<PAGE>
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO _____________
COMMISSION FILE NUMBER: 0-23569
HEADLANDS MORTGAGE COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
----------------
CALIFORNIA 94-2851992
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1100 LARKSPUR LANDING CIRCLE, SUITE 101
LARKSPUR, CALIFORNIA 94939
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(415) 461-6790
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
The number of shares of the Registrant's Common Stock outstanding on
November 10, 1998 was 19,743,134.
================================================================================
<PAGE>
HEADLANDS MORTGAGE COMPANY
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<C> <S> <C>
PART I -- FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of September 30, 1998 and
December 31, 1997.............................................. 3
Consolidated Statements of Operations for the nine and three
months ended September 30, 1998 and 1997...................... 4
Consolidated Statements of Stockholders' Equity................ 5
Consolidated Statements of Cash Flows for the nine months ended
September 30, 1998 and 1997................................... 6
Notes to Consolidated Financial Statements..................... 7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.......................................... 11
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..... 18
PART II -- OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K............................... 18
Signatures.............................................................. 19
</TABLE>
FORWARD-LOOKING STATEMENTS
When used in this Form 10-Q or future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases or other
public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases "would be",
"will allow", "intends to", "will likely result", "are expected to", "will
continue", "is anticipated", "estimate", "project", or similar expressions are
intended to identify "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995.
The Company wishes to caution readers not to place undue reliance on any
such forward-looking statements, which speak only as of the date made, and to
advise readers that various factors, including regional and national economic
conditions, substantial changes in levels of market interest rates, credit and
other risks of lending and investment activities and competitive and
regulatory factors, could affect the Company's financial performance and could
cause the Company's actual results for future periods to differ materially
from those anticipated or projected. For a discussion of such factors that
could cause actual results to differ from those contained in forward-looking
statements, see "Risk Factors" in the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1997.
The Company does not undertake, and specifically disclaims any obligation,
to update any forward-looking statements to reflect occurrences or
unanticipated events or circumstances after the date of such statements.
2
<PAGE>
PART I
ITEM 1. FINANCIAL STATEMENTS
HEADLANDS MORTGAGE COMPANY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents........................... $ 6,442,955 $ 4,322,701
Retained interests in securitizations............... 32,647,004 32,552,277
Accounts receivable................................. 22,344,952 13,166,574
Accounts receivable from related parties............ 162,044 61,539
Mortgage loans held for sale, pledged............... 862,693,255 651,080,189
Originated mortgage servicing rights, net........... 19,769,210 26,127,391
Property, equipment and leasehold improvements,
net................................................ 15,134,756 7,715,431
Mortgage loans held for investment, net............. 157,490 824,307
Real estate owned, net.............................. 148,680 118,772
Other assets........................................ 2,239,135 1,836,021
------------ ------------
TOTAL ASSETS.................................... $961,739,481 $737,805,202
============ ============
LIABILITIES AND
STOCKHOLDERS' EQUITY
Notes payable....................................... $791,595,262 $641,960,679
Notes payable to stockholders....................... -- 9,670,000
Accounts payable.................................... 36,080,838 12,014,212
Accrued liabilities................................. 11,271,952 7,629,072
------------ ------------
Total liabilities............................... 838,948,052 671,273,963
------------ ------------
Commitments and contingencies
Stockholders' equity:
Common Stock (no par value; 50,000,000 shares
authorized, 19,743,134 and 19,700,000 shares
issued and outstanding, respectively)............ 92,153,243 1,000
Additional paid-in-capital-stock options.......... 1,037,620 118,585
Retained earnings................................. 29,600,566 66,411,654
------------ ------------
Total stockholders' equity...................... 122,791,429 66,531,239
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY...... $961,739,481 $737,805,202
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
HEADLANDS MORTGAGE COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
INCOME:
Net gain from sales of
mortgage loans............ $32,545,936 $27,078,400 $84,129,301 $45,009,683
Loan administration in-
come...................... 3,330,370 2,535,948 9,844,360 7,195,976
Gain from sale of mortgage
servicing rights.......... 581,842 336,167 712,464 9,374,526
Production income.......... 6,469,070 2,405,777 15,130,460 6,223,237
Interest income, net of
interest expense.......... 7,410,247 3,455,957 18,377,574 8,826,202
Net unrealized (loss) gain
in valuation of retained
interests in
securitizations........... (3,475,004) 72,939 (3,448,304) 667,979
----------- ----------- ----------- -----------
Total income ............ 46,862,461 35,885,188 124,745,855 77,297,603
EXPENSES:
Personnel.................. 14,404,943 8,341,248 38,966,449 20,799,293
General and
administrative............ 8,353,730 4,233,942 20,418,174 10,978,295
Occupancy and rents........ 1,120,226 589,147 2,835,927 1,658,899
Depreciation and
amortization of property,
equipment and leasehold
improvements.............. 1,643,312 760,951 3,927,199 1,983,178
Amortization and impairment
of originated mortgage
servicing rights.......... 5,294,198 1,701,924 12,504,714 3,599,393
----------- ----------- ----------- -----------
Total expenses........... 30,816,409 15,627,212 78,652,463 39,019,058
----------- ----------- ----------- -----------
Income before income
taxes................... 16,046,052 20,257,976 46,093,392 38,278,545
Income taxes related to
earnings ............... 6,749,670 666,606 21,313,246 1,342,215
Income taxes related to S
corporation conversion.. -- -- 18,487,965 --
----------- ----------- ----------- -----------
Net income............... $ 9,296,382 $19,591,370 $ 6,292,181 $36,936,330
=========== =========== =========== ===========
PRO FORMA INFORMATION:
Income before income taxes
and pro forma data........ $16,046,052 $20,257,976 $46,093,392 $38,278,545
Provision for pro forma
income taxes ............. 6,749,670 8,508,350 37,847,190 16,076,989
----------- ----------- ----------- -----------
Pro forma net income..... $ 9,296,382 $11,749,626 $ 8,246,202 $22,201,556
=========== =========== =========== ===========
Weighted average basic
shares
outstanding............. 19,733,579 14,000,000 18,945,461 14,000,000
Pro forma income per
share--Basic ........... $ 0.47 $ 0.84 $ 0.44 $ 1.59
=========== =========== =========== ===========
Weighted average diluted
shares
outstanding............. 20,039,734 14,017,697 19,239,785 14,006,151
Pro forma income per
share--Diluted ......... $ 0.46 $ 0.84 $ 0.43 $ 1.59
=========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
HEADLANDS MORTGAGE COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL
PAID-IN- TOTAL
NINE MONTHS ENDED COMMON CAPITAL RETAINED STOCKHOLDERS'
SEPTEMBER 30, 1997 STOCK STOCK OPTIONS EARNINGS EQUITY
- ------------------ ----------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
Balances at December 31,
1996................... $ 1,000 $ -- $ 29,143,241 $ 29,144,241
Net income.............. -- -- 36,936,330 36,936,330
----------- ---------- ------------ ------------
Balances at September
30, 1997............... $ 1,000 $ -- $ 66,079,571 $ 66,080,571
=========== ========== ============ ============
<CAPTION>
ADDITIONAL
PAID-IN- TOTAL
NINE MONTHS ENDED COMMON CAPITAL RETAINED STOCKHOLDERS'
SEPTEMBER 30, 1998 STOCK STOCK OPTIONS EARNINGS EQUITY
- ------------------ ----------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
Balances at December 31,
1997................... $ 1,000 $ 118,585 $ 66,411,654 $ 66,531,239
Net loss as S
corporation, including
loss related
to establishment of C
corporation deferred
tax liability.......... -- -- (23,308,385) (23,308,385)
Accrued distribution to
S corporation
stockholders........... -- -- (13,748,975) (13,748,975)
Constructive
recapitalization of S
corporation
undistributed
earnings............... 29,354,294 -- (29,354,294) --
Net proceeds of initial
public offering........ 62,453,152 -- -- 62,453,152
Proceeds from Exercise
of stock options....... 344,797 344,797
Stock option
contribution to
capital................ -- 919,035 -- 919,035
Net income as C
corporation............ -- -- 29,600,566 29,600,566
----------- ---------- ------------ ------------
Balances at September
30, 1998............... $92,153,243 $1,037,620 $ 29,600,566 $122,791,429
=========== ========== ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
HEADLANDS MORTGAGE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
1998 1997
------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net income....................................... $ 6,292,181 $ 36,936,330
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization of property,
equipment and leasehold improvements.......... 3,927,199 1,983,178
Amortization and impairment of originated
mortgage servicing rights..................... 12,504,714 3,599,393
Compensation from stock options................ 919,035 --
Gain from sale of mortgage servicing rights.... (712,464) (9,374,526)
Net gain from sales of mortgage loans.......... (84,129,301) (45,009,683)
Net purchase of retained interests in
securitizations............................... (94,727) (17,541,826)
Increase in accounts receivable................ (9,278,883) (8,998,579)
(Increase) decrease in mortgage loans held for
sale, pledged................................. (127,483,765) 20,885,685
Net (increase) decrease in originated mortgage
servicing rights.............................. (5,434,069) 841,991
Increase in other assets....................... (403,114) (1,226,150)
Increase in accounts payable and accrued
liabilities................................... 27,709,506 10,702,737
------------- ------------
Net cash used in operating activities........ (176,183,688) (7,201,450)
Net cash used in investing activities:
Purchase of property, equipment and leasehold
improvements................................... (11,346,524) (6,015,087)
Net proceeds from mortgage loans held for
investment..................................... 666,817 (133,791)
Net purchase of real estate owned............... (29,908) 418,132
------------- ------------
Net cash used in investing activities........ (10,709,615) (5,730,746)
Net cash provided by financing activities:
Net draws on notes payable...................... 149,634,583 13,368,791
Repayment of notes payable to stockholders...... (9,670,000) --
Payment of stockholders' distribution........... (13,748,975) --
Proceeds from sale of common stock.............. 62,797,949 --
------------- ------------
Net cash provided by financing activities.... 189,013,557 13,368,791
------------- ------------
Net increase in cash.............................. 2,120,254 436,595
Cash and cash equivalents beginning of period..... 4,322,701 2,701,332
------------- ------------
Cash and cash equivalents end of period........... $ 6,442,955 $ 3,137,927
============= ============
Supplemental disclosures of cash flow information:
Cash paid for interest.......................... $ 36,767,337 $ 21,754,430
Cash paid for income taxes...................... 16,701,662 576,135
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
HEADLANDS MORTGAGE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Headlands Mortgage Company (the "Company") is a publicly held California
corporation which was organized in 1981, and completed an initial public
offering of common stock on February 4, 1998. The Company is a specialty
mortgage banking company in the business of originating, selling, securitizing
and servicing residential mortgage loans secured by one-to four-unit family
residences, and purchasing and selling mortgage servicing rights.
The Company is headquartered in Northern California, and has production
branches in California, Washington, Oregon, Nevada, Florida, New Jersey,
Virginia, Idaho, New Mexico, and Arizona. Loans are originated primarily
through the Company's wholesale division, through a network of independent
mortgage loan brokers approved by the Company, and also through its
correspondent lending and retail lending divisions. The mortgage loans are
acquired by the Company in one of the three following manners: (i) originated
by an independent broker and purchased by the Company, (ii) originated by a
broker and funded by the Company, or (iii) originated and funded by the
Company in the ordinary course of business. The market for the Company's
mortgage banking operations is predominantly California and the western United
States.
The consolidated financial statements include Headlands Mortgage Company
("HMC"), and its wholly-owned subsidiary Headlands Mortgage Securities Inc.
("HMSI"). The activity of the subsidiary is related to the Company's
securitizations. All material intercompany balances and transactions have been
eliminated.
The Company diversified its residential mortgage loan sales activities in
1996 to include the securitization of such loans into Real Estate Mortgage
Investment Conduits ("REMICs") and Asset-Backed Securities ("ABS"). The
REMICs, which consist of pooled fixed-rate first-lien mortgages, were issued
by the Company to the public through the registration statement of the related
underwriter during 1996, and through the registration statement of HMSI during
1997 and 1998. The ABS, which consist of revolving home equity loans and
closed-end second mortgages, were issued by the Company through Headlands
Mortgage LLC (HMSI's predecessor) and the registration statement of the
related underwriter in 1996, and through the registration statement of HMSI
during 1997 and 1998.
The Company's executive offices are located in Larkspur, California, and its
loan servicing center is located in Santa Rosa, California. The Company's
source of servicing is from mortgage loans it has originated and sold.
2. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in conformity with generally accepted accounting principals and with
the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,
they do not include all of the information and notes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
Operating results for the nine months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1998. The financial information presented herein should be read
in conjunction with the consolidated financial statements and notes included
in the Headlands Mortgage Company Annual Report on Form 10-K for the year
ended December 31, 1997. Certain prior period amounts have been reclassified
to conform to current period presentation.
In preparing the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities as of the dates of the balance sheets and revenues and expenses
for the periods presented. Actual results could differ significantly from
those estimates.
7
<PAGE>
HEADLANDS MORTGAGE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. PRO FORMA INFORMATION
(a) Pro Forma Income Taxes
On January 31, 1998, the Company converted from an S corporation to a C
corporation. As a C corporation, the Company bears the tax obligation relating
to the net income earned for federal and state tax purposes.
The accompanying pro forma consolidated statements of operations for the nine
months ended September 30, 1998 and 1997, and the three months ended September
30, 1997, reflect the income tax expense of the Company as if it had been
subject to federal and state C corporation income taxes for the periods
presented. The pro forma information also takes into consideration the one-
time, non-cash charge relating to deferred income taxes on historical earnings
resulting from termination of the Company's S corporation status.
(b) Pro Forma Earnings Per Share Data
The weighted average number of diluted shares outstanding for the nine months
ended September 30, 1998 includes all options issued under the Company's Stock
Option Plan, and is calculated using the treasury stock method.
4. CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with an original maturity
of 90 days or less to be cash equivalents, including restricted cash and cash
equivalents in the amount of $3,009,234 and $2,053,613 at September 30, 1998
and December 31, 1997, respectively.
5. RETAINED INTERESTS IN SECURITIZATIONS
Retained interests in securitizations consist of assets generated by the
Company's loan securitizations. These assets were as follows at:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
REMIC subordinate certificates................. $ 5,764,155 $ 6,310,052
ABS Interest-only residual interest............ 10,267,489 16,264,219
ABS principal interest......................... 16,615,360 9,978,006
----------- -----------
$32,647,004 $32,552,277
=========== ===========
</TABLE>
The Company classifies REMIC and ABS securities as trading securities in
accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" and carries them as current assets at market value.
The Company is contractually bound by the Headlands Home Equity Loan (HHEL)
ABS Trusts to retain its principal interest and overcollateralization. While
the Company can sell these certificates, it would be considered a "Rapid
Amortization Event" under the terms of the trust, and would trigger rapid
amortization of the trust senior certificates.
8
<PAGE>
HEADLANDS MORTGAGE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale included net deferred fees and costs, and
consisted of the following at:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Mortgage loans................................ $748,907,120 $536,520,290
Home equity lines of credit................... 103,247,817 107,800,278
Deferred costs, net of fees................... 10,538,318 6,759,621
------------ ------------
$862,693,255 $651,080,189
============ ============
</TABLE>
7. ORIGINATED MORTGAGE SERVICING RIGHTS
Originated mortgage servicing rights, net, consist of the following:
<TABLE>
<CAPTION>
ACCUMULATED IMPAIRMENT NET
OMSR AMORTIZATION ALLOWANCE OMSR
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
Balance at December 31,
1996 .................. $ 22,279,656 $(246,141) $ (1,757,922) $ 20,275,593
Current year additions.. 22,975,958 (403,857) (5,409,000) 17,163,101
Servicing sold.......... (11,806,387) 125,418 369,666 (11,311,303)
Write-downs due to
prepayments............ (5,618,849) 126,059 5,492,790 --
------------ --------- ------------- ------------
Balance at December 31,
1997 $ 27,830,378 $(398,521) $ (1,304,466) $ 26,127,391
Current year additions.. 16,118,294 (297,619) (12,207,095) 3,613,580
Servicing sold.......... (9,991,362) 19,601 -- (9,971,761)
Write-downs due to
prepayments............ (8,873,410) 165,586 8,707,824 --
------------ --------- ------------- ------------
Balance at September 30,
1998................... $ 25,083,900 $(510,953) $ (4,803,737) $ 19,769,210
============ ========= ============= ============
</TABLE>
8. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements, net, consist of the
following at:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Furniture and fixtures....................... $ 2,477,787 $ 1,483,317
Office equipment............................. 27,176,112 17,940,908
Leasehold improvements....................... 1,646,920 1,063,892
Automobiles.................................. 47,911 49,411
------------ ------------
31,348,730 20,537,528
Less accumulated depreciation and
amortization................................ (16,213,974) (12,822,097)
------------ ------------
$ 15,134,756 $ 7,715,431
============ ============
</TABLE>
9. MORTGAGE LOANS HELD FOR INVESTMENT
During the normal course of business, the Company is required from time to
time to repurchase certain loans from investors. Mortgage loans held for
investment consisted of residential real estate mortgage loans at
September 30, 1998 and December 31, 1997. All properties are located in the
state of California. Interest rates on these mortgage loans are at variable
and fixed rates which range from 7.88% to 12.00% at September 30, 1998, and
from 7.25% to 12.00% at December 31, 1997. The maturities range from 3 months
to 4 years at September 30, 1998, and from 11 months to 28 years at December
31, 1997.
9
<PAGE>
HEADLANDS MORTGAGE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. REAL ESTATE OWNED
Real estate owned, net, consists of the following at:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Residential real estate at cost............... $ 259,094 $ 165,463
Less valuation allowance:
Balance at beginning of year................ (46,691) (52,255)
Additions to allowance...................... (187,341) (164,016)
Deductions related to real estate sold...... 123,618 169,580
--------- ---------
Real estate owned, net........................ $ 148,680 $ 118,772
========= =========
</TABLE>
11. NOTES PAYABLE
Notes payable consist of the following at:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Warehouse line of credit with banks, expiring on
November 4, 1999, $310 million at
September 30, 1998, and $215 million at December
31, 1997, bearing variable interest rates,
including a rate adjusted for compensating
balances........................................... $292,245,623 $195,688,752
Master repurchase agreement with an investment
banker, secured by mortgage loans and expiring
September 10, 1999, $250 million at September 30,
1998 and December 31, 1997, bearing variable
interest rates .................................... 49,330,539 174,542,715
Master repurchase agreement with an investment
banker, secured by mortgage loans, bearing a
variable interest rate ............................ 61,807,860 238,613,472
Master repurchase agreement with an investment
banker, secured by mortgage loans and expiring
December 11, 1998, bearing a variable interest rate
based on the LIBOR................................. 245,975,845 21,312,832
Master repurchase agreement with an investment
banker, secured by mortgage loans, bearing a
variable interest rate based on the LIBOR.......... 132,084,181 --
Warehouse line of credit with a major corporation
which was terminated on April 1, 1998, $15 million
at December 31, 1997, bearing variable interest
rates based on the LIBOR........................... -- 1,491,935
Master repurchase agreement with an investment
banker, secured by marketable securities, bearing a
variable interest rate based on the LIBOR.......... 2,558,653 2,949,223
Master repurchase agreement with an investment
banker, secured by marketable securities, bearing a
variable interest rate based on the LIBOR.......... 1,745,000 1,817,000
Master lease agreement with a leasing company,
secured by fixed assets of the Company, bearing
various interest rates based on the LIBOR.......... 5,847,561 5,544,750
------------ ------------
$791,595,262 $641,960,679
============ ============
</TABLE>
12. NOTES PAYABLE TO STOCKHOLDERS
The Company issued notes during 1996 to two of its stockholders. The
principal amount outstanding under the notes at December 31, 1997 was
$9,670,000. On February 5, 1998, the Company commenced trading shares of its
stock on the NASDAQ under the symbol HDLD. A portion of the proceeds received
from the sale of its stock to the public was used to repay the balance due
under the notes.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Headlands Mortgage Company (the "Company") is primarily engaged in the
origination, purchase, sale, securitization and servicing of mortgage loans
secured by one- to four-unit family residences. The Company's total income
represents revenues derived from net gain from sales of mortgage loans, loan
administration income, gain from sales of mortgage servicing rights,
production income, net interest income and net unrealized gain in valuation of
retained interests in securitizations. The net gain from sales of mortgage
loans consists of two components: (i) gain on sale of mortgage loans sold
through securitizations, which is recognized based on the sum of the selling
price of the portion sold and the value of the portion retained less the
carrying value of the mortgage loans sold; and (ii) net gain on mortgage loans
sold through whole loan transactions, which is recognized based upon the
difference between the selling price and the carrying value of the mortgage
loans sold. If a whole loan is sold servicing released, the servicing release
premium is included in the net gain on the sale of the mortgage loan. Loan
administration income includes fees earned as servicer for mortgage loans
owned by investors, net of fees paid to the subservicer. The Company
recognizes gain on the sale of mortgage servicing rights which are sold
separately from the mortgage loans, based upon the difference between the
selling price, net of selling expenses, and the carrying value of the mortgage
loan servicing rights. Production income includes fees paid to the Company by
borrowers for the preparation, documentation and underwriting of mortgage
loans. Net interest income consists of the net spread between interest
received by the Company on its mortgage loans held for sale and interest paid
by the Company under its credit facilities. It also includes interest earned
on retained interests in securitizations net of interest expenses for the
related investment financing.
As of the date of this Report, the Company had 12 wholesale branches and a
network of approximately 6,200 mortgage brokers. In addition, the Company
initiated its correspondent and retail lending divisions in 1994 to access new
mortgage loan origination markets. These strategies were designed to expand
and diversify the Company's mortgage loan origination network and decrease the
Company's reliance on the California real estate market.
The Company has experienced significant growth in the last few years,
particularly since April 1, 1995. Management believes that this growth is
primarily attributable to (i) its changing mortgage loan product mix, (ii) the
Company's geographic expansion, (iii) the Company's further penetration into
its established markets, and (iv) the Company's increased access to additional
funding sources which has enabled the Company to accumulate larger pools of
mortgage loans for sales through securitizations.
In connection with its growth, the Company has continued to focus its
resources on developing mortgage loan production from borrowers, brokers and
correspondents by designing mortgage loan products to meet the evolving needs
of these customers. Any future growth will be limited by, among other things,
the Company's need for continued funding sources, access to capital markets,
sensitivity to economic slowdowns, ability to attract and retain qualified
personnel, fluctuations in interest rates and competition from other mortgage
lenders and from new market entrants.
The Company's primary source of mortgage loan servicing rights is from
mortgage loans originated or acquired and sold by the Company. Of the
Company's $4.4 billion of mortgage loans serviced at September 30, 1998, $3.2
billion were serviced for others and $1.2 billion were either mortgage loans
held for sale or other assets of the Company. Of the mortgage loans serviced
for others, approximately $1.4 billion were mortgage loans serviced for Fannie
Mae or Freddie Mac, $1.6 billion were mortgage loans included in securities
created by the Company, and $0.2 billion were mortgage loans serviced for
private investors. Of the total mortgage loans serviced for others at
September 30, 1998 and December 31, 1997, 1.7% were 30 days or more
delinquent. As of September 30, 1998 and December 31, 1997, the Company had
not purchased mortgage loan servicing rights.
11
<PAGE>
TERMINATION OF S CORPORATION STATUS AND INCOME TAXES
On January 31, 1998, the Company's status as an S corporation terminated. In
connection with the termination of the Company's S corporation status, the
Company distributed approximately $13.7 million, calculated as of January 31,
1998 to the stockholders of the Company prior to the S corporation
termination.
As an S corporation, the Company's income, whether or not distributed, was
taxed at the stockholder level for federal and state tax purposes. Upon
termination of its S corporation status, the Company became fully subject to
federal and state income taxes and recorded a deferred tax liability on its
consolidated balance sheets. The amount of the deferred tax liability recorded
as of the date of termination of the S corporation status depends upon timing
differences between tax and book accounting relating principally to
recognition of gains on sale of mortgage loans. The deferred tax liability
recognized was approximately $18.5 million (included in accounts payable), and
was recorded as a current tax expense on January 31, 1998. The provision for
pro forma income taxes on the consolidated statements of operations shows
results as if the Company had always been fully subject to federal and state
taxes at the tax rates effective for the periods presented, as well as the
recording of the deferred tax liability relating to the conversion to a C
corporation.
IMPACT OF THE YEAR 2000
The Year 2000 issue is the result of prior computer programs and embedded
logic devices using two digits to define the applicable year. Any computer
programs and embedded logic devices that have time-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. Any
such occurrence could result in a system failure or miscalculations, causing
disruption of operations and possibly a temporary inability to process
transactions or engage in normal business activities.
The Company management has reviewed the critical systems for Year 2000
compliance to determine whether these systems will properly utilize dates
beyond December 31, 1999. Management believes that these systems are
currently, or will be with planned modifications, able to perform in the year
2000. Planned modifications are expected to be completed in the fourth quarter
of 1998 and the first quarter of 1999. However, if the planned modifications
are not completed on a timely basis, the Year 2000 issue could have an adverse
effect on the Company's operations.
The Company is presently engaged in various procedures to determine if the
computer systems and software of its suppliers, customers, brokers and agents
will be Year 2000 compliant. The Company is actively working with these third
parties to assess their compliance endeavors and the effect on the Company,
and the Company has thus far been notified by its venders that the systems
upon which it relies will be compliant prior to the end of the first quarter
of 1999. There can be no guarantee that the systems of third parties, upon
which the Company relies, will be Year 2000 compliant in a timely manner. The
Company is currently evaluating alternative vendors with Year 2000 compliant
systems to establish a contingency plan.
The Company is also using internal resources to test, identify and correct
its systems for Year 2000 compliance. The Company has established a Year 2000
committee to mitigate and/or prevent the adverse effects of Year 2000 issues.
The total cost for modifications and conversions is not known at this time;
however, it is not expected to be material to the Company's financial
position, results of operations or cash flows and is being expensed as
incurred.
RESULTS OF OPERATIONS
Three and Nine Months Ended September 30, 1998 Compared to Three and Nine
Months Ended September 30, 1997
Summary. The financial results for the three and nine months ended September
30, 1998 reflect the Company's ability to successfully originate mortgage
loans, and securitize and market them in the capital markets. Refinancing
activity accounted for approximately 56% and 52% of the mortgage loans
originated by the Company during the three months ended September 30, 1998 and
1997, respectively, compared to 60% and 54% of the mortgage loans originated
by the Company during the nine months ended September 30, 1998 and 1997,
respectively.
12
<PAGE>
Net income for the three months ended September 30, 1998 decreased $10.3
million, or 53%, to $9.3 million compared to net income of $19.6 million for
the same period in the prior year. The percentage decrease in net income was
greater than the percentage decrease in income before income taxes due to the
Company's change in tax status from an S corporation to a C corporation.
Income before income taxes for the three months ended September 30, 1998
decreased $4.3 million, or 21%, to $16.0 million compared to income before
income taxes of $20.3 million for the same period in the prior year. The
percentage increase in income was less than the percentage increase in
expenses due to a relatively higher increase in operating expenses during the
three months ended September 30, 1998 compared to the three months ended
September 30, 1997.
Net income for the nine months ended September 30, 1998 decreased $30.6
million, or 83%, to $6.3 million compared to net income of $36.9 million for
the same period in the prior year. The decrease in net income from the prior
year was primarily due to the one-time non-cash deferred tax charge of $18.5
million recognized by the Company at the C corporation commencement as
described in "Termination of S Corporation Status and Income Taxes" above.
Additionally, the Company was taxed as a C corporation for eight months during
the nine months ended September 30, 1998, compared to an S corporation tax
status for the same period in the prior year. The increased tax expense of
$38.5 million was partially offset by an increase in income before income
taxes.
Income before income taxes for the nine months ended September 30, 1998
increased $7.8 million, or 20%, to $46.1 million compared to income before
income taxes of $38.3 million for the same period of the prior year. The
percentage increase in income before income taxes was lower than the
percentage increase in revenue due to a relatively higher increase in
operating expenses during the nine months ended September 30, 1998 compared to
the nine months ended September 30, 1997.
Revenue. Revenue for the three months ended September 30, 1998 increased
$11.0 million, or 31%, to $46.9 million as compared to $35.9 million for the
three months ended September 30, 1997. Revenue for the nine months ended
September 30, 1998 increased $47.4 million, or 61%, to $124.7 million as
compared to $77.3 million for the nine months ended September 30, 1997.
Net gain from sales of mortgage loans increased $5.4 million, or 20%, to
$32.5 million for the three months ended September 30, 1998 compared to $27.1
million for the same period in the previous year. The increase was the result
of an increase in mortgage loans sold through securitizations and on a whole
loan basis. Mortgage loans either sold or securitized during the three months
ended September 30, 1998 increased $1,145.7 million, or 99%, to $2,302.0
million from $1,156.3 million during the three months ended September 30,
1997, with a weighted average net gain on sale as a percentage of mortgage
loans sold or securitized of 1.4% and 2.3%, respectively. The decrease in net
gain on sale percentage is due primarily to a high margin HELOC transaction
which took place in the third quarter of 1997. The Company sold 73% of its
loans with servicing rights released during the three months ended September
30, 1998, compared to 30% for the same period in the prior year. The Company
retains 100% of the servicing rights on mortgage loans it sells through
securitizations.
Net gain from sales of mortgage loans increased $39.1 million, or 87%, to
$84.1 million for the nine months ended September 30, 1998 compared to $45.0
million for the same period in the previous year. The increase was the result
of an increase in mortgage loans sold through securitizations and on a whole
loan basis. Mortgage loans either sold or securitized during the nine months
ended September 30, 1998 increased $3,149.5 million, or 127%, to $5,623.3
million from $2,473.8 million during the nine months ended September 30, 1997,
with a weighted average net gain on sale as a percentage of mortgage loans
sold or securitized of 1.5% and 1.8%, respectively. The Company sold 71% of
its loans with servicing rights released during the nine months ended
September 30, 1998, compared to 23% for the same period in the prior year. The
Company retains 100% of the servicing rights on mortgage loans it sells
through securitizations.
13
<PAGE>
Loan administration income increased $0.8 million, or 32%, to $3.3 million
for the three months ended September 30, 1998 from $2.5 million for the three
months ended September 30, 1997. The increase was due to an increase of $0.3
billion, or 8%, in the average monthly balance of mortgage loans serviced for
others to $4.3 billion from $4.0 billion in the prior year, and the weighted
average service fee rate increased 0.03%, or 11%, to 0.31% at September 30,
1998 compared to 0.28% at September 30, 1997. Additionally, ancillary fees
collected in relation to loan servicing activities increased $0.5 million.
Loan administration income increased $2.6 million, or 36%, to $9.8 million
for the nine months ended September 30, 1998 from $7.2 million for the nine
months ended September 30, 1997. The increase was due primarily to an increase
of $0.8 billion, or 22%, in the average monthly balance of mortgage loans
serviced for others to $4.5 billion from $3.7 billion in the prior year, as
well as an increase in the weighted average service fee rate noted in the
previous paragraph.
The Company sold mortgage servicing rights relating to $0.6 billion and $0.3
billion of mortgage loan principal balances during the three months ended
September 30, 1998 and 1997, respectively, resulting in a pre-tax gain of $0.6
million and $0.3 million, respectively. These gains represent a 10 basis point
gain based on the outstanding principal balance of the underlying mortgage
loans for the three months ended September 30, 1998 and 1997. Of the mortgage
servicing rights sold during the three months ended September 30, 1998 and
1997, 100% had capitalized values in accordance with SFAS 125.
The Company sold mortgage servicing rights relating to $0.8 billion and $1.8
billion of mortgage loan principal balances during the nine months ended
September 30, 1998 and 1997, respectively, resulting in a pre-tax gain of $0.7
million and $9.4 million, respectively. These gains represent a 9 basis point
and 52 basis point gain based on the outstanding principal balance of the
underlying mortgage loans for the nine months ended September 30, 1998 and
1997, respectively. Of the mortgage servicing rights sold during the nine
months ended September 30, 1998, 100% had capitalized values in accordance
with SFAS 125, compared to 56% during the same period in the prior year. The
remaining 44% in the prior year were mortgage servicing rights which were
originated prior to 1995 and had no capitalized value. Thus, the decrease in
gain is due to a lower book value related to the mortgage servicing rights
sold during the nine months ended September 30, 1997, partially offset by an
increase in the weighted average sales price of 34 basis points, or 31%, to
145 basis points for the nine months ended September 30, 1998 compared to 111
basis points in the prior year. The increase in weighted average sales price
from the prior year is partially due to the type and characteristics of
servicing rights sold.
In general, the decision to sell, buy or retain mortgage servicing rights is
based upon the market for and value of mortgage servicing rights, and the
Company's current financial needs and objectives. The Company's ability to
sell its mortgage servicing rights under its various mortgage loan servicing
agreements with investors is generally subject to the consent of the
investors. In addition, under the mortgage loan servicing provisions governing
the Company's securitizations, the successor servicer is subject to prior
approval of the rating agencies rating the subject securities.
Production income increased $4.1 million, or 171%, to $6.5 million for the
three months ended September 30, 1998 from $2.4 million for the three months
ended September 30, 1997. The increase is due primarily to the growth in
mortgage loan originations and purchases, and a 27% increase in per loan fees
collected during the three months ended September 30, 1998 over the same
period in the prior year. During the three months ended September 30, 1998,
mortgage loan originations increased $1,277.5 million, or 127%, to $2,287.2
million compared to $1,009.7 million during the three months ended September
30, 1997.
Production income increased $8.9 million, or 144%, to $15.1 million for the
nine months ended September 30, 1998 from $6.2 million for the nine months
ended September 30, 1997. The increase is due primarily to the growth in
mortgage loan originations and purchases, and a 15% increase in per loan fees
collected during the nine months ended September 30, 1998 over the same period
in the prior year. During the nine months ended September 30, 1998, mortgage
loan originations increased $3,341.8 million, or 132%, to $5,869.0 million
compared to $2,527.2 million during the nine months ended September 30, 1997.
14
<PAGE>
Net interest income increased $3.9 million, or 111%, to $7.4 million during
the three months ended September 30, 1998 from $3.5 million during the three
months ended September 30, 1997. Net interest income increased $9.6 million,
or 109%, to $18.4 million during the nine months ended September 30, 1998 from
$8.8 million during the nine months ended September 30, 1997. The increase in
net interest income was due to several factors: (i) a higher average balance
of mortgage loans held for sale during the three and nine months ended
September 30, 1998 compared to the same periods in 1997; (ii) earnings on
subordinate certificates retained by the Company relating to securitizations;
(iii) the Company's increase in available cash to invest in the warehouse
lines of credit thereby increasing the margin between mortgage coupons and
borrowing costs; and (iv) repayment of the $9.7 million notes to shareholders
during the first quarter of 1998.
Net unrealized gain/loss in valuation of retained interests in
securitizations decreased $3.6 million to a loss of $3.5 million for the three
months ended September 30, 1998 from a gain of $0.1 million during the three
months ended September 30, 1997. Net unrealized gain/loss in valuation of
retained interests in securitizations decreased $4.1 million, to a loss of
$3.4 million for the nine months ended September 30, 1998 from a gain of
$0.7 million during the nine months ended September 30, 1997. The decrease in
value was due to a 5% increase in the prepayment speeds experienced by the
Company relating to its interest only residual interests.
Expenses. Operating expenses increased $15.2 million, or 97%, to $30.8
million during the three months ended September 30, 1998 from $15.6 million
for the three months ended September 30, 1997. Operating expenses increased
$39.7 million, or 102%, to $78.7 million during the nine months ended
September 30, 1998 from $39.0 million for the nine months ended September 30,
1997. The increase in expense was primarily the result of additional personnel
required for the greater volume of mortgage loan originations, higher general
and administrative expenses related to the increase in mortgage loan
originations and an increase in amortization and impairment of originated
mortgage servicing rights relating to the increase in loan prepayments
relating to the capitalized asset during the three and nine months ended
September 30, 1998 as compared to the three and nine months ended
September 30, 1997.
Personnel expense increased $6.1 million, or 73%, to $14.4 million during
the three months ended September 30, 1998 from $8.3 million for the three
months ended September 30, 1997. Personnel expense increased $18.2 million, or
88%, to $39.0 million during the nine months ended September 30, 1998 from
$20.8 million for the nine months ended September 30, 1997. The increase in
personnel expense was due primarily to increased staffing in the Company's
mortgage loan originations area. As of September 30, 1998, the Company
employed 1,034 people compared to 616 people at September 30, 1997, a 68%
increase. Additionally, personnel expense includes volume-based compensation
expenses which increased in direct proportion with mortgage loan originations.
General and administrative expenses increased $4.2 million, or 100%, to $8.4
million during the three months ended September 30, 1998 from $4.2 million for
the three months ended September 30, 1997. General and administrative expenses
increased $9.4 million, or 85%, to $20.4 million during the nine months ended
September 30, 1998 from $11.0 million for the nine months ended September 30,
1997. The increase in general and administrative expenses is due primarily to
expenses incurred in connection with the increase in loan originations, and
includes such items as office supplies, telephone, computers and postage.
Amortization and impairment of originated mortgage loan servicing rights
increased $3.6 million, or 212%, to $5.3 million for the three months ended
September 30, 1998, from $1.7 million for the three months ended September 30,
1997. Amortization and impairment of originated mortgage loan servicing rights
increased $8.9 million, or 247%, to $12.5 million for the nine months ended
September 30, 1998, from $3.6 million for the nine months ended September 30,
1997. The increase in amortization and impairment of originated mortgage loan
servicing rights was due to additional impairment recognized by the Company
relating to an increase in prepayment rates.
15
<PAGE>
FINANCIAL POSITION
September 30, 1998 Compared to December 31, 1997
The balance of mortgage loans held for sale is affected by the timing of
securitizations and whole loan sales. Mortgage loans held for sale increased
$211.6 million, or 32%, to $862.7 million at September 30, 1998 from
$651.1 million at December 31, 1997. The increase in mortgage loans held for
sale resulted primarily from mortgage loan originations and purchases of
$5,869.0 million and HELOC draws of $5.7 million during the nine months ended
September 30, 1998, partially offset by sales into securities of $621.4
million and whole loan sales of $5,001.9 million.
Notes payable under warehouse lines of credit increased $149.6 million, or
23%, to $791.6 million at September 30, 1998 from $642.0 million at December
31, 1997, reflecting the mortgage loan origination, purchase and sale activity
described above. The percentage increase in the borrowings under warehouse
lines of credit was less than the percentage increase in the mortgage loans
held for sale due to the Company's investment of available cash balances in
the mortgage loans held for sale.
Accounts payable increased $24.1 million, or 201%, to $36.1 million at
September 30, 1998 from $12.0 million at December 31, 1997. The increase
resulted primarily from the recognition of the C corporation deferred tax
liability of $18.5 million and the additional tax liability relating to the
eight months the Company was taxed as a C corporation during the nine months
ended September 30, 1998.
Accounts receivable increased $9.1 million, or 69%, to $22.3 million at
September 30, 1998 from $13.2 million at December 31, 1997. The increase
resulted primarily from an increase in proceeds due relating to servicing
sales of $6.2 million and mortgage loan sales of $4.2 million, partially
offset by a decrease in servicing advances of $3.7 million.
Notes payable to shareholders of $9.7 million at December 31, 1997 were
repaid in full from proceeds of the initial public offering.
Originated mortgage servicing rights decreased $6.3 million, or 24%, to
$19.8 million at September 30, 1998 from $26.1 million at December 31, 1997.
The decrease in originated mortgage servicing rights resulted from the sale of
mortgage loans with servicing rights retained with a relative fair value of
$16.1 million during the nine months ended September 30, 1998, offset by
amortization and impairment recorded of $12.5 million and capitalized
servicing sold with a net book value of $10.0 million.
Property, equipment and leasehold improvements, net, increased $7.4 million,
or 96%, to $15.1 million at September 30, 1998 from $7.7 million at December
31, 1997. As a result of the Company's ongoing commitment to modern
technology, this growth reflects the purchase of upgraded office equipment of
$9.7 million, additional furniture and fixtures of $1.0 million and leasehold
improvements of $0.6 million. These increases were partially offset by
depreciation and amortization of $3.9 million.
Accrued liabilities increased $3.7 million, or 49%, to $11.3 million at
September 30, 1998 from $7.6 million at December 31, 1997. The increase was
due to the general increase in operating expenses and the timing of payment of
those expenses.
Stockholders' equity increased $56.3 million, or 85%, to $122.8 million at
September 30, 1998 from $66.5 million at December 31, 1997. This increase is
due to net proceeds from the Company's initial public offering of $62.5
million, additional paid in capital relating to stock options granted of $0.9
million, shares issued through the Company's stock option plans of $0.3
million and earnings as a C corporation of $29.6 million, partially offset by
the recognition of a stockholder distribution of $13.7 million, and the loss
as an S corporation of $23.3 million (which includes the recognition of the
deferred tax charge).
16
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal liquidity requirements include the funding or
payment of: (i) mortgage loan originations and purchases; (ii) investments and
overcollateralization requirements in connection with its securitization
program; (iii) fees and expenses incurred in connection with securitizations;
(iv) advances of delinquent principal and interest payments and escrow
balances required to be made as a mortgage loan servicer; and (v) ongoing
administrative and other operating expenses.
The Company must be able to sell mortgage loans and obtain adequate credit
facilities and other sources of funding in order to continue to originate and
purchase mortgage loans. As a result of increased loan originations and
purchases, the Company used cash of $176.2 million for operating activities
during the nine months ended September 30, 1998.
Recently, there has been a liquidity shortage in the secondary mortgage
market and related pricing pressures. The Company has continued to sell its
originations on a whole loan basis and through securitizations, but at less
attractive prices than the Company had previously been receiving.
Additionally, the Company experienced some difficulty completing two
transactions with committed investors which were in process when the liquidity
shortage occurred in the market. The Company believes it will continue to be
able to sell its mortgage loans at or above their cost basis. However, if
market conditions worsen, the Company's ability to continue to sell and
securitize its mortgage loans may be adversely impacted.
The Company used cash of $11.3 million for the purchase of property,
equipment and leasehold improvements during the nine months ended September
30, 1998. The increase during 1998 represents upgrades to office equipment,
the purchase of additional furniture and fixtures, and leasehold improvements.
The Company had cash flow from financing activities relating to the proceeds
from the sale of Common Stock of $62.8 million, repayment of notes to
shareholders of $9.7 million, and payment of stockholders' distribution of
$13.7 million. Additionally, the Company utilizes short-term warehouse
facilities and repurchase agreements to fund mortgage loan originations and
purchases. Thus, the increase in loan production resulted in cash provided
under notes payable of $149.6 million during the nine months ended September
30, 1998.
The Company increased its committed mortgage loan warehousing facility
during the nine months ended September 30, 1998 to $310.0 million from $215.0
million at December 31, 1997. As of November 12, 1998 this facility was
increased to $750.0 million, and extends through November 4, 1999. At
September 30, 1998, the outstanding balance under the Warehouse Facility was
$292.2 million.
In addition to the Warehouse Facility, the Company makes regular use of
certain uncommitted lines of credit, short-term credit facilities and purchase
and sale agreements (such as repurchase or "gestation" agreements) provided by
major investment banks that typically come due within 30 days of the borrowing
date. Amounts outstanding under these various facilities at September 30, 1998
were $489.2 million. Despite the recent liquidity shortages present in the
secondary mortgage market in general, the Company currently expects to be able
to repay the full amounts coming due or enter into new transactions under
these facilities. However, if the liquidity problems in the market worsen
during the coming months, the Company may be adversely impacted. The Company
terminated its $15.0 million warehouse line of credit with a major corporation
during the nine months ended September 30, 1998.
The Company decreased its servicing secured line of credit during the nine
months ended September 30, 1998 to $3.0 million from $15.0 million at December
31, 1997. As of November 12, 1998, this line of credit was increased to $8.0
million, and expires on November 4, 1999. At September 30, 1998, the Company
had no outstanding balance under this line of credit.
The Company has a master lease agreement with a leasing company for
borrowing arrangements relating to fixed assets. At September 30, 1998, the
Company had $5.8 million outstanding under this agreement.
17
<PAGE>
RECENT ACCOUNTING PRONOUNCEMENTS
In June, 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"), which amends the disclosure requirements
of Statement No. 52, "Foreign Currency Translations" and of Statement No. 107,
"Disclosures about Fair Value of Financial Instruments." SFAS 133 supersedes
Statements No. 80 "Accounting for Future Contracts," No. 105 "Disclosure of
Information about Financial Instruments with Off-Balance Sheet Risk and
Financial Instruments with Concentrations of Credit Risk" and No. 119,
"Disclosure about Derivative Financial Instruments and Fair Value of Financial
Instruments." Under the provisions of SFAS 133, the Company is required to
recognize all derivatives as either assets or liabilities in the statement of
financial condition and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated as (a) a hedge
of the exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment, (b) a hedge of the exposure to
variable cash flows of a forecasted transaction, or (c) a hedge of the foreign
currency exposure of a net investment in a foreign operation, an unrecognized
firm commitment, an available-for-sale security or a foreign-currency-
denominated forecasted transaction. The accounting for changes in the fair
value of a derivative (that is, gain and losses) depends on the intended use
of the derivative and the resulting operation. SFAS 133 is effective for all
fiscal quarters of fiscal years beginning June 15, 1999, with early
application encouraged, but it is permitted only as of the beginning of any
fiscal quarter that begins after the issuance of the statement. SFAS 133
should not be applied retroactively to financial statements of prior periods.
The Company does not expect that the adoption of SFAS 133 will have a material
impact on its financial condition and results of operation.
In October, 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 134 "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale
by a Mortgage Banking Enterprise" ("SFAS 134"), which amends Statement No. 65,
"Accounting for Certain Mortgage Banking Activities." Under the provisions of
SFAS 134, the Company is required to classify retained interests in a
securitization based on its ability and intent to sell or hold those
investments. SFAS 134 is effective for the first fiscal quarter beginning
after December 15, 1998, with early application encouraged. The Company has
not yet determined whether the adoption of SFAS 134 will have a material
impact on its financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not required.
18
<PAGE>
PART II
ITEM 1. LEGAL PROCEEDINGS
At September 30, 1998, there were no pending legal proceedings to which the
Company was a party or of which any of its property was subject.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UNDER SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Shareholders of the Company was held on September
17, 1998.
(b) The following matters were voted on at the Annual Meeting:
<TABLE>
<CAPTION>
VOTES
------------------------------
FOR WITHHELD EXEMPTIONS
---------- -------- ----------
<S> <C> <C> <C>
1.Election of Directors
Steven M. Abreu............................ 17,378,536 500 200
Leonard Auerbach........................... 17,378,736 500
Mark L. Korell............................. 17,378,736 500
Mark E. Lachtman........................... 17,378,736 500
Gilbert J. MacQuarrie...................... 17,378,536 500 200
Peter T. Paul.............................. 17,378,736 500
Becky S. Poisson........................... 17,378,536 500 200
<CAPTION>
VOTES
------------------------------
FOR AGAINST ABSTAIN
---------- -------- ----------
<S> <C> <C> <C>
2. Ratification of KPMG Peat Marwick
L.L.P. as the Company's independent
public accountants for the fiscal
year ending December 31, 1998........ 17,375,186 3,976 74
</TABLE>
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits filed with this report are as follows:
27.1 Financial data schedule
(b) The Company filed the following report on Form 8-K during the quarter
ended September 30, 1998:
None
19
<PAGE>
SIGNATURES
Pursuant to the requirements 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.
HEADLANDS MORTGAGE COMPANY
Date: November 13, 1998 By: /s/ Gilbert J. MacQuarrie
_______________________________
Gilbert J. MacQuarrie
Executive Vice President and CFO
(SIGNING IN THE CAPACITY OF (i) DULY
AUTHORIZED OFFICER OF THE REGISTRANT
AND (ii) PRINCIPAL FINANCIAL OFFICER
OF THE REGISTRANT)
20
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