<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 10, 1997
REGISTRATION NO. 333-35747
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
AMENDMENT NO. 1
TO
FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------
SOUTHERN PACIFIC FUNDING CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<CAPTION>
CALIFORNIA 6159 33-0636924
<S> <C> <C>
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
ONE CENTERPOINTE DRIVE, SUITE 500, LAKE OSWEGO, OREGON 97035, (503) 684-4700
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
ROBERT W. HOWARD, CHIEF EXECUTIVE OFFICER
SOUTHERN PACIFIC FUNDING CORPORATION
ONE CENTERPOINTE DRIVE, SUITE 500, LAKE OSWEGO, OREGON 97035, (503) 684-4700
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
--------------
HALLMARK AMERICA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<CAPTION>
WASHINGTON 6159 92-1793075
<S> <C> <C>
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
ONE CENTERPOINTE DRIVE, SUITE 500, LAKE OSWEGO, OREGON 97035
(503) 684-4700
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
ROBERT W. HOWARD, CHIEF EXECUTIVE OFFICER
SOUTHERN PACIFIC FUNDING CORPORATION
ONE CENTERPOINTE DRIVE, SUITE 500, LAKE OSWEGO, OREGON 97035
(503) 684-4700
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
OCEANMARK FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<CAPTION>
DELAWARE 6159 65-0748545
<S> <C> <C>
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
ONE CENTERPOINTE DRIVE, SUITE 500, LAKE OSWEGO, OREGON 97035
(503) 684-4700
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
ROBERT W. HOWARD, CHIEF EXECUTIVE OFFICER
SOUTHERN PACIFIC FUNDING CORPORATION
ONE CENTERPOINTE DRIVE, SUITE 500, LAKE OSWEGO, OREGON 97035
(503) 684-4700
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
--------------
NATIONAL CAPITAL HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<CAPTION>
DELAWARE 6159 58-2301532
<S> <C> <C>
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
ONE CENTERPOINTE DRIVE, SUITE 500, LAKE OSWEGO, OREGON 97035
(503) 684-4700
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
ROBERT W. HOWARD, CHIEF EXECUTIVE OFFICER
SOUTHERN PACIFIC FUNDING CORPORATION
ONE CENTERPOINTE DRIVE, SUITE 500, LAKE OSWEGO, OREGON 97035
(503) 684-4700
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
--------------
COPIES TO:
BRYANT B. EDWARDS NICHOLAS P. SAGGESE
LATHAM & WATKINS SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP
633 W. FIFTH STREET, SUITE 3800 300 S. GRAND AVENUE, SUITE 3400
LOS ANGELES, CA 90071 LOS ANGELES, CA 90071
(213) 485-1234 (213) 687-5000
--------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
--------------
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the
following box. [_]
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or
interest reinvestment plans, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
--------------
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.
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<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 STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED OCTOBER 10, 1997
PROSPECTUS
$125,000,000
[LOGO OF SOUTHERN PACIFIC FUNDING CORPORATION]
% SENIOR NOTES DUE 2004
The % Senior Notes due 2004 (the "Notes") are being offered (the
"Offering") by Southern Pacific Funding Corporation ("SPFC" or the "Company")
and will mature on , 2004. The Notes will bear interest at a rate of %
per annum, payable semi-annually on and , commencing on ,
1998. On or after , 2001, the Notes are redeemable at the option of the
Company, in whole or in part, at the redemption price set forth herein plus
accrued and unpaid interest to the date of redemption. In addition, prior to
, 2001, the Company may redeem up to 30% of the originally issued
principal amount of Notes at a redemption price of % of the principal amount,
thereof, plus accrued and unpaid interest, if any, with the proceeds of a
Public Equity Offering (as defined); provided that at least $87.5 million
aggregate principal amount of Notes remains outstanding immediately after such
redemption. Upon a Change of Control (as defined), each holder of the Notes (a
"Holder") may require the Company to repurchase the Notes held by such Holder
at 101% of the principal amount thereof plus accrued and unpaid interest to the
date of repurchase.
The Notes will be general unsecured obligations of the Company and will rank
pari passu in right of payment with all existing and future unsecured
unsubordinated Indebtedness (as defined) of the Company and senior in right of
payment to all existing and future subordinated Indebtedness of the Company. In
addition, the obligations of the Company under the Notes will be fully and
unconditionally guaranteed on a joint and several basis (each, a "Guarantee")
by each of the Company's existing and future Subsidiaries (as defined), other
than Subsidiaries designated as "Unrestricted Subsidiaries" in accordance with
the Indenture, Foreign Subsidiaries (as defined) and Subsidiaries with less
than $1.0 million of assets (collectively, the "Subsidiary Guarantors"). The
Guarantees will rank pari passu in right of payment with all existing and
future unsubordinated Indebtedness of the Subsidiary Guarantors and senior in
right of payment to all existing and future subordinated Indebtedness of the
Subsidiary Guarantors. See "Description of the Notes." The Notes and the
Guarantees will be effectively subordinated to all existing and future secured
Indebtedness of the Company and the Subsidiary Guarantors. As of June 30, 1997,
after giving pro forma effect to the Offering and the application of the net
proceeds therefrom, the Company and the Subsidiary Guarantors would have had
approximately $102.0 million of secured Indebtedness outstanding. See
"Description of the Notes."
There is no existing market for the Notes and the Company does not intend to
list the Notes on any national securities exchange. See "Risk Factors--Absence
of Public Market for the Notes."
SEE "RISK FACTORS" BEGINNING ON PAGE 9 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED IN CONNECTION WITH AN INVESTMENT IN THE NOTES.
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>
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PRICE UNDERWRITING PROCEEDS
TO THE DISCOUNTS AND TO THE
PUBLIC(1) COMMISSIONS(2) COMPANY(3)
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<S> <C> <C> <C>
Per Note....................................... % % %
Total.......................................... $ $ $
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</TABLE>
(1) Plus accrued interest, if any, from the date of issuance.
(2) See "Underwriting" for information relating to indemnification of the
Underwriters.
(3) Before deducting expenses payable by the Company, estimated to be $ .
The Notes are offered by the several Underwriters subject to prior sale,
when, as and if delivered to and accepted by the Underwriters and subject to
various prior conditions, including the right of the Underwriters to reject any
order in whole or in part. It is expected that delivery of the Notes will be
made in New York, New York, on or about , 1997.
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
NATIONSBANC MONTGOMERY SECURITIES, INC.
SMITH BARNEY INC.
<PAGE>
[MAP APPEARS HERE]
IN CONNECTION WITH THE OFFERING, THE UNDERWRITERS MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE NOTES.
SPECIFICALLY, THE UNDERWRITERS MAY OVERALLOT IN CONNECTION WITH THE OFFERING
AND MAY BID FOR AND PURCHASE NOTES ON THE OPEN MARKET. FOR A DESCRIPTION OF
THESE ACTIVITIES, SEE "UNDERWRITING."
CERTAIN INFORMATION CONTAINED IN THIS PROSPECTUS CONSTITUTES "FORWARD-LOOKING
STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS
AMENDED (THE "SECURITIES ACT"), AND SECTION 21E OF THE SECURITIES EXCHANGE ACT
OF 1934, AS AMENDED (THE "EXCHANGE ACT"), WHICH CAN BE IDENTIFIED BY THE USE OF
FORWARD-LOOKING TERMINOLOGY SUCH AS "BELIEVES," "MAY," "WILL," "EXPECT,"
"ANTICIPATE," "ESTIMATE" OR "CONTINUE" OR THE NEGATIVES THEREOF OR OTHER
VARIATION THEREON OR COMPARABLE TERMINOLOGY. THE STATEMENTS IN "RISK FACTORS"
BEGINNING ON PAGE 9 OF THIS PROSPECTUS CONSTITUTE CAUTIONARY STATEMENTS
IDENTIFYING IMPORTANT FACTORS, INCLUDING CERTAIN RISKS AND UNCERTAINTIES, WITH
RESPECT TO SUCH STATEMENTS THAT COULD CAUSE THE ACTUAL RESULTS, PERFORMANCE OR
ACHIEVEMENTS OF THE COMPANY TO DIFFER MATERIALLY FROM THOSE REFLECTED IN SUCH
FORWARD-LOOKING STATEMENTS. THE REGISTRANT UNDERTAKES NO OBLIGATION TO UPDATE
PUBLICLY OR REVISE ANY FORWARD-LOOKING STATEMENTS.
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by, and should be read in
conjunction with, the more detailed information and Financial Statements,
including the Notes thereto, appearing elsewhere in this Prospectus. 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. Unless the context otherwise requires, references to the "Company"
herein shall be to Southern Pacific Funding Corporation and its consolidated
subsidiaries.
THE COMPANY
Southern Pacific Funding Corporation ("SPFC" or the "Company") is a specialty
finance company engaged in the business of originating, purchasing and selling
non-conforming mortgage loans secured primarily by one-to-four family
residences. The majority of the Company's loans are made to owners of single
family residences who use the loan proceeds for purposes such as mortgage
refinancing, home purchase, debt consolidation, home improvements and
educational expenditures. The Company focuses primarily on lending to
individuals who have significant equity in the value of their homes but have
impaired or limited credit histories. As a result, the Company's customers are
less likely to qualify for loans from conventional mortgage lenders and
generally pay higher interest rates than interest rates charged by conventional
mortgage lenders.
The Company's origination strategy is to develop and maintain diversified
production channels that enable the Company to originate and purchase loans on
a consistent, low cost basis. The Company's total direct costs of production,
which include premiums paid on all loans originated or purchased, net of
origination fees collected, for the year ended December 31, 1996 and the six
months ended June 30, 1997 were 1.6% and 2.4%, respectively, of loans produced.
The Company originates or purchases loans in all 50 states and the District of
Columbia through its Wholesale Division, Correspondent Program, Strategic
Alliance Program and Consumer Loan Division.
The Wholesale Division originates a majority of the Company's loans. The
Wholesale Division consists of approximately 125 account executives located in
23 regional branch centers. These account executives have established
relationships with, and market directly to, licensed independent mortgage
brokers. Independent mortgage brokers identify potential borrowers, assist
borrowers in completing loan applications and submit such loan applications and
other documents to the Company for underwriting review and credit decision. All
loans funded by the Wholesale Division are underwritten to the Company's
guidelines. In most cases, the Company conditionally approves loans submitted
by an independent mortgage broker within 24 hours from receipt of the loan
application and funds loans within 21 days after approval. The Company believes
its competitive strength in maintaining and expanding independent mortgage
broker relationships is attributable to its ability to provide quality service,
including responsive execution and funding of loans, as well as offering a
broad range of loan products to applicants. The Wholesale Division originated
$267.4 million, $529.0 million and $495.5 million of mortgage loans during the
years ended December 31, 1995 and 1996 and the six months ended June 30, 1997,
respectively, representing 92.7%, 67.0% and 65.5% of the Company's total loan
originations and purchases during the respective periods.
The Company purchases closed loans through its Correspondent Program. Loans
purchased through the Correspondent Program are complete loan packages that
have been underwritten and funded by approved mortgage bankers or financial
institutions. The Company reunderwrites each loan submitted in the loan
portfolio to ensure that all loans comply with the Company's underwriting
guidelines. As part of the reunderwriting process, the Company's underwriters
review the appraisal and the applicant's creditworthiness and ensure that all
necessary compliance and disclosure documentation is included in the loan
package. Loans that do not meet the Company's underwriting guidelines are not
purchased. Through the Correspondent Program, the Company purchased $21.1
million, $204.8 million and $164.7 million of mortgage loans during the years
ended
1
<PAGE>
December 31, 1995 and 1996 and the six months ended June 30, 1997,
respectively, representing 7.3%, 25.9% and 21.8% of the Company's total loan
originations and purchases during the respective periods.
The Company also purchases loans through its Strategic Alliance Program.
Through the Strategic Alliance Program, the Company obtains a committed source
of loan production from select mortgage lenders who form strategic alliances
with the Company (each, a "Strategic Alliance"). To date, the Company has
entered into Strategic Alliances with four mortgage lenders. The Strategic
Alliance Program generally permits the Strategic Alliance to obtain financing
support from the Company and to securitize its qualifying loan production with
the Company's loan production. In return, the Company receives interest and fee
income, warrants to acquire an equity interest in the Strategic Alliance and
the right to acquire all of the Strategic Alliance's qualifying non-conforming
loan production. In addition, the Strategic Alliance Program provides the
Company with access to a broader network of independent mortgage broker
relationships. The Company reunderwrites all loans submitted by each Strategic
Alliance for an initial period, generally 60 to 90 days. After the initial
period, the Strategic Alliance's loans are monitored through the Company's
quality control process. Through the Strategic Alliance Program, the Company
purchased $51.5 million and $66.4 million of mortgage loans during the year
ended December 31, 1996 and the six months ended June 30, 1997, respectively,
representing 6.5% and 8.8% of the Company's total loan originations and
purchases during the respective periods.
The Consumer Loan Division was recently formed to broaden the Company's loan
products to include second mortgage loans. The Consumer Loan Division offers
second mortgage loans to credit-impaired borrowers and high loan-to-value
("LTV") loans to borrowers with better credit than the Company's average non-
conforming borrower. The Consumer Loan Division originates loans by marketing
directly to potential borrowers using direct mail advertising, telemarketing
and radio advertising. The Consumer Loan Division also originates loans through
independent mortgage brokers. The Consumer Loan Division currently has retail
offices in Ontario and Newport Beach, California, and is scheduled to open
three additional offices by the end of 1997. All loans originated by the
Consumer Loan Division are underwritten and processed through its dedicated
underwriting department. Traditional non-conforming second mortgage loans are
underwritten to substantially the same underwriting criteria as the Wholesale
Division's product while applicants for high LTV loans are underwritten to
criteria primarily based on a credit scoring system developed by Fair, Issacs &
Company ("FICO"). The Consumer Loan Division originated $4.5 million and $30.1
million of loans during the year ended December 31, 1996 and the six months
ended June 30, 1997, respectively, representing 0.6% and 3.9% of the Company's
total loan originations and purchases during the respective periods.
The Company sells the majority of its originated and purchased loans in the
secondary market through public securitizations in order to enhance
profitability, improve liquidity and reduce the Company's exposure to
fluctuations in interest rates. In a securitization, the Company recognizes a
gain on sale at the time the loans are sold, but receives cash flows in the
form of excess spread over the actual life of such loans. This excess spread
(the "Excess Spread") represents the difference between all principal and
interest received from the loans sold and (i) all principal and interest
required to be passed through to the asset-backed bond investors, (ii) all
servicing fees and (iii) other recurring fees. At the time of the
securitization, the Company capitalizes the Excess Spread, based upon certain
prepayment and loan loss assumptions and a discount rate that the Company
believes is consistent with what market participants would use for similar
financial instruments. The capitalized assets are recorded on the Company's
balance sheet as interest-only and residual certificates. A gain or loss is
recorded in the statement of earnings equal to the value of the interest-only
and residual certificates created by the securitization in excess of the cost
basis of the loans and transaction and hedging expenses. The cash flow
generated by the Excess Spread is first used to fund the amount of reserves
required to credit-enhance each securitization (the "overcollateralization
requirement"). Typically, the overcollateralization requirement is fully funded
8 to 12 months from the date of securitization, although this period may be
shorter or longer subject to the structure and performance of the loans in the
securitization. Subsequent to funding the overcollateralization requirement,
the Excess Spread is received by the Company. Over time, the Company will also
receive the overcollateralization requirement depending upon the structure and
performance of the mortgage loans in each
2
<PAGE>
securitization. During the years ended December 31, 1995 and 1996 and the six
months ended June 30, 1997, the Company securitized $164.9 million, $657.4
million and $755.0 million of mortgage loans, respectively.
The Company obtains the servicing rights on all loans it originates or
purchases. The Company currently outsources substantially all its loan
servicing operations to Advanta Mortgage Corp. USA (the "Servicer"), which the
Company believes is the largest third-party servicer of non-conforming home
equity loans. The Company believes that by outsourcing substantially all of its
loan servicing, it is able to benefit from the Servicer's experience in
servicing non-conforming mortgage loans, its comprehensive reporting
capabilities, and the cost efficiencies related to having large amounts of
loans serviced by the Servicer. Through its relationship with the Servicer, the
Company is able to reduce the overhead, administrative and other fixed costs
associated with servicing loans. As of June 30, 1997, the Servicer serviced
$1.6 billion principal amount of loans originated or purchased by the Company
(inclusive of securitized loans for which the Company has ongoing risk of
loss). The Company periodically examines other possible servicing alternatives,
including other third party servicers and the costs associated with
establishing its own servicing operations to service the loans it originates
and purchases.
The Company commenced operations in January 1993 as a division of Southern
Pacific Thrift & Loan Association ("SPTL"), a wholly-owned subsidiary of
Imperial Credit Industries, Inc. ("ICII"), and was an operating subsidiary of
ICII from April 1995 until March 1997. The Company completed an initial public
offering of its common stock in June 1996 and, through subsequent offerings,
ICII has reduced its ownership stake in the Company to approximately 47% of the
Company's outstanding common stock. ICII is a diversified specialty finance
company.
The Company's headquarters are located at One Centerpointe Drive, Suite 500,
Lake Oswego, Oregon 97035, and its telephone number is (503) 684-4700.
RECENT DEVELOPMENTS
In May 1997, the Company acquired certain assets of Oceanmark Bank for $7.6
million. This consideration included $3.8 million in cash and a $3.8 million
note payable over three years. The Company transferred the acquired assets to
its newly-formed subsidiary, Oceanmark Financial Corporation ("Oceanmark").
Oceanmark is a non-conforming mortgage lender based in Miami, Florida that
originates loans through a network of independent mortgage brokers and regional
offices located in California, Florida, Georgia, Virginia, Michigan and
Missouri. Oceanmark originated $174.3 million of loans in the year ended
December 31, 1996 and $83.8 million in the six months ended June 30, 1997. The
Company included in its securitizations $140.1 million and $50.7 million of
loans from Oceanmark Bank in the respective periods.
During the second quarter of 1997, the Company strengthened its senior
management infrastructure by appointing two new individuals to key positions.
In April 1997, John D. Horak joined the Company as Senior Vice President,
Credit and Risk Manager. Mr. Horak is responsible for oversight of the
Company's credit management policies and procedures, underwriting and quality
control. In June 1997, the Company appointed Peter F. Makowiecki as Executive
Vice President, Chief Financial Officer and Secretary. Mr. Makowiecki is
responsible for the administration of the accounting, finance, treasury, tax,
audit and secondary marketing functions of the Company as well as the Strategic
Alliance Program.
In November 1996, the Company established a new subsidiary, Southern Pacific
Mortgage Limited in London, England that originates non-conforming home equity
loans in the United Kingdom. Southern Pacific Mortgage Limited originates loans
through loan brokers and mortgage bankers. The Company approves, underwrites,
processes and funds non-conforming mortgage loans in the United Kingdom in a
manner substantially similar to its domestic operations. This subsidiary has
funded over $27.9 million in non-conforming loans through June 30, 1997.
3
<PAGE>
On October 1, 1997, the Company signed a non-binding letter of intent to
acquire the loan servicing platform and management personnel of North American
Mortgage Company. Subject to due diligence and other conditions, the purchase
price is estimated at $400,000.
Results of the Quarter and Nine Months Ended September 30, 1997
The Company reported net earnings for the three months ended September 30,
1997 of $13.8 million, or earnings per share of $0.57, an increase of 68% from
$8.2 million, or $0.37 per share, from the three months ended September 30,
1996. The increase in earnings was primarily attributable to the Company's
continued expansion of its loan production sources and the sale of such loans.
For the three months ended September 30, 1997, the Company originated and
purchased $578.6 million of loans, an increase of 151% from $230.3 million of
loans originated and purchased in the comparable period in the preceding year.
During the three months ended September 30, 1997, the Company sold $450 million
in loans through securitization transactions compared to $189.4 million sold
through securitization transactions in the comparable period in the preceding
year. In addition, during the three months ended September 30, 1997, the
Company completed whole loan sales of $129.1 million, which included $65.4
million of non-conforming loans originated in the United Kingdom and
$53.8 million of commercial loans originated through National Capital Funding.
The Company reported net earnings for the nine months ended September 30,
1997 of $39.9 million, or earnings per share of $1.65, an increase of 127% from
$17.6 million, or $0.93 per share, for the nine months ended September 30,
1996. The increase in earnings was primarily attributable to the Company's
continued expansion of its loan production sources and the sale of such loans.
For the nine months ended September 30, 1997, the Company originated and
purchased $1,356.3 million of loans, an increase of 177% from $490.2 million of
loans originated and purchased in the comparable period in the preceding year.
During the nine months ended September 30, 1997, the Company sold $1,205.0
million in loans through securitization transactions compared to $422.4 million
sold through securitization transactions in the comparable period in the
preceding year. In addition, during the nine months ended September 30, 1997,
the Company completed whole loan sales of $139.1 million.
The Company's total loans serviced at September 30, 1997 were $1.9 billion,
compared to $651.3 million as of September 30, 1996. The Company reported a
delinquency rate of 4.5% of the servicing portfolio and loans in default of
4.7% at September 30, 1997. During the three months ending September 30, 1997,
the Company experienced net losses of $1.4 million on an average servicing
portfolio of $1.8 billion.
4
<PAGE>
THE OFFERING
Securities Offered.......... $125,000,000 aggregate principal amount of %
Senior Notes due 2004.
Maturity Date............... , 2004.
Interest Payment Dates...... Each , and , commencing ,
1998.
Guarantees.................. The obligations of the Company under the Notes
will be fully and unconditionally guaranteed on a
joint and several basis by each of the existing
and future subsidiaries of the Company, other
than (i) subsidiaries designated as "Unrestricted
Subsidiaries" in accordance with the Indenture
governing the Notes (the "Indenture"), (ii)
Foreign Subsidiaries and (iii) Subsidiaries with
less than $1.0 million of assets. The Company
will pledge 65% of the outstanding equity
interests of the Company's current Foreign
Subsidiary and each future Foreign Subsidiary to
secure the Company's obligations on the Notes.
The guarantees will be released under certain
circumstances. See "Description of the Notes--
Guarantees."
Optional Redemption......... On or after , 2001, the Notes will be
redeemable at the option of the Company, in whole
or in part, at the redemption prices set forth
herein, plus accrued and unpaid interest to the
date of redemption. In addition, prior to
, 2001, the Company may redeem up to 30%
of the originally issued principal amount of the
Notes at a Redemption Price of % thereof,
plus accrued and unpaid interest, if any, with
the proceeds of a Public Equity Offering;
provided that at least $87.5 million aggregate
principal amount of the Notes remains outstanding
after such redemption.
Change of Control........... Upon a Change of Control (as defined), each
Holder of the Notes may require the Company to
repurchase the Notes held by such Holder at 101%
of the principal amount thereof plus accrued and
unpaid interest to the date of repurchase. See
"Description of the Notes--Repurchase at the
Option of Holders--Change of Control."
Asset Sales................. The Indenture requires that the proceeds of
certain Asset Sales (as defined) be applied as
specified in the Indenture or be used to
repurchase the Notes, at the option of the Holder
thereof, at 100% of the principal amount thereof,
plus accrued and unpaid interest thereon to the
date of purchase.
Ranking..................... The Notes will be general unsecured obligations
of the Company and will rank pari passu in right
of payment with all existing and future unsecured
unsubordinated Indebtedness of the Company and
senior in right of payment to all existing and
future subordinated Indebtedness of the Company.
The Guarantee of each of the Subsidiary
Guarantors will rank pari passu in right of
payment with all existing and future
unsubordinated Indebtedness of such
5
<PAGE>
Subsidiary Guarantor and senior in right of
payment to all existing and future subordinated
Indebtedness of the Subsidiary Guarantors.
However, the Notes and Guarantees will be
effectively subordinated to all existing and
future secured Indebtedness of the Company and
the Subsidiary Guarantors (to the extent of the
value of the collateral securing such
Indebtedness). As of June 30, 1997, after giving
pro forma effect to the Offering, the Company and
the Subsidiary Guarantors had approximately
$102.0 million of secured Indebtedness
outstanding.
Certain Covenants........... The Indenture will contain certain covenants,
including, but not limited to, covenants with
limitations on the following matters:
(i) restricted payments, including dividends and
payments affecting subsidiaries; (ii) incurrence
of additional Indebtedness; (iii) issuance of
preferred stock; (iv) incurrence of liens;
(v) restrictions on distributions from
subsidiaries; (vi) merger, consolidation or sale
of assets; (vii) transactions with affiliates;
and (viii) lines of business. However, all these
limitations are subject to a number of important
exceptions and qualifications. See "Description
of the Notes--Certain Covenants."
Use of Proceeds............. The net proceeds will be used: (i) to repay
amounts outstanding under certain of Company's
warehouse lines of credit and its residual
financing facility; (ii) to fund loan
originations and purchases; (iii) to support
securitization transactions; (iv) for potential
acquisitions of complementary companies; and (v)
for general corporate purposes. See "Use of
Proceeds" and "Underwriting."
RISK FACTORS
SEE "RISK FACTORS" FOR A DESCRIPTION OF CERTAIN FACTORS WHICH SHOULD BE
CONSIDERED CAREFULLY IN EVALUATING AN INVESTMENT IN THE NOTES OFFERED BY THIS
PROSPECTUS.
6
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------- ------------------------
1993 1994 1995 1996 1996 1997
-------- -------- -------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
STATEMENTS OF EARNINGS
DATA:
Revenues:
Gains on sales of
loans................. $ 1,218 $ 9,572 $ 16,329 $ 55,361 $ 18,886 $ 61,938
Interest income........ 407 2,136 4,305 13,849 4,971 16,427
Other income........... -- -- 1,666 4,265 1,901 1,298
-------- -------- -------- ----------- ----------- -----------
Total revenues....... 1,625 11,708 22,300 73,475 25,758 79,663
-------- -------- -------- ----------- ----------- -----------
Expenses:
Interest expense....... 175 886 3,414 7,800 3,365 9,395
Personnel and
commission expense.... 475 2,156 4,190 10,997 4,105 16,464
General and
administrative
expense............... 239 1,262 2,153 6,599 1,939 9,234
-------- -------- -------- ----------- ----------- -----------
Total expenses....... 889 4,304 9,757 25,396 9,409 35,093
-------- -------- -------- ----------- ----------- -----------
Earnings before taxes... 736 7,404 12,543 48,079 16,349 44,570
Income taxes............ 305 3,073 5,205 20,447 6,954 18,497
-------- -------- -------- ----------- ----------- -----------
Net earnings............ $ 431 $ 4,331 $ 7,338 $ 27,632 $ 9,395 $ 26,073
======== ======== ======== =========== =========== ===========
Earnings per share(1):
Primary................ $ 1.40 $ 0.56 $ 1.17
Fully-diluted.......... $ 1.37 $ 0.56 $ 1.08
Weighted average number
of shares
outstanding(1):
Primary................ 19,804,331 16,772,043 22,272,284
Fully-diluted.......... 20,511,936 16,772,043 25,423,409
CASH FLOW DATA:
(Used in) provided by
operating activities... $(17,711) $ 1,515 $(85,207) $ (157,701) $ (31,856) $ (31,110)
(Used in) provided by
investing activities... -- (43) (437) (8,554) (1,898) (6,258)
Provided by (used in)
financing activities... 17,711 (1,222) 85,394 180,431 35,702 39,446
-------- -------- -------- ----------- ----------- -----------
Net increase (decrease)
in cash and cash
equivalents............ $ -- $ 250 $ (250) $ 14,176 $ 1,948 $ 2,078
======== ======== ======== =========== =========== ===========
OPERATING DATA:
Mortgage loans
originated or
purchased:
Wholesale Division..... $ 38,642 $183,010 $267,409 $ 529,026 $ 206,552 $ 495,493
Correspondent Program.. 2,914 7,287 21,073 204,799 53,236 164,714
Consumer Loan
Division.............. -- -- -- 4,553 -- 30,082
Strategic Alliance
Program............... -- -- -- 51,536 -- 66,385
-------- -------- -------- ----------- ----------- -----------
Total................ $ 41,556 $190,297 $288,482 $ 789,914 $ 259,788 $ 756,674
======== ======== ======== =========== =========== ===========
Average principal
balance per loan....... $ 127 $ 117 $ 87 $ 110 $ 117 $ 91
Weighted average
interest rate:
Fixed rate............. 10.5% 10.1% 11.8% 11.5% 11.3% 11.8%
Variable rate(2)....... 8.0% 8.8% 9.3% 10.1% 9.7% 10.4%
Combined weighted
average initial LTV
ratio.................. 67.7% 69.5% 76.1% 73.5% 73.6% 74.0%
Percent of first
mortgage loans......... 96.4% 98.0% 83.2% 98.9% 98.5% 97.2%
Loan sales:
Loans sold through
securitizations....... $ -- $ 70,173 $164,870 $ 657,353 $ 233,000 $ 754,991
Whole loan sales....... 23,410 121,362 58,595 -- -- 10,006
-------- -------- -------- ----------- ----------- -----------
Total................ $ 23,410 $191,535 $223,465 $ 657,353 $ 233,000 $ 764,997
======== ======== ======== =========== =========== ===========
DELINQUENCY DATA:
Total delinquent loans
as a percentage of
loans serviced(3)(4).. 6.90% 0.76% 1.66% 4.41% 2.54% 4.85%
Total loans in
foreclosure and
bankruptcy as a
percentage of loans
serviced(3)(4)........ 0.00% 0.56% 1.81% 2.47% 1.15% 3.87%
Net losses on
foreclosed loans as a
percentage of loans
serviced.............. 0.00% 0.00% 0.00% 0.00% 0.00% 0.04%
FINANCIAL RATIOS:
Ratio of earnings to
fixed charges(5)....... 5.20x 9.36x 4.67x 7.13x 5.86x 5.67x
Ratio of indebtedness to
total
capitalization(6)...... N/A 73.9% 25.2% 46.9% 2.9% 40.3%
</TABLE>
7
<PAGE>
<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
----------------------
PRO FORMA
ACTUAL (AS ADJUSTED)
-------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Loans held for sale...................................... $225,643 $225,643
Interest-only and residual certificates.................. 172,664 172,664
Total assets............................................. 442,180 447,180
Borrowings under warehouse lines of credit............... 191,974 101,974
% Senior Notes due 2004................................. -- 125,000
Convertible subordinated notes........................... 75,000 75,000
Notes payable to Strategic Alliances..................... 1,288 1,288
Notes payable............................................ 3,268 3,268
Total liabilities........................................ 330,801 365,801
Shareholders' equity..................................... 111,298 111,298
</TABLE>
- --------------------
(1) For an explanation of the weighted average number of shares outstanding
used to compute pro forma earnings per share, see Note 3 of the Notes to
the Consolidated Financial Statements included herein. Fully-diluted
earnings per share include interest accrued on convertible subordinated
notes.
(2) Variable rates are based on rate at origination.
(3) Excludes loans in foreclosure.
(4) For the year ended December 31, 1996 and the six months ended June 30,
1997, excludes loans in bankruptcy.
(5) For the purpose of determining the ratio of earnings to fixed charges,
earnings consist of income before income taxes; fixed charges consist of
interest expense and amortization of bond issuance costs.
(6) Represents the ratio of (i) total debt, exclusive of warehouse financing,
to (ii) the sum of total shareholders' equity and total debt, exclusive of
warehouse financing.
8
<PAGE>
RISK FACTORS
An investment in the Notes involves certain risks. Prospective investors
should carefully consider the following risk factors, which constitute all the
material risk factors, in addition to the other information contained in this
Prospectus, in evaluating an investment in the Notes offered hereby.
LEVERAGE; ASSET ENCUMBRANCE
The Company currently has substantial outstanding Indebtedness, and,
subsequent to the Offering, the Company will be significantly leveraged.
Although the covenants under the Indenture will restrict the incurrence of
Indebtedness by the Company and its Restricted Subsidiaries, the Indenture
does not limit the amount of Indebtedness under the Company's warehouse
facilities that qualifies as Permitted Warehouse Debt (as defined). With
respect to the Company's existing warehouse facilities, Permitted Warehouse
Debt generally means indebtedness used exclusively to finance or refinance the
origination or purchase of mortgage loans by the Company or a Subsidiary, up
to the lesser or (i) the amount advanced by the warehouse lender or (ii) 100%
of the principal amount of such loans. See "Description of the Notes--Certain
Definitions." All Permitted Warehouse Debt is secured by the mortgage loans
financed thereby. Although the Company intends to use a portion of the
proceeds from this Offering to pay off its residual facility, the Indenture
will limit but not prohibit the Company's incurrence of Indebtedness secured
by interest-only and residual certificates, and such Indebtedness would also
be recourse to the Company. Thus, if the value of the collateral securing any
such Indebtedness was to be insufficient to repay such Indebtedness in full,
the lenders could be entitled to seek payment of the shortfall, if any, from
the Company. The Indenture also will permit the Company and its Restricted
Subsidiaries to incur substantial amounts of additional secured Indebtedness.
At June 30, 1997 on a pro forma basis giving effect to the Offering and the
application of the net proceeds therefrom, the aggregate outstanding
consolidated Indebtedness of the Company and the Subsidiary Guarantors
(including the current maturities thereof) would have been approximately
$302.0 million, of which $102.0 million would have been secured Indebtedness
to which the Notes and the Guarantees are effectively subordinated. In
addition, assuming additional financing was available to the Company, it could
have incurred a substantial amount of Indebtedness (in addition to Permitted
Warehouse Debt) and complied with the covenants of the Indenture that will
restrict incurrence of Indebtedness.
The degree to which the Company is leveraged could have important
consequences to the holders of the Notes, including: (i) the Company may be
more vulnerable to adverse general economic and industry conditions; (ii) the
Company may find it more difficult to obtain additional financing for future
working capital, capital expenditures, acquisitions, general corporate
purposes or other purposes; and (iii) the Company will have to dedicate a
substantial portion of the Company's cash flows from operations to the payment
of principal and interest on Indebtedness (a substantial portion of which may
become due prior to the maturity of the Notes), thereby reducing the funds
available for operations and future business opportunities.
ABILITY TO SERVICE OUTSTANDING INDEBTEDNESS
There can be no assurance that the cash available from operations and
financing activities will be sufficient to enable the Company to make required
interest payments on the Notes and interest and principal payments on its
other debt obligations.
The Company's ability to make scheduled payments of the principal of, or to
pay the interest on, or to refinance its indebtedness (including the Notes)
will depend on its future operating performance, which to a certain extent is
subject to economic, financial, competitive, regulatory, and other factors
beyond its control. If the Company is unable to generate sufficient cash flow
to service its debt, it may be required to refinance all or a portion of its
existing debt, including the Notes, or to obtain additional financing. There
can be no assurance that any such refinancing would be possible or that any
additional financing could be obtained. Failure to obtain any such financing
could have a material adverse effect on the Company's financial condition and
results of operations.
9
<PAGE>
Although the Company has recognized significant increases in profitability,
it has operated and continues to operate on a negative cash flow basis. The
Company attributes this negative cash flow to three primary factors: the
timing of cash received in the gain on sale of loans in securitizations;
points or premiums paid by the Company to acquire loans; and operating and
administrative expenses associated with the Company's expansion. For the year
ended December 31, 1996 and six months ended June 30, 1997, the Company
operated on a negative cash flow basis using $157.7 million and $31.1 million,
respectively, in operating activities.
DEPENDENCE ON FUNDING SOURCES
Dependence on Warehouse Financing. The Company relies upon short-term
warehouse facilities to fund loan originations and purchases. The Company
currently has warehouse lines of credit aggregating $700 million, of which
$192 million was outstanding at June 30, 1997. Such amounts are secured by the
loans the Company originates or purchases with such funds. The Company is
required to comply with various operating and financial covenants as defined
in the agreements governing such lines of credit. Such covenants include
restrictions on (i) changes in the Company's business that would materially
and adversely affect the Company's ability to perform its obligations under
the warehouse lines of credit, (ii) selling any asset other than in the
ordinary course of business, (iii) guaranteeing the debt obligation of any
other entity, (iv) the use of proceeds from such facilities, including
delivery standards, LTV, and product mix, and (v) the Company's minimum net
worth, debt to net worth ratio, profitability and borrowing base. The
Indenture will impose certain restrictions on the Company's ability to incur
warehouse financing. The continued availability of funds provided to the
Company under these lines of credit is subject to the Company's continued
compliance with the operating and financial covenants contained in such
agreements. Company currently has three warehouse facilities, a $200 million
facility that expires on October 24, 1997, a $400 million facility that
expires February 5, 1998, and a $100 million facility that expires August 21,
1998. To the extent that the Company is not successful in maintaining or
replacing adequate warehouse financing, it would not be able to hold a large
volume of loans pending securitization and therefore would have to curtail its
loan production activities or sell loans either through whole loan sales or in
smaller securitizations, thereby having a material adverse effect on the
Company's financial condition and results of operations.
The Company has also entered into a residual financing facility of $30
million that allows the Company to obtain debt secured by interest-only and
residual certificates. The terms of this facility require that all outstanding
borrowings be repaid, at the lender's option, through the proceeds of the
Offering. The Company expects that this facility will be terminated upon
consummation of the Offering. The Indenture will require the Company to
achieve, and thereafter maintain, a specified amount of unencumbered interest-
only and residual certificates, thereby precluding the Company's ability to
access residual financing until the Company reaches predetermined levels in
accordance with the Indenture.
There can be no assurance that when the above-mentioned credit facilities
expire or are paid off that the Company will be able to renew or replace such
facilities on similar or commercially reasonable terms, or at all.
Dependence on Securitizations. The Company pools and sells through
securitizations substantially all of the loans which it originates or
purchases. The Company relies significantly upon securitizations to generate
cash proceeds for repayment of its warehouse lines and to create credit
availability to purchase additional loans. Further, gains on sales from the
Company's securitizations represent a significant portion of the Company's
revenues. Several factors affect the Company's ability to complete
securitizations of its loans, including conditions in the securities markets
generally, conditions in the asset-backed securities market specifically, the
credit quality of the Company's portfolio of loans and the Company's ability
to obtain credit enhancement. If the Company were unable to securitize
profitably a sufficient number of its loans in a particular financial
reporting period, then the Company's revenues for such period would decline
which could result in lower income or a loss for such period. In addition,
unanticipated delays in closing a securitization could also increase the
Company's interest rate risk by increasing the warehousing period for its
loans. Any such delays could have a material adverse effect on the Company's
financial condition and results of operations.
10
<PAGE>
In order to gain access to the securitization market, the Company has relied
on credit enhancements provided by monoline insurance companies to enable it
to obtain a "AAA/Aaa" rating for asset-backed bonds issued by the
securitization trust. The Company has also relied on credit enhancements from
the subordination of a class of securities issued by the securitization trust
to a senior class of securities of the same trust (the "Senior/Sub Structure")
whereby the senior certificate holders are protected against losses by having
their interests senior to the subordinate certificate holders' interests. Any
substantial reductions in the size or availability of the securitization
market for the Company's loans or changes in the securitization market's
acceptance of such credit enhancements could have a material adverse effect on
the Company's results of operations and financial condition.
POTENTIAL CHANGES IN VALUATIONS OF INTEREST-ONLY AND RESIDUAL CERTIFICATES
At June 30, 1997, the Company's balance sheet reflected interest-only and
residual certificates of approximately $172.7 million valued by the Company in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities" ("SFAS No. 125"). These assets are carried on the Company's
balance sheet at fair value. The Company uses an estimate of expected future
cash flows as the best estimate of fair value. This estimate is based upon
what the Company believes are reasonable and supportable assumptions and
projections. The primary factors considered in developing estimates of
expected fair market value are prepayment speeds, discount rate and credit
losses. The Company values these assets utilizing assumptions that it believes
are consistent with those that would be utilized by an unaffiliated third
party purchaser and records them in accordance with SFAS No. 125. The Company
estimates the expected cash flows that it will receive over the life of a
portfolio of loans. These expected cash flows constitute the excess of the
interest rate payable by the obligors of loans over the interest rate passed
through to the purchasers of the related securities, less applicable recurring
fees and credit losses. The Company discounts the expected cash flows using an
interest rate that market participants would use for similar financial
instruments.
The Company has elected to carry these assets as trading securities. If
actual experience in the assumptions used in the determination of the carrying
value of the assets differs from the projections, or if valuation assumptions
change in the marketplace, the Company would be required to make a fair value
adjustment to the asset and record that adjustment in the Company's statement
of earnings. The valuation of such interest-only and residual certificates can
fluctuate widely and is sensitive to various assumptions, including estimated
loan losses, discount rates and projected mortgage loan prepayments. No
assurance can be given that the loans securitized by the Company will not
experience significant prepayments or loan losses or as to whether, and in
what amounts, the Company in the future may have to write down the value of
its interest-only and residual certificates. To the Company's knowledge, there
is no active market for the sale of these interest-only and residual
certificates. No assurance can be given that interest-only and residual
certificates could be sold at their reported value, if at all. A decline in
the value of the Company's interest-only and residual certificates could have
a material adverse effect on the Company's financial condition or results of
operations. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Accounting Considerations."
LIMITED HISTORY OF INDEPENDENT OPERATIONS; RECENT AND PLANNED EXPANSION
The Company commenced operations in January 1993 as a division of SPTL and
was an operating subsidiary of ICII from April 1995 until March 1997. The
Company's total revenues and net earnings have grown significantly since
inception, primarily due to increased mortgage origination, purchasing and
sales activities. The Company may experience difficulties in integrating
newly-acquired entities and newly-established relationships with its
operations. The Company intends to continue to pursue a growth strategy for
the foreseeable future, primarily through the growth and expansion of its
Wholesale Division and Correspondent Program, through the development of its
Consumer Loan Division and entering into Strategic Alliances. The Company has
acquired and may consider acquiring related businesses, some of which could be
material.
