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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File Number 000-23725
BNC MORTGAGE, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 33-0661303
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1063 McGaw Avenue Irvine, California 92614-5532
- --------------------------------------------------------------------------------
(Address of principal executive offices including ZIP Code)
(949) 260-6000
- --------------------------------------------------------------------------------
(Registrants' telephone number including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
As of November 13, 1998, registrant had 5,409,479 outstanding shares of Common
Stock.
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BNC MORTGAGE, INC.
TABLE OF CONTENTS
TO FORM 10-Q
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Item 1. Financial Statements Page
----
<S> <C>
Consolidated Balance Sheet as of September 30, 1998 and June 30, 1998.......................3
Consolidated Statement of Income for the Three Months Ended
September 30, 1998 and 1997.................................................................4
Consolidated Statement of Cash flows for the Three Months Ended September 30, 1998
and 1997....................................................................................5
Notes to the Consolidated Financial Statements..............................................6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......9
PART II - OTHER INFORMATION
Item 1. Legal Proceedings..........................................................................16
Item 2. Changes in Securities......................................................................16
Item 3. Defaults Upon Senior Securities............................................................16
Item 4. Submission of Matters to a Vote of Securities Holders......................................16
Item 5. Other Information..........................................................................16
Item 6. Exhibits and Reports on Form 8-K...........................................................16
(a) Exhibits...............................................................................16
Signatures.........................................................................................18
</TABLE>
2
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ITEM 1. FINANCIAL STATEMENTS
BNC MORTGAGE, INC.
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
September 30, 1998 June 30, 1998
------------------ -------------
<S> <C> <C>
ASSETS
Cash and cash equivalents .................. $ 30,527,000 $ 25,890,000
Restricted cash ............................ 600,000 638,000
Mortgage loans held for sale ............... 98,982,000 98,717,000
Property and equipment, net ................ 1,734,000 1,533,000
Deferred income taxes ...................... 2,131,000 2,131,000
Notes receivable from officers ............. 100,000 100,000
Other assets ............................... 1,310,000 1,546,000
------------ ------------
Total assets ....................... $135,384,000 $130,555,000
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Warehouse line-of-credit ................... $ 97,251,000 $ 96,022,000
Accounts payable and accrued liabilities ... 3,933,000 2,880,000
Income taxes payable ....................... 2,198,000 802,000
------------ ------------
Total liabilities .................. 103,382,000 99,704,000
Stockholders' equity:
Preferred stock, $.001 par value:
Authorized shares -- 50,000,000
Issued and outstanding shares -- none at
September 30, 1998 and June 30, 1998 ....... -- --
Common stock, voting $0.001 par value:
Authorized Shares -- 50,000,000
Issued and outstanding shares 5,691,779 at
September 30, 1998 and 5,875,979 at June 30,
1998 ..................................... 6,000 6,000
Additional paid in capital ................. 14,893,000 16,193,000
Retained earnings .......................... 17,103,000 14,652,000
------------ ------------
Total stockholders' equity ......... 32,002,000 30,851,000
------------ ------------
Total liabilities and stockholders'
equity ........................... $135,384,000 $130,555,000
============ ============
</TABLE>
See accompanying notes.
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BNC MORTGAGE, INC.
CONSOLIDATED STATEMENT OF INCOME
<TABLE>
<CAPTION>
Three Months Ended
September 30,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
Revenues:
Gain on sale of mortgage loans .......... $11,482,000 $ 6,635,000
Loan origination income ................. 1,652,000 1,240,000
Interest income ......................... 1,903,000 1,645,000
Other income ............................ 374,000 102,000
----------- -----------
Total revenues .................. 15,411,000 9,622,000
----------- -----------
Expenses:
Employees' salaries and commissions ..... 6,823,000 3,755,000
General and administrative expenses ..... 3,214,000 1,798,000
Interest expense ........................ 1,295,000 1,179,000
----------- -----------
Total expenses .................. 11,332,000 6,732,000
Income before income taxes .............. 4,079,000 2,890,000
Income tax expense ...................... 1,628,000 1,193,000
----------- -----------
Net income ...................... $ 2,451,000 $ 1,697,000
=========== ===========
Net income per share basic .............. $ 0.42 $ 0.41
=========== ===========
Net income per share diluted ............ $ 0.42 $ 0.41
=========== ===========
Weighted average shares used in computing
Net income per share:
Basic Shares .................... 5,884,000 4,147,000
=========== ===========
Diluted Shares .................. 5,884,000 4,147,000
=========== ===========
</TABLE>
See accompanying notes.
