<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 24, 1997
REGISTRATION NO. 333-
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
BNC MORTGAGE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
---------------
<TABLE>
<S> <C> <C>
DELAWARE 6162 33-0661303
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. LDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER)
</TABLE>
1740 EAST GARRY AVENUE, SUITE 109
SANTA ANA, CALIFORNIA 92705
(714) 260-6000
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
---------------
EVAN R. BUCKLEY
PRESIDENT AND CHIEF EXECUTIVE OFFICER
BNC MORTGAGE, INC.
1740 EAST GARRY AVENUE, SUITE 109
SANTA ANA, CALIFORNIA 92705
(714) 260-6000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
COPIES TO:
<TABLE>
<S> <C>
THOMAS J. POLETTI, ESQ. ROBERT E. DEAN, ESQ.
KATHERINE J. BLAIR, ESQ. GIBSON, DUNN & CRUTCHER LLP
DARREN O. BIGBY, ESQ. 4 PARK PLAZA
FRESHMAN, MARANTZ, ORLANSKI, COOPER & KLEIN IRVINE, CALIFORNIA 92614
9100 WILSHIRE BOULEVARD, 8TH FLOOR EAST TELEPHONE (714) 451-3948
BEVERLY HILLS, CALIFORNIA 90212 FACSIMILE (714) 451-4220
TELEPHONE (310) 273-1870
FACSIMILE (310) 274-8357
</TABLE>
---------------
Approximate Date of Commencement of Proposed Sale to the Public: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, please check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------
PROPOSED MAXIMUM
PROPOSED MAXIMUM AGGREGATE
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE OFFERING AMOUNT OF
SECURITIES REGISTERED REGISTERED(1) PER SHARE(2) PRICE(2) REGISTRATION FEE
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, $.001 par
value................. 5,103,866 shares $11.00 $56,142,526 $17,013
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------
</TABLE>
(1) Includes 665,722 shares which the Underwriters have the option to purchase
to cover over-allotments, if any.
(2) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457(a) under the Securities Act of 1933.
---------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE
REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED OCTOBER 24, 1997
PROSPECTUS
4,438,144 SHARES
[LOGO]
BNC MORTGAGE, INC.
COMMON STOCK
-----------
Of the 4,438,144 shares of Common Stock offered hereby (the "Offering"),
2,000,000 are being sold by BNC Mortgage, Inc., a Delaware corporation (the
"Company"), and 2,438,144 are being sold by DLJ Mortgage Capital, Inc. ("DLJ"
or the "Selling Stockholder"). The Company will not receive any of the proceeds
from the sale of shares by the Selling Stockholder. After the Offering, the
Selling Stockholder will own no shares of the Company. Prior to the Offering,
there has been no public market for the Company's Common Stock. It is currently
anticipated that the initial public offering price will be between $9.00 and
$11.00 per share. See "Underwriting" for a discussion of factors to be
considered in determining the initial public offering price.
The Company intends to apply for quotation of the Common Stock on the Nasdaq
National Market under the symbol "BNCM."
SEE "RISK FACTORS" COMMENCING ON PAGE 7 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF COMMON STOCK OFFERED
HEREBY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRICE UNDERWRITING PROCEEDS TO
TO DISCOUNTS AND PROCEEDS TO SELLING
PUBLIC COMMISSIONS(1) COMPANY(2) STOCKHOLDER(2)
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share........................ $ $ $ $
- -----------------------------------------------------------------------------------------------
Total (3)........................ $ $ $ $
- -----------------------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
(1) See "Underwriting" for information relating to indemnification of the
Underwriters, and other matters.
(2) Before deducting expenses estimated to be $850,000, of which $385,000 are
payable by the Company and $465,000 are payable by the Selling Stockholder.
(3) The Company has granted the Underwriters a 30-day option to purchase
665,722 additional shares of Common Stock on the same terms and conditions
as set forth above, solely to cover over-allotments, if any. If such option
is exercised in full, the total Price to Public will be $ ,
Underwriting Discount will be $ , Proceeds to the Company will be
$ and Proceeds to Selling Stockholder will be $ . See
"Underwriting."
The shares of Common Stock are offered by the Underwriters, subject to prior
sale, when, as and if delivered to and accepted by them, subject to receipt and
subject to the right of the Underwriters to reject any order in whole or in
part. It is expected that delivery of the shares of Common Stock will be made
against payment therefor at the offices of Friedman, Billings, Ramsey & Co.,
Inc., Arlington, Virginia or in book entry form through the book entry
facilities of The Depository Trust Company on or about , 1997.
-----------
FRIEDMAN, BILLINGS, RAMSEY & CO., INC. OPPENHEIMER & CO., INC.
The date of this Prospectus is , 1997
<PAGE>
[MAP]
<TABLE>
<CAPTION>
AT OR FOR THE
AT OR FOR THE THREE MONTHS
YEAR ENDED JUNE ENDED SEPTEMBER
30, 30,
----------------- -----------------
1996 1997 1996 1997
-------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Mortgage Loan Originations.................. $199,963 $532,621 $ 93,427 $164,402
Mortgage Loan Sales......................... $156,559 $519,909 $103,140 $159,517
States with Origination Locations........... 8 21 15 23
States in which Loans were Originated....... 21 34 21 35
Origination Locations with Offices.......... 18 30 25 32
Origination Locations without Offices....... 1 8 2 21
Account Executives.......................... 29 59 38 81
Approved Independent Brokers................ 620 1,830 894 2,230
</TABLE>
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING PURCHASES OF THE COMMON STOCK TO STABILIZE ITS MARKET PRICE,
PURCHASES OF THE COMMON STOCK TO COVER SOME OR ALL OF A SHORT POSITION IN THE
COMMON STOCK MAINTAINED BY THE UNDERWRITERS AND THE IMPOSITION OF PENALTY
BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS (AND SELLING GROUP
MEMBERS, IF ANY) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE
COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF
REGULATION M UNDER THE SECURITIES EXCHANGE ACT OF 1934. SEE "UNDERWRITING."
2
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by, and should be read in
conjunction with, the more detailed information and Consolidated Financial
Statements, including the Notes thereto, appearing elsewhere in this
Prospectus. Except as otherwise specified, all information in this Prospectus
(i) assumes no exercise of the Underwriters' over-allotment option (see
"Underwriting"), (ii) regarding outstanding shares, excludes shares of Common
Stock reserved for issuance under the Company's 1997 Stock Option, Deferred
Stock and Restricted Stock Plan (the "Stock Option Plan") and (iii) gives
effect to (A) a 5,670.1031-for-1 stock split of the outstanding shares of
Common Stock, (B) the reincorporation of the Company in Delaware and the
authorization of 50,000,000 shares of Common Stock and 5,000,000 shares of
Preferred Stock, (C) the repurchase by the Company of all outstanding shares of
the Company's Series A Preferred Stock for approximately $1.6 million (the
"Stock Repurchase") and (D) the conversion on a one-for-one basis of all
outstanding shares of Class A and Class B Common Stock into shares of $.001 par
value Common Stock (the "Common Stock"), each of which will be effected prior
to the consummation of this Offering. Unless otherwise indicated, all
references herein to the Company refer to BNC Mortgage, Inc. and its
subsidiaries. This Prospectus contains forward-looking statements which involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth under "Risk Factors" and elsewhere
in this Prospectus.
THE COMPANY
The Company is a specialty finance company that originates and sells sub-
prime residential mortgage loans secured by one-to-four family residences. The
Company's loans are made primarily to refinance existing mortgages, consolidate
other debt, finance home improvements, education and other similar needs, and,
to a lesser extent, to purchase single family residences. The Company has two
divisions: (i) a wholesale division which has relationships with approximately
2,200 approved independent loan brokers and which historically accounted for
substantially all of the Company's total loan originations and (ii) a retail
division which is being developed to market loans directly to homeowners. Since
it commenced operations in August 1995, the Company has experienced significant
growth in loan originations, with approximately $532.6 million of originations
in 34 states during the year ended June 30, 1997 compared to $200.0 million in
21 states during its first full fiscal year ended June 30, 1996. Total
originations were $164.4 million during the three months ended September 30,
1997, as compared to $93.4 million during the three months ended September 30,
1996, a 76% increase. This growth in originations resulted in an increase in
the Company's net income to $7.5 million for the year ended June 30, 1997 as
compared to $417,000 for the year ended June 30, 1996. Net income rose to $1.7
million for the three months ended September 30, 1997 from $1.1 million for the
three months ended September 30, 1996.
The Company currently sells substantially all of its mortgage loans through
whole loan sales resulting in gain on sale of mortgage loans consisting solely
of cash. For the three months ended September 30, 1997 and the years ended June
30, 1997 and 1996, the Company had mortgage loan sales of $159.5 million,
$519.9 million and $156.6 million, respectively, with resulting cash gain on
sale of mortgage loans of $6.6 million, $21.9 million and $4.2 million,
respectively.
Substantially all loans originated by the Company are secured by a first
priority mortgage on the subject property. During the three months ended
September 30, 1997, less than 1.0% of the principal balance of the loans
originated were secured by second priority mortgages; none of such loans were
originated for the years ended June 30, 1997 or 1996. The Company's core
borrower base consists of individuals who do not qualify for traditional "A"
credit because their credit history, income or other factors cause them not to
conform to standard agency lending criteria. During the three months ended
September 30, 1997 and the year ended June 30, 1997,
3
<PAGE>
approximately 65.3% and 57.5% of the principal balance of the loans originated
by the Company, respectively, were to borrowers with a Company risk
classification of "A+" or "A-" while the remainder were to borrowers with a
Company risk classification of "B", "C+", "C" or "C-", respectively,
representing approximately 34.7% and 42.5% of the total principal amount of
loans originated by the Company. During each of the three months ended
September 30, 1997 and the year ended June 30, 1997, approximately 3.9% of the
principal balance of the loans originated by the Company were to borrowers with
a Company risk classification of "C-", which includes borrowers with numerous
derogatory credit items up to and including a bankruptcy in the most recent 12
month period.
The Company believes that its primary strengths are (i) the experience of its
management, account executives and staff in the sub-prime lending industry,
which enhances the Company's ability to establish and maintain long-term
relationships with mortgage brokers, (ii) its service oriented sales culture
whereby the Company strives to respond quickly and efficiently to customer
needs and market demands, (iii) its operating philosophy to create stable and
deliberate loan origination growth by utilizing consistent and prudent
underwriting guidelines designed to produce mortgage products readily saleable
in the secondary market and (iv) its ability to manage and control operating
costs in order for it to remain a low cost wholesale originator.
The Company's growth and operating strategy is based on the following key
elements:
Whole Loan Sales for Cash. The Company sells substantially all of its
originated mortgage loans monthly for cash, historically at a premium over the
principal balance of the mortgage loans. Management believes that the cash
received in loan sales provides the Company greater flexibility and operating
leverage than a traditional portfolio lender, which holds the loans it
originates, by allowing the Company to generate income through interest on
loans held for sale and gain on loans sold. This strategy of frequent loan
sales has been an important factor in generating the Company's earnings,
creating consistent positive cash flow to fund operations, decreasing the need
for other forms of financing and reducing the level of interest rate and
default risk borne by the Company.
Continuing Growth of Wholesale Production. The Company's growth strategy for
its Wholesale Division is greater penetration in existing markets and selective
geographic expansion. The Company intends to add additional sales personnel to
its existing origination locations in order to provide continued high levels of
service to brokers, to increase loan origination and further the basis for
repeat business, referral and other future lending opportunities. The Company
anticipates that short-term geographic expansion will focus on the development
of lending operations in Texas, Pennsylvania, North Carolina, New Jersey,
Virginia, Tennessee and Oklahoma. Thereafter, further expansion will be focused
on those geographic regions which management believes represent the most
attractive markets for the Company's products.
Expertise on Product Offerings. The Company utilitizes long-term
relationships with mortgage loan brokers to quickly and efficiently tailor
existing products or introduce new products to satisfy broker and consumer
product needs. Examples of recently introduced products include loans with
higher loan-to-value ratios for borrowers with good credit histories. Also, the
Company attempts to anticipate changing demands and formulate new products
accordingly.
Securitization Flexibility. While a substantial majority of the Company's
mortgage loan originations will continue to be sold through whole loan sales in
cash transactions, the Company may in the future sell a portion of its loans
through securitizations. The ability to conduct securitizations may provide the
Company with the flexibility to take advantage of favorable pricing
differentials between the securitization and whole loan sale markets that may
exist from time to time.
In connection with the capitalization of the Company in August 1995, DLJ
agreed to provide a warehouse line of credit and an outlet for the Company's
loan production. In exchange, DLJ received the exclusive right to
4
<PAGE>
purchase all of the Company's loan production. In addition, DLJ purchased
shares of the Company's capital stock which represented approximately 44% of
the outstanding shares of Common Stock as of September 30, 1997 and which are
offered hereby. The Company has determined to expand the scope of the Company's
financing and loan sale activity beyond the arrangements with DLJ, with the
concurrence of DLJ. DLJ has also agreed to provide the Company with an
increased $150.0 million financing facility. See "Business-Financing and Sale
of Loans."
The Company's administrative offices are located at 1740 East Garry Avenue,
Santa Ana, California 92705, and its telephone number is (714) 260-6000.
THE OFFERING
<TABLE>
<C> <S>
Common Stock Offered Hereby:
By the Company.................................... 2,000,000 shares
By the Selling Stockholder........................ 2,438,144 shares
Common Stock to be Outstanding After the Offering(1). 7,500,000 shares
Use of Proceeds...................................... The net proceeds
received by the Company
will be used to fund
future loan originations
and for general
corporate purposes.
Proposed Nasdaq National Market Symbol............... "BNCM"
</TABLE>
- --------
(1) Excludes shares of Common Stock reserved for issuance pursuant to the
Company's Stock Option Plan. The Stock Option Plan authorizes the grant of
options to purchase, and awards of, 900,000 shares; of this amount, options
to acquire 200,000 shares were granted prior to this Offering at a per
share exercise price of $5.00. Options to acquire an additional 400,000
shares are expected to be granted to certain employees, officers and
directors of the Company on the effective date of the Offering at an
exercise price equal to the initial public offering price. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--General" and "Management--Stock Options."
RISK FACTORS
See "Risk Factors" for a description of certain factors which should be
carefully considered before making an investment in the Company.
5
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA
(In thousands, except per share data and ratios)
The financial data set forth below should be read in conjunction with the
Consolidated Financial Statements of the Company and related notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere herein.
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
JUNE 30, SEPTEMBER 30,
-------------- -------------
1996 1997 1996 1997
STATEMENT OF OPERATIONS DATA: ------ ------- ------ ------
<S> <C> <C> <C> <C>
Revenues:
Gain on sale of mortgage loans.................. $4,240 $21,855 $3,410 $6,635
Loan origination income......................... 1,978 5,473 1,022 1,240
Interest income................................. 1,960 5,182 1,101 1,645
Other income.................................... 52 250 39 102
------ ------- ------ ------
Total revenues................................. 8,230 32,760 5,572 9,622
------ ------- ------ ------
Expenses:
Employees' salaries and commissions............. 3,624 11,052 1,837 3,505
General and administrative expenses............. 2,400 5,543 1,055 2,048
Interest expense................................ 1,452 3,693 846 1,179
------ ------- ------ ------
Total expenses................................. 7,476 20,288 3,738 6,732
------ ------- ------ ------
Income before income taxes........................ 754 12,472 1,834 2,890
Income tax expense................................ 337 4,930 723 1,193
------ ------- ------ ------
Net income...................................... $ 417 $ 7,542 $1,111 $1,697
====== ======= ====== ======
Pro forma net income per share.................... $ 0.10 $ 1.31 $ 0.20 $ 0.30
====== ======= ====== ======
Shares used in computing pro forma net income per
share(1)......................................... 3,985 5,776 5,543 5,722
</TABLE>
<TABLE>
<CAPTION>
AT JUNE 30, AT SEPTEMBER 30, 1997
--------------- -----------------------------------
1996 1997 ACTUAL PRO FORMA(2) AS ADJUSTED(3)
------- ------- ------- ------------ --------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.. $ 2,452 $ 8,268 $ 9,111 $ 7,536 $25,751(4)
Restricted cash............ -- -- 605 605 605
Mortgage loans held for
sale...................... 42,723 55,145 59,431 59,431 59,431
Total assets............... 46,352 65,713 72,180 70,605 88,820
Warehouse line of credit... 42,723 54,625 58,961 58,961 58,961
Total liabilities.......... 44,506 56,509 61,458 61,458 61,458
Total stockholders' equity. 1,846 9,204 10,722 9,147 27,362
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
JUNE 30, SEPTEMBER 30,
------------------ ------------------
1996 1997 1996 1997
OPERATING STATISTICS: -------- -------- -------- --------
<S> <C> <C> <C> <C>
Loan originations:
Mortgage loan originations........... $199,963 $532,621 $ 93,427 $164,402
Average initial principal balance per
loan................................ $ 101 $ 98 $ 97 $ 94
Weighted average interest rate:
Fixed rate residential loans........ 10.7% 10.5% 11.0% 10.5%
Variable rate residential loans..... 9.2% 9.4% 9.4% 9.5%
Small commercial rate loans(5)...... -- 9.8% -- --
Weighted average initial loan-to-
value ratio......................... 68.5% 69.3% 68.2% 72.0%
Whole loan sales....................... $156,559 $519,909 $103,140 $159,517
Credit risk(6):
A+.................................. 9.7% 30.7% 20.9% 40.8%
A-.................................. 41.9% 26.7% 34.7% 24.5%
B................................... 26.0% 18.9% 21.2% 19.3%
C+.................................. 12.0% 10.7% 13.2% 8.4%
C................................... 7.7% 5.7% 7.3% 3.1%
C-.................................. 2.7% 3.9% 2.7% 3.9%
Small commercial(5)................. -- 3.4% -- --
</TABLE>
- --------
(1) See Note 1 of Notes to Consolidated Financial Statements.
(2) Pro forma reflects the repurchase by the Company of all outstanding shares
of the Company's Series A Preferred Stock for approximately $1.6 million
(the "Stock Repurchase") which will be effected prior to the consummation
of this Offering.
(3) As adjusted to reflect the sale of the shares of Common Stock by the
Company in this Offering at an assumed initial public offering price of
$10.00 per share and the application of the estimated net proceeds
therefrom. See "Use of Proceeds" and "Capitalization."
(4) The net proceeds of this Offering will be principally used to fund future
loan originations. See "Use of Proceeds."
(5) The Company discontinued the origination of small commercial loans in April
1997.
(6) Credit ratings are based on the Company's classification of loan products.
See "Business--Underwriting Guidelines."
6
<PAGE>
RISK FACTORS
Before investing in the shares offered hereby, prospective investors should
give special consideration to the following risk factors in addition to the
information set forth elsewhere in this Prospectus. The following risk factors
are interrelated, and consequently, investors should treat such risk factors
as a whole. This Prospectus contains forward-looking statements that
inherently involve risks and uncertainties. The Company's actual results could
differ materially from those anticipated in these forward-looking statements
as a result of certain factors, including those set forth in the following
risk factors and elsewhere in this Prospectus.
LIMITED HISTORY OF OPERATIONS LIMITS PRIOR PERFORMANCE AS AN INDICATOR OF
FUTURE PERFORMANCE
The Company commenced operations in August 1995 and began originating loans
in October 1995. Although the Company has been profitable for each fiscal
period presented herein and has experienced substantial growth in mortgage
loan originations and total revenues, there can be no assurance that the
Company will be profitable in the future or that these rates of growth will be
sustainable or indicative of future results.
Since it commenced operations in August 1995, the Company's growth in
originating loans has been significant. In light of this growth, the
historical financial performance of the Company may be of limited relevance in
predicting future performance. Since the Company historically has sold
substantially all loans originated on a whole loan basis, it has not tracked
the performance of its loans in the secondary market and thus is unable to
determine the history of loan losses associated with such loans. If a material
portion of such loans result in loan losses to the holders thereof, the market
for and pricing of the Company's loans could be adversely affected.
NO ASSURANCE OF PLANNED GROWTH; INABILITY OF THE COMPANY TO GROW COULD
ADVERSELY AFFECT THE COMPANY'S OPERATING RESULTS
The Company's total revenues and net income have grown significantly since
inception, primarily due to increased mortgage loan origination and sales
activities. The Company intends to continue to pursue a growth strategy for
the foreseeable future. Since the Company expects recent higher levels of
mortgage broker compensation, which reduce the gain on sale of mortgage loans,
to continue for the three months ending December 31, 1997 and possibly
thereafter, the Company believes that its future operating results will depend
largely upon its ability to expand its mortgage origination and sales
activities. While the Company plans to continue its growth of loan
originations through the expansion of its Wholesale Division and Retail
Division, these plans require additional personnel and assets. There can be no
assurance that the Company will be able to successfully expand and operate
such divisions and programs profitably. It also is expected that such
expansion plans will result in a substantial increase in operating expenses in
the short-run. Furthermore, since management expects that there will be a time
lag between the expenditure of such monies and the receipt of any revenues
from such expansion efforts, the Company's results of operations may be
adversely affected in the short-run. There can be no assurance that the
Company will anticipate and respond effectively to all of the changing demands
that its expanding operations will have on the Company's management,
information and operating systems, and the failure to adapt its systems could
have a material adverse effect on the Company's results of operations and
financial condition. There can be no assurance that the Company will
successfully achieve its planned expansion or, if achieved, that the expansion
will result in profitable operations.
RISK OF VARIATIONS IN QUARTERLY OPERATING RESULTS
Several factors affecting the Company's business can cause significant
variations in its quarterly results of operations. In particular, variations
in the volume of the Company's loan originations, the differences between the
Company's costs of funds and the average interest rates of originated loans,
the inability of the Company to complete significant loan sales transactions
in a particular quarter, and problems generally affecting the mortgage loan
industry can result in significant increases or decreases in the Company's
revenues from quarter to quarter. For example, the Company's total revenues
and net income decreased to $9.6 million and $1.7 million,
7
<PAGE>
respectively, for the three months ended September 30, 1997 as compared to
$10.6 million and $2.5 million, respectively, for the three months ended June
30, 1997. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Quarterly Data." A delay in closing a particular loan
sale transaction during a particular quarter would postpone recognition of
gain on sale of loans. In addition, unanticipated delays in closing a
particular loan sale transaction would also increase the Company's exposure to
interest rate fluctuations by lengthening the period during which its variable
rate borrowings under its warehouse facilities are outstanding. If the Company
were unable to sell a sufficient number of its loans at a premium in a
particular reporting period, the Company's revenues for such period would
decline, resulting in lower net income and possibly a net loss for such
period, which could have a material adverse effect on the Company's results of
operations and financial condition. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
DISCONTINUANCE OF EXCLUSIVE ARRANGEMENTS WITH DLJ COULD ADVERSELY AFFECT THE
COMPANY'S OPERATING RESULTS
The Company commenced operations in August 1995 and prior to this Offering,
has benefitted from its relationship with DLJ, which owned approximately 44%
of the Company's outstanding Common Stock as of September 30, 1997. Since
commencement of operations, DLJ has provided the Company with a $50.0 million
warehouse line of credit to fund operations (the "DLJ Facility"), which has
been the only financing facility the Company has used to date. The interest
rate under the DLJ Facility was equal to the federal funds rate plus 1.0%,
subject to increase based on the length of time loans are held by the Company.
The Company is substantially dependent upon its access to warehouse lines of
credit and other lending facilities in order to fund loan originations.
In October 1997, the Company and DLJ agreed to amend the terms of the DLJ
Facility (the "Amended DLJ Facility") to increase the amount of the DLJ
Facility to $150.0 million and modified the term of the DLJ Facility to two
years after the closing of this Offering. The interest rate of the DLJ
Facility will remain effective until the closing of this Offering; therefore,
borrowings under the Amended DLJ Facility during the first 12 months will bear
interest at the federal funds rate plus 50 basis points and thereafter the
rate will be the federal funds rate plus 100 basis points. See "Business--
Financing and Sale of Loans." It is expected that the Amended DLJ Facility
will not be extended beyond the modified term. The Company is seeking to
obtain additional and alternative sources of financing on favorable terms to
decrease its reliance on DLJ. While the Company is currently negotiating with
other lenders to obtain additional warehouse lines of credit, the Company
currently has no financing commitment for such lines of credit. Any failure by
DLJ to continue to provide financing under the Amended DLJ Facility or the
Company's failure to obtain adequate funding under any additional or
alternative facilities, on favorable terms or otherwise, could cause the
Company to curtail loan origination activities, which could have a material
adverse effect on the Company's operations.
In addition, under the Company's master loan purchase agreement with DLJ,
since the Company commenced business, DLJ has purchased substantially all of
the Company's loan production through whole loan sales. Gain on sales of loans
represents the primary source of the Company's revenues and net income. The
Company relies almost entirely on proceeds from loan sales to generate cash
for repayment of borrowings under the Company's warehouse facilities. There
can be no assurance that DLJ will continue to purchase loans originated by the
Company or will be willing to purchase such loans on terms under which it had
historically purchased the Company's loans. Following the completion of this
Offering, the Company intends to sell loan production to DLJ and other
institutional purchasers in the secondary market. While the Company has
historically assisted DLJ in identifying purchasers of those loans purchased
by DLJ under the master loan purchase agreement (see "Business--Financing and
Sale of Loans--Loan Sales"), there can be no assurance that the Company would
be successful in identifying other institutional purchasers or in negotiating
favorable terms for such loan sales.
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SUBSTANTIAL DEPENDENCE ON WHOLESALE BROKERS
The Company depends largely on independent mortgage brokers, financial
institutions and mortgage bankers for its originations of mortgage loans.
Substantially all of the independent mortgage brokers with whom the Company
does business deal with multiple loan originators for each prospective
borrower. Sub-prime originators, including the Company, compete for business
based upon pricing, service, loan fees and costs and other factors. The
Company's competitors also seek to establish relationships with such
independent mortgage brokers, financial institutions and mortgage bankers,
none of whom is contractually obligated to continue to do business with the
Company. In addition, the Company expects the volume of wholesale loans that
it originates to increase which will depend in large part on maintaining and
expanding its relationships with its independent mortgage brokers. The
Company's future results may become increasingly exposed to fluctuations in
the volume and cost of its wholesale loans resulting from competition from
other originators and purchasers of such loans, market conditions and other
factors.
SUBSTANTIAL COMPETITION MAY ADVERSELY AFFECT THE COMPANY'S ABILITY TO
ORIGINATE OR SELL MORTGAGE LOANS
As an originator of mortgage loans, the Company faces intense competition,
primarily from mortgage banking companies, commercial banks, credit unions,
thrift institutions and finance companies. Many of these competitors are
substantially larger and have more capital and other resources than the
Company. Competition can take many forms, including convenience in obtaining a
loan, customer service, marketing distribution channels and loan pricing.
Furthermore, the current level of gains realized by the Company and its
competitors on the sale of the type of loans they originate and purchase is
attracting and may continue to attract additional competitors into this market
with the possible effect of lowering gains that may be realized on the
Company's loan sales. Establishing a broker-sourced loan business typically
requires a substantially smaller commitment of capital and personnel resources
than a direct-sourced loan business. This relatively low barrier to entry
permits new competitors to enter the broker-sourced loan market quickly,
particularly existing direct-sourced lenders which can draw upon existing
branch networks and personnel in seeking to sell products through independent
brokers. Competition may be affected by fluctuations in interest rates and
general economic conditions. During periods of rising rates, competitors which
have locked in low borrowing costs may have a competitive advantage. See
"Business--Competition."
