<PAGE> 1
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 June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission file number 1-12898
SOURCE ONE MORTGAGE SERVICES CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 38-2011419
(State or other juridiction of (I.R.S. employer
incorporation or organization identification
27555 Farmington Road, Farmington Hills, Michigan 48334-3357
(Address of principal executive offices,
including zip code)
Registrant's telephone number, including area code: (248) 488-7000
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 .
---- -----
As of August 14, 1998, the number of shares of the Registrant's Common Stock
outstanding was 3,211,811.
<PAGE> 2
FORM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
<S> <C>
ITEM 1. FINANCIAL STATEMENTS
Consolidated Statements of Condition
June 30, 1998 (Unaudited) and December 31, 1997.............................. 2
Consolidated Statements of Income (Unaudited),
Six Months and Three Months Ended June 30, 1998 and 1997..................... 3
Consolidated Statements of Comprehensive Income (Unaudited),
Six Months and Three Months Ended June 30, 1998 and 1997..................... 4
Consolidated Statements of Cash Flows (Unaudited),
Six Months Ended June 30, 1998 and 1997...................................... 5
Notes to Consolidated Financial Statements (Unaudited)....................... 6-8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.................................................... 9-18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........... 19
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K..................................... 20
SIGNATURES................................................................... 21
</TABLE>
1
<PAGE> 3
FORM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CONDITION
(in thousands, except for share and per share amounts)
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------
June 30, December 31,
1998 1997
----------------------------------------------------------------------------------------------------------
(Unaudited)
ASSETS
<S> <C> <C>
Cash $ 3,519 $ 3,134
Investments 64,503 86,239
Investment in unconsolidated affiliate (net) 243,972 192,137
Mortgage loans receivable 568,215 519,247
Pool loan purchases 152,857 149,791
Loans held for investment 126 5,191
Capitalized servicing (net) 204,360 181,025
Mortgage claims receivable and real estate acquired
(net of allowance for loan losses of $12,800) 40,323 41,199
Premises and equipment 22,103 22,171
Other assets 103,163 104,556
-----------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 1,403,141 $ 1,304,690
-----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Senior debt $ 717,521 $ 686,906
Subordinated debt 55,462 55,153
Accounts payable and other liabilities 203,441 107,582
-----------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 976,424 849,641
-----------------------------------------------------------------------------------------------------------
Stockholders' Equity:
Preferred stock, $.01 par value, 12,000,000 shares authorized,
1,760,939 shares of 8.42% cumulative, Series A (aggregate
liquidation preference of $25 per share) issued and
outstanding as of June 30, 1998 and December 31, 1997 18 18
Common stock, $.01 par value, 8,000,000 shares authorized,
3,211,811 shares issued and outstanding 32 32
Paid-in capital 382,380 462,480
Accumulated other comprehensive income 71,111 41,102
Retained deficit (26,824) (48,583)
-----------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 426,717 455,049
-----------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,403,141 $ 1,304,690
-----------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
</TABLE>
2
<PAGE> 4
FROM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except for per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
Six Months Ended Three Months Ended
June 30, June 30,
- -------------------------------------------------------------------------------------------------------------------
1998 1997 1998 1997
- -------------------------------------------------------------------------------------------------------------------
REVENUE
<S> <C> <C> <C> <C>
Mortgage servicing revenue $ 41,127 $ 48,639 $ 18,616 $ 19,018
Amortization of capitalized servicing (29,446) (25,802) (14,761) (16,370)
Net gain (loss) on financial instruments 5,523 (1,740) 3,836 4,356
- -------------------------------------------------------------------------------------------------------------------
Net servicing revenue 17,204 21,097 7,691 7,004
- -------------------------------------------------------------------------------------------------------------------
Interest income 40,690 19,988 22,900 10,736
Interest expense (33,476) (16,276) (18,141) (8,217)
- -------------------------------------------------------------------------------------------------------------------
Net interest revenue 7,214 3,712 4,759 2,519
- -------------------------------------------------------------------------------------------------------------------
Net realized investment gain on exchange
of securities with affiliates - 326 - -
Net realized investment gain (loss) 2,085 (406) 69 (300)
Equity in earnings from unconsolidated affiliate 6,412 3,241 3,295 3,059
Net gain on sale of mortgages 42,154 9,260 25,459 1,341
Net gain (loss) on sale of servicing and
assumption of subservicing 8,989 (4,296) 937 (1,101)
Other 13,722 8,997 7,573 4,657
- -------------------------------------------------------------------------------------------------------------------
TOTAL REVENUE 97,780 41,931 49,783 17,179
- -------------------------------------------------------------------------------------------------------------------
EXPENSES
Salaries and employee benefits 36,204 26,794 19,300 13,026
Office occupancy and equipment 5,852 6,591 3,030 3,398
Provision for loan losses 1,109 2,490 265 1,594
Restructuring charges - 1,728 - 1,728
Other operating expenses 18,495 12,900 11,125 6,517
- -------------------------------------------------------------------------------------------------------------------
TOTAL EXPENSES 61,660 50,503 33,720 26,263
- -------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and
extraordinary loss 36,120 (8,572) 16,063 (9,084)
Income tax expense (benefit) 12,508 (2,468) 5,571 (2,793)
- -------------------------------------------------------------------------------------------------------------------
Income (loss) before extraordinary loss 23,612 (6,104) 10,492 (6,291)
Extraordinary loss on early retirement of debt (net of
$3,217 income tax benefit) - (5,975) - (5,975)
- -------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 23,612 $ (12,079) $ 10,492 $ (12,266)
Less dividends on preferred stock 1,853 1,853 926 926
- -------------------------------------------------------------------------------------------------------------------
Net income (loss) applicable to common stock $ 21,759 $ (13,932) $ 9,566 $ (13,192)
- -------------------------------------------------------------------------------------------------------------------
BASIC NET INCOME (LOSS) PER COMMON SHARE:
Before extraordinary loss $ 6.77 $ (2.91) $ 2.98 $ (2.25)
Extraordinary loss - (2.19) - (1.86)
- -------------------------------------------------------------------------------------------------------------------
Basic net income (loss) per common share $ 6.77 $ (5.10) $ 2.98 $ (4.11)
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
</TABLE>
3
<PAGE> 5
FROM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands, except for per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------
Six Months Ended Three Months Ended
June 30, June 30,
--------------------------------------------------------------------------------------------------------------------
1998 1997 1998 1997
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income (loss) $ 23,612 $ (12,079) $ 10,492 $ (12,266)
Other comprehensive income, net of tax
Unrealized gains on investments:
Unrealized holding gain arising during period
(net of income tax expense of $16,159 and $7,174 for
the six months ended June 30, 1998 and 1997, respectively
and $6,453 and $7,226 for the three months ended
June 30, 1998 and 1997, respectively) 30,009 13,325 11,983 13,421
Less: reclassification adjustment for gains included in
net income (net of income tax expense of $114 for 1997) - (212) - -
--------------------------------------------------------------------------------------------------------------------
Other comprehensive income 30,009 13,113 11,983 13,421
--------------------------------------------------------------------------------------------------------------------
Comprehensive income 53,621 1,034 22,475 1,155
Less dividends on preferred stock 1,853 1,853 926 926
--------------------------------------------------------------------------------------------------------------------
Comprehensive income (loss) applicable to common stock $ 51,768 $ (819) $ 21,549 $ 229
--------------------------------------------------------------------------------------------------------------------
Basic comprehensive income (loss) per common share $ 16.12 $ (.30) $ 6.71 $ .07
--------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
</TABLE>
4
<PAGE> 6
FORM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Six months ended June 30, 1998 1997
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 23,612 $ (12,079)
Noncash items included in the determination of net income (loss):
Amortization of capitalized servicing 29,446 25,802
Net unrealized loss on financial instruments 255 1,312
Provision for loan losses 1,109 2,490
Depreciation and amortization 1,696 2,979
Gain on sale of financial instruments (2,087) -
Write-down of loans held for investment - 3,000
Net realized (gain) loss on investments (2,085) 80
(Gain) loss on sale of servicing (8,989) 4,296
Gain on sale of permanent investments (849) -
Amortization of deferred gain on sale of servicing - (1,291)
Undistributed earnings from unconsolidated affiliate (5,667) (3,146)
Extraordinary loss of early retirement of debt - 5,975
Mortgage loan production (5,219,039) (1,467,672)
Mortgage loan sales and amortization 5,170,071 1,581,241
Net proceeds from the sale of financial instruments 19,371 -
Additions to financial instruments (1,690) -
Net increase (decrease) in accounts payable and other liabilities 61,543 (5,521)
Net decrease in other assets 15,192 43,867
Net change in current and deferred income taxes receivable and payable 11,972 (8,557)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 93,861 172,776
- --------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Collections on and sales of pool loan purchases, mortgage claims receivable
and real estate acquired 134,800 177,018
Additions to pool loan purchases, mortgage claims receivable and real estate
acquired (139,904) (218,517)
Additions to capitalized mortgage servicing rights (122,123) (61,087)
Net proceeds from sale of servicing 63,755 226,482
Net proceeds from sale of permanent investments 7,544 -
Additions to long-term investments (2,806) (51,480)
Collections on notes receivable 7,000 -
Principal payments received on long-term investments 3,785 385
Net decrease in short-term investments 7,154 29,369
Net (acquisition) disposition of premises and equipment (1,218) 1,670
Net decrease in loans held for investment 123 8,124
- --------------------------------------------------------------------------------------------------------------------
Net cash (used) provided by investing activities (41,890) 111,964
- --------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Proceeds from issuance of commercial paper - 4,098,141
Repayments on commercial paper - (4,365,321)
Net increase in credit agreement borrowings 30,518 101,422
Retirement of debt - (129,872)
Proceeds from issuance of common stock - 12,675
Dividends paid (81,953) (1,853)
Other (151) -
- --------------------------------------------------------------------------------------------------------------------
Net cash used by financing activities (51,586) (284,808)
- --------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 385 (68)
Cash at beginning of period 3,134 923
- --------------------------------------------------------------------------------------------------------------------
Cash at end of period $ 3,519 $ 855
- --------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
</TABLE>
5
<PAGE> 7
FORM 10-Q
Source One Mortgage Service Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Source
One Mortgage Services Corporation (together with its subsidiaries, the
"Company") have been prepared in conformity with generally accepted
accounting principles for interim financial information and with the
instructions for 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. The operating results for the three month and six month
periods ended June 30, 1998 are not necessarily indicative of the results
to be expected for the year ending December 31, 1998.
For further information, refer to the consolidated financial statements
and notes thereto included in the Company's Annual Report on Form 10-K
for the year ended December 31, 1997 as filed with the Securities and
Exchange Commission.
Certain reclassifications have been made to the financial statements to
achieve consistent presentation of the 1998 and 1997 results.
NOTE 2. ACCOUNTING STANDARDS RECENTLY ADOPTED
Earnings Per Share
The Company adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings per Share" in December 1997. SFAS
No. 128 simplifies the calculation of earnings per share and is intended
to make the U.S. standard more comparable to the new international
standard. The adoption of SFAS No. 128 resulted in no change to the
method by which the Company calculates its earnings per share but
replaces the Company's historic presentation of "earnings per share" with
a presentation of "basic earnings per share".
Comprehensive Income
The Company adopted the provisions of SFAS No. 130, "Reporting
Comprehensive Income" as of December 31, 1997. SFAS No. 130 establishes
standards for the reporting and display of comprehensive income and its
components (such as changes in net unrealized investment gains and
losses) in a financial statement that is displayed with the same
prominence as other financial statements. In accordance with the adoption
of SFAS No. 130, the Company now reports comprehensive income in a
separate statement. In addition, the Company has provided a supplemental
disclosure of comprehensive earnings per share. Application of SFAS No.
130 will not impact amounts previously reported for net income or affect
the comparability of previously issued financial statements.
The adoption of SFAS No. 128 and SFAS No. 130 resulted in a change in
financial statement disclosures only and had no effect on the Company's
financial position or results of operations.
Certain Provisions of SFAS No. 125
In December 1996, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 127, "Deferral of the Effective Date of Certain
Provisions of SFAS No. 125" which deferred the adoption of certain
transfer and collateral provisions of SFAS No. 125 to periods beginning
after December 31, 1997. The adoption of the remaining provisions of SFAS
No. 125 did not have a material effect on the Company's current financial
position or results of operations.
6
<PAGE> 8
FORM 10-Q
Source One Mortgage Service Corporation and Subsidiaries
NOTE 3. RECENTLY ISSUED ACCOUNTING STANDARD
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that companies record all derivatives as either assets or liabilities
in the statement of condition and measure those instruments at fair value. The
manner in which the companies are to record gains and losses resulting from
changes in the values of those derivatives depends on the use of the derivative
and whether it qualifies for hedge accounting. SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999 with earlier
adoption permitted. Upon initial application, hedging relationships must be
designated anew and documented pursuant to the provisions of the statement. The
Company has not yet evaluated the impact of the adoption of SFAS No. 133.
NOTE 4. FINANCIAL INSTRUMENTS
The Company invests in various financial instruments in order to offset
changes in the value of its capitalized servicing asset and to mitigate the
effect on earnings of higher amortization and impairment of the asset which
results from increased prepayment activity that can occur with decreases in
market interest rates. As interest rates decline, prepayment activity generally
increases, thereby reducing the value of the capitalized servicing asset, while
the value of the financial instruments increases. Conversely, as interest rates
increase, the value of the capitalized servicing asset increases, while the
value of the financial instruments decreases. The financial instruments utilized
by the Company include interest rate floor contracts ("floors") and
principal-only ("P/O") swap transactions.
The floors are derivative contracts which derive their value from differences
between the floor rate specified in the contract and market interest rates. The
cash flow from the floors is equal to the difference between the floor rate and
the prevailing interest rate applied to the notional amount. Payments are made
to the Company only when the prevailing interest rates are below the floor rate.
The floor rates range from 4.35% to 5.35%. To the extent that prevailing
interest rates decrease, the value of the floors increases, even if interest
rates do not fall below the floor rate. To the extent that prevailing interest
rates increase, the value of the floors decreases. However, the Company is not
exposed to losses in excess of its initial investment of $2.5 million in the
floors. During the second quarter of 1998, the Company sold six of its floor
contracts with a carrying value of $6.7 million and a notional value of $614.6
million for proceeds of $7.7 million and a net realized gain of $1.0 million. In
June 1998, the Company entered into two floor contracts with a notional value of
$300.0 million for an initial investment of $1.7 million. As of June 30, 1998,
the carrying value of the Company's open interest rate floor contracts totaled
$2.3 million with a total notional principal amount of $400.0 million. The
floors have remaining terms ranging from approximately 4.5 to 5 years.
The P/O swaps are derivative contracts, the value of which is determined by
changes in the value of the referenced P/O strip security. The payments received
by the Company under the P/O swaps relate to the cash flows of the referenced
P/O security. The payments made by the Company are based upon a notional amount
tied to the market price and the remaining balance of the referenced P/O
security multiplied by a floating rate indexed to the London Interbank Offered
Rates for U.S. dollar deposits ("LIBOR"). During the second quarter of 1998, the
Company sold P/O swaps with a carrying value of $10.6 million and a notional
value of $74 million for proceeds of $11.7 million and a net realized gain of
$1.1 million. In June 1998, the Company entered into two P/O swap transactions
with a total notional value of $50.0 million. As of June 30, 1998, the carrying
value of the Company's P/O swap transactions totaled $2.5 million, with
remaining original notional value of $74.1 million. The P/O swaps have
remaining terms ranging from approximately 2.5 to 5 years.
Note 5. BASIC NET INCOME AND COMPREHENSIVE INCOME PER SHARE
Basic net income and comprehensive income per share amounts were computed
based on 3,211,811 weighted average total number of common shares outstanding
for both the six month and three month periods ended June 30, 1998. Basic net
income and comprehensive income per share amounts were computed based on
2,732,174 and 3,211,811 weighted average total number of common shares
outstanding for the six month and three month periods ended June 30, 1997,
respectively.
7
<PAGE> 9
FORM 10-Q
Source One Mortgage Service Corporation and Subsidiaries
NOTE 6. Supplemental Cash Flow Information
For purposes of reporting cash flows, cash includes cash on hand and
amounts on deposit at banks, excluding custodial bank accounts.
The following table provides additional cash and noncash information
not presented elsewhere in the consolidated financial statements:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
Six months ended June 30, (in thousands) 1998 1997
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest paid $ 38,522 $ 27,765
-----------------------------------------------------------------------------------------------------------------
Income taxes paid $ 346 $ 5,961
-----------------------------------------------------------------------------------------------------------------
Noncash investing and financing activities:
Exchange of common equity securities for shares of common stock from parent $ - $ 2,638
Sales of servicing rights 50,354 45,011
Capital contribution from parent in exchange for investment in unconsolidated
affiliate - 106,365
-----------------------------------------------------------------------------------------------------------------
</TABLE>
NOTE 7. RECENT DEVELOPMENTS
In July of 1998, the Company paid return of capital dividends on its
common stock totaling $20.3 million.
8
<PAGE> 10
FORM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the financial condition and results
of operations of the Company should be read in conjunction with the condensed
consolidated financial statements and the notes thereto included elsewhere in
this report and in the Company's Annual Report on Form 10-K for the year ended
December 31, 1997. The following discussion and analysis contains certain
forward-looking statements relating to anticipated future financial conditions
and operating results of the Company and its current business plans. In the
future, the financial condition and operating results of the Company could
differ materially from those discussed herein and its current business plans
could be altered in response to market conditions and other factors beyond the
Company's control. Important factors that could cause or contribute to such
difference or changes include those discussed in the Company's Annual Report on
Form 10-K for the year ended December 31, 1997. (See the disclosures under "Item
1. Business - Certain Business Conditions", "Item 1. Business - Forward Looking
Statements" and under "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.")
Results of Operations - Six Months Ended June 30, 1998 and 1997
SUMMARY- Source One Mortgage Services Corporation (together with its
subsidiaries, the "Company") reported net income of $23.6 million for the six
months ended June 30, 1998 compared to a net loss of $12.1 million for 1997. The
1998 results include a $9.0 million pretax gain on sales of servicing to third
parties and adjustments to previous sales, $6.4 million pretax equity in
earnings of an unconsolidated affiliate and a $6.5 million pretax charge for
impairment of the Company's capitalized servicing asset, which was offset by a
$5.5 million net gain on financial instruments. The 1997 results include the
following one-time charges recorded by the Company in the second quarter of
1997: a $9.2 million pretax extraordinary loss on the early retirement of debt,
a $3.0 million pretax charge related to mortgage loans held for investment which
were identified for sale and marked down from amortized cost to current market
value, a $1.7 million pretax restructuring charge related to a reduction in
workforce and $.7 million of other pretax miscellaneous charges. The 1997
results also include a $4.3 million pretax loss on the sale of servicing to a
third party and the related assumption of subservicing, $3.2 million pretax
equity in earnings of an unconsolidated affiliate, a $1.4 million pretax charge
for impairment of the Company's capitalized servicing asset and a $1.7 million
pretax net loss on financial instruments.
The Company reported comprehensive income (which includes the net change in
after tax unrealized gains and losses) of $53.6 million for the six months ended
June 30, 1998, compared to $1.0 million for 1997. The Company's unrealized gains
and losses are primarily associated with its investment in Financial Security
Assurance Holdings Ltd. ("FSA") which it acquired in the first and second
quarters of 1997.
During the first half of 1998, the Company sold the rights to service
approximately $4.0 billion of its nonrecourse mortgage servicing portfolio to
third parties. During the first half of 1997, the Company sold the rights to
service $17.0 billion of its nonrecourse mortgage servicing portfolio to a third
party. The Company will continue to service the loans sold in 1997 pursuant to a
subservicing agreement at least until March 1999, June 1999 and August 1999 for
Federal Home Loan Mortgage Corporation ("FHLMC" or "Freddie Mac"), Government
National Mortgage Association ("GNMA" or "Ginnie Mae"), and Federal National
Mortgage Association ("FNMA" or "Fannie Mae") loans, respectively. The
subservicing period can be extended for one additional year beyond these dates
at the option of the purchaser.
9
<PAGE> 11
FORM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The Company's mortgage loan production and mortgage servicing portfolio
activity for the first six months of 1998 and 1997 are summarized in the
following tables:
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------
Six Months Ended
June 30,
-------------------------------------------------------------------------------------------------------------------
MORTGAGE LOAN PRODUCTION: (in millions) 1998 1997
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BY TYPE:
FHA/VA Insured $ 3,634 $ 888
Conventional 1,585 580
----------------------------------------------------------------------------------------------------------------
Total $ 5,219 $ 1,468
----------------------------------------------------------------------------------------------------------------
BY SOURCE:
Retail $ 1,438 $ 593
Wholesale 3,781 875
----------------------------------------------------------------------------------------------------------------
Total $ 5,219 $ 1,468
----------------------------------------------------------------------------------------------------------------
<CAPTION>
----------------------------------------------------------------------------------------------------------------
Six Months Ende
June 30,
----------------------------------------------------------------------------------------------------------------
MORTGAGE SERVICING PORTFOLIO: (in millions) 1998 1997
----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Servicing portfolio owned at beginning of period $ 11,627 $ 26,410
Mortgage loan production 5,219 1,468
----------------------------------------------------------------------------------------------------------------
Total servicing in 5,219 1,468
----------------------------------------------------------------------------------------------------------------
Regular payoffs 809 643
Sale of servicing 3,970 17,018
Principal amortization, foreclosures and other 537 566
----------------------------------------------------------------------------------------------------------------
Total servicing out 5,316 18,227
----------------------------------------------------------------------------------------------------------------
Servicing portfolio owned at end of period 11,530 9,651
----------------------------------------------------------------------------------------------------------------
Subservicing portfolio 13,320 18,932
----------------------------------------------------------------------------------------------------------------
Total servicing portfolio at end of period $ 24,850 $ 28,583
----------------------------------------------------------------------------------------------------------------
</TABLE>
The significant increase in 1998 mortgage loan production reflects
lower market interest rates and a corresponding increase in refinance
activity throughout the first half of 1998 compared to the first half of
1997. The modest increase in payoffs also reflects lower market interest
rates and a corresponding increase in refinance activity, the effects of
which were offset by a smaller average owned servicing portfolio.
10
<PAGE> 12
FORM 10-Q
Source One Mortgage Services Corporation and Subsidaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Additional information regarding the Company's mortgage loan servicing
portfolio is shown below:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
June 30, December 31,
1998 1997
- --------------------------------------------------------------------------------------------------------------------
MORTGAGE SERVICING PORTFOLIO: Owned Total (a) Owned Total (a)
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Number of loans serviced 160,049 390,211 184,289 438,261
Weighted average net servicing fee
(at end of period) .414% (c) .420% (c)
Weighted average interest rate 7.96% 8.17% 8.52% 8.45%
Percent delinquent (b) 7.50% 6.97% 8.40% 7.53%
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes loans subserviced for others having a principal balance of
$13,320 million and $14,919 million as of June 30, 1998 and December 31,
1997, respectively.
(b) Includes loans in process of foreclosure.
(c) This amount is not meaningful, as it would be calculated as a combination
of two different measurements: the net servicing fee earned on the
Company's owned servicing portfolio, which is calculated as a percentage of
the outstanding principal balance serviced; and the subservicing fee earned
on the Company's subservicing portfolio, which is calculated based upon the
terms of the various subservicing agreements.
REVENUE- Mortgage servicing revenue decreased to $41.1 million in the first
half of 1998 from $48.6 million in 1997. The decrease in mortgage servicing
revenue is primarily a result of the 1997 and 1998 servicing sales. Amortization
of capitalized servicing was $29.4 million and $25.8 million for the six months
ended June 30, 1998 and 1997, respectively. Amortization includes a $6.5 million
and a $1.4 million increase to the valuation allowances for impairment of the
Company's capitalized servicing asset in 1998 and 1997, respectively. Excluding
the effects of these items, amortization expense decreased to $22.9 million in
the first half of 1998 from $24.4 million in 1997. This decrease in amortization
expense is primarily the result of a smaller average servicing asset due to the
1997 and 1998 servicing sales, partially offset by an increase in the average
amortization rate for 1998 due to higher market consensus prepayment rates
during the first half of 1998 compared to the first half of 1997.
The Company recorded a net gain on its financial instruments of $5.5 million
for the first six months of 1998. The net gain includes a net realized gain of
$2.1 million on the sales of financial instruments in the second quarter and
realized gains of $3.7 from net cash flows received. These gains were slightly
offset by unrealized losses of $.3 million due to a net decrease in the fair
market value of the remaining financial instruments. The Company recorded a net
loss on its financial instruments of $1.7 million for the first six months of
1997. The 1997 net loss includes realized losses of $.4 million from net cash
flows paid and $1.3 million of unrealized losses due to a net decrease in the
fair market value of the various instruments.
Interest income increased to $40.7 million in the first six months of 1998
from $20.0 million in the first six months of 1997. The increase in interest
income is primarily the result of the increase in mortgage loan production and
the corresponding increase in the average mortgage loans receivable inventory.
Interest expense was $33.5 million and $16.3 million for the six months ended
June 30, 1998 and 1997, respectively. This increase is primarily the result of
increased short-term borrowings necessary to fund the increase in 1998
production and an increase in the cost of borrowings due to the Company's
inability to issue commercial paper, slightly offset by the effect of the early
retirement of medium-term notes in the second quarter of 1997.
The Company realized a net investment gain of $2.1 million for the six months
ended June 30, 1998 compared to a net investment loss of $.1 million for the
comparable 1997 period. The 1998 amount is primarily the result of a realized
gain from the distribution received on a partnership investment. The 1997 amount
is primarily the result of the write-down of certain investments to realizable
value.
11
<PAGE> 13
FORM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
In mid-March 1997, the Board of Directors of Fund American Enterprises
Holdings, Inc. ("Fund American") and several of its subsidiaries approved
a corporate restructuring plan that strengthened the Company by
increasing its stockholders' equity. The most significant part of the
plan was the contribution by White Mountains Holdings, Inc. ("White
Mountains") of its investment in FSA to the Company in exchange for shares
of the Company's common stock. The Company recognized $6.4 million and $3.2
million of equity in earnings of FSA as a result of its investment for the
six months ended June 30, 1998 and 1997, respectively.
Net gain on sale of mortgages increased to $42.2 million in the first
half of 1998 from $9.3 million in the comparable 1997 period. This
increase is primarily the result of increased mortgage loan sales volumes
and the corresponding increase in capitalized originated mortgage
servicing rights ("OMSR") income and gains on mortgage sales resulting
from increased mortgage loan production in 1998. The 1997 net gain on
sale of mortgages also reflects a $3.0 million pretax charge in the
second quarter of 1997 relating to the Company's mortgage loans held for
investment which were identified for sale and marked down from amortized
cost to current market value.
The Company recorded a $9.0 million pretax gain on sales of servicing
during the first half of 1998, which reflects the sales of the rights to
service approximately $4.0 billion of the Company's nonrecourse mortgage
servicing portfolio to third parties and adjustments to previous
servicing sales. The Company recorded a $4.3 million pretax loss from the
sale of the rights to service $17.0 billion of its nonrecourse mortgage
servicing portfolio and the related assumption of subservicing in the
first half of 1997.
Other revenue was $13.7 million and $9.0 million for the six months
ended June 30, 1998 and 1997, respectively. The increase in other revenue
primarily reflects an increase in ancillary production income associated
with the increase in production volumes in 1998.
EXPENSES - Salaries and employee benefits expense was $36.2 million and
$26.8 million for the six months ended June 30, 1998 and 1997,
respectively. Generally accepted accounting principles ("GAAP") require
certain loan origination revenues to be netted against direct loan
origination costs. Since salaries and employee benefits expense is the
largest component of loan origination costs, approximately 90% of loan
origination revenues are accounted for as a reduction to salaries and
benefits expense as indicated in the following table:
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------
Six Months Ended
June 30,
-------------------------------------------------------------------------------------------------
(in thousands) 1998 1997
-------------------------------------------------------------------------------------------------
<S> <C> <C>
Unadjusted salaries and employee benefits expense $ 53,213 $ 34,587
GAAP net origination revenues (17,009) (7,793)
-------------------------------------------------------------------------------------------------
GAAP salaries and employee benefits expense $ 36,204 $ 26,794
-------------------------------------------------------------------------------------------------
</TABLE>
An increase in loan origination revenues, reflecting the significant
increase in retail mortgage loan production during the first half of 1998
as compared to the first half of 1997, partially offset the increase in
unadjusted salaries and benefits expense. Excluding the effects of loan
origination revenue, salaries and employee benefits expense increased
54%. This increase is primarily due to the increase in loan officer
commissions associated with the significant increase in mortgage loan
production.
The provision for loan losses was $1.1 million and $2.5 million for the
six months ended June 30, 1998 and 1997, respectively. The decrease in
the provision is primarily due to lower loss volumes during the first six
months of 1998 compared to the first six months of 1997. In addition, the
1997 provision includes a $.4 million charge related to the sale of
commercial real estate owned property in the second quarter of 1997.
12
<PAGE> 14
FORM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
In April 1997, the Company's management approved and implemented a
restructuring plan designed to reduce its operating costs in order to improve
its financial performance. As part of this plan, the Company reduced its
workforce, primarily in overhead areas, by approximately 100 employees during
the second quarter to bring its overhead costs in line with its production and
servicing operations. As a result, the Company recognized restructuring charges
totaling $1.7 million during the second quarter of 1997.
Other operating expenses were $18.5 million and $12.9 million for the six
month periods ended June 30, 1998 and 1997, respectively. The increase in 1998
is primarily due to increased loan processing expense related to increased
production volumes and additional travel, advertising and promotional expenses
incurred in 1998 related to the Company's subprime and high loan-to-value
("LTV") business entered into during the third quarter of 1997.
The Company recognized an extraordinary loss of $6.0 million, net of income
tax benefit, on the early retirement of $119.6 million of its outstanding 8.875%
medium-term notes due October 15, 2001 in the second quarter 1997.
The Company's income tax provision for the first half of 1997 includes an
additional provision for the effect of the February 1997 servicing sale.
13
<PAGE> 15
FORM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 1998 AND 1997
SUMMARY- Source One Mortgage Services Corporation (together with its
subsidiaries, the "Company") reported net income of $10.5 million for the
three months ended June 30, 1998 compared to a net loss of $12.3 million
for 1997. The 1998 results include a $.9 million pretax gain on the sale
of servicing to a third party and adjustments to previous sales, $3.3
million pretax equity in earnings of an unconsolidated affiliate and a
$5.0 million pretax charge for impairment of the Company's capitalized
servicing asset, which was offset by a $3.8 million net gain on financial
instruments. The 1997 results include the following one-time charges
recorded by the Company in the second quarter of 1997: a $9.2 million
pretax extraordinary loss on the early retirement of debt, a $3.0 million
pretax charge related to mortgage loans held for investment which were
identified for sale and marked down from amortized cost to current market
value, a $1.7 million pretax restructuring charge related to a reduction
in workforce and $.7 million of other pretax miscellaneous charges. The
second quarter 1997 results also include a $1.1 million pretax adjustment
to the loss on the sale of servicing to a third party and the related
assumption of subservicing, $3.1 million pretax equity in earnings of an
unconsolidated affiliate and a $7.1 million pretax charge for impairment
of the Company's capitalized servicing asset, which was offset by a $4.4
million pretax net gain on financial instruments.
The Company reported comprehensive income (which includes the net
change in after tax unrealized gains and losses) of $22.5 million for the
three months ended June 30, 1998, compared to $1.1 million for 1997. The
Company's unrealized gains are associated with its investment in FSA.
The Company's mortgage loan production and mortgage servicing portfolio
activity for the three months ended June 30, 1998 and 1997 are summarized
in the following tables:
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------
Three Months Ended
June 30,
-------------------------------------------------------------------------------------
MORTGAGE LOAN PRODUCTION: (in millions) 1998 1997
-------------------------------------------------------------------------------------
<S> <C> <C>
BY TYPE:
FHA/VA Insured $ 2,066 $ 518
Conventional 778 309
-------------------------------------------------------------------------------------
Total $ 2,844 $ 827
-------------------------------------------------------------------------------------
BY SOURCE:
Retail $ 751 $ 325
Wholesale 2,093 502
-------------------------------------------------------------------------------------
Total $ 2,844 $ 827
-------------------------------------------------------------------------------------
<CAPTION>
--------------------------------------------------------------------------------------
Three Months Ended
June 30,
--------------------------------------------------------------------------------------
MORTGAGE SERVICING PORTFOLIO: (in millions) 1998 1997
--------------------------------------------------------------------------------------
<S> <C> <C>
Servicing portfolio owned at beginning of period $ 9,770 $ 9,266
Mortgage loan production 2,844 827
--------------------------------------------------------------------------------------
Total servicing in 2,844 827
--------------------------------------------------------------------------------------
Regular payoffs 320 219
Sale of servicing 436 -
Principal amortization, foreclosures and other 328 223
---------------------------------------------------------------------------------------
Total servicing out 1,084 442
---------------------------------------------------------------------------------------
Servicing portfolio owned at end of period 11,530 9,651
---------------------------------------------------------------------------------------
Subservicing portfolio 13,320 18,932
---------------------------------------------------------------------------------------
Total servicing portfolio at end of period $ 24,850 $ 28,583
---------------------------------------------------------------------------------------
</TABLE>
14
<PAGE> 16
FORM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The significant increase in 1998 mortgage loan production and payoffs
reflects lower market interest rates and a corresponding increase in refinance
activity throughout the second quarter of 1998 compared to the second quarter of
1997.
REVENUE- Mortgage servicing revenue was $18.6 million and $19.0 million for
the three months ended June 30, 1998 and 1997, respectively. Amortization of
capitalized servicing was $14.8 million and $16.4 million for the second
quarters ended June 30, 1998 and 1997, respectively. Amortization includes a
$5.0 million and a $7.1 million increase to the valuation allowances for
impairment of the Company's capitalized servicing asset in 1998 and 1997,
respectively. Excluding the effects of these items, amortization expense
slightly increased to $9.8 million from $9.3 million for the quarters ended June
30, 1998 and 1997, respectively. The impairment charges are a result of
increased market consensus prepayment rates and a corresponding decrease in the
fair value of the Company's capitalized servicing asset from the quarters ended
March 31, 1998 and 1997.
The Company recorded a net gain on its financial instruments of $3.8 million
and $4.4 million for the second quarters ended June 30, 1998 and 1997,
respectively. The 1998 net gain includes a net realized gain of $2.1 million
from the sales of financial instruments in the second quarter and realized gains
of $1.9 million from net cash flows received. These gains were slightly offset
by unrealized losses of $.2 million due to a net decrease in the fair market
value of the remaining financial instruments. The 1997 net gain includes
realized losses of $.2 million from net cash flows paid and $4.6 million of
unrealized gains due to a net increase in the fair market value of the various
instruments.
Interest income increased to $22.9 million in the second quarter of 1998 from
$10.7 million in 1997. The increase in interest income is primarily the result
of the increase in mortgage loan production and the corresponding increase in
the average mortgage loans receivable inventory. Interest expense was $18.1
million and $8.2 million for the three months ended June 30, 1998 and 1997,
respectively. This increase is primarily the result of increased short-term
borrowings necessary to fund the increase in 1998 production and an increase in
the cost of borrowings due to the Company's inability to issue commercial paper.
Net gain on sale of mortgages increased to $25.5 million for the second
quarter of 1998 from $1.3 million in the comparable 1997 period. This increase
is primarily the result of increased mortgage loan sales volumes and the
corresponding increase in capitalized originated mortgage servicing rights
("OMSR") income and gains on mortgage sales resulting from increased mortgage
loan production in 1998. In addition, the 1997 gain reflects a $3.0 million
pretax charge in the second quarter of 1997 relating to the Company's mortgage
loans held for investment which were identified for sale and marked down from
amortized cost to current market value.
The Company recorded an $.9 million pretax gain on sales of servicing during
the second quarter of 1998, which reflects the sale of the rights to service
approximately $.5 billion of the Company's nonrecourse mortgage servicing
portfolio to a third party and adjustments to previous servicing sales. The
Company recorded an additional $1.1 million pretax loss from the sale of the
rights to service $17.0 billion of its nonrecourse mortgage servicing portfolio
and the related assumption of subservicing in the second quarter of 1997.
Other revenue was $7.6 million and $4.7 million for the three months ended
June 30, 1998 and 1997, respectively. The increase in other revenue primarily
reflects an increase in ancillary production income associated with the increase
in production volumes in 1998.
15
<PAGE> 17
FORM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
EXPENSES - Salaries and employee benefits expense was $19.3 million and
$13.0 million for the three months ended June 30, 1998 and 1997,
respectively. Generally accepted accounting principles ("GAAP") require
certain loan origination revenues to be netted against direct loan
origination costs. Since salaries and employee benefits expense is the
largest component of loan origination costs, approximately 90% of loan
origination revenues are accounted for as a reduction to salaries and
benefits expense as indicated in the following table:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
Three Months Ended
June 30,
-----------------------------------------------------------------------------------------------
(in thousands) 1998 1997
-----------------------------------------------------------------------------------------------
<S> <C> <C>
Unadjusted salaries and employee benefits expense $ 28,221 $ 17,414
GAAP net origination revenues (8,921) (4,388)
-----------------------------------------------------------------------------------------------
GAAP salaries and employee benefits expense $ 19,300 $ 13,026
-----------------------------------------------------------------------------------------------
</TABLE>
An increase in loan origination revenues, reflecting increased retail
mortgage loan production during the second quarter of 1998 as compared to
the second quarter of 1997, partially offset the increase in unadjusted
salaries and benefits expense. Excluding the effects of loan origination
revenue, salaries and employee benefits expense increased 62%. This
increase is primarily due to the increase in loan officer commissions
associated with the significant increase in mortgage loan production.
The provision for loan losses was $.3 million and $1.6 million for the
three months ended June 30, 1998 and 1997, respectively. The decrease in
the provision is primarily due to lower loss volumes during the second
quarter of 1998, as compared to the second quarter of 1997. In addition,
the 1997 provision includes a $.4 million charge related to the sale of a
commercial real estate owned property in the second quarter of 1997.
The Company recorded $1.7 million in restructuring charges in the
second quarter of 1997 as a result of a restructuring plan implemented in
April 1997.
Other operating expenses were $11.1 million and $6.5 million for the
three month periods ended June 30, 1998 and 1997, respectively. The
increase in 1998 is primarily due to increased loan processing expense
related to increased production volumes and additional travel,
advertising and promotional expenses incurred in 1998 related to the
Company's subprime and high LTV business entered into during the third
quarter of 1997.
The Company recognized an extraordinary loss of $6.0 million, net of
income tax benefit, on the early retirement of $119.6 million of its
outstanding 8.875% medium-term notes due October 15, 2001 in the second
quarter 1997.
The Company's income tax provision for the second quarter of 1997
includes an additional provision for the effect of the February 1997
servicing sale.
16
<PAGE> 18
FORM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary cash flow requirements relate to funding mortgage loan
production and investments in mortgage servicing rights. To meet these financing
needs, the Company relies on short-term credit facilities, medium and long-term
debt, early funding programs and cash flow from operations. The Company also
generates cash from sales of mortgage servicing rights. Management believes
capital resources will be sufficient to meet the Company's operating needs as
well as to fund maturing medium and long-term debt.
Senior and subordinated debt consists of the following:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
June 30, December 31,
(in thousands) 1998 1997
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Credit agreements, weighted average interest rates
of 6.36% and 6.34% as of June 30, 1998 and
December 31, 1997, respectively $ 599,988 $ 569,470
8.875% medium-term notes due October 15, 2001 18,723 18,723
9.0% debentures due June 1, 2012 100,000 100,000
9.375% subordinated debentures due December 31, 2025 55,976 55,976
Less unamortized discount,
premium and issuance costs (net) (1,705) (2,110)
- -----------------------------------------------------------------------------------------------------
Total senior and subordinated debt $ 772,982 $ 742,059
- -----------------------------------------------------------------------------------------------------
</TABLE>
In March 1998, the Company increased and amended its $600.0 million secured
revolving credit agreement. The Company exercised its right under the agreement
to request additional commitments, with bank concurrence, increasing its
available revolving facility to $701.0 million to meet higher borrowing
requirements resulting from increased production volumes. The provisions of the
amendment allow the Company to more fully utilize the facility by easing its
restrictions with respect to the Company's use of its subprime production as
collateral and its repurchase of delinquent loans out of mortgage pools.
Borrowings under the facility are secured primarily by the Company's mortgage
loans receivable and pool loan purchases. As of June 30, 1998 and December 31,
1997, the Company had $574.0 million and $559.0 million outstanding under this
facility, respectively.
On July 10, 1998, the Company amended and restated this secured credit
agreement to increase its borrowing capacity and flexibility. The provisions of
the amended agreement increase its borrowing capacity from $701.0 million to
$800.0 million, which will allow the Company to finance planned growth in
production and servicing. The provisions also allow the Company to more fully
utilize the facility by easing its restrictions with respect to the Company's
use of its high LTV mortgage loans and non-conforming second mortgage loans as
collateral and increasing the collateral value of the Company's
mortgage-backed-security ("MBS") pools. The revolving credit facility expires on
July 9, 1999.
The Company must comply with certain financial covenants provided in its
secured revolving credit facility, including restrictions relating to tangible
net worth and leverage. In addition, the secured facility contains certain
covenants which limit the Company's ability to pay dividends or make
distributions of its capital. The limits do not apply to preferred stock
dividend and subordinated debt interest requirements each year. The Company is
currently in compliance with all such covenants.
In July 1998, the Company entered into an additional secured credit agreement
to be used for working capital and general corporate purposes, including the
funding of mortgage loans. Under this agreement, the Company may borrow up to
$35.0 million through July 9, 1999. Borrowings under this facility are secured
by the Company's investment in FSA common stock. The Company must comply with
certain financial convenants provided in the agreement, including restrictions
relating to tangible net worth and leverage. The Company is currently in
compliance with all such covenants.
17
<PAGE> 19
FORM 10-Q
Source One Mortgage Service Corporation and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
In May 1998, the Company entered into a new secured credit agreement
for purposes of financing the origination or acquisition of subprime and
high LTV loans. Under this agreement, the Company may borrow up to $175.0
million through April 29, 1999. Borrowings under this facility are
secured by the underlying loans. As of June 30, 1998, the company had
$5.8 million outstanding under this facility. The Company must comply
with certain financial covenants provided in the agreement, including
restrictions relating to tangible net worth and leverage. The Company is
currently in compliance with all such covenants.
In April 1998, Central Pacific Mortgage Company ("Central Pacific"), a
wholly-owned subsidiary of the Company, replaced its existing $15.0
million unsecured revolving credit agreement with a new mortgage
warehousing agreement under which it can borrow up to $25.0 million
through April 15, 1999. Borrowings under this new facility are secured by
the underlying loans, as each advance under this facility will be used to
finance the origination or acquisition of mortgage loans and holding of
such loans until they are sold, delivered or pledged with the issuance of
agency or other mortgage-backed securities. As of June 30, 1998 and
December 31, 1997, there was $20.2 million and $10.5 million outstanding
under these credit agreements, respectively. Central Pacific must comply
with certain financial covenants provided in the agreement, including
restrictions relating to tangible net worth and leverage. Central Pacific
is currently in compliance with all such covenants.
The Company has a dividend policy which may result in the payment of
dividends on the Company's common stock, dependent upon the earnings,
cash position and capital needs of the Company, limitations in credit
agreements, general business conditions and other factors deemed relevant
by the Company's Board of Directors. The Company paid dividends on its
common stock totaling $80.1 million for the six months ended June 30,
1998 which have been reflected as reductions in paid-in capital. The
Company did not declare any dividends on its common stock for the six
months ended June 30, 1997.
During the first six months of 1998, the Company sold the rights to
service approximately $4.0 billion of its nonrecourse mortgage servicing
portfolio to third parties for net proceeds of $86.4 million. The Company
used the initial proceeds received from the sales totaling $59.8 million
for general corporate purposes. The remaining balance of $26.6 million is
included in other assets in the consolidated statement of condition as of
June 30, 1998.
The Company invests in various financial instruments in order to offset
changes in the value of its capitalized servicing asset and to mitigate
the effect on earnings of higher amortization and impairment of the asset
which results from increased prepayment activity that can occur with
decreases in market interest rates. See Note 4 to the consolidated
financial statements for further discussion.
YEAR 2000 COMPLIANCE
During the fourth quarter of 1996, the Company established a team to
coordinate the identification, evaluation and implementation of changes
to computer systems and applications necessary to achieve a year 2000
date conversion with no effect on customers or disruption to business
operations. These actions are necessary to ensure that the systems and
applications will recognize and process the year 2000 and beyond.
Currently, the project is 100% unit tested and 50% application tested,
with an estimated completion date of year end 1998. The cost of achieving
year 2000 compliance is estimated to be less than $2.0 million above the
cost of normal software upgrades and replacements. As of June 30, 1998
approximately $1.2 million had been spent on the project, of which
approximately $.2 million was incurred during the first half of 1998.
The Company has initiated formal communications with all of its
significant business partners to determine the extent to which the
Company's interface systems are vulnerable to those third parties'
failure to remedy their own year 2000 issues. There is no guarantee that
the systems of other companies on which the Company's systems rely will
be converted on a timely basis and will not have an adverse effect on the
Company's systems.
18
<PAGE> 20
FORM 10-Q
Source One Mortgage Services Corporation and Subsidiaries
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
By virtue of General Instruction 1 to Item 305 of Regulation S-K, and because
it is neither a bank nor a thrift and its market capitalization on January 28,
1997 did not exceed $2.5 billion, the Company is not required at this time to
provide disclosures under this Item 3.
19
<PAGE> 21
FORM 10-Q
Source One Mortgage Services Corporation and Subsdiaries
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits:
Exhibit
No. Description
------ -----------------------
27 Financial Data Schedule
Data Schedule
b. Form 8-K: The Company filed seven current Reports on Form 8-K with
the Securities and Exchange Commission during the quarter ended
June 30, 1998.
(i) April 23, 1998: Reported Distribution Date Statements for April 25,
May 1, May 1, and April 20, 1998 relating to the Source One
Mortgage Services Corporation Agency MBS Multi-Class Pass-Through
Certificates Series 1987-2, 1988-1, 1988-2 and 1990-1,
respectively.
(ii) April 27, 1998: Reported Report to the Trustee and Report to the
Certificate Holders for the month of April 1998 relating to the
Source One Mortgage Services Corporation 11-1/2% Mortgage
Pass-Through Certificates, Series A.
(iii) May 22, 1998: Reported Distribution Date Statements for May 25,
June 1, June 1, and May 20, 1998 relating to the Source One
Mortgage Services Corporation Agency MBS Multi-Class Pass-Through
Certificates Series 1987-2, 1988-1, 1988-2 and 1990-1,
respectively.
(iv) May 26, 1998: Reported Report to the Trustee and Report to the
Certificate Holders for the month of May 1998 relating to the
Source One Mortgage Services Corporation 11-1/2% Mortgage
Pass-Through Certificates, Series A.
(v) June 23, 1998: Under Item 5 as exhibits:
First Amendment to Third Amended and Restated Revolving Credit
Agreement dated as of July 25, 1997 by and among Source One
Mortgage Services Corporation, The Mortgage Authority Inc., and
Central Pacific Mortgage Company (subsidiaries of Source One
Mortgage Services Corporation), and the First National Bank of
Chicago, individually and as Administrative Agent and Certain Other
Lenders.
Master Loan and Security Agreement dated as of May 1, 1998 between
Source One Mortgage Services Corporation and Greenwich Capital
Financial Products, Inc.
New/Modified Commitment Supplement dated as of March 25, 1998 to
Third Amended and Restated Revolving Credit Agreement dated as of
July 25, 1997 by and among Source One Mortgage Services
Corporation, The Mortgage Authority, Inc. and Central Pacific
Mortgage Company (subsidiaries of Source One Mortgage Services
Corporation), and the First National Bank of Chicago, individually
and as Administrative Agent and Certain Other Lenders.
(vi) June 23, 1998: Reported Distribution Date Statements for June 25,
June 25, July 1, July 1, and June 20, 1998 relating to the Source
One Mortgage Services Corporation Agency MBS Multi-Class
Pass-Through Certificates Series 1987-1, 1987-2, 1988-1, 1988-2 and
1990-1, respectively.
(vii) June 25, 1998: Reported Report to the Trustee and Report to the
Certificate Holders for the month of June 1998 relating to the
Source One Mortgage Services Corporation 11-1/2% Mortgage
Pass-Through Certificates, Series A.
20
<PAGE> 22
FORM 10-Q
Source One Mortgage Services Corporation and Subsidiries
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.
SOURCE ONE MORTGAGE SERVICES CORPORATION
----------------------------------------
(Registrant)
DATE: AUGUST 14, 1998 /S/ MICHAEL C. ALLEMANG
- ---------------------- ------------------------
Michael C. Allemang
Executive Vice President and Chief
Financial Officer (Principal Financial
Officer and Principal Accounting Officer)
21
<PAGE> 23
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
- ------- -- -----------
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 3,519
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 22,103
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,403,141
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
18
<COMMON> 32
<OTHER-SE> 426,667
<TOTAL-LIABILITY-AND-EQUITY> 1,403,141
<SALES> 0
<TOTAL-REVENUES> 97,780
<CGS> 0
<TOTAL-COSTS> 61,660
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,109
<INTEREST-EXPENSE> 33,476
<INCOME-PRETAX> 36,120
<INCOME-TAX> 12,508
<INCOME-CONTINUING> 23,612
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 23,612
<EPS-PRIMARY> 6.77
<EPS-DILUTED> 0
</TABLE>
