<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
------------- -------------
Commission file number 1-12898
SOURCE ONE MORTGAGE SERVICES CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 38-2011419
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
27555 Farmington Road, Farmington Hills, Michigan 48334-3357
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (248) 488-7000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<TABLE>
<S> <C>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
8.42% CUMULATIVE PREFERRED STOCK, SERIES A NEW YORK STOCK EXCHANGE
9.375% QUARTERLY INCOME CAPITAL SECURITIES NEW YORK STOCK EXCHANGE
(SUBORDINATED INTEREST DEFERRED DEBENTURES, DUE 2025)
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No .
------- -------
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
THERE IS NO AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES OF
THE REGISTRANT. AS OF MARCH 29, 1999, THE NUMBER OF SHARES OF THE REGISTRANT'S
COMMON STOCK OUTSTANDING WAS 3,211,881.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Annual Report to Shareholders for the year ended
December 31, 1998 (Parts I, II and IV).
<PAGE> 2
PART I
ITEM 1. BUSINESS
GENERAL
Source One Mortgage Services Corporation (together with its subsidiaries, the
"Company"), a Delaware corporation, is one of the largest mortgage banking
companies in the United States that is not affiliated with a commercial bank. As
of December 31, 1998, the Company had a mortgage loan servicing portfolio
totaling $25.1 billion, including $15.9 billion of loans subserviced for others,
which is serviced on behalf of approximately 213 institutional investors and
numerous other security holders. As of December 31, 1998, the Company had 163
retail branch offices in 31 states and Puerto Rico and originated $10.9 billion
in mortgage loans for the year then ended.
As a mortgage banker, the Company primarily engages in the business of
producing and selling conforming and subprime residential mortgage loans,
servicing conforming residential mortgage loans and subservicing residential
mortgage loans for third parties. The Company's primary sources of revenue are
net servicing revenue, net interest revenue, net gain on sale of mortgages, net
gain on sale of servicing, earnings from unconsolidated affiliate and other
revenue. The Company is also engaged, through certain of its subsidiaries, in
the sale of credit-related insurance products (such as life, disability, health,
accidental death and property and casualty insurance).
The Company was incorporated in 1972 and is the successor to Citizens Mortgage
Corporation which was organized in 1946. The Company is a wholly-owned
subsidiary of White Mountains Holdings, Inc. ("White Mountains") (formerly Fund
American Enterprises, Inc.) and its parent Fund American Enterprises Holdings,
Inc. ("Fund American"), a Delaware corporation organized in 1980, which was
formerly known as The Fund American Companies, Inc. and Fireman's Fund
Corporation.
The Company's principal executive offices are located at 27555 Farmington
Road, Farmington Hills, Michigan 48334-3357; its telephone number is (248)
488-7000.
INDUSTRY OVERVIEW
Mortgage banking is the business of serving as a financial intermediary in (i)
the origination and purchase of mortgage loans, (ii) the holding of such loans
while aggregating sufficient loans to form appropriate mortgage-backed security
pools, (iii) the subsequent sale of such loans through pools or directly to
investors, and (iv) the ongoing servicing or subservicing of such loans during
the repayment period. Mortgage bankers generate revenue in each of the four
stages of the mortgage banking process.
MORTGAGE LOAN PRODUCTION
The Company produces residential mortgage loans through (i) a system of retail
branch offices; (ii) a correspondent network of banks, thrift institutions and
other mortgage lenders; (iii) mortgage brokers; and (iv) a specialized marketing
program. The existence of these mortgage production sources gives the Company
the flexibility to shift its production between those sources as market
conditions warrant and allows it to emphasize the production mode which is most
economically advantageous. Loans produced, whether through origination or
purchase, include conventional, conforming, subprime and high loan-to-value
("high LTV") residential mortgage loans as well as conforming mortgage loans
which are either insured by the Federal Housing Administration ("FHA") or
partially guaranteed by the Veterans Administration ("VA") ("government loans").
In evaluating loans purchased through its correspondent network and loans
originated through its broker network, the Company applies the same quality
standards as required for loans originated by the Company itself. The Company's
quality control department reviews a sample of the loans purchased to determine
compliance with Company standards.
It is a policy of the Company to primarily produce fixed rate mortgage loans.
Fixed rate mortgages tend to capture a larger share of the market in a declining
interest rate environment and are less susceptible to prepayment risk than
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<PAGE> 3
adjustable-rate mortgages. Accordingly, in a rising interest rate environment,
consumer preference for adjustable-rate mortgages tends to increase, which could
have an adverse impact on the Company's mortgage production operations. In 1998,
fixed rate mortgage originations accounted for approximately 98% of the
Company's total mortgage loan production as compared to 88% in 1997.
The following table sets forth selected information regarding the Company's
mortgage loan production:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
(in millions)
Year ended December 31, 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FHA/VA $ 7,675 $ 2,985 $ 2,035 $ 1,565 $ 2,065
Conventional 3,191 1,418 1,796 1,287 2,521
- --------------------------------------------------------------------------------------------------------------------
Total production(a) $ 10,866 $ 4,403 $ 3,831 $ 2,852 $ 4,586
- --------------------------------------------------------------------------------------------------------------------
Retail branch originations $ 2,741 $ 1,339 $ 1,590 $ 1,347 $ 2,005
Correspondent network
acquisitions 6,896 2,552 1,640 1,157 1,081
Mortgage broker originations 910 390 369 196 696
Specialized marketing program
originations 319 122 232 152 804
- --------------------------------------------------------------------------------------------------------------------
Total production (a) $ 10,866 $ 4,403 $ 3,831 $ 2,852 $ 4,586
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Excludes mortgage loan production originated by the Company's retail
branches that is sold directly to third parties on a whole loan basis
totaling $1,201 million, $680 million, $496 million and $390 million for the
years ended December 31, 1998, 1997, 1996 and 1995, respectively.
Mortgage loans originated by the Company are subject to a defined underwriting
process in order to assess each prospective borrower's ability to repay the loan
requested and the adequacy of each property as collateral. In addition, the
Company is subject to the underwriting guidelines of FHA, VA, the Federal Home
Loan Mortgage Corporation ("FHLMC" or "Freddie Mac") and the Federal National
Mortgage Association ("FNMA" or "Fannie Mae"), as well as specific contractual
requirements of institutional investors who have agreed to acquire mortgage
loans originated by the Company.
In response to increased industry competition for producing and servicing
conforming mortgage loans, the Company decided to broaden its product line by
offering higher margin products. The Company began to produce 203(k) (FHA home
improvement) loans, manufactured housing loans, subprime loans and high LTV
second mortgage loans in late 1997. The 203(k) loans and manufactured housing
loans are being sold into agency pools with servicing retained. The subprime and
high LTV loans are being originated for a fee and sold to third parties on a
servicing released basis. The Company is currently subservicing subprime loans
and has the capability to service and subservice subprime and high LTV loans.
Although these higher margin products are a new focus for the Company, they
accounted for less than 4% of total production in 1998 and are currently
expected to account for approximately 8% of total production in 1999.
RETAIL BRANCH OFFICES. As of December 31, 1998, the Company had 163 retail
branch offices in 31 states and Puerto Rico. Each office has sales
representatives who originate mortgage loans through contacts with real estate
brokers, builders, developers and others, as well as through direct contact with
homebuyers.
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As of December 31, 1998, the Company's retail branch offices were located in
the following states and commonwealths:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
Number Number Number
State of Offices State of Offices State of Offices
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
California 33 Alabama 4 Arkansas 1
Washington 20 Colorado 4 Idaho 1
New York 11 Illinois 4 Indiana 1
Georgia 9 Kentucky 4 Kansas 1
Nevada 8 Missouri 4 Maryland 1
Texas 8 Oregon 4 Oklahoma 1
Michigan 7 Alaska 3 Rhode Island 1
Arizona 6 Utah 3 Vermont 1
Florida 5 Massachusetts 2 Virginia 1
Ohio 5 New Jersey 2 Puerto Rico 1
Tennessee 5 Pennsylvania 2
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
Most branch office originations are referred to regional operating centers
for preparation of loan documentation, evaluation of compliance with the
Company's underwriting conditions and closing of the loans.
CORRESPONDENT NETWORK. The Company conducts a program through which it agrees
to purchase mortgage loans from a network of banks, thrift institutions and
other mortgage lenders. The funding price for such loans is set by the Company
on a daily basis. In addition, the Company pays a premium for the release of
servicing rights, which is negotiated on a case-by-case basis. As of December
31, 1998 there were approximately 253 participants in the Company's
correspondent network, with no single participant or group of affiliated
participants accounting for more than 12% of the Company's total mortgage loan
originations.
MORTGAGE BROKERS. The Company conducts a program through which it closes loans
originated by a network of mortgage brokers. The funding price for such loans is
set by the Company on a daily basis. The mortgage broker receives compensation
equivalent to the difference between the Company's pricing schedule and the
closing price. As of December 31, 1998 there were approximately 478 active
participants in the Company's mortgage broker network, with no single broker or
group of affiliated brokers accounting for more than 1% of the Company's total
mortgage loan originations.
SPECIALIZED MARKETING PROGRAM. The Company also generates mortgage loan
originations primarily by responding to refinancing requests from borrowers that
have mortgage loans currently serviced by the Company. The products currently
offered by the Specialized Marketing Program consist of purchase money first
mortgages, home equity lines of credit, closed-end second mortgages, refinance
mortgages and relocation assistance.
SALES OF LOANS
The Company sells loans either through mortgage-backed securities issued
pursuant to programs of the Government National Mortgage Association ("GNMA" or
"Ginnie Mae"), FNMA and FHLMC or through whole loan sales to investors. Most
loans are aggregated in pools of $1.0 million or more, which are purchased by
institutional investors after having been guaranteed by GNMA, FNMA or FHLMC.
Approximately 48% of the Company's total consolidated revenue is generated from
sales of loans to GNMA, FNMA and FHLMC and the related servicing of those loans.
Substantially all GNMA securities are sold without recourse to the Company for
loss of principal in the event of a subsequent default by the mortgage borrower
due to the underlying FHA and VA insurance. Prior to December 1992,
substantially all conventional securities were sold with recourse to the Company
to the extent of insufficient proceeds from private mortgage insurance,
foreclosure and other recoveries. Since December 1992, conventional loans have
been sold without recourse to the Company.
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The following table summarizes the principal amount of loans sold by the
Company:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Year Ended
December 31, 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
Principal Principal Principal
amount Percentage amount Percentage amount Percentage
(in millions) of total (in millions) of total (in millions) of total
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
GNMA $ 7,667 71.1% $ 2,763 65.6% $ 1,678 42.8%
FNMA 2,227 20.6 983 23.3 1,384 35.3
FHLMC 573 5.3 283 6.7 453 11.6
Other 324 3.0 186 4.4 404 10.3
- --------------------------------------------------------------------------------------------------------------------
Total loan sales $ 10,791 100.0% $ 4,215 100.0% $ 3,919 100.0%
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
Servicing agreements relating to mortgage-backed securities issued pursuant to
the programs of GNMA, FNMA and FHLMC require the Company to advance funds to
make the required payments to investors in the event of a delinquency by the
borrower. The Company expects that it would recover most funds advanced upon
cure of default by the borrower or at foreclosure. However, in connection with
VA partially guaranteed loans and certain conventional loans (which may be, at
most, partially insured by private mortgage insurers), funds advanced may not
cover losses due to potential declines in collateral value. The Company is
subject to limited amounts of principal risk with respect to these loans since
the insurer has the option to reimburse the servicer for the lower of fair
market value of the property or the mortgage loan outstanding, in addition to
the VA guarantee on the loan. In addition, most of the Company's servicing
agreements for mortgage-backed securities typically require the payment to
investors of a full month's interest on each loan although the loan may be paid
off (by optional prepayment or foreclosure) other than on a month-end basis. In
this instance, the Company is obligated to pay the investor interest at the
pass-through rate from the date of the loan payoff through the end of that
calendar month without reimbursement.
The Company, through private placements and public offerings, has also sold
mortgage loans through the issuance of mortgage pass-through certificates. The
Company issued $521.7 million of real estate mortgage investment conduit
("REMIC") certificates through December 31, 1990. The Company is the primary
servicer for these REMIC certificates, which were sold pursuant to five separate
trusts that have no recourse provisions. The Company has not issued any mortgage
pass-through certificates since 1990, however, the Company may offer additional
mortgage pass-through certificates in the future if economic and market
conditions warrant.
Historically, the Company's sales of loans have generated net gains. However,
if secondary market interest rates decline after the Company obtains a mandatory
forward commitment for a loan, the loan may not close and the Company may incur
a loss from the cost of covering its obligations under such commitment. If
secondary market interest rates increase before the Company obtains a mandatory
forward commitment for a loan and the loan closes, the Company may realize a
loss when the loan is subsequently sold. The Company obtains mandatory forward
commitments of up to 120 days to sell mortgage-backed securities to hedge the
market risk associated with a substantial portion of its loans in process
("mortgage loan pipeline") that is expected to close and all mortgage loan
receivables.
The Company's risk management function closely monitors the mortgage loan
pipeline to determine appropriate forward commitment coverage on a daily basis.
In addition, the risk management area seeks to reduce counterparty risk by
committing to sell mortgage loans only to approved dealers, with no dealer
having in excess of 20% of current commitments. The Company currently transacts
business with eighteen approved dealers.
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LOAN SERVICING
Mortgage loan servicing consists primarily of (i) collecting principal,
interest and funds to be escrowed for tax and insurance payments from mortgage
loan borrowers; (ii) remitting principal and interest to mortgage loan
investors; (iii) paying property taxes and insurance premiums on mortgaged
property; (iv) in some cases, advancing uncollected payments to mortgage loan
investors; (v) administering delinquent loans; (vi) supervising foreclosures in
the event of unremedied defaults; and (vii) performing all related accounting
and reporting activities. Servicing generates cash income in the form of fees,
which represent a percentage of the declining outstanding principal amount of
the loans serviced and are collected from each mortgage loan payment received
plus any late charges. Subservicing involves the administrative servicing of
loans owned by others for a fee.
The Company generally retains the rights to service the conforming mortgage
loans it produces, while selling the rights to service its subprime and high LTV
loans. The Company is currently subservicing subprime loans and has the
capability to service and subservice subprime and high LTV loans. In addition,
the Company may acquire the rights to service a mortgage loan portfolio without
originating or acquiring the underlying mortgage loans. The Company periodically
makes such purchases of servicing rights from banks, thrift institutions and
other mortgage lenders. The fees paid to acquire such servicing rights are
negotiated on a case-by-case basis. During 1998, no such purchases were made.
During 1997 and 1996, the Company purchased the rights from third parties to
service $.04 billion and $2.8 billion, respectively.
During 1996 through 1998, the Company forged a new strategy with respect to
its servicing operations. A major focus of this strategy is reducing exposure to
interest rate risk, which increases with the size of an owned servicing
portfolio. To reduce the exposure, the Company took steps to reduce its owned
servicing portfolio and expand its subservicing business. During 1998, the
Company sold the rights to service approximately $10.6 billion of its
nonrecourse mortgage servicing portfolio to third parties resulting in a pretax
gain of approximately $15.2 million. The Company continues to service $4.1
million of these loans pursuant to the subservicing agreement discussed below.
In February 1997, the Company sold the rights to service $17.0 billion of its
nonrecourse mortgage servicing portfolio to a third party and recognized a
pretax loss of $4.3 million on the sale and related assumption of subservicing.
The Company recorded an additional loss of $3.7 million in the fourth quarter of
1997 in connection with the first amendment of the subservicing arrangement
which extended the Company's subservicing responsibilities for one additional
year at less favorable terms than the original agreement provided. In November
1998, the Company amended its subservicing agreement again to extend its
subservicing responsibilities for two additional years at slightly more
favorable terms than the first amendment provided. As a result, the Company will
continue to service these loans pursuant to a subservicing agreement until March
2001, June 2001 and August 2001 for FHLMC loans, GNMA loans and FNMA loans,
respectively. During 1996, the Company sold the rights to service $3.3 billion
of its mortgage servicing portfolio to third parties resulting in a pretax gain
of $10.1 million.
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The following table summarizes the changes in the Company's mortgage loan
servicing portfolio, excluding loans sold but not transferred:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
(in millions)
Year ended December 31, 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Servicing portfolio owned at
beginning of year $ 11,627 $ 26,410 $ 27,792 $ 35,274 $ 38,403
Mortgage loan production 10,866 4,403 3,831 2,852 4,586
Servicing acquisitions and other - 36 2,789 4,674 3,707
- --------------------------------------------------------------------------------------------------------------------
Total servicing in 10,866 4,439 6,620 7,526 8,293
- --------------------------------------------------------------------------------------------------------------------
Regular payoffs 1,576 1,236 3,006 2,271 4,728
Sale of servicing 10,647 17,018 3,302 10,973 3,868
Principal amortization,
foreclosures and other 1,073 968 1,694 1,764 2,826
- --------------------------------------------------------------------------------------------------------------------
Total servicing out 13,296 19,222 8,002 15,008 11,422
- --------------------------------------------------------------------------------------------------------------------
Servicing portfolio owned at
end of year 9,197 11,627 26,410 27,792 35,274
- --------------------------------------------------------------------------------------------------------------------
Subservicing portfolio 15,915 14,919 2,791 4,039 4,294
- --------------------------------------------------------------------------------------------------------------------
Total servicing portfolio at end
of year $ 25,112 $ 26,546 $ 29,201 $ 31,831 $ 39,568
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
The Company closely monitors the rate of delinquencies and foreclosures
incident to its servicing portfolio. The following table summarizes the
Company's delinquency and foreclosure experience with respect to residential
mortgage loans serviced by the Company:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
(% of total residential loans serviced
and subserviced)
December 31, 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
<C> <C> <C> <C> <C> <C>
31-59 days past due 5.15% 4.77% 4.74% 3.99% 3.15%
60-89 days past due 1.12 .96 .95 .70 .54
90 days or more past due .80 .62 .55 .59 .38
- ---------------------------------------------------------------------------------------------------------------------
Total delinquencies 7.07% 6.35% 6.24% 5.28% 4.07%
- ---------------------------------------------------------------------------------------------------------------------
Foreclosures 1.50% 1.18% .93% .80% .77%
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
The increase in delinquencies for 1998 is primarily the result of (i)
servicing sales that require loans be current when transferred (therefore,
delinquent loans remain in the servicing portfolio at least until current), (ii)
no addition of new loan product as the Company sold the rights to service a
majority of its production in 1998, and (iii) the recent efforts to subservice
subprime loans. The increase in delinquencies for 1997, 1996 and 1995, is
primarily the result of servicing portfolio acquisitions made by the Company
during the fourth quarters of 1996 and 1995. The delinquency rates of these
portfolios, which the Company acquired on favorable terms considered to be
reflective of these higher delinquency rates, were higher than the Company's
historical average delinquency rate. The Company has established an allowance
for mortgage loan losses which totaled $11.5 million and $12.8 million as of
December 31, 1998 and 1997, respectively. In addition, the Company's valuation
allowance for its capitalized servicing asset which relates to its principal
recourse portfolio includes a $5.2 million and $8.2 million reserve at December
31, 1998 and 1997, respectively, for estimated losses on the corresponding
loans. Considering the decrease in the size of its owned servicing portfolio
during 1998, the Company believes that the allowances are adequate to provide
for estimated uninsured losses on its mortgage servicing portfolio.
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RELATED ACTIVITIES
In conjunction with its mortgage origination and servicing activities, the
Company provides certain credit-related insurance products (such as life,
disability, health, accidental death and property and casualty insurance)
through subsidiaries. The insurance subsidiaries act as agents and receive fees
based on premium value, but do not assume any insurance risk. Insurance products
are sold through (i) solicitation at the time of mortgage application, (ii)
direct mail solicitation shortly after mortgage loan closing, (iii) solicitation
by a direct solicitor and (iv) resolicitation of the Company's servicing
portfolio on an annual basis. At certain locations, personal solicitation by
Company staff is permitted by state regulations which determine allowable
insurance sales practices. The fees recognized under these programs were as
follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
(in thousands)
Year ended December 31, 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Insurance revenue $ 3,290 $ 4,240 $ 4,554 $ 4,762 $ 4,582
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
CERTAIN BUSINESS CONDITIONS
Changes in the economy or prevailing interest rates can have significant
effects, including material adverse effects, on the mortgage banking business
and the Company.
Inflation and changes in interest rates can have differing effects on various
aspects of the Company's business, particularly with respect to marketing gains
and losses from the sale of mortgage loans, mortgage loan production, the value
of the Company's servicing portfolio and net interest revenue. Historically, the
Company's loan originations and loan production income have increased in
response to falling interest rates and have decreased during periods of rising
interest rates. Periods of low inflation and falling interest rates tend to
reduce loan servicing income and the value of the Company's mortgage loan
servicing portfolio because prepayments of mortgages increase and the average
life of loan servicing rights is shortened. Conversely, periods of increasing
inflation and rising interest rates tend to increase loan servicing income and
the value of the Company's mortgage loan servicing portfolio because prepayments
of mortgages decline and the average life of loan servicing rights is
lengthened. To mitigate the Company's exposure to changes in market interest
rates, the Company utilizes various derivative financial instruments (refer to
Item 7a for further discussion).
COMPETITION
The Company competes nationally and locally with other mortgage bankers, state
and national banks, thrift institutions and insurance companies. National banks
and thrift institutions have substantially more flexibility in their loan
origination programs than the Company, which generally originates loans meeting
the standards of the secondary market. Mortgage lenders compete primarily with
respect to price and service. Competition may also occur on mortgage terms and
closing costs. The Company competes, in part, by using its commissioned sales
force to maintain close relationships with real estate brokers, builders,
developers and members of its correspondent and broker networks. In the opinion
of management, no single mortgage lender dominates the industry.
