UNITED STATES
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 AND
EXCHANGE ACT OF 1934
For the fiscal year ended February 28, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 1-12655
HomeSide, Inc.
(Exact name of registrant as specified in its charter)
Delaware 59-3387041
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7301 Baymeadows Way, Jacksonville, FL 32256
(Address of principal executive offices) (Zip Code)
(904) 281-3000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common Stock, $.01 Par Value New York Stock Exchange
- ---------------------------- -----------------------
Securities registered pursuant to Section 12(g) of the Act: None
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 ___
As of May 5, 1997, there were 43,375,430 shares of HomeSide, Inc. common stock,
$.01 par value, outstanding and 97,138 shares of Class C common stock
outstanding. Based on the closing price for shares of Common Stock on that date,
the aggregate market value of Common Stock held by non-affiliates of the
registrant was approximately $132 million.
1
<PAGE>
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) 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.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the HomeSide, Inc. 1997 Annual Report to Stockholders are
incorporated by reference into Parts II and IV of this Annual Report on Form
10-K. With the exception of those portions which are specifically incorporated
by reference in this Annual Report on Form 10-K, the HomeSide, Inc. 1997 Annual
Report to Stockholders is not to be deemed filed as part of this Report.
Portions of the HomeSide, Inc. Proxy Statement for the 1997 Annual Meeting
of Stockholders to be filed with the Commission on or before May 21, 1997 are
incorporated by reference into Part III of this Annual Report on Form 10-K. With
the exception of those portions which are specifically incorporated by reference
in this Annual Report on Form 10-K, the HomeSide, Inc. Proxy Statement for the
1997 Annual Meeting of Stockholders is not to be deemed filed as part of this
Report.
PART I
ITEM 1. BUSINESS
General
HomeSide, Inc. ("HomeSide" or the "Company") was formed on December 11,
1995 by an investor group, consisting of Thomas H. Lee Company and its
affiliates and Madison Dearborn Partners, HomeSide signed a definitive stock
purchase agreement with BankBoston, N.A. (formerly The First National Bank of
Boston)("Bank of Boston" or "BKB") for the purpose of acquiring certain assets
and liabilities of the mortgage banking business owned by Bank of Boston ("BBMC
Acquisition"). The transaction closed on March 15, 1996 and HomeSide began
operations on March 16, 1996 through its operating subsidiary, HomeSide Lending,
Inc.
On May 31, 1996, Barnett Banks, Inc. sold certain of its mortgage banking
operations, primarily its servicing portfolio and proprietary mortgage banking
software systems, to HomeSide. Barnett received cash and an ownership interest
in HomeSide. On January 30, 1997 HomeSide made its initial public offering of
shares of common stock. From May 31, 1996 until the 1997 public offering of
common stock, the investors as a group, Bank of Boston and Barnett each owned
approximately one-third of HomeSide. Following the public offering, the
Investors as a group, Bank of Boston and Barnett own in the aggregate
approximately 79% of the outstanding common stock.
HomeSide is one of the largest full-service residential mortgage banking
companies in the United States. HomeSide's strategy emphasizes variable cost
mortgage origination and low cost servicing. HomeSide's mortgage loan production
volume, excluding bulk purchases, was $20.9 billion for the period March 16,
1996 to February 28, 1997 and its servicing portfolio was $90.2 billion on
February 28, 1997. HomeSide ranks as the 5th largest originator and 7th largest
servicer in the United States for calendar 1996 based on data published by
National Mortgage News.
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The residential mortgage market totaled over $3.9 trillion in 1996 and is
the second largest debt market in the world, exceeded only by the United States
Treasury market. The residential mortgage market has grown at a compound annual
rate of approximately 8% since 1985. HomeSide competes in a mortgage banking
market which is highly fragmented with no single company controlling or
dominating the market. In 1996, the largest originator represented 6.4% of the
market and the largest servicer represented 4.6%, while the top 30 originators
and servicers represented 41.7% and 44.7% of their markets, respectively, based
on data published by Inside Mortgage Finance. Residential mortgage lenders
compete primarily on the basis of loan pricing and service, making effective
cost management essential. The industry has experienced rapid consolidation
which has been accelerated by the introduction of significant technology
improvements and the economies of scale present in mortgage servicing. The top
25 mortgage loan servicers have increased their aggregate market share from
20.7% in 1990 to 41.9% in 1996.
HomeSide's business strategy is to increase the volume of its loan
originations and the size of its servicing portfolio while continuing to improve
operating efficiencies. In originating mortgages, HomeSide focuses on variable
cost channels of production, including correspondent, broker, consumer direct,
affinity, and co-issue sources. HomeSide pursues strategic relationships such as
its existing 5-year agreements to acquire residential mortgage loans from BKB
and Barnett production sources, which, for the period May 31, 1996 through
February 28, 1997, represented 18.8% of HomeSide's loan production. Management
believes that these variable cost channels of production deliver consistent
origination opportunities for HomeSide without the fixed cost investment
associated with traditional retail mortgage branch networks. HomeSide believes
that its ongoing investment in technology will further enhance and expand
existing processing capabilities and improve its efficiency. Based on
independent surveys of direct cost per loan and loans serviced per employee,
management believes that HomeSide has been one of the industry's most efficient
mortgage servicers. The Company's average cost per employee is not higher than
the average cost per employee of its competitors.
HomeSide plans to build its core operations through (i) improved economies
of scale in servicing costs; (ii) increased productivity using proprietary
technology; and (iii) expanded and diversified variable cost origination
channels. In addition, HomeSide intends to pursue additional loan portfolio
acquisitions and strategic origination relationships similar to the existing BKB
and Barnett arrangements.
HomeSide's business activities consist primarily of:
Mortgage production: origination and purchase of residential single
family mortgage loans through multiple channels including
correspondents, strategic partners (BKB and Barnett), mortgage
brokers, co-issue partners, direct consumer telemarketing and affinity
programs;
Servicing: administration, collection and remittance of monthly
mortgage principal and interest payments, collection and payment of
property taxes and insurance premiums and management of certain loan
default activities;
Secondary marketing: sale of residential single family mortgage loans
as pools underlying mortgage-backed securities guaranteed or issued by
governmental or quasi-governmental agencies or as whole loans or
private securities to investors; and
Risk management: management of a program designed primarily to protect
the economic performance of the servicing portfolio that could
otherwise be adversely affected by loan prepayments due to declines in
interest rates.
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Production
HomeSide, Inc. participates in several origination channels, with a focus
on wholesale origination. Since the BBMC Acquisition, wholesale channels
(correspondent, co-issue, and broker) have represented more than 95% of
HomeSide's total production. Excluding the volumes purchased from BKB and
Barnett, no single source within the correspondent or broker channels accounted
for more than 2% of total production during the period March 16, 1996 to
February 28,1997. HomeSide's other origination channels include telemarketing,
direct mail campaigns and other advertising, and mortgages related to affinity
group and co-branding partnerships. HomeSide also purchases servicing rights in
bulk from time to time. This multi-channel production base provides access to
and flexibility among production channels in a wide variety of market and
economic conditions. The following table sets forth production detail by
HomeSide's origination channels:
<TABLE>
<CAPTION>
Residential Loan Production by Channel
(dollars in millions) For the Period For the Three For the Three
from March 16 1996 to Months Ended Months Ended
May 31, 1996 (b) August 31, 1996 November 30, 1996
------------------------- -------------------- ----------------------
<S> <C> <C> <C>
Wholesale:
Correspondent (includes
volumes purchased from $1,893 $2,950 $3,249
BKB and Barnett)
Co-issue (a) 1,419 2,208 1,985
Broker 220 155 168
------ ------ ------
Total wholesale 3,532 5,313 5,402
Direct 248 179 139
------ ------ ------
Total production 3,780 5,492 5,541
Bulk acquisitions (a) -- 4,073 --
------ ------ ------
Total production and
acquisitions $3,780 $9,565 $5,541
====== ====== ======
<CAPTION>
(dollars in millions) For the Three Months For the Period from
Ended February 28, March 16, 1996 to
1997 February 28, 1997
---------------------- ------------------------
<S> <C> <C>
Wholesale:
Correspondent (includes
volumes purchased from $3,021 $11,113
BKB and Barnett)
Co-issue (a) 2,610 8,222
Broker 300 843
------ -------
Total wholesale 5,931 20,178
Direct 134 700
------ -------
Total production 6,065 20,878
Bulk acquisitions (a) -- 4,073
------ -------
Total production and
acquisitions $6,065 $24,951
====== =======
</TABLE>
- ---------------------
(a) Represents the acquisition of servicing rights, not the underlying loans.
Amounts represent the unpaid principal balance of mortgage debt to which
the acquired servicing rights relate.
(b) HomeSide acquired Barnett Mortgage Company ("BMC") on May 31, 1996 and
therefore BMC's loan production is not included in these amounts. During
the three months ended May 31, 1996, BMC's loan production totaled $1.5
billion.
HomeSide competes nationwide by offering a wide variety of mortgage
products designed to respond to consumer needs and tailored to address market
competition. HomeSide is primarily an originator of fixed rate 15- and 30-year
mortgage loans, which collectively represented 76% of the total production in
the period March 16, 1996 to February 28, 1997. HomeSide also offers other
products, such as ARMs, balloon and jumbo mortgages.
4
<PAGE>
HomeSide's national loan production operation has resulted in
geographically diverse originations, enabling HomeSide to diversify its risk
across many markets in the United States. HomeSide's servicing portfolio
composition reflects its production markets. The largest segments of the
servicing portfolio by state on February 28, 1997 were Florida (18.7% of unpaid
principal balance of production), California (15.4%), Massachusetts (8.4%),
Texas (6.1%), and Maryland (4.6%).
The mortgage banking industry is generally subject to seasonal trends.
These trends reflect the general national pattern of sales and resales of homes,
although refinancings tend to be less seasonal and more closely related to
changes in interest rates. Sales and resales of homes typically peak during the
spring and summer seasons and decline to lower levels from mid-November through
February. In addition, delinquency rates typically rise in the winter months,
which result in higher servicing costs. However, late charge income has
historically been sufficient to offset such incremental expenses.
HomeSide's production strategy is to maintain and improve its reputation as
one of the largest, most cost effective originators of mortgage loans
nationwide. HomeSide pursues this strategy through an emphasis on wholesale and
centralized direct production, the use of contract and delegated underwriters, a
high degree of automation in its processing and direct originations and quality
control. HomeSide plans to expand production through its low cost wholesale and
direct channels and to continue to streamline its production operation. HomeSide
plans to continue to pursue bulk acquisitions in the secondary market for
mortgage servicing rights on an opportunistic basis.
Wholesale Production
Correspondent Production
Through its correspondent program, HomeSide purchases loans from
approximately 500 commercial banks, savings and loan associations, licensed
mortgage lenders and other financial intermediaries. The correspondent takes the
mortgage application and processes the loan, which is either underwritten
through contract underwriters or, in some cases, the correspondent to whom
underwriting authority has been delegated. Closing documents are submitted to
HomeSide for legal review and funding. The participants in this program are
prequalified and monitored on an ongoing bases by HomeSide. If a correspondent
subsequently fails to meet HomeSide's requirements, HomeSide typically
terminates the relationship. Correspondents are also required to repurchase
loans in the event of fraud or misrepresentation in the origination process and
for certain other reasons.
Co-Issue Production
Co-issue production, which represents the purchase of servicing rights from
a correspondent under contracts to deliver specified volumes on a monthly or
quarterly basis, is another main source of HomeSide's production. The co-issue
correspondent controls the entire loan process from application to closing. This
arrangement particularly suits large originators who have the ability to deliver
on an automated basis. Reflecting this delegated underwriting authority, the
co-issue correspondent is obligated to make certain representations and
warranties and is required to repurchase loans in the event of fraud or
misrepresentation in the origination process or for certain other reasons.
5
<PAGE>
Broker Production
Under its broker program, HomeSide funds loans at closing from a network of
approximately 450 mortgage brokers nationwide. The broker controls the process
of application and loan processing. A pre-closing quality control review is
performed by HomeSide to verify the borrower's credit. All loans originated
through brokers are underwritten by HomeSide's approved contract underwriters.
Loans are funded by HomeSide and may be closed in either the broker's name or
HomeSide's name. Participants in this program prequalify on the basis of
creditworthiness, mortgage lending experience and reputation. Each broker is
subject to annual and ongoing reviews by HomeSide.
Direct Production
HomeSide's direct production includes the use of telemarketing to solicit
loans from several sources, including refinancing of mortgage loans in
HomeSide's existing servicing portfolio, leads generated from direct mail
campaigns and other advertising, and mortgages related to affinity group and
co-branding partnerships. HomeSide acquired BBMC's telemarketing system which
was established in May 1995. HomeSide believes that these efforts will have a
significant effect on increasing the percentage of loans captured by the direct
division from loan prepayments in HomeSide's servicing portfolio. Refinancing
retention represents the percentage of loans refinanced through HomeSide's
direct channel that were serviced by HomeSide prior to refinancing.
In April 1996, pursuant to a two-year agreement, HomeSide began offering
mortgage loans through the American Airlines Advantage Program, which
encompasses approximately 14 million households. Under this program, a borrower
receives one frequent flyer mile for every dollar of interest paid on time.
HomeSide offers loans in four out of five geographic regions in the United
States, along with two other lenders in each region. Each lender receives one
third of the referrals from the Advantage program, or prospective borrowers may
contact the lender directly. HomeSide pays American Airlines a fee for each mile
earned by a borrower. Under the program, such fees are paid to American Airlines
on a monthly basis as the borrower earns miles by making monthly interest
payments. The program is in its infancy and fees paid to American Airlines by
HomeSide for miles earned have thus far been insignificant. HomeSide plans to
establish additional affinity relationships.
Under the terms of the BBMC and BMC Acquisitions, BKB has retained all of
its retail production facilities in the New England area and Barnett retained
all of its loan production facilities except for Honolulu Mortgage. Upon selling
BBMC and BMC to HomeSide, BKB and Barnett entered into exclusive five-year
agreements to sell, subject to certain limitations, all loans originated from
these sources to HomeSide on a broker or correspondent basis at market rates. In
1996, HomeSide sold or closed BBMC's remaining retail branches.
Bulk Acquisition
Bulk acquisition is the large scale purchase of mortgage servicing rights.
In connection with such acquisitions, HomeSide does not purchase the underlying
mortgage loans which were originated by other originators. HomeSide may purchase
servicing rights on an exclusive basis or through a competitive bidding process
and plans to continue this practice on an opportunistic basis in order to grow
its servicing portfolio and benefit from economies of scale.
6
<PAGE>
Underwriting and Quality Control
Underwriting
HomeSide's loans are underwritten in accordance with applicable Fannie Mae,
FHLMC, VA, and FHA guidelines, as well as certain private investor requirements.
The underwriting process is organized by origination channel and by loan type.
HomeSide currently employs underwriters with an average of ten years of
underwriting experience.
HomeSide requires approximately 80% of its correspondent lenders to have
their loans underwritten by third party contract underwriters prior to purchase.
These contract underwriters are designated by HomeSide and include General
Electric Capital Corp., Mortgage Guaranty Insurance Corp., and Private Mortgage
Insurance Corp. HomeSide grants delegated underwriting status to the remaining
approximately 20% of correspondents which enables the correspondents to submit
conventional loans to HomeSide without prior underwriting approval. Generally,
HomeSide grants delegated underwriting status to its larger correspondents who
meet financial strength, delinquency, underwriting and quality control
standards, and such correspondents are monitored regularly. The FHA and VA
require that loans be underwritten by the originating lender on an
Agency-approved or delegated basis. If issuance of FHA guarantees or VA
insurance certificates is denied, the correspondent must repurchase the loan.
HomeSide's underwriting process for its retail production operation is
fully automated. The automated underwriting technology incorporates credit
scoring and appraisal evaluation systems. These systems employ rules-based and
statistical technologies to evaluate the borrower, the property and salability
of the loan to the secondary market. HomeSide believes that these technologies
have contributed to improved productivity and reduced underwriting and
processing turnaround time.
Quality Control
HomeSide maintains a compliance and quality assurance department that
operates independently of the production, underwriting, secondary marketing and
loan administration department. For its production compliance process, HomeSide
randomly selects a statistical sample of all closed loans monthly for review.
The sample generally comprises 3.5% - 4% of all loans closed each month. This
review includes a credit scoring and reunderwriting of such loans, ordering
second appraisals on 10% of the sample, reverifying funds, employment and final
applications and reordering credit reports on all loans selected. In addition, a
full underwriting review is conducted on (i) all jumbo loans that go into
default during the first thirty-six months from the date of origination and (ii)
all other loans that go into default during the first six months from the date
of origination. Document and file reviews are also undertaken to ensure
regulatory compliance. In addition, random reviews of the servicing portfolio,
covering selected aspects of the loan administration process, are conducted.
HomeSide monitors the performance of the underwriting department through
quality assurance reports, HUD/VA reports and audits, reviews and audits by
regulatory agencies, investor reports and mortgage insurance company audits.
According to HomeSide's quality control findings, less that 1% of its loans have
underwriting issues that affect salability to the secondary market. Flaws in
these loans are generally corrected; otherwise, the holder of the
mortgage-backed security is indemnified against future losses resulting from
such flaws by HomeSide or, ultimately, the originating correspondent.
Correspondents or co-issue partners are required to repurchase any flawed loans
originated by them.
7
<PAGE>
Secondary Marketing
HomeSide customarily sells all loans that it originates or purchases while
retaining the servicing rights to such loans. HomeSide aggregates mortgage loans
into pools and sells these pools, as well as individual mortgage loans, to
investors principally at prices established under forward sales commitments.
HomeSide's FHA and VA loans are generally pooled and sold in the form of GNMA
MBS. Conforming conventional mortgage loans are generally pooled and exchanged
under the purchase and guarantee programs sponsored by Fannie Mae and FHLMC for
Fannie Mae MBS or FHLMC participation certificates, respectively. HomeSide pays
certain guarantee fees to the Agencies in connection with these programs and
then sells the GNMA, Fannie Mae and FHLMC securities to securities dealers. A
limited number of mortgage loans (i.e. non-conforming loans) are sold to private
investors. For the year ended February 28, 1997, approximately 78% of the
mortgage loans originated by HomeSide were sold to GNMA (38%), Fannie Mae (27%),
and FHLMC (13%). The remaining were sold to private investors.
The sale of mortgage loans may generate a gain or loss to HomeSide. Gains
or losses result primarily from two factors. First, HomeSide may purchase a loan
at a price that may be higher or lower than HomeSide would receive if it
immediately sold the loan in the secondary market. These pricing differences
occur principally as a result of competitive pricing conditions in the primary
loan origination market. Second, gains or losses may result from fluctuations in
interest rates that create changes in the market value of the loans or
commitments to purchase loans, from the time the interest rate commitment is
given to the mortgagor until the loan is sold to an investor.
HomeSide assesses the interest rate risk associated with outstanding
commitments that it has extended to fund loans and hedges the interest rate risk
of these commitments based upon a number of factors, including the remaining
term of the commitment, the interest rate at which the commitment was provided,
current interest rates and interest rate volatility. HomeSide constantly
monitors these factors and adjusts its hedging on a daily basis as needed.
HomeSide uses the Quantitative Risk Management system, a sophisticated hedging,
reporting and evaluation system, which has the ability to perform analyses under
various interest rate scenarios. HomeSide's interest rate risk is currently
hedged using a combination of forward sales of MBS and over-the-counter options,
including both puts and calls, on fixed income securities. HomeSide generally
commits to sell to investors for delivery at a future time for a stated price
all of its closed loans and a percentage of the mortgage loan commitments for
which the interest rate has been established. HomeSide aims to price loans
competitively, hedge the interest rate risk of loan originations and sell loans
on a break-even basis. For the period March 16, 1996 to February 28, 1997,
HomeSide has not experienced secondary marketing losses on an aggregate basis.
HomeSide's policy is to sell mortgage loans on a non-recourse basis.
However, in the case of VA loans used to form GNMA pools, the VA's loan
guarantees do not cover the entire principal balance of the loan and HomeSide is
responsible for losses which exceed the VA's guaranteed limitations. In
connection with HomeSide's loan exchanges and sales, HomeSide makes
representations and warranties customary in the industry relating to, among
other things, compliance with laws, regulations and program standards, and to
the accuracy of information. In the event of a breach of these representations
and warranties, HomeSide typically corrects such flaws, but, if the flaws cannot
be corrected, may be required to repurchase such loans. In cases where loans are
originated by a correspondent, HomeSide may sell the flawed loan back to the
correspondent under a repurchase obligation.
8
<PAGE>
Loan Servicing
HomeSide derives its revenues predominantly from its servicing operations.
HomeSide anticipates that the sale of servicing rights will not be a significant
component of its business strategy in the future. Since its formation, HomeSide
has also maintained a risk management program designed to protect, within
certain parameters, the economic value of its servicing portfolio, which is
subject to prepayment risk when interest rates decline, providing mortgagors
with refinancing opportunities.
Loan servicing includes collecting payments of principal and interest from
borrowers, remitting aggregate loan payments to investors, accounting for
principal and interest payments, holding escrow funds for payment of mortgage
related expenses such as taxes and insurance, making advances to cover
delinquent payments, inspecting the mortgaged premises as required, contacting
delinquent mortgagors, supervising foreclosures and property dispositions in the
event of unremedied defaults, and other miscellaneous duties related to loan
administration. HomeSide collects servicing fees from monthly mortgage payments.
These fees generally range from 0.25% to 0.50% of the declining principal
balances of the loans per annum. HomeSide's weighted average servicing fee was
0.359% at February 28, 1997. HomeSide also maintains certain subservicing
relationships whereby servicing is performed by another servicer under an
agreement with HomeSide, which remains contractually responsible for servicing
the loans. Subservicing relationships are often entered into as part of a bulk
servicing acquisition where the selling institution continues to perform
servicing until the loans are transferred to the purchasing institution.
HomeSide's servicing strategy is to continue to build its mortgage
servicing portfolio and benefit from the economies of scale inherent in the
business. HomeSide services substantially all of the mortgage loans that it
originates. In addition, HomeSide purchases the rights to service mortgage loans
originated by other lenders.
As part of the BMC Acquisition, HomeSide acquired a full-service mortgage
company in Hawaii, Honolulu Mortgage Co. Honolulu Mortgage's servicing portfolio
totaled $1.9 billion at November 30, 1996 and its loan production was $257.4
million since its acquisition on May 31, 1996. In February 1997, Honolulu
Mortgage Co. sold substantially all its assets to an unaffiliated third party.
The sale did not materially affect HomeSide's financial results.
HomeSide's servicing strategy is also to enhance the profitability of its
servicing activities through low cost and efficient processes. This strategy is
pursued through highly automated, cost effective processing systems, strategic
outsourcing of selected servicing functions and effective control of
delinquencies and foreclosures. HomeSide outsources to third party vendors
functions relating to insurance, taxes and default management, contributing to
HomeSide's ability to maintain a highly variable cost structure. Using a variety
of factors, including loans serviced per employee and direct cost per loan,
management believes that HomeSide is one of the nation's most efficient
servicers based on industry surveys. Management believes that its low cost
servicing provides it with a competitive advantage in the industry.
9
<PAGE>
<TABLE>
<CAPTION>
The following table provides certain information regarding HomeSide's servicing portfolio:
(dollars in millions) For the Period For the Three For the Three For the Three For the Period
March 1,1996 Months Ended Months Ended Months Ended March 1, 1996 to
to May 31, August 31, November 30, February 28, February 28,
1996(a) 1996 1996 1997 1997
----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Servicing Portfolio Balance,
beginning of period $42,907 $78,391 $85,835 $88,706 $42,907
----------------------------------------------------------------------------------------------
Total additions 37,184 9,842 5,244 6,064 58,334
----------------------------------------------------------------------------------------------
Scheduled amortization 235 494 517 576 1,822
Prepayments 1,321 1,702 1,529 1,674 6,226
Foreclosures 130 137 106 141 514
Servicing sales 14 65 221 2,187 2,487
----------------------------------------------------------------------------------------------
Total reductions 1,700 2,398 2,373 4,578 11,049
----------------------------------------------------------------------------------------------
Servicing Portfolio Balance,
end of period $78,391 $85,835 $88,706 $90,192 $90,192
======= ======= ======= ======= =======
</TABLE>
- -------------------------------------------------
(a) Excludes loans purchased not yet on servicing system of $4.9 billion.
HomeSide originates and purchases servicing rights for mortgage loans
nationwide. The broad geographic distribution of HomeSide's servicing portfolio
reflects the national scope of HomeSide's originations and bulk servicing
acquisitions. The nine largest states accounted for 66.9% of the outstanding UPB
of HomeSide's total servicing portfolio on February 28, 1997, while the largest
volume by state is Florida with an 18.7% share of the total portfolio on
February 28, 1997. HomeSide actively monitors the geographic distribution of its
servicing portfolio to maintain a mix that it deems appropriate and makes
adjustments as it considers necessary.
The following table sets forth the geographic distribution of the Company's
servicing portfolio as of February 28, 1997:
Servicing Portfolio by State (a)
At February 28, 1997
---------------------------
(dollars in millions) UPB %of UPB
---------------------------
Florida $16,559 18.7%
California 13,686 15.4
Massachusetts 7,383 8.4
Texas 5,434 6.1
Maryland 4,079 4.6
Georgia 3,427 3.9
Virginia 3,218 3.6
Illinois 2,913 3.3
New York 2,517 2.9
Other (b) 29,244 33.1
---------------------------
Total $88,460 100.0%
===========================
- --------------
(a) Servicing statistics are based on loans serviced by HomeSide and exclude
loans purchased not yet on servicing system.
(b) No other state represents more than 2.9% of HomeSide's servicing portfolio.
10
<PAGE>
On February 28, 1997, HomeSide's servicing portfolio consisted of $29.4
billion of FHA/VA servicing and $59.0 billion of conventional servicing.
The weighted average interest rate of the loans in the Company's servicing
portfolio on February 28, 1997 was 7.92%. HomeSide's servicing portfolio of
loans was stratified by interest rate as follows:
Servicing Portfolio by Coupon at February 28, 1997
At February 28, 1997
------------------------------------------------
Cumulative
Interest Rate UPB(a) % of UPB % of UPB
------ -------- --------
(dollars in
millions)
Less than 6.0% $ 983 1.1% 1.1%
6.0% to 6.9% 9,633 10.9 12.0
7.0% to 7.9% 37,542 42.4 54.4
8.0% to 8.9% 29,293 33.1 87.5
9.0% to 9.9% 7,274 8.2 95.7
10.0% to 10.9% 2,912 3.3 99.0
Over 11.0% 823 1.0 100.0
----------------------------
Total $88,460 100.0%
============================
- --------------
(a) Servicing statistics are based on loans serviced by HomeSide and exclude
loans purchased not yet on servicing system.
Loan Servicing Credit Issues
HomeSide is affected by loan delinquencies and defaults on loans that it
services. Under certain types of servicing contracts, particularly contracts to
service loans that have been pooled or securitized, HomeSide must forward all or
part of the scheduled payments to the owner of the loan, even when loan payments
are delinquent. Also, to protect their liens on mortgaged properties, owners of
loans usually require a servicer to advance scheduled mortgage and hazard
insurance and tax payments even if sufficient escrow funds are not available.
HomeSide is generally reimbursed, subject to certain limitations with respect to
FHA/VA loans as described below, by the mortgage owner or from liquidation
proceeds for payments advanced that the servicer is unable to recover from the
mortgagor, although the timing of such reimbursements is typically uncertain. In
the interim, HomeSide absorbs the cost of funds advanced during the time the
advance is outstanding. Further, HomeSide bears the increased costs of
collection activities on delinquent and defaulted loans. HomeSide also foregoes
servicing income from the time such loans become delinquent until foreclosure,
when, if any proceeds are available, HomeSide may recover such amounts.
