<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
Date of Report: July 2, 1997
Date of Earliest Event Reported: June 17, 1997
H&R BLOCK, INC.
(Exact name of registrant as specified in its charter)
Missouri
(State or other jurisdiction of incorporation or organization)
1-6089 44-0607856
(Commission File Number) (I.R.S. Employer Identification No.)
4400 Main Street, Kansas City, Missouri 64111
(Address of principal executive office, including zip code)
(816) 753-6900
(Registrant's telephone number, including area code)
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS
(a) FINANCIAL STATEMENTS OF BUSINESSES ACQUIRED.
The audited financial statements of Option One
Mortgage Corporation for the years ended December 31, 1996 and 1995, together
with the Independent Auditors' Report, and the unaudited financial statements
for the three months ended March 31, 1997, and 1996 are filed as part of this
Current Report on Form 8-K.
(b) PRO FORMA FINANCIAL INFORMATION.
The unaudited pro forma financial statements of H&R
Block, Inc. for the year ended April 30, 1997 are filed as part of this
Current Report on Form 8-K.
(c) EXHIBITS.
The Exhibits listed in the Exhibit Index are filed as
part of this Current Report on Form 8-K.
2
<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 hereunto duly authorized.
H&R BLOCK, INC.
By: /s/ Frank L. Salizzoni
-------------------------
Frank L. Salizzoni
President and Chief Executive Officer
Date: August 8, 1997
3
<PAGE>
H & R BLOCK
Index to Financial Statements
Page
----
Option One Mortgage Corporation
Unaudited Balance Sheets as of March 31, 1996 and 1997.................. F-2
Unaudited Statements of Earnings for the three months ended
March 31, 1996 and March 31, 1997.................................... F-3
Unaudited Statements of Cash Flows for the three months ended
March 31, 1996 and March 31, 1997.................................... F-4
Notes to Unaudited Financial Statements................................. F-5
Independent Auditor's Report............................................ F-6
Balance Sheets as of December 31, 1996 and 1995......................... F-7
Statements of Earnings for the year ended December 31, 1996, the period
from March 3, 1995 to December 31, 1995, and the period from
January 1, 1995 to March 2, 1995..................................... F-8
Statements of Stockholder Equity for the year ended December 31, 1996,
the period from March 3, 1995 to December 31, 1995, and the period
from January 1, 1995 to March 2, 1995................................ F-9
Statements of Cash Flows for the year ended December 31, 1996, the
period from March 3, 1995 to December 31, 1995, and the period
from January 1, 1995 to March 2, 1995................................ F-10
Notes to Financial Statements........................................... F-11
H & R Block, Inc. (Pro Forma)
Description of Transaction.............................................. F-33
Pro Forma Financial Statement Assumptions............................... F-33
Pro Forma Consolidated Balance Sheet as of April 30, 1997............... F-34
Notes to Pro Forma Consolidated Balance Sheet........................... F-35
Pro Forma Consolidated Statement of Earnings for the year ended
April 30, 1997....................................................... F-36
Notes to Pro Forma Consolidated Statement of Earnings................... F-37
F-1
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island
BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1997 1996
---------------- ----------------
Assets
<S> <C> <C>
Cash and cash equivalents $ 9,112,547 $ 1,398,184
Loans receivable held for sale, net 86,180,969 63,201,496
Accrued interest receivable 1,369,342 279,994
Real estate owned 318,465 192,785
Receivable from affiliates 84,354 167,089
Prepaid expenses and other assets 13,544,435 6,522,454
Purchased mortgage servicing rights, net 1,994,419 2,858,559
Originated mortgage servicing rights, net 7,095,082 3,385,983
Residual interests in securitization 21,298,507 --
Office property, and equipment 3,144,008 4,671,548
Goodwill, net 15,390,052 16,581,540
------------- ------------
$ 159,532,180 $ 99,259,632
============= ============
<CAPTION>
Liabilities and Stockholder's Equity
<S> <C> <C>
Borrowings from parent $ 100,288,077 $ 73,673,126
Income taxes payable 13,803,875 3,244,886
Accounts payable and other liabilities 7,151,120 4,130,082
Deferred income taxes payable 24,883 (1,812,350)
------------- ------------
121,267,955 79,235,744
Stockholder's equity:
Common stock, $.01 par value per share. Authorized
1,000,000 shares; issued and outstanding 250,000 shares 2,500 2,500
Additional paid-in capital 22,778,500 22,778,500
Retained earnings 15,483,225 (2,721,112)
------------- ------------
38,264,225 20,059,888
$ 159,532,180 $ 99,295,632
============= ============
</TABLE>
F-2
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
STATEMENTS OF EARNINGS
3 MONTHS 3 MONTHS
ENDED ENDED
MARCH 31, 1997 MARCH 31, 1996
-------------- --------------
Revenues:
Net gain on sale of loans $15,240,366 $ 3,041,938
Interest on loans 4,533,709 2,439,750
ABS interest income, net 668,536 --
Service fee income, net 2,789,492 1,802,140
Other income 403,572 148,655
----------- -----------
23,635,675 7,432,483
Expenses:
Employee compensation and benefits $ 5,934,358 $ 2,723,797
Interest expense 2,979,090 1,428,480
Office and occupancy expense 2,225,331 1,376,321
Other operating expenses 834,679 515,419
Provision (credit) for loan losses 295,647 370,916
Amortization of goodwill 297,872 272,428
Advertising and promotion 82,835 91,799
Legal and professional services 225,552 65,473
----------- -----------
12,875,364 6,844,633
Earnings before income taxes 10,760,311 587,850
----------- -----------
Income taxes 4,627,768 359,706
----------- -----------
Net earnings $ 6,132,543 $ 228,144
=========== ===========
F-3
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
3 MONTHS 3 MONTHS
ENDED ENDED
MARCH 31, 1997 MARCH 31, 1996
--------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 6,132,543 $ 228,142
Adjustments to reconcile net earnings to net cash provided by (used in)
operating activities:
Depreciation and amortization (2,536,334) 305,903
Deferred income taxes 17,600 (560,901)
Capitalized servicing 2,356,120 (180,442)
Provision (credit) for estimated losses (1,116,802) (45,407)
Loans originated or acquired (367,301,000) (169,184,000)
Proceeds on loan sales 359,510,822 151,593,480
Residual interests in securitization (904,600) --
Decrease (increase) in real estate owned 172,159 (149,358)
Decrease in accrued interest receivable 121,072 519,243
Increase in prepaid expenses and other assets (438,546) (17,976)
Increase (decrease) in income taxes payable 3,694,794 (448,114)
Increase in accounts payable and other liabilities 1,266,959 201,449
----------- -----------
Net cash provided by (used in) operating activities 974,787 (17,737,981)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of office property and equipment 2,844,878 (329,014)
Payoffs and amortization of loans receivable held for sale 9,137,809 7,387,065
----------- -----------
Net cash provided by investing activities 11,982,687 7,058,051
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings from parent, net (6,776,555) 17,656,625
Dividends paid -- (7,000,000)
----------- -----------
Net cash provided by (used in) financing activities (6,776,555) 10,656,625
----------- -----------
Net increase (decrease) in cash 6,180,919 (23,305)
Cash, beginning of period 2,931,629 1,421,489
----------- -----------
Cash, end of period $ 9,112,548 $ 1,398,184
============ ============
Supplemental cash flow disclosure:
Interest paid $ 2,979,090 $ 1,428,480
Income taxes paid 930,997 565,532
</TABLE>
F-4
<PAGE>
OPTION ONE MORTGAGE CORPORATION
NOTES TO FINANCIAL STATEMENTS
Unaudited
1. The Balance Sheet as of March 31, 1997, and 1996 the Statements of
Earnings for the three months ended March 31, 1997 and 1996 and the
Statements of Cash Flows for the three months ended March 31, 1997 and
1996 have been prepared by Option One Mortgage Corporation (the
"Company"), without audit. In the opinion of management, all adjustments
(which include only normal recurring adjustments) necessary to present
fairly the financial position, results of operations and cash flows at
March 31, 1997 and for all periods presented have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. These financial statements
should be read in conjunction with the financial statements and notes
thereto in the Company's December 31, 1996 audited financial statements
included with this Current Report on Form 8-K/A.
2. On January 1, 1997, the Company adopted Statement of Financial Accounting
Standards No. 125, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities." This statement requires that,
after a transfer of financial assets, an entity recognize the financial
and servicing assets it controls and the liabilities it has incurred, and
derecognize financial assets when control has been surrendered. The
adoption of this statement has not had a material impact on the Company or
its results of operations.
F-5
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Option One Mortgage Corporation:
We have audited the accompanying balance sheets of Option One
Mortgage Corporation (the Company) as of December 31, 1996 and 1995 and the
related statements of earnings, stockholder's equity and cash flows for the year
ended December 31, 1996 and for the period from March 3, 1995 to December 31,
1995 (Successor period) and from January 1, 1995 to March 2, 1995 (Predecessor
period). These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosure in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position of Option One
Mortgage Corporation as of December 31, 1996 and 1995 and the results of its
operations and its cash flows for the year ended December 31, 1996 and for the
period from March 3, 1995 to December 31, 1995 (Successor period) and from
January 1, 1995 to March 2, 1995 (Predecessor period) in conformity with
generally accepted accounting principles.
As discussed in note 2 to the financial statements, effective
March 3, 1995, Fleet National Bank, Rhode Island acquired all of the outstanding
stock of Option One Mortgage Corporation in a business combination accounted for
as a purchase. As a result of the acquisition, the financial information for the
periods after the acquisition is presented on a different cost basis than that
for the periods before the acquisition and, therefore, is not comparable.
Effective September 27, 1995, Fleet National Bank, Rhode Island transferred its
investment in the Company to one of its wholly owned subsidiaries, Fleet Holding
Corporation.
/s/ KPMG Peat Marwick LLP
Orange County, California
February 18, 1997
F-6
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Balance Sheets
December 31, 1996 and 1995
<TABLE>
<CAPTION>
Assets 1996 1995
------------------ ------------------
<S> <C> <C>
Cash and cash equivalents $ 2,931,629 1,421,489
Loans receivable held for sale, net (note 3) 86,411,797 52,952,634
Accrued interest receivable 1,490,415 799,237
Real estate owned (note 5) 490,625 43,427
Receivable from affiliates 70,447 358,466
Prepaid expenses and other assets (note 4) 13,053,042 6,146,009
Purchased mortgage servicing rights, net (note 4) 2,198,809 3,112,046
Originated mortgage servicing rights, net (note 4) 6,224,373 2,973,183
Residual interests in securitization (note 5) 20,393,907 --
Deferred taxes (note 10) -- 1,251,448
Office property, building and equipment (note 7) 6,177,116 4,354,879
Goodwill, net of accumulated amortization of $2,184,394 and
$1,018,350, respectively (note 2) 15,687,925 17,311,953
------------------ -----------------
$ 155,130,085 90,724,771
================== ==================
Liabilities and Stockholder's Equity
Borrowings from parent company (note 8) $ 106,980,279 55,813,411
Income taxes payable (note 10) 10,109,081 3,693,000
Accounts payable and other liabilities (note 9) 5,884,162 4,386,615
Deferred income taxes payable (note 10) 24,883 --
------------------ ------------------
122,998,405 63,893,026
Stockholder's equity:
Common stock, $.01 par value per share. Authorized
1,000,000 shares; issued and outstanding 250,000 shares 2,500 2,500
Additional paid-in capital 22,778,500 22,778,500
Retained earnings 9,350,680 4,050,745
------------------ ------------------
Total stockholder's equity 32,131,680 26,831,745
Commitments and contingencies (notes 4, 9 and 13)
Subsequent event (note 14)
------------------ ------------------
$ 155,130,085 90,724,771
================== ==================
</TABLE>
See accompanying notes to financial statements.
F-7
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Statements of Earnings
<TABLE>
<CAPTION>
Period from Period from
March 3, January 1,
Year ended 1995 to 1995 to
December 31, December 31, March 2,
1996 1995 1995
-------------------- ---------------------- --------------------
Successor Predecessor
---------------------- --------------------
<S> <C> <C> <C>
Revenues:
Gain on sales of loans (notes 4,5 and 11) $ 37,883,533 19,538,436 3,214,131
Interest on loans 14,242,403 9,768,251 638,042
Servicing fee income, net (notes 4 and 8) 7,893,744 4,973,318 523,484
Other income (note 8) 723,075 474,400 --
-------------------- ----------------------- --------------------
60,742,755 34,754,405 4,375,657
-------------------- ----------------------- --------------------
Expenses:
Employee compensation and benefits 16,884,420 10,607,475 1,811,854
Interest expense (note 8) 8,543,910 5,865,493 342,611
Office and occupancy expense (note 9) 6,795,969 3,797,584 658,019
Amortization of goodwill (note 2) 1,166,044 1,018,350 --
Provision (credit) for loan losses (note 3) 999,896 1,107,451 (19,010)
Legal and professional services 713,136 168,883 20,304
Advertising and promotion 438,947 360,049 48,026
Other operating expense (note 8) 3,196,563 1,545,729 76,262
-------------------- ----------------------- --------------------
38,738,885 24,471,014 2,938,066
-------------------- ----------------------- --------------------
Earnings before income taxes 22,003,870 10,283,391 1,437,591
Income taxes (note 10) 9,703,935 4,732,646 595,000
-------------------- ----------------------- --------------------
Net earnings $ 12,299,935 5,550,745 842,591
==================== ======================= ====================
</TABLE>
See accompanying notes to financial statements
F-8
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Statements of Stockholder Equity
Year ended December 31, 1996 and period from March 3, 1995 to December 31, 1995
and from January 1, 1995 to March 2, 1995
<TABLE>
<CAPTION>
Additional Total
Common stock paid-In Retained stockholder's
Shares Amount capital earnings equity
------------ ------------- -------------- ------------ ---------------
<S> <C> <C> <C> <C> <C>
Predecessor
Balance, December 31, 1994 250,000 $ 2,500 6,097,500 2,167,082 8,267,082
Net earnings for the period from
January 1, 1995 to March 2, 1995 -- -- -- 842,591 842,591
------------ ------------- -------------- ------------ ---------------
Balance, March 2, 1995 250,000 2,500 6,097,500 3,009,673 9,109,673
Successor
Application of purchase
accounting in connection with
acquisition by Fleet (note 2) -- -- 16,681,000 (3,009,673) 13,671,327
Dividend paid -- -- -- (1,500,000) (1,500,000)
Net earnings for the period from
March 3, 1995 to December 31, 1995 -- -- -- 5,550,745 5,550,745
---------- ---------- ------------ ---------- -------------
Balance, December 31, 1995 250,000 2,500 22,778,500 4,050,745 26,831,745
Dividend paid -- -- -- (7,000,000) (7,000,000)
Net earnings for the year ended
December 31,1996 -- -- -- 12,299,935 12,299,935
------------ ------------- -------------- ------------ ---------------
Balance, December 31, 1996 250,000 $ 2,500 22,778,500 9,350,680 32,131,680
============ ============== ============== ============ ===============
</TABLE>
See accompanying notes to financial statements.
F-9
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Statements of Cash Flows
<TABLE>
<CAPTION>
Period from Period from
Year ended March 3, 1995 to January 1, 1995 to
December 31, December 31, March 2,
1996 1995 1995
------------------ --------------- -----------------
Successor Predecessor
---------------- -----------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings $ 12,299,935 5,550,745 842,591
Adjustments to reconcile net earnings to net cash
provided by (used in) operating activities:
Depreciation and amortization 4,475,132 2,634,911 268,510
Deferred income taxes 1,276,331 -- (292,000)
Capitalized servicing (4,893,229) (3,205,541) (743,090)
(Credit) provision for estimated losses 999,896 1,107,451 (19,010)
Loans originated or acquired (1,005,456,804) (642,110,504) (107,875,007)
Proceeds from loan sales 963,165,224 604,504,166 109,493,612
Residual interests in securitization (20,393,907) -- --
Increase in accrued interest receivable (691,178) (646,268) (121,312)
Increase in prepaid expenses and other assets (6,619,013) (7,532,894) (41,073)
Increase in income taxes payable 6,416,081 3,693,000 --
(Decrease) increase in accounts payable and other
liabilities 1,955,532 2,301,210 (176,976)
------------------ ---------------- -----------------
Net cash provided by (used in)
operating activities (47,466,000) (33,703,724) 1,336,245
------------------ ---------------- -----------------
Cash flows from investing activities:
Purchase of office property and equipment (2,576,049) (337,276) (96,463)
Payoffs and amortization of loans receivable held for sale 6,207,134 3,586,298 729,488
Sales of real estate owned 1,178,187 124,283 --
------------------ ---------------- -----------------
Net cash provided by investing activities 4,809,272 3,373,305 633,025
------------------ ---------------- -----------------
Cash flows from financing activities:
Net increase in borrowings from parent 51,166,868 33,150,386 --
Dividends paid to parent (7,000,000) (1,500,000) --
Proceeds from participation interest sold to Bank -- -- 116,007,002
Repurchase of participation interests sold to Bank -- -- (116,102,677)
Net increase in due to affiliate for loan fundings -- -- (987,499)
Decrease in payable to Bank, net -- -- (107,004)
Payment to parent in connection with acquisition by
Fleet -- -- (2,435,427)
------------------ ---------------- -----------------
Net cash provided by (used in) financing
activities 44,166,868 31,650,386 (3,625,605)
------------------ ---------------- -----------------
Net (decrease) increase in cash 1,510,140 1,319,967 (1,656,335)
Cash, beginning of period 1,421,489 101,522 1,757,857
------------------ ---------------- -----------------
Cash, end of period $ 2,931,629 1,421,489 101,522
================== ================ =================
Supplemental cash flow disclosure:
Interest paid $ 8,543,910 5,030,673 342,611
Income taxes paid 1,553,539 -- --
================== ================ =================
Supplemental disclosure of noncash - transfers to real
estate owned $ 1,625,385 -- --
================== ================ =================
</TABLE>
See accompanying notes to financial statements.
F-10
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements
December 31, 1996 and 1995
(1) Organization and Summary of Significant Accounting Policies
Option One Mortgage Corporation (the Company) was incorporated in
California on October 29, 1992 as a wholly owned subsidiary of Plaza
Home Mortgage Corporation (PHMC). The Company became a wholly owned
subsidiary of Plaza Home Mortgage Bank, F.S.B. (the Bank) on December
31, 1994. On March 3, 1995, Fleet National Bank, Rhode Island (Fleet)
purchased all of the outstanding stock of PHMC. Therefore, the Company
has become a wholly owned subsidiary of Fleet (note 2). On September
27, 1995, Fleet transferred its investment in the Company to a wholly
owned subsidiary, Fleet Holding Corporation.
The Company has provided statements of earnings, stockholder's equity,
cash flows and related footnote disclosure for the period from March 3,
1995 to December 31, 1995 which represents the successor period and
statements of earnings, stockholder's equity, cash flows and related
footnote disclosure for the period from January 1, 1995 to March 2,
1995 which represent the predecessor period. As a result of the
acquisition by Fleet, the successor period is presented on a different
cost basis than that for the predecessor period and, therefore, is not
comparable.
The Company commenced operations on February 1, 1993, engaging in the
origination, purchase, sale and servicing of single-family residential
mortgage loans and mortgage-backed securities. The Company offers a
flexible product line to borrowers who are creditworthy, but do not
meet traditional underwriting criteria.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the company considers all
highly liquid debt instruments with original maturities of three months
or less to be cash equivalents. Cash equivalents consist of cash on
hand and in banks and money market accounts.
Loans Receivable Held for Sale
Interest on loans receivable held for sale is credited to income as
earned. Interest is accrued only if deemed collectible.
Mortgage loans held for sale are stated at the lower of amortized cost
or market as determined by outstanding commitments from investors or
current investor-yield requirements calculated on an aggregate basis.
F-11
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
Gains or losses resulting from sales or securitization of mortgage
loans are recognized at the date of settlement and are based on the
difference between the selling price and the carrying value of the
related loans sold and related transaction costs. Such gains and losses
may be increased or decreased by the amount of any servicing released
premiums received. Nonrefundable fees and direct costs associated with
the origination of mortgage loans are deferred and recognized when the
loans are sold.
Allowance for Loan Losses
On an ongoing basis, management monitors the loans receivable held for
sale and evaluates the adequacy of the allowance for loan losses. In
determining the adequacy of the allowance for loan losses, management
considers such factors as historical loan loss experience, underlying
collateral values, known problem loans, assessment of economic
conditions and other appropriate data to identify the risks in the
loans receivable held for sale. Loan losses are charged to the
allowance for loan losses. Recoveries on loans previously charged off
are credited to the allowance. Provisions for loan losses are charged
to expense and credited to the allowance in amounts deemed appropriate
by management based upon its evaluation of the known and inherent risks
in the loans receivable held for sale.
Servicing Rights and Excess Servicing Fee Receivable
In May 1995, the FASB issued Statement of Financial Accounting
Standards No. 122 (SFAS 122), "Accounting for Mortgage Servicing
Rights," an amendment to Statement of Financial Accounting Standards
No. 65 (SFAS 65). In April 1995, the Company adopted early application
of SFAS 122. SFAS 122 requires an institution that purchases or
originates mortgage loans and subsequently sells or securitizes those
loans with servicing rights retained to allocate the total cost of the
mortgage loans to the mortgage servicing rights and the loans (without
the mortgage servicing rights) based on their relative fair values.
Institutions are required to assess impairment of the capitalized
mortgage servicing portfolio based on the fair value of those rights on
a stratum basis aggregated by similar risk characteristics with any
impairment recognized through a valuation allowance for each impaired
stratum.
The Company elected to retroactively implement SFAS 122 as of April 1,
1995. As a result, the Company capitalizes originated mortgage
servicing rights (OMSR) that result from sales of mortgage loans with
servicing retained where a clearly defined value of those rights are
available.
F-12
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
OMSR is capitalized using a valuation model that calculates the present
value of future cash flows. Assumptions used in the valuation model
include market discount rates, default and anticipated prepayment
speeds. The prepayment speeds are determined from historical experience
and market sources for fixed-rate mortgages with similar coupons and
prepayment reports for comparable ARM loans.
The OMSR is amortized to operations in proportion to and over the
estimated lives of the loans, taking into account prepayment
assumptions.
Purchased mortgage servicing rights (PMSR) represents all of the
Company's rights to service mortgage loans for investors that were
acquired in the purchase by Fleet. PMSR was capitalized using a
valuation model that calculates the present value of future cash flows.
Assumptions used in the valuation model include market discount rates,
default and anticipated prepayment speeds. The prepayment speeds are
determined from historical experience and market sources for fixed-rate
mortgages with similar coupons and prepayment reports on comparable ARM
mortgages.
The PMSR is amortized to operations in proportion to and over the
estimated lives of the loans, taking into account prepayment
assumptions.
Excess servicing fee receivables (ESFR) result from the sale of loans
on which the Company retains servicing rights. The amount of ESFR is
determined by computing the difference between the weighted average
yield of the loans sold and the yield guaranteed to the purchaser,
adjusted for a normal servicing fee rate. Normal servicing fees are
generally defined as the total of the minimum servicing fee which
comparable mortgage issuers typically require servicers to charge and
other costs borne by the Company, if any. The resulting excess
servicing fee receivables are recorded as a gain in the year of sale
equal to the present value of net cash flows to be received in future
years. ESFR was capitalized using a valuation model that calculates the
present value of future cash flows. Assumptions used in the valuation
model include market discount rates, default and anticipated prepayment
speeds. The prepayment speeds are determined from historical experience
and market sources for fixed-rate mortgages with similar coupons and
prepayment reports on comparable ARM mortgages.
The ESFR was amortized using the effective interest method over the
estimated lives of the loans, taking into account prepayment
assumptions.
F-13
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
OMSR, PMSR and ESFR are periodically reviewed for impairment by
management. Impairment is assessed based upon the fair value of each
risk stratum. Risk stratums are determined by the Company based upon
many factors. Fair values take into account the historical prepayment
activity of the related loans and management's estimates of the
remaining future cash flows to be generated by the underlying mortgage
loans. At any point in time in which OMSR, PMSR and ESFR are reviewed,
an estimate of the future prepayment rates of the underlying mortgage
loans is made by management. If the actual future prepayment rate
proves to be higher than the estimate, impairment of OMSR, PMSR and
ESFR could occur.
Servicing Fee Income
Servicing fee income represents revenue earned for servicing real
estate mortgage loans owned by investors. The fees are equal to the
servicing amount agreed with the investors, net of amortization of
excess servicing fee receivables, originated mortgage servicing rights
and purchased mortgage servicing rights. Also included in servicing
revenue are late charges and miscellaneous loan servicing income.
Loans services for others are not included on the Company's balance
sheets. The Company's policy is to sell all mortgages on nonrecourse or
limited recourse terms. In accordance with these terms, foreclosure
losses are the responsibility of the investor, although the Company
incurs certain administrative costs of foreclosure on these loans.
Residual Interests in Securitization
The accompanying balance sheets include residual interests in
securitization (residual) of real estate mortgage investment conduits
(REMICs) which are recorded as a result of the Company's securitization
of mortgage loans through various special purpose trust vehicles. The
Company estimates future cash flows from these residuals and values
them utilizing assumptions that it believes are consistent with those
that would be utilized by an unaffiliated third-party purchaser and
records them as available-for-sale securities at fair value in
accordance with SFAS 115, "Accounting for Certain Debt and Equity
Securities." Unrealized gains and losses are excluded from earnings and
reported as a separate component of stockholder's equity, net of the
related tax effect. To the Company's knowledge, there is no active
market for the purchase or sale of these residuals.
F-14
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
The fair value of the residual is determined by computing the present
value of the excess of the weighted average coupon on the loans sold
over the sum of: (1) the coupon on the senior interests, (2) a base
servicing fee paid to servicer of the loans, (3) expected losses to be
incurred on the portfolio of loans sold over the lives of the loans,
and (4) fees payable to the trustee, insurer and other fees. Prepayment
assumptions used in estimating the cash flows are based on recent
evaluations of the actual prepayments of the Company's servicing
portfolio or on market prepayment rates on new portfolios, taking into
consideration the current interest rate environment and its expected
impact on future prepayment rates. The estimated cash flows expected to
be received by the Company are discounted at an interest rate that the
Company believes an unaffiliated third-party purchaser would require as
a rate of return on such a financial instrument. To the extent that
actual future excess cash flows are different from estimated excess
cash flows, the fair value of the Company's residual could become
impaired.
The Company is required under the terms of the securitization to build
overcollateralization to specified levels using the excess cash flows
described above until set percentages of the securitized portfolio are
attained. Future cash flows to the residual holder are all held by the
REMIC trust until a specific percentage of either the original or
current certificate balance is retained which is specified in the
securitization agreement. The certificate holders' recourse to the
Company for credit losses is limited to the amount of
overcollateralization held by the REMIC trust. Upon maturity of the
certificates, any remaining amounts in the trust are distributed. The
current amount of any overcollateralization balances held by the trust
are recorded by the Company as part of its residual.
Goodwill
The Company has classified as goodwill the cost in excess of fair value
of the Company's net assets (including tax attributes) acquired in the
purchase by Fleet. Goodwill is being amortized on a straight-line
method over 15 years. The Company periodically reviews goodwill to
assess recoverability from projected profitability and undiscounted net
cash flows of the Company, and impairments would be recognized in
operating results if a permanent diminution in value were to occur.
Real Estate Owned
Real estate owned represents properties acquired through foreclosure.
Real estate owned is carried at fair value less estimated costs to
sell. Fair value is the amount the Company could reasonably expect to
receive in a current sale between a willing buyer and willing seller.
F-15
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
Office Property and Equipment
Office property and equipment are stated at cost. The straight-line
method of depreciation is followed for financial reporting purposes.
Depreciation and amortization are provided in amounts sufficient to
relate the cost of assets to operations over their estimated service
lives or the lives of the respective leases. The estimated service
lives for furniture and office equipment, computer hardware/software
and building and leasehold improvement are 5 years, 3 years and 40
years, respectively.
Financial Statement Presentation
The Company prepares its financial statements using an unclassified
balance sheet presentation as is customary in the mortgage banking
industry. A classified balance sheet presentation would have aggregated
current assets, current liabilities and net working capital as of
December 31, 1996 as follows:
Current assets $ 107,367,666
Current liabilities 122,973,520
-------------
Net working capital
(deficit) $ (15,605,854)
==============
Errors and Omissions Policy
In connection with the Company's loan servicing activities, the Company
has Fidelity Bond and Errors and Omissions insurance coverage of $50
million each at December 31, 1996 through Fleet.
Income Taxes
Income taxes are provided by the Company based on income reported for
financial accounting purposes. Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets
and liabilities of a change in rates is recognized in income in the
period that includes the enactment date.
F-16
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
Use of Estimates
Management of the Company has made certain estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure
of contingent assets and liabilities to prepare these financial
statements in accordance with generally accepted accounting principles.
Actual results could differ from these estimates.
Advertising
The Company accounts for its advertising costs as nondirect response
advertising. Accordingly, advertising costs are expensed as incurred.
Reclassification
Certain amounts for 1995 have been reclassified to conform to 1996
presentation.
Recent Accounting Developments
In June 1996, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 125 (FASB 125),
"Accounting for Transfer and Servicing of Financial Assets and
Extinguishment of Liabilities." FASB 125 addresses the accounting for
all types of securitization transactions, securities lending and
repurchase agreements, collateralized borrowing arrangements and other
transactions involving the transfer of financial assets. FASB 125
distinguishes transfers of financial assets that are sales from
transfers that are secured borrowings. FASB 125 is effective for
transactions that occur after December 31, 1996, and it is to be
applied prospectively. FASB 125 will require the Company to allocate
the total cost of mortgage loans sold in a securitization between the
portion of the loans sold and those retained such as residual interests
in securitization based on their relative fair values. The Company will
be required to assess the residual interests in securitization for
impairment based upon their fair value. The pronouncement also will
require the Company to provide additional disclosure about the residual
interests in securitization and to account for these assets at fair
value in accordance with SFAS 115.
Management of the Company does not expect that adoption of FASB 125
will have a material impact on the Company's financial position,
results of operations or liquidity.
F-17
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
(2) PARENT COMPANY MATTERS
On September 6, 1994, PHMC entered into a definitive merger agreement
with Fleet National Bank (Fleet). Such definitive merger agreement was
renegotiated, and PHMC entered into an amended and restated merger
agreement on January 18, 1995.
On March 3, 1995, Fleet consummated the merger with PHMC by purchasing
all of the outstanding stock of PHMC. Summarized below are the assets
and liabilities allocated to the Company and recorded at fair value at
the date of acquisition:
<TABLE>
<CAPTION>
VALUE OF ASSETS
ACQUIRED
AND LIABILITIES
ASSUMED
---------------
<S> <C>
Assets:
Cash and cash equivalents $ 101,522
Loans receivable held for sale, net 20,040,045
Office property 2,975,000
Furniture and equipment 1,556,753
Purchased mortgage servicing rights 3,982,099
Deferred taxes 1,709,432
Other assets (707,737)
Excess purchase price over fair value
of net assets acquired (goodwill) 17,872,319
---------------
Total assets $ 47,529,433
===============
Liabilities:
Borrowings from parent company $ 22,663,026
Other liabilities 2,085,407
---------------
Total liabilities $ 24,748,433
===============
Purchase price and other acquisition costs $ 22,781,000
===============
</TABLE>
F-18
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
The excess purchase price over the fair value of net assets acquired
is being amortized using the straight-line method over 15 years. For
the year ended December 31, 1996 and period from March 3, 1995 to
December 31, 1995, $1,166,044 and $1,018,350, respectively, were
deducted from income before income taxes in the accompanying statement
of income as a result of the amortization of the excess of purchase
price over fair value of net assets acquired.
The deferred income taxes payable was adjusted by $457,984 as the
deferred income tax effect on goodwill was revised from the earlier
estimate. The adjustment was made within one year of acquisition.
Unaudited Pro forma Summary of Operations
The following Unaudited Pro forma Summary of Operations presents a Pro
forma Summary of Operations for the Company for the year ended December
31, 1995. The Unaudited Pro forma Summary of Operations is presented as
if the purchase of the Company by Fleet had been effective as of
January 1, 1995 and was adjusted solely for the amortization of
purchase accounting adjustments. The Unaudited Pro forma Summary of
Operations data is intended for informational purposes only and is not
necessarily indicative of the future results of operations of the
Company, or the results of operations that would have actually occurred
had the purchase been in effect for the full periods presented.
1995
-----------
Total income $43,129,011
Total expenses 31,653,768
-----------
Income before taxes 11,475,243
Income taxes 5,310,818
-----------
Net income $ 6,164,425
===========
<PAGE>
(3) LOANS RECEIVABLE HELD FOR SALE
A summary of loans receivable held for sale, at the lower of cost or
market at December 31, 1996 and 1995 follows:
F-19
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
1996 1995
------------------ ------------------
Mortgage loans receivable $ 86,185,479 52,807,093
Net deferred origination costs 1,308,859 950,571
Allowance for loan losses (1,082,541) (805,030)
------------------ ------------------
86,411,797 52,952,634
Allowance for cost basis in
excess of market value -- --
------------------ ------------------
$ 86,411,797 52,952,634
================== ==================
A summary of changes in the allowance for loan losses for the period
indicated:
<TABLE>
<CAPTION>
Period from
March 3, 1995 Period from
Year ended to January 1, 1995
December 31, December 31, to March 2,
1996 1995 1995
---------------- -------------- --------------
Successor Predecessor
-------------- --------------
<S> <C> <C> <C>
Balance at beginning of period $ 805,030 368,220 245,170
Provision (credit) for loan losses 999,896 1,107,451 (19,010)
Charge-offs, net of recoveries (722,385) (670,641) 142,060
---------------- --------------- --------------
Balance at end of
period $ 1,082,541 805,030 368,220
================ =============== ==============
</TABLE>
(4) LOAN SERVICING
The Company's portfolio of mortgage loans serviced for others was
comprised of approximately $1.6 billion and $1.3 billion at December
31, 1996 and 1995, respectively. At December 31, 1996 and 1995, the
Company was responsible for the subservicing of approximately $270
million and $23 million, respectively. The terms of these subservicing
agreements are consistent with the terms of the Company's other
servicing agreements.
F-20
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
At December 31, 1996 and 1995, 35% and 47%, respectively, of the
servicing portfolio was collaterized by real estate properties located
in California.
Fiduciary bank accounts are maintained on behalf of investors and for
impounded collections. These bank accounts are not assets of the
Company and are not reflected in the accompanying financial statements.
These amounts are as follows at December 31, 1996 and 1995:
1996 1995
----------- -----------
Impounded collections, taxes and
insurance $ 5,672,389 3,755,694
Principal and interest collections 37,141,476 20,329,200
----------- -----------
$ 42,813,865 24,084,894
=========== ===========
Subsequent to PHMC's entering into the definitive merger agreement with
Fleet, the Company commenced selling mortgage loans to Fleet Finance,
an affiliate of Fleet. The Company sold mortgage loans of approximately
$0, $960,000 and $70 million to Fleet Finance and recorded gains on
sales of such mortgage loans of approximately $0, $0 and $2.4 million,
respectively, for the year ended December 31, 1996, period from March
3, 1995 to December 31, 1995 and period from January 1, 1995 to March
2, 1995.
The following is a summary of the activity in ESFR for the periods
indicated:
<TABLE>
<CAPTION>
Period from
March 3, 1995
Year ended to Period from
December 31, December 31, January 1, 1995
1996 1995 to March 2, 1995
-------------- -------------- -----------------
Successor Predecessor
-------------- -----------------
<S> <C> <C> <C>
Balance, beginning of period $ -- -- 2,578,411
Additions -- -- 743,090
Amortization -- -- (133,873)
Purchase adjustment -- -- (3,187,628)
-------------- ------------- -----------------
Balance, end of period $ -- -- --
============== ============= =================
</TABLE>
F-21
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
The following is a summary of the activity in PMSR for the periods
indicated:
<TABLE>
<CAPTION>
Period from
March 3, Period from
Year ended 1995 to January 1,
December 31, December 31, 1995 to
1996 1995 March 2, 1995
----------------- -------------- ---------------
Successor Predecessor
-------------- ---------------
<S> <C> <C> <C>
Balance, beginning of period $ 3,112,046 -- --
Purchase adjustment -- 3,982,099 --
Additions -- -- --
Amortization (913,237) (870,053) --
---------------- --------------- ---------------
Balance, end of period $ 2,198,809 3,112,046 --
================ =============== ===============
</TABLE>
The following is a summary of the activity in OMSR for the
periods indicated:
<TABLE>
<CAPTION>
Period from Period from
Year ended March 3, 1995 January 1,
December 31, to 1995 to
1996 December 31, 1995 March 2, 1995
---------------- ----------------- ----------------
Successor Predecessor
----------------- ----------------
<S> <C> <C> <C>
Balance, beginning of period $ 2,973,183 -- --
Additions 4,893,229 3,205,541 --
Amortization (1,642,039) (232,358) --
---------------- ----------------- ---------------
Balance, at end of period $ 6,224,373 2,973,183 --
================ ================= ==============
</TABLE>
For the purpose of measuring impairment, the Company stratified the
capitalized OMSR and PMSR using the following risk characteristics:
loan sale date (which approximates date of origination); and loan type
(6-month adjustable, 3-year adjustable and 30-year fixed). Impairment
of the respective portfolios with similar risk characteristics is
measured utilizing their estimated fair value.
<PAGE>
F-22
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
Servicing fee income, net, consisted of the following for the periods
indicated:
<TABLE>
Period from
Year Ended March 3, 1995 to Period from
December 31, December 31, January 1, 1995
1996 1995 to March 2, 1995
------------------- ---------------- ------------------
Successor Predecessor
---------------- ------------------
<S> <C> <C> <C>
Servicing fee incom $ 7,224,511 3,857,457 574,088
Amortization of PMSR, OMSR
ESFR (2,555,276) (1,102,411) (133,873)
Other, net 3,224,509 2,218,272 83,269
---------------- ---------------- ----------------
Servicing fee income, net $ 7,893,744 4,973,318 523,484
================ ================ ================
</TABLE>
A summary of the Company's foreclosure advances, escrow advances and
principal and interest advances which are included in other assets at
December 31 follows:
1996 1995
----------- -----------
Foreclosure advances $ 2,178,382 586,453
Escrow advances 2,898,069 1,231,569
Principal and interest advances 2,460,582 1,139,311
----------- -----------
$ 7,537,033 2,957,333
=========== ===========
(5) RESIDUAL INTERESTS IN SECURITIZATION
A summary of residual interests in securitization at December 31, 1996
and 1995 follows:
1996 1995
----------- -----------
Balance, beginning of year $ -- --
Residual interest in securitization 20,393,907 --
Amortization -- --
----------- -----------
Balance, end of year $20,393,907 --
=========== ===========
F-23
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
The Company determines fair value by discounting the estimated cash
flows of the residual interest in each securitization. The most
significant assumption the Company utilizes to estimate these cash
flows are estimated annual prepayments (approximately 27% to 30%) and
estimated credit losses (approximately 0.92% to 1.30% annually). These
cash flows are then discounted at a rate it believes a purchaser would
require as a rate of return (approximately 13% to 15%) for similar
investments.
At December 31, 1996, the Company held as available-for-sale the
residual interests in securitization.
(6) REAL ESTATE OWNED
Changes in the allowance for losses on real estate owned is as follows:
December 31
----------------------
1996 1995
--------- ---------
Balance, beginning of year $ 48,866 --
Add provisions 977,196 48,866
Less charge-offs (698,502) --
--------- --------
Balance, end of year $ 327,560 48,866
========= ========
(7) OFFICE PROPERTY AND EQUIPMENT
Office property and equipment consist of the following at December 31:
1996 1995
----------- -----------
Land, building and leasehold improvements $ 3,830,427 3,015,468
Furniture and office equipment 3,614,651 1,853,561
---------- -----------
7,445,078 4,869,029
Less accumulated depreciation and
amortization (1,267,962) (514,150)
----------- -----------
$ 6,177,116 4,354,879
=========== ===========
F-24
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
At December 31, 1996, included in office property is an office building
owned by the Company, with a net carrying value of $2,862,266, which is
held for sale and accounted for at the lower of cost or market. This
building was transferred to the Company as part of the merger of PHMC
with Fleet.
(8) RELATED PARTY TRANSACTIONS
Borrowings from Parent Company
Borrowings from Fleet, FHMC and the Bank consist of the following at
December 31:
1996 1995
-------------- ----------
Unsecured revolving line of credit
with Fleet $ 106,980,279 55,813,411
============== ==========
Effective March 3, 1995, the Company entered into an unsecured
revolving line of credit agreement with Fleet. The interest rate
charged to the Company represents Fleet's average cost of short-term
and variable rate borrowings. The interest rate at December 31, 1996
and 1995 was 5.6% and 6.1%, respectively. Interest paid to Fleet
totaled $8,543,910 and $5,865,493, respectively, for the year ended
December 31, 1996 and for the period from March 3, 1995 to December 31,
1995.
In 1993, the Company entered into a loan participation agreement
with the Bank under which the Bank purchases participation interests in
certain loans owned by the Company. The Bank is paid interest on the
loans at the borrower's note rate. Interest expense paid to the Bank
totaled $342,611 for the period from January 1, 1995 to March 2, 1995.
SUBSERVICING AGREEMENT
For the period January 1, 1995 to April 30, 1995, an affiliated
company, Plaza Home Mortgage Servicing Corporation, provided certain
loan servicing functions for all of the Company's loans held for sale
and all loans sold for which the Company owned servicing rights.
Included as a reduction of servicing fee income for the period from
March 3, 1995 to December 31, 1995 and the period from January 1, 1995
to March 2, 1995 was $163,261 and $122,325, respectively, were fees
related to these services.
F-25
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
OFFICE SPACE LEASE AGREEMENT
On April 1, 1995, the Company entered into a lease agreement with an
affiliated company, Fleet Mortgage Corporation, whereby the Company
leases certain office space in the building owned by the Company. Lease
income for the year ended December 31, 1996 and period from March 3,
1995 to December 31, 1995 was $194,437 and $306,725, respectively, and
is included in other income.
ADMINISTRATION COSTS
Included in other operating expenses are $1,007,446 and $118,723 for
the years ended December 31, 1996 and 1995, respectively, representing
administrative costs charged by the parent company.
(9) COMMITMENTS AND CONTINGENCIES
The Company conducts its operations in leased facilities. The
noncancelable lease agreements, classified as operating leases, expire
at various dates through 2002. Minimum rental commitments for these
leases are as follows:
Year ending December 31:
1997 $ 1,348,616
1998 1,467,962
1999 673,776
2000 197,597
2001 128,808
2002 113,950
----------------
$ 3,930,709
================
Included in occupancy expense are facilities rental expense of
$1,255,536, $734,711 and $134,964 for the year ended December 31, 1996,
the period from March 3, 1995 to December 31, 1995 and from January 1,
1995 to March 2, 1995, respectively.
F-26
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
The Company is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of
its customers. These financial instruments represent commitments to
fund loans. These instruments involve, to varying degrees, elements of
interest rate risk and credit risk in excess of the amount recognized
in the financial statements. The interest rate risk is mitigated by the
Company's commitments to sell loans to investors and option positions
on interest rate-sensitive investments. The credit risk is mitigated by
the Company's evaluation of the creditworthiness of potential borrowers
on a case-by-case basis.
Commitments to fund loans are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses. Also, external market forces impact the probability of
commitments being exercised; therefore, total commitments outstanding
do not necessarily represent future cash requirements.
The Company had commitments to fund loans of approximately $40
million and $34 million at December 31, 1996 and 1995, respectively.
The Company had no commitments to sell loans at December 31, 1996 and
1995.
The Company has entered into whole loan sale agreements with investors
in the normal course of business which include standard representations
and warranties customary to the mortgage banking industry. Violations
of these representations and warranties may require the Company to
repurchase loans previously sold. In the opinion of management, the
potential exposure related to the Company's loan sale agreements will
not have a material adverse effect on the financial position and
operating results of the Company. In accordance with these loan sale
agreements, the Company repurchased loans with an outstanding principal
balance of approximately $2,739,955, $807,000 and $745,000 for the year
ended December 31, 1996 and period from March 3, 1995 to December 31,
1995 and from January 1, 1995 to March 2, 1995, respectively. At
December 31, 1996 and 1995, included in other liabilities are
$1,718,089 and $1,586,239, respectively, in allowances related to
possible off-balance sheet recourse and repurchase agreement
provisions.
The Company is a party to legal actions arising in the normal course of
business. In the opinion of management, based in part on discussions
with outside legal counsel, resolution of such matters will not have a
material adverse effect on the financial position and operating results
of the Company.
F-27
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
(10) INCOME TAXES
Pursuant to a tax-sharing agreement, the Company joins with its parent
and other affiliates in filing consolidated Federal and state income
tax returns. This agreement specifies that members of the consolidated
group pay or receive funds based on their respective taxable income or
loss.
Components of the Company's provision for income taxes for the periods
indicated are as follows:
Period from
March 3, 1995 Period from
Year ended to January 1, 1995
December 31, December 31, to March 2,
1996 1995 1995
----------- ------------- --------------
Successor Predecessor
------------- --------------
Current:
Federal $ 6,420,604 3,539,000 433,000
State 2,007,000 1,193,646 162,000
------------ ------------- --------------
8,427,604 4,732,646 595,000
Deferred:
Federal 1,212,110 -- --
State 64,221 -- --
------------ ------------- --------------
1,276,331 -- --
------------ ------------- --------------
$ 9,703,935 4,732,646 595,000
============ ============= ==============
F-28
<PAGE>
Actual income taxes (benefit) differs from the amount determined by
applying the statutory Federal rate of 35% for the year ended December
31, 1996 and period from March 3, 1995 to December 31, 1995 and 34% for
period from January 1, 1995 to March 2, 1995 to earnings before taxes
as follows:
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
Period from
March 3, 1995 Period from
Year ended to January 1, 1995
December 31, December 31, to March 2,
1996 1995 1995
----------- ------------- --------------
Successor Predecessor
------------- --------------
Computed "expected"
income taxes $ 7,701,355 3,600,000 489,000
Amortization of goodwill 489,738 356,776 --
State tax, net 1,512,842 775,870 104,000
Other -- -- 2,000
----------- ------------- --------------
$ 9,703,935 4,732,646 595,000
=========== ============= ==============
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31 are as follows:
<TABLE>
<CAPTION>
1996 1995
---------- ------------
<S> <C> <C>
Deferred tax assets:
Office property $ 440,197 1,211,000
Allowance for possible loan losses 492,556 190,000
Accruals for tax purposes not deductible 868,027 206,000
Purchased mortgage servicing rights 1,035,339 139,000
State taxes 144,336 --
Nonaccrual interest 407,415 --
Other 14,738 21,448
----------- -----------
3,402,608 1,767,448
----------- -----------
Deferred tax liabilities:
Deferred loan fees (595,531) (173,000)
Originated mortgage servicing rights (2,831,960) --
Other -- (243,000)
----------- ---------
(3,427,491) (516,000)
----------- ----------
Net deferred income tax asset (liability) $ (24,883) 1,251,448
=========== ==========
</TABLE>
The valuation allowance for deferred tax assets was $0 at December 31,
1996 and 1995. The net change in the total valuation allowance for the
year ended December 31, 1996 was $0.
F-29
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
Deferred tax assets are initially recognized for differences between
the financial statement carrying amount and the tax bases of assets and
liabilities which will result in future deductible amounts and net
operating loss and tax credit carryforwards. A valuation allowance is
then established to reduce that deferred tax asset to the level at
which it is "more likely than not" that the tax benefits will be
realized. Realization of tax benefits of deductible temporary
differences and operating loss or tax credit carryforwards depends on
having sufficient taxable income of an appropriate character within the
carryback and carryforward periods. Sources of taxable income that may
allow for the realization of tax benefits include (1) taxable income in
the current year or prior years that is available through carryback,
(2) future taxable income that will result from the reversal of
existing taxable temporary differences, (3) future taxable income
generated by future operations and (4) tax planning strategies that, if
necessary, would be implemented to accelerate taxable income into years
in which net operating losses might otherwise expire.
(11) SIGNIFICANT CUSTOMERS
The Company has entered into a number of transactions with customers
which each accounted for more than ten percent of the companies loan
sales including affiliates of two major investment bankers and a
financial services company. These transactions include a whole loan
sales agreement, under which the investment bankers and the financial
services company agree to periodically purchase certain loans from the
Company in anticipation of securitization of the loans into a real
estate mortgage investment conduit. During the year ended December 31,
1996, the period from March 3, 1995 to December 31, 1995 and the period
from January 1, 1995 to March 2, 1995, the Company sold a total of
approximately $551 million, $497 million and $28 million,
respectively, of loans held for sale under this agreement and
recognized gross gains on sales of approximately $27.8 million, $25.8
million and $1 million, respectively.
The Company also securitized loans receivable on a nonrecourse basis
with a real estate mortgage investment conduit affiliated to one of the
investment bankers described above. During the year ended December 31,
1996, the Company securitized a total of approximately $275 million of
loans held for sale and recognized gains on sales of approximately
$20.4 million.
F-30
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
(12) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments is made using estimated fair value amounts that have been
determined using available market information and appropriate valuation
methodologies considered appropriate by the Company. However,
considerable judgment is necessarily required to interpret market data
to develop the estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts that
could be realized in a current market exchange. The use of different
market assumptions or estimation methodologies may have a material
impact on the estimated fair value amounts.
The estimated fair values of the Company's financial instruments are as
follows:
December 31, 1996
-----------------------------
Carrying Fair
value value
------------- -----------
Financial assets:
Cash and cash equivalents $ 2,931,629 2,931,629
Loans receivable held for sale,
net 86,411,797 89,612,367
Residual interests in
securitization 20,393,907 20,393,907
Financial liabilities - borrowing
from parent company 106,869,989 106,869,989
Off balance sheet items:
Mortgage loan applications in
process with locked interest
rates -- 2,015,033
Mandatory forward commitments -- (219,269)
============ ===========
The following methods and assumptions were used in estimating the
Company's fair value disclosures for financial instruments.
Cash and Cash Equivalents
The fair value of cash and cash equivalents approximates the carrying
value reported in the balance sheet to the short-term nature of the
investments.
F-31
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
Loans Receivable Held for Sale, net
The fair value of mortgage loans held for sale is determined in the
aggregate based on outstanding commitments from investors or current
investor yield requirements.
Residual Interests in Securitization
The residual interest in securitization was unrated and as such there
was no current established market values. Estimates of the fair market
value based on discounted cash flow analysis indicates that the
carrying value of the certificate approximates its fair value.
Borrowings from Parent Company
The carrying value reported in the balance sheet approximates fair
value as the borrowings from parent company are due upon demand and
bear interest at a rate that approximates current market interest rates
for similar type borrowings from a parent company. The Company would
not necessarily be able to borrow similar amounts from third-parties as
a separate Company.
Mortgage Loan Applications in Process with Locked Interest Rates
The fair value of mortgage loan applications in process with locked
interest rates is determined in the aggregate based on expected
fundings and outstanding commitments from investors or current investor
yield requirements.
Mandatory Forward Commitments
The fair value of mandatory forward commitments is based on quoted
market prices of the related loans.
(13) EMPLOYEE BENEFIT PLANS
On January 1, 1996, the Company established the Option One Mortgage
Corporation Retirement Plus Plan (the Plan) for the benefit of eligible
employees and their beneficiaries. The Plan is a defined contribution
401(k) plan which allows eligible employees to save for retirement
through pretax contributions. Prior to establishment of the Plan, the
Company participated in PHMC's 401(k) plan. Company contributions to
the Plan and PHMC's 401(k) are/were discretionary and for the year
ended December 31, 1996 and period from
F-32
<PAGE>
OPTION ONE MORTGAGE CORPORATION
(A Wholly Owned Subsidiary
of Fleet Holding Corporation, Rhode Island)
Notes to Financial Statements, Continued
March 3, 1995 to December 31, 1995 and from January 1, 1995 to
March 2, 1995, the Company made $153,406, $0 and $0 contributions,
respectively, to these Plans.
(14) SUBSEQUENT EVENT
In January 1997, the parent company announced that it will attempt to
seek qualified buyers to sell its investment in the Company. As a
result, the realized price for the Company may not necessarily be
consistent with the financial statements amounts.
<PAGE>
H&R BLOCK, INC.
PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
DESCRIPTION OF TRANSACTION
On June 17, 1997, H&R Block, Inc. (the "Company") completed
its acquisition of Option One Mortgage Corporation ("Option One") from Fleet
Financial Group, Inc. ("Fleet"). The cash purchase price was equal to $190
million plus adjusted stockholder's equity of Option One on the closing date of
$28.1 million. In accordance with the terms of the agreement, adjusted
stockholder's equity represents stockholder's equity less goodwill recorded by
Option One as of the closing date. In addition, the Company agreed to make a
cash payment to Fleet to eliminate intercompany loans made by Fleet to Option
One to finance its mortgage loan business.
PRO FORMA FINANCIAL STATEMENT ASSUMPTIONS
The Company's fiscal year end is April 30. Accordingly, the
accompanying pro forma balance sheet is as of April 30, 1997, and assumes that
the acquisition of Option One occurred on that date. The accompanying pro
forma income statement is for the year ended April 30, 1997, and assumes that
the acquisition of Option One occurred on May 1, 1996. Since these pro forma
financial statements are as of April 30 and are based on preliminary information
related to the purchase, the actual purchase adjustments will differ from those
as presented herein.
The pro forma financial statements assume that: (i) Since the
adjusted stockholder's equity of Option One as of April 30, 1997 was $21.979
million, the purchase price at April 30, 1997 was $211.979 million, (ii) the
Company financed the acquisition through the issuance of $250 million in
seven-year medium-term notes at a fixed interest rate of 7.2% per annum, (iii)
the Company used its existing commercial paper program to obtain cash to repay
Fleet for intercompany advances, (iv) the carrying value of Option One's assets
and liabilities approximated fair market value on the date of acquisition, with
the exception of mortgage loans held for sale, and (v) goodwill arising from
the transaction will be amortized on a straight-line basis over 15 years. Since
the Company regularly securitizes or otherwise sells its mortgage loans held for
sale, the related premiums or discounts on such loans are not amortized or
accreted, respectively.
F-33
<PAGE>
H&R BLOCK, INC.
PRO FORMA CONSOLIDATED BALANCE SHEET
APRIL 30, 1997
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Pro Forma
Consolidated Option One Subtotal Adjustments Pro Forma
------------ ---------- -------- ----------- ---------
<S> <C> <C> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 595,851 $ 6,788 $ 602,639 $ - $ 602,639
Marketable securtie 84,362 - 84,362 - 84,362
Receivables, net 418,959 - 418,959 - 418,959
Mortgage Loans held for sale, net 106,818 225,906 332,724 11,656 (1) 344,380
Prepaid expenses and other
current assets 64,008 33,131 97,139 - 97,139
---------- -------- ---------- ----------- ----------
Total current assets 1,269,998 265,825 1,535,823 11,656 1,547,479
INVESTMENTS AND OTHER ASSETS:
Investments in marketable securities 20,887 - 20,887 - 20,887
Excess of cost over fair value of
net tangible assets acquired 80,133 15,291 94,424 163,553 (1) 258,977
Deferred subscriber acquisition
costs, net 43,959 - 43,959 43,959
Other 71,003 8,813 79,816 - 79,816
---------- -------- ---------- ----------- ----------
215,982 24,104 240,086 163,553 403,639
PROPERTY AND EQUIPMENT, net 420,278 3,242 423,520 - 423,520
---------- -------- ---------- ----------- ----------
$1,906,258 $293,171 $2,199,429 $ 175,209 $2,374,638
========== ======== ========== =========== ==========
CURRENT LIABILITIES:
Notes payable $ 269,619 $ 235,961 $ 505,580 $ (24,361) (2) $ 481,219
Accounts payable, accrued expenses
and deposits 193,628 4,585 198,213 - 198,213
Accrued salaries, wages and payroll
taxes 120,709 2,195 122,904 - 122,904
Accrued taxes on earning 129,186 13,160 142,346 (13,160) (2) 129,186
---------- -------- ---------- ----------- ----------
Total current liabilities 713,142 255,901 969,043 (37,521) 931,522
NONCURRENT LIABILITIES:
Medium-term notes - - - 250,000 (1) 250,000
Deferred income taxes 25,750 - 25,750 - 25,750
Other noncurrent liabilities 38,952 - 38,952 38,952
---------- -------- ---------- ----------- ----------
64,702 - 64,702 250,000 314,702
MINORITY INTEREST 129,317 - 129,317 - 129,317
STOCKHOLDERS' EQUITY:
Common stock 1,089 - 1,089 - 1,089
Convertible preferred stock 4 - 4 - 4
Additional paid-in capital 502,308 15,781 518,089 (15,781) (1) 502,308
Retained earnings 684,071 21,489 705,560 (21,489) (1) 684,071
---------- -------- ---------- ----------- ----------
1,187,472 37,270 1,224,742 (37,270) 1,187,472
Less cost of common stock in treasury 188,375 - 188,375 - 188,375
---------- -------- ---------- ----------- ----------
999,097 37,270 1,036,367 (37,270) 999,097
---------- -------- ---------- ----------- ----------
$1,906,258 $293,171 $2,199,429 $ 175,209 $2,374,638
========== ======== ========== =========== ==========
</TABLE>
F-34
The accompanying notes are an integral part of this
pro forma financial statement.
<PAGE>
H&R BLOCK, INC.
NOTES TO PRO FORMA CONSOLIDATED BALANCE SHEET
APRIL 30, 1997
(AMOUNTS IN THOUSANDS)
(1) Adjustment to the balance sheet is made to record the changes in
goodwill and medium-term borrowing resulting from the purchase of
Option One, as if the transaction had occurred on April 30, 1997.
The computation of the purchase price is as follows:
Premium paid $ 190,000
Plus: Stockholder's equity:
Additional paid-in capital 15,781
Retained earnings 21,489
---------
37,270
Less: Goodwill recorded at Option
One at April 30, 1997 (15,291)
---------
CASH PURCHASE PRICE $ 211,979
=========
The computation of goodwill to be recorded on the purchase is as
follows:
Assets purchased $ 293,171
Less: Goodwill recorded at Option One at
April 30, 1997 (15,291)
Liabilities assumed (255,901)
Plus: Mortgage loans mark-to-market 11,656
---------
Net assets acquired 33,635
---------
Cash purchase price 211,979
Plus: Estimated acquisition expenses 500
Less: Net assets acquired (33,635)
---------
GOODWILL 178,844
Less: Goodwill recorded at
Option One at April 30, 1997 (15,291)
---------
PRO FORMA ADJUSTMENT TO GOODWILL $ 163,553
=========
The computation of medium-term notes issued
is as follows:
Cash purchase price $ 211,979
Plus: Estimated acquisition expenses 500
Payment to Fleet for current
income taxes payable 13,160
Excess proceeds applied
to outstanding notes payable 24,361
---------
TOTAL MEDIUM-TERM BORROWINGS $ 250,000
=========
F-35
<PAGE>
H&R BLOCK, INC.
PRO FORMA CONSOLIDATED STATEMENT OF EARNINGS
YEAR ENDED APRIL 30, 1997
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Pro Forma
Consolidated Option One Subtotal Adjustments Pro Forma
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
REVENUES:
Service revenues $ 1,805,711 $ 33,467 $ 1,839,178 -- $ 1,839,178
Royalties 110,519 -- 110,519 -- 110,519
Other income 13,433 73,571 87,004 -- 87,004
------------ ----------- ----------- ----------- -----------
1,929,663 107,038 2,036,701 -- 2,036,701
------------ ----------- ----------- ----------- -----------
EXPENSES:
Employee compensation and
benefits 604,336 30,804 635,140 -- 635,140
Occupancy and equipment 583,420 5,629 589,049 -- 589,049
Marketing and advertising 239,255 457 239,712 -- 239,712
Supplies, freight and postage 69,929 1,305 71,234 -- 71,234
Other 414,897 37,380 452,277 27,395 (1) 479,672
----------- ----------- ----------- ----------- -----------
1,911,837 75,575 1,987,412 27,395 2,014,807
----------- ----------- ----------- ----------- -----------
Operating earnings 17,826 31,463 49,289 (27,395) 21,894
OTHER INCOME:
Investment income, net 20,730 -- 20,730 -- 20,730
----------- ----------- ----------- ----------- -----------
Earnings before income taxes and
minority interest 38,556 31,463 70,019 (27,395) 42,624
Taxes on earnings 14,613 13,659 28,272 (10,164)(2) 18,108
----------- ----------- ----------- ----------- -----------
Net earnings before minority interest 23,943 17,804 41,747 (17,231) 24,516
Minority interest in consolidated
subsidiary (23,812) -- (23,812) -- (23,812)
----------- ----------- ----------- ----------- -----------
NET EARNINGS $ 47,755 $ 17,804 $ 65,559 $ (17,231) $ 48,328
=========== =========== =========== =========== ===========
Net earnings per share $ 0.45 $ 0.62 $ 0.46
=========== =========== ===========
Weighted average shares
outstanding 105,840 105,840 105,840
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of this
pro forma financial statement.
F-36
<PAGE>
H&R BLOCK, INC.
NOTES TO PRO FORMA CONSOLIDATED STATEMENT OF EARNINGS
YEAR ENDED APRIL 30, 1997
(AMOUNTS IN THOUSANDS)
(1) Adjustment to the income statement is made to reflect the change in
interest expense, goodwill and certain management expenses resulting
from the purchase of Option One, as if the transaction had occurred on
May 1, 1996.
Interest expense on medium-term notes $ 18,000 (a)
Decrease in interest expense on intercompany advances (373) (b)
Increase in goodwill amortization 10,734 (c)
Management fees paid to Fleet (966) (d)
--------
ADJUSTMENT TO OTHER OPERATING EXPENSES $ 27,395
========
(a)The Company will issue medium-term notes of $250,000 to fund the
purchase of Option One. The computation of the increased interest
expense is as follows, using an assumed interest rate of 7.2%. The
assumed rate is based on the average of seven year treasury constant
maturities plus 50 basis points.
Medium-term notes $250,000
Assumed rate 7.2%
--------
Interest expense $ 18,000
========
(b) Option One borrowed funds from Fleet to finance its mortgage loan
business. The Company will continue to finance Option One's
mortgage loan business through its commercial paper program. The
variable interest rate Option One was paying to Fleet is higher
than the rate the Company pays through its commercial paper program
by approximately 30 basis points. The difference in interest
expense was calculated on the monthly average borrowings of Option
One and resulted in a decrease in interest expense of $373.
(c) Goodwill related to the purchase of Option One is $178,844.
The computation of goodwill amortization is as follows:
Goodwill arising from the purchase of Option One $178,844
Divided by: Amortization period (years) 15
--------
Goodwill amortization 11,923
Goodwill amortization previously recorded by Option One (1,189)
--------
Increase in goodwill amortization $ 10,734
========
F-37
<PAGE>
H&R BLOCK, INC.
NOTES TO PRO FORMA CONSOLIDATED STATEMENT OF EARNINGS
YEAR ENDED APRIL 30, 1997
(AMOUNTS IN THOUSANDS)
(d)Option One paid management fees to Fleet of $966 during the year ended
April 30, 1997. These fees would be eliminated as intercompany charges
on a consolidated basis.
(2) The tax effect of the adjustments to consolidated earnings is
calculated at the Company's statutory federal rate and blended state
rate for the year ended April 30, 1997 of 37.1%.
Tax effect
----------
Interest expense on medium-term notes $ 18,000 $ (6,678)
Interest expense on intercompany advances (373) 138
Goodwill amortization 10,734 (3,982)
Management fees paid to Fleet (966) 358
-------- --------
PRO FORMA ADJUSTMENTS $ 27,395 $(10,164)
======== ========
F-38
<PAGE>
EXHIBIT INDEX
Exhibit No. Description of Exhibit
----------- ----------------------
23.1 Consent of Independent Auditors
<PAGE>
Independent Auditors' Consent
Board of Directors
Option One Mortgage Corporation:
We consent to the incorporation by reference in the Registration Statements Nos.
33-185, 33-33889, 33-54985, 33-64147 and 333-33039 of H&R Block, Inc. and
subsidiaries on Forms S-8 of our report dated February 18, 1997, with respect to
the balance sheets of Option One Mortgage Corporation as of December 31, 1996
and 1995, and the related statements of earnings, stockholder's equity and cash
flows for the year ended December 31, 1996 and for the period from March 3, 1995
to December 31, 1995 (Successor period) and from January 1, 1995 to March 2,
1995 (Predecessor period), which report appears in the Form 8-K/A of H&R Block,
Inc. dated August 14, 1997, and to the inclusion of such report in such Form
8-K/A.
Our report dated February 18, 1997 contains an explanatory paragraph that states
that effective March 3, 1995, Fleet National Bank, Rhode Island acquired all of
the outstanding stock of Option One Mortgage Corporation in a business
combination accounted for as a purchase. As a result of the acquisition, the
financial information for the periods after the acquisition is presented on a
different cost basis than that for the periods before the acquisition and,
therefore, is not comparable. Effective September 27, 1995, Fleet National
Bank, Rhode Island transferred its investment in the Company to one of its
wholly owned subsidiaries, Fleet Holding Corporation.
/s/ KPMG PEAT MARWICK LLP
Orange County, California
August 14, 1997