REGULATION
The Company is subject to the rules and regulations of, and examinations by,
investors and insurers, including, FNMA, FHLMC, GNMA, FHA and VA with respect to
originating, selling, servicing and subservicing mortgage loans. Lenders are
required to submit audited financial statements annually and to maintain
specified net worth levels which vary depending on the amount of loans serviced
and annual mortgage loan production. Mortgage loan origination activities are
also subject to fair housing laws, the Equal Credit Opportunity Act, the Federal
Truth-in-Lending Act, the Real Estate Settlement Procedures Act, the Fair Credit
Reporting Act, licensing laws, usury laws, the Home Mortgage Disclosure Act and
the regulations promulgated thereunder which, among other things, prohibit
discrimination in residential lending and require the disclosure of certain
information to borrowers. There are various other state laws and regulations
affecting
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<PAGE> 9
the Company's mortgage banking and insurance operations. The Company's internal
audit and quality control departments monitor compliance with these laws and
regulations.
EMPLOYEES
As of December 31, 1998, the Company employed approximately 2,212 persons (of
whom approximately 360 were engaged in loan servicing activities and
approximately 1,852 were engaged in residential loan production activities,
administrative and managerial responsibilities).
None of the Company's employees are covered by a collective bargaining
agreement. Management believes that the Company's employee relations are good.
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 that the Company currently believes are
necessary to achieve a year 2000 date conversion with no material adverse
effects to its 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. The Company has substantially completed the testing
phase for all information technology ("IT") systems and is currently
concentrating efforts on testing outside constituents. Additionally, non-IT
systems have also been reviewed for effects of the Year 2000 dilemma. Non-IT
systems influenced by Year 2000 date conversion will be upgraded or replaced by
the second quarter of 1999.
During 1998, the Company engaged an independent consultant to perform an
assessment of the Company's Year 2000 readiness. The assessment confirmed that
the Company was in the final stages of completion and that the Company was a low
risk entity for adverse Year 2000 incidents.
The total pretax cost of achieving Year 2000 compliance, including $1.0
million for hardware and software upgrades, is approximately $2.5 million. To
date, the Company has incurred approximately $2.4 million in costs. These costs
have been expensed as incurred, with the exception of hardware costs, which were
capitalized in accordance with GAAP. The Year 2000 project has accounted for
less than 15% of the total IT budget for the years ended December 31, 1998, 1997
and 1996.
The Company has been closely monitoring the Year 2000 issues of its third
party constituents with whom it voluntarily interacts (e.g. customers,
suppliers, reinsurers, creditors, borrowers). These third party constituents
were requested to demonstrate their ability to become Year 2000 compliant by
year-end 1998. For those constituents who either failed to respond to this
inquiry or were deemed to be unlikely to remedy their own Year 2000 issues in a
timely manner, the Company is in the process of establishing similar
relationships with new parties that expect to be Year 2000 compliant.
The failure to identify or correct significant Year 2000 issues could result
in an interruption in, or a failure of, certain normal business activities or
operations concerning the Company. Such failure could adversely affect the
Company's results of operations, liquidity and financial condition. Due to
general uncertainties inherent in the Year 2000 problem, resulting in part from
uncertainty of potential business interruptions caused by third party
constituents in which the Company must interact (including but not limited to
the suppliers of electric power, various private and public markets for equity
and debt securities, certain agencies of the Federal government and states in
which the Company conducts business), the Company is unable to determine at this
time whether the consequences of any Year 2000 failures will have a material
impact on its results of operations, liquidity or financial condition. However,
the Company currently believes that, with the implementation of its Year 2000
plan (which is in the final stages of completion), the possibility of
significant interruptions of normal business activities due to Year 2000 issues
should be reduced. In addition, the Company is currently in the process of
developing and updating Business Continuance Plans, to facilitate continued
operations in the event of adverse Year 2000 incidents.
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FORWARD-LOOKING STATEMENTS
We make forward-looking statements in this Annual Report on Form 10-K and may
make such statements in future filings with the Securities Exchange Commission.
We may also make forward-looking statements in our press releases or other
public communications. Our forward-looking statements, which are subject to
risks and uncertainties, include information about our expectations and possible
or assumed future results of our operations. When we use any of the words
"believes," "expects", "anticipates," "estimates" or similar expressions, we are
making forward-looking statements.
We claim the protection of the safe harbor for forward-looking statements
contained in the Private Securities Litigation Reform Act of 1995 for all of our
forward-looking statements. While we believe that our forward-looking statements
are reasonable, you should not place undue reliance on any such forward-looking
statements, which speak only as of the date made. You should understand that a
number of factors, all of which are difficult to predict and many of which are
beyond our control, could affect our future results and performance and any
other expectations expressed in our forward-looking statements. This could cause
our actual results, performance and experience to differ materially from those
expressed in our forward-looking statements. Factors that might cause such a
difference include the following:
- inflation and changes in the interest rate environment that decrease
our mortgage loan production and gain on sale of mortgage loans, or
reduce the fair value of our servicing portfolio or financial
instruments, or otherwise adversely impact our operations;
- significantly increased industry consolidation and competition that
causes reduced profitability;
- general economic conditions, either nationally or in our market
areas, that are worse than expected;
- adverse changes in the securities markets;
- legislative or regulatory changes that adversely affect our
business;
- restrictions on our ability to enter new markets successfully and
capitalize on growth opportunities; and
- technological changes, including "Year 2000" data systems compliance
issues, that are more difficult or expensive than we expect.
We do not undertake, and we specifically disclaim, any obligation to update
any forward-looking statements to reflect the occurrence of unanticipated events
or circumstances after the date of such statements.
ITEM 2. PROPERTIES
The Company owns its principal executive offices in Farmington Hills, Michigan
which house the majority of the Company's employees. The Company leases several
other office facilities and operating equipment under cancelable and
noncancelable agreements. Most leases contain renewal clauses.
ITEM 3. LEGAL PROCEEDINGS
Various claims have been made against the Company in the ordinary course of
business. Management believes that any liabilities which could result from such
claims would not materially affect the Company's financial position and results
of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
9
<PAGE> 11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Reported on page 4 of the Company's 1998 Annual Report to Shareholders, herein
incorporated by reference.
ITEM 6. SELECTED FINANCIAL DATA
Reported on pages 3-4 of the Company's 1998 Annual Report to Shareholders,
herein incorporated by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Reported on pages 5-14 of the Company's 1998 Annual Report to Shareholders,
herein incorporated by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's consolidated statement of condition includes certain assets and
liabilities whose fair values are subject to market risk. The term market risk
refers to the risk of loss arising from adverse changes in: interest rates,
foreign currency exchange rates, commodity prices, and other relevant market
rates and prices such as prices for common equity securities. Due to the
Company's sizable investments in mortgage production and servicing assets and
financial instruments and its use of medium and long-term debt financing, market
risk can have a significant affect on the Company's consolidated financial
position.
INTEREST RATE RISK
MORTGAGE PRODUCTION AND SERVICING ASSETS. The Company's mortgage loan
production and servicing activities are subject to interest rate risk and are
generally counter cyclical in nature. In addition, the Company utilizes various
financial instruments, including derivatives, to manage the interest rate risk
related specifically to its mortgage loan pipeline, mortgage loans receivable
and capitalized servicing asset. The overall objective of the Company's interest
rate risk management policies is to offset changes in values of these items
resulting from changes in interest rates.
The Company obtains mandatory forward commitments of up to 120 days to sell
mortgage-backed securities. These commitments hedge the market risk associated
with a substantial portion of the loans in process ("pipeline") that is expected
to close and all loans which have been funded (mortgage loans receivable). If
secondary market interest rates decline after the Company obtains a mandatory
forward commitment for a loan, the loan may not close and the Company may incur
a loss from the cost of covering its obligations under such commitment. If
secondary market rates increase before the Company obtains a mandatory forward
commitment for a loan and the loan closes, the Company may realize a loss when
the loan is subsequently sold. The Company's risk management function closely
monitors the mortgage loan pipeline to determine appropriate forward commitment
coverage on a daily basis in order to manage the risk inherent in these
off-balance-sheet financial instruments.
As part of the interest rate risk management process, the Company performs
various sensitivity analyses that quantify the net financial impact in interest
rate-sensitive assets and commitments. These analyses incorporate scenarios
including assumed shifts in the yield curve. Various modeling techniques are
employed to forecast the value of these assets and commitments. For pipeline
commitments, an option-adjusted spread model is used which incorporates implied
market volatilities and prepayment speeds. For mortgage servicing rights, a
discounted cash flow model is used which incorporates prepayment speeds,
discount rates and credit losses.
10
<PAGE> 12
Utilizing the sensitivity analyses described above, the table below summarizes
the estimated effects of hypothetical increases and decreases in market interest
rates on the Company's mortgage production and servicing assets that management
believes are reasonably possible near-term changes in market interest rates:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Estimated Fair
Carrying Value at Value after Change
December 31, 1998 Assumed Change in in Interest Rate After tax gain (loss)
(in millions) Interest Rate (in millions) (in millions)
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Capitalized servicing asset $ 171.3 (a) 50 bp decrease $ 156.0 $ (9.9)
50 bp increase $ 183.9 $ 8.2
Mortgage forward contracts $ - 50 bp decrease $ 11.6 $ 7.5
50 bp increase $ (11.6) $ (7.5)
Mortgage loan pipeline $ - 50 bp decrease $ (11.7) $ (7.6)
50 bp increase $ 11.4 $ 7.4
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Represents the carrying value of capitalized mortgage servicing, excludiing
$1.6 million of capitalized subservicing.
As shown above, the projected increase or decrease in the value of the
mortgage loan pipeline would be expected to be substantially offset by a
decrease or increase in the related mortgage loan forward contracts. In
addition, the projected increase or decrease in the value of the mortgage
servicing rights would be expected to be substantially offset by a decrease or
increase in the value of the related financial instruments as described below.
This analysis is limited by the fact that it was performed at a specific point
in time and does not incorporate other factors that would impact the Company's
financial performance. Actual results would likely vary.
DERIVATIVE SECURITIES. The value of the Company's capitalized servicing asset
is affected by changes in market interest rates. Interest rates directly
influence prepayment rates as well as other assumptions used in valuing the
asset. 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 which results from increased prepayment activity, the Company invests
in various financial instruments. 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 such financial instruments decreases. The financial
instruments utilized by the Company include interest rate floor contracts
("floors"), interest rate swap agreements ("I/R swaps") and principal-only swap
agreements ("P/O swaps"). With respect to the floors, the Company is not exposed
to losses in excess of its initial investment in the floors. The Company's
exposure to loss in the P/O swaps is related to changes in the market value of
the underlying P/O security over the life of the contract. The exposure to loss
in the I/R swaps is related to the differences between the contracted fixed
interest rates and the variable interest rates over the life of the contract.
These financial instruments are carried at market value and are included in
investments in the consolidated statements of condition. Realized and unrealized
gains and losses are recorded as net gain on financial instruments in the
consolidated statements of income.
INDEBTEDNESS. Increases and decreases in prevailing interest rates generally
translate into decreases and increases in fair values of fixed rate
indebtedness, respectively, particularly long-term debt. Additionally, fair
values of interest rate sensitive instruments may be affected by the credit
worthiness of the issuer, prepayment options, relative values of alternative
investments, the liquidity of the instrument and other general market
conditions.
11
<PAGE> 13
The table below summarizes the estimated effects of hypothetical increases and
decreases in market interest rates on the Company's derivative securities and
medium and long-term fixed rate indebtedness outstanding. Significant variations
in market interest rates could produce changes in the timing of repayments due
to prepayment options available to the issuer or the holder which are not
reflected herein. It is assumed that the changes occur immediately and uniformly
to each category of instrument containing interest rate risk.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Estimated Fair
Carrying Value at Value after Change After tax
December 31, 1998 Assumed Change in in Interest Rate gain (loss)
(in millions) Interest Rate (in millions) (in millions)
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Derivative securities $ 17.5 50 bp decrease $ 31.5 $ 9.1
50 bp increase $ 5.4 $ (7.9)
100 bp increase $ (4.7) $ (14.4)
200 bp increase $ (20.7) $ (24.8)
- --------------------------------------------------------------------------------------------------------------------
Fixed rate indebtedness* $ 117.1 50 bp decrease $ 121.4 $ (2.8)
50 bp increase $ 113.0 $ 2.7
100 bp increase $ 109.1 $ 5.2
200 bp increase $ 101.8 $ 9.9
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
* Excludes short-term indebtedness and long-term indebtedness callable by the
Company during 1999.
EQUITY PRICE RISK
The carrying values of the Company's investments in FSA Options and Preferred
Stock are based on quoted market prices or management's estimates of fair value
(which is based, in part, on quoted market prices) as of the balance sheet date.
Market prices of common equity securities are subject to fluctuations which
could cause the amount to be realized upon sale of the investment to differ
significantly from the current report value. The fluctuations may result from
perceived changes in the underlying economic characteristics of the investee,
the relative price of alternative investments, general market conditions and
supply and demand imbalances for a particular security.
The table below summarizes the Company's equity price risks as of December
31, 1998 and shows the effects of a hypothetical 20% increase and a 20% decrease
in market prices as of that date.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Estimated Fair Value
Carrying Value at after Assumed Price After tax
December 31, 1998 Assumed Price Change gain (loss)
(in millions) Change (in millions) (in millions)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FSA Options and Preferred $ 114.4 20% increase $ 136.6 $ 14.4
Stock 20% decrease $ 91.5 $ (14.9)
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
ACCOUNTING FOR FSA OPTIONS AND CONVERTIBLE PREFERRED STOCK. The Company
currently owns 3,460,200 shares of the common stock of FSA ("FSA Shares") and
various fixed price options and shares of convertible preferred stock of FSA
(the "FSA Options and FSA Preferred Stock") which, in total, gives the Company
the right to acquire up to 4,560,607 additional FSA Shares. The Company's
investment in FSA Shares is accounted for using the equity method of accounting
pursuant to which the investment is reported at FSA's equity value ($35.87 per
FSA Share at December 31, 1998). The Company's investments in FSA Options and
FSA Preferred Stock are currently accounted for under the provisions of SFAS No.
115 pursuant to which the investments are reported at fair value ($52.62 per
underlying FSA Share at December 31, 1998).
The Company currently expects to exercise the FSA Options during 1999 and
convert the FSA Preferred Stock during 2004. Assuming that equity accounting
continues to be the proper accounting method for valuing the Company's
investment in FSA Shares, upon exercise of the FSA Options and conversion of the
FSA Preferred Stock, the Company expects that it would be required to restate
its historic balance sheets to account for its investments in FSA Options and
FSA Preferred Stock from fair value to their original cost. Upon exercise, the
Company's original cost basis in the FSA Shares acquired will be increased by
the exercise price paid. Because the new cost basis of the Company's investment
in FSA Shares is expected to be considerably less than its portion of the fair
value of FSA's net identifiable assets at the date of exercise, the Company
would be required to record a deferred credit that would be amortized to income
over an anticipated five year period. Assuming the FSA Options were exercised
and the FSA Preferred Stock
12
<PAGE> 14
converted as of December 31, 1998, the Company would be required to reduce its
stockholders' equity by $62.6 million and would record a deferred credit of
$19.9 million. This net difference in carrying value of $42.7 million (which
represents the effective write-down of the FSA Options and FSA Preferred Stock
from fair value to FSA's equity value) would continue to exist until such time
as equity accounting is no longer appropriate for the Company's investment in
FSA Shares.
This analysis is based solely on the Company's current circumstances
concerning its investments in FSA Options and FSA Preferred Stock. The Company's
actual accounting valuation will be determined at the point of exercise for the
FSA Options and upon the conversion of the FSA Preferred Stock and will be based
on the circumstances concerning such investments existing at that time.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements reported in the consolidated financial statements of the
Company and the notes thereto and the report thereon of KPMG LLP, independent
auditors, appearing on pages 15-43 of the Company's Annual Report to
Shareholders, herein incorporated by reference. Selected Quarterly Financial
Data reported on page 44 of the Company's 1998 Annual Report to Shareholders,
herein incorporated by reference. The report of Ernst & Young LLP, independent
auditors, included as Exhibit 13(b) hereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
13
<PAGE> 15
PART III
<TABLE>
<CAPTION>
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- --------------------------------------------------------------------------------------------------------------------
Board of Directors
(as of March 29, 1999)
Director
Name Age Since
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Michael C. Allemang 56 1993
Raymond Barrette 48 1998
Terry L. Baxter 53 1994
Robert R. Densmore 50 1986
Mark A. Janssen 40 1997
Francis X. Mohan 59 1997
James H. Ozanne 55 1996
Roger K. Taylor 47 1995
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
Mr. Allemang has served as a director, Executive Vice President and Chief
Financial Officer of the Company since November 1993. He was a director and Vice
President of Fund American Enterprises, Inc. from August 1992 to December 1993.
Mr. Allemang was formerly Senior Vice President of Fireman's Fund Insurance
Company ("Fireman's Fund") from 1991 to 1992 and served as Vice President and
Treasurer of Fund American from 1989 to 1991 and Vice President of Fireman's
Fund from 1986 to 1991.
Mr. Barrette has served as a director of the Company since February 1998. He
has served as Executive Vice President and Chief Financial Officer of Fund
American since November 1997. He holds the same positions with, and is a
director of White Mountains Holdings, Inc. He is also a director of Folksamerica
Holding Company, Inc., Valley Group, Inc., MSA Holdings, Inc. and Fund American
Enterprises, Inc. (formerly Fund American Enterprises II, Inc.) From 1994 to
1996, he was an actuarial consultant with Tillinghast-Towers Perrin. He joined
Fireman's Fund Insurance Company in 1973 and held various positions with that
company, including Chief Actuary and Chief Financial Officer. Prior to his
departure in 1993, he was a Director and Executive Vice President of Fireman's
Fund Insurance Company and President of its Personal Insurance Division.
Mr. Baxter has served as a director of the Company since 1994. He served as
Chairman of the Company from June 1996 to March 1997. He has served as President
of White Mountains Holdings, Inc. since February 1997 and President of Fund
American Enterprises, Inc. from January 1994 to February 1997. He was the
Managing Director of the National Transportation Safety Board from 1990 to 1993,
and prior to that was Senior Vice President of the National Bank of Washington.
Mr. Baxter previously served as Assistant Director of The Office of Management
and Budget under President Reagan and was a Vice President of GEICO Corporation.
Mr. Baxter is also a director of Fund American Enterprises, Inc., Centricut,
LLC., Main Street America Holdings, Inc., White Mountains Holdings, Inc. and
White Mountains Insurance Company.
Mr. Densmore has served as a director of the Company since 1986. He has served
as Executive Vice President of the Company's Servicing Division since 1987. He
was the Chief Financial Officer from 1978 to 1987. Mr. Densmore joined the
Company in 1976.
Mr. Janssen has served as a director of the Company since November 1997. He
has served as Executive Vice President - Production and Capital Markets since
1997. He has also served as Executive Vice President of Capital Markets from
1996 to 1997, Senior Vice President of Finance from 1992 to 1996, Corporate Vice
President and Controller from 1991 to 1992 and Vice President of the Financial
Division from 1988 to 1992. Mr. Janssen joined the Company in 1981.
14
<PAGE> 16
Mr. Mohan has served as a director of the Company since November 1997. He
assumed the position of President and Chief Executive Officer of the Company in
September 1997. Mr. Mohan was with Beneficial Corporation from 1963 to 1997. He
held various positions which included District Manager, Operating Vice
President, Senior Vice President and President of several Beneficial Corporation
subsidiaries.
Mr. Ozanne has served as a director of the Company since August 1996. He has
served as Chairman of the Company since March 1997 and as President of Fund
American Enterprises, Inc. since February 1997. He is the founder and principal
of Greenrange Partners. He was Chairman, President & Chief Executive Officer of
Nations Financial Holdings Corporation (formerly U S WEST Capital Corporation)
from 1989 to 1996. From 1983 to 1989 he was Executive Vice President, Asset
Management and Consumer Groups, of General Electric Capital Corporation
("GECC"), Stamford, Connecticut and held other executive positions with GECC. He
is currently a director of Financial Security Assurance Holdings Ltd.("FSA"), a
publicly-held financial guaranty insurer with securities listed on the New York
Stock Exchange.
Mr. Taylor has served as a director of the Company since August 1995. He has
served as President of FSA since November 1997 and Chief Operating Officer since
May 1993. He is also a member of FSA's management review committee for
structured transactions and underwriting committee for municipal transactions.
Prior to joining FSA in 1990 as an advisor for its new municipal bond insurance
business, Mr. Taylor was an Executive Vice President, founder and executive
committee member of Financial Guaranty Insurance Company. He is also a director
of FSA.
COMMITTEES OF THE BOARD OF DIRECTORS
The major committees of the Board of Directors, committee membership and the
functions of those committees are described below.
EXECUTIVE COMMITTEE. The members of the Executive Committee are: James H.
Ozanne (Chairman), Terry L. Baxter and Francis X. Mohan.
The Executive Committee has been delegated all of the powers and authority of
the Board on all but such matters which are reserved to the Board by the
Delaware General Corporation.
AUDIT COMMITTEE. The members of the Audit Committee are: Raymond Barrette
(Chairman) and Roger K. Taylor.
The Audit Committee exercises the powers of the Board in the management of the
business and affairs of the Company regarding the accounting, reporting and
financial control practices of the Company. It reviews the qualifications of the
independent certified public accountants, makes recommendations to the Board as
to their selection, reviews the plan, fees and results of their audits and
reviews their non-audit services and related fees.
HUMAN RESOURCES COMMITTEE. The members of the Human Resources Committee are:
Terry L. Baxter (Chairman), James H. Ozanne and Roger K. Taylor.
