FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark one)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES AND EXCHANGE ACT OF 1934
For the quarterly period ended November 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 333-06737
HomeSide, Inc.
(Exact name of registrant as specified in its charter)
Delaware 59-3387041
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7301 Baymeadows Way, Jacksonville, FL 32256
(Address of principal executive offices) (Zip Code)
(904) 281-3000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports 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 __ No _x_
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
HOMESIDE, INC.
UNAUDITED CONSOLIDATED BALANCE SHEET
(Dollars in Thousands, Except Share Data)
(Unaudited)
November 30, 1996
-----------------
ASSETS
Cash and cash equivalents $ 1,183
Mortgage loans held for sale, net 1,101,229
Mortgage servicing rights receivable, net 1,339,819
Accounts receivable 173,145
Premises and equipment, net 29,221
Other assets 214,114
----------
Total Assets $2,858,711
==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable to banks $2,010,813
Accounts payable and accrued liabilities 141,555
Deferred income taxes payable 97,139
Long term debt 221,278
----------
Total Liabilities 2,470,785
Common stock:
Common stock, $.01 par value, 119,610,000 shares authorized and
34,825,792 shares issued and outstanding 348
Class B non-voting common stock, $.01 par value, 195,000 shares
authorized, and 97,138 shares issued and outstanding 1
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 360,054
Retained earnings 29,276
---------
389,776
Less: Notes received in payment for capital stock (1,850)
----------
Total Stockholders' Equity 387,926
Total Liabilities and Stockholders' Equity $2,858,711
==========
<PAGE>
HOMESIDE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Thousands)
(Unaudited)
For the
For the Three Period From
Months Ended March 16, 1996 to
November 30, 1996 November 30, 1996
----------------- -----------------
REVENUES:
Mortgage servicing fees $ 91,636 $ 216,470
Amortization of mortgage servicing rights (48,831) (105,737)
-------- ---------
Net servicing revenue 42,805 110,733
Interest income 25,241 60,230
Interest expense (22,321) (61,203)
-------- --------
Net interest expense 2,920 (973)
Net mortgage origination revenue 16,521 43,604
Other income 79 541
-------- --------
Total revenue 62,325 153,905
EXPENSES:
Salaries and employee benefits 20,650 53,307
Occupancy and equipment 3,337 8,267
Servicing losses on investor-owned loans 4,957 12,953
Other expenses 11,711 29,579
-------- --------
Total expenses 40,655 104,106
Income before income taxes 21,670 49,799
Income tax expense 9,015 20,523
-------- --------
Net income 12,655 29,276
Retained earnings at beginning of period 16,621 --
-------- --------
Retained earnings at end of period $ 29,276 $ 29,276
======== ========
<PAGE>
<TABLE>
HOMESIDE, INC.
UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
<CAPTION>
For the Period From
March 16, 1996 to
November 30, 1996
-----------------
CASH FLOWS USED IN OPERATING ACTIVITIES:
<S> <C>
Net income $ 29,276
Amortization 108,818
Depreciation 3,178
Servicing losses on investor-owned loans 12,953
Deferred income tax expense 20,523
Capitalized excess servicing rights (16,373)
Mortgage loans originated and purchased for sale (9,081,815)
Proceeds and principal repayments of mortgage loans held for sale 8,853,510
Change in accounts receivable (78,235)
Change in other assets and accounts payable and accrued liabilities (33,624)
----------
Net cash used in operating activities (181,789)
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of premises and equipment (3,354)
Acquisition of mortgage servicing rights (344,288)
Net purchases of risk management contracts (88,438)
Acquisition of BBMC, net of cash acquired (133,392)
Acquisition of BMC, net of cash acquired (106,244)
-----------
Net cash used in investing activities (675,716)
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Net borrowings from banks 526,480
Issuance of bridge financing 90,000
Repayment of bridge financing (90,000)
Issuance of notes 200,000
Payment of debt issue costs (20,290)
Repayment of long term debt (417)
Proceeds from issuance of common stock 152,915
-----------
Net cash provided by financing activities 858,688
Net increase in cash 1,183
Cash and cash equivalents at beginning of period --
-----------
Cash and cash equivalents at end of period $ 1,183
===========
</TABLE>
<PAGE>
HOMESIDE, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
- -------------------------
The accompanying unaudited consolidated financial statements of HomeSide,
Inc. ("HomeSide" or the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
in accordance with Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management of the Company,
all material adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the
period from March 16, 1996 (date operations began) to November 30, 1996 and the
three months ended November 30, 1996 are not necessarily indicative of the
results that may be expected for the fiscal year ended February 28, 1997.
The accompanying interim financial statements of HomeSide have been prepared
for the period March 16, 1996 to November 30, 1996 to coincide with the
commencement of operations of HomeSide as discussed in "ORGANIZATION" below and
the end of the Company's third fiscal quarter based on a February 28 year end.
The financial statements for the third quarter of fiscal 1997 include the period
September 1, 1996 to November 30, 1996. The financial statements presented
include the results of operations of the Company's wholly-owned operating
subsidiary, HomeSide Lending, Inc., and beginning June 1, 1996, the results of
operations of the servicing activities of Barnett Mortgage Company ("BMC")
acquired on May 31, 1996.
References to the first quarter of fiscal 1997 relate to the period March
16, 1996 to May 31, 1996. References to the second quarter of fiscal 1997 relate
to the three months ended August 31, 1996. References to the third quarter of
fiscal 1997 relate to the three months ended November 30, 1996. Year to date
operating results include the period March 16, 1996 to November 30, 1996.