Delinquency rates typically rise in the winter months, which result in higher
servicing costs. However, late charge income has historically been sufficient to
offset such incremental expenses.
HomeSide periodically incurs losses attributable to servicing FHA and VA
loans for investors, including actual losses for final disposition of loans that
have been foreclosed or assigned to the FHA or VA and accrued interest on such
FHA or VA loans for which payment has not been received. For HomeSide, servicing
losses on investor-owned loans totaled $17.9 million for the period March 16,
1996 to February 28, 1997, primarily
11
<PAGE>
representing losses on VA loans. The VA guarantees the initial losses on a loan.
The guaranteed amount generally ranges from 20% to 35% of the original principal
balance. Before each foreclosure sale, the VA determines whether to bid by
comparing the estimated net sale proceeds to the outstanding principal balance
and the servicer's accumulated reimbursable costs and fees. If this amount is a
loss and exceeds the guaranteed amount, the VA typically issues a no-bid and
pays the servicer the guaranteed amount. Whenever a no-bid is issued, the
servicer absorbs the loss, if any, in excess of the sum of the guaranteed
principal and amounts recovered at the foreclosure sale. HomeSide's historical
delinquency and foreclosure rate experience on VA loans has generally been
consistent with that of the industry.
Management believes that it has an adequate level of reserve based on
HomeSide's servicing volume, portfolio composition, credit quality and
historical loss rates, as well as estimated future losses.
The following table sets forth HomeSide's delinquency and foreclosure
experience:
Servicing Portfolio Delinquencies
(Percent by Loan Count)
<TABLE>
<CAPTION>
For the Period For the Three For the Three For the Three
March 1, 1996 to Months Ended Months Ended Months Ended
May 31, August 31, November 30, February 28,
1996(a) 1996 1996 1997
---------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Delinquent Mortgage Loans (at end of period)
30 Days 2.97% 3.08% 3.50% 3.27%
60 Days 0.60 0.64 0.68 0.69
90 Days 0.35 0.48 0.58 0.54
Total Delinquencies 3.92% 4.20% 4.76% 4.50%
Foreclosure Pending (at end of period) 0.66% 0.95% 1.02% 1.09%
- --------------------------
(a) Excludes BMC portfolio acquired on May 31, 1996.
</TABLE>
Servicing Portfolio Hedging Program
The value of HomeSide's servicing portfolio is subject to volatility in the
event of unanticipated changes in prepayments. As interest rates increase,
prepayments by mortgagors decrease as fewer owners refinance, increasing
expected future cash flows from servicing revenue. Conversely, as interest rates
decrease, prepayments by mortgagors increase as homeowners seek to refinance
their mortgages, reducing expected future cash flows from servicing revenues on
those prepaid mortgages. Since the value of servicing rights is based on the net
present value of future cash flows, the value of the portfolio decreases in a
declining interest rate environment and increases in a rising rate environment.
HomeSide's risk management policy is designed to minimize exposure to loss
in the value of the servicing portfolio caused by prepayments due to declines in
interest rates. The servicing portfolio is valued using market discount rates
and market consensus prepayment speeds, among other variables. The value is then
analyzed under various interest rate scenarios that help HomeSide estimate its
exposure to loss. This potential loss exposure determines the hedge profile,
which is monitored daily and may be adjusted to reflect significant moves in key
variables such as interest rate and yield curve changes and revised prepayment
speed
12
<PAGE>
assumptions. Results of the risk management program depend on a variety of
factors, including the hedge instruments typically issued by HomeSide, the
relationship between mortgage rates and Treasury securities and certain other
factors. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - HomeSide - for the Period March 16, 1996 to February 28,
1997 Results of Operations - Risk Management Activities".
The FASB has been evaluating the accounting for derivative financial
instruments and hedging activities. The FASB has issued an exposure draft and
numerous comments have been received. It is unclear what changes will ultimately
be made to such exposure draft. Under current practice, derivative financial
instruments may be accounted for as hedges with changes in the value deferred as
a component of the asset or liability being hedged, provided the instruments are
designated as a hedge and reduce exposure to loss with a high correlation.
Management of HomeSide is unable to predict what effect, if any, changes in
accounting principles would have on HomeSide's financial statements or
HomeSide's use of hedge accounting.
Servicing Integration and Software
To facilitate administration and to effect the economies of scale targeted
by management, HomeSide's servicing operations are expected to be integrated
over the next fiscal year. HomeSide has a servicing site located in
Jacksonville, Florida, which at February 28, 1997 serviced approximately 681,115
loans with a servicing staff of approximately 550, and a servicing site located
in San Antonio, Texas, which at February 28, 1997 serviced approximately 406,221
loans with a servicing staff of approximately 280. BMC had servicing operations
located in Jacksonville, Florida and San Antonio, Texas. Prior to the sale of
substantially all the assets of Honolulu Mortgage in February, 1997 to an
unaffiliated third party, approximately 11,000 loans were serviced at Honolulu
Mortgage. These loans and the servicing rights were sold as part of the
February, 1997 sale. HomeSide plans to integrate the existing former BBMC
portfolio with the former BMC portfolio in stages based on the capacity and
capabilities of each of the respective servicing sites. HomeSide has completed
the transfer of its approximately 145,000 loans at BMC's Jacksonville facility
to the San Antonio facility for servicing.
In addition to the physical consolidation of servicing operations, HomeSide
intends to convert the entire servicing platform to BMC's proprietary software.
This proprietary servicing technology accommodates all areas of loan servicing,
including loan setup and maintenance, cashiering, escrow administration,
investor accounting, customer service and default management. The platform is
mainframe based, with on-line, real-time architecture and is supported by an
experienced staff of over 30 technology providers.
HomeSide expects to achieve significant competitive advantages over time by
converting to the proprietary servicing software, which is expected to cost less
to operate and is configured to accommodate growth more efficiently than
HomeSide's current outsourced system. Once the conversion has been completed,
this architecture is expected to support HomeSide's portfolio growth up to
approximately twice the number of loans currently serviced. The system is also
expected to permit continued development of workflow and other client-server
applications, contributing to increased productivity.
Several other measures are expected to be undertaken by HomeSide in order
to operate more efficiently. HomeSide has outsourced BMC's hazard insurance, tax
payments and default functions to specialized vendors, as was the historic
practice at BBMC. The consolidation of the two servicing operations in
Jacksonville is expected to result in a reduction in headcount. In addition, the
plan to have dedicated centers for conventional and FHA/VA servicing in
Jacksonville and San Antonio, respectively, is expected to yield additional
economies through specialization.
13
<PAGE>
Regulation
HomeSide's mortgage banking business is subject to the rules and
regulations of HUD, FHA, VA, Fannie Mae, FHLMC, GNMA and other regulatory
agencies with respect to originating, processing, underwriting, selling,
securitizing and servicing mortgage loans. In addition, there are other federal
and state statutes and regulations affecting such activities. These rules and
regulations, among other things, impose licensing obligations on HomeSide,
prohibit discrimination and establish underwriting guidelines which include
provisions for inspections and appraisals, require credit reports on prospective
borrowers and set maximum loan amounts. Moreover, lenders such as HomeSide are
required annually to submit audited financial statements to Fannie Mae, FHLMC,
GNMA and HUD and to comply with each regulatory entity's own financial
requirements. HomeSide's business is also subject to examination by Fannie Mae,
FHLMC and GNMA and state regulatory agencies at all times to assure compliance
with applicable regulations, policies and procedures.
Mortgage origination activities are subject to the provisions of various
federal and state statutes including, among others, the Equal Credit Opportunity
Act, the Federal Truth-in Lending Act, RESPA, the Fair Housing Act, and the
regulations promulgated thereunder, which among other provisions, prohibit
discrimination, prohibit unfair and deceptive trade practices and require the
disclosure of certain basic information to mortgagors concerning credit terms
and settlement costs, limit fees and charges paid by borrowers and lenders, and
otherwise regulate terms and conditions of credit and the procedures by which
credit is offered and administered. Many of the aforementioned regulatory
requirements are designed to protect the interests of consumers, while others
protect the owners or insurers of mortgage loans. Failure to comply with these
requirements can lead to loss of approved status, termination of servicing
contracts without compensation to the servicers, demands for indemnification or
loan repurchases, class action lawsuits and administrative enforcement actions.
Such regulatory requirements are subject to change from time to time and may in
the future become more restrictive, thereby making compliance more difficult or
expensive or otherwise restricting HomeSide's ability to conduct its business as
it is now conducted.
Prior to the BBMC Acquisition, BBMC was a wholly-owned operating subsidiary
of a national bank, and subject to substantially all of the regulations and
restrictions applicable to a national bank. Prior to the BMC Acquisition, BMC
was a wholly-owned subsidiary of a bank holding company. During the period that
BKB or Barnett, or any of their subsidiaries, retains a material ownership
interest in HomeSide, HomeSide and its subsidiaries (i) will be under the
jurisdiction, supervision, and examining authority of the OCC, and (ii) may only
engage in activities that are part of, or incidental to, the business of
banking. The OCC has specifically ruled that mortgage banking is a proper
incident to the business of banking.
There are various other state and local laws and regulations affecting
HomeSide's operations. HomeSide is licensed in those states that require
licensing to originate, purchase and/or service mortgage loans. Conventional
mortgage operations may also be subject to state usury statutes. FHA and VA
loans are exempt from the effect of such statutes.
Competition
Mortgage bankers operate in a highly competitive and fragmented market. In
1996 the largest originator of loans represented 6.4% of the market and the
largest servicer represented 4.6%, while the top 30 originators and servicers
represented 41.7% and 44.7% of their markets, respectively, based on data
published by Inside Mortgage Finance.
14
<PAGE>
<TABLE>
<CAPTION>
TOP 10 ORIGINATORS AND SERVICERS
(dollars in billions)
<S> <C> <C> <C>
1996 Originations Servicing Portfolio at December 31, 1996
1 Norwest Mortgage, IA $51.5 1 Norwest Mortgage, IA $179.7
2 Countrywide Home Loans, CA 38.8 2 Countrywide Home Loans, CA 151.9
3 Chase Manhattan Mortgage Holdings, FL 38.4 3 Chase Manhattan Mortgage Holdings, FL 137.6
4 Fleet Mortgage Group, SC 22.5 4 Fleet Mortgage Group, SC 120.1
5 HomeSide Lending, FL 19.7 5 GE Capital Mortgage Corp., NC 103.7
6 BankAmerica, CA 15.8 6 NationsBanc & Affiliates, TX 96.4
7 NationsBanc & Affiliates, TX 12.1 7 HomeSide Lending, FL 84.7
8 Standard Federal Bank, MI 10.4 8 Home Savings of America, CA 59.5
9 FT Mortgage Companies, TN 10.1 9 First Nationwide, MD 58.4
10 Resource BancShares Mtg. Co., SC 10.0 10 Mellon Mortgage, TX 58.1
- -----------------
Source: National Mortgage News.
</TABLE>
HomeSide competes with other mortgage bankers, financial institutions, and
other providers of financial services. The underwriting guidelines and servicing
requirements set by the participants in the secondary markets are standardized.
As a result, mortgage banking products (i.e., mortgage loans and the servicing
of those loans) have become difficult to differentiate. Therefore, mortgage
bankers compete primarily on the basis of price or service, making effective
cost management essential.
Mortgage bankers generally seek to develop cost efficiencies in one of two
ways: economies of scale or specialization. Large full-service national or
regional mortgage bankers have sought economies of scale through an emphasis on
wholesale originations, the introduction of automated processing systems and
expansion through acquisition. Smaller companies frequently identify and pursue
a particular expertise or customer base in an attempt to create a market niche.
The industry has experienced rapid consolidation which has been accelerated
by the introduction of significant technology improvements and the economies of
scale present in mortgage servicing. The automation of many functions in
mortgage banking, especially those related to servicing, has reduced costs
significantly for industry participants. Many mortgage bankers that were not low
cost, high volume producers or did not operate in a low cost specialized field
experienced earnings declines in the nineties, causing many to exit the business
or to be acquired. Surviving cost effective firms purchased servicing portfolios
or other companies to expand their servicing economies of scale, while others
acquired market niche operations. As evidence of this consolidation, the top 25
mortgage loan servicers have increased their aggregate market share from 20.7%
in 1990 to 41.9% in 1996.
Employees
As of February 28, 1997, HomeSide had approximately 1,698 total employees,
substantially all of whom were full-time employees. HomeSide has no unionized
employees and considers its relationship with its employees generally to be
satisfactory.
15
<PAGE>
ITEM 2. PROPERTIES
HomeSide's corporate, administrative, and servicing headquarters are
located in Jacksonville, Florida, in facilities, which comprise approximately
145,000 square feet of owned space and approximately 135,000 square feet of
leased space. The servicing center lease expires on August 31, 1999 unless
HomeSide exercises its options to renew, which could extend the lease for an
additional six years. HomeSide also leases approximately 53,000 square feet of
warehouse space in Jacksonville, Florida for storing certain loan files, loan
servicing documents and other corporate records. In addition HomeSide owns an
additional 190,000 square feet of space in San Antonio, Texas. HomeSide believes
that its present facilities are adequate for its operations.
ITEM 3. LEGAL PROCEEDINGS
HomeSide is a defendant in a number of legal proceedings arising in the
normal course of business. HomeSide, in management's estimation, has recorded
adequate reserves in the financial statements for pending litigation.
Management, after reviewing all actions and proceedings pending against or
involving HomeSide, considers that the aggregate liability or loss, if any,
resulting from the final outcome of these proceedings will not have a material
effect on the financial position of HomeSide.
In recent years, the mortgage banking industry has been subject to class
action lawsuits which allege violations of federal and state laws and
regulations, including the propriety of collecting and paying various fees and
charges. Class action lawsuits may be filed in the future against the mortgage
banking industry.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year 1997, except that in January, 1997 prior to
HomeSide's initial public offering of Common Stock, the stockholders, by
unanimous written consent, amended the Certificate of Incorporation and Bylaws
of the Company, appointed BankBoston, N.A. as the Transfer Agent for the
Company's Common Stock and took other actions in anticipation of the initial
public offering. The Restated Certificate of Incorporation and Bylaws were filed
as Exhibits to the Registration Statement for the initial public offering
(Registration No. 333-17685).
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
HomeSide's Common Stock is listed on the New York Stock Exchange ("NYSE")
under the symbol HSL. As of February 28, 1997, there were 86 shareholders of
record of the Company's Common Stock. Class C common stock has no voting rights
and is not publicly traded. There was 1 shareholder of record of Class C common
stock as of February 28, 1997.
Common stock of HomeSide, Inc. was initially sold to the public on January
30, 1997, and the transaction closed on February 5, 1997. The high and low sales
prices (as reported by the NYSE) for the Company's stock for the month of
February 1997 were $19 and $ 16 1/8, respectively.
16
<PAGE>
During the fiscal year ended February 28, 1997, no dividends were declared
or paid on HomeSide's Common Stock.
Prior to the Company's January 1997 initial public offering of Common
Stock, the Company issued certain securities without registration under the
Securities Act of 1933, as amended. The information set forth in Item 15 of the
Company's Registration Statement on Form S-1 (Registration No. 333-17685)
concerning such issuances is incorporated herein by reference.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The information set forth under the caption, "Selected Consolidated
Financial Data" which appears on page 9 of the Company's 1997 Annual Report to
Stockholders is incorporated herein by reference.
ITEM 7. MANAGEMENT'S' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The information set forth under the caption, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" which appears on
pages 10 through 21 of the Company's 1997 Annual Report to Stockholders is
incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements, together with the reports therein of
Arthur Andersen LLP and Coopers and Lybrand LLP appearing on pages 22 through 52
of the Company's 1997 Annual Report to Stockholders are incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no changes in accountants or disagreements with accountants
on accounting and financial disclosure matters which require disclosure pursuant
to Item 304 of Regulation S-K.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 hereby is incorporated by
reference from the information set forth under the captions "Election of
Directors" and "Compliance with Section 16(e) of the Securities Exchange Act of
1934" in the Company's definitive proxy statement for the 1997 Annual Meeting of
Shareholders to be held June 10, 1997.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 hereby is incorporated by
reference from the information set forth under the caption "Executive
Compensation" in the Company's definitive proxy statement for the 1997 Annual
Meeting of Shareholders to be held June 10, 1997.
17
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required by this Item 12 hereby is incorporated by
reference from the information set forth under the captions "Security Ownership
of Certain Beneficial Owners and Management" in the Company's definitive proxy
statement for the 1997 Annual Meeting of Shareholders to be held June 10, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 hereby is incorporated by
reference from the information set forth under the captions "Compensation
Committee Interlocks and Insider Participation" and "Certain Transactions" in
the Company's definitive proxy statement for the 1997 Annual Meeting of
Shareholders to be held June 10, 1997.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
(a) The following documents are filed as a part of this Report:
1. Financial Statements: See Part II, Item 7 hereof.
2. Financial Statement Schedule and Auditors' Report
All schedules omitted are inapplicable or the information required is
shown in the Consolidated Financial Statements or notes thereto.
3. The following exhibits are submitted herewith:
Unless otherwise indicated, all Exhibits are incorporated by reference
to the Company's Registration Statement on Form S-1, No. 333-17685.
Number Description
------ -----------
3.1 Certificate of Incorporation of HomeSide, Inc.
3.2 By-Laws of HomeSide, Inc.
3.3 Form of Restated Certificate of Incorporation of HomeSide, Inc.
3.4 Form of Amended and Restated By-Laws of HomeSide, Inc.
4.1 Form of Common Stock Certificate
10.1 Stock Purchase Agreement dated December 11, 1995 between
HomeAmerica Capital, Inc. (currently known as HomeSide, Inc.) and
The First National Bank of Boston (the "BBMC Purchase Agreement")
10.2 Amendment No. 1, dated as of March 15, 1996, to the BBMC Purchase
Agreement
18
<PAGE>
Number Description
------ -----------
10.3 Marketing Agreement dated as of March 15, 1996 between HomeSide,
Inc. and The First National Bank of Boston
10.4 Repurchase of Mortgage Loan Servicing Rights Letter Agreement
between The First National Bank of Boston (currently known as
BankBoston, N.A.) and BancBoston Mortgage Corporation (currently
known as HomeSide Lending, Inc.)
10.5 Operating Agreement effective as of March 15, 1996 between The
First National Bank of Boston (currently known as BankBoston,
N.A.) and BancBoston Mortgage Corporation (currently known as
HomeSide Lending, Inc.)
10.6 Brokered Loan Purchase and Sale Agreement dated as of March 15,
1996 between BancBoston Mortgage Corporation (currently known as
HomeSide Lending, Inc.) and each of The First National Bank of
Boston (currently known as BankBoston N.A.), Bank of Boston
Connecticut, Rhode Island Hospital Trust National Bank and Bank of
Boston Florida, N.A.
10.7 Master Take-Out Commitment dated as of March 15, 1996 between
BancBoston Mortgage Corporation (currently known as HomeSide
Lending, Inc.) and each of The First National Bank of Boston
(currently known as BankBoston, N.A.), Bank of Boston Connecticut,
Rhode Island Hospital Trust National Bank and Bank of Boston
Florida, N.A.
10.8 Neighborhood Assistance Corporation of America Mortgage Loan
Take-Out Commitment dated as of March 15, 1996 between BancBoston
Mortgage Corporation (currently known as HomeSide Lending, Inc.)
and The First National Bank of Boston (currently known as
BankBoston, N.A.)
10.9+ PMSR Flow Agreement dated as of March 15, 1996 between BancBoston
Mortgage Corporation (currently known as HomeSide Lending, Inc.)
and each of The First national Bank of Boston (currently known as
BankBoston, N.A.), Bank of Boston Connecticut, Rhode Island
Hospital Trust National Bank and Bank of Boston Florida, N.A.
10.10+ Mortgage Loan Servicing Agreement dated as of March 15, 1996
between BancBoston Mortgage Corporation (currently known
asHomeSide Lending, Inc.) and each of the First National Bank of
Boston, Bank of Boston Connecticut, Rhode Island Hospital Trust
National Bank and Bank of Boston Florida, N.A.
10.11 Stock Purchase Agreement dated as of March 4, 1996 between Grant
America, Inc. (currently known as HomeSide, Inc.) and Barnett
Banks, Inc. (the "BMC Purchase Agreement")
10.12 Amendment No. 1, dated as of May 31, 1996, to the BMC Purchase
Agreement
10.13 Tax Indemnity Letter Agreement dated as of March 4, 1996 between
Barnett Mortgage Company (currently known as HomeSide Holdings,
Inc.) and Barnett Banks, Inc.
10.14 Amended and Restated Shareholder Agreement dated as of May 31,
1996 among HomeSide, Inc. and the shareholders thereof
10.15 Amended and Restated Registration Rights Agreement dated as of May
31, 1996 between HomeSide, Inc. and certain shareholders thereof
10.16 Marketing Agreement dated as of May 31, 1996 between HomeSide,
Inc. and Barnett Banks, Inc.
10.17 Transitional Services Agreement dated as of may 31, 1996 between
Barnett Banks, Inc., Barnett Mortgage Company (currently known as
HomeSide Holdings, Inc.) and HomeSide, Inc.
10.18 Operating Agreement dated as of May 31, 1996 between HomeSide
Lending, Inc. and Barnett Banks, Inc.
19
<PAGE>
Number Description
------ -----------
10.19+ Mortgage Loan Servicing Agreement dated as of April, 1996 between
HomeSide Lending, Inc. and Barnett Banks, Inc.
10.20+ PMSR Flow Agreement dated as of May 31, 1996 between HomeSide
Lending, Inc. and Barnett Banks, Inc.
10.21 Correspondent Agreement dated May 16, 1996 between HomeSide
Lending, Inc. and Barnett Banks, Inc.
10.22 Delegated Underwriting Agreement dated as of May 15, 1996 between
HomeSide Lending, Inc. and HomeSide Holdings, Inc.
10.23* Amended and Restated Credit Agreement dated as of January 31, 1997
among HomeSide Lending, Inc., Honolulu Mortgage Company, Inc., the
Lenders parties thereto, and The Chase Manhattan Bank as
Administrative Agent (the "Credit Agreement")
10.24* Amended and Restated Holdings Pledge Agreement dated as of January
31, 1997 between HomeSide, Inc. and The Chase Manhattan Bank, as
Administrative Agent for the Lenders parties to the Credit
Agreement
10.25* Amended and Restated HomeSide Pledge Agreement dated as of January
31, 1997 between HomeSide Lending, Inc. and The Chase Manhattan
Bank, as Administrative Agent for the Lenders parties to the
Credit Agreement
10.26* Amended and Restated BMC Pledge Agreement dated as of January 31,
1997 between HomeSide Holdings, Inc. and The Chase Manhattan Bank,
as Administrative Agent for the Lenders parties to the Credit
Agreement
10.27 Registration Rights Agreement dated as of May 14, 1996 among
HomeSide, Inc. and Merrill Lynch & Co., Merrill Lynch, Pierce,
Fenner & Smith Incorporated, Smith Barney Inc. and Friedman,
Billings, Ramsey & Co., Inc.
10.28* Amended and Restated Holdings Guaranty dated as of January 31,
1997 by HomeSide, Inc. in favor of The Chase Manhattan Bank, as
Administrative Agent for the Lenders parties to the Credit
Agreement
10.29* Amended and Restated HomeSide Guaranty dated as of January 31,
1997 by HomeSide Lending, Inc. in favor of The Chase Manhattan
Bank, as Administrative Agent for the Lenders parties to the
Credit Agreement
10.30* Amended and Restated Subsidiaries Guaranty dated as of January 31,
1997 by each of SWD Properties, Inc., Stockton Plaza, Inc.,
HomeSide Mortgage Securities, Inc. and Honolulu Mortgage Company,
Inc. in favor of The Chase Manhattan Bank, as Administrative Agent
for the Lenders parties to the Credit Agreement
10.31* Amended and Restated BMC Guaranty dated as of January 31, 1997 by
HomeSide Holdings, Inc. in favor of The Chase Manhattan Bank, as
Administrative Agent for the Lenders parties to the Credit
Agreement
10.32* Amended and Restated Security and Collateral Agency Agreement
dated as of January 31, 1997 between HomeSide Lending, Inc. and
The Chase Manhattan Bank, as Administrative Agent for the Lenders
parties to the Credit Agreement
10.33* Amended and Restated Security and Collateral Agency Agreement
dated as of January 31, 1997 between Honolulu Mortgage Company,
Inc. and The Chase Manhattan Bank, as Administrative Agent for the
Lenders parties to the Credit Agreement
10.34* Amended and Restated Security and Collateral Agency Agreement
dated as of January 31, 1997 between HomeSide Holdings, Inc. and
The Chase Manhattan Bank, as Administrative Agent for the Lenders
parties to the Credit Agreement
20
<PAGE>
Number Description
------ -----------
10.35* Intercreditor Agreement dated as of May 31, 1996 between HomeSide,
Inc. HomeSide Holdings, The Bank of New York, as Trustee, and The
Chase Manhattan Bank, as Administrative Agent under the Credit
Agreement
10.36 HomeSide, Inc. Time Accelerated Restricted Stock Option Plan
10.37 HomeSide, Inc. Non-Qualified Stock Option Plan
10.38 Class B Non-Voting Common Stock Issuance Agreement dated as of
March 14, 1996 between HomeSide, Inc. and Smith Barney Inc.
10.39 Transitional Services Agreement dated as of March 15, 1996 between
The First National Bank of Boston (currently known as BankBoston,
N.A.) and BancBoston Mortgage Corporation (currently known as
HomeSide Lending, Inc.)
10.40 Transitional Services Agreement dated as of March 15, 1996 between
The First National Bank of Boston (currently known as BankBoston,
N.A.) and BancBoston Mortgage corporation (currently known as
HomeSide Lending, Inc.)
10.41 Management Agreement dated as of March 15, 1996 between BancBoston
Mortgage Corporation (currently known as HomeSide Lending, Inc.)
and The First National Bank of Boston (currently known as
BankBoston, N.A.)
10.42 Management Agreement dated as of March 15, 1996 between BancBoston
Mortgage Corporation (currently known as HomeSide Lending, Inc.)
and Thomas H. Lee Company
10.43 Management Agreement dated as of March 15, 1996 between BancBoston
Mortgage Corporation (currently known as HomeSide Lending, Inc.)
and Madison Dearborn Partners, Inc.
10.44 Management Stockholder Agreement dated as of May 15, 1996 between
HomeSide, Inc., The First National Bank of Boston (currently known
BankBoston, N.A.), Thomas H. Lee Equity Fund III, L.P. and certain
affiliates thereof, Madison Dearborn Capital Partners, L.P. and
certain employees of HomeSide, Inc. and its subsidiaries
10.45 Management Agreement dated as of May 31, 1996 between HomeSide
Lending, Inc. and Barnett Banks, Inc.
10.46 Form of HomeSide Severance Agreement
10.47* Loan and Security Agreement dated January 15, 1997 between
HomeSide Lending, Inc. and The Chase Manhattan Bank
10.48* First Amendment dated February 28, 1997 to Loan and Security
Agreement dated January 15, 1997 between HomeSide Lending, Inc.
and The Chase Manhattan Bank
10.49* Second Amendment dated March 31, 1997 to Loan and Security
Agreement dated January 15, 1997 between HomeSide Lending, Inc.
and The Chase Manhattan Bank.
10.50* Loan and Security Agreement dated March 14, 1997 between HomeSide
Lending, Inc. and Merrill Lynch Mortgage Capital Inc.