The Human Resources Committee establishes compensation for executive officers
of the Company.
15
<PAGE> 17
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
EXECUTIVE OFFICERS (as of March 29, 1999)
Executive
Officer
Name Age Position Since
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Michael C. Allemang * 56 Executive Vice President and 1993
Chief Financial Officer
John A. Courson 56 Senior Vice President; 1990
President and Chief Executive Officer
of Central Pacific Mortgage Company
Robert R. Densmore * 50 Executive Vice President 1983
Mark A. Janssen * 40 Executive Vice President and Secretary 1996
Francis X. Mohan * 59 President and Chief Executive Officer 1997
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
* Member of the Board of Directors.
Mr. Courson has served as a Senior Vice President of the Company and President
and Chief Executive Officer of Central Pacific Mortgage Company ("Central
Pacific"), a wholly-owned subsidiary of the Company, since July 1990. Prior to
that he was President and Chief Operating Officer of Fundamental Mortgage
Corporation of Dallas, Texas.
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the
Company's directors and executive officers, and persons who own more than 10% of
a registered class of the Company's equity securities, to file with the
Securities and Exchange Commission initial reports of ownership and reports of
changes in ownership of the Company's equity securities. Officers, directors and
greater than 10% stockholders are required by the Securities and Exchange
Commission regulation to furnish the Company with copies of all Section 16(a)
forms they file.
To the Company's knowledge, all Section 16(a) filing requirements applicable
to its officers, directors and greater than 10% beneficial owners were complied
with during the year ended December 31, 1998.
16
<PAGE> 18
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION OF EXECUTIVE OFFICERS
The following table sets forth certain information regarding the salary,
incentive compensation and benefits paid by the Company to its Chief Executive
Officer and its four most highly compensated executive officers other than the
Chief Executive Officer during each of the three most recent fiscal years.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
Annual Compensation Long Term Compensation
------------------- ----------------------
Awards Payouts
------ -------
Other Long-term All
Annual Incentive Other
Name and Compensation SARs Plan Compensation
Principal Position Year Salary Bonus a (#)b Payouts b c
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Francis X. Mohan 1998 $ 250,016 $450,000 $ - - $ - $ 20,000
President and Chief 1997 63,466 300,000 - - - -
Executive Officer
Robert R. Densmore 1998 $ 191,306 $ 70,468 $ - 2,194 $ 163,440 $ 20,000
Executive Vice President 1997 184,079 30,000 - - - 4,800
1996 178,196 64,000 1,468 - - 7,500
Michael C. Allemang 1998 $ 187,250 $ 60,000 $ - 2,194 $ 163,440 $ 20,000
Executive Vice President and 1997 178,049 30,000 - - - 4,800
Chief Financial Officer 1996 172,136 62,000 9,000 - - 7,500
Mark A. Janssen 1998 $ 167,910 $120,000 $ - 1,757 $ 130,932 $ 20,000
Executive Vice President 1997 152,043 140,000 - - - 4,800
and Secretary 1996 125,033 75,000 9,000 - - 7,352
John A. Courson 1998 $ 212,056 $300,000 $12,000 439 $ 32,695 $ 20,000
Senior Vice President; 1997 212,056 110,988 12,000 - - 4,800
President and Chief 1996 187,044 138,496 12,570 - - 7,500
Executive Officer of Central
Pacific
- -------------------------------------------------------------------------------
</TABLE>
a Amounts shown for 1998 consist of the following: (i) Mr. Courson:
reimbursement of automobile expense. Amounts shown for 1997 consist of the
following: (i) Mr. Courson: reimbursement of automobile expenses. Amounts
shown for 1996 consist of the following: (i) Mr. Densmore: reimbursement of
automobile expenses; (ii) Mr. Allemang: reimbursement of automobile expenses;
(iii) Mr. Janssen: reimbursement of automobile expenses; (iv) Mr. Courson:
interest reimbursement of $570 on amounts paid to purchase investment
contracts and reimbursement of automobile expenses.
b Represents amounts earned pursuant to the Company's Long-Term Incentive
Plans.
c Represents amounts allocated pursuant to the Company's Employee Stock
Ownership and 401(k) Savings Plan.
INVESTMENT CONTRACTS AND STOCK APPRECIATION RIGHTS
In 1993, certain directors and executive officers of the Company exchanged all
their shares of the Company's Class B common stock for 1.558 units in an
investment contract and 1.558 units of Stock Appreciation Rights ("SAR") for
each Class B share held. The investment contract entitles the holder to receive
the lesser of $86.625 or the closing price of Fund American's common stock on
the day preceding exercise of the investment contract, multiplied by a factor of
1.223 in cash for each unit held. The units may be exercised at any time at the
option of the holder.
The SARs may be exercised at any time simultaneously with each exercised
investment contract unit at the option of the holders thereof. The value of each
SAR is equal to the difference between $86.625 and the closing price of Fund
American's common stock on the date preceding the exercise of the SAR multiplied
by a factor of 1.223.
17
<PAGE> 19
LONG-TERM INCENTIVE PLAN
The Company has long-term incentive plans that provide for granting stock-based
and cash incentive awards to key management employees. Awards under the plans
are payable upon the achievement of specific return on investment (ROE) goal
covering overlapping three-year periods. Payments under the plans may
accelerate in the event of a change in control of the Company, upon sale of
substantially all of the assets of the Company related to mortgage banking or
upon certain other events.
For the three-year periods beginning January 1, 1994, 1995 and 1996, the
participants received a provisional allocation of phantom shares whose base
value was equal to the market price of Fund American common stock at the
beginning of the period. Based on the specific ROE achieved during the period,
each participant vests in up to two times the phantom shares provisionally
allocated. Each participant then receives a cash payment equal to the base
value of these vested phantom shares and is awarded an equal number of stock
appreciation rights (SARs). The value of each SAR equals the current price of
Fund American common stock plus the total cash dividends paid on that stock
since the beginning of the applicable three-year period less the market price
of Fund American common stock at the beginning of the period. The SARs can be
exercised for cash by the employee at any time and must be exercised no later
than the earlier of the day of termination of employment or the last day of the
year in which the employee attains age 65.
For the three-year periods beginning January 1, 1998 and 1999, participants
received a number of units based on the participants' annual base salary. At the
end of the three-year period, each unit is worth between $0.00 and $3.00
depending on specific ROE performance during the period. The unit values are
paid in cash within 90 days after the end of the period.
SAR GRANTS IN LAST FISCAL YEAR
The following table summarizes stock appreciation right awards granted to the
Named Executive Officers:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Potential realizable
value at assumed
annual rates of stock
price appreciation for
Percent of SAR term
Number of total SARs (in thousands)(b)
securities granted to -----------------------
underlying employees in Expiration
Name SARs granted(a) fiscal year Base price Date 5% 10%
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Robert R. Densmore 2,194 27.68% $74.50 b 160 168
Michael C. Allemang 2,194 27.68% 74.50 b 160 168
Mark A. Janssen 1,757 22.17% 74.50 b 128 135
John A. Courson 439 5.54% 74.50 b 32 34
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) The number of securities underlying SARs granted are based on shares of
Fund American common stock.
(b) The SARs have no specific term and may be exercised at any time at the
option of the holders. However, the SARs are deemed to be exercised should
the holders cease to be employees of the Company. For purposes of this
disclosure, the term of the SARs was assumed to expire six months after
the year ended December 31, 1998, due to the definitive agreement reached
in late March 1999, under which Citicorp Mortgage, Inc., will acquire
substantially all of the mortgage-banking related assets of the Company and
employ substantially all of the Company's employees as discussed in Note 23
on page 43 of the Company's 1998 Annual Report to Shareholders, herein
incorporated by reference.
18
<PAGE> 20
The following table summarizes SAR activity for the year ended December 31,
1998.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END
OPTION/SAR VALUES
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Number of Securities Value of unexercised
underlying unexercised in-the-money
SARs at fiscal year end(b) SARs at fiscal year-end(b)
------------------------- -------------------------
Shares acquired Value realized
Name on exercise(a) Exercisable Unexercisable Exercisable Unexercisable
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Robert R. Densmore 0 0 2,194 0 150,853 0
Michael C. Allemang 0 0 2,194 0 150,853 0
Mark A. Janssen 0 0 1,757 0 120,848 0
John A. Courson 871 71,035 439 0 30,177 0
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Represents the number of investment contract units with respect to which
the SARs were exercised.
(b) The number and value of unexercised SARs are based on shares of Fund
American common stock.
PENSION BENEFITS
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Years of Service
------------------------------------------------------------------------------------------
Remuneration 15 20 25 30 35
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 125,000 $ 30,000 $ 40,000 $ 50,000 $ 60,000 $ 70,000
150,000 36,000 48,000 60,000 72,000 84,000
175,000 42,000 56,000 70,000 84,000 98,000
200,000 48,000 64,000 80,000 96,000 112,000
225,000 54,000 72,000 90,000 108,000 126,000
250,000 60,000 80,000 100,000 120,000 140,000
300,000 72,000 96,000 120,000 144,000 168,000
400,000 96,000 128,000 160,000 192,000 224,000
450,000 108,000 144,000 180,000 216,000 252,000
500,000 120,000 160,000 200,000 240,000 280,000
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
The gross annual benefit paid is computed as a straight-life annuity reduced
by .485% of average salary up to covered compensation; that is, the average of
social security wage bases for the 35 years prior to retirement. The annual
benefits shown in the above table are not reduced to reflect the limitations
imposed by the Internal Revenue Code, which limit the annual benefits payable
from qualified plans to any individual. The Company maintains a Supplemental
Retirement Plan which is a non-qualified, unfunded deferred compensation plan.
Under the plan, certain highly compensated employees affected by these
limitations will receive additional retirement income payments from the Company
so that their pension benefits will equal the amounts they would otherwise have
been were it not for the limitations.
Messrs. Mohan, Densmore, Allemang, Janssen and Courson participate in
retirement plans under which they are entitled to receive estimated annual
retirement benefits in accordance with the table shown above.
Participants in the retirement plans are eligible to receive normal retirement
benefits at age 65, reduced normal retirement benefits if qualified for early
retirement or a deferred vested benefit if they terminate employment prior to
retirement but after five years of service. In the fourth quarter of 1997, the
Company's Board of Directors approved certain amendments to the Company's
pension plan. The approved amendments included the expansion of eligibility
requirements for early retirement from age 55 with ten years of service to the
earlier of age 55 with ten years of service or age 50 with fifteen years of
service for retirements beginning on or after January 1, 1997.
Eligible compensation for Messrs. Mohan, Densmore, Allemang, Janssen and
Courson includes base salary plus bonus received, but is limited to not more
than one and one-third of base salary in total. Benefits accrued under the
retirement plans are limited to eligible compensation of $160,000 for 1998 for
each of the Named Executive Officers.
Benefits under the retirement plans for a single person are computed on a
straight-life basis and benefits for a married person are generally computed on
a joint and 50% survivor basis, subject to each participant's right to elect
alternative
19
<PAGE> 21
survivor benefits. As of December 31, 1998, Messrs. Mohan, Densmore, Allemang,
Janssen and Courson had 1, 22, 5, 17 and 8 whole years of credited service,
respectively, for purposes of computing their benefits under the retirement
plans.
COMPENSATION OF DIRECTORS
Directors who are neither employees of the Company nor employees or directors
of Fund American (Mr. Taylor) receive a fee of $1,500 for each board meeting
attended.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS
In connection with the employment of Mr. Mohan as President and Chief
Executive Officer of the Company, the Company and Mr. Mohan entered into an
employment agreement ("the Agreement"). The Agreement principally called for:
(i) Mr. Mohan to receive an annual base salary of $250,000; (ii) Mr. Mohan to
receive a bonus for 1997 equal to his base salary, provided he achieved specific
performance objectives; (iii) Mr. Mohan to receive additional payments of
$50,000 on November 1, 1997 and $200,000 on November 1, 1998 and 1999, provided
that he is an employee of the Company on those dates; (iv) Mr. Mohan to
participate in the Company's Long-Term Incentive Plan; (v) Mr. Mohan to
participate in an investment and option program; and (vi) in the event Mr. Mohan
is terminated without cause prior to December 31, 2000, Mr. Mohan to receive two
years of base salary and vest immediately in any options. Amounts relating to
1998 and 1997 are included in the "Summary Compensation Table" on page 17.
In 1998, the Company established an Incentive Compensation Plan ("ICP") for
certain key executives and directors of the Company. Under this plan,
participants were provided the opportunity to invest in simulated equity shares
of the Company. The value of the shares represents the calculated fair value of
the Company as defined by the plan which was equal to $42.783 per share at the
time of issuance in May 1998. The Company issued approximately 50,253 shares in
exchange for cash proceeds of $2.2 million. Concurrent with the purchase of each
equity share, the participants were granted five simulated equity options. The
value of the options is equal to the appreciation in the value of the equity
shares over the strike price. The initial strike price is equal to $42.783 per
share and increases each January 1 by 4% beginning in 1999. The Company issued
approximately 251,267 options which vest over a three-year period beginning May
1, 1998. In September 1998, the Company established a second Incentive
Compensation Plan ("ICP II") for certain other key employees of the Company.
Under this plan, the Company issued approximately 31,900 options with an initial
strike price of $49.198 which vest over a three-year period beginning September
1, 1998. The strike price increases each September 1, by 4% beginning in 1999.
Vesting of the options may accelerate in the event of a change in control of the
Company (upon the sale of a majority of the Company's primary business
operations, upon the sale of more than 50% of the Company's common stock, or
upon certain other events. Messrs. Mohan, Densmore, Allemang, Janssen and
Courson participate in the ICP described above and hold approximately 9.3%,
2.3%, 4.7%, 7.0% and 1.2%, respectively, of the total outstanding simulated
equity shares and options.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Human Resources Committee of the Board of Directors establishes
compensation for executive officers of the Company. None of the members of the
Human Resources Committee, namely Terry L. Baxter, James H. Ozanne and Roger K.
Taylor, is, or was, an officer or employee of the Company or any of the
Company's subsidiaries.
20
<PAGE> 22
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As of March 29, 1999, there were two holders of the 3,211,881 shares of the
Company's issued and outstanding common stock, with each share entitled to one
vote, as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Title Name and address of Number of Percent
of beneficial owners shares owned of class
Class
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Common stock White Mountains Holdings, Inc. 3,106,881 96.7%
80 South Main Street
Hanover, NH 03755
Fund American Enterprises Holdings, Inc. 105,000 3.3%
80 South Main Street
Hanover, NH 03755
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
The following table sets forth, as of March 29, 1999, beneficial ownership of
Fund American common stock by each director of the Company and each of the
current "Named Executive Officers" as defined herein.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Title of Name of Number of Percent
Class beneficial owner shares owned b of class c
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Common stock a Michael C. Allemang 11 *
Raymond Barrette 2,131 *
Terry L. Baxter 3,642 *
John A. Courson - *
Robert R. Densmore - *
Mark A. Janssen 18 *
Francis X. Mohan 38 *
James H. Ozanne 697 *
Roger K. Taylor - *
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
* Represents less than 1% of the outstanding shares.
a Represents Fund American common stock pursuant to Item 403(b) of Regulation
S-K of the Securities Act of 1933.
b Except for Messrs. Barrette, Courson, Densmore and Taylor, includes shares
beneficially owned by the Company's Employee Stock Ownership and 401(k)
Savings Plan (whereby voting rights are exercised by the Plan's trustee and
attributable under the terms of the Plan to such person).
c Determined based on the beneficial ownership provisions specified in Rule
13d-3(d)(1) of the Exchange Act. Except to the extent indicated above, all
executive officers and directors have (or share with their spouses) sole
voting and investment power with respect to the shares for which they claim
beneficial ownership.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to the terms of a tax allocation agreement between the Company and
Fund American, Fund American has agreed to compensate the Company for the use of
certain accumulated unrealized losses associated with the Company's common
equity securities portfolio if such losses, when realized, can be utilized in
Fund American's consolidated tax returns.
During 1998, Mr. Courson received $146,502 upon the exercise of 871 investment
contract units. See discussion of "Investment Contracts and Stock Appreciation
Rights" on page 17.
During 1998, the Company's directors and "Named Executive Officers" as
defined herein invested approximately $1.9 million in simulated equity shares of
the Company pursuant to an Incentive Compensation Plan established in 1998. See
discussion of "Employment Contracts and Termination of Employment and
Change-in-Control Arrangements" on page 20.
21
<PAGE> 23
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
a. (1) Financial Statements
The Financial Statements applicable to Source One Mortgage Services
Corporation and consolidated subsidiaries have been incorporated by
reference herein from Source One Mortgage Services Corporation's 1998
Annual Report to Shareholders as they appear in the Index to Financial
Statements and Financial Statement Schedules appearing on page 23 of
this Annual Report on Form 10-K.
(2) Financial Statement Schedules
None.
(3) Exhibits
The exhibits required to be filed by Item 601 of Regulation S-K and by
this form are listed on page 25 of this Annual Report on Form 10-K.
The management contracts and compensatory plans or arrangements
required to be filed as exhibits and included in such list of exhibits
are as follows:
Exhibit 10(a) Source One Mortgage Services Corporation Employee Stock
Ownership and 401(k) Savings Plan and Trust Agreement, as amended and
restated effective as of October 1, 1996
Exhibit 10(b) Form of Source One Mortgage Services Corporation
Voluntary Deferred Compensation Plan
Exhibit 10(c) First Amendment to Source One Mortgage Services
Corporation Voluntary Deferred Compensation Plan
Exhibit 10(d) Form of Source One Mortgage Services Corporation
Retirement Plan, as amended and restated
Exhibit 10(e) First Amendment to Source One Mortgage Services
Corporation Retirement Plan
Exhibit 10(f) Second Amendment to Source One Mortgage Services
Corporation Retirement Plan
Exhibit 10(g) Third Amendment to Source One Mortgage Services
Corporation Retirement Plan
Exhibit 10(h) Form of Source One Mortgage Services Corporation
Retirement Plan Trust Agreement
Exhibit 10(i) Source One Mortgage Services Corporation Supplemental
Retirement Plan
Exhibit 10(j) Source One Mortgage Services Corporation Stock
Appreciation Rights Plan
Exhibit 10(k) Source One Mortgage Services Corporation Long Term
Incentive Plan
Exhibit 10(l) Source One Mortgage Services Corporation New Long-Term
Incentive Plan
Exhibit 10(m) Source One Mortgage Services Corporation Incentive
Compensation Plan
Exhibit 10(n) Source One Mortgage Services Corporation Incentive
Compensation Plan II
Exhibit 10(o) Investment Contract by and between Source One Mortgage
Services Corporation and John A. Courson
Exhibit 10(p) Incentive Agreement in the event of a sale of Source One
Mortgage Services Corporation among certain Senior Officers of Source
One Mortgage Services Corporation and Fund American Enterprises, Inc.
Exhibit 10(q) Retirement Agreement dated October 22, 1997 between
Source One Mortgage Services Corporation and James A. Conrad
Exhibit 10(r) Employment Agreement by and between Source One Mortgage
Services Corporation and Francis X. Mohan
22
<PAGE> 24
Source One Mortgage Services Corporation and Subsidiaries
Index to Financial Statements and Financial Statement Schedules
(Item 14(a))
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Annual Report
page(s)*
- --------------------------------------------------------------------------------------------------------------------
<S> <C>
FINANCIAL STATEMENTS:
Consolidated statements of condition
as of December 31, 1998 and 1997..........................................................................16
Consolidated statements of income for each of the
years ended December 31, 1998, 1997 and 1996..............................................................17
Consolidated statements of comprehensive income for
each of the years ended December 31, 1998, 1997, and 1996.................................................18
Consolidated statements of stockholders' equity for each
of the years ended December 31, 1998, 1997 and 1996.......................................................19
Consolidated statements of cash flows for each
of the years ended December 31, 1998, 1997 and 1996.......................................................20
Notes to consolidated financial statements...............................................................21-43
OTHER FINANCIAL INFORMATION:
Report of independent auditors..............................................................................15
Selected quarterly financial data (Unaudited)...............................................................44
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
* Source One Mortgage Services Corporation's 1998 Annual Report to
Shareholders.
Schedules for which provision is made in Regulation S-X are not required under
the related instructions or are inapplicable and, therefore, have been omitted
or the information required is included in the consolidated financial statements
or notes thereto.
23
<PAGE> 25
b. Reports on Form 8-K
The Company filed 6 reports on Form 8-K during the fourth quarter of 1998. The
dates and contents are described below:
October 26, 1998 Reported Report to the Trustee and Report to the Certificate
Holders for the month of October 1998 relating to the Source
One Mortgage Services Corporation 11 1/2% Mortgage
Pass-Through Certificates, Series A
October 29, 1998 Reported Distribution Date Statements for October 25,
November 1, November 1, and October 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
November 25, 1998 Reported Report to the Trustee and Report to the Certificate
Holders for the month of November 1998 relating to the Source
One Mortgage Services Corporation 11 1/2% Mortgage
Pass-Through Certificates, Series A
November 30, 1998 Reported Distribution Date Statements for November 25,
December 1, December 1, and November 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
December 22, 1998 Reported Distribution Date Statements for December 25, 1998,
December 25, 1998, January 1, 1999, January 1, 1999 and
December 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
December 28, 1998 Reported Report to the Trustee and Report to the Certificate
Holders for the month of December 1998 relating to the Source
One Mortgage Services Corporation 11 1/2% Mortgage
Pass-Through Certificates, Series A
24
<PAGE> 26
c. Exhibits
Exhibit No.