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BNC MORTGAGE, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended
September 30,
---------------------------------
1998 1997
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ...................................... $ 2,451,000 $ 1,697,000
Adjustment to reconcile net income to net cash
used in operating activities:
Depreciation .............................. 210,000 90,000
Origination of mortgage loans held for sale (283,358,000) (164,402,000)
Sales and principal repayments of mortgage
loans held for sale ..................... 282,938,000 159,910,000
Deferred loan origination fees ............ 156,000 184,000
Change in accounts payable and accrued
liability ............................... 1,053,000 759,000
Change in income taxes payable ............ 1,396,000 (143,000)
Change in deferred income taxes ........... -- (175,000)
Change in notes receivable from officers .. -- (250,000)
Change in other assets .................... 235,000 (239,000)
------------- -------------
Total adjustments ................................. 2,630,000 (4,266,000)
------------- -------------
Net cash used in operating activities ............ 5,081,000 (2,569,000)
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures .............................. (411,000) (141,000)
------------- -------------
Net cash used in investing activities ............. (411,000) (141,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in warehouse line of credit ............ 1,229,000 4,338,000
Payment of dividends on preferred stock ........... -- (47,000)
Repurchase of common stock ........................ (1,300,000) (132,000)
Decrease in restricted cash ....................... 38,000 (605,000)
Net cash provided by financing activities ......... (33,000) 3,554,000
Net increase in cash and cash equivalents ......... 4,637,000 844,000
Cash and cash equivalents, beginning of the period 25,890,000 8,267,000
------------- -------------
Cash and cash equivalents, end of the period ...... $ 30,527,000 $ 9,111,000
============= =============
</TABLE>
See accompanying notes.
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BNC MORTGAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF THE BUSINESS, INITIAL PUBLIC OFFERING AND BASIS OF
PRESENTATION
DESCRIPTION OF THE BUSINESS
BNC Mortgage, Inc. ("BNC" or the "Company"), is a specialty finance company
engaged in the business of originating, purchasing and selling, on a whole loan
basis for cash, non-conforming and, to a lessor extent, conforming, residential
mortgage loans secured by one-to-four family residences. The term
"non-conforming loans" as used herein means (i) subprime loans, which are loans
made to borrowers who are unable or unwilling to obtain mortgage financing from
conventional mortgage sources, whether for reasons of credit impairment, income
qualification, credit history or a desire to receive funding on an expedited
basis and (ii) non-conforming loan products for primarily high credit borrowers
whose credit scores equal or exceed levels required for the sale or exchange of
their mortgage loans through the Federal National Mortgage Association ("FNMA")
and Federal Home Loan Mortgage Corporation ("FHLMC"), but where the loan itself
fails to meet conventional mortgage guidelines, such as the principal balance
exceeds the maximum loan limit of $227,150 or the loan structure documentation
does not conform to agency requirements. 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 three divisions: (i) a
wholesale subprime division which has relationships with approximately 3,600
approved independent loan brokers and which to date has accounted for a
substantial portion of the Company's total loan originations, (ii) a wholesale
prime division which originates conforming loans that meet the FNMA, FHLMC and
other conventional mortgage guidelines and non-conforming loan products which
are not subprime loans, and (iii) a 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.
BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and in accordance with the instructions to Form 10-Q and Regulation S-X. In the
opinion of management, all adjustments (consisting only of normal recurring
accruals) necessary for a fair presentation of the results for the interim
periods have been included. The results of operations for the interim periods
are not necessarily indicative of the results to be expected for the full year.
In addition, this document should be read in conjunction with the financial
statements and footnotes included in the Company's Form 10-K for the fiscal year
ended June 30, 1998.
The preparation of the 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.
2. MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale are collateralized by first and second trust deeds
on underlying real properties and are used as collateral for the Company's
borrowings. Approximately 37% of these properties are located in California, as
of September 30, 1998. Mortgage loans held for sale include net deferred fees of
$613,000 and $769,000 at September 30, 1998 and June 30, 1998, respectively.
3. WAREHOUSE LINE OF CREDIT
The Company has entered into a Warehouse Line of Credit Agreement with DLJ,
which provides for borrowings up to $150,000,000 and terminates on March 16,
2000. Borrowings under this line of credit are collateralized by mortgage loans
held for sale. Interest is payable monthly at the Federal Funds rate plus 50
basis points through March 16, 1999 and thereafter at the Federal Funds rate
plus 100 basis points. As of September 30, 1998, the interest rate was 6.375%.
6
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BNC MORTGAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. COMMITMENTS AND CONTINGENCIES
FORWARD LOAN SALES COMMITMENTS
The Company has entered into a forward loan sale contract with an investment
bank under which it can deliver up to $280 million in loans originated. At
September 30, 1998, $46.6 million in loans had been delivered under this
commitment which expires December 30, 1998. The price received under the
commitment includes adjustments for the actual weighted average coupons,
weighted average margins and prepayment terms of the loans sold, and the
commitment expires on December 31, 1998.
In June 1998, the Company entered into a $50 million optional delivery master
commitment to sell certain nonconforming mortgage loans at current market rates
to Impac Funding Corporation. The forward sales commitment is for a 12 months
period and provides an option to increase the commitment to $100 million. The
Company paid a commitment fee of $63,000 which was recorded as an asset and will
be amortized as the loans are sold into the commitment. At September 30, 1998,
$2.5 million in loans had been sold under this commitment. Joseph R. Tomkinson,
Director of BNC Mortgage, Inc., is also the Chairman and Chief Executive Officer
of Impac Funding Corporation.
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 $800,000 and $500,000 at September 30, 1998 and
June 30, 1998, respectively, is included in accounts payable and accrued
liabilities.
5. SUBSEQUENT EVENTS
COMMON STOCK REPURCHASE PLAN
The Company's Board of Directors has authorized the Company to repurchase up to
$3 million of the Company's common stock in open market purchases from time to
time at the discretion of the Company's management. As of November 13, 1998, the
Company had repurchased 466,500 shares of Common Stock at a cost of $2.7
million.
STOCKHOLDERS' RIGHT PLAN
On October 13, 1998, the Company's Board of Directors adopted a Stockholders'
Rights Plan in which preferred stock purchase rights will be distributed as a
dividend at the rate of one Right for each outstanding share of Common Stock.
The Rights will be attached to the Company's common stock and will trade
separately and be exercisable only in the event that a person or group acquires
or announces the intent to acquire 15 percent or more of BNC's common stock.
Each Right will entitle stockholders to buy one one-hundredth of a share of a
new series of junior participating preferred stock at an exercise price of $25.
If BNC is acquired in a merger or other transaction after a person has acquired
15 percent or more of BNC's outstanding common stock, each Right will entitle
the stockholder to purchase, at the Right's then-current exercise price, a
number of the acquiring Company's common shares having a market value of twice
such price.
In addition, if a person or group acquires 15 percent or more of BNC's common
stock, each Right will entitle the stockholder (other than the acquiring person)
to purchase, at the Right's then-current exercise price, a number of shares of
BNC common stock having a market value of twice such price.
Following the acquisition by a person of 15 percent or more of the Company's
common stock and before an acquisition of 50 percent or
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BNC MORTGAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
more of the common stock, the Board of Directors may exchange the Rights (other
than the Rights owned by such person), at an exchange ratio of one share of
common stock per Right.