10.51* First Amendment dated March 31, 1997 to Loan and Security
Agreement dated March 14, 1997 between HomeSide Lending, Inc. and
Merrill Lynch Mortgage Capital Inc.
10.52* Third Amendment dated April 11, 1997 to Loan and Security
Agreement dated January 15, 1997 between HomeSide Lending, Inc.
and The Chase Manhattan Bank.
10.53* Second Amendment dated April 14, 1997 to Loan and Security
Agreement dated March 14, 1997 between HomeSide Lending, Inc. and
Merrill Lynch Mortgage Capital Inc.
10.54* Fourth Amendment dated April 29, 1997 to Loan and Security
Agreement dated January 15, 1997 between HomeSide Lending, Inc.
and The Chase Manhattan Bank.
10.55* Third Amendment dated April 29, 1997 to Loan and Security
Agreement dated March 14, 1997 between HomeSide Lending, Inc. and
Merrill Lynch Mortgage Capital Inc.
21.1* List of subsidiaries of HomeSide, Inc.
21
<PAGE>
Number Description
------ -----------
23.4 Consent of Hutchins, Wheeler & Dittmar, A Professional Corporation
(included in Exhibit 5.1)
24.1 Powers of Attorney
26.0^ Excerpts from 1997 Annual Report to Stockholders
26.1 Item 15 of the Company's Registration Statement on form S-1, No.
333-17685
- ----------------
* Incorporated by reference to Exhibits of HomeSide Lending, Inc.'s
(a wholly-owned subsidiary of the Registrant Registration
Statement on Form S-1, Registration No. 333-21193
+ Portions of this Exhibit have been omitted pursuant to an order by
the Securities and Exchange Commission granting confidential
treatment.
^ This Exhibit is filed with this Registration Statement.
(b) Reports on form 8-K
HomeSide filed no reports on form 8-K for the fiscal year ended February
28, 1997.
22
<PAGE>
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
HomeSide, Inc.
--------------
(Registrant)
By: /s/ Joe K. Pickett
--------------------------------
Joe K. Pickett
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
Signiture Title Date
--------- ----- ----
/s/Joe K. Pickett Chairman of the Board, May 21, 1997
- --------------------------- Chief Executive Officer and
Joe K. Pickett Director (Principal Executive
Officer)
/s/Hugh R. Harris President, May 21, 1997
- --------------------------- Chief Operating Officer
Hugh R. Harris and Director
/s/Kevin D. Race Vice President and Chief May 21, 1997
- --------------------------- Financial Officer and
Kevin D. Race Treasurer(Principal Financial
and Accounting Officer)
- --------------------------- Director May 21, 1997
Thomas M. Hagerty
- --------------------------- Director May 21, 1997
David V. Harkins
- --------------------------- Director May 21, 1997
Justin S. Huscher
/s/Peter J. Mannng Director May 21, 1997
- ---------------------------
Peter J. Manning
/s/William J. Shea Director May 21, 1997
- ---------------------------
William J. Shea
___________________________ Director May 21, 1997
Kathleen M. McGillycuddy
/s/Hinton F. Nobles, Jr. Director May 21, 1997
- ---------------------------
Hinton F. Nobles, Jr.
/s/Douglas K. Freeman Director May 21, 1997
- ---------------------------
Douglas K. Freeman
/s/Charles W. Newman Director May 21, 1997
- ---------------------------
Charles W. Newman
23
SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
For the For the For the For the For the
Period From Three Months Three Months Three Months Period From
March 16, 1996 Ended Ended Ended March 16, 1996
to May 31, August 31, November 30, February 28, to February 28,
(Dollar amounts in thousands, except per share data) 1996 1996 1996 1997 1997
---------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Selected Statement of Income Data:
Revenues:
Mortgage servicing fees ............................. $41,485 $83,349 $91,636 $95,871 $312,341
Amortization of mortgage servicing rights ........... (16,442) (40,464) (48,831) (50,090) (155,827)
---------------------------------------------------------------------------
Net servicing revenue ............................. 25,043 42,885 42,805 45,781 156,514
Interest income ..................................... 12,719 22,270 25,241 21,277 81,507
Interest expense .................................... (14,962) (23,920) (22,321) (26,497) (87,700)
---------------------------------------------------------------------------
Net interest revenue .............................. (2,243) (1,650) 2,920 (5,220) (6,193)
Net mortgage origination revenue .................... 10,810 16,273 16,521 22,469 66,073
Other income ........................................ 107 355 79 141 682
---------------------------------------------------------------------------
Total revenues .................................... 33,717 57,863 62,325 63,171 217,076
Salaries and employee benefits ...................... 11,480 21,177 20,650 19,669 72,976
Occupancy and equipment ............................. 1,846 3,084 3,337 3,503 11,770
Servicing losses on investor-owned loans and
foreclosure-related expenses ...................... 3,938 4,058 4,957 4,981 17,934
Other expenses ...................................... 5,345 12,523 11,711 12,135 41,714
---------------------------------------------------------------------------
Total expenses .................................... 22,609 40,842 40,655 40,288 144,394
Income before income taxes and extraordinary
loss on early extinguishment of debt ................ 11,108 17,021 21,670 22,883 72,682
Income tax expense .................................... 4,554 6,954 9,015 8,750 29,273
---------------------------------------------------------------------------
Income before extraordinary loss on early
extinguishment of debt .............................. 6,554 10,067 12,655 14,133 43,409
Extraordinary loss on early extinguishment
of debt, net of tax ................................. -- -- -- 6,440 6,440
---------------------------------------------------------------------------
Net income ............................................ $6,554 $10,067 $12,655 $7,693 $36,969
===========================================================================
Per Share Data:
Income per share before extraordinary loss ............ $0.34 $0.29 $0.36 $0.37 $1.33
Net income per share .................................. $0.34 $0.29 $0.36 $0.20 $1.13
Weighted average shares outstanding ................... 19,246,902 34,973,790 34,996,360 38,279,486 32,687,780
===========================================================================
Selected Balance Sheet Data at End of Period:
Mortgage loans held for sale .......................... $974,484 $1,290,841 $1,101,229 $805,274 $805,274
Mortgage servicing rights ............................. 1,235,708 1,428,117 1,339,819 1,614,307 1,614,307
Total assets .......................................... 2,666,771 2,934,938 2,858,711 2,752,182 2,752,182
Warehouse credit facility ............................. 954,994 1,245,591 1,074,583 835,396 835,396
Long-term debt ........................................ 1,168,059 1,064,067 1,157,508 1,134,235 1,134,235
Total liabilities ..................................... 2,301,817 2,559,817 2,470,785 2,239,886 2,239,886
Total stockholders' equity ............................ 364,954 375,121 387,926 512,296 512,296
===========================================================================
Selected Operating Data:
Volume of loan production ............................. $3,780,236 $5,492,199 $5,540,875 $6,064,225 $20,877,535
Loan servicing portfolio (at period end) .............. 78,391,496 85,835,155 88,706,478 90,192,247 90,192,247
Loan servicing portfolio (average during the period) .. 44,718,020(a) 82,247,794 87,537,188 90,540,220 75,692,214(b)
Weighted average interest rate of the servicing
portfolio (at period end) .......................... 7.86% 7.92% 7.91% 7.92% 7.92%
Weighted average servicing fee of the servicing
portfolio (at period end) .......................... 0.367% 0.363% 0.359% 0.359% 0.359%
</TABLE>
- ------------
(a) Period information is for March 1, 1996 through May 31, 1996.
(b) Period information is for March 1, 1996 through February 28, 1997.
9
HomeSide, Inc.
<PAGE>
Management's Discussion and Analysis of Financial
Condition and Results of Operations
HomeSide--For the Period From March 16, 1996 to February 28, 1997
General
HomeSide, Inc. ("HomeSide" or the "Company") was formed on December 11, 1995 by
an investor group, consisting of Thomas H. Lee Company and its affiliates and
Madison Dearborn Partners (collectively, the "Investors"), and signed a
definitive stock purchase agreement with The First National Bank of Boston
("Bank of Boston" or "BKB") for the purpose of acquiring certain assets and
liabilities of the mortgage banking business ("BBMC") owned by Bank of Boston.
Bank of Boston received cash and an ownership interest in the Parent. The
transaction closed on March 15, 1996 and HomeSide began operations on March 16,
1996.
On May 31, 1996, Barnett Banks, Inc. ("Barnett") sold certain of its mortgage
banking operations ("BMC"), primarily its mortgage servicing portfolio, mortgage
servicing operations and proprietary mortgage banking software systems, to
HomeSide. Barnett received cash and an ownership interest in HomeSide. Barnett
Mortgage Company was subsequently renamed HomeSide Holdings, Inc. For more
information on these acquisitions, see Note 4 of Notes to Consolidated Financial
Statements.
HomeSide has adopted a February 28 fiscal year end. The purchase method of
accounting was used for the BBMC and BMC acquisitions, and accordingly, assets
acquired and liabilities assumed were recorded at their estimated fair values at
the date of acquisition.
HomeSide's operating results are not directly comparable to BBMC and BMC
historical operating results due, in part, to different balance sheet valuations
(estimated fair value as compared to historical cost). In addition, certain
production channels were retained by Bank of Boston and all of BMC's production
channels were retained by Barnett. Accordingly, comparative financial statements
for the same period in the prior year have not been presented. Instead, a
comparison is presented of the four quarters in the period from March 16, 1996
to February 28, 1997. Results of operations prior to May 31, 1996 do not include
the results of operations of BMC, which was acquired on May 31, 1996.
Mortgage banking is a specialized branch of the financial services industry
which primarily involves (i) originating and purchasing mortgage loans
("origination" and/or "production"); (ii) selling the originated mortgages to
third parties either as mortgage-backed securities or as whole loans ("secondary
marketing"); (iii) servicing of mortgage loans on behalf of the ultimate
purchasers, which includes the collection and disbursement of payments of
mortgage principal and interest, the collection of payments of taxes and
insurance premiums to pay property taxes and insurance premiums and management
of certain loan default activities (collectively, "servicing"); and (iv) the
purchase and sale of the rights to service mortgage loans.
Mortgage bankers originate loans generally through two channels: wholesale and
direct. Wholesale origination involves the origination of mortgage loans from
sources other than homeowners, including mortgage brokers and other mortgage
lenders. Direct origination typically includes (i) networks of retail loan
offices with sales staff that solicit business from homeowners, realtors,
builders and other real estate professionals, (ii) centers that use
telemarketing, direct mail and advertising to market loans directly to home
buyers or homeowners, (iii) affinity and co-branding partnerships and (iv)
corporate relocation programs. Once originated or purchased, mortgage bankers
hold the loans temporarily ("warehousing") until they are sold, typically
earning an interest spread equal to the difference between the loan's interest
rate and the cost of financing the loan. Each loan is sold either excluding or
including the associated right to service the loan.
Mortgage bankers rely mainly on short-term borrowings, such as warehouse lines,
to finance the origination of mortgages that are then typically sold. Mortgage
bankers also borrow on a longer term basis to finance their servicing assets and
working capital requirements. Revenues consist primarily of those related to
servicing and, to a lesser extent, fees and interest spreads from originations.
The major expenses of a mortgage banker include costs of financing, operating
costs related to origination and servicing and the amortization of mortgage
servicing rights. Included in costs of financing is the benefit derived from
holding custodial deposits. Custodial deposits are comprised of amounts
collected from borrowers and not yet remitted to investors, taxing authorities
and other third parties.
Mortgage bankers typically seek to retain the rights to service the loans they
originate and to acquire rights to service additional loans in order to generate
recurring fee income. The purchase and sale of servicing rights can occur on a
loan-by-loan basis or on a portfolio (group of loans) basis. Prices for
servicing rights are typically stated as a multiple of the servicing fee or as a
percentage of the outstanding unpaid principal balance for a group of mortgage
loans. Values of servicing portfolios are determined on the basis of the present
value of the servicing fee income stream (net of servicing costs) expected to be
received over the estimated life of the loans. The assets of a mortgage banking
company consist primarily of loans in warehouse and the value of the servicing
rights purchased ("purchased mortgage servicing rights" or "PMSR") or originated
("originated mortgage servicing rights" or "OMSR").
The following information regarding loan production activities and the servicing
portfolio for HomeSide is presented to aid in understanding the results of
operations and financial condition of HomeSide for the period from March 16,
1996 to May 31, 1996, each of the three months ended August 31, 1996, November
30, 1996 and February 28, 1997 and the period from March 16, 1996 to February
28, 1997.
HomesSide, Inc.
10
<PAGE>
Loan Production Activities
<TABLE>
<CAPTION>
For the For the For the For the For the
Period From Three Months Three Months Three Months Period From
March 16, 1996 Ended Ended Ended March 16, 1996 to
to May 31, 1996 August 31, 1996 November 30, 1996 February 28, 1997 February 28, 1997
-----------------------------------------------------------------------------------------------
(dollars in millions)
<S> <C> <C> <C> <C> <C>
Total production and acquisitions
Correspondent (includes volumes
purchased from BKB and Barnett) .. $1,893 2,950 $3,249 $3,021 $11,113
Co-issue(a) ........................ 1,419 2,208 1,985 2,610 8,222
Broker ............................. 220 155 168 300 843
-----------------------------------------------------------------------------------------------
Total Wholesale .................... 3,532 5,313 5,402 5,931 20,178
Direct ............................. 248 179 139 134 700
-----------------------------------------------------------------------------------------------
Total production ................... 3,780 5,492 5,541 6,065 20,878
Bulk acquisitions .................. -- 4,073 -- -- 4,073
-----------------------------------------------------------------------------------------------
Total production and acquisitions .. $3,780 $9,565 $5,541 $6,065 $24,951
===============================================================================================
</TABLE>
- ------------
(a) Co-issue production represents the purchase of servicing rights from a
correspondent under contracts to deliver specified volumes on a monthly or
quarterly basis. The substance of this transaction is the purchase of a
loan and mortgage servicing right with the instantaneous sale of the loan
with the servicing right retained. Amounts represent the unpaid principal
balance of mortgage debt to which the acquired servicing rights relate.
Total loan production increased from $3.8 billion in the period from March 16,
1996 to May 31, 1996 to $5.5 billion in the second and third quarters and $6.1
billion for the three months ended February 28, 1997. These increases were due
to the additional production resulting from the acquisition of BMC on May 31,
1996 and growth in HomeSide's existing wholesale channels. In addition, HomeSide
made bulk servicing acquisitions of $4.1 billion during the second quarter of
fiscal 1997.
<PAGE>
Servicing Portfolio
<TABLE>
<CAPTION>
For the For the For the For the For the
Period From Three Months Three Months Three Months Period From
March 1, 1996 Ended Ended Ended March 1, 1996 to
to May 31, 1996 August 31, 1996 November 30, 1996 February 28, 1997 February 28, 1997
-----------------------------------------------------------------------------------------------
(dollars in millions)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period ... $42,907 $78,391 $85,835 $88,706 $42,907
Acquisition of BMC ............... 33,082 -- -- -- 33,082
Other additions .................. 4,102 9,842 5,244 6,064 25,252
-----------------------------------------------------------------------------------------------
Total additions .............. 37,184 9,842 5,244 6,064 58,334
-----------------------------------------------------------------------------------------------
Scheduled amortization ........... 235 494 517 576 1,822
Prepayments ...................... 1,321 1,702 1,529 1,674 6,226
Foreclosures ..................... 130 137 106 141 514
Sales of servicing ............... 14 65 221 2,187(a) 2,487(a)
-----------------------------------------------------------------------------------------------
Total reductions ................. 1,700 2,398 2,373 4,578 11,049
-----------------------------------------------------------------------------------------------
Balance at end of period ......... $78,391 $85,835 $88,706 $90,192 $90,192
===============================================================================================
</TABLE>
- ------------
(a) Includes $1.9 billion of servicing sold as part of the sale of Honolulu
Mortgage Company.
The number of loans being serviced at February 28, 1997 was 1,087,336, compared
to 1,085,000 as of November 30, 1996, 1,059,000 as of August 31, 1996, 984,000
as of May 31, 1996 and 510,000 as of March 1, 1996. HomeSide's strategy is to
build its mortgage servicing portfolio and benefit from the economies of scale
inherent in the business.
Results of Operations
Summary
HomeSide reported net income before an extraordinary item of $14.1 million
during the fourth quarter of fiscal 1997, compared to net income of $12.6
million during the third quarter of fiscal 1997, $10.1 million during the second
quarter of fiscal 1997 and $6.6 million during the first quarter of fiscal 1997.
Net income before an extraordinary item for the period from March 16, 1996 to
February 28, 1997 was $43.4 million. Included in net income for fiscal 1997 and
the fourth fiscal quarter is an extraordinary charge. HomeSide used a portion of
the proceeds from the sale of common stock to pre-pay $70.0 million of Notes. In
connection with the early repayment of notes, HomeSide wrote off a portion of
the unamortized debt-issue cost related to the Notes and incurred a pre-payment
penalty of $7.9 million. The
11
HomeSide, Inc.
<PAGE>
Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
extraordinary loss amounted to $6.4 million net of tax of $4.3 million, or $0.13
per share. For the fourth fiscal quarter, net income after the extraordinary
item was $7.7 million. Net income after the extraordinary item was $37.0 million
for fiscal 1997.
Total revenues during fiscal 1997 increased from $33.7 million in the first
quarter to $57.9 million in the second quarter, $62.3 million in the third
quarter and $63.2 million in the fourth quarter. The primary reasons for the
increase of $0.9 million in total revenue in the fourth quarter as compared to
the third quarter of fiscal 1997 were an increase of $3.0 million in net
servicing revenue and an increase of $6.0 million in net mortgage origination
revenue, offset by a decrease of $8.1 million in net interest revenue. The
increase in net servicing revenue was due to an increase in the size of the
servicing portfolio, and the increase in net mortgage origination revenue was
accounted for by increased loan production. Net interest revenue decreased,
because the average balances of mortgage loans held for sale and custodial
balances declined from quarter to quarter.
The primary reason for the increase of $4.4 million in total revenue in the
third quarter as compared to the second quarter of fiscal 1997 was an increase
of $4.6 million in net interest revenue. Interest income increased in the third
quarter as compared with the second quarter of fiscal 1997 as the result of an
increase in the average balance of mortgage loans held for sale. Lower
short-term interest rates, improved pricing on borrowings under the bank line of
credit and higher balances of custodial deposits lowered the interest expense
for the third quarter of fiscal 1997 compared to the second quarter.
The increase of $24.2 million in total revenues in the second quarter as
compared to the first quarter of fiscal 1997 was primarily a result of the
acquisition of BMC on May 31, 1996. Results of operations for BMC are included
from the date of acquisition and, therefore, are not included in HomeSide's
first quarter of fiscal 1997 results. The BMC servicing portfolio was $33.1
billion at May 31, 1996 and its acquisition increased HomeSide's servicing
portfolio by 75% on that date and also increased net servicing revenue from
$25.0 million in the first quarter of fiscal 1997 to $42.9 million in the second
quarter of fiscal 1997. Also as part of the BMC acquisition, Barnett agreed to
sell HomeSide the loans produced by the loan production networks retained by
Barnett. This additional production increased net mortgage origination revenue.
Net Servicing Revenue
Net servicing revenue increased from $25.0 million in the first quarter of
fiscal 1997 to $42.9 million in the second quarter, $42.8 million in the third
quarter and $45.8 million in the fourth quarter. Net servicing revenue for the
period from March 16, 1996 to February 28, 1997 was $156.5 million. Mortgage
servicing fees generally range from 0.25% to 0.50% per annum of the declining
principal balances of the loans. HomeSide's weighted average servicing fee,
excluding ancillary income, during each of the quarters of fiscal 1997 was as
follows: 0.367% during the first quarter, 0.363% during the second quarter,
0.359% during the third quarter and 0.359% during the fourth quarter. The
decrease in the weighted average servicing fee from the first quarter to the
second quarter of fiscal 1997 was due to the servicing rights acquired in the
BMC acquisition. These servicing rights generally had lower servicing fees due
to the lower proportion of government loans in BMC's servicing portfolio as
compared to the servicing portfolio acquired from BBMC and serviced by HomeSide
during the first quarter. Likewise, the second quarter bulk acquisition of
servicing rights consisted of a relatively lower proportion of government
servicing, further reducing the weighted average servicing fee from the second
quarter to the third quarter. The acquisition took place on August 31, 1996 but
was not transferred to HomeSide's servicing system until the third fiscal
quarter. Mortgage servicing fees increased from $41.5 million in the first
quarter to $83.3 million in the second quarter, primarily as a result of the BMC
acquisition. The increases in mortgage servicing fees from $83.3 million in the
second quarter to $91.6 million in the third quarter and $95.9 million in the
fourth quarter are the result of increases in the size of the servicing
portfolio. Amortization of mortgage servicing rights, which is recorded over the
estimated servicing period in proportion to estimated servicing revenue
increased throughout the period from March 16, 1996 to February 28, 1997 as a
result of a higher average servicing portfolio balance.
Risk Management Activities
HomeSide has a risk management program designed to protect the economic value of
its mortgage servicing portfolio from declines in value due to increases in
estimated loan prepayment speeds, which are primarily influenced by declines in
interest rates. When loans prepay faster than anticipated, the cash flow
HomeSide expects to receive from servicing such loans is reduced. The value of
mortgage servicing rights is based on the present value of the cash flows to be
received over the life of the loan and therefore, the value of the servicing
portfolio declines as prepayments increase.
During the period from March 16, 1996 to February 28, 1997, HomeSide purchased
options on U.S. Treasury bond futures to protect a significant portion of the
market value of its mortgage servicing portfolio from a decline in value. The
option contracts used by HomeSide have characteristics such that they tend to
increase in value as interest rates decline. Conversely, these option contracts
tend to decline in value as interest rates rise. Accordingly, changes in value
of these securities will tend to move inversely with changes in value of
HomeSide's mortgage servicing rights.
12
HomeSide, Inc.
<PAGE>
These option contracts are designated as hedges on the purchase date and such
designation is at a level at least as specific as the level at which mortgage
servicing rights are evaluated for impairment. The option contracts are
marked-to-market with changes in market value deferred as an adjustment to the
carrying value of the related mortgage servicing right asset being hedged.
Changes in market value that are deferred are amortized and evaluated for
impairment in the same manner as the related mortgage servicing rights. The
effectiveness of HomeSide's hedging activity can be measured by the correlation
between changes in the value of the options and changes in the value of
HomeSide's mortgage servicing rights. This correlation is assessed on a
quarterly basis to ensure that high correlation is maintained over the term of
the hedging program. During each of the periods presented, HomeSide has
experienced a high measure of correlation between changes in the value of
mortgage servicing rights and the option contracts. However, in periods of
rising interest rates, the increase in value of mortgage servicing rights may
outpace the decline in value of the option contracts, because the loss on the
options is limited to the premium paid.
Since HomeSide's inception, cumulative net deferred gains and losses on risk
management contracts resulted in a $121.6 million net loss. Of the $121.6
million net loss, $11.0 million was amortized and recognized as a component of
amortization of mortgage servicing rights, resulting in a net deferred hedge
loss of $110.6 million, which is included in the carrying value of mortgage
servicing rights at February 28, 1997. The increase in the estimated fair value
of the mortgage servicing rights approximated the net hedge loss. HomeSide's
future cash needs as they relate to its hedging program will be influenced by
such factors as long-term interest rates, loan production levels and growth in
the mortgage servicing portfolio. The fair value of open risk management
contracts at February 28, 1997 was $45.2 million, which was equal to their
carrying amount because the options are marked-to-market at each reporting date.
See "--Liquidity and Capital Resources" for further discussion of HomeSide's
sources and uses of cash. See Note 3 of Notes to Consolidated Financial
Statements for a description of HomeSide's accounting policy for its risk
management contracts. See Notes 14, 15 and 16 of Notes to Consolidated Financial
Statements for additional fair value disclosures with respect to HomeSide's risk
management contracts.
Net Interest Revenue
Net interest revenue is driven by the level of interest rates, the direction in
which rates are moving and the spread between short- and long-term interest
rates. These factors influence the size of the residential mortgage origination
market, HomeSide's production volumes and the interest rates HomeSide earns on
loans and pays to its lenders.
Loan refinancing levels are the biggest contributor to changes in the size of
the mortgage origination market. To reduce the cost of their home mortgages,
borrowers tend to refinance their loans during periods of declining interest
rates, increasing the size of the market and HomeSide's production volumes.
Higher production volumes result in higher average balances of loans held for
sale and consequently higher levels of interest income from interest earned on
such loans prior to their sale. This higher level of interest income due to
increased volumes is partially offset by the lower rates earned on the loans.
Overall borrowing costs also fluctuate with changes in interest rates.
Currently, the interest expense HomeSide pays to finance mortgage loans held for
sale and other net assets is generally calculated with reference to short-term
interest rates. In addition, because mortgage loans held for sale earn interest
based on longer term interest rates, the level of net interest revenue is also
influenced by the spread between long-term and short-term interest rates.
Net interest revenue during fiscal 1997 was $(2.2) million during the first
quarter, $(1.7) million during the second quarter, $2.9 million during the third
quarter and $(5.2) million during the fourth quarter. Net interest revenue for
the period from March 16, 1996 to February 28, 1997 was $(6.2) million. Interest
income and interest expense increased during the second quarter of fiscal 1997
as compared with the first quarter as a result of an increase in the average
balance of mortgage loans held for sale from $770.0 million in the first quarter
of fiscal 1997 to $1.3 billion during the second quarter of fiscal 1997 and an
increase in the average balance of notes payable to banks from $1.3 billion to
$2.0 billion from the first quarter to the second quarter of fiscal 1997,
respectively. The acquisition of BMC on May 31, 1996 contributed to the
increased balances of mortgage loans held for sale and borrowings. Interest
income during the second quarter was also positively affected by a general
increase in long-term interest rates during the second quarter.
Interest income increased, while interest expense decreased, during the third
quarter of fiscal 1997 as compared with the second quarter of fiscal 1997. The
increase in interest income during the third quarter was the result of an
increase in the average balance of mortgage loans held for sale from $1.3
billion in the second quarter to $1.4 billion during the third quarter of fiscal
1997. Lower short-term interest rates and improved pricing on borrowings under
the bank line of credit contributed to the reduction in interest expense in the
third quarter of fiscal 1997 as compared with the second quarter of fiscal 1997.
In addition, the average balance of custodial deposits increased from $1.3
billion in the second fiscal quarter to $1.4 billion in the third fiscal quarter
of 1997. Interest expense is reduced by credits received on borrowings for
custodial deposits.
Interest income decreased, while interest expense increased, in the fourth
quarter of fiscal 1997 as compared with the third quarter of fiscal 1997. The
decrease in interest income during the fourth quarter was the result of a lower
average balance of
13
HomeSide, Inc.
<PAGE>
Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
mortgage loans held for sale during the fourth quarter compared to the third
quarter. During the fourth quarter, more mortgage loans were sold under
repurchase agreements than in previous quarters in fiscal 1997. Repurchase
agreements provide an alternative to the bank line of credit for mortgage loans
held for sale. Under these agreements, mortgage loans are sold earlier and not
held as long in the warehouse. These agreements have the effect of increasing
gains on sales of loans and reducing interest income. The increase in interest
expense in the fourth quarter of fiscal 1997 as compared with the third quarter
reflects the lower average balances for custodial deposits. The benefit from
custodial deposits reduces interest expense.
Net Mortgage Origination Revenue
Net mortgage origination revenue is comprised of fees earned on the origination
of mortgage loans, gains and losses on the sale of loans, gains and losses
resulting from hedges of secondary marketing activity and fees charged to review
loan documents for purchased loan production.