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 ("BBMC") owned by Bank
of Boston. The transaction closed on March 15, 1996 and HomeSide began
operations on March 16, 1996 through its operating subsidiary, HomeSide Lending,
Inc.
<PAGE>
On May 31, 1996, Barnett Banks, Inc. ("Barnett") 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. For more information on these acquisitions see
Note 4.
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 has a risk management program in place to offset the risk that a
change in interest rates will result in a decrease in the value of HomeSide's
mortgage loan inventory and commitments to originate loans. To manage its
interest rate risk exposure, HomeSide enters into forward sales agreements and
purchases option contracts. These agreements and contracts are not considered
trading instruments and are primarily entered into for purposes of managing
interest rate risk relative to commitments to originate mortgage loans against
market value declines resulting from fluctuations in interest rates.
The cost of option contracts to manage HomeSide's fixed and variable rate
loan origination commitments are capitalized and amortized as an adjustment of
gain or loss on the sale of the loan over the life of the underlying option
contract. Unamortized premiums are included in other assets in the accompanying
consolidated balance sheet. HomeSide is not exposed to loss beyond its initial
outlay to acquire the option contract.
Risk Management of Mortgage Servicing Rights
Mortgage servicing rights are a significant asset of HomeSide and possess
economic value as they permit the owner to receive a portion of the interest
coupon from the mortgagor for performing specified servicing activities. Because
the underlying mortgage loan note permits the borrower to prepay the loan, the
value of the related servicing rights tends to diminish in periods of declining
interest rates and increase in value in periods of rising rates. This tendency
of the mortgage servicing rights portfolio to change in value with changes in
interest rates subjects HomeSide to substantial interest rate risk, which
directly affects the volatility of reported earnings as capitalized mortgage
servicing rights are carried at the lower of amortized cost or fair value. It is
the policy of HomeSide to mitigate this risk through its risk management
program.
Qualifying risk management instruments with a demonstrated ability to
mitigate this risk are used in this program. 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 HomeSide's
mortgage servicing rights.
To date, option contracts on U.S. Treasury bond futures have been purchased
to manage interest rate risk on HomeSide's mortgage servicing rights. These
option contracts are designated as hedges on the purchase date and such
designation must be 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 and recognized as an
adjustment to the cost of the related mortgage servicing right asset being
hedged. As a result, any changes in market value that are deferred are amortized
and evaluated for impairment in the same manner as the related mortgage
servicing rights. Correlation between changes in value of the option and changes
in the value of HomeSide's mortgage servicing rights is assessed on a quarterly
basis to ensure that high correlation is maintained over the term of the hedging
program.
At November 30, 1996, the carrying value of the risk management contracts
included in other assets was $162,351,000, the market value of the contracts.
Further, net gains on risk management contracts of $60,181,000 were deferred as
a component of mortgage servicing rights as of November 30, 1996. During the
third fiscal quarter, $133,348,000 of gains were deferred as a component of
mortgage servicing rights, which offset the deferred losses recorded as of the
end of the second fiscal quarter. Of the gains deferred during the third fiscal
quarter, $107,256,000 were realized. At any point in time, HomeSide's maximum
loss exposure on its option contracts is limited to the amount paid for such
contracts.
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.
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 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.
<PAGE>
Mortgage servicing rights
Mortgage servicing rights are initially recorded at fair value as of their
date of acquisition or origination. Purchased mortgage servicing rights ("PMSR")
represent the value of rights to service mortgage loans originated by others.
Originated mortgage servicing rights ("OMSR") represent the value of mortgage
servicing rights associated with mortgage loans originated by HomeSide. OMSR are
capitalized in accordance with Statement of Financial Accounting Standards No.
122, "Accounting for Mortgage Servicing Rights" ("SFAS 122"). Mortgage servicing
rights 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.
SFAS 122 also requires that capitalized mortgage servicing rights be
evaluated for impairment based on the fair value of these rights. For purposes
of determining impairment, HomeSide'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
and included in the amortization of mortgage servicing rights.
Mortgage servicing rights also includes excess mortgage servicing
receivables ("EMSR"), which represent 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.
The following table presents a breakdown of the components of mortgage
servicing rights at November 30, 1996:
(In thousands)
Mortgage servicing rights and excess servicing receivables $1,505,737
Deferred gains on risk management contracts, net (60,181)
----------
1,445,556
Less: Accumulated amortization (105,737)
----------
$1,339,819
==========
<PAGE>
Accounts receivable
Accounts receivable includes advances, consisting primarily of payments for
property taxes and insurance premiums, as well as principal and interest
remitted to investors before they are collected from mortgagors, made in
connection with loan servicing activities. Accounts receivable also includes
loans purchased from 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.
Deferred Charges
Included in other assets are deferred charges of $17,209,000, representing
costs incurred to obtain a $2.5 billion line of credit from an independent
syndicate of banks and costs incurred in the issuance of $200,000,000 of
long-term debt. The deferred charges are being amortized to interest expense
over the terms of the related line of credit (3 years) and long-term debt (7
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
HomeSide 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 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 the balance of accounts payable and accrued liabilities.
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.
Income taxes
HomeSide accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes." Under the
Statement, 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.