Before a person or group acquires beneficial ownership of 15 percent or more of
the Company's common stock, the Rights are redeemable for $.0001 per Right at
the option of the Board of Directors.
The dividend distribution was made on October 26, 1998, payable to stockholders
on record on that date. The Rights will expire on October 26, 2008. The Rights
distribution is not taxable to stockholders.
The Rights are intended to enable all BNC stockholders to realize the long-term
value of their investment in the Company. They will not prevent a takeover, but
should encourage anyone seeking to acquire the Company to negotiate with the
Board of Directors prior to attempting a takeover.
8
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the financial condition and results of
operations of the Company should be read in conjunction with the Company's
consolidated financial statements and notes included in Item 1 of this 10-Q.
GENERAL
BNC Mortgage, Inc. ("BNC" or the "Company"), is a specialty finance company
engaged in the business of originating, purchasing and selling, on a whole loan
basis for cash, non-conforming and, to a lessor extent, conforming, residential
mortgage loans secured by one-to-four family residences. The term
"non-conforming loans" as used herein means (i) subprime loans, which are loans
made to borrowers who are unable or unwilling to obtain mortgage financing from
conventional mortgage sources, whether for reasons of credit impairment, income
qualification, credit history or a desire to receive funding on an expedited
basis and (ii) non-conforming loan products for primarily high credit borrowers
whose credit scores equal or exceed levels required for the sale or exchange of
their mortgage loans through the Federal National Mortgage Association ("FNMA")
and Federal Home Loan Mortgage Corporation ("FHLMC"), but where the loan itself
fails to meet conventional mortgage guidelines, such as the principal balance
exceeds the maximum loan limit of $227,150 or the loan structure documentation
does not conform to agency requirements. 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 three divisions: (i) a
wholesale subprime division which has relationships with approximately 3,600
approved independent loan brokers and which to date has accounted for the
substantial portion of the Company's total loan originations, (ii) a wholesale
prime division which originates conforming loans that meet FNMA, FHLMC and other
conventional mortgage guidelines and non-conforming loan products which are not
subprime loans, and (iii) a retail division which markets loans directly to
homeowners.
The conforming division's loan production accounted for approximately 10.7% of
total loan production for the three months ended September 30, 1998.
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.
As a result of this strategy, the Company receives cash revenue, rather than
recognizing non-cash revenue attributable to residual interests in future loan
payments on the loan, as is the case with securitizations.
The following table shows the Company's mortgage loan originations, mortgage
loan sales, cash gain on sale of mortgage loans and origination locations with
account executives for the periods indicated:
Three Months Ended
September 30,
------------------
1998 1997
---- ----
(Dollars in Thousands)
Mortgage loan originations ........... $283,358 $164,402
Mortgage loan sales .................. $282,370 $159,560
Gain on sale of mortgage loans ....... $ 11,482 $ 6,635
Origination locations at end of period 57 53
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. Cash 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.
Total revenues increased 60.16% to $15.4 million for the three months ended
September 30, 1998 as compared to $9.6 million for the three months ended
September 30, 1997.
The major components of expenses are employees' salaries and commissions,
general and administrative, and interest. Employees' salaries and commissions,
for the three months ended September 30, 1998 and 1997 accounted for 60.2% and
55.8% of total expenses,
9
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
respectively. Employees' salaries and commissions are primarily 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 $11.3
million for the three months ended September 30, 1998, compared to $6.7 million
for the three months ended September 30, 1997.
The Company's net income increased to $2.5 million for the three months ended
September 30, 1998, compared to $1.7 million for the three months ended
September 30, 1997.
