<PAGE>
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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: MARCH 31, 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
(I.R.S. EMPLOYER
(STATE OR OTHER JURISDICTION IDENTIFICATION NO.)
OF INCORPORATION OR ORGANIZATION)
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 May 10,
1998 was 19,700,000.
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<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 March 31, 1998 and December
31, 1997....................................................... 3
Consolidated Statements of Operations for the three months
ended March 31, 1998 and 1997................................. 4
Consolidated Statement of Stockholders' Equity................. 5
Consolidated Statements of Cash Flows for the three months
ended March 31, 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
PART II -- OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits filed with this report are as follows:
4.2* Indenture, dated as of March 1, 1998, between Headlands Home
Equity Loan Trust 1998-1 and the First National Bank of
Chicago, as trustee.
11.1 Schedule regarding computation of per share earnings
27.1 Financial data schedule
(b) The Company filed the following report on Form 8-K during the
quarter ended March 31, 1998:
Form 8-K filed on February 5, 1998 in connection with the
Company's initial public offering.
Signatures.............................................................. 16
</TABLE>
- --------
* Incorporated by reference to the Form 8-K filed by Headlands Mortgage
Securities, Inc. (a wholly-owned, consolidated subsidiary of the Company)
on April 9, 1998.
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>
HEADLANDS MORTGAGE COMPANY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents............................ $ 9,410,465 $ 4,322,701
Retained interests in securitizations................ 48,855,797 35,119,658
Accounts receivable.................................. 14,444,940 13,166,574
Accounts receivable from related parties............. 43,329 61,539
Mortgage loans held for sale, pledged................ 763,590,967 651,080,189
Originated mortgage servicing rights, net............ 25,294,448 26,127,391
Property, equipment and leasehold improvements, net.. 9,969,537 7,715,431
Mortgage loans held for investment, net.............. 492,476 824,307
Real estate owned, net............................... 229,126 118,772
Other assets......................................... 2,125,560 1,836,021
------------ ------------
TOTAL ASSETS..................................... $874,456,645 $740,372,583
============ ============
LIABILITIES AND
STOCKHOLDERS' EQUITY
Notes payable........................................ $697,890,856 $641,960,679
Notes payable to stockholders........................ -- 9,670,000
Stockholder distributions payable.................... 12,519,988 --
Accounts payable..................................... 43,256,067 12,014,212
Accrued liabilities.................................. 14,025,566 10,196,453
------------ ------------
Total liabilities................................ 767,692,477 673,841,344
------------ ------------
Commitments and contingencies
Stockholders' equity:
Common Stock (no par value; 50,000,000 shares
authorized, 19,700,000 shares issued and
outstanding)...................................... 93,037,433 1,000
Additional paid-in-capital-stock options........... 474,340 118,585
Retained earnings.................................. 13,252,395 66,411,654
------------ ------------
Total stockholders' equity....................... 106,764,168 66,531,239
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY....... $874,456,645 $740,372,583
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
HEADLANDS MORTGAGE COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------
1998 1997
-------------- --------------
<S> <C> <C>
INCOME:
Net gain from sales of mortgage loans.......... $ 28,136,810 $ 7,890,940
Loan administration income..................... 3,050,995 2,386,570
Gain from sale of mortgage servicing rights.... 130,622 8,794,455
Production income.............................. 4,189,223 1,647,748
Interest income, net of interest expense....... 4,913,683 2,341,293
Net unrealized loss in valuation of retained
interests in securitizations.................. (221,978) --
-------------- -------------
Total income ................................ 40,199,355 23,061,006
EXPENSES:
Personnel...................................... 11,339,545 5,964,211
General and administrative..................... 5,909,379 3,118,774
Occupancy and rents............................ 803,041 520,149
Depreciation and amortization of property,
equipment and leasehold improvements.......... 999,955 628,926
Amortization and impairment of originated mort-
gage servicing rights......................... 3,288,670 519,978
-------------- -------------
Total expenses............................... 22,340,590 10,752,038
-------------- -------------
Income before income taxes................... 17,858,765 12,308,968
Income taxes related to quarterly earnings .. 9,426,790 429,783
Income taxes related to S corporation
conversion.................................. 18,487,965 --
-------------- -------------
Net (loss) income............................ $ (10,055,990) $ 11,879,185
============== =============
PRO FORMA INFORMATION:
Income before income taxes and pro forma
data.......................................... $17,858,765 $ 12,308,968
Provision for pro forma
income taxes ................................. 27,586,875 5,169,767
-------------- -------------
Pro forma net (loss) income ................. $(9,728,110) $ 7,139,201
============== =============
Pro forma loss per share--Basic ............. $ (0.56)
==============
Pro forma loss per share--Diluted ........... $ (0.56)
==============
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
HEADLANDS MORTGAGE COMPANY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL PAID- TOTAL
COMMON IN-CAPITAL RETAINED STOCKHOLDERS'
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 corpora-
tion, including loss
related to establish-
ment of C corporation
deferred tax liabili-
ty..................... -- -- (23,308,385) (23,308,385)
Accrued distribution to
S corporation
stockholders........... -- -- (12,519,988) (12,519,988)
Constructive
recapitalization of S
corporation
undistributed
earnings............... 30,583,281 -- (30,583,281) --
Stock option contribu-
tion to capital........ -- 118,585 -- 118,585
----------- -------- ------------ ------------
Balances at January 31,
1998................... 30,584,281 237,170 -- 30,821,451
Net proceeds of initial
public offering........ 62,453,152 -- -- 62,453,152
Stock option contribu-
tion to capital........ -- 237,170 -- 237,170
Net income as C corpora-
tion................... -- -- 13,252,395 13,252,395
----------- -------- ------------ ------------
Balances at March 31,
1998................... $93,037,433 $474,340 $ 13,252,395 $106,764,168
=========== ======== ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
HEADLANDS MORTGAGE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31,
----------------------------
1998 1997
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income............................... $ (10,055,990) $ 11,879,185
Adjustments to reconcile net (loss) income to
net cash used in operating activities:
Depreciation and amortization of property,
equipment and leasehold improvements......... 999,955 628,926
Amortization and impairment of originated
mortgage servicing rights.................... 3,288,670 519,978
Compensation from stock options............... 355,755 --
Gain from sale of mortgage servicing rights... (130,622) (8,794,455)
Net gain from sales of mortgage loans......... (28,136,810) (7,890,940)
Net purchase of retained interests in
securitizations.............................. (13,736,139) (2,736,182)
Increase in accounts receivable............... (1,260,156) (5,582,810)
Increase in mortgage loans held for sale,
pledged...................................... (84,373,968) (73,323,340)
Net (increase) decrease in originated mortgage
servicing rights............................. (2,325,105) 10,904,826
Increase in other assets...................... (289,539) (1,076,991)
Increase in accounts payable and accrued lia-
bilities..................................... 35,070,968 307,813
------------- -------------
Net cash used in operating activities....... (100,592,981) (75,163,990)
Net cash used in investing activities:
Purchase of property, equipment and leasehold
improvements.................................. (3,254,061) (1,846,889)
Net proceeds from mortgage loans held for in-
vestment...................................... 331,831 45,423
Net purchase of real estate owned.............. (110,354) (471,368)
------------- -------------
Net cash used in investing activities....... (3,032,584) (2,272,834)
Net cash provided by financing activities:
Net draws on notes payable..................... 55,930,177 76,161,547
Repayment of notes payable to stockholders..... (9,670,000) --
Proceeds from sale of common stock............. 62,453,152 --
------------- -------------
Net cash provided by financing activities... 108,713,329 76,161,547
------------- -------------
Net increase (decrease) in cash.................. 5,087,764 (1,275,277)
Cash and cash equivalents beginning of period.... 4,322,701 2,701,332
------------- -------------
Cash and cash equivalents end of period.......... $ 9,410,465 $ 1,426,055
------------- -------------
Supplemental disclosures of cash flow informa-
tion:
Cash paid for interest......................... $ 12,832,294 $ 5,315,599
Cash paid for income taxes..................... 19,045 58,790
</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,
Idaho, 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 footnotes 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 three months ended March 31, 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 footnotes
included in the Headlands Mortgage Company Annual Report on Form 10-K for the
year ended December 31, 1997.
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 consolidated statements of operations for the three months
ended March 31, 1998 and 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 pro forma earnings per share data is based upon weighted average shares
outstanding of 17,284,746 during the three months ended March 31, 1998, which
did not include shares related to the Company's Stock Option Plan as they were
anti-dilutive for the period presented.
4.MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale included net deferred fees and costs, and
consisted of the following at:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
Mortgage loans................................. $743,846,940 $536,520,290
Home equity lines of credit.................... 12,031,244 107,800,278
Deferred costs, net of fees.................... 7,712,783 6,759,621
------------ ------------
$763,590,967 $651,080,189
============ ============
</TABLE>
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>
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
<S> <C> <C>
REMIC subordinate certificates................... $ 6,157,193 $ 6,310,052
ABS Interest-only residual interest.............. 27,242,270 18,831,600
ABS principal interest........................... 11,255,029 6,422,286
ABS overcollateralization........................ 4,201,305 3,555,720
----------- -----------
$48,855,797 $35,119,658
=========== ===========
</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.PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements, net, consist of the following
at :
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
Furniture and fixtures........................ $ 1,770,312 $ 1,483,317
Office equipment.............................. 20,609,291 17,940,908
Leasehold improvements........................ 1,269,213 1,063,892
Automobiles................................... 47,911 49,411
------------ ------------
23,696,727 20,537,528
Less accumulated depreciation and
amortization................................. (13,727,190) (12,822,097)
------------ ------------
$ 9,969,537 $ 7,715,431
============ ============
</TABLE>
7.NOTES PAYABLE
Notes payable consist of the following at:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
Warehouse line of credit with banks, expiring on
November 4, 1999, $275 million at
March 31, 1998, $215 million at December 31, 1997
and bearing variable interest rates, including a
rate adjusted for compensating balances............ $238,299,262 $195,688,752
Master repurchase agreement with an investment
banker, secured by mortgage loans and expiring
September 10, 1998, $250 million at March 31, 1998
and December 31, 1997, bearing variable interest
rates ............................................. 71,523,647 174,542,715
Master repurchase agreement with an investment bank-
er, secured by morgage loans, bearing a variable
interest rate ..................................... 357,518,433 238,613,472
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................................. 21,146,155 21,312,832
Warehouse line of credit with a major corporation,
expiring October 31, 1998, $15 million at March 31,
1998 and December 31, 1997, and bearing variable
interest rates based on the LIBOR.................. -- 1,491,935
Servicing secured working capital line of credit,
expiring on November 4, 1998, $3 million at March
31, 1998 and $12 million at December 31, 1997,
bearing a variable interest rate based on the open
Federal Funds rate or the LIBOR including a rate
adjusted for compensating balances................. -- --
Master repurchase agreement with an investment bank-
er, secured by marketable securities, bearing a
variable interest rate based on the LIBOR.......... 2,831,665 2,949,223
Master repurchase agreement with an investment bank-
er, secured by marketable securities, bearing a
variable interest rate based on the LIBOR.......... 1,803,000 1,817,000
Master lease agreement with a leasing company, se-
cured by fixed assets of the Company, bearing vari-
ous interest rates based on the LIBOR.............. 4,768,694 5,544,750
------------ ------------
$697,890,856 $641,960,679
============ ============
</TABLE>
9
<PAGE>
HEADLANDS MORTGAGE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
8. 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
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 gains 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 10 wholesale branches and a
network of approximately 5,500 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 $4.6 billion of mortgage loans serviced at March 31, 1998, $3.7
billion were serviced for others and $0.9 billion were mortgage loans held for
sale by the Company. Of the mortgage loans serviced for others, approximately
$1.4 billion were mortgage loans serviced for Fannie Mae or Freddie Mac, $2.0
billion were mortgage loans included in securities created by the Company, and
$0.3 billion were mortgage loans serviced for private investors. Of the total
mortgage loans serviced for others at March 31, 1998 and 1997, respectively,
1.4% and 1.3% were 30 days or more delinquent. As of March 31, 1998 and 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 will distribute approximately $12.5 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, 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.
RESULTS OF OPERATION
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31,
1997
Summary. The financial results for the three months ended March 31, 1998
reflect not only the growth in the Company's mortgage loan originations, but
also its ability to successfully securitize and market the mortgage loans in
the capital markets. Refinancing activity accounted for approximately 66% and
64% of the mortgage loans originated by the Company during the three months
ended March 31, 1998 and 1997, respectively.
Net loss for the three months ended March 31, 1998 was $10.1 million
compared to net income of $11.9 million for the same period in the prior year.
The $22 million decrease in net income from the prior year was primarily due
to the one-time non-cash deferred tax liability 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 two months during the three months ended March
31, 1998, compared to an S corporation tax status for the same period in the
prior year. These increased tax expenses were partially offset by an increase
in income before income taxes.
Income before income taxes for the three months ended March 31, 1998
increased $5.6 million, or 46%, to $17.9 million compared to income before
income taxes of $12.3 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 three months ended March 31, 1998 from the three
months ended March 31, 1997.
Revenue. Revenue for the three months ended March 31, 1998 increased $17.1
million, or 74%, to $40.2 million as compared to $23.1 million for the three
months ended March 31, 1997.
Net gain from sales of mortgage loans increased $20.2 million, or 256%, to
$28.1 million for the three months ended March 31, 1998 compared to $7.9
million for the same period in the previous year. The increase was the result
of increased mortgage loan originations and purchases as well as the
corresponding increase in mortgage loans sold through securitizations and on a
whole loan basis. During the three months ended March 31, 1998, mortgage loan
originations increased $837.2 million, or 121%, to $1,529.4 million compared
to $692.2 million during the three months ended March 31, 1997. Mortgage loans
either sold or securitized during the three months ended March 31, 1998
increased $836.6 million, or 142%, to $1,425.7 million from $589.1 million
during the three months ended March 31, 1997, with a weighted average net gain
on sale as a percentage of mortgage loans sold or securitized of 2.0% and
1.3%, respectively. The increase in net gain on sale percentage is primarily
due to the Company's ability to obtain higher margins on ABS securities over
REMIC securities. Additionally, the Company sold 65% of its loans with
servicing rights released during the three months ended March 31, 1998,
compared to 22% for the same period in the prior year. The Company retains
100% of the servicing rights on mortgage loans it sells through
securitizations.
12
<PAGE>
Loan administration income increased $0.7 million, or 29%, to $3.1 million
for the three months ended March 31, 1998 from $2.4 million for the three
months ended March 31, 1997. The increase was due primarily to a 28% increase
in the average monthly balance outstanding in the mortgage loan servicing
portfolio to $4.6 billion from $3.6 billion in the prior year. The increase in
the average mortgage loan servicing portfolio is primarily due to a decrease
of mortgage loan servicing rights sold during the three months ended March 31,
1998, compared to the three months ended March 31, 1997.
The Company sold mortgage servicing rights relating to $0.3 billion and $1.5
billion of mortgage loan principal balances during the three months ended
March 31, 1998 and 1997, respectively, resulting in a pre-tax gain of $0.1
million and $8.8 million, respectively. These gains represent a 5 basis point
and 58 basis point gain based on the outstanding principal balance of the
underlying mortgage loans for the three months ended March 31, 1998 and 1997,
respectively. Of the mortgage servicing rights sold during the three months
ended March 31, 1998, 100% had capitalized values in accordance with SFAS 125,
compared to 48% during the same period in the prior year. The remaining 52% in
the prior year were mortgage servicing rights which were originated prior to
1995 and had no book value. Thus, the decrease in gain is due to a lower book
value related to the mortgage servicing rights sold during the three months
ended March 31, 1997, partially offset by an increase in the weighted average
sales price of 34 basis points, or 31%, to 142 basis points for the three
months ended March 31, 1998.
In general, the decision to sell, buy or retain mortgage servicing rights is
based upon the market for and value of mortgage servicing rights, 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 $2.6 million, or 163%, to $4.2 million for the
three months ended March 31, 1998 from $1.6 million for the three months ended
March 31, 1997. The increase is due primarily to the 121% growth in mortgage
loan originations and purchases, and a 29% increase in per loan fees collected
during the three months ended March 31, 1998 over the same period in the prior
year.
Net interest income increased $2.6 million, or 113%, to $4.9 million during
the three months ended March 31, 1998 from $2.3 million during the three
months ended March 31, 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 months ended March 31, 1998 than 1997; (ii) earnings on
subordinate certificates retained by the Company relating to securitizations;
and (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. These factors were partially offset by a decrease in gross
interest margin.
Net unrealized loss in valuation of retained interests in securitizations
was $0.2 million for the three months ended March 31, 1998. This loss was the
result of a decrease in the cash flows relating to retained interests in
securitizations from December 31, 1997 to March 31, 1998.
Expenses. Operating expenses increased $11.5 million, or 106%, to $22.3
million during the three months ended March 31, 1998 from $10.8 million for
the three months ended March 31, 1997. The increase in expense was primarily
the result of additional personnel required for the greater volume of mortgage
loan originations, higher operating 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 the
capitalized asset during the three months ended March 31, 1998 as compared to
the three months ended March 31, 1997.
Personnel expense increased $5.3 million or 88% to $11.3 million during the
three months ended March 31, 1998 from $6.0 million for the three months ended
March 31, 1997. The increase in personnel expense was due primarily to
increased staffing in the Company's mortgage loan originations area. As of
March 31, 1998, the Company employed 779 people compared to 546 people at
March 31, 1997, a 43% increase. Additionally, personnel expense includes
volume-based compensation expenses which increased in direct proportion with
mortgage loan originations.
13
<PAGE>
General and administrative expenses increased $2.8 million, or 90%, to $5.9
million during the three months ended March 31, 1998 from $3.1 million for the
three months ended March 31, 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, postage and reserve for future loan losses.
Amortization and impairment of originated mortgage loan servicing rights
increased $2.8 million, or 560%, to $3.3 million for the three months ended
March 31, 1998, as compared to $0.5 million for the three months ended March
31, 1997. The increase in amortization and impairment of originated mortgage
loan servicing rights was due to two factors: (1) an increase in the related
asset of 43% from March 31, 1997, and (ii) additional impairment recognized by
the Company relating to an increase in prepayment rates.
FINANCIAL POSITION
March 31, 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
$112.6 million, or 17%, to $763.6 million at March 31, 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
$1,529.4 million and HELOC draws of $26 million during the three months ended
March 31, 1998, partially offset by sales into securities of $213.4 million
and whole loan sales of $1,212.3 million.
Notes payable under warehouse lines of credit increased $55.9 million, or
9%, to $697.9 million at March 31, 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.
Retained interests in securitizations increased $13.8 million, or 39%, to
$48.9 million at March 31, 1998 from $35.1 million at December 31, 1997. The
increase is due to interests retained by the Company in the securitization it
effected during the three months ended March 31, 1998 with an estimated market
value of $13.3 million.
Accounts payable increased $31.3 million or 261% to $43.3 million at March
31, 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 current tax liability of $3.9 million.
Accounts payable also increased due to an increase of $0.8 million of unpaid
expenses related to bulk servicing sales, as well as a general increase due to
the Company's increased mortgage loan production.
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 $0.8 million, or 3%, to $25.3
million at March 31, 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
$5.2 million during the three months ended March 31, 1998, partially offset by
amortization and impairment recorded of $3.3 million and capitalized servicing
sold with a net book value of $2.7 million.
Property, equipment and leasehold improvements, net, increased $2.3 million,
or 30%, to $10.0 million at March 31, 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 $2.7
million, additional furniture and fixtures of $0.3 million and leasehold
improvements of $0.2. These increases were partially offset by depreciation
and amortization of $1.0 million.
14
<PAGE>
Accrued liabilities increased $3.8 million, or 37%, to $14.0 million at
March 31, 1998 from $10.2 million at December 31, 1997. The increase was
primarily due to deferred revenue recorded by the Company in the amount of
$2.9 million in connection with the building of the asset-backed security's
overcollateralization as described above.
Stockholders' equity increased $40.3 million, or 61%, to $106.8 million at
March 31, 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 $0.4 million,
and the first quarter earnings as a C corporation of $13.2 million, offest by
the recognition of a stockholder distribution of $12.5 million, and the first
quarter loss as an S corporation of $23.3 million (which includes the
recognition of the deferred tax liability).
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 $100.6 million for operating activities
during the three months ended March 31, 1998.
The Company used cash of $3.3 million for the purchase of property,
equipment and leasehold improvements during the three months ended March 31,
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 activities from financing activities relating to
the proceeds from the sale of Common Stock of $62.5 million and repayment of
notes to shareholders of $9.7 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,
combined with the other two financing activities, resulted in cash provided by
financing activities of $108.7 million during the three months ended March 31,
1998.
The Company increased its mortgage loan warehousing facility during the
three months ended March 31, 1998 to $275 million from $230 million at
December 31, 1997. The facility extends through November 4, 1999. At March 31,
1998, the outstanding balance under the Warehouse Facility was $238.3 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 and a major corporation. Amounts outstanding under
these various facilities at March 31, 1998 were $454.8 million.
The Company decreased its servicing secured line of credit during the three
months ended March 31, 1998 to $3 million from $15 million at December 31,
1997. This line of credit expires on November 4, 1998. At March 31, 1998, the
Company had no outstanding balance under this line of credit.
15
<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: March 14, 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)
16
<PAGE>
EXHIBIT 11.1
HEADLANDS MORTGAGE COMPANY
STATEMENT RE COMPUTATION OF PRO FORMA PER SHARE EARNINGS
<TABLE>
<CAPTION>
FOR THE
THREE MONTHS
ENDED
MARCH 31,
------------
1998
------------
<S> <C>
Basic and diluted pro forma income per share:
Pro forma net loss to common Stockholders(1)................. $ (9,728,110)
============
Weighted average shares outstanding(2)--basic................ 17,284,746
Weighted average shares outstanding(2)--diluted.............. 17,284,746
Pro forma earnings per share--basic.......................... (0.56)
============
Pro forma earnings per share--diluted........................ (0.56)
============
</TABLE>
- --------
(1) Prior to January 31, 1998, the Company was treated as an S corporation for
federal and state income tax purposes. The pro forma presentation reflects
the provision for income taxes as if the Company had always been fully
subject to federal and state taxes as a C corporation at the effective tax
rate of 42%. The pro forma presentation also reflects the one-time, non-
cash charge relating to deferred income taxes on historical earnings
resulting from termination of the Company's S corporation status.
(2) No shares related to the Company's stock option plan were included in the
weighted average number of shares outstanding, as their effect would have
been anti-dilutive for the period presented.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM A THREE
MONTH PERIOD ENDING MARCH 31, 1998
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> 3-MOS YEAR
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> MAR-31-1998 DEC-31-1997
<CASH> 9,410,465 4,322,701
<INT-BEARING-DEPOSITS> 0 0
<FED-FUNDS-SOLD> 0 0
<TRADING-ASSETS> 21,613,527 16,288,058
<INVESTMENTS-HELD-FOR-SALE> 763,590,967 651,080,189
<INVESTMENTS-CARRYING> 0 0
<INVESTMENTS-MARKET> 0 0
<LOANS> 0 0
<ALLOWANCE> 0 0
<TOTAL-ASSETS> 874,456,645 740,372,583
<DEPOSITS> 495,174 426,150
<SHORT-TERM> 0 0
<LIABILITIES-OTHER> 742,099,175 664,171,344
<LONG-TERM> 25,593,302 9,670,000
0 0
0 0
<COMMON> 93,037,433 1,000
<OTHER-SE> 13,252,395 66,411,654
<TOTAL-LIABILITIES-AND-EQUITY> 874,456,645 740,372,583
<INTEREST-LOAN> 0 0
<INTEREST-INVEST> 0 0
<INTEREST-OTHER> 0 0
<INTEREST-TOTAL> 0 0
<INTEREST-DEPOSIT> 0 0
<INTEREST-EXPENSE> 0 0
<INTEREST-INCOME-NET> 4,913,683 12,524,096
<LOAN-LOSSES> 1,579,429 3,587,806
<SECURITIES-GAINS> 0 0
<EXPENSE-OTHER> 0 0
<INCOME-PRETAX> 17,858,765 38,622,337
<INCOME-PRE-EXTRAORDINARY> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (10,055,990) 37,268,413
<EPS-PRIMARY> 0 0
<EPS-DILUTED> 0 0
<YIELD-ACTUAL> 0 0
<LOANS-NON> 0 0
<LOANS-PAST> 0 0
<LOANS-TROUBLED> 0 0
<LOANS-PROBLEM> 0 0
<ALLOWANCE-OPEN> 0 0
<CHARGE-OFFS> 0 0
<RECOVERIES> 0 0
<ALLOWANCE-CLOSE> 0 0
<ALLOWANCE-DOMESTIC> 0 0
<ALLOWANCE-FOREIGN> 0 0
<ALLOWANCE-UNALLOCATED> 0 0
</TABLE>