3(a) Restated Certificate of Incorporation of Source One Mortgage Services
Corporation (incorporated by reference to Exhibit 4(a) of the February
28, 1994 Current Report on Form 8-K, File No. 1-12898, formerly File
No. 33-8562)
(b) Certificate of Designation for Series A Preferred Stock of Source One
Mortgage Services Corporation (incorporated by reference to Exhibit
3(b) of the Annual Report on Form 10-K for the year ended December 31,
1993, File No. 1-12898)
(c) Amended and Restated Bylaws of Source One Mortgage Services Corporation
(incorporated by reference to Exhibit 4(d) of Amendment No. 1 to the
registration statement on Form S-3, Registration No. 33-71924)
4(a) Pooling and Servicing Agreement between Manufacturers Hanover Mortgage
Corporation (now "Source One Mortgage Services Corporation") and
National Bank of Detroit dated March 1, 1983 and relating to Mortgage
Pass-Through Certificates, Series A, 11 1/2% Pass-Through Rate
(incorporated by reference to Exhibit 4(a) of the Annual Report on Form
10-K for the year ended December 31, 1991, File No. 1-12898, formerly
File No. 33-8562)
(b) Deposit Trust Agreement between Fireman's Fund Mortgage Corporation
(now "Source One Mortgage Services Corporation") and the First National
Bank of Chicago dated September 25, 1987 and relating to Agency MBS
Multi-Class Pass-Through Certificates, Series 1987-1 (incorporated by
reference to Exhibit 10(jj) of the September 22, 1988 Current Report on
Form 8-K, File No. 1-12898, formerly File No. 33-8562)
(c) Deposit Trust Agreement between Fireman's Fund Mortgage Corporation
(now "Source One Mortgage Services Corporation") and the First National
Bank of Chicago dated January 28, 1988 and relating to Agency MBS
Multi-Class Pass-Through Certificates, Series 1987-2 (incorporated by
reference to Exhibit 10(kk) of the September 22, 1988 Current Report on
Form 8-K, File No. 1-12898, formerly File No. 33-8562)
(d) Deposit Trust Agreement between Fireman's Fund Mortgage Corporation
(now "Source One Mortgage Services Corporation") and the First National
Bank of Chicago dated March 30, 1988 and relating to Agency MBS
Multi-Class Pass-Through Certificates, Series 1988-1 (incorporated by
reference to Exhibit 10(ll) of the September 22, 1988 Current Report on
Form 8-K, File No. 1-12898, formerly File No. 33-8562)
(e) Deposit Trust Agreement between Fireman's Fund Mortgage Corporation
(now "Source One Mortgage Services Corporation") and the First National
Bank of Chicago dated June 28, 1988 and relating to Agency MBS
Multi-Class Pass-Through Certificates, Series 1988-2 (incorporated by
reference to Exhibit 10(mm) of the September 22, 1988 Current Report on
Form 8-K, File No. 1-12898, formerly File No. 33-8562)
(f) Deposit Trust Agreement between Fireman's Fund Mortgage Corporation
(now "Source One Mortgage Services Corporation") and the First National
Bank of Chicago dated July 30, 1990 and relating to Agency MBS
Multi-Class Pass-Through Certificates, Series 1990-1 (incorporated by
reference to Exhibit 4(a) of the July 30, 1990 Current Report on Form
8-K, File No. 1-12898, formerly File No. 33-8562)
(g) Indenture between Source One Mortgage Services Corporation and The
First National Bank of Chicago dated May 7, 1992 (incorporated by
reference to Exhibit 19(a) of the Quarterly Report on Form 10-Q for the
quarter ended March 31, 1992, File No. 1-12898, formerly File No.
33-8562)
25
<PAGE> 27
(h) Resolutions of the Chairman of the Board of Source One Mortgage
Services Corporation regarding the issuance of medium-term indebtedness
adopted pursuant to authority delegated by the Board of Directors of
Source One Mortgage Services Corporation (incorporated by reference to
Exhibit 19(b) of the Quarterly Report on Form 10-Q for the quarter
ended March 31, 1992, File No. 1-12898, formerly File No. 33-8562).
(Said resolutions establish the terms of the Medium-Term Notes, Series
B, of Source One Mortgage Services Corporation issuable under the
Indenture between Source One Mortgage Services Corporation and The
First National Bank of Chicago dated May 7, 1992)
(i) Resolutions of the Chairman of the Board of Source One Mortgage
Services Corporation regarding the issuance of a series of medium-term
notes, Series B, entitled "9% Debentures due June 1, 2012" adopted
pursuant to authority delegated by the Board of Directors of Source One
Mortgage Services Corporation (incorporated by reference to Exhibit (i)
of the Quarterly Report on Form 10-Q for the quarter ended June 30,
1992, File No. 1-12898, formerly File No. 33-8562). (Said resolutions
establish the terms of the 9% Debentures due June 1, 2012 of Source One
Mortgage Services Corporation issued under the Indenture between Source
One Mortgage Services Corporation and The First National Bank of
Chicago dated May 7, 1992)
(j) Indenture dated December 1, 1995 between Source One Mortgage Services
Corporation and IBJ Schroeder Bank & Trust Company, as trustee
(incorporated by reference to Exhibit (a)(1) of Amendment No. 4 to the
Report on Schedule 13E-4 filed with the Securities and Exchange
Commission on December 21, 1995)
(k) First Supplemental Indenture dated December 1, 1995 between Source One
Mortgage Services Corporation and IBJ Schroeder Bank & Trust Company,
as trustee (incorporated by reference to Exhibit (a)(2) of Amendment
No. 4 to the Report on Schedule 13E-4 filed with the Securities and
Exchange Commission on December 21, 1995)
(l) Form of 8.875% Notes due 2001 (incorporated by reference to Exhibit
4(r) of the Annual Report on Form 10-K for the year ended December 31,
1992, File No. 1-12898, formerly File No. 33-8562)
(m) Form of 9% Debentures due 2012 (incorporated by reference to Exhibit
4(s) of the Annual Report on Form 10-K for the year ended December 31,
1992, File No. 1-12898, formerly File No. 33-8562)
(n) Specimen Certificate for 8.42% Cumulative Preferred Stock, Series A, of
Source One Mortgage Services Corporation (incorporated by reference to
Exhibit 4(a) of the Quarterly Report on Form 10-Q for the quarter ended
September 30, 1994, File No. 1-12898)
(o) Form of 9.375% Quarterly Income Capital Securities (Subordinated
Interest Deferrable Debentures, Due 2025); included in the First
Supplemental Indenture dated December 1, 1995 between Source One
Mortgage Services Corporation and IBJ Schroeder Bank & Trust Company,
as trustee (incorporated by reference to Exhibit (a)(2) of Amendment
No. 4 to the Report on Schedule 13E-4 filed with the Securities and
Exchange Commission on December 21, 1995)
10 Material Contracts
(a) Source One Mortgage Services Corporation Employee Stock Ownership and
401(k) Savings Plan and Trust Agreement (as amended and restated
effective as of October 1, 1996) (incorporated by reference to Exhibit
10(a) of the Annual Report on Form 10-K for the year ended December 31,
1996, File No. 1-12898)
(b) Form of Source One Mortgage Services Corporation Voluntary Deferred
Compensation Plan (incorporated by reference to Exhibit 10(e) of the
Annual Report on Form 10-K for the year ended December 31, 1993, File
No. 1-12898)
(c) First Amendment to Source One Mortgage Services Corporation Voluntary
Deferred Compensation Plan (incorporated by reference to Exhibit 10(g)
of the Annual Report on Form 10-K for the year ended December 31, 1994,
File No. 1-12898)
26
<PAGE> 28
(d) Form of Source One Mortgage Services Corporation Retirement Plan, as
amended and restated (incorporated by reference to Exhibit 10(hh) of
the Annual Report on Form 10-K for the year ended December 31, 1990,
File No. 1-12898, formerly File No. 33-8562)
(e) First Amendment to Source One Mortgage Services Corporation Retirement
Plan (incorporated by reference to Exhibit 10(j) of the Annual Report
on Form 10-K for the year ended December 31, 1994, File No. 1-12898)
(f) Second Amendment to Source One Mortgage Services Corporation Retirement
Plan (incorporated by reference to Exhibit 10(k) of the Annual Report
on Form 10-K for the year ended December 31, 1994, File No. 1-12898)
(g) Third Amendment to Source One Mortgage Services Corporation Retirement
Plan (incorporated by reference to Exhibit 10(l) of the Annual Report
on Form 10-K for the year ended December 31, 1994, File No. 1-12898)
(h) Form of Source One Mortgage Services Corporation Retirement Plan Trust
Agreement (incorporated by reference to Exhibit 10(d) of the
registration statement on Form S-1, Registration No. 33-8562)
(i) Source One Mortgage Services Corporation Supplemental Retirement Plan
(incorporated by reference to Exhibit 10(n) of the Annual Report on
Form 10-K for the year ended December 31, 1989, File No. 1-12898,
formerly File No. 33-8562)
(j) Source One Mortgage Services Corporation Stock Appreciation Rights Plan
(incorporated by reference to Exhibit 10(c) of the Current Report on
Form 8-K dated November 11, 1993, File No. 1-12898, formerly File No.
33-8562)
(k) Source One Mortgage Services Corporation Long-Term Incentive Plan
(incorporated by reference to Exhibit 10(ii) of the Annual Report on
Form 10-K for the year ended December 31, 1994, File No. 1-12898)
(l) Source One Mortgage Services Corporation New Long-Term Incentive Plan*
(m) Source One Mortgage Services Corporation Incentive Compensation Plan*
(n) Source One Mortgage Services Corporation Incentive Compensation Plan
II*
(o) Investment Contract by and between Source One Mortgage Services
Corporation and John A. Courson (incorporated by reference to Exhibit
10(ee) of the Annual Report on Form 10-K for the year ended December
31, 1993, File No. 1-12898)
(p) Incentive Agreement in the event of a sale of Source One Mortgage
Services Corporation among certain Senior Officers of Source One
Mortgage Services Corporation and Fund American Enterprises, Inc.
(incorporated by reference to Exhibit 10(ll) of the Annual Report on
Form 10-K for the year ended December 31, 1995, File No. 1-12898)
(q) Retirement Agreement dated October 22, 1997 between Source One Mortgage
Services Corporation and James A. Conrad (incorporated by reference to
Exhibit 10(hh) of the Annual Report on Form 10-K for the year ended
December 31, 1997, File No. 1-12898)
(r) Employment Agreement by and between Source One Mortgage Services
Corporation and Francis X. Mohan (incorporated by reference to Exhibit
10(jj) of the Annual Report on Form 10-K for the year ended December
31, 1997, File No. 1-12898)
(s) Federal Tax Sharing Agreement dated as of January 1, 1991, and
effective for taxable years beginning after December 31, 1990, by and
among Fund American Enterprises Holdings, Inc. and Source One Mortgage
Services Corporation (incorporated by reference to Exhibit 10(m) of the
Annual Report on Form 10-K for the year ended December 31, 1996, File
No. 1-12898)
(t) Depository Agreement dated June 16, 1993 between Source One Mortgage
Services Corporation and The First National Bank of Chicago
(incorporated by reference to Exhibit 10(a) of the Current Report on
Form 8-K dated February 28, 1994, File No. 1-12898, formerly File No.
33-8562)
27
<PAGE> 29
(u) Mortgage Warehousing Loan Agreement dated as of April 18, 1998 by and
between Central Pacific Mortgage and PNC Bank National Association
(incorporated by reference to Exhibit 10(a) of the current Report on
Form 8-K dated July 10, 1998, File No. 1-12898)
(v) Master Loan and Security Agreement dated as of May 1, 1998 between
Source One Mortgage Services Corporation and Greenwich Capital
Financial Products, Inc (incorporated by reference to Exhibit 10(b) of
the current Report on Form 8-K dated June 23, 1998, File No. 1-12898)
(w) Fourth Amended and Restated Revolving Credit Agreement dated as of July
10, 1998 by and among Source One Mortgage Services Corporation and the
First National Bank of Chicago, individually and as Administrative
Agent and Certain Other Lenders (incorporated by reference to Exhibit
10(a) of the current Report on Form 8-K dated September 2, 1998, File
No. 1-12898)
(x) Fourth Amended and Restated Security and Collateral Agency Agreement
dated as of July 10, 1998 by and among Source One Mortgage Services
Corporation and The First National Bank of Chicago (in its capacity as
Administrative Agent for the lenders) and National City Bank, Kentucky,
as Collateral Agent (incorporated by reference to Exhibit 10(d) of the
current Report on Form 8-K dated September 2, 1998, File No. 1-12898)
(y) Revolving Credit Agreement dated as of July 10, 1998 by and among
Source One Mortgage Services Corporation and the First National Bank of
Chicago, individually and as Administrative Agent and Certain Other
Lenders (incorporated by reference to Exhibit 10(b) of the current
Report on Form 8-K dated September 2, 1998, File No. 1-12898)
(z) Pledge and Security Agreement dated as of July 10, 1998 between Source
One Mortgage Services Corporation and the First National Bank of
Chicago, as Collateral Agent for the Lenders (incorporated by reference
to Exhibit 10(c) of the current Report on Form 8-K dated September 2,
1998, File No. 1-12898)
(aa) FNMA/FHLMC/GNMA Mortgage Servicing Purchase and Sale Agreement dated
February 28, 1997, by and between Source One Mortgage Services
Corporation and Chemical Mortgage Company (now "Chase Mortgage
Company") (incorporated by reference to Exhibit 10(dd) of the Annual
Report on Form 10-K for the year ended December 31, 1996, File No.
1-12898)
(bb) Mortgage Loan Interim Subservicing Agreement made as of March 1, 1997,
by and between Chemical Mortgage Company (now "Chase Mortgage Company")
and Source One Mortgage Services Corporation (incorporated by reference
to Exhibit 10(ee) of the Annual Report on Form 10-K for the year ended
December 31, 1996, File No. 1-12898)
(cc) Mortgage Loan Subservicing Agreement, by and between Chemical Mortgage
Company (now "Chase Mortgage Company") and Source One Mortgage Services
Corporation (incorporated by reference to Exhibit 10(ff) of the Annual
Report on Form 10-K for the year ended December 31, 1996, File No.
1-12898)
(dd) Mortgage Loan Subservicing Agreement Extension Amendment, by and
between Chemical Mortgage Company (now "Chase Mortgage Company") and
Source One Mortgage Services Corporation (incorporated by reference to
Exhibit 10(ii) of the Annual Report on Form 10-K for the year ended
December 31, 1997, File No. 1-12898)
(ee) Mortgage Loan Subservicing Agreement Second Extension Amendment dated
as of November 4, 1998, by and between Chase Mortgage Company and
Source One Mortgage Services Corporation*
(ff) Asset Purchase Agreement dated as of March 23, 1999 by and among Source
One Mortgage Services Corporation, Fund American Enterprises Holdings,
Inc., and Citicorp Mortgage, Inc.*
(gg) Transition Services Agreement dated as of March 25, 1999 by and among
Source One Mortgage Services Corporation and Citicorp Mortgage, Inc.*
13 Annual Report to Security Holders
(a) Source One Mortgage Services Corporation 1998 Annual Report to
Shareholders. Such report, except for
28
<PAGE> 30
those portions which are expressly incorporated by reference in this
Annual Report on Form 10-K, is furnished only for the information of
the Commission and is not deemed filed as part hereof*
(b) Audit opinion of Ernst & Young LLP*
16 (a) Letter of Ernst & Young LLP dated March 27, 1997 (incorporated by
reference to Exhibit 16(a) of the Annual Report on Form 10-K for the
year ended December 31, 1996, File No. 1-12898)
21 Subsidiaries of Source One Mortgage Services Corporation (incorporated
by reference to Exhibit 21 of the Annual Report on Form 10-K for the
year ended December 31, 1996, File No. 1-12898)
23 Consents of experts
(a) Consent of KPMG LLP*
(b) Consent of Ernst & Young LLP*
(c) Consent of PricewaterhouseCoopers LLP dated March 29, 1999 relating to
Financial Security Assurance Holdings Ltd.*
24 Powers of Attorney*
27 Financial Data Schedule*
99 The Consolidated Financial Statements of Financial Security Assurance
Holdings Ltd. and the related Report of Independent Accountants as of
December 31, 1998 and 1997 and for each of the three years in the
period ended December 31, 1998*
* Filed herewith
29
<PAGE> 31
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Source One Mortgage Services Corporation
Date: March 29, 1999 By: /s/ MICHAEL C. ALLEMANG
-----------------------
Michael C. Allemang
Executive Vice President,
Chief Financial Officer and Director
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
* Chairman and Director March 29, 1999
- ---------------------------------------
James H. Ozanne
President, Chief Executive Officer and March 29, 1999
* Director (Principal Executive Officer)
- ---------------------------------------
Francis X. Mohan
/s/ MICHAEL C. ALLEMANG Executive Vice President, Chief Financial March 29, 1999
- ---------------------------------------- Officer and Director (Principal Financial
Michael C. Allemang Officer and Principal Accounting Officer)
Executive Vice President - Servicing and March 29, 1999
* Director
- ---------------------------------------
Robert R. Densmore
Executive Vice President, - Production & March 29, 1999
* Capital Markets, Secretary and Director
- ----------------------------------------
Mark A. Janssen
* Director March 29, 1999
- ---------------------------------------
Terry L. Baxter
* Director March 29, 1999
- ---------------------------------------
Raymond Barrette
* Director March 29, 1999
- ---------------------------------------
Roger K. Taylor
*By: /s/ MICHAEL C. ALLEMANG
-----------------------
Michael C. Allemang
As Attorney-in-fact for the persons indicated
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
Supplemental Information to be Furnished with Reports Filed Pursuant to
Section 15(d) of the Act by Registrants Which Have Not Registered Securities
Pursuant to Section 12 of the Act.
The Company does not have any voting securities registered under Section 12
of the Act, and all of the Company's voting securities are held by two entities.
Accordingly, no proxy statement, form of proxy or other proxy soliciting
material has been, or will be, sent to more than 10 of the registrant's security
holders with respect to any annual or other meeting of security holders.
30
<PAGE> 1
EXHIBIT 10(l)
SOURCE ONE MORTGAGE SERVICES CORPORATION
NEW LONG-TERM INCENTIVE PLAN
(effective as of January 1, 1998)
<PAGE> 2
SOURCE ONE MORTGAGE SERVICES CORPORATION
NEW LONG-TERM INCENTIVE PLAN
---------------------------
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
1. Purposes and Effective Date of the Plan .................................................................1
2. Definitions .............................................................................................1
3. Administration of Plan ..................................................................................2
4. Participation ...........................................................................................3
5. Allocation of Units .....................................................................................4
6. Valuation of Accounts ...................................................................................5
7. Non-Assignability; Beneficiary Designation ..............................................................5
8. Vesting..................................................................................................5
9. Change in Control........................................................................................7
10. Payment for Units .......................................................................................9
11. Miscellaneous Provisions ...............................................................................10
12. Claims and Disputes; Arbitration .......................................................................11
13. Amendment ..............................................................................................13
14. Termination ............................................................................................13
</TABLE>
-2-
<PAGE> 3
SOURCE ONE MORTGAGE SERVICES CORPORATION
NEW LONG-TERM INCENTIVE PLAN
---------------------------
1. Purposes and Effective Date of the Plan
The purposes of the Source One Mortgage Services Corporation New
Long-Term Incentive Plan (the "Plan"), effective as of January 1, 1998, are to
provide a means to attract, reward and retain strong management, to encourage
teamwork among members of management and excellence in the performance of their
individual responsibilities, and to align the interests of key managers
participating in the Plan with the interests of shareholders by offering an
incentive compensation vehicle that is based upon the return on shareholders'
equity as measured by adjusted net income of the Company available to common
shareholders, averaged over a three year period.
2. Definitions
In the Plan, the following terms shall have the meanings set forth
below:
(a) "Base Salary" means a Participant's annual rate of base
compensation from the Company, rounded to the nearest whole number, as
in effect on the first business day of the Earning Period. Such
compensation shall be determined without regard to this or any other
incentive compensation or profit-sharing plan, director's fees, or
other forms of extra compensation. If a Participant is not actively
employed on the first business day of the Earning Period, his or her
Base Salary shall be determined as of the first day worked during the
Earning Period.
(b) "Board" means the Board of Directors of the Company.
(c) "Company" means Source One Mortgage Services Corporation
(the operating company), a Delaware corporation, and its successors and
assigns.
(d) "Earning Period" means a period of three consecutive
years beginning January 1, 1998.
(e) "Participant" means a person who is employed by the
Company or a participating Subsidiary of the Company and who is
selected by the Committee to participate in the Plan in accordance with
Section 4.
(f) "Three-year Average ROE" for the Earning Period means
the Company's average annual rate of return on equity for the Earning Period,
determined by the same method as the Company uses for other performance
measurement purposes (rounded to the nearest one-hundredth of a percent).
3
<PAGE> 4
(g) "Top Management" means the individual or individuals
who, at the relevant time, are Chairman of the Board, President and
Chief Executive Officer of the Company.
(h) The following terms are defined elsewhere in the Plan:
Section
-------
Account 5
Adverse Change in Plan 9(d)
Cause (Termination for Cause) 8(e)
Change in Control of the Company 9(b)
Code 10(b)
Committee 3(a)
Constructive Termination 9(c)
Continuing Director 9(e)
Disabled, Disability 8(h)
Plan 1
Subsidiary 4(b)
Vested 8(a)
3. Administration of Plan
(a) The Plan shall be administered by the Human Resources Committee (the
"Committee") of the Board. No member of the Committee shall participate
in any decision or recommendation involving such Committee member's own
participation in the Plan. If and when a Subsidiary is participating in
the Plan, the word Company as used in the Plan shall include such
Subsidiary unless the context otherwise requires.