Increased competition in the non-conforming mortgage industry could have the
effect of (i) lowering gains that may be realized on loan sales through lower
cash premiums paid for loans or an increase in demand for yield spread premium
paid to the mortgage brokers, (ii) reducing an individual company's volume of
loan originations and sales, (iii) increasing demand for experienced personnel
increasing the likelihood such personnel will be recruited by competitors and
(iv) lowering the industry standard for non-conforming underwriting guidelines
as competitors attempt to increase or maintain market share in the face of
increased competition. In the past, certain of these factors have caused the
revenues and net income of many participants in the non-conforming mortgage
industry, including the Company, to fluctuate from quarter to quarter.
During the fiscal year ended June 30, 1998 and the three months ended September
30, 1998, the Company's total loan originations, net income and operating
expenses all increased as the Company experienced substantial growth. However,
the mortgage loan industry experienced significant turmoil in the quarter ended
September 30, 1998 due to a lack of liquidity in the mortgage and asset-backed
securitization market. These recent developments in the mortgage and
asset-backed securitization markets have caused a tightening in the pricing of
whole loan sales as many mortgage securitizers have been forced to sell their
loans on a whole loan basis for cash. The Company, with its forward sales
commitment expiring in December 1998, understands that prices paid for its loans
in the future may decrease if the increased supply of mortgage loans available
for sale in the whole loan market continues after the expiration of the
Company's forward sales commitment.
In the event that declines in whole loan pricing continue, the Company would
expect to see a decrease in cash gain on sale of mortgage loans in future
quarters. In the second fiscal quarter of 1998, the Company made certain
internal adjustments in response to market conditions in the mortgage industry.
The Company reduced yield spread premiums paid to brokers and compensation paid
to employees. The Company also reduced its employees and raised interest rates
charged to borrowers to boost profitability. While the Company would also expect
to receive some benefit from these and other adjustments with regard to
profitability of its mortgage loan originations, the effect of these adjustments
may have an adverse effect on future mortgage loan production.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 1997
REVENUES. The following table sets forth the components of the Company's
revenues for the periods indicated:
Three Months Ended
September 30,
----------------
1998 1997
---- ----
(Dollars in Thousands)
Gain on sale of mortgage loans $11,482 $ 6,635
Loan origination income ...... 1,652 1,240
Interest income .............. 1,903 1,645
Other income ................. 374 102
------- -------
$15,411 $ 9,622
======= =======
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The increase in revenues was due primarily to increased mortgage loan
originations and cash gain on sales of mortgage loans. Mortgage loan
originations increased $119.0 million to $283.4 million for the three months
ended September 30, 1998 from $164.4 million for the three months ended
September 30, 1997. There can be no assurance that the Company will recognize
comparable levels of revenues and mortgage loan originations in future periods.
Cash gain on sale of mortgage loans increased $4.9 million to $11.5 million for
the three months ended September 30, 1998 from $6.6 million for the three months
ended September 30, 1997. The increase was due primarily to a $122.8 million
increase in mortgage loan sales to $282.4 from $159.6 million for the three
months ended September 30, 1998 and 1997, respectively. The weighted average
cash premium paid for mortgage loans sold was 4.07% for the three months ended
September 30, 1998 and 4.16% for the three months ended September 30, 1997.
There can be no assurance that the Company will recognize comparable levels of
cash 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 cash gain on sale of
mortgage loans for the three months ended September 30, 1998. The Company
expects to receive some benefit from recent reduction in yield spread premiums
payable to brokers.
Loan origination income increased to $1.7 million for the three months ended
September 30, 1998 from $1.2 million for the three months ended September 30,
1997. As a percentage of total revenues, loan origination income for the three
months ended September 30, 1998 decreased to 10.7% as compared to 12.9% for the
three months ended September 30, 1997. This decrease was 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. Loan originations may be adversely affected in future periods as a
result of a decrease in yield spread premiums payable to brokers and raised
interest rates charged to borrowers.
Interest income increased $258,000 to $1.9 million for the three months ended
September 30, 1998 from $1.6 million for the three months ended September 30,
1997. This increase is due to an increase in loan originations during the
period.