11
<PAGE>
In certain cases the Company enters into arrangements to acquire new
businesses. These arrangements provide options to management to repurchase
equity interests of the acquired company if certain performance targets are
met. The Company reports the results of operations of these subsidiaries on a
consolidated basis. The exercise of such options could result in the
deconsolidation of such subsidiaries which could result in a decline in the
Company's net earnings and the termination of any such subsidiary's guarantee
of the Notes. In addition, upon deconsolidation such subsidiary would cease to
be subject to the restrictive covenants of the Indenture.
Each of these plans requires additional personnel, assets and cash
expenditures and there can be no assurance that the Company will be able to
successfully expand and operate such divisions and programs profitably. 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 cash reserves and
the failure of the Company to meet challenges of any such expansion could have
a material adverse effect on the Company's results of operations and financial
condition. The Company may face unforeseen difficulties in the securitization
or whole loan resale of loans obtained through acquisitions of smaller lenders
due to the different quality control and underwriting standards employed by
such lenders.
RISKS OF SERVICING
The Company currently contracts for the servicing of substantially all of
the loans it originates, purchases and holds for sale with the Servicer. This
arrangement allows the Company to increase the volume of loans it originates
and purchases without incurring the overhead investment in servicing
operations. As with any external service provider, the Company is subject to
risks associated with inadequate or untimely services. Many of the Company's
borrowers require notices and reminders to keep their loans current and to
prevent delinquencies and foreclosures. A substantial increase in the
Company's delinquency rate or foreclosure rate could have a material adverse
effect on the Company's financial condition and results of operations. See
"Business--Loan Servicing and Delinquencies."
If the Company terminates its agreement with the Servicer without cause (as
defined in the agreement), the Company will be required to pay the Servicer an
amount equal to 1% of the aggregate principal balance of the mortgage loans
being serviced by the Servicer at such time. Further, the agreement provides
that the Company shall pay the Servicer a transfer fee of $100 per loan for
any mortgage loan which the Company transfers from the Servicer to another
servicer, without terminating the agreement. Depending upon the size of the
Company's loan portfolio serviced by the Servicer at any point in time, the
termination penalty that the Company would be obligated to pay the Servicer
may be substantial.
Advanta currently services the mortgage loans in each of the Company's
public securitizations. With respect to such mortgage loans, the related
pooling and servicing agreements governing the securitization process
generally provide that, in certain circumstances, the Trustee may terminate
all rights and obligations of the Servicer as servicer of the loans upon
written notice, provided that such termination is at the direction of the
monoline insurer for such securitization or of the majority of holders of
certificates thereof, with the prior written consent of the monoline insurer,
but not at the option of the Company. The ability to effect such termination
is restricted to specific conditions described in the pooling and servicing
agreements, which generally include various loss and delinquency tests and
failure to make payments, including advances, within specific time periods. If
a new servicer were selected with respect to any such securitization, the
change in servicing may result in greater delinquencies and losses on the
related loans, which would adversely impact the value of the interest-only and
residual certificates held by the Company in connection with such
securitization.
DELINQUENCIES; NEGATIVE IMPACT ON CASH FLOW
The Company's cash flow is also adversely impacted by high delinquency rates
in the Company's public securitizations. Generally, provisions in the pooling
and servicing agreements entered into in connection with such securitizations
require that amounts retained as reserves in an overcollateralization account,
which is funded primarily by cash flow from the Excess Spread on the loans
held in the trust, be increased when the delinquency rates of the loans in
such securitization exceed specified limits. As of June 30, 1997, the Company
was
12
<PAGE>
required to maintain an additional $23.8 million in overcollateralization
accounts as a result of the level of its delinquency rates and other factors.
The Company has been required to increase the overcollateralization account
for five of its eight securitization trusts due to its delinquency rates and
other factors.
Delinquency and loss rates also affect the assumptions used by the Company
in computing Excess Spread and the value of the Company's interest-only and
residual certificates and could affect the Company's ability to effect
securitizations in the capital markets. No assurance can be given that future
delinquencies will not increase or that any such increase will not have a
material adverse effect on the Company.
RISKS RELATED TO CREDIT-IMPAIRED BORROWERS
The Company believes that the non-conforming loans it originates and
purchases will experience higher losses than conforming loans would
experience. Loans made to non-conforming borrowers may entail a higher risk of
delinquency and higher losses than loans made to borrowers who utilize
conventional mortgage sources. While the Company believes that the
underwriting criteria it employs enable it to mitigate the higher risks
inherent in loans made to non-conforming borrowers, no assurance can be given
that such criteria or methods will protect the Company from higher than
anticipated losses. In the event that pools of loans sold by the Company in
which the Company retains interest-only and residual certificates experience
higher losses than anticipated, the Company's results of operations or
financial condition could be adversely affected.
RISKS RELATED TO OPERATIONS IN THE UK
The Company has recently begun operations in the United Kingdom through its
wholly-owned subsidiary, Southern Pacific Mortgage Limited. The Company's
operations in the United Kingdom market are subject to most of the same risks
faced by the Company's US operations, as well as the additional risks
customarily associated with US corporations conducting foreign activities. The
Consumer Affairs Division of the Office of Fair Trading (the "Office of Fair
Trading") issued "Non-Status Lending Guidelines for Lenders and Brokers" in
July 1997 (the "Guidelines"), relating to the conduct of business by non-
conforming mortgage lenders and brokers in the United Kingdom, including
prepayment penalties, late fees and fees paid to mortgage brokers. The Company
plans to comply fully with the Guidelines and any other applicable regulations
in the United Kingdom. Failure to comply with such guidelines and/or
regulations can result in the suspension or revocation of licenses of lenders
in the United Kingdom. There can be no assurance that the final form of any
regulations promulgated in the United Kingdom will be similar to the
Guidelines. At the current time the Company is unable to estimate the cost, if
any, of complying with the Guidelines or any other regulations, and there can
be no assurance that the imposition of such costs will not have a material
adverse effect on the Company's business in the United Kingdom.
The Company is also exposed to fluctuations in foreign currency exchange
rates. To the extent that unfavorable fluctuations in foreign currency
exchange rates occur, the Company's results of operations will be adversely
affected. Additional risks in the United Kingdom include fluctuations in
foreign currency controls, expropriations, nationalization and other economic,
tax and regulatory policies of the United Kingdom government as well as the
laws and policies of the United States affecting foreign trade and investment.
CREDIT RISK ASSOCIATED WITH NEW PRODUCTS
From time to time the Company introduces new products. To the extent the
Company securitizes new loan products, it must make certain assumptions
regarding the estimated delinquencies, prepayments and foreclosures relating
to such loans, and such assumptions affect the gain on sale recorded by the
Company upon the securitization of such loans. Although some data for the
mortgage loan industry in general is available to the Company in preparing
such assumptions, there can be no assurance that such data will be similar to
the Company's experience with the performance of new loan products. There can
be no assurance that the
13
<PAGE>
performance of these products will meet the Company's estimates, have the
expected impact on the value of Company's interest-only and residual
certificates or be sufficient to enable securitization or whole-loan sales of
such new products.
Beginning in the second quarter of 1996, the Company began offering a "2-28"
adjustable rate mortgage product. The 2-28 product has an initial fixed
interest rate for two years which is typically 100 to 200 basis points lower
than the fully-indexed interest rate. Since none of the 2-28 loans made by the
Company have reached the end of their initial two-year fixed interest rate
period, the Company does not have statistical experience as to the performance
of these loans once such initial period is over. The 2-28 product may be
subject to a number of risks, including increased prepayment due to the
increase of the interest rate to the fully-indexed level and increased
delinquencies as the higher adjustable interest rates take effect. In
addition, the Company's assumptions regarding prepayments or credit losses
used to assess loans may not simulate the actual performance of such loans.
For the six months ended June 30, 1997, approximately 26.8% of the Company's
loan production consisted of 2-28 product. The occurrence of any of the
foregoing risks could have a material adverse effect on the Company's
financial condition or results of operations.
Certain of the Company's loan products have high LTV ratios and, although
secured by real property, the collateral of such loans often will not be
sufficient to cover the principal amount of the loans in the event of default.
The principal balance of such a loan, inclusive of other loans secured by the
same property, often exceeds the value of the underlying property by as much
as 25%. Consequently, the Company is less likely to use foreclosure as a means
to mitigate its losses upon the default of such loans or to recover any
meaningful amounts in the event of a foreclosure. Losses not covered by the
value of the underlying properties could have a material adverse effect on the
Company's results of operations and financial condition.
The Company has recently begun operations in the United Kingdom. The market
for non-conforming loans in the United Kingdom is relatively undeveloped and
the performance of such loans may be substantially different from the non-
conforming loan market in the United States. Although the Company believes
that there will be some correlation between the performance of non-conforming
loans in the United Kingdom to the same type of loans in the United States,
there can be no assurance that the performance of such loans will be similar
to the Company's experience with the performance of non-conforming loans in
the United States. Adverse performance of such loans could have a material
adverse effect on the Company's financial condition and results of operations.
RESTRICTIVE COVENANTS
The instruments governing the indebtedness of the Company, including the
Indenture, impose significant operating and financial restrictions on the
Company. Such restrictions will affect, and in many respects significantly
limit or prohibit, among other things, the ability of the Company to incur
additional indebtedness, pay dividends, repay indebtedness prior to its stated
maturity, sell assets or engage in mergers or acquisitions. See "Description
of Notes--Certain Covenants." These restrictions could also limit the ability
of the Company to effect future financings, make needed capital expenditures,
withstand a future downturn in the business or the economy, or otherwise
conduct necessary corporate activities.
ECONOMIC CONDITIONS
General. 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 LTV ratios of loans previously made by
the Company, thereby weakening collateral coverage and increasing the
possibility of a loss in the event of default. Further, delinquencies and
foreclosures 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
14
<PAGE>
Company's loan sales whether through whole loan sales or securitizations and
the value of the Company's interest-only and residual certificates, which
could have a material adverse effect on the Company's financial condition or
results of operations.
Changes in Interest Rates. Profitability may be directly affected by the
level of and fluctuations in interest rates which affect the Company's ability
to earn a spread between interest received on its loans held for sale and
rates paid on the Company's warehouse lines. The Company's profitability may
be adversely affected during any period of unexpected or rapid change in
interest rates. A substantial and sustained increase in interest rates could
adversely affect the Company's ability to originate and purchase loans and can
result in increased loan losses. A significant decline in interest rates could
increase the level of loan prepayments and require the Company to write down
the value of its interest-only and residual certificates, thereby adversely
impacting the Company's financial condition or results of operations.
Variable-rate mortgage loans (which include loans that typically have
initial fixed rate terms of up to two years) originated or purchased by the
Company amounted to $155.1 million, $528.9 million and $563.0 million in
principal amount during the years ended December 31, 1995 and 1996 and the six
months ended June 30, 1997, respectively. Substantially all such variable-rate
mortgage loans are made at an initial interest rate approximately 100 to 200
basis points below the fully indexed interest rate at origination. Although
these loans are underwritten assuming the fully indexed rate at origination,
borrowers may encounter financial difficulties as a result of increases in the
interest rate over the life of the loans.
The market value of fixed-rate mortgage loans has a greater sensitivity to
changes in market interest rates than adjustable-rate mortgage loans. As the
Company's production of fixed-rate mortgage loans has increased, the Company
has implemented various hedging strategies to mitigate the change in market
value of fixed-rate mortgage loans held for sale between the date of
origination and sale. Commencing in August 1995, these strategies have
included selling short and selling forward United States Treasury securities
and pre-funding loan originations in its securitizations. The Company
currently hedges its fixed-rate mortgage loans held for sale by selling
forward a combination of United States Treasury securities of various
maturities whose combined change in value due to a change in interest rates
closely approximates the change in value of the mortgage loans hedged. In the
future the Company may hedge its variable-rate mortgage loans and interest-
only and residual certificates 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 are 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. See
"Business--Hedging."
RISKS RELATED TO REPRESENTATIONS AND WARRANTIES IN WHOLE LOAN SALES AND
SECURITIZATIONS
In connection with its securitizations, the Company transfers loans
originated or purchased by the Company to a trust in exchange for cash and
interest-only and residual certificates issued by the trust. The trustee and
the monoline insurance company, if any, with respect to such securitization
have recourse to the Company with respect to the breach of representations or
warranties made by the Company at the time such loans are transferred. In
connection with any such breach with respect to any loan, the Company will be
required either to (i) purchase such loan from the trust or (ii) substitute
such loan with a substantially similar one. While the Company generally has
recourse to the sellers of mortgage loans for any such breaches, there can be
no assurance of the sellers' abilities to honor their respective obligations.
Also, the Company has in the past and may in the future engage in bulk whole
loan sales pursuant to agreements that generally provide for recourse by the
purchaser against the Company in the event of a breach of a representation or
warranty made by the Company, any fraud or misrepresentation during the
mortgage loan origination process or upon early default on such mortgage
loans. To the extent the Company purchases loans, the Company generally limits
the potential remedies of such purchasers to the potential remedies the
Company receives from the persons from whom the Company
15
<PAGE>
purchased such mortgage loans. However, in some cases, the remedies available
to a purchaser of mortgage loans from the Company may be broader than those
available to the Company against the sellers of such loans, and should a
purchaser enforce its remedies against the Company, the Company may not always
be able to enforce whatever remedies the Company may have against such
sellers.
In the ordinary course of its business, the Company is subject to claims
made against it by borrowers, and by monoline insurance carriers and trustees
in the Company's securitizations, arising from, among other things, losses
that are claimed to have been incurred as a result of alleged breaches of
contractual obligations, misrepresentations, errors and omissions of
employees, officers and agents of the Company (including its appraisers),
incomplete documentation and failures by the Company to comply with various
laws and regulations applicable to its business. The Company believes that
liability with respect to any currently asserted claims or legal actions will
not be material to the Company's results of operations or financial condition;
however, any claims asserted in the future may result in legal expenses or
liabilities which could have a material adverse effect on the Company's
results of operations and financial condition.
DEPENDENCE ON MORTGAGE BROKERS
The Company depends largely on mortgage brokers, and to a lesser extent,
financial institutions and mortgage bankers for its originations and purchases
of mortgage loans. The Company's competitors also seek to establish
relationships with such mortgage brokers, financial institutions and mortgage
bankers, none of whom (other than the Strategic Alliances) is contractually
obligated to continue to do business with the Company. The Company's future
results may become more exposed to fluctuations in the volume and cost of
loans available for purchase or origination resulting from competition from
other originators and purchasers of such loans, market conditions and other
factors.
LEGISLATIVE OR REGULATORY RISKS
Members of Congress and government officials have from time to time
suggested the elimination of the mortgage interest deduction for federal
income tax purposes, either entirely or in part, based on borrower income,
type of loan or principal amount. Because many of the Company's loans are made
to borrowers for the purpose of consolidating consumer debt or financing other
consumer needs, the competitive advantages of tax deductible interest, when
compared with alternative sources of financing, could be eliminated or
seriously impaired by such government action. Accordingly, the reduction or
elimination of these tax benefits could have a material adverse effect on the
demand for loans of the kind offered by the Company.
The Company's domestic business is subject to extensive regulation,
supervision and licensing by federal, state and local governmental authorities
and is subject 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, the Federal Real Estate Settlement Procedures Act ("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 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, and should the Company fail to comply with the Truth-in-Lending Act,
borrowers could have their loan transactions rescinded.
16
<PAGE>
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.
Several class-action lawsuits have been filed against a number of consumer
finance companies alleging that the compensation of mortgage brokers through
the payment of yield spread premiums violates various federal and state
consumer protection laws. These lawsuits might result in a similar suit being
brought against the Company or the publicity generated by such suits might
result in legislation that affects the manner in which the Company conducts
its relationships with mortgage brokers, either of which could have a material
adverse effect on the Company's financial condition and results of operations.
In addition, a lawsuit containing similar allegations, but not a class-action
claim, has been filed against the Company's subsidiary, National Capital
Holdings, Inc. The resolution of such suit in a manner adverse to such
subsidiary might have a material adverse effect on such subsidiary's financial
condition and results of operations.
CONTROL BY EXISTING SHAREHOLDER; LIMITATIONS IMPOSED
ICII beneficially owns approximately 47% of the outstanding common stock of
the Company. Although the percentage ownership by ICII is less than 50%, ICII
will continue to be able to control the election of at least a majority of the
members of the Company's Board of Directors and to determine all corporate
actions for the foreseeable future. The Company's Board of Directors will
independently approve ordinary corporate transactions, including, but not
limited to, financing arrangements between the Company and ICII or its
affiliates. Under the Company's bylaws, as long as ICII directly owns at least
25% of the Company's outstanding voting stock, the Audit Committee of the
Company's Board of Directors (consisting of directors independent of both
management and ICII) must independently approve all transactions between the
Company and ICII.
COMPETITION
As a purchaser and 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. 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. During periods of declining rates, competitors may solicit the
Company's customers to refinance their loans.
ENVIRONMENTAL LIABILITIES
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. There can be no assurances that the cost of such
removal would not substantially exceed the value of the affected properties or
the loans secured by such properties or 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.
DEPENDENCE ON A LIMITED NUMBER OF KEY PERSONNEL
The Company's growth and development to date have been largely dependent
upon the services of Robert W. Howard and Bernard A. Guy, Chief Executive
Officer and President of the Company, respectively.
17
<PAGE>
The Company does not have life insurance on any of its key personnel. The
Company has entered into employment agreements with Messrs. Howard and Guy.
The loss of Messrs. Howard's or Guy's services for any reason could have a
material adverse effect on the Company.
FRAUDULENT TRANSFER CONSIDERATIONS
The obligation of any Subsidiary Guarantor under its guarantee of the Notes
may be subject to review under state or federal fraudulent transfer laws in
the event of the Subsidiary Guarantor's bankruptcy or other financial
difficulty. Under those laws, in a lawsuit by an unpaid creditor or
representative of creditors of a Subsidiary Guarantor, such as a trustee in
bankruptcy or the Subsidiary Guarantor as debtor in possession, if a court
were to find that when the Subsidiary Guarantor entered into its guarantee, it
(a) received less than fair consideration or reasonably equivalent value
therefore, and (b) either (i) was insolvent, (ii) was rendered insolvent,
(iii) was engaged in a business or transaction for which its remaining
unencumbered assets constituted unreasonably small capital, or (iv) intended
to incur or believed that it would incur debts beyond its ability to pay as
such debts matured, the court could avoid such Subsidiary Guarantee and the
Subsidiary Guarantee and the Subsidiary Guarantor's obligations thereunder,
and direct the return of any amounts paid thereunder to the Subsidiary
Guarantor or to a fund for the benefit of its creditors. Moreover, regardless
of the factors indentified in the foregoing clauses (i) through (iv), the
court could avoid a Subsidiary Guarantee and direct such repayment if it found
that the Subsidiary Guarantee was entered into with actual intent to hinder,
delay, or defraud the Subsidiary Guarantor's creditors.
To the extent that a Subsidiary Guarantor's obligation under its Subsidiary
Guarantee exceeds the actual benefit that it receives from the issuance of the
Notes, such Subsidiary Guarantor may be deemed not to have received fair
consideration or reasonably equivalent value for its Subsidiary Guarantee. The
Indenture will contain a savings clause that will generally limit the
obligation of each Subsidiary Guarantor under its guarantee to the maximum
amount (if any) of the obligation that the Subsidiary Guarantor could incur
without that obligation being subject to avoidance as a fraudulent transfer,
taking into account all of the Subsidiary Guarantor's other obligations. There
can be no assurance that the savings clause would permit a Subsidiary
Guarantee to survive a fraudulent transfer attack, even in a reduced amount.
If effective, the savings clause may reduce, perhaps substantially, the
obligation of one or more Subsidiary Guarantors under their respective
guarantees to an amount less than required to pay the Notes in full. If any
Subsidiary Guarantee is avoided or reduced as a result of a fraudulent
transfer attack, holders of the Notes would have to look to the assets of the
Company and any other Subsidiary Guarantors for payment. There can be no
assurance that there would remain sufficient assets to satisfy the claims of
the holders of the Notes.
The measure of insolvency for purposes of the foregoing will vary depending
on the law of the jurisdiction being applied. Generally, however, an entity
would be considered insolvent if the sum of its debts (including contingent or
unliquidated debts) is greater than all of its property at a fair valuation or
if the present fair salable value of its assets is less than the amount that
will be required to pay its probable liability on its existing debts as they
become absolute and matured.
LACK OF PUBLIC MARKET
There is no public market for the Notes, and the Company does not intend to
list the Notes on any national securities exchange. The Company has been
advised by the Underwriters that, following completion of the Offering, they
intend to make a market in the Notes; however, they are under no obligation to
do so and market-making activities may be discontinued at any time without
notice. There can be no assurance as to the liquidity of the trading market
for the Notes or that an active public market for the Notes will develop. If
such a market were to develop, the Notes could trade at prices that may be
higher or lower than the initial offering price thereof depending on a number
of factors, including prevailing interest rates, the Company's operating
results and markets for similar securities. If an active public market for the
Notes does not develop, the market price and liquidity of the Notes may be
adversely affected. See "Underwriting."
18
<PAGE>
CHANGE OF CONTROL
The Indenture will provide that upon the occurrence of any Change of Control
the Company will be required to make an offer to purchase all of the Notes
issued and then outstanding under the Indenture at a purchase price equal to
101% of the principal amount thereof, plus accrued and unpaid interest, if
any, thereon to the date of purchase. Certain future credit or other borrowing
agreements may contain similar restrictions. The Company's ability to pay cash
to the holders of Notes upon a repurchase may prohibit the Company from
purchasing any Note prior to its stated maturity and may provide that certain
Change of Control events would constitute a default thereunder. See
"Description of Notes--Certain Covenants."
If a Change of Control were to occur, it is unlikely that the Company would
be able to both repurchase all of the Notes and repay all of its obligations
under other indebtedness that would become payable upon the occurrence of such
Change of Control, unless it could obtain alternate financing. There can be no
assurance that the Company would be able to obtain any such financing on
commercially reasonable terms or at all, and consequently no assurance can be
given that the Company would be able to purchase any of the Notes tendered
pursuant to a Change of Control Offer.
19
<PAGE>
USE OF PROCEEDS
The net proceeds to be received by the Company from the sale of the Notes
offered hereby, after deducting underwriting discounts and commissions and
estimated expenses payable by the Company are estimated to be approximately
$120 million. The Company intends to apply the net proceeds from the Offering
in the following manner: (i) to pay down amounts outstanding under certain of
the Company's warehouse lines of credit; (ii) to repay the Company's residual
financing facility of approximately $30 million, which accrues interest at a
rate based on LIBOR plus 2.5% and matures on July 14, 2000, whose proceeds had
been used to pay off other lines of credit and for general corporate purposes;
(iii) to fund loan originations and purchases; (iv) to support securitization
transactions; (iv) to support Strategic Alliances; (vi) for potential
acquisitions of related businesses; and (vii) for general corporate purposes.
CAPITALIZATION
The following table sets forth the capitalization of the Company at June 30,
1997 and as adjusted, to give pro forma effect to the Offering and the
anticipated application of the net proceeds therefrom. See "Use of Proceeds."
This table should be read in conjunction with the Company's Consolidated
Financial Statements and the Notes thereto included elsewhere herein.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
---------------------
ACTUAL AS ADJUSTED
-------- -----------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Short-term debt:
Borrowings under warehouse lines of credit......... $191,974 $101,974
Due to affiliates.................................. 80 80
-------- --------
Total short-term debt............................ $192,054 $102,054(1)
======== ========
Long-term debt:
% Senior Notes due 2004.......................... $ -- $125,000
6.75% Convertible Subordinated Notes due 2006...... 75,000 75,000
Notes payable to Strategic Alliances............... 1,288 1,288
Notes payable...................................... 3,268 3,268
-------- --------
Total long-term debt............................. $ 79,556 $204,556
======== ========
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares
authorized; none issued and outstanding........... -- --
Common Stock, no par value; 50,000,000 shares
authorized; 20,748,750 shares issued and
outstanding....................................... $ 53,951 $ 53,951
Contributed capital................................ 248 248
Translation adjustment............................. (15) (15)
Retained earnings.................................. 57,114 57,114
-------- --------
Total shareholders' equity....................... 111,298 111,298
-------- --------
Total capitalization............................. $382,908 $417,908
======== ========
</TABLE>
- ---------------------
(1) Approximately $30 million of the net proceeds of the Offering will be used
to repay a residual facility which was not outstanding at June 30, 1997.
20
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The selected data presented below under the captions "Statements of Earnings
Data," "Cash Flow Data" and "Balance Sheet Data" for, and as of each of the
years in the four-year period ended December 31, 1996 are derived from the
consolidated financial statements of Southern Pacific Funding Corporation and
Subsidiaries, which financial statements have been audited by KPMG Peat
Marwick LLP, independent auditors. The consolidated financial statements as of
December 31, 1995 and 1996 and for each of the years in the three-year period
ended December 31, 1996, and the independent auditors report thereon, are
included and incorporated by reference elsewhere herein. Such selected
consolidated financial data should be read in conjunction with those financial
statements and the notes thereto and with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included elsewhere
herein. The following selected consolidated statements of earnings and balance
sheet data as of June 30, 1997 and for the six-month periods ended June 30,
1996 and 1997 have been derived from the unaudited consolidated financial
statements of the Company and include all adjustments, consisting only of
normal recurring accruals, which management considers necessary for a fair
presentation of such financial information for those periods. Results for the
six months ended June 30, 1997 are not necessarily indicative of results to be
expected for the year ending December 31, 1997 or for any other period within
that year.
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE
YEAR ENDED DECEMBER 31, 30,
---------------------------------------- ----------------------
1993 1994 1995 1996 1996 1997
-------- -------- -------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
STATEMENTS OF EARNINGS
DATA:
Revenues:
Gains on sales of
loans................. $ 1,218 $ 9,572 $ 16,329 $ 55,361 $ 18,886 $ 61,938
Interest income........ 407 2,136 4,305 13,849 4,971 16,427
Other income........... -- -- 1,666 4,265 1,901 1,298
-------- -------- -------- ---------- ---------- ----------
Total revenues....... 1,625 11,708 22,300 73,475 25,758 79,663
======== ======== ======== ========== ========== ==========
Expenses:
Interest expense....... 175 886 3,414 7,800 3,365 9,395
Personnel and
commission expense.... 475 2,156 4,190 10,997 4,105 16,464
General and
administrative
expense............... 239 1,262 2,153 6,599 1,939 9,234
-------- -------- -------- ---------- ---------- ----------
Total expenses....... 889 4,304 9,757 25,396 9,409 35,093
-------- -------- -------- ---------- ---------- ----------
Earnings before taxes... 736 7,404 12,543 48,079 16,349 44,570
Income taxes............ 305 3,073 5,205 20,447 6,954 18,497
-------- -------- -------- ---------- ---------- ----------
Net earnings............ $ 431 $ 4,331 $ 7,338 $ 27,632 $ 9,395 $ 26,073
======== ======== ======== ========== ========== ==========
Earnings per share(1):
Primary................ $ 1.40 $ 0.56 $ 1.17
Fully-diluted.......... $ 1.37 $ 0.56 $ 1.08
Weighted average number
of shares
outstanding(1):
Primary................ 19,804,331 16,772,043 22,272,284
Fully-diluted.......... 20,511,936 16,772,043 25,423,409
CASH FLOW DATA:
(Used in) provided by
operating activities... $(17,711) $ 1,515 $(85,207) $ (157,701) $ (31,856) $ (31,110)
(Used in) investing
activities............. -- (43) (437) (8,554) (1,898) (6,258)
Provided by (used in)
financing activities... 17,711 (1,222) 85,394 180,431 35,702 39,446
-------- -------- -------- ---------- ---------- ----------
Net increase (decrease)
in cash and cash
equivalents............ $ -- $ 250 $ (250) $ 14,176 $ 1,948 $ 2,078
======== ======== ======== ========== ========== ==========
OPERATING DATA:
Mortgage loans
originated or
purchased:
Wholesale Division..... $ 38,642 $183,010 $267,409 $ 529,026 $ 206,552 $ 495,493
Correspondent Program.. 2,914 7,287 21,073 204,799 53,236 164,714
Consumer Loan
Division.............. -- -- -- 4,553 -- 30,082
Strategic Alliance
Program............... -- -- -- 51,536 -- 66,385
-------- -------- -------- ---------- ---------- ----------
Total................ $ 41,556 $190,297 $288,482 $ 789,914 $ 259,788 $ 756,674
======== ======== ======== ========== ========== ==========
</TABLE>
(Continued on following page)
21
<PAGE>
(Continued from previous page)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------- ------------------
1993 1994 1995 1996 1996 1997
------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Average principal
balance per loan....... $ 127 $ 117 $ 87 $ 110 $ 117 $ 91
Weighted average
interest rate:
Fixed rate............. 10.5% 10.1% 11.8% 11.5% 11.3% 11.8%
Variable rate(2)....... 8.0% 8.8% 9.3% 10.1% 9.7% 10.4%
Combined weighted
average initial LTV
ratio.................. 67.7% 69.5% 76.1% 73.5% 73.6% 74.0%
Percent of first
mortgage loans......... 96.4% 98.0% 83.2% 98.9% 98.5% 97.2%
Loan sales:
Loans sold through
securitizations....... $ -- $ 70,173 $164,870 $657,353 $233,000 $754,991
Whole loan sales....... 23,410 121,362 58,595 -- -- 10,006
------- -------- -------- -------- -------- --------
Total................ $23,410 $191,535 $223,465 $657,353 $233,000 $764,997
======= ======== ======== ======== ======== ========
DELINQUENCY DATA:
Total delinquent loans
as a percentage of
loans serviced(3)(4)... 6.90% 0.76% 1.66% 4.41% 2.54% 4.85%
Total loans in
foreclosure and
bankruptcy as a
percentage of loans
serviced(3)(4)......... 0.00% 0.56% 1.81% 2.47% 1.15% 3.87%
Net losses on foreclosed
loans as a percentage
of loans serviced...... 0.00% 0.00% 0.00% 0.00% 0.00% 0.04%
FINANCIAL RATIOS:
Ratio of earnings to
fixed charges(5)....... 5.20x 9.36x 4.67x 7.13x 5.86x 5.67x
Ratio of indebtedness to
total
capitalization(6)...... N/A 73.9% 25.2% 46.9% 2.9% 40.3%
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF JUNE 30, 1997
------------------------- ----------------------
PRO FORMA
1994 1995 1996 ACTUAL (AS ADJUSTED)
------- -------- -------- -------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Loans held for sale........... $16,727 $ 80,264 $223,059 $225,643 $225,643
Interest-only and residual
certificates................. 4,234 22,469 87,017 172,664 172,664
Total assets.................. 21,296 117,215 340,377 442,180 447,180
Borrowings under warehouse
lines of credit.............. -- 96,130 152,680 191,974 101,974
% Senior Notes due 2004..... -- -- -- -- 125,000
Convertible subordinated notes
............................. -- -- 75,000 75,000 75,000
Notes payable to strategic
alliances.................... -- -- -- 1,288 1,258
Notes payable................. -- -- -- 3,268 3,268
Total liabilities............. 15,745 104,326 255,228 330,801 365,801
Shareholders' equity.......... 5,551 12,889 85,086 111,298 111,298
</TABLE>
- ---------------------
(1) For an explanation of the weighted average number of shares outstanding
used to compute pro forma earnings per share, see Note 3 of the Notes to
the consolidated financial statements included herein. Fully-diluted
earnings per share include interest accrued on convertible subordinated
notes.
(2) Variable rates are based on rate at origination.
(3) Excludes loans in foreclosure.
(4) For the year ended December 31, 1996 and the six months ended June 30,
1997, excludes loans in bankruptcy.
(5) For the purpose of determining the ratio of earnings to fixed charges,
earnings consist of income before income taxes; fixed charges consist of
interest expense and amortization of bond issuance costs.
(6) Represents the ratio of (i) total debt, exclusive of warehouse financing,
to (ii) the sum of total shareholders' equity and total debt, exclusive of
warehouse financing.
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the preceding
Selected Financial Data and the Company's Financial Statements and the Notes
thereto and the other financial data included elsewhere in this Prospectus.
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations 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.
GENERAL
OVERVIEW
The Company is engaged in the business of originating, purchasing and
selling mortgage loans secured primarily by one-to-four family residences. The
majority of the Company's loans are made to owners of single family residences
who use the loan proceeds for mortgage refinancing, home purchase, debt
consolidation, home improvements and educational expenditures. The Company has
experienced significant growth in loan production primarily due to geographic
expansion, further penetration into established markets and the addition of
new loan production sources. As a result, the Company has experienced dramatic
increases in loan originations and purchases, revenues and results of
operations.
OPERATING CASH FLOW
Although the Company has recognized significant increases in revenues and
profitability, it has operated and continues to operate on a negative cash
flow basis. The Company attributes this negative cash flow to three primary
factors: the timing of cash received in the gain on sale of loans in
securitizations; points or premiums paid by the Company to acquire loans; and
operating and administrative expenses associated with the Company's expansion.
The Company's primary source of revenue is the recognition of gains from the
sale of its loans through securitizations. In a securitization, the Company
recognizes a gain on sale at the time the loans are sold, but receives
corresponding cash flows, represented by Excess Spread, over the actual life
of loans. The Excess Spread represents the difference between all principal
and interest received from the loans sold and (i) all principal and interest
required to be passed through to the asset-backed bond investors, (ii) all
servicing fees and (iii) other recurring fees. At the time of the
securitization, the Company capitalizes the Excess Spread, based upon certain
prepayment and loan loss assumptions and a discount rate that the Company
believes is consistent with what market participants would use for similar
financial instruments. The capitalized assets are recorded on the Company's
balance sheet as interest-only and residual certificates. A gain or loss is
recorded on the income statement equal to the value of the interest-only and
residual certificates created by the securitization in excess of the cost
basis of the loans and transaction and hedging expenses.
Prior to the time the Company begins to receive cash flows from the Excess
Spread, a reserve position is created within each securitization trust which
uses cash flows from the Excess Spread to retire a portion of the asset-backed
bonds until the spread between the outstanding principal balance of the
mortgage loans in the securitization trust and the asset-backed bonds equals
the lesser of two to four percent of the initial securitization bond debt
principal balance or four to six percent of the remaining principal balance
(known as the "overcollateralization requirement"). The cash flow generated by
the Excess Spread is first used to fund the amount of reserves required to
credit-enhance each securitization. Typically, the overcollateralization
requirement is fully funded eight to 12 months from the date of
securitization, although this period may be shorter or longer subject to the
structure and performance of the loans in the securitization. Subsequent to
funding the overcollateralization requirement, the Excess Spread is received
directly by the Company. Over time, the Company will also receive the
overcollateralization requirement depending upon the structure and performance
of the mortgage loans in each securitization.
23
<PAGE>
In connection with the origination or purchase of loans, the Company may
either receive or pay origination fees. These fees, referred to as "points" or
"premiums" in the mortgage industry, are dependent on the source of loan
production and typically correspond to the amount of further processing
required for a loan to be funded and are determined as a percentage of the
loan amount. The Company can receive up to 8% in origination fees for retail
loan originations, and may pay up to 7% for loans purchased through the
Correspondent Program and Strategic Alliance Program. For the year ended
December 31, 1996 and the six months ended June 30, 1997, the Company's direct
costs to originate or purchase loans, net of origination fees collected, were
approximately 1.6% and 2.4%, respectively. The premiums paid to acquire loans
are reflected in the income statement as a reduction in the amount of gain
recognized from the sale of the loans.
The table below summarizes certain of the Company's sources and uses of cash
in its operating activities and is not intended to represent cash flows from
operating activities in accordance with generally accepted accounting
principles.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
----------------------------------------------
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1996 1996 1997 1997
------------- ------------ --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Operating cash sources:
Interest income............... $ 2,504 $ 2,407 $ 5,060 $ 5,082
Cash from securitization
trusts....................... 563 492 3,238 5,278
Other income.................. 643 416 186 1,539
------- -------- -------- --------
Total operating cash sources.. 3,710 3,315 8,484 11,899
Operating cash uses:
Interest on warehouse
borrowings................... 1,345 1,981 1,859 3,514
Interest on other borrowings.. -- -- -- 2,138
Personnel and commissions
expense...................... 3,108 4,471 6,159 8,825
General and administrative
expense...................... 3,420 2,242 4,523 5,459
Securitization expenses....... 1,838 2,172 1,787 2,538
Taxes paid.................... -- -- 3,890 1,208
------- -------- -------- --------
Total operating cash uses..... 9,711 10,866 18,218 23,682
------- -------- -------- --------
Net operating cash used......... (6,001) (7,551) (9,734) (11,783)
Premiums paid for loan
originations and purchases..... (3,382) (5,073) (8,427) (9,102)
------- -------- -------- --------
Adjusted net operating cash
used......................... $(9,383) $(12,624) $(18,161) $(20,885)
======= ======== ======== ========
Reconciliation to net earnings
for non-cash items:
Gross gain on sale of loans... $20,465 $ 28,475 $ 35,183 $ 40,968
Reserve for pool buyouts...... -- -- -- (2,550)
Non-cash tax expenses......... (6,075) (7,417) (5,085) (8,313)
Other non-cash items.......... 3,212 1,584 711 4,205
------- -------- -------- --------
Net earnings.................... $ 8,219 $ 10,018 $ 12,648 $ 13,425
======= ======== ======== ========
</TABLE>
24
<PAGE>
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1996
Total revenues increased $53.9 million or 208.9% to $79.7 million for the
six months ended June 30, 1997 from $25.8 million for the six months ended
June 30, 1996. During the same period, the Company's total expenses increased
$25.7 million or 273.4% to $35.1 million for the six months ended June 30,
1997 from $9.4 million for the six months ended June 30, 1996. As a result,
the Company's earnings increased $16.7 million or 177.7% to $26.1 million in
the six months ended June 30, 1997 from $9.4 million in the six months ended
June 30, 1996.
The increase in revenues was primarily the result of increased gain on sale
of loans and increased interest income due to higher loan originations and
securitizations. Gains on sales of loans increased $43.0 million or 227.5% to
$61.9 million in the six months ended June 30, 1997 from $18.9 million in the
six months ended June 30, 1996. This increase was primarily the result of
higher loan origination and purchase volume, which resulted in a higher level
of loan securitizations. In the six months ended June 30, 1997, Wholesale
Division loan originations increased $288.9 million or 139.8% to $495.5
million compared to $206.6 million in the comparable period in 1996,
Correspondent Program purchases of loans increased $111.5 million or 209.6% to
$164.7 million in the six months ended June 30, 1997 compared to $53.2 million
in the comparable period in 1996, Consumer Loan Division loan originations
increased to $30.1 million in the six months ended June 30, 1997 from $0.0
million in the comparable period in 1996, Strategic Alliance loan originations
increased to $66.4 million in the six months ended June 30, 1997 from $0.0
million in the comparable period in 1996 and conforming loan originations
increased to $15.9 million in the six months ended June 30, 1997 from
$0.0 million in the comparable period in 1996. As a result, total non-
conforming and conforming loan originations and purchases increased $512.8
million or 197.4% to $772.6 million in the six months ended June 30, 1997 from
$259.8 million in the comparable period in 1996. Total loans of $755.0 million
were securitized in the six months ended June 30, 1997 compared to $233.0
million of loans sold or securitized during the comparable period in 1996,
with a weighted average net gain on securitization of 8.42% and 9.27%,
respectively.
Interest income increased $11.4 million or 228.0% to $16.4 million in the
six months ended June 30, 1997 from $5.0 million in the comparable period in
1996. The increase in interest income was primarily due to a higher average
balance of loans held for sale in 1997 resulting from the increased loan
origination and purchase volume during such period.
Securities valuation and other income decreased $0.6 million or 31.6% to
$1.3 million in the six months ended June 30, 1997 from $1.9 million in the
six months ended June 30, 1996. The decrease was primarily the result of a
$0.3 million decrease in securities valuation adjustments on interest-only and
residual certificates, a $2.6 million adjustment to anticipated recourse
liability, and a $2.3 million increase in miscellaneous income.
Interest expense increased $6.0 million or 176.5% to $9.4 million in the six
months ended June 30, 1997 from $3.4 million in the six months ended June 30,
1996. The increase in interest expense was attributable to the interest costs
associated with higher borrowings due to a higher balance of loans held
pending sale during 1997 resulting from increased loan origination and
purchase volume during the period.
Personnel and commission expense increased $12.4 million or 302.4% to $16.5
million in the six months ended June 30,1997 from $4.1 million in the
comparable period in 1996. The increase in personnel and commission expenses
was primarily due to new acquisitions and increased staffing levels related to
the Wholesale Division's growth and increased loan originations. As of June
30, 1997 the Company operated 23 regional branch centers and satellite offices
and employed 927 persons as compared to 13 regional branch centers and 175
employees as of June 30, 1996.
General and administrative expense, which consists primarily of occupancy,
supplies and other expenses, increased $7.3 million or 384.2% to $9.2 million
in the six months ended June 30, 1997 from $1.9 million in the comparable
period in 1996. The increase in general and administrative expense was
primarily due to new
25
<PAGE>
acquisitions and expenses incurred in association with the increase in the
number of regional branch centers and satellite offices to 23 as of June 30,
1997 from 13 as of June 30, 1996 and increased loan origination and purchase
volume.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED DECEMBER 31, 1995
Total revenues increased $51.2 million or 229% to $73.5 million in 1996 from
$22.3 million in 1995. During the same period, the Company's total expenses
increased $15.6 million or 159% to $25.4 million from $9.8 million. As a
result, the Company's net earnings increased $20.3 million or 278% to
$27.6 million in 1996 from $7.3 million in 1995.
The increase in revenues was primarily the result of increased gain on sale
of loans and increased interest income due to higher loan originations and
securitizations. Gains on sales of loans increased $39.1 million or 239.9% to
$55.4 million in 1996 from $16.3 million in 1995. This increase was primarily
the result of higher loan origination and purchase volume as well as a higher
volume of loans at the beginning of the period which resulted in a higher
level of loan securitization. In 1996, Wholesale Division loan originations
increased $261.6 million or 97.8% to $529.0 million compared to $267.4 million
in the comparable period in 1995, correspondent purchases of loans increased
$183.7 million or 871% to $204.8 million in 1996 compared to $21.1 million in
the comparable period in 1995, Consumer Loan Division loan originations
increased to $4.6 million in 1996 from $0 in 1995, and Strategic Alliance loan
originations increased to $51.5 million in 1996 from $0 in 1995. As a result,
total loan originations and purchases increased $501.4 million or 174% to
$789.9 million in 1996 from $288.5 million in the comparable period in 1995.
Total loans of $657.4 million were securitized in 1996 compared to $223.5
million of loans sold or securitized during the comparable period in 1995,
with a weighted average gain on securitization of 8.4% in both years.
Interest income increased $9.5 million or 220.9% to $13.8 million in 1996
from $4.3 million in 1995. The increase in interest income was primarily due
to a higher average balance of loans held for sale in 1996 resulting from the
increased loan origination and purchase volume during such period, and a
higher balance of loans held for sale at the beginning of such period as
compared to the corresponding period in 1995.
Securities valuation and other income increased $2.6 million or 152.9% to
$4.3 million in 1996 from $1.7 million in 1995. The increase was primarily the
result of a $1.5 million or 92% increase in securities valuation adjustments
on interest-only and residual certificates to $3.2 million in 1996 from $1.7
million in 1995.
Total expenses increased $15.6 million or 159.2% to $25.4 million in 1996
from $9.8 million in 1995. The increase in expenses was primarily the result
of additional personnel and commission expenses, increases in interest expense
on loans held for sale, and higher operating expenses related to increased
loan origination and purchase volume in 1996 compared to 1995.
Interest expense increased $4.4 million or 129.4% to $7.8 million in 1996
from $3.4 million in 1995. The increase in interest expense was attributable
to the interest costs associated with a higher balance of loans held pending
sale during 1996 resulting from increased loan origination and purchase volume
during the year.
Personnel and commission expense increased $6.8 million or 161.9% to $11.0
million in 1996 from $4.2 million in 1995. The increase in personnel and
commission expenses was primarily due to increases staffing levels related to
the Wholesale Division's growth and increased loan originations. As of
December 31, 1996, the Company operated 14 regional branch centers and
employed 370 persons as compared to 8 regional branch centers and 104
employees as of December 31, 1995. In addition, the Company started the
Consumer Loan Division which employed 45 persons as of December 31, 1996.
General and administrative expense, which consists primarily of occupancy,
supplies and other expenses, increased $4.4 million or 200% to $6.6 million in
1996 from $2.2 million in 1995. The increase in general and administrative
expense was primarily due to expenses incurred in association with the
increase in the number of regional branch centers to 14 in 1996 from 8 in 1995
and increased loan origination and purchase volume.
26
<PAGE>
YEAR ENDED DECEMBER 31, 1995 COMPARED TO THE YEAR ENDED DECEMBER 31, 1994
Total revenues increased $10.6 million or 90.6% to $22.3 million in 1995
from $11.7 million in 1994. During the same period, the Company's total
expenses increased $5.5 million or 128% to $9.8 million from $4.3 million. As
a result, the Company's net earnings increased $3.0 million or 69.8% to $7.3
million in 1995 from $4.3 million in 1994.
The increase in revenues was primarily the result of increased loan sales
and greater loan originations resulting from the expansion of the Company's
Wholesale Division.
Gains on sales of loans increased $6.7 million or 69.8% to $16.3 million in
1995 from $9.6 million in 1994. This increase was primarily the result of
higher loan origination and purchase volume which resulted in a higher level
of loan sales. During 1995, loan originations increased $84.4 million or 46%
to $267.4 million compared to $183.0 million in 1994. In addition, the Company
acquired $21.1 million in bulk purchases of loans in 1995 compared to $7.3
million in 1994. Total loan originations and purchases increased $98.2 million
or 52% to $288.5 million in 1995 from $190.3 million in 1994. Total loans of
$223.5 million were sold or securitized in 1995 compared to $191.5 million
during the comparable period in 1994, with a weighted average gain on
securitization of 8.4% in both years. Included in the gains on sales of loans
in 1994 was $0.8 million on the gain on sale of the servicing of loans. No
such gain was recorded in 1995.
Interest income increased $2.2 million or 105% to $4.3 million in 1995 from
$2.1 million in 1994. The increase in interest income was primarily due to a
higher average balance of loans held for sale during 1995 resulting from the
increased loan origination and purchase volume and a longer holding period for
such loans resulting from regular quarterly securitizations. Interest income
also increased as a result of higher weighted average interest rates on loans
held in 1995 as compared to 1994, due in large part to the initiation of
originations and purchases of second mortgages.
Securities valuation and other income increased $1.7 million in 1995 from $0
million in 1994.
Total expenses increased $5.5 million or 128% to $9.8 million in 1995 from
$4.3 million in 1994. The increase in expenses was primarily the result of
increased interest expense on loans held for sale, additional personnel for
the Wholesale Division, added selling expenses and higher operating expenses
related to increased loan origination and purchase volume in 1995 as compared
to 1994.
Interest expense increased $2.5 million or 278% to $3.4 million in 1995 from
$0.9 million in 1994. The increase in interest expense was attributable to the
interest costs associated with a higher balance of loans held pending sale in
1995 resulting from increased loan origination and purchase volume during the
year as well as a longer holding period for such loans resulting from regular
quarterly securitizations.
Personnel and commission expense increased $2.1 million or 100% to $4.2
million in 1995 from $2.1 million in 1994. The increase in personnel and
commission expense was primarily due to increased staffing levels related to
the Wholesale Division's growth and increased loan originations. As of
December 31, 1995, the Company operated eight regional branch centers and
employed 104 persons as compared to operating five regional branch centers and
employing 61 persons as of December 31, 1994.
General and administrative expense, which consists primarily of occupancy,
supplies and other expenses, increased $0.9 million or 69% to $2.2 million in
1995 from $1.3 million in 1994. The increase in general and administrative
expense was primarily due to expenses incurred in association with the growth
of the Wholesale Division and increased loan origination and purchase volume.
Had the Company exclusively used its current independent loan servicer in 1995
and 1994, its general and administrative expenses would have been higher by
approximately $234,000 and $120,000, respectively.
27
<PAGE>
FINANCIAL CONDITION
JUNE 30, 1997 COMPARED TO DECEMBER 31, 1996
Loans held for sale increased $2.5 million or 1.1% to $225.6 million at June
30, 1997 from $223.1 million at December 31, 1996. The increase in loans held
for sale resulted from increased residential loan originations and purchases
of $756.7 million and increased commercial loan originations of $21.0 million.
This was offset by higher sales into securitizations of $755.0 million and
whole loan sales of $10.0 million, in addition to approximately $10.2 million
in adjustments and decreases to FASB 91 assets.
Interest-only and residual certificates increased $85.7 million or 98.5% to
$172.7 million at June 30, 1997 from $87.0 million at December 31, 1996. The
increase is primarily attributable to securitizations, which increased the
interest-only and residual certificate assets by $83.4 million during the six
months ended June 30, 1997. The discounted recourse liability was
retroactively reclassified as a contra-asset to interest-only and residual
certificates to comply with SFAS 125, for each of the years ended December 31,
1994, 1995 and 1996.
Accrued interest receivable increased $0.7 million or 21.9% to $3.9 million
at June 30, 1997 from $3.2 million at December 31, 1996. This increase
primarily reflects the increased loan production during the six months ended
June 30, 1997.
Premises and equipment, net, increased $2.7 million or 90.0% to $5.7 million
at June 30, 1997 from $3.0 million at December 31, 1996. This growth reflects
the Company's acquisitions as well as increased computer and office equipment
purchased for the addition of new regional branch centers during the six
months ended June 30, 1997.
Goodwill increased $2.7 million or 57.4% to $7.4 million at June 30, 1997
from $4.7 million at December 31, 1996. This growth reflects the Company's
acquisitions.
Other assets increased $0.5 million or 9.6% to $5.7 million at June 30, 1997
from $5.2 million at December 31, 1996. Other assets represent prepaid
expenses, accounts receivable and bond issuance costs.
Borrowings under warehouse lines of credit increased $39.3 million or 25.7%
to $192.0 million at June 30, 1997 from $152.7 million at December 31, 1996,
reflecting an increase in loan production over loan securitizations and sales
of $7.0 million and increased use of cash for operations of $31.7 million.
Deferred tax liability increased $17.3 million or 94.0% to $35.7 million at
June 30, 1997 from $18.4 million at December 31, 1996. This increase is the
result of the deferral of non-cash gains resulting from the sale of loans
through securitizations during the six months ended June 30, 1997.
Shareholders' equity increased $26.2 million or 30.8% to $111.3 million at
June 30, 1997 from $85.1 million at December 31, 1996, due to net income for
the six months ended June 30, 1997 of $26.1 million and the issuance of common
stock under the Employee Stock Option Plan.
DECEMBER 31, 1996 COMPARED TO DECEMBER 31, 1995
Loans held for sale increased $142.8 million or 177.8% to $223.1 million in
1996 from $80.3 million in 1995. The increase in loans held for sale was due
to the fact that the Company originated and purchased $789.9 million of loans
compared to loan securitizations of $657.4 million. Originations increased
173.8% primarily as a result of the Company's geographic expansion and further
penetration into established markets.
Loans held under repurchase agreements decreased to $0 in 1996 from $12.8
million in 1995. During the second quarter of 1996, the Company canceled its
agreement to acquire certain mortgage loans under a master repurchase
agreement with a financial institution.
Interest-only and residual certificates increased $64.5 million, or 286.7%,
to $87.0 million in 1996 from $22.5 million in 1995. This increase is the
result of four securitizations occurring in 1996 of $657.4 million.
28
<PAGE>
Accrued interest receivable increased $2.2 million or 220% to $3.2 million
in 1996 from $1.0 million in 1995. This increase was primarily due to a 178%
increase in loans held for sale to $223.1 million in 1996 from $80.3 million
from $80.3 million in 1995.
Premises and equipment, net increased $2.6 million or 650% to $3.0 million
in 1996 from $0.4 million in 1995. This growth was the result of an expansion
of regional branch centers to 14 in 1996 from eight in 1995 and an increase in
employees to 370 persons in 1996 from 104 persons in 1995.
Goodwill increased to $4.7 million in 1996 from $0 in 1995. This increase
reflects the acquisition in 1996 of National Capital Funding, Inc.
Other assets increased $4.9 million or 1,633% to $5.2 million in 1996 from
$0.3 million in 1995. Other assets represents prepaid expenses, accounts
receivable and bond issuance costs. The increase is primarily due to the
capitalization of bond issuance costs of $2.8 million relating to the
November, 1996 issuance of $75 million of convertible subordinated notes and
increased prepaid expenses relating to the final securitization of 1996.
Borrowings under warehouse lines of credit increased $56.6 million or 59% to
$152.7 million in 1996 from $96.1 million in 1995. The increase in borrowings
is primarily the result of funding required for a greater amount of loans held
for sale.
Deferred tax liability increased $18.4 million, or 100%, to $18.4 million in
1996 from $0 in 1995. This increase is the result of the deferral of non-cash
gains resulting from the sale of loans through securitizations during the year
ended December 31, 1996.
Convertible subordinated notes increased $75 million from $0 in 1995. In
November 1996, the Company issued $75 of million convertible subordinated
notes, due October 2006.
Due to affiliates decreased $1.5 million or 94% to $80,166 in 1996 from $1.6
million in 1995. The decrease reflects repayment of borrowings from ICII from
proceeds of the Company's initial public offering.
Other liabilities increased $5.8 million or 181% to $9.0 million in 1996
from $3.2 million in 1995. This increase resulted primarily from current taxes
payable and interest payable on warehouse lines and convertible subordinated
notes.
Shareholders' equity increased $72.2 million or 560% to $85.1 million in
1996 from $12.9 million in 1995, due to net income for the year of $27.6
million. In addition, the Company received proceeds of $53.8 million from the
issuance and sale of common stock.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. The Company anticipates that it will continue operating on a
negative cash flow basis as long as it continues to sell loans through
securitizations and it continues to retain interest-only and residual
certificates in the loans sold. During the years ended December 31, 1994,
1995, 1996 and the six months ended June 30, 1997, the Company generated
(used) cash in operations of approximately $1.5 million, $(85.2) million,
$(157.7) million and $(31.1) million, respectively. The Company funds these
cash requirements primarily through capital market transactions, working
capital, warehouse and residual financings as well as whole loan sales and
securitizations.
The Company relies in part upon short-term warehouse facilities to fund loan
originations and purchases. In November 1995, the Company entered into a
warehouse and purchase facility (the "First Facility") and in October 1996, a
second warehouse facility (the "Second Facility"). Under these facilities, the
Company has available $600 million warehouse lines of credit secured by the
loans the Company originates and purchases. The $200 million First Facility
expires October 24, 1997. The $400 million Second Facility expires February 5,
1998. The Company is required to comply with various operating and financial
covenants as defined in the
29
<PAGE>
agreements governing the facilities. Such covenants include restrictions on
(i) changes in the Company's business that would materially and adversely
affect the Company's ability to perform its obligations under the facilities,
(ii) selling any asset other than in the ordinary course of business, (iii)
guaranteeing the debt obligations of any other entity, (iv) the use of
proceeds from such facilities, including delivery standards, LTV and product
mix and (v) the Company's minimum net worth, debt to net worth ratio,
profitability and minimum borrowing base requirements. The continued
availability of funds provided to the Company under the facilities is subject
to the Company's continued compliance with the operating and financial
covenants contained in such agreements.
The Company also has a $100 million, 364 day warehouse facility to finance
first mortgage loans and high LTV second mortgage loans. The Company plans on
utilizing this line during the third quarter of 1997. This facility has
covenant and operating requirements similar to the Company's other warehouse
facilities and expires August 21, 1998.
Subsequent to June 30, 1997, the Company entered into a residual financing
facility of $30.0 million that allows the Company to obtain debt secured by
interest-only and residual certificates. The Company has drawn upon
approximately $30 million of this facility. The Company expects to use a
portion of the proceeds of the Offering to repay this facility and expects
that the facility will be terminated.
Prior to January 1, 1994, the Company sold its loans to institutional
purchasers in whole loan transactions. In March 1994, the Company completed
its first securitization of loans for $44.5 million. From March 1994 and
during each of the quarters thereafter through the quarter ended June 30,
1997, the Company securitized loans in the aggregate principal amount of $1.6
billion. The Company expects to continue to depend on its ability to
securitize loans in the secondary market. Several factors affect the Company's
ability to complete securitizations of its loans, including conditions in the
securities markets generally, conditions in the asset-backed securities market
specifically, the credit quality of the Company's portfolio of loans and the
Company's ability to obtain credit enhancement. Adverse changes in such
factors may affect the Company's results of operations, financial condition
and ability to generate sufficient cash flows needed to continue originating
and purchasing loans at increased levels.
The Company had cash and cash equivalents of approximately $16.3 million at
June 30, 1997. The Company believes that its current cash position, including
the net proceeds of the Offering and borrowings available under its current
warehouse facilities and anticipated refinancings thereof will be sufficient
to fund the Company's liquidity requirements for approximately 12 months. The
Company has no commitments for additional bank borrowings or additional debt
or equity financings, including the refinancing of its warehouse facilities,
and there can be no assurance that the Company will be successful in
consummating any such financing transaction or, if consummated whether such
refinancings will be on terms the Company would consider to be favorable.
ACCOUNTING CONSIDERATIONS
In June 1996, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities". SFAS No. 125 provides accounting and reporting
standards for transfers and servicing of financial assets and extinguishment
of liabilities. Those standards are based on consistent application of a
financial-components approach that focuses on control. Under that approach,
after a transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and the liabilities it has incurred, derecognizes
financial assets when control has been surrendered, and derecognizes
liabilities when extinguished. SFAS No. 125 provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers
that are secured borrowings.
SFAS No. 125 requires that liabilities and derivatives incurred or obtained
by transferors as part of a transfer of financial assets be initially measured
at fair value, if practicable. It also requires that servicing assets and
other retained interest in the transferred assets be measured by allocating
the previous carrying amount between the assets sold, if any, and retained
interests, if any, based on their relative fair values at the date of the
transfer. SFAS No. 125 provides implementation guidance for assessing
isolation of transferred assets and for accounting
30
<PAGE>
for transfers of partial interests, servicing of financial assets,
securitizations, transfers of sales-type and direct financing lease
receivables, securities lending transactions, repurchase agreements including
"dollar rolls," "wash sales," loan syndications and participations, risk
participations in banker's acceptances, factoring arrangements, transfers of
receivables with recourse, and extinguishment of liabilities. SFAS No. 125 is
effective for transfers and servicing of financial assets and extinguishment
of liabilities occurring after December 31, 1996, and is to be applied
prospectively.
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share". This
Statement specifies the computation, presentation, and disclosure requirements
for earnings per share for entities with publicly held common stock or
potential common stock. This Statement shall be effective for financial
statements for both interim and annual periods ending after December 15, 1997.
Earlier application is not permitted. 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 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.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." This Statement establishes standards
for the way that public business enterprises report information about
operating segments in annual financial statements and requires that
enterprises report selected information about operating segments in interim
financial reports issued to shareholders. This Statement shall be effective
for fiscal years beginning after December 15, 1997. In the initial year of
application, comparative information for earlier years is to be restated. 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.
31
<PAGE>
BUSINESS
GENERAL
Southern Pacific Funding Corporation is a specialty finance company engaged
in the business of originating, purchasing and selling non-conforming mortgage
loans secured primarily by one-to-four family residences. The majority of the
Company's loans are made to owners of single family residences who use the
loan proceeds for purposes such as mortgage refinancing, home purchase, debt
consolidation, home improvements and educational expenditures. The Company
focuses primarily on lending to individuals who have significant equity in the
value of their homes but have impaired or limited credit histories. As a
result, the Company's customers are less likely to qualify for loans from
conventional mortgage lenders and generally pay higher interest rates than
interest rates charged by conventional mortgage lenders.
The Company's origination strategy is to develop and maintain diversified
production channels that enable the Company to originate and purchase loans on
a consistent, low cost basis. The Company's total direct costs of production,
which include premiums paid on all loans originated or purchased, net of
origination fees collected, for the year ended December 31, 1996 and the six
months ended June 30, 1997 were 1.6% and 2.4%, respectively of loans produced.
The Company originates or purchases loans in all 50 states and the District of
Columbia through its Wholesale Division, Correspondent Program, Strategic
Alliance Program and Consumer Loan Division.
The Wholesale Division originates a majority of the Company's loans. The
Wholesale Division consists of approximately 125 account executives located in
23 regional branch centers. These account executives have established
relationships with, and market directly to, licensed independent mortgage
brokers. Independent mortgage brokers identify potential borrowers, assist
borrowers in completing loan applications and submit such loan applications
and other documents to the Company for underwriting review and credit
decision. All loans funded by the Wholesale Division are underwritten to the
Company's guidelines. In most cases, the Company conditionally approves loans
submitted by an independent mortgage broker within 24 hours from receipt of
the loan application and funds loans within 21 days after approval. The
Company believes its competitive strength in maintaining and expanding
independent mortgage broker relationships is attributable to its ability to
provide quality service, including responsive execution and funding of loans,
as well as offering a broad range of loan products to applicants. The
Wholesale Division originated $267.4 million, $529.0 million and $495.5
million of mortgage loans during the years ended December 31, 1995 and 1996
and the six months ended June 30, 1997, respectively, representing 92.7%,
67.0% and 65.5% of the Company's total loan originations and purchases during
the respective periods.
The Company purchases closed loans through its Correspondent Program. Loans
purchased through the Correspondent Program are complete loan packages that
have been underwritten and funded by approved mortgage bankers or financial
institutions. The Company reunderwrites each loan submitted in the loan
portfolio to ensure that all loans comply with the Company's underwriting
guidelines. As part of the reunderwriting process, the Company's underwriters
review the appraisal and the applicant's creditworthiness and ensure that all
necessary compliance and disclosure documentation is included in the loan
package. Loans that do not meet the Company's underwriting guidelines are not
purchased. Through the Correspondent Program, the Company purchased $21.1
million, $204.8 million and $164.7 million of mortgage loans during the years
ended December 31, 1995 and 1996 and the six months ended June 30, 1997,
respectively, representing 7.3%, 25.9% and 21.8% of the Company's total loan
originations and purchases during the respective periods.
The Company also purchases loans through its Strategic Alliance Program.
Through the Strategic Alliance Program, the Company obtains a committed source
of loan production from select mortgage lenders who form Strategic Alliances
with the Company. To date, the Company has entered into Strategic Alliances
with four mortgage lenders. The Strategic Alliance Program generally permits
the Strategic Alliance to obtain financing support from the Company and to
securitize its qualifying loan production with the Company's loan production.
In return, the Company receives interest and fee income, warrants to acquire
an equity interest in the Strategic
32
<PAGE>
Alliance and the right to acquire all of the Strategic Alliance's qualifying
non-conforming loan production. In addition, the Strategic Alliance Program
provides the Company with access to a broader network of independent mortgage
broker relationships. The Company reunderwrites all loans submitted by each
Strategic Alliance for an initial period, generally 60 to 90 days. After the
initial period, the Strategic Alliance's loans are monitored through the
Company's quality control process. Through the Strategic Alliance Program, the
Company purchased $51.5 million and $66.4 million of mortgage loans during the
year ended December 31, 1996 and the six months ended June 30, 1997,
respectively, representing 6.5% and 8.8% of the Company's total loan
originations and purchases during the respective periods.
The Consumer Loan Division was recently formed to broaden the Company's loan
products to include second mortgage loans. The Consumer Loan Division offers
second mortgage loans to credit-impaired borrowers and high LTV loans to
borrowers with better credit than the Company's average non-conforming
borrower. The Consumer Loan Division originates loans by marketing directly to
potential borrowers using direct mail advertising, telemarketing and radio
advertising. The Consumer Loan Division also originates loans through
independent mortgage brokers. The Consumer Loan Division currently has retail
offices in Ontario and Newport Beach, California, and is scheduled to open
three additional offices by the end of 1997. All loans originated by the
Consumer Loan Division are underwritten and processed through its dedicated
underwriting department. Traditional non-conforming second mortgage loans are
underwritten to substantially the same underwriting criteria as the Wholesale
Division's product while applicants for high LTV loans are underwritten to
criteria primarily based on a credit scoring system developed by Fair, Issacs &
Company. The Consumer Loan Division originated $4.5 million and $30.1 million
of loans during the year ended December 31, 1996 and the six months ended June
30, 1997, respectively, representing 0.6% and 3.9% of the Company's total loan
originations and purchases during the respective periods.
The Company sells the majority of its originated and purchased loans in the
secondary market through public securitizations in order to enhance
profitability, improve liquidity and reduce the Company's exposure to
fluctuations in interest rates. In a securitization, the Company recognizes a
gain on sale at the time the loans are sold, but receives cash flows in the
form of Excess Spread over the actual life of such loans. This Excess Spread
represents the difference between all principal and interest received from the
loans sold and (i) all principal and interest required to be passed through to
the asset-backed bond investors, (ii) all servicing fees and (iii) other
recurring fees. At the time of the securitization, the Company capitalizes the
Excess Spread, based upon certain prepayment and loan loss assumptions and a
discount rate that the Company believes is consistent with what market
participants would use for similar financial instruments. The capitalized
assets are recorded on the Company's balance sheet as interest-only and
residual certificates. A gain or loss is recorded in the statement of earnings
equal to the value of the interest-only and residual certificates created by
the securitization in excess of the cost basis of the loans and transaction and
hedging expenses. The cashflow generated by the Excess Spread is first used to
fund the amount of reserves required to credit-enhance each securitization.
Typically, the overcollateralization requirement is fully funded 8 to 12 months
from the date of securitization, although this period may be shorter or longer
subject to the structure and performance of the loans in the securitization.
Subsequent to funding the overcollateralization requirement, the Excess Spread
is received directly by the Company. Over time, the Company will also receive
the overcollateralization requirement depending upon the structure and
performance of the mortgage loans on each securitization. During the years
ended December 31, 1995 and 1996 and the six months ended June 30, 1997, the
Company securitized $164.9 million, $657.4 million and $755.0 million of
mortgage loans, respectively.
The Company obtains the servicing rights on all loans it originates or
purchases. The Company currently outsources substantially all its loan
servicing operations to the Servicer, which the Company believes is the largest
third-party servicer of non-conforming home equity loans. The Company believes
that by outsourcing substantially all of its loan servicing, it is able to
benefit from the Servicer's experience in servicing non-conforming mortgage
loans, its comprehensive reporting capabilities, and the cost efficiencies
related to having large amounts of loans serviced by the Servicer. Through its
relationship with the Servicer, the Company is able to reduce the overhead,
administrative and other fixed costs associated with servicing loans. As of
June 30, 1997,
33
<PAGE>
the Servicer serviced $1.6 billion principal amount of loans originated or
purchased by the Company (inclusive of securitized loans for which the Company
has ongoing risk of loss). The Company periodically examines other possible
servicing alternatives, including other third party servicers and the costs
associated with establishing its own servicing operations to service the loans
it originates and purchases.
BUSINESS STRATEGY
Emphasize Low Cost Originations. The Company's origination strategy is to
develop and maintain diversified production channels that enable the Company
to originate or purchase mortgage loans on a consistent, low cost basis. The
Company's total direct costs of production include premiums paid to originate
or purchase loans, net of origination fees collected. The Company believes by
focusing its loan origination growth through its Wholesale Division and its
Consumer Loan Division, it will be able to reduce its overall costs of loan
production. In addition, the Company emphasizes a disciplined overhead cost
control structure to benefit from economies of scale while supporting the
growth of the Company.
Emphasize Strong Underwriting Policies and Procedures. The Company's
underwriters use underwriting standards developed by the Company that
emphasize both credit quality of the borrower and the collateral value of real
estate. All loans originated or purchased by the Company are underwritten or
re-underwritten, undergo an appraisal review by the Company's underwriters and
are subject to further review from the Company's quality control personnel.
The Company monitors the performance of the loans it originates and purchases
with a view towards modifying underwriting procedures as appropriate.
Further Development and Expansion of Production Channels. The Company seeks
to increase loan originations and purchases through the development of
additional new branches for its Wholesale Division and its Consumer Loan
Division. This development will occur by opening new offices and the
acquisition of branch mortgage operations. The Company also seeks to expand
the Wholesale Division's loan originations by establishing new independent
mortgage broker relationships in both existing and new markets.
Maximize Liquidity and Diversify Funding Sources. The Company intends to
continue to expand and diversify its short-term funding sources in order to
improve cash flow by seeking higher advance rates for both its warehouse and
residual financing facilities. In addition, the Company intends to improve its
liquidity and financial condition through optimizing securitization structures
as well as through the monetization of certain assets. The Company's asset
monetization alternatives include whole loan sales, sales of interest-only
strips, and financing and securitization of interest-only and residual
certificates. The Company continues to seek improved cash flow received from
securitizations through new securitization structures, such as a Senior/Sub
Structure, that enables the Company to receive cash flow from a securitization
faster than traditional monoline-insured credit-enhanced structures.
Continue to Enhance Corporate and Operating Infrastructure. The Company
regularly invests in additional personnel, systems and infrastructure to
support its growth in originations and profitability. The Company has
fortified its senior management team with the hiring of Peter F. Makowiecki as
Chief Financial Officer, with over 14 years of financing experience in
mortgage lending, and John D. Horak as Chief Credit Officer, with over 20
years of experience in developing and enhancing credit management,
underwriting and quality control infrastructures for mortgage lending
institutions. The Company continues to invest in its information and operating
systems. The Company has modified its loan processing and underwriting
platform to support its geographic expansion and product diversification. The
Company has also upgraded its secondary marketing and financial accounting
systems to provide additional analytical and monitoring support as to the
profitability and performance of each branch, division and production channel.
34
<PAGE>
LOAN ORIGINATIONS AND PURCHASES
OVERVIEW
The Company primarily originates and purchases non-conforming home equity
loans which are typically secured by a first mortgage on the borrower's
residence. The majority of the Company's loans are made to borrowers who use
the loan proceeds for purposes such as mortgage refinancing, home purchase,
debt consolidation, home improvements and educational expenditures. The
Company focuses primarily on lending to individuals who have significant
equity in the value of their homes but have impaired or limited credit
histories. As a result, the Company's customers are less likely to qualify for
loans from conventional mortgage lenders and generally pay higher interest
rates than interest rates charged by conventional mortgage lenders. The
Company originates or purchases loans in all 50 states and the District of
Columbia through its Wholesale Division, Correspondent Program, Strategic
Alliance Program and Consumer Loan Division.
The Company offers a wide range of loan products to meet the needs of
borrowers with varying credit profiles and borrowing needs. The Company's loan
products include fixed rate first mortgage loans, variable rate first mortgage
loans, fixed rate second mortgage loans and variations thereof. Historically,
the majority of loans originated and purchased by the Company have been
variable rate first mortgage loans. The Company believes that its
concentration in variable rate loans reflects preferences of borrowers who
reside in the western United States, where the Company conducts a majority of
its operations.
Wholesale Division. The Wholesale Division originates a majority of the
Company's loans. The Wholesale Division consists of approximately 125 account
executives located in 23 regional branch centers. These account executives
have established relationships with, and market directly to, licensed
independent mortgage brokers. Independent mortgage brokers identify potential
borrowers, assist borrowers in completing loan applications and submit such
loan applications and other documents to the Company. All loans funded by the
Wholesale Division are underwritten to the Company's guidelines, which provide
the Company's underwriters with the flexibility to make exceptions to the
Company's underwriting criteria when an upgrade is warranted by a particular
loan applicant's situation, such as evidence of strong mortgage repayment
history relative to a weaker overall consumer credit repayment history. In
most cases, the Company conditionally approves loans submitted by an
independent mortgage broker within 24 hours from receipt of application and
funds loans within 21 days after approval. The Company believes its
competitive strength in maintaining and expanding independent mortgage broker
relationships is attributable to its ability to provide quality service,
including responsive execution and funding of loans, as well as offering a
broad range of loan products to applicants.
By concentrating on wholesale mortgage banking through its network of
independent mortgage brokers, the Company believes it is able to originate
loans cost-effectively. The Company's direct costs to originate loans through
its network of independent mortgage brokers for the year ended December 31,
1996 and six months ended June 30, 1997 was 0.5% and 0.8%, respectively, of
the principal balance of loans originated through the Wholesale Division.
These costs include points paid to brokers, net of miscellaneous fees
collected. The Company is actively seeking to geographically expand its
Wholesale Division by using selected demographic statistics and other criteria
developed by the Company which are intended to identify the most attractive
markets for the Company's products. The Company typically enters into a new
market using its national sales team, which initially penetrates a market, to
recruit brokers for the Company's wholesale network. Prior to purchasing loans
from a new broker, the Company conducts an investigation of the broker which
typically includes verification of current licenses and financial condition.
The Company actively monitors the independent mortgage brokers it uses to
determine productivity and quality of loans originated. The Company's sales
strategy is to limit the number of sales offices and personnel needed to
generate and effectively process and underwrite loans. As such, the Company
typically opens a sales office only after a minimum level of volume is
achieved in a new market. By utilizing this expansion strategy, the Company
can maintain lower overhead expenses than generally associated with competing
companies utilizing a more extensive retail branch office system. The
Wholesale Division originated $267.4 million, $529.0 million and $495.5
million of mortgage loans during the years ended December 31, 1995 and 1996
and the six months ended June 30, 1997, respectively, representing 92.7%,
67.0% and 64.1% of the Company's total loan originations and purchases during
the respective periods.
35
<PAGE>
The following table sets forth selected information relating to loan
originations by the Wholesale Division during the periods shown.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------- SIX MONTHS ENDED
1994 1995 1996 JUNE 30, 1997
-------- -------- -------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Principal balance of loans...... $183,010 $267,409 $529,026 $495,493
Average principal balance per
loan........................... $ 118 $ 89 $ 117 $ 91
Percent of first mortgage loans. 97.9% 83.2% 96.4% 99.3%
Weighted average interest rate.. 9.0% 10.4% 10.5% 10.8%
Weighted average initial LTV
ratio.......................... 69.4% 76.4% 72.3% 72.4%
</TABLE>
Correspondent Program. The Company purchases closed loans through its
Correspondent Program. Loans purchased through the Correspondent Program are
complete loan packages that have been underwritten and funded by approved
mortgage bankers or financial institutions. The Company reunderwrites each
loan submitted in the loan portfolio to ensure that all loans comply with the
Company's underwriting guidelines. As part of the reunderwriting process, the
Company's underwriters review the appraisal and the applicant's
creditworthiness and ensure that all necessary compliance and disclosure
documentation is included in the loan package. Loans that do not meet the
Company's underwriting guidelines are not purchased. Through the Correspondent
Program, the Company purchased $21.1 million, $204.8 million and $164.7
million of mortgage loans during the years ended December 31, 1995 and 1996
and the six months ended June 30, 1997, respectively, representing 7.3%, 25.9%
and 21.3% of the Company's total loan originations and purchases during the
respective periods.
The Company analyzes the expected profitability of each loan package it
considers and tenders a bid only for those packages that meet both certain
levels of predicted profitability and comply with the Company's underwriting
guidelines. The majority of loan packages purchased by the Correspondent
Program are less than $5 million. The Company believes that smaller loan
packages typically attract fewer competitive bids and therefore are available
for purchase at lower loan premiums than larger loans packages.
Prior to the purchase of loans from a mortgage banker or financial
institution the Company has not purchased loans from previously, the Company
analyzes the financial condition and ensures that a current license exists for
such banker or institution. Upon approval of the loan package, the Company
executes a purchase and sale agreement with customary representations and
warranties. For the year ended December 31, 1996 and the six months ended June
30, 1997 premiums paid by the Company for loans purchased through the
Correspondent Program were 4.5% and 5.1%, respectively. The Company generally
pays higher premiums for mortgages acquired through the Correspondent Program,
as such loans have been underwritten, appraised, funded and closed by the
mortgage banker or financial institution prior to the sale to the Company.
The following table sets forth selected information relating to the bulk
purchase of loans through the Correspondent Program during the periods shown.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------- SIX MONTHS ENDED
1994 1995 1996 JUNE 30, 1997
-------- -------- --------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Principal balance of loans...... $ 7,287 $ 21,073 $ 204,799 $164,714
Average principal balance per
loan........................... $ 101 $ 69 $ 101 $ 98
Percent of first mortgage loans. 99.9% 81.7% 99.2% 99.9%
Weighted average interest rate.. 8.7% 10.9% 10.6% 10.7%
Weighted average initial LTV
ratio.......................... 73.3% 72.9% 74.8% 74.0%
</TABLE>
Strategic Alliances. The Company also purchases loans through its Strategic
Alliance Program. Through the Strategic Alliance Program, the Company obtains
a committed source of loan production from select mortgage lenders who form
Strategic Alliances with the Company. To date, the Company has entered into
Strategic Alliances with four mortgage lenders. The Strategic Alliance Program
generally permits the Strategic
36
<PAGE>
Alliance to obtain financing support from the Company and to securitize its
qualifying loan production with the Company's loan production. In return, the
Company receives interest and fee income, warrants to acquire an equity
interest in the Strategic Alliance and the right to acquire all of the
Strategic Alliance's qualifying non-conforming loan production. In addition,
the Strategic Alliance Program provides the Company with access to a broader
network of independent mortgage broker relationships. The Company
reunderwrites all loans originated submitted by each Strategic Alliance for an
initial period, generally 60 to 90 days. After the initial period, the
Strategic Alliance's loans are monitored through the Company's quality control
process. Through the Strategic Alliance Program, the Company purchased
$51.5 million and $66.4 million of mortgage loans during the year ended
December 31, 1996 and the six months ended June 30, 1997, respectively,
representing 6.5% and 8.6% of the Company's total loan originations and
purchases during the respective periods.
The Company typically securitizes loans obtained from Strategic Alliances
and compensates the Strategic Alliances for such loans through the issuance of
a corporate note payable equal to the value of the interest-only and residual
certificates created by the Strategic Alliance loans, less a securitization
fee. If loans purchased experience unfavorable performance resulting from
prepayments, credit losses, or interest rates, and such experience results in
a write-down of the related residual asset, the Company has recourse back to
the Strategic Alliance for the life of the related loans. The Company will pay
off this note with the Excess Spread related to the specific Strategic
Alliance's loans. In a related transaction, the Company will typically provide
the Strategic Alliance with a working capital loan secured by the Company's
note payable. Currently, such loans can be in an amount up to 75% of the
outstanding note payable.
Due to this unique relationship, and the reduction of risk associated with
the related residual, the Company is willing to pay high premiums for the
Strategic Alliance volume. For the period ended June 30, 1997, the Company
paid 6.5% of loans purchased for this volume.
The following table sets forth selected information relating to loan
originations by Strategic Alliances during the periods shown:
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, 1996 JUNE 30, 1997
----------------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Principal balance of loans........... $51,536 $66,385
Average principal balance per loan... $ 87 $ 161
Percent of first mortgage loans...... 100.0% 100.0%
Weighted average interest rate....... 11.0% 10.1%
Weighted average initial LTV ratio... 80.5% 80.4%
</TABLE>
Consumer Loan Division. The Consumer Loan Division offers second mortgage
loans to credit-impaired borrowers and high LTV loans to borrowers with better
credit than the Company's average non-conforming borrower. The majority of the
loans originated by the Consumer Loan Division are fixed-rate, fully
amortizing loans secured by owner-occupied one-to-four family residences. A
high LTV loan, together with other loans secured by the same property,
typically exceeds the value of such property by as much as 25%. The Consumer
Loan Division originates loans by marketing directly to potential borrowers
using direct mail advertising, telemarketing and radio advertising. The
Consumer Loan Division also originates loans through independent mortgage
brokers. The Consumer Loan Division currently has retail offices in Ontario
and Newport Beach, California, and is scheduled to open three additional
offices by the end of 1997. The Company believes that by offering second lien
mortgages it is able to diversify its loan production and provide means for
the Company's existing borrowers to utilize equity in their homes for
additional borrowings. The Consumer Loan Division generates loans directly
from consumers, it is able to recognize loan origination fees from such
production. The Company generated fees of 3.0% of loans produced for the six
months ended June 30, 1997.
Loan processing, including underwriting, funding and closing, for all
Consumer Loan Division loans is performed by the Consumer Loan Division's
dedicated, centralized underwriting and credit assessment staff. Applicants
for high LTV loans are evaluated primarily through a default and loss
predictive scoring system developed by Fair, Issacs & Co., a consulting firm
which specializes in consumer credit assessment. Based on
37
<PAGE>
the FICO scoring system, scores can range from 400 to 800 points. The average
FICO score for the Company's high LTV loans for the six months ended June 30,
1997 was 669. Underwriting guidelines for the Company's more traditional non-
conforming second mortgage loans are not based on the FICO scoring system, but
focus on the borrower's credit profile and the value of the collateral
property. Such underwriting guidelines are substantially similar to the
underwriting guidelines used by the Company's other divisions. The Consumer
Loan Division performs or reviews appraisals for all loans.
The Company has in the past sold the majority of second lien mortgage loans
originated by the Consumer Loan Division on a whole loan basis. After an
assessment of the underlying risks and economics of high LTV loans, the
Company plans to examine the possibility of securitizing loans originated by
the Consumer Loan Division. The Consumer Loan Division originated $4.5 million
and $30.1 million of loans during the year ended December 31, 1996 and the six
months ended June 30, 1997, respectively, representing 0.6% and 3.9% of the
Company's total loan originations and purchases during the respective periods.
The following table sets forth selected information relating to loan
originations by the Consumer Loan Division during the six months ended June
30, 1997.
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE
30, 1997
----------------------
(DOLLARS IN THOUSANDS)
<S> <C>
Principal balance of loans............................... $30,082
Average principal balance per loan....................... $ 39.3
Percent of first mortgage loans.......................... 41.6%
Weighted average interest rate........................... 11.1%
Weighted average initial LTV ratio....................... 84.7%
</TABLE>
Geographic Distribution. The following table sets forth origination by
location during the periods shown:
GEOGRAPHIC DISTRIBUTION OF LOAN ORIGINATIONS AND PURCHASES
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, SIX MONTHS
------------------- ENDED
LOCATION 1994 1995 1996 JUNE 30, 1997
-------- ----- ----- ----- -------------
<S> <C> <C> <C> <C>
California.............................. 39.5% 29.8% 25.0% 18.6%
Washington.............................. 10.9 8.8 6.6 8.1
Florida................................. 0.3 1.0 5.5 7.2
Oregon.................................. 15.5 13.6 9.1 5.8
Colorado................................ 6.6 5.9 7.9 4.8
Georgia................................. 0.3 1.7 3.2 4.7
Texas................................... 0.4 0.3 1.4 4.7
All other............................... 26.5 38.9 41.3 46.1*
----- ----- ----- -----
Total................................. 100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
</TABLE>
- ---------------------
* Includes $27.9 million of United Kingdom loans.
38
<PAGE>
LOAN PRODUCTION BY BORROWER RISK CLASSIFICATION
The following tables set forth information concerning the Company's non-
conforming first mortgage loan production by borrower risk classification for
loans secured by mortgages for the periods shown.
