<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 19, 1999
REGISTRATION NO. 333-68995
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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POST-EFFECTIVE
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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ALTIVA FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
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<S> <C> <C>
DELAWARE 6162 88-0286042
(State or other jurisdiction of (Primary standard industrial (I.R.S. employer
incorporation or organization) classification code number) identification number)
</TABLE>
1000 PARKWOOD CIRCLE, SUITE 600
ATLANTA, GEORGIA 30339
(770) 952-6700
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
---------------------
J. RICHARD WALKER
1000 PARKWOOD CIRCLE, SUITE 600
ATLANTA, GEORGIA 30339
(770) 952-6700
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
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COPIES TO:
JOHN D. CAPERS, JR.
KING & SPALDING
191 PEACHTREE STREET
ATLANTA, GEORGIA 30303-1763
(404) 572-4600
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier registration statement for the same
offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] __________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED OR UNTIL THIS REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
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ALTIVA FINANCIAL CORPORATION
1000 PARKWOOD CIRCLE
SUITE 600
ATLANTA, GEORGIA 30339
(770) 952-6700
6,974,614 SHARES OF COMMON STOCK, PAR VALUE $.01 PER SHARE
This prospectus describes Altiva Financial Corporation (formerly, Mego Mortgage
Corporation) and the sale of shares of our common stock that:
- are owned by certain of our stockholders or
- may be acquired by certain of our stockholders, if they convert their
shares of our Series A convertible preferred stock into shares of our
common stock or
- may be acquired by certain of our optionholders upon exercise of their
options to purchase common stock.
We will not receive any of the proceeds from the sale of these shares of common
stock. The holders of the common stock will determine if, and when, these shares
will be sold and will receive the proceeds from these sales.
We are a specialized consumer finance company that funds, purchases, makes and
sells consumer loans secured by deeds of trust on one-to-four family residences.
These loans primarily are used to purchase one-to-four family residences,
refinance existing mortgages, consolidate debt and/or finance home improvements.
THIS INVESTMENT INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS"
BEGINNING ON PAGE 14.
The common stock is traded on the Nasdaq Small Cap Market under the symbol
"ATVA."
Closing sale price on , 1999: $
Neither the Securities and Exchange Commission nor any state securities
commission has approved the securities offered by this prospectus. These
organizations have not determined if this prospectus is truthful or complete. It
is illegal for any person to tell you otherwise.
This prospectus is dated August , 1999.
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TABLE OF CONTENTS
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PAGE
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Prospectus Summary.............. 5
Risk Factors.................... 14
Significant Deterioration in
Our Financial Condition Due
to Losses in Fiscal 1998... 14
Risks Associated with
Implementing Our New
Strategic Plan............. 15
Risks Associated with New
Management Team............ 16
Liquidity Risks............... 16
Performance of Future
Acquisitions............... 18
Risks Associated with Mortgage
Backed Securities.......... 18
Risks from the Sale of
Servicing Rights........... 20
Interest Rate Risks........... 21
Risk of Variations in
Quarterly Operating
Results.................... 22
Risks Associated with
Delinquencies and Defaults
on Loans................... 22
Risks Associated with Title I
Loans Backing Our Mortgage
Related Securities......... 23
Risks Associated with Existing
Equity + Loans............. 23
Litigation; Risk of Claims.... 24
Concentration of Operations... 24
Competition................... 24
Volatility of Stock Price..... 25
Risk of Failing to Comply with
the Listing Requirements of
the Nasdaq Small Cap
Market..................... 26
Factors Inhibiting Takeover;
Effect of Change of
Control.................... 26
Legislative and Regulatory
Risks...................... 26
Environmental Risks........... 27
Year 2000..................... 27
Shares Eligible for Future
Sale....................... 28
Use of Proceeds................. 29
Dividend Policy................. 29
Price Range of Common Stock..... 29
Capitalization.................. 30
Selected Financial Data......... 31
</TABLE>
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Management's Discussion and
Analysis of Financial
Condition and Results of
Operations.................... 34
General....................... 34
Securitization Transactions... 35
Results of Operations......... 42
Liquidity and Capital
Resources.................. 57
Quantitative and Qualitative
Disclosure About Market
Risk....................... 59
Effects of Changing Prices and
Inflation.................. 60
Recent Accounting
Pronouncements............. 61
Impact of the Year 2000
Issue...................... 62
Special Cautionary Notice
Regarding Forward-Looking
Statements................. 64
The Recapitalization............ 65
General....................... 65
Private Placements............ 65
Exchange Offer................ 66
Management.................... 66
Transactions with Strategic
Partners................... 66
Business........................ 68
General....................... 68
Strategic Initiatives......... 70
Mortgage Industry............. 71
Company Loan Products......... 72
Lending Operations............ 73
Loan Processing and
Underwriting............... 77
Quality Control............... 79
Technology Systems............ 80
Loan Servicing................ 80
Sale of Loans................. 83
Competition................... 84
Government Regulation......... 86
Seasonality................... 87
Employees..................... 87
Properties.................... 87
Legal Proceedings............. 87
Recent Developments........... 88
Management...................... 89
Directors and Executive
Officers................... 89
Executive Compensation........ 91
Employment Agreements......... 93
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Company Stock Option Plans.... 94
Compensation Committee
Interlocks and Insider
Participation.............. 95
Principal Stockholders.......... 96
Selling Stockholders............ 98
Certain Transactions............ 100
Relationship with Greenwich... 100
Tax Sharing and Indemnity
Agreement.................. 100
Management Services Agreement
with PEC................... 100
Sub-Servicing Agreement with
PEC........................ 101
Funding and Guarantees by Mego
Financial.................. 101
Relationships with FBR........ 102
The Recapitalization.......... 102
Description of Notes............ 103
General....................... 103
</TABLE>
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PAGE
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Registration Rights........... 103
Description of Capital Stock.... 104
General....................... 104
Common Stock.................. 104
Preferred Stock............... 104
Certain Provisions of Delaware
Law........................ 105
Certain Charter and Bylaw
Provisions................. 105
Registration Rights........... 106
Transfer Agent................ 106
Shares Eligible for Future
Sale.......................... 107
Plan of Distribution............ 108
Where You Can Find More
Information................... 109
Legal Matters................... 109
Experts......................... 109
Index to Financial Statements... F-1
</TABLE>
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PROSPECTUS SUMMARY
Because this is a summary, it does not contain all the information that may
be important to you. You should read the entire prospectus carefully before you
purchase shares of our common stock. Unless otherwise indicated, all information
in this prospectus gives effect to a 1,600-for-1 stock split that occurred in
October 1996 and a 1-for-10 reverse stock split that occurred in March 1999.
THE COMPANY
Altiva Financial Corporation (formerly, Mego Mortgage Corporation) is a
specialized consumer finance company that funds, purchases, makes and sells
consumer loans secured by deeds of trust on one-to-four family residences.
Historically, we have retained the right to service a substantial portion of the
loans we have sold. Our borrowers generally do not qualify for traditional "A"
credit mortgage loans. Typically, their credit histories, income or other
factors do not conform to the lending criteria of government-chartered agencies
that traditional lenders rely on in evaluating whether to make loans to
potential borrowers.
Our loan products are:
- First mortgage loans and home equity loans (which we call "Home Equity
loans") that typically are secured by first liens, and in some cases by
second liens, on the borrowers' residence. In making Home Equity loans,
we rely primarily on the appraised values of the borrowers' residences.
We determine the loan amount based on the appraised values and the
creditworthiness of the borrowers. These loans generally are used to
purchase residences and refinance existing mortgages.
- High loan-to-value loans (which we call "Equity + loans") that are based
on the borrowers' credit. These loans typically are secured by second
liens on the borrowers' primary residences. The initial amount of an
Equity + loan, when added to other outstanding senior or secured debt on
the residences, resulted in a combined loan-to-value ratio that averaged
112% during fiscal 1997 and 1998. The loan-to-value ratio on these loans
may be as high as 125%. These loans generally are used to consolidate
debt and make home improvements.
Our loans are produced by our wholesale and retail divisions.
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WHOLESALE DIVISION RETAIL DIVISION
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<S> <C> <C> <C>
- - underwrites and funds loans - makes loans directly to
originated by a network of pre- consumers charging loan fees to
approved mortgage brokers the borrowers that should
offset our total cost of making
the loans
- - purchases closed loans,
historically at a premium (100%
or more of the loans' principal
amount), from a nationwide
network of independent mortgage
bankers and other qualified
financial intermediaries
</TABLE>
5
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Since we made our first loan in March 1994, we have substantially changed
our business strategy. In addition, we have made further substantial changes in
our business strategy since consummation of a recapitalization in July 1998,
which is described below. The timeline below summarizes the changes in our
business.
TIME PERIOD ACTION
From March 1994 through
May 1996 We purchased home improvement contracts and
closed loans insured under the Title I credit
insurance program of the Federal Housing
Administration ("Title I loans") from mortgage
bankers and home improvement contractors.
May 1996 We began purchasing Equity + loans from mortgage
bankers.
March 1996 through
August 1997 We sold substantially all of the loans we
purchased in securitization transactions. These
securitization transactions resulted in
substantial negative cash flow, because the cash
proceeds from the sale of the loans were
substantially less than our total cost of
producing the loans sold.
September 1997 We established a retail division that began
making Equity + loans directly to consumers.
December 1997 We began making Home Equity loans, through our
retail division, directly to consumers.
Through our wholesale division, we began funding
Equity + and Home Equity loans originated by
brokers.
January through June 1998 We substantially reduced our loan production
(fundings and purchases) because our warehouse
lender stopped making advances on our warehouse
line of credit after we violated certain
borrowing agreements with our warehouse lender.
We had used these advances to fund new loan
production. We funded and purchased $68.8
million of loans from January through June 1998
as compared to $312.0 million of loans in
January through June 1997.
We implemented cost savings primarily through a
32% personnel reduction initiated in January
1998. We closed our dealer division, which
traditionally had purchased Title I and Equity +
loans from our network of home improvement
contractors.
We substantially increased the sale of our loan
portfolio to generate cash to repay outstanding
indebtedness under our warehouse line, to pay
general and administrative expenses for
personnel retention and to maintain our systems
while we explored alternatives for raising new
capital.
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May 1998 Our independent auditors expressed substantial
doubt about our ability to continue as a going
concern.
July 1, 1998 We completed a recapitalization (described
below), which raised approximately $84.5 million
in additional equity.
By using the $50.0 million in cash proceeds from
the recapitalization, we began to increase the
funding and purchase of mortgage loans. We
produced $1.7 million of mortgage loans in July
and August 1998.
September 1998 A liquidity shortage and a focus by the buyers
of asset backed bonds on U.S. treasury
securities impacted the specialty finance
industry.
October 1998 We adjusted our strategic initiatives (described
below), which are designed to return us to a
positive cash flow position and to
profitability.
We produced $1.1 million of mortgage loans in
October.
THE RECAPITALIZATION
We have historically operated on a negative cash flow basis, funding the
deficits principally from borrowings. In addition, during fiscal 1998 we were
required to write down the value of our mortgage related securities, which
resulted in substantial losses. These losses caused us to violate certain
covenants contained in agreements with our lenders, restricting our ability to
borrow money to fund new loans prior to their sale. Beginning in January 1998,
these events caused us to reduce substantially our loan production, liquidate
our loan portfolio, reduce our borrowings and seek additional capital to
continue in operation. On July 1, 1998, we completed our recapitalization, as
described below.
Private Placements - We sold an aggregate of 25,000 shares of
Series A convertible preferred stock for a
price of $1,000 per share.
- We sold 1.67 million shares of common stock
for a price of $15.00 per share.
- We issued $41.5 million principal amount of
new 12 1/2% subordinated notes (the "Current
Notes") and 37,500 shares of Series A
convertible preferred stock in exchange for
$79.0 million principal amount of 12 1/2%
subordinated notes sold in November 1996 and
October 1997 (collectively, the "Old Notes").
We purchased all of the Old Notes still
outstanding after the recapitalization for
cash in September and October 1998.
- We issued 160,000 shares of common stock to
the placement agent as part of its fee.
- These private placements raised approximately
$84.5 million of additional equity.
Use of Proceeds - We used $5.1 million to pay interest on our
Old Notes.
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- We used $2.4 million to pay off our warehouse
line of credit, which we had used to fund
loans prior to their sale.
- We used $1.6 million to pay loan and
management fees and other miscellaneous
charges due to Mego Financial Corp., our
former parent ("Mego Financial")
- We used $428,000 to pay a portion of the costs
of the recapitalization.
- We used the balance to fund and purchase loans
and for other general corporate purposes.
Management Changes - Four of the five members of our board of
directors resigned from the board and Champ
Meyercord was elected our Chairman and Chief
Executive Officer.
- Purchasers of the shares of preferred stock
and common stock in the recapitalization,
including the strategic partners described
below, exercised their rights to have three
new directors elected to the board.
Transactions with Strategic
Partners As part of the recapitalization:
- Sovereign Bancorp, Inc. ("Sovereign Bancorp")
and City National Bank of West Virginia ("City
National Bank"), a wholly owned subsidiary of
City Holding Company, each purchased 10,000
shares of Series A convertible preferred stock
at a price of $1,000 per share
- Sovereign Bancorp agreed to provide us up to
$90.0 million in borrowings (the "Sovereign
Warehouse Line"), which was reduced to $25.0
million as of March 31, 1999
- Sovereign Bancorp agreed to purchase up to
$100.0 million of our loans per quarter at
specified prices through September 2001
- City National Bank purchased our existing
mortgage servicing rights
- City Mortgage Services, a division of City
National Bank, agreed to service all of our
mortgage loans held for sale and loans sold by
us on a servicing retained basis
- Sovereign Bancorp and City National Bank were
each granted an option which expires in
December 2000 to purchase 666,666 shares of
common stock at a price of $15.00 per share
- Sovereign Bancorp and City National Bank were
each granted a right of first refusal to
purchase a controlling voting interest or a
majority of our assets if the board of
directors determines to sell us
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- City National Bank has appointed, and
Sovereign Bancorp has the right to appoint,
one member to the board of directors. Each has
the right to appoint an additional member to
the board of directors if they exercise their
option to purchase shares of common stock
For more details on, and a description of, the recapitalization, see "The
Recapitalization" beginning on page 66.
STRATEGIC INITIATIVES
Our strategic initiatives have been substantially impacted by recent events
in the capital markets and their effect on the specialty finance industry. There
has been a significant reduction in the number of institutions willing to
provide warehouse facilities to mortgage lenders producing home equity and high
loan-to-value loans. Additionally, there has been a reduction in the number of
buyers of senior interests issued in securitization transactions backed by home
equity and high loan-to-value loans, and a concurrent increase in the yield (and
a reduction in the price) demanded by such buyers on the senior interests they
purchase. Finally, the number of institutional investors acquiring loans similar
to the loans we produce has declined, along with the premiums, if any, these
investors are willing to pay for these loans. These events have substantially
reduced the liquidity available to companies in our business to make new loans.
With these events in mind, we have redefined our strategic initiatives.
OUR PRIMARY FOCUS WILL BE IN PRODUCING HOME EQUITY LOANS. We anticipate
reducing our reliance on high loan-to-value loans and significantly increasing
the percentage and amount of our business devoted to the production of Home
Equity loans by expanding our network of mortgage brokers and bankers and
acquiring other mortgage lending companies that produce Home Equity loans. We
will produce Home Equity loans solely for sale for cash, generally at premiums
to their principal amounts, to institutional purchasers in the secondary market
without recourse for credit losses or risk of prepayment. Based on our
experience in the industry, we believe that currently there are more buyers for
Home Equity loans than for high loan-to-value loans.
DUAL PRODUCTION PLATFORMS SHOULD LOWER OUR TOTAL LOAN PRODUCTION COSTS.
While pursuing our mortgage broker and banker wholesale loan programs, we intend
to pursue loan production on a retail (direct-to-consumer) basis. Although a
retail loan platform is relatively expensive, we expect it to produce loans at a
lower cost than our wholesale platform. When we make a loan directly to a
consumer, we typically receive loan fees and we avoid any premium due when we
purchase a loan from our network of mortgage bankers. We expect our dual loan
production platform strategy to lower our overall cost of producing mortgage
loans and improve our cash flow.
WE INTEND TO INCREASE PRODUCTION BY ACQUIRING OTHER MORTGAGE LENDING
COMPANIES. We intend to increase our loan production significantly by acquiring
companies that produce mortgage loans. Because we raised cash in the
recapitalization, we expect the current lack of liquidity available to companies
in our industry to create opportunities for us in this area.
SELLING LOANS FOR CASH WILL BE OUR PRIMARY METHOD OF LOAN DISPOSITION. We
intend to sell substantially all of the loans we produce for cash to
institutional purchasers in the secondary market as our primary loan disposition
strategy. We expect this method of
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loan sales to generate positive cash flow, because Home Equity and Equity +
loans can generally be sold for more than their principal amount. To this end,
we are expanding the number of institutions with which we have loan purchase and
sale relationships. We do not anticipate selling our loans in securitization
transactions. Securitization transactions typically result in substantial
negative cash flow, because the initial cash proceeds to us are substantially
less than our total cost of producing the loans sold.
WE INTEND TO CONTINUE TO IMPLEMENT COST SAVING MEASURES. We are continuing
an internal restructuring, which has resulted in a reduction of our workforce
from a peak of 475 employees in January 1998 to 134 employees as of August 31,
1998 and 78 employees as of May 31, 1999. This reduction and other cost saving
measures we have taken have significantly reduced our monthly recurring general
and administrative expenses from approximately $2.7 million in June 1998 (the
month prior to completion of the recapitalization) to approximately $1.2 million
in May 1999. In addition, we have reduced by $4.7 million the annual interest
expense on our outstanding subordinated notes by issuing 37,500 shares of
preferred stock and $41.5 million principal amount of Current Notes in exchange
for $79.0 million principal amount of Old Notes.
RISK FACTORS
The purchase of shares of our common stock is a high-risk investment. You
should carefully consider all of the matters described in this prospectus under
"Risk Factors" beginning on page 14.
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SUMMARY FINANCIAL DATA
You should read the summary financial information set forth below in
conjunction with our audited financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" beginning on page 34 of this prospectus. During the last eight
months of fiscal 1998, our operations consisted principally of: (1) liquidating
for cash our portfolio of loans to pay down our outstanding indebtedness; (2)
paying general and administrative expenses to maintain our systems and retain
the personnel necessary to resume operations while exploring alternative sources
of new capital; and (3) designing and beginning the implementation of our
strategic initiatives. Results for the nine months ended May 31, 1999 are not
necessarily indicative of the results for the entire year. Due to recent
substantial changes to our business and operating strategy, we believe that our
historical financial and operating data are not likely to be indicative of our
future performance and our results of operation for fiscal 1998 are not
comparable to fiscal 1997.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
FISCAL YEAR ENDED AUGUST 31, MAY 31,
------------------------------------------------------- -------------------------
1994 1995 1996 1997 1998 1998 1999
------- ------- ------- ----------- ----------- ----------- -----------
(THOUSANDS OF DOLLARS EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues:
Gain (loss) on sale of
loans................... $ 579 $12,233 $16,539 $ 45,123 $ (26,578) $ (15,562) $ 759
Net unrealized gain (loss)
on mortgage related
securities(1)........... -- -- 2,697 3,518 (70,024) (44,120) (532)
Loan servicing income,
net..................... -- 873 3,348 3,036 999 1,137 230
Interest revenue, net of
interest expense of
$107, $468, $1,116,
$6,374, $13,162, $11,175
and $5,686.............. 172 473 988 3,133 1,624 2,026 (654)
------- ------- ------- ----------- ----------- ----------- -----------
Total revenues (losses)..... 751 13,579 23,572 54,810 (93,979) (56,519) (197)
------- ------- ------- ----------- ----------- ----------- -----------
Total expenses.............. 2,262 7,660 12,417 31,000 32,010 30,181 13,469
------- ------- ------- ----------- ----------- ----------- -----------
Income (loss) before income
taxes and extraordinary
item(2)................... (1,511) 5,919 11,155 23,810 (125,989) (86,700) (13,666)
Income tax expense (benefit)
before extraordinary
item(2)................... -- 2,277 4,235 9,062 (6,334) -- (5,177)
------- ------- ------- ----------- ----------- ----------- -----------
Net (loss) before
extraordinary item........ (86,700) (8,489)
Extraordinary item, net of
taxes of $2.9 million..... -- 4,812
----------- -----------
Net income (loss)(2)........ $(1,511) $ 3,642 $ 6,920 $ 14,748 $ (119,655) $ (86,700) $ (3,677)
======= ======= ======= =========== =========== =========== ===========
Net income (loss) per common
share(3):
Basic..................... $ 12.50 $ (77.18) $ (70.49) $ (1.20)
=========== =========== =========== ===========
Diluted................... $ 12.50 $ (77.18) $ (70.49) $ (1.20)
=========== =========== =========== ===========
Weighted-average number of
common shares(3).......... 1,180,219 1,550,292 1,230,000 3,056,666
=========== =========== =========== ===========
Weighted-average number of
common shares and assumed
conversions(3)............ 1,180,219 1,550,292 1,230,000 3,056,666
=========== =========== =========== ===========
</TABLE>
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<TABLE>
<CAPTION>
AS OF
AS OF AUGUST 31, MAY 31,
----------------------------------------------- --------
1994 1995 1996 1997 1998 1999
------ ------- ------- -------- ------- --------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF FINANCIAL CONDITION
DATA:
Cash and cash equivalents.......... $ 824 $ 752 $ 443 $ 6,104 $36,404(4) $ 9,231(4)
Loans held for sale, net........... 1,463 3,676 4,610 9,523 10,975(5) 15,557(5)
Mortgage related securities(1)..... -- -- 22,944 106,299 34,830 34,214
Excess servicing rights(1)......... 904 14,483 12,121 -- -- --
Mortgage servicing rights.......... -- 1,076 3,827 9,507 83 --
Total assets....................... 5,122 24,081 50,606 156,554 104,535 84,709
Allowance for credit losses on
loans sold with recourse......... 66 886 920 7,014 2,472 --
Subordinated debt(6)............... -- -- -- 40,000 42,693 30,750
Total liabilities.................. 983 13,300 32,905 103,447 77,941 61,792
Stockholders' equity............... 4,139 10,781 17,701 53,107 26,594 22,917
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
FISCAL YEAR ENDED AUGUST 31, MAY 31,
------------------------------------------------- ------------------
1994 1995 1996 1997 1998 1998 1999
------ ------- -------- -------- -------- -------- -------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Loan production............. $8,164 $87,751 $139,367 $526,917 $338,942 $337,050 $40,560
Weighted-average interest
rate on loan production... 14.18% 14.55% 14.03% 13.92% 13.89% 13.89% 11.00%
Loans in servicing portfolio
(end of period):
Company-owned(7).......... 1,471 3,720 4,698 9,563 12,450(5) 12,583 18,586
Securitized............... 6,555 88,566 209,491 618,505 18,772 533,662 --
------ ------- -------- -------- -------- -------- -------
Total servicing
portfolio............. $8,026 $92,286 $214,189 $628,068 $ 31,222 $546,245 $18,586
====== ======= ======== ======== ======== ======== =======
Cash used in operations..... $4,402 $ 3,619 $ 12,440 $ 72,438 $ 39,723 $ 26,934 $24,096
====== ======= ======== ======== ======== ======== =======
</TABLE>
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(1) Mortgage related securities are junior subordinated interests retained by us
in pools of mortgage loans sold by us in securitization transactions. SFAS
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," required us, as of January 1, 1997, to
reclassify our excess servicing rights (junior subordinated interests
retained by us in pools of mortgage loans sold in transactions similar to a
securitization) to mortgage related securities. The fair value (the dollar
amount on our balance sheet) of our mortgage related securities was written
down from $106.3 million at the end of fiscal 1997 to $34.8 million at the
end of fiscal 1998. For additional details concerning the sale of loans in
securitization transactions and the fair value of our mortgage related
securities, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations" beginning on page 34 of this prospectus and Notes
2, 4 and 17 to our financial statements located later in this prospectus.
(2) Our results of operations were included in the consolidated federal income
tax returns filed by Mego Financial Corporation ("Mego Financial"), our
former parent, through September 2, 1997, the date the shares of our common
stock owned by Mego Financial were distributed by Mego Financial to its
shareholders in a tax-free spin-off. Mego Financial charged us an amount
equal to the taxes we would have paid if we had filed a separate return. For
more details on this and other transactions with Mego Financial and its
affiliates, see "Certain Transactions" beginning on page 102 of this
prospectus.
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(3) Earnings per share for the fiscal years ended August 31, 1994, 1995 and 1996
are not presented because, during these fiscal years, we were a wholly-owned
subsidiary of Mego Financial.
(4) As part of the recapitalization, we sold an aggregate of $50.0 million of
common stock and Series A convertible preferred stock for cash. For more
details, see "The Recapitalization" beginning on page 66 of this prospectus.
(5) Loans held for sale, net includes a valuation reserve which reflects our
best estimate of the amount we expect to receive on the sale of these loans.
(6) We sold $40.0 million principal amount of Old Notes in November 1996 and an
additional $40.0 million principal amount of Old Notes in October 1997. As
part of the recapitalization, we issued $37.5 million of Series A
convertible preferred stock and $41.5 million principal amount of Current
Notes in exchange for $79.0 million principal amount of Old Notes. We
purchased all of the Old Notes still outstanding after the recapitalization
in September and October 1998, including premiums and accrued and unpaid
interest. Additionally, we repurchased $11.0 million of Current Notes in
February, 1999.
(7) Excludes approximately $9.4 million of Equity + loans to be repurchased at
August 31, 1998. We repurchased a majority of these loans prior to November
30, 1998. The amount on our balance sheet as of August 31, 1998 is the
amount we expect to receive on the sale of these loans. For additional
details, see Note 3 to our financial statements located later in this
prospectus.
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RISK FACTORS
The purchase of common stock involves, among other things, your evaluation
of our business strategy and the significant risks and other factors that will
affect whether we will be successful. As a result, we cannot guarantee that we
will achieve our objectives. You should carefully consider the risk factors we
discuss below, along with all of the other information included in this
prospectus, before you decide to purchase shares of our common stock.
Some of the information in this prospectus may contain forward-looking
statements. Such statements can be identified by the use of forward-looking
terminology such as "may," "will," "expect," "anticipate," "estimate,"
"continue" or other similar words. These statements discuss future expectations,
contain projections of results of operations or of financial condition or state
other "forward-looking" information. When considering such forward-looking
statements, you should keep in mind the risk factors and other cautionary
statements in this prospectus. The risk factors noted in this section and other
factors noted throughout this prospectus, including certain risks and
uncertainties, could cause our actual results to differ materially from those
contained in any forward-looking statement.
SIGNIFICANT DETERIORATION IN OUR FINANCIAL CONDITION DUE TO LOSSES IN FISCAL
1998
We generated a $119.7 million net loss in fiscal 1998 compared to a net
profit of $14.7 million in fiscal 1997 and $6.9 million in fiscal 1996. Our
fiscal 1998 loss primarily resulted from:
(1) writing down the fair value of our mortgage related securities
from $106.3 million at the end of fiscal 1997 to $34.8 million at the end
of fiscal 1998;
(2) substantially reducing loan production;
(3) liquidating our loan portfolio; and
(4) spending significant amounts on general and administrative
expenses to:
(a) maintain our systems;
(b) retain our personnel;
(c) design and implement a new strategic plan; and
(d) explore alternative capital-raising transactions.
In fiscal 1997, we made ordinary course adjustments to the value of our mortgage
related securities based on certain assumptions with respect to prepayment
rates, delinquency rates, default rates and credit losses on the loans backing
the securities. During fiscal 1998, we experienced substantially higher
prepayment rates, delinquency rates, default rates and credit losses than we had
assumed at the end of fiscal 1997. As a result, during fiscal 1998 we
substantially increased our assumptions on prepayment rates, delinquency rates,
default rates and credit losses on the remaining loans backing our mortgage
related securities and we made corresponding writedowns to the value of our
mortgage related securities throughout fiscal 1998. We had produced the Equity +
and Title I loans that backed these securities in prior periods and sold them in
securitization transactions. For additional information on our mortgage related
securities, see "Management's Discussion and
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Analysis of Financial Condition and Results of Operations" and Notes 2, 4, and
17 to our financial statements included later in this prospectus.
The $119.7 million net loss in fiscal 1998 reduced our stockholders' equity
at the end of fiscal 1998 to $26.6 million, despite an $84.5 million addition to
stockholders' equity in July 1998 as a result of the recapitalization.
Stockholders' equity was $53.1 million at the end of fiscal 1997 and $17.7
million at the end of fiscal 1996. In May 1998, our independent auditors,
revised their report on our fiscal 1997 financial statements to include an
explanatory paragraph related to their substantial doubt that we could continue
as a going concern. We cannot guarantee that our results of operations and
financial condition will not continue to decline.
RISKS ASSOCIATED WITH IMPLEMENTING OUR NEW STRATEGIC PLAN
Since February 1998, our business strategy has been substantially revised.
Our new business strategy has three main components:
(1) focusing on producing Home Equity loans and reducing our historical
focus on the production of Equity + loans;
(2) increasing loan production by acquiring other mortgage lending
companies; and
(3) selling loans produced by us for cash to institutional purchasers in a
secondary market instead of selling loans in securitization transactions.
During the three months ended August 31, 1998, we produced only $1.9
million principal amount of mortgage loans. During the nine months ended May 31,
1999, we produced only $40.6 million principal amount of mortgage loans. Our
ability to increase loan production will depend on many factors, including our
ability to:
- successfully acquire and integrate the operations of other mortgage
lending companies
- offer attractive loan products to prospective borrowers
- successfully market our loan products
- establish, maintain and expand relationships with mortgage brokers and
bankers
- obtain and maintain increasingly larger lines of credit to fund loans
prior to their sale
- access capital markets
- attract and retain qualified funding, quality control and other personnel
You should consider our future prospects in light of the risks, delays,
expenses and difficulties frequently encountered by an early-stage business in a
highly-regulated, competitive environment. We cannot guarantee that we will
implement successfully our new business strategy, develop our current operations
in a timely or effective manner, or generate significant revenues, positive cash
flow or profits.
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RISKS ASSOCIATED WITH NEW MANAGEMENT TEAM
We have only recently assembled our management team and the management
control structure is still in its formative stages. We cannot guarantee that the
new management team will be able to operate effectively or implement
successfully our new strategic plan. The new management team's ability to manage
our growth as we implement our strategic initiatives depends upon many factors,
including their ability to:
(1) maintain appropriate procedures, policies and systems to ensure that
our loans perform at least in accordance with industry standards;
(2) satisfy our need for additional financing on reasonable terms;
(3) manage the costs associated with expanding our infrastructure,
including systems, personnel and facilities; and
(4) operate profitably and on a cash flow positive basis.
If management cannot execute successfully our new business strategy, it
will have a material adverse effect on our financial condition, results of
operations and cash flow.
Our expansion and development largely will be dependent upon the continued
services of the senior members of our new management team including Champ
Meyercord, our Chief Executive Officer, and J. Richard Walker, our Executive
Vice President and Chief Financial Officer. The loss of the services of Messrs.
Meyercord or Walker for any reason could have a material adverse effect on us.
In addition, our future success will require us to recruit and retain additional
key personnel, including additional sales and marketing personnel. We do not
maintain key person life insurance on any members of senior management.
LIQUIDITY RISKS
Our business operations require continued access to adequate cash to fund,
purchase and make mortgage loans, to pay interest on, and repay, our debts and
to pay general and administrative expenses. Specialty finance companies similar
to us currently are experiencing a liquidity shortage. This liquidity shortage,
among other things, has reduced the availability of warehouse credit lines to
finance first mortgage loans, home equity loans and high loan-to-value loans
prior to their sale. We are currently dependent on the Sovereign Warehouse Line
to fund, purchase and make mortgage loans before we sell them. If we
successfully increase loan production, we will need increasingly larger amounts
of cash for our operations.
Risks Related to the Sale of Loans
We historically have principally relied on selling loans in securitization
transactions to generate cash. As a major part of our strategic initiatives, we
intend to generate positive cash flow mainly by selling loans to institutional
purchasers in the secondary market. Under the terms of the Flow Purchase
Agreement with Sovereign Bancorp (the "Flow Purchase Agreement"), we have agreed
to sell, and Sovereign Bancorp has agreed to buy, up to $100.0 million of our
mortgage loans per quarter through September 2001. Sovereign Bancorp also has a
right of first refusal to buy the balance of our loans, subject to our mutual
agreement as to the purchase terms. The right of first refusal could make it
more difficult for us to sell our loans to others if Sovereign Bancorp decides
not to acquire some
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of our loans or if we cannot negotiate mutually acceptable terms for the
purchase of our loans.
The value of, and markets for, selling our loans are dependent on, among
other things:
(1) the willingness of banks, thrifts and other institutional purchasers to
acquire Home Equity and Equity + loans;
(2) the premiums over the principal amount of these loans that
institutional purchasers are willing to pay; and
(3) the resale market for our loans.
The markets also are affected by more general factors, including general
economic conditions, interest rates and government regulations. These factors
currently affect, and may continue to affect, our ability to sell loans in the
secondary market for acceptable prices within reasonable time frames. A
reduction in the secondary market for first mortgage loans, home equity loans
and high loan-to-value loans would hurt our ability to sell loans in the
secondary market as well as our liquidity and future loan production. We cannot
predict whether the liquidity of the secondary market will continue to diminish
in the future.
Risks Associated with the Need For Alternative Financing
If the amounts available under the Sovereign Warehouse Line to fund our
loan production prior to its sale are insufficient to enable us to produce the
volume of loans necessary for us to operate profitably or on a positive cash
flow basis, we will have to seek out other sources of liquidity. This may
include additional warehouse financing and debt and/or equity securities
offerings. The Sovereign Warehouse Line terminates at the end of August 1999 and
is renewable, at Sovereign's option, in six-month intervals for up to five
years. Sovereign Bancorp may terminate the Sovereign Warehouse Line if we do not
sell them $100.0 million of loans in each fiscal quarter beginning with the
calendar quarter ending March 31, 1999. If that happens, we cannot guarantee
that additional financing will be available on favorable terms, or at all. If we
are not successful in maintaining or replacing existing financing or obtaining
additional financing, we would have to reduce our activities. For additional
details about our liquidity, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources" and Notes 9 and 15 to our financial statements located later in this
prospectus.
Except for certain financial covenants in a pledge and security agreement
entered into in April 1997, we are currently complying with the Sovereign
Warehouse Line, the indenture governing the New Notes and agreements with our
other lenders. Before the recapitalization, we were in violation of our
warehouse agreement, the indenture governing the Old Notes and agreements with
our other lenders. If we breach or violate any covenant or condition contained
in our borrowing arrangements, we might be unable to obtain funding for our
operations which would have a material adverse effect on us.
Some of our borrowing arrangements limit the amount of advances that can be
made to us. These limitations are based on the value of, and the delinquency
experience relating to, our mortgage related securities pledged to the lender. A
decrease in the value of the pledged securities would reduce the amount of funds
that we can borrow under the facilities, requiring us to pay down the loans.
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Risk of Violation of Representations Made to Loan Purchasers
We make representations and warranties to the purchasers of our mortgage
loans regarding compliance with laws, regulations and program standards and the
accuracy of information. Under certain circumstances we could become liable for
damages or be required to repurchase a loan if there has been a breach of these
representations or warranties. We generally receive similar representations and
warranties from our loan sources. If these representations and warranties are
breached, we would be subject to the risk that a loan source will not have the
financial capacity to repurchase loans or that a loan source will not otherwise
respond to our demands. We cannot guarantee that we will not experience losses
due to breaches of representations and warranties in the future.
PERFORMANCE OF FUTURE ACQUISITIONS
As part of our business strategy, we intend to acquire other mortgage
lending companies. By acquiring other mortgage lending companies, we believe we
can expand our loan production, while avoiding the time and expense required to
build new mortgage loan production platforms. The value of these companies
generally will be in their ability to immediately produce mortgage loans at a
low cost. This type of value will typically be a substantial portion of the
assets acquired and it is classified under generally accepted accounting
principles as an intangible. Generally acceptable accounting principles require
us to amortize (write off) expenses related to goodwill and other intangible
assets that we acquire. This will reduce our earnings. Future acquisitions may
also result in dilutive issuances of equity securities and our incurrence of
additional debt. All of these factors could have a material adverse effect on
our financial condition, results of operations and cash flows.
Future acquisitions would involve numerous additional risks, including:
- difficulties in the integration of the acquired company's operations,
services, products and personnel
- entry into markets in which we have little or no direct prior experience
- the potential loss of the acquired company's key employees
Mortgage lending companies that we acquire in the future may not perform in
accordance with our expectations. We cannot predict whether we will identify
acquisition opportunities, whether we can negotiate acquisitions on favorable
terms or whether any acquisition will result in profitable operations in the
future or be successfully integrated with our existing business.
Acquisitions in which all or a portion of the purchase price is in shares
of common stock would require, in certain cases, the written consent of each of
City National Bank and Sovereign Bancorp. We cannot guarantee that we would be
able to obtain any such consent.
RISKS ASSOCIATED WITH MORTGAGE BACKED SECURITIES
Risks Related to our Junior Interest
We historically have sold the greater portion of our Equity + and Title I
loans in securitization transactions. As a result, we are at risk because these
loans back our mortgage related securities. In a securitization transaction, the
cash flow from the
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mortgage loans backing the securitization, principal and interest is first paid
to the owners of the senior interests according to a pre-established schedule of
required interest and principal payments. Payment of cash flow to our mortgage
related securities is junior to the scheduled principal and interest payments to
the senior interests.
If the borrowers do not make their payments on the loans backing a
securitization or if the payments are insufficient to make required principal
and interest payments on the senior interests, the amounts that would be paid to
us will be used to cover the shortfall. This would reduce or in some cases
eliminate the stream of revenues that would have been paid to us on our mortgage
related securities. If payments received from the loans backing a securitization
are less than the amounts we anticipated at the time we sold the loans in a
securitization transaction, we may be required to write down the fair value of
our mortgage related securities retained in that securitization. This would
result in a charge to earnings. We cannot guarantee that estimates of future
losses on loans backing our mortgage related securities will be adequate in the
future.
Risk of Write Down of the Value of Mortgage Backed Securities due to Poor
Performance of Mortgage Loans
As noted above under "-- Significant Deterioration in our Financial
Condition Due to Losses in Fiscal 1998," we had to write down the fair value of
our mortgage related securities during fiscal 1998. This write down resulted
from unexpectedly high rates of prepayments, delinquencies, default, and credit
losses. As a result, we substantially increased the anticipated prepayment
rates, delinquency rates, default rates and credit losses on the mortgage loans
backing our mortgage related securities. The new assumptions significantly
decreased the cash flow we expected to receive on these securities in the
future, which required us to reduce the fair value of our mortgage related
securities to $34.8 million on August 31, 1998 compared to $106.3 million on
August 31, 1997.
In the future, we may have to make additional reductions in the carrying
value of our mortgage related securities. We cannot guarantee that the
prepayment rate, delinquency rate, default rate, and credit losses on the
mortgage loans backing the securities will not increase above the levels we
currently anticipate. If we have to further write down these securities' value,
we may incur losses in the quarter when we write them down. We may then violate
the net worth covenants in our borrowing agreements. Any of these events could
have a material adverse effect on our financial condition and operations. For
additional details concerning the valuation of our mortgage backed securities,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Securitization Transactions" and Notes 2, 4 and 17 to our
financial statements located later in this prospectus.
Risks Related to Over-Collateralization
As part of the sale of loans in securitization transactions, we are
required to establish over-collateralization and/or build over-collateralization
levels by retaining distributions of excess cash flow otherwise payable to us on
our mortgage related securities. Excess cash flow results from the positive
difference between the higher interest rate paid by our borrowers on the
mortgage loans sold in the securitization and the lower yield paid to the owners
of the senior interests in the trust established to own the loans sold by us.
Over-collateralization serves as credit enhancement for the owners of the senior
interests and is available to absorb losses realized on loans backing the
securitization. Were it not for these over-collateralization requirements, we
would be able to use the excess cash flow
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in our operations. Because of those requirements, if borrowers default on
principal and interest payments on their loans, the securitization trust holding
the mortgages would have to use part of the over-collateralization to pay the
owners of the senior interests. This could delay, reduce or eliminate the excess
cash flow otherwise payable to us on our mortgage related securities.
Risk Related to Interest Rate Spread
During fiscal 1997, we sold $398.4 million principal amount of mortgage
loans, that had a weighted-average interest rate of 14.0%, in securitization
transactions. The $390.1 million principal amount of senior interests sold to
institutional investors as part of these securitizations had an initial
weighted-average interest rate of 6.88%. The $8.3 million difference between the
amount of mortgage loans sold and the amount of senior interests sold creates
the initial over-collateralization. The 7.1% difference between the interest
paid by the borrowers and the interest paid to the owners of the senior
interests (the "spread") declines over time primarily because of payoffs
(including defaults) of the loans backing the securitization. The initial spread
would be equal to 7.1% times $390.1 million, or $27.7 million annually plus
interest at 14.0% on the $8.3 million principal amount of loans in the
over-collateralization account. We use the spread and the cash flow from the
loans in an initial over-collateralization to reduce the principal balances of
the senior interests or fund the additional over-collateralization.
The initial over-collateralization and retained amounts are determined by
the entity that, as a condition to obtaining insurance, issues any guarantee of
the related senior interests and/or by the rating agencies as a condition to
obtaining the desired rating on the senior interests. If we use the spread and
the cash flow from the loans in an initial over-collateralization in this
manner, we will continue to be subject to the risks of faster than anticipated
rates of voluntary prepayments, delinquencies, defaults and credit losses on
foreclosure on the mortgage loans backing our mortgage related securities that
we sold in prior securitizations.
In addition, using the spread to fund reserves delays or in some cases
eliminates cash distributions that we would be entitled to receive on our
mortgage related securities. For a detailed explanation of excess cash flow,
mortgage related securities and securitization transactions, see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Securitization Transactions" located later in this prospectus.
Risks Related to Loan Repurchases
We agree to repurchase or replace loans that do not conform to our
representations and warranties at the time we sell the loans. If we were
required to repurchase or replace loans, we cannot guarantee that the loans
repurchased or replaced repurchased could be sold at a price equal to our total
cost of acquisition. For additional details, see "Business -- Loan Servicing"
and "-- Sale of Loans" and Note 2 to our financial statements located later in
this prospectus.
RISKS FROM THE SALE OF SERVICING RIGHTS
We historically have sold substantially all of our mortgage loans with
servicing retained. This means that we retained the right to service the loans.
As part of the recapitalization, we sold our existing mortgage loan servicing
rights, including the right to
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service all of the mortgage loans backing our mortgage related securities, to
City Mortgage Services. To the extent that City Mortgage Services is ineffective
in servicing these loans, we would experience increased delinquencies, defaults
and credit losses, which would have an adverse effect on us. Consequences could
include the additional write downs of the fair value of our mortgage related
securities and a restriction on our ability to access capital markets for our
future financing requirements.
The delinquency and default rates on the mortgage loans backing our
mortgage related securities has increased significantly since we sold the
servicing rights on these loans to City Mortgage Services. In the past, this
increase in delinquencies and defaults has caused us to write down the fair
value of these securities. We cannot guarantee that City Mortgage Services will
perform up to industry standards, which could result in the adverse consequences
described above. If City Mortgage Services does not perform well, we have the
right to terminate City Mortgage Services. However, we would have to find a new
servicer for these loans after such a termination. We might be unable to find an
appropriate servicer or, if identified, we may not be able to hire such servicer
on favorable terms.
INTEREST RATE RISKS
Changes in interest rates affect our business by decreasing the demand for
loans during periods of higher interest rates and increasing prepayment rates
during periods of lower interest rates. The profits we realize from loans are,
in part, a function of the difference between the fixed long term interest rates
we charge to borrowers and the adjustable short term interest rates we pay on
the Sovereign Warehouse Line, which we use to fund loans until we sell them.
Generally, short-term rates are lower than long-term rates. We benefit from
the positive interest rate differential during the time we own the loans pending
their sale. During the period from 1994 to the present, the interest rate
differential was high. Interest rates are not predictable or controllable, and
we cannot predict whether the positive interest rate differential will continue
in the future. A change in the differential could have a material adverse effect
on our financial position, results of operations and cash flows.
Changes in interest rates during the period between the establishment of
the borrowers' interest rate on a loan and the sale of the loan affect the
revenues we realize. As part of our loan production process, we issue loan
commitments (sometimes referred to as "interest rate locks") for periods of up
to 30 days to mortgage bankers and brokers. The period of time between the
closing of a loan and the sale of the loan generally ranges from 10 to 90 days.
Increases in interest rates during these periods will result in lower gains (or
even losses) on loan sales than would be recorded if interest rates had remained
stable or had declined. We intend to expand our loan production, increase the
amount of our borrowings under the warehouse lines of credit and increase the
amount of loans held for sale, which will increase our exposure to the risk of
interest rate increases.
Increases in interest rates also may require us to write down the fair
value of our mortgage related securities, which could have a material adverse
effect on our financial condition, results of operations, and cash flows. This
interest rate is the rate we believe would be used by a third party in
determining the value of our mortgage related securities. At the end of fiscal
1998, we were using a 16.0% rate and at the end of fiscal 1997 we were using a
12.0% rate. Increasing the rate at which we discount to present value the cash
flow we expect to receive on our mortgage related securities reduces their fair
value.
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Decreases in interest rates may result in increased prepayment rates which may
require us to write down the fair value of our mortgage related securities. For
additional details on the risks to the fair value of our mortgage related
securities, see "-- Increased Prepayments and Other Factors May Adversely Affect
Valuation of Mortgage Related Securities" located earlier in this section of
this prospectus.
RISK OF VARIATIONS IN QUARTERLY OPERATING RESULTS
Several factors affecting our business can cause significant variation in
our quarterly operating results. Variations in the volume of our production,
differences between our costs of borrowings and the average interest rates paid
by our borrowers, our inability to complete scheduled loan sale transactions and
the condition of the mortgage loan industry and the specialty finance industry
can result in significant increases or decreases in our revenues from quarter to
quarter. A delay in closing a particular loan sale transaction during a
particular quarter would postpone recognition of revenues and gain or loss on
the sale of those loans. In addition, unanticipated delays in closing a
particular loan sale transaction would also increase our exposure to interest
rate fluctuations by lengthening the period during which our variable rate
borrowings under the Sovereign Warehouse Agreement are outstanding. If we were
unable to sell a sufficient number of loans at a premium in a particular
reporting period, our revenues for that period would decline, resulting in lower
net income and possibly a net loss for that period. This could have a material
adverse effect on our financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition, Results of
Operations -- Liquidity and Capital Resources" located later in this prospectus.
RISKS ASSOCIATED WITH DELINQUENCIES AND DEFAULTS ON LOANS
Potential loan delinquencies and defaults by our borrowers expose us to
risks of loss and reduced net earnings. During economic slowdowns or recessions,
loan delinquencies, defaults and credit losses generally increase. In addition,
significant declines in market values of residences securing the loans reduce
homeowners' equity in their homes. The limited borrowing power of our customers
also increases the likelihood of delinquencies, defaults and credit losses on
foreclosure. For Home Equity loans, we rely primarily on the appraised value of
the borrower's home and for Equity + loans we rely on the creditworthiness of
the borrower. We determine the amount of a loan based on the loan-to-value ratio
and the borrower's creditworthiness. After a default by a borrower, we, or the
servicer of the mortgage loan, evaluates the cost effectiveness of foreclosing
on the property. Such default may cause us to charge our allowances for credit
losses on loans held for sale, except to the extent that FHA insurance proceeds
are available. If we must take losses on a loan backing our mortgage related
securities or loans that exceed our allowances, our financial position, results
of operations and cash flows could suffer.
Many of our borrowers have limited access to consumer financing for a
variety of reasons, including insufficient home equity value and unfavorable
past credit histories. We are subject to various risks associated with these
borrowers, including, but not limited to, the risk that borrowers will not pay
interest and principal due, and that the value received from the sale of the
borrower's residence in a foreclosure will not be sufficient to repay the
borrower's obligation to us.
The risks associated with the our business increase during an economic
downturn or recession. These periods also may be accompanied by decreased demand
for consumer
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credit and declining real estate values. Any material decline in real estate
values reduces the ability of borrowers to use the value of their homes to
support borrowings and increases the loan-to-value ratios of our loans and the
loans backing our mortgage related securities. This weakens collateral values
and the amount, if any, obtained upon foreclosures.
The frequency and severity of losses generally increases during economic
downturns or recessions. Because our borrowers generally do not satisfy criteria
of government agencies that traditional lenders rely on in evaluating whether to
make loans to potential borrowers, these borrowers do not qualify for
traditional "A" credit loans. The actual rate of delinquencies, foreclosures and
credit losses on these loans are often higher under adverse economic conditions
than those currently experienced in the mortgage loan industry in general
because of the lower credit quality of the borrower. Any sustained period of
increased delinquencies, foreclosures and losses could hurt our financial
condition, results of operations and cash flows.
RISKS ASSOCIATED WITH TITLE I LOANS BACKING OUR MORTGAGE RELATED SECURITIES
At the end of our 1998 fiscal year, the Title I loans sold in
securitization transactions backed $10.7 million (representing 30.6%) of the
$34.8 million aggregate fair value of our mortgaged related securities. During
the period in which these Title I loans back our mortgage related securities, we
bear the risk of delinquencies, defaults and credit losses on these loans except
to the limited amount of FHA insurance remaining.
We have exhausted our reserves with respect to substantially all of the
Title I loans which back our mortgage related securities, and the remaining
pools of Title I loans backing our mortgage related securities have been
performing poorly. In addition, if the prepayment rates, delinquencies and
credit losses on the Title I loans backing our mortgage related securities
increase beyond the levels we have anticipated, we will need to further write
down the value of our Title I mortgage related securities.
RISKS ASSOCIATED WITH EXISTING EQUITY + LOANS
During fiscal 1997, 81.4% of the loans we produced were Equity + loans and,
during fiscal 1998, 91.6% of the loans we produced were Equity + loans. Their
weighted-average loan-to-value ratio was 112.0% for both of these periods. In
almost all cases, the value of the residences that secure these loans will not
be sufficient to cover the principal amount of the loans in the event of
defaults. During the nine months ended May 31, 1999, 5.4% of the loans we
produced were Equity + loans.
We historically sold a substantial portion of our Equity + loans in
securitization transactions. At the end of fiscal 1998, $24.1 million
(representing 69.4%) of our mortgage related securities were backed by Equity +
loans.
We bear the risk of delinquencies and defaults with respect to the entire
principal amount of, and interest on, these loans. Delinquencies, defaults and
credit losses on these loans in excess of the levels we anticipated in
determining the fair value of our mortgage related securities at the end of
fiscal 1998 would require us to further write down the fair value of these
securities. A write down would adversely affect our financial condition, results
of operations and cash flows. To the extent that borrowers with high
loan-to-value ratios default on their loan obligations, we are unlikely to use
foreclosure as a means to mitigate our losses. As of August 31, 1998, 9.7% of
the principal amount of the Equity +
23
<PAGE> 25
loans backing our mortgage related securities were more than 30 days
contractually past due. We will apply these losses to our allowances for
possible credit losses. If the credit losses exceeded this allowance, we would
be required to record additional provisions for losses on loans held for sale,
which would have a material adverse effect on our financial condition and
results of operations.
LITIGATION; RISK OF CLAIMS
In the ordinary course of business, we are subject to claims made by
borrowers and private investors from, among other things, losses allegedly
incurred as a result of potentially breaches of fiduciary obligations and
misrepresentations, errors and omissions of our employees, officers and agents.
Industry participants are frequently named as defendants in litigation involving
alleged violations of federal and state consumer lending laws because of the
consumer-oriented nature of the industry and uncertainties with respect to the
application of various laws and regulations. Pending claims and any claims made
in the future may result in legal expenses or liabilities which could have a
material adverse effect on our financial condition, results of operations and
cash flows. For details about pending litigation, see "Business -- Legal
Proceedings" located later in this prospectus.
CONCENTRATION OF OPERATIONS
The residences securing our loans have historically been concentrated in
California and Florida. We expect this trend to continue. As of August 31, 1998,
loans backed by residences in Florida and California represented a substantial
portion of the loans securing our mortgage backed securities. Consequently, our
financial condition, results of operations and cash flows are dependent upon
general trends in the California and Florida economies and their residential
real estate markets. Residential real estate market declines may adversely
reduce the value of the residences that are the collateral for our loans.
In addition, California and Florida historically have been vulnerable to
certain natural disaster risks, such as earthquakes, floods, hurricanes, fires
and erosion-caused mudslides, which are not typically covered by standard
borrower's hazard insurance policies. Uninsured disasters will adversely impact
borrowers' ability to repay our loans. The existence of adverse economic
conditions or the occurrence of such natural disasters in California or Florida
could have a material adverse effect on our financial condition, results of
operations and cash flows.
COMPETITION
We face intense competition in producing and selling Home Equity loans and
Equity + loans. Our competitors include other consumer finance companies,
mortgage banking companies, commercial banks, credit unions, thrifts, credit
card issuers and insurance finance companies. Many of these competitors are
substantially larger than we are. In addition, our competitors may have more
capital and other resources and a lower cost of capital than we do. In addition,
we may face competition from government-sponsored entities which have entered
the market for non-conforming mortgage loans. Existing mortgage loan purchase
programs may be expanded by the Federal National Mortgage Association ("FNMA"),
the Federal Home Loan Mortgage Corporation ("FHLMC"), or the Government National
Mortgage Association ("GNMA") to include non-conforming mortgages, particularly
loans similar to our Home Equity loans. Entries of government-
24
<PAGE> 26
sponsored entities into the non-conforming loan market may reduce the interest
rate borrowers are willing to pay on our mortgage loans and may reduce or
eliminate premiums on their sale.
Industry participants compete for business in many ways. Some provide
borrowers more convenience in obtaining a loan, some have better customer
service and others have strong marketing and distribution channels. This
industry has a relatively low barrier to entry, which permits new competitors to
enter the broker-sourced loan market quickly. This may lower the rates we can
charge borrowers, potentially lowering gains on future loan sales. If any of our
competitors significantly expand their activities in our markets, such action
could have a material adverse effect on us.
Changes in interest rates and general economic conditions may also affect
our competition. During periods of increasing interest rates, competitors who
have locked in low borrowing costs may have a competitive advantage. During
periods of declining rates, competitors have solicited, and may in the future
solicit, our customers to refinance their loans. To the extent these
solicitations are successful, the prepayment rates on the loans backing our
mortgage related securities may increase beyond the levels currently anticipated
which may result in a write down in the fair value of these securities.
We depend on mortgage brokers and bankers for substantially all of our
mortgage loan production. These mortgage brokers and bankers generally deal with
multiple lenders for each prospective borrower. Our competitors also attempt to
establish relationships with these entities, none of which are contractually or
otherwise obligated to deal exclusively, or to continue to do business, with us.
In addition, we expect the volume of broker and mortgage banker-sourced loans
funded and purchased by us to increase significantly. Our future operating and
financial results may be more susceptible to fluctuations in the volume and cost
of our broker and mortgage banker-sourced loans from, among other things,
competition from other purchasers of these loans.
As we expand our retail, broker and mortgage banker-sourced loan production
into new geographic markets, we will face competition from lenders with
established positions in these markets. We cannot predict whether we will be
able to compete successfully with those established lenders.
VOLATILITY OF STOCK PRICE
The price of our common stock has experienced significant volatility since
our initial public offering in November 1996. The market price of our common
stock, as adjusted to reflect a one-for-ten reverse stock split which became
effective on March 22, 1999, has ranged from a high of $157.50 per share to a
low of $1.00 per share through April 23, 1999. As of August , 1999, the
last sale price of our common stock as reported on the Nasdaq Small Cap Market
was $ per share. The stock market recently has experienced extreme price and
volume fluctuations which may be unrelated to the operating performance of
particular companies. Market conditions in the specialty finance industry and
factors such as legislative and regulatory changes, announcements of new
products and services by us, our competitors or third parties, and changes in
earnings estimates by analysts may have a significant effect on the price of our
common stock.
25
<PAGE> 27
RISK OF FAILING TO COMPLY WITH THE LISTING REQUIREMENTS OF THE NASDAQ SMALL CAP
MARKET
The Company's common stock formerly traded on the Nasdaq National Market.
Since June 4, 1999, the Company's stock has traded on the Nasdaq Small Cap
Market requires that all listed companies maintain certain levels with respect
to each of the following:
- net tangible assets
- number of publicly held shares
- value of capital stock traded
- bid price
- number of stockholders
- number of market makers
If we fail to comply with any of these requirements, our shares of common stock
could be delisted from the Nasdaq Small-Cap Market. If our common stock was
delisted, we cannot guarantee that there would be a market for you to trade in
the common stock.
FACTORS INHIBITING TAKEOVER; EFFECT OF CHANGE OF CONTROL
Sovereign Bancorp and City Holding Company each has a right of first
refusal to acquire us if our board of directors decides to offer us for sale. In
addition, the change of control provisions of the New Notes, as well as the
change in for sale control provisions of certain of our other credit
arrangements and employment agreements with our senior executives, could inhibit
a takeover attempt by a third party.
Certain provisions of our Certificate of Incorporation and Bylaws may
delay, defer or prevent a takeover attempt by a third party. Our Certificate of
Incorporation authorizes the board of directors to determine the rights,
preferences, privileges and restrictions of unissued series of preferred stock
and to fix the number of shares and designation of any series of preferred stock
without any vote or action by our stockholders. The issuance of preferred stock
may have the effect of delaying, deferring or preventing a change of control,
since the terms of the preferred stock that might be issued could potentially
prohibit or otherwise restrict our ability to consummate any merger,
reorganization, sale of substantially all of our assets, liquidation or other
extraordinary corporate transaction without the approval of the holders of the
outstanding shares of the preferred stock. Other provisions of our Certificate
of Incorporation and Bylaws provide that special meetings of the stockholders
may be called only by the board of directors or upon the written demand of the
holders of not less than 30% of the votes entitled to be cast at a special
meeting.
LEGISLATIVE AND REGULATORY RISKS
Our business is subject to extensive regulation, supervision and licensing
by federal, state and local governmental authorities. These rules and
regulations, among other things, impose licensing obligations on us, establish
eligibility criteria for mortgage loans, prohibit discrimination, provide for
inspections and appraisals of properties, govern credit reports on loan
applicants, regulate assessment, collection, foreclosure and claims handling,
investment and interest payments on escrow balances and payment features,
mandate disclosures and notices to borrowers and, in some cases, fix maximum
interest rates, fees and mortgage loan amounts. If we do not comply with these
requirements, many of which are highly technical, we could lose our approved
status, our servicing contracts could be
26
<PAGE> 28
terminated or suspended without compensation to the servicer, we could face
demands for indemnification or mortgage loan repurchases, we may suffer the
exercise of certain rights of rescission for mortgage loans by our borrowers,
and we may be subject to class action lawsuits and administrative enforcement
actions. For a discussion of pending litigation see "Business -- Legal
Proceedings" located later in this prospectus.
The Internal Revenue Service is considering a rule that would require
lenders to "flag" all of their high loan-to-value loans and to inform consumers
that some portion of their interest payments on high loan-to-value loans are not
tax-deductible. The adoption of this change could have an adverse affect on our
Equity + loan production. In addition, Congress is considering a recommendation
of the National Bankruptcy Review Commission that, if adopted, would treat in a
consumer bankruptcy proceeding the portion of a second mortgage loan that
exceeds the value of a house as unsecured debt. Adoption of these or more
restrictive laws, rules and regulations would have an adverse effect on our
financial condition, results of operations and cash flows. For more details, see
"Business -- Government Regulation" located later in this prospectus.
Members of Congress and government officials periodically have suggested
the elimination of the mortgage interest as a deduction for federal income tax
purposes in certain situations, based on, among other things, borrower income,
type of loan or the principal amount of the loan. Because many of our loans are
used by borrowers to consolidate consumer debt, make home improvements or for
other consumer needs, the reduction or elimination of these tax benefits could
substantially reduce the demand for the type of loans that we offer.
ENVIRONMENTAL RISKS
In the course of our business, we have acquired, and may acquire in the
future, residences that are the collateral or security for loans that are in
default. There is a risk that hazardous substances or waste, contaminants,
pollutants or their sources could be discovered on-site after these residences
are acquired by us. In that event, we may be required by law to remove the
substances from the residences at our cost and expense. We cannot guarantee
that: (1) the cost of removal would not substantially exceed the value of the
residence that is the collateral or security for a loan; (2) we would have
adequate remedies against the prior owner or other responsible parties; or (3)
we would be able to sell the residence prior to or following the removal.
YEAR 2000
At August 31, 1998, the Company had begun to make inquiry of substantially
all of its strategic partners, vendors and third party entities with which it
has material relationships, and had begun to compile data related to their Year
2000 plans. The Company's reliance upon certain third parties, vendors and
strategic partners for loan servicing, investor reporting, document custody and
other functions, means that their failure to adequately address the Year 2000
issue could have a material adverse impact on the Company's operations and
financial results. The Company has received assurances from its two major
strategic partners, City Mortgage Services and Sovereign Bank, NA, that they
have implemented plans to address the Year 2000 issue. The Company has not
evaluated these plans or assurances for their accuracy and adequacy, or
developed contingency plans in the event of their failure. As of May 31, 1999,
the Company had received responses from all of the strategic partners and
vendors.
27
<PAGE> 29
The Company also relies upon certain government entities (such as the U.S. Dept.
of Housing and Urban Development and various state regulatory agencies), utility
companies, telecommunication service companies and other service providers
outside of the Company's control. There can be no assurance that such suppliers,
government entities, or other third parties will not suffer a Year 2000 business
disruption. Such failures could have a material adverse effect on the Company's
financial condition and results of operations.
In addition, the Company's credit risk associated with its borrowers may
increase as a result of borrowers' individual Year 2000 issues. Negative impact
of Year 2000 issues upon borrowers may result in borrowers' inability to pay,
increases in delinquent loans, and a corresponding loss of residual income to
the Company. While at this time, it is not possible to calculate the potential
impact of such increased delinquent loans or default; it is believed that
increased delinquencies and defaults would have a material adverse impact on the
financial condition of the Company.
Until system testing is substantially completed, the Company cannot fully
estimate the risks of the Year 2000 issue. To date, the Company has not
identified any of its own business critical information technology assets that
it believes present a material risk of not being Year 2000 compliant or for
which a suitable alternative cannot be implemented. However, as the Company's
Year 2000 plan proceeds into subsequent phases, it is possible that the Company
may identify assets that do present a risk of a Year 2000-related disruption.
Such a disruption could have a material adverse effect on the Company's
financial condition and results of operations. Because the Company has not begun
system testing, and has not fully assessed its risks from potential Year 2000
failures, the Company has not yet developed specific Year 2000 contingency
plans.
Because of uncertainties, the actual effects of the Year 2000 issue on the
Company may be different from the Company's current assessment. The effect on
the Company's results of operations if the Company, its strategic partners,
vendors or other third parties are not fully Year 2000 compliant is not
reasonably estimable.
SHARES ELIGIBLE FOR FUTURE SALE
The sale of substantial amounts of our common stock into the market or the
prospects of a sale could have a material and adverse effect on the market price
of our common stock. As of July 31, 1999, there were 3,656,666 shares of common
stock outstanding. The 6,974,614 shares of common stock being offered by the
selling stockholders listed in this prospectus will be immediately eligible for
sale in the public market, without restriction, beginning on the date of this
prospectus. In addition, Sovereign Bancorp and City National Bank each have the
option to purchase 666,666 shares of common stock, subject to adjustment, at an
exercise price of $15.00 per share which, if exercised in full, would add
1,333,333 shares of common stock to the number of shares of common stock
outstanding. Our stock option plans authorize the granting of options to
purchase an aggregate of 1.4 million shares of common stock, of which options to
purchase 786,859 shares of common stock have been granted.
28
<PAGE> 30
USE OF PROCEEDS
All of the proceeds from the sale of the shares of common stock that may be
sold using this prospectus will be received by the selling stockholders. The
Company will not receive any of the proceeds from the sale of these shares of
common stock.
DIVIDEND POLICY
The Company has never paid cash dividends on its common stock, and the
board of directors currently intends to retain any earnings for use in the
Company's business for the foreseeable future. Any future payment of dividends
will depend on the Company's financial condition, results of operations, cash
requirements and other factors that the board of directors believes are
important.
PRICE RANGE OF COMMON STOCK
The Company completed its initial public offering on November 19, 1996 and,
until June 4, 1999, the common stock has traded on the Nasdaq Stock Market under
the symbol "MMGC." The common stock currently trades on the Nasdaq Small Cap
Market under the symbol "ATVA." The following table sets forth the high and low
sales prices of the common stock as reported on the Nasdaq National Market or
the Nasdaq Small Cap Market for the periods indicated. The information set forth
in the table below has been adjusted to reflect a one-for-ten reverse stock
split that was completed on March 22, 1999.
<TABLE>
<CAPTION>
HIGH LOW
--------- --------
<S> <C> <C>
FISCAL YEAR 1997:
First Quarter (November 19, 1996 to November 30,
1996)................................................ $120.00 $107.50
Second Quarter.......................................... 157.50 101.25
Third Quarter........................................... 146.25 80.00
Fourth Quarter.......................................... 135.00 90.00
FISCAL YEAR 1998:
First Quarter........................................... 150.00 95.625
Second Quarter.......................................... 102.50 30.00
Third Quarter........................................... 33.75 18.75
Fourth Quarter.......................................... 20.625 10.00
FISCAL YEAR 1999:
First Quarter........................................... 15.3125 3.75
Second Quarter.......................................... 8.13 3.75
Third Quarter........................................... 8.50 1.00
Fourth Quarter (through August , 1999)................
</TABLE>
As of August , 1999, there were holders of record of the Company's
common stock.
29
<PAGE> 31
CAPITALIZATION
The following table sets forth the capitalization of the Company at August
31, 1998 and May 31, 1999. This table should be read in conjunction with the
financial statements, the related notes, and the other financial information
appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
AUGUST 31, 1998 MAY 31, 1999
---------------------- ------------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Debt:
Revolving lines of credit.................... $ 14,576 $ 25,248
Other notes and contracts payable............ 1,769 1,344
12 1/2% Senior Subordinated Notes due
2001("Old Notes")(1)...................... 1,193 --
12 1/2% Subordinated Notes due 2001 ("Current
Notes")................................... 41,500 30,750
-------- --------
Total debt........................... 59,038 57,342
-------- --------
Stockholders' equity:
Preferred Stock, par value $.01 per share;
5,000,000 shares authorized; 62,500 shares
issued and outstanding.................... 1 1
Common Stock, par value $.01 per share;
400,000,000 shares authorized; 3,056,666
shares issued and outstanding as of August
31, 1998 and 3,056,666 shares issued and
May 31, 1999; shares issued and
outstanding as adjusted(2)................ 306 306
Additional paid-in capital................... 122,143 122,143
Accumulated deficit.......................... (95,856) (99,533)
-------- --------
Total stockholders' equity........... 26,594 22,917
-------- --------
Total capitalization................. $ 85,632 $ 80,259
======== ========
</TABLE>
- -------------------------
(1) As of October 31, 1998, the Company had completed the repurchase of all the
outstanding Old Notes.
(2) Does not include: (1) 1,000 shares of common stock reserved for issuance
upon the exercise of stock options granted and available to be granted under
the Company's 1996 Employee Stock Option Plan; (2) 200,000 shares of common
stock reserved for issuance upon the exercise of stock options granted and
available to be granted under the Company's 1997 Stock Option Plan; and (3)
an aggregate of approximately 481,859 shares of common stock reserved for
issuance upon the exercise of stock options granted to management. For
details on the Company's stock option plans, see "Management -- Company
Stock Option Plans" located later in this prospectus.
30
<PAGE> 32
SELECTED FINANCIAL DATA
The selected financial data set forth below has been derived from our
audited financial statements. The financial data as of August 31, 1997 and 1998
and for each of the three years in the period ended August 31, 1998 have been
derived from financial statements audited by the Company's independent auditors,
whose report for the year ended August 31, 1997 included an explanatory
paragraph related to their substantial doubt about our ability to continue as a
going concern. The Company's financial statements are included elsewhere in this
prospectus. The financial data as of August 31, 1994, 1995 and 1996 and for the
years ended August 31, 1994 and 1995 have been derived from audited financial
statements not included herein. The income statement data for the nine months
ended May 31, 1998 and 1999 and the balance sheet data as of May 31, 1999 have
been derived from unaudited interim financial statements contained elsewhere
herein, which in the opinion of management, include all adjustments (consisting
of only normal recurring adjustments) necessary for a fair presentation of the
information set forth therein. Results for the nine months ended May 31, 1999
are not necessarily indicative of the results for the entire year. We have
reclassified certain items to conform to prior years. You should read the
selected financial information set forth below in conjunction with the financial
statements, the related notes, and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" appearing elsewhere in this
prospectus. However, due to recent substantial changes to our business and
operating strategy, we believe that our historical financial and operating data
are not likely to be indicative of our future performance and our results of
operation for fiscal 1998 are not comparable to fiscal 1997.
<TABLE>
<CAPTION>
NINE MONTHS
FISCAL YEAR ENDED AUGUST 31, ENDED MAY 31,
------------------------------------------------------- -------------------------
1994 1995 1996 1997 1998 1998 1999
------- ------- ------- ----------- ----------- ----------- -----------
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Gain (loss) on sale of
loans.................... $ 579 $12,233 $16,539 $ 45,123 $ (26,578) $ (15,562) $ 759
Net unrealized gain (loss)
on mortgage related
securities(1)............ -- -- 2,697 3,518 (70,024) (44,120) (532)
Loan servicing income,
net...................... -- 873 3,348 3,036 999 1,137 230
Interest income, net of
interest expense of $107,
$468, $1,116, $6,374,
$13,162, $11,175 and
$5,686................... 172 473 988 3,133 1,624 2,026 (654)
------- ------- ------- ----------- ----------- ----------- -----------
Total revenues
(losses)........... 751 13,579 23,572 54,810 (93,979) (56,519) (197)
------- ------- ------- ----------- ----------- ----------- -----------
Expenses:
Provision/(Benefit) for
credit losses, net....... 96 864 55 6,300 (3,198) 2,404 (276)
Depreciation and
amortization............. 136 403 394 672 1,013 844 759
Other interest............. 22 187 167 245 439 330 96
General and administrative:
Payroll and benefits..... 975 3,611 6,328 13,052 18,582 14,925 5,385
Commissions and
selling(2)............. 13 552 -- -- -- -- --
Credit reports........... 13 133 367 1,387 510 474
Rent and lease
expenses............... 85 249 338 1,199 1,616 1,118 967
Professional services.... 548 1,043 1,771 2,271 4,783 3,637 2,281
Sub-servicing fees....... 13 232 709 1,874 2,160 1,795 210
Other services........... 128 340 665 1,352 2,068 1,615 2,424
Travel and
entertainment.......... 261 107 677 1,005 1,159 967 428
Insurance................ 11 231 572 558 430 335 630
</TABLE>
31
<PAGE> 33
<TABLE>
<CAPTION>
NINE MONTHS
FISCAL YEAR ENDED AUGUST 31, ENDED MAY 31,
------------------------------------------------------- -------------------------
1994 1995 1996 1997 1998 1998 1999
------- ------- ------- ----------- ----------- ----------- -----------
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
Other.................... (39) (292) 374 1,085 2,448 1,737 565
------- ------- ------- ----------- ----------- ----------- -----------
Total costs and
expenses........... 2,262 7,660 12,417 31,000 32,010 30,181 13,469
------- ------- ------- ----------- ----------- ----------- -----------
Income (loss) before income
taxes(3) and extraordinary
item....................... (1,511) 5,919 11,155 23,810 (125,989) (86,700) (13,666)
Income tax expense
(benefit)(3) before
extraordinary item......... -- 2,277 4,235 9,062 (6,334) -- (5,177)
------- ------- ------- ----------- ----------- ----------- -----------
Net income (loss)(3) before
extraordinary item......... $ (86,700) $ (8,489)
=========== ===========
Extraordinary item net of
taxes of $2.9 million...... 0 4,812
------- ------- ------- ----------- ----------- ----------- -----------
Net income (loss)............ $(1,511) $ 3,642 $ 6,920 $ 14,748 $ (119,655) $ (86,700) $ (3,677)
======= ======= ======= =========== =========== =========== ===========
Net income (loss) per
share(4):
Basic...................... $ 12.50 $ (77.18) $ (70.49) $ (1.20)
=========== =========== =========== ===========
Diluted.................... $ 12.50 $ (77.18) $ (70.49) $ (1.20)
=========== =========== =========== ===========
Weighted-average number of
common shares(4)........... 1,180,219 1,550,292 1,230,000 3,056,666
=========== =========== =========== ===========
Weighted-average number of
common shares and assumed
conversions(4)............. 1,180,219 1,550,292 1,230,000 3,056,666
=========== =========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
AS OF
AS OF AUGUST 31, MAY 31,
------------------------------------------------- -----------
1994 1995 1996 1997 1998 1999
------ ------- ------- -------- --------- -----------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF FINANCIAL CONDITION DATA:
Cash and cash equivalents..................... $ 824 $ 752 $ 443 $ 6,104 $ 36,404(5) 9,231(5)
Loans held for sale, net...................... 1,463 3,676 4,610 9,523 10,975(6) 15,557(6)
Mortgage related securities(1)................ -- -- 22,944 106,299 34,830 34,214
Excess servicing rights(1).................... 904 14,483 12,121 -- -- --
Mortgage servicing rights..................... -- 1,076 3,827 9,507 83 --
Total assets.................................. 5,122 24,081 50,606 156,554 104,535 84,709
Allowance for credit losses on loans sold with
recourse.................................... 66 886 920 7,014 2,472 --
Subordinated debt(7).......................... -- -- -- 40,000 42,693 30,750
Total liabilities............................. 983 13,300 32,905 103,447 77,941 61,792
Stockholders' equity.......................... 4,139 10,781 17,701 53,107 26,594 22,917
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS
FISCAL YEAR ENDED AUGUST 31, ENDED MAY 31,
------------------------------------------------- -------------------
1994 1995 1996 1997 1998 1998 1999
------ ------- -------- -------- -------- -------- --------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Loan production....................... $8,164 $87,751 $139,367 $526,917 $338,942 $337,050 $ 40,560
Weighted-average interest rate on loan
production.......................... 14.18% 14.55% 14.03% 13.92% 13.89% 13.89% 11.00%
Loans in servicing portfolio (end of
period):
Company-owned:
Equity +.......................... $ -- $ -- $ 922 $ 8,661 $ 8,217 $ 9,700 $ 18,144
Title I........................... 1,471 3,720 3,776 902 4,233 2,883 442
------ ------- -------- -------- -------- -------- --------
Total Company-owned(8)........ 1,471 3,720 4,698 9,563 12,450(6) 12,583 18,586
</TABLE>
32
<PAGE> 34
<TABLE>
<CAPTION>
NINE MONTHS
FISCAL YEAR ENDED AUGUST 31, ENDED MAY 31,
------------------------------------------------- -------------------
1994 1995 1996 1997 1998 1998 1999
------ ------- -------- -------- -------- -------- --------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C> <C> <C>
Securitized:
Equity +.......................... -- -- 10,501 363,961 -- 304,628 --
Title I........................... 6,555 88,566 198,990 254,544 18,772 229,034 --
------ ------- -------- -------- -------- -------- --------
Total securitized............. 6,555 88,566 209,491 618,505 18,772 533,662 --
------ ------- -------- -------- -------- -------- --------
Total servicing portfolio..... $8,026 $92,286 $214,189 $628,068 $ 31,222 $546,245 $ 18,586
====== ======= ======== ======== ======== ======== ========
Cash used in operations............... $4,402 $ 3,619 $ 12,440 $ 72,438 $ 39,723 $ 26,934 $ 24,096
====== ======= ======== ======== ======== ======== ========
</TABLE>
- ---------------
(1) Mortgage related securities are junior subordinated interests retained by
the Company in pools of mortgage loans sold by the Company in securitization
transactions. SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," required the Company,
as of January 1, 1997, to reclassify excess servicing rights (junior
subordinate interests retained by the Company in pools of mortgage loans
sold in transactions similar to a securitization) to mortgage related
securities. The fair value (the dollar amount on the Company's balance
sheet) of the Company's mortgage related securities was written down from
$106.3 million at the end of fiscal 1997 to $34.8 million at the end of
fiscal 1998. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Notes 2, 4 and 17 to the Company's
financial statements located later in this prospectus.
(2) For fiscal 1996, 1997, 1998 and the nine months ended May, 1999, commissions
and selling expenses have been reclassified into its functional
classifications within general and administrative expenses.
(3) The results of the Company's operations were included in the consolidated
federal income tax returns filed by Mego Financial through September 2,
1997, the date the shares of common stock of the Company were distributed by
Mego Financial to its shareholders in a tax free spin-off. For more details
on this and other transactions with Mego Financial and its affiliates, see
"Certain Transactions" located later in this prospectus.
(4) Earnings per share for the fiscal years ended August 31, 1994, 1995 and 1996
are not presented because, during these years, the Company was a wholly
owned subsidiary of Mego Financial.
(5) As part of the recapitalization, the Company sold an aggregate of $50.0
million of common stock and Series A convertible preferred stock. For more
details, see "The Recapitalization" located later in this prospectus.
(6) Loans held for sale, net includes a valuation reserve which reflects the
Company's best estimate of the amount that the Company expects to receive on
the sale of these loans.
(7) The Company sold $40.0 million principal amount of Old Notes in November
1996 and an additional $40.0 million principal amount of Old Notes in
October 1997. As part of the recapitalization, the Company issued $37.5
million of Series A convertible preferred stock and $41.5 million principal
amount of Current Notes in exchange for $79.0 million of Old Notes. The
Company purchased all of the Old Notes remaining outstanding as of October
1998.
(8) Excludes approximately $9.4 million and Equity + loans repurchased on August
31, 1998. The majority of these loans have been repurchased prior to
November 30, 1998. The amount on the Company's balance sheet as of August
31, 1998 is the amount the Company expected to receive on the sale of these
loans. For additional details, see Note 3 to the Company's financial
statements located later in this prospectus.
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<PAGE> 35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The purpose of Management's Discussion and Analysis of Financial Conditions
and Results of Operations is to provide a detailed explanation of the Company's
financial performance in fiscal 1996, 1997 and 1998 and the nine months ended
May 31, 1998 and 1999, the factors that had a significant impact on the
Company's performance in those periods and a description of any trends affecting
financial performance during the periods discussed. We also describe the
Company's liquidity situation at the end of the quarter ended May 31, 1999,
including the amount that the Company owed to its lenders on that date, and the
additional amounts, if any, available to be borrowed by the Company. In
addition, we describe the major changes to the balance sheet. This information
is the primary basis for our belief that we have enough cash and borrowing
ability to carry out our business plan for fiscal 1999. You should read this
section in conjunction with the Company's financial statements, including the
notes to the financial statements, located later in this prospectus.
During the last eight months of fiscal 1998 and the nine months ended May
31, 1999, the Company's operations consisted principally of:
(1) liquidating its portfolio of loans to repay outstanding debt;
(2) maintaining its systems and retaining personnel necessary to resume
operations while exploring alternatives to locate new capital; and
(3) designing and beginning to implement its strategic initiatives.
Due to recent substantial changes to the Company's business and operating
strategy, we believe that the Company's historical financial and operating data
are not likely to be indicative of the Company's future performance and the
Company's results of operation for fiscal 1998 are not comparable to fiscal
1997.
GENERAL
The Company substantially expanded its operations during fiscal 1996 and
1997 and the first four months of fiscal 1998. During these periods the
Company's loan production was $139.4 million (fiscal 1996), $526.9 million
(fiscal 1997) and $268.5 million (first four months of fiscal 1998). As it
expanded its business, the Company's general and administrative expenses
increased from $11.8 million in fiscal 1996 to $23.8 million in fiscal 1997 and
$13.8 million in the first four months of fiscal 1998.
During these periods, a substantial majority of the Company's loan
production was sold in securitization transactions. The sale of loans by the
Company in securitization transactions, as described below, typically results in
substantial negative cash flow, because the cash proceeds from the sale of loans
in a securitization transaction is substantially less the Company's total cost
of producing the loans sold. The combination of negative cash flow from the sale
of loans in securitization transactions and increases in general and
administrative expenses caused the Company, historically, to operate on a
substantial negative cash flow basis. The Company's negative cash flow from
operations was $12.4 million for fiscal 1996, $72.4 million for fiscal 1997 and
$49.7 million for the first four months of fiscal 1998.
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<PAGE> 36
As a result of a $11.7 million loss in the first quarter of fiscal 1998 and
continuing cash flow deficits, the Company violated certain provisions of its
warehouse line. In February 1998, the warehouse lender requested that the
Company repay a significant portion of the principal balance of the line or be
declared in default. Since a default on the warehouse line would have triggered,
among other things, a default on the Company's $80 million principal amount of
outstanding Old Notes, the Company agreed to reduce the outstanding balance of
the warehouse line from $55.0 million periodically. The Company repaid the
balance on June 29, 1998.
To generate cash to reduce the outstanding balance of the warehouse line
and continue to operate, the Company began to liquidate, through sales for cash,
its mortgage loan portfolio and the warehouse lender refused to make further
advances under the line. In addition, because the Company's old warehouse line
was used to fund loans produced by the Company prior to their sale, the Company
substantially curtailed its loan production beginning in January 1998. The cash
received from the Company's sale of loans from its loan portfolio was used to
pay down the old warehouse line and other Company borrowings and to pay
substantial general and administrative expenses to retain personnel and maintain
the Company's operations while it sought to locate new capital.
On July 1, 1998, the Company completed the recapitalization. As part of the
recapitalization, the Company received $50.0 million in proceeds from the
private placement of approximately 1.67 million shares of common stock at a
price of $15.00 per share and 25,000 shares of Series A convertible preferred
stock at a price of $1,000 per share. In addition, the Company issued $37.5
million of Series A convertible preferred stock and $41.5 million principal
amount of Current Notes in exchange for approximately $79.0 million principal
amount of Old Notes. The recapitalization resulted in approximately $84.5
million of new equity. For more information on the recapitalization, see "The
Recapitalization" located later in this prospectus.
SECURITIZATION TRANSACTIONS
Securitization transactions historically had been the main source of the
Company's revenue and income. In a securitization transaction, a specific group
of the Company's mortgage loans having similar characteristics, loan type
(Equity + or Title I) and loan amounts are pooled for sale. By selling loans in
a securitization transaction, the Company could sell a very large group of loans
at one time. The Company sold an average of $79.7 million of mortgage loans in
each of the five securitizations completed in fiscal 1997. However, the sale of
loans in a securitization transaction generates a significant cash flow deficit,
because the cash received by the Company from the sale of the loans is
significantly less than the Company's total cost of producing the loans sold.
The purchaser of the loans in a securitization transaction is a special
trust created:
(1) to purchase and hold title to the loans;
(2) to sell debt securities or ownership interests backed by the cash flow
to be received on the loans owned by the trust, i.e., the principal and interest
payments from the Company's borrowers; and
(3) to distribute payments over time to the holders of securities issued by
the trust.
Once the trust purchases the loans from the Company, it generally has no
recourse against the Company other than for breaches of certain representations
and warranties
35
<PAGE> 37
made by the Company at the time the loans were sold. Likewise, after the trust
purchases the loans from the Company, creditors of the Company have no recourse
against the loans in the event the Company experiences financial difficulties.
The trust purchases the loans from the Company with money it obtains by selling
the securities.
The trust sells both senior "rated" securities and issues an unrated
subordinate residual security to the Company. Only qualified institutional
investors, such as insurance companies, banks and thrifts, can purchase the
senior securities sold by the trust.
Because the Company's Equity + loans are not insured and its Title I loans
have only limited FHA insurance, the trust, as the owner of these mortgage
loans, has credit risk. If the borrowers default on their loans, the trust (as
the owner of the loans) typically will lose its entire investment (except to the
extent of the limited FHA insurance on Title I loans). As a result of these
potential losses, the purchasers of the trust's senior securities are willing to
buy the securities only if they receive additional assurance that they will get
paid. This assurance is provided by a rating from the national rating agencies,
such as Standard & Poor's and Moody's.
As a general matter, the more predictable the cash flow to the senior
securities, the higher the rating on the senior securities and the lower the
yield that will be demanded by purchasers of the senior securities relative to
prevailing market yields. The lower the yield paid to the senior security
holders, the greater the positive spread (the "spread") between the interest
paid by the Company's borrowers on the mortgage loans in the trust and (i) the
interest costs of the senior securities sold and (ii) fees paid to the trustee
and the servicer for servicing the mortgage loans. In general, the greater the
spread, the greater the amount of cash flow in excess of the principal and
interest payments to the senior security holders the Company anticipates it will
receive on the mortgage related securities issued to the Company in the
securitization, and the greater their fair value. During fiscal 1997, the
Company sold $398.4 million principal amount of loans in securitization
transactions that had a weighted-average interest rate of 14.0% and in which the
senior securities sold had an initial weighted-average yield of 6.88%.
In order for the senior securities to gain a sufficiently high rating to
attract investors, the rating agencies require that the trust create various
forms of credit enhancement to increase the likelihood that the loans in the
trust will generate sufficient cash flow to pay the interest and principal
payments on the senior securities. Credit enhancement may be achieved in several
ways. The trust may purchase the loans the Company sells in the securitization
transaction for a combination of cash and by issuing the Company a subordinated
residual interest in the securitization. The security issued by the trust to the
Company receives cash flow only after required payments of interest and
principal have been made to the senior security holders, and absorbs any losses
from defaults or foreclosures on the loans in the trust. The junior subordinated
interests issued to the Company in securitization transactions are called
mortgage related securities. Another credit enhancement is a "guaranty," a form
of insurance issued by an insurance company. While some of the Company's
securitizations have included guaranty insurance, the Company has always
received a subordinate mortgage related security and has provided
over-collateralization as credit enhancement in order to achieve acceptable
ratings.
Credit enhancement may also be achieved through "over-collateralization."
National rating agencies will give higher ratings if the senior securities
receive assurance that they will be paid. This is achieved by requiring an
initial level of over-collateralization and by building more
over-collateralization through the trust's retaining cash flow (from the
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<PAGE> 38
spread) that would otherwise be paid to the Company on its mortgage related
securities. The initial over-collateralization is created by having the
principal amount of loans sold to the trust be greater than the principal amount
(and cash proceeds from the sale) of senior interests sold. In the five
securitization transactions during fiscal 1997, the trusts purchased $398.4
million principal amount of loans from the Company, but the trusts sold only
$379.2 principal amount of senior securities.
As borrowers make their monthly mortgage loan payments to the servicer of
the loans in the trust, the payments are remitted by the servicer to a trustee
that collects these payments and make payments of interest and principal to the
holders of the senior securities pursuant to a pre-established schedule. The
priority of the payments is determined by the terms of an indenture.
The mortgage related securities owned by the Company, while offering the
potential of a substantially higher yield than the senior securities, have very
high credit risk. The Company's mortgage related securities absorb all losses
caused by defaults on the mortgage loans backing the securitization. The
Company's mortgage related securities are highly speculative and are subject to
the special risks which are described in more detail under "Risk Factors"
earlier in this prospectus.
Sample Securitization Transaction
In order to make the concept of negative cash flow that results from the
sale of mortgage loans in a securitization transaction more understandable, the
Company has provided the following example.
THE EXAMPLE BELOW ILLUSTRATES THE MECHANICS OF A SECURITIZATION AND THE
RESULTING NEGATIVE CASH FLOW BUT DOES NOT REFLECT (1) AN ACTUAL SALE OF MORTGAGE
LOANS BY THE COMPANY IN A SECURITIZATION TRANSACTION OR (2) THE ACTUAL AMOUNT OF
NEGATIVE CASH FLOW FROM THE DISPOSITION OF LOANS IN THIS MANNER. ACTUAL RESULTS
WILL BE MATERIALLY DIFFERENT FROM THE EXAMPLE.
This example is based on five general assumptions:
(1) mortgage bankers originated $100.0 million of mortgage loans having a
weighted average interest rate of 13.98%;
(2) the Company purchased the loans from mortgage bankers for a premium of
$4.0 million (the mortgage bankers received an aggregate of $104.0 million for
the loans);
(3) the Company sells the loans to the securitization trust for $97.0
million in cash, the trust sells $97.0 million of senior securities having a
weighted average interest rate of 6.88% and issues a subordinate mortgage
related security to the Company;
(4) the securitization process costs $1.0 million in fees and costs paid to
investment bankers, attorneys, accountants and others; and
(5) Standard & Poor's and Moody's require (A) an initial level of "over-
collateralization" of 3% ($3.0 million) of the original amount of loans sold in
the securitization and (B) that the level of over-collateralization must reach
6% of the original principal amount of loans ($6.0 million) before the cash flow
will be paid by the trustee to the holder of the subordinate mortgage related
security.
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<PAGE> 39
In this example, the sale of this pool of $100.0 million of mortgage loans
would result in negative cash flow of $8.0 million. The negative cash flow
results from the following factors:
- $104.0 million, representing the total cost of producing the loans sold
in the securitization minus
- $97.0 million is received by the trust from the sale of the senior
securities, all of which is paid to the Company, minus
- $1.0 million of fees and expenses.
The $3.0 million difference between the $100.0 million of mortgage loans
purchased by the trust and the $97.0 million of senior securities sold by the
trust creates the 3.0% initial over-collateralization. The senior securities
have the "protection" or credit enhancement of the cash flow, principal and
interest received on the $3.0 million of loans plus the spread initially equal
to $7.4 million per year. The spread represents 7.1% (the difference between
13.98%, the interest paid by the borrower on the loans in the trust, and 6.88%,
the interest paid by the trust on the senior securities) on the $97.0 million of
loans plus 13.98% on the $3.0 million of loans in the over-collateralization
account. The trustee would retain the spread until the over-collateralization
reaches $6.0 million.
After the required level of over-collateralization is achieved, the trustee
pays all of the cash flow, after the payment of interest and principal to the
senior interest, to the Company's mortgage related securities. Loan
delinquencies and defaults reduce this over-collateralization. If the amount in
the account falls below 6.0% of the amount of loans sold to the trust, the
trustee stops the payment of cash to the Company's mortgage related securities
and retains it until the 6.0% level is again achieved.
Accounting for a Securitization Transaction
Under generally accepted accounting principles, the sale of mortgage loans
by the Company in securitization transactions requires the Company to recognize
revenue on the completion of the securitization transaction based on the
discounted present value of the estimated future cash flow stream ("gain on sale
accounting") to be received by the Company on its mortgage related securities.
As described in more detail later in this "Management's Discussion and Analysis
of Financial Condition and Results of Operations," the Company determines the
fair value of each of its mortgage related securities using prepayment,
delinquency, default and credit loss assumptions on the mortgage loans backing
each of its mortgage related securities that the Company believes to be
appropriate for the particular mortgage loans. The anticipated cash to be
received by the Company's mortgage related securities from the mortgage loans is
discounted to present value to establish the fair value of the mortgage related
securities shown on the Company's balance sheet.
Accounting for specialty finance companies that sell assets in
securitization transactions is particularly complex. The most complex item is
the source of the Company revenues. The Company gets its revenues from the
following items:
- Gain (loss) on the sale of loans;
- Unrealized gain (loss) on mortgage related securities retained in
securitization transactions;
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<PAGE> 40
- Interest income, net; and
- Loan servicing income, net.
Gain (Loss) on the Sale of Loans. Historically, the most significant
portion of the Company's revenues comes from Gain (loss) on the sale of loans.
One component is the Gain (loss) resulting from the sale of loans in
securitization transactions. Refer to the example the Company used earlier,
where the sale of $100.0 million of our loans in the securitization transaction
resulted in negative cash flow of $8.0 million. Assume the mortgage related
security issued by the trust to the seller of the loans from that securitization
had a fair value of $18.0 million (see discussion on "gain on sale" accounting
above). The seller then would have received a total of $115.0 million from the
securitization, consisting of $97.0 million in cash and a mortgage related
security having a fair value of $18.0 million. The total cost of the loans sold
in the securitization were $105.0 million, consisting of the total cost of
producing the loans of $104.0 million and $1.0 million in fees and expenses for
the securitization. In this example, the revenues recorded from this
securitization would be $10.0 million. This amount is divided between two
revenue items, Gain (loss) on sale of loans and Net unrealized gain (loss) on
mortgage related securities. The division of the revenues between these two
items is determined by allocating the total revenues of $10.0 million,
proportionately between the cash proceeds from the sale of the loans, in this
case $97.0 million (allocated to revenues from "Gain (Loss) on the Sale of
Loans"), and the fair value of the mortgage related security issued by the trust
to the seller of the loans in the securitization, in this case $18.0 million
(allocated to revenues from "Unrealized gain (loss) on mortgage related
securities").
Another component represents the gain (loss) on the sale of loans for cash.
It is equal to the Company's total cost (expense) of producing loans including
any premiums paid when the Company purchases loans from its network of mortgage
bankers, minus the amount received by the Company at the time the loans are sold
for cash to an institutional purchaser. For example, if the Company purchased a
$100,000 principal balance loan from a mortgage banker for $104,000 and sold
that loan to an institutional purchaser for $107,000, the Company would
recognize $3,000 of revenue from gain on the sale of loans.
Unrealized Gain (Loss) on Mortgage Related Securities Retained in
Securitization Transactions. Revenues from "Unrealized gain (loss) on mortgage
related securities" results from the allocation of total revenues from the sale
of mortgage loans in securitization transactions described immediately above and
from two other sources. Revenues from the amortization on the Company's mortgage
related securities generally is equal to the amount of cash flow received on the
Company's mortgage related securities. In addition, Unrealized gain (loss) on
mortgage related securities generates negative revenues equal to (i) the write
down, if any, of the fair value of the Company's mortgage related securities;
and (ii) positive revenues from the write up, if any, of those securities.
Interest Income, Net. Interest income, net, is the interest received by
the Company on its portfolio of mortgage loans prior to their sale plus
accretion interest on its mortgage related securities minus the Company's
interest expense on its borrowings including its subordinated debt, warehouse
line of credit and other borrowings.
Loan Servicing Income, Net. "Loan servicing income, net", are the fees
paid to the Company for servicing loans owned by the Company or loans sold with
servicing retained. The prepayment penalties, if any, received from the
Company's borrowers who repay their
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<PAGE> 41
loans prior to their scheduled maturity date are included in Loan servicing
income, net. As discussed earlier in this prospectus, the Company historically
retained the servicing on a substantial majority of loans it sold. The Company
uses "net" as a part of the revenues from loan servicing because, under
generally accepted accounting principles, the amount of servicing fees earned is
reduced by the amortization of the Company's servicing rights. The Company
values the anticipated servicing fees the Company will receive for servicing a
loan from inception until its anticipated maturity and discounts the anticipated
cash flow to its present value similar to the way the Company determines the
fair value of its mortgage related securities. Historically, the Company's fee
for servicing a loan was 1% of the loan's outstanding principal balance. The
fair value of the anticipated cash flow is recorded on the Company's balance
sheet as "Mortgage servicing rights." As servicing revenues are received, the
discounted present value of the future cash flow is reduced. The amount of the
reduction is the "amortization." Revenue from mortgage servicing rights will not
be significant in the future, because the Company sold all of its servicing
rights to City Mortgage Servicing as part of the recapitalization.
Revision of Assumptions
As described immediately above, the most significant source of the
Company's revenues and income historically has resulted from the sale of loans
produced by the Company and sold in securitization transactions and the fair
value of the mortgage related security issued to the Company by the trusts. The
Company explained earlier in this prospectus under "Risk Factors" that it
projects the anticipated cash flow to be received from the loans backing its
mortgage related securities based on assumptions of voluntary prepayment speeds
and losses. When prepayments, delinquencies, default and credit losses on the
mortgage loans backing the Company's mortgage related securities exceed the
Company's assumptions, the Company is required to modify its assumptions as to
the prepayments, delinquencies, defaults and credit loss rates on the mortgage
loans backing its mortgage related securities. This generally reduces the
anticipated cash flow to be received from the mortgage loans and results in a
write down in the fair value of the particular mortgage related securities. The
amount of the writedown is treated as negative revenues from Unrealized gain
(loss) on mortgage related securities.
The fair value of the Company's mortgage related securities are affected
by, among other things, changes in market interest rates and prepayment and loss
experiences of these and similar securities. The Company estimates the fair
value of its mortgage related securities using prepayment and credit loss
assumptions on the mortgage loans backing these securities that the Company
believes to be appropriate for the characteristics (weighted-average interest
rate, weighted-average maturity date, etc.) of the mortgage loans backing each
particular securitization. The Company discounts the projected cash flow at the
rate it believes an independent third-party purchaser would require as a rate of
return.
During the fiscal year ended August 31, 1998, the Company experienced
prepayment activity and delinquencies with respect to its securitized Equity +
loans, which substantially exceeded the levels that had been assumed for the
applicable time frame. As a result of this increase, the Company adjusted the
assumptions previously utilized in calculating the carrying value of its
mortgage related securities. The application of these revised assumptions to the
Company's portfolio of Equity + and Title I loans backing its mortgage related
securities caused the Company to adjust the carrying value of these securities
by approximately $72.1 million during fiscal 1998. The changes in prepayment
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<PAGE> 42
and credit loss assumptions also caused the Company to write down the fair value
of its mortgage servicing rights by $1.1 million during fiscal 1998. As
discussed earlier in this prospectus, the fair value of the Company's mortgage
related securities and the fair value of its mortgage servicing rights are
determined in a similar manner.
The Company has revised its assumptions based on information from a variety
of sources including, among other things, the Company's experience with its own
portfolio of loans, pertinent information from a variety of market sources and
consultations with its financial advisors. However, the Company has not obtained
an independent evaluation of the assumptions utilized in calculating the
carrying value of its mortgage related securities for any period subsequent to
August 31, 1997. To the Company's knowledge, there is no active market for the
sale of these securities. During the year ended August 31, 1998, negative
adjustments of approximately $72.1 million were recognized. See Note 4 to the
Company's financial statements included later in this prospectus.
Although the Company believes that it has made reasonable estimates of the
prepayment and default rates in determining the fair value of the Company's
mortgage related securities, the rate of prepayments and defaults utilized are
estimates, and actual experience will vary from these estimates and such
variances may be material. There can be no assurance that the revised prepayment
and loss assumptions used to determine the fair value of the Company's mortgage
related securities and mortgage servicing rights will remain appropriate for the
life of the loans backing such securities. If actual loan prepayments or credit
losses vary from the Company's estimates, the fair value of the Company's
mortgage related securities and mortgage servicing rights, if any, may have to
be further adjusted through a charge or credit to earnings.
The Company's revised prepayment assumptions used for Title I loans at
August 31, 1998 reflect an annualized rate of 23.0% for the life of the
portfolio. Actual annualized prepayment rates of the Title I loans backing the
Company's mortgage related securities were 22.5% for the fiscal year ended
August 31, 1998 and 22.7% for the six months ended August 31, 1998. These
revised loss assumptions for Title I loans at August 31, 1998 are based on a
historical "migration" analysis of delinquent loans that the Company anticipates
will become "defaulted loans." The new assumed default rate and the restricted
rates are shown below in the following model and historical default rates:
<TABLE>
<CAPTION>
HISTORICAL DEFAULT RATES
FOR THE PERIODS ENDED AUGUST 31, 1998
NEW ASSUMED ---------------------------------------
DELINQUENCY (DAYS) STATUS DEFAULT RATES 12 MONTHS 6 MONTHS 3 MONTHS
- ------------------------- ------------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
31 - 60....................... 5% 1.51% 1.69% 2.64%
61 - 90....................... 20-25 21.80 24.80 29.55
91 - 120...................... 50 43.02 46.43 54.78
121 - 150..................... 80 55.90 55.55 63.28
151 - 180..................... 95 59.25 59.85 68.34
Over 180...................... 100 100 100 100
</TABLE>
The Company assumes that a defaulted Title I loan will result in loss of
95.0% of the loan balance and that all Title I insurance has been exhausted. On
a cumulative basis, the new assumptions anticipate aggregate losses of 11.9% of
the original principal balance of Title I loans.
The prepayment assumptions for Equity + loans were also increased at the
end of fiscal 1998 to reflect an annualized prepayment rate of 4.5% in the first
month following the completion of the securitization with the annualized rate
increases in level monthly
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<PAGE> 43
increments so that by the 18th month the annualized prepayment rate is 18.75%.
The annualized prepayment rate is maintained at that level through the 36th
month at which time it is assumed to decline in level monthly increments to
15.25% by the 43rd month, and is maintained at 15.25% for the remaining life of
the portfolio. The weighted-average annualized prepayment speed for the loans
backing the Company's mortgage related securities was 17.4% during fiscal 1998
and 4.1% during fiscal 1997.
The loss assumptions for the Equity + loans backing the Company's mortgage
related securities have also been increased to reflect losses commencing in the
second month following a securitization and building in level monthly increments
until a 4.25% annualized loss rate is reached in the 15th month. The annualized
loss rate is maintained at that level through the 43rd month at which time it is
assumed to decline in level monthly increments to 4.0% at month 48 and is
maintained for the life of the portfolio. On a cumulative basis this model
assumes aggregate losses of approximately 16% of the initial principal balance
of Equity + loans backing the Company's mortgage related securities. The actual
losses on Equity + loans backing the Company's mortgage related securities
during fiscal 1998 were approximately 2.5% of the original principal balance.
The Company utilizes a 16% discount rate at August 31, 1998 to discount to
their present sale of the cash flow streams to be received by the Company on its
mortgage related securities. During fiscal 1996 and 1997, the Company used an
annual weighted-average discount rate of 12% for Title I and Equity + loans and
generally utilized annual prepayment assumptions ranging from 1% to 15%, annual
estimated losses of up to 1.75% on Equity + loans resulting in an aggregate loss
of 15%, and estimated losses on Title I loans based on the then current
migration analysis and assuming recoveries of 20% after exhaustion of insured
reserves.
We believe that due to recent substantial changes to the Company's business
and operating strategy, the Company's historical financial and operating data is
not likely to be indicative of the Company's future performance.
RESULTS OF OPERATIONS
Nine Months Ended May 31, 1999 Compared to Nine Months Ended May 31, 1998
Loan Production
The following table sets forth certain data regarding loans produced,
securitized, and serviced by the Company during the nine months ended May 31,
1998 and 1999:
<TABLE>
<CAPTION>
NINE MONTHS ENDED MAY 31,
-----------------------------------
1998 1999
---------------- ---------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Principal balance of loans produced:
Wholesale (includes Bankers/Brokers):
Title I............................. $ 7,056 2.1% $ 0 0.0%
Equity + loans...................... 0 236 0.6
Home Equity......................... 289,043 85.8 35,080 86.5
-------- ----- ------- -----
Total Wholesale................ 296,099 87.9 35,316 87.1
-------- ----- ------- -----
</TABLE>
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<TABLE>
<CAPTION>
NINE MONTHS ENDED MAY 31,
-----------------------------------
1998 1999
---------------- ---------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Dealers(1):
Title I............................. $ 11,595 3.4% $ 0 0%
Home Equity......................... 14,001 4.2 0 0
-------- ----- ------- -----
Total Dealers.................. 25,596 7.6 0 0
-------- ----- ------- -----
Retail:
Equity + loans...................... 0 0.0 1,956 4.8
Home Equity......................... 15,355 4.5 3,288 8.1
-------- ----- ------- -----
Total Retail................... 15,355 4.5 5,244 12.9
-------- ----- ------- -----
Total Principal Amount of Loans
Produced..................... $337,050 100.0% $40,560 100.0%
======== ===== ======= =====
Number of Loans Produced:
Wholesale (includes Bankers/Brokers):
Title I............................. $ 326 2.9% $ 0 0.0%
Equity + loans...................... 8,837 78.8 7 1.0
Home Equity......................... 0 0.0 607 85.0
-------- ----- ------- -----
Total Wholesale................ 9,163 81.7 614 86.0
-------- ----- ------- -----
Dealers(1):
Title I............................. 971 8.7 0 0
Equity + loans...................... 742 6.6 0 0
-------- ----- ------- -----
Total Dealers.................. 1,713 15.3 0 0
-------- ----- ------- -----
Retail:
Equity + loans...................... 341 3.0 52 7.3
Home Equity......................... 0 0.0 48 6.7
-------- ----- ------- -----
Total Retail................... 341 3.0 100 14.0
-------- ----- ------- -----
Total Number of Loans
Produced..................... 11,217 100.0% 714 100.0%
======== ===== ======= =====
Loans Serviced at End of Period
(including loans securitized, sold to
investors servicing retained and held
for sale):
Title I................................ $231,917 42.4% $ 442 2.4%
Conventional (Equity + and Home Equity
loans).............................. 314,328 57.6 18,144 97.6
-------- ----- ------- -----
Total Loans Serviced at End of
Period....................... $546,245 100.0% $18,586 100.0%
======== ===== ======= =====
</TABLE>
- ---------------
(1) The Company closed its dealer division, which purchased loans from home
improvement contractors, in February 1998.
43
<PAGE> 45
Loan Sales
Sales of loans in securitization transactions had historically been the
main source of the Company's revenue and income. In a securitization
transaction, a specific group of the Company's mortgage loans having similar
characteristics, loan type (Equity + or Title I) and loan amounts are pooled for
sale. As part of its new business strategy, the Company is no longer pursuing
securitization transactions but is instead focusing on the sale of whole loans.
The following table sets forth the principal balance of loans sold or
securitized and related gain (loss) on sale data for the nine months ended May
31, 1998 and 1999:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
MAY 31,
-----------------------
1998 1999
--------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Principal Amount of Loans Sold:
Title I........................................... $ 19,406(1) $ 3,446
Equity +.......................................... 310,259 19,991
Home Equity....................................... 5,684 16,987
-------- -------
Total..................................... $335,349 $40,424
======== =======
Gain (loss) on sale of loans........................ $(15,562) $ 759
======== =======
Net unrealized (loss) on mortgage related
securities(1)..................................... $(44,120) $ (685)
======== =======
Gain on sale of loans as a percentage of principal
balance of loans sold(2).......................... (4.6)% 1.9%
======== =======
Gain on sale of loans plus net unrealized loss on
mortgage related securities as a percentage of
principal balance of loans sold(2)................ (17.8)% 0.2%
======== =======
</TABLE>
- ---------------
(1) Negative Title I Loan sales resulted from the repurchase of loans sold with
recourse from a financial institution and the sale of certain of such loans
to FNMA without recourse.
(2) Excludes $38.4 million of loans sold with servicing released during the nine
months ended May 31, 1998. Includes approximately $4.5 million principal
amount of repurchased loans sold in the nine months ended May 31, 1999.
The gain (loss) on sale of loans can vary for several reasons, including
the relative amounts of Equity +, Home Equity and Title I Loans, each of which
type of loan has different (i) estimated prepayment rates, (ii) weighted-average
interest rates, (iii) weighted-average maturities and (iv) estimated future
default rates. Typically, the gain on sale of loans through securitizations is
higher than on whole loan sales; however, engaging in securitizations requires
an up-front cash expenditure and can have an adverse effect on a company's
financial condition due to unanticipated write downs in the value of the
residual securities retained by the company which may be caused by, among other
things, unanticipated changes in prepayment and default rates assumed by the
company. The Company did no securitizations during the nine months ended May 31,
1999.
As the holder of the residual securities issued in securitizations, the
Company is entitled to receive certain excess cash flows. These excess cash
flows are calculated as the difference between (a) principal and interest paid
by borrowers and (b) the sum of (i) pass-through interest and principal to be
paid to the holders of the regular securities and interest only securities, (ii)
trustee fees, (iii) third-party credit enhancement fees, (iv) servicing fees and
(v) estimated loan pool losses. The Company's right to receive the
44
<PAGE> 46
excess cash flows is subject to the satisfaction of certain reserve or
over-collateralization requirements that are specific to each securitization and
are used as a means of credit enhancement.
Loan Delinquencies
The following table sets forth the Title I, Equity + and Home Equity Loan
delinquencies and Title I insurance claims experience of loans serviced for the
Company as of the dates indicated:
<TABLE>
<CAPTION>
AUGUST 31, MAY 31,
1998 1999
---------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Delinquency period(1)
31-60 days past due................................. 7.69% 2.56%
61-90 days past due................................. 2.16 0
91 days and over past due........................... 24.95 5.58
Total past due.............................. 34.88 8.13
91 days and over past due, net of claims filed(2)... 7.56 5.58
Outstanding claims filed with HUD(3)(4)............... 17.39 0
Outstanding number of Title I insurance claims........ 207 0
Title I Loans serviced................................ 23,005 442
Conventional Loans serviced (Equity + and Home Equity
loans).............................................. 8,217 18,144
Total servicing portfolio................... $31,222 $18,586
Aggregate losses on liquidated loans (twelve and six
months ended, respectively)(5)...................... $ 1,368 $ 0
</TABLE>
- ---------------
(1) Represents the dollar amount of delinquent loans as a percentage of the
total dollar amount of loans serviced by the Company for the period ending
August 31, 1998 and loans owned by the Company for the period ending May 31,
1999.
(2) Represents the dollar amount of delinquent loans net of delinquent Title I
Loans for which claims have been filed with HUD. Payment is pending as a
percentage of the total dollar amount of total loans serviced by the Company
(including loans owned by the Company) as of the dates indicated.
(3) Represents the dollar amount of delinquent Title I Loans for which claims
have been filed with HUD. Payment is pending as a percentage of total dollar
amounts of total loans serviced by the Company (including loans owned by the
Company) as of the dates indicated.
(4) All claims filed with HUD have been processed and the amount of FHA
insurance available for serviced Title I Loans have been reduced to zero.
(5) On Title I Loans, a loss is recognized upon receipt of payment of a claim or
final rejection thereof. Claims paid in a period may relate to a claim filed
in an earlier period. Since the Company commenced its Title I lending
operations in March 1994, there has been no final rejection of a claim by
the FHA. Aggregate losses on liquidated Title I Loans related to 1,522 Title
I insurance claims made by the Company, as servicer, since commencing
operations through May 31, 1999. Losses on Title I Loans liquidated will
increase as the balance of the claims are processed by HUD. The Company has
received an average payment from HUD equal to 90% of the outstanding
principal balance of such Title I Loans, plus appropriate interest and
costs.
45
<PAGE> 47
The Company substantially reduced its loan production after January 1, 1998
as compared to the first four months of fiscal 1998. In the last eight months of
fiscal 1998 and the first months of fiscal 1999, the Company focused on (1)
liquidating its loan portfolio for cash to reduce its indebtedness while it
explored alternatives to raise new capital and (2) initiating new strategic
initiatives to return the Company to profitability. As a result, the Company
does not believe that its results for the nine months ended May 31, 1999 are
comparable to the Company's results for the nine months ended May 31, 1998.
Net Revenues. Net losses decreased $56.3 million to a loss of $197,000
during the nine months ended May 31, 1999 from losses of $56.5 million during
the nine months ended May 31, 1998. The loss for the nine months ended May 31,
1998 was primarily the result of continued low loan production and difficulty in
selling closed loans. The decrease in net losses for the nine months ending May
31, 1999 resulted from the reduction in the Company's business while the Company
pursued its new strategic initiatives. Additionally, during the period in 1998,
sales were generally for cash, and were for less than par value, thus
contributing to losses in fiscal 1998. Loan originations during the nine months
ending May 31, 1999 were $40.6 million, as compared to originations of $337.0
million during the nine months ended May 31, 1998. Sales of loans during the
nine months ended May 31, 1999 were $40.4 million, while during the nine months
ended May 31, 1998 they were $335.3 million.
Gain (loss) on sale of loans decreased $16.4 million to $759,000 during the
nine months ended May 31, 1999 from a loss of ($15.6) million during the nine
months ended May 31, 1998. The decrease was primarily the result of a lower
volume of loans sold in the nine months ended May 31, 1999 compared to the nine
months ended May 31, 1998.
Net unrealized (loss) on mortgage related securities decreased to a loss of
$532,000 during the nine months ended May 31, 1999 from a loss of ($44.1)
million during the nine months ended May 31, 1998, a change of $43.6 million.
During the nine months ended May 31, 1998, the Company recorded a $38.7 million
downward valuation adjustment relating to the Company's mortgage backed
securities. No valuation adjustments were recorded in the nine months ended May
31, 1999.
Loan servicing income, net, decreased $870,000 to $230,000 during the nine
months ended May 31, 1999 from $1.1 million during the nine months ended May 31,
1998. This decline was the result of the elimination of most of the servicing
revenue previously earned by the Company due to the sale of its servicing rights
to City Mortgage Services.
Interest income on loans held for sale and mortgage related securities, net
of interest expense, decreased $2.7 million to an expense of $654,000 during the
nine months ended May 31, 1999 from income of $2.0 million during the nine
months ended May 31, 1998. The decline was primarily the result of a decrease in
average balance of loans held for sale during the nine months ended May 31, 1999
of $22.0 million compared to the average during the nine months ended May 31,
1998 of $48.2 million.
Net Provision (Benefit) for Credit Losses. The net provision (benefit) for
credit losses was ($276,000) for the nine months ended May 31, 1999, a reduction
of $2.7 million from the $2.4 million recorded for the nine months ended May 31,
1998. The decrease was the result of an adjustment to the allowance for credit
losses on loans sold with recourse. The Company's liability is related to the
valuation of the excess spread recorded as part of the mortgage related
securities. A reduction in value of $598,000 due
46
<PAGE> 48
to amortization was recorded on the excess spread as of May 31, 1999; as a
result, a reduction in the valuation allowance in the same amount was recorded.
At the same time, an increase of $322,000 was recorded on the allowance for
credit losses for loans held for sale, as a result of increasing inventory. No
allowance for credit losses on loans sold with recourse was established on loans
sold through securitizations. The Company has no recourse obligation under those
securitization agreements for credit losses and estimated credit losses on loans
sold through securitizations considered in the Company's valuation of its
residual interest securities. The provision for credit losses is based upon
periodic analysis of the portfolio, economic conditions and trends, historical
credit loss experience, borrowers' ability to repay, collateral values, and
estimated FHA insurance recoveries on Title I loans produced and sold.
Total General and Administrative Expenses. General and administrative
expenses decreased $13.7 million to $12.9 million for the nine months ended May
31, 1999 from $26.6 million for the nine months ended May 31, 1998. This decline
can be attributed to reductions in business activity, along with the cost
reductions implemented by management since the recapitalization in June 1998.
Payroll and benefits expense decreased $9.5 million to $5.4 million for the
nine months ended May 31, 1999 from $14.9 million for the nine months ended May
31, 1998. This reduction can be attributed to the staff reductions which have
occurred over the past year.
Supplies and postage expense declined $689,000 to $254,000 during the nine
months ending May 31, 1999 from $943,000 during the nine months ended May 31,
1998. This decrease can be attributed to the reduction in business between the
two periods and to steps taken to control costs.
Professional services expense decreased $1.3 to $2.3 million during the
nine months ended May 31, 1999 from $3.6 million during the nine months ended
May 31, 1998. This decrease is attributed to the elimination of the management
overhead fees formerly paid to Preferred Equities Corporation, reduced
expenditures for inspection fees due to the reduction of loan originations and
reduced employee recruiting cost offset, in part by an increased legal and audit
fees.
Sub-servicing fees paid decreased $1.6 million to $210,000 during the nine
months ended May 31, 1999 from $1.8 million during the nine months ended May 31,
1998. This is the result of the reduction in size of the servicing portfolio
over the past fiscal year due to the sale of servicing to City Mortgage Services
and a decline in loan volume.
During the nine months ending May 31, 1999, travel and entertainment
expenses decreased $539,000, from $967,000 during the nine months ending May 31,
1998, to $428,000 during the same nine months ended May 31, 1999. This reduction
can be attributed to reductions in business and to cost control measures
implemented over the past year.
As a result of the foregoing the Company incurred a net loss before taxes
and extraordinary items of $13.7 million during the nine months ended May 31,
1999, compared with a net loss before taxes of $86.7 million for the nine month
period ending May 31, 1998.
47
<PAGE> 49
Extraordinary Item-Purchase of Subordinated Notes. In February 1999, the
Company repurchased $11.0 million of the Company's 12 1/2% Subordinated notes,
due 2001, which resulted in a gain, net of tax, of $4.8 million.
Fiscal 1998 Compared to Fiscal 1997
As previously discussed, the Company reduced substantially its loan
production after January 1, 1998 as compared to the first four months of fiscal
1998. In the last eight months of fiscal 1998, the Company focused on (1)
liquidating its loan portfolio for cash to reduce its indebtedness while it
explored alternatives to raise new capital and (2) initiating new strategic
initiatives to return the Company to profitability. As a result, the Company
does not believe that its results for fiscal 1998 are comparable to the
Company's results for fiscal 1997.
The Company produced $338.9 million of loans during fiscal 1998 compared to
$526.9 million of loans during fiscal 1997, a decrease of 35.7%. The decrease is
due to a substantial reduction in the Company's loan production after January
1998 caused by the Company's inability to obtain funds to produce loans due to
its violation of covenants contained in the old warehouse line.
The Company's loan production by month during fiscal 1997 and 1998 is
illustrated in the chart below.
(Loan Production Chart)
Net Revenues. Net revenues were negative $94.0 million during fiscal 1998
compared with positive $54.8 million during fiscal 1997. The Company's revenues
are determined largely by special accounting requirements that required the
Company in fiscal 1997 to recognize significant revenue on loans sold in
securitization transactions ("gain on sale") even though these transactions
generated negative cash flow.
48
<PAGE> 50
We have separated below the following four components of the Company's
revenues in fiscal 1998 and compared them to the same four components of revenue
in fiscal 1997:
1. Revenues from gain (loss) on sale of loans
- in securitization transactions
- for cash
2. Revenues from net unrealized gain (loss) on mortgage related securities
3. Loan servicing income, net
4. Revenues from net interest income
Revenues from Gain (loss) on sale of loans in fiscal 1998 were a negative
$26.6 million compared to a positive $45.1 million in fiscal 1997. The table
below shows the principal components of Gain (loss) on sale of loans in each of
these periods.
<TABLE>
<CAPTION>
COMPONENTS
OF GAIN (LOSS)
ON THE SALE OF LOANS
-------------------------
FISCAL 1997 FISCAL 1998
----------- -----------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Gain (loss) on the sale of loans in securitization
transactions........................................... 62,014 (6,187)
Gain on the sale of loans for cash....................... 833 11,775
Mark-to-market adjustment to loans held for sale......... -- (13,674)
Write off of loan origination costs...................... (12,573) (12,541)
Write off of commitment fee.............................. -- (2,849)
Amortization of commitment fee........................... (817) (734)
Write off of placement fee............................... (4,129) (1,153)
Interest expense......................................... (205) --
Write off of servicing................................... -- (1,215)
-------- ---------
Total.......................................... 45,123 (26,578)
======== =========
</TABLE>
Revenues from gain on the sale of loans in securitization transactions in
fiscal 1997 of $62.0 million resulted from the allocation of 79.4% of the $78.2
million total revenues earned by the Company on loans sold in these
transactions. The $16.2 million balance of these revenues was allocated to Net
unrealized gain (loss) on mortgage related securities. In fiscal 1997, the
Company sold $398.4 million principal amount of loans in securitization
transactions, with a total cost of production of $20.0 million. This includes
premiums of $18.4 million (3.5% of the principal amount of the Company's loans
produced) paid to the Company's network of mortgage bankers for closed loans. In
fiscal 1998, only $90.5 million principal amount of loans were sold in
securitization transactions. The substantially lower amount of loans sold in
securitization transactions in fiscal 1998 and the lower revenues from these
transactions resulted from the continuing cash flow deficits of the Company.
These deficits were principally due to substantial increases in the Company's
loan production in fiscal 1997, the sale of these loans in securitization
transactions and a major increase in general and administrative expenses.
49
<PAGE> 51
Revenues from gain on the sale of loans for cash were $11.8 million in
fiscal 1998 compared to $833,000 in fiscal 1997. In fiscal 1998, the Company
sold $160.1 million principal amount of loans for cash as part of its plan to
continue operating while it was exploring alternatives for locating new capital.
The Company's total cost of producing these loans was $15.0 million in fiscal
1998 compared to $20.0 million in fiscal 1997 (representing 12.5% of the $160.1
million of the amount of loans sold for cash in that period). In fiscal 1997,
revenues from the sale of $99.0 million principal amount of loans for cash were
$833,000. The Company believes that its loan sales for cash in fiscal 1998 may
have been adversely impacted by the market's knowledge that the Company was
liquidating its loan portfolio to pay down the Company's lenders. The Company's
revenues from gain (loss) on the sale of loans for cash in fiscal 1998 were also
impacted by a lower of cost or market write down of $13.7 million of the
Company's $21.9 million principal amount of loans in its portfolio at the end of
fiscal 1998. The loans in the Company's portfolio at August 31, 1998 primarily
had document deficiencies or the borrowers were delinquent in their loan
payments. The lower of cost or market adjustment is based on the Company's
estimate of the proceeds to be received when these loans are sold. The Company
believes that liquidity shortage in the specialty finance industry may have also
hurt the market value of these loans.
As part of the recapitalization, the Company terminated its Master
Warehouse Agreement with Greenwich Capital Markets. This termination resulted in
negative revenues of $4.0 million from gain (loss) on sale of loans due to the
write off of a $2.85 million commitment fee. Negative revenues of $1.2 million
also resulted from payments to Greenwich Capital Markets in connection with
their sale of the Company's loans. For additional details, see "Certain
Transactions" located later in this prospectus.
Revenues from Net unrealized gain (loss) on mortgage related securities
were negative $70.0 million in fiscal 1998 compared to a positive $3.5 million
in fiscal 1997. Substantially all of fiscal 1998's negative revenues resulted
from a write down of $73.0 million in the fair value of the Company's mortgage
related securities. The write down was required because prepayment, delinquency,
default and credit loss rates on the Equity + and Title I loans backing these
securities substantially exceeded the assumptions the Company used to value its
mortgage related securities at the end of fiscal 1997. These loans were produced
by the Company in prior periods. Additionally, in response to recent adverse
changes in the liquidity and market value of these and other similar asset
backed residual interests, the Company increased the rate used to discount to
present value the anticipated cash flow to be received on its mortgage related
securities from 12% at the end of fiscal 1997 to 16% at the end of fiscal 1998.
The positive revenues of $3.5 million from Net unrealized gain (loss) on
mortgage related securities recorded in fiscal 1997 resulted from a write up of
$2.0 million in the fair value of the Company's mortgage related securities and
favorable cash flow from the Company's mortgage related securities.
In August 1998, the Company pooled approximately $90.5 million of loans
with approximately $239.6 million of loans from a second party to create a home
loan owner trust securitization. The Company was issued a residual interest
mortgage related security in this securitization calculated on the pro rata
share of the Company loans originated in the total pool. This residual interest
mortgage related security will be owned two-thirds by the Company and one-third
by Greenwich Capital Markets. Cash flow on the Company's residual interest
mortgage related security will be subordinated to recovery by Greenwich of: (1)
premium paid for in the acquisition of the pool; (2) upfront
overcollateralization of
50
<PAGE> 52
1.25% of the total pool; (3) Greenwich's underwriting fee and (4) transaction
costs. The total of these recoveries will accrue interest at a 12% per annum
rate until recovered. The target overcollateralization level of 6% must be
achieved prior to recovery by Greenwich. See "Certain
Transactions -- Relationship With Greenwich."
Loan servicing income, net, decreased from $3.0 million in fiscal 1997 to
$1.0 million in fiscal 1998. The decrease was a result of negative revenues of
$1.1 million from a write down in the fair value of the Company's mortgage
servicing rights in the third quarter of fiscal 1998 due to an increase in the
Company assumptions of prepayment, delinquency, default and credit loss rates on
the loans in the Company's servicing portfolio, which reduced the discounted
present value of the Company's anticipated servicing revenues on those loans. In
addition, in fiscal 1998 the Company had negative loan servicing revenues of
$703,000 from the loss on the sale of the Company's servicing rights to City
Mortgage Services as part of the recapitalization.
Revenues from net interest income decreased from $3.1 million in fiscal
1997 to $1.6 million in fiscal 1998. The table below shows the amount of the
Company's interest income and interest expense for fiscal 1997 and 1998.
<TABLE>
<CAPTION>
NET INTEREST INCOME
-------------------------
FISCAL 1997 FISCAL 1998
----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Interest Income:
Short-term investments and accretion on mortgage related
securities........................................... $ 7,353 8,964
Loans held in portfolio pending sale.................... 2,038 5,492
Cash.................................................... 116 330
-------- --------
Total Interest Income........................... $ 9,507 $ 14,786
======== ========
Interest Expense:
Subordinated debt....................................... $ 4,266 $ 8,839
Old warehouse line...................................... 1,805 3,961
Other borrowings........................................ 303 362
-------- --------
Total Interest Expense.................................. $ 6,374 13,162
-------- --------
Net Interest Income............................. $ 3,133 $ 1,624
======== ========
</TABLE>
Interest income increased from $9.5 million in fiscal 1997 to $14.8 million
in fiscal 1998. The increase was due to the sale of the Company's 1998 loan
production in cash transactions over a period of time, compared to the sale of
fiscal 1997 loan production in quarterly securitization transactions. In
addition, the Company earned approximately $304,600 in interest in fiscal 1998
from the short-term investment of $50.0 million in proceeds from the
recapitalization.
Interest expense in fiscal 1998 was substantially higher than interest
expense in fiscal 1997 due primarily to additional interest expense of $3.5
million on the Company's subordinated debt as a result of the October 1997 sale
of $40.0 million principal amount of 12 1/2% subordinated notes. In addition,
the Company borrowed an aggregate of $15.0 million secured by certain of its
mortgage related securities in the first quarter of fiscal 1998. The principal
amount of these borrowings were outstanding for all of fiscal 1998 and for only
a portion of fiscal 1997.
51
<PAGE> 53
Provision for Credit Losses. The net provision for credit losses decreased
$9.5 million to income of $3.2 million for fiscal 1998 from losses of $6.3
million for fiscal 1997. The decrease in the provision for credit losses was due
to the decrease in the volume of loans produced and the ratio of Equity + loans
to Title I loans produced during fiscal 1998 compared to fiscal 1997. An
allowance for credit losses is not established on loans sold in securitization
transactions, because the Company typically does not have recourse obligations
for these losses. Estimated credit losses on loans sold in securitization
transactions are considered in the Company's determination of the fair value of
its mortgage related securities. The provision for credit losses is based upon
periodic analysis of the portfolio, economic conditions and trends, historical
credit loss experience, borrowers' ability to repay, collateral values, and
estimated FHA insurance recoveries on Title I loans originated and sold.
Total General and Administrative Expenses. Total general and
administrative expenses increased $10.0 million, or 42.0%, to $33.8 million
during fiscal 1998 from $23.8 million during fiscal 1997. The increase was
primarily a result of increased costs of professional services due to:
(1) increased outside legal and audit expenses associated with
additional securities filings;
(2) the recapitalization;
(3) amendments to existing debt agreements;
(4) increased loan servicing expenses due to an increase in loans
serviced; and
(5) increased payroll and benefits related to the hiring of additional
personnel to support the Company's expansion in the first quarter of fiscal
1998.
The substantial individual changes in general and administrative expenses
are discussed in more detail below.
Payroll and benefits expense increased $5.5 million, or 42.4%, to $18.6
million during fiscal 1998 from $13.1 million during fiscal 1997 primarily due
to an increased number of employees prior to January 1998 and expenses
associated with the reduction in the Company's workforce. Although the number of
employees decreased to 134 at August 31, 1998 from 405 at August 31, 1997, the
average number of employees employed was higher during fiscal 1998 than fiscal
1997.
Credit reports expense decreased $877,000, or 63.2%, to $510,000 during
fiscal 1998 from $1.4 million for fiscal 1997 due to the decrease in loan
production during the second half of fiscal 1998.
Rent and lease expenses increased $417,000, or 34.8%, to $1.6 million for
fiscal 1998 from $1.2 million for fiscal 1997 due to annual escalation in rent
and expiration of tenant discounts the Company enjoyed in fiscal 1997 for office
space at the Company's corporate offices.
Professional services increased $2.5 million, or 110.6%, to $4.8 million
for fiscal 1998 from $2.3 million for fiscal 1997 due to increased outside legal
and audit expenses associated with the Company's private placement of $40.0
million principal amount of Old Notes in fiscal 1997, additional securities
filings, amendments to existing debt agreements and higher consulting and
management services expenses. A substantial portion of the
52
<PAGE> 54
increase in professional services was due to actions taken by the Company
subsequent to January 1, 1998 as a result of its adverse financial position and
the recapitalization.
Sub-servicing fees increased $286,000, or 15.3%, to $2.2 million for fiscal
1998 from $1.9 million for fiscal 1997 due primarily to a larger average loan
servicing portfolio, partially offset by a lower sub-servicing rate paid to the
sub-servicer in the latter part of fiscal 1998.
Other services increased $716,000, or 53.0%, to $2.1 million for fiscal
1998 from $1.4 million for fiscal 1997, due to higher telephone and overnight
mailing expenses.
FHA insurance expense decreased $128,000, or 22.9%, to $430,000 during
fiscal 1998 from $558,000 during fiscal 1997 due to decreased production of
insured Title I loans.
Other general and administrative expenses increased $1.3 million, or
125.6%, to $2.4 million during fiscal 1998 from $1.1 million during fiscal 1997
due primarily to increased expenses related to the expansion of facilities
related to the Company's business expansion at the beginning of fiscal 1998.
The Company had a $126.0 million loss before income taxes for fiscal 1998
compared to income of $23.8 million for fiscal 1997. An income tax expense of
$9.1 million was provided for in fiscal 1997 while an income tax benefit of $6.3
million has been provided for in fiscal 1998.
As a result of the above, the Company incurred a net loss of $119.7 million
for fiscal 1998 compared to net income of $14.7 million for fiscal 1997.
Fiscal 1997 Compared to Fiscal 1996
The Company produced $526.9 million principal amount of loans during fiscal
1997 compared to $139.4 million of loans during fiscal 1996. The increase is a
result of the overall growth in the Company's business, including an increase in
the number of active mortgage bankers that sold the Company closed Equity +, and
to a lesser extent, Title I loans and home improvement contractors ("dealers")
that sold the Company closed Title I loans and an increase in the number of
states served. At August 31, 1996 and 1997, the Company's network consisted of
the following:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
AUGUST 31,
----------------------
1996 1997
---- ----
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Active mortgage bankers................................ 310 694
Active dealers......................................... 435 670
</TABLE>
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<PAGE> 55
The following table describes the types of loans produced by the Company
during fiscal 1996 and 1997:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
AUGUST 31,
------------------------
1996 1997
-------- --------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Equity + loans....................................... $ 11,582 $428,832
Title I loans........................................ 127,785 98,085
-------- --------
Total...................................... $139,367 $526,917
======== ========
</TABLE>
The following table sets forth certain data regarding loans produced by the
Company during fiscal 1996 and 1997:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED AUGUST 31,
--------------------------------------
1996 1997
----------------- -----------------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C>
PRINCIPAL AMOUNT OF LOANS PRODUCED:
Mortgage bankers:
Title I............................ $ 82,596 59.3% $ 50,815 9.7%
Equity +........................... 11,582 8.3 409,603 77.7
-------- ----- -------- -----
Total mortgage bankers........ 94,178 67.6 460,418 87.4
-------- ----- -------- -----
Dealers:
Title I............................ 45,189 32.4 47,270 9.0
Equity +........................... -- -- 19,229 3.6
-------- ----- -------- -----
Total dealers................. 45,189 32.4 66,499 12.6
-------- ----- -------- -----
Total principal amount of
loans produced............. $139,367 100.0% $526,917 100.0%
======== ===== ======== =====
NUMBER OF LOANS PRODUCED:
Mortgage bankers:
Title I............................ 4,382 50.9% 2,445 12.0%
Equity +........................... 392 4.6 12,831 62.7
-------- ----- -------- -----
Total mortgage bankers........ 4,774 55.5 15,276 74.7
-------- ----- -------- -----
Dealers:
Title I............................ 3,836 44.5 3,893 19.0
Equity +........................... -- -- 1,296 6.3
-------- ----- -------- -----
Total dealers................. 3,836 44.5 5,189 25.3
-------- ----- -------- -----
Total number of loans
produced................... 8,610 100.0% 20,465 100.0%
======== ===== ======== =====
</TABLE>
Net Revenues. Net revenues increased $31.2 million, or 132.5%, to $54.8
million for fiscal 1997 from $23.6 million for fiscal 1996. The increase was
primarily the result of the increased volume of loans produced and the principal
amount of loans sold.
Gain on sale of loans and net unrealized gain on mortgage related
securities together increased $29.4 million, or 152.9%, to $48.6 million during
fiscal 1997 from $19.2 million during fiscal 1996. The increase was primarily
due to increases in the principal amount of loans sold in securitization and
similar transactions of $521.6 million during fiscal 1997 compared to $137.9
million during fiscal 1996.
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<PAGE> 56
The following table sets forth the principal balance of loans sold or
securitized and related gain on sale data for fiscal 1996 and 1997:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED AUGUST 31,
----------------------------
1996 1997
---------- ----------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
LOANS SOLD IN SECURITIZATION TRANSACTIONS:
Principal amount of loans sold:
Title I............................................ $127,414 $ 62,097
Equity +........................................... 10,494 360,411
-------- --------
Total principal amount..................... $137,908 $422,508
======== ========
Gain on sale of loans................................ $ 16,539 $ 41,132
======== ========
Net unrealized gain on mortgage related securities... $ 2,697 $ 3,524
======== ========
Gain on sale of loans as a percentage of principal
balance of loans sold.............................. 12.0% 9.7%
======== ========
Gain on sale of loans plus net unrealized gain on
mortgage related securities as a percentage of
principal balance of loans sold.................... 13.9% 10.6%
======== ========
LOANS SOLD FOR CASH WITH SERVICING RELEASED TO FNMA
AND OTHERS:
Principal amount of loans sold:
Title I............................................ $ -- $ 39,810
Equity +........................................... -- 59,189
-------- --------
Total principal amount..................... $ -- $ 98,999
======== ========
Gain on sale of loans................................ $ -- $ 3,991
======== ========
Net unrealized loss on mortgage related securities... $ -- $ (6)
======== ========
Gain on sale of loans as a percentage of principal
balance of loans sold.............................. 0.0% 4.0%
======== ========
Gain on sale of loans plus net unrealized loss on
mortgage related securities as a percentage of
principal balance of loans sold.................... 0.0% 4.0%
======== ========
LOANS SERVICED AT END OF YEAR:
Title I............................................ $202,766 $255,446
Equity +........................................... 11,423 372,622
-------- --------
Total servicing portfolio at end of
period.................................. $214,189 $628,068
======== ========
</TABLE>
For additional details on gain on the sale of Loans sold in securitization
transactions, see Note 2 to the Company's financial statements located later in
this prospectus.
Loan servicing income, net decreased $312,000, or 9.3%, to $3.0 million
during fiscal 1997 from $3.3 million during fiscal 1996. The decrease was
primarily the result of the reclassification of net revenue in compliance with
SFAS No. 125 and increased interest advances and reduced servicing fees related
to $34.0 million in delinquent loans serviced by the Company at August 31, 1997
compared to $16.2 million at August 31, 1996.
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<PAGE> 57
Interest income on loans held for sale and mortgage related securities, net
of interest expense, increased $2.1 million, or 217.1%, to $3.1 million during
fiscal 1997 from $988,000 during fiscal 1996. The increase was primarily the
result of the increase in the average principal amount of the Company-owned
loans held for sale and the increased mortgage related securities portfolio.
Provision for Credit Losses. The net provision for credit losses increased
$6.2 million to $6.3 million for fiscal 1997 from $55,000 for fiscal 1996. The
increase in the provision was directly related to the increase in the volume of
loans produced and the increased ratio of Equity + loans to Title I loans
produced during fiscal 1997 compared to fiscal 1996. No allowance for credit
losses on loans sold with recourse is established on loans sold through in
securitization and similar transactions. The Company has no recourse obligation
for credit losses on loans sold. Estimated credit losses on loans sold are
considered in the Company's valuation of its mortgage related securities. The
provision for credit losses is based upon periodic analysis of the portfolio,
economic conditions and trends, historical credit loss experience, borrowers'
ability to repay, collateral values, and estimated FHA insurance recoveries on
Title I loans produced and sold in securitization and similar transactions. For
details on mortgage related securities, see Notes 2 and 4 to the Company's
financial statements located later in this prospectus.
Total General and Administrative Expenses. Total general and
administrative expenses increased $12.0 million, or 101.5%, to $23.8 million
during fiscal 1997 compared to $11.8 million during fiscal 1996. The increase
was primarily a result of increased credit reports expense due to increased loan
production volume, increased rent and lease expense due to facilities expansion,
increased loan servicing expenses due to an increase in loans serviced, and
increased payroll related to the hiring of additional underwriting, loan
processing, administrative, loan quality control and other personnel as a result
of the expansion of the Company's business.
Payroll and benefits expense increased $6.7 million, or 106.3%, to $13.1
million during fiscal 1997 from $6.3 million during fiscal 1996 primarily due to
an increased number of employees. The number of employees increased to 405 at
August 31, 1997 from 170 at August 31, 1996 due to increased staff necessary to
support the business expansion and maintain quality control.
Credit reports expense increased $1.0 million, or 277.9%, to $1.4 million
during fiscal 1997 from $367,000 during fiscal 1996 primarily due to increased
loan origination volume to $526.9 million during fiscal 1997 from $139.4 million
during fiscal 1996.
Rent and lease expenses increased $861,000, or 254.7%, to $1.2 million
during fiscal 1997 from $338,000 during fiscal 1996 primarily due to increased
expansion costs for the corporate headquarters and additional branch offices.
Professional services fees increased $500,000, or 28.2%, to $2.3 million
during fiscal 1997 from $1.8 million during fiscal 1996 primarily due to
increased audit and legal fees attributable to continued growth.
Sub-servicing fees paid increased $1.2 million, or 164.3%, to $1.9 million
during fiscal 1997 from $709,000 during fiscal 1996 due primarily to a larger
loan servicing portfolio.
Other services increased $687,000, or 103.3%, to $1.4 million during fiscal
1997 from $665,000 during fiscal 1996. These expenses represent executive,
accounting, legal,
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<PAGE> 58
management information, data processing, human resources and advertising
services provided and promotional materials.
Travel expenses increased $328,000, or 48.4%, to $1.0 million during fiscal
1997 from $677,000 during fiscal 1996 due to increased travel needed to support
the Company's business expansion.
Other general and administrative expenses increased $711,000, or 190.1%, to
$1.1 million during fiscal 1997 from $374,000 during fiscal 1996 due primarily
to increased expenses related to the ongoing expansion of facilities.
Income before income taxes increased $12.7 million, or 113.4%, to $23.8
million for fiscal 1997 from $11.2 million for fiscal 1996. The provision for
income taxes increased to $9.1 million for fiscal 1997 compared to $4.2 million
for fiscal 1996.
As a result of the foregoing, the Company's net income increased $7.8
million, or 113.1%, to $14.7 million for fiscal year 1997 from $6.9 million for
fiscal 1996.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $9.2 million at May 31, 1999 compared to
$36.4 million at August 31, 1998. The Company's principal cash requirements
arise from loan production and payments of operating and interest expenses.
The Company currently has three significant sources of financing and
liquidity: (1) the balance of the cash proceeds from the sale of preferred stock
and common stock in the recapitalization which totaled approximately $9 million
at May 31, 1999; (2) a warehouse line of $25.0 million with Sovereign Bancorp
(the "Sovereign Warehouse Line"); and (3) sales of loans in the institutional
whole loan market. The Sovereign warehouse line dropped to $25.0 million from
$50 million on March 31, 1999.
The Company's liquidity and capital resources are impacted by certain
material covenant restrictions existing in the Indenture governing the Company's
outstanding 12 1/2% senior subordinated notes due 2001. These covenants include
limitations on the Company's ability to incur certain types of additional
indebtedness, grant liens on its assets and to enter into extraordinary
corporate transactions. The Company may not incur certain additional
indebtedness if, on the date of such incurrence and after giving effect thereto,
the Consolidated Leverage Ratio (as defined therein) would exceed 1.5:1, subject
to certain exceptions. At May 31, 1999, the Consolidated Leverage Ratio was
1.48:1.
The Sovereign Warehouse Line originally terminated on December 29, 1998 and
was renewable, at Sovereign's option, in six-month intervals for up to five
years. During December 1998, the Sovereign Warehouse Line was renewed at $50.0
million and was reduced to $25.0 million on March 31, 1999 through August, 1999.
The Sovereign Warehouse Line may be increased with certain consents and contains
pricing/fees which vary by product and the dollar amount outstanding. The
Sovereign Warehouse Line is to be secured by specific loans held for sale and
includes certain material covenants including maintaining books and records,
providing financial statements and reports, maintaining its properties,
maintaining adequate insurance and fidelity bond coverage and providing timely
notice of material proceedings. As of May 31, 1999, the Company had
approximately $18.1 million outstanding under the Sovereign Warehouse Line.
57
<PAGE> 59
In April 1997, the Company entered into a pledge and security agreement
with another financial institution for an $11.0 million revolving credit
facility. The amount that can be borrowed under the agreement was increased to
$15.0 million in June 1997 and $25.0 million in July 1997. This facility is
secured by a pledge of certain of the Company's interest only and residual class
certificates relating to securitizations carried as mortgage related securities
on the Company's Statements of Financial Condition, payable to the Company
pursuant to its securitization agreements. A portion of the borrowings under the
credit line agreement accrues interest at one-month LIBOR + 3.5% (9.1% at August
31, 1998 and 8.4% at , 1999). The remaining borrowings under the
credit line accrues interest at one-month LIBOR + 2.0% (7.6% at August 31, 1998
and 6.9% at May 31, 1999), expiring one year from the initial advance. As of May
31, 1999, approximately $3.3 million was outstanding under the agreement. The
agreement, which was originally scheduled to mature in December 1998, was
extended until December 1999. Certain material covenant restrictions exist in
the credit agreement governing the April 1997 revolving line of credit. These
covenants include limitations to incur additional indebtedness, provide adequate
collateral and achieve certain financial tests. These tests include achieving a
minimum net worth (as defined therein) and that the debt-to-net worth ratio (as
defined therein) shall not exceed 2.5:1. As of August 31, 1998, the Company's
net worth was $15.9 million below the minimum required and the debt-to-net worth
ratio was 2.93:1. On December 2, 1998, the Company obtained an amendment to the
agreement whereby the financial institution waived its right to declare an event
of default of borrower due to the Company's failure to comply with the minimum
required net worth as of August 31, 1998. Additionally, the minimum net worth
test was amended such that the Company is required to maintain a net worth equal
to or greater than 75% of the Company's net worth as of the end of the preceding
fiscal quarter. Additionally, the Company agreed to pay down the outstanding
borrowings from $10.0 million at August 31, 1998 to $6.0 million at December 31,
1998 and subsequently agreed to pay the remaining $6.0 million in equal monthly
payments during calendar 1999. As of May 31, 1999, the Company's net worth was
$3.6 million above the minimum required and the debt-to-net worth ratio was
1.91:1.
In October 1997, the Company entered into a credit agreement with another
financial institution for an $8.8 million revolving line of credit. This
institution initially funded $5.0 million of this credit facility. The facility
is secured by a pledge of certain of the Company's mortgage related securities.
The loan balance under this agreement bears interest at the prime rate plus
2.5%. In May 1998, this loan converted into a term loan with monthly
amortization derived from the cash flow generated from the respective mortgage
related certificates. This term loan bears interest at the prime rate plus 2.5%.
This facility matures in October 2002. As of May 31, 1999, approximately $3.8
million was outstanding under the agreement. The credit agreement governing the
October 1997 revolving line of credit includes certain material covenants. These
covenants include restrictions relating to extraordinary corporate transactions,
maintenance of adequate insurance and complying with certain financial tests.
These tests include complying with a minimal consolidated adjusted tangible net
worth (as defined therein) and that the consolidated adjusted leverage ratio (as
defined therein) shall not exceed 3:1. As of August 31, 1998, the Company's
consolidated adjusted tangible net worth was $54.1 million below the minimum
required and the consolidated adjusted leverage ration was 0.53:1. On December
9, 1998, the parties agreed to temporarily amend the borrowing base definition
for the period from September 30, 1998 through April 30, 1000 by increasing the
borrowing base from 50% to 55%. On May 1, 1999, the borrowing base returned to
50%. The minimum consolidated tangible net worth covenant was also adjusted,
commencing
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<PAGE> 60
retroactively, as of September 30, 1998 and the Company agreed to paydown the
line by approximately $405,000 (the amount exceeding the applicable maximum
amount of tranche credit) and pay an accommodation fee of $10,000. As of May 31,
1999, the Company's consolidated adjusted tangible net worth was $32.7 million
above the minimum required and the consolidated adjusted leverage ratio was
0.60:1.
While the Company believes that it will be able to maintain its existing
credit facilities and obtain replacement financing as its credit arrangements
mature and additional financing, if necessary, there can be no assurance that
such financing will be available on favorable terms, or at all. The lack of
adequate capital may result in the curtailment of loan originations and thereby
impair the Company's revenue and income stream. At May 31, 1999, no commitments
existed for material capital expenditures.
Net cash used in the Company's operating activities for the nine months
ended May 31, 1998 and 1999 was $26.9 million and $24.1 million, respectively.
During the nine months ended May 31, 1998 and 1999, cash provided (used) by
financing activities amounted to $34.0 million and $(1.7) million, respectively.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's various business activities generate liquidity, market and
credit risk:
- liquidity risk is the possibility of being unable to meet all present and
future financial obligations in a timely manner.
- market risk is the possibility that changes in future market rates or
prices will make the Company's positions less valuable.
- credit risk is the possibility loss from a customer's failure to perform
according to the terms of the transaction.
Compensation for assuming these risks is reflected in interest income and
fee income. The following table provides information as of August 31, 1998 about
the Company's mortgage related securities and other financial instruments that
are sensitive to changes in interest rates. The table presents sensitivity
analysis associated with fluctuations in prepayment speeds, increase or decrease
in defaulted loans and the discount rates associated with valuing the
securities.
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<PAGE> 61
(Loan Production Chart)
Although the Company is exposed to credit loss in the event of
non-performance by the borrowers, this exposure is managed through credit
approvals, review and monitoring procedures into the extent possible restricting
the period during which unpaid balances are allowed to accumulate.
As of May 31, 1999 the net fair value of all financial instruments with
exposure to interest rate risk was approximately $35.9 million. The potential
decrease in fair value resulting from a hypothetical 5% increase in interest
rates would be approximately $26.1 million.
There are certain shortcomings inherent to the Company's sensitivity
analysis presented. The model assumes interest rate changes are instantaneous
parallel shifts in the yield curve. In reality, changes are rarely
instantaneous. Although certain assets and liabilities may have similar
maturities or periods to repricing, they may not react in line with changes in
market interest rates. Also, the interest rates on certain types of assets and
liabilities may fluctuate with changes in market interest rates while interest
rates on other types of assets may lag behind changes in market rates.
Prepayments on the Company's mortgage related instruments are directly affected
by a change in interest rates. As such, the table considers prepayment risk.
However, in the event of a change in interest rates, actual loan prepayments may
deviate significantly from assumptions used in the table. Further, certain
assets, such as adjustable rate loans, have features, such as annual and
lifetime caps that restrict changing the interest rates both on a short term
basis and over the life of the asset. Finally, the ability of certain borrowers
to make scheduled payments on their adjustable rate loans may decrease in the
event of an interest rate increase.
EFFECTS OF CHANGING PRICES AND INFLATION
The Company's operations are sensitive to increases in interest rates and
to inflation. Increased borrowing costs resulting from increases in interest
rates may not be immediately recoverable from prospective purchasers. The
Company's loans held for sale consist primarily of fixed-rate long term
obligations the interest rates of which do not increase or
60
<PAGE> 62
decrease as a result of changes in interest rates charged to the Company. In
addition, delinquency and loss exposure may be affected by changes in the
national economy. See Note 4 to the Company's financial statements located later
in this prospectus.
RECENT ACCOUNTING PRONOUNCEMENTS
SFAS 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" was issued by the FASB in June 1996. SFAS 125
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. This statement also
provides consistent standards for distinguishing transfers of financial assets
that are sales from transfers that are secured borrowings. It requires that
liabilities and derivatives incurred or obtained by transferors as part of a
transfer of financial assets be initially measured at fair value. SFAS 125 also
requires that servicing assets be measured by allocating the carrying amount
between the assets sold and retained interests based on their relative fair
values at the date of transfer. Additionally, this statement requires that the
servicing assets and liabilities be subsequently measured by (a) amortization in
proportion to and over the period of estimated net servicing income or loss and
(b) assessment for asset impairment or increased obligation based on their fair
values. The statement requires that the Company's excess servicing rights be
measured at fair market value and be reclassified as interest only receivables
and accounted for in accordance with SFAS No. 115 "Accounting for Certain
Investments in Debt and Equity Securities". As required by the statement, the
Company adopted the new requirements effective January 1, 1997. Implementation
of the statement did not have any material impact on the financial statements of
the Company, as the book value of the Company's excess servicing rights and
mortgage related securities approximated fair value.
SFAS No. 128, "Earnings per Share" was issued by the FASB in March 1997,
effective for financial statements issued after December 15, 1997. SFAS 128
provides simplified standards for the computation and presentation of earnings
per share ("EPS"), making EPS comparable to international standards. SFAS 128
requires dual presentation of "Basic" and "Diluted" EPS, by entities with
complex capital structures, replacing "Primary" and "Fully Diluted" EPS under
APB Opinion No. 15.
Basic EPS excludes dilution from Common Stock equivalents and is computed
by dividing income available to stockholders by the weighted-average number of
shares of Common Stock outstanding for the period. Diluted EPS reflects the
potential dilution from Common Stock equivalents, similar to fully diluted EPS,
but uses only the average stock price during the period as part of the
computation.
In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive
Income", and SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information". SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components in a full set of
general-purpose financial statements. SFAS No. 131 establishes standards of
reporting by publicly held business enterprises and disclosure of information
about operating segments in annual financial statements and, to a lesser extent,
in interim financial reports issued to shareholders. SFAS Nos. 130 and 131 are
effective for fiscal years beginning after December 15, 1997. As both SFAS Nos.
130 and 131 deal with financial statement disclosure, the Company does not
anticipate the adoption of these new standards will have a material impact on
its financial position, results of operations or cash flows. The Company has not
yet determined what its reporting segments will be under SFAS No. 131.
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<PAGE> 63
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which establishes accounting
and reporting standards for derivative instruments and for hedging activities.
It requires the entity to recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The accounting for changes in fair value of these designated
derivatives ("hedge accounting") depends on the intended use and designation. An
entity that elects to apply hedge accounting is required to establish at the
inception of its hedge the method it will use for assessing the effectiveness of
the hedging derivative and the measurement approach for determining the
ineffective aspect of the hedge. Those methods must be consistent with the
entity's approach to managing risk. SFAS 133 is effective for the fiscal years
beginning after June 15, 1999. The Company has not yet evaluated the effect of
adopting SFAS 133.
In October 1998, the FASB issued SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by Mortgage Banking Enterprise" ("SFAS 134"), which allows the
reclassification of mortgage-related securities and other beneficial interests
retained after the securitization of mortgage loans held for sale from the
trading category, as required by FASB 115, to either available for sale or held
to maturity based upon the Company's ability and intent to hold those
investments. SFAS 134 is effective for the first quarter beginning after
December 15, 1998. The Company has not yet evaluated the effect of adopting SFAS
134. As of August 31 and November 30, 1998, all mortgage-related securities are
classified as trading securities.
IMPACT OF THE YEAR 2000 ISSUE
The term "Year 2000 issue" is a general term used to describe the various
problems that may result from the improper processing of dates and
date-sensitive calculations by computers and other machinery as the year 2000 is
approached and reached. These problems generally arise from the fact that most
of the world's computer hardware and software have historically used only two
digits to identify the year in a date, often meaning that the computer will fail
to distinguish dates in the "2000's" from dates in the "1900's." These problems
may also arise from other sources as well, such as embedded computer chips
contained in devices and special codes in software that make use of the date
field.
The Company has developed plans to address the Year 2000 issue. The
Company's present Year 2000 plan consists of five phases:
(1) inventory of business critical information technology assets;
(2) assessment of repair requirements;
(3) repair or replacement;
(4) testing of systems; and
(5) creation of contingency plans in the event of Year 2000 failures.
As of May 31, 1999, the Company had completed the first, second and third
phases of the Year 2000 plan for its own business critical information
technology assets including its accounting systems, loan origination systems,
word and data processing systems, customer telephone service center, and
business machines. The Company is relying upon the representations of third
party vendors as to the Year 2000 readiness of certain of its software, its
business machines, such as copiers and facsimile machines, and of facilities,
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<PAGE> 64
such as physical office locations. The Company does not have plans for testing
embedded computer chips contained in devices, or in special codes in software
that make use of the date field incidental to their operation.
It is the Company's plan to have all five phases of the Company's Year 2000
plan completed by August 31, 1999. Based on information currently available, the
Company's costs to remedy its own critical information technology assets are
estimated to be approximately $125,000. These costs will cover hardware and
software upgrades, systems consulting and computer maintenance. The Company
plans to charge these costs to expense as incurred, and it believes such costs
will not have a material effect on its liquidity or financial condition. As of
May 31, 1999, the Company had spent approximately $99,000 to purchase or upgrade
portions of its own hardware and software. As part of its Year 2000 plan, the
Company has accelerated the schedule of implementation of certain of the
Company's previously planned information technology projects. Therefore, the
Company does not expect to defer any specific information technology project as
a result of the implementation of its Year 2000 plan.
Until system testing is substantially in process, the Company cannot fully
estimate the risks of the Year 2000 issue. To date, the Company has not
identified any of its own business critical information technology assets that
it believes present a material risk of not being Year 2000 compliant or for
which a suitable alternative cannot be implemented. However, as the Company's
Year 2000 plan proceeds into subsequent phases, it is possible that the Company
may identify assets that do present a risk of a Year 2000-related disruption.
Such a disruption would have a material adverse effect on financial condition
and results of operations. Because the Company has not begun system testing,
and, accordingly, has not fully assessed its risks from potential Year 2000
failures, the Company has not yet developed specific Year 2000 contingency
plans.
As of August 31, 1998, the Company had begun to make inquiry of
substantially all of its strategic partners, vendors and third party entities
with which it has material relationships, and had begun to compile data related
to their Year 2000 plans. The Company's reliance upon certain third parties,
vendors and strategic partners for loan servicing, investor reporting, document
custody and other functions, means that their failure to adequately address the
Year 2000 issue could have a material adverse impact on the Company's operations
and financial results. The Company has received assurances from its two major
strategic partners, City Mortgage Services and Sovereign Bank, N.A., that they
have implemented plans to address the Year 2000 issue. The Company has not
evaluated these plans or assurances for their accuracy and adequacy, or
developed contingency plans in the event of their failure. As of May 31, 1999,
the Company had received responses from all of the strategic partners and
vendors.
The Company also relies upon certain government entities (such as the U.S.
Dept. of Housing and Urban Development and various state regulatory agencies),
utility companies, telecommunication service companies and other service
providers outside of the Company's control. There can be no assurance that such
suppliers, government entities, or other third parties will not suffer a Year
2000 business disruption. Such failures would have a material adverse effect on
the Company's financial condition and results of operations.
In addition, the Company's credit risk associated with its borrowers may
increase as a result of borrowers' individual Year 2000 issues. Negative impact
of Year 2000 issues upon borrowers may result in borrowers' inability to pay,
increases in delinquent loans, and a loss of residual income to the Company.
While at this time, it is not possible to calculate the
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<PAGE> 65
potential impact of such increased delinquent loans, it is believed that
increased delinquencies would have a material adverse impact on the financial
condition of the Company.
Because of uncertainties, the actual effects of the Year 2000 issue on the
Company may be different from the Company's current assessment. The effect on
the Company's results of operations if the Company, its strategic partners,
vendors or other third parties are not fully Year 2000 compliant is not
reasonably estimable. The description of the Company's Year 2000 plans contain
"forward-looking" statements about matters that are inherently difficult to
predict. Those statements include statements regarding the intent, belief or
current expectations of the Company and its management. Some of the important
factors that affect these statements have been briefly described. Such
forward-looking statements involve risks and uncertainties that may affect
future developments such as, for example, the ability to deal with the Year 2000
issue, including problems that may arise on the part of third parties. If the
repairs and modifications required to make the Company Year 2000 ready are not
made or are not completed on a timely basis, the resulting problems would have a
material adverse impact on the operations and financial condition of the
Company.
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains certain statements as to our future expectations,
which are referred to as forward-looking statements. These forward-looking
statements are based on our beliefs as well as assumptions made by and
information currently available to us. These forward-looking statements are
principally contained in the sections "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business." They relate to our expectations and estimates of the
Company's business operations, including the implementation of new business and
operating strategies, future financial performance, and expected growth in
revenues, net income and cash flows. However, these statements reflect only our
current views with respect to future events and are subject to risks,
uncertainties and assumptions. In addition to factors that are described
elsewhere in this prospectus, you must keep in mind that the factors listed
under the caption "Risk Factors," located earlier in this prospectus, could
cause actual results to differ materially from those expressed in any
forward-looking statement. If one or more of these risks or uncertainties
materialize, or if our assumptions prove incorrect, actual results may
materially differ from the results expressed in this prospectus, as anticipated,
believed, estimated or expected. In addition, we believe that due to recent
substantial changes to the Company's business and operating strategies, the
Company's historical financial and operating data are not likely to be
indicative of the Company's future performance.
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THE RECAPITALIZATION
GENERAL
As described earlier in this prospectus, the Company has historically
operated on a negative cash flow basis primarily due to substantial increases in
loan production and general and administrative expenses used to support the
expansion of the Company's operations and the significant negative cash flow
from the Company's sale of a substantial majority of its loan production in
securitization transactions.
Continuing deficits in cash flow combined with a $32.5 million loss
recognized by the Company for the three months ended November 30, 1997 and a
$32.5 million loss recognized for the Company for the six months ended February
28, 1998 resulted in the Company's violation of certain covenants contained in
agreements with its warehouse lender and some of its other lenders. From January
1998, when the Company violated these covenants with its lenders, until the
completion of the recapitalization on July 1, 1998, the Company's principal
activities consisted of liquidating its portfolio of loans to reduce the
Company's borrowings, maintaining the systems and personnel necessary to enable
the Company to resume operations and exploring alternatives to raise new
capital.
PRIVATE PLACEMENTS
In an effort to resume operations, the Company explored a number of
alternatives to raise new capital. These activities resulted in the Company's
recapitalization, completed on July 1, 1998, which provided the Company with
approximately $84.5 million of new equity. Two strategic partners, City National
Bank and Sovereign Bancorp, each purchased 10,000 shares of the Company's newly
designated Series A convertible preferred stock at a price of $1,000 per share.
The terms of the preferred stock are described under "Description of Capital
Stock -- Preferred Stock" later in this prospectus. In addition, City National
Bank and Sovereign Bancorp were each granted an option, which expires in
December 2000, to acquire 666,666 shares of common stock at a price of $15.00
per share. City National Bank and Sovereign Bancorp each has a right of first
refusal to purchase the Company in the event the Company's board of directors
determines to sell the Company. In addition, one other private investor
purchased an aggregate of 5,000 shares of Series A Convertible preferred stock
at a purchase price of $1,000 per share and several other investors purchased an
aggregate of 1.67 million shares of common stock at a purchase price of $15.00
per share. An additional 160,000 shares of common stock were issued to FBR as
the placement agent's fees for the recapitalization. In addition, the Company
has paid FBR an advisory fee of $416,667 in connection with the recapitalization
and reimbursed FBR for out-of-pocket expenses of approximately $250,000. These
sales were made pursuant to private placements.
The cash proceeds from the recapitalization were approximately $50.0
million. Approximately $5.1 million was used to pay interest on the Company's
Old Notes, $2.4 million was used to retire the old warehouse line, $1.6 million
was used for the payment of loan and management fees and other miscellaneous
charges due to Mego Financial, and approximately $428,000 was used for the
payment of a portion of the costs of the recapitalization. The balance will be
used to fund, purchase and make new loans and for general and administrative
expenses and other corporate purposes.
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EXCHANGE OFFER
As part of the recapitalization, the Company completed an exchange offer of
Current Notes and preferred stock for any and all of the outstanding $80.0
million principal amount of the Company's Old Notes. Pursuant to that exchange
offer, the Company issued approximately 37,500 shares of Series A convertible
preferred stock at a price of $1,000 per share and $41.5 million principal
amount of Current Notes in exchange for approximately $79.0 million principal
amount of the Old Notes. The Company completed the purchase of all of the
remaining Old Notes in September and October 1998.
MANAGEMENT
Upon completion of the recapitalization, Jerome J. Cohen, Robert
Nederlander, Herbert B. Hirsch and Don A. Mayerson resigned as directors of the
Company and Champ Meyercord was elected the Company's Chairman of the board of
directors and Chief Executive Officer. Mr. Meyercord has been a special
consultant to the Company since May 1998. In addition, City National Bank and
Sovereign Bancorp each were granted the right to appoint one member to the
Company's board of directors and have the right to appoint an additional board
member if they exercise their option to purchase additional shares of common
stock. Upon completion of the recapitalization, David J. Vida, Jr. was appointed
to the board of directors at the request of City National Bank. Three private
investors each have the right to appoint one board member. Wm. Paul Ralser was
appointed to the board of directors at the request of an ad hoc committee of
holders of the Old Notes, and Hubert J. Stiles, Jr. was appointed to the board
of directors at the request of one of the two private investors. Sovereign
Bancorp and the other private investor have not exercised their right to appoint
a board member, but have exercised their right to have a representative attend
each board meeting. On August 14, 1998, Jeffrey S. Moore resigned as President
of the Company. Effective September 1, 1998, Mr. Ralser was elected the
President and Chief Operating Officer of the Company.
TRANSACTIONS WITH STRATEGIC PARTNERS
As part of the recapitalization, the Company and each of Sovereign Bancorp
and City Holding Company entered into the following agreements (some of which
are described earlier in the prospectus) that the Company believes will provide
liquidity and increase the efficiency of the Company's operations:
- Sovereign Bancorp and City National Bank each purchased 10,000 shares of
Series A convertible preferred stock at a price of $1,000 per share
- Sovereign Bancorp agreed to provide the Company up to $90.0 million in
borrowings under the Sovereign Warehouse Line to fund its loan production
prior the sale of the loans, this amount was lowered to $25 million as of
March 31, 1999
- Sovereign Bancorp agreed to purchase up to $100.0 million of the
Company's loans per quarter and has a right of first refusal to purchase
all other loans produced by the Company
- City National Bank purchased the Company's existing mortgage servicing
rights
- City Mortgage Services agreed to service all of the Company's mortgage
loans held for sale and loans sold on a servicing retained basis by the
Company
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- Sovereign Bancorp and City National Bank were each granted an option to
purchase 666,666 shares of common stock at a price of $15.00 per share
- Sovereign Bancorp and City National Bank each has a right of first
refusal to purchase a controlling voting interest or a majority of the
Company's assets if the board of directors determines to sell the Company
- City National Bank has appointed, and Sovereign Bancorp has the right to
appoint, one member to the board of directors. Each has the right to
appoint an additional member to the board of directors if they exercise
their option to purchase shares of common stock
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BUSINESS
GENERAL
The Company is a specialized consumer finance company that funds,
purchases, makes and sells consumer loans secured by deeds of trust on
single-family residences. Historically, the Company retained the right to
service a substantial portion of the loans it has sold. The Company's borrowers
generally do not qualify for traditional "A" credit mortgage loans. Typically,
their credit histories, income or other factors do not conform to the lending
criteria of government-chartered agencies (including GNMA, FNMA, FHLMC) that
traditional lenders rely on in evaluating whether to make loans to potential
borrowers.
The Company's loan products are:
- Home Equity loans that typically are secured by first liens, and in some
cases by second liens, on the borrower's residence. In making Home Equity
loans, the Company relies primarily on the appraised value of the
borrower's residence. The Company determines the loan amount based on the
loan-to-value ratio and the creditworthiness of the borrower. These loans
generally are used to purchase single-family residences and refinance
existing mortgages.
- Equity + loans that are based on the borrowers' credit. These loans
typically are secured by second liens on the borrowers' primary
residences. The initial amount of an Equity + loan, when added to other
outstanding senior or secured debt on the residence, resulted in a
combined loan-to-value ratio that averaged 112% during fiscal 1997 and
1998. The loan-to-value ratio on these loans may be as high as 125%.
These loans generally are used to consolidate debt and make home
improvements.
The Company funds loans originated by its network of pre-approved mortgage
brokers which numbered over 169 mortgage brokers as of August 31, 1998. These
brokers submit loan packages to the Company which in turn funds loans made to
approved borrowers. The loans are made directly by the Company to the borrower.
Historically, the Company has produced substantially all of its loans by
purchasing previously closed loans from approved mortgage bankers and other
financial intermediaries and purchasing closed Title I loans from its network of
home improvement contractors. All loans produced by the Company are underwritten
and graded by the Company's personnel. The Company's current operating strategy
is to sell substantially all of the loans it produces for cash to institutional
purchasers. The Company currently does not intend to produce a material amount
of Title I loans in the future.
The Company's loans are primarily produced by its wholesale division and,
to a lesser extent, is retail division. The wholesale division funds loans
originated by a network of pre-approved mortgage brokers. The wholesale division
also underwrites and purchases closed loans sometimes at a premium to their
principal amount from a nationwide network of independent mortgage bankers and
other qualified financial intermediaries. To diversify its loan production
channels, the Company, through its retail division, currently intends to resume
making direct-to-consumer loans during fiscal 1999. The retail division makes
loans directly to consumers charging fees to the borrower that are expected to
offset the Company's total cost of making the loan.
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The Company historically has sold, in securitization transactions, a
substantial majority of the loans it produces on servicing-retained basis (which
means the Company retains the right to service the loans and receives an annual
fee based on a fractional percentage of the outstanding principal balance of the
loans). Generally, sales on a servicing released basis (which means the
servicing on the loan is sold or "released" to the purchaser of the loan) and
some sales on a servicing retained basis are at a premium to the principal
amount of the loan. For additional details on the sale of loans in
securitization transactions, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Securitization Transactions"
earlier in this prospectus. For additional details on the risks of the Company's
mortgage related securities retained in securitizations, see "Risk
Factors -- Liquidity Risks" earlier in this prospectus.
As described earlier in this prospectus, the Company, during fiscal 1996
and 1997 and the first four months of fiscal 1998, substantially expanded its
operations. During these periods the Company's loan production was $139.4
million (fiscal 1996), $526.9 million (fiscal 1997) and $268.5 million (first
four months of fiscal 1998). As the Company expanded its business, the general
and administrative expenses required to support the expansion also increased
from $11.8 million in fiscal 1996 to $23.8 million in fiscal 1997 and $13.8
million in the first four months of fiscal 1998. As a percentage of the total
principal amount of loans produced, general and administrative expenses during
these periods represented 8.5% in fiscal 1996, 4.5% in fiscal 1997 and 5.2% in
the first four months of fiscal 1998.
Prior to January 1998, a substantial majority of the Company's loan
production was sold in securitization and similar transactions. The sale of
loans in securitization transactions typically results in negative cash flow
because the cash proceeds from the sale of the loans in a securitization
transaction is substantially less than the Company's total cost of producing the
loans sold. The combination of negative cash flow from the sale of loans in
securitization transactions and the level of general and administrative expenses
caused the Company, historically, to operate on a substantial negative cash flow
basis.
During fiscal 1996 and 1997 and the six months ended February 28, 1998, the
Company used $12.4 million, $72.4 million and $59.5 million of cash used in
operations, respectively. The cash was principally funded from the sale of $20.0
million of common stock and $40.0 million of subordinated debt in November 1996
and $40.0 million principal amount of subordinated debt in October 1997, as well
as its warehouse line of credit and other borrowings.
As a result of a $11.7 million loss in the Company's first quarter of
fiscal 1998 and continuing cash flow deficits, the Company violated certain
provisions of its old warehouse line. The warehouse lender requested in February
1998 that the Company, in order to avoid a default, repay a significant portion
of the principal balance of the line. Since a default on the warehouse line
would have triggered, among other things, a default on the Company's $80.0
million principal amount of outstanding Old Notes, the Company agreed to
periodically reduce the outstanding balance of the old warehouse line from $55.0
million and the Company repaid the balance on June 29, 1998.
To generate cash to reduce the outstanding amount of the warehouse line and
continue to operate, the Company began to liquidate, through sales for cash, its
mortgage loan portfolio and explore a number of alternatives to locate new
capital. In addition, because the old warehouse line was used to fund loans
produced by the Company prior to their sale, the Company greatly curtailed its
loan production beginning in January 1998.
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The cash received from the Company's sale of loans was used to pay down the old
warehouse line and other Company borrowings and to pay general and
administrative expenses to retain personnel and maintain the Company's
operations while it sought to locate new capital. These matters, among others,
raised substantial doubt in the opinion of the Company's independent auditors,
with respect to the Company's ability to continue as a going concern.
On July 1, 1998, the Company completed the recapitalization. As part of the
recapitalization, the Company received $50.0 million in cash proceeds from the
private placement of approximately 1.67 million shares of common stock at a
price of $15.00 per share and 25,000 shares of Series A convertible preferred
stock at a price of $1,000 per share. In addition, the Company issued $37.5
million of Series A convertible preferred stock and $41.5 million principal
amount of Current Notes in exchange for $79.0 million principal amount of Old
Notes. The recapitalization resulted in $84.5 million of additional equity. For
more information on the recapitalization, see "The Recapitalization" earlier in
this prospectus.
STRATEGIC INITIATIVES
Our strategic initiatives have been substantially impacted by recent events
in the capital markets and their effect on the specialty finance industry. There
has been a significant reduction in the number of institutions willing to
provide warehouse facilities to mortgage lenders producing home equity and high
loan-to-value loans. Additionally, there has been a reduction in the number of
buyers of senior interests issued in securitization transactions backed by home
equity and high loan-to-value loans, and a concurrent increase in the yield (and
a reduction in the price) demanded by such buyers on the senior interests they
purchase. Finally, the number of institutional investors acquiring loans similar
to the Company's Home Equity and Equity + loans has declined, along with the
premiums, if any, these investors are willing to pay for these loans. These
events have substantially reduced the liquidity available to companies in our
business to make new loans. With these events in mind, we have redefined our
strategic initiatives.
OUR PRIMARY FOCUS WILL BE IN PRODUCING HOME EQUITY LOANS. We anticipate
reducing our reliance on Equity + loans with high loan-to-value ratios and
significantly increasing the percentage and amount of our business devoted to
the production of Home Equity loans by expanding our network of brokers and
bankers and acquiring other companies that produce Home Equity loans. The
Company will produce Home Equity loans solely for sale for cash, generally at
premiums to their principal amounts, to institutional purchasers in the
secondary market without recourse for credit losses or risk of prepayment. Based
on our experience in the industry, we believe that currently there are more
buyers for Home Equity loans than for Equity + loans.
DUAL PRODUCTION PLATFORMS SHOULD LOWER OUR TOTAL LOAN PRODUCTION COSTS.
While pursuing our broker and mortgage banker wholesale loan programs, we intend
to pursue loan production on a retail (direct-to-consumer) basis. Although a
retail loan platform is relatively expensive, we expect it to produce loans at a
lower cost than our wholesale platform. When the Company makes a loan directly
to a consumer, it typically receives loan fees and it avoids any premium due
when the Company purchases a loan from its network of mortgage bankers. The
Company expects its dual loan production platform strategy to lower its overall
cost of producing mortgage loans and improve its cash flow.
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THE COMPANY INTENDS TO INCREASE PRODUCTION BY ACQUIRING OTHER MORTGAGE
LENDING COMPANIES. The Company intends to increase its loan production
significantly by acquiring companies that produce mortgage loans. Because the
Company raised cash in the recapitalization, it expects the current lack of
liquidity available to companies in the industry to create opportunities for the
Company in this area.
SELLING LOANS FOR CASH WILL BE THE COMPANY'S PRIMARY METHOD OF LOAN
DISPOSITION. The Company intends to sell substantially all of the loans it
produces for cash to institutional purchasers in the secondary market as our
primary loan disposition strategy. The Company expects this method of loan sales
to generate positive cash flow, because Home Equity and Equity + loans can
generally be sold for more than their principal amount. To this end, we are
expanding the number of institutions with which it has loan purchase and sale
relationships. The Company does not anticipate selling its loans in
securitization transactions. Securitization transactions tend to result in
negative cash flow, because the initial cash proceeds to the Company are less
than the Company's total cost of producing the loans to be sold.
THE COMPANY INTENDS TO CONTINUE TO IMPLEMENT COST SAVING MEASURES. We are
continuing an internal restructuring, which has resulted in a reduction of our
workforce from a peak of 475 employees in January 1998 to 134 employees as of
August 31, 1998 and 78 employees as of May 31, 1999. This reduction and other
cost saving measures the Company has taken, have significantly reduced our
monthly recurring general and administrative expenses from approximately $2.7
million in June 1998 (the month prior to completion of the recapitalization) to
approximately $1.2 million in May 1999. In addition, the Company has reduced by
$4.7 million the annual interest expense on its outstanding subordinated notes
by issuing 37,500 shares of preferred stock and $41.5 million principal amount
of Current Notes in exchange for $79.0 million principal amount of Old Notes.
MORTGAGE INDUSTRY
Home Equity
A substantial number of residential homeowners are unable or unwilling to
obtain mortgage financing from conventional financing sources, whether for
reasons of credit impairment, income qualification, credit history, or a desire
to receive loan approval and funding more quickly than that offered by
conventional sources. Many of these homeowners have credit scores or debt ratios
that prohibit them from meeting the requirements of lenders who sell loans to
FNMA or FHLMC. Such borrowers seek loans that rely more heavily upon the
borrower's equity in their home, and to a lesser extent, upon the borrower's
credit scores or debt ratios. Because the properties securing such loans are the
borrower's primary residence, the borrower is less likely to default on payment
than might be the case with unsecured debt -- and in the event of the borrower's
bankruptcy, the loan is fully secured. Such loans rely more heavily on accurate
appraisals of the property prior to funding, and are generally made in
loan-to-value ratios of less than 80%.
Home Improvement
As the costs of home improvements escalate, home owners are seeking
financing to improve their property and maintain and enhance its value. The
National Association of Home Builders Economics Forecast in 1995 estimates that
home improvement expenditures will exceed $200.0 billion by the year 2003.
Lenders of home improvement financing typically rely more heavily on the
borrowers' creditworthiness, and ability to pay their debts
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than the value of the collateral. These loans are secured by a real estate
mortgage lien on the property improved. The market for Equity + loans and Home
Equity loans continues to grow, as many homeowners have limited access to
traditional financing sources due to insufficient home equity, limited or
impaired credit history or high ratios of debt service-to-income. The loan
proceeds can be used for a variety of improvements such as large remodeling
projects. Borrowers also have the opportunity to consolidate a portion of their
outstanding debt in order to reduce their monthly debt service.
Debt Consolidation
An increasing number of financial institutions are originating loans to
borrowers who use the proceeds to reduce outstanding consumer finance
obligations. These loans may also be made in conjunction with a home improvement
project where the borrowers seek to enhance the value of their residence and
ultimately reduce their monthly debt service obligations. These consumer finance
obligations are often in the form of unsecured credit card debt which have high
interest rates and relatively short-term maturity dates. Under this type of
loan, the consumer uses the loan proceeds to consolidate multiple outstanding
debt into a single loan. In turn, the consumer receives the benefit of a lower
interest rate and an extended loan maturity date, often as high as 25 years,
reducing the amount of monthly debt service payments, and in certain instances
the interest paid may be tax deductible. These loan products are secured by a
mortgage lien on the consumer's primary residence. These liens are typically in
a junior position and when combined with first mortgage liens may exceed the
market value of the subject residence. Debt consolidation loans are typically
made to high credit worthy borrowers who have a credit history of honoring their
financial obligations on a timely basis. Within the specialty finance industry
it is typical for loans to qualified borrowers to be limited to the amount
which, when added to the outstanding senior liens on the property, will not
exceed 125% of the market value of the property.
COMPANY LOAN PRODUCTS
The Company originates Home Equity loans and, to a lesser extent, Equity +
loans. Home Equity loans generally have a lower loan-to-value ratio than Equity
+ loans. When combined with other outstanding senior secured indebtedness on the
residence, Equity + loans may result in a combined loan-to-value ratio of up to
125%. During both fiscal 1997 and 1998, the Company's Equity + loans had an
average loan-to-value ratio of 112%. The Company lends to borrowers of varying
degrees of creditworthiness. See "-- Loan Processing and Underwriting." The
Company's primary loan products include the following:
<TABLE>
<CAPTION>
HOME EQUITY LOANS EQUITY + LOANS
- ----------------- --------------
<S> <C> <C> <C>
- - fixed and adjustable rate - fixed rate
- - typically secured by first liens, - secured by a junior lien on the
and to a lesser extent, second borrowers' principal residence
mortgage liens on the borrowers'
principal residences
- - terms of up to 360 months - terms from 60 to 300 months
- - principal amounts up to $500,000 - principal amounts up to $50,000
</TABLE>
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Home Equity Loans
In furtherance of its strategy to expand its loan products, in December
1997 the Company commenced the production of Home Equity loans to borrowers with
a credit grade ranging from "A" to "D". Loan amounts may range up to a maximum
of $500,000 for "A" credit borrowers with maturities of up to 360 months. The
Company expects the average loan amount to be less than $100,000. The average
loan amount in this program for the fiscal year ended August 31, 1998 was
$60,019. In making Home Equity loans, the Company places increased emphasis on
the underlying collateral value of the residence which is fully supported by an
independent appraisal. The Company intends to pool its Home Equity loans for
eventual sale in the secondary market to institutional purchasers on a servicing
released basis, without recourse for credit losses or risk of prepayment, for
cash premiums over the principal amount of the loan. To date, substantially all
of the Home Equity loans produced by the Company have been to borrowers with "B"
and "C" credit grades under the Company's underwriting guidelines. The Company
believes that there are several advantages to producing Home Equity loans
including:
- the existence of a more liquid secondary market than for Equity + loans
- the larger average principal amount of such loans which are typically two
times greater than that of a Equity + loan
- the lower total costs of producing Home Equity loans from mortgage
bankers and brokers than the Company's Equity + loans
Equity + Loans
An Equity + loan is a non-insured debt consolidation or home improvement
loan typically used to retire consumer debt and/or pay for a home improvement
project. All of the Equity + loans produced by the Company are secured by a
mortgage lien on the borrower's principal residence. The Company began producing
Equity + loans through its wholesale division in May 1996. Currently, Equity +
loans are offered through both the Company's wholesale and retail divisions.
Debt consolidation loans account for a major portion of the Company's Equity +
loan production.
The Company has focused its Equity + loan program on higher credit quality
borrowers who may have limited equity in their residence after giving effect to
other debt secured by the residence. Most of the Company's Equity + loans have
loan-to-value ratios greater than 100% and, accordingly, the value of the
residence securing the loan generally will not be sufficient to cover the
principal amount of the loan in the event of default. The Company relies
principally on the creditworthiness and income stability of the borrower and, to
a lesser extent, on the underlying value of the borrower's residence for
repayment of its Equity + loans. For fiscal 1998, the average market value of
the residence securing the Equity + loans produced by the Company was
approximately $108,000 without added value from the respective home improvement
work, the amount of senior liens was approximately $88,500 and the Company's
loan amount was approximately $31,700.
LENDING OPERATIONS
Mortgage Brokers and Bankers
The Company produces loans through its wholesale and, to a lesser extent,
retail divisions. The wholesale division represents the Company's largest source
of loan
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production. Through its wholesale division, the Company funds loans originated
through a nationwide network of licensed mortgage brokers and purchases loans
from a nationwide network of licensed mortgage bankers. Mortgage bankers produce
mortgage loans by lending their own funds to the borrower and closing the loan
in their own name. Mortgage brokers, like mortgage bankers, initiate the loan
application and process necessary underwriting documentation. However, unlike
mortgage bankers, mortgage brokers ordinarily do not fund loans with their own
money, but work as agents on behalf of investors, including mortgage bankers,
banks, savings and loans or investment bankers. The Company funds loans
originated by mortgage brokers by lending the Company's funds to the borrower
and closing the loan to the borrower in the Company's name.
The Company funds loans originated by mortgage brokers on an individual
loan basis, pursuant to which each loan is underwritten by the Company and is
closed in the Company's name. The Company's network of mortgage brokers earn
fees which are paid by the borrower at closing, and which are disclosed and
agreed to by the borrower as required by law. The Company purchases loans from
its network of mortgage bankers after underwriting closed loans or pools of
closed loans for compliance with the Company's underwriting criteria. When the
Company buys closed loans from mortgage bankers, the Company has historically,
and may in the future, pay premiums based upon the characteristics of the loans,
including the range of credit scores of the borrowers and the interest rates on
the loans. The wholesale division conducts operations from its headquarters in
Atlanta, Georgia. To build and maintain its networks of mortgage bankers and
brokers, the wholesale division uses account executives responsible for
developing and maintaining relationships with mortgage bankers and brokers. At
August 31, 1998, the Company had a network of 169 active mortgage brokers and 56
active mortgage bankers.
Mortgage bankers and brokers qualify to participate in the Company's
programs only after a review by the Company's management of the mortgage
brokers' and mortgage bankers' respective reputations and expertise, including a
review of references and financial statements. The Company's compliance
department performs a periodic review of each mortgage banker and broker,
recommending suspension or continuance of a relationship with the mortgage
banker or broker based upon the results of the review. We do not believe that
the loss of any particular mortgage banker or broker would have a material
adverse effect upon the Company.
None of the Company's arrangements with its mortgage bankers and brokers is
on an exclusive basis. Each relationship is documented by a written agreement,
in which the Company agrees to fund or purchase loans that comply with the
Company's underwriting guidelines. On each loan produced, the mortgage banker or
broker makes customary representations and warranties regarding, among other
things, the credit history of the borrower, the status of the loan and its lien
priority, if applicable, and agrees to indemnify the Company for breaches of any
representation or warranty. In the agreements, the mortgage banker or broker
makes customary representations and warranties regarding, among other things,
their corporate status, as well as regulatory compliance, title to the property,
enforceability, status of payments and advances on the loans. The mortgage
bankers and brokers agree, among other things, not to disclose confidential
information of the Company, to provide supplementary financial and licensing
information, maintain government approvals, and to refrain from soliciting the
Company's borrowers. Each agreement also contains provisions requiring that the
mortgage banker or broker indemnify the Company against material
misrepresentations or non-performance of its obligations.
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Retail Loans
The Company commenced making direct-to-consumer Equity + loans in September
1997 and Home Equity loans in December 1997, although the Company's retail
channels are not being actively pursued. Marketing strategies typically used in
retail production include telemarketing, direct mail, television and radio
advertising, third-party loan programs and consumer trade shows. Telemarketing
services, both inbound and outbound, are outsourced to keep the cost of
originations to a minimum. A Company website is currently under construction and
may be used to provide consumers loan applications and information to the public
about the Company's products and services. As part of its business strategy, the
Company intends to acquire retail mortgage lending companies in fiscal 1999.
By making direct-to-consumer loans, the Company avoids the payment of
premiums that it pays when it purchases closed loans from its network of
mortgage bankers. The loan fees charged by the Company to consumers on the
direct loans are expected to cover the Company's total cost of the underwriting
and making the loan and place the Company on a positive cash flow basis with
respect to the production of direct-to-consumer loans.
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The following table provides information about the Company's loan
applications processed and loans produced during the periods indicated. As a
result of recent changes to the Company's business strategy, we do not believe
that this information is indicative of future loan applications and loans
produced.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED AUGUST 31,
------------------------------------------------------
1996 1997 1998
---------------- ---------------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
TOTAL LOAN APPLICATIONS:
Number processed.............. 42,236 92,165 46,361
Number approved............... 20,910 52,269 24,876
Approved ratio................ 49.5% 56.7% 53.7%
LOAN PRODUCTION:
Principal balance of loans
produced:
Wholesale:
Title I.................... $ 82,596 59.3% $ 50,815 9.7% $ 7,081 2.1%
Equity + loans............. 11,582 8.3 409,603 77.7 289,354 85.4
-------- ----- -------- ----- -------- -----
Total Wholesale....... 94,178 67.6% 460,418 87.4% 296,435 87.5%
Dealers/Bankers/Brokers(1):
Title I.................... 45,189 32.4% 47,270 9.0% 11,619 3.4%
Equity + loans............. -- -- 19,229 3.6 14,051 4.2
Home Equity................ -- -- -- -- 8,940 2.6
-------- ----- -------- ----- -------- -----
Total
Dealers/Bankers/Brokers.. 45,189 32.4% 66,499 12.6% 34,610 10.2%
Retail:
Equity + loans............. -- -- -- -- $ 7,114 2.1%
Home Equity................ -- -- -- -- 783 0.2
-------- ----- -------- ----- -------- -----
Total Retail.......... -- -- -- -- $ 7,897 2.3%
-------- ----- -------- ----- -------- -----
Total principal
balance of loans
produced............ $139,367 100.0% $526,917 100.0% $338,942 100.0%
======== ===== ======== ===== ======== =====
Number of loans produced:
Wholesale:
Title I.................... 4,382 50.9% 2,445 12.0% 327 2.9%
Equity + loans............. 392 4.6 12,831 62.7 8,848 78.6
-------- ----- -------- ----- -------- -----
Total Wholesale....... 4,774 55.5% $ 15,276 74.7% 9,175 81.5%
Dealers/Bankers/Brokers (1):
Title I.................... 3,836 44.5% 3,893 19.0% 975 8.7%
Equity + loans............. -- -- 1,296 6.3 744 6.6
Home Equity................ -- -- -- -- 145 1.2
-------- ----- -------- ----- -------- -----
Total
Dealers/Bankers/Brokers.. 3,836 44.5% 5,189 25.3% 1,864 16.5%
Retail:
Equity + loans............. -- -- -- -- 208 1.8%
Home Equity................ -- -- -- -- 17 0.2
-------- ----- -------- ----- -------- -----
Total Retail.......... -- -- -- -- 225 2.0%
-------- ----- -------- ----- -------- -----
Total number of loans
produced............ 8,610 100.0% 20,465 100.0% 11,264 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
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<PAGE> 78
<TABLE>
<CAPTION>
FISCAL YEAR ENDED AUGUST 31,
------------------------------------------------------
1996 1997 1998
---------------- ---------------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Average principal balance of
loans produced................ $ 16 $ 26 $ 30
Weighted-average interest rate
on loans produced............. 14.03% 13.92% 13.89%
Weighted-average term of loans
produced (months)............. 198 226 235
</TABLE>
- -------------------------
(1) The Company closed its dealer division, which purchased loans from home
improvement contractors, in February 1998.
LOAN PROCESSING AND UNDERWRITING
The Company's loan application and approval process generally is conducted
over the telephone with applications usually received from mortgage bankers,
mortgage brokers and consumers at the Company's centralized processing facility
in Atlanta, Georgia. After receiving an application, the information is entered
into the Company's system and processing begins. The information provided in
loan applications is first verified by, among other things, the following:
- written confirmations of the applicant's income and, if necessary, bank
deposits
- a formal credit bureau report on the applicant from a credit reporting
agency
- a title report
- a real estate appraisal, if necessary
- evidence of flood insurance, if necessary
Loan applications are then reviewed to determine whether or not they
satisfy the Company's underwriting criteria, including loan-to-value ratios,
occupancy status, borrower income qualifications, employment stability,
purchaser requirements and necessary insurance and property appraisal
requirements.
The Company has developed its credit index profile ("CIP") as a statistical
credit based tool to predict likely future performance of a borrower. A
significant component of the CIP system is the credit evaluation score
methodology developed by Fair Isaacs Company ("FICO"), a consulting firm
specializing in creating default predictive models using a number of variable
components. A FICO score is calculated by a system of scorecards. FICO uses
actual credit data on millions of consumers, and applies complex mathematical
methods to perform extensive research into credit patterns that attempt to
forecast consumer credit performance. The principal components of the FICO
predictive model include a consumer's credit payment history, outstanding debt,
availability and pursuit of new credit and types of credit in use. Through this
scorecard process, FICO identifies distinctive credit patterns, which correspond
to a likelihood that consumers will make their future loan payments. The score
is based on all the credit-related data in the credit report. The other major
components of the CIP include debt-to-income analysis, employment stability,
self employment criteria, residence stability and whether the applicants use the
premises as their primary residence. By using both scoring models
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<PAGE> 79
together, all applicants are considered on the basis of their ability to repay
the loan obligation while allowing the Company to price the loan based on the
extent of the evaluated risk.
The Company's underwriters review the applicant's credit history, based on
the information contained in the application and reports available from credit
reporting bureaus and the Company's CIP score, to determine whether the
applicant meets the Company's underwriting guidelines. Based on the
underwriter's approval authority level, certain exceptions to the guidelines may
be made when there are compensating factors subject to approval from a more
senior designated authority. The underwriter's decision is communicated to the
broker, banker or consumer depending on the source of the loan and, if approved,
the proposed loan terms are fully explained. The Company attempts to respond
within 24 hours of receipt of a loan application.
Loan commitments are generally issued for periods of up to 30 days. Prior
to disbursement of funds, all loans are carefully reviewed by funding auditors
to ensure that all documentation is complete, all contingencies specified in the
approval have been met and the loan complies with Company and regulatory
procedures.
Home Equity Loans
The Company produces Home Equity loans through a mortgage banker and broker
loan source network as well as through the Company's retail division. Home
Equity loan mortgages produced under this program are limited to a first or
second lien position. Loan amounts are determined by taking a specific amount of
the collateral value of the property and adjusting the percentage based on the
creditworthiness of the borrower. For example, if the Company's guidelines set a
minimum loan-to-value ratio of 75% ($75,000 for a home with a collateral value
of $100,000), a more creditworthy borrower may be able to borrow in excess of
$75,000, and a less credit worthy borrower may only be able to borrow $65,000.
Full appraisals generated by approved licensed appraisers are required on all
loans within the Uniform Standards of Professional Appraisal Practice (the
"Uniform Standards of Appraisal"). Any loan amount of $250,000 or more would
require two independent appraisals. The credit grade will be determined by using
the CIP. In connection with Home Equity loans, the Company seeks commitments
from third party financial institutions to purchase the loans in accordance with
their respective guidelines, without recourse for credit losses or risk of
prepayment.
As part of the underwriting process, the Company requires an appraisal of
the residence that will be the collateral for the loan. The Company requires the
independent appraiser to be state licensed and certified. The Company requires
that all independent appraisals be completed within the Uniform Standards of
Appraisal as adopted by the Appraisal Standards Board of the Appraisal
Foundation. The Company audits the appraisal for accuracy to ensure that the
appraiser used sufficient care in analyzing data to avoid errors that would
significantly affect the appraiser's opinion and conclusion. This audit includes
a review of housing demand, physical adaptability of the real estate,
neighborhood trends and the highest and best use of the real estate. In the
event the audit reveals any discrepancies as to the method and technique that
the Company believes are necessary to produce a credible appraisal, the Company
will perform additional property data research or may request a second appraisal
to be performed by an independent appraiser selected by the Company in order to
further substantiate the value of the subject property.
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<PAGE> 80
The Company may require a full title insurance policy substantially in
compliance with the requirements of the American Loan Title Association. The
applicant also is required to secure hazard insurance and may be required to
secure flood insurance if the mortgaged property has been identified by the
Federal Emergency Management Agency as having special flood hazards.
Equity + Loans
The Company has implemented policies for its Equity + loan program that are
designed to minimize losses by adhering to high credit quality standards. Based
on FICO score default predictors and the Company's internal CIP score, borrowers
are classified by the Company based on its belief of their credit risk and
quality, from "A" credits to "D" credits. Quality is a function of both the
borrowers' creditworthiness and the extent of the value of the collateral, which
is typically a second lien on the borrowers' primary residence. "A+" credits
generally have a FICO score greater than 700. An applicant with a FICO score of
less than 640 would be rated a "C" credit. Currently, the Company will not
approve an Equity + loan to a borrower with less than an "A" or "B" credit grade
using the CIP. All of the Equity + loans originated to date by the Company are
secured by first or second mortgage liens on single-family, owner occupied
properties.
Terms of Equity + loans produced by the Company, as well as the maximum
combined loan-to-value ratios and debt service to income coverage (calculated by
dividing fixed monthly debt payments by gross monthly income), vary depending
upon the Company's evaluation of the borrower's creditworthiness. In general,
Equity + loans have higher interest rates than Home Equity loans, but are
generally lower than rates changed on credit cards. Borrowers with lower
creditworthiness generally pay higher interest rates and loan origination fees.
QUALITY CONTROL
The Company employs various quality control personnel and procedures in
order to ensure that loan product standards are adhered to and regulatory
compliance is maintained.
In accordance with Company policy, the quality control department reviews a
statistical sample of loans produced each month. This review is generally
completed within 60 days and circulated to appropriate department heads and
senior management. Finalized reports generally are maintained in the Company's
files for a period of two years from completion. Typical review procedures
include reverification of employment and income, re-appraisal of the subject
property, obtaining separate credit reports and recalculation of debt-to-income
ratios. The statistical sample is intended to cover 10% of all new loan
products. Emphasis will also be placed on those loan sources where higher levels
of delinquency are experienced or payment defaults occur within the first six
months of funding. On occasion, the quality control department may review all
loans generated from a particular loan source in the event an initial review
determines a higher than normal number of exceptions. The account selection of
the quality control department is also designed to include a statistical sample
of loans by each processor, closer and underwriter, and provides management with
information as to any material difference from Company policies and procedures
in the loan production process.
On a daily basis, a sample of recently approved loans are reviewed to
insure compliance with underwriting guidelines and criteria. Particular
attention may be focused on those underwriters who have developed a higher than
normal level of exceptions.
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<PAGE> 81
TECHNOLOGY SYSTEMS
The Company uses a computerized loan production tracking system that allows
us to monitor the performance of our wholesale and retail divisions. The system
automates various other functions such as Home Mortgage Disclosure Act and HUD
reporting requirements and routine tasks such as decline letters and the flood
certification process. The system also gives management access to a wide range
of decision support information including data on the approval pipeline and the
activities and performance of underwriters and loan funders. The Company uses
intercompany electronic mail for internal communications and for receiving loan
servicing, collection and delinquency information from City Mortgage Services on
each group of loans being serviced.
The Company's existing loan production system provides for the automation
of the loan production process as well as loan file indexing and routing. This
system includes automated credit report inquiries and consumer credit scoring,
along with on-screen underwriting and approval functions. The Company also uses
a system which allows for electronic routing of loan application facsimiles. The
Company recognizes that there have been significant advances made by a number of
mortgage production software vendors in the last year and intends to review a
number of the solutions provided by these vendors. It is the intention of the
Company to upgrade its automation infrastructure by the purchase of a new
system. This approach will shift the burden of development and maintenance of
the production system from the Company's in-house development staff to third
party vendors to allow the Company to focus its in-house development efforts to
its own unique business automation needs. Currently, the Company's existing loan
production system is not Year 2000 compliant. The cost for replacing the
Company's existing loan production system has been included in its plans and
estimated expenses for Year 2000 compliance. For additional details on Year 2000
compliance, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Impact of Year 2000 Issue" earlier in this prospectus.
LOAN SERVICING
The Company's strategy has historically been to retain the bulk of the
servicing rights associated with the loans it originates. As part of the
recapitalization, City Mortgage Services purchased the Company's existing loan
servicing rights and agreed to service all of the Company's loans held for sale
and loans sold on a servicing retained basis. The Company has an option,
contingent upon the delivery to City Mortgage Services of servicing on $1.0
billion of loans to purchase up to 20% equity position in a new entity to be
created should City National Bank determine to spin-off City Mortgage Services
into a separate entity. When the Company sold its loan servicing portfolio to
City Mortgage, the Company eliminated substantially all of its collections and
claim staff.
Among the Company's loan servicing activities performed by City Mortgage
Services are processing and administering loan payments, reporting and sending
principal and interest to the owners who own interests in the loans and to the
trustee of loans sold in securitization transactions, collecting delinquent loan
payments, processing Title I insurance claims, conducting foreclosure
proceedings and disposing of foreclosed properties and other loan administration
duties. In addition, under the loan servicing agreements, the Company is
entitled to receive a certain portion of the servicing fees collected by City
Mortgage Services. The Company will retain responsibility for certain functions
related to initial customer service and continued tax and insurance monitoring.
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<PAGE> 82
The following table sets forth certain historical information regarding the
Company's loan servicing for the periods indicated:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED AUGUST 31,
--------------------------------
1996 1997 1998
-------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Servicing portfolio at beginning of period(2)... $ 92,286 $ 214,189 $ 628,068
Additions to servicing portfolio................ 139,367 526,917 338,942
Reductions in servicing portfolio(1)............ (17,464) (113,038) (935,788)
-------- --------- ---------
Servicing portfolio at end of period(2)......... $214,189 $ 628,068 $ 31,222
======== ========= =========
Servicing portfolio at end of period(2):
Company-owned loans:
Equity +...................................... $ 922 $ 8,661 $ 8,217
Title I....................................... 3,776 902 4,233
-------- --------- ---------
Total Company-owned loans............. 4,698 9,563 12,450
Loans sold in securitization transactions:
Equity +...................................... 10,501 363,961 --
Title I....................................... 198,990 254,544 18,772
-------- --------- ---------
Total loans sold in securitization
transactions....................... 209,491 618,505 18,772
-------- --------- ---------
Total servicing portfolio(2).......... $214,189 $ 628,068 $ 31,222
======== ========= =========
</TABLE>
- ---------------
(1) Reductions resulted from scheduled payments, prepayments, loans sold with
servicing released, and writeoffs during the period.
(2) Not adjusted for the sale of the Company's mortgage servicing rights to City
Mortgage Services on August 1, 1998 as part of the recapitalization.
Excludes approximately $9.4 million of Equity + loans to be repurchased at
August 31, 1998.
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<PAGE> 83
The following table sets forth the Title I Loan and Equity + loan
delinquency and Title I insurance claims experience of loans serviced by the
Company as of the dates indicated. The Company is not producing a significant
amount of Title I Loans.
<TABLE>
<CAPTION>
AUGUST 31,
--------------------------------
1996 1997 1998
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Equity + loan delinquency data(1):
31-60 days past due.......................... 0.44% 0.40% 7.14%
61-90 days past due.......................... 0.00 0.20 1.52
91 days and over past due.................... 0.00 0.34 24.83
Total past due................................. 0.44 0.94 33.49
Title I loan delinquency data(1):
31-60 days past due.......................... 2.27 3.19 7.88
61-90 days past due.......................... 0.90 1.68 2.39
91 days and over past due.................... 4.78(2) 7.06(2) 25.00
Total past due................................. 7.95 11.93 35.27
91 days and over past due,
net of claims filed(3).................... 2.05 5.20 8.54
Outstanding claims filed with HUD(4)........... 2.73 1.86 16.46
Amount of FHA insurance available for Title I
loans serviced............................... $ 21,205 $ 21,094 $ 14,134(5)
Amount of FHA insurance available as a
percentage of Title I loans serviced......... 10.46% 8.26% 61.44%(5)
Total delinquency data:
31-60 days past due.......................... 2.17 1.54 7.69
61-90 days past due.......................... 0.85 0.80 2.16
91 days and over past due.................... 4.53(7) 3.07(2) 24.95
Total past due................................. 7.55 5.41 34.88
91 days and over past due, net of claims
filed(6).................................. 1.94 2.32 7.56
Outstanding claims filed with HUD(7)........... 2.59 0.75 17.39
Outstanding number of Title I insurance claims
filed........................................ 255 269 207
Total servicing portfolio(9)................... $214,189 $628,068 $ 31,222
Title I loans serviced......................... 202,766 255,446 23,005
Equity + loans serviced(9)..................... $ 11,423 $372,622 $ 8,217
Home Equity loans serviced..................... -- -- --
Aggregate losses on liquidated loans(8)........ $ 32.0 $ 201.0 $1,368.0
</TABLE>
- ---------------
(1) Represents the dollar amount of delinquent loans as a percentage of the
total dollar amount of each respective type of loan serviced by the Company
(including loans owned by the Company but excluding loans repurchased and
loans contained in securitization 1998-1) as of period end. Equity + loan
delinquencies represented 0.31% of the Company's total delinquencies for the
year ended August 31, 1996, 10.35% for the year ended August 31, 1997 and
17.39% for the year ended August 31, 1998 of the Company's total
delinquencies. The Company did not produce Equity + loans until May 1996.
The Company did not produce Home Equity loans until December 1997.
(2) During fiscal 1996 and the first two quarters of fiscal 1997, the processing
and payment of claims filed with HUD was delayed. Claims paid by HUD during
fiscal 1998 totaled $8.8 million.
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<PAGE> 84
(3) Represents the dollar amount of delinquent Title I loans net of delinquent
Title I loans for which claims have been filed with HUD and payment is
pending as a percentage of the total dollar amount of Title I loans serviced
by the Company (including loans owned by the Company) as of the dates
indicated.
(4) Represents the dollar amount of delinquent Title I loans for which claims
have been filed with HUD and payment is pending as a percentage of the total
dollar amount of Title I loans serviced by the Company (including loans
owned by the Company) as of the dates indicated.
(5) If all claims filed with HUD had been processed and paid as of August 31,
1998, the amount of FHA insurance available for all serviced Title I loans
would have been reduced to $8.9 million, which as a percentage of Title I
loans serviced would have been 4.2%.
(6) Represents the dollar amount of delinquent loans net of delinquent Title I
loans for which claims have been filed with HUD and payment is pending as a
percentage of the total dollar amount of loans serviced by the Company
(including loans owned by the Company) as of the dates indicated.
(7) Represents the dollar amount of delinquent Title I loans for which claims
have been filed with HUD and payment is pending as a percentage of the total
dollar amount of total loans serviced by the Company (including loans owned
by the Company) as of the dates indicated.
(8) On Title I loans, a loss is recognized upon receipt of payment of a claim or
final rejection thereof. Claims paid in a period may relate to a claim filed
in an earlier period. Since the Company commenced its Title I lending
operations in March 1994, there has been no final rejection of a claim by
the FHA. Aggregate losses on liquidated Title I loans related to 1,227 Title
I insurance claims made by the Company, as servicer, since commencing
operations through August 31, 1998. Losses on Title I loans liquidated will
increase as the balance of the claims are processed by HUD. The Company has
received an average payment from HUD equal to 90% of the outstanding
principal balance of such Title I loans, plus appropriate interest and
costs.
(9) Excludes approximately $9.4 million of Equity + loans to be repurchased at
August 31, 1998.
SALE OF LOANS
The Company has historically sold on a servicing-retained basis a
substantial majority of all loans it produced in securitization transactions.
The balance was sold for cash servicing released to institutional purchasers.
Currently, sales on a servicing-released basis, and some sales on a
servicing-retained basis, are sold at a premium to their principal balance. As
part of the sale of loans in securitization transactions, senior securities in
the related securitization are sold to institutional purchasers with a junior
subordinated interest in the transaction retained by or issued to the Company as
a mortgage related security. As part of its business strategy, the Company
intents to sell its loan production in the secondary market to institutional
purchasers for cash premiums and reduce its historically dependence on
securitization transactions as a method to sell loans. The Company will also
attempt to reduce the acquisition premiums paid to its network of mortgage
bankers of Equity + and Home Equity loans. During the year ended August 30,
1997, these cash acquisition premiums totaled $18.0 million or approximately
3.5% of the Company's total loan production and, for the year ended August 31,
1998, these premiums totaled $13.7 million or approximately 4.1% of the
Company's total loan production.
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<PAGE> 85
Pursuant to the Flow Purchase Agreement entered into as part of the
recapitalization, the Company agreed to sell, and Sovereign Bancorp agreed to
buy, $100.0 million principal amount of Home Equity and Equity + loans, on a
quarterly basis, commencing in the calendar quarter beginning January 1, 1999.
Up to $200.0 million of the $400.0 million in principal amount of the loans the
Company is required to sell to Sovereign Bancorp on an annual basis can be
Equity + loans. The Flow Purchase Agreement, which is renewable every six
months, expires on December 31, 1998, but is renewable for additional six-month
periods until September 2001. Sovereign Bancorp has the exclusive right to
acquire the first $100 million of mortgage loans produced by the Company each
quarter during the term of the Flow Purchase Agreement. The Flow Purchase
Agreement does not require the Company to sell loans to Sovereign Bancorp at a
loss.
When the Company completed the recapitalization, the Company terminated its
existing master purchase agreement with a financial institution in which the
financial institution agreed to purchase up to $2.0 billion of loans over a
five-year period ending in September 2001. For a description of the risks to the
Company from the Flow Purchase Agreement with Sovereign Bancorp, see "Risk
Factors -- Liquidity Risks" earlier in this prospectus. For additional details
of the master purchase agreement that was terminated, see "Certain Transactions"
later in this prospectus.
The following table sets forth certain data regarding loans securitized or
sold by the Company during the periods indicated with servicing retained, and
excluding loans sold with servicing released:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED AUGUST 31,
-------------------------------
1996 1997 1998
-------- -------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Principal amount of loans sold................... $137,908 $462,318 $ 181,931
Gain (loss) on sales of loans(1)................. 16,539 45,123 (26,578)
Net unrealized gain (loss) on mortgage related
securities..................................... 2,697 3,518 (70,024)
Weighted-average stated interest rate on loans
sold(2)........................................ 14.09% 13.91% 11.77%
Weighted-averaged pass-through interest rate on
loans sold(2).................................. 7.50 7.36 6.77
Weighted-average excess spread retain on loans
sold(2)
6.59 6.55 5.00
</TABLE>
- -------------------------
(1) Excludes gain on sale of $2.0 million relating to whole loan sales with
servicing released of $59.2 million during the year ended August 31, 1997.
Excludes gain on sale of $2.3 million relating to whole loan sales with
servicing released of $160.1 million during the year ended August 31, 1998.
(2) Includes all loans sold with servicing released or servicing retained.
COMPETITION
The Company faces intense competition in the business of originating and
selling Home Equity loans and, to a lesser extent, Equity + loans. The Company's
competitors include other consumer finance companies, mortgage banking
companies, commercial banks, credit unions, thrift institutions, credit card
issuers and insurance companies. Many of these entities are substantially
larger, have lower costs of capital and have considerably greater financial,
technical and marketing resources than the Company. In addition, many
84
<PAGE> 86
of the financial services organizations that are much larger than the Company
have formed national loan production networks offering loan products that are
substantially similar to the Company's loan programs. The Company believes that
Conti Mortgage Corp., The Money Store, First Plus Financial Group, Associates
First Capital Corporation, and Household Finance Corporation are some of its
largest direct competitors. The Company competes principally by providing
prompt, professional service to its mortgage bankers, brokers and retail
customers and, depending on circumstances, by providing competitive lending
rates.
Competition among industry participants can take many forms, including
convenience in obtaining a loan, customer service, marketing and distribution
channels, amount and term of the loan, loan origination fees and interest rates.
Additional competition may lower the rates the Company can charge borrowers,
potentially lowering the gain on future loan sales. The Company may face
competition from, among others, government-chartered entities, such as FNMA,
FHLMA, and GNMA. The Company's competitors may expand their existing or new loan
purchase programs to include Home Equity loans. Entries of government-sponsored
entities into the Home Equity loan market could lower the interest rates the
Company is able to charge its borrowers and reduce or eliminate premiums on loan
sales. To the extent any of these competitors significantly expand their
activities in the Company's market, the Company could be materially adversely
affected. Fluctuations in interest rates and general economic conditions may
also affect the Company's competition. During periods of rising rates,
competitors that have locked in low borrowing costs may have a competitive
advantage. During periods of declining rates, competitors may solicit the
Company's customers to refinance their loans. See "Risk Factors -- Competition"
located earlier in this prospectus.
If the Company is unable to remain competitive in these areas, the volume
of the Company's loan production may be materially adversely affected as
borrowers seek out other lenders for their financing needs. Lower loan
production may have an adverse effect on the Company's ability to negotiate and
obtain sufficient financing under warehouse lines of credit upon acceptable
terms. Establishing a broker-sourced loan business typically requires a
substantially smaller commitment of capital and personnel resources than a
direct-sourced loan business. This relatively low barrier to entry permits new
competitors to enter the broker-sourced loan market quickly, particularly
existing direct-sourced lenders which can draw upon existing branch networks and
personnel in seeking to sell products through independent brokers. Competition
may be affected by fluctuations in interest rates and general economic
conditions. During periods of rising rates, competitors which have locked in low
borrowing costs may have a competitive advantage.
The Company has historically been dependent on certain of its competitors
to purchase loans not purchased by Sovereign Bancorp. If such competitors
refrained from purchasing the Company's loans and the Company were unable to
replace such purchasers, the Company's financial condition and results of
operations could be materially adversely affected. The Flow Purchase Agreement
between the Company and Sovereign Bancorp is expected to alleviate this
situation. See "-- Sale of Loans" located earlier in this prospectus. The
Company continues to seek other purchasers who are not competitors of the
Company.
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<PAGE> 87
GOVERNMENT REGULATION
The Company's lending activities are subject to the Truth in Lending Act
and Regulation Z (including the Home Ownership and Equity Protection Act of
1994), the Equal Credit Opportunity Act and Regulation B, the Fair Credit
Reporting Act, as amended, the Real Estate Settlement Procedures Act and
Regulation X, the Home Mortgage Disclosure Act of 1975, the Fair Debt Collection
Practices Act and the Fair Housing Act, as well as other federal and state
statutes and regulations affecting the Company's activities. Failure to comply
with these requirements can lead to loss of approved status, termination or
suspension of servicing contracts without compensation to the servicer, demands
for indemnifications or mortgage loan repurchases, certain rights of rescission
for mortgage loans, class action lawsuits and administrative enforcement
actions.
The Company is subject to the rules and regulations of, and examinations
by, HUD, FHA and other federal and state regulatory authorities with respect to
originating, underwriting, funding, acquiring, selling and to the extent that it
engages in servicing activities, to servicing consumer and mortgage loans. In
addition, there are other federal and state statutes and regulations affecting
the Company's activities. These rules and regulations, among other things,
impose licensing obligations on the Company, establish eligibility criteria for
loans, prohibit discrimination, provide for inspection and appraisals of
properties, require credit reports on prospective borrowers, regulate payment
features and, in some cases, fix maximum interest rates, fees and loan amounts.
The Company is required to submit annual audited financial statements to various
governmental regulatory agencies that require the maintenance of specified net
worth levels. The Company's affairs are also subject to examination, at all
times, by the Federal Housing Commissioner to assure compliance with FHA
regulations, policies and procedures.
Although the Company is no longer originating a significant volume of Title
I Loans, the Company is a HUD approved Title I mortgage lender and is subject to
the supervision of HUD. In addition, the Company's operations are subject to
supervision by state authorities (typically state banking or consumer credit
authorities), many of which generally require that the Company be licensed to
conduct its business. This normally requires state examinations and reporting
requirements on an annual basis.
The Federal Consumer Credit Protection Act ("FCCPA") requires a written
statement showing an annual percentage rate of finance charges and requires that
other information be presented to debtors when consumer credit contracts are
executed. The Fair Credit Reporting Act requires certain disclosures to
applicants concerning information that is used as a basis for denial of credit.
The Equal Credit Opportunity Act prohibits discrimination against applicants
with respect to any aspect of a credit transaction on the basis of sex, marital
status, race, color, religion, national origin, age, derivation of income from
public assistance program, or the good faith exercise of a right under the
FCCPA.
The interest rates which the Company may charge on its loans are subject to
state usury laws, which specify the maximum rate which may be charged to
consumers. In addition, both federal and state truth-in-lending regulations
require that the Company disclose to its customers prior to execution of the
loans, all material terms and conditions of the financing, including the payment
schedule and total obligation under the loans. The Company believes that it is
in compliance in all material respects with such regulations.
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<PAGE> 88
SEASONALITY
The Company's production of Home Equity and Equity + loans is seasonal to
the extent that borrowers used the proceeds for home improvement contract work.
The Company's production of loans for this purpose tends to build during the
spring and early summer months, particularly where the proceeds are used for
pool installations. A decline is typically experienced in late summer and early
fall until temperatures begin to drop. This change in seasons precipitates the
need for new siding, window and insulation contracts. Peak volume is experienced
in November and early December and declines dramatically from the holiday season
through the winter months. While the Company does not have substantial
experience making loans to borrowers who intend to use the proceeds to purchase
a residence, management believes that the market for such loans will follow the
home sale cycle, higher in the spring through early fall than during the
remainder of the year.
EMPLOYEES
As of May 31, 1999, the Company had 78 employees. None of the Company's
employees is represented by a collective bargaining agreement. The Company
believes that its relations with its employees are satisfactory.
PROPERTIES
The Company leases 45,950 square feet of office space at 1000 Parkwood
Circle, Atlanta, Georgia, consisting of two full floors. The Company's corporate
headquarters have been consolidated into 22,975 square feet, consisting of one
floor at this location. The Company has subleased the other floor at this
location. The Company's lease is for an initial six-year term expiring August
2002 with a conditional option to extend the term to August 2007. The Company is
searching for alternative space for its corporate headquarters. If it finds
space, the Company expects to sublease the presently occupied space and relocate
its corporate headquarters. In addition, as of December 11, 1998 the Company
also leased office space on short-term or month-to-month leases in Phoenix,
Arizona; Dublin, California; Denver, Colorado; Tallahassee, Florida; Elmhurst,
Illinois; Woburn, Massachusetts; Waterford, Michigan; Blue Springs, Missouri;
Waldwick, New Jersey; Las Vegas, Nevada; Patchogue, New York; Columbus, Ohio;
Bridgeville, Pennsylvania; Brentwood, Tennessee; Austin, Texas; Seattle,
Washington; and Atlanta, Georgia. The Company believes that all of its
facilities are suitable and adequate for the current conduct of its operations.
LEGAL PROCEEDINGS
On October 8, 1998, the Office of the Consumer Credit Commissioner of the
State of Texas issued a denial of the Company's application for licensing as a
secondary mortgage lender. On October 20, 1998, the Company filed an appeal of
the Commissioner's decision. As a result of settlement terms reached with the
Commissioner on May 13, 1999, the Company's secondary mortgage license
application remains valid and pending.
On February 23, 1998, an action was filed in the United States District
Court for the Northern District of Georgia by Robert J. Feeney, as a purported
class action against the Company and Jeffrey S. Moore, the Company's former
President and Chief Executive Office. The complaint alleges, among other things,
that the defendants violated the federal
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<PAGE> 89
securities laws in connection with the preparation and issuance of certain of
the Company's financial statements. The named plaintiff seeks to represent a
class consisting of purchasers of the Common Stock between April 11, 1997 and
December 18, 1997, and seeks damages in an unspecified amount, costs, attorney's
fees and such other relief as the court may deem proper. On June 30, 1998, the
plaintiff amended the complaint to add additional plaintiffs, to add as a
defendant Mego Financial, the Company's former parent, and to extend the class
period through and including May 20, 1998. On September 18, 1998, the company,
Jeffrey S. Moore and Mego Financial filed motions to dismiss the complaint. On
April 8, 1999, the court granted each of these motions,. In the court's order
dismissing the complaint, the plaintiffs were permitted, upon proper motions, to
serve and file a second amended and redrafted complaint within 30 days. On May
10, 1999, the Plaintiffs moved for leave to file and serve the second amended
and redrafted complaint contemplated in the earlier order. On July 19, 1999, the
Company, Jeffrey S. Moore and Mego Financial filed motions to dismiss the second
amended and redrafted complaint. The Company believes that it has meritorious
defenses to this lawsuit and that resolution of this matter will not result in a
material adverse effect on the business or financial condition of the Company.
In the ordinary course of its business, the Company is, from time to time,
named in lawsuits. The Company believes that resolution of these matters will
not have a material adverse effect on the business or financial condition of the
Company.
RECENT DEVELOPMENTS
On July 7, 1999 the Company announced the execution of a definitive
purchase agreement to acquire 100% of the outstanding stock of The Money Centre,
Inc. based in Charlotte, North Carolina.
On July 15, 1999, Altiva Financial closed its previously announced purchase
of 100% of the outstanding stock of The Money Centre, Inc. The principal
components of the purchase price for the acquisition by the company were
$7,000,000 of cash, $3 million of the Company's common stock (600,000 shares
valued at $5 per share), $2.1 million in the forgiveness of debt, $1.3 million
in various contractual obligations, and 20% of the pre-tax net cash flow of the
acquired company through May 2003 up to a maximum of $6.6 million as defined in
the purchase agreement.
Effective July 30, 1999 Wm. Paul Ralser resigned as President, Chief
Operating Officer and as a Director of Altiva in order to pursue other
interests.
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<PAGE> 90
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth certain information with respect to the
directors and executive officers of the Company as of April 1, 1999.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Champ Meyercord........................... 58 Chairman of the Board and Chief
Executive Officer
J. Richard Walker......................... 51 Executive Vice President and Chief
Financial Officer
Spencer I. Browne......................... 48 Director
Hubert M. Stiles.......................... 51 Director
David J. Vida, Jr......................... 32 Director
John D. Williamson, Jr.................... 63 Director
</TABLE>
Edward B. "Champ" Meyercord has been Chairman and Chief Executive Officer
of the Company since July 1998 and, prior thereto, he was a special consultant
to the Company since May 1998. From 1994 to 1998, Mr. Meyercord was a senior
investment banker with Greenwich Capital Markets, most recently as a co-head of
the Mortgage and Asset Backed Finance Group. In addition to his involvement with
asset backed securities, Mr. Meyercord was involved in the development of
financing vehicles for specialty finance companies. Greenwich Capital Markets
has performed investment banking services for the Company since 1994. Prior to
1994, Mr. Meyercord was a co-managing partner of Hillcrest Partners, a private
investment bank specializing in mergers and acquisitions for financial
institutions. Mr. Meyercord is a member of the Board of Directors of The
National Home Equity Mortgage Association.
J. Richard Walker has been Executive Vice President and Chief Financial
Officer of the Company since October 1998. Since 1988, Mr. Walker has been a
principal of Walker & Mikloucich, P.C., an accounting firm. Since 1986, Mr.
Walker has been managing director of Vulcan Capital, Inc., formerly TVG
Associates, Inc., a business advisory services firm.
Spencer I. Browne has been a Director of the Company since consummation of
the initial public offering in November 1996. For more than five years prior to
September 1996, Mr. Browne held various executive and management positions with
several publicly traded companies engaged in businesses related to the
residential and commercial mortgage loan industry. From August 1988 until
September 1996, Mr. Browne served as President, Chief Executive Officer and a
Director of Asset Investors Corporation ("AIC"), a New York Stock Exchange
("NYSE") traded company he co-founded in 1986. He also served as President,
Chief Executive Officer and a Director of Commercial Assets, Inc., an American
Stock Exchange traded company affiliated with AIC, from its formation in October
1993 until September 1996. In addition, from June 1990 until March 1996, Mr.
Browne served as President and a Director of M.D.C. Holdings, Inc., a NYSE
traded company and the parent company of a major home builder in Colorado.
Hubert M. Stiles, Jr. Mr. Stiles has been a Director of the Company since
July 1998. Since September 1996, Mr. Stiles has been a money manager for and
President of T. Rowe Price Recovery Fund II Associates, L.L.C. Mr. Stiles has
been Vice President of
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<PAGE> 91
T. Rowe Price Associates, Inc. and a money manager for and President of T. Rowe
Price Recovery Fund Associates, Inc. since May 1988.
David J. Vida, Jr. Mr. Vida has been a Director of the Company since June
1998. Since July 1996, Mr. Vida has been President of City Mortgage Services, a
division of City National Bank. Mr. Vida served as Chief Financial Officer of
Prime Financial Corp. from June 1994 until June 1996. From January 1992 to June
1996, Mr. Vida was a Senior Accountant for KPMG Peat Marwick LLP.
John D. Williamson, Jr. has been a Director of the Company since September
1998. Since January 1997, Mr. Williamson has been practicing law as a sole
practitioner, focusing on consulting, mediation and expert witnesses. From 1976
to January 1997, Mr. Williamson worked in various capacities at Transport Life
Insurance Company (a subsidiary of Travelers Group, Inc.) including Vice
Chairman of the Board from 1995 to 1997 and Chairman of the Board from 1995 to
1998.
The Company's officers are elected annually by the Board of Directors and
serve at the discretion of the Board of Directors. The Company's directors hold
office until the next annual meeting of stockholders and until their successors
have been duly elected and qualified. The Company reimburses all directors for
their expenses in connection with their activities as directors of the Company.
Directors of the Company who are also employees of the Company do not receive
additional compensation for their services as directors. Members of the Board of
Directors of the Company who are not employees of the Company receive an annual
retainer fee of $30,000 plus $1,500 for chairing a committee or $1,000 for
serving as a member of a committee. In addition, each director receives $1,000
for each Board or committee meeting (but only $500 for a committee meeting held
on the same day as a board meeting). Directors are also reimbursed for their
expenses incurred in attending meetings of the board of directors and its
committees.
The board of directors has delegated certain functions to the following
standing committees:
Audit Committee. The Audit Committee's functions include recommending to
the board the engagement of the Company's independent certified public
accountants, reviewing with the accountants the plan and results of their audit
of the Company's financial statements and determining the independence of the
accountants. The Audit Committee held six meetings in fiscal 1998. The Audit
Committee is currently composed of Messrs. Stiles, Browne and Vida.
Compensation Committee. The Compensation Committee has the authority to
approve the compensation of the Company's executive officers. The Compensation
Committee held three meetings in fiscal 1998. Currently, the Compensation
Committee consists of Messrs. Williamson and Browne.
Nominating Committee. During fiscal 1998, the Nominating Committee had the
responsibility to recommend the nominees for election as Directors of the
Company to the Board of Directors. The Nominating Committee met one time during
fiscal 1998. The Company currently does not maintain a nominating committee.
Plan Committee. The Plan Committee was established in January 1999 to
administer the Plan. The Plan Committee is currently composed of Messrs. Stiles
and Williamson.
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<PAGE> 92
EXECUTIVE COMPENSATION
The following table sets forth information concerning the annual and
long-term compensation earned by the Company's chief executive officer and the
other executive officer as of August 31, 1998 whose annual salary and bonus
during fiscal 1998 exceeded $100,000 (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
ANNUAL ------------
COMPENSATION NUMBER OF
FISCAL ------------------- OTHER ANNUAL OPTIONS ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION(1) GRANTED(2) COMPENSATION(3)
- --------------------------- ------ -------- -------- --------------- ------------ ---------------
<S> <C> <C> <C> <C> <C> <C>
Champ Meyercord(4)....... 1998 $ 63,462 $ -- $ -- 481,859 $ --
Chairman of the 1997 -- -- -- -- --
Board and Chief 1996 -- -- -- -- --
Executive Officer
James L. Belter(5)....... 1998 $212,519 $100,000(6) $ 9,919 -- $135,868
Executive Vice 1997 180,003 100,000(6) 15,896 10,000 --
President and 1996 159,080 50,000(6) 4,330 -- --
Treasurer
</TABLE>
- -------------------------
(1) Other annual compensation consisted of car allowances, contributions to
401(k) plans and moving expenses.
(2) See "-- Employment Agreements" and "-- Company Stock Option Plans" below.
(3) All other compensation consisted of funds received from the Company to
repurchase outstanding SARs and stock options.
(4) Mr. Meyercord became Chief Executive Officer of the Company in August 1998.
(5) Mr. Belter resigned from the Company on November 30, 1998.
(6) Bonuses paid to Mr. Belter during fiscal years 1996 and 1997 were
discretionary bonuses determined by the board of directors. The bonus paid
during fiscal 1998 was paid pursuant to an employment contract entered into
with Mr. Belter in August 1997.
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<PAGE> 93
The following table sets forth certain information concerning grants of
stock options made during the fiscal year ended August 31, 1998 to the Named
Executive Officers.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
------------------------------------------------- POTENTIAL REALIZABLE VALUE
PERCENT OF AT ASSUMED ANNUAL RATES
NUMBER OF TOTAL OF STOCK PRICE
SECURITIES OPTIONS APPRECIATION FOR OPTION
UNDERLYING GRANTED TO EXERCISE TERM
OPTIONS EMPLOYEES IN PRICE EXPIRATION ---------------------------
NAME GRANTED(#) FISCAL YEAR ($/SH) DATE 5%($) 10%($)
- ---- ---------- ------------ -------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Champ Meyercord...... 481,859 80.1% $15.00 06/29/08 $11,773,465 $18,747,276
Chairman of the
Board and Chief
Executive Officer
James L. Belter...... -- -- -- -- -- --
Executive Vice
President and
Treasurer(1)
</TABLE>
- -------------------------
(1) Mr. Belter resigned from the Company on November 30, 1998.
The following table sets forth certain information concerning unexercised
stock options held by the Named Executive Officers as of August 31, 1998. No
stock options were exercised by the Named Executive Officers during the fiscal
year ended August 31, 1998. See "-- Company Stock Option Plans."
AGGREGATED FISCAL YEAR-END OPTION VALUE TABLE
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS HELD AT HELD AT
AUGUST 31, 1998 AUGUST 31, 1998(1)
--------------------------- ---------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Champ Meyercord.................. -- 481,859 $ -- $144,558
James L. Belter(2)............... 2,000 8,000 -- --
</TABLE>
- -------------------------
(1) The closing sales price of the Company's common stock as reported on the
Nasdaq Stock Market on August 31, 1998 was $15.30, as adjusted to reflect
the one-for-ten reverse stock split. All options held by Mr. Belter as of
August 31, 1998 were granted at exercise prices in excess of such market
price.
(2) Mr. Belter resigned from the Company on November 30, 1998.
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<PAGE> 94
EMPLOYMENT AGREEMENTS
On June 23, 1998, the Company entered into an employment agreement with
Champ Meyercord pursuant to which Mr. Meyercord became the Chairman of the Board
and Chief Executive Officer of the Company. The Company and Mr. Meyercord
elected to renegotiate the original employment agreement and entered into a new
employment agreement (the "Meyercord Agreement") on February 12, 1999. The
initial term of the Meyercord Agreement terminates on December 31, 2001 and the
agreement will continue on a year-to-year basis unless terminated by either
party. The Meyercord Agreement provides for an initial annual base salary of
$300,000. From the date of the Meyercord Agreement until December 31, 1998, Mr.
Meyercord is entitled to a bonus of at least $250,000. For each subsequent
calendar year during the term of the agreement, Mr. Meyercord shall be entitled
to receive bonuses pursuant to a management incentive compensation plan for
senior management to be established by the Company. Pursuant to the Meyercord
Agreement Mr. Meyercord was granted options to purchase 481,859 shares of common
stock upon approval by the Company's stockholders of the 1999 Plan.
Upon termination of the agreement for "cause," Mr. Meyercord will be
entitled to receive his base salary through the effective date of termination
and any determined but unpaid incentive compensation for any bonus period ending
on or before the date of termination. In the event of his termination by the
Company "without cause" or his voluntary termination on six months notice, Mr.
Meyercord will be entitled to (1) any unpaid base salary through the date of
termination, (2) accrued but unpaid incentive compensation, if any, for the
bonus period ending on or before the date of termination, (3) the continuation
of any benefits through the expiration of the Meyercord Agreement and (4) the
payment, through the date of expiration of the Meyercord Agreement, of his base
salary and incentive compensation (in an amount equal to the incentive
compensation paid to Mr. Meyercord for the calendar year immediately preceding
termination). In the event of a change of control of the Company accompanied
within two years by either (1) termination of Mr. Meyercord's employment by the
Company "without cause" or (2) Mr. Meyercord's voluntarily termination for "good
reason," Mr. Meyercord will be entitled to the amounts receivable upon a
termination "without cause." In addition, upon a change of control any vested
stock options granted to Mr. Meyercord will accelerate and become immediately
vested. The Meyercord Agreement contains a non-competition provision that
generally prohibits Mr. Meyercord from competing with the Company during his
employment by the Company and for the lesser of the two-year period following
the termination of his employment for any reason or the period of time during
which Mr. Meyercord is entitled to continuing payments from the Company due to a
termination of the Meyercord Agreement due to disability, voluntary termination,
termination "without cause" or change of control of the Company.
During fiscal 1998, James Belter, the Company's Executive Vice President
and Chief Financial Officer until November 30, 1998, was employed pursuant to an
employment agreement entered into in August 1997. The employment agreement
provided that Mr. Belter was entitled to receive discretionary performance
bonuses based on factors determined by the Committee and the board of directors
in accordance with the Company's executive bonus pool program. Notwithstanding
the foregoing, Mr. Belter was guaranteed to receive a bonus of $100,000 for each
of the first two years of his employment agreement.
The Company intends to enter into employment agreements with certain other
members of senior management, including Mr. Walker.
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<PAGE> 95
COMPANY STOCK OPTION PLANS
1996 Plan
Under the Company's 1996 Employee Stock Option Plan (the "1996 Plan"),
1,000 shares of common stock remain reserved for issuance upon exercise of stock
options. The 1996 Plan was designed as a means to retain and motivate key
employees and directors. The board of directors, or a committee thereof,
administers and interprets the 1996 Plan and is authorized to grant options
thereunder to all eligible employees and directors of the Company, except that
no incentive stock options (as defined in Section 422 of the Code) may be
granted to a director who is not also an employee of the Company or a
subsidiary. The 1996 Plan provides for the granting of both incentive stock
options and nonqualified stock options. Options may be granted under the 1996
Plan on such terms and at such prices as determined by the board of directors,
or a committee thereof, except that the per share exercise price of incentive
stock options cannot be less than the fair market value of the common stock on
the date of grant. Each option is exercisable after the period or periods
specified in the related option agreement, but no option may be exercisable
after the expiration of ten years from the date of grant. Options granted to an
individual who owns (or is deemed to own) at least 10% of the total combined
voting power of all classes of stock of the Company must have an exercise price
of at least 110% of the fair market value of the common stock on the date of
grant and a term of no more than five years. The 1996 Plan also authorizes the
Company to make or guarantee loans to optionees to enable them to exercise their
options. Such loans must (1) provide for recourse to the optionee, (2) bear
interest at a rate no less than the prime rate of interest, and (3) be secured
by the shares of common stock purchased. The board of directors has the
authority to amend or terminate the 1996 Plan, provided that no such action may
impair the rights of the holder of any outstanding option without the written
consent of such holder, and provided further that certain amendments of the 1996
Plan are subject to stockholder approval. Unless terminated sooner, the 1996
Plan will continue in effect until all options granted thereunder have expired
or been exercised, provided that no options may be granted ten years after
commencement of the 1996 Plan. In connection with the spin-off of the Company,
all options outstanding under the 1996 Plan were converted into SARs in August
1997. In October 1997, the Company repurchased all SARs outstanding under the
1996 Plan.
1997 Plan
In August 1997, the Company's Board of Directors adopted the Company's 1997
Stock Option Plan (the "1997 Plan"). The 1997 Plan was approved by the
stockholders of the Company in June 1998. Under the 1997 Plan, as amended,
200,000 shares of common stock are reserved for issuance upon the exercise of
stock options and/or SARs. The board of directors, or a committee thereof,
administers and interprets the 1997 Plan and is authorized to grant options
and/or SARs thereunder to any person who has rendered services to the Company,
except that no incentive stock options may be granted to any person who is not
also an employee of the Company or any subsidiary. As of August 31, 1998, a
total of 120,000 options had been granted under the 1997 Plan, of which 6,325
were held by directors and executive officers.
1999 Plan
In February 1999, the Company's stockholders approved the Company's 1999
Incentive Stock Plan (the "1999 Plan"). 1,200,000 shares were reserved for
issuance under
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<PAGE> 96
the 1999 Plan. The 1999 Plan provides for the issuance of options and restricted
stock to certain of the Company's employees and outside directors and the
issuance of SARs to certain of the Company's key employees. The 1999 Plan is
administered by a committee of two or more of the Company's outside directors
each of whom must satisfy the requirements for a "non-employee" director under
Rule 16b-3 of the Securities Exchange Act of 1934 and an "outside director"
under Section 162(m) of the Code. No Key Employee of the Company (as defined in
the 1999 Plan) may be granted an option or SAR with respect to more than 150,000
shares of the Company's common stock, except that an option to purchase 481,859
shares of common stock may be granted to the Company's chief executive officer
in connection with the renegotiation of his June 23, 1998 employment agreement.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Company's Compensation Committee was formed by the board of directors
in August 1997. From September 1, 1997 until June 29, 1998, the Compensation
Committee was comprised of Robert Nederlander and Spencer I. Browne,
non-employee directors. From July 1, 1998 until November 14, 1998, the Company
did not have a Compensation Committee and compensation decisions were made by
the full Board of Directors. Champ Meyercord did not participate in decisions
regarding his specific employment by the Company. On November 14, 1998, Spencer
I. Browne and John D. Williamson, Jr. were appointed to the Compensation
Committee. See "Certain Transactions" located later in this prospectus.
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<PAGE> 97
PRINCIPAL STOCKHOLDERS
The following table sets forth, as of August 16, 1999, information with
respect to the beneficial ownership of the common stock by (1) each person known
by the Company to be the beneficial owner of more than 5% of the outstanding
shares of common stock, (2) each director of the Company, (3) each of the Named
Executive Officers, and (4) all directors and executive officers of the Company
as a group. Unless otherwise noted, the Company believes that all persons named
in the table have sole voting and investment power with respect to all shares of
common stock beneficially owned by them.
<TABLE>
<CAPTION>
NAME AND ADDRESS OF NUMBER OF SHARES PERCENTAGE
BENEFICIAL OWNER(1) BENEFICIALLY OWNED OWNERSHIP(2)
- ------------------- ------------------ ------------
<S> <C> <C>
DIRECTORS AND EXECUTIVE OFFICERS:
Champ Meyercord(3)................................ 163,120 4.3%
J. Richard Walker................................. -- *
Spencer I. Browne(4).............................. 21,558 *
Hubert M. Stiles, Jr.(5)(6)....................... 667,832 18.2%
David J. Vida, Jr.(6)............................. 1,166 *
John D. Williamson, Jr.(6)........................ 3,166 *
All executive officers and directors of the
Company as a group (6 persons).................. 856,842 22.3%
OTHER LARGE STOCKHOLDERS:
Value Partners, Ltd.(7)........................... 1,466,674 28,6%
City National Bank(8)............................. 1,333,336 26.7%
Sovereign Bancorp(9).............................. 1,333,336 26.7%
Friedman, Billings, Ramsey Group, Inc.(10)........ 974,245 23.8%
Emanuel J. Friedman(10)(11)....................... 666,666 18.2%
T. Rowe Price Recovery Fund II, L.P.(5)........... 667,832 18.2%
First Fidelity Bancorp, Inc.(12).................. 333,335 8.4%
Merrill Lynch Phoenix Fund, Inc................... 300,000 8.2%
Rodney D. Atkinson................................ 200,000 5.5%
</TABLE>
- -------------------------
* Less than 1%.
(1) A person is deemed to be the beneficial owner of securities that can be
acquired by such person within 60 days from the date of this prospectus
upon the exercise of options and warrants. Each beneficial owner's
percentage ownership is determined by assuming that options and warrants
that are held by such person (but not those held by any other person) and
that are exercisable within 60 days from the date of this prospectus have
been exercised. Unless otherwise stated, the address for each of the
following persons is 1000 Parkwood Circle, 6th Floor, Atlanta, Georgia
30339.
(2) Based on 3,656,666 shares of common stock outstanding as of August 16,
1999.
(3) Includes 160,620 shares issuable upon the exercise of currently outstanding
options.
(4) Includes 17,832 shares issuable upon the exercise of currently outstanding
options.
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<PAGE> 98
(5) The address of Mr. Stiles and T. Rowe Price Recovery Fund II, L.P. is 100
East Pratt Street, Baltimore, Maryland 21202. Represents shares
beneficially owned by T. Rowe Price Recovery Fund II, L.P., T. Rowe Price
Recovery Fund II Associates, L.L.C. and T. Rowe Price Associates, Inc. (of
which Mr. Stiles is a vice president). Mr. Stiles disclaims beneficial
ownership of these shares. Based on a Schedule 13G filed with the SEC on
July 10, 1998.
(6) Includes 1,166 shares issuable upon the exercise of currently outstanding
options.
(7) The address of Value Partners, Ltd. is 4514 Cole Avenue, Suite 808, Dallas,
Texas 75205. Represents shares issuable upon the conversion of 22,000
shares of preferred stock.
(8) City National Bank's address is 25 Gatewater Road, Charleston, West
Virginia 25313. Represents (i) 666,670 shares issuable upon conversion of
preferred stock and (ii) 666,666 shares issuable upon exercise of currently
outstanding options.
(9) Sovereign Bancorp's address is 1130 Berkshire Boulevard, P.O. Box 12646,
Reading, Pennsylvania 19612. Represents (i) 666,670 shares issuable upon
conversion of preferred stock and (ii) 666,666 shares issuable upon
exercise of currently outstanding options.
(10) The address of Friedman, Billings, Ramsey Group, Inc. ("FBRG") is 1001 19th
Street North, Arlington, Virginia 22209. As of March 31, 1999, FBRG,
through its two wholly-owned subsidiaries Friedman, Billings, Ramsey
Investment Management, Inc. ("Investment Management") and Orkney Holdings,
Inc. ("Orkney"), had sole voting and dispositive power with respect to
535,910 shares of common stock. This number does not include 666,666 shares
of common stock owned by Emanuel J. Friedman, as to which FBRG disclaims
beneficial ownership. Investment Management serves as general partner and
discretionary investment manager for FBR Ashton, L.P. ("Ashton") which, as
of March 31, 1999, owned 4,450 shares of preferred stock (which are
convertible into 296,668 shares of common stock). Investment Management
also serves as discretionary manager for FBR Opportunity Fund, Ltd.
("Opportunity Fund") which, as of March 31, 1999, owned 90,680 shares of
common stock. Orkney is a wholly-owned subsidiary of FBRG which, as of
March 31, 1999, owned 445,230 shares of common stock and 2,125 shares of
preferred stock (which are convertible into an aggregate of 141,667 shares
of common stock). Each of FBRG, Ashton, Investment Management, Opportunity
Fund and Orkney disclaims beneficial ownership of the shares of common
stock owned by the other four entities. In addition, Emanuel J. Friedman,
Eric F. Billings and W. Russell Ramsey are each control persons with
respect to FBRG.
(11) Mr. Friedman's address is 1001 19th Street, Arlington, Virginia 22209.
Excludes 535,910 shares beneficially owned by FBRG, as to which Mr.
Friedman disclaims beneficial ownership. Mr. Friedman has notified the
Company that, until the earlier of (i) the first date on which he, together
with FBR and its affiliates, holds shares of common stock representing less
than 20% of the total issued and outstanding common stock or (ii) the date
on which he deposits his shares of common stock in a voting trust to be
voted by an unaffiliated third party, he waives the right to vote his
shares of common stock.
(12) The address of First Fidelity Bancorp, Inc. is 2601 Main Street, Suite 100,
Irvine, California 72614. Represents shares issuable upon conversion of
preferred stock.
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<PAGE> 99
SELLING STOCKHOLDERS
The following table assumes that each selling stockholder is offering for
sale securities previously issued by the Company. The Company has agreed to pay
all expenses in connection therewith (other than brokerage commissions and fees
and expenses of their respective counsel). None of the selling stockholders has
ever held any position with the Company or had any other material relationship
with the Company, except that certain of the selling stockholders are also
Principal Stockholders of the Company as described under "The Recapitalization",
"Principal Stockholders" and "Certain Transactions."
The following table sets forth the beneficial ownership of the shares of
common stock of each person who is a selling stockholder. The Company will not
receive any proceeds from the sale of the common stock by the selling
stockholders.
<TABLE>
<CAPTION>
PERCENTAGE
OWNERSHIP(2)
-------------------
NUMBER OF SHARES NUMBER OF SHARES BEFORE AFTER
NAME OF SELLING STOCKHOLDER(1) BENEFICIALLY OWNED OFFERED HEREBY OFFERING OFFERING
- ------------------------------ ------------------ ---------------- -------- --------
<S> <C> <C> <C> <C>
Value Partners, Ltd.(3).............. 1,466,674 1,466,674 28.6% 0
City National Bank(4)................ 1,333,336 1,333,336 26.7% 0
Sovereign Bancorp Inc.(4)............ 1,333,336 1,333,336 26.7% 0
Friedman, Billings, Ramsey Group,
Inc.(5)............................ 974,245 456,668 11.6% 0
Emanuel J. Friedman(6)............... 666,666 666,666 18.2% 0
T. Rowe Price Recovery Fund II,
L.P. .............................. 666,666 666,666 18.2% 0
First Fidelity Bancorp, Inc.(3)...... 333,335 333,335 8.4% 0
Merrill Lynch Phoenix Fund, Inc. .... 300,000 300,000 8.2% 0
Continental Casualty Company(3)...... 266,668 266,668 6.8% 0
West Broadway Partners, LP(3)........ 39,000 39,000 * 0
Rath Foundation, Inc.(3)............. 25,333 25,333 * 0
ITLA Capital Corporation............. 25,000 25,000 * 0
West Broadway Securities, LTD(3)..... 18,200 18,200 * 0
Thomas Baer and Michelle Baer(3)..... 13,333 13,333 * 0
James R. Sanger(3)................... 13,333 13,333 * 0
Marathon Associates, L.P. ........... 5,000 5,000 * 0
Dorothy S. Lockspeiser(3)............ 5,000 5,000 * 0
Peter E. and Dianne C. Spreadbury
Trust(7)........................... 3,333 3,333 * 0
J. Rock Tonkel, Jr.(7)............... 3,333 3,333 * 0
Premium Total Return
Portfolio -- Boston Partners Asset
Management(3)...................... 400 400 * 0
</TABLE>
- ---------------------
* Less than 1%.
(1) A person is deemed to be the beneficial owner of securities that can be
acquired by such person within 60 days from the date of this prospectus upon
the exercise of options and warrants. Each beneficial owner's percentage
ownership is determined by assuming that options and warrants that are held
by such person (but not those held
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<PAGE> 100
by any other person) and that are exercisable within 60 days from the date
of this prospectus have been exercised.
(2) Based on 3,056,666 shares of Common Stock outstanding as of April 20, 1998.
Assumes the sale of all shares being offered by the selling stockholder in
this prospectus.
(3) Represents shares issuable upon conversion of preferred stock.
(4) Represents (i) 666,670 shares issuable upon conversion of preferred stock
and (ii) 666,670 shares issuable upon exercise of currently outstanding
options.
(5) Represents shares held by Ashton and Orkney. Orkney is a wholly-owned
investment subsidiary of FBRG. FBR, a wholly-owned subsidiary of FBRG, was a
managing underwriter for the Company's IPO and its public offering of Old
Notes in November 1996. In addition, FBR acted as initial purchaser for the
Company's private placement of Current Notes in October 1997. 160,000 of the
shares offered hereunder were acquired by FBR as compensation for FBR's
service, in connection with the recapitalization, as placement agent for the
common stock and the Series A convertible preferred stock as well as
dealer-manager in connection with the Company's offer to exchange the Old
Notes for the Current Notes. FBR is also entitled to a cash fee in
connection with the recapitalization. FBR distributed the shares received to
FBRG, is corporate parent, and FBRG contributed the shares to Orkney. In
addition to the relationships set forth above, FBR is currently serving as
the Company's exclusive financial advisor, and FBR will be entitled to a
portion of the proceeds generated should the Company elect to proceed with a
stock purchase rights offering.
(6) Mr. Friedman is a control person with respect to Friedman, Billings, Ramsey
Group, Inc., which is the beneficial owner of 535,910 shares of common stock
or 17.5% of the issued and outstanding common stock, not including the
shares owned by Mr. Friedman.
(7) Peter E. Spreadbury and J. Rock Tonkel, Jr. are managing directors of FBR.
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<PAGE> 101
CERTAIN TRANSACTIONS
Listed below are transactions the Company has entered into with its
affiliates in the past three years. An "affiliate" generally is a person or
entity that is (1) "controlled by the Company," such as an officer of the
Company, (2) that "controls the Company" such as a director of a company, and in
the case of the Company, Mego Financial, the Company's former parent; or (3)
entities under "common control" with a company. PEC, a subsidiary of Mego
Financial, is an affiliate of Mego Financial because it is "controlled by" Mego
Financial, and is an affiliate of the Company, because the directors that
controlled the Company until the completion of the recapitalization also
controlled Mego Financial.
RELATIONSHIP WITH GREENWICH
Champ Meyercord, the Company's Chairman of the Board and Chief Executive
Officer, was formerly a senior investment banker at Greenwich Capital Markets
("Greenwich"). In October 1996, Greenwich agreed to purchase from the Company
$2.0 billion of loans over a five year period. The Company has sold Greenwich
approximately $800 million in loans from the inception of the agreement. The
agreement with Greenwich was terminated in June 1998 and the Company has no
further obligation under the agreement.
In April 1997, the Company entered into a pledge and security agreement
with Greenwich for an $11.0 million revolving credit facility. The amount which
could be borrowed under the agreement was increased to $15.0 million in June
1997 and to $25.0 million in July 1997. This facility is secured by a pledge of
certain of the Company's interest only and residual class certificates relating
to securitizations carried as mortgage related securities on the Company's
Statements of Financial Condition, payable to the Company pursuant to its
securitization agreements. As of August 31, 1998, approximately $10.0 million
was outstanding under the agreement. This agreement, which was originally
scheduled to mature in December 1998, was extended until December 1999.
TAX SHARING AND INDEMNITY AGREEMENT
For taxable periods up to the date of the spin-off, the Company's results
of operations were includable in the tax returns filed by Mego Financial's
affiliated group for federal income tax purposes. Under a tax allocation and
indemnity agreement with Mego Financial, the Company recorded a liability to
Mego Financial for federal income taxes calculated on a separate company basis.
Under a prior tax sharing arrangement with Mego Financial, the Company recorded
a liability to Mego Financial for federal income taxes applied to the Company's
financial statement income after giving consideration to applicable income tax
law and statutory rates. In addition, both the agreement and the arrangement
provided that the Company and Mego Financial each will indemnify the other under
certain circumstances. The Company no longer files consolidated returns with
Mego Financial's affiliated group. The Company believes that all obligations
under the tax sharing agreement have been satisfied.
MANAGEMENT SERVICES AGREEMENT WITH PEC
Until the recapitalization; PEC, a subsidiary of Mego Financial, supplied
the Company on an as-needed basis with certain executive, accounting, legal,
management information, data processing, human resources, advertising services
and promotional
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personnel of PEC provided services to the Company on an "as needed" basis. The
Company paid management fees to PEC in an amount equal to the direct and
indirect expenses of PEC related to the services supplied by its employees to
the Company, including an allocable portion of the salaries and expenses of
these employees based upon the percentage of time these employees spent
performing services for the Company. This arrangement was formalized on
September 1, 1996 by execution of a management agreement (the "Management
Agreement"), in which PEC agreed to provide management services to the Company
for an aggregate annual fee of approximately $967,000. Effective January 1,
1998, the annual fee payable by the Company under the Management Agreement was
reduced to $528,000. The Management Agreement was terminated on June 29, 1998.
For the years ended August 31, 1996, 1997 and 1998 and the nine months
ended May 31, 1998 and 1999, approximately $671,000, $967,000, $617,000,
$542,000 and $0, respectively, of the salaries and expenses of these employees
of PEC were attributable to and paid by the Company in connection with services
supplied by these employees to the Company. In addition, during the years ended
August 31, 1996 and 1997, the Company paid PEC for developing computer
programming, incurring costs of $56,000 and $0, respectively. During the year
ended August 31, 1998 and the nine months ended May 31, 1998 and 1999, these
costs were $0.
SUB-SERVICING AGREEMENT WITH PEC
Prior to September 1, 1996, PEC sub-serviced the Company's loans pursuant
to which it paid servicing fees of 50 basis points on the principal balance of
loans serviced per year. For the years ended August 31, 1996, 1997 and 1998 and
the nine months ended May 31, 1998 and 1999, the Company paid sub-servicing fees
to PEC of approximately $709,000, $1.9 million, $2.1 million, $1.8 million and
$0, respectively. The Company entered into a servicing agreement with PEC (the
"Servicing Agreement"), effective as of September 1, 1996, providing for the
payment of servicing fees of 50 basis points on the principal balance of loans
serviced per year. For the years ended August 31, 1996, 1997 and 1998 and the
nine months ended May 31, 1998 and 1999, the Company incurred interest expense
in the amount of $29,000, $16,000, $0, $0 and $0, respectively, related to fees
payable to PEC for these services. The interest rates were based on PEC's
average cost of funds and equaled 10.68% in 1996 and 10.48% in 1997. Effective
September 1, 1997, the servicing fees were reduced to 40 basis points per year
and effective January 1, 1998, the servicing fees were further reduced to 35
basis points per year. The Servicing Agreement has been terminated as the
mortgage servicing rights were transferred to City National Bank.
FUNDING AND GUARANTEES BY MEGO FINANCIAL
In order to fund the Company's past operations and growth, and in
conjunction with filing consolidated returns, the Company borrowed money from
Mego Financial. As of August 31, 1996, 1997 and 1998, the amount of intercompany
debt owed to Mego Financial was $12.0 million, $9.7 million and $0,
respectively. Prior to the initial public offering, Mego Financial had
guaranteed the Company's obligations under the Company's credit agreements and
an office lease. The guarantees of the Company's credit agreements were released
on the completion of the initial public offering. The Company did not pay any
compensation to Mego Financial for such guarantees.
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In November 1996, Greenwich agreed to purchase from the Company $2.0
billion of loans over a five year period. Pursuant to the agreement, Mego
Financial issued to Greenwich four-year warrants to purchase 1.0 million shares
of Mego Financial's common stock. The value of the warrants, estimated at $3.0
million (0.15% of the commitment amount) as of the commitment date (the "Warrant
Value") plus a $150,000 fee has been written off as the commitment for the
purchase of loans has been terminated.
On August 29, 1997, the Company and Mego Financial entered into the Payment
Agreement for the Company's repayment after the spin-off of (1) a portion of the
debt owed by the Company to Mego Financial as of May 31, 1997 and (2) debt owed
by the Company to Mego Financial as of August 31, 1997. Upon consummation of the
sale of the Old Notes in October 1997, $3.9 million was paid in accordance with
the Payment Agreement. In April 1998, the Company and Mego Financial entered
into an agreement (the "1998 Agreement") superseding the Payment Agreement.
Pursuant to the 1998 Agreement, the parties agreed to reduce the amounts owed to
Mego Financial and agreed to pay such amounts upon the occurrence of certain
events. In connection with the Recapitalization, the Company paid PEC $1.6
million to satisfy fully all amounts owed to Mego Financial pursuant to the
Payment Agreement and the 1998 Agreement, and the 1998 Agreement was terminated.
RELATIONSHIPS WITH FBR
FBR served as placement agent for the private placements pursuant to a
placement agreement (the "Placement Agreement"). Under the terms of the
Placement Agreement, the Company paid FBR a fee of 160,000 shares of common
stock equal to 6.0% of the gross proceeds received by the Company from the sale
of the shares of common stock and preferred stock in the recapitalization. The
gross proceeds did not include $10.0 million of Common Stock acquired by an
affiliate of FBR. In addition, the Company has agreed, pursuant to the Placement
Agreement, to indemnify FBR against certain liabilities, including liabilities
under the Securities Act, and other liabilities incurred in connection with the
recapitalization. In addition, the Company paid FBR an advisory fee of $416,667
in connection with the recapitalization.
FBR was a managing underwriter for the Company's initial public offering
and the Company's public offering of $40.0 million of the Old Notes, and was the
initial purchaser for the Company's private offering of another $40.0 million of
the Old Notes. FBR received compensation for such services and the Company
agreed to indemnify FBR against certain liabilities, including liabilities under
the Securities Act, and other liabilities arising in connection with such
offerings. In addition, FBR has in the past provided certain investment banking
services to the Company and affiliates of the Company.
THE RECAPITALIZATION
For a description of transactions with related parties in connection with
the recapitalization, see "The Recapitalization" located earlier in this
prospectus.
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DESCRIPTION OF NOTES
GENERAL
In the exchange offer, the Company issued $41.5 million aggregate principal
amount of Current Notes under an indenture together with shares of Series A
convertible preferred stock in exchange for $79.0 million of Old Notes. The
Current Notes mature on December 1, 2001 and are general unsecured obligations
of the Company, subordinated in right of payment to all senior indebtedness of
the Company. Interest on the Current Notes accrues at a rate of 12 1/2% per year
and is payable in cash semi-annually on June 1 and December 1 of each year.
Guarantees. The Current Notes are not guaranteed by any entity.
Subordination. The indebtedness represented by the Current Notes is
subordinated in right of payment to all existing and future senior indebtedness
of the Company, including without limitation, all obligations of the Company
under any Warehouse Facility, (as defined) and will be senior in right of
payment to all future indebtedness of the Company that by its terms is expressly
subordinated in right of payment to the Current Notes.
Redemption. The Current Notes are redeemable, in whole but not in part,
prior to maturity at the option of the Company at any time and from time to time
at a redemption price (expressed as a percentage of principal amount), (1) prior
to December 1, 1999, of 100% and (2) after December 1, 1999 but prior to
December 1, 2001, of 106%, in either case plus accrued and unpaid interest
(including added interest, if any) to the redemption date (subject to the right
of holders of record on the relevant record date to receive interest (including
added interest, if any) due on the relevant interest payment date).
Covenants. The Current Notes contain covenants limiting the incurrence of
certain indebtedness, liens, affiliate transactions, and merger and
consolidation.
REGISTRATION RIGHTS
The Company has entered into a registration rights agreement with FBR (the
"Current Notes Registration Rights Agreement") on behalf of the holders of the
Current Notes pursuant to which the Company has agreed, for the benefit of the
holders of the Current Notes, at the Company's cost, (1) to file a registration
statement (the "Current Notes Registration Statement") pursuant to which the
Company will offer to exchange notes (the "Current Notes Exchange Offer") for
registered notes ("New Notes") for Current Notes with the SEC on or before
December 15, 1998 and (2) to use its best efforts to cause the Current Notes
Registration Statement to be declared effective under the Securities Act on or
before March 15, 1999. The New Notes will have terms substantially identical in
all material respect to the Current Notes, except that the New Notes will not
contain terms with respect to transfer restrictions, registration rights or
interest rate increases as described herein. Promptly after the Current Notes
Registration Statement has been declared effective, the Company will offer the
New Notes in exchange for surrender of the Current Notes. The Company will keep
the Current Notes Exchange Offer open for not less than 30 days (or longer if
required by applicable law) after the date notice of the Current Notes Exchange
Offer is mailed to the holders of the Current Notes. For each Current Note
validly tendered to the Company pursuant to the Current Notes Exchange Offer and
not withdrawn by the holder thereof, the holder of such Current Note will
receive a New Note having a principal amount equal to that of the tendered
Current Note. Interest on each New Note will accrue from the last interest
payment date on which interest was paid on the tendered Current Note in exchange
therefor or, if no interest has been paid on such New Note, from the date of its
original issue.
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DESCRIPTION OF CAPITAL STOCK
GENERAL
The Company's authorized capital stock consists of 400,000,000 shares of
common stock, $.01 par value, and 5,000,000 shares of preferred stock, par value
$.01 per share. The following brief description of the Company's capital stock
is not complete and is subject in all respects to applicable law and the
provisions of the Company's Certificate of Incorporation and Bylaws, copies of
which have been filed or incorporated as exhibits in the Company's various
filings with the SEC and to the applicable provisions of the Delaware General
Corporation Law.
COMMON STOCK
The holders of common stock are entitled to one vote per share on all
matters to be voted on by the stockholders. Such stockholders do not have
cumulative voting rights in the election of directors. Subject to the rights of
any holders of preferred stock, holders of common stock are entitled to receive
ratably dividends, if any, as may be declared by the Board of Directors out of
funds legally available for dividend. For a description of the Company's
dividend policy see "Dividend Policy" located earlier in this prospectus. In the
event of any liquidation, dissolution or winding up of the Company, the holders
of the common stock would be entitled to receive, after payment or provision for
payment of all its debts and liabilities, all of the assets of the Company
available for distribution, subject to the rights of any holders of preferred
stock. The holders of common stock have no preemptive rights to subscribe for
additional shares of the Company and no right to convert their stock into other
securities. In addition, there are no redemption or sinking fund provisions
applicable to the common stock. All of outstanding shares of common stock are
fully paid and nonassessable.
PREFERRED STOCK
The Company has 5,000,000 shares of authorized preferred stock, of which
65,000 shares have been designated as Series A convertible preferred stock. The
Board of Directors is authorized to provide for the issuance of additional
classes and series of preferred stock out of remaining undesignated shares, and
the Board of Directors may establish the voting powers, designations,
preferences and relative, participating, optional or other special rights and
qualifications, limitations or restrictions of any such additional class or
series of preferred stock, including the dividend rights, dividend rate, terms
of redemption, redemption price or prices, conversion rights and liquidation
preferences of the shares constituting any series, without any further vote or
action by the stockholders of the Company. The issuance of preferred stock by
the Board of Directors could have the effect of making it more difficult for a
third party to acquire a majority of the outstanding voting stock of the
Company, thereby delaying, deferring or preventing a change in control of the
Company.
Series A Convertible Preferred Stock. As part of the recapitalization the
Company issued 62,500 shares of Series A convertible preferred stock. On any
matter on which the holders of Series A Preferred Stock may vote, each holder is
entitled to one vote for each share held. The holders of Series A convertible
preferred stock may vote only as a separate class, and their votes will not be
counted together with the holders of common stock as a single class. If declared
by the board of directors, holders of shares of Series A convertible
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<PAGE> 106
preferred stock are entitled to receive cash dividends, out of funds legally
available therefor, equal to the amount of dividends payable on the number of
shares of common stock into which each share of Series A Preferred Stock is
convertible. With respect to dividend rights, the Series A Preferred Stock ranks
on a parity with the common stock. No class or series of equity securities may
rank senior to the Series A Preferred Stock as to the payment of dividends. In
the event of any voluntary or involuntary liquidation, dissolution or winding up
of the Company, the holders of shares of Series A Preferred Stock are entitled
to receive out of assets of the Company available for distribution to
stockholders under applicable law, before any payment or distribution of assets
is made to holders of common stock or any other class or series of stock ranking
junior to the Series A Preferred Stock upon liquidation, liquidating
distributions in the amount of $1,000 per share plus accrued and unpaid
dividends (whether or not earned) to the date fixed for such liquidation,
dissolution or winding up. The Series A Preferred Stock is convertible at the
option of the holder on or after 180 days from the date of issuance, and will
automatically convert on the second anniversary of the date of issuance, into a
number of shares of common stock equal to $100 divided by the conversion price
(equal to $1.50, subject to certain adjustments). The holders of Series A
Preferred Stock have no preemptive rights to subscribe for additional shares of
the Company. In addition, there are no redemption or sinking fund provisions
applicable to the Series A Preferred Stock. All of the outstanding shares of
Series A Preferred Stock are fully paid and nonassessable.
CERTAIN PROVISIONS OF DELAWARE LAW
The Company is subject to the provisions of section 203 of the Delaware
General Corporation Law. Section 203 prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the business
combination is approved in a prescribed manner. A "business combination"
includes a merger, asset sale or other transaction resulting in a financial
benefit to the interested stockholder. Subject to certain exceptions, an
"interested stockholder" is a person who, together with affiliates and
associates, owns or within three years prior to the proposed business
combination has owned 15% or more of the corporation's voting stock.
CERTAIN CHARTER AND BYLAW PROVISIONS
The Company's Certificate of Incorporation and Bylaws contain certain
provisions that could discourage potential takeover attempts and make attempts
by stockholders to change management more difficult. The Certificate of
Incorporation and Bylaws provide that special meetings of stockholders may be
called only by the board of directors or upon the written demand of the holders
of not less than 30% of the votes entitled to be cast at a special meeting.
The Certificate of Incorporation permits the board of directors to create
new directorships and the Company's Bylaws permit the board of directors to
elect new directors to serve the full term of the class of directors in which
the new directorship was created. The Bylaws also provide that the board of
directors (or its remaining members, even though less than a quorum) is
empowered to fill vacancies on the board of directors occurring for any reason
for the remainder of the terms of the class of directors in which the vacancy
occurred.
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The Company's Certificate of Incorporation provides that liability of
directors of the Company is eliminated to the fullest extent permitted under the
Delaware General Corporation Law. As a result, no director of the Company will
be liable to the Company or its stockholders for monetary damages for breach of
fiduciary duty as a director, except for liability: (1) for any breach of the
director's duty of loyalty to the Company or its stockholders; (2) for acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law; (3) for any willful or negligent payment of an unlawful
dividend, stock purchase or redemption; or (4) for any transaction from which
the director derived an improper personal benefit.
REGISTRATION RIGHTS
The Company has entered into a registration rights agreement with FBR (the
"Equity Registration Rights Agreement") on behalf of the purchasers of common
stock and preferred stock in the Recapitalization and on behalf of the holders
of Old Notes who received preferred stock in the Exchange Offer. In addition,
the Company has entered into registration rights agreements with each of City,
Sovereign and one private investor which are substantially identical to the
Equity Registration Rights Agreement. Together these agreements are referred to
as the "Equity Registration Rights Agreements." Pursuant to the Equity
Registration Rights Agreements, as amended, the Company had agreed to file with
the SEC, on or before September 16, 1998 a registration statement relating to
the shares of common stock issued as part of the recapitalization and the shares
of common stock underlying the shares of preferred stock issued in the Exchange
Offer. The purchasers in the Recapitalization have agreed to extend this
deadline to December 15, 1998, and this Registration Statement has been filed in
accordance with the Equity Registration Rights Agreement. The Company will use
its reasonable efforts to maintain the effectiveness of this registration
statement continuously for a period of two years or until the shares of common
stock covered by this registration statement may be sold without restriction
under the Securities Act. However, such continual effectiveness is subject to
periods of time when the Company must suspend the use of this prospectus for the
purpose of amending the registration statement.
TRANSFER AGENT
The transfer agent and registrar for the common stock and Series A
convertible preferred stock is American Stock Transfer & Trust Company.
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<PAGE> 108
SHARES ELIGIBLE FOR FUTURE SALE
As of July 31, 1999 the Company had 3,656,666 shares of common stock
outstanding. Of these shares, 1,230,000 shares of common stock are freely
tradable without restriction or further registration under the Securities Act,
unless purchased by "affiliates" of the Company, as defined under the Securities
Act. The remaining 2,426,666 shares of common stock are "restricted shares" and
are subject to restrictions under the Securities Act. In addition 4,167,554
shares are issuable upon the conversion of preferred stock.
In general, under Rule 144, a person (or person whose shares are
aggregated) who has beneficially owned restricted shares for at least one year,
including a person who may be deemed an affiliate of the Company, is entitled to
sell within any three-month period a number of shares of common stock that does
not exceed the greater of 1% of the then-outstanding shares of common stock
(approximately 305,667 shares) or the average weekly trading volume of the
common stock on the Nasdaq Stock Market during the four calendar weeks preceding
such sale. Sale under Rule 144 are subject to certain restrictions relating to
manner of sale, notice and the availability of current public information about
the Company. A person who has not been an affiliate of the Company at any time
during the 90 days preceding a sale, and who has beneficially owned shares for
at least two years, would be entitled to sell such shares without regard to the
volume limitations, manner of sale provisions and other requirements of Rule
144.
Sovereign Bank NA and City Mortgage Services each have the option to
purchase 666,666 shares of common stock at a price of $15.00 per share which, if
exercised in full, would add 13,333,334 shares of common stock to the number of
shares of common stock outstanding on the date these options are exercised. All
of these shares are being registered in this registration statement.
Furthermore, the Company's stock option plans authorize the granting of options
to purchase an aggregate of 1.4 million shares of common stock, of which options
to purchase 786,859 shares of common stock have been granted.
The Company has filed, and intends to continue to file, registration
statements on Form S-8 under the Securities Act to register shares of common
stock subject to outstanding options or future grants under the Company's stock
option plans.
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PLAN OF DISTRIBUTION
The shares may be sold from time to time by the selling stockholders on the
Nasdaq National Market or any national securities exchange or automated
interdealer quotation system on which shares of common stock are then listed,
through negotiated transactions or otherwise. The shares will be sold at prices
and on terms then prevailing, at prices related to the then current market price
or in negotiated transactions. The selling stockholders may effect sales of the
shares through "brokers' transactions" (within the meaning of Section 4(4) of
the Securities Act) or in transactions directly with a "market maker" (as
defined in Section 3(a)(38) of the Securities Exchange Act of 1934). Upon the
Company being notified by any selling stockholder that a material arrangement
has been entered into with a broker or dealer for the sale of shares, a
prospectus supplement will be filed and distributed, if required, pursuant to
Rule 424(c) under the Securities Act, disclosing (a) the name of each such
broker-dealer, (b) the number of shares involved, (c) the price at which shares
were sold, (d) the commissions paid or discounts or concessions allowed to such
broker-dealer(s), where applicable and (e) other facts material to the
transaction. In effecting sales, broker-dealers engaged by any selling
stockholder and/or the purchasers of the shares may arrange for other
broker-dealers to participate. Broker-dealers will receive commissions,
concessions or discounts from the selling stockholders and/or the purchasers of
the shares in amounts to be negotiated prior to the sale. Sales will be made
only through broker-dealers registered as such in a subject jurisdiction or in
transactions exempt from such registration. As of the date of this prospectus,
there are no selling arrangements between the selling stockholders and any
broker or dealer.
In offering the shares covered by this prospectus, the selling stockholders
and any broker-dealers who participate in a sale of the shares by the selling
stockholders may be considered "underwriters" within the meaning of Section
2(11) of the Securities Act, and any profits realized by the selling
stockholders and the compensation of any broker-dealers may be deemed to be
underwriting discounts and commissions. However, the selling stockholders
disclaim being underwriters under the Securities Act.
As required by the Equity Registration Rights Agreement, the Company has
filed the registration statement, of which this prospectus forms a part, with
respect to the sale of the Shares. The Company has agreed to use its best
efforts to keep the registration statement current and effective for two years,
with certain exceptions.
The Company will not receive any of the proceeds from the sale of the
shares by the selling stockholders. The Company will bear the costs of
registering the shares under the Securities Act, including the registration fee
under the Securities Act, certain legal and accounting fees and any printing
fees. The selling stockholders will bear all other expenses in connection with
this offering, including brokerage fees and the fees and disbursements of
counsel representing the selling stockholders.
Pursuant to the terms of the Equity Registration Rights Agreement, the
Company and the selling stockholders have agreed to indemnify each other and
certain other related parties for certain liabilities in connection with the
registration of the shares.
108
<PAGE> 110
WHERE YOU CAN FIND MORE INFORMATION
Our company files annual, quarterly and current reports, proxy statements
and other information with the SEC. You may read and copy these reports,
statements or other information at the SEC's public reference room in
Washington, D.C. located at 450 Fifth Street, N.W., Washington, D.C. 20549. The
SEC also maintains regional offices where you can read and copy the reports.
These are located at 500 West Madison Street, Room 1400, Chicago, Illinois 60606
and at 7 World Trade Center, Suite 1300, New York, New York 10048. You can
request copies of these documents, upon payment of photocopying fees, by writing
to the SEC. Please call the SEC at 1-800-SEC-0330 for further information on the
operation of the public reference rooms. Our SEC filings are also available to
the public on the SEC's internet site (http://www.sec.gov). These documents are
also available for viewing and copying at the offices of The Nasdaq Stock
Market, Inc. at 1735 K Street, NW, Washington, D.C. 20006-1506.
This prospectus is part of a registration statement on Form S-1 that we
filed with the SEC. This prospectus does not contain all of the information in
that registration statement. For further information with respect to the Company
and the securities offered under the registration statement, you should review
the registration statement. You can obtain the registration statement from the
SEC and The Nasdaq Stock Market at the public reference facilities we referred
to above.
LEGAL MATTERS
The validity of the shares of common stock offered by this prospectus will
be passed upon for the Company by King & Spalding, Atlanta, Georgia.
EXPERTS
The financial statements of the Company as of August 31, 1997 and 1998 and
for each of the three years in the period ended August 31, 1998 included in this
prospectus have been audited by Deloitte & Touche LLP, independent auditors, as
stated in their reports appearing herein, and have been so included in reliance
upon the reports of such firm given their authority as experts in accounting and
auditing. The financial statements of TMCI as of December 31, 1997 and 1998 and
for each of the two years in the period ended December 31, 1998 included in this
prospectus have been audited by Moyer, Smith & Roller, P.A., as stated in their
report appearing herein and have been so included in reliance upon the reports
of such firm given their authority as experts in auditing and accounting.
109
<PAGE> 111
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
Independent Auditors' Report................................ F-2
Statements of Financial Condition at August 31, 1997 and
1998 and May 31, 1999 (unaudited)......................... F-3
Statements of Operations -- Years Ended August 31, 1996,
1997 and 1998 and the Nine Months Ended May 31, 1998
(unaudited) and 1999 (unaudited).......................... F-4
Statements of Cash Flows -- Years Ended August 31, 1996,
1997 and 1998 and the Nine Months Ended May 31, 1998
(unaudited) and 1999 (unaudited).......................... F-5
Statements of Stockholders' Equity -- Years Ended August 31,
1996, 1997 and 1998 and the Nine Months Ended May 31, 1999
(unaudited)............................................... F-7
Notes to Financial Statements -- Years Ended August 31,
1996, 1997 and 1998 and the unaudited Nine Months Ended
May 31, 1998 and 1999..................................... F-8
</TABLE>
F-1
<PAGE> 112
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Altiva Financial Corporation
Atlanta, Georgia
We have audited the accompanying statements of financial condition of
Altiva Financial Corporation (formerly Mego Mortgage Corporation) (the
"Company") as of August 31, 1997 and 1998, and the related financial statements
of operations, stockholders' equity, and cash flows for each of the three years
in the period ended August 31, 1998. 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, such financial statements present fairly, in all material
respects, the financial position of Altiva Financial Corporation at August 31,
1997 and 1998, and the results of its operations and its cash flows for each of
the three years in the period ended August 31, 1998 in conformity with generally
accepted accounting principles.
DELOITTE & TOUCHE LLP
San Diego, California
December 14, 1998
F-2
<PAGE> 113
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
AUGUST 31,
----------------------- MAY 31
1997 1998 1999
---------- ---------- ------------
(THOUSANDS OF DOLLARS, (UNAUDITED)
EXCEPT PER SHARE
AMOUNTS)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents....................... $ 6,104 $ 36,404 $ 9,231
Cash deposits, restricted....................... 6,890 3,662 2,934
Loans held for sale, net of allowance for credit
losses of $100, $76 and $399 (unaudited) and
valuation allowance of $0, $10,901 and $1,732
(unaudited)................................... 9,523 10,975 15,557
Mortgage related securities, at fair value...... 106,299 34,830 34,214
Mortgage servicing rights....................... 9,507 83 --
Other receivables............................... 7,945 5,078 5,669
Property and equipment, net of accumulated
depreciation of $675, $1,181 and $1,775
(unaudited)................................... 2,153 1,813 2,590
Organizational costs, net of amortization....... 289 96 --
Prepaid debt expenses........................... 2,362 2,790 2,178
Prepaid commitment fee.......................... 2,333 -- --
Deferred federal income tax asset............... 2,354 5,376 8,444
Deferred state income tax asset................. -- 3,064 767
Other assets.................................... 795 364 3,125
-------- -------- --------
Total assets.......................... $156,554 $104,535 $ 84,709
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Warehouse line................................ $ -- $ -- $ 18,136
Notes and contracts payable................... 35,572 16,345 8,456
Accounts payable and accrued liabilities...... 20,212 16,431 4,450
Allowance for credit losses on loans sold with
recourse................................... 7,014 2,472 --
State income taxes payable.................... 649 -- --
Subordinated debt............................. 40,000 42,693 30,750
-------- -------- --------
Total liabilities..................... 103,447 77,941 61,792
-------- -------- --------
Commitments and contingencies (Note 16)
Stockholders' equity:
Convertible Preferred stock, $.01 par value
per share (authorized -- 5,000,000 shares;
issued and outstanding -- 0, 62,500, and
62,500 (unaudited))........................ -- 1 1
Common stock, $.01 par value per share
(authorized -- 400,000,000 shares; issued
and outstanding -- 1,230,000, 3,056,666,
and
3,056,666 (unaudited))..................... 123 306 306
Additional paid-in capital.................... 29,185 122,143 122,143
Retained earnings (accumulated deficit)....... 23,799 (95,856) (99,533)
-------- -------- --------
Total stockholders' equity............ 53,107 26,594 22,917
-------- -------- --------
Total liabilities and stockholders'
equity............................. $156,554 $104,535 $ 84,709
======== ======== ========
</TABLE>
See notes to financial statements.
F-3
<PAGE> 114
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
MAY 31,
FOR THE YEARS ENDED AUGUST 31, (UNAUDITED)
--------------------------------- -----------------------
1996 1997 1998 1998 1999
------- ---------- ---------- ---------- ----------
(THOUSANDS OF DOLLARS, EXCEPT PER
SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
REVENUES:
Gain (loss) on sale of loans......... $16,539 $ 45,123 $ (26,578) $ (15,562) $ 759
Net unrealized gain (loss) on
mortgage related securities........ 2,697 3,518 (70,024) (44,120) (532)
Loan servicing income, net........... 3,348 3,036 999 1,137 230
Interest income...................... 2,104 9,507 14,786 13,201 5,032
Less: interest expense............... (1,116) (6,374) (13,162) (11,175) (5,686)
------- ---------- ---------- ---------- ----------
Net interest income (expense)...... 988 3,133 1,624 2,026 (654)
------- ---------- ---------- ---------- ----------
Total revenues (losses)....... 23,572 54,810 (93,979) (56,519) (197)
------- ---------- ---------- ---------- ----------
COST AND EXPENSES:
Net provision (benefit) for credit
losses............................. 55 6,300 (3,198) 2,404 (276)
Depreciation and amortization........ 394 672 1,013 844 759
Other interest....................... 167 245 439 330 96
General and administrative:
Payroll and benefits............... 6,328 13,052 18,582 14,925 5,385
Credit reports(1).................. 367 1,387 510 -- --
Rent and lease expenses............ 338 1,199 1,616 1,118 967
Professional services.............. 1,771 2,271 4,783 3,637 2,281
Sub-servicing fees................. 709 1,874 2,160 1,795 210
Other services..................... 665 1,352 2,068 1,417 1,128
Insurance.......................... 572 558 430 335 630
Travel and entertainment........... 677 1,005 1,159 967 428
Legal settlement................... 1,296
Other.............................. 374 1,085 2,448 2,409 565
------- ---------- ---------- ---------- ----------
Total costs and expenses...... 12,417 31,000 32,010 30,181 13,469
------- ---------- ---------- ---------- ----------
Income (Loss) Before Income Taxes and
Extraordinary Item................... 11,155 23,810 (125,989) (86,700) (13,666)
Income Tax Expense (Benefit) Before
Extraordinary Item................... 4,235 9,062 (6,334) -- (5,177)
------- ---------- ---------- ---------- ----------
Net Income (Loss) Before Extraordinary
Item................................. 6,920 14,748 (119,655) (86,700) (8,489)
Extraordinary Item, Net of Taxes of
$2.9 million......................... 4,812
------- ---------- ---------- ---------- ----------
NET INCOME LOSS...................... $ 6,920 $ 14,748 $ (119,655) $ (86,700) $ (3,677)
======= ========== ========== ========== ==========
EARNINGS PER COMMON SHARE:
Basic:
Net income (loss).................. $ 12.50 $ (77.18) $ (70.49) $ (1.20)
========== ========== ========== ==========
Weighted-average number of common
shares........................... 1,180,219 1,550,293 1,230,000 3,056,666
========== ========== ========== ==========
Diluted:
Net income (loss).................. $ 12.50 $ (77.18) $ (70.49) $ (1.20)
========== ========== ========== ==========
Weighted-average number of common
shares and assumed conversions... 1,180,219 1,550,293 1,230,000 3,056,666
========== ========== ========== ==========
</TABLE>
- ---------------
(1) For the nine months ended May 31, 1998 and 1999 amounts paid for credit
reports are included in Other.
See notes to financial statements.
F-4
<PAGE> 115
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS
ENDED MAY 31,
FOR THE YEARS ENDED AUGUST 31, (UNAUDITED)
--------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- --------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................ $ 6,920 $ 14,748 $(119,655) $ (86,700) $ (3,677)
--------- --------- --------- --------- --------
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Loans originated for sales, net of loan fees... (139,367) (526,917) (365,694) (347,876) (38,266)
Proceeds from sale of loans.................... 135,483 514,413 360,303 336,745 40,461
Payments on loans held for sale................ 504 431 2,191 1,896 2,032
Lower of cost or market adjustment............. -- -- 10,901 44,120 (9,110)
Net provisions (benefit) for estimated credit
losses....................................... 55 6,300 (3,198) 2,404 (276)
Additions to mortgage related securities....... -- (135,549) (22,469) -- (1,125)
Amortization of mortgage related securities.... -- -- -- -- 920
Accretion of residual interest on mortgage
related securities........................... (243) (6,207) (8,467) (7,295) (2,330)
Write-off/sale of mortgage related
securities................................... -- 67,040 27,573
Market valuation of mortgage related
securities................................... (2,697) 5,612 73,390 2,659 --
Payments on mortgage related securities........ 1,547 801 1,442 974 1,266
Additions to excess servicing rights........... (20,563) (3,887) -- (3,529) --
Amortization of excess servicing rights........ 2,144 956 -- -- --
Additions to mortgage servicing rights......... (3,306) (7,184) (3,529) -- --
Amortization of mortgage servicing rights...... 555 1,504 3,166 2,903 7
Proceeds from sale of mortgage servicing
rights....................................... -- -- 4,137 -- --
Write-off /valuation of mortgage servicing
rights....................................... -- -- 3,870 3,804 76
Gain on disposal of fixed assets............... -- -- (16) -- --
Depreciation and amortization expense.......... 394 672 1,013 844 689
Additions to prepaid debt expenses, net........ -- -- (4,066) -- --
Amortization of prepaid debt expense........... 163 684 1,387 (176) 611
Additions to prepaid commitment fee, net....... -- -- (1,250) -- --
Amortization/write-off of prepaid commitment
fee.......................................... -- 817 3,583 2,333 --
Changes in operating assets and liabilities:
Cash deposits, restricted.................... (1,942) (2,416) 3,228 545 728
Deferred income taxes (benefit).............. 673 (3,267) (6,086) (2,157) (771)
Other assets, net............................ 1,056 (1,813) 5,017 4,664 (3,350)
State income taxes payable................... 670 (260) (649) (649) --
Other liabilities, net....................... 5,514 1,084 (5,845) 17,557 (11,981)
--------- --------- --------- --------- --------
Total adjustments.......................... (19,360) (87,186) 79,932 59,766 (20,419)
--------- --------- --------- --------- --------
Net cash used in operating activities...... (12,440) (72,438) (39,723) (26,934) (24,096)
--------- --------- --------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment............... (608) (1,688) (345) (58) (1,371)
Proceeds from the sale of property and
equipment...................................... -- 4 16 -- --
--------- --------- --------- --------- --------
Net cash used in investing activities...... (608) (1,684) (329) (58) (1,371)
--------- --------- --------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings on notes and contracts
payable........................................ 146,448 511,878 334,143 333,899 18,135
Payments on notes and contracts payable.......... (133,709) (490,503) (353,370) (338,197) (7,898)
Issuance of subordinated debt.................... -- 37,750 40,400 38,373 --
Repurchase of subordinated debt.................. -- -- (125) -- (11,875)
Amortization of premium of subordinated debt..... -- -- (82) (57) (68)
Sale of common stock............................. -- 20,658 25,000 -- --
</TABLE>
F-5
<PAGE> 116
<TABLE>
<CAPTION>
NINE MONTHS
ENDED MAY 31,
FOR THE YEARS ENDED AUGUST 31, (UNAUDITED)
--------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- --------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C>
Sale of preferred stock.......................... -- -- 25,000 -- --
Payment of issuance costs........................ -- -- (614) -- --
--------- --------- --------- --------- --------
Net cash provided by financing
activities............................... 12,739 79,783 70,352 34,018 (1,706)
--------- --------- --------- --------- --------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS...................................... (309) 5,661 30,300 7,026 (27,173)
CASH AND CASH EQUIVALENTS -- BEGINNING OF PERIOD... 752 443 6,104 6,014 36,404
--------- --------- --------- --------- --------
CASH AND CASH EQUIVALENTS -- END OF YEAR........... $ 443 $ 6,104 $ 36,404 $ 13,130 $ 9,231
========= ========= ========= ========= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest....................................... $ 964 $ 5,212 $ 12,380 $ 4,997 $ 2,663
State income taxes............................. $ 25 $ 1,691 $ 506 504 197
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
Mortgage related security and settlement of
recourse ability............................... $ -- $ -- $ -- $ -- $ 1,885
Additional paid-in capital created from deferred
tax asset...................................... $ -- $ -- $ 2,354 $ 2,354 $ --
Forgiveness of due to Mego Financial liability... $ -- $ -- $ 6,153 $ -- $ --
Record liability to repurchase loans from City
Mortgage Services.............................. $ -- $ -- $ 9,255 $ -- $ --
Exchange of Subordinated Notes for Subordinated
Notes.......................................... $ -- $ -- $ 41,500 $ -- $ --
Exchange of Subordinated Notes for Preferred
Stock.......................................... $ -- $ -- $ 37,500 $ -- $ --
Placement agent service fee paid in common
stock.......................................... $ -- $ -- $ 2,400 $ -- $ --
Addition to prepaid commitment fee and due to
Mego Financial in connection with loan sale
commitment received............................ $ -- $ 3,000 $ -- $ -- $ --
In connection with the securitization of loans
and creation of mortgage related securities,
the Company retained an interest only security
and a residual interest security............... $ 20,096 $ -- $ -- $ -- $ --
</TABLE>
See notes to financial statements.
F-6
<PAGE> 117
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998 AND THE NINE MONTHS ENDED MAY
31, 1999
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK
$.01 PAR VALUE $.01 PAR VALUE ADDITIONAL RETAINED
--------------- -------------------- PAID-IN EARNINGS
SHARES AMOUNT SHARES AMOUNT CAPITAL (DEFICIT) TOTAL
------ ------ ----------- ------ ---------- --------- ---------
(THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at September 1,
1995................... -- $-- 1,000,000 $100 $ 8,550 $ 2,131 $ 10,781
Net income............... -- -- -- -- -- 6,920 6,920
------ --- ----------- ---- -------- --------- ---------
Balance at August 31,
1996................... -- -- 1,000,000 100 8,550 9,051 17,701
Sale of common stock, net
of issuance costs...... -- -- 230,000 23 20,635 -- 20,658
Net income............... -- -- -- -- -- 14,748 14,748
------ -- ----------- ---- -------- --------- ---------
Balance at August 31,
1997................... -- -- 1,230,000 123 29,185 23,799 53,107
Increase in additional
paid-in capital due to
adjustment of deferred
federal income tax
asset related to
Spin-off............... -- -- -- -- 2,354 -- 2,354
Increase in additional
paid-in capital due to
settlement of amount
payable to Mego
Financial Corp. related
to Spin-off............ -- -- -- -- 6,153 -- 6,153
Sale of common stock, net
of issuance costs...... -- -- 1,826,666 183 26,854 -- 27,037
Sale of Series A
convertible preferred
stock and exchange of
Senior Subordinated
Notes for Series A
convertible preferred
stock, net of issuance
costs.................. 62,500 1 -- -- 57,597 -- 57,598
Net loss................. -- -- -- -- -- (119,655) (119,655)
------ --- ----------- ---- -------- --------- ---------
Balance at August 31,
1998................... 62,500 1 3,056,666 306 122,143 (95,856) 26,594
Net Loss (unaudited)..... -- -- -- -- -- (3,677) (3,677)
------ --- ----------- ---- -------- --------- ---------
Balance at May 31, 1999
(unaudited)............ 62,500 $ 1 3,056,666 $306 $122,143 $ (99,533) $ 22,917
====== === =========== ==== ======== ========= =========
</TABLE>
See notes to financial statements.
F-7
<PAGE> 118
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
1. NATURE OF OPERATIONS
Altiva Financial Corporation, formerly Mego Mortgage Corporation (the
"Company"), was incorporated on June 12, 1992, in the State of Delaware. The
Company is a specialized consumer finance company that funds, purchases, makes
and sells consumer loans secured by deeds of trust on one-to-four family
residences. These loans are used to, among other things, purchase one-to-four
family residences, refinance existing mortgages, consolidate debt and finance
home improvements. The Company's loan products are:
- Home Equity loans, primarily secured by first liens, and to a
substantially lesser extent by second liens, on the borrower's residence.
The Company's Home Equity loans are made to borrowers who, because of
their credit history, income or other factors, do not conform to the
lending criteria of government-chartered agencies (including GNMA, FHLMC
or FNMA) mortgage guarantee or purchase programs. As a result, the
Company's borrowers pay a higher rate of interest and are able to borrow
a lesser amount of the appraised value of their residences than
conforming borrowers;
- Equity + loans, typically secured by a second lien on the borrower's
primary residence. The initial principal amount of an Equity + loan when
added to the other outstanding senior secured debt on the residence may
result in a loan to value ("LTV") of up to 125%.
Historically, a significant majority of the Company's loan production was
purchased from approved mortgage bankers and other financial intermediaries. The
Company funds loans that are originated through its network of over 169
pre-approved mortgage brokers as of August 31, 1998. These brokers submit loan
packages to the Company, which in turn funds the loans to approved borrowers.
All loans funded or purchased by the Company are underwritten and graded by the
Company's personnel. Effective in January 1998, the Company's operating strategy
was to sell substantially all of its loan production for cash to institutional
purchasers.
Certain of the loans produced by the Company qualify under the provisions
of Title I of the National Housing Act which is administered by the U.S.
Department of Housing and Urban Development ("HUD"). Prior to May 1996, the
Company produced only Title I loans. Pursuant to the Title I credit insurance
program, 90% of the principal balances of the loans are U.S. government insured
("Title I loans"), with cumulative maximum coverage equal to 10% of all Title I
loans produced by the Company. As a result of prior losses, no FHA insurance
remained with respect to the Company's portfolio of Title I loans as of August
31, 1998. In May 1996, the Company commenced the production of Equity + home
improvement loans, generally secured by residential real estate, and debt
consolidation loans ("Equity + loans") through its network of mortgage bankers
and mortgage brokers.
During fiscal 1995, all loans produced were Title I loans. During fiscal
1996, 91.7% of loans produced were Title I loans and 8.3% of loans produced were
Equity + loans. The
F-8
<PAGE> 119
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
Company's loan production during the fiscal year ended August 31, 1997 was
comprised of 81.4% Equity + loans and 18.6% Title I loans. In December 1997, the
Company commenced the origination of Home Equity loans. The Company's loan
production during the fiscal year ended August 31, 1998 was comprised of 91.6%
Equity + loans, 5.5% Title I loans, and 2.9% Home Equity loans.
The Company was a wholly owned subsidiary of Mego Financial Corp. ("Mego
Financial") until November 1996, when the Company issued 2.3 million shares of
its Common Stock, $.01 par value per share (the "Common Stock"), in an
underwritten public offering (the "IPO") at $10.00 per share. As a result of the
IPO, Mego Financial's ownership in the Company was reduced from 100% at August
31, 1996 to 81.3%. Concurrently with the IPO, the Company issued $40.0 million
of 12.5% Senior Subordinated Notes due in 2001 in an underwritten public
offering. The proceeds from the offerings received by the Company were used to
repay borrowings and provide funds for production and securitizations of loans.
In October 1997, the Company issued an additional $40.0 million of 12.5% Senior
Subordinated Notes due in 2001 in a private placement (the "Private Placement").
The proceeds from the Private Placement were used to repay borrowings, including
borrowings from Mego Financial, and to provide funds for loan production, the
securitizations of loans and working capital. The $80.0 million of 12.5% Senior
Subordinated Notes due in 2001 are herein referred to as old notes (the "Old
Notes").
On September 2, 1997, Mego Financial distributed all of its 10 million
shares of the Company's Common Stock to its stockholders in a tax-free spin-off
("Spin-off").
On July 1, 1998, the Company completed a series of transactions to
recapitalize the Company (the "Recapitalization"). Pursuant to the
Recapitalization, the Company raised approximately $84.5 million of additional
equity, net of issuance costs. Two strategic partners each purchased 10,000
shares of the Company's newly-designated Series A Convertible Preferred Stock
(the "Preferred Stock") at a purchase price of $1,000 per share. The purchasers
have each been granted an option, which expires in December 2000, to acquire
6.67 million shares of the Company's Common Stock, subject to adjustment. The
number and price of the Company's Common Stock purchasable upon exercise of the
option is subject to adjustment from time to time upon the occurrence of: (1)
mergers and reclassifications; (2) dividends, subdivisions, and combinations;
(3) adjustments for issuance below option price; (4) adjustments for issuances
below fair market value; (5) special rules and (6) other actions affecting
capital stock. The Preferred Stock will be mandatorily converted into Common
Stock on June 18, 2000. Each purchaser has a right of first refusal to purchase
the Company in the event the Company's Board of Directors determines to sell the
Company. In addition, other private investors purchased an aggregate of 5,000
shares of Preferred Stock at a purchase price of $1,000 per share and 16.67
million shares of Common Stock at a purchase price of $1.50 per share. All of
the foregoing sales were made pursuant to private placements.
As part of the Recapitalization, the Company completed an offer to exchange
(the "Exchange Offer") new subordinated notes and Preferred Stock, subject to
certain
F-9
<PAGE> 120
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
limitations, for any and all of the outstanding Old Notes. The Exchange Offer
was conditioned upon at least $76.0 million aggregate principal amount of Old
Notes being tendered for exchange and conditioned upon at least $30.0 million
shares of Common Stock and Preferred Stock being sold in the offerings. The
Company would not have consummated the Exchange Offer if less than $30.0 million
was raised in the offerings. Pursuant to the Exchange Offer, the Company issued
approximately 37,500 shares of Preferred Stock at an issuance price of $1,000
per share, and $41.5 million principal amount of new 12.5% Subordinated Notes
due 2001 (the "Current Notes") in exchange for approximately $79.0 million
principal amount of Old Notes. The balance of the Old Notes was repurchased by
the Company in September and October 1998. The proceeds of the Recapitalization
was $50.0 million. The proceeds were used to repay indebtedness, including $1.6
million to a subsidiary of Mego Financial, $5.1 million of interest on the Old
Notes and $2.4 million on the warehouse line of credit, to provide capital to
originate loans and for other general corporate uses.
In the opinion of management, the accompanying unaudited financial
statements contain all adjustments (consisting only of various normal accruals)
necessary to present fairly the Company's financial position, results of
operations and cash flows. The financial position at May 31, 1999 is not
necessarily indicative of the financial position to be expected at August 31,
1999 and results of operations for the nine months ended May 31, 1999 are not
necessarily indicative of the results of operations to be expected for the year
ending August 31, 1999.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents -- Cash and cash equivalents consist of cash on
hand and on deposit at financial institutions and short term investments with
original maturities of 90 days or less when purchased.
Cash Deposits, Restricted -- Restricted cash represents cash on deposit
which is restricted in accordance with the loan sale agreements and funds
received from collection of loans which have not yet been disbursed to the
purchasers of such loans in accordance with the loan sale agreements.
Loans Held for Sale -- Loans held for sale are carried at the lower of
aggregate cost or market value in the accompanying Statements of Financial
Condition, net of allowance for credit losses.
Allowance for Credit Losses -- Provision for credit losses relating to
unsold loans is recorded as expense in amounts sufficient to maintain the
allowance at a level considered adequate to provide for anticipated probable
losses resulting from liquidation of outstanding loans. The provision for credit
losses is based upon periodic analysis of the portfolio, economic conditions and
trends, historical credit loss experience, borrowers' ability to repay,
collateral values, and estimated FHA insurance recoveries on loans produced.
Valuation Allowance -- Provision for decreases in the market value relating
to unsold loans is recorded as expense in amounts sufficient to maintain the
allowance at a level
F-10
<PAGE> 121
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
considered adequate to provide for anticipated probable losses from liquidation
of outstanding loans. The provision for valuation is based upon the estimated
fair market value of the portfolio primarily derived from recent sale data in
the marketplace.
Loan Origination Costs and Fees -- Loan origination costs and fees
including non-refundable loan origination fees and incremental direct costs
associated with loan production are deferred in compliance with Statement of
Financial Accounting Standards ("SFAS") No. 91 "Accounting for Nonrefundable
Fees and Costs associated with Originating or Acquiring Loans and Indirect
Direct Costs of Leases." ("SFAS 91") and recorded as expense or income upon the
sale of the related loans.
Mortgage Related Securities -- In fiscal 1996, the Company securitized a
majority of loans produced into the form of a REMIC. A REMIC is a trust issuing
multi-class securities with certain tax advantages to investors and which
derives its cash flow from a pool of underlying mortgages. Certain of the senior
classes of the REMIC are sold, and an interest only strip and a subordinated
residual class are retained by the Company. The subordinated residual class is
in the form of residual certificates which are classified as residual interest
securities. The documents governing the Company's securitizations require the
Company to establish initial over-collateralization or build
over-collateralization levels through retention of distributions by the REMIC
trust otherwise payable to the Company as the residual interest holder. This
over-collateralization causes the aggregate principal amount of the loans in the
related pool and/or cash reserves to exceed the aggregate principal balance of
the outstanding investor certificates. Such excess amounts serve as credit
enhancement for the related REMIC trust. To the extent that borrowers default on
the payment of principal or interest on the loans, losses will reduce the over-
collateralization and cash flows otherwise payable to the residual interest
security holder to the extent that funds are available. If payment defaults
exceed the amount of over-collateralization, as applicable, the insurance policy
maintained by the related REMIC trust will pay any further losses experienced by
holders of the senior interests in the related REMIC trust. The Company does not
have any recourse obligations for credit losses in the REMIC trust.
In fiscal 1997, the Company completed five securitizations, including two
non-monoline securitizations, two owner's trust securitizations and a combined
REMIC grantor trust securitization. No securitizations were completed during the
nine months ended May 31, 1999.
The two non-monoline securitizations completed in June and August 1997 were
accomplished on a senior subordinated basis without insurance as a credit
enhancement and were generally collateralized by Equity + home improvement and
debt consolidation mortgage loans with typically high loan-to-value ratios. The
other three securitization transactions were insured and collateralized by a
combination of Title I and Equity + loans. The two monoline owner's trust
securitizations were completed in March and May 1997. The REMIC/grantor trust
securitization, completed in December 1996, placed all secured Title I loans and
those Equity + loans which qualified with a loan-to-value ratio of 125% or less,
into the REMIC pool. The grantor trust pool was comprised of
F-11
<PAGE> 122
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
unsecured Title I loans and other Equity + loans which did not qualify for the
REMIC pool.
In August 1998, the Company pooled approximately $90.5 million (27.4%) of
its loans with an additional $239.6 million (72.6%) from a second party to
create a home loan owner trust securitization. The Company is to receive a
residual interest in this securitization calculated on a pro rata share of the
Company loans originated in the total pool. This residual interest will be owned
two-thirds by the Company and one-third by another financial institution.
Cashflow on the Company's residual interest will be subordinated to recovery by
the financial institution of: (1) premium paid for in the acquisition of the
pool; (2) upfront overcollateralization of 1.25% of the total pool; (3) the
financial institution's underwriting fee and (4) transaction costs. The total of
these recoveries will accrue interest at a 12% per annum rate until recovered.
The target overcollateralization level of 6% must be achieved prior to the
financial institution receiving any recoveries.
Pursuant to these securitizations, various classes of mortgage-backed notes
and certificates were issued and sold to the public. The Company received
residual interest securities, servicing rights and, in some of the transactions,
interest-only strip securities, all of which (except for the servicing rights)
were recorded as mortgage related securities on the Statements of Financial
Condition. The residual interest securities and the servicing rights represent
the excess differential (after payment of any subservicing, interest and other
fees, and the contractual obligations payable to the note and certificate
holders) between the interest paid by the obligors of the sold loans and the
yield on the sold notes, certificates and interest-only strip securities. The
Company has also received interest-only strip securities from the first two
securitizations completed in fiscal 1996 and the first two securitizations
completed in fiscal 1997. These interest-only securities yield annual rates
between 0.45% and 1.00% calculated on the principal balances of loans not in
default. The Company may be required to repurchase loans that do not conform to
the representations and warranties made by the Company in the securitization
agreements, and as servicer, may be required to advance interest in connection
with the securitizations. Effective January 1, 1997, the Company prospectively
adopted SFAS 125 (as defined below).
In accordance with the provisions of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS 115"), the Company classifies
residual-interest securities, interest-only strip securities and interest-only
receivables as trading securities which are recorded at fair value with any
unrealized gains or losses recorded in the results of operations in the period
of the change in fair value. Valuations at origination and at each reporting
period are based on discounted cash flow analyses. The cash flows are estimated
as the excess of the weighted-average coupon on each pool of loans securitized
over the sum of the pass-through interest rate, servicing fees, a trustee fee,
an insurance fee and an estimate of annual future credit losses, net of Federal
Housing Administration ("FHA") insurance recoveries, related to the loans
securitized, over the life of the loans. These cash flows are projected over the
life of the loans using prepayment, default, and loss assumptions that the
Company believes market participants would use for similar financial instruments
and are discounted using an interest rate that
F-12
<PAGE> 123
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
the Company believes a purchaser unrelated to the seller of such a financial
instrument would require. The valuation includes consideration of
characteristics of the loans including loan type and size, interest rate,
origination date, and term. The Company also uses other available information
such as externally prepared reports on prepayment rates and industry default
rates of the type of loan portfolio under review. To the Company's knowledge,
there is no active market for the sale of these mortgage-related securities. The
range of values attributable to the factors used in determining fair value is
broad. Although the Company believes that it has made reasonable estimates of
the fair value of the mortgage-related securities, the rate of prepayments,
discount and default rates utilized are estimates, and actual experience may
differ.
Revenue Recognition-Gain(Loss) on Sale of Loans -- Gain on sale of loans
includes the gain on sale of mortgage-related securities and the gain(loss) on
sale of loans held for sale. In accordance with SFAS 125 (as discussed below)
the gain on sale of mortgage-related securities is determined by an allocation
of the cost of the securities based on the relative fair value of the securities
sold and the securities retained. In sales of loans through securitization
transactions, the Company retains residual-interest securities and may retain
interest-only strip securities. The fair value of the interest-only strip
securities and residual interest securities is the present value of the
estimated cash flow to be received after considering the effects of estimated
prepayments and credit losses. The interest-only strip securities and
residual-interest securities are included in mortgage-related securities on the
Company's Statements of Financial Condition. Market valuation adjustments on
loans held for sale and loans reacquired under recourse provisions are included
in the gain(loss) on sale of loans.
In discounting cash flows related to loan sales, the Company defers
servicing income at annual rates of 1% to 1.25% and discounts cash flows on its
sales at the rate it believes a purchaser would require as a rate of return. The
cash flows were discounted to present value using discount rates which
approximated 12% for each of the years ended August 31, 1996 and 1997 and 16%
for the year ended August 31, 1998 and the nine months ended May 31, 1999. The
Company has developed its assumptions based on experience with its own
portfolio, available market data and ongoing consultation with its investment
bankers.
In determining expected cash flows, management considers economic
conditions at the date of sale. In subsequent periods, these estimates may be
revised as necessary using the original discount rate, and any losses arising
from prepayment and loss experience will be recognized as realized.
Mortgage Servicing Rights -- The fair value of capitalized mortgage
servicing rights is estimated by calculating the present value of expected net
cash flows from mortgage servicing rights using assumptions the Company believes
market participants would use in their estimates of future servicing income and
expense, including assumptions about prepayment, default and interest rates.
Mortgage servicing rights are amortized in proportion to and over the period of
estimated net servicing income. The estimate of fair value was based on a 125,
100, 100 and 100 basis points per annum, respectively, servicing fee reduced by
estimated costs of servicing for the years ended August 31, 1996, 1997 and
F-13
<PAGE> 124
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
1998 and the nine months ended May 31, 1999. The estimated net cash flow from
servicing utilized a discount rate of 12% for the fiscal years ending August 31,
1996 and 1997 and 16% for the year ended August 31, 1998 and the nine months
ended May 31, 1999. At August 31, 1997 and 1998 and at May 31, 1999, the book
value of mortgage servicing rights approximated fair value. The Company
periodically reviews mortgage servicing rights to determine impairment. This
review is performed on a disaggregated basis, based upon loan type and date of
origination. Impairment is recognized in a valuation allowance for each pool in
the period of impairment. The Company has developed its assumptions based on
experience with its own portfolio, available market data and ongoing
consultation with its investment bankers.
Property and Equipment -- Property and equipment is stated at cost and is
depreciated over its estimated useful life (generally five years) using the
straight-line method. Costs of maintenance and repairs that do not improve or
extend the life of the respective assets are recorded as expense.
Organizational Costs -- Organizational costs associated with the
organization of the Company, which commenced loan production on March 1, 1994,
are being amortized over a five year period. These organizational costs are
comprised of costs to incorporate, and legal, accounting, and other professional
fees. Such amortization is included in depreciation and amortization expense on
the Statements of Operations. Accumulated amortization related to organizational
costs was $482,000, $675,000 and $867,000 during the years ended August 31,
1996, 1997 and 1998, respectively, and $819,000 and $963,000 at May 31, 1998 and
1999, respectively.
Allowance for Credit Losses on Loans Sold with Recourse -- Recourse to the
Company on sales of loans is governed by the agreements between the purchasers
and the Company. The allowance for credit losses on loans sold with recourse
represents the Company's estimate of the fair value of its probable future
credit losses to be incurred, considering estimated future FHA insurance
recoveries on Title I loans. No allowance for credit losses on loans sold with
recourse is established on loans sold with servicing released, as the Company
has no recourse obligation for credit losses under those whole loan sale
agreements. Estimated credit losses on loans sold through securitizations are
considered in the Company's valuation of its mortgage-related securities.
Proceeds from the sale of loans with recourse provisions were $118.1 million,
$415.5 million and $146.4 million during the years ended August 31, 1996, 1997
and 1998, respectively, and $153.8 million and $0 during the nine months ended
May 31, 1998 and 1999, respectively.
Loan-Servicing Income -- Fees for servicing loans produced or acquired by
the Company and sold with servicing rights retained are generally based on a
stipulated percentage of the outstanding principal balance of such loans and are
recognized when earned. Interest received on loans sold, less amounts paid to
investors, is reported as loan-servicing income. Capitalized mortgage servicing
rights are amortized in proportion to and over the period of estimated servicing
income. Late charges and other miscellaneous income are recognized when
collected. Costs to service loans are recorded to expense as incurred.
F-14
<PAGE> 125
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
Interest Income -- Interest income is recorded as earned. Interest income
represents the interest earned on loans held for sale during the period prior to
their securitization or other sale, mortgage-related securities, and short term
investments. The Company computes an effective yield based on the carrying
amount of each mortgage-related security and its estimated future cash flow.
This yield is then used to accrue interest income on the mortgage-related
security.
During the period that a Title I loan is 30 days through 270 days
delinquent, the Company previously accrued interest at the HUD guaranteed rate
of 7% in lieu of the contractual rate of the loan. When a Title I loan becomes
over 270 days contractually delinquent, it is placed on non-accrual status and
interest is recognized only as cash is received. As the HUD reserve was depleted
in fiscal 1998, the Company ceased the accrual of interest on delinquent Title I
loans. During the year ended August 31, 1997, interest income on Equity + and
Home Equity loans greater than 90 days delinquent was recognized on a cash
basis. During the year ended August 31, 1998 and the nine months ended May 31,
1999, interest income on Equity + and Home Equity loans greater than 30 days
delinquent was recognized on a cash basis.
Income Taxes -- The Company has historically filed consolidated federal
income tax returns with its former parent, Mego Financial. Income taxes for the
Company were provided for on a separate return basis. As part of a tax sharing
arrangement, the Company had recorded a liability to Mego Financial for federal
income taxes applied to the Company's financial statement income after giving
consideration to applicable income tax law and statutory rates. This liability
was forgiven by Mego Financial at the time of the Recapitalization. The Company
accounts for taxes under SFAS No. 109, "Accounting for Income Taxes" ("SFAS
109"), which requires an asset and liability approach.
The provision for income taxes includes deferred income taxes, which result
from reporting items of income and expense for financial statement purposes in
different accounting periods than for income tax purposes. The Company also
provides for state income taxes at the rate of 6% of income before income taxes
for the years ended August 31, 1996, 1997 and 1998 and for the nine months ended
May 31, 1998 and 1999.
Recently Issued Accounting Standards -- In June 1997, The Financial
Accounting Standards Board (the "FASB") issued SFAS No. 130, "Reporting
Comprehensive Income" ("SFAS 130"), and SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information", ("SFAS 131"). SFAS No. 130
establishes standards for reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements. SFAS No. 131
establishes standards of reporting by publicly-held business enterprises and
disclosure of information about operating segments in annual financial
statements and, to a lesser extent, in interim financial reports issued to
shareholders. SFAS Nos. 130 and 131 are effective for fiscal years beginning
after December 15, 1997. As both SFAS Nos. 130 and 131 deal with financial
statement disclosure, the Company does not anticipate the adoption of these new
standards will have a material impact on its financial position, results of
operations or cash flows. The Company has not yet determined what its reporting
segments will be under SFAS 131.
F-15
<PAGE> 126
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which establishes accounting
and reporting standards for derivative instruments and for hedging activities.
It requires the entity to recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The accounting for changes in fair value of these designated
derivatives ("Hedge Accounting") depends on the intended use and designation. An
entity that elects to apply Hedge Accounting is required to establish at the
inception of its hedge the method it will use for assessing the effectiveness of
the hedging derivative and the measurement approach for determining the
ineffective aspect of the hedge. Those methods must be consistent with the
entity's approach to managing risk. SFAS 133 is effective for the fiscal years
beginning after June 15, 1999. The Company has not yet evaluated the effect of
adopting SFAS 133.
In October 1998, the FASB issued SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by Mortgage Banking Enterprise" ("SFAS 134"), which allows the
reclassification of mortgage-related securities and other beneficial interests
retained after the securitization of mortgage loans held for sale from the
trading category, as required by FASB 115, to either available for sale or held
to maturity based upon the Company's ability and intent to hold those
investments. SFAS 134 is effective for the first quarter beginning after
December 15, 1998. The Company has not yet evaluated the effect of adopting SFAS
134. As of August 31, and May 31, 1999, all mortgage-related securities are
classified as trading securities.
Stock Split -- The accompanying financial statements retroactively reflect
both a 1,600 for 1 stock split, an increase in authorized shares of Common Stock
to 50 million and the establishment of a $.01 par value per share effective
October 28, 1996, an increase in authorized shares of Common Stock to 400
million in June, 1998, and a 1 for 10 reverse stock split effective March 22,
1999.
Reclassification -- Certain reclassifications have been made to conform
prior years with the current year presentation.
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 and disclosures 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.
F-16
<PAGE> 127
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
3. LOANS HELD FOR SALE, ALLOWANCE FOR CREDIT LOSSES, LOAN ORIGINATIONS, AND
LOANS SERVICED
Loans held for sale, net of allowance for credit losses and allowance for
valuation consist of the following:
<TABLE>
<CAPTION>
AUGUST 31, MAY 31,
----------------- ------------
1997 1998 1999
------ -------- ------------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Loans held for sale..................... $9,345 $ 21,860 $ 17,655
Deferred loan fees...................... 278 93 33
Less allowance for credit losses........ (100) (76) (399)
Less allowance for valuation to lower of
cost or market........................ -- (10,902) (1,732)
------ -------- --------
Total......................... $9,523 $ 10,975 $ 15,557
====== ======== ========
</TABLE>
The Company provides an allowance for credit losses in an amount that the
Company believes will be adequate to absorb probable losses after FHA insurance
recoveries on the Title I loans. The Company bases its belief on its continual
review of its portfolio of loans, historical experience and current economic
factors. These reviews take into consideration changes in the nature and level
of the portfolio, historical rates, collateral values, current and future
economic conditions which may affect the obligors' ability to pay and overall
portfolio quality. Changes in the allowance for credit losses and the allowance
for credit losses on loans sold with recourse consist of the following:
<TABLE>
<CAPTION>
FOR THE NINE
MONTHS ENDED
FOR THE YEARS ENDED AUGUST 31, MAY 31,
------------------------------- ---------------
1996 1997 1998 1998 1999
-------- --------- -------- ------ ------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C>
Balance at beginning of
year....................... $ 960 $ 1,015 $ 7,114 $7,114 $2,548
Net provision (benefit) for
credit losses.............. 1,510 23,048 (3,198) 2,404 (276)
Reductions to the provision
due to securitizations or
loans sold without
recourse................... (1,455) (16,748) (0) -- --
Reductions due to charges to
allowance for credit
losses..................... -- (201) (1,368) (89) (1,873)
Increase due to adjustment to
allowance for credit
losses..................... -- -- -- -- --
------- -------- ------- ------ ------
Balance at end of year....... $ 1,015 $ 7,114 $ 2,548 $9,429 $ 399
======= ======== ======= ====== ======
Allowance for credit
losses..................... $ 95 $ 100 $ 76 $1,407 $ 399
Allowance for credit losses
on loans sold with
recourse................... 920 7,014 2,472 8,022 --
------- -------- ------- ------ ------
Total.............. $ 1,015 $ 7,114 $ 2,548 $9,429 $ 399
======= ======== ======= ====== ======
</TABLE>
F-17
<PAGE> 128
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
Changes in the valuation allowance on loans held for sale for the nine
months ended May 31, 1999 consist of the following (thousands of dollars) while
no such valuation allowance was provided for the nine months ended May 31, 1998:
<TABLE>
<S> <C>
Balance at August 31, 1998.................................. $10,901
Provision for valuation changes........................... 714
Reductions to the allowance on loans sold................. (9,883)
-------
Balance at May 31, 1999..................................... $ 1,732
=======
</TABLE>
During fiscal 1997 and 1998 and the nine months ended May 31, 1999, $398.3
million, $0 and $0, respectively, of loans sold under recourse provisions were
repurchased and securitized as further described in Note 2. Reductions to the
provision due to securitizations or loans sold without recourse represent
amounts transferred to the valuation basis of the mortgage-related securities
and reductions in the allowance due to a lack of recourse provisions on loans
sold without recourse. Loans produced and serviced consist of the following:
<TABLE>
<CAPTION>
AUGUST 31, MAY 31,
------------------- -------
1997 1998 1999
-------- -------- -------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Loan production:
Title I.................................. $ 98,085 $ 18,701 $ 0
Equity +................................. 428,832 310,518 2,192
Home Equity.............................. -- 9,723 38,368
-------- -------- -------
Total............................ $526,917 $338,942 $40,560
======== ======== =======
Loans serviced (including notes
securitized, sold to investors, and held
for sale):
Title I.................................. $255,446 $ 23,005 $ 442
Equity +................................. 372,622 8,217 18,144
-------- -------- -------
Total............................ $628,068 $ 31,222 $18,586
======== ======== =======
</TABLE>
4. MORTGAGE-RELATED SECURITIES
Mortgage-related securities consist of interest-only strips and
residual-interest certificates of FHA Title I and Equity + mortgage-backed
securities collateralized by loans produced, purchased and serviced by the
Company.
F-18
<PAGE> 129
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
Mortgage-related securities are classified as trading securities and are
recorded at estimated fair value. Changes in the estimated fair value are
recorded in current operations. Mortgage-related securities consist of the
following:
<TABLE>
<CAPTION>
AUGUST 31, MAY 31,
------------------- -------
1997 1998 1999
-------- ------- -------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Interest-only strip securities................ $ 6,398 $ 2,748 $ 1,558
Residual-interest securities.................. 84,597 28,189 31,364
Interest-only receivables (formerly excess
servicing rights)........................... 15,304 3,893 1,292
-------- ------- -------
Total............................... $106,299 $34,830 $34,214
======== ======= =======
</TABLE>
Activity in total mortgage-related securities consist of the following:
<TABLE>
<CAPTION>
FOR THE NINE
FOR THE YEARS ENDED MONTHS ENDED
AUGUST 31, MAY 31,
------------------- ------------
1997 1998 1999
-------- -------- ------------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Balance at beginning of year.................. $ 22,944 $106,299 $34,830
Additions due to securitizations, at cost..... 135,549 22,469 1,125
Net unrealized (loss)......................... (5,612) (73,390) (920)
Accretion of residual interest................ 6,207 8,467 2,330
Write-off/sale of mortgage-related
securities.................................. (67,040) (27,573) --
Transfer and settlement of recourse
liability................................... -- -- (1,885)
Net transfers from excess servicing rights.... 15,052 -- --
Principal reductions.......................... (801) (1,442) (1,266)
-------- -------- -------
Balance at end of year........................ $106,299 $ 34,830 $34,214
======== ======== =======
</TABLE>
During the year ended August 31, 1998, the Company experienced
significantly higher prepayment activity and delinquencies with regard to its
securitized Equity + and Title I loans than the levels which had been assumed.
This acceleration in the speed of prepayment has caused management, after
consultation with its financial advisors, to adjust the assumptions previously
utilized in calculating the carrying value of its mortgage-related securities.
The Equity + loan prepayment speed assumptions reflect an annualized rate
of 4.5% in the first month following securitization with that annualized rate
building in level monthly increments so that by the 18th month the annualized
rate is 18.75%. The annualized prepayment rate is maintained at that level
through the 36th month at which time it is assumed to decline in level monthly
increments to 15.25% by the 43rd month, and is maintained at 15.25% for the
remaining life of the portfolio. The loss assumptions for Equity + loans have
also been increased to reflect losses commencing in the second
F-19
<PAGE> 130
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
month following a securitization and building in level monthly increments until
a 4.25% annualized loss rate is achieved in the 15th month. The annualized loss
rate is maintained at that level through the 43rd month at which time it is
assumed to decline in level monthly increments to 4.0% at month 48 and is
maintained for the life of the portfolio. On a cumulative basis this model
assumes aggregate losses of approximately 16% of the original portfolio balance.
The estimated loss on Title I loans is reduced by recoveries on defaulted
loans of 5%-10% assuming the Title I insurance has been exhausted. On a
cumulative basis, this assumes aggregate losses of approximately 11.92% of the
original principal balance. The prepayment speed utilized for Title I loans is
23% for the remaining life of the portfolio. The loss assumptions for Title I
loans are based on the aging of each portfolio and a historical migration
analysis resulting in the following estimated default rates:
<TABLE>
<CAPTION>
DELINQUENCY STATUS (IN DAYS) ESTIMATED DEFAULT RATES
- ---------------------------- ----------------------------
<S> <C> <C>
Current.................... 5%
31-60...................... 5%
61-90...................... 20-25%
91-120..................... 50%
121-150.................... 80%
151-180.................... 95%
Over 180................... 100%
</TABLE>
The Company utilized a 16% discount rate at August 31 and May 31, 1999 to
calculate the present value of cash flow streams. Taken in conjunction with the
above prepayment and loss assumptions, management believes these valuations
reflect current market values. Because of the inherent uncertainty of the
valuations, those estimated market values may differ from values that would have
been used had a ready market for the securities existed, and the difference
could be material. The Company has not obtained an independent validation of the
assumptions utilized in calculating the carrying value of mortgage-related
securities for any period subsequent to August 31, 1997.
During fiscal 1996 and 1997, the Company generally utilized annual
prepayment assumptions ranging from 1% to 15%, annual estimated loss factor
assumptions of up to 1.75%, and annual weighted average discount rates of up to
12% for Title I and Equity + loans.
The Company has pledged certain of its interest-only and residual class
certificates, that are included in its mortgage-related securities, pursuant to
the pledge and security agreement with a financial institution. The Company has
also pledged certain residual interests and interest-only securities pursuant to
its revolving credit facility with another financial institution. See Note 9.
F-20
<PAGE> 131
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
5. EXCESS SERVICING RIGHTS
Activity in excess servicing rights for the year ended August 31, 1997
consist of the following (thousands of dollars):
<TABLE>
<S> <C>
Balance at beginning of year................................ $ 12,121
Plus additions.............................................. 3,887
Less amortization........................................... (956)
Less amounts related to loans repurchased, securitized and
transferred to mortgage-related securities................ (15,052)
--------
Balance at end of year...................................... $ --
========
</TABLE>
As of August 31, 1997 and 1998, interest-only receivables consisted of
excess cash flows on serviced loans totaling $88.2 million, and $87.4 million,
yielding weighted-average interest rates of 12.5%, and 12.2% and net of normal
servicing and pass-through fees with weighted-average pass-through yields to the
investor of, 8.8%, and 9.5% respectively. These loans were sold under recourse
provisions as described in Note 2 and the interest-only receivables are included
in Mortgage-Related Securities in the Company's Statement of Financial
Condition.
6. MORTGAGE SERVICING RIGHTS
Activity in mortgage servicing rights consist of the following:
<TABLE>
<CAPTION>
FOR THE NINE
MONTHS ENDED
FOR THE YEARS ENDED AUGUST 31, MAY 31,
-------------------------------- ------------
1996 1997 1998 1999
-------- --------- --------- ------------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C>
Balance at beginning of
year........................ $1,076 $ 3,827 $ 9,507 $ 83
Plus additions................ 3,306 7,184 3,529 --
Less amortization............. (555) (1,504) (3,166) (7)
Less write-down of
valuation................... -- -- (3,870) --
Less sale of servicing
rights...................... -- -- (5,917) (76)
------ ------- ------- ------
Balance at end of year........ $3,827 $ 9,507 $ 83 $ --
====== ======= ======= ======
</TABLE>
The Company had no valuation allowance for mortgage servicing rights during
fiscal 1996, 1997 or 1998, as the cost basis of mortgage servicing rights
approximated fair value.
The Company also entered into an agreement with City Mortgage Services in
June 1998, to acquire and service the majority of the mortgage loans that the
Company owned at the date of the Recapitalization at 90% of its carrying value.
As a result, the Company recorded an impairment of $703,225, which is reflected
in the accompanying Statement of Operations as a charge to Loan Servicing
Income. In addition, the Company and City Mortgage Services entered into an
agreement in June, 1998 for City Mortgage Services to
F-21
<PAGE> 132
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
service all of the mortgage loans produced or purchased by the Company after the
Recapitalization.
7. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
AUGUST 31, MAY 31,
------------------ -------
1997 1998 1999
------ ------- -------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Office equipment and furnishings........ $1,702 $ 1,768 $ 1,754
EDP equipment........................... 948 1,226 2,610
Building improvements................... 144 -- 1
Vehicles................................ 34 -- --
------ ------- -------
2,828 2,994 4,365
Less accumulated depreciation........... (675) (1,181) (1,775)
------ ------- -------
Total......................... $2,153 $ 1,813 $ 2,590
====== ======= =======
</TABLE>
Included in property and equipment as of August 31, 1997 and 1998 and May
31, 1999 are various capitalized leases totaling $1.5 million, $1.8 million and
$1.3 million, net of accumulated amortization of approximately $532,000, $1.1
million and $1.8 million, respectively.
8. OTHER ASSETS
Other assets consist of the following:
<TABLE>
<CAPTION>
AUGUST 31, MAY 31,
------------- --------
1997 1998 1999
----- ----- --------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Accrued income from securitizations............... $537 $111 $ --
Software costs, net of amortization (See Note
15)............................................. 92 31 --
Deposits and impounds............................. 80 81 81
Debt offering costs............................... -- -- 707
Other............................................. 86 141 2,337
---- ---- ------
Total................................... $795 $364 $3,125
==== ==== ======
</TABLE>
F-22
<PAGE> 133
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
9. NOTES AND CONTRACTS PAYABLE
Notes and contracts payable consist of the following:
<TABLE>
<CAPTION>
AUGUST 31, MAY 31,
------------------ -------
1997 1998 1999
------- ------- -------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Note payable -- warehouse line of
credit................................. $ 8,500 $ -- $18,136
Notes payable -- revolving lines of
credit................................. 24,976 9,961 3,343
Term Note................................ -- 4,615 3,769
Contracts payable........................ 2,096 1,769 1,344
------- ------- -------
Total.......................... $35,572 $16,345 $26,592
======= ======= =======
</TABLE>
Loan production was initially funded principally through the Company's
$40.0 million warehouse line of credit that was executed in June 1997 and
increased to $65.0 million in October 1997. This line accrued interest at the
lower of one month LIBOR plus 1.5% or the Federal Funds rate plus 0.25%. At
August 31, 1997, $8.5 million was outstanding under this warehouse line of
credit. This line was paid off with the proceeds of the Recapitalization.
Loan sale transactions generally require the subordination of certain cash
flows payable to the Company to the payment of scheduled principal and interest
due to the loan purchasers. In connection with certain of such sale
transactions, a portion of amounts payable to the Company from the excess
interest spread is required to be maintained in a reserve account to the extent
of the subordination requirements. The subordination requirements generally
provide that the excess interest spread is payable to the reserve account until
a specified percentage of the principal balances of the sold loans is
accumulated therein. The excess interest required to be deposited and maintained
in the respective reserve accounts is not available to support the cash flow
requirements of the Company. At August 31, 1997 and 1998 and May 31, 1999,
amounts on deposit in such reserve accounts totaled $6.9 million, $3.7 million
and $2.9 million, respectively, and are included in Cash Deposits -- Restricted
on the Statement of Financial Position.
As part of the Recapitalization, the Company executed a new warehouse line
of credit for up to $90.0 million with Sovereign Bancorp (the "Sovereign
Warehouse Line"), which replaced the Company's existing warehouse line of
credit. The Sovereign Warehouse Line originally terminated on December 29, 1998
and is renewable, at Sovereign's option, in six-month intervals. During December
1998, the Sovereign Warehouse Line was extended through August 1999. The
Sovereign Warehouse Line may be increased with certain consents and contains
pricing/fees which vary by product and the dollar amount outstanding. The
Sovereign Warehouse Line is to be secured by specific loans held for sale and
includes certain material covenants including maintenance of books and records,
provide financial statements and reports, maintenance of its existence and
properties, maintenance of adequate fidelity bond coverage and insurance and
provision of timely notice of material proceedings. As of August 31, 1998, the
Company had not utilized the
F-23
<PAGE> 134
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
Sovereign Warehouse Line. At May 31, 1999, approximately $18.1 million was
outstanding under the Sovereign Warehouse Line.
In April 1997, the Company entered into a pledge and security agreement
with another financial institution for an $11.0 million revolving credit
facility. The amount which can be borrowed under the agreement was increased to
$15.0 million in June 1997 and $25.0 million in July 1997. This facility is
secured by a pledge of certain of the Company's interest-only and residual class
certificates carried as mortgage-related securities on the Company's Statements
of Financial Condition. A portion of the advances under the credit line
agreement accrues interest at one-month LIBOR + 3.5% (9.1% at August 31, 1998
and 8.4% at May 31, 1999), expiring one year from the initial advance. The
remaining advances accrue interest at one-month LIBOR + 2.0% (7.6% at August 31,
1998 and 6.9% at May 31, 1999). As of August 31, 1998 and May 31, 1999,
approximately $4.9 million and $3.3 million was outstanding under the agreement.
The agreement, which was originally scheduled to mature in December 1998, was
extended until December 1999.
Certain material covenants restrictions exist in the credit agreement
governing the April 1997 revolving line of credit. These covenants include
limitations to incur additional indebtedness, provide adequate collateral and
achieve certain financial tests. These tests include achieving a minimal net
worth (as defined therein) and that the debt-to-net worth ratio (as defined
therein) shall not exceed 2.5:1. As of August 31, 1998, the Company's net worth
was $15.9 million below the minimal required and the debt-to-net worth ratio as
2.93:1. On December 2, 1998, the Company obtained a waiver for the minimal
required net worth and debt-to-net worth ratio for the period that the Company
was not in compliance. Additionally, the Company agreed to pay down the
outstanding borrowings from $10.0 million at August 31, 1998 to $6.0 million at
December 31, 1998 and subsequently agreed to pay the remaining $6.0 million in
equal monthly payments during calendar 1999. As of May 31, 1999, the Company's
net worth was $3.6 million above the minimal required and the debt-to-net worth
ratio was 1.91:1.
In October, 1997, the Company entered into a credit agreement with another
financial institution for an $8.8 million revolving line of credit. This
institution funded $5.0 million of this credit facility. The facility is secured
by a pledge of certain of the Company's mortgage-related securities. The loan
balance under this agreement bears interest at the prime rate plus 2.5% (11.0%
at August 31, 1998 and 10.25% at May 31, 1999). In May, 1998 this loan converted
to a term loan with monthly amortization derived from the cashflow generated
from the respective mortgage-related certificates. This term loan bears interest
at the prime rate plus 2.5% (11.0% at August 31, 1998 and 10.25% at May 31,
1999). The final maturity of this loan is October, 2002. As of August 31, 1998
and May 31, 1999, approximately $4.6 million and $3.8 million was outstanding
under the agreement.
The credit agreement governing the October 1997 revolving line of credit
includes certain material covenants. These covenants include restrictions
relating to extraordinary corporate transactions, maintenance of adequate
insurance and achieving certain financial tests. These tests include achieving a
minimal consolidated adjusted tangible net worth (as
F-24
<PAGE> 135
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
detailed therein) and that the consolidated adjusted leverage ratio (as defined
therein) shall not exceed 3:1. As of August 31, 1998, the Company's consolidated
adjusted tangible net worth was $54.1 million below the minimum required and the
consolidated adjusted leverage ratio was 0.53:1. On December 9, 1998, the
Company agreed to temporarily amend the borrowing base definition for the period
from September 30, 1998 through April 30, 1999 to increase the borrowing base
from 50% to 55%.
On May 31, 1999, the borrowing base returned to 50%. The minimum
consolidated tangible net worth covenant was also adjusted, commencing
retroactively, as of September 30, 1998 and the Company agreed to paydown the
line by approximately $405,000 (the amount exceeding the applicable maximum
amount of tranche credit) and pay an accommodation fee of $10,000. As of May 31,
1999, the Company's consolidated adjusted tangible net worth was $32.7 million
above the minimum required and the consolidated adjusted leverage ratio was
0.60:1.
At August 31, 1997 and 1998, and May 31, 1999, contracts payable consisted
of $2.1 million, $1.8 million and $1.3 million, respectively, in obligations
under lease purchase arrangements secured by property and equipment, bearing a
weighted-average interest rate of 9.25% at August 31, 1998.
Scheduled maturities of the Company's contracts payable of $1.8 million at
August 31, 1998 are as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED AUGUST 31,
--------------------------------
TOTAL 1999 2000 2001 2002 2003
- ------ ---- ---- ---- ---- ----
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C>
$1,769 $534 $525 $425 $268 $17
</TABLE>
10. SUBORDINATED DEBT
In November 1996, the Company consummated the IPO, pursuant to which it
issued 2.3 million shares of Common Stock at $10.00 per share. Concurrently with
the IPO, the Company issued $40.0 million of its Old Notes in an underwritten
public offering. The Company used approximately $13.9 million of the aggregate
net proceeds from these offerings to repay intercompany debt due to Mego
Financial and Preferred Equities Corporation ("PEC") and approximately $24.3
million to reduce the amounts outstanding under the Company's lines of credit.
The balance of the net proceeds has been used to originate loans. At August 31,
1997, $40.0 million principal amount of Old Notes were outstanding. Prepaid debt
expenses related to these notes was $2.4 million at August 31, 1997, and it was
being amortized over the term of the Old Notes. In October 1997, the Company
issued an additional $40.0 million of Old Notes in a private placement, which
increased the aggregate principal amount of outstanding Old Notes from $40.0
million to $80.0 million. The Company used the net proceeds to repay $3.9
million of debt due to Mego Financial, to reduce by $29.0 million the amounts
outstanding under the Company's lines of credit, and to provide capital to
originate and securitize loans. The Old Notes were subject to the Indenture
governing all of the Company's subordinated notes.
F-25
<PAGE> 136
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
As part of the Recapitalization, the Company completed an offer to exchange
(the "Exchange Offer") new subordinated notes and Preferred Stock, subject to
certain limitations, for any and all of the outstanding $80.0 million principal
amount of the Company's Old Notes. The Exchange Offer was conditioned upon at
least $76.0 million aggregate principal amount of Old Notes being tendered for
exchange and conditioned upon at least $30.0 million shares of Common Stock and
Preferred Stock being sold in the offerings. The Company would not have
consummated the Exchange Offer if less than $30.0 million was raised in the
offerings. Pursuant to the Exchange Offer, the Company issued approximately
37,500 shares of Preferred Stock at $1,000 per share, and $41.5 million
principal amount of new 12.5% Subordinated Notes due 2001 (the "Current Notes")
in exchange for approximately $79.0 million principal amount of Old Notes. The
balance of the Old Notes were retired in September and October 1998.
Certain material covenant restrictions exist in the Indenture governing the
Current Notes. These covenants include limitations on the Company's ability to
incur indebtedness, grant liens on its assets and to enter into extraordinary
corporate transactions. The Company may not incur indebtedness if, on the date
of such incurrence and after giving effect thereto, the Consolidated Leverage
Ratio would exceed 1.5:1, subject to certain exceptions. At August 31 and May
31, 1999, the Consolidated Leverage Ratio, as defined herein, was 2.4:1 and
1.48:1, respectively, and the Company could not incur any additional
indebtedness other than permitted indebtedness.
F-26
<PAGE> 137
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
11. INCOME TAXES
As described in Note 2, prior to the Spin-off, the Company recorded a
liability to Mego Financial for federal income taxes at the statutory rate
(currently 34%). State income taxes are computed at the appropriate state rate
(currently an effective rate of 3.5%) net of any available operating loss
carryovers and are recorded as state income taxes payable. Income tax expense
(benefit) has been computed as follows:
<TABLE>
<CAPTION>
FOR THE NINE
MONTHS ENDED
FOR THE YEARS ENDED AUGUST 31, MAY 31,
-------------------------------- -------------------
1996 1997 1998 1998 1999
-------- -------- ---------- -------- --------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C>
Income (loss) before
income taxes.......... $11,155 $23,810 $(125,989) $(86,700) $(13,666)
======= ======= ========= ======== ========
Federal income taxes at
34% of income......... $ 3,793 $ 8,095 (40,683) (29,478) (4,646)
Lost benefits due to
change in control..... -- -- 27,142 -- --
Valuation allowance..... -- -- 7,715 32,513 --
Tax affect of
extraordinary item....
Federal tax of
$2,618............. 2,888
State tax of $270.....
State income taxes, net
of federal income tax
benefit............... 442 943 (553) (3,035) (531)
Other................... -- 24 45 -- --
------- ------- --------- -------- --------
Income tax expense
(benefit)............. $ 4,235 $ 9,062 $ (6,334) $ -- $ (2,289)
======= ======= ========= ======== ========
Income tax expense
(benefit) is comprised
of the following:
Current............... $ 3,562 $12,319 $ (405) $ -- $ --
Deferred.............. 673 (3,257) (5,929) -- (2,289)
------- ------- --------- -------- --------
Total......... $ 4,235 $ 9,062 $ (6,334) $ -- $ (2,289)
======= ======= ========= ======== ========
</TABLE>
F-27
<PAGE> 138
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
Deferred income taxes reflect the net tax effects of (a) temporary
differences between the carrying amount of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes, (b) temporary
differences between the timing of revenue recognition for book purposes and
income tax purposes and (c) operating loss and tax credit carry forwards. The
tax effects of significant items comprising the Company's net deferred tax asset
are as follows:
<TABLE>
<CAPTION>
AUGUST 31, MAY 31,
---------------------- --------
1997 1998 1999
------- --------- --------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Deferred tax assets:
Realized gain on mortgage-related
securities......................... $2,373 $ 9,838 $ 9,948
Net operating loss carry forward...... -- 6,002 8,369
Receivable due from carrybacks and
payments........................... -- 2,511 --
Other................................. 91 -- 5
------ -------- --------
2,464 18,351 18,322
------ -------- --------
Deferred tax liabilities:
Provision for loan loss............... -- 2,196 1,892
Difference between book and tax
carrying value of assets........... 110 -- --
------ -------- --------
110 2,196 1,892
------ -------- --------
Net deferred tax asset before
valuation............................. 2,354 16,155 16,430
------ -------- --------
Less valuation allowance................ -- (7,715) (7,219)
------ -------- --------
Net deferred tax asset.................. $2,354 $ 8,440 9,211
====== ======== ========
</TABLE>
Beginning September 1, 1997, the Company filed a separate tax return for
both federal and state tax purposes. On July 1, 1998, the Company had a change
in control as defined by Section 382 of the Internal Revenue Code. As a result
of this change in control, no material tax benefit is available to the Company
attributed to losses incurred prior to July 1, 1998. Accordingly, a deferred tax
asset has not been recorded for losses incurred prior to this date.
The Company has provided a partial valuation allowance against the net
deferred tax assets recorded as of August 31, 1998 and May 31, 1999 due to
uncertainties as to their ultimate realization. The net operating loss generated
subsequent to July 1, 1998 will expire in the year 2018. In the event of any
future ownership changes, Section 382 of the Internal Revenue Code imposes
certain restrictions on the amount of net operating loss carry forwards that can
be used in any year by the Company.
F-28
<PAGE> 139
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
12. STOCKHOLDERS' EQUITY
General In November 1996, additional paid-in capital was increased by $20.6
million due to the sale of 2.3 million shares of Common Stock, net of issuance
costs, in the IPO.
Prior to the Spin-off, the Company filed a consolidated federal income tax
return with Mego Financial's affiliated group under a Tax Allocation and
Indemnity Agreement ("Tax Agreement"). As a result of the Spin-Off, $2.4 million
due to Mego Financial under the Tax Agreement was recorded as a deferred tax
asset and as additional paid-in capital. Additionally, in April 1998, an
agreement was made to adjust by $6.2 million the income tax portion of a payable
that the Company owed Mego Financial under the Tax Agreement. The final
settlement of the $6.2 million is recorded as an additional capital contribution
as if the settlement occurred on the date of Spin-off.
In July 1998, the Company issued 62,500 shares of Preferred Stock and
approximately 18.27 million shares of Common Stock in the Recapitalization. As a
result, additional paid-in capital increased by $84.5 million.
Earnings Per Share Data utilized in calculating actual earnings per share
under SFAS 128 is as follows:
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
FOR THE YEARS ENDED AUGUST 31, MAY 31,
------------------------------- --------------------------
1997 1998 1998 1999
------------- --------------- ------------ -----------
<S> <C> <C> <C> <C>
BASIC:
Net income (loss)........ $14,748,000 $(119,655,000) $(86,700,000) $(3,677,000)
=========== ============= ============ ===========
Weighted-average number
of common shares....... 1,180,219 1,550,293 1,230,000 3,056,666
=========== ============= ============ ===========
DILUTED:
Net income (loss)........ $14,748,000 $(119,655,000) $(86,700,000) $(3,677,000)
=========== ============= ============ ===========
Weighted-average number
of common shares and
assumed conversions.... 1,180,219 1,550,293 1,230,000 3,056,666
=========== ============= ============ ===========
</TABLE>
F-29
<PAGE> 140
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
The following tables reconcile the net income applicable to Common
Stockholders, basic and diluted shares, and EPS for the following periods:
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31, 1997 YEAR ENDED AUGUST 31, 1998
------------------------------------ --------------------------------------
PER-SHARE PER-SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
----------- ---------- --------- ------------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Net income (loss)..... $14,748,000 $(119,655,000)
----------- -------------
BASIC EPS
Income (loss)
applicable to Common
Stockholders........ 14,748,000 1,180,219 $12.50 (119,655,000) 1,550,293 $(77.18)
----------- ---------- ------ ------------- ---------- -------
Effect of dilutive
securities:
Warrants............ -- -- -- -- -- --
Stock options....... -- -- -- -- -- --
----------- ---------- ------------- ----------
DILUTED EPS
Income (loss)
applicable to Common
Stockholders and
assumed
conversions......... $14,748,000 1,180,219 $12.50 $(119,655,000) 1,550,293 $(77.18)
=========== ========== ====== ============= ========== =======
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED
MAY 31, 1998 MAY 31, 1999
------------------------------------ -----------------------------------
PER-SHARE PER-SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
------------ --------- --------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Net (loss)............... $(86,700,000) $(3,677,000)
------------ -----------
BASIC EPS
(Loss) applicable to
Common Stockholders.... (86,700,000) 1,230,000 $(70.49) (3,677,000) 3,056,666 $(1.20)
------------ --------- ------- ----------- --------- ------
Effect of dilutive
securities:
Warrants............... -- -- -- -- -- --
Stock options.......... -- -- -- -- -- --
------------ --------- ----------- ---------
DILUTED EPS
(Loss) applicable to
Common Stockholders and
assumed conversions.... $(86,700,000) 1,230,000 $(70.49) $(3,677,000) 3,056,666 $(1.20)
============ ========= ======= =========== ========= ======
</TABLE>
Stock options after the years ended August 31, 1997 and 1998 and the nine
month periods ended May 31, 1998 and 1999 are anti-dilutive. The earnings per
share for the year ended August 31, 1996 is not presented because the Company
was a wholly-owned subsidiary of Mego Financial Corporation.
13. STOCK OPTIONS
The Company has several stock option plans ("1996 Stock Option Plan" and
"1997 Stock Option Plan", collectively the "Stock Option Plans") for officers
and employees which provide for both incentive stock options and non-qualified
incentive options. The Company's Board of Directors (the "Board") determines the
option price (not to be less than fair value for incentive stock options) at the
date of grant. The options generally
F-30
<PAGE> 141
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
expire ten years from the date of grant and as a result of a change in control
of the Company, in conjunction with the recapitalization, all options
outstanding on June 28, 1998 became fully exercisable. All other options granted
subsequent to the recapitalization, are exercisable at various points in time
ranging from fully exercisable at grant date to 33% increments over 3 years. In
addition, the Board is authorized to grant stock appreciation rights ("SARs")
under the Stock Option Plans to any person who has rendered services to the
Company.
During August 1997, all stock options outstanding under the 1996 Stock
Option Plan were converted into SARs. As of August 31, 1997, an aggregate of
915,000 SARs were issued and outstanding under the 1996 Stock Option Plan. As a
result no SFAS 123 disclosures were required for the fiscal year ended August
31, 1997.
In October 1997, the Board voted to purchase all of the outstanding SARs
under the Stock Option Plans at $1.00 per share for SARs previously held at
$10.00 to $11.00 per share and $0.70 per share for SARs held at $12.00 per
share. During the year ended August 31, 1998, $761,250, (excluding payroll tax
items) was expensed related to the purchase of SARs.
Additionally, in October 1997, the Board voted, subject to stockholder
approval, to amend the Company's 1997 Stock Option Plan to increase the number
of shares of stock reserved for issuance upon the exercise of options to
purchase Common Stock granted from one million to two million shares.
A summary of the stock options granted under the Stock Option Plans as of
August 31, 1997 and 1998 and the changes during the years ending on those dates
is presented below:
<TABLE>
<CAPTION>
AS OF AUGUST 31, 1997 AS OF AUGUST 31, 1998
----------------------------- ------------------------------
SHARES WEIGHTED-AVERAGE SHARES WEIGHTED AVERAGE
(000) EXERCISE PRICE (000) EXERCISE PRICE
---------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C>
Outstanding at
beginning of
year............... 0 $ 0 0 $ 0
Granted.............. 915,000 10.22 19,354,425 2.23
Exercised............ 0 0 0 0
Forfeited............ 915,000 10.22 620,000 14.75
Outstanding at end of
year............... 0 0 18,734,425 1.81
Options Exercisable
at year end........ 0 0 582,500 11.57
Weighted-average fair
value of options
granted during the
year............... $6,115,516 $24,238,512
</TABLE>
F-31
<PAGE> 142
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
The following table summarizes information about stock options outstanding
at August 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- ------------------------------
NUMBER WEIGHTED-AVERAGE NUMBER
RANGE OF OUTSTANDING REMAINING WEIGHTED-AVERAGE EXERCISABLE WEIGHTED-AVERAGE
EXERCISE PRICES AT 8/31/98 CONTRACTUAL LIFE EXERCISE PRICE AT 8/31/98 EXERCISE PRICE
--------------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
1.50 18,291,925 4.01 1.50 140,000 1.50
14.75 442,500 5.08 14.75 442,500 14.75
</TABLE>
SFAS 123 establishes financial accounting and reporting standards for
stock-based employee compensation plans and for transactions in which an entity
issues its equity instruments to acquire goods or services from non-employees.
Those transactions must be accounted for based on the fair value of the
considerations received or the fair value of the equity instruments issued,
whichever is more reliably measured. The Company elected to continue to apply
the provisions of Accounting Principles Bulletin ("APB") Opinion 25 as permitted
by SFAS 123 and accordingly, provides pro forma disclosure.
The fair value of each option granted during the year ended August 31, 1998
is estimated on the date of grant using the Black-Scholes option-pricing model
with the following assumptions: (1) dividend yield of zero; (2) expected
volatility of 48.9%; (3) risk-free interest rate of 5.45% and; (4) expected life
of two to ten years. The weighted average fair value of the options granted
during the year ended August 31, 1998 was $24,238,512. As of August 31, 1998,
there were 18,734,425 options outstanding which have an exercise price ranging
from $1.50 to $14.75 per common share and a weighted average contractual life of
4.21 years.
14. RETIREMENT PLAN
The Company participates in a defined contribution plan (the "Plan") with a
plan year end of December 31st. During fiscal 1996 and 1997, the Company
participated in PEC's defined contribution plan. Effective January 1, 1998, the
Company established its owned defined contribution plan. Employees may
contribute between 1% and 15% of their gross salary. The Company's matching
contribution equals 25% of the first 6% of gross salary that the participant
elects to contribute to the Plan. In addition, the Company may elect to make an
additional matching contribution or qualified nonelective contribution, as
defined in the Plan document, at its discretion. For the years ended August 31,
1996, 1997 and 1998, the Company contributed approximately $14,116, $24,779 and
$80,391, respectively, to the Plan.
15. RELATED PARTY TRANSACTIONS
Preferred Equity Corporation (PEC) During the years ended August 31, 1996,
1997 and 1998 and the nine months ended May 31, 1998 and 1999, PEC, a wholly
owned subsidiary of Mego Financial, provided certain services to the Company
including loan servicing and collection for a cost of $709,000, $1.9 million,
$2.2 million, $0, and $0
F-32
<PAGE> 143
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
respectively, which is included in general and administrative expense. In
addition, PEC provided services including executive, accounting, legal,
management information, data processing, human resources, advertising, and
promotional materials (management services), totaling $671,000, $967,000,
$617,000, $542,000 and $0, which were included in general and administrative
expenses for the years ended August 31, 1996, 1997 and 1998, and the nine months
ended May 31, 1998 and 1999, respectively. Included in other interest expense
for the years ended August 31, 1996, 1997 and 1998, and the nine months ended
May 31, 1998 and 1999, are $29,000, $16,000, $0, $0, and $0, respectively,
related to advances from PEC.
During the year ended August 31, 1996, the Company paid PEC for developing
certain computer programming (see Note 8), incurring costs of $56,000. No such
costs were incurred during the years ended August 31, 1997 and 1998 and the nine
months ended May 31, 1999. The Company is amortizing these costs over a five
year period. During fiscal 1996, 1997 and 1998 and the nine months ended May 31,
1998 and 1999, amortization of $29,000, $62,000, $62,000, $46,000 and $31,000
respectively, was included in expense. As of August 31, 1998, the Company had
terminated the management services and loan servicing agreement with PEC.
Management believes the allocation methodologies and contractual
arrangements for services performed by PEC have been reasonable and are
representative of an approximation of the expense the Company would have
incurred had it operated as a stand alone entity performing such services.
Mego Financial Corporation In April 1998, an agreement was made to reduce
by $5.3 million the income tax portion of a payable that the Company owed Mego
Financial under a Tax Allocation and Indemnity Agreement dated November 19,
1996. The Company filed a consolidated federal tax return with Mego Financial's
affiliated group prior to the Spin-off under such Tax Allocation and Indemnity
Agreement. The final settlement of the amount payable is recorded as an
additional capital contribution as if the settlement occurred on the date of the
Spin-off.
At August 31, 1996, 1997 and 1998, and May 31, 1999, the Company had a non-
interest bearing liability to Mego Financial of $12.0 million, $9.7 million,
$6.2 million and $0, respectively, for federal income taxes and cash advances
which is included in Accounts Payable in the accompanying Statements of
Financial Position.
F-33
<PAGE> 144
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
Activity in Due to Mego Financial consists of the following:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED AUGUST 31,
--------------------------------
1996 1997 1998
--------- -------- ---------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Balance at beginning of year............... $ 8,453 $11,994 $ 9,653
Provision for federal income taxes......... 3,566 7,630 (5,284)
Cash advances from Mego Financial.......... 5,475 5,123 --
Forgiveness of advances.................... -- -- (869)
Repayment of advances...................... (5,500) (15,094) (3,500)
-------- ------- --------
Balance at end of year..................... $ 11,994 $ 9,653 $ 0
======== ======= ========
Average balance during the year............ $ 11,874 $ 6,876 $ 3,624
======== ======= ========
</TABLE>
Greenwich Capital Markets Champ Meyercord, the Company's Chairman of the
Board and Chief Executive Officer, was formerly a senior investment banker at
Greenwich Capital Markets ("Greenwich"). In October 1996, Greenwich agreed to
purchase $2.0 billion of loans over a five year period from the Company. The
Company has sold Greenwich approximately $800.0 million in loans from the
inception of the agreement. The agreement with Greenwich was terminated in June
1998 and the Company has no further obligation under the agreement.
In April 1997, the Company entered into a pledge and security agreement
with Greenwich for an $11.0 million revolving credit facility. The amount which
could be borrowed under the agreement was increased to $15.0 million in June
1997 and to $25.0 million in July 1997. As of August 31, 1998 and May 31, 1999,
approximately $10.0 million and $3.3 million was outstanding under the
agreement. Amounts borrowed under this facility are secured by certain of the
Company's mortgage-related securities. The Company was in default under the
first credit facility as a result of a default under the indenture governing the
Old Notes. The default was waived on December 2, 1998 effective August 31, 1998.
Additionally, the Company agreed to pay down the outstanding borrowings from
$10.0 million at August 31, 1998 to $6.0 million at December 31, 1998 and
subsequently agreed to pay the remaining $6.0 million in equal monthly payments
during calendar 1999. As of May 31, 1999, the Company's net worth was $32.7
million above the minimal required and the debt-to-net worth ratio was 0.60:1.
The agreement, which was originally scheduled to mature in December 1998, was
extended until December 1999.
Friedman, Billings, Ramsey & Co., Inc. Friedman, Billings, Ramsey & Co.,
Inc. ("FBR") served as placement agent for the Old Notes pursuant to a placement
agreement (the "Placement Agreement"). Under the terms of the Placement
Agreement, the Company paid the placement agent a fee of 1.6 million shares of
common stock representing 6.0% of the gross proceeds received by the Company
from the shares of Common Stock and Preferred Stock in the Recapitalization. The
gross proceeds did not include $10.0 million of common stock acquired by an
affiliate of FBR received by the
F-34
<PAGE> 145
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
Company from the shares of common stock and preferred stock in the
Recapitalization. In addition, the Company has agreed, pursuant to the Placement
Agreement, to indemnify the Placement Agent against certain liabilities,
including liabilities under the Securities Act, and other liabilities incurred
in connection with the Recapitalization.
According to FBR, as of December 1, 1998, Friedman, Billings, Ramsey Group,
Inc. ("FBRG"), through its three wholly owned subsidiaries, Friedman, Billings,
Ramsey Investment Management, Inc. ("Investment Management"), FBR Offshore
Management, Inc. ("Offshore Management") and Orkney Holdings, Inc. ("Orkney"),
had sole voting and dispositive power with respect to 5,359,116 shares of Common
Stock. FBR has advised the Company that it may at any time hold long or short
positions in such securities. Investment Management serves as general partner
and discretionary investment manager for FBR Ashton, L.P. ("Ashton") which, as
of December 1, 1998, owned 824,187 shares of Common Stock. Offshore Management
serves as discretionary manager for FBR Opportunity Fund, Ltd. ("Opportunity
Fund") which, as of December 1, 1998, owned 82,622 shares of Common Stock. Each
of FBRG, Investment Management and Offshore Management disclaims beneficial
ownership of shares of Common Stock owned by the other two entities. Orkney is a
wholly owned subsidiary of FBRG which, as of December 1, 1998, owned 4,452,307
shares of Common Stock and 2,125 shares of Preferred Stock (which are
convertible into an aggregate of 1,416,673 shares of Common Stock). Each of
FBRG, Ashton, Opportunity Fund and Orkney disclaims beneficial ownership of
shares of Common Stock owned by the other three entities. In addition, Emmanuel
J. Friedman, Eric F. Billings and W. Russell Ramsey are each control persons
with respect to FBR. In addition, Emmanuel J. Friedman owns and has shared
voting and dispositive power with his wife over an additional 6,766,667 shares
of Common Stock.
In addition, FBR was a managing underwriter for the Company's initial
public offering and the Company's offering of the Current Notes, and was the
purchaser of Current Notes. FBR received compensation for such services and the
Company agreed to indemnify FBR against certain liabilities, including
liabilities under the Securities Act, and other liabilities arising in
connection with such offerings. In addition, FBR has in the past provided
certain investment banking services to the Company and affiliates of the
Company.
During fiscal 1998, the Company paid FBR 1.6 million shares of common stock
for its fee in conjunction with the Recapitalization. Additionally, the Company
has reimbursed FBR for out-of-pocket expenses totaling approximately $250,000.
FBR is also entitled to a cash fee of $416,667 in connection with the
recapitalization.
Sovereign Bancorp and City Mortgage Services
As a result of their investment in the Company in the recapitalization,
both Sovereign Bancorp and City Mortgage Services have a substantial ownership
position in the Company. As part of the Recapitalization, the Company, entered
into agreements with Sovereign Bancorp, for a new $90.0 million warehouse line,
(subject to the availability of collateral), and a mortgage loan purchase and
sale commitment. As of August 31, 1998,
F-35
<PAGE> 146
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
the Company had not utilized the Sovereign warehouse line. At May 31, 1999,
approximately $18.1 million was outstanding under the Sovereign warehouse line.
The Company also entered into an agreement with City Mortgage services to
acquire and service all of the mortgage loans that the Company owned at the date
of the Recapitalization at 90% of its carrying value for approximately $5.9
million. The Company, as a result, recorded an impairment of $703,225, which is
reflected in the accompanying Statement of Operations as a charge to Loan
Servicing Income. In addition, the Company and City Mortgage Services entered
into an agreement for City Mortgage Services to acquire and service all of the
mortgage loans produced or purchased by the Company after the Recapitalization
on a servicing-retained basis. During August 1998 and the six months ended May
31, 1999, the Company paid City Mortgage Services approximately $9,000 and
approximately $118,000, respectively, to service the Company's loans.
Other
In June 1998, the Company retained Spencer I. Browne, a member of the
Company's Board of Directors, as a special consultant to the Company. In
connection with certain business development activities of the Company during
the period beginning May 15, 1998 and ending December 31, 1998, the Company has
paid a total of approximately $177,500 to Strategic Asset Management, LLC for
Mr. Browne's services and reimbursement of out-of-pocket expenses. In addition,
the Company has tentatively agreed to grant Mr. Browne options to purchase
500,000 shares of the Company's common stock. The stock options have an exercise
price of equal to the cost of common stock in the Recapitalization of $1.50 per
share. During this period, Mr. Browne continued as a Director of the Company.
16. COMMITMENTS AND CONTINGENCIES
Leases. The Company leases office space and equipment under operating
leases that expire at various dates through February 2003. The office space
lease is subject to an annual rent escalation of 2%. During fiscal 1996, 1997
and 1998, the Company's rent expense totaled $338,000, $1.2 million and $1.6
million respectively. Future minimum payments at August 31, 1998 under these
operating leases are set forth below (thousands of dollars):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED AUGUST 31,
- ------------------------------
<S> <C>
1999........................................................ $1,478
2000........................................................ 1,336
2001........................................................ 1,208
2002........................................................ 844
2003........................................................ 15
------
Total............................................. $4,881
======
</TABLE>
On October 8, 1998, the Office of the Consumer Credit Commissioner of the
State of Texas issued a denial of the Company's application for licensing as a
secondary mortgage
F-36
<PAGE> 147
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
lender. On October 20, 1998, the Company filed an appeal of the Commissioner's
decision. An administrative hearing on this matter has been scheduled for April
22, 1999.
On February 23, 1998, an action was filed in the United States District
Court for the Northern District of Georgia by Robert J. Feeney, as a purported
class action against the Company and Jeffrey S. Moore, the Company's former
President and Chief Executive Officer. The complaint alleges, among other
things, that the defendants violated the federal securities laws in connection
with the preparation and issuance of certain of the Company's financial
statements. The named plaintiff seeks to represent a class consisting of
purchasers of the Common Stock between April 11, 1997 and December 18, 1997, and
seeks damages in an unspecified amount, costs, attorney's fees and such other
relief as the court may deem proper. On June 30, 1998, the plaintiff amended the
complaint to add additional plaintiffs, to add as a defendant Mego Financial,
the Company's former parent, and to extend the class period through and
including May 20, 1998. On September 18, 1998, the Company, Jeffrey S. Moore and
Mego Financial filed motions to dismiss the complaint. On April 8, 1999, the
court granted each of these motions. In the court's order dismissing the
complaint, the plaintiffs were permitted, upon proper motions, to serve and file
a second amended (and redrafted) complaint within 30 days. On May 10, 1999, the
Plaintiffs moved for leave to file and serve the second amended and redrafted
complaint contemplated in the earlier order.
In the general course of business, the Company, at various times, has been
named in lawsuits. The Company believes that it has meritorious defenses to
these lawsuits and that resolution of these matters will not have a material
adverse affect on the business or financial condition, results of operation or
cash flows of the Company.
Other Commitments. In the first quarter of fiscal 1997, the Company
entered into an agreement with Greenwich Capital Markets providing for the
purchase of up to $2.0 billion of loans over a 5 year period. Pursuant to the
agreement, Mego Financial issued to Greenwich Capital Markets four-year warrants
to purchase 1 million shares of Mego Financial's Common Stock at an exercise
price of $7.125 per share. The value of the warrants of $3.0 million plus a
$150,000 fee (0.15% of the commitment amount) as of the commitment date (the
"Warrant Value"), were being amortized as the commitment for the purchase of
loans was utilized.
In December, 1997, an agreement was reached with Greenwich Capital Markets
in regards to various modifications to the master purchase agreement, in return
for which the Company agreed to pay $1.0 million in December 1997, with a
further $1.0 million to be paid in quarterly installments in 1998.
As part of the Recapitalization, the Company terminated its existing master
purchase agreement with Greenwich Capital Markets. In connection with the
termination of this master purchase agreement, the remaining unamortized prepaid
commitment fees totaling approximately $2.8 million were written-off and are
reflected as a loss on the sale of loans in the Company's Statement of
Operations.
F-37
<PAGE> 148
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
17. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosure about Fair Value of Financial Instruments" ("SFAS
107"), requires disclosure of estimated fair value information for financial
instruments, whether or not recognized in the Statements of Financial Condition.
Fair values are based upon estimates using present value or other valuation
techniques in cases where quoted market prices are not available. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. In that regard, the derived
fair value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate settlement of the
instrument. SFAS 107 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Company.
Estimated fair values, carrying values and various methods and assumptions
used in valuing the Company's financial instruments at August 31, 1997 and 1998
and May 31, 1999 are set forth below:
<TABLE>
<CAPTION>
AUGUST 31, 1997 AUGUST 31, 1998 MAY 31, 1999
------------------------- ------------------------- -------------------------
CARRYING ESTIMATED FAIR CARRYING ESTIMATED FAIR CARRYING ESTIMATED FAIR
VALUE VALUE VALUE VALUE VALUE VALUE
-------- -------------- -------- -------------- -------- --------------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C> <C>
FINANCIAL ASSETS:
Cash and cash
equivalents(a).... $ 6,104 $ 6,104 $36,404 $36,404 $ 9,231 $ 9,231
Loans held for sale,
net(b)............ 9,523 11,414 10,975 10,975 15,557 15,557
Mortgage-related
securities(c)..... 106,299 106,299 34,830 34,830 34,214 34,214
Mortgage-servicing
rights(c)......... 9,507 9,507 83 83 -- --
FINANCIAL LIABILITIES:
Notes and contracts
payable(d)........ 35,572 35,572 16,345 16,345 26,592 26,592
Subordinated
debt(e)........... 40,000 40,000 42,693 32,020 30,750 16,144
</TABLE>
- -------------------------
(a) Carrying value was used as the estimate of fair value.
(b) Since it is the Company's business to sell loans it makes, the fair value
was estimated by using outstanding commitments from investors adjusted for
non-qualified loans and the collateral securing such loans.
(c) The fair value was estimated by discounting future cash flows of the
instruments using discount rates, default, loss and prepayment assumptions
based upon available market data, opinions from investment bankers and
portfolio experience. As part of the Recapitalization, an agreement was
reached with City Mortgage Services for the sale of the Mortgage Servicing
Rights at 90% of their computed carrying value. The Company, as a result,
recorded an impairment of $703,225, which is reflected in the accompanying
Statement of Operations as a charge to Loan Servicing Income.
F-38
<PAGE> 149
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
(d) Notes payable generally are adjustable rate, indexed to the prime rate;
therefore, carrying value approximates fair value. Contracts payable
represent capitalized equipment leases with a weighted-average interest
rate of 9.32% at August 31, 1997, 9.25% at August 31, 1998 and 9.23% at May
31, 1999, which approximates fair value.
(e) The fair value was calculated based upon estimated market prices obtained
from investment bankers.
At August 31, 1997 and 1998, the Company had $190.5 million and $3.6
million, respectively, in outstanding commitments to originate and purchase
loans. The fair value of the commitments was estimated at $14.9 million at
August 31, 1997 and $145,000 at August 31, 1998. The fair values were calculated
based on a theoretical gain or loss on the sale of a funded loan adjusted for an
estimate of loan commitments not expected to fund, considering the difference
between investor yield requirements and the committed loan rates. The estimated
fair value is not necessarily representative of the actual gain to be recorded
on such loan sales in the future.
The fair value estimates made at August 31, 1997 and 1998 and May 31, 1999
were based upon pertinent market data and relevant information on the financial
instruments at that time. These estimates do not reflect any premium or discount
that could result from the sale of the entire portion of the financial
instruments. Because no market exists for a substantial portion of the financial
instruments, fair value estimates are based upon judgments regarding future
expected loss experience, current economic conditions, 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 assumptions could
significantly affect the estimates. The Company had no other off-balance sheet
instruments at August 31, 1997 and 1998 and May 31, 1999.
Fair value estimates are based upon existing on-and off-balance sheet
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. [For instance, the Company has certain fee-generating
business lines (e.g., its loan servicing operations) that were not considered in
these estimates since these activities are not financial instruments.] In
addition, the tax implications related to the realization of the unrealized
gains and losses can have a significant effect on fair value estimates and have
not been considered in any of the estimates.
18. CONCENTRATIONS OF RISK
Availability of Funding Source -- The Company funds substantially all of
the loans which it produces or purchases with borrowings through its financing
facilities and internally generated funds, as well as public and private sales
of debt and equity securities. These borrowings are in turn repaid with the
proceeds received by the Company from selling such loans through loan sales or
securitizations. Any failure to renew or obtain adequate financing under its
financing facilities, or other borrowings, or any substantial reduction in the
size of or pricing in the markets for the Company's loans, could have a
F-39
<PAGE> 150
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
material adverse effect on the Company's operations. To the extent that the
Company is not successful in maintaining or replacing its existing financing, it
would have to curtail its loan production activities or sell loans earlier than
is optimal, thereby having a material adverse effect on the Company's financial
condition, results of operations and cash flows.
Dependence on Securitizations -- In 1996, 1997 and to a lesser extent in
1998, the Company pooled and sold through securitizations a significant
percentage of the loans that it produced. The Company historically has derived a
significant portion of its income by recognizing gains on sale of loans through
securitizations. Adverse changes in the securitization market could impair the
Company's ability to sell loans through securitizations on a favorable or timely
basis. Any such impairment could have a material adverse effect upon the
Company's financial condition, results of operations and cash flows.
The Company has relied on credit enhancement and over-collateralization to
generally achieve the "AAA/Aaa" rating for the senior interests in its
securitizations. The credit enhancement has generally been in the form of an
insurance policy issued by an insurance company insuring the timely repayment of
senior interests in each of the trusts. The Company's last three securitizations
were completed without the requirement of an insurance policy. There can be no
assurance that the Company will be able to obtain credit enhancement in any form
from the current insurer or any other provider of credit enhancement on
acceptable terms or that future securitizations will be similarly rated. A
downgrading of the insurer's credit rating or its withdrawal of credit
enhancement could have a material adverse effect on the Company's financial
condition, results of operations and cash flows.
Geographic Concentrations -- The Company's servicing portfolio and loans
sold with recourse are geographically diversified within the United States. At
August 31, 1997 and 1998, 26% of the loans in the Company's portfolio had been
produced in California, and 15% in Florida. No other state accounted for more
than 10% of the servicing portfolio for either period. The risk inherent in such
concentrations is dependent upon regional and general economic stability which
affects property values and the financial stability of the borrowers.
Credit Risk -- The Company is exposed to on-balance sheet credit risk
related to its loans held for sale and mortgage-related securities. The Company
is exposed to off-balance sheet credit risk related to loans which the Company
has committed to originate and loans sold under recourse provisions. The
outstanding balance of loans sold with recourse provisions totaled $88.2 million
and $87.4 million at August 31, 1997 and 1998, respectively.
Off-Balance Sheet Activities -- These financial instruments consist of
commitments to extend credit to borrowers and commitments to purchase loans from
others. As of August 31, 1997 and 1998, the Company had outstanding commitments
to extend credit or purchase loans in the amounts of $190.5 million and $3.6
million, respectively. These commitments do not represent the expected total
cash outlay of the Company, as historically only 40% of these commitments result
in loan production or purchases. The
F-40
<PAGE> 151
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
prospective borrower or seller is under no obligation as a result of the
Company's commitment. The Company's credit and interest rate risk is therefore
limited to those commitments which result in loan production and purchases. The
commitments are made for a specified fixed rate of interest, therefore the
Company is exposed to interest rate risk, to the extent changes in market
interest rates change prior to the origination and prior to the sale of the
loan.
Interest Rate Risk -- The Company's profitability is in part determined by
the difference, or "spread," between the effective rate of interest received on
the loans produced or purchased by the Company and the interest rates payable
under its financing facilities during the warehousing period and yield required
by investors on loan sales and securitizations. The spread can be adversely
affected after a loan is produced or purchased and while it is held during the
warehousing period by increases in the interest rate demanded by investors in
securitizations or sales. In addition, because the loans produced and purchased
by the Company have fixed rates, the Company bears the risk of narrowing spreads
because of interest rate increases during the period from the date the loans are
produced or purchased until the closing of the sale or securitization of such
loans. Additionally, the fair value of mortgage related securities and mortgage
servicing rights owned by the Company may be adversely affected by changes in
the interest rate environment which could effect the discount rate and
prepayment assumptions used to value the assets. Any such adverse change in
assumptions could have a material adverse effect on the Company's financial
condition, results of operations and cash flows.
19. SUBSEQUENT EVENTS
In September and October 1998, the Company repurchased the remaining
$250,000 and $651,000, respectively, principal amounts of the Old Notes issued
November 22, 1996 for 101% of the principal balance and accrued interest at
13.5%.
On October 2, 1998, an action was filed in the United States District Court
for the Western Division of Tennessee by Traci Parris, as a purported class
action against Mortgage Lenders Association Inc., the Company and City Mortgage
Services, Inc., one of the Company's strategic partners. The complaint alleges,
among other things that the defendants charged interest rates, origination fees,
and loan brokerage commissions in excess of those allowed by law. The named
plaintiff seeks to represent a class of borrowers and seeks damages in an
unspecified amount, reform or nullification of loan agreements, injunction,
costs, attorney's fees and such other relief as the court may deem just and
proper. On October 27, 1998, the Company filed a motion to dismiss the
complaint, The Company believes it has meritorious defenses to this lawsuit and
that any resolution of this matter will not result in a material adverse effect
on the business or financial condition of the Company.
On October 8, 1998, the Office of the Consumer Credit Commissioner of the
State of Texas issued a denial of the Company's application for licensing as a
secondary mortgage lender. On October 20, 1998, the Company filed an appeal of
the Commissioner's decision and an administrative hearing has been set for
December 3, 1998. The administrative
F-41
<PAGE> 152
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
hearing, originally set for December 3, 1998, was postponed and no new hearing
date has been scheduled. The denial will not become final until the Company's
appeal has been resolved. The Company believes that it is capable of meeting
such requirements as the Commissioner may set to amend the Company's license
application. If the denial becomes final, the Company will not be able to make
secondary mortgage loans in the State of Texas at interest rates greater than
10%. The Company is not required to hold a secondary mortgage lender license in
order to continue to produce or acquire first mortgage loans. The Company
believes that any resolution of this matter will not result in a material
adverse effect on the business or financial condition of the Company.
On December 1, 1998, the Company completed a 39.4% reduction in its
workforce, the majority of which were loan production and administrative
personnel. The Company believes that its remaining workforce is adequate to meet
its needs for the foreseeable future.
The Company entered into an agreement to purchase certain assets of LL
Funding Corp., a privately-held loan origination company headquartered in
Columbia, Maryland on December 15, 1998. On January 4, 1999, the Company
terminated the asset purchase agreement pursuant to provisions contained
therein. LL Funding Corp. has disputed the Company's right to terminate the
asset purchase agreement, and on January 11, 1999, the Company filed suit asking
that the court declare that the Company properly terminated the asset purchase
agreement and was not liable to LL Funding Corp. as a result of such
termination. This suit was voluntarily dismissed by the Company pursuant to a
settlement agreement entered into in February 1999.
At March 31, 1999, the Sovereign warehouse line limit was reduced to $25
million.
The Company, on January 8, 1999, consummated the purchase of substantially
all of the operating assets of a retail, sub-prime loan production facility
located in Las Vegas, Nevada from FirstPlus Financial, Inc. for approximately
$3.25 million in cash.
In February, 1999, the Company repurchased $11 million principal amount of
the Company's 12 1/2% Subordinated Notes, due 2001.
Effective March 22, 1999 Mego Mortgage Corporation has changed its
corporate name to Altiva Financial Corporation (Nasdaq: ATVA).
The Company completed a one-for-ten reverse stock split of its common
stock, par value $0.01, effective March 22, 1999 with respect to shares of the
Company's common stock outstanding as of that date. As a result, the outstanding
shares and related earnings per share adjusted to reflect this reverse stock
split.
On September 18, 1998, the Company, Jeffery S. Moore, and Mego Financial
filed motions to dismiss the complaint filed by Robert J. Feeney. On April 8,
1999, the court granted each of these motions. In the court's order dismissing
the complaint, the plaintiffs were permitted, upon proper motions, to serve and
file a second amended (and redrafted) complaint within 30 days. On May 10, 1999,
the plaintiffs moved for leave to file and serve the second amended and
redrafted complaint contemplated in the earlier order.
F-42
<PAGE> 153
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
On July 15, 1999, the Company consummated the previously announced purchase
of all of the outstanding stock of The Money Centre, Inc. The principal
components of the purchase price for the acquisition by the Company were
$7,000,000 of cash, $3 million of the Company's common stock (600,000 shares
valued at $5 per share), and 20% of the pre-tax net cash flow, as defined in the
purchase agreement for a period not to exceed 48 months.
Effective July 30, 1999 Wm. Paul Ralser has resigned as President, Chief
Operating Officer and as a Director of Altiva, in order to pursue other
interests.
20. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables reflect quarterly financial data for the Company.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
--------------------------------------------------
NOVEMBER 30, FEBRUARY 29, MAY 31, AUGUST 31,
1995 1996 1996 1996
------------ ------------ ------- ----------
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Revenues:
Gain on sale of loans and net
unrealized gain on
mortgage-related securities..... $5,965 $4,845 $2,151 $6,275
Interest income (expense), net..... 138 (3) 403 450
Loan-servicing income, net......... 891 870 1,288 299
------ ------ ------ ------
Total revenues............. 6,994 5,712 3,842 7,024
------ ------ ------ ------
Expenses:
Operating expenses................. 2,805 2,882 3,305 3,203
Net provision (benefit) for credit
losses.......................... 297 200 (524) 82
Interest........................... 47 31 42 47
------ ------ ------ ------
Total expenses............. 3,149 3,113 2,823 3,332
------ ------ ------ ------
Income before income taxes........... 3,845 2,599 1,019 3,692
Income tax expense................... 1,538 1,040 255 1,402
------ ------ ------ ------
Net income........................... $2,307 $1,559 $ 764 $2,290
====== ====== ====== ======
</TABLE>
F-43
<PAGE> 154
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
-------------------------------------------------------
NOVEMBER 30, FEBRUARY 28, MAY 31, AUGUST 31,
1996 1997 1997 1997
------------ ------------ ----------- -----------
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Revenues:
Gain on sale of loans and
net unrealized gain on
mortgage-related
securities............... $ 9,366 $ 8,966 $ 15,532 $ 14,777
Interest income, net........ 355 526 1,137 1,115
Loan-servicing income,
net...................... 638 560 726 1,112
----------- ----------- ----------- -----------
Total revenues...... 10,359 10,052 17,395 17,004
----------- ----------- ----------- -----------
Expenses:
Operating expenses.......... 4,589 5,352 6,274 8,240
Net provision (benefit) for
credit losses............ 1,711 (800) 4,108 1,281
Interest.................... 47 51 122 25
----------- ----------- ----------- -----------
Total expenses...... 6,347 4,603 10,504 9,546
----------- ----------- ----------- -----------
Income before income taxes.... 4,012 5,449 6,891 7,458
Income tax expense............ 1,533 2,078 2,619 2,832
----------- ----------- ----------- -----------
Net income.................... $ 2,479 $ 3,371 $ 4,272 $ 4,626
=========== =========== =========== ===========
Earnings per share:
Basic....................... $ 2.40 $ 2.70 $ 3.45 $ 3.76
=========== =========== =========== ===========
Diluted..................... $ 2.40 $ 2.69 $ 3.45 $ 3.76
=========== =========== =========== ===========
Weighted-average number of
shares outstanding:
Basic....................... 1,031,710 1,247,607 1,237,937 1,230,000
=========== =========== =========== ===========
Diluted..................... 1,031,710 1,254,429 1,237,937 1,230,000
=========== =========== =========== ===========
</TABLE>
F-44
<PAGE> 155
ALTIVA FINANCIAL CORPORATION (FORMERLY MEGO MORTGAGE CORPORATION)
NOTES TO FINANCIAL STATEMENTS (Continued)
FOR THE YEARS ENDED AUGUST 31, 1996, 1997 AND 1998
AND THE UNAUDITED NINE MONTHS ENDED MAY 31, 1998 AND 1999
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
----------------------------------------------------------------------------------------------
NOVEMBER 30, FEBRUARY 28, MAY 31, AUGUST 31, NOVEMBER 30, FEBRUARY 28, MAY 31,
1997 1998 1998 1998 1998 1999 1999
------------ ------------ --------- ---------- ------------ ------------ ---------
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
(Loss) Gain on sale of loans
and net unrealized gain
(loss) on mortgage-related
securities................... $ (9,387) $ (5,564) $ (44,731) $ (36,920) $ 442 $ (219) $ 3
Interest income (expense),
net.......................... 1,210 684 132 (402) (162) (561) 70
Loan-servicing income, net..... 1,194 1,310 (1,367) (138) 240 92 (102)
--------- --------- --------- --------- --------- --------- ---------
Total revenues
(losses)............... (6,983) (3,570) (45,966) (37,460) 520 (688) (29)
--------- --------- --------- --------- --------- --------- ---------
Expenses:
Operating expenses............. 10,198 9,265 7,984 7,322 4,397 4,874 4,378
Net provision (benefit) for
credit losses................ 1,590 706 108 (5,602) 43 (340) 20
Interest....................... 77 150 103 109 42 21 34
--------- --------- --------- --------- --------- --------- ---------
Total expenses........... 11,865 10,121 8,195 1,829 4,482 4,555 4,432
--------- --------- --------- --------- --------- --------- ---------
Loss before income taxes and
extraordinary item............. (18,848) (13,691) (54,161) (39,289) (3,962) (5,243) (4,461)
Income tax expense (benefit)..... (7,153) 7,153 -- (6,334) (1,468) (2,120) (1,589)
Extraordinary item, net of taxes
of $2.9 million................ 4,812
--------- --------- --------- --------- --------- --------- ---------
Net (loss)....................... $ (11,695) $ (20,844) $ (54,161) $ (32,955) $ (2,494) $ (1,689) $ (2,872)
========= ========= ========= ========= ========= ========= =========
Loss per share:
Basic.......................... $ (9.50) $ (16.95) $ (44.03) $ (13.18) $ (0.82) $ (0.55) $ (0.94)
========= ========= ========= ========= ========= ========= =========
Diluted........................ $ (9.50) $ (16.95) $ (44.03) $ (13.18) $ (0.82) $ (0.55) $ (0.94)
========= ========= ========= ========= ========= ========= =========
Weighted-average number of shares
outstanding:
Basic.......................... 1,230,000 1,230,000 1,230,000 2,500,725 3,056,666 3,056,666 3,056,666
========= ========= ========= ========= ========= ========= =========
Diluted........................ 1,230,000 1,230,000 1,230,000 2,500,725 3,056,666 3,056,666 3,056,666
========= ========= ========= ========= ========= ========= =========
</TABLE>
F-45
<PAGE> 156
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
The Money Centre, Inc.
Audited Financial Statements for the Years ended December 31, 1997 and 1998
Independent Auditors' Report.......................................................... F-48
Consolidated Balance Sheets as of December 31, 1997 and 1998.......................... F-49
Consolidated Statements of Operations and Retained Earnings for the Years ended
December 31, 1997 and 1998........................................................ F-51
Consolidated Statements of Shareholders' Equity for the Years ended
December 31, 1997 and 1998........................................................ F-52
Consolidated Statements of Cash Flows for the Years ended December 31, 1997
and 1998.......................................................................... F-53
Notes to Consolidated Financial Statements for the Years ended December 31, 1997
and 1998.......................................................................... F-55
Unaudited Interim Financial Statements for the Five Month Period ended May 31, 1999
Condensed Consolidated Balance Sheet as of May 31, 1999............................... F-63
Condensed Consolidated Statement of Operations and Retained Earnings for the
Five Month Period ended May 31, 1999.............................................. F-64
Condensed Consolidated Statement of Cash Flows for the Five Months ended
May 31, 1999...................................................................... F-65
Notes to Condensed Consolidated Financial Statements for the Five Month Period ended
May 31, 1999...................................................................... F-66
</TABLE>
F-47
<PAGE> 157
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
The Money Centre, Inc. And Subsidiaries
Charlotte, North Carolina
We have audited the consolidated balance sheets of The Money Centre, Inc. (an S
Corporation) and Subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, retained earnings, stockholders' equity
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 audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of The Money Centre,
Inc. and Subsidiaries as of December 31, 1998 and 1997, and the results of
its operations and its cash flows for the years then ended in conformity
with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the financial
statements taken as a whole. The accompanying other financial information on
page 11 is presented for the purposes of additional analysis and is not a
required part of the basic financial statements. Such information has been
subjected to the auditing procedures applied in the audits of the basic
financial statements and, in our opinion, is fairly stated in all material
respects in relation to the basic financial statements taken as a whole.
/s/ Moyer, Smith & Roller, P.A.
February 10, 1999 (except as to Note L; which is as of June 4, 1999)
F-48
<PAGE> 158
THE MONEY CENTRE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
ASSETS
1998 1997
----------- -----------
<S> <C> <C>
CURRENT ASSETS:
Cash -- Operating $ 1,353,518 $ 1,069,072
Cash -- Escrow 455,261 147,309
Mortgage Receivables, less allowance of
$140,000 in 1998 and $140,000 in 1997 38,743,616 27,133,557
Accrued Interest Receivables 415,163 258,775
Other Receivables 29,103 99,941
Note Receivable--short term 1,849,015 3,017,837
Employee Advances 20,626 62,834
Stockholder Advances 293,629 438,526
Other Assets 33,750 11,750
----------- -----------
Total Current Assets 43,193,681 32,239,601
----------- -----------
PROPERTY AND EQUIPMENT:
Computer Equipment 569,828 204,210
Office Equipment 550,285 373,598
Furniture and Fixtures 337,034 242,441
Leasehold Improvements 120,254 90,184
----------- -----------
1,577,401 910,433
Less: Accumulated Depreciation (384,619) (259,311)
----------- -----------
Property and Equipment, Net 1,192,782 651,122
----------- -----------
OTHER ASSETS:
Covenant not to compete, net of accumulated
amortization of $6,943 in 1998 and $3,611 in 1997 43,057 46,389
Deposits 59,120 31,401
Investment in Subsidiary 16,893 10,500
Investment--Other 20,400 20,400
Goodwill, net of accumulated amortization
of $4,100 in 1998 241,900 --
Note Receivable--long term 329,070 371,487
----------- -----------
Total Other Assets 710,440 480,177
----------- -----------
TOTAL ASSETS $45,096,903 $33,370,900
=========== ===========
</TABLE>
See Independent Auditors' Report And Accompanying Notes.
F-49
<PAGE> 159
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
CURRENT LIABILITIES:
Accounts Payable and Accrued Liabilities $ 259,755 $ 457,530
Accounts Payable - Escrow 455,859 144,342
Notes Payable - Line of Credit 37,541,478 27,484,613
Current Portion of Long-Term Debt 466,008 583,618
Accrued Interest Expense 286,353 218,244
Accrued Salaries and Payroll Liabilities 165,047 500,113
----------- -----------
Total Current Liabilities 39,174,500 29,388,460
----------- -----------
LONG-TERM DEBT:
Net of Current Portion 231,989 166,389
----------- -----------
Total Liabilities 39,406,489 29,554,849
----------- -----------
STOCKHOLDERS' EQUITY:
Common Stock - par value $1.00;
100,000 shares authorized;
25,000 shares issued and outstanding 25,000 25,000
Additional Paid-In Capital 47,565 47,565
Retained Earnings 6,117,849 4,243,486
----------- -----------
6,190,414 4,316,051
Treasury Stock (500,000) (500,000)
----------- -----------
Total Stockholders' Equity 5,690,414 3,816,051
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $45,096,903 $33,370,900
=========== ===========
</TABLE>
F-50
<PAGE> 160
THE MONEY CENTRE, INC. AND SUBSIDIARIES
Consolidated Statements of Operations and Retained Earnings
For The Years Ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
GAIN ON SALE OF LOANS $16,944,805 $ 9,413,990
----------- -----------
OPERATING EXPENSES
10,176,468 7,639,440
----------- -----------
INCOME FROM OPERATIONS 6,678,337 1,774,550
OTHER INCOME (EXPENSES)
Rental Income 10,044 -
Interest Income 3,446,200 2,432,791
Interest Expense (3,281,703) (2,143,852)
Loss on Investment in Subsidiary (9,607) -
Loss on Disposal of Fixed Assets (4,338) (32,121)
Loss on Disposal of REO (26,263) -
----------- -----------
Total Other Income (Expenses) 134,333 256,818
----------- -----------
INCOME BEFORE INCOME TAXES 6,902,670 2,031,368
PROVISION FOR (BENEFIT FROM)
INCOME TAXES - -
----------- -----------
NET INCOME 6,902,670 2,031,368
RETAINED EARNINGS, beginning of year 4,243,486 3,163,617
Prior period adjustment (16,000) 640,341
----------- -----------
RETAINED EARNINGS, beginning of year as restated 4,227,486 3,803,958
Less: Retained (Deficit) from Acquisition
of Subsidiary - (2,840)
Less: S Corporation Distributions (5,012,307) (1,589,000)
----------- -----------
RETAINED EARNINGS, end of year $ 6,117,849 $ 4,243,486
=========== ===========
</TABLE>
See Independent Auditors' Report and Accompanying Notes.
F-51
<PAGE> 161
THE MONEY CENTRE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
Common Paid-In Treasury Retained
Stock Capital Stock Earnings Total
------- ------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $25,000 $47,565 $(500,000) $3,163,617 $2,736,182
Prior period adjustment -
correction of prior years for
implementation of SFAS 91
and accrued interest income -- -- -- 640,341 640,341
------- ------- --------- ---------- ----------
Restated balance at December 31, 1996 25,000 47,565 (500,000) 3,803,958 3,376,523
Retained (deficit) from Acquisition
of Subsidiary -- -- -- (2,840) (2,840)
Net income for 1997 -- -- -- 2,031,368 2,031,368
Cash dividends:
Common stock, $63.56 on
25,000 shares, $1,589,000 -- -- -- (1,589,000) (1,589,000)
------- ------- --------- ---------- ----------
Balance at December 31, 1997 25,000 47,565 (500,000) 4,243,486 3,816,051
Prior period adjustment -
correction of prior year over (under)
tax accrual -- -- -- (16,000) (16,000)
------- ------- --------- ---------- ----------
Restated balance at December 31, 1997 25,000 47,565 (500,000) 4,227,486 3,800,051
Net income for 1998 -- -- -- 6,902,670 6,902,670
Cash dividends:
Common stock, $200.49 on
25,000 shares, $5,012,307 -- -- -- (5,012,307) (5,012,307)
------- ------- --------- ---------- ----------
Balance at December 31, 1998 $25,000 $47,565 $(500,000) $6,117,849 $5,690,414
======= ======= ========= ========== ==========
</TABLE>
See Independent Auditors' Report and Accompanying Notes.
F-52
<PAGE> 162
THE MONEY CENTRE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATIONS
Net Income $ 6,902,670 $ 2,031,368
Non-cash expenses included in net income:
Amortization 7,431 3,333
Depreciation 125,698 86,383
Loss on disposal of fixed assets 4,338 32,121
Changes in current and other asset accounts:
(Increase) in Loans Held for Sale (11,610,059) (10,921,745)
Decrease in Other Receivables 70,838 231,782
(Increase) in Accrued Interest Receivable (156,388) (47,606)
Decrease in Employee Advances 42,208 96,313
Decrease in Prepaid Expenses - 35,472
(Increase) Decrease in Stockholder Advances 144,897 (438,526)
(Increase) in Other Assets (22,000) (11,750)
Changes in current and other liability accounts:
Increase in Accounts Payable and Accrued
Liabilities (197,776) 397,073
Increase in Accounts Payable - Escrow 311,517 28,706
Increase in Notes Payable - Line of Credit 10,056,865 13,266,819
Increase in Accrued Interest Expense 68,109 39,594
Increase (Decrease) in Accrued Salaries
and Payroll Liabilities (335,066) 268,982
Increase (Decrease) in Accrued Income Taxes - (1,234,243)
------------ ------------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES $ 5,413,282 $ 3,864,076
============ ============
</TABLE>
See Independent Auditors' Report and Accompanying Notes.
F-53
<PAGE> 163
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of Property and Equipment............ $ (671,694) $ (421,370)
(Increase) Decrease in Notes Receivable........ 1,211,239 (2,529,621)
(Increase) in Deposits and Other Investments... (34,112) (16,390)
(Increase) Decrease in Goodwill................ (246,000) (-)
----------- -----------
NET CASH PROVIDED BY (USED IN) INVESTING
ACTIVITIES..................................... 259,433 2,967,381
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from Long-Term Debt.................... 556,161 731,932
Purchase of Retained (Deficit) from Subsidiary.. - (2,840)
S Distributions of Earnings..................... (5,012,307) (1,589,000)
Principal Payments on Long-term Debt............ (608,171) (508,205)
Prior Period Adjustment......................... (16,000) 23,492
----------- -----------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES............................ (5,080,317) (1,344,621)
----------- -----------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS............................ 592,398 (447,926)
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR............................... 1,216,381 1,664,307
----------- -----------
CASH AND CASH EQUIVALENTS AT
END OF YEAR..................................... $ 1,808,779 $ 1,216,381
=========== ===========
</TABLE>
F-54
<PAGE> 164
THE MONEY CENTRE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
BUSINESS ACTIVITY
The Money Centre, Inc. is engaged in the mortgage banking industry with
branches throughout North Carolina, South Carolina, Tennessee, Georgia,
Colorado, Indiana, Florida, Kentucky, Maryland, Montana, and Oklahoma. It is
the originator of mortgages on residential real estate. It then sells those
loans to permanent investors. The accounting policies of The Money Centre, Inc.
are in accordance with generally accepted accounting principles and conform to
general practices within the mortgage origination industry.
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of The Money Centre,
Inc. and all controlled, majority-owned subsidiaries. Investments in companies
in which The Money Center, Inc.'s interest is between 20 percent and 50 percent
are accounted for using the equity method.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost, less accumulated depreciation.
Depreciation expense is computed under the straight-line method over the
estimated useful life of the asset. For income tax purposes, depreciation is
calculated under IRS accelerated cost recovery methods.
INCOME TAXES
On January 1, 1997, The Money Centre, Inc., with the consent of its
shareholders, elected under the Internal Revenue Code to be an S Corporation.
In lieu of corporation income taxes, the shareholders of an S Corporation are
taxed on their proportionate share of the company's taxable income. Therefore,
no provision or liability for income taxes has been included in these financial
statements.
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 and 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.
F-55
<PAGE> 165
THE MONEY CENTRE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid unrestricted investments with
maturities of three months or less to be cash equivalents for purposes of the
statement of cash flows.
LOANS HELD FOR SALE
Loans held for sale are carried at the lower of aggregate cost or market value
in the accompanying Consolidated Balance Sheet, net of allowance for valuation
losses.
VALUATION ALLOWANCE
Provision for decreases in the market value relating to unsold loans is recorded
as expense in amounts sufficient to maintain the allowance at a level considered
adequate to provide for anticipated probable losses from liquidation of
outstanding loans. The provision for valuation is based upon the estimated fair
market value of the portfolio primarily derived from recent sale data in the
marketplace.
LOAN ORIGINATION COSTS AND FEES
Loan origination costs and fees including non-refundable loan origination fees
and incremental direct costs associated with loan production are deferred in
compliance with Statement of Financial Accounting Standards ("SFAS") No. 91
"Accounting for Non-refundable Fees and costs associated with Originating or
Acquiring Loans and Indirect Direct Costs of Leases." ("SFAS 91") and recorded
as expense or income upon the sale of the related loans.
REVENUE RECOGNITION
The Money Centre, Inc. derives its revenue principally from the gains on the
sale of loans. Upon the sale of the loans, gain or loss is recognized when the
loans are transferred to a permanent investor and the sales proceeds are
received. Interest income on loans held for sale is accrued based on the
anticipated yield-to-maturity. Market valuation adjustments on loans held for
sale are included in gain on sale of loans.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, The Financial Accounting Standards Board (the "FASB") issued SFAS
No. 130, "Reporting Comprehensive Income" ("SFAS 130"), and SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information", ("SFAS
131"), SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. SFAS No. 131 establishes standards of reporting by
publicly-held business enterprises and disclosure of information about operating
segments in annual financial statements and, to a lesser extent, in interim
financial reports issued to shareholders. SFAS Nos. 130 and 131 are effective
for fiscal years beginning after December 15, 1997. As both SFAS Nos. 130 and
131 deal with financial statement disclosure, the Company does not anticipate
the adoption of these new standards will have a material impact on its financial
position, results of operations or cash flows. The Company has not yet
determined what its reporting segments will be under SFAS 131.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which establishes accounting
and reporting standards and derivative instruments and for hedging activities.
It requires the entity to recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The accounting for changes in fair value of those designated
derivatives ("Hedge Accounting") depends on the intended use and designation. An
entity that elects to apply Hedge Accounting is required to establish at the
inception of its hedge the method it will use for assessing the effectiveness of
the hedging derivative and the measurement approach for determining the
ineffective aspect of the hedge. Those methods must be consistent with the
entity's approach to managing risk. SFAS 133 is effective for the fiscal years
beginning after June 15, 1999. The Company has not yet evaluated the effect of
adopting SFAS 133.
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Cash paid during the year:
Interest $3,213,594 $2,104,258
Income Tax $ 16,000 $1,210,751
</TABLE>
NOTE B - LOANS HELD FOR SALE
The Company funds loans to residential customers using its lines of credit. The
loans are collateralized by the real estate and are normally resold to permanent
investors within sixty (60) days. Historically, the Company has held very few
loans for over ninety (90) days. However, due to the increased volume, the
Company has held some loans for over ninety (90) days. The Company has
established a reserve of 5% of the original loan amounts for all loans over
ninety (90) days for potential uncollectible amounts. The allowance for doubtful
accounts is $140,000 for 1998 and 1997.
F-56
<PAGE> 166
THE MONEY CENTRE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION> 1998
-----------
NOTE C - NOTES RECEIVABLE
<S> <C>
A secured note from an officer due on December 31, 1998,
interest due in monthly installments beginning May 1, 1998
at 7%, secured by real estate. $ 1,824,378
An unsecured note with an affiliated corporation due on
demand with 10% interest. 12,150
An unsecured note with an affiliated limited liability company
due in monthly installments of $3,000.00 including interest at
7% beginning March 1, 1998. 341,557
-----------
Total 2,178,085
Less amounts due within one year (1,849,015)
-----------
Long-term note receivables $329,070
===========
</TABLE>
NOTE D - COVENANT NOT TO COMPETE
On November 20, 1996, the Company purchased the stock of one of the minority
stockholders. The Company paid the minority stockholder $50,000 for a covenant
not to compete. The $50,000 covenant not to compete is being amortized over
fifteen years. Amortization expense was $3,333 and $3,333 for 1998 and 1997
respectively.
NOTE E - FINANCING AGREEMENTS
The Money Centre, Inc. has various lines of credit established with commercial
banks which allows for funding of loans to potential customers. The financing
agreements include certain financial covenants including requirements to
maintain defined levels of tangible net worth, debt to tangible net worth, and
other financial covenants. The Company was in violation of certain of these
covenants as of December 31, 1998. The lender has waived the violation of these
covenants as of December 31, 1998, and through the period ending March 31, 1999,
but has not waived these violations for any period beyond March 31, 1999.
F-57
<PAGE> 167
THE MONEY CENTRE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
NOTE F - NOTES PAYABLE - LINE OF CREDIT
1998 1997
------------ ------------
<S> <C> <C>
A line of credit with a bank with interest payable monthly at prime
plus .375%, secured by mortgages receivable maximum of $15,000,000. $ 16,482,878 $ 14,867,045
A line of credit with a bank with interest payable at prime plus
.5%, secured by mortgages receivable, maximum of $20,000,000. 16,943,724 10,174,724
A line of credit with a bank with interest payable monthly at
prime plus 1.5%, secured by mortgages receivable, maximum
$5,000,000. 3,754,995 1,944,272
A line of credit with a mortgage company with interest
payable monthly at prime plus 1%, secured by mortgages
receivable. 359,881 498,572
------------ ------------
Notes Payable - Lines of Credit $ 37,541,478 $ 27,484,613
============ ============
NOTE G - LONG TERM-DEBT
A note payable with a bank due in monthly installments of
$1,059.72, including interest at 9.5%, unsecured. $ 14,003 $ 24,815
A note payable with a bank due in monthly installments of
$18,750.00, including interest at prime plus 1.25%, secured by
17.5 shares of The Money Centre, Inc. stock. -- 225,000
A note payable with a bank due in monthly installments of
$25,000.00 including interest at prime plus 1.25%, unsecured. 50,000 350,000
A capital lease obligation with a leasing corporation due in
monthly payments of $202.57 due May 23, 1998, including
interest imputed at 20.69%, secured by equipment. -- 587
A capital lease obligation with a leasing corporation due in
monthly payments of $750.20 due August 27, 1999, including
interest imputed at 14.55%, secured by equipment. 5,687 13,253
</TABLE>
F-58
<PAGE> 168
THE MONEY CENTRE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
NOTE G - LONG TERM DEBT (CONTINUED)
<TABLE>
<CAPTION>
1998 1997
-------- -------
<S> <C> <C>
A capital lease obligation with a leasing corporation due in
monthly payments of $1,562.48 due August 13, 1999, including
interest imputed at 17.10%, secured by telephone system. 8,925 24,654
A capital lease obligation with a leasing corporation due in
monthly payments of $2,701.97 due January 26, 2002, including
interest imputed at 8.424%, secured by furniture. 87,774 111,698
A capital lease obligation with a leasing corporation due in
monthly payments of $1,430.69 due February 4, 2001, including
interest imputed at 12.416%, secured by cubicles. 32,468 --
A capital lease obligation with a leasing corporation due in
monthly payments of $7,785.51 due October 5, 2001, including
interest imputed at 9.892%, secured by software. 224,139 --
A note payable with a corporation due in quarterly installments
of $68,750 due October 15, 1999, unsecured. 275,000 --
-------- --------
697,997 750,007
Less amounts due within one year 466,008 583,618
-------- --------
Long-term debt $231,989 $166,389
======== ========
</TABLE>
Maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
Year Ending
December 31 Amount
----------- --------
<S> <C>
1999 466,008
2000 128,446
2001 100,860
2002 2,683
2003 --
Thereafter --
--------
TOTAL $697,997
========
</TABLE>
F-59
<PAGE> 169
THE MONEY CENTRE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
NOTE H - LEASES
The Company leases facilities for its headquarters under an operating lease
that expires February 28, 2007. It leases facilities for its branch offices in
various cities under operating leases having terms ranging from month-to-month
to three years.
The Company also leases vehicles and certain office equipment. Most of these
are operating leases with two- and three-year terms.
The following is a schedule of future minimum rental payments required by the
operating leases as of December 31, 1998:
<TABLE>
<CAPTION>
1999 2000 2001 2002 2003 Total
-------- -------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Property $473,950 $370,126 $339,279 $351,207 $311,932 $1,846,494
Vehicles &
Equipment 64,102 22,073 - - - 86,175
-------- -------- -------- -------- -------- ----------
$538,052 $392,199 $339,279 $351,207 $311,932 $1,932,669
======== ======== ======== ======== ======== ==========
</TABLE>
NOTE I - RELATED PARTIES
The Money Centre, Inc. is owned 70% by one individual. During 1997, the Company
loaned $3,000,328 to the 70% owner and accepted a note for the repayment which
was collateralized by his residence. The note was due on December 31, 1998, with
interest payable in monthly installments. The balance of the note as of December
31, 1998 is $1,824,379.
The Money Centre, Inc. owns 49% of the stock of Carolina One Mortgage, Inc. The
Money Centre, Inc. made an initial investment of $10,000 for the purchase of
49% of the stock and subsequently loaned Carolina One Mortgage, Inc. an
additional $12,150 which is due on demand.
The Money Centre, Inc. is leasing office space for its headquarters from Royal
County Downs, LLC. Royal County Downs, LLC is owned 100% by the 70% owner of
the Money Center, Inc. The Money Centre, Inc. loaned Royal County Downs, LLC
$376,846 for the purchase of the land where the office was built. The note is to
be repaid in monthly installments of $3,000.00 each, including interest at 7%.
The balance of the note as of December 31, 1998 is $341,556.62.
On October 15, 1997, The Money Centre, Inc. purchased 100% of Mortgage Security,
Inc. This acquisition has been accounted for under the purchase method. Net
assets and results of operations have been included in the consolidated
financial statements since the acquisition date. The acquisition did not have a
material impact on consolidated earnings.
F-60
<PAGE> 170
THE MONEY CENTRE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
NOTE I - RELATED PARTIES (CONTINUED)
The Money Centre, Inc. has advanced the following amounts to stockholders as of
December 31, 1998:
<TABLE>
<S> <C>
Bo Lewis $ 78,746
Richie Love 56,615
Chuck Cunningham 80,876
Steve Walker 77,392
--------
$293,629
========
</TABLE>
NOTE J - CONCENTRATION OF CREDIT RISK
The Company maintains most of its cash balances at two financial institutions.
Accounts are insured by the Federal Deposit Insurance Corporation up to
$100,000. At December 31, 1998, uninsured cash totaled $1,502,985. At
December 31, 1997, the uninsured cash balance was $956,509.
NOTE K - 401(K) PLAN
The Company maintains a 401(k) Plan which became effective January 1, 1994. The
employees are allowed to make deferral contributions to the plan according to
plan specifications. The Company will match one-half of the employees
contribution up to 4% of the employee's gross earnings. Employer contributions
for 1998 and 1997 were $127,264 and $92,909, respectively.
NOTE L - PRIOR PERIOD ADJUSTMENTS AND RESTATEMENT
The Company has restated the financial statements for the implementation of
Statement of Financial Accounting Standards ("SFAS") No. 91, SFAS No. 91
requires that loan origination fees, processing fees and direct loan origination
costs be deferred and recognized over the life of the loan a an adjustment to
gain on sale of loans. The Money Centre, Inc. properly and retroactively
implemented SFAS No. 91 and restated the financial statements to reflect the
implementation. The effects of the implementation resulted in an increase in
loans held for ale of $554,746 and $464,905 for 1998 and 1997, respectively.
The Company also began accruing interest on loans held for sale as of December
31. Accrued interest receivables was $415,163 and $258,775 for 1998 and 1997,
respectively. Interest income increased by $156,338 and $47,606 for 1998 and
1997, respectively. The financial statements have also been restated to reflect
prior year over (under) accrual of tax liabilities. The prior period adjustment
reflects a $16,000 under accrual from 1998 and a $23,492 over accrual from 1997.
F-61
<PAGE> 171
THE MONEY CENTRE, INC. AND SUBSIDIARIES
CONSOLIDATED SCHEDULES OF OPERATING EXPENSES
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
OPERATING EXPENSES
Officers Salaries $ 2,072,047 $1,035,577
Salaries and Wages 1,500,674 1,869,804
Advertising 368,683 281,686
Amortization 7,431 3,333
Appraisals and Closing Costs 26,675 44,907
Automobile Expenses 158,095 113,624
Awards and Contests 13,707 --
Bank Charges 19,107 20,871
Bad Debt Expense 939,915 798,030
Computer Software 148,304 10,046
Consulting Fees 30,000 --
Contracts Terminated 201,000 --
Contributions 27,022 5,848
Credit Reports 54,854 44,669
Depreciation 125,698 86,383
Document Preparation Fees 130 --
Dues and Subscriptions 12,855 12,549
Employee Benefits 127,264 92,909
Entertainment 124,522 95,532
General Corporate Taxes and Licenses 62,779 27,291
Insurance Expenses 343,872 156,091
Miscellaneous Expense 43,882 126,177
Office Expenses 265,706 241,540
Payroll Taxes 721,017 602,486
Postage and Delivery 398,653 229,521
Printing Services 52,045 52,238
Professional Fees 133,891 99,988
Rent 759,930 567,683
Repairs and Maintenance 87,607 92,079
Telephone and Utilities 581,474 482,297
Temporary Staffing 307,473 135,822
Training and Workshops 7,430 3,421
Travel 139,324 125,842
Warehouse Line Fees 313,402 181,196
----------- ----------
Total Operating Expenses $10,176,468 $7,639,440
=========== ==========
</TABLE>
See Independent Auditors' Report And Accompany Notes.
F-62
<PAGE> 172
THE MONEY CENTRE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
MAY 31, 1999
<TABLE>
<CAPTION>
ASSETS
- ------
<S> <C>
Cash $ 2,211,218
Loans Held for Sale, net 37,381,687
Accrued Interest Receivable 390,438
Other Receivables 94,575
Note Receivable - short-term 1,893,668
Employee Advances 33,354
Stockholder Advances 346,797
Other Assets 33,750
-----------
Total Current Assets 42,385,487
-----------
Property Plant & Equipment, net 1,171,157
Covenant not to compete, net 41,946
Deposits 79,206
Investment in Sub. 16,893
Goodwill 241,900
Note Receivable - long term 349,526
-----------
Total Other Assets 1,900,628
-----------
TOTAL ASSETS $44,286,115
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Accounts Payable $ 396,076
Notes Payable - Line of Credit 35,596,875
Current Portion of Long Term Debt 916,301
Accrued Expenses 304,287
Accrued Payroll 76,525
-----------
Total Current Liabilities 37,290,064
-----------
Long Term Debt 174,602
-----------
TOTAL LIABILITIES 37,464,666
-----------
Common Stock 25,000
Additional Paid in Capital 47,565
Retained Earnings 7,248,884
Treasury Stock (500,000)
-----------
TOTAL STOCKHOLDERS' EQUITY 6,821,449
-----------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $44,286,115
===========
</TABLE>
F-63
<PAGE> 173
THE MONEY CENTRE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS AND RETAINED EARNINGS
FOR THE FIVE MONTHS ENDED MAY 31, 1999
<TABLE>
<S> <C>
GAIN ON SALE OF LOANS $5,315,142
OPERATING EXPENSES 4,316,125
----------
INCOME FROM OPERATIONS 999,017
OTHER INCOME (EXPENSES) 132,018
----------
INCOME BEFORE INCOME TAXES 1,131,035
PROVISION FOR INCOME TAXES 0
----------
NET INCOME 1,131,035
RETAINED EARNINGS, BEGINNING OF PERIOD 6,117,849
----------
RETAINED EARNINGS, END OF PERIOD $7,248,884
==========
</TABLE>
F-64
<PAGE> 174
THE MONEY CENTRE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE FIVE MONTHS ENDED MAY 31, 1999
<TABLE>
<CAPTION>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 1,131,035
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and Amortization 59,397
Changes in operating assets and liabilities:
Loans Held for Sale 1,361,929
Accrued Interest Receivable 24,725
Other Receivables (65,472)
Employee Advances (12,728)
Stockholder Advances (53,168)
Deposits (20,085)
Accounts Payable (319,538)
Accrued Expenses (70,590)
-----------
Net cash provided by operating activities 2,035,505
-----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Advances on notes receivable (65,109)
Purchases of property, plant & equipment (36,660)
Proceeds from sale of investment 20,400
-----------
Net cash used in investing activities (81,369)
-----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on line of credit, net (1,944,603)
Proceeds from Long-Term Debt 392,906
-----------
Net cash used in financing activities (1,551,697)
-----------
Net increase in cash 402,439
Cash at beginning of period 1,808,779
-----------
Cash at end of period $ 2,211,218
===========
</TABLE>
F-65
<PAGE> 175
THE MONEY CENTRE INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FIVE MONTHS ENDED MAY 31, 1999
1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, when read in conjunction with the audited
Consolidated Financial Statements for the years ended December 31, 1997 and
1998, the accompanying unaudited Condensed Consolidated Financial Statements
contain all of the information necessary to present fairly the financial
position of The Money Centre Inc. and Subsidiaries (the "Company") at May 31,
1999, the results of its operations for the five months ended May 31, 1999, the
change in retained earnings for the five months ended May 31, 1999 and the cash
flows for the five months ended May 31, 1999.
The preparation of financial statements, in conformity with generally
accepted accounting principles ("GAAP") requires management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
disclosures 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. In the
opinion of management, all material adjustments necessary for the fair
presentation of these statements have been included herein, which are normal and
recurring in nature. The results of operations for the five months ended May
31, 1999 are not necessarily indicative of the results to be expected for the
full year.
Capitalized terms not defined herein are defined in the Company's audited
Financial Statements for the years ended December 31, 1997 and 1998.
F-66
<PAGE> 176
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
ALTIVA FINANCIAL CORPORATION
Unaudited Pro Forma Condensed Consolidating Balance Sheet as of May 31, 1999.......... F-68
Unaudited Pro Forma Condensed Consolidating Statement of Operations for the
Year ended August 31, 1998........................................................ F-69
Unaudited Pro Forma Condensed Consolidating Statement of Operations for the
Nine months ended May 31, 1999.................................................... F-70
</TABLE>
F-67
<PAGE> 177
ALTIVA FINANCIAL, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATING BALANCE SHEET
MAY 31, 1999
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
MONEY PRO FORMA PRO FORMA
ALTIVA CENTRE ADJUSTMENTS ADJUSTED
------- ------ ----------- ---------
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 9,231 $ 2,221 $ 11,442
Loans held for sale 15,557 37,382 52,939
Mortgage related securities 34,214 34,214
Total assets 84,709 44,286 10,600 (1) 139,595
Total debt 57,342 36,688 3,650 (2) 97,680
Stockholders' equity 22,917 6,821 (3,821)(3) 25,917
</TABLE>
Notes to pro forma condensed consolidated balance sheet:
(1) To record goodwill recorded in conjunction with the purchase of MC, Inc.
(2) To record the $3.65M of debt incurred in conjunction with the purchase of
MC, Inc.
(3) To record the issuance of Altiva Financial, Inc. stock (600,000 shares at
$5) and eliminate the equity of MC, Inc.
F-68
<PAGE> 178
ALTIVA FINANCIAL, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
YEAR ENDED AUGUST 31, 1998
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
MONEY PRO FORMA PRO FORMA
ALTIVA CENTRE ADJUSTMENTS ADJUSTED
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Total Revenues (Losses)................................ $ (93,979) $ 14,755 $ (438)(1) $ (79,662)
Cost and Expenses...................................... 32,010 10,836 708(2) 43,554
---------- ---------- ---------- ----------
Income (Loss) before taxes............................. (125,989) 3,919 (1,146) (123,216)
Income tax (benefit).................................. (6,334) 28 (6,306)
---------- ---------- ---------- ----------
Net Income (Loss)...................................... $ (119,655) $ 3,891 $ (1,146) $ (116,910)
========== ========== ========== ==========
EARNINGS PER SHARE:
Basic:
Net Income (Loss)...................................... $ (32.72) $ 1.06 $ (0.31) $ (31.97)
========== ========== ========== ==========
Weighted-average number of common shares............... 3,656,666 3,656,666 3,656,666 3,656,666
========== ========== ========== ==========
Diluted:
Net Income (Loss)...................................... $ (32.72) $ 1.06 $ (0.31) $ (31.97)
========== ========== ========== ==========
Weighted-average number of common shares and assumed
conversions.......................................... 3,656,666 3,656,666 3,656,666 3,656,666
========== ========== ========== ==========
</TABLE>
Notes to pro forma condensed financial statement of operations for the year
ended August 31, 1998.
The following entries are made to adjust the condensed consolidated statement of
operations for the year ended August 31, 1998 as if the acquisition of MC, Inc.
had occurred on September 1, 1997.
(1) To record interest expense on the $3,650,000 borrowed for the acquisition of
MC, Inc. for the year ended August 31, 1998.
(2) To amortize the goodwill recorded in conjunction with the purchase of
The Money Centre, Inc. over 15 years.
F-69
<PAGE> 179
ALTIVA FINANCIAL, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
NINE MONTHS ENDED MAY 31, 1999
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
MONEY PRO FORMA PRO FORMA
ALTIVA CENTRE ADJUSTMENTS ADJUSTED
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Total Revenues (Losses) $ (197) $ 10,648 $ (329)(1) $ 10,122
Cost and Expenses 13,469 7,700 531(2) 21,700
---------------------------------------- ----------
Income (Loss) before taxes (13,666) 2,948 (860) (11,578)
Income tax (benefit) (5,177) (28) (5,205)
Extraordinary item, net of taxes of
$2.9 million 4,812 4,812
---------------------------------------- ----------
Net Income (Loss) $ (3,677) $ 2,976 $ (860) $ (1,561)
======================================== ==========
EARNINGS PER SHARE:
Basic:
Net Income (Loss) $ (1.01) $ 0.82 $ (0.24) $ (0.43)
======================================== ==========
Weighted-average number of common
shares 3,656,666 3,656,666 3,656,666 3,656,666
======================================== ==========
Diluted
Net Income (Loss) $ (1.01) $ 0.82 $ (0.24) $ (0.43)
======================================== ==========
Weighted-average number of common
shares and assumed conversions 3,656,666 3,656,666 3,656,666 3,656,666
======================================== ==========
</TABLE>
Notes to pro forma condensed consolidated financial statement of operations for
the nine months ended May 31, 1999.
The following entries are made to adjust the condensed consolidated statement
of operations to give effect to the acquisition of MC, Inc. as if it has
occurred at the beginning of the period, September 1, 1998.
(1) To record interest expense on the $3,650,000 borrowed for the acquisition
of MC, Inc. for the nine month period ended May 31, 1999.
(2) To amortize the goodwill recorded in conjunction with the purchase of The
Money Centre, Inc. over 15 years.
F-70
<PAGE> 180
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
THE COMPANY HAS NOT AUTHORIZED ANY PERSON TO MAKE A STATEMENT THAT DIFFERS
FROM WHAT IS IN THIS PROSPECTUS. IF ANY PERSON DOES MAKE A STATEMENT THAT
DIFFERS FROM WHAT IS IN THIS PROSPECTUS, YOU SHOULD NOT RELY ON IT. THIS
PROSPECTUS IS NOT AN OFFER TO SELL, NOR IS IT SEEKING AN OFFER TO BUY, THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. THE
INFORMATION IN THIS PROSPECTUS IS COMPLETE AND ACCURATE AS OF ITS DATE, BUT THE
INFORMATION MAY CHANGE AFTER THAT DATE.
ALTIVA FINANCIAL CORPORATION
(Altiva Financial Corporation Logo)
6,974,614 SHARES
COMMON STOCK
($.01 PAR VALUE)
PROSPECTUS
August , 1999
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 181
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following are the estimated expenses in connection with the issuance
and distribution of the securities being registered, all of which will be paid
by the Company.
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee......... $ 11,831
Nasdaq National Market listing fee.......................... 17,500
Blue Sky qualification fees and expenses.................... 2,000
Printing and engraving expenses............................. 150,000
Legal fees and expenses..................................... 150,000
Accounting fees and expenses................................ 100,000
Miscellaneous............................................... 68,669
--------
Total............................................. $500,000
========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 145 of the General Corporation Law of the State of Delaware
("DGCL") provides that a corporation has the power to indemnify any director or
officer, or former director or officer, who was or is a party or is threatened
to be made a party to any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative (other than
an action by or in the right of the corporation) against the expenses,
(including attorney's fees), judgments, fines or amounts paid in settlement
actually and reasonably incurred by them in connection with the defense of any
action by reason of being or having been directors or officers, if such person
shall have acted in good faith and in a manner reasonably believed to be in or
not opposed to the best interests of the corporation, and, with respect to any
criminal action or proceeding, provided that such person had no reasonable cause
to believe his conduct was unlawful, except that, if such action shall be in the
right of the corporation, no such indemnification shall be provided as to any
claim, issue or matter as to which such person shall have been judged to have
been liable to the corporation unless and to the extent that the Court of
Chancery of the State of Delaware, or any court in which such suit or action was
brought, shall determine upon application that, in view of all of the
circumstances of the case, such person is fairly and reasonably entitled to
indemnity for such expenses as such court shall deem proper.
As permitted by Section 102(b)(7) of the DGCL, the Amended and Restated
Certificate of Incorporation of the Company (filed herewith as Exhibit 3.2) (the
"Restated Certificate of Incorporation") provides that no director shall be
liable to the Company or its stockholders for monetary damages for breach of
fiduciary duty as a director other than (i) for breaches of the director's duty
of loyalty to the Company and its stockholders, (ii) for acts or omissions not
in good faith or which involve intentional misconduct or a knowing violation of
law, (iii) for the unlawful payment of dividends or unlawful stock purchases or
redemptions under Section 174 of the DGCL, and (iv) for any transaction from
which the director derived an improper personal benefit.
The Company's Bylaws provide indemnification of the Company's directors and
officers, both past and present, to the fullest extent permitted by the DGCL,
and allow the Company to advance or reimburse litigation expenses upon
submission by the director or
II-1
<PAGE> 182
officer of an undertaking to repay such advances or reimbursements if it is
ultimately determined that indemnification is not available to such director or
officer pursuant to the Bylaws. The Company's Bylaws also authorize the Company
to purchase and maintain insurance on behalf of an officer or director, past or
present, against any liability asserted against him in any such capacity whether
or not the Company would have the power to indemnify him against such liability
under Section 145 of the DGCL.
The Company has entered into indemnification agreements with each of its
directors and certain of its executive officers. The indemnification agreements
require the Company, among other things, to indemnify such directors and
officers against certain liabilities that may arise by reason of their status or
service as directors or officers (other than liabilities arising from willful
misconduct of a culpable nature), and to advance their expenses incurred as a
result of any preceding against them as to which they could be indemnified.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
On July 15, 1999, the Company issued 600,000 shares of common stock to the
shareholders of The Money Centre, Inc. ("Money Centre") in exchange for all of
the outstanding stock of Money Centre. This sale was conducted pursuant to Rule
506 under Regulation D ("Rule 506").
On July 1, 1998, the Company completed a private placement of 25,000 shares
of Series A convertible preferred stock (the "Series A Preferred Stock") and
1,826,666 shares of common stock (modified to reflect a one-for-ten reverse
stock split completed on March 22, 1999) to a number of qualified institutional
investors, as defined under Rule 144A under the Securities Act, and to other
accredited investors, as defined in Rule 501 under Regulation D ("Rule 501").
These sales were conducted pursuant to Rule 506. The aggregate purchase price of
the Series A Preferred Stock was $25.0 million, and the aggregate purchase price
of the common stock was $25.0 million.
Friedman, Billings, Ramsey & Co. ("FBR") acted as the placement agent for
the preferred stock and the common stock. Under a placement agreement between
FBR and the Company, the Company issued FBR 160,000 shares of common stock
(modified to reflect a 1-for-ten reverse stock split completed on March 22,
1999). This issuance was conducted pursuant to Rule 506.
In addition, on July 1, 1998, the Company issued 37,500 shares of preferred
stock and $41.5 million principal amount of a new series of 12 1/2% Subordinated
Notes due 2001 (the "Current Notes") in exchange for approximately $79.0 million
of 12 1/2% Subordinated Notes due 2001 (the "Old Notes"). The Exchange Offer was
conducted pursuant to Rule 506.
II-2
<PAGE> 183
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- -----------
<C> <C> <S>
2.1(1) -- Stock Purchase Agreement among the Company, The Money
Centre, Inc., Rodney D. Atkinson, Charles R. Cunningham,
Stuart A. Lewis, John Richard Love and Stephen L. Walker
dated July 7, 1999.
3.1(2) -- Amended and Restated Certificate of Incorporation of the
Company.
3.2** -- Certificate of Amendment of the Amended and Restated
Certificate of Incorporation of the Company dated March 17,
1999.
3.3(2) -- By-laws of the Company, as amended.
4.1(2) -- Specimen Common Stock Certificate.
5.1** -- Opinion of King & Spalding regarding the validity of the
shares being registered
10.1(2) -- 1996 Stock Option Plan.
10.2(2) -- Office Lease by and between Mass Mutual and the Company
dated April 1996.
10.3(3) -- Credit Agreement between the Company and Textron Financial
Corporation dated October 22, 1997.
10.4(3) -- Excess Yield and Servicing Rights and Assumption Agreement
between the Company and Greenwich Capital Markets, Inc.
dated January 22, 1998
10.5(3) -- Agreement between the Company and Preferred Equities
Corporation, dated February 9, 1998, regarding assignment of
rights related to the Loan Program Sub-Servicing Agreement
to Greenwich Capital Markets, Inc.
10.6(3) -- Amendment to Excess Yield and Servicing Rights and
Assumption Agreement between the Company and Greenwich
Capital Markets, Inc. dated February 10, 1998
10.7(3) -- Second Amendment to Excess Yield and Servicing Rights and
Assumption Agreement between the Company and Greenwich
Capital Markets, Inc. dated February, 1998
10.8(4) -- Preferred Stock Purchase Agreement dated as of June 9, 1998
between City National Bank of West Virginia and Mego
Mortgage Corporation
10.9(4) -- Stock Option Agreement dated as of June 29, 1998 by Mego
Mortgage Corporation in favor of City National Bank of West
Virginia
10.10(5) -- Registration Rights Agreement dated as of June 29, 1998
between Mego Mortgage Corporation and City National Bank of
West Virginia*
10.11(4) -- Bulk Servicing Purchase Agreement dated as of June 26, 1998
between City National Bank of West Virginia and Mego
Mortgage Corporation
10.12(4) -- Servicing Agreement dated as of June 26, 1998 between Mego
Mortgage Corporation and City Mortgage Services
10.13(4) -- Subservicing Agreement dated as of June 29, 1998 between
Mego Mortgage Corporation and City Mortgage Services
</TABLE>
II-3
<PAGE> 184
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- -----------
<C> <C> <S>
10.14(4) -- City Mortgage Services Option Agreement dated as of June 29,
1998 between City National Bank of West Virginia and Mego
Mortgage Services
10.15(4) -- Right of First Refusal Agreement dated as of June 29, 1998
among City National Bank of West Virginia, Sovereign
Bancorp, Inc. and Mego Mortgage Corporation
10.16(4) -- Preferred Stock Purchase Agreement dated as of June 9, 1998
between Mego Mortgage Corporation and Sovereign Bancorp,
Inc.
10.17(4) -- Stock Option Agreement Dated as of June 29, 1998 by Mego
Mortgage Corporation in favor of Sovereign Bancorp, Inc.
10.18(5) -- Registration Rights Agreement dated as of June 29, 1998
between Mego Mortgage Corporation in favor of Sovereign
Bancorp, Inc.
10.19(5) -- Participation Agreement dated as of June 29, 1998 between
Mego Mortgage Corporation and Sovereign Bank
10.20(5) -- Master Mortgage Loan Purchase Agreement dated as of June 29,
1998 between Sovereign Bank and Mego Mortgage Corporation
10.21(5) -- Form of Custodian Agreement dated as of June 29, 1998 among
Sovereign Bank, State Street Bank and Trust Company and Mego
Mortgage Corporation
10.22(5) -- Common Stock Purchase Agreement dated as of June 9, 1998
between Mego Mortgage Corporation and Emanuel J. Friedman
10.23(5) -- Registration Rights Agreement dated as of June 29, 1998
between Mego Mortgage Corporation and Emanuel J. Friedman
10.24(5) -- Indenture dated as of June 29, 1998 between Mego Mortgage
Corporation and American Stock Transfer & Trust Company, as
Trustee
10.25(5) -- Form of Note issued pursuant to Indenture dated as of June
29, 1998 between Mego Mortgage Corporation and American
Stock Transfer & Trust Company, as Trustee
10.26(5) -- Registration Rights Agreement dated as of June 29, 1998
between Mego Mortgage Corporation and Friedman, Billings,
Ramsey & Co., Inc., as placement agent
10.27(5) -- Registration Rights Agreement dated as of June 29, 1998
between Mego Mortgage Corporation and Friedman, Billings,
Ramsey & Co., Inc., as placement agent
10.28(5) -- Certificate of Designations, Preferences and Rights of
Series A Convertible Preferred Stock of Mego Mortgage
Corporation
10.29(4) -- Co-Sale Agreement dated as of June 29, 1998 among Mego
Mortgage Corporation, Emanuel J. Friedman, Friedman,
Billings, Ramsey & Co., Inc., City National Bank of West
Virginia and Sovereign Bancorp, Inc.
10.30(5) -- Employment Agreement dated June 23, 1998 between Mego
Mortgage Corporation and Edward B. "Champ" Meyercord
10.31** -- Employment Agreement dated February 12, 1999 between Mego
Mortgage Corporation and Edward B. "Champ" Meyercord
10.32(6) -- Form of Director Indemnification Agreement
10.33(1) -- Loan Agreement by and between the Company, Value Partners,
Ltd. and T. Rowe Price Recovery Fund II, L.P. dated as of
July 14, 1999.
10.34(1) -- Pledge Agreement by and between the Company and Value
Partners, Ltd. dated as of July 14, 1999
</TABLE>
II-4
<PAGE> 185
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- -----------
<C> <C> <S>
21.1(7) -- Subsidiaries of the Registrant
23.1** -- Consent of King & Spalding (contained in Exhibit 5.1)
23.2 -- Consent of Deloitte & Touche LLP
23.3 -- Consent of Moyer, Smith & Roller
24.1(6) -- Power of Attorney
</TABLE>
- -------------------------
* To be filed by amendment.
** Previously filed.
(1) Filed as part of the Form 8-K/A filed on August 17, 1999.
(2) Filed as part of the Registration Statement on Form S-1 filed by the
Company, as amended (File No. 333-12443), and incorporated herein by
reference.
(3) Filed as part of the Form 10-Q for the quarter ended February 28, 1998 and
incorporated herein by reference.
(4) Filed as part of the Form 10-Q for the quarter ended May 31, 1998 and
incorporated herein by reference.
(5) Filed as part of the Form 10-Q/A for the quarter ended May 31, 1998.
(6) Previously filed.
(7) Filed as part of the Form 10-K for the year ended August 31, 1998.
(b) Financial Statement Schedules of Mego Mortgage Corporation.
All schedules are omitted because the information is not required or
because the information is included in the combined financial statements or
notes thereto.
ITEM 17. UNDERTAKINGS.
The Company hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1993;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than 20 percent change in
the maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement.
II-5
<PAGE> 186
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration statement
or any material change to such information in the registration
statement;
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the Company
pursuant to the provisions referred to in Item 14 or otherwise, the Company has
been advised that in the opinion of the Commission such indemnification is
against the public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Company of expenses incurred or paid
by a director, officer or controlling person of the Company in the successful
defense of any action, suit or proceeding) is asserted by such director, officer
or controlling person in connection with the securities being registered, the
Company will, unless in the opinion of its counsel the matter has been settled
by controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of such issue.
The Company hereby undertakes that:
1. For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be a part of this
Registration Statement as of the time it was declared effective.
2. For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-6
<PAGE> 187
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized in the City of Atlanta, State of Georgia
on August 19, 1999.
ALTIVA FINANCIAL CORPORATION
By: /s/ EDWARD B. MEYERCORD
-----------------------------------
Edward B. Meyercord
Chairman and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities indicated on this 19th day of August, 1999.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
/s/ EDWARD B. MEYERCORD* Chairman and Chief Executive Officer
- ---------------------------------------- (Principal Executive Officer)
Edward B. Meyercord
/s/ J. RICHARD WALKER Executive Vice President and Chief
- ---------------------------------------- Financial Officer (Principal Financial
J. Richard Walker Officer)
/s/ SPENCER I. BROWNE* Director
- ----------------------------------------
Spencer I. Browne
/s/ HUBERT M. STILES, JR.* Director
- ----------------------------------------
Hubert M. Stiles, Jr.
/s/ DAVID J. VIDA, JR.* Director
- ----------------------------------------
David J. Vida, Jr.
/s/ JOHN D. WILLIAMSON, JR.* Director
- ----------------------------------------
John D. Williamson, Jr.
*By: /s/ J. RICHARD WALKER
- ----------------------------------------
J. Richard Walker
As Attorney-in-Fact
</TABLE>
II-7
<PAGE> 1
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Post-Effective Amendment No. 2 to Registration
Statement No. 333-68995 of Altiva Financial Corporation (formerly Mego Mortgage
Corporation) on Form S-1 of our report dated December 14, 1998, appearing in the
Prospectus which is part of this Registration Statement. We also consent to the
reference to us under the heading "Experts" in such Prospectus.
Deloitte & Touche LLP
San Diego, California
August 16, 1999
<PAGE> 1
EXHIBIT 23.3
CONSENT OF INDEPENDENT AUDITORS
We consent to the use in this Post-Effective Amendment No. 2 to the registration
statement on Form S-1 (registration number 333-68995) of Altiva Financial
Corporation of our report for the financial statements of The Money Centre, Inc.
for the years ended December 31, 1998 and 1997, dated February 10, 1999 (except
as to Note "L"; which is as of June 4, 1999) appearing in the prospectus which
is part of this registration statement.
We also consent to the reference to us under the heading "Experts" in such
prospectus, as it relates to our authority as experts in auditing and
accounting.
/s/ Moyer, Smith & Roller
August 17, 1999