Other income, which is comprised of investment income, prepayment penalties and
late charges, increased to $374,000 for the three months ended September 30,
1998 as compared to $102,000 for the three months ended September 30, 1997
largely as a result of interest earned on the net proceeds from the Offering
completed on March 10, 1998.
EXPENSES. The following table sets forth the components of the Company's
expenses for the periods indicated:
Three Months Ended
September 30,
----------------
1998 1997
---- ----
(Dollars in Thousands)
Employees' salaries and commissions $ 6,823 $ 3,755
General and administrative expenses 3,214 1,798
Interest expense .................. 1,295 1,179
------- -------
$11,332 $ 6,732
======= =======
Total expenses increased to $11.3 million for the three months ended September
30, 1998 from $6.7 million for the three months ended September 30, 1997. This
increase is related to geographical expansion to 57 origination locations at
September 30, 1998 from 53 at September 30, 1997, and to an increase in mortgage
loan originations. Total expenses are expected to be positively affected by
decreased employee compensation, a reduction in staffing and a decrease in loan
originations.
11
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Employee salaries and commissions increased $3.0 million to $6.8 million during
the three months ended September 30, 1998 from $3.8 million for the three months
ended September 30, 1997. The primary reason for the increase was due to an
increase in mortgage loan originations and continued geographical expansion.
General and administrative expenses increased $1.4 million to $3.2 million for
the three months ended September 30, 1998 from $1.8 million for the three months
ended September 30, 1997. This increase is due primarily to an increase in the
number of origination locations and the related increase in mortgage loan
originations.
Interest expense increased $116,000 to $1.3 million for the three months ended
September 30, 1998 from $1.2 million for the three months ended September 30,
1997 and is attributable to higher levels of warehouse borrowing as a result of
the increase in mortgage loan originations.
DISCLOSURE ABOUT MARKET RISK
The Company's earnings can be affected significantly by the movement of interest
rates, which is the primary component of market risk to the Company. The
interest rate risk affects the value of the mortgage loans held for sale, net
interest income earned on its mortgage inventory, interest income earned on idle
cash, interest expense and cash gain on sale of mortgage loans, as well as
consumer demand for mortgage loan production.
As it relates to lending activities, the Company originates mortgage loans,
which are generally presold through forward loan sales commitments. However,
between the time that the loan is originated and sold to the ultimate investor,
the Company earns interest income. The loans are funded through the use of the
DLJ warehouse line of credit and the interest charged by DLJ is generally based
upon short-term interest rates. Therefore, the net interest income that is
earned by the Company is generally dependent upon the spread between long-term
mortgage rates and short-term mortgage rates.
The Company currently does not maintain a trading portfolio. As a result, the
Company is not exposed to market risk as it relates to trading activities. The
majority of the Company's loan portfolio is held for sale which requires the
Company to perform quarterly market valuations of its portfolio in order to
properly record the portfolio at the lower of cost or market. Therefore, the
Company continually monitors the interest rates of its loan portfolio as
compared to prevalent interest rates in the market.
The Company currently does not enter into any hedging activities as it currently
sells its loan production on a monthly basis.
Based on the information available and the interest environment as of September
30, 1998, the Company believes that a 100 basis point increase in long-term
interest rates over a twelve month period, with all else being constant, would
have an adverse effect on the pricing for the Company's whole loan sales.
Therefore, the Company believes that its net income could be adversely affected
in the range of $1.3 to $2.5 million. However, the Company believes that a 100
basis point decrease in long-term interest rates over a twelve-month period may
not result in a similar increase of its net income. These estimates are limited
by the fact that they are performed at a particular point in time and
incorporate many other factors and thus should not be used as a forecast.
Therefore, there can be no assurance that the amount of such decrease would not
substantially vary from these estimates.
YEAR 2000
The Company has performed a review of its internal systems to identify and
resolve the effect of Year 2000 software issues on the integrity and reliability
of the Company's financial and operational systems. Based on this review,
management believes that its internal systems are substantially compliant with
the Year 2000 issues. In addition, the Company is also communicating with its
principal service providers to ensure Year 2000 issues will not have an adverse
impact on the Company. Service providers which the Company is reviewing for year
2000 compliance includes payroll, loan servicing and telecommunications. The
Company however, cannot be assured that these third party providers won't have
other problems internally, which could have an adverse impact on the Company.
Presently, the Company does not have a contingency plan to handle the worst case
scenarios, but it intends to create one by the end of fiscal year 1999. Based
upon its
12
<PAGE> 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
internal review and communications with external service providers, the Company
believes that the costs of achieving Year 2000 compliance will not have a
material adverse impact on the Company's business, operations or financial
condition.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of cash flow include cash gain on sale of mortgage loans,
origination income, net interest income and borrowings. The Company sells its
mortgage loans generally on a monthly basis to generate cash for operations. The
Company's uses of cash in the short-term include the funding of mortgage loan
originations, payment of interest, repayment of amounts borrowed under warehouse
lines of credit, operating and administrative expenses, start-up costs for new
origination locations, income taxes and capital expenditures. Long-term uses of
cash may also include the funding of securitization activities and selective
acquisitions of other specialty finance companies or portfolios of loan assets.
The Company currently has no formal agreements with regard to any potential
acquisition and there can be no assurance that future acquisitions, if any, will
be consummated. Capital expenditures totaled $411,000 and $141,000 for the three
months ended September 30, 1998 and 1997, respectively. Capital expenditures
were primarily comprising furniture, fixtures and equipment software and
leasehold improvements.
Cash and cash equivalents were $30.5 million at September 30, 1998. The Company
invests its cash in short-term investments maintaining flexibility for funding
of loan originations and strategic opportunities. In March 1998 the Company
concluded its initial public offering and received net proceeds of $16.2 million
from the Offering. As of September 30, 1998, of these proceeds, approximately
$4.05 million was used to fund loan originations, and the remaining balance has
been invested in short-term investments.
The Company funds its operations through cash reserves, loan sales, net earnings
and a revolving warehouse credit facility with DLJ, under which it borrows money
to finance the origination of mortgage loans. As of September 30, 1998, the DLJ
Facility provide borrowings up to $150.0 million and terminates on March 16,
2000. The DLJ Facility bears interest at the Federal Funds rate plus 50 basis
points through March 16, 1999 and thereafter, the Federal Funds rate plus 100
basis points. It is expected that the DLJ Facility will not be extended beyond
the term. The Company is currently negotiating with other lenders to obtain
additional warehouse lines of credit with interest rates and terms that are
consistent with management's objectives. The Company repays borrowings with
proceeds from its loan sales.
During the three months ended September 30, 1998 and 1997, the Company used cash
of $283.4 million and $164.4 million, respectively, for new loan originations.
During the same periods, the Company received cash proceeds from the sale of
loans of $282.9 million and $159.9 million, respectively, representing the
principal balance of loans sold. The Company received cash proceeds from the
premiums on such sale of loans of $11.5 million and $6.6 million, for the three
months ended September 30, 1998 and 1997, respectively.
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.
The Company currently sells its subprime loan production monthly on a whole loan
basis for cash under a forward sales commitment. As of September 30, 1998, the
Company had sold $46.6 million of loans into the commitment. Under this
commitment, the Company can sell up to $280 million of its subprime loan
production.
Turmoil in the mortgage and asset-backed securitization market has caused a
tightening in the pricing of whole loan sales as many mortgage securitizers have
been forced to sell their loans on a whole loan basis for cash. Prices paid for
the Company's loans in the future may decrease, if the increased supply of
mortgage loans available for sale in the whole loan market continues after the
expiration of the Company's forward sales commitment on December 31, 1998. In
the event that declines in the whole loan pricing continue, the Company would
expect to see a decrease in cash gain on sale of mortgage loans in future
quarters. The Company would also expect to see some
13
<PAGE> 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
benefit from adjustments made to the yield spread premiums paid to brokers,
employee compensation, interest rates charged to borrowers and other
adjustments. However, the effect of these adjustments may have an adverse effect
on mortgage loan production in future periods.
14
<PAGE> 15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
* * * * *
Except for the historical information contained herein, this Form 10-Q contains
forward-looking statements that involve risks and uncertainties that could cause
actual results to differ materially. Such risks and uncertainties include, but
are not limited to, changes in the performance of the financial markets, changes
in the demand for and market acceptance of the Company's products, changes in
the mortgage lending industry or changes in general economic conditions,
including interest rates; the impact of competition; changes in the value of
real estate; the ability to maintain and increase sources of funding; and other
risks disclosed from time to time in the Company's SEC reports and filings.
Forward-looking statements used in this report can be identified by the use of
words such as: "could," "may," "will," "expects," "believes," and the negatives
or derivatives thereof , and similar expressions. Investors are encouraged to
fully examine such risks prior to making an investment decision in the Company's
securities.
15
<PAGE> 16
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings - Not Applicable
ITEM 2. Changes in Securities - Not Applicable
ITEM 3. Defaults upon Senior Securities - Not Applicable
ITEM 4. Submission of Matters to a Vote of Security Holders - Not Applicable
ITEM 5. Other Information - Not Applicable
ITEM 6. Exhibits
(a) Exhibits
11.1 Statement regarding computation of per share earnings
27.1 Financial Statement Data Schedule (EDGAR filing only)
16
<PAGE> 17
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on behalf of the undersigned
thereunto duly authorized, in the City of Irvine, State of California.
BNC MORTGAGE, INC.
(Registrant)
By: /s/EVAN R. BUCKLEY November 13, 1998
----------------------------- -----------------
Evan R. Buckley Date
Chief Executive Officer and
Secretary
By: /s/KELLY W. MONAHAN November 13, 1998
----------------------------- -----------------
Kelly W. Monahan Date
President and
Chief Financial Officer
17
<PAGE> 18
EXHIBIT INDEX
Exhibit Number Description
- -------------- -----------
11.1 Statement regarding computation of per share earnings
27.1 Financial Statement Data Schedule (EDGAR filing only)
<PAGE> 1
Exhibit 11.1
Computation of Per Share Earnings
<TABLE>
<CAPTION>
Three Months Ended
September 30,
--------------------------
1998 1997
---------- ----------
<S> <C> <C>
Basic earnings per common share
Net income for calculating basic earnings
per common share ........................ $2,451,000 $1,697,000
========== ==========
Average common shares outstanding ....... 5,884,000 4,147,000
---------- ----------
Basic earnings per common share ......... $ 0.42 $ 0.41
========== ==========
Diluted earnings per common share
Net income for calculating basic earnings
per common share ........................ $2,451,000 $1,697,000
========== ==========
Average common shares outstanding ....... 5,884,000 4,147,000
Add exercise of options and warrants .... -- --
---------- ----------
Diluted common shares outstanding ....... 5,884,000 4,147,000
========== ==========
Diluted earnings per common share ....... $ 0.42 $ 0.41
========== ==========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 5-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 30,527,000
<SECURITIES> 600,000
<RECEIVABLES> 3,541,000
<ALLOWANCES> 0
<INVENTORY> 98,982,000
<CURRENT-ASSETS> 133,650,000
<PP&E> 2,756,000
<DEPRECIATION> 1,022,000
<TOTAL-ASSETS> 135,384,000
<CURRENT-LIABILITIES> 103,382,000
<BONDS> 0
0
0
<COMMON> 6,000
<OTHER-SE> 31,996,000
<TOTAL-LIABILITY-AND-EQUITY> 135,384,000
<SALES> 15,411,000
<TOTAL-REVENUES> 15,411,000
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 10,037,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,295,000
<INCOME-PRETAX> 4,079,000
<INCOME-TAX> 1,628,000
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,451,000
<EPS-PRIMARY> .42
<EPS-DILUTED> .42
</TABLE>