(b) The Committee shall have all the powers vested in it by the terms of
the Plan, such powers to include authority to interpret the Plan and
any other written instruments issued or adopted pursuant to the Plan,
to establish, amend and rescind any rules and regulations relating to
the Plan, and to make any other determinations which it believes
necessary or advisable for the administration of the Plan. The
Committee may correct any defect or supply any omission or reconcile
any inconsistency in the Plan or in any written instrument issued or
adopted pursuant to the Plan in the manner and to the extent the
Committee deems desirable to carry it into effect. Subject to Section
12 relating to claims, disputes and arbitration, any decision of the
Committee in the administration of the Plan, as described herein, shall
be final and conclusive, unless otherwise determined by the Board. The
Committee may act only by a majority of its members in office, except
that the members thereof may authorize any one or more of their number
or any officer of the Company to execute and deliver documents on
behalf of the Committee. No member of the Committee shall be liable for
anything done or omitted to be done by him/her or by any other member
of the Committee in connection with the Plan, except for his/her own
willful misconduct or as expressly provided by statute.
4
<PAGE> 5
(c) The Committee may employ or retain agents and may designate one or more
employees of the Company, by name or by position, to perform such
clerical, accounting, and other services as the Committee may require
in carrying out the provisions of the Plan.
4. Participation
(a) The Participants in the Plan shall consist of key employees of the
Company selected by Top Management. At the time of selection, Top
Management shall classify each Participant as Tier 1, Tier 2 or Tier 3.
Top Management may modify the terms of participation (including the
method of awarding Units and calculating Unit value) for any key
employee who becomes a Participant as of a date other than the
beginning of the Earning Period, in whatever manner Top Management
deems advisable.
(b) If a Subsidiary of the Company wishes to participate in the Plan and
its participation shall have been approved by the Committee, the board
of directors of the Subsidiary shall adopt a resolution in form and
substance satisfactory to the Committee authorizing participation by
the Subsidiary in the Plan with respect to its employees. As used in
the Plan, the term "Subsidiary" means any corporation at least one-half
of whose outstanding voting stock is owned, directly or indirectly, by
the Company.
A Subsidiary participating in the Plan may cease to be a participating
company at any time by action of the Committee or by action of the board of
directors of such Subsidiary, which latter action shall be effective not earlier
than the date of delivery to the Secretary of the Company of a certified copy of
a resolution of the Subsidiary's board of directors taking such action. If the
participation in the Plan of the Subsidiary shall terminate, such termination
shall not relieve it of any obligations theretofore incurred by it under the
Plan except with the approval of the Committee.
5. Allocation of Units
Units awarded under the Plan shall be allocated to bookkeeping accounts
("Accounts") maintained by the Company in the name of each Participant receiving
an allocation of Units.
Subject to adjustment by Top Management in accordance with the
next-following paragraph, the number of Units allocated to the Account of each
Participant as of the beginning of the Earning Period shall be calculated as a
percentage of Base Salary, corresponding to his/her Tier-classification for the
Earning Period, in accordance with the following schedule:
Tier Level % of Base Salary = No. of Units
---------- -------------------------------
1 60%
2 40%
3 20%
5
<PAGE> 6
EXAMPLE: A Participant in Tier 2 with a Base Salary of $50,000 would receive
20,000 units (i.e. 50,000 X .40 = 20,000).
Top Management may increase or decrease the number of Units allocated
to any Participant, provided that the number of Units allocated to a Tier 2 or
Tier 3 Participant may not exceed 50% of such Participant's Base Salary.
Once Top Management has decided on increases or decreases, if any, in
the number of Units to be allocated, then Top Management shall promptly notify
Participants of their selection for Plan participation, their
Tier-classifications and number of Units allocated to them for the Earning
Period.
At any time before the end of the Earning Period the Committee in its
discretion may allocate to the Account of any Participant for the Earning Period
additional Units over and above the Units allocated to such account as of the
beginning of the Earning Period.
The Board in its discretion may extend the Plan for one or more
additional periods commencing after the first year of the Earning Period.
6. Valuation of Accounts
The value of a Participant's Account shall be determined under the
formula N x UV where-
"N" represents the number of Units in the account at the end of the
Earning Period, and
"UV" represents the Unit Value of each Unit determined as of the last
day of the Earning Period by reference to the following table:
Three-Year Average ROE ("ROE") Unit Value
----------------------------- ----------
9% or less $0.00
13% $1.00
20% $2.00
25% or more $3.00
Intermediate ROE values greater than 9% and less than 25% shall be
pro-rated. Example: ROE of 16.5% results in Unit Value of $1.50.
7. Non-Assignability; Beneficiary Designation
Except as provided herein, a Participant's interest in the Account in
his or her name shall not be transferable other than by will or the laws of
descent and distribution. Each Participant may designate a beneficiary or
beneficiaries, including a trust, to receive any amount payable under the Plan
on account of the Participant's death. Such designation shall be in a form
authorized by Top Management. In the absence of an effective designation of
beneficiary at the time of a Participant's death, any amount
6
<PAGE> 7
payable under the Plan on account of the Participant's death shall be paid to
the Participant's estate.
8. Vesting.
(a) A Participant's interest in the Units allocated to his/her Account for
the Earning Period will become non-forfeitable ("Vested") provided that
the Participant has been in the continuous employ of the Company
through the last day of the Earning Period and remains in the Company's
employ through the payment date determined under Section 10(a).
(b) A Participant's interest in the Units allocated to his/her Account for
the Earning Period will be forfeited upon that Participant's voluntary
termination or involuntary termination for Cause if such interest has
not Vested at the time of termination.
(c) Notwithstanding the provisions of subsections (a) and (b) above, upon
the Participant's (i) involuntary termination of employment other than
for Cause; (ii) death or Disability while in the employ of the Company;
or (iii) retirement from the Company after attaining age 62 or
otherwise with the consent of the Committee, a fractional portion,
X / 36, of the Units allocated to his/her Account for the Earning
Period shall be Vested, where "X" represents the number of full months
which have elapsed since the first day of the Earning Period to the end
of the first month in which occurs one of the events described above.
(d) In the event a Participant (who is not terminated for Cause or due to
Disability) is no longer employed by the Company as a result of the
removal of the Participant from an office which the Participant held
(i) on January 1, 1998 or (ii) on the later date as of which he/she is
selected as a Participant by the Committee (provided that a promotion
or lateral transfer shall not be deemed to constitute such a removal,
except for a lateral transfer or promotion to a more senior title but
to a job which has less responsibilities and duties), a significant
reduction in the nature or scope of the authorities, powers, functions,
or duties attached to such Participant's position or a reduction in the
compensation (exclusive of bonuses or other incentive compensation) of
such Participant which is not remedied within 30 calendar days after
receipt by the Company of written notice from such Participant, the
Committee in its sole discretion acting in good faith may treat such
termination in the same manner as an involuntary termination other than
for Cause under subsection (c) above.
(e) For purposes of the Plan, an involuntary termination other than for
Cause occurs with respect to a Participant if the Company terminates
the Participant's employment with the Company for any reason other than
for Cause or Disability. The termination of a Participant's employment
with the Company shall be deemed to have been for "Cause" if such
termination shall have been the result of the material failure of such
person, in Top Management's reasonable judgment, to perform competently
the Participant's duties; the Participant's conviction of a crime
involving acts of moral turpitude, dishonesty, theft, unethical
7
<PAGE> 8
or unlawful business conduct or conduct which, in Top Management's
judgment, impairs the reputation or standing of the Company (provided,
that if the Participant is arrested or indicted for such a crime, the
Company shall have the right to suspend the Participant without pay
until the matter is judicially resolved); the failure of the
Participant to devote his full time and attention exclusively to the
business and affairs of the Company as herein provided; or the material
violation by the Participant of any term, provision or condition of any
employment agreement between the Participant and the Company.
(h) For purposes of this Section 8 of the Plan, a Participant shall be
deemed to be "Disabled" (or to have a "Disability") if such Participant
has been declared to be permanently and totally disabled after
examination by an independent physician satisfactory to the Company and
Top Management has reasonably determined that the physical or mental
condition of the Participant was such as would entitle the Participant
to payment of monthly disability benefits under the Company's Long-Term
Disability Plan.
(i) Notwithstanding the foregoing provisions of this Section 8, the
Committee may provide by written rule or regulation that, in the event
of a disposition of all or a substantial portion of the Company's
business or business related assets or any other event constituting a
Change in Control of the Company, the Vesting of all or any portion of
the Units allocated to the Account of any Participant for the Earning
Period will be accelerated, subject to such terms and conditions as the
Committee may impose.
9. Change in Control
(a) In the event there occurs a Change in Control of the Company, and if
within 24 months after the Change in Control:
(i) There is an involuntary termination other than for Cause
of the employment of the Participant;
(ii) There is a Constructive Termination, of the employment
of the Participant; or
(iii) There occurs an Adverse Change in the Plan, in respect
of the Participant;
then, the Participant shall be fully Vested in the Units his/her
Account(s) under the Plan.
(b) For purposes of Section 9(a) relating to a change in control of the
Company, a "Change in Control of the Company" shall occur if:
(i) Any person or group (within the meaning of Sections 13
(d) and 14(d)(2) of the Exchange Act), other than Fund American
Enterprises Holdings, Inc. ("FAEH") or a subsidiary of FAEH becomes the
beneficial
8
<PAGE> 9
owner (within the meaning of Rule 13d-3 under the Exchange Act) of
thirty-five percent (35%) or more of the Company's then outstanding
capital stock;
(ii) The Continuing Directors cease for any reason to
constitute a majority of the Board of the Company; or
(iii) The business of the Company for which the Participant's
services are principally performed is disposed of by the Company
pursuant to a sale or other disposition of all or substantially all of
the business or business related assets of the Company (including stock
of a Subsidiary of the Company).
(c) For purposes of Section 9(a) relating to a Change in Control of the
Company, "Constructive Termination" shall mean a termination of
employment with the Company or any of its subsidiaries at the
initiative of the Participant that the Participant declares by prior
written notice delivered to the Secretary of the Company to be a
Constructive Termination by the Company and which follows (i) a
material decrease in his salary, or (ii) a material diminution in the
authority, duties or responsibilities of his position with the result
that the Participant makes a determination in good faith that he or she
cannot continue to carry out his job in substantially the same manner
as it was intended to be carried out immediately before such
diminution. Notwithstanding anything herein to the contrary,
Constructive Termination shall not occur within the meaning of this
Section 9(c) until and unless 30 days have elapsed from the date the
Company receives such written notice without the Company curing or
causing to be cured the circumstance or circumstances described in this
Section 9(c) on the basis of which the declaration of Constructive
Termination is given.
(d) For purposes of Section 9(a) relating to a Change in Control of the
Company, an "Adverse Change in the Plan" shall mean:
(i) Termination of the Plan pursuant to Section 14;
(ii) Amendment of the Plan pursuant to Section 13 that
materially diminishes the value of the Units that have been allocated
under the Plan, either to individual Participants or in the aggregate,
unless there is substituted concurrently authority to grant long-term
incentive awards of comparable value, to individual Participants or in
the aggregate, as the case may be; or
(iii) In respect of any Participant a material diminution
in his rights in connection with such Units (except as may occur under
the terms of the Plan applicable to such Units as originally allocated)
unless there is substituted concurrently a long-term incentive award
with a value at least comparable to the loss in value attributable to
such diminution in his rights.
9
<PAGE> 10
(e) For purposes of Section 9(b)(ii) of the Plan, "Continuing Directors"
shall mean those individuals who, as of January 1, 1998, constituted
the Board or, alternatively, those members elected or nominated after
January 1, 1998 who were approved for such election or nomination by a
vote of at least a majority of the directors then comprising the
Continuing Directors. Further, individuals shall be excluded whose
initial assumption of office is or was in connection with an actual or
threatened election contest relating to the election of the directors
of the Company (as used in rule 14a-11 under the Securities Exchange
Act of 1934).
10. Payment for Units
(a) Automatic Payment of Full Value. Subject to deferral rights, if any,
under any other plan maintained by the Company, the full value of all
Units allocated to the Account of a Participant for the Earning Period
which become Vested under Section 9 or Section 10(a) shall be paid to
the Participant (or to the Participant's designated beneficiary or
legal representative) in a single sum as soon as practicable after the
end of the Earning Period, and in all events within 90 days after the
end of the Earning Period; provided, however, that:
(i) If the Participant dies before the end of the Earning
Period and there is no effective designation of the Participant's
beneficiary at the time of his death, any amount payable under the Plan
on account of the Participant's death shall be paid to his legal
representative, after the end of the Earning Period, by the later of:
(A) the date specified in the preceding paragraph, or (B) 30 days after
the qualification of the legal representative.
(ii) If the Participant becomes Vested in any Units before
the end of the Earning Period on account of a Change in Control of the
Company, and remains employed by the Company, the value of his/her
Vested Units shall be paid to him or her after the end of the Earning
Period, on or before the date specified in the second-preceding
paragraph; provided that the value of such Vested Units shall be the
larger of (A) the value as calculated under Section 6 or (B) an
alternate value calculated by using average ROE for the time period
from the beginning of the Earning Period until the Change in Control
date.
(b) Notwithstanding any provision of the Plan other than this subsection
(b), if part of a payment under the Plan resulting from the operation
of Section 9 (relating to a Change in Control of the Company) and this
Section 10 would be an "excess parachute payment" under Section 280G of
the Internal Revenue Code of 1986, as amended (the "Code"), such
payment shall be reduced by the smallest amount required so that no
part of the payment is not deductible under Section 280G of the Code.
However, prior to making any such reduction the Committee shall request
the Company's independent certified public accountants to determine
whether it would be in the best interest of the Participant to make the
reduction. If such accountants determine that it is not in the best
interest of the Participant to make the reduction, the reduction shall
not be made.
10
<PAGE> 11
11. Miscellaneous Provisions
(a) Except as otherwise provided in the Plan, no employee or other person
shall have any claim or right to be granted any Units under the Plan.
Neither the Plan nor any action taken hereunder shall be construed as
giving any employee any right to be retained in the employ of the
Company or any Subsidiary.
(b) A Participant's interest under the Plan may not be assigned or
transferred in whole or in part either directly or by operation of law
or otherwise (except in the event of a Participant's death), including
but not limited to, sale, execution, levy, garnishment, attachment,
pledge, bankruptcy or any other transfer and no such interest of any
Participant in the Plan shall be subject to any obligation or liability
of such Participant or any beneficiary of such Participant.
(c) The Company shall have the right to deduct from any payment made under
the Plan any federal, state or local income or other taxes required by
law to be withheld with respect to such payment.
(d) The Company has only a contractual obligation to make payments under
Section 10. Participants have the status of general unsecured creditors
of the Company. The satisfaction of Plan obligations is to be made
solely out of the general corporate funds of the Company, which shall
at all times remain subject to the claims of the Company's creditors.
It is the intention of the Company and the Participants that the
amounts payable under the Plan be unfunded for tax purposes and for
purposes of the Employee Retirement Income Security Act of 1974, as
amended.
(e) By accepting an allocation of Units or other benefits under the Plan,
each Participant and each person claiming under or through each
Participant shall, subject to the Plan, be deemed to have indicated
such Participant's or claimant's acceptance and ratification of, and
consent to, any action taken under the Plan by the Company, the Board
or the Committee.
12. Claims and Disputes; Arbitration
(a) Claims for benefits under the Plan shall be made in writing to the
Committee. If a claim for benefits is wholly or partially denied, the
Committee shall, within a reasonable period of time but not later than
ninety (90) days after receipt of the claim, provide the claimant who
was denied a benefit written notice setting forth in a manner
calculated to be understood by the claimant:
(i) The specific reason or reasons for denial;
(ii) Specific reference to the pertinent provisions of the
Plan on which the denial is based;
11
<PAGE> 12
(iii) A description of any additional material or information
necessary for the claimant to perfect the claim and an explanation of
why such material or information is necessary; and
(iv) An explanation of the Plan's claim review procedure.
A person whose claim for benefits under the Plan has been denied, or
his duly authorized representative, may request a review upon written
application to the Committee, may review pertinent documents, and may
submit issues and comments in writing. The claimant's written request
for review must be submitted to the Committee within sixty (60) days
after receipt by the claimant of written notification of the denial of
a claim. A decision by the Committee shall be made promptly, and not
later than sixty (60) days after the Committee's receipt of a request
for review, unless special circumstances require an extension of time
for proceeding, in which cases a decision shall be rendered as soon as
possible, but not later than one hundred twenty (120) days after
receipt of the request for review. The decision on review shall be in
writing and shall include specific reasons for the decision, specific
reference to the pertinent provision of the Plan on which the decision
is based, and be written in a manner calculated to be understood by the
claimant.
(b) Unless otherwise required by law, any controversy or claim arising out
of (i) the denial of a claim for benefits by the Committee under (a)
above or any action taken by the Committee under Section 3, or
otherwise relating to the Plan or the breach thereof, shall be settled
by binding arbitration in the City of Farmington Hills in accordance
with the laws of the State of Michigan by three arbitrators, one of
whom shall be appointed by the Company, one by the Participant (or in
the event of his prior death, his beneficiary(ies) or other
distributee), and the third of whom shall be appointed by the first two
arbitrators. If the selected (third) arbitrator declines or is unable
to serve for any reason, the appointed arbitrators shall select another
arbitrator. Upon their failure to agree on another arbitrator, the
jurisdiction of the Circuit Court of Oakland County, Michigan shall be
invoked to make such selection. The arbitration shall be conducted in
accordance with the commercial arbitration rules of the American
Arbitration Association except as hereinabove provided in subsection
(c) below. Judgment upon the award rendered by the arbitrators may be
entered in any court having jurisdiction thereof. Review by the
arbitrators of any decision, action or interpretation of the Board or
Committee shall be limited to a determination of whether it was
arbitrary and capricious or constituted an abuse of discretion, within
the guidelines of Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101
(1989). In the event the Participant or his beneficiary shall
retain legal counsel and/or incur other costs and expenses in
connection with enforcement of any of the Participant's rights under
the Plan, the Participant or beneficiary shall not be entitled to
recover from the Company any attorneys fees, costs or expenses in
connection with the enforcement of such rights (including enforcement
of any arbitration award in court) regardless of the final outcome;
except that the arbitrators in their discretion may award reasonable
attorneys fees and reasonable costs to the
12
<PAGE> 13
Participant in an arbitration initiated by the Participant following a
Company Change in Control, to enforce the Participant's rights under
the Plan, provided the Participant is the prevailing party in such
arbitration.
(c) Any arbitration shall be conducted as follows:
(i) The arbitrators shall follow the Commercial arbitration
Rules of the American Arbitration Association, except as otherwise
provided herein. The arbitrators shall substantially comply with the
rules of evidence; shall grant essential but limited discovery; shall
provide for the exchange of witness lists and exhibit copies; and shall
conduct a pretrial and consider dispositive motions. Each party shall
have the right to request the arbitrators to make findings of specific
factual issues.
(ii) The arbitrators shall complete their proceedings and
render their decision within 40 days after submission of the dispute to
them, unless both parties agree to an extension. Each party shall
cooperate with the arbitrators to comply with procedural time
requirements and the failure of either to do so shall entitle the
arbitrators to extend the arbitration proceedings accordingly and to
impose sanctions on the party responsible for the delay, payable to the
other party. In the event the arbitrators do not fulfill their
responsibilities on a timely basis, either party shall have the right
to require a replacement and the appointment of new arbitrators.
(iii) The decision of the arbitrator shall be final and
binding upon the parties and accordingly a judgment by any Circuit
Court of the State of Michigan or any other court of competent
jurisdiction may be entered in accordance therewith.
(iv) Subject to the provisions of subsection (b) relating to
reasonable attorneys fees and costs in an arbitration following a
Company Change in Control, the costs of the arbitration shall be borne
equally by the parties to such arbitration, except that each party
shall bear its own legal and accounting expenses relating to its
participation in the arbitration.
14. Amendment
The Plan may be amended at any time and from time to time by the Board.
No amendment of the Plan shall adversely affect any right of any Participant
with respect to any Units theretofore allocated without such Participant's
written consent.
15. Termination
This Plan shall terminate (A) upon payment of all benefits due at the
conclusion of the Earning Period (or at the conclusion of any extension of the
Plan by the Board, as permitted in Section 5) or (B) upon the adoption of a
resolution of the Board terminating the Plan. No termination of the Plan shall
alter or impair any of the rights or obligations
13
<PAGE> 14
of any person, without that person's consent, with respect to any Units
theretofore allocated under the Plan.
-14-
<PAGE> 1
EXHIBIT 10(m)
SOURCE ONE
INCENTIVE COMPENSATION PLAN
- --------------------------------------------------------------------------------
SOURCE ONE
INCENTIVE COMPENSATION PLAN
1. PURPOSE
The purpose of the Source One Incentive Compensation Plan (the "Plan") is
to advance the interests of Source One Mortgage Services Corporation (the
"Company") and its stockholders by offering an enhanced simulated
investment opportunity to certain key executives and directors of the
Company in order to align their interests with those of its stockholder(s).
2. ADMINISTRATION
The Plan shall be administered by the Compensation Committee (the
"Committee") of the Board of Directors (the "FA Board") of Fund American
Enterprises Holdings, Inc. ("Ultimate Parent").
The Committee shall have exclusive authority to select the employees and
directors to be offered participation in the Plan, to determine the type,
size and terms of participation and to prescribe the form of the
instruments embodying participation. The Committee shall be authorized to
interpret the Plan and the rights granted under the Plan, to establish,
amend and rescind any rules and regulations relating to the Plan and to
make any other determinations which it believes necessary or advisable for
the administration of the Plan. The Committee may correct any defect or
supply any omission or reconcile any inconsistency in the Plan or in any
right in the manner and to the extent the Committee deems desirable to
carry it into effect. Any decision of the Committee in the administration
of the Plan, as described herein, shall be final and conclusive. The
Committee may act only by a majority of its member in office, except that
the members thereof may authorize any one or more of their number or any
officer of the Company to execute and deliver documents on behalf of the
Committee. No member of the Committee shall be liable for anything done or
omitted to be done by him or by any other member of the Committee in
connection with the Plan, except for his own willful misconduct or as
expressly provided by statute.