Net mortgage origination revenue increased during fiscal 1997 from $10.8 million
during the first quarter to $16.3 million during the second quarter, $16.5
million during the third quarter and $22.5 million during the fourth quarter.
Total net mortgage origination revenue for the period from March 16, 1996 to
February 28, 1997 was $66.1 million. As noted above, loan production, exclusive
of bulk servicing acquisitions, increased during fiscal 1997 from $3.8 billion
in the first quarter to $5.5 billion in the second quarter, $5.5 billion in the
third quarter and $6.1 billion in the fourth quarter. The increase in loan
production from the first to the second quarter of fiscal 1997 is reflective of
production from the preferred seller relationship with Barnett established as
part of the BMC acquisition. HomeSide's primary origination activities during
fiscal 1997 were through correspondent and co-issue channels. HomeSide expects
these channels to continue to be the primary loan origination sources in the
future.
Salaries and Employee Benefits
Salaries and employee benefits expense increased from $11.5 million in the first
quarter of fiscal 1997 to $21.2 million in the second quarter of fiscal 1997,
decreased to $20.6 million during the third quarter of fiscal 1997 and decreased
to $19.7 million during the fourth quarter of fiscal 1997. Salaries and employee
benefits for the period from March 16, 1996 to February 28, 1997 were $73.0
million. The increase in salaries and employee benefits from the first quarter
to the second quarter of fiscal 1997 was due to growth in the number of
employees as a result of the acquisition of the mortgage servicing operations of
BMC on May 31, 1996. The average number of full time equivalent employees grew
from 1,096 during the first quarter of fiscal 1997 to 1,879 during the second
quarter of fiscal 1997. The subsequent decreases were due to the continuing
integration of the BMC servicing operations and the corresponding reduction in
the number of employees. The average number of full time equivalent employees
fell from 1,879 during the second quarter to 1,708 during the third quarter and
1,689 during the fourth quarter.
Occupancy and Equipment Expense
Occupancy and equipment expense primarily includes rental expense, repairs and
maintenance costs, certain computer software expenses and depreciation of
HomeSide's premises and equipment. Occupancy and equipment expense for the
period from March 16, 1996 to February 28, 1997 was $11.8 million. Occupancy and
equipment expense grew during fiscal 1997 from $1.9 million during the first
quarter to $3.1 million during the second quarter, $3.3 million during the third
quarter and $3.5 million during the fourth quarter.
The increase in occupancy and equipment expense was due to the premises and
equipment acquired in the BMCacquisition and increases in information systems
required to handle the growing mortgage servicing portfolio.
Servicing Losses on Investor-Owned Loans and
Foreclosure-Related Expenses
Servicing losses on investor-owned loans and foreclosure-related expenses
represent anticipated losses primarily attributable to servicing FHA and VA
loans for investors. These amounts include actual losses for final disposition
of loans, accrued interest for which payment has been denied, non-recoverable
foreclosure costs and estimates for potential losses based on HomeSide's
experience as a servicer of government loans.
During fiscal 1997 the servicing losses on investor-owned loans and
foreclosure-related expenses increased from $3.9 million for the first quarter
to $4.1 million for the second quarter, $4.9 million for the third quarter and
$5.0 million for the fourth quarter. Servicing losses on investor-owned loans
and foreclosure-related expenses for the period from March 16, 1996 to February
28, 1997 was $17.9 million. The increases are largely attributable to the
acquisition of the BMC servicing portfolio and the growth of the servicing
portfolio resulting from loan production.
Included in the balance of accounts payable and accrued liabilities at February
28, 1997 is a reserve for estimated servicing losses on investor-owned loans of
$21.7 million. The reserve has been established for potential losses related to
the mortgage servicing portfolio. Increases to the reserve are charged to
earnings as servicing losses on investor-owned loans. The reserve is decreased
for actual losses incurred related to the mortgage servicing portfolio.
HomeSide's historical loss experience on VA loans generally has been consistent
with industry experience.
14
HomeSide, Inc.
<PAGE>
Other Expenses
Other expenses consist mainly of professional fees, communications expense,
advertising and public relations, data processing expenses and certain loan
origination expenses. The level of other expenses fluctuates in part based upon
the level of HomeSide's mortgage servicing portfolio and loan production
volumes.
Other expenses during fiscal 1997 were $5.4 million for the first quarter, $12.5
million for the second quarter, $11.7 million for the third quarter and $12.1
million for the fourth quarter. Other expenses for the period from March 16,
1996 to February 28, 1997 were $41.7 million. The increase in other expenses
from the first to the second quarter of fiscal 1997 was the result of the
acquisition of BMC.
Income Tax Expense
HomeSide's income tax expense was $4.6 million during the first quarter of
fiscal 1997, $7.0 million during the second fiscal quarter, $9.0 million during
the third fiscal quarter and $8.7 million during the fourth fiscal quarter.
Income tax expense was $29.3 million for the period from March 16, 1996 to
February 28, 1997, all of which was deferred. The increases in income tax
expense were attributable to the increases in net income. The effective income
tax rate for fiscal 1997 was approximately 40%.
Liquidity and Capital Resources
Operations
Net cash provided by operations was $203.8 million for the period from March 16,
1996 to February 28, 1997. The primary uses of cash in operations were to fund
loan originations and pay corporate expenses. These uses of cash were offset by
cash provided from servicing fee income, loan sales and principal repayments.
Cash flows from loan originations are dependent upon current economic conditions
and the level of long-term interest rates. Decreases in long-term interest rates
generally result in higher loan refinancing activity which results in higher
cash demands to meet increased loan production levels. Cash needs in times of
increased production are primarily met through borrowings and loan sales.
Investing
Net cash used in investing activities was $862.2 million during the period from
March 16, 1996 to February 28, 1997. Cash used in investing activities was
primarily used for the purchase and origination of mortgage servicing rights and
the purchase of options on U.S. Treasury bond futures as part of HomeSide's
hedging program. During the period from March 16, 1996 to February 28, 1997,
HomeSide also made payments of $133.4 million and $106.2 million to acquire
certain mortgage banking operations of BBMC and BMC, respectively (see Note 4 of
Notes to Consolidated Financial Statements). Future uses of cash for investing
activities will be dependent on the mortgage origination market and HomeSide's
hedging needs. HomeSide is not able to estimate the timing and amount of cash
uses for future acquisitions of other mortgage banking entities, if such
acquisitions were to occur.
Financing
During the period from March 16, 1996 to February 28, 1997, HomeSide had $711.1
million of net cash provided by financing activities. The primary sources of
cash from financing activities during the period were $269.6 million from
proceeds from issuance of common stock, net borrowings under HomeSide's lines of
credit of $334.2 million and $200.0 million from the issuance of Notes. Cash
used in financing activities was used to repay a $90.0 million bridge loan,
$70.0 million of the Notes issued earlier in the year and the payment of debt
issue costs.
Cash from financing activities was provided by the three-year senior revolving
credit facility that was entered into on March 15, 1996 and re-issued on January
31, 1997. The line of credit is subject to a $2.5 billion limit and is
unsecured. Under certain circumstances, amounts outstanding under the credit
facility become secured obligations. The $2.5 billion commitment is comprised of
a servicing-related credit facility, capped at $950.0 million, and a warehouse
loan commitment. Such borrowings bear interest at rates per annum based on, at
HomeSide's option, (A) the highest of (i) the lead bank's prime rate, (ii) the
secondary market rate of certificates of deposit plus 100 basis points, and
(iii) the federal funds rate in effect from time to time plus 0.5% or (B) a
eurodollar rate. Cash provided by the bank line of credit is the result of
borrowings needed to finance loan origination activity. In periods of higher
loan origination activity, cash needs are greater and, accordingly, HomeSide
must borrow under the credit facility in order to meet production demand. In
periods of reduced loan demand, proceeds from loan sales can be used to pay down
the bank line of credit. In future periods, it is expected that cash financing
needs will primarily be met from drawings under the bank line of credit and
other facilities which may be entered into from time to time, as well as from
the issuance of debt securities in the public markets. There can be no assurance
that such additional facilities will be available or that market conditions at
any given time will be such that public issuances of debt securities can be
effected on favorable terms. On January 15, 1997, HomeSide entered into a
short-term credit facility in an aggregate principal amount of $85.0 million. On
March 14, 1997, HomeSide entered into another short-term credit facility in an
aggregate principal amount of $100.0 million. These facilities each expire on
the earlier to occur of May 1, 1997, or the consummation of the initial sale of
the medium-term debt securities. Drawings under both the facilities are based on
a variety of indices, including the bank's prime rate, federal funds and the
secondary market rate for certificates of deposit.
15
HomeSide, Inc.
<PAGE>
Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
In February 1997, HomeSide Lending, Inc., HomeSide's primary operating
subsidiary, filed a shelf registration statement in connection with a public
offering of various debt securities. The proceeds from the issuance of such
securities, if drawn upon, will be used to reduce amounts outstanding under the
bank line of credit or to repay other outstanding indebtedness and for working
capital and general corporate purposes, including the purchase of mortgage
servicing rights.
During the period from March 16, 1996 to February 28, 1997, net cash provided by
operations was $203.8 million, cash used in investing activities was $862.2
million and cash provided by financing activities was $711.1 million, resulting
in a net increase in cash of $52.7 million. HomeSide expects that to the extent
cash generated from operations is inadequate to meet its liquidity needs, those
needs can be met through financing from its bank credit facility, other credit
facilities which may be entered into from time to time and the public issuance
of debt securities. Accordingly, HomeSide does not currently anticipate that it
will make sales of servicing rights to any significant degree for the purpose of
generating cash. Nevertheless, in addition to its cash and mortgage loans held
for sale balances, HomeSide's portfolio of mortgage servicing rights provides a
potential source of funds to meet liquidity requirements, especially in periods
of rising interest rates when loan origination volume slows. Future cash needs
are highly dependent on future loan production and servicing results, which are
influenced by changes in long-term interest rates.
Cautionary Statement Pursuant to Safe Harbor Provisions
of the Private Securities Litigation Reform Act of 1995
This report contains "forward-looking statements" within the meaning of the
federal securities laws. Forward-looking statements in this report regarding
trends in interest rates, loan production levels, values of mortgage servicing
rights and potential acquisitions are subject to risks and uncertainties that
could cause actual results to differ materially from those expressed in or
implied by the statements.
16
HomeSide, Inc,
<PAGE>
Management's Discussion and Analysis of Financial
Condition and Results of Operations
BBMC--For the Periods January 1, 1996 to March 15, 1996 and January 1, 1995 to
March 31, 1995 and for the Two Years Ended December 31, 1995
General
Prior to March 15, 1996, BBMC was a wholly-owned subsidiary of Bank of Boston, a
subsidiary of Bank of Boston Corporation ("BKBC"). On March 15, 1996, BBMC was
acquired by HomeSide. The interim financial statements of BBMC have been
prepared for the period January 1, 1996 to March 15, 1996 to coincide with the
closing of the BBMC Acquisition. Results of operations for periods subsequent to
March 15, 1996 are included in the financial statements of HomeSide. Results of
operations for the three months ended March 31, 1995 have been presented for
comparative purposes. Unless otherwise noted, references to the first quarter
1996 pertain to the period January 1, 1996 to March 15, 1996. BBMC reported
earnings on a calendar year basis.
BBMC operates as a full-service mortgage banking firm emphasizing wholesale
mortgage originations and low cost mortgage servicing. Servicing activities
represent BBMC's primary revenue source. BBMC also generates revenue, to a
lesser extent, from mortgage loan origination fees. BBMC incurs expenses for
amortization of mortgage servicing rights, interest on its line of credit and
general corporate activities.
On June 1, 1995, BBMC purchased certain assets and assumed certain liabilities
of Bell Mortgage Company ("Bell Mortgage"), a privately-held mortgage
origination company located in Minneapolis, Minnesota. The acquisition of Bell
Mortgage was accounted for under the purchase method of accounting. Results of
operations of Bell Mortgage are included in the 1995 consolidated financial
statements from the date of acquisition. See Note 16 of Notes to Consolidated
Financial Statements of BancBoston Mortgage Corporation on page 51 for further
discussion.
Results of Operations
Summary
BBMC reported net income of $58.8 million in 1995 and $5.4 million in 1994. Net
income in 1994 included an after tax positive effect of $3.5 million from a
change in the accounting for mortgage servicing fee income. Prior to the effect
of such adjustment, BBMC had income of $58.8 million in 1995 and $2.0 million in
1994. See Note 2 of Notes to Consolidated Financial Statements for further
discussion of BBMC's accounting changes.
The increase in net income in 1995 as compared to 1994 was primarily due to
factors that resulted from a decrease in interest rates coupled with growth in
BBMC's servicing portfolio. The lower interest rate environment resulted in a
gain related to BBMC's risk management activities in 1995 as compared to a loss
in 1994. BBMC also benefited from a 9% increase in the balance of its
residential servicing portfolio from $38.0 billion at December 31, 1994 to $41.6
billion at December 31, 1995.
The increases were partially offset, however, by higher mortgage servicing
rights amortization charges as a result of larger mortgage servicing volumes and
higher prepayment activity in 1995.
Long-term interest rates declined through mid-February 1996, the continuation of
a trend which began in 1995. This decline led to an increase in loan production
to $4.2 billion during the first quarter of 1996 from $1.2 billion during the
first quarter of 1995, and resulted in growth in BBMC's mortgage servicing
portfolio, which increased from $41.6 billion at December 31, 1995 to $44.2
billion at March 31, 1996. Beginning in late February and continuing through
March 1996, long-term interest rates increased and negatively affected BBMC's
results of operations for the first quarter. BBMC reported a net loss of $73.9
million during the first quarter of 1996, compared to net income of $3.4 million
in the first quarter of 1995. The decrease in net income was primarily due to
losses of $128.8 million on BBMC's risk management contracts during the first
quarter of 1996, a result of increasing interest rates in late February and
March 1996.
Net Servicing Revenue
Net servicing revenue increased from $67.0 million to $173.7 million, an
increase of $106.7 million or 159.3%, from 1994 to 1995. This growth was
comprised of a $115.4 million increase in gain on risk management contracts and
a $32.5 million increase in mortgage servicing fees, offset by a $41.2 million
increase in amortization of mortgage servicing rights. The gain on risk
management contracts resulted primarily from a decline in interest rates in the
fourth quarter of 1995 and was substantially offset by a related decrease in the
economic value of the servicing portfolio, which was not reflected in earnings
for the period. The cost of acquiring the right to service mortgage loans
originated by others is capitalized and amortized as a reduction of servicing
fee revenue over the estimated servicing period. The increases in mortgage
servicing fees and amortization of mortgage servicing rights were primarily due
to growth in BBMC's average servicing portfolio during 1995. Average servicing
fees, excluding ancillary income, decreased slightly from 0.389% in 1994 to
0.383% in 1995.
At December 31, 1995, BBMC serviced approximately 510,000 loans, including loans
purchased not yet on BBMC's servicing system, with an unpaid principal balance
("UPB") of $41.6 billion, compared to approximately 484,000 loans with UPB of
$38.0 billion at December 31, 1994, an increase of $3.6 billion, or 9.5%. The
average servicing volume increased from $33.2 billion in 1994 to $39.3 billion
in 1995, an increase of $6.1 billion or 18.4%. Growth in BBMC's servicing
portfolio was primarily generated by wholesale loan production, which includes
correspondent, co-issue and broker channels. BBMC also purchased servicing
rights in bulk from other mortgage servicing entities. Bulk purchases totalled
$5.5 billion and $0.7 billion in 1994 and 1995, respectively.
17
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996
and now known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
Management's Discussion and Analysis of Financial
Condition and Results of Operations (Continued)
In addition to growth in the servicing portfolio, an increase in late fee income
contributed to the rise in mortgage servicing revenue during 1995. Late fees are
included as a component of mortgage servicing revenue. BBMC instituted efforts
to improve the collection of ancillary fee income during the year which
contributed to an increase in late fee charges collected from $10.5 million in
1994 to $14.4 million in 1995. Late fee income also increased as a result of
increases in BBMC's servicing portfolio size and average loan size. The higher
average loan size translates into higher loan payments on which late fees are
based. There was little or no change in the rate on which late fees were
computed during 1995 as compared to 1994.
During the first quarter of 1996, BBMC had net servicing revenues of $(97.1)
million, as compared to servicing revenues of $24.2 million in the first quarter
of 1995. The net negative amount recorded as servicing revenue in 1996 was
primarily due to losses on BBMC's risk management contracts. Excluding the
effect of risk management contracts, net servicing revenue increased from $20.6
million in the first quarter 1995 to $31.7 million in the first quarter 1996. In
the first quarter of 1995, BBMC recorded gains on risk management contracts of
$3.6 million. Due to an increase in long-term interest rates in late February
and early March 1996, BBMC experienced losses on risk management contracts of
$128.8 million during the quarter. Changes in the value of BBMC's mortgage
servicing rights substantially offset the loss on risk management contracts.
However, such changes in value were not fully recorded in the financial
statements of BBMC because servicing rights were recorded at the lower of
amortized cost or market value.
The decrease in net servicing revenue was partially offset by a reduction in
amortization of mortgage servicing rights from $23.1 million in the first
quarter of 1995 to $7.2 million in the first quarter of 1996. The reduction in
amortization was due to the increase in long-term interest rates noted above,
which had a favorable effect on the prepayment estimates used in calculating
BBMC's periodic amortization expense. Because mortgage servicing rights are
amortized over the expected period of service fee revenues, a reduction in
mortgage prepayment activity typically results in a longer estimated life of the
mortgage servicing asset and, accordingly, lower amortization expense.
Amortization charges are highly dependent upon the level of prepayments during
the period and changes in prepayment expectations, which are significantly
influenced by the direction and level of long-term interest rate movements.
Risk Management Activities
BBMC had a risk management program designed to protect the economic value of its
mortgage servicing portfolio from declines in value due to increases in
estimated prepayment speeds, which are primarily influenced by declines in
interest rates. When loans prepay faster than anticipated, the cash flow BBMC
would expect to receive from servicing such loans was reduced. Because the value
of the mortgage servicing rights is based on the present value of the net cash
flows to be received over the life of the loan, the value of the servicing
portfolio declines as prepayments increase.
Prior to 1994, risk management of the mortgage servicing rights value was
principally conducted by BKB as part of a consolidated risk management program.
Through the third quarter of 1995, BKB continued to manage a portion of the risk
associated with the servicing portfolio.
To implement its risk management objectives, BBMC purchased risk management
contracts that increased in value when long-term interest rates declined, or
when prepayment speeds increased above a specified level. During 1994 and 1995,
BBMC purchased options on long-term United States Treasury bond futures to
protect a significant portion of the market value of its mortgage servicing
portfolio from a decline in value. The value of BBMC's risk management position
was designed to perform inversely with changes in value of mortgage servicing
rights due to the effects of the changes in interest rates. The options were
marked to market at each reporting date with changes in value reported in
revenues. BBMC recognized a gain on risk management contracts of $108.7 million
in 1995. While the value of the servicing portfolio declined, the full effect of
such decline was not reflected in BBMC's financial results because the value of
the associated service rights exceeded its book value. Due to a rising interest
rate environment, BBMC experienced a $6.7 million loss related to its risk
management contracts in 1994.
BBMC recognized a gain on risk management contracts of $108.7 million in 1995,
of which $86.5 million was unrealized. During the first quarter of 1996,
long-term interest rates increased, reversing the declining trend which
prevailed during 1995. As a result, through the date of the sale of BBMC in
March 1996, BBMC recognized a loss on risk management contracts of $128.8
million, which included a reversal of such $86.5 million unrealized gain
recognized during 1995. In 1995 and 1996, changes in the value of BBMC's
mortgage servicing rights substantially offset the gain and loss on the risk
management contracts. However, such changes in value were not fully recorded in
the financial statements of BBMC because servicing rights are recorded at the
lower of amortized cost or market value.
Net Interest Revenue/Expense
Net interest expense was $2.4 million in 1994 and $2.8 million in 1995. Interest
income decreased $7.3 million in 1995 as compared with 1994, primarily as a
result of a decrease in the average rate earned on warehouse loans from 9.52% in
1994 to 7.78% in 1995. The reduction in interest income on warehouse loans was
partially offset by a $2.1 million increase in interest earned on mortgage loans
held for investment. Interest expense decreased $6.8 million in 1995 as compared
with 1994 as a
18
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996
and now known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
result of a decline in the average rate paid on BBMC's borrowings from 7.14% in
1994 to 6.89% in 1995.
Net interest expense decreased from $2.0 million in the first quarter of 1995 to
$1.7 million in the first quarter of 1996. Interest income increased in the
first quarter of 1996 as compared with the first quarter of 1995 as a result of
an increase in the average balance of mortgage loans held for sale from $124.6
million during the first quarter of 1995 to $535.6 million during the first
quarter of 1996. Increased loan production volumes, $4.2 billion in the first
quarter of 1996 compared to $1.2 billion in the first quarter of 1995, created
the increased average balance of mortgage loans held for sale. In addition, an
increase in long-term interest rates during February and March 1996 improved the
yield on its mortgage loans held for sale. Interest expense incurred on BBMC's
credit facility with Bank of Boston increased in the first quarter of 1996 as
compared with the first quarter of 1995 as a result of the increase in the
average balance of BBMC's loans held for sale. In the first quarter of 1996 as
well as the first quarter of 1995, interest earned on loans held for sale was
less than interest expense on borrowings, thereby creating net interest expense
for BBMC; but the increase in long-term interest rates during February and March
1996, without a corresponding increase in short-term rates on BBMC's credit
facility, resulted in a decrease in net interest expense in the first quarter of
1996 as compared with the first quarter of 1995.
Net Mortgage Origination Revenue
Net mortgage origination revenue decreased from $5.0 million in 1994 to $3.4
million in 1995. Lower production volumes and gains on sales of mortgage loans
were the primary reasons for this decline.
Net mortgage origination revenue (expense) increased from $(1.1) million in the
first quarter of 1995 to $7.6 million in the first quarter of 1996. The increase
in net origination revenue during the first quarter of 1996 was partially due to
the adoption of SFAS No. 122, "Accounting for Mortgage Servicing Rights" as of
January 1, 1996, which had the effect of increasing net mortgage origination
revenue by $3.1 million. In previous periods, the cost of mortgage servicing
rights for originated loans was included in the basis of the related loan. SFAS
No. 122 requires that the cost of an originated loan be allocated between the
loan sold and the servicing rights retained. Consequently, the cost basis of
loans originated in 1996 was lower than the basis that would have been recorded
prior to the adoption of SFAS No. 122 and resulted in additional gain on the
sale of loans. The remaining increase was due to increases in origination income
resulting from higher loan production volumes.
Gain on Sales of Servicing Rights
Gain on sales of servicing rights decreased from $10.9 million in 1994 to $10.2
million in 1995. Gains on sales of servicing rights represent the excess of
proceeds from the sale over the cost basis of the assets. Gains tend to be
higher on sales of servicing rights with little or no cost basis, as was the
case for BBMC's sales in 1994. The servicing rights sold during 1994 consisted
primarily of retail originated loans and consequently had relatively low cost
basis. The servicing rights sales in 1995 consisted of a higher percentage of
servicing on purchased loans, which had a higher basis because servicing rights
on purchased loans are capitalized.
Gain on sales of servicing rights during the first quarter of 1995 was $4.3
million. There were no sales of servicing rights during the first quarter of
1996.
Salaries and Employee Benefits
Salaries and employee benefits increased from $40.4 million in 1994 to $45.4
million in 1995, or 12.4%. Including capitalized direct loan origination costs
(principally salary and employee benefits), salaries and employee benefits
increased from $51.5 million to $56.5 million from 1994 to 1995, or 9.7%. The
increase included a $3.9 million increase in salaries and a $1.1 million
increase in benefits and were the result of a larger staff needed to support
BBMC's growing servicing portfolio. The increases in salaries and benefits were
partially offset by the outsourcing of certain default administration and tax
payment administration activities during 1995. BBMC determined that the
performance of these services on a contracted basis was more cost effective than
maintaining the personnel and infrastructure necessary to carry out these
functions in-house.
Salaries and employee benefits decreased from $11.7 million in the first quarter
of 1995 to $10.3 million in the first quarter of 1996, or 12.1%. If capitalized
direct loan origination costs (principally salary and employee benefits) were
included, the salaries and employee benefits increased from $12.8 million in the
first quarter of 1995 to $13.5 million in the first quarter of 1996, or 5.8%.
The increase reflected general salary and benefit increases as compared to the
first quarter of 1995 and a slight increase in the number of full time
equivalent employees from 1,117 as of March 31, 1995 to approximately 1,120 as
of March 15, 1996.
Occupancy and Equipment Expense
Occupancy and equipment expense increased from $9.0 million in 1994 to $10.0
million in 1995, or 11.1%, due primarily to the acquisition of Bell Mortgage and
the larger servicing operations.
19
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996
and now known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
Management's Discussion and Analysis of Financial
Condition and Results of Operations (Continued)
Occupancy and equipment expense decreased $0.4 million, from $2.4 million for
the first quarter of 1995 to $2.0 million for the first quarter of 1996. The
decrease was primarily due to a decline in equipment repair and maintenance
expenses in the first quarter of 1996 as compared to the first quarter of 1995.
Servicing Losses on Investor-Owned Loans
Servicing losses on investor-owned loans primarily represent anticipated losses
attributable to servicing FHA and VA loans for investors. These amounts include
actual losses for final disposition of loans, accrued interest for which payment
has been denied and estimates for potential losses based on experience as a
servicer of government loans. Servicing losses on investor-owned loans totaled
$7.2 million and $10.0 million for 1994 and 1995, respectively, primarily
representing losses on VA loans. In 1994 and 1995, BBMC recorded provisions in
excess of actual foreclosure losses. Management believes that BBMC had an
adequate level of reserve based on its servicing volume, portfolio composition,
credit quality and historical loss rates, as well as estimated future losses.
For an analysis of changes in the reserve for estimated servicing losses on
investor-owned loans for each of the two years ended December 31, 1995, see Note
4 of Notes to Consolidated Financial Statements of BancBoston Mortgage
Corporation.
Servicing losses on investor-owned loans increased from $0.7 million in the
first quarter of 1995 to $5.6 million in the first quarter of 1996. The increase
was primarily due to a change in the VA's method of calculating the amount it
will guarantee on any loan, coupled with planned military base closings in
California that may have an impact on the performance of certain VA loans
serviced by BBMC. The increase in the VA marketing rate effectively represents a
potential increase in BBMC's exposure on properties conveyed to the VA. BBMC
analyzed the effect of these factors on the level of its reserve for estimated
servicing losses and recorded a higher provision in the first quarter of 1996 in
order to bring the reserve to an acceptable level.
Real Estate Owned Expense
Real estate owned expense increased from $0.3 million in 1994 to $1.1 million in
1995. Real estate owned expense is incurred from foreclosed properties on which
BBMC has taken title and includes declines in the value of the property, as well
as the incurrence of property holding and maintenance costs. The change in real
estate owned expense in 1995 was due primarily to an increase in the average
balance of real estate owned from $1.4 million in 1994 to $1.6 million in 1995.
As part of the BBMC Acquisition, BKB retained all real estate owned.
Real estate owned expense increased from $0.2 million in the first quarter of
1995 to $0.3 million in the first quarter of 1996. The change was due to an
increase in the average balance of real estate owned from $1.2 million during
the first quarter of 1995 to $2.6 million during the first quarter of 1996.
Other Expenses
Other expenses increased from $19.3 million to $21.9 million, or 13.3%, from
1994 to 1995. The increase in other expenses from 1994 to 1995 included
increases of $1.1 million in advertising and public relations, $1.0 million in
contracted services, $0.9 million in software costs and $0.6 million in
communication expenses. These increases were partially offset by a $0.7 million
reduction in loan-related expenses. The increase in advertising and public
relations expense was due to a major advertising campaign carried out during
1995 in addition to normal advertising activity. Contracted services increased
due to an increase in bank service charges for loan payment processing, which
also increased with the larger BBMC servicing volume. Software costs increased
as BBMC continued to expand and redesign its computer platform in order to
deliver more efficient and reliable service. The increase in communications
expense was due to higher telephone postage and delivery expenses resulting from
higher loan production levels.
Other expense increased $2.7 million, from $4.7 million during the first quarter
of 1995 to $7.4 million in the first quarter of 1996. The increase was the
result of a $0.5 million increase in communications expense and a $0.4 million
increase in loan expense, coupled with a decrease in expense credits resulting
from a decline in early pool buyout activity in 1996. These increases are
reflective of the increase in BBMC's servicing portfolio, $44.2 billion at March
31, 1996 as compared to $37.8 billion at March 31, 1995, and higher loan
production levels in the first quarter of 1996 as compared to the first quarter
of 1995.
Provision for (Benefit from) Income Taxes
BBMC recorded a provision for income taxes of $2.5 million and $37.9 million for
1994 and 1995, respectively. The effective income tax rate was 39.2% and 56.4%
for 1995 and 1994, respectively. The difference between these rates and the
statutory federal tax rate was primarily due to state income taxes, net of
federal tax benefit. The changes in the provisions for, and benefit from, income
taxes were the result of variances in BBMC's pre-tax income and loss for each of
the years presented. For additional information regarding income taxes, refer to
Note 10 of Notes to Consolidated Financial Statements of BancBoston Mortgage
Corporation on pages 47 and 48.
BBMC's benefit from income taxes was $42.5 million during the first quarter of
1996 as compared to a provision for income taxes of $2.3 million in the first
quarter of 1995. The change in BBMC's income tax provision was the result of a
decline in pre-tax income during the first quarter of 1996 as compared to the
first quarter of 1995, and a decrease in the effective tax rate from 39.9%
during the first quarter of 1995 to 36.5% during the first quarter of 1996.
20
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996
and now known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
Accounting Changes
On January 1, 1994, BBMC changed its method of accounting for mortgage servicing
fees from the cash basis to the accrual basis. See Note 2 of Notes to
Consolidated Financial Statements of BancBoston Mortgage Corporation on page 45
for further discussion of BBMC's accounting changes. See "--Liquidity and
Capital Resources--New Accounting Standard" for a discussion of Statement of
Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing
Rights," which was adopted by BBMC in 1996.
Liquidity and Capital Resources
Overview
BBMC's primary sources of cash were revenues earned from the servicing of
mortgage loans, sales of mortgage loans and servicing rights and borrowings
under BBMC's warehouse line of credit. BBMC's primary uses of cash were to fund
loan originations and purchases, purchase bulk servicing rights, repay its
warehouse line of credit and pay general corporate expenses. BBMC had a net
increase (decrease) in cash of ($4.8 million) and $0.3 million in 1995 and 1994,
respectively, and ($4.4 million) and $22.4 million in the first quarter of 1995
and the first quarter of 1996, respectively.
The net decrease in cash in 1995 compared with 1994 was primarily attributable
to the use of cash to meet growth in loan origination volume and purchases of
mortgage servicing rights, coupled with a reduction in proceeds on sales of
mortgage loans. Declining interest rates in 1995 increased loan production
across the industry. Cash inflows in 1995 were positively affected by an
increase in the proceeds from risk management contracts, which increased in
value as a result of the decline in interest rates.
Prior to the BBMC Acquisition, a line of credit with Bank of Boston was used to
fund the origination and purchase of mortgage loans until the loans were sold to
investors. The proceeds of such sales were typically used to pay down the
related warehouse debt, with any excess retained by BBMC. Maximum borrowings
under the line of credit were $1.25 billion. The higher level of borrowings in
1995 was indicative of higher loan production and purchase volumes during that
year as compared to 1994.
Net cash provided by operating activities and investing activities decreased in
the first quarter of 1996 as compared with the first quarter of 1995,
principally as a result of an increase in net cash used in the origination and
purchase of loans held for sale and in the purchase and origination of mortgage
servicing rights and the purchase of risk management contracts. These increases
were the result of higher loan production levels and an increasing loan
servicing portfolio. As a result of increased loan production and held for sale
balances in the first quarter of 1996 as compared to the first quarter of 1995,
BBMC had net borrowings of $290.0 million on its line of credit with Bank of
Boston during the first quarter of 1996, as opposed to net repayments of $130.5
million on the line of credit during the first quarter of 1995.
Impact of Inflation
Inflation affects BBMC primarily through its effect on interest rates because
interest rates normally increase during periods of high inflation and decrease
during periods of low inflation.
New Accounting Standard
In May 1995, FASB issued SFAS No. 122, "Accounting for Mortgage Servicing
Rights." This Statement, among other provisions, requires that the value of
mortgage servicing rights associated with mortgage loans originated by an entity
be capitalized as assets, which results in an increase in mortgage origination
revenues. The value of originated mortgage servicing rights is determined by
allocating the total costs of the mortgage loans between the loans and the
mortgage servicing rights based on their relative fair values. Also, the
Statement requires that capitalized servicing rights be evaluated for impairment
based on the fair value of these rights. For the purposes of determining
impairment, mortgage servicing rights that are capitalized after the adoption of
this Statement are stratified based on one or more of the predominant risk
characteristics of the underlying loans. Impairment is recognized through a
valuation allowance for each impaired stratum. BBMC adopted this Statement
effective January 1, 1996.
21
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996
and now known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
Consolidated Balance Sheet
(Dollars in Thousands, Except Share Data)
<TABLE>
<CAPTION>
Februay 28, 1997
----------------
ASSETS
<S> <C>
Cash and cash equivalents .......................................................................... $ 52,691
Mortgage loans held for sale, net .................................................................. 805,274
Mortgage servicing rights, net ..................................................................... 1,614,307
Accounts receivable, net ........................................................................... 157,518
Premises and equipment, net ........................................................................ 29,515
Other assets ....................................................................................... 92,877
-----------
Total Assets ....................................................................................... $ 2,752,182
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable ...................................................................................... $ 1,818,503
Accounts payable and accrued liabilities ........................................................... 140,304
Deferred income taxes .............................................................................. 129,951
Long-term debt ..................................................................................... 151,128
-----------
Total Liabilities .................................................................................. 2,239,886
-----------
Commitments and Contingencies
Stockholders' Equity:
Common stock, $.01 par value, 119,610,000 shares authorized and 43,375,430 shares
issued and outstanding ......................................................................... 434
Class C non-voting common stock, $1.00 par value, 195,000 shares authorized, and 97,138 shares
issued and outstanding ......................................................................... 97
Additional paid-in capital ....................................................................... 476,646
Retained earnings ................................................................................ 36,969
-----------
514,146
Less: Notes received in payment for capital stock .................................................. (1,850)
-----------
Total Stockholders' Equity ......................................................................... 512,296
-----------
Total Liabilities and Stockholders' Equity ......................................................... $ 2,752,182
===========
</TABLE>
The accompanying notes are an integral part of this consolidated financial
statement.
22
HomeSide, Inc.
<PAGE>
Consolidated Statement of Income
(Dollars in Thousands, Except Per Share Data)
<TABLE>
<CAPTION>
For the Period From
March 16, 1996 to
February 28, 1997
-----------------
<S> <C>
REVENUES:
Mortgage servicing fees .................................................................. $ 312,341
Amortization of mortgage servicing rights ................................................ (155,827)
-----------
Net servicing revenue .................................................................. 156,514
Interest income .......................................................................... 81,507
Interest expense ......................................................................... (87,700)
-----------
Net interest expense ................................................................... (6,193)
Net mortgage origination revenue ......................................................... 66,073
Other income ............................................................................. 682
-----------
Total Revenues ......................................................................... 217,076
EXPENSES:
Salaries and employee benefits ........................................................... 72,976
Occupancy and equipment .................................................................. 11,770
Servicing losses on investor-owned loans and foreclosure-related expenses ................ 17,934
Other expenses ........................................................................... 41,714
-----------
Total Expenses ......................................................................... 144,394
Income before income taxes and extraordinary loss on early extinguishment of debt ........ 72,682
Income tax expense ....................................................................... 29,273
-----------
Income before extraordinary loss on early extinguishment of debt ......................... 43,409
Extraordinary loss on early extinguishment of debt, net of tax ........................... 6,440
-----------
Net Income ............................................................................... $ 36,969
===========
Income Per Share:
Income before extraordinary loss on early extinguishment of debt ....................... $ 1.33
Extraordinary loss, net of tax ......................................................... 0.20
-----------
Net Income ............................................................................. $ 1.13
===========
</TABLE>
The accompanying notes are an integral part of this consolidated financial
statement.
23
HomeSide, Inc.
<PAGE>
Consolidated Statement of Changes in Stockholders' Equity
(Dollars in Thousands)
<TABLE>
<CAPTION>
Notes
Total Common Stock Additional Received in
Number of ------------------------- Subscription Paid-in Payment for Retained
Shares(d) Class A Class B Class C Receivable Capital Capital Stock Earnings Total
--------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance,
March 15, 1996(a) .... 19,457,724 $193 $-- $97 $(200,000) $199,710 $ -- $ -- $ --
Subscription payment
associated with
acquisition of
BancBoston Mortgage
Corporation .......... 200,000 (1,850) 198,150
Issuance of common
stock associated
with acquisition of
Barnett Mortgage
Company(b) ........... 15,562,344 156 160,135 160,291
Public offering of
common stock(c) ...... 8,452,500 85 116,801 116,886
Net income ............. 36,969 36,969
--------------------------------------------------------------------------------------------------------
Balance,
February 28, 1997 .... 43,472,568 $434 $-- $97 $ -- $476,646 $(1,850) $36,969 $512,296
========================================================================================================
</TABLE>
(a) Total number of shares includes 19,263,448 shares of Class A common stock
(par value $.01), 97,138 shares of Class B common stock (par value $.01)
and 97,138 shares of Class C common stock (par value $1.00).
(b) Total number of shares includes 15,562,344 shares of Class A common stock.
(c) Total number of shares includes 8,452,500 shares of Class A common stock of
which 97,138 shares of Class B common stock were converted to Class A on a
1-for-1 basis.
(d) Number of shares reflects a 17-for-1 stock split resulting from the initial
public offering.
The accompanying notes are an integral part of this consolidated financial
statement.
24
HomeSide, Inc.
<PAGE>
Consolidated Statement of Cash Flows
(Dollars in Thousands)
<TABLE>
<CAPTION>
For the Period From
March 16, 1996 to
February 28, 1997
-----------------
<S> <C>
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income ................................................................................ $ 36,969
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of mortgage servicing rights ............................................... 155,827
Depreciation and amortization ........................................................... 9,015
Servicing losses on investor-owned loans ................................................ 13,683
Deferred income tax expense ............................................................. 24,973
Capitalized servicing rights ............................................................ (21,015)
Mortgage loans originated and purchased for sale ........................................ (12,504,567)
Proceeds and principal repayments of mortgage loans held for sale ....................... 12,572,217
Change in accounts receivable ........................................................... (63,378)
Change in other assets and accounts payable and accrued liabilities ..................... (19,900)
-----------
Net cash provided by operating activities ................................................. 203,824
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of premises and equipment, net ................................................... (4,929)
Acquisition of mortgage servicing rights .................................................. (475,729)
Purchases of risk management contracts, net ............................................... (141,944)
Acquisition of BancBoston Mortgage Corporation, net of cash acquired ...................... (133,392)
Acquisition of Barnett Mortgage Company, net of cash acquired ............................. (106,244)
-----------
Net cash used in investing activities ..................................................... (862,238)
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Net borrowings from banks ................................................................. 334,170
Issuance of bridge financing .............................................................. 90,000
Repayment of bridge financing ............................................................. (90,000)
Issuance of Notes ......................................................................... 200,000
Payment of debt issue costs ............................................................... (22,090)
Repayment of long-term debt ............................................................... (70,567)
Proceeds from issuance of common stock .................................................... 269,592
-----------
Net cash provided by financing activities ................................................. 711,105
Net increase in cash and cash equivalents ................................................. 52,691
Cash and cash equivalents at beginning of period .......................................... --
-----------
Cash and cash equivalents at end of period ................................................ $ 52,691
===========
</TABLE>
The accompanying notes are an integral part of this consolidated financial
statement.
25
HomeSide, Inc.
<PAGE>
Notes to Consolidated Financial Statements
1. BASIS OF PRESENTATION
HomeSide, Inc. ("HomeSide" or the "Company"), through its primary operating
subsidiary HomeSide Lending, Inc., is engaged in the mortgage banking business
and as such originates, purchases, sells and services mortgage loans throughout
the United States. The accompanying consolidated financial statements of
HomeSide include the accounts of HomeSide and its subsidiaries, after
elimination of all material intercompany balances and transactions. Amounts for
acquired companies have been included from the date of acquisition.
The accompanying consolidated financial statements of HomeSide have been
prepared for the period from March 16, 1996 to February 28, 1997 to coincide
with the commencement of operations as discussed in Note 2. The carrying amounts
of assets and liabilities in the accompanying consolidated financial statements
reflect the effects of the purchase accounting adjustments made in connection
with the acquisition of BancBoston Mortgage Corporation ("BBMC") and Barnett
Mortgage Company ("BMC").
2. ORGANIZATION
On December 11, 1995, HomeSide was formed by an investor group, consisting of
Thomas H. Lee Company and Madison Dearborn Partners (collectively, the
"Investors"), and signed a definitive stock purchase agreement with The First
National Bank of Boston ("Bank of Boston") for the purpose of acquiring certain
assets and liabilities of the mortgage banking business owned by Bank of Boston.
Bank of Boston received cash and an ownership interest in HomeSide. The
transaction closed on March 15, 1996 and HomeSide began operations on March 16,
1996 through its primary operating subsidiary, HomeSide Lending, Inc.
On May 31, 1996, Barnett Banks, Inc. ("Barnett") sold certain of its mortgage
banking operations, primarily its servicing portfolio, mortgage servicing
operations and proprietary mortgage banking software systems, to HomeSide.
Barnett received cash and an ownership interest in HomeSide. The accompanying
financial statements reflect the effects of the acquisitions of BBMC and BMC.
For more information on these acquisitions, see Note 4. From May 31, 1996 until
the 1997 public offering of common stock, the Investors as a group, Bank of
Boston and Barnett each owned approximately one-third of HomeSide. Following the
public offering, the Investors as a group, Bank of Boston and Barnett own in the
aggregate approximately 79% of the outstanding common stock.
3. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Risk management of mortgage loan originations
HomeSide utilizes a risk management program to protect and manage the value of
its mortgage loans held for sale and mortgage commitment pipeline. As a result,
the Company is party to various derivative financial instruments to reduce its
exposure to interest rate risk. These financial instruments primarily include
mandatory forward delivery commitments, put and call option contracts and
treasury futures contracts. The Company uses these financial instruments for the
purposes of managing its resale pricing and interest rate risks. These financial
instruments are designated as hedges to the extent they demonstrate a high
degree of correlation with the underlying hedged items. Accordingly, hedging
gains and losses related to this risk management program are deferred and
recognized as a component of the gain or loss on sale of the underlying mortgage
loans or mortgage-backed securities. Such gains and losses are included in net
mortgage origination revenue. Hedge losses are recognized currently if the
deferral of such losses would result in mortgage loans held for sale and the
pipeline being valued in excess of their estimated net realizable value.
Premiums paid for purchased put and call option contracts are included in other
assets and amortized over the options' contract periods as a component of net
mortgage origination revenue. Unamortized premiums are recognized as a component
of the gain or loss on sale of mortgage loans at the earlier of the expiration
of the underlying contract or when exercise of the contract is considered
unlikely.
Risk management of mortgage servicing rights
Mortgage servicing rights permit HomeSide to receive a portion of the interest
coupon and fees collected from the mortgagor for performing specified servicing
activities. The mortgage notes underlying the mortgage servicing rights permit
the borrower to prepay the loan. As a result, the value of the related mortgage
servicing rights tends to diminish in periods of declining interest rates and
increase in value in periods of rising rates. This tendency subjects HomeSide to
substantial interest rate risk and directly affects the volatility of reported
earnings as mortgage servicing rights are carried at the lower of amortized cost
or fair value. It is HomeSide's policy to mitigate and hedge this risk through
its risk management program.
26
HomeSide, Inc.
<PAGE>
Notes to Consolidated Financial Statements (Continued)
The risk management instruments used by HomeSide have characteristics such that
they tend to increase in value as interest rates decline. Conversely, these risk
management instruments tend to decline in value as interest rates rise.
Accordingly, changes in value of these contracts will tend to move inversely
with changes in value of mortgage servicing rights.
Historically, option contracts on U.S. Treasury bond futures have been purchased
by HomeSide to manage interest rate risk. When purchased, the option contracts
are designated to a specific strata of mortgage servicing rights. The option
contracts are marked-to-market with changes in market value included as
adjustments to the basis of the related mortgage servicing rights being hedged.
Deferred hedge gains and losses are amortized and evaluated for impairment in
the same manner as the related mortgage servicing rights. Correlation between
changes in the value of the option contracts and changes in the value of
HomeSide's mortgage servicing rights is assessed on a quarterly basis to ensure
that a high correlation is maintained over the term of the hedging program.
Mortgage loans
Mortgage loans held for sale are carried at the lower of aggregate cost or fair
value. Fair value is based on the contract prices at which the mortgage loans
will be sold or, if the loans are not committed for sale, the current market
price. Deferred hedge gains and losses on risk management hedge instruments are
included in the cost of the mortgage loans held for sale for the purpose of
determining the lower of aggregate cost or fair value.
Mortgage loans held for investment are stated at the lower of cost or fair value
at the time the permanent investment decisions are made. Discounts, if any, are
amortized over the anticipated life of the investment.
Loans are placed on non-accrual status when any portion of the principal or
interest is ninety days past due or earlier when concern exists as to the
ultimate collectibility of principal or interest. When loans are placed on
nonaccrual status, the related interest receivable is reversed against interest
income in the current period. Interest payments received on nonaccrual loans are
applied as a reduction of the principal balance when concern exists as to the
ultimate collection of principal; otherwise, such payments are recognized as
interest income. Loans are removed from nonaccrual status when principal and
interest become current and they are anticipated to be fully collectible.
Mortgage servicing rights
From the period of inception through December 31, 1996, mortgage servicing
rights were capitalized and accounted for in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 122, "Accounting for Mortgage
Servicing Rights." The total cost of loans originated or acquired is allocated
between the mortgage servicing rights and the mortgage loans (without the
servicing rights) based on relative fair values. The value of servicing rights
acquired through bulk transactions is capitalized at cost.
Effective January 1, 1997, the Company adopted SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
SFAS No. 125 supersedes SFAS No. 122 and is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
December 31, 1996. SFAS No. 125 is based on a financial-components approach
which focuses on control. Under the approach required by this Standard, after a
transfer of financial assets (for example, the sale of mortgage loans), 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. The capitalization,
amortization and impairment principles of SFAS No. 125 are substantially
consistent with the principles previously defined by SFAS No. 122, insofar as
they relate to the mortgage banking activities of HomeSide. Accordingly, the
impact of adopting SFAS No. 125 was not material to the Company's financial
statements.
Mortgage servicing rights are amortized in proportion to and over the period of
estimated net servicing revenue. They are evaluated for impairment by comparing
the carrying amount of the servicing rights to their fair value. Fair value is
estimated using market prices of similar mortgage servicing assets and
discounted future net cash flows considering market prepayment estimates,
historical prepayment rates, portfolio characteristics, interest rates and other
economic factors. For purposes of measuring impairment, the mortgage servicing
rights are stratified by the predominant risk characteristics which include
product types of the underlying loans and interest rates of the mortgage notes.
Impairment is recognized through a valuation reserve for each impaired stratum
and is included in amortization of mortgage servicing rights. The components of
HomeSide's mortgage servicing rights are included in Note 5.
Prior to January 1, 1997, mortgage servicing rights included excess mortgage
servicing rights, which represent the present value of servicing fee income in
excess of a normal servicing fee rate. Until the adoption of SFAS No. 125 on
January 1, 1997, when loans were sold, the estimated excess servicing was
recognized as income and amortized over the estimated servicing period in
proportion to the estimated future aggregate net cash flows from the loans
serviced. Remaining asset balances were evaluated for impairment based on
current estimates of future discounted cash flows. Such writedowns were included
in amortization of mortgage servicing rights. Upon the adoption of SFAS No. 125,
previously recognized excess mortgage servicing rights were combined with and
accounted for as mortgage servicing rights.
Accounts receivable
Accounts receivable includes advances, consisting primarily of payments for
property taxes, insurance premiums and principal and interest remitted to
investors before collected from mortgagors, made in connection with loan
servicing activities. Accounts receivable also includes loans purchased from
27
HomeSide, Inc.
<PAGE>
mortgage-backed securities serviced by HomeSide for others and mortgage claims
filed primarily with the FHA and the VA.
Premises and equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets. Leasehold improvements are amortized over the lesser
of the estimated life of the improvement or the term of the lease.
Long-lived assets are evaluated regularly for other-than-temporary impairment.
If circumstances suggest that their value may be impaired and the write-down
would be material, an assessment of recoverability is performed prior to any
write-down of the asset. Impairment, if any, is recognized through a valuation
allowance with a corresponding charge recorded in the statement of income.
Goodwill
Net assets acquired in purchase transactions (Note 4) are recorded at fair value
at the date of acquisition. Goodwill, representing the excess of the purchase
price over the fair value of the net assets purchased, is amortized on a
straight-line basis over 15 years. Goodwill is reviewed periodically for events
or changes in circumstances that may indicate that the carrying amounts of the
assets are not recoverable on an undiscounted cash flow basis.
Goodwill related to the BMC acquisition is subject to change until final
estimates are received on the value of certain assumed assets and liabilities
and final settlement with Barnett.
Mortgage servicing fees
Mortgage servicing fees represent servicing and other fees earned for servicing
mortgage loans owned by investors. Servicing fees are generally calculated on
the outstanding principal balances of the loans serviced and are recognized as
income on an accrual basis.
HomeSide's mortgage servicing portfolio totaled $90.2 billion at February 28,
1997. Related custodial deposits are segregated in trust accounts, principally
held with depository institutions, and are not included in the accompanying
financial statements.
Interest expense
Interest expense is reduced by credits received on borrowings with depository
institutions for custodial balances placed with such institutions.
Net mortgage origination revenue
Net mortgage origination revenue includes gains and losses from sales of
mortgage loans and fees associated with the origination and purchase of mortgage
loans.
Servicing losses on investor-owned loans and foreclosure-related expenses
HomeSide records losses attributable to servicing FHA and VA loans for
investors. These amounts include actual losses for final disposition of loans,
foreclosure-related expenses, accrued interest for which payment has been denied
and estimates for potential losses based on HomeSide's experience as a servicer
of government loans.
A reserve for estimated servicing losses on investor-owned loans is available
for potential losses related to the mortgage servicing portfolio and is included
in accounts payable and accrued
liabilities.
Income taxes
Current tax liabilities or assets are recognized through charges or credits to
the current tax provision for the estimated taxes payable or refundable for the
current year.
Deferred tax liabilities are recognized for temporary differences that will
result in amounts taxable in the future and deferred tax assets are recognized
for temporary differences and tax benefit carryforwards that will result in
amounts deductible or creditable in the future. Net deferred tax liabilities or
assets are recognized through charges or credits to the deferred tax provision.
A deferred tax valuation reserve is established if it is more likely than not
that all or a portion of the deferred tax assets will not be realized. Changes
in the deferred tax valuation reserve are recognized through charges or credits
to the deferred tax provision.
The effect of enacted changes in tax law, including changes in tax rates, on
deferred tax assets and liabilities is recognized in income in the period that
includes the enactment date.
Statement of Cash Flows
For purposes of reporting on the statement of cash flows, cash and cash
equivalents include cash and due from banks and interest-bearing deposits with
an original maturity of three months or less.
Income per Share
Income per share amounts were computed based on the weighted average total
number of common shares outstanding, plus common shares calculated for stock
options outstanding using the treasury stock method. There were 32,687,780
common shares outstanding for the period from March 16, 1996 to February 28,
1997.
4. ACQUISITIONS
Acquisition of BancBoston Mortgage Corporation
On March 15, 1996, HomeSide acquired from Bank of Boston all of the outstanding
stock of BBMC, which was subsequently renamed HomeSide Lending, Inc. Certain
assets and liabilities of BBMC were retained by Bank of Boston, including BBMC's
mortgage retail production operations in New England.
HomeSide made cash payments of $139.5 million in cash and issued $86.8 million
of HomeSide common stock to Bank of Boston in consideration for certain assets,
net of assumed liabilities, and the stock of BBMC. Also in connection with the
BBMC acquisition, the Investors purchased approximately 55% of the then
outstanding common stock of HomeSide for $107.2
28
HomeSide, Inc.
<PAGE>
Notes to Consolidated Financial Statements (Continued)
million in cash. Simultaneously, Bank of Boston paid approximately $1.0 million
in cash for all the shares of HomeSide's class C non-voting common stock. In
consideration of services rendered to HomeSide with respect to the BBMC
Acquisition, class B non-voting stock valued at $1.0 million was issued to an
investment bank. Management purchased common stock for $4.1 million in cash,
$1.9 million of which was financed by loans from HomeSide. On May 31, 1996,
HomeSide paid an additional $5 million to Bank of Boston in connection with the
closing of the BMC acquisition. The transaction was accounted for using the
purchase method of accounting. The assets and liabilities of BBMC were recorded
at their estimated fair values at March 16, 1996, which totaled $1.5 billion and
$1.2 billion, respectively. The total purchase price paid for BBMC, including
transaction costs and interest, was $247.0 million. The excess of fair value of
net assets acquired over the purchase price was $56.0 million and was allocated
as a reduction to mortgage servicing rights.
Acquisition of Barnett Mortgage Company
On May 31, 1996, HomeSide acquired from Barnett certain assets, net of assumed
liabilities, and the outstanding common stock of BMC (the "BMC Acquisition").
Certain assets and liabilities of BMC were retained by Barnett, including those
assets of BMC associated with the loan origination or production activities.
HomeSide made cash payments of $228.0 million to Barnett in consideration for
certain assets, net of assumed liabilities, and the stock of BMC. In connection
with the BMC Acquisition, an affiliate of Barnett purchased shares of HomeSide
common stock for an aggregate purchase price of $118.0 million. Also in
connection with the BMC acquisition, Bank of Boston and the Investors paid
approximately $42.3 million in cash for additional shares of HomeSide. The
transaction was accounted for using the purchase method of accounting and,
accordingly, the results of operations of HomeSide include BMC from the date of
acquisition. The assets and liabilities of BMC were recorded by HomeSide at
their estimated fair values at May 31, 1996, which totaled $764.8 million and
$521.4 million, respectively. The total purchase price paid for BMC, including
transaction costs and interest, was $235.0 million. The excess of the purchase
price over the fair value of net assets acquired was $8.4 million and was
allocated to goodwill and is being amortized on a straight-line basis over 15
years.
Unaudited pro forma statements of income for the year ended December 31, 1995
(the fiscal year end of BBMC and BMC), assuming BBMC and BMC had been acquired
as of January 1, 1995, and the period from March 16, 1996 to February 28, 1997,
assuming BMC had been acquired as of March 16, 1996 are as follows (in millions,
except per share data):
Pro Forma for
Pro Forma for the Period From
the Year Ended March 16, 1996 to
December 31, 1995 February 28, 1997
------------------------------------
Net servicing revenue .................... $ 235.1 $ 167.3
Net interest revenue ..................... 17.9 (4.5)
Net mortgage
origination revenue .................... 0.7 67.1
Other income ............................. 0.7 0.7
------------------------------------
Total revenues ....................... 254.4 230.6
Expenses ................................. (142.7) (157.5)
------------------------------------
Income before income taxes
and extraordinary loss ................. 111.7 73.1
Income tax expense ....................... (45.7) (29.5)
------------------------------------
Income before
extraordinary loss ..................... 66.0 43.6
Extraordinary loss ....................... -- 6.4
------------------------------------
Net income ........................... $ 66.0 $ 37.2
====================================
Net income per share ..................... -- $ 1.13
The purchase accounting adjustments in the above pro forma statements of income
are based on the actual purchase price and the amount of assets and liabilities
actually acquired. In addition, gains on sales of mortgage servicing rights are
not included in pro forma results for the year ended December 31, 1995. No
adjustments have been made for restructuring costs that might have been incurred
or for cost efficiencies that might have been realized during the periods
presented. Accordingly, these pro forma results are not indicative of future
results.
5. MORTGAGE SERVICING RIGHTS
The components of mortgage servicing rights are as follows (in thousands):
February 28,
1997
-----------
Additions, including BBMC and BMC acquisitions .............. $ 1,685,242
Sales of servicing .......................................... (25,745)
Deferred hedge loss, net .................................... 110,637
Amortization ................................................ (155,827)
-----------
Ending balance .............................................. $ 1,614,307
===========
Net deferred hedge loss of $110.6 million consists of gains of $133.3 million
and losses of $254.9 million, less $11.0 million of amortization recognized as a
component of amortization of mortgage servicing rights.
29
HomeSide, Inc.
<PAGE>
6. PREMISES AND EQUIPMENT
Premises and equipment consist of the following (in thousands):
February 28,
1997
------------
Land ....................................................... $ 3,451
Building ................................................... 10,986
Furniture and equipment .................................... 15,739
Leasehold improvements ..................................... 3,808
--------
33,984
Accumulated depreciation and amortization .................. (4,469)
--------
Ending balance ............................................. $ 29,515
========
7. RESERVE FOR ESTIMATED SERVICING LOSSES ON INVESTOR-OWNED LOANS
An analysis of the reserve for estimated servicing losses on investor-owned
loans is as follows (in thousands):
For the
Period From
March 16, 1996 to
February 28, 1997
-----------------
Beginning balance, assumed from BBMC ....................... $ 11,100
Provision for servicing losses on
investor-owned loans ..................................... 13,683
Charge-offs ................................................ (10,295)
Recoveries ................................................. 60
Additions from acquisition of BMC .......................... 7,102
--------
Ending balance ............................................. $ 21,650
========
8. NOTES PAYABLE
Notes payable consist of the following (dollars in thousands):
Weighted Average
Interest Rate
---------------------------------
At At
February 28, February 28, During
1997 1997 the Period
--------------------------------------------------
Bank line of credit ....... $1,778,496 5.65% 5.83%
Short-term
credit facilities ....... 40,007 8.25% 8.25%
-------------
$ 1,818,503
=============
HomeSide borrows funds on a demand basis from an independent syndicate of banks
under a $2.5 billion line of credit. Under certain circumstances set forth in
the bank line of credit agreement, borrowings under such line of credit become
collateralized by substantially all of HomeSide's assets. The bank line of
credit is used to provide funds for HomeSide's business of originating,
acquiring and servicing mortgage loans. The bank line of credit includes both a
warehouse credit facility, which is limited to 98% of the fair value of eligible
mortgage loans held for sale, and a servicing-related facility which is capped
at $950.0 million. At February 28, 1997, $943.1 million outstanding is due on
February 14, 2000 at which time the bank line of credit will terminate. The bank
line of credit agreement contains covenants that impose limitations and
restrictions on HomeSide, including the maintenance of certain net worth and
ratio requirements. Amounts outstanding under the bank line of credit are
comprised of a warehouse credit facility of $835.4 million and a
servicing-related credit facility of $943.1 million. The amount of the unused
bank line of credit was $721.5 million as of February 28, 1997.
During the period from March 16, 1996 to February 28, 1997, the maximum and
average outstanding balances under the bank line of credit were $2.4 billion and
$2.1 billion, respectively.
On January 15, 1997, HomeSide entered into a short-term credit facility with a
bank in a maximum aggregate principal amount of $85.0 million. On March 14,
1997, HomeSide entered into another short-term credit facility in an aggregate
principal amount of $100.0 million. These facilities each expire on the earlier
of May 1, 1997, or the consummation of the initial sale of medium-term debt
securities. On February 5, 1997, HomeSide Lending, Inc. filed a registration
statement for the issuance of $1.0 billion of debt securities, including
medium-term notes.
Drawings under the bank line of credit bear interest at rates per annum, based
on, at HomeSide's option (A) the highest of (i) the lead bank's prime rate, (ii)
the secondary market rate of certificates of deposit plus 100 basis points and
(iii) the federal funds rate in effect from time to time plus 0.5% or (B) a
eurodollar rate.
Drawings under the short-term facilities bear interest at the greater of (i) the
lead bank's prime rate, (ii) the secondary market rate for certificates of
deposit (grossed up for maximum statutory requirements) plus 1% and (iii) the
federal funds effective rate from time to time plus 0.5%.
9. LONG-TERM DEBT
On May 14, 1996, HomeSide issued $200.0 million of 11.25% notes ("Notes")
maturing on and payable in full on May 15, 2003 and paying interest semiannually
in arrears on May 15 and November 15 of each year. The Notes are redeemable at
the option of HomeSide, in whole or in part, at any time on or after May 15,
2001, at certain pre-set redemption prices. The indenture contains covenants
that impose limitations and restrictions on HomeSide, including the maintenance
of certain net worth and ratio requirements. In addition, the Notes are secured
by a second priority pledge of the common stock of HomeSide. HomeSide is in
compliance with all net worth and ratio requirements contained in the indenture
relating to the notes.
On February 5, 1997, HomeSide issued 8,452,500 shares of common stock to the
public at $15.00 per share. A portion of the proceeds from the offering was used
to pre-pay $70.0 million of the Notes at a premium of $7.9 million. In
connection with the early repayment of the Notes, HomeSide wrote off a portion
of the unamortized debt issuance costs related to the Notes and
30
HomeSide, Inc.
<PAGE>
Notes to Consolidated Financial Statements (Continued)
incurred a prepayment penalty equal to one year's interest on the Notes retired.
The loss amounted to $6.4 million, net of tax, and was recorded as an
extraordinary item. The remaining proceeds were used to reduce amounts
outstanding under the bank line of credit.
HomeSide assumed a mortgage note payable that is due in 2017 and bears interest
at a contractual rate of 9.50%. HomeSide's main office building is pledged as
collateral. Principal payments due on the mortgage note payable are as follows
(in thousands):
Fiscal Year
- --------------------------------------------------------------------
1998 ................................................... $ 232
1999 ................................................... 256
2000 ................................................... 281
2001 ................................................... 309
2002 ................................................... 340
Thereafter ............................................. 12,169
Unamortized purchase accounting premium ................ 7,541
--------
$ 21,128
========
10. INCOME TAXES
The Company files a consolidated federal income tax return. All companies
included in the consolidated federal income tax return are jointly and severally
liable for any tax assessments based on such
consolidated return.
Components of the provision for income taxes before the effect of the tax
benefit associated with the early extinguishment of debt were as follows (in
thousands):
For the
Period From
March 16, 1996 to
February 28, 1997
-----------------
Current:
Federal ............................................. $ --
State ............................................... --
--------
Deferred:
Federal ............................................. 23,756
State ............................................... 5,517
--------
$29,273
========
The following is a reconciliation of the statutory federal income tax rate to
the effective income tax rate as reflected in the consolidated statement of
income:
For the
Period From
March 16, 1996 to
February 28, 1997
-----------------
Statutory federal income tax rate ..................... 35.0%
State income and franchise taxes,
net of federal tax effect ........................... 5.0
--------
Effective income tax rate ......................... 40.0%
========
The extraordinary loss on the early extinguishment of debt is stated net of the
related tax benefit of $4.3 million at an effective tax rate of 40%.
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are presented below (in
thousands):
February 28, 1997
-----------------
Deferred tax assets:
Net operating and capital loss
carryforwards ................................. $ 53,355
Loss reserves ................................... 17,563
Other assets .................................... 12,087
--------
Total gross deferred tax assets ............... 83,005
--------
Deferred tax liabilities:
Mortgage servicing fees ......................... 207,278
Other liabilities ............................... 5,678
--------
Total gross deferred tax liabilities .......... 212,956
--------
Net deferred tax liability .................... $129,951
========
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which these temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies in making this assessment. No valuation allowance
was recorded as of February 28, 1997.
The Company had consolidated tax net operating loss and capital loss
carryforwards at February 28, 1997. These carryovers expire in the years 2002
and 2012.
11. LEASE COMMITMENTS
HomeSide leases office facilities and equipment under noncancelable leases that
include renewal options and escalation clauses which extend into 2001. Rental
expense for office facilities and equipment leases was $3.9 million for the
period from March 16, 1996 to February 28, 1997. HomeSide's minimum future lease
commitments are as follows (in thousands):
Fiscal Year
- --------------------------------------------------------------------
1998 .................................................... $2,015
1999 .................................................... 1,508
2000 .................................................... 423
2001 .................................................... 74
2002 .................................................... 22
Thereafter .............................................. --
------
Total ................................................. $4,042
======
31
HomeSide, Inc.
<PAGE>
12. STOCKHOLDERS' EQUITY
On March 15, 1996, in connection with the BBMC acquisition discussed in Note 4,
the Investors contributed cash of $107.3 million for 10,836,293 shares of common
stock. Also on March 15, 1996, HomeSide issued 8,427,155 shares of common stock
and cash to Bank of Boston in exchange for BBMC. The common stock issued to Bank
of Boston was assigned a value of $86.8 million.
Simultaneously with the closing of the BBMC acquisition, HomeSide also issued
97,138 shares of its Class B Non-Voting common stock to Smith Barney, Inc. in
consideration of services rendered to HomeSide in connection with the BBMC
acquisition. Bank of Boston also paid $1.0 million in cash for 97,138 shares of
HomeSide's Class C Non-Voting common stock. Bank of Boston then sold the Class C
shares to an unaffiliated third party.
On May 31, 1996, in connection with the BMC Acquisition discussed in Note 4,
Bank of Boston, the Investors and certain directors and executive managers of
HomeSide contributed a total of approximately $46.0 million in cash for
4,100,944 shares of common stock. Approximately $1.9 million of the amount
contributed by certain directors and management was financed by HomeSide and,
accordingly, is reported as a reduction of stockholders' equity. Also on May 31,
1996, HomeSide issued 11,461,400 shares of common stock and cash to Barnett in
exchange for BMC. The common stock issued to Barnett was assigned a value of
$118.0 million.
On February 5, 1997, HomeSide issued 8,452,500 shares of common stock to the
public at $15.00 per share. The stock is listed on the New York Stock Exchange
under the symbol HSL. The transaction, net of underwriting discount and
estimated expenses, resulted in net proceeds to the Company of $116.9 million. A
portion of the proceeds from the sale was used to pre-pay $70.0 million of Notes
at a premium of $7.9 million. Pro forma earnings per share giving effect for the
public offering as of the date of the issuance of the Notes and the related use
of proceeds to repay $70.0 million of the Notes and to reduce the bank line of
credit borrowings was $1.27. Upon completion of the issue, all shares of Class B
non-voting common stock converted automatically, on a 1-for-1 basis, into shares
of common stock.
13. SUPPLEMENTAL CASH FLOW INFORMATION
During the period from March 16, 1996 to February 28, 1997, HomeSide extended
loans totaling $1.9 million to certain members of management in connection with
their purchase of shares of common stock.
In connection with the acquisitions of BBMC and BMC, HomeSide recorded non-cash
assets and assumed liabilities, including fair value adjustments, of
approximately $2.3 billion and $1.7 billion, respectively.
HomeSide paid $81.8 million of interest during the period from March 16, 1996 to
February 28, 1997.
14. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value estimates are made as of a specific point in time based on the
characteristics of the financial instruments and the relevant market
information. Where available, quoted market prices are used. In other cases,
fair values are based on estimates using other valuation techniques, such as
discounting estimated future cash flows using a rate commensurate with the risks
involved or other acceptable methods. These techniques involve uncertainties and
are significantly affected by the assumptions used and the judgments made
regarding risk characteristics of various financial instruments, prepayments,
discount rates, estimates of future cash flows, future suspected loss experience
and other factors. Changes in assumptions could significantly affect these
estimates. Derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in an immediate
sale of the instrument. Also, because of differences in methodologies and
assumptions used to estimate fair value, the Company's fair values should not be
compared to those of other companies.
Fair value estimates are based on existing financial instruments without
attempting to estimate the value of anticipated future business and the value of
assets and liabilities that are not considered financial instruments.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company. For certain assets and liabilities, the
information required is supplemented with additional information relevant to an
understanding of the fair value.
The methods and assumptions used to estimate the fair values of each class of
financial instruments are as follows:
Cash and cash equivalents
The carrying amount reported in the balance sheet approximates fair value.
Mortgage loans held for sale
Fair values are based on the estimated value at which the loans could be sold in
the secondary market. These loans are priced to be sold with servicing rights
retained, as is the Company's normal business practice.
Accounts receivable
Carrying amounts are considered to approximate fair value.
Risk management contracts
Fair values are estimated based on actual market quotes or option models.
Notes payable
The carrying amount of the notes payable reported in the balance sheet
approximates its fair value due to the short-term nature of the borrowings under
the credit agreements.
32
HomeSide, Inc.
<PAGE>
Notes to Consolidated Financial Statements (Continued)
Long-term debt
Fair value of long-term debt is estimated by discounting
estimated future cash flows using a rate commensurate with the risks involved.
Commitments to or iginate mortgage loans
Fair value is estimated using quoted market prices for securities backed by
similar loans adjusted for differences in loan characteristics.
Forward contracts to sell mortgages
Forward contracts to sell mortgages, which represent legally binding agreements
to sell loans to permanent investors at a specified price or yield, are valued
using market prices for securities backed by similar loans and are reflected in
the fair values of the mortgages held for sale, to the extent that these
commitments relate to mortgage loans already originated, or to the related
commitments to extend credit.
Options on mortgage-backed securities
The fair values of options are estimated based on actual market quotes. In some
instances, quoted prices for the underlying loans or option models are used.
Fair Value
The fair values of the Company's financial instruments as of February 28, 1997
are as follows (in thousands):
Carrying Fair
Amount Value
--------------------------
Assets
Cash and cash equivalents ...................... $ 52,691 $ 52,691
Mortgage loans held for sale ................... 805,274 806,432
Accounts receivable ............................ 157,518 157,518
Risk management contracts for
mortgage servicing rights .................... 45,212 45,212
Liabilities
Notes payable .................................. 1,818,503 1,818,503
Long-term debt ................................. 151,128 151,128
Accounts payable and accrued liabilities ....... 140,304 140,304
Off-Balance Sheet(1)
Commitments to originate
mortgage loans ............................... -- (2,805)
Mandatory forward contracts to
sell mortgages ............................... -- 3,588
Mandatory forward contracts
to sell U.S. treasuries ...................... 7
Option contracts on
mortgage-backed securities ................... -- 1,741
Option contracts on U.S. treasury
bond futures ................................. -- (147)
- ------------
(1) Parenthesis denote a liability
Fair value estimates are made as of a specific point in time, based on relevant
market data and information about the financial instrument. These estimates do
not reflect any premium or discount that could result from offering for sale the
Company's entire holding of a particular financial instrument. Because no active
market exists for some portion of the Company's financial instruments, fair
value estimates are based on judgments regarding future expected loss
experience, current economic conditions, current interest rate and mortgage
prepayment trends, risk characteristics of various financial instruments and
other factors.
These estimates are subjective in nature and involve uncertainties and matters
of significant judgment and, therefore, cannot be determined with precision.
Changes in any of these assumptions used in calculating fair value would also
significantly affect the estimates. Further, the fair value estimates were
calculated as of February 28, 1997. Subsequent changes in market interest rates
and prepayment assumptions could significantly change the fair value.
15. RISK MANAGEMENT OF
MORTGAGE SERVICING RIGHTS
As discussed in Note 3, HomeSide purchases option contracts on U.S. Treasury
bond futures to manage the interest rate risk related to the value of HomeSide's
mortgage servicing rights. A summary of HomeSide's investments in purchased
option instruments as of February 28, 1997 is as follows:
Notional amount of U.S. Treasury bond future options .......... $ 3.6 billion
Fair value of outstanding options ............................. $45.2 million
Cash requirements for HomeSide's option contracts are limited to the initial
premium paid. The amount of contracts purchased depends on factors, such as
interest rates, interest rate volatility and growth in the mortgage servicing
portfolio. HomeSide is subject to market risk to the extent that interest rates
fluctuate; however, the purpose of the option contracts is to hedge the value of
its mortgage servicing rights portfolio, which tends to react inversely with
changes in the value of HomeSide's option contracts. HomeSide's credit risk on
its option contracts is limited, because the option contracts are traded on a
national exchange, which guarantees counterparty performance.
16. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
As discussed in Note 3, HomeSide purchases financial instruments and enters into
financial agreements with off-balance sheet risk in the normal course of
business and as part of its risk management programs. These instruments involve,
to varying degrees, elements of credit and interest rate risk. Credit risk is
the possibility that a loss may occur if a counterparty to a transaction fails
to perform according to the terms of the contract. Interest rate risk is the
possibility that a change in interest rates will cause the value of a financial
instrument to decrease or become more costly to settle.
Options and forward contracts
The notional amount of the options and forward contracts used in HomeSide's risk
management programs is the amount upon which interest and other payments under
the contract
33
HomeSide, Inc.
<PAGE>
are based and is generally not exchanged. Therefore, the notional amounts should
not be taken as the measure of credit risk or a reflection of future cash
requirements. The risk associated with options and forwards is the exposure to
current and expected market movements in the interest rates and the ability of
the counterparties to meet the terms of the contracts. The cash requirements
associated with these options and forward contracts, aside from the initial
purchase price, are minimal. These contracts generally require future
performance on the part of the counterparty upon exercise of the option or
execution of the forward contract by HomeSide.
HomeSide is exposed to credit loss in the event of nonperformance by the
counterparties to the various instruments. HomeSide controls credit and market
risk associated with interest rate products by establishing and monitoring
limits with counterparties as to the types and degree of risks that may be
undertaken. HomeSide's exposure to credit risk in the event of default by the
counterparties for the options is $45.2 million which was due at February 28,
1997.
HomeSide's exposure to credit risk in the event of default by the counterparty
for mandatory forward commitments to sell mortgage loans is the difference
between the contract price and the current market price, offset by any available
margins retained by HomeSide or an independent clearing agent. The amount of
credit risk as of February 28, 1997, if all counterparties failed completely and
if the margins, if any, retained by HomeSide or an independent clearing agent
were to become unavailable, was approximately $3.6 million for mandatory forward
commitments of mortgage-backed securities.
The following is a summary of HomeSide's notional amounts and fair values of
interest rate products (in thousands):
February 28, 1997
------------------------
Notional Estimated
Amount Fair Value(1)
------------------------
Purchased commitments to sell mortgaged loans:
Mandatory forward contracts ..................... $1,445,345 $ 3,588
Option contracts on mortgage-
backed securities ............................. 755,000 1,741
Option contracts on US treasury
bond futures .................................. 140,000 (147)
Risk management contracts on
mortgage servicing rights:
Purchased ....................................... 3,572,300 45,212
- ------------
(1) Fair value represents the amount at which a given instrument could be
exchanged in an arm's length transaction with a third party as of the
balance sheet date.
(2) See Note 14 for additional disclosures on fair value of financial
instruments.
Commitments to originate and purchase mortgage loans
HomeSide regularly enters into commitments to originate and purchase mortgage
loans at a future date subject to compliance with stated conditions. Commitments
to originate and purchase mortgage loans have off-balance sheet risk to the
extent HomeSide does not have matching commitments to sell loans, which exposes
HomeSide to lower of cost or market valuation adjustments in a rising interest
rate environment. Additionally, the extension of a commitment, which is subject
to HomeSide's credit review and approval policies, gives rise to credit exposure
when certain borrowing conditions are met and the loan is made. Until such time,
it represents only potential exposure. The obligation to lend may be voided if
the customer's financial condition deteriorates or if the customer fails to meet
certain conditions. Commitments to originate and purchase mortgage loans do not
necessarily reflect future cash requirements because some of the commitments are
expected to expire without being drawn upon. Commitments to originate and
purchase mortgage loans totaled $2.7 billion at February 28, 1997.
Mortgage loans sold with recourse
HomeSide sells mortgage loans with recourse to various investors and retains the
servicing rights and responsibility for credit losses on these loans. The total
outstanding balance of loans sold with recourse does not necessarily represent
future cash outflows. The total outstanding principal balance of loans sold with
recourse was $14.2 million at February 28, 1997.
For five years following the May 31, 1996 acquisition of BMC, Barnett is
obligated to repurchase or reimburse HomeSide for any credit losses related to
$101.0 million of loans serviced with recourse.
Servicing commitment to investors
HomeSide is required to submit to certain investors, primarily GNMA, guaranteed
principal and interest payments from the underlying mortgage loans regardless of
actual collections.
Purchase mortgage servicing rights commitments
HomeSide routinely enters into commitments to purchase mortgage servicing rights
associated with mortgages originated by third parties, subject to compliance
with stated conditions. These commitments to purchase mortgage servicing rights
correspond to mortgage loans having an aggregate loan principal balance of
approximately $2.3 billion at February 28, 1997.
Geographical concentration of credit risk
HomeSide is engaged in business nationwide and has no material concentration of
credit risk in any geographic region.
17. OTHER RELATED PARTY TRANSACTIONS
HomeSide entered into agreements with Bank of Boston and Barnett for certain
corporate support services. For the period from March 16, 1996 through February
28, 1997, HomeSide paid Bank of Boston and Barnett approximately $2.5 million
and $0.9 million, respectively, for these services.
HomeSide purchases mortgage loans eligible for sale from Bank of Boston and
Barnett. For the period from March 16, 1996 through February 28, 1997, HomeSide
paid approximately $4.7 million and $27.6 million, respectively, to Bank of
Boston and Barnett for the purchase of mortgage servicing rights. HomeSide
purchases the mortgage servicing rights to the mortgage loans Bank of Boston and
Barnett hold in their
34
HomeSide, Inc.
<PAGE>
Notes to Consolidated Financial Statements (Continued)
portfolios. For the period from March 16, 1996 to February 28, 1997, HomeSide
purchased mortgage servicing rights from Bank of Boston and Barnett totaling
approximately $1.3 million and $8.2 million, respectively. The Bank of Boston
and Barnett purchases represent 2.8% and 16.0%, respectively, of the Company's
total production for the period from May 31, 1996 to February 28, 1997.
HomeSide services residential mortgage loans held in portfolio by Bank of Boston
and Barnett. The servicing fees paid by Bank of Boston and Barnett to HomeSide
are market-based fees consistent with the fees charged by HomeSide to other
investors. For the period from March 16, 1996 to February 28, 1997, Bank of
Boston and Barnett paid $5.3 million and $23.6 million in servicing fees,
respectively.
As of February 28, 1997, certain members of management owed $1.9 million related
to loans granted to purchase shares of the Company's common stock. Such loans
are secured by a pledge of the shares purchased, have terms of approximately
five years and bear interest at 8.25% per annum.
18. STOCK-BASED COMPENSATION
HomeSide has established the HomeSide 1996 Employee Stock Option Plan under
which 582,845 shares of common stock are reserved for issuance. Options issued
under the plan may be either non-qualified or incentive stock options and the
options will be exercisable at such prices as are set by HomeSide's board of
directors. Under the plan, options will vest annually in five equal installments
in arrears. During the period from March 16, 1996 to February 28, 1997, options
to purchase 447,066 shares were granted at an exercise price of $10.294 per
share. To date, there have been no exercises of options and options to purchase
6,494 shares were canceled under this plan.
HomeSide has also adopted a 1996 Time Accelerated Restricted Stock Option Plan
under which 1,165,724 shares of common stock are reserved for issuance. Options
granted under this plan will be non-qualified and will be exercisable at such
prices as are set by the board of directors. Options granted under the plan will
vest nine years from the date of grant. Vesting will accelerate upon the
achievement of certain performance criteria. During the period from March 16,
1996 to February 28, 1997, options to purchase 894,132 shares were granted at an
exercise price of $10.294 per share. To date, there have been no exercises of
options and options to purchase 12,988 shares were canceled under this plan.
There was no compensation expense associated with the above option grants
because the exercise price was equal to the estimated fair value of the common
stock at the date of grant.
In 1995, SFAS No. 123, "Accounting for Stock-Based Compensation" was issued
requiring HomeSide either to continue its current accounting for stock-based
compensation under Accounting Principles Board ("APB") No. 25 or elect the fair
value-based method of accounting prescribed by SFAS No. 123. HomeSide elected to
continue to account for stock-based compensation under APB No. 25.
Under SFAS No. 123, the fair value of stock options granted in fiscal 1997 has
been estimated using a Black-Scholes option pricing model with the following
weighted average assumptions for grants in fiscal 1997: risk free interest rate
ranging from 6.5% to 6.86%, expected option life ranging from 7.5 to 8.5 years,
expected volatility of 35.0% and no expected dividend yield. Using these
assumptions, the estimated fair value of options granted for the period from
March 16, 1996 to February 28, 1997 was approximately $0.5 million and such
amounts would be included in compensation expense over the vesting period of the
options. Pro forma net income and net income per share for the period from March
16, 1996 to February 28, 1997, assuming the Company had accounted for the plan
under SFAS No. 123, are as follows (in thousands, except per share data):
Net income:
As reported .......................................... $ 36,969
Pro forma ............................................ 36,692
Net income per share:
As reported .......................................... $ 1.33
Pro forma ............................................ 1.32
A summary of stock options activity for fiscal year 1997 is presented in the
table and narrative below:
Weighted Average
Shares Exercise Price
-------------------------------
Options outstanding,
beginning of year .......................... -- $ 10.294
Granted ...................................... 1,341,198 10.294
Exercised .................................... -- 10.294
Forfeited .................................... (19,482) 10.294
-------------------------------
Options outstanding, end of year ............. 1,321,716 $ 10.294
===============================
Options exercisable, end of year ............. -- --
Weighted average per share
fair value of options granted .............. $ 3.21 --
At February 28, 1997, options for 440,572 shares are outstanding having an
exercise price $10.29 and a weighted average contractual life of 7.5 years, none
of which are exercisable. Options for 881,144 shares are also outstanding having
an exercise price of $10.29 and a weighted average contractual life of 8.5
years, none of which are exercisable.
19. EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 128, "Earnings per Share." This Statement establishes standards for
computing and presenting earnings per share (EPS) and applies to entities with
publicly held common stock or potential common stock. It replaces the
presentation of primary EPS with a presentation of basic EPS and requires dual
presentation of basic and diluted EPS on the face of the income statement and a
reconciliation of the numer-
35
HomeSide, Inc.
<PAGE>
ator and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation.
Basic EPS excludes dilution and is computed by dividing income available to
common stockholders by the weighted-average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity. Diluted EPS is computed similarly to fully
diluted EPS pursuant to APB Opinion 15.
