UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE
ACT OF 1934
For the fiscal year ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 1-12979
HomeSide Lending, Inc.
(Exact name of registrant as specified in its charter)
Florida 59-2725415
(State or other jurisdiction of
incorporation or organization) (I.R.S. Employer Identification No.)
7301 Baymeadows Way, Jacksonville, FL 32256
(Address of principal executive offices) (Zip Code)
(904) 281-3000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes _x_ No __
Indicate the number of shares outstanding of each of the Company's classes of
common stock, as of the latest practicable date.
Title of each class Outstanding at December 28, 1998
------------------- --------------------------------
Common stock $1.00 par value 100 shares
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.
<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
PART I
ITEM 1. BUSINESS
General
HomeSide Lending, Inc. (the "Company" or "HomeSide") is one of the
largest full service residential mortgage banking companies in the United
States. On February 10, 1998, National Australia Bank, Ltd. (the "National")
acquired all outstanding shares of the common stock of HomeSide International,
Inc. (the "Parent") and the Company adopted a fiscal year end of September 30 to
conform to the fiscal year of the National (see Note 2 of the Consolidated
Financial Statements). HomeSide's predecessor ("HomeSide Predecessor") was
formed through the acquisition of the mortgage banking operations of BankBoston,
N.A. ("BBMC Predecessor" to HomeSide Predecessor) on March 16, 1996 and
subsequently purchased the mortgage banking operations of Barnett Banks, Inc.
Unless otherwise designated, the term "HomeSide" refers to the Company for the
periods subsequent to February 10, 1998, to HomeSide Predecessor for the periods
from March 16, 1996 to February 10, 1998 and to BBMC Predecessor for periods
prior to March 16, 1998.
HomeSide's strategy emphasizes variable cost mortgage loan originations,
low cost mortgage servicing and effective risk management. Headquartered in
Jacksonville, Florida, HomeSide ranks as the 9th largest mortgage loan
originator and the 6th largest servicer in the United States at September 30,
1998 based on data published by Inside Mortgage Finance.
The residential mortgage market, which totaled over $4.2 trillion at
September 30, 1998 is the second largest debt market in the world, exceeded only
by the United States Treasury market. The residential mortgage market has grown
at a compound annual rate of approximately 8% since 1985. HomeSide competes in a
mortgage banking market which is highly fragmented with no single company
controlling or dominating the market. At September 30, 1998, the largest
originator represented 7.4% of the market and the largest servicer represented
5.7%, while the top 30 originators and servicers represented 56% and 52% of
their markets, respectively, based on data published by Inside Mortgage Finance.
Residential mortgage lenders compete primarily on the basis of loan pricing and
service, making effective cost management essential. The industry has
experienced rapid consolidation which has been accelerated by the introduction
of significant technology improvements and the economies of scale present in
mortgage servicing. The top 10 mortgage loan servicers have increased their
aggregate market share from 16.6% in 1990 to 34.3% as of September 30, 1998.
HomeSide's business strategy is to increase the volume of its loan
originations and the size of its servicing portfolio while continuing to improve
operating efficiencies. In originating mortgages, HomeSide focuses on variable
cost channels of production, including correspondent, broker, consumer direct,
affinity, and co-issue sources. HomeSide also pursues strategic relationships
with other production sources to acquire and service residential mortgage loans.
Management believes that these variable cost channels of production deliver
consistent origination opportunities for HomeSide without the fixed cost
investment associated with traditional retail mortgage branch networks. HomeSide
believes that its ongoing investment in technology will further enhance and
expand existing processing capabilities and improve its efficiency. Based on
independent surveys of direct cost per loan and loans serviced per employee,
management believes that HomeSide has been one of the industry's most efficient
mortgage servicers. The Company's average cost per employee approximates the
average cost per employee of its major competitors.
HomeSide plans to build its core operations through (i) improved
economies of scale in servicing costs; (ii) increased productivity using
proprietary technology; and (iii) expanded and diversified variable cost
origination channels. In addition, HomeSide intends to pursue additional loan
portfolio acquisitions and strategic origination relationships similar to its
existing agreement with BankBoston, N.A. ("BKB") and Banc One Mortgage
Corporation ("Banc One").
HomeSide's business activities consist primarily of:
Mortgage production: origination and purchase of residential single
family mortgage loans through multiple channels including correspondents,
strategic partners, mortgage brokers, co-issue partners, direct consumer
telemarketing and affinity programs;
Servicing: administration, collection and remittance of monthly
mortgage principal and interest payments, collection and payment of
property taxes and insurance premiums and management of certain loan
default activities;
Secondary marketing: sale of residential single family mortgage loans
as pools underlying mortgage-backed securities guaranteed or issued by
governmental or quasi-governmental agencies or as whole loans or private
securities to investors; and
Risk management: management of a program designed primarily to protect
the economic performance of the servicing portfolio that could otherwise be
adversely affected by loan prepayments due to declines in interest rates.
Production
HomeSide participates in several origination channels, with a focus on
wholesale origination. Since the acquisition of BancBoston Mortgage Corporation
("BBMC"), wholesale channels (correspondent, co-issue, and broker) have
represented more than 90% of HomeSide's total production. Excluding the volumes
purchased from BKB, Barnett Bank, N.A. ("Barnett") and Banc One, no single
source within the correspondent or broker channels accounted for more than 7% of
total production since March 16, 1996. HomeSide's other origination channels
include telemarketing, direct mail campaigns and other advertising, and
mortgages related to affinity group and co-branding partnerships. HomeSide also
purchases servicing rights in bulk from time to time. This multi-channel
production base provides access to and flexibility among production channels in
a wide variety of market and economic conditions. The following table sets forth
production detail by HomeSide's origination channels. The periods presented
coincide with the commencement of operations of HomeSide and the acquisition of
HomeSide by the National (see Note 2 of the Consolidated Financial Statements):
RESIDENTIAL LOAN PRODUCTION BY CHANNEL
(DOLLARS IN MILLIONS)
HOMESIDE HOMESIDE
FOR THE PERIOD FROM PREDECESSOR PREDECESSOR
FEBRUARY 11, 1998 FOR THE PERIOD FROM FOR THE PERIOD FROM
TO MARCH 1, 1997 TO MARCH 16, 1996 TO
SEPTEMBER 30, 1998 FEBRUARY 10, 1998 FEBRUARY 28, 1997
------------------- ------------------- -------------------
Wholesale:
Correspondent $11,309 $13,304 $11,113
Co-issue (a) 2,906 5,584 8,222
Broker 1,980 1,305 843
------- ------- -------
Total wholesale 16,195 20,193 20,178
Direct 631 337 700
------- ------- -------
Total production 16,826 20,530 20,878
Bulk acquisitions (b) 18,947 3,446 4,073
------- ------- -------
Total production and
acquisitions $35,773 $23,976 $24,951
======= ======= =======
(a) Represents the acquisition of servicing rights, not the underlying loans.
Amounts represent the unpaid principal balance of mortgage debt to which
the acquired servicing rights relate.
(b) Represents the acquisition of servicing rights from another servicer.
Amounts represent the unpaid principal balance of mortgage debt to which
the acquired servicing rights relate.
HomeSide competes nationwide by offering a wide variety of mortgage
products designed to respond to consumer needs and tailored to address market
competition. HomeSide is primarily an originator of fixed rate 15- and 30-year
mortgage loans, which collectively represented 98% of the total production in
the period from February 11, 1998 to September 30, 1998, 78% of the total
production in the HomeSide predecessor period from March 1, 1997 to February 10,
1998 and 73% of total production in the HomeSide predecessor period from March
16, 1996 to February 28, 1997. HomeSide also offers other products, such as
ARMs, balloon, and jumbo mortgages.
HomeSide's national loan production operation has resulted in
geographically diverse originations, enabling HomeSide to diversify its risk
across many markets in the United States. HomeSide's servicing portfolio
composition reflects its production markets. The largest segments of the
servicing portfolio by state on September 30, 1998 were California (14.1% of
unpaid principal balance), Florida (14.0%), Texas (6.9%), Massachusetts (5.5%),
and Illinois (4.9%). The largest segments of the servicing portfolio by state on
February 10, 1998 were Florida (17.2% of unpaid principal balance), California
(15.3%), Massachusetts (7.0%), Texas (6.3) and Maryland (4.6%). The largest
segments of the servicing portfolio by state on February 28, 1997 were Florida
(18.7% of unpaid principal balance), California (15.4%), Massachusetts (8.4%),
Texas (6.1%), and Maryland (4.6%).
The mortgage banking industry is generally subject to seasonal trends.
These trends reflect the general national pattern of sales and resales of homes.
Sales and resales of homes typically peak during the spring and summer seasons
and decline to lower levels from mid-November through February. Refinancings
tend to be less seasonal and more closely related to changes in interest rates.
Historically, changes in the interest rate environment have mitigated the impact
of seasonality on HomeSide's results of operations. In addition, delinquency
rates typically rise in the winter months, which result in higher servicing
costs. However, late charge income has historically been sufficient to offset
such incremental expenses.
HomeSide's production strategy is to maintain and improve its reputation
as one of the largest, most cost effective originators of mortgage loans
nationwide. HomeSide pursues this strategy through an emphasis on wholesale and
centralized direct production, the use of contract and delegated underwriters, a
high degree of automation in its processing and direct originations and quality
control. HomeSide plans to expand production through its low cost wholesale and
direct channels and to continue to streamline its production operation. HomeSide
plans to continue to pursue bulk acquisitions in the secondary market for
mortgage servicing rights on an opportunistic basis.
Wholesale Production
Correspondent Production
Through its correspondent program, HomeSide purchases loans from
approximately 500 commercial banks, savings and loan associations, licensed
mortgage lenders and other financial intermediaries. The correspondent takes the
mortgage application and processes the loan, which is either underwritten
through contract underwriters or, in some cases, the correspondent to whom
underwriting authority has been delegated. Closing documents are submitted to
HomeSide for legal review and funding. The participants in this program are
prequalified and monitored on an ongoing basis by HomeSide. If a correspondent
subsequently fails to meet HomeSide's requirements, HomeSide typically
terminates the relationship. Correspondents are also required to repurchase
loans in the event of fraud or misrepresentation in the origination process and
for certain other reasons.
Co-Issue Production
Co-issue production, which represents the purchase of servicing rights
from a correspondent under contracts to deliver specified volumes on a monthly
or quarterly basis, is another main source of HomeSide's production. The
co-issue correspondent controls the entire loan process from application to
closing. This arrangement particularly suits large originators who have the
ability to deliver on an automated basis. Reflecting this delegated underwriting
authority, the co-issue correspondent is obligated to make certain
representations and warranties and is required to repurchase loans in the event
of fraud or misrepresentation in the origination process or for certain other
reasons.
Broker Production
Under its broker program, HomeSide funds loans at closing from a network
of approximately 450 mortgage brokers nationwide. The broker controls the
process of application and loan processing. A pre-closing quality control review
is performed by HomeSide to verify the borrower's credit. All loans originated
through brokers are underwritten by HomeSide's approved contract underwriters.
Loans are funded by HomeSide and may be closed in either the broker's name or
HomeSide's name. Participants in this program prequalify on the basis of
creditworthiness, mortgage lending experience and reputation. Each broker is
subject to annual and ongoing reviews by HomeSide.
Direct Production
HomeSide's direct production includes the use of telemarketing to solicit
loans from several sources, including refinancing of mortgage loans in
HomeSide's existing servicing portfolio, leads generated from direct mail
campaigns and other advertising, and mortgages related to affinity group and
co-branding partnerships. HomeSide believes that these efforts will have a
significant effect on increasing the percentage of loans captured by the direct
division from loan prepayments in HomeSide's servicing portfolio. Refinancing
retention represents the percentage of loans refinanced through HomeSide's
direct channel that were serviced by HomeSide prior to refinancing.
Bulk Acquisition
Bulk acquisition is the large scale purchase of mortgage servicing rights.
In connection with such acquisitions, HomeSide does not purchase the underlying
mortgage loans which were originated by other originators. HomeSide may purchase
servicing rights on an exclusive basis or through a competitive bidding process
and plans to continue this practice on an opportunistic basis in order to grow
its servicing portfolio and benefit from economies of scale.
<PAGE>
Underwriting and Quality Control
Underwriting
HomeSide's loans are underwritten in accordance with applicable Fannie
Mae, FHLMC, VA, and FHA guidelines, as well as certain private investor
requirements. The underwriting process is organized by origination channel and
by loan type. HomeSide currently employs underwriters with an average of ten
years of underwriting experience.
HomeSide requires approximately 80% of its correspondent lenders to have
their loans underwritten by third party contract underwriters prior to purchase.
These contract underwriters are designated by HomeSide and include General
Electric Capital Corp., Mortgage Guaranty Insurance Corp., and Private Mortgage
Insurance Corp. HomeSide grants delegated underwriting status to the remaining
approximately 20% of correspondents which enables the correspondents to submit
conventional loans to HomeSide without prior underwriting approval. Generally,
HomeSide grants delegated underwriting status to its larger correspondents who
meet financial strength, delinquency, underwriting and quality control
standards, and such correspondents are monitored regularly. The FHA and VA
require that loans be underwritten by the originating lender on an
Agency-approved or delegated basis. If issuance of FHA guarantees or VA
insurance certificates is denied, the correspondent must repurchase the loan.
HomeSide's underwriting process for its retail production operation is
fully automated. The automated underwriting technology incorporates credit
scoring and appraisal evaluation systems. These systems employ rules-based and
statistical technologies to evaluate the borrower, the property and salability
of the loan to the secondary market. HomeSide believes that these technologies
have contributed to improved productivity and reduced underwriting and
processing turnaround time.
Quality Control
HomeSide maintains a compliance and quality assurance department that
operates independently of the production, underwriting, secondary marketing and
loan administration department. For its production compliance process, HomeSide
randomly selects a statistical sample of all closed loans monthly for review.
The sample generally comprises 3.5% - 4% of all loans closed each month. This
review includes reunderwriting of such loans, ordering second appraisals on 10%
of the sample, reverifying funds, employment and final applications and
reordering credit reports. In addition, a full underwriting review is conducted
on (i) all jumbo loans that become thirty days delinquent in the first four
payments and jumbo loans that go into foreclosure in the first thirty-six months
and (ii) all conventional loans that become sixty days delinquent in the first
six payments. Document and file reviews are also undertaken to ensure regulatory
compliance. In addition, random reviews of the servicing portfolio, covering
selected aspects of the loan administration process, are conducted.
HomeSide monitors the performance of loan underwriting through quality
assurance reports, HUD/VA reports and audits, reviews and audits by regulatory
agencies, investor reports and mortgage insurance company audits. According to
HomeSide's quality control findings, less than 5% of its loans have underwriting
issues that affect salability to the secondary market. Flaws in these loans are
generally corrected; otherwise, the holder of the mortgage-backed security is
indemnified against future losses resulting from such flaws by HomeSide or,
ultimately, the originating correspondent. Correspondents or co-issue partners
are required to repurchase any flawed loans originated by them.
Secondary Marketing
HomeSide customarily sells all loans that it originates or purchases while
retaining the servicing rights to such loans. HomeSide aggregates mortgage loans
into pools and sells these pools, as well as individual mortgage loans, to
investors principally at prices established under forward sales commitments.
HomeSide's FHA and VA loans are generally pooled and sold in the form of
GinnieMae ("GNMA") Mortgage Backed Securities. Conforming conventional mortgage
loans are generally pooled and exchanged under the purchase and guarantee
programs sponsored by Fannie Mae and FHLMC for Fannie Mae Mortgage Backed
Securities or FHLMC participation certificates, respectively. HomeSide pays
certain guarantee fees to the Agencies in connection with these programs and
then sells the GNMA, Fannie Mae and FHLMC securities to securities dealers. A
limited number of mortgage loans (i.e. non-conforming loans) are sold to private
investors on a servicing-released basis. For the period from February 11, 1998
to September 30, 1998, approximately 92% of the mortgage loans originated by
HomeSide were sold to GNMA (34%), Fannie Mae (36%), and FHLMC (22%). For the
HomeSide predecessor period from March 1, 1997 to February 10, 1998,
approximately 92% of the mortgage loans originated by HomeSide were sold to GNMA
(47%), Fannie Mae (31%), and FHLMC (14%). For the HomeSide predecessor period
from March 16, 1996 to February 28, 1997, approximately 78% of the mortgage
loans originated by HomeSide were sold to GNMA (38%), Fannie Mae (27%), and
FHLMC (13%). The remaining were sold to private investors.
The sale of mortgage loans may generate a gain or loss to HomeSide. Gains
or losses result primarily from two factors. First, HomeSide may purchase a loan
at a price that may be higher or lower than HomeSide would receive if it
immediately sold the loan in the secondary market. These pricing differences
occur principally as a result of competitive pricing conditions in the primary
loan origination market. Second, gains or losses may result from fluctuations in
interest rates that create changes in the market value of the loans or
commitments to purchase loans, from the time the interest rate commitment is
given to the mortgagor until the loan is sold to an investor.
HomeSide assesses the interest rate risk associated with outstanding
commitments that it has extended to fund loans and hedges the interest rate risk
of these commitments based upon a number of factors, including the remaining
term of the commitment, the interest rate at which the commitment was provided,
current interest rates and interest rate volatility. HomeSide constantly
monitors these factors and adjusts its hedging on a daily basis as needed.
HomeSide uses the Quantitative Risk Management system, a sophisticated hedging,
reporting and evaluation system, which has the ability to perform analyses under
various interest rate scenarios. HomeSide's interest rate risk is currently
hedged using a combination of forward sales of mortgage backed securities and
over-the-counter options, including both puts and calls, on fixed income
securities. HomeSide generally commits to sell to investors for delivery at a
future time for a stated price all of its closed loans and a percentage of the
mortgage loan commitments for which the interest rate has been established.
HomeSide aims to price loans competitively, hedge the interest rate risk of loan
originations and sell loans on a break-even basis. For the period from February
11, 1998 to September 30, 1998, the HomeSide predecessor periods from March 1,
1997 to February 10, 1998 and March 16, 1996 to February 28, 1997, HomeSide has
not experienced secondary marketing losses on an aggregate basis.
HomeSide's policy is to sell mortgage loans on a non-recourse basis.
However, in the case of VA loans used to form GNMA pools, the VA's loan
guarantees do not cover the entire principal balance of the loan and HomeSide is
responsible for losses which exceed the VA's guaranteed limitations. In
connection with HomeSide's loan exchanges and sales, HomeSide makes
representations and warranties customary in the industry relating to, among
other things, compliance with laws, regulations and program standards, and to
the accuracy of information. In the event of a breach of these representations
and warranties, HomeSide typically corrects such problems, but, if the problems
cannot be corrected, may be required to repurchase such loans. In cases where
loans are originated by a correspondent, HomeSide may sell the flawed loan back
to the correspondent under a repurchase obligation.
Loan Servicing
HomeSide derives its revenues predominantly from its servicing operations.
HomeSide anticipates that the sale of servicing rights will not be a significant
component of its business strategy in the future. Since its formation, HomeSide
has also maintained a risk management program designed to protect, within
certain parameters, the economic value of its servicing portfolio, which is
subject to prepayment risk when interest rates decline, providing mortgagors
with refinancing opportunities.
Loan servicing includes collecting payments of principal and interest from
borrowers, remitting aggregate loan payments to investors, accounting for
principal and interest payments, holding escrow funds for payment of mortgage
related expenses such as taxes and insurance, making advances to cover
delinquent payments, inspecting the mortgaged premises as required, contacting
delinquent mortgagors, supervising foreclosures and property dispositions in the
event of unremedied defaults, and other miscellaneous duties related to loan
administration. HomeSide collects servicing fees from monthly mortgage payments.
These fees generally range from 0.25% to 0.50% of the declining principal
balances of the loans per annum. HomeSide's weighted average servicing fee
including ancillary income was 0.468% for the period from February 11, 1998 to
September 30, 1998, 0.438% for the HomeSide predecessor period from March 1,
1997 to February 10, 1998 and 0.432% for the HomeSide predecessor period from
March 16, 1996 to February 28, 1997. HomeSide also maintains certain
subservicing relationships whereby servicing is performed by another servicer
under an agreement with HomeSide, which remains contractually responsible for
servicing the loans. Subservicing relationships are often entered into as part
of a bulk servicing acquisition where the selling institution continues to
perform servicing until the loans are transferred to the purchasing institution.
HomeSide's servicing strategy is to continue to build its mortgage
servicing portfolio and benefit from the economies of scale inherent in the
business. HomeSide services substantially all of the mortgage loans that it
originates. In addition, HomeSide purchases the rights to service mortgage loans
originated by other lenders.
HomeSide's servicing strategy is also to enhance the profitability of its
servicing activities through low cost and efficient processes. This strategy is
pursued through highly automated, cost effective processing systems, strategic
outsourcing of selected servicing functions and effective control of
delinquencies and foreclosures. HomeSide outsources to third party vendors
functions relating to insurance, taxes and default management, contributing to
HomeSide's ability to maintain a highly variable cost structure. Using a variety
of factors, including loans serviced per employee and direct cost per loan,
management believes that HomeSide is one of the nation's most efficient
servicers based on industry surveys. Management believes that its low cost
servicing provides it with a competitive advantage in the industry.
<PAGE>
Servicing Portfolio Composition
HomeSide originates and purchases servicing rights for mortgage loans
nationwide. The broad geographic distribution of HomeSide's servicing portfolio
reflects the national scope of HomeSide's originations and bulk servicing
acquisitions. Nine states accounted for 59.9% of the outstanding unpaid
principal balance ("UPB") of HomeSide's total servicing portfolio, and the
largest volume by state is California with a 14.1% share of the total portfolio
on September 30, 1998. Nine states accounted for 64.5% of the outstanding unpaid
principal balance ("UPB") of HomeSide's total servicing portfolio on February
10, 1998, while the largest volume by state was Florida with a 17.2% share of
the total portfolio. Nine states accounted for 66.9% of the outstanding UPB of
HomeSide's total servicing portfolio on February 28, 1997, while the largest
volume by state was Florida with a 18.7% share of the total portfolio. HomeSide
actively monitors the geographic distribution of its servicing portfolio to
maintain a mix that it deems appropriate and makes adjustments as it considers
necessary.
The following table sets forth the geographic distribution of the Company's
servicing portfolio as of September 30, 1998, February 10, 1998 and February 28,
1997:
<TABLE>
<CAPTION>
SERVICING PORTFOLIO BY STATE (a)
HOMESIDE HOMESIDE
PREDECESSOR PREDECESSOR
AT SEPTEMBER 30, 1998 AT FEBRUARY 10, 1998 AT FEBRUARY 28, 1997
--------------------- -------------------- --------------------
UPB % OF UPB UPB % OF UPB UPB % OF UPB
--- -------- --- -------- --- --------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
California $15,859 14.1% $14,858 15.3% $13,686 15.4%
Florida 15,750 14.0 16,664 17.2 16,559 18.7
Texas 7,772 6.9 6,096 6.3 5,434 6.1
Massachusetts 6,190 5.5 6,792 7.0 7,383 8.4
Illinois 5,544 4.9 3,729 3.8 2,913 3.3
Maryland 4,498 4.0 4,424 4.6 4,079 4.6
Arizona 4,405 3.9 (b) (b) (b) (b)
Colorado 3,716 3.3 (b) (b) (b) (b)
Georgia 3,676 3.3 3,720 3.8 3,427 3.9
Ohio 3,519 3.1 (b) (b) (b) (b)
Virginia 3,504 3.1 3,377 3.5 3,218 3.6
New York 3,144 2.8 2,939 3.0 2,517 2.9
Other (b) 34,832 31.1 34,327 35.5 29,244 33.1
============ =========== ============ ============ ============= ============
Total $ 112,409 100.0% $96,926 100.0% $88,460 100.0%
============ =========== ============ ============ ============= ============
</TABLE>
(a) Servicing statistics are based on loans serviced by HomeSide and
exclude loans purchased but not yet on the servicing system.
(b) No other state represents more than 2.8% of HomeSide's servicing
portfolio.
Servicing Portfolio by Loan Type
At September 30, 1998, HomeSide's servicing portfolio consisted of $47.5
billion of FHA/VA servicing and $67.4 billion of conventional servicing. At
February 10, 1998, HomeSide's servicing portfolio consisted of $46.4 billion of
FHA/VA servicing and $52.5 billion of conventional servicing. At February 28,
1997, HomeSide's servicing portfolio consisted of $29.4 billion of FHA/VA
servicing and $59.0 billion of conventional servicing.
The weighted average interest rate of the loans in the Company's servicing
portfolio was 7.72% at September 30, 1998, 7.85% at February 10, 1998 and 7.92%
at February 28, 1997. HomeSide's servicing portfolio of loans was stratified by
interest rate as follows:
<PAGE>
<TABLE>
<CAPTION>
SERVICING PORTFOLIO BY INTEREST RATE (a)
HOMESIDE, PREDECESSOR HOMESIDE PREDECESSOR
AT SEPTEMBER 30, 1998 AT FEBRUARY 10, 1998 AT FEBRUARY 28,1997
------------------------------ ---------------------------- --------------------------
UPB UPB UPB
(DOLLARS IN % OF CUMULATIVE (DOLLARS IN % OF CUMULATIVE (DOLLARS IN % OF CUMULATIVE
INTEREST RATE MILLIONS) UPB % OF UPB MILLIONS) UPB % OF UPB MILLIONS) UPB % OF UPB
- ------------- ------------ ---- ---------- ---------- ---- ---------- ----------- ---- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Less than 6.0% 1,113 1.0% 1.0% $922 0.9% 0.9% $983 1.1% 1.1%
6.0% to 6.9% 13,491 12.0 13.0 10,851 11.2 12.1 9,633 10.9 12.0
7.0% to 7.9% 56,217 50.0 63.0 41,895 43.2 55.3 37,542 42.4 54.4
8.0% to 8.9% 33,012 29.4 92.4 34,076 35.2 90.5 29,293 33.1 87.5
9.0% to 9.9% 5,907 5.2 97.6 6,331 6.5 97.0 7,274 8.2 95.7
10.0% to 10.9% 2,081 1.8 99.4 2,227 2.3 99.3 2,912 3.3 99.0
Over 11.0% 588 0.6 100.0 624 0.7 100.0 823 1.0 100.0
- ------------- ------------ ----- ---------- ----- ----------- -----
Total $112,409 100.0% $96,926 100.0% $88,460 100.0%
============= ============ ===== ========== ===== =========== =====
</TABLE>
(a) Servicing statistics are based on loans serviced by HomeSide and exclude
loans purchased not yet on servicing system.
Loan Servicing Portfolio Delinquencies, Foreclosures and Losses
HomeSide is affected by loan delinquencies and defaults on loans that it
services. Under certain types of servicing contracts, particularly contracts to
service loans that have been pooled or securitized, HomeSide must forward all or
part of the scheduled payments to the owner of the loan, even when loan payments
are delinquent. Also, to protect their liens on mortgaged properties, owners of
loans usually require a servicer to advance scheduled mortgage and hazard
insurance and tax payments even if sufficient escrow funds are not available.
HomeSide is generally reimbursed, subject to certain limitations with respect to
FHA/VA loans as described below, by the mortgage owner or from liquidation
proceeds for payments advanced that the servicer is unable to recover from the
mortgagor, although the timing of such reimbursements is typically uncertain. In
the interim, HomeSide absorbs the cost of funds advanced during the time the
advance is outstanding. Further, HomeSide bears the increased costs of
collection activities on delinquent and defaulted loans. HomeSide also foregoes
servicing income from the time such loans become delinquent until foreclosure,
when, if any proceeds are available, HomeSide may recover such amounts.
Delinquency rates typically rise in the winter months, which result in higher
servicing costs. However, the late payment fees collected income have
historically been sufficient to offset such incremental expenses.
HomeSide periodically incurs losses attributable to servicing FHA and VA
loans for investors, including actual losses for final disposition of loans that
have been foreclosed or assigned to the FHA or VA and accrued interest on such
FHA or VA loans for which payment has not been received. The VA guarantees the
initial losses on a loan. The guaranteed amount generally ranges from 20% to 35%
of the original principal balance. Before each foreclosure sale, the VA
determines whether to bid by comparing the estimated net sale proceeds to the
outstanding principal balance and the servicer's accumulated reimbursable costs
and fees. If this amount is a loss and exceeds the guaranteed amount, the VA
typically issues a no-bid and pays the servicer the guaranteed amount. Whenever
a no-bid is issued, the servicer absorbs the loss, if any, in excess of the sum
of the guaranteed principal and amounts recovered at the foreclosure sale.
HomeSide's historical delinquency and foreclosure rate experience on VA loans
has generally been consistent with that of the industry.
For HomeSide, servicing losses on investor-owned loans and
foreclosure-related expenses, primarily representing losses on VA loans, totaled
$21.2 million for the period February 11, 1998 to September 30, 1998, $22.0
million for the HomeSide predecessor period March 1, 1997 to February 10, 1998
and $17.9 million for the HomeSide predecessor period from March 16, 1996 to
February 28, 1997. The increases, on an annualized basis, were largely
attributable to the growth of the servicing portfolio and increased foreclosure
losses, which may continue at this level as the servicing portfolio ages.
Management believes that it has an adequate level of reserve for servicing
losses on investor-owned loans based on HomeSide's servicing volume, portfolio
composition, credit quality and historical loss rates, as well as estimated
future losses. Servicing losses are generally greatest during the three to six
year age of the loan.
The following table sets forth HomeSide's delinquency and foreclosure
experience:
<PAGE>
SERVICING PORTFOLIO DELINQUENCIES
(PERCENT BY LOAN COUNT)
HOMESIDE HOMESIDE
PREDECESSOR PREDECESSOR
AT SEPTEMBER 30, AT FEBRUARY 10, AT FEBRUARY 28,
1998 1998 1997
---------------- --------------- ---------------
Delinquent Mortgage Loans
(at end of period)
30 Days 3.72% 3.52% 3.27%
60 Days 0.81 0.78 0.69
90 Days 0.65 0.72 0.54
---------------- --------------- ---------------
Total Delinquencies 5.18% 5.02% 4.50%
================ =============== ===============
Foreclosure Pending (at end
of period) 0.70% 0.74% 0.72%
Servicing Portfolio Hedging Program
The value of HomeSide's servicing portfolio is subject to volatility in the
event of unanticipated changes in prepayments. As interest rates increase,
prepayments by mortgagors decrease as fewer owners refinance, increasing
expected future cash flows from servicing revenue. Conversely, as interest rates
decrease, prepayments by mortgagors increase as homeowners seek to refinance
their mortgages, reducing expected future cash flows from servicing revenues on
those prepaid mortgages. Since the value of servicing rights is based on the net
present value of future cash flows, the value of the portfolio decreases in a
declining interest rate environment and increases in a rising rate environment.
HomeSide's risk management policy is designed to minimize exposure to loss
in the value of the servicing portfolio caused by prepayments due to declines in
interest rates. The servicing portfolio is valued using sophisticated cash flow
valuation tools. Key assumptions involved in the valuation include servicing
costs and revenues, market discount rates, prepayment speeds and a number of
other variables. The value is then analyzed under various interest rate
scenarios that help HomeSide estimate its exposure to loss. This potential loss
exposure determines the hedge profile, which is monitored daily and may be
adjusted to reflect significant moves in key variables such as interest rate and
yield curve changes and revised prepayment speed assumptions. Results of the
risk management program depend on a variety of factors, including the hedge
instruments typically used by HomeSide, the relationship between mortgage rates
and Treasury securities and certain other factors. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Risk Management
Activities" for the period from February 11, 1998 to September 30, 1998, the
HomeSide predecessor period from March 1, 1997 to February 10, 1998 and the
HomeSide predecessor period from March 16, 1996 to February 28, 1997.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Statement No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement standardizes the accounting for
derivative instruments and hedging activities by requiring that an entity
recognize those items as assets or liabilities in the statement of financial
position and measure them at fair value. If certain conditions are met, a
derivative instrument may be specifically designated as (a) a hedge of the
exposure to changes in the fair value of a recognized asset or liability, or of
an unrecognized firm commitment, (b) a hedge of the exposure to variability in
the cash flows of recognized assets, liability or forecasted transaction or (c)
a hedge of the foreign currency exposure of an unrecognized firm commitment, an
available-for-sale security, a forecasted transaction or a net investment in a
foreign operation. This statement is effective for fiscal quarters beginning
after June 15, 1999. Management has not yet determined the impact of this
statement on the presentation of the financial statements of HomeSide or on the
nature of its hedging program.
Servicing Technology
HomeSide's proprietary servicing technology accommodates all areas of loan
servicing, including loan setup and maintenance, cashiering, escrow
administration, investor accounting, customer service and default management.
The platform is mainframe based, with on-line, real-time architecture and is
supported by an experienced staff of over 30 technology providers.
HomeSide expects to achieve significant competitive advantages over time
through the use of its proprietary servicing software. At September 30, 1998,
HomeSide has substantially completed the conversion of its mortgage servicing
portfolio to its proprietary servicing software and services approximately 1.4
million loans on the system. This architecture will support HomeSide's portfolio
growth up to approximately twice the number of loans typically serviced on a
single system. The system will also permit continued development of workflow and
other client-server applications, contributing to increased productivity.
Regulation
As a United States subsidiary of a foreign bank, HomeSide is subject to
regulation, supervision and examination by the Federal Reserve Bank. HomeSide's
mortgage banking business is also subject to the rules and regulations of the
U.S. Department of Housing and Urban Development ("HUD"), the Federal Housing
Administration ("FHA"), the Veterans Administration ("VA"), the Federal National
Mortgage Association ("Fannie Mae"), the Federal Home Loan Mortgage Corporation
("FHLMC" or "Freddie Mac"), the Government National Mortgage Association ("GNMA"
or "Ginnie Mae") and other regulatory agencies with respect to originating,
processing, underwriting, selling, securitizing and servicing mortgage loans. In
addition, there are other federal and state statutes and regulations affecting
such activities. These rules and regulations, among other things, impose
licensing obligations on HomeSide, prohibit discrimination and establish
underwriting guidelines which include provisions for inspections and appraisals,
require credit reports on prospective borrowers and set maximum loan amounts.
Moreover, lenders such as HomeSide are required annually to submit audited
financial statements to Fannie Mae, FHLMC, GNMA and HUD and to comply with each
regulatory entity's own financial requirements. HomeSide's business is also
subject to examination by Fannie Mae, FHLMC and GNMA and state regulatory
agencies at all times to assure compliance with applicable regulations, policies
and procedures.
Mortgage origination activities are subject to the provisions of various
federal and state statutes including, among others, the Equal Credit Opportunity
Act, the Federal Truth-in Lending Act, RESPA, the Fair Housing Act, and the
regulations promulgated thereunder, which among other provisions, prohibit
discrimination, prohibit unfair and deceptive trade practices and require the
disclosure of certain basic information to mortgagors concerning credit terms
and settlement costs, limit fees and charges paid by borrowers and lenders, and
otherwise regulate terms and conditions of credit and the procedures by which
credit is offered and administered. Many of the aforementioned regulatory
requirements are designed to protect the interests of consumers, while others
protect the owners or insurers of mortgage loans. Failure to comply with these
requirements can lead to loss of approved status, termination of servicing
contracts without compensation to the servicers, demands for indemnification or
loan repurchases, class action lawsuits and administrative enforcement actions.
Such regulatory requirements are subject to change from time to time and may in
the future become more restrictive, thereby making compliance more difficult or
expensive or otherwise restricting HomeSide's ability to conduct its business as
it is now conducted.
During the period that the National, BKB, Barnett or any of their
subsidiaries held a material ownership interest in HomeSide, HomeSide and its
subsidiaries (i) were under the jurisdiction, supervision, and examining
authority of the Office of the Comptroller of the Currency ("OCC"), and (ii)
could only engage in activities that were part of, or incidental to, the
business of banking. The OCC has specifically ruled that mortgage banking is a
proper incident to the business of banking.
There are various other state and local laws and regulations affecting
HomeSide's operations. HomeSide is licensed in those states that require
licensing to originate, purchase and/or service mortgage loans. Conventional
mortgage operations may also be subject to state usury statutes. FHA and VA
loans are exempt from the effect of such statutes.
Competition
Mortgage bankers operate in a highly competitive and fragmented market. As
of September 30, 1998, the largest originator of loans represented 7.4% of the
market and the largest servicer represented 5.7%, while the top 30 originators
and servicers represented 56% and 52% of their markets, respectively, based on
data published by Inside Mortgage Finance.
<TABLE>
<CAPTION>
TOP 10 ORIGINATORS AND SERVICERS (DOLLARS IN BILLIONS)
9 MONTHS - 1998 ORIGINATIONS SERVICING PORTFOLIO AT SEPTEMBER 30, 1998
<S> <C> <C> <C>
1 Norwest Mortgage, IA $74.8 1 Bank of America Mtg. & Affiliates, CA $241.9
2 Countrywide Credit Services, CA 61.4 2 Norwest Mortgage, IA 232.7
3 Chase Manhattan & Affiliates, NJ 54.3 3 Countrywide Credit Services, CA 194.6
4 Bank of America Mtg. & Affiliates, NC 53.4 4 Chase Manhattan & Affiliates, NJ 183.7
5 Fleet Mortgage Group, SC 24.7 5 Fleet Mortgage Group, SC 118.2
6 Washington Mutual, WA 24.7 6 HomeSide Lending, Inc., FL 115.8
7 Dime/North American Mortgage Co., CA 21.1 7 Washington Mutual, WA 92.6
8 ABN AMRO Mortgage Group, IL 20.4 8 GE Capital Mortgage Svcs Inc., NJ 92.6
9 HomeSide Lending, Inc., FL 19.3 9 First Nationwide Mortgage, CA 89.1
10 Cendant Mortgage Services, NJ 18.2 10 GMAC Mortgage Corp., PA 88.0
Source: Inside Mortgage Finance.
</TABLE>
HomeSide competes with other mortgage bankers, financial institutions, and
other providers of financial services. The underwriting guidelines and servicing
requirements set by the participants in the secondary markets are standardized.
As a result, mortgage banking products (i.e., mortgage loans and the servicing
of those loans) have become difficult to differentiate. Therefore, mortgage
bankers compete primarily on the basis of price or service, making effective
cost management essential.
Mortgage bankers generally seek to develop cost efficiencies in one of two
ways: economies of scale or specialization. Large full-service national or
regional mortgage bankers have sought economies of scale through an emphasis on
wholesale originations, the introduction of automated processing systems and
expansion through acquisition. Smaller companies frequently identify and pursue
a particular expertise or customer base in an attempt to create a market niche.
The industry has experienced rapid consolidation which has been accelerated
by the introduction of significant technology improvements and the economies of
scale present in mortgage servicing. The automation of many functions in
mortgage banking, especially those related to servicing, has reduced costs
significantly for industry participants. Many mortgage bankers that were not low
cost, high volume producers or did not operate in a low cost specialized field
experienced earnings declines in the nineties, causing many to exit the business
or to be acquired. Surviving cost effective firms purchased servicing portfolios
or other companies to expand their servicing economies of scale, while others
acquired market niche operations. As evidence of this consolidation, the top 25
mortgage loan servicers have increased their aggregate market share from 16.6%
in 1990 to 49.6% as of September 30, 1998.
Employees
As of September 30, 1998, February 10, 1998 and February 28, 1997,
respectively, HomeSide had approximately 2,356 total employees, 1,891 total
employees and 1,689 total employees, substantially all of who were full-time
employees. HomeSide has no unionized employees and considers its relationship
with its employees generally to be satisfactory.
ITEM 2. PROPERTIES
HomeSide's corporate, administrative, and servicing headquarters are
located in Jacksonville, Florida, in facilities, which comprise approximately
145,000 square feet of owned space and approximately 189,000 square feet of
leased space. The servicing center lease expires on August 31, 1999 unless
HomeSide exercises its options to renew, which could extend the lease for an
additional six years. HomeSide also leases approximately 104,000 square feet of
warehouse space in Jacksonville, Florida for storing certain loan files, loan
servicing documents and other corporate records. In addition HomeSide owns an
additional 190,000 square feet of space in San Antonio, Texas. On December 4,
1998, HomeSide entered into a long-term lease for a 137,000 square foot building
to be constructed adjacent to its Jacksonville headquarters. The new building
should be ready for occupancy by September 1999. HomeSide believes that its
present facilities are adequate for its operations.
ITEM 3. LEGAL PROCEEDINGS
HomeSide is a defendant in a number of legal proceedings arising in the
normal course of business. HomeSide, in management's estimation, has recorded
adequate reserves in the financial statements for pending litigation.
Management, after reviewing all actions and proceedings pending against or
involving HomeSide, considers that the aggregate liability or loss, if any,
resulting from the final outcome of these proceedings will not have a material
effect on the financial position of HomeSide.
In recent years, the mortgage banking industry has been subject to class
action lawsuits which allege violations of federal and state laws and
regulations, including the propriety of collecting and paying various fees and
charges. Class action lawsuits may be filed in the future against the mortgage
banking industry.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
As a consequence of the merger with the National, there is no market for
the Parent's common equity. The Parent is a wholly-owned subsidiary of the
National.
<PAGE>
PART II
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial and operating information of HomeSide set
forth below is for the periods from February 11, 1998 to September 30, 1998, and
the HomeSide predecessor period from March 1, 1997 to February 10, 1998 and
March 16, 1996 to February 28, 1997 should be read in conjunction with, and is
qualified in its entirety by reference to, the Consolidated Financial Statements
and the notes thereto and in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" of HomeSide included
elsewhere in this document. The periods presented coincide with the commencement
of operations of HomeSide and the acquisition of HomeSide by the National (see
Note 2 of the Consolidated Financial Statements):
<TABLE>
<CAPTION>
HOMESIDE HOMESIDE
(DOLLAR AMOUNTS IN THOUSANDS, PREDECESSOR PREDECESSOR
EXCEPT SHARE DATA) FOR THE PERIOD FOR THE PERIOD FOR THE PERIOD
FEBRUARY 11, 1998 TO MARCH 1, 1997 TO MARCH 16, 1996 TO
SEPTEMBER 30, 1998 FEBRUARY 10, 1998 FEBRUARY 28, 1997
-------------------- ----------------- -----------------
<S> <C> <C> <C>
SELECTED STATEMENT OF EARNINGS DATA:
Revenues:
Mortgage servicing fees $ 312,678 $ 393,292 $ 308,906
Amortization of mortgage servicing rights (189,881) (207,508) (153,694)
-------------------- ----------------- ------------------
Net servicing revenue 122,797 185,784 155,212
Interest income 99,749 97,050 81,507
Interest expense (62,476) (81,770) (66,833)
-------------------- ----------------- ------------------
Net interest revenue 37,273 15,280 14,674
Net mortgage origination revenue 79,179 85,206 66,073
Other income 11,028 1,671 682
-------------------- ----------------- ------------------
Total revenues 250,277 287,941 236,641
Expenses:
Salaries and employee benefits 73,983 75,419 72,976
Occupancy and equipment 13,107 15,447 11,770
Servicing losses on investor-owned loans 21,202 21,974 17,934
Goodwill amortization 22,283 592 150
Other expenses 39,156 37,639 40,616
-------------------- ----------------- ------------------
Total expenses 169,731 151,071 143,446
Income before income taxes 80,541 136,870 93,195
Income tax expense 40,101 53,379 37,278
-------------------- ----------------- ------------------
Net income $ 40,440 $ 83,491 $ 55,917
==================== ================= ==================
SELECTED BALANCE SHEET DATA AT END OF PERIOD:
Mortgage loans held for sale $ 2,048,989 $ 1,292,403 $ 805,274
Mortgage servicing rights 1,766,214 1,766,357 1,596,838
Total assets 5,720,155 3,859,291 2,717,321
Bank credit facility 2,749,000 2,074,956 1,818,503
Long-term debt 1,185,926 770,466 21,128
Total liabilities 4,364,647 3,178,468 2,105,277
Total stockholders' equity 1,355,508 680,823 612,044
=================== ================= =================
SELECTED OPERATING DATA:
Volume of loan production $ 16,826,364 $ 20,529,530 $ 20,877,535
Loan servicing portfolio (at period end) 114,902,121 98,906,102 89,217,846
Loan servicing portfolio (average
outstanding during the period) 106,857,298 94,963,812 74,677,171
Weighted average interest rate of the
servicing portfolio (at period end) 7.72% 7.85% 7.92%
Weighted average servicing fee of the
Servicing portfolio, including
ancillary income (for the period) 0.469% 0.438% 0.432%
</TABLE>
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
HOMESIDE - FOR THE PERIOD FROM FEBRUARY 11, 1998 TO SEPTEMBER 30, 1998, THE
HOMESIDE PREDECESSOR PERIOD FROM MARCH 1, 1997 TO FEBRUARY 10, 1998 AND THE
HOMESIDE PREDECESSOR PERIOD FROM MARCH 16, 1996 TO FEBRUARY 28, 1997
General
HomeSide Lending, Inc. (the "Company" or "HomeSide") is one of the largest
full service residential mortgage banking companies in the United States.
HomeSide's predecessor ("HomeSide Predecessor") was formed through the
acquisition of the mortgage banking operations of BankBoston, N.A. ("BBMC
Predecessor" to HomeSide Predecessor) on March 16, 1996 and subsequently
purchased the mortgage banking operations of Barnett Banks, Inc. Unless
otherwise designated, the term "HomeSide" refers to the Company for the periods
subsequent to February 10, 1998, to HomeSide Predecessor for the periods from
March 16, 1996 to February 10, 1998 and to BBMC Predecessor for periods prior to
March 16, 1998.
On February 10, 1998, National Australia Bank, Ltd. (the "National")
acquired all outstanding shares of the common stock of HomeSide International,
Inc. (the "Parent"). As consideration, the National paid $27.825 per share for
all of the outstanding common stock and $17.7 million cash to retire all
outstanding stock options. The total purchase price was approximately $1.2
billion. The transaction was accounted for as a purchase. As a result, all
assets and liabilities were recorded at their fair value on February 11, 1998,
and the purchase price in excess of the fair value of net assets acquired of
$716.4 million was recorded as goodwill. Following the transaction described
above, the National owns 100% of the Parent's common stock and the Parent has
become an indirect wholly-owned subsidiary of the National. The Company also
adopted a fiscal year end of September 30 to conform to the fiscal year of the
National.
HomeSide's strategy emphasizes variable cost mortgage loan originations,
low cost mortgage servicing and effective risk management. Headquartered in
Jacksonville, Florida, HomeSide ranks as the 9th largest mortgage loan
originator and the 6th largest servicer in the United States at September 30,
1998 based on data published by Inside Mortgage Finance.
The following periods presented coincide with the commencement of
operations of HomeSide and the acquisition of HomeSide by the National (see Note
2 of the Consolidated Financial Statements). HomeSide's operating results are
not directly comparable to its historical operating results due, in part, to
different balance sheet valuations (estimated fair value as compared to
historical cost).
Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for certain forward-looking statements. This report contains
forward-looking statements, which reflect the Company's current views with
respect to future events and financial performance. These forward-looking
statements are subject to certain risks and uncertainties, including those
identified below, which could cause actual results to differ materially from
historical results or those anticipated. The words "believe," "expect,"
"anticipate," "intend," "estimate" and other expressions, which indicate future
events and trends, identify forward-looking statements, which speak only as of
their dates. The Company undertakes no obligation to publicly update or revise
any forward-looking statements whether as a result of new information, future
events or otherwise. The following factors could cause actual results to differ
materially from historical results or those anticipated: (1) the Company's
ability to grow which is dependent on its ability to obtain additional financing
in the future for originating loans, investment in servicing rights, working
capital, capital expenditures and general corporate purposes, (2) economic
factors may negatively affect the Company's profitability as the frequency of
loan default tends to increase in such environments and (3) changes in interest
rates may affect the volume of loan originations and acquisitions, the interest
rate spread on loans held for sale, the amount of gain or loss on the sale of
loans and the value of the Company's servicing portfolio. These risks and
uncertainties are more fully detailed in the Company's filings with the
Securities and Exchange Commission.
Mortgage Banking
Mortgage banking is a specialized branch of the financial services
industry which primarily involves (i) originating and purchasing mortgage loans
("origination" and/or "production"); (ii) selling the originated mortgages to
third parties either as mortgage-backed securities or as whole loans ("secondary
marketing"); (iii) servicing of mortgage loans on behalf of the ultimate
purchasers, which includes the collection and disbursement of payments of
mortgage principal and interest, the collection of payments of taxes and
insurance premiums to pay property taxes and insurance premiums and management
of certain loan default activities (collectively, "servicing"); and (iv) risk
management, a program primarily designed to protect the economic performance of
the servicing portfolio that could otherwise be adversely affected by increased
loan prepayments due to declines in interest rates.
Mortgage bankers originate loans generally through two channels: wholesale
and direct. Wholesale origination involves the origination of mortgage loans
from sources other than homeowners, including mortgage brokers and other
mortgage lenders. Direct origination typically includes (i) networks of retail
loan offices with sales staff that solicit business from homeowners, realtors,
builders and other real estate professionals, (ii) centers that use
telemarketing, direct mail, and advertising to market loans directly to home
buyers or homeowners, (iii) affinity and co-branding partnerships and (iv)
corporate relocation programs. Once originated or purchased, mortgage bankers
hold the loans temporarily ("warehousing") until they are sold, typically
earning an interest spread equal to the difference between the loan's interest
rate and the cost of financing the loan. Each loan is sold either excluding or
including the associated right to service the loan ("servicing retained" or
"servicing released," respectively).
Mortgage bankers rely mainly on short-term borrowings, such as warehouse
lines, to finance the origination of mortgages that are sold. Mortgage bankers
also borrow on a longer term basis to finance their servicing assets and working
capital requirements. Revenues consist primarily of those related to servicing
and, to a lesser extent, fees and interest spreads from originations. The major
expenses of a mortgage banker include costs of financing, operating costs
related to origination and servicing and the amortization of mortgage servicing
rights.
Mortgage bankers typically seek to retain the rights to service the loans
they originate or acquire in order to generate recurring fee income. The
purchase and sale of servicing rights can occur on a loan-by-loan basis ("flow")
or on a portfolio (group of loans) basis ("bulk" or "mini-bulk"). Prices for
servicing rights are typically stated as a multiple of the servicing fee or as a
percentage of the outstanding unpaid principal balance for a group of mortgage
loans. Values of servicing portfolios are generally based on the present value
of the servicing fee income stream, net of servicing costs, expected to be
received over the estimated life of the loans. The assets of a mortgage banking
company consist primarily of mortgage loans held for sale and the value of the
servicing rights.
HomeSide plans to build its core operations through (i) improved economies
of scale in servicing costs; (ii) increased productivity using proprietary
technology; and (iii) expanded and diversified variable cost origination
channels. In addition, HomeSide intends to pursue additional loan portfolio
acquisitions and strategic origination relationships.
Loan Production Activities
As a multi-channel loan production lender, HomeSide has one of the
industry's largest correspondent lending production operations, a full-service
brokered loan program and a national production center for consumer direct
mortgage lending. By focusing on production channels with a variable cost
structure, HomeSide eliminates the fixed costs associated with traditional
mortgage branch offices. Without the burden of high fixed cost loan origination
networks, HomeSide is positioned to weather a variety of interest rate
environments. For the nine months ended September 30, 1998, HomeSide was ranked
the ninth largest originator in the United States, according to Inside Mortgage
Finance, with approximately 2% market share of the estimated $1.0 trillion
single-family mortgage origination market.
The following information regarding loan production activities for HomeSide
is presented to aid in understanding the results of operations and financial
condition of HomeSide for the period from February 11, 1998 to September 30,
1998, and the HomeSide predecessor periods March 1, 1997 to February 10, 1998
and March 16, 1996 to February 28, 1997 (in millions):
HOMESIDE HOMESIDE
FOR THE PERIOD FROM PREDECESSOR PREDECESSOR
FEBRUARY 11, 1998 FOR THE PERIOD FROM FOR THE PERIOD FROM
TO MARCH 1, 1997 TO MARCH 16, 1996 TO
SEPTEMBER 30, 1998 FEBRUARY 10, 1998 FEBRUARY 28, 1997
------------------- ------------------- -------------------
Wholesale:
Correspondent $11,309 $13,304 $11,113
Co-issue (a) 2,906 5,584 8,222
Broker 1,980 1,305 843
------- ------- -------
Total wholesale 16,195 20,193 20,178
Direct 631 337 700
------- ------- -------
Total production 16,826 20,530 20,878
Bulk acquisitions (b) 18,947 3,446 4,073
------- ------- -------
Total production and
acquisitions $35,773 $23,976 $24,951
======= ======= =======
(a) Represents the acquisition of servicing rights, not the underlying loans.
Amounts represent the unpaid principal balance of mortgage debt to which
the acquired servicing rights relate.
(b) Represents the acquisition of servicing rights from another servicer.
Amounts represent the unpaid principal balance of mortgage debt to which
the acquired servicing rights relate.
Total loan production, excluding bulk acquisitions, was $16.8 billion for
the period from February 11, 1998 to September 30, 1998 compared to $20.5
billion for the HomeSide predecessor period from March 1, 1997 to February 10,
1998, a 21% increase on an annualized basis. HomeSide's correspondent lending
and broker channels were the primary contributors to production volume increases
on an annualized basis. On June 5, 1998, HomeSide completed the addition of Banc
One as a Preferred Partner. As a Preferred Partner, Banc One will sell a
significant portion of the residential mortgage loans it originates to HomeSide
over the next five years. During the period from February 11, 1998 to September
30, 1998, HomeSide also purchased the operations of NationsBank's subsidiary
Loan America, a national broker network. This purchase will contribute to
HomeSide's expansion of its broker network, a production channel that is key to
HomeSide's variable cost origination strategy. Total loan production, excluding
bulk acquisitions, of $20.5 billion for the HomeSide predecessor period from
March 1, 1997 to February 10, 1998 was relatively equal to the HomeSide
predecessor period from March 16, 1996 to February 28, 1997.
The interest rate environment has significantly affected the size of the
mortgage origination market. When interest rates decline, increasing numbers of
mortgagees refinance their loans. As a result, the mortgage origination market
grows. The estimated mortgage origination market for the year ending December
31, 1998 is $1.4 trillion (estimated), compared to $0.8 trillion and $0.8
trillion for the years ended December 31, 1997 and 1996, respectively. The
percentage of refinance volume is 50% (estimated) , 31% and 29% , respectively,
for the years ending December 31, 1998, 1997 and 1996.
During this period of high refinances, HomeSide has strived to keep
production at a level which is sustainable should the market size return to 1997
and 1996 volumes. To maintain and increase the servicing portfolio size during
this period of relatively high portfolio runoff, HomeSide has emphasized its
acquisitions strategy.
Bulk servicing acquisitions totaled $18.9 billion for the period from
February 11, 1998 to September 30, 1998 and included a $16.6 billion servicing
portfolio purchase from Banc One. This purchase was a continuation of HomeSide's
targeted approach to grow the servicing portfolio. HomeSide also made bulk
servicing acquisitions of $3.4 billion and $4.1 billion during the HomeSide
predecessor periods from March 1, 1997 to February 10, 1998 and March 16, 1996
to February 28, 1997, respectively.
As borrowers took advantage of declining interest rates, HomeSide's
percentage of loan production attributable to refinances totaled 57% for the
period from February 11, 1998 to September 30, 1998. The interest rate that
prevailed during the period from February 11, 1998 to September 30, 1998, was
favorable for fixed rate mortgages, which totaled 95% of total fundings for the
period.
HomeSide continues to examine a number of ways to diversify and grow
revenue sources from its existing and new customer base. As part of this effort,
HomeSide formed an alliance with a subprime lender, which allows HomeSide to
offer additional mortgage-related products to the production network. The
subprime lending division, HomeSide Equities, launched operations in January
1998.
Servicing Portfolio
Management believes that HomeSide is one of the most efficient mortgage
loan servicers in the industry based on its servicing cost per loan and the
number of loans serviced per employee. The servicing operation makes extensive
use of state-of-the-art technology, process re-engineering and expense
management. With a portfolio size of $114.9 billion, HomeSide services the loans
of approximately 1.4 million homeowners from across the United States and is
committed to protecting the value of this important asset by a sophisticated
risk management strategy. HomeSide anticipates its low cost of servicing loans
will continue to maximize the bottom-line impact of its growing servicing
portfolio. HomeSide's focus on efficient and low cost processes is pursued
through the selective use of automation as well as the strategic outsourcing of
selected servicing functions and effective control of delinquencies and
foreclosures. At September 30, 1998, HomeSide was ranked the sixth largest
servicer in the United States, with approximately 3% market share of the $4.2
trillion single family mortgages outstanding.
The following information on the dollar amounts of loans serviced is
presented to aid in understanding the results of operations and financial
condition of HomeSide for the period from February 11, 1998 to September 30,
1998, and the HomeSide predecessor periods from March 1, 1997 to February 10,
1998 and March 16, 1996 to February 28, 1997 (in millions):
<PAGE>
<TABLE>
<CAPTION>
HOMESIDE HOMESIDE
FOR THE PERIOD FROM PREDECESSOR PREDECESSOR
FEBRUARY 11, 1998 FOR THE PERIOD FROM FOR THE PERIOD FROM
TO MARCH 1, 1997 TO MARCH 16, 1996 TO
SEPTEMBER 30, 1998 FEBRUARY 10, 1998 FEBRUARY 28, 1997
------------------- ------------------- -------------------
<S> <C> <C> <C>
Balance at beginning of period $98,906 $89,218 $41,844
Acquisition of Barnett Mortgage
Company - - 33,082
Other additions 35,773 23,976 25,252
------------------- ------------------- -------------------
Total additions 35,773 23,976 58,334
------------------- ------------------- -------------------
Scheduled amortization 1,747 2,035 1,733
Prepayments 16,809 11,176 6,226
Foreclosures 848 682 514
Sales of servicing 373 395 2,487(a)
------------------- ------------------- -------------------
Total reductions 19,777 14,288 10,960
------------------- ------------------- -------------------
Balance at end of period $114,902 $98,906 $89,218
=================== =================== ===================
</TABLE>
(a) Includes $1.9 billion of servicing sold as part of the sale of Honolulu
Mortgage Company.
The number of loans serviced at September 30, 1998 was 1,394,286, compared
to 1,167,210 at February 10, 1998 and 1,070,210 at February 28, 1997. HomeSide's
strategy is to build its mortgage servicing portfolio by concentrating on
variable cost loan origination strategies, and as a result, benefit from
improved economies of scale. A key to HomeSide's future growth is its
proprietary servicing software. This system allows HomeSide to double the number
of loans typically serviced on a single system. At September 30, 1998, HomeSide
has substantially converted its loan servicing portfolio to its proprietary
servicing software.
Results of Operations for the period from February 11, 1998 to September 30,
1998 compared to the HomeSide predecessor period from March 1,1997 to February
10, 1998:
Summary
HomeSide's net income, excluding goodwill amortization from the acquisition
of HomeSide by the National, increased 15% on an annualized basis to $62.7
million for the period from February 11, 1998 to September 30, 1998 from $83.5
for the HomeSide predecessor period from March 1, 1997 to February 10, 1998.
Total revenues for the period from February 11, 1998 to September 30, 1998
increased 33%, on an annualized basis, to $250.3 million from $287.9 million for
the HomeSide predecessor period from March 1, 1997 to February 10, 1998. Strong
production volumes, growth in fee income, and lower cost of funds were the key
contributors to HomeSide's success. The U.S. housing market was exceptionally
strong during the period from February 11, 1998 to September 30, 1998, with
record low mortgage rates and high mortgage pre-payment activity. HomeSide
acquired Banc One Mortgage's $16.6 billion servicing portfolio on June 5, 1998.
This acquisition increased HomeSide's servicing portfolio by 15% on that date.
As part of the acquisition, Banc One agreed to sell HomeSide the loans produced
by its loan production networks, which contributed to the increase in net
mortgage origination revenue. Net interest revenue increased as a result of
increases in average interest-earning assets and reduced borrowing costs from
improved credit ratings and the issuance of medium-term notes. Total expenses
increased, on an annualized basis, for the period from February 11, 1998 to
September 30, 1998 from the period from March 1, 1997 to February 10, 1998 as a
result of increases in production volume, amortization expense related to the
goodwill associated with the merger with the National (see Note 1) and expenses
associated with the growing mortgage servicing portfolio and high loan
pre-payment activity.
Net Servicing Revenue
Net servicing revenue was $122.8 million for the period from February 11,
1998 to September 30, 1998 compared to $185.8 million for the HomeSide
predecessor period from March 1, 1997 to February 10, 1998. Net servicing
revenue is comprised of mortgage servicing fees, ancillary servicing revenue,
and amortization of mortgage servicing rights expense.
Mortgage servicing fees increased 22%, on an annualized basis, to $312.7
million for the period from February 11, 1998 to September 30, 1998 from $393.3
million for the HomeSide predecessor period from March 1, 1997 to February
10,1998, primarily as a result of the Banc One Mortgage acquisition and growth
of the servicing portfolio through loan production channels. The servicing
portfolio increased to $114.9 billion at September 30, 1998 compared to $98.9
billion at February 10, 1998, due to increased production volume and bulk
acquisitions, partially offset by prepayments and scheduled amortization. The
prepayment rate of the servicing portfolio was 25% for the period from February
11, 1998 to September 30, 1998, up from 16% from the period from March 1, 1997
to February 10, 1998. The prepayment rate is affected by the level of refinance
activity, which is driven by the relative level of mortgage interest rates and
activity in the home purchase market. HomeSide's weighted average interest rate
of the mortgage loans in the servicing portfolio was 7.72% at September 30, 1998
and 7.85% at February 10, 1998. The weighted average servicing fee, including
ancillary income, for the servicing portfolio was 0.469% for the period from
February 11, 1998 to September 30, 1998 and 0.438% for the HomeSide predecessor
period from March 1, 1997 to February 10, 1998. The increase in the weighted
average servicing fee for the period from February 11, 1998 to September 30,
1998 compared to the HomeSide predecessor period from March 1, 1997 to February
10, 1998 was due to growth of ancillary revenues, including late fees and other
mortgage-related products.
Amortization expense increased 40%, on an annualized basis, to $189.9
million for the period from February 11, 1998 to September 30, 1998 from $207.5
million for the HomeSide predecessor period from March 1, 1997 to February 10,
1998, as a result of the record low interest rate environment. Amortization
charges are highly dependent upon the level of prepayments during the period and
changes in prepayment expectations, which are significantly influenced by the
direction and level of long-term interest rate movements. A decrease in mortgage
interest rates results in an increase in prepayment estimates used in
calculating periodic amortization expense. Because mortgage servicing rights are
amortized over the expected period of service fee revenues, an increase in
mortgage prepayment activity typically results in a shorter estimated life of
the mortgage servicing assets and, accordingly, higher amortization expense.
Net Interest Revenue
Net interest revenue is driven by the level of interest rates, the
direction in which rates are moving, the spread between short and long-term
interest rates, and the rates at which HomeSide is able to borrow. These factors
influence the size of the residential mortgage origination market, HomeSide's
loan production volumes and the interest rates HomeSide earns on loans and pays
to its lenders.
Loan refinancing levels are the largest contributor to changes in the size
of the mortgage origination market. To reduce the cost of their home mortgages,
borrowers tend to refinance their loans during periods of declining interest
rates, increasing the size of the origination market and HomeSide's loan
production volumes. Higher loan production volumes resulted in higher average
balances of loans held for sale and consequently higher levels of interest
income earned on such loans prior to their sale. This higher level of interest
income due to increased volumes is partially offset by the lower rates earned on
the loans.
Overall borrowing costs also fluctuate with changes in interest rates.
Currently, the interest expense HomeSide pays to finance mortgage loans held for
sale and other net assets is generally calculated with reference to short-term
interest rates. In addition, because mortgage loans held for sale earn interest
based on longer term interest rates, the level of net interest revenue is also
influenced by the spread between long-term and short-term interest rates.
Net interest revenue increased to $37.3 million for the period from
February 11, 1998 to September 30, 1998 from $15.3 million for the HomeSide
predecessor period from March 1, 1997 to February 10, 1998, primarily due to
increases in net interest earned on mortgage loans held for sale and escrow
deposits partially offset by increased interest expense on borrowings to fund
the growing mortgage servicing assets. The average balance of mortgage loans
held for sale increased as a result of increased production, on an annualized
basis, during the period from February 11, 1998 to September 30, 1998. The
principal balances of prepaid mortgage loans are accumulated in escrow accounts
before they are remitted to investors. During periods of declining interest
rates, prepayments, escrow balances and the related earnings increase. During
the period from February 11, 1998 to September 30, 1998, net interest income was
also positively affected by lower funding rates obtained through improved credit
ratings, the issuance of medium-term notes and net interest income from the
early pool buyout program. On June 23, 1998, HomeSide established a line of
credit with the National with a borrowing rate of LIBOR. HomeSide issued $410
million of medium-term notes to the public market at an average borrowing cost
of 6.0% during the period from February 11, 1998 to September 30, 1998 and
$750.0 million of medium-term notes issued with an average borrowing cost of
6.251% as of February 10, 1998. The proceeds were used to pay down existing bank
debt, purchase the Banc One servicing portfolio, and fund the early pool buyout
program. The early pool buyout program involves the purchase of delinquent
government loans from pools early in the foreclosure process, thereby reducing
the unreimbursed interest expense that HomeSide incurs.
Net Mortgage Origination Revenue
Net mortgage origination revenue is comprised of fees earned on the
origination of mortgage loans, gains and losses on the sale of loans, gains and
losses resulting from hedging of secondary marketing activities and fees charged
to review loan documents for purchased loan production.
Net mortgage origination revenue was $79.2 million for the period from
February 11, 1998 to September 30, 1998 compared to $85.2 million for the
HomeSide predecessor period from March 1, 1997 to February 10, 1998, a 43%
increase on an annualized basis. Favorable results were largely attributable to
the declining mortgage interest rates, which sparked significant increases in
refinancing levels and the origination market. As a result, HomeSide's loan
production volumes increased, on an annualized basis, primarily through
preferred seller relationships and HomeSide's broker and correspondent lending
channels. The increase also reflects an increase in margins due to a declining
interest rate environment.
Other Income
Other income for the period from February 11, 1998 to September 30, 1998
was $11.0 million compared to $1.7 million for the HomeSide predecessor period
from March 1, 1997 to February 10, 1998. The increase was primarily due to gains
on sales of reinstated loans from the early pool buyout program and real estate
tax service fees.
Salaries and Employee Benefits
Salaries and employee benefits expense was $74.0 million for the period
from February 11, 1998 to September 30, 1998 compared to $75.4 million for the
HomeSide, Inc. predecessor period from March 1, 1997 to February 10, 1998. The
increase on an annualized basis was due to growth in the number of employees to
service the growing mortgage servicing portfolio, increased prepayment activity
and increased production volume. Additional servicing employees were added for
the Banc One acquisition. Although substantially all of the servicing operations
acquired from Banc One were integrated into the existing Jacksonville and San
Antonio servicing sites at September 30, 1998. The average number of full-time
equivalent employees increased to 2,356 for the period from February 11, 1998 to
September 30, 1998 from 1,891 for the HomeSide, Inc. predecessor period from
March 1, 1997 to February 10, 1998.
Occupancy and Equipment Expense
Occupancy and equipment expense primarily includes rental expense, repairs
and maintenance costs, certain computer software expenses and depreciation of
HomeSide's premises and equipment. Occupancy and equipment expense for the
period from February 11, 1998 to September 30, 1998 was $13.1 million compared
to $15.4 million for the HomeSide predecessor period from March 1, 1997 to
February 10, 1998. The annualized increase was mainly due to increased expenses
incurred to enhance processing systems and technology expenditures necessary to
support targeted business growth.
Servicing Losses on Investor-Owned Loans and Foreclosure-Related Expenses
Servicing losses on investor-owned loans represent anticipated losses
primarily attributable to servicing FHA and VA loans for investors. These
amounts include actual losses for final disposition of loans, non-recoverable
foreclosure costs, accrued interest for which payment has been denied and
estimates for potential losses based on HomeSide's experience as a servicer of
government loans.
During the period from February 11, 1998 to September 30, 1998, the
servicing losses on investor-owned loans and foreclosure-related expenses
totaled $21.2 million compared to $22.0 million for the HomeSide predecessor
period from March 1, 1997 to February 10, 1998. The increase, on an annualized
basis, was largely attributable to the growth of the servicing portfolio and
increased foreclosure losses, which may continue at this level as the servicing
portfolio ages.
Included in accounts payable and accrued liabilities at September 30, 1998
and February 10, 1998 is a reserve for estimated servicing losses on
investor-owned loans of $21.7 million. The reserve has been established for
potential losses related to the mortgage servicing portfolio. Increases to the
reserve are charged to earnings as servicing losses on investor-owned loans. The
reserve is decreased for actual losses incurred related to the mortgage
servicing portfolio. HomeSide's historical loss experience on VA loans generally
has been consistent with industry experience. Management believes that HomeSide
has an adequate level of reserve based on servicing volume, portfolio
composition, credit quality and historical loss rates, as well as estimated
future losses. Servicing losses are generally greatest during the three to six
year age of the loan.
The following table sets forth HomeSide's delinquency and foreclosure
experience:
SERVICING PORTFOLIO DELINQUENCIES
(PERCENT BY LOAN COUNT)
SEPTEMBER 30, 1998 FEBRUARY 10, 1998
------------------ -----------------
Servicing Portflio Delinquencies
excluding bankruptcies (at end of period)
30 Days 3.72% 3.52%
60 Days 0.81 0.78
90 Days 0.65 0.72
------------------ -----------------
Total past due 5.18% 5.02%
================== =================
Foreclosure Pending (at end
of period) 0.70% 0.74%
================== =================
Weighted average portfolio age in months 46.1 43.6
Other Expenses and Goodwill Amortization
Other expenses consist mainly of professional fees, communications expense,
advertising and public relations, data processing expenses and certain loan
origination expenses. The level of other expenses fluctuates in part based upon
the level of HomeSide's mortgage servicing portfolio and loan production
volumes.
Other expenses, excluding goodwill amortization of $22.3 million resulting
from the acquisition of HomeSide by the National, were $39.2 million during the
period from February 11, 1998 to September 30, 1998, compared to $37.6 million
for the HomeSide predecessor period from March 1, 1997 to February 10, 1998. The
annualized increase was primarily due to expenses associated with higher
production volumes and the growing mortgage servicing portfolio.
Income Tax Expense
HomeSide's income tax expense was $40.4 million for the period from
February 11, 1998 to September 30, 1998 and $53.4 million for the HomeSide
predecessor period from March 1, 1997 to February 10, 1998. The effective income
tax rate for the period from February 11, 1998 to September 30, 1998 and the
HomeSide predecessor period from March 1, 1997 to February 10, 1998 was
approximately 50% and 39%, respectively. The increase was due to the tax effects
of goodwill as a result of the merger with the National.
Results of operations for the HomeSide predecessor period from March 1, 1997 to
February 10, 1998 compared to the HomeSide predecessor period from March 16,
1996 to February 28, 1997
Summary
HomeSide's net income increased 49% to $83.5 million for the period from
March 1, 1997 to February 10, 1998 from $55.9 million for the period from March
16, 1996 to February 28, 1997. Total revenues for the period from March 1, 1997
to February 10, 1998 increased 22% to $287.9 million from $236.6 million for the
period from March 16, 1996 to February 28, 1997. The increases in net income and
revenues for the period from March 1, 1997 to February 10, 1998 compared to the
period from March 16, 1996 to February 28, 1997 were primarily attributable to
the acquisition of Barnett Mortgage Company ("BMC") on May 31, 1996 and
increases of $30.6 million in net servicing revenue, $19.1 million in net
mortgage origination revenue and $0.6 million in net interest revenue. The BMC
servicing portfolio was $33.1 billion at May 31, 1996. Its acquisition increased
HomeSide's servicing portfolio by 75% on that date, and was a major factor in
the increase in net servicing revenue. In addition, subsequent increases in the
size of the servicing portfolio contributed to the increased revenue. The
servicing portfolio increased to $98.9 billion at February 10, 1998 from $89.2
billion at February 28, 1997, an 11% increase. As part of the BMC acquisition,
Barnett agreed to sell HomeSide the loans produced by the loan production
networks retained by Barnett, which contributed to the increase in net mortgage
origination revenue. Net interest revenue increased primarily because of lower
borrowing costs resulting from the lower interest rate environment during the
period ending February 10, 1998, improved terms for the bank line of credit and
the issuance of medium-term notes. The Company's improved credit ratings lowered
the cost of borrowing under the bank line of credit and enabled HomeSide to
issue publicly traded notes, which expanded borrowing capacity.
Net Servicing Revenue
Net servicing revenue was $185.8 million for the period from March 1, 1997
to February 10, 1998 compared to $155.2 million for the period from March 16,
1996 to February 28, 1997. Mortgage servicing fees increased 27% to $393.3
million for the period from March 1, 1997 to February 10, 1998 from $308.9
million for the period from March 16, 1996 to February 28,1997, primarily as a
result of the BMC acquisition and growth of the servicing portfolio through loan
production channels and bulk servicing acquisitions. The servicing portfolio
increased to $98.9 billion at February 10, 1997 compared to $89.2 billion at
February 28, 1997. HomeSide's weighted average interest rate of the mortgage
loans in the servicing portfolio was 7.85% at February 10, 1998 and 7.92% at
February 28, 1997. The weighted average servicing fee, including ancillary
income, for the servicing portfolio was 0.438% and 0.432% for the period from
March 1, 1997 to February 10, 1998 and the period from March 16, 1996 to
February 28, 1997, respectively. The increase in the weighted average servicing
fee for the period from March 1, 1997 to February 10, 1998 compared to the
period from March 16, 1996 to February 28, 1997 was due to growth of ancillary
revenues, including late fees and other mortgage-related products. Amortization
expense increased to $207.5 million for the period March 1, 1997 to February 10,
1998 from $153.7 million for the period from March 16, 1996 to February 28, 1997
mainly as a result of a higher average balance of mortgage servicing rights and
a decrease of 86 basis points in average mortgage interest rates from the period
from March 16, 1996 to February 28, 1997 to the period from March 1, 1997 to
February 10, 1998.
Net Interest Revenue
Net interest revenue increased $0.6 million for the period from March 1,
1997 to February 10, 1998 to $15.3 million from $14.7 million for the period
from March 16, 1996 to February 28, 1997, primarily due to improved funding
rates obtained through improved credit ratings, the issue of medium-term notes
and the adoption of an early pool buyout program. During the period from March
1, 1997 to February 10, 1998, HomeSide issued $750.0 million of medium-term
notes to the public market at an average cost of 6.251% as of February 10, 1998.
The proceeds were used to pay down existing bank debt, increasing HomeSide's
borrowing capacity. An immediate benefit of this increased borrowing capacity
was the initiation of an early pool buyout program, which involves the purchase
of delinquent government loans from pools early in the foreclosure process,
thereby reducing the unreimbursed interest expense that HomeSide incurs.
Interest income increased from the period from March 16, 1996 to February
28, 1997 to the period from March 1, 1997 to February 10, 1998, primarily as a
result of an increase of $246.6 million in the average balance of loans held for
sale. Interest expense increased from the period from March 16, 1996 to February
28, 1997 to the period from March 1, 1997 to February 10, 1998 as a result of
increased borrowings to fund growth of the servicing portfolio and loan
origination activity. These expenses were offset by an increase in credits
received on borrowings as a result of higher average balances of custodial
deposits.
Net Mortgage Origination Revenue
Net mortgage origination revenue was $85.2 million for the period from
March 1, 1997 to February 10, 1998 compared to $66.1 million for the period from
March 16, 1996 to February 28, 1997, a 29% increase. The increase in net
mortgage origination revenue during the period from March 1, 1997 to February
10, 1998 as compared to the period from March 16, 1996 to February 28, 1998 is
due in part to an increase in loan production volumes resulting from the
preferred seller relationships with Barnett and BankBoston and HomeSide's broker
and correspondent lending channels. The increase also reflects larger gains from
secondary marketing activities.
Salaries and Employee Benefits
Salaries and employee benefits expense was $75.4 million for the period
from March 1, 1997 to February 10, 1998 compared to $73.0 million for the period
from March 16, 1996 to February 28, 1997 due to growth in the number of
employees as a result of the purchase of the BMC mortgage servicing operations
acquired on May 31, 1996. The average number of full-time equivalent employees
increased to 1,805 for the period from March 1, 1997 to February 10, 1998 from
1,593 for the period from March 16, 1996 to February 28, 1997.
Occupancy and Equipment Expense
Occupancy and equipment expense for the period from March 1, 1997 to
February 10, 1998 was $15.4 million compared to $11.8 million for the period
from March 16, 1996 to February 28, 1997. The increase in expense was mainly due
to increases in the costs of information systems required to handle the growing
mortgage servicing portfolio.
Servicing Losses on Investor-Owned Loans and Foreclosure-Related Expenses
During the period from March 1, 1997 to February 10, 1998, the servicing
losses on investor-owned loans and foreclosure-related expenses totaled $22.0
million compared to $17.9 million for the period from March 16, 1996 to February
28, 1997. The increase was largely attributable to the growth of the servicing
portfolio resulting from loan production and increased foreclosure losses.
Included in accounts payable and accrued liabilities at February 10, 1998 and
February 28, 1997 is a reserve for estimated servicing losses on investor-owned
loans of $21.7 million.
The following table sets forth HomeSide's delinquency and foreclosure
experience:
<PAGE>
SERVICING PORTFOLIO DELINQUENCIES
(PERCENT BY LOAN COUNT)
SEPTEMBER 30, 1998 FEBRUARY 10, 1998
------------------ -----------------
Servicing Portflio Delinquencies
excluding bankruptcies (at end of period)
30 Days 3.52% 3.27%
60 Days 0.78 0.69
90 Days 0.72 0.54
------------------ -----------------
Total past due 5.02% 4.50%
================== =================
Foreclosure Pending (at end
of period) 0.74% 0.72%
================== =================
Other Expenses
Other expenses during the period from March 1, 1997 to February 10, 1998
were $38.2 million, compared to $40.8 million for the period from March 16, 1996
to February 28, 1997. The decrease was primarily due to decreases in advertising
and certain loan origination expenses.
Income Tax Expense
HomeSide's income tax expense was $53.4 million for the period from March
1, 1997 to February 10, 1998 and $37.3 million for the period from March 16,
1996 to February 28, 1997. The increase was attributable to an increase in net
income. The effective income tax rate for the period from March 1, 1997 to
February 10, 1998 and the period from March 16, 1996 to February 28, 1997 was
approximately 39% and 40%, respectively.
Risk Management Activities
HomeSide has a risk management program designed to protect the economic
value of its mortgage servicing portfolio from declines in value due to
increases in estimated loan prepayment speeds, which are primarily influenced by
declines in interest rates. When loans prepay faster than anticipated, the cash
flow HomeSide expects to receive from servicing such loans is reduced. The value
of mortgage servicing rights is based on the present value of the cash flows to
be received over the life of the loan and therefore, the value of the servicing
portfolio declines as prepayments increase.
During the period from February 11, 1998 to September 30, 1998, HomeSide
utilized options on U.S. Treasury bond and note futures and U.S. Treasury bond
and note futures to protect a significant portion of the market value of its
mortgage servicing portfolio from a decline in value. The risk management
contracts used by HomeSide have characteristics such that they tend to increase
in value as interest rates decline. Conversely, these risk management contracts
tend to decline in value as interest rates rise. Accordingly, changes in value
of these risk management instruments will tend to move inversely with changes in
value of HomeSide's mortgage servicing rights.
These risk management instruments are designated as hedges on the purchase
date and such designation is at a level at least as specific as the level at
which mortgage servicing rights are evaluated for impairment. The risk
management instruments are marked-to-market with changes in market value
deferred and applied as an adjustment to the basis of the related mortgage
servicing right asset being hedged. As a result, any changes in market value
that are deferred are amortized and evaluated for impairment in the same manner
as the related mortgage servicing rights. The effectiveness of HomeSide's
hedging activity can be measured by the correlation between changes in the value
of the risk management instruments and changes in the value of HomeSide's
mortgage servicing rights. This correlation is assessed on a quarterly basis to
ensure that high correlation is maintained over the term of the hedging program.
If management's ongoing assessment of correlation indicates that high
correlation is not being achieved, the Company will discontinue the application
of hedge accounting and recognize a gain or loss to the extent the hedge results
have not been offset by changes in value of the hedged asset during the hedge
period. During the periods presented, HomeSide has experienced a high measure of
correlation between changes in the value of mortgage servicing rights and the
risk management contracts. However, in periods of rising interest rates, the
increase in values of mortgage servicing rights may outpace the decline in value
of the options included in the hedge position, because the loss on the options
is limited to the premium paid.
During the period from February 11, 1998 to September 30, 1998, deferred
gains on risk management contracts resulted in net deferred hedge gains of
$389.6 million which are included in the carrying value of mortgage servicing
rights. Activity in the deferred hedge account during the period from February
11, 1998 to September 30, 1998 is as follows (in thousands):
<PAGE>
Net deferred hedge balance at February 11, 1998 -
Net deferred hedge gains 394,157
Amortization of net deferred hedge gains (4,585)
===========
Net deferred hedge balance at September 30, 1998 $ 389,572
===========
HomeSide's future cash needs as they relate to its hedging program will be
influenced by such factors as long-term interest rates, loan production levels
and growth in the mortgage servicing portfolio. The fair value of open risk
management contracts at September 30, 1998 was $120.2 million, which was equal
to their carrying amount because the risk management contracts are
marked-to-market at each reporting date. See "-Liquidity and Capital Resources"
for further discussion of HomeSide's sources and uses of cash. See Note 3 of
Notes to Consolidated Financial Statements for a description of HomeSide's
accounting policy for its risk management contracts. See Notes 13 and 14 of
Notes to Consolidated Financial Statements for additional fair value disclosures
with respect to HomeSide's risk management contracts.
Liquidity and Capital Resources
The Company's principal financing needs are the financing of loan
origination activities and the investment in mortgage servicing rights. To meet
these needs, the Company currently utilizes funding from an independent
syndicate of banks and from the National, including a warehouse credit facility
and a servicing-related facility, medium-term notes and cash flow from
operations. In the past, the Company has also utilized short-term credit
facilities and public offerings of common stock. HomeSide continues to
investigate and pursue alternative and supplementary methods to finance its
growing operations through the public and private capital markets. These may
include methods designed to expand the Company's financial capacity and reduce
its cost of capital. In addition, to facilitate the sale and distribution of
certain mortgage products, HomeSide Mortgage Securities, Inc., a wholly-owned
subsidiary of HomeSide, may continue to issue mortgage backed securities.
Operations
Net cash used in operations for the period from February 11, 1998 to
September 30, 1998 was $342.3 million. Net cash used in operations for the
HomeSide predecessor period from March 1, 1997 to February 10, 1998 was $231.0
million. Net cash provided by operations for the HomeSide predecessor period
from March 16, 1996 to February 28, 1997 was $216.6 million. The primary uses of
cash in operations were to fund loan originations and pay corporate expenses.
These uses of cash were offset by cash provided from servicing fee income, loan
sales and principal repayments. Cash flows from loan originations are dependent
upon current economic conditions and the level of long-term interest rates.
Decreases in long-term interest rates generally result in higher loan
refinancing activity, which results in higher cash demands to meet increased
loan production levels. Higher cash demands to meet increased loan production
levels are primarily met through borrowings and loan sales.
Investing
Net cash used in investing activities for the period from February 11, 1998
to September 30, 1998 was $677.9 million. Net cash used in investing activities
was $773.7 million and $862.2 million for the HomeSide predecessor periods from
March 1, 1997 to February 10, 1998 and March 16, 1996 to February 28, 1997. Cash
was used for the purchase and origination of mortgage servicing rights. For the
period from February 11, 1998 to September 30, 1998 and the HomeSide predecessor
period from March 1, 1997 to February 10, 1998, cash was also used for funding
the early pool buyout program. During the period from February 11, 1998 to
September 30, 1998 and the HomeSide predecessor period from March 1, 1997 to
February 10, 1998, these uses of cash were offset by net proceeds from risk
management contracts, while during the period from March 16, 1997 to February
28, 1997, cash was used to purchase risk management contracts. During the period
from February 11, 1998 to September 30, 1998, HomeSide also made a net payment
of $201.0 million to acquire the servicing portfolio of Banc One. During the
period from March 16, 1996 to February 28, 1997, HomeSide made net payments of
$133.4 million and $106.2 million to acquire certain mortgage banking operations
of BBMC and BMC, respectively (see Note 4 of Notes to Consolidated Financial
Statements). Future uses of cash for investing activities will be dependent on
the mortgage origination market and HomeSide's hedging needs. HomeSide is not
able to estimate the timing and amount of cash uses for future acquisitions of
other mortgage banking entities, if such acquisitions were to occur.
Financing
Net cash provided by financing activities was $1,023.1 million for the
period from February 11, 1998 to September 30, 1998, $773.7 million for the
HomeSide predecessor period from March 1, 1997 to February 10, 1998 and $862.2
million for the HomeSide predecessor period from March 16, 1996 to February 28,
1997. The primary source of cash from financing activities during the period
from February 11, 1998 to September 30, 1998 and the HomeSide predecessor period
from March 1, 1997 to February 10, 1998 was from the issuance of medium-term
notes and net borrowings from HomeSide's line of credit. The primary sources of
cash from financing activities during the period from March 16, 1996 to February
28, 1997 were net borrowings under HomeSide's lines of credit, proceeds from
issuance of common stock and from the issuance of Notes. Cash used in financing
activities during the period ended September 30, 1998 and the HomeSide
predecessor period ended February 10, 1998 was used for the payment of debt
issue costs. Cash used in financing activities for the period ended February 28,
1997 was used to repay a bridge loan, partially repay Notes and the payment of
debt issue costs.
During the period from February 11, 1998 to September 30, 1998, net cash
used in operations was $342.3 million, net cash used in investing activities was
$677.9 million and net cash provided by financing activities was $1,023.1
million, resulting in a net increase in cash of $2.9 million. HomeSide expects
that to the extent cash generated from operations is inadequate to meet its
liquidity needs, those needs can be met through financing from its bank credit
facility and other facilities which may be entered into from time to time, as
well as from the issuance of debt securities in the public markets. Accordingly,
HomeSide does not currently anticipate that it will make sales of servicing
rights to any significant degree for the purpose of generating cash.
Nevertheless, in addition to its cash and mortgage loans held for sale balances,
HomeSide's portfolio of mortgage servicing rights provides a potential source of
funds to meet liquidity requirements, especially in periods of rising interest
rates when loan origination volume slows. Repurchase agreements also provide an
alternative to the bank line of credit for mortgages held for sale. Future cash
needs are highly dependent on future loan production and servicing results,
which are influenced by changes in long-term interest rates.
Year 2000
General. In common with many business users of computers around the world, the
Company has investigated to what extent the date change from 1999 to 2000 may
affect its business. The Company has established a program designed to minimize
the impact of the change to 2000 on the Company and its customers. The Board of
Directors has made the work associated with the change to 2000 a key priority
for management.
The Company uses and is dependent upon a significant number of computer software
programs and operating systems to conduct its business. Such programs and
systems include those developed and maintained by the Company, software and
systems purchased from outside vendors and software and systems used by the
Company's third party providers. The Company recognizes that the Year 2000 issue
is one of the most complex data processing problems faced by businesses
worldwide. As the Company approaches the century change, its primary objective
is to maintain "business as usual."
The Company began its information technology Year 2000 assessment and
remediation efforts in the third quarter of calendar 1996 under the sponsorship
of its executive management. A formal, enterprise-wide program commenced in
January 1998. The Year 2000 issue has been identified as a top priority. The
Company's executive management and Board of Directors are provided with frequent
detailed updates. The Company has dedicated resources to assess, repair and test
programs, applications, equipment and facilities. The Company has established a
Year 2000 Program Office that is coordinating the preparations for the change to
2000 with each business unit throughout the Company.
The Company's program involves an extensive review of its own operations and
scoping the work that needs to be completed to minimize any potential impact.
This includes reviewing the possible effects on the Company arising out of how
third parties manage their transition to 2000. The work demonstrates that there
are two possible key impacts:
Internal - the change to 2000 could cause interruptions, errors in
calculations or delays to the Company's critical business processes via
unexpected system or application malfunctioning.
External - the impact on the Company's own operations from third
parties, including customers, vendors, suppliers, regulators and
electronic distribution channels which may be impacted by the change to
2000. This includes any secondary or systemic impact that may arise from
the change to 2000 and the risk of disruption in the capital and
secondary mortgage markets on which the Company is dependent.
The Company's strategy for addressing Year 2000 focuses on four teams, which
together address all aspects of the Company's business. The Information
Technology team addresses all of the Mainframe, LAN and client server
applications. The End User Computing (or Business) team addresses the business
risks within each of the operating departments, including facilities' risk. This
area of the strategy involves the greatest concentration of embedded chips. The
Enterprise team addresses the corporate-wide risks posed by the Year 2000,
including business continuity planning to be implemented by individual business
units. Finally, the Year 2000 Program Office coordinates the Company's Year 2000
readiness efforts and is responsible for communications, vendor management,
project documentation and reporting. The Company's Year 2000 Program Office and
overall Year 2000 Program are managed by a Year 2000 Program Director whose
full-time resources and responsibilities are dedicated to this effort under the
sponsorship of the Chief Financial Officer and Chief Information Officer.
Throughout all phases of the Year 2000 Program, including the inventory and
assessment phases, the Year 2000 teams aim to complete all required work while
minimizing disruption to the current service delivery levels of the Company.
Central management of the project is executed using fully dedicated staff with
high levels of subject matter knowledge. In order to speed the assessment and
remediation aspects of the mainframe and client server IT projects, a factory
philosophy has been adopted using Paragon Computer Professionals, Inc. as the
primary outsourcer. Contractors are used internally where subject matter
expertise is not required.
State of Readiness. The Company's approach to preparing for the change to 2000
includes a standard set of methods and tools, customized as applicable to each
team, to coordinate and drive the project to completion.
The approach consists of six phases:
1. Assessment - Defining each system and process to determine if there are
date dependencies and how to resolve them. For business continuity
purposes, assessment includes identifying event and dependency risk.
2. Remediation - Implementing the steps identified in the assessment phase,
including code remediation and development of contingency plans.
3. Testing - Developing and implementing test scripts to determine if
remediated code is correct and assurance testing of business continuity
plans.
4. Implementation - Moving all approved changes from testing into production
and execution of contingency plans as may be required.
5. Check-Off - Formally acknowledging that each process has been implemented
and is functioning correctly.
6. Clean Management - Employing procedures and practices to prevent the
reintroduction of non-compliant applications, products and processes into
the operating environment, once check-off has been completed.
The Company's Information Technology and Business Teams have substantially
completed its assessment of the Company's systems and business processes for
Year 2000 vulnerability. The assessment has included substantially all hardware
and software systems, embedded systems, buildings and equipment, and business
processes. The assessment has also included a review of the Company's
dependencies on third parties, including vendors, suppliers and customers.
The Company has established certain key milestones in its Year 2000 Program.
Those milestones are:
o Assessment of substantially all systems and processes by July 31,
1998;
o Remediation and internal testing of all mission critical applications
substantially completed by December 31, 1998;
o End-to-end testing of all mission critical systems with material third
parties substantially completed by March 31, 1999; and
o Remediation and testing of all non-mission critical systems and clean
management of all systems through 1999.
The Company has completed its assessment of all systems and processes.
Remediation and internal testing of mission critical systems is underway and, as
of the date of this filing, substantially complete. The Company is presently "on
time" in complying with the milestones and internal timetable the Company has
established in preparation for the change to 2000 in line with its regulator's
suggested completion dates for core systems. Set forth below is a graphical
depiction of the Company's state of readiness in the first five action phases of
the Company's project plan, divided to show progress as to the Information
Technology (IT) portion of the project, the Company's two primary servicing
systems, and the end-user computing portion of the project as of December 11,
1998:
<TABLE>
<CAPTION>
IT ACHIEVEMENTS (EXCLUDES SERVICING SYSTEMS) %
DATE COMPLETE
ASSESSMENT
<S> <C> <C>
Full assessment of all IT components impacted by the turn of 6/30/98 100%
the century.
REMEDIATION
Repair or Replace all IT components found to be non-compliant. 9/30/98 68%
10/31/98 91%
12/11/98 100%
TESTING INTERNAL
Test all IT Y2K impacted internal components in a simulated and 9/30/98 30%
real future date environment. 10/31/98 41%
12/11/98 76%
12/31/98 82%
3/31/99 100%
TESTING EXTERNAL
Testing with customers,and vendors/service providers. 12/11/98 0%
3/31/99 65%
6/30/99 100%
IMPLEMENTATION
Place into the production operating environment all IT 9/30/98 17%
components tested and deemed to be Y2K ready. 10/31/98 26%
12/11/98 87%
3/31/99 100%
CHECK-OFF
Official sign-off by the business and technology owner of the 9/30/98 5%
component that the component is Y2K ready. 10/31/98 17%
12/11/98 65%
3/31/99 100%
</TABLE>
The charts set forth above show the status of completion of the number of gross
technology applications identified by the Company for remediation measured by
each of the various phases of the Company's Year 2000 Program. This chart
measures the progress on thirty-four (34) key Information Technology
applications, of which 15 have been designated as mission critical. As to these
thirty-four (34) key applications, as of December 15, 1998, assessment is 100%
complete, remediation is 100% complete, and internal testing is 76% complete.
The balance of testing is primarily end-to-end testing with material third
parties, which is scheduled to take place prior to March 31, 1999.
The Company's two most critical business applications are its primary mortgage
servicing software systems: MSP (licensed from and supported by Alltel
Information Services, Inc.) and ALSS (a proprietary software system supported by
the Company). Because of their critical importance to the Company's operations,
these systems are not included in the above charts. Rather, progress as to these
two systems is set forth separately in the charts below. As to these two
systems, as of December 15, 1998, assessment is 100% complete, remediation is
100% complete, and internal testing is 70% complete. The balance of testing is
primarily end-to-end testing with material third parties, which is scheduled to
take place prior to March 31, 1999.
<TABLE>
<CAPTION>
IT ACHIEVEMENTS (SERVICING SYSTEMS) %
DATE COMPLETE
ASSESSMENT
<S> <C> <C>
Full assessment of all IT components impacted by the turn of 9/30/98 100%
the century.
REMEDIATION
Repair or Replace all IT components found to be non-compliant. 9/30/98 90%
12/11/98 100%
TESTING INTERNAL
Test all IT Y2K impacted internal components in a simulated and 12/11/98 69%
real future date environment. 12/31/98 95%
3/31/99 100%
TESTING EXTERNAL
Testing with customers,and vendors/service providers. 12/31/99 0%
3/31/99 100%
IMPLEMENTATION
Place into the production operating environment all IT 12/31/98 50%
components tested and deemed to be Y2K ready. 3/31/99 100%
CHECK-OFF
Official sign-off by the business and technology owner of the 12/31/98 50%
component that the component is Y2K ready. 3/31/99 100%
</TABLE>
The Company's Year 2000 Program also addresses end-user computing issues
presented by the year 2000 change. The following charts depict the Company's
progress in addressing systems and business processes other than information
technology systems. As to those business processes and systems, as of December
15, 1998, assessment is 100% complete, remediation is 96% complete and testing
is 56% complete. The balance of remediation is scheduled for completion by March
31, 1999. Testing, implementation and check-off is scheduled to be completed
prior to June 30, 1999.
<TABLE>
<CAPTION>
END-USER COMPUTING ACHIEVEMENTS %
DATE COMPLETE
ASSESSMENT
<S> <C> <C>
Full assessment of all non-IT components impacted by the turn of 12/11/98 94%
the century.
REMEDIATION
Repair or replace all non-IT components found to be non-compliant. 12/11/98 51%
3/31/99 90%
6/30/99 100%
TESTING
Test all non-IT Y2K impacted components in a simulated and real 12/11/98 39%
future date environment. Includes testing with customers,and 3/31/99 60%
vendors/service providers. 6/30/99 100%
IMPLEMENTATION
Place into the production operating environment all non-IT 12/11/98 0%
components tested and deemed to be Y2K ready. 3/31/99 40%
6/30/99 100%
CHECK-OFF
Official sign-off by the business owner of the non-IT component 12/11/98 0%
that the component is Y2K ready. 3/31/99 40%
6/30/99 100%
</TABLE>
The information set forth above is not weighted to reflect the relative
criticality of individual applications. Moreover, not all applications require
the same level of effort for remediation and testing. Therefore, a significant
percentage of completion of one phase of the program, taken out of context, may
not fully reflect the Company's overall state of preparedness. In addition, the
reality of the Year 2000 work, its breadth, dependencies and linkages (including
satisfactory and timely delivery by key vendors) means that there may be some
work which will not be completed by the milestone target.
The Company has relationships with vendors, customers and other third parties
that rely on software and systems that may not be ready for the change to 2000.
However, it is not possible in all cases to obtain complete, accurate and timely
information regarding the Year 2000 programs of third parties. Further, the
Company's ability to direct such third parties efforts or change relations with
such third parties is often limited. There can be no assurance that third
parties on which the Company relies will complete their Year 2000 programs on
time or that Year 2000 failures by such third parties will not have a material
adverse effect on the Company's results of operations.
The Company is currently reviewing the Year 2000 efforts of its mission critical
vendors, customers and service providers. The Company has identified a number of
mission critical third parties whose Year 2000 failure may reasonably be
expected to have a material adverse impact on the Company's results of
operations. Examples of such third parties include: the Company's primary
software licensor, Alltel Information Services, Inc.; the Company's sole
provider of insurance processing services; the Company's sole provider of tax
payment services; and the Company's sole provider of foreclosure services.
Catastrophic failure by any of these parties would have a material adverse
effect on the Company. The Company is targeting these mission critical third
parties for particular scrutiny regarding their preparations for the change to
2000. That process is ongoing and testing is planned for the first quarter of
1999. The Company is also scheduled to participate in inter-industry testing
sponsored by the Mortgage Bankers Association of America and the Federal
National Mortgage Association in the first quarter of 1999.
The Company has been successful in negotiating Year 2000 amendments to its
contracts with several mission critical vendors. These amendments contain
representations and warranties by the vendors as to their state of readiness to
meet the Year 2000 challenge and indemnification and other remedies in favor of
the Company in the event the Company suffers a loss because the vendor does not
successfully manage the change to 2000.
Cost of Year 2000 Efforts. The Company acknowledges that work needs to be
carried out in virtually all aspects of its business to ensure that the Company
successfully manages the change to 2000. The Company presently estimates these
costs to total approximately $15.0 million.
Year 2000 costs are based on management's best estimates, which were derived
utilizing numerous assumptions of future events including the continued
availability of certain resources, third party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those plans. The
Company does not separately track the indirect costs incurred in its Year 2000
program.
Through September 30, 1998, the Company had expended approximately $4.7 million
of its total budget. Through November 30, 1998, the most recent date for which
information is available prior to this filing, the Company had expended
approximately $5.8 million of its total Year 2000 budget. A significant portion
of the budget is allocated to testing and will be expended in the period ending
March 31, 1999, the scheduled conclusion of end-to-end testing. In addition, the
Company anticipates significant expenditures after March 31, 1999 associated
with employee retention efforts, continued testing, clean management of systems
and maintenance of its Year 2000 Program Office. The Company expensed its
remediation costs as they were incurred, with the exception of new hardware and
software purchases, which were capitalized. The source of funds for Year 2000
remediation is operating income of the Company. The percentage of the Company's
information technology budget devoted to Year 2000 efforts in the fiscal year
ended September 30, 1998 was approximately 23%. The percentage of the Company's
information technology budget devoted to Year 2000 efforts in the fiscal year
ending September 30, 1999 is estimated at 13%. The Company is unable to readily
determine the cost of replacement of non-compliant systems that are being
replaced in the ordinary course of business. No significant information
technology projects have been deferred due to Year 2000 efforts.
The Company's Year 2000 Program is complex and reliant upon coordination with
numerous third parties. Accordingly, the effort and costs in any given period
will depend upon progress. The Company's current Year 2000 budget of $15 million
is based on the current status of the Year 2000 Program and is subject to
change. The budget of $15 million does not take into account any potential
losses the Company may suffer as a result of Year 2000 failures, or any claims
for loss or damage that may be asserted against the Company by third parties,
which may result if the Company or third parties do not successfully manage the
effect of the Year 2000 date change.
Risks. The Company's risk management office is actively involved in the
Company's Year 2000 Program. The most reasonably likely worst case Year 2000
scenario, disregarding the Company's remediation efforts and contingency
planning, is a failure in its loan servicing software and/or systems. Such a
failure would result in material disruption in the Company's operations
preventing it from discharging its contractual obligations to service mortgage
loans in an accurate and timely fashion. The consequences of such disruption
could include, among other things, revocation of the Company's status as an
FHA/VA approved lender/servicer and Fannie Mae/Freddie Mac approved
seller/servicer, incorrect processing and/or reporting of payments to consumers
and investors, a material loss of revenue, and litigation with third parties
alleging losses related to servicing failure.
While working to ensure that the Company's primary objective of business as
usual before, during and through 2000 is achieved, there can be no guarantee
that its Year 2000 program will be successful in all respects or that the date
change for 1999 to 2000 will not materially affect the Company's business in
some form.
Contingency Planning. The Company's Year 2000 Program is based on the assumption
that 100% impact coverage is neither feasible nor practical. It is possible that
the Company or third parties on which the Company depends may have unplanned
system difficulties during the transition through 2000, or that third parties
may not successfully manage the change to 2000. Therefore, an integral part of
the Company's Year 2000 Program is the development of contingency plans in
anticipation of systems or third party failure. These contingency plans are
being developed for individual applications, systems and business processes.
Individual departments within the Company, acting under the supervision and
direction of the Year 2000 Program Enterprise team, are reviewing and adjusting
existing business continuity planning to incorporate these circumstances, and to
seek to ensure that the Company meets its primary objective of "business as
usual" before, during and through 2000.
The foregoing disclosure, including the description of a worst case Year 2000
scenario, is furnished in response to and in compliance with the Statement of
the Commission Regarding Disclosure of Year 2000 Issues and Consequences by
Public Companies, Investment Advisers, Investment Companies, and Municipal
Securities Issuers, Securities Act Rel. No. 33-7448 (July 30, 1998)
Quantitative and Qualitative Market Risk
Interest rate risk is the most significant market risk affecting HomeSide.
Interest rate risk is the possibility that changes in interest rates will cause
unfavorable changes in net income or in the value of interest rate-sensitive
assets, liabilities and commitments. From a corporate perspective, the economics
of the Company's production and servicing lines-of-business can be leveraged, in
part, to mitigate the Company's exposure to interest rate risk. In addition and
as part of its risk management programs, the Company purchases financial
instruments and enters into financial agreements with off-balance sheet risk in
the normal course of business to manage its exposure to interest rate risk. The
Company uses financial instruments for the purpose of managing interest rate
risks to protect the value of its mortgage loans held for sale and mortgage
commitment pipeline. Risk management instruments are used by HomeSide to manage
interest rate risk associated with the value of its mortgage servicing rights
which have characteristics such that they tend to decrease in value as interest
rates decline and increase in value as interest rates rise. Interest rate swaps
are also used to convert funding sources to floating rates. The Company has no
market risk sensitive instruments held for trading purposes.
Management actively monitors and manages its exposure to interest rate risk.
Various valuation tools are employed to perform sensitivity analyses in order to
quantify the financial impact of changes in interest rates. These analyses are
performed for various interest rate scenarios to capture the expected economic
change in market value of rate-sensitive assets, liabilities and commitments.
Additionally, the analyses are performed to capture the expected accounting
impact on future earnings for a specified time frame.
Several modeling techniques are utilized including static shock, option adjusted
spread, option pricing, and discounted cash flow models. A number of key rate
sensitive assumptions are included in the modeling such as implied volatility,
prepayment rates, and yield requirements. Various analyses of the Company's
exposure to interest rate risk are reviewed on at least a monthly basis by the
Company's Asset/Liability Committee, which reports to the Board of Directors.
The sensitivity analyses described above were applied to the Company's
rate-sensitive assets, liabilities, commitments and the Company's on- and
off-balance sheet financial instruments at September 30, 1998. The sensitivity
analyses reflect that an instantaneous 50 basis point increase in rates would
result in a positive variance to net income of $9.0 million over a simulated
12-month period. An instantaneous 50 basis point decrease in rates would result
in a negative variance to net income of $12.0 million over a simulated 12-month
period. Under neither rate scenario would net income be affected by impairment
of rate-sensitive assets. The sensitivity analyses relate solely to the
Company's rate-sensitive assets, liabilities, commitments and financial
instruments at September 30, 1998 and do not capture changes in cash flows and
earnings related to certain production and servicing activities that would be
expected to affect financial performance in the simulated rate environments.
Accordingly, the aforementioned variances should not be viewed as indicative of
the actual changes in financial performance that would occur in a rate
environment equivalent to the one simulated.
For additional information, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Risk Management Activities",
Note 13, "Disclosures About Fair Value of Financial Instruments" and Note 14,
"Risk Management and Off-Balance Sheet Financial Instruments" in the Notes to
Consolidated Financial Statements in the Company's Annual Report.
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
HomeSide Lending, Inc.
We have audited the accompanying consolidated balance sheet of HomeSideLending,
Inc. and subsidiaries as of September 30, 1998, and the related consolidated
statements of income, changes in stockholder's equity, and cash flows for the
period from February 11, 1998 through September 30, 1998. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of HomeSideLending,
Inc. and subsidiaries as of September 30, 1998, and the results of its
operations and its cash flows for the period from February 11, 1998 through
September 30, 1998 in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
October 16, 1998
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholder of HomeSide Lending, Inc.
We have audited the accompanying consolidated balance sheets of HomeSide
Lending, Inc., (see Note 1) and subsidiaries as of February 10, 1998 and
February 28, 1997 (not included herein), and the related consolidated statements
of income, changes in stockholder's equity and cash flows for the periods from
March 1, 1997 to February 10, 1998 and March 16, 1996 to February 28, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of HomeSide Lending,
Inc. and subsidiaries as of February 10, 1998 and February 28, 1997(not included
herein) and the results of their operations and their cash flows for the periods
from March 1, 1997 to February 10, 1998 and March 16, 1996 to February 28, 1997,
in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Jacksonville, Florida
April 15, 1998
<PAGE>
<TABLE>
<CAPTION>
HOMESIDE LENDING, INC. and SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, Except Share Data)
HomeSide
Predecessor
September 30, 1998 February 10,1998
------------------ ----------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 35,008 $32,113
Mortgage loans held for sale, net 2,048,989 1,292,403
Mortgage servicing rights, net 1,766,214 1,766,357
Early pool buyout advances 759,579 374,097
Accounts receivable, net 272,005 227,294
Premises and equipment, net 45,657 41,982
Goodwill, net 677,049 8,870
Other assets 115,654 116,175
------------------- --------------
Total Assets $5,720,155 $3,859,291
=================== ==============
LIABILITIES AND STOCKHOLDER'S EQUITY
Notes payable $2,749,000 $2,074,956
Long-term debt 1,185,926 770,466
Deferred income taxes 192,781 197,243
Accounts payable and accrued liabilities 236,940 135,803
------------------- --------------
Total Liabilities 4,364,647 3,178,468
------------------- --------------
Commitments and Contingencies
Stockholder's Equity:
Common stock:
Common stock, $1.00 par value, 100 shares
authorized, issued and outstanding, all
pledged as second priority collateral on the
long-term debt of the Parent
Additional paid-in capital 1,322,387 573,092
Retained earnings 33,121 107,731
------------------- --------------
Total Stockholder's Equity 1,355,508 680,823
------------------- --------------
Total Liabilities and Stockholder's Equity $5,720,155 $3,859,291
=================== ==============
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
<TABLE>
<CAPTION>
HOMESIDE LENDING, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Thousands)
HOMESIDE HOMESIDE
PREDECESSOR PREDECESSOR
FOR THE PERIOD FROM FOR THE PERIOD FOR THE PERIOD
FEBRUARY 11, 1998 FROM FROM
TO MARCH 1, 1997 TO MARCH 16, 1996 TO
SEPTEMBER 30, 1998 FEBRUARY 10, 1998 FEBRUARY 28, 1997
------------------ ----------------- -----------------
<S> <C> <C> <C>
REVENUES:
Mortgage servicing fees $312,678 $393,292 $308,906
Amortization of mortgage servicing rights (189,881) (207,508) (153,694)
------------------ -------------------- -------------------
Net servicing revenue 122,797 185,784 155,212
Interest income 99,749 97,050 81,507
Interest expense (62,476) (81,770) (66,833)
------------------ -------------------- -------------------
Net interest revenue 37,273 15,280 14,674
Net mortgage origination revenue 79,179 85,206 66,073
Other income 11,028 1,671 682
------------------ -------------------- -------------------
Total Revenues 250,277 287,941 236,641
EXPENSES:
Salaries and employee benefits 73,983 75,419 72,976
Occupancy and equipment 13,107 15,447 11,770
Servicing losses on investor-owned loans
and foreclosure-related expenses 21,202 21,974 17,934
Goodwill amortization 22,283 592 150
Other expenses 39,156 37,639 40,616
------------------ -------------------- -------------------
Total Expenses 169,731 151,071 143,446
Income before income taxes 80,546 136,870 93,195
Income tax expense 40,101 53,379 37,278
------------------ ==================== ===================
Net Income $40,445 $83,491 $55,917
================== ==================== ===================
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
<TABLE>
<CAPTION>
HOMESIDE LENDING, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
(dollars in thousands, except share data)
Additional
Numbers Common Paid-in Retained
of Shares Stock Capital Earnings Total
----------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance, February 11, 1998 100 -- $1,322,387 $ -- $1,322,387
Net Income -- -- -- 40,439 40,439
Dividends declared and paid to Parent -- -- -- (7,318) (7,318)
----------------------------------------------------------------
Balance, September 30, 1998 100 -- $1,322,387 $ 33,121 $1,355,508
================================================================
HomeSide Predecessor Balance,
March 15, 1996 -- -- $ -- $ -- $ --
Issuance of common stock 100 -- -- -- --
Contribution associated with
BancBoston Mortgage Corporation
acquisition, net -- -- 290,000 -- 290,000
Contribution associated with
Barnett Mortgage Company acquisition, net -- -- 244,294 -- 244,294
Additional capital contributions -- -- 38,798 -- 38,798
Net income -- -- -- 55,917 55,917
Dividends declared and paid to Parent -- -- -- (16,965) (16,965)
----------------------------------------------------------------
HomeSide Predecessor Balance,
February 28, 1997 100 -- 573,092 38,952 612,044
----------------------------------------------------------------
Net income -- -- -- 83,491 83,491
Dividends declared and paid to Parent -- -- -- (14,712) (14,712)
----------------------------------------------------------------
HomeSide Predecessor Balance,
February 10, 1998 100 -- $ 573,092 $ 107,731 $680,823
================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
<TABLE>
<CAPTION>
HOMESIDE LENDING, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
HOMESIDE HOMESIDE
PREDECESSOR PREDECESSOR
FOR THE PERIOD FROM FOR THE PERIOD FOR THE PERIOD
FEBRUARY 11, 1998 FROM FROM
TO MARCH 1, 1997 TO MARCH 16, 1996 TO
SEPTEMBER 30, 1998 FEBRUARY 10, 1998 FEBRUARY 28, 1997
------------------ ----------------- -----------------
<S> <C> <C> <C>
CASH FLOWS (USED IN) PROVIDED BY OPERATING
ACTIVITIES:
Net income $40,440 $83,491 $55,917
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Amortization of mortgage servicing rights 189,881 207,508 153,694
Depreciation and amortization 24,595 8,850 8,173
Servicing losses on investor-owned loans 9,960 12,346 13,683
Deferred income tax expense 18,089 56,352 37,278
Capitalized servicing rights -- -- (21,015)
Mortgage loans originated and purchased for sale (12,697,763) (23,975,752) (12,504,567)
Proceeds and principal repayments of mortgage 12,008,178 23,540,371 12,572,217
loans held for sale
Change in accounts receivable (11,694) (82,121) (63,378)
Change in other assets and accounts payable and
accrued liabilities 9,879 (82,036) (35,448)
------------------ ----------------- -----------------
Net cash (used in) provided by operating activities (408,435) (230,991) 216,554
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of premises and equipment, net (20,067) (17,252) (4,929)
Acquisition of mortgage servicing rights (392,396) (519,694) (475,729)
Net proceeds from (purchases of) risk management contracts 387,276 137,393 (141,944)
Purchase of early pool buyout advances, net of repayments (385,580) (374,097) --
Acquisition of Banc One Mortgage Corp., net of repayments (201,000)
Acquisition of BancBoston Mortgage Corp., net of
cash acquired -- -- (133,392)
Acquisition of Barnett Mortgage Co., net of cash acquired -- -- (106,244)
------------------ ----------------- -----------------
Net cash used in investing activities (611,767) (773,650) (862,238)
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Net borrowings from banks and short-term lines of credit 624,044 256,453 334,170
Issuance of notes payable 410,000 750,000 --
Payment of debt issue costs (3,262) (7,017) (11,681)
Repayment of long-term debt (372) (661) (567)
Capital contributions from the Parent -- -- 393,418
Dividends paid to the Parent (7,313) (14,712) (16,965)
------------------ ----------------- -----------------
Net cash provided by financing activities 1,023,097 984,063 698,375
Net (decrease) increase in cash and cash equivalents 2,895 (20,578) 52,691
Cash and cash equivalents at beginning of period 32,113 52,691 --
------------------ ----------------- -----------------
Cash and cash equivalents at end of period $35,008 $32,113 $52,691
================== ================= =================
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
HOMESIDELENDING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
HomeSide Lending, Inc. ("HomeSide" or the "Company") is primarily engaged in the
mortgage banking business and as such originates, purchases, sells and services
mortgage loans throughout the United States. As discussed in Note 2, on February
10, 1998 National Australia Bank, Ltd. (the "National") acquired all outstanding
shares of the common stock of HomeSide International, Inc. (the "Parent") and
the Company adopted a fiscal year end of September 30 to conform to the fiscal
year of the National. HomeSide's predecessor ("HomeSide Predecessor") commenced
operations and was formed through the acquisition of the mortgage banking
operations of BankBoston, N.A. ("BBMC Predecessor" to HomeSide Predecessor) on
March 16, 1996 and subsequently purchased the mortgage banking operations of
Barnett Banks, Inc. Unless otherwise designated, the term "HomeSide" refers to
the Company for the periods subsequent to February 10, 1998, to HomeSide
Predecessor for the periods from March 16, 1996 to February 28, 1998 and to BBMC
Predecessor for the periods prior to March 16, 1998. The accompanying
consolidated financial statements of HomeSide include the accounts of HomeSide
and its subsidiaries, after elimination of all material intercompany balances
and transactions. Amounts of acquired companies have been included from the date
of acquisition.
HomeSide is a wholly-owned subsidiary of HomeSide Holdings, Inc., which is a
wholly-owned subsidiary of HomeSide International, Inc. (the "Parent")(see Note
2). The Parent has no operations and its only significant assets are its
investments in HomeSide Holdings, Inc., HomeSide and certain capitalized debt
issue costs. The Parent has $130 million in outstanding long-term debt. All of
the stock of HomeSide Holdings, Inc. and HomeSide is pledged as collateral on
the debt of the Parent. The Parent is dependent upon dividends from HomeSide
Holdings, Inc. and HomeSide for the cash flow necessary to service the Parent's
debt.
The accompanying financial statements of HomeSide Lending, Inc. have been
prepared for the period from February 11, 1998 to September 30, 1998 to coincide
with the acquisition of HomeSide by the National and the subsequent adoption of
a September 30 fiscal year end. The accompanying consolidated financial
statements of HomeSide Predecessor have been prepared using its February 28
fiscal year end and are presented for the period from march 16, 1996 to February
28, 1997 to coincide with the commencement of operations of HomeSide Predecessor
and for the period March 1, 1997 to February 10, 1998 when HomeSide Predecessor
was acquired by the National.
2. ORGANIZATION
On December 11, 1995, HomeSide was formed by an investor group, consisting of
Thomas H. Lee Company and Madison Dearborn Partners (collectively, the
"Investors"), and signed a definitive stock purchase agreement with The First
National Bank of Boston ("BankBoston") for the purpose of acquiring certain
assets and liabilities of the mortgage banking business owned by BankBoston.
BankBoston (the "BBMC Predecessor") received cash and an ownership interest in
HomeSide . The transaction closed on March 15, 1996 and HomeSide began
operations on March 16, 1996.
On May 31, 1996, Barnett Banks, Inc. ("Barnett") sold certain of its mortgage
banking operations, primarily its servicing portfolio, mortgage servicing
operations and proprietary mortgage banking software systems, to HomeSide .
Barnett received cash and an ownership interest in HomeSide . The accompanying
financial statements reflect the effects of both of these acquisitions. For more
information on these acquisitions, see Note 4. From May 31, 1996 until the 1997
public offering of common stock, the Investors as a group, BankBoston and
Barnett each owned approximately one-third of HomeSide . Following the public
offering, the Investors as a group, BankBoston and Barnett owned in the
aggregate approximately 79% of the outstanding common stock.
On January 9, 1998, NationsBank Corporation, now BankAmerica, Corporation,
acquired all the outstanding common stock of Barnett Banks, Inc.
On February 10, 1998, National Australia Bank, Ltd. (the "National") acquired
all outstanding shares of the common stock of the Parent. As consideration, the
National paid $27.825 per share for all of the outstanding common stock and paid
$17.7 million cash to retire all outstanding stock options. The total purchase
price was approximately $1.2 billion. The National paid for the purchase with
borrowed and available funds. The transaction was accounted for as a purchase.
As a result, all assets and liabilities were recorded at their fair value on
February 11, 1998, and the purchase price in excess of the fair value of net
assets acquired of $716.4 million was recorded as goodwill. Following the
transaction described above, the National now owns 100% of the Parent's common
stock and the Parent has become an indirect wholly-owned subsidiary of the
National. HomeSide also adopted a fiscal year end of September 30 to conform to
the fiscal year of the National. The "HomeSide Predecessor" periods presented
coincide with the commencement of operations of the Company on March 16, 1996
and the acquisition by the National on February 10, 1998.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of estimates
The preparation of financial statements and notes thereto in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses and the disclosed amount of contingent liabilities.
Although the Company has internal control systems in place to ensure that
estimates can be reliably measured, actual results may differ from those
estimates. It is not anticipated that such differences would be material.
Risk management of mortgage loan originations
HomeSide utilizes a risk management program to protect and manage the value of
its mortgage loans held for sale and mortgage commitment pipeline. As a result,
the Company is party to various derivative financial instruments to reduce its
exposure to interest rate risk. These financial instruments primarily include
mandatory forward delivery commitments, treasury forwards, put and call option
contracts on mortgage-backed securities and Treasurys. The Company uses these
financial instruments for the purposes of managing its resale pricing and
interest rate risks. These financial instruments are designated as hedges to the
extent they demonstrate a high degree of correlation with the underlying hedged
items. Accordingly, hedging gains and losses related to this risk management
program are deferred and recognized as a component of the gain or loss on sale
of the underlying mortgage loans or mortgage-backed securities. Such gains and
losses are included in mortgage origination revenue. Hedge losses are recognized
currently if the deferral of such losses would result in mortgage loans held for
sale and the pipeline being valued in excess of their estimated net realizable
value.
Premiums paid for purchased put and call option contracts are included in other
assets and amortized over the options' contract period as a component of
mortgage origination revenue. Unamortized premiums are recognized as a component
of the gain or loss on sale of loans at the earlier of the expiration of the
underlying contract or when exercise of the contract is considered unlikely.
Risk management of mortgage servicing rights
Mortgage servicing rights permit HomeSide to receive a portion of the interest
coupon and fees collected from the mortgagor for performing specified servicing
activities. The mortgage notes underlying the mortgage servicing rights permit
the borrower to prepay the loan. As a result, the value of the related mortgage
servicing rights tends to diminish in periods of declining interest rates and
increase in value in periods of rising rates. This tendency subjects HomeSide to
substantial interest rate risk. It also directly affects the volatility of
reported earnings because mortgage servicing rights are carried at the lower of
amortized cost or fair value. It is HomeSide's policy to mitigate and hedge this
risk through its risk management program.
The risk management instruments used by HomeSide have characteristics such that
they tend to increase in value as interest rates decline. Conversely, these risk
management instruments tend to decline in value as interest rates rise.
Accordingly, changes in the value of these hedge instruments will tend to move
inversely with changes in value of HomeSide's mortgage servicing rights.
Options on U.S. Treasury bond and note futures and U.S. Treasury bond and note
futures have been purchased by HomeSide to manage interest rate risk. When
purchased, the options and futures contracts are designated to a specific strata
of mortgage servicing rights. The risk management instruments are
marked-to-market and changes in market value are included as adjustments to the
basis of the related mortgage servicing right asset being hedged. Deferred hedge
gains and losses are amortized and evaluated for impairment in the same manner
as the related mortgage servicing rights. Correlation between changes in the
risk management contracts and changes in value of HomeSide 's mortgage servicing
rights is assessed on a quarterly basis to ensure that high correlation is
maintained over the term of the hedging program. If management's ongoing
assessment of correlation indicates that high correlation is not being achieved,
the Company will discontinue the application of hedge accounting and recognize a
gain or loss to the extent the hedge results have not been offset by changes in
value of the hedged asset during the hedge period.
Mortgage loans
Mortgage loans held for sale are carried at the lower of aggregate cost or fair
value. Fair value is based on the contract prices at which the mortgage loans
will be sold or, if the loans are not committed for sale, the current market
price. Deferred hedge gains and losses on risk management hedge instruments are
included in the cost of the mortgage loans held for sale for the purpose of
determining the lower of aggregate cost or fair value. Mortgage loans are
typically sold within three months.
Mortgage loans held for investment are included in other assets and stated at
the lower of cost or fair value at the time the permanent investment decisions
are made. Discounts, if any, are amortized over the anticipated life of the
investment.
Loans are placed on non-accrual status when any portion of the principal or
interest is ninety days past due or earlier when concern exists as to the
ultimate collectibility of principal or interest. When loans are placed on
nonaccrual status, the related interest receivable is reversed against interest
income of the current period. Interest payments received on nonaccrual loans are
applied as a reduction of the principal balance when concern exists as to the
ultimate collection of principal; otherwise, such payments are recognized as
interest income. Loans are removed from nonaccrual status when principal and
interest become current and they are anticipated to be fully collectible.
Mortgage servicing rights
Mortgage servicing rights are the rights to receive a portion of the interest
coupon and fees collected from the mortgagor for performing specified servicing
activities. The total cost of loans originated or acquired is allocated between
the mortgage servicing rights and the mortgage loans, without the servicing
rights, based on relative fair values. The value of servicing rights acquired
through bulk acquisitions is capitalized at cost.
Mortgage servicing rights are amortized in proportion to and over the period of
the estimated net servicing revenue. They are evaluated for impairment by
comparing the carrying amount of the servicing rights to their fair value. Fair
value is estimated based on the market prices of similar mortgage servicing
assets and on discounted future net cash flows considering market prepayment
estimates, historical prepayment rates, portfolio characteristics, interest
rates and other economic factors. For purposes of measuring impairment, the
mortgage servicing rights are stratified by the predominant risk characteristics
which include product types of the underlying loans and interest rates of
mortgage notes . Impairment is recognized through a valuation reserve for each
impaired stratum and is included in amortization of mortgage servicing rights.
Accounts receivable
Accounts receivable includes advances, consisting primarily of payments for
property taxes and insurance premiums, accrued servicing fees, as well as
principal and interest remitted to investors before they are collected from
mortgagors, made in connection with loan servicing activities. Accounts
receivable also includes loans purchased from mortgage-backed securities
serviced by HomeSide for others and mortgage claims filed primarily with the FHA
and the VA.
Early pool buyout advances
Early pool buyout advances consist of delinquent government loans in process of
foreclosure that have been purchased from pools. The program reduces the
unreimbursed interest expense that HomeSide incurs. The funding of the purchases
of these delinquent loans for the early pool buyout program is recorded as
interest expense. Interest income earned from the guarantor agency during the
foreclosure process is accrued to match the funding expense incurred. Scheduled
interest payments made to the investor before the loans were purchased from the
pool are recorded as early pool buyout advances with a reserve for advances
which will not ultimately be collected.
Premises and equipment
Premises and equipment are carried at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, which range up to thirty years. Leasehold
improvements are amortized over the shorter of the estimated life of the
improvement or the term of the lease.
Long-lived assets are evaluated regularly for the other-than- temporary
impairment. If circumstances suggest that their value may be impaired and the
write-down would be material, an assessment of recoverability is performed prior
to any write-down of the asset. Impairment, if any, is recognized through a
valuation allowance with a corresponding charge recorded in the statement of
income.
The Company capitalizes certain software development and implementation costs.
Development and implementation costs are expensed until the company has
determined that the software will result in probable future economic benefits
and management has committed to funding the project. Thereafter, all direct
external implementation costs and purchase software costs are capitalized and
amortized using the straight-line method over the remaining estimated useful
lives, not exceeding five years.
Goodwill
Goodwill, representing the excess of the purchase consideration over the fair
value of the identifiable net assets aquired on the date of acquisition, is
recognized as an asset. Goodwill is amortized from the date of acquisition by
systematic charges on a straight-line basis against income over the period in
which the benefits are expected to arise, but not exceeding 20 years.
Accumulated goodwill amortization at September 30, 1998 was $22.8 million. The
carrying value of goodwill is reviewed at least annually. If the carrying value
of goodwill exceeds the value of the expected future benefits, the difference is
charged against income.
Mortgage servicing fees
Mortgage servicing fees represent servicing and other fees earned for servicing
mortgage loans owned by investors. Servicing fees are generally calculated on
the outstanding principal balances of the loans serviced and are recognized as
income over the period of service.
Related custodial deposits are segregated in trust accounts, principally held
with depository institutions, and are not included in the accompanying financial
statements.
Interest expense
Interest expense is reduced by credits received from depository institutions for
custodial balances placed with such institutions.
Net mortgage origination revenue
Mortgage origination revenue includes gains and losses from sales of mortgage
loans and fees associated with the origination and purchase of mortgage loans.
Servicing losses on investor-owned loans and foreclosure-related expenses
HomeSide records losses attributable to servicing FHA and VA loans for
investors. These amounts include actual losses for final disposition of loans,
foreclosure-related expenses, accrued interest for which payment is
uncollectible and estimates for potential losses based on HomeSide 's experience
as a servicer of government loans.
A reserve for estimated servicing losses on investor-owned loans is available
for potential losses related to the mortgage servicing portfolio and is included
in accounts payable and accrued liabilities (see Note 7).
Income taxes
Current tax liabilities or assets are recognized through charges or credits to
the current tax provision for the estimated taxes payable or refundable for the
current year.
Deferred tax liabilities are recognized for temporary differences that will
result in amounts taxable in the future and deferred tax assets are recognized
for temporary differences and tax benefit carryforwards that will result in
amounts deductible or creditable in the future. Net deferred tax liabilities or
assets are recognized through charges or credits to the deferred tax provision.
A deferred tax valuation reserve is established if it is more likely than not
that all or a portion of the deferred tax assets will not be realized. Changes
in the deferred tax valuation reserve are recognized through charges or credits
to the deferred tax provision. The effect of enacted changes in tax law,
including changes in tax rates, on deferred tax assets and liabilities is
recognized in income in the period that includes the enactment date.
Statement of cash flow
For purposes of reporting on the statement of cash flows, cash and cash
equivalents include cash and due from banks and interest-bearing deposits with
an original maturity of three months or less.
New accounting standards
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Statement No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement standardizes the accounting for
derivative instruments and hedging activities by requiring that an entity
recognize those items as assets or liabilities in the statement of financial
position and measure them at fair value. If certain conditions are met, a
derivative instrument may be specifically designated as (a) a hedge of the
exposure to changes in the fair value of a recognized asset or liability, or of
an unrecognized firm commitment, (b) a hedge of the exposure to variability in
the cash flows of recognized assets, liability or forecasted transaction or (c)
a hedge of the foreign currency exposure of an unrecognized firm commitment, an
available-for-sale security, a forecasted transaction or a net investment in a
foreign operation. This statement is effective for fiscal quarters beginning
after June 15, 1999. Management has not yet determined the impact of this
statement on the presentation of the financial statements of HomeSide or on the
nature of its hedging program .
In October 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 134, "Accounting for Mortgage-Backed
Securities Retained after Securitization of Mortgage Loans Held for Sale by a
Mortgage Banking Enterprise." This statement further amends Statement No. 65 to
require that after the securitization of mortgage loans held for sale, an entity
engaged in mortgage banking activities classify the resulting mortgage-backed
securities or other retained interests based on its ability and intent to sell
or hold those investments. This statement is effective for the first fiscal
quarter beginning after December 15, 1998. Management expects that the impact of
this statement on the presentation of the financial statements of HomeSide will
be immaterial.
4. ACQUISITIONS
Acquisition of Banc One Mortgage Corporation
On April 1, 1998, HomeSide entered into an agreement with Banc One Mortgage
Corporation ("Banc One") to acquire the mortgage servicing assets of Banc One.
HomeSide and Banc One have also entered into a Preferred Partner agreement,
whereby Banc One will sell a significant portion of its residential mortgage
loan production to HomeSide over the next five years. The total purchase
consideration for the mortgage servicing assets was $201.0 million cash. The
mortgage servicing rights acquired relate to mortgage servicing loans of $16.6
billion. The transaction closed on June 5, 1998 and was accounted for as a
purchase. The excess of the aggregate purchase price over the fair value of net
assets acquired and is being amortized over 20 years.
The unaudited condensed pro forma statement of income for the period from
February 11, 1998 to September 30 1998 and the HomeSide predecessor period from
March 1, 1997 to February 10, 1998, assuming Banc One had been acquired as of
the beginning of the period is as follows (in millions):
PRO FORMA FOR THE PERIOD PRO FORMA FOR THE PERIOD
FROM FEBRUARY 11, 1998 FROM MARCH 1, 1997 TO
TO SEPTEMBER 30, 1998 FEBRUARY 10, 1998
------------------------ ------------------------
Net servicing revenue $129.5 $202.6
Net interest revenue 29.5 1.2
Net mortgage origination
revenue 81.1 90.1
Other income 11.0 1.7
------------------------ ------------------------
Total revenues 251.1 295.6
Expenses (174.7) (162.1)
------------------------ ------------------------
Income before income taxes 76.4 133.5
Income tax expense (38.7) (52.1)
------------------------ ------------------------
Net income $ 37.7 $ 81.4
======================== ========================
The purchase accounting adjustments in the above pro forma statement of
operations are based on the actual purchase price and the amount of assets and
liabilities actually acquired. No adjustments have been made for restructuring
costs that might have been incurred or for cost efficiencies that might have
been realized during the period presented. Accordingly, these pro forma results
are not indicative of future results.
Acquisition of Loan America
On April 6, 1998, HomeSide signed an agreement with NationsBank
Corporation ("NationsBank") whereby NationsBank agreed to sell HomeSide a
national wholesale mortgage loan network which was formerly owned by Barnett
Banks, Inc. The transaction closed on May 29, 1998. The excess of the aggregate
purchase price over the fair value of net assets acquired was recorded as
goodwill and is being amortized over 20 years.
Acquisition of BancBoston Mortgage Corporation
On March 15, 1996, HomeSide acquired from BankBoston all of the outstanding
stock of BancBoston Mortgage Corporation ("BBMC"), which was subsequently
renamed HomeSide Lending , Inc. Certain assets and liabilities of BBMC were
retained by BankBoston, including BBMC's mortgage retail production operations
in New England. HomeSide made cash payments of $139.5 million in cash and issued
$86.8 million of common stock to BankBoston in consideration for certain assets,
net of assumed liabilities, and the stock of BBMC. Also, in connection with the
BBMC acquisition, the Investors purchased approximately 55% of the then
outstanding common stock of HomeSide for $107.2 million in cash. Simultaneously,
BankBoston paid approximately $1.0 million in cash for all of HomeSide's class C
non-voting common stock. In consideration of services rendered to HomeSide with
respect to the BBMC Acquisition, class B non-voting stock valued at $1.0 million
was issued to an investment bank. Management purchased common stock for $4.1
million in cash, $1.9 million of which was financed by loans from HomeSide. On
May 31, 1996, HomeSide paid an additional $5.0 million to BankBoston in
connection with the closing of the Barnett Mortgage Company ("BMC") acquisition.
The transaction was accounted for under the purchase method of accounting. The
assets and liabilities of BBMC were recorded at their fair values at March 16,
1996, which totaled $1.5 billion and $1.2 billion, respectively. The total
purchase price paid for BBMC, including transaction costs and interest, was
$247.0 million. The excess of fair value of net assets acquired over cost was
$56.0 million and was allocated as a reduction mortgage servicing rights.
Acquisition of Barnett Mortgage Company
On May 31, 1996, HomeSide acquired from Barnett certain assets, net of assumed
liabilities, and the outstanding common stock of BMC (the "BMC Acquisition").
Certain assets and liabilities of BMC were retained by Barnett, including those
assets of BMC and its subsidiaries (other than Honolulu Mortgage Company, Inc.)
associated with the loan origination or production activities. HomeSide made
cash payments of $228.0 million to Barnett in consideration for certain assets,
net of assumed liabilities, and the stock of BMC. In connection with the BMC
Acquisition, an affiliate of Barnett purchased shares of HomeSide common stock
for an aggregate purchase price of $118.0 million. Also in connection with the
BMC Acquisition, BankBoston and the Investors paid approximately $42.3 million
in cash for additional shares of HomeSide. The transaction was accounted for
using the purchase method of accounting and, accordingly, the results of
operations of HomeSide include BMC from the date of acquisition. The assets and
liabilities of BMC were recorded by HomeSide at their estimated fair values at
May 31, 1996, which totaled $764.8 million and $521.4 million, respectively. The
total purchase price paid for BMC, including transaction costs and interests,
was $235.0 million. The excess of the purchase price over the fair value of net
assets acquired was $8.4 million and was allocated to goodwill and is being
amortized on a straight-line basis over 15 years.
The unaudited condensed pro forma statement of income for the period from March
16, 1996 to February 28, 1997, assuming BMC had been acquired as of March 16,
1996 is as follows (in millions):
HomeSide Predecessor
Pro Forma for the Period
From March 16, 1996 to
February 28, 1997
-------------------------
Net servicing revenue $167.3
Net interest revenue (4.5)
Net mortgage origination revenue 67.1
Other income 0.7
------------------------
Total revenues 230.6
Expenses (157.5)
------------------------
Income before income taxes
and extraordinary loss 73.1
Income tax expense (29.5)
------------------------
Income before extraordinary loss 43.6
Extraordinary loss (6.4)
------------------------
Net income $ 37.2
========================
The purchase accounting adjustments in the above pro forma statement of
operations are based on the actual purchase price and the amount of assets and
liabilities actually acquired. No adjustments have been made for restructuring
costs that might have been incurred or for cost efficiencies that might have
been realized during the period presented. Accordingly, these pro forma results
are not indicative of future results.
5. MORTGAGE SERVICING RIGHTS
An analysis of mortgage servicing rights is as follows (in thousands):
HOMESIDE
PREDECESSOR
SEPTEMBER 30, 1998 FEBRUARY 10, 1998
------------------ -----------------
Beginning balance $1,766,357 $1,596,838
Additions 593,862 416,822
Sales of servicing (9,967) (342)
Net deferred hedge gain,
net of amortization (394,157) (39,453)
Amortization (189,881) (207,508)
------------------ ------------------
Ending balance $1,766,214 $1,766,357
================== ==================
6. PREMISES AND EQUIPMENT
Premises and equipment consist of the following (in thousands):
HOMESIDE
PREDECESSOR
SEPTEMBER 30, 1998 FEBRUARY 10, 1998
------------------ -----------------
Land $3,451 $ 3,451
Buildings and building improvements 9,932 10,604
Furniture and equipment 29,327 22,464
Leasehold improvements 6,234 14,717
------------------ -----------------
48,944 51,236
Accumulated depreciation and amortization (3,287) (9,254)
------------------ -----------------
Ending balance $45,657 $41,982
================== =================
7. RESERVE FOR ESTIMATED SERVICING LOSSES ON INVESTOR-OWNED LOANS
An analysis of the reserve for estimated servicing losses on investor-owned
loans is as follows (in thousands):
HOMESIDE
PREDECESSOR
FOR THE PERIOD FOR THE PERIOD
FEBRUARY 11, 1998 MARCH 1, 1997 TO
TO SEPTEMBER 30, 1998 FEBRUARY 10, 1998
--------------------- -----------------
Beginning balance $ 21,650 $ 21,650
Provision for servicing losses on
investor-owned loans 10,314 12,346
Charge-offs (10,341) (12,747)
Recoveries 27 401
--------------------- -----------------
Ending balance $ 21,650 $ 21,650
===================== =================
8. NOTES PAYABLE
Notes payable consist of the following (in thousands):
<TABLE>
<CAPTION>
WEIGHTED AVERAGE INTEREST RATE
TOTAL AT PERIOD END DURING THE PERIOD
OUTSTANDING
----------------- ------------- -----------------
<S> <C> <C> <C>
Bank line of credit $ 995,000 5.88% 5.96%
National Australia Bank Unsecured
Facility 1,754,000 5.66% 5.67%
-----------------
Total, September 30, 1998 $ 2,749,000
=================
Bank line of credit, February 10, 1998 $ 2,074,956 6.00% 6.04%
=================
</TABLE>
On June 23, 1998, HomeSide entered into an unsecured revolving credit facility
with the National pursuant to which it can borrow up to $2.1 billion, subject to
any lending limitations imposed by regulatory authorities. As of September 30,
1998, regulations limited the National's ability to lend funds to HomeSide , its
non-bank affiliate, to approximately $1.8 billion. The interest rates on these
borrowings are equal to 30 day LIBOR.
HomeSide borrows funds on a demand basis from an independent syndicate of banks
under a $2.5 billion credit facility which, at the request of HomeSide, may be
increased to $3.0 billion. The line of credit is used to provide funds for
HomeSide's business of originating, acquiring and servicing mortgage loans. The
line of credit includes both a warehouse credit facility, which is limited to
98% of the fair value of eligible mortgage loans held for sale, and a
servicing-related facility, which is capped at $950.0 million. On February 14,
2000, the line of credit will terminate. The credit agreement contains covenants
that impose limitations and restrictions on HomeSide, including the maintenance
of certain net worth and ratio requirements. Under certain circumstances set
forth in the credit agreement, borrowings under the agreement become
collateralized by HomeSide's assets. HomeSide is in compliance with all
requirements included in the credit agreement. At September 30, 1998 and
February 10, 1998, $1.0 billion and $2.1 billion, respectively, were outstanding
under the credit line. The amount outstanding at September 30, 1998 under the
bank line of credit is comprised of a warehouse credit facility of $1.0 billion.
The amount outstanding at February 10, 1998 is made up of a warehouse credit
facility of $1.2 billion and a servicing related credit facility of $0.9
billion.
Borrowings under the bank line of credit bear interest at rates per annum, based
on, at HomeSide's option (A) the highest of (i) the lead bank's prime rate, (ii)
the secondary market rate of certificates of deposit plus 100 basis points and
(iii) the federal funds rate in effect from time to time plus 0.5% or (B)
various rates based on federal fund rates.
9. LONG-TERM DEBT
Long-term debt, including the fair value adjustments resulting from the merger
with the National, consists of the following (in thousands):
HOMESIDE
PREDECESSOR
SEPTEMBER 30, 1998 FEBRUARY 10, 1998
------------------ -----------------
Medium-term notes $ 1,161,629 $ 750,000
Mortgage note payable 24,297 20,466
------------------- ------------------
Total $ 1,185,926 $ 770,466
=================== ==================
Medium-term notes
As of September 30, 1998, $850.0 million of the outstanding medium-term notes
had been effectively converted by interest rate swap agreements to floating-rate
notes. The weighted average borrowing rates on medium-term borrowings issued for
the period from February 11, 1998 to September 30, 1998 and the HomeSide
predecessor period from March 1, 1997 to February 10, 1998, including the effect
of the interest rate swap agreements, was 6.0% and 6.25%, respectively. Net
proceeds from the issuance were primarily used to reduce the amounts outstanding
under the bank credit agreement. Amounts were subsequently reborrowed under the
bank credit facility to fund the early pool buyout program.
As of September 30, 1998, outstanding medium-term notes issued by HomeSide under
a $1.5 billion shelf registration statement were as follows (in thousands):
Issue Date Outstanding Balance Interest Rate Maturity Date
May 20, 1997 $ 250,000 6.875% May 15, 2000
June 30, 1997 200,000 6.875% June 30, 2002
June 30, 1997 40,000 6.820% July 2, 2001
July 1, 1997 15,000 6.860% July 2, 2001
July 31, 1997 200,000 6.750% August 1, 2004
September 15, 1997 45,000 6.770% September 17, 2001
March 19, 1998 60,000 5.688% March 20, 2000
April 23, 1998 125,000 5.788% April 24, 2001
May 22, 1998 225,000 6.200% May 15, 2003
----------------------
Total $ 1,160,000
======================
As of September 30, 1998, $340.0 million was available for future issuances
under the shelf registration.
11.25% Notes of Parent
On May 14, 1996, the Parent issued $200.0 million of 11.25% notes ("Notes")
maturing on May 15, 2003 and paying interest semi-annually in arrears on May 15
and November 15 of each year, commencing on November 15, 1996. The Notes are
redeemable at the option of the Parent, in whole or in part, at any time on or
after May 15, 2001, at certain redemption prices. The indenture contains
covenants that impose limitations and restrictions on the Parent, including the
maintenance of certain net worth and ratio requirements. In addition, the Notes
are secured by a second priority pledge of the common stock of the Parent. The
Parent is in compliance with all net worth and ratio requirements contained in
the indenture relating to the notes. The amount of Notes outstanding at
September 30, 1998 is $130.0 million.
On February 5, 1997, the Parent issued 8,452,500 shares of common stock to the
public at $15 per share. A portion of the proceeds from the offering was used to
pre-pay $70.0 million of the Notes at a premium of $7.9 million. In connection
with the early repayment of the Notes, the Parent wrote off a portion of the
unamortized debt issuance costs related to the Notes and incurred a prepayment
penalty equal to one year's interest on the Notes retired . The loss amounted to
$6.4 million, net of tax, and was recorded as an extraordinary item. The
remaining proceeds were used to reduce amounts outstanding under the bank line
of credit.
Mortgage note payable
HomeSide assumed a mortgage note payable that is due in 2017 and bears interest
at a stated rate of 9.50%. HomeSide's main office building is pledged as
collateral. A purchase accounting premium was recorded in connection with
HomeSide assuming the mortgage note payable.
Principal payments due on long-term debt at September 30, 1998 are as follows
(in thousands):
Fiscal Year
1999 $ 272
2000 310,300
2001 225,329
2002 200,362
2003 355,398
Thereafter 211,526
Unamortized purchase accounting premium 34,596
=====================
Total $ 1,337,783
=====================
10. INCOME TAXES
The Company files a consolidated federal income tax return. All companies
included in the consolidated federal income tax return are jointly and severally
liable for any tax assessments based on such consolidated return.
Components of the provision for income taxes before the effect of the tax
benefit associated with the early extinguishment of debt were as follows (in
thousands):
HOMESIDE HOMESIDE
PREDECESSOR PREDECESSOR
FOR THE PERIOD FROM FOR THE PERIOD FOR THE PERIOD
FEBRUARY 11, 1998 FROM FROM
TO MARCH 1, 1997 TO MARCH 16, 1996 TO
SEPTEMBER 30, 1998 FEBRUARY 10, 1998 FEBRUARY 28, 1997
------------------ ----------------- ------------------
Current:
Federal $23,399 $ 2,856 $ -
State 2,794 - -
------------------ ----------------- ------------------
$32,193 $ 2,856 $ -
Deferred
Federal 4,459 42,462 30,872
State 3,449 8,061 6,406
------------------ ----------------- ------------------
$ 7,908 $50,523 $37,278
------------------ ----------------- ------------------
Total $40,101 $53,379 $37,278
================== ================= ==================
The following is a reconciliation of the statutory federal income tax rate to
the effective income tax rate as reflected in the consolidated statements of
income.
<PAGE>
<TABLE>
<CAPTION>
HOMESIDE HOMESIDE
PREDECESSOR PREDECESSOR
FOR THE PERIOD FROM FOR THE PERIOD FOR THE PERIOD
FEBRUARY 11, 1998 FROM FROM
TO MARCH 1, 1997 TO MARCH 16, 1996 TO
SEPTEMBER 30, 1998 FEBRUARY 10, 1998 FEBRUARY 28, 1997
------------------ ----------------- ------------------
<S> <C> <C> <C>
Statutory federal income tax rate 35.0% 35.0% 35.0%
State income and franchise taxes,
net of federal tax effect 4.0% 3.5% 4.0%
Goodwill 10.8% - -
Other - .5% 1.0%
--------------------- -------------------- ---------------------
Effective income tax rate 49.8% 39.0% 40.0%
===================== ==================== =====================
</TABLE>
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are presented below (in
thousands):
HOMESIDE
PREDECESSOR
SEPTEMBER 30, 1998 FEBRUARY 10, 1998
------------------ -----------------
Deferred tax assets:
Net operating loss carryforwards $ 11,229 $ 23,114
Alternative minimum tax credit
carry forward - 2,856
Loss reserves 19,535 25,404
Hedge activities 73,899 30,754
Purchase Accounting Adjustment 32,630 -
Other assets - 4,879
------------------ -----------------
Total gross deferred tax assets $137,293 $ 87,007
================== =================
Deferred tax liabilities:
Mortgage servicing fees $313,856 $267,871
Other liabilities 16,218 16,379
------------------ -----------------
Total gross deferred tax liabilities 330,074 284,250
------------------ -----------------
Net deferred tax liability $192,781 $197,243
=================== =================
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which these temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies in making this assessment. No valuation allowance
was recorded September 30, 1998 or February 10, 1998. The Company has
consolidated tax net operating loss carryforwards at September 30, 1998. These
carryforwards expire in the years 2001 to 2011.
11. LEASE COMMITMENTS
HomeSide leases office facilities and equipment under noncancelable leases that
include renewal options and escalation clauses which extend into 2010. Rental
expense for leases of office facilities and equipment was $4.0 million, $4.5
million and $3.9 million for the period February 11, 1998 to September 30, 1998
and for the HomeSide predecessor periods March 1, 1997 to February 10, 1998 and
March 16, 1996 to February 28, 1997, respectively. HomeSide's minimum future
lease commitments are as follows (in thousands):
FISCAL YEAR
1999 $ 5,669
2000 4,199
2001 3,993
2002 3,935
2003 3,278
Thereafter 9,422
-----------
Total $30,496
===========
12. SUPPLEMENTAL CASH FLOW INFORMATION
HomeSide paid $57.2 million, $58.8 million, and $60.1 million of interest during
the period from February 11, 1998 to September 30, 1998, March 1, 1997 to
February 10, 1998, and March 16, 1996 to February 28, 1997, respectively.
HomeSide paid taxes totaling $2.7 million and $0.3 million for the periods
February 11, 1998 to September 30, 1998 and March 1, 1997 to February 10, 1998,
respectively. HomeSide received $70.1 million and $51.7 million cash for
reinstated loans from early pool buyout advances for the period from February
11, 1998 to September 30, 1998 and March 1, 1997 to February 10, 1998,
respectively.
In connection with the acquisitions of BBMC and BMC, HomeSide recorded non-cash
assets and assumed liabilities, including fair value adjustments, of
approximately $2.3 billion and $1.7 billion for the periods from March 1, 1997
to February 10, 1998 and March 16, 1996 to February 28, 1997, respectively.
13. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value estimates are made as of a specific point in time based on the
characteristics of the financial instruments and the relevant market
information. Where available, quoted market prices are used. In other cases,
fair values are based on estimates using other valuation techniques, such as
discounting estimated future cash flows using a rate commensurate with the risks
involved or other acceptable methods. These techniques involve uncertainties and
are significantly affected by the assumptions used and the judgments made
regarding risk characteristics of various financial instruments, prepayments,
discount rates, estimates of future cash flows, future anticipated loss
experience and other factors. Changes in assumptions could significantly affect
these estimates. Derived fair value estimates cannot be substantiated by
comparison to independent markets and, in many cases, could not be realized in
an immediate sale of the instrument. Also because of differences in
methodologies and assumptions used to estimate fair value, the Company's fair
values should not be compared to those of other companies.
Fair value estimates are based on existing financial instruments without
attempting to estimate the value of anticipated future business and the value of
assets and liabilities that are not considered financial instruments.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company. For certain assets and liabilities, the
information required is supplemented with additional information relevant to an
understanding of the fair value.
The methods and assumptions used to estimate the fair values of each class of
financial instruments are as follows:
Cash and cash equivalents
The carrying amount reported in the balance sheet approximates fair value.
Mortgage loans held for sale
Fair values are based on the estimated value at which the loans could be sold in
the secondary market. These loans are priced to be sold with servicing rights
retained, as this is the Company's normal business practice.
Accounts receivable, early pool buyout advances and accounts payable
Carrying amounts are considered to approximate fair value.
Risk management contracts
Fair values are estimated based on actual market quotes or option models.
Notes payable
The carrying amount of the notes payable reported in the balance sheet
approximates its fair value due to the short-term nature of the borrowings under
the credit agreements.
Long-term debt
Fair value of long-term debt is estimated by discounting estimated future cash
flows using a rate consistent with the Company's current borrowing rate as
adjusted for the effects of certain prepayment penalties.
<PAGE>
Commitments to originate mortgage loans
Fair value is estimated using quoted market prices for securities backed by
similar loans adjusted for differences in loan characteristics.
Forward contracts to sell mortgages
Forward contracts to sell mortgages, which represent legally binding agreements
to sell loans to permanent investors at a specified price or yield, are valued
using market prices for securities backed by similar loans and are reflected in
the fair values of the mortgages held for sale, to the extent that these
commitments relate to mortgage loans already originated, or of the related
commitments to extend credit.
Options on mortgage-backed securities and U.S. treasury bond and note futures
The fair values of options are estimated based on actual market quotes. In some
instances, quoted prices for the underlying loans or valuations determined by
option models are used.
Interest rate swaps
The fair values of interest rate swaps are estimated based on dealer quotes.
Fair Value
The fair values of the Company's financial instruments are as follows (in
thousands):
<TABLE>
<CAPTION>
HOMESIDE PREDECESSOR
SEPTEMBER 30, 1998 FEBRUARY 10, 1998
------------------ -----------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- -------
<S> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents $ 35,008 $ 35,008 $ 32,113 $ 32,113
Mortgage loans held for sale 2,048,989 2,064,853 1,292,403 1,296,685
Accounts receivable 272,005 272,005 227,294 227,294
Early pool buyout advances 759,579 759,579 374,097 374,097
Risk management contracts for
mortgage servicing rights 120,211 120,211 43,947 43,947
LIABILITIES
Notes payable 2,749,000 2,749,000 2,074,956 2,074,956
Long-term debt 1,337,783 1,312,983 770,466 799,893
Accounts payable and accrued liabilities 236,940 236,940 135,802 135,802
OFF-BALANCE SHEET(1)
Commitments to originate mortgage loans -- 23,522 -- (1,510)
Mandatory forward contracts to sell
mortgages -- (45,557) -- (3,621)
Mandatory forward contracts to sell U.S.
treasuries -- (463) -- 65
Options on mortgage-backed securities 6,120 2,864 3,543 5,890
Options on U.S treasury bond futures 113 57 743 604
Interest rate swaps -- 24,800 -- 13,496
</TABLE>
- ---------------------------------------------
(1) Parenthesis denote a liability
Fair value estimates are made as of a specific point in time, based on relevant
market data and information about the financial instrument. These estimates do
not reflect any premium or discount that could result from offering for sale the
Company's entire holding of a particular financial instrument. Because no active
market exists for some portion of the Company's financial instruments, fair
value estimates are based on judgments regarding future expected loss
experience, current economic conditions, current interest rates and prepayment
trends, risk characteristics of various financial instruments and other factors.
These estimates are subjective in nature and involve uncertainties and matters
of significant judgment and, therefore, cannot be determined with precision.
Changes in any of these assumptions used in calculating fair value would also
significantly affect the estimates. Further, the fair value estimates were
calculated as of September 30, 1998 and February 10, 1998. Subsequent changes in
market interest rates and prepayment assumptions could significantly change the
fair value.
<PAGE>
14. RISK MANAGEMENT AND OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
As discussed in Note 3, HomeSide utilizes risk management financial instruments
to manage interest rate risk related to the value of its mortgage servicing
rights. A summary of HomeSide 's position in risk management financial
instruments at September 30, 1998 and February 10, 1998 is included below.
The fair value of HomeSide 's risk management contracts is based on quoted
market prices of the underlying instruments at September 30, 1998 and February
10, 1998. The notional amounts represent the par value of the underlying U.S.
Treasury bonds or notes. However, the notional amounts are not recognized in the
balance sheet and should not be considered as a measure of credit risk or future
cash requirements.
The amount of the risk management contracts maintained depends on factors such
as interest rates, interest rate volatility and growth in the mortgage servicing
portfolio. HomeSide is subject to market risk to the extent that interest rates
fluctuate; however, the purpose of the risk management contracts is to hedge the
value of the mortgage servicing rights portfolio. HomeSide's risk management
financial instruments qualify as hedges, and gains or losses on the risk
management instruments correlate with movements in the value of the mortgage
servicing rights. Cash requirements for HomeSide 's option contracts are limited
to premiums paid. Cash requirements for futures contracts are managed based on
limits established by HomeSide 's risk management committee. HomeSide's credit
risk on its risk management contracts is limited because the contracts are
traded on a national exchange which guarantees counterparty performance.
As discussed in Note 3, HomeSide purchases financial instruments and enters into
financial agreements with off-balance sheet risk in the normal course of
business through the origination and selling of mortgage loans and as part of
its risk management programs. These instruments involve, to varying degrees,
elements of credit and interest rate risk. Credit risk is the possibility that a
loss may occur if a counterparty to a transaction fails to perform according to
the terms of the contract. Interest rate risk is the possibility that a change
in interest rates will cause the value of a financial instrument to decrease or
become more costly to settle.
Options and forward contracts
The notional amount of the options and forward contracts used in HomeSide 's
risk management programs is the amount upon which interest and other payments
under the contract are based and is generally not exchanged. Therefore, the
notional amounts should not be taken as the measure of credit risk or a
reflection of future cash requirements. The risk associated with options and
forwards is the exposure to current and expected market movements in interest
rates and the ability of the counterparties to meet the terms of the contracts.
The cash requirements associated with these options and forward contracts, aside
from the initial purchase price, are minimal. These contracts generally require
future performance on the part of the counterparty upon exercise of the option
or execution of the forward contract by HomeSide .
HomeSide is exposed to credit loss in the event of nonperformance by the
counterparties to the various instruments. HomeSide controls credit and market
risk associated with interest rate products by establishing and monitoring
limits with counterparties as to the types and degree of risks that may be
undertaken. HomeSide 's exposure to credit risk in the event of default by the
counterparties for the options was $57.4 million at September 30, 1998 and $57.0
million at February 10, 1998.
HomeSide 's exposure to credit risk in the event of default by the counterparty
for mandatory forward commitments to sell mortgage loans and related options is
the difference between the contract price and the current market price, offset
by any available margins retained by HomeSide or an independent clearing agent,
which totaled $0.4 million at September 30, 1998 and $30.2 million at February
10, 1998.
The amount of credit risk as of September 30, 1998 and February 10, 1998, if all
counterparties failed completely and if the margins, if any, retained by
HomeSide or an independent clearing agent were to become unavailable, was
approximately $37.4 million and $4.4 million, respectively, for all risk
management instruments related to mortgage servicing rights and the origination
and selling of mortgage loans.
The following is a summary of HomeSide 's notional amounts and fair values of
interest rate products (in thousands):
<PAGE>
<TABLE>
<CAPTION>
HomeSide Predecessor
September 30, 1998 February 10, 1998
------------------ --------------------------
Notional Notional
Amount FairValue(1) Amount Fair Value (1)
--------- ----------- -------- --------------
<S> <C> <C> <C> <C>
Purchased commitments to sell
Mortgage loans:
Mandatory forward contracts 3,281,196 ($45,640) 2,847,668 ($3,556)
Options on mortgage-backed
securities 1,845,000 2,864 835,000 5,890
Options on U.S. treasury
bond futures 127,000 57 145,000 604
Risk management contracts on
Mortgage servicing rights:
Options on U.S. treasury
bond/note futures 7,905,900 57,368 4,440,100 50,487
Futures contracts on U.S. treasury
bonds/notes 5,545,500 62,843 2,121,800 (6,540)
</TABLE>
- ----------------------------------------
(1) Parenthesis denote liability. Fair value represents the amount at which a
given instrument could be exchanged in an arms length transaction with a
third party as of the balance sheet date.
Commitments to originate mortgage loans
HomeSide regularly enters into commitments to originate and purchase mortgage
loans at a future date subject to compliance with stated conditions. Commitments
to originate mortgage loans have off-balance sheet risk to the extent HomeSide
does not have matching commitments to sell loans, which exposes HomeSide to
lower of cost or market valuation adjustments in a rising interest rate
environment. Additionally, the extension of a commitment, which is subject to
HomeSide 's credit review and approval policies, gives rise to credit exposure
when certain borrowing conditions are met and the loan is made. Until such time,
it represents only potential exposure. The obligation to lend may be voided if
the customer's financial condition deteriorates or if the customer fails to meet
certain conditions. Commitments to originate mortgage loans do not necessarily
reflect future cash requirements since some of the commitments will not be drawn
upon before expiration. Commitments to originate mortgage loans totaled $4.1
billion and $3.2 billion at September 30, 1998 and February 10, 1998,
respectively.
Mortgage loans sold with recourse
HomeSide sells mortgage loans with recourse to various investors and retains the
servicing rights and responsibility for credit losses on these loans. The total
outstanding balance of loans sold with recourse does not necessarily represent
future cash outflows. The total outstanding principal balance of loans sold with
recourse was $15.0 million and $16.7 million at September 30, 1998 and February
10, 1998, respectively.
Servicing commitment to investors
HomeSide is required to submit to certain investors, primarily GNMA, guaranteed
principal and interest payments from the underlying mortgage loans regardless of
actual collections.
Purchase mortgage servicing rights commitments
HomeSide routinely enters into commitments to purchase mortgage servicing rights
associated with mortgages originated by third parties, subject to compliance
with stated conditions. These commitments to purchase mortgage servicing rights
correspond to mortgage loans having an aggregate loan principal balance of
approximately $4.3 billion and $0.6 billion at September 30, 1998 and February
10, 1998, respectively.
Interest rate swaps
The amount of credit risk as of September 30, 1998 if all counterparties failed
completely was approximately $24.8 million for interest rate swaps.
<PAGE>
Geographical concentration of credit risk
HomeSide is engaged in business nationwide and has no material concentration of
credit risk in any geographic region. For additional information on geographical
distribution see "Servicing Portfolio Composition Servicing Portfolio by State"
under Item 1 of this document.
15. CONTINGENCIES
HomeSide, along with its subsidiaries, is a defendant in a number of legal
proceedings arising in the normal course of business. HomeSide, in management's
estimation, has recorded adequate reserves in the financial statements for
pending litigation. Management, after reviewing all actions and proceedings
pending against or involving HomeSide, considers that the aggregate liabilities
or loss, if any, resulting from the final outcome of these proceedings will not
have a material effect on the financial position, results of operations or
liquidity of HomeSide .
16. EMPLOYEE BENEFITS
HomeSide offers a 401(k) defined contribution benefit plan in which employees
may contribute a portion of their compensation. Substantially all employees are
eligible for participation in the plan. The Company matches 100% of amounts
contributed up to 4% of an employee's compensation. Further, the Company may
contribute additional amounts at its discretion. Total expense related to the
benefit plan was approximately $4.1 million and $3.0 million for the period from
February 11, 1998 to September 30, 1998 and the HomeSide predecessor period from
March 16, 1997 to February 10, 1998, respectively.
17. QUARTERLY FINANCIAL DATA (Unaudited)
<TABLE>
<CAPTION>
(in thousands) For the Three For the Three For the Period From
Months Ended Months Ended February 11, 1998
September 30, 1998 June 30, 1998 to March 31, 1998
------------------ ------------- -------------------
<S> <C> <C> <C>
Revenue $104,469 $99,650 $46,158
Expenses 71,255 66,726 31,750
Provision for income taxes 16,347 16,236 7,518
-------------------- ------------------ ---------------------
Net income $ 16,867 $16,688 $ 6,890
==================== ================== =====================
</TABLE>
<TABLE>
<CAPTION>
HOMESIDE PREDECESSOR
--------------------- ----------------- ------------------ ------------------
(in thousands) For the Period From For the Three For the Three For the Three
December 1, 1997 to Months Ended Months Ended Months Ended
February 10, 1998 November 30, August 31, 1997 May 31, 1997
1997
------------------- -------------- --------------- -------------
<S> <C> <C> <C> <C>
Revenue $62,264 $75,619 $76,330 70,727
Expenses 35,943 38,241 39,432 37,454
Provision for income taxes 11,433 14,577 14,391 12,978
------------------- -------------- --------------- -------------
Net income $17,888 $22,801 $22,507 $20,295
=================== ============== =============== =============
</TABLE>
<TABLE>
<CAPTION>
HOMESIDE PREDECESSOR
--------------------- ------------------ ----------------- --------------------
(in thousands) For the Three For the Three For the Three For the Period From
Months Ended Months Ended Months Ended March 16, 1996 to
February 28, 1997 November 30, 1996 August 31, 1996 May 31, 1996
----------------- ----------------- --------------- ------------
<S> <C> <C> <C> <C>
Revenue $68,841 $68,073 $63,640 $36,087
Expenses 39,987 40,335 40,515 22,609
Provision for income taxes 10,898 11,373 9,481 5,526
--------------------- ------------------ ----------------- --------------------
Net income $17,956 $13,365 $13,644 $ 7,952
===================== ================== ================= ====================
</TABLE>
18. OTHER RELATED PARTY TRANSACTIONS
For the HomeSide predecessor period March 1, 1997 through February 10, 1998,
HomeSide paid BankBoston and Barnett approximately $5.2 million and $0.5
million, respectively, for certain corporate services. For the HomeSide
predecessor period March 16, 1996 to February 28, 1997, HomeSide paid BankBoston
and Barnett approximately $2.5 million and $0.9 million, respectively, for these
services.
For the HomeSide predecessor period March 1, 1997 through February 10, 1998,
HomeSide paid approximately $5.3 million and $45.4 million, respectively, to
BankBoston and Barnett for the purchase of mortgage servicing rights. For the
HomeSide predecessor period from March 1, 1996 through February 28, 1997,
HomeSide paid approximately $4.7 million and $27.6 million, respectively, to
BankBoston and Barnett for the purchase of mortgage servicing rights. HomeSide
also purchases the mortgage servicing rights to the mortgage loans BankBoston
and Barnett hold in their portfolios. For the HomeSide predecessor period March
1, 1997 through February 10, 1998, HomeSide purchased mortgage servicing rights
for loans retained by BankBoston and Barnett totaling approximately $1.6 million
and $9.5 million, respectively. For the HomeSide predecessor period from March
16, 1996 to February 28, 1997 HomeSide purchased mortgage servicing rights for
loans retained by BankBoston and Barnett totaling approximately $1.3 million and
$8.2 million, respectively. The BankBoston and Barnett purchases represented
2.8% and 20.4%, respectively, of the Company's total production for the HomeSide
predecessor period from March 1, 1997 to February 10, 1998. For the HomeSide
predecessor period of March 16, 1996 through February 28, 1997, the BankBoston
and Barnett purchases represented 2.8% and 16.0 %, respectively, of the
Company's total production.
For the HomeSide predecessor period March 1, 1997 to February 10, 1998,
BankBoston and Barnett paid $3.8 million and $29.1 million in servicing fees,
respectively, and were consistent with the fees charged by HomeSide to other
investors. For the HomeSide predecessor period March 16, 1996 to February 28,
1997, BankBoston and Barnett paid $5.3 million and $ 23.6 million in servicing
fees, respectively.
As a result of NationsBank Corporation's acquisition of Barnett Banks, Inc., the
Company agreed to release Barnett from a five year agreement to sell certain of
its mortgage loans to HomeSide. In consideration, the Company received $3.0
million cash in June 1998.
On June 23, 1998, HomeSide entered into an unsecured revolving credit facility
with the National pursuant to which it can borrow up to $2.1 billion, subject to
any lending limitations imposed by regulatory authorities. As of September 30,
1998, regulations limited the National's ability to lend funds to HomeSide, its
non-bank affiliate, to approximately $1.8 billion. The interest rates on these
borrowings are equal to 30 day LIBOR.
19. SUBSEQUENT EVENTS
On October 21, 1998, HomeSide established a $1.5 billion commercial paper
program. A total of $.15 billion of commercial paper was issued at an average
borrowing rate of LIBOR less 2 basis points as of November 30, 1998.
On December 4, 1998, HomeSide entered into a Pooling and Servicing Agreement
with Bank One Trust Company, N.A., as Trustee, and HomeSide Funding Corporation,
as Transferor, pursuant to which approximately $41 million in delinquent
mortgage loans, which HomeSide had repurchased from GNMA pools, were sold to
HomeSide Funding Corporation. The loans were then sold to the HomeSide Mortgage
Loan Buyout Trust 1998-A. This transaction allowed HomeSide to sell the
delinquent loans while retaining the servicing rights and attendant income.
On December 3, 1998, HomeSide announced that it had entered into a Preferred
Partner relationship with People's Bank, the largest bank headquartered in
Connecticut. Under the Preferred Partner relationship, HomeSide will service
substantially all new mortgage loans originated by People's Bank. In addition,
HomeSide purchased the servicing rights to approximately $2.7 billion in
mortgage loans serviced by People's and will provide subservicing for
approximately $2.3 billion in mortgage loans held in People's portfolio.
On December 4, 1998, HomeSide entered into a long-term lease for a 137,000
square foot building to be constructed adjacent to its Jacksonville
headquarters. The new building should be ready for occupancy by September 1999.
On April 10, 1998, Banc One Corporation and First Chicago NBD Corporation
entered into an Agreement and Plan of Reorganization pursuant to which the two
banks then merged effective October 1, 1998. HomeSide has reviewed its
agreements with Banc One Corporation and has determined that the merger with
First Chicago NBD is unlikely to have a material adverse impact on HomeSide's
relationship with Banc One.
<PAGE>
BBMC (ACQUIRED BY HOMESIDE, INC. ON MARCH 15, 1996 AND NOW KNOWN AS HOMESIDE
LENDING, INC.)
ITEM 6. SUMMARY HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING INFORMATION
The following table sets forth summary historical consolidated financial
and operating information for BBMC (formerly BancBoston Mortgage Corporation and
the BBMC predecessor to the Issuer) for the periods prior to its acquisition by
the Parent. Such information should be read in conjunction with, and is
qualified in its entirety by reference to, the Consolidated Financial Statements
and the Notes thereto and in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" of BBMC included
elsewhere in this document.
<TABLE>
<CAPTION>
FOR THE PERIOD
FROM JANUARY 1, 1996
1995 TO MARCH 15, 1996
-------------- --------------------
CONSOLIDATED STATEMENTS OF
OPERATIONS DATA:
<S> <C> <C>
Revenues:
Mortgage servicing fees $173,038 $38,977
Gain (loss) on risk management
contracts 108,702 (128,795)
Amortization of mortgage servicing
rights (108,013) (7,245)
-------------- --------------------
Net servicing revenue 173,727 (97,063)
Interest income 24,324 8,423
Interest expense (27,128) (10,089)
-------------- --------------------
Net interest revenue (2,804) (1,666)
Net mortgage origination revenue
(expense) 3,417 7,638
Gain on sales of servicing rights 10,230 -
Other income 511 253
-------------- --------------------
Total revenues 185,081 (90,838)
Expenses:
Salaries and employee benefits 45,381 10,287
Occupancy and equipment 10,009 2,041
Servicing losses on investor-owned
loans 9,981 5,560
Real estate acquired 1,054 291
Other expenses 21,896 7,377
--------------- --------------------
Total expenses 88,321 25,556
Income (loss) before income taxes
and cumulative effects of changes
in accounting principles $96,760 ($116,394)
============== ====================
Net income (loss) $58,826 ($73,861)
============== ====================
SELECTED BALANCE SHEET DATA (AT
PERIOD END):
Mortgage loans held for sale $ 388,436 $ 628,504
Mortgage servicing rights 551,338 542,862
Total assets 1,254,303 1,520,357
Note payable to Bank of Boston 966,000 1,256,000
Total Liabilities 1,067,712 1,407,627
Total stockholders' equity 186,591 112,730
SELECTED OPERATING DATA
Volume of loans originated and
acquired $ 9,567,521 $ 4,187,603(a)
Loan servicing portfolio (at period
end) 41,555,354 44,158,163(a)
Loan servicing portfolio (average) 39,283,700 43,158,072(a)
Weighted average interest rate (at
period end) 7.97% 7.90%(a)
Weighted average servicing fee
(average for period) 0.383% 0.380%(a)
</TABLE>
- -------------------------
(a) Period information is for the period January 1, 1996 to March 31, 1996 and
period end information is at March 31, 1996.
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS BANCBOSTON MORTGAGE CORPORATION--FOR THE PERIODS JANUARY 1, 1996
TO MARCH 15, 1996 AND JANUARY 1, 1995 TO MARCH 31, 1995 AND FOR THE YEAR ENDED
DECEMBER 31, 1996
GENERAL
Prior to March 15, 1996, BBMC was a wholly-owned subsidiary of Bank of
Boston, a subsidiary of Bank of Boston Corporation ("BKBC"). On March 15, 1996,
BBMC was acquired by HomeSide. The interim financial statements of BBMC have
been prepared for the period January 1, 1996 to March 15, 1996 to coincide with
the closing of the BBMC Acquisition. Results of operations for periods
subsequent to March 15, 1996 are included in the financial statements of
HomeSide. Results of operations for the three months ended March 31, 1995 have
been presented for comparative purposes. Unless otherwise noted, references to
the first quarter 1996 pertain to the period January 1, 1996 to March 15, 1996.
BBMC reported earnings on a calendar year basis.
BBMC operates as a full-service mortgage banking firm emphasizing
wholesale mortgage originations and low cost mortgage servicing. Servicing
activities represent BBMC's primary revenue source. BBMC also generates revenue,
to a lesser extent, from mortgage loan origination fees. BBMC incurs expenses
for amortization of mortgage servicing rights, interest on its line of credit
and general corporate activities.
On June 1, 1995, BBMC purchased certain assets and assumed certain
liabilities of Bell Mortgage Company ("Bell Mortgage"), a privately-held
mortgage origination company located in Minneapolis, Minnesota. The acquisition
of Bell Mortgage was accounted for under the purchase method of accounting.
Results of operations of Bell Mortgage are included in the 1995 consolidated
financial statements from the date of acquisition. See Note 16 of Notes to
Consolidated Financial Statements of BancBoston Mortgage Corporation for further
discussion.
RESULTS OF OPERATIONS
Summary
BBMC reported net income of $58.8 million in 1995 and $5.4 million in
1994. Net income in 1994 included an after tax positive effect of $3.5 million
from a change in the accounting for mortgage servicing fee income. Prior to the
effect of such adjustment, BBMC had income of $58.8 million in 1995 and $2.0
million in 1994. See Note 2 of Notes to Consolidated Financial Statements for
further discussion of BBMC's accounting changes.
The increase in net income in 1995 as compared to 1994 was primarily due
to factors that resulted from a decrease in interest rates coupled with growth
in BBMC's servicing portfolio. The lower interest rate environment resulted in a
gain related to BBMC's risk management activities in 1995 as compared to a loss
in 1994. BBMC also benefited from a 9% increase in the balance of its
residential servicing portfolio from $38.0 billion at December 31, 1994 to $41.6
billion at December 31, 1995. The increases were partially offset, however, by
higher mortgage servicing rights amortization charges as a result of larger
mortgage servicing volumes and higher prepayment activity in 1995.
Long-term interest rates declined through mid-February 1996, the
continuation of a trend which began in 1995. This decline led to an increase in
loan production to $4.2 billion during the first quarter of 1996 from $1.2
billion during the first quarter of 1995, and resulted in growth in BBMC's
mortgage servicing portfolio, which increased from $41.6 billion at December 31,
1995 to $44.2 billion at March 31, 1996. Beginning in late February and
continuing through March 1996, long-term interest rates increased and negatively
affected BBMC's results of operations for the first quarter. BBMC reported a net
loss of $73.9 million during the first quarter of 1996, compared to net income
of $3.4 million in the first quarter of 1995. The decrease in net income was
primarily due to losses of $128.8 million on BBMC's risk management contracts
during the first quarter of 1996, a result of increasing interest rates in late
February and March 1996.
Net Servicing Revenue
Net servicing revenue increased from $67.0 million to $173.7 million, an
increase of $106.7 million or 159.3%, from 1994 to 1995. This growth was
comprised of a $115.4 million increase in gain on risk management contracts and
a $32.5 million increase in mortgage servicing fees, offset by a $41.2 million
increase in amortization of mortgage servicing rights. The gain on risk
management contracts resulted primarily from a decline in interest rates in the
fourth quarter of 1995 and was substantially offset by a related decrease in the
economic value of the servicing portfolio, which was not reflected in earnings
for the period. The cost of acquiring the right to service mortgage loans
originated by others is capitalized and amortized as a reduction of servicing
fee revenue over the estimated servicing period. The increases in mortgage
servicing fees and amortization of mortgage servicing rights were primarily due
to growth in BBMC's average servicing portfolio during 1995. Average servicing
fees, excluding ancillary income, decreased slightly from 0.389% in 1994 to
0.383% in 1995.
At December 31, 1995, BBMC serviced approximately 510,000 loans,
including loans purchased not yet on BBMC's servicing system, with an unpaid
principal balance ("UPB") of $41.6 billion, compared to approximately 484,000
loans with UPB of $38.0 billion at December 31, 1994, an increase of $3.6
billion, or 9.5%. The average servicing volume increased from $33.2 billion in
1994 to $39.3 billion in 1995, an increase of $6.1 billion or 18.4%. Growth in
BBMC's servicing portfolio was primarily generated by wholesale loan production,
which includes correspondent, co-issue and broker channels. BBMC also purchased
servicing rights in bulk from other mortgage servicing entities. Bulk purchases
totalled $5.5 billion and $0.7 billion in 1994 and 1995, respectively.
In addition to growth in the servicing portfolio, an increase in late
fee income contributed to the rise in mortgage servicing revenue during 1995.
Late fees are included as a component of mortgage servicing revenue. BBMC
instituted efforts to improve the collection of ancillary fee income during the
year which contributed to an increase in late fee charges collected from $10.5
million in 1994 to $14.4 million in 1995. Late fee income also increased as a
result of increases in BBMC's servicing portfolio size and average loan size.
The higher average loan size translates into higher loan payments on which late
fees are based. There was little or no change in the rate on which late fees
were computed during 1995 as compared to 1994.
During the first quarter of 1996, BBMC had net servicing revenues of
$(97.1) million, as compared to servicing revenues of $24.2 million in the first
quarter of 1995. The net negative amount recorded as servicing revenue in 1996
was primarily due to losses on BBMC's risk management contracts. Excluding the
effect of risk management contracts, net servicing revenue increased from $20.6
million in the first quarter 1995 to $31.7 million in the first quarter 1996. In
the first quarter of 1995, BBMC recorded gains on risk management contracts of
$3.6 million. Due to an increase in long-term interest rates in late February
and early March 1996, BBMC experienced losses on risk management contracts of
$128.8 million during the quarter. Changes in the value of BBMC's mortgage
servicing rights substantially offset the loss on risk management contracts.
However, such changes in value were not fully recorded in the financial
statements of BBMC because servicing rights were recorded at the lower of
amortized cost or market value.
The decrease in net servicing revenue was partially offset by a
reduction in amortization of mortgage servicing rights from $23.1 million in the
first quarter of 1995 to $7.2 million in the first quarter of 1996. The
reduction in amortization was due to the increase in long-term interest rates
noted above, which had a favorable effect on the prepayment estimates used in
calculating BBMC's periodic amortization expense. Because mortgage servicing
rights are amortized over the expected period of service fee revenues, a
reduction in mortgage prepayment activity typically results in a longer
estimated life of the mortgage servicing asset and, accordingly, lower
amortization expense. Amortization charges are highly dependent upon the level
of prepayments during the period and changes in prepayment expectations, which
are significantly influenced by the direction and level of long-term interest
rate movements.
Risk Management Activities
BBMC had a risk management program designed to protect the economic
value of its mortgage servicing portfolio from declines in value due to
increases in estimated prepayment speeds, which are primarily influenced by
declines in interest rates. When loans prepay faster than anticipated, the cash
flow BBMC would expect to receive from servicing such loans was reduced. Because
the value of the mortgage servicing rights is based on the present value of the
net cash flows to be received over the life of the loan, the value of the
servicing portfolio declines as prepayments increase.
Prior to 1994, risk management of the mortgage servicing rights value
was principally conducted by BKB as part of a consolidated risk management
program. Through the third quarter of 1995, BKB continued to manage a portion of
the risk associated with the servicing portfolio.
To implement its risk management objectives, BBMC purchased risk
management contracts that increased in value when long-term interest rates
declined, or when prepayment speeds increased above a specified level. During
1994 and 1995, BBMC purchased options on long-term United States Treasury bond
futures to protect a significant portion of the market value of its mortgage
servicing portfolio from a decline in value. The value of BBMC's risk management
position was designed to perform inversely with changes in value of mortgage
servicing rights due to the effects of the changes in interest rates. The
options were marked to market at each reporting date with changes in value
reported in revenues. BBMC recognized a gain on risk management contracts of
$108.7 million in 1995. While the value of the servicing portfolio declined, the
full effect of such decline was not reflected in BBMC's financial results
because the value of the associated service rights exceeded its book value. Due
to a rising interest rate environment, BBMC experienced a $6.7 million loss
related to its risk management contracts in 1994.
BBMC recognized a gain on risk management contracts of $108.7 million in
1995, of which $86.5 million was unrealized. During the first quarter of 1996,
long-term interest rates increased, reversing the declining trend which
prevailed during 1995. As a result, through the date of the sale of BBMC in
March 1996, BBMC recognized a loss on risk management contracts of $128.8
million, which included a reversal of such $86.5 million unrealized gain
recognized during 1995. In 1995 and 1996, changes in the value of BBMC's
mortgage servicing rights substantially offset the gain and loss on the risk
management contracts. However, such changes in value were not fully recorded in
the financial statements of BBMC because servicing rights are recorded at the
lower of amortized cost or market value.
Net Interest Revenue/Expense
Net interest expense was $2.4 million in 1994 and $2.8 million in 1995.
Interest income decreased $7.3 million in 1995 as compared with 1994, primarily
as a result of a decrease ~in the average rate earned on warehouse loans from
9.52% in 1994 to 7.78% in 1995. The reduction in interest income on warehouse
loans was partially offset by a $2.1 million increase in interest earned on
mortgage loans held for investment. Interest expense decreased $6.8 million in
1995 as compared with 1994 as a result of a decline in the average rate paid on
BBMC's borrowings from 7.14% in 1994 to 6.89% in 1995.
Net interest expense decreased from $2.0 million in the first quarter of
1995 to $1.7 million in the first quarter of 1996. Interest income increased in
the first quarter of 1996 as compared with the first quarter of 1995 as a result
of an increase in the average balance of mortgage loans held for sale from
$124.6 million during the first quarter of 1995 to $535.6 million during the
first quarter of 1996. Increased loan production volumes, $4.2 billion in the
first quarter of 1996 compared to $1.2 billion in the first quarter of 1995,
created the increased average balance of mortgage loans held for sale. In
addition, an increase in long-term interest rates during February and March 1996
improved the yield on its mortgage loans held for sale. Interest expense
incurred on BBMC's credit facility with Bank of Boston increased in the first
quarter of 1996 as compared with the first quarter of 1995 as a result of the
increase in the average balance of BBMC's loans held for sale. In the first
quarter of 1996 as well as the first quarter of 1995, interest earned on loans
held for sale was less than interest expense on borrowings, thereby creating net
interest expense for BBMC; but the increase in long-term interest rates during
February and March 1996, without a corresponding increase in short-term rates on
BBMC's credit facility, resulted in a decrease in net interest expense in the
first quarter of 1996 as compared with the first quarter of 1995.
Net Mortgage Origination Revenue
Net mortgage origination revenue decreased from $5.0 million in 1994 to
$3.4 million in 1995. Lower production volumes and gains on sales of mortgage
loans were the primary reasons for this decline.
Net mortgage origination revenue (expense) increased from $(1.1) million
in the first quarter of 1995 to $7.6 million in the first quarter of 1996. The
increase in net origination revenue during the first quarter of 1996 was
partially due to the adoption of SFAS No. 122, "Accounting for Mortgage
Servicing Rights" as of January 1, 1996, which had the effect of increasing net
mortgage origination revenue by $3.1 million. In previous periods, the cost of
mortgage servicing rights for originated loans was included in the basis of the
related loan. SFAS No. 122 requires that the cost of an originated loan be
allocated between the loan sold and the servicing rights retained. Consequently,
the cost basis of loans originated in 1996 was lower than the basis that would
have been recorded prior to the adoption of SFAS No. 122 and resulted in
additional gain on the sale of loans. The remaining increase was due to
increases in origination income resulting from higher loan production volumes.
Gain on Sales of Servicing Rights
Gain on sales of servicing rights decreased from $10.9 million in 1994
to $10.2 million in 1995. Gains on sales of servicing rights represent the
excess of proceeds from the sale over the cost basis of the assets. Gains tend
to be higher on sales of servicing rights with little or no cost basis, as was
the case for BBMC's sales in 1994. The servicing rights sold during 1994
consisted primarily of retail originated loans and consequently had relatively
low cost basis. The servicing rights sales in 1995 consisted of a higher
percentage of servicing on purchased loans, which had a higher basis because
servicing rights on purchased loans are capitalized.
Gain on sales of servicing rights during the first quarter of 1995 was
$4.3 million. There were no sales of servicing rights during the first quarter
of 1996.
Salaries and Employee Benefits
Salaries and employee benefits increased from $40.4 million in 1994 to
$45.4 million in 1995, or 12.4%. Including capitalized direct loan origination
costs (principally salary and employee benefits), salaries and employee benefits
increased from $51.5 million to $56.5 million from 1994 to 1995, or 9.7%. The
increase included a $3.9 million increase in salaries and a $1.1 million
increase in benefits and were the result of a larger staff needed to support
BBMC's growing servicing portfolio. The increases in salaries and benefits were
partially offset by the outsourcing of certain default administration and tax
payment administration activities during 1995. BBMC determined that the
performance of these services on a contracted basis was more cost effective than
maintaining the personnel and infrastructure necessary to carry out these
functions in-house. Salaries and employee benefits decreased from $11.7 million
in the first quarter of 1995 to $10.3 million in the first quarter of 1996, or
12.1%. If capitalized direct loan origination costs (principally salary and
employee benefits) were included, the salaries and employee benefits increased
from $12.8 million in the first quarter of 1995 to $13.5 million in the first
quarter of 1996, or 5.8%. The increase reflected general salary and benefit
increases as compared to the first quarter of 1995 and a slight increase in the
number of full time equivalent employees from 1,117 as of March 31, 1995 to
approximately 1,120 as of March 15, 1996.
<PAGE>
Occupancy and Equipment Expense
Occupancy and equipment expense increased from $9.0 million in 1994 to
$10.0 million in 1995, or 11.1%, due primarily to the acquisition of Bell
Mortgage and the larger servicing operations. Occupancy and equipment expense
decreased $0.4 million, from $2.4 million for the first quarter of 1995 to $2.0
million for the first quarter of 1996. The decrease was primarily due to a
decline in equipment repair and maintenance expenses in the first quarter of
1996 as compared to the first quarter of 1995.
Servicing Losses on Investor-Owned Loans
Servicing losses on investor-owned loans primarily represent anticipated
losses attributable to servicing FHA and VA loans for investors. These amounts
include actual losses for final disposition of loans, accrued interest for which
payment has been denied and estimates for potential losses based on experience
as a servicer of government loans. Servicing losses on investor-owned loans
totaled $7.2 million and $10.0 million for 1994 and 1995, respectively,
primarily representing losses on VA loans. In 1994 and 1995, BBMC recorded
provisions in excess of actual foreclosure losses. Management believes that BBMC
had an adequate level of reserve based on its servicing volume, portfolio
composition, credit quality and historical loss rates, as well as estimated
future losses. For an analysis of changes in the reserve for estimated servicing
losses on investor-owned loans for each of the two years ended December 31,
1995, see Note 4 of Notes to Consolidated Financial Statements of BancBoston
Mortgage Corporation.
Servicing losses on investor-owned loans increased from $0.7 million in
the first quarter of 1995 to $5.6 million in the first quarter of 1996. The
increase was primarily due to a change in the VA's method of calculating the
amount it will guarantee on any loan, coupled with planned military base
closings in California that may have an impact on the performance of certain VA
loans serviced by BBMC. The increase in the VA marketing rate effectively
represents a potential increase in BBMC's exposure on properties conveyed to the
VA. BBMC analyzed the effect of these factors on the level of its reserve for
estimated servicing losses and recorded a higher provision in the first quarter
of 1996 in order to bring the reserve to an acceptable level.
Real Estate Owned Expense
Real estate owned expense increased from $0.3 million in 1994 to $1.1
million in 1995. Real estate owned expense is incurred from foreclosed
properties on which BBMC has taken title and includes declines in the value of
the property, as well as the incurrence of property holding and maintenance
costs. The change in real estate owned expense in 1995 was due primarily to an
increase in the average balance of real estate owned from $1.4 million in 1994
to $1.6 million in 1995. As part of the BBMC Acquisition, BKB retained all real
estate owned.
Real estate owned expense increased from $0.2 million in the first
quarter of 1995 to $0.3 million in the first quarter of 1996. The change was due
to an increase in the average balance of real estate owned from $1.2 million
during the first quarter of 1995 to $2.6 million during the first quarter of
1996.
Other Expenses
Other expenses increased from $19.3 million to $21.9 million, or 13.3%,
from 1994 to 1995. The increase in other expenses from 1994 to 1995 included
increases of $1.1 million in advertising and public relations, $1.0 million in
contracted services, $0.9 million in software costs and $0.6 million in
communication expenses. These increases were partially offset by a $0.7 million
reduction in loan-related expenses. The increase in advertising and public
relations expense was due to a major advertising campaign carried out during
1995 in addition to normal advertising activity. Contracted services increased
due to an increase in bank service charges for loan payment processing, which
also increased with the larger BBMC servicing volume. Software costs increased
as BBMC continued to expand and redesign its computer platform in order to
deliver more efficient and reliable service. The increase in communications
expense was due to higher telephone postage and delivery expenses resulting from
higher loan production levels.
Other expense increased $2.7 million, from $4.7 million during the first
quarter of 1995 to $7.4 million in the first quarter of 1996. The increase was
the result of a $0.5 million increase in communications expense and a $0.4
million increase in loan expense, coupled with a decrease in expense credits
resulting from a decline in early pool buyout activity in 1996. These increases
are reflective of the increase in BBMC's servicing portfolio, $44.2 billion at
March 31, 1996 as compared to $37.8 billion at March 31, 1995, and higher loan
production levels in the first quarter of 1996 as compared to the first quarter
of 1995.
Provision for (Benefit from) Income Taxes
BBMC recorded a provision for income taxes of $2.5 million and $37.9
million for 1994 and 1995, respectively. The effective income tax rate was 39.2%
and 56.4% for 1995 and 1994, respectively. The difference between these rates
and the statutory federal tax rate was primarily due to state income taxes, net
of federal tax benefit. The changes in the provisions for, and benefit from,
income taxes were the result of variances in BBMC's pre-tax income and loss for
each of the years presented. For additional information regarding income taxes,
refer to Note 10 of Notes to Consolidated Financial Statements of BancBoston
Mortgage Corporation.
BBMC's benefit from income taxes was $42.5 million during the first
quarter of 1996 as compared to a provision for income taxes of $2.3 million in
the first quarter of 1995. The change in BBMC's income tax provision was the
result of a decline in pre-tax income during the first quarter of 1996 as
compared to the first quarter of 1995, and a decrease in the effective tax rate
from 39.9% during the first quarter of 1995 to 36.5% during the first quarter of
1996.
Accounting Changes
On January 1, 1994, BBMC changed its method of accounting for mortgage
servicing fees from the cash basis to the accrual basis. See Note 2 of Notes to
Consolidated Financial Statements of BancBoston Mortgage Corporation for further
discussion of BBMC's accounting changes. See "-Liquidity and Capital
Resources-New Accounting Standard" for a discussion of Statement of Financial
Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights," which
was adopted by BBMC in 1996.
LIQUIDITY AND CAPITAL RESOURCES
Overview
BBMC's primary sources of cash were revenues earned from the servicing
of mortgage loans, sales of mortgage loans and servicing rights and borrowings
under BBMC's warehouse line of credit. BBMC's primary uses of cash were to fund
loan originations and purchases, purchase bulk servicing rights, repay its
warehouse line of credit and pay general corporate expenses. BBMC had a net
increase (decrease) in cash of ($4.8 million) and $0.3 million in 1995 and 1994,
respectively, and ($4.4 million) and $22.4 million in the first quarter of 1995
and the first quarter of 1996, respectively.
The net decrease in cash in 1995 compared with 1994 was primarily
attributable to the use of cash to meet growth in loan origination volume and
purchases of mortgage servicing rights, coupled with a reduction in proceeds on
sales of mortgage loans. Declining interest rates in 1995 increased loan
production across the industry. Cash inflows in 1995 were positively affected by
an increase in the proceeds from risk management contracts, which increased in
value as a result of the decline in interest rates.
Prior to the BBMC Acquisition, a line of credit with Bank of Boston was
used to fund the origination andpurchase of mortgage loans until the loans were
sold to investors. The proceeds of such sales were typically used to pay down
the related warehouse debt, with any excess retained by BBMC. Maximum borrowings
under the line of credit were $1.25 billion. The higher level of borrowings in
1995 was indicative of higher loan production and purchase volumes during that
year as compared to 1994.
Net cash provided by operating activities and investing activities
decreased in the first quarter of 1996 as compared with the first quarter of
1995, principally as a result of an increase in net cash used in the origination
and purchase of loans held for sale and in the purchase and origination of
mortgage servicing rights and the purchase of risk management contracts. These
increases were the result of higher loan production levels and an increasing
loan servicing portfolio. As a result of increased loan production and held for
sale balances in the first quarter of 1996 as compared to the first quarter of
1995, BBMC had net borrowings of $290.0 million on its line of credit with Bank
of Boston during the first quarter of 1996, as opposed to net repayments of
$130.5 million on the line of credit during the first quarter of 1995.
Impact of Inflation
Inflation affects BBMC primarily through its effect on interest rates
because interest rates normally increase during periods of high inflation and
decrease during periods of low inflation.
New Accounting Standard
In May 1995, FASB issued SFAS No. 122, "Accounting for Mortgage
Servicing Rights." This Statement, among other provisions, requires that the
value of mortgage servicing rights associated with mortgage loans originated by
an entity be capitalized as assets, which results in an increase in mortgage
origination revenues. The value of originated mortgage servicing rights is
determined by allocating the total costs of the mortgage loans between the loans
and the mortgage servicing rights based on their relative fair values. Also, the
Statement requires that capitalized servicing rights be evaluated for impairment
based on the fair value of these rights. For the purposes of determining
impairment, mortgage servicing rights that are capitalized after the adoption of
this Statement are stratified based on one or more of the predominant risk
characteristics of the underlying loans. Impairment is recognized through a
valuation allowance for each impaired stratum. BBMC adopted this Statement
effective January 1, 1996.
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORTS OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
BancBoston Mortgage Corporation
We have audited the accompanying consolidated balance sheet of BancBoston
Mortgage Corporation as of December 31, 1995, and the related consolidated
statements of operations and retained earnings and cash flows for the year 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 audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of BancBoston
Mortgage Corporation as of December 31, 1995, and the consolidated results of
their operations and their cash flows for the year then ended, in conformity
with generally accepted accounting principles.
Coopers & Lybrand L.L.P.
Jacksonville, Florida
January 18, 1996, except for the second paragraph of Note 1 and the fifth
paragraph of Note 2, as to which the date is March 4, 1996
<PAGE>
REPORTS OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors of
BancBoston Mortgage Corporation
We have audited the accompanying consolidated balance sheet of BancBoston
Mortgage Corporation and subsidiaries (see Note 1) as of March 15, 1996, and the
related consolidated statements of operations and retained earnings and cash
flows for the period from January 1, 1996 to March 15, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of BancBoston
Mortgage Corporation and subsidiaries as of March 15, 1996 and the consolidated
results of their operations and their cash flows for the period from January 1,
1996 to March 15, 1996, in conformity with generally accepted accounting
principles.
Arthur Andersen LLP
Jacksonville, Florida
March 14, 1997
<PAGE>
BANCBOSTON MORTGAGE CORPORATION
(The BBMC Predecessor, acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc. -- Note 1)
CONSOLIDATED BALANCE SHEETS
AT DECEMBER 31, AT MARCH 15,
(in thousands) 1995 1996
----------------- ------------
ASSETS
Cash....................................... $ 830 $ 23,216
Mortgage loans
Held for sale, net....................... 388,436 628,504
Held for investment...................... 33,183 65,068
Purchased mortgage servicing rights, net... 533,891 522,469
Excess mortgage servicing receivable, net.. 17,447 20,393
Accounts receivable........................ 82,473 65,599
Accounts receivable from Bank of Boston and
affiliates............................... 343 --
Pool loan purchases........................ 65,272 56,261
Mortgage claims receivable, net............ 45,422 17,563
Accrued income tax receivable.............. -- 40,867
Deferred tax asset......................... 40,724 36,390
Real estate acquired....................... 2,627 2,797
Premises and equipment, net................ 25,386 25,071
Other assets............................... 18,269 16,159
================= ============
Total Assets..................... $1,254,303 $1,520,357
================= ============
LIABILITIES & STOCKHOLDER'S EQUITY
Note payable to Bank of Boston............. $ 966,000 $1,256,000
Accounts payable and accrued liabilities... 51,683 137,837
Accrued income taxes....................... 36,213 --
Long-term debt............................. 13,816 13,790
----------------- ------------
Total liabilities................ 1,067,712 1,407,627
----------------- ------------
Commitments and Contingencies
(Notes 9, 11, 12, 13, 15, and 16)
Stockholder's Equity:
Common stock, $1 par value per share:
10,000 shares authorized; 100 shares
issued and outstanding -- --
Additional paid-in capital............... 156,666 156,666
Retained earnings (accumulated deficit).. 29,925 (43,936)
----------------- ------------
Total stockholder's equity....... 186,591 112,730
----------------- ------------
Total Liabilities and
Stockholder's Equity $1,254,303 $1,520,357
============= ================
The accompanying notes are an integral part of these financial statements.
<PAGE>
<TABLE>
<CAPTION>
BANCBOSTON MORTGAGE CORPORATION
(The BBMC Predecessor, acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc. -- Note 1)
CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
FOR THE PERIOD
YEAR ENDED JANUARY 1, 1996
DECEMBER 31, THROUGH
1995 MARCH 15, 1996
-------------- ---------------
(IN THOUSANDS)
<S> <C> <C>
Revenues:
Mortgage servicing fees.............. $173,038 $38,977
Gain (loss) on risk management contracts 108,702 (128,795)
Amortization of mortgage servicing rights (108,013) (7,245)
---------------------------------------
Net servicing revenues............ 173,727 (97,063)
---------------------------------------
Interest income...................... 24,324 8,423
Interest expense..................... (27,128) (10,089)
---------------------------------------
Net interest revenue (expense).... (2,804) (1,666)
---------------------------------------
Net mortgage origination revenue..... 3,417 7,638
Gain on sales of servicing rights.... 10,230 --
Other income......................... 511 253
---------------------------------------
Total Revenues............... 185,081 (90,838)
---------------------------------------
Expenses:
Salaries and employee benefits....... 45,381 10,287
Occupancy and equipment.............. 10,009 2,041
Servicing losses on investor-owned loans 9,981 5,560
Real estate acquired................. 1,054 291
Other expenses....................... 21,896 7,377
---------------------------------------
Total Expenses............... 88,321 25,556
---------------------------------------
Income (loss) before income taxes and cumulative
effect of change in accounting principle 96,760 (116,394)
Income tax expense (benefit) before cumulative
effect of change in accounting principle:
Current.............................. 47,646 (46,867)
Deferred............................. (9,712) 4,334
---------------------------------------
Total Income Tax Expense (Benefit) 37,934 (42,533)
---------------------------------------
Net Income (Loss)............ 58,826 (73,861)
Retained Earnings (Accumulated Deficit), January 1 (28,901) 29,925
---------------------------------------
Retained Earnings (Accumulated Deficit), end of
period............................... $29,925 $(43,936)
=======================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
BANCBOSTON MORTGAGE CORPORATION
(The BBMC Predecessor, acquired by HomeSide, Inc. on March 15, 1996 and now
known as HomeSide Lending, Inc. -- Note 1)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE PERIOD
YEAR ENDED JANUARY 1, 1996
DECEMBER 31, THROUGH
1995 MARCH 15, 1996
(IN THOUSANDS) ------------ --------------
Cash flows provided by (used in)
operating activities:
Net income (loss)................... $ 58,826 $ (73,861)
Adjustments to reconcile net income
(loss) to cash
provided by (used in) operations:
Cumulative effect of change in accounting
for mortgage servicing fees, net of tax -- --
Amortization..................... 108,404 7,327
Depreciation..................... 3,133 719
Servicing losses on investor-owned
loans................................. 9,981 5,560
Deferred tax (benefit) expense... (9,712) 4,334
Gain on sale of mortgage servicing
rights................................ (10,230) --
(Gain) loss on risk management
contracts............................ (108,702) 128,795
Write down of real estate acquired..... 1,699 1,067
Capitalized excess mortgage servicing
receivable............................ (7,513) (3,967)
Mortgage loans originated and
purchased for sale.................... (4,816,964) (2,027,741)
Proceeds and principal repayments
of mortgage loans held for sale....... 4,694,909 1,787,673
Change in accounts receivable.... (16,053) 17,217
Change in pool loan purchases.... 12,205 9,011
Change in mortgage claims
receivable............................ (5,383) 25,863
Change in accrued income taxes......... 31,388 (77,080)
Change in other assets and accounts
payable and accrued liabilities....... (11,899) 82,622
------------------------------
Net cash provided by (used in)
operating activities................... (65,911) (112,461)
------------------------------
Cash flows provided by (used in)
investing activities:
Principal payments on (net
origination) of mortgage loans
held for investment.............. 12,966 (31,885)
Purchase of premises and equipment.. (3,141) (404)
Acquisition of Bell Mortgage........ (891) --
Purchase of mortgage servicing rights (193,013) (60,171)
Proceeds from (amounts paid for) risk
management contracts, net 27,120 (63,426)
Proceeds from real estate acquired.. 2,610 759
Proceeds from sales of mortgage
servicing rights...................... 28,649 --
------------------------------
Net cash used in investing
activities............................. (125,700) (155,127)
------------------------------
Cash flows provided by (used in)
financing activities:
Borrowings from Bank of Boston...... 3,669,085 1,692,500
Repayments to Bank of Boston........ (3,482,106) (1,402,500)
Repayment of long-term debt......... (191) (26)
------------------------------
Net cash provided by (used in)
financing activities................ 186,788 289,974
------------------------------
Net increase (decrease) in cash....... (4,823) 22,386
Cash at January 1................... 5,653 830
------------------------------
Cash at end of period............... $ 830 $ 23,216
==============================
Supplemental disclosures of cash flow
information:
Cash paid during the year for:
Interest......................... $ 27,498 $ 9,211
Income taxes..................... $ 16,258 $ 30,213
==============================
Supplemental schedule of non-cash
investing activities:
BBMC purchased bulk mortgage
servicing rights during the
years 1994 and 1995. In conjunction $ 23,022 $ --
with purchases, accounts payable
were assumed..........................
==============================
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
BancBoston Mortgage Corporation ("BBMC" or the "Company") was a
wholly-owned subsidiary of The First National Bank of Boston ("Bank of Boston"),
which was a wholly-owned subsidiary of Bank of Boston Corporation. In December
1995, Bank of Boston Corporation signed an agreement with Thomas H. Lee Company
and Madison Dearborn Partners ("Investors") to sell BBMC, creating an
independent mortgage company. Under the terms of the agreement, Bank of Boston
received cash and an equity interest in the new company, HomeSide, Inc. The
Investors acquired majority interest in HomeSide, Inc. The transaction closed
March 15, 1996. Upon completion of the transaction, BBMC was renamed HomeSide
Lending, Inc. BBMC is the BBMC Predecessor company to both HomeSide, Inc. and
HomeSide Lending, Inc.
On March 4, 1996, Barnett Banks, Inc. ("Barnett") entered into an
agreement to sell certain of its mortgage banking operations, primarily its
servicing portfolio and proprietary mortgage banking software systems to
HomeSide, Inc. Barnett received cash and an ownership interest in HomeSide, Inc.
The transaction closed May 31, 1996.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The consolidated financial statements include BBMC and its wholly-owned
subsidiaries. All material intercompany transactions have been eliminated. These
financial statements have been prepared using the carrying values of BBMC and do
not reflect the purchase of BBMC as discussed in Note 1.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Specifically, management adjusts the amount of amortization recorded based on
the effect of anticipated changes in prepayment speeds.
Interest rate products
BBMC enters into financial agreements and purchases financial
instruments as part of its interest rate risk management strategy. These
agreements are not considered trading instruments and are primarily entered into
for purposes of managing the prepayment risk associated with mortgage servicing
rights and interest rate risk relative to commitments to originate mortgage
loans against market value declines resulting from fluctuations in interest
rates. These instruments and agreements are designated as a part of BBMC's risk
management strategy and are linked to the related assets being managed.
BBMC acquires financial instruments, including derivative contracts
(risk management contracts), to partially protect the value of mortgage
servicing rights from the effects of prepayment activity caused by interest rate
declines. These financial instruments increase or decrease in value in an
inverse relationship to changes in market interest rates. Accordingly, as
interest rates decline, these financial instruments will increase in value, and
as interest rates increase, these financial instruments will decline in value.
The value of these financial instruments will fluctuate daily with interest rate
changes, and these fluctuations may be significant. However, the decline in the
value of these financial instruments is limited to the value recorded in the
balance sheet. These financial instruments primarily include options on U.S.
treasury futures, forward contracts, and interest rate floors.
As of March 15, 1996, due to rising interest rates, the risk management
contracts had declined in value by the carrying amount recorded on the balance
sheet at December 31, 1995 (see Note 14).
The cost of option contracts to manage BBMC's fixed and variable rate
loan origination commitments are capitalized and amortized as an adjustment of
gain or loss over the life of the underlying option contract. Unamortized
premiums are included in other assets on the balance sheet. At March 15, 1996,
BBMC had call options to purchase mortgage-backed securities with a total face
amount of $653.0 million. The unamortized premiums associated with these options
were $2.6 million at March 15, 1996. There were no put options outstanding as of
the balance sheet date.
Short-term option contracts that are used to manage interest rate risk
on BBMC's mortgage servicing rights are marked-to-market with gains or losses
recognized in current income. The current market value of these option contracts
are included in the balance of capitalized mortgage servicing rights. At March
15, 1996, the current market value of these option contracts included in
mortgage servicing rights was $20.2 million. Unrealized gains (losses) at
December 31, 1995 and March 15, 1996, included in the consolidated statements of
operations were $86.5 million and ($56.6) million, respectively.
Mortgage loans
Mortgage loans held for sale are carried at the lower of aggregate cost
or fair value. Fair value is based on the contract prices at which the mortgage
loans will be sold or, if the loans are not committed for sale, the current
market price. Loan origination fees and certain direct costs are deferred until
the related mortgage loans are sold.
Mortgage loans held for investment are stated at the lower of cost or
fair value at the time the permanent investment decisions are made. Discounts,
if any, are amortized over the anticipated life of the investment.
Loans are placed on nonaccrual status when any portion of the principal or
interest is ninety days past due or earlier when concern exists as to the
ultimate collectibility of principal or interest. When loans are placed on
nonaccrual status, the related interest receivable is reversed against interest
income of the current period. Interest payments received on nonaccrual loans are
applied as a reduction of the principal balance when concern exists as to the
ultimate collection of principal; otherwise, such payments are recognized as
interest income. Loans are removed from nonaccrual status when principal and
interest become current and they are estimated to be fully collectible.
Purchased and originated mortgage servicing rights
Purchased mortgage servicing rights (PMSR) represent the cost of
purchasing the right to service mortgage loans originated by others. PMSR are
amortized as a reduction of servicing fee income over the estimated servicing
period in proportion to the estimated future net cash flows from the loans
serviced. Remaining PMSR asset balances are evaluated for impairment by
determining their estimated recoverable amount through applying the discount
rate in effect at the time the servicing was purchased to the estimated future
aggregate net cash flows from the underlying mortgages. The carrying value is
written down for any impairment; such write-downs are included in the
amortization of mortgage servicing rights.
On January 1, 1996, BBMC adopted Statement of Financial Accounting
Standards (SFAS) No. 122 which, among other provisions, requires that the value
of mortgage servicing rights associated with mortgage loans originated by an
entity be capitalized as assets. The value of BBMC's originated mortgage
servicing rights (OMSR) is determined by allocating the total costs of the
mortgage loans between the loans and the mortgage servicing rights based on
their relative fair values. Previously, OMSRs were included with the cost of the
related loans and considered in determining the gain or loss on sale when the
loans were sold. Through March 15, 1996, BBMC capitalized $3.1 million of OMSR,
which had the effect of increasing net mortgage origination revenue by $3.1
million for the period January 1, 1996 to March 15, 1996 since a portion of the
basis of loans originated for sale was allocated to OMSR. Since SFAS No. 122
prohibits retroactive application, historical accounting results have not been
restated and, accordingly, the accounting results for the previous years ended
are not directly comparable with the period January 1, 1996 through March 15,
1996.
SFAS No. 122 also requires that capitalized mortgage servicing rights be
evaluated for impairment based on the fair value of these rights. For the
purposes of determining impairment, BBMC's mortgage servicing rights are
stratified based on interest rate and type of loan (conventional/government).
Impairment, if any, is recognized through a valuation allowance for each
impaired stratum. BBMC did not record any impairment charges related to its
mortgage servicing right portfolio for the period January 1, 1996 through March
15, 1996.
Excess mortgage servicing receivable
Excess mortgage servicing receivable (EMSR) represents the present value
of servicing fee income in excess of a normal servicing fee. When loans are
sold, the estimated excess servicing is recognized as income and amortized over
the estimated servicing period in proportion to the estimated future aggregate
net cash flows from the loans serviced. Remaining asset balances are evaluated
for impairment based on current estimates of future discounted cash flows. Such
write-downs are included in amortization of mortgage servicing rights.
Accounts receivable
Accounts receivable includes advances made in connection with loan
servicing activities. These advances consist primarily of payments for property
taxes and insurance premiums, as well as, principal and interest remitted to
investors before they are collected from mortgagors.
<PAGE>
Pool loan purchases
Pool loan purchases are carried at cost and consist of FHA-insured,
VA-guaranteed, and conventional loans purchased from mortgage-backed securities
serviced by BBMC for others. At the purchase date, these loans were delinquent
or in the process of foreclosure or repayment. Losses associated with pool loan
purchases are largely reimbursed by the insurer.
Mortgage claims receivable
Mortgage claims receivable includes claims filed primarily with the FHA
and the VA. These receivables are carried at cost, less an allowance for
estimated amounts that are not collectible from the mortgage insuring agencies.
Real estate acquired
Real estate acquired includes properties on which BBMC has foreclosed
and taken title. It is initially reported at the lower of the carrying value of
the loan or the fair value of the real estate obtained, less estimated selling
costs. The excess, if any, of the loan balance over the fair value of the
property at the time of transfer to real estate acquired is charged to the
reserve for estimated servicing losses on investor-owned loans. Subsequent
declines in the value of the property and costs related to holding the property
are charged against income.
Premises and equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets. Leasehold improvements are amortized over the lesser
of the estimated life of the improvement or the term of the lease.
Other assets
Other assets consist primarily of a prepaid pension asset of ($9.8
million at March 15, 1996) allocated from the Bank of Boston, and the excess of
cost over fair value of net assets acquired. The excess of cost over fair value
of net assets acquired is amortized using a straight-line basis over periods
varying from seven to twenty-five years.
Mortgage servicing fees
Mortgage servicing fees represent fees earned for servicing mortgage
loans owned by investors. The fees are generally calculated on the outstanding
principal balances of the loans serviced and are recognized as income on
anaccrual basis.
Servicing losses on investor-owned loans
BBMC records losses attributable to servicing FHA and VA loans for
investors. These amounts include actual losses for final disposition of loans,
accrued interest for which payment has been denied, and estimates for potential
losses based on BBMC's experience as a servicer of government loans.
A reserve for estimated servicing losses on investor-owned loans is
available for potential losses related to the mortgage servicing portfolio and
is included in the balance of accounts payable and accrued liabilities.
Net mortgage origination revenue
Net mortgage origination revenue includes gains and losses from sales of
mortgage loans, deferred origination fees and expenses, and the present value of
gains from the EMSR.
Income taxes
BBMC files its federal tax return through inclusion in Bank of Boston
Corporation's consolidated return. Accordingly, Bank of Boston's federal tax
provision is allocated to all member subsidiaries as if each member were a
separate taxpayer. However, the timing of utilization of certain of BBMC's tax
attributes may differ from a stand-alone tax-paying basis. BBMC accounts for
income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes."
Under SFAS No. 109, current tax liabilities or assets are recognized through
charges or credits to the current tax provision for the estimated taxes payable
or refundable for the current year.
Deferred tax liabilities are recognized for temporary differences that
will result in amounts taxable in the future and deferred tax assets are
recognized for temporary differences and tax benefit carryforwards that will
result in amounts deductible or creditable in the future. Net deferred tax
liabilities or assets are recognized through charges or credits to the deferred
tax provision. A deferred tax valuation reserve is established if it is more
likely than not that all or a portion of the deferred tax assets will not be
realized. Changes in the deferred tax valuation reserve are recognized through
charges or credits to the deferred tax provision.
The effect of enacted changes in tax law, including changes in tax
rates, on deferred tax assets and liabilities is recognized in income in the
period that includes the enactment date.
3. PURCHASED MORTGAGE SERVICING RIGHTS AND EXCESS MORTGAGE SERVICING RECEIVABLE
PMSR consist of the following:
December 31, March 15,
1995 1996
---------------- -----------------
(in thousands)
PMSR $ 954,931 $ 951,817
Accumulated amortization (421,040) (429,348)
================ =================
Balance $ 533,891 $ 522,469
================ =================
EMSR consist of the following:
December 31, March 15,
1995 1996
---------------- -----------------
(in thousands)
PMSR $ 66,465 $ 70,432
Accumulated amortization (49,018) (50,039)
================ =================
Balance $ 17,447 $ 20,393
================ =================
4. RESERVE FOR ESTIMATED SERVICING LOSSES ON INVESTOR-OWNED LOANS
An analysis of the reserve for estimated servicing losses on investor-owned
loans is as follows:
December 31, March 15,
1995 1996
---------------- -----------------
(in thousands)
Balance at January 1 $ (6,650) $ (9,400)
Servicing losses on investor-owned loans (9,981) (5,560)
Charge-offs 7,473 2,725
Recoveries (242) -
================ =================
Ending Balance $ (9,400) $(12,235)
================ =================
5. MORTGAGE SERVICING PORTFOLIO
BBMC's residential mortgage servicing portfolio totaled $41.5 billion
and $44.2 billion at December 31, 1995 and March 15, 1996, respectively, and
included mortgage-backed securities of $28.5 billion and $29.1 billion at
December 31, 1995 and March 15, 1996, respectively. In addition, BBMC's
commercial loan servicing portfolio totaled $0.9 billion and $0.2 billion at
December 31, 1995 and March 15, 1996, respectively. Related fiduciary funds are
segregated in trust accounts, principally deposited with Bank of Boston, and are
not included in the accompanying consolidated financial statements.
BBMC has in force an errors and omissions policy in the amount of $25
million. Fidelity coverage up to a limit of $75 million, subject to a $1 million
deductible, is provided under a Bank of Boston master program.
6. PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
December 31, March 15,
1995 1996
---------------- -----------------
(in thousands)
Land $ 4,086 $ 4 086
Building 14,477 14,476
Furniture and Equipment 26,870 25,967
Leasehold improvements 824 877
---------------- -----------------
46,257 45,406
Accumulated depreciation and amortization (20,871) (20,335)
================ =================
Balance $ 25,386 $ 25,071
================ =================
7. NOTE PAYABLE TO BANK OF BOSTON
BBMC borrows funds on a demand basis from Bank of Boston under a $1.25
billion line of credit, collateralized by substantially all of BBMC's assets. At
December 31, 1995 and March 15, 1996, the interest rate was 6.8% and 7.7%,
respectively, less the benefit received from balances held at Bank of Boston.
Interest expense, net of this benefit, was $20.5 million and $6.7 million for
the years ended December 31, 1995, and for the period January 1, 1996 to March
15, 1996, respectively.
8. LONG-TERM DEBT
Long-term debt consists of a 30-year mortgage note, payable monthly with
interest at 9.5%, maturing in 2017. BBMC's main office building is pledged as
collateral. Principal payments due on long-term debt as of March 15, 1996, are
as follows:
March 15, 1996
---------------------
(in thousands)
1997 $ 230
1998 234
1999 258
2000 283
2001 312
Thereafter 12,473
=====================
Total Due $ 13,790
=====================
9. EMPLOYEE BENEFITS
BBMC participates with Bank of Boston and its affiliates in a
non-contributory defined benefit pension plan (Plan) covering substantially all
full-time employees. Bank of Boston funds the Plan in compliance with the
requirements of the Employee Retirement Income Security Act.
The Plan is an account balance defined benefit plan in which each employee
has an account to which amounts are allocated based on level of pay and years of
service and which grows at a specific rate of interest. Benefits accrued prior
to 1989 are based on years of service, highest average compensation, and social
security benefits. Expense (income) associated with this Plan was $0.5 million
for the year ended December 31, 1995, and $0.3 million for the period January 1,
1996 to March 15, 1996.
BBMC also maintains non-qualified deferred compensation and retirement
plans for certain officers. All benefits provided under these plans are unfunded
and any payments to plan participants are made by BBMC. As of December 31, 1995
and March 15, 1996, approximately $0.7 million and $0.7 million, respectively,
were included in accrued expenses and other liabilities for these plans. For the
year ended December 31, 1995 and for the period January 1, 1996 to March 15,
1996, expense related to these plans was $0.2 million and $0.1 million,
respectively.
BBMC also participates with Bank of Boston and its affiliates in a
thrift incentive plan. Under this plan, employer contributions are generally
based on the amount of eligible employee contributions. The amounts charged to
operating expense under this plan were $0.2 million and $0.1 million for the
year ended December 31, 1995 and for the period January 1, 1996 to March 15,
1996, respectively. BBMC employees are eligible to participate in the thrift
plan until October 1, 1996 at which time BBMC participant accounts will become
part of a similar plan offered by the new company.
BBMC participates with Bank of Boston and its affiliates by providing
certain health and life insurance benefits for retired employees. Eligible
employees currently receive credits up to $10 thousand based on years of
service, which are used to purchase post-retirement health care coverage. Life
insurance coverage is dependent on years of service at retirement. Amounts
charged to employee benefits expense for these benefits were $0.5 million and
$0.8 million for the year ended December 31, 1995 and for the period January 1,
1996 to March 15, 1996, respectively. After March 15, 1996 retiree benefits
associated with current retirees will be assumed by Bank of Boston.
The components of post-retirement benefits expense for the year ended December
31 were as follows:
1995
-------------
(In Thousands)
Service cost (benefits earned during the period) $ 53
Interest cost on projected benefit obligation 264
Amortization:
Unrecognized net asset 250
Unamortized gain (53)
=============
Net post-retirement benefit cost $ 514
=============
BBMC's unfunded accumulated post-retirement benefit obligation for the year
ended December 31 was as follows:
1995
--------------
(In Thousands)
Accumulated post-retirement benefit
obligation for retirees $ 3,515
Unrecognized net gain 1,541
Unrecognized net obligation (4,250)
==============
Post-retirement benefit liability $ 806
==============
Assumptions used in actuarial computations were:
1995
-------------------
Rate of increase in future
compensation levels 4.50%
Weighted average discount rate 7.25%
Medical inflation rate 8% declining to
5% in 1999
An increase of 1% in the assumed health care cost trend rate would
result in an increase of 5.8% in the accumulated post-retirement benefit
obligation and 4.9% in annual post-retirement benefit expense for the yearended
December 31, 1995.
These retirement plans are assessed annually. There was no actuarial
valuation at March 15, 1996. Post-retirement benefit expense for the period
January 1, 1996 to March 15, 1996 was $0.1 million.
10. INCOME TAXES
The components of the net deferred tax asset are as follows:
December 31, March 15,
1995 1996
---------------- -----------------
(In Thousands)
PMSR $ 34,008 $ 28,167
EMSR 8,957 8,881
Reserve for estimated servicing
losses on investor-owned loans 3,657 4,759
Other (1,301) (1,303)
Valuation reserve (4,597) (4,114)
Net deferred tax assets,
================ =================
Net of reserve $ 40,724 $ 36,390
================ =================
The deferred tax assets, net of the valuation reserve, can be realized
from the reversal of existing deferred tax liabilities and by carryback to
previous years with taxable income. The valuation reserve has been primarily
established against state deferred tax assets where carryback is not permitted.
The components of the provision for (benefit from) income taxes are as follows:
December 31, March 15,
1995 1996
---------------- -----------------
(In Thousands)
Current tax provision (benefit) $ 47,646 $ (46,867)
Deferred tax (benefit) expense on income (8,651) 4,817
Change in valuation reserve (1,061) (483)
---------------- -----------------
Net deferred tax (benefit) expense (9,712) 4,334
Income tax provision (benefit) before
cumulative effect of changes in
accounting principles 37,934 (42,533)
Total income tax provision (benefit) $ 37,934 $ (42,533)
================ =================
The following table reconciles the expected federal tax provision
(benefit) on income (loss) before cumulative effect of change in accounting
principle, based on the federal statutory tax rate of 35%, to the actual tax
provision (benefit) before cumulative effect of changes in accounting
principles:
December 31, March 15,
1995 1996
---------------- --------------
(In Thousands)
Expected tax provision (benefit) applicable to
income (loss) before cumulative effect of
change in accounting principle $ 33,866 $ (40,738)
Effect of:
State income taxes, net of federal tax
benefits 3,774 743
Other 294 (2,538)
---------------- --------------
Actual tax provision (benefit) before
cumulative effect of change in
accounting principle $ 37,934 $ (42,533)
================ ==============
11. LEASE COMMITMENTS
BBMC leases office facilities and equipment under noncancelable leases
that include renewal options and escalation clauses which extend into 1999.
Rental expense for leases of office facilities and equipment was $3.9 million
for the year ended December 31, 1995 and $1.8 million for the period January 1,
1996 to March 15, 1996. BBMC's minimum future lease commitments are as follows:
December 31, March 15,
1995 1996
---------------- -----------------
(In Thousands)
1996 $ 1,996 $ 1,837
1997 622 1,910
1998 280 1,764
1999 52 1,079
2000 - 107
Thereafter - 21
---------------- -----------------
Total $ 2,950 $ 6,718
================ =================
12. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
BBMC purchases financial instruments and enters into financial
agreements with off-balance sheet risk in the normal course of business through
the origination and selling of mortgage loans and the management of the risk of
fluctuations in interest rates. These instruments involve, to varying degrees,
elements of credit and interest rate risk. Credit risk is the possibility that a
loss may occur if a counterparty to a transaction fails to perform according to
the terms of the contract. Interest rate risk is the possibility that a change
in interest rates will cause the value of a financial instrument to decrease or
become more costly to settle. Financial instruments primarily used by BBMC
include commitments to extend credit, mandatory and optional forward
commitments, commitments to purchase mortgage servicing rights, and other
instruments to minimize the interest rate risk of capitalized servicing assets,
primarily options on treasury bond futures.
Options and forward contracts
BBMC purchases options and forward contracts to protect the value of
mortgage servicing assets from exposure to increases in prepayment activity and
to reduce the impact of interest rate fluctuations on its lending commitments.
The notional amount of the options and forward contracts is the amount upon
which interest and other payments under the contract are based and is generally
not exchanged. Therefore, the notional amounts should not be taken as the
measure of credit risk or a reflection of future cash requirements. The risk
associated with options and forwards is the exposure to current and expected
market movements in the interest rates and the ability of the counterparties to
meet the terms of the contracts. The cash requirements associated with these
options and forward contracts, aside from the initial purchase price, are
minimal. These contracts generally require future performance on the part of the
counterparty upon exercise of the option or execution of the forward contract by
BBMC.
BBMC is exposed to credit loss in the event of nonperformance by the
counterparties to the various instruments. BBMC controls credit and market risk
associated with interest rate products by establishing and monitoring limits as
to the types and degree of risks that may be undertaken. BBMC's exposure to
credit risk in the event of default by the counterparties for the options is
$20.2 million which was due at March 15, 1996.
BBMC's exposure to credit risk in the event of default by the
counterparty for mandatory forward commitments to sell mortgage loans is the
difference between the contract price and the current market price, offset by
any available margins retained by BBMC or an independent clearing agent. The
amount of credit risk as of March 15, 1996, if all counterparties failed
completely and if the margins, if any, retained by BBMC or an independent
clearing agent were to become unavailable, was approximately $16.1 million for
mandatory forward commitments of mortgage-backed securities.
<PAGE>
The following is a summary of BBMC's notional amounts and fair values of
interest rate products as of December 31, 1995, and March 15, 1996:
<TABLE>
<CAPTION>
December 31, 1995 March 15, 1996
Notional Estimated Notional Estimated
Amount Fair Value(1) Amount Fair Value(1)
-------------- ---------------- ------------ ----------------
(In Thousands)
<S> <C> <C> <C> <C>
Purchased commitments to sell mortgage loans:
Mandatory forward contracts $ 1,169,559 $ (9,798) $ 941,087 $ 16,099
Options on mortgage-backed securities 315,000 - 653,000 7,607
Risk management contracts:
Purchased 3,107,500 118,753 781,000 17,990
Sold 295,000 (33,833) - -
</TABLE>
(1) Fair value represents the amount at which a given instrument could be
exchanged in an arms length transaction with a third party as of the
balance sheet date.
(2) See Note 14 for additional disclosures on fair value of financial
instruments.
Commitments to originate mortgage loans
BBMC regularly enters into commitments to originate mortgage loans at a
future date subject to compliance with stated conditions. Commitments to
originate mortgage loans have off-balance sheet risk to the extent BBMC does not
have matching commitments to sell loans, which exposes BBMC to lower of cost or
market valuation adjustments in a rising interest rate environment.
Additionally, the extension of a commitment, which is subject to BBMC's credit
review and approval policies, gives rise to credit exposure when certain
borrowing conditions are met and the loan is made.
Until such time, it represents only potential exposure. The obligation
to lend may be voided if the customer's financial condition deteriorates or if
the customer fails to meet certain conditions. Commitments to originate mortgage
loans do not necessarily reflect future cash requirements since some of the
commitments are expected to expire without being drawn upon. Commitments to
originate mortgage loans totaled $885.6 million at December 31, 1995 and $956.4
million at March 15, 1996.
Mortgage loans sold with recourse
BBMC sells mortgage loans with recourse to various investors and retains
the servicing rights on these loans. The total outstanding balance of loans sold
with recourse does not necessarily represent future cash outflows. The total
outstanding principal balance of loans sold with recourse was $6.8 million at
December 31, 1995 and $7.0 million at March 15, 1996.
Servicing commitments to investors
BBMC is required to submit to certain investors, primarily GNMA,
guaranteed principal and interest payments from the underlying mortgage loans
regardless of actual collections.
Purchase mortgage servicing rights commitments BBMC routinely enters
into commitments to purchase mortgage servicing rights associated with mortgages
originated by third parties, subject to compliance with stated conditions. These
commitments to purchase mortgage servicing rights, correspond to mortgage loans
having an aggregate loan principal balance of approximately $2.7 billion at
December 31, 1995 and $0.9 billion at March 15, 1996.
Geographical concentration of credit risk
BBMC is engaged in business nationwide and has no material concentration
of credit risk in any geographic region.
13. OTHER RELATED PARTY TRANSACTIONS
BBMC services mortgage loans for Bank of Boston and its affiliates. The
balances of those portfolios totaled $2.0 billion and $2.0 billion at December
31, 1995 and March 15, 1996, respectively. Related servicing fees are included
in mortgage servicing fees and were $7.6 million and $1.2 million for the year
ended December 31, 1995 and for the period January 1, 1996 to March 15, 1996,
respectively. BBMC reimburses Bank of Boston and its affiliates for certain
occupancy and supplies costs. Total costs reimbursed were $0.7 million for the
year ended December 31, 1995 and $0.2 million for the period January 1, 1996 to
March 15, 1996.
BBMC services real estate acquired by the Bank of Boston and its
affiliates. Related expenses are reimbursed and were $1.7 million for the year
ended December 31, 1995 and $1.7 million for the period January 1, 1996 to March
15, 1996.
An affiliate of Bank of Boston purchases a 99.25% participation in
mortgages in the process of being sold to permanent investors. The principal
balances sold under this agreement aggregated approximately $6.5 billion for the
year ended December 31, 1995, and $0.7 billion for the period January 1, 1996 to
March 15, 1996.
BBMC purchased mortgage servicing rights from Bank of Boston during 1995
and capitalized $4.8 million in mortgage servicing rights associated with this
transaction.
BBMC sold mortgage loans to Bank of Boston and its affiliates in its
normal course of business. These sales totaled $0.5 billion for the year ended
December 31, 1995, and $0.6 billion for the period January 1, 1996 to March 15,
1996. Included in mortgage loans held for sale are loans which will be sold to
Bank of Boston and its affiliates totaling $18.1 million at December 31, 1995,
and $64.1 million at March 15, 1996.
Miscellaneous administrative services are provided by related companies.
These services did not have a material impact on the consolidated financial
statements.
14. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires disclosure of fair value information about financial instruments
whether or not recognized in the balance sheet, for which it is practicable to
estimate fair value.
Financial instruments include such items as mortgage loans held for
sale, mortgage loans held for investment, interest rate contracts, notes
payable, and other instruments.
Fair value estimates are made as of a specific point in time based on
the characteristics of the financial instruments and the relevant market
information. Where available, quoted market prices are used. In other cases,
fair values are based on estimates using other valuation techniques, such as
discounting estimated future cash flows using a rate commensurate with the risks
involved or other acceptable methods. These techniques involve uncertainties and
are significantly affected by the assumptions used and the judgments made
regarding risk characteristics of various financial instruments, prepayments,
discount rates, estimates of future cash flows, future expected loss experience,
and other factors. Changes in assumptions could significantly affect these
estimates. Derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in an immediate
sale of the instrument. Also, because of differences in methodologies and
assumptions used to estimate fair value, BBMC's fair values should not be
compared to those of other companies.
Under the Statement, fair value estimates are based on existing
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. Accordingly, the aggregate fair value amounts presented
do not represent the underlying value of BBMC. For certain assets and
liabilities, the information required under the Statement is supplemented with
additional information relevant to an understanding of the fair value.
The methods and assumptions used to estimate the fair values of each
class of financial instruments are as follows:
Cash
The carrying amount reported in the balance sheet approximates fair value.
Mortgages held for sale
Fair values are based on the estimated value at which the loans could be
sold in the secondary market. These loans are priced to be sold with servicing
rights retained, as is BBMC's normal business practice.
Mortgages held for investment
Fair value is estimated using market quotes for securities backed by
similar loans or by discounting contractual cash flows, adjusted for credit risk
and prepayment estimates. These loans are priced with servicing rights retained.
Discount rates are obtained from secondary market sources.
Accounts receivable, pool loan purchases, and mortgage claims
receivable, net Carrying amounts are considered to approximate fair value. All
amounts that are assumed to be uncollectible within a reasonable time are
written off.
Excess mortgage servicing receivable
Fair value is based on the present value of expected future net cash
flows and the current estimated servicing life.
Risk management contracts Fair values are estimated based on actual
market quotes or option models.
Note payable to Bank of Boston
The carrying amount of the note payable to Bank of Boston reported in
the balance sheet approximates its fair value.
Long-term debt
Fair value of long-term debt is estimated by discounting estimated
future cash flows using a rate commensurate with the risks involved.
Commitments to originate mortgage loans
Fair value is estimated using quoted market prices for securities backed
by similar loans adjusted for differences in loan characteristics.
Forward contracts to sell mortgages
Forward contracts to sell mortgages, which represent legally binding
agreements to sell loans to permanent investors at a specified price or yield,
are valued using market prices for securities backed by similar loans and are
reflected in the fair values of the mortgages held for sale, to the extent that
these commitments relate to mortgage loans already originated, or of the related
commitments to extend credit.
Options on mortgage-backed securities
The fair values of options are estimated based on actual market quotes.
In some instances, quoted prices for the underlying loans or option models are
used.
The estimated fair values of BBMC's financial instruments are as follows:
<TABLE>
<CAPTION>
December 31, 1995 March 15, 1996
Carrying Fair Carrying Fair
Amount Value Amount Value
--------------- --------------- -------------- ------------------
(In Thousands)
<S> <C> <C> <C> <C>
ASSETS
Cash $ 830 $ 830 $ 23,216 $ 23,216
Mortgages held for sale 388,436 395,984 628,504 633,993
Mortgages held for investment 33,183 35,003 65,068 65,068
Accounts receivable 82,816 82,816 65,599 65,599
Pool loan purchases 65,272 65,272 56,261 56,261
Mortgage claims receivable 45,422 45,422 17,563 17,563
Excess mortgage servicing receivable 17,447 19,117 20,393 23,100
Risk management contracts, classified as
PMSR, and other assets (2) 84,520 84,920 20,169 20,169
LIABILITIES
Note payable to Bank of Boston 966,000 966,000 1,256,000 1,256,000
Long-term debt 13,816 16,211 13,790 21,695
OFF-BALANCE SHEET (1)
Commitments to originate mortgage loans - 1,094 - 27,250
Mandatory forward contracts to
sell mortgages (2) - (9,798) - 16,099
Options on mortgage-backed securities (2) - - - 7,607
</TABLE>
(1) Parentheses denote a liability.
(2) See Note 12 for additional disclosures on notional amounts.
Fair value estimates are made as of a specific point in time, based on
relevant market data andinformation about the financial instrument. These
estimates do not reflect any premium or discount that could result from offering
for sale BBMC's entire holding of a particular financial instrument. Because no
active market exists for some portion of BBMC's financial instruments, fair
value estimates are based on judgments regarding future expected loss
experience, current economic conditions, current interest rates and repayment
trends, risk characteristics of various financial instruments, and other
factors.
These estimates are subjective in nature and involve uncertainties and
matters of significant judgment and, therefore, cannot be determined with
precision. Changes in any of these assumptions used in calculating fair value
would also significantly affect the estimates. Further, the fair value estimates
were calculated as of December 31, 1995 and March 15, 1996. Changes in market
interest rates and prepayment assumption could significantly change the fair
value.
15. CONTINGENCIES
BBMC is a defendant in a number of legal proceedings arising in the
normal course of business. BBMC, in management's estimation, has recorded
adequate reserves in the financial statements for pending litigation.
Management, after reviewing all actions and proceedings pending against or
involving BBMC, considers that the aggregate liability or loss, if any,
resulting from the final outcome of these proceedings will not have a material
effect on the financial position or results of operations of BBMC.
16. ACQUISITION OF BELL MORTGAGE
On June 1, 1995, BBMC purchased the assets and liabilities of Bell
Mortgage Company ("Bell Mortgage"), a privately-held mortgage origination
company located in Minneapolis, Minnesota, for $0.9 million in cash. The
acquisition of Bell Mortgage was accounted for as a purchase. Accordingly, the
purchase price was allocated to net assets acquired based upon their estimated
fair market value. As of a result of the acquisition, goodwill of $0.4 million
was recorded and is being amortized over a 7-year period using the straight-line
method.
Also, under the terms of the agreement, the shareholders of Bell
Mortgage will receive additional contingent cash payments based on Bell Mortgage
reaching specific performance goals over the next 3 years. These additional cash
payments will be recorded as additions to goodwill and will be amortized over
the remainder of the original 7-year period using the straight-line method.
Results of operations after the acquisition date are included in the
consolidated financial statements. Pro forma financial results would not have
been materially different as a result of this acquisition.
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Effective April 1, 1998, HomeSide dismissed its prior certifying
accountants, Arthur Andersen, L.L.P. and retained as its new certifying
accountants, KPMG Peat Marwick, L.L.P. Arthur Andersen's report on HomeSide's
financial statements during the two most recent fiscal years and all subsequent
interim periods preceding the date hereof contained no adverse opinion or a
disclaimer of opinions, and was not qualified as to uncertainty, audit scope or
accounting principles. The decision to change accountants was approved by
HomeSide, Inc.'s Board of Directors.
During the last two fiscal years and the subsequent interim period to the
date hereof, there were no disagreements between HomeSide and Arthur Andersen on
any matters of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure, which disagreements, if not resolved
to the satisfaction of Arthur Andersen would have caused it to make a reference
to the subject matter of the disagreements in connection with its reports.
None of the "reportable events" described in Item 304(a)(1) of Regulation
S-K occurred with respect to HomeSide within the last two fiscal years and the
subsequent interim period to the date hereof.
Effective April 1, 1998, HomeSide engaged KPMG Peat Marwick, L.L.P. as its
principal accountants. During the last two fiscal years and the subsequent
interim period to the date hereof, HomeSide did not consult KPMG Peat Marwick
regarding any of the matters or events set forth in Item 304(a)(2) of Regulation
S-K.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
MANAGEMENT
The following table sets forth the name, age and position with the Company of
each person who is an executive officer or director of the Company.
<TABLE>
<CAPTION>
Name Age Position
<S> <C> <C>
Joe K. Pickett ........... 52 Chairman of the Board and Chief Executive Officer, Director
Hugh R. Harris ........... 46 President and Chief Operating Officer; Director
Kevin D. Race ............ 37 Executive Vice President and Chief Financial Officer
Robert J. Jacobs ......... 45 Executive Vice President, Secretary and General Counsel, Director
Betty L. Francis.......... 51 Chief Credit Officer and Executive Vice President
Mark F. Johnson........... 43 Executive Vice President - Production
William Glasgow, Jr....... 48 Executive Vice President - Servicing
Daniel T. Scheuble........ 39 Executive Vice President - Technology
W. Blake Wilson........... 32 Executive Vice President, Director of Capital Markets
Ann R. Mackey............. 40 Senior Vice President and Finance Director
Debra F. Watkins.......... 40 Senior Vice President, Cash Management and Marketing
Operations
</TABLE>
The directors of the Company are elected each year by vote of the directors.
Each of the officers and directors shall serve until their successors are
elected and qualified or until their earlier resignation or removal. It is
expected that corporate officers of the Company will be appointed annually by
its Board of Directors.
Joe K. Pickett has served as chairman of the Board and Chief Executive Officer
of HomeSide since April 1990 and as Chairman of the Board, Chief Executive
Officer and a Director of the Parent since March 14, 1996. From October 1994
through October 1995, Mr. Pickett served concurrently as President of the
Mortgage Bankers Association of America. Mr. Pickett also serves as a Director
of Fannie Mae and of Baptist Medical Center, Jacksonville, Florida.
Hugh R. Harris has served as President and Chief Operating Officer of HomeSide
since January 1993 and as President, Chief Operating Officer and a Director of
the Parent since March 14, 1996. From January 1988 to January 1993, Mr. Harris
served as Vice Chairman of HomeSide in charge of production and secondary
marketing. Mr. Harris currently serves as a Director of Republic Mortgage
Insurance Company (RMIC).
Kevin D. Race has served as Executive Vice President and Chief Financial Officer
of HomeSide and Vice President, Chief Financial Officer and Treasurer of the
Parent since October 1996. From 1993 to 1996, Mr. Race served as Executive Vice
President, Chief Financial Officer and Treasurer of Fleet Mortgage Group. In
1996, Mr. Race was named president of Fleet Mortgage Group. In 1989, Mr. Race
served in the mortgage capital markets and non-conforming products areas of
Fleet Mortgage Group. From 1985 to 1989, Mr. Race served as Vice President and
National Product Manager for Mortgage Backed Securities for Citicorp. From 1982
to 1985, Mr. Race served in the secondary marketing area of North American
Mortgage Company.
Robert J. Jacobs has served as Executive Vice President and Secretary of
HomeSide since February 2, 1996. Mr. Jacobs has served as a Director of HomeSide
since March 14, 1996. Mr. Jacobs has also served as Secretary of the Parent
since March 14, 1996 and as Vice president of the Parent since April 10, 1996.
From 1987 to 1996, Mr. Jacobs served as a Senior Vice President and Chief Legal
Officer of Chase Manhattan Mortgage Corporation, and served as General Counsel
for Citicorp Savings of Florida from 1984 to 1986. Mr. Jacobs currently serves
as President and Legislative Chairman of the Mortgage Bankers Association of
Florida.
Betty L. Francis has served as Chief Credit Officer and as Executive Vice
President of HomeSide since October 1996 and as Vice President of the Parent
since April 10, 1996. Ms. Francis served from March 1994 to October 1996 as
Chief Financial Officer of HomeSide. Ms. Francis served from April 1993 to March
1994 as the Senior Finance Officer of the Personal Banking Group, and from April
1990 to April 1993 as the Comptroller of Bank of Boston and BKBC. Ms. Francis is
a Trustee of Commonwealth Energy Services, a gas and electric utility in
Massachusetts.
Mark F. Johnson has served as Executive Vice President of Production of HomeSide
since April 1, 1992. From 1988 to 1992, Mr. Johnson served as Senior Vice
President and Director of Wholesale Lending for HomeSide. Mr. Johnson also has
served as Vice President of the Parent since April 10, 1996.
William Glasgow, Jr. has served as Executive Vice President of HomeSide since
July 1991. From October 1989 to July 1991, Mr. Glasgow served as Senior Vice
President with Citicorp Mortgage Inc. in St. Louis, Missouri. Mr.Glasgow has
also served as Vice President of the Parent since April 10, 1996.
Daniel T. Scheuble has served as Executive Vice President for Technology, Loan
Processing and Consumer Direct Lending of HomeSide since 1993. From 1990 to
1992, Mr. Scheuble served as a Senior Technology and Operational Manager at Bank
of Boston. Mr. Scheuble has also served as Vice President of the Parent since
April 10, 1996.
W. Blake Wilson has served as Executive Vice President and Director of Capital
Markets of HomeSide since September 1997. He previously served as Senior Vice
President and Director of Capital Markets of the Company from June 1996. Before
joining HomeSide, Mr. Wilson served in Capital Markets for Prudential Home
Mortgage ("PHM") from 1992 through June 1996. Prior to joining PHM, he worked in
KPMG Peat Marwick's National Mortgage and Structured Finance Group in
Washington, D.C.
Ann R. Mackey has served as Senior Vice President and Finance Director of
HomeSide since July 1993. From September 1992 to July 1993, Ms. Mackey served as
a manager in International Risk Management for Bank of Boston. Ms. Mackey
previously served as Senior Audit Manager at KPMG Peat Marwick from 1985 to
1992.
Debra F. Watkins has served as Senior Vice President, Cash Management and
Marketing Operations of HomeSide since October 1993. From July 1987 to October
1993, Ms. Watkins served in various management positions in Secondary Marketing
and Production Operations at the Company. Ms. Watkins currently serves as
Chairperson of the GNMA Liaison Committee of Mortgage Association of America.
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION
The following table sets forth all compensation awarded to, earned by or paid to
the Company's Chief Executive Officer and the Company's five most highly
compensated executive officers for all services rendered in all capacities to
the Company and its subsidiaries for the periods from February 11, 1998 to
September 30, 1998, and the HomeSide predecessor periods from March 1, 1997 to
February 10, 1998 and March 16, 1996 to February 28, 1997.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
Lont-Term
Compensation
Awards
Annual ----------------
Compensation Securities
Name and Principal Fiscal ------------------ Underlying All Other
HomeSide Lending Position Year Salary Bonus Options Compensation
- ----------------------------------- ------- ---------- ----------- ---------------- ---------------------
<S> <C> <C> <C> <C> <C>
Joe K. Pickett............... 1998(a) $291,000 $500,000(c) 50,000(d) $ 4,801,289(f)(g)(h)
Chairman & CEO 1998(b) 372,000 500,000 45,000 23,954
1997 312,000 362,000 242,862(e) 16,135(i)
- ----------------------------------- ------- ---------- --------- ------------------ ---------------------
Hugh R. Harris............... 1998(a) 266,000 500,000(c) 45,000(d) 4,763,533(f)(g)(h)
Presidend and Chief 1998(b) 360,000 470,000 45,000 14,411
Operating Officer 1997 300,000 350,000 242,862(e) 7,842(i)
- ----------------------------------- ------- ---------- --------- ----------------- ---------------------
Kevin D. Race................ 1998(a) 194,000 211,000(c) 35,000(d) 2,385,547(f)(g)(h)
Executive Vice President 1998(b) 250,000 300,000 45,000 9,333
and Chief Financial Officer 1997 250,000(j) 100,000 97,155(e) 413,145(i)(k)
- ----------------------------------- ------- ---------- --------- ----------------- ---------------------
Mark F. Johnson.............. 1998(a) 150,000 227,000(c) 30,000(d) 1,753,605(f)(g)(h)
Executive Vice President
Secondary Marketing and 1998(b) 230,000 200,000 30,000 10,623
Production 1997 200,000 150,000 97,155(e) 6,714(i)
- ----------------------------------- ------- ---------- --------- ----------------- ---------------------
William Glasgow, Jr.......... 1998(a) 150,000 227,000(c) 30,000(d) 1,754,109(f)(g)(h)
Executive Vice President 1998(b) 230,000 200,000 30,000 14,299
1997 200,000 150,000 97,155 (e) 6,522 (i)
- -----------------------------------
</TABLE>
(a) For the fiscal period from February 11, 1998 to September 30, 1998.
(b) For the fiscal period from March 1, 1997 to February 10, 1998.
(c) Bonus amounts relate to the proportion of the guaranteed annual bonus under
employment agreements with the National earned during the period from
February 11, 1998 to September 30, 1998. Annual bonus amounts under
HomeSide's bonus plan will not be determined until January 1999.
(d) Options to purchase common stock of National Australia Bank, Ltd., the
parent.
(e) Reflects a 17 for 1 stock split of the Company's Common Stock effected
immediately prior to the Company's January 1997 initial public offering.
(f) Includes amounts received for (1) matching contributions under the
Company's 401K plan of $6,400 with respect to each individual, (2) profit
sharing contributions of $9,600 with respect to each individual, and (3)
relocation expenses of $33,043 with respect to Mr. Pickett.
(g) In consideration of entering into the Confidentiality and Noncompetition
Agreements with the National, Messrs. Pickett, Harris, Race, Johnson and
Glasgow received a one time cash payment in the amount of $1,500,000,
$1,500,000, $1,000,000, $400,000 and $400,000, respectively, immediately
following the Merger with the National.
(h) Executive officers received the following amounts with respect to
accelerated Options pursuant to the Merger Agreement: Joe K. Pickett -
$2,380,595 Hugh R. Harris - $2,380,595, Kevin D. Race - $1,018,261, Mark F.
Johnson - $981,636 and William Glasgow, Jr. - $981,636. In addition, such
individuals received the following amounts with respect to previously
vested options pursuant to the Merger Agreement: Joe K. Pickett - $851,533,
Hugh R. Harris - $851,533, Kevin D. race - $340,645, Mark F. Johnson
$340,645 and William Glasgow, Jr. - $340,645.
(i) Includes amounts received for (1) matching contributions under the
Company's savings plan of $6,000 with respect to each of Messrs. Pickett,
Harris, Johnson, Glasgow; and (2) the dollar value of life insurance
premiums paid by the Company with respect to: Mr. Pickett $10,135; Mr.
Harris $1,842; Mr. Race $74; Mr. Johnson $714; Mr. Glasgow $522.
(j) The salary of Mr. Race was per annum. Mr. Race has been employed by the
Company since October 1996.
(k) Includes a bonus of $375,000 received by Mr. Race as an inducement to join
the Company and $38,071 in relocation expenses.
<PAGE>
Option Grants for the Period from February 11, 1998 to September 30, 1998
The following table provides information on option grants with respect
to common stock of the parent, National Australia Bank, Ltd., for the period
from February 11, 1998 to September 30, 1998 to the named executive officers.
Pursuant to applicable regulations of the Securities and Exchange commission
(the "Commission"), the following table also sets forth the hypothetical value
which might have been realized with respect to such options based on assumed
rates of stock appreciation of 5% and 10% compounded annually from date of grant
to the end of the option terms:
<TABLE>
<CAPTION>
Individual
Grants
------------------------------------------------------
% of PotentialRealizable
Total Value at
Number of Options Assumed Annual Rates
Securities Granted of Stock
Underlying to Price Appreciation for
Options Employees Exercise Option Term (c)
Granted in the Price Expiration -----------------
Name (#)(a) period ($/Sh) Date 5% 10%
- ------------------ ---------- --------- ------------- ----------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Joe K. Pickett 50,000 (b) $11.81 02/26/03 $160,233 $332,211
Hugh R. Harris 45,000 (b) 11.81 02/26/03 144,210 298,990
Kevin D. Race 35,000 (b) 11.81 02/26/03 112,163 232,548
Mark F. Johnson 30,000 (b) 11.81 02/26/03 96,140 199,327
William Glasgow, 30,000 (b) 11.81 02/26/03 96,140 199,327
Jr.
</TABLE>
(a) Options granted during the period from February 11, 1998 to September 30,
1998 pursuant to National Australia Bank's Executive Share Option Plan. The
options may be exercised during the period from February 26, 2001 to
February 26, 2003 only if on any day during this period the total return to
shareholders exceeds 65% of the exercise price. The total return includes
the value of dividends and the share price growth over the relevant period.
(b) Represents less than 1% of the total options granted to the National's
employees during the fiscal year ended September 30, 1998.
(c) These values are based on assumed rates of appreciation only. Actual gains,
if any, on shares acquired on option exercises are dependent on the future
performance of the National's Common Stock and in accordance with the
Executive Share Option Plan. The market price of the National's common
stock at September 30, 1998 was $12.10.
AGGREGATED OPTION EXERCISES AND OPTION VALUES
FOR THE PERIOD FROM FEBRUARY 11, 1998 TO SEPTEMBER 30, 1998
The following table provides information on option exercises during the
period from February 11, 1998 to September 30, 1998 with respect to the Common
Stock of the National and on the values of the named executive officers'
unexercised options at September 30, 1998:
<TABLE>
<CAPTION>
Shares Value of Unexercised
Acqired Securities Underlying Unexercised In-the-Money
on Value Options at Year-End (#) Options at Year-End
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable (a)
- -------------------- ---------- ---------- ----------- --------------- ---------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Joe K. Picket....... 0 $0 0 50,000 $0 $14,500
Hugh R. Harris...... 0 0 0 45,000 0 13,050
Kevin D. Race....... 0 0 0 35,000 0 10,150
Mark F. Johnson..... 0 0 0 30,000 0 8,700
William Glasgow, Jr. 0 0 0 30,000 0 8,700
</TABLE>
- --------------------
(a) Value of unexercised in-the-money stock options represents the difference
between the exercise price of the stock options and the closing price of
the National's Common Stock on September 30, 1998.
<PAGE>
Employment Contracts and Termination of Employment Arrangements
Certain of the Company's executive officers including each of the named
executive officers are party to employment agreements and/or non-competition
agreements with the Company. The Company is therefore contractually obligated to
continue to pay such salaries during the executive officer's term of employment
with the Company.
Employment Agreements with the National and the Company. In connection
with the acquisition of HomeSide by the National, the National and the Company
entered into employment agreements (the "Employment Agreement") with Joe K.
Pickett, the Company's Chairman and Chief Executive Officer; Hugh R. Harris, the
Company's President and Chief Operating Officer; Kevin D. Race, the Company's
Vice President, Treasurer and Chief Financial Officer; Mark F. Johnson, the
Company's Vice President, Loan Production; and William Glasgow, Jr., the
Company's Vice President, Loan Administration and six other officers of the
Company (the "Executives"). Each Employment Agreement became effective upon the
consummation of the merger with the National (the "Merger") and provides for a
three-year term of employment commencing upon the consummation of the Merger.
Pursuant to the Employment Agreements, Mr. Pickett serves as Chairman and Chief
Executive Officer of the Company. Mr. Harris serves as President and Chief
Operating Officer of the Company and Mr. Race serves as Executive Vice President
and Chief Financial Officer of the Company. The Employment Agreements for
Messrs. Johnson and Glasgow provide that each such Executive serves as an
Executive Vice President of the Company.
Pursuant to their respective Employment Agreements, Messrs. Pickett,
Harris, Race, Johnson and Glasgow each (i) receives an annual base salary of
$450,000, $410,000, $300,000, $230,000 and $230,000, respectively, (ii) receives
a guaranteed annual bonus of $800,000, $800,000, $337,500, $362,500 and $362,500
respectively, payable on each of the first and second anniversaries of the
Effective Time, February 10, 1998, of the Merger, (iii) is eligible to
participate in the Company's annual bonus plan ("ABP"), (iv) is eligible to
participate in the National's Executive Share Option Plan and will receive an
initial grant of options to purchase 50,000, 45,000, 35,000, 30,000 and 30,000
NAB ordinary shares, respectively, and (v) is eligible to participate in a
long-term incentive plan (funded by the National with a cash pool not in excess
of $15,000,000), the first award under such plan (the "Anniversary Award") to be
payable in a lump sum cash payment within 30 days following the third
anniversary of the effective time of the Merger (the "Anniversary Date"),
provided that the Executive is employed by the Company on the Anniversary Date.
The Employment Agreements provide that the National shall cause the entire
long-term incentive plan cash pool to be distributed to eligible Company
executives. The Employment Agreements for the six other officers provide for
annual base salaries aggregating $1,120,000, and guaranteed annual bonuses
aggregating $712,500; and such officers will receive in the aggregate initial
grants of options to purchase 150,000 NAB ordinary shares and will be eligible
to participate in the Company's annual bonus plan and in the long-term incentive
plan referred to in clause (v) above. The Employment Agreements also provide
that each Executive will be (i) entitled to participate in employee benefit
plans as may be in effect for senior executives of the Company from time to
time, (ii) entitled to paid vacation in accordance with the vacation policy
applicable to the Company's senior executives, (iii) reimbursed by the Company
for reasonable business expenses and (iv) entitled to receive the same
perquisites that such Executives received immediately prior to the Effective
Time. The Employment Agreements further provide that each Executive will be
eligible to participate in a nonqualified deferred compensation plan to which
such Executive may elect to defer any amount of such Executive's cash
compensation.
Each Employment Agreement may be terminated by the applicable Executive for
"good reason" and by the Company for "cause," as such terms are defined in the
Employment Agreements, or by voluntary resignation of the Executive, upon ninety
(90) days' written notice provided the Executive waives any amounts payable
under the Employment Agreement and provided further that Executive's obligations
under the Confidentiality and Noncompetition Agreement (described below) to
which such Executive is a party remain unaffected by such resignation. In the
event that the Company terminates the Executive's employment for any reason
other than cause or disability or the Executive terminates his employment for
good reason, the Company is obligated to (A) pay to the Executive his
Anniversary Award pursuant to the long-term incentive plan if he is terminated
prior to the third anniversary of the Merger and (B) (i) pay to the Executive
for the twenty-four (24) month period ( the eighteen (18) month period, in the
case of each Executive other than Messrs. Pickett and Harris) following the
Executive's termination (the "Continuation Period"), an amount equal to his
average monthly base salary for the two year period (or portion thereof)
immediately preceding the date of termination, plus (ii) at the end of the
Continuation Period, an amount equal to two times (1.5 times, in the case of
each Executive other than Messrs. Pickett and Harris) the average of (x) the
Executive's target bonus under the ABP for the year in which termination occurs
and (y) the annual bonus under the ABP for the year immediately preceding the
year in which termination occurs, (iii) the pro rata portion of the guaranteed
annual bonus, if any, for the year of termination and (iv) the pro rata portion
of Executive's ABP award for the year of termination, and (C) provide the
Executive during the Continuation Period with continued coverage under the
Company's health, life and disability insurance plans, provided that Executive
continues to contribute the employee share of the cost applicable to such
coverages. The amounts under clauses (B) (i) and (ii) and the coverage under
clause (C) in the immediately preceding sentence will be payable or provided, as
the case may be, only so long as the Executive complies with his obligations
under the confidentiality and Noncompetition Agreement (described below) to
which such Executive is a party.
In the event an Executive's employment is terminated by reason of death or
disability, the Company shall pay such Executive (or his designated beneficiary
or estate, as the case may be) the pro-rated portion of (i) the guaranteed
annual bonus, if any, for the year of termination of employment, (ii) any ABP
award such Executive would have received for the year of termination of
employment, and (iii) any applicable award payable under the long-term incentive
plan (which is the Anniversary Award in the event of termination of employment
on or before the third anniversary of the Merger).
Each Employment Agreement provides that the Executive waives any and all
rights to benefits payable under any prior severance agreement to which the
Executive and the Company are parties and agrees that such severance agreement
shall be void and of no further effect and shall be superseded in its entirety
by the Employment Agreement
Historical Executive Compensation
The following table sets forth all compensation awarded to, earned by or
paid to the Company's Chief Executive Officer and the Company's four most highly
compensated Executive Officers other than the Chief executive officer whose
total annual salary and bonus exceeded $100,000 for all services rendered in all
capacities to BancBoston Mortgage Corporation and its subsidiaries for the
fiscal year ended December 31, 1995. None of the Company's named executive
officers received any compensation from Barnett Mortgage Company during 1995.
<TABLE>
<CAPTION>
Summary Compensation Table
Long-Term Compensation
---------------------------------
Awards (b) Payouts
--------------- ---------
Long-Term
Annual Restricted Securities Incentive
Name and Principal Fiscal Compensation Stock Underlying Plan
Position Year Salary(a)Bonus(a) Awards Options Payouts (c) Compensation (d)
- --------------------- ------ -------- -------- ------------ --------- ---------- -----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Joe K. Pickett...... 1995 $287,000 $200,000 $68,700 9,600 $215,156 $11,480
Chairman & CEO
Hugh R. Harris...... 1995 275,000 225,000 42,938 6,000 0 11,000
President
Charles D. Gilmer... 1995 170,769 155,000 0 0 0 0
Director, Risk
Management
Mark F. Johnson..... 1995 190,577 125,000 28,625 4,000 0 7,623
Director, Wholesale/
Securities Marketing
William Glasgow, Jr. 1995 189,230 125,000 28,625 4,000 0 7,569
Director, Loan
Administration
</TABLE>
- ---------------------
(a) The salary and bonus amounts presented were earned in 1995. The payment of
certain such amounts occurred in 1996. The amounts reflected in the table
do not include the following bonuses paid to the named executive officers
in 1996 in connection with the closing of the acquisition of BancBoston
Mortgage Corporation: Mr. Pickett, $50,000; Mr. Harris, $225,000; Mr.
Gilmer, $175,000; Mr. Johnson, $200,000; and Mr. Glasgow, $200,000.
(b) Involves common stock of BKBC. As of December 31, 1995, the named executive
officers held the following number of restricted shares of BKBC common
stock having the corresponding year-end market values:
AS OF DECEMBER 31, 1995
Total Number of
Restricted Aggregate
Name Shares Held Market Value
-------------- ------------
Joe K. Pickett............................. 5,600 $259,900
Hugh R. Harris............................. 4,135 191,244
Charles D. Gilmer.......................... 0 0
Mark F. Johnson............................ 1,784 82,510
William Glasgow, Jr........................ 1,700 78,625
In connection with the BancBoston Mortgage Corporation acquisition,
vesting on all of the restricted stock owned by its employees, including
the restricted stock listed above, was accelerated and all prior
forfeiture and transferability restrictions thereon were removed.
(c) Represents the dollar value of vested shares of performance restricted
stock calculated by multiplying the closing price of BKBC common stock
on each vesting date by the number of shares that vested on that date.
(d) Includes matching employer contributions and credits under the
BankBoston thrift-incentive plan and the BankBoston deferred
compensation plan for the named executive officers.
RETIREMENT BENEFITS
The following table shows the years of service and the estimated annual
retirement benefits that are payable at age 65 from BKBC to each of the named
executive officers in the form of a single lifetime annuity with an assumed
future annual interest rate of 6.3% through 1996 and 5.5% thereafter on each
individual's cash balance account:
Prior Years of Estimated Annual
Service
Name as of 12/31/95 Retirement Benefit
- ------------------- ------------------- ----------------------------------
Joe K. Picket....... 15 $73,883
Hugh R. Harris...... 12 50,676
Charles D. Gilmer 2 2,386
Mark F. Johnson..... 13 48,616
William Glasgow, Jr. 4 6,836
The estimates shown above reflect BankBoston's cash balance formula as of
December 31, 1995 (under which credits are made annually to an individual's
account at a rate based on the individual's age and years of service), plus any
accrued benefits under the prior plan formula. These benefits are provided under
a combination of BankBoston's tax-qualified retirement plan and certain
supplemental plans.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Capital Stock of the Company
All of the outstanding common stock of HomeSide Lending, Inc., consisting
of 100 shares, is owned by the Parent.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On June 23, 1998, HomeSide entered into an unsecured revolving credit facility
with the National pursuant to which it can borrow up to $2.1 billion, subject to
any lending limitations imposed by regulatory authorities. As of September 30,
1998, regulations limited the National's ability to lend funds to HomeSide, its
non-bank affiliate, to approximately $1.8 billion. The interest rates on these
borrowings are equal to 30 day LIBOR.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this Report:
1. Financial Statements: See Part II, Item 7 hereof.
2. Financial Statement Schedule and Auditors' Report
All schedules omitted are inapplicable or the information required is shown in
the Consolidated Financial Statements or notes thereto.
3. The following exhibits are submitted herewith:
Unless otherwise indicated, all Exhibits are incorporated by reference to the
Company's Registration Statement on Form S-1, No. 333-17685.
Number Description
3.1 Certificate of Incorporation of HomeSide Lending, Inc.
3.2 By-Laws of HomeSide Lending, Inc.
4.1 Form of Common Stock Certificate
10.1 Stock Purchase Agreement dated December 11, 1995 between HomeAmerica
Capital, Inc. (currently known as HomeSide, Inc.) and The First National
Bank of Boston (the "BBMC Purchase Agreement")
10.2 Amendment No. 1, dated as of March 15, 1996, to the BBMC Purchase Agreement
10.3 Marketing Agreement dated as of March 15, 1996 between HomeSide, Inc. and
The First National Bank of Boston
10.4 Repurchase of Mortgage Loan Servicing Rights Letter Agreement between The
First National Bank of Boston (currently known as BankBoston, N.A.) and
BancBoston Mortgage Corporation (currently known as HomeSide Lending, Inc.)
10.5Operating Agreement effective as of March 15, 1996 between The First
National Bank of Boston (currently known as BankBoston, N.A.) and
BancBoston Mortgage Corporation (currently known as HomeSide Lending, Inc.)
10.6Brokered Loan Purchase and Sale Agreement dated as of March 15, 1996 between
BancBoston Mortgage Corporation (currently known as HomeSide Lending, Inc.)
and each of The First National Bank of Boston (currently known as
BankBoston N.A.), Bank of Boston Connecticut, Rhode Island Hospital Trust
National Bank and Bank of Boston Florida, N.A.
10.7 Master Take-Out Commitment dated as of March 15, 1996 between BancBoston
Mortgage Corporation (currently known as HomeSide Lending, Inc.) and each
of The First National Bank of Boston (currently known as BankBoston, N.A.),
Bank of Boston Connecticut, Rhode Island Hospital Trust National Bank and
Bank of Boston Florida, N.A.
10.8Neighborhood Assistance Corporation of America Mortgage Loan Take-Out
Commitment dated as of March 15, 1996 between BancBoston Mortgage
Corporation (currently known as HomeSide Lending, Inc.) and The First
National Bank of Boston (currently known as BankBoston, N.A.)
10.9(DELTA)PMSR Flow Agreement dated as of March 15, 1996 between BancBoston
Mortgage Corporation (currently known as HomeSide Lending, Inc.) and each
of The First national Bank of Boston (currently known as BankBoston, N.A.),
Bank of Boston Connecticut, Rhode Island Hospital Trust National Bank and
Bank of Boston Florida, N.A.
10.10(DELTA) Mortgage Loan Servicing Agreement dated as of March 15, 1996
between BancBoston Mortgage Corporation (currently known asHomeSide
Lending, Inc.) and each of the First National Bank of Boston, Bank of
Boston Connecticut, Rhode Island Hospital Trust National Bank and Bank of
Boston Florida, N.A.
10.11Stock Purchase Agreement dated as of March 4, 1996 between Grant America,
Inc. (currently known as HomeSide, Inc.) and Barnett Banks, Inc. (the "BMC
Purchase Agreement")
10.12Amendment No. 1, dated as of May 31, 1996, to the BMC Purchase Agreement
10.13Tax Indemnity Letter Agreement dated as of March 4, 1996 between Barnett
Mortgage Company (currently known as HomeSide Holdings, Inc.) and Barnett
Banks, Inc.
10.14Amended and Restated Shareholder Agreement dated as of May 31, 1996 among
HomeSide, Inc. and the shareholders thereof
10.15Amended and Restated Registration Rights Agreement dated as of May 31, 1996
between HomeSide, Inc. and certain shareholders thereof
10.16Marketing Agreement dated as of May 31, 1996 between HomeSide, Inc. and
Barnett Banks, Inc. 10.17Transitional Services Agreement dated as of may
31, 1996 between Barnett Banks, Inc., Barnett Mortgage Company (currently
known as HomeSide Holdings, Inc.) and HomeSide, Inc.
10.18Operating Agreement dated as of May 31, 1996 between HomeSide Lending, Inc.
and Barnett Banks, Inc.
10.19(DELTA)Mortgage Loan Servicing Agreement dated as of April, 1996 between
HomeSide Lending, Inc. and Barnett Banks, Inc.
10.20(DELTA)PMSR Flow Agreement dated as of May 31, 1996 between HomeSide
Lending, Inc. and Barnett Banks, Inc.
10.21Correspondent Agreement dated May 16, 1996 between HomeSide Lending, Inc.
and Barnett Banks, Inc.
10.22Delegated Underwriting Agreement dated as of May 15, 1996 between HomeSide
Lending, Inc. and HomeSide Holdings, Inc.
10.23* Amended and Restated Credit Agreement dated as of January 31, 1997 among
HomeSide Lending, Inc., Honolulu Mortgage Company, Inc., the Lenders
parties thereto, and The Chase Manhattan Bank as Administrative Agent (the
"Credit Agreement")
10.24* Amended and Restated Holdings Pledge Agreement dated as of January 31,
1997 between HomeSide Lending, Inc. and The Chase Manhattan Bank, as
Administrative Agent for the Lenders parties to the Credit Agreement
10.25* Amended and Restated HomeSide Lending Pledge Agreement dated as of
January 31, 1997 between HomeSide Lending, Inc. and The Chase Manhattan
Bank, as Administrative Agent for the Lenders parties to the Credit
Agreement
10.26* Amended and Restated BMC Pledge Agreement dated as of January 31, 1997
between HomeSide Holdings, Inc. and The Chase Manhattan Bank, as
Administrative Agent for the Lenders parties to the Credit Agreement
10.27Registration Rights Agreement dated as of May 14, 1996 among HomeSide,
Inc. and Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith
Incorporated, Smith Barney Inc. and Friedman, Billings, Ramsey & Co., Inc.
10.28* Amended and Restated Holdings Guaranty dated as of January 31, 1997 by
HomeSide, Inc. in favor of The Chase Manhattan Bank, as Administrative
Agent for the Lenders parties to the Credit Agreement
10.29* Amended and Restated HomeSide Lending Guaranty dated as of January 31,
1997 by HomeSide Lending, Inc. in favor of The Chase Manhattan Bank, as
Administrative Agent for the Lenders parties to the Credit Agreement
10.30* Amended and Restated Subsidiaries Guaranty dated as of January 31, 1997
by each of SWD Properties, Inc., Stockton Plaza, Inc., HomeSide Lending
Mortgage Securities, Inc. and Honolulu Mortgage Company, Inc. in favor of
The Chase Manhattan Bank, as Administrative Agent for the Lenders parties
to the Credit Agreement
10.31* Amended and Restated BMC Guaranty dated as of January 31, 1997 by
HomeSide Holdings, Inc. in favor of The Chase Manhattan Bank, as
Administrative Agent for the Lenders parties to the Credit Agreement
10.32* Amended and Restated Security and Collateral Agency Agreement dated as of
January 31, 1997 between HomeSide Lending, Inc. and The Chase Manhattan
Bank, as Administrative Agent for the Lenders parties to the Credit
Agreement
10.33* Amended and Restated Security and Collateral Agency Agreement dated as of
January 31, 1997 between Honolulu Mortgage Company, Inc. and The Chase
Manhattan Bank, as Administrative Agent for the Lenders parties to the
Credit Agreement
10.34* Amended and Restated Security and Collateral Agency Agreement dated as of
January 31, 1997 between HomeSide Holdings, Inc. and The Chase Manhattan
Bank, as Administrative Agent for the Lenders parties to the Credit
Agreement
10.35* Intercreditor Agreement dated as of May 31, 1996 between HomeSide
Lending, Inc. HomeSide Holdings, The Bank of New York, as Trustee, and The
Chase Manhattan Bank, as Administrative Agent under the Credit Agreement
10.36 HomeSide, Inc. Time Accelerated Restricted Stock Option Plan
10.37 HomeSide, Inc. Non-Qualified Stock Option Plan
10.38Class B Non-Voting Common Stock Issuance Agreement dated as of March 14,
1996 between HomeSide, Inc. and Smith Barney Inc.
10.39Transitional Services Agreement dated as of March 15, 1996 between The
First National Bank of Boston (currently known as BankBoston, N.A.) and
BancBoston Mortgage Corporation (currently known as HomeSide Lending, Inc.)
10.40Transitional Services Agreement dated as of March 15, 1996 between The
First National Bank of Boston (currently known as BankBoston, N.A.) and
BancBoston Mortgage corporation (currently known as HomeSide Lending, Inc.)
10.41Management Agreement dated as of March 15, 1996 between BancBoston
Mortgage Corporation (currently known as HomeSide Lending, Inc.) and The
First National Bank of Boston (currently known as BankBoston, N.A.)
10.42Management Agreement dated as of March 15, 1996 between BancBoston
Mortgage Corporation (currently known as HomeSide Lending, Inc.) and Thomas
H. Lee Company
10.43Management Agreement dated as of March 15, 1996 between BancBoston
Mortgage Corporation (currently known as HomeSide Lending, Inc.) and
Madison Dearborn Partners, Inc.
10.44Management Stockholder Agreement dated as of May 15, 1996 between
HomeSide, Inc., The First National Bank of Boston (currently known
BankBoston, N.A.), Thomas H. Lee Equity Fund III, L.P. and certain
affiliates thereof, Madison Dearborn Capital Partners, L.P. and certain
employees of HomeSide Lending, Inc. and its subsidiaries
10.45Management Agreement dated as of May 31, 1996 between HomeSide Lending,
Inc. and Barnett Banks, Inc.
10.46 Form of HomeSide Severance Agreement
10.47* Loan and Security Agreement dated January 15, 1997 between HomeSide
Lending, Inc. and The Chase Manhattan Bank
10.48* First Amendment dated February 28, 1997 to Loan and Security Agreement
dated January 15, 1997 between HomeSide Lending, Inc. and The Chase
Manhattan Bank
10.49* Second Amendment dated March 31, 1997 to Loan and Security Agreement
dated January 15, 1997 between HomeSide Lending, Inc. and The Chase
Manhattan Bank.
10.50* Loan and Security Agreement dated March 14, 1997 between HomeSide
Lending, Inc. and Merrill Lynch Mortgage Capital Inc.
10.51* First Amendment dated March 31, 1997 to Loan and Security Agreement dated
March 14, 1997 between HomeSide Lending, Inc. and Merrill Lynch Mortgage
Capital Inc.
10.52* Third Amendment dated April 11, 1997 to Loan and Security Agreement dated
January 15, 1997 between HomeSide Lending, Inc. and The Chase Manhattan
Bank.
10.53* Second Amendment dated April 14, 1997 to Loan and Security Agreement
dated March 14, 1997 between HomeSide Lending, Inc. and Merrill Lynch
Mortgage Capital Inc.
10.54* Fourth Amendment dated April 29, 1997 to Loan and Security Agreement
dated January 15, 1997 between HomeSide Lending, Inc. and The Chase
Manhattan Bank.
10.55* Third Amendment dated April 29, 1997 to Loan and Security Agreement dated
March 14, 1997 between HomeSide Lending, Inc. and Merrill Lynch Mortgage
Capital Inc.
10.56* Amendment dated as of September 30, 1997 to the Credit Agreement dated as
of January 31, 1997.
10.57* Second Amendment dated as of December 31, 1997 to the Credit Agreement
dated as of January 31, 1997.
10.58* Employment Agreement and Confidentiality and Non-Competition Agreement,
each dated as of October 25, 1997, each between HomeSide Lending, Inc. and
Joe K. Pickett.
10.59* Employment Agreement and Confidentiality and Non-Competition Agreement,
each dated as of October 25, 1997, each between HomeSide Lending, Inc. and
Hugh R. Harris.
10.60* Employment Agreement and Confidentiality and Non-Competition Agreement,
each dated as of October 25, 1997, each between HomeSide Lending, Inc. and
Kevin D. Race.
10.61* Employment Agreement and Confidentiality and Non-Competition Agreement,
each dated as of October 25, 1997, each between HomeSide Lending, Inc. and
William Glasgow.
10.62* Employment Agreement and Confidentiality and Non-Competition Agreement,
each dated October 25, 1997, each between HomeSide Lending, Inc., and Mark
F. Johnson.
12.1 Computation of the ratio of earnings to fixed charges
21.1* List of subsidiaries of HomeSide Lending, Inc.
23.1 Consent of Arthur Andersen LLP
23.2 Consent of PriceWaterhouseCoopers LLP
23.6(a) Consent of Hutchins, Wheeler & Dittmar, A Professional Corporation
(included in Exhibit 5.1) 24.1Powers of Attorney 26.0Excerpts from 1997 and
1998 Annual Report to Stockholders
26.1 Item 15 of the Company's Registration Statement on form S-1, No. 333-17685
27 Financial Data Schedule
- ----------------
* Incorporated by reference to Exhibits of HomeSide Lending, Inc.'s (a
wholly-owned subsidiary of the Registrant Registration Statement on Form
S-1, Registration No. 333-21193
(DELTA) Portions of this Exhibit have been omitted pursuant to an order by the
Securities and Exchange Commission granting confidential treatment.
(b) Reports on form 8-K
HomeSide filed no reports on form 8-K during the three months ended
September 30, 1998.
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
HomeSide Lending, Inc.
(Registrant)
By: /s/Joe K. Pickett
-----------------
Joe K. Pickett
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
<S> <C> <C> <C>
/s/Joe K. Pickett Chairman of the Board, Chief Executive Officer and December 28, 1998
- -------------------- Director (Principal Executive Officer)
Joe K. Pickett
/s/Hugh R. Harris President, Chief Operating Officer and Director December 28, 1998
- --------------------
Hugh R. Harris
/s/Kevin D. Race Vice President and Chief Financial Officer and Treasurer December 28, 1998
- -------------------- (Principal Financial and Accounting Officer)
Kevin D. Race
/s/Robert J. Jacobs Vice President and Secretary, General Counsel December 28, 1998
- --------------------
Robert J. Jacobs
</TABLE>
HOMESIDE LENDING, INC.
EXHIBIT 12.1 - COMPUTATION OF THE RATIO OF EARNINGS TO FIXED CHARGES
(Dollar amounts in thousands)
The following table sets forth the ratio of earnings to fixed charges of
HomeSide Lending, Inc. for the period from February 11, 1998 to September 30,
1998 and the predecessor periods March 1, 1997 to February 10, 1998 and March
16, 1996 to February 28,1997. The ratio of earnings to fixed charges is computed
by dividing net fixed charges (interest expense on all debt plus the interest
portion of rent expense) into earnings before income taxes and fixed charges.
<TABLE>
<CAPTION>
For the period For the period For the period
February 11, 1998 to March 1, 1997 to March 16, 1996 to
September 30, 1998 February 10, 1998 February 28, 1997
<S> <C> <C> <C>
Earnings before income taxes $ 80,546 $ 136,870 $ 93,195
---------------------------- -------------------- -------------------------
Interest expense 62,476 81,770 66,833
Interest portion of rental expense 1,320 1,387 1,550
---------------------------- -------------------- -------------------------
Fixed charges 63,796 83,157 68,383
---------------------------- -------------------- -------------------------
Earnings before fixed charges 144,342 220,027 161,578
---------------------------- -------------------- -------------------------
Fixed Charges:
Interest expense 62,476 81,770 66,833
Interest portion of rental expense 1,320 1,387 1,550
---------------------------- -------------------- -------------------------
Fixed charges $ 63,796 $ 83,157 $ 68,383
============================ ==================== =========================
Ratio of earnings to fixed harges $ 2.26 $ 2.65 $ 2.36
============================ ==================== =========================
</TABLE>
Exhibit 23.1
Consent of Independent Certified Public Accountants
As independent certified public accountants, we hereby consent to the
incorporation by reference of our report included in this Form 10-K into
HomeSide, Lending Inc.'s previously filed Registration Statement File No.
333-45603.
Arthur Andersen LLP
Jacksonville, Florida
December 22, 1998
Exhibit 23.2
Consent of Independent Accountants
We consent to the incorporation by reference in Pre-effective Amendment No.
1 to registration statement on Form S-3 and Post-Effective Amendment No. 2 of
this registration statement on Form S-3 to Form S-1 (File No. 333-45603) of our
report, dated January 18, 1996, except for the second paragraph of Note 1 and
the fifth paragraph of Note 2, as to which the date is March 4, 1996, on our
audits of the consolidated financial statements of BancBoston Mortgage
Corporation as of December 31, 1995 and for the year then ended, which report is
included (or incorporated by reference) in this Annual Report on Form 10-K.
PricewaterhouseCoopers LLP
Jacksonville, Florida
December 22, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0001031258
<NAME> HomeSide Lending, Inc.
<MULTIPLIER> 1
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 8-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> FEB-11-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 35,008
<SECURITIES> 0
<RECEIVABLES> 272,005
<ALLOWANCES> 0
<INVENTORY> 0
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0
0
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</TABLE>