3. EQUITY RIGHTS
(a) TYPE OF EQUITY RIGHTS. The opportunity to invest shall be through
"Equity Rights." Equity Rights shall be limited to the following
two types: (i) "Equity Shares", and (ii) Equity Options." A Equity
Share is a right to receive the cash value of the Fair Value per
Adjusted Share Outstanding (both defined below) upon exercise. An
Equity Option is a right to receive the cash value of the Fair
Value per Adjusted Share Outstanding less the Strike Price upon
exercise.
(b) FAIR VALUE (OF THE COMPANY). The Fair Value of the Company shall be
determined by one or a combination of the following methods. In all
cases the Equity Adjustments, as defined in Section 3(c), shall
apply:
<PAGE> 2
Method A: P/E multiple. The average of the most recent four prior
quarters Gaap earnings (excluding earnings prior to January
1, 1998) of the Company after deducting from earnings all
net after tax interest, dividends and gains or adding back
losses accrued or received from assets in items 3(c)(i)
through 3(c)(v) expensing interest and charges as per 3(c)
(1)3(c)(vii), and adding back all expenses associated with
the Plan net of any benefits (e.g. tax), times the average
market price to four prior quarters Gaap earnings (excluding
earnings prior to January 1, 1998) multiples of the Peer
Companies (defined as six publically traded companies:
including two mortgage banks, two sub-prime finance
companies, and two REIT's, or if no such publically traded
companies exist then other comparable finance companies). If
this P/E valuation approach does not produce a reasonable
valuation due to the rigidities of such a formulaic approach
(e.g. the earnings of the Company or the Peer Companies are
negative or negligible) then the Committee may substitute
Method D. The purpose of the preceding sentence is not to
prevent a loss or significant gain to the participants, but
to address circumstances in which a strict P/E multiple
approach is impractical.
Method B: Book value multiple. Adjusted Gaap Equity (as defined
below) of the Company times the average of each of the Peer
Companies' most recent month end market capitalization of
its common equity to its most recent quarter end Gaap common
equity.
Method C: As determined by an investment bank or other qualified
party. Such Fair Value shall take into account the
adjustments provided for in calculating the Adjusted Gaap
Equity and shall value the remaining entity in whole
relative to comparable companies. In determining the
Company's Fair Value, the third party may compare the
Company to other companies using size and book value
multiples (based on the Company's Adjusted Gaap Equity),
historical earnings multiples (with the Company's earnings
adjusted as per Method A, discounted risk-adjusted cash
flows, progress with regard to new product development and
growing profitability of the Company and/or other methods
which the value (deems appropriate. Such Fair Value will
also take into account the lack of marketability of the
Company's common shares relative to the comparable companies
(e.g. and "ipo discount").
Method D: As determined by the Committee, subject to the
revaluation by a third party (as per Method C, above) with
50% of the costs of the revaluation to be borne directly by
the participants. The parameters for the Committee's
valuation shall be the same as they would for a third party
valuer under Method C. In practice, upon determination of
the Company's Fair Value pursuant to an exercise, the
Committee shall, within 60 days, deliver notice of its
recommended Fair Value for the participants. Within 15 days,
each participant shall have the opportunity to call for a
third party valuation of the Fair Value by delivering notice
of such to the Committee. If notice is so delivered, then
Committee shall procure a third party valuer that is
mutually agreed upon with the participants, or if no such
party can be agreed upon, Lehman Brothers (or its successor
company). The cost of such third party valuation will be
borne 50% by the Company and 50% by the dissenting
participants in proportion to the proceeds to be delivered
to each participant (inclusive of amounts to be deferred as
per 3(m)) pursuant to the then exercise.
Method E: Transaction price. Sale or initial public offering price
less any transaction related expenses.
Method F: Adjusted Gaap Equity of the Company.
<PAGE> 3
(c) EQUITY ADJUSTMENTS. For the purposes of any valuation of the Company
under the Plan the following adjustments shall apply:
(i) less net after tax equity in the securities of Financial
Security Assurance Holdings Ltd., US WEST, Inc., Insurance
Partners LLC and Insurance Partners Chairman LLC,
(ii) less intercompany debt as permitted by the Committee,
(iii) less intercompany preferred equity as permitted by the
Committee,
(iv) less undistributed net proceeds, after tax, from the sales of
securitites listed in 3(c)(i) after December 31, 1997,
(v) less undistributed net dividends or other proceeds, after tax,
received from securities listed in 3(c)(i) after December 31,
1997.
(vi) less undistributed intercompany interest, dividends, proceeds
and principal paid on items 3(c)(ii) and (iii),
(vii) less undistributed capital charges which shall be calculated
at an annualized rate of .10% pretax on item (i), accruing
from December 31, 1997.
(viii) less undistributed equity charges, imputed at 15% after tax,
on the undistributed proceeds from 3(c)(iv) through (vii) and
this item (viii) effective beginning June 30, 1998,
(ix) plus or minus, as the case may be, other adjustments to offset
the effects of any material transactions with Ultimate Parent,
or any of its affiliates, insofar as the transaction is not
within the Company's normal course of business, or upon Change
in Control pro forma adjustments for the Change in Control
event if applicable, (however, if the effects of such
transactions are already captured in items (i) through (viii)
above there shall be no adjustments. In other words, no
transaction shall be double counted),
(x) plus or minus as the case may be, all assets, liabilities
including all expenses and benefits arising out of the Plan so
that the effect of the Plan are backed out of the Fair Value
of the Company, except as specifically printed below,
(xi) plus the number of Equity Shares outstanding under the Plan
times $42.78312,
(xii) plus the number of Equity Options outstanding times the then
applicable Strike Price when the Adjusted GAAP Equity per
Adjusted Share is equal to or greater than the then applicable
Strike Price.
For the purpose of the preceding "undistributed" shall mean net
proceeds not paid to common shareholders (see Share Repurchase
Mechanism defined below), rolled into a new Adjusted Shares (see Share
Issuance Mechanism defined below), or rolled into intercompany debt
per 3(c)(ii). Also intercompany shall mean the hypothetical
transactions that occur between what have been referred to as the
"operating company" and the "capital company" in the internal Company
documents from time to time.
(d) ADJUSTED GAAP EQUITY. Adjusted GAAP Equity shall be equal to common
equity book value of the Company calculated in accordance with GAAP
after taking into account the Equity Adjustments, calculated monthly,
and pro forma for material (including imminent) events. Through March
31, 1998 the Adjusted
<PAGE> 4
Gaap Equity, Equity Adjustments, and Adjusted Shares Outstanding have
been calculated as per Exhibit A attached hereto.
(e) ADJUSTED SHARES OUTSTANDING. Adjusted Shares Outstanding shall mean the
$1 par common shares outstanding of 3,211,881 at December 31, 1997 with
the following adjustments:
(i) plus of the number of outstanding Equity Shares under the
Plan,
(ii) plus the number of outstanding Equity Options when the
Adjusted Gaap Equity per Adjusted Shares is equal to or
greater than the Strike Price,
(iii) less, Adjusted Shares repurchased pursuant to the Share
Repurchase Mechanism,
(iv) plus, shares issued pursuant to the Share Issuance Mechanism.
Fractional shares will be used.
(f) (THEORETIC) SHARE REPURCHASE MECHANISM (FOR THE PURPOSES OF THE PLAN
ONLY). For the purposes of the Plan each actual dividend or actual
share repurchase by the Company shall first retire any outstanding
undistributed balances under 3(c)(iv) through (viii). Any remaining
proceeds will be allocated to the theoretic repurchase of the Adjusted
Shares Outstanding at the then repurchased price per share determined
by the following formula:
(i) Adjusted Gaap Equity per Adjusted Share, times
(ii) [1x(15% times the number of days since most recent prior
month end divided by 365]
(THEORETIC) SHARES ISSUANCE MECHANISM (FOR THE PURPOSES OF THE PLAN
ONLY). For the purposes of the Plan the Committee may deem that any
outstanding undistributed balances under 3(c)(iv) through (viii) be
allocated to the theoretic issuance of Adjusted Shares Outstanding. Any
such theoretic issuance shall occur at the then issuance price per
share determined by the following formula:
(iii) Adjusted Gaap Equity per Adjusted Share, times
(iv) [1+(15% times the number of days since most recent prior month
end divided by 365)]
Note that the Share Repurchase Mechanism and the Share Issuance
Mechanism do not infer an actual repurchase or issuance of the
Company's shares by the Company, but shall merely be used for the
purposes of this Plan in determining Adjusted Shares Outstanding.
(g) OFFER OF EQUITY RIGHTS. The Committee shall select executives who shall
be offered the opportunity to purchase from the Company Equity Shares
at the 12/31/97 Fair Value Per Share ($42.78312) during the Offer
Period. Concurrent with the purchase of each Equity Share, the
Committee shall grant the purchaser five Equity Options. In total, the
Committee shall offer 50,253.46445 Equity Shares ($2,150,000) and
251,267.32225 Equity Options under the Plan, subject to subsequent
adjustment as provided in paragraph 8. Not more than 46,749.39752
Equity Shares ($2,000,000), and not less than 584.34261 Equity Shares
($25,000), shall be offered to any one person.
(h) OFFER PERIOD. The Offer Period shall commence on April 20, 1998
and end on May 8, 1998. Payment to the Company must be made on or
before May 22, 1998.
<PAGE> 5
(i) RIGHTS WITH RESPECT TO EQUITY RIGHTS. A participant to whom Equity
Shares or Equity Options are granted (and any person succeeding to
such rights pursuant to the Plan) shall have no rights as a
shareholder. Except as provided in paragraphs 3(c) and 8, no
adjustment shall be made for dividends, distributions or other rights.
(j) TRANSFER. Equity Rights shall not be transferable by the participant
otherwise than by will or the laws of descent and distribution, and
shall be exercisable during his lifetime only by him.
(k) EXERCISE AND APPLICABLE FAIR VALUE METHODOLOGY. Outstanding
unexercised Equity Rights shall be exercised only under one of the
following conditions (the applicable Fair Value methodology for each
such exercise is indicated below). Note that exercise is mandatory
in all cases except with the written consent of the Committee or as
provided for at the time of sale under (viii).
(i) If the number of Equity Rights outstanding are greater than
35% of the number of then outstanding common shares of the
Company then Equity Rights (in the ratio of 1 Equity
Share to 5 Equity Options) of all participants shall be
exercised on a pro rata basis so that the number of Equity
Rights subsequently outstanding is 35% of the number of common
shares outstanding. Fair Value Method F.
(ii) If within one year of a Change in Control (A) a participant
incurs a Termination Without Cause (section 13) or, (B) incurs
a Constructive Termination (section 14) the Equity Rights for
such a terminated participant (only) shall be exercised. Fair
Value 50% Method D, 25% Method A and 25% Method B.
(iii) Upon effective termination of the Company's primary business
operations by the Board of Directors of the Company (the
"Company Board") without delivering six months prior written
notice to least two participants. Fair Value 50% Method D, 25%
Method A, and 25% Method B.
(iv) Upon effective termination of the Company's primary business
operations by the Company Board after having delivered six
months prior written notice to at least two participants. Fair
Value Method F.
(v) Upon sale of more than 50% of the Company's common stock or a
majority of its primary business operations in a private
transaction in which at least $40 million (market value) of
the assets listed in 3(c)(i) are sold to the same purchaser.
Fair Value 50% Method C, 25% Method A and 25% Method B.
(vi) Upon sale of more than 50% of the Company's common stock or a
majority of its primary business operations including no more
than $40 million (market value) of the assets listed in
3(c)(i). Fair Value Method E.
(vii) Upon an initial public offering ("ipo") of more than 50%
of the Company's common stock (pro forma for the ipo).
Fair Value Method E
(viii) Upon sale or ipo of more than 20% but less than 50% of the
Company's common stock, each participant shall be offered the
one time opportunity to exercise on a pro rata basis (in the
ratio of 1 Equity Share to 5 Equity Options) the number of
Equity Rights equal to such participant's then outstanding
unexercised Equity Rights times the ratio of the common shares
of the Company beneficially owned by the Parent (and/or
Ultimate Parent) to the number of common shares issued and
outstanding of the Company (both of which shall be calculated
pro forma for the sale). The cash value attributable to such
exercise shall be subject to a participant's prior valid
written deferral election (if any) under section 3(m) below.
Fair Value Method E.
<PAGE> 6
(ix) December 31, 2002. If the FA Board does not permit management
of the Company (including at least one participant) to solicit
a sale or ipo of the Company's primary business operations
within the six months period prior to such date, or the FA
Board refuses to consider or approve a bonafide transaction
presented by management at a price which would cause the
applicable Fair Value for such a transaction to be above
Adjusted Book Value during that same period, then Fair Value
shall be 50% Method D, 25% Method A and 25% Method B.
Otherwise, Fair Value shall be determined according to Method
F.
(l) PAYMENT. Upon exercise, the Company shall pay to the participant the
applicable cash value within sixty (60) days, subject to the following:
(i) the completion of a valuation of the Fair Value per
Adjusted Share Outstanding by a third party, if
applicable, and
(ii) a participant's valid prior written election to defer receipt
of a designated portion of such value under section 3(m),
below.
(m) DEFERRAL ELECTION. A participant may, by written election in a form
specified by the Committee, choose to defer receipt of a designated
portion of the cash value to be paid upon exercise of such
participant's Equity Rights (excluding, however, amounts representing
return of sums paid by participant to acquire Equity Shares). The
portion deferred shall be converted into one or more of the Investment
Options available under the Source One Mortgage Services Corporation
Voluntary Deferred Compensation Plan ("VDC" Plan). Any such written
election shall be irrevocable and shall be subject to all provisions of
this Plan and the VDC Plan. To be valid, the election must be made and
filed with the Committee (i) at least six months prior to the data such
Equity Rights become subject to exercise under 3(k) of the Plan and
(ii) in the calendar year preceding the calendar year which includes
such date. The Committee shall have full authority to determine
conclusively the date when Equity Rights become subject to exercise.
4. EQUITY SHARES
(a) VESTING. Purchased Equity Shares are immediately fully vested.
(b) RETIREMENT OR TERMINATION OF EMPLOYMENT. To the extent that unexercised
Equity Shares remain outstanding to a participant at the time at which
such participant leaves employment or ceases to serve as a director on
the Company Board, such Equity Shares shall survive until they may be
exercised pursuant to section 3(k).
5. EQUITY OPTIONS
(a) STRIKE PRICE. The Strike Price shall initially be $42.78312. The Strike
Price shall increase each January 1 hereafter by 4% of the immediately
preceding Strike Price.
(b) VESTING. For a participant who remains in the employment of the
Company at May 1, 2001 Equity Options shall vest at such time.
Additionally, Equity Options shall vest sooner as necessary to permit
exercise under section 3(k) for participants employed at the time of
such exercise. However, if a participant voluntarily leaves employment
prior to such vesting then his or her Equity Options shall expire
without vesting. In the case of death or Disability (as defined in
section 6) while in the employ of the Company, Equity Options shall
become fully vested as necessary to permit exercise under 3(k). If a
participant is Terminated Without Cause, Equity Options shall vest pro
rata based upon the termination date and the three year term beginning
May 1, 1998 except in the case of Change in Control and either
Termination Without Cause or Constructive Termination in which case
Equity Options shall become fully vested and shall be exercisable as
permitted in section 3(k). For the purposes of the Plan directors
serving on the Company Board are deemed to be employed by the Company,
former directors are deemed to have been terminated.
<PAGE> 7
6. DISABILITY
DISABILITY. For the purpose of this Plan, a participant shall be deemed
to be disabled if the Committee shall determine that the physical or
mental condition of the participant is such as would entitle him to
payment of monthly disability benefits under any disability plan of the
Company or a subsidiary in which he is a participant.
7. CHANGE IN CONTROL
For purposes of this Plan, a "Change in Control" of the Company shall occur
if any person or group (within the meaning of Sections 13(d) and 14(d)(2)
of the Securities Exchange Act of 1934, as amended ("Exchange Act")), other
than John J. Byrne, Ultimate Parent, White Mountains Holding, Inc.
("Parent") or an affiliate of Ultimate Parent becomes the beneficial owner
(within the meaning of Rule 13d-3 under the Exchange Act) of thirty-five
percent (35%) or more of Ultimate Parent or Parent's then outstanding
common shares;
8. DILUTION AND OTHER ADJUSTMENTS
In the event of any change in the then outstanding common shares of the
Company by reason of any stock split, stock dividend, recapitalization,
merger, consolidation, reorganization, combination or exchange of shares or
other similar event, and if the Committee shall determine that such change
equitable requires an adjustment in the number or kind of Equity Rights
that may be issued under the Plan pursuant to paragraph 3, or in any
measure of the Fair Value Per Share, then such adjustment shall be made by
the Committee and shall be conclusive and binding for all purposes of the
Plan.
9. DESIGNATION OF BENEFICIARY BY PARTICIPANT
A participant may name a beneficiary to receive any payment to which he may
be entitled in respect of Equity Rights under the Plan in the event of his
death, on a form provided by the Committee. A participant may change his
beneficiary from time to time in the same manner. If no designated
beneficiary is living on the date on which any amount becomes payable to a
participant's executors or administrators, the term "beneficiary" as used
in the Plan shall include such person or persons.
10. MISCELLANEOUS PROVISIONS
(a) No employee or other person shall have any claim or right to be granted
an Equity Right under the Plan. Neither the Plan nor any action taken
hereunder shall be construed as giving an employee any right to be
retained in the employment of the Company or any subsidiary.
(b) A participant's rights and interest under the Plan may not be assigned
or transferred in whole or in part either directly or by operation of
law or otherwise (except in the event of a participant's death),
including but not limited to, execution, levy, garnishment, attachment,
pledge, bankruptcy or in any other manner and no such rights or
interest of any participant in the Plan shall be subject to any
obligation or liability or such participant.
<PAGE> 8
(c) The Company and its subsidiaries shall have the right to deduct from
any payment made under the Plan any federal, state or local income
taxes or other taxes required by law to be withheld with respect to
such payment. Notwithstanding the preceding, the participants shall be
grossed up by the Company for additional taxes paid on gains
(calculated at the time of exercise) on their investment in the Equity
Shares (not Equity options) representing the difference between capital
gains taxes and ordinary income taxes thereon. For the sake of clarity
it is expected that the Company will treat payments to participants
(above the repayment of the initial "investment" to the participants)
as compensation expense.
(d) The Plan shall be unfunded. The Company shall not require to establish
any special or separate fund or to make any other segregation of assets
to assure the payment of any Equity Right under the Plan.
11. AMENDMENT
The Plan may be amended at any time by the Committee. No amendment of the
Plan shall adversely affect any right of any participant with respect to
any Equity Right previously granted without such participant's written
consent.
12. TERMINATION OF PLAN
This Plan shall terminate upon the earlier of the following dates or events
to occur:
(a) the adoption of a resolution of the Committee terminating the Plan; or
(b) five years from the date the Plan is initially approved and adopted by
the Committee unless extended by action of the Committee.
No termination of the Plan shall alter or impair any rights or obligations
of any person, without his consent, under any Equity Right previously
granted under the Plan.
13. TERMINATION WITHOUT CAUSE
For the purposes of this Plan, Termination Without Cause shall mean the
participant's employment with the Company or any of its subsidiaries is
terminated by the Company or the subsidiary other than (i) for Disability
as described in paragraph 6 or (ii) for Cause. For this purpose "Cause"
shall mean (a) an act or omission by the participant that constitutes a
felony or any crime involving mortal turpitude; or (b) willful gross
negligence or willful gross misconduct by the participant in connection
with his employment by the Company or by any of its subsidiaries which
causes, or is likely to cause, material loss or damage to the Company
(directly, or indirectly through a subsidiary).
14. CONSTRUCTIVE TERMINATION
"Constructive Termination" shall mean a termination of employment with the
Company or any of its subsidiaries at the initiative of the participant
that the participant declares by prior written notice delivered to the
Secretary of the Company to be a Constructive Termination by the Company
and which follows (a) a material decrease in his salary, or (b) a material
diminution in the authority, duties or responsibilities of his position
with the result that the participant makes a determination in good faith
that he cannot continue to carry out his job in substantially the same
manner as it was intended to be carried out immediately before such
diminution. Notwithstanding anything herein to the contrary, Constructive
Termination shall not occur within the meaning of this paragraph 14 until
and unless 30 days have elapsed from the date the Company receives such
written notice without the
<PAGE> 9
Company curing or causing to be cured the circumstance or circumstances
described in this paragraph 14 on the basis of which the declaration of
Constructive Termination is given.
<PAGE> 1
EXHIBIT 10(n)
SOURCE ONE
INCENTIVE COMPENSATION PLAN II
- --------------------------------------------------------------------------------
SOURCE ONE
INCENTIVE COMPENSATION PLAN II
1. PURPOSE AND DEFINITIONS
The purpose of the Source One Incentive Compensation Plan II (the "Plan")
is to advance the interests of Source One Mortgage Services Corporation
(the "Company") and its stockholder(s) by providing incentives to certain
key employees of the Company in order to align their interests with the
interests of its stockholder(s) by providing rewards based on growth in
value of Company stock.
As used in the Plan, the following terms, when capitalized, have
specialized meanings as given below:
(a) "Company Board" means the Board of Directors of the Company.