This Statement is effective for financial statements issued for periods ending
after December 15, 1997, including interim periods; earlier application is not
permitted. Management expects that the impact of this Statement on the
presentation of the financial statements of HomeSide will be immaterial.
20. DISCLOSURE OF INFORMATION ABOUT CAPITAL STRUCTURE
In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information about
Capital Structure." This Statement establishes standards for the disclosure of
descriptive information about securities, the liquidation preference of
preferred stock and redeemable stock. This Statement is effective for HomeSide's
fiscal year ending February 28, 1998. Management expects that the impact of this
Statement on the presentation of the financial statements of HomeSide will be
immaterial.
21. CONTINGENCIES
HomeSide, along with its subsidiaries, is a defendant in a number of legal
proceedings arising in the normal course of business. HomeSide, in management's
estimation, has adequate reserves in the financial statements for pending
litigation. Management, after reviewing all actions and proceedings pending
against or involving HomeSide, considers that the aggregate liabilities or loss,
if any, resulting from the final outcome of these proceedings will not have a
material effect on the financial position, operations or liquidity of HomeSide.
22. EMPLOYEE BENEFITS
HomeSide offers a 401(k) defined contribution benefit plan in which employees
may contribute a portion of their compensation. Substantially all employees are
eligible for participation in the plan. The Company matched 100% of amounts
contributed up to 4% of an employee's compensation. Further, the Company may
contribute additional amounts at its discretion. Total expense related to the
benefit plan was approximately $4.0 million for fiscal year 1997.
23. QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
For the Period From For the Three For the Three For the Three
March 16, 1996 Months Ended Months Ended Months Ended
to May 31, 1996 August 31, 1996 November 30, 1996 February 28, 1997
------------------------------------------------------------------------
(dollars in thousands, except per share data)
<S> <C> <C> <C> <C>
Revenues ............................................... $33,717 $57,863 $62,325 $63,171
Expenses ............................................... 22,609 40,842 40,655 40,288
Income tax expense ..................................... 4,554 6,954 9,015 8,750
------------------------------------------------------------------------
Income before extraordinary loss on early
extinguishment of debt .............................. 6,554 10,067 12,655 14,133
Extraordinary loss from the early
extinguishment of debt, net of tax .................. -- -- -- 6,440
------------------------------------------------------------------------
Net income ............................................. $6,554 $10,067 $12,655 $7,693
========================================================================
Net income per share before extraordinary
loss on early extinguishment of debt(a) .............. $0.34 $0.29 $0.36 $0.37
Net income per share(a) ................................ $0.34 $0.29 $0.36 $0.20
Weighted average shares outstanding .................... 19,246,902 34,973,790 34,996,360 38,279,486
</TABLE>
- ------------
(a) Net income per share is computed independently for each of the quarters
presented. Therefore, the sum of the quarterly earnings per share amounts
may not equal the annual amount. This is caused by rounding and the
averaging effect of the number of share equivalents utilized throughout the
year, which changes with the market price of the common stock.
36
HomeSide, Inc.
<PAGE>
Notes to Consolidated Financial Statements (Continued)
24. PARENT COMPANY ONLY
CONDENSED FINANCIAL INFORMATION
Balance Sheet
(Dollars in thousands) February 28, 1997
-----------------
Assets
Investment in subsidiary .................................... $629,513
Other assets ................................................ 17,105
---------
Total assets ................................................ $646,618
=========
Liabilities and stockholders' equity
Accounts payable and accrued expenses ....................... $4,322
Long-term debt .............................................. 130,000
---------
Total liabilities ........................................... 134,322
Common stock ................................................ 531
Additional paid-in capital .................................. 476,646
Retained earnings ........................................... 36,969
---------
514,146
Less: Notes received in payment
for capital stock ......................................... (1,850)
---------
Total stockholders' equity .................................. 512,296
Total liabilities and stockholders' equity .................. $646,618
=========
Statement of Income
For the
Period From
March 16, 1996 to
(Dollars in thousands) February 28, 1997
------------------
Revenues:
Dividends from subsidiary ................................... $16,965
-------
Total revenues ............................................ 16,965
-------
Expenses:
Interest expense ............................................ 19,445
Other expenses .............................................. 842
-------
Total expenses ............................................ 20,287
-------
Loss before income taxes, equity in undistributed
income of subsidiary and extraordinary loss
on early extinguishment of debt ........................... 3,322
Income tax benefit .......................................... 8,171
-------
Income before equity in undistributed income
of subsidiary and extraordinary loss on
early extinguishment of debt .............................. 4,849
Equity in undistributed income of subsidiary ................ 38,560
Extraordinary loss on early extinguishment
of debt, net of tax ....................................... 6,440
-------
Net income .................................................. $36,969
=======
Statement of Cash Flows
For the
Period From
March 16, 1996 to
(Dollars in thousands) February 28, 1997
------------------
Cash flows used in operating activities:
Net income $ 36,969
Adjustments to reconcile net income to net cash
used in operating activities:
Amortization 842
Equity in undistributed earnings of subsidiary (38,560)
Deferred income tax benefit (8,171)
Change in other assets and accounts payable
and accrued liabilities (3,810)
-------
Net cash used in operating activities (12,730)
-------
Cash flows used in investing activities:
Capital contribution to subsidiary (376,453)
-------
Net cash used in investing activities (376,453)
-------
Cash flows provided by financing activities:
Issuance of bridge financing 90,000
Repayment of bridge financing (90,000)
Issuance of Notes 200,000
Payment of debt issue costs (10,409)
Repayment of long-term debt (70,000)
Proceeds from issuance of common stock 269,592
-------
Net cash provided by financing activities 389,183
-------
Net increase in cash
Cash and cash equivalents at beginning of period --
Cash and cash equivalents at end of period --
-------
$ --
=======
37
HomeSide, Inc.
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors of
HomeSide, Inc.
We have audited the accompanying consolidated balance sheet of HomeSide, Inc.,
(a Delaware corporation, see Note 1) and subsidiaries as of February 28, 1997,
and the related consolidated statements of income, changes in stockholders'
equity and cash flows for the period from March 16, 1996 to February 28, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of HomeSide, Inc. and
subsidiaries as of February 28, 1997 and the consolidated results of their
operations and their cash flows for the period from March 16, 1996 to February
28, 1997, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
- ------------------------
Jacksonville, Florida
April 18, 1997
38
<PAGE>
Consolidated Balance Sheets
<TABLE>
<CAPTION>
At December 31, At March 15,
1994 1995 1996
----------------------------------------
(In thousands)
ASSETS
<S> <C> <C> <C>
Cash .................................................................. $ 5,653 $ 830 $ 23,216
Mortgage loans
Held for sale, net .................................................. 271,215 388,436 628,504
Held for investment ................................................. 28,589 33,183 65,068
Purchased mortgage servicing rights, net .............................. 415,815 533,891 522,469
Excess mortgage servicing receivable, net ............................. 15,333 17,447 20,393
Accounts receivable ................................................... 66,390 82,473 65,599
Accounts receivable from Bank of
Boston and affiliates ............................................... 373 343 --
Pool loan purchases ................................................... 77,477 65,272 56,261
Mortgage claims receivable, net ....................................... 48,835 45,422 17,563
Accrued income tax receivable ......................................... -- -- 40,867
Deferred tax asset .................................................... 31,012 40,724 36,390
Real estate acquired .................................................. 924 2,627 2,797
Premises and equipment, net ........................................... 25,279 25,386 25,071
Other assets .......................................................... 19,992 18,269 16,159
----------------------------------------
Total Assets ...................................................... $1,006,887 $1,254,303 $1,520,357
========================================
LIABILITIES & STOCKHOLDER'S EQUITY
Note payable to Bank of Boston ........................................ $ 779,021 $ 966,000 $1,256,000
Accounts payable and accrued liabilities .............................. 81,269 51,683 137,837
Accrued income taxes .................................................. 4,825 36,213 --
Long-term debt ........................................................ 14,007 13,816 13,790
----------------------------------------
Total liabilities ................................................. 879,122 1,067,712 1,407,627
----------------------------------------
Commitments and Contingencies (Notes 9, 11, 12, 13, 15 and 16)
Stockholder's Equity:
Common stock, $1 par value per share:
10,000 shares authorized; 100 shares issued and outstanding ........ -- -- --
Additional paid-in capital .......................................... 156,666 156,666 156,666
Retained earnings (accumulated deficit) ............................... (28,901) 29,925 (43,936)
----------------------------------------
Total stockholder's equity .......................................... 127,765 186,591 112,730
----------------------------------------
Total Liabilities & Stockholder's Equity .......................... $1,006,887 $1,254,303 $1,520,357
========================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
39
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc.--Note 1)
<PAGE>
Consolidated Statements of Operations and
Retained Earnings
<TABLE>
<CAPTION>
For the
Period From
January 1, 1996
Years Ended December 31, through
1994 1995 March 15, 1996
-----------------------------------------------
(In thousands)
<S> <C> <C> <C>
Revenues:
Mortgage servicing fees ..................................................... $ 140,491 $ 173,038 $ 38,977
Gain (loss) on risk management contracts .................................... (6,702) 108,702 (128,795)
Amortization of mortgage servicing rights ................................... (66,801) (108,013) (7,245)
-----------------------------------------------
Net servicing revenue ..................................................... 66,988 173,727 (97,063)
-----------------------------------------------
Interest income ............................................................. 31,585 24,324 8,423
Interest expense ............................................................ (33,952) (27,128) (10,089)
-----------------------------------------------
Net interest revenue (expense) ............................................ (2,367) (2,804) (1,666)
-----------------------------------------------
Net mortgage origination revenue ............................................ 4,983 3,417 7,638
Gain on sales of servicing rights ........................................... 10,862 10,230 --
Other income ................................................................ 147 511 253
-----------------------------------------------
Total Revenues ............................................................ 80,613 185,081 (90,838)
-----------------------------------------------
Expenses:
Salaries and employee benefits .............................................. 40,370 45,381 10,287
Occupancy and equipment ..................................................... 9,012 10,009 2,041
Servicing losses on investor-owned loans .................................... 7,177 9,981 5,560
Real estate acquired ........................................................ 253 1,054 291
Other expenses .............................................................. 19,326 21,896 7,377
-----------------------------------------------
Total Expenses ............................................................ 76,138 88,321 25,556
-----------------------------------------------
Income (loss) before income taxes and cumulative effect of change
in accounting principle ..................................................... 4,475 96,760 (116,394)
Income tax expense (benefit) before cumulative effect of change
in accounting principle:
Current ................................................................... 4,773 47,646 (46,867)
Deferred .................................................................. (2,248) (9,712) 4,334
-----------------------------------------------
Total Income Tax Expense (Benefit) ...................................... 2,525 37,934 (42,533)
-----------------------------------------------
Income (loss) before cumulative effect of change
in accounting principle ..................................................... 1,950 58,826 (73,861)
Cumulative effect on prior years of change in accounting for mortgage
servicing fee income, net of tax ............................................ 3,455 -- --
-----------------------------------------------
Net Income (Loss) ......................................................... 5,405 58,826 (73,861)
Retained Earnings (Accumulated Deficit), January 1 ............................ (34,306) (28,901) 29,925
-----------------------------------------------
Retained Earnings (Accumulated Deficit), end of period ........................ $ (28,901) $ 29,925 $ (43,936)
===============================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
40
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996 and
now known as HomeSide Lending, Inc.--Note 1)
<PAGE>
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
For the
Period From
January 1, 1996
Years Ended December 31, through
1994 1995 March 15, 1996
-----------------------------------------------
(In thousands)
<S> <C> <C> <C>
Cash flows provided by (used in) operating activities:
Net income (loss) .......................................................... $5,405 $58,826 $(73,861)
Adjustments to reconcile net income (loss) to cash provided by
(used in) operations:
Cumulative effect of change in accounting for mortgage
servicing fees, net of tax ........................................... (3,455) -- --
Amortization ........................................................... 67,207 108,404 7,327
Depreciation ........................................................... 2,621 3,133 719
Servicing losses on investor-owned loans ............................... 7,177 9,981 5,560
Deferred tax (benefit) expense ......................................... (2,248) (9,712) 4,334
Gain on sale of mortgage servicing rights .............................. (10,862) (10,230) --
(Gain) loss on risk management contracts ............................... 6,702 (108,702) 128,795
Write down of real estate acquired ..................................... 1,066 1,699 1,067
Capitalized excess mortgage servicing receivable ....................... (3,653) (7,513) (3,967)
Mortgage loans originated and purchased for sale ....................... (4,673,100) (4,816,964) (2,027,741)
Proceeds and principal repayments of mortgage loans held for sale ...... 5,005,969 4,694,909 1,787,673
Change in accounts receivable .......................................... (7,482) (16,053) 17,217
Change in pool loan purchases .......................................... 9,002 12,205 9,011
Change in mortgage claims receivable ................................... 4,574 (5,383) 25,863
Change in accrued income taxes ......................................... (1,231) 31,388 (77,080)
Change in other assets and accounts payable and accrued liabilities .... (13,051) (11,899) 82,622
-----------------------------------------------
Net cash provided by (used in) operating activities .................. 394,641 (65,911) (112,461)
-----------------------------------------------
Cash flows provided by (used in) investing activities:
Principal payments on (net origination) of mortgage loans
held for investment ...................................................... 11,216 12,966 (31,885)
Purchase of premises and equipment ......................................... (5,355) (3,141) (404)
Acquisition of Bell Mortgage ............................................... -- (891) --
Purchase of mortgage servicing rights ...................................... (164,047) (193,013) (60,171)
Proceeds from (amounts paid for) risk management contracts, net ............ (9,641) 27,120 (63,426)
Proceeds from real estate acquired ......................................... 2,773 2,610 759
Proceeds from sales of mortgage servicing rights ........................... 10,862 28,649 --
-----------------------------------------------
Net cash used in investing activities ............................... (154,192) (125,700) (155,127)
-----------------------------------------------
Cash flows provided by (used in) financing activities:
Borrowings from Bank of Boston ............................................. 3,988,224 3,669,085 1,692,500
Repayments to Bank of Boston ............................................... (4,228,214) (3,482,106) (1,402,500)
Repayment of long-term debt ................................................ (173) (191) (26)
-----------------------------------------------
Net cash provided by (used in) financing activities .................. (240,163) 186,788 289,974
-----------------------------------------------
Net increase (decrease) in cash .............................................. 286 (4,823) 22,386
Cash at January 1 .......................................................... 5,367 5,653 830
-----------------------------------------------
Cash at end of period ...................................................... $5,653 $830 $23,216
===============================================
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest ................................................................. $32,819 $27,498 $9,211
===============================================
Income taxes ............................................................. $7,864 $16,258 $30,213
===============================================
Supplemental schedule of non=cash investing activities:
BBMC purchased bulk mortgage servicing rights during the years
1994 and 1995. In conjunction with purchases, accounts payable
were assumed ............................................................. $60,188 $23,022 --
===============================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
41
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
Notes to Consolidated Financial Statements
1. ORGANIZATION
BancBoston Mortgage Corporation ("BBMC" or the "Company") was a wholly=owned
subsidiary of The First National Bank of Boston ("Bank of Boston"), which was a
wholly-owned subsidiary of Bank of Boston Corporation. In December 1995, Bank of
Boston Corporation signed an agreement with Thomas H. Lee Company and Madison
Dearborn Partners ("Investors") to sell BBMC, creating an independent mortgage
company. Under the terms of the agreement, Bank of Boston received cash and an
equity interest in the new company, HomeSide, Inc. The Investors acquired
majority interest in HomeSide, Inc. The transaction closed March 15, 1996. Upon
completion of the transaction, BBMC was renamed HomeSide Lending, Inc. BBMC is
the Predecessor company to both HomeSide, Inc. and HomeSide Lending, Inc.
On March 4, 1996, Barnett Banks, Inc. ("Barnett") entered into an agreement to
sell certain of its mortgage banking operations, primarily its servicing
portfolio and proprietary mortgage banking software systems to HomeSide, Inc.
Barnett received cash and an ownership interest in HomeSide, Inc. The
transaction closed May 31, 1996.
2. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
Basis of presentation
The consolidated financial statements include BBMC and its wholly=owned
subsidiaries. All material intercompany transactions have been eliminated. These
financial statements have been prepared using the carrying values of BBMC and do
not reflect the purchase of BBMC as discussed in Note 1.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Specifically, management
adjusts the amount of amortization recorded based on the effect of anticipated
changes in prepayment speeds.
Interest rate products
BBMC enters into financial agreements and purchases financial instruments as
part of its interest rate risk management strategy. These agreements are not
considered trading instruments and are primarily entered into for purposes of
managing the prepayment risk associated with mortgage servicing rights and
interest rate risk relative to commitments to originate mortgage loans against
market value declines resulting from fluctuations in interest rates. These
instruments and agreements are designated as a part of BBMC's risk management
strategy and are linked to the related assets being managed.
BBMC acquires financial instruments, including derivative contracts (risk
management contracts), to partially protect the value of mortgage servicing
rights from the effects of prepayment activity caused by interest rate declines.
These financial instruments increase or decrease in value in an inverse
relationship to changes in market interest rates. Accordingly, as interest rates
decline, these financial instruments will increase in value, and as interest
rates increase, these financial instruments will decline in value. The value of
these financial instruments will fluctuate daily with interest rate changes, and
these fluctuations may be significant. However, the decline in the value of
these financial instruments is limited to the value recorded in the balance
sheet. These financial instruments primarily include options on U.S. treasury
futures, forward contracts, and interest rate floors.
As of March 15, 1996, due to rising interest rates, the risk management
contracts had declined in value by the carrying amount recorded on the balance
sheet at December 31, 1995 (see Note 14).
The cost of option contracts to manage BBMC's fixed and variable rate loan
origination commitments are capitalized and amortized as an adjustment of gain
or loss over the life of the underlying option contract. Unamortized premiums
are included in other assets on the balance sheet. At March 15, 1996, BBMC had
call options to purchase mortgage=backed securities with a total face amount of
$653.0 million. The unamortized premiums associated with these options were $2.6
million at March 15, 1996. There were no put options outstanding as of the
balance sheet date.
Short-term option contracts that are used to manage interest rate risk on BBMC's
mortgage servicing rights are marked-to-market with gains or losses recognized
in current income. The current market value of these option contracts are
included in the balance of capitalized mortgage servicing rights. At March 15,
1996, the current market value of these option contracts included in mortgage
servicing rights was $20.2 million. Unrealized gains (losses) at December 31,
1994, 1995 and March 15, 1996, included in the consolidated statements of
operations were ($2.9) million, $86.5 million and ($56.6) million, respectively.
Mortgage loans
Mortgage loans held for sale are carried at the lower of aggregate cost or fair
value. Fair value is based on the contract prices at which the mortgage loans
will be sold or, if the loans are not committed for sale, the current market
price. Loan origination fees and certain direct costs are deferred until the
related mortgage loans are sold.
Mortgage loans held for investment are stated at the lower of cost or fair value
at the time the permanent investment decisions are made. Discounts, if any, are
amortized over the anticipated life of the investment.
42
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
Notes to Consolidated Financial Statements (Continued)
Loans are placed on nonaccrual status when any portion of the principal or
interest is ninety days past due or earlier when concern exists as to the
ultimate collectibility of principal or interest. When loans are placed on
nonaccrual status, the related interest receivable is reversed against interest
income of the current period. Interest payments received on nonaccrual loans are
applied as a reduction of the principal balance when concern exists as to the
ultimate collection of principal; otherwise, such payments are recognized as
interest income. Loans are removed from nonaccrual status when principal and
interest become current and they are estimated to be fully collectible.
Purchased and originated mortgage servicing rights
Purchased mortgage servicing rights (PMSR) represent the cost of purchasing the
right to service mortgage loans originated by others. PMSR are amortized as a
reduction of servicing fee income over the estimated servicing period in
proportion to the estimated future net cash flows from the loans serviced.
Remaining PMSR asset balances are evaluated for impairment by determining their
estimated recoverable amount through applying the discount rate in effect at the
time the servicing was purchased to the estimated future aggregate net cash
flows from the underlying mortgages. The carrying value is written down for any
impairment; such write=downs are included in the amortization of mortgage
servicing rights.
On January 1, 1996, BBMC adopted Statement of Financial Accounting Standards
(SFAS) No. 122 which, among other provisions, requires that the value of
mortgage servicing rights associated with mortgage loans originated by an entity
be capitalized as assets. The value of BBMC's originated mortgage servicing
rights (OMSR) is determined by allocating the total costs of the mortgage loans
between the loans and the mortgage servicing rights based on their relative fair
values. Previously, OMSRs were included with the cost of the related loans and
considered in determining the gain or loss on sale when the loans were sold.
Through March 15, 1996, BBMC capitalized $3.1 million of OMSR, which had the
effect of increasing net mortgage origination revenue by $3.1 million for the
period January 1, 1996 to March 15, 1996 since a portion of the basis of loans
originated for sale was allocated to OMSR. Since SFAS No. 122 prohibits
retroactive application, historical accounting results have not been restated
and, accordingly, the accounting results for the previous years ended are not
directly comparable with the period January 1, 1996 through March 15, 1996.
SFAS No. 122 also requires that capitalized mortgage servicing rights be
evaluated for impairment based on the fair value of these rights. For the
purposes of determining impairment, BBMC's mortgage servicing rights are
stratified based on interest rate and type of loan (conventional/government).
Impairment, if any, is recognized through a valuation allowance for each
impaired stratum. BBMC did not record any impairment charges related to its
mortgage servicing right portfolio for the period January 1, 1996 through March
15, 1996.
Excess mortgage servicing receivable
Excess mortgage servicing receivable (EMSR) represents the present value of
servicing fee income in excess of a normal servicing fee. When loans are sold,
the estimated excess servicing is recognized as income and amortized over the
estimated servicing period in proportion to the estimated future aggregate net
cash flows from the loans serviced. Remaining asset balances are evaluated for
impairment based on current estimates of future discounted cash flows. Such
write-downs are included in amortization of mortgage servicing rights.
Accounts receivable
Accounts receivable includes advances made in connection with loan servicing
activities. These advances consist primarily of payments for property taxes and
insurance premiums, as well as, principal and interest remitted to investors
before they are collected from mortgagors.
Pool loan purchases
Pool loan purchases are carried at cost and consist of FHA=insured,
VA=guaranteed, and conventional loans purchased from mortgage=backed securities
serviced by BBMC for others. At the purchase date, these loans were delinquent
or in the process of foreclosure or repayment. Losses associated with pool loan
purchases are largely reimbursed by the insurer.
Mortgage claims receivable
Mortgage claims receivable includes claims filed primarily with the FHA and the
VA. These receivables are carried at cost, less an allowance for estimated
amounts that are not collectible from the mortgage insuring agencies.
Real estate acquired
Real estate acquired includes properties on which BBMC has foreclosed and taken
title. It is initially reported at the lower of the carrying value of the loan
or the fair value of the real estate obtained, less estimated selling costs. The
excess, if any, of the loan balance over the fair value of the property at the
time of transfer to real estate acquired is charged to the reserve for estimated
servicing losses on investor=owned loans. Subsequent declines in the value of
the property and costs related to holding the property are charged against
income.
Premises and equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets. Leasehold improvements are amortized over the lesser
of the estimated life of the improvement or the term of the lease.
43
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
Other assets
Other assets consist primarily of a prepaid pension asset of ($9.8 million at
March 15, 1996) allocated from the Bank of Boston, and the excess of cost over
fair value of net assets acquired. The excess of cost over fair value of net
assets acquired is amortized using a straight=line basis over periods varying
from seven to twenty=five years.
Mortgage servicing fees
Mortgage servicing fees represent fees earned for servicing mortgage loans owned
by investors. The fees are generally calculated on the outstanding principal
balances of the loans serviced and are recognized as income on an accrual basis.
Servicing losses on investor=owned loans
BBMC records losses attributable to servicing FHA and VA loans for investors.
These amounts include actual losses for final disposition of loans, accrued
interest for which payment has been denied, and estimates for potential losses
based on BBMC's experience as a servicer of government loans.
A reserve for estimated servicing losses on investor-owned loans is available
for potential losses related to the mortgage servicing portfolio and is included
in the balance of accounts payable and accrued liabilities.
Net mortgage origination revenue
Net mortgage origination revenue includes gains and losses from sales of
mortgage loans, deferred origination fees and expenses, and the present value of
gains from the EMSR.
Income taxes
BBMC files its federal tax return through inclusion in Bank of Boston
Corporation's consolidated return. Accordingly, Bank of Boston's federal tax
provision is allocated to all member subsidiaries as if each member were a
separate taxpayer. However, the timing of utilization of certain of BBMC's tax
attributes may differ from a stand-alone tax-paying basis. BBMC accounts for
income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes".
Note 10 includes additional information with respect to the adoption of this
statement. Under SFAS No. 109, current tax liabilities or assets are recognized
through charges or credits to the current tax provision for the estimated taxes
payable or refundable for the current year.
Deferred tax liabilities are recognized for temporary differences that will
result in amounts taxable in the future and deferred tax assets are recognized
for temporary differences and tax benefit carryforwards that will result in
amounts deductible or creditable in the future. Net deferred tax liabilities or
assets are recognized through charges or credits to the deferred tax provision.
A deferred tax valuation reserve is established if it is more likely than not
that all or a portion of the deferred tax assets will not be realized. Changes
in the deferred tax valuation reserve are recognized through charges or credits
to the deferred tax provision.
The effect of enacted changes in tax law, including changes in tax rates, on
deferred tax assets and liabilities is recognized in income in the period that
includes the enactment date.
Accounting changes
Effective January 1, 1994, BBMC changed its method of accounting for mortgage
servicing fees from the cash basis to the accrual basis. The cumulative effect
to January 1, 1994 of this accounting change was an increase in net income of
approximately $3.5 million, which is net of income taxes of $1.9 million.
3. PURCHASED MORTGAGE SERVICING RIGHTS AND EXCESS MORTGAGE
SERVICING RECEIVABLE
PMSR consist of the following:
<TABLE>
<CAPTION>
December 31, March 15,
---------------------------------------------
1994 1995 1996
---------------------------------------------
(In thousands)
<S> <C> <C> <C>
PMSR .................................................... $732,775 $954,931 $951,817
Accumulated amortization ................................ (316,960) (421,040) (429,348)
--------------------------------------------
Balance ................................................. $415,815 $533,891 $522,469
============================================
<CAPTION>
EMSR consist of the following:
December 31, March 15,
-------------------------------------------
1994 1995 1996
-------------------------------------------
(In thousands)
<S> <C> <C> <C>
EMSR .................................................... $60,419 $66,465 $70,432
Accumulated amortization ................................ (45,086) (49,018) (50,039)
--------------------------------------------
Balance ................................................. $15,333 $17,447 $20,393
============================================
</TABLE>
4. RESERVE FOR ESTIMATED SERVICING LOSSES ON INVESTOR=OWNED LOANS
An analysis of the reserve for estimated servicing losses on investor-owned
loans is as follows:
<TABLE>
<CAPTION>
December 31, March 15,
---------------------------------------------
1994 1995 1996
---------------------------------------------
(In thousands)
<S> <C> <C> <C>
Balance at January 1 .................................... $(4,700) $(6,650) $(9,400)
Servicing losses on
investor-owned loans .................................. (7,177) (9,981) (5,560)
Charge-offs ............................................. 5,304 7,473 2,725
Recoveries .............................................. (77) (242) --
---------------------------------------------
Ending Balance .......................................... $(6,650) $(9,400) $(12,235)
=============================================
</TABLE>
5. MORTGAGE SERVICING PORTFOLIO
BBMC's residential mortgage servicing portfolio totaled $37.9 billion, $41.5
billion and $44.2 billion at December 31, 1994, 1995 and March 15, 1996,
respectively, and included mortgage-backed securities of $24.0 billion, $28.5
billion and $29.1 billion
44
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
Notes to Consolidated Financial Statements (Continued)
at December 31, 1994, 1995 and March 15, 1996, respectively. In addition, BBMC's
commercial loan servicing portfolio totaled $1.0 billion, $0.9 billion and $0.2
billion at December 31, 1994, 1995 and March 15, 1996, respectively. Related
fiduciary funds are segregated in trust accounts, principally deposited with
Bank of Boston, and are not included in the accompanying consolidated financial
statements.
BBMC has in force an errors and omissions policy in the amount of $25 million.
Fidelity coverage up to a limit of $75 million, subject to a $1 million
deductible, is provided under a Bank of Boston master program.
6. PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
December 31, March 15,
---------------------------------------
1994 1995 1996
---------------------------------------
(In thousands)
Land .............................. $4,086 $4,086 $4,086
Building .......................... 14,251 14,477 14,476
Furniture and equipment ........... 24,300 26,870 25,967
Leasehold improvements ............ 752 824 877
---------------------------------------
43,389 46,257 45,406
Accumulated depreciation
and amortization ................ (18,110) (20,871) (20,335)
---------------------------------------
Balance ........................... $25,279 $25,386 $25,071
=======================================
7. NOTE PAYABLE TO BANK OF BOSTON
BBMC borrows funds on a demand basis from Bank of Boston under a $1.25 billion
line of credit, collateralized by substantially all of BBMC's assets. At
December 31, 1994 and 1995 and March 15, 1996, the interest rate was 8.5%, 6.8%
and 7.7%, respectively, less the benefit received from balances held at Bank of
Boston. Interest expense, net of this benefit, was $24.6 million, $20.5 million
and $6.7 million for the years ended December 31, 1994 and 1995, and for the
period January 1, 1996 to March 15, 1996, respectively.
8. LONG-TERM DEBT
Long-term debt consists of a 30-year mortgage note, payable monthly with
interest at 91/2%, maturing in 2017. BBMC's main office building is pledged as
collateral. Principal payments due on long-term debt as of March 15, 1996, are
as follows:
March 15, 1996
(In thousands)
--------------
1997 ......................................................... $ 230
1998 ......................................................... 234
1999 ......................................................... 258
2000 ......................................................... 283
2001 ......................................................... 312
Thereafter ................................................... 12,473
----------
Total Due .................................................... $13,790
==========
9. EMPLOYEE BENEFITS
BBMC participates with Bank of Boston and its affiliates in a non-contributory
defined benefit pension plan (Plan) covering substantially all full-time
employees. Bank of Boston funds the Plan in compliance with the requirements of
the Employee Retirement Income Security Act.
The Plan is an account balance defined benefit plan in which each employee has
an account to which amounts are allocated based on level of pay and years of
service and which grows at a specific rate of interest. Benefits accrued prior
to 1989 are based on years of service, highest average compensation, and social
security benefits. Expense (income) associated with this Plan was ($1.1) million
and $0.5 million for the years ended December 31, 1994 and 1995, respectively
and $0.3 million for the period January 1, 1996 to March 15, 1996.
BBMC also maintains non-qualified deferred compensation and retirement plans for
certain officers. All benefits provided under these plans are unfunded and any
payments to plan participants are made by BBMC. As of December 31, 1994, 1995
and March 15, 1996, approximately $0.8 million, $0.7 million and $0.7 million,
respectively, were included in accrued expenses and other liabilities for these
plans. For the years ended December 31, 1994, 1995 and for the period January 1,
1996 to March 15, 1996, expense related to these plans was $0.2 million, $0.2
million and $0.1 million, respectively.
BBMC also participates with Bank of Boston and its affiliates in a thrift
incentive plan. Under this plan, employer contributions are generally based on
the amount of eligible employee contributions. The amounts charged to operating
expense under this plan were $0.8 million, $0.2 million and $0.1 million for the
years ended December 31, 1994, 1995 and for the period January 1, 1996 to March
15, 1996, respectively. BBMC employees are eligible to participate in the thrift
plan until October 1, 1996 at which time BBMC participant accounts will become
part of a similar plan offered by the new company.
BBMC participates with Bank of Boston and its affiliates by providing certain
health and life insurance benefits for retired employees. Eligible employees
currently receive credits up to $10 thousand based on years of service, which
are used to purchase post-retirement health care coverage. Life insurance
coverage is dependent on years of service at retirement. Amounts charged to
employee benefits expense for these benefits were $0.6 million, $0.5 million and
$0.8 million for the years ended December 31, 1994 and 1995 and for the period
January 1, 1996 to March 15, 1996, respectively. After March 15, 1996 retiree
benefits associated with current retirees will be assumed by Bank of Boston.
45
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
The components of post-retirement benefits expense for the two years ended
December 31 were as follows:
1994 1995
----------------------
(In thousands)
Service cost (benefits earned
during the period) ............................. $63 $53
Interest cost on projected
benefit obligation ............................. 282 264
Amortization:
Unrecognized net asset ......................... 250 250
Unamortized gain ............................... (11) (53)
----------------------
Net post-retirement benefit cost ................. $584 $514
======================
BBMC's unfunded accumulated post-retirement benefit obligation for the two years
ended December 31 was as follows:
1994 1995
----------------------
(In thousands)
Accumulated post-retirement benefit
obligation for retirees ........................ $3,711 $3,515
Unrecognized net gain ............................ 1,385 1,541
Unrecognized net obligation ...................... (4,500) (4,250)
----------------------
Post-retirement benefit liability ................ $596 $806
======================
Assumptions used in actuarial computations were:
1994 1995
------------------------------
(In thousands)
Rate of increase in future
compensation levels 4.50% 4.50%
Weighted average discount rate 8.25% 7.25%
Medical inflation rate 11% declining 8% declining
to 5% in 2001 to 5% in 1999
An increase of 1% in the assumed health care cost trend rate would result in an
increase of 5.9%, and 5.8% in the accumulated post-retirement benefit obligation
and 4.9%, and 4.9% in annual post-retirement benefit expense for the years ended
December 31, 1994, and 1995, respectively.
These retirement plans are assessed annually. There was no actuarial valuation
at March 15, 1996. Post-retirement benefit expense for the period January 1,
1996 to March 15, 1996 was $0.1 million.
10. INCOME TAXES
The components of the net deferred tax asset are as follows:
December 31, March 15,
--------------------------------------
1994 1995 1996
--------------------------------------
(In thousands)
PMSR .............................. $27,223 $34,008 $28,167
EMSR .............................. 9,303 8,957 8,881
Reserve for estimated
servicing losses on
investor-owned loans ............ 2,529 3,657 4,759
Other ............................. (2,385) (1,301) (1,303)
Valuation reserve ................. (5,658) (4,597) (4,114)
--------------------------------------
Net deferred tax assets,
net of reserve .................. $31,012 $40,724 $36,390
======================================
The deferred tax assets, net of the valuation reserve, can be realized from the
reversal of existing deferred tax liabilities and by carryback to previous years
with taxable income. The valuation reserve has been primarily established
against state deferred tax assets where carryback is not permitted.
The components of the provision for (benefit from) income taxes are as follows:
December 31, March 15,
--------------------------------------
1994 1995 1996
--------------------------------------
(In thousands)
Current tax provision
(benefit) ........................... $4,773 $47,646 $(46,867)
Deferred tax (benefit)
expense on income ................... (2,587) (8,651) 4,817
Change in valuation
reserve ........................... 339 (1,061) (483)
--------------------------------------
Net deferred tax
(benefit) expense ................... (2,248) (9,712) 4,334
Income tax provision (benefit)
before cumulative effect of
changes in accounting
principles .......................... 2,525 37,934 (42,533)
Change in accounting for
mortgage servicing fee .............. 1,860 -- --
Total income tax
provision (benefit) ................. $4,385 $37,934 $(42,533)
======================================
The following table reconciles the expected federal tax provision (benefit) on
income (loss) before cumulative effect of change in accounting principle, based
on the federal statutory tax rate of
46
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
Notes to Consolidated Financial Statements (Continued)
35%, to the actual tax provision (benefit) before cumulative effect of changes
in accounting principles:
December 31, March 15,
--------------------------------------
1994 1995 1996
--------------------------------------
(In thousands)
Expected tax provision (benefit)
applicable to income (loss)
before cumulative effect of
change in accounting
principle ............................ $1,567 $33,866 $(40,738)
Effect of:
State income taxes, net of
federal tax benefits ............... 381 3,774 743
Other ................................ 577 294 (2,538)
--------------------------------------
Actual tax provision (benefit)
before cumulative effect of
change in accounting
principle ............................ $2,525 $37,934 $(42,533)
======================================
11. LEASE COMMITMENTS
BBMC leases office facilities and equipment under noncancelable leases that
include renewal options and escalation clauses which extend into 1999. Rental
expense for leases of office facilities and equipment was $3.6 million, and $3.9
million for the years ended December 31, 1994 and 1995 and $1.8 million for the
period January 1, 1996 to March 15, 1996. BBMC's minimum future lease
commitments are as follows:
December 31, 1995 March 15, 1996
---------------------------------------------
(In thousands)
1996 ........................ $1,996 $1,837
1997 ........................ 622 1,910
1998 ........................ 280 1,764
1999 ........................ 52 1,079
2000 ........................ -- 107
Thereafter .................. -- 21
=============================================
Total ....................... $2,950 $6,718
---------------------------------------------
12. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
BBMC purchases financial instruments and enters into financial agreements with
off-balance sheet risk in the normal course of business through the origination
and selling of mortgage loans and the management of the risk of fluctuations in
interest rates. These instruments involve, to varying degrees, elements of
credit and interest rate risk. Credit risk is the possibility that a loss may
occur if a counterparty to a transaction fails to perform according to the terms
of the contract. Interest rate risk is the possibility that a change in interest
rates will cause the value of a financial instrument to decrease or become more
costly to settle. Financial instruments primarily used by BBMC include
commitments to extend credit, mandatory and optional forward commitments,
commitments to purchase mortgage servicing rights, and other instruments to
minimize the interest rate risk of capitalized servicing assets, primarily
options on treasury bond futures.
Options and forward contracts
BBMC purchases options and forward contracts to protect the value of mortgage
servicing assets from exposure to increases in prepayment activity and to reduce
the impact of interest rate fluctuations on its lending commitments. The
notional amount of the options and forward contracts is the amount upon which
interest and other payments under the contract are based and is generally not
exchanged. Therefore, the notional amounts should not be taken as the measure of
credit risk or a reflection of future cash requirements. The risk associated
with options and forwards is the exposure to current and expected market
movements in the interest rates and the ability of the counterparties to meet
the terms of the contracts. The cash requirements associated with these options
and forward contracts, aside from the initial purchase price, are minimal. These
contracts generally require future performance on the part of the counterparty
upon exercise of the option or execution of the forward contract by BBMC.
BBMC is exposed to credit loss in the event of nonperformance by the
counterparties to the various instruments. BBMC controls credit and market risk
associated with interest rate products by establishing and monitoring limits as
to the types and degree of risks that may be undertaken. BBMC's exposure to
credit risk in the event of default by the counterparties for the options is
$20.2 million which was due at March 15, 1996.
BBMC's exposure to credit risk in the event of default by the counterparty for
mandatory forward commitments to sell mortgage loans is the difference between
the contract price and the current market price, offset by any available margins
retained by BBMC or an independent clearing agent. The amount of credit risk as
of March 15, 1996, if all counterparties failed completely and if the margins,
if any, retained by BBMC or an independent clearing agent were to become
unavailable, was approximately $16.1 million for mandatory forward commitments
of mortgage-backed securities.
47
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
The following is a summary of BBMC's notional amounts and fair values of
interest rate products as of December 31, 1994 and 1995, and March 15, 1996.
<TABLE>
<CAPTION>
December 31, 1994 December 31, 1995 March 15, 1996
Notional Estimated Notional Estimated Notional Estimated
Amount Fair Value(1) Amount Fair Value(1) Amount Fair Value(1)
-------------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Purchased commitments to sell mortgage loans:
Mandatory forward contracts ........................ $286,430 $4,413 $1,169,559 $(9,798) $941,087 $16,099
Options on mortgage-backed securities .............. 87,000 172 315,000 -- 653,000 7,607
Risk management contracts:
Purchased .......................................... 371,000 2,157 3,107,500 118,753 781,000 17,990
Sold ............................................... -- -- 295,000 (33,833) -- --
</TABLE>
- ------------
(1) Fair value represents the amount at which a given instrument could be
exchanged in an arms length transaction with a third party as of the
balance sheet date.
(2) See Note 14 for additional disclosures on fair value of financial
instruments.
Commitments to originate mortgage loans
BBMC regularly enters into commitments to originate mortgage loans at a future
date subject to compliance with stated conditions. Commitments to originate
mortgage loans have off-balance sheet risk to the extent BBMC does not have
matching commitments to sell loans, which exposes BBMC to lower of cost or
market valuation adjustments in a rising interest rate environment.
Additionally, the extension of a commitment, which is subject to BBMC's credit
review and approval policies, gives rise to credit exposure when certain
borrowing conditions are met and the loan is made. Until such time, it
represents only potential exposure. The obligation to lend may be voided if the
customer's financial condition deteriorates or if the customer fails to meet
certain conditions. Commitments to originate mortgage loans do not necessarily
reflect future cash requirements since some of the commitments are expected to
expire without being drawn upon. Commitments to originate mortgage loans totaled
$194.5 million at December 31, 1994, $885.6 million at December 31, 1995 and
$956.4 million at March 15, 1996.
Mortgage loans sold with recourse
BBMC sells mortgage loans with recourse to various investors and retains the
servicing rights on these loans. The total outstanding balance of loans sold
with recourse does not necessarily represent future cash outflows. The total
outstanding principal balance of loans sold with recourse was $9.0 million at
December 31, 1994, $6.8 million at December 31, 1995 and $7.0 million at March
15, 1996.
Servicing commitments to investors
BBMC is required to submit to certain investors, primarily GNMA, guaranteed
principal and interest payments from the underlying mortgage loans regardless of
actual collections.
Purchase mortgage servicing rights commitments
BBMC routinely enters into commitments to purchase mortgage servicing rights
associated with mortgages originated by third parties, subject to compliance
with stated conditions. These commitments to purchase mortgage servicing rights,
correspond to mortgage loans having an aggregate loan principal balance of
approximately $2.7 billion at December 31, 1995 and $0.9 billion at March 15,
1996.
Geographical concentration of credit risk
BBMC is engaged in business nationwide and has no material concentration of
credit risk in any geographic region.
13. OTHER RELATED PARTY TRANSACTIONS
BBMC services mortgage loans for Bank of Boston and its affiliates. The balances
of those portfolios totaled $3.3 billion, $2.0 billion and $2.0 billion at
December 31, 1994 and 1995 and March 15, 1996, respectively. Related servicing
fees are included in mortgage servicing fees and were $8.4 million, $7.6 million
and $1.2 million for the year ended December 31, 1994, 1995 and for the period
January 1, 1996 to March 15, 1996, respectively.
BBMC reimburses Bank of Boston and its affiliates for certain occupancy and
supplies costs. Total costs reimbursed were $0.7 million for the year ended
December 31, 1994, 1995 and $0.2 million for the period January 1, 1996 to March
15, 1996.
BBMC services real estate acquired by the Bank of Boston and its affiliates.
Related expenses are reimbursed and were $2.1 million and $1.7 million for the
years ended December 31, 1994, 1995 and $1.7 million for the period January 1,
1996 to March 15, 1996.
An affiliate of Bank of Boston purchases a 99.25% participation in mortgages in
the process of being sold to permanent investors. The principal balances sold
under this agreement aggregated approximately $3.6 billion and $6.5 billion for
the year ended December 31, 1994 and 1995, respectively, and $0.7 billion for
the period January 1, 1996 to March 15, 1996.
BBMC purchased mortgage servicing rights from Bank of Boston during 1995 and
capitalized $4.8 million in mortgage servicing rights associated with this
transaction.
48
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
Notes to Consolidated Financial Statements (Continued)
BBMC sold mortgage loans to Bank of Boston and its affiliates in its normal
course of business. These sales totaled $0.4 billion and $0.5 billion for the
years ended December 31, 1994 and 1995, respectively and $0.6 billion for the
period January 1, 1996 to March 15, 1996. Included in mortgage loans held for
sale are loans which will be sold to Bank of Boston and its affiliates totaling
$94.5 million and $18.1 million at December 31, 1994 and 1995, respectively, and
$64.1 million at March 15, 1996.
Miscellaneous administrative services are provided by related companies. These
services did not have a material impact on the consolidated financial
statements.
14. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires
disclosure of fair value information about financial instruments whether or not
recognized in the balance sheet, for which it is practicable to estimate fair
value.
Financial instruments include such items as mortgage loans held for sale,
mortgage loans held for investment, interest rate contracts, notes payable, and
other instruments.
Fair value estimates are made as of a specific point in time based on the
characteristics of the financial instruments and the relevant market
information. Where available, quoted market prices are used. In other cases,
fair values are based on estimates using other valuation techniques, such as
discounting estimated future cash flows using a rate commensurate with the risks
involved or other acceptable methods. These techniques involve uncertainties and
are significantly affected by the assumptions used and the judgments made
regarding risk characteristics of various financial instruments, prepayments,
discount rates, estimates of future cash flows, future expected loss experience,
and other factors. Changes in assumptions could significantly affect these
estimates. Derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in an immediate
sale of the instrument. Also, because of differences in methodologies and
assumptions used to estimate fair value, BBMC's fair values should not be
compared to those of other companies.
Under the Statement, fair value estimates are based on existing financial
instruments without attempting to estimate the value of anticipated future
business and the value of assets and liabilities that are not considered
financial instruments. Accordingly, the aggregate fair value amounts presented
do not represent the underlying value of BBMC. For certain assets and
liabilities, the information required under the Statement is supplemented with
additional information relevant to an understanding of the fair value.
The methods and assumptions used to estimate the fair values of each class of
financial instruments are as follows:
Cash
The carrying amount reported in the balance sheet approximates fair value.
Mortgages held for sale
Fair values are based on the estimated value at which the loans could be sold in
the secondary market. These loans are priced to be sold with servicing rights
retained, as is BBMC's normal business practice.
Mortgages held for investment
Fair value is estimated using market quotes for securities backed by similar
loans or by discounting contractual cash flows, adjusted for credit risk and
prepayment estimates. These loans are priced with servicing rights retained.
Discount rates are obtained from secondary market sources.
Accounts receivable, pool loan purchases, and mortgage claims
receivable, net
Carrying amounts are considered to approximate fair value. All amounts that are
assumed to be uncollectible within a reasonable time are written off.
Excess mortgage servicing receivable
Fair value is based on the present value of expected future net cash flows and
the current estimated servicing life.
Risk management contracts
Fair values are estimated based on actual market quotes or option models.
Note payable to Bank of Boston
The carrying amount of the note payable to Bank of Boston reported in the
balance sheet approximates its fair value.
Long-term debt
Fair value of long-term debt is estimated by discounting estimated future cash
flows using a rate commensurate with the risks involved.
Commitments to originate mortgage loans
Fair value is estimated using quoted market prices for securities backed by
similar loans adjusted for differences in loan characteristics.
Forward contracts to sell mortgages
Forward contracts to sell mortgages, which represent legally binding agreements
to sell loans to permanent investors at a specified price or yield, are valued
using market prices for securities backed by similar loans and are reflected in
the fair values of the mortgages held for sale, to the extent that these
commitments relate to mortgage loans already originated, or of the related
commitments to extend credit.
Options on mortgage-backed securities
The fair values of options are estimated based on actual market quotes. In some
instances, quoted prices for the underlying loans or option models are used.
49
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc.-- Note 1)
<PAGE>
The estimated fair values of BBMC's financial instruments are as follows:
<TABLE>
<CAPTION>
December 31, 1994 December 31, 1995 March 15, 1996
Carrying Carrying Carrying
Amount Fair Value Amount Fair Value Amount Fair Value
-----------------------------------------------------------------------------
(In thousands)
ASSETS
<S> <C> <C> <C> <C> <C> <C>
Cash ............................................... $ 5,653 $ 5,653 $ 830 $ 830 $ 23,216 $ 23,216
Mortgages held for sale ............................ 271,215 272,535 388,436 395,984 628,504 633,993
Mortgages held for investment ...................... 28,589 26,988 33,183 35,003 65,068 65,068
Accounts receivable ................................ 66,763 66,763 82,816 82,816 65,599 65,599
Pool loan purchases ................................ 77,477 77,477 65,272 65,272 56,261 56,261
Mortgage claims receivable ......................... 48,835 48,835 45,422 45,422 17,563 17,563
Excess mortgage servicing receivable ............... 15,333 20,700 17,447 19,117 20,393 23,100
Risk management contracts, classified as
PMSR, and other assets(2) ........................ 3,727 2,157 84,520 84,920 20,169 20,169
LIABILITIES
Note payable to Bank of Boston ..................... 779,021 779,021 966,000 966,000 1,256,000 1,256,000
Long-term debt ..................................... 14,007 13,853 13,816 16,211 13,790 21,695
OFF-BALANCE SHEET(1)
Commitments to originate mortgage loans ............ (1,455) 1,094 -- 27,250
Mandatory forward contracts
to sell mortgages(2) ............................. 4,413 (9,798) -- 16,099
Options on mortgage-backed securities(2) ........... 172 -- -- 7,607
Risk management contracts .......................... (6,998) -- -- --
</TABLE>
- ------------
(1) Parentheses denote a liability
(2) See Note 12 for additional disclosures on notional amounts
Fair value estimates are made as of a specific point in time, based on relevant
market data and information about the financial instrument. These estimates do
not reflect any premium or discount that could result from offering for sale
BBMC's entire holding of a particular financial instrument. Because no active
market exists for some portion of BBMC's financial instruments, fair value
estimates are based on judgments regarding future expected loss experience,
current economic conditions, current interest rates and repayment trends, risk
characteristics of various financial instruments, and other factors.
These estimates are subjective in nature and involve uncertainties and matters
of significant judgment and, therefore, cannot be determined with precision.
Changes in any of these assumptions used in calculating fair value would also
significantly affect the estimates. Further, the fair value estimates were
calculated as of December 31, 1994 and 1995 and March 15, 1996. Changes in
market interest rates and prepayment assumption could significantly change the
fair value.
15. CONTINGENCIES
BBMC is a defendant in a number of legal proceedings arising in the normal
course of business. BBMC, in management's estimation, has recorded adequate
reserves in the financial statements for pending litigation. Management, after
reviewing all actions and proceedings pending against or involving BBMC,
considers that the aggregate liability or loss, if any, resulting from the final
outcome of these proceedings will not have a material effect on the financial
position or results of operations of BBMC.
During 1994, BBMC settled a class action lawsuit pertaining to escrow practices.
BBMC agreed to change its escrow calculations to the aggregate method and, as a
result, refunded approximately $45.0 million in excess escrow balance to
mortgagors. In addition, BBMC paid interest on these excess funds in the amount
of approximately $1.3 million. The change in escrow calculations did not have a
material impact on the consolidated financial statements.
50
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc.--Note 1)
<PAGE>
Notes to Consolidated Financial Statements (continued)
16. ACQUISITION OF BELL MORTGAGE
On June 1, 1995, BBMC purchased the assets and liabilities of Bell Mortgage
Company (Bell Mortgage), a privately-held mortgage origination company located
in Minneapolis, Minnesota, for $0.9 million in cash. The acquisition of Bell
Mortgage was accounted for as a purchase. Accordingly, the purchase price was
allocated to net assets acquired based upon their estimated fair market value.
As of a result of the acquisition, goodwill of $0.4 million was recorded and is
being amortized over a 7-year period using the straight-line method.
Also, under the terms of the agreement, the shareholders of Bell Mortgage will
receive additional contingent cash payments based on Bell Mortgage reaching
specific performance goals over the next 3 years. These additional cash payments
will be recorded as additions to goodwill and will be amortized over the
remainder of the original 7-year period using the straight-line method.
Results of operations after the acquisition date are included in the
consolidated financial statements. Pro forma financial results would not have
been materially different as a result of this acquisition.
BancBoston Mortgage Corporation
(Acquired by HomeSide, Inc. on March 15, 1996 and no
known as HomeSide Lending, Inc.--Note 1)
- --------------------------------------------------------------------------------
Reports of Independent Certified Public Accountants
To the Board of Directors of
BancBoston Mortgage Corporation:
We have audited the accompanying consolidated balance sheet of BancBoston
Mortgage Corporation and subsidiaries (see Note 1) as of March 15, 1996, and the
related consolidated statements of operations and retained earnings and cash
flows for the period from January 1, 1996 to March 15, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of BancBoston
Mortgage Corporation and subsidiaries as of March 15, 1996 and the consolidated
results of their operations and their cash flows for the period from January 1,
1996 to March 15, 1996, in conformity with generally accepted accounting
principles.
/s/ Arthur Andersen LLP
- -----------------------
Jacksonville, Florida
March 14, 1997
51
<PAGE>
Reports of Independent Certified Public Accountants
The Board of Directors
BancBoston Mortgage Corporation
We have audited the accompanying consolidated balance sheets of BancBoston
Mortgage Corporation as of December 31, 1994 and 1995, and the related
consolidated statements of operations and retained earnings and cash flows for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of BancBoston
Mortgage Corporation as of December 31, 1994 and 1995, and the consolidated
results of their operations and their cash flows for the years then ended, in
conformity with generally accepted accounting principles.
As discussed in Notes 2, BancBoston Mortgage Corporation also changed its method
of accounting for mortgage servicing fee income, effective January 1, 1994.
/s/Coopers & Lybrand L.L.P.
- ----------------------------
Jacksonville, Florida
January 18, 1996, except
for the second paragraph
of Note 1 and the fifth
paragraph of Note 2, as to
which the date is March 4, 1996
- --------------------------------------------------------------------------------
HomeSide, Inc.
Market for the Registrant's Common Equity and
Related Stockholder Matters
HomeSide's common stock is listed on the New York Stock Exchange ("NYSE") under
the symbol HSL. As of February 28, 1997, there were 86 shareholders of record of
the Company's commonstock. Class C common stock has no voting rights and is not
publicly traded. There was 1 shareholder of record of Class C common stock as of
February 28, 1997.
Common stock of HomeSide, Inc. was initially sold to the public on January 30,
1997, and the transaction closed on February 5, 1997. The high and low sales
prices as reported by the NYSE for the Company's stock from January 31, 1997 to
February 28, 1997 was $19 and $161/8, respectively.
During the fiscal year ended February 28, 1997, no dividends were declared or
paid on HomeSide's common stock.
52
HomeSide, Inc.
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> FEB-28-1997
<PERIOD-END> FEB-28-1997
<CASH> 52,691,000
<SECURITIES> 0
<RECEIVABLES> 157,518,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,722,667,000
<PP&E> 33,984,000
<DEPRECIATION> 4,469,000
<TOTAL-ASSETS> 2,752,182,000
<CURRENT-LIABILITIES> 2,239,886,000
<BONDS> 0
0
0
<COMMON> 531,000
<OTHER-SE> 511,765,000
<TOTAL-LIABILITY-AND-EQUITY> 2,752,182,000
<SALES> 0
<TOTAL-REVENUES> 217,076,000
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 144,394,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 72,682,000
<INCOME-TAX> 29,273,000
<INCOME-CONTINUING> 43,409,000
<DISCONTINUED> 0
<EXTRAORDINARY> 6,440,000
<CHANGES> 0
<NET-INCOME> 36,969,000
<EPS-PRIMARY> 1.13
<EPS-DILUTED> 1.13
</TABLE>