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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10 -K
[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the year ended December 31, 1997
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
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Commission file number: 001-13417
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 13-3950486
(State or other Jurisdiction of ( I.R.S. Employer Identification No.)
Incorporation or Organization)
90 WEST STREET, SUITE 1508, NEW YORK, NY 10006
(Address of principal executive offices) (Zip Code)
(212) 732-5086
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.01 Par Value per Share - American Stock Exchange
Warrants - American Stock Exchange
Units - American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ]
The aggregate market value of units held by nonaffiliates of the registrant
as of February 20, 1998 was approximately $112,777,025 (based on closing sales
price of $19.625 per unit as reported for the American Stock Exchange).
The registrant had 6,466,677 shares of common stock outstanding as of
February 20, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement to be delivered to shareholders in
connection with the Annual Meeting of Shareholders to be held May 21, 1998 are
incorporated by reference into Part III.
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HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31, 1997
INDEX
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PART I PAGE
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Item 1. Business................................................................................. 1
Item 2. Properties............................................................................... 22
Item 3. Legal Proceedings........................................................................ 23
Item 4. Submission of Matters to a Vote of Security Holders...................................... 24
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................... 25
Item 6. Selected Financial Data.................................................................. 25
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 26
Item 8. Financial Statements and Supplementary Data.............................................. 33
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.... 33
PART III
Item 10. Directors and Executive Officers of the Registrant....................................... 34
Item 11. Executive Compensation................................................................... 34
Item 12. Security Ownership of Certain Beneficial Owners and Management........................... 34
Item 13. Certain Relationships and Related Transactions........................................... 34
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.......................... 35
Signatures......................................................................................... 36
</TABLE>
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PART I
ITEM 1: BUSINESS
GENERAL
Background
In September 1997, Hanover Capital Mortgage Holdings, Inc. (the "Company")
raised net proceeds of approximately $79.1 million in its initial public
offering, pursuant to which the Company sold 5,750,000 units at $15.00 per unit.
Each unit consisted of one share of common stock, par value $.01, and one stock
purchase warrant. Each warrant entitles the holder to purchase one share of
common stock at $15.00 per share (subject to adjustment in certain events). The
warrants became exerciseable on March 19, 1998 and remain exerciseable until
September 15, 2000.
In connection with the initial public offering, the Company acquired a 97%
ownership interest (representing a 100% ownership of the non-voting preferred
stock) in Hanover Capital Partners Ltd. ("HCP") and its wholly-owned
subsidiaries, Hanover Capital Mortgage Corporation ("HCMC") and Hanover Capital
Securities, Inc. ("HCS"), in exchange for 716,667 shares of the Company's common
stock.
The Company is a specialty finance company the activities of which include
(i) acquiring primarily single-family subprime mortgage loans (as defined
below), (ii) securitizing mortgage loans and retaining interests therein, (iii)
offering due diligence services to buyers, sellers and holders of mortgage
loans, and (iv) originating, holding, selling and servicing multifamily mortgage
loans and commercial mortgage loans. The Company's principal business objective
is to generate increasing earnings and dividends for distribution to
stockholders. The Company acquires single-family mortgage loans through a
network of sales representatives targeting financial institutions throughout the
United States. The Company originates multifamily mortgage loans and commercial
mortgage loans through HCMC. The Company operates as a tax-advantaged REIT. The
Company is generally not subject to Federal income tax to the extent that it
distributes its earnings to its stockholders and maintains its qualification as
a REIT. Taxable affiliates of the Company, however, including HCP, HCMC and HCS,
are subject to Federal income tax. The Company has engaged HCP to render due
diligence, asset management and administrative services pursuant to a Management
Agreement.
The Company elected REIT status primarily for the tax advantages.
Management believes that the REIT structure is the most desirable structure for
owning mortgage assets because it eliminates corporate-level Federal income
taxation. In addition, as the Company is not a traditional lender which accepts
deposits, it is subject to substantially less regulatory oversight and incurs
lower operating expenses than banks, thrifts and many other originators of
mortgage assets. Management believes that the Company will generate attractive
earnings and dividends per share for stockholders through the combination of (i)
purchasing subprime single-family mortgage loans which generally have higher
yields than newly originated mortgage loans, (ii) using long-term financing that
allows the Company to realize net interest income over time as REIT-qualified
income, as opposed to fully taxable gain-on-sale income, and (iii) its focus on
originating multifamily mortgage loans and commercial mortgage loans, which
generally have higher yields than conforming single-family mortgage loans. As
used herein, the term "subprime single-family mortgage loan" means a single-
family mortgage loan that is either twelve months or older or
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that does not meet the originally intended credit quality due to documentation
errors or credit deterioration. Although HCP has previously rendered advisory
services in connection with securitization transactions, neither it nor HCMC has
securitized any significant amount of mortgage loans.
Business Strategy
The Company's strategy is to pursue acquisitions and originations of
mortgage loans where it believes it can receive acceptable rates of return on
invested capital and effectively utilize leverage. Key elements of this strategy
include:
o growing the Company's investment portfolio by utilizing the Company's
single-family mortgage loan acquisition network and multifamily and
commercial origination operation to create attractive investment
opportunities;
o financing the Company's investments in a manner that limits the
Company's interest rate risk while earning an attractive return on
equity; and
o owning mortgage assets in the REIT structure and thereby eliminating a
layer of taxes relative to most traditional real estate lenders.
The Company's principal executive offices are located at 90 West Street,
Suite 1508, New York, New York 10006.
INVESTMENT PORTFOLIO
General
The primary business of the Company is investing, generally on a long-term
basis, in first lien single-family mortgage loans, multifamily mortgage loans
and commercial mortgage loans and mortgage securities secured by or representing
an interest in mortgage loans (the "Investment Portfolio"). The percentage of
the Company's mortgage assets which is invested in various sectors of the
Investment Portfolio may vary significantly from time to time depending upon the
availability of mortgage loans and mortgage securities. The Company utilizes its
organization to acquire and securitize single-family mortgage loans and
originate commercial mortgage loans to earn higher returns than could generally
be earned from purchasing mortgage securities in the marketplace.
Single Family Mortgage Operations
Single-Family Mortgage Loans. The Company focuses on the purchase of pools
of whole single-family mortgage loans that do not fit into the large
government-sponsored or private conduit programs. Single-family mortgage loans
generally are acquired in pools from a wide variety of sources, including
private sellers such as banks, thrifts, finance companies, mortgage companies
and governmental agencies. The majority (65% - 70%) of the Company's acquisition
of single-family mortgage loan pools to date have been fixed rate loans, with
the balance made up of adjustable rate mortgage ("ARM") loans. At December 31,
1997, the Company had an investment in mortgage securities of $348 million. The
Company intends to liquidate these investments over the next twelve months as it
identifies and purchases additional single-family mortgage loan pools.
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The Company uses seven sales representatives from HCP, located in Illinois,
Minnesota, California, Massachusetts and New York, to source single-family
mortgage loan products. For the foreseeable future, the Company believes that
there will be an adequate supply of mortgage loan product that can be sourced by
the existing HCP sales force.
At December 31, 1997, the Company had invested $160,970,000 or 31.1% of the
Company's total assets in the following types of single-family mortgage loans in
accordance with the operating policies established by the Board of Directors.
<TABLE>
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Whole Loan Mortgage Loan Summary
Fixed Rate Mortgage Loans
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Face or principal amount $106,424,000
Carrying value 107,953,000
Weighted average net coupon 8.265%
Weighted average maturity
(in months) 242
Number of loans 1,763
Average loan size $60,365
Average loan-to-
value ratio (LTV) 67.13%
Adjustable Rate Mortgage (ARM) Loans
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Face or principal amount $52,365,000
Carrying value $53,017,000
Weighted average net coupon 7.925%
Weighted average maturity
(in months) 319
Number of loans 439
Average loan size $119,281
Average loan-to-
value ratio (LTV) 76.98%
</TABLE>
At March 6, 1998, the Company had purchased since inception in excess of
$286 million of single-family mortgage loan pools and had committed to purchase
an additional $153 million of single-family mortgage loan pools.
In addition, HCP has a due diligence and underwriting staff, located in
Edison, New Jersey, consisting of approximately seven full-time employees. The
due diligence staff contributes to the single-family mortgage loan acquisition
process by providing expertise in the analysis of many characteristics of the
single-family mortgage loans. It has been Management's experience that buyers
generally discount the price of a single-family mortgage loan if there is a lack
of information. By having additional information on loan pools through its due
diligence operations, the Company is better able to assess the value of loan
pools.
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Because mortgage loan pools can be purchased from virtually any bank,
insurance company or financial institution, the Company is not dependent upon
any one source. At December 31, 1997, the Company had purchased approximately
29% of the Company's single-family mortgage loan portfolio from one source.
Management does not believe this concentration of purchases is indicative of
future trends. The Company does not service its single-family mortgage loans.
The servicing is outsourced to unrelated third parties specializing in loan
servicing.
The Company purchases ARM securities from broker-dealers and financial
institutions that regularly make markets in these securities. The Company can
also purchase mortgage-backed securities from other mortgage suppliers,
including mortgage bankers, banks, savings and loans, investment banking firms,
home builders and other firms involved in originating, packaging and selling
mortgage loans.
The mortgage loans and to a lesser extent the mortgage securities held in
the Investment Portfolio generally will be held on a long-term basis, so that
the returns will be earned over the lives of the mortgage loans and mortgage
securities rather than from sales of the investments.
Single-family mortgage loan pools are usually acquired through competitive
bids or negotiated transactions. The competition for larger single-family
mortgage loan portfolios is generally more intense, while there is less
competition for smaller single-family mortgage loan portfolios. Management
believes that the Company's funding flexibility, personnel, proprietary due
diligence software and single-family mortgage loan trading relationships provide
it with certain advantages over competitors in pricing and purchasing certain
single-family mortgage loan portfolios.
Prior to making an offer to purchase a single-family mortgage loan
portfolio, HCP employees conduct an extensive investigation and evaluation of
the loans in the portfolio. This examination typically consists of analyzing the
information made available by the portfolio seller (generally, an outline of the
portfolio with the credit and collateral files for each loan in the pool),
reviewing other relevant material that may be available, analyzing the
underlying collateral (including reviewing the Company's single-family mortgage
loan database which contains, among other things, listings of property values
and loan loss experience in local markets for similar assets), and obtaining
opinions of value from third parties (and, in some cases, conducting site
inspections). The Company's senior management determines the amount to be
offered for the portfolio using a proprietary stratification and pricing system
which focuses on, among other things, rate, term, location and types of the
loans. The Company also reviews information on the local economy and real estate
markets (including the amount of time and procedures legally required to
foreclose on real property) where the loan collateral is located.
In conducting due diligence operations, HCP often discovers non-conforming
elements of single-family mortgage loans, such as: (i) problems with documents,
including missing or lost documentation, errors on documents, nonstandard forms
of documents and inconsistent dates between documents, (ii) problems with the
real estate, including inadequate initial appraisals, deterioration in property
values or economic decline in the general geographic area, and (iii)
miscellaneous problems, including poor servicing, poor credit history of the
borrower, poor payment history by the borrower and current delinquency status.
The price paid for such loans is adjusted to compensate for these non-conforming
elements.
The Company maintains a process to improve the value of its single-family
mortgage loan portfolio, including updating data, obtaining lost note affidavits
in the event that a note has been misplaced, updating property values with new
appraisals, assembling historical records, obtaining mortgage insurance if the
value of a loan is in question, grouping similar loans in
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packages for securitization, and segmenting portfolios for different buyers.
However, Management believes any value created will be extracted by financing or
securitizing the single-family mortgage loans and then realizing the enhanced
spread on the retained pool, as opposed to recognizing a gain upon sale of the
single-family mortgage loan portfolio.
Single-Family Market Trends. The Company focuses on subprime mortgage loans
which are generally available in bulk from loan originators such as mortgage
bankers, banks and thrifts that originate primarily for sale and from mortgage
portfolio holders as they restructure their holdings.
Single-Family Acquisition Strategy. The Company believes that it can
continue to acquire single-family mortgage loans that have a relatively high
yield when compared to the applicable risk of loss. In many cases, portions of a
pool may be made eligible for inclusion in agency pools, which will raise the
credit level of the Investment Portfolio, while preserving the higher yield
obtained at the time of purchase. In addition, the Company may securitize a
single-family mortgage loan pool. In structuring a securitization, the Company
retains subordinated or other interests.
Single-Family Underwriting Guidelines. The Company has developed an
underwriting approval policy to maintain uniform control over the quality of the
single-family mortgage loans it purchases. This policy sets forth a three step
review process: (i) collateral valuation, (ii) credit review, and (iii) property
valuation. Prior to pricing a bid or final purchase of a portfolio, a senior
manager of the Company reviews the results of all three underwriting
evaluations. The collateral valuation entails a check on the collateral
documents (i.e., the note, mortgage, title policy and assignment chain). The
documents are examined for conformity among the documents and adherence to
secondary market standards. The credit review involves an analysis of the credit
of the borrower, including an examination of the origination and credit
documents, credit report and payment history. For more seasoned single-family
mortgage loans, the analysis may be more directed at payment histories and
credit scores. The property valuation involves an analysis of the loan-to-value
of the collateral, including an examination of the original appraisal in the
context of the current regional property market conditions and often a drive-by
valuation of the subject property and review of recent comparable sales.
Single-Family Servicing. Pools of single-family mortgage loans are
purchased with servicing retained or released by the seller. In the case of
pools purchased with servicing retained by the seller, the Company considers the
reputation and the servicing capabilities of the servicer. In some instances,
the Company requires a master servicer to provide the assurance of quality
required. A master servicer provides oversight of its subservicers and stands
ready, and is contractually obligated, to take over the servicing if there is a
problem with the subservicer. In the case of pools purchased with servicing
released, the Company places the servicing with a qualified servicer. In some
cases, the Company may retain the servicing and contract with a qualified
servicer to provide subservicing. In this case, the Company keeps the risk of
ownership of the servicing with respect to any change in value as a result of
prepayment of the underlying single-family mortgage loans or other factors. No
single-family mortgage loans are currently serviced by the Company.
Commercial Mortgage Loans and Multifamily Mortgage Loans
The Company's affiliate HCMC was one of the first commercial mortgage
banking operations to originate multifamily mortgage loans for sale to conduits.
From direct borrower originations and its network of third party brokers, it can
provide multifamily mortgage loans and commercial mortgage loans of sufficient
credit quality to meet the requirements for securitization, as well as sales to
third party investors and purchases by the Company for the
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Investment Portfolio. Due to low interest spreads, no multifamily mortgage loans
or commercial mortgage loans were purchased by the Company in 1997. However, in
the future, the Company may originate multifamily mortgage loans and commercial
mortgage loans, including mortgage loans secured by income-producing commercial
properties such as office, retail, warehouse and mini-storage facilities,
through HCMC and subsequently either sell the mortgage loans to investors or
hold them in the Investment Portfolio. Management of the Company believes that
the Company has certain competitive advantages in the commercial mortgage market
due to the speed, consistency and flexibility with which it can act as a
vertically integrated company (acting as originator, servicer, and owner of
commercial mortgage loans).
Commercial Production Process. The commercial process differs from the
single-family mortgage loan acquisition process because HCMC operates as a
direct originator of loans. HCMC has been engaged in this process since 1992 and
has been an active supplier to the Wall Street conduit/securitization firms,
which are Wall Street dealer firms that have set up a conduit to purchase
multifamily mortgage loans and commercial mortgage loans from national brokers
and mortgage bankers for the purpose of issuing commercial mortgage-backed
securities. HCMC has the ability to source new commercial mortgage loans
directly and through brokers, to process and underwrite the loans to the
Company's standards and to service the loans.
Commercial and Multifamily Loan Acquisition/Production Strategies. The
Company adheres to specified underwriting and due diligence requirements for the
origination of multifamily and commercial mortgage loans, such that they will
qualify for sale to third party conduits or for inclusion in securitizations.
The Company continually monitors the underwriting criteria by contacting rating
agencies and the third party conduit purchasers. In addition to the underwriting
and due diligence completed at the origination level, a separate credit
committee approves all multifamily mortgage loans and commercial mortgage loans
purchased for the Investment Portfolio. The Company intends that, with prudent
underwriting and due diligence, combined with the securitization option, it will
achieve a satisfactory reward/risk ratio; however, there are no assurances that
it will be able to do so.
HCMC originates new multifamily and commercial mortgage loans through
originators that call on brokers, real estate developers and owners. While the
Company's sales force concentrates primarily on sourcing pools of single-family
mortgage loans, it also can find leads for the multifamily and commercial
mortgage loan origination business of HCMC and the due diligence operations of
HCP.
Commercial and Multifamily Underwriting Guidelines. The Company's
underwriting guidelines for commercial and multifamily mortgage loans focus on
the origination of loans eligible for securitization. The due diligence process
focuses on four main areas: (i) a property level review, (ii) borrower credit
issues, (iii) cash flow structures, and (iv) adequacy of legal documentation.
The property level review begins with a review of the on-site inspection report
and includes an analysis of the third party reports, including the appraisal,
engineering report and environmental report. The borrower credit issues include
an analysis of the borrower's legal structure, a review of financial statements,
past credit history of principals, management's ability and experience and
prior/existing relationships. The cash flow structures include an analysis of
the loan-to-value ratio, the expense ratio, the debt service coverage, the value
per unit, the occupancy levels and the historical expense records. The legal
documentation review includes a review of any changes to the approved program
loan documents, including the note, mortgage, reserve agreements, assignments of
leases and any borrower certifications. The program loan documents will be
structured in order to meet the requirements of securitization with respect to
such matters as prepayment penalties, recourse carve-outs and the overall
soundness of the documents. In addition, the Company obtains a "Phase I"
environmental site assessment (i.e.,
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generally a record search with no invasive testing) of the property that will
secure a commercial or multifamily mortgage loan. Depending on the results of
the Phase I assessment, the Company may require a Phase II assessment. The
Company's loan servicing guidelines require that the Company obtain a Phase I
assessment (which includes invasive testing) of any mortgaged property prior to
the Company acquiring title to or assuming operation of the mortgaged property.
This requirement effectively precludes the Company from enforcing the rights
under the mortgage loan until a satisfactory Phase I environmental site
assessment is obtained or until any required remedial action is thereafter
taken, but also decreases the likelihood that the Company will become liable for
any material environmental condition at a mortgaged property.
Commercial and Multifamily Mortgage Loan Servicing. To control the credit
risk of retained interests in securitized loans, HCMC will retain the servicing
rights on any commercial mortgage loans and multifamily mortgage loans held in
the Investment Portfolio. HCMC may also retain the servicing rights on loans
originated and sold to third party conduits. HCMC, as servicer, will have the
risks associated with operating a mortgage servicing business as well as the
risk of ownership of the servicing.
At December 31, 1997, HCMC serviced approximately $121 million of
multifamily mortgage loans. The servicing of mortgage loans involves processing
and administering the mortgage loan payments for a fee. It involves collecting
mortgage payments on behalf of investors, reporting information to investors and
maintaining escrow accounts for the payment of principal and interest to
investors and property taxes and insurance premiums on behalf of borrowers.
The primary risk of operating a servicing business is failing to service
the loans in accordance with the servicing contracts, which exposes the servicer
to liability for possible losses suffered by the owner of the loans. The
operational requirements include proper handling and accounting for all payment
and escrow amounts, proper borrower and periodic credit reviews, proper value
and property reviews and proper payment of all monies due to third parties, such
as real estate taxing authorities and insurance companies.
The primary risks of ownership of servicing rights include the loss of
value through faster than anticipated loan prepayments (even though there may be
prepayment penalties) or improper servicing as outlined above.
Commercial Market Trends. The market for commercial and multifamily
mortgage loans has undergone dramatic changes in recent years with the advent of
securitizations. Financing of income-producing property has evolved from a
traditional two-party lending relationship, with the borrower obtaining funding
from a traditional lending institution, to a market in which lenders with
expertise in the creation of mortgage-backed securities offer borrowers an
alternative source of competitive financing. Securitization involves multiple
parties, each with specialized roles and responsibilities creating profitable
lending opportunities for those with experience in commercial mortgage finance
and the capital markets. Securitizations of commercial and multifamily mortgage
loans have grown rapidly during the 1990s.
The growth in securitization has been the result of two market forces.
First, during the recession of the early 1990s, traditional lenders withdrew
from the real estate credit market. Securitization filled the resulting void.
Second, Congress established the Resolution Trust Corporation ("RTC") in 1989 in
order to liquidate the commercial and single-family mortgage assets of failed
financial institutions. After unsuccessfully trying to sell the mortgages, the
RTC began securitizing commercial mortgages. The RTC's enormous securitization
program stimulated the growth of the private sector securitization market by
providing experience and knowledge to participants such as investment bankers,
rating agencies, mortgage companies,
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attorneys, accountants and loan servicers. These participants have applied the
experience and knowledge gained in the securitization of RTC assets to the
securitization of non-governmental, private-label securities. The RTC's program
also helped create an informed and active investor base for the securities
created from the securitization of commercial mortgage assets.
The Company believes that success in the commercial market depends on a
vertically integrated strategy, which includes origination of commercial and
multifamily mortgage loans, servicing, securitization and investment in the
residual security after securitization. The Company is structured to take
advantage of efficiencies in the vertically integrated strategy, which it
anticipates will result in attractive returns to equity. However, there can be
no assurance that such returns will be achieved.
ACCUMULATION PERIOD ACQUISITIONS
The Company initially allocated a majority of the net proceeds of its
initial public offering to build a portfolio of mortgage assets, primarily
composed of adjustable rate mortgage pass-through securities of high investment
quality to provide income during the time required to acquire mortgage loans.
The Company acquires mortgage loans in the secondary mortgage market as
soon as attractive opportunities are identified. Management anticipates that
the Company will earn an acceptable level of return on the initial portfolio
until the net proceeds from the initial public offering can be fully invested in
higher yielding mortgage assets. A similar portfolio acquisition strategy will
be employed whenever the Company obtains new financing or capital.
At December 31, 1997, the Company had invested $348,131,000 or 67.3% of the
Company's total assets in the following types of mortgage securities in
accordance with the operating policies established by the Board of Directors.
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FEDERAL NATIONAL MORTGAGE ASSOCIATION (FNMA) SECURITIES
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Par value at purchase date $200,524,000
December 31, 1997 adjusted principal $200,524,000
Amortized cost basis $207,898,000
Market value $207,397,000
Weighted average net coupon 7.761%
Weighted average maturity
(in months) 291
FEDERAL HOME LOAN MORTGAGE BANK (FHLMC) SECURITIES
Par value at purchase date $136,237,000
December 31, 1997 adjusted principal $136,237,000
Amortized cost basis $141,075,000
Market value $140,734,000
Weighted average net coupon 7.891%
Weighted average maturity
(in months) 305
</TABLE>
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DUE DILIGENCE OPERATIONS
The Company conducts due diligence operations through HCP for commercial
banks, government agencies, mortgage banks, credit unions and insurance
companies. The operations consist of the underwriting of credit, analysis of
loan documentation and collateral, and analysis of the accuracy of the
accounting for mortgage loan servicing by third party servicers. The due
diligence analyses are performed on a loan by loan basis. Audits of the accuracy
of the interest charged on adjustable rate mortgage loans are frequently a part
of the due diligence services provided to customers. HCP performs due diligence
on mortgage loans acquired by the Company and by unrelated third parties.
FINANCING
General
The Company's purchases of mortgage assets are initially financed primarily
with equity and short-term borrowings through reverse repurchase agreements
until long-term financing is arranged or the assets are securitized. Generally,
upon repayment of each borrowing in the form of a reverse repurchase agreement,
the mortgage asset used to collateralize the financing will immediately be
pledged to secure a new reverse repurchase agreement or long term financing. The
Company had established mortgage asset financing agreements with various
financial institutions at December 31, 1997 and is currently negotiating a
back-up line of credit agreement with several major financial institutions.
Reverse Repurchase Agreements
A reverse repurchase agreement, although structured as a sale and
repurchase obligation, is a financing transaction in which the Company pledges
its mortgage assets as collateral to secure a short-term loan. Generally, the
other party to the agreement will loan an amount equal to a percentage of the
market value of the pledged collateral, typically 80% to 98%. At the maturity of
the reverse repurchase agreement, the Company is required to repay the loan and
correspondingly receives back its collateral. Under reverse repurchase
agreements, the Company generally retains the incidents of beneficial ownership,
including the right to distributions on the collateral and the right to vote on
matters as to which certificate holders vote. If the Company defaults in a
payment obligation under such agreements, the lending party may liquidate the
collateral.
In the event of the insolvency or bankruptcy of the Company, certain
reverse repurchase agreements may qualify for special treatment under the United
States Bankruptcy Code, which permits the creditor to avoid the automatic stay
provisions of the Bankruptcy Code and to foreclose on the collateral without
delay. In the event of the insolvency or bankruptcy of a lender during the term
of a reverse repurchase agreement, the lender may be permitted, under the
Bankruptcy Code, to repudiate the contract, and the Company's claim against the
lender for damages therefrom may be treated simply as that of an unsecured
creditor. In addition, if the lender is a broker or dealer subject to the
Securities Investor Protection Act of 1970 or an insured depository institution
subject to the Federal Deposit Insurance Act, the Company's ability to exercise
its rights to recover its mortgage assets under a reverse repurchase agreement
or to be compensated for damages resulting from the lender's insolvency may be
limited by those laws. The effect of these various statutes is, among other
things, that a bankrupt lender, or its conservator or receiver, may be permitted
to repudiate or disaffirm its reverse repurchase agreements, and the Company's
claims against the bankrupt lender may be treated as an unsecured claim. Should
this occur, the Company's claims would be subject to significant delay
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and, if and when paid, could be in an amount substantially less than the damages
actually suffered by the Company.
To reduce its exposure to the credit risk of reverse repurchase agreements,
the Company enters into the arrangements with several different parties. The
Company monitors the financial condition of its reverse repurchase agreement
lenders on a regular basis, including the percentage of its mortgage loans that
are the subject of reverse repurchase agreements with a single lender.
Notwithstanding these measures, no assurance can be given that the Company will
be able to avoid such third party risks.
The reverse repurchase borrowings bear short-term fixed (one year or less)
interest rates varying from LIBOR to LIBOR plus 125 basis points depending on
the credit of the related mortgage assets. Generally, the borrowing agreements
require the Company to deposit additional collateral in the event the market
value of existing collateral declines, which, in dramatically rising
interest-rate markets, could require the Company to sell assets to reduce the
borrowings.
SECURITIZATION AND SALE PROCESS
General
When the Company acquires a sufficient volume of mortgage loans with
similar characteristics, generally $50 million to $100 million or more, the
Company plans to securitize them through the issuance of mortgage-backed
securities in the form of REMICs or CMOs. Alternatively, to a lesser extent and
to the extent consistent with the Company's qualification as a REIT, the Company
may resell loans in bulk whole loan sales. The length of time from when the
Company commits to purchase a mortgage loan to when it sells or securitizes the
loan will generally range from 30 days to one year or more, depending on certain
factors, including the length of the purchase commitment period, the amount and
type of the mortgage loan, and the securitization process. Any decision by the
Company to issue CMOs or REMICs or to sell mortgage loans in bulk will be
influenced by a variety of factors.
For accounting and tax purposes, mortgage loans financed through the
issuance of CMOs are treated as assets of the Company, and the CMOs are treated
as debt of the Company. The Company earns the net interest spread between the
interest income on the mortgage loans and the interest and other expenses
associated with the CMO financing. The net interest spread will be directly
affected by prepayments of the underlying mortgage loans and, to the extent the
CMOs have variable interest, may be affected by changes in short-term
interest-rates.
As an alternative to CMOs, the Company may issue REMICs. REMIC transactions
are generally accounted for as sales of the mortgage loans. REMIC securities
consist of one or more classes of "regular interests" and a single "residual
interest." The regular interests are tailored to the needs of investors and may
be issued in multiple classes with varying maturities, average lives and
interest-rates. These regular interests are predominantly senior securities but,
in conjunction with providing credit enhancement, may be subordinated to the
rights of other regular interests. The residual interest represents the
remainder of the cash flows from the underlying mortgage loans over the amounts
required to be distributed on the regular interests. In some cases, the regular
interests may be structured so that there is no significant residual cash flow.
In such a REMIC transaction, the Company sells its entire interest in the
mortgage loans, and all of the capital originally invested in the mortgage loans
may be redeployed. The
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Company may retain regular and residual interests on a short-term or long-term
basis. Income from REMIC issuances is not treated as REIT qualifying income.
Accordingly, REMIC issuances are not the Company's primary securitization
technique and will generally be undertaken through the taxable subsidiaries.
The Company expects that its retained interests in securitizations will be
subordinated to the securities issued to third party investors with respect to
losses of principal and interest on the underlying mortgage loans. Accordingly,
any such losses on underlying mortgage loans will be applied first to reduce the
remaining amount of the Company's retained interest, until reduced to zero. Any
retained regular interest may include "principal only" or "interest only"
securities or other interest rate or prepayment sensitive securities or
investments. Any retained securities may subject the Company to credit, interest
rate and/or prepayment risks. The Company anticipates it will retain securities
only on terms which it believes are sufficiently attractive to compensate it for
assuming the associated risks.
The Company may also retain subordinated mortgage backed securities, with
ratings ranging from AA to unrated, generally fixed-rate. The fixed-rate
securities generally evidence interests in 30-year single-family mortgage loans.
Securities backed by multifamily mortgage loans and commercial loans are
generally interests in 7 or 10 year balloon loans with 25 or 30 year
amortization schedules. In general, subordinated classes bear all losses prior
to the related senior classes. Losses in excess of losses anticipated at the
time subordinated securities are purchased would adversely affect the Company's
yield on the securities and, in extreme circumstances, could result in the
failure of the Company to recoup its initial investment.
Except in the case of breach of the representations and warranties made by
the Company when mortgage loans are securitized, the securitization of mortgage
loans will be non-recourse to the Company. As a result, the Company is able to
maintain the economic benefit of financing the mortgage assets and earning a
positive net interest spread, while limiting its potential risk of credit loss
to its investment in the subordinated or residual securities (generally
approximately 5% to 10% of the loan pool amount). A second advantage to the CMO
structure is that it is permanent financing and, therefore not subject to
margin calls during periods in which the value of the pool assets are declining
due to increases in interest rates.
The Company typically pays a monoline bond insurer a monthly fee to assume
a portion of the credit risk in a pool of mortgage loans. The monoline insurer
would generally require the issuer to retain a portion of the credit risk and
over-collateralize a particular pool of mortgage loans.
Proceeds from securitizations will be available to support new loan
originations and acquisitions. In addition to providing relatively less
expensive long-term financing, Management believes that the Company's
securitizations will reduce the Company's interest-rate risk on mortgage assets
held for long-term investment.
Credit Enhancement
REMICs or CMOs created by the Company are structured so that one or more of
the classes of the securities are rated investment grade by at least one
nationally recognized rating agency. The ratings for the Company's mortgage
assets will be based on the rating agency's view of the perceived credit risk of
the underlying mortgage loans, the structure of the mortgage assets and
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the associated level of credit enhancement. Credit enhancement is designed to
provide protection to the holders of the securities in the event of borrower
defaults and other losses including reductions in the principal or interest as
required by law or a bankruptcy court. The Company can utilize multiple forms of
credit enhancement, including special hazard insurance, monoline insurance,
reserve funds, letters of credit, surety bonds and subordination or any
combination thereof. A decline in the credit quality of the mortgage loans
backing any mortgage securities or of any third party providing credit
enhancement, or adverse developments in general economic trends affecting real
estate values or the mortgage industry, could result in ratings being
downgraded.
In determining whether to provide credit enhancement, the Company takes
into consideration the costs associated with each method. The Company generally
provides credit enhancement through the issuance of mortgage-backed securities
in senior/subordinated structures or by over-collaterization of its mortgage
assets. The need for additional collateral or other credit enhancements will
depend upon factors such as the type of collateral provided and the
interest-rates paid thereon, the geographic concentration of the mortgaged
property and other criteria established by the rating agency. The pledge of
additional collateral would reduce the capacity of the Company to raise
additional funds through short-term secured borrowings or additional CMOs and
will diminish the potential expansion of the Investment Portfolio. Accordingly,
collateral would be pledged for CMOs only in the amount required to obtain the
highest rating category of a nationally-recognized rating agency. The
subordinated mortgage securities may be sold, retained by the Company or
accumulated for sale in subsequent transactions.
Other Mortgage-Backed Securities
As an additional alternative for the financing of the Investment Portfolio,
the Company may cause to be issued other mortgage-backed securities if the
issuance of such other securities is advantageous and consistent with the
Company's qualification as a REIT. In particular, mortgage pass-through
certificates representing undivided interests in pools of mortgage loans formed
by the Company may prove to be attractive vehicles for raising funds.
The holders of mortgage pass-through certificates receive their pro rata
share of the principal payments made on a pool of mortgage loans and interest at
a pass-through interest rate that is fixed at the time of the offering. The
Company intends to retain significant portions of the undivided interests in the
mortgage loans underlying pass-through certificates. The retained interest may
also be subordinated so that, in the event of a loss, payments to certificate
holders will be made before the Company receives its payments. Unlike the
issuance of CMOs, the issuance of mortgage pass-through certificates will not
create an obligation of the Company to security holders in the event of a
borrower default. However, as in the case of CMOs, the Company may be required
to obtain credit enhancement in order to obtain a rating for the mortgage
pass-through certificates in one of the top two rating categories established of
a nationally-recognized rating agency.
Capital Allocation Guidelines (CAG)
The Company has adopted capital allocation guidelines ("CAG") in order to
strike a balance between the under-utilization of leverage and excess dependence
on leverage, which could reduce the Company's ability to meet its obligations
during adverse market conditions. Modifications to the CAG require the approval
of a majority of the Company's Board of
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Directors. The CAG are intended to keep the Company's leverage balanced by (i)
matching the amount of leverage to the riskiness (return and liquidity) of each
mortgage asset, and (ii) monitoring the credit and prepayment performance of
each mortgage asset to adjust the required capital. This analysis takes into
account the Company's various hedging and other risk containment programs
discussed below. In this way, the use of balance sheet leverage is optimized
through the implementation of the CAG controls. The lender haircut indicates the
minimum amount of equity the lender requires with a mortgage asset. There is
some variation in haircut levels among lenders from time to time. From the
lender's perspective, the haircut is a "cushion" to protect capital in case the
borrower is unable to meet a margin call. The size of the haircut depends on the
liquidity and price volatility of each mortgage asset. Agency securities are
very liquid, with price volatility in line with the fixed income markets which
means a lender requires a smaller haircut, typically 3%. On the other extreme,
"B" rated securities and securities not registered with the Securities and
Exchange Commission are substantially less liquid, and have more price
volatility than agency securities, which results in a lender requiring a larger
haircut. Particular securities that are performing below expectations would also
typically require a larger haircut. The haircut for residential whole loan pools
will generally range between 3% and 5% depending on the documentation and
delinquency characteristics of the pool. Certain whole loan pools may have
haircuts which may be negotiated with lenders in excess of 5% due to other
attributes of the pool.
Implementation of the CAG -- Mark to Market Accounting
Each quarter, for financial management purposes, the Company marks its
mortgage assets to market. This process consists of (i) valuing the Company's
mortgage assets acquired in the secondary market, and (ii) valuing the Company's
non-security investments, such as retained interests in securitizations. For the
purchased mortgage assets, the Company obtains benchmark market quotes from
traders who make markets in securities similar in nature to the mortgage assets.
The Company then adjusts for the difference in pricing between securities and
whole loan pools. Market values for the Company's retained interests in
securitizations are calculated internally using market assumptions for losses,
prepayments and discount rates.
The face amount of the financing used for the securities and retained
interests is subtracted from the current market value of the mortgage assets
(and hedges). This is the current market value of the Company's equity
positions. This value is compared to the required capital as determined by the
CAG. If the actual equity of the Company falls below the capital required by the
CAG, the Company must prepare a plan to bring the actual capital above the level
required by the CAG.
Periodically, Management presents to the Board of Directors the results of
the CAG compared to actual equity. Management may propose changing the capital
required for a class of investments or for an individual investment based on its
prepayment and credit performance relative to the market and the ability of the
Company to predict or hedge the risk of the mortgage asset.
As a result of these procedures, the leverage of the balance sheet will
change with the performance of the Company's mortgage assets. Good credit or
prepayment performance may release equity for purchase of additional mortgage
assets, leading to increased earnings. Poor credit or prepayment performance may
cause additional equity to be allocated to existing investments, forcing a
reduction in mortgage assets on the balance sheet and lower future earnings. In
either case, the constant mortgage asset performance evaluation, along with the
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corresponding leverage adjustments, helps to maintain the maximum acceptable
leverage (and earnings) while protecting the capital base of the Company.
RISK MANAGEMENT
The Company believes that its portfolio income is subject to three primary
risks: credit risk, interest rate risk and prepayment risk.
Credit Risk Management
The Company reduces credit risk through (i) the review of each mortgage
loan prior to purchase to ensure that it meets the guidelines established by the
Company, (ii) use of early intervention, aggressive collection and loss
mitigation techniques in the servicing process, (iii) use of insurance in the
securitization process, (iv) maintenance of appropriate capital and reserve
levels, and (v) obtaining representations and warranties, to the extent
possible, from originators. Although the Company does not set specific
geographic diversification requirements, the Company closely monitors the
geographic dispersion of the mortgage loans and makes decisions on a portfolio
by portfolio basis about adding to specific concentrations.
Commercial mortgage loans held by the Company generally are originated by
HCMC to underwriting standards established by the Company. These underwriting
standards reflect the experience of HCMC in its past originations as well as the
requirements of the rating agencies for commercial mortgage loans. The credit
underwriting includes a financial and credit check of the borrower, technical
reports including appraisal, engineering and environmental reports, as well as a
review of the economic status of the geographic area where the mortgaged
property is located. In addition, a separate credit sign-off is required before
commercial mortgage loans are transferred to the Investment Portfolio from HCMC.
The commercial mortgage loans in the Investment Portfolio will be monitored by
the servicing department of HCMC, which includes a periodic review of financial
statements of the mortgaged property as well as property inspections.
Single-family mortgage loans are generally purchased in bulk pools of $2
million to $100 million. The credit underwriting process varies depending on the
pool characteristics, including seasoning, loan-to-value ratios and payment
histories. For a new pool of single-family mortgage loans, a full due diligence
review is undertaken, including a review of the documentation, appraisal reports
and credit underwriting. Where required, an updated property valuation is
obtained. The bulk of the work is performed by employees in the due diligence
operations of HCP.
Interest Rate Risk Management
There are two basic types of mortgage loans held by the Company: mortgage
loans held for securitization or sale and mortgage loans held in securitized
form. Mortgage loans held for securitization or sale are generally hedged. A
variety of hedging instruments may be used, depending on the asset to be hedged
and the relative price of the various hedging instruments. Hedging instruments
include forward sales of mortgage securities, and may also include interest rate
futures or options, interest rate swaps, and cap and floor agreements. Mortgage
loans held in securitized form are generally financed in a manner designed to
maintain a consistent spread in a variety of interest rate environments and
therefore do not require any hedging.
The Company may purchase interest rate caps, interest rate swaps and
similar instruments to attempt to mitigate the risk of the cost of its variable
rate liabilities increasing at a faster rate than the earnings on its mortgage
assets during a period of rising interest rates. The Company
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generally hedges as much of the interest rate risk as management determines is
reasonable, given the cost of such hedging transactions and the need to maintain
the Company's status as a REIT, among other factors. The Company may also, to
the extent consistent with its qualification as a REIT and Maryland law, utilize
financial futures contracts, options and forward contracts and other instruments
as a hedge against future interest rate changes. See "Business - Hedging."
Prepayment Risk Management
With respect to commercial and multifamily mortgage loans, the Company will
seek to minimize the effects of faster or slower than anticipated prepayment
rates by originating mortgage loans with prepayment penalties and utilizing
various financial hedging instruments. With respect to single-family mortgage
loans, the Company utilizes various financial instruments as a hedge against
prepayment risk. Prepayment risk is monitored by senior management and through
periodic review of the impact of a variety of prepayment scenarios on the
Company's revenues, net earnings, dividends, cash flow and net balance sheet
market value.
Although the Company believes it has developed a cost-effective
asset/liability management program to provide a level of protection against
interest rate and prepayment risks, no strategy can completely insulate the
Company from the effects of interest rate changes, prepayments and defaults by
counterparties. Further, certain of the Federal income tax requirements that the
Company must satisfy to qualify as a REIT limit the Company's ability to fully
hedge its interest rate and prepayment risks.
HEDGING
Investment Portfolio
The Company's primary method of addressing interest rate risk on its
mortgage assets is through its strategy of securitizing mortgage loans with
collateralized mortgage obligation ("CMO") borrowings, which are designed to
provide long term financing while maintaining a consistent spread in a variety
of interest-rate environments. The Company believes that its primary interest
rate risk relates to mortgage assets that are financed with reverse repurchase
agreements and are held for securitization.
The Company uses certain hedging strategies in connection with the
management of the Investment Portfolio. To the extent consistent with the
Company's REIT status, the Company follows a hedging program intended to protect
against interest rate changes and to enable the Company to earn net interest
income in periods of generally rising, as well as declining or static, interest
rates. Specifically, the goal of the hedging program is to offset the potential
adverse effects of changes in interest rates relative to the interest rates of
the mortgage assets held in the Investment Portfolio. As part of its hedging
program, the Company also monitors prepayment risks that arise in fluctuating
interest rate environments.
The Company may use a variety of instruments in its hedging program. One
example is an interest rate cap. In a typical interest rate cap agreement, the
cap purchaser makes an initial lump sum cash payment to the cap seller in
exchange for the seller's promise to make cash payments to the purchaser on
fixed dates during the contract term if prevailing interest rates exceed the
rate specified in the contract. The Company may also purchase mortgage
derivative securities. Mortgage derivative securities can be effective hedging
instruments in certain situations as the value and yields of some of these
instruments tend to increase as interest rates rise and to decrease as interest
rates decline, while the experience for others is the converse. The
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Company will limit its purchases of mortgage derivative securities to
investments that must meet REIT requirements. To a lesser extent, the Company
may also enter into interest rate swap agreements, financial futures contracts
and options on financial futures contracts, and forward contracts. However, the
Company will not invest in these instruments unless the Company is exempt from
the registration requirements of the Commodity Exchange Act or otherwise
complies with the provisions of that Act. The REIT rules may restrict the
Company's ability to purchase certain instruments and may restrict the Company's
ability to employ other strategies. In all its hedging transactions, the Company
deals only with counterparties that the Company believes are sound credit risks.
In connection with securitizations of mortgage loans, the Company is
subject to the risk of rising mortgage interest rates between the time it
commits to a fixed price purchase and the time it sells or securitizes the
mortgage loans. To mitigate this risk, the Company may utilize hedging
strategies, including mandatory and optional forward selling of mortgage loans
or mortgage-backed securities, interest rate caps and floors, and buying and
selling of futures and options on futures. The nature and quantity of these
hedging transactions is determined by the management of the Company based on
various factors, including market conditions and expected volume of mortgage
loan purchases.
Costs and Limitations
The Company believes that it has implemented a cost-effective hedging
policy to provide an adequate level of protection against interest-rate risks.
However, maintaining an effective hedging strategy is complex, and no hedging
strategy can completely insulate the Company from interest-rate risks. Moreover,
as noted above, certain of the REIT rules limit the Company's ability to fully
hedge its interest rate risks. The Company monitors carefully, and may have to
limit, its hedging strategies to assure that it does not violate the REIT rules,
which could result in disqualification and/or payment of penalties.
In addition, hedging involves transaction and other costs, which can
increase dramatically as the period covered by the hedge increases and also
increase in periods of rising and fluctuating interest-rates. Therefore, the
Company may be prevented from effectively hedging its interest-rate risks
without significantly reducing the Company's return on equity.
SERVICING RIGHTS
Whether servicing is purchased (along with purchased single-family mortgage
loans) or created (by the origination of multifamily mortgage loans and
commercial mortgage loans), a value is placed on the servicing as a purchased
mortgage servicing right ("PMSR") or an originated mortgage servicing right
("OMSR"), as the case may be, and recorded as an asset on the books of the
Company.
The valuation of a PMSR and an OMSR includes an analysis of the
characteristics of the size, rate, escrow amounts, type, maturity, etc. of the
loan, as well as an estimate of the mortgage loan's remaining life. To the
extent the characteristics change or the estimate of remaining life changes, the
value of the PMSR or OMSR will be adjusted. For example, if mortgage loans are
repaid more quickly than originally forecasted (increased speed), the value of
the OMSR or PMSR will be reduced.
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REGULATION
There are various state and local laws and regulations affecting the
Investment Portfolio. HCMC has mortgage-banking licenses in Arizona, Illinois,
New Jersey, Vermont and Wisconsin. In addition, the Company's activities are
subject to the rules and regulations of HUD. Mortgage operations also may be
subject to applicable state usury and collection statutes. The Company believes
that it is currently in compliance with all material rules and regulations to
which it is subject and has all required licenses.
COMPETITION
The Company participates on a national level in the mortgage market, which
is estimated at $3.8 trillion for single-family mortgage loans and $1.0 trillion
for multifamily mortgage loans and commercial loans. In purchasing mortgage
loans and issuing mortgage-backed securities, the Company competes with other
REITs, established mortgage conduit programs, investment banking firms, savings
and loan associations, banks, thrift and loan associations, finance companies,
mortgage bankers, insurance companies, other lenders and other entities
purchasing mortgage assets. In addition, there are several mortgage REITs
similar to the Company and others may be organized in the future. Continued
consolidation in the mortgage banking industry may reduce the number of sellers
of mortgage loans, which would reduce the Company's potential customer base and
result in the Company purchasing a larger percentage of mortgage loans from a
smaller number of sellers. These changes could negatively impact the Company. As
an issuer of mortgage securities, the Company will face competition for
investors from other investment opportunities.
Increasingly, mortgage lending is being conducted by mortgage lenders who
specialize in the origination and servicing of mortgage loans and then sell
these loans to other mortgage investment institutions, such as the Company. The
Company believes it has a competitive advantage because of the low cost of its
operations relative to traditional mortgage investors such as banks and savings
and loans. Like traditional financial institutions, the Company seeks to
generate income for distribution to its shareholders primarily from the
difference between the interest income on its mortgage assets and the financing
costs associated with carrying the mortgage assets.
EMPLOYEES
The Company had no employees at December 31, 1997. The Principals became
employees of the Company as of January 1, 1998. The Company engages the services
of HCP to provide management expertise, product sourcing, due diligence support,
and general and administrative services to assist the Company in accomplishing
its business objectives. At December 31, 1997, HCP employed 50 people on a
full-time basis. To date, HCP believes it has been successful in its efforts to
recruit qualified employees, but there is no assurance that it will continue to
be successful in the future. None of HCP's employees are subject to collective
bargaining agreements.
SERVICE MARKS
HCP owns two service marks that have been registered with the United States
Patent and Trademark Office, each of which expires in the year 2003.
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FUTURE REVISIONS IN POLICIES AND STRATEGIES
The Board of Directors has established the Company's investment and
operating policies, which can be revised only with the approval of the Board of
Directors, including a majority of the unaffiliated directors. Except as
otherwise restricted, the Board of Directors may revise the policies without the
consent of stockholders if the Board of Directors determines that the change is
in the best interests of stockholders. Developments in the market which affect
the policies and strategies mentioned herein or which change the Company's
assessment of the market may cause the Board of Directors to revise the
Company's policies and financing strategies.
The Company has elected to qualify as a REIT for tax purposes (see "Federal
Income Tax Considerations"). The Company has adopted certain compliance
guidelines which include restrictions on the acquisition, holding and sale of
assets. Prior to the acquisition of any asset, the Company determines whether
the asset meets REIT requirements. Substantially all of the assets that the
Company has acquired and will acquire for investment are expected to qualify as
REIT assets. This requirement limits the Company's investment strategies.
The Company closely monitors its purchases of mortgage assets and the
sources of its income, including from its hedging strategies, to ensure at all
times that it maintains its qualifications as a REIT. The Company has developed
certain accounting systems and testing procedures to facilitate its ongoing
compliance with the REIT provisions of the Code. No changes in the Company's
investment policies and operating strategies, including credit criteria for
mortgage asset investments, may be made without the approval of the Company's
Board of Directors, including a majority of the unaffiliated directors.
The Company intends to conduct its business so as not to become regulated
as an investment company under the Investment Company Act of 1940. The
Investment Company Act exempts entities that are "primarily engaged in the
business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate" ("Qualifying Interests"). Under current interpretation
of the staff of the Securities and Exchange Commission, in order to qualify for
this exemption, the Company must maintain at least 55% of its assets directly in
Qualifying Interests. In addition, unless certain mortgage securities represent
all the securities issued with respect to an underlying pool of mortgages, the
securities may be treated as securities separate from the underlying mortgage
pool and, thus, may not be considered Qualifying Interests for purposes of the
55% requirement. The Company closely monitors its compliance with this
requirement and intends to maintain its exempt status. As of this date, the
Company has been able to maintain its exemption through the purchase of mortgage
loan pools and certain whole pool government agency securities that qualify for
the exemption.
RELATIONSHIPS WITH AFFILIATES AND PRIOR BUSINESS
HCP has rendered asset management services in connection with the
short-term trading of seasoned (more than one year since origination)
single-family mortgage loans since 1995. In managing mortgage activities, HCP
typically targeted mortgage loan pools containing subprime single-family
mortgage loans with deficiencies that could be corrected so as to permit resales
on favorable terms. In managing sale activities, HCP generally has pursued a
strategy of selling single-family mortgage loans within eighteen months after
their acquisition. The Company, on the other hand, generally holds mortgage
loans on a long-term basis, so that returns are earned over the lives of
mortgage loans rather than from their sales.
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In the past, HCP has engaged in single-family mortgage loan acquisition,
financing, hedging and sale activities pursuant to private management
arrangements with (i) Alpine Associates, a Limited Partnership ("Alpine
Associates"), (ii) a limited liability company formed by HCP, Alpine Associates
and an affiliate of Bankers Trust New York Corp. and (iii) certain affiliates of
Bankers Trust New York Corp. The objective in each of those arrangements was to
profit from purchasing and reselling mortgage loans rather than, as in the case
of the Company, from holding, financing and securitizing mortgage loans.
Alpine Associates and HCP formed Alpine/Hanover LLC in May of 1996, as a
successor to a partnership formed by them in February of 1994, to trade in
portfolios of subprime single-family mortgage loans. In October of 1995, HCP,
Alpine/Hanover LLC and BAHT 1995-1 Corp., an affiliate of Bankers Trust New York
Corp., formed ABH-I LLC to trade in subprime single-family mortgage loans.
Pursuant to separate asset management contracts with BT Realty Resources, Inc.,
HCP has rendered management services similar to those it has rendered for ABH-I
LLC. HCP intends to wind down and terminate Alpine/Hanover LLC and ABH-I LLC at
such time as all of the ABH-I LLC assets have been sold. As of February 28,
1998, the remaining assets of ABH-I LLC had an aggregate principal amount of
approximately $300,000. HCP intends to wind down and terminate its management
arrangement with BT Realty Resources, Inc. at such time as all of the assets
under management have been sold. As of February 28, 1998, the remaining assets
under management had an aggregate principal amount of approximately $100,000.
After the closing of the initial public offering, the Company acquired and
holds the Investment Portfolio. HCP has continued to conduct the due diligence
operations and, in addition, support the Company's acquisition and investment
activities by providing due diligence services to the Company. HCMC has
continued to originate, sell and service multifamily mortgage loans and
commercial mortgage loans and, in addition, may in the future support the
Company's acquisition and investment activities by serving as a source of
multifamily mortgage loans and commercial mortgage loans. HCS facilitates the
Company's trading activities by acting as a broker/dealer.
MANAGEMENT AGREEMENT
Effective as of January 1, 1998, the Company entered into a Management
Agreement (the "Management Agreement") with HCP. Under this agreement, HCP,
subject to the direction and control of the Company's Board of Directors,
provides certain services for the Company, including, among other things: (i)
serving as the Company's consultant with respect to formulation of investment
criteria and preparation of policy guidelines by the Board of Directors; (ii)
assisting the Company in developing criteria for the purchase of mortgage assets
that are specifically tailored to the Company's investment objectives; (iii)
representing the Company in connection with the purchase and commitment to
purchase or sell mortgage assets; (iv) arranging for the issuance of mortgage
securities from a pool of mortgage loans; (v) furnishing reports and statistical
and economic research to the Company regarding the Company's activities and the
services performed for the Company by HCP; (vi) monitoring and providing to the
Board of Directors on an ongoing basis price information and other data; (vii)
investing or reinvesting any money of the Company in accordance with its
policies and procedures and the terms and conditions of the Management
Agreement; (viii) providing the executive and administrative personnel office
space and services required in rendering such services to the Company; and (ix)
administering the day-to-day operations of the Company. For these services, the
Company pays HCP for each month an amount equal to the sum of (a)
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the wages and salaries of the personnel employed by HCP and/or its affiliates
(other than independent contractors and other third parties rendering due
diligence services in connection with the acquisition of any mortgage assets)
apportioned to the Company for such month, plus (b) twenty-five percent (25%) of
(a). The Company also is required to pay HCP for each month an amount equal to
the sum of (c) the expense of HCP for any due diligence services provided by
independent contractors and other third parties in connection with the
acquisition of any mortgage assets during such month plus (d) three percent (3%)
of (c). Any amount that may become payable by HCP to the Company for any
services provided by the Company to HCP, including the services of the
Principals, is offset against amounts payable to HCP.
Subject to other contractual limitations, the Management Agreement does not
prevent HCP from acting as an investment advisor or manager for any other
person, firm or corporation. The term of the Management Agreement continues
until December 31, 1999 and thereafter is automatically renewed for successive
one-year periods unless the Unaffiliated Directors (as defined therein) resolve
to terminate the Management Agreement.
FEDERAL INCOME TAX CONSIDERATIONS
General
The Company has elected to be treated as a REIT for tax purposes. In brief,
if certain detailed conditions imposed by the REIT provisions of the Code are
met, entities that invest primarily in real estate investments and mortgage
loans, and that otherwise would be taxed as corporations are, with certain
limited exceptions, not taxed at the corporate level on their taxable income
that is currently distributed to their shareholders. This treatment eliminates
most of the "double taxation" (at the corporate level and then again at the
shareholder level when the income is distributed) that typically results from
the use of corporate investment vehicles. In the event that the Company does not
qualify as a REIT in any year, it would be subject to federal income tax as a
domestic corporation and the amount of the Company's after-tax cash available
for distribution to its shareholders would be reduced. The Company believes it
has satisfied the requirements for qualification as a REIT since commencement of
its operations in September 1997. The Company intends at all times to continue
to comply with the requirements for qualification as a REIT under the Code, as
described below.
Requirements for Qualification as a REIT
To qualify for tax treatment as a REIT under the Code, the Company must
meet certain tests which are described briefly below.
Ownership of Common Stock
For all taxable years after its first taxable year, the Company's shares of
capital stock must be held by a minimum of 100 persons for at least 335 days of
a 12 month year (or a proportionate part of a short tax year). In addition, at
all times during the second half of each taxable year, no more than 50% in value
of the capital stock of the Company may be owned directly or indirectly by five
or fewer individuals. The Company is required to maintain records regarding the
actual and constructive ownership of its shares, and other information, and to
demand statements from persons owning above a specified level of the REITs
shares (if the Company has 200 or fewer shareholders of record, from persons
holding 0.5% or more of the Company's outstanding shares of capital stock)
regarding their ownership of shares. The Company must keep a list of those
shareholders who fail to reply to such a demand. The Company is required to use
and does use the calendar year as its taxable year for income.
20
<PAGE> 23
Nature of Assets
On the last day of each calendar quarter, the Company must satisfy three
tests relating to the nature of its assets. First, at least 75% of the value of
the Company's assets must consist of mortgage loans, certain interests in
mortgage loans, real estate, certain interests in real estate (the foregoing,
"Qualified REIT Assets"), government securities, cash and cash items. The
Company expects that substantially all of its assets will continue to be
Qualified REIT Assets. Second, not more than 25% of the Company's assets may
consist of securities that do not qualify under the 75% asset test. Third, of
the investments in securities not included in the 75% asset test, the value of
any one issuer's securities may not exceed 5% by value of the Company's total
assets, and the Company may not own more than 10% of any one issuer's
outstanding voting securities. Pursuant to its compliance guidelines, the
Company intends to monitor closely the purchase and holding of its assets in
order to comply with the above asset tests.
Sources of Income
The Company must meet the following three separate income-based tests each
year:
1. 75% INCOME TEST. At least 75% of the Company's gross income for the
taxable year must be derived from Qualified REIT Assets including interest on
obligations secured by mortgages on real property or interests in real property.
During the first year of operations certain temporary investment income also
qualify under the 75% income test. The investments that the Company has made and
will continue to make will give rise primarily to mortgage interest qualifying
under the 75% income test.
2. 95% INCOME TEST. In addition to deriving 75% of its gross income from
the sources listed above, at least an additional 20% of the Company's gross
income for the taxable year must be derived from those sources, or from
dividends, interest or gains from the sale or disposition of stock or other
securities that are not dealer property. The Company intends to limit
substantially all of the assets that it acquires to Qualified REIT Assets. The
policy of the Company to maintain REIT status may limit the types of assets,
including hedging contracts and other securities, that the Company otherwise
might acquire.
3. 30% INCOME LIMIT. Through the close of 1997, the Company must also
derive less than 30% of its gross income from the sale or other disposition of
(i) Qualified REIT Assets held for less than four years, other than foreclosure
property or property involuntarily or compulsorily converted through
destruction, condemnation or similar events, (ii) stock or securities held for
less than one year (including hedges) and (iii) property in a prohibited
transaction (generally, a sale of dealer property that is not foreclosure
property).
Distributions
The Company must distribute to its shareholders on a pro rata basis each
year an amount equal to at least (i) 95% of its taxable income before deduction
of dividends paid and excluding net capital gains, plus (ii) 95% of the excess
of the net income from foreclosure property over the tax imposed on such income
by the Code, less (iii) certain "excess noncash income". The Company intends to
make distributions to its shareholders in sufficient amounts to meet this 95%
distribution requirement.
21
<PAGE> 24
Taxation of the Company's Shareholders
For any taxable year in which the Company is treated as a REIT for federal
income purposes, amounts distributed by the Company to its shareholders out of
current or accumulated earnings and profits will be includable by the
shareholders as ordinary income for federal income tax purposes unless properly
designated by the Company as capital gain dividends. Distributions of the
Company will not be eligible for the dividends received deduction for
corporations. Shareholders may not deduct any net operating losses or capital
losses of the Company. Any loss on the sale or exchange of shares of the common
stock of the Company held by a shareholder for six months or less will be
treated as a long-term capital loss to the extent of any capital gain dividends
received on the common stock held by such shareholder.
If the Company makes distributions to its shareholders in excess of its
current and accumulated earnings and profits, those distributions will be
considered first a tax-free return of capital, reducing the tax basis of a
shareholder's shares until the tax basis is zero. Such distributions in excess
of the tax basis will be taxable as gain realized from the sale of the Company's
shares. The Company will withhold 30% of dividend distributions to shareholders
that the Company knows to be foreign persons unless the shareholder provides the
Company with a properly completed IRS form claiming a reduced withholding rate
under an applicable income tax treaty.
Under the Code, if a portion of the Company's assets were treated as a
taxable mortgage pool or if the Company were to hold REMIC residual interests, a
portion of the Company's dividends would be treated as unrelated business
taxable income ("UBTI") for pension plans and other tax exempt entities. The
Company believes that it has not engaged in activities that would cause any
portion of the Company's income to be taxable as UBTI for pension plans and
similar tax exempt shareholders. The Company believes that its shares of stock
will be treated as publicly offered securities under the plan asset rules of the
Employment Retirement Income Security Act ("ERISA") for Qualified Plans.
The provisions of the Code are highly technical and complex and are subject
to amendment and interpretation from time to time. This summary is not intended
to be a detailed discussion of all applicable provisions of the Code, the rules
and regulations promulgated thereunder, or the administrative and judicial
interpretations thereof. The Company has not obtained a ruling from the Internal
Revenue Service with respect to tax considerations relevant to its organization
or operations.
ITEM 2: PROPERTIES
The Company's operations are conducted in several leased office facilities
throughout the United States. A summary of the office leases is shown below:
<TABLE>
<CAPTION>
MINIMUM
-------
OFFICE ANNUAL EXPIRATION
SPACE ------ ----------
LOCATION (SQ.FT.) RENTAL DATE OFFICE USE
- -------- -------- ------ ---- ----------
<S> <C> <C> <C> <C>
New York, New York 2,300 $42,800 November 2001 Executive, Administration,
Investment Operations
</TABLE>
22
<PAGE> 25
<TABLE>
<S> <C> <C> <C> <C>
Edison, New Jersey 5,850 75,400 June 2002 Accounting, Administration, Due
Diligence Operations, Mortgage
Loan Servicing, Investment
Operations
Chicago, Illinois 3,900 58,900 June 1999 Due Diligence Operations,
Investment Operations
St., Louis, Missouri 1,007 26,800 August 1998 Mortgage Origination Operations
Rockland, Massachusetts 300 6,000 Month to Month Investment Operations
Sacramento, California 150 7,400 Month to Month Due Diligence Operations,
Investment Operations
St. Paul, Minnesota 150 5,600 July 1998 Investment Operations
------ --------
13,657 $222,900
Total: ------ --------
</TABLE>
Management of the Company believes that these facilities are adequate for
the Company's foreseeable needs and that lease renewals and/or alternate space
at comparable rental rates is available, if necessary.
ITEM 3: LEGAL PROCEEDINGS
The Company is not engaged in any material legal proceedings. However, two
affiliates have been parties to certain proceedings described below. To the
extent that the results of these proceedings are adverse to the affiliates, the
proceedings could also adversely affect the Company.
On or about January 15, 1997, Quarters on Melody Lane Partnership
("Quarters") brought suit against HCMC in the District Court in Dallas County,
Texas (titled Quarters on Melody Lane Partnership v. Hanover Capital Mortgage
Corporation et al.) In a letter dated December 17, 1996, Quarters threatened to
sue HCMC and others unless Quarters was permitted to repay a multifamily
mortgage loan, which had been originated by HCMC, without pre-payment penalties.
The initial principal balance of the multifamily mortgage loan, which closed on
June 28, 1994, was approximately $1.76 million. A portion of the proceeds of the
loan was retained in an escrow account to fund the cost of repairs, replacements
and improvements. Quarters alleged that HCMC personnel orally represented before
the closing that funds would be disbursed from the escrow account other (and
more favorably to the obligor) than as provided in the loan documents.
Disbursements have not been made in accordance with such alleged
representations. HCMC sold the loan on the day of closing and sold the servicing
rights to the loan in December 1994. In a written response to the letter, HCMC
denied that its representatives made any misrepresentations to Quarters.
Thereafter, Quarters filed suit against HCMC and others as defendants, in
District Court in Dallas County, Texas. The complaint alleges that HCMC is
guilty of fraudulent misrepresentation, breach of contract, fraudulent
withholding of funds, breach of fiduciary duty and conversion. On July 17, 1997,
Quarters filed an amended petition, alleging actual damages in the amount of
$300,000.00 and seeking punitive damages in the amount of $1,000,000.00. On
August 29, 1997, a court-ordered mediation between all parties was held, at
which time it was believed that a settlement had been reached. In exchange for a
complete release, HCMC agreed to pay Quarters $20,000.00. However, as of this
date, a final settlement agreement has not yet been executed and other
defendants have not yet agreed to the settlement. In early January 1998,
Quarters requested certain defendants, including HCMC, to settle separately.
However, HCMC elected not to settle separately. HCMC has retained counsel and is
defending itself in such action. Management of the Company does not believe
23
<PAGE> 26
that this claim will have a material adverse effect on the Company's financial
condition and results of operations.
In August 1992, the IRS proposed a tax deficiency against HCP arising from
HCP's treatment of certain alleged employees as independent contractors for tax
purposes. HCP negotiated a closing agreement with the IRS and, on October 6,
1997, accepted a settlement offer of $99,240 from the IRS, which also requires
HCP to treat the individuals in question as employees on a prospective basis
beginning in 1998. The treatment of the individuals as employees requires HCP to
withhold income and employment taxes from payments made to them and to make
certain matching employment tax payments.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
24
<PAGE> 27
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
In September 1997, the Company raised net proceeds of approximately $79.1
million in its initial public offering (the "IPO"). In the IPO, the Company
sold 5,750,000 units at $15.00 per unit. Each unit consists of one share of
common stock, par value $.01 and one stock purchase warrant. Each warrant
entitles the holder to purchase one share of common stock at $15.00 per share
(subject to adjustment in certain events). The warrants became exerciseable on
March 19, 1998 and remain exerciseable until September 15, 2000.
On September 19, 1997 the units began trading on the American Stock
Exchange under the trading symbol HCM.U or HCM/U. Commencing March 19, 1998,
the warrants became detachable from the common stock and, commencing March 20,
1998, the common stock and warrants began trading separately on the American
Stock Exchange under the trading symbols HCM and HCM.WS, respectively. As of
February 24, 1998, the Company had 6,466,677 shares of common stock issued and
outstanding, which was held by 86 holders of record and approximately 2,900
beneficial owners.
The following table sets forth, for the periods indicated, the high, low
and closing sales price per unit as reported on the American Stock Exchange.
<TABLE>
<CAPTION>
Unit Prices Dividends
High Low Close Declared Per Share
---- --- ----- ------------------
<S> <C> <C> <C> <C>
Third Quarter Ended September 30, 1997 17 1/4 15 17 1/8 --
Fourth Quarter Ended December 31, 1997 18 7/8 15 1/8 16 1/2 $0.16
</TABLE>
The Company intends to pay quarterly dividends and other distributions to
its shareholders of all or substantially all of its taxable income in each year
in order to quality for the tax benefits accorded to a REIT under the Code. All
distributions will be made by the Company at the discretion of the Board of
Directors and will depend on the earnings of the Company, financial condition
of the Company, maintenance of REIT status and such other factors as the Board
of Directors deems relevant.
ITEM 6: SELECTED FINANCIAL DATA
The following selected financial data are derived from audited financial
statements of the Company for the period from inception (June 10, 1997) through
December 31, 1997. The selected financial data should be read in conjunction
with the more detailed information contained in the Financial Statements and
Notes thereto and "Management's Discussion and Analysis of Financial Conditions
and Results of Operations" included elsewhere in this Form 10-K.
25
<PAGE> 28
OPERATIONS STATEMENT HIGHLIGHTS
<TABLE>
<CAPTION>
1997
----
<S> <C>
Net interest income $1,676,000
Net income 499,000
Basic earnings per share 0.15
Diluted earnings per share 0.14
Dividends declared per share $0.16
BALANCE SHEET HIGHLIGHTS
<CAPTION>
December 31
1997
----
<S> <C>
Adjustable-rate mortgage securities $348,131,000
Mortgage loans 160,970,000
Total assets 517,543,000
Shareholders' Equity 78,098,000
Number of common
shares outstanding 6,466,677
</TABLE>
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is a specialty finance company the activities of which
include (i) acquiring primarily subprime single-family mortgage loans, (ii)
securitizing mortgage loans and retaining interests therein, (iii) offering due
diligence services to buyers, sellers and holders of mortgage loans and (iv)
originating, holding, selling and servicing multifamily mortgage loans and
commercial mortgage loans. The Company's principal business objective is to
generate increasing earnings and dividends for distribution to stockholders.
The Company acquires single-family mortgage loans through a network of sales
representatives targeting financial institutions throughout the United States.
The Company originates multifamily mortgage loans and commercial mortgage loans
through HCMC.
RESULTS OF OPERATIONS
The Company was organized on June 10, 1997, but did not commence
operations until September 19, 1997 (the date of the IPO closing). For the
period from June 10, 1997 to December 31, 1997, the Company's net income was
$499,000 or
26
<PAGE> 29
$0.15 per share based on a weighted average of 3,296,742 shares of common stock
outstanding. The Company's net income for the period September 19, 1997
to December 31, 1997 was $499,000 or $.08 per share based on a weighted average
of 6,466,677 shares of common stock outstanding.
Net interest income for 1997 totaled $1,676,000. Net interest income is
interest income earned on mortgage securities, fixed rate and adjustable rate
mortgage loans, and other temporary investments less interest expense from
borrowings related to the investments.
General and administration expenses for 1997 totaled $940,000. The majority
of general and administrative expenses relate to management and administrative
expenses, due diligence acquisition costs, commission expenses, and legal and
professional fees. Due diligence acquisition costs averaged .156 % of the
principal balance of the mortgage loans purchased in 1997.
On September 19, 1997 (the IPO date), the Company acquired 100% of the
nonvoting preferred stock of HCP, which represents a 97% ownership interest in
HCP and its wholly owned subsidiaries. While the Company will generally have no
right to control the affairs of HCP because the Company owns only the preferred
stock of HCP, management believes that the Company has the ability to exert
significant influence over HCP and therefore the investment in HCP is accounted
for on the equity method. The Company recorded a loss of $254,000 in 1997 for
its equity investment in HCP. The HCP loss was a result of a decline in
consulting (due diligence/ARMS audit) revenues and a slowdown in the mortgage
originations division during the fourth quarter of 1997.
The table below highlights the Company's brief historical trends and
components of return on average equity.
COMPONENTS OF ANNUALIZED RETURN ON AVERAGE EQUITY (1)
<TABLE>
<CAPTION>
Gain on Equity in
Net Interest Sale of G & A Earnings (Loss) Annualized
For the Income/ Securities/ Expense/ of Subsidiary/ Return on
Quarter Ended Equity Equity Equity Equity Equity
------------- ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
June 30, 1997 (2) 0.00% 0.00% 0.00% 0.00% 0.00%
September 30, 1997(3) 4.85% 0.00% 3.59% 0.97% 2.23%
December 31, 1997 7.71% 0.18% 4.26% (1.41%) 2.22%
</TABLE>
(1) Average equity excludes unrealized loss on investments available for sale.
(2) The Company was organized on June 10, 1997, but did not begin operations
until September 19, 1997.
(3) Average equity is based on equity balances at September 19, 1997 (IPO date),
and equity balances at September 30, 1997, excluding unrealized loss on
investments available for sale.
For the period from inception through December 31, 1997, the Company's
taxable income was $1,077,000 or $0.167 per weighted average share outstanding.
Taxable income is higher than GAAP net income primarily because taxable income
does not include the equity in the loss of HCP ($254,000), and due diligence
costs and
27
<PAGE> 30
commission expenses incurred to acquire mortgage loan pools ($324,000) that are
expensed under GAAP, but capitalized and amortized for tax purposes.
As a REIT, the Company is required to declare dividends amounting to 85% of
each years taxable income by the end of each calendar year and to have declared
dividends amounting to 95% of the Company's taxable income for each year by the
time the Company files its federal tax return. Therefore, a REIT generally
passes through substantially all of its earnings to shareholders without paying
federal income tax at the corporate level. The Company paid a fourth quarter
dividend of $0.16 per share, which was equivalent to a dividend of
approximately 96.0% of taxable income.
The following table reflects the average balances for each major category
of the Company's interest earning assets as well as the Company's interest
bearing liabilities with the corresponding effective rate of interest annualized
for the period September 30, 1997 (initial purchase of mortgage assets) through
December 31, 1997:
<TABLE>
<CAPTION>
Average Effective
Balance Rate
------- ----
<S> <C> <C>
Interest Earning Assets:
Mortgage Loans (1) $ 83,776,000 7.317%
Mortgage Securities 116,375,000 6.268%
------------ -----
$200,151,000 6.707%
============ =====
Interest Bearing Liabilities
Reverse repurchase borrowings on mortgage loans $ 32,674,000 6.313%
Reverse repurchase borrowings on mortgage securities 113,803,000 5.723%
------------ -----
$146,477,000 5.855%
============ -----
Net Interest Earning Assets $ 53,674,000
Net Interest Spread ============ 0.852%
=====
Yield on Net Interest Earnings Assets (2) 9.034%
=====
</TABLE>
(1) Loan loss reserves are excluded in above calculations.
(2) Yield on Net Interest Earning Assets is computed by dividing annualized
net interest income by the average daily balance of net interest earnings
assets.
For the year ended December 31, 1997, the Company's ratio of operating
expenses to average assets was 1.59%. The Company's 1997 operating expense did
not include any incentive bonus compensation. In order for the eligible
participants to earn incentive bonus compensation, the rate of return on
shareholders' investment must exceed the average ten-year U.S. Treasury rate
during the year plus 4.0%.
FINANCIAL CONDITION
At December 31, 1997, the Company had total assets of $517,543,000.
Mortgage loans totaled $160,970,000 or 31.1% of total assets, while mortgage
securities totaled $348,131,000 or 67.3% of total assets.
28
<PAGE> 31
The following table presents a schedule of mortgage loans at December
31, 1997, classified by fixed rate mortgage and adjustable rate mortgages:
<TABLE>
<CAPTION>
Carrying Portfolio
Value Mix
----- ---
<S> <C> <C>
Fixed rate mortgages $107,953,000 67.1%
Adjustable rate mortgages 53,017,000 32.9%
------------ -----
$160,970,000 100.0%
============ =====
</TABLE>
The following table presents a schedule of mortgage securities at
December 31, 1997, classified by type of issue:
<TABLE>
<CAPTION>
Carrying Portfolio
Value Mix
----- ---
<S> <C> <C>
FNMA $207,397,000 59.6%
FHLMC 140,734,000 40.4%
------------ -----
$348,131,000 100.0%
============ =====
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
The Company expects to meet its short-term and long-term liquidity
requirements generally from its existing working capital, cash flow provided by
operations, reverse repurchase agreements and other possible sources of
financings, including CMO's and REMICs, additional equity generated by the
exercise of some or all of the outstanding warrants and additional equity
offerings. The Company considers its ability to generate cash to be adequate to
meet operating requirements both in the short-term and long-term.
Net cash provided by operating activities for the period June 10, 1997
to December 31, 1997 was $49,000. The cash flows generated from operating
activities (mainly from net income ($499,000), non cash expense items such as
amortization of mortgage loans and mortgage security premiums, and the increase
of certain liability accounts) were reduced by amounts expended for the
purchase of accrued interest on mortgage loan pools and by loans ($482,000)
made to John A. Burchett, Irma N. Tavares and Joyce S. Mizerak (together with
George J. Ostendorf, the "Principals").
Net cash used in investing activities for the period from June 10, 1997 to
December 31, 1997 was $510,287,000. The majority of the cash used in investing
activities related to the purchase of FNMA securities and FHLMC securities
($349,287,000) and mortgage loan pools ($163,030,000).
Cash flows from financing activities generated $514,260,000 during the
period from June 10, 1997 to December 31, 1997. The cash flows from financing
activities represent net proceeds from reverse repurchase agreements used to
finance the purchase of mortgage securities ($341,407,000), pools of
single-family mortgage loans ($93,731,000), and the net proceeds of the IPO
($79,122,000).
Management anticipates that the Company will continue to purchase single
family mortgage loan pools and will finance the purchase of the mortgage loan
pools through existing equity,
29
<PAGE> 32
reverse repurchase agreements, and other sources of financing including CMO's
and REMICs. The Company may also realize additional liquidity beginning in
March 1998 when the warrants become exercisable.
The Company is obligated to make additional loans to the Principals
($1,268,000) at their request. It is anticipated that the Principals will
request additional loans in April 1998 for tax purposes. Further, in lieu of
their exercise of certain registration rights, the Principals have also
requested additional loans in the aggregate amount of $1,500,000, which was
approved by the Board of Directors. The Company has guaranteed HCP's line of
credit facility. The Company has advanced $900,000 to HCP in February 1998 for
working capital purposes and Management anticipates that the Company may advance
additional funds in 1998 to HCP.
OTHER MATTERS
REIT Requirements
The Company has elected to be taxed as a REIT under the Code. The Company
believes that it was in full compliance with the REIT tax rules as of December
31, 1997 and intends to remain in compliance with all REIT tax rules. If the
Company fails to qualify as a REIT in any taxable year and certain relief
provisions of the Code do not apply, the Company will be subject to Federal
income tax as a regular, domestic corporation, and its stockholders will be
subject to tax in the same manner as stockholders of a regular corporation.
Distributions to its stockholders in any year in which the Company fails to
qualify as a REIT would not be deductible by the Company in computing its
taxable income. As a result, the Company could be subject to income tax
liability, thereby significantly reducing or eliminating the amount of cash
available for distribution to its stockholders. Further, the Company could also
be disqualified from re-electing REIT status for the four taxable years
following the year during which it became disqualified.
Investments in Certain Mortgage Assets
The Company takes certain risks in investing in subprime single-family
mortgage loans. If these mortgage loans are missing relevant documents, such as
the original note, they may be difficult to enforce. These mortgage loans may
also have inadequate property valuations. In addition, if a single-family
mortgage loan has a poor payment history, it is more likely to have future
delinquencies because of poor borrower payment habits or a continuing cash flow
problem.
Defaults on Mortgage Assets
The Company makes long-term investments in mortgage assets. During the time
it holds mortgage assets for investment, the Company is subject to the risks of
borrower defaults and bankruptcies and hazard losses (such as those occurring
from earthquakes or floods) that are not covered by insurance. If a default
occurs on any mortgage loan held by the Company, the Company will bear the risk
of loss of principal to the extent of any deficiency between the value of the
mortgaged property, plus any payments from an insurer or guarantor, and the
amount owing on the mortgage loan.
With respect to commercial mortgage loans, the Company may be subject to
certain additional risks. Commercial properties tend to be unique and more
difficult to value than single-family residential properties. Commercial
mortgage loans often have shorter maturities
30
<PAGE> 33
than single-family mortgage loans and often have a significant principal balance
or "balloon" due on maturity. A balloon payment creates a greater risk for the
lender because the ability of a borrower to make a balloon payment normally
depends on its ability to refinance the loan or sell the related property at a
price sufficient to permit the borrower to make the payment. Commercial mortgage
lending is generally viewed as exposing the lender to a relatively greater risk
of loss than single-family mortgage lending because it usually involves larger
mortgage loans to single borrowers or groups of related borrowers and the
repayment of the loans is typically dependent upon the successful operation of
the related properties.
Negative Effects of Fluctuating Interest Rates
Changes in interest rates may impact the Company's earnings in various
ways. While the Company anticipates that over the long term less than 25% of
its mortgage loans will be ARMs, rising short term interest rates may
negatively affect the Company's earnings in the short term. Increases in the
interest rate on an ARM loan are generally limited to either 1% or 2% per
adjustment period. ARM loans owned by the Company are subject to such
limitations, while adjustments in interest rate on the Company's borrowings are
not correspondingly limited. As a result, in periods of rising interest rates,
the Company's net interest income could temporarily decline.
The rate of prepayment on the Company's mortgage loans may increase if
interest rates decline, or if the difference between long-term and short-term
interest rates diminishes. Increased prepayments would cause the Company to
amortize any premiums paid on the acquisition of its mortgage loans faster than
currently anticipated, resulting in a reduced yield on its mortgage loans.
Additionally, to the extent proceeds of prepayments cannot be reinvested at a
rate of interest at least equal to the rate previously earned on the prepaid
mortgage loans, the Company's earnings may be adversely affected.
Insufficient Demand for Mortgage Loans and the Company's Loan Products
The availability of mortgage loans that meet the Company's criteria depends
on, among other things, the size of and level of activity in the residential,
multifamily and commercial real estate lending markets. The size and level of
activity in these markets, in turn, depends on the level of interest rates,
regional and national economic conditions, inflation and deflation in property
values and the general regulatory and tax environment as it relates to mortgage
lending. If the Company can not obtain sufficient mortgage loans that meet its
criteria, its business will be adversely affected.
Year 2000 Compliance
The inability of computers, software and other equipment utilizing
microprocessors to recognize and properly process data fields containing a two
digit year is commonly referred to as the Year 2000 Compliance issue. As the
year 2000 approaches, such systems may be unable to accurately process certain
date-based information.
The Company has identified all significant applications that will require
modification to ensure Year 2000 Compliance. Internal resources are primarily
being used to make the required modifications and test Year 2000 Compliance.
The modification process of all significant applications is substantially
complete. The Company plans to complete the testing process of all significant
applications by December 31, 1998.
31
<PAGE> 34
In addition, the Company has communicated with others with whom it does
significant business to determine their Year 2000 readiness and the extent to
which the Company may be vulnerable to any third party Year 2000 issues.
However, there can be no guarantee that the systems of other companies on which
the Company's systems rely will be timely converted, or that a failure to
convert by another company, or a conversion that is incompatible with the
Company's systems, would not have a material adverse effect on the Company.
The total cost to the Company of these Year 2000 Compliance activities has
not been and is not anticipated to be material to the Company's financial
position or results of operations in any year. These costs and the date on
which the Company plans to complete the Year 2000 modification and testing
processes 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 from those plans.
Investment Company Act
The Company at all times intends to conduct its business so as not to
become regulated as an investment company under the Investment Company Act. If
the Company were to become regulated as an investment company, the Company's use
of leverage would be substantially reduced. The Investment Company Act exempts
entities that are "primarily engaged in the business of purchasing or otherwise
acquiring mortgages and other liens on interest in real estate" ("Qualifying
Interests"). Under current interpretation of the staff of the Securities and
Exchange Commission, in order to qualify for this exemption, the Company must
maintain at least 55% of its assets directly in Qualifying Interests. As of
December 31, 1997, Management calculates that the Company is in compliance with
this requirement.
IMPORTANT FACTORS RELATED TO FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
The preceding section, "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and other sections of this Annual Report
on Form 10-K contain various "forward-looking statements" within the meaning of
Section 27A of the Securities Act 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. These forward-looking statements
represent the Company's expectations or beliefs concerning future events,
including, without limitation, statements containing the words "believes,"
"anticipates," "expects" and words of similar import; and also including,
without limitation, the following: statements regarding the Company's
continuing ability to target and acquire mortgage loans; expected availability
of the master repurchase agreement; the sufficiency of the Company's working
capital, cash flows and financing to support the Company's future operating and
capital requirements; results of operations and overall financial performance;
the expected dividend distribution rate; and the expected tax treatment of the
Company's operations. Such forward-looking statements relate to future events
and the future financial performance of the Company and the industry and
involve known and unknown risks, uncertainties and other important factors
which could cause actual results, performance or achievements of the Company or
industry to differ materially from the future results, performance or
achievements expressed or implied by such forward-looking statements.
32
<PAGE> 35
Investors should carefully consider the various factors identified in
"Management's Discussion and Analysis of Financial Condition and Results of
Operation - Other Matters," and elsewhere in this Annual Report that could cause
actual results to differ materially from the results predicted in the
forward-looking statements. Further, the Company specifically cautions
investors to consider the following important factors in conjunction with the
forward-looking statements: the possible decline in the Company's ability to
locate and acquire mortgage loans; the possible adverse effect of changing
economic conditions, including fluctuations in interest rates and changes in the
real estate market both locally and nationally; the effect of severe weather or
natural disasters; the effect of competitive pressures from other financial
institutions, including mortgage REITs; and the possible changes, if any, in
the REIT rules. Because of the foregoing factors, the actual results achieved
by the Company in the future may differ materially from the expected results
described in the forward-looking statements.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of the Company and the related notes, together
with the Independent Auditors' Report thereon begin on pages F-1 through F-34
of this Form 10-K.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
33
<PAGE> 36
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference to the Company's definitive proxy
statement to be filed with the Securities and Exchange Commission.
ITEM 11: EXECUTIVE COMPENSATION
Incorporated herein by reference to the Company's definitive proxy
statement to be filed with the Securities and Exchange Commission.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference to the Company's definitive proxy
statement to be filed with the Securities and Exchange Commission.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference to the Company's definitive proxy
statement to be filed with the Securities and Exchange Commission.
34
<PAGE> 37
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
See Part II, Item 8 hereof.
2. Financial Statements and Auditors' Reports
All schedules omitted are inapplicable or the information required is
shown in the Financial Statements or notes thereto. The auditors'
reports of Deloitte & Touche LLP with respect to the Financial
Statements are located at pages F-2 and F-22.
3. Exhibits
Exhibits required to be attached by Item 601 of Regulation S-K are listed
in the Exhibit Index attached hereto, which is incorporated herein by this
reference. Following is a list of management contracts and compensatory
plans and arrangements required to be filed as exhibits to this form by
Item 14(c) hereof:
Management Agreement, dated as of January 1, 1998, by and between the
Company and HCP.
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the last quarter of 1997.
(c) Exhibits
See Item 14(a)3 above.
35
<PAGE> 38
SIGNATURES
Pursuant to the requirements of 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, on March 30, 1998.
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
By /s/ Ralph F. Laughlin
-------------------------------------------------
Ralph F. Laughlin
Senior Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on be half of Registrant
and the capacities indicated on March 30, 1998.
SIGNATURE TITLE
/s/ John A. Burchett Chairman of the Board of Directors
- ------------------------ and Chief Executive Officer
John A. Burchett
/s/ Irma N. Tavares Managing Director and a Director
- ------------------------
Irma N. Tavares
/s/ Joyce S. Mizerak Managing Director, Secretary and a Director
- ------------------------
Joyce S. Mizerak
/s/ George J. Ostendorf Managing Director and a Director
- ------------------------
George J. Ostendorf
/s/ John A. Clymer Director
- ------------------------
John A. Clymer
/s/ Joseph J. Freeman Director
- ------------------------
Joseph J. Freeman
/s/ Robert E. Campbell Director
- ------------------------
Robert E. Campbell
/s/ Saiyid T. Naqvi Director
- ------------------------
Saiyid T. Naqvi
/s/ Ralph F. Laughlin Senior Vice President and Chief Financial Officer
- ------------------------ (Principal Financial and Accounting Officer)
Ralph F. Laughlin
<PAGE> 39
EXHIBIT INDEX
* 3.1 Articles of Incorporation of the Company, as amended
* 3.2 By-Laws of the Company
* 4.1 Specimen Common Stock Certificate
* 4.2 Warrant Agreement pursuant to which Warrants are to be issued
(including form of Warrant)
* 4.3 Representatives' Warrant Agreement pursuant to which the
Representatives' Warrants are to be issued.
* 4.4 Specimen Unit Certificate
*10.3 Registration Rights Agreement
*10.4 Shareholders' Agreement of HCP
*10.5 Agreement and Plan of Recapitalization
*10.6 Bonus Incentive Compensation Plan
*10.7 1997 Executive and Non-Employee Director Stock Option Plan
*10.8 Employment Agreement by and between the Company and John A. Burchett
*10.9 Employment Agreement by and between the Company and Irma N. Tavares
*10.10 Employment Agreement by and between the Company and Joyce S. Mizerak
*10.11 Employment Agreement by and between the Company and George J. Ostendorf
*10.12 Standard Form of Office Lease, dated as of May 6, 1991, by and between
Irwin Kahn and HCP, as amended by the First Amendment of Lease, dated
as of July 1, 1996
*10.13 Office Lease Agreement, dated as of March 1, 1994, by and between
Metroplex Associates and HCMC, as amended by the First Modification
and Extension of Lease Agreement, dated as of February 28, 1997
*10.14 Indenture, dated as of June 28, 1993, by and between LaSalle National
Bank, N.A., as Trustee, and HCP, as amended by the Lease Amendment
dated as of August 23, 1995
*10.15 Office building space, dated as of February 5, 1993, by and between
Bonhomme Place Associates, Inc. and HCMC, as amended by Lease
Amendment #1, dated as of December 1, 1993 and as further amended
by Second Amendment and Extention of Lease, dated as of March 1,
1996
*10.16 Office Lease and Service Agreement, dated as of August 28, 1995 by and
between Federal Deposit Insurance Receiver for Merchants Bank and
HCP
*10.17 Agreement of Lease, dated as of January 8, 1997 by and between Saint
Paul Executive Office Suites, Inc., d.b.a. LesWork Inc. and HCP
*10.18 Revolving Credit Agreement, dated as of December 10, 1996 between Fleet
National Bank and HCP
*10.19 Guaranty, dated as of December 10, 1996, by John A. Burchett to Fleet
National Bank
*10.20 Guaranty, dated as of December 10, 1996, by HCMC to Fleet National Bank
*10.21 Guaranty, dated as of December 10, 1996, by HCMF to Fleet National Bank
*10.22 Guaranty, dated as of December 10, 1996, by HCA to Fleet National Bank
*10.23 Guaranty, dated as of December 10, 1996, by HCS to Fleet National Bank
*10.24 Modification Agreement, dated as of June , 1997, among Fleet
National Bank, HCP, HCMC, HCMF, HCS, HCA and John A. Burchett
*10.25 Contribution Agreement
*10.26 Participation Agreement
*10.27 Loan Agreement
**10.28 Master Repurchase Agreement Governing Purchases and Sales of Mortgage
Loans, between Nomura Asset Capital Corporation and the Company,
dated September 29, 1997
10.29 Management Agreement, dated as of January 1, 1998, by and between the
Company and HCP
10.30 Master Loan and Security Agreement between the Company and Morgan
Stanely Mortgage Capital Inc., dated as of December 8,1997
*21 Subsidiaries of the Company
27 Financial Data Schedule
- -------------
* Incorporated herein by reference to the Company's Registration Statement
No. 333-29261, as amended, as filed with the Securities and Exchange
Commission.
** Incorporated herein by reference to the Company's Form 10-Q, as amended, for
the quarter ended September 30, 1997, as filed with the Securities and
Exchange Commission.
<PAGE> 40
TABLE OF CONTENTS TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
Independent Auditors' Report................................................... F-2
Financial Statements as of December 31, 1997 and for the Period from June 10,
1997 (inception) through December 31, 1997:
Balance Sheet............................................................... F-3
Statement of Operations..................................................... F-4
Statement of Stockholders' Equity........................................... F-5
Statement of Cash Flows..................................................... F-6
Notes to Financial Statements............................................... F-7
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
Independent Auditors' Report................................................... F-22
Consolidated Financial Statements as of December 31, 1997 and December 31, 1996
and for each of the Three Years in the Period Ended December 31, 1997:
Balance Sheet............................................................... F-23
Statements of Operations.................................................... F-24
Statements of Stockholders' Equity.......................................... F-25
Statements of Cash Flows.................................................... F-26
Notes to Consolidated Financial Statements.................................. F-27
</TABLE>
F-1
<PAGE> 41
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Hanover Capital Mortgage Holdings, Inc.
New York, New York
We have audited the accompanying balance sheet of Hanover Capital Mortgage
Holdings, Inc. (the "Company") as of December 31, 1997 and the related
statements of operations, stockholders' equity and cash flows for the period
June 10, 1997 (inception) through December 31, 1997. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Hanover Capital Mortgage
Holdings, Inc. as of December 31, 1997 and the results of its operations and
its cash flows for the period June 10, 1997 (inception) through December 31,
1997, in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Parsippany, New Jersey
March 20, 1998
F-2
<PAGE> 42
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
BALANCE SHEET
(in thousands, except as noted)
<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------
<S> <C>
ASSETS
ARM securities, available for sale $ 348,131
Mortgage loans, held for sale 160,970
Cash and cash equivalents 4,022
Accrued interest receivable 3,597
Equity investment 100
Notes receivable from related parties 482
Prepaid expenses and other assets 241
---------
TOTAL ASSETS $ 517,543
=========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Reverse repurchase agreements $ 435,138
Accrued interest payable 2,250
Dividends payable 1,035
Due to related party 540
Accrued expenses and other liabilities 482
---------
Total liabilities 439,445
---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01
authorized, 10 million shares, issued
and outstanding, -0- shares --
Common stock, par value $.01
authorized, 90 million shares, issued
and outstanding, 6,466,677 shares 65
Additional paid-in-capital 79,411
Available for sale securities:
Unrealized (loss) on investments available
for sale (842)
Retained earnings (deficit) (536)
---------
Total stockholders' equity 78,098
---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 517,543
=========
</TABLE>
See notes to financial statements
F-3
<PAGE> 43
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
STATEMENT OF OPERATIONS
PERIOD FROM JUNE 10 (INCEPTION) TO DECEMBER 31, 1997
(in thousands, except per share data)
<TABLE>
<S> <C>
REVENUES:
Interest income $ 4,880
Interest expense 3,204
-----------
Net interest income 1,676
Loan loss provision 18
-----------
Net interest income after loan loss
provision 1,658
-----------
Gain on sale of securities 35
-----------
Total revenues 1,693
-----------
EXPENSES:
General and administrative expenses
Management and administrative 400
Due diligence 266
Commissions 61
Legal and professional 170
Other 43
-----------
Total expenses 940
-----------
Operating income 753
Equity in (loss) of unconsolidated subsidiary (254)
-----------
NET INCOME $ 499
===========
BASIC EARNINGS PER SHARE $ 0.15
===========
DILUTED EARNINGS PER SHARE $ 0.14
===========
</TABLE>
See notes to financial statements
F-4
<PAGE> 44
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
PERIOD FROM JUNE 10 (INCEPTION) TO DECEMBER 31, 1997
(in thousands)
<TABLE>
<CAPTION>
AVAILABLE
FOR SALE
ADDITIONAL SECURITIES RETAINED
COMMON STOCK PAID-IN UNREALIZED EARNINGS
SHARES AMOUNT CAPITAL (LOSS) (DEFICIT) TOTAL
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock 6,466,677 $ 65 $ 79,411 $ 79,476
Unrealized (loss) on available-for-sale $(842) (842)
securities
Net income $499 499
Dividends declared (1,035) (1,035)
-----------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 6,466,677 $ 65 $ 79,411 $(842) $(536) $78,098
===================================================================================
</TABLE>
See notes to financial statements
F-5
<PAGE> 45
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
STATEMENT OF CASH FLOWS
PERIOD FROM JUNE 10 (INCEPTION) TO DECEMBER 31, 1997
(in thousands)
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 499
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization of net premium - ARM securities 314
Amortization of net premium - mortgage loans 47
Loan loss provision 18
Gain on sale of securities (35)
Equity in loss of unconsolidated subsidiary 254
Increase in accrued interest receivable (3,597)
Loans to officers/stockholders (482)
Increase in prepaid expenses and other assets (241)
Increase in accrued interest payable 2,250
Increase in due to related party 540
Increase in accrued expenses and other liabilities 482
---------
Net cash provided by operating activities 49
---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of ARM securities (349,287)
Purchase of mortgage loans (163,030)
Principal payments on mortgage loans 1,995
Proceeds from sale of securities 35
---------
Net cash (used in) investing activities (510,287)
---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings from reverse repurchase agreements 435,138
Net proceeds of initial public offering 79,122
---------
Net cash provided by investing activities 514,260
---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 4,022
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 0
---------
CASH AND CASH EQUIVALENTS, END OF PERIOD 4,022
=========
</TABLE>
SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES
Operating activity - increase in dividends payable ($1,035,000) relating to the
declaration of dividends in December 1997.
Investing activity - acquisition of a 97% ownership interest in Hanover Capital
Partners Ltd ($354,000).
Financing activities - issuance of 716,667 shares of the Company's common stock
used to acquire an equity investment in HCP ($354,000), and the declaration of
$1,035,000 of dividends in December 1997 that was paid in January 1998.
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the period for:
<TABLE>
<S> <C>
Income taxes $ -0-
==========
Interest $ 884
==========
</TABLE>
See notes to financial statements
F-6
<PAGE> 46
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997
1. BUSINESS DESCRIPTION
GENERAL
Hanover Capital Mortgage Holdings, Inc. (the "Company") was incorporated in
Maryland on June 10, 1997. The Company is a self-managed real estate investment
trust ("REIT"), formed to operate as a specialty finance company. The principal
business strategy of the company is to (i) acquire primarily single-family
mortgage loans that are at least twelve months old or that were intended to be
of certain credit quality but that do not meet the originally intended market
parameters due to errors or credit deterioration, (ii) securitize the mortgage
loans and retain interests therein, (iii) originate, hold, sell and service
multifamily mortgage loans and commercial mortgage loans and (iv) acquire
multifamily mortgage loans. The Company's principal business objective is to
generate increasing earnings and dividends for distribution to its stockholders.
The Company acquires single-family mortgage loans through a network of sales
representatives targeting financial institutions throughout the United States.
The Company may also acquire multifamily mortgage loans from a taxable
subsidiary of the Company.
CAPITALIZATION
In September 1997, the Company raised net proceeds of approximately $79 million
in its initial public offering (the "IPO"). In the IPO, the Company sold
5,750,000 units (each unit consists of one share of common stock, par value
$.01 and one stock warrant) at $15.00 per unit including 750,000 units sold
pursuant to the underwriters' overallotment option, which was exercised in
full. Each warrant entitles the holder to purchase one share of common stock at
the original issue price - $15.00. The warrants became exercisable on March 19,
1998 and remain exercisable until September 15, 2000. The Company will utilize
substantially all of the net proceeds of the IPO to fund leveraged purchases of
mortgage assets.
In connection with the closing of the IPO the Company acquired a 97% ownership
interest (representing a 100% ownership of the non-voting preferred stock) in
Hanover Capital Partners Ltd. and its wholly-owned subsidiaries: Hanover Capital
Mortgage Corporation and Hanover Capital Securities, Inc., in exchange for
716,667 shares of the Company's common stock. Hanover Capital Partners Ltd. and
its wholly-owned subsidiaries offer due diligence services to buyers, sellers
and holders of mortgage loans and originate, sell and service multifamily
mortgage loans and commercial loans.
F-7
<PAGE> 47
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
RISKS AND UNCERTAINTIES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amount of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. The
Company's estimates and assumptions primarily arise from risks and uncertainties
associated with interest rate volatility, credit exposure and regulatory
changes. Although management is not currently aware of any factors that would
significantly change its estimates and assumptions in the near term, future
changes in market trends and conditions may occur which could cause actual
results to differ materially.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand, overnight investments deposited
with banks and government securities with maturities less than 30 days.
ADJUSTABLE RATE MORTGAGE SECURITIES
The Company's policy is to classify its adjustable rate mortgage ("ARM")
securities as available-for-sale as they are purchased and each asset is
monitored for a period of time, generally three to six months, prior to making a
determination whether the asset will be classified as held-to-maturity. At
December 31, 1997 management has made the determination that all ARM securities
are available-for-sale in order to be prepared to respond to potential future
opportunities in the market, to sell ARM securities in order to optimize the
portfolio's total return and to retain its ability to respond to economic
conditions that require the Company to sell assets in order to maintain an
appropriate level of liquidity. Management re-evaluates the classification of
the ARM securities on a quarterly basis. ARM securities classified as
held-to-maturity are carried at the fair value of the security at the time the
designation is made and any fair value adjustment to the cost basis as of the
date of the classification is amortized into interest income as a yield
adjustment. All ARM securities designated as available-for-sale are reported at
fair value, with unrealized gains and losses excluded from earnings and reported
as a separate component of stockholders' equity.
Premiums and discounts associated with the purchase of ARM securities are
amortized into interest income over the lives of the securities using the
effective yield method adjusted for the effects of estimated prepayments. ARM
securities transactions are recorded on the date the ARM securities are
purchased or sold. Purchases of new issue ARM securities are recorded when all
significant uncertainties regarding the characteristics of the securities are
removed, generally on or shortly before settlement date. Realized gains and
losses on ARM securities transactions are determined on the specific
identification basis.
F-8
<PAGE> 48
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
The Company has limited its exposure to credit losses on its portfolio of ARM
securities by only purchasing ARM securities that have some form of credit
enhancement and that are either guaranteed by an agency of the federal
government or have an investment grade rating at the time of purchase, or the
equivalent, by at least one of two nationally recognized rating agencies,
Moody's or Standard & Poor's (the "Rating Agencies"). The Company monitors the
delinquencies and losses on the underlying mortgages of its ARM securities and,
if the credit performance of the underlying mortgage loans is not as good as
expected, makes a provision for possible credit losses as well as unidentified
potential future losses in its ARM securities portfolio. The provision is based
on management's assessment of numerous factors affecting its portfolio of ARM
securities including, but not limited to, current and projected economic
conditions, delinquency status, credit losses to date on underlying mortgages
and remaining credit protection. The provision is made by reducing the cost
basis of the individual security and the amount of such write-down is recorded
as a realized loss, thereby reducing earnings. Provisions for credit losses do
not reduce taxable income and therefore do not affect the dividends paid by the
Company to stockholders in the period the provisions are taken. Actual losses
realized by the Company reduce taxable income in the period the actual loss is
realized and would affect the dividends paid to stockholders for that tax year.
MORTGAGE LOANS
The Company's policy is to classify each of its mortgage loans as held for sale
as they are purchased and each asset is monitored for a period of time,
generally four to nine months, prior to making a determination as to whether the
asset will be classified as held-to-maturity. At December 31, 1997 management
has made the determination that all mortgage loans are held for sale in order to
be prepared to respond to potential future opportunities in the market, to sell
mortgage loans in order to optimize the portfolio's total return and to retain
its ability to respond to economic conditions that require the Company to sell
mortgage loans in order to maintain an appropriate level of liquidity.
Management re-evaluates the classification of mortgage loans on a quarterly
basis. All mortgage loans designated as held for sale are reported at the lower
of cost or market, with unrealized losses reported as a charge to earnings in
the current period.
Premiums and discounts associated with the purchase of mortgage loans are
amortized into interest income over the lives of the mortgage loans using the
effective yield method adjusted for the effects of estimated prepayments.
Mortgage loan transactions are recorded on the date the mortgage loans are
purchased or sold. Purchases of new mortgage loans are recorded when all
significant uncertainties regarding the characteristics of the mortgage loans
are removed, generally on or shortly before settlement date. Realized gains and
losses on mortgage loan transactions are determined on the specific
identification basis.
F-9
<PAGE> 49
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
The accrual of interest on impaired loans is discounted when, in management's
opinion, the borrower may be unable to meet payments as they become due. When
interest accrual is discontinued, all unpaid accrued interest is reversed.
Interest income is subsequently recognized only to the extent cash payments are
received.
The Company has limited its exposure to credit losses on its portfolio of
mortgage loans by performing an in-depth due diligence on every loan purchased.
The due diligence encompasses the borrowers credit, the enforceability of the
documents, and the value of the mortgage property. In addition many mortgage
loans are guaranteed by an agency of the federal government or private mortgage
insurance. The Company monitors the delinquencies and losses on the underlying
mortgages and makes a provision for known losses as well as unidentified
potential losses in its mortgage loan portfolio if the impairment is deemed to
be other than temporary. The provision is based on management's assessment of
numerous factors affecting its portfolio of mortgage loans including, but not
limited to, current and projected economic conditions, delinquency status,
losses to date on mortgages and remaining credit protection.
FINANCIAL INSTRUMENTS
The Company from time to time enters into interest rate hedge mechanisms to
manage its exposure to interest rate changes in connection with the purchase,
securitization and sale of its mortgage loans. The Company closes out the hedge
position to coincide with the related mortgage loan sale and securitization
transactions and recognizes the results of the hedge transaction in determining
the amount of the related mortgage loan sale gain for loans sold or, as a basis
adjustment to mortgage loans held to maturity.
EQUITY INVESTMENT
The Company's 97% ownership investment in Hanover Capital Partners Ltd. ("HCP")
is accounted for by the equity method of accounting. The Company generally has
no right to control the affairs of HCP because the Company's investment in HCP
is based solely on a 100% ownership of HCP's non-voting preferred stock. Even
though the Company has no right to control the affairs of HCP, management
believes that the Company has the ability to exert significant influence over
HCP and therefore the investment in HCP is accounted for by the equity method of
accounting.
REVERSE REPURCHASE AGREEMENTS
Reverse repurchase agreements are accounted for as collateralized financing
transactions and recorded at their contractual amounts, plus accrued interest.
F-10
<PAGE> 50
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
INCOME TAXES
The Company has elected to be taxed as a real estate investment trust ("REIT")
and intends to comply with the provisions of the Internal Revenue Code of 1986,
as amended (the "Code") with respect thereto. Accordingly, the Company will not
be subject to Federal income tax to the extent of its distributions to
stockholders as long as certain asset, income and stock ownership tests are met.
EARNINGS PER SHARE
At December 31, 1997 the Company adopted Statement of Financial Accounting
Standards No. 128 "Earnings per Share"("SFAS 128"). Under SFAS 128 basic
earnings per share excludes dilution and is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock that then shared in earnings.
Shares issued during the period and shares reacquired during the period are
weighted for the period they were outstanding.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income
("SFAS 130"). SFAS 130 establishes standards for reporting and displaying of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general purpose financial statements. SFAS 130 requires that
all items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. SFAS 130 is
effective for fiscal years beginning after December 15, 1997. Reclassification
of financial statements for earlier periods provided for comparative purposes is
required.
The FASB issued SFAS No.131 Disclosures About Segments of an Enterprise and
Related Information ("SFAS 131") in June 1997. SFAS 131 establishes standards
for the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to stockholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
SFAS 131 is effective for financial statements for periods beginning after
December 15, 1997. Management has not yet determined what effect, if any,
adoption will have on the Company's financial condition and results of
operations.
3. ADJUSTABLE RATE MORTGAGE SECURITIES
ARM securities consist of FNMA and FHLMC mortgage certificates secured by ARM
loans on single-family residential housing. The following table summarizes the
Company's ARM
F-11
<PAGE> 51
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
securities classified as available-for-sale as of December 31, 1997, which are
carried at their fair value (dollars in thousands):
<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE PORTFOLIO MIX
------------------ -------------
<S> <C> <C>
Amortized cost :
FNMA certificates $ 207,898 59.6%
FHLMC certificates 141,075 40.4%
--------- -----
Total amortized cost 348,973 100.0%
=====
Gross unrealized (losses) (842)
---------
Fair value $ 348,131
=========
</TABLE>
The scheduled maturities of ARM securities available for sale at December 31,
1997, were as follows:
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
--------- ---------
<S> <C> <C>
Due in one year or less $ -0- $ -0-
Due from one to five years -0- -0-
Due from five to ten years -0- -0-
Due after ten years 348,973 348,131
--------- ---------
Total $ 348,973 $ 348,131
========= =========
</TABLE>
As mentioned above, actual maturities may differ from scheduled maturities
because borrowers may have the right to prepay certain obligations, often times
without penalties. Maturities of mortgage securities depend on the repayment
characteristics and experience of the underlying obligations.
As of December 31, 1997, the average effective yield on the ARM securities
including the amortization of the net premiums paid for the ARM securities, was
6.268%.
4. MORTGAGE LOANS HELD FOR SALE
Investments in single-family mortgage loans held for sale consist of fixed rate
mortgages and adjustable rate mortgages. The following table summarizes the
Company's single-family mortgage loan pools as of December 31, 1997, which are
carried at the lower of cost or market (dollars in thousands):
F-12
<PAGE> 52
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
<TABLE>
<CAPTION>
COST MIX
---- ---
<S> <C> <C>
Fixed rate $ 106,397 67.1%
Adjustable rate 52,392 32.9%
--------- -----
Subtotal 158,789 100.0%
=====
Net deferred loan fees,
Premiums and discounts 2,199
Loan loss provision (18)
---------
Total $ 160,970
=========
</TABLE>
An analysis of the change in the loan loss provision is as follows:
<TABLE>
<S> <C>
Balance beginning of period $ 0
Loan loss provision 18
---
Balance at December 31, 1997 $18
===
</TABLE>
The following table summarizes certain characteristics of the Company's
single-family fixed rate and adjustable rate mortgage loan portfolios as of
December 31, 1997 (dollars in thousands):
<TABLE>
<CAPTION>
CARRYING VALUE PRINCIPAL WEIGHTED WEIGHTED
OF MORTGAGE AMOUNT OF AVERAGE NET AVERAGE
LOANS MORTGAGE LOANS COUPON MATURITY (1)
----- -------------- ------ ------------
<S> <C> <C> <C> <C>
Fixed Rate $107,953 $106,424 8.265% 242
Adjustable Rate 53,017 52,365 7.925% 319
-------- -------- ----- --------
$160,970 $158,789 8.153% 267
======== ======== ===== ========
</TABLE>
(1) weighted average maturity reflects the number of months remaining until
maturity
As of December 31, 1997 the average effective yield on the mortgage loan
portfolio, including the amortization of the net premiums paid for the mortgage
loans, was 7.317%.
5. CONCENTRATION OF CREDIT RISK
The Company's exposure to credit risk associated with its lending activities is
measured on an individual customer basis as well as by groups of customers that
share similar attributes. In the normal course of its business, the Company has
concentrations of credit risk in its portfolio for the mortgage loans in certain
geographic areas. At December 31, 1997, the percent of total principal amount of
mortgage loans outstanding in any one state, exceeding 5% of the principal
amount of mortgage loans held for sale, are as follows:
F-13
<PAGE> 53
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
<TABLE>
<CAPTION>
STATE PERCENT
----- -------
<S> <C>
Florida 25%
South Carolina 13%
California 10%
Ohio 9%
Texas 6%
</TABLE>
The Company's management believes exposure to credit risk associated with agency
ARM securities is minimal due to the guarantees provided by FNMA and FHLMC.
During 1997 the Company purchased approximately 61.9% of its total outstanding
principal amount of mortgage loans from three financial institutions (the
largest of which represented approximately 29.1% of the total outstanding
principal amount of mortgage loans). Management attributes the high
concentration of purchases from these three financial institutions to the
initial ramp up phase of mortgage loan acquisitions and does not foresee that
this is a trend that will continue into the future.
ARM securities were purchased from six securities firms in 1997. The largest
concentration of ARM purchases from one firm represented approximately 22.8% of
the total principal amount of ARM securities outstanding at December 31, 1997.
The company has cash and cash equivalents in a financial institution which is
insured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000 per
institution. As of December 31, 1997, the Company had amounts on deposit with
the financial institution in excess of FDIC limits. The Company limits its risk
by placing its cash and cash equivalents in a high quality financial
institution.
6. REVERSE REPURCHASE AGREEMENTS
In September 1997, the Company entered into a master repurchase agreement with a
lender in an amount up to $200 million ($100 million committed and $100 million
uncommitted) for a period of one year. Any borrowings under this facility will
be secured by mortgage loans, or other securities, and will bear interest at the
six-month LIBOR, plus a spread ranging from 0.70% to 1.25%.
In December 1997 the Company entered into a second master repurchase agreement
with another lender in an amount up to $125 million ($100 million committed and
$25 million uncommitted) for a period of one year. Any borrowings under this
facility will be secured by mortgage loans, or other securities and will bear
interest at the six-month LIBOR, plus a spread of 60 basis points.
At December 31, 1997 the Company had outstanding borrowings of $93,731,000 under
the above mentioned reverse repurchase agreements with a weighted average
borrowing rate of 6.313% and a weighted average remaining maturity of
approximately one month. The reverse
F-14
<PAGE> 54
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
repurchase agreements at December 31, 1997 were collateralized by mortgage loans
with a cost basis of $160,970,000 (which approximates market value).
In November 1997 the Company entered into six separate reverse repurchase
agreements to finance all of its ARM securities purchases. Each of the reverse
repurchase agreements are secured by the market value of the Company's ARM
securities ($348,131,000) at December 31, 1997 and bear interest at LIBOR.
As of December 31, 1997, the Company had outstanding ARMS securities reverse
repurchase agreements of $341,407,000 with a weighted average borrowing rate of
5.723 % and a weighted average remaining maturity of less than one month.
Information concerning the reverse repurchase agreements and the pledged
collateral at December 31, 1997 is summarized as follows: (dollars in
thousands):
<TABLE>
<CAPTION>
Collateral (dollars in thousands)
---------------------------------
ARM Mortgage
Reverse Repurchase Agreements Securities Loans
- ----------------------------- ---------- -----
<S> <C> <C>
Average balance during the period (1) $113,803 $ 32,674
Average interest rate during period (1) 5.723% 6.313%
Maximum month-end balance during
the period $341,407 $ 93,731
Collateral Underlying the Agreements
- ------------------------------------
Carrying balance $348,131 $160,970
Estimated fair value $348,131 $160,970
</TABLE>
(1) above table reflects the period beginning September 30, 1997 (the date
of the first mortgage asset purchase) through December 31, 1997.
7. EMPLOYEE BENEFIT PLANS
401(k) PLAN
The Company participates in the HCP non-contributory retirement plan ("401(k)
Plan"). The 401(k) plan is available to all full-time company employees with at
least six months of service. The 401(k) Plan is designed to be tax deferred in
accordance with provisions of Section 401(k) of the Internal Revenue Code. The
401(k) Plan provides that each participant may contribute 15.0% of his or her
salary subject to the maximum allowable each fiscal year ($9,500 in 1997). Under
the 401(k) Plan, an employee may elect to enroll on January 1, or July 1,
provided that the employee has met the six month employment service requirement.
F-15
<PAGE> 55
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
1997 STOCK OPTION PLAN
The Company's 1997 Executive and Non-Employee Director Stock Option Plan (the
"1997 Stock Option Plan") provides for the grant of qualified incentive stock
options ("ISOs") which meet the requirements of Section 422 of the Internal
Revenue Code, stock options not so qualified ("NQSOs"), deferred stock,
restricted stock, performance shares, stock appreciation rights and limited
stock awards ("Awards") and dividend equivalent rights ("DERs").
Subject to anti-dilution provisions of stock splits, stock dividends and similar
events, the 1997 Stock Option Plan authorizes the grant of options to purchase,
and Awards of, an aggregate of up to 325,333 shares of the common stock. If an
option granted under the 1997 Stock Option Plan expires or terminates, or an
Award is forfeited, the shares subject to any unexercised portion of such option
or Award will again become available for the issuance of further options or
Awards under the 1997 Stock Option Plan.
Unless previously terminated by the Board of Directors, the 1997 Stock Option
Plan will terminate ten years from the date of approval (or five years in the
case of ISO's granted to an employee who is deemed to own in excess of 10% of
combined voting power of the Company's outstanding equity stock) and no options
or Awards may be granted under the 1997 Stock Option Plan thereafter, but
existing options or Awards remain in effect until the options are exercised or
the options or the Awards are terminated by their terms. The aggregate fair
market value (determined as of the time of grant) of the shares of the common
stock with respect to which ISOs are exercisable for the first time by an
employee during any calendar year may not exceed $100,000.
All stock options granted by the Compensation Committee pursuant to the 1997
Stock Option Plan will be contingent and may vest, subject to other vesting
requirements imposed by the Compensation Committee in full or in part on any
September 30 beginning with September 30, 1998 and ending with September 30,
2002 (each, an "Earn-Out Measuring Date"). Subject to any other applicable
vesting restrictions, any outstanding stock options will vest in full as of any
Earn-Out Measuring Date through which the return on a unit (a unit is composed
of one common stock certificate and one warrant certificate) is at least equal
to the initial public offering price of the unit. In addition, subject to any
other applicable vesting restrictions, one-third of any outstanding stock
options will vest as of any Earn-Out Measuring Date through which the return on
a unit is at least equal to a 20% annualized return on the initial public
offering price of the unit. The return on a unit is determined by adding (i) the
appreciation in the value of the unit since the closing of the initial public
offering and (ii) the amount of distributions made by the Company on the share
of common stock included in the unit since the closing of the initial public
offering. The appreciation in the value of a unit as of any Earn-Out Measuring
Date is the average difference, during the 30 day period that ends on the
Earn-Out Measuring Date, between the market price of the share of common stock
included in the unit and the initial public offering price of the unit
multiplied by two to take into account the value of the stock warrant included
in the unit. In determining whether such stock options have vested, appropriate
adjustments will be made for stock splits, recapitalizations, stock dividends
and transactions having similar effects.
F-16
<PAGE> 56
\ HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
A summary of the status of the Company's 1997 Stock Options Plan as of December
31, 1997 and changes during the period from September 19, 1997 through December
31, 1997 is presented below:
<TABLE>
<CAPTION>
STOCK OPTION SHARES EXERCISE PRICE
- ------------ ------ --------------
<S> <C> <C>
Granted - September 19, 1997 162,664 $15.00
Granted - September 28, 1997 160,660 15.75
Cancelled (3,000) 15.75
-------- ------
Outstanding at December 31, 1997 320,324 $15.37
======== ======
</TABLE>
No shares were exercisable at December 31, 1997.
The per share weighted average fair value of stock options granted during the
period ended December 31, 1997 was $0.27 at the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:
<TABLE>
<CAPTION>
1997
----
<S> <C>
Expected life (years) 5
Risk-free interest rate 5.77%
Volatility 12.0%
Expected dividend yield 10.0%
</TABLE>
The Company applies APB opinion No. 25 in accounting for its 1997 Stock Option
Plan and, accordingly, no compensation cost has been recognized for its stock
options in the financial statements. Had the Company determined compensation
cost based on the fair value at the grant date for its stock options under
Statements of Financial Accounting Standards No. 123, Accounting For Stock-Based
Compensation, the Company's net income would have been reduced to the pro forma
amounts indicated below (in thousands, except per share data):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1997
-----------------
<S> <C>
Net earnings:
As reported $ 499
Pro forma 417
Earnings per share - basic:
As reported $0.15
Pro forma 0.13
Earnings per share - diluted
As reported $0.14
Pro forma 0.11
</TABLE>
BONUS INCENTIVE COMPENSATION PLAN
A bonus incentive compensation plan was established in 1997, whereby an annual
bonus will be accrued for eligible participants of the Company. The annual bonus
will be paid one-half in cash
F-17
<PAGE> 57
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
and (subject to ownership limits) one-half in shares of common stock in the
following year. The Company must generate annual net income before bonus
accruals that allow for a return of equity to stockholders in excess of the
average weekly ten-year U.S. Treasury rate plus 4.0% before any bonus accrual is
recorded. No such accrual was recorded in 1997.
8. AFFILIATED PARTY TRANSACTIONS
The Company has engaged HCP pursuant to a Management Agreement to render, among
other things, due diligence, asset management and administrative services. The
1997 statement of operations of the Company includes management and
administrative expenses of $400,000, due diligence expenses of $266,000 and
commission expenses of $61,000 relating to billings from HCP. At December 31,
1997 the balance sheet of the Company included an amount due HCP of $540,000.
The term of the Management Agreement continues until December 31, 1999 with
subsequent renewal provisions.
The Company has agreed to lend (a maximum of) $1,750,000 collectively, to four
officer/stockholders (collectively referred to as the "Principals") to enable
the Principals to pay tax on the gains they must recognize upon contributing
their HCP preferred stock to the Company for shares of the Company's common
stock. The loans will be secured solely by 116,667 shares of the Company's
common stock owned by the Principals, collectively. The loans bear interest at
the lowest applicable federal tax rate during the month the loans are made. At
December 31, 1997 loans outstanding to three of the Principals totaled $482,000.
9. EARNINGS PER SHARE
On December 31, 1997 the Company adopted SFAS 128 for calculating earnings per
share as shown below: (dollars in thousands, except per share data)
<TABLE>
<S> <C>
Earnings per share - basic:
Net income (numerator) $ 499
==========
Average common shares
outstanding (denominator) 3,296,742
==========
Per share $ 0.15
==========
Earnings per share - diluted:
Net income (numerator) $ 499
==========
Average common shares outstanding 3,296,742
Add: Incremental shares from
assumed conversion of
warrants 374,943
----------
Dilutive potential common shares 374,943
----------
Adjusted weighted average shares
(denominator) 3,671,685
==========
Per share $ 0.14
==========
</TABLE>
F-18
<PAGE> 58
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
10. COMMITMENTS AND CONTINGENCIES
At December 31, 1997 the Company had committed to purchase approximately
$111,092,000 of fixed and ARM loans.
The Company entered into employment agreements with the Principals. Such
agreements are for five year terms which expire in 2002, and provide for
aggregate annual base salaries of $975,000. A portion of the aggregate base
salaries is allocated to the Company's taxable subsidiary based on management's
actual and estimated time involved with the subsidiary's activities.
As additional consideration to the Principals for their contribution of their
HCP preferred stock to the Company, the Company has agreed to (1) issue to the
Principals up to 216,667 additional shares of the Company's common stock and (2)
forgive a maximum of $1,750,000 in loans made to the Principals; if certain
financial returns to stockholders are met, at certain Earn-Out Measuring Dates
as described in the Company's IPO Prospectus dated September 15, 1997.
The Company has guaranteed the line-of-credit of its majority owned subsidiary,
Hanover Capital Partners Ltd. The maximum line-of-credit obligation and the
actual line-of-credit obligation at December 31, 1997 was $1,700,000 and
$1,405,000, respectively.
11. FINANCIAL INSTRUMENTS
In accordance with SFAS No. 107, Disclosure about Derivative Financial
Instruments, and SFAS No. 119, Disclosure about Derivative Financial Instruments
and Fair Value of Financial Instruments, the Company has provided fair value
estimates and information about valuation methodologies. The estimated fair
value amounts have been determined using available market information or
appropriate valuation methodologies. However, considerable judgment is required
in interpreting market data to develop estimates of fair value, so the estimates
are not necessarily indicative of the amounts that would be realized in a
current market exchange. The effect of using different market assumptions and/or
estimation methodologies may materially impact the estimated fair value amounts.
The estimated fair value of the Company's assets and liabilities classified as
financial instruments and off-balance sheet financial instruments at December
31, 1997 are as follows (dollars in thousands):
F-19
<PAGE> 59
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
<TABLE>
<CAPTION>
CARRYING FAIR
AMOUNT VALUE
-------- --------
<S> <C> <C>
Assets:
ARM securities $348,131 $348,131
Mortgage loans 160,970 160,970
Cash and cash equivalents 4,022 4,022
Accrued interest receivable 3,597 3,597
Notes receivable 482 482
-------- --------
Total $517,202 $517,202
======== ========
Liabilities:
Reverse repurchase agreements 435,138 435,138
Accrued interest payable 2,250 2,250
Other liabilities 2,057 2,057
-------- --------
Total $439,445 $439,445
======== ========
Off-Balance Sheet: Notional
--------
Commitments to purchase loans $111,092 $111,132
======== ========
Forward commitments to sell
mortgage securities $122,650 $122,378
======== ========
</TABLE>
The following methods and assumptions were used to estimate the fair value of
the Company's financial instruments:
Cash and cash equivalents, accrued interest receivable, notes receivable,
reverse repurchase agreements, accrued interest payable, other liabilities - The
fair value of these financial instruments was determined to be their carrying
value due to their short-term nature.
ARM securities - The fair values of these financial instruments are based upon
either or all of the following: actual prices received upon recent sales of
mortgage securities to investors, projected prices which could be obtained
through investor estimates considering interest rates, mortgage loan type,
quality and discounted cash flow analysis based on prepayment and interest rate
assumptions used in the market place for similar securities with similar credit
ratings.
Mortgage loans held for sale - The fair values of these financial instruments
are based upon actual prices received upon recent sales of mortgage loans and
securities to investors and projected prices which could be obtained through
investors considering interest rates, mortgage loan type, an credit quality.
Commitments to purchase/originate mortgages - The Company has outstanding
commitments to purchase mortgage loans at market terms at the time of
commitment. The fair value of these financial instruments was determined through
a review of published market information associated with similar instruments.
These commitment obligations are considered in conjunction with the Company's
lower of cost or market valuation of its mortgage loans held for sale.
F-20
<PAGE> 60
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)
Forward commitments to sell mortgage securities - The Company has outstanding
forward commitments to sell mortgages and/or mortgage securities into mandatory
delivery contracts with investment bankers, private mortgage investors and
agency mortgage-backed securities. The fair value of these financial instruments
was determined through review of published market information associated with
similar instruments. These commitment obligations are considered in conjunction
with the Company's lower of cost or market valuation of its mortgage loans held
for sale.
12. SUBSEQUENT EVENT
On January 12, 1998 a $0.16 cash dividend previously declared by the Board of
Directors was paid to stockholders of record as of December 31, 1997.
13. QUARTERLY FINANCIAL DATA - UNAUDITED
Selected quarterly financial data are as follows (dollars in thousands, except
per share data):
Period from June 10, 1997 (inception)
through December 31, 1997
<TABLE>
<CAPTION>
(1) (1)
THREE MONTHS THREE MONTHS JUNE 10, 1997
ENDED ENDED THROUGH
DECEMBER 31, 1997 SEPTEMBER 30, 1997 JUNE 30, 1997
---------------------------------------------------------------------------
<S> <C> <C> <C>
Net interest income $ 1,548 $ 128 $ 0
=================================================================
Net income 440 59 0
=================================================================
Basic earnings per share(2) 0.07 0.07 0.00
=================================================================
Diluted earnings per share(2) 0.07 0.07 0.00
=================================================================
Dividends declared 0.16 0.00 0.00
=================================================================
</TABLE>
(1) - the Company was organized on June 10, 1997, however operations did not
begin until the IPO date - September 19, 1997
(2) - earnings per share are computed independently for each of the quarters
presented; therefore the sum of the quarterly earnings per share do not equal
the earnings per share total for the year
F-21
<PAGE> 61
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Hanover Capital Partners Ltd.
We have audited the accompanying consolidated balance sheets of Hanover Capital
Partners Ltd. and Subsidiaries (the "Company") as of December 31, 1997 and 1996,
and the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Hanover Capital Partners Ltd. and
Subsidiaries at December 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997 in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Parsippany, New Jersey
March 20, 1998
F-22
<PAGE> 62
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 1997 1996
---- ----
<S> <C> <C>
CURRENT ASSETS:
Cash $ 208,315 $ 161,546
Investment in marketable securities 17,394 16,443
Accounts receivable 133,829 3,683,865
Receivables from related parties 757,384 521,539
Accrued revenue on contracts in progress 35,413 549,781
Prepaid expenses and other current assets 118,552 143,026
---------- ----------
Total current assets 1,270,887 5,076,200
PROPERTY AND EQUIPMENT - Net 213,137 316,057
MORTGAGE SERVICING RIGHTS 49,449 30,587
DEFERRED TAX ASSET 20,081 --
OTHER ASSETS 166,670 227,548
INCOME TAX RECEIVABLE 292,885 --
DUE FROM OFFICER 53,766 107,532
---------- ----------
TOTAL ASSETS $2,066,875 $5,757,924
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accrued appraisal and subcontractor costs $ 131,978 $2,807,172
Accounts payable and accrued expenses 334,591 678,390
Income taxes payable -- 89,477
Deferred revenue 104,950 194,334
Notes payable to related parties -- 133,018
Deferred income taxes -- 12,993
Other liabilities -- 122,400
---------- ----------
Total current liabilities 571,519 4,037,784
---------- ----------
LONG-TERM LIABILITIES
Note payable to bank 1,405,000 1,045,000
Minority interest 616 250
---------- ----------
Total long-term liabilities 1,405,616 1,045,250
---------- ----------
Total liabilities 1,977,135 5,083,034
---------- ----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock: $.01 par value, 100,000
shares authorized, 97,000 shares
outstanding at December 31, 1997 970 --
Common stock: Class A: $.01 par value,
5,000 and 1,000 shares authorized at
December 31, 1997 and 1996, 3,000
and 166.424 shares outstanding at
December 31, 1997 and 1996 30 2
Additional paid-in capital 56,442 57,440
Retained earnings 32,298 617,448
---------- ----------
Total stockholders' equity 89,740 674,890
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $2,066,875 $5,757,924
========== ==========
</TABLE>
See notes to consolidated financial statements.
F-23
<PAGE> 63
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
REVENUES:
Due diligence fees $ 4,058,609 $ 8,323,789 $ 7,525,620
Loan brokering/asset management
fees 3,027,319 2,469,378 1,770,665
Mortgage sales and servicing 826,486 970,757 2,289,440
Other income 58,151 355,715 295,944
----------- ----------- -----------
Total revenues 7,970,565 12,119,639 11,881,669
----------- ----------- -----------
EXPENSES:
Personnel expense 5,373,331 4,227,226 3,831,426
Appraisal, inspection and other
professional fees 618,059 3,128,225 2,593,001
Subcontractor expense 1,386,979 2,919,509 2,738,903
Travel and subsistence 302,936 616,795 860,253
Occupancy expense 495,285 536,520 437,830
General and administrative expense 419,543 525,143 1,066,220
Reversal of reserve for IRS
assessment (23,160) (277,600) --
Interest expense 117,894 134,393 160,439
Depreciation and amortization 117,675 125,928 114,174
----------- ----------- -----------
Total expenses 8,808,542 11,936,139 11,802,246
----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAX
PROVISION (BENEFIT) (837,977) 183,500 79,423
INCOME TAX (BENEFIT) PROVISION (325,959) 73,870 51,165
----------- ----------- -----------
NET INCOME (LOSS) $ (512,018) $ 109,630 $ 28,258
=========== =========== ===========
BASIC EARNINGS (LOSS) PER SHARE $ (525.79) $ 658.74 $ 169.80
=========== =========== ===========
</TABLE>
See notes to consolidated financial statements.
F-24
<PAGE> 64
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Common Stock Common Stock Common Stock Additional
Preferred Stock New Class A Old Class A Class B Paid-in Retained
Shares Amount Shares Amount Shares Amount Shares Amount Capital Earnings Total
--------- ------ ------------- ------------- ------------- ------- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 $165.800 $1 41,600 $1 $165,999 $500,846 $666,847
-------- -- ------ -- -------- -------- --------
Net income 109,630 109,630
Distribution of subsidiary to stockholders 6,972 6,972
Shareholders' Exchange Agreement:
Redemption of Class A shares (40.836) (108,559) (108,559)
Exchange of Class B shares for Class A shares 41.460 1 (41,600) (1) -- -- --
-------- -- ------ -- -------- -------- --------
BALANCE, DECEMBER 31, 1996 166.424 2 57,440 617,448 674,890
Net(loss) (512,018) (512,018)
Dividends (noncash) (73,132) (73,132)
Agreement and Plan of Recapitalization:
Exchange of "old" Class A shares
for "new" Class A shares and
Series A preferred Stock 97,000 $970 3,000 $30 (166.474) (2) (998) -- --
------ ---- ----- --- -------- -- -------- -------- --------
BALANCE, DECEMBER 31, 1997 97,000 $970 3,000 $30 -- -- $ 56,442 $ 32,298 $ 89,740
====== ==== ===== === ======== == ======== ======== ========
</TABLE>
See notes to consolidated financial statements.
F-25
<PAGE> 65
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (512,018) $ 109,630 $ 28,258
Adjustments to reconcile net income (loss)
to net cash (used in) provided by
operating activities:
Depreciation and amortization 117,675 125,928 114,174
Gain on sale of mortgage servicing rights (16,916) (52,318) (232,587)
Reversal of reserve for IRS assessment (23,160) (277,600) --
IRS payroll tax settlement (99,240) -- --
Loss on disposal of property and equipment 35,696 -- 10,261
Loss on sale of trading securities -- 1,360 753
Purchase of trading securities (951) (1,931) (29,951)
Sale of trading securities -- 26,593 100,016
Distribution of subsidiary to stockholders -- 6,972 --
Changes in assets - (increase) decrease:
Accounts receivable 3,550,036 (2,150,117) 862,364
Receivables from related parties (315,097) (308,808) 22,582
Accrued revenue on contracts in progress 514,368 (384,880) 1,011,785
Income tax receivable (292,885) -- --
Prepaid expenses and other current assets 24,474 (49,871) (39,169)
Deferred tax asset (20,081) -- --
Other assets (12,254) (22,914) (154,108)
Changes in liabilities - increase (decrease):
Accrued appraisal and subcontractor costs (2,675,194) 2,741,014 21,931
Accounts payable and accrued expenses (343,799) 104,018 (913,692)
Income taxes payable (89,477) (90,490) 15,634
Deferred income taxes (12,993) (17,222) (114,326)
Deferred revenue (89,384) (14,946) 113,855
Minority interest 366 (26,935) (147,057)
---------- ---------- ----------
Net cash (used in) provided by
operating activities (260,834) (282,517) 670,723
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (43,060) (133,317) (43,421)
Sale of property and equipment -- 4,592 1,704
Proceeds from sale of mortgage servicing rights 34,446 94,043 423,563
Capitalization of mortgage servicing rights (43,783) (37,451) (264,141)
---------- ---------- ----------
Net cash (used in) provided
by investing activities (52,397) (72,133) 117,705
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from (repayment of) note
payable to bank 360,000 (330,000) (125,000)
Redemption of Class A common stock -- (66,000) --
Repayment of subordinated debt -- -- (51,299)
---------- ---------- ----------
Net cash provided by (used in)
financing activities 360,000 (396,000) (176,299)
---------- ---------- ----------
NET INCREASE (DECREASE) WITH IN CASH AND
CASH EQUIVALENTS 46,769 (750,650) 612,129
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 161,546 912,196 300,067
---------- ---------- ----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 208,315 $ 161,546 $ 912,196
========== ========== ==========
SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES:
Loans of $25,649,378 and $35,831,617 were
originated by HCMC and funded by investors
in 1997 and 1996, respectively.
Noncash dividends of $73,132, were distributed
to the Company's stockholders on
September 19, 1997.
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for:
Income taxes $ 129,359 $ 205,075 $ 176,119
========== ========== ==========
Interest $ 116,993 $ 125,748 $ 164,420
========== ========== ==========
</TABLE>
See notes to consolidated financial statements.
F-26
<PAGE> 66
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- --------------------------------------------------------------------------------
1. BUSINESS DESCRIPTION
Hanover Capital Partners Ltd. ("HCP") and its subsidiaries operate as a
specialty finance company which is principally engaged in performing due
diligence services, mortgage and investment banking services and, prior to
September 1997, asset management services. A wholly-owned subsidiary of
HCP, Hanover Capital Mortgage Corporation ("HCMC"), is an originator and
servicer of multifamily mortgage loans. HCMC's operations are conducted
from multiple branches located throughout the United States. HCMC is
approved by the U.S. Department of Housing and Urban Development (HUD) as
a Title II Nonsupervised Mortgagee under the National Housing Act. Another
wholly-owned subsidiary of HCP, Hanover Capital Securities, Inc. ("HCS")
is a registered broker/dealer with the Securities and Exchange Commission.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Principles of Consolidation - The consolidated financial statements
include the accounts of HCP and its majority and wholly-owned
subsidiaries (the "Company"). The wholly owned subsidiaries include
HCMC, HCS, Hanover Capital Advisors, Inc. (through September 1997)
and Hanover Capital Mortgage Fund, Inc. (through September 1997).
Majority owned subsidiaries include Hanover Joint Ventures, Inc.
(75% owned) and Hanover On-Line Mortgage Edge, LLC (50% owned,
through September 1997). All significant intercompany accounts and
transactions have been eliminated.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amount of assets and
liabilities at the date of the financial statements and the required
amounts of revenues and expenses during the reporting period.
b. Investments in Limited Liability Companies - Minority ownership
interests in limited liability companies are accounted for by the
equity method of accounting. HCP's investment in limited liability
companies are classified as other assets in the accompanying
consolidated balance sheets. The ownership of each limited liability
company at December 31, 1997 and 1996 is detailed below:
1997 1996
---- ----
AGR Financial, LLC - 25.0%
Alpine/Hanover, LLC 1.0% 1.0%
ABH-I, LLC 1.0% 1.0%
Alpine/Hanover II, LLC - 1.0%
c. Minority Interests - Minority interests, representing other
stockholders' interests in majority-owned companies are consolidated
in the accompanying balance sheets.
F-27
<PAGE> 67
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- --------------------------------------------------------------------------------
d. Revenue Recognition - Revenues from due diligence contracts in
progress are recognized for the services provided as they are earned
and billed.
e. Loan Origination Fees and Costs - Loan origination fees and costs
are deferred until the sale of the loan. The Company sells all
originated loans to investors at the time of origination, and
accordingly, recognizes loan origination fees at that time. Direct
loan origination costs and loan origination fees are offset and
included in mortgage sales revenue.
f. Loan Servicing Fees - Loan servicing fees consist of fees paid by
investors for the collection of monthly mortgage payments,
maintenance of required escrow accounts, remittance to investors,
and ancillary income associated with those activities. The Company
recognizes loan servicing fees as payments are collected.
g. Deferred Revenue - Cash advances received for certain service
contracts are recorded in the accompanying consolidated balance
sheets as deferred revenue and are recognized during the period the
services are provided and the related revenue is earned.
h. Income Taxes - The Company records deferred taxes in accordance with
Statement of Financial Accounting Standards No. 109, Accounting for
Income Taxes ("SFAS 109"). Under SFAS 109 a current or deferred tax
liability or asset is recognized for the current or deferred tax
effects of all events recognized in the financial statements. Those
effects are measured based on provisions of current tax law to
determine the amount of taxes payable or refundable currently or in
future years. The tax effects of earning income or incurring
expenses in future years or the future enactment of a change in tax
laws or rates are not anticipated in determining deferred tax assets
or liabilities.
The Company files a consolidated Federal income tax return. The
Company has not been subject to an examination of their income tax
returns by the Internal Revenue Service.
i. Property and Equipment - Property and equipment is stated at cost
less accumulated depreciation. Depreciation is computed on the
straight-line method over the estimated useful lives of the assets,
generally three to seven years. Leasehold improvements are
depreciated over the terms of the respective leases or their
estimated useful lives, whichever is shorter.
j. Investment in Marketable Securities - Investment in marketable
securities which the Company has classified as trading securities
are reported in the accompanying consolidated balance sheets at
market value at December 31, 1997 and 1996.
k. Cash and Cash Equivalents - For cash flow purposes, the Company
considers highly liquid investments, purchased with an original
maturity of three months or less, to be cash equivalents. There were
no cash equivalents at December 31, 1997 and 1996.
l. Mortgage Servicing Rights - Effective January 1, 1997, the Company
adopted Statement of Financial Accounting Standards No. 125,
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities ("SFAS 125"). SFAS 125 supersedes
Statement of Financial Accounting Standards No. 122, Accounting for
Mortgage Servicing Rights, an amendment of FASB Statement No. 65.
Under SFAS 125, after the transfer of a financial asset, the Company
recognizes the financial assets it controls and the liabilities it
has incurred. Furthermore, the Company no longer recognizes the
financial assets for which control has been
F-28
<PAGE> 68
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- --------------------------------------------------------------------------------
surrendered and liabilities have been extinguished. The adoption of
SFAS 125 did not have an effect on the financial position or results
of operations of the Company.
In December 1996, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 127, Deferral of the
Effective Date of Certain Provisions of FASB Statement No. 125
("SFAS 127"). SFAS 127 defers for one year the effective date of
certain sections of SFAS 125, including those relating to repurchase
agreement, dollar-roll, securities lending and similar transactions,
as prescribed by SFAS 125. The adoption of SFAS 127 will not have a
material effect on the Company's financial position or results of
operations.
Prior to January 1, 1997, the Company accounted for mortgage
servicing rights in accordance with SFAS 122. For purposes of
assessing impairment, the lower of carrying value or fair value of
servicing rights is determined on an individual loan basis.
Capitalized servicing rights are amortized in proportion to
projected net servicing revenue. The fair value of servicing rights
is determined using a discounted cash flow method.
m. Basic Earnings per Share - The Company computes earnings per share
in accordance with statement of Financial Accounting Standards No.
128, Earnings per Share ("SFAS 128"). Basic earnings per share is
computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding during the
period. Shares issued during the period and shares reacquired during
the period are weighted for the portion of time they were
outstanding.
3. PAYROLL TAX SETTLEMENT
In 1994, the Internal Revenue Service ("IRS") began an examination of the
Company's payroll tax withholding practices with respect to independent
contractors who provided services to HCP's due diligence business.
Pursuant to the IRS Classification Settlement Program ("CSP"), HCP settled
all disputed payroll taxes relating to the IRS examination of HCP's
payroll withholding practices with respect to independent contractors. In
October 1997, management agreed to the terms of the CSP which required HCP
to pay the United States Government $99,240 in full discharge of any
federal employment tax liability and to further treat the workers as
employees (rather than independent contractors) on a prospective basis
effective April 1, 1998.
At December 31, 1995, HCP had recorded an accrual of $400,000 for payroll
withholding tax for independent contractors. HCP recorded a reversal of
reserve of $23,160 and $277,600 for the payroll tax matter in the
accompanying consolidated statements of operations for the years ended
December 31, 1997 and 1996, respectively, to adjust the previously
established reserve to the actual and expected settlement amounts.
F-29
<PAGE> 69
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- --------------------------------------------------------------------------------
4. CONCENTRATION RISK
For the years ended December 31, 1997, 1996 and 1995, the Company received
revenues from certain customers, which are subject to change annually,
which exceeded 10% of total revenues as follows:
1997 1996 1995
---- ---- ----
24% 46% 32%
18% 26% 16%
5. MORTGAGE SERVICING
The Company, through its wholly-owned subsidiary HCMC, services
multifamily mortgage loans on behalf of others. Loan servicing consists of
the collection of monthly mortgage payments on behalf of investors,
reporting information to those investors on a monthly basis and
maintaining custodial escrow accounts for the payment of principal and
interest to investors and property taxes and insurance premiums on behalf
of borrowers. As of December 31, 1997 and 1996, HCMC was servicing 43 and
46 loans, respectively, with unpaid principal balances of $120,736,400 and
$129,315,400, including loans subserviced for others of $40,055,200 and
$44,241,919, respectively. Escrow balances maintained by HCMC were
$3,087,400 and $4,352,400 at December 31, 1997 and 1996, respectively. The
aforementioned servicing portfolio and related escrow accounts are not
included in the accompanying consolidated balance sheets as of December
31, 1997 and 1996.
Activity in mortgage servicing rights for the years ended December 31,
1997 and 1996 was as follows:
1997 1996
-------- --------
Beginning balance $ 30,587 $ 46,904
Capitalization 43,783 37,451
Sales (17,530) (41,725)
Scheduled amortization (7,391) (12,043)
-------- --------
$ 49,449 $ 30,587
======== ========
The fair value of the Company's servicing rights at December 31, 1997 and
1996 was $79,504 and $46,606, respectively.
F-30
<PAGE> 70
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- --------------------------------------------------------------------------------
6. RELATED PARTY TRANSACTIONS
Receivables from related parties at December 31, 1997 and 1996 consist of
the following:
1997 1996
-------- --------
Due from Hanover Capital Mortgage Holdings, Inc. (1) $540,044 $ --
Due from ABH-I, LLC (includes $28,984 and
$431,118 of asset management fees at
December 31, 1997 and 1996, respectively) (2) 51,321 451,604
Due from Hanover Asset Services, Inc. (3) 8,070 6,420
Due from Alpine/Hanover, LLC (2) 9,273 4,361
Due from Alpine/Hanover II, LLC (3) 5,000 --
Due from Hanover Mortgage Capital Corporation (3) 5,962 --
Due from AGR Financial, LLC (4) 80,813 --
-------- --------
Due from related entities 700,483 462,385
Due from officers (5) 110,667 166,686
-------- --------
Receivables from related parties $811,150 $629,071
======== ========
(1) The Company entered into a Management Agreement in 1998 to provide,
among other things, due diligence, asset management and
administrative services to Hanover Capital Mortgage Holdings, Inc.
("HCHI") in connection with acquiring single-family mortgage loan
pools and managing and servicing HCHI's investment portfolio. The
term of the Management Agreement continues until December 31, 1999
with subsequent renewal provisions.
(2) Amounts due from entities that the Company had a minority ownership
percentage in for all of 1997 represent receivables resulting
primarily from fees generated from asset management services and
out-of-pocket expenses. The Company ceased providing asset
management services to these entities in September 1997. Asset
management fees are recognized in the period earned and amounted to
$2,446,000, $1,370,000 and $1,362,000 for the years ended December
31, 1997, 1996 and 1995, respectively.
(3) Amounts due from entities that are owned by certain of the Company's
officers/owners at December 31, 1997 represent receivables resulting
primarily from accounting fees and out-of-pocket expenses.
(4) Amounts due from AGR Financial, LLC represent unpaid billings for
services that the Company provides to AGR Financial, LLC pursuant to
an agreement dated August 1996. The services include but are not
limited to providing AGR Financial, LLC with office space, office
equipment, software operating systems, processing capabilities and
accounting services.
(5) Amounts due from officers in 1997 include $107,532 from the
Company's President which will be repaid in annual amounts of
$53,766 in August 1998 and August 1999.
F-31
<PAGE> 71
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- --------------------------------------------------------------------------------
Notes payable to related parties at December 31, 1996 consisted of the
following:
1996
----
Note payable to officer $ 42,559
Notes payable to ABH-I, LLC 90,459
--------
Notes payable to related parties $133,018
========
On January 1, 1996, HCP and its stockholders entered into an Exchange
Agreement (see Note 9) whereby HCP redeemed 40.836 shares of Class A
common stock from one of its stockholders in exchange for cash ($66,000)
and a term note in the amount of $42,559. The note was paid in full, with
interest at the prime rate plus 2.0% in January 1997.
Notes payable to ABH-I, LLC at December 31, 1996 consisted of three (3)
promissory notes totaling $90,459. All of the promissory notes bear
interest at the prime rate (8.25% at December 31, 1996). The promissory
notes were paid in full in 1997.
7. PROPERTY AND EQUIPMENT
Property and equipment at December 31, 1997 and 1996 consists of the
following:
1997 1996
--------- ---------
Office machinery and equipment $ 381,189 $ 388,123
Furniture and fixtures 111,246 111,246
Leasehold improvements 68,553 68,553
--------- ---------
560,988 567,922
Less accumulated depreciation and
amortization (347,851) (251,865)
--------- ---------
Property and equipment - net $ 213,137 $ 316,057
========= =========
Depreciation expense for the years ended December 31, 1997, 1996 and 1995
was $110,284, $113,885 and $87,913, respectively.
8. INCOME TAXES
The components of deferred income taxes as of December 31, 1997 and 1996
are as follows:
1997 1996
--------- ---------
Deferred tax assets $ 44,499 $ 52,409
Deferred tax liabilities (24,418) (65,402)
--------- ---------
Net deferred tax assets (liabilities) $ 20,081 $ (12,993)
========= =========
The items resulting in significant temporary differences for the years
ended December 31, 1997 and 1996 that generate deferred tax assets relate
primarily to the recognition of deferred revenue, accounts payable and
accrued liabilities for financial reporting purposes. Temporary
differences that generate
F-32
<PAGE> 72
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- --------------------------------------------------------------------------------
deferred tax liabilities relate primarily to the Company's change from the
cash method to the accrual method of accounting for income tax reporting
purposes.
The components of the income tax provision (benefit) for the years ended
December 31, 1997, 1996 and 1995 consist of the following:
1997 1996 1995
--------- --------- ---------
Current - Federal, state and local $(292,885) $ 91,092 $ 165,491
Deferred - Federal, state and local (33,074) (17,222) (114,326)
--------- --------- ---------
Total $(325,959) $ 73,870 $ 51,165
========= ========= =========
The income tax provision (benefit) differs from amounts computed at
statutory rates, as follows:
1997 1996 1995
--------- --------- ---------
Federal income taxes at statutory rate $(285,167) $ 56,518 $ 27,006
State and local income taxes net
of Federal benefit (59,486) 14,836 9,417
Unconsolidated subsidiary's net income (12,793) -- 1,177
Meals and entertainment 4,052 3,719 6,291
Officer's life insurance 9,613 8,576 9,114
Other, net 3,852 3,014 (663)
--------- --------- ---------
Total $(325,959) $ 73,870 $ 51,165
========= ========= =========
9. STOCKHOLDERS' EQUITY
On September 19, 1997, the Company entered into an Agreement and Plan of
Recapitalization ("Agreement") with its four stockholders to recapitalize
the Company. The Agreement provided for the tax-free exchange of the
stockholders 166.424 Class A "old" common stock shares for 3,000 shares of
"new" Class A common stock shares, $0.01 par value (representing a 3%
economic interest in the Company and 97,000 shares of Series A preferred
stock, $0.01 par value (representing a 97% economic interest in the
Company). The preferred stock has no dividend rate or preference over the
common stock. Dividend distributions will be made in the same amount on a
per share basis of the common stock as for the preferred stock. Dividend
distributions will be made to the common stockholders and the preferred
stockholders in proportion to the number of outstanding shares. The
preferred stockholder has the right to receive $10,750,005 upon
liquidation of the Company before common stockholders receive any
liquidating distributions.
On January 1, 1996, HCP entered into an exchange agreement ("Exchange
Agreement") with its stockholders in order to restructure the ownership of
HCP so that HCP had only 166.424 Class A shares of common stock
outstanding. The terms of the Exchange Agreement required HCP to: (1)
redeem 40.836 shares of Class A common stock; (2) exchange 41.460 shares
of Class B common stock for Class A common stock; (3) effect an exchange
of 8.468 shares of Class A common stock among certain stockholders; and
(4) transfer the ownership of Hanover Mortgage Capital Corporation
(formerly a wholly-owned subsidiary of HCP) to HCP's stockholders.
F-33
<PAGE> 73
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- --------------------------------------------------------------------------------
On January 1, 1996, pursuant to the Exchange Agreement, HCP transferred
its total ownership interests in its wholly-owned subsidiary, Hanover
Mortgage Capital Corporation to HCP's stockholders. Hanover Mortgage
Capital Corporation had a retained earnings deficiency at the time of
transfer.
10. NOTE PAYABLE TO BANK
In December 1996, HCP entered into a $2.0 million Line of Credit Facility
Agreement ("Line") with a bank that extends through December 31, 1999. The
note payable to the bank at December 31, 1997 and 1996 consisted of a
short-term note of $1,405,000 and $1,045,000, respectively, with an annual
interest rate at the prime rate as of December 31, 1997. In October 1997,
the terms of the Line were amended to decrease the interest rate on the
Line from the prime rate plus 1.5% to the prime rate. The interest rate in
effect at December 31, 1997 and 1996 was 8.50% and 9.75%, respectively.
The maximum borrowing capacity under the terms of the Line reduce every
six (6) months, beginning at June 30, 1997, by $150,000. The line is
collateralized by all of the assets of HCHI and guaranteed by HCHI. Prior
to September 1997, the line was collateralized by all of the assets of the
Company and guaranteed by the President and all of the wholly-owned
subsidiaries of HCP.
At December 31, 1997, the Company was in violation of certain financial
debt covenants of the Line that required the Company (on a stand-alone
basis) to: (1) maintain a maximum debt to net worth ratio of 3 to 1 at
December 31, 1997 and (2) to maintain a minimum debt service coverage
ratio of 1.25 to 1.00 at December 31, 1997. To mitigate the above
violations, the Company agreed to make a voluntary paydown on the Line of
$860,000 on February 17, 1998, thereby reducing the outstanding borrowings
on the line to $505,000.
11. COMMITMENTS AND CONTINGENCIES
The Company is involved in ongoing litigation regarding a mortgage loan
and a related reserve agreement. The Company has retained the services of
outside counsel. As of the date of this report, an evaluation of the
likelihood of success or an unfavorable outcome could not be performed. As
such, no amount has been provided for in the accompanying financial
statements. The Company intends to attempt to achieve final settlement of
the matter and if for any reason, the final settlement cannot be
effectuated, the Company intends to respond vigorously and will evaluate
the progress of the litigation as information becomes available.
The Company has noncancelable operating lease agreements for office space.
Future minimum rental payments for such leases are as follows:
YEAR AMOUNT
---- ------
1998 $187,414
1999 104,882
2000 37,714
--------
Total $330,010
========
Rent expense for the years ended December 31, 1997, 1996 and 1995 amounted
to $310,814, $339,421, and $345,716 respectively.
******
F-34
<PAGE> 1
EXHIBIT 10.29
MANAGEMENT AGREEMENT
THIS MANAGEMENT AGREEMENT (this "AGREEMENT") is made as of the 1st day of
January, 1998 (the "EFFECTIVE DATE"), by and between Hanover Capital Mortgage
Holdings, Inc., a Maryland corporation (the "COMPANY"), and Hanover Capital
Partners Ltd., a New York corporation (the "MANAGER").
WHEREAS, the Company intends to (i) invest in Mortgage Assets (as such
term is defined herein) using the proceeds of borrowings and equity offerings;
(ii) borrow against and securitize Mortgage Loans (as such term is defined
herein) and retain interests therein; and (iii) qualify as a "real estate
investment trust" under the Internal Revenue Code of 1986, as amended (the
"CODE");
WHEREAS, since the time of the Company's initial public offering, the
Manager has been acting on the Company's behalf subject to the direction and
oversight of the Company's Board of Directors (the "BOARD OF DIRECTORS");
WHEREAS, the Company desires to have the Manager continue to undertake, on
the Company's behalf, the duties and responsibilities set forth in this
Agreement, subject to the direction and oversight of the Board of Directors on
the terms and conditions set forth in this Agreement;
WHEREAS, the Manager desires to continue to undertake, on the Company's
behalf, the duties and responsibilities set forth in this Agreement, subject to
the direction and oversight of the Board of Directors, on the terms and
conditions set forth in this Agreement; and
WHEREAS, the Company and the Manager desire to formalize their
relationship by executing and delivering to each other this Agreement.
NOW, THEREFORE, in consideration of the mutual agreements set forth in
this Agreement and for other good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, the Company and the Manager agree
as follows:
1. DEFINITIONS. Capitalized terms used but not defined in this Agreement
shall have the respective meanings assigned to them below:
1.1 "AFFILIATE" means, when used with reference to a specified
person, any person that directly, or indirectly through one or more
intermediaries, controls or is controlled by, or is under common control with
the specified person. For purposes of this definition, the term "PERSON" means
and includes individuals, corporations, limited liability companies, general and
limited partnerships, stock companies, land trusts, business trusts and other
entities and governments and agencies and political subdivisions thereof. For
purposes of this definition, "CONTROL" (including the correlative meanings of
the terms "CONTROLLED BY" and "UNDER COMMON CONTROL WITH"), as used with respect
to any
<PAGE> 2
person, shall mean the possession, directly or indirectly, of the
power to direct or cause the direction of the management and
policies of such person, through the ownership of voting securities,
partnership interests or other equity interests.
1.2 "AGENCY CERTIFICATES" means Pass-Through Certificates
guaranteed by FNMA, FHLMC or GNMA.
1.3 "AGREEMENT" means this Management Agreement.
1.4 "BOARD OF DIRECTORS" has the meaning set forth in the
Recitals to this Agreement.
1.5 "CODE" has the meaning set forth in the Recitals to this
Agreement.
1.6 "COMMERCIAL MORTGAGE ASSETS" means Commercial Mortgage
Loans and Commercial Mortgage Securities.
1.7 "COMMERCIAL MORTGAGE LOANS" means Mortgage Loans secured
by commercial property.
1.8 "COMMERCIAL MORTGAGE SECURITIES" means Mortgage Securities
representing an interest in, or secured by, Commercial Mortgage
Loans.
1.9 "COMPANY" means Hanover Capital Mortgage Holdings, Inc., a
Maryland corporation, and its successors.
1.10 "CMO" means an adjustable or fixed-rate debt obligation
(bond) that is collateralized by Mortgage Loans or mortgage
certificates and issued by private institutions or issued or
guaranteed by FNMA, FHLMC or GNMA.
1.11 "FHLMC" means the Federal Home Loan Mortgage Corporation.
1.12 "FNMA" means the federally chartered and privately owned
corporation organized and existing under the Federal National
Mortgage Association Charter Act (12 U.S.C. ss. 1716 et seq.),
formerly known as the Federal National Mortgage Association.
1.13 "FEDERAL RESERVE BOARD" means the Board of Governors of
the Federal Reserve System.
1.14 "GAAP" means generally accepted accounting principles.
1.15 "GNMA" means the Governmental National Mortgage
Association.
1.16 "GOVERNING INSTRUMENTS" means the articles or certificate
of incorporation or charter, as the case may be, and the bylaws of
the Company.
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1.17 "INVESTMENT ADVISERS ACT" means the Investment Advisers
Act of 1940, as amended from time to time.
1.18 "MANAGEMENT COMPENSATION" has the meaning set forth in
Section 6 of this Agreement.
1.19 "MANAGER" means Hanover Capital Partners Ltd., a New York
corporation, and its successors hereunder.
1.20 "MORTGAGE ASSETS" means Single-Family Mortgage Assets,
Multifamily Mortgage Assets, Commercial Mortgage Assets and
Short-Term Investments.
1.21 "MORTGAGE LOANS" means Single-Family Mortgage Loans,
Multifamily Mortgage Loans and Commercial Mortgage Loans.
1.22 "MORTGAGE SECURITIES" means (i) Pass-Through
Certificates, (ii) CMOs, and (iii) REMICs.
1.23 "MULTIFAMILY MORTGAGE ASSETS" means Multifamily Mortgage
Loans and Multifamily Mortgage Securities.
1.24 "MULTIFAMILY MORTGAGE LOANS" means Mortgage Loans secured
by multifamily (in excess of four units) residential property.
1.25 "MULTIFAMILY MORTGAGE SECURITIES" means Mortgage
Securities representing an interest in, or secured by, Multifamily
Mortgage Loans.
1.26 "PASS-THROUGH CERTIFICATES" means securities (or
interests therein) which are Qualified REIT Assets evidencing
undivided ownership interests in a pool of Single-Family Mortgage
Loans, the holders of which receive a "pass-through" of the
principal and interest paid in connection with the underlying
Single-Family Mortgage Loans in accordance with the underlying
Single-Family Mortgage Loans in accordance with the holders'
respective, undivided interests in the pool.
1.27 "QUALIFIED HEDGE" means an interest rate swap or cap
agreement, option, futures contract, forward rate agreement or
similar financial instrument entered into to reduce the interest
rate risks with respect to indebtedness incurred or to be incurred
to acquire or carry Real Estate Assets and the payments on (or gain
on the disposition of) which qualify under Section 856(c)(2) of the
Code.
1.28 "QUALIFIED REIT ASSETS" means Pass-Through Certificates,
Mortgage Loans, Agency Certificates and other assets qualifying as
"real estate assets" under Code Section 856(c)(5)(B).
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1.29 "REAL ESTATE ASSETS" means interests in real property,
interests in mortgages on real property, regular and residual
interests in REMICs and stock in qualifying REITs.
1.30 "REIT" means real estate investment trust as defined
under Section 856 of the Code.
1.31 "REIT PROVISIONS OF THE CODE" means Sections 856 through
860 of the Code. 1.32 "REMIC" means serially maturing debt
securities secured by a pool of Mortgage Loans, the payments on
which bear a relationship to the debt securities and the issuer of
which qualifies as a "real estate investment conduit" as defined
under Section 860D of the Code.
1.33 "SHORT-TERM INVESTMENTS" means short-term bank
certificates of deposit, short-term United States Treasury
securities, short-term United States government agency securities,
commercial paper, repurchase agreements, short-term CMOs, short-term
asset-backed securities and other similar types of short-term
investment instruments, all of which will have maturities or average
lives of less than one (1) year.
1.34 "SINGLE-FAMILY MORTGAGE ASSETS" means Single-Family
Mortgage Loans and Single-Family Mortgage Securities.
1.35 "SINGLE-FAMILY MORTGAGE LOANS" means Mortgage Loans
secured by single-family (one to four unit) residential property.
1.36 "SINGLE-FAMILY MORTGAGE SECURITIES" means Mortgage
Securities representing an interest in, or secured by, Single-Family
Mortgage Loans.
1.37 "TEN-YEAR U.S. TREASURY RATE" means the arithmetic
average of the weekly average yield to maturity for actively traded
current coupon U.S. Treasury fixed interest rate securities
(adjusted to a constant maturity of ten years) published by the
Federal Reserve Board during a quarter, or, if such rate is not
published by the Federal Reserve Board, any Federal Reserve Bank or
agency or department of the federal government selected by the
Company. If the Company determines in good faith that the Ten-Year
U.S. Treasury Rate cannot be calculated as provided above, then the
rate shall be the arithmetic average of the per annum average yields
to maturities, based upon closing asked prices on each business day
during a quarter, for each actively traded marketable U.S. Treasury
fixed interest rate security with a final maturity date not less
than eight nor more than twelve years from the date of the closing
asked prices as chosen and quoted for each business day in each such
quarter in New York City by at least three recognized dealers in
U.S. government securities selected by the Company.
1.38 "UNAFFILIATED DIRECTORS" means a director who is not
affiliated directly or indirectly, with the Manager, whether by
ownership of, ownership interest in,
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employment by, any material business or professional
relationship with, or serving as an officer or director of the
Manager, and are not employed by or officers of the Company.
2. GENERAL DUTIES OF THE MANAGER.
2.1 SERVICES TO BE PROVIDED BY THE MANAGER. Subject to
the direction and oversight of the Board of Directors and in
accordance with the Governing Instruments, the Manager shall,
during the term of this Agreement, perform such services as
may be required from time to time for the management of the
Company and such other activities relating to the assets of
the Company as the Board of Directors shall reasonably request
or the Manager in good faith shall deem appropriate under the
particular circumstances, including the following:
2.1.1 serving as the Company's consultant with respect
to formulation of investment criteria and preparation of
policy guidelines by the Board of Directors;
2.1.2 assisting the Company in developing criteria for
the purchase of Mortgage Assets that are specifically tailored
to the Company's investment objectives;
2.1.3 representing the Company in connection with the
purchase and commitment to purchase or sell Mortgage Assets,
including the accumulation of Mortgage Loans for
securitization and the incurrence of debt;
2.1.4 arranging for the issuance of Mortgage Securities
from a pool of Mortgage Loans;
2.1.5 furnishing reports and statistical and economic
research to the Company regarding the Company's activities and
the services performed for the Company by the Manager;
2.1.6 monitoring and providing to the Board of Directors
on an ongoing basis price information and other data, obtained
from certain nationally recognized dealers that maintain
markets in Mortgage Assets identified by the Board of
Directors from time to time, and providing data and advice to
the Board of Directors in connection with the identification
of such dealers;
2.1.7 investing or reinvesting any money of the Company
in accordance with its policies and procedures and the terms
and conditions of this Agreement;
2.1.8 providing the executive and administrative
personnel, office space and services required in rendering
such services to the Company;
2.1.9 administering the day-to-day operations of the
Company and performing and supervising the performance of such
other administrative functions
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necessary for the management of the Company as may be agreed
upon by the Manager and the Board of Directors, including the
collection of revenues and the payment of the Company's debts
and obligations and maintenance of appropriate computer
systems to perform such administrative functions;
2.1.10 providing the Company with general data
processing, legal and administrative services to the extent
required to implement the business strategy of the Company;
2.1.11 counseling the Company in connection with policy
decisions made by the Board of Directors;
2.1.12 communicating on behalf of the Company with the
holders of the securities of the Company as required to
satisfy the reporting and other requirements of any
governmental bodies or agencies and to maintain effective
relations with such holders;
2.1.13 evaluating and recommending hedging strategies to
the Board of Directors and, upon approval by the Board of
Directors, engaging in hedging activities on behalf of the
Company, in all cases consistent with the Company's status as
a REIT;
2.1.14 supervising compliance with the REIT Provisions
of the Code and maintenance of an exemption from the
Investment Company Act and from any state or other laws
requiring the registration of investment companies;
2.1.15 qualifying and causing the Company to qualify to
do business in all applicable jurisdictions;
2.1.16 causing the Company to retain qualified
independent public accountants and tax experts to assist in
developing appropriate accounting procedures and testing
systems and conducting quarterly compliance reviews;
2.1.17 providing all actions necessary for compliance by
the Company with all federal, state and local regulatory
requirements applicable to the Company in respect of its
business activities, including preparing or causing to be
prepared all financial statements required under applicable
regulations and contractual undertakings and all reports,
filings and documents, if any, required under the Securities
Exchange Act of 1934, as amended;
2.1.18 providing all actions necessary to enable the
Company to make required federal, state and local tax filings
and reports and generally enable the Company to maintain its
status as a REIT, including soliciting stockholders for
required information to the extent provided in the REIT
Provisions of the Code;
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2.1.19 performing such other services as may be required
from time to time for management and other activities relating
to the assets of the Company as the Board of Directors shall
reasonably request or the Manager shall deem appropriate under
the particular circumstances; and
2.1.20 complying with and using commercially reasonable
efforts to cause the Company to comply with all applicable
laws.
2.2 ADDITIONAL OBLIGATIONS OF THE MANAGER.
2.2.1 VERIFY CONFORMITY WITH ACQUISITION CRITERIA. The
Manager shall use commercially reasonable efforts to ensure
that each Mortgage Asset acquired by the Company conforms to
the acquisition criteria of the Company and shall require each
seller or transferor of Mortgage Assets to the Company to make
such representations and warranties regarding such Mortgage
Assets as may, in the judgment of the Manager, be necessary
and appropriate for such purpose. With respect to Mortgage
Loans and consistent with prevailing industry practices, the
Manager shall use commercially reasonable efforts to require
the seller or transferor to repurchase any Mortgage Loan with
respect to which there is fraud or misrepresentation. In
addition, the Manager shall take any and all such other
actions as it deems necessary or appropriate with regard to
the protection of the Company's investments.
2.2.2 CONDUCT ACTIVITIES IN CONFORMITY WITH REIT STATUS
AND ALL APPLICABLE RESTRICTIONS. The Manager shall refrain
from any action which, in its judgment made in good faith or
in the judgment of the Board of Directors and communicated to
the Manager, would adversely affect the status of the Company
as a REIT or which, in the Manager's judgment made in good
faith or in the judgment of the Board of Directors and
communicated to the Manager, would violate any material law,
rule or regulation of any governmental body or agency having
jurisdiction over the Company or which would otherwise not be
permitted by the Company's Governing Instruments; any
operating policies adopted by the Company; or any agreements
to which the Company or any of its assets is subject or bound,
including without limitation any action which would result in
the requirement that the Company register as an Investment
Company under the Investment Company Act or under any state or
other law. If the Manager is ordered to take any such action
by the Board of Directors, the Manager shall promptly notify
the Board of Directors of the Manager's good faith judgment
that such action would adversely affect such status or violate
any such law, rule or regulation or the Governing Instruments;
operating policies adopted by the Company; or any agreements
to which the Company is a party or by or to which it is bound
or any of its assets are subject. Notwithstanding the
foregoing, the Manager, its directors, officers, stockholders
and employees shall not be liable to the Company, the
Unaffiliated Directors or any security holders of the Company
for any act or omission by the Manager, its directors,
officers, stockholders or employees except as provided in
Section 8 of this Agreement.
2.2.3 REPORTS. The Manager shall prepare an annual
compliance report to be reviewed for each fiscal year by
a firm independent of the Manager and its
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Affiliates and having the proper expertise to determine compliance with the REIT
Provisions of the Code and related matters. The Manager shall deliver such
report to the Company no later than March 31 of the following year. In
addition, the Manager will prepare regular reports for the Company's Board of
Directors that will review the Company's acquisitions of Mortgage Assets,
portfolio composition and characteristics, credit quality, performance and
compliance with the policies approved by the Company's Board of Directors.
2.2.4 PORTFOLIO TRANSACTIONS. In placing portfolio
transactions and selecting brokers or dealers, the Manager shall endeavor to
obtain on behalf of the Company commercially reasonable terms. In assessing
commercially reasonable terms for any transaction, the Manager shall consider
all factors it deems relevant, including the breadth of the market in the
security, the price of the security, the financial condition and execution
capability of the broker or dealer, and the reasonableness of the commission, if
any, both for the specific transaction and on a continuing basis.
Notwithstanding anything contained herein, the Manager shall place portfolio
transactions with Hanover Capital Securities, Inc., a New York corporation
("HCS"), whenever feasible.
2.3 COMPLIANCE WITH THE INVESTMENT ADVISERS ACT. The Manager
shall operate in compliance with the provisions of the Investment Advisers Act
applicable to the performance of the Manager's duties hereunder, including
without limitation the anti-fraud provisions of Section 206 of such Act.
2.4 COOPERATION OF THE COMPANY. The Company agrees to take all
actions reasonably required to permit the Manager to carry out its duties and
obligations under this Agreement. The Company further agrees to make available
to Manager all materials reasonably requested by the Manager to enable the
Manager to satisfy its obligations to deliver financial statements and any other
information or reports with respect to the Company.
3. ADDITIONAL ACTIVITIES OF THE MANAGER AND ITS AFFILIATES.
3.1 OTHER ACTIVITIES OF THE MANAGER. Nothing in this Agreement
shall prevent the Manager, its Affiliates, or any of the officers, directors or
employees of the Manager or its Affiliates, from engaging in other businesses or
from rendering services of any kind to any other person or entity, including the
purchase of, or advisory service to others investing in, any type of real estate
investment, including investments that meet the principal investment objectives
of the Company. Directors, officers, employees and agents of the Manager and of
Affiliates of the Manager may serve as trustees, directors, officers, employees,
agents, nominees or signatories for the Company or any subsidiary of the
Company, to the extent permitted by their Governing Instruments, as from time to
time amended, or by any resolutions duly adopted by the Board of Directors
pursuant to the Company's or such subsidiary's Governing Instruments. When
executing documents or otherwise acting in such capacities for the Company or
such subsidiary, such persons shall use their respective titles in the Company.
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3.2 OTHER INVESTMENT ADVISORY ACTIVITIES OF THE MANAGER.
Subject to any applicable contractual limitations, nothing contained in this
Agreement shall prevent the Manager, or any Affiliate of the Manager, from
acting as investment advisor or manager for any other person, firm or
corporation (including any investment company), whether or not the investment
objectives or policies of any such other person, firm or corporation are similar
to those of the Company, and shall not in any way bind or restrict the Manager
or any such Affiliate from buying, selling or trading any securities or
commodities for their own accounts or for the account of others for whom the
Manager or any such Affiliate may be acting. The Company acknowledges that the
Manager will base allocation decisions on the procedures the Manager considers
fair and equitable, including without limitation, such considerations as
investment objectives, restrictions and time horizon, availability of cash and
the amount of existing holdings. While information and recommendations supplied
to the Company shall, in the Manager's good faith judgment, be appropriate under
the circumstances and in light of the investment objectives and policies of the
Company, they may be different from the information and recommendations supplied
by the Manager or its Affiliates to investment companies, funds and advisory
accounts. The Company shall be entitled to equitable treatment under the
circumstances in receiving information, recommendations and any other services,
but the Company recognizes that it is not entitled to receive preferential
treatment as compared with the treatment given by the Manager to any investment
company, fund or advisory account.
4. BANK ACCOUNTS. At the direction of the Board of Directors, the
Manager may establish and maintain one or more bank accounts in the name of the
Company, and may collect and deposit into any such account or accounts, and
disburse funds from any such account or accounts, under such terms and
conditions as the Board of Directors may approve. The Manager shall from time to
time render appropriate accountings of such collections and payments to the
Board of Directors and, upon request, to the auditors of the Company.
5. RECORDS; CONFIDENTIALITY. The Manager shall maintain appropriate
books of account and records relating to services performed under this
Agreement, and such books of account and records shall be accessible for
inspection by representatives of the Company at any time during normal business
hours. Except in the ordinary course of business of the Company, the Manager
shall keep confidential any and all information it obtains from time to time in
connection with the services it renders under this Agreement and shall not
disclose any portion thereof to non-affiliated third-parties (other than lenders
to, and holders of stock of, the Manager) except with the prior written consent
of the Company.
6. COMPENSATION OF THE MANAGER.
6.1 MANAGEMENT COMPENSATION. For services rendered under this
Agreement, the Company shall pay to the Manager, commencing on the Effective
Date and payable as described below, the following (together, the "MANAGEMENT
Compensation"):
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6.1.1 PAYROLL COMPENSATION. The Company shall pay the Manager
for each month an amount equal to the sum of (x) the salaries and
wages (excluding payroll taxes and benefits) of the personnel
employed by the Manager and/or its Affiliates (other than
independent contractors and other third parties rendering due
diligence services in connection with the acquisition of any
Mortgage Assets) apportioned to providing services under this
Agreement to the Company (as reasonably determined by the Manager)
for such month plus (y) twenty-five percent (25%) of (x); and
6.1.2 THIRD PARTY DUE DILIGENCE SERVICES. The Company shall
also pay the Manager for each month an amount equal to the sum of
(x) the expenses of the Manager for any due diligence services
provided by independent contractors and other third parties in
connection with the acquisition of any Mortgage Assets during such
month plus (y) three percent (3%) of (x).
6.2 BILLING AND OFFSET. The Manager shall prepare, for each month
during the term of this Agreement, a statement documenting the Management
Compensation for such month, and shall deliver such statement to the Company.
Management Compensation for any month as set forth on the statement for such
month shall be due and payable by the Company thirty (30) days after the receipt
by the Company of the statement for such month. Any amount that may become
payable by the Manager to the Company for any services provided by the Company
to the Manager, including without limitation the services of John A. Burchett,
Joyce S. Mizerak, Irma N. Tavares and George J. Ostendorf, shall be offset
against amounts payable to the Manager as provided in this Section 6.
6.3 STOCK OPTION. The Manager and the Company agree and acknowledge
that the Company shall grant to the Manager a non-qualified stock option under
the Company's 1997 Stock Option Plan for 72,509 shares (or such lesser number as
is available for grant under such Stock Option Plan) of the Company's Common
Stock, par value $.01 per share, at an exercise price of $15.75 per share with
the understanding that such option may be transferred, directly or indirectly,
in whole or in part, including by the Manager's grant of options with respect to
such option, by the Manager to its officers, directors and employees and such
other persons who are expected to provide significant services to the Manager
provided that any such transfer has been registered or qualified under the
Securities Act of 1933, as amended, and any state or other securities laws or,
in the opinion of counsel to the Manager and reasonably satisfactory to the
Company, the transfer is exempt from the registration or qualification
requirements of such Act and such state and other securities laws.
7. EXPENSES OF THE MANAGER AND THE COMPANY.
7.1 EXPENSES OF THE MANAGER. Without regard to the compensation
received under this Agreement by the Manager, the Manager shall bear the
following expenses: rent, telephone, utilities, office furniture, equipment,
machinery, and other
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office expenses of the Manager and/or its Affiliates required for the Company's
day-to-day operations, including bookkeeping, clerical and back-office services
provided by the Manager or its Affiliates.
7.2 EXPENSES OF THE COMPANY. The Company shall pay all of its
expenses except those that are the responsibility of the Manager pursuant to
Section 7.1 of this Agreement, and without limiting the generality of the
foregoing, it is specifically agreed that the following expenses of the Company
shall be paid by the Company and shall not be paid by the Manager or Affiliates
of the Manager:
7.2.1 the cost of money borrowed by the Company, including interest;
7.2.2 all taxes and license fees applicable to the Company,
including interest and penalties thereon;
7.2.3 legal, audit, accounting, underwriting, brokerage, listing,
filing, rating agency, registration and other fees, printing, engraving,
clerical, personnel and other expenses and taxes incurred in connection with the
issuance, distribution, transfer, registration and stock exchange listing of the
Company's securities;
7.2.4 fees and expenses paid to advisors and independent
contractors, consultants, managers, and other agents engaged directly by the
Company or by the Manager at the Company's request for the account of the
Company or any subsidiary of the Company (other than the Manager or its
Affiliates);
7.2.5 expenses connected with the acquisition, disposition,
financing and ownership of the Company's investment assets, including, but not
limited to, commitment fees, brokerage fees or commissions, guaranty fees, ad
valorem taxes, costs of foreclosure, maintenance, repair and improvement of
property and premiums for insurance on property owned by the Company;
7.2.6 costs related to hedging transactions;
7.2.7 the expenses of organizing, modifying or dissolving the
Company;
7.2.8 all insurance costs incurred by the Company, including any
costs to obtain liability or other insurance to indemnify the Manager and
underwriters of any securities of the Company;
7.2.9 expenses connected with payments of dividends or interest or
distributions in any other form made or caused to be made by the Board of
Directors to holders of the securities of the Company;
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7.2.10 expenses connected with the structuring, issuance and
administration of Mortgage Securities by the Company, including, but
not limited to, legal fees, trustee's fees, insurance premiums, and
costs of required credit enhancements;
7.2.11 expenses of third parties connected with communications
to holders of securities issued by the Company and the other
bookkeeping and clerical work necessary in maintaining relations
with holders of such securities and in complying with the continuous
reporting and other requirements of governmental bodies or agencies,
including any costs of computer services in connection with this
function, the cost of printing and mailing certificates for such
securities and proxy solicitation materials and reports to holders
of the Company's securities and reports to third parties required
under any indenture to which the Company is a party;
7.2.12 custodian's, transfer agent's and registrar's fees and
charges;
7.2.13 compensation, fees and expenses paid to Unaffiliated
Directors of the Company, the cost of director and officer liability
insurance and premiums for errors and omissions insurance;
7.2.14 legal, accounting and auditing fees and expenses
relating to the Company's operations (excluding litigation-related
fees and expenses described in Section 7.2.15);
7.2.15 legal, expert and other fees and expenses relating to
any actions, proceedings, lawsuits, demands, causes of action and
claims, whether actual or threatened, made by or against the
Company, or which the Company is authorized or obligated to pay
under applicable law or its Governing Instruments or by the Board of
Directors;
7.2.16 any judgment rendered against the Company, or against
any director or officer of the Company in his capacity as such for
which the Company is required to indemnify such director or officer
by any court or governmental agency, or settlement of pending or
threatened litigation;
7.2.17 expenses relating to any office or office facilities
maintained by the Company exclusive of the office of the Manager
and/or its Affiliates;
7.2.18 expenses related to the accumulation, servicing and
subservicing of Mortgage Loans;
7.2.19 travel and related expenses of directors, officers and
employees of the Manager and of directors, officers and employees of
the Company who are also directors, officers or employees of the
Manager, incurred in connection with attending meetings of the Board
of Directors or holders of securities of the Company or performing
other business activities that relate to the Company, including,
where
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applicable, a proportionate share of such expenses as reasonably determined by
Manager where such expenses were not incurred solely for the benefit of the
Company;
7.2.20 costs associated with computer hardware and software, third
party information services and office expenses that relate solely to the
business activities of the Company;
7.2.21 any extraordinary or non-recurring costs or charges incurred
by the Company; and
7.2.22 other expenses of the Company that are not expenses of the
Manager under Section 7.1 of this Agreement.
7.3 EXPENSE REIMBURSEMENT TO THE MANAGER. Expenses incurred by the
Manager on behalf of the Company shall be reimbursed monthly to the Manager
within thirty (30) days after the end of each month. The Manager shall prepare a
statement documenting the expenses of the Company and those incurred by the
Manager on behalf of the Company during each month, and shall deliver such
statement to the Company within fifteen (15) days after the end of the month to
which the expenses relate. Expense reimbursement to the Manager shall be subject
to adjustment at the end of each fiscal year in connection with the annual audit
of the Company. Any amount that may become payable by the Manager pursuant to
such an annual adjustment shall be offset against future Management Compensation
amounts payable to the Manager pursuant to Section 6 hereof.
8. LIMITS OF MANAGER RESPONSIBILITY. The Manager assumes no responsibility
under this Agreement other than to render the services specifically called for
under this Agreement and shall not be responsible for any action of the Board of
Directors in following or declining to follow any advice or recommendations of
the Manager, including as set forth in Section 2.2.2 of this Agreement. The
Manager, its directors, officers, stockholders and employees will not be liable
to the Company, any issuer of Mortgage Securities or the Unaffiliated Directors
for any acts or omissions, errors of judgment or mistakes of law by the Manager,
its directors, officers, stockholders or employees under or in connection with
this Agreement, except by reason of acts or omissions, errors of judgment or
mistakes of law constituting bad faith, willful misconduct, gross negligence or
reckless disregard of their duties under this Agreement. The Company shall
reimburse, indemnify and hold harmless the Manager, its directors, officers,
stockholders and employees of and from any and all expenses, losses, damages,
liabilities, demands, charges and claims of any nature whatsoever (including,
without limitation, reasonable attorneys' fees) in respect of or arising from
any acts or omissions, errors of judgment or mistakes of law of the Manager, its
stockholders, directors, officers and employees made in good faith in the
performance of the Manager's duties under this Agreement or pursuant to any
underwriting agreement or similar agreement to which the Manager is a party in
connection with any debt or equity sales of the Company's securities and not
constituting bad faith, willful misconduct, gross negligence or reckless
disregard of their duties under this Agreement or any such underwriting
agreement. The
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Manager shall be indemnified by the Company as an agent of the Company in
accordance with the terms of the Company's Governing Instruments.
9. NO JOINT VENTURE. The Company and the Manager are not partners or joint
venturers with each other, and nothing in this Agreement shall be construed to
make them such partners or joint venturers or impose any liability as such on
any of them. The Manager is an independent contractor and, except as expressly
provided or authorized in this Agreement, shall have no authority to act for or
represent the Company.
10. TERM AND TERMINATION. This Agreement shall commence on the Effective
Date and shall continue in force until December 31, 1999 and thereafter it shall
be subject to successive one-year renewal periods upon the review and approval
of the Unaffiliated Directors. If the Unaffiliated Directors do not resolve to
renew or terminate this Agreement within at least sixty (60) days prior to the
end of the then-current period of this Agreement, this Agreement shall be
automatically extended for a one-year period. The Company and the Manager shall
have the right, following the initial term of this Agreement, to terminate this
Agreement at any time upon not less than sixty (60) days prior written notice.
11. ASSIGNMENTS. Upon not less than sixty (60) days prior written notice
to the Board of Directors of the Company, this Agreement may be assigned by the
Manager to an Affiliate of the Manager without the consent of the Company.
Except in the event of an assignment by the Manager to an Affiliate of the
Manager or as otherwise set forth in this Section 11, this Agreement shall
terminate automatically in the event of its assignment, in whole or in part, by
the Manager (other than the pledge of amounts payable to the Manager under this
Agreement to secure the Manager's obligations to its lenders), unless such
assignment is consented to in writing by the Company with the consent of a
majority of the Unaffiliated Directors. The Company shall not withhold its
consent to any assignment of this Agreement by the Manager in connection with
any acquisition, consolidation or merger of the Manager, to the extent such
consent is required by the Investment Advisers Act. Any assignment shall bind
the assignee under this Agreement in the same manner as the Manager is bound. In
addition, the assignee shall execute and deliver to the Company a counterpart of
this Agreement naming such assignee as Manager. This Agreement shall not be
assigned by the Company without the prior written consent of the Manager, except
in the case of assignment by the Company to a REIT or other organization which
is a successor (by merger, consolidation or purchase of assets) to the Company,
in which case such successor organization shall be bound under this Agreement
and by the terms of such assignment in the same manner as the Company is bound
under this Agreement.
12. TERMINATION BY COMPANY FOR CAUSE. At the option of the Company, this
Agreement shall be and become terminated immediately (subject to any opportunity
to cure set forth below) upon written notice of termination from the Board of
Directors to the Manager if any of the following events shall occur (termination
for any of such events shall constitute termination for "cause"):
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12.1 if a majority of the Unaffiliated Directors determines that the
Manager has violated this Agreement in any material respect and, after written
notice of such violation, the Manager has failed to cure such violation within
thirty (30) days, unless during such thirty (30)-day period the Manager has
commenced to cure such violation and thereafter diligently prosecutes to cure
such violation; or
12.2 there is entered an order for relief or similar decree or order
with respect to the Manager by a court having competent jurisdiction in an
involuntary case under the federal bankruptcy laws as now or hereafter
constituted or under any applicable federal or state bankruptcy, insolvency or
other similar laws; or the Manager (i) admits in writing its inability to pay
its debts as they become due and payable, or makes a general assignment for the
benefit of, or enters into any composition or arrangement with, creditors; (ii)
applies for, or consents (by admission of material allegations of a petition or
otherwise) to the appointment of a receiver, trustee, assignee, custodian,
liquidator or sequestrator (or other similar official) of the Manager or of any
substantial part of its properties or assets, or authorizes such an application
or consent, or proceedings seeking such appointment are commenced without such
authorization, consent or application against the Manager and continue
undismissed for thirty (30) days; (iii) authorizes or files a voluntary petition
in bankruptcy, or applies for or consents (by admission of material allegations
of a petition or otherwise) to the application of any bankruptcy,
reorganization, arrangement, readjustment of debt, insolvency, dissolution,
liquidation or other similar law of any jurisdiction, or authorizes such
application or consent, or proceedings to such end are instituted against the
Manager without such authorization, application or consent and are approved as
properly instituted and remain undismissed for thirty (30) days or result in
adjudication of bankruptcy or insolvency; or (iv) permits or suffers all or any
substantial part of its properties or assets to be sequestered or attached by
court order and the order remains undismissed for thirty (30) days; provided,
however, that in the event the Manager becomes the subject of a case under
federal bankruptcy or similar federal or state laws and remains in possession of
its property and continues to operate its business (as a debtor in possession or
otherwise), the Company shall not have the option to terminate this Agreement
unless the Unaffiliated Directors determine in good faith that as a result of
such proceeding the Manager cannot reasonably be expected to fulfill its
obligations under this Agreement. If any of the events specified in Section 12.2
of this Agreement shall occur, the Manager shall give prompt written notice
thereof to the Board of Directors upon the happening of such event.
13. ACTION UPON TERMINATION. From and after the effective date of
termination of this Agreement, pursuant to Sections 10, 11 or 12 of this
Agreement, the Manager shall not be entitled to compensation for further
services under this Agreement, but shall be paid all Management Compensation
accruing to the date of termination. Upon such termination, the Manager shall
forthwith:
13.1 after deducting any accrued Management Compensation and
reimbursement for its expenses to which it is then entitled, pay over to the
Company all money collected and held for the account of the Company pursuant to
this Agreement;
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13.2 deliver to the Board of Directors, upon their request therefor,
a full accounting, including a statement showing all payments collected by it
and a statement of all money held by it, covering the period following the date
of the last accounting furnished to the Board of Directors with respect to the
Company; and
13.3 deliver to the Board of Directors all property and documents of
the Company then in the custody of the Manager.
14. RELEASE OF MONEY OR OTHER PROPERTY UPON WRITTEN REQUEST. The
Manager agrees that any money or other property of the Company held by the
Manager under this Agreement shall be held by the Manager as custodian for the
Company, and the Manager's records shall be appropriately marked clearly to
reflect the ownership of such money or other property by the Company. Upon the
receipt by the Manager of a written request signed by a duly authorized officer
of the Company requesting the Manager to release to the Company any money or
other property then held by the Manager for the account of the Company under
this Agreement, the Manager shall release such money or other property to the
Company within a reasonable period of time, but in no event later than the later
to occur of (i) thirty (30) days following such request and (ii) the earliest
time following such request that remittance will not cause the Manager to
violate any law or breach any agreement to which it or the Company is a party.
The Manager shall not be liable to the Company, the Unaffiliated Directors, or
the Company's stockholders for any acts performed or omissions to act by the
Company in connection with the money or other property released to the Company
in accordance with this Section 14 and not constituting bad faith, willful
misconduct, gross negligence or reckless disregard of its duties under this
Agreement. The Company shall indemnify the Manager, its directors, officers,
stockholders and employees against any and all expenses, losses, damages,
liabilities, demands, charges and claims of any nature whatsoever, which arise
in connection with the Manager's release of such money or other property to the
Company in accordance with the terms of this Section 14 unless such expenses,
losses, damages, liabilities, demands, charges and claims arise in connection
with acts or omissions which constitute bad faith, willful misconduct, gross
negligence or reckless disregard of its duties under this Agreement.
Indemnification pursuant to this provision shall be in addition to any right of
the Manager to indemnification under Section 8 of this Agreement.
15. REPRESENTATIONS AND WARRANTIES.
15.1 COMPANY IN FAVOR OF THE MANAGER. The Company hereby represents
and warrants to the Manager as follows:
15.1.1 DUE FORMATION. The Company is duly organized, validly
existing and in good standing under the laws of the state of Maryland and has
the power to own its assets and to transact the business in which it is now
engaged.
15.1.2 POWER AND AUTHORITY. The Company has the requisite corporate
power and authority to execute, deliver and perform this Agreement and all
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obligations required under this Agreement and has taken all necessary action to
authorize this Agreement on the terms and conditions hereof and the execution,
delivery and performance of this Agreement and all obligations required under
this Agreement. Except as shall have been obtained, no consent of any other
person, including without limitation, stockholders and creditors of the Company,
and no license, permit, approval or authorization of, exemption by, notice or
report to, or registration, filing or declaration with, any governmental
authority is required by the Company in connection with this Agreement or the
execution, delivery, performance, validity or enforceability of this Agreement
and all obligations required under this Agreement. This Agreement has been, and
each instrument or document required under this Agreement will be, executed and
delivered by a duly authorized officer of the Company, and this Agreement
constitutes, and each instrument or document required under this Agreement when
executed and delivered under this Agreement will constitute, the legally valid
and binding obligation of the Company enforceable against the Company in
accordance with its terms.
15.1.3 EXECUTION, DELIVERY AND PERFORMANCE. The execution, delivery
and performance of this Agreement and the documents or instruments required
under this Agreement will not violate any provision of any existing law or
regulation binding on the Company, or any order, judgment, award or decree of
any court, arbitrator or governmental authority binding on the Company, or the
Governing Instruments of, or any securities issued by, the Company or of any
mortgage, indenture, lease, contract or other agreement, instrument or
undertaking to which the Company is a party or by which the Company or any of
its assets may be bound, the violation of which would have a material adverse
effect on the business operations, assets or financial condition of the Company
and its subsidiaries, taken as a whole, and will not result in, or require, the
creation or imposition of any lien on any of its property, assets or revenues
pursuant to the provisions of any such mortgage, indenture, lease, contract or
other agreement, instrument or undertaking (other than the pledge of amounts
payable to the Manager under this Agreement to secure the Manager's obligations
to its lenders).
15.2 MANAGER IN FAVOR OF THE COMPANY. The Manager hereby represents
and warrants to the Company as follows:
15.2.1 DUE FORMATION. The Manager is duly organized, validly
existing and in good standing under the laws of the state of New York and has
the corporate power to own its assets and to transact the business in which it
is now engaged.
15.2.2 POWER AND AUTHORITY. The Manager has the corporate power and
authority to execute, deliver and perform this Agreement and all obligations
required under this Agreement and has taken all necessary corporate action to
authorize this Agreement on the terms and conditions hereof and the execution,
delivery and performance of this Agreement and all obligations required under
this Agreement. Except as shall have been obtained, no consent of any other
person including, without limitation, stockholders and creditors of the Manager,
and no license, permit, approval or authorization of, exemption by, notice or
report to, or registration, filing or declaration with, any governmental
authority is required by the Manager in connection with this
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Agreement or the execution, delivery, performance, validity or enforceability
of this Agreement and all obligations required under this Agreement. This
Agreement has been and each instrument or document required under this Agreement
will be executed and delivered by a duly authorized officer of the Manager, and
this Agreement constitutes, and each instrument or document required under this
Agreement when executed and delivered under this Agreement will constitute, the
legally valid and binding obligation of the Manager enforceable against the
Manager in accordance with its terms.
15.2.3 EXECUTION, DELIVERY AND PERFORMANCE. The execution, delivery
and performance of this Agreement and the documents or instruments required
under this Agreement will not violate any provision of any existing law or
regulation binding on the Manager, or any order, judgment, award or decree of
any court, arbitrator or governmental authority binding on the Manager, or the
governing instruments of, or any securities issued by, the Manager or of any
mortgage, indenture, lease, contract or other agreement, instrument or
undertaking to which the Manager is a party or by which the Manager or any of
its assets may be bound, the violation of which would have a material adverse
effect on the business operations, assets, or financial condition of the Manager
and its subsidiaries, taken as a whole, and will not result in, or require, the
creation or imposition of any lien on any of its property, assets or revenues
pursuant to the provisions of any such mortgage indenture, lease, contract or
other agreement, instrument or undertaking.
16. NOTICES. Unless expressly provided otherwise in this Agreement, all
notices, requests, demands and other communications required or permitted under
this Agreement shall be in writing and shall be deemed to have been duly given,
made and received when (i) delivered by hand, (ii) otherwise delivered against
receipt therefor, or (iii) upon actual receipt of registered or certified mail,
postage prepaid, return receipt requested. The parties may deliver to each other
notice by electronically transmitted facsimile copies, provided that such
facsimile notice is followed within 24 hours by any type of notice otherwise
provided for in this Section 16. Any notice shall be duly addressed to the
parties as follows:
(a) If to the Company:
90 West Street
Suite 1508
New York, New York 10006
Attn: President
Telecopy: (212) 732-4728
(b) If to the Manager:
90 West Street
Suite 1508
New York, New York 10006
Attn: President
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Telecopy: (212) 732-4728
Any party may alter the address to which communications or copies are to be sent
by giving notice of such change of address in conformity with the provisions of
this Section 16 for the giving of notice.
17. BINDING NATURE OF AGREEMENT; SUCCESSORS AND ASSIGNS. This Agreement
shall be binding upon and inure to the benefit of the parties hereto and their
respective heirs, personal representatives, successors and assigns as provided
in this Agreement.
18. ENTIRE AGREEMENT. This Agreement contains the entire agreement and
understanding among the parties hereto with respect to the subject matter
hereof, and supersedes all prior and contemporaneous agreements, understandings,
inducements and conditions, express or implied, oral or written, of any nature
whatsoever with respect to the subject matter hereof. The express terms hereof
control and supersede any course of performance and/or usage of the trade
inconsistent with any of the terms hereof. This Agreement may not be modified or
amended other than by an agreement in writing.
19. CONTROLLING LAW. This Agreement and all questions relating to its
validity, interpretation, performance and enforcement shall be governed by and
construed, interpreted and enforced in accordance with the laws of the State of
New York notwithstanding any New York or other conflict of law provisions to the
contrary.
20. INDULGENCES, NOT WAIVERS. Neither the failure nor any delay on the
part of a party to exercise any right, remedy, power or privilege under this
agreement shall operate as a waiver thereof, nor shall any single or partial
exercise of any right, remedy, power or privilege preclude any other or further
exercise of the same or of any right, remedy, power or privilege, nor shall any
waiver of any right, remedy, power or privilege with respect to any occurrence
be construed as a waiver of such right, remedy, power or privilege with respect
to any other occurrence. No waiver shall be effective unless it is in writing
and is signed by the party asserted to have granted such waiver.
21. TITLES NOT TO AFFECT INTERPRETATION. The titles of paragraphs and
subparagraphs contained in this Agreement are for convenience only, and they
neither form a part of this Agreement nor are they to be used in the
construction or interpretation hereof.
22. EXECUTION IN COUNTERPARTS. This Agreement may be executed in any
number of counterparts, each of which shall be deemed to be an original as
against any party whose signature appears thereon, and all of which shall
together constitute one and the same instrument. This Agreement shall become
binding when one or more counterparts hereof, individually or taken together,
shall bear the signatures of all of the parties reflected hereon as the
signatories.
23. PROVISIONS SEPARABLE. The provisions of this Agreement are independent
of and separable from each other, and no provision shall be affected or rendered
invalid or
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unenforceable by virtue of the fact that for any reason any other or others of
them may be invalid or unenforceable in whole or in part.
24. GENDER. Words used herein regardless of the number and gender
specifically used shall be deemed and construed to include any other number,
singular or plural, and any other gender, masculine, feminine or neuter, as the
context requires.
25. ATTORNEYS' FEES. Should any action or other proceeding be necessary to
enforce any of the provisions of this Agreement or the various transactions
contemplated hereby, the prevailing party will be entitled to recover its actual
reasonable attorneys' fees and expenses from the non-prevailing party.
26. AMENDMENTS. This Agreement may not be amended, modified or changed (in
whole or in part), except by a formal, definitive written agreement expressly
referring to this Agreement, which agreement is executed by all of the parties.
The parties hereto expressly acknowledge that no consent or approval of the
Company's stockholders is required in connection with any amendment,
modification or change to this Agreement.
27. AUTHORITY. Each signatory to this Agreement warrants and represents
that he is authorized to sign on behalf of and to bind the party on whose behalf
he, she or it is signing.
[Remainder of Page Intentionally Left Blank]
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IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of
the effective date.
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
By:__________________________________
Title:
HANOVER CAPITAL PARTNERS LTD.
By:__________________________________
Title:
<PAGE> 1
MASTER LOAN AND SECURITY AGREEMENT
MASTER LOAN AND SECURITY AGREEMENT, dated as of December 8, 1997, between
HANOVER CAPITAL MORTGAGE HOLDINGS, INC., a Maryland corporation (the
"BORROWER"), and MORGAN STANLEY MORTGAGE CAPITAL INC., a Delaware corporation
(the "LENDER").
RECITALS
The Borrower has requested that the Lender from time to time make revolving
credit loans to it to finance certain residential mortgage loans owned by the
Borrower, and the Lender is prepared to make such loans upon the terms and
conditions hereof. Accordingly, the parties hereto agree as follows:
Section 1. DEFINITIONS AND ACCOUNTING MATTERS.
1.01 CERTAIN DEFINED TERMS. As used herein, the following terms shall have
the following meanings (all terms defined in this Section 1.01 or in other
provisions of this Loan Agreement in the singular to have the same meanings when
used in the plural and VICE VERSA):
"AFFILIATE" shall mean, (i) with respect to the Lender, MS & Co. and Morgan
Stanley, Dean Witter, Discover & Co., and Morgan Stanley Group Inc. and MS & Co.
and (ii) with respect to the Borrower, any "affiliate" of the Borrower as such
term is defined in the United States Bankruptcy Code in effect from time to
time.
"APPLICABLE COLLATERAL PERCENTAGE" shall mean (a) with respect to all
Eligible Mortgage Loans other than Second Lien Mortgage Loans and Delinquent
Mortgage Loans, 97%, (b) with respect to all Eligible Mortgage Loans that are
Second Lien Mortgage Loans, 90%, and (c) with respect to all Eligible Mortgage
Loans that are Delinquent Mortgage Loans, 85%.
"APPLICABLE MARGIN" shall mean 60 basis points (0.60%).
"APPRAISED VALUE" shall mean the value set forth in an appraisal made in
connection with the origination of the related Mortgage Loan as the value of the
Mortgaged Property.
"BANKRUPTCY CODE" shall mean the United States Bankruptcy Code of 1978, as
amended from time to time.
"BLOCKED ACCOUNT AGREEMENT" shall mean an agreement between the Servicer
and the Lender, substantially in the form of EXHIBIT G hereto, as the same may
be amended, supplemented or otherwise modified from time to time, in which the
Servicer acknowledges the Lender's lien on the Collection Account, and agrees
that, in the event that it receives notice that an Event of Default hereunder
has occurred and until such notice is rescinded by the Lender, the Servicer
shall only withdraw funds from the Collection Account on instruction from the
Lender.
"BORROWER" shall have the meaning provided in the heading hereof.
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<PAGE> 2
"BORROWING BASE" shall mean the aggregate Collateral Value of all Eligible
Mortgage Loans.
"BORROWING BASE DEFICIENCY" shall have the meaning provided in Section 2.06
hereof.
"BUSINESS DAY" shall mean any day other than (i) a Saturday or Sunday or
(ii) a day on which the New York Stock Exchange, the Federal Reserve Bank of New
York or the Custodian is authorized or obligated by law or executive order to be
closed.
"CAPITAL EXPENDITURES" shall mean, as to any Person for any period, the
aggregate amount paid or accrued by such Person and its Affiliates for the
rental, lease, purchase (including by way of the acquisition of securities of
any Person), construction or use of any Property during such period, the value
or cost of which, in accordance with GAAP, would appear on such Person's
consolidated balance sheet in the category of property, plant or equipment at
the end of such period.
"CAPITAL LEASE OBLIGATIONS" shall mean, for any Person, all obligations of
such Person to pay rent or other amounts under a lease of (or other agreement
conveying the right to use) Property to the extent such obligations are required
to be classified and accounted for as a capital lease on a balance sheet of such
Person under GAAP, and, for purposes of this Loan Agreement, the amount of such
obligations shall be the capitalized amount thereof, determined in accordance
with GAAP.
"CODE" shall mean the Internal Revenue Code of 1986, as amended from time
to time.
"COLLATERAL" shall have the meaning provided in Section 4.01(b) hereof.
"COLLATERAL VALUE" shall mean, with respect to each Eligible Mortgage Loan,
the lesser of (a) the Applicable Collateral Percentage of the Market Value of
such Mortgage Loan, and (b) the outstanding principal balance of such Mortgage
Loan; provided that,
(a) the Collateral Value shall be deemed to be zero with respect to each
Mortgage Loan (1) in respect of which there is a breach of a representation and
warranty set forth on SCHEDULE 1 (assuming each representation and warranty is
made as of the date Collateral Value is determined), (2) which is an Eligible
Mortgage Loan which remains pledged to the Lender hereunder later than 270 days
after the date on which it is first included in the Collateral, (3) in respect
of which there is a delinquency in the payment of principal and/or interest
which continues for a period of 90 days or more (without regard to any
applicable grace periods), or (4) which has been released from the possession of
the Custodian under the Custodial Agreement to the Borrower for a period in
excess of 14 days;
(b) the aggregate Collateral Value of Eligible Mortgage Loans which are
Second Lien Mortgage Loans may not exceed 4% of the aggregate principal amount
outstanding under the Loans;
(c) the aggregate Collateral Value of Eligible Mortgage Loans which are 30
Day Delinquent Mortgage Loans may not exceed 7% of the aggregate principal
amount outstanding under the Loans; and
(d) the aggregate Collateral Value of Eligible Mortgage Loans which are 60
Day Delinquent Mortgage Loans may not exceed 3% of the aggregate principal
amount outstanding under the Loans.
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"COLLECTION ACCOUNT" shall mean one or more accounts established by the
Borrower with the Servicer subject to a security interest in favor of the Lender
and to the Blocked Account Agreement, into which all Collections shall be
deposited by the Servicer.
"COLLECTIONS" shall mean, collectively, all Principal Collections, all Sale
Proceeds and other collections and proceeds on or in respect of the Mortgage
Loans, excluding collections required to be paid to the Servicer or a mortgagor
on the Mortgage Loans.
"COMBINED LTV" OR "CLTV" shall mean with respect to any Mortgage Loan, the
ratio of (a) the outstanding principal balance as of the related date of
origination of such Mortgage Loan of (i) the Mortgage Loan plus (ii) the
mortgage loan constituting the first lien (if any) to (b) the Appraised Value of
the Mortgaged Property.
"COMMITTED LOAN" shall have the meaning assigned thereto in Section 2.01(a)
hereof.
"CUSTODIAL AGREEMENT" shall mean the Custodial Agreement, dated as of the
date hereof, among the Borrower, the Custodian and the Lender, substantially in
the form of EXHIBIT B hereto, as the same shall be modified and supplemented and
in effect from time to time.
"CUSTODIAN" shall mean First Chicago National Processing Corp., as
custodian under the Custodial Agreement, and its successors and permitted
assigns thereunder.
"DEFAULT" shall mean an Event of Default or an event that with notice or
lapse of time or both would become an Event of Default.
"DELINQUENT MORTGAGE LOAN" shall mean a 30 Day Delinquent Mortgage Loan or
a 60 Day Delinquent Mortgage Loan, as applicable.
"DOLLARS" and "$" shall mean lawful money of the United States of America.
"DUE DILIGENCE REVIEW" shall mean the performance by the Lender of any or
all of the reviews permitted under Section 11.15 hereof with respect to any or
all of the Mortgage Loans, as desired by the Lender from time to time.
"EFFECTIVE DATE" shall mean the date upon which the conditions precedent
set forth in Section 5.01 shall have been satisfied.
"ELIGIBLE MORTGAGE LOAN" shall mean a Mortgage Loan secured by a first or
second mortgage lien on a one-to-four family residential property, as to which
the representations and warranties in Section 6.10 and Part I of Schedule 1
hereof are correct.
"ERISA" shall mean the Employee Retirement Income Security Act of 1974, as
amended from time to time.
"ERISA AFFILIATE" shall mean any corporation or trade or business that is a
member of any group of organizations (i) described in Section 414(b) or (c) of
the Code of which the Borrower is a member and (ii) solely for purposes of
potential liability under Section 302(c)(11) of ERISA and Section 412(c)(11) of
the Code and the lien created under Section 302(f) of ERISA and Section 412(n)
of the Code, described in Section 414(m) or (o) of the Code of which the
Borrower is a member.
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"EURODOLLAR BASE RATE" shall mean:
(a) for any One-Month LIBOR Loan, with respect to each day such Loan is
outstanding (or if such day is not a Business Day, the next succeeding Business
Day), the rate per annum equal to the rate appearing at page 5 of the Telerate
Screen as one-month LIBOR on the first day of such Interest Period, and if such
rate shall not be so quoted, the rate per annum at which the Lender is offered
Dollar deposits at or about 10:00 A.M., New York City time, on such date by
prime banks in the interbank eurodollar market where the eurodollar and foreign
currency and exchange operations in respect of its Loans are then being
conducted for delivery on such day for a period of thirty (30) days and in an
amount comparable to the amount of the Loans to be outstanding on such day; and
(b) for any Loan other than a One-Month LIBOR Loan, with respect to each
day during each Interest Period pertaining to such Loan, the rate per annum as
of the first day of such Interest Period equal to the interpolated percentage
based on the rates appearing at page 5 of the Telerate screen as the LIBOR rates
closest to the number of days in the applicable Interest Period, and if such
rates shall not be so quoted, the rates per annum at which the Lender is offered
Dollar deposits at or about 10:00 A.M., New York City time, on the first day of
such Interest Period, by prime banks in the interbank eurodollar market where
the eurodollar and foreign currency and exchange operations in respect of its
Loans are then being conducted for delivery on the first day of such Interest
Period for the number of days comprised therein and in an amount comparable to
the amount of the Loans to be outstanding during such Interest Period.
"EVENT OF DEFAULT" shall have the meaning provided in Section 8 hereof.
"FEDERAL FUNDS RATE" shall mean, for any day, the weighted average of the
rates on overnight federal funds transactions with members of the Federal
Reserve System arranged by federal funds brokers, as published on the next
succeeding Business Day by the Federal Reserve Bank of New York, or, if such
rate is not so published for any day which is a Business Day, the average of the
quotations for the day of such transactions received by the Lender from three
federal funds brokers of recognized standing selected by it.
"FIRST LIEN MORTGAGE LOAN" shall mean an Eligible Mortgage Loan secured by
the lien on the Mortgaged Property, subject to no prior liens on such Mortgaged
Property.
"FUNDING DATE" shall mean the date on which a Loan is made hereunder.
"GAAP" shall mean generally accepted accounting principles as in effect
from time to time in the United States.
"GOVERNMENTAL AUTHORITY" shall mean any nation or government, any state or
other political subdivision thereof, any entity exercising executive,
legislative, judicial, regulatory or administrative functions of or pertaining
to government and any court or arbitrator having jurisdiction over the Borrower,
any of its Subsidiaries or any of its properties.
"GUARANTEE" shall mean, as to any Person, any obligation of such Person
directly or indirectly guaranteeing any Indebtedness of any other Person or in
any manner providing for the payment of any Indebtedness of any other Person or
otherwise protecting the holder of such Indebtedness against loss (whether by
virtue of partnership arrangements, by agreement to keep-well,
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<PAGE> 5
to purchase assets, goods, securities or services, or to take-or-pay or
otherwise); provided that the term "Guarantee" shall not include (i)
endorsements for collection or deposit in the ordinary course of business, or
(ii) obligations to make servicing advances for delinquent taxes and insurance
or other obligations in respect of a Mortgaged Property, to the extent required
by the Lender. The amount of any Guarantee of a Person shall be deemed to be an
amount equal to the stated or determinable amount of the primary obligation in
respect of which such Guarantee is made or, if not stated or determinable, the
maximum reasonably anticipated liability in respect thereof as determined by
such Person in good faith. The terms "GUARANTEE" and "GUARANTEED" used as verbs
shall have correlative meanings.
"INDEBTEDNESS" shall mean, for any Person: (a) obligations created, issued
or incurred by such Person for borrowed money (whether by loan, the issuance and
sale of debt securities or the sale of Property to another Person subject to an
understanding or agreement, contingent or otherwise, to repurchase such Property
from such Person); (b) obligations of such Person to pay the deferred purchase
or acquisition price of Property or services, other than trade accounts payable
(other than for borrowed money) arising, and accrued expenses incurred, in the
ordinary course of business so long as such trade accounts payable are payable
within 90 days of the date the respective goods are delivered or the respective
services are rendered; (c) Indebtedness of others secured by a Lien on the
Property of such Person, whether or not the respective Indebtedness so secured
has been assumed by such Person; (d) obligations (contingent or otherwise) of
such Person in respect of letters of credit or similar instruments issued or
accepted by banks and other financial institutions for account of such Person;
(e) Capital Lease Obligations of such Person; (f) obligations of such Person
under repurchase agreements or like arrangements; (g) Indebtedness of others
Guaranteed by such Person; (h) all obligations of such Person incurred in
connection with the acquisition or carrying of fixed assets by such Person; and
(i) Indebtedness of general partnerships of which such Person is a general
partner.
"INTEREST PERIOD" shall mean, either (i) with respect to One-Month Libor
Loans, one month or (ii) with respect to Loans other than One-Month Libor Loans,
an interest period requested by the Borrower under Section 2.03(a), and approved
by the Lender in its sole discretion, which interest period shall be a minimum
of thirty-one (31) days. With respect to One-Month Libor Loans, each such
Interest Period shall (a) initially commence on the Funding Date and continue to
but excluding the first Payment Date; and (b) thereafter, commence on a Payment
Date and continue to but excluding the next Payment Date. With respect to Loans
other than One-Month Libor Loans, each such Interest Period shall continue to
the last day of such Interest Period and thereafter, commence on the day
following the last day of the previous Interest Period. Notwithstanding the
foregoing, no Interest Period may end after the Termination Date.
"INTEREST RATE PROTECTION AGREEMENT" shall mean, with respect to any or all
of the Mortgage Loans, any short sale of US Treasury Security, or futures
contract, or mortgage related security or Eurodollar futures contract, or
options related contract, or interest rate swap, cap or collar agreement or
similar arrangements providing for protection against fluctuations in interest
rates or the exchange of nominal interest obligations, either generally or under
specific contingencies, entered into by the Borrower and reasonably acceptable
to the Lender.
"LENDER" shall have the meaning provided in the heading hereto.
"LIEN" shall mean any mortgage, lien, pledge, charge, security interest or
similar encumbrance.
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"LOAN" shall mean any Committed Loan or Uncommitted Loan, as applicable,
and collectively "Loans" shall mean the sum of all Committed Loans and
Uncommitted Loans.
"LOAN AGREEMENT" shall mean this Master Loan and Security Agreement, as the
same may be amended, supplemented or otherwise modified from time to time.
"LOAN DOCUMENTS" shall mean, collectively, this Loan Agreement, the Note,
the Custodial Agreement, and the Blocked Account Agreement.
"MARKET VALUE" shall mean, as of any date in respect of an Eligible
Mortgage Loan, the price at which such Eligible Mortgage Loan could readily be
sold as determined in good faith by the Lender, which price may be determined to
be zero. The Lender's determination of Market Value shall be conclusive upon the
parties absent manifest error on the part of the Lender.
"MATERIAL ADVERSE EFFECT" shall mean a material adverse effect on (a) the
Property, business, operations, financial condition or prospects of the
Borrower, (b) the ability of the Borrower to perform its obligations under any
of the Loan Documents to which it is a party, (c) the validity or enforceability
of any of the Loan Documents, (d) the rights and remedies of the Lender under
any of the Loan Documents, (e) the timely payment of the principal of or
interest on the Loans or other amounts payable in connection therewith or (f)
the Collateral.
"MAXIMUM COMMITTED AMOUNT" shall mean $100,000,000.
"MAXIMUM CREDIT" shall mean the sum of the Maximum Committed Amount and the
Maximum Uncommitted Amount, which shall equal $125,000,000.
"MAXIMUM UNCOMMITTED AMOUNT" shall mean $25,000,000.
"MORTGAGE" shall mean the mortgage, deed of trust or other instrument
securing a Mortgage Note, which creates a first lien on the fee in real property
securing the Mortgage Note.
"MORTGAGE FILE" shall have the meaning assigned thereto in the Custodial
Agreement.
"MORTGAGE LOAN" shall mean a mortgage loan which the Custodian has been
instructed to hold for the Lender pursuant to the Custodial Agreement, and which
Mortgage Loan includes, without limitation, (i) a Mortgage Note and related
Mortgage and (ii) all right, title and interest of the Borrower in and to the
Mortgaged Property covered by such Mortgage.
"MORTGAGE LOAN DOCUMENTS" shall mean, with respect to a Mortgage Loan, the
documents comprising the Mortgage File for such Mortgage Loan.
"MORTGAGE LOAN SCHEDULE" shall have the meaning assigned thereto in the
Custodial Agreement.
"MORTGAGE LOAN SCHEDULE AND EXCEPTION REPORT" shall mean the mortgage loan
schedule and exception report prepared by the Custodian pursuant to the
Custodial Agreement.
"MORTGAGE LOAN TAPE" shall mean a computer-readable magnetic tape
containing such fields as shall be mutually agreed upon by the Borrower and the
Lender with respect to each Mortgage Loan to be delivered by the Borrower to the
Lender pursuant to Section 2.03(a) hereof.
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"MORTGAGE NOTE" shall mean the original executed promissory note or other
evidence of the indebtedness of a mortgagor/borrower with respect to a Mortgage
Loan.
"MORTGAGED PROPERTY" shall mean the real property (including all
improvements, buildings, fixtures, building equipment and personal property
thereon and all additions, alterations and replacements made at any time with
respect to the foregoing) and all other collateral securing repayment of the
debt evidenced by a Mortgage Note.
"MORTGAGOR" shall mean the obligor on a Mortgage Note.
"MS & CO." shall mean Morgan Stanley & Co. Incorporated, a registered
broker-dealer.
"MULTIEMPLOYER PLAN" shall mean a multiemployer plan defined as such in
Section 3(37) of ERISA to which contributions have been or are required to be
made by the Borrower or any ERISA Affiliate and that is covered by Title IV of
ERISA.
"NET INCOME" shall mean, for any period, the net income of the Borrower for
such period as determined in accordance with GAAP.
"NOTE" shall mean the promissory note provided for by Section 2.02(a)
hereof for Loans and any promissory note delivered in substitution or exchange
therefor, in each case as the same shall be modified and supplemented and in
effect from time to time.
"ONE-MONTH LIBOR LOANS" shall mean Loans that bear interest at rates based
on the rate referred to as the rate for One-Month LIBOR Loans in the definition
of Eurodollar Base Rate.
"PAYMENT DATE" shall mean (a) the first Business Day of each calendar
month, commencing with January 2, 1998, and (b) the Termination Date.
"PBGC" shall mean the Pension Benefit Guaranty Corporation or any entity
succeeding to any or all of its functions under ERISA.
"PERSON" shall mean any individual, corporation, company, voluntary
association, partnership, joint venture, limited liability company, trust,
unincorporated association or government (or any agency, instrumentality or
political subdivision thereof).
"PLAN" shall mean an employee benefit or other plan established or
maintained by the Borrower or any ERISA Affiliate and covered by Title IV of
ERISA, other than a Multiemployer Plan.
"POST-DEFAULT RATE" shall mean, in respect of any principal of any Loan or
any other amount under this Loan Agreement, the Note or any other Loan Document
that is not paid when due to the Lender (whether at stated maturity, by
acceleration, by optional or mandatory prepayment or otherwise), a rate per
annum during the period from and including the due date to but excluding the
date on which such amount is paid in full equal to 2% per annum PLUS the Prime
Rate.
"PRIME RATE" shall mean the prime rate announced to be in effect from time
to time, as published as the average rate in THE WALL STREET JOURNAL.
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"PRINCIPAL COLLECTIONS" shall mean collections on the Mortgage Loans
attributable to principal payments thereon.
"PROPERTY" shall mean any right or interest in or to property of any kind
whatsoever, whether real, personal or mixed and whether tangible or intangible.
"REGULATIONS G, T, U AND X" shall mean Regulations G, T, U and X of the
Board of Governors of the Federal Reserve System (or any successor), as the same
may be modified and supplemented and in effect from time to time.
"REQUEST FOR BORROWING" shall have the meaning provided in Section 2.03(a).
"RESPONSIBLE OFFICER" shall mean, as to any Person, the chief executive
officer or, with respect to financial matters, the chief financial officer of
such Person.
"SALE PROCEEDS" shall mean (i) any proceeds of any sales, transfers or
dispositions of any Mortgage Loan, net of reasonable and customary costs,
including reasonable and necessary attorneys' fees, and (ii) any proceeds of any
sales, dispositions, condemnations, casualty insurance and other amounts from
any disposition, taking, damage or destruction of all or any portion of any real
property acquired upon foreclosure (or deed in lieu of foreclosure) of Mortgage
Loans, net of reasonable and customary costs of closing, including brokerage
commissions, make-ready expenses, title insurance, financing costs, recording
fees, transfer taxes, tax certificates, title and closing agent fees and
pro-rated items.
"SECOND LIEN MORTGAGE LOAN" shall mean an Eligible Mortgage Loan secured by
the lien on the Mortgaged Property, subject to only one prior lien on such
Mortgaged Property.
"SECURED OBLIGATIONS" shall have the meaning provided in Section 4.01(c)
hereof.
"SERVICER" shall have the meaning provided in Section 11.14(c) hereof.
"SERVICING AGREEMENT" shall have the meaning provided in Section 11.14(c)
hereof.
"SERVICING RECORDS" shall have the meaning provided in Section 11.14(b)
hereof.
"60 DAY DELINQUENT MORTGAGE LOAN" shall mean an Eligible Mortgage Loan
which is at least 60 days, but not more than 89 days, delinquent with respect to
the payment of principal or interest (without regard to any applicable grace
period).
"SUBSIDIARY" shall mean, with respect to any Person, any corporation,
partnership or other entity of which at least a majority of the securities or
other ownership interests having by the terms thereof ordinary voting power to
elect a majority of the board of directors or other persons performing similar
functions of such corporation, partnership or other entity (irrespective of
whether or not at the time securities or other ownership interests of any other
class or classes of such corporation, partnership or other entity shall have or
might have voting power by reason of the happening of any contingency) is at the
time directly or indirectly owned or controlled by such Person or one or more
Subsidiaries of such Person or by such Person and one or more Subsidiaries of
such Person.
"TANGIBLE NET WORTH" shall mean, as of a particular date,
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(a) all amounts which would be included under capital on a balance sheet of
the Borrower at such date, determined in accordance with GAAP, LESS
(b) (i) amounts owing to the Borrower from Affiliates and (ii) intangible
assets.
"TERMINATION DATE" shall mean December 8, 1998 or such earlier date on
which this Loan Agreement shall terminate in accordance with the provisions
hereof or by operation of law.
"TEST PERIOD" shall have the meaning provided in Section 7.16 hereof.
"30 DAY DELINQUENT MORTGAGE LOAN" shall mean an Eligible Mortgage Loan
which is at least 30 days, but not more than 59 days, delinquent with respect to
the payment of principal or interest (without regard to any applicable grace
period).
"TOTAL INDEBTEDNESS" shall mean, for any period, the aggregate Indebtedness
of the Borrower during such period LESS the amount of any nonspecific balance
sheet reserves maintained in accordance with GAAP.
"UNCOMMITTED LOAN" shall have the meaning assigned thereto in Section
2.01(b) hereof.
"UNDERWRITING GUIDELINES" shall mean the underwriting guidelines attached
as EXHIBIT F hereto.
"UNIFORM COMMERCIAL CODE" shall mean the Uniform Commercial Code as in
effect on the date hereof in the State of New York; provided that if by reason
of mandatory provisions of law, the perfection or the effect of perfection or
non-perfection of the security interest in any Collateral is governed by the
Uniform Commercial Code as in effect in a jurisdiction other than New York,
"Uniform Commercial Code" shall mean the Uniform Commercial Code as in effect in
such other jurisdiction for purposes of the provisions hereof relating to such
perfection or effect of perfection or non-perfection.
1.02 ACCOUNTING TERMS AND DETERMINATIONS. Except as otherwise expressly
provided herein, all accounting terms used herein shall be interpreted, and all
financial statements and certificates and reports as to financial matters
required to be delivered to the Lender hereunder shall be prepared, in
accordance with GAAP.
Section 2. LOANS, NOTE AND PREPAYMENTS.
2.01 LOANS.
(a) Subject to fulfillment of the conditions precedent set forth in
Sections 5.01 and 5.02 hereof, and provided that no Default shall have occurred
and be continuing hereunder, the Lender agrees from time to time, on the terms
and conditions of this Agreement, to make loans (individually, a "COMMITTED
LOAN"; collectively, the "COMMITTED LOANS") to the Borrower in Dollars, from and
including the Effective Date to and including the Termination Date in an
aggregate principal amount at any one time outstanding up to but not exceeding
the Maximum Committed Amount as in effect from time to time.
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(b) In addition to the foregoing, the Lender may from time to time in its
sole discretion, on the terms and conditions of this Agreement, make loans
(individually, an "UNCOMMITTED LOAN"; collectively, the "UNCOMMITTED LOANS") to
the Borrower in Dollars during the period from and including the Effective Date
to and including the Termination Date in an aggregate principal amount at any
one time outstanding up to but not exceeding the Maximum Uncommitted Amount as
in effect from time to time. In determining whether Loans outstanding secured by
Eligible Mortgage Loans are Committed Loans or Uncommitted Loans, such Loans
shall first be deemed Committed Loans up to the Maximum Committed Amount, and
then the remainder shall be deemed Uncommitted Loans.
(c) Subject to the terms and conditions of this Loan Agreement, during the
term of the Loan Agreement the Borrower may borrow, repay and reborrow
hereunder.
(d) In no event shall a Loan be made when any Default or Event of Default
has occurred and is continuing.
2.02 NOTES.
(a) The Loans made by the Lender shall be evidenced by a single promissory
note of the Borrower substantially in the form of EXHIBIT A hereto (the "NOTE"),
dated the date hereof, payable to the Lender in a principal amount equal to the
amount of the Maximum Credit as originally in effect and otherwise duly
completed. The Lender shall have the right to have its Note subdivided, by
exchange for promissory notes of lesser denominations or otherwise.
(b) The date, amount and interest rate of each Loan made by the Lender to
the Borrower, and each payment made on account of the principal thereof, shall
be recorded by the Lender on its books and, prior to any transfer of the Note,
endorsed by the Lender on the schedule attached to the Note or any continuation
thereof; PROVIDED that the failure of the Lender to make any such recordation or
endorsement shall not affect the obligations of the Borrower to make a payment
when due of any amount owing hereunder or under the Note in respect of the
Loans.
2.03 PROCEDURE FOR BORROWING.
(a) The Borrower may request a borrowing hereunder, on any Business Day
during the period from and including the Effective Date to and including the
Termination Date, by delivering to the Lender, with a copy to the Custodian, an
irrevocable written request for borrowing, substantially in the form of EXHIBIT
D attached hereto (a "REQUEST FOR BORROWING"), which request must be received by
the Lender prior to 3:00 p.m., New York City time, one (l) Business Day prior to
the requested Funding Date. Such Request for Borrowing shall (i) attach a
schedule identifying the Eligible Mortgage Loans that the Borrower proposes to
pledge to the Lender and to be included in the Borrowing Base in connection with
such borrowing, (ii) specify if the requested Loan shall be a One-Month LIBOR
Loan, and if not a One-Month LIBOR Loan, specify the applicable Interest Period
requested, which Interest Period shall be at least thirty-one (31) days, and
subject to the approval of the Lender in the Lender's sole discretion, (iii) the
requested Funding Date, and (iv) include a Mortgage Loan Tape containing
information with respect to the Eligible Mortgage Loans that the Borrower
proposes to pledge to the Lender and to be included in the Borrowing Base in
connection with such borrowing, and (v) attach an officer's certificate signed
by a Responsible Officer of the Borrower as required by Section 5.02(b) hereof.
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(b) Upon the Borrower's request for a borrowing pursuant to Section
2.03(a), the Lender shall, assuming all conditions precedent set forth in
Section 5.01 and 5.02 have been met and provided no Default shall have occurred
and be continuing, make a Committed Loan to the Borrower on the requested
Funding Date, in the amount so requested.
(c) Upon the Borrower's request for a borrowing pursuant to Section
2.03(a), the Lender may at its sole option, assuming all conditions precedent
set forth in Section 5.01 and 5.02 have been met and provided no Default shall
have occurred and be continuing, make an Uncommitted Loan to the Borrower on the
requested Funding Date, in the amount so requested.
(d) The Borrower shall release to the Custodian no later than 12:00 p.m.,
New York City time, two (2) Business Days prior to the requested Funding Date,
the Mortgage File pertaining to each Eligible Mortgage Loan to be pledged to the
Lender and included in the Borrowing Base on such requested Funding Date, so
long as there are no more than two hundred such Mortgage Files delivered on such
Business Day (if the number of Mortgage Files equals or exceeds two hundred, the
Borrower shall deliver to the Custodian such Mortgage Files in as many Business
Days prior to the Funding Date as is reasonably acceptable to the Custodian), as
in accordance with the terms and conditions of the Custodial Agreement.
(e) Pursuant to the Custodial Agreement, the Custodian shall deliver to the
Lender and the Borrower, no later than 11:00 a.m. on a Funding Date, a Trust
Receipt (as defined in the Custodial Agreement) in respect of all Mortgage Loans
pledged to the Lender on such Funding Date, and a Mortgage Loan Schedule and
Exception Report. Subject to Section 5 hereof, such borrowing will then be made
available to the Borrower by the Lender transferring, via wire transfer, to the
account set forth in the applicable Request for Borrowing, in the aggregate
amount of such borrowing in funds immediately available to the Borrower.
2.04 LIMITATION ON TYPES OF LOANS; ILLEGALITY. Anything herein to the
contrary notwithstanding, if, on or prior to the determination of any Eurodollar
Rate:
(a) the Lender determines, which determination shall be conclusive, that
quotations of interest rates for the relevant deposits referred to in the
definition of "Eurodollar Rate" in Section 1.01 hereof are not being provided
in the relevant amounts or for the relevant maturities for purposes of
determining rates of interest for Loans as provided herein; or
(b) the Lender determines, which determination shall be conclusive, that
the relevant rate of interest referred to in the definition of "Eurodollar
Rate" in Section 1.01 hereof upon the basis of which the rate of interest for
Loans is to be determined is not likely adequately to cover the cost to the
Lender of making or maintaining Loans; or
(c) it becomes unlawful for the Lender to honor its obligation to make or
maintain Loans hereunder using a Eurodollar Rate;
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then the Lender shall give the Borrower prompt notice thereof and, so long as
such condition remains in effect, the Lender shall be under no obligation to
make additional Loans, and the Borrower shall, either prepay all such Loans as
may be outstanding or pay interest on such Loans at a rate per annum equal to
the Federal Funds Rate plus 1%.
2.05 REPAYMENT OF LOANS; INTEREST.
(a) The Borrower hereby promises to repay in full on the Termination Date
the then aggregate outstanding principal amount of the Loans.
(b) The Borrower hereby promises to pay to the Lender interest on the
unpaid principal amount of each Loan for the period from and including the date
of such Loan to but excluding the date such Loan shall be paid in full, at a
rate per annum equal to the Eurodollar Rate PLUS the Applicable Margin.
Notwithstanding the foregoing, the Borrower hereby promises to pay to the Lender
interest at the applicable Post-Default Rate on any principal of any Loan and on
any other amount payable by the Borrower hereunder or under the Note that shall
not be paid in full when due (whether at stated maturity, by acceleration or by
mandatory prepayment or otherwise) for the period from and including the due
date thereof to but excluding the date the same is paid in full. Accrued
interest on each Loan shall be payable monthly on the first Business Day of each
month following the month for which it accrues and for the last month of the
Loan Agreement on the first Business Day of such last month and on the
Termination Date, except that interest payable at the Post-Default Rate shall
accrue daily and shall be payable upon such accrual. Promptly after the
determination of any interest rate provided for herein or any change therein,
the Lender shall give notice thereof to the Borrower.
(c) It is understood and agreed that, unless and until a Default shall have
occurred and be continuing, the Borrower shall be entitled to the proceeds of
the Mortgage Loans pledged to the Lender hereunder.
2.06 MANDATORY PREPAYMENTS; ADDITIONAL PLEDGE.
(a) The Borrower shall prepay the principal of the Loans on each Payment
Date in an amount equal to all Principal Collections with respect to the
Mortgage Loans received during the calendar month ended most recently prior to
such Payment Date.
(b) The Borrower shall prepay the principal of the Loans on each Payment
Date in an amount equal to all Sale Proceeds with respect to the Mortgage Loans
received during the calendar month ended most recently prior to such Payment
Date.
(c) If at any time the aggregate outstanding principal amount of Loans
exceeds the Borrowing Base (a "BORROWING BASE DEFICIENCY"), as determined by the
Lender and notified to the Borrower on any Business Day, the Borrower shall no
later than one Business Day after receipt of such notice, either prepay the
Loans in part or in whole or pledge additional Eligible Mortgage Loans (which
Collateral shall be in all respects acceptable to the Lender) to the Lender,
such that after giving effect to such prepayment or pledge the aggregate
outstanding principal amount of the Loans does not exceed the Borrowing Base.
2.07 OPTIONAL PREPAYMENTS. The Loans are prepayable on any Payment Date
without premium or penalty, in whole or in part, and may be prepaid on any other
date subject to Section 2.08 hereof. Any amounts prepaid shall be applied to
repay the outstanding principal amount of any Loans
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(together with interest thereon) until paid in full. Amounts repaid may be
reborrowed in accordance with the terms of this Loan Agreement. If the Borrower
intends to prepay a Loan in whole or in part from a source other than the
proceeds of the Mortgage Loans, the Borrower shall give three (3) Business Days'
prior written notice thereof to the Lender. If such notice is given, the amount
specified in such notice shall be due and payable on the date specified therein,
together with accrued interest to such date on the amount prepaid. Partial
prepayments shall be in a minimum aggregate principal amount of $1,000,000.
2.08 INDEMNITY
If the Borrower makes a prepayment of the Loans on any day which is not a
Payment Date, the Borrower shall indemnify the Lender and hold the Lender
harmless from any actual loss or expense which the Lender may sustain or incur
arising from the reemployment of funds obtained by the Lender to maintain the
Loans hereunder or from fees payable to terminate the deposits from which such
funds were obtained. This Section 2.08 shall survive termination of Loan
Agreement and payment of the Note.
Section 3. PAYMENTS; COMPUTATIONS; ETC.
3.01 PAYMENTS.
(a) Except to the extent otherwise provided herein, all payments of
principal, interest and other amounts to be made by the Borrower under this Loan
Agreement and the Note, shall be made in Dollars, in immediately available
funds, without deduction, set-off or counterclaim, to the Lender at the
following account maintained by the Lender: Account No. 40615114, For the A/C of
Morgan Stanley Mortgage Capital Inc., ABA# 021000089, not later than 1:00 p.m.,
New York City time, on the date on which such payment shall become due (and each
such payment made after such time on such due date shall be deemed to have been
made on the next succeeding Business Day). The Borrower acknowledges that it has
no rights of withdrawal from the foregoing account.
(b) Except to the extent otherwise expressly provided herein, if the due
date of any payment under this Loan Agreement or the Note would otherwise fall
on a day that is not a Business Day, such date shall be extended to the next
succeeding Business Day, and interest shall be payable for any principal so
extended for the period of such extension.
3.02 COMPUTATIONS. Interest on the Loans shall be computed in arrears on
the basis of a 360-day year for the actual days elapsed (including the first day
but excluding the last day) occurring in the period for which payable.
3.03 COMMITMENT FEE. The Borrower agrees to pay to the Lender a one-time
commitment fee equal to $100,000, such payment to be made in Dollars, in
immediately available funds, without deduction, set-off or counterclaim, to the
Lender on or prior to the Effective Date. The Lender may, in its sole
discretion, net such commitment fee from the proceeds of any Loan advanced to
the Borrower on the Effective Date.
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Section 4. COLLATERAL SECURITY.
4.01 COLLATERAL; SECURITY INTEREST.
(a) Pursuant to the Custodial Agreement, the Custodian shall hold the
Mortgage Loan Documents as exclusive bailee and agent for the Lender pursuant to
terms of the Custodial Agreement and shall deliver to the Lender Trust Receipts
(as defined in the Custodial Agreement) each to the effect that it has reviewed
such Mortgage Loan Documents in the manner and to the extent required by the
Custodial Agreement and identifying any deficiencies in such Mortgage Loan
Documents as so reviewed.
(b) All of the Borrower's right, title and interest in, to and under each
of the following items of property, whether now owned or hereafter acquired, now
existing or hereafter created and wherever located, is hereinafter referred to
as the "COLLATERAL":
(i) all Mortgage Loans;
(ii) all Mortgage Loan Documents, including without limitation all
promissory notes, and all Servicing Records (as defined in Section 11.14(b)
below), servicing agreements and any other collateral pledged or otherwise
relating to such Mortgage Loans, together with all files, documents,
instruments, surveys, certificates, correspondence, appraisals, computer
programs, computer storage media, accounting records and other books and
records relating thereto;
(iii) all mortgage guaranties and insurance (issued by governmental
agencies or otherwise) and any mortgage insurance certificate or other
document evidencing such mortgage guaranties or insurance relating to any
Mortgage Loan and all claims and payments thereunder;
(iv) all other insurance policies and insurance proceeds relating to any
Mortgage Loan or the related Mortgaged Property;
(v) all Interest Rate Protection Agreements;
(vi) the Collection Account and all monies from time to time on deposit in
the Collection Account;
(vii) all "general intangibles" as defined in the Uniform Commercial Code
relating to or constituting any and all of the foregoing; and
(viii) any and all replacements, substitutions, distributions on or
proceeds of any and all of the foregoing.
(c) The Borrower hereby assigns, pledges and grants a security interest in
all of its right, title and interest in, to and under the Collateral to the
Lender to secure the repayment of principal of and interest on all Loans and all
other amounts owing to the Lender hereunder, under the Note and under the other
Loan Documents (collectively, the "SECURED OBLIGATIONS"). The Borrower agrees to
mark its computer records and tapes to evidence the interests granted to the
Lender hereunder.
4.02 FURTHER DOCUMENTATION. At any time and from time to time, upon the
written request of the Lender, and at the sole expense of the Borrower, the
Borrower will promptly and duly
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execute and deliver, or will promptly cause to be executed and delivered, such
further instruments and documents and take such further action as the Lender may
reasonably request for the purpose of obtaining or preserving the full benefits
of this Loan Agreement and of the rights and powers herein granted, including,
without limitation, the filing of any financing or continuation statements under
the Uniform Commercial Code in effect in any jurisdiction with respect to the
Liens created hereby. The Borrower also hereby authorizes the Lender to file any
such financing or continuation statement without the signature of the Borrower
to the extent permitted by applicable law. A carbon, photographic or other
reproduction of this Loan Agreement shall be sufficient as a financing statement
for filing in any jurisdiction.
4.03 CHANGES IN LOCATIONS, NAME, ETC. The Borrower shall not (i) change the
location of its chief executive office/chief place of business from that
specified in Section 6 hereof or (ii) change its name, identity or corporate
structure (or the equivalent) or change the location where it maintains its
records with respect to the Collateral unless it shall have given the Lender at
least 30 days prior written notice thereof and shall have delivered to the
Lender all Uniform Commercial Code financing statements and amendments thereto
as the Lender shall request and taken all other actions deemed necessary by the
Lender to continue its perfected status in the Collateral with the same or
better priority.
4.04. LENDER'S APPOINTMENT AS ATTORNEY-IN-FACT.
(a) The Borrower hereby irrevocably constitutes and appoints the Lender and
any officer or agent thereof, with full power of substitution, as its true and
lawful attorney-in-fact with full irrevocable power and authority in the place
and stead of the Borrower and in the name of the Borrower or in its own name,
from time to time in the Lender's discretion, for the purpose of carrying out
the terms of this Loan Agreement, to take any and all appropriate action and to
execute any and all documents and instruments which may be necessary or
desirable to accomplish the purposes of this Loan Agreement, and, without
limiting the generality of the foregoing, the Borrower hereby gives the Lender
the power and right, on behalf of the Borrower, without assent by, but with
notice to, the Borrower, if an Event of Default shall have occurred and be
continuing, to do the following:
(i) in the name of the Borrower or its own name, or otherwise, to take
possession of and endorse and collect any checks, drafts, notes, acceptances
or other instruments for the payment of moneys due under any mortgage
insurance or with respect to any other Collateral and to file any claim or to
take any other action or proceeding in any court of law or equity or
otherwise deemed appropriate by the Lender for the purpose of collecting any
and all such moneys due under any such mortgage insurance or with respect to
any other Collateral whenever payable;
(ii) to pay or discharge taxes and Liens levied or placed on or threatened
against the Collateral; and
(iii) (A) to direct any party liable for any payment under any Collateral
to make payment of any and all moneys due or to become due thereunder
directly to the Lender or as the Lender shall direct; (B) to ask or demand
for, collect, receive payment of and receipt for, any and all moneys, claims
and other amounts due or to become due at any time in respect of or arising
out of any Collateral; (C) to sign and endorse any invoices, assignments,
verifications, notices and other documents in connection with any of the
Collateral; (D) to commence and prosecute any suits, actions or proceedings
at law or in equity in any court of
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competent jurisdiction to collect the Collateral or any thereof and to
enforce any other right in respect of any Collateral; (E) to defend any
suit, action or proceeding brought against the Borrower with respect to
any Collateral; (F) to settle, compromise or adjust any suit, action or
proceeding described in clause (E) above and, in connection therewith,
to give such discharges or releases as the Lender may deem appropriate;
and (G) generally, to sell, transfer, pledge and make any agreement with
respect to or otherwise deal with any of the Collateral as fully and
completely as though the Lender were the absolute owner thereof for all
purposes, and to do, at the Lender's option and the Borrower's expense,
at any time, and from time to time, all acts and things which the Lender
deems necessary to protect, preserve or realize upon the Collateral and
the Lender's Liens thereon and to effect the intent of this Loan
Agreement, all as fully and effectively as the Borrower might do.
The Borrower hereby ratifies all that said attorneys shall lawfully do or cause
to be done by virtue hereof. This power of attorney is a power coupled with an
interest and shall be irrevocable.
(b) The Borrower also authorizes the Lender, at any time and from time to
time, to execute, in connection with any sale provided for in Section 4.07
hereof, any endorsements, assignments or other instruments of conveyance or
transfer with respect to the Collateral.
(c) The powers conferred on the Lender are solely to protect the Lender's
interests in the Collateral and shall not impose any duty upon the Lender to
exercise any such powers. The Lender shall be accountable only for amounts that
it actually receives as a result of the exercise of such powers, and neither the
Lender nor any of its officers, directors, or employees shall be responsible to
the Borrower for any act or failure to act hereunder, except for its own gross
negligence or willful misconduct.
4.05. PERFORMANCE BY LENDER OF BORROWER'S OBLIGATIONS. If the Borrower
fails to perform or comply with any of its agreements contained in the Loan
Documents and the Lender may itself perform or comply, or otherwise cause
performance or compliance, with such agreement, the expenses of the Lender
incurred in connection with such performance or compliance, together with
interest thereon at a rate per annum equal to the Post-Default Rate, shall be
payable by the Borrower to the Lender on demand and shall constitute Secured
Obligations.
4.06. PROCEEDS. If an Event of Default shall occur and be continuing, (a)
all proceeds of Collateral received by the Borrower consisting of cash, checks
and other near-cash items shall be held by the Borrower in trust for the Lender,
segregated from other funds of the Borrower, and shall forthwith upon receipt by
the Borrower be turned over to the Lender in the exact form received by the
Borrower (duly endorsed by the Borrower to the Lender, if required) and (b) any
and all such proceeds received by the Lender (whether from the Borrower or
otherwise) may, in the sole discretion of the Lender, be held by the Lender as
collateral security for, and/or then or at any time thereafter may be applied by
the Lender against, the Secured Obligations (whether matured or unmatured), such
application to be in such order as the Lender shall elect. Any balance of such
proceeds remaining after the Secured Obligations shall have been paid in full
and this Loan Agreement shall have been terminated shall be paid over to the
Borrower or to whomsoever may be lawfully entitled to receive the same. For
purposes hereof, proceeds shall include, but not be limited to, all principal
and interest payments, all prepayments and payoffs, insurance claims,
condemnation awards, sale proceeds, real estate owned rents and any other income
and all other amounts received with respect to the Collateral.
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4.07. REMEDIES. If an Event of Default shall occur and be continuing, the
Lender may exercise, in addition to all other rights and remedies granted to it
in this Loan Agreement and in any other instrument or agreement securing,
evidencing or relating to the Secured Obligations, all rights and remedies of a
secured party under the Uniform Commercial Code. Without limiting the generality
of the foregoing, the Lender without demand of performance or other demand,
presentment, protest, advertisement or notice of any kind (except any notice
required by law referred to below) to or upon the Borrower or any other Person
(each and all of which demands, presentments, protests, advertisements and
notices are hereby waived), may in such circumstances forthwith collect,
receive, appropriate and realize upon the Collateral, or any part thereof,
and/or may forthwith sell, lease, assign, give option or options to purchase, or
otherwise dispose of and deliver the Collateral or any part thereof (or contract
to do any of the foregoing), in one or more parcels or as an entirety at public
or private sale or sales, at any exchange, broker's board or office of the
Lender or elsewhere upon such terms and conditions as it may deem advisable and
at such prices as it may deem best, for cash or on credit or for future delivery
without assumption of any credit risk. The Lender shall have the right upon any
such public sale or sales, and, to the extent permitted by law, upon any such
private sale or sales, to purchase the whole or any part of the Collateral so
sold, free of any right or equity of redemption in the Borrower, which right or
equity is hereby waived or released. The Borrower further agrees, at the
Lender's request, to assemble the Collateral and make it available to the Lender
at places which the Lender shall reasonably select, whether at the Borrower's
premises or elsewhere. The Lender shall apply the net proceeds of any such
collection, recovery, receipt, appropriation, realization or sale, after
deducting all reasonable costs and expenses of every kind incurred therein or
incidental to the care or safekeeping of any of the Collateral or in any way
relating to the Collateral or the rights of the Lender hereunder, including
without limitation reasonable attorneys' fees and disbursements, to the payment
in whole or in part of the Secured Obligations, in such order as the Lender may
elect, and only after such application and after the payment by the Lender of
any other amount required or permitted by any provision of law, including
without limitation Section 9-504(1)(c) of the Uniform Commercial Code, need the
Lender account for the surplus, if any, to the Borrower. To the extent permitted
by applicable law, the Borrower waives all claims, damages and demands it may
acquire against the Lender arising out of the exercise by the Lender of any of
its rights hereunder, other than those claims, damages and demands arising from
the gross negligence or willful misconduct of the Lender. If any notice of a
proposed sale or other disposition of Collateral shall be required by law, such
notice shall be deemed reasonable and proper if given at least 10 days before
such sale or other disposition. The Borrower shall remain liable for any
deficiency (plus accrued interest thereon as contemplated pursuant to Section
2.05(b) hereof) if the proceeds of any sale or other disposition of the
Collateral are insufficient to pay the Secured Obligations and the fees and
disbursements of any attorneys employed by the Lender to collect such
deficiency.
4.08. LIMITATION ON DUTIES REGARDING PRESENTATION OF COLLATERAL. The
Lender's duty with respect to the custody, safekeeping and physical preservation
of the Collateral in its possession, under Section 9-207 of the Uniform
Commercial Code or otherwise, shall be to deal with it in the same manner as the
Lender deals with similar property for its own account. Neither the Lender nor
any of its directors, officers or employees shall be liable for failure to
demand, collect or realize upon all or any part of the Collateral or for any
delay in doing so or shall be under any obligation to sell or otherwise dispose
of any Collateral upon the request of the Borrower or otherwise.
4.09. POWERS COUPLED WITH AN INTEREST. All authorizations and agencies
herein contained with respect to the Collateral are irrevocable and powers
coupled with an interest.
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4.10 RELEASE OF SECURITY INTEREST. Upon termination of this Loan Agreement
and repayment to the Lender of all Secured Obligations and the performance of
all obligations under the Loan Documents the Lender shall release its security
interest in any remaining Collateral.
Section 5. CONDITIONS PRECEDENT.
5.01 INITIAL LOAN. The obligation of the Lender to make its initial Loan
hereunder is subject to the satisfaction, immediately prior to or concurrently
with the making of such Loan, of the condition precedent that the Lender shall
have received all of the following documents, each of which shall be
satisfactory to the Lender and its counsel in form and substance:
(a) LOAN DOCUMENTS.
(i) NOTE. The Note, duly completed and executed;
(ii) CUSTODIAL AGREEMENT. The Custodial Agreement, duly executed and
delivered by the Borrower, the Lender and the Custodian. In addition, the
Borrower shall have taken such other action as the Lender shall have
requested in order to perfect the security interests created pursuant to
the Loan Agreement;
(iii) BLOCKED ACCOUNT AGREEMENT. A Blocked Account Agreement, duly
executed by the parties thereto;
(b) ORGANIZATIONAL DOCUMENTS. A good standing certificate and certified
copies of the operating agreement and by-laws (or equivalent documents) of
the Borrower and of all corporate or other authority for the Borrower with
respect to the execution, delivery and performance of the Loan Documents
and each other document to be delivered by the Borrower from time to time
in connection herewith (and the Lender may conclusively rely on such
certificate until it receives notice in writing from the Borrower to the
contrary);
(c) LEGAL OPINION. A legal opinion of counsel to the Borrower,
substantially in the form attached hereto as EXHIBIT C.
(d) MORTGAGE LOAN SCHEDULE AND EXCEPTION REPORT. A Mortgage Loan
Schedule and Exception Report, dated the Effective Date, from the Custodian,
duly completed;
(e) SERVICING AGREEMENT(S). Any Servicing Agreement, certified as a
true, correct and complete copy of the original;
(f) OTHER DOCUMENTS. Such other documents as the Lender may reasonably
request.
(g) PAYMENT OF COMMITMENT FEE. The Borrower shall pay the commitment fee
pursuant to Section 3.03 hereof.
5.02 INITIAL AND SUBSEQUENT LOANS. The making of each Loan to the
Borrower (including the initial Loan) on any Business Day is subject to the
satisfaction of the following further conditions precedent, both immediately
prior to the making of such Loan and also after giving effect thereto and to
the intended use thereof:
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(a) no Default or Event of Default shall have occurred and be
continuing;
(b) both immediately prior to the making of such Loan and also after
giving effect thereto and to the intended use thereof, the representations
and warranties made by the Borrower in Section 6 and Schedule 1 hereof, and
elsewhere in each of the Loan Documents, shall be true and complete on and as
of the date of the making of such Loan in all material respects (in the case
of the representations and warranties in Section 6.10 and Schedule 1, solely
with respect to Mortgage Loans included in the Borrowing Base) with the same
force and effect as if made on and as of such date (or, if any such
representation or warranty is expressly stated to have been made as of a
specific date, as of such specific date). The Lender shall have received an
officer's certificate signed by a Responsible Officer of the Borrower
certifying as to the truth and accuracy of the above, which certificate shall
specifically include a statement that the Borrower is in compliance with all
governmental licenses and authorizations and is qualified to do business and
in good standing in all required jurisdictions.
(c) the aggregate outstanding principal amount of the Loans shall not
exceed the Borrowing Base;
(d) subject to the Lender's right to perform one or more Due Diligence
Reviews pursuant to Section 11.15 hereof, the Lender shall have completed its
due diligence review of the Mortgage Loan Documents for each Loan and such
other documents, records, agreements, instruments, mortgaged properties or
information relating to such Loans as the Lender in its sole discretion deems
appropriate to review and such review shall be satisfactory to the Lender in
its sole discretion;
(e) the Lender shall have received from the Custodian a Trust Receipt
with exceptions as are acceptable to the Lender in its sole discretion in
respect of Eligible Mortgage Loans to be pledged hereunder on such Business
Day and a Mortgage Loan Schedule and Exception Report, in each case dated
such Business Day and duly completed;
(f) the Lender shall have received from the Borrower a Warehouse
Lender's Release Letter substantially in the form of EXHIBIT E-2 hereto (or
such other form acceptable to the Lender) or a Seller's Release Letter
substantially in the form of EXHIBIT E-1 hereto (or such other form
acceptable to the Lender) covering each Mortgage Loan to be pledged to the
Lender;
(g) none of the following shall have occurred and/or be continuing:
(i) an event or events shall have occurred resulting in the effective
absence of a "repo market" or comparable "lending market" for financing debt
obligations secured by mortgage loans or securities for a period of (or
reasonably expected to be) at least 30 consecutive days or an event or events
shall have occurred resulting in the Lender not being able to finance any
Loans through the "repo market" or "lending market" with traditional
counterparties at rates which would have been reasonable prior to the
occurrence of such event or events;
(ii) an event or events shall have occurred resulting in the effective
absence of a "securities market" for securities backed by mortgage loans for
a period of (or reasonably expected to be) at least 30 consecutive days or an
event or events shall have occurred resulting
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in the Lender not being able to sell securities backed by mortgage loans at
prices which would have been reasonable prior to such event or events; or
(iii) there shall have occurred a material adverse change in the
financial condition of the Lender which effects (or can reasonably be
expected to effect) materially and adversely the ability of the Lender to
fund its obligations under this Loan Agreement.
Each request for a borrowing by the Borrower hereunder shall constitute a
certification by the Borrower that all the conditions set forth in this
Section 5 have been satisfied (both as of the date of such notice, request or
confirmation and as of the date of such borrowing). In the event that the
Lender fails to make a Loan to the Borrower due solely to any of the
circumstances set forth in Section 5.02(g) hereof, then, upon request of the
Borrower, the Lender shall refund to the Borrower that portion of the
commitment fee paid pursuant to Section 3.03 hereof, pro-rated over the
number of days during which the Lender fails to make Loans requested by the
Borrower solely because of the circumstances set forth in Section 5.02 (g)
hereof.
Section 6. REPRESENTATIONS AND WARRANTIES. The Borrower represents and
warrants to the Lender that throughout the term of this Loan Agreement:
6.01 EXISTENCE. The Borrower (a) is a corporation duly organized,
validly existing and in good standing under the laws of the jurisdiction of
its organization, (b) has all requisite corporate or other power, and has all
governmental licenses, authorizations, consents and approvals necessary to
own its assets and carry on its business as now being or as proposed to be
conducted, except where the lack of such licenses, authorizations, consents
and approvals would not be reasonably likely to have a material adverse
effect on its Property, business or financial condition or prospects; and (c)
is qualified to do business and is in good standing in all other
jurisdictions in which the nature of the business conducted by it makes such
qualification necessary, except where failure so to qualify would not be
reasonably likely (either individually or in the aggregate) to have a
material adverse effect on its Property, business or financial condition or
prospects.
6.02 FINANCIAL CONDITION. The Borrower has heretofore furnished to the
Lender a copy of its Form 10Q (as filed with the SEC) showing its balance
sheet for the quarterly fiscal periods of the Borrower ended September 30,
1997 and the related consolidated statements of income and retained earnings
and of cash flows for the Borrower for such quarterly fiscal periods. All
such financial statements are complete and correct and fairly present, in all
material respects, the financial condition of the Borrower and the results of
its operations as at such dates and for such fiscal periods, all in
accordance with GAAP applied on a consistent basis. Since September 30, 1997,
there has been no material adverse change in the business, operations or
financial condition of the Borrower from that set forth in said financial
statements.
6.03 LITIGATION. There are no actions, suits, arbitrations,
investigations or proceedings pending or, to its knowledge, threatened
against the Borrower or affecting any of its Property before any Governmental
Authority (i) as to which there is a reasonable likelihood of an adverse
decision which would be reasonably likely to have a material adverse effect
on its Property, business or financial condition or prospects or (ii) which
questions the validity or enforceability of any of the Loan Documents or any
action to be taken in connection with the transactions contemplated hereby.
6.04 NO BREACH. Neither (a) the execution and delivery of the Loan
Documents nor (b) the consummation of the transactions therein contemplated
in compliance with the terms and
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provisions thereof will conflict with or result in a breach of the operating
agreement or by-laws of the Borrower, or any applicable law, rule or
regulation, or any order, writ, injunction or decree of any Governmental
Authority, or any Servicing Agreement or other material agreement or
instrument to which the Borrower is a party or by which it or any of its
Property is bound or to which it is subject, or constitute a default under
any such material agreement or instrument or result in the creation or
imposition of any Lien (except for the Liens created pursuant to this Loan
Agreement) upon any Property of the Borrower pursuant to the terms of any
such agreement or instrument.
6.05 ACTION. The Borrower has all necessary corporate or other power,
authority and legal right to execute, deliver and perform its obligations
under each of the Loan Documents; the execution, delivery and performance by
the Borrower of each of the Loan Documents have been duly authorized by all
necessary corporate or other action on its part; and each Loan Document has
been duly and validly executed and delivered by the Borrower and constitutes
a legal, valid and binding obligation of the Borrower, enforceable against
the Borrower in accordance with its terms.
6.06 APPROVALS. No authorizations, approvals or consents of, and no
filings or registrations with, any Governmental Authority or any securities
exchange are necessary for the execution, delivery or performance by the
Borrower of the Loan Documents or for the legality, validity or
enforceability thereof, except for filings and recordings in respect of the
Liens created pursuant to this Loan Agreement.
6.07 MARGIN REGULATIONS. Neither the making of any Loan hereunder, nor
the use of the proceeds thereof, will violate or be inconsistent with the
provisions of Regulation G, T, U or X.
6.08 TAXES. The Borrower has filed all Federal income tax returns and
all other material tax returns that are required to be filed by it and has
paid all taxes due pursuant to such returns or pursuant to any assessment
received by it, except for any such taxes as are being appropriately
contested in good faith by appropriate proceedings diligently conducted and
with respect to which adequate reserves have been provided. The charges,
accruals and reserves on the books of the Borrower in respect of taxes and
other governmental charges are, in the opinion of the Borrower, adequate.
6.09 INVESTMENT COMPANY ACT. The Borrower is not an "investment
company", or a company "controlled" by an "investment company," within the
meaning of the Investment Company Act of 1940, as amended.
6.10 COLLATERAL; COLLATERAL SECURITY.
(a) The Borrower has not assigned, pledged, or otherwise conveyed or
encumbered any Mortgage Loan to any other Person, and immediately prior to
the pledge of such Mortgage Loan to the Lender, the Borrower was the sole
owner of such Mortgage Loan and had good and marketable title thereto, free
and clear of all Liens, in each case except for Liens to be released
simultaneously with the Liens granted in favor of the Lender hereunder. No
Mortgage Loan pledged to the Lender hereunder was acquired by the Borrower
from an Affiliate of the Borrower
(b) The provisions of this Loan Agreement are effective to create in
favor of the Lender a valid security interest in all right, title and
interest of the Borrower in, to and under the Collateral.
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(c) Upon receipt by the Custodian of each Mortgage Note, endorsed in
blank by a duly authorized officer of the Borrower, the Lender shall have a
fully perfected first priority security interest therein, in the Mortgage
Loan evidenced thereby and in the Borrower's interest in the related
Mortgaged Property.
(d) Upon the filing of financing statements on Form UCC-1 naming the
Lender as "Secured Party" and the Borrower as "Debtor", and describing the
Collateral, in the jurisdictions and recording offices listed on Schedule 2
attached hereto, the security interests granted hereunder in the Collateral
will constitute fully perfected first priority security interests under the
Uniform Commercial Code in all right, title and interest of the Borrower in,
to and under such Collateral which can be perfected by filing under the
Uniform Commercial Code.
6.11 CHIEF EXECUTIVE OFFICE. The Borrower's chief executive office on
the Effective Date is located at 90 West Street, Suite 1508, New York, NY
10006.
6.12 LOCATION OF BOOKS AND RECORDS. The location where the Borrower
keeps its books and records, including all computer tapes and records
relating to the Collateral is its chief executive office.
6.13 HEDGING. The Borrower has entered into Interest Rate Protection
Agreements, having a notional amount not less than 80% of the aggregate
unpaid principal amount of the fixed-rate Mortgage Loans having terms with
respect to protection against fluctuations in interest rates reasonably
acceptable to the Lender.
6.14 TRUE AND COMPLETE DISCLOSURE. The information, reports, financial
statements, exhibits and schedules furnished in writing by or on behalf of
the Borrower to the Lender in connection with the negotiation, preparation or
delivery of this Loan Agreement and the other Loan Documents or included
herein or therein or delivered pursuant hereto or thereto, when taken as a
whole, do not contain any untrue statement of material fact or omit to state
any material fact necessary to make the statements herein or therein, in
light of the circumstances under which they were made, not misleading. All
written information furnished after the date hereof by or on behalf of the
Borrower to the Lender in connection with this Loan Agreement and the other
Loan Documents and the transactions contemplated hereby and thereby will be
true, complete and accurate in every material respect, or (in the case of
projections) based on reasonable estimates, on the date as of which such
information is stated or certified. There is no fact known to a Responsible
Officer of the Borrower, after due inquiry, that could reasonably be expected
to have a Material Adverse Effect that has not been disclosed herein, in the
other Loan Documents or in a report, financial statement, exhibit, schedule,
disclosure letter or other writing furnished to the Lender for use in
connection with the transactions contemplated hereby or thereby.
6.15 TANGIBLE NET WORTH. On the Effective Date, the Tangible Net Worth
is not less than $65,000,000.
6.16 ERISA. Each Plan to which the Borrower or its Subsidiaries make
direct contributions, and, to the knowledge of the Borrower, each other Plan
and each Multiemployer Plan, is in compliance in all material respects with,
and has been administered in all material respects in compliance with, the
applicable provisions of ERISA, the Code and any other Federal or State law.
No event or condition has occurred and is continuing as to which the Borrower
would be under an obligation to furnish a report to the Lender under Section
7.01(d) hereof.
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6.17 PERCENTAGE OWNERSHIP. No Person beneficially owns (directly or
indirectly) more than 49% of the Borrower.
Section 7. COVENANTS OF THE BORROWER. The Borrower covenants and agrees
with the Lender that, so long as any Loan is outstanding and until payment in
full of all Secured Obligations:
7.01 FINANCIAL STATEMENTS. The Borrower shall deliver to the Lender:
(a) as soon as available and in any event within 45 days after the end
of each of the first three quarterly fiscal periods of each fiscal year of
the Borrower, the unaudited balance sheets of the Borrower as at the end of
such period and the related unaudited statements of income and retained
earnings and of cash flows for the Borrower for such period and the portion
of the fiscal year through the end of such period, setting forth in each case
in comparative form the figures for the previous year, accompanied by a
certificate of a Responsible Officer of the Borrower, which certificate shall
state that said consolidated financial statements fairly present the
financial condition and results of operations of the Borrower in accordance
with GAAP, consistently applied, as at the end of, and for, such period
(subject to normal year-end audit adjustments);
(b) as soon as available and in any event within 90 days after the end
of each fiscal year of the Borrower, the balance sheets of the Borrower as at
the end of such fiscal year and the related statements of income and retained
earnings and of cash flows for the Borrower for such year, setting forth in
each case in comparative form the figures for the previous year, accompanied
by an opinion thereon of independent certified public accountants of
recognized national standing, which opinion shall not be qualified as to
scope of audit or going concern and shall state that said financial
statements fairly present the financial condition and results of operations
of the Borrower as at the end of, and for, such fiscal year in accordance
with GAAP, and a certificate of such accountants stating that, in making the
examination necessary for their opinion, they obtained no knowledge, except
as specifically stated, of any Default or Event of Default;
(c) from time to time such other information regarding the financial
condition, operations, or business of the Borrower as the Lender may
reasonably request; and
(d) as soon as reasonably possible, and in any event within thirty (30)
days after a Responsible Officer of the Borrower knows, or with respect to
any Plan or Multiemployer Plan to which the Borrower or any of its
Subsidiaries makes direct contributions, has reason to believe, that any of
the events or conditions specified below with respect to any Plan or
Multiemployer Plan has occurred or exists, a statement signed by a senior
financial officer of the Borrower setting forth details respecting such event
or condition and the action, if any, that the Borrower or its ERISA Affiliate
proposes to take with respect thereto (and a copy of any report or notice
required to be filed with or given to PBGC by the Borrower or an ERISA
Affiliate with respect to such event or condition):
(i) any reportable event, as defined in Section 4043(b) of ERISA
and the regulations issued thereunder, with respect to a Plan, as to
which PBGC has not by regulation waived the requirement of Section
4043(a) of ERISA that it be notified within thirty (30) days of the
occurrence of such event (PROVIDED that a failure to meet the minimum
funding standard of Section 412 of the Code or Section 302 of ERISA,
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including without limitation the failure to make on or before its due
date a required installment under Section 412(m) of the Code or Section
302(e) of ERISA, shall be a reportable event regardless of the issuance
of any waivers in accordance with Section 412(d) of the Code); and any
request for a waiver under Section 412(d) of the Code for any Plan;
(ii) the distribution under Section 4041(c) of ERISA of a notice of
intent to terminate any Plan or any action taken by the Borrower or an
ERISA Affiliate to terminate any Plan;
(iii) the institution by PBGC of proceedings under Section 4042 of
ERISA for the termination of, or the appointment of a trustee to
administer, any Plan, or the receipt by the Borrower or any ERISA
Affiliate of a notice from a Multiemployer Plan that such action has
been taken by PBGC with respect to such Multiemployer Plan;
(iv) the complete or partial withdrawal from a Multiemployer Plan
by the Borrower or any ERISA Affiliate that results in liability under
Section 4201 or 4204 of ERISA (including the obligation to satisfy
secondary liability as a result of a purchaser default) or the receipt
by the Borrower or any ERISA Affiliate of notice from a Multiemployer
Plan that it is in reorganization or insolvency pursuant to Section 4241
or 4245 of ERISA or that it intends to terminate or has terminated under
Section 4041A of ERISA;
(v) the institution of a proceeding by a fiduciary of any
Multiemployer Plan against the Borrower or any ERISA Affiliate to
enforce Section 515 of ERISA, which proceeding is not dismissed within
30 days; and
(vi) the adoption of an amendment to any Plan that, pursuant to
Section 401(a)(29) of the Code or Section 307 of ERISA, would result in
the loss of tax-exempt status of the trust of which such Plan is a part
if the Borrower or an ERISA Affiliate fails to provide timely security
to such Plan in accordance with the provisions of said Sections.
The Borrower will furnish to the Lender, at the time it furnishes each set of
financial statements pursuant to paragraphs (a) and (b) above, a certificate
of a Responsible Officer of the Borrower to the effect that, to the best of
such Responsible Officer's knowledge, the Borrower during such fiscal period
or year has observed or performed all of its covenants and other agreements,
and satisfied every condition, contained in this Loan Agreement and the other
Loan Documents to be observed, performed or satisfied by it, and that such
Responsible Officer has obtained no knowledge of any Default or Event of
Default except as specified in such certificate (and, if any Default or Event
of Default has occurred and is continuing, describing the same in reasonable
detail and describing the action the Borrower has taken or proposes to take
with respect thereto).
7.02 LITIGATION. The Borrower will promptly, and in any event within 10
days after service of process on any of the following, give to the Lender
notice of all legal or arbitrable proceedings affecting the Borrower that
questions or challenges the validity or enforceability of any of the Loan
Documents or as to which there is a reasonable likelihood of adverse
determination which would result in a Material Adverse Effect.
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7.03 EXISTENCE, ETC. The Borrower will:
(a) preserve and maintain its legal existence and all of its
material rights, privileges, licenses and franchises (provided that
nothing in this Section 7.03(a) shall prohibit any transaction expressly
permitted under Section 7.04 hereof);
(b) comply with the requirements of all applicable laws, rules,
regulations and orders of Governmental Authorities (including, without
limitation, all environmental laws) if failure to comply with such
requirements would be reasonably likely (either individually or in the
aggregate) to have a material adverse effect on its Property, business
or financial condition, or prospects;
(c) keep adequate records and books of account, in which complete
entries will be made in accordance with GAAP consistently applied;
(d) not move its chief executive office from the address referred
to in Section 6.11 unless it shall have provided the Lender 30 days'
prior written notice of such change;
(e) pay and discharge all taxes, assessments and governmental
charges or levies imposed on it or on its income or profits or on any of
its Property prior to the date on which penalties attach thereto, except
for any such tax, assessment, charge or levy the payment of which is
being contested in good faith and by proper proceedings and against
which adequate reserves are being maintained; and
(f) permit representatives of the Lender, during normal business
hours, to examine, copy and make extracts from its books and records, to
inspect any of its Properties, and to discuss its business and affairs
with its officers, all to the extent reasonably requested by the Lender.
7.04 PROHIBITION OF FUNDAMENTAL CHANGES. The Borrower shall not enter
into any transaction of merger or consolidation or amalgamation, or
liquidate, wind up or dissolve itself (or suffer any liquidation, winding up
or dissolution) or sell all or substantially all of its assets; PROVIDED,
that the Borrower may merge or consolidate with (a) any wholly owned
subsidiary of the Borrower, or (b) any other Person if the Borrower is the
surviving corporation; and PROVIDED FURTHER, that if after giving effect
thereto, no Default would exist hereunder.
7.05 BORROWING BASE DEFICIENCY. If at any time there exists a
Borrowing Base Deficiency the Borrower shall cure same in accordance with
Section 2.06 hereof.
7.06 NOTICES. The Borrower shall give notice to the Lender:
(a) promptly upon receipt of notice or knowledge of the occurrence
of any Default or Event of Default;
(b) with respect to any Mortgage Loan pledged to the Lender
hereunder, immediately upon receipt of any principal prepayment (in full
or partial) of such pledged Mortgage Loan;
(c) with respect to any Mortgage Loan pledged to the Lender
hereunder, immediately upon receipt of notice or knowledge that the
underlying Mortgaged Property has
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been damaged by waste, fire, earthquake or earth movement, windstorm,
flood, tornado or other casualty, or otherwise damaged so as to affect
adversely the Collateral Value of such pledged Mortgage Loan; and
(d) promptly upon receipt of notice or knowledge of (i) any default
related to any Collateral, (ii) any Lien or security interest (other
than security interests created hereby or by the other Loan Documents)
on, or claim asserted against, any of the Collateral or (iii) any event
or change in circumstances which could reasonably be expected to have a
material adverse effect on the Property, business or financial condition
or prospects of the Borrower.
Each notice pursuant to this Section shall be accompanied by a statement of a
Responsible Officer of the Borrower setting forth details of the occurrence
referred to therein and stating what action the Borrower has taken or proposes
to take with respect thereto.
7.07 HEDGING. The Borrower shall at all times maintain Interest Rate
Protection Agreements, having a notional amount not less than 80% of the
aggregate outstanding principal balance of all fixed-rate Mortgage Loans
having terms with respect to protection against fluctuations in interest
rates reasonably acceptable to the Lender. The Borrower shall deliver to the
Lender monthly a written summary of the notional amount of all outstanding
Interest Rate Protection Agreements.
7.08 REPORTS. The Borrower shall provide the Lender with a
quarterly report, which report shall include, among other items, a summary of
the Borrower's delinquency and loss experience with respect to mortgage loans
serviced by the Borrower, if applicable, any Servicer or any designee of either,
if applicable, plus any such additional reports as the Lender may reasonably
request with respect to the Borrower's or any Servicer's servicing portfolio.
7.09 UNDERWRITING GUIDELINES. Without the prior written consent
of the Lender, the Borrower shall not amend or otherwise modify the
Underwriting Guidelines.
7.10 TRANSACTIONS WITH AFFILIATES. The Borrower will not enter
into any transaction, including without limitation any purchase, sale, lease or
exchange of property or the rendering of any service, with any Affiliate unless
such transaction is (a) otherwise permitted under this Loan Agreement, (b) in
the ordinary course of the Borrower's business and (c) upon fair and reasonable
terms no less favorable to the Borrower than it would obtain in a comparable
arm's length transaction with a Person which is not an Affiliate, or make a
payment that is not otherwise permitted by this Section 7.10 to any Affiliate.
In no event shall the Borrower pledge to the Lender hereunder any Mortgage Loan
acquired by the Borrower from an Affiliate of the Borrower.
7.11 LIMITATION ON LIENS. The Borrower will defend the
Collateral against, and will take such other action as is necessary to remove,
any Lien, security interest or claim on or to the Collateral, other than the
security interests created under this Loan Agreement, and the Borrower will
defend the right, title and interest of the Lenders in and to any of the
Collateral against the claims and demands of all persons whomsoever.
7.12 LIMITATION ON GUARANTEES. The Borrower shall not create,
incur, assume or suffer to exist any Guarantees, except with respect to those
Guarantees previously disclosed to and approved by the Lender guaranteeing
Indebtedness in amounts previously disclosed to and approved by the Lender to
Hanover Capital Partners, Ltd.
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7.13 LIMITATION ON DISTRIBUTIONS. After the occurrence and
during the continuation of any Event of Default, the Borrower shall not make any
payment on account of, or set apart assets for, a sinking or other analogous
fund for the purchase, redemption, defeasance, retirement or other acquisition
of any equity or partnership interest of the Borrower, whether now or hereafter
outstanding, or make any other distribution in respect thereof, either directly
or indirectly, whether in cash or property or in obligations of the Borrower.
7.14 MAINTENANCE OF TANGIBLE NET WORTH. The Borrower shall not
permit Tangible Net Worth at any time to be less than $60,000,000.
7.15 MAINTENANCE OF RATIO OF TOTAL INDEBTEDNESS TO TANGIBLE NET
WORTH. The Borrower shall not permit the ratio of Total Indebtedness to
Tangible Net Worth at any time to be greater than 10:1.
7.16 MAINTENANCE OF PROFITABILITY. The Borrower shall not permit, for
any period of three consecutive fiscal quarters (each such period, a
"TEST PERIOD"), Net Income for such Test Period, before income taxes for such
Test Period and distributions made during such Test Period, to be less than
$1.00.
7.17 SERVICING TAPE. The Borrower shall provide to the Lender
on a monthly basis a computer readable magnetic tape containing servicing
information, including without limitation those fields specified by the Lender
from time to time, on a loan-by-loan basis and in the aggregate, with respect to
the Mortgage Loans serviced hereunder by the Borrower or any Servicer.
7.18 LIMITATION ON SUBSIDIARY FORMATION. Except with respect
to those Subsidiaries formed solely for the purpose of issuing collateralized
mortgage obligations, the Borrower shall not form any Subsidiaries.
Section 8. EVENTS OF DEFAULT. Each of the following events
shall constitute an event of default (an "EVENT OF DEFAULT") hereunder:
(a) the Borrower shall default in the payment of any principal of
or interest on any Loan when due (whether at stated maturity, upon
acceleration or at mandatory prepayment); or
(b) the Borrower shall default in the payment of any other amount
payable by it hereunder or under any other Loan Document after
notification by the Lender of such default, and such default shall have
continued unremedied for five Business Days; or
(c) any representation, warranty or certification made or deemed
made herein or in any other Loan Document by the Borrower or any
certificate furnished to the Lender pursuant to the provisions hereof or
thereof shall prove to have been false or misleading in any material
respect as of the time made or furnished (other than the representations
and warranties set forth in Schedule 1, which shall be considered solely
for the purpose of determining the Collateral Value of the Mortgage
Loans; unless the Borrower shall have made any such representations and
warranties with knowledge that they were materially false or misleading
at the time made); or
(d) the Borrower shall fail to comply with the requirements of
Section 7.03(a), Section 7.04, Section 7.06, or Sections 7.09 through
7.18 hereof; or the Borrower shall default in the performance of its
obligations under Section 7.05 hereof and such default shall continue
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unremedied for a period of one (1) Business Day; or the Borrower shall
otherwise fail to comply with the requirements of Section 7.03 hereof
and such default shall continue unremedied for a period of five Business
Days; or the Borrower shall fail to observe or perform any other
covenant or agreement contained in this Loan Agreement or any other Loan
Document and such failure to observe or perform shall continue
unremedied for a period of seven Business Days; or
(e) a final judgment or judgments for the payment of money in
excess of $5,000,000 in the aggregate shall be rendered against the
Borrower by one or more courts, administrative tribunals or other bodies
having jurisdiction and the same shall not be discharged (or provision
shall not be made for such discharge) or bonded, or a stay of execution
thereof shall not be procured, within 60 days from the date of entry
thereof, and the Borrower shall not, within said period of 60 days, or
such longer period during which execution of the same shall have been
stayed or bonded, appeal therefrom and cause the execution thereof to be
stayed during such appeal; or
(f) the Borrower shall admit in writing its inability to pay its
debts as such debts become due; or
(g) the Borrower shall (i) apply for or consent to the appointment
of, or the taking of possession by, a receiver, custodian, trustee,
examiner or liquidator or the like of itself or of all or a substantial
part of its property, (ii) make a general assignment for the benefit of
its creditors, (iii) commence a voluntary case under the Bankruptcy
Code, (iv) file a petition seeking to take advantage of any other law
relating to bankruptcy, insolvency, reorganization, liquidation,
dissolution, arrangement or winding-up, or composition or readjustment
of debts, (v) fail to controvert in a timely and appropriate manner, or
acquiesce in writing to, any petition filed against it in an involuntary
case under the Bankruptcy Code or (vi) take any corporate or other
action for the purpose of effecting any of the foregoing; or
(h) a proceeding or case shall be commenced, without the
application or consent of the Borrower, in any court of competent
jurisdiction, seeking (i) its reorganization, liquidation, dissolution,
arrangement or winding-up, or the composition or readjustment of its
debts, (ii) the appointment of, or the taking of possession by, a
receiver, custodian, trustee, examiner, liquidator or the like of the
Borrower or of all or any substantial part of its property, or (iii)
similar relief in respect of the Borrower under any law relating to
bankruptcy, insolvency, reorganization, liquidation, dissolution,
arrangement or winding-up, or composition or adjustment of debts, and
such proceeding or case shall continue undismissed, or an order,
judgment or decree approving or ordering any of the foregoing shall be
entered and continue unstayed and in effect, for a period of 60 or more
days; or an order for relief against the Borrower shall be entered in an
involuntary case under the Bankruptcy Code; or
(i) the Custodial Agreement or any Loan Document shall for whatever
reason be terminated or cease to be in full force and effect, or the
enforceability thereof shall be contested by the Borrower; or
(j) the Borrower shall grant, or suffer to exist, any Lien on any
Collateral except the Liens contemplated hereby; or the Liens
contemplated hereby shall cease to be first priority perfected Liens on
the Collateral in favor of the Lender or shall be Liens in favor of any
Person other than the Lender; or
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(k) any materially adverse change in the Property, business,
financial condition or prospects of the Borrower shall occur, in each
case as determined by the Lender in its sole discretion, or any other
condition shall exist which, in the Lender's sole discretion,
constitutes a material impairment of the Borrower's ability to perform
its obligations under this Loan Agreement, the Note or any other Loan
Document; or
(l) any person shall beneficially own (directly or indirectly) more
than 49% of the Borrower; or
(m) the Borrower or any Affiliate of the Borrower shall default
under any other agreement with the Lender or an Affiliate of the Lender.
Section 9. REMEDIES UPON DEFAULT.
(a) Upon the occurrence of one or more Events of Default other than
those referred to in Section 8(g) or (h), the Lender may immediately declare
the principal amount of the Loans then outstanding under the Note to be
immediately due and payable, together with all interest thereon and fees and
expenses accruing under this Loan Agreement. Upon the occurrence of an Event
of Default referred to in Sections 8(g) or (h), such amounts shall
immediately and automatically become due and payable without any further
action by any Person. Upon such declaration or such automatic acceleration,
the balance then outstanding on the Note shall become immediately due and
payable, without presentment, demand, protest or other formalities of any
kind, all of which are hereby expressly waived by the Borrower.
(b) Upon the occurrence of one or more Events of Default, the Lender
shall have the right to obtain physical possession of the Servicing Records and
all other files of the Borrower relating to the Collateral and all documents
relating to the Collateral which are then or may thereafter come in to
the possession of the Borrower or any third party acting for the Borrower and
the Borrower shall deliver to the Lender such assignments as the Lender shall
request. The Lender shall be entitled to specific performance of all agreements
of the Borrower contained in this Loan Agreement.
Section 10. NO DUTY OF LENDER. The powers conferred on the Lender
hereunder are solely to protect the Lender's interests in the Collateral
and shall not impose any duty upon it to exercise any such powers. The Lender
shall be accountable only for amounts that it actually receives as a result of
the exercise of such powers, and neither it nor any of its officers, directors,
employees or agents shall be responsible to the Borrower for any act or failure
to act hereunder, except for its or their own gross negligence or willful
misconduct.
Section 11. MISCELLANEOUS.
11.01 WAIVER. No failure on the part of the Lender to exercise and no
delay in exercising, and no course of dealing with respect to, any right,
power or privilege under any Loan Document shall operate as a waiver thereof,
nor shall any single or partial exercise of any right, power or privilege under
any Loan Document preclude any other or further exercise thereof or the exercise
of any other right, power or privilege. The remedies provided herein are
cumulative and not exclusive of any remedies provided by law.
11.02 NOTICES. Except as otherwise expressly permitted by this Loan
Agreement, all notices, requests and other communications provided for
herein and under the Custodial Agreement
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(including without limitation any modifications of, or waivers, requests or
consents under, this Loan Agreement) shall be given or made in writing
(including without limitation by telex or telecopy) delivered to the intended
recipient at the "Address for Notices" specified below its name on the
signature pages hereof or thereof); or, as to any party, at such other
address as shall be designated by such party in a written notice to each
other party. Except as otherwise provided in this Loan Agreement and except
for notices given under Section 2 (which shall be effective only on receipt),
all such communications shall be deemed to have been duly given when
transmitted by telex or telecopy or personally delivered or, in the case of a
mailed notice, upon receipt, in each case given or addressed as aforesaid.
11.03 INDEMNIFICATION AND EXPENSES.
(a) The Borrower agrees to hold the Lender harmless from and
indemnify the Lender against all liabilities, losses, damages, judgments, costs
and expenses of any kind which may be imposed on, incurred by or asserted
against the Lender relating to or arising out of this Loan Agreement, the Note,
any other Loan Document or any transaction contemplated hereby or thereby, or
any amendment, supplement or modification of, or any waiver or consent under or
in respect of, this Loan Agreement, the Note, any other Loan Document or any
transaction contemplated hereby or thereby, that, in each case, results from
anything other than the Lender's gross negligence or willful misconduct. In any
suit, proceeding or action brought by the Lender in connection with any Mortgage
Loan for any sum owing thereunder, or to enforce any provisions of any Mortgage
Loan, the Borrower will save, indemnify and hold the Lender harmless from and
against all expense, loss or damage suffered by reason of any defense, set-off,
counterclaim, recoupment or reduction or liability whatsoever of the account
debtor or obligor thereunder, arising out of a breach by the Borrower of any
obligation thereunder or arising out of any other agreement, indebtedness or
liability at any time owing to or in favor of such account debtor or obligor or
its successors from the Borrower. The Borrower also agrees to reimburse the
Lender as and when billed by the Lender for all the Lender's costs and expenses
incurred in connection with the enforcement or the preservation of the Lender's
rights under this Loan Agreement, the Note, any other Loan Document or any
transaction contemplated hereby or thereby, including without limitation the
reasonable fees and disbursements of its counsel. The Borrower hereby
acknowledges that, notwithstanding the fact that the Note is secured by the
Collateral, the obligation of the Borrower under the Note is a recourse
obligation of the Borrower.
(b) The Borrower agrees to pay as and when billed by the
Lender all of the out-of-pocket costs and expenses incurred by the Lender in
connection with the development, preparation and execution of, and any
amendment, supplement or modification to, this Loan Agreement, the Note, any
other Loan Document or any other documents prepared in connection herewith or
therewith. The Borrower agrees to pay as and when billed by the Lender all of
the out-of-pocket costs and expenses incurred in connection with the
consummation and administration of the transactions contemplated hereby and
thereby including without limitation (i) all the reasonable fees, disbursements
and expenses of counsel to the Lender and (ii) all the due diligence,
inspection, testing and review costs and expenses incurred by the Lender with
respect to Collateral under this Loan Agreement, including, but not limited to,
those costs and expenses incurred by the Lender pursuant to Sections 11.03(a),
11.14 and 11.15 hereof.
11.04 AMENDMENTS. Except as otherwise expressly provided in
this Loan Agreement, any provision of this Loan Agreement may be modified or
supplemented only by an instrument in writing signed by the Borrower and the
Lender and any provision of this Loan Agreement may be waived by the Lender.
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11.05 SUCCESSORS AND ASSIGNS. This Loan Agreement shall be
binding upon and inure to the benefit of the parties hereto and their respective
successors and permitted assigns.
11.06 SURVIVAL. The obligations of the Borrower under Sections
3.03 and 11.03 hereof shall survive the repayment of the Loans and the
termination of this Loan Agreement. In addition, each representation and
warranty made or deemed to be made by a request for a borrowing, herein or
pursuant hereto shall survive the making of such representation and warranty,
and the Lender shall not be deemed to have waived, by reason of making any Loan,
any Default that may arise because any such representation or warranty shall
have proved to be false or misleading, notwithstanding that the Lender may have
had notice or knowledge or reason to believe that such representation or
warranty was false or misleading at the time such Loan was made.
11.07 CAPTIONS. The table of contents and captions and section
headings appearing herein are included solely for convenience of reference and
are not intended to affect the interpretation of any provision of this Loan
Agreement.
11.08 COUNTERPARTS. This Loan Agreement may be executed in any
number of counterparts, all of which taken together shall constitute one and the
same instrument, and any of the parties hereto may execute this Loan Agreement
by signing any such counterpart.
11.09 LOAN AGREEMENT CONSTITUTES SECURITY AGREEMENT; GOVERNING
LAW. This Loan Agreement shall be governed by New York law without reference to
choice of law doctrine, and shall constitute a security agreement within the
meaning of the Uniform Commercial Code.
11.10 SUBMISSION TO JURISDICTION; WAIVERS. THE BORROWER
HEREBY IRREVOCABLY AND UNCONDITIONALLY:
(A) SUBMITS FOR ITSELF AND ITS PROPERTY IN ANY LEGAL ACTION OR
PROCEEDING RELATING TO THIS LOAN AGREEMENT, THE NOTE AND THE OTHER LOAN
DOCUMENTS, OR FOR RECOGNITION AND ENFORCEMENT OF ANY JUDGMENT IN
RESPECT THEREOF, TO THE NON-EXCLUSIVE GENERAL JURISDICTION OF THE
COURTS OF THE STATE OF NEW YORK, THE FEDERAL COURTS OF THE UNITED
STATES OF AMERICA FOR THE SOUTHERN DISTRICT OF NEW YORK, AND APPELLATE
COURTS FROM ANY THEREOF;
(B) CONSENTS THAT ANY SUCH ACTION OR PROCEEDING MAY BE BROUGHT
IN SUCH COURTS AND, TO THE EXTENT PERMITTED BY LAW, WAIVES ANY
OBJECTION THAT IT MAY NOW OR HEREAFTER HAVE TO THE VENUE OF ANY SUCH
ACTION OR PROCEEDING IN ANY SUCH COURT OR THAT SUCH ACTION OR
PROCEEDING WAS BROUGHT IN AN INCONVENIENT COURT AND AGREES NOT TO PLEAD
OR CLAIM THE SAME;
(C) AGREES THAT SERVICE OF PROCESS IN ANY SUCH ACTION OR
PROCEEDING MAY BE EFFECTED BY MAILING A COPY THEREOF BY REGISTERED OR
CERTIFIED MAIL (OR ANY SUBSTANTIALLY SIMILAR FORM OF MAIL), POSTAGE
PREPAID, TO ITS ADDRESS SET FORTH UNDER ITS SIGNATURE BELOW OR AT SUCH
OTHER ADDRESS OF WHICH THE LENDER SHALL HAVE BEEN NOTIFIED; AND
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(D) AGREES THAT NOTHING HEREIN SHALL AFFECT THE RIGHT TO
EFFECT SERVICE OF PROCESS IN ANY OTHER MANNER PERMITTED BY LAW OR SHALL
LIMIT THE RIGHT TO SUE IN ANY OTHER JURISDICTION.
11.11 WAIVER OF JURY TRIAL. EACH OF THE BORROWER AND THE
LENDER HEREBY IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE
LAW, ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY LEGAL PROCEEDING ARISING OUT OF
OR RELATING TO THIS LOAN AGREEMENT, ANY OTHER LOAN DOCUMENT OR THE TRANSACTIONS
CONTEMPLATED HEREBY OR THEREBY.
11.12 ACKNOWLEDGMENTS. The Borrower hereby acknowledges that:
(a) it has been advised by counsel in the negotiation,
execution and delivery of this Loan Agreement, the Note and the other
Loan Documents;
(b) the Lender has no fiduciary relationship to the
Borrower, and the relationship between the Borrower and the Lender is
solely that of debtor and creditor; and
(c) no joint venture exists between the Lender and the
Borrower.
11.13 HYPOTHECATION OR PLEDGE OF LOANS. The Lender shall have
free and unrestricted use of all Collateral and nothing in this Loan Agreement
shall preclude the Lender from engaging in repurchase transactions with the
Collateral or otherwise pledging, repledging, hypothecating, or rehypothecating
the Collateral. Nothing contained in this Loan Agreement shall obligate the
Lender to segregate any Collateral delivered to the Lender by the Borrower.
11.14 SERVICING.
(a) The Borrower covenants to maintain or cause the servicing
of the Mortgage Loans to be maintained in conformity with accepted and prudent
servicing practices in the industry for the same type of mortgage loans as the
Mortgage Loans and in a manner at least equal in quality to the servicing the
Borrower provides for mortgage loans which it owns. In the event that the
preceding language is interpreted as constituting one or more servicing
contracts, each such servicing contract shall terminate automatically upon the
earliest of (i) an Event of Default, (ii) the date on which all the Secured
Obligations have been paid in full or (iii) the transfer of servicing approved
by the Borrower.
(b) If the Mortgage Loans are serviced by the Borrower, (i)
the Borrower agrees that the Lender is the collateral assignee of all servicing
records, including but not limited to any and all servicing agreements, files,
documents, records, data bases, computer tapes, copies of computer tapes, proof
of insurance coverage, insurance policies, appraisals, other closing
documentation, payment history records, and any other records relating to or
evidencing the servicing of Mortgage Loans (the "SERVICING RECORDS"), and (ii)
the Borrower grants the Lender a security interest in all servicing fees and
rights relating to the Mortgage Loans and all Servicing Records to secure the
obligation of the Borrower or its designee to service in conformity with this
Section and any other obligation of the Borrower to the Lender. The Borrower
covenants to safeguard such Servicing Records and to deliver them promptly to
the Lender or its designee (including the Custodian) at the Lender's request.
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(e) NO DEFENSES. The Mortgage Loan is not subject to any right
of rescission, set-off, counterclaim or defense, including without limitation
the defense of usury, nor will the operation of any of the terms of the Mortgage
Note or the Mortgage, or the exercise of any right thereunder, render either the
Mortgage Note or the Mortgage unenforceable, in whole or in part and no such
right of rescission, set-off, counterclaim or defense has been asserted with
respect thereto, and no Mortgagor in respect of the Mortgage Loan was a debtor
in any state or Federal bankruptcy or insolvency proceeding at the time the
Mortgage Loan was originated. The Borrower has no knowledge nor has it received
any notice that any Mortgagor in respect of the Mortgage Loan is a debtor in any
state or federal bankruptcy or insolvency proceeding.
(f) HAZARD INSURANCE. The Mortgaged Property is insured by a
fire and extended perils insurance policy, issued by a Qualified Insurer, and
such other hazards as are customary in the area where the Mortgaged Property is
located, and to the extent required by the Borrower as of the date of
origination consistent with the Underwriting Guidelines, against earthquake and
other risks insured against by Persons operating like properties in the locality
of the Mortgaged Property, in an amount not less than the greatest of (i) 100%
of the replacement cost of all improvements to the Mortgaged Property, (ii)
either (A) the outstanding principal balance of the Mortgage Loan with respect
to each First Lien Mortgage Loan (as identified on the Mortgage Loan Tape) or
(B) with respect to each Second Lien Mortgage Loan (as identified on the
Mortgage Loan Tape), the sum of the outstanding principal balance of the First
Lien Mortgage Loan and the outstanding principal balance of the Second Lien
Mortgage Loan, or (iii) the amount necessary to avoid the operation of any
co-insurance provisions with respect to the Mortgaged Property, and consistent
with the amount that would have been required as of the date of origination in
accordance with the Underwriting Guidelines. If any portion of the Mortgaged
Property is in an area identified by any federal Governmental Authority as
having special flood hazards, and flood insurance is available, a flood
insurance policy meeting the current guidelines of the Federal Insurance
Administration is in effect with a generally acceptable insurance carrier, in an
amount representing coverage not less than the least of (1) the outstanding
principal balance of the Mortgage Loan, (2) the full insurable value of the
Mortgaged Property, and (3) the maximum amount of insurance available under the
Flood Disaster Protection Act of 1973, as amended. All such insurance policies
(collectively, the "hazard insurance policy") contain a standard mortgagee
clause naming the Borrower, its successors and assigns (including without
limitation, subsequent owners of the Mortgage Loan), as mortgagee, and may not
be reduced, terminated or canceled without 30 days' prior written notice to the
mortgagee. No such notice has been received by the Borrower. All premiums on
such insurance policy have been paid. The related Mortgage obligates the
Mortgagor to maintain all such insurance and, at such Mortgagor's failure to do
so, authorizes the mortgagee to maintain such insurance at the Mortgagor's cost
and expense and to seek reimbursement therefor from such Mortgagor. Where
required by state law or regulation, the Mortgagor has been given an opportunity
to choose the carrier of the required hazard insurance, provided the policy is
not a "master" or "blanket" hazard insurance policy covering a condominium, or
any hazard insurance policy covering the common facilities of a planned unit
development. The hazard insurance policy is the valid and binding obligation of
the insurer and is in full force and effect. The Borrower has not engaged in,
and has no knowledge of the Mortgagor's having engaged in, any act or omission
which would impair the coverage of any such policy, the benefits of the
endorsement provided for herein, or the validity and binding effect of either
including, without limitation, no unlawful fee, commission, kickback or other
unlawful compensation or value of any kind has been or will be received,
retained or realized by any attorney, firm or other Person, and no such unlawful
items have been received, retained or realized by the Borrower.
Schedule 1-2
<PAGE> 34
(g) COMPLIANCE WITH APPLICABLE LAWS. Any and all requirements
of any federal, state or local law including, without limitation, usury,
truth-in-lending, real estate settlement procedures, consumer credit protection,
equal credit opportunity or disclosure laws applicable to the Mortgage Loan have
been complied with, the consummation of the transactions contemplated hereby
will not involve the violation of any such laws or regulations, and the Borrower
shall maintain or shall cause its agent to maintain in its possession, available
for the inspection of the Lender, and shall deliver to the Lender, upon demand,
evidence of compliance with all such requirements.
(h) NO SATISFACTION OF MORTGAGE. The Mortgage has not been
satisfied, canceled, subordinated or rescinded, in whole or in part, and the
Mortgaged Property has not been released from the lien of the Mortgage, in whole
or in part, nor has any instrument been executed that would effect any such
release, cancellation, subordination or rescission. The Borrower has not waived
the performance by the Mortgagor of any action, if the Mortgagor's failure to
perform such action would cause the Mortgage Loan to be in default, nor has the
Borrower waived any default resulting from any action or inaction by the
Mortgagor.
(i) LOCATION AND TYPE OF MORTGAGED PROPERTY. The Mortgaged
Property is located in an Acceptable State as identified in the Mortgage Loan
Schedule and consists of a single parcel of real property with a detached single
family residence erected thereon, or a two- to four-family dwelling, or an
individual condominium unit in a low-rise condominium project, or an individual
unit in a planned unit development or a de minimis planned unit development,
provided, however, that any condominium unit or planned unit development shall
conform with the applicable FNMA and FHLMC requirements regarding such dwellings
and that no residence or dwelling is a mobile home or a manufactured dwelling.
No portion of the Mortgaged Property is used for commercial purposes.
(j) VALID FIRST LIEN. The Mortgage is a valid, subsisting,
enforceable and perfected (A) first lien and first priority security interest
with respect to each Mortgage Loan which is indicated by such Borrower to be a
First Lien Mortgage Loan (as reflected on the Mortgage Loan Tape), or (B) second
lien and second priority security interest with respect to each Mortgage Loan
which is indicated by such Borrower to be a Second Lien Mortgage Loan (as
reflected on the Mortgage Loan Tape), in either case, on the real property
included in the Mortgaged Property, including all buildings on the Mortgaged
Property and all installations and mechanical, electrical, plumbing, heating and
air conditioning systems located in or annexed to such buildings, and all
additions, alterations and replacements made at any time with respect to the
foregoing. The lien of the Mortgage is subject only to:
(1) the lien of current real property taxes and
assessments not yet due and payable;
(2) covenants, conditions and restrictions, rights of way,
easements and other matters of the public record as of the date of
recording acceptable to prudent mortgage lending institutions generally
and specifically referred to in the lender's title insurance policy
delivered to the originator of the Mortgage Loan and (a) referred to or
otherwise considered in the appraisal made for the originator of the
Mortgage Loan or (b) which do not adversely affect the Appraised Value
of the Mortgaged Property set forth in such appraisal; and
(3) other matters to which like properties are commonly
subject which do not materially interfere with the benefits of the
security intended to be provided by the Mortgage or the use, enjoyment,
value or marketability of the related Mortgaged Property.
Schedule 1-3
<PAGE> 35
(4) with respect to each Mortgage Loan which is indicated by
such Borrower to be a Second Lien Mortgage Loan (as reflected on the
Mortgage Loan Tape) a prior first mortgage lien on the Mortgaged
Property.
Any security agreement, chattel mortgage or equivalent document related to and
delivered in connection with the Mortgage Loan establishes and creates a valid,
subsisting and enforceable (A) first lien and first priority security interest
with respect to each Mortgage Loan which is indicated by such Borrower to be a
First Lien Mortgage Loan (as reflected on the Mortgage Loan Tape), or (B) second
lien and second priority security interest with respect to each Mortgage Loan
which is indicated by such Borrower to be a Second Lien Mortgage Loan (as
reflected on the Mortgage Loan Tape), in either case, on the property described
therein and the Borrower has full right to pledge and assign the same to the
Lender. The Mortgaged Property was not, as of the date of origination of the
Mortgage Loan, subject to a mortgage, deed of trust, deed to secure debt or
other security instrument creating a lien subordinate to the lien of the
Mortgage.
(k) VALIDITY OF MORTGAGE DOCUMENTS. The Mortgage Note and the
Mortgage and any other agreement executed and delivered by a Mortgagor or
guarantor, if applicable, in connection with a Mortgage Loan are genuine, and
each is the legal, valid and binding obligation of the maker thereof enforceable
in accordance with its terms. All parties to the Mortgage Note, the Mortgage and
any other such related agreement had legal capacity to enter into the Mortgage
Loan and to execute and deliver the Mortgage Note, the Mortgage and any such
agreement, and the Mortgage Note, the Mortgage and any other such related
agreement have been duly and properly executed by such related parties. No
fraud, error, omission, misrepresentation, negligence or similar occurrence with
respect to a Mortgage Loan has taken placed on the part of any Person,
including, without limitation, the Mortgagor, any appraiser, any builder or
developer, or any other party involved in the origination of the Mortgage Loan.
The Borrower has reviewed all of the documents constituting the Servicing File
and has made such inquiries as it deems necessary to make and confirm the
accuracy of the representations set forth herein.
(l) FULL DISBURSEMENT OF PROCEEDS. The Mortgage Loan has been
closed and the proceeds of the Mortgage Loan have been fully disbursed and there
is no further requirement for future advances thereunder, and any and all
requirements as to completion of any on-site or off-site improvement and as to
disbursements of any escrow funds therefor have been complied with. All costs,
fees and expenses incurred in making or closing the Mortgage Loan and the
recording of the Mortgage were paid, and the Mortgagor is not entitled to any
refund of any amounts paid or due under the Mortgage Note or Mortgage.
(m) OWNERSHIP. The Borrower is the sole owner and holder of
the Mortgage Loan. The Mortgage Loan is not assigned or pledged, and the
Borrower has good, indefeasible and marketable title thereto, and has full right
to transfer, pledge and assign the Mortgage Loan to the Lender free and clear of
any encumbrance, equity, participation interest, lien, pledge, charge, claim or
security interest, and has full right and authority subject to no interest or
participation of, or agreement with, any other party, to assign, transfer and
pledge each Mortgage Loan pursuant to this Loan Agreement and following the
pledge of each Mortgage Loan, the Lender will hold such Mortgage Loan free and
clear of any encumbrance, equity, participation interest, lien, pledge, charge,
claim or security interest except any such security interest created pursuant to
the terms of this Loan Agreement.
(n) DOING BUSINESS. All parties which have had any interest in
the Mortgage Loan, whether as mortgagee, assignee, pledgee or otherwise, are
(or, during the period in which they held
Schedule 1-4
<PAGE> 36
and disposed of such interest, were) (i) in compliance with any and all
applicable licensing requirements of the laws of the state wherein the
Mortgaged Property is located, and (ii) either (A) organized under the laws
of such state, (B) qualified to do business in such state, (C) a federal
savings and loan association, a savings bank or a national bank having a
principal office in such state, or (D) not doing business in such state.
(o) LTV. No First Lien Mortgage Loan has an LTV
greater than 125%. No Second Lien Mortgage Loan has a Combined LTV greater
than 100%.
(p) TITLE INSURANCE. The Mortgage Loan is covered by either
(i) an attorney's opinion of title and abstract of title, the form and substance
of which is acceptable to prudent mortgage lending institutions making mortgage
loans in the area wherein the Mortgaged Property is located or (ii) an ALTA
lender's title insurance policy or other generally acceptable form of policy or
insurance acceptable to FNMA or FHLMC and each such title insurance policy is
issued by a title insurer acceptable to FNMA or FHLMC and qualified to do
business in the jurisdiction where the Mortgaged Property is located, insuring
the Borrower, its successors and assigns, as to the first priority lien of the
Mortgage in the original principal amount of the Mortgage Loan (or to the extent
a Mortgage Note provides for negative amortization, the maximum amount of
negative amortization in accordance with the Mortgage), subject only to the
exceptions contained in clauses (1), (2) and (3) , and with respect to each
Mortgage Loan which is indicated by the Borrower to be a Second Lien Mortgage
Loan (as reflected on the Mortgage Loan Schedule) clause (4) of paragraph (j) of
this Part I of Schedule 1, and in the case of adjustable rate Mortgage Loans,
against any loss by reason of the invalidity or unenforceability of the lien
resulting from the provisions of the Mortgage providing for adjustment to the
Mortgage Interest Rate and Monthly Payment. Where required by state law or
regulation, the Mortgagor has been given the opportunity to choose the carrier
of the required mortgage title insurance. Additionally, such lender's title
insurance policy affirmatively insures ingress and egress and against
encroachments by or upon the Mortgaged Property or any interest therein. The
title policy does not contain any special exceptions (other than the standard
exclusions) for zoning and uses and has been marked to delete the standard
survey exception or to replace the standard survey exception with a specific
survey reading. The Borrower, its successors and assigns, are the sole insureds
of such lender's title insurance policy, and such lender's title insurance
policy is valid and remains in full force and effect and will be in force and
effect upon the consummation of the transactions contemplated by this Loan
Agreement. No claims have been made under such lender's title insurance policy,
and no prior holder or servicer of the related Mortgage, including the Borrower,
has done, by act or omission, anything which would impair the coverage of such
lender's title insurance policy, including, without limitation, no unlawful fee,
commission, kickback or other unlawful compensation or value of any kind has
been or will be received, retained or realized by any attorney, firm or other
Person, and no such unlawful items have been received, retained or realized by
the Borrower.
(q) NO DEFAULTS. There is no default, breach, violation or
event of acceleration existing under the Mortgage or the Mortgage Note and no
event has occurred which, with the passage of time or with notice and the
expiration of any grace or cure period, would constitute a default, breach,
violation or event of acceleration, and neither the Borrower nor its
predecessors have waived any default, breach, violation or event of
acceleration. With respect to each Mortgage Loan which is indicated by such
Borrower to be a Second Lien Mortgage Loan (as reflected on the Mortgage Loan
Schedule) to the best of Borrower's knowledge (i) the prior mortgage is in full
force and effect, (ii) there is no default, breach, violation or event of
acceleration existing under such prior mortgage or the related mortgage note,
(iii) no event which, with the passage of time or with notice and the expiration
of any grace or cure period, would constitute a default, breach, violation or
event of acceleration
Schedule 1-5
<PAGE> 37
thereunder, and either (A) the prior mortgage contains a provision which
allows or (B) applicable law requires, the mortgagee under the Second Lien
Mortgage Loan to receive notice of, and affords such mortgagee an opportunity
to cure any default by payment in full or otherwise under the prior mortgage.
(r) NO MECHANICS' LIENS. There are no mechanics' or similar
liens or claims which have been filed for work, labor or material (and no rights
are outstanding that under the law could give rise to such liens) affecting the
Mortgaged Property which are or may be liens prior to, or equal or coordinate
with, the lien of the Mortgage.
(s) LOCATION OF IMPROVEMENTS; NO ENCROACHMENTS. All
improvements which were considered in determining the Appraised Value of the
Mortgaged Property lie wholly within the boundaries and building restriction
lines of the Mortgaged Property, and no improvements on adjoining properties
encroach upon the Mortgaged Property. No improvement located on or being part of
the Mortgaged Property is in violation of any applicable zoning and building
law, ordinance or regulation.
(t) ORIGINATION; PAYMENT TERMS. The Mortgage Loan was
originated by or in conjunction with a mortgagee approved by the Secretary of
Housing and Urban Development pursuant to Sections 203 and 211 of the National
Housing Act, a savings and loan association, a savings bank, a commercial bank,
credit union, insurance company or similar banking institution which is
supervised and examined by a federal or state authority. Principal payments on
the Mortgage Loan commenced no more than 60 days after funds were disbursed in
connection with the Mortgage Loan. The Mortgage Interest Rate is adjusted, with
respect to adjustable rate Mortgage Loans, on each Interest Rate Adjustment Date
to equal the Index plus the Gross Margin (rounded up or down to the nearest
.125%), subject to the Mortgage Interest Rate Cap. The Mortgage Note is payable
on the first day of each month in equal monthly installments of principal and
interest, which installments of interest, with respect to adjustable rate
Mortgage Loans, are subject to change due to the adjustments to the Mortgage
Interest Rate on each Interest Rate Adjustment Date, with interest calculated
and payable in arrears, sufficient to amortize the Mortgage Loan fully by the
stated maturity date, over an original term of not more than 30 years from
commencement of amortization; provided, however, in the case of a balloon
Mortgage Loan, the Mortgage Loan matures at least five years after the first
payment date thereby requiring a final payment of the outstanding principal
prior to full amortization of the Mortgage Loan. The due date of the first
payment under the Mortgage Note is no more than 60 days from the date of the
Mortgage Note.
(u) CUSTOMARY PROVISIONS. The Mortgage Note has a stated
maturity. The Mortgage contains customary and enforceable provisions such as to
render the rights and remedies of the holder thereof adequate for the
realization against the Mortgaged Property of the benefits of the security
provided thereby, including, (i) in the case of a Mortgage designated as a deed
of trust, by trustee's sale, and (ii) otherwise by judicial foreclosure. Upon
default by a Mortgagor on a Mortgage Loan and foreclosure on, or trustee's sale
of, the Mortgaged Property pursuant to the proper procedures, the holder of the
Mortgage Loan will be able to deliver good and merchantable title to the
Mortgaged Property. There is no homestead or other exemption available to a
Mortgagor which would interfere with the right to sell the Mortgaged Property at
a trustee's sale or the right to foreclose the Mortgage.
(v) CONFORMANCE WITH UNDERWRITING GUIDELINES AND AGENCY
STANDARDS. The Mortgage Loan was underwritten in accordance with the
Underwriting Guidelines. The Mortgage Note and Mortgage are on forms similar to
those used by FHLMC or FNMA and the Borrower has not made any representations to
a Mortgagor that are inconsistent with the mortgage instruments used.
Schedule 1-6
<PAGE> 38
(w) OCCUPANCY OF THE MORTGAGED PROPERTY. As of the Funding
Date the Mortgaged Property is lawfully occupied under applicable law. All
inspections, licenses and certificates required to be made or issued with
respect to all occupied portions of the Mortgaged Property and, with respect to
the use and occupancy of the same, including but not limited to certificates of
occupancy and fire underwriting certificates, have been made or obtained from
the appropriate authorities. The Borrower has not received notification from any
governmental authority that the Mortgaged Property is in material non-compliance
with such laws or regulations, is being used, operated or occupied unlawfully or
has failed to have or obtain such inspection, licenses or certificates, as the
case may be. The Borrower has not received notice of any violation or failure to
conform with any such law, ordinance, regulation, standard, license or
certificate.
(x) NO ADDITIONAL COLLATERAL. The Mortgage Note is
not and has not been secured by any collateral except the lien of the
corresponding Mortgage and the security interest of any applicable security
agreement or chattel mortgage referred to in clause (j) above.
(y) DEEDS OF TRUST. In the event the Mortgage constitutes a
deed of trust, a trustee, authorized and duly qualified under applicable law to
serve as such, has been properly designated and currently so serves and is named
in the Mortgage, and no fees or expenses are or will become payable by the
Custodian or the Lender to the trustee under the deed of trust, except in
connection with a trustee's sale after default by the Mortgagor.
(z) DELIVERY OF MORTGAGE DOCUMENTS. The Mortgage Note, the
Mortgage, the Assignment of Mortgage and any other documents required to be
delivered under the Custodial Agreement for each Mortgage Loan have been
delivered to the Custodian. The Borrower or its agent is in possession of a
complete, true and accurate Mortgage File in compliance with the Custodial
Agreement, except for such documents the originals of which have been delivered
to the Custodian.
(aa) TRANSFER OF MORTGAGE LOANS. The Assignment of
Mortgage is in recordable form and is acceptable for recording under the laws
of the jurisdiction in which the Mortgaged Property is located.
(bb) DUE-ON-SALE. The Mortgage contains an enforceable
provision for the acceleration of the payment of the unpaid principal balance of
the Mortgage Loan in the event that the Mortgaged Property is sold or
transferred without the prior written consent of the mortgagee thereunder.
(cc) NO BUYDOWN PROVISIONS; NO GRADUATED PAYMENTS OR
CONTINGENT INTERESTS. The Mortgage Loan does not contain provisions pursuant to
which Monthly Payments are paid or partially paid with funds deposited in any
separate account established by the Borrower, the Mortgagor, or anyone on behalf
of the Mortgagor, or paid by any source other than the Mortgagor nor does it
contain any other similar provisions which may constitute a "buydown" provision.
The Mortgage Loan is not a graduated payment mortgage loan and the Mortgage Loan
does not have a shared appreciation or other contingent interest feature.
(dd) CONSOLIDATION OF FUTURE ADVANCES. Any future advances
made to the Mortgagor prior to the Cut-off Date have been consolidated with the
outstanding principal amount secured by the Mortgage, and the secured principal
amount, as consolidated, bears a single interest rate and single repayment term.
The lien of the Mortgage securing the consolidated principal amount is expressly
insured as having (A) first lien priority with respect to each Mortgage Loan
which is
Schedule 1-7
<PAGE> 39
indicated by such Borrower to be a First Lien Mortgage Loan (as reflected on
the Mortgage Loan Schedule), or (B) second lien priority with respect to each
Mortgage Loan which is indicated by such Borrower to be a Second Lien
Mortgage Loan (as reflected on the Mortgage Loan Schedule), in either case,
by a title insurance policy, an endorsement to the policy insuring the
mortgagee's consolidated interest or by other title evidence acceptable to
FNMA and FHLMC. The consolidated principal amount does not exceed the
original principal amount of the Mortgage Loan.
(ee) MORTGAGED PROPERTY UNDAMAGED. The Mortgaged Property is
undamaged by waste, fire, earthquake or earth movement, windstorm, flood,
tornado or other casualty so as to affect adversely the value of the Mortgaged
Property as security for the Mortgage Loan or the use for which the premises
were intended and each Mortgaged Property is in good repair. There have not been
any condemnation proceedings with respect to the Mortgaged Property and the
Borrower has no knowledge of any such proceedings.
(ff) COLLECTION PRACTICES; ESCROW DEPOSITS; INTEREST RATE
ADJUSTMENTS. The origination and collection practices used by the originator,
each servicer of the Mortgage Loan and the Borrower with respect to the Mortgage
Loan have been in all respects in compliance with Accepted Servicing Practices,
applicable laws and regulations, and have been in all respects legal and proper.
With respect to escrow deposits and Escrow Payments (other than with respect to
each Mortgage Loan which is indicated by such Borrower to be a Second Lien
Mortgage Loan and for which the mortgagee under the prior mortgage lien is
collecting Escrow Payments (as reflected on the Mortgage Loan Schedule)), all
such payments are in the possession of, or under the control of, the Borrower or
the Servicer and there exist no deficiencies in connection therewith for which
customary arrangements for repayment thereof have not been made. All Escrow
Payments have been collected in full compliance with state and federal law. An
escrow of funds is not prohibited by applicable law and has been established in
an amount sufficient to pay for every item that remains unpaid and has been
assessed but is not yet due and payable. No escrow deposits or Escrow Payments
or other charges or payments due the Borrower have been capitalized under the
Mortgage or the Mortgage Note. All Mortgage Interest Rate adjustments have been
made in strict compliance with state and federal law and the terms of the
related Mortgage Note. Any interest required to be paid pursuant to state,
federal and local law has been properly paid and credited.
(gg) OTHER INSURANCE POLICIES. No action, inaction or event
has occurred and no state of facts exists or has existed that has resulted or
will result in the exclusion from, denial of, or defense to coverage under any
applicable special hazard insurance policy, PMI Policy or bankruptcy bond,
irrespective of the cause of such failure of coverage. In connection with the
placement of any such insurance, no commission, fee, or other compensation has
been or will be received by the Borrower or by any officer, director, or
employee of the Borrower or any designee of the Borrower or any corporation in
which the Borrower or any officer, director, or employee had a financial
interest at the time of placement of such insurance.
(hh) SOLDIERS' AND SAILORS' CIVIL RELIEF ACT. The Mortgagor
has not notified the Borrower, and the Borrower has no knowledge, of any relief
requested or allowed to the Mortgagor under the Soldiers' and Sailors' Civil
Relief Act of 1940.
(ii) APPRAISAL. The Mortgage File contains an appraisal of the
related Mortgaged Property signed prior to the approval of the Mortgage Loan
application by a qualified appraiser, duly appointed by the Borrower, who had no
interest, direct or indirect in the Mortgaged Property or in any loan made on
the security thereof, and whose compensation is not affected by the approval or
Schedule 1-8
<PAGE> 40
disapproval of the Mortgage Loan, and the appraisal and appraiser both satisfy
the requirements of FNMA or FHLMC and Title XI of the Federal Institutions
Reform, Recovery, and Enforcement Act of 1989 as amended and the regulations
promulgated thereunder, all as in effect on the date the Mortgage Loan was
originated.
(jj) DISCLOSURE MATERIALS. The Mortgagor has executed a
statement to the effect that the Mortgagor has received all disclosure materials
required by applicable law with respect to the making of adjustable rate
mortgage loans, and the Borrower maintains such statement in the Mortgage File.
(kk) CONSTRUCTION OR REHABILITATION OF MORTGAGED
PROPERTY. No Mortgage Loan was made in connection with the construction or
rehabilitation of a Mortgaged Property or facilitating the trade-in or
exchange of a Mortgaged Property.
(ll) NO DEFENSE TO INSURANCE COVERAGE. No action has been
taken or failed to be taken, no event has occurred and no state of facts exists
or has existed on or prior to the Funding Date (whether or not known to the
Borrower on or prior to such date) which has resulted or will result in an
exclusion from, denial of, or defense to coverage under any private mortgage
insurance (including, without limitation, any exclusions, denials or defenses
which would limit or reduce the availability of the timely payment of the full
amount of the loss otherwise due thereunder to the insured) whether arising out
of actions, representations, errors, omissions, negligence, or fraud of the
Borrower, the related Mortgagor or any party involved in the application for
such coverage, including the appraisal, plans and specifications and other
exhibits or documents submitted therewith to the insurer under such insurance
policy, or for any other reason under such coverage, but not including the
failure of such insurer to pay by reason of such insurer's breach of such
insurance policy or such insurer's financial inability to pay.
(mm) CAPITALIZATION OF INTEREST. The Mortgage Note
does not by its terms provide for the capitalization or forbearance of
interest.
(nn) NO EQUITY PARTICIPATION. No document relating to the
Mortgage Loan provides for any contingent or additional interest in the form of
participation in the cash flow of the Mortgaged Property or a sharing in the
appreciation of the value of the Mortgaged Property. The indebtedness evidenced
by the Mortgage Note is not convertible to an ownership interest in the
Mortgaged Property or the Mortgagor and the Borrower has not financed nor does
it own directly or indirectly, any equity of any form in the Mortgaged Property
or the Mortgagor.
(oo) PROCEEDS OF MORTGAGE LOAN. The proceeds of the Mortgage
Loan have not been and shall not be used to satisfy, in whole or in part, any
debt owed or owing by the Mortgagor to the Borrower or any Affiliate or
correspondent of the Borrower.
(pp) WITHDRAWN MORTGAGE LOANS. If the Mortgage Loan has been
released to the Borrower pursuant to a Request for Release as permitted under
Section 5 of the Custodial Agreement, then the promissory note relating to the
Mortgage Loan was returned to the Custodian within 10 days (or if such tenth day
was not a Business Day, the next succeeding Business Day).
(qq) NO EXCEPTION. The Custodian has not noted any material
exceptions on an Exception Report (as defined in the Custodial Agreement) with
respect to the Mortgage Loan which
Schedule 1-9
<PAGE> 41
would materially adversely affect the
Mortgage Loan or the Lender's security interest, granted by the Borrower, in the
Mortgage Loan.
(rr) QUALIFIED ORIGINATOR. The Mortgage Loan has been
originated by, and, if applicable, purchased by the Borrower from, a Qualified
Originator.
(ss) MORTGAGE SUBMITTED FOR RECORDATION. The Mortgage
either has been or will promptly be submitted for recordation in the
appropriate governmental recording office of the jurisdiction where the
Mortgaged Property is located.
Schedule 1-10
<PAGE> 42
Part II DEFINED TERMS
In addition to terms defined elsewhere in the Loan Agreement,
the following terms shall have the following meanings when used in this Schedule
1:
"ACCEPTABLE STATE" shall mean any state notified by the
Borrower to the Lender from time to time and approved in writing by the Lender,
which approval has not been revoked by the Lender in their sole discretion, any
such notice of revocation to be given no later than 10 Business Days prior to
its intended effective date.
"ACCEPTED SERVICING PRACTICES" shall mean, with respect to any
Mortgage Loan, those mortgage servicing practices of prudent mortgage lending
institutions which service mortgage loans of the same type as such Mortgage
Loans in the jurisdiction where the related Mortgaged Property is located.
"ALTA" means the American Land Title Association.
"APPRAISED VALUE" shall mean the value set forth in an
appraisal made in connection with the origination of the related Mortgage Loan
as the value of the Mortgaged Property.
"BEST'S" means Best's Key Rating Guide, as the same shall be
amended from time to time.
"COMBINED LTV" OR "CLTV" shall mean with respect to any
Mortgage Loan, the ratio of (a) the outstanding principal balance as of the
related Cut-off Date of (i) the Mortgage Loan plus (ii) the mortgage loan
constituting the first lien to (b) the Appraised Value of the Mortgaged
Property.
"CUT-OFF DATE" means the first day of the month in which the
related Funding Date occurs.
"DUE DATE" means the day of the month on which the Monthly
Payment is due on a Mortgage Loan, exclusive of any days of grace.
"ESCROW PAYMENTS" means with respect to any Mortgage Loan, the
amounts constituting ground rents, taxes, assessments, water rates, sewer rents,
municipal charges, mortgage insurance premiums, fire and hazard insurance
premiums, condominium charges, and any other payments required to be escrowed by
the Mortgagor with the mortgagee pursuant to the Mortgage or any other document.
"FHLMC" means the Federal Home Loan Mortgage Corporation, or
any successor thereto.
"FNMA" means the Federal National Mortgage Association, or any
successor thereto.
"GROSS MARGIN" means with respect to each adjustable rate
Mortgage Loan, the fixed percentage amount set forth in the related Mortgage
Note.
"INDEX" means with respect to each adjustable rate Mortgage
Loan, the index set forth in the related Mortgage Note for the purpose of
calculating the interest rate thereon.
Schedule 1-11
<PAGE> 43
"INSURANCE PROCEEDS" means with respect to each Mortgage Loan,
proceeds of insurance policies insuring the Mortgage Loan or the related
Mortgaged Property.
"INTEREST RATE ADJUSTMENT DATE" means with respect to each
adjustable rate Mortgage Loan, the date, specified in the related Mortgage Note
and the Mortgage Loan Schedule, on which the Mortgage Interest Rate is adjusted.
"LOAN-TO-VALUE RATIO" or "LTV" means with respect to any
Mortgage Loan, the ratio of the original outstanding principal amount of the
Mortgage Loan to the lesser of (a) the Appraised Value of the Mortgaged Property
at origination or (b) if the Mortgaged Property was purchased within 12 months
of the origination of the Mortgage Loan, the purchase price of the Mortgaged
Property.
"MONTHLY PAYMENT" means the scheduled monthly payment of
principal and interest on a Mortgage Loan as adjusted in accordance with changes
in the Mortgage Interest Rate pursuant to the provisions of the Mortgage Note
for an adjustable rate Mortgage Loan.
"MORTGAGE INTEREST RATE" means the annual rate of interest
borne on a Mortgage Note, which shall be adjusted from time to time with respect
to adjustable rate Mortgage Loans.
"MORTGAGE INTEREST RATE CAP" means with respect to an
adjustable rate Mortgage Loan, the limit on each Mortgage Interest Rate
adjustment as set forth in the related Mortgage Note.
"MORTGAGEE" means the Borrower or any subsequent holder of a
Mortgage Loan.
"ORIGINATION DATE" shall mean, with respect to each Mortgage
Loan, the date of the Mortgage Note relating to such Mortgage Loan, unless such
information is not provided by the Borrower with respect to such Mortgage Loan,
in which case the Origination Date shall be deemed to be the date that is 40
days prior to the date of the first payment under the Mortgage Note relating to
such Mortgage Loan.
"PMI POLICY" or "PRIMARY INSURANCE POLICY" means a policy of
primary mortgage guaranty insurance issued by a Qualified Insurer.
"QUALIFIED INSURER" means an insurance company duly qualified
as such under the laws of the states in which the Mortgaged Property is located,
duly authorized and licensed in such states to transact the applicable insurance
business and to write the insurance provided, and approved as an insurer by FNMA
and FHLMC and whose claims paying ability is rated in the two highest rating
categories by any of the rating agencies with respect to primary mortgage
insurance and in the two highest rating categories by Best's with respect to
hazard and flood insurance.
"QUALIFIED ORIGINATOR" means an originator of Mortgage Loans
reasonably acceptable to the Lender.
"SERVICING FILE" means with respect to each Mortgage Loan, the
file retained by the Borrower consisting of originals of all documents in the
Mortgage File which are not delivered to a Custodian and copies of the Mortgage
Loan Documents set forth in Section 2 of the Custodial Agreement.
Schedule 1-12
<PAGE> 44
SCHEDULE 2
FILING JURISDICTIONS AND OFFICES
Secretary of State of the State of Maryland
Secretary of State of the State of New Jersey
Secretary of State of the State of New York
Schedule 2-1
<PAGE> 45
Exhibit A
---------
[FORM OF PROMISSORY NOTE]
$125,000,000 December 8, 1997
New York, New York
FOR VALUE RECEIVED, HANOVER CAPITAL MORTGAGE HOLDINGS, INC., a
Maryland corporation (the "BORROWER"), hereby promises to pay to the order of
MORGAN STANLEY MORTGAGE CAPITAL INC. (the "LENDER"), at the principal office of
the Lender at 1585 Broadway, New York, New York, 10036, in lawful money of the
United States, and in immediately available funds, the principal sum of ONE
HUNDRED TWENTY-FIVE MILLION DOLLARS $125,000,000 (or such lesser amount as shall
equal the aggregate unpaid principal amount of the Loans made by the Lender to
the Borrower under the Loan Agreement), on the dates and in the principal
amounts provided in the Loan Agreement, and to pay interest on the unpaid
principal amount of each such Loan, at such office, in like money and funds, for
the period commencing on the date of such Loan until such Loan shall be paid in
full, at the rates per annum and on the dates provided in the Loan Agreement.
The date, amount and interest rate of each Loan made by the
Lender to the Borrower, and each payment made on account of the principal
thereof, shall be recorded by the Lender on its books and, prior to any transfer
of this Note, endorsed by the Lender on the schedule attached hereto or any
continuation thereof; PROVIDED, that the failure of the Lender to make any such
recordation or endorsement shall not affect the obligations of the Borrower to
make a payment when due of any amount owing under the Loan Agreement or
hereunder in respect of the Loans made by the Lender.
This Note is the Note referred to in the Master Loan and
Security Agreement dated as of December 8, 1997 (as amended, supplemented or
otherwise modified and in effect from time to time, the "LOAN AGREEMENT")
between the Borrower and the Lender, and evidences Loans made by the Lender
thereunder. Terms used but not defined in this Note have the respective meanings
assigned to them in the Loan Agreement.
The Borrower agrees to pay all the Lender's costs of
collection and enforcement (including reasonable attorneys' fees and
disbursements of Lender's counsel) in respect of this Note when incurred,
including, without limitation, reasonable attorneys' fees through appellate
proceedings.
Notwithstanding the pledge of the Collateral, the Borrower
hereby acknowledges, admits and agrees that the Borrower's obligations under
this Note are recourse obligations of the Borrower to which the Borrower pledges
its full faith and credit.
The Borrower, and any indorsers or guarantors hereof, (a)
severally waive diligence, presentment, protest and demand and also notice of
protest, demand, dishonor and nonpayments of this Note, (b) expressly agree that
this Note, or any payment hereunder, may be extended from time to time, and
consent to the acceptance of further Collateral, the release of any Collateral
for this Note, the release of any party primarily or secondarily liable hereon,
and (c) expressly agree that it will not be necessary for the Lender, in order
to enforce payment of this Note, to first institute or exhaust the Lender's
remedies against the Borrower or any other party liable hereon or against any
Collateral for this Note. No extension of time for the payment of this Note, or
any installment hereof, made by
A-1
<PAGE> 46
agreement by the Lender with any person now or hereafter liable for the payment
of this Note, shall affect the liability under this Note of the Borrower, even
if the Borrower is not a party to such agreement; PROVIDED, HOWEVER, that the
Lender and the Borrower, by written agreement between them, may affect the
liability of the Borrower.
Any reference herein to the Lender shall be deemed to include
and apply to every subsequent holder of this Note. Reference is made to the Loan
Agreement for provisions concerning optional and mandatory prepayments,
Collateral, acceleration and other material terms affecting this Note.
A-2
<PAGE> 47
THIS NOTE SHALL BE GOVERNED BY AND CONSTRUED UNDER THE LAWS OF
THE STATE OF NEW YORK (WITHOUT REFERENCE TO CHOICE OF LAW DOCTRINE) WHOSE LAWS
THE BORROWER EXPRESSLY ELECTS TO APPLY TO THIS NOTE. THE BORROWER AGREES THAT
ANY ACTION OR PROCEEDING BROUGHT TO ENFORCE OR ARISING OUT OF THIS NOTE MAY BE
COMMENCED IN THE SUPREME COURT OF THE STATE OF NEW YORK, BOROUGH OF MANHATTAN,
OR IN THE DISTRICT COURT OF THE UNITED STATES FOR THE SOUTHERN DISTRICT OF NEW
YORK.
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
By: _______________________________
Name:
Title:
A-3
<PAGE> 48
SCHEDULE OF LOANS
This Note evidences Loans made under the within-described Loan
Agreement to the Borrower, on the dates, in the principal amounts and bearing
interest at the rates set forth below, and subject to the payments and
prepayments of principal set forth below:
<TABLE>
<CAPTION>
PRINCIPAL AMOUNT OF INTEREST AMOUNT PAID UNPAID PRINCIPAL NOTATION
DATE MADE LOAN RATE OR PREPAID AMOUNT MADE BY
<S> <C> <C> <C> <C> <C>
- ----------------- ---------------------- ---------------- -------------------- ---------------------- ---------------
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</TABLE>
A-4
<PAGE> 49
Exhibit B
---------
[FORM OF CUSTODIAL AGREEMENT]
[to be stored as a separate document]
B-1
<PAGE> 50
Exhibit C
---------
[FORM OF OPINION OF COUNSEL TO BORROWER]
(date)
Morgan Stanley Mortgage Capital Inc.
1585 Broadway
New York, New York 10036
Dear Sirs and Mesdames:
You have requested [our] [my] opinion, as counsel to Hanover
Capital Mortgage Holdings, Inc., a Maryland corporation (the "BORROWER"), with
respect to certain matters in connection with that certain Master Loan and
Security Agreement, dated as of December 8, 1997 (the "LOAN AND SECURITY
AGREEMENT"), by and between the Borrower and Morgan Stanley Mortgage Capital
Inc. (the "LENDER"), being executed contemporaneously with a Promissory Note
dated December 8, 1997 from the Borrower to the Lender (the "NOTE"), a Custodial
Agreement, dated as of December 8, 1997 (the "CUSTODIAL AGREEMENT"), by and
among the Borrower, First Chicago National Processing Corp. (the "CUSTODIAN"),
and the Lender. Capitalized terms not otherwise defined herein have the meanings
set forth in the Loan and Security Agreement.
[We] [I] have examined the following documents:
1. the Loan and Security Agreement;
2. the Note;
3. Custodial Agreement;
4. unfiled copies of the financing statements listed on
SCHEDULE 1 (collectively, the "FINANCING STATEMENTS")
naming the Borrower as Debtor and the Lender as
Secured Party and describing the Collateral (as
defined in the Loan and Security Agreement) as to
which security interests may be perfected by filing
under the Uniform Commercial Code of the States
listed on SCHEDULE 1 (the "FILING COLLATERAL"), which
I understand will be filed in the filing offices
listed on SCHEDULE 1 (the "FILING OFFICES");
5. the reports listed on SCHEDULE 2 as to UCC financing
statements (collectively, the
"UCC SEARCH REPORT"); and
6. such other documents, records and papers as we have
deemed necessary and relevant as a
basis for this opinion.
C-1
<PAGE> 51
To the extent [we] [I] have deemed necessary and proper, [we]
[I] have relied upon the representations and warranties of the Borrower
contained in the Loan and Security Agreement. [We] [I] have assumed the
authenticity of all documents submitted to me as originals, the genuineness of
all signatures, the legal capacity of natural persons and the conformity to the
originals of all documents.
Based upon the foregoing, it is [our] [my] opinion that:
1. The Borrower is a Maryland corporation duly organized,
validly existing and in good standing under the laws of ___________ and is
qualified to transact business in, and is in good standing under, the laws of
the state of _____________.
2. The Borrower has the power to engage in the transactions
contemplated by the Loan and Security Agreement, the Note, and the Custodial
Agreement and all requisite power, authority and legal right to execute and
deliver the Loan and Security Agreement, the Note, and the Custodial Agreement
and observe the terms and conditions of such instruments. The Borrower has all
requisite power to borrow under the Loan and Security Agreement and to grant a
security interest in the Collateral pursuant to the Loan and Security Agreement.
3. The execution, delivery and performance by the Borrower of
the Loan and Security Agreement, the Note, and the Custodial Agreement, and the
borrowings by the Borrower and the pledge of the Collateral under the Loan and
Security Agreement have been duly authorized by all necessary action on the part
of the Borrower. Each of the Loan and Security Agreement, the Note and the
Custodial Agreement have been executed and delivered by the Borrower and are
legal, valid and binding agreements enforceable in accordance with their
respective terms against the Borrower, subject to bankruptcy laws and other
similar laws of general application affecting rights of creditors and subject to
the application of the rules of equity, including those respecting the
availability of specific performance, none of which will materially interfere
with the realization of the benefits provided thereunder or with the Lender's
security interest in the Mortgage Loans.
4. No consent, approval, authorization or order of, and no
filing or registration with, any court or governmental agency or regulatory body
is required on the part of the Borrower for the execution, delivery or
performance by the Borrower of the Loan and Security Agreement, the Note and the
Custodial Agreement or for the borrowings by the Borrower under the Loan and
Security Agreement or the granting of a security interest to the Lender in the
Collateral, pursuant to the Loan and Security Agreement.
5. The execution, delivery and performance by the Borrower of,
and the consummation of the transactions contemplated by, the Loan and Security
Agreement, the Note and the Custodial Agreement do not and will not (a) violate
any provision of the Borrower's charter or by-laws, (b) violate any applicable
law, rule or regulation, (c) violate any order, writ, injunction or decree of
any court or governmental authority or agency or any arbitral award applicable
to the Borrower of which I have knowledge (after due inquiry) or (d) result in a
breach of, constitute a default under, require any consent under, or result in
the acceleration or required prepayment of any indebtedness pursuant to the
terms of, any agreement or instrument of which I have knowledge (after due
inquiry) to which the Borrower is a party or by which it is bound or to which it
is subject, or (except for the Liens created pursuant to the Loan and Security
Agreement) result in the creation or imposition of any Lien upon any Property of
the Borrower pursuant to the terms of any such agreement or instrument.
6. There is no action, suit, proceeding or investigation
pending or, to the best of [our] [my] knowledge, threatened against the Borrower
which, in [our] [my] judgment, either in any one instance or in the aggregate,
would be reasonably likely to result in any material adverse change in the
properties, business or financial condition, or prospects of the Borrower or in
any material impairment of the right or ability of the Borrower to carry on its
business substantially as now conducted or in any material liability on the part
of the Borrower or which would draw into question
C-2
<PAGE> 52
the validity of the Loan and Security Agreement, the Note, the Custodial
Agreement or the Mortgage Loans or of any action taken or to be taken in
connection with the transactions contemplated thereby, or which would be
reasonably likely to impair materially the ability of the Borrower to perform
under the terms of the Loan and Security Agreement, the Note, the Custodial
Agreement or the Mortgage Loans.
7. The Loan and Security Agreement is effective to create, in
favor of the Lender, a valid security interest under the Uniform Commercial Code
in all of the right, title and interest of the Borrower in, to and under the
Collateral as collateral security for the payment of the Secured Obligations (as
defined in the Loan and Security Agreement), except that (a) such security
interests will continue in Collateral after its sale, exchange or other
disposition only to the extent provided in Section 9-306 of the Uniform
Commercial Code, (b) the security interests in Collateral in which the Borrower
acquires rights after the commencement of a case under the Bankruptcy Code in
respect of the Borrower may be limited by Section 552 of the Bankruptcy Code.
8. When the Mortgage Notes are delivered to the Custodian,
endorsed in blank by a duly authorized officer of the Borrower, the security
interest referred to in paragraph 7 above in the Mortgage Notes will constitute
a fully perfected first priority security interest in all right, title and
interest of the Borrower therein, in the Mortgage Loan evidenced thereby and in
the Borrower's interest in the related Mortgaged Property.
9. (a) Upon the filing of financing statements on Form UCC-1
naming the Lender as "Secured Party" and the Borrower as "Debtor", and
describing the Collateral, in the jurisdictions and recording offices listed on
SCHEDULE 1 attached hereto, the security interests referred to in paragraph 7
above will constitute fully perfected security interests under the Uniform
Commercial Code in all right, title and interest of the Borrower in, to and
under such Collateral, which can be perfected by filing under the Uniform
Commercial Code.
(b) The UCC Search Report sets forth the
proper filing offices and the proper debtors necessary to identify those
Persons who have on file in the jurisdictions listed on SCHEDULE 1 financing
statements covering the Filing Collateral as of the dates and times specified on
SCHEDULE 2. Except for the matters listed on SCHEDULE 2, the UCC Search Report
identifies no Person who has filed in any Filing Office a financing statement
describing the Filing Collateral prior to the effective dates of the UCC Search
Report.
10. The Assignments of Mortgage are in recordable form, except
for the insertion of the name of the assignee, and upon the name of the assignee
being inserted, are acceptable for recording under the laws of the state where
each related Mortgaged Property is located.
Very truly yours,
C-3
<PAGE> 53
Exhibit D
---------
FORM OF REQUEST FOR BORROWING
Master Loan and Security Agreement, dated as of December 8, 1997
(the "LOAN AND SECURITY AGREEMENT"), by and between the
Borrower and Morgan Stanley Mortgage Capital Inc. (the
"LENDER"),
Lender: Morgan Stanley Mortgage Capital Inc.
Borrower: Hanover Capital Mortgage Holdings, Inc.
Requested Fund Date: ________________________________________
Transmission Date: ________________________________________
Transmission Time:
Number of Mortgage
Loans to be Pledged: ________________________________________
UPB: $________________________________________
Requested Wire Amount: $________________________________________
Wire Instructions:
Requested by:
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
By:________________________________________
Name:
Title:
D-1
<PAGE> 54
Exhibit E-1
FORM OF BORROWER'S RELEASE LETTER
[Date]
Morgan Stanley Mortgage Capital Inc.
1585 Broadway
New York, New York 10036
Attention: ____________________
Facsimile: ____________________
Re: Master Loan and Security Agreement, dated as of December 8,
1997 (the "LOAN AND SECURITY AGREEMENT"), by and between
Hanover Capital Mortgage Holdings, Inc. (the "BORROWER") and
Morgan Stanley Mortgage Capital Inc. (the "LENDER")
Ladies and Gentlemen:
With respect to the mortgage loans described in the attached
SCHEDULE A (the "MORTGAGE LOANS") (a) we hereby certify to you that the Mortgage
Loans are not subject to a lien of any third party and (b) we hereby release all
right, interest or claim of any kind with respect to such Mortgage Loans, such
release to be effective automatically without further action by any party upon
payment from Morgan Stanley Mortgage Capital Inc., of the amount of the Loan
contemplated under the Loan and Security Agreement (calculated in accordance
with the terms thereof) in accordance with the wiring instructions set forth in
the Loan and Security Agreement.
Very truly yours,
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
By: __________________________
Name: __________________________
Title: __________________________
E 1-1
<PAGE> 55
Exhibit E-2
-----------
FORM OF WAREHOUSE LENDER'S RELEASE LETTER
(Date)
Morgan Stanley Mortgage Capital Inc.
1585 Broadway
New York, New York 10036
Attention: ________________
Facsimile:________________
Re: Certain Mortgage Loans Identified on SCHEDULE A hereto and
owned by Hanover Capital Mortgage Holdings, Inc.
The undersigned hereby releases all right, interest, lien or
claim of any kind with respect to the mortgage loan(s) described in the attached
SCHEDULE A, such release to be effective automatically without any further
action by any party upon payment in one or more installments, in immediately
available funds of $__________________, in accordance with the following wire
instructions:
------------------------
------------------------
Very truly yours,
[WAREHOUSE LENDER]
By:
---------------------------
Name:
-------------------------
Title:
------------------------
E-2-1
<PAGE> 56
Exhibit F
---------
UNDERWRITING GUIDELINES
F-1
<PAGE> 57
HANOVER CAPITAL
CREDIT AND RISK MANAGEMENT
POLICIES AND PROCEDURES
1
<PAGE> 58
HANOVER CAPITAL
CREDIT AND RISK MANAGEMENT
POLICIES AND PROCEDURES
TABLE OF CONTENTS
I. General Policy Statement & Summary of Policies
II. Business Description- Overview
III. Commitment Procedures and Risk Limits
IV. Counterparty Approval
V. Asset Quality Evaluation
VI. Interest Rate Risk Management
Exhibits
i. Bid Sheet
ii. Standard Bid Letter
iii. Standard Commitment Letter
iv. Approved BPO Providers
v. Approved Credit Scoring Companies
vi. Standard Position Report
vii. Credit Grades
2
<PAGE> 59
GENERAL POLICY STATEMENT & SUMMARY OF POLICIES
1. General Policy Statement
The primary business is investing in pools of residential mortgage
loans. Pools may be unrated or rated and traded in either the private
or public markets. Loan types eligible for purchase include fixed and
adjustable rate performing, sub-performing and non-performing mortgage
loans of varying lien positions. The strategy is to optimize
financing by securitizing loans conforming to agency standards as
Fannie Mae or Freddie Mac securities and non-eligible pools as
private-label securities or whole loans. Subordinated tranches of
securitized loan pools may be retained.
2. Summary of Policies
a) Loans types eligible for purchase are approved by the Chief Executive
Officer ("CEO"), Head of Trading and Head of Operations. Eligible loan
types are updated on a quarterly basis.
b) Monitoring and reporting of inventory levels is the responsibility of
the Head of Trading and is reported to the CEO on a weekly basis.
c) Credit exposure is the responsibility of the Chief Credit Officer and
is reported to the CEO on a monthly basis.
d) Inventory delinquency statistics and servicer performance is the
responsibility of the Head of Operations and is reported to the CEO and
the Head of Trading on a monthly basis.
e) Due diligence reviews are performed on all loan pools purchased unless
waived jointly by the CEO, Head of Trading and Head of Operations. The
nature and level of the reviews is detailed in Section V - Asset
Quality Evaluation. Any changes to the review process must be approved
by the Head of Trading and the Head of Operations.
f) All credit risks including the risks associated with servicers, buying
and selling loans and holding subordinated trenches must be approved by
the Chief Credit Officer or CEO. Counterparties are initially approved
and then reviewed on an annual basis, or more frequently as
appropriate.
3
<PAGE> 60
GENERAL POLICY STATEMENT & SUMMARY OF POLICIES (CON'T)
g) Legal documentation for all transactions is approved by the Head of
Operations or outside law firms approved by the Head of Operations.
h) Exceptions to policy as it relates to eligible loan types and the due
diligence process must be approved the Head of Trading and the Head of
Operations. Exceptions to counterparty credit and servicing risk policy
must be approved by the Chief Credit Officer or CEO.
4
<PAGE> 61
BUSINESS DESCRIPTION - OVERVIEW
* The primary business is investing in pools of residential mortgage loans.
Loan types eligible for purchase in the private and public markets include:
rated and unrated loan pools
fixed and adjustable rate mortgage loans
performing, sub-performing and non-performing loans
* Within the above categories mortgages may vary in terms of seasoning,
credit quality, geographic location and lien position.
* Portfolios of mortgage loans are identified through Hanover's salesforce
and from broker/dealers. Portfolios may be available from asset sales by
federal or state governmental agencies (e.g. FDIC and HUD).
* In order to evaluate a portfolio a bid sheet is completed and loan level
data obtained (see Exhibit i). For portfolios of genetic product being sold
by established counterparties summary pool data may be substituted for loan
level detail. Financial and non-financial information on the selling and
servicing entity(s) is required for credit approval.
* Purchased portfolios are hedged with respect to both financing risk and
adverse interest rate movement. Financing is secured for the expected
portfolio holding period, to the extent possible. Interest rate caps may be
purchased to protect against cap risk in ARM portfolios. Fixed-rate loans
are hedged with similar coupon mortgage-backed securities issued by Fannie
Mae or Freddie Mac to minimize interest rate and basis risk. ARMs may be
hedged with a combination of mortgage-backed and US treasury securities
and options. Prepayment rates are projected and monitored during the
holding period (see Section VI - Interest Rate Risk Management).
* Due diligence is performed on all portfolios unless waived jointly by the
CEO, Head of Trading and Head of Operations. Due diligence concentrates on
validating loan level data and obtaining missing information. Particular
focus is paid to credit underwriting for loans with less than 5 years of
seasoning and to loan-to-value ratios for mortgages in volatile real estate
markets, both current and historically. (see Section V - Asset Quality
Evaluation)
5
<PAGE> 62
BUSINESS DESCRIPTION - OVERVIEW (CON'T)
* The strategy is to optimize financing by securitizing agency eligible
product as Fannie Mae or Freddie Mac securities and non-eligible pools as
private-label securities or whole loans. Hanover may retain subordinated
tranches of securitized mortgage pools.
6
<PAGE> 63
COMMITMENT PROCEDURES AND RISK LIMITS
1. Eligible Loan Types and Risk Limits
a) Loan types eligible for purchase are jointly approved by the CEO, Head
of Trading and Head of Operations and are updated on a quarterly basis.
Exceptions must be approved by the CEO, Head of Trading and Head of
Operations.
b) Residential mortgage loan types eligible for purchase are:
Rate Classes: Fixed and Adjustable
Indexes: US Treasury, Cost of Funds, Libor, Prime
Lien Types: 1st, 2nd, 3rd & 4th
Credit Grades: A,B,C & D
Performance
Status: Performing
Current paid-to-status
Sub-Performing
30 & 60 day delinquent
Non-Performing
90 days or greater delinquent
Amortization
Types: Fully Amortizing
Balloon
Open-ended lines of credit
Property
Locations: United States of America
Puerto Rico
2. Risk limits (based upon current UPB per transaction)
Senior Vice President $10 mm of performing loans
of Trading ("SVP"):
Head of Trading: $50 mm of performing loans
$25 mm of sub-performing loans
7
<PAGE> 64
COMMITMENT PROCEDURES AND RISK LIMITS (CON'T)
Any 2 of: CEO, Head of
Trading or SVP: $100 mm of performing loans
$ 50 mm of sub-performing loans
CEO, Head of Trading and
SVP jointly: > $100 mm of performing loans
> $ 50 mm of sub-performing loans
all non-performing loan pools
3. Commitment Procedures
a) A Bid Sheet is completed for each pool of loans being considered for
purchase (see Exhibit i). The Bid Sheet must be signed by the person
responsible for identifying the loan pool.
b) The selling institution, investor and servicer is identified, financial
statements received and submitted to the Chief Credit Officer or CEO
for approval (see Section IV - Counterparty Approval). Credit approval
must be obtained before a commitment can be issued.
c) A bid letter is submitted for all trades and must be executed by the
SVP, Head of Trading or CEO.
d) Forward trades are limited to maximum of 45 days. Approval for trade
settlement beyond 45 days must be obtained from the CEO.
e) The bid letter will contain at a minimum the following (see
Exhibit ii):
i. Name and address of the selling institution
(or loan sale advisor if applicable)
ii. Bid Price or Yield
iii. Trade Date
iv. Time and Date Bid Price is valid until
v. Settlement Date
vi. Servicing status: released or retained
vii. Description of the loan pool
viii. All conditions of the trade
ix. Name and Title of Signatory
8
<PAGE> 65
COMMITMENT PROCEDURES AND RISK LIMITS (CON'T)
f) If a pool is purchased on a firm price basis a hedge is calculated by
the SVP of Trading and approved by the Head of Trading (see Section VI
- Interest Rate Risk Management). No hedging is required for loan pools
purchased on a yield spread basis.
g) If a loan pool is sold on a firm price basis the corresponding hedge is
closed out. Hedges remain in place for sales on a yield spread basis.
h) Within 48 hours of the acceptance of a bid or offer a commitment
letter is issued by the Operations Department. The commitment letter
must be approved by the Head of Operations, trading officer responsible
for the transaction and the Chief Credit Officer or CEO.
i) The commitment letter is sent out in duplicate with one original to be
returned to the Head of Operations within 48 hours after receipt by the
counterparty. The CEO and Head of Trading must be notified if a
countersigned commitment is not received within the 48 hour period.
j) The commitment letter will contain at a minimum (see Exhibit iii):
i. Counterparty Name and Address
ii. Price or Yield Spread
iii. Current Unpaid Principal Balance
iv. Settlement Date
v. Servicing Status-retained or released
vi. Loan Types
vii. Property Types and Locations
viii. Number of Loans
ix. Maximum Loan Balance
x. Average Loan Balance
xi. Weighted Average Remaining Term
xii. Weighted Average Gross Rate
xiii. Servicing Fee (if applicable)
xiv. Servicing Type-actual/actual; scheduled/scheduled
(if applicable)
xv. Remittance Date (if applicable)
xvi. Pool Description-underwriting standards
xvii. Due Diligence Requirements
xviii. Representations & Warranties-standard;
"where-is-as-is"
xix. Closing Conditions - documents to be delivered vs.
funding
xx. Any other conditions of the trade
9
<PAGE> 66
COUNTERPARTY APPROVAL
1. Trading Counterparties
a) Trading counterparties are purchasers and sellers of loans or
securities. Prior to issuing a commitment counterparties must be
approved by the Chief Credit Officer or the CEO.
b) Forward trades are limited to a maximum of 45 days unless an exception
is approved by the CEO.
c) Approval is based upon both financial and non-financial information.
d) Non-financial information is the counterparty's reputation in the
market and reasons for the type of transaction involved.
e) The maintenance and ongoing monitoring of financial information is the
responsibility of the Credit Department.
f) Required financial information is:
A. Banks & Thrifts
1) Public Institutions
a) Audited Reports
i. Two most current fiscal years with complete
attached footnotes.
ii. Quarterly SEC 10Q reports to be submitted on a
current and ongoing basis.
b) Regulatory Reports
i. FDIC reports (cumulative year-end statements
will suffice) for the two most current calendar
years with all inclusive schedules attached.
ii. FDIC reports to be submitted on an ongoing
basis.
10
<PAGE> 67
COUNTERPARTY APPROVAL (CON'T)
2) Private Institutions
a) Audited Reports
i. Two most current fiscal years with complete
attached footnotes.
ii. Most recent interim statement (unaudited
acceptable if audited is unavailable).
iii. Quarterly financial statements on an ongoing
basis (unaudited acceptable if audited not
available).
b) Regulatory Reports
i. FDIC reports (cumulative year-end statements
will suffice) for the two most current calendar
years with all inclusive schedules attached.
ii. FDIC reports to be submitted on an ongoing
basis.
B. Insurance Companies
Insurance companies are typically subsidiaries of publicly traded holding
companies. Insurance companies are regulated by state authorities and file
statements on a statutory basis. Financial statements on both companies are
required:
1) Public Institutions
a) Audited Reports
i. Two most current fiscal years with complete
attached footnotes.
ii. Quarterly SEC 10Q reports to be submitted on a
current and ongoing basis.
b) Statutory Statements
i. Two most current fiscal years with complete
attached footnotes.
ii. Interim statutory statements, if available, for
the current year.
iii. Statutory reports to be submitted on an ongoing
basis.
2) Private Institutions
a) Audited Reports
i. Two most current fiscal years with complete
attached footnotes.
ii. Most recent interim statement (unaudited
acceptable if audited is unavailable).
11
<PAGE> 68
COUNTERPARTY APPROVAL (CON'T)
iii. Quarterly financial statements on an ongoing
basis (unaudited acceptable if audited not
available).
b) Statutory Statements
i. Two most current fiscal years with complete
attached footnotes.
ii. Interim statutory statements, if available,
for the current year.
iii. Statutory reports to be submitted on an ongoing
basis.
C. Other Companies
1) Public Institutions
a) Audited Reports
i. Two most current fiscal years with complete
attached footnotes.
ii. Quarterly SEC 10Q reports to be submitted on a
current and ongoing basis.
2) Private Institutions
b) Audited Reports
i. Two most current fiscal years with complete
attached footnotes.
ii. Most recent interim statement (unaudited
acceptable if audited is unavailable).
iii. Quarterly financial statements on an ongoing
basis (unaudited acceptable if audited not
available).
2. Servicing Counterparties
a) Servicers are approved by the Head of Trading, Head of Operations and the
Chief Credit Officer or CEO. The Operations Department will monitor
compliance with servicing obligations. Servicing exceptions are reported
to the Head of the Operations and Head of Trading on a monthly basis.
b) The maintenance and ongoing monitoring of financial and non-financial
servicing information is the responsibility of the Credit Department.
c) Servicers must submit the following information:
12
<PAGE> 69
COUNTERPARTY APPROVAL (CON'T)
A. Financial
1) Public Institutions
a) Audited Reports
i. Two most current fiscal years with complete
attached footnotes.
ii. Quarterly SEC 10Q reports to be submitted on a
current and ongoing basis.
2) Private Institutions
b) Audited Reports
i. Two most current fiscal years with complete
attached footnotes.
ii. Most recent interim statement (unaudited
acceptable if audited is unavailable).
iii. Quarterly financial statements on an ongoing
basis (unaudited acceptable if audited not
available).
B. Non-Financial (for servicers of non-subordinated pools of loans):
a) Most recent two years of Fannie Mae/Freddie Mac audits
b) List of loans in foreclosure, bankruptcy or delinquency as
of most recent quarter-end.
c) Property valuation process.
d) Name of tax service company
C. Non-Financial (for servicers of subordinated tranches):
a) Most recent two years of Fannie Mae/Freddie Mac audits
b) Name of Tax Service Company and copy of contract
c) List of loans with past due tax dates and no tax due dates
d) List of loans with past due insurance dates or no insurance
expiration date
e) Force Place Insurance Carrier and force place procedures
f) Schedule of Foreclosure and REO losses from the past year
g) Copy of most recent escrow analysis
h) Geographic breakdown of the portfolio
i) Geographic breakdown of delinquencies
j) Timeframes from 90 day delinquency to foreclosure to REO
sale
k) Missing document inventory listing
13
<PAGE> 70
COUNTERPARTY APPROVAL (CON'T)
1) List of loans in foreclosure, bankruptcy or delinquency as
of most recent quarter-end
m) Flood zone determination process
n) Property valuation process
o) Quality control program
p) Attorney and broker approval process and tracking
procedures
q) Current portfolio segregated by loan delinquency and REO
r) REO Reports:
i. Current REO inventory breakdown by state
ii. Average marketing time statistics
iii. Property type breakdown
iv. Average maintenance costs
v. Initial make-ready and rehab costs
vi. Sales price to BPO percentage
vii. Expenses as a percent of BPO value
viii. Time from foreclosure sale to property
disposition
ix. REO tracking reports.
14
<PAGE> 71
ASSET QUALITY EVALUATION
- - Due Diligence is required on all loan portfolios prior to settlement unless
waived by the Head of Operations, Head of Trading and Chief Credit Officer
(or CEO).
- - The scope of due diligence is determined by the Head of Operations and Head
of Trading and is a function of seasoning, missing information and the
terms and conditions of the trade.
- - The following Due Diligence procedures are minimum standards and additional
due diligence may be required by the Head of Operations and Head of
Trading.
- - All exceptions from due diligence as directed by the Head of Operations and
Head of Trading must be approved.
DUE DILIGENCE PROCEDURES
A. Loans with less than 18 months seasoning:
1. Sample Size: Entire pool is underwritten.
2. Documentation
a) Legal Documents: The following documents are checked for
completeness, discrepancies such as white outs and internal
consistency between the various documents themselves.
Additionally, information contained in the documents such
as mortgagor name, property address, etc., is compared to
the delivery schedule.
i. Original recorded mortgage required; must be
FNMA/HLMC standard.
ii. Original note required; must be FNMA/FHLMC
standard.
iii. All original modifications, riders, and
assumptions required; must be FNMA/FHLMC
standard.
iv. Original title policy required for all
loans. ARM, PUD, condo endorsement is
required. Policy coverage other than the
standard ALTA policy (the FNMA/FHLMC
standard) must be reviewed and approved.
15
<PAGE> 72
ASSET QUALITY EVALUATION (CON'T)
v. If required per terms of the trade, original
mortgage insurance certificate for loans
with a current LTV in excess of 80%.
Mortgage insurance must be from a FNMA/HLMC
approved MI company.
b) Closing Documents
i. Truth-in-Lending disclosure is required with
ARM disclosure.
ii. Settlement Statement (HUD-1).
iii. Right of Rescission (Cancellation Notice)
for refinances.
iv. Current hazard insurance required with
correct mortgagee clause and coverage at
least equal to the loan amount or the
maximum amount of insurance available. This
requirement is waived where the Seller has
acceptable Errors and Omissions and Blanket
Hazard Insurance policies in amounts and
from insurance companies acceptable to the
Chief Credit Officer. Flood insurance is
required for properties in Flood Zone A and
v. Earthquake insurance must also be checked
for in recognized earthquake areas.
c) Credit Documents
i. Application required; must be FNMA/FHLMC
standard for all loans.
(Contents of a credit package will depend on the
terms of the trade, however, deviations from the
following "Full credit package" must be documented.)
ii. Full credit package, including standard
factual credit report and verifications of
employment, rental income if needed to
qualify, and deposit/downpayment may be
required. All debts "to be paid" must be
verified as having been paid. All
verifications must not have been in excess
of 90 days old at closing.
16
<PAGE> 73
ASSET QUALITY EVALUATION (CON'T)
iii. Appraisal required; must be FNMA/FHLMC
standard and include photographs of the
property. Property must be verified as
complete including any noted repairs. Final
value and marketability must be
substantiated through the appraisal
valuation process. Appraisal must not have
been more than 6 months old at loan closing.
iv. Final sales agreement with any and all
modifications is required.
3. Pool Criteria
a) General
i. Borrower must be an individual unless, in
such instances as Trust Estates, the
Beneficiary is an individual.
ii. Fee simple title is required. Leaseholds are
allowed as long as the term of the lease
expires at least ten years after the loan
maturity date and only in areas where leases
are common.
iii. "Add-on" second mortgages are not allowed if
the combined loan-to-value ratio of the
first and second liens is in excess of 85%.
iv. Loans for investment properties and second
homes are limited to two per borrower per
pool. Investment properties are those not
occupied by the borrower and for which
rental income is necessary to qualify the
loan. Second homes, are those occupied on a
part-time basis by the borrower and for
which the borrower can support the monthly
payment without rental income.
v. Co-signers (signers of the note and not
co-title holders) are not allowed.
vi. The properties securing the loans must be
located in the states agreed upon by the
commitment letter. All property types must
meet FNMA/FHLMC requirements and in the case
of condos, be FNMA approved or approvable.
17
<PAGE> 74
ASSET QUALITY EVALUATION (CON'T)
vii. Gifts are allowed if the borrowers made a
minimum of 5% cash downpayment. The gift
must be made prior to closing and the
relationship of the donor to the borrower
must be documented by Lender.
viii. The loan purpose may be purchase, refinance,
home-improvement or construction/permanent.
ix. Remaining and original loan terms may not
exceed 360 months.
x. The Delivery Schedule must be accurate.
b) Underwriting Criteria
i. Loans are underwritten for borrower's
ability to pay, borrower's willingness to
pay and property valuation. Loans then
assigned a credit grade based upon the
borrower's ability and willingness to pay
(see Exhibit vii for credit grade criteria).
All loans graded "A" are further analyzed
for conformance to agency standards (see
Fannie Mae/Freddie Mac underwriting
manuals).
ii. Ability to pay is measured by the housing
ratio and total debt ratio. The housing
ratio is the sum of the proposed monthly P&I
payment, property taxes and hazard
insurance divided by gross monthly income.
The total debt ratio is the sum of monthly
housing expenses (as defined in the housing
ratio) plus all installment debt with
contractual maturities of greater than 6
months divided by gross monthly income.
For ARM loans the proposed monthly P&I is
calculated using the fully indexed interest
rate.
iii. Willingness to pay is determined from credit
scores (see Exhibit v), bankruptcy and
delinquency history of mortgage and consumer
debt.
iv. Adverse property quality/condition is
grounds for rejection. Any repairs noted
and/or required by the appraiser must be
certified complete. The appraisal must be no
more than 6 months old at time of loan
closing. Loans in areas subject to
earthquakes, radon problems, mud slides must
be approved by the Head of Operations and
the Head of Trading.
18
<PAGE> 75
ASSET QUALITY EVALUATION (CON'T)
4. Current Conditions
a) Payment histories are examined for all of the pool. Current
delinquency status and delinquency history must conform to
the terms of the trade.
b) Drive-by property inspection ("BPO") performed on 10%
random sample of the pool. The BPOs must be obtained from
an approved BPO provider (see Exhibit iv).
c) Desk reviews of the original appraisals and property
inspections on the 10% sample selected above. Reviews focus
on overall quality of the portfolio and highlight
potentially negative trends.
B. Loans with 18 through 60 months seasoning.
1. Sample Size: Selected based on the quality of the counterparty,
terms of the transaction, and particulars of the package. Minimum
sample size for credit underwriting purposes is 10% of the pool.
Should the underwriting yield a large number of rejects then sample
size should be increased. For example, in a large package if the
rejection rate is 5% or greater (for reasons other than delinquency
then the sample size should be doubled. If the rejects run 10% on
the expanded sample then Hanover will (a) do a 100% underwriting,
(b) stop there and not close the package or (c) restructure the
package with consideration given to asking for collateral from the
seller/servicer.
2. Documentation
a) Legal Documents-a 100% review is performed, identical to
the review for new loans.
19
<PAGE> 76
ASSET QUALITY EVALUATION (CON'T)
b) Closing Documents
i. Truth-in-Lending disclosure is required.
ii. Absence of Settlement Statement is noted.
iii. Right of Recission (Cancellation Notice) for
refinances is required.
iv. Current hazard insurance is required with
correct mortgagee clause and coverage at least
equal to the loan amount. The requirement is
waived where the Seller has acceptable Errors
and Omissions and Blanket Hazard Insurance
policies in amounts and from insurance companies
acceptable to the Chief Credit Officer. Flood
insurance is required for properties in Flood
Zone A and V. Earthquake insurance must also be
checked for in recognized earthquake areas.
c) Credit Package-A complete review of the sample is
performed using the same requirements as for new loans.
3. Pool Criteria - Same as for new loans.
4. Current Conditions - Same as for new loans.
C. Loans with 61 months or more seasoning
1. Sample Size-The entire pool is examined for legal documents only.
No credit underwriting is done.
2. Documentation-Legal documents and Closing documents-same as for new
loans except that non-standard documents may be frequent and are
acceptable if approved by the Head of Operations and the Head of
Trading.
3. Pool Criteria-Same as for new loans except the requirements
regarding co-signers, gifts and add-on seconds are waived due to the
20
<PAGE> 77
ASSET QUALITY EVALUATION (CON'T)
4. Current Conditions
a) Payment histories are examined for all of the pool. Current
delinquency status and delinquency history must conform to
the terms of the trade.
b) Drive-by property inspection ("BPO") performed on 10%
random sample of the pool. The BPOs must be obtained from
an approved BPO provider (see Exhibit iv).
21
<PAGE> 78
INTEREST RATE RISK MANAGEMENT
a) Hedging strategies and amounts are calculated by the Senior Vice
President of Trading and approved by the Head of Trading.
b) Fixed rate loans are hedged with agency mortgage-backed securities
of similar coupon and duration. Treasury hedges are allowed only
when an investor has committed to a trade based on a yield spread to
treasuries.
c) ARM portfolios may be hedged using a combination of mortgage-backed,
treasury securities and options.
d) Hedge counterparties are approved by the Chief Credit Officer or
CEO.
e) Actual and forecasted prepayment rates are monitored on a monthly
basis and hedges are adjusted to reflect revised prepayment
assumptions. Should the Senior Vice President of Trading decide more
frequent hedge revisions are necessary such adjustments may be made
with the approval of the Head of Trading.
f) Hedge amounts are adjusted monthly to reflect the paydown of
mortgage loan balances.
g) Financing terms are matched with the expected holding period of the
loan portfolio, to the extent possible. Financing counterparties are
approved by the Chief Credit Officer or CEO.
h) For ARM portfolios interest rate caps may be purchased to attempt to
limit or partially offset adverse changes in interest rates on ARM
portfolios. The decision to purchase interest rate caps must be
approved by the Head of Trading.
i) Financing of hedges is matched with the expected holding period of
the corresponding loan portfolio and is approved by either the Head
or Senior Vice President of Trading.
j) Positions are marked on a weekly basis by the Senior Vice President
of Trading and reported to the Chief Executive Officer and Head of
Trading.
22
<PAGE> 79
INTEREST RATE RISK MANAGEMENT (CON'T)
k) Position reports will include the following information (see Exhibit vi):
Profitability Analysis
i. Deal Number
ii. Deal name
iii. Asset Gain/Loss
iv. Hedge Gain/Loss
v. Coupon interest earned on Asset
vi. Financing cost on hedge
vii. Net Gain Loss (sum of the above)
Assets
i. Deal Number
ii. Deal Name
iii. Rate Class (Fixed or ARM)
iv. Indexcode (ARM only)
v. Current Unpaid Principal Balance
vi. Gross Weighted Average Coupon
vii. Net Weighted Average Coupon
viii. Weighted Average Remaining Term
ix. Gross Margin (ARM only)
x. Periodic and Lifetime Interest Rate Caps
(ARM only)
xi. Purchase Price
xii. Prepayment Assumption
xiii. Average Life
xiv. Duration
xv. Benchmark Security
xvi. Yield Spread to Benchmark Security
xvii. Mark-to-Mark Price
xviii. Finance Rate
xix. Financed Amount
xx. Expiration Date of Financing
Hedges
i. Security type
ii. Amount
iii. Coupon
iv. Maturity
v. Settlement Date
vi. Initial Price
23
<PAGE> 80
INTEREST RATE RISK MANAGEMENT (CON'T)
vii. Strike Price (if option)
viii. Expiration Date (if option)
ix. Prepayment Assumption
x. Average Life
xi. Duration
xii. Mark-to-Market Price
xiii. Finance Rate
xiv. Financed Amount
xv. Expiration Date of Financing
24
<PAGE> 81
EXHIBIT i
BID SHEET
DATE:_________
DEAL#_________ (TERM SHEET IF APPLICABLE FROM CUSTOMER MUST
BE ATTACHED!!!)
BID DATE: / /
------------------
UPB_________________ PRICE EXPECTATION__________________
PRODUCT TYPE (ARMS/FIXED/OTHER-EXPLAIN)_________________________________________
INSTITUTION NAME__________________________________
SALES PERSON______________________________________
IS BROKER INVOLVED? YES________ NO________
IF YES, BROKERS NAME:_____________________________
WHO PAYS FEE?_____________________ FEE AMOUNT__________________
WHOLE LOAN________________________ PARTICIPATION_____________
IF YES%_____________
SERVICING: RETAINED____________ RELEASED_____________
IF RETAINED, FEES ARE: IF RELEASED:
FIXED________________ TRANSFER DATE_____________________
ARM__________________
WHO IS CURRENTLY SERVICING?______________________
IF RELEASED, WILL SELLER SUB-SERVICE ON AN INTERIM BASIS? YES_____ NO____
TAPE RECEIVED? YES_____ NO____ (SEE ATTACHMENT A FOR REQUIRED DATA
FIELDS.)
IF NO WHEN / /
------------------
IS BID BASED ON SELLER TERM SHEET ONLY? YES_____ NO____
SELLER'S FINANCIALS RECEIVED: YES_____ NO____
SELLER'S REQUIRED SETTLEMENT DATE: / /
------------------
HOW MANY OTHER BIDDERS?_________________
TYPE OF ACCOUNTS:__________________________
ANY PRE-BID DUE DILIGENCE ALLOWED:__________________
<PAGE> 82
EXHIBIT i
WHAT ARE LTV'S BASED ON? ORIGINAL APPRAISAL________ BPO'S________
WILL SELLER PROVIDE BPO DATA?___________
LIEN STATUS:
FIRST ONLY_______________
SECONDS ONLY_____________
MIXED____________________
ARE FORECLOSURES OR BANKRUPTCIES INCLUDED?_________
REPRESENTATIONS:
AS IS WHERE IS___________
ENFORCEABILITY___________
OTHER LIMITED REPS_______
FULL REPS________________
UNDERWRITING STANDARDS:
FNMA/FHLMC_______________
B CREDITS
EXPLAIN:
-----------------------------------------------------------------------
-----------------------------------------------------------------------
C CREDITS
EXPLAIN:
-----------------------------------------------------------------------
-----------------------------------------------------------------------
D CREDITS
EXPLAIN:
-----------------------------------------------------------------------
-----------------------------------------------------------------------
OTHER (e.g. "WHOOPS")
EXPLAIN: (If"WHOOPS" LOAN BY LOAN COMMENTS REQUIRED)
-----------------------------------------------------------------------
-----------------------------------------------------------------------
DUE DILIGENCE:
DO WE NEED TO TRAVEL TO SELLER'S SITE?__________
SELLER WILL DELIVER LOANS TO FIRST CHICAGO___________
*BAILEE ARRANGEMENT REQUIRED.
<PAGE> 83
EXHIBIT i
RIGHT TO REJECT LOANS THAT DO NOT MEET
PARAMETERS OF TRADE.______________
SELLER PREPARES MORTGAGE ASSIGNMENTS IN BLANK
AND PAYS FOR RECORDING OF MORTGAGE ASSIGNMENTS.__________
ADDITIONAL COMMENTS:
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 84
EXHIBIT i
ATTACHMENT A
REQUESTED LOAN LEVEL DATA
ACCOUNT NUMBER
BORROWER NAME
ADDRESS
CITY
STATE
ZIP
ORIGINATION DATE
MATURITY DATE
ORIGINAL TERM
ORIGINAL BALANCE
CURRENT BALANCE
RATE CLASS (FIXED OR ARM)
INDEX TYPE
MONTHLY P&I PAYMENT & T&I PAYMENT
CURRENT NOTE RATE
ESCROW BALANCE
SERVICING FEE
ORIGINAL LTV
CURRENT LTV (CURRENT UPB/ORIGINAL APPRAISAL)
CURRENT PROPERTY VALUE (IF AVAILABLE)
PAID TO DATE
CUT OFF DATE
DELINQUENCY COUNTER FOR PAST 12 MONTHS
OCCUPANCY STATUS
LIEN POSITION
PROPERTY TYPE
NOTE TYPE (FHA/VA/CONVENTIONAL)
MORTGAGE INSURANCE (IF APPLICABLE)
ARM INFO INDEX
MARGIN
PERIODIC RATE CAP
LIFETIME RATE CAP
ADJUSTMENT FREQUENCY
NEGATIVE AMORTIZATION LIMIT(S)
NEXT INTEREST CHANGE DATE
ORIGINAL RATE
FIRST RATE CHANGE DATE
CONVERTIBILITY
AMORTIZATION TYPE (e.g. BALLOON)
LOAN PURPOSE
NO. OF UNITS
BANKRUPTCY/FORECLOSURE
CREDIT SCORE (IF AVAILABLE)
<PAGE> 85
EXHIBIT ii
STANDARD BID LETTER
Date:_________
Counterparty Name & Address
Dear__________:
Hanover Capital Partners is pleased to submit to ___________________________the
following servicing released/retained bid:
POOL. DESCRIPTION PRICE UPB NO. LOANS
- ---------------------------------------------------------------------------
The bid is subject to the following conditions:
(conditions will vary on a deal by deal basis)
- First mortgage liens on single family, owner occupied primary
residences.
- A mutually acceptable purchase and sale agreement.
- A mutually acceptable interim servicing agreement.
- Due diligence of the loan files which may include verification
of current property values and reunderwriting of the loans.
- All legal documentation is on FHLMC/FNMA approved forms with
exception of Notes. Notes will be fully enforceable and
comply with all Federal, State and Local laws and regulations.
- Loans over 80% LTV are eligible for mortgage insurance.
- Accuracy of the mortgage loan data.
- Funding within 30 days and all loans current at funding.
- Material market movement.
- Review of payment histories.
- Credit review of the selling institution.
<PAGE> 86
EXHIBIT ii
- Repurchase of any loan that goes 90 days delinquent during the
first 12 months.
- Valid title.
Should you have any questions please contact me at __________. Thank you for the
opportunity to bid on your portfolios.
Sincerely,
- ------------------
Name
- ------------------
Title
<PAGE> 87
EXHIBIT iii
STANDARD COMMITMENT LETTER
Date:____________
Counterparty Name
and Address
COMMITMENT LETTER
Dear_____________:
This letter is to confirm the intention of _______________ (the
"Seller" or "Buyer") to sell/purchase to/from Hanover Capital (the "Purchaser"
or "Seller") approximately $(UNPAID PRINCIPAL BALANCE) in (LOAN DESCRIPTION)
residential mortgage loans (the "Mortgage Loans" or "Loans") which are described
on the schedule attached as Exhibit A.
The Mortgage Loans and the characteristics of the transaction are
further described as follows:
SETTLEMENT DATE: The Mortgage Loans shall be purchased by the
Purchaser and sold by the Seller on _____ or such
other date as shall be mutually agreed upon by the
parties (the "Closing Date").
LOAN TYPE: The loans are backed by (FIXED RATE OR ADJUSTABLE
RATE) mortgage loans.
PROPERTY TYPE: All of the Mortgage Loans are (OCCUPANCY and secured
by (PROPERTY TYPE).
LOCATION: The mortgaged properties are located in the States of
___________________.
NUMBER OF LOANS: Approximately _______Loans.
LOAN SIZE: The average current loan balance is approximately
$_____________.
1
<PAGE> 88
EXHIBIT iii
WEIGHTED AVERAGE
REMAINING TERM TO
MATURITY: _________ months.
WEIGHTED AVERAGE
GROSS RATE: Approximately __________%.
SERVICING: The Loans will be sold on a (SERVICING RELEASED/
RETAINED) basis (for _____basis points). (Remittances
will be made by wire transfer on an (SERVICING TYPE)
basis on the ______ day of the month.)
WEIGHTED AVERAGE
NET RATE: Approximately __________%.
PURCHASE PRICE: The purchase price for the Loans is _________of the
unpaid principal balance of the Loans based upon a
Gross/Net Weighted Average Coupon ("WAC") of _______
and a weighted average remaining term to maturity
("WAM") of _______ months. Should the final WAC
and/or WAM differ from the current WAC and WAM a
revised purchase price for the Loans will be computed
by discounting the mortgage pool's final WAC and WAM
by a _____% semi-annual yield, using a ____ day
payment delay and ______% prepayment rate.
FINANCIAL
STATEMENTS: Purchaser's/Seller's commitment to purchase/sell the
Loans is subject to credit review of Seller's/
Purchaser's most recent audited financial statements.
UNDERWRITING: Loans have been underwritten in accordance with
generally accepted underwriting standards. All legal
documentation is on FHLMC/FNMA approved forms.
DUE DILIGENCE: The Purchaser's obligation to buy and the Seller's
obligation to sell the Loans is subject to the
Purchaser's, or its designee's, due diligence review
of the Loans and the Collateral Files to the
satisfaction of the Purchaser, in its sole
discretion, no later than ______, unless an extension
of time is mutually agreed upon by Purchaser and
Seller
2
<PAGE> 89
EXHIBIT iii
(the "Final Review Date"). (Due diligence may include
the Purchaser's verification of current property
values and re-underwriting of the Loans.) The Seller
will arrange for the availability of the Collateral
Files, payment histories and any additional
documentation reasonably requested by Purchaser for
Purchaser's review and due diligence at the
_________'s document custodian location on
___________. No later than five (5) days after such
Final Review Date, the Purchaser may notify Seller of
those Loans that do not meet the Purchaser's
standards for purchase ("Rejected Loans"). The Seller
will then have the ability to either promptly cure
such Rejected Loan deficiencies or substitute a Loan
that conforms to the requirements of this Commitment
Letter and is found to be acceptable for purchase by
Purchaser.
FORM OF SALE: The Loans will be sold, conveyed, transferred and
assigned under a Loan Sale Agreement and (INTERIM)
Servicing Agreement mutually agreeable to the Seller
and Purchaser. The Loan Sale Agreement will contain
secondary marketing representations and warranties
which shall include, but not be limited to, the items
that follow. The Seller represents and warrants that:
(1) they are the owner of the loans being conveyed;
(2) they have the authority to sell the loans; (3)
the notes are fully enforceable and comply with all
Federal, State and Local laws and regulations; (4)
all mortgage loans sold are first liens on the
mortgaged property; (5) the coupon rate and balances
established at the time of closing are accurate; (6)
the loans have been underwritten in accordance with
generally accepted underwriting standards; (7) all
loans are current and have not been over 30 days
delinquent in the last 12 month period; (8) they
will repurchase any loan that become 90 days
delinquent during the 12 month period following the
closing of this transaction; and (9) all loans over
80% LTV are eligible for mortgage insurance; (10) all
loans conform to the same delinquency profile as of
the bid date.
CLOSING CONDITIONS: The Seller shall provide to the Purchaser, or its
designees, contemporaneously with the payment of the
Purchase Price by the Purchaser to the Seller on the
Closing Date, the following mortgage loan documents
for each Loan (in each circumstance to be
satisfactory to Purchaser): a) an original note; b)
an original recorded security instrument (Mortgage,
Deed of Trust or Security Deed); c) an original title
policy; d) original recorded interim assignments, if
3
<PAGE> 90
EXHIBIT iii
any; e) an assignment from the Seller to blank; and
f) an endorsement from the Seller to blank. Where
applicable, modification agreements, extension
agreements, assumption agreements, mortgage insurance
certificates, HUD-1 settlement statement, and all
other appropriate legal documentation relating to
each underlying mortgage loan (the "Collateral File")
will also be provided. In addition, credit and
servicing files are to be provided to the full extent
available.
FEES: Purchaser and Seller will each bear its own incurred
costs, fees and expenses.
Sincerely,
HANOVER CAPITAL
By:_____________________________
Name:
Title:
Agreed and accepted:
(Counterparty)
By:______________________________
Name:
Title:
4
<PAGE> 91
EXHIBIT iii
SCHEDULE A
Mortgage Loan Schedule
5
<PAGE> 92
EXHIBIT iv
APPROVED BPO PROVIDERS
(AS OF 5/97)
1. Property & Appraisal Services Corp.
2. Spectrum Field Services
3. Market Intelligence
4. MGIC
5. Westfall & Company
6. New City Asset Management Inc.
7. Case Schiller Weiss Inc.
8. Mortgage Risk Assessment Corp.
9. Greenthlal/Harlan Realty Services
10. PHH Asset Management
11. HNC Software
12. PMI
<PAGE> 93
EXHIBIT v
APPROVED CREDIT SCORING PROVIDERS
(AS OF 5/97)
1. Equifax
2. TransUnion
3. TRW
4. Experian
<PAGE> 94
Exhibit vi
STANDARD POSITION REPORT
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------
Deal Deal Rate Index Current Gross Net Pur.
Number Name Class Code UPB WAC WAC WAM Margin Caps Price
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
Total Assets
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
Hedges
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
Total Hedges
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
Grand Total
- -------------------------------------------------------------------------------------------------------------------------
<CAPTION>
-------------------------------------------------------------------------------------------------------
Spread to Mark-to Asset
Prepay Avg Life/ Bench Bench Market Finance Finance Asset Interest Finance Total
Rate Mod. Dur. Security Security Price Amount Rate Gain/Loss Income Cost Gain/Loss
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
Total Assets
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
Hedges
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
Total Hedges
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
Grand Total
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE> 95
EXHIBIT vii
CREDIT GRADE
UNDERWRITING GUIDELINES
<TABLE>
- ----------------------------------------------------------------------------------------------------
A A- B C D
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
MORTGAGE 0 x 30 2 x 30 3 x 30 4 x 30 6 x 30
CREDIT 1 x 60 2 x 60
HISTORY (1) 1 x 90
- ----------------------------------------------------------------------------------------------------
CONSUMER 1 x 30 2 x 30 3 x 30 4 x 30 5 x 30
CREDIT 1 x 60 2 x 60 3 x 60 4 x 60
HISTORY (1) 1 x 90 2 x 90
- ----------------------------------------------------------------------------------------------------
BANKRUPTCY none none in past none in past none in past within past 2
5 years 3 years 2 years years
- ----------------------------------------------------------------------------------------------------
CREDIT 700 625 600 less than 600 less than 600
SCORE (2)
- ----------------------------------------------------------------------------------------------------
LTV (3) 90% 85% 80% 70% 65%
- ----------------------------------------------------------------------------------------------------
TOTAL DEBT 38% 45% 50% 55% 60%
RATIO
- ----------------------------------------------------------------------------------------------------
</TABLE>
(1) Last 12 months
(2) See Exhibit v for approved credit scoring companies
(3) Mortgage insurance required for LTVs greater than 80%
<PAGE> 96
EXHIBIT G
---------
FORM OF BLOCKED ACCOUNT AGREEMENT
December 8, 1997
- ------------------
- ------------------
- ------------------
Attn:________________
Re: Collection Account Established by ____________
("Servicer") Pursuant to that Certain Servicing
Agreement (as amended, supplemented or otherwise
modified from time to time, the "Servicing
Agreement"), dated __________, 1997, between
Servicer and Hanover Capital Mortgage Holdings,
Inc. ("Borrower")
Ladies and Gentlemen:
We refer to the collection account established by the Servicer
pursuant to the Servicing Agreement, at _______________, ___________, _____,
Account No._____________, ABA# ____________ (the "Blocked Account"), which
Servicer maintains in the Servicer's name in trust for Morgan Stanley Mortgage
Capital Inc. (the "Lender").
The Servicer will, from time to time, deposit funds received in
accordance with the Servicing Agreement into the Blocked Account. Lender has
established a secured loan arrangement with the Borrower. By its execution of
this letter, the Servicer acknowledges that the Borrower has granted a security
interest in all of the Borrower's right, title and interest in and to the
Blocked Account and any funds from time to time on deposit therein, that such
funds are received by the Servicer in trust for the benefit of Lender and,
except as provided below, are for application against the Borrower's liabilities
to Lender.
By the Servicer's execution of this letter, it agrees: (a) that all
funds from time to time hereafter in the Blocked Account are the property of the
Borrower held in trust for the benefit of the Lender and that unless and until
the Servicer receives notice from the Lender that an event of default has
occurred and is continuing under the Lender's secured lending arrangement with
the Borrower (a "Notice of Event of Default"), the Servicer shall transfer funds
from the Blocked Account in accordance with the Borrower's instructions; (b)
that Servicer will not exercise any right of set-off, banker's lien or any
similar right in connection with such funds PROVIDED, that in the event any
check is returned to the Servicer because of insufficient funds (or is otherwise
unpaid) the Servicer shall be entitled to set off the amount of any such
returned check; (c) that until the Servicer receives written notification from
the Lender to the contrary, the Servicer will not withdraw (other than as
expressly set forth in the Servicing Agreement or herein) or permit any person
or entity to withdraw or transfer funds from the Blocked Account; and (d) that
if the Servicer receives a Notice of Event of Default from the Lender, the
Servicer shall not withdraw or permit the Borrower to withdraw or transfer funds
from
H-1
<PAGE> 97
the Blocked Account and shall cause or permit withdrawals from the Blocked
Account in any manner as the Lender may instruct.
All bank statements in respect to the Blocked Account shall be sent
to the Borrower with copies to:
Morgan Stanley Mortgage Capital Inc.
1585 Broadway
New York, New York 10036
Attention: Mr. Peter Mozer
H-2
<PAGE> 98
Kindly acknowledge your agreement with the terms of this agreement by
signing the enclosed copy of this letter and returning it to the undersigned.
Very truly yours,
MORGAN STANLEY MORTGAGE CAPITAL INC.
By:_______________________________________
Title:
Agreed and acknowledged:
- ---------------------------------------
By:____________________________________
Title:
H-3
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE HANOVER
CAPITAL MORTGAGE HOLDINGS, INC'S ANNUAL REPORT ON FORM 10-K FOR THE PERIOD FROM
JUNE 10, 1997 TO DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> OTHER
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JUN-10-1997
<PERIOD-END> DEC-31-1997
<CASH> 4,022
<SECURITIES> 509,101
<RECEIVABLES> 3,597
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 517,543
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 517,543
<CURRENT-LIABILITIES> 439,445<F1>
<BONDS> 0
0
0
<COMMON> 65
<OTHER-SE> 78,033<F2>
<TOTAL-LIABILITY-AND-EQUITY> 517,543
<SALES> 0
<TOTAL-REVENUES> 4,898
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 940
<LOSS-PROVISION> 18
<INTEREST-EXPENSE> 3,204
<INCOME-PRETAX> 499
<INCOME-TAX> 0
<INCOME-CONTINUING> 499
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 499
<EPS-PRIMARY> .15
<EPS-DILUTED> .14
<FN>
<F1>As a Real Estate Investment Trust our balance sheet is not classified.
<F2>Includes Retained Earnings and Paid In Capital.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE HANOVER
CAPITAL MORTGAGE HOLDINGS, INC. DECEMBER 31, 1997 ANNUAL REPORT ON FORM 10-K
RELATING TO HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 208,315
<SECURITIES> 17,394
<RECEIVABLES> 133,829
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,270,887
<PP&E> 560,988
<DEPRECIATION> 347,851
<TOTAL-ASSETS> 2,066,875
<CURRENT-LIABILITIES> 571,519
<BONDS> 0
0
970
<COMMON> 30
<OTHER-SE> 88,740<F1>
<TOTAL-LIABILITY-AND-EQUITY> 2,066,875
<SALES> 0
<TOTAL-REVENUES> 7,970,565
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 8,808,542
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 117,894
<INCOME-PRETAX> (837,977)
<INCOME-TAX> (325,959)
<INCOME-CONTINUING> (512,018)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (512,018)
<EPS-PRIMARY> (525.79)
<EPS-DILUTED> .0
<FN>
<F1>Includes Retained Earnings and Paid In Capital.
</FN>
</TABLE>