Increased competition could have the possible effects of (i) lowering gains
that may be realized on the Company's loan sales, (ii) reducing the volume of
the Company's loan originations and loan sales, (iii) increasing the demand
for the Company's experienced personnel and the potential that such personnel
will be recruited by the Company's competitors and (iv) lowering the industry
standard for sub-prime underwriting guidelines (i.e., providing for higher
loan-to-value ratios) as competitors attempt to increase or maintain market
share in the face of increased competition.
There can be no assurance that the Company will be able to continue to
compete successfully in the markets it serves. Inability to compete
successfully would have a material adverse effect on the Company's results of
operations and financial condition.
RISK OF COMPETITION IN NEW MARKETS
As the Company expands into new geographic markets, it may face competition
from lenders with established positions in these locations. There can be no
assurance that the Company will be able to successfully compete with such
established lenders.
RISK OF COMPETITION FROM GOVERNMENT-SPONSORED ENTITIES
In the future, the Company may also face competition from, among others,
government-sponsored entities which may enter the sub-prime mortgage market.
Existing or new loan purchase programs may be expanded by
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the Federal National Mortgage Association ("FNMA"), the Federal Home Loan
Mortgage Corporation ("FHLMC"), or the Government National Mortgage
Association ("GNMA") to include sub-prime mortgages, particularly those in the
"A-" category, which constitute a significant portion of the Company's loan
production. For example, the FHLMC has announced that it is entering the sub-
prime market in 1998. Entries of such government-sponsored entities into the
sub-prime market may have an adverse effect on loan yields on mortgage loans
originated by the Company and reduce or eliminate premiums on loan sales.
GENERAL ECONOMIC CONDITIONS MAY ADVERSELY AFFECT COMPANY OPERATIONS
The Company's business may be adversely affected by periods of economic
slowdown or recession which may be accompanied by decreased demand for
consumer credit and declining real estate values. Any material decline in real
estate values reduces the ability of borrowers to use home equity to support
borrowings and increases the loan-to-value ratios of loans previously made by
the Company, thereby weakening collateral coverage and increasing the
possibility of a loss in the event of default. To the extent that the loan-to-
value ratios of prospective borrowers' home equity collateral do not meet the
Company's underwriting criteria, the volume of loans originated by the Company
could decline. Further, delinquencies, foreclosures and losses generally
increase during economic slowdowns or recessions. Because of the Company's
focus on borrowers who are unable or unwilling to obtain mortgage financing
from conventional mortgage sources, whether for reasons of credit impairment,
income qualification or credit history or a desire to receive funding on an
expedited basis, the actual rates of delinquencies, foreclosures and losses on
such loans could be higher under adverse economic conditions than those
currently experienced in the mortgage lending industry in general. Any
sustained period of such increased delinquencies, foreclosures or losses could
adversely affect the pricing of the Company's loan sales whether through whole
loan sales or future securitizations. A decline in loan origination volumes
could have a material adverse effect on the Company's operations and financial
condition.
CHANGES IN INTEREST RATES MAY ADVERSELY AFFECT NET INCOME AND PROFITABILITY
Profitability may be directly affected by the level of and fluctuations in
interest rates which affect the Company's ability to earn a spread between
interest received on its loans held for sale and rates paid on warehouse
lines. The Company's profitability may be adversely affected during any period
of unexpected or rapid change in interest rates due to the fact that the
Company does not currently hedge its portfolio of mortgage loans held for
sale. A substantial and sustained increase in interest rates could adversely
affect the Company's ability to originate loans. Also, a significant decline
in interest rates could increase the level of loan prepayments and require the
Company to write down the value of the interest-only and residual certificates
retained in any future securitizations, thereby adversely impacting earnings.
Adjustable-rate mortgage loans originated by the Company amounted to $20.7
million, $110.9 million and $96.9 million in principal amount during the three
months ended September 30, 1997 and the years ended June 30, 1997 and 1996,
respectively. Substantially all such adjustable-rate mortgage loans included a
"teaser" rate, i.e., an initial interest rate significantly below the fully
indexed interest rate at origination. Although these loans are underwritten at
1.0% above the initial or start rate at origination, borrowers may encounter
financial difficulties as a result of increases in the interest rate over the
life of the loan, which may impact the performance of the Company's loans in
the secondary market.
SUBSTANTIAL RISKS RELATED TO LENDING TO LOWER CREDIT GRADE BORROWERS
The Company is a lender in the sub-prime mortgage banking industry, which
means that the Company focuses its marketing efforts on borrowers who may be
unable to obtain mortgage financing from conventional mortgage sources.
Approximately 3.9% of the total principal amount of loans originated by the
Company during each of the three months ended September 30, 1997 and the year
ended June 30, 1997 were to borrowers with a Company risk classification of
"C-", which includes borrowers with numerous derogatory credit items up to and
including a bankruptcy in the most recent 12 month period. In addition, for
the three months ended September 30, 1997 and the year ended June 30, 1997,
approximately 52.8% and 48.8%, respectively, of the
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Company's total loan organizations were under its "Stated Income
Documentation" program pursuant to which the Company does not require any
income documentation. Loans made to such sub-prime borrowers entail a higher
risk of delinquency and higher losses than loans made to borrowers who utilize
conventional mortgage sources. Delinquencies, foreclosures and losses
generally increase during economic slowdowns or recessions. Further, any
material decline in real estate values increase the loan-to-value ratios of
loans previously made by the Company, thereby weakening collateral coverage
and increasing the possibility of a loss in the event of a borrower default.
Any sustained period of increased delinquencies, foreclosures or losses after
the loans are sold could adversely affect the pricing of the Company's future
loan sales and the ability of the Company to sell its loans in the future. See
"Business--Underwriting."
ELIMINATION OF LENDER PAYMENTS TO BROKERS COULD ADVERSELY AFFECT RESULTS OF
OPERATIONS
Lawsuits have been filed against several mortgage lenders, alleging that
such lenders have made certain payments to independent mortgage brokers in
violation of the Federal Real Estate Settlement Procedures Act of 1974, as
amended ("RESPA"). These lawsuits have generally been filed on behalf of a
purported nationwide class of borrowers alleging that payments made by a
lender to a broker in addition to payments made by the borrower to a broker
are prohibited by RESPA and are therefore illegal. If these cases are resolved
against the lenders, it may cause an industry-wide change in the way
independent mortgage brokers are compensated. The Company's broker
compensation programs permit such payments. The Company makes such payments in
the ordinary course of business. Due to competitive conditions, these payments
have increased in recent periods, which adversely affected the Company's gain
on sale of mortgage loans for the three months ended September 30, 1997.
Management expects this increased level of payments to continue for the three
months ending December 31, 1997 and possibly thereafter. Although the Company
believes that its broker compensation programs comply with all applicable laws
and are consistent with long-standing industry practice and regulatory
interpretations, in the future new regulatory interpretations or judicial
decisions may require the Company to change its broker compensation practices.
Such a change may have a material adverse effect on the Company and the entire
mortgage lending industry.
POTENTIAL ADVERSE EFFECT OF REPRESENTATIONS AND WARRANTIES IN LOAN SALES
Loan sales are made to DLJ on a non-recourse basis pursuant to a master loan
purchase agreement containing customary representations and warranties by the
Company regarding the underwriting criteria and the origination process. The
Company is required to provide similar representations and warranties to those
institutional purchasers to whom DLJ sells the subject loans. The Company,
therefore, may be required to repurchase or substitute loans in the event of a
breach of a representation or warranty to DLJ or the institutional purchaser,
any misrepresentation during the mortgage loan origination process or, in some
cases, upon any fraud or first payment default on such mortgage loans. In an
environment of rapid whole loan sales, the Company may not have substitute
loans which are not previously committed for sale readily available in which
case the Company would be required to effect a repurchase. During the year
ended June 30, 1997, the Company repurchased $178,000 of loans; no loans were
repurchased during the three months ended September 30, 1997 and the year
ended June 30, 1996. There can be no assurance that such repurchase levels
will not substantially increase in future periods. Any claims asserted against
the Company in the future by its loan purchasers may result in liabilities or
legal expenses that could have a material adverse effect on the Company's
results of operations and financial condition. In addition, any material
repurchase or substitution of loans may have an adverse effect on the market
for and pricing of the Company's loans.
DEPENDENCE ON A LIMITED NUMBER OF KEY PERSONNEL
The Company's growth and development to date have been largely dependent
upon the services of Evan R. Buckley, the Company's Chief Executive Officer,
and Kelly W. Monahan, the Company's Chief Financial Officer. The loss of
Messrs. Buckley's or Monahan's services for any reason could have a material
adverse effect on the Company. In addition, the Company's future success will
require it to recruit additional
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key personnel, including additional sales and marketing personnel. The Company
believes that its future success also substantially depends on its ability to
attract, retain and motivate highly skilled employees, who are in great
demand. There can be no assurance that the Company will be successful in doing
so.
COMPANY PERFORMANCE MAY BE AFFECTED BY CONTRACTED SUB-SERVICING
While the Company currently sells substantially all of the mortgage loans it
originates servicing released, it is required to service the loans from the
date of funding through the date of sale. Since the Company conducts whole
loan sales monthly, the Company currently does not have a substantial
servicing portfolio. Nonetheless, the Company currently contracts for the sub-
servicing of all mortgage loans it originates through the date of sale and is
subject to risks associated with inadequate or untimely services. To the
extent that the Company decides to retain servicing rights in the future or
conduct securitizations, it currently intends to contract for the sub-
servicing of such mortgage loans, which would expose it to more substantial
risks associated with contracted sub-servicing. In such event, it is expected
that many of the Company's borrowers will require notices and reminders to
keep their mortgage loans current and to prevent delinquencies and
foreclosures. A substantial increase in the Company's delinquency rate or
foreclosure rate could adversely affect its ability to access profitably the
capital market for its financing needs, including any future securitizations.
Any of the Company's sub-servicing agreements with its third-party sub-
servicers are expected to provide that if the Company terminates the agreement
without cause (as defined in the agreement), the Company may be required to
pay the third-party sub-servicer a fee. Depending upon the size of the
Company's loan portfolio sub-serviced at any point in time, the termination
penalty that the Company would be obligated to pay upon termination without
cause, may be substantial.
The Company intends to subcontract with sub-servicers to service the
mortgage loans for any of its public securitizations. With respect to such
mortgage loans, the related pooling and servicing agreements would permit the
Company to be terminated as master servicer under specific conditions
described in such agreements, which generally include the failure to make
payments, including advances, within specific time periods. Such termination
would generally be at the option of the trustee but not at the option of the
Company. If, as a result of a sub-servicer's failure to perform adequately,
the Company were terminated as master servicer of a securitization, the value
of any servicing rights held by the Company would be adversely impacted. In
addition, if a new sub-servicer were selected with respect to any such
securitization, the change in sub-servicing may result in greater
delinquencies and losses on the related loans, which would adversely impact
the value of any "interest-only," "principal-only," residual interest and
subordinated securities held by the Company in connection with such
securitization.
SUBSTANTIAL RISKS ASSOCIATED WITH FUTURE SECURITIZATIONS
The Company may in the future sell loans through securitizations which
involve substantial risks, including the following:
Inability to Securitize Mortgage Loans. The Company anticipates that it may
in the future acquire and accumulate mortgage loans until a sufficient
quantity has been acquired for securitization. There can be no assurance that
the Company will be successful in securitizing mortgage loans. During the
accumulation period, the Company will be subject to risks of borrower defaults
and bankruptcies, fraud losses and special hazard losses. In the event of any
default under mortgage loans held by the Company, the Company will bear the
risk of loss of principal to the extent of any deficiency between the value of
the mortgage collateral and the principal amount of the mortgage loan. Also
during the accumulation period, the costs of financing the mortgage loans
through warehouse lines of credit or reverse repurchase agreements could
exceed the interest income on the mortgage loans. It may not be possible or
economical for the Company to complete the securitization of all mortgage
loans that it acquires, in which case the Company will continue to hold the
mortgage loans and bear the risks of borrower defaults and special hazard
losses.
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Potential Recourse Against Company in Securitizations. To the extent that
the Company engages in securitizations, the Company intends to transfer loans
originated by the Company to a trust in exchange for cash, "interest-only" and
residual certificates issued by the trust. The trustee will have recourse to
the Company with respect to the breach of standard representations or
warranties made by the Company at the time such loans are transferred.
Value of Interest-Only, Principal-Only, Residual Interest and Subordinated
Securities Subject to Fluctuation. To the extent that the Company engages in
securitizations, the Company's assets will likely include "interest-only,"
"principal-only," residual interest and subordinated securities, which will be
valued by the Company in accordance with SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities." The Company will record its retained interest in securitizations
(including "interest-only," "principal-only" and subordinated securities) as
investments classified as trading securities. Realization of these "interest-
only," "principal-only," residual interest and subordinated securities in cash
is subject to the timing and ultimate realization of cash flows associated
therewith, which is in turn effected by the prepayment and loss
characteristics of the underlying loans. The Company will estimate future cash
flows from these "interest-only," "principal-only," residual interest and
subordinated securities and will value such securities with assumptions that
it believes to be consistent with those that would be utilized by an
unaffiliated third-party purchaser. If actual experience differs from the
assumptions used in the determination of the asset value, future cash flows
and earnings could be negatively impacted, and the Company could be required
to reduce the value of its "interest-only," "principal-only," residual
interest and subordinated securities in accordance with SFAS 125. The value of
such securities can fluctuate widely and may be extremely sensitive to changes
in discount rates, projected mortgage loan prepayments and loss assumptions.
Risks Regarding Hedging. In the future the Company may hedge its variable-
rate mortgage loans and any interest-only and residual certificates retained
in connection with any future securitizations with hedging transactions which
may include forward sales of mortgage loans or mortgage-backed securities,
interest rate caps and floors and buying and selling of futures and options on
futures. The nature and quantity of hedging transactions will be determined by
the Company's management based on various factors, including market conditions
and the expected volume of mortgage loan originations and purchases. No
assurance can be given that such hedging transactions will offset the risks of
changes in interest rates, and it is possible that there will be periods
during which the Company could incur losses after accounting for its hedging
activities.
POSSIBLE NEED FOR ADDITIONAL EQUITY FINANCING
The Company's primary operating cash requirements include the funding or
payment of (i) loan originations, (ii) interest expense incurred on borrowings
under warehouse lines of credit, (iii) income taxes, (iv) capital expenditures
and (v) other operating and administrative expenses. The Company funds these
cash requirements primarily through warehouse lines of credit and whole loan
sales. In addition, if the Company conducts securitizations, it would require
liquidity to fund its investments in "interest-only" and residual certificates
and for fees and expenses incurred with securitizations. The Company's ability
to implement its business strategy will depend upon its ability to establish
alternative long-term financing arrangements with parties other than DLJ and
obtain sufficient financing under warehouse facilities upon acceptable terms.
There can be no assurance that such financing will be available to the Company
on favorable terms, if at all. If such financing were not available or the
Company's capital requirements exceed anticipated levels, then the Company
would be required to obtain additional equity financing which would dilute the
interests of stockholders who invest in this Offering. The Company cannot
presently estimate the amount and timing of additional equity financing
requirements because such requirements are tied to, among other things, the
growth of the Company. If the Company were unable to raise such additional
capital, its results of operations and financial condition would be adversely
affected. See "Management's Discussion and Analysis of Results of Operations
and Financial Condition--Liquidity and Capital Resources."
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CONCENTRATION OF OPERATIONS MAY ADVERSELY AFFECT COMPANY OPERATIONS
Approximately 31.1%, 36.9% and 53.6% of the dollar volume of loans
originated by the Company during the three months ended September 30, 1997 and
the years ended June 30, 1997 and 1996 were secured by properties located in
California. No other state contained properties securing more than 10% of the
dollar volume of loans originated by the Company during such periods, other
than Florida which accounted for 10.1% for the three months ended September
30, 1997, Illinois which accounted for 13.0% and 10.4% for the three months
ended September 30, 1997 and year ended June 30, 1997, respectively, and
Hawaii which accounted for 12.0% for the year ended June 30, 1997. Although
the Company has a growing independent broker network outside of California,
the Company is likely to continue to have a significant amount of its loan
originations in California for the foreseeable future, primarily because
California represents a significant portion of the national mortgage
marketplace. Consequently, the Company's results of operations and financial
condition are dependent upon general trends in the California economy and its
residential real estate market. The California economy experienced a slowdown
or recession in recent years that has been accompanied by a sustained decline
in the California real estate market. Residential real estate market declines
may adversely affect the values of the properties securing loans such that the
principal balances of such loans will equal or exceed the value of the
mortgaged properties. Reduced collateral value will adversely affect the
volume of the Company's loans as well as the pricing of the Company's mortgage
loans and the Company's ability to sell its loans.
In addition, California historically has been vulnerable to certain natural
disaster risks, such as earthquakes and erosion-caused mudslides, which are
not typically covered by the standard hazard insurance policies maintained by
borrowers. Uninsured disasters may adversely impact borrowers' ability to
repay mortgage loans made by the Company, any sustained period of increased
delinquencies or defaults could adversely affect the pricing of the Company's
future loan sales and the ability of the Company to sell its loans. The
existence of adverse economic conditions or the occurrence of such natural
disasters in California could have a material adverse effect on the Company's
results of operations and financial condition.
REAL PROPERTY WITH ENVIRONMENTAL PROBLEMS MAY CREATE LIABILITY FOR THE COMPANY
In the course of its business, the Company may acquire real property
securing loans that are in default. There is a risk that hazardous substances
or waste, contaminants, pollutants or sources thereof could be discovered on
such properties after acquisition by the Company. In such event, the Company
might be required to remove such substances from the affected properties at
its sole cost and expense. The cost of such removal may substantially exceed
the value of the affected properties or the loans secured by such properties.
There can be no assurance that the Company would have adequate remedies
against the prior owners or other responsible parties, or that the Company
would not find it difficult or impossible to sell the affected real properties
either prior to or following any such removal.
COMPANY SUBJECT TO EXTENSIVE LEGISLATIVE AND REGULATORY RISKS
The Company's business is subject to extensive regulation, supervision and
licensing by federal, state and local governmental authorities and is
subjected to various laws and judicial and administrative decisions imposing
requirements and restrictions on a substantial portion of its operations. The
Company's consumer lending activities are subject to the Federal Truth-in-
Lending Act and Regulation Z (including the Home Ownership and Equity
Protection Act of 1994), the Federal Equal Credit Opportunity Act and
Regulation B, as amended ("ECOA"), the Fair Credit Reporting Act of 1970, as
amended, RESPA and Regulation X, the Fair Housing Act, the Home Mortgage
Disclosure Act and the Federal Debt Collection Practices ACT, as well as other
federal and state statutes and regulations affecting the Company's activities.
The Company is also subject to the rules and regulations of and examinations
by the Department of Housing and Urban Development ("HUD") and state
regulatory authorities with respect to originating, processing, underwriting,
selling, securitizing and servicing loans. These rules and regulations, among
other things, impose licensing obligations on the Company, establish
eligibility criteria for mortgage loans, prohibit discrimination, provide for
inspections and appraisals of properties, require credit reports on loan
applicants, regulate assessment, collection, foreclosure
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and claims handling, investment and interest payments on escrow balances and
payment features, mandate certain disclosures and notices to borrowers and, in
some cases, fix maximum interest rates, fees and mortgage loan amounts.
Failure to comply with these requirements can lead to loss of approved status,
termination or suspension of servicing contracts without compensation to the
servicer, demands for indemnifications or mortgage loan repurchases, certain
rights of rescission for mortgage loans, class action lawsuits and
administrative enforcement actions.
The Company is subject to licensing by state authorities. In addition, any
person who acquires more than 10% of the Company's stock will become subject
to certain state licensing regulations requiring such person periodically to
file certain financial and other information. If any person holding more than
10% of the Company's stock refuses to adhere to such filing requirements, the
Company's existing licensing arrangements could be jeopardized. The loss of
required licenses could have a material adverse effect on the Company's
results of operations and financial condition.
Although the Company believes that it has systems and procedures to
facilitate compliance with these requirements and believes that it is in
compliance in all material respects with applicable local, state and federal
laws, rules and regulations, there can be no assurance that more restrictive
laws, rules and regulations will not be adopted in the future that could make
compliance more difficult or expensive.
Members of Congress and government officials have from time to time
suggested the elimination of the mortgage interest deduction for federal
income tax purposes, either entirely or in part, based on borrower income,
type of loan or principal amount. Because many of the Company's loans are made
to borrowers for the purpose of consolidating consumer debt or financing other
consumer needs, the competitive advantage of tax deductible interest, when
compared with alternative sources of financing, could be eliminated or
seriously impaired by such government action. Accordingly, the reduction or
elimination of these tax benefits could have a material adverse effect on the
demand for loans of the kind offered by the Company.
CONTROL OF THE COMPANY BY CURRENT MANAGEMENT
After the Offering, the officers and directors of the Company will
beneficially own 33.0% of the outstanding Common Stock of the Company (or
approximately 30.3% of the outstanding Common Stock if the Underwriters' over-
allotment option is exercised in full). As a result, the Company's current
management through its stock ownership and otherwise will be able to exert
significant influence over the business and affairs of the Company. See
"Management" and "Principal and Selling Stockholders."
ANTI-TAKEOVER EFFECT OF DELAWARE LAW
The Company intends to reincorporate as a Delaware corporation prior to
completion of the Offering and as such will be subject to the anti-takeover
provisions of Section 203 of the Delaware General Corporation Law. In general,
Section 203 prevents an "interested stockholder" (defined generally as a
person owning more than 15% or more of the Company's outstanding voting stock)
from engaging in a "business combination" with the Company for three years
following the date that person became an interested stockholder unless the
business combination is approved in a prescribed manner. This statute could
make it more difficult for a third party to acquire control of the Company.
See "Description of Capital Stock--Certain Provisions of Delaware Law."
ISSUANCE OF PREFERRED STOCK MAY ADVERSELY AFFECT HOLDERS OF COMMON STOCK
The Board of Directors has the authority to issue up to 5,000,000 shares of
undesignated Preferred Stock and to determine the rights, preferences,
privileges and restrictions of such shares without any further vote or action
by the stockholders. Although at present the Company has no plans to issue any
of the Preferred Stock, the Preferred Stock could be issued with voting,
liquidation, dividend and other rights superior to the rights of the Common
Stock. The issuance of Preferred Stock under certain circumstances could have
the effect of delaying or preventing a change in control of the Company. See
"Description of Capital Stock."
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NO ASSURANCE OF ACTIVE TRADING MARKET FOR COMMON STOCK; DETERMINATION OF
OFFERING PRICE
Prior to this Offering, there has been no public market for the Common Stock
of the Company. Although the Company intends to apply for quotation of the
Common Stock on the Nasdaq National Market, there can be no assurance that an
active public trading market for the Common Stock will develop after the
Offering or that, if developed, it will be sustained. The public offering
price of the Common Stock offered hereby has been determined by negotiations
between the Company and the Representatives of the Underwriters and may not be
indicative of the price at which the Common Stock will trade after the
Offering. See "Underwriting." Consequently, there can be no assurance that the
market price for the Common Stock will not fall below the initial public
offering price.
The Company may increase its capital by making additional private or public
offerings of its Common Stock, securities convertible into its Common Stock or
debt securities. The actual or perceived effect of such offerings, the timing
of which cannot be predicted, may be the dilution of the book value or
earnings per share of the Common Stock outstanding, which may result in the
reduction of the market price of the Common Stock.
SHARES ELIGIBLE FOR FUTURE SALE MAY ADVERSELY AFFECT THE MARKET PRICE OF THE
COMPANY'S COMMON STOCK
The sales of substantial amounts of the Company's Common Stock in the public
market or the prospect of such sales could materially and adversely affect the
market price of the Common Stock. Upon completion of this Offering, the
Company will have outstanding 7,500,000 shares of Common Stock. The 4,438,144
shares of Common Stock offered hereby will be immediately eligible for sale in
the public market without restriction beginning on the date of this
Prospectus. The remaining 3,061,856 shares of Common Stock are restricted in
nature and are saleable to the extent permitted for "affiliates" pursuant to
Rule 144 under the Securities Act. The Company and its executive officers,
directors and stockholders have agreed that they will not, without the prior
written consent of the Representatives (which consent may be withheld in its
sole discretion) and subject to certain limited exceptions, sell, transfer, or
otherwise dispose of any shares of Common Stock, options or warrants to
acquire Common Stock, or securities exchangeable or exercisable for or
convertible into Common Stock for a period commencing on the date of this
Prospectus and continuing to a date 180 days after such date. See "Shares
Eligible for Future Sale" and "Underwriting." The Stock Option Plan authorizes
the grant of options to purchase, and awards of, 900,000 shares; of this
amount, options to acquire 200,000 shares of Common Stock were granted prior
to this Offering at a per share exercise price of $5.00. In addition, it is
expected that stock options for an additional 400,000 shares of Common Stock
will be granted to certain employees, officers and directors of the Company on
the date of this Offering at a per share exercise price equal to the initial
public offering price. The Company intends to register under the Securities
Act of 1933, as amended (the "Securities Act"), shares reserved for issuance
pursuant to the Stock Option Plan.
IMMEDIATE AND SUBSTANTIAL DILUTION
The initial public offering price is substantially higher than the book
value per outstanding shares of the Common Stock. Purchasers of the Common
Stock will experience immediate and substantial dilution in pro forma net
tangible book value per share of Common Stock from the initial public offering
price per share of Common Stock. See "Dilution."
16
<PAGE>
USE OF PROCEEDS
The net proceeds to be received by the Company from the sale of the
2,000,000 shares of Common Stock offered by the Company at an assumed initial
public offering price of $10.00 (after deducting the estimated underwriting
discount and offering expenses payable by the Company), are estimated to be
$18.2 million. The Company intends to apply the net proceeds from this
Offering to fund future loan originations and for general corporate purposes.
Prior to their eventual use, the net proceeds will be invested in high
quality, short-term investment instruments such as short-term corporate
investment grade or United States Government interest-bearing securities. The
Company will not receive any proceeds from the sale of Common Stock by the
Selling Stockholder.
DIVIDEND POLICY
The Company has never paid any cash dividends on its Common Stock. The
Company intends to retain all of its future earnings to finance its operations
and does not anticipate paying cash dividends in the foreseeable future. Any
decision made by the Company's Board of Directors to declare dividends in the
future will depend upon the Company's future earnings, capital requirements,
financial condition and other factors deemed relevant by the Company's
Directors.
17
<PAGE>
DILUTION
The pro forma net tangible book value of the Company at September 30, 1997
was $9,147,000 or $1.66 per share. Pro forma net tangible book value per share
represents the amount of the Company's total tangible assets less total
liabilities, divided by the number of shares of Common Stock outstanding,
after giving effect to the Stock Repurchase. After giving effect to the
receipt by the Company of the net proceeds from the sale of the shares of
Common Stock offered hereby at an assumed initial public offering price of
$10.00 per share and the application of the net proceeds therefrom, after
deducting the estimated underwriting discount and offering expenses, the pro
forma as adjusted net tangible book value of the Company at September 30, 1997
would have been $27,362,000 or $3.65 per share. This represents an immediate
increase in pro forma net tangible book value of $1.99 per share to the
existing stockholders and an immediate dilution of $6.35 per share to new
investors purchasing shares in this Offering. The following table illustrates
this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share.................... $10.00
Pro forma net tangible book value per share before this Offering. $1.66
Increase per share attributable to new investors................. 1.99
-----
Pro forma net tangible book value per share after this Offering.... 3.65
------
Dilution per share to new investors................................ $ 6.35
======
</TABLE>
The following table summarizes on a pro forma basis as of September 30,
1997, after giving effect to the Stock Repurchase, the differences between
existing stockholders and new investors (before deducting underwriting
discounts and commissions and estimated offering expenses) with respect to the
number of shares of Common Stock purchased from the Company, the total
consideration paid and the average price per share:
<TABLE>
<CAPTION>
SHARES OWNED
AFTER THE
OFFERING TOTAL CONSIDERATION
----------------- ------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders....... 3,061,856 40.82% $ 6,300 0.01% --
New investors............... 4,438,144 59.18 44,381,440 99.99 $10.00
--------- ------ ----------- ------
Total..................... 7,500,000 100.00% $44,387,740 100.00%
========= ====== =========== ======
</TABLE>
18
<PAGE>
CAPITALIZATION
The following table sets forth, as of September 30, 1997, the Company's (i)
actual capitalization, (ii) pro forma capitalization after giving effect to
the Stock Repurchase and (iii) capitalization as adjusted to reflect the sale
by the Company of the 2,000,000 shares of Common Stock offered by the Company
hereby at an assumed initial public offering price of $10.00 per share and
application of the net proceeds therefrom (after deducting the estimated
underwriting discount and offering expenses payable by the Company). This
table should be read in conjunction with the Consolidated Financial Statements
and the Notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AT SEPTEMBER 30, 1997
---------------------------
PRO AS
ACTUAL FORMA ADJUSTED(1)
------- ------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Warehouse line of credit............................ $58,961 $58,961 $58,961
======= ======= =======
Stockholders' Equity(2):
Preferred Stock, $.001 par value; 5,000,000 shares
authorized,
Series A Preferred Stock, $.001 par value, 1,000
shares authorized, 160 shares issued and
outstanding actual; none issued and outstanding
pro forma and as adjusted........................ $ 1,575 $ -- $ --
Common Stock, $.001 par value; 50,000,000 shares
authorized(3); 5,500,000 shares issued and
outstanding actual and pro forma; 7,500,000
shares issued and outstanding as adjusted........ 6 6 8
Additional paid-in capital........................ -- -- 18,213
Retained Earnings................................. 9,141 9,141 9,141
------- ------- -------
Total stockholders' equity and capitalization... $10,722 $ 9,147 $27,362
======= ======= =======
</TABLE>
- --------
(1) After deducting the estimated underwriting discount and offering expenses
payable by the Company, and assuming no exercise of the Underwriters'
over-allotment option.
(2) Gives effect to (i) a 5,670.1031-for-1 stock split of the outstanding
shares of Common Stock, (ii) the reincorporation of the Company in
Delaware and the authorization of 50,000,000 shares of Common Stock and
5,000,000 shares of Preferred Stock, and (iii) the conversion of all
outstanding shares of Class A and Class B Common Stock into shares of
$.001 par value Common Stock on a one-for-one basis, each of which will be
effected prior to the consummation of this Offering.
(3) Excludes shares reserved for issuance pursuant to the Company's Stock
Option Plan. The Stock Option Plan authorizes the grant of options to
purchase, and awards of, 900,000 shares; of this amount, options to
acquire 200,000 were granted prior to this Offering at a per share
exercise price of $5.00. Options to acquire an additional 400,000 shares
are expected to be granted to employees, officers and directors of the
Company at the effective date of this Offering at a per share exercise
price equal to the initial public offering price. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
General" and "Management--Stock Options."
19
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
(In thousands, except per share data and ratios)
The following selected statement of operations data for the years ended June
30, 1996 and 1997 and the balance sheet data at June 30, 1996 and 1997 are
derived from consolidated financial statements of the Company included
elsewhere in this Prospectus, which have been audited by Ernst & Young LLP,
independent auditors, as indicated in their report included elsewhere in this
Prospectus, and are qualified by reference to such financial statements
including the related notes thereto. The selected statements of operations
data for the three months ended September 30, 1996 and 1997 and the balance
sheet data at September 30, 1997 have been derived from unaudited interim
condensed consolidated financial statements of the Company contained elsewhere
herein and reflect in management's opinion, all adjustments, consisting only
of normal recurring adjustments, necessary for a fair presentation of
financial position and results of operations for these periods. Results of
operations for the three months ended September 30, 1997 are not necessarily
indicative of results to be expected for the year ending June 30, 1998. The
selected financial data set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements, notes thereto and the
independent auditors' report included elsewhere in this Prospectus. The
Company was formed on May 2, 1995 and began operations in August 1995. For the
period of May 2, 1995 through June 30, 1995, the Company did not have any
revenue and recorded start-up costs of $10,000. Financial statements are not
presented for the period May 2, 1995 through June 30, 1995 as the operations
were not material.
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
JUNE 30, SEPTEMBER 30,
---------------- ---------------
1996 1997 1996 1997
------- -------- ------- -------
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Gain on sale of mortgage loans.............. $ 4,240 $ 21,855 $ 3,410 $ 6,635
Loan origination income..................... 1,978 5,473 1,022 1,240
Interest income............................. 1,960 5,182 1,101 1,645
Other income................................ 52 250 39 102
------- -------- ------- -------
Total revenues............................ 8,230 32,760 5,572 9,622
------- -------- ------- -------
Expenses:
Employees' salaries and commissions......... 3,624 11,052 1,837 3,505
General and administrative expense.......... 2,400 5,543 1,055 2,048
Interest expense............................ 1,452 3,693 846 1,179
------- -------- ------- -------
Total expenses............................ 7,476 20,288 3,738 6,732
------- -------- ------- -------
Income before taxes........................... 754 12,472 1,834 2,890
Income tax expense............................ 337 4,930 723 1,193
------- -------- ------- -------
Net income.................................. $ 417 $ 7,542 $ 1,111 $ 1,697
======= ======== ======= =======
Pro forma net income per share................ $ 0.10 $ 1.31 $ 0.20 $ 0.30
======= ======== ======= =======
Shares used in computing pro forma net income
per share(1)................................. 3,985 5,776 5,543 5,722
</TABLE>
<TABLE>
<CAPTION>
AT JUNE 30, AT SEPTEMBER 30, 1997
--------------- -------------------------
1996 1997 ACTUAL PRO FORMA (2)
------- ------- ---------- --------------
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents............ $ 2,452 $ 8,268 $ 9,111 $ 7,536
Restricted cash...................... -- -- 605 605
Mortgage loans held for sale......... 42,723 55,145 59,431 59,431
Total assets......................... 46,352 65,713 72,180 70,605
Warehouse line of credit............. 42,723 54,625 58,961 58,961
Total liabilities.................... 44,506 56,509 61,458 61,458
Total stockholders' equity........... 1,846 9,204 10,722 9,147
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED JUNE 30, SEPTEMBER 30,
-------------------- --------------------
1996 1997 1996 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
OPERATING STATISTICS:
Loan originations:
Mortgage loan originations....... $ 199,963 $ 532,621 $ 93,427 $ 164,402
Average initial principal balance
per loan........................ $ 101 $ 98 $ 97 $ 94
Weighted average interest rate:
Fixed rate residential loans.... 10.7% 10.5% 11.0% 10.5%
Variable rate residential loans. 9.2% 9.4% 9.4% 9.5%
Small commercial rate loans(3).. -- 9.8% -- --
Weighted average, initial loan-
to-value ratios................ 68.5% 69.3% 68.2% 72.0%
Whole loan sales................. $ 156,559 $ 519,909 $ 103,140 $ 159,517
Credit risk(4):
A+.............................. 9.7% 30.7% 20.9% 40.8%
A-.............................. 41.9% 26.7% 34.7% 24.5%
B............................... 26.0% 18.9% 21.2% 19.3%
C+.............................. 12.0% 10.7% 13.2% 8.4%
C............................... 7.7% 5.7% 7.3% 3.1%
C-.............................. 2.7% 3.9% 2.7% 3.9%
Small commercial(3)............. -- 3.4% -- --
</TABLE>
- --------
(1) See Note 1 of Notes to Consolidated Financial Statements.
(2) Pro forma reflects the Stock Repurchase.
(3) The Company discontinued the origination of small commercial loans in April
1997.
(4) Credit ratings are based on the Company's classification of loan products.
See "Business--Underwriting Guidelines."
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Company's
consolidated financial statements and notes thereto appearing elsewhere
herein.
GENERAL
The Company is a specialty finance company engaged in the business of
originating and selling sub-prime residential mortgage loans secured by one-
to-four family residences. The Company's principal borrower base consists of
individuals who do not qualify under traditional lending criteria established
by agencies such as FNMA and FHLMC, because of their credit history, income or
other factors. The Company originates loans through independent mortgage
brokers and, to a lesser extent, through its retail origination division.
Substantially all of the Company's mortgage loan originations are sold in the
secondary market through loan sales in which the Company disposes of its
entire economic interest in the loans including the related servicing rights
for cash. See "Business."
The following table shows the Company's mortgage loan originations, mortgage
loan sales, and origination locations with account executives for the periods
indicated:
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED JUNE ENDED SEPTEMBER
30, 30,
----------------- -----------------
1996 1997 1996 1997
-------- -------- -------- --------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C> <C>
Mortgage loan originations.............. $199,963 $532,621 $ 93,427 $164,402
Mortgage loan sales..................... $156,559 $519,909 $103,140 $159,517
Origination locations at end of period . 19 38 27 53
</TABLE>
Revenues are derived primarily from gain on sales of loans and interest
income from loans held for sale. The major components of the Company's
revenues are (i) the volume of loans originated, (ii) the premium over
principal amount received in loan sales, (iii) origination points received or
paid, (iv) origination fees received and (v) the differential between the
interest rate on borrowings under revolving warehouse credit facilities and
the interest rate of loans held for sale. Gain on sale of mortgage loans is
affected by, among other things, borrower credit risk classification, loan-to-
value ratio, interest rate and margin of the loans. Revenues increased to $9.6
million and $32.8 million for the three months ended September 30, 1997 and
the year ended June 30, 1997, respectively, compared to $5.6 million and $8.2
million for the three months ended September 30, 1996 and the year ended June
30, 1996, respectively.
The major components of expenses are employees' salaries and commissions,
general and administrative, and interest. Employees' salaries and commissions,
which for the three months ended September 30, 1997 and the years ended June
30, 1997 and 1996 accounted for 52.1%, 54.5% and 48.5% of total expenses,
respectively, is significantly related to the loan origination volume because
the Company's sales force is compensated on a commission basis in addition to
salaries. Total expenses increased to $6.7 million and $20.3 million for the
three months ended September 30, 1997 and the year ended June 30, 1997,
respectively, compared to $3.7 million and $7.5 million for the three months
ended September 30, 1996 and the year ended June 30, 1996, respectively.
The Company's net income increased to $1.7 million and $7.5 million for the
three months ended September 30, 1997 and the year ended June 30, 1997,
respectively, compared to $417,000 and $1.1 million for the three months ended
September 30, 1996, and the year ended June 30, 1996, respectively.
22
<PAGE>
RESULTS OF OPERATIONS
Three Months Ended September 30, 1997 Compared to Three Months Ended
September 30, 1996
Revenues. The following table sets forth the components of the Company's
revenues for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
-----------------------
1996 1997
----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Gain on sale of mortgage loans...................... $ 3,410 $ 6,635
Loan origination income............................. 1,022 1,240
Interest income..................................... 1,101 1,645
Other income........................................ 39 102
----------- -----------
$ 5,572 $ 9,622
=========== ===========
</TABLE>
The increase in revenues was due primarily to increased mortgage loan
originations and gain on sales of mortgage loans. Mortgage loan originations
increased $71.0 million to $164.4 million for the three months ended September
30, 1997 from $93.4 million for the three months ended September 30, 1996.
Gain on sale of mortgage loans increased $3.2 million to $6.6 million for
the three months ended September 30, 1997 from $3.4 million for the three
months ended September 30, 1996. This was due primarily to a 27.3% increase in
weighted average gain on sale to 4.2% for the three months ended September 30,
1997 from 3.3% for the three months ended September 30, 1996, primarily due to
improved pricing of whole loan sales. There can be no assurance that the
Company will recognize comparable levels of gain on sale of mortgage loans in
future periods. The Company makes yield spread premium payments to its
mortgage broker customers in the ordinary course of business. Due to
competitive conditions, these payments have increased in recent periods, which
adversely affected the Company's gain on sale of mortgage loans for the three
months ended September 30, 1997. Management expects this increased level of
payments to continue for the three months ending December 31, 1997 and
possibly thereafter.
Loan origination income, which consists of loan origination fees, increased
to $1.2 million for the three months ended September 30, 1997 from $1.0
million for the three months ended September 30, 1996 due to an increase in
mortgage loan originations. However, as a percentage of total revenues, loan
origination income for the three months ended September 30, 1997 decreased
41.9% as compared to the three months ended September 30, 1996 as a result of
competitive conditions as management was required to lower the amount of
origination points and fees charged on its loan products to satisfy mortgage
broker and consumer demands.
Interest income increased $544,000 to $1.6 million for the three months
ended September 30, 1997 from $1.1 million for the three months ended
September 30, 1996. This increase is due to an increase in loan originations
during the period.
Other income, which is composed of investment income, prepayment penalties
and late charges, increased to $102,000 for the three months ended September
30, 1997 as compared to $39,000 for the three months ended September 30, 1996
largely as a result of an increase in mortgage loan originations.
Expenses. The following table sets forth the components of the Company's
expenses for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
-----------------------
1996 1997
----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Employees' salaries and commissions................. $ 1,837 $ 3,505
General and administrative expenses................. 1,055 2,048
Interest expense.................................... 846 1,179
----------- -----------
$ 3,738 $ 6,732
=========== ===========
</TABLE>
23
<PAGE>
Total expenses increased to $6.7 million for the three months ended
September 30, 1997 from $3.7 million for the three months ended September 30,
1996. This increase is related to geographical expansion to 53 origination
locations at September 30, 1997 from 27 at September 30, 1996, and to an
increase in mortgage loan originations.
Employee salaries and commissions increased $1.7 million to $3.5 million
during the three months ended September 30, 1997 from $1.8 million for the
three months ended September 30, 1996. The primary reason for the increase was
due to an increase in mortgage loan originations and continued geographical
expansion.
General and administrative expenses increased $993,000 to $2.0 million for
the three months ended September 30, 1997 from $1.1 million for the three
months ended September 30, 1996. This increase is due primarily to a
corresponding increase in the origination locations and the related increase
in mortgage loan originations.
Interest expense increased $333,000 to $1.2 million for the three months
ended September 30, 1997 from $846,000 for the three months ended September
30, 1996 as a result of higher levels of warehouse borrowing.
It is expected that the Company's expansion plans will result in an increase
in operating expenses in the short-term. Furthermore, since management expects
that there will be a lag time between the incurrence of such expense and the
receipt of any revenues from such expansion efforts, the Company's results of
operations may be adversely affected in the short-term.
In October 1997, the Company issued stock options to purchase 200,000 shares
of the Company's Common Stock at a per share exercise price of $5.00. The
stock options vest 33 1/3% on each anniversary date from the date of the
grant. In connection therewith, the Company will recognize stock compensation
expense of $333,000 per year over the three-year period ended October 2000, or
$83,000 per quarter commencing with the quarter ending December 31, 1997.
Fiscal Year Ended June 30, 1997 Compared to Fiscal Year Ended June 30, 1996
Revenues. The following table sets forth the components of the Company's
revenues for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
----------------------
1996 1997
----------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Gain on sale of mortgage loans....................... $ 4,240 $ 21,855
Loan origination income.............................. 1,978 5,473
Interest income...................................... 1,960 5,182
Other income......................................... 52 250
---------- -----------
$ 8,230 $ 32,760
========== ===========
</TABLE>
Revenues increased to $32.8 million for the year ended June 30, 1997 from
$8.2 million for the year ended June 30, 1996 largely due to increased
mortgage loan originations and gain on sale of mortgage loans.
The increase in mortgage loan originations was due to both increased
production from existing branches and expansion into new markets. Origination
locations increased to 38 at June 30, 1997 from 19 at June 30, 1996.
Gain on sale of mortgage loans increased $17.6 million to $21.9 million in
the year ended June 30, 1997 from $4.2 million in the year ended June 30,
1996. The increase was due primarily to the $332.7 million increase in
mortgage loan originations during the year ended June 30, 1997. Total loans of
$519.9 million were sold in the year ended June 30, 1997 with a weighted
average gain on sale of 4.2%. During the year ended June 30, 1996, total loans
of $156.6 million were sold with a weighted average gain on sale of 2.7%. The
increase in weighted average gain on sale was primarily attributable to
improved pricing of whole loan sales.
24
<PAGE>
Loan origination income increased to $5.5 million in the year ended June 30,
1997 from $2.0 million in the year ended June 30, 1996 due to increased
mortgage loan originations.
Interest income increased $3.2 million to $5.2 million in the year ended
June 30, 1997 from $2.0 million in the year ended June 30, 1996 due to a
higher balance of loans held for sale as a result of the increase in mortgage
loan originations.
Other income increased to $250,000 for the year ended June 30, 1997 as
compared to $52,000 for the year ended June 30, 1996 largely as a result of
increased mortgage loan originations and an increase in cash and cash
equivalents.
Expenses. The following table sets forth the components of the Company's
expenses for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
----------------------
1996 1997
----------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Employees' salaries and commissions................... $3,624 $11,052
General and administrative expenses................... 2,400 5,543
Interest expense...................................... 1,452 3,693
---------- -----------
$7,476 $20,288
========== ===========
</TABLE>
Expenses increased to $20.3 million for the year ended June 30, 1997 from
$7.5 million for the year ended June 30, 1996, due to the cost of geographical
expansion and in large part to increased compensation and other personnel
costs related to the 166% increase in mortgage loan originations.
Employee salaries and commissions increased $7.4 million to $11.1 million in
the year ended June 30, 1997 from $3.6 million in the year ended June 30,
1996, primarily due to an increase in the number of employees to 257 at June
30, 1997 from 148 at June 30, 1996 and increases in commissions paid to
employees.
General and administrative expense increased $3.1 million to $5.5 million in
the year ended June 30, 1997 from $2.4 million in the year ended June 30,
1996. The increase was due to the expansion of the Company's loan origination
network and the related increase in mortgage loan originations.
Interest expense increased $2.2 million to $3.7 million in the year ended
June 30, 1997 from $1.5 million in the year ended June 30, 1996 due to greater
borrowings to fund the increased mortgage loan originations.
25
<PAGE>
SELECTED QUARTERLY RESULTS OF OPERATIONS
The following table sets forth results of operations for each of the
Company's last five quarters. In the opinion of management, this information
has been presented on the same basis as the audited consolidated financial
statements appearing elsewhere in this Prospectus, and includes all
adjustments, consisting only of normal recurring adjustments and accruals,
that the Company considers necessary for a fair presentation. The unaudited
quarterly information should be read in conjunction with the audited
consolidated financial statements of the Company and the notes thereto. The
operating results for any quarter are not necessarily indicative of results
for any future period.
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS THREE MONTHS THREE MONTHS THREE MONTHS
ENDED ENDED ENDED ENDED ENDED
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1996 1996 1997 1997 1997
------------- ------------ ------------ ------------ -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA AND OPERATING STATISTICS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues:
Gain on sale of
mortgage loans........ $ 3,410 $ 5,116 $ 6,017 $ 7,312 $ 6,635
Mortgage loan
origination Income.... 1,022 1,360 1,453 1,638 1,240
Interest income........ 1,101 1,114 1,403 1,564 1,645
Other income........... 39 52 67 92 102
------- -------- -------- -------- --------
Total revenues......... 5,572 7,642 8,940 10,606 9,622
Expenses:
Employees' salaries and
commissions........... 1,837 2,558 3,131 3,526 3,505
General and
administrative
expenses.............. 1,055 1,224 1,461 1,803 2,048
Interest expense....... 846 750 980 1,117 1,179
------- -------- -------- -------- --------
Total expenses......... 3,738 4,532 5,572 6,446 6,732
------- -------- -------- -------- --------
Income before taxes..... 1,834 3,110 3,368 4,160 2,890
Income tax expense...... 723 1,230 1,332 1,645 1,193
------- -------- -------- -------- --------
Net income.............. $ 1,111 $ 1,880 $ 2,036 $ 2,515 $ 1,697
======= ======== ======== ======== ========
Operating statistics:
Mortgage loan
originations.......... $93,427 $130,432 $152,140 $156,622 $164,402
Weighted average
interest rate......... 9.6% 9.7% 9.4% 9.6% 9.6%
Weighted average
initial loan-to-value
ratios................ 68.2% 68.4% 69.3% 70.7% 72.0%
Number of employees.... 181 220 254 257 309
Number of account
executives............ 38 50 64 59 81
Loan origination
locations with office. 25 24 28 30 32
Loan origination
locations without
office................ 2 2 7 8 21
</TABLE>
For the three months ended September 30, 1997, revenues, gain on sale of
mortgage loans, and net income were at lower levels than for the three months
ended June 30, 1997, primarily due to increased yield spread premium payments
made by the Company to its mortgage broker customers. These payments were
necessitated due to competitive pressure in the broker-originated sub-prime
loan market. Loan origination income for the three months ended September 30,
1997 was also affected by competitive pressure; the Company was required to
lower the amount of origination points and fees charged on its loan products
to satisfy mortgage broker and consumer demands. Management expects these
competitive trends to continue in the three months ending December 31, 1997
and possibly thereafter.
The Company will attempt to increase profitability through growth in loan
origination volume. Future managed growth will be related to the opening of
new origination locations, the hiring of additional account executives, the
recruitment of additional mortgage brokers into the Company's wholesale
network, the expansion of its Retail Division and its ability to control
costs. The Company plans to open up to 15 additional origination locations,
and increase the total number of account executives to 120 by the end of 1998
from 81 at September 30, 1997.
It is expected that the Company's expansion plans will result in an increase
in operating expenses in the short-term. Furthermore, since management expects
that there will be a lag time between the incurrence of such expenses and the
receipt of any revenues from such expansion efforts, the Company's results of
operations may be adversely affected in the short-term.
26
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically generated positive cash flow. The Company's
sources of cash flow include gain on sale of mortgage loans, net interest
income and borrowings. The Company sells its mortgage loans generally on a
monthly basis. The Company's uses of cash include the funding of mortgage loan
originations, payment of interest, repayment of amounts borrowed under a
warehouse line of credit, operating and administrative expenses, start-up
costs for new origination locations, income taxes and capital expenditures.
Capital expenditures totaled $142,000, $448,000 and $488,000 for three months
ended September 30, 1997 and the years ended June 30, 1997 and 1996,
respectively.
Cash and cash equivalents were $9.1 million, $8.3 million and $2.5 million
at September 30, 1997 and at June 30, 1997 and 1996, respectively. During the
quarter ending December 31, 1997, the Company will redeem all outstanding
shares of Series A Preferred Stock at a price of approximately $1.6 million.
The Company funds its business through cash reserves and from August 1995
through October 1997, the DLJ Facility under which it borrowed money to
finance the origination of loans. The DLJ Facility provided a $50.0 million
warehouse line of credit to the Company, subject to periodic upward
adjustments to facilitate increases in the Company's loan production. The
interest rate under the DLJ Facility was equal to the federal funds rate plus
1.0%, subject to increase based on the length of time loans are held by the
Company. The term of the DLJ Facility was through August 31, 2000. In October
1997, the Company and DLJ modified the DLJ Facility and the terms under which
DLJ would purchase mortgage loans from the Company (the "Amended DLJ
Facility"). The Amended DLJ Facility provides borrowings up to $150.0 million.
The interest rate from the DLJ Facility will remain effective until the
closing of the Offering; thereafter, borrowings under the Amended DLJ Facility
will bear an interest rate of the federal funds rate plus 50 basis points for
12 months after the closing of the Offering and, thereafter, the federal funds
rate plus 100 basis points. The Amended DLJ Facility also modifies the
termination date to two years after the closing of the Offering. It is
expected that the Amended DLJ Facility will not be extended beyond the
modified term. The Company is currently negotiating with other lenders to
obtain additional warehouse lines of credit and interest rates and terms that
are consistent with management's objectives. The Company repays borrowings
with the proceeds of its loan sales.
The Company's ability to continue to originate loans is dependent in large
part upon its ability to sell the mortgage loans at par or for a premium in
the secondary market in order to generate cash proceeds to repay borrowings
under the warehouse facility, thereby creating borrowing capacity to fund new
originations. The value of and market for the Company's loans are dependent
upon a number of factors, including the borrower credit risk classification,
loan-to-value ratios and interest rates, general economic conditions,
warehouse facility interest rates and governmental regulations. During the
three months ended September 30, 1997 and the years ended June 30, 1997 and
1996, the Company used cash of $164.4 million, $532.6 million and $200.0
million, respectively, for new loan originations. During the same periods, the
Company received cash proceeds from the sale of loans of $159.5 million,
$519.9 million and $156.6 million, respectively, representing the principal
balance of loans sold. The Company received cash proceeds from the premiums on
such sale of loans of $6.6 million, $21.9 million and $4.2 million,
respectively, for the three months ended September 30, 1997 and the years
ended June 30, 1997 and 1996, respectively. A significant amount of the
Company's loan production in any month is funded during the last several
business days of that month.
RECENTLY ISSUED ACCOUNTING CONSIDERATIONS
In October 1995, the Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation", was issued and is
effective for the Company's 1998 fiscal year end. The Company intends to
account for employee stock options in accordance with Accounting Principles
Board Opinion No. 25 "Accounting for Stock Issued to Employees", and related
interpretations in accounting for its stock options. The Company will make the
pro forma disclosures required by FAS 123 beginning in the year ending June
30, 1997.
27
<PAGE>
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, "Earnings Per Share" which is effective for financial statements issued
for periods ending after December 15, 1997. It replaces the presentation of
primary earnings per share with a presentation of basic earnings per share. It
also requires the presentation of diluted earnings per share for entities with
complex capital structures. Diluted earnings per share takes into account the
potential dilution that could occur if securities or other contracts to issue
common stock, such as options, were exercised or converted into common stock.
The Company does not believe that SFAS No. 128 will have a material impact on
its financial statements.
In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information
about Capital Structure." This Statement shall be effective for financial
statements for both interim and annual periods ending after December 15, 1997.
At this time the Company has determined that this Statement will have no
significant impact on the financial position or results of operations for
1997.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." This Statement establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. This Statement shall be
effective for fiscal years beginning after December 15, 1997. Reclassification
of financial statements for earlier periods provided for comparative purposes
is required. At this time the Company has determined that this Statement will
have no significant impact on the financial position or results of operations
for 1997.
28
<PAGE>
BUSINESS
The Company is a specialty finance company that originates and sells sub-
prime residential mortgage loans secured by one-to-four family residences. The
Company's loans are made primarily to refinance existing mortgages,
consolidate other debt, finance home improvements, education and other similar
needs, and, to a lesser extent, to purchase single family residences. The
Company has two divisions: (i) a wholesale division which has relationships
with approximately 2,200 approved independent loan brokers and which
historically accounted for substantially all of the Company's total loan
originations and (ii) a retail division which is being developed to market
loans directly to homeowners. Since it commenced operations in August 1995,
the Company has experienced significant growth in loan originations, with
approximately $532.6 million of originations in 34 states during the year
ended June 30, 1997 compared to $200.0 million in 21 states during its first
full fiscal year ended June 30, 1996. Total originations were $164.4 million
during the three months ended September 30, 1997, as compared to $93.4 million
during the three months ended September 30, 1996, a 76% increase.This growth
in originations resulted in an increase in the Company's net income to $7.5
million for the year ended June 30, 1997 as compared to $417,000 for the year
ended June 30, 1996. Net income rose to $1.7 million for the three months
ended September 30, 1997 from $1.1 million for the three months ended
September 30, 1996.
The Company currently sells substantially all of its mortgage loans through
whole loan sales resulting in gain on sale of mortgage loans consisting solely
of cash. For the three months ended September 30, 1997 and the years ended
June 30, 1997 and 1996, the Company had mortgage loan sales of $159.5 million,
$519.9 million and $156.6 million, respectively, with resulting cash gain on
sale of mortgage loans of $6.6 million, $21.9 million and $4.2 million,
respectively.
The Company believes its primary strengths are the following:
Experience of Management. The Company believes that it derives substantial
benefits from the experience of its management, account executives and staff,
in the sub-prime lending industry, including the establishment of long-term
relationships with mortgage brokers. Evan R. Buckley, the Company's founder
and Chief Executive Officer, and Kelly W. Monahan, the Company's Chief
Financial Officer, have over 25 years of sub-prime mortgage industry
experience, collectively, and have assembled a management team with
substantial experience in the sub-prime mortgage loan origination industry.
Through equity ownership and other incentives, Messrs. Buckley and Monahan
have developed a highly motivated management team whose goals are aligned with
the overall performance of the Company. The Company believes that its long-
term relationships with mortgage brokers enhance the likelihood of loan
origination growth.
Service Oriented Sales Culture. The Company strives to respond quickly and
efficiently to customer needs and market demands. The Company believes that
its ongoing emphasis on prompt and responsive customer service provides
support for an increased level of originations and repeat lending
opportunities from its independent broker network. Typically, the Company
approves loan applications (subject to credit verification, an independent
third-party appraisal and other documentation) within 24 to 48 hours of
receipt and funds within 15 to 40 days thereafter. The Company funds and
closes substantially all loan production under the BNC name. The Company is
continuously seeking to improve its customer service efforts as its operations
expand.
Stable and Deliberate Loan Origination Growth. A key element of the
Company's operating philosophy is to create stable and deliberate loan
origination growth by utilizing consistent and prudent underwriting guidelines
designed to provide high quality products acceptable to the secondary market.
The Company's policy is to underwrite loans in accordance with its
underwriting guidelines to ensure that its loans receive optimal pricing in
the secondary market. Since inception, the Company has successfully sold
substantially all of its production to third parties without having to retain
a substantial amount of rejected loans. The Company has been able to achieve
this standard by continually reevaluating its underwriting guidelines and
quality control criteria.
Low Cost Originator of Sub-Prime Mortgage Loans. The Company's success has
been due in part on its ability to manage and control operating costs. The
Company has established a low-cost origination network, which during the three
months ended September 30, 1997 originated sub-prime mortgage loans in 35
states. For
29
<PAGE>
the three months ended September 30, 1997 and the year ended June 30, 1997,
the Company's cost to originate averaged 3.3% and 3.1% of loan volume,
respectively. Low cost origination is driven in part by the Company's
wholesale expansion strategy; the Company initially penetrates a market with a
limited number of employees to recruit brokers for the Company's wholesale
network. The Company typically opens an office in a market only after it
achieves a minimum loan volume. By utilizing this strategy, the Company
believes it can maintain lower overhead expenses compared with companies
utilizing a more extensive branch office system. In addition, the Company has
the flexibility to expand or contract its operations quickly in response to
local demand.
Substantially all loans originated by the Company are secured by a first
priority mortgage on the subject property. During the three months ended
September 30, 1997, less than 1.0% of the principal balance of the loans
originated were secured by second priority mortgages; none of such loans were
originated for the years ended June 30, 1997 or 1996. The Company's core
borrower base consists of individuals who do not qualify for traditional "A"
credit because their credit history, income or other factors cause them not to
conform to standard agency lending criteria. During the three months ended
September 30, 1997 and the year ended June 30, 1997, approximately 65.3% and
57.5% of the principal balance of the loans originated by the Company,
respectively, were to borrowers with a Company risk classification of "A+" or
"A-" while the remainder were to borrowers with a Company risk classification
of "B", "C+", "C" or "C-", respectively, representing approximately 34.7% and
42.5% of the total principal amount of loans originated by the Company. During
each of the three months ended September 30, 1997 and the year ended June 30,
1997, approximately 3.9% of the principal balance of the loans originated by
the Company were to borrowers with a Company risk classification of "C-",
which includes borrowers with numerous derogatory credit items up to and
including a bankruptcy in the most recent 12 month period.
Historically, the Company's primary source of mortgage loans has been its
Wholesale Division which originates mortgage loans through approved
independent mortgage loan brokers. Mortgage loan brokers qualify to
participate in the Wholesale Division's program only after a formal
application process that includes obtaining the broker's financial statements,
state licensing qualifications and references and general lending expertise.
At September 30, 1997, the Company had approved relationships with
approximately 2,200 mortgage loan brokers compared with approximately 890 as
of September 30, 1996. During the three months ended September 30, 1997 and
the year ended June 30, 1997, 678 and 1,141 brokers, respectively, funded
mortgage loans through the Company. At September 30, 1997, the Wholesale
Division originated loans through a sales force of approximately 75 account
executives located in 53 origination locations in 23 states that solicit these
mortgage loan brokers for loan applications that meet the Company's
underwriting criteria. Each mortgage loan is accepted for funding by the
Company only after approval by the Company's loan underwriters. Of the
mortgage loan applications submitted during the year ended June 30, 1997,
approximately 38.5%, were approved and funded with the remaining 61.5% either
rejected by the Company's underwriters or withdrawn by the brokers.
By concentrating on wholesale mortgage banking services through independent
mortgage loan brokers, the Company is able to originate mortgage loans in a
cost effective manner. By monitoring and controlling the number of branch
offices and personnel needed to generate mortgage loans, the Company has
effectively transferred the overhead burden of mortgage origination to the
independent mortgage loan brokers who originate the loans, with a commensurate
reduction in fee income obtained. As a result, the Company can match its costs
more directly with loan origination volume so that a substantial portion of
the Company's cost is variable rather than fixed. Loans originated through the
Wholesale Division accounted for $161.3 million and $507.3 million or 98.1%
and 95.2% of the Company's mortgage loan production during the three months
ended September 30, 1997 and the year ended June 30, 1997, respectively.
The Company is developing a Retail Division to market mortgage loans
directly to homeowners. Over the past six months the Company has formulated a
retail marketing strategy designed to produce stable and sustained retail
growth. The Company has created a cost effective method of retail origination
by directly soliciting loan originations from borrowers from a central office
in California through telemarketing and television and radio advertising.
Prior to this Offering, the Company strategically decided not to focus on the
expansion of this division but rather to utilize operating capital to fund the
growth of its wholesale operations. The Company
30
<PAGE>
believes this centralized strategic approach allows the Company to originate
mortgage loans at a competitive cost while maintaining credit quality. In
connection with mortgage loan originations, the Company obtains origination
fees which offset the costs of retail lending. The Retail Division accounted
for $3.1 million and $7.5 million or 1.9% and 1.4% of the Company's mortgage
loan production during the three months ended September 30, 1997 and the year
ended June 30, 1997, respectively.
The Company's growth and operating strategy is based on the following key
elements:
Whole Loan Sales for Cash. The Company sells substantially all of its
originated mortgage loans monthly for cash, historically at a premium over the
principal balance of the mortgage loans. The Company enhances earnings and
cash flows from whole loan sales by tailoring the composition of its whole
loan pools to meet the investment preferences of specific buyers. This
strategy, as opposed to securitizations, in which a residual interest in
future payments on the loans is retained, provides certain benefits. The
Company receives cash revenue, rather than recognizing non-cash revenue
attributable to residual interests, as is the case in securitizations, thereby
avoiding the risk of having to adjust revenue in future periods to reflect a
lower realization on residual interests because actual prepayments or defaults
exceeded levels assumed at the time of securitization. By selling its
originated loans, the Company also reduces its exposure to default risk (other
than certain first payment defaults) and the prepayment risk normally inherent
in a mortgage lender's business. Management believes that the cash received in
loan sales provides the Company greater flexibility and operating leverage
than a traditional portfolio lender, which holds the loans it originates, by
allowing the Company to generate income through interest on loans held for
sale and gain on loans sold. This strategy of frequent loan sales has been an
important factor in generating the Company's earnings, creating consistent
positive cash flow to fund operations, decreasing the need for other forms of
financing and reducing the level of interest rate and default risk borne by
the Company.
Continuing Growth of Wholesale Production. The Company intends to continue
the growth of its Wholesale Division through greater penetration in existing
markets and selective geographic expansion. Greater market penetration is
expected to be accomplished through adding additional sales personnel to
existing origination locations in order to provide continued high levels of
service to brokers to increase loan origination and further the basis for
repeat business, referral and other future lending opportunities. The Company
will seek to improve and enhance relationships with mortgage brokers by
continuing to (i) improve response times to loan applications, (ii) streamline
wholesale origination and funding activities and (iii) provide a broad
selection of attractive product offerings. The Company anticipates that short-
term geographic expansion will focus on the development of lending operations
in the Texas, Pennsylvania, North Carolina, New Jersey, Virginia, Tennessee
and Oklahoma. The Company plans to open up to 15 additional origination
locations and to increase the total number of account executives to
approximately 120 by the end of 1998. Management intends to focus further
expansion on those geographic regions which it believes represent the most
attractive markets for the Company's products.
Expanding Product Offerings. The Company frequently reviews and tailors its
products and pricing for competitiveness, as well as introducing new products
to meet the needs of its borrowers and brokers, expand its customer base and
diversify its product mix. The Company utilizes long-term relationships with
mortgage loan brokers to quickly and efficiently tailor existing products or
introduce new products to satisfy its broker and consumer product needs. Also,
the Company attempts to anticipate changing demands and formulate new products
accordingly. The Company believes that these mortgage products enable the
Company to increase loan production from brokers who have customers seeking
such products and from borrowers identified through the Company's retail
marketing efforts.
Securitization Flexibility. While a substantial majority of the Company's
mortgage loan originations will continue to be sold through whole loan sales
in cash transactions, the Company may in the future sell a portion of its
loans through securitizations. The ability to conduct securitizations may
provide the Company with the flexibility to take advantage of favorable
pricing differentials between the securitization and whole loan sales markets
that may exist from time to time. The Company may seek to enhance earnings by
securitizing loans
31
<PAGE>
with characteristics which the securitization market considers most favorable.
The percentage of loans, if any, sold through securitizations will be based on
economic conditions, secondary market conditions and available financial
resources.
MORTGAGE LOAN ORIGINATIONS
The Company originates mortgage loans through its Wholesale and Retail
Divisions. The Wholesale Division originates loans through a network of
independent mortgage brokers and the Retail Division is being developed to
solicit loans directly from prospective borrowers. The following table sets
forth selected data regarding the Company's mortgage loan originations for the
periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED JUNE THREE MONTHS
30, ENDED
------------------ SEPTEMBER 30,
1996 1997 1997
-------- -------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Mortgage loan originations:
Wholesale Division principal balance.... $199,963 $507,250 $161,294
Retail Division principal balance....... -- 7,451 3,108
Small Commercial principal balance(1)... -- 17,920 --
-------- -------- --------
$199,963 $532,621 $164,402
======== ======== ========
Number of mortgage loans.................. 1,988 5,425 1,755
Average principal balance per loan........ $ 101 $ 98 $ 94
Weighted average loan-to-value ratio(2)... 68.5% 69.3% 72.0%
Weighted average fixed interest rate...... 10.7% 10.5% 10.5%
Weighted average adjustable interest rate. 8.6% 9.2% 9.2%
Weighted average fixed/adjustable interest
rate..................................... 10.0% 9.5% 9.5%
"A+" and "A-" loans as a percentage of
total mortgage loans originated(3)....... 51.6% 57.5% 65.3%
</TABLE>
- --------
(1) The Company discontinued the origination of small commercial loans in
April 1997.
(2) Determined by dividing the amount of the loan by the lesser of the
purchase price or the appraised value of the mortgaged property at
origination.
(3) Based on initial principal balance.
Substantially all mortgage loans originated by the Company are secured by a
first priority mortgage on the subject property and for the three months ended
September 30, 1997, less than 1.0% of the principal balance of the mortgage
loans originated were secured by second priority mortgages; none of such
mortgage loans were originated for the years ended June 30, 1997 and 1996.
Wholesale Division. Historically, the Company's primary source of mortgage
loans has been its Wholesale Division, which maintains relationships with
approximately 2,200 independent mortgage brokers which, during the three
months ended September 30, 1997, originated mortgage loans in 35 states.
During the three months ended September 30, 1997 and the year ended June 30,
1997, 678 and 1,141 brokers, respectively, funded loans through the Company.
At September 30, 1997, the Company had 53 origination locations in 23 states
and employed 75 account executives who service mortgage brokers. The Wholesale
Division funded $161.3 million in loans, or 98.1% of the Company's total
mortgage loan production, during the three months ended September 30, 1997.
During the three months ended September 30, 1997, the Company's 10 largest
producing brokers originated approximately 11.2% of the Company's mortgage
loans, with the largest broker accounting for approximately 1.8%.
Mortgage loan brokers act as intermediaries between property owners and the
Company in arranging mortgage loans. In wholesale originations, the broker's
role is to identify the applicant, assist in completing the loan application
form, gather necessary information and documents and serve as the Company's
liaison with the borrower through the lending process. The Company reviews and
underwrites the applications submitted by the
32
<PAGE>
broker, approves or denies the application, sets the interest rate and other
terms of the loan and, upon acceptance by the borrower and satisfaction of all
conditions imposed by the Company, funds the loan. Because brokers conduct
their own marketing and employ their own personnel to obtain loan applications
and maintain contact with borrowers, originating loans through the Wholesale
Division allows the Company to increase its loan volume without incurring the
higher marketing, labor and other overhead costs associated with increased
retail originations.
Loan applications generally are submitted by mortgage brokers to an account
executive in one of the Company's sales offices. The loan is logged-in for
RESPA and other regulatory compliance purposes, underwritten and, in most
cases, conditionally approved or denied within 24 to 48 hours of receipt.
Because mortgage brokers generally submit individual loan files to several
prospective lenders simultaneously, the Company attempts to respond to each
application as quickly as possible. If approved, a "conditional approval" will
be issued to the broker with a list of specific conditions to be met (for
example, credit verifications and independent third-party appraisals) and
additional documents to be supplied prior to the funding of the loan. The
originating account executive and a production assistant will work directly
with the submitting mortgage broker to collect the requested information and
to meet the underwriting conditions and other requirements. In most cases, the
Company funds loans within 15 to 40 days after approval of the loan
application.
All independent mortgage brokers who submit loan applications to the Company
must be registered or licensed as required by the jurisdiction in which they
operate and must be approved by the Company. The Company audits 100% of its
brokers on an annual basis in order to confirm possession of a current
license, updated financials on file and any changes in broker staff or
address.
The Company believes that an important element in developing, maintaining
and expanding its independent mortgage broker relationships is to provide a
high level of product knowledge and customer service to its brokers. Each
account executive receives training prior to being assigned to a territory
which, in most cases, includes experience in the loan production department so
that the account executive will be familiar with all phases of loan
origination and production. This training enables the account executive to
quickly review a loan application in order to identify the borrower's probable
risk classification and then assist the broker in identifying the appropriate
product for the borrower, thereby enhancing the likelihood that the loan will
be approved at the rate and on the terms anticipated by the borrower. After a
loan package is submitted to the Company, the account executive and production
assistant provides assistance to the broker the process to complete the loan
transaction. Account executives are compensated based on the number and the
dollar volume of loans funded.
The following table sets forth selected information relating to wholesale
loan originations during the periods shown:
<TABLE>
<CAPTION>
YEAR ENDED JUNE THREE MONTHS
30, ENDED
------------------ SEPTEMBER 30,
1996 1997 1997
-------- -------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Principal balance......................... $199,963 $507,250 $161,294
Average principal balance per loan........ $ 101 $ 96 $ 94
Weighted average initial loan-to-value
ratio.................................... 68.5% 69.5% 72.0%
Weighted average interest rate............ 9.4% 9.6% 9.6%
Occupancy:
Owner occupied.......................... 86.6% 85.1% 84.6%
Non-owner occupied...................... 13.4% 14.9% 15.4%
</TABLE>
Retail Division. The Company's Retail Division, which markets mortgage loans
directly to homeowners, began operations in March 1996. The Company operates
the Retail Division, which as of September 30, 1997 consisted of 11 persons,
including six account executives, to further diversify loan production sources
and to capture origination fees typically collected by retail brokers. By
creating a direct relationship with the borrower, retail lending provides a
sustainable loan origination franchise, offering greater control over the
lending process
33
<PAGE>
while generating loan origination fees to offset the higher costs of retail
lending. The gain on sales of retail loans is generally greater than the gain
on sales of broker-sourced loans because, unlike in the case of broker-sourced
originations, a third party does not share in the fees and points paid by the
borrower. The Company's Retail Division offers the same products as those of
its Wholesale Division.
Over the past six months, the Company formulated a low cost retail marketing
strategy designed to produce growth in its Retail Division. The Company's
strategy focuses on loan originations from borrowers through telemarketing and
radio and television advertising coordinated at the Company's executive
offices by its retail sales staff. This centralized approach enables the
Company to conduct its retail operations with less overhead than a retail
business that operates through a sales office network. Prior to this Offering,
the Company strategically decided not to focus on the expansion of the Retail
Division but rather to utilize operating capital to fund the growth of its
Wholesale Division. During the three months ended September 30, 1997 and the
year ended June 30, 1997, the Company originated $3.1 million and $7.5
million, respectively, in loans, or 1.9% and 1.4%, respectively, of its total
mortgage loan production, through its Retail Division.
The Company emphasizes telemarketing and television and radio advertising to
attract borrowers for the Retail Division. Using database screening, the
Company selects the areas of concentration for the Company's retail activities
and a target group of borrowers within these areas. This database screening
involves a marketing analysis intended to identify current homeowners who are
likely to be qualified candidates for the Company's loan products. Factors
considered by the Company identifying homeowners for its telemarketing
activities include the length of time the homeowner has owned the home and the
individual's credit profile. Longer periods of home ownership increase the
likelihood that the homeowner has substantial equity in the home and will
satisfy the Company's loan-to-value requirements. Aspects of an individual's
credit profile, such as credit problems, limited credit history and prior
borrowings from consumer finance companies, also indicate that the individual
is a likely candidate for the Company's loan programs.
The Company then provides this profile information to selected telemarketing
organizations which provide phone lists of potential borrowers for use by the
Retail Division. Concurrently, the Company runs radio and television
advertising to heighten borrower awareness within the subject areas. The
Company tracks the success of its marketing efforts and regularly assesses the
accuracy of its database screening, telemarketing efforts and advertising
campaigns in identifying likely candidates for its products. By utilizing
centralized retail activities focused at a limited group of likely borrowers,
the Company believes it more efficiently utilizes its retail marketing
expenditures.
The following table sets forth selected information relating to retail loan
originations during the periods shown:
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS
JUNE 30, ENDED
-------------- SEPTEMBER 30,
1996(1) 1997 1997
------- ------ -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Principal balance................................. -- $7,451 $3,108
Average principal balance per loan................ -- $ 83 $ 72
Weighted average initial loan-to-value ratio...... -- 70.1% 71.3%
Weighted average interest rate.................... -- 9.6% 9.4%
Occupancy:
Owner occupied.................................. -- 87.8% 90.7%
Non-owner occupied.............................. -- 12.2% 9.3%
</TABLE>
- --------
(1) The Company did not originate any loans in the Retail Division for the
year ended June 30, 1996.
Other Activities. In August 1996, the Company formed a division to originate
commercial and multi-family loans. Of total loan originations for the year
ended June 30, 1997, this division originated $17.9 million or 3.4% of total
originations. This division was discontinued in April 1997.
34
<PAGE>
PRODUCT TYPES
The Company offers both fixed-rate and adjustable-rate loans, as well as
loans with an interest rate that is initially fixed for a period of time and
subsequently converts to an adjustable-rate. Most of the adjustable-rate loans
originated by the Company are offered at a low initial rate, sometimes
referred to as a "teaser" rate. At each interest rate adjustment date, the
Company adjusts the rate, subject to certain limitations on the amount of any
single adjustment, until the rate charged equals the fully indexed rate. The
Company's borrowers fall into six sub-prime risk classifications and products
are available at different interest rates and with different origination and
application points and fees depending on the particular borrower's risk
classification (see "Underwriting"). The Company offers a wide variety of
interest rate and points paid combinations on many of its products so that
customers may elect to pay higher points at closing to secure a lower rate
over the life of the loan or pay a higher interest rate and reduce or
eliminate points payable at closing. The interest rate on the Company's
adjustable rate mortgages is typically tied to six-month LIBOR and the Company
offers 1.0% or 1.5% semi-annual interest rate caps and 6.5% or 7.0% life caps.
The Company sets mortgage loan coupons and fees after considering several
factors, including the borrower's credit rating, the loan-to-value ratio of
the property, the state in which the loan was originated and competitive and
market conditions. The Company's maximum loan amounts are generally $500,000
with a loan-to-value ratio of up to 85%. The Company does, however, offer
larger loans with lower loan-to-value ratios on a case-by-case basis, and also
offers products that permit a loan-to-value ratio of up to 90% for selected
borrowers with a Company risk classification of "A+" or "A-."
Loans originated by the Company for the three months ended September 30,
1997 and the year ended June 30, 1997 had an average principal balance per
loan of approximately $93,676 and $98,179, respectively, and a weighted
average initial loan-to-value ratio of approximately 72.0% and 69.3%,
respectively. Unless prohibited by state law or otherwise waived by the
Company upon the payment by the related borrower of higher origination fees
and a higher interest rate, the Company generally imposes a prepayment penalty
on the borrower. Approximately 62.9% and 58.1% of the loans the Company
originated during the three months ended September 30, 1997 and the year ended
June 30, 1997, respectively, provided for the payment by the borrower of a
prepayment charge in limited circumstances on certain full or partial
prepayments.
The Company's current products are as follows:
Standard Products
2-Year or 5-Year Fixed/Adjustable Rate Programs--A 30-year fully amortized
program with the initial interest rate fixed for the first two or five years
of the loan. Beginning with the 25th or 61st monthly payment, the loan
converts to an adjustable rate, LIBOR-indexed loan. There is no rate cap on
the first adjustment (at conversion). Thereafter, all interest rate caps apply
as described in the LIBOR loan product.
6-Month LIBOR Adjustable--A 30-year fully amortized adjustable rate program
indexed to LIBOR, featuring a semi-annual interest rate cap of 1.0%-1.5%, and
a life cap of 6.5%-7.0%.
15- or 30-Year Fixed Rate Program--A fixed rate loan program fully amortized
over a 15- or 30-year period.
All of the standard mortgage products have prepayment penalties (where
legally allowed) for a period of one to five years with the exception of the
2-Year Fixed Rate product which has a two-year prepayment penalty period.
Other Products
90% LTV First Mortgage Loan--A 30-year fully amortized adjustable rate or
fixed rate program. The adjustable rate program is indexed to LIBOR featuring
a semi-annual interest rate cap of 1.0% and a life cap of 6.5%. This product
is limited to the A+ and A- credit risk categories.
35
<PAGE>
Conforming Mortgage Products--Both fixed rate and adjustable rate conforming
loan programs, as defined by FNMA and FHLMC, are offered through the Retail
Division.
Second Mortgage Program--Fixed rate amortizing and fixed rate with balloon
payments are offered. This product is limited to the A+ through B credit risk.
125% LTV Program--Fixed rate and fixed rate with balloon payments are
offered. Terms range from five years to 25 years.
36
<PAGE>
The following table sets forth selected information relating to loan
originations by product type for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, 1997
------------------------------------------------------------------------
WEIGHTED
WEIGHTED AVERAGE
PRINCIPAL NUMBER AVERAGE AVERAGE WEIGHTED INITIAL
AMOUNT % OF TOTAL OF BALANCE INTEREST AVERAGE LOAN-TO-VALUE
TYPE ORIGINATED ORIGINATIONS LOANS PER LOAN RATE(1) MARGIN(2) RATIO
---- ---------- ------------ ------ -------- -------- --------- -------------
(DOLLARS IN THOUSANDS, EXCEPT AVERAGE BALANCE)
<S> <C> <C> <C> <C> <C> <C> <C>
2-Year Fixed............ $115,710 70.3% 1,153 $100,356 9.5% 6.4% 72.9%
6-Month Adjustable...... 20,673 12.6 185 $111,746 9.2% 6.7% 72.6%
30-Year Fixed........... 17,436 10.6 266 $ 65,549 10.5% -- 67.8%
5-Year Fixed............ 7,024 4.3 72 $ 97,549 9.5% 6.7% 69.4%
15-Year Fixed........... 3,407 2.1 75 $ 45,431 10.4% -- 64.9%
Second Mortgages........ 152 0.1 4 $ 37,688 12.0% -- 29.6%
-------- ----- -----
$164,402 100.0% 1,755 $ 93,676 9.6% 6.4% 72.0%
======== ===== =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, 1997
------------------------------------------------------------------------
WEIGHTED
WEIGHTED AVERAGE
PRINCIPAL NUMBER AVERAGE AVERAGE WEIGHTED INITIAL
AMOUNT % OF TOTAL OF BALANCE INTEREST AVERAGE LOAN-TO-VALUE
TYPE ORIGINATED ORIGINATIONS LOANS PER LOAN RATE(1) MARGIN(2) RATIO
---- ---------- ------------ ------ -------- -------- --------- -------------
(DOLLARS IN THOUSANDS, EXCEPT AVERAGE BALANCE)
<S> <C> <C> <C> <C> <C> <C> <C>
2-Year Fixed............ $289,549 54.4% 2,838 $102,026 9.5% 6.4% 70.5%
6-Month LIBOR
Adjustable............. 110,870 20.8 1,066 $104,006 9.2% 6.5% 70.2%
30-Year Fixed........... 74,162 13.9 1,011 $ 73,355 10.5% -- 66.1%
5-Year Fixed............ 30,379 5.7 286 $106,220 9.2% 6.5% 67.4%
15-Year Fixed........... 9,741 1.8 198 $ 49,197 10.6% -- 62.3%
Small Commercial(3)..... 17,920 3.4 26 $689,231 9.8% -- 63.8%
-------- ----- -----
$532,621 100.0% 5,425 $ 98,179 9.6% 6.4% 69.3%
======== ===== =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, 1996
------------------------------------------------------------------------
WEIGHTED
WEIGHTED AVERAGE
PRINCIPAL NUMBER AVERAGE AVERAGE WEIGHTED INITIAL
AMOUNT % OF TOTAL OF BALANCE INTEREST AVERAGE LOAN-TO-VALUE
TYPE ORIGINATED ORIGINATIONS LOANS PER LOAN RATE(1) MARGIN(2) RATIO
---- ---------- ------------ ------ -------- -------- --------- -------------
(DOLLARS IN THOUSANDS, EXCEPT AVERAGE BALANCE)
<S> <C> <C> <C> <C> <C> <C> <C>
2-Year Fixed............ $ 61,141 30.6% 592 $103,280 10.0% 5.5% 67.6%
6-Month LIBOR
Adjustable............. 96,866 48.4 901 $107,509 8.6% 5.9% 70.6%
30-Year Fixed........... 29,993 15.0 371 $ 80,843 10.7% -- 65.3%
5-Year Fixed............ 10,020 5.0 94 $106,595 10.0% 5.7% 64.9%
15-Year Fixed........... 1,943 1.0 30 $ 64,764 10.7% -- 65.6%
-------- ----- -----
$199,963 100.0% 1,988 $100,585 9.4% 5.7% 68.5%
======== ===== =====
</TABLE>
- --------
(1) Each fixed rate loan bears interest at a fixed rate set on its date of
funding and lasting through the term of the loan. Loans bearing interest
at the adjustable rate adjust every six months to a new rate through the
term of the loan. The weighted average interest rate for loans bearing
interest at an adjustable rate is the weighted average of the rates of
such loans during the initial six month period. Loans bearing interest at
the fixed/adjustable rate bear interest at a fixed rate for an initial
period commencing on the date of funding (e.g., two years or five years)
and thereafter adjust to new rates every six months for the remaining term
of the loans. The weighted average interest rate for loans bearing
interest at a fixed/adjustable rate is the weighted average of the rates
of such loans during the initial period.
(2) The margin for a loan is a fixed amount set for the life of the loan,
which when added to the index (as described below) determines the interest
rate on the loan (subject to interest rate floors, ceilings and caps). The
index used by the Company is the six-month LIBOR, as published each Monday
in the Wall Street Journal. Fixed rate loans have no margin because such
loans are not tied to an index.
(3) The Company discontinued the origination of small commercial loans in
April 1997.
37
<PAGE>
GEOGRAPHIC CONCENTRATION
The following table sets forth aggregate dollar amounts and the percentage
of all loans originated by the Company by state for the periods shown:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
FOR THE YEAR ENDED JUNE 30, SEPTEMBER 30, 1997
----------------------------------------------- -----------------------
1996 1997
----------------------- -----------------------
PRINCIPAL PRINCIPAL PRINCIPAL
AMOUNT % OF TOTAL AMOUNT % OF TOTAL AMOUNT % OF TOTAL
ORIGINATED ORIGINATIONS ORIGINATED ORIGINATIONS ORIGINATED ORIGINATIONS
---------- ------------ ---------- ------------ ---------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
California.............. $107,063 53.6% $196,526 36.9% $ 51,249 31.1%
Illinois................ 13,741 6.9 55,352 10.4 21,441 13.0
Florida................. 7,430 3.7 28,597 5.4 16,589 10.1
Hawaii.................. 12,021 6.0 63,868 12.0 11,669 7.1
Utah.................... 6,934 3.5 20,486 3.8 8,939 5.4
Wisconsin............... 5,251 2.6 22,174 4.2 5,719 3.5
Colorado................ 14,693 7.3 24,102 4.5 5,521 3.4
Ohio.................... 2,472 1.2 19,938 3.7 5,319 3.2
Oregon.................. 12,420 6.2 21,123 4.0 5,189 3.2
Indiana................. -- -- 12,757 2.4 5,040 3.1
Massachusetts........... -- -- 6,277 1.2 4,163 2.5
Washington.............. 9,564 4.8 9,495 1.8 3,819 2.3
Idaho................... 2,246 1.1 8,314 1.6 3,707 2.3
Missouri................ 27 0.0 10,712 2.0 3,320 2.0
Maryland................ -- -- 5,009 0.9 2,897 1.8
Michigan................ -- -- 2,353 0.4 1,735 1.1
Other(1)................ 6,101 3.1 25,538 4.8 8,086 4.9
-------- ----- -------- ----- -------- -----
$199,963 100.0% $532,621 100.0% $164,402 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
- --------
(1)Except for Texas which accounted for 1.3% for the year ended June 30, 1996,
no other state accounted for greater than 1.0%.
QUALITY CONTROL
The Company has implemented a loan quality control process designed to
ensure sound lending practices and compliance with the Company's policies and
procedures. Prior to the funding of a loan, the Company performs a "pre-
funding quality control audit" which consists of the verification of a
borrower's credit and employment, utilizing automated services and verbal
verifications.
Properties underlying the potential mortgage loans are appraised by an
appraiser selected by the submitting broker. Every independent appraisal is
reviewed by the Company's chief appraiser (the "Chief Appraiser"), other
Company appraisers or by another independent appraiser approved by the
Company's Chief Appraiser to confirm the adequacy of the property as
collateral prior to funding.
Subsequent to funding, the Company's quality assurance department audits
100% of all closed loans. The department performs a review of documentation
for compliance with established underwriting guidelines and lending procedures
along with independent appraisal reviews and recertifications. All funding
documents are reviewed for accuracy, completeness and adherence to corporate,
state and federal requirements. As a part of this audit process, deficiencies
are reported to the Company's senior management to determine trends and the
need for additional training of Company personnel.
38
<PAGE>
UNDERWRITING
The Company originates its mortgage loans in accordance with the
underwriting criteria (the "Underwriting Guidelines") described below. The
loans the Company originates generally do not satisfy underwriting standards
such as those utilized by the Federal National Mortgage Association and the
Federal Home Loan Mortgage Corporation; therefore, the Company's loans are
likely to result in rates of delinquencies and foreclosures that are higher,
and may be substantially higher, than those rates experienced by portfolios of
mortgage loans underwritten in a more traditional manner. The Underwriting
Guidelines are intended to evaluate the credit history of the potential
borrower, the capacity of the borrower to repay the mortgage loan, the value
of the real property and the adequacy of such property as collateral for the
proposed loan. Based upon the underwriter's review of the loan application and
related data and application of the Underwriting Guidelines, the loan terms,
including interest rate and maximum loan-to-value, are determined.
The Company employs experienced underwriters and the Company's chief
underwriter (the "Chief Underwriter") must approve the hiring of all
underwriters, including those located in the regional offices and branch
locations. The Company's underwriters are required to have had either
substantial underwriting experience with a consumer finance company or other
subprime lender or substantial experience with the Company in other aspects of
the subprime mortgage finance industry before becoming part of the Company's
underwriting department. As of September 30, 1997, 33 underwriters with an
average of approximately five years of subprime mortgage lending experience
were employed by the Company. All underwriters participate in ongoing
training, including regular supervisory critiques of each underwriter's work.
The Company believes that its experienced underwriting personnel have the
ability to analyze the specific characteristics of each loan application and
make appropriate credit judgments.
The underwriting staff reviews the value of the underlying collateral based
on a full appraisal completed by pre-approved qualified licensed independent
appraisers. All appraisers are required to conform to the Uniform Standards of
Professions Appraisal Practice adopted by the Appraisal Standards Board of the
Appraisal Foundation. In addition, every independent appraisal is reviewed by
the Company's Chief Appraiser, other Company appraisers or by another
independent appraiser approved by the Company's Chief Appraiser to confirm the
adequacy of the property as collateral.
The Underwriting Guidelines include three levels of applicant documentation
requirements, referred to as the "Full Documentation," "Lite Documentation"
and "Stated Income Documentation" programs. Under each of the programs, the
Company reviews the applicant's source of income, calculates the amount of
income from sources indicated on the loan application or similar
documentation, reviews the credit history of the applicant, calculates the
debt service-to-income ratio to determine the applicant's ability to repay the
loan, reviews the type and use of the property being financed, and reviews the
property. In determining the ability of the applicant to repay the loan, the
Company's underwriters use (i) a qualifying rate that is equal to the stated
interest rate on fixed-rate loans, (ii) the initial interest rate on loans
which provide for two or five years of fixed payments before the initial
interest rate adjustment, or (iii) one percent above the initial interest rate
on other adjustable-rate loans. The Underwriting Guidelines require that
mortgage loans be underwritten in a standardized procedure which complies with
applicable federal and state laws and regulations and requires the Company's
underwriters to be satisfied that the value of the property being financed, as
indicated by an appraisal and the appraisal review. In general, the maximum
loan amount for mortgage loans originated under the programs is $500,000;
however, larger loans may be approved on a case-by-case basis. The
Underwriting Guidelines permit one-to-four family residential property loans
to have loan-to-value ratios at origination of generally up to 80%, or up to
90% for borrowers in the Company's highest credit grade categories, depending
on, among other things, the purpose of the mortgage loan, a borrower's credit
history, repayment ability and debt service-to-income ratio, income
documentation, as well as the type and use of the property.
Under the Full Documentation program, applicants are generally required to
submit two written forms of verification of stable income for at least twelve
months. Under the Lite Documentation program, one such form of verification is
required for six months. Under the Stated Income Documentation program, an
applicant may
39
<PAGE>
be qualified based upon monthly income as stated on the mortgage loan
application if the applicant meets certain criteria. All the foregoing
programs require that with respect to salaried employees there be a telephone
verification of the applicant's employment. Verification of the source of
funds required to be deposited by the applicant into escrow in the case of a
purchase money loan is generally required under the Full Documentation program
guidelines and on all purchase loans where the loan-to-value ratio is greater
than 80%. No such verification is required under any of the programs where the
loan-to-value ratio is less than 80%. The maximum loan-to-value ratio is
reduced by 5% to 10% for the Lite Documentation and Stated Income
Documentation programs. The level of documentation percentages of loan
originations are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
JUNE 30,
------------ THREE MONTHS ENDED
1996 1997 SEPTEMBER 30, 1997
----- ----- ------------------
<S> <C> <C> <C>
Full........................................ 50.9% 50.5% 44.8%
Stated Income............................... 49.1 48.8 52.8
Lite........................................ -- 0.7 2.4
----- ----- -----
100.0% 100.0% 100.0%
===== ===== =====
</TABLE>
The Company's categories and criteria for grading the credit history of
potential borrowers is set forth in the table below. Generally, borrowers in
lower credit grades are less likely to satisfy the repayment obligations of a
mortgage loan and, therefore, are subjected to lower loan-to-value ratios and
are charged higher interest rates and loan origination fees. Loans made to
lower credit grade borrowers, including credit-impaired borrowers, entail a
higher risk of delinquency and may result in higher losses than loans made to
borrowers who use conventional mortgage sources. The Company believes that the
amount of equity present in the collateral securing its loans generally
mitigates these risks.
40
<PAGE>
UNDERWRITING GUIDELINES(1)
<TABLE>
<CAPTION>
A+ RISK A- RISK B RISK C+ RISK C RISK C- RISK
------------ ------------ ------------ -------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Existing Mortgage No 30-day Maximum one Maximum Maximum six Unlimited Unlimited 30-
late payment 30-day late three 30-day 30-day late number of and 60-day
in the last payment and late payments; or, 30-day and late payments
12 months if no 60-day payments and four 30-day, 60-day late and a maximum
LTV is late no 60-day one 60-day and payments and of one 150-
greater than payments in late one 90-day a maximum of day late
80%. Maximum the last 12 payments late payment one 120-day payment if
of one 30- months if within the in the last 12 late payment LTV is
day late and LTV is last 12 months if LTV within the greater than
no 60-day greater than months is 75% or last 12 65%, maximum
late 80%. If LTV allowed if less. Maximum months. one 180-day
payments in is less than LTV is five 30-day There may be late payment
the last 12 80%, a greater late payments a current if LTV is
months if maximum of than 80%. and no 60-day notice of less than
LTV is 80% two 30-day Maximum four late payments default, 65%.
or less. late 30-day late if LTV is however the Delinquencies
payments in payments; above 75%. maximum more than 180
the last 12 or, two 30- Maximum six delinquency days may be
months. day late 30-day cannot allowed if
payments and payments if exceed 120 LTV is less
one 60-day LTV is greater days. than 60%.
late payment than 65% and
in the last loan is under
12 months if the Stated
LTV is 80% Income
or less. Documentation
program.
Other Credit Very good to Very good Generally Some Frequent Significant
excellent credit good credit significant derogatory credit
credit history within the derogatory consumer defaults.
within the within the last 12 credit in the credit. Collections
last 24 last 12 months. Some past 12 Collections and
months. months. late months. and chargeoffs
Minor late Minor late payments Generally, chargeoffs may remain
payments payments (not more collections may remain open after
(not more (not more than 90 and chargeoffs open after closing.
than 30 than 30 days) may be not more than funding.
days) may be days) may be allowed. $2,000 may
allowed on a allowed on a remain open
limited limited after funding.
basis. basis.
Bankruptcy filings Generally, Generally, Generally, Chapter 7 Chapter 7 Current
no no no Bankruptcy Bankruptcy Bankruptcy
bankruptcy bankruptcy bankruptcy must have been must have allowed on a
filings in filings in filings in discharged at been case by case
the last two the last two the last two least 12 discharged basis;
years. years. years. months prior at least six Bankruptcy
to months prior must be
application. to discharged
Chapter 13 application. prior to
Bankruptcy Chapter 13 funding.
must have been Bankruptcy
filed for at must have
least 24 been filed
months and for at least
borrower must 18 months
have paid and borrower
according to must have
the Chapter 13 paid
Plan. Chapter according to
13 Bankruptcy the Chapter
must be paid 13 Plan.
or discharged Chapter 13
at closing. Bankruptcy
must be paid
or
discharged
at closing.
Debt service-to- 45% 45% to 90% 45% to 85% 50% to 80% LTV 60% 60%
income ratio LTV 50% to LTV 50% to 55% to 75% LTV
80% LTV 80% LTV 55% 60% to 70% LTV
to 75% LTV
Maximum LTV(2) 90% 90% 85% 80% 70% 70%
</TABLE>
- -------
(1) The letter grades applied to each risk classification reflect the
Company's internal standards and do not necessarily correspond to the
classifications used by other mortgage lenders. "LTV" means loan-to-value
ratio.
(2) The maximum LTV set forth in the table is for borrowers providing Full
Documentation. The LTV is reduced 5% for Lite Documentation and 10% for
Stated Income Documentation, if applicable.
41
<PAGE>
The Company evaluates its Underwriting Guidelines on an ongoing basis and
periodically modifies the Underwriting Guidelines to reflect the Company's
current assessment of various issues related to an underwriting analysis. In
addition, the Company adopts underwriting guidelines appropriate to new loan
products, such as those offered by the Retail Division. The conventional
mortgage loans and second mortgage loans, including 125% loan-to-value loans,
offered by the Retail Division are underwritten to the standards of the
intended buyers thereof and utilize information not considered by the Company
in its standard Underwriting Guidelines, including credit scores.
Exceptions. As described above, the Company uses the foregoing categories
and characteristics as underwriting guidelines only. On a case-by-case basis,
the Company's underwriters may determine that the prospective borrower
warrants a risk category upgrade, a debt service-to-income ratio exception, a
pricing exception, a loan-to-value exception or an exception from certain
requirements of a particular risk category (collectively called an "upgrade"
or an "exception"). An upgrade or exception may generally be allowed if the
application reflects certain compensating factors, including among others: low
loan-to-value ratio; pride of ownership; stable employment; and the length or
residence in the subject property. Accordingly, the Company may classify
certain mortgage loan applications in a more favorable risk category than
other mortgage loan applications that, in the absence of such compensating
factors, would only satisfy the criteria of a less favorable risk category.
42
<PAGE>
LOAN PRODUCTION BY BORROWER RISK CLASSIFICATION
The following tables set forth information concerning the Company's loan
production by borrower risk classification for the three months ended
September 30, 1997 and the years ended June 30, 1997 and 1996.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, 1997
---------------------------------------------------------------
WEIGHTED
WEIGHTED AVERAGE
PRINCIPAL % OF NUMBER AVERAGE WEIGHTED INITIAL
AMOUNT TOTAL OF INTEREST AVERAGE LOAN-TO-VALUE
CREDIT RATING ORIGINATED ORIGINATIONS LOANS RATE(1) MARGIN(2) RATIO
- ------------- ---------- ------------ ------ -------- --------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Adjustable Rate (6-Month
LIBOR):
A+.................... $ 7,224 35.0% 52 8.1% 6.1% 73.3%
A-.................... 5,403 26.1 46 9.1% 6.5% 76.6%
B..................... 4,075 19.7 36 9.5% 6.7% 73.6%
C+.................... 1,665 8.1 17 10.6% 7.4% 63.7%
C..................... 665 3.2 10 11.0% 8.0% 68.4%
C-.................... 1,641 7.9 24 12.3% 8.1% 63.8%
-------- ----- -----
$ 20,673 100.0% 185 9.2% 6.6% 72.6%
======== ===== =====
Fixed/Adjustable Rate
(2-Year; 5-Year):
A+.................... $ 51,489 41.9% 424 8.7% 6.0% 75.1%
A-.................... 28,970 23.6 268 9.5% 6.4% 74.0%
B..................... 23,909 19.5 256 9.8% 6.5% 72.0%
C+.................... 10,396 8.5 151 10.9% 7.2% 67.5%
C..................... 3,852 3.1 64 12.1% 7.7% 63.4%
C-.................... 4,119 3.4 62 12.9% 8.0% 60.2%
-------- ----- -----
$122,735 100.0% 1,225 9.5% 6.4% 72.7%
======== ===== =====
Fixed Rate (15-Year; 30-
Year):
A+.................... $ 8,364 39.9% 115 9.8% -- 69.3%
A-.................... 5,859 27.9 88 10.2% -- 66.5%
B..................... 3,843 18.3 71 10.9% -- 66.7%
C+.................... 1,689 8.0 42 11.9% -- 64.4%
C..................... 588 2.8 17 13.3% -- 59.5%
C-.................... 651 3.1 12 13.9% -- 59.5%
-------- ----- -----
$ 20,994 100.0% 345 10.5% -- 67.1%
======== ===== =====
$164,402 1,755
======== =====
</TABLE>
- --------
(1) Each fixed rate loan bears interest at a fixed rate set on its date of
funding and lasting through the term of the loan. Loans bearing interest
at the adjustable rate adjust every six months to a new rate through the
term of the loan. The weighted average interest rate for loans bearing
interest at an adjustable rate is the weighted average of the rates of
such loans during the initial six month period. Loans bearing interest at
the fixed/adjustable rate bear interest at a fixed rate for an initial
period commencing on the date of funding (e.g., two years or five years)
and thereafter adjust to new rates every six months for the remaining term
of the loans. The weighted average interest aate for loans bearing
interest at a fixed/adjustable rate is the weighted average of the rates
of such loans during the initial period.
(2) The margin for a loan is a fixed amount set for the life of the loan,
which when added to the Index (as described below) determines the interest
rate on the loan (subject to interest rate floors, ceiling and caps). The
index used by the Company is the six-month LIBOR, as published each Monday
in The Wall Street Journal. Fixed rate loans have no margin because such
loans are not tied to an index.
43
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, 1997
---------------------------------------------------------------
WEIGHTED
WEIGHTED AVERAGE
PRINCIPAL % OF NUMBER AVERAGE WEIGHTED INITIAL
AMOUNT TOTAL OF INTEREST AVERAGE LOAN-TO-VALUE
CREDIT RATING ORIGINATED ORIGINATIONS LOANS RATE(1) MARGIN(2) RATIO
- ------------- ---------- ------------ ------ -------- --------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Adjustable Rate (6-Month
LIBOR):
A+.................... $ 21,239 19.1% 181 8.0% 6.0% 71.4%
A- ................... 32,913 29.7 280 8.5% 6.2% 72.6%
B..................... 24,915 22.5 236 9.0% 6.6% 72.4%
C+.................... 16,480 14.9 179 10.0% 6.7% 68.8%
C..................... 9,398 8.5 114 10.9% 7.3% 63.1%
C-.................... 5,925 5.3 76 12.7% 8.0% 59.3%
-------- ----- -----
$110,870 100.0% 1,066 9.2% 6.5% 70.2%
======== ===== =====
Fixed/Adjustable Rate
(2-Year; 5-Year):
A+.................... $116,138 36.4% 927 8.5% 6.1% 71.8%
A-.................... 82,401 25.8 708 9.2% 6.2% 71.8%
B..................... 60,571 18.9 613 9.7% 6.5% 70.9%
C+.................... 32,031 10.0 416 10.8% 6.9% 67.3%
C..................... 16,790 5.2 271 11.9% 7.2% 63.6%
C-.................... 11,997 3.7 189 12.4% 7.6% 57.7%
-------- ----- -----
$319,928 100.0% 3,124 9.5% 6.4% 70.2%
======== ===== =====
Fixed Rate (15-Year; 30-
Year):
A+.................... $ 26,249 31.2% 299 9.6% -- 64.2%
A-.................... 27,110 32.3 347 10.1% -- 66.3%
B..................... 14,980 17.9 225 10.9% -- 68.3%
C+.................... 8,529 10.2 177 11.8% -- 66.9%
C..................... 4,373 5.2 107 13.2% -- 63.5%
C-.................... 2,662 3.2 54 13.6% -- 57.9%
-------- ----- -----
$ 83,903 100.0% 1,209 10.5% -- 65.7%
======== ===== =====
Small Commercial(3)..... $ 17,920 26 9.8% -- 63.8%
======== =====
$532,621 5,425
======== =====
</TABLE>
- --------
(1) Each fixed rate loan bears interest at a fixed rate set on its date of
funding and lasting through the term of the loan. Loans bearing interest
at the adjustable rate adjust every six months to a new rate through the
term of the loan. The weighted average interest rate for loans bearing
interest at an adjustable rate is the weighted average of the rates of
such loans during the initial six month period. Loans bearing interest at
the fixed/adjustable rate bear interest at a fixed rate for an initial
period commencing on the date of funding (e.g., two years or five years)
and thereafter adjust to new rates every six months for the remaining term
of the loans. The weighted average interest aate for loans bearing
interest at a fixed/adjustable rate is the weighted average of the rates
of such loans during the initial period.
(2) The margin for a loan is a fixed amount set for the life of the loan,
which when added to the index (as described below) determines the interest
rate on the loan (subject to interest rate floors, ceiling and caps). The
index used by the Company is the six-month LIBOR, as published each Monday
in The Wall Street Journal. Fixed rate loans have no margin because such
loans are not tied to an index.
(3) The Company discontinued the origination of small commercial loans in
April 1997.
44
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, 1996
---------------------------------------------------------------
WEIGHTED
WEIGHTED AVERAGE
PRINCIPAL % OF NUMBER AVERAGE WEIGHTED INITIAL
AMOUNT TOTAL OF INTEREST AVERAGE LOAN-TO-VALUE
CREDIT RATING ORIGINATED ORIGINATIONS LOANS RATE(1) MARGIN(2) RATIO
- ------------- ---------- ------------ ------ -------- --------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Adjustable Rate
(6-Month LIBOR):
A+.................... $ 5,789 6.0% 48 7.8% 5.6% 69.1%
A- ................... 44,399 45.8 389 8.1% 5.5% 72.3%
B..................... 24,967 25.8 237 8.6% 6.1% 71.8%
C+.................... 11,932 12.3 125 9.5% 6.4% 68.1%
C..................... 7,809 8.1 76 10.0% 6.5% 64.4%
C-.................... 1,970 2.0 26 10.9% 6.8% 58.9%
-------- ----- -----
$ 96,866 100.0% 901 8.6% 5.9% 70.6%
======== ===== =====
Fixed/Adjustable Rate
(2-Year; 5-Year):
A+.................... $ 12,530 17.6% 117 9.1% 4.9% 65.8%
A-.................... 21,899 30.8 197 9.6% 5.2% 67.4%
B..................... 19,717 27.7 171 10.1% 5.8% 70.1%
C+.................... 8,680 12.2 105 10.8% 6.1% 66.9%
C..................... 5,960 8.4 66 11.0% 6.3% 64.3%
C-.................... 2,375 3.3 30 12.5% 6.7% 58.6%
-------- ----- -----
$ 71,161 100.0% 686 10.0% 5.6% 67.2%
======== ===== =====
Fixed Rate (15-Year;
30-Year):
A+.................... $ 1,121 3.5% 11 10.3% -- 70.3%
A-.................... 17,469 54.7 200 10.2% -- 65.4%
B..................... 7,263 22.7 91 10.9% -- 66.6%
C+.................... 3,483 10.9 54 12.0% -- 66.5%
C..................... 1,590 5.0 26 12.2% -- 61.2%
C-.................... 1,010 3.2 19 13.1% -- 50.9%
-------- ----- -----
$ 31,936 100.0% 401 10.7% -- 65.3%
======== ===== =====
$199,963 1,988
======== =====
</TABLE>
- --------
(1) Each fixed rate loan bears interest at a fixed rate set on its date of
funding and lasting through the term of the loan. Loans bearing interest
at the adjustable rate adjust every six months to a new rate through the
term of the loan. The weighted average interest rate for loans bearing
interest at an adjustable rate is the weighted average of the rates of
such loans during the initial six month period. Loans bearing interest at
the fixed/adjustable rate bear interest at a fixed rate for an initial
period commencing on the date of funding (e.g., two years or five years)
and thereafter adjust to new rates every six months for the remaining term
of the loans. The weighted average interest rate for loans bearing
interest at a fixed/adjustable rate is the weighted average of the rates
of such loans during the initial period.
(2) The margin for a loan is a fixed amount set for the life of the loan,
which when added to the index (as described below) determines the interest
rate on the loan (subject to interest rate floors, ceiling and caps). The
index used by the Company is the six-month LIBOR, as published each Monday
in The Wall Street Journal. Fixed rate loans have no margin because such
loans are not tied to an index.
FINANCING AND SALE OF LOANS
Warehouse Facility
From August 1995 through October 1997, the Company funded its business
primarily through the DLJ Facility under which it borrowed money to finance
the origination of loans. The DLJ Facility provided a $50.0 million warehouse
line of credit to the Company, subject to periodic upward adjustments to
facilitate increases in the Company's loan production. The interest rate under
the DLJ Facility was equal to the federal funds rate plus 1.0% subject to
increase based on the length of time loans are held by the Company, and DLJ
received a
45
<PAGE>
security interest on all loans, and other rights in connection therewith,
originated by the Company. Any loan not purchased by DLJ was not allowed to
remain subject to the warehouse line for more than nine months. The term of
the DLJ Facility was through August 31, 2000.
In October 1997, the Company and DLJ modified the DLJ Facility and the
terms under which DLJ would purchase mortgage loans from the Company (the
"Amended DLJ Facility"). The Amended DLJ Facility has similar terms to the DLJ
Facility with certain modifications. The Amended DLJ Facility provides for
advances of up to $150.0 million. The interest rate of the DLJ Facility will
remain effective until the closing of this Offering; thereafter, borrowings
under the Amended DLJ Facility will bear an interest rate of the federal funds
rate plus 50 basis points for 12 months after the closing of the Offering and,
thereafter, the federal funds rate plus 100 basis points. The Amended DLJ
Facility also modifies the termination date to two years after the closing of
the Offering. The Amended DLJ Facility further provides that as of the closing
of the Offering, DLJ will no longer have the exclusive right to purchase loans
from the Company. Furthermore, DLJ has agreed to provide the Company with up
to $5.0 million of financing for a term of one year for subordinated
"interest-only" securities to the extent they are retained by the Company in
connection with any future securitizations of loans originated by the Company.
Advances will be made to the extent the Company does not have sufficient cash,
in excess of reasonable reserves, to fund the retention of such securities.
The Company is currently negotiating with other lenders to obtain additional
warehouse lines of credit at interest rates and terms that are consistent with
management's objectives.
Loan Sales
The Company follows a strategy of selling for cash substantially all of its
loan originations through loan sales in which the Company disposes of its
entire economic interest in the loans for a cash price that represents a
premium over the principal balance of the loans sold. The Company sold $159.5
million, $519.9 million and $156.6 million of loans through loan sales during
the three months ended September 30, 1997 and the years ended June 30, 1997
and 1996, respectively. Loan sales are typically made monthly. The Company did
not sell any loans directly through securitizations during these periods.
In connection with the DLJ Facility, the Company had granted DLJ, pursuant
to a master loan purchase agreement, an exclusive right to purchase all
mortgage loans originated by the Company which are then sold by DLJ in the
secondary market. The Company has historically sold substantially all loans to
DLJ as whole loans (servicing released). DLJ purchases the loans with a view
towards securitization or other resale transactions in the secondary mortgage
market. Since substantially all of the loans purchased by DLJ under the master
repurchase agreement are resold by DLJ to institutional purchasers generally
within 48 hours of the initial purchase from the Company, DLJ has agreed for
the Company to assist it in the marketing of loans so resold by DLJ. Prior to
the purchase of the loans by DLJ under the Master Repurchase Agreement, the
Company undertakes a process to identify the institutional purchasers who will
immediately buy the subject loans from DLJ. This program utilizes a
competitive bidding process typically involving two to four potential
purchasers (including Wall Street firms, financial institutions and conduits,
along with other institutional purchasers) who in most cases have purchased
similar resold loans from DLJ in the past. The successful bidder is committed
to a minimum quantity of loans at a determined price, and is generally granted
the option to purchase more than the minimum quantity at a negotiated price.
DLJ then agrees to pay the Company the determined price minus 50 basis points,
which represents DLJ's fees. As a result of this agreement, Management is able
to directly control the sales price for its loans in order to obtain more
favorable pricing and other terms. A successful bidder is not obligated to
purchase loans other than those to which its bid applies.
Gain on sale of mortgage loans represented 69.0% and 66.7% and 51.5% of the
Company's total revenues for the three months ended September 30, 1997 and the
years ended June 30, 1997 and June 30, 1996, respectively. The Company
maximizes its gain on sale of mortgage loan revenue by closely monitoring
institutional purchasers' requirements and focusing on originating the types
of loans that meet those requirements and for which institutional purchasers
tend to pay higher rates. During the three months ended September 30,
46
<PAGE>
1997 and the years ended June 30, 1997 and 1996, the Company sold 1,691, 4,965
and 1,606 loans to DLJ, having an aggregate principal balance of $157.8
million, $476.6 million and $153.2 million, respectively.
Loan sales are made to DLJ on a non-recourse basis pursuant to a purchase
agreement containing customary representations and warranties by the Company
regarding the underwriting criteria and the origination process. The Company
is required to provide similar representations and warranties to those
institutional purchasers to whom DLJ sells the subject loans. The Company,
therefore, may be required to repurchase or substitute loans in the event of a
breach of its representations and warranties. In addition, the Company
sometimes commits to repurchase or substitute a loan if a payment default
occurs within the first month following the date the loan is funded, unless
other arrangements are made. The Company is also required in some cases to
repurchase or substitute a loan if the loan documentation is alleged to
contain fraudulent misrepresentations made by the borrower. Any claims
asserted against the Company in the future by its loan purchasers may result
in liabilities or legal expenses that could have a material adverse effect on
the Company's results of operations and financial condition. In addition, any
material repurchase or substitution may have an adverse effect on the market
for and pricing of the Company's loans. Since the Company commenced operations
in August 1995 through September 30, 1997, the Company had repurchased loans
with an aggregate principal balance of $178,000.
Securitization Capability
While the Company has not sold loans directly through securitizations, part
of the Company's loan sale strategy may include the sale of loans directly
through securitizations in the future if management determines that such sales
are more beneficial. Management has significant securitization experience in
that several members were involved in securitization prior to their employment
with the Company. In addition, rating agencies and bond insurers have
evaluated and are familiar with the Company's procedures and underwriting
guidelines in connection with such securitizations.
Typically in a securitization, the issuer aggregates mortgages into a real
estate mortgage investment conduit trust. The regular interests or the senior
tranches of the trust are investment grade. While the issuer generally retains
the residual interests in the trust, it immediately sells the regular
interests and generally uses the proceeds to repay borrowings that were used
to fund or purchase the loans in the securitized pool. The holders of the
regular interests are entitled to receive scheduled principal collected on the
pool of securitized loans and interest at the pass-through interest rate on
the certificate balance for such interests. The residual interests represents
the subordinated right to receive cash flows from the pool of securitized
loans after payment of the required amounts to the holders of the regular
interests and the cost associated with the securitization. The issuer
recognizes non- cash revenue relating to the residual interest at the time of
the securitization.
SUB-SERVICING
While the Company currently sells substantially all of the mortgage loans it
originates servicing released, it is required to service the loans from the
date of funding through the date of sale. Since the Company conducts whole
loan sales monthly, the Company currently does not have a substantial
servicing portfolio. Nonetheless, the Company currently contracts for the sub-
servicing of all mortgage loans it originates through the date of sale and is
subject to risks associated with inadequate or untimely services. To the
extent that the Company decides to retain servicing rights in the future or
conduct securitizations, it currently intends to contract for the sub-
servicing of such mortgage loans, which would expose it to more substantial
risks associated with contracted sub-servicing. In such event, it is expected
that many of the Company's borrowers will require notices and reminders to
keep their mortgage loans current and to prevent delinquencies and
foreclosures. A substantial increase in the Company's delinquency rate or
foreclosure rate could adversely affect its ability to access profitably the
capital market for its financing needs, including any future securitizations.
Any of the Company's sub-servicing agreements with its third-party sub-
servicers are expected to provide that if the Company terminates the agreement
without cause (as defined in the agreement), the Company may be required to
pay the third-party sub-servicer a fee. Depending upon the size of the
Company's loan portfolio sub-
47
<PAGE>
serviced at any point in time, the termination penalty that the Company would
be obligated to pay upon termination without cause, may be substantial.
INTEREST RATE RISK MANAGEMENT
The Company's profits depend, in part, on the difference, or "spread,"
between the effective rate of interest received by the Company on the loans it
originates or purchases and the interest rates payable by the Company under
its warehouse facilities or for securities issued in any future
securitizations. The spread can be adversely affected because of interest rate
increases during the period from the date the loans are originated until the
closing of the sale or securitization of such loans.
Since the Company historically has retained loans for a short period of time
pending sale, it has not engaged in hedging activities to date. However, in
the future the Company may hedge its variable-rate mortgage loans and any
interest-only and residual certificates retained in connection with any future
securitizations with hedging transactions which may include forward sales of
mortgage loans or mortgage-backed securities, interest rate caps and floors
and buying and selling of futures and options on futures. The nature and
quantity of hedging transactions will be determined by the Company's
management based on various factors, including market conditions and the
expected volume of mortgage loan originations and purchases. No assurance can
be given that such hedging transactions will offset the risks of changes in
interest rates, and it is possible that there will be periods during which the
Company could incur losses after accounting for its hedging activities.
COMPETITION
The Company faces intense competition in the business of originating and
selling mortgage loans. The Company's competitors in the industry include
other consumer finance companies, mortgage banking companies, commercial
banks, credit unions, thrift institutions, credit card issuers and insurance
finance companies. Many of these competitors are substantially larger and have
considerably greater financial, technical and marketing resources than the
Company. In addition, many financial services organizations that are much
larger than the Company have formed national loan origination networks
offering loan products that are substantially similar to the Company's loan
programs. Competition among industry participants can take many forms,
including convenience in obtaining a loan, customer service, marketing and
distribution channels, amount and term of the loan, loan origination fees and
interest rates. In addition, the current level of gains realized by the
Company and its competitors on the sale of subprime loans could attract
additional competitors into this market. Additional competition may lower the
rates the Company can charge borrowers, thereby potentially lowering gain on
future loan sales and future securitizations. The Company may in the future
also face competition from, among others, government-sponsored entities which
may enter the sub-prime mortgage market. Existing or new loan purchase
programs may be expanded by FNMA, FHLMC, or GNMA to include sub-prime
mortgages, particularly those in the "A-" category, which constitute a
significant portion of the Company's loan production. For example, the FHLMC
has announced that it is entering the sub-prime market in 1998. Entries of
such government-sponsored entities into the sub-prime market may have an
adverse effect on loan yields on mortgage loans originated by the Company and
reduce or eliminate premiums on loan sales. To the extent any of these
competitors significantly expand their activities in the Company's market, the
Company could be materially adversely affected. Fluctuations in interest rates
and general economic conditions may also affect the Company's competition.
During periods of rising rates, competitors that have locked in low borrowing
costs may have a competitive advantage. During periods of declining rates,
competitors may solicit the Company's customers to refinance their loans.
REGULATION
The consumer financing industry is a highly regulated industry. The
Company's business is subject to extensive and complex rules and regulations
of, and examinations by, various federal, state and local government
authorities. These rules impose obligations and restrictions on the Company's
loan origination, credit activities and secured transactions. In addition,
these rules limit the interest rates, finance charges and other fees the
48
<PAGE>
Company may assess, mandate extensive disclosure to the Company's customers,
prohibit discrimination and impose multiple qualification and licensing
obligations on the Company. Failure to comply with these requirements may
result in, among other things, loss of approved status, demands for
indemnification or mortgage loan repurchases, certain rights of rescission for
mortgage loans, class action lawsuits, administrative enforcement actions and
civil and criminal liability. Management believes that the Company is in
compliance with these rules and regulations in all material respects.
The Company's loan origination activities are subject to the laws and
regulations in each of the states in which those activities are conducted. For
example, state usury laws limit the interest rates the Company can charge on
its loans. The Company's lending activities are also subject to various
federal laws, including the Truth in Lending Act, Homeownership and Equity
Protection Act of 1994, the Equal Credit Opportunity Act, the Fair Credit
Reporting Act, the Real Estate Settlement Procedures Act and the Home Mortgage
Disclosure Act.
The Company is subject to certain disclosure requirements under the Truth in
Lending Act ("TILA") and Regulation Z promulgated under TILA. TILA is designed
to provide consumers with uniform, understandable information with respect to
the terms and conditions of loan and credit transactions. TILA also guarantees
consumers a three-day right to cancel certain credit transactions, including
loans of the type originated by the Company. In addition, TILA gives
consumers, among other things, a right to rescind loan transactions in certain
circumstances if the lender fails to provide the requisite disclosure to the
consumer.
The Company is also subject to the Homeownership and Equity Protection Act
of 1994 (the "High Cost Mortgage Act"), which makes certain amendments to
TILA. The High Cost Mortgage Act generally applies to consumer credit
transactions secured by the consumer's principal residence, other than
residential mortgage transactions, reverse mortgage transactions or
transactions under an open end credit plan, in which the loan has either (i)
total points and fees upon origination in excess of the greater of eight
percent of the loan amount or $400, or (ii) an annual percentage rate of more
than ten percent points higher than United States Treasury securities of
comparable maturity ("Covered Loans"). The High Cost Mortgage Act imposes
additional disclosure requirements on lenders originating Covered Loans. In
addition, it prohibits lenders from, among other things, 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 and 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 High Cost Mortgage Act also restricts,
among other things, certain balloon payments and negative amortization
features.
The Company is also required to comply with the Equal Credit Opportunity Act
of 1974, as amended ("ECOA") and Regulation B promulgated thereunder, the Fair
Credit Reporting Act, as amended, the Real Estate Settlement Procedures Act of
1975, as amended, and the Home Mortgage Disclosure Act of 1975, as amended.
ECOA prohibits creditors from discriminating against applicants on the basis
of race, color, sex, age, religion, national origin or marital status.
Regulation B restricts creditors from requesting certain types of information
from loan applicants. The Fair Credit Reporting Act, as amended, requires
lenders, among other things, to supply an applicant with certain information
if the lender denied the applicant credit. The Real Estate Settlement
Procedures ACT mandates certain disclosure concerning settlement fees and
charges and mortgage servicing transfer practices. It also prohibits the
payment or receipt of kickbacks or referral fees in connection with the
performance of settlement services. In addition, beginning with loans
originated in 1997, the Company must file an annual report with the Department
of Housing and Urban Development pursuant to the Home Mortgage Disclosure Act,
which requires the collection and reporting of statistical data concerning
loan transactions.
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.
49
<PAGE>
Because the Company's business 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.
EMPLOYEES
At September 30, 1997, the Company employed 309 persons. None of the
Company's employees is subject to a collective bargaining agreement. The
Company believes that its relations with its employees are satisfactory.
PROPERTIES
The Company's executive and administrative offices are located in numerous
suites at 1700, 1720, and 1740 East Garry Avenue, Santa Ana, California 92705
and consist of an aggregate of approximately 32,000 square feet. The leases on
the premises are month to month and the current aggregate monthly rent is
approximately $22,861.
On June 15, 1997, the Company entered into a lease agreement for the
relocation of its executive and administrative offices to 1063 McGaw, Irvine,
California 92714, which consists of approximately 54,768 square feet. The
lease on the premises expires on or around September 1, 2002 and the current
monthly rent is approximately $71,198. The Company intends to move into these
facilities by the end of 1997.
The Company also leases space for its other offices. These facilities
aggregate approximately 39,401 square feet, with monthly aggregate base rental
of approximately $45,672. The terms of these leases vary as to duration and
rent escalation provisions. In general, the leases expire between October 31,
1997 and August 31, 2001 and provide for rent escalations tied to either
increases in the lessor's operating expenses or fluctuations in the consumer
price index in the relevant geographical area.
LEGAL PROCEEDINGS
The Company occasionally becomes involved in litigation arising from the
normal course of business. Management believes that any liability with respect
to pending legal actions, individually or in the aggregate, will not have a
material adverse effect on the Company's financial position or results of
operations.
50
<PAGE>
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The following table sets forth the name, age and position with the Company
of each person who is a director or executive officer and of certain key
employees of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Evan R. Buckley(1)(2)... 45 President, Chief Executive Officer, Secretary and Director
Kelly W. Monahan(1)(2).. 40 Executive Vice President and Chief Financial Officer and Director
Gary Vander-Haeghen..... 43 Vice President, Sales
David A. Littlefield.... 53 Chief Underwriter
David J. Rae............ 38 Chief Appraiser
Al Lapena............... 38 Director of Secondary Marketing
Karen N. Neyman......... 44 Compliance Officer and Director of Quality Assurance
</TABLE>
- --------
(1)Member of Audit Committee
(2)Member of Compensation Committee
The Company intends to add at least three non-management directors to the
Board of Directors prior to the completion of this Offering.
EVAN R. BUCKLEY has been the President, Chief Executive Officer, Secretary
and a Director of the Company since its inception. Prior to founding the
Company, Mr. Buckley was a co-founder of Quality Mortgage USA, Inc. ("Quality
Mortgage"), a residential mortgage banker. From November 1991 to May 1995, Mr.
Buckley was the Vice President of Sales & Marketing of Quality Mortgage, where
he was responsible for assembling and managing the loan production activities.
Mr. Buckley brings over 21 years of experience in real estate financing and
mortgage banking to the Company.
KELLY W. MONAHAN has been Executive Vice President and Chief Financial
Officer of the Company since its inception and a Director of the Company since
October 1997. From July 1992 to July 1995, Mr. Monahan served as Vice
President and the Chief Financial Officer of Quality Mortgage, where his
responsibilities included the management of all financial aspects of a
national mortgage banker, including the issuance of mortgage backed
securities, secondary marketing, interest rate hedging, cash management,
financial reporting, and strategic planning. From February of 1989 to July
1992, Mr. Monahan was a practitioner for Monahan and Associates, an accounting
and consulting firm, and from 1987 to 1989, he was Equities Controller at the
Koll Company, a real estate development company. Mr. Monahan is a certified
public accountant.
GARY VANDER-HAEGHEN has been the Vice-President of Sales of the Company
since November 1995. From December 1991 to November 1995, Mr. Vander-Haeghen
was a Branch Manager for Quality Mortgage, where he opened and managed its San
Diego branch. Mr. Vander-Haeghen has been in the real estate financing
industry for over 20 years.
DAVID A. LITTLEFIELD has been the Chief Underwriter of the Company since
September 1995. Mr. Littlefield is responsible for the coordination, training
and supervision of the underwriting staff of the Company's corporate and
branch offices. From August 1992 to August 1995, Mr. Littlefield was a Senior
Underwriter for Quality Mortgage with the responsibility of training and
supervising underwriters. From January 1992 to August 1992, he was a Senior
Lending Officer for Transamerica Equity, Inc., a mortgage lender. From 1990 to
1992, he was the Executive Vice-President of Tennecal Funding Corporation, a
mortgage lender, and from 1988 to 1990, he was the Vice-President of Mortgage
Banking for First Pacific Bank.
DAVID J. RAE has been the Chief Appraiser of the Company since September
1995. Mr. Rae is responsible for the coordination and development of the
Company internal appraisers and outside third party review appraisers. From
February 1993 to September 1995, Mr. Rae was the Assistant Chief Appraiser for
Quality
51
<PAGE>
Mortgage, where he was responsible for recruiting and training of management
for the western region staff review appraisers. From January 1986 to February
1993, he was Regional Supervisor and Senior Staff Appraiser for Hawthorne
Savings & Loan Association.
AL LAPENA has been the Director of Secondary Marketing for the Company since
February 1997 and is responsible for coordinating the Company's loan sales.
From 1992 to 1997, Mr. Lapena was the Vice-President of the Real Estate
Finance Group of the Taxable Fixed Income Division for Donaldson, Lufkin &
Jenrette, Inc. where he was responsible for the management of whole loan
trades involving prime and subprime mortgage loans purchased from
sellers/originators with contractual relationships with DLJ Mortgage Capital,
Inc. From 1989 to 1992, he was an independent secondary market mortgage
consultant and from 1988 to 1989, he was Vice-President/Operations Manager of
the West Coast Region for U.S. Mortgage Co., Inc.
KAREN N. NEYMAN has been the Compliance Officer and Director of Quality
Assurance with the Company since September 1995. From March 1992 to September
1995, Ms. Neyman was Vice-President and Compliance Officer for Quality
Mortgage, where her responsibilities included monitoring compliance with state
and federal laws, monitoring adherence to internal underwriting and appraisal
guidelines and consumer protection laws, and coordinating the preparation of
reports to Management and the Board of Directors. From 1991 to 1992, she was
Vice-President and Compliance Officer of TOPA Savings Bank.
The Company's Board of Directors currently has two members. At least three
additional non-management directors will be added to the Board of Directors
prior to the completion of this Offering. The Board of Directors is divided
into three classes. Class I Directors will serve until the annual meeting of
stockholders in 1998 and thereafter for the terms of three years until their
successors have been elected and qualified. Class II Directors will serve
until the annual meeting of stockholders in 1999 and thereafter for terms of
three years until their successors have been elected and qualified. Class III
Directors will serve until the annual meeting of stockholders in 2000 and
thereafter for terms of three years until their successors have been elected
and qualified. Evan R. Buckley is a Class I Director; Kelly W. Monahan and one
of the to-be-added Board members will be a Class II Director; and the
remaining two to-be-added Board members will be Class III Directors.
The Company plans to pay its non-employee directors an annual fee of $10,000
payable quarterly, $2,500 for each board meeting attended (up to a maximum of
four meetings) and to reimburse them for reasonable expenses incurred in
attending meetings. Concurrently with this Offering, the Company will grant
options to purchase 20,000 shares of Common Stock under its Stock Option Plan
to each of its non-employee directors at a per share exercise price equal to
the initial public offering price. See "--Stock Options." No family
relationships exist between any of the executive officers or directors of the
Company.
COMMITTEES OF THE BOARD OF DIRECTORS
Audit Committee
The Board of Directors will establish an audit committee (the "Audit
Committee"). The Audit Committee, among other things, will make
recommendations to the Board of Directors concerning the engagement of
independent public accountants; monitor and review the quality and activities
of the Company's internal audit function and those of its independent
accountants; and monitor the adequacy of the Company's operating and internal
controls as reported by management and the independent or internal auditors.
The members of the Audit Committee will be Kelly W. Monahan (Chairman), and at
least two independent directors.
Compensation Committee
The Board of Directors will establish a compensation committee (the
"Compensation Committee"). The Compensation Committee, among other things,
will review salaries, benefits and other compensation, including stock based
compensation under the Company's Stock Option Plan, of directors, officers and
other employees of the Company and make recommendations to the Board of
Directors. The members of the Compensation Committee will be Evan R. Buckley
(Chairman), and at least two independent directors.
52
<PAGE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Company does not currently have a compensation committee. Messrs.
Buckley and Monahan participated in deliberations concerning compensation of
executive officers during fiscal 1997. None of the executive officers of the
Company has served on the board of directors or on the compensation committee
of any other entity which had officers who served on the Company's Board of
Directors.
EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth information concerning the annual and long-
term compensation earned by the Company's Chief Executive Officer and each of
the two other executive officers whose annual salary and bonus during fiscal
1997 exceeded $100,000 (the "Named Executive Officers").
<TABLE>
<CAPTION>
ANNUAL
COMPENSATION
NAME AND -----------------
PRINCIPAL POSITION(1) SALARY BONUS
--------------------- -------- --------
<S> <C> <C>
Evan R. Buckley........................................... $155,769 $189,200
President, Chief Executive Officer and Director
Kelly W. Monahan.......................................... $116,584 $ 52,500
Executive Vice President and Chief Financial Officer
Gary Vander-Haeghen ...................................... $ 98,000 $ 35,200
Vice President, Sales
</TABLE>
STOCK OPTIONS
In October 1997, the Board of Directors and stockholders of the Company
adopted the 1997 Stock Option, Deferred Stock and Restricted Stock Plan (the
"Stock Option Plan"), which provides for the grant of qualified incentive
stock options ("ISOs") that meet the requirements of Section 422 of the
Internal Revenue Code of 1986, as amended (the "Code"), stock options not so
qualified ("NQSOs"), deferred stock, restricted stock, stock appreciation
rights and limited stock appreciation rights awards ("Awards"). The Stock
Option Plan is administered by a committee of directors appointed by the Board
of Directors (the "Committee"). ISOs may be granted to the officers and key
employees of the Company or any of its subsidiaries. The exercise price for
any option granted under the Stock Option Plan may not be less than 100% (or
110% in the case of ISOs granted to an employee who is deemed to own in excess
of 10% of the outstanding Common Stock) of the fair market value of the shares
of Common Stock at the time the option is granted. The purpose of the Stock
Option Plan is to provide a means of performance- based compensation in order
to attract and retain qualified personnel and to provide an incentive to those
whose job performance affects the Company.
The Stock Option Plan authorizes the grant of options to purchase, and
awards of 900,000 shares of the Company's Common Stock. The number of shares
reserved for issuance under the Stock Option Plan is subject to anti-dilution
provisions for stock splits, stock dividends and similar events. If an option
granted under the Stock Option Plan expires or terminates, or an Award is
forfeited, the shares subject to any unexercised portion of such option or
Award will again become available for the issuance of further options or
Awards under the Stock Option Plan.
Under the Stock Option Plan, the Company may make loans available to stock
option holders, subject to the Committee's approval, in connection with the
exercise of stock options granted under the Stock Option Plan. If shares of
Common Stock are pledged as collateral for such indebtedness, such shares may
be returned to the Company in satisfaction of such indebtedness. If so
returned, such shares shall again be available for issuance in connection with
future stock options and Awards under the Stock Option Plan.
53
<PAGE>
Unless the Stock Option Plan is previously terminated by the Board of
Directors, no options or Awards may be granted under the Stock Option Plan ten
years after the effective date of the Offering.
Options granted under the Stock Option Plan will become exercisable
according to the terms of the grant made by the Committee. Awards will be
subject to the terms and restrictions of the award made by the Committee. The
Committee has discretionary authority to select participants from among
eligible persons and to determine at the time an option or Award is granted
and in the case of options, whether it is intended to be an ISO or a NQSO, and
when and in what increments shares covered by the option may be purchased.
Under current law, ISOs may not be granted to any individual who is not also
an officer or employee of the Company or any subsidiary.
The exercise price of any option granted under the Stock Option Plan is
payable in full (i) in cash, (ii) by surrender of shares of the Company's
Common Stock already owned by the option holder having a market value equal to
the aggregate exercise price of all shares to be purchased including, in the
case of the exercise of NQSOs, restricted stock subject to an Award under the
Stock Option Plan, (iii) by cancellation of indebtedness owed by the Company
to the optionholder, (iv) by a full recourse promissory note executed by the
optionholder or (v) by any combination of the foregoing. The terms of any
promissory note may be changed from time to time by the Board of Directors to
comply with applicable Internal Revenue Service or Commission regulations or
other relevant pronouncements.
The Board of Directors may from time to time revise or amend the Stock
Option Plan, and may suspend or discontinue it at any time. However, no such
revision or amendment may impair the rights of any participant under any
outstanding Award without such participant's consent or may, without
shareholder approval, increase the number of shares subject to the Stock
Option Plan or decrease the exercise price of a stock option to less than 100%
of fair market value on the date of grant (with the exception of adjustments
resulting from changes in capitalization), materially modify the class of
participants eligible to receive options or Awards under the Stock Option
Plan, materially increase the benefits accruing to participants under the
Stock Option Plan or extend the maximum option term under the Stock Option
Plan.
The Company has granted options to purchase 200,000 shares of Common stock
at a per share exercise price of $5.00, vesting 33 1/3% on each anniversary of
the date of grant. On the effective date of this Offering, the Company will
also grant options to purchase an additional 400,000 shares of Common Stock at
a per share exercise price equal to the initial public offering price, vesting
33 1/3% on each anniversary of the date of grant.
401(K) PLAN
The Company adopted a 401(k) savings plan (the "40l(k) Plan") effective on
July 1, 1996. Eligible employees may participate in the 401(k) Plan.
Participants in the 401(k) Plan may defer compensation in an amount not in
excess of the annual statutory limit ($9,500 in 1997). The Company may make
matching contributions in the amount determined annually by the Board of
Directors. All contributions are credited to separate accounts maintained in
trust for each participant and are invested, at the participant's direction,
in one or more of the investment funds made available under the 401(k) Plan.
Matching contributions if any, vest after three years. The 401(k) Plan is
intended to qualify under Section 401 and 501 of the Code, so that
contributions to the 401(k) Plan and income earned on the plan contributions
are not taxable to employees until withdrawn and so that the contributions
will be deductible by the Company when made.
54
<PAGE>
CERTAIN TRANSACTIONS
ARRANGEMENTS WITH DLJ
In October 1995, the Company entered into a Stock Purchase Agreement with
DLJ pursuant to which DLJ purchased shares of the Company's Class A Common
Stock, Class B Common Stock, and Series A Preferred Stock. All shares of
Series A Preferred Stock will be redeemed by the Company in the fourth quarter
of 1997 for approximately $1.6 million; of this amount $800,000 will be paid
to DLJ and $775,000 will be paid to BNC Equity Investors, LLC ("BNC LLC") (see
"--Arrangements with BNC Equity Investors, LLC"). DLJ currently holds
2,438,144 shares of the Company's Common Stock, all of which is being sold
pursuant to this Offering. In October 1995, the Company, DLJ and Evan R.
Buckley, the President, Chief Executive Officer and a director of the Company,
entered into a shareholders agreement restricting certain actions by the
shareholders. This agreement will be terminated at or before the closing of
the Offering.
The Company from August 1995 through October 1997 financed its origination
of loans primarily with the proceeds of borrowings under the DLJ Facility. As
of September 30, 1997 and June 30, 1997 and 1996, $59.0 million, $54.0 million
and $42.7 million, respectively, was outstanding under the DLJ Facility. In
October 1997, the Company and DLJ entered into the Amended DLJ Facility. For
further information regarding the terms of the DLJ Facility and the Amended
DLJ Facility, see "Business--Financing and Sale of Loans--Warehouse Facility."
Substantial loan sales have been made to DLJ under a master mortgage loan
purchase agreement pursuant to which DLJ has the right to buy all loans
originated under the DLJ Facility at a negotiated price less 50 basis points.
For the three months ended September 30, 1997 and the years ended June 30,
1997 and 1996, an aggregate of $788,000, $2.1 million and $1.8 million,
respectively, was paid to DLJ as fees pursuant to said agreement. During the
three months ended September 30, 1997 and the years ended June 30, 1997 and
1996, the Company sold 1,691, 4,965 and 1,606 loans to DLJ, having an
aggregate principal balance of $157.8 million, $476.6 million and $153.2
million, respectively. See "Business--Financing and Sale of Loans."
ARRANGEMENTS WITH BNC EQUITY INVESTORS, LLC
BNC LLC is a California limited liability company which was formed to
acquire and hold an ownership interest in the Company. BNC LLC currently holds
453,600 shares of the Company's Common Stock. Mr. Buckley and Mr. Vander-
Haeghen own approximately 32.2% and 6.5%, respectively, of BNC LLC. BNC LLC's
manager is the Company.
OTHER TRANSACTIONS
In January 1996, Kelly W. Monahan purchased 283,505 shares of Class B Common
Stock for $1,000, and in July 1996 and September 1996, each of David J. Rae
and Al Lapena, and Gary Vander-Haeghen, respectively, purchased 28,351 shares
of Class B Common Stock for $1,375 and $1,375 and $100, respectively. All
shares of Class B Common Stock will convert into Common Stock prior to the
consummation of the Offering. Each person purchased their shares pursuant to
an Executive Stock Purchase and Repurchase Rights Agreement which set forth
certain transfer restrictions and repurchase rights by the Company which will
terminate upon the closing of the Offering.
In August 1997, the Company loaned Evan R. Buckley an aggregate of $150,000
at an annual rate equal to the federal funds rate. The principal balance, with
interest, is due upon the sale of shares of Common Stock owned by Mr. Buckley.
As of September 30, 1997, no payments had been made on the loan.
In August 1997, the Company loaned Kelly W. Monahan $100,000 at an annual
rate equal to the federal funds rate. The note is secured by 56,701 shares of
the Common Stock of the Company held by Mr. Monahan. The principal balance,
with interest, is due upon the sale of such shares of Common Stock. As of
September 30, 1997, no payments had been made on the loan.
55
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of October 20, 1997, and as
adjusted to reflect the sale of 2,000,000 shares by the Company and 2,438,144
shares by the Selling Stockholder, by (i) each director of the Company, (ii)
each of the Named Executive Officers, (iii) each person known to the Company
to be beneficial owner of more than 5% of the Common Stock and (iv) all
directors and executive officers of the Company as a group.
<TABLE>
<CAPTION>
COMMON STOCK
OWNED COMMON STOCK
PRIOR TO TO BE OWNED
OFFERING(1) AFTER THE OFFERING
----------------- NUMBER ---------------------
NUMBER OF SHARES NUMBER OF
OF SHARES PERCENT BEING OFFERED SHARES PERCENT
--------- ------- ------------- ------------ --------
<S> <C> <C> <C> <C> <C>
DLJ Mortgage Capital,
Inc.(2)................ 2,438,144 44.3% 2,438,144 -- --
Evan R. Buckley(3)(4)... 2,130,861 38.7% -- 2,130,861 28.4%
Kelly W. Monahan(3)..... 283,505 5.2% -- 283,505 3.8%
Gary Vander-
Haeghen(3)(5).......... 57,616 1.1% -- 57,616 *
All Directors and
Officers as a Group (6
persons)............... 2,471,982 44.9% -- 2,471,982 33.0%
</TABLE>
- --------
*Less than 1%.
(1) The persons named in the table have sole voting and investment power with
respect to all shares of Common Stock shown as beneficially owned.
(2) DLJ Mortgage Capital, Inc. may be reached at 277 Park Avenue, New York,
New York 10172.
(3) Each of such persons may be reached through the Company at 1740 East Garry
Avenue, Suite 109, Santa Ana, California 92705.
(4) Included in this amount are 146,325 shares which Mr. Buckley is deemed to
beneficially own through his ownership interest in BNC LLC.
(5) Included in this amount are 29,265 shares which Mr. Vander-Haeghen is
deemed to beneficially own through his ownership interest in BNC LLC.
56
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 50,000,000 shares of
Common Stock and 5,000,000 shares of Preferred Stock. After giving effect to
this Offering, there will be 7,500,000 shares of Common Stock outstanding and
no shares of Preferred Stock outstanding.
COMMON STOCK
As of September 30, 1997, there were approximately 5,500,000 shares of
Common Stock outstanding held by approximately 13 stockholders of record.
There will be 7,500,000 shares of Common Stock outstanding after giving effect
to the sale of the shares of Common Stock offered hereby. The holders of
Common Stock are entitled to one vote per share on all matters to be voted on
by stockholders. Subject to preferences that may be applicable to any
outstanding Preferred Stock, if any, the holders of Common Stock are entitled
to receive ratably such dividends, if any, as may be declared from time to
time by the Board of Directors in its discretion out of funds legally
available therefor. See "Dividend Policy." In the event of a liquidation,
dissolution or winding up of the Company, the holders of Common Stock are
entitled to share ratably in all assets remaining after payment of
liabilities, subject to prior rights of Preferred Stock, if any, then
outstanding. The Common Stock has no preemptive or other subscription rights
and there are no conversion rights or redemption or sinking fund provisions
with respect to such shares. All of the outstanding shares of Common Stock are
fully paid and nonassessable.
PREFERRED STOCK
The Board of Directors has the authority, without further action by the
stockholders of the Company, to issue up to 5,000,000 shares of Preferred
Stock in one or more series, and to fix the designations, rights, preferences,
privileges, qualifications and restrictions thereof including dividend rights,
conversion rights, voting rights, rights and terms of redemption, liquidation
preferences and sinking fund terms, any or all of which may be greater than
the rights of the Common Stock. The Board of Directors, without stockholder
approval, can issue Preferred Stock with voting, conversion and other rights
which could adversely affect the voting power and other rights of the holders
of Common Stock. Preferred Stock could thus be issued quickly with terms
calculated to delay or prevent a change in control of the Company or to make
removal of management more difficult. In certain circumstances, such issuance
could have the effect of decreasing the market price of the Common Stock. The
issuance of Preferred Stock may have the effect of delaying, deterring or
preventing a change in control of the Company without any further action by
the stockholders including, but not limited to, a tender offer to purchase
Common Stock at a premium over then current market prices. The Company has no
present plan to issue any shares of Preferred Stock.
CERTAIN PROVISIONS OF DELAWARE LAW
Prior to the consummation of this Offering, the Company intends to
reincorporate in Delaware on the date of reincorporation the Company will
become subject to Section 203 of the Delaware General Corporation Law. In
general, Section 203 prevents an "interested stockholder" (defined generally
as a person owning 15% or more of the Company's outstanding voting stock) from
engaging in a "business combination" (as defined in Section 203) with the
Company for three years following the date that person became an interested
stockholder unless: (i) before that person became an interested stockholder,
the Board of Directors approved the transaction in which the interested
stockholder became an interested stockholder or approved the business
combination; (ii) upon completion of the transaction that resulted in such
person becoming an interested stockholder, such person owned at least 85% of
the voting stock of the Company outstanding at the time the transaction
commenced (excluding stock held by directors who are also officers of the
Company and by employee stock plans that do not provide employees with the
right to determine confidentially whether shares held subject to the plan will
be tendered in a tender or exchange offer); or, (iii) on or following the date
on which that person became an interested stockholder, the business
combination is approved by the Company's Board of Directors and authorized at
a
57
<PAGE>
meeting of stockholders by the affirmative vote of the holders of at least 66
2/3% of the outstanding voting stock of the Company not owned by the
interested stockholder.
Under Section 203, these restrictions also do not apply to certain business
combinations proposed by an interested stockholder following the announcement
or notification of one of certain extraordinary transactions involving the
Company and a person who was not an interested stockholder during the previous
three years or who became an interested stockholder with the approval of a
majority of the Company's directors, if that extraordinary transaction is
approved or not opposed by a majority of the directors (but not less than one)
who were directors before any person became an interested stockholder in the
previous three years or who were recommended for election or elected to
succeed such directors by a majority of such directors then in office.
Pursuant to Section 162 of the Delaware General Corporation Law, the Board
of Directors of the Company can, without stockholder approval, issue shares of
capital stock, which may have the effect of delaying, deferring or preventing
a change of control of the Company. The Company has no plan or arrangement for
the issuance of any shares of capital stock other than in the ordinary course
pursuant to the Stock Option Plan.
CERTAIN CHARTER AND BYLAW PROVISIONS
The Company's Certificate of Incorporation will provide that no action which
has not been previously approved by the Board of Directors may be taken by the
stockholders except at an annual meeting or a special meeting of the
stockholders.
The Company's Bylaws will require stockholders to provide advance notice of
any stockholder nominations for directors and of any business to be brought
before any meeting of stockholders. Stockholders will not be entitled to
cumulative voting in connection with the election of directors. As a result, a
person or a group controlling the majority of shares of Common Stock could
elect all of the directors.
The Certificate of Incorporation of the Company contain certain provisions
permitted under the Delaware General Corporation Law relating to the liability
of directors. These provisions will eliminate the directors' liability for
monetary damages for a breach of fiduciary duty, except in certain
circumstances involving wrongful acts, including the breach of a director's
duty of loyalty or acts or omissions which involve intentional misconduct or a
knowing violation of a law. The Company's Certificate of Incorporation will
also contain provisions to indemnify its directors and officers to the fullest
extent permitted by the Delaware General Corporation Law.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is U.S. Stock
Transfer, Glendale, California.
58
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
After this Offering, the Company will have outstanding 7,500,000 shares of
Common Stock. Of the outstanding shares, the 4,438,144 shares to be sold in
this Offering will be freely tradeable without restriction or further
registration under the Securities Act unless purchased by "affiliates" of the
Company as that term is defined in Rule 144 under the Securities Act.
The remaining 3,061,856 shares of Common Stock outstanding upon completion
of this Offering (assuming no exercise of the Underwriters' over-allotment
option) are "restricted securities" as that term is defined in Rule 144, all
of which will be eligible for sale under Rule 144 upon completion of this
Offering, subject to the lock-up described below. As described below, Rule 144
permits resales of restricted securities subject to certain restrictions.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who beneficially owned shares for at least one
year, including any person who may be deemed an "affiliate" of the Company (as
the term "affiliate" is defined under the Securities Act), would be entitled
to sell within any three month period a number of such shares that does not
exceed the greater of 1% of the shares of the Company's Common Stock then
outstanding 7,500,000 shares immediately after this Offering) or the average
weekly trading volume in the Company's Common Stock during the four calendar
weeks preceding the date on which notice of the sale is filed with the
Commission. A person who is not deemed to have been an "affiliate" of the
Company any time during the three months immediately preceding a sale and who
has beneficially owned shares for at least two years would be entitled to sell
such shares under Rule 144 without regard to the volume limitation described
above.
The Company and its executive officers, directors and stockholders have
agreed that they will not, without the prior written consent of Friedman,
Billings, Ramsey & Co., Inc. (which consent may be withheld in its sole
discretion) and subject to certain limited exceptions, directly or indirectly,
sell offer, contract or grant any option to sell, make any short sale, pledge,
transfer, establish an open "put equivalent position" within the meaning of
Rule 16a-1(h) under the Exchange Act, or otherwise dispose of any shares of
Common Stock, options or warrants to acquire Common Stock, or securities
exchangeable or exercisable for or convertible into Common Stock currently
owned either of record or beneficially by them or announce the intention to do
any of the foregoing, for a period commencing on the date of this Prospectus
and continuing to a date 180 days after such date. Friedman, Billings, Ramsey
& Co., Inc. may, in its sole discretion and at any time without notice,
release all or any portion of the securities subject to these lock up
agreements. In addition, the Company has agreed that, for a period of 180 days
after the date of this Prospectus, it will not, without the consent of
Friedman, Billings, Ramsey & Co., Inc. issue, offer, sell or grant options to
purchase or otherwise dispose of any equity securities or securities
convertible into or exchangeable for equity securities except for (i) the
issuance of shares of Common stock offered hereby and (ii) the grant of
options to purchase shares of Common Stock pursuant to the Stock Option Plan
and shares of Common Stock issued pursuant to the exercise of such options,
provided that such options shall not vest, or the Company shall obtain the
written consent of the grantee not to transfer such shares, until the end of
such 180-day period. See "Underwriting."
The Stock Option Plan authorizes the grant of options to purchase, and
awards of 900,00 shares of the Company's Common Stock; of this amount, options
to acquire 200,000 shares were granted prior to this Offering at a per share
exercise price of $5.00. Options to purchase an additional 400,000 shares are
expected to be granted to employees, officers and directors of the Company on
the effective date of this Offering. The Company intends to file a
Registration Statement on Form S-8 covering the shares that have been reserved
for issuance under the Stock Option Plan, thus permitting the resale of such
shares in the public market.
59
<PAGE>
UNDERWRITING
The Underwriters named below represented by Friedman, Billings, Ramsey &
Co., Inc. and Oppenheimer & Co., Inc. (the "Representatives") have severally
agreed, subject to the terms and conditions set forth in the Underwriting
Agreement, to purchase from the Company and the Selling Stockholder the number
of shares of Common Stock indicated below opposite their respective names at
the initial public offering price less the underwriting discounts set forth on
the cover page of this Prospectus:
<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
- ----------- ----------------
<S> <C>
Friedman, Billings, Ramsey & Co., Inc. ........................
Oppenheimer & Co., Inc. .......................................
---------
Total...................................................... 4,438,144
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters are
committed to purchase all of such shares if any are purchased.
The Representatives have advised the Company and the Selling Stockholder
that the Underwriters propose initially to offer the shares of Common Stock to
the public on the terms set forth on the cover page of this Prospectus. The
Underwriters may allow to selected dealers a concession of not more than $
per share, and the Underwriters may allow, and such dealers may reallow, a
concession of not more than $ per share to certain other dealers. After
this Offering, the offering price and other selling terms may be changed by
the Representatives. The shares of Common Stock are offered subject to receipt
and acceptance by the Underwriters and to certain other conditions, including
the right to reject orders in whole or in part.
The Company has granted an option to the Underwriters, exercisable during
the 30-day period after the date of this Prospectus, to purchase up to a
maximum of 665,722 additional shares of Common Stock to cover over-allotments,
if any, at the offering price less the underwriting discounts set forth on the
cover page of this Prospectus. To the extent the Underwriters exercise this
option, each of the Underwriters will be committed, subject to certain
conditions, to purchase such additional shares in approximately the same
proportion as set forth in the above table. The Underwriters may purchase such
shares only to cover over-allotments made in connection with the Offering.
The Underwriting Agreement provides that the Company and the Selling
Stockholder will indemnify the Underwriters against certain liabilities,
including liabilities under the Securities Act, or will contribute to payments
that the Underwriters may be required to make in respect thereof.
The Company, and its executive officers, directors and stockholders have
agreed that they will not, without the prior written consent of Friedman,
Billings, Ramsey & Co., Inc. (which consent may be withheld in its sole
discretion) and subject to certain limited exceptions, directly or indirectly,
sell, offer, contract or grant any option to sell, make any short sale,
pledge, transfer, establish an open "put equivalent position" within the
meaning of Rule 16a-1(h) under the Exchange Act, or otherwise dispose of any
shares of Common Stock, options or warrants to acquire Common Stock, or
securities exchangeable or exercisable for or convertible into Common Stock
currently owned either of record or beneficially by them or announce the
intention to do any of the foregoing,
60
<PAGE>
for a period commencing on the date of this Prospectus and continuing to a
date 180 days after such date. Friedman, Billings, Ramsey & Co., Inc. may, in
its sole discretion and at any time without notice, release all or any portion
of the securities subject to these lock up agreements. In addition, the
Company has agreed that, for a period of 180 days after the date of this
Prospectus, it will not, without the consent of Friedman, Billings, Ramsey &
Co., Inc., issue, offer, sell or grant options to purchase or otherwise
dispose of any equity securities or securities convertible into or
exchangeable for equity securities except for (i) the issuance of shares of
Common stock offered hereby and (ii) the grant of options to purchase shares
of Common Stock pursuant to the Stock Option Plan and shares of Common Stock
issued pursuant to the exercise of such options, provided that such options
shall not vest, or the Company shall obtain the written consent of the grantee
not to transfer such shares, until the end of such 180-day period. See
"Management--Stock Options" and "Shares Eligible for Future Sale."
Prior to this Offering, there has been no public market for the Common
Stock. Consequently, the initial public offering price will be determined by
negotiations among the Company, the Selling Stockholder and the
Representatives. Among the factors to be considered in such negotiations are
the history of, and prospects for, the Company and the industry in which it
competes, an assessment of the Company management, its past and present
operations and financial performance, the prospects for further earnings of
the Company, the present state of the Company's development, the general
condition of the securities markets at the time of the Offering, the market
prices of and demand for publicly traded common stocks of comparable companies
in recent periods and other factors deemed relevant.
The Representatives have advised the Company that, pursuant to Regulation M
under the Exchange Act, certain persons participating in this Offering may
engage in transactions, including stabilizing bids, syndicate covering
transactions or the imposition of penalty bids, which may have the effect of
stabilizing or maintaining the market price of the Common Stock at a level
above that which might otherwise prevail in the open market. A "stabilizing
bid" is a bid for or the purchase of the Common Stock on behalf of the
Underwriters for the purpose of fixing or maintaining the price of the Common
Stock. A "syndicate covering transaction" is the bid for or the purchase of
the Common Stock on behalf of the Underwriters to reduce a short position
incurred by the Underwriters in connection with this Offering. A "penalty bid"
is an arrangement permitting the Representatives to reclaim the selling
concession otherwise accruing to an Underwriter or syndicate member in
connection with this Offering if the Common Stock originally sold by such
Underwriter or syndicate member is purchased by the Representative in a
syndicate covering transaction and has therefore not been effectively placed
by such Underwriter or syndicate member. The Representatives have advised the
Company that such transactions may be effected on the Nasdaq National Market
or otherwise and, if commenced, may be discontinued at any time.
The Representatives have informed the Company that the Underwriters do not
expect to make sales to accounts over which they exercise discretionary
authority in excess of 5% of the number of shares of Common Stock offered
hereby. Certain of the Underwriters may from time to time in the future enter
into reverse repurchase agreements or other financing arrangements with the
Company to finance the purchase of mortgage assets.
61
<PAGE>
LEGAL MATTERS
Certain matters relating to this offering are being passed upon for the
Company and the Selling Stockholder by Freshman, Marantz, Orlanski, Cooper &
Klein, a law corporation, Beverly Hills, California. Certain legal matters
will be passed upon for the Underwriters by Gibson, Dunn & Crutcher LLP,
Orange County, California.
EXPERTS
The consolidated financial statements of BNC Mortgage, Inc. at June 30, 1996
and 1997, and for the years then ended, appearing in this Prospectus and
Registration Statement have been audited by Ernst & Young LLP, independent
auditors, as set forth in their report thereon appearing elsewhere herein, and
are included in reliance upon such report given upon the authority of such
firm as experts in accounting and auditing.
AVAILABLE INFORMATION
The Company has filed a Registration Statement on Form S-1 under the
Securities Act with the Commission with respect to the Common Stock offered
hereby. This Prospectus, which constitutes part of the Registration Statement,
omits certain of the information contained in the Registration Statement and
the exhibits thereto on file with the Commission pursuant to the Securities
Act and the rules and regulations of the Commission. Statements contained in
this Prospectus, such as the descriptions of the contents of any contract or
other document referred to, are not necessarily complete and in each instance
reference is made to the copy of such contract or other document filed as an
exhibit to the Registration Statement, each such statement being qualified in
all respects by such reference. A copy of the Registration Statement,
including the exhibits thereto, may be inspected without charge at the
Commission's principal office at 450 Fifth Street, N.W., Judiciary Plaza,
Washington, D.C. 20549, and copies of all or any part thereof may be obtained
from the Commission upon the payment of certain fees prescribed by the
Commission. The Commission also maintains a World Wide Web site that contains
reports, proxy and information statements and other information regarding
registrants, such as the Company, that file electronically with the
Commission. The address of the site is http:/ / www.sec.gov.
The Company intends to furnish its stockholders with annual reports
containing financial statements audited by an independent accounting firm and
quarterly reports containing unaudited financial information for the first
three quarters of each fiscal year.
62
<PAGE>
BNC MORTGAGE, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Auditors............................................ F-2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheet................................................ F-3
Consolidated Statement of Income.......................................... F-4
Consolidated Statement of Stockholders' Equity............................ F-5
Consolidated Statement of Cash Flows...................................... F-6
Notes to Consolidated Financial Statements................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
BNC Mortgage, Inc.
We have audited the accompanying consolidated balance sheet of BNC Mortgage,
Inc. as of June 30, 1996 and 1997, and the related consolidated statements of
income, stockholders' equity and cash flows for the years then ended. These
consolidated 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 consolidated 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 BNC
Mortgage, Inc. at June 30, 1996 and 1997, and the results of its operations
and its cash flows for the years then ended, in conformity with generally
accepted accounting principles.
Orange County, California
August 2, 1997, except for Note 10,
as to which the date is October 24, 1997
F-2
<PAGE>
BNC MORTGAGE, INC.
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
PRO FORMA
JUNE 30, STOCKHOLDERS'
----------------------- SEPTEMBER EQUITY
1996 1997 30, 1997 SEPTEMBER 30, 1997
----------- ----------- ----------- ------------------
(UNAUDITED) (UNAUDITED NOTE 10)
ASSETS
------
<S> <C> <C> <C> <C>
Cash and cash equivalents.... $ 2,452,000 $ 8,268,000 $ 9,111,000
Restricted cash.............. -- -- 605,000
Mortgage loans held for sale. 42,723,000 55,145,000 59,431,000
Property and equipment, net.. 411,000 609,000 663,000
Deferred income taxes........ 567,000 1,154,000 1,329,000
Notes receivable from
officers.................... -- -- 250,000
Other assets................. 199,000 537,000 791,000
----------- ----------- -----------
Total assets............. $46,352,000 $65,713,000 $72,180,000
=========== =========== ===========
<CAPTION>
LIABILITIES AND STOCKHOLDERS'
EQUITY
- -----------------------------
<S> <C> <C> <C> <C>
Liabilities:
Warehouse line-of-credit... $42,723,000 $54,625,000 $58,961,000
Accounts payable and
accrued liabilities....... 879,000 1,358,000 2,114,000
Income taxes payable....... 904,000 526,000 383,000
----------- ----------- -----------
Total liabilities........ 44,506,000 56,509,000 61,458,000
----------- ----------- -----------
Commitments and contingencies
(Note 8)
Stockholders' equity:
Series A preferred stock,
$0.001 par value:
Authorized shares--1,000
Issued and outstanding
shares--160 at June 30,
1996 and 1997 and
September 30, 1997
(liquidation value
$1,600,000)............. 1,575,000 1,575,000 1,575,000 --
Series A common stock,
voting, no par value:
Authorized shares--
3,969,072
Issued and outstanding
shares--3,969,072 at
June 30, 1996 and 1997
and September 30, 1997.. -- -- -- --
Series B common stock,
nonvoting, no par value:
Authorized shares--
1,701,031
Issued and outstanding
shares--1,474,227 at
June 30, 1996, 1,701,031
at June 30, 1997 and
1,530,928 at September
30, 1997................ 2,000 7,000 6,000 6,000
Retained earnings.......... 269,000 7,622,000 9,141,000 9,141,000
----------- ----------- ----------- ----------
Total stockholders'
equity................ 1,846,000 9,204,000 10,722,000 $9,147,000
----------- ----------- ----------- ==========
Total liabilities and
stockholders' equity.. $46,352,000 $65,713,000 $72,180,000
=========== =========== ===========
</TABLE>
See accompanying notes.
F-3
<PAGE>
BNC MORTGAGE, INC.
CONSOLIDATED STATEMENT OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
JUNE 30, SEPTEMBER 30,
---------------------- ---------------------
1996 1997 1996 1997
---------- ----------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Gain on sale of mortgage loans.. $4,240,000 $21,855,000 $3,410,000 $6,635,000
Loan origination income......... 1,978,000 5,473,000 1,022,000 1,240,000
Interest income................. 1,960,000 5,182,000 1,101,000 1,645,000
Other income.................... 52,000 250,000 39,000 102,000
---------- ----------- ---------- ----------
Total revenues................ 8,230,000 32,760,000 5,572,000 9,622,000
---------- ----------- ---------- ----------
Expenses:
Employees' salaries and
commissions.................... 3,624,000 11,052,000 1,837,000 3,505,000
General and administrative
expenses....................... 2,400,000 5,543,000 1,055,000 2,048,000
Interest expense................ 1,452,000 3,693,000 846,000 1,179,000
---------- ----------- ---------- ----------
Total expenses................ 7,476,000 20,288,000 3,738,000 6,732,000
---------- ----------- ---------- ----------
Income before income taxes........ 754,000 12,472,000 1,834,000 2,890,000
Income tax expense................ 337,000 4,930,000 723,000 1,193,000
---------- ----------- ---------- ----------
Net income.................... $ 417,000 $ 7,542,000 $1,111,000 $1,697,000
========== =========== ========== ==========
Pro forma net income per share.... $ 0.10 $ 1.31 $ 0.20 $ 0.30
========== =========== ========== ==========
Shares used in computing pro forma
net income per share............. 3,984,640 5,776,317 5,543,299 5,722,030
========== =========== ========== ==========
</TABLE>
See accompanying notes.
F-4
<PAGE>
BNC MORTGAGE, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
SERIES A SERIES A SERIES B
PREFERRED STOCK COMMON STOCK COMMON STOCK TOTAL
----------------- ---------------- ----------------- RETAINED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT EARNINGS EQUITY
------ ---------- --------- ------ --------- ------ ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at June 30,
1995................... 25 $ 250,000 1,984,536 $-- -- $ -- $ (10,000) $ 240,000
Issuance of preferred
stock.................. 135 1,325,000 -- -- -- -- -- 1,325,000
Issuance of common
stock.................. -- -- 1,984,536 -- 1,474,227 2,000 -- 2,000
Cash dividends on
preferred stock ($863
per share)............. -- -- -- -- -- -- (138,000) (138,000)
Net income.............. -- -- -- -- -- -- 417,000 417,000
--- ---------- --------- ---- --------- ------ ---------- -----------
Balance at June 30,
1996................... 160 1,575,000 3,969,072 -- 1,474,227 2,000 269,000 1,846,000
Issuance of common
stock.................. -- -- -- -- 255,155 6,000 -- 6,000
Repurchase of common
shares................. -- -- -- -- (28,351) (1,000) -- (1,000)
Cash dividends on
preferred stock ($1,181
share)................. (189,000) (189,000)
Net income.............. -- -- -- -- -- -- 7,542,000 7,542,000
--- ---------- --------- ---- --------- ------ ---------- -----------
Balance at June 30,
1997................... 160 1,575,000 3,969,072 -- 1,701,031 7,000 7,622,000 9,204,000
Repurchase of common
shares (unaudited)..... -- -- -- -- (170,103) (1,000) (131,000) (132,000)
Cash dividends on
preferred stock ($295
per share) (unaudited). -- -- -- -- -- -- (47,000) (47,000)
Net income (unaudited).. -- -- -- -- -- -- 1,697,000 1,697,000
--- ---------- --------- ---- --------- ------ ---------- -----------
Balance at September 30,
1997 (unaudited)....... 160 $1,575,000 3,969,072 -- 1,530,928 6,000 $9,141,000 $10,722,000
=== ========== ========= ==== ========= ====== ========== ===========
</TABLE>
See accompanying notes.
F-5
<PAGE>
BNC MORTGAGE, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, THREE MONTHS ENDED SEPTEMBER 30,
---------------------------- ---------------------------------
1996 1997 1996 1997
------------- ------------- ---------------- ----------------
(UNAUDITED)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income.............. $ 417,000 $ 7,542,000 $ 1,111,000 $ 1,697,000
Adjustment to reconcile
net income to net cash
provided by (used in)
operating activities:
Depreciation.......... 77,000 250,000 49,000 88,000
Origination of
mortgage loans held
for sale............. (199,963,000) (532,621,000) (93,427,000) (164,402,000)
Sales and principal
repayments of
mortgage loans held
for sale............. 157,240,000 520,600,000 103,514,000 159,928,000
Deferred loan
orgination costs
(fees)............... -- (401,000) (61,000) 188,000
Change in other
assets............... (199,000) (338,000) (395,000) (254,000)
Change in notes
receivable from
officers............. -- -- -- (250,000)
Change in accounts
payable and accrued
liabilities.......... 879,000 479,000 274,000 756,000
Change in income taxes
payable.............. 904,000 (378,000) 385,000 (143,000)
Change in deferred
income taxes......... (567,000) (587,000) -- (175,000)
------------- ------------- --------------- ----------------
Net cash provided by
(used in) operating
activities............. (41,212,000) (5,454,000) 11,450,000 (2,567,000)
------------- ------------- --------------- ----------------
INVESTING ACTIVITIES
Capital expenditures.... (488,000) (448,000) (155,000) (142,000)
------------- ------------- --------------- ----------------
Net cash used in
investing activities... (488,000) (448,000) (155,000) (142,000)
------------- ------------- --------------- ----------------
FINANCING ACTIVITIES
Payment of dividends on
preferred stock........ (138,000) (189,000) (47,000) (47,000)
Repurchase of common
stock.................. -- (1,000) -- (132,000)
Proceeds from the
issuance of preferred
stock.................. 1,325,000 -- -- --
Proceeds from issuance
of common stock........ 2,000 6,000 -- --
Increase in restricted
cash................... -- -- -- (605,000)
Change in warehouse
line-of-credit......... 42,723,000 11,902,000 (10,231,000) 4,336,000
------------- ------------- --------------- ----------------
Net cash provided by
(used in) financing
activities............. 43,912,000 11,718,000 (10,278,000) 3,552,000
------------- ------------- --------------- ----------------
Net increase in cash and
cash equivalents....... 2,212,000 5,816,000 1,017,000 843,000
Cash and cash
equivalents at
beginning of year...... 240,000 2,452,000 2,452,000 8,268,000
------------- ------------- --------------- ----------------
Cash and cash
equivalents at end of
year................... $ 2,452,000 $ 8,268,000 $ 3,469,000 $ 9,111,000
============= ============= =============== ================
SUPPLEMENTAL CASH FLOWS
INFORMATION
Interest paid........... $ 1,452,000 $ 3,693,000 $ 846,000 $ 1,179,000
============= ============= =============== ================
Taxes paid.............. $ -- $ 5,351,000 $ 708,000 $ 1,511,000
============= ============= =============== ================
</TABLE>
See accompanying notes.
F-6
<PAGE>
BNC MORTGAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AT SEPTEMBER 30, 1997 AND FOR THE THREE-MONTH PERIODS ENDED
SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS AND BASIS OF PRESENTATION
The Company is a specialty finance company engaged in the business of
originating, purchasing and selling sub-prime residential mortgage loans
secured by one-to-four family residences. The Company's loans are made to
owners of single family residence who typically use the loan proceeds for
purposes such as refinancing existing mortgages, debt consolidation, financing
of home improvements, education and other similar needs, and, to a lesser
extent, to purchase residences. The Company originates loans through its
wholesale division, which originates mortgage loans through approved
independent loan brokers, and through its retail division, which markets loans
directly to homeowners. The Company currently sells all of its mortgage loans
to institutional purchasers such as investment banks, real estate investment
trusts and other large mortgage bankers for cash through whole loan sales.
For the year ended June 30, 1997, DLJ Mortgage Capital, Inc. (DLJ) which
owns approximately 44% of the Company's outstanding stock purchased 91% of the
loans originated by the Company, pursuant to a Master Mortgage Loan Purchase
Agreement.
The Company was formed on May 2, 1995 and began originating mortgage loans
in October 1995. For the period May 2, 1995 through June 30, 1995, the Company
did not have any revenue and recorded start-up costs of $10,000. Financial
statements are not presented for the period May 2, 1995 through June 30, 1995
as the operations were not material.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of the Company include the accounts of
the Company and all of its wholly owned subsidiaries. All significant
intercompany transactions and balances are eliminated.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of the consolidated financial statements of the Company
requires management to make estimates and assumptions that affect reported
amounts. These estimates are based on information available as of the date of
the financial statements. Therefore, actual results could differ from those
estimates.
MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale are stated at the lower of cost or aggregate
market value. Market value is determined by purchase commitments from
investors and prevailing market prices.
LOAN ORIGINATION FEES
Loan origination fees and certain direct loan origination costs for mortgage
loans held for sale are deferred until the related loans are sold.
GAIN ON SALE OF MORTGAGE LOANS HELD FOR SALE
Gains or losses on the sale of mortgage loans held for sale are recognized
at the date of sale.
CASH AND CASH EQUIVALENTS
The Company accounts for all highly liquid investments with a maturity of
three months or less when purchased as cash equivalents.
F-7
<PAGE>
BNC MORTGAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AT SEPTEMBER 30, 1997 AND FOR THE THREE-MONTH PERIODS ENDED
SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)
PROPERTY AND EQUIPMENT
Property and equipment, consisting primarily of computer hardware and
software, is stated at cost, net of accumulated depreciation and amortization.
Depreciation is provided using the straight line method over their estimated
useful lives of three years.
RECENTLY ISSUED ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128 Earnings Per Share (FAS 128), which simplifies the standards for
computing earning per share (EPS) and replaces the presentation of primary EPS
with a presentation of basic EPS. The Company believes that the adoption of
FAS 128 in fiscal year 1998 will not have a material impact on the financial
statements.
In February 1997, the FASB issued SFAS No. 129, Disclosure of Information
about Capital Structure. This Statement shall be effective for financial
statements for both interim and annual periods ending after December 15, 1997.
At this time the Company has determined that this Statement will have no
significant impact on the financial position or results of operations for
1997.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income.
This Statement establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. This Statement shall be
effective for fiscal years beginning after December 15, 1997. Reclassification
of financial statements for earlier periods provided for comparative purposes
is required. At this time the Company has determined that this Statement will
have no significant impact on the financial position or results of operations
for 1997.
INCOME TAXES
The Company accounts for income taxes using Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes (FAS 109). FAS 109
requires the use of the asset and liability method of accounting for taxes.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. Under FAS 109,
the effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
PRO FORMA NET INCOME PER SHARE
Pro forma net income per share is computed using the weighted average number
of shares of common stock outstanding. In accordance with Securities and
Exchange Commission Staff Accounting Bulletins, common equivalents shares
issued by the Company at prices substantially below the anticipated initial
public offering price during the period beginning one year prior to the
proposed public offering have been included in the calculation as if they were
outstanding for all periods presented (using the treasury stock method and the
estimated initial public offering price).
INTERIM RESULTS
The accompanying balance sheet as of September 30, 1997 and the statements
of income, stockholders' equity and cash flows for the three months ended
September 30, 1996 and 1997 are unaudited. In the opinion of
F-8
<PAGE>
BNC MORTGAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AT SEPTEMBER 30, 1997 AND FOR THE THREE-MONTH PERIODS ENDED
SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)
management, the statements have been prepared on the same basis as the audited
financial statements and include all adjustments, consisting only of normal
recurring adjustments, necessary for the fair statement of the results of
interim periods.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values presented in Note 6 are estimates of the fair values of the
financial instruments at a specific point in time using available market
information and appropriate valuation methodologies. These estimates are
subjective in nature and involve uncertainties and significant judgment in the
interpretation of current market data. Therefore, the fair values presented
are not necessary indicative of amounts the Company could realize or settle
currently.
2. MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale are collateralized by first trust deeds on
underlying real properties and are used as collateral for the Company's
borrowings. Approximately 32% of these properties are located in California.
Mortgage loans held for sale include net deferred origination fees and (costs)
of $3,000, $401,000 and $(217,000) at June 30, 1996 and 1997 and September 30,
1997, respectively.
Subsequent to June 30, 1997, substantially all of the mortgage loans were
sold to DLJ pursuant to the Master Mortgage Loan Purchase Agreement.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at June 30, 1996 and 1997:
<TABLE>
<CAPTION>
JUNE 30,
------------------- SEPTEMBER 30,
1996 1997 1997
-------- --------- -------------
<S> <C> <C> <C>
Office equipment.......................... $406,000 $ 840,000 $ 945,000
Software.................................. 82,000 96,000 133,000
-------- --------- ----------
488,000 936,000 1,078,000
Less accumulated depreciation............. (77,000) (327,000) (415,000)
-------- --------- ----------
$411,000 $ 609,000 $ 663,000
======== ========= ==========
</TABLE>
4. INCOME TAXES
Income tax expense for the years ended June 30, 1996 and 1997 are summarized
as follows:
<TABLE>
<CAPTION>
1996 1997
--------- ----------
<S> <C> <C>
Current:
Federal............................................. $ 749,000 $4,119,000
State............................................... 155,000 1,398,000
--------- ----------
904,000 5,517,000
Deferred:
Federal............................................. (504,000) (603,000)
State............................................... (63,000) 16,000
--------- ----------
(567,000) (587,000)
--------- ----------
$ 337,000 $4,930,000
========= ==========
</TABLE>
F-9
<PAGE>
BNC MORTGAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AT SEPTEMBER 30, 1997 AND FOR THE THREE-MONTH PERIODS ENDED
SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)
The reconciliation of income tax expense at the U.S. federal statutory tax
rate to the income tax expense for the years ended June 30, 1996 and 1997 is
as follows:
<TABLE>
<CAPTION>
1996 1997
-------- ----------
<S> <C> <C>
Tax computed at the statutory rate...................... $272,000 $4,365,000
State income tax, net of federal income tax benefit..... 61,000 665,000
Other................................................... 4,000 (100,000)
-------- ----------
Income tax expense...................................... $337,000 $4,930,000
======== ==========
</TABLE>
The components of the Company's deferred income tax assets and liabilities
as of June 30, 1996 and 1997 are as follows:
<TABLE>
<CAPTION>
1996 1997
-------- ----------
<S> <C> <C>
Deferred tax assets (liabilities):
Depreciation........................................ $ (7,000) $ (16,000)
State income taxes.................................. 32,000 479,000
Reserve for loan repurchases........................ 68,000 263,000
Accrued vacation.................................... 37,000 104,000
Litigation reserve.................................. 104,000 15,000
Mark-to-market adjustments.......................... 289,000 491,000
Deferred loan fees.................................. -- (186,000)
Other accrued liabilities........................... 44,000 4,000
-------- ----------
Total deferred tax assets............................. $567,000 $1,154,000
======== ==========
</TABLE>
5. WAREHOUSE LINE-OF-CREDIT
The Company entered into a Master Mortgage Loan Purchase Agreement (the
Agreement) with DLJ whereby DLJ will purchase substantially all mortgage loans
originated by the Company.
The Agreement provides for borrowings up to $50,000,000 with interest
payable monthly at the Federal Funds rate plus 1% (7.25% at June 30, 1997). At
June 30, 1997, borrowings under this line of $54,625,000 are collateralized by
mortgage loans held for sale. The Agreement provides that the amount borrowed
under the facility can exceed the maximum amount available from time to time
as the Company's production increases so as to enable the Company to continue
to fund mortgage loans without delay or interruption. The line-of-credit
matures and is subject to renewal on August 31, 2000. The weighted average
interest rate for the fiscal year ended June 30, 1997 was 6.4%.
6. FINANCIAL INSTRUMENTS
The following describes the methods and assumptions used by the Company in
estimating fair value:
Mortgage loans held for sale--Fair value is estimated using the quoted
market prices for securities backed by similar types of loans and investor
commitments to purchase loans on a service-released basis.
Warehouse line-of-credit--Fair value is estimated using rates currently
available to the Company for debt with similar terms and remaining
maturities.
F-10
<PAGE>
BNC MORTGAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AT SEPTEMBER 30, 1997 AND FOR THE THREE-MONTH PERIODS ENDED
SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)
The carrying values and the estimated fair values of the Company's financial
instruments for which it is practical to calculate a fair value are as
follows:
<TABLE>
<CAPTION>
JUNE 30, 1996 JUNE 30, 1997 SEPTEMBER 30, 1997
----------------------- ----------------------- -----------------------
CARRYING FAIR CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE VALUE VALUE
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans held for
sale................... $42,723,000 $43,188,000 $55,145,000 $56,816,000 $59,431,000 $61,977,000
Warehouse line-of-
credit................. 42,723,000 42,723,000 54,625,000 54,625,000 58,961,000 58,961,000
</TABLE>
7. RELATED PARTY TRANSACTION
In July 1997, the Company loaned an aggregate of $250,000 to two officers of
the Company. The loans accrue interest monthly at the Federal Funds rate and
are due upon the sale of common stock. For the three months ended September
30, 1997 interest expense of $3,000 was recorded related to these notes.
8. COMMITMENTS AND CONTINGENCIES
Repurchase Obligation
The Company engages in bulk loan sales pursuant to agreements that generally
require the Company to repurchase or substitute loans in the event of a breach
of a representation or warranty made by the Company to the loan purchaser, any
misrepresentation during the mortgage loan origination process or, in some
cases, upon any fraud or first payment default on such mortgage loans. A
reserve for potential repurchases of $150,000, $503,000 and $503,000 at June
30, 1996 and 1997 and September 30, 1997, respectively, is included in
accounts payable and accrued liabilities.
Leases
The Company's executive and administrative offices are occupied under
various month to month leases with aggregate monthly payments of approximately
$23,000. In June 1997, the Company entered into a noncancelable operating
lease which expires in 2002. The lease agreement, requires the Company to
deliver a letter of credit to the lessor in the amount of $600,000. Cash
deposited into escrow to secure the letter of credit and accrued interest
thereon is classified as restricted cash on the balance sheet.
The Company's loan offices are occupied under noncancelable operating leases
which expire between October 31, 1997 and August 31, 2001 and provide for rent
escalations tied to either increases in the lessor's operating expenses or
fluctuations in the consumer price index in the relevant geographical area.
The minimum annual rental payments under these operating leases is as
follows:
<TABLE>
<S> <C>
1998........................................................... $ 836,000
1999........................................................... 1,033,000
2000........................................................... 916,000
2001........................................................... 832,000
2002........................................................... 832,000
Thereafter..................................................... 347,000
----------
$4,796,000
==========
</TABLE>
F-11
<PAGE>
BNC MORTGAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AT SEPTEMBER 30, 1997 AND FOR THE THREE-MONTH PERIODS ENDED
SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)
Rent expense for the years ended June 30, 1996 and 1997 and the three months
ended September 30, 1997 was $169,000, $597,000 and $204,000, respectively.
9. STOCKHOLDERS' EQUITY
PREFERRED STOCK
The Series A Preferred stock has a par value of $0.001 per share and has no
voting rights. The holders of the Preferred stock are entitled to receive, to
the extent of available funds from the operations of the Company, dividends on
a cumulative basis at a rate equal to $1,200 per annum per share.
No dividends or other distributions on any other class of stock may be made
until the Series A Preferred stock has been fully redeemed. The Company may at
its option, redeem the Series A Preferred stock at any time, in whole or in
part, at a price per share in cash equal to the liquidation value. The
liquidation value shall be the sum of (i) $10,000 per share plus (ii) all
accrued but unpaid dividends as of the date the liquidation value of such
share is determined.
COMMON STOCK
The relative rights, privileges and limitations of the Class A common stock
and the Class B common stock are identical except that the Class A common
stock has exclusive voting rights and the Class B common stock does not.
10. SUBSEQUENT EVENTS
Reorganization
In October 1997, the Board of Directors authorized management of the Company
to file a registration statement with the Securities and Exchange Commission
authorizing the issuance of 2,000,000 shares of common stock to the public
(the Offering). If the Offering is consummated under the terms presently
anticipated 1) a 5,670.1031-for-1 stock split of the outstanding shares of
Series A and B Common Stock will be affected; 2) the Company will
reincorporate in Delaware and 50,000,000 shares of Common Stock and 5,000,000
shares of Preferred Stock will be authorized; 3) all the outstanding shares of
Series A preferred stock will be redeemed; and 4) all the outstanding shares
of Series A and B Common Stock will be converted into shares of $0.001 par
value Common Stock on a one-for-one basis.
Unaudited pro forma stockholders' equity, as adjusted for the assumed
redemption of the Series A preferred stock, is set forth in the accompanying
consolidated balance sheet. All common share and per share amounts included in
the consolidated financial statements have been retroactively adjusted to
reflect the stock split discussed above.
Stock Option Plan
In October 1997, the Company adopted the 1997 Stock Option, Deferred Stock
and Restricted Stock Plan (the Stock Option Plan), which provides for a
committee of the Board of Directors (the Committee) to authorize the grant of
incentive stock options, nonqualified stock options, deferred stock,
restricted stock, stock appreciation rights and limited stock appreciation
rights awards to any officer or key employee of the Company.
F-12
<PAGE>
BNC MORTGAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AT SEPTEMBER 30, 1997 AND FOR THE THREE-MONTH PERIODS ENDED
SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)
The Stock Option Plan authorizes the grant of options to purchase, and awards
of, an aggregate of 900,000 shares. Incentive stock options are granted at a
price not less than 100% (110% in the case of incentive stock options granted
to an employee who is deemed to own in excess of 10% of the outstanding common
stock) of the fair market value of the shares of common stock at the time the
option is granted. Incentive stock options and nonqualified stock options
become exercisable according to the terms of the grant made by the Committee
and remain exercisable until their specified expiration date. The effective
date of the Stock Option Plan will be the effective date of the Offering.
The Committee has authorized the issuance nonqualified stock options to an
employee for the purchase of 200,000 shares of common stock at $5.00 per
share. The options vest ratably over a three year period beginning on the
effective date of the Offering. The difference between the fair market value
of the common stock and the exercise price of the options of $1,000,000 will
be recorded as compensation expense over the vesting period of the options
beginning with the reporting of the Company's first quarterly results of
operations subsequent to the effective date of the Offering.
The Company has elected to follow Accounting Principles Board No. 25,
Accounting for Stock Issued to Employees and related Interpretations in
accounting for its employee stock options and make the required pro forma
disclosures regarding net income and earnings per share required by FASB
Statement No. 123, Accounting for Stock-Based Compensation in the notes to
financial statements for its fiscal year ended June 30, 1998.
Warehouse Line of Credit
In October 1997, the Company renegotiated its warehouse line-of-credit with
DLJ, to increase the maximum borrowing to $150 million with interest payable
monthly at the Federal Funds rate plus 50 basis points during the first 12
months and 100 basis points during the second 12 months. The maturity of the
warehouse line-of-credit is two years following the closing date of the
initial public offering.
F-13
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER MADE IN THIS PROSPECTUS AND, IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE COMPANY, ANY OF THE UNDERWRITERS OR THE SELLING
STOCKHOLDER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF, ANY OFFER TO BUY ANY SHARES OF COMMON STOCK OTHER THAN THE
SHARES OF COMMON STOCK TO WHICH IT RELATES OR AN OFFER TO, OR A SOLICITATION
OF, ANY PERSON IN ANY JURISDICTION WHERE SUCH AN OFFER OR SOLICITATION WOULD
BE UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE
HEREOF.
------------
TABLE OF CONTENTS
------------
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary ....................................................... 3
Risk Factors.............................................................. 7
Use of Proceeds........................................................... 17
Dividend Policy........................................................... 17
Dilution.................................................................. 18
Capitalization............................................................ 19
Selected Consolidated Financial Data...................................... 20
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 22
Business.................................................................. 29
Management................................................................ 51
Certain Transactions...................................................... 55
Principal and Selling Stockholders........................................ 56
Description of Capital Stock.............................................. 57
Shares Eligible for Future Sale........................................... 59
Underwriting.............................................................. 60
Legal Matters............................................................. 62
Experts................................................................... 62
Available Information..................................................... 62
Index to Financial Statements............................................. F-1
</TABLE>
UNTIL , 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS) ALL DEALERS
EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
4,438,144 SHARES
[LOGO]
COMMON STOCK
------------
PROSPECTUS
------------
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
OPPENHEIMER & CO., INC.
, 1997
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The Registrant estimates that expenses in connection with the offering
described in this registration statement will be as follows:
<TABLE>
<CAPTION>
AMOUNT TO
BE PAID
---------
<S> <C>
Securities and Exchange Commission registration fee............... $ 17,013
NASD filing fee................................................... 6,115
Nasdaq National Market Listing fee................................ 50,000
Printing expenses................................................. 200,000
Accounting fees and expenses...................................... 200,000
Legal fees and expenses........................................... 300,000
Fees and expenses (including legal fees) for qualifications under
state securities laws............................................ 50,000
Transfer agent's fees and expenses................................ 10,000
Miscellaneous..................................................... 16,872
--------
Total......................................................... $850,000*
========
</TABLE>
- --------
* Of this amount, $465,000 is payable by the Selling Stockholder.
All amounts except the Securities and Exchange Commission registration fee
and the NASD filing fee are estimated.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law permits the Registrant
to, and Article 8 of the Certificate of Incorporation provides that the
Registrant may, indemnify each person who was or is a party or is threatened
to be made a party to any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative, by
reason of the fact that he is or was, or has agreed to become, a director or
officer of the Registrant, or is or was servicing, or has agreed to serve, at
the request of the Registrant, as a director, officer or trustee of, or in a
similar capacity with, another corporation, partnership, joint venture, trust
or other enterprise (including any employee benefit plan), or by reason of any
action alleged to have been taken or omitted in such capacity, against all
expenses (including attorneys' fees), judgments, fines and amounts paid in
settlement actually and reasonably incurred by him or on his behalf in
connection with such action, suit or proceeding and any appeal therefrom.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
During the past three years the Registrant issued unregistered securities in
the following transactions (shares and dollar amounts have not been adjusted
to reflect a proposed 1 for 5,670.1031 stock split to be effected by the
Registrant prior to the consummation of this Offering):
(a) In October 1995, in connection with its organization, the Registrant
issued 350 shares of its Class A Common Stock and 25 shares of it Series A
Preferred Stock to Evan R. Buckley for an aggregate consideration of
$250,000.
(b) In October 1995, in connection with its organization, the Registrant
issued 350 shares of its Class A Common Stock, 80 shares of its Class B
Common Stock and 80 shares of its Series A Preferred Stock to DLJ Mortgage
Capital Inc. for an aggregate consideration of $800,004.
II-1
<PAGE>
(c) In October 1995, in connection with its organization, the Registrant
issued 55 shares of Class B Common Stock and 55 shares of its Series A
Preferred Stock to BNC Equity Investors, LLC for an aggregate consideration
of $250,000.
(d) In January 1996, the Registrant issued 80 shares of its Class B
Common Stock to two of its employees for an aggregate consideration of
$1,600.
(e) In February 1996, the Registrant issued 20 shares of its Class B
Common Stock to one of its employees for an aggregate consideration of
$400.
(f) In June 1996, the Registrant issued 20 shares of its Class B Common
Stock to four of its employees for an aggregate consideration of $400.
(g) In July 1996, the Registrant issued 20 shares of its Class B Common
Stock to two of its employees for an aggregate consideration of $5,500.
(h) In September 1996, the Registrant issued 5 shares of its Class B
Common Stock to one of its employees for an aggregate consideration of
$100.
The aforementioned issuances of stock were deemed to be exempt from
registration under the Securities Act in reliance in Section 4(2) promulgated
under the Securities Act as transactions by an issuer not involving a public
offering or on Rule 701 promulgated under the Securities Act. In addition, the
recipients of securities in each such transaction represented their intentions
to acquire the securities for investment only and not with a view to or for
sale in connection with any distribution thereof and appropriate legends were
affixed to the share certificates issued in such transactions. All recipients
had adequate access, through their relationships with the Company, to
information about the Company.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
1.1* Form of Underwriting Agreement
3.1* Certificate of Incorporation of BNC Mortgage, Inc., a Delaware
corporation
3.2* Bylaws of BNC Mortgage, Inc., a Delaware corporation
4.1* Specimen Stock Certificate
5.1* Opinion of Freshman, Marantz, Orlanski, Cooper & Klein
10.1* Form of 1997 Stock Option Plan and Form of Option Agreement
10.2* Form of Indemnification Agreement
10.3(a)* Letter Agreement, dated August 28, 1995, from DLJ Mortgage
Capital, Inc. to the Registrant.
(b)* Whole Loan Financing Facility, dated September 26, 1995, between
the Registrant and DLJ Mortgage Capital, Inc.
(c)* Promissory Note, dated September 26, 1995, by the Registrant made
in favor of DLJ Mortgage Capital, Inc.
(d)* Pledge Agreement, dated September 26, 1995, between the Registrant
and DLJ Mortgage Capital, Inc.
(e)* Whole Loan Financing Program Tri-Party Custody Agreement, dated
September 26, 1995, among the Registrant, DLJ Mortgage Capital,
Inc. and Bankers Trust Company
10.4* Master Mortgage Loan Purchase Agreement, dated October 31, 1995,
between the Registrant and DLJ Mortgage Capital, Inc.
11.1 Statement re: Computation of Per Share Earnings
21.1 Subsidiaries
23.1 Consent of Ernst & Young LLP
23.2* Consent of Freshman, Marantz, Orlanski, Cooper & Klein (contained in
Exhibit 5.1)
24.1 Power of Attorney (included on signature page of Registration
Statement)
27* Financial Data Schedule
- -------
* To be filed by amendment
II-2
<PAGE>
ITEM 17. UNDERTAKINGS
(a) The undersigned registrant hereby undertakes to provide to the
Underwriter at the closing specified in the Underwriting Agreement
certificates in such denominations and registered in such names as required by
the Underwriter to permit prompt delivery to each purchaser.
(b) insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act
and will be governed by the final adjudication of such issue.
(c) The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrant pursuant to Rule 424(b) (1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it is declared effective.
(2) For the purpose of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
HAS DULY CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF SANTA ANA, STATE OF
CALIFORNIA ON OCTOBER 24, 1997.
By /s/ Evan R. Buckley
_____________________________________
Evan R. Buckley
President, Chief Executive Officer
(Principal Executive Officer)
POWER OF ATTORNEY
We, the undersigned managers and officers of BNC Mortgage, Inc. do hereby
constitute and appoint Evan R. Buckley and Kelly W. Monahan, or either of
them, our true and lawful attorneys and agents, to do any and all acts and
things in our names in the capacities indicated below, which said attorneys
and agents, or either of them, may deem necessary or advisable to enable said
corporation to comply with the Securities Act of 1933, and as amended, and any
rules, regulations, and requirements of the Securities and Exchange
Commission, in connection with this Registration Statement, including
specifically, but without limitation, power and authority to sign for us or
any of us in our names and in the capacities indicated below, any and all
amendments (including post-effective amendment) to this Registration
Statement, or any related registration statement that is to be effective upon
filing pursuant to Rule 462(b) under the Securities Act of 1933, as amended;
and we do hereby ratify and confirm all that the said attorneys and agents, or
either of them, shall do or cause to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITY INDICATED ON OCTOBER 24, 1997.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ Evan R. Buckley President, Chief Executive
____________________________________ Officer
Evan R. Buckley and Director
(Principal Executive
Officer)
/s/ Kelly W. Monahan Chief Financial Officer
____________________________________ Executive
Kelly W. Monahan Vice President
(Principal Accounting
Officer) and Director
</TABLE>
II-4
<PAGE>
EXHIBIT 11.1
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
YEARS ENDED THREE MONTHS ENDED
JUNE 30, SEPTEMBER 30,
--------------------- ---------------------
1996 1997 1996 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Weighted average shares
outstanding....................... 3,884,640 5,676,317 5,443,299 5,622,030
Net effect of dilutive stock
options based on the treasury
stock method using the IPO price.. 100,000 100,000 100,000 100,000
---------- ---------- ---------- ----------
Total.............................. 3,984,640 5,776,317 5,543,299 5,722,030
---------- ---------- ---------- ----------
Net Income......................... $ 417,000 $7,542,000 $1,111,000 $1,697,000
---------- ---------- ---------- ----------
Per share amount................... $ 0.10 $ 1.31 $ 0.20 $ 0.30
========== ========== ========== ==========
</TABLE>
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES
<TABLE>
<CAPTION>
NAME OF SUBSIDIARY STATE OF INCORPORATION
- ------------------ ----------------------
<S> <C>
BNC Trustee Services, Inc. Missouri
Equity Credit Corporation California
</TABLE>
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated August 2, 1997, except for Note 10, as to which
the date is October 24, 1997 in the Registration Statement (Form S-1 No. 333-
and related Prospectus of BNC Mortgage, Inc., for the registration of
4,438,144 shares of its common stock.
Orange County, California
October 24, 1997