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 paid $139,500,000 in cash and issued $86,750,000 of common stock,
$.01 par value per share, of HomeSide ("Common Stock") to Bank of Boston in
consideration for certain assets, net of assumed liabilities and the stock of
BBMC. The Common Stock issued to Bank of Boston was assigned a value of $10.294
per share, the same per share amount paid by the Investors. On May 31, 1996,
HomeSide paid an additional $5,000,000 to Bank of Boston in connection with the
closing of the BMC acquisition. The transaction was accounted for under the
purchase method of accounting and, accordingly, the results of operations of
HomeSide Lending, Inc. are included from the date of purchase. The assets and
liabilities of BBMC were recorded by HomeSide at their fair values at March 15,
1996, which totaled $1,525,314,000 and $1,221,808,000, respectively. The total
purchase price paid for BBMC, including transaction costs and interest, was
$247,403,000. The excess of fair value of net assets acquired over cost was
$56,103,000 and was allocated entirely to mortgage servicing rights. The excess
is being amortized over the estimated servicing period in proportion to the
estimated future net cash flows from the loans serviced, in the same manner as
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, which was
subsequently renamed HomeSide Holdings, Inc. (the "BMC Acquisition"). HomeSide
Holdings, Inc. then became the parent company of HomeSide Lending, Inc. and
transferred all of the assets and liabilities of HomeSide Holdings, Inc., with
the exception of certain portions of HomeSide Holdings, Inc.'s GNMA servicing
rights, to HomeSide Lending, Inc. Certain assets and liabilities of BMC were
retained by Barnett, including those assets of BMC and its subsidiaries (other
than Honolulu Mortgage Company, Inc.) associated with the loan origination or
production activities of such entities.
HomeSide paid $228,234,000 in cash 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 11,461,400 shares of Common
Stock for an aggregate purchase price of $117,985,000, or $10.294 per share, the
same per share amount paid by the Investors and Bank of Boston. The transaction
was accounted for under 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 fair values at
May 31, 1996, which totaled $764,825,000 and $516,129,000, respectively. The
total purchase price paid for BMC, including transaction costs and interest, was
$235,432,000. The excess of fair value of net assets acquired over cost was
$13,264,000 and was allocated entirely to mortgage servicing rights. The excess
is being amortized over the estimated servicing period in proportion to the
estimated future net cash flows from the loans serviced, in the same manner as
mortgage servicing rights.
The assets acquired and liabilities assumed in each of the transactions
noted above have been recorded at their estimated fair value as of the date of
the acquisition. Changes in those estimates may affect the amounts recorded and
the resulting allocation of purchase price.
<PAGE>
Unaudited pro forma statements of operations for the year ended December 31,
1995 and the period from March 16, 1996 to November 30, 1996, assuming BBMC and
BMC had been acquired as of January 1, 1995, and assuming BMC had been acquired
as of March 15, 1996 are as follows (in millions):
Pro Forma Pro Forma Period
Year Ended March 16, 1996 to
December 31, 1995 November 30, 1996
------------------- ------------------
Net servicing revenue $ 237.4 $ 121.5
Net warehouse interest (expense) revenue (5.5) 0.7
Net mortgage origination revenue 0.7 44.6
Other income 0.7 0.6
------ ------
Total revenues 233.3 167.4
Expenses (144.1) (117.2)
------ ------
Income before income taxes 89.2 50.2
Income tax expense (36.5) (20.7)
------ ------
Net income $ 52.7 $ 29.5
====== ======
The purchase accounting adjustments in the above pro forma statements of
operations are based on the actual purchase price and the amount of assets
actually acquired. In addition, gains on sales of mortgage servicing rights are
not included in net servicing revenue in these pro forma results. No adjustments
have been made for restructuring costs that might have been incurred during the
periods presented or for cost efficiencies that might have been realized.
Accordingly, these pro forma results are not indicative of future results.
5. Notes Payable to Banks
- --------------------------
HomeSide borrows funds on a demand basis from a syndicate of banks under a
$2.5 billion line of credit collateralized by substantially all of HomeSide
Lending, Inc.'s assets. The line of credit is used to provide funds for HomeSide
Lending, Inc.'s business of making, originating, acquiring and servicing
mortgage loans. The line of credit includes both a warehouse credit facility and
servicing-secured credit facility, of which the servicing secured facility is
capped at $950 million. The line of credit terminates on May 31, 1999. The line
of credit agreement contains covenants that impose limitations and restrictions
on HomeSide, including the maintenance of certain net worth and ratio
requirements. The amount of the unused line of credit was $449,261,000 as of
November 30, 1996.
Drawings under the 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. As of November 30, 1996, the weighted average interest rate on
the amounts borrowed was 5.98%.
<PAGE>
6. Long Term Debt
- ------------------
On May 14, 1996, HomeSide issued $200,000,000 of 11.25% notes ("Notes")
maturing on May 15, 2003 and paying interest semiannually in arrears on May 15
and November 15 of each year, commencing on November 15, 1996. 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 accordance with
certain of these restrictions, effective August 15, 1996, the interest rate on
the Notes was increased to 11.75% until the exchange notes discussed below were
issued.
The Notes were initially issued as part of a private placement offering.
HomeSide filed a Form S-4 with the SEC to register notes, with terms identical
to the Notes, under the Securities Act of 1933 (such registered notes also
referred to herein as the "Notes"). The registration statement was declared
effective during October 1996. The exchange was completed on December 9, 1996.
HomeSide is in the process of registering common stock for issuance to the
public. A portion of the proceeds from such issuance, which is expected to be
completed during the fourth quarter of fiscal 1997, is to be used to repay
$70,000,000 in principal amount of the Notes prior to maturity. The indenture
governing the terms of the Notes requires that such repayment be made at a
11.25% premium. Therefore, HomeSide expects to record a loss from the early
extinguishment of debt during the fourth quarter of fiscal 1997. In addition,
the portion of deferred charges associated with the debt to be repaid will be
written-off and included in the determination of loss on early extinguishment of
debt. The total loss is estimated to be approximately $10,500,000, $6,500,000
net of tax, and will be recorded as an extraordinary item.
HomeSide also has a mortgage note payable on its headquarters building that
is due in 2017 and bears interest at 9.50%. HomeSide's main office building is
pledged as collateral. Principal payments due on the mortgage note payable are
as follows:
Fiscal Year (In thousands)
1997 $ 56
1998 234
1999 258
2000 283
2001 312
Thereafter 12,481
-------
$13,624
=======
<PAGE>
7. Stockholders' Equity
- ------------------------
On March 15, 1996, in connection with the BBMC acquisition discussed in Note
4, the Investors contributed cash of $107,250,000 for 10,418,569 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 $86,750,000.
Simultaneously with the closing of the BBMC acquisition, HomeSide also
issued 97,138 shares of its Class B Non-Voting Common Stock ("Class B shares")
to Smith Barney, Inc. in consideration of services rendered to HomeSide in
connection with the BBMC acquisition. Bank of Boston also paid $1,000,000 in
cash for 97,138 shares of HomeSide's Class C Non-Voting Common Stock ("Class C
shares"). 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 $46,015,000 in cash for 4,470,065
shares of Common Stock. In August 1996 and November 1996, another 19,448 shares
and 29,155 shares, respectively, were purchased by certain executives for
approximately $200,000 and $300,000, respectively. Approximately, $1,850,000 of
the amount contributed by certain directors and management was financed by
HomeSide Lending, Inc. and, accordingly, is reported as a reduction of
stockholders' equity of HomeSide. 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 $117,985,000.
The following is a breakdown of HomeSide's Common Stock ownership as of
November 30, 1996, including the effect of the BMC Acquisition:
Cash Shares
Contributed Issued
Bank of Boston $117,985,000 11,461,400
Barnett 117,985,000 11,461,400
Investors 117,985,000 11,461,400
Directors and management 4,545,000 441,592
------------ ----------
$358,500,000 34,825,792
============ ==========
HomeSide is in the process of registering 7,350,000 shares of Common Stock
(excluding the over-allotment option) for issuance to the public. The total
proceeds expected to be received from the issuance, net of underwriting fees,
and estimated expenses is $115,141,000 and will be used to repay a portion of
long-term debt, and reduce amounts outstanding under the bank credit agreement.
The issuance is expected to occur during the fourth quarter of fiscal 1997.
<PAGE>
8. Stock Options
- -----------------
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 in five equal installments in
arrears. During the period March 16, 1996 to November 30, 1996, 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 March 16, 1996 to
November 30, 1996, 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
since the exercise price was equal to the estimated fair value of the Common
Stock at the date of grant.
9. Supplemental Cash Flow Information
- --------------------------------------
During the period March 16, 1996 to November 30, 1996, HomeSide extended
loans totaling $1,850,000 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 $2,251,676,000 and $1,737,937,000, respectively. As part of the
purchase price of BBMC and BMC, HomeSide issued 8,427,138 shares of Common Stock
with a value of $86,750,000 and 11,461,400 shares of Common Stock with a value
of $117,985,000 to Bank of Boston and Barnett, respectively. In addition,
HomeSide issued 97,138 shares of Class B shares in exchange for certain services
performed in connection with the acquisition of BBMC. The Class B shares were
valued at $10.294 per share, or $1,000,000.
HomeSide paid $57,680,000 and $1,000 of interest and income taxes,
respectively, during the period ended November 30, 1996.
<PAGE>
10. 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 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.
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 the Company. 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 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.
<PAGE>
Accounts receivable
Carrying amounts are considered to approximate fair value. All amounts that
are assumed to be uncollectible within a reasonable time are written off.
Risk management contracts
Fair values are estimated based on actual market quotes or option models.
Notes payable to banks
The carrying amount of the notes payable to banks 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.
<PAGE>
Fair Value
The fair values of the Company's financial instruments as of November 30,
1996 are as follows:
Carrying Fair
Amount Value
ASSETS
Cash and cash equivalents $ 1,183 $ 1,183
Mortgage loans held for sale 1,101,229 1,101,229
Accounts receivable 173,145 173,145
Risk management contracts 162,351 162,351
Other assets 51,763 51,763
LIABILITIES
Notes payable to banks 2,010,813 2,010,813
Long-term debt 221,278 221,278
OFF-BALANCE SHEET(1)
Commitments to originate mortgage loans -- 20,836
Mandatory forward contracts to sell mortgages -- (19,954)
Options on mortgage-backed securities -- (391)
- ----------
(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 rates
and 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 November 30, 1996. Changes in market interest rates and
prepayment assumptions could significantly change the fair value.
<PAGE>
11. Risk Management of Financial Instruments
- ---------------------------------------------
As discussed in Note 3, HomeSide purchases options 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 November 30, 1996 is as follows:
Notional amount of U.S. Treasury bond future options $3.5 billion
Fair value of outstanding options $162.4 million
Cash requirements for HomeSide's option contracts are limited to the initial
premium paid. The amount of contracts purchased depends on certain factors, such
as interest rates 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 since the option contracts are traded on a national exchange, which
guarantees performance by the counterparty.
12. 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 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 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.
For five years following the consummation of the BMC Acquisition, which
occurred on May 31, 1996, Barnett is obligated to repurchase or reimburse
HomeSide for any credit losses related to $101.0 million of loans serviced with
recourse, which is less than 1.0% of HomeSide's total mortgage servicing
portfolio.
<PAGE>
13. Subsequent Events
- ----------------------
In December 1996 the Company filed a Registration Statement in connection with a
public offering of its Common Stock. Immediately prior to the effective date of
the Registration Statement (i) the Certificate of Incorporation of the Company
will be amended to change the title of the Company's Class A Common Stock to
Common Stock and to increase the number of shares of capital stock which the
Company is authorized to issue to 120.0 million shares of capital stock of which
119,610,000 shares will be Common Stock (voting), par value $.01 per share,
195,000 shares will be Class B Common Stock (non-voting), par value $.01 per
share and 195,000 shares will be Class C Common Stock (non-voting), par value
$1.00 per share; and (ii) the Company will effect a 17 for 1 split of its
capital stock in the form of a 1,600% stock dividend. Such stock split is
reflected throughout these Financial Statements.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
General
HomeSide, Inc. ("HomeSide" or the "Company") is a holding company, owning
100% of the outstanding common stock of HomeSide Holdings, Inc., which in turn
owns 100% of the outstanding common stock of HomeSide Lending, Inc. HomeSide 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 ("HLI") owned by
Bank of Boston. 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. ("Barnett") sold certain of its
mortgage banking operations ("HHI"), primarily its servicing portfolio and
proprietary mortgage banking software systems, to HomeSide. Barnett received
cash and an ownership interest in HomeSide. For more information on these
acquisitions see Note 4 of Notes to Consolidated Financial Statements. Since May
31, 1996, each of the Investors as a group, Bank of Boston and Barnett has owned
approximately one-third of HomeSide. Barnett Mortgage Company was subsequently
renamed HomeSide Holdings, Inc.
HomeSide has adopted a February 28 fiscal year end. The consolidated
financial statements of HomeSide have been prepared for the period March 16,
1996 to November 30, 1996 to coincide with the end of the Company's third
quarter of fiscal 1997. HomeSide did not have any operations prior to March 16,
1996. The purchase method of accounting was used for the HLI and HHI
acquisitions and, accordingly, assets acquired and liabilities assumed were
recorded at their estimated fair values at the date of acquisition.
Comparative financial statements for the same period in the prior year have
not been presented due to a lack of comparability between HomeSide and HLI and
HHI. As noted above, the assets acquired and liabilities assumed by HomeSide in
each of the acquisitions were recorded at their estimated fair values as of the
date of acquisition. As a result, HomeSide's operating results are not directly
comparable to HLI 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 HLI
and all of BMC's production channels were retained by Barnett. The results of
operations for the three months ended November 30, 1996 are, therefore, most
directly comparable to the results of operations for the three months ended
August 31, 1996. Results of operations prior to May 31, 1996 do not include the
results of operations of HHI, which was acquired by the Company 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 ("servicing retained" or
"servicing released," respectively).
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.
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 ("flow") or on a portfolio (group of loans) basis
("bulk" or "mini-bulk"). Prices for servicing rights are typically stated as a
multiple of the servicing fee or as a percentage of the outstanding UPB 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").
<PAGE>
The following operating statistics for HomeSide are presented to aid in
understanding the results of operations and financial condition of HomeSide for
the period March 16, 1996 to May 31, 1996, and each of the three months ended
August 31, 1996 and November 30, 1996 and the period March 16, 1996 to November
30, 1996. References to the first quarter of fiscal 1997 relate to the period
March 16, 1996 to May 31, 1996. References to the second quarter of fiscal 1997
relate to the three months ended August 31, 1996 and references to the third
quarter of fiscal 1997 relate to the three months ended November 30, 1996.
Loan Production Activities
<TABLE>
<CAPTION>
For the Period For the Three For the Three For the Period
March 16, 1996 Months Ended Months Ended March 16, 1996
to May 31, 1996 August 31, 1996 November 31, 1996 November 31, 1996
--------------- --------------- ----------------- -----------------
(dollars in millions)
<S> <C> <C> <C> <C>
Correspondent (includes BKB
and Barnett) $1,893 $2,950 $3,249 $ 8,092
Co-issue (a) 1,419 2,208 1,985 5,612
Broker 220 155 168 543
------ ------ ------ -------
Total wholesale 3,532 5,313 5,402 14,247
Direct 248 179 139 566
------ ------ ------ -------
Total purchases 3,780 5,492 5,541 14,813
Bulk acquisitions -- 4,073 -- 4,073
------ ------ ------ -------
Total purchases and acquisitions $3,780 $9,565 $5,541 $18,886
====== ====== ====== =======
- ----------
<FN>
(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.
</FN>
</TABLE>
During each of the second and third quarters of fiscal 1997, HomeSide's loan
production totaled approximately $5.5 billion. Total loan production increased
from $3.8 billion in the period March 16, 1996 to May 31, 1996 to $5.5 billion
for the three months ended August 31, 1996. This increase was due to the
additional production resulting from the acquisition of HHI on May 31, 1996 and
growth in HomeSide's existing wholesale channel. 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 Period
March 1, 1996 For the Three For the Three For the Period
to Months Ended Months Ended March 1, 1996 to
May 31, 1996 August 31, 1996 November 30, 1996 November 30, 1996
------------ --------------- ----------------- -----------------
(dollars in millions)
<S> <C> <C> <C> <C>
Balance at beginning
of period $42,907 $78,391 $85,835 $42,907
Acquisition of HHI 33,082 -- -- 33,082
Other additions 4,102 9,842 5,244 19,188
------- ------- ------- -------
Total additions 37,184 9,842 5,244 52,270
------- ------- ------- -------
Scheduled amortization 235 494 517 1,246
Prepayments 1,321 1,702 1,529 4,552
Foreclosures 130 137 106 373
Sale of servicing 14 65 221 300
------- ------- ------- -------
Total reductions 1,700 2,398 2,373 6,471
------- ------- ------- -------
Balance at end of period $78,391 $85,835 $88,706 $88,706
======= ======= ======= =======
</TABLE>
At November 30, 1996, HomeSide's servicing portfolio stood at $88.7 billion
compared to $85.8 billion at August 31, 1996, $78.4 billion at May 31, 1996 and
$42.9 billion at March 1, 1996. The number of loans being serviced at November
30, 1996 was 1,085,000, compared to 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 of $12.7 million during the third quarter of
fiscal 1997 compared to net income of $10.1 million during the second quarter of
fiscal 1997 and $6.6 million during the first quarter of fiscal 1997. Net income
for the period March 16, 1996 to November 30, 1996 was $29.3 million. Total
revenue for the third quarter of fiscal 1997 was primarily comprised of net
servicing revenue of $42.8 million, net interest revenue of $2.9 million, and
net mortgage origination revenue of $16.5 million. These revenues were partially
offset by operating expenses of $40.7 million and income taxes of $9.0 million.
The primary reason for the growth in revenues was increased net interest revenue
during the third quarter of fiscal 1997 as compared to the second quarter of
fiscal 1997. Higher average balances of mortgage loans held for sale during the
third fiscal quarter compared to the second fiscal quarter contributed to the
$3.0 million increase in interest income. Lower short-term interest rates and
the improved pricing on borrowings under the Bank Credit Agreement lowered the
interest expense for third quarter of fiscal 1997 compared to the second fiscal
quarter.
<PAGE>
HomeSide reported net income of $10.1 million during the second quarter of
fiscal 1997 compared to net income of $6.6 million during the first quarter of
fiscal 1997. Total revenue for the second quarter was primarily comprised of net
servicing revenue of $42.9 million and net mortgage origination revenue of $16.3
million. These revenues were partially offset by operating expenses of $40.8
million, net interest expense of $1.7 million and income tax expense of $7.0
million. The primary reason for the increase in revenues and expenses during the
second quarter as compared to the first quarter was the acquisition of HHI on
May 31, 1996. Results of operations for HHI are included from the date of
acquisition and, therefore, are not included in HomeSide's first quarter of
fiscal 1997 results.
Net Servicing Revenue
During the third quarter of fiscal 1997, HomeSide had net servicing revenue
of $42.8 million, compared to net servicing revenue of $42.9 million during the
second quarter of fiscal 1997. Net servicing revenue during the third quarter of
fiscal 1997 was comprised of mortgage servicing fees of $91.6 million, offset by
mortgage servicing rights amortization of $48.8 million. Mortgage servicing 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 during the third
quarter of fiscal 1997 was 0.368% compared to 0.367% during the second quarter
of fiscal 1997. Amortization of mortgage servicing rights is recorded over the
estimated servicing period in proportion to estimated servicing revenue and
increased from $40.5 million in the second quarter of fiscal 1997 to $48.8
million in the third quarter of fiscal 1997 as a result of a higher average
servicing portfolio balance and higher projected mortgage loan prepayment
speeds.
During the second quarter of fiscal 1997, HomeSide had net servicing revenue
of $42.9 million, compared to net servicing revenue of $25.0 million during the
first quarter of fiscal 1997. Net servicing revenue during the second quarter of
fiscal 1997 was comprised of mortgage servicing fees of $83.3 million, offset by
mortgage servicing rights amortization of $40.5 million. HomeSide's weighted
average servicing fee during the second quarter of fiscal 1997 was 0.367%
compared to 0.389% during the first quarter of fiscal 1997. The decrease in the
weighted average servicing fee was due to the servicing rights acquired from
HHI. These servicing rights generally had lower servicing fees due to the lower
proportion of government loans in HHI's servicing portfolio. Amortization of
mortgage servicing rights is recorded over the estimated servicing period in
proportion to estimated servicing revenue and increased from $16.4 million in
the first quarter of fiscal 1997 to $40.5 million in the second quarter of
fiscal 1997 as a result of a higher average servicing portfolio.
<PAGE>
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 March 16, 1996 to November 30, 1996, 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.
These option contracts are designated as hedges on the purchase date and
such designation must be 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 and recognized as an
adjustment to the cost of the related mortgage servicing right asset being
hedged. As a result, any 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 option 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 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 since the loss on the
options is limited to the premium paid.
Since HomeSide's inception, cumulative gains and losses on risk management
contracts resulted in a $60.2 million net gain which reduced the cost basis of
mortgage servicing rights at November 30, 1996. Of the $60.2 million of net
gains included in the carrying value of HomeSide's mortgage servicing rights
portfolio, $133.3 million of gains occurred during the third quarter of fiscal
1997 and offset deferred losses of $74.7 million recorded during the first and
second quarters of fiscal 1997. 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 November 30, 1996 was $162.4
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 10 and
11 of Notes to Consolidated Financial Statements for additional fair value
disclosures with respect to HomeSide's risk management contracts.
Net Interest Expense
Net interest expense was $1.7 million during the second quarter of fiscal
1997 compared to net interest revenue of $2.9 million during the third quarter
of fiscal 1997. Net interest revenue during the third quarter of fiscal 1997 was
comprised of interest income of $25.2 million, which was offset by interest
expense of $22.3 million on the Company's borrowings. Interest income and
expense during the second quarter of fiscal 1997 were $22.3 million and $23.9
million, respectively. The increase in interest income during the third quarter
of fiscal 1997 was the result of an increase in the average balance of loans
held for sale from $1.3 billion in the second quarter of fiscal 1997 to $1.4
billion during the third quarter of fiscal 1997. Interest expense decreased from
$23.9 million in the second quarter of fiscal 1997 to $22.3 million during the
third quarter of fiscal 1997. Lower short-term interest rates and the improved
pricing on borrowings under the Bank Credit Agreement contributed to this
reduction.
Net interest expense decreased from $2.2 million during the first quarter of
fiscal 1997 to $1.7 million during the second quarter of fiscal 1997, or 23%.
Net interest expense during the second quarter was comprised of interest income
of $22.3 million and was exceeded by interest expense of $23.9 million on the
Company's borrowings. Interest income and expense during the first quarter of
fiscal 1997 were $12.7 million and $15.0 million, respectively. The increases in
interest income and interest expense during the second quarter are the result of
an increase in the average balance of mortgage loans held for sale from $770
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. HomeSide's acquisition of HHI on May 31,
1996 generally 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 expense during the second quarter also included $5.7
million of interest incurred on the $200.0 million principal amount of Notes
issued on May 15, 1996. Interest expense on the Notes during the first quarter
of fiscal 1997 was $2.3 million. First quarter interest expense also included
interest on $90.0 million of bridge financing, which was outstanding from March
16, 1996 to May 15, 1996 and incurred interest at 9.25%. The bridge financing
was paid off with a portion of the proceeds from the Notes. The Company intends
to use a portion of the proceeds of the Offering (see Note 13 of Notes to
Consolidated Financial Statements) to retire $70.0 million principal amount of
the Notes. See "Use of Proceeds."
<PAGE>
Net Mortgage Origination Revenue
Net mortgage origination revenue was $16.5 million during the third quarter
of fiscal 1997 compared to $16.3 million during the second quarter of fiscal
1997, a $0.2 million increase. 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 correspondents for the review of loan documents. Net
mortgage origination revenue also includes gains from excess mortgage servicing
receivables. As noted above, loan production, exclusive of bulk servicing
acquisitions, was $5.5 billion for the third quarter of fiscal 1997, slightly
higher than the second quarter of fiscal 1997 loan production, excluding bulk
acquisitions. HomeSide's primary origination activities during the second and
third quarters of fiscal 1997 took place through correspondent and co-issue
channels. Currently, HomeSide expects these channels to continue to be the
primary loan origination sources in the future.
Net mortgage origination revenue was $16.3 million during the second quarter
of fiscal 1997 compared to $10.8 million during the first quarter of fiscal
1997, a 51% increase. As noted above, loan production, exclusive of bulk
servicing acquisitions, was $5.5 billion for the second quarter of fiscal 1997,
$1.7 billion, or 45% higher than the first fiscal quarter loan production of
$3.8 billion. The increase in loan production is reflective of the production
from the preferred seller relationship with HHI established as part of the HHI
Acquisition. HomeSide's primary origination activities during the first and
second quarters of 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 decreased $0.5 million, or 2.5%, from
$21.2 million in the second quarter of fiscal 1997 to $20.7 million during the
third quarter of fiscal 1997. The decrease was due to the continuing integration
of the Barnett servicing operations. The average number of full time equivalent
employees fell from 1,879 during the second quarter of fiscal 1997 to 1,708
during the third quarter of fiscal 1997.
Salaries and employee benefits expense increased $9.7 million, or 84%, from
$11.5 million in the first quarter of fiscal 1997 to $21.2 million during the
second quarter of fiscal 1997. The increase was due to growth in the number of
employees as a result of the acquisition of HHI 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.
<PAGE>
Occupancy and Equipment Expense
Occupancy and equipment expense increased $0.2 million from $3.1 million
during the second quarter of fiscal 1997 to $3.3 million during the third
quarter of fiscal 1997. 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 increased $1.3 million, or 67%, from $1.8
million during the first quarter to $3.1 million during the second quarter of
fiscal 1997. The increase in occupancy and equipment expense was due to certain
premises and equipment acquired from HHI and increases in information systems
required to handle the growing mortgage servicing portfolio.
Servicing Losses on Investor-Owned Loans
Servicing losses on investor-owned loans increased from $4.1 million for the
second quarter of fiscal 1997 to $5.0 million for the third quarter of fiscal
1997, a 22% increase. Servicing losses on investor-owned loans primarily
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, and estimates for
potential losses based on HomeSide's experience as a servicer of government
loans.
Servicing losses on investor-owned loans increased slightly from $3.9
million for the first quarter of fiscal 1997 to $4.1 million for the second
quarter of fiscal 1997, a 3% increase.
Included in the balance of accounts payable and accrued liabilities at
November 30, 1996 is a reserve for estimated servicing losses on investor-owned
loans of $21.6 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.
Other Expense
Other expense decreased $0.8 million from $12.5 million for the second
quarter of fiscal 1997 to $11.7 million during the third quarter of fiscal 1997.
Other expense consists mainly of professional fees, communications expense,
advertising and public relations and certain loan origination expenses. The
level of other expense will fluctuate in part based upon the level of HomeSide's
mortgage servicing portfolio and loan production volumes. Future production
levels are dependent on the level of long-term interest rates and other economic
factors, which are difficult to accurately predict.
Other expense increased $7.2 million from $5.3 million for the first quarter
of fiscal 1997 to $12.5 million during the second quarter of fiscal 1997.
Provision for Income Taxes
HomeSide's provision for income taxes was $9.0 million during the third
quarter of fiscal 1997, an increase of $2.0 million over the $7.0 million
provision recorded during the second quarter of fiscal 1997. The provision for
income taxes for the period March 16, 1996 to May 31, 1996 was $4.6 million. The
effective income tax rates for the first, second and third quarters of fiscal
1997 was approximately 41%.
Liquidity and Capital Resources
Operations
Net cash used in operations was $181.8 million for the period March 16, 1996
to November 30, 1996. The primary uses of cash in operations were to fund loan
originations and pay corporate expenses. These uses of cash were partially
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 $675.7 million during the period
March 16, 1996 to November 30, 1996. 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 the Company's
hedging program. During the period March 16, 1996 to November 30, 1996, HomeSide
also used cash of $133.4 million and $106.2 million to purchase certain mortgage
banking operations of HLI and HHI, 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 the Company'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.
<PAGE>
Financing
During the period March 16, 1996 to November 30, 1996, HomeSide had $858.7
million of net cash provided by financing activities. The primary sources of
cash from financing activities during the period were $152.8 million from the
issuance of common stock of HomeSide, the issuance of $200.0 million of Notes
and increases in the Company's line of credit borrowings. Cash used in financing
activities was used to repay a $90.0 million bridge loan and the payment of debt
issue costs related to the Notes and the Bank Credit Agreement.
The bridge financing was used to finance a portion of the HLI Acquisition
and was repaid with a portion of the proceeds from the Notes. The Notes were
issued on May 14, 1996, pay interest semiannually at 11.25% and are due May 15,
2003. Proceeds of $87.5 million were held in escrow until the close of the HHI
Acquisition and an additional $6.5 million were used to pay underwriting fees
and expenses. During the third quarter of fiscal 1997, the Notes were registered
under the Securities Act. The holders have exchanged unregistered Notes for
registered Notes. The registered Notes are identical in all respects to the
terms of the unregistered Notes, except that the registered Notes will generally
be freely transferable by the holders thereof. The registered Notes will be
recorded at the carrying value of the unregistered Notes that were exchanged.
The proceeds from common stock issuances were received upon the close of the HLI
Acquisition on March 15, 1996. Additional proceeds were received upon the
issuance of stock as part of the HHI Acquisition on May 31, 1996. For additional
information regarding the Notes and the issuance of common stock, see Notes 6
and 7 of Notes to Consolidated Financial Statements.
Cash from financing activities was also provided by the three-year senior
secured revolving credit facility that was entered into by certain of HomeSide's
subsidiaries on March 15, 1996 and re-issued as part of the Bank Credit
Agreement on May 31, 1996. The line of credit is subject to a $2.5 billion limit
and is secured by primarily all of the assets of HomeSide. The $2.5 billion
commitment is comprised of a servicing secured credit facility, capped at $950
million, and a warehouse loan commitment. Drawings under the 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. Cash provided by the
Company's line of credit facility 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 credit facility. In future
periods, it is expected that cash financing needs will primarily be met from
drawings on the credit facility as opposed to further issuances of notes or
common stock.
<PAGE>
HomeSide does not expect to pay dividends for the foreseeable future. The
ability of HomeSide to pay dividends is restricted by covenants in the indenture
governing the Notes. See "Description of the Notes." The ability of HomeSide's
subsidiaries to pay dividends to HomeSide is restricted by covenants contained
in the Bank Credit Agreement.
During the period March 16, 1996 to November 30, 1996, net cash used in
operations and investing activities was $181.8 million and $675.7 million,
respectively, while cash provided by financing activities was $858.7 million,
resulting in a net increase in cash of $1.2 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.
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 servicing rights portfolio 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.
New Accounting Standard
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS
125"). This Statement, among other things, provides accounting and reporting
standards for transfers and servicing of financial assets and extinguishments of
liabilities. SFAS 125 requires that after a transfer of financial assets, an
entity recognize the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished. SFAS 125 also
requires that liabilities and derivatives incurred or obtained by transferors as
part of a transfer of financial assets be initially measured at fair value. This
Statement is effective for transfers and servicing of financial assets and
extinguishment of liabilities occurring after December 31, 1996 and is to be
applied prospectively. Management expects that the impact of this Statement on
the results of operations, financial condition, or liquidity of HomeSide will be
immaterial.
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
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 recorded adequate reserves in the financial statements for
pending litigation. For additional information, see Note 12 of Notes to
Consolidated Financial Statements in Item 1. Financial Statements of Part I.
Financial Information.
Item 5. Other Information
During the period ended November 30, 1996, HomeSide filed a Form S-4 with
the Securities and Exchange Commission to register notes (Exchange Notes), with
terms identical to the private placement notes discussed in Note 6 of Notes to
Consolidated Financial Statements in Item 1. Financial Statements under Part I.
Financial Information., under the Securities Act of 1933. The Form S-4 covering
the Exchange Notes was declared effective by the Securities and Exchange
Commission in October 1996. The private placement notes were exchanged for the
Exchange Notes at the conclusion of the exchange period on December 9, 1996.
In December 1996, HomeSide filed a Form S-1 with the Securities and Exchange
Commission to register 7,350,000 shares of common stock for issuance to the
public. A portion of the proceeds from the offering is to be used to repay a
portion of HomeSide's $200 million of senior secured second priority notes. The
remainder of the proceeds is to be used for general corporate purposes. The
issuance is expected to occur during the fourth fiscal quarter of 1997. See Note
13 of Notes to Consolidated Financial Statements under Part I. Financial
Information.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
27 Financial Data Schedule
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and 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)
Date: January 14, 1997 /s/ Kevin D. Race
-------------------
Kevin D. Race
Vice President, Chief Financial
Officer and Treasurer (Principal
Financial and Accounting Officer)
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated financial statements of HomeSide, Inc. as of and for the period
ended November 30, 1996 appearing on Form 10Q and is qualified in its entirety
by reference to such Form 10Q.
</LEGEND>
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<FISCAL-YEAR-END> Feb-28-1997
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0
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