the
three months ended June 30, 1997.
During the life of the REMICs, owner trusts or grantor trusts, the Company
subordinates to the rights of holders of senior interests a portion of the
Excess Spread otherwise due to the Company as a credit enhancement to support
the sale of senior interests. The terms of the REMICs, owner trusts and grantor
trusts generally require that the Excess Spread otherwise payable to the Company
during the early months of the trusts be used to increase the cash reserve
account, or to repay the senior interests in order to increase over
collateralization to specified maximums. The value of such "deposit" accounts is
included in the value of Excess Spread Receivables and the related gain on sale
of receivables, net of necessary reserves for credit losses, if applicable.
In addition, increased use of securitization transactions as a funding
source by the Company has resulted in a significant increase in the amount of
gain on sale of receivables recognized by the Company. During the three months
ended June 30, 1997, the Company recognized gain on sale of receivables in the
amount of $64.3 million compared to $31.2 million for the corresponding period
in 1996. The recognition of gain on sale of receivables will have a negative
impact on the cash flows of the Company to the extent the Company is required to
pay state and Federal income taxes on these amounts in the period recognized,
notwithstanding that the Company does not receive the cash representing the gain
until later periods as the related loans are repaid or otherwise collected.
The Company's primary sources of liquidity are sales of loans, leases and
other assets through securitization, the sale of loans, leases and other assets
under the Purchase and Sale Facilities and Repurchase Agreement, the issuance of
shares of common stock, the issuance of long-term debt and the unsecured
revolving credit facility. While the Company sells Excess Spread Receivables
from time to time, there is no liquid market for such Excess Spread Receivables.
B-16
<PAGE>
The Company had $2.6 billion of committed sale capacity under its Purchase
and Sale Facilities and Repurchase Agreements with various financial
institutions as of June 30, 1997. The Purchase and Sale Facilities allow the
Company to sell, with limited recourse, interests in designated pools of loans
and other assets. On March 31, 1997, the Company entered into the Repurchase
Agreement. The Repurchase Agreement allows the Company to sell receivables held
for sale to a financial institution under an agreement that the Company will
repurchase the assets. These facilities generally have one year renewable terms
(one Purchase and Sale Facility has a two-year term), all of which will expire
between October 1997 and July 1998. On June 30, 1997, the Company utilized
$995.5 million of the capacity under the Purchase and Sale Facilities and
Repurchase Agreements. The Company currently anticipates that it will be able to
renew these facilities when they expire and to obtain additional facilities.
The Company has sold Excess Spread Receivables, with limited recourse, to
provide cash to fund the Company's securitization program. At June 30, 1997,
$132.2 million of these sales were outstanding. Under the recourse provisions of
the agreements, the Company is responsible for losses incurred by the purchaser
within an agreed-upon range. The Company's performance obligations in these
transactions are guaranteed by Continental Grain for an agreed-upon fee.
Although the Company intends to continue to pursue opportunities to sell Excess
Spread Receivables, no assurance can be given that such opportunities will be
available in the future.
On June 4, 1997, the Company completed a primary offering of 2,800,000
shares of common stock and an additional 420,000 shares were purchased by the
underwriters for over allotments. The net proceeds of the offering to the
Company were $100.8 million which were used by the company for general corporate
purposes including funding loan originations and purchases, supporting
securitization transactions (including the retention of Excess Spread
Receivables), other working capital needs and to make certain strategic
acquisitions.
In anticipation of growth in the Company's future operations, additional
financing sources will be required. The Company currently has commitments for
financing through the unsecured revolving credit facility, however, there can be
no assurance that the Company will be successful in consummating additional
financing transactions in the future on terms that the Company would consider to
be favorable. Furthermore, no assurance can be given that Continental Grain will
provide such financing if the Company is unable to obtain third party financing
or that the terms of the Continental Grain debt agreements will permit the
Company to obtain such financing.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Quarterly Report on Form 10-Q which are
not historical fact, may be deemed to be forward-looking statements under the
federal securities laws. There are many important factors that could cause the
Company's actual results to differ materially from those indicated in the
forward-looking statements. Such factors include, but are not limited to,
general economic conditions, interest rate risk, prepayment speeds, delinquency
and default rates, changes (legislative and otherwise) in the asset
securitization industry, demand for the Company's services, the impact of
certain covenants in loan agreements of the Company and Continental Grain, the
degree to which the Company is leveraged, its needs for financing, and other
risks identified in the Company's Securities and Exchange Commission filings. In
addition, it should be noted that past financial and operational performance of
the Company is not necessarily indicative of future financial and operational
performance.
B-17
<PAGE>
PART II--OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
11.1 Computation of the Company's earnings per common share
27.1 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K.
None.
B-18
<PAGE>
SIGNATURES
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.
<TABLE>
<CAPTION>
CONTIFINANCIAL CORPORATION
DATE SIGNATURE TITLE
- -------------- -------------------------------------------- ------------------------------
Senior Vice President and
August 14, /s/ DANIEL J. WILLETT Chief
1997 ------------------------------------------- Financial Officer (Principal
Daniel J. Willett Financial Officer)
<C> <C> <S>
/s/ SUSAN E. O'DONOVAN Vice President and Controller
August 14, ------------------------------------------- (Principal Accounting
1997 Susan E. O'Donovan Officer)
</TABLE>
B-19
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFERING DESCRIBED HEREIN, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY OR THE UNDERWRITER OF THE STRYPES. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY
SECURITIES OTHER THAN THOSE SPECIFICALLY OFFERED HEREBY OR OF ANY SECURITIES
OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM, IT IS UNLAWFUL TO MAKE
SUCH OFFER OR SOLICITATION IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN
IMPLICATION THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS
PROSPECTUS OR IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Available Information........................... 2
Incorporation of Certain Documents by
Reference..................................... 2
Prospectus Summary.............................. 3
Risk Factors.................................... 9
Price Range of Common Stock..................... 18
Dividend Policy................................. 18
Capitalization.................................. 19
Selected Financial Data......................... 20
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.................................... 22
Business........................................ 39
Regulation...................................... 39
Management...................................... 40
Description of Certain Indebtedness and
Financing Arrangements........................ 43
Shares Eligible for Future Sale................. 44
Description of Capital Stock.................... 44
Plan of Distribution............................ 47
Legal Matters................................... 48
Experts......................................... 48
Special Note Regarding Forward-Looking
Statements.................................... 48
Glossary........................................ i
Annex A--Form 10-K for the Fiscal Year Ended
March 31, 1997................................ A-1
Annex B--Form 10-Q for the Quarter Ended June
30, 1997...................................... B-1
</TABLE>
2,800,000 SHARES
CONTIFINANCIAL
CORPORATION
COMMON STOCK
---------------------
PROSPECTUS
------------------------
, 1997
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCES AND DISTRIBUTION
The following table sets forth the fees and expenses payable by the Company
in connection with the issuance and distribution of the securities other than
underwriting discounts and commissions. All of such expenses except the
Securities and Exchange Commission (the "Commission") registration fee and the
NASD filing fee are estimated:
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee............. $36,073.76
NASD filing fee................................................. *
Blue Sky fees and expenses...................................... *
Printing expense................................................ *
Accounting fees and expenses.................................... *
Legal fees and expenses......................................... *
Miscellaneous................................................... *
---------
Total........................................................... $36,073.76
---------
---------
</TABLE>
- ------------------------
* To be completed by amendment.
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145(a) of the General Corporation Law of the State of Delaware (the
"DGCL") provides that a Delaware corporation may indemnify any person who was or
is a party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding, whether civil, criminal, administrative or
investigative (other than an action by or in the right of the corporation) by
reason of the fact that he is or was a director, officer, employee or agent of
the corporation or is or was serving at the request of the corporation as a
director, officer, employee or agent of another corporation or enterprise,
against expenses, judgments, fines and amounts paid in settlement actually and
reasonably incurred by him in connection with such action, suit or proceeding if
he acted in good faith and in a manner he reasonably believed to be in or not
opposed to the best interests of the corporation, and, with respect to any
criminal action or proceeding, had no reasonable cause to believe his conduct
was unlawful.
Section 145(b) of the DGCL provides that a Delaware corporation may
indemnify any person who was or is a party or is threatened to be made a party
to any threatened, pending or completed action or suit by or in the right of the
corporation to procure a judgment in its favor by reason of the fact that such
person acted in any of the capacities set forth above, against expenses actually
and reasonably incurred by him in connection with the defense or settlement of
such action or suit if he acted under similar standards, except that no
indemnification may be made in respect of any claim, issue or matter as to which
such person shall have been adjudged to be liable to the corporation unless and
only to the extent that the Court of Chancery or the court in which such action
or suit was brought shall determine that despite the adjudication of liability,
such person is fairly and reasonably entitled to be indemnified for such
expenses which the court shall deem proper.
Section 145 of the DGCL further provides that to the extent a director or
officer of a corporation has been successful in the defense of any action, suit
or proceeding referred to in subsections (a) and (b) or in the defense of any
claim, issue, or matter therein, he shall be indemnified against expenses
actually and reasonably incurred by him in connection therewith; that
indemnification provided for by Section 145 shall not be deemed exclusive of any
other rights to which the indemnified party may be entitled; and that the
corporation may purchase and maintain insurance on behalf of a director or
officer of the corporation against any liability asserted against him or
incurred by him in any such capacity or arising out of his status
II-1
<PAGE>
as such whether or not the corporation would have the power to indemnify him
against such liabilities under such Section 145.
Section 102(b)(7) of the DGCL provides that a corporation in its original
certificate of incorporation or an amendment thereto validly approved by
stockholders may eliminate or limit personal liability of members of its board
of directors or governing body for breach of a director's fiduciary duty.
However, no such provision may eliminate or limit the liability of a director
for breaching his duty of loyalty, failing to act in good faith, engaging in
intentional misconduct or knowingly violating a law, paying a dividend or
approving a stock repurchase which was illegal, or obtaining an improper
personal benefit. A provision of this type has no effect on the availability of
equitable remedies, such as injunction or rescission, for breach of fiduciary
duty. The Company's Restated Certificate of Incorporation contains such a
provision.
The Company's Restated Certificate of Incorporation provides that, to the
extent not prohibited by law, the Company shall indemnify any person who is or
was made, or threatened to be made, a party to any threatened, pending or
completed action, suit or proceeding (a "Proceeding"), whether civil, criminal,
administrative or investigative, including, without limitation, an action by or
in the right of the Company to procure a judgment in its favor, by reason of the
fact that such person, or a person of whom such person is the legal
representative, is or was a director or officer of the Company, or is or was
serving as a director, officer, employee or agent or in any other capacity at
the request of the Company for any other company, partnership, joint venture,
trust, employee benefit plan or other enterprise (an "Other Entity") while
serving as a director or officer of the Company, against judgments, fines,
penalties, excise taxes, amounts paid in settlement and costs, charges and
expenses (including attorneys' fees and disbursements) actually and reasonably
incurred by such person in connection with such Proceeding if such person acted
in good faith and in a manner such person believed to be in or not opposed to
the best interests of the Company and, with respect to any criminal action or
proceeding, had no reasonable cause to believe his or her conduct was unlawful.
To the extent specified by the Board of Directors of the Company at any time and
to the extent not prohibited by law, the Company may indemnify any person who is
or was made, or threatened to be made, a party to any threatened, pending or
completed Proceeding, whether civil, criminal, administrative or investigative,
including, without limitation, an action by or in the right of the Company to
procure a judgment in its favor, by reason of the fact that such person is or
was an employee or agent of the Company, or is or was serving as a director,
officer, employee or agent or in any other capacity at the request of the
Company for any Other Entity, against judgment, fines, penalties, excise taxes,
amounts paid in settlement and costs, charges and expenses (including attorneys'
fees and disbursements) actually and reasonably incurred by such person in
connection with such Proceeding if such person acted in good faith and in a
manner such person believed to be in or not opposed to the best interests of the
Company and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his or her conduct was unlawful. In addition, the
Restated Certificate of Incorporation also permits the Board of Directors to
authorize the Company to purchase and maintain insurance against any liability
asserted against any director, officer, employee or agent of the Company arising
out of his capacity as such.
Pursuant to the Registration Rights Agreement between Continental Grain and
the Company, in connection with any future registration of the shares of Common
Stock held by Continental Grain, Continental Grain has agreed to indemnify,
under certain conditions, the Company, its officers, directors, employees,
agents and each person, if any, who controls the Company within the meaning of
the Securities Act, against certain liabilities.
Pursuant to the Indemnification Agreement between Continental Grain and the
Company, each of Continental Grain and the Company has agreed to indemnify the
other in the event of certain liabilities, including liabilities under the
Securities Act or the Exchange Act.
The form of registration agreement, filed as Exhibit 1.1 hereto, contains
provisions by which the Underwriter agrees to indemnify the Company, its
officers and directors and each person who controls the Company within the
meaning of the Securities Act against certain liabilities.
II-2
<PAGE>
ITEM 16. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------------- -------------------------------------------------------------------------------------------------------
<C> <S>
1.1 Form of Registration Agreement*
5.1 Opinion of Dewey Ballantine*
23.1 Consent of Dewey Ballantine (included in Exhibit 5.1)
23.2 Consent of Arthur Andersen LLP+
24.1 Powers of Attorney, included on signature page+
</TABLE>
- ------------------------
* To be filed by amendment.
+ Filed herewith.
ITEM 17. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "Securities Act"), may be permitted to directors,
officers and controlling persons of the registrant pursuant to the foregoing
provisions, or otherwise, the registrant has been advised that in the opinion of
the Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes:
(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of a
registration statement in reliance upon Rule 430A and contained in the form
of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
(3) For purposes of determining any liability under the Securities Act
of 1933, each filing of the Registrant's annual report pursuant to Section
13(a) or Section 15(d) of the Securities Exchange Act of 1934 (and, where
applicable, each filing of an employee benefit plan's annual report pursuant
to Section 15(d) of the Securities Exchange Act of 1934) that is
incorporated by reference in the registration statement shall be deemed to
be a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form S-3 and has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in The City of New York, New York, on the 15th day of August, 1997.
CONTIFINANCIAL CORPORATION
BY: /S/ JAMES E. MOORE
-----------------------------------------
Name: James E. Moore
Title: President, Chief Executive
Officer and Director
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints James E. Moore, Daniel J. Willett, Jerome M.
Perelson and Alan L. Langus his true and lawful attorneys-in-fact and agents,
each acting alone, with full power of substitution and resubstitution, for him
and his name, place and stead, in any and all capacities, to sign any or all
amendments to this Registration Statement, including post-effective amendments,
and to file the same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorneys-in-fact and agents, full power and authority to do and perform
each and every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in
person, and hereby ratifies and confirms all his said attorneys-in-fact and
agents, each acting alone, or his substitute or substitutes, may lawfully do or
cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, as amended, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
President, Chief Executive
/s/ JAMES E. MOORE Officer and Director
- ------------------------------ (Principal Executive August 15, 1997
James E. Moore Officer)
Senior Vice President and
/s/ DANIEL J. WILLETT Chief Financial Officer
- ------------------------------ (Principal Financial August 15, 1997
Daniel J. Willett Officer)
/s/ SUSAN E. O'DONOVAN Vice President and
- ------------------------------ Controller (Principal August 15, 1997
Susan E. O'Donovan Accounting Officer)
/s/ JAMES J. BIGHAM Director and Chairman of
- ------------------------------ the Board August 15, 1997
James J. Bigham
/s/ PAUL J. FRIBOURG Director
- ------------------------------ August 15, 1997
Paul J. Fribourg
II-4
<PAGE>
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
/s/ JOHN W. SPIEGEL Director
- ------------------------------ August 15, 1997
John W. Spiegel
/s/ DONALD L. STAHELI Director
- ------------------------------ August 15 1997
Donald L. Staheli
/s/ JOHN P. TIERNEY Director
- ------------------------------ August 15, 1997
John P. Tierney
/s/ LAWRENCE G. WEPPLER Director
- ------------------------------ August 15, 1997
Lawrence G. Weppler
/s/ MICHAEL J. ZIMMERMAN Director
- ------------------------------ August 15, 1997
Michael J. Zimmerman
II-5
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------------- -------------------------------------------------------------------------------------------------------
<C> <S>
1.1 Form of Registration Agreement*
5.1 Opinion of Dewey Ballantine*
23.1 Consent of Dewey Ballantine (included in Exhibit 5.1)
23.2 Consent of Arthur Andersen LLP+
24.1 Powers of Attorney, included on signature page+
</TABLE>
- ------------------------
* To be filed by amendment.
+ Filed herewith.
<PAGE>
EXHIBIT 23.2
CONSENT OF ARTHUR ANDERSEN LLP
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference in this registration statement of our report dated May 8, 1997
included in ContiFinancial Corporation's Annual Report on Form 10-K for the year
ended March 31, 1997 and to all references to our Firm included in this
registration statement.
ARTHUR ANDERSEN LLP
New York, New York
August 14, 1997