(b) "Company Committee" means the Human Resources Committee of the Company
Board.
(c) "FA Board" means the Board of Directors of the Ultimate Parent.
(d) "FA Committee" means the Compensation Committee of the FA Board.
(e) "Parent" means White Mountain Holdings, Inc.
(f) "Plan I" means the Source One Incentive Compensation Plan for key
executives and directors of the Company, established in May 1998.
(g) "Plans" means this Plan and Plan I.
(h) "Top Management" means the individual or individuals who, at the
relevant time, are Chairman of the Board, President and Chief Executive
Officer of the Company.
(i) "Ultimate Parent" means Fund American Enterprises Holdings, Inc.
2. ADMINISTRATION
The Plan shall be administered by the Company Committee. The Company
Committee shall be authorized to interpret the Plan and the rights granted
under the Plan, to establish, amend and rescind any rules and regulations
relating to the Plan and to make any other determinations which it believes
necessary or advisable for the administration of the Plan. The Company
Committee may correct any defect or supply any omission or reconcile any
inconsistency in the Plan or in any right in the manner and to the extent
the Company Committee deems desirable to carry it into effect. Any decision
of the Company Committee in the administration of the Plan, as described
herein, shall be final and conclusive. The Company Committee may act only
by a majority of its members in office, except that the members thereof may
authorize any one or more of their number or any officer of the Company to
execute and deliver documents on behalf of the Company Committee. No member
of
-1-
<PAGE> 2
the Company Committee shall be liable for anything done or omitted to be
done by him or by any other member of the Company Committee in connection
with the Plan, except for his own willful misconduct or as expressly
provided by statute.
Top Management shall have exclusive authority to select the employees to be
offered participation in the Plan and to determine the size of their
participation.
3. EQUITY OPTIONS
(a) DESCRIPTION OF EQUITY OPTIONS. An Equity Option is a right to receive
the cash value of the Fair Value per Adjusted Share Outstanding less
the Strike Price upon exercise.
(b) FAIR VALUE (OF THE COMPANY). The Fair Value of the Company shall be
determined by one or a combination of the following methods. In all
cases the Equity Adjustments, as defined in Section 3(c), shall apply:
Method A: P/E multiple. The average of the most recent four prior
quarters Gaap earnings (excluding earnings prior to January 1,
1998) of the Company after deducting from earnings all net after
tax interest, dividends and gains or adding back losses accrued
or received from assets in items 3(c)(i) through 3(c)(v),
expensing interest and charges as per 3(c)(vi) through
3(c)(viii), and adding back all expenses associated with the Plan
I net of any benefits (e.g. tax), times the average market price
to four prior quarters Gaap earnings multiples (excluding
earnings prior to January 1, 1998) of the Peer Companies (defined
as six publicly traded companies: including two mortgage banks,
two sub-prime finance companies, and two REIT's, or if no such
publicly traded companies exist then other comparable finance
companies). If this P/E valuation approach does not produce a
reasonable valuation due to the rigidities of such a formulaic
approach (e.g. the earnings of the Company or of the Peer
Companies are negative or negligible) then the FA Committee may
substitute Method D. The purpose of the preceding sentence is not
to prevent a loss or significant gain to the participants, but to
address circumstances in which a strict P/E multiple approach is
impractical.
Method B: Book value multiple. Adjusted Gaap Equity (as defined below)
of the Company times the average of each of the Peer Companies'
most recent month-end market capitalization of its common equity
to it's most recent quarter-end Gaap common equity.
Method C: As determined by an investment bank or other qualified party.
Such Fair Value shall take into account the adjustments provided
for in calculating the Adjusted Gaap Equity and shall value the
remaining entity in whole relative to comparable companies. In
determining the Company's Fair Value, the third party may compare
the Company to other companies using size and book value
multiples (based on the Company's Adjusted Gaap Equity),
historical earnings multiples (with the Company's earnings
adjusted as per Method A, discounted risk-adjusted cash flows,
progress with regard to new product development and growing
profitability of the Company and/or other methods which the
valuer deems appropriate). Such Fair Value will also take into
account the lack of marketability of the Company's common shares
relative to the comparable companies (e.g. an "ipo discount").
Method D: As determined by the FA Committee, subject to the revaluation
by a third party (as per Method C, above) with 50% of the costs
of the revaluation to be borne directly by the participants of
Plan I. The parameters for the FA Committee valuation shall be
the same as they would for a third party valuer under Method C.
In practice, upon determination of the Company's Fair Value
pursuant to an exercise, the FA Committee shall, within 60 days,
deliver notice of the FA Committee's recommended Fair Value to
the Plan I participants. Within 15 days, participants holding a
majority of Equity Options under the Plan I shall have the
opportunity to call for a third party valuation of the Fair Value
by delivering notice of such to the FA Committee. If notice is so
delivered, then FA Committee shall
-2-
<PAGE> 3
procure a third party valuer that is mutually agreed upon with
the participants of Plan I, or if no such party can be agreed
upon, Lehman Brothers (or its successor company). The cost of
such third party valuation will be borne 50% by the Company and
50% by the dissenting participants of Plan I in proportion to the
proceeds to be delivered to each Plan I participant (inclusive of
amounts to be deferred as per 3(m)) pursuant to the then
exercise.
Method E: Transaction price. Sale or initial public offering price less
any transaction related expenses.
Method F: Adjusted Gaap Equity of the Company.
(c) EQUITY ADJUSTMENTS. For the purposes of any valuation of the Company
under the Plan the following adjustments shall apply:
(i) less net after tax equity in the securities of Financial
Security Assurance Holdings Ltd, US WEST, Inc., Insurance
Partners LLC and Insurance Partners Charman LLC,
(ii) less intercompany debt as permitted by the FA COMMITTEE,
(iii) less intercompany preferred equity as permitted by the FA
COMMITTEE,
(iv) less undistributed net proceeds, after tax, from the sale of
securities listed in 3(c)(i) after December 31, 1997,
(v) less undistributed net dividends or other proceeds, after tax,
received from securities listed in 3(c)(i) after December 31,
1997,
(vi) less undistributed intercompany interest, dividends, proceeds
and principal paid on items 3(c)(ii) and (iii),
(vii) less undistributed capital charges which shall be calculated at
an annualized rate of .10% pretax on item (i), accruing from
December 31, 1997,
(viii) less undistributed equity charges, imputed at 15% after tax, on
the undistributed proceeds from 3(c)(iv) through (vii) and this
item (viii) effective beginning June 30, 1998,
(ix) plus or minus, as the case may be, other adjustments to offset
the effects of any material transactions with Ultimate Parent,
or any of its affiliates, insofar as the transaction is not
within the Company's normal course of business, or upon Change
in Control pro forma adjustments for the Change in Control event
if applicable, (however, if the effects of such transactions are
already captured in items (i) through (viii) above there shall
be no adjustments. In other words, no transaction shall be
double counted),
(x) plus or minus as the case may be, all assets, liabilities
including all expenses and benefits arising out of Plan I so
that the effects of the Plan I are backed out of the Fair Value
of the Company, except as specifically provided below,
(xi) plus the number of Equity Shares outstanding under Plan I times
$42.78312,
(xii) plus the number or Equity Options outstanding under Plan I times
the then applicable Strike Price when the Adjusted Gaap Equity
per Adjusted Share is equal to or greater than the then
applicable Strike Price.
-3-
<PAGE> 4
For the purposes of the preceding, "undistributed" shall mean net
proceeds not paid to common shareholders (see Share Repurchase
Mechanism defined below), rolled into new Adjusted Shares (see Share
Issuance Mechanism defined below), or rolled into intercompany debt per
3(c)(ii). Also, intercompany shall mean the hypothetic transactions
that occur between what have been referred to as the "operating
company" and the "capital company" in internal Company documents from
time to time.
(d) ADJUSTED GAAP EQUITY. Adjusted Gaap Equity shall be equal to common
equity book value of the Company calculated in accordance with GAAP
after taking into account the Equity Adjustments, calculated monthly,
and pro forma for material (including imminent) events. Through March
31, 1998 the Adjusted Gaap Equity, Equity Adjustments, and Adjusted
Shares Outstanding have been calculated as per Exhibit A attached
hereto.
(e) ADJUSTED SHARES OUTSTANDING. Adjusted Shares Outstanding shall mean the
$1 par common shares outstanding of 3,211,881 at December 31, 1997 with
the following adjustments:
(i) plus the number of outstanding Equity Shares under Plan I,
(ii) plus the number of Equity Options outstanding under Plan I when
the Adjusted Gaap Equity per Adjusted Share is equal to or
greater than the Strike Price,
(iii) less, Adjusted Shares repurchased pursuant to the Share
Repurchase Mechanism,
(iv) plus, shares issued pursuant to the Share Issuance Mechanism.
Fractional shares will be used.
(f) (THEORETIC) SHARE REPURCHASE MECHANISM (FOR THE PURPOSES OF THE PLAN
ONLY). For the purposes of the Plan, each actual dividend or actual
share repurchase by the Company shall first retire any outstanding
undistributed balances under 3(c)(iv) through (viii). Any remaining
proceeds will be allocated to the theoretic repurchase of Adjusted
Shares Outstanding at the then repurchase price per share determined by
the following formula:
(i) Adjusted Gaap Equity per Adjusted Share, times
(ii) [1+(15% times the number of days since most recent prior month
end divided by 365)]
(THEORETIC) SHARE ISSUANCE MECHANISM (FOR THE PURPOSES OF THE PLAN
ONLY). For the purposes of the Plan the FA COMMITTEE may deem that any
outstanding undistributed balances under 3(c)(iv) through (viii) be
allocated to the theoretic issuance of Adjusted Shares Outstanding. Any
such theoretic issuance shall occur at the then issuance price per
share determined by the following formula::
(iii) Adjusted Gaap Equity per Adjusted Share, times
(iv) [1+(15% times the number of days since most recent prior month
end divided by 365)]
Note that the Share Repurchase Mechanism and the Share Issuance
Mechanism do not infer an actual repurchase or issuance of the
Company's shares by the Company, but shall merely be used for the
purposes of this Plan in determining Adjusted Shares Outstanding.
(g) GRANT OF EQUITY OPTIONS. Top Management shall select executives who
shall be granted Equity Options. In total, Top Management may grant
35,000 Equity Options under the Plan, subject to subsequent adjustment
as provided in paragraph 8.
-4-
<PAGE> 5
(h) OFFER PERIOD. [Not applicable at this time.]
(i) RIGHTS WITH RESPECT TO EQUITY OPTIONS. A participant to whom Equity
Options are granted (and any person succeeding to such rights pursuant
to the Plan) shall have no rights as a shareholder. Except as provided
in paragraphs 3(c) and 8, no adjustment shall be made for dividends,
distributions or other rights.
(j) TRANSFER. Equity Options shall not be transferable by the participant
otherwise than by will or the laws of descent and distribution, and
shall be exercisable during his lifetime only by him.
(k) EXERCISE AND APPLICABLE FAIR VALUE METHODOLOGY. Outstanding unexercised
Equity Options shall be exercised only under one of the following
conditions (the applicable Fair Value methodology for each such
exercise is indicated below). Note that exercise is mandatory in all
cases except with the written consent of the Company Committee or as
provided for at the time of sale under (viii).
(i) If the number of Equity Rights outstanding under Plan I is
greater than 35% of the number of then outstanding common shares
of the Company, then Equity Rights under Plan I (in the ratio of
1 Equity Share to 5 Equity Options) and Equity Options under
this Plan shall be exercised on a pro rata basis so that the
number of such Equity Rights subsequently outstanding is 35% of
the number of common shares outstanding. Fair Value Method F.
(ii) If within one year of a Change in Control (A) a participant
incurs a Termination Without Cause (section13) or, (B) incurs a
Constructive Termination (section 14) the Equity Options for
such a terminated participant (only) shall be exercised. Fair
Value 50% Method D, 25% Method A and 25% Method B.
(iii) Upon effective termination of the Company's primary business
operations by the Company Board without delivering six months
prior written notice to at least two participants of Plan I.
Fair Value 50% Method D, 25% Method A and 25% Method B.
(iv) Upon effective termination of the Company's primary business
operations by the Company Board after having delivered six
months prior written notice to at least two participants of Plan
I. Fair Value Method F.
(v) Upon sale of more than 50% of the Company's common stock or a
majority of its primary business operations in a private
transaction in which at least $40 million (market value) of the
assets listed in 3(c)(i) are sold to the same purchaser. Fair
Value 50% Method C, 25% Method A and 25% Method B.
(vi) Upon the sale of more than 50% of the Company's common stock or
a majority of its primary business operations including no more
than $40 million (market value) of the assets listed in 3(c)(i).
Fair Value Method E.
(vii) Upon an initial public offering ("ipo") of more than 50% of the
Company's common stock (pro forma for the ipo). Fair Value
Method E.
(viii) Upon sale or ipo of more than 20% but less than 50% of the
Company's common stock, each participant shall be offered the
one time opportunity to exercise on a pro rata basis the number
of Equity Options equal to such participant's then outstanding
unexercised Equity Options times the ratio of common shares of
the Company beneficially owned by the Parent (and/or Ultimate
Parent) to the number of common shares issued and outstanding of
the Company (both of which shall be calculated pro forma for the
sale). Fair Value Method E.
-5-
<PAGE> 6
(ix) December 31, 2002. If the FA Board does not permit management of
the Company (including at least one participant in Plan I) to
solicit a sale or ipo of the Company's primary business
operations within the six months period prior to such date, or
the FA Board refuses to consider or approve a bona fide
transaction presented by management at a price which would cause
the applicable Fair Value for such a transaction to be above
Adjusted Book Value during that same period, then Fair Value
shall be 50% Method D, 25% Method A and 25% Method B. Otherwise,
Fair Value shall be determined according to Method F.
(l) PAYMENT. Upon exercise, the Company shall pay to the participant
the applicable cash value within sixty (60) days, subject to the
completion of a valuation of the Fair Value per Adjusted Share
Outstanding by a third party, if applicable.
(m) DEFERRAL ELECTION. [Not applicable at this time.]
4. EQUITY SHARES [Not applicable at this time.]
5. EQUITY OPTIONS
(a) STRIKE PRICE. The Strike Price shall initially be $49.198. The Strike
Price shall increase each September 1 hereafter by 4% of the
immediately preceding Strike Price.
(b) VESTING. For a participant who remains in the employ of the Company at
May 1, 2001 Equity Options shall vest at such time. Additionally,
Equity Options shall vest sooner as necessary to permit exercise under
section 3(k) for participants employed at the time of such exercise.
However, if a participant voluntarily leaves employment prior to such
vesting then his or her Equity Options shall expire without vesting. In
the case of death or Disability (as defined in section 6) while in the
employ of the Company, Equity Options shall become fully vested as
necessary to permit exercise under 3(k). If a participant is Terminated
Without Cause, Equity Options shall vest pro rata based upon the
termination date and the three year term beginning May 1, 1998 except
in the case of Change in Control and either Termination Without Cause
or Constructive Termination in which case Equity Options shall become
fully vested and shall be exercisable as permitted in section 3(k).
6. DISABILITY
DISABILITY. For the purposes of this Plan, a participant shall be deemed to
be disabled if the Company Committee shall determine that the physical or
mental condition of the participant is such as would entitle him to payment
of monthly disability benefits under any disability plan of the Company or
a subsidiary in which he is a participant.
7. CHANGE IN CONTROL
For purposes of this Plan, a "Change in Control" of the Company shall occur
if any person or group (within the meaning of Sections 13(d) and 14(d)(2)
of the Securities Exchange Act of 1934, as amended ("Exchange Act")), other
than John J. Byrne, Ultimate Parent, Parent or an affiliate of Ultimate
Parent becomes the beneficial owner (within the meaning of Rule 13d-3 under
the Exchange Act) of thirty-five percent (35%) or more of Ultimate Parent
or Parent's then outstanding common shares.
8. DILUTION AND OTHER ADJUSTMENTS
In the event of any change in the then outstanding common shares of the
Company by reason of any stock split, stock dividend, recapitalization,
merger, consolidation, reorganization, combination or exchange of shares or
other similar event, and if the FA Committee shall determine that such
change equitably requires an adjustment
-6-
<PAGE> 7
in the number or kind of Equity Options that may be issued under the Plan
pursuant to paragraph 3, or in any measure of the Fair Value Per Share,
then such adjustment shall be made by the Company Committee and shall be
conclusive and binding for all purposes of the Plan.
9. DESIGNATION OF BENEFICIARY BY PARTICIPANT
A participant may name a beneficiary to receive any payment to which he may
be entitled in respect of Equity Options under the Plan in the event of his
death, on a form to be provided by the Company Committee. A participant may
change his beneficiary from time to time in the same manner. If no
designated beneficiary is living on the date on which any amount becomes
payable to a participant's executors or administrators, the term
"beneficiary" as used in the Plan shall include such person or persons.
10. MISCELLANEOUS PROVISIONS
(a) No employee or other person shall have any claim or right to be granted
Equity Options under the Plan. Neither the Plan nor any action taken
hereunder shall be construed as giving an employee any right to be
retained in the employ of the Company or any subsidiary.
(b) A participant's rights and interest under the Plan may not be assigned
or transferred in whole or in part either directly or by operation of
law or otherwise (except in the event of a participant's death),
including but not limited to, execution, levy, garnishment, attachment,
pledge, bankruptcy or in any other manner and no such right or interest
of any participant in the Plan shall be subject to any obligation or
liability or such participant.
(c) The Company and its subsidiaries shall have the right to deduct from
any payment made under the Plan any federal, state or local income or
other taxes required by law to be withheld with respect to such
payment.
(d) The Plan shall be unfunded. The Company shall not be required to
establish any special or separate fund or to make any other segregation
of assets to assure the payment of any Equity Option under the Plan.
11. AMENDMENT
The Plan may be amended at any time by the Company Board. No amendment of
the Plan shall adversely affect any right of any participant with respect
to any Equity Options previously granted without such participant's written
consent.
12. TERMINATION OF PLAN
This Plan shall terminate upon the earlier of the following dates or events
to occur:
(a) the adoption of a resolution of the Company Board terminating the
Plan; or
(b) five years from the date the Plan is initially approved and adopted by
the Company Board unless extended by action of the Company Board.
No termination of the Plan shall alter or impair any of the rights or
obligations of any person, without his consent, under any Equity Options
previously granted under the Plan.
13. TERMINATION WITHOUT CAUSE
-7-
<PAGE> 8
For purposes of this Plan, Termination Without Cause shall mean the
participant's employment with the Company or any of its subsidiaries is
terminated by the Company or the subsidiary other than (i) for Disability
as described in paragraph 6 or (ii) for Cause. For this purpose "Cause"
shall mean (a) an act or omission by the participant that constitutes a
felony or any crime involving moral turpitude; or (b) willful gross
negligence or willful gross misconduct by the participant in connection
with his employment by the Company or by any of its subsidiaries which
causes, or is likely to cause, material loss or damage to the Company
(directly, or indirectly through a subsidiary).
14. CONSTRUCTIVE TERMINATION
"Constructive Termination" shall mean a termination of employment with the
Company or any of its subsidiaries at the initiative of the participant
that the participant declares by prior written notice delivered to the
Secretary of the Company to be a Constructive Termination by the Company
and which follows (a) a material decrease in his salary, or (b) a material
diminution in the authority, duties or responsibilities of his position
with the result that the participant makes a determination in good faith
that he cannot continue to carry out his job in substantially the same
manner as it was intended to be carried out immediately before such
diminution. Notwithstanding anything herein to the contrary, Constructive
Termination shall not occur within the meaning of this paragraph 14 until
and unless 30 days have elapsed from the date the Company receives such
written notice without the Company curing or causing to be cured the
circumstance or circumstances described in this paragraph 14 on the basis
of which the declaration of Constructive Termination is given.
-8-
<PAGE> 1
EXHIBIT 10(ee)
MORTGAGE LOAN SUBSERVICING AGREEMENT SECOND EXTENSION AMENDMENT
THIS MORTGAGE LOAN SUBSERVICING AGREEMENT SECOND EXTENSION AMENDMENT
("Amendment") is dated as of November 4, 1998, by and between CHASE MANHATTAN
MORTGAGE CORPORATION, formerly known as Chemical Mortgage Company, an Ohio
corporation, with offices at 3415 Vision Drive, Columbus, Ohio 43219
("Servicer") and SOURCE ONE MORTGAGE SERVICES CORPORATION, a Delaware
corporation, with offices located at 27555 Farmington Road, Farmington Hills,
Michigan 48334-3357 ("Subservicer").
WHEREAS, Servicer and Subservicer entered into that certain Mortgage Loan
Subservicing Agreement ("First Subservicing Agreement") relating to the
administration and subservicing of certain mortgage loans, the Servicing to
which was purchased by the Servicer from the Subservicer pursuant to a
FNMA/FHLMC/GNMA Mortgage Servicing Purchase and Sale Agreement ("First Sale
Agreement") between Servicer and Subservicer, dated as of February 28, 1997,
which First Subservicing Agreement and First Sale Agreement were amended by a
Mortgage Loan Subservicing Agreement Extension Amendment ("Extension Amendment")
dated December 11, 1997;
WHEREAS, Servicer and Subservicer entered into that certain Mortgage Loan
Subservicing Agreement ("Second Subservicing Agreement") relating to the
administration and subservicing of certain mortgage loans, the Servicing to
which was purchased by the Servicer from the Subservicer pursuant to a GNMA
Mortgage Servicing Purchase and Sale Agreement ("Second Sale Agreement") between
Servicer and Subservicer, dated as of September 30, 1998 (the First Subservicing
Agreement and the Second Subservicing Agreement shall collectively be referred
to as the "Subservicing Agreements");
WHEREAS, the Servicer and Subservicer desire to amend the First Subservicing
Agreement, the First Sale Agreement, the Extension Amendment, the Second
Subservicing Agreement, and the Second Sale Agreement, as follows:
Servicer elects to extend the terms of the First Subservicing Agreement and the
Second Subservicing Agreement for an additional two (2) years as follows: for
that portion of the Servicing which pertains to GNMA Mortgage Loans and the
owned portfolio to May 31, 2001; for that portion of the Servicing which
pertains to FNMA Mortgage Loans to July 31, 2001; and, for that portion of
Servicing which pertains to FHLMC Mortgage Loans to March 15, 2001, provided,
however, that notwithstanding the one hundred fifty (150) day minimum servicing
period set forth in Section 7 of the Subservicing Agreements, in the event
Servicer changes to first-of-the month cut-off for the GNMA Mortgage Loans, the
termination date for the Servicing of GNMA Mortgage Loans may be revised
downward or upward by up to five (5) calendar days. Nothing in this paragraph
shall affect Servicer's existing rights, pursuant to the terms and provisions of
the Subservicing Agreements, to terminate Subservicer earlier for cause due to a
<PAGE> 2
breach of the Subservicing Agreements, as amended by the terms and provisions of
this Amendment. The one hundred fifty (150) day minimum servicing period set
forth in Section 7 of the Subservicing Agreements shall be reduced to sixty (60)
days in the event that Subservicer does not deliver to Servicer servicing rights
on mortgage loans having an unpaid principal balance of at least $1.5 Billion
dollars within the time frame provided and in accordance with the terms of that
certain Agreement for the Purchase of GNMA Servicing to be executed by and
between Servicer (Correspondent Negotiated Transactions division) and
Subservicer. Within a reasonable time before any Transfer Date, Servicer shall
provide Subservicer updated transfer instructions. Such transfer instructions
shall be mutually acceptable to Servicer and Subservicer.
The definition of Subservicing Fee is hereby amended to provide that effective
June 1, 1999, the compensation to be paid to Subservicer under the Subservicing
Agreements for subservicing any Mortgage Loan in existence on the first day of
each month shall be $1.50 per Mortgage Loan.
Upon written request of Servicer, Subservicer shall repurchase certain
designated GNMA Mortgage Loan delinquencies and service release those
repurchased GNMA Mortgage Loans to Servicer as are identified for release in
such written request. Any such request shall specify the GNMA Mortgage Loan
delinquencies to be repurchased and the repurchased GNMA Mortgage Loan
delinquencies to be service released, and shall be provided to Subservicer at
least two (2) business days prior to the designated buyout date. Servicer shall
provide funds for such buyouts at least one (1) business day prior to the
designated buyout date in an amount equal to the unpaid principal balance of the
GNMA Mortgage Loan plus accrued interest at the pool pass-through rate to the
end of the month in which such repurchase will occur. Within three (3) business
days of the servicing release date, Servicer shall remit to Subservicer any
funds held back from the Purchase Price in connection with any such repurchased
and service released GMNA Mortgage Loan delinquency in accordance with Section
3.2(c) of the First Sale Agreement, together with any outstanding advances in
accordance with the terms of the Subservicing Agreements.
Subservicer represents and warrants that its computer systems are as of the date
of this Amendment, and will continue to be, compliant in the year 2000.
Subservicer shall engage KPMG Peat Marwick, L.L.P., at Subservicer's expense, to
prepare a site inspection regarding Subservicer's year 2000 program management
status. Servicer shall execute the engagement letter setting forth the terms of
the inspection, attached hereto as Exhibit A. Subservicer shall provide Servicer
with a copy of the executed engagement letter and any reports generated in
connection with the services performed under the engagement letter.
As directed by Servicer, Subservicer shall solicit the portfolio for optional
products. In addition to the Subservicing Fee earned, Subservicer shall retain
for each product successfully solicited, $1.75 per Mortgage Loan per month, for
the first 90 days the optional product is in effect, and $0.50 per Mortgage Loan
per month for each month the optional product is maintained. All other fees
associated with the product shall be remitted to Servicer.
Servicer shall remit, within 10 days of the execution of this Amendment, Six
Million Dollars ($6,000,000.00) of the Document Holdback Funds that were
withheld pursuant to Paragraph
<PAGE> 3
3.2(d)(iii) of the First Sale Agreement. The remaining Document Holdback funds
will be released to Subservicer in accordance with Paragraph 3.2(d)(iii) of the
First Sale Agreement.
As of the date of this Agreement, the Servicer is withholding approximately
Fourteen Million Eight Hundred Thousand Dollars ($14,800,000.00) of the Purchase
Price according to Paragraph 3.2(c) of the First Sale Agreement. Servicer shall
remit, within 10 days of the execution of this Amendment, all but Twelve Million
Dollars ($12,000,000.00) of the remaining Purchase Price. The remaining funds
shall continue to bear interest and be held by Servicer until the Payment Date
in accordance with Paragraph 3.2(c) of the First Sale Agreement.
All other terms of the Subservicing Agreements, the First Sale Agreement, the
Extension Amendment and Second Sale Agreement shall remain in full force and
effect. Only the amended provisions listed above shall constitute changes or
additions to such agreements.
<PAGE> 4
IN WITNESS WHEREOF, each of the undersigned parties to this Amendment has caused
this Amendment to be duly executed in its corporate name by one of its duly
authorized officers, all as of the date first written above.
SERVICER:
ATTEST: CHASE MORTGAGE
CORPORATION
By: /s/ Judith A. Wolfe, By: /s/ J. Gregory Harrington
---------------------------- -------------------------------
Title: JUDITH A. WOLFE, AVP Title: J. GREGORY HARRINGTON, VICE PRESIDENT
------------------------ ----------------------------
Date: NOVEMBER 4, 1998 Date: NOVEMBER 4, 1998
-------------------------- ----------------------------
SUBSERVICER:
ATTEST: SOURCE ONE MORTGAGE
SERVICES CORPORATION
Judith S. McDonough By: /s/ Melinda F. Cain
Judith S. McDonough -------------------------------
November 24, 1998 Title: MELINDA F. CAIN
----------------------------
SENIOR VICE PRESIDENT
----------------------------
Date: Nov. 4, 1998
-----------------------------
<PAGE> 1
- --------------------------------------------------------------------------------
Exhibit 10(ff)
ASSET PURCHASE AGREEMENT
Dated as of
March 23, 1999
by and among
Source One Mortgage Services Corporation,
as Seller,
Fund American Enterprises Holdings, Inc.,
as Parent,
and
Citicorp Mortgage, Inc.,
as Purchaser
<PAGE> 2
TABLE OF CONTENTS
Page
----
ARTICLE I - Certain Definitions...............................................1
Section 1.01 Certain Definitions..........................................1
ARTICLE II - Transfer of Assets and Assumption of Liabilities.................8
Section 2.01 Assets to be Sold............................................8
Section 2.02 Nonassignable Permits, Licenses, Leases and Contracts........10
Section 2.03 Liabilities Assumed by the Purchaser.........................11
Section 2.04 Liabilities Not Assumed by the Purchaser.....................11
ARTICLE III - Payment.........................................................12
Section 3.01 Calculation of Payment.......................................12
ARTICLE IV - Representations and Warranties of the Seller and the Parent......15
Section 4.01 Organization of the Seller and the Parent....................15
Section 4.02 Subsidiaries.................................................15
Section 4.03 Power and Authority..........................................15
Section 4.04 No Conflicts.................................................15
Section 4.05 Litigation; Compliance with Laws.............................16
Section 4.06 Financial Statements; SEC Reports............................17
Section 4.07 Purchased Assets; Real Property; Leases and Other
Contracts; Insurance.........................................18
Section 4.08 Employee Benefit and Pension Plan Matters....................19
Section 4.09 Labor Relations..............................................19
Section 4.10 Mortgage Loans...............................................20
Section 4.11 [Reserved]...................................................26
Section 4.12 Transactions with Affiliates.................................26
Section 4.13 Interest Rate Risk Management Instruments....................26
Section 4.14 Intellectual Property........................................27
Section 4.15 Environmental Liability......................................29
Section 4.16 Brokers......................................................29
Section 4.17 Information Supplied; Accuracy of Data.......................29
Section 4.18 Taxes........................................................30
ARTICLE V - Representations and Warranties of the Purchaser...................31
Section 5.01 Organization of the Purchaser................................31
Section 5.02 Power and Authority..........................................31
Section 5.03 No Conflicts.................................................31
Section 5.04 Brokers......................................................32
Section 5.05 Licenses.....................................................32
i
<PAGE> 3
ARTICLE VI - Employee and Employee-Related Matters............................32
Section 6.01 Basic Employment Matters.....................................32
Section 6.02 Defined Benefit Plans........................................33
Section 6.03 Defined Contribution Plans...................................33
Section 6.04 Severance Arrangements.......................................34
Section 6.05 Other Employee Benefits......................................34
ARTICLE VII - Closing.........................................................35
Section 7.01 The Closing..................................................35
ARTICLE VIII - Conditions to Obligations of the Purchaser to Consummate
the Transaction................................................35
Section 8.01 Representations and Warranties; Compliance with Covenants....35
Section 8.02 No Injunction................................................36
Section 8.03 Approvals....................................................36
Section 8.04 Third Party Consents.........................................36
Section 8.05 Bill of Sale, etc............................................36
Section 8.06 Survey; Title Policies.......................................36
Section 8.07 Employment Agreement.........................................36
Section 8.08 Transfer Instructions........................................36
ARTICLE IX - Conditions to Obligations of the Seller and the Parent to
Consummate the Transaction.......................................37
Section 9.01 Representations and Warranties; Compliance with Covenants....37
Section 9.02 No Injunction................................................37
Section 9.03 Approvals....................................................37
Section 9.04 Third Party Consents.........................................37
Section 9.05 Assumption Agreement.........................................37
ARTICLE X - Covenants.........................................................38
Section 10.01 HSR Filings.................................................38
Section 10.02 Injunctions.................................................38
Section 10.03 Access to Information.......................................38
Section 10.04 No Extraordinary Actions by the Seller......................38
Section 10.05 Commercially Reasonable Efforts; Further Assurances.........40
Section 10.06 Bulk Sales Laws.............................................41
Section 10.07 Insurance and Benefits Contracts............................41
Section 10.08 Use of Names................................................41
Section 10.09 Transfer of Mortgage Loans..................................41
Section 10.10 Mail Received After Closing.................................42
Section 10.11 Confidentiality; Publicity..................................42
Section 10.12 Transition Services.........................................42
Section 10.13 Access to Records After the Closing.........................42
Section 10.14 Title Commitments; Surveys..................................43
Section 10.15 Updated Mortgage Loan Schedule..............................44
Section 10.16 System Upgrade..............................................44
Section 10.17 Final Certification and Recertification, etc................44
ii
<PAGE> 4
Section 10.18 Repurchase of Mortgage Loans................................44
Section 10.19 Agreement Not to Compete; Non-Solicitation..................45
Section 10.20 Parent Guarantee............................................46
Section 10.21 Redemption of QUICS.........................................46
Section 10.22 Collection of Receivables...................................46
Section 10.23 SOM.........................................................47
Section 10.24 Private Label Subservicing Capability.......................47
Section 10.25 Northwest Pacific...........................................47
ARTICLE XI - Tax Matters......................................................48
Section 11.01 Allocation of Responsibility................................48
Section 11.02 Tax Returns.................................................48
Section 11.03 Tax Sharing and Tax Payment Agreements......................49
Section 11.04 Assistance and Cooperation..................................49
Section 11.05 Record Retention............................................50
Section 11.06 Contest.....................................................50
Section 11.07 Section 338(h)(10) Election.................................50
Section 11.08 Allocation of Purchase Price................................51
Section 11.09 Purchaser Activity on Closing Date and Post-Closing.........51
Section 11.10 Liability for Taxes and Related Matters.....................52
ARTICLE XII - Survival and Indemnification....................................53
Section 12.01 Survival....................................................53
Section 12.02 Indemnification by the Seller...............................53
Section 12.03 Indemnification by the Purchaser............................54
Section 12.04 Procedures for Making Claims Against Indemnifying Party.....54
Section 12.05 Limitations and Rules of Construction Regarding
Indemnification Obligations.................................55
Section 12.06 Defense of Claims...........................................56
Section 12.07 Remedies Exclusive..........................................57
ARTICLE XIII - Termination....................................................58
Section 13.01 Termination.................................................58
Section 13.02 Obligations Shall Cease.....................................58
Section 13.03 Fees and Expenses...........................................58
ARTICLE XIV - Miscellaneous...................................................58
Section 14.01 Complete Agreement..........................................58
Section 14.02 Waiver, Discharge, etc......................................58
Section 14.03 Notices.....................................................59
Section 14.04 Governing Law; Waiver of Jury Trial.........................60
Section 14.05 Headings....................................................60
Section 14.06 Successors..................................................60
Section 14.07 Third Parties...............................................60
Section 14.08 Counterparts................................................60
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EXHIBITS
Exhibit A Form of Assumption Agreement
Exhibit B Form of Bill of Sale
Exhibit C Form of Transition Services Agreement
Exhibit D Form of Trademark Assignment
Exhibit E Form of Claim Notice
Appendix I 1998 Financial Statements
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SCHEDULES
Schedule 1.01 Disclosure Schedule
Schedule 2.01(a) Purchased Assets
Schedule 2.01(b) Excluded Assets
Schedule 2.03 Assumed Liabilities
Schedule 2.04 Subsidiary Obligations
Schedule 3.01(a) Closing Statement Procedures
Schedule 3.01(a)(ii) Chase Allocation
Schedule 5.03 Purchaser's Conflicts and Approvals
Schedule 6.01(a) Basic Employment Matters
Schedule 6.01(c) "Reinstated" Employees
Schedule 8.04 Third Party Consents (Purchaser's Condition)
Schedule 8.07 Employment Agreements
Schedule 8.08 Transfer Instructions
Schedule 9.04 Third Party Consents (Seller's Condition)
Schedule 10.04(a)(iv) Capital Expenditures
Schedule 10.04(a)(vi) Open Employee Requisitions
Schedule 10.16 System Upgrade
Schedule 10.22 Collection of Accounts
Schedule 10.23 SOM Approvals to Be Obtained
Schedule 12.05(b) Disregarded Exceptions
DISCLOSURE SCHEDULE
Sections 4.04, 4.05(b), 4.05(c), 4.06(c), 4.06(e), 4.07(a), 4.07(b), 4.07(c),
4.07(d), 4.08(a), 4.10(a), 4.10(f), 4.10(i)(A), 4.10(i)(B), 4.10(j), 4.10(k),
4.10(l), 4.10(q), 4.10(r)(i), 4.10(r)(ii), 4.10(u), 4.10(v)(iii), 4.12, 4.14(a),
4.14(c), 4.14(d), 4.14(f), 4.14(g), 4.17, 4.18(a)(iii), 4.18(a)(vii), 4.18(a)(x)
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ASSET PURCHASE AGREEMENT
ASSET PURCHASE AGREEMENT dated as of March 23, 1999, among Source One
Mortgage Services Corporation, a Delaware corporation (the "Seller"), Fund
American Enterprises Holdings, Inc., a Delaware corporation and the direct or
indirect owner of all of the common stock of the Seller (the "Parent"), and
Citicorp Mortgage, Inc., a Delaware corporation (the "Purchaser").
W I T N E S S E T H:
WHEREAS, upon the terms and subject to the conditions of this Agreement,
the Seller desires to sell, convey, assign, transfer and deliver to the
Purchaser, and the Purchaser desires to purchase and acquire from the Seller,
substantially all of the assets, subject to certain of the liabilities, of the
Seller's business of origination, selling and servicing of residential and
commercial mortgage loans and Seller's business relating to the sale of certain
insurance products (collectively, the "Business");
NOW, THEREFORE, in consideration of the premises and the mutual promises
and covenants contained herein, the parties hereby agree as follows:
ARTICLE I
CERTAIN DEFINITIONS
Section 1.01 CERTAIN DEFINITIONS. As used in this Agreement, unless the
context requires otherwise, the following terms shall have the meanings
indicated, and additional capitalized terms shall have the meanings assigned
elsewhere in this Agreement (with terms being defined in the singular having a
corresponding meaning in the plural and vice versa):
"ADJUSTMENT SCHEDULE" has the meaning assigned in Section 3.01(c).
"AFFILIATE" of any Person means any other Person, existing or future,
directly or indirectly, Controlling, Controlled by or under common Control with
the former Person.
"APPLICABLE REQUIREMENTS" means, with respect to a Mortgage Loan, all
applicable contractual requirements (including contractual requirements of
private investors), all applicable Laws, all requirements of any insurer under
any applicable Primary Insurance Policy, and all applicable requirements and
guidelines of FNMA, FHLMC, HUD, GNMA, FHA and VA.
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"APPRAISED VALUE" means with respect to any Mortgaged Property, the lesser
of (i) the purchase price paid for the related Mortgaged Property by the
Mortgagor with the proceeds of the Mortgage Loan and (ii) the value thereof as
determined by an appraisal made for the originator of the Mortgage Loan at the
time of origination of the Mortgage Loan by an appraiser who met the minimum
requirements of FNMA, FHLMC and HUD (an "approved appraiser"), provided,
however, in the case of a Refinanced Mortgage Loan, either (x) the appraisal was
made at the time of origination of such Refinanced Mortgage Loan by an approved
appraiser or (y) if a new appraisal was not needed to satisfy the Applicable
Requirements, the appraisal was made for the originator of the mortgage loan
that was replaced by such Refinanced Mortgage Loan at the time of origination of
such initial mortgage loan by an approved appraiser.
"APPROVALS" means franchises, licenses, permits, certificates of occupancy
and other approvals, authorizations and consents.
"ASSIGNMENT OF MORTGAGE" means an individual assignment of the Mortgage,
notice of transfer or equivalent instrument in recordable form, sufficient under
the laws of the jurisdiction wherein the related Mortgaged Property is located
to give record notice of the sale of the Seller's interest in the Mortgage to
the Purchaser or its designee.
"ASSUMED LIABILITIES" has the meaning assigned in Section 2.03.
"ASSUMPTION AGREEMENT" means a duly executed assumption agreement in
substantially the form of Exhibit A hereto.
"BILL OF SALE" means a duly executed bill of sale in substantially the
form of Exhibit B hereto.
"BUSINESS" has the meaning assigned in the preamble to this Agreement.
"BUSINESS DAY" means any day on which the Seller, Parent, Purchaser and
commercial banks in New York City and Michigan are open for business.
"CLOSING" means the closing of the transactions contemplated by this
Agreement.
"CLOSING DATE" means the date on which the Closing actually occurs.
"CLOSING STATEMENT" has the meaning assigned in Section 3.01(a).
"CODE" means the Internal Revenue Code of 1986, as amended.
"COMMERCIALLY REASONABLE EFFORTS" means the efforts that a prudent Person
desirous of achieving a result would use in similar circumstances to ensure that
such result is achieved in the required time frame.
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"CONTRACT" means any note, bond, mortgage, indenture, deed of trust,
license agreement, franchise, contract, agreement, Lease, instrument or
guarantee.
"CONTROL" means the power to direct or cause the direction of the
management and policies of another Person, whether through the ownership of
voting securities, by contract or otherwise.
"CONVENTIONAL MORTGAGE LOAN" means any Mortgage Loan that is neither an
FHA Loan nor a VA Loan.
"CUT-OFF DATE" has the meaning assigned in Section 4.10(b).
"DISCLOSURE SCHEDULE" means the disclosure schedule attached hereto as
Schedule 1.01.
"EMPLOYEES" has the meaning assigned in Section 6.01.
"EMPLOYEE PLANS" has the meaning assigned in Section 4.08.
"EMPLOYER" has the meaning assigned in Section 6.01.
"EXCLUDED ASSETS" has the meaning assigned in Section 2.01(b).
"FHA INSURANCE CONTRACT" or "FHA INSURANCE" means the contractual
obligation of FHA respecting the insurance of an FHA Loan pursuant to the
National Housing Act, as amended.
"FHA LOAN" means a Mortgage Loan which is the subject of an FHA Insurance
Contract as evidenced by a Mortgage Insurance Certificate.
"GAAP" means generally accepted accounting principles, applied
consistently with the Seller's past practices (to the extent such past practices
are consistent with generally accepted accounting principles).
"GAAP BOOK VALUE" means book value determined in accordance with GAAP.
"GOVERNMENTAL AGENCY" means any governmental body or other regulatory or
administrative agency or commission (including FNMA, FHLMC and GNMA).
"HAZARDOUS MATERIALS" means (a) any petroleum or petroleum products,
radioactive materials, asbestos in any form that is or could become friable,
polychlorinated biphenyls and radon gas; (b) any chemicals, materials or
substances defined as or included in the definition of "hazardous substances,"
"hazardous waste," "hazardous materials," "extremely hazardous substances,"
"toxic substances," "toxic pollutants," "contaminants," or "pollutants," or
words of similar import, under any applicable Laws; and (c) any materials which
could be or are defined by any applicable Law to be hazardous to human health.
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"INCOME TAX" means any federal, state, local, or foreign income or
franchise tax, and any other tax imposed on or measured by income, including any
interest, penalty, or addition thereto, whether disputed or not.
"INCOME TAX RETURN" means any return, declaration, report, claim for
refund, or information return or statement relating to Income Taxes, including
any schedule or attachment thereto.
"INDEMNIFIABLE LOSS" means a Purchaser Indemnifiable Loss or a Seller
Indemnifiable Loss, as such terms are defined in Section 12.02 and Section
12.03, respectively.
"INDEMNIFIED PARTY" has the meaning assigned in Section 12.05.
"INDEMNIFYING PARTY" means a party having indemnification obligