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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, 1998
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
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(Commission File Number)
CONTIFINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
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DELAWARE 13-3852588
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(State of other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
277 Park Avenue
NEW YORK, NEW YORK 10172
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(Address of principal executive offices) (Zip Code)
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
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(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
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(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 1, 1998 the aggregate market value of the voting stock held by
non-affiliates of the registrant was $275,495,383.
The Company had 47,068,135 shares of common stock outstanding as of June 1,
1998.
DOCUMENTS 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, 1998.
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CONTIFINANCIAL CORPORATION
TABLE OF CONTENTS
PART I.
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Item 1. Business ........................................................ 3
Item 2. Properties....................................................... 19
Item 3. Legal Proceedings................................................ 19
Item 4. Submission of Matters to a Vote of Security Holders.............. 19
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters.......................................................... 20
Item 6. Selected Financial Data.......................................... 21
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................ 24
Item 7A. Quantitative and Qualitative Disclosures About Market Risk....... 39
Item 8. Financial Statements and Supplementary Data...................... 40
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure......................................... 69
PART III.
Item 10. Directors and Executive Officers of the Registrant............... 70
Item 11. Executive Compensation........................................... 70
Item 12. Security Ownership of Certain Beneficial Owners and Management. 70
Item 13. Certain Relationships and Related Transactions................... 70
PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.. 70
Signatures................................................................ 73
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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, the degree to which
the Company is leveraged, its needs for financing, the Net Interest Margin
Notes market 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.
PART I.
ITEM I. BUSINESS.
GENERAL
ContiFinancial Corporation together with its subsidiaries, (collectively, the
"Company" or "ContiFinancial"), engages in the consumer and commercial
finance business by originating home equity loans, commercial real estate
loans and non-prime auto loans. The Company also provides financing and
asset securitization structuring and placement services to originators of a
broad range of loans, leases, receivables and other assets. The Company is a
leading originator, purchaser, seller and servicer of home equity loans made
to borrowers whose needs may not be met by traditional financial institutions
due to credit exceptions or other factors. Loans are primarily for debt
consolidation, home improvements, education or refinancing and are primarily
secured by first mortgages on one- to four-family residential properties.
For the years ended March 31, 1998 and 1997, the Company originated $6.8
billion and $4.0 billion, respectively, of home equity, home improvement and
other residential mortgage loans, and securitized or sold $6.7 billion and
$3.8 billion, respectively, of such loans. For the same periods, the
Company originated $1.9 billion and $632.5 million, respectively, and
securitized or sold $1.5 billion and $742.3 million, respectively, of
commercial real estate loans, and originated $192.0 million and $47.0
million, respectively, of non-prime auto loans through its subsidiary, Triad
Financial Corporation ("Triad"), and securitized $178.0 million and $43.5
million, respectively, of Triad auto loans.
Through the years the Company's home equity business has expanded through
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 Corporation ("ContiMortgage") and ContiWest Corporation
("ContiWest") is able to focus exclusively on expanding the volume of loans
originated or purchased, enhancing loan underwriting efficiencies and
building ContiMortgage's 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, 1998, ContiMortgage
completed 31 Real Estate Mortgage Investment Conduit ("REMIC")
securitizations and as of March 31, 1998, ContiMortgage had a servicing
portfolio of $10.1 billion.
The Company, through investments, strategic acquisitions and internal growth,
is continually pursuing opportunities to expand the origination capabilities
of its current asset classes and diversifying into the origination and
servicing of other under-served, securitizable asset classes. This is
demonstrated by changes in the composition of the Company's revenues in
fiscal 1998. ContiMortgage/ContiWest securitizations, which
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provided the Company with 74.7% of its gain on sale of receivables in fiscal
1997, represented 57.6% of gain on sale during the current fiscal year.
Income from other home equity/home improvement sales and fees increased to
21.4% of gain on sale in fiscal 1998 from 13.6% in fiscal 1997. These
increases were indicative of the continued growth of the Company's retail
origination platform. Commercial real estate loan sales and securitizations
produced 11.9% of total gain on sale in fiscal 1998, up from 7.8% in fiscal
1997.
In fiscal 1997, the Company acquired 100% of three home equity companies,
California Lending Group, Inc., d/b/a United Lending Group ("ULG"), Resource
One Consumer Discount Company, Inc. ("Resource One"), Royal Mortgage
Partners, L.P., d/b/a Royal MortgageBanc ("Royal") and 56% of an auto finance
company, Triad. Also during fiscal 1997, the Company organized ContiWest, a
Nevada corporation, to better administer and underwrite the Company's
origination portfolio. In fiscal 1998, the Company acquired the remaining
44% of Triad and 100% of two additional home equity companies, Fidelity
Mortgage Decisions Corporation ("Fidelity") and Crystal Mortgage Company,
Inc. ("Crystal") along with its subsidiary Lenders M.D., Inc. In each case,
the companies acquired were former Strategic Alliances or ContiMortgage loan
origination sources.
In fiscal 1998, the Company acquired a 24% interest in Empire Funding Holding
Corp., ("Empire") a long-term strategic alliance that is one of the largest
high loan-to-value and F.H.A. Title I lenders in the United States. Upon
closing, the Company's majority shareholder, Continental Grain Company
("Continental Grain"), exchanged a warrant for a 25% equity interest in
Empire. The Company also established new business units during 1998 focusing
on small ticket equipment lease financing services and the securitization of
charged-off credit card and other consumer debt.
Towards diversifying into other securitizable asset classes, the Company, in
February 1998, through its subsidiary ContiAsset Receivables Management LLC
("CARMA"), acquired Pacific Advisory Services LLC, a
California-based firm specializing in sourcing, pricing and acquiring
charged-off consumer receivable portfolios. CARMA made a 33% equity
investment in Arrow Service Bureau, Inc., a midwest-based accounts receivable
management firm specializing in the collection of charged-off consumer
receivables to service and collect the charged-off consumer debt sourced by
CARMA. Also, in January 1998, the Company formed ContiBusiness Services
Corporation d/b/a ContiLeasing Corporation ("ContiLeasing"). ContiLeasing is
80% owned by the Company and will provide equipment financing solutions to
small businesses nationwide, targeting relationships with equipment
manufacturers and dealers to develop customized financing programs.
Since fiscal 1996, the Company's commercial real estate loan originations,
made through ContiMAP-Registered Trademark-, the Company's commercial real
estate conduit, have increased at an annual compound growth rate of 128% to
$1.9 billion. The Company purchases and underwrites commercial real estate
loans suitable for securitization and sale into the capital markets. 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. As part of this strategy, in April 1998, the Company
acquired a 75% interest in Keystone Mortgage Partners L.L.C. an originator
and servicer of commercial mortgage loans. In March 1998, the Company also
expanded its commercial mortgage business by investing in convertible
preferred stock and warrants of Crown NorthCorp, Inc. ("Crown"). The
preferred stock, when converted, together with the warrants, when exercised,
will represent 7% of the common stock of Crown. Crown is an international
financial services firm which originates commercial mortgages and provides
asset management and loan servicing capabilities.
As previously noted, 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 and ContiWest'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"). Understanding
the cash flow and credit characteristics associated with each of the asset
classes with which it works, ensuring that each pool of
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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 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
("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'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, 1998: twelve commercial/
multi-family securitizations and sales for $2.5 billion, twenty-eight home
equity loan securitizations and sales representing $2.3 billion (other than
ContiMortgage/ContiWest), twenty equipment lease securitizations for $1.5
billion, five adjustable rate mortgage securitizations for $642 million,
eight Title I home improvement loan securitizations for $384 million, seven
non-prime and sub-prime auto securitizations for $380 million, six franchisee
loan securitizations for $312 million and two other securitizations for $50
million.
HOME EQUITY LOAN ORIGINATION AND SERVICING
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, can have a fixed or adjustable interest rate and is typically
secured by a first mortgage on the borrower's residence. Currently, over
93.5% of ContiMortgage/ContiWest loan 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 obtains its loans through two primary sources in 50 states:
wholesale, which represents loans purchased from mortgage bankers and
commercial banks; and retail which represents loans make directly to
customers.
For fiscal year 1998, wholesale purchases accounted for approximately 81% of
the Company's loan production. Wholesale sources underwrite loans to
ContiMortgage and ContiWest's underwriting guidelines and fund those loans in
their own name and 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 those associated with direct
retail loans which are originated on a loan-by-loan basis. For fiscal 1998,
ContiMortgage and ContiWest purchased loans from approximately 254 wholesale
sources, with no one source accounting for more than 10% of total home
equity,
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home improvement and other residential mortgage loans and the top five
wholesale sources accounting for 20.7% of total home equity, home improvement
and other residential mortgage loan production.
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 significant 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 $40,000. 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 collateral 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
90%. 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.
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
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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 benefit from the
reduced cost of funds and greater leverage provided through securitization.
Through March 31, 1998, the Company has completed 31 ContiMortgage/ContiWest
AAA/Aaa-rated REMIC securitizations. Management has structured the Company's
operations and processes specifically for the purpose of efficiently
originating, underwriting, and servicing 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. See "Gain on Sale
of Receivables and Excess Spread Receivables" in Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations
for further discussion of the Company's securitization procedures.
The purchasers of the pass-through certificates receive a credit-enhanced
security. Credit enhancement is generally achieved by the Company's
subordination of its Excess Spread in the form of over collateralization or
by one or both of the following: (i) subordination of subsidiary classes of
bonds to senior classes; and (ii) an insurance policy provided by an
AA/Aaa-rated monoline insurance company. As a result, each offering of the
senior class of 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.
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 not been any
writedowns of subordinated classes of bonds or any calls on monoline
insurance company policies obtained in any of the Company's
ContiMortgage/ContiWest securitizations.
LOAN SERVICING
OVERVIEW. The Company retains the right to service the home equity loans
originated or purchased and included in ContiMortgage/ContiWest
securitizations. 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, 1998, ContiMortgage serviced 157,365 loans in 50
states with an outstanding balance of $10.1 billion, up 57.8% from March 31,
1997 earning a servicing fee of approximately 50 basis points per annum.
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ContiMortgage has 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.
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.
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, current excess spread, the related reserve account,
out of principal and interest payments on over collateralized amounts or, if
necessary, from the related monoline insurance company policy.
COLLECTIONS. The ContiMortgage collection department is organized into
divisions each led by a collections or a default manager. The collection
divisions are comprised of teams 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. The default divisions are
comprised of teams of foreclosure and bankruptcy coordinators assigned
different geographic regions and REO and property preservation units assigned
the task of monitoring and preserving collateral values. If a property is
acquired through foreclosure, the Company will market the property for
liquidation and recovery.
During fiscal 1998, the Company's loss mitigation team further developed its
loss mitigation strategy. This strategy includes, in certain circumstances,
the identification of individual defaulted loans and repossessed properties
to be purchased out of its REMICs. After buying these assets out of the
REMICs, they are resolved using loss mitigation techniques which may include
sales to third party investors. This process, while successfully meeting the
Company's goal of reducing loss severity and improving long term REMIC and
residual loss performance, did have the effect during fiscal 1998 of
accelerating losses. For the Company's fiscal years ended March 31, 1998 and
1997, accelerated losses were 26 basis points and 8 basis points,
respectively. See "Defaults and Losses" in Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations for further
discussion.
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 emphasizes 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.
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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 property preservation unit
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.
See Item 6. Selected Financial Data for information regarding the ContMortgage
Servicing portfolio's delinquencies, defaults and loan loss experience.
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The following chart outlines certain parameters of the credit grades of
ContiMortgage's and ContiWest's current underwriting guidelines:
DESCRIPTION OF CREDIT GRADES
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"A" CREDIT GRADE "B" CREDIT GRADE "C" CREDIT GRADE "D" CREDIT GRADE
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GENERAL Has good credit Pays the Marginal credit Designed to
REPAYMENT but might have majority of history which provide a
some minor accounts on is offset by borrower with
delinquency. time but has other positive poor credit
some 30- and/or attributes. history an
60-day opportunity to
delinquency. correct past
credit problems
through lower
monthly
payments.
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EXISTING Current at Current at Cannot exceed Must be paid in
MORTGAGE LOANS application application four 30-day full from loan
time and a time and a delinquencies proceeds and no
maximum of two maximum of or one 60-day more than 119
30-day three 30-day delinquency in days'
delinquencies delinquencies the past 12 delinquency.
in the past 12 in the past 12 months.
months. months.
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NON-MORTGAGE Major credit Major credit Major credit Major and minor
CREDIT and installment and installment and installment credit
debt should be debt can debt can delinquency is
current but may exhibit some exhibit some acceptable, but
exhibit some minor 30-and/or minor 30-and/or must
minor 30-day 60-day 90-day demonstrate
delinquency. delinquency. delinquency. some payment
Minor credit Minor credit Minor credit regularity.
may exhibit may exhibit up may exhibit
some minor to 90-day more serious
delinquency. delinquency. delinquency.
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BANKRUPTCY Charge-offs, Discharged more Discharged more Discharged
FILINGS judgments, than two years than two years prior to
liens, and with with closing.
former reestablished reestablished
bankruptcies credit. credit.
are
unacceptable.
- --------------------------------------------------------------------------------------------------
DEBT SERVICE- Generally not Generally not Generally not Generally not
TO-INCOME to exceed 45%. to exceed 50%. to exceed 50%. to exceed 50%.
RATIO
- --------------------------------------------------------------------------------------------------
MAXIMUM LOAN-
TO-VALUE RATIO:
- --------------------------------------------------------------------------------------------------
OWNER OCCUPIED Generally 80% Generally 80% Generally 75% Generally 65%
(or 90%) for a (or 85%) for a (or 85%) for a (or 70%) for a
1 to 4 family 1 to 4 family 1 to 4 family 1 to 4 family
dwelling dwelling dwelling dwelling
residence; 75% residence; 75% residence; 70% residence.
for a for a for a
condominium. condominium. condominium.
- --------------------------------------------------------------------------------------------------
NON-OWNER Generally 75% Generally 70% Generally 65% N/A
OCCUPIED for a 1 to 2 for a 1 to 2 for a 1 to 2
family family family
dwelling or dwelling or dwelling or
condominium, 70% condominium 65% condominium 60%
for a 3 to 4 for a 3 to 4 for a 3 to 4
family. family. family.
- --------------------------------------------------------------------------------------------------
</TABLE>
10
<PAGE>
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 ContiTrade and ContiFinancial
Services, the Company provides financing and asset securitization services to
its subsidiaries and Strategic Alliance Clients. ContiTrade provides
financing and structuring of asset-backed securities. ContiFinancial
Services, a 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.
TARGETING OPPORTUNITIES
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.
CLIENT SERVICES
The Company provides warehouse financing, whole loan purchasing, hedging,
credit enhancement and Excess Spread Receivables financing services to the
Company's subsidiaries, equity investments and 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, 1998, through ContiTrade, the
Company had committed $1.7 billion of financing to its third party clients
and equity investments, of which $848 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 up to 90
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
11
<PAGE>
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 Company will receive ownership
participations either in the Strategic Alliance Clients or in the portfolio
of loans securitized. As of March 31, 1998, the total committed amount of
such financing was $42.0 million and the amount outstanding of such financing
was $26.3 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, 1998, the Company has
structured or placed $22.0 billion of securitized assets representing 123
transactions for ContiMortgage, Triad 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 $6.0 billion shelf registration
statement with the Securities and Exchange Commission (the "Commission") with
$5.0 billion available at March 31, 1998 to securitize certain asset-backed
securities.
12
<PAGE>
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 ("FACILITIES")
As of March 31, 1998, the Company had $2.8 billion of committed and an
additional $3.1 billion of uncommitted sale capacity under its Facilities.
The 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 $18.7 billion, $7.4 billion and $5.7
billion, in the fiscal years 1998, 1997 and 1996, respectively. As of March
31, 1998, the Company had utilized $1.0 billion of the sale capacity under
the Facilities.
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.
The following table illustrates the Company's securitizations and sales
volume:
The Company's Securitizations and Sales
Volume by Asset Classes
<TABLE>
<CAPTION>
Years Ended March 31, Total By
---------------------------------------------------------- Asset
1998 1997 1996 1995 1994 Class
(in millions) -------- -------- --------- ---------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Home equity, home improvement and other
residential mortgage loans:
ContiMortgage/ContiWest securitizations.............. $ 6,150 $ 3,454 $ 2,030 $ 1,259 $ 733 $ 13,626
Other home equity, home improvement and
other residential mortgage sales.................. 596 586 755 374 99 2,410
---------- ---------- -------- ---------- --------- ----------
Total home equity, home improvement and
other residential mortgage sales (1).............. $ 6,746 $ 4,040 $ 2,785 $ 1,633 $ 832 $ 16,036
Commercial real estate mortgage loans .................... 1,498 742 186 89 -- 2,515
Non-prime and sub-prime auto loans and leases............. 309 91 162 39 -- 601
ARMs ..................................................... -- -- 505 101 36 642
Equipment leasing......................................... 46 250 190 179 178 843
Title I home improvement loans............................ 139 -- -- 149 96 384
Franchisee loans.......................................... 21 145 98 48 312
Other..................................................... 30 -- 20 -- -- 50
---------- ---------- -------- ---------- --------- ----------
Total securitization volume............................... $ 8,768 $ 5,144 $ 3,993 $ 2,288 $ 1,190 $ 21,383
---------- ---------- -------- ---------- --------- ----------
---------- ---------- -------- ---------- --------- ----------
</TABLE>
- ---------------
(1) Includes Strategic Alliances' sales.
HOME EQUITY, HOME IMPROVEMENT AND OTHER RESIDENTIAL MORTGAGE LOANS. The Company
leveraged its financing capabilities and structured finance expertise by
acquiring ContiMortgage in 1990 and establishing
13
<PAGE>
Strategic Alliances with other clients in the home equity loan industry. In
addition to providing its financing, hedging and securitization services to
ContiMortgage, the Company also provided its services to other clients.
COMMERCIAL REAL ESTATE MORTGAGE 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 $150,000 to $40 million
loans secured by commercial properties, such as multi-family dwellings, self
storage facilities, assisted living and other health related facilities,
retail and industrial buildings. Since fiscal 1996, the Company's commercial
real estate loan securitizations, made through ContiMAP-Registered
Trademark-, the Company's commercial real estate conduit, has increased at an
annual compound growth rate of 156% to $1.5 billion.
ContiMAP-Registered Trademark- purchases commercial real estate loans
suitable for securitization and sale into the capital markets. The Company
underwrites the loans and manages the aggregation 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. As part of this strategy, in April 1998, as previously
discussed, the Company acquired a 75% interest in Keystone Mortgage Partners
L.L.C. an originator and servicer of commercial mortgage loans. In March
1998, the Company also expanded its commercial mortgage business by investing
in convertible preferred stock and warrants of Crown NorthCorp, Inc.
("Crown"). The preferred stock, when converted, and the warrants, when
exercised will represent 7% of the common stock of Crown. Crown is an
international financial services firm which originates commercial mortgages
and provides asset management and loan servicing capabilities.
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.
In Fiscal 1997, the Company purchased 56% 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 and in fiscal
1998, the Company purchased the remaining 44% of the common stock of Triad.
As of March 31, 1998, Triad has relationships with over 2,000 dealerships in
28 states, with California representing approximately 34% of loan
originations. As with ContiMortgage, Triad utilizes centralized origination,
underwriting and servicing techniques.
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.
ADJUSTABLE RATE MORTGAGES. The Company established an Adjustable Rate
Mortgage Conduit ("ARM Conduit") in 1994. 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.
14
<PAGE>
EQUIPMENT LEASING. The equipment leasing industry is a highly fragmented
industry where leases of a wide array of equipment are made 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. In January 1998, the Company formed ContiLeasing to provide
equipment financing solutions to small businesses nationwide, targeting
relationships with equipment manufacturers and dealers to develop customized
financing programs.
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's, wholly-owned subsidiary ULG and Empire, in which the Company
owns a minority interest, also originate Title I and conventional home
improvement loans through retail origination channels.
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.
WARRANTS AND STOCK OWNERSHIP
In certain of its Strategic Alliances, the Company may receive Strategic
Alliance Equity Interests. 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 1998, the Company received $1.1 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.
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
15
<PAGE>
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 certain mortgage loans 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 Riegle Act imposes 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 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.
EQUAL CREDIT OPPORTUNITY ACT OF 1974, as amended ("ECOA"), 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.
THE REAL ESTATE SETTLEMENT PROCEDURES ACT ("RESPA") and Regulation X are
designed to protect borrowers against abusive practices, such as kick-backs
and hidden fees, and to provide additional disclosures so borrowers know the
nature and cost of the real estate settlement process, including escrow
payments.
16
<PAGE>
THE HOME MORTGAGE DISCLOSURE ACT ("HMDA") and Regulation C enables the
government and regulators to determine whether financial institutions are
serving the housing needs of their communities, assist public officials in
distributing public sector investments so as to attract private investment to
where there is economic decline, assist in identifying possible
discriminatory lending practices and enforce nondiscrimination statutes.
Regulation C requires lenders to collect and report certain information
about applicants including : loan type, loan purpose, loan amount, credit
decision, location of the property, race, sex and income of the applicant.
HMDA requires lenders to place notices in certain public locations regarding
the availability of its reporting data.
THE FAIR CREDIT REPORTING ACT ("FCRA") is designed to regulate the consumer
reporting industry. It places disclosure obligations on the users of
consumer credit reports and is designed to ensure fair, timely, and accurate
reporting of credit information. FCRA also restricts the use of consumer
credit reports and in certain circumstances requires the deletion of obsolete
information.
THE FAIR DEBT COLLECTION PRACTICES ACT ("FDCPA") generally specifies the
manner in which debt collectors may pursue debtors to receive payment for
outstanding obligations including but not limited to communication regarding
a debt, harassment or abuse, unfair practices or false or misleading
representations.
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.
Also, 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
17
<PAGE>
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
See "Competition" in Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations for discussion of the Company's
competition.
EMPLOYEES
At March 31, 1998 the Company had 2,881 employees. None of the Company's
employees are represented by a labor union. The Company believes that its
relations with its employees are good.
18
<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. In
addition, the Company also occupies office space at another location in New
York, New York and a location in Santa Monica, California under leases with
third parties that expires in October 1999 and September 1999, respectively.
ContiMortgage's headquarters are in Hatboro, Pennsylvania, and has offices
located in Phoenix, Arizona; Orange and Pleasanton, California; Maitland,
Florida; Atlanta, Georgia; Oak Brook, Illinois; Carmel, Indiana; Bridgewater,
New Jersey; Charlotte, North Carolina; Horsham, Pennsylvania and Irving,
Texas. These properties are operated under leases with third parties that
expire through August 2009.
ContiWest, ULG, Resource One, Royal, Triad, Fidelity, Crystal, ContiLeasing
and CARMA have various offices throughout the United States and operate under
various leases with third parties that expire through December 2003.
The Company believes that its present facilities are adequate for its current
needs.
ITEM 3. LEGAL PROCEEDINGS.
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.
19
<PAGE>
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's common stock is traded under the symbol "CFN" on the New York
Stock Exchange. The following table sets forth, for the periods indicated, the
high and low closing sale price per share of the Company's common stock:
<TABLE>
<CAPTION>
SALES PRICE
------------------------------
HIGH LOW
----------- ----------
<S> <C> <C>
Fiscal Year Ended March 31, 1998:
First Quarter $36.8750 $26.5000
Second Quarter $40.3125 $31.0000
Third Quarter $32.3750 $23.7500
Fourth Quarter $32.1875 $18.3125
Fiscal Year Ended March 31, 1997:
First Quarter $33.0000 $28.5000
Second Quarter $30.2500 $23.2500
Third Quarter $39.2500 $28.8750
Fourth Quarter $39.3750 $31.0000
</TABLE>
As of June 1, 1998, the Company had 101 stockholders of record, and
approximately 6,150 beneficial owners of its common stock.
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 loan agreements restrict the payment
of dividends by the Company. If these covenants are still in place at the
time the Company decides to declare a dividend, a waiver from the related
lenders would have to be obtained. In addition, there can be no assurance
that dividends will be permitted under applicable law.
20
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
SELECTED FINANCIAL DATA
(in thousands, except share data)
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Gross income
Gain on sale of receivables $ 311,606 $ 210,861 $ 146,529 $ 67,512 $ 49,671
Interest 236,494 161,402 91,737 42,929 20,707
Net servicing income 90,509 46,340 29,298 9,304 3,989
Other income 21,553 9,227 4,252 2,252 162
----------- ----------- ----------- ----------- -----------
Total gross income 660,162 427,830 271,816 121,997 74,529
----------- ----------- ----------- ----------- -----------
Expenses
Compensation and benefits 161,992 82,170 52,203 23,812 14,674
Interest 165,904 120,636 74,770 29,635 12,124
Provision for loan losses 5,668 3,043 285 1,935 4,499
General and administrative 101,633 44,940 18,022 9,627 7,946
----------- ----------- ----------- ----------- -----------
Total expenses 435,197 250,789 145,280 65,009 39,243
----------- ----------- ----------- ----------- -----------
Income before income taxes and minority interest 224,965 177,041 126,536 56,988 35,286
Income taxes 91,149 71,341 49,096 22,168 13,726
Minority interest in subsidiaries (488) (304) 3,310 8,728 5,076
----------- ----------- ----------- ----------- -----------
Net income $ 134,304 $ 106,004 $ 74,130 $ 26,092 $ 16,484
=========== =========== =========== =========== ===========
Basic earnings per common
share (pro forma for 1996)(1) $ 2.90 $ 2.44 $ 2.01
=========== =========== ===========
Diluted earnings per common
share (pro forma for 1996)(1) $ 2.86 $ 2.40 $ 2.00
=========== =========== ===========
Basic weighted average number of shares
outstanding (pro forma for 1996)(1) 46,330,810 43,361,253 36,942,363
=========== =========== ===========
Diluted weighted average number of shares
outstanding (pro forma for 1996)(1) 46,992,449 44,152,343 37,050,165
=========== =========== ===========
During fiscal 1995 and 1996, the Company paid cash dividends to Continental
Grain of $30,000 and $305, respectively.
<CAPTION>
AS OF MARCH 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Interest-only and residual certificates $ 648,785 $ 445,005 $ 293,218 $ 143,031 $ 94,491
Trade receivables, net 888,905 709,151 352,325 92,050 47,624
Total assets 2,808,579 1,545,798 892,540 327,742 217,856
Due to affiliates 163 36,367 337,734 114,907 49,846
Short-term debt 366,104 25,299 -- -- --
Long-term debt 499,553 498,817 -- -- --
Total liabilities 2,161,642 1,136,726 597,721 243,579 138,513
Minority interest in subsidiaries 629 1,288 -- 16,248 7,520
Stockholders' equity 646,308 407,784 294,819 67,915 71,823
</TABLE>
- -------------------------------
(1) Because of the Company's December 1995 reorganization and changes in
capital structure, per share data for the years ended March 31, 1995 and 1994
is not meaningful.
21
<PAGE>
SELECTED FINANCIAL DATA--(continued)
(in thousands)
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
LOAN ORIGINATIONS:
Home equity, home improvement and other
residential mortgage loans:
Wholesale:
Brokers $ 1,031,465 $ 827,096 $ 505,587 $ 265,535 $ 138,054
Correspondents 4,455,070 2,921,296 1,736,909 1,023,704 642,152
Direct retail 1,321,596 293,842 68,975 38,919 6,548
----------- ----------- ----------- ----------- -----------
Total home equity, home improvement and
other residential mortgage loans 6,808,131 4,042,234 2,311,471 1,328,158 786,754
Commercial real estate mortgage loans 1,873,849 632,524 321,165 158,343 --
Triad auto loans 191,967 47,049 -- -- --
----------- ----------- ----------- ----------- -----------
Total loan originations $ 8,873,947 $ 4,721,807 $ 2,632,636 $ 1,486,501 $ 786,754
=========== =========== =========== =========== ===========
SECURITIZATIONS AND SALES:
ContiMortgage/ContiWest securitizations $ 6,150,000 $ 3,454,259 $ 2,030,000 $ 1,258,919 $ 733,182
Other home equity, home improvement and
other residential mortgage sales 596,132 335,991 270 33,772 39,142
----------- ----------- ----------- ----------- -----------
Total home equity, home improvement
and other residential mortgage sales 6,746,132 3,790,250 2,030,270 1,292,691 772,324
Commercial real estate mortgage loans 1,497,507 742,259 185,980 89,000 --
Triad auto loans 177,985 43,530 -- -- --
Strategic alliances 346,464 568,401 1,776,700 906,000 418,000
----------- ----------- ----------- ----------- -----------
Total securitizations and sales $ 8,768,088 $ 5,144,440 $ 3,992,950 $ 2,287,691 $ 1,190,324
=========== =========== =========== =========== ===========
CONTIMORTGAGE SERVICING PORTFOLIO:
Number of loans serviced (at year end) 157,365 104,568 65,121 38,740 20,146
Serviced loan portfolio (at year end) $10,135,785 $ 6,423,376 $ 3,863,575 $ 2,192,190 $ 1,105,393
Delinquencies:
30-59 days 1.50% 2.18% 1.81% 0.83% 0.45%
60-89 days 0.51% 0.68% 0.47% 0.36% 0.19%
90 days and over 0.35% 0.38% 0.23% 0.45% 0.27%
----------- ----------- ----------- ----------- -----------
Total delinquencies (%) 2.36% 3.24% 2.51% 1.64% 0.91%
=========== =========== =========== =========== ===========
Total delinquencies ($) $ 239,015 $ 208,084 $ 97,082 $ 35,980 $ 10,036
=========== =========== =========== =========== ===========
Defaults:
Foreclosure 2.31% 2.90% 2.42% 0.46% 0.59%
Bankruptcy 1.70% 1.15% 0.74% 0.41% 0.23%
Real estate owned 0.83% 0.52% 0.13% 0.09% 0.05%
Forbearance 0.74% 0.13% 0.25% 0.20% N/A
----------- ----------- ----------- ----------- -----------
Total defaults (%) 5.58% 4.70% 3.54% 1.16% 0.87%
=========== =========== =========== =========== ===========
Total defaults ($) $ 565,238 $ 302,164 $ 136,796 $ 25,486 $ 9,615
=========== =========== =========== =========== ===========
</TABLE>
22
<PAGE>
SELECTED FINANCIAL DATA--(continued)
(in thousands)
Loan Loss Experience on ContiMortgage's
Servicing Portfolio of Home Equity Loans
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Loan loss experience (1):
Average amount outstanding $ 8,166,407 $ 4,845,304 $ 2,858,790 $ 1,663,865 $ 745,351
Net losses:
REMICs and loans held
pending securitization $ 37,600 $ 12,719 $ 3,686 $ 1,308 $ 1,108
Loans and properties
purchased out of REMICs 21,162 3,576 -- -- --
----------- ----------- ----------- ----------- -----------
Total net losses $ 58,762 $ 16,295 $ 3,686 $ 1,308 $ 1,108
=========== =========== =========== =========== ===========
Realized net losses as a percentage
of average amount outstanding:
REMICs and loans held
pending securitization 0.46% 0.26% 0.13% 0.08% 0.15%
Loans and properties
purchased out of REMICs 0.26% 0.08% -- -- --
----------- ----------- ----------- ----------- -----------
Total realized net losses as
a percentage of average
amount outstanding 0.72% 0.34% 0.13% 0.08% 0.15%
=========== =========== =========== =========== ===========
</TABLE>
(1) See "Defaults and Losses" included in Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations for a discussion of
the Company's loss mitigation program.
23
<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. In
addition, this year's report includes a separate section Gain on Sale of
Receivables and Excess Spread Receivables, which should be read in
conjunction with Results of Operations. Certain statements under this caption
constitute "forward-looking statements" under federal securities laws. See
the "Forward-looking Statements" on page 3 of this annual report.
GENERAL
ContiFinancial engages in the consumer and commercial finance business by
originating home equity loans, commercial real estate loans and non-prime
auto loans. ContiFinancial also provides financing and asset securitization
structuring and placement services to originators of a broad range of loans,
leases, receivables and other assets. ContiFinancial is a leading originator,
purchaser, seller and servicer of home equity loans to borrowers whose needs
may not be met by traditional financial institutions due to credit exceptions
or other factors. These loans are primarily for debt consolidation, home
improvements, education or refinancing and are secured primarily by first
mortgages on one- to four-family residential properties.
The Company through ContiTrade Services L.L.C. ("ContiTrade"), a wholly-owned
subsidiary, provides financing and asset securitization structuring
expertise, and through ContiFinancial Services Corporation ("ContiFinancial
Services"), a wholly-owned subsidiary, provides placement services.
ContiTrade's management and execution of the Company's financing, hedging and
securitization needs serve as a model for the Company's "Strategic Alliances"
with originators of a broad range of consumer and commercial loans and other
assets. The Company offers Strategic Alliances complete balance sheet
liability management, including warehouse financing, interest rate hedging
services and structuring and placement of asset portfolios in the form of
asset-backed securities.
The Company, through investments and strategic acquisitions, as well as
through internal growth, has continued to expand and diversify its
businesses. Within its core home equity business, the Company has developed a
significant retail origination platform to complement its established
wholesale origination capabilities. Acquisitions of retail home equity loan
originators are discussed below. The retail origination subsidiaries provide
a source of cash revenues through loan origination points and fees and whole
loan sales. Significant growth in origination volume has been accompanied by
infrastructure investments that have enhanced and expanded ContiMortgage
Corporation's ("ContiMortgage") home equity loan servicing capacity, which
represents another source of cash income to the Company. With a managed
portfolio of $10.1 billion at March 31, 1998, ContiMortgage is among the
largest originators and servicers of non-conforming home equity loans. In
addition to expanding its retail origination capabilities, the Company has
expanded home equity loan originations through its broker network, which
represents a lower cost source of origination volume. Originations from
direct retail operations and brokers were $2.4 billion in fiscal 1998, or
34.6% of total home equity, home improvement and other residential mortgage
loan origination volume. This compares with $1.1 billion, or 27.7% of total
originations in fiscal 1997.
The Company's commercial real estate activities have grown considerably over
the past three years. Notable developments with respect to this business
include the April 1998 acquisition of a 75% interest in Keystone Mortgage
Partners L.L.C. and the June 1997 acquisition of a minority interest in First
Security Commercial Mortgage, L.P. As a consequence of its relatively low
level of operating expenses, commercial real estate's contribution to the
Company's pre-tax earnings exceeded 15% in fiscal 1998.
24
<PAGE>
In fiscal 1997, the Company acquired 100% of three home equity companies,
California Lending Group, Inc., d/b/a United Lending Group ("ULG"), Resource
One Consumer Discount Company, Inc. ("Resource One"), Royal Mortgage
Partners, L.P., d/b/a Royal MortgageBanc ("Royal") and 56% of an auto finance
company, Triad Financial Corporation ("Triad"). Also during fiscal 1997, the
Company organized ContiWest Corporation ("ContiWest"), a Nevada corporation,
to better administer and underwrite the Company's origination portfolio. In
fiscal 1998, the Company acquired the remaining 44% of Triad and 100% of two
additional home equity companies, Fidelity Mortgage Decisions Corporation
("Fidelity") and Crystal Mortgage Company, Inc. ("Crystal") along with its
subsidiary Lenders M.D., Inc. ("Lenders"). ULG, Resource One, Royal, Triad,
Fidelity and Crystal are collectively referred to herein as the
"Acquisitions". In each case, the companies acquired were former Strategic
Alliances or ContiMortgage loan origination sources.
In fiscal 1998, the Company acquired a 24% interest in Empire Funding Holding
Corp. ("Empire") a long-term strategic alliance that is one of the largest
high loan-to-value and F.H.A. Title I lenders in the United States. The
Company also established new business units during 1998 focusing on small
ticket equipment lease financing services and the securitization of
charged-off credit card and other consumer debt. Upon closing, the Company's
majority shareholder, Continental Grain Company ("Continental Grain"),
exchanged a warrant for a 25% equity interest in Empire.
RESULTS OF OPERATIONS
The Company's development of its retail origination platform has resulted in
a change in the profile of the Consolidated Statements of Income. Retail
origination expenses focus heavily on compensation and benefits and general
and administrative expenses, whereas wholesale origination costs in the form
of origination points, are netted against gain on sale of receivables.
Consequently, the accompanying Consolidated Statements of Income reflect
increases in operating expenses, as well as higher income from origination
points.
YEAR ENDED MARCH 31, 1998 COMPARED TO YEAR ENDED MARCH 31, 1997 AND
YEAR ENDED MARCH 31, 1996
Net income increased $28.3 million or 26.7% to $134.3 million in fiscal 1998
from $106.0 million in fiscal 1997, which in turn increased $31.9 million or
43.0% from net income of $74.1 million in fiscal 1996. The Company's total
gross income increased 54.3% to $660.2 million in fiscal 1998 from $427.8
million in fiscal 1997, which in turn increased 57.4% from $271.8 million in
fiscal 1996.
25
<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,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Gross income
Gain on sale of receivables 47.20% 49.28% 53.91%
Interest 35.82% 37.73% 33.75%
Net servicing income 13.71% 10.83% 10.78%
Other income 3.27% 2.16% 1.56%
------- ------- -------
Total gross income 100.00% 100.00% 100.00%
------- ------- -------
Expenses
Compensation and benefits 24.54% 19.21% 19.21%
Interest 25.13% 28.20% 27.51%
Provision for loan losses 0.86% 0.71% 0.10%
General and administrative 15.39% 10.50% 6.63%
------- ------- -------
Total expenses 65.92% 58.62% 53.45%
------- ------- -------
Income before income taxes and minority interest 34.08% 41.38% 46.55%
Income taxes 13.81% 16.67% 18.06%
Minority interest -0.07% -0.07% 1.22%
------- ------- -------
Net income 20.34% 24.78% 27.27%
======= ======= =======
</TABLE>
See "Gain on Sale of Receivables and Excess Spread Receivables", for a
discussion of year to year changes in the amount and composition of gain on
sale of receivables.
Interest Income and Expense:
In the normal course of its activities, the Company carries inventories of
loans pending sale or securitization and earns a positive spread between the
interest income earned on those loans and its cost of financing those loans.
The Company's sales and securitization volume has increased significantly,
contributing to a concurrent increase in the average level of loans held in
inventory pending securitization. As a result, net interest income has
increased significantly, reaching $70.6 million in fiscal 1998 compared with
$40.8 million in fiscal 1997 and $17.0 million in fiscal 1996. Interest
income also includes accrued interest on Excess Spread Receivables ("ESR").
In addition to the cost of financing loans pending sale or securitization,
interest expense includes the cost of financing the Company's longer term
capital requirements, including the cost of strategic acquisitions. Interest
income increased $75.1 million or 46.5% in fiscal 1998 over fiscal 1997 and
increased $69.7 million or 75.9% in fiscal 1997 over fiscal 1996. Interest
expense increased $45.3 million or 37.5% in fiscal 1998 over fiscal 1997 and
increased $45.9 million or 61.3% in fiscal 1997 over fiscal 1996. During
fiscal 1998, the Company benefited from the expansion and diversification of
its funding sources (see "Liquidity and Capital Resources - Sources of
Liquidity and Capital").
26
<PAGE>
Net servicing Income:
Net servicing income increased $44.2 million or 95.3% in fiscal 1998 over
fiscal 1997 and $17.0 million or 58.2% in fiscal 1997 over fiscal 1996 due to
the increase in the size of the servicing portfolio and the volume of
securitizations. The Company's home equity loan servicing portfolio increased
to $10.1 billion at March 31, 1998 from $6.4 billion at March 31, 1997 and
$3.9 billion at March 31, 1996. Servicing income consists of fee income and
capitalized servicing. The fee income component (which is realized in cash)
represents income earned from Real Estate Mortgage Investment Conduits
("REMICs") and trusts based on the level of loans serviced. The fee income
component of servicing income was $52.8 million in 1998, $30.0 million in
1997 and $17.6 million in 1996. Capitalized servicing consists of servicing
assets recorded in connection with new securitizations (i.e., the present
value of future servicing income, net of expenses), reduced by amortization
of capitalized servicing from prior securitizations. The capitalized
servicing component of servicing income was $37.7 million in 1998, $16.3
million in 1997 and $11.7 million in 1996.
Other income:
Other income increased to $21.6 million in fiscal 1998 from $9.2 million in
fiscal 1997 and $4.3 million in fiscal 1996. Other income consists primarily
of purchase premium refunds, mortgage banking and other fees and for fiscal
1998, income from unconsolidated subsidiaries of $5.4 million. Purchase
premium refunds are received from certain wholesale origination sources when
loans prepay within a specified time period. Purchase premium refunds were
$8.1 million in 1998, $4.6 million in 1997 and $3.9 million in 1996. Mortgage
banking and other fee income was $5.2 million in 1998, $1.9 million in 1997
and $0.2 million in 1996. In addition, income of $1.1 million was received in
fiscal 1998 from the sale of stock warrants in a Strategic Alliance company.
27
<PAGE>
<TABLE>
<CAPTION>
INCREASES OVER
YEAR ENDED MARCH 31, PRIOR YEAR
--------------------------------------- -------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Compensation and benefits:
Acquisitions $ 69,746 $ 16,078 $ -- $ 53,668 $ 16,078
Operations excluding Acquisitions 92,246 66,092 52,203 26,154 13,889
----------- ----------- ----------- ----------- -----------
Total compensation and benefits $ 161,992 $ 82,170 $ 52,203 $ 79,822 $ 29,967
=========== =========== =========== =========== ===========
General and administrative:
Acquisitions $ 49,400 $ 9,434 $ -- $ 39,966 $ 9,434
Operations excluding Acquisitions 52,233 35,506 18,022 16,727 17,484
----------- ----------- ----------- ----------- -----------
Total general and administrative $ 101,633 $ 44,940 $ 18,022 $ 56,693 $ 26,918
=========== =========== =========== =========== ===========
Headcount (at period end):
Acquisitions 1,723 859 -- 864 859
Headcount excluding Acquisitions 1,158 703 455 455 248
----------- ----------- ----------- ----------- -----------
Total headcount 2,881 1,562 455 1,319 1,107
=========== =========== =========== =========== ===========
</TABLE>
Compensation and Benefits and General and Administrative Expenses:
The above table allocates the Company's compensation and benefits, general
and administrative expenses and headcount between the Acquisitions and all
other activities. As noted earlier, the Company has significantly expanded
its retail origination platform, which in turn has resulted in a significant
increase in expenses. From the date of the acquisition of majority ownership,
expenses of the acquired subsidiaries are included in the Company's
consolidated expenses.
As previously discussed and as demonstrated in the table above, the
acquisition of retail origination subsidiaries has resulted in significantly
higher levels of compensation and benefits expense and general and
administrative expenses. With respect to the Company's activities exclusive
of the Acquisitions, the expense increases are indicative of the significant
growth in ContiMortgage's origination volume, its serviced loan portfolio and
the related growth in headcount to support these activities. Combined
compensation and benefits and general and administrative expenses for
ContiMortgage (exclusive of its acquisitions) increased by $27.6 million in
1998 and $20.9 million in 1997. ContiMortgage's headcount (exclusive of its
acquisitions) was 1,059 at the end of fiscal 1998 compared with 629 at the
end of fiscal 1997 and 411 at the end of fiscal 1996. Combined compensation
and benefits and general and administrative expenses for activities other
than ContiMortgage and the Acquisitions increased by $15.3 million in 1998
and $10.5 million in 1997.
Minority Interest:
In fiscal 1996, minority interest was attributable to the 20% minority
shareholders of ContiMortgage prior to the Company's June 19, 1995
acquisition of that interest. In fiscal 1997 and 1998, minority interest was
primarily attributable to the 44% minority shareholders of Triad prior to the
Company's March 1998 acquisition of that interest.
28
<PAGE>
DEFAULTS AND LOSSES:
(SEE "CONTIMORTGAGE SERVICING PORTFOLIO" ON PAGE 22)
ContiMortgage's servicing portfolio has grown considerably. Annual growth in
the portfolio was 98% in fiscal 1995, 76% in fiscal 1996, 66% in fiscal 1997
and 58% in fiscal 1998. Compound annual growth over this four-year period was
74%. As the annual growth rate has slowed and the portfolio has seasoned,
defaults as a percentage of loans outstanding have increased. Included in the
default total at March 31, 1998 were loans performing under bankruptcy plans
and REOs, which represented 0.63% and 0.83%, respectively, of the servicing
portfolio.
Early in the life of a securitization, realized losses are generally very
low. Losses as a percentage of average serviced loans have increased over
time as the portfolio has seasoned and annual growth has decelerated. Losses
in the portfolio are overwhelmingly attributable to the time period a loan
remains in foreclosure status and are primarily a function of interest
foregone on the loans and the deterioration of collateral value over this
time frame. During the course of fiscal 1998, the Company implemented an
aggressive loss mitigation program focused on this issue, with the long-term
objective of a significant reduction in the time period defaulted loans are
held in the serviced portfolio. This program, which includes purchasing loans
and properties out of REMICs for early disposition, results in a near term
acceleration of losses and a longer term mitigation of total potential
losses. These accelerated losses were 8 basis points in fiscal 1997 and 26
basis points in fiscal 1998. The Company anticipates that the continuation of
this program in fiscal 1999 will result in a combination of REMIC losses and
loss mitigation program losses on the order of 75 to 85 basis points as a
percentage of loans serviced (on a trailing 12 month basis). However, due in
part to this acceleration of losses in fiscal 1998 and 1999, the Company
expects a significant reduction in total losses as a percentage of serviced
loans in fiscal 2000 and beyond. As of March 31, 1998, the Company projects
an average annual loss rate over remaining REMIC lives of 62 basis points.
See "Accounting for ESR - Valuation Process and Significant Assumptions" for
information regarding the Company's estimated future credit losses.
GAIN ON SALE OF RECEIVABLES AND EXCESS SPREAD RECEIVABLES
General
A major source of income for the Company is the recognition of gains in
connection with securitizations and whole loan sales. In a whole loan sale,
the Company recognizes a gain and receives cash upon completion of the
transaction. Although whole loan sales represent a growing source of cash
income for the Company, the largest component of the Company's gain on sale
revenues is the securitization of home equity loans originated and serviced
by the Company's wholly-owned subsidiaries, ContiMortgage/ContiWest.
In a typical securitization, the Company sells loans or other assets to a
special purpose entity, established for the limited purpose of buying the
assets from the Company and transferring such assets to a trust, most often a
REMIC. The REMIC issues interest-bearing securities that are collateralized
by the underlying pool of mortgage loans or other assets, as the case may be.
The proceeds are used as consideration to purchase the assets from the
Company. Typically, the securities are sold at an amount that is the same (or
nearly the same) as the underlying mortgage loan amounts and the Company
retains a residual interest that represents its right to receive, over the
life of the securitization, the excess of the weighted average coupon on the
loans securitized over the sum of the interest rate on the securities sold, a
normal servicing fee, a trustee fee, an insurance fee (where applicable) and
the credit losses relating to the loans or other assets securitized (the
"Excess Spread"). In a securitization, the Company may also sell a portion of
this Excess Spread in the form of interest-only ("IO") securities, which are
not exposed to the risk of credit losses.
29
<PAGE>
The ESR is recorded as a receivable at the time of securitization. It is
subsequently realized over the life of the securitization as cash
distributions are received from the trust. ESR, reported as "Interest-only
and residual certificates" in the accompanying Consolidated Balance Sheets,
is the present value of the Excess Spread that the Company expects to receive
over the life of a securitization, taking into consideration estimated
prepayment speeds and credit losses.
As a credit enhancement to support the sale of senior collateralized
securities, the Company's ESR is subordinate to the rights of such holders.
Terms of the REMICs or trusts generally require the establishment of a level
of over-collateralization, based largely on projected cumulative default and
loss levels of the underlying pools of mortgages. The required level of
over-collateralization is attained by utilizing cash flows otherwise
distributable to ESR holders to either pay down outstanding principal of
senior interests or to be placed in segregated deposit accounts. At March 31,
1998, over-collateralization of ContiMortgage/ContiWest REMICs totaled $233.4
million.
GAIN ON SALE OF RECEIVABLES
The following table sets forth the components of gain on sale of receivables
for each of the last three fiscal years:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31, YEAR ENDED MARCH 31, YEAR ENDED MARCH 31,
1998 1997 1996
--------------------- -------------------- ---------------------
(IN THOUSANDS) PERCENT OF PERCENT OF PERCENT OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
------ ---------- ------ ---------- ------ ----------
<S> <C> <C> <C> <C> <C> <C>
Home equity/home improvement:
ContiMortgage/ContiWest
securitizations $ 179,640 57.6% $ 157,483 74.7% $ 110,229 75.2%
Other (including whole
loan sales, origination
points and fees) 66,640 21.4 28,640 13.6 26,886 18.3
--------- ----- --------- ----- --------- -----
Total home equity/home
improvement 246,280 79.0 186,123 88.3 137,115 93.5
Commercial real estate 37,058 11.9 16,420 7.8 3,456 2.4
Auto 20,781 6.7 4,976 2.3 1,467 1.0
Other 7,487 2.4 3,342 1.6 4,491 3.1
--------- ----- --------- ----- --------- -----
Total $ 311,606 100.0% $ 210,861 100.0% $ 146,529 100.0%
========= ===== ========= ===== ========= =====
</TABLE>
Gain on sale of receivables increased to $311.6 million in 1998 from $210.9
million in 1997 and $146.5 million in 1996. Gain on sale of receivables
includes the gain recorded upon the completion of securitizations and whole
loan sales. In a securitization, the gain is significantly affected by the
estimated fair value attributed to the retained ESR (see "Accounting for ESR
- - Valuation Process and Significant Assumptions"). Gain on sale of
receivables also includes unrealized gains or losses that result from the
quarterly adjustment of ESR to fair value, points and fees generated through
direct retail mortgage originations (included in earnings when the loans are
securitized or sold) and fees earned in connection with securitization
services provided to Strategic Alliance clients.
30
<PAGE>
See "Securitizations - Hedging Interest Rate Risk" for a discussion of
the impact of hedging activities on gain on sale of receivables.
Securitizations of home equity loans originated by ContiMortgage/ContiWest
represent the largest component of gain on sale of receivables. Revenues from
ContiMortgage/ContiWest securitizations were $179.6 million in 1998 compared
with $157.5 million in 1997 and $110.2 million in 1996. The gain on sale
percentage (i.e., gain as a percentage of ContiMortgage/ContiWest
securitization volume) was 2.92% in 1998 compared with 4.56% in 1997 and
5.43% in 1996.
The 1998 growth in ContiMortgage/ContiWest gain on sale of receivables was
driven by a 78% increase in securitization volume to $6.1 billion, offset in
part by the lower gain on sale percentage. Approximately 30 basis points of
the 1998 decrease in gain on sale percentage was attributable to a higher
level of premiums paid to acquire loans from wholesale sources. A further
decrease of approximately 30 basis points was the result of a narrowing of
the spread between the weighted average interest rate on mortgage loans
securitized and the pass-through interest rate on securities sold. This was
attributable in part to a further flattening of the U.S. Treasury yield
curve. Declines in long-term mortgage interest rates exceeded declines in the
related pass-through interest rates. The remaining 1998 decrease of
approximately 100 basis points resulted largely from the fair value
adjustment of ESR retained in connection with securitizations prior to fiscal
1998 due to higher prepayment speeds than those used to determine fair value
as of March 31, 1997. On a weighted average basis, the estimated future
Conditional (or Constant) Prepayment Rate ("CPR") on ContiMortgage/ContiWest
REMICs was increased from approximately 24% at the end of fiscal 1997 to
approximately 27% at the end of fiscal 1998. See "Accounting for ESR -
Valuation Process and Significant Assumptions" for further discussion of CPR.
The 1997 increase in ContiMortgage/ContiWest gain on sale over the 1996
amount was driven by a 70% increase in securitization volume, offset in part
by the lower gain on sale percentage. The decrease in the gain on sale
percentage was primarily the result of a tightening in the spread between the
weighted average interest rate on mortgage loans securitized and the
pass-through interest rate on securities sold. A contributing factor was the
flattening of the U.S. Treasury yield curve in fiscal 1997; a decline in
long-term mortgage interest rates was accompanied by an increase in the
related pass-through interest rates.
Cash flow and gain on sale on ContiMortgage/ContiWest securitizations are
reduced by premiums paid to acquire loans from wholesale sources. These
premiums increased in 1998, in both absolute terms and as a percentage of
loans acquired. In fiscal 1998, premiums paid totaled $253.7 million,
compared with $130.9 million in 1997 and $80.5 million in 1996. Cash expended
for premiums in 1998 was largely recovered through the sale of IO securities
in conjunction with the securitizations and Net Interest Margin Notes
("NIMS") subsequent to securitizations. Proceeds of $85.4 million were
generated from IO sales. Fiscal 1998 NIMS sales generated proceeds of $159.7
million.
The Company has taken steps to mitigate its reliance on wholesale loan
sources, primarily through the development, including acquisitions, of its
retail origination platform. In 1998, the Company's direct retail origination
operations represented 19.4% of the Company's total home equity, home
improvement and other residential mortgage loan origination volume, up from
7.3% in 1997. In addition to originating loans for inclusion in
ContiMortgage/ContiWest securitizations, the Company's retail activities
generate cash gains on sale through whole loan sales and origination points
and fees. Gain on home equity whole loan sales, origination points and fees
increased to $66.6 million in 1998 from $28.6 million in 1997 and $26.9
million in 1996.
Over the past three years, the Company has expanded and diversified its
revenue sources beyond the home equity product. Commercial real estate loan
sales and securitizations generated gains on sale of $37.1 million in fiscal
1998, up from $16.4 million in 1997 and $3.5 million in 1996. The vast
majority of gain on
31
<PAGE>
sale resulting from commercial real estate activity is realized in cash upon
completion of the transactions. As discussed in "General", the Company has
significantly expanded this business and expects that commercial real estate
gains on sale, as a percentage of total gains on sale, will continue to
increase.
Gain on sale of receivables in connection with automobile loan
securitizations was $20.8 million in fiscal 1998 compared with $5.0 million
in fiscal 1997 and $1.5 million in 1996. In March 1998, the Company increased
its ownership of Triad, its non-prime automobile loan origination subsidiary,
from 56% (originally acquired in November 1996) to 100%.
SECURITIZATIONS - HEDGING INTEREST RATE RISK
The most significant variable in the determination of gain on sale in a
securitization is the spread between the weighted average coupon on the
securitized loans and the weighted average interest rate on the securities
issued. In the interim period between loan origination and securitization of
such loans, the Company is exposed to interest rate risk. The majority of
loans are securitized within 90 days of origination. However, a portion of
the loans are held for sale or securitization for as long as twelve months
(or longer, in very limited circumstances) prior to securitization. If
interest rates rise during the period that the mortgage loans are held, the
spread between the weighted average interest rate on the loans to be
securitized and the pass-through interest rates on the securities to be sold
(the latter having increased as a result of market interest rate movements)
would narrow. Upon securitization, this would result in a reduction of the
fair value of the retained ESR and the related gain on sale. The Company
mitigates this exposure through short sales of U.S. Treasury securities and
interest rate futures contracts. Hedge gains or losses are initially deferred
and subsequently included in gain on sale upon completion of the
securitization. With respect to ContiMortgage/ContiWest securitizations, gain
on sale included hedge losses of $11.9 million and $5.4 million in fiscal
1998 and 1997, respectively. These hedging activities help mitigate the risk
of absolute movements in interest rates but they do not mitigate the risk of
a change in the spreads between pass-through certificates and U.S. Treasury
securities with comparable maturities.
EXCESS SPREAD RECEIVABLES
At March 31, 1998 and 1997, the Company's ESR portfolio was comprised of the
following :
<TABLE>
<CAPTION>
March 31, Percentage March 31, Percentage
1998 of Total 1997 of Total
---------- ---------- ---------- ----------
(in thousands)
<S> <C> <C> <C> <C>
Home equity:
ContiMortgage/ContiWest $ 555,884 85.7% $ 344,613 77.4%
Other servicers 37,428 5.8 55,890 12.6
---------- ------ ---------- ------
Total home equity 593,312 91.5 400,503 90.0
Home improvement 7,919 1.2 9,868 2.2
Commercial real estate 8,233 1.3 7,966 1.8
Auto 28,223 4.3 7,245 1.6
Leases 8,960 1.4 17,333 3.9
Franchise 2,138 0.3 2,090 0.5
---------- ------ ---------- ------
Total ESR portfolio $ 648,785 100.0% $ 445,005 100.0%
========== ====== ========== ======
</TABLE>
32
<PAGE>
Although ESR does not carry a stated rate of interest, it represents the
present value of an estimated stream of future cash flows. Accordingly, over
the life of the asset, interest income is accrued and, as a result, ESR is
increased. As cash distributions are received, ESR is reduced. The aggregate
value of ESR at March 31, 1998 was $648.8 million, compared with $445.0
million at March 31, 1997. This increase includes $381.0 million in
connection with fiscal 1998 gain on sale (new securitizations and changes in
fair value of prior securitizations) and $52.3 million of accrued interest
income, less $69.8 million of cash received. ESR was further reduced by
$159.7 million in connection with sale of NIMS securities.
ACCOUNTING FOR ESR - VALUATION PROCESS AND SIGNIFICANT ASSUMPTIONS
Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 125,
"Accounting for Transfer and Servicing of Financial Assets and Extinguishment
of Liabilities," the fair value of the retained ESR is accounted for as a
component of sale proceeds. Consequently, the Company recognizes a gain upon
completion of the securitization.
In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities," the Company classifies ESR as "trading securities".
As such, they are carried at fair value in the Consolidated Balance Sheets.
Unrealized changes in ESR fair value are included in the Company's results of
operations (in Gain on sale of receivables) in the period of the change.
The Company has, from time to time, completed sales of ESR, as either sales
with limited recourse or NIMS sales. Nevertheless, there is only a limited
market for ESR. The Company estimates the fair value of ESR through the
application of discounted cash flow analysis, which requires the use of
various assumptions. A significant factor affecting the level of estimated
future ESR cash flows is the rate at which the underlying principal of the
securitized loans is reduced. Prepayments represent principal reductions in
excess of contractually scheduled reductions; prepayment speeds are generally
expressed as an annualized CPR. Estimated future CPR is a significant
assumption in the determination of ESR fair value. Additional assumptions
include estimated future credit losses and the discount rate. A discount rate
of 10% was used to arrive at the fair values presented in the March 31, 1998
and 1997 Consolidated Balance Sheets. The Company continuously monitors the
fair value of ESR and reviews the factors expected to influence future CPR
and credit losses. If changes in assumptions regarding expected future CPR or
credit losses are necessary, ESR fair value is adjusted accordingly.
Both the amount and timing of expected ESR cash flows are dependent on the
performance of the underlying loans, and actual cash flows may vary
significantly from expectations. If actual prepayments or credit losses
exceed the assumptions used to determine ESR fair value, the ESR carrying
value would be reduced through a charge to earnings. (Similarly, actual
prepayment or credit losses that are less than the assumptions used to
determine ESR fair value, would result in an increase in ESR carrying value
and earnings.) Further, assumptions regarding future CPR and credit losses
are subject to volatility that could materially affect operating results.
33
<PAGE>
PREPAYMENT SPEEDS
The following table presents historical data as well as expected future CPR
for ContiMortgage/ContiWest related ESR amounts, which represent 86% of the
Company's total ESR value at March 31, 1998.
<TABLE>
<CAPTION>
REMICS BY YEAR OF ISSUE (A)
---------------------------
(IN MILLIONS)
1994 AND
EARLIER 1995 1996 1997 1998 TOTAL
-------- ---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C> <C>
Pool balances:
Original $ 1,100 $ 1,259 $ 2,030 $ 3,454 $ 6,150 $ 13,993
At March 31, 1998 $ 334 $ 432 $ 881 $ 2,112 $ 5,678 $ 9,437
Fair value of ESR $ 10 $ 10 $ 27 $ 141 $ 368 $ 556
CPR:
Actual life-to-date 20.8% 25.1% 27.8% 29.3% 17.8% 24.8%
Projected for the remaining
pool over its estimated remaining life 23.8% 27.9% 28.2% 28.3% 27.0% 27.3%
</TABLE>
(a) This table includes ContiMortgage/ContiWest REMICs, based on fiscal years
ended March 31.
In developing assumptions regarding expected future CPR, the Company
considers a variety of factors, many of which are inter-related. These
include, among other things, historical performance, characteristics of
borrowers, and market factors that influence competition. For example,
historical performance indicates that the rate of prepayments generally
increases from a low level shortly after loan origination and peaks in
approximately 12 to 15 months. Subsequently, as the loan portfolio "seasons",
the level of prepayments generally declines. This is commonly referred to as
the prepayment "ramp" or "curve". For the most part, the fiscal 1998
securitizations included in the table have not yet reached the expected peak
of the prepayment ramp. Consequently, actual life-to-date CPR for those
transactions is lower than that of the prior years' transactions.
The shape of the prepayment curve (i.e., rate of CPR increase, timing of the
peak, timing and extent of subsequent decline, absolute CPR levels, etc.) may
vary considerably based upon the characteristics of the underlying loans. For
example, in recent years prepayment speeds for variable-rate loans have
exceeded prepayment rates for fixed-rate loans. Specific terms, such as the
existence of prepayment penalties, will further influence prepayment
performance. For various reasons, historical performance may not necessarily
be indicative of future performance. Nevertheless, it is one of many factors
that are considered.
Characteristics of borrowers are an important consideration in determining
CPR assumptions. Credit quality and loan-to-value relationships both have an
impact on the borrower's capacity to refinance. Improvements in borrowers'
credit quality, coupled with an increase in the level of competition among
lenders, has created
34
<PAGE>
opportunities for borrowers to refinance at advantageous terms, for example,
with positive up-front cash flows. Industry competition has intensified, in
part the result of technological improvements that enhance the ability of
lenders to re-solicit borrowers. The Company's analysis of prepayment
performance also considers the historical performance by specific origination
source (e.g., individual correspondents, brokers and retail units).
Factors that influence prepayments range from the very broad (e.g., national
and regional housing market conditions, lenders' access to low cost
financing) to the very specific (e.g., state and local laws regarding the use
of prepayment penalties), and the factors identified in this discussion are
not all-inclusive.
CREDIT LOSSES
Like prepayment assumptions, there are a variety of factors that the Company
considers in determining future credit loss assumptions. Credit losses have a
direct impact on ESR cash flows and, consequently, ESR fair value. The review
of credit exposure considers historical experience, including frequency of
defaults and loss severity (i.e., realized loss as a percentage of liquidated
loan principal). Frequency is influenced by borrower credit quality and
market conditions that may affect the borrower's ability to perform. Loss
severity is influenced by the relationship of loan balances to property value
and, more importantly, the length of the foreclosure and liquidation process.
The following table presents historical credit loss information, as well as
expected future credit losses, for ContiMortgage/ContiWest REMICs, including
loans and properties purchased out of the REMICs. Annual loss rates represent
losses as a percentage of average loan principal outstanding, expressed at an
annualized rate.
ANNUAL LOSS RATES:
Weighted average life-to-date 0.47%
Projected over remaining REMIC lives 0.62%
AGGREGATE LOSSES AS A PERCENT OF ORIGINAL POOL BALANCES:
Actual life-to-date 0.51%
Projected over entire life (i.e., historical plus future losses) 1.84%
Estimated future credit losses (undiscounted) $185 million
Further information on credit losses is included in Selected Financial Data
and "Results of Operations - Defaults and Losses."
LIQUIDITY AND CAPITAL RESOURCES
The following discussion of Liquidity and Capital Resources should be read in
conjunction with the separate discussion of Gain on Sale of Receivables and
Excess Spread Receivables.
FUNDING REQUIREMENTS
The Company requires continued access to short- and long-term sources of
funding. The Company's primary cash requirements include the funding of: (i)
mortgage, loan and lease originations and purchases
35
<PAGE>
pending their pooling and sale; (ii) premiums 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 relating to
the Company's long-term debt and short-term borrowed funds; (viii) the costs
of sales under the Company's asset purchase and sale facilities with certain
financial institutions ("Purchase and Sale Facilities") and funding under an
agreement to repurchase (the "Repurchase Agreement"), collectively, the
"Facilities"; and (ix) the cost of any new acquisitions and subsequent
purchase price adjustments on prior acquisitions.
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 realizes the
Excess Spread, which occurs over the actual lives of the loans or other
assets securitized. Home equity securitizations are cash flow negative upon
their initial execution, primarily as a result of premiums paid to acquire
loans from wholesale sources. For ContiMortgage/ContiWest securitizations in
fiscal 1998, these premiums totaled $253.7 million and were largely recovered
through the sale of IO securities and NIMS totaling $245.1 million.
The Company has taken steps to improve the cash flow characteristics of its
business activities. For example, NIMS and IO sales have accelerated the
monetization of ESR. The Company has increased the relative contribution of
its commercial real estate business which, for the most part, generates cash
gain on sale. Development of the Company's retail home equity origination
platform provides a source of cash income through whole loan sales and
origination points and fees.
Specific cash funding requirements are listed above. In general, cash is
required to fund a) operations - to the extent that they generate negative
cash flow and b) investments - strategic acquisitions and infrastructure
expansion. Operating cash flows consist primarily of the cash components of
gross income and expenses and the cash used to fund trade receivables
including loans held pending sale or securitization, advances to affiliates
and servicing advances.
CASH GROSS INCOME: The principal non-cash components of gross income include
gain on sale attributable to retained ESR, capitalized servicing (net of related
amortization) and equity in undistributed earnings of less than 50% owned
subsidiaries. Interest income includes non-cash interest accrued on ESR. With
respect to ESR, however, cash realization occurs through the receipt of cash
distributions from the REMICs (or trusts) and NIMS and IO sales.
Total gross income of $660.2 million in fiscal 1998 included cash interest
income of $184.2 million, cash servicing income of $52.8 million and other cash
income of $16.1 million. Gain on sale, excluding the ContiMortgage/ContiWest
securitizations was $132.0 million, of which $109.7 million was realized in cash
at the time of the sale or securitization. Net cash flow from
ContiMortgage/ContiWest securitizations, taking into consideration proceeds from
NIMS sales and, at the time of the securitization, IO sales, was negative $40.0
million. Cash distributions on ESR during fiscal 1998 were $69.8 million.
Aggregate cash gross income in fiscal 1998, taking into consideration all of the
aforementioned items, was $392.6 million.
CASH EXPENSES: Most of the Company's expenses represent cash outflows. Total
expenses in fiscal 1998, excluding non-cash deferred compensation and
depreciation and amortization, were $420.7 million.
Trade receivables increased by approximately $180.0 million in fiscal 1998,
while trade receivables sold under agreements to repurchase declined by $6.0
million. Thus, cash required to fund the growth in trade receivables in fiscal
1998 was approximately $186.0 million. Cash required to fund acquisitions and
infrastructure investments totaled $68.6 million in fiscal 1998.
36
<PAGE>
Aggregate cash required to fund trade receivables growth, acquisitions and
infrastructure investments, adjusted for net cash gross income and expenses,
was approximately $280.0 million. Other net cash requirements (e.g., taxes,
shares repurchased, payments of amounts due affiliates, etc.) totaled
approximately $40.0 million. The Company generated cash proceeds of $340.8
million from short-term borrowings and $100.8 million from its common stock
offering. The excess of such proceeds over aggregate cash requirements was
approximately $122.0 million and is reflected as an increase in cash and cash
equivalents in the accompanying Consolidated Balance Sheets. In the normal
course of its activities, the Company must maintain sufficient liquidity to
finance loan acquisitions by its subsidiaries and Strategic Alliance clients.
The increase in cash and cash equivalents was primarily the result of the
timing of loan acquisitions. The Company's financing requirements and cash
balances will vary considerably on a daily basis.
SOURCES OF LIQUIDITY AND CAPITAL
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 its Facilities, the issuance of shares of common stock, the
issuance of long-term debt and short-term borrowed funds.
In previous fiscal years, the Company sold ESR, with limited recourse, to
provide cash to fund the Company's securitization program. Under the recourse
provisions of the agreements, the Company is responsible for losses incurred
by the purchaser within an agreed-upon range. At March 31, 1998 $100.9
million of these sales were outstanding. The Company's performance
obligations in these transactions are guaranteed by Continental Grain for an
agreed-upon fee. Another method of generating liquidity from the ESR is
through the sale of NIMS, which generated proceeds of $159.7 million in
fiscal 1998. Although the Company intends to continue to pursue opportunities
to sell ESR, there is only a limited market for such instruments and no
assurance can be given that such opportunities will be available in the
future.
The Company had $2.8 billion of committed and $3.1 billion of uncommitted
sale capacity under the Facilities as of March 31, 1998. 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 to repurchase the receivables. The Facilities
generally have one year renewable terms (one Purchase and Sale Facility has a
two-year term), all of which will expire between June 1998 and April 1999. As
of March 31, 1998, the Company had utilized $1.0 billion of the capacity
under the Facilities. Although the Company currently anticipates that it will
be able to renew these facilities when they expire and to obtain additional
facilities, there can be no assurance that such financing will be obtainable
on as favorable terms, if at all.
On June 4, 1997, the Company completed a primary offering of 2,800,000 shares
of common stock; 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 for general corporate purposes
including funding loan originations and purchases, supporting securitization
transactions (including the retention of ESR), supporting other working
capital needs and funding strategic acquisitions.
In February 1998, the Company's Board of Directors authorized the purchase up
to one million shares of the Company's outstanding common stock. The
purchased shares will be held in treasury for use in connection with
ContiFinancial's 1995 Long-Term Stock Incentive Plan. Through June 9, 1998,
the Company repurchased 830,000 shares under the plan at an average cost of
$29.05 per share.
37
<PAGE>
On September 9, 1997, the Company initiated a $275 million Commercial Paper
Program, supported by an irrevocable direct-pay letter of credit provided by
a syndicate of banks. At March 31, 1998, $270.7 million of commercial paper
was outstanding.
In anticipation of growth in the Company's operations, additional financing
sources will be required. The Company currently has commitments for financing
through the unsecured revolving credit facility and, in April 1998, issued
$200 million of senior unsecured debt. However, there can be no assurance
that the Company will be successful in obtaining additional financing 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.
See Note 9 to the Consolidated Financial Statements for further discussion of
the Company's short- and long-term borrowings. See Note 13 to the
Consolidated Financial Statements for further discussion of the Company's
sales of assets with recourse and loan warehousing activities.
FINANCIAL POSITION - MARCH 31, 1998 COMPARED WITH MARCH 31, 1997
Trade receivables, net increased $179.8 million from $709.2 million at March
31, 1997 to $889.0 million at March 31, 1998. This increase was primarily due
to a $101.4 million increase in receivables held for sale and a $77.2 million
increase in other receivables. Receivables held for sale fluctuate based upon
the volume of loans originated and the timing of securitizations. The growth
in other receivables was primarily due to a $20.3 million increase in REMIC
advances for delinquent loans made by ContiMortgage on loans serviced and an
increase in receivables from unconsolidated subsidiaries of $47.6 million.
The Company hedges, in part, its interest rate exposure on receivables held
for sale and loans and other assets sold, with limited recourse, through the
use of futures contracts and short sales of United States Treasury
securities. Securities purchased under agreements to resell increased $633.6
million from $224.0 million at March 31, 1997 to $857.6 million at March 31,
1998. Securities sold but not yet purchased increased $622.4 million from
$225.1 million at March 31, 1997 to $847.5 million at March 31, 1998. The
increases in securities purchased under agreements to resell and securities
sold but not yet purchased, which are integral to this hedging strategy,
reflect growth in the level of loans and other assets sold with limited
recourse or held for sale.
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 Company's loan agreements restrict the payment
of dividends by the Company. If these covenants are still in place at the
time the Company decides to declare a dividend, a waiver from the related
lenders would have to be obtained. In addition, there can be no assurance
that dividends will be permitted under applicable law.
YEAR 2000
The "Year 2000" issue involves computer programs and applications that were
written using two digits (instead of four) to describe the applicable year.
Failure to successfully modify such programs and
38
<PAGE>
applications to be Year 2000 compliant would have a material adverse impact
on the Company. Exposure arises not only from potential consequences (e.g.,
business interruption) of certain of the Company's own applications not being
Year 2000 compliant, but the impact of non-compliance by certain significant
counterparties, including Strategic Alliances. The Company has undertaken an
assessment to determine the anticipated costs and remediation of the systems
and applications, either its own or those of material business
counterparties, to make them Year 2000 compliant. These efforts are being
coordinated by a task force whose members include the Company's senior
management and information technology, finance, accounting and legal staffs,
supported by external consultants. At this time, the Company estimates that
the cost of its Year 2000 remediation will be approximately $5.0 million.
This estimate is subject to change as the project progresses. The Company
expects to implement a solution to the Year 2000 issue by March 31, 1999. The
Company presently believes, based on the information obtained during its
assessment of the Year 2000 issue, that the matter will not have a material
adverse impact on its computer systems or operations. The Company will,
however, reassess the expected cost of compliance and the risk that the Year
2000 issue will have a material adverse impact during the modification,
testing and implementation phases of its Year 2000 conversion effort.
COMPETITION
The home equity lender 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. Some 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.
Although the 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 their purchasers of such loans, market
conditions and other factors.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
39
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
CONTIFINANCIAL CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Report of Independent Public Accountants.................................... 41
Consolidated Balance Sheets as of March 31, 1998 and 1997................... 42
Consolidated Statements of Income for the Years Ended March 31, 1998, 1997
and 1996................................................................. 43
Consolidated Statements of Changes in Stockholders' Equity for the Years
Ended March 31, 1998, 1997 and 1996...................................... 44
Consolidated Statements of Cash Flows for the Years Ended March 31, 1998,
1997 and 1996............................................................ 45
Notes to Consolidated Financial Statements.................................. 47
40
<PAGE>
ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of ContiFinancial Corporation:
We have audited the accompanying consolidated balance sheets of
ContiFinancial Corporation (a Delaware corporation) and subsidiaries as of
March 31, 1998 and 1997, 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, 1998. 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
ContiFinancial Corporation and its subsidiaries as of March 31, 1998 and
1997, and the results of their operations and their cash flows for each of
the three years in the period ended March 31, 1998, in conformity with
generally accepted accounting principles.
/s/ Arthur Andersen LLP
New York, New York
May 15, 1998
41
<PAGE>
CONTIFINANCIAL CORPORATION
Consolidated Balance Sheets
as of March 31, 1998 and 1997
(in thousands, except share data)
MARCH 31,
------------------------
1998 1997
ASSETS
Cash and cash equivalents $ 173,588 $ 51,200
Restricted cash 1,147 464
Securities purchased under agreements to resell 857,649 223,962
Trade receivables:
Receivables held for sale 726,990 625,545
Other receivables 164,600 87,353
Allowance for loan losses (2,685) (3,747)
---------- ----------
Total trade receivables, net 888,905 709,151
---------- ----------
Interest-only and residual certificates 648,785 445,005
Capitalized servicing rights 74,292 29,353
Premises and equipment, net of accumulated
depreciation of $7,951 and $4,298 as of
March 31, 1998 and 1997, respectively 18,887 7,789
Cost in excess of equity acquired 55,738 48,200
Equity investments in unconsolidated subsidiaries 53,660 4,080
Other assets 35,928 26,594
---------- ----------
Total assets $2,808,579 $1,545,798
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Accounts payable $ 91,179 $ 71,060
Securities sold but not yet purchased 847,470 225,131
Trade receivables sold under agreements to repurchase 245,556 251,539
Due to affiliates 163 36,367
Short-term debt 366,104 25,299
Taxes payable 81,190 16,710
Long-term debt 499,553 498,817
Other liabilities 30,427 11,803
---------- ----------
Total liabilities 2,161,642 1,136,726
---------- ----------
Commitments and contingencies
Minority interest in subsidiaries 629 1,288
---------- ----------
STOCKHOLDERS' EQUITY:
Preferred stock (par value $0.01 per share;
25,000,000 shares authorized; none issued at
March 31, 1998 and 1997) -- --
Common stock (par value $0.01 per share;
250,000,000 shares authorized; 47,657,539 and
44,390,335 shares issued at March 31, 1998 and
1997, respectively) 477 444
Paid-in capital 399,776 295,029
Retained earnings 262,956 128,652
Treasury Stock (201,209 and 27,931 shares of
common stock, at cost, at March 31, 1998 and 1997,
respectively) (5,794) (586)
Deferred compensation (11,107) (15,755)
---------- ----------
Total stockholders' equity 646,308 407,784
---------- ----------
Total liabilities and stockholders' equity $2,808,579 $1,545,798
========== ==========
The accompanying notes to consolidated financial statements are
an integral part of these statements.
42
<PAGE>
CONTIFINANCIAL CORPORATION
Consolidated Statements of Income
for the years ended March 31, 1998, 1997 and 1996
(in thousands, except share data)
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Gross income:
Gain on sale of receivables $ 311,606 $ 210,861 $ 146,529
Interest 236,494 161,402 91,737
Net servicing income 90,509 46,340 29,298
Other income 21,553 9,227 4,252
----------- ----------- -----------
Total gross income 660,162 427,830 271,816
----------- ----------- -----------
Expenses:
Compensation and benefits 161,992 82,170 52,203
Interest 165,904 120,636 74,770
Provision for loan losses 5,668 3,043 285
General and administrative 101,633 44,940 18,022
----------- ----------- -----------
Total expenses 435,197 250,789 145,280
----------- ----------- -----------
Income before income taxes and minority interest 224,965 177,041 126,536
Income taxes 91,149 71,341 49,096
----------- ----------- -----------
Income before minority interest 133,816 105,700 77,440
Minority interest in subsidiaries (488) (304) 3,310
----------- ----------- -----------
Net income $ 134,304 $ 106,004 $ 74,130
=========== =========== ===========
Basic earnings per common share (pro forma for 1996) $ 2.90 $ 2.44 $ 2.01
=========== =========== ===========
Diluted earnings per common share (pro forma for 1996) $ 2.86 $ 2.40 $ 2.00
=========== =========== ===========
Basic weighted average number of shares
outstanding (pro forma for 1996) 46,330,810 43,361,253 36,942,363
=========== =========== ===========
Diluted weighted average number of shares
outstanding (pro forma for 1996) 46,992,449 44,152,343 37,050,165
=========== =========== ===========
</TABLE>
The accompanying notes to consolidated financial statements are
an integral part of these statements.
43
<PAGE>
CONTIFINANCIAL CORPORATION
Consolidated Statements of Changes in Stockholders' Equity
for the years ended March 31, 1998, 1997 and 1996
(in thousands, except share data)
<TABLE>
<CAPTION>
NUMBER OF SHARES TOTAL
OF COMMON STOCK COMMON PAID-IN RETAINED TREASURY DEFERRED STOCKHOLDERS'
ISSUED TREASURY STOCK CAPITAL EARNINGS STOCK COMPENSATION EQUITY
----- -------- ------ ------- -------- ----- ------------ -------------
<S> <C> <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 -- 33,931 -- -- -- (712) 712 --
Restricted stock awards -- (6,000) -- 88 -- 126 (214) --
Amortization of deferred
compensation -- -- -- -- -- -- 6,721 6,721
---------- ------- ------- -------- -------- --------- --------- ----------
Balance at March 31, 1997 44,390,335 27,931 444 295,029 128,652 (586) (15,755) 407,784
Net income -- -- -- -- 134,304 -- -- 134,304
Common stock issued in
public offering 3,220,000 -- 32 100,746 -- -- -- 100,778
Repurchase of common stock -- 193,700 -- -- -- (5,636) -- (5,636)
Exercise of options 47,204 -- 1 994 -- -- -- 995
Forfeiture of restricted stock -- 15,978 -- -- -- (335) 335 --
Restricted stock awards -- (36,400) -- 364 -- 763 (1,127) --
Amortization of deferred
compensation -- -- -- 2,643 -- -- 5,440 8,083
---------- ------- ------- -------- -------- --------- --------- ----------
Balance at March 31, 1998 47,657,539 201,209 $ 477 $399,776 $262,956 $ (5,794) $ (11,107) $ 646,308
========== ======= ======= ======== ======== ========= ========= ==========
</TABLE>
The accompanying notes to consolidated financial statements are
an integral part of these statements.
44
<PAGE>
CONTIFINANCIAL CORPORATION
Consolidated Statements of Cash Flows
for the years ended March 31, 1998, 1997 and 1996
(in thousands)
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 134,304 $ 106,004 $ 74,130
Adjustments to reconcile net income to net cash used
in operating activities:
Amortization of deferred compensation 5,440 6,721 4,967
Depreciation and amortization 9,106 4,536 1,690
Equity in earnings of unconsolidated subsidiaries (net of
dividends received) (4,919) -- --
Minority interest in subsidiaries (488) (304) 3,310
Provision for deferred taxes 72,449 5,680 3,830
Provision for loan losses 5,668 3,043 285
Net changes in operating assets and liabilities:
(Increase) decrease in restricted cash (683) 156 140
(Increase) decrease in receivables held for sale:
Originations and purchases (35,681,653) (16,094,071) (12,532,051)
Sales and principal repayments 35,581,823 15,774,222 12,304,078
Increase in other receivables (78,071) (34,858) (33,924)
Increase in interest-only and residual certificates (203,780) (150,701) (150,187)
Increase in capitalized servicing rights (44,939) (17,664) (11,689)
Increase (decrease) in accounts payable 17,359 (5,612) 30,786
(Increase) in securities purchased under
agreements to resell less the increase in securities
sold but not yet purchased (11,348) 315 3,887
Increase (decrease) in trade receivables sold under
agreements to repurchase (5,983) 251,539 --
Increase in taxes payable 6,613 13,520 570
Other, net 844 (15,950) (279)
----------- ----------- -----------
Net cash used in operating activities (198,258) (153,424) (300,457)
----------- ----------- -----------
Cash flows from investing activities:
Acquisitions of majority owned subsidiaries
(net of cash acquired) (10,315) (28,277) (34,600)
Acquisitions of minority owned subsidiaries (44,385) -- --
Purchase of property and equipment, net
(13,922) (3,535) (2,643)
----------- ----------- -----------
Net cash used in investing activities (68,622) (31,812) (37,243)
----------- ----------- -----------
(continued)
45
<PAGE>
CONTIFINANCIAL CORPORATION
Consolidated Statements of Cash Flows, continued
for the years ended March 31, 1998, 1997 and 1996
(in thousands)
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from financing activities:
Increase (decrease) in due to affiliates, net (48,156) 17,972 (94,451)
Increase (decrease) in notes payable to affiliates -- (324,000) 324,000
Increase in short-term borrowed funds 340,573 25,000 --
Increase in long-term debt 714 498,423 --
Proceeds from exercise of employee stock options 995 240 --
Debt issuance costs -- (12,982) --
Other, net -- (696) --
Repurchase of common stock (5,636) -- --
Net proceeds from public common stock offerings 100,778 -- 138,113
Dividends paid -- -- (305)
----------- ----------- -----------
Net cash provided by financing activities 389,268 203,957 367,357
----------- ----------- -----------
Net increase in cash and cash equivalents 122,388 18,721 29,657
Cash and cash equivalents at beginning of year 51,200 32,479 2,822
----------- ----------- -----------
Cash and cash equivalents at end of year $ 173,588 $ 51,200 $ 32,479
=========== =========== ===========
</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.
46
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
1. BASIS OF PRESENTATION
ContiFinancial Corporation ("ContiFinancial" or the "Company") was
incorporated in Delaware on September 29, 1995. The accompanying consolidated
financial statements include the accounts of the Company and its majority
owned subsidiaries. All significant intercompany accounts and transactions
have been eliminated in consolidation. 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, liabilities and results of operations. Actual
results could differ from these estimates.
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. ("ContiTrade"), ContiMortgage
Corporation ("ContiMortgage"), all Delaware corporations or limited liability
companies, and ContiFinancial Services Corporation ("ContiFinancial
Services"), a New York corporation.
On February 14, 1996, ContiFinancial completed 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
ContiTrade and the common stock of its subsidiaries, ContiMortgage and
ContiFinancial Services, and its interest-only and residual certificates to
Continental Grain Company ("Continental Grain") and (ii) Continental Grain
transferred all of the common stock of ContiMortgage, ContiFinancial
Services, CSAF and CFC, all of the members' interest held by it in ContiTrade
and CSAF II and the transferred interest-only and residual certificates to
ContiFinancial. As a result, ContiFinancial owns all of the common stock or
members' interests in ContiTrade, ContiMortgage, ContiFinancial Services,
CFC, CSAF and CSAF II (collectively, the "Previous Companies"). Prior to the
IPO, both ContiFinancial and the Previous Companies (exclusive of
ContiMortgage) were direct or indirect wholly-owned subsidiaries of
Continental Grain. On June 19, 1995, CTSC effectively acquired control of the
remaining 20% minority interest of ContiMortgage for $34,600.
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 March 31, 1996 Consolidated Statement of Income and Consolidated
Statement of Changes in Stockholders' Equity include a period prior to the
IPO which has been combined to reflect the Reorganization accounted for
similar to the pooling of interests method. All material intercompany
transactions have been eliminated in the combination. Included are additional
charges and liabilities related to expenses incurred by Continental Grain on
behalf of 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 8).
47
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
2. NATURE OF BUSINESS
The Company, together with its subsidiaries, engages in the consumer and
commercial finance business by originating and servicing home equity loans,
commercial real estate loans and non-prime auto loans. The Company also
provides financing and asset securitization structuring and placement
services to originators of a broad range of loans, leases, receivables and
other assets. The Company considers its business to be one operating segment.
Through ContiMortgage and ContiWest Corporation ("ContiWest"), a Nevada
corporation organized in fiscal 1997, the Company is an 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 loans are 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 securitized
loans are sold on a servicing retained basis. The outstanding principal
balance of ContiMortgage's mortgage servicing portfolio at March 31, 1998 and
1997 was $10,135,785 and $6,423,376, respectively. Through ContiTrade and
ContiMAP(R), the Company's commercial real estate conduit, the Company
finances a wide range of commercial real estate. Through ContiTrade and
ContiFinancial Services, the Company provides other originators ("Strategic
Alliances") 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. In certain of the
Strategic Alliances, the Company receives warrants or warrant-like equity
participations ("Strategic Alliance Equity Interests") in the Strategic
Alliance client. 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 impairment as appropriate.
ContiMortgage is subject to minimum capital requirements imposed by the
states in which it operates, with the highest being $250. In addition,
ContiMortgage 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, ContiMortgage is
required by the Federal National Mortgage Association ("FNMA") to maintain
minimum capital of $250 plus 0.20% of the principal balance of the portfolio
being serviced for FNMA.
ContiFinancial Services is registered as a broker/dealer with the Securities
and Exchange Commission ("SEC") and is subject to the SEC's Uniform Net
Capital Rule 15c3-1, under which the ratio of aggregate indebtedness to net
capital, as defined, may not exceed 15 to 1. At March 31, 1998,
ContiFinancial Services' net capital, as defined, totaled $1,869 which was
$1,769 in excess of the SEC regulatory requirement of $100; its ratio of
aggregate indebtedness to net capital was .3481 to 1.
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.
48
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
INCOME RECOGNITION
See Note 4 for a discussion of "Gain on Sale of Receivables and Interest-Only
and Residual Certificates."
Net servicing income consists of fee income and capitalized servicing. The
fee income component (which is realized in cash) represents income earned
from REMICs and trusts and is based on the level of assets serviced.
Capitalized servicing consists of servicing assets recorded in connection
with new securitizations (i.e., the present value of future servicing income,
net of expenses), reduced by amortization of capitalized servicing from prior
securitizations.
Interest income is recorded as earned. Interest income represents the
interest earned on the loans and leases ("Receivables") during the
warehousing period (the period prior to their securitization) and the accrual
of interest income on the interest-only and residual certificates ("ESR").
Receivables are placed on non-accrual status when they become sixty days past
due. When a Receivable is classified as non-accrual, the accrual of interest
income ceases, and all interest income previously accrued and unpaid on such
Receivable is reversed.
CASH, CASH EQUIVALENTS AND RESTRICTED CASH
The Company considers all highly liquid debt instruments purchased with an
original maturity of no more than three months to be cash equivalents.
Restricted cash includes amounts segregated in connection with the sale of
mortgage loans with limited recourse and amounts specifically designated for
paydowns of warehouse financing.
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 held for sale 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. 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 1998 and, as of March 31,
1998, had interest rates ranging from 4.95% to 5.35%. See Note 13 for a
discussion of the Company's hedging activities.
RECEIVABLES HELD FOR SALE/TRADE RECEIVABLES SOLD UNDER AGREEMENTS TO
REPURCHASE
Receivables held for sale include 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 aggregate cost or market. Market value is determined
by outstanding commitments from investors or current investor yield
requirements, adjusted for deferred hedging gains or losses. The
49
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
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 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 amortized over their estimated life and
assessment of asset impairment be based on such assets' fair value. SFAS 125
was applied to transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996. The
adoption of this standard did not have a material impact on the Company's
results of operations.
OTHER RECEIVABLES
Other receivables consist primarily of advances made to Strategic Alliances to
finance their purchase of ESR, advances to unconsolidated subsidiaries,
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.
CAPITALIZED SERVICING RIGHTS
Upon sale or securitization of servicing retained receivables, the fair value
associated with the right to service such receivables is capitalized. The
Company determines fair value based on the present value of estimated net future
cash flows relating to servicing. This consists of servicing fees received
relating to sold receivables and prepayment penalties, where applicable, reduced
by direct servicing expenses. Capitalized servicing rights are amortized in
proportion to and over the period of estimated net future servicing fee income.
The Company capitalized $63,609 and $25,340 of servicing rights during the years
ended March 31, 1998 and 1997, respectively. During the same periods,
amortization of these assets was $18,670 and $7,676, respectively. At March 31,
1998 and 1997, the carrying value of capitalized servicing rights approximated
fair value. The Company periodically reviews capitalized servicing rights for
valuation impairment. This review is performed
50
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
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 to be 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.
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 twenty years.
COST IN EXCESS OF EQUITY ACQUIRED
Cost in excess of equity acquired represents the excess of investments in
subsidiaries over the net asset value at acquisition, adjusted for subsequent
amortization. Amortization is recorded over the estimated useful life of the
capitalized asset, usually 25 years, on a straight line basis. The Company
evaluates the excess of cost over the equity of businesses acquired for
impairment. No impairment losses have been recognized by the Company.
OTHER ASSETS
Other assets is primarily comprised of prepaid expenses, margin and other
deposits and deferred bond issuance costs.
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 was
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 to adopt a fair value based method of accounting for stock options
as compensation expense over the service period (generally the vesting period)
as defined in the 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 continues to
account for stock based compensation under APB Opinion No. 25.
RECENT ACCOUNTING PRONOUNCEMENTS
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
51
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
comprehensive income and its components in a full set of general-purpose
financial statements. SFAS 130 requires that all 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 will
not 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
fiscal years beginning after December 15, 1997. SFAS 131 establishes
standards for reporting information about operating segments in annual
financial statements and in interim financial reports. It also establishes
standards for related disclosures about products and services, geographic
areas and major customers. The adoption of this standard will not have an
impact on the Company's financial position or results of operations.
PRO FORMA EARNINGS PER COMMON SHARE AND EARNINGS PER COMMON SHARE
Due to the Reorganization and the issuance of common stock in the IPO, basic
and diluted 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. Common shares issued by the Company in the IPO
plus the effect of equivalent common shares under the restricted stock awards
and stock option plans are included in basic and diluted earnings per common
share, as appropriate, from the date of issuance (see Notes 5 and 10).
During fiscal 1998, the Company adopted SFAS No. 128 "Earnings Per Share"
which replaced primary and fully diluted earnings per common share
computations with basic and diluted earnings per common share computations.
The effects of this statement have been applied to previous years' results.
CONSOLIDATED STATEMENTS OF CASH FLOWS--SUPPLEMENTAL DISCLOSURES
Total interest paid was $164,772, $119,223 and $71,539 for the years ended
March 31, 1998, 1997, and 1996, respectively. Total income taxes paid were
$59,684, $45,624 and $896 for the years ended March 31, 1998, 1997 and 1996,
respectively. Through June 4, 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 8). 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 were not
repaid to Continental Grain on a current basis, and as such were not included
in total income taxes paid for the year ended March 31, 1996.
RECLASSIFICATIONS
Certain reclassifications of prior years' amounts have been made to conform to
the current year presentation.
52
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
4. GAIN ON SALE OF RECEIVABLES AND INTEREST-ONLY AND RESIDUAL CERTIFICATES
A major source of income for the Company is the recognition of gains in
connection with securitizations and whole loan sales. In a typical
securitization, the Company sells loans or other assets to a special purpose
entity, established for the limited purpose of buying the assets from the
Company and transferring such assets to a trust, most often a REMIC. The
REMIC issues interest-bearing securities that are collateralized by the
underlying pool of mortgage loans or other assets, as the case may be. The
proceeds are used as consideration to purchase the assets from the Company.
Typically, the securities are sold at an amount that is the same (or nearly
the same) as the underlying mortgage loan amounts and the Company retains a
residual interest that represents its right to receive, over the life of the
securitization, the excess of the weighted average coupon on the loans
securitized over the sum of the interest rate on the securities sold, a
normal servicing fee, a trustee fee, an insurance fee (where applicable) and
the credit losses relating to the loans or other assets securitized (the
"Excess Spread"). In a securitization, the Company may also sell a portion of
this Excess Spread in the form of interest-only securities. In a whole loan
sale, the Company recognizes a gain and receives cash upon completion of the
transaction. Gain on sale of receivables also includes unrealized gain or
losses that result from the quarterly adjustment of ESR to fair value, point
and fees generated through direct retail mortgage originations (included in
earnings when the loans are securitized or sold) and fees earned in
connection with securitization services provided to Strategic Alliance
clients.
ESR is realized over the life of the securitization as cash distributions are
received from the trust. ESR, reported as "Interest-only and residual
certificates" in the accompanying Consolidated Balance Sheets, is the present
value of the Excess Spread that the Company expects to receive over the life
of a securitization, taking into consideration estimated prepayment speeds
and credit losses.
At March 31, 1998 and 1997, the Company's ESR portfolio was comprised of the
following:
March 31, March 31,
1998 1997
---------- ----------
Home Equity:
ContiMortgage/ContiWest $ 555,884 $ 344,613
Other Servicers 37,428 55,890
---------- ----------
Total Home Equity 593,312 400,503
Home Improvement 7,919 9,868
Commercial Real Estate 8,233 7,966
Auto 28,223 7,245
Leases 8,960 17,333
Franchise 2,138 2,090
---------- ----------
Total ESR Portfolio $ 648,785 $ 445,005
========== ==========
53
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
Pursuant to SFAS No. 125, the fair value of the retained ESR is accounted for
as a component of sale proceeds. Consequently, the Company recognizes a gain
upon completion of the securitization.
In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities", the Company classifies ESR as "trading securities."
As such, they are carried at fair value in the Consolidated Balance Sheets.
Unrealized changes in ESR fair value are included in the Company's
Consolidated Statements of Income (in Gain on sale of receivables) in the
period of the change.
The Company has, from or time to time, completed sales of ESR as either sales
with limited recourse or Net Interest Margin Notes sales. Nevertheless, there
is only a limited market for ESR. The Company estimates the fair value of ESR
through the application of discounted cash flow analysis, which requires the
use of various assumptions. A significant factor affecting the level of
estimated future ESR cash flows is the rate at which the underlying principal
of the securitized loans is reduced. Prepayments represent principal
reductions in excess of contractually scheduled reductions; prepayment speeds
are generally expressed as an annualized Conditional (or Constant) Prepayment
Rate ("CPR"). Estimated future CPR is a significant assumption in the
determination of ESR fair value. Additional assumptions include estimated
future credit losses and the discount rate. A discount rate of 10% was used
to arrive at the fair values as of March 31, 1998 and 1997.
The Company continuously monitors the fair value of ESR and reviews the
factors expected to influence future CPR and credit losses. In developing
assumptions regarding expected future CPR, the Company considers a variety of
factors, many of which are inter-related. These include, among other things,
historical performance, characteristics of borrowers (e.g. credit quality and
loan-to-value relationships) and market factors that influence competition.
If changes in assumptions regarding expected future CPR or credit losses are
necessary, ESR fair value is adjusted accordingly.
Both the amount and timing of expected ESR cash flows are dependent on the
performance of the underlying loans, and actual cash flows may vary
significantly from expectations. If actual prepayments or credit losses
exceed the assumptions used to determine ESR fair value, the ESR carrying
value would be reduced through a charge to earnings. (Similarly, actual
prepayment or credit losses that are less than the assumptions used to
determine ESR fair value, would result in an increase in ESR carrying value
and earnings.) Further, assumptions regarding future CPR and credit losses
are subject to volatility that could materially affect operating results.
54
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
The following table presents historical data as well as expected future CPR for
ContiMortgage/ContiWest related ESR, which represent 86% of the Company's total
ESR value at March 31, 1998.
<TABLE>
<CAPTION>
(IN MILLIONS)
REMICS BY YEAR OF ISSUE (A)
1994 AND
EARLIER 1995 1996 1997 1998 TOTAL
-------- ------- ------- ------- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Pool balances:
Original $ 1,100 $ 1,259 $ 2,030 $ 3,454 $ 6,150 $13,993
At March 31, 1998 $ 334 $ 432 $ 881 $ 2,112 $ 5,678 $ 9,437
Fair value of ESR $ 10 $ 10 $ 27 $ 141 $ 368 $ 556
CPR:
Actual life-to-date 20.8% 25.1% 27.8% 29.3% 17.8% 24.8%
Projected for the remaining pool
over its estimated remaining life 23.8% 27.9% 28.2% 28.3% 27.0% 27.3%
</TABLE>
(a) This table includes ContiMortgage/ContiWest REMICs, based on fiscal years
ended March 31.
Like prepayment assumptions, there are a variety of inter-related factors
that the Company considers in determining future credit loss assumptions,
such as historical experience, default frequency, loss severity and the
length of the foreclosure and liquidation process. The following table
presents historical credit loss information, as well as expected future
credit losses, for ContiMortgage/ContiWest REMICs, including loans and
properties purchased out of the REMICs. Annual loss rates represent losses as
a percentage of average loan principal outstanding, expressed at an
annualized rate.
ANNUAL LOSS RATES:
Weighted average life-to-date 0.47%
Projected over remaining REMIC lives 0.62%
AGGREGATE LOSSES AS A PERCENT OF ORIGINAL POOL BALANCES:
Actual life-to-date 0.51%
Projected over entire life (i.e., historical plus future losses) 1.84%
Estimated future credit losses (undiscounted) 185 million
55
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
5. STOCKHOLDERS' EQUITY
On June 4, 1997, the Company completed a primary offering of 2,800,000 shares of
common stock; an additional 420,000 shares were issued to cover over-allotments.
The proceeds of the offering to the Company, net of expenses and underwriting
discount, were $100.8 million. The net proceeds were used for general corporate
purposes including funding loan originations and purchases, supporting
securitization transactions (including the retention of ESR), supporting other
working capital needs and financing certain strategic acquisitions. The offering
reduced Continental Grain's ownership of the Company from 81% to 75% and caused
the vesting of certain outstanding employee stock options.
The following table presents a reconciliation of basic and diluted earnings per
common share .
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
-----------------------------------------
1998 1997 1996*
----------- ----------- -----------
<S> <C> <C> <C>
Net income $ 134,304 $ 106,004 $ 74,130
=========== =========== ===========
Basic weighted average number of shares
outstanding 46,330,810 43,361,253 36,942,363
Adjustments for dilutive shares outstanding:
Restricted shares 194,190 246,576 34,352
Options 467,449 544,514 73,450
----------- ----------- -----------
Diluted weighted average number of shares outstanding 46,992,449 44,152,343 37,050,165
=========== =========== ===========
Earnings per common share:
Basic $ 2.90 $ 2.44 $ 2.01
=========== =========== ===========
Diluted $ 2.86 $ 2.40 $ 2.00
=========== =========== ===========
</TABLE>
* Amounts for the year ended March 31, 1996 are pro-forma. The weighted
average number of shares outstanding are presented as if the Reorganization
occurred at the beginning of the year.
Options to purchase 295,000 and 347,319 shares of common stock, at weighted
average strike prices of $31.78 and $30.88 were outstanding during the third
and fourth quarters of fiscal 1998, respectively, but were not included in
the computation of diluted earnings per share as they were antidilutive.
In February 1998, the Company's Board of Directors authorized the purchase up
to one million shares of the Company's outstanding common stock. The
purchased shares will be held in treasury for use in connection with
ContiFinancial's 1995 Long-Term Stock Incentive Plan (the "Stock Plan").
During fiscal 1998, the Company repurchased 193,700 shares under the plan at
an average cost of $29.07 per share.
6. ALLOWANCE FOR LOAN LOSSES
56
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
The allowance for loan losses and related additions and deductions to the
allowance for the years ended March 31, 1998, 1997 and 1996, were as follows:
<TABLE>
<CAPTION>
Balance at Reversals
Year Ended Beginning Acquired from Additions Charged and Balance at End
March 31, of Year Acquisitions to Expenses Charge-offs of Year
- ---------- ---------- ------------- ----------------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
1998 $3,747 $ 654 $5,668 $(7,384) $2,685
1997 1,824 1,547 3,043 (2,667) 3,747
1996 1,808 -- 285 (269) 1,824
</TABLE>
7. ACQUISITIONS
On November 8, 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 via direct
mail and telemarketing throughout the United States.
On November 15, 1996 ContiMortgage purchased 100% of Royal Mortgage Partners,
L.P., d/b/a Royal MortgageBanc ("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 Financial Corporation ("Triad"), an additional 2.5% of the common stock
in January 1997 and the remaining 44% of the common stock in March 1998.
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 ContiMortgage purchased 100% of the outstanding stock of
Resource One Consumer Discount Company, Inc. ("Resource One"), a
Pennsylvania-based home equity lender specializing in retail origination via
direct mail, television, and telemarketing.
On October 1, 1997, ContiMortgage purchased 100% of the equity of Fidelity
Mortgage Decisions Corporation ("Fidelity"). Fidelity, headquartered in
Lincolnshire, Illinois, is a wholesale and retail originator of fixed and
adjustable rate home equity loans.
On January 8, 1998, ContiMortgage purchased 100% of the equity of Crystal
Mortgage Company, Inc. ("Crystal") and its subsidiary Lenders M.D., Inc.
("Lenders"). Crystal is a retail mortgage broker and Lenders is a mortgage
bank. Both Crystal and Lenders are based in Amherst, Ohio, and work together
to originate conforming and non-conforming mortgage loans.
ULG, Royal, Triad, Resource One, Fidelity and Crystal are collectively
referred to as the "Acquisitions". In each case the companies acquired were
former Strategic Alliances or ContiMortgage loan origination sources. These
transactions have been accounted for as purchases, and the results of
operations have been included in the Company's results of operations since
the effective acquisition dates. The aggregate purchase price of the
Acquisitions during fiscal 1998 and 1997 was approximately $11,000 and
$38,000, respectively. As a result of the Acquisitions, approximately $9,000
and $35,000 of cost in excess of equity acquired was recorded during fiscal
1998 and 1997, respectively, which is being amortized on a straight-line
basis over a 25 year useful life. Certain acquisitions' terms provide for
payments which are contingent upon future earnings or employment of
57
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
key management. Such contingent payments will be recorded as additions to
cost in excess of equity acquired or compensation as is appropriate.
In April 1998, the Company acquired, for approximately $18,000, a 75%
interest in Keystone Mortgage Partners L.L.C. ("Keystone"). Keystone is an
originator and servicer of commercial mortgage loans.
On December 5, 1997, the Company acquired, for approximately $30,000, 24% of
the equity of Empire Funding Holding Corporation ("EFHC") with an option to
acquire additional shares of EFHC at a later date. EFHC, a newly formed
entity, owns 100% of Empire Funding Corp. ("Empire"). Empire, headquartered
in Austin, Texas, specializes in originating, servicing and securitizing high
loan-to-value home improvement loans. This investment is accounted for using
the equity method and the Company's appropriate share of EFHC's results of
operations have been included in the Company's Consolidated Statements of
Income in "Other Income" beginning December 5, 1997. Upon the closing of the
acquisition, Continental Grain, exchanged a warrant for a 25% equity interest
in Empire for a 25% equity interest in EFHC.
During fiscal 1998, the Company made other equity investments in
unconsolidated subsidiaries totaling approximately $15,000.
8. RELATED PARTY TRANSACTIONS
DUE FROM AFFILIATES
Included in other receivables as of March 31, 1998, was $46,922, of amounts
due from affiliates primarily consisting of a subordinated loan, financed
residuals and related interest receivable.
DUE TO AFFILIATES
Prior to the IPO, Continental Grain provided the Company with financing to
support its operations. In connection with the IPO, this financing was
replaced with term notes payable to Continental Grain. As of March 12, 1997,
in conjunction with the Company's $200 million term debt issue (see Note 9),
the Company's term notes payable to Continental Grain were paid in full.
Interest expense for the years ended March 31, 1997 and 1996 includes $18,598
and $22,635, respectively, in connection with the Company's obligations to
Continental Grain.
On February 14, 1996, the Company entered into an agreement with Continental
Grain (the "Services Agreement") under which Continental Grain provides the
Company with certain corporate services through March 31, 1999 and on a
year-to-year basis thereafter.
AFFILIATE CHARGES
Continental Grain incurs certain general and administrative expenses on
behalf of the Company. Expenses directly attributable to the Company, such as
occupancy and communication charges, are directly charged to the Company. 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 requires an annual payment of approximately $1,209 through the year
2000. The determination of other general and administrative expenses incurred
by Continental Grain and applicable to
58
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
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. The amount of such indirect expenses charged to the Company was
$2,138, $1,749 and $1,907 for the years ended March 31, 1998, 1997 and 1996,
respectively.
TAX SHARING AGREEMENT
Effective June 4, 1997, upon the completion of the primary offering of common
stock, Continental Grain's ownership of the Company decreased from 81% to
75%. Consequently, from that date, the Company was no longer included in
Continental Grain's consolidated U.S. Federal tax return. With respect to the
periods prior to the June 4, 1997 offering, the Company's Federal taxes were
determined in accordance with the tax sharing agreement (the "Tax Sharing
Agreement") between the Company and Continental Grain. On February 14, 1996,
Continental Grain and the Company entered into 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) governed the conduct of all audits and other
tax matters relating to the Company. Pursuant to the Tax Sharing Agreement,
the Company was charged or credited 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 permitted 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 was allocated to the
Company based on the actual cost of benefit accruals and an allocated cost of
administration of the plans and overhead. Effective April 1, 1998, the
Company discontinued its participation in the Continental Grain health care
plan and obtained independent coverage. Effective July 1, 1998, the Company
will discontinue participation in the pension plan (see Note 10).
59
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
9. DEBT
Short-term and long-term debt at March 31, 1998 and 1997 consisted of the
following:
March 31, March 31,
1998 1997
----------- -----------
Short-term debt:
Commercial paper $ 270,708 $ --
Revolving Credit Facility 95,000 25,000
Current portion of long-term debt 396 299
----------- -----------
Total short-term debt $ 366,104 $ 25,299
=========== ===========
Long-term debt:
8 3/8% Senior Notes, $300 million
face amount, due 2003 $ 299,295 $ 299,194
7 1/2% Senior Notes, $200 million
face amount, due 2002 199,412 199,288
Capitalized lease 846 335
----------- -----------
Total long-term debt $ 499,553 $ 498,817
=========== ===========
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.
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.
On April 2, 1998, the Company issued $200 million of 8.125% unsecured Senior
Notes due April 1, 2008. Proceeds to the Company, net of underwriting fees,
market discount and other costs were $188,264. Interest on these notes is
payable semi-annually on April 1 and October 1 commencing October 1, 1998.
The notes are redeemable in 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.
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.
60
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
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.
On January 8, 1997, the Company closed a $200 million unsecured revolving credit
facility (the "Revolving Credit Facility"). The three-year Revolving Credit
Facility has several interest rate pricing alternatives, including the prime
rate, London Inter-Bank Offered Rates ("LIBOR") and federal funds rate. The
amount available under the Revolving Credit Facility is formula-driven, based on
certain of the Company's consolidated assets. The weighted average interest rate
on the Revolving Credit Facility was 6.57% for fiscal 1998 and the rate in
effect on March 31, 1998 was 8.23%.
On September 9, 1997, the Company initiated a $275 million one year renewable
unsecured Commercial Paper Program ("Commercial Paper Program") backed by an
irrevocable direct-pay letter of credit that is being provided by a syndicate of
banks. The weighted average interest rate on the Commercial Paper Program was
5.62% for fiscal 1998 and the rate in effect on March 31, 1998 was 5.60%.
10. EMPLOYEE BENEFITS
The Company's employees were previously included in Continental Grain's various
employee benefits programs, and the Company reimbursed Continental Grain for the
actual cost of benefit accruals and an allocable cost of administration and
overhead. Effective April 1, 1998, the Company discontinued its participation in
Continental Grain's health care plan and obtained independent coverage.
Effective July 1, 1998, the Company will discontinue participation in
Continental Grain's pension plan and will institute the ContiFinancial Employee
Savings Plan.
The previous Continental Grain pension plan covered salaried employees and
provided benefits that were generally based on a percentage of the employee's
salary during the five years before retirement. Continental Grain's funding
policy for these plans was generally to make the minimum annual contribution
required by applicable regulations. Pension costs charged to the Company by
Continental Grain were $465, $374 and $118 for the years ended March 31, 1998,
1997 and 1996, respectively.
In fiscal 1997 and 1996, post-retirement health care coverage under Continental
Grain's Salaried Health Care Plan was available on a cost sharing basis to
retired employees. Post-retirement health care costs were $419 and $680 for
fiscal 1997 and 1996, respectively. The Company's participation in this plan
ceased in 1998 and, consequently, no post-retirement health care costs were
expensed during the year ended March 31, 1998.
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, 1998, 1997 and 1996 was $31,252, $24,580 and $27,986, 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 $3,609 and $200 in expense for this plan for the
years ended March 31, 1998 and 1997, respectively.
61
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
1995 LONG-TERM STOCK INCENTIVE PLAN
The Company has adopted the Stock Plan pursuant to which the Company is
authorized to grant certain key employees 5,437,895 of options and restricted
stock. In fiscal 1998, 1997 and 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 would have changed the method for measurement and
recognition of stock-based compensation on plans similar to those of the
Company. As permitted, the Company elected not to adopt the accounting
prescribed by SFAS 123. However, as required, the Company has adopted the
disclosure requirements of SFAS 123. Pro forma disclosures as if the Company had
adopted the expense 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 three to four year period; and (3)
expire ten years subsequent to the award.
A summary of the status of the Company's stock options as of March 31, 1998,
1997 and 1996 and the changes during the respective years is presented
below:
<TABLE>
<CAPTION>
MARCH 31, 1998 MARCH 31, 1997 MARCH 31, 1996
------------------------- ------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------ -------------- ------ -------------- ------ --------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning 2,484,730 $21.41 2,623,500 $21.11 -- $ --
of year
Granted 1,053,500 26.38 50,000 35.63 2,623,500 21.11
Exercised (47,204) 21.11 (11,382) 21.11 -- --
Forfeited (62,211) 22.70 (177,388) 21.11 -- --
--------- --------- ---------
Outstanding at end of
Year 3,428,815 $22.91 2,484,730 $21.41 2,623,500 $21.11
========= ========= =========
Options exercisable at
end of year 1,903,252 $21.38 491,946 $21.26 196,763 $21.11
========= ========= =========
</TABLE>
The fair value of each option granted during fiscal 1998, 1997 and 1996 was
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 39.70% for 1998 and 49.75% for 1997 and 1996; (3) risk-free
interest rate of 5.85% for 1998, 6.32% for 1997 and 5.05% for 1996 ; (4)
expected life of 3.5 years. The weighted average fair value of options
granted during fiscal 1998, 1997 and 1996 was $9.63, $15.33 and $8.78,
respectively.
62
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
Had compensation cost for the Company's fiscal 1998, 1997 and 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 1998,
1997 and 1996 would be:
<TABLE>
<CAPTION>
MARCH 31, 1998 MARCH 31, 1997 MARCH 31, 1996
------------------------- ------------------------- -------------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- --------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Net income $134,304 $131,540 $106,004 $99,730 $74,130 $72,217
Net income per common
share:
Basic $2.90 $2.84 $2.44 $2.30 $2.01 $1.95
Diluted $2.86 $2.80 $2.40 $2.25 $2.00 $1.95
</TABLE>
Restricted stock granted under the Stock Plan is recorded as deferred
compensation in the Consolidated Statements of Changes 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
amortization of deferred compensation, the Company recorded compensation expense
of $5,440, $6,721 and $4,967 in fiscal 1998, 1997 and 1996, respectively.
A summary of the status of the Company's restricted stock as of March 31,
1998, 1997 and 1996 and the changes during those years is presented below:
<TABLE>
<CAPTION>
MARCH 31, 1998 MARCH 31, 1997 MARCH 31, 1996
------------------------- ------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
GRANT GRANT GRANT
SHARES PRICE SHARES PRICE SHARES PRICE
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year 1,245,551 $21.07 1,330,532 $21.00 -- $ --
Granted 36,400 30.99 6,000 35.63 1,330,532 21.00
Forfeited (15,978) 21.00 (33,931) 21.00 -- --
Vested and transferable (12,805) 21.00 (57,050) 21.00 -- --
--------- --------- ---------
Outstanding at end of
year 1,253,168 $21.36 1,245,551 $21.07 1,330,532 $21.00
========= ========= =========
</TABLE>
63
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
11. INCOME TAXES
Income taxes included in the Consolidated Statements of Income represent the
following:
CURRENT DEFERRED TOTAL
------- ------- -------
Year ended March 31, 1998
Federal $15,687 $59,608 $75,295
State and local 3,013 12,841 15,854
------- ------- -------
$18,700 $72,449 $91,149
======= ======= =======
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
======= ======= =======
The following table reconciles the "expected" tax provision, computed by
applying the U.S. Federal statutory tax rate to income before income taxes
and minority interest, to the Company's actual effective tax rate and expense:
<TABLE>
<CAPTION>
MARCH 31, 1998 MARCH 31, 1997 MARCH 31, 1996
------------------------- ------------------------- -------------------------
PERCENT OF PERCENT OF PERCENT OF
PRE-TAX PRE-TAX PRE-TAX
EARNINGS AMOUNT EARNINGS AMOUNT EARNINGS AMOUNT
-------- ------ -------- ------ -------- ------
<S> <C> <C> <C> <C> <C> <C>
Computed "expected" tax
provision $78,738 35.0% $61,963 35.0% $44,288 35.0%
State and local taxes, net
of related Federal benefit 10,236 4.6% 8,055 4.6% 4,808 3.8%
Other 2,175 1.0% 1,323 0.7% -- --
------- ---- ------- ---- ------- ----
Total $91,149 40.6% $71,341 40.3% $49,096 38.8%
======= ==== ======= ==== ======= ====
</TABLE>
The effects of temporary differences that give rise to deferred tax assets
and deferred tax liabilities are as follows:
<TABLE>
<CAPTION>
MARCH 31,
-----------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Deferred Tax Assets:
Nondeductible reserves $ 5,268 $ 1,069 $ 982
Compensation related 4,985 5,136 1,927
Other 1,874 2,776 377
Deferred Tax Liabilities:
Capitalized servicing rights (25,986) (11,081) (4,535)
Interest-only and residual certificates (73,531) (12,942) (9,813)
Other (217) (115) (18)
----------- ----------- -----------
Net deferred tax liability $ (87,607) $ (15,157) $ (11,080)
=========== =========== ===========
</TABLE>
64
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
12. 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, 1998, 1997
and 1996 was $8,595, $3,470 and $1,884, respectively. The Company also has a
capital lease on certain machinery and equipment included as part of
"Premises and equipment". The future minimum lease payments under the
Company's operating and capital leases, are as follows:
Operating Capital
Fiscal Year Leases Leases
1999 $ 13,901 $ 495
2000 13,303 417
2001 10,245 298
2002 7,625 143
2003 6,176 104
Thereafter 23,277 --
----------- --------
$ 74,527 $ 1,457
=========== ========
Less: amounts representing interest (215)
--------
Present value of net minimum lease payments 1,242
Less: current maturities (396)
--------
Long-term obligation $ 846
========
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.
13. FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET ACTIVITIES
SALES OF ASSETS WITH RECOURSE
During 1998, 1997 and 1996, the Company utilized agreements with financial
institutions (the "Purchasers") to sell, with limited recourse, interests in
designated pools of 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. During 1998, 1997 and 1996, the Company utilized these
agreements to sell receivables totaling approximately
65
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
$18,680,000, $7,350,000 and $5,671,000, respectively. At March 31, 1998 and
1997, approximately $758,000 and $591,000, respectively, were outstanding and
reflected as reductions in Receivables held for sale in the Consolidated
Balance Sheets.
During 1997, 1996 and 1995 the Company sold, with limited recourse, interests
in certain ESR for $96,545, $54,500, and $50,000, respectively. At March 31,
1998 and 1997 $100,867 and $144,926, respectively, of such sales were
outstanding and reflected as reductions in Interest-only and residual
certificates in the Consolidated Balance Sheets. Under 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.
SECURITIZATIONS - HEDGING INTEREST RATE RISK
The most significant variable in the determination of gain on sale in a
securitization is the spread between the weighted average coupon on the
securitized loans and the pass-through interest rate. In the interim period
between loan origination and securitization of such loans, the Company is
exposed to interest rate risk. The majority of loans are securitized within
90 days of origination. However, a portion of the loans are held for sale or
securitization for as long as twelve months (or longer, in very limited
circumstances) prior to securitization. If interest rates rise during the
period that the mortgage loans are held, the spread between the weighted
average interest rate on the loans to be securitized and the pass-through
interest rates on the securities to be sold (the latter having increased as a
result of market interest rate movements) would narrow. Upon securitization,
this would result in a reduction of the fair value of the retained ESR and
the related gain on sale. The Company mitigates this exposure through short
sales of U.S. Treasury securities and interest rate futures contracts. Hedge
gains or losses are initially deferred and subsequently included in gain on
sale upon completion of the securitization. With respect to
ContiMortgage/ContiWest securitizations, gain on sale included hedge losses
of $11,946 and $5,413 in fiscal 1998 and 1997, respectively. These hedging
activities help mitigate the risk of absolute movements in interest rates but
they do not mitigate the risk of a widening in the spreads between
pass-through certificates and U.S. Treasury securities with comparable
maturities.
The Company's deferred gains (losses) in connection with hedging activities
were as follows:
At March 31,
1998 1997
------- --------
Futures contracts $ 1,082 $ 2,821
Short sales of U.S. Treasury securities (3,088) 4,061
------- --------
Total $(2,006) $ 6,882
======= ========
The total principal amount pertaining to sales of U.S. Treasury futures
contracts was $543,200 at March 31, 1998 and $364,900 at March 31, 1997. The
total principal amount pertaining to short sales of U.S. Treasury securities
was $815,060 at March 31, 1998 and $231,947 at March 31, 1997.
66
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
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, 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 amount of the Company's long-term debt
approximates fair value when valued using available quoted market prices. As
discussed in Note 4, Interest-only and residual certificates are recorded at
fair value.
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 and ESR 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, 1998, 1997 and 1996, these instruments had a weighted
average interest rate of 5.3%, 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, 1998 and 1997, the Company had outstanding commitments to extend
credit or purchase loans in the amount of $666,380 and $428,234, 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.
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
67
<PAGE>
CONTIFINANCIAL CORPORATION
Notes to Consolidated Financial Statements (continued)
March 31, 1998, 1997 and 1996
(in thousands, except share data and where noted)
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, 1998,
and 1997 the majority of loans with on-balance sheet and off-balance sheet
credit risk were collateralized by properties located throughout the United
States.
WAREHOUSING EXPOSURE
The Company utilizes warehouse financing in the form of asset purchase and
sale facilities with certain financial institutions and a funding agreement
under an agreement to repurchase, collectively the ("Facilities") to
facilitate the accumulation of securitizable products prior to
securitization. As of March 31, 1998 and 1997, the Company had $2,780,000,
and $2,250,000 of committed warehousing, and $3,100,000 and $1,100,000 of
uncommitted warehousing, respectively. As of March 31, 1998 and 1997,
$1,003,747 and $842,268 respectively, was drawn down. Warehouse commitments
are typically for a term of one year or less and are designated to fund only
securitizable assets. The majority of the assets remain in the Facilities for
a period of up to 90 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.
14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following table presents the quarterly results of operations for the
years ended March 31, 1998 and 1997:
<TABLE>
<CAPTION>
Three Months Ended
June 30, September 30, December 31, March 31,
1997 1997 1997 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Gross income $ 134,023 $ 158,130 $ 177,255 $ 190,754
Net income 26,873 34,837 35,140 37,454
Basic earnings per common share 0.60 0.74 0.75 0.80
Diluted earnings per common share $ 0.59 $ 0.73 $ 0.74 $ 0.79
<CAPTION>
Three Months Ended
June 30, September 30, December 31, March 31,
1996 1996 1996 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Gross income $ 69,763 $ 89,683 $ 121,332 $ 147,052
Net income 19,433 25,516 29,025 32,030
Basic earnings per common share 0.45 0.59 0.67 0.73
Diluted earnings per common share $ 0.44 $ 0.58 $ 0.66 $ 0.72
</TABLE>
68
<PAGE>
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
None.
69
<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 1998 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 1998 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 1998 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 1998 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.
70
<PAGE>
(3) Exhibits
EXHIBIT
NO. DESCRIPTION
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)
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)
10.19 Indenture - 83/8 % Senior Notes due 2003 (3)
10.20 First Amendment to Note Purchase Agreement (4)
10.21 First Supplemental Indenture (5)
10.22 Revolving credit facility-Credit Agreement (6)
10.23 Letter of Credit and Reimbursement Agreement (8)
11.1 Computation of the Company's earnings per common share
12.1 Ratio of Earnings to Fixed Charges
21.1 List of Subsidiaries of the Company
23.2 Consent of Arthur Andersen LLP (2)
23.3 Consent of Arthur Andersen LLP
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 (7)
27.1 Financial Data Schedule for the year-to-date period ended June
30, 1996
27.2 Financial Data Schedule for the year-to-date period ended
September 30, 1996
27.3 Financial Data Schedule for the year-to-date period ended
December 31, 1996
27.4 Financial Data Schedule for the fiscal year ended March 31, 1997
27.5 Financial Data Schedule for the year-to-date period ended June
30, 1997
27.6 Financial Data Schedule for the year-to-date period ended
September 30, 1997
27.7 Financial Data Schedule for the year-to-date period ended
December 31, 1997
27.8 Financial Data Schedule for the fiscal year ended March 31, 1998
- -----------------------------
71
<PAGE>
(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.
(3) Incorporated by reference to exhibit 10.2 from the Company's
quarterly Report on Form 10-Q for the quarterly period ended September
30, 1996, File No. 1-14074.
(4) Incorporated by references to exhibit 10.3 form the Company's
Quarterly Report on Form 10-Q for the quarterly period ended September
30, 1996, File No. 1-14074.
(5) Incorporated by references to exhibit 10.4 form the Company's
Quarterly Report on Form 10-Q for the quarterly period ended September
30, 1996, File No. 1-14074.
(6) Incorporated by reference to exhibit 10.5 from the Company's
Quarterly Report on Form 10-Q for the quarterly period ended December
31, 1996, File No. 1-14074.
(7) Incorporated by reference to exhibit 24.8 from the Company's Annual
Report on Form 10-K for the fiscal year ended March 31, 1997, File No.
1-14074.
(8) Incorporated by reference to exhibit 10.23 from the Company's
Quarterly Report on Form 10-Q for the quarterly period ended September
30, 1997, 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.
72
<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 29, 1998
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
- --------- ----- ----
/s/ James E. Moore President, Chief Executive Officer June 29, 1998
- ----------------------- and Director (Principal Executive
James E. Moore Officer)
/s/ Daniel J. Willett Senior Vice President and Chief June 29, 1998
- ----------------------- Financial Officer (Principal
Daniel J. Willett Financial Officer)
/s/ Dennis G. Sullivan Vice President and Controller June 29, 1998
- ----------------------- (Principal Accounting Officer)
Dennis G. Sullivan
* Director and Chairman of the Board June 29, 1998
- -----------------------
James J. Bigham
* Director June 29, 1998
- -----------------------
Paul J. Fribourg
* Director June 29, 1998
- -----------------------
John W. Spiegel
* Director June 29, 1998
- -----------------------
Donald L. Staheli
* Director June 29, 1998
- -----------------------
John P. Tierney
* Director June 29, 1998
- -----------------------
Lawrence G. Weppler
* Director June 29, 1998
- -----------------------
Michael J. Zimmerman
* By: /s/ James E. Moore
--------------------------
James E. Moore
Attorney-In-Fact
73
<PAGE>
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
- ------- -----------
11.1 Computation of the Company's earnings per common share
12.1 Ratio of Earnings to Fixed Charges
21.1 List of Subsidiaries of the Company
23.3 Consent of Arthur Andersen LLP
27.1 Financial Data Schedule for the year-to-date period ended June 30, 1996
27.2 Financial Data Schedule for the year-to-date period ended September 30,
1996
27.3 Financial Data Schedule for the year-to-date period ended December 31,
1996
27.4 Financial Data Schedule for the fiscal year ended March 31, 1997
27.5 Financial Data Schedule for the year-to-date period ended June 30, 1997
27.6 Financial Data Schedule for the year-to-date period ended September 30,
1997
27.7 Financial Data Schedule for the year-to-date period ended December 31,
1997
27.8 Financial Data Schedule for the fiscal year ended March 31, 1998
<PAGE>
Exhibit 11.1
ContiFinancial Corporation
Computation of Earnings Per Common Share
BASIC
Net Income 134,304,000
Weighted Average Shares
1st Quarter 44,757,322
2nd Quarter 46,853,920
3rd Quarter 46,870,941
4th Quarter 46,841,059
------------
Average 46,330,810
------------
Year ended March 31,1998 Basic EPS $ 2.90
============
DILUTED
Net Income 134,304,000
Weighted Average Shares
1st Quarter 45,588,626
2nd Quarter 47,619,685
3rd Quarter 47,415,299
4th Quarter 47,346,187
------------
Average 46,992,449
------------
Year ended March 31,1998 Diluted EPS $ 2.86
============
<PAGE>
<TABLE>
<CAPTION>
BASIC
Weighted
# of shares weighting Ave. Shares
---------------------------------------------
<S> <C> <C> <C>
Continental Grain Shares 35,918,421 100% 35,918,421
Shares Issued in IPO 7,130,000 100% 7,130,000
Shares Acquired through exercise of options 1,996 100% 1,996
Shares Aquired Through Accelerated Vesting -8/15/96 1,996 100% 1,996
Shares Aquired Through Accelerated Vesting -8/15/96 53,220 100% 53,220
Shares Aquired Through Accelerated Vesting -11/19/96 3,990 100% 3,990
Shares Acquired through exercise of options - 1/23/97 5,991 100% 5,991
Shares Acquired through exercise of options - 2/19/97 3,395 100% 3,395
Shares Acquired through exercise of options - 4/11/97 5,328 100% 5,328
Shares Acquired through exercise of options - 4/30/97 5,326 100% 5,326
Shares Acquired through exercise of options - 5/9/97 2,995 100% 2,995
Shares Acquired through exercise of options - 8/19/97 11,185 100% 11,185
Vested Restricted Stock of former Employees 5,328 100% 5,328
Vested Restricted Stock of former Employees 5,321 100% 5,321
Secondary Equity Offering 3,220,000 100% 3,220,000
Shares Acquired through exercise of options - 11/17/97 22,370 100% 22,370
Less: Shares repurchased for treasury:
03/04/98 (15,900) 30% (4,770)
03/06/98 (40,000) 28% (11,111)
03/10/98 (45,800) 23% (10,687)
03/11/98 (23,400) 22% (5,200)
03/12/98 (30,300) 21% (6,397)
03/13/98 (4,100) 20% (820)
03/16/98 (7,200) 17% (1,200)
03/17/98 (21,000) 16% (3,267)
03/23/98 (6,000) 9% (533)
<PAGE>
EFFECT OF RESTRICTED SHARES:
Effect of Restricted Shares:
Restricted Shares Outstanding during the Quarter
Restricted Shares Granted - IPO 1,330,532
Vested Shares of Departed Employees:
During the whole quarter (119,764)
------------
Oustanding Restricted Shares 1,210,768
Percentage Vested for whole quarter 40.00%
------------
Shares Outstanding during whole quarter 484,307 484,307 100% 484,307
============
Percentage Vested on 3/31/98 20.00%
------------
Shares Outstanding for one day 242,154 242,154 1.10% 2,661
============
New Awards of Restricted Shares
Restricted Shares Granted - 1/15/97 6,000
Percentage Vested for whole quarter 20.00%
------------
Shares Outstanding during whole quarter 1,200 1,200 100% 1,200
============
Percentage Vested on 3/31/98 20.00%
------------
Shares Outstanding for one day 1,200 1,200 1.10% 13
============
New Awards of Restricted Shares
Restricted Shares Granted - 4/10/97 20,000
Percentage Vested 0.00%
------------
Shares Outstanding 0 0 100% 0
============
New Awards of Restricted Shares
Restricted Shares Granted - 5/1/97 6,400
Percentage Vested 0.00%
------------
Shares Outstanding 0 0 100% 0
============
New Awards of Restricted Shares
Restricted Shares Granted - 9/17/97 10,000
Percentage Vested 0.00%
------------
Shares Outstanding 0 0 100% 0
============
Restricted Shares Outstanding for part of the Quarter:
none 0
Oustanding Restricted Shares
Percentage Vested
Shares Outstanding 0
Weighted Average Shares 46,841,059
============
Quarter income 37,454,000
============
Basic Earnings Per Common Share $0.80
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
DILUTED
Weighted
# of shares weighting Ave. Shares
---------------------------------------------
<S> <C> <C> <C>
Continental Grain Shares 35,918,421 100% 35,918,421
Shares Issued in IPO 7,130,000 100% 7,130,000
Shares Acquired through exercise of options 1,996 100% 1,996
Shares Aquired Through Accelerated Vesting -8/15/96 1,996 100% 1,996
Shares Aquired Through Accelerated Vesting -8/15/96 53,220 100% 53,220
Shares Aquired Through Accelerated Vesting -11/19/96 3,990 100% 3,990
Shares Acquired through exercise of options - 1/23/97 5,991 100% 5,991
Shares Acquired through exercise of options - 2/19/97 3,395 100% 3,395
Shares Acquired through exercise of options - 4/11/97 5,328 100% 5,328
Shares Acquired through exercise of options - 4/30/97 5,326 100% 5,326
Shares Acquired through exercise of options - 5/9/97 2,995 100% 2,995
Shares Acquired through exercise of options - 8/19/97 11,185 100% 11,185
Vested Restricted Stock of former Employees 5,328 100% 5,328
Vested Restricted Stock of former Employees 5,321 100% 5,321
Secondary Equity Offering 3,220,000 100% 3,220,000
Shares Acquired through exercise of options - 11/17/97 22,370 100% 22,370
Less: Shares repurchased for treasury:
03/04/98 (15,900) 30% (4,770)
03/06/98 (40,000) 28% (11,111)
03/10/98 (45,800) 23% (10,687)
03/11/98 (23,400) 22% (5,200)
03/12/98 (30,300) 21% (6,397)
03/13/98 (4,100) 20% (820)
03/16/98 (7,200) 17% (1,200)
03/17/98 (21,000) 16% (3,267)
03/23/98 (6,000) 9% (533)
<PAGE>
EFFECT OF RESTRICTED SHARES:
Effect through March 31, 1998
Assumed Proceeds:
Unamortized deferred comp. @ 3/31/98 11,107,357
------------
Tax benefit on assumed exercise:
Total Restricted Shares 1,253,168
Ave. Market Price for quarter 25.515
-------------
Value 31,974,582
=============
Tax Effect (40%) 12,789,833
Tax Effect of compensation 10,707,161
-------------
2,082,671
------------
Total Assumed Proceeds 13,190,028
============
Repurchase Shares on Market
Total Assumed Proceeds 13,190,028
Ave. Market Price for quarter 25.515
------------
Number of Shares 516,951.92
============
Incremental Shares Considered to be Outstanding
Restricted Shares 1,253,168
Repurchase Shares 516,952
------------
Incremental Shares 736,216 100% 736,216
============
Effect of Options:
Options Exercised:
NONE
Options Remaining:
Number of Options 3,081,496
Offering Price 21.97
-------------
Proceeds on exercising options 67,691,486
Tax Effect:
Options Remaining 3,081,496
Ave. Market Price for quarter 25.515
-------------
Estimated value 78,624,370
=============
Tax Effect (40%) 31,449,748
Tax Effect of compensation 27,076,594
-------------
4,373,154
-------------
Total Assumed Proceeds 72,064,640
=============
Repurchase Shares on Market
Total Assumed Proceeds 72,064,639.88
Average Market Price for quarter 25.515
-------------
Number of Shares 2,824,403
=============
Incremental Shares Considered to be Outstanding
Granted Options 3,081,496
Repurchase Shares 2,824,403
-------------
Incremental Shares 257,093 100.00% 257,093
=============
Weighted Average Shares 47,346,187
============
Quarter income 37,454,000
============
Diluted Earnings Per Common Share $0.79
============
</TABLE>
<PAGE>
Exhibit 12.1
ContiFinancial Corporation
Ratio of Earnings to Fixed Charges
Exhibit 12.1 of March 31, 1998 Form 10-K
<TABLE>
<CAPTION>
Fiscal 98 Fiscal 97 Fiscal 96 Fiscal 95 Fiscal 94
<S> <C> <C> <C> <C> <C>
Summary:
Earnings 385,425 297,677 197,996 77,895 42,334
Fixed Charges 165,904 120,636 74,770 29,635 12,124
-------- -------- -------- -------- --------
Ratio 2.32 2.47 2.65 2.63 3.49
======== ======== ======== ======== ========
Earnings:
Income before income taxes and minority interest 224,965 177,041 126,536 56,988 35,286
Plus: Interest expense 165,904 120,636 74,770 29,635 12,124
Less: Equity income in unconsolidated subsidiaries (5,444) - - - -
Less: Minority interest n/a n/a (3,310) (8,728) (5,076)
-------- -------- -------- -------- --------
Total "Earnings" 385,425 297,677 197,996 77,895 42,334
======== ======== ======== ======== ========
Fixed Charges:
Interest expense 165,904 120,636 74,770 29,635 12,124
</TABLE>
<PAGE>
Exhibit 21.1
CONTIFINANCIAL CORPORATION
Subsidiary Companies
March 31, 1998
ContiFinancial Services Corporation
ContiMortgage Corporation
California Lending Group, Inc.
ContiWest Corporation
ContiTrade Services L.L.C. (99%)
Triad Financial Corporation
ContiAsset Receivables Management, LLC (90%)
ContiBusiness Services Corporation (80%)
Warminster National Abstract, Inc.
Keystone Mortgage Partners L.L.C. (75%)
American Commercial Capital LLC (50%)
ZTS Corp. [Royal MortgageBanc] (99%)*
Resource One Consumer Discount Company, Inc.*
ContiInsurance Agency, Inc.*
Fidelity Mortgage Decisions Corporation*
Crystal Mortgage Company, Inc.*
Lenders M.D., Inc.*
* Subsidiary of ContiMortgage Corporation
<PAGE>
Exhibit 23.3
ARTHUR ANDERSEN LLP
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report included in this Form 10-K, into ContiFinancial Corporation's
previously filed Registration Statements, File No. 333-33783 and 333-01370.
/s/ Arthur Andersen LLP
June 26, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1996
<PERIOD-END> JUN-30-1996
<CASH> 24,919
<SECURITIES> 406,954
<RECEIVABLES> 435,492
<ALLOWANCES> (1,893)
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 6,460
<DEPRECIATION> (2,773)
<TOTAL-ASSETS> 891,672
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 444
<OTHER-SE> 315,364
<TOTAL-LIABILITY-AND-EQUITY> 891,672
<SALES> 0
<TOTAL-REVENUES> 69,763
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 17,187
<LOSS-PROVISION> 219
<INTEREST-EXPENSE> 19,662
<INCOME-PRETAX> 32,695
<INCOME-TAX> 13,262
<INCOME-CONTINUING> 19,433
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 19,433
<EPS-PRIMARY> .45
<EPS-DILUTED> .44
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1996
<PERIOD-END> SEP-30-1996
<CASH> 42,822
<SECURITIES> 667,135
<RECEIVABLES> 593,029
<ALLOWANCES> (1,942)
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 3,719
<DEPRECIATION> (2,541)
<TOTAL-ASSETS> 1,337,054
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 444
<OTHER-SE> 343,230
<TOTAL-LIABILITY-AND-EQUITY> 1,337,054
<SALES> 0
<TOTAL-REVENUES> 159,446
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 39,953
<LOSS-PROVISION> 308
<INTEREST-EXPENSE> 43,988
<INCOME-PRETAX> 75,197
<INCOME-TAX> 30,248
<INCOME-CONTINUING> 44,949
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 44,949
<EPS-PRIMARY> 1.04
<EPS-DILUTED> 1.02
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAR-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 39,043
<SECURITIES> 846,962
<RECEIVABLES> 575,954
<ALLOWANCES> (4,483)
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 9,908
<DEPRECIATION> (3,054)
<TOTAL-ASSETS> 1,542,738
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 444
<OTHER-SE> 373,616
<TOTAL-LIABILITY-AND-EQUITY> 1,542,738
<SALES> 0
<TOTAL-REVENUES> 280,778
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 76,700
<LOSS-PROVISION> 1,302
<INTEREST-EXPENSE> 79,989
<INCOME-PRETAX> 122,787
<INCOME-TAX> 49,192
<INCOME-CONTINUING> 73,974
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 73,974
<EPS-PRIMARY> 1.71
<EPS-DILUTED> 1.68
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-END> MAR-31-1997
<CASH> 51,200
<SECURITIES> 668,967
<RECEIVABLES> 742,251
<ALLOWANCES> (3,747)
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 12,087
<DEPRECIATION> 4,298
<TOTAL-ASSETS> 1,545,798
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 444
<OTHER-SE> 407,340
<TOTAL-LIABILITY-AND-EQUITY> 1,545,798
<SALES> 0
<TOTAL-REVENUES> 427,830
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 127,110
<LOSS-PROVISION> 3,043
<INTEREST-EXPENSE> 120,636
<INCOME-PRETAX> 177,041
<INCOME-TAX> 71,341
<INCOME-CONTINUING> 106,004
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 106,004
<EPS-PRIMARY> 2.44
<EPS-DILUTED> 2.40
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> JUN-30-1997
<CASH> 111,146
<SECURITIES> 1,021,279
<RECEIVABLES> 882,691
<ALLOWANCES> (2,768)
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 14,032
<DEPRECIATION> 5,112
<TOTAL-ASSETS> 2,106,534
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 476
<OTHER-SE> 538,259
<TOTAL-LIABILITY-AND-EQUITY> 2,106,534
<SALES> 0
<TOTAL-REVENUES> 134,023
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 51,304
<LOSS-PROVISION> 1,311
<INTEREST-EXPENSE> 35,863
<INCOME-PRETAX> 45,545
<INCOME-TAX> 18,641
<INCOME-CONTINUING> 26,873
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 26,873
<EPS-PRIMARY> 0.60
<EPS-DILUTED> 0.59
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> SEP-30-1997
<CASH> 88,738
<SECURITIES> 843,486
<RECEIVABLES> 882,888
<ALLOWANCES> (3,307)
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 16,046
<DEPRECIATION> (5,958)
<TOTAL-ASSETS> 1,923,368
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 476
<OTHER-SE> 574,835
<TOTAL-LIABILITY-AND-EQUITY> 1,923,368
<SALES> 0
<TOTAL-REVENUES> 292,153
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 110,499
<LOSS-PROVISION> 2,514
<INTEREST-EXPENSE> 76,362
<INCOME-PRETAX> 102,778
<INCOME-TAX> 41,984
<INCOME-CONTINUING> 61,710
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 61,710
<EPS-PRIMARY> 1.35
<EPS-DILUTED> 1.32
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> DEC-31-1997
<CASH> 116,668
<SECURITIES> 1,227,228
<RECEIVABLES> 866,749
<ALLOWANCES> (2,904)
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 21,539
<DEPRECIATION> (7,009)
<TOTAL-ASSETS> 2,357,986
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 477
<OTHER-SE> 611,825
<TOTAL-LIABILITY-AND-EQUITY> 2,357,986
<SALES> 0
<TOTAL-REVENUES> 469,408
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 183,057
<LOSS-PROVISION> 3,379
<INTEREST-EXPENSE> 119,913
<INCOME-PRETAX> 163,059
<INCOME-TAX> 66,154
<INCOME-CONTINUING> 96,850
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 96,850
<EPS-PRIMARY> 2.10
<EPS-DILUTED> 2.07
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 173,588
<SECURITIES> 1,506,434
<RECEIVABLES> 965,882
<ALLOWANCES> (2,685)
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 26,838
<DEPRECIATION> (7,951)
<TOTAL-ASSETS> 2,808,579
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 477
<OTHER-SE> 645,831
<TOTAL-LIABILITY-AND-EQUITY> 2,808,579
<SALES> 0
<TOTAL-REVENUES> 660,162
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 263,625
<LOSS-PROVISION> 5,668
<INTEREST-EXPENSE> 165,904
<INCOME-PRETAX> 224,965
<INCOME-TAX> 91,149
<INCOME-CONTINUING> 134,304
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 134,304
<EPS-PRIMARY> 2.90
<EPS-DILUTED> 2.86
</TABLE>