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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (NO FEE REQUIRED)
For the fiscal year ended December 31, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ___________________ to ______________________
COMMISSION FILE NUMBER: 1-11785
SOUTHERN PACIFIC FUNDING CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 33-0636924
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
ONE CENTERPOINTE DRIVE, SUITE 500 97035
LAKE OSWEGO, OR (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
(503) 684-4700
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
COMMON STOCK, NO PAR VALUE
6.75% CONVERTIBLE SUBORDINATED NOTES DUE 2006
(TITLE OF EACH CLASS)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
NEW YORK STOCK EXCHANGE
(NAME OF EACH EXCHANGE ON WHICH REGISTERED)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO
SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO ____.
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM
405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO
THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION
STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY
AMENDMENT TO THIS FORM 10-K. [X]
As of March 25, 1997, the aggregate market value of voting stock held by
nonaffiliates of the registrant was approximately $180,268,362 based on the
closing price of the registrant's Common Stock as reported on the New York
Stock Exchange. For purposes of this calculation, shares owned by officers,
directors and 5% stockholders known to the registrant have been deemed to be
owned by affiliates: this assumption is not deemed to be an admission by such
persons that they are affiliates of the registrant.
As of March 25, 1997, the shares outstanding of the registrant's class of
common stock were as follows: 20,737,500.
DOCUMENTS INCORPORATED BY REFERENCE
Part III, items 10, 11, 12 and 13, incorporate by reference Southern Pacific
Funding Corporation's definitive proxy statement to shareholders for the 1997
Annual Meeting of Stockholders which will be filed with the Commission no
later than 120 days after December 31, 1996.
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SOUTHERN PACIFIC FUNDING CORPORATION
TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I
Item 1. Business.......................................................... 1
Item 2. Properties........................................................ 16
Item 3. Legal Proceedings................................................. 17
Item 4. Submission of Matters to a Vote of Security Holders............... 17
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters........................................................... 17
Item 6. Selected Financial Data........................................... 18
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 19
Item 8. Financial Statements and Supplementary Data....................... 25
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.............................................. 42
PART III
Item 10. Directors and Executive Officers of the Registrant................ 42
Item 11. Executive Compensation............................................ 42
Item 12. Security Ownership of Certain Beneficial Owners and Management.... 42
Item 13. Certain Relationships and Related Transactions.................... 42
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K... 42
Signatures........................................................ 45
</TABLE>
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PART I
ITEM 1. BUSINESS
GENERAL
The Company is a specialty finance company engaged in the business of
originating, purchasing and selling high-yielding, sub-prime 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 debt consolidation, financing of home
improvements and educational expenditures. The Company focuses on lending to
individuals who often have impaired or unsubstantiated credit histories and/or
unverifiable income ("Sub-prime Borrowers"). As a result, the Company's
customers generally pay higher interest rates as compared to interest rates
charged by conventional mortgage sources. Approximately 97.5% and 83.2% of the
Company's mortgage loans originated or purchased during the years ended
December 31, 1996 and 1995, respectively, were secured by first mortgages, and
the remainder were secured by second mortgages. The Company originates and
purchases loans through its Wholesale Division, its Correspondent Program, its
Retail/Telemarketing Division, its Institutional Division, and its Strategic
Alliance Program. The Company commenced operations in January 1993 as a
division of Southern Pacific Thrift and Loan Association ("SPTL"), a wholly-
owned subsidiary of Imperial Credit Industries, Inc. ("ICII"), and has been a
wholly-owned subsidiary of ICII since April 1995. The Company completed the
initial public offering of its Common Stock in June 1996 and ICII completed
secondary offerings (the "Secondary Offerings") of 1,000,000 and 370,000
shares of the Company's Common Stock in November 1996 and March 1997,
respectively. Upon completion of the Secondary Offerings , ICII owned
approximately 49.4% of the Company's outstanding Common Stock. Concurrently
with the Secondary Offering in November 1996, the Company sold $75 million
principal amount of Convertible Notes due 2006 (the "Notes Offering"). ICII is
a diversified specialty finance company offering financial products in the
following four sectors: sub-prime residential mortgage banking, commercial
mortgage banking, business lending and consumer lending.
The Company originates a majority of its loans through the Wholesale
Division, which is currently comprised of approximately 68 account executives
located in 14 regional branch centers who have established relationships with
independent mortgage loan brokers. For the year ended December 31, 1996, the
Wholesale Division originated loans in 50 states and the District of Columbia.
Of the Wholesale Division's 14 regional branch centers, four are located in
California, two in Oregon, and one in each of Ohio, Washington, Florida,
Colorado, Illinois, Massachusetts, Virginia and Texas. The Company believes
that its competitive strengths include providing prompt, responsive service
and flexible underwriting to independent mortgage brokers. The Company's
underwriters apply its underwriting guidelines on an individual basis but have
the flexibility to deviate from them when an exception or upgrade is warranted
by a particular loan applicant's situation, such as evidence of a strong
mortgage repayment history relative to a weaker overall consumer-credit
repayment history. See "Business--Underwriting". This provides independent
mortgage brokers working with the Company the ability to offer loan packages
to borrowers whose financing needs are not met (whether for reasons of credit
impairment, income qualification or credit history or a desire to receive
funding on an expedited basis) by traditional financial institutions. In most
cases, the Company conditionally approves loans within 24 hours from receipt
of application and funds loans within 21 days after approval. During the years
ended December 31, 1996, 1995, and 1994, the Wholesale Division originated
$511.8 million, $267.4 million and $183.0 million of loans, respectively,
representing 64.8%, 92.7%, and 96.2% of total loan originations and purchases
during the respective periods.
The Company recently formed its Retail/Telemarketing Division to solicit
loans directly from prospective borrowers. The Retail/Telemarketing Division
originates loans through predictive dialing machines, which combine telephone
dialing technology with an on-line computer to facilitate the loan origination
process. The predictive dialing machine (i) automatically dials prospective
borrowers, (ii) provides the telemarketer with an on-screen marketing
presentation to market efficiently the Company's loan products, and (iii)
provides an
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interactive loan underwriting program and loan quotation system to assess
immediately the prospect's borrowing capability. The Company believes that the
Retail/Telemarketing Division represents a significant opportunity to expand
origination volume by marketing directly to borrowers and utilizing predictive
dialers which enable the Company to originate such loans at a lower cost than
traditional retail organizations. During the year ended December 31, 1996, the
Company originated $4.5 million of mortgage loans through the Retail/
Telemarketing Division, representing 0.5% of total loan originations and
purchases during 1996.
The Company purchases loans through its Correspondent Program. Loans
purchased through the Correspondent Program are complete loan packages that
have been originated, underwritten and funded by mortgage bankers or financial
institutions. All loans purchased through the Correspondent Program are
reunderwritten by the Company's underwriting staff to determine that the loan
packages are complete and materially adhere to the Company's underwriting
guidelines. During the years ended December 31, 1996, 1995 and 1994, the
Company purchased $204.8 million, $21.1 million, and $7.3 million of mortgage
loans, respectively, through the Correspondent Program, representing 25.9%,
7.3%, and 3.8% of total loan originations and purchases during the respective
periods.
The Institutional Division, which began operations in 1996, also originates
and purchases loans through relationships developed with small to medium-sized
commercial banks, savings banks and thrift institutions. During the year ended
December 31, 1996, the Company originated and purchased $17.3 million of
mortgage loans through the Institutional Division, representing 2.2% of total
loan originations and purchases during 1996.
The Company recently formed its Strategic Alliance Program to increase the
Company's volume and diversify its sources of loan originations. To date, the
Company has entered into two strategic alliances with certain mortgage
lenders, has acquired one and capitalized another under arrangements which
will generally permit the lenders to operate with the Company's financial
support in return for the Company's right to acquire those lenders' mortgage
loan production. All four mortgage lenders specialize in home equity loans. In
its strategic alliance relationships, the Company provides financing
arrangements and a commitment to purchase qualifying loans, and the
participant participates in the potential profitability of Company sponsored
securitizations. In return, the Company receives a more predictable flow of
loans, interest and fee income, and, in some cases, an option to acquire an
equity interest in the strategic alliance participant. Through the Strategic
Alliance Program, the Company has also acquired and capitalized mortgage
lenders whose operations are complementary to the Company's. Such acquisition
and capitalization provide the Company with new broker relationships,
additional experienced management personnel and a greater share of the
residential mortgage loan origination market. During the year ended December
31, 1996, the Company purchased $51.5 million of mortgage loans through its
Strategic Alliance Program, representing 6.5% of total loan originations and
purchases during 1996.
The Company sells a majority of its loan origination and purchase volume in
the secondary market through public securitizations (the process of
aggregating similar assets into pools that are used to collateralize newly-
issued securities, which are referred to as mortgage-backed securities).
Securitization sales provide the Company with greater flexibility and
operating leverage than a portfolio lender by allowing the Company to generate
fee and interest income and participate in the continuing profitability of the
loans with a significantly smaller capital commitment than that required by
traditional portfolio lenders. Generally, in each securitization transaction,
the Company retains an interest in the loans sold through interest-only and
residual certificates, which are amortized over an estimated average life.
Cash flow received from these interest-only and residual certificates is
subject to the prepayment and loss characteristics of the underlying loans.
During the years ended December 31, 1996, 1995 and 1994, the Company
securitized $657.4 million, $164.9 million, and $70.2 million of mortgage
loans, respectively.
The Company retains the servicing rights on all loans it originates or
purchases. In September 1995, the Company chose to outsource its loan
servicing operations to Advanta Mortgage Corp. USA ("Advanta"), which the
Company believes is one of the largest servicers of sub-prime mortgage loans.
The Company believes that by outsourcing loan servicing to Advanta, it is able
to benefit from Advanta's experience in servicing sub-prime mortgage loans,
its comprehensive reporting capabilities, and the cost efficiencies related to
having large amounts
2
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of loans serviced by Advanta for itself and others. Under the Company's
servicing agreement with Advanta, the Company is able to reduce the overhead,
administrative and other fixed costs associated with servicing loans while
maintaining control of its servicing portfolio. Advanta currently services
every mortgage loan originated by the Company. As of December 31, 1996, the
Company's servicing portfolio (inclusive of securitized loans for which the
Company has ongoing risk of loss but has no remaining servicing rights or
obligations) was $908.2 million.
THE CONTRIBUTION TRANSACTION
In October 1994, ICII incorporated the Company as part of a strategic
decision to form a separate subsidiary through which to operate SPTL's
residential lending division. To further this strategy, in December 1994, ICII
made a capital contribution of $250,000 to the Company in exchange for 100% of
its outstanding capital stock, and in April 1995, ICII caused SPTL to
contribute to the Company certain customer lists of SPTL's residential lending
division relating to the ongoing operations of such division. In addition, in
April 1995 all employees of SPTL's residential lending division became
employees of the Company. SPTL retained all other assets and all liabilities
related to the contributed operations including all residual interests
generated in connection with securitizations effected by SPTL's residential
lending division. Shareholders in the Company will not have any interest in
assets that were retained by SPTL as part of the Contribution Transaction.
BUSINESS STRATEGY
Expand Sources of Loan Production. The Company intends to continue to
further its existing relationships with wholesale and correspondent lenders
and to seek new loan production sources from mortgage lenders in order to
diversify its existing loan production channels and seek more cost efficient
means of originating or purchasing loans. As part of this strategy, the
Company has entered into strategic alliances with selected mortgage lenders
and will continue to seek new opportunities to enter into strategic alliances
with, or to acquire, additional mortgage lenders.
Expand Market Base. The Company currently offers multiple mortgage loan
products to borrowers ranging from sub-prime A through D credit levels. The
Company intends to increase its focus on lower credit levels such as C and D
credit loans. The Company requires a higher interest rate and a lower loan-to-
value ratio on C and D loans than it requires for higher grade sub-prime
mortgage loans. The Company believes that market opportunities exist in these
lower credit grade mortgage loans and that it will be able to increase volume
and profitability without a commensurate increase in overhead. Additionally,
the Company believes that its ability to approve these loans quickly and
efficiently will enable it to attract a larger percentage of loans from
independent mortgage brokers and provide it with a competitive advantage over
other conventional and non-conventional mortgage lenders.
Maximize Pull-Through Ratio. The Company intends to increase the percentage
of approved loans which are ultimately funded. The Company continually seeks
greater efficiencies in its underwriting and loan processing operations to
better serve the needs of mortgage brokers and loan applicants. By emphasizing
these efficiencies, the Company believes that it can fund a greater percentage
of approved loans without compromising its selling efforts.
Control Operating Costs. The Company intends to continue to emphasize cost
maintenance as it implements its expansion plans. In particular, the Company
believes its practice of establishing regional branch centers permits the
Company to expand within and outside of the United States without incurring
the costs associated with an extensive retail system. As a further example of
cost controls, the Company has chosen to outsource its loan servicing
operations to Advanta, significantly reducing overhead, administrative and
other fixed costs associated with servicing operations.
Commitment to the Company's Underwriting Guidelines. The Company believes a
key factor in its success to date has been its ability to maintain acceptable
delinquency levels and minimize loan losses when lending to Sub-prime
Borrowers. The Company has been able to achieve these standards by continually
monitoring the
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performance of its loans as well as reevaluating its underwriting guidelines
and quality control criteria. As a result of these factors, the Company has
been able to maintain delinquency and foreclosure ratios at acceptable levels.
Emphasis on Customer Service. The Company believes that its ongoing emphasis
on prompt and responsive customer service provides support for an increased
level of originations from its independent broker network and repeat lending
opportunities from its existing loan portfolio. Typically, the Company
approves loan applications (subject to credit verification, an independent
third-party appraisal and other documentation) within 24 hours of receipt and
funds loans within 21 days thereafter. The Company is actively seeking to
improve its customer service efforts as its operations expand.
Maximize Gains from Loan Sales. The Company employs a loan sales strategy
which focuses on maximizing operating profits. The Company intends to
continually assess the investment objectives of its loan purchasers to
identify the method of loan sales which maximizes operating profits. The
implementation of this strategy has resulted in securitizations of
substantially all of the loans recently originated and purchased by the
Company. The Company, however, will continue to maintain relations with
institutional purchasers of whole loans, as whole loan transactions permit the
Company to reduce its dependence on the potential volatility of the
securitization market and to better manage its cash flows.
EXPANSION STRATEGY
Wholesale Division. The Company plans to continue the expansion of its
Wholesale Division on a nationwide basis and to enter international markets.
The Company originates loans through its sales force of approximately 68
account executives located in 14 regional branch centers in ten states that
have developed relationships with independent mortgage brokers, through which
the Company has originated loans in 50 states and the District of Columbia.
The Company is actively seeking to expand its Wholesale Division pursuant to
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 to recruit selected brokers for the Company's wholesale network.
The Company's sales strategy is to limit the number of regional branch centers
and personnel needed to generate and effectively process and underwrite loans.
As such, the Company typically opens a regional branch center 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.
Retail/Telemarketing Division. The Company recently formed its
Retail/Telemarketing Division to solicit loans directly from prospective
borrowers. The Company has entered into an agreement with vendors to provide
predictive dialing machines, software and training in support of its
Retail/Telemarketing Division. The Company believes that the
Retail/Telemarketing Division represents a significant opportunity to expand
origination volume by marketing directly to borrowers and that the greater use
of automation permitted by the predictive dialers enables the Company to
originate such loans at a lower cost than traditional retail organizations.
The Company believes that by utilizing predictive dialers, it will be able to
achieve a new source of loan origination volume without incurring the fixed
overhead costs associated with traditional retail operations. The cost per
originated loan of such a system is expected to be significantly less than the
cost per originated loan of traditional methods of originating loans, such as
originations in the Wholesale Division. See "--Loan Originations and
Purchases-- Retail/Telemarketing Division."
Correspondent Program. The Company seeks to increase its purchases of loans
from selected financial institutions and mortgage bankers through its
Correspondent Program. The Correspondent Program enables the Company to
increase loan production and enter new markets without incurring significant
operating expenses.
Strategic Alliances. The Company recently formed its Strategic Alliance
Program to increase the Company's volume and diversify its sources of loan
originations. The Company is seeking to enter into new strategic alliance
relationships with, and to acquire, additional mortgage lenders. Such
strategic alliances and acquisitions are expected to provide the Company with
new broker relationships, additional experienced management personnel and a
greater share of the residential mortgage loan origination market. The Company
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may consider acquiring smaller lenders from whom the Company has purchased or
financed mortgage loans or larger companies with operations and resources
similar to the Company's.
Institutional Division. The Company seeks to expand its Institutional
Division which originates and purchases sub-prime loans based on relationships
with selected financial institutions.
LOAN ORIGINATIONS AND PURCHASES
Overview
The Company originates and purchases loans through its Wholesale Division,
its Correspondent Program, its Retail/Telemarketing Division, its
Institutional Division, and its Strategic Alliance Program. The Wholesale
Division originates loans through a network of independent brokers in
coordination with approximately 68 account executives located in 14 regional
branch centers. The Retail/Telemarketing Division originates loans through
predictive dialing machines, which combine telephone dialing technology with
an on-line computer to facilitate the loan origination process. Loans
purchased through the Company's Correspondent Program are originated,
underwritten and funded by approved mortgage bankers and financial
institutions in accordance with industry underwriting standards. Loans
originated or purchased through the Institutional Division are acquired in
connection with relationships with small- to medium-sized regional banks and
thrift institutions. Loans purchased through the Strategic Alliance Division
are acquired from lenders who solicit loans directly from the borrower or
through mortgage brokers as these lenders are able to originate loans for
minimal cash premiums.
The Company's borrowers are individuals who do not qualify for or are
unwilling to obtain loans from conventional mortgage lending sources such as
thrift institutions and commercial banks. These conventional mortgage sources
generally impose strict and inflexible underwriting guidelines, such as those
defined by secondary market investors, and require longer to approve and fund
loans than the Company. The Company's borrowers often have impaired or
unsubstantiated credit histories and/or unverifiable income and place a
premium on personalized service and prompt responses to their loan
applications. As a result, the Company's borrowers are less averse to the
higher interest rates charged by the Company than those charged by
conventional sources.
All of the Company's loans are secured by first or second mortgages on
owner-occupied single family residences and are loans that are made to Sub-
prime Borrowers. Proceeds from the Company's loans are typically used to
consolidate or refinance existing indebtedness, finance home improvements and
pay for educational expenditures.
Geographic Distribution. The following table breaks down by state the number
of loans currently either held by the Company or securitized by the Company:
GEOGRAPHIC DISTRIBUTION OF LOAN ORIGINATIONS AND PURCHASES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
STATES 1996 1995 1994
------ ------- ------- -------
<S> <C> <C> <C>
California..................................... 25.0% 29.8% 39.5%
Oregon......................................... 9.0 13.6 15.5
Colorado....................................... 7.9 5.9 6.6
Washington..................................... 6.6 8.8 10.9
Florida........................................ 5.5 1.0 0.3
Maryland....................................... 3.3 4.4 2.4
Georgia........................................ 3.1 1.7 0.2
Utah........................................... 2.7 3.4 3.6
Hawaii......................................... 2.6 12.4 9.4
New York....................................... 2.5 1.1 0.6
Illinois....................................... 2.4 1.6 0.2
Virginia....................................... 2.4 1.5 0.1
All other states .............................. 27.0 14.8 10.7
------- ------- -------
Total......................................... 100.0% 100.0% 100.0%
======= ======= =======
</TABLE>
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Wholesale Division. The Company originates a majority of its loans through
its Wholesale Division, which consists of a branch network of 14 regional
branch centers, four of which are located in California, two in Oregon, and
one in each of Colorado, Florida, Illinois, Massachusetts, Ohio, Texas,
Virginia and Washington. The regional branch centers are staffed with account
executives who have developed relationships with independent mortgage loan
brokers through which the Company has originated loans in 50 states, and the
District of Columbia. Mortgage loan brokers act as intermediaries between
property owners and the Company in arranging mortgage loans that adhere to the
Company's underwriting guidelines. By concentrating on wholesale mortgage
banking through its network of mortgage loan brokers, the Company believes it
is able to originate loans cost-effectively.
Generally, loan applications are submitted by mortgage brokers to one of the
Company's regional branch centers where the loan is logged-in for Real Estate
Settlement Procedures Act and other regulatory compliance purposes,
underwritten and conditionally approved or denied within 24 hours of receipt.
The Company strives to respond to each broker submitting applications as
quickly as possible, as mortgage brokers may submit loan files to several
prospective lenders at the same time. If approved, a "conditional approval"
will be issued to the broker with a list of specific conditions to be met and
additional documents to be supplied prior to the Company funding the loan. A
production coordinator and the originating Company account executive will work
directly with the submitting mortgage broker to collect the requested
information and meet all underwriting conditions and requirements. In most
cases, the Company funds loans within 21 days after approval of the loan
application.
The following table sets forth selected information relating to loan
originations during the periods shown.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Principal balance of loans ............... $511,840 $267,409 $183,010
Average principal balance per loan........ $ 117 $ 89 $ 118
Percent of first mortgage loans .......... 96.4% 83.2% 97.9%
Weighted average interest rate ........... 10.5% 10.4% 9.0%
Weighted average initial loan-to-value ra-
tio...................................... 72.2% 76.4% 69.4%
</TABLE>
Retail/Telemarketing Division. In addition to originating loans through its
Wholesale Division, the Company recently formed its Retail/Telemarketing
Division to solicit loans directly from prospective borrowers. During the year
ended December 31, 1996, the Company originated and purchased $4.5 million of
mortgage loans through its Retail/Telemarketing Division, representing 2.2% of
total loan originations and purchases during 1996. The Retail/Telemarketing
Division originates loans through predictive dialing machines, which combine
telephone dialing technology with an on-line computer to facilitate the loan
origination process. The predictive dialing machine (i) automatically dials
prospective borrowers, (ii) provides the telemarketer with an on-screen
marketing presentation to market efficiently the Company's loan products, and
(iii) provides an interactive loan underwriting program and loan quotation
system to assess immediately the prospect's borrowing capability. The Company
believes that the Retail/Telemarketing Division represents a significant
opportunity to expand origination volume by marketing directly to borrowers
and utilizing predictive dialers which enable the Company to originate such
loans at a lower cost than traditional retail organizations.
Correspondent Program. In addition to originating loans through its
Wholesale Division and the Retail/Telemarketing Divisions, the Company
purchases loans through its Correspondent Program. Purchases under the
Correspondent Program are in the form of complete loan packages that have been
originated, underwritten and funded by mortgage bankers or financial
institutions. All loans purchased through the Correspondent Program are
reunderwritten by the Company's underwriting staff to determine that the loan
packages are complete and materially adhere to the Company's underwriting
guidelines. Depending on the size of the pool of loans purchased, the Company
will engage a third-party underwriter to reunderwrite the loans, verify the
borrower's employment status, determine credit grade and verify the quality of
the appraisal.
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The Company has established relationships with several mortgage bankers who
have been reviewed by the Company to ensure the quality and type of loans
originated. The Company also analyzes the financial condition of the mortgage
banker, including a review of the mortgage bankers' licenses and financial
statements. Upon approval, the Company typically requires each mortgage banker
to enter into a purchase and sale agreement with customary representations and
warranties regarding the loans such mortgage banker will sell to the Company.
The following table sets forth selected information relating to the
correspondent purchase of loans during the periods shown.
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
-------------------------
1996 1995 1994
-------- ------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Principal balance of loans................... $204,799 $21,073 $7,287
Average principal balance per loan........... $ 101 $ 69 $ 101
Percent of first mortgage loans ............. 99.2% 81.7% 99.9%
Weighted average interest rate .............. 10.6% 10.9% 8.7%
Weighted average initial loan-to-value ra-
tio......................................... 74.8% 72.9% 73.3%
</TABLE>
Strategic Alliances. In addition to originating and acquiring loans through
its Wholesale Division, Retail/Telemarketing and the Correspondent Program,
the Company purchases loans through its Strategic Alliance Program. The
Company recently formed its Strategic Alliance Program to increase the
Company's volume and diversify its sources of loan originations. To date, the
Company has entered into two strategic alliances with certain mortgage
lenders, has acquired one and capitalized another under arrangements which
will generally permit the lenders to operate with the Company's financial
support in return for the Company's right to acquire those lenders' mortgage
loan production. All four mortgage lenders specialize in home equity loans. In
its strategic alliance relationships, the Company provides financing
arrangements and a commitment to purchase qualifying loans, and the
participant participates in the potential profitability of Company sponsored
securitizations. In return, the Company receives a more predictable flow of
loans, interest and fee income, and, in some cases, an option to acquire an
equity interest in the strategic alliance participant. Through the Strategic
Alliance Program, the Company has also acquired and capitalized mortgage
lenders whose operations are complementary to the Company's. Such acquisition
and capitalization provide the Company with new broker relationships,
additional experienced management personnel and a greater share of the
residential mortgage loan origination market. During the year ended December
31, 1996, the Company purchased $51.5 million of mortgage loans through its
Strategic Alliance Program, representing 6.5% of total loan originations and
purchases during 1996.
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31, 1996
----------------------
(DOLLARS IN THOUSANDS)
<S> <C>
Principal balance of loans........................ $51,536
Average principal balance per loan................ $ 87
Percent of first mortgage loans................... 99.2%
Weighted average interest rate.................... 11.0%
Weighted average initial loan-to-value ratio...... 80.5%
</TABLE>
National Capital Funding, Inc., the mortgage lender acquired through the
Strategic Alliance Program, is a Delaware corporation. National's residential
lending division underwrites first and second lien mortgage loans primarily
secured by one- to four-family residences. National acquires mortgage loans
through a network of approved mortgage brokers. National also acquires
mortgage loans from other financial institutions. National began originating
and acquiring mortgage loans as of March 1, 1995. On December 31, 1996, SPPC
acquired a 95% ownership interest in National. National had assets as of
December 30, 1996, of approximately $5 million.
7
<PAGE>
Institutional Division. The Company's Institutional Division originates and
purchases sub prime loans based on relationships with selected financial
institutions. The following table sets forth selected information relating to
the loans originated or purchased through the Institutional Division.
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31, 1996
----------------------
(DOLLARS IN THOUSANDS)
<S> <C>
Principal balance of loans......................... $17,186
Average principal balance per loan................. $ 129
Percent of first mortgage loans.................... 98.5%
Weighted average interest rate..................... 10.4%
Weighted average initial loan-to-value ratio....... 74.7%
</TABLE>
UNDERWRITING
The Company's underwriting guidelines are provided to all mortgage loan
brokers and mortgage bankers so they can create loan applications or bulk
purchase packages which meet such guidelines. Upon receipt of a loan
application or package 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 each loan, the Company's underwriters consider
various factors, including the appraised value of the collateral property, the
applicant's debt payment history, credit profile and employment status, and
the combined debt ratio and loan-to-value ratio upon completion of the loan.
Appraisals of loans originated or purchased by the Company are conducted by
Company approved, licensed, independent appraisers. The Company's underwriting
staff then reviews the value of the underlying collateral based on a full
review of the appraisal completed by such pre-approved licensed independent
appraiser. The Company selects its review appraisers based on professional
experience, education, membership in related professional organizations 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.
Prior to funding a loan, the Company's underwriting staff determines the
applicant's creditworthiness and ability to service the loan. Verification of
personal financial information, credit history, and employment history is
required prior to closing the loan. 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 loan-to-value 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. Borrowers with lower
credit ratings generally pay higher interest rates and loan origination fees.
The criteria currently used by the Company in classifying loan applicants are
described below. 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 two years. 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.
8
<PAGE>
Underwriting Risk Categories
Under the Company's "A" risk category, the prospective borrower must have
generally repaid consumer debt (revolving and installment) according to its
terms with a maximum of three 30-day late payments within the last 12 months
or five 30-day late payments or two 60-day late payments on such obligations
within the last 24 months. Within this 24 month period, however, a maximum of
one 30-day late payment and no 60-day late payments are acceptable in the last
12 months or a maximum of two 30-day late payments and no 60-day payments
within the last 24 months are acceptable on an existing mortgage loan on the
subject property. The existing mortgage obligation must be current. Minor
derogatory items are allowed as to non-mortgage credit. No collections,
charge-offs or judgments over $500 within the last five years are allowed. No
bankruptcy or notice of default filings by the borrower may have occurred
during the preceding three years. A maximum loan-to-value ratio of up to 90%
(or 75% for mortgage loans originated under the non-conforming, no-income
qualifier program, but 80% if the borrower is self-employed) is permitted for
a mortgage loan on a single family owner-occupied property. A maximum loan-to-
value ratio of 80% (or 70% for mortgage loans originated under the non-
conforming no-income qualifier program, but 75% if the borrower is self-
employed) is permitted for a mortgage loan on non-owner-occupied properties
and second home properties. The debt service-to-income ratio generally is 45%
or less, depending on the qualifying rate. The maximum loan amount is $400,000
for single-family owner-occupied properties, regardless of the documentation
program. Exceptions to the maximum loan amount for single-family owner-
occupied properties are considered by the Company on a limited basis. The
maximum loan amount is $350,000 (or $300,000 for mortgage loans originated
under the non-conforming no-income qualifier program) for mortgage loans on
single-family non-owner-occupied properties or second homes.
Under the Company's "A-" risk category, the prospective borrower must have
generally repaid consumer debt (revolving and installment) according to its
terms with a maximum of five 30-day late payments or two60-day late payments
within the last 12 months. A maximum of two 30-day late payments, and no 60-
day late payments, within the last 12 months is acceptable on an existing
mortgage loan on the subject property. The existing mortgage obligation must
be current. Minor derogatory items are allowed as to non-mortgage credit. No
unpaid collection accounts, charge-offs or judgments over $1,000 within the
last two years are allowed. No bankruptcy or notice of default filings by the
borrower may have occurred during the preceding two years. A maximum loan-to-
value ratio of up to 85% (or 75% for mortgage loans originated under the non-
conforming no-income qualifier program, but 80% if the borrower is self-
employed) is permitted for a mortgage loan on a single-family owner-occupied
property. A maximum loan-to-value ratio of up to 75% (or 70% for mortgage
loans originated under the non-conforming no-income qualifier program) is
permitted for a mortgage loan on a non-owner-occupied property or a second
home. The debt service-to-income ratio is generally 45% or less, depending on
the qualifying rate. The maximum loan amount is $650,000 for single-family
owner-occupied properties under the non-conforming full documentation program.
Exceptions to the maximum loan amount for single-family owner-occupied
properties are considered by the Company on a limited basis. The maximum loan
amount is $500,000 for mortgage loans on single-family owner-occupied
properties under the non-conforming no-income qualifier program. The maximum
loan amount is $400,000 (or $350,000 for mortgage loans originated under the
non-conforming no-income qualifier program) for mortgage loans on a single-
family non-owner-occupied property or a second home. Loan applicants with less
favorable credit ratings generally are offered loans with higher interest
rates and lower loan-to-value ratios than applicants with more favorable
credit ratings.
Under the Company's "B" risk category, the prospective borrower must have
generally repaid consumer debt according to its terms, with a maximum of eight
30-day late payments or four 60-day late payments or two 90-day late payments
on such obligations within the last 12 months. A maximum of four 30-day late
payments or three 30-day late payments and one 60-day late payment within the
last 12 months is acceptable on an existing mortgage loan on the subject
property. The existing mortgage obligation must be current. As to non-mortgage
credit, some prior defaults may have occurred. Isolated and insignificant
collections and/or charge-offs, and judgments within the last 18 months,
totaling less than $2,000 are acceptable. No bankruptcy or notice of default
filing by the borrower may have occurred during the preceding 18 months. A
maximum loan-to-value ratio of 80% (70% for mortgage loans originated under
the non-conforming, no-income qualifier program, but 75% if the borrower is
self-employed) is permitted for a mortgage loan on a single family, owner-
occupied property. A
9
<PAGE>
maximum loan-to-value ratio of 70% (or 65% for mortgage loans originated under
the non-conforming, no-income qualifier program) is permitted for a mortgage
loan on a non-owner-occupied property or second home. The debt service-to-
income ratio generally is 50% or less, depending on the qualifying rate. The
maximum loan amount is $600,000 for single family owner-occupied properties
under the non-conforming full documentation program. The maximum loan amount
is $350,000 (or $300,000 for mortgage loans originated under the non-
conforming, no-income qualifier program) for mortgage loans on a non-owner-
occupied property or a second home.
Under the Company's "C" risk category, the prospective borrower may have
experienced significant credit problems in the past. A maximum of twelve 30-
day late payments or six 60-day late payments or four 90-day late payments on
consumer debt within the last 12 months is acceptable. A maximum of five 30-
day late payments or three 30-day late payments and two 60-day late payments
or three 30-day late payments and one 90-day late payment within the last 12
months is acceptable on an existing mortgage loan on the subject property. The
existing mortgage can be up to 40 days past due at the time of funding of the
loan. As with non-mortgage credit, significant prior defaults may have
occurred. There may be open collections or charge-offs not to exceed $4,000
and up to $6,000 in isolated circumstances. No bankruptcy or notice of default
filings by the borrower may have occurred during the preceding year. A maximum
loan-to-value ratio of 75% (or 65% for mortgage loans originated under the
non-conforming, no-income qualifier program, but 70% if the borrower is self-
employed) is permitted on a mortgage loan on a single-family owner-occupied
property. A maximum loan-to-value ratio of 70% (or 60% for mortgage loans
originated under the non-conforming, no-income qualifier program, but 65% if
the borrower is self-employed) is permitted for a mortgage loan on a non-
owner-occupied property or second home. The debt service-to-income ratio is
generally 55% or less, depending on the qualifying rate. The maximum loan
amount is $500,000 (or $400,000 for mortgage loans originated under the non-
conforming, no-income qualifier program) for mortgage loans on single-family
owner-occupied properties. The maximum loan amount is $300,000 (or $200,000
for mortgage loans originated under the non-conforming no-income qualifier
program) for mortgage loans on a non-owner-occupied property or a second home.
Under the Company's "D" risk category, the prospective borrower may have
experienced significant credit problems in the past. As to non-mortgage
credit, significant prior defaults may have occurred. The borrower is sporadic
in some or all areas with a general disregard for timely payment or credit
standing. With respect to an existing mortgage loan on the subject property.
Such existing mortgage loan is not required to be current at the time the
application is submitted. The borrower may have open collections, charge-offs
and judgments, all of which may be paid simultaneously with the funding of the
loan. Borrowers who are in foreclosure are considered. A maximum loan-to-value
ratio of 65% is permitted for a mortgage loan on a single-family owner-
occupied property and non-owner-occupied property. The maximum loan amount is
$350,000 for mortgage loans on a non-owner-occupied property, owner-occupied
property or a second home. The debt service-to-income ratio generally is 60%
or less, depending on the qualifying rate.
Exceptions. As described above, the Company uses the foregoing categories
and characteristics as underwriting guidelines only. On a case-by-case basis,
the Company's underwriters may determine that the prospective mortgagor
warrants a risk category upgrade, a debt service-to-income ratio exception, a
pricing exception, a loan-to-value exception or an exception from certain
requirements of a particular risk category (collectively called an "upgrade"
or an "exception"). An upgrade or exception may generally be allowed if the
application reflects certain compensating factors, including among others: low
loan-to-value ratio; pride of ownership; a maximum of one 30-day late payment
on all mortgage loans during the last 12 months; stable employment; and the
length of residence in the subject property. Accordingly, the Company may
classify certain mortgage loan applications in a more favorable risk category
than other mortgage loan applications that, in the absence of such
compensating factors, would only satisfy the criteria of a less favorable risk
category.
10
<PAGE>
Loan Production by Borrower Risk Classification
The following tables set forth information concerning the Company's loan
production by borrower risk classification for loans secured by mortgages for
the years ended December 31, 1996 and 1995. Dollars in the table below are in
thousands.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996 YEAR ENDED DECEMBER 31, 1995
------------------------------------ ------------------------------------
WEIGHTED WEIGHTED
AVERAGE WEIGHTED AVERAGE WEIGHTED
LOAN % OF INTEREST AVERAGE LOAN % OF INTEREST AVERAGE
CREDIT RATING AMOUNT MORTGAGES RATE LTV AMOUNT MORTGAGES RATE LTV
- ------------- -------- --------- -------- -------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
A....................... $127,325 16.1% 10.6% 81.7% $ 98,455 34.1% 11.36% 80.6%
A-...................... 414,544 52.5 10.1 73.4 135,001 46.8 9.65 76.8
B....................... 154,601 19.6 10.9 71.8 34,906 12.1 10.50 68.2
C....................... 59,214 7.5 11.6 67.8 17,716 6.1 11.01 64.1
D....................... 34,230 4.3 12.5 60.6 2,404 0.9 12.10 58.6
-------- ----- -------- -----
Total.................. $789,914 100.0% 10.6 73.5 $288,482 100.0% 10.44 76.1
======== ===== ======== =====
</TABLE>
LOAN SALES AND SECURITIZATIONS
The Company sells a majority of its loan origination and purchase volume
through public securitizations. Securitization sales provide the Company with
greater flexibility and operating leverage than a portfolio lender by allowing
the Company to generate fee and interest income and participate in the
continuing profitability of the loans with a significantly smaller capital
commitment than that required by traditional portfolio lenders. During the
years ended December 31, 1996, 1995 and 1994, the Company securitized $657.4
million, $164.9 million, and $70.2 million of mortgage loans, respectively.
Generally, in each securitization transaction, the Company sells mortgage
loans it has originated or purchased to a trust which qualifies as a real
estate mortgage investment conduit. The trust issues mortgage pass-through
certificates. The senior certificates are sold in an offering and the Company
retains the interest-only and residual certificates, which are amortized over
an estimated average life. Cash flow realized from these interest-only and
residual certificates is subject to the prepayment and loss characteristics of
the underlying loans. The interest-only and residual certificates retained by
the Company through securitizations amounted to $95.8 million and $25.7
million for the years ended December 31, 1996 and 1995.
With respect to the aforementioned securitizations, the Company arranged for
the related trusts to purchase credit enhancements for the senior interests in
the related trusts in the form of insurance policies provided by AAA/Aaa rated
monoline insurance companies, and, as a result, the senior interests in each
trust received a rating of "AAA" from Standard & Poor's Ratings Services and
"Aaa" from Moody's Investors Service, Inc.
The pooling and servicing agreements that govern the distribution of cash
flows from the loans included in the trusts provide for additional credit
enhancement for the senior interests of the related trusts by creating
overcollateralization of the senior interests. This is effected by using
interest receipts on the mortgage loans to reduce the outstanding principal
balance of the senior interests to a pre-set percentage of the mortgage loans.
The overcollateralization percentage may be reduced over time according to the
delinquency and loss experience of the loans. The Company's interest in each
overcollateralized amount is reflected in the Company's financial statements
as a portion of "interest-only and residual certificates." 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 Company's discounted recourse allowance,
the excess losses in any period will result in a reduction in the value of the
interest-only and residual certificates held by the Company. 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.
11
<PAGE>
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, the Company hedges future production of mortgage loans through
a pre-funding mechanism in connection with its securitizations. In its
securitization transactions, investors deposit cash in a pre-funded amount
into the related trust to purchase the loans the Company commits to 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 1995, the Company had open positions of $32.6
million and $0 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. At December 31, 1996 and 1995, the Company's unrealized
loss on open positions is $43,023 and $84,375, respectively, on forward
positions of United States Treasury securities.
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 Advanta
(the "Advanta Agreement") to service all of its current and ongoing
production. In addition, Advanta services or subservices each public
securitization of the Company's loans pursuant to the related pooling and
servicing agreement. According to Advanta's Annual Report on Form 10-K for the
year ended December 31, 1995, Advanta serviced approximately $1.8 billion in
loans with an overall average delinquency rate of approximately 6%. 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 Advanta Agreement, the
Company is obligated to pay Advanta a monthly servicing fee on the declining
principal balance of each loan serviced and a set-up fee for each loan
delivered to Advanta for servicing.
12
<PAGE>
Advanta is required to pay all expenses related to the performance of its
duties under the Advanta Agreement. Further, Advanta 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, Advanta
generally will be reimbursed prior to the Company receiving the remaining
proceeds. Advanta 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 Advanta's expenses in the sale, are less than the principal
balance of the related mortgage loan.
The Company may terminate the Advanta Agreement upon the occurrence of one
or more of the events specified in the Advanta Agreement generally relating to
Advanta's proper and timely performance of its duties and obligations under
the Advanta Agreement. Either the Company or Advanta may terminate the Advanta
Agreement without cause upon 90 days' prior written notice to the other party;
provided, that if the Company terminates the Advanta Agreement without cause,
the Company shall pay to Advanta a termination fee of 1% of the aggregate
principal balance of the mortgage loans being serviced by Advanta at such
time; provided, further, that if the Company transfers servicing of any amount
of mortgage loans being serviced by Advanta to another servicer without
terminating the Advanta Agreement, the Company shall pay to Advanta $100 per
mortgage loan transferred. With respect to mortgage loans securitized by the
Company, the Company will not be able to terminate the servicer without the
approval of the trustee for such securities.
As is customary in the mortgage loan servicing industry, Advanta 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. Advanta 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 impound funds. Advanta 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 subcontracts with an outside servicer, Advanta. This arrangement
allows the Company to increase the volume of its loan originations and
purchases without incurring related overhead investments in servicing
operations.
The following table sets forth certain information regarding the Company's
servicing portfolio of loans for the periods shown.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1996 1995 1994
--------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Beginning servicing portfolio.................. $ 270,193 $ 68,721 $ 18,074
Loans added to the servicing portfolio......... 789,914 288,482 190,297
Loans sold servicing released and principal
paydowns...................................... (151,887) (87,010) (139,650)
--------- -------- ---------
Ending servicing portfolio..................... $ 908,220 $270,193 $ 68,721
========= ======== =========
</TABLE>
Advanta Corp. Advanta Corp., the parent of the servicer of the Company's
mortgage loan portfolio, recently announced that it was exploring strategic
alternatives as a result of increased losses from credit card loans. Although
Advanta Corp. stated that its mortgage business was performing well, there can
be no assurance that a sale of Advanta Corp. or some of its businesses will
not have an adverse effect on the Company.
Delinquencies and Foreclosures. Loans originated or purchased by the Company
are secured by mortgages, deeds of trust, security deeds or deeds to secure
debt, depending upon the prevailing practice in the state in which the
property securing the loan is located. Depending on local law, foreclosure is
effected by judicial action or
13
<PAGE>
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. 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. Where a
loan has not yet been sold or securitized, the Company will generally allow a
borrower to reinstate the loan up to the date of foreclosure sale.
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.
The following table sets 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,
-------------------------------------------------------
1996 1995 1994
------------------ ------------------ -----------------
% OF % OF % OF
LOANS LOANS LOANS
IN IN IN
SERVICING SERVICING SERVICING
AMOUNT PORTFOLIO AMOUNT PORTFOLIO AMOUNT PORTFOLIO
-------- --------- -------- --------- ------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Loans serviced.......... $908,220 100.0% $270,193 100.0% $68,721 100.0%
30-59 days delinquent... 23,486 2.6 3,072 1.1 321 0.5
60-89 days delinquent... 16,183 1.8 1,896 0.7 199 0.3
90 days or more
delinquent............. 22,751 2.5 4,396 1.6 383 0.5
-------- ----- -------- ----- ------- -----
Total delinquencies..... $ 62,420 6.9% $ 9,364 3.4% $ 903 1.3%
======== ===== ======== ===== ======= =====
Delinquent loans in
foreclosure............ $ 20,546 2.3% $ 4,883 1.8% $ 383 0.5%
Total real estate
owned.................. 1,227 .1% 141 -- -- --
</TABLE>
As of December 31, 1996, statements to certificateholders prepared by the
trustee for each of six securitizations in which loans originated and
purchased by the Company were included reported losses of $369,613. The
Company's loans securitized and sold in the secondary market and included in
these securitizations have been outstanding for a relatively short period of
time and consequently the delinquencies, foreclosures and loss experience to
date are not indicative of results to be experienced in the future. In
addition, the mortgage loans related to the interest-only and residual
certificates retained by SPTL pursuant to the Contribution Transaction have
generally had higher delinquency ratios than the Company's delinquency ratios,
even though such loans were generally underwritten to SPFC's underwriting
standards.
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.
14
<PAGE>
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.
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.
15
<PAGE>
Because the Company's business is highly regulated, the laws, rules and
regulations applicable to the Company are subject to regular modification and
change. There are currently proposed various laws, rules and regulations
which, if adopted, could impact the Company. There can be no assurance that
these proposed laws, rules and regulations, or other such laws, rules or
regulations, will not be adopted in the future which could make compliance
much more difficult or expensive, restrict the Company's ability to originate,
broker, purchase or sell loans, further limit or restrict the amount of
commissions, interest and other charges earned on loans originated, brokered,
purchased or sold by the Company, or otherwise adversely affect the business
or prospects of the Company.
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 sub-prime 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. The Company's underwriters apply its underwriting guidelines on an
individual basis but have the flexibility to deviate from them when an
exception or upgrade is warranted by a particular loan applicant's situation,
such as evidence of a strong mortgage repayment history relative to a weaker
overall consumer-credit repayment history. This provides independent mortgage
brokers working with the Company the ability to offer loan packages to Sub-
prime Borrowers.
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, 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.
EMPLOYEES
At December 31, 1996, the Company employed 370 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.
ITEM 2. PROPERTIES
The Company's executive and administrative offices are located at One
Centerpointe Drive, Suite 500, Lake Oswego, Oregon, and consist of
approximately 9,922 square feet. The leases on the premises expire between
1999 and 2001, and the current annual rent is approximately $189,175.
16
<PAGE>
The Company also leases space for its branch offices. These facilities
aggregate approximately 57,673 square feet, with an annual aggregate base
rental of approximately $752,116. 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. The branch offices range in size from 675
to 13,068 square feet with lease terms typically ranging from one to five
years. Annual base rents for the branch offices range from $2,400 to $82,328.
ITEM 3. LEGAL PROCEEDINGS
The Company 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND REGULATED STOCKHOLDER
MATTERS
The Company's Common Stock began to trade on the New York Stock Exchange
("NYSE") on June 13, 1996 under the symbol "SFC." The following table sets
forth the range of high and low last reported sale prices per share for the
Common Stock for the periods indicated as reported by the NYSE from the
completion of the IPO on June 13, 1996.
FISCAL 1996:
<TABLE>
<CAPTION>
MONTH HIGH LOW
----- ----- -----
<S> <C> <C>
June.......................................................... 12.67 10.92
July ......................................................... 13.00 10.17
August........................................................ 18.00 13.33
September .................................................... 18.42 16.50
October....................................................... 22.67 16.67
November...................................................... 21.17 17.33
December...................................................... 21.92 19.50
</TABLE>
As of March 25, 1997, there were 16 holders of record of the Common Stock
who the Company believes held shares for in excess of 2,000 beneficial owners.
The Company has never paid any cash dividends on its Common Stock. The
Company intends to retain all of its future earnings to finance its operations
and does not anticipate paying cash dividends in the foreseeable future. Any
decision made by the Company's Board of Directors to declare dividends in the
future will depend upon the Company's future earnings, capital requirements,
financial condition and other factors deemed relevant by the Company's Board
of Directors.
On April 1, 1996 the Company declared a stock split of 4,150 for one and on
January 7, 1997, the Company declared a stock split of three for two. All
pertinent share and per share information for 1996, has been retroactively
restated to reflect these splits.
17
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL AND OTHER DATA
(In thousands, except per share data and ratios)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1996 1995 1994 1993
---------- ------- ------ ------
<S> <C> <C> <C> <C>
STATEMENTS OF EARNINGS DATA:
Revenues:
Gains on sales of loans..................... $ 55,361 $16,329 $9,572 $1,218
Interest income............................. 13,849 4,305 2,136 407
Securities valuation and other income....... 4,265 1,666 -- --
---------- ------- ------ ------
Total revenues............................ 73,475 22,300 11,708 1,625
---------- ------- ------ ------
Expenses:
Interest expense............................ 7,800 3,414 886 175
Personnel and commission expense............ 10,997 4,190 2,156 475
General and administrative expense.......... 6,599 2,153 1,262 239
---------- ------- ------ ------
Total expenses............................ 25,396 9,757 4,304 889
---------- ------- ------ ------
Earnings before taxes......................... 48,079 12,543 7,404 736
Income taxes.................................. 20,447 5,205 3,073 305
---------- ------- ------ ------
Net earnings.................................. $ 27,632 $ 7,338 $4,331 $ 4,31
========== ======= ====== ======
Earnings per share............................ $ 1.37
Weighted average number of shares outstand-
ing(1)....................................... 20,511,936
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------
1996 1995
--------- ---------
<S> <C> <C>
BALANCE SHEET DATA:
Cash................................................. $ 14,176 $ --
Loans held for sale ................................. 223,059 80,264
Loans held under repurchase agreement ............... -- 12,801
Interest-only and residual certificates.............. 95,810 25,659
Other Assets......................................... 16,125 1,681
Total assets......................................... 349,170 120,405
Borrowings under warehouse lines of credit .......... 152,680 96,130
Convertible subordinated notes payable .............. 75,000 --
Due to affiliates.................................... 80 4,343
Other Liabilities.................................... 36,261 7,043
Total Liabilities.................................... 264,021 107,516
Total shareholders' equity........................... 85,086 12,889
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994 1993
-------- -------- -------- -------
<S> <C> <C> <C> <C>
OPERATING STATISTICS:
Loan origination and purchases:
Fixed-rate loans...................... $261,020 $133,360 $ 28,599 $ 2,668
Variable-rate loans................... 528,894 155,122 161,698 38,888
-------- -------- -------- -------
Total loan originations and pur-
chases............................. $789,914 $288,482 $190,297 $41,556
-------- -------- -------- -------
Percent of loans secured by first mort-
gages.................................. 97.5% 83.2% 98.0% 96.4%
Average principal balance per loan...... $ 110 $ 87 $ 117 127
Weighted average initial loan-to-value
ratio.................................. 73.5% 76.1% 69.5% 67.7%
Loan sales:
Whole loan sales...................... -- $ 58,595 $121,362 $23,410
--------
Loans sold through securitizations.... 657,353 164,870 70,173 --
-------- -------- -------- -------
Total loan sales.................... $657,353 $223,465 $191,535 $23,410
======== ======== ======== =======
Weighted average interest rate:
Fixed-rate loans...................... 11.5% 11.8% 10.1% 10.5%
Variable-rate loans................... 10.1% 9.3% 8.8% 8.0%
Delinquencies as a % of loan servicing
portfolio(at period end)(2)............ 6.9% 3.4% 1.3% 6.9%
Net losses on loans as a % of loan ser-
vicing portfolio(at period end)(3)..... 0.0% 0.0% 0.0% 0.0%
</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 Financial Statements included herein.
(2) Includes securitized loans serviced by others and loans held for sale.
Delinquencies include all loans over 30 days past due.
(3) Includes securitized loans serviced by others and loans held for sale. The
Company has not experienced material loan losses in part due to the
relatively unseasoned portfolio. The Company believes that over time its
delinquency and loan loss experience will increase as its loan portfolio
matures.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following should be read in conjunction with the Consolidated financial
statements of the Company and the accompanying notes for the years ended
December 31, 1996, 1995, and 1994. The discussion below 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 results of certain factors.
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 to consolidate and refinance debt, finance home
improvements and fund educational expenses. The Company originates and
purchases loans through its Wholesale Division, its Correspondent Program, its
Retail/Telemarketing Division, its Strategic Alliance Division, and its
Institutional Division.
The Company's primary source of revenue is the recognition of gains from the
sale of interests in loans through securitizations. The Company recognizes
gains from the sale of senior interests in trusts of loans as the excess of
the net proceeds received on the sale and the fair value of the interest-only
and residual certificates retained by the Company over the Company's basis in
such loans and a provision for credit losses. The fair value of the interest-
only and residual certificates is an estimate of the present value of the
future cash flows from such
19
<PAGE>
certificates, which are subject to the prepayment and loss characteristics of
the underlying loans. See "Business--Loan Sales and Securitizations." The
Company securitized and sold senior interests in loans with principal balances
of $657.4 million, $164.9 million, and $70.2 million during the years ended
December 31, 1996, 1995 and 1994, respectively, which represented 100.0%,
73.8%, and 36.7% of total loans sold by the Company during the respective
periods. The Company anticipates that it will continue to sell senior
interests in a majority of its loans through securitization transactions and
will strategically sell loans in whole loan transactions when such
transactions are economically advantageous.
In October 1994, ICII incorporated the Company as part of a strategic
decision to form a separate subsidiary through which to operate SPTL's
residential lending business. To further this strategy, in December 1994, ICII
incorporated the Company and made a capital contribution of $250,000 to the
Company in exchange for 100% of its outstanding capital stock, and in April
1995, ICII caused SPTL to contribute to the Company certain customer lists of
SPTL's residential lending division relating to the ongoing operations of such
division. In addition, in April 1995, all employees of SPTL's residential
lending division became employees of the Company. SPTL retained all other
assets and all liabilities related to the contributed operations including all
residual interests generated in connection with securitizations effected by
SPTL's residential lending division. Shareholders of the Company do not have
any interest in assets retained by SPTL as part of the Contribution
Transaction. In June 1996, the Company completed the IPO, raising net proceeds
of approximately $54 million.
FINANCIAL CONDITION
Loans held for sale increased $142.8 million or 178% 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 sales of $657.4 million. Originations increased 174%
primarily as a result of the Company diversifying its methods of loan
originations through its retail/telemarketing division, institutional division
and strategic alliance division, complemented by geographic expansion.
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 $70.1 million or 273% to
$95.8 million in 1996 from $25.7 million in 1995. This increase is the result
of four securitizations occurring in 1996 of $657.4 million compared to two
securitizations in 1995 of $164.9 million.
Accrued interest receivable increased $2.2 million or 226% 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 620% 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.
Other assets increased $4.9 million or 1,726% 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 October,
1996 issuance of $75 million of convertible subordinated notes and increased
prepaid expenses relating to the final securitization of 1996.
Discounted recourse liability increased $5.6 million or 176% to $8.8 million
in 1996 from $3.2 million in 1995. This increase is the result of four
securitizations occurring in 1996 totaling $657.4 million compared to two
securitizations in 1995 totaling $164.9 million.
20
<PAGE>
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 the result of originations increasing 174% from 1995 primarily as a result
of the Company diversifying its methods of loan originations through its
retail/telemarketing division, institutional division and strategic alliance
division, complemented by geographic expansion.
Deferred tax liability increased $16.0 million or 661% to $18.4 million in
1996 from $2.4 million in 1995. Prior to the IPO, the Company was consolidated
with ICII on their tax return. Post IPO, the Company will file a separate tax
return.
Convertible subordinated debentures increased $75 million from $0 in 1995.
In October 1996, the Company issued $75 million convertible subordinated
debentures, due October 2006.
Due to affiliates decreased $1.5 million or 94% to $80,166 in 1996 from $1.6
million in 1995. A majority of the amount due to affiliates was paid at the
time of the IPO. Remaining amount due is for various administrative expenses
provided by ICII for human resources and other administrative functions.
Other liabilities increased $5.8 million or 179% 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
debentures.
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.
RESULTS OF OPERATIONS
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 160% to $25.4 million from $9.8 million. As a
result, the Company's net earnings increased $20.3 million or 277% 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 $39.0 million or 239% 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 $244.4 million or 91% to $511.8 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, retail/telemarketing division loan originations
increased to $4.6 million in 1996 from $0 million in the comparable period in
1995, institutional division loan originations increased to $17.2 million in
1996 from $0 million in the comparable period in 1995, and strategic alliance
loan originations increased to $51.5 million in 1996 from $0 million in the
comparable period 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 222% 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 156% 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.
21
<PAGE>
Total expenses increased $15.6 million or 160% 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 128% 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 162% 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
Telemarketing 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 206% 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.
Year Ended December 31, 1995 Compared to the Year Ended December 31, 1994
Total revenues increased $10.6 million or 91% 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 70% 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 $6.8 million or 71% 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.
22
<PAGE>
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.
LIQUIDITY AND CAPITAL RESOURCES
The Company relies upon short-term warehouse facilities to fund loan
originations and purchases. In November 1995, the Company entered into a
warehouse and purchases facility (the "First Facility"). Under the First
Facility, the Company has available a $200 million warehouse line of credit
secured by the loans the Company originates and purchases. The First Facility
extends through August 24, 1997. The Company is required to comply with
various operating and financial covenants as defined in the agreement
governing the First Facility. 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 Facility, (ii)
selling any asset other than in the ordinary course of business and (iii)
guaranteeing the debt obligations of any other entity. The continued
availability of funds provided to the Company under this facility is subject
to the Company's continued compliance with the operating and financial
covenants contained in such agreement.
In October 1996, the Company entered into a second warehouse facility (the
"Second Facility"). Under the Second Facility, the Company has available a
$400 million warehouse line of credit secured by the loans the Company
originates or purchases using the facility. The Company is required to comply
with various operating and financial covenants as defined in the agreement
governing the Second Facility. 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 Facility, (ii)
selling any assets other than in the ordinary course of business and (iii)
guaranteeing the debt obligations of any other entity. The continued
availability of funds provided to the Company under this facility is subject
to the Company's continued compliance with the operating and financial
covenants contained in such agreements.
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. In December 1996 and
during successive preceding quarters dating to the fourth quarter in 1994, the
Company securitized 234.9 million, 189.4 million, $130.6 million, $102.4
million, $30.3 million, $62.1 million, $44.9 million, $27.6 million, and $25.7
million of loans, respectively. 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.
In addition, in order to gain access to the securitization market, the Company
has relied on credit enhancements provided by monoline insurance companies to
guarantee senior interests in the related
23
<PAGE>
securitization trusts to enable it to obtain an "AAA/Aaa" rating for such
interests. Unwillingness of insurance companies to guarantee senior interests
in the Company's loan pools could have a material adverse effect on the
Company's results of operations and financial condition. The Company 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. The use of cash in excess of cash
generated was primarily the result of the ongoing cash requirements of the
Company's operations and the sale of loans through securitizations and the
resulting investment in interest-only and residual certificates. The Company
has historically invested its entire gain on securitization in the related
interest-only and residual certificates resulting in an insignificant net cash
flow from the securitization to the Company.
CASH FLOWS
Year Ended December 31, 1996 compared to the year ended December 31, 1995
Operating Activities. For the year ended December 31, 1996, the Company's
operating activities used cash of $79.3 million on a short term basis to fund
the increases in mortgage loans held for sale. Cash used by operating
activities increased $14.8 million to $79.3 million for the year ended
December 31, 1996 as compared to $64.5 for the year ended December 31, 1995.
At December 31, 1996, total cash on hand amounted to $14.2 million as compared
to $0 at December 31, 1995.
Investment Activities. The primary investing activity for which cash was
used during the year ended December 31, 1996 was the investment in interest
only and residual certificates. Net cash used by investing activities
increased to $87.0 million for the year ended December 31, 1996 from $21.2
million for the year ended December 31, 1995.
Financing Activities. Net cash provided by financing activities increased
$95.1 million to $180.4 million for the year ended December 31, 1996 as
compared to $85.4 million for the year ended December 31, 1995. The increase
in net cash provided was primarily the result of net proceeds of $72.2 million
from the Company's convertible subordinated debt offering during the year and
$53.8 million from the issuance and sale of common stock in the initial public
offering.
RECENT ACCOUNTING DEVELOPMENTS
In June 1996, the FASB issued Statement of Financial Accounting Standards
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" ("SFAS 125"). SFAS 125 provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments 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 125 provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings.
SFAS 125 requires that liabilities and derivatives incurred or obtained by
transferors as part of a transfer of financial assets be initially measured at
fair value, if practicable. 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 125 provides implementation guidance for assessing isolation of
transferred assets and for accounting 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
extinguishments of liabilities.
SFAS 125 is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996, and is to be
applied prospectively. The Company does not anticipate a material impact on
its operations or financial position from the implementation of SFAS 125.
24
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Southern Pacific Funding Corporation
Consolidated Financial Statements
December 31, 1996 and 1995
(With Independent Auditors' Report Thereon)
25
<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, 1996 and 1995,
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,
1996, and 1995, 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
26
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
------------ ------------
<S> <C> <C>
ASSETS
Cash................................................. $ 14,175,566 $ --
Loans held for sale.................................. 223,059,102 80,263,671
Loans held under repurchase agreement................ -- 12,800,565
Interest-only and residual certificates.............. 95,810,137 25,658,601
Accrued interest receivable.......................... 3,181,449 977,374
Premises and equipment, net.......................... 3,036,388 421,695
Goodwill............................................. 4,742,571 --
Other assets......................................... 5,165,048 282,831
------------ ------------
Total assets..................................... $349,170,261 $120,404,737
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Bank overdraft....................................... $ -- $ 619,517
Discounted recourse liability........................ 8,793,237 3,189,959
Borrowings under warehouse lines of credit........... 152,680,395 96,130,120
Borrowings from SPTL................................. -- 2,758,147
Deferred tax liability............................... 18,445,495 --
Convertible subordinated debentures.................. 75,000,000 --
Due to affiliates.................................... 80,166 1,585,150
Other liabilities.................................... 9,022,000 3,233,125
------------ ------------
Total liabilities................................ 264,021,293 107,516,018
Minority Interest.................................... $ 62,735 --
Shareholders' equity:
Preferred stock, no par value, 5,000,000 shares
authorized; none issued or outstanding at December
31, 1996 and 1995, and ............................. -- --
Common stock, no par value, 75,000,000 shares
authorized; 20,737,500 issued and outstanding at
December 31, 1996 and 1995 and 15,562,000 shares
issued and outstanding at December 31, 1996......... 53,798,099 --
Contributed capital.................................. 247,500 789,591
Retained earnings.................................... 31,040,634 12,099,128
------------ ------------
Total shareholders' equity....................... 85,086,233 12,888,719
Total liabilities and shareholders' equity....... $349,170,261 $120,404,737
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
27
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Gains on sales of loans.................. $55,360,515 $16,328,621 $ 9,571,583
Interest income.......................... 13,848,976 4,304,760 2,135,886
Securities valuation and other income.... 4,265,285 1,666,682 --
----------- ----------- -----------
Total revenues......................... 73,474,776 22,300,063 11,707,469
----------- ----------- -----------
Expenses:
Interest................................. 7,799,986 3,413,652 886,055
Personnel and commission expense......... 10,996,713 4,190,566 2,155,945
General and administrative expense....... 6,599,474 2,153,220 1,261,708
----------- ----------- -----------
Total expenses......................... 25,396,173 9,757,438 4,303,708
----------- ----------- -----------
Earnings before taxes...................... 48,078,603 12,542,625 7,403,761
Income taxes............................... 20,446,614 5,205,190 3,072,560
----------- ----------- -----------
Net earnings........................... $27,631,989 $ 7,337,435 $ 4,331,201
=========== =========== ===========
Net earnings per share..................... $ 1.37
===========
Weighted average number of shares
outstanding............................... 20,511,936
</TABLE>
See accompanying notes to consolidated financial statements.
28
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON CONTRIBUTED RETAINED SHAREHOLDER'S
STOCK CAPITAL EARNINGS EQUITY
----------- ----------- ----------- -------------
<S> <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
=========== ========= =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
29
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------
1996 1995 1994
------------- ------------ -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings........................ $ 27,631,989 $ 7,337,435 $ 4,331,201
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation and amortization..... 615,258 51,488 6,446
Securities valuation (4,265,285)
Discounted recourse liability..... 6,915,322 2,525,582 664,377
Changes in certain assets and
liabilities, net of effect of
acquisitions and contribution
transaction:
Mortgage loans held for sale.... (143,632,836) (63,536,648) 1,347,881
Loans held under repurchase
agreement...................... 12,800,565 (12,800,565) --
Accrued interest receivable..... (2,204,075) (928,119) 17,083
Deferred tax liability.......... 20,446,614 -- --
Other assets.................... (1,387,556) (282,831) --
Other liabilities............... 3,787,856 3,186,942 46,183
------------- ------------ -----------
Net cash provided by (used in)
operating activities................ (79,292,148) (64,446,716) 6,413,171
------------- ------------ -----------
Cash flows used in investing
activities:
Net changes in interest only and
residual certificates.............. (78,409,162) (20,760,681) (4,897,920)
Purchases of premises and equipment. (3,028,897) (436,853) (42,776)
Payment for acquisitions............ (5,000,000) -- --
Payment for long-term investment and
loan commitment.................... (525,000) -- --
------------- ------------ -----------
Net cash used in investment
activities:......................... (86,963,059) (21,197,534) (4,940,696)
------------- ------------ -----------
Cash flows from financing activities:
Net change in:
Borrowings under warehouse lines
of credit........................ 56,550,275 96,130,120 --
Borrowings from SPTL.............. 322,053 (12,940,537) (1,472,475)
Due to affiliates................. (1,504,984) 1,585,150 --
Bank overdraft.................... (619,517) 619,517 --
Proceeds from convertible
subordinated debentures.......... 72,162,436 -- --
Proceeds from issuance of common
stock............................ 53,798,099 -- --
Contribution transaction.......... (277,589) -- --
------------- ------------ -----------
Net cash provided by (used in)
financing activities................ 180,430,773 85,394,250 (1,222,475)
------------- ------------ -----------
Net change in cash................... 14,175,566 (250,000) 250,000
Cash at beginning of year........... -- 250,000 --
------------- ------------ -----------
Cash at end of year................. $ 14,175,566 $ -- $ 250,000
============= ============ ===========
Supplementary information:
Interest paid....................... $ 6,330,097 $ 2,129,369 $ --
Taxes paid $ 1,213,252 $ -- $ --
</TABLE>
See accompanying notes to consolidated financial statements.
30
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR 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 and sells
interests in them to investors. 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.
Currently the Company conducts its business from 14 regional branch centers
located in ten states.
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.
Certain adjustments, as described below, are made to historical operations in
order to provide fair presentation of the financial operations of SPFC. In the
opinion of management, except for the adjustments described below, the
historical accounting records reflect all costs that would have been incurred
had the Company operated as a stand-alone company for all periods presented
(See Note 9).
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,
1996, 1995 and 1994 are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1996 1995 1994
---------- ----------- -----------
<S> <C> <C> <C>
Estimated average borrowings ...... $3,890,267 $34,777,138 $25,195,833
Interest rate ..................... 6.25% 3.69% 4.15%
Interest on borrowings............. $ 230,236 $ 1,284,282 $ 866,055
</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.
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
31
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1996
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. Based on the Company's experience, no allowance
for loan loss has been established.
Interest-only and Residual Certificates
Assets reflected in the accompanying consolidated 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 is subject to certain
recourse provisions in connection with its securitizations which are measured
using a 6% risk free rate. The Company has presented its obligation under
these provisions as a liability in the accompanying balance sheets. 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. 115, "Accounting for Certain Debt and Equity Securities."
Initial 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, and (3) 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, not considering the expected losses, are discounted at an
interest rate that the Company believes an unaffiliated third-party purchaser
would require as a rate of return on such a financial instrument. Expected
losses are discounted using a rate equivalent to the risk-free rate for
securities with a duration similar to that estimated for the underlying loans
sold and a discounted recourse liability is recorded. The undiscounted
recourse liability as of December 31, 1996 and 1995 was $11,156,882 and
$3,858,553, respectively. The overall effect of discounting the cash flows
expected to be received by the Company using an interest rate (12%) that the
Company believes an unaffiliated third party purchaser would require and a
rate equivalent to a risk-free rate for expected credit losses is a discount
rate of approximately 15%. 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 amount of overcollateralization is
recorded by the Company as part of its interest-only and residual
certificates.
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.
32
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1996
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 and
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 the improvements, whichever is shorter.
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 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, 1996 and 1995, the Company held $0 and $12,800,565,
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 year ended December 31,
1996 and 1995
33
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1996
was approximately $25,376,000 and $14,904,000, respectively, and the average
amount held during the year ended December 31, 1996 and 1995 was approximately
$3,251,000 and $4,718,000, respectively.
5. INTEREST-ONLY AND RESIDUAL CERTIFICATES
Assets generated from the Company's loan securitizations as of December 31,
1996 and 1995, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1996 1995
----------- -----------
<S> <C> <C>
Interest-only Certificates....................... $74,353,837 $ 2,629,184
Residual Certificates............................ $21,456,300 23,029,417
----------- -----------
$95,810,137 $25,658,601
=========== ===========
</TABLE>
6. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following at December 31, 1996 and
1995:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
---------- --------
<S> <C> <C>
Premises and equipment.............................. $3,634,193 $479,629
Less accumulated depreciation and amortization...... (597,805) (57,934)
---------- --------
$3,036,388 $421,695
========== ========
</TABLE>
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, 1996 and 1995 in accordance with SFAS 107:
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1995
------------------------- -----------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
------------ ------------ ----------- -----------
<S> <C> <C> <C> <C>
Cash......................... $ 14,175,566 $ 14,175,566 $ -- $ --
Loans held for sale.......... 223,059,102 231,981,466 80,263,671 82,671,581
Loans held under repurchase
agreement................... -- -- 12,800,565 13,453,656
Interest-only and residual
certificates................ 95,810,137 95,810,137 25,658,601 25,658,601
Less: Discounted recourse li-
ability..................... 8,793,237 8,793,237 3,189,959 3,189,959
------------ -----------
Net........................ 350,760,406 22,468,642
Bank overdraft............... -- -- 619,517 619,517
Borrowings under warehouse
lines of credit............. 152,680,395 152,680,395 96,130,120 96,130,120
Borrowings from SPTL......... -- -- 2,758,147 2,758,147
Due to affiliates............ 80,166 80,166 1,585,150 1,585,150
</TABLE>
34
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1996
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 and discounted recourse
liability. 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.
As of December 31, 1996 and 1995, the Company had open positions of $32.6
million and $0 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. At December 31, 1996 and 1995, the Company's unrealized
loss on open positions is $43,023 and $84,375, respectively, on forward
positions of United States Treasury securities.
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
ICII and SPTL
35
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1996
management believe is 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, 1996,
1995 and 1994 were $292,000, $256,000 and $92,700, respectively.
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:
<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 for a servicing rate equal
to what the Company receives contractually. Had the Company exclusively used
its current independent loan servicer in 1995 and 1994, management estimates
its servicing fees would have been higher by approximately $234,000 and
$120,000, 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 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, 1996 and 1995 consists
of the following:
<TABLE>
<CAPTION>
1996 1995
----------- ---------
<S> <C> <C>
Convertible subordinated debentures, interest at
6.75%, due semi-annually, principal due October
15, 2006....................................... $75,000,000 $0
=========== =========
</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.
36
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1996
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, 1996
and 1995:
<TABLE>
<CAPTION>
1996 1995 1994
----------- ---------- ----------
<S> <C> <C> <C>
Current:
Federal............................... $ 3,680,000 $2,731,115 $2,064,622
State................................. 772,000 602,452 455,431
----------- ---------- ----------
Total current....................... 4,452,000 3,333,567 2,520,053
Deferred:
Federal............................... 11,461,414 1,533,378 452,656
State................................. 4,533,200 338,245 99,851
----------- ---------- ----------
Total deferred...................... 15,994,614 1,871,623 552,507
----------- ---------- ----------
Total income taxes...................... $20,446,614 $5,205,190 $3,072,560
=========== ========== ==========
</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, 1996 and 1995. 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>
1996 1995
----------- ----------
<S> <C> <C>
Deferred tax liabilities:
Interest-only and residual certificates......... $18,445,495 $2,424,130
=========== ==========
</TABLE>
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, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
---- ----
<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............................................. 7.5 6.5
---- ----
Effective income tax rate.................................... 42.5% 41.5%
==== ====
</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.
37
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1996
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 $111,000, $26,000 and
$12,100 for the years ended December 31, 1996, 1995, and 1994, 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 $0, $23,000, and $21,700 were charged to operations of SPFC for
the years ending December 31, 1996, 1995, and 1994, 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. As of December 31, 1996, 965,250 options had been granted under the
Stock Option Plan.
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>
1996 1995
---------- ---------
<S> <C> <C> <C>
Net Income As reported 27,631,989 7,337,435
Pro forma 26,266,703 7,105,518
EPS As reported $1.37 $0.47
Pro forma $1.28 $0.46
</TABLE>
38
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1996
Stock option activity during the period indicated is as follows:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED-AVERAGE
SHARES EXERCISE 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 1996 and 1995 was $13.34 and $15.74 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, 1996 and 1995, $0 and $41,181,611 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 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 $269,000 and
$1,999,000 for the years ended December 31, 1996 and 1995, 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 August 24, 1997.
As of December 31, 1996 and 1995, $0 and $54,948,509, 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, 1996 and 1995 amounted to approximately $5,505,512 and $131,000,
respectively, with a weighted average interest rate of 6.26% for 1996 and 5.5%
for 1995.
39
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE-YEAR PERIOD ENDED DECEMBER 31, 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 $150 million, and the line
is scheduled to expire on October 22, 1997.
As of December 31, 1996, $152,680,397 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% for 1996.
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 1996, the Company purchased 95% of the common stock of a diversified
financial services company for $5 million in cash. The amount in excess of the
fair value of 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
During 1996, 25.0%, 9.1% and 7.9% of the Company's loan origination and
purchase volume was concentrated in California, Oregon and Colorado,
respectively. In addition, approximately 4.9% of the 1996 loan originations
were attributed to a single mortgage loan broker. The Company does not believe
that it is exposed to any significant credit risk as of December 31, 1996 as
its portfolio of loans held for sale is well diversified, and the economies of
the states of loan origination are diverse. Upon securitization, any estimate
of credit loss is computed based on a percent of loan value basis and included
as part of the discounted recourse allowance.
The Company currently contracts for the servicing 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 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.
Although the Company periodically reviews the cost associated with
establishing servicing operations to service the loans it originates and
purchases, it has no plans to establish and perform servicing operations at
this time.
40
<PAGE>
SOUTHERN PACIFIC FUNDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1996
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
December 31, 1996 and 1995, the Company had agreements to fund loans of
$29,981,729 and $3,248,500, respectively.
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, 1996 and 1995, the Company had approximately $223,059,102
and $93,064,236, respectively, in loans held for sale and under a repurchase
agreement which were serviced by Advanta Mortgage Corp. USA ("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 December 31, 1996 the Company's servicing portfolio (inclusive of
securitized loans where the Company has ongoing risk of loss but has no
remaining servicing rights or obligations) was $908 million. All of the
Company's loan servicing has either been outsourced or subcontracted to
Advanta.
41
<PAGE>
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 $484,416, $309,607, and $139,030 for the years
ended December 31, 1996, 1995 and 1994, respectively.
17. SUBSEQUENT EVENTS
In February 1997, the capacity under the Second Facility increased to $400
million.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company incorporates by reference herein information in its proxy
statement which complies with the information called for by item 10 of the
Form 10-K. The proxy will be filed at a later date, that is not more than 120
days after the end of the Company's 1996 fiscal year, with the Commission.
ITEM 11. EXECUTIVE COMPENSATION
The Company incorporates by reference herein information in its proxy
statement which complies with the information called for by Item 11 of the
Form 10-K. The proxy will be filed at a later date, that is not more than 120
days after the end of the Company's 1996 fiscal year, with the Commission.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Company incorporates by reference herein information in its proxy
statement which complies with the information called for by Item 12 of the
Form 10-K. The proxy will be filed at a later date, that is not more than 120
days after the end of the Company's 1996 fiscal year, with the Commission.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company incorporates by reference herein information in its proxy
statement which complies with the information called for by Item 13 of the
Form 10-K. The proxy will be filed at a later date, that is not more than 120
days after the end of the Company's 1996 fiscal year, with the Commission.
42
<PAGE>
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements, Financial Statement Schedules and Exhibits.
(1) Financial Statements
The following consolidated financial statements of Southern Pacific
Funding Corporation are included in Part II, Item 8 of this report
<TABLE>
<CAPTION>
PAGE(S)
-------
<S> <C>
Independent Auditor's Report........................................ 26
Consolidated Statements of Financial Condition--December 31, 1996
and 1995........................................................... 27
Consolidated Statements of Earnings--Years ended December 31, 1996,
1995, and 1994..................................................... 28
Consolidated Statements of Shareholder's Equity--Years ended
December 31, 1996, 1995, and 1994.................................. 29
Consolidated Statements of Cash Flows--Years ended December 31,
1996, 1995, and 1994............................................... 30
Notes to Consolidated Financial Statements.......................... 31
</TABLE>
(2) Financial Statement Schedules
None required.
(3) EXHIBITS
<TABLE>
<C> <S>
3.1** Certificate of Incorporation of the Company, as amended
3.2** Bylaws of the Company, as amended
4.1 Form of Indenture incorporated by reference to Exhibit 4.1 of the
Company's Registration Statement No. 333-14627 on Form S-1
4.2 Form of Notes incorporated by reference to Exhibit 4.2 of the
Company's Registration Statement No. 333-14627 on Form S-1
10.1** 1995 Senior Management Stock Option Plan and Form of Senior Management
Stock Option Agreement
10.2** 1995 Stock Option, Deferred Stock and Restricted Stock Plan and Form
of Stock Option Agreement
10.3** Services Agreement effective June 13, 1996 by and between the
Registrant and Imperial Credit Industries, Inc.
10.4** Tax Agreement effective June 13, 1996 by and between the Registrant
and Imperial Credit Industries, Inc.
10.5** Loan Servicing Agreement dated September 14, 1995 by and between the
Registrant and Advanta Mortgage Corp. USA
10.6** Whole Loan Financing Program dated March 21, 1995 by and among the
Registrant, DLJ Mortgage Capital, Inc. And Bankers Trust Company
10.7** Master Repurchase Agreement dated August 5, 1995 by and between the
Registrant and Oceanmark Bank
10.8** Revolving Credit and Term Loan Agreement by and between Registrant and
Southern Pacific Thrift and Loan Association
10.9** Wet Inc., Interim and Pre-Sale Funding Facility dated November 17,
1995 by and between the Registrant and Lehman Commercial Paper, Inc.
10.10** Telemarketing Agreement dated March 25, 1995 by and among the
Registrant, Results Technologies, Inc. And Tele-Quote, Inc.
</TABLE>
43
<PAGE>
<TABLE>
<C> <S>
10.11** Office Lease Agreement dated September 13, 1995 by and between the
Registrant and Property Reserve, Inc.
10.12** Office Lease Agreement dated November 29, 1995 by and between the
Registrant and Property Reserve, Inc.
10.13** Sublease dated January 23, 1996 by and between the Registrant and
Property Reserve, Inc.
10.14** Office Building Lease dated January 23, 1996 by and between the
Registrant and Property Reserve, Inc.
10.15** Employment Agreement effective January 1, 1996 by and between the
Registrant and Robert W. Howard
10.16** Employment Agreement effective January 1, 1996 by and between the
Registrant and Bernard A. Guy
10.17** Contribution Agreement effective April 1, 1995 by and among the
Registrant, Imperial Credit Industries, Inc., and Southern Pacific
Thrift and Loan Association, Inc.
10.18*+ Consulting and Noncompetition Agreement, dated May 15, 1996, by and
between the Registrant and the Dewey Consulting Group
10.20*+ Amendment to Loan Servicing Agreement, dated August 12, 1996, by and
between the Registrant and Advanta Mortgage Corp. USA
10.21* Registration Rights Agreement, dated October 17, 1996, between the
Registrant and Imperial Credit Industries, Inc.
10.22*+ Master Loan and Security Agreement, dated as of October 22, 1996,
between the Registrant and Morgan Stanley Mortgage Capital, Inc.
11 Statement re: computation of per share earnings
12 Statement re: computation of ratios
23.1 Consent of KPMG Peat Marwick LLP
27.1 Financial Data Schedule
</TABLE>
- --------
* Previously filed in connection with Registration Statement No. 333-14181
and hereby incorporated by reference
** Previously filed in connection with Registration Statement No. 333-3270 and
hereby incorporated by reference
+ Portions of these exhibits have been omitted and are subjected to a
confidential treatment request filed with the Securities Exchange
Commission pursuant to Rule 46.
44
<PAGE>
SIGNATURES
Pursuant to the requirements of the of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Southern Pacific Funding Corporation has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SOUTHERN PACIFIC FUNDING CORPORATION
By /s/ Robert W. Howard
_____________________________________
Robert W. Howard
President, Chief Executive Officer
and Director
Date: March 26, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Robert W. Howard President, Chief Executive March 26, 1997
____________________________________ Officer and Director
Robert W. Howard (Principal Executive
Officer)
/s/ Bernard A. Guy Executive Vice President and March 26, 1997
____________________________________ Chief Financial Officer
Bernard A. Guy (Principal Financial
Officer)
/s/ Ann L. Muir Vice President and March 26, 1997
____________________________________ Controller (Principal
Ann L. Muir Accounting Officer)
/s/ H. Wayne Snavely Director and Chairman of the March 26, 1997
____________________________________ Board
H. Wayne Snavely
/s/ Stephen J. Shugerman Director March 26, 1997
____________________________________
Stephen J. Shugerman
</TABLE>
<PAGE>
EXHIBIT 11
EPS-CALC
SOUTHERN PACIFIC FUNDING CORPORATION
STATEMENT REGARDING COMPUTATION OF NET INCOME PER SHARE
<TABLE>
<CAPTION>
FOR THE YEAR ENDING
DECEMBER 31, 1996
-------------------
<S> <C>
FULLY DILUTED NET INCOME PER SHARE:
Net income................................................. $27,631,989
Interest on convertible subordinated debentures (net of
taxes).................................................... $ 510,078
Adjusted net income........................................ $28,142,067
Average number of shares outstanding....................... 20,030,493
Net effect of dilutive stock options....................... 481,443
Total average shares....................................... 20,511,936
-----------
Fully diluted net income per share......................... $ 1.37
===========
PRIMARY NET INCOME PER SHARE:
Net income................................................. $28,142,067
Average number of shares outstanding....................... 19,804,331
-----------
Primary net income per share............................... $ 1.42
===========
</TABLE>
<PAGE>
EXHIBIT 12
SOUTHERN PACIFIC FUNDING CORPORATION
STATEMENT REGARDING COMPUTATION OF RATIOS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
----------------------------------
1996 1995 1994
----------- ----------- ----------
<S> <C> <C> <C>
Income from continuing operations........... $27,631,989 $ 7,337,435 $4,331,201
Add:
Provision for taxes..................... 20,446,614 5,205,190 3,072,560
Interest and debt expense............... 7,799,986 3,413,652 886,055
----------- ----------- ----------
28,246,600 8,618,842 3,958,615
----------- ----------- ----------
Earnings before fixed charges............... 55,878,589 15,956,277 8,289,816
=========== =========== ==========
Fixed charges
Interest and debt expense............... 7,799,986 3,413,652 886,055
=========== =========== ==========
Ratio of earnings to fixed charges.......... 7.16 4.67 9.36
=========== =========== ==========
</TABLE>
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Southern Pacific Funding Corporation:
We consent to incorporation by reference in the registration statements (No.
333-11075 and No. 333-11189) on Forms S-8 of Southern Pacific Funding
Corporation of our report dated January 23, 1997, relating to the consolidated
balance sheets of Southern Pacific Funding Corporation and subsidiaries as of
December 31, 1996, and 1995, 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, which report appears in the
December 31, 1996, annual report on Form 10-K of Southern Pacific Funding
Corporation.
KPMG Peat Marwick LLP
Portland, Oregon
March 26, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEETS AND STATEMENTS OF INCOME FOUND ON PAGES 3 AND 4 OF THE COMPANY'S FORM
10-Q FOR THE YEAR-TO-DATE, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 14,176
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 331,958
<PP&E> 3,634
<DEPRECIATION> 598
<TOTAL-ASSETS> 349,170
<CURRENT-LIABILITIES> 264,021
<BONDS> 0
0
0
<COMMON> 53,798
<OTHER-SE> 31,351
<TOTAL-LIABILITY-AND-EQUITY> 349,170
<SALES> 55,361
<TOTAL-REVENUES> 73,475
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 17,596
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7,800
<INCOME-PRETAX> 48,079
<INCOME-TAX> 20,447
<INCOME-CONTINUING> 27,632
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 27,632
<EPS-PRIMARY> 0.47
<EPS-DILUTED> 0.43
</TABLE>