<TABLE>
<CAPTION>
PERCENT
PERIOD CREDIT TOTAL OF TOTAL WAC(1) WLTV(2)
------ ------ ----- -------- ------ -------
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
1995.................................... A $ 98,455 34.1% 11.4% 80.6%
A- 135,001 46.8 9.7 76.8
B 34,906 12.1 10.5 68.2
C 17,716 6.1 11.0 64.1
D 2,404 0.9 12.1 58.6
-------- -----
$288,482 100.0% 10.4% 76.1%
======== =====
1996.................................... A $127,325 16.1% 10.6% 81.7%
A- 414,544 52.5 10.1 73.4
B 154,601 19.6 10.9 71.8
C 59,214 7.5 11.6 67.8
D 34,230 4.3 12.5 60.6
-------- -----
$789,914 100.0% 10.6% 73.5%
======== =====
Six months ended
June 30, 1997.......................... A $137,496 19.3% 10.1% 82.7%
A- 295,436 41.5 10.1 74.4
B 155,431 21.8 10.9 72.9
C 50,472 7.1 11.6 68.2
D 73,026 10.3 13.1 61.0
-------- -----
Totals(3)............................. $711,861 100.0% 10.8% 73.9%
======== =====
</TABLE>
- ---------------------
(1) Weighted average coupon ("WAC").
(2) Weighted average initial LTV ratio ("WLTV").
(3) Does not include second mortgage loan originations from the Consumer Loan
Division, loans originated by the Company's United Kingdom subsidiary or
conforming loans.
UNDERWRITING
The Company has established classifications with respect to the credit
profiles of loans based on certain of the borrower's characteristics. Each
loan applicant is placed into one of four letter ratings ("A" through "D,"
with subratings within those categories), depending upon a number of factors
including the applicant's credit history and employment status. Terms of loans
made by the Company, as well as the maximum LTV ratio and debt service-to-
income coverage (calculated by dividing fixed monthly debt payments by gross
monthly income), vary depending upon the classification of the borrower. Loan
applicants with less favorable credit ratings generally are offered loans with
higher interest rates and lower LTV ratios than applicants with more favorable
credit ratings. The criteria currently used by the Company in classifying loan
applicants can be generalized as follows:
39
<PAGE>
NON-CONFORMING UNDERWRITING CRITERIA
<TABLE>
<CAPTION>
"A" RISK "A-" RISK "B" RISK "C" RISK "D" RISK
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Existing mortgage
history................ Maximum of one Maximum of two Maximum of Maximum of six Existing
30-day late 30-day late four 30-day 30-day late mortgage may
payment and no payment and no late payments payments or be materially
60-day late 60-day late or three 30- three 30-day past due.
payments in payments in day late late payments
the last 12 the last 12 payments and and two 60-day
months or a months. one 60-day late payments
maximum of two late payment or two 30-day
30-day late in the last 12 late payments
payments and months. and one 90-day
no 60-day late late payment
payments within the
within the last 12
last 24 months.
months.
Existing consumer credit
history................ Maximum of Maximum of Maximum of Maximum of 12 General
three 30-day five 30-day eight 30-day 30-day late disregard for
late payments late payments late payments payments, six credit.
in the last 12 or two 60-day or four 60-day 60-day late
months, two late payments late payments payments or
60-day late in the last 12 or two 90-day four 90-day
payments in months. late payments late payments
the last 24 in the last 12 in the last 12
months, or months. months.
five 30-day or
two 60-day
late payments
in the last 24
months.
Other credit............ Minor 30-day Minor items Small isolated Slow pays, Not a factor.
late items allowed as to charge-offs, some open Derogatory
allowed with a non-mortgage collections, delinquencies credit must be
letter of credit. or judgments up to $4,000 paid with
explanation. allowed case- allowed. proceeds. Must
by-case. demonstrate
ability to
pay.
Bankruptcy filings...... None in None during None in None in May be open at
preceding preceding two preceding 18 preceding one closing, but
three years. years. months. year. must be paid
off with
proceeds.
Debt service to income
ratio.................. Generally 45% Generally 45% Generally 50% Generally 55% Generally 60%
or less. or less. or less. or less. or less.
Maximum loan-to-value
ratio:
Owner-occupied......... Generally 90% Generally 85% Generally 80% Generally 70% Generally 65%
Non-owner occupied..... Generally 80% Generally 75% Generally 70% Generally 55% N/A
Maximum loan amount:
Owner- occupied........ $400,000 $500,000 $600,000 $500,000 $350,000
Non-owner occupied..... $350,000 $400,000 $350,000 $300,000 N/A
</TABLE>
The Company's underwriting guidelines are provided to all mortgage loan
brokers and mortgage bankers prior to accepting any loan application or bulk
purchase package. Upon receipt of a loan application from a mortgage loan
broker, the Company's underwriting staff determines if the loan meets the
Company's underwriting guidelines. To assess the credit quality of the loan,
the underwriter considers various factors, including the appraisal of the
collateral property and its value, the applicant's debt payment history,
credit profile and employment status, and the debt ratio and LTV ratio upon
completion of the loan.
Prior to funding a loan, the Company's underwriting staff determines the
applicant's creditworthiness and ability to service the loan. In addition, the
underwriting staff reviews the value of the underlying collateral based on an
original appraisal and also a review appraisal completed by a pre-approved
licensed independent appraiser. For properties valued over $500,000, the
review appraisal must be a full re-appraisal of the subject property;
otherwise the Company requires either a desk review or a drive-by appraisal.
Beginning in the second quarter of 1997, the Company amended its process to
require the underwriter to order the second appraisal for all loans from a
pre-approved licensed independent appraiser. The Company selects its review
appraisers based on professional experience, education, membership in related
professional organizations
40
<PAGE>
and by reviewing the review appraiser's experience with the type of property
being used as collateral. For loans purchased through its Correspondent
Program, the Company will typically request a second review appraisal if the
original review appraisal was completed by a review appraiser not approved by
the Company. All loans submitted for inclusion in a securitization by
Strategic Alliances are reunderwritten and re-appraised by the Company's
underwriters for an initial period. After that initial period, loans submitted
for inclusion in a securitization by Strategic Alliances are checked on an
ongoing basis by the Company's quality control personnel.
Verification of income and credit history is also required prior to closing
the loan. Generally, loan applicants are required to have two years of
employment with their current employer or two years of similar business
experience. Applicants who are salaried must provide current employment
information as well as recent employment history. The Company verifies this
information for salaried borrowers based on written confirmation from
employers, or a combination of a telephone confirmation from the employer and
the most recent pay stub or W-2 tax form. Self-employed applicants are
generally required to provide copies of complete federal income tax returns
filed for the most recent one to two years, depending on credit grade. A
merged credit report combining information gathered from two independent,
nationally recognized credit reporting agencies reflecting the applicant's
credit history is also used. Verification of information regarding the first
mortgage, if any, is also required, including balance, status and whether
local taxes, interest, insurance and assessments are included in the
applicant's monthly payment. All taxes and assessments not included in the
payment are required to be verified as current. Upon completion of the
underwriting process, the closing of the loan is scheduled with an independent
closing attorney who is responsible for closing the loan in accordance with
the Company's closing procedures.
Quality Control. The Company's quality control program is intended to (i)
monitor and improve the overall quality of loan production generated by the
Company's Wholesale Division, Consumer Loan Division or loans presented or
purchased from Strategic Alliances or Correspondent Program and (ii) identify
and communicate to management existing or potential underwriting and loan
packaging problems or areas of concern. The quality control review examines
compliance with the Company's underwriting guidelines and federal and state
regulations. This is accomplished by focusing on the accuracy of all credit
and legal information, a collateral analysis (which may include a review of
the appraisal), employment or income verification, and legal document review
to ensure the necessary documents are in place.
The Company reviews each loan submitted for inclusion in a securitization
from Strategic Alliances for an initial period, generally 60 to 90 days. The
Company also reviews each loan submitted for purchase from new retail
branches, mortgage brokers or financial institutions the Company does not have
an existing business relationship with, as well as loans with appraisals done
by appraisers who are not on the Company's approved appraiser list. The
underwriting staff reunderwrites a sample of the Company's originated and
purchased loans chosen at random. The Company uses this ongoing underwriting
process to gauge the effectiveness of its underwriting guidelines and to
determine whether amendments to such guidelines are advisable.
Credit Management Review. The Company employs a credit management system and
procedures to amend and upgrade its credit management practices. The Company
continually monitors the performance of its loans, and tracks loans by
borrower category, loan originator (whether inside or outside the Company),
type of loan product, prepayments and effectiveness of servicing. The Company
uses the results of this monitoring to determine revisions to product
definitions, product mix, and underwriting guidelines and authorities, as may
be deemed necessary to reduce delinquencies, loan losses and prepayments.
The Company uses the foregoing categories and characteristics as
underwriting criteria only. The Company's underwriting guidelines provide the
flexibility to vary from these criteria. On a case-by-case basis, the
Company's underwriters may determine that the prospective mortgagor warrants a
debt service-to-income ratio, a pricing, an LTV variance or a waiver from
certain requirements of a particular risk category (collectively called
an "upgrade" or a "variance"). An upgrade or variance may generally be allowed
if the application reflects certain compensating factors, including, but not
limited to: low LTV ratio; a superior FICO score; a maximum of one 30-day late
payment on the mortgage loan during the last 12 months; stable income; and an
increased capacity
41
<PAGE>
to repay debt. Accordingly, the Company may classify certain mortgage loan
applications in a more favorable credit grade when an upgrade is granted than
other mortgage loan applications that, in the absence of such compensating
factors, would only satisfy the criteria of a less favorable risk category.
Consumer Loan Division Underwriting Guidelines. All underwriting for all
Consumer Loan Division loans is performed by the Division's dedicated,
centralized underwriting and credit assessment staff. The Consumer Loan
Division has its own California-licensed appraiser who reviews appraisals for
California loans, and independent third-party appraisers are employed for
properties outside of California. The Consumer Loan Division's underwriters
use different underwriting guidelines for the Division's two different loan
products: high LTV loans and non-conforming loans.
Applicants for high LTV loans are evaluated primarily through a default and
loss predictive scoring system developed by FICO, a consulting firm which
specializes in consumer credit assessment. In the FICO scoring system, scores
can range from 400 to 800 points. Based on the applicant's FICO score, the
borrower is placed in a category of "A" to "D," different from the Company's
other A to D categories. "A+" category borrowers are borrowers with FICO
scores above 700, who may borrow up to $100,000 for a 300 month term. "A"
category borrowers are borrowers with FICO scores of 680 to 699, who may
borrow up to $75,000 for a 300 month term. "B+" category borrowers are
borrowers with FICO scores of 660 to 679, who may borrow up to $65,000 for a
300 month term. "B" category borrowers are borrowers with FICO scores of 640
to 659, who may borrow up to $45,000 for 300 month term. "C+" category
borrowers are borrowers with FICO scores of 620 to 639, who may borrow up to
$30,000 for a 180 month term. The average FICO score for the Company's high
LTV loans for the six months ended June 30, 1997 was 669.
Underwriting guidelines for non-conforming second mortgage loans are not
based on the FICO scoring system, but focus on the borrower's credit profile
and the value of the collateral property. Such underwriting guidelines are
substantially similar to the underwriting guidelines used by the Company's
other divisions and use the same A to D categories used by the other
divisions. Due to the limited size of second mortgage loans, underwriters
generally have more flexibility to grant upgrades or exceptions for second
mortgage loans based upon a borrower's length of ownership, length of
employment in the same job and general net worth.
LOAN SALES AND SECURITIZATIONS
The Company sells substantially all loans originated and purchased through
either securitizations or whole loan sales. The means by which the loans are
sold is determined by comparing the market conditions for securitizations
versus whole loan sales and evaluating the risk characteristics of the loans.
Since the latter half of 1995, the Company has sold the vast majority of its
loans through securitizations. Recently, the Company began selling through
whole loan sales certain loans that do not meet the Company's risk objectives,
such as those with higher LTVs relative to the weighted average coupon and new
loan products for which the Company has limited loan performance history.
Whole loan sales generally permit the Company to sell its loans without future
recourse to the Company from the future performance of such loans.
The securitization process involves the pooling of mortgage loans and the
sale of such loans to a securitization trust which simultaneously sells the
senior interest in the form of asset-backed bonds to investors. The remaining
interest is issued to the Company in the form of interest-only and residual
certificates, which entitle the Company to receive Excess Spread over the life
of the loans in the securitization trust. For securitizations completed in the
first two quarters of 1997, the Company elected to sell a portion of its
interest-only certificates and retain the remaining certificates. The sale of
interest-only certificates permits the Company to partially offset negative
cash flow associated with selling loans through securitizations. The Company
intends to consider the sale of interest-only and residual certificates from
future securitizations on a case by case basis.
Each securitization, with the exception of the securitizations completed in
the second quarter of 1997, was insured by monoline insurance companies which
guarantee the timely interest payment and ultimate principal payment of the
asset-backed bonds. The securitizations completed in the second quarter of
1997 were structured
42
<PAGE>
as Senior/Sub Structures. In such structures, several classes of asset-backed
bonds with a combined principal balance approximately equal to the mortgage
loans securitized are issued, each with a different seniority interest in
monthly payments collected from the mortgage loans or expected maturity. Under
the Senior/Sub Structure, the risk for nonpayment of interest and principal
payments for asset-backed bonds is assumed by the asset-backed investors.
The pooling and servicing agreements that govern the distribution of cash
flows from the loans included in the trusts require the overcollateralization
of the senior interests by using cash flows from interest-only and residual
certificates to reduce the outstanding principal balance of the senior
interests to a pre-set percentage of the mortgage loans. The
overcollateralization percentage may be adjusted over time according to the
delinquency and loss experience of the loans. The Company's delinquency and
loan loss experience is affected primarily by the following factors: (i) the
credit grade distribution of originated loan production; (ii) underwriting
guidelines; (iii) servicing; (iv) loss mitigation strategies; and (v) general
economic conditions. Where losses and delinquencies exceed predicted levels,
the cash flow from Excess Spread is used to increase or replenish the
overcollateralization account until such increased losses or delinquencies
have been reserved against. To the extent that a loss is realized on the
loans, losses will be paid first out of interest available to the interest-
only and residual certificates and ultimately out of the overcollateralization
amount available to the interest-only and residual certificates. If losses
exceed the amounts available to the interest-only and residual certificates,
the monoline insurance company policy will pay any further losses experienced
by holders of the senior interests in the related trust. Interest available to
the interest-only and residual certificates, when available, and distributions
from the overcollateralization amount will be used to reimburse the monoline
insurance company for any such payments.
The Company may be required either to repurchase or to substitute for loans
which do not conform to the representations and warranties made by the Company
in the pooling and servicing agreements entered into when the loans are pooled
and sold through securitizations.
HEDGING
The market value of fixed-rate mortgage loans has a greater sensitivity to
changes in market interest rates than adjustable-rate mortgage loans. As the
Company's production of fixed-rate mortgage loans has increased, the Company
has begun to implement various hedging strategies to mitigate the change in
market value of fixed-rate mortgage loans held for sale between the date of
origination and sale. Commencing in August 1995, these strategies have
included selling short and selling forward United States Treasury securities
and pre-funding loan originations in its securitizations. The Company
currently hedges its fixed-rate mortgage loans held for sale by selling
forward a combination of United States Treasury securities of various
maturities whose combined change in value due to a change in interest rates
closely approximates the change in value of the mortgage loans hedged. In the
future the Company may hedge its variable-rate mortgage loans and its
interest-only and residual certificates 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 are determined by the
Company's management based on various factors, including market conditions and
the expected volume of mortgage loan originations and purchases.
The Company believes that it has implemented a cost-effective hedging
program to provide a level of protection against changes in market value of
its fixed-rate mortgage loans held for sale. However, an effective hedging
strategy is complex and no hedging strategy can completely insulate the
Company from such changes. In addition, hedging involves transaction and other
costs, and such costs could increase as the period covered by the hedging
protection increases or in periods of rising and fluctuating interest rates.
In addition, in connection with its securitizations in the future the
Company may use a pre-funding mechanism to hedge future production of mortgage
loans. In any such securitization transactions, investors would deposit cash
in a pre-funded amount into the related trust to purchase the loans the
Company would commit to
43
<PAGE>
sell on a forward basis. This pre-funded amount is invested pending use in
short term obligations which pay a lower interest rate than the interest rate
the trust is obligated to pay certificate investors on the outstanding balance
of the pre-funded amount. The Company is required to deposit at the closing of
the related transaction an amount sufficient to make up the difference between
these rates.
As of December 31, 1996 and June 30, 1997, the Company had open hedge
positions of $32.6 million and $86.4 million, respectively, related to the
sales of United States Treasury securities in the forward market. The proceeds
from the short sale are shown net of the related liability in the accompanying
balance sheet at December 31, 1996 and June 30, 1997.
LOAN SERVICING AND DELINQUENCIES
Servicing. The Company currently originates or purchases all mortgage loans
on a servicing released basis, thereby acquiring the servicing rights. In
September 1995, the Company entered into a servicing agreement with the
Servicer, as amended (the "Servicing Agreement"), pursuant to which the
Servicer services substantially all of the Company's current and ongoing
production. In addition, the Servicer services or subservices each public
securitization of the Company's loans pursuant to the related pooling and
servicing agreement. Servicing includes collecting and remitting loan
payments, making required advances, accounting for principal and interest,
holding escrow or impound funds for payment of taxes and insurance, if
applicable, making required inspections of the mortgaged property, contacting
delinquent borrowers and supervising foreclosures and property dispositions in
the event of unremedied defaults in accordance with the Company's guidelines.
Under the Servicing Agreement, the Company is obligated to pay the Servicer a
monthly servicing fee on the declining principal balance of each loan serviced
and a set-up fee for each loan delivered to the Servicer for servicing.
The Servicer is required to pay all expenses related to the performance of
its duties under the Servicing Agreement. However, the Servicer is required to
make advances of taxes and required insurance premiums that are not collected
from borrowers with respect to any mortgage loan, only if it determines that
such advances are recoverable from the mortgagor, insurance proceeds or other
sources with respect to such mortgage loan. If such advances are made, the
Servicer generally will be reimbursed prior to the Company receiving the
remaining proceeds. The Servicer also will be entitled to reimbursement by the
Company for expenses incurred by it in connection with the liquidation of
defaulted mortgage loans and in connection with the restoration of mortgaged
property. If claims are not made or paid under applicable insurance policies
or if coverage thereunder has ceased, the Company will suffer a loss to the
extent that the proceeds from liquidation of the mortgaged property, after
reimbursement of the Servicer's expenses in the sale, are less than the
principal balance of the related mortgage loan.
The Company may terminate the Servicing Agreement upon the occurrence of one
or more of the events specified in the Servicing Agreement generally relating
to the Servicer's proper and timely performance of its duties and obligations
under the Servicing Agreement. Either the Company or the Servicer may
terminate the Servicing Agreement without cause upon 90 days' prior written
notice to the other party; provided, that if the Company terminates the
Servicing Agreement without cause, the Company shall pay to the Servicer a
termination fee of 1% of the aggregate principal balance of the mortgage loans
being serviced by the Servicer at such time; provided, further, that if the
Company transfers servicing of any amount of mortgage loans being serviced by
the Servicer to another servicer without terminating the Servicing Agreement,
the Company shall pay to the Servicer $100 per mortgage loan transferred.
The pooling and servicing agreements governing the securitization process
generally provide that the Trustee may terminate all rights and obligations of
the Servicer as servicer of the securitized loans upon written notice,
provided that such termination is at the direction of the monoline insurer for
such securitization or of the majority of holders of certificates thereof,
with the prior written consent of the monoline insurer, but not at the option
of the Company. The ability to effect such termination is restricted to
specific conditions described in the pooling and servicing agreements, which
generally include various loss and delinquency tests and failure to make
payments, including advances, within specific time periods.
44
<PAGE>
As is customary in the mortgage loan servicing industry, the Servicer is
entitled to retain any late payment charges, penalties and assumption fees
collected in connection with the mortgage loans, net of pre-payment penalties,
which accrue to the Company. The Servicer receives any benefit derived from
interest earned on collected principal and interest payments between the date
of collection and the date of remittance to the Company and from interest
earned on tax and insurance escrow funds. The Servicer is required to remit to
the Company no later than the 18th day of each month all principal and
interest collected from borrowers during the monthly reporting period.
The Company periodically reviews its servicing operations, the Servicer's
performance and its current costs of servicing on an ongoing basis. The
Company periodically examines other possible servicing alternatives, including
other third party servicers and the costs associated with establishing its own
servicing operations to service the loans it originates and purchases.
The following table sets forth certain information regarding the servicing
portfolio of loans originated or purchased by the Company (inclusive of
securitized loans for which the Company has ongoing risk of loss), for the
periods shown.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS
------------------------------ ENDED
1994 1995 1996 JUNE 30, 1997
--------- -------- --------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Beginning servicing portfolio.... $ 18,074 $ 68,721 $ 270,193 $ 908,220
Loans added to the servicing
portfolio....................... 190,297 288,482 789,914 756,674
Loans sold servicing released and
principal paydowns.............. (139,650) (87,010) (151,887) (64,248)
--------- -------- --------- ----------
Ending servicing portfolio..... $ 68,721 $270,193 $ 908,220 $1,600,646
========= ======== ========= ==========
</TABLE>
Delinquencies and Foreclosures. Commencing after the fifth day a loan
becomes late, information with regard to the loan is transferred from the
Servicer's servicing department to a dedicated collection department which is
responsible for contacting the borrower and bringing the loan to current
status. To increase effectiveness and efficiency in collections, the means and
timing of collection procedures vary in accordance with a behavioral model
based on the borrower's credit statistics, the size and type of loan and
responses to prior collection efforts undertaken. Generally, after the fifth
day a loan becomes late, a letter informing the borrower of the tardiness is
mailed and a telephone call is made to the borrower shortly thereafter. If the
borrower is not contacted or a voice message is left, a followup call or calls
are typically made until the reason for tardiness is ascertained and actions
required to bring the loan to current status are determined.
Efforts to maintain verbal and written contact with the borrower continues
as long as the borrower remains contractually delinquent. After 62 days, a
notice to foreclose is mailed to borrowers who are generally considered to
have credit "A" to "B" profiles. A notice to foreclose to borrowers who have
"C" to "D" credit profiles is mailed in 32 days. If these collection measures
do not succeed, the loan is referred to the loss mitigation and foreclosure
department.
The loss mitigation department assesses the procedure to best minimize any
potential loss on the delinquent loan, including the possibility of a short
sale. If payment is not made by the 75th day after it was due, an appraisal of
the property is ordered. The cost of such appraisal is added to the Company's
basis in the loan. The foreclosure department then analyzes the Company's
basis in the loan, the value of the collateral property, the accrued interest,
the carrying costs of the property, and repairs required on the property
before foreclosure sale. After the reinstatement period has expired without
the default having been cured, the borrower or junior lienholder no longer has
the right to reinstate the loan and may be required to pay the loan in full to
prevent the scheduled foreclosure sale.
45
<PAGE>
As a foreclosure sale becomes imminent, the Servicer reviews the local
jurisdiction's foreclosure laws and the borrower's statutory rights. Local
counsel may be retained to represent the Company's interests. Depending on
local law, foreclosure is effected by judicial action or nonjudicial sale, and
is subject to various notice and filing requirements. In general, the
borrower, or any person having a junior encumbrance on the real estate, may
cure a monetary default by paying the entire amount in arrears plus other
designated costs and expenses incurred in enforcing the obligation during a
statutorily prescribed reinstatement period. Generally, state law controls the
amount of foreclosure expenses and costs, including attorneys fees, which may
be recovered by a lender. If the Company obtains the property in a
foreclosure, an expedited process begins to sell the property as rapidly as
possible.
Although foreclosure sales are typically public sales, third-party
purchasers rarely bid in excess of the lender's lien because of the difficulty
of determining the exact status of title to the property, the possible
deterioration of the property during the foreclosure proceedings and a
requirement that the purchaser pay for the property in cash or by cashier's
check. Thus, the foreclosing lender often purchases the property from the
trustee or referee for an amount equal to the sum of the principal amount
outstanding under the loan, accrued and unpaid interest and the expenses of
foreclosure. Depending on market conditions, the ultimate proceeds of the sale
may not equal the lender's investment in the property.
As of June 30, 1997, the Company has realized life-to-date losses of
$983,000 on its loan portfolio of $1.6 billion. In valuing the Company's
interest-only and residual certificates, expectations with respect to
anticipated losses are considered. The present value of these loss
expectations at June 30, 1997 was approximately $20.7 million. The Company
continually monitors its credit loss data and will adjust its credit loss
assumptions as appropriate as its portfolio and loss experience increases, and
as the Company's loan portfolio ages.
The following tables set forth the combined delinquency and foreclosure
experience of: (1) loans held for sale or securitization included in the
Company's servicing portfolio; and (2) securitized loans originated by the
Company but serviced by an affiliate of the Company or by Advanta for the
periods indicated.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------------------------------------------------
1994 1995 1996 AS OF JUNE 30, 1997
-------------------- --------------------- --------------------- -----------------------
% OF LOANS % OF LOANS % OF LOANS % OF LOANS
IN SERVICING IN SERVICING IN SERVICING IN SERVICING
AMOUNT PORTFOLIO AMOUNT PORTFOLIO AMOUNT PORTFOLIO AMOUNT PORTFOLIO
------- ------------ -------- ------------ -------- ------------ ---------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans serviced.......... $68,721 100.0% $270,193 100.0% $908,220 100.0% $1,600,646 100.0%
30-59 days delinquent... 321 0.5 3,072 1.2 23,062 2.5 46,465 2.9
60-89 days delinquent... 199 0.3 1,409 0.5 15,883 1.7 19.442 1.2
90 days or more
delinquent............. 0 0.0 0 0.0 1,123 0.1 11,800 0.8
------- ----- -------- ----- -------- ----- ---------- -----
Total delinquencies... $ 520 0.8% $ 4,481 1.7% $ 40,018 4.4% $ 77,707 4.9%
======= ===== ======== ===== ======== ===== ========== =====
Delinquent loans in
foreclosure and
bankruptcy(1).......... $ 383 0.5% $ 4,883 1.8% $ 22,402 2.5% $ 61,902 3.9%
Total real estate
owned................ -- -- 141 -- 1,227 0.1% 8,092 0.5%
</TABLE>
- ---------------------
(1) For the year ended December 31, 1996 and the six months ended June 30,
1997, excludes loans in bankruptcy.
46
<PAGE>
COMPETITION
The Company is a relatively new entrant in the industry, is relatively small
compared to many of its competitors and faces intense competition in the
business of originating, purchasing and selling mortgage loans. Competition in
the industry takes many forms including convenience in obtaining a loan,
customer service, marketing and distribution channels, amount and term of the
loan. Traditional competitors in the financial services business include other
mortgage banking companies, commercial banks, credit unions, thrift
institutions, credit card issuers and finance companies. Most of these
competitors in the consumer finance business 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 that
are substantially similar to the Company's loan origination programs. In
addition, the current level of gains realized by the Company and its
competitors on the sale of non-conforming loans could attract additional
competitors into this market with the possible effect of lowering gains on
future loan sales. The Company believes that its competitive strengths include
providing prompt, responsive service and flexible underwriting to independent
mortgage brokers.
REGULATION
The Company's operations are subject to extensive regulation, supervision
and licensing by federal, state and local government authorities. Regulated
matters include, without limitation, loan origination, credit activities,
maximum interest rates and finance and other charges, disclosure to customers,
the terms of secured transactions, the collection, repossession and claims
handling procedures utilized by the Company, multiple qualification and
licensing requirements for doing business in various jurisdictions and other
trade practices.
The Company's loan origination activities are subject to the laws and
regulations in each of the states in which those activities are conducted. The
Company's activities as a lender are also subject to various federal laws
including the Truth in Lending Act, the Real Estate Settlement Procedures Act,
the Equal Credit Opportunity Act, the Home Mortgage Disclosure Act, the Fair
Credit Reporting Act and the Fair Housing Act.
The Truth in Lending Act ("TILA") and Regulation Z promulgated thereunder
contain disclosure requirements designed to provide consumers with uniform,
understandable information with respect to the terms and conditions of loans
and credit transactions in order to give consumers the ability to compare
credit terms. TILA also guarantees consumers a three day right to cancel
certain credit transactions including loans of the type originated by the
Company. A lender's failure to provide the requisite material disclosures may,
among other things, give rise to a borrower's right of rescission, if
applicable to the transaction and validly invoked. Management of the Company
believes that it is in compliance with TILA in all material respects.
In September 1994, the Riegle Community Development and Regulatory
Improvement Act of 1994 (the "Riegle Act") was enacted. The Riegle Act
contains, among other things, the Homeownership and Equity Protection Act of
1994 (the "High Cost Mortgage Act"), which makes certain amendments to TILA.
The High Cost Mortgage Act, which became effective with respect to loans
consummated after October 1, 1995, generally applies to closed-end loans
secured by a consumer's principal dwelling but not obtained for the purchase
or construction of the dwelling in which the loan has either (i) total points
and fees upon origination in excess of eight percent of the loan amount or
(ii) an annual percentage rate of more than ten percentage points higher than
United States Treasury securities of comparable maturity ("Covered Loans"). A
substantial majority of the loans originated or purchased by the Company are
not Covered Loans.
The High Cost Mortgage Act imposes additional disclosure requirements on
lenders originating Covered Loans and 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. The Company believes that only a small portion of loans it
originated are of the type that, unless modified, would be prohibited by the
High Cost Mortgage Act. The Company's underwriting criteria have always taken
into consideration the borrower's ability to repay.
47
<PAGE>
The High Cost Mortgage Act also prohibits lenders from including prepayment
fee clauses in Covered Loans to borrowers with a debt-to-income ratio in
excess of 50% or Covered Loans used to refinance existing loans originated by
the same lender. The Company will continue to collect prepayment fees on loans
originated prior to the effectiveness of the High Cost Mortgage Act and on
non-Covered Loans as well as on Covered Loans in permitted circumstances.
Because the High Cost Mortgage Act does not apply to loans consummated before
October 1, 1995, the level of prepayment fee revenue was not affected in 1995,
but the level of prepayment fee revenue may decline in future years. The High
Cost Mortgage Act imposes other restrictions on Covered Loans, including
restrictions on balloon payments and negative amortization features, which the
Company does not believe will have a material impact on its operations.
The Company is also required to comply with the Equal Credit Opportunity Act
of 1974, as amended ("ECOA"), which prohibits creditors from discriminating
against applicants on the basis of race, color, sex, age or marital status.
These bases are referred to as "prohibited bases." ECOA, as implemented by
Regulation B, prohibits creditors from discriminating on prohibited bases or
from considering certain types of information in rendering a credit decision.
It also requires certain disclosures by the lender regarding consumer rights
and requires lenders to advise applicants of the reasons for credit denial. In
instances where the applicant is denied credit or the rate or charge for loans
increases as a result of information obtained from consumer reports prepared
by a consumer reporting agency, another statute, the Fair Credit Reporting Act
of 1970, as amended, requires lenders to supply the applicant with the name
and address of the consumer reporting agency and the consumer has a right to
obtain the information contained in the consumer report. The Company is also
subject to the Real Estate Settlement Procedures Act and is required to file
an annual report with the Department of Housing and Urban Development pursuant
to the Home Mortgage Disclosure Act.
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.
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 June 30, 1997, the Company employed 927 full-time employees. 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
Lake Oswego, Oregon. The leases on the premises expire between 1999 and 2000,
and the current annual rent is approximately $699,373. The Company has also
entered into a lease for approximately 44,000 square feet of new headquarters
office space, with an annual aggregate base rental of approximately $1.0
million. The term of this lease is expected to commence in November 1997 and
run for five years. The Company has an option to renew the term for an
additional five years.
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The Company also leases space for its branch offices. The aggregate base
rental for these facilities is approximately $907,757. The terms of these
leases vary as to duration and rent escalation provisions. In general, the
leases expire between 1997 and 2000 and provide for rent escalations dependent
upon either increases in the lessors' operating expenses or fluctuations in
the consumer price index in the relevant geographical area.
In the design of its branch operations, the Company has been able to
maintain low overhead expenses by leasing space in office complexes located in
accessible but non-prime locations. Annual base rents for the branch offices
range from $2,400 to $96,667.
LEGAL PROCEEDINGS
SPFC occasionally becomes involved in litigation arising in the normal
course of business. Management believes that any liability with respect to
such legal actions, individually or in the aggregate, will not have a material
adverse effect on the Company's financial position or results of operations.
49
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth the name, age and position with the Company
of each person who is an executive officer or director of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<C> <C> <S>
H. Wayne Snavely(1)......... 55 Chairman of the Board
Robert W. Howard............ 51 Chief Executive Officer and Director
Bernard A. Guy.............. 40 President and Director
Stephen J. Shugerman(1)..... 49 Director
John D. Dewey(1)............ 36 Director
Allan Van Ruiter(1)(2)...... 45 Director
Frank P. Willey(1)(2)....... 43 Director
Peter F. Makowiecki......... 37 Executive Vice President, Chief Financial
Officer and Secretary
Thomas Bowser............... 43 Executive Vice President, Production
Frank A. Frazzitta.......... 33 Senior Vice President, Treasury
John D. Horak............... 49 Senior Vice President, Credit and Risk
Manager
</TABLE>
- ---------------------
(1)Member of Compensation Committee.
(2)Member of Audit Committee.
H. Wayne Snavely has been the Chairman of the Board of the Company since
April 1995. He has been Chairman of the Board and Chief Executive Officer of
ICII since December 1991, Chairman of the Board of Imperial Credit Advisors,
Inc. ("ICAI") since January 1995 and Chairman of the Board of Imperial Credit
Mortgage Holdings, Inc. since November 1995. He has been a director of
Imperial Bancorp and Imperial Bank since 1994. From 1986 to February 1992, Mr.
Snavely served as Executive Vice President of Imperial Bancorp and Imperial
Bank with direct management responsibility for the following bank subsidiaries
and divisions: Imperial Bank Mortgage, SPTL, Imperial Trust Company, Wm. Mason
& Company, Imperial Ventures, Inc. and The Lewis Horwitz Organization.
Robert W. Howard has been Chief Executive Officer and a Director of the
Company since April 1995. From January 1994 to April 1995, he was Senior Vice
President of SPTL's Residential Lending Division and from December 1992 to
January 1994, he was Vice President of the same division. From January 1990 to
December 1992, Mr. Howard was Senior Vice President at Preferred Financial
Funding Corp., a retail mortgage banking company specializing in non-
conforming credit loans. From March 1981 to December 1990, Mr. Howard was
President of R.W. Howard Financial, a privately owned company specializing in
construction and permanent financing for commercial and residential projects.
Mr. Howard is a licensed CPA in the State of California.
Bernard A. Guy has been President of the Company since July 1997 and was
Executive Vice President of the Company prior to assuming his current
position. Since April 1995 he has served as a Director of the Company. From
January 1994 to April 1995, he was Senior Vice President of SPTL's Residential
Lending Division and from December 1992 to January 1994, he was Vice President
of the same division. From June 1989 to December 1992, Mr. Guy was Senior Vice
President at Preferred Financial Funding Corp., an independent retail mortgage
banking company specializing in non-conforming credit loans. From June 1984 to
June 1989, Mr. Guy was Vice President/Controller for United First Funding.
Stephen J. Shugerman has been a Director of the Company since April 1995.
From June 1987 to the present, Mr. Shugerman has been the President of SPTL.
From June 1985 to May 1987, Mr. Shugerman was President of ATI Thrift & Loan
Association, a privately owned thrift and loan. From 1979 to 1985, he was
Senior Vice
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<PAGE>
President of Imperial Thrift and Loan Association, a former subsidiary of
Imperial Bank. Mr. Shugerman is a past president of the California Association
of Thrift & Loan Companies.
John D. Dewey has been a Director of the Company since June 1996. He has
been Chairman, President and Chief Executive Officer of B Motor Acceptance
Corp., a privately-owned sub-prime auto finance company since November 1996.
He has been a director of Sierra Capital Acceptance, a privately held
wholesale mortgage broker, since May 1995 and was their Chief Operating
Officer from May 1995 to January 1996. From October 1993 to May 1995, Mr.
Dewey served as Consultant and Transaction Coordinator for ContiTrade Services
Corporation's non-conforming credit, ARM conduit program and was responsible
for administering the program. From March 1991 to September 1993, Mr. Dewey
served as Director of Securitization for First Alliance Mortgage Company, a
privately held retail mortgage banking company specializing in non-conforming
credit loans.
Allan Van Ruiter has been a Director of the Company since June 1996. He has
been co-owner of Vantage LLC, a venture capital firm, since January 1996. From
April 1993 to December 1995, he was Chairman, President and Chief Executive
Officer of Gentra Capital Corporation. From May 1989 to December 1991, he was
an Executive Vice President and Chief Financial Officer of Pacific First
Financial Corporation and Pacific First Bank F.S.B; from January 1992 to April
1993 he was an Executive Vice President and the Chief Administrative Officer
of such Company. From March 1986 to May 1989, he was Vice President, Taxation
for Royal Trustco Corporation.
Frank P. Willey has been a Director of the Company since June 1996. He has
been the President of Fidelity National Financial, Inc. since January 1995.
From 1984 to 1994, Mr. Willey was the Executive Vice President, General
Counsel and a Director of Fidelity National Title Insurance Company. Mr.
Willey is a director of CKE Restaurants, Inc. and Mortgage Capital Resources
Company.
Peter F. Makowiecki has been the Executive Vice President, Chief Financial
Officer and Secretary of the Company since June, 1997. From October, 1996 to
June, 1997, Mr. Makowiecki served as the Executive Vice President and Chief
Financial Officer of Fleet Mortgage Group ("Fleet") and served as Senior Vice
President and Controller of Fleet from October 1990 to October 1996. Prior to
his positions with Fleet, Mr. Makowiecki served as Director of Finance of
Citicorp Mortgage from May 1993 to February 1994. From November 1990 to May
1993, Mr. Makowiecki also held the position of Senior Vice President and
Controller of Fleet Bank of Maine. Prior to that time he served as an Audit
Manager for KPMG Peat Marwick LLP.
Thomas Bowser has been Executive Vice President, Production since August
1995. From January 1993 to August 1995, he was a Regional Vice President of
the Wholesale Division for the northwest region. From August 1990 to January
1993 he was an assistant manager or manager at various branches of Preferred
Financial Funding.
Frank A. Frazzitta has been Senior Vice President, Treasurer and Strategic
Alliances Manager since January 1997. From February 1996 to December 1996, Mr.
Frazzitta served as Vice President, Treasurer and Controller of the Company.
From January 1995 to May 1995, Mr. Frazzitta served as Vice President and
Treasurer of Allied Federal Savings Bank and from April 1992 to January 1995,
he served as Assistant Vice President, Cash Management for North American
Mortgage Company. From January 1991 to February 1992, Mr. Frazzitta was
Controller of Chevron Federal Credit Union.
John D. Horak has been the Senior Vice President, Credit and Risk Manager of
the Company since April, 1997. From September 1994 until March, 1996 he served
as Vice President of Credit Administration at First Interstate Bancorp of Los
Angeles, California. From 1988 to 1994, Mr. Horak served as Vice President of
Credit Management for ITT Consumer Financial Corp. From 1980 to 1988 Mr. Horak
held various credit management positions at The Associates. Mr. Horak is a
certified public accountant and has his M.B.A. from the University of Texas at
Austin.
51
<PAGE>
DESCRIPTION OF THE NOTES
GENERAL
The Notes will be issued pursuant to an Indenture dated as of the Issue Date
(the "Indenture"), among the Company, the Subsidiary Guarantors and ,
as trustee (the "Trustee"). The terms of the Notes include those stated in the
Indenture and those made part of the Indenture by reference to the Trust
Indenture Act of 1939, as amended (the "Trust Indenture Act"). The Notes are
subject to all such terms, and Holders of the Notes are referred to the
Indenture and the Trust Indenture Act for a statement thereof. The following
summary of certain provisions of the Indenture does not purport to be complete
and is qualified in its entirety by reference to the Indenture, including the
definitions therein of certain terms used below. A copy of the form of
Indenture has been filed as an exhibit to the Registration Statement of which
this Prospectus is a part. The definitions of certain terms used in the
following summary are set forth below under "Certain Definitions." For
purposes of this summary, the term "Company" refers only to Southern Pacific
Funding Corporation and not to any of its Subsidiaries.
The Notes will be general unsecured obligations of the Company and will rank
pari passu in right of payment with all current and future unsecured
unsubordinated Indebtedness of the Company. However, the Notes will be
effectively subordinated to secured Indebtedness of the Company and the
Subsidiary Guarantors, and interests (including Indebtedness) of
Securitization Trusts which rank senior in right of payment to the Company's
right to receive Excess Spread. The operations of the Company are conducted in
part through its Subsidiaries and, therefore, the Company is dependent in part
upon the cash flow of its Subsidiaries to meet its obligations, including its
obligations under the Notes. All of the Company's current and future domestic
Restricted Subsidiaries (other than Restricted Subsidiaries having total
assets with a book value of less than $1 million and that do not guarantee any
Indebtedness of the Company or any of its Subsidiary Guarantors) will
guarantee the Company's payment obligations under the Notes on a senior
unsecured basis. See "Risk Factors--Fraudulent Conveyance Considerations." As
of the Issue Date, all of the Subsidiaries will be Restricted Subsidiaries.
However, under certain circumstances, the Company will be able to designate
current or future Subsidiaries as Unrestricted Subsidiaries. Unrestricted
Subsidiaries will not be subject to many of the restrictive covenants set
forth in the Indenture. The Company's Foreign Subsidiary will not guarantee
the Company's payment obligations under the Notes; provided, however that the
Company will pledge 65% of the outstanding Equity Interests of such Foreign
Subsidiary and each future Foreign Subsidiary to secure the Company's
obligations on the Notes.
As of June 30, 1997, after giving effect to this Offering and the
application of the proceeds thereof, the Company and the Subsidiary Guarantors
had approximately $ million of secured Indebtedness outstanding under
credit facilities and an additional $ million was available for borrowing
thereunder. The Indenture will permit substantial additional borrowings by the
Company and the Subsidiary Guarantors under its credit facilities in the
future, subject to certain restrictions. See "Risk Factors--Leverage; Asset
Encumbrances."
PRINCIPAL MATURITY AND INTEREST
The Notes will be limited in aggregate principal amount to $125 million and
will mature on , 2004. Interest on the Notes will accrue at the rate of
% per annum and will be payable semi-annually in arrears on and ,
commencing on , 1998, to Holders of record on the immediately preceding
and . Interest on the Notes will accrue from the most recent date to which
interest has been paid or, if no interest has been paid, from the date of
original issuance. Interest will be computed on the basis of a 360-day year
comprised of twelve 30-day months. Principal, premium, if any, and interest on
the Notes will be payable at the office or agency of the Company maintained
for such purpose within the City and State of New York or, at the option of
the Company, payment of interest may be made by check mailed to the Holders of
the Notes at their respective addresses set forth in the register of Holders
of the Notes; provided that all payments of principal, premium, if any, and
interest with respect to the Notes the Holders of which have given
52
<PAGE>
valid, timely and complete wire transfer instructions to the Company and the
Trustee will be required to be made by wire transfer of immediately available
funds to the accounts specified by the Holders thereof in such instructions.
Until otherwise designated by the Company, the Company's office or agency in
New York will be the office of the Trustee maintained for such purpose. The
Notes will be issued in denominations of $1,000 and integral multiples
thereof.
SUBSIDIARY GUARANTEES
The Indenture will provide that all existing and future Restricted
Subsidiaries of the Company, except as provided below, jointly and severally
will guarantee irrevocably and unconditionally all principal, premium, if any,
and interest on the Notes on a senior unsecured basis. The Company will
covenant pursuant to the Indenture to cause (a) each of its Restricted
Subsidiaries which is not a Foreign Subsidiary and which is not a Subsidiary
Guarantor (other than Restricted Subsidiaries having total assets with a book
value of less than $1 million and that do not guarantee any Indebtedness of
the Company or any of the Subsidiary Guarantors) and (b) each Foreign
Subsidiary, if, in the case of Foreign Subsidiaries, such Person guarantees or
otherwise becomes liable for Indebtedness of the Company or any Subsidiary
Guarantor to promptly execute and deliver to the Trustee a Subsidiary
Guarantee pursuant to which such Subsidiary will guarantee payment of the
Notes and the performance of the Company's other obligations under the
Indenture to the extent set forth in the provisions of the Indenture relating
to Subsidiary Guarantors. The obligations of each Subsidiary Guarantor under
its Subsidiary Guarantee will be designed so as not to constitute a fraudulent
conveyance under applicable law; however, there can be no assurance that a
court of competent jurisdiction would reach the same conclusion. See "Risk
Factors--Fraudulent Conveyance Considerations." Separate financial statements
of the Subsidiary Guarantors are not presented because management has
determined that they would not be material to investors.
The Indenture will provide that no Subsidiary Guarantor may consolidate with
or merge with or into (whether or not such Subsidiary Guarantor is the
surviving Person), another Person whether or not affiliated with such
Subsidiary Guarantor unless (i) subject to the provisions of the following
paragraph, the Person formed by or surviving any such consolidation or merger
(if other than such Subsidiary Guarantor) assumes all the obligations of such
Subsidiary Guarantor pursuant to a supplemental indenture in form and
substance reasonably satisfactory to the Trustee, under the Notes and the
Indenture and (ii) immediately after giving effect to such transaction, no
Default or Event of Default exists.
The Indenture will provide that, subject to the covenant described below
under "Certain Covenants--Merger, Consolidation or Sale of Assets," in the
event of a sale or other disposition of all of the assets of any Subsidiary
Guarantor, including by way of merger, consolidation or otherwise, or a sale
or other disposition of all of the capital stock of any Subsidiary Guarantor,
then such Subsidiary Guarantor or the Person acquiring the property (in the
event of a sale or other disposition of all of the assets of such Subsidiary
Guarantor) will be released and relieved of its obligations under its
Subsidiary Guarantee; provided that the Net Proceeds of such sale or other
disposition are applied in accordance with the applicable provisions of the
Indenture. The Indenture will also provide that in the event of a sale or
other disposition of capital stock of a Quasi-Subsidiary pursuant to the
exercise of a call option or similar arrangement on such capital stock as a
result of which the Company and its Restricted Subsidiaries beneficially own
less than 50% of the issued and outstanding capital stock of any such Quasi-
Subsidiary, then such Quasi-Subsidiary will be released and relieved of its
obligations under its Subsidiary Guarantee; provided that the Net Proceeds of
such sale or other disposition are applied in accordance with the applicable
provisions of the Indenture. In addition, the Indenture will provide that, in
the event the Company designates a Restricted Subsidiary to be an Unrestricted
Subsidiary in accordance with the Indenture, then such Restricted Subsidiary
shall be released from its obligations under its Subsidiary Guarantee. See
"Repurchase at the Option of Holders--Asset Sales."
The Company conducts its United Kingdom operations through a Foreign
Subsidiary. Accordingly, the Company's ability to meet its cash obligations
may in part depend upon the ability of such Foreign Subsidiary and any future
Foreign Subsidiary to make cash distributions to the Company. Furthermore, any
right of the Company to receive the assets of any such Foreign Subsidiary upon
such Foreign Subsidiary's liquidation or reorganization (and the consequent
right of the Holders of the Notes to participate in the distribution of the
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<PAGE>
proceeds of those assets) effectively will be subordinated by operation of law
to the claims of such Foreign Subsidiary's creditors (including trade
creditors) and holders of its preferred stock, except to the extent that the
Company is itself recognized as a creditor or preferred stockholder of such
Foreign Subsidiary, in which case the claims of the Company would still be
subordinate to any indebtedness or preferred stock of such Foreign
Subsidiaries senior in right of payment to that held by the Company. The
Company's United Kingdom Subsidiary will not, and future Foreign Subsidiaries
are not expected to, guarantee the Notes; provided, however that the Company
will pledge 65% of the outstanding Equity Interests of such Foreign Subsidiary
and each future Foreign Subsidiary to secure the Company's obligations on the
Notes.
OPTIONAL REDEMPTION
The Notes will not be redeemable at the option of the Company prior to ,
2001. Thereafter, the Notes will be redeemable at the Company's option, in
whole or in part, at any time or from time to time, upon not less than 30 nor
more than 60 days' prior notice to each Holder, at the following redemption
prices (expressed in percentages of principal amount), plus accrued and unpaid
interest thereon to the applicable redemption date, if redeemed during the
twelve-month period commencing on of the years set forth below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
---- ----------
<S> <C>
2001............................................................ %
2002............................................................ %
2003 and thereafter............................................. %
</TABLE>
In the case of a partial redemption, the Trustee shall select the Notes or
portions thereof for redemption on a pro rata basis, by lot or in such other
manner it deems appropriate and fair. The Notes may be redeemed in part in
multiples of $1,000 only.
Notice of any redemption will be sent, by first class mail, at least 30 days
and not more than 60 days prior to the date fixed for redemption to the Holder
of each Note to be redeemed to such Holder's last address as then shown upon
the registry books of the Registrar. Any notice which relates to a Note to be
redeemed in part only must state the portion of the principal amount equal to
the unredeemed portion thereof and must state that on and after the date of
redemption, upon surrender of such Note, a new Note or Notes in a principal
amount equal to the unredeemed portion thereof will be issued. On and after
the date of redemption, interest will cease to accrue on the Notes or portions
thereof called for redemption, unless the Company defaults in the payment
thereof.
If the redemption date is on or after an interest payment record date and on
or before the related interest payment date, any accrued and unpaid interest
will be paid to the Person in whose name a Note is registered at the close of
business on such record date, and such interest will not be payable to Holders
who tender the Notes pursuant to the redemption.
In addition, at any time prior to , 2001, upon a Public Equity Offering
of common stock of the Company for cash, up to 30% of the aggregate principal
amount of the Notes originally issued may be redeemed at the option of the
Company within 60 days of such Public Equity Offering, on not less than 30
days, but not more than 60 days notice to each holder of the Notes to be
redeemed, with cash from the net cash proceeds of such Public Equity Offering,
at a redemption price equal to % of the principal amount thereof, together
with accrued and unpaid interest, if any (subject to the right of Holders of
record on an interest payment record date to receive interest due on an
interest payment date that is on or prior to such redemption date), provided
that at least $87.5 million of the aggregate principal amount of the Notes
remain outstanding immediately following such redemption.
MANDATORY REDEMPTION
The Company is not required to make mandatory redemption or sinking fund
payments with respect to the Notes.
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<PAGE>
REPURCHASE AT THE OPTION OF HOLDERS
CHANGE OF CONTROL
The Indenture will provide that, upon the occurrence of a Change of Control,
each Holder of the Notes will have the right to require the Company to
repurchase all or any part (equal to $1,000 or an integral multiple thereof)
of such Holder's Notes pursuant to the offer described below (the "Change of
Control Offer") at an offer price in cash equal to 101% of the aggregate
principal amount thereof plus accrued and unpaid interest thereon, if any, to
the date of purchase (the "Change of Control Payment"). Within ten days
following any Change of Control, the Company will mail a notice to each Holder
describing the transaction or transactions that constitute the Change of
Control and offering to repurchase the Notes on the date specified in such
notice (the "Change of Control Payment Date"), which date shall be no earlier
than the earliest date permitted under Rule 14e-1 under the Exchange Act
("Rule 14e-1") and no later than 60 days from the date such notice is mailed,
pursuant to the procedures required by the Indenture and described in such
notice. The Company will comply with the requirements of Rule 14e-1 and any
other securities laws and regulations thereunder to the extent such laws and
regulations are applicable in connection with the repurchase of the Notes as a
result of a Change of Control. To the extent that the provisions of any
securities laws or regulations conflict with the provisions of the covenant
described hereunder, the Company shall comply with the applicable securities
laws and regulations and shall not be deemed to have breached its obligations
under the covenant described hereunder by virtue thereof.
Pursuant to the Indenture, on the Change of Control Payment Date, the
Company will, to the extent lawful, (1) accept for payment all the Notes or
portions thereof properly tendered pursuant to the Change of Control Offer,
(2) deposit with the Paying Agent an amount equal to the Change of Control
Payment in respect of all the Notes or portions thereof so tendered and (3)
deliver or cause to be delivered to the Trustee the Notes so accepted together
with an Officers' Certificate stating the aggregate principal amount of the
Notes or portions thereof being purchased by the Company. The Paying Agent is
required to promptly mail to each Holder of the Notes so tendered the Change
of Control Payment for such Notes, and the Trustee is required to promptly
authenticate and mail (or cause to be transferred by book entry) to each
Holder a new Note equal in principal amount to any unpurchased portion of the
Notes surrendered, if any; provided that each such new Note will be in a
principal amount of $1,000 or an integral multiple thereof. The Company will
publicly announce the results of the Change of Control Offer on or as soon as
practicable after the Change of Control Payment Date.
The Change of Control provisions described above will be applicable whether
or not the covenant described below under "--Certain Covenants--Merger,
Consolidation or Sale of Assets" is applicable. Except as described above with
respect to a Change of Control, the Indenture does not contain provisions that
permit the Holders of the Notes to require that the Company repurchase or
redeem the Notes in the event of a takeover, recapitalization or similar
transaction.
The Company's Warehouse Facilities contain, and future Indebtedness of the
Company may contain, restrictions on certain transactions that could
constitute a Change of Control. In addition, the financial effect on the
Company of the exercise by the Holders of the Notes of their right to require
the Company to repurchase the Notes could cause a default under outstanding
Indebtedness, even if the Change of Control itself does not. In addition, the
Company's ability to pay cash to the Holders of the Notes upon a repurchase
may be limited by the Company's then existing financial resources.
The Company will not be required to make a Change of Control Offer upon a
Change of Control if a third party makes the Change of Control Offer in the
manner, at the times and otherwise in compliance with the requirements set
forth in the Indenture applicable to a Change of Control Offer and purchases
all the Notes validly tendered and not withdrawn under such Change of Control
Offer.
If the Change of Control Payment Date is on or after an interest payment
record date and on or before the related interest payment date, any accrued
and unpaid interest will be paid to the Person in whose name a Note is
registered at the close of business on such record date, and such interest
will not be payable to Holders who tender the Notes pursuant to the Change of
Control Offer.
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The definition of Change of Control includes a phrase relating to the sale,
lease, transfer, conveyance or other disposition of "all or substantially all"
of the assets of the Company and its Restricted Subsidiaries taken as a whole.
There is no precise established definition of the phrase "substantially all"
under applicable law. Accordingly, the ability of a Holder of the Notes to
require the Company to repurchase such Notes as a result of a sale, lease,
transfer, conveyance or other disposition of less than all of the assets of
the Company and its Restricted Subsidiaries, taken as a whole, to another
Person or group may be uncertain.
The Change of Control purchase feature of the Notes may make more difficult
or discourage a takeover of the Company, and, thus, the removal of incumbent
management.
ASSET SALES
The Indenture will provide that the Company will not, and will not permit
any of its Restricted Subsidiaries to, consummate an Asset Sale unless (i) the
Company (or the Restricted Subsidiary, as the case may be) receives
consideration at the time of such Asset Sale at least equal to the fair market
value (evidenced by an Officers' Certificate delivered to the Trustee and,
with respect to any Asset Sale involving consideration in excess of $5.0
million, a resolution of the Company's Board of Directors) of the assets or
Equity Interests issued or sold or otherwise disposed of except in the case of
a Qualifying Disposition and (ii) at least 85% (or, in the case of the sale or
other disposition of any Residual Receivables (or interest therein), 50%,
subject to the restrictions in the following paragraph) of the consideration
therefor received by the Company or such Restricted Subsidiary is in the form
of Cash Equivalents; provided that the amount of (x) any liabilities (as shown
on the Company's or such Restricted Subsidiary's most recent balance sheet) of
the Company or any Restricted Subsidiary (other than contingent liabilities
and liabilities that are by their terms subordinated to the Notes or any
Subsidiary Guarantee thereof) that are expressly assumed by the transferee of
any such assets pursuant to a customary novation agreement that releases the
Company or such Restricted Subsidiary from further liability and (y) any
currencies, securities, notes or other obligations received by the Company or
any such Restricted Subsidiary from such transferee that are converted by the
Company or such Restricted Subsidiary into Cash Equivalents within 30 days
after receipt (to the extent of the cash received), shall be deemed to be Cash
Equivalents for purposes of this provision.
The Indenture will further provide that the Company will not, and will not
permit any of its Restricted Subsidiaries to, directly or indirectly sell or
otherwise convey or dispose of any Residual Receivables or interest therein
for consideration of which less than 85% is in the form of Cash Equivalents,
unless: (i) from and after the Issue Date, upon the creation of any Senior
Residual Receivables by the Company or any Restricted Subsidiary, the Company
shall designate, by an Officers' Certificate delivered to the Trustee, Senior
Residual Receivables with an aggregate book value equal to 25% of the book
value of the Senior Residual Receivables so created as Retained Residual
Receivables and which Retained Residual Receivables are of a quality at least
equal to the mean quality of such Senior Residual Receivables so created
(which determination shall be made by the officers of the Company in good
faith) ("Retained Residual Receivables") and no such designation shall have
been revoked; (ii) none of the Residual Receivables sold, conveyed or
otherwise disposed of constitute Retained Residual Receivables unless after
giving effect to such sale, conveyance or other disposition, the aggregate
amount of Senior Residual Receivables of the Company and its Restricted
Subsidiaries which are unencumbered by any Lien would be greater than or equal
to 250% of all Senior Indebtedness of the Company and its Restricted
Subsidiaries; and (iii) after giving effect to any such sale, conveyance or
other disposition of Residual Receivables the aggregate amount of Senior
Residual Receivables of the Company and its Restricted Subsidiaries which are
unencumbered by any Lien would be greater than or equal to 150% of all Senior
Indebtedness of the Company and its Restricted Subsidiaries; provided, that
for purposes of calculating the aggregate amount of Senior Residual
Receivables of the Company and its Restricted Subsidiaries which are
unencumbered by any Lien in clauses (ii) and (iii) above, no more than 25% of
the aggregate book value thereof shall constitute Retained Residual
Receivables. The Indenture will provide that from time to time the Company may
revoke the designation of any Senior Residual Receivable as a Retained
Residual Receivable if the Company simultaneously designates as Retained
Residual Receivables (in addition to any other such designation otherwise
required by the Indenture) Senior Residual Receivables (not subject to any
Lien) with an aggregate book value and of a quality
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equal to or greater than that of the Senior Residual Receivables as to which
such designation has been revoked (which determination shall be made by the
officers of the Company in good faith). Any determination of the amount of
Residual Receivables shall be based on the consolidated balance sheet of the
Company and its Restricted Subsidiaries for the most recently ended fiscal
quarter for which financial statements are available, after giving pro forma
effect to the Asset Sale for which such determination is being made and to any
other sale of or Lien on or reduction of Residual Receivables, including
Retained Residual Receivables, since the date of such balance sheet.
The Indenture will permit the Company or any Restricted Subsidiary, as the
case may be, within 180 days after the receipt of any Net Proceeds from an
Asset Sale subject to this covenant, to apply an amount equal to 100% of such
Net Proceeds to (i) a Permitted Investment (other than in Receivables that, at
the time of purchase, are not Eligible Receivables), (ii) the making of any
capital expenditure, or (iii) the acquisition of any other tangible assets
(other than in Receivables that, at the time of purchase, are not Eligible
Receivables), in each case, in or with respect to a Permitted Business.
Pending the final application of any such Net Proceeds, the Company or such
Restricted Subsidiary may temporarily reduce outstanding Indebtedness or
otherwise invest such Net Proceeds in any manner not prohibited by the
Indenture. Any Net Proceeds from Asset Sales not applied or invested as
provided in the first sentence of this paragraph will be deemed to constitute
"Excess Proceeds." When the aggregate amount of Excess Proceeds exceeds $10.0
million, the Indenture will require the Company to make an offer to all
Holders of the Notes (an "Asset Sale Offer") to purchase the maximum principal
amount of the Notes that may be purchased out of the Excess Proceeds, at an
offer price in cash in an amount equal to 100% of the principal amount thereof
plus accrued and unpaid interest thereon to the date of purchase, in
accordance with the procedures set forth in the Indenture.
To the extent that the aggregate amount of the Notes tendered pursuant to an
Asset Sale Offer is less than the Excess Proceeds, the Company or the
Restricted Subsidiary, as the case may be, may use any remaining Excess
Proceeds for general corporate purposes. If the aggregate principal amount of
the Notes surrendered by Holders thereof exceeds the amount of Excess
Proceeds, the Trustee is required to select the Notes to be purchased on a pro
rata basis. Upon completion of such Asset Sale Offer, the amount of Excess
Proceeds shall be reset at zero.
Under the Indenture, the Asset Sale Offer is required to remain open for the
minimum period of time required by Rule 14e-1 and no longer (the "Asset Sale
Offer Period"). Under the Indenture, no later than five Business Days after
termination of the Asset Sale Offer Period (the "Asset Sale Purchase Date"),
the Company is required to purchase the principal amount of the Notes required
to be purchased pursuant to this covenant (the "Asset Sale Offer Amount") or,
if less than the Asset Sale Offer Amount has been tendered, all the Notes
tendered in response to the Asset Sale Offer.
If the Asset Sale Purchase Date is on or after an interest payment record
date and on or before the related interest payment date, any accrued and
unpaid interest will be paid to the Person in whose name a Note is registered
at the close of business on such record date, and such interest will not be
payable to Holders who tender the Notes pursuant to the Asset Sale Offer.
Under the Indenture, on or before the Asset Sale Purchase Date, the Company
is required, to the extent lawful, to accept for payment, on a pro rata basis,
to the extent necessary, the Asset Sale Offer Amount of the Notes or portions
thereof tendered pursuant to the Asset Sale Offer, or if less than the Asset
Sale Offer Amount has been tendered, all such Notes tendered, and to deliver
to the Trustee an Officers' Certificate stating that such Notes or portions
thereof were accepted for payment by the Company in accordance with the terms
of this covenant. The Company, the depositary or the Paying Agent, as the case
may be, is required, not later than the Asset Sale Purchase Date, to mail or
deliver to each tendering Holder an amount equal to the purchase price of the
Notes tendered by such Holder and accepted by the Company for purchase, and
the Company is required to issue a new Note, and the Trustee, upon delivery of
an Officers' Certificate from the Company, is required to authenticate and
mail or deliver such new Note to such Holder, in a principal amount equal to
any unpurchased portion of any Note surrendered. Any Note not so accepted is
required to be promptly mailed or delivered by the
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Company to the Holder thereof. The Company will publicly announce the results
of the Asset Sale Offer on the Asset Sale Purchase Date.
The Company will comply, to the extent applicable, with the requirements of
Rule 14e-1 and any other securities laws or regulations in connection with the
repurchase of any Notes pursuant to the covenant described hereunder. To the
extent that the provisions of any securities laws or regulations conflict with
the provisions of the covenant described hereunder, the Company shall comply
with the applicable securities laws and regulations and shall not be deemed to
have breached its obligations under the covenant described hereunder by virtue
thereof.
CERTAIN COVENANTS
RESTRICTED PAYMENTS
The Indenture will provide that the Company will not, and will not permit
any of its Restricted Subsidiaries to, directly or indirectly: (i) declare or
pay any dividend or make any other payment or distribution on account of the
Company's or any of its Restricted Subsidiaries' Equity Interests (including,
without limitation, any payment in connection with any merger or consolidation
involving the Company) other than dividends or other payments or distributions
payable in Equity Interests (excluding Disqualified Stock) of the Company or
dividends or other payments or distributions payable to the Company or any
Subsidiary Guarantor; (ii) purchase, redeem or otherwise acquire or retire for
value (including, without limitation, any payment in connection with any
merger or consolidation involving the Company) any Equity Interests of the
Company or any of its Subsidiaries (other than any such Equity Interests owned
by any Wholly-Owned Restricted Subsidiary of the Company); (iii) make any
principal payment on or with respect to, purchase, redeem, defease or
otherwise acquire or retire for value any Indebtedness that is subordinated to
the Notes or any Subsidiary Guarantee (other than intercompany Indebtedness
payable to the Company or a Subsidiary Guarantor by any Restricted
Subsidiary), except at its final stated maturity; or (iv) make any Restricted
Investment (all such payments and other actions set forth in clauses (i)
through (iv) above being collectively referred to as "Restricted Payments"),
unless, at the time of and after giving effect to such Restricted Payment:
(a) no Default or Event of Default shall have occurred and be continuing
or would occur as a consequence thereof;
(b) the Company would, at the time of such Restricted Payment and after
giving pro forma effect thereto, have been permitted to incur at least
$1.00 of additional Indebtedness pursuant to the test set forth in the
first paragraph of the covenant described below under "--Incurrence of
Indebtedness and Issuance of Preferred Stock"; and
(c) such Restricted Payment, together with the aggregate amount of all
other Restricted Payments made by the Company and its Restricted
Subsidiaries after the Issue Date (excluding Restricted Payments permitted
by clauses (ii) and (iii) of the next succeeding paragraph), is less than
the sum of (i) 25% of the aggregate cumulative Consolidated Net Income of
the Company for the period (taken as one accounting period) from but not
including the last day of the first fiscal quarter ending immediately
following the Issue Date to the last day of the Company's most recently
ended fiscal quarter for which internal financial statements are available
at the time of such Restricted Payment, unless such Restricted Payment
occurs after the date which financial statements for such fiscal quarter
would be required to be filed pursuant to the Exchange Act, in which case
the period shall include the last day of the Company's most recently ended
fiscal quarter regardless of whether internal financial statements are
available (or, if such Consolidated Net Income for such period is a
deficit, less 100% of such deficit); plus (ii) 100% of the aggregate net
Cash Equivalents proceeds received by the Company (other than from its
Subsidiaries) from Capital Contributions after the Issue Date or the issue
or sale after the Issue Date of (x) Equity Interests of the Company (other
than Disqualified Stock) or (y) Disqualified Stock or Indebtedness
represented by securities of the Company that have been converted into (or
exchanged for) such Equity Interests (other than Equity Interests (or
Disqualified Stock or convertible or exchangeable debt securities) sold to
a Subsidiary of the Company and other than Disqualified Stock or other
Indebtedness represented by securities that have been converted into
Disqualified Stock); plus (iii) to the extent that any Restricted
Investment that was made after the Issue Date
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is sold for cash or otherwise liquidated or repaid for cash, the lesser of
(A) the cash return to the Company or one of its Restricted Subsidiaries of
capital with respect to such Restricted Investment (less the cost of
disposition, if any) which cash is not subject to restriction and (B) the
initial amount of such Restricted Investment.
The foregoing provisions will not prohibit the following Restricted
Payments: (i) the payment of any dividend within 60 days after the date of
declaration thereof, if at said date of declaration such payment would have
complied with the provisions of the Indenture; (ii) the purchase, redemption
or other acquisition or retirement for value of any Equity Interests of the
Company in exchange for, or out of the proceeds of, the
substantially concurrent sale (other than to a Subsidiary of the Company) of
other Equity Interests of the Company (other than any Disqualified Stock);
provided, that the amount of any such net Cash Equivalents proceeds that are
utilized for such redemption, repurchase, retirement or other acquisition
shall be excluded from clause (c)(ii) of the preceding paragraph; (iii) the
payment of principal on, or purchase, redemption, defeasance or other
acquisition or retirement for value of Indebtedness with the net cash proceeds
from an incurrence of, Permitted Refinancing Indebtedness or the substantially
concurrent sale (other than to a Subsidiary of the Company) of Equity
Interests of the Company (other than Disqualified Stock); provided, that the
amount of any such net Cash Equivalents proceeds from any such sale of Equity
Interests or Indebtedness (to the extent such Indebtedness is used to
refinance the Convertible Notes) that are utilized for such redemption,
repurchase, retirement or other acquisition shall be excluded from clause
(c)(ii) of the preceding paragraph; (iv) payments in an amount not to exceed
$500,000 in the aggregate during any fiscal year of the Company (plus (x) any
such amount not utilized in the preceding fiscal year and (y) the aggregate
amount of net proceeds from the reissuance of such Equity Interests to
employees or directors of the Company other than Disqualified Stock, provided,
that the amount of net proceeds from any such reissuance of Equity Interests
shall be excluded from clause (c)(ii) of the preceding paragraph) in
connection with the repurchase, redemption or other acquisition or retirement
for value of any Equity Interests of the Company held by an employee or
director of the Company or any of its Subsidiaries, related to compensation or
severance arrangements; (v) advances to a Securitization Trust required to be
made by the Company or any Restricted Subsidiary (in its capacity as the
holder of the residual interest in such trust) if such advances rank senior in
right of payment to all other interests in, and Indebtedness of, such trust;
(vi) the exercise or conversion of an option, warrant or other security
convertible or exchangeable for an equity security of a Strategic Alliance
Client in connection with a substantially simultaneous sale or other
disposition by the Company or a Restricted Subsidiary of such equity security
for an amount in excess of the exercise price or other consideration paid by
the Company or a Restricted Subsidiary in connection with such exercise or
conversion; (vii) the making and consummation of any offer to repurchase any
Indebtedness upon the occurrence of a change of control under and as defined
in the documents governing such Indebtedness; provided, that in connection
with Indebtedness incurred after the Issue Date, the definition of "change of
control" is the same in all material respects as the definition of "Change of
Control" set forth in the Indenture and payments pursuant thereto are not
required to be made prior to the date on which the Change of Control Payment
is required to be made under the Indenture and, with respect to any
Indebtedness pari passu or subordinated in right of payment to the Notes, no
sooner than 60 days after the date such Change of Control Offer is required to
be made and (viii) the purchase, redemption or other acquisition or retirement
for value by any Restricted Subsidiary of any Equity Interests of such
Restricted Subsidiary.
The Board of Directors may designate any Restricted Subsidiary to be an
Unrestricted Subsidiary if such designation would not cause a Default. For
purposes of making such determination, all outstanding Investments by the
Company and its Restricted Subsidiaries (except to the extent repaid to the
Company or a Restricted Subsidiary in cash) in the Subsidiary so designated
will be deemed to be Restricted Payments at the time of such designation and
will reduce the amount available for Restricted Payments under the first
paragraph of this covenant. All such outstanding Investments will be deemed to
constitute Investments in an amount equal to the fair market value of such
Investments at the time of such designation. Such designation will only be
permitted if such Restricted Payment would be permitted at such time and if
such Restricted Subsidiary otherwise meets the definition of an Unrestricted
Subsidiary.
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The amount of all Restricted Payments other than cash shall be the fair
market value (evidenced by an Officers' Certificate on the date of the
Restricted Payment) of the asset(s) or securities proposed to be transferred
or issued by the Company or such Restricted Subsidiary, as the case may be,
pursuant to the Restricted Payment. The fair market value of any non-cash
Restricted Payment in excess of $1.0 million shall be determined by the Board
of Directors whose resolution with respect thereto shall be delivered to the
Trustee, such determination to be based upon an opinion or appraisal issued by
an accounting, appraisal or investment banking firm, in each case, of national
standing if such fair market value exceeds $10.0 million. Not later than the
date of making any Restricted Payment, the Company shall deliver to the
Trustee an Officers' Certificate stating that such Restricted Payment is
permitted and setting forth the basis upon which the calculations required by
the covenant "Restricted Payments" were computed.
INCURRENCE OF INDEBTEDNESS AND ISSUANCE OF PREFERRED STOCK
The Indenture will provide that the Company will not, and will not permit
any of its Subsidiaries to, directly or indirectly, create, incur, issue,
assume, guaranty or otherwise become directly or indirectly liable,
contingently or otherwise, with respect to (collectively, "incur") any
Indebtedness (including Acquired Debt) or issue Disqualified Stock, and that
the Company will not permit any of its Restricted Subsidiaries to issue any
shares of preferred stock except for preferred stock issued to and held by the
Company or any Subsidiary Guarantor, provided that any subsequent issuance or
transfer of Capital Stock that results in such Subsidiary Guarantor ceasing to
be a Subsidiary Guarantor or any subsequent transfer of such preferred stock
(other than to the Company or any other Subsidiary Guarantor) will be deemed,
in each case, to constitute the issuance of such preferred stock by the issuer
thereof; provided, however, that the Company or any Subsidiary Guarantor may
incur Indebtedness (including Acquired Debt) or issue Disqualified Stock and
any Subsidiary Guarantor may issue preferred stock if, on the date of such
incurrence or issuance and after giving effect thereto, the Consolidated
Leverage Ratio does not exceed 2.0 to 1.0.
The foregoing provisions will not apply to:
(1) the existence of Warehouse Facilities, regardless of amount, and the
incurrence of Permitted Warehouse Debt by the Company or any of its
Restricted Subsidiaries; provided, however, that to the extent any such
Indebtedness of the Company or a Restricted Subsidiary of the Company
ceases to constitute Permitted Warehouse Debt, to such extent such
Indebtedness shall be deemed to be incurred by the Company or such
Restricted Subsidiary of the Company, as the case may be, at such time;
(2) the incurrence by the Company or any Restricted Subsidiary of
intercompany Indebtedness owing to the Company or any Subsidiary Guarantor;
provided, however, that (i)(A) any subsequent issuance or transfer of any
Capital Stock which results in any such Indebtedness being held by a Person
other than a Subsidiary Guarantor and (B) any sale or transfer of any such
Indebtedness to a Person that is not either the Company or a Subsidiary
Guarantor, shall be deemed, in each case, to constitute the incurrence of
such Indebtedness by the Company or such Subsidiary Guarantor, as the case
may be, at such time, and (ii) any Indebtedness (x) of the Company to any
Subsidiary Guarantor or (y) of any Subsidiary Guarantor to the Company is
permitted as a Restricted Payment by the covenant described above under "--
Restricted Payments;"
(3) the incurrence by the Company of Indebtedness represented by the
Notes and the incurrence by the Subsidiary Guarantors of Subsidiary
Guarantees;
(4) Indebtedness of the Company and the Subsidiary Guarantors outstanding
on the Issue Date;
(5) the incurrence by the Company or any of the Subsidiary Guarantors of
Permitted Refinancing Indebtedness;
(6) the incurrence by the Company or any of its Restricted Subsidiaries
of Hedging Obligations directly related to (i) Indebtedness of the Company
or a Restricted Subsidiary of the Company that was permitted by the
Indenture to be incurred, (ii) Receivables held by the Company or a
Restricted Subsidiary pending sale in a Securitization of a Qualified Whole
Loan Sale, (iii) Receivables of the Company or a
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Restricted Subsidiary that have been sold pursuant to a Warehouse Facility
or (iv) Receivables that the Company or a Restricted Subsidiary reasonably
expects to purchase or commit to purchase, finance or accept as collateral;
provided, however, that, in the case of each of the foregoing clauses (i)
through (iv), such Hedging Obligations are customary in the industry.
(7) the Guarantee by the Company or any of the Subsidiary Guarantors of
the Indebtedness of the Company or another Subsidiary Guarantor that was
permitted to be incurred by another provision of this covenant;
(8) the incurrence by the Company and the Subsidiary Guarantors of
Indebtedness in an aggregate principal amount at any time outstanding
(including any Indebtedness issued to refinance, replace, retire or
otherwise acquire such Indebtedness) not to exceed $15.0 million;
(9) (A) the incurrence by an Unrestricted Subsidiary of the Company of
Non-Recourse Debt (including, without limitation, Non-Recourse Debt that
would constitute Permitted Warehouse Debt if
incurred by a Subsidiary Guarantor); provided, however, that if any such
Indebtedness ceases to be Non-Recourse Debt of the Unrestricted Subsidiary,
such event shall be deemed to constitute an incurrence of Indebtedness by a
Restricted Subsidiary at such time and (B) the issuance by an Unrestricted
Subsidiary of the Company of preferred stock; provided, however, that if
any such Unrestricted Subsidiary shall become a Restricted Subsidiary, such
event shall be deemed to constitute the issuance of Disqualified Capital
Stock or preferred stock, as applicable, by a Restricted Subsidiary at such
time; and
(10) the incurrence by the Company or any Subsidiary Guarantor of
Indebtedness owing to any Strategic Alliance Client in an aggregate
principal amount outstanding at any one time (including any Indebtedness
issued to refinance, replace, retire or otherwise acquire such
Indebtedness) not to exceed the aggregate amount of the Book Entry Residual
Receivable relating to such Strategic Alliance Client outstanding at any
one time.
The Indenture will also provide that the Company will not, and will not
permit any Subsidiary Guarantor to, incur any Indebtedness that is
contractually subordinated to any Indebtedness of the Company or any such
Subsidiary Guarantor unless such Indebtedness is also contractually
subordinated to the Notes, or the Subsidiary Guarantee of such Subsidiary
Guarantor (as applicable), on substantially identical terms; provided,
however, that no Indebtedness shall be deemed to be contractually subordinated
to any other Indebtedness solely by virtue of being unsecured or of limited
recourse.
For purposes of determining compliance with this covenant, in the event that
an item of Indebtedness meets the criteria of more than one of the categories
of Indebtedness described in clauses (1) through (10) above or is entitled to
be incurred pursuant to the first paragraph of this covenant, at the time
incurred or deemed incurred the Company shall, in its sole discretion,
classify such item of Indebtedness in any manner that complies with this
covenant and such item of Indebtedness will be treated as having been incurred
pursuant to only one of such clauses or pursuant to the first paragraph
hereof.
LIENS
The Indenture will provide that the Company will not, and will not permit
any of its Restricted Subsidiaries to, directly or indirectly, create, incur,
assume or suffer to exist any Lien on any asset now owned or hereafter
acquired, or any income or profits therefrom or assign or convey any right to
receive income therefrom, except Permitted Liens.
OWNERSHIP OF SUBSIDIARY STOCK
The Company (i) will not directly or indirectly beneficially own less than a
majority of the aggregate voting power of any of its now owned or hereafter
acquired or formed Quasi-Subsidiaries and (ii) will not permit any of its
Quasi-Subsidiaries to cease being eligible to file consolidated financial
statements with the Company in accordance with GAAP, (including, without
limitation, pursuant to any transaction which results in a Quasi-Subsidiary
ceasing to be a Subsidiary of the Company or pursuant to the exercise of a
call option) unless, in
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each case, all outstanding Investments made by the Company and its Restricted
Subsidiaries in such Quasi-Subsidiary (excluding any Investments consisting of
common stock of the Company) shall have been repaid to the Company or to the
Restricted Subsidiary making such Investment, in Cash Equivalents (which Cash
Equivalents are not subject to restriction).
DIVIDEND AND OTHER PAYMENT RESTRICTIONS AFFECTING RESTRICTED SUBSIDIARIES
The Indenture will provide that the Company will not, and will not permit
any of its Restricted Subsidiaries to, directly or indirectly, create or
otherwise cause or suffer to exist or become effective any consensual
encumbrance or restriction on the ability of any Restricted Subsidiary to
(i)(A) pay dividends or make any other distributions to the Company or any of
its Restricted Subsidiaries (1) on its Capital Stock or (2) with respect to
any other interest or participation in, or measured by, its profits, or (B)
pay any indebtedness owed to the Company or any of its Restricted
Subsidiaries, (ii) make loans or advances to the Company or any of its
Restricted Subsidiaries or (iii) transfer any of its properties or assets
(other than Receivables) to the Company or any of its Restricted Subsidiaries,
except for such encumbrances or restrictions existing under or by reason of
(a) agreements relating to Indebtedness as in effect as of the Issue Date, and
any amendments, modifications, restatements, renewals, increases, supplements,
refundings, additions (including additional Warehouse Facilities),
replacements or refinancings thereof, provided that such amendments,
modifications, restatements, renewals, increases, supplements, refundings,
additions, replacements or refinancings are no more restrictive with respect
to such dividend and other payment restrictions than those contained in the
agreements relating to Indebtedness as in effect on the Issue Date, (b)
applicable law, (c) any instrument governing Acquired Debt or Capital Stock of
a Person acquired by the Company or any of its Restricted Subsidiaries as in
effect at the time of such acquisition (except to the extent such Acquired
Debt was incurred or such Capital Stock was incurred or issued or its terms
amended in connection with or in contemplation of such acquisition), which
encumbrance or restriction is not applicable to any Person, or the property or
assets of any Person, other than the Person or the property or assets of the
Person, so acquired, provided that such Person is not taken into account in
determining on a pro forma basis whether such acquisition subject to such
Acquired Debt was permitted by the terms of the Indenture, (d) customary non-
assignment provisions in leases entered into in the ordinary course of
business and consistent with past practices, (e) purchase money obligations
for property acquired in the ordinary course of business that impose
restrictions of the nature described in clause (iii) above on the property so
acquired, and (f) Permitted Refinancing Indebtedness; provided that the
restrictions contained in the agreements governing such Permitted Refinancing
Indebtedness are no more restrictive than those contained in the agreements
governing the Indebtedness being refinanced.
MERGER, CONSOLIDATION OR SALE OF ASSETS
The Indenture will provide that the Company may not consolidate or merge
with or into (whether or not the Company is the surviving corporation), or
sell, assign, transfer, lease, convey or otherwise dispose of all or
substantially all of its properties or assets in one or more related
transactions to, another Person unless (i) the Company is the surviving
corporation or the Person formed by or surviving any such consolidation or
merger (if other than the Company) or to which such sale, assignment,
transfer, lease, conveyance or other disposition shall have been made is a
corporation organized or existing under the laws of the United States, any
state thereof or the District of Columbia; (ii) the Person formed by or
surviving any such consolidation or merger (if other than the Company) or the
Person to which such sale, assignment, transfer, lease, conveyance or other
disposition shall have been made assumes all the obligations of the Company
under the Notes and the Indenture pursuant to a supplemental indenture in a
form reasonably satisfactory to the Trustee; (iii) immediately after such
transaction no Default or Event of Default exists; and (iv) the Company or the
Person formed by or surviving any such consolidation or merger (if other than
the Company), or to which such sale, assignment, transfer, lease, conveyance
or other disposition shall have been made (A) will have Consolidated Net Worth
immediately after the transaction equal to or greater than the Consolidated
Net Worth of the Company immediately preceding the transaction and (B) will
(unless such transaction involves the merger of the Company and one of its
Wholly-Owned Subsidiaries which is also a Subsidiary Guarantor and which
transaction is not in connection with any other transaction) at the time of
such transaction and after giving pro forma effect thereto, be permitted
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to incur at least $1.00 of additional Indebtedness pursuant to the first
paragraph of the covenant described above under "--Incurrence of Indebtedness
and Issuance of Preferred Stock." For purposes of this covenant, the sale,
lease, conveyance, assignment, transfer, or other disposition of all or
substantially all of the properties and assets of one or more Subsidiaries of
the Company, which properties and assets, if held by the Company instead of
such Subsidiaries, would constitute all or substantially all of the properties
and assets of the Company on a consolidated basis, shall be deemed to be the
transfer of all or substantially all of the properties and assets of the
Company.
TRANSACTIONS WITH AFFILIATES
The Indenture will provide that the Company will not, and will not permit
any of its Restricted Subsidiaries to, sell, lease, transfer or otherwise
dispose of any of its properties or assets to, or purchase any property or
assets
from, or enter into or make or amend any transaction, contract, agreement,
understanding, loan, advance or guarantee with, or for the benefit of, any
Affiliate (each of the foregoing actions, considered separately, an "Affiliate
Transaction"), unless (i) such Affiliate Transaction is on terms that are no
less favorable to the Company or the relevant Restricted Subsidiary than those
that would have been obtained in a comparable transaction by the Company or
such Restricted Subsidiary with an unrelated Person and (ii) the Company
delivers to the Trustee (a) with respect to any Affiliate Transaction or
series of related Affiliate Transactions involving aggregate consideration in
excess of $1.0 million, a resolution of the Board of Directors set forth in an
Officers' Certificate certifying that such Affiliate Transaction complies with
clause (i) above and that such Affiliate Transaction has been approved by a
majority of the disinterested members of the Board of Directors and (b) with
respect to any Affiliate Transaction or series of related Affiliate
Transactions involving aggregate consideration in excess of $5.0 million, an
opinion as to the fairness to the Company or such Restricted Subsidiary of
such Affiliate Transaction from a financial point of view issued by an
accounting, appraisal or investment banking firm, in each case, of national
standing; provided that Affiliate Transactions shall not include (A) any
employment agreement, stock option, employee benefit, indemnification,
compensation (including the payment of reasonable fees to Directors of the
Company or its Restricted Subsidiaries who are not employees of the Company or
its Restricted Subsidiaries), business expense reimbursement or other
employment-related agreement, arrangement or plan entered into by the Company
or any of its Restricted Subsidiaries in the ordinary course of business of
the Company or such Restricted Subsidiary, (B) transactions between or among
the Company and/or its Restricted Subsidiaries and Strategic Alliance Clients
not otherwise prohibited by the Indenture, (C) loans or advances to employees
in the ordinary course of business of the Company or its Restricted
Subsidiaries, but in any event not to exceed $500,000 in aggregate principal
amount outstanding at any one time, and (D) Restricted Payments that are
permitted by the provisions of the Indenture described above under the caption
"--Restricted Payments," (E) Permitted Investments enumerated in clauses (a),
(b), (c), (g) and (h), (F) the tax sharing agreement with ICII, relating to
periods prior to the Company's initial public offering, (G) administrative
benefits and services provided to the Company by ICII, including computer
hardware and software, in an annual amount not in excess of $100,000, (H) a
registration rights agreement with ICII entered into in November 1996 and (I)
a five year consulting agreement with The Dewey Consulting Group entered into
in June 1996.
BUSINESS ACTIVITIES
The Company will not, and will not permit any Restricted Subsidiary to,
engage to any substantial extent in any business other than Permitted
Businesses.
PAYMENTS FOR CONSENT
The Indenture will provide that neither the Company nor any of its
Subsidiaries will, directly or indirectly, pay or cause to be paid any
consideration, whether by way of interest, fee or otherwise, to any Holder of
any of the Notes for or as an inducement to any consent, waiver or amendment
of any of the terms or provisions of the Indenture or the Notes unless such
consideration is offered to be paid or is paid to all Holders of Notes that
consent, waive or agree to amend in the time frame set forth in the
solicitation documents relating to such consent, waiver or agreement.
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REPORTS
The Indenture will provide that, whether or not required by the rules and
regulations of the Commission, so long as any of the Notes are outstanding,
the Company will furnish to the Holders of the Notes (i) all quarterly and
annual financial information that would be required to be contained in a
filing with the Commission on Forms 10-Q and 10-K if the Company were required
to file such Forms (but excluding exhibits thereto; provided that the Company
shall make such exhibits available free of charge upon request), including a
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" that describes the financial condition and results of operations
of the Company and its consolidated Subsidiaries (showing in reasonable
detail, either on the face of the financial statements or in the notes thereto
and in Management's Discussion and Analysis of Financial Condition and Results
of Operations, the financial condition and results of operations of the
Company and its Restricted Subsidiaries separately from the financial
condition and results of operations of the Unrestricted
Subsidiaries of the Company) and, with respect to the annual information only,
a report thereon by the Company's certified independent accountants and (ii)
all current reports that would be required to be filed with the Commission on
Form 8-K (but excluding exhibits thereto; provided that the Company shall make
such exhibits available free of charge upon request) if the Company were
required to file such reports. In addition, whether or not required by the
rules and regulations of the Commission, the Company will file a copy of all
such information and reports with the Commission for public availability
(unless the Commission will not accept such a filing) and make such
information available to securities analysts and prospective investors upon
request.
EVENTS OF DEFAULT AND REMEDIES
The Indenture will provide that each of the following constitutes an Event
of Default: (i) default for 30 days in the payment when due of interest on the
Notes; (ii) default in payment when due of the principal of or premium, if
any, on the Notes; (iii) failure by the Company to comply with the provisions
described above under "Change of Control," "Asset Sales," "Restricted
Payments," "Incurrence of Indebtedness and Issuance of Preferred Stock,"
"Merger, Consolidation or Sale of Assets" or "Liens"; (iv) failure by the
Company for 30 days after notice to comply with any of its other agreements in
the Indenture or the Notes; (v) default under any mortgage, indenture or
instrument under which there may be issued or by which there may be secured or
evidenced any Indebtedness for money borrowed by the Company or any of its
Subsidiaries (or the payment of which is guaranteed by the Company or any of
its Subsidiaries) whether such Indebtedness or guarantee now exists, or is
created after the date of the Indenture, which default (a) is caused by a
failure to pay principal of or premium, if any, or interest on such
Indebtedness prior to the expiration of the grace period provided in such
Indebtedness on the date of such default (a "Payment Default") or (b) results
in the acceleration of such Indebtedness prior to its express maturity and, in
each case, the principal amount of any such Indebtedness, together with the
principal amount of any other such Indebtedness under which there has been a
Payment Default or the maturity of which has been so accelerated, aggregates
$5.0 million or more; (vi) failure by the Company or any of its Subsidiaries
to pay final judgments aggregating in excess of $2.0 million, which judgments
are not paid, discharged or stayed for a period of 60 days; (vii) certain
events of bankruptcy or insolvency with respect to the Company or any of its
Subsidiaries; and (viii) except as permitted by the Indenture, any Subsidiary
Guarantee shall be held in any judicial proceeding to be invalid or
unenforceable or shall cease for any reason to be in full force and effect or
any Subsidiary Guarantor or any Person acting on behalf of any Subsidiary
Guarantor shall deny or disaffirm its obligations under its Subsidiary
Guarantee.
If any Event of Default occurs and is continuing, the Trustee or the Holders
of at least 25% in principal amount of the then outstanding Notes may declare
all the Notes to be due and payable immediately. Notwithstanding the
foregoing, in the case of an Event of Default arising from certain events of
bankruptcy or insolvency, with respect to the Company or any Subsidiary, all
outstanding Notes will become due and payable without further action or
notice. Holders of the Notes may not enforce the Indenture or the Notes except
as provided in the Indenture. Subject to certain limitations, Holders of a
majority in principal amount of the then outstanding Notes may direct the
Trustee in its exercise of any trust or power. The Trustee may withhold from
Holders of the Notes notice of any continuing Default or Event of Default
(except a Default or Event of Default relating to the payment of principal or
interest) if it determines that withholding notice is in their interest.
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In the case of any Event of Default occurring by reason of any willful
action (or inaction) taken (or not taken) by or on behalf of the Company with
the intention of avoiding payment of the premium that the Company would have
had to pay if the Company then had elected to redeem the Notes pursuant to the
optional redemption provisions of the Indenture, an equivalent premium shall
also become and be immediately due and payable to the extent permitted by law
upon the acceleration of the Notes. If an Event of Default occurs prior to
, 2003 by reason of any willful action (or inaction) taken (or not taken)
by or on behalf of the Company with the intention of avoiding the prohibition
on redemption of the Notes prior to , 2003 then the premium specified in
the Indenture shall also become immediately due and payable to the extent
permitted by law upon the acceleration of the Notes.
The Holders of a majority in aggregate principal amount of the Notes then
outstanding by notice to the Trustee may on behalf of the Holders of all of
the Notes waive any existing Default or Event of Default (other than a Default
or Event of Default relating to the release of any Subsidiary Guarantor from
its obligations under the Indenture or its Subsidiary Guaranty which waiver
shall require the Holders of at least 66 2/3% in principal amount of the Notes
then outstanding) and its consequences under the Indenture except a continuing
Default or Event of Default in the payment of premium, if any, or interest on,
or the principal of, the Notes.
The Company is required to deliver to the Trustee annually a statement
regarding compliance with the Indenture, and the Company is required, upon
becoming aware of any Default or Event of Default, to deliver to the Trustee a
statement specifying such Default or Event of Default. The "Events of Default
and Remedies" provisions described above shall apply to the Notes in lieu of
those described in the accompanying Prospectus.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of the Company
or a Subsidiary Guarantor, as such, shall have any liability for any
obligations of the Company or the Subsidiary Guarantors under the Notes, the
Indenture, the Subsidiary Guarantees or for any claim based on, in respect of,
or by reason of, such obligations or their creation. Each Holder of the Notes
by accepting a Note waives and releases all such liability, except, in the
case of the Company or a Subsidiary Guarantor, in its capacity as obligor of
the Notes or as a guarantor thereof. The waiver and release are part of the
consideration for issuance of the Notes. Such waiver may not be effective to
waive liabilities under the federal securities laws and it is the view of the
Commission that such a waiver is against public policy.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Company may, at its option and at any time, elect to have all of its
obligations and the obligations of the Subsidiary Guarantors discharged with
respect to the outstanding Notes ("Legal Defeasance") except for (i) the
rights of Holders of outstanding Notes to receive payments in respect of the
principal of, premium, if any, and interest on such Notes when such payments
are due from the trust referred to below, (ii) the Company's obligations with
respect to the Notes concerning issuing temporary Notes, registration of the
Notes, mutilated, destroyed, lost or stolen Notes and the maintenance of an
office or agency for payment and money for security payments held in trust,
(iii) the rights, powers, trusts, duties and immunities of the Trustee, and
the Company's obligations in connection therewith and (iv) the Legal
Defeasance provisions of the Indenture. In addition, the Company may, at its
option and at any time, elect to have the obligations of the Company and the
Subsidiary Guarantors released with respect to certain covenants that are
described in the Indenture ("Covenant Defeasance") and thereafter any omission
to comply with such obligations shall not constitute a Default or Event of
Default with respect to the Notes. In the event Covenant Defeasance occurs,
certain events (not including non-payment, bankruptcy, receivership,
rehabilitation and insolvency events) described under "Events of Default" will
no longer constitute an Event of Default with respect to the Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance, (i) the
Company must irrevocably deposit with the Trustee, in trust, for the benefit
of the Holders of the Notes, cash in U.S. dollars, non-callable Government
Securities, or a combination thereof, in such amounts as will be sufficient,
in the opinion of a
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nationally recognized firm of independent public accountants, to pay the
principal of, premium, if any, and interest on the outstanding Notes on the
stated maturity or on the applicable redemption date, as the case may be, and
the Company must specify whether the Notes are being defeased to maturity or
to a particular redemption date; (ii) in the case of Legal Defeasance, the
Company shall have delivered to the Trustee an opinion of counsel in the
United States reasonably acceptable to the Trustee confirming that (A) the
Company has received from, or there has been published by, the Internal
Revenue Service a ruling (B) since the date of the Indenture, there has been a
change in the applicable federal income tax law, in either case to the effect
that, and based thereon such opinion of counsel shall confirm that, the
Holders of the outstanding Notes will not recognize income, gain or loss for
federal income tax purposes as a result of such Legal Defeasance and will be
subject to federal income tax on the same amounts, in the same manner and at
the same times as would have been the case if such Legal
Defeasance had not occurred; (iii) in the case of the Covenant Defeasance, the
Company shall have delivered to the Trustee an opinion of counsel in the
United States reasonably acceptable to the Trustee confirming that the Holders
of the outstanding Notes will not recognize income, gain or loss for federal
income tax purposes as a result of such Covenant Defeasance and will be
subject to federal income tax on the same amounts, in the same manner and at
the same times as would have been the case if such Covenant Defeasance had not
occurred; (iv) no Default or Event of Default shall have occurred and be
continuing on the date of such deposit (other than a Default or Event of
Default resulting from the borrowing of funds to be applied to such deposit)
or insofar as Events of Default from bankruptcy or insolvency events are
concerned, at any time in the period ending on the 91st day after the date of
deposit; (v) such Legal Defeasance or Covenant Defeasance will not result in a
breach or violation of, or constitute a default under any material agreement
or instrument (other than the Indenture covered by clause (iv) above) to which
the Company or any of its Subsidiaries is a party or by which the Company or
any of its Subsidiaries is bound; (vi) the Company must have delivered to the
Trustee an opinion of counsel to the effect that after the 91st day following
the deposit, the trust funds will not be subject to the effect of any
applicable bankruptcy, insolvency, reorganization or similar laws affecting
creditors' rights generally; (vii) the Company must deliver to the Trustee an
Officers' Certificate stating that the deposit was not made by the Company
with the intent of preferring the Holders of the Notes over the other
creditors of the Company or the Subsidiary Guarantors with the intent of
defeating, hindering, delaying or defrauding creditors of the Company, the
Subsidiary Guarantors or others; and (viii) the Company must deliver to the
Trustee an Officers' Certificate and an opinion of counsel, each stating that
it has complied with all conditions precedent provided for relating to the
Legal Defeasance or the Covenant Defeasance.
TRANSFER AND EXCHANGE
A Holder may transfer or exchange the Notes in accordance with the
Indenture. The Registrar and the Trustee may require a Holder, among other
things, to furnish appropriate endorsements and transfer documents and the
Company is not required to transfer or exchange any Note selected for
redemption. Also, the Company is not required to transfer or exchange any Note
for a period of 15 days before a selection of the Notes to be redeemed.
The registered Holder of a Note will be treated as the owner of it for all
purposes.
AMENDMENT, SUPPLEMENT AND WAIVER
Except as provided in the next three succeeding paragraphs, the Indenture or
the Notes may be amended or supplemented with the consent of the Holders of at
least a majority in principal amount of the Notes then outstanding (including,
without limitation, consents obtained in connection with a purchase of, or
tender offer or exchange offer for, the Notes), and any existing default or
compliance with any provision of the Indenture or the Notes may be waived with
the consent of the Holders of a majority in principal amount of the then
outstanding Notes (including consents obtained in connection with a tender
offer or exchange offer for the Notes).
Without the consent of each Holder affected, an amendment or waiver may not
(with respect to any Notes held by a non-consenting Holder): (i) reduce the
principal amount of the Notes whose Holders must consent to an amendment,
supplement or waiver, (ii) reduce the principal of or change the fixed
maturity of any Note or alter the provisions with respect to the redemption of
the Notes (other than provisions relating to the covenants
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described above under "Repurchase at the Option of Holders"), (iii) reduce the
rate of or change the time for payment of interest on any Note, (iv) waive a
Default or Event of Default in the payment of principal of or premium, if any,
or interest on the Notes (except a rescission of acceleration of the Notes by
the Holders of at least a majority in aggregate principal amount of the Notes
and a waiver of the payment default that resulted from such acceleration), (v)
make any Note payable in money other than that stated in the Notes, (vi) make
any change in the provisions of the Indenture relating to waivers of past
Defaults or the rights of Holders of the Notes to receive payments of
principal of or premium, if any, or interest on the Notes, (vii) waive a
redemption payment with respect to any Note (other than a payment required by
one of the covenants described above under "--Repurchase at the Option of
Holders"), or (viii) make any change in the foregoing amendment and waiver
provisions.
Without the consent of at least 66 2/3% in principal amount of the Notes
then outstanding (including, without limitation, consents obtained in
connection with a purchase of, or tender offer or exchange offer for, the
Notes), an amendment or waiver may not (with respect to any Notes held by a
non-consenting Holder) release any Subsidiary Guarantor from its obligations
under the Indenture or its Subsidiary Guarantee of the Notes (other than in
accordance with the Indenture).
Notwithstanding the foregoing, without the consent of any Holder of the
Notes, the Company and the Trustee may amend or supplement the Indenture or
the Notes to cure any ambiguity, defect or inconsistency, to provide for
uncertificated Notes in addition to or in place of certificated Notes
(provided that the uncertificated Notes are issued in registered form for
purposes of Section 163(f) of the Code, or in a manner such that the
uncertificated Notes are described in Section 163(f)(2)(B) of the Code), to
provide for the assumption of the Company's obligations to Holders of the
Notes in the case of a merger or consolidation, to make any change that would
provide any additional rights or benefits to the Holders of the Notes or that
does not adversely affect the legal rights under the Indenture of any such
Holder, or to comply with requirements of the Commission in order to effect or
maintain the qualification of the Indenture under the Trust Indenture Act.
CERTAIN DEFINITIONS
Set forth below are certain defined terms used in the Indenture. Reference
is made to the Indenture for a full disclosure of all such terms, as well as
any other capitalized terms used herein for which no definition is provided.
"Acquired Debt" means, with respect to any specified Person, (i)
Indebtedness of any other Person existing at the time such other Person is
merged with or into such Person or a Subsidiary of such Person or became a
Subsidiary of such specified Person, including, without limitation,
Indebtedness incurred in connection with, or in contemplation of, such other
Person merging with or into or becoming a Subsidiary of such specified Person,
and (ii) Indebtedness secured by a Lien encumbering any asset acquired by such
specified Person.
"Affiliate" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled
by" and "under common control with"), as used with respect to any Person,
shall mean the possession, directly or indirectly, of the power to direct or
cause the direction of the management or policies of such Person, whether
through the ownership of voting securities, by agreement or otherwise;
provided, that beneficial ownership of 10% or more of the voting securities of
a Person shall be deemed to be control.
"Asset Sale" means (i) the sale, lease, conveyance or other disposition of
any assets (including, without limitation, by way of a sale and leaseback and
the sale or other disposition of any Residual Receivables) other than sales of
Receivables in connection with Securitizations, Qualified Whole Loan Sales or
Warehouse Facilities and sales of defaulted assets, in each case in the
ordinary course of business (provided that the sale, lease, conveyance or
other disposition of all or substantially all of the assets of the Company and
its Restricted Subsidiaries taken as a whole will be governed by the
provisions of the Indenture described above under the
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caption "Change of Control" and/or the provisions described above under
"Merger, Consolidation or Sale of Assets" and not by the provisions of the
Asset Sale covenant), and (ii) the issuance by any of the Company's Restricted
Subsidiaries of Equity Interests, or the sale by the Company or any of its
Restricted Subsidiaries of any Equity Interests of their Restricted
Subsidiaries (other than directors qualifying shares), in the case of either
clause (i) or (ii), whether in a single transaction or a series of related
transactions (a) that have a fair market value in excess of $1.0 million or
(b) for net proceeds in excess of $1.0 million. Notwithstanding the foregoing,
the following will not be deemed to be Asset Sales: (i) an issuance of Equity
Interests by a Subsidiary of the Company to the Company or to a Subsidiary
Guarantor of the Company; (ii) a Restricted Payment that is permitted by the
covenant described above under "Restricted Payments"; (iii) a sale, lease,
conveyance or other disposition by a Restricted Subsidiary of the Company to
the Company or a Subsidiary Guarantor or by the Company to a Subsidiary
Guarantor and (iv) stock splits, dividends or other distributions to the
Company's shareholders payable in Equity Interests of the Company (other than
Disqualified Capital Stock).
"Book-Entry Residual Receivables" means the interest represented by a ledger
entry on the books of a trustee of a Securitization Trust relating to Residual
Receivables of the Company derived from Receivables originated by a Strategic
Alliance Client for sale into such Securitization Trust as part of a
Securitization of Receivables by the Company or any of its Restricted
Subsidiaries, net of the amount of fees paid to the Company by such Strategic
Alliance Client for arranging the securitization of such Receivables.
"Capital Lease Obligation" means, at the time any determination thereof is
to be made, the amount of the liability in respect of a capital lease that
would at such time be required to be capitalized on a balance sheet in
accordance with GAAP.
"Capital Contribution" means any contribution to the equity of the Company
for which no consideration (other than the issuance of Equity Interests (other
than Disqualified Stock) of the Company) is paid.
"Capital Stock" means (i) in the case of a corporation, corporate stock,
(ii) in the case of an association or business entity, any and all shares,
interests, participations, rights or other equivalents (however designated) of
corporate stock, (iii) in the case of a partnership or limited liability
company, partnership (whether general or limited) or membership interests and
(iv) any other interest or participation that confers on a Person the right to
receive a share of the profits and losses of, or distributions of assets of,
the issuing Person.
"Cash Equivalents" means (i) United States dollars, (ii) securities issued
or directly and fully guaranteed or insured by the United States government or
any agency or instrumentality thereof having maturities of not more than one
year from the date of acquisition, (iii) certificates of deposit and
Eurodollar time deposits with maturities of one year or less from the date of
acquisition, bankers' acceptances with maturities not exceeding one year and
overnight bank deposits, in each case with any domestic commercial bank having
capital and surplus in excess of $500.0 million and a Keefe Bank Watch Rating
of "B" or better, (iv) repurchase obligations with a term of not more than
seven days for underlying securities of the types described in clauses (ii)
and (iii) above entered into with any financial institution meeting the
qualifications specified in clause (iii) above, (v) commercial paper having
one of the two highest ratings obtainable from Moody's or Standard & Poor's
and in each case maturing within nine months after the date of acquisition,
and (vi) money market funds, the portfolios of which are limited to
investments described in clauses (i) through (v) above.
"Change of Control" means the occurrence of any of the following: (i) the
sale, lease, transfer, conveyance or other disposition (other than by way of
merger or consolidation and excluding sales, leases, transfers, conveyances or
other dispositions pursuant to whole loan sales, Securitizations, Warehouse
Facilities or Residual Receivables financing arrangements otherwise permitted
by the Indenture entered into in the ordinary course of business), in one or a
series of related transactions, of all or substantially all of the assets of
the Company and its Restricted Subsidiaries taken as a whole to any "person"
(as such term is used in Section 13(d)(3) of the Exchange Act) other than a
Permitted Holder, (ii) the adoption of a plan relating to the liquidation or
dissolution of the Company, (iii) the consummation of any transaction
(including, without limitation, any merger or consolidation) the result of
which is that any "person" (as defined above) other than a Permitted Holder
becomes the "beneficial owner" (as such term is defined in Rule 13d-3 and Rule
13d-5 under the Exchange Act), directly
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or indirectly, of more than 50% of the Voting Stock of the Company (measured
by general voting power rather than number of shares), (iv) the first day on
which a majority of the members of the Board of Directors of the Company are
not Continuing Directors or (v) the Company consolidates with, or merges with
or into, any Person, or any Person consolidates with, or merges with or into,
the Company, in any such event pursuant to a transaction in which any of the
outstanding Voting Stock of the Company is converted into or exchanged for
cash, securities or other property, other than any such transaction where the
Voting Stock of the Company outstanding immediately prior to such transaction
is converted into or exchanged for Voting Stock (other than Disqualified
Stock) of the surviving or transferee Person constituting a majority of the
outstanding shares of such Voting Stock of such surviving or transferee Person
(immediately after giving effect to such issuance). For purposes of this
definition, any transfer of an equity interest of an entity that was formed
for the purpose of acquiring Voting Stock of the Company will be deemed to be
a transfer of such portion of such Voting Stock as corresponds to the portion
of the equity of such entity that has been so transferred.
"Code" means the Internal Revenue Code of 1986, as amended.
"Consolidated Leverage Ratio" as of any date of determination means the
ratio of (i) the aggregate amount of all consolidated Indebtedness of the
Company and its Restricted Subsidiaries excluding (A) Permitted Warehouse
Debt, and (B) Hedging Obligations permitted to be incurred pursuant to clause
(6) of the covenant described under "--Incurrence of Indebtedness and Issuance
of Preferred Stock" to (ii) the Consolidated Net Worth of the Company.
"Consolidated Net Income" means, with respect to any Person for any period,
the aggregate of the Net Income of such Person and its Restricted Subsidiaries
(for such period, on a consolidated basis, determined in accordance with
GAAP); provided, that (i) the Net Income (but not loss) of any Person that is
not a Restricted Subsidiary or that is accounted for by the equity method of
accounting shall be included only to the extent of the amount of dividends or
distributions paid in cash to the referent Person or a Restricted Subsidiary
thereof, (ii) the Net Income of any Restricted Subsidiary shall be excluded to
the extent that the declaration or payment of dividends or similar
distributions by that Restricted Subsidiary of that Net Income is not at the
date of determination permitted without any prior governmental approval (that
has not been obtained) or, directly or indirectly, by operation of the terms
of its charter or any agreement, instrument, judgment, decree, order, statute,
rule or governmental regulation applicable to that Restricted Subsidiary or
its stockholders, (iii) the Net Income of any Person acquired in a pooling of
interests transaction for any period prior to the date of such acquisition
shall be excluded and (iv) the cumulative effect of a change in accounting
principles shall be excluded.
"Consolidated Net Worth" means, with respect to any Person as of any date,
the sum of (i) the consolidated equity of the common stockholders of such
Person and its consolidated Restricted Subsidiaries as of such date plus (ii)
the respective amounts reported on such Person's balance sheet as of such date
with respect to any series of preferred stock (other than Disqualified Stock)
that by its terms is not entitled to the payment of dividends unless such
dividends may be declared and paid only out of net earnings but only to the
extent of any cash received by such Person upon issuance of such preferred
stock, less (x) all write-ups (other than write-ups resulting from foreign
currency translations and write-ups of tangible assets of a going concern made
within 12 months after the acquisition of such business) subsequent to the
date of the Indenture in the book value of any asset owned by such Person or a
consolidated Restricted Subsidiary of such Person, (y) all Investments as of
such date in unconsolidated Restricted Subsidiaries and in Persons that are
not Restricted Subsidiaries and (z) all unamortized debt discount and expense
and unamortized deferred charges as of such date, all of the foregoing
determined in accordance with GAAP.
"Continuing Director" means, as of any date of determination, any member of
the Board of Directors of the Company who (i) was a member of such Board of
Directors on the Issue Date or (ii) was nominated for election or elected to
such Board of Directors with the approval of a majority of the Directors
constituting Continuing Directors who were members of such Board at the time
of such nomination or election.
"Convertible Notes" shall mean the Company's Convertible Subordinated Notes
Due 2006 issued November 1, 1996.
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"Credit Enhancement Agreements" means, collectively, any document,
instrument or agreement entered into by the Company, or any of its Restricted
Subsidiaries, and any Person exclusively for the purpose of providing credit
support for asset-backed securities issued in connection with Securitizations.
"Default" means any event that is or with the passage of time or the giving
of notice or both would be an Event of Default.
"Disqualified Stock" means any Capital Stock that either (A) by its terms
(or by the terms of any security into which it is convertible or for which it
is exchangeable), or upon the happening of any event, (i) matures or is
mandatorily redeemable, in whole or in part, pursuant to a sinking fund
obligation or otherwise, or (ii) is convertible into or exchangeable for
Indebtedness or Disqualified Stock, in whole or in part, or (iii) is
redeemable, in whole or in part, at the option of the Holder thereof at any
time, in any such case, on or prior to the date that is 91 days after the date
on which the Notes mature, or (B) is designated by the Company (in a
resolution of the Board of Directors delivered to the Trustee) as Disqualified
Stock.
"Eligible Receivables" means, at the time of determination, Receivables
meeting the sale or loan eligibility criteria set forth in one or more of the
Warehouse Facilities to which the Company or any of its Restricted
Subsidiaries is a party at such time and is eligible for sale in a
Securitization or pursuant to a Qualified Whole Loan Purchase.
"Equity Interests" means Capital Stock and all warrants, options or other
rights to acquire such Capital Stock (but excluding any debt security that is
convertible into, or exchangeable for, such Capital Stock).
"Excess Spread" means, over the life of a pool of Receivables that have been
sold by the Company or a Restricted Subsidiary in a Securitization (including
Receivables which have been contributed by a Strategic Alliance Client to any
such Securitization), the amount determined by deriving the net present value
of the cash flows expected to be received by the Company or any Restricted
Subsidiary of the Company from the Securitization of such Receivables
(exclusive of any proceeds from the sale of certificates by the Company or any
of its Restricted Subsidiaries to any underwriter of the related
certificates), less the net present value of any servicing fees and any
liabilities of the Company or any of its Restricted Subsidiaries (based on the
Company's or such Restricted Subsidiary's historical liabilities to
Securitization trustees).
"fair market value" means, with respect to any asset or property, the price
which could be negotiated in an arm's-length, free market transaction, for
cash, between an informed and willing seller and an informed, willing and able
buyer, neither of whom is under undue pressure or compulsion to complete the
transaction.
"Foreign Residual Receivables" means Residual Receivables that relate to
Receivables which originated from jurisdictions outside the United States of
America.
"Foreign Subsidiary" means any Restricted Subsidiary of the Company that is
incorporated in a jurisdiction other than the United States of America or 80%
of the sales, earnings or assets of which are located in, generated from or
derived from operations located in jurisdictions outside the United States of
America.
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as have been approved by a significant segment of the accounting
profession, which are in effect at the relevant time.
"Guarantee" means a guarantee (other than by endorsement of negotiable
instruments for collection in the ordinary course of business), direct or
indirect, in any manner (including, without limitation, letters of credit and
reimbursement agreements in respect thereof), of all or any part of any
Indebtedness. Notwithstanding the foregoing, the term "Guarantee" does not
include obligations pursuant to representations, warranties, covenants and
indemnities in connection with a Securitization or Warehouse Facility.
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"Hedging Obligations" means, with respect to any Person, the obligations of
such Person under (i) interest rate or currency swap agreements, cap
agreements, collar agreements and related agreements and (ii) other agreements
or arrangements designed to protect such Person against fluctuations in value
of assets owned, financed or sold, or of liabilities incurred or assumed, or
of pre-funding arrangements, in any case in the ordinary course of business of
such Person and not for speculative purposes.
"Indebtedness" means, with respect to any Person, any indebtedness of such
Person, whether or not contingent, in respect of (i) borrowed money or
evidenced by bonds, notes, debentures or similar instruments or letters of
credit (or reimbursement agreements in respect thereof) or banker's
acceptances or representing Capital Lease Obligations or the unpaid deferred
balance of the purchase price of any property or representing any Hedging
Obligations, except any such balance that constitutes an accrued expense or
trade payable, if and to the extent any of the foregoing indebtedness (other
than letters of credit and Hedging Obligations) would appear as a liability
upon a balance sheet of such Person prepared in accordance with GAAP, (ii) all
indebtedness of others secured by a Lien on any asset of such Person (whether
or not such indebtedness is assumed by such Person; provided that if such
indebtedness is not assumed by such Person such indebtedness shall be limited
to the lesser of the principal amount of such indebtedness or the fair market
value of the asset encumbered by such Lien), (iii) without duplication, all
Warehouse Debt, (iv) all obligations of such Person with respect to the
redemption, repayment or other repurchase of any Disqualified Stock and, in
the case of any Subsidiary Guarantor, preferred stock (but excluding in each
case any accrued dividends thereon), and (v) to the extent not otherwise
included, the Guarantee by such Person of any indebtedness of any other Person
to the extent of any Guarantee of such indebtedness provided by such Person.
Except in the case of Warehouse Debt (the amount of which shall be determined
in accordance with the definition thereof) and except in the case of Hedging
Obligations (the amount of which shall be determined on a net basis after
rights of set-off and related positions), the amount of Indebtedness of any
Person at any date shall be the outstanding balance at such date of all
unconditional obligations as described above and the maximum liability, upon
the occurrence of the contingency giving rise to the obligation, of any
contingent obligations at such date. Notwithstanding the foregoing, the term
"Indebtedness" does not include obligations pursuant to representations,
warranties, covenants and indemnities in connection with a Securitization,
Qualified Whole Loan Sale or Warehouse Facility.
"Investments" means, with respect to any Person, all investments by such
Person in other Persons (including Affiliates including, without limitation,
Quasi-Subsidiaries and Strategic Alliance Clients) in the forms of direct or
indirect loans (including Guarantees of Indebtedness), advances or capital
contributions (excluding commission, travel and similar advances to officers
and employees made in the ordinary course of business), purchases or other
acquisitions for consideration of Indebtedness of another Person, Equity
Interests or other securities, together with all items that are or would be
classified as investments on a balance sheet prepared in accordance with GAAP;
provided that an acquisition of Equity Interests or other securities by the
Company or any Restricted Subsidiary for consideration consisting solely of
common equity securities of the Company (other than Disqualified Stock) shall
not be deemed to be an Investment.
"Issue Date" means , 1997.
"Lien" means, with respect to any asset, any mortgage, lien, pledge, charge,
security interest or encumbrance of any kind in respect of such asset, whether
or not filed, recorded or otherwise perfected under applicable law (including
any conditional sale or other title retention agreement, any lease in the
nature thereof, any option or other agreement to sell or give a security
interest in and any filing of or agreement to give any financing statement
under the Uniform Commercial Code (or equivalent statutes) of any
jurisdiction).
"Mortgage Loan" means any mortgage, deed of trust or other instrument
creating a lien on an estate in fee simple in a property, secured by a note or
other evidence of an obligor's indebtedness under such mortgage, deed of trust
or other instrument.
"Net Income" means, with respect to any Person, the net income (loss) of
such Person, determined in accordance with GAAP and before any reduction in
respect of preferred stock dividends, excluding, however, (i) any gain (but
not loss), together with any related provision for taxes on such gain (but not
loss), realized in
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connection with (a) any Asset Sale (including, without limitation,
dispositions pursuant to sale and leaseback transactions and dispositions of
any equity Investment in a Strategic Alliance Client or Quasi-Subsidiary) or
(b) the disposition of any securities by such Person or any of its Restricted
Subsidiaries or the extinguishment of any Indebtedness of such Person or any
of its Restricted Subsidiaries and (ii) any extraordinary or nonrecurring gain
(but not loss), together with any related provision for taxes on such
extraordinary or nonrecurring gain (but not loss).
"Net Proceeds" means the aggregate Cash Equivalent proceeds received by the
Company or any of its Restricted Subsidiaries in respect of any Asset Sale
(including, without limitation, any Cash Equivalent received upon the sale or
other disposition of any non-cash consideration received in any Asset Sale),
net of the direct costs relating to such Asset Sale (including, without
limitation, legal, accounting and investment banking fees, and sales
commissions) incurred as a result thereof, taxes paid or payable, in the good
faith estimation of the Company, as a result thereof (after taking into
account any available tax credits or deductions and any tax sharing
arrangements), amounts required to be applied to the repayment of Indebtedness
(other than Indebtedness subordinated in right of payment to the Notes)
secured by a Lien on the asset or assets that were the subject of such Asset
Sale and any reserve for adjustment in respect of the sale price of such asset
or assets established in accordance with GAAP.
"Non-Recourse Debt" means Indebtedness (i) as to which neither the Company
nor any of its Restricted Subsidiaries (a) provides credit support of any kind
(including any undertaking, agreement or instrument that would constitute
Indebtedness), or (b) is directly or indirectly liable (as a guarantor or
otherwise); and (ii) as to which the lenders have been notified in writing
that they will not have any recourse to the stock or assets of the Company or
any of its Restricted Subsidiaries, including the stock of such Unrestricted
Subsidiary.
"Permitted Businesses" means any consumer or commercial finance business or
any financial service business.
"Permitted Holder" means Imperial Credit Industries, Inc.
"Permitted Investments" means (a) any Investment in the Company or in a
Restricted Subsidiary that is engaged in a Permitted Business; (b) any
Investment in Cash Equivalents; (c) any Investment by the Company or any
Restricted Subsidiary in a Person if, as a result of such Investment, (i) such
Person becomes a Restricted Subsidiary and a Subsidiary Guarantor that is
engaged in a Permitted Business or (ii) such Person is merged, consolidated or
amalgamated with or into, or transfers or conveys substantially all of its
assets to, or is liquidated into, the Company or a Restricted Subsidiary that
is a Subsidiary Guarantor and that is engaged in a Permitted Business; (d) any
Restricted Investment made as a result of the receipt of non-cash
consideration from an Asset Sale that was made pursuant to and in compliance
with the covenant described above under "Repurchase at the Option of Holders--
Asset Sales;" (e) any creation, purchase or other acquisition of Receivables,
Residual Receivables or Servicing Receivables in the ordinary course of
business; (f) other Investments in any Person that do not exceed $5.0 million
in the aggregate since the Issue Date; (g) any Investment in a Strategic
Alliance Client to the extent such Investment consists of options, warrants or
other securities that are convertible or exchangeable for equity securities of
such Strategic Alliance Client and is received by the Company or a Restricted
Subsidiary without the payment of any consideration other than the concurrent
provision by the Company or such Restricted Subsidiary to such Strategic
Alliance Client of asset securitization or asset sale expertise on terms
determined by the Company to be fair and reasonable to the Company or such
Restricted Subsidiary from a financial point of view without taking into
consideration any value that may inhere in such option, warrant or convertible
or exchangeable security; and (h) any loans or advances to a Strategic
Alliance Client to the extent such loans or advances consist of Indebtedness
of such Strategic Alliance Client in an aggregate principal amount at any time
outstanding not to exceed 100% of the aggregate book value (calculated in
accordance with GAAP) of the Book-Entry Residual Receivables credited to such
Strategic Alliance Client.
"Permitted Liens" means (i) Liens on Receivables or other assets (other than
Residual Receivables and Book-Entry Residual Receivables) securing Warehouse
Debt or Hedging Obligations (or Guarantees of
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Warehouse Debt or Hedging Obligations); (ii) Liens on Servicing Receivables,
Residual Receivables and on the Capital Stock of Restricted Subsidiaries of
the Company substantially all of the assets of which are Residual Receivables;
provided, however, that, (x) no Lien shall be placed on any Retained Residual
Receivable unless after giving effect to such sale, conveyance or other
disposition the aggregate amount of Senior Residual Receivables of the Company
and its Restricted Subsidiaries which are unencumbered by any Lien would be
greater than or equal to 250% of all Senior Indebtedness of the Company and
its Restricted Subsidiaries, (y) after giving effect to the incurrence of such
Lien the aggregate amount of Senior Residual Receivables of the Company and
its Restricted Subsidiaries which are unencumbered by any Lien would be
greater than or equal to 150% of all Senior Indebtedness of the Company and
its Restricted Subsidiaries; provided, that for purposes of calculating the
aggregate amount of Senior Residual Receivables of the Company and its
Restricted Subsidiaries which are unencumbered by any Lien in clauses (x) and
(y) above, no more than 25% of the aggregate book value thereof shall
constitute Retained Residual Receivables; (iii) Liens in favor of the Company
or any Restricted Subsidiary; (iv) Liens on property of a Person existing at
the time such Person is merged into or consolidated with the Company or any
Restricted Subsidiary of the Company; provided that such Liens were in
existence prior to the contemplation of such merger or consolidation and do
not extend to any assets other than those of the Person merged into or
consolidated with the Company or such Restricted Subsidiary; (v) Liens on
property existing at the time of acquisition thereof by the Company or any
Restricted Subsidiary of the Company, provided that such Liens were in
existence prior to the contemplation of such acquisition; (vi) Liens to secure
the performance of statutory obligations, surety or appeal bonds, performance
bonds or other obligations of a like nature incurred in the ordinary course of
business; (vii) Liens existing on the Issue Date; (viii) Liens for taxes,
assessments or governmental charges or claims that are not yet delinquent or
that are being contested in good faith by appropriate proceedings, provided
that any reserve or other appropriate provision as shall be required in
conformity with GAAP shall have been made therefor; (ix) Liens (including,
without limitation, Liens on Residual Receivables) in favor of a monoline
insurance company or other provider of credit enhancement pursuant to a Credit
Enhancement Agreement; (x) Liens incurred in the ordinary course of business
of the Company or any Restricted Subsidiary of the Company with respect to
obligations that do not exceed $1.0 million at any one time outstanding and
that (a) are not incurred in connection with the borrowing of money or the
obtaining of advances or credit (other than trade credit in the ordinary
course of business) and (b) do not in the aggregate materially detract from
the value of the property or materially impair the use thereof in the
operation of business by the Company or such Restricted Subsidiary; (xi) Liens
imposed by law, including but not limited to carriers', warehousemen's and
mechanics' Liens, in each case for sums not yet due or being contested in good
faith by appropriate proceedings or, other Liens arising out of judgments or
awards against the Company or any of its Restricted Subsidiaries with respect
to which the Company or such Restricted Subsidiary shall then be proceeding
with an appeal or other proceedings for review; (xii) survey exceptions,
easements and other restrictions on the use of property; (xiii) Liens securing
Indebtedness the proceeds of which were utilized by the Company or a
Restricted Subsidiary solely to fund any advances to Securitization Trusts
permitted by clause (v) of the second full paragraph under the caption "--
Certain Covenants--Restricted Payments," provided that such Liens encumber no
assets other than the contractual right of the Company or such Restricted
Subsidiary, as the case may be, to be reimbursed in respect of any advances
funded by such Indebtedness; and (xiv) Liens to secure any Refinancing (or
successive Refinancings), in whole or in part, of any Indebtedness (or
commitment for Indebtedness) existing on the Issue Date; provided, however,
that (x) any such new Lien shall be a Lien on the same asset class or interest
securing the original Lien, (y) the Indebtedness secured by such Lien is not,
solely by virtue of the Refinancing (unless otherwise permitted by the
Indenture), increased to an amount greater than the greater of (A) the
outstanding principal amount of the Indebtedness existing on the Issue Date
secured by such Lien, or (B) if such Lien secures Indebtedness under a line of
credit, the commitment amount of such line of credit existing on the Issue
Date and (z) such Indebtedness is not otherwise prohibited by the Indenture.
Any determination of Senior Residual Receivables shall be based on the
consolidated balance sheet of the Company and its Restricted Subsidiaries for
the most recently ended fiscal quarter for which financial statements are
available, after giving pro forma effect to the Lien for which such
determination is being made and to any other sale of or Lien on or reduction
of Residual Receivables since the date of such balance sheet.
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"Permitted Refinancing Indebtedness" means any Indebtedness or Disqualified
Stock of the Company or any of its Restricted Subsidiaries issued in exchange
for or the net proceeds of which are used to extend, refinance, renew,
replace, defease or refund other Indebtedness or Disqualified Stock of the
Company or any of its Restricted Subsidiaries (other than Indebtedness
incurred pursuant to clauses (1), (2), (6), (7), (8), (9) and (10) of the
second paragraph of the covenant described under "Limitation on Incurrence of
Indebtedness and Issuance of Preferred Stock"); provided that: (i) the
principal amount (or accreted value, if applicable) or mandatory redemption
amount of such Permitted Refinancing Indebtedness does not exceed the
principal amount of (or accreted value, if applicable) or mandatory redemption
amount, plus accrued but unpaid interest or dividends on, the Indebtedness or
Disqualified Stock so extended, refinanced, renewed, replaced, defeased or
refunded (plus the amount of contractual prepayment charges and reasonable
expenses incurred in connection therewith); (ii) such Permitted Refinancing
Indebtedness has a final maturity or final redemption date later than the
final maturity or final redemption date of, and has a Weighted Average Life to
Maturity equal to or greater than the Weighted Average Life to Maturity of,
the Indebtedness or Disqualified Stock being extended, refinanced, renewed,
replaced, defeased or refunded; (iii) if the Indebtedness or Disqualified
Stock being extended, refinanced, renewed, replaced, defeased or refunded is
subordinated in right of payment to the Notes, such Permitted Refinancing
Indebtedness is subordinated in right of payment to, the Notes on terms at
least as favorable to the Holders of the Notes as those contained in the
documentation governing the Indebtedness or Disqualified Stock being extended,
refinanced, renewed, replaced, defeased or refunded; and (iv) such
Indebtedness is incurred or such Disqualified Stock is issued either by the
Company or by the Restricted Subsidiary who is the obligor on the Indebtedness
or Disqualified Stock being extended, refinanced, renewed, replaced, defeased
or refunded.
"Permitted Warehouse Debt" means Warehouse Debt of the Company or a
Restricted Subsidiary outstanding under one or more Warehouse Facilities
(excluding any Guarantees issued by the Company or a Restricted Subsidiary in
connection therewith); provided, however, that (i) the assets purchased with
proceeds of such Warehouse Debt are or, prior to any funding under the
Warehouse Facility with respect to such assets, were eligible to be recorded
as held for sale on the consolidated balance sheet of the Company and its
Restricted Subsidiaries in accordance with GAAP, (ii) such Warehouse Debt will
be deemed Permitted Warehouse Debt (a) in the case of a Purchase Facility,
only to the extent the holder of such Warehouse Debt has no contractual
recourse to the Company or any of its Restricted Subsidiaries to satisfy
claims in respect of such Warehouse Debt in excess of the realizable value of
the Eligible Receivables financed thereby, and (b) in the case of any other
Warehouse Facility, at the time such Warehouse Debt is incurred, only to the
extent of the lesser of (A) the amount advanced by the lender with respect to
the Eligible Receivables financed under such Warehouse Facility, and (B) 100%
of the aggregate principal amount of such Eligible Receivables and (iii) any
such Indebtedness incurred under such Warehouse Facility has not been
outstanding in excess of 364 days.
"Person" means any individual, corporation, partnership, joint venture,
association, joint stock company, limited liability company, trust,
unincorporated organization, government or any agency or political subdivision
thereof or any other entity.
"Public Equity Offering" means an underwritten offering of common stock of
the Company for cash pursuant to an effective registration statement under the
Securities Act.
"Purchase Facility" means any Warehouse Facility in the form of a purchase
and sale facility pursuant to which the Company or a Restricted Subsidiary
sells Receivables to a financial institution, commercial paper facility or
conduit and retains a right of first refusal or other repurchase arrangement
upon the subsequent resale of such Receivables by such financial institution,
commercial paper facility or conduit.
"Qualified Whole Loan Sale" means any sale of a pool of Receivables to one
or more third parties on an arms length basis and pursuant to a sale and
purchase agreement containing standard representations, warranties and
covenants relating to the Mortgage Loans sold and purchased thereunder.
"Qualifying Disposition" means an Asset Sale resulting from the exercise by
a Quasi-Subsidiary (or any of its Affiliates other than the Company and its
Affiliates) of a call option on Equity Interests of such Quasi-
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Subsidiary owned by the Company (or any of its Restricted Subsidiaries), so
long as the Company (or such Restricted Subsidiary) receives Net Proceeds in
Cash Equivalents therefrom in an amount at least equal to the initial book
value of the Company's (or such Restricted Subsidiary's) Investment in such
Equity Interests.
"Quasi-Subsidiary" means any Person (i) who is a Subsidiary of the Company
and (ii) who has (together with any call options held by any of its Affiliates
other than the Company and its Affiliates) one or more call options or similar
arrangements which, upon exercise thereof, would result in the Company no
longer, directly or indirectly through any of its Restricted Subsidiaries, (x)
with respect to any corporation, association or other business entity, owning
more than 50% of the total voting power of shares of Capital Stock entitled
(without regard to the occurrence of any contingency) to vote in the election
of directors, managers or trustees thereof, or (y) with respect to any
partnership or limited liability company (a) being the sole general partner or
the managing general partner or managing member of such Person or (b) being
the only general partner or managing member of such Person.
"Receivables" means consumer and commercial loans, including Mortgage Loans,
leases and receivables purchased or originated by the Company or any
Restricted Subsidiary; provided, however, that for purposes of determining the
principal value of a Receivable at any time, such principal value shall be
determined in accordance with GAAP, consistently applied, as of the then most
recent practicable date.
"Refinance" means, in respect of any Indebtedness, to extend, refinance,
renew, replace, defease, refund, repay, prepay, redeem, or retire, or to issue
other Indebtedness in exchange or replacement for, such Indebtedness.
"Refinanced" and "Refinancing" shall have correlative meanings.
"Residual Receivables" means at any time, the capitalized asset value of
Excess Spread of the Company and its Restricted Subsidiaries (including,
without limitation, interest-only and residual certificates of a
Securitization Trust), with respect to any Receivable pool of any
Securitization Trust, calculated in accordance with GAAP, consistently
applied, less an amount equal to the net Indebtedness owed by the Company to a
Strategic Alliance Client in consideration for a contribution of Receivables
(represented by a Book-Entry Receivable of such entity).
"Restricted Investment" means an Investment other than a Permitted
Investment.
"Restricted Subsidiary" means any Subsidiary other than an Unrestricted
Subsidiary.
"Retained Residual Receivables" has the meaning specified under "--
Repurchase at Option of Holders-Asset Sales."
"Securitization" means a public or private sale or pledge of Receivables in
the ordinary course of business and by which the Company or a Restricted
Subsidiary directly or indirectly sells, conveys, pledges or otherwise creates
a Lien on a pool of specified Receivables, including any such transaction
involving the sale of specified Receivables to a Securitization Trust which
issues securities to investors in such Securitization Trust and creates
Residual Receivables.
"Securitization Trust" means any Person that is not a Restricted Subsidiary
established exclusively for the purpose of issuing securities in connection
with any Securitization, the obligations of which are without recourse to the
Company or any of its Subsidiaries (other than obligations constituting
Indebtedness incurred in accordance with the first paragraph of the covenant
described under "Certain Covenants--Incurrence of Indebtedness and Issuance of
Preferred Stock").
"Senior Indebtedness" means all Indebtedness of any Person that is not
subordinated in right of payment to any other Indebtedness or other
obligations of such Person, excluding Permitted Warehouse Debt and Hedging
Obligations permitted to be incurred under the Indenture and, in the case of
Indebtedness secured by Senior
Residual Receivables, the lesser of (x) the amount of such Indebtedness and
(y) the amount of the Senior Residual Receivables securing such Indebtedness.
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"Senior Residual Receivables" means Residual Receivables of the Company or
any of its Restricted Subsidiaries which are not structurally subordinated to
any other interest in the Securitization of a pool of Receivables creating
such Residual Receivables other than the certificates initially distributed by
an underwriter or underwriters in connection with such Securitization.
"Servicing Receivables" means the servicing rights or any interest therein
with respect to any Receivables.
"Strategic Alliance Client" means any Person (other than a Restricted
Subsidiary) engaged in a Permitted Business to which the Company provides, or
reasonably expects to provide, financing, asset securitization or asset sales
expertise in return for commitments by such Strategic Alliance Client to sell
Receivables, from time to time, to the Company or a Restricted Subsidiary of
the Company.
"Subsidiary" means, with respect to any Person, (i) any corporation,
association or other business entity of which more than 50% of the total
voting power of shares of Capital Stock entitled (without regard to the
occurrence of any contingency) to vote in the election of directors, managers
or trustees thereof is at the time owned or controlled, directly or
indirectly, by such Person or one or more of the other Subsidiaries of that
Person (or a combination thereof) and (ii) any partnership or limited
liability company (a) the sole general partner or the managing general partner
or managing member of which is such Person or a Subsidiary of such Person or
(b) the only general partners or managing members of which are such Person or
one or more Subsidiaries of such Person (or any combination thereof).
"Subsidiary Guarantee" means the Guarantee of the Notes in accordance with
the provisions of the Indenture.
"Subsidiary Guarantor" means any Subsidiary of the Company that executes a
Subsidiary Guarantee in accordance with the provisions of the Indenture.
"Unrestricted Subsidiary" means any Subsidiary that is designated by the
Board of Directors as an Unrestricted Subsidiary pursuant to a Board
Resolution; but only to the extent that such Subsidiary: (a) is not party to
any agreement, contract, arrangement or understanding with the Company or any
Restricted Subsidiary unless the terms of any such agreement, contract,
arrangement or understanding are no less favorable to the Company or such
Restricted Subsidiary than those that might be obtained at the time from
Persons who are not Affiliates of the Company; (b) is a Person with respect to
which neither the Company nor any of its Restricted Subsidiaries has any
direct or indirect obligation (other than obligations constituting
Indebtedness incurred in accordance with the first paragraph of the covenant
described under "Certain Covenants--Incurrence of Indebtedness and Issuance of
Preferred Stock") (x) to subscribe for additional Equity Interests or (y) to
maintain or preserve such Person's financial condition or to cause such Person
to achieve any specified levels of operating results; and (c) has not
guaranteed or otherwise directly or indirectly provided credit support for any
Indebtedness of the Company or any of its Restricted Subsidiaries. Any such
designation by the Board of Directors shall be evidenced to the Trustee by
filing with the Trustee a certified copy of the Board Resolution giving effect
to such designation and an Officers' Certificate certifying that such
designation complied with the foregoing conditions and was permitted by the
covenant described above under the caption "Certain Covenants--Restricted
Payments." If, at any time, any Unrestricted Subsidiary would fail to meet the
foregoing requirements as an Unrestricted Subsidiary, it shall thereafter
cease to be an Unrestricted Subsidiary for purposes of the Indenture and any
Indebtedness of such Subsidiary shall be deemed to be incurred by a Restricted
Subsidiary of the Company as of such date (and, if such Indebtedness is not
permitted to be incurred as of such date under the covenant described under
the caption "Incurrence of Indebtedness and Issuance of Preferred Stock," the
Company shall be in default of such covenant). The Board of Directors of the
Company may at any time designate any Unrestricted Subsidiary to be a
Restricted Subsidiary; provided that such designation shall be deemed to be an
incurrence of Indebtedness and issuance of preferred stock by a Restricted
Subsidiary of the
Company of any outstanding Indebtedness or outstanding issue of preferred
stock of such Unrestricted Subsidiary and such designation shall only be
permitted if (i) such Indebtedness and preferred stock is permitted under the
covenant described under the caption "Certain Covenants--Incurrence of
Indebtedness and Issuance of Preferred
76
<PAGE>
Stock," (ii) such Subsidiary becomes a Subsidiary Guarantor, and (iii) no
Default or Event of Default would exist following such designation.
"Voting Stock" of any Person as of any date means the Capital Stock of such
Person that is at the time entitled to vote generally in the election of the
Board of Directors of such Person.
"Warehouse Debt" means Indebtedness of the Company or a Restricted
Subsidiary equal to the greater of (x) the consideration received by the
Company or its Restricted Subsidiaries under a Warehouse Facility and (y) in
the case of a Purchase Facility, the book value of the Eligible Receivables
financed under such Warehouse Facility, until such time as such Eligible
Receivables are (i) securitized, (ii) repurchased by the Company or its
Restricted Subsidiaries or (iii) sold by the counterparty under the Warehouse
Facility to a Person who is not an Affiliate of the Company, including any
Guarantees issued by the Company or a Restricted Subsidiary in connection
therewith.
"Warehouse Facility" means any funding arrangement, including Purchase
Facilities, with a financial institution or other lender or purchaser or any
conduit or special purpose vehicle used in connection with such funding
arrangement, to the extent (and only to the extent) that the Company or any of
its Restricted Subsidiaries incurs Warehouse Debt thereunder exclusively to
finance or refinance the purchase or origination of Receivables by the Company
or a Restricted Subsidiary prior to securitization.
"Weighted Average Life to Maturity" means, when applied to any Indebtedness
or Disqualified Stock at any date, the number of years obtained by dividing
(i) the sum of the products obtained by multiplying (a) the amount of each
then remaining installment, sinking fund, serial maturity or other required
payments of principal, including payment at final maturity (or final
redemption, in the case of Disqualified Stock), in respect thereof, by (b) the
number of years (calculated to the nearest one-twelfth) that will elapse
between such date and the making of such payment, by (ii) the then outstanding
principal amount of such Indebtedness or mandatory redemption amount of
Disqualified Stock.
"Wholly-Owned Restricted Subsidiary" of any Person means a Restricted
Subsidiary of such Person all of the outstanding Capital Stock or other
ownership interests of which (other than directors' qualifying shares) shall
at the time be owned by such Person or by one or more Wholly-Owned Restricted
Subsidiaries of such Person.
77
<PAGE>
DESCRIPTION OF OTHER INDEBTEDNESS
6.75% CONVERTIBLE SUBORDINATED NOTES
In November 1996, the Company issued its 6.75% Convertible Subordinated
Notes (the "Convertible Notes") in aggregate principal amount of $75.0 million
pursuant to an Indenture (the "6.75% Indenture") dated as of October 1, 1996,
by and between the Company and The Bank of New York, as trustee (the
"Convertible Note Trustee"). The terms of the Convertible Notes include those
set forth in the 6.75% Indenture and those made part of the 6.75% Indenture by
reference to the Trust Indenture Act of 1939, as amended (the "Trust Indenture
Act").
The Convertible Notes are unsecured obligations of the Company, subordinated
in right of payment to all existing and future Senior Indebtedness of the
Company, as described under "Subordination" below. Neither the 6.75% Indenture
nor the Convertible Notes will limit the amount of Senior Indebtedness or
other indebtedness that the Company or any subsidiary may incur.
The Convertible Notes will mature on October 15, 2006. The Convertible Notes
bear interest at 6.75% per annum payable semi-annually in arrears on April 15
and October 15 of each year, commencing on April 15, 1997.
SUBORDINATION
The Convertible Notes are subordinated in right of payment to all existing
and future Senior Indebtedness of the Company and rank at least pari passu
with other unsecured subordinated indebtedness of the Company that pursuant to
its terms provides for such ranking. The rights of holders of Convertible
Notes are effectively subordinated by operation of law to all liabilities
(including trade payables and commitments under leases) of the Company's
subsidiaries, if any. Neither the 6.75% Indenture nor the Convertible Notes
restrict the incurrence of Senior Indebtedness or other indebtedness by the
Company or any subsidiary, or the right of the Company to form, acquire or
have an interest in any subsidiary. Any right of the Company to receive assets
of any subsidiary upon liquidation or reorganization thereof (and the
consequent right of the holders of the Convertible Notes to participate in
those assets) are effectively subordinated to the claims of that subsidiary's
creditors, except to the extent that the Company is itself recognized as a
creditor of such subsidiary, in which case the claims of the Company would
still be subject to any security interests in the assets of such subsidiary
and subordinated to any indebtedness of such subsidiary senior to that held by
the Company.
CONVERSION RIGHTS
The Convertible Notes are convertible into Common Stock, initially at the
conversion price of $23.80 per share (equivalent to approximately 42.02 shares
of Common Stock for each $1,000 principal amount of Convertible Notes), at any
time prior to redemption or maturity. The right to convert a Note called for
redemption or delivered for repurchase pursuant to an offer to repurchase the
Convertible Notes upon a Change of Control will terminate at the close of
business on the fifth Business Day next preceding the redemption date for such
Note (unless the Company shall default in making the redemption payment when
due, in which case the conversion right shall terminate at the close of
business on the date such default is cured or such Note is redeemed). Holders
of the Convertible Notes have the right to convert Convertible Notes called
for redemption until terminated in accordance with the preceding sentence.
The conversion price is subject to adjustment in certain events, including
(i) dividends (and other distributions) payable in Common Stock on any class
of capital stock of the Company, (ii) the issuance to all holders of Common
Stock of rights, options or warrants entitling them to subscribe for or
purchase Common Stock (or securities convertible into Common Stock) at less
than the then-current market price (as determined in accordance with the
Convertible Notes) unless holders of Convertible Notes are entitled to receive
the same upon conversion, (iii) subdivisions, combinations and
reclassifications of Common Stock and (iv) distributions to all
78
<PAGE>
holders of Common Stock of evidences of indebtedness of the Company or assets
(including securities, but excluding not only those rights, options, warrants,
but also dividends and distributions referred to above, dividends and
distributions paid in cash out of the retained earnings of the Company).
OPTIONAL REDEMPTION
The Convertible Notes may be redeemed, at the option of the Company, in
whole or in part, at any time on and after October 31, 1999, upon not less
than 30 nor more than 60 days notice at a redemption price equal to 103% of
their principal amount if redeemed during the period commencing October 31,
1999 through October 14, 2000, 102% of their principal amount if redeemed
during the 12-month period commencing October 15, 2000, 101% of their
principal amount if redeemed during the 12-month period commencing October 15,
2001 and 100% of their principal amount if redeemed on or after October 15,
2002, in each case together with accrued and unpaid interest to the date fixed
for redemption. In the event of a partial redemption, the Convertible Notes to
be redeemed will be selected by the Convertible Note Trustee by such method as
the Convertible Note Trustee shall deem fair and appropriate.
CHANGE OF CONTROL
Each holder of a Convertible Note has the right, at such holder's option, to
cause the Company to purchase such Note (equal to $1,000 or an integral
multiple thereof) in whole or in part, for a cash amount equal to 100% of the
principal amount, together with accrued and unpaid interest to the repurchase
date, if certain events constituting a change of control occur.
EVENTS OF DEFAULT
The 6.75% Indenture defines an Event of Default with respect to the
Convertible Notes as any of the following events: (i) the failure by the
Company to pay any installment of interest on, the Convertible Notes as and
when the same becomes due and payable and the continuance of any such failure
for a period of 30 days, (ii) the failure by the Company to pay all or any
part of the principal of, or premium, if any, on the Convertible Notes as and
when the same becomes due and payable at maturity, redemption, by acceleration
or otherwise, (iii) the failure of the Company to perform any conversion of
Convertible Notes required under the 6.75% Indenture and the continuance of
any such failure for a period of 60 days, (iv) the failure by the Company to
observe or perform any other covenant or agreement contained in the
Convertible Notes or the 6.75% Indenture and, subject to certain exceptions,
the continuance of such failure for a period of 60 days after appropriate
written notice is given to the Company by the Convertible Note Trustee or to
the Company and the Convertible Note Trustee by the holders of at least 25% in
aggregate principal amount of the Convertible Notes outstanding, (v) certain
events of bankruptcy, insolvency or reorganization in respect of the Company
or any of its significant subsidiaries, (vi) a default in the payment of
principal, premium, if any, or interest when due that extends beyond any
stated period of grace applicable thereto or an acceleration for any other
reason of the maturity of any Indebtedness of the Company or any of its
significant subsidiaries with an aggregate principal amount in excess of
$5 million, and (vii) final judgements not covered by insurance aggregating in
excess of $2 million, at any one time rendered against the Company or any of
its subsidiaries and not satisfied, stayed, bonded or discharged within 60
days.
The 6.75% Indenture provides that if an Event of Default occurs and is
continuing, then the Company will provide notice thereof to the Convertible
Note Trustee within five Business Days after the Company becomes aware of such
Event of Default, and the Convertible Note Trustee shall then notify the
holders of Convertible Notes thereof within 90 days after its receipt of
notice from the Company. If an Event of Default occurs and is continuing, the
Convertible Note Trustee or the holders of 25% in aggregate principal amount
of the Convertible Notes then outstanding may, by notice in writing to the
Company (and to the Convertible Note Trustee, if given by the holders),
declare all principal and accrued interest thereon to be due and payable
immediately.
79
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement (the
"Underwriting Agreement"), each of the underwriters named below (the
"Underwriters"), has agreed to purchase from the Company and the Company has
agreed to sell to the Underwriters, the aggregate principal amount of the
Notes set forth opposite its name below:
<TABLE>
<CAPTION>
PRINCIPAL AMOUNT
UNDERWRITER OF NOTES
----------- ----------------
<S> <C>
Donaldson, Lufkin & Jenrette Securities Corporation......... $
NationsBanc Montgomery Securities, Inc. ....................
Smith Barney Inc. ..........................................
------------
Total................................................... $125,000,000
============
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
to purchase and accept delivery of the Notes offered hereby are subject to
certain conditions precedent. If any of the Notes are purchased by the
Underwriters pursuant to the Underwriting Agreement, all such Notes must be
purchased.
The Underwriters propose initially to offer the Notes directly to the public
at the public offering price set forth on the cover page of this Prospectus
and to certain dealers at such price less a concession not to exceed % of
the principal amount of the Notes. The Underwriters may allow, and such
dealers may reallow, discounts not to exceed % of the principal amount of
the Notes on sales to certain other dealers. After the initial public offering
of the Notes, the public offering price and concession and reallowance and
other selling terms may be changed by the Underwriters.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including the liabilities under the Securities Act, and to
contribute to payments which the Underwriters may be required to make in
respect thereof.
The Notes are a new issue of securities with no existing market and the
Company does not intend to list the Notes on any national securities exchange.
The Underwriters have advised the Company that they currently intend to make a
market in the Notes, but are not obligated to do so and may discontinue any
such market making at any time without notice. Accordingly, no assurance can
be given as to the liquidity of the trading market for the Notes or that an
active trading market for the Notes will develop.
In connection with the Offering, the Underwriters may engage in transactions
that stabilize, maintain or otherwise affect the price of the Notes.
Specifically, the Underwriters may overallot the Offering, creating a
syndicate short position. Underwriters may bid for and purchase Notes in the
open market to cover syndicate short positions. In addition, the Underwriters
may bid for and purchase Notes in the open market to stabilize the price of
the Notes. These activities may stabilize or maintain the market price of the
Notes above independent market levels. The Underwriters are not required to
engage in these activities, and may end these activities at any time.
Under the Rules of Fair Practice of the National Association of Securities
Dealers ("NASD"), if more than 10% of the net proceeds of a public offering of
debt securities, not including underwriting compensation, are intended to be
paid to members of the NASD or affiliated or associated persons that are
participating in the distribution of the offering, the yield at which the debt
securities are distributed to the public must be no lower than that
recommended by a "qualified independent underwriter," as defined in Rule 2720
of the Conduct Rules of the NASD. Donaldson, Lufkin & Jenrette Securities
Corporation provides an interest-only and residual loan line of credit which
is being repaid in connection with the Offering. See "Use of Proceeds." As a
result, Donaldson, Lufkin & Jenrette Securities Corporation is expected to
receive in the aggregate more than 10% of the net proceeds of the Offering.
Accordingly, Smith Barney Inc. has agreed to act as the qualified independent
underwriter in connection with this Offering. The yield on the Notes, when
sold to the public at the
80
<PAGE>
public offering price set forth on the cover of this Prospectus, will be no
lower than that recommended by Smith Barney Inc. In exchange for its service
for acting as a qualified independent underwriter, Smith Barney Inc. will
receive $5,000 from the Company.
The Underwriters have informed the Company that they do not expect
discretionary sales by the Underwriters to exceed 5% of the principal amount
of the Notes being offered hereby.
Investment banking and/or other advisory services have been provided to the
Company, ICII and their respective subsidiaries by Donaldson, Lufkin and
Jenrette Securities Corporation and, in the case of ICII and its subsidiaries,
also by NationsBanc Montgomery Securities, Inc. Each of Donaldson, Lufkin and
Jenrette Securities Corporation and NationsBanc Montgomery Securities, Inc.
expects to continue to provide such services in the future.
LEGAL MATTERS
The validity of the issuance of the Notes offered hereby will be passed upon
for the Company by Latham & Watkins, Los Angeles, California. Certain legal
matters in connection with the Offering will be passed upon for the
Underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, Los Angeles,
California.
EXPERTS
The consolidated financial statements of Southern Pacific Funding
Corporation as of December 31, 1995 and 1996 and for each of the years in the
three-year period ended December 31, 1996 have been included and incorporated
by reference herein in reliance upon the report of KPMG Peat Marwick LLP,
independent certified public accountants, appearing elsewhere herein, and upon
the authority of said firm as experts in accounting and auditing.
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-3 (the "Registration
Statement") under the Securities Act with respect to the Notes offered
pursuant to this Prospectus. Statements contained in this Prospectus as to the
contents of any agreement or other document referred to herein are not
necessarily complete and reference is made to the copy of such agreement or
other document filed as an exhibit or schedule to the Registration Statement.
For further information, reference is made to the Registration Statement and
to the exhibits and schedules filed therewith, which are available for
inspection without charge at the principal office of the Commission in
Washington, D.C. Copies of the materials containing this information may be
obtained from the Commission upon payment of the prescribed fee. This
Prospectus omits certain information contained in the Registration Statement,
and reference is made to the Registration Statement, including the exhibits
thereto, for further information with respect to the Company and the Notes
offered hereby. Statements contained in this Prospectus concerning the
provisions of such documents are necessarily summaries of such documents and
each such statement is qualified in its entirety by reference to the copy of
the applicable document filed with the Commission as an exhibit hereto.
The Company is subject to the periodic reporting and other informational
requirements of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and in accordance therewith, files reports, proxy statements and other
information with the Commission. For further information with respect to the
Company, reference is hereby made to such reports and other information which
can be inspected and copied (at prescribed rates) at the public reference
facilities maintained by the Commission at 450 Fifth Street, N.W., Room 1025,
Washington, D.C. 20549 and at the Commission's regional offices located at
Seven World Trade Center, 13th Floor, New York, New York 10048 and at 500 West
Madison, Suite 1400, Chicago, Illinois 60661. Copies may also be obtained at
prescribed rates from the Public Reference Section of the Commission at Room
1024, 450 Fifth Street, N.W., Washington, D.C. 20549. The Commission also
maintains a Web site that contains reports and other information regarding the
Company at (http://www.sec.gov). The Company's Common Stock
81
<PAGE>
is listed on the New York Stock Exchange. The Company's reports, proxy
statements and other information concerning the Company can be inspected at
the New York Stock Exchange, 20 Broad Street, New York, New York 10005.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents filed by the Company with the Commission are hereby
incorporated by reference herein:
(a) the Company's Annual Report on Form 10-K for the year ended
December 31, 1996;
(b) the Company's Proxy Statement dated April 30, 1997;
(c) the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997;
(d) the Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1997; and
(e) the Company's Report on Form 8-K dated October 10, 1997.
In addition, each document filed by the Company pursuant to Section 13(a),
13(c) 14 or 15(d) of the Exchange Act subsequent to the date of this
Prospectus and prior to the termination of the Offering shall be deemed to be
incorporated by reference herein and to be a part hereof from the date of
filing of such document.
Any statement contained in this Prospectus or in a document incorporated or
deemed to be incorporated by reference in this Prospectus shall be deemed to
be modified or superseded for purposes of the Registration Statement and this
Prospectus to the extent that a statement contained in this Prospectus, or in
any subsequently filed document that also is or is deemed to be incorporated
by reference in this Prospectus, modifies or supersedes such statement. Any
such statement so modified or superseded shall not be deemed, except as so
modified or superseded, to constitute a part of the Registration Statement or
this Prospectus.
The Company will provide without charge to each person to whom this
Prospectus is delivered, upon the written or oral request of such person, a
copy of any and all of the documents that are incorporated by reference in
this Prospectus (not including the exhibits to and such document unless such
exhibits are specifically incorporated by reference into the information that
this Prospectus incorporates by reference). Requests for such copies should be
directed to Southern Pacific Funding Corporation, One Centerpointe Drive,
Suite 500, Lake Oswego, Oregon 97035, Attention: Director of Corporate
Communications, telephone number (503) 684-4700.
82
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Independent Auditors' Report.............................................. F-2
Consolidated Balance Sheets as of December 31, 1995 and 1996 (audited) and
June 30, 1997 (unaudited)................................................ F-3
Consolidated Statements of Earnings for the Years Ended December 31, 1994,
1995 and 1996 (audited) and the Six Months Ended June 30, 1996 and 1997
(unaudited).............................................................. F-4
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1994, 1995 and 1996 (audited) and the six months ended June
30, 1997 (unaudited)..................................................... F-5
Consolidated Statements of Cash Flows for the Years Ended December 31,
1994, 1995 and 1996 (audited) and for the Six Months Ended June 30, 1996
and 1997 (unaudited)..................................................... F-6
Notes to Consolidated Financial Statements................................ F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Southern Pacific Funding Corporation:
We have audited the accompanying consolidated balance sheets of Southern
Pacific Funding Corporation and subsidiaries as of December 31, 1995 and 1996,
and the related consolidated statements of earnings, shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1996. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Southern Pacific Funding Corporation and subsidiaries as of December 31,
1995 and 1996, and the consolidated results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 1996
in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Portland, Oregon
January 23, 1997
F-2
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, JUNE 30,
1995 1996 1997
------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
------
Cash................................... $ -- $ 14,175,566 $ 16,253,655
Loans held for sale.................... 80,263,671 223,059,102 225,643,025
Loans held under repurchase agreement.. 12,800,565 -- --
Interest-only and residual
certificates.......................... 22,468,642 87,016,900 172,663,986
Accrued interest receivable............ 977,374 3,181,449 3,909,321
Premises and equipment, net............ 421,695 3,036,388 5,670,266
Goodwill............................... -- 4,742,571 7,419,158
Other assets........................... 282,831 5,165,048 10,620,179
------------ ------------ ------------
Total assets......................... $117,214,778 $340,377,024 $442,179,590
============ ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Liabilities:
Bank overdraft......................... $ 619,517 $ -- $ --
Borrowings under warehouse lines of
credit................................ 96,130,120 152,680,395 191,974,065
Borrowings from SPTL................... 2,758,147 -- --
Deferred tax liability................. -- 18,445,495 35,709,371
Due to affiliates...................... 1,585,150 80,166 80,096
Convertible subordinated notes......... -- 75,000,000 75,000,000
Other liabilities...................... 3,233,125 9,022,000 28,037,832
------------ ------------ ------------
Total liabilities.................... 104,326,059 255,228,056 330,801,364
Minority Interest...................... -- $ 62,735 $ 80,673
Shareholders' equity:
Preferred stock, no par value,
5,000,000 shares authorized; none
issued or outstanding at December 31,
1995 and 1996, and June 30, 1997
(unaudited)........................... -- -- --
Common stock, no par value, 75,000,000
shares authorized; 15,562,500 issued
and outstanding at December 31, 1995,
20,737,500 issued and outstanding at
December 31, 1996 and 20,748,750
issued and outstanding at June 30,
1997 (unaudited)...................... -- 53,798,099 53,950,780
Contributed capital.................... 789,591 247,500 247,500
Translation adjustment (unaudited)..... -- -- (14,683)
Retained earnings...................... 12,099,128 31,040,634 57,113,956
------------ ------------ ------------
Total shareholders' equity........... 12,888,719 85,086,233 111,297,553
------------ ------------ ------------
Total liabilities and shareholders'
equity.............................. $117,214,778 $340,377,024 $442,179,590
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE
YEARS ENDED DECEMBER 31, 30,
----------------------------------- -----------------------
1994 1995 1996 1996 1997
----------- ----------- ----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Gains on sales of
loans................ $ 9,571,583 $16,328,621 $55,360,515 $18,885,698 $61,938,379
Interest income....... 2,135,886 4,304,760 13,848,976 4,970,922 16,427,030
Securities valuation
and other income..... -- 1,666,682 4,265,285 1,901,811 1,297,968
----------- ----------- ----------- ----------- -----------
Total revenues...... 11,707,469 22,300,063 73,474,776 25,758,431 79,663,377
----------- ----------- ----------- ----------- -----------
Expenses:
Interest on other
borrowings........... 886,055 3,413,652 7,799,986 3,365,230 9,395,394
Personnel and
commission expense... 2,155,945 4,190,566 10,996,713 4,105,060 16,463,872
General and
administrative
expense.............. 1,261,708 2,153,220 6,599,474 1,938,250 9,234,329
----------- ----------- ----------- ----------- -----------
Total expenses...... 4,303,708 9,757,438 25,396,173 9,408,540 35,093,595
----------- ----------- ----------- ----------- -----------
Earnings before taxes... 7,403,761 12,542,625 48,078,603 16,349,891 44,569,782
Income taxes............ 3,072,560 5,205,190 20,446,614 6,954,430 18,496,460
----------- ----------- ----------- ----------- -----------
Net earnings.......... $ 4,331,201 $ 7,337,435 $27,631,989 $ 9,395,461 $26,073,322
=========== =========== =========== =========== ===========
Net earnings per share:
Primary............... $ 1.40 $ 0.56 $ 1.17
Fully-diluted......... $ 1.37 $ 0.56 $ 1.08
Weighted average number
of shares outstanding
(in thousands):
Primary............... 19,804 16,772 22,272
Fully-diluted......... 20,512 16,772 25,423
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON CONTRIBUTED TRANSLATION RETAINED SHAREHOLDERS'
STOCK CAPITAL ADJUSTMENT EARNINGS EQUITY
----------- ----------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balance, December 31,
1992................... $ -- $ -- $ -- $ -- $ --
Capital contribution,
1993................... -- 539,591 -- -- 539,591
Net earnings, 1993...... -- -- -- 430,492 430,492
----------- --------- -------- ----------- ------------
Balance, December 31,
1993................... -- 539,591 -- 430,492 970,083
Common stock issued,
1994................... -- 250,000 -- -- 250,000
Net earnings, 1994...... -- -- -- 4,331,201 4,331,201
----------- --------- -------- ----------- ------------
Balance, December 31,
1994................... -- 789,591 -- 4,761,693 5,551,284
Net earnings, 1995...... -- -- -- 7,337,435 7,337,435
----------- --------- -------- ----------- ------------
Balance, December 31,
1995................... -- 789,591 -- 12,099,128 12,888,719
Effect of contribution
transaction............ -- (542,091) -- (8,690,483) (9,232,574)
Proceeds from initial
public offering of
5,175,000 shares of
common stock, net of
offering expenses of
$4,810,911............. 53,798,099 -- -- -- 53,798,099
Net earnings, December
31, 1996............... -- -- -- 27,631,989 27,631,989
----------- --------- -------- ----------- ------------
Balance, December 31,
1996................... 53,798,099 247,500 -- 31,040,634 85,086,233
Exercise of stock
options (unaudited).... 152,681 -- -- -- 152,601
Translation adjustment
(unaudited)............ -- -- (14,683) -- (14,683)
Net earnings, six months
ended June 30, 1997
(unaudited)............ -- -- -- 26,073,322 26,073,322
----------- --------- -------- ----------- ------------
Balance, June 30, 1997
(unaudited)............ $53,950,780 $ 247,500 $(14,683) $57,113,956 $111,297,553
=========== ========= ======== =========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
---------------------------------------- -------------------------------
1994 1995 1996 1996 1997
----------- ------------ ------------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from
operating activities:
Net earnings.......... $ 4,331,201 $ 7,337,435 $ 27,631,989 $ 9,395,461 $ 26,073,322
Adjustments to
reconcile net income
to net cash provided
by (used in)
operating activities:
Depreciation and
amortization....... 6,446 51,488 615,258 207,553 875,007
Minority interest... -- -- -- -- 17,938
Translation
adjustment......... -- -- -- -- (14,683)
Securities
valuation.......... -- -- (4,265,285) (1,901,811) (1,597,543)
Changes in certain
assets and
liabilities, net
of effect of
acquisitions and
contribution
transaction:
Mortgage loans
held for sale.. 1,347,881 (63,536,648) (143,632,836) (36,019,620) (2,583,923)
Loans held under
repurchase
agreement...... -- (12,800,565) 12,800,565 12,800,565 --
Net changes in
interest only
and residual
certificates... (4,233,543) (18,235,099) (71,493,840) (22,838,563) (84,049,543)
Accrued interest
receivable..... 17,083 (928,119) (2,204,075) (329,609) (727,872)
Deferred tax
liability...... -- -- 20,446,614 -- 17,263,876
Other assets.... -- (282,831) (1,387,556) (1,516,963) (5,382,019)
Other
liabilities.... 46,183 3,186,942 3,787,856 8,347,344 19,015,832
----------- ------------ ------------- ------------ ------------
Net cash provided by
(used in) operating
activities........... 1,515,251 (85,207,397) (157,701,310) (31,855,645) (31,109,608)
----------- ------------ ------------- ------------ ------------
Cash used in investing
activities:
Purchases of premises
and equipment........ (42,776) (436,853) (3,028,897) (1,897,953) (2,458,584)
Payment for
acquisitions......... -- -- (5,000,000) -- (3,800,000)
Payment for long-term
investment and loan
commitment........... -- -- (525,000) -- --
----------- ------------ ------------- ------------ ------------
Net cash used in
investing activities. (42,776) (436,853) (8,553,897) (1,897,953) (6,258,584)
----------- ------------ ------------- ------------ ------------
Cash flows from
financing activities:
Net changes in:
Borrowings under
warehouse lines of
credit............. -- 96,130,120 56,550,275 (17,960,229) 39,293,670
Borrowings from
SPTL............... (1,222,475) (12,940,537) 322,053 322,053 --
Due to affiliates... -- 1,585,150 (1,504,984) 382,148 (70)
Bank overdraft...... -- 619,517 (619,517) (619,517) --
Proceeds from
convertible
subordinated notes... -- -- 72,162,436 -- --
Capital contribution.. -- -- (277,589) (262,003) --
Proceeds from issuance
of common stock...... -- -- 53,798,099 53,839,089 152,681
----------- ------------ ------------- ------------ ------------
Net cash provided by
(used in) financing
activities........... (1,222,475) 85,394,250 180,430,773 35,701,541 39,446,281
----------- ------------ ------------- ------------ ------------
Net change in cash.... 250,000 (250,000) 14,175,566 1,947,945 2,078,089
Cash at beginning of
year................. -- 250,000 -- -- 14,175,566
----------- ------------ ------------- ------------ ------------
Cash at end of year... $ 250,000 $ -- $ 14,175,566 $ 1,947,945 $ 16,253,655
=========== ============ ============= ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED JUNE 30, 1996 AND 1997 (UNAUDITED)
AND THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1996
1. ORGANIZATION
Southern Pacific Funding Corporation ("SPFC" or the "Company") is the
successor to the Residential Lending Division of Southern Pacific Thrift and
Loan ("SPTL"). The Company originates and acquires non-conforming single-
family residential loans, including loans secured by second mortgages. In
October 1994, Imperial Credit Industries, Inc. ("ICII") incorporated the
Company as part of a strategic decision to form a separate subsidiary through
which to operate SPTL's Residential Lending Division. In April 1995, ICII
caused SPTL to contribute (the "Contribution Transaction") to SPFC certain
customer lists of SPTL's Residential Lending Division to the ongoing
operations of such division. In addition, in April 1995 all employees of
SPTL's Residential Lending Division became employees of SPFC.
2. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of SPFC and its
majority owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation. The historical operations
of SPFC as a division of SPTL have been presented in the financial statements
as if SPFC had operated as a stand-alone company.
BORROWINGS FROM AFFILIATES
The average borrowings from affiliates and interest rates used to determine
the weighted average interest on borrowings for the years ended December 31,
1994, 1995 and 1996 are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1994 1995 1996
----------- ----------- ----------
<S> <C> <C> <C>
Estimated average borrowings......... $25,195,833 $34,777,138 $3,890,267
Interest rate........................ 4.15% 3.69% 6.25%
Interest on borrowings............... $ 866,055 $ 1,284,282 $ 230,236
</TABLE>
INCOME TAXES
The accompanying financial statements reflect income taxes for SPFC as if it
had been a separate entity for all years presented. SPFC accounts for income
taxes under the asset and liability method of accounting for income taxes.
Under the asset and liability method, 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 the asset and liability method, 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.
F-7
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale are carried at the lower of aggregate cost or
market. The cost of mortgage loans held for sale is the cost of the mortgage
loans reduced or increased by the net deferred fees or costs associated with
originating or acquiring the loan and increased by costs that are recognized
upon sale. On an ongoing basis, management of the Company monitors the loan
portfolio and considers such factors as historical loan loss experience,
underlying collateral values, known problem loans, assessment of economic
conditions, including changes in interest rates, and other appropriate data to
identify risks in the loan portfolio.
INTEREST-ONLY AND RESIDUAL CERTIFICATES
Assets reflected in the accompanying balance sheets as interest-only and
residual certificates in real estate mortgage investment conduits (REMICs) are
recorded as a result of the Company's securitization of loans through various
trust vehicles. The Company considers its obligations under recourse
provisions in connection with its securitizations in valuing its interest-only
and residual certificates. The Company estimates future cash flows from these
interest-only and residual certificates and values them utilizing assumptions
that it believes are consistent with those that would be utilized by an
unaffiliated third party purchaser and records them as trading securities at
fair value in accordance with SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities." Unrealized
gains and losses are included in gains on sales of loans in the accompanying
financial statements. To the Company's knowledge, there is no active market
for the sale of these interest-only and residual certificates.
The fair value of interest-only and residual certificates is determined by
computing the present value of the excess of the weighted average coupon on
the loans sold over the sum of: (1) the coupon on the senior interests, (2) a
base servicing fee paid to the loan servicer, (3) expected losses to be
incurred on the portfolio of loans sold over the lives of the loans, and (4)
fees payable to the trustee and monoline insurer. Prepayment assumptions used
in the present value computation are based on recent evaluations of the actual
prepayments of the Company's servicing portfolio or on market prepayment rates
on new portfolios, taking into consideration the current interest rate
environment and its expected impact on prepayment rates. The cash flows
expected to be received by the Company are discounted at an interest rate
(15%) that the Company believes an unaffiliated third-party purchaser would
require as a rate of return on such a financial instrument. To the extent that
actual future excess cash flows are different from estimated excess cash
flows, the fair value of the Company's interest-only and residual certificates
will be adjusted quarterly with corresponding adjustments made to earnings in
that period.
In certain of its securitizations, the Company provided an initial
overcollateralization on the securities sold and in all its securitizations
the Company builds overcollateralization as cash flows projected as described
above are used by the trustee to reduce the outstanding balance of the
securities sold by the Company. The current amount of such
overcollateralization is recorded by the Company as part of its interest-only
and residual certificates.
F-8
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
GAINS ON SALES OF LOANS
Gains on sales of loans are determined by deducting from the gross proceeds
of the sales or securitizations the allocated basis in the loans sold or
securitized and related transaction costs. Included in gains on sales of loans
are gains on sales of loan servicing, which amounted to $810,000 in 1994. The
initial fair value on interest-only and residual certificates are included in
gains on sales of loans.
INTEREST INCOME
Interest income includes interest earned on mortgage loans held for sale.
SECURITIES VALUATION AND OTHER INCOME
Securities Valuation and Other Income includes the change in unrealized
gains and losses on interest-only and residual certificates.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, less accumulated depreciation or
amortization. Depreciation is recorded using the straight-line method over the
estimated useful lives of individual assets (three to five years). Leasehold
improvements are amortized over the terms of the related leases or the
estimated useful lives of improvements, whichever is shorter.
DIVIDENDS
The Company intends to retain all of its future earnings to finance its
operations.
GOODWILL
Goodwill, which represents the excess of purchases price over fair value of
net assets acquired, is amortized on a straight-line basis over the expected
periods to be benefited, generally 15 years. The Company assesses the
recoverability of this intangible asset by determining whether the
amortization of the goodwill balance over its remaining life can be recovered
through undiscounted future operating cash flows of the acquired operation.
LONG-TERM INVESTMENTS
Long-term investments, included in other assets, are carried at cost and
consist of preferred stock of $360,000.
USE OF ESTIMATES
Management has made a number of estimates and assumptions relating to the
reporting of assets, liabilities, revenues and expenses and the disclosure of
contingent assets and liabilities to prepare these financial statements in
conformity with generally accepted accounting principles. Actual results could
differ from those estimates.
NET EARNINGS PER SHARE
Net earnings per share is determined by dividing net earnings, adjusted for
common stock equivalents and interest accrued on convertible subordinated
notes, by the average number of shares of common stock outstanding during the
year adjusted for the dilutive effect of common stock equivalents. Earnings
per share for
F-9
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1996 and all share data related to shares issued and outstanding have been
restated to give recognition to a 4,150 for one stock split effected April 1,
1996. Also, all share data related to shares issued and outstanding have been
restated to give retroactive recognition to a three for two stock split
effected January 23, 1997.
4. LOANS HELD UNDER REPURCHASE AGREEMENT
In September 1995, the Company entered into an agreement to acquire certain
mortgage loans under a master repurchase agreement with a financial
institution. The Company advances the financial institution 98% of the
outstanding principal balance of a loan, and all rights (including title) are
transferred to the Company under the repurchase agreement. In the event that
the financial institution defaults on its obligations under the repurchase
agreement, the Company could receive less than its cost basis on the sale of
the loans to another party. This risk is offset by the requirement that the
financial institution maintain at all times a margin account for the Company
equal to 102% of the value of the loans underlying the repurchase agreement.
At December 31, 1995 and 1996, the Company held $12,800,565, and $0,
respectively, in loans under repurchase agreements which were scheduled to
mature within 60 days. The maximum amount of loans held under repurchase
agreements with the financial institution during the years ended December 31,
1995 and 1996 was approximately $14,904,000 and $25,376,000, respectively, and
the average amount held during the years ended December 31, 1995 and 1996 was
approximately $4,718,000 and $3,251,000, respectively.
5. INTEREST-ONLY AND RESIDUAL CERTIFICATES
Assets generated from the Company's loan securitizations as of December 31,
1995 and 1996, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1995 1996
----------- -----------
<S> <C> <C>
Interest-only Certificates........................ $ 2,629,184 $74,353,837
Residual Certificates............................. 23,029,417 21,456,300
----------- -----------
$25,658,601 $95,810,137
=========== ===========
</TABLE>
6. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following at December 31, 1995 and
1996:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
-------- ----------
<S> <C> <C>
Premises and equipment............................... $479,629 $3,634,193
Less accumulated depreciation and amortization....... (57,934) (597,805)
-------- ----------
$421,695 $3,036,388
======== ==========
</TABLE>
F-10
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The table below summarizes the information about the fair value of the
financial instruments recorded on the Company's financial statements at
December 31, 1995 and 1996 in accordance with SFAS 107:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1996
----------------------- -------------------------
CARRY FAIR CARRY FAIR
VALUE VALUE VALUE VALUE
----------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
Cash......................... $ -- $ -- $ 14,175,566 $ 14,175,566
Loans held for sale.......... 80,263,671 82,671,581 223,059,102 231,981,466
Loans held under repurchase
agreement................... 12,800,565 13,453,656 -- --
Interest-only and residual
certificates................ 22,468,642 22,468,642 87,016,900 87,016,900
Bank overdraft............... 619,517 619,517 -- --
Borrowings under warehouse
lines of credit............. 96,130,120 96,130,120 152,680,395 152,680,395
Borrowings from SPTL......... 2,758,147 2,758,147 -- --
Due to affiliates............ 1,585,150 1,585,150 80,166 80,166
</TABLE>
Because no market exists for certain of the Company's assets and
liabilities, fair value estimates are based on judgments regarding credit
risk, investor expectations of future economic conditions, normal cost of
administration and other risk characteristics, including interest rate and
prepayment risk. These estimates are subjective in nature and involve
uncertainties and matters of judgment and therefore cannot be determined with
precision. Changes in assumptions could significantly affect the estimates.
The methodology and assumptions utilized to estimate the fair value of the
Company's financial instruments, including the off balance sheet instruments
disclosed in Note 14, are as follows:
Cash (bank overdraft). The carrying values reported are the asset's
(liability's) fair value.
Loans held for sale and loans held under repurchase agreement. The Company
has estimated the fair values reported based on recent sales and
securitizations.
Interest-only and residual certificates. Fair value is determined using
estimated discounted future cash flows taking into consideration anticipated
prepayment rates and loss experience.
Borrowings under warehouse lines of credit. The carrying value reported
approximates fair value due to the short-term nature of the borrowings and the
variable interest rates charged on the borrowings.
Borrowings from SPTL and due to affiliates. The carrying value reported
approximates fair value due to the variable interest rates on the borrowings.
Commitments to originate loans and loans in process. Many loan commitments
are expected to, and typically do, expire without being drawn upon. As the
rates and terms of the commitments to lend and loans in process are
competitive with others in which the Company operates, the values disclosed in
Note 15 are determined to be a reasonable estimate of fair value.
Hedging Transactions. The Company regularly securitizes and sells fixed and
variable-rate mortgage loans. To offset the effects of interest rate
fluctuations on the value of its fixed-rate loans held for sale, the Company
in certain cases will hedge its interest rate risk related to loans held for
sale by selling U.S. Treasury securities short or in the forward market.
F-11
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As of December 31, 1996 and June 30, 1997, the Company had open hedge
positions of $32.6 million and $86.4 (unaudited) million respectively, related
to the sales of United States Treasury securities in the forward market. The
proceeds from the short sale are shown net of the related liability in the
accompanying balance sheet at December 31, 1996 and June 30, 1997.
8. RELATED PARTY TRANSACTIONS
INTRACOMPANY COST ALLOCATIONS
The Company historically has been allocated expenses of various
administrative services provided to it by ICII and SPTL. The costs of such
services were not directly attributable to a specific division or subsidiary
and primarily included general corporate overhead, such as accounting and cash
management services, human resources and other administrative functions. These
expenses were calculated as a pro rata share of certain administrative costs
based on relative assets and liabilities of the division or subsidiary, which
management believes was a reasonable method of allocation. The allocation of
expenses that are included as part of personnel and commission expense and
general and administrative expenses for the years ended December 31, 1994,
1995 and 1996 were $92,700, $256,000 and $292,000, respectively. No
administrative services are being provided by ICII, effective January 1, 1997.
CONTRIBUTION TRANSACTION
As part of the Contribution Transaction described in Note 1, on the
effective date of the IPO, certain assets and related liabilities generated
from securitizations occurring in December 1994 and March and June 1995 were
retained by SPTL as follows (unaudited):
<TABLE>
<S> <C>
Loans held for sale......................................... $ 837,405
Interest only and residual certificates..................... 12,522,911
Discounted recourse liability............................... 1,312,044
Borrowings from SPTL........................................ 3,080,200
</TABLE>
LOAN SERVICING
From the point of commencement of operations until March 1994, SPTL served
as the loan servicer for the Company and the Company was allocated its pro
rata portion of SPTL's loan servicing expenses. In March 1994, ICII assumed
the role of loan servicer for a servicing fee of approximately $7.50 per loan
per month, so that the Company could complete its first securitization. In
September 1995, the Company began to utilize the services of Advanta, an
independent loan servicer, as the master servicer. Fees charged by Advanta are
$25 per loan and 37.5 basis points per annum on the declining principal
balance of each loan serviced, paid monthly, respectively, which fees are
higher than those previously paid to ICII due to the additional collection
activities performed by Advanta. Had the Company exclusively used its current
independent loan servicer in 1994 and 1995, its servicing fees would have been
higher by approximately $120,000 and $234,000, respectively.
CONSULTING AGREEMENTS
In June 1996, the Company entered into a five-year consulting agreement with
The Dewey Consulting Group, owned by one of the Company's directors, John D.
Dewey. Under the agreement, Mr. Dewey has agreed to assist the Company in the
development of strategic alliances with selected mortgage lenders, including
the identification of potential strategic alliance participants. The Company
has agreed to compensate Mr. Dewey
F-12
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
based upon actual strategic alliances entered into and loan production and
earnings resulting from those alliances which amounts to .015% of the
Company's share of warrants, interest-only cash received, and interest-only
strips. No amounts were paid in 1996 or owing at December 31, 1996.
9. CONVERTIBLE SUBORDINATED DEBENTURES
Convertible subordinated debentures at December 31, 1995 and 1996 consists
of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1995 1996
---- -----------
<S> <C> <C>
Convertible subordinated debentures, interest at 6.75%, due
semi-annually, principal due October 15, 2006............. -- $75,000,000
</TABLE>
The Convertible subordinated debentures are convertible into 3,151,125
shares of common stock, for a conversion price of $23.80 per share, at any
time prior to maturity. Interest on the debentures is payable semi-annually.
Debt issuance costs of $2,837,564, included in other assets, associated with
the convertible subordinated debentures have been deferred and are being
amortized over ten years using the effective yield method.
10. INCOME TAXES
For 1995 and for the 1996 period through the effective date of the IPO in
June 1996, SPFC is included in a consolidated tax return filing with ICII. For
the 1996 period subsequent to the IPO, SPFC will file a separate tax return on
a stand-alone basis.
SPFC's income taxes were as follows for the years ended December 31, 1995
and 1996:
<TABLE>
<CAPTION>
1995 1996
---------- -----------
<S> <C> <C>
Current:
Federal............................................. $2,731,115 $ 3,680,000
State............................................... 602,452 772,000
---------- -----------
Total current..................................... 3,333,567 4,452,000
Deferred:
Federal............................................. 1,533,378 11,461,414
State............................................... 338,245 4,533,200
---------- -----------
Total deferred.................................... 1,871,623 15,994,614
---------- -----------
Total income taxes.................................... $5,205,190 $20,446,614
========== ===========
</TABLE>
The following table shows the tax effects of temporary differences which
give rise to the primary components of SPFC's net deferred tax liability at
December 31, 1995 and 1996. Net deferred tax liabilities at December 31, 1995
are included in borrowings from SPTL for the period of time during which the
Company operated as a division of SPTL, and are included as part of other
liabilities for the period during which the Company operated as a subsidiary
of ICII.
<TABLE>
<CAPTION>
1995 1996
---------- -----------
<S> <C> <C>
Deferred tax liabilities:
Interest-only and residual certificates............ $2,424,130 $18,445,495
========== ===========
</TABLE>
F-13
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A reconciliation of the income tax provision and the amount computed by
applying the statutory Federal corporate income tax rate to income before
income taxes are as follows for the years ended December 31, 1995 and 1996:
<TABLE>
<CAPTION>
1995 1996
---- ----
<S> <C> <C>
Statutory U.S. Federal income tax rate.......................... 35.0% 35.0%
Increases in rate resulting from state income taxes, net of
Federal benefit................................................ 6.5 7.5
---- ----
Effective income tax rate....................................... 41.5% 42.5%
==== ====
</TABLE>
At the effective date of the IPO, the Company entered into a tax agreement
with ICII whereby, among other things, ICII will indemnify and hold the
Company harmless from any tax liability attributable to periods ending on or
before the effective date of the IPO in excess of such taxes as the Company
has already paid or provided for. For periods ending after the effective date
of the IPO, the Company will pay its tax liability directly to the appropriate
taxing authorities.
11. EMPLOYEE BENEFIT PLANS
PROFIT SHARING AND 401(k) PLAN
Employees of SPFC are eligible to participate in the ICII 401(k) plan,
employees may elect to enroll in the plan on the first day of any month,
provided that they have been employed by SPFC for at least six months.
Employees may contribute up to 14% of their compensation to the ICII 401(k)
Plan and SPFC will match 50% of the first 4% of employee pretax contributions.
SPFC matching contributions are made as of December 31st each year. SPFC
recorded 401(k) matching expense of approximately $12,100, $26,000 and
$111,000 for the years ended December 31, 1994, 1995, and 1996, respectively.
An additional company contribution may be made to the ICII 401(k) Plan, at
the discretion of SPFC. Should a discretionary contribution be made, the
contribution would first be allocated to those employees deferring salaries in
excess of 4%. The matching contribution would be 50% of any deferral in excess
of 4% up to a maximum deferral of 8%. Should discretionary contribution funds
remain following the allocation outlined above, any remaining company matching
funds would be allocated as a 50% match of employee contributions, based on
the first 4% of the employee's deferrals. Discretionary contributions of
approximately $21,700, $23,000, and $0 were charged to operations of SPFC for
the years ending December 31, 1994, 1995, and 1996, respectively.
12. STOCK OPTIONS
Effective November 1, 1995, the Company reserved and granted options for
1,942,200 shares of Company common stock pursuant to the 1995 Senior
Management Stock Option Plan (the "Senior Management Plan"). All of the
options granted under the Senior Management Plan have been issued to senior
management personnel at an exercise price of $7.00 per share, the fair value
on the date of grant. The options vest ratably over a five-year period
commencing one year after the date of grant.
Also effective November 1, 1995, the Company adopted the 1995 Stock Option,
Deferred Stock and Restricted Stock Plan (the "Stock Option Plan"), which
provides for the grant of qualified incentive stock options, incentive stock
options, and awards consisting of deferred stock, restricted stock, stock
appreciation rights and limited stock appreciation rights. The Stock Option
Plan authorizes the grant of options to purchase, and awards of, an aggregate
of 1,942,200 shares of Company common stock. 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.
F-14
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
All share data related to shares issued and outstanding have been restated
to give retroactive recognition to a 4,150 for one stock split effective April
1, 1996 and a three for two stock split effective January 23, 1997.
The Company applies APB Opinion No. 25 in accounting for its Plans and,
accordingly, no compensation cost has been recognized for its stock options in
the financial statements. Had the Company determined compensation cost based
on the fair value at the grant date for its stock options under SFAS No. 123,
the Company's net income would have been reduced to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
1995 1996
---------- -----------
<S> <C> <C>
Net Earnings:
As reported......................................... $7,337,435 $27,631,989
Pro forma........................................... 7,105,518 26,266,703
EPS:
As reported......................................... $0.47 $1.37
Pro forma........................................... $0.46 $1.28
</TABLE>
Stock option activity during the period indicated is as follows:
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- ---------
<S> <C> <C>
Balance at December 31, 1994............................ -- --
Granted............................................... 1,942,200 $ 7.00
Exercised............................................. -- --
Forfeited............................................. -- --
Expired............................................... -- --
Balance at December 31, 1995............................ 1,942,200 7.00
Granted............................................... 1,078,500 12.57
Exercised............................................. -- --
Forfeited............................................. (113,250) 11.90
Expired............................................... -- 0.00
Balance at December 31, 1996............................ 2,907,450 8.85
</TABLE>
At December 31, 1996, there were 976,950 additional shares available for
grant under the Stock Option Plan. The per share weighted-average fair value
of stock options granted during 1995 and 1996 was $15.74 and $13.34 on the
date of grant using the Black Scholes option pricing model with the following
weighted-average assumptions: expected dividend yield 0.00%, risk free
interest rate of 6.206%, an expected life of 5 years and an annualized
volatility rate of 49.98%.
At December 31, 1996, the range of exercise prices and weighted-average
remaining contractual life of outstanding options was $7.00-$20.00 and 9.08
years, respectively.
At December 31, 1995, there were no options exercisable. At December 31,
1996, there were 388,440 options exercisable.
13. WAREHOUSE LINES OF CREDIT AND BORROWINGS FROM AFFILIATES
INITIAL FACILITY
In April 1995, SPFC obtained a warehouse line of credit in the amount of $50
million from an investment bank (the "Initial Facility") for the purpose of
funding one-to-four family residential first lien mortgage loans. As of
December 31, 1995 and 1996, $41,181,611 and $0, respectively, were outstanding
on the line of credit. Interest rates charged on the line of credit vary based
on the type of loan funded with the proceeds. The weighted
F-15
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
average interest rate on borrowings on the Initial Facility for 1995 and 1996
was 6.7%. Interest expense associated with the line of credit approximated
$1,999,000 and $269,000 for the years ended December 31, 1995 and 1996,
respectively.
FIRST FACILITY
In November 1995, the Company obtained a second line of credit from another
investment bank, for the purpose of funding one-to-four family residential
first and second mortgage loans (the "First Facility"), which is subject to
certain operating and financial covenants and collateral requirements. Under
the terms of the First Facility, the Company must pay a quarterly commitment
fee of $62,500. Total borrowings under the warehouse line are limited to $200
million and the line is scheduled to expire on October 24, 1997.
As of December 31, 1995 and 1996, $54,948,509 and $0, respectively was
outstanding on the line of credit, on which interest was charged based on the
type of loan funded. Interest expense incurred for the years ended
December 31, 1995 and 1996 amounted to approximately $131,000 and $5,505,512,
respectively, with a weighted average interest rate of 5.5% for 1995 and 6.26%
for 1996.
SECOND FACILITY
In October, 1996 the Company obtained a third line of credit from another
investment bank, for the purpose of funding one-to-four family residential
first and second mortgage loans (the "Second Facility"), which is subject to
certain operating and financial covenants and collateral requirements. Total
borrowings under the warehouse line are limited to $400 million, and the line
is scheduled to expire on October 22, 1997.
As of December 31, 1996 and June 30, 1997, $152,680,397 and $191,974,065,
respectively, was outstanding on the line of credit, on which interest was
charged based on the type of loan funded. Interest expense incurred for the
year ended December 31, 1996 amounted to $903,549, with a weighted average
interest rate of 6.16%.
SPTL
In March 1996, the Company entered into a $10 million revolving credit and
term loan agreement with SPTL (the "SPTL Agreement") which was scheduled to
expire on September 30, 1996. Advances under the SPTL Agreement were
collateralized by the Company's interest-only and residual certificates (other
than such interests retained by SPTL pursuant to the Contribution Transaction)
and bore interest at 2% above LIBOR. In April, 1996 the Company repaid all
borrowings outstanding under the SPTL Agreement and it was canceled.
14. ACQUISITIONS
In December, 1996, the Company purchased 95% of the common stock of a
diversified financial services company for $5,000,000 cash. The amount in
excess of the fair value of the net assets acquired is $4,742,571. The Company
acquired net assets of $5,000,000 consisting primarily of goodwill of
$4,742,571.
15. BUSINESS CONCENTRATIONS
The Company currently contracts for the servicing of substantially all loans
it originates, purchases and holds for sale with Advanta. This arrangement
allows the Company to increase the volume of loans it originates and purchases
without incurring the overhead investment in servicing operations. As with any
external service provider, the Company is subject to risks associated with
inadequate or untimely services. The Company regularly reviews the delinquency
of its servicing portfolio. Many of the Company's borrowers require notices
and reminders to keep their loans current and to prevent delinquencies and
foreclosures. A substantial increase
F-16
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
in the Company's delinquency rate or foreclosure rate could adversely affect
its ability to profitably access the capital markets for its financing needs,
including future securitizations.
16. COMMITMENTS AND CONTINGENCIES
FINANCIAL INSTRUMENTS WITH OFF BALANCE SHEET RISK
The Company is a party to financial instruments with off balance sheet risk
in the normal course of business. These financial instruments include
agreements to fund fixed and variable-rate mortgage loans and loans in
process. For agreements to fund fixed-rate loans, the contract amounts
represent exposure to loss from market fluctuations as well as credit loss.
The Company controls the credit risk of its agreements to fund fixed and
variable-rate loans through credit approvals, limits and monitoring
procedures.
Agreements to fund mortgage loans are agreements to lend to customers as
long as there is no violation of any condition established in the contracts.
Such agreements generally have fixed expiration dates or other termination
clauses. Since some agreements may expire without being drawn upon, the total
agreement amounts do not necessarily represent future cash requirements. As of
June 30, 1997, the Company had agreements to fund loans of $30,295,818
(unaudited).
SALES OF LOANS AND SERVICING RIGHTS
In the ordinary course of business, SPFC is exposed to liability from
representations and warranties made to purchasers and insurers of mortgage
loans and the purchasers of servicing rights. Under certain circumstances,
SPFC is required to repurchase mortgage loans if there has been a breach of a
representation or warranty. For loans which have been securitized, the Company
includes an estimate of credit loss, using a risk free rate, in determining
its discounted recourse liability. On a periodic basis, the Company reviews
its assumptions in light of historical experience and economic trends to
evaluate their reasonableness in measuring the fair value of recorded assets.
At December 31, 1995 and 1996, the Company had approximately $93,064,236 and
$223,059,102, respectively, in loans held for sale and under a repurchase
agreement which were serviced by Advanta. The Company's servicing agreement
with Advanta provides that if the Company desires to terminate the agreement
without cause upon 90 days' written notice, the Company will be required to
pay Advanta an amount equal to 1.0% of the aggregate principal balance of the
mortgage loans being serviced by Advanta at that time. The agreement also
provides that a transfer service fee of $100 per loan shall be paid to Advanta
for any mortgage loan for which the Company transfers servicing from Advanta
to another servicer, without terminating the agreement.
LOAN SERVICING
As of June 30, 1997 the Company's servicing portfolio (inclusive of
securitized loans where the Company has ongoing risk of loss) was
$1,600,646,215 (unaudited). Substantially all of the Company's loan servicing
has either been outsourced or subcontracted to Advanta.
F-17
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
OPERATING LEASES
The Company leases premises and equipment under operating leases with
various expiration dates. Minimum annual rental payments at December 31, 1996
were as follows:
<TABLE>
<S> <C>
1997............................................ $ 891,157
1998............................................ 705,302
1999............................................ 452,529
2000............................................ 225,220
2001............................................ 54,231
----------
Total......................................... $2,328,439
==========
</TABLE>
Rent expense amounted to $139,030, $309,607 and $484,416 for the years ended
December 31, 1994, 1995 and 1996, respectively.
17. SUBSEQUENT EVENTS (UNAUDITED)
The Company entered into a $100.0 million, 364 day warehouse facility to
finance first mortgage loans and high loan-to-value second mortgage loans. The
Company plans on utilizing this line during the third quarter of 1997. This
facility has covenant and operating requirements similar to the Company's
other warehouse facilities and that are typical of such facilities within the
industry and are consistent with current requirements.
The Company has also entered into a residual financing facility of $30.0
million that allows the Company to obtain debt secured by interest-only and
residual certificates. The facility requires the Company to encumber interest-
only and residual certificates. The Company's facility is committed for 18
months and will pay down through the cash flows of the encumbered interest-
only and residual certificates. At June 30, 1997, the Company had drawn upon
$14.5 million of this facility.
The Company obtained a short-term $15.0 million working capital facility
from ICII. This facility is a 60 day facility from its draw date. The Company
drew down the $15.0 million on July 16, 1997, which was repaid on August 11,
1997.
In May 1997, the Company capitalized a new subsidiary, Oceanmark Financial
Corporation and acquired goodwill, fixed assets and residual assets from
Oceanmark Bank, FSB for $3.8 million cash and a $3.8 million note payable over
three years. Oceanmark Financial Corporation will operate as a wholly-owned
subsidiary of the Company. Oceanmark Financial Corporation originates non-
conforming home equity loans through a national network of mortgage brokers.
The subsidiary operates five regional branch offices located in Florida,
Georgia, Virginia, Michigan and Missouri.
In May, 1997, the Company's Board of Directors approved the issuance of $125
million of high yield senior notes to be guaranteed by certain subsidiaries of
the Company.
F-18
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
18. CONSOLIDATING CONDENSED FINANCIAL INFORMATION (UNAUDITED)
Following is consolidating condensed financial information of SPFC, the
Subsidiary Guarantors of the % Senior Notes due 2004 and the Subsidiary
which is not a Subsidiary Guarantor:
CONSOLIDATING BALANCE SHEET
<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
------------------------------------------------------------------------------
NON-
SUBSIDIARY GUARANTOR
SPFC GUARANTORS SUBSIDIARY SUBTOTAL ELIMINATIONS TOTAL
------------ ----------- ----------- ------------ ------------ ------------
ASSETS
------
<S> <C> <C> <C> <C> <C> <C>
Cash.................... $ 10,490,805 $ 942,906 $ 4,819,944 $ 16,253,655 $ -- $ 16,253,655
Loans held for sale..... 158,420,703 36,844,300 30,378,022 225,643,025 -- 225,643,025
Interest-only and
residual certificates.. 172,663,986 10,827,854 -- 183,491,840 (10,827,854) 172,663,986
Investment in
subsidiaries........... 5,611,866 -- -- 5,611,866 (5,611,866) --
Other assets............ 91,385,729 16,460,452 689,145 108,535,326 (80,916,402) 27,618,924
------------ ----------- ----------- ------------ ------------ ------------
Total assets......... $438,573,089 $65,075,512 $35,887,111 $539,535,712 $(97,356,122) $442,179,590
============ =========== =========== ============ ============ ============
<CAPTION>
LIABILITIES AND
SHAREHOLDERS' EQUITY:
---------------------
<S> <C> <C> <C> <C> <C> <C>
Borrowings of credit
under warehouse line... $191,974,065 $ -- $ -- $191,974,065 $ -- $191,974,065
Deferred tax liability.. 35,812,869 231,442 (334,940) 35,709,371 -- 35,709,371
Convertible subordinated
notes.................. 75,000,000 -- -- 75,000,000 -- 75,000,000
Other liabilities....... 24,473,919 58,636,964 37,151,265 120,262,148 (92,144,220) 28,117,928
------------ ----------- ----------- ------------ ------------ ------------
Total liabilities.... $327,260,853 $58,868,406 $36,816,325 $422,945,584 $(92,144,220) $330,801,364
============ =========== =========== ============ ============ ============
Minority Interest....... -- -- -- -- 80,673 80,673
Shareholders' equity:
Common stock........... 53,950,780 639,981 1,583 54,592,344 (641,564) 53,950,780
Contributed capital.... 247,500 5,547,209 -- 5,794,709 (5,547,209) 247,500
Translation
adjustment............ -- -- (14,683) (14,683) -- (14,683)
Retained earnings...... 57,113,956 19,916 (916,114) 56,217,758 896,198 57,113,956
------------ ----------- ----------- ------------ ------------ ------------
Total shareholders'
equity.............. 111,312,236 6,207,106 (929,214) 116,590,128 (5,292,575) 111,297,553
------------ ----------- ----------- ------------ ------------ ------------
Total liabilities and
shareholders'
equity.............. $438,573,089 $65,075,512 $35,887,111 $539,535,712 $(97,356,122) $442,179,590
============ =========== =========== ============ ============ ============
</TABLE>
F-19
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
CONSOLIDATING STATEMENT OF EARNINGS
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED JUNE 30, 1997
---------------------------------------------------------------------------
NON-
GUARANTOR GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARY SUBTOTAL ELIMINATIONS TOTAL
----------- ------------ ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Gains on sales of
loans................ $56,529,901 $5,408,478 $ -- $61,938,379 $ -- $61,938,379
Interest income....... 16,199,304 2,792,125 358,428 19,349,857 (2,922,827) 16,427,030
Securities valuation
and other income..... (218,219) 1,135,592 26,814 944,187 353,781 1,297,968
----------- ---------- ----------- ----------- ----------- -----------
Total revenues....... 72,510,986 9,336,195 385,242 82,232,423 (2,569,046) 79,663,377
----------- ---------- ----------- ----------- ----------- -----------
Expenses:
Interest on other
borrowings........... 9,429,819 2,610,560 277,842 12,318,221 (2,922,827) 9,395,394
Personnel and
commission expense... 11,765,223 4,190,324 508,325 16,463,872 -- 16,463,872
General and
administrative
expense.............. 6,642,664 1,977,620 614,046 9,234,329 -- 9,234,330
----------- ---------- ----------- ----------- ----------- -----------
Total expenses....... 27,837,706 8,778,504 1,400,213 38,016,422 (2,922,827) 35,093,596
----------- ---------- ----------- ----------- ----------- -----------
Earnings before taxes... 44,673,280 557,691 (1,014,971) 44,216,001 353,781 44,569,781
Income taxes............ 18,599,958 231,441 (334,940) 18,496,459 -- 18,496,459
----------- ---------- ----------- ----------- ----------- -----------
Net earnings......... $26,073,322 $ 326,250 $ (680,031) $25,719,542 $ 353,781 $26,073,322
=========== ========== =========== =========== =========== ===========
</TABLE>
F-20
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
CONSOLIDATING STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED JUNE 30, 1997
-----------------------------------------------------------------------------
NON-
SUBSIDIARY GUARANTOR
SPFC GUARANTORS SUBSIDIARY SUBTOTAL ELIMINATIONS TOTAL
------------ ---------- ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Net cash provided by
(used in) operating
activities............. $(37,905,004) $1,800,818 $4,994,578 $(31,109,608) $ -- $(31,109,608)
------------ ---------- ---------- ------------ ------- ------------
Net cash used in
investing activities... (5,226,038) (857,912) (174,634) (6,258,584) -- (6,258,584)
------------ ---------- ---------- ------------ ------- ------------
Cash flows from
financing activities:
Net changes in:
Borrowings under
warehouse lines of
credit............. 39,293,670 -- -- 39,293,670 -- 39,293,670
Other............... 152,611 -- -- 152,611 -- 152,611
------------ ---------- ---------- ------------ ------- ------------
Net cash provided by
(used in) financing
activities............. 39,446,281 -- -- 39,446,281 -- 39,446,281
Net change in cash...... (3,684,761) 942,906 4,819,944 2,078,089 -- 2,078,089
Cash at beginning of
period................. 14,175,566 -- -- 14,175,566 -- 14,175,566
------------ ---------- ---------- ------------ ------- ------------
Cash at end of year..... $ 10,490,805 $ 942,906 $4,819,944 $ 16,253,655 $ -- $ 16,253,655
============ ========== ========== ============ ======= ============
</TABLE>
F-21
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
$125,000,000
LOGO
OF SOUTHERN PACIFIC FUNDING CORPORATION
% SENIOR NOTES DUE 2004
----------------
PROSPECTUS
----------------
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
NATIONSBANC
MONTGOMERY
SECURITIES, INC.
SMITH BARNEY INC.
, 1997
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFOR-
MATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PRO-
SPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE
RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS
PROSPECTUS DOES NOT CONSTITUTE ANY OFFER TO SELL OR A SOLICITATION OF AN OFFER
TO BUY ANY OF THE SECURITIES BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER
OR SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING THE OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL
TO MAKE SUCH OFFER OR SOLICITATION. 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
ITS DATE.
------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Prospectus Summary........................................................ 1
Risk Factors.............................................................. 9
Use of Proceeds........................................................... 20
Capitalization............................................................ 20
Selected Consolidated Financial and Other Data............................ 21
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 23
Business.................................................................. 32
Management................................................................ 50
Description of the Notes.................................................. 52
Description of Other Indebtedness......................................... 78
Underwriting.............................................................. 80
Legal Matters............................................................. 81
Experts................................................................... 81
Available Information..................................................... 81
Incorporation of Certain Documents by Reference........................... 82
Index to Consolidated Financial Statements................................ F-1
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
EDGAR APPENDIX
MAP ON INSIDE COVER OF PROSPECTUS SHOWS THE LOCATION OF THE COMPANY'S
OFFICES THROUGHOUT THE UNITED STATES.
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. 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.............. $37,878.79
NASD filing fee.................................................. 13,000
Printing expenses................................................
Accounting fees and expenses.....................................
Legal fees and expenses..........................................
Fees and expenses (including legal fees) for qualifications under
state securities laws...........................................
Transfer agent's fees and expenses...............................
Miscellaneous....................................................
----------
Total.......................................................... $
==========
</TABLE>
All amounts except the Securities and Exchange Commission registration fee
and the NASD filing fee are estimated.
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Under Section 317 of the California General Corporation Law (the "CGCL"),
the Registrant is in certain circumstances permitted to indemnify its
directors and officers against certain expenses (including attorneys' fees),
judgments, fines, settlements and other amounts actually and reasonably
incurred in connection with threatened, pending or completed civil, criminal,
administrative or investigative actions, suits or proceedings (other than an
action by or in the right of the Registrant), in which such persons were or
are parties, or are threatened to be made parties, by reason of the fact that
they were or are directors or officers of the Registrant, if such persons
acted in good faith and in a manner they reasonably believed to be in the best
interests of the Registrant, and with respect to any criminal action or
proceeding, had no reasonable cause to believe their conduct was unlawful. In
addition, the Registrant is in certain circumstances permitted to indemnify
its directors and officers against certain expenses incurred in connection
with the defense or settlement of a threatened, pending or completed action by
or in the right of the Registrant, and against amounts paid in settlement of
any such action, if such persons acted in good faith and in a manner they
believed to be in the best interests of the Registrant and its shareholders
provided that the specified court approval is obtained.
As permitted by Section 317 of the CGCL, the Articles of Incorporation and
By-Laws of the Registrant provide that the Registrant is authorized to provide
indemnification for its directors and officers for breach of their duty to the
Registrant and its shareholders through bylaw provisions or through agreements
with the directors and officers, or both, in excess of the indemnification
otherwise permitted by Section 317 of the CGCL. The Registrant's By-laws
provide for indemnification of its directors and officers to the maximum
extent permitted by Section 317 of the CGCL. In addition, agreements entered
into by the Registrant with its directors and its executive officers require
the Registrant to indemnify such persons against expenses, judgments, fines,
settlements and other amounts reasonably incurred in connection with any
proceeding to which any such person may be made a party by reason of the fact
that such person was an agent of the Registrant (including judgments, fines
and settlements in or of a derivative action, unless indemnification is
otherwise prohibited by law), provided such person acted in good faith and in
a manner he reasonably believed to be in the best interests of the Registrant
and, in the case of a criminal proceeding, had no reason to believe his
conduct was unlawful. The indemnification agreements also set forth certain
procedures that will apply in the event of a claim for indemnification
thereunder.
II-1
<PAGE>
The Articles of Incorporation of the Registrant provide that the personal
liability of the directors of the Registrant for monetary damages shall be
eliminated to the fullest extent permissible under California law. Under
Section 204(a)(10) of the CGCL, the personal liability of a director for
monetary damages in an action brought by or in the right of the corporation
for breach of the director's duty to the corporation may be eliminated, except
for the liability of a director resulting from (i) acts or omissions involving
intentional misconduct or the absence of good faith, (ii) any transaction from
which a director derived an improper personal benefit, (iii) acts or omissions
showing a reckless disregard for the director's duty, (iv) acts or omissions
constituting an unexcused pattern of inattention to the director's duty or (v)
the making of an illegal distribution to shareholders or an illegal loan or
guaranty.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits
1.1 Form of Underwriting Agreement
12 Statement re: computation of ratios
23.1 Consent of KPMG Peat Marwick LLP
23.2 Consent of Latham & Watkins (contained in Exhibit 5.1)
Power of Attorney (included on signature page of Registration
24.1 Statement)
25 Statement of Eligibility of Trustee
27.1 Financial Data Schedule
ITEM 17. UNDERTAKINGS
(a) The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement;
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement;
and
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
(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.
II-2
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Lake Oswego, State of Oregon on October 10, 1997.
Southern Pacific Funding Corporation
*
By: ___________________________________
Robert W. Howard
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
* Chairman of the Board October 10, 1997
______________________________________
H. Wayne Snavely
* Chief Executive Officer October 10, 1997
______________________________________ and Director (Principal
Robert W. Howard Executive Officer)
* President and Director October 10, 1997
______________________________________
Bernard A. Guy
* Director October 10, 1997
______________________________________
Stephen J. Shugerman
* Director October 10, 1997
______________________________________
John D. Dewey
* Director October 10, 1997
______________________________________
A. Van Ruiter
* Director October 10, 1997
______________________________________
Frank P. Willey
/s/ Peter F. Makowiecki Chief Financial Officer October 10, 1997
______________________________________ and Secretary (Chief
Peter F. Makowiecki Accounting Officer)
*By: /s/ Peter F. Makowiecki
------------------------------------
Peter F. Makowiecki
Attorney-In-Fact
</TABLE>
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Lake Oswego, State of Oregon on October 10, 1997.
Hallmark America, Inc.
*
By: ___________________________________
Terry Kirkey
President
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
* President and Director October 10, 1997
______________________________________ (Principal Executive
Terry Kirkey Officer
* Director October 10, 1997
______________________________________
Robert W. Howard
* Director October 10, 1997
______________________________________
Bernard A. Guy
* Director and Executive October 10, 1997
______________________________________ Vice-President (Chief
Bruce Gardner Accounting Officer)
/s/ Peter F. Makowiecki Director October 10, 1997
______________________________________
Peter F. Makowiecki
* Director October 10, 1997
______________________________________
Frank A. Frazzitta
*By: /s/ Peter F. Makowiecki
----------------------------------
Peter F. Makowiecki
Attorney-In-Fact
</TABLE>
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Lake Oswego, State of Oregon on October 10, 1997.
National Capital Holdings, Inc.
*
By: ___________________________________
David W. Cobb
President
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
* President and Director October 10, 1997
______________________________________ (Principal Executive
David W. Cobb Officer)
* Director October 10, 1997
______________________________________
Robert W. Howard
* Director October 10, 1997
______________________________________
Frank A. Frazzitta
Director
______________________________________
Stuart Ladell
* Chief Financial Officer Octobe 10, 1997
______________________________________ (Chief Accounting
H. John Steele Officer)
*By: /s/ Peter F. Makowiecki
-------------------------------
Peter F. Makowiecki
Attorney-In-Fact
</TABLE>
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Lake Oswego, State of Oregon on October 10, 1997.
Oceanmark Financial Corporation
*
By: ___________________________________
Frank A. Frazzitta
Secretary
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
* President (Principal October 10, 1997
______________________________________ Executive Officer)
Mark Wasser
* Director October 10, 1997
______________________________________
Robert W. Howard
* Director October 10, 1997
______________________________________
Bernard A. Guy
* Director, Chief October 10, 1997
______________________________________ Financial Officer and
Frank A. Frazzitta Secretary (Chief
Accounting Officer)
*By: /s/ Peter F. Makowiecki
----------------------------------
Peter F. Makowiecki
Attorney-In-Fact
</TABLE>
II-6
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
<C> <S> <C>
1.1* Form of Underwriting Agreement..........................
5.1* Opinion of Latham & Watkins.............................
12** Statement re: computation of ratios.....................
23.1** Consent of KPMG Peat Marwick LLP........................
23.2* Consent of Latham & Watkins (contained in Exhibit 5.1)..
24.1** Power of Attorney (included on signature page of
Registration Statement)................................
25** Statement of Eligibility of Trustee.....................
27.1** Financial Data Schedule.................................
</TABLE>
- ---------------------
* To be filed by amendment
** Previously filed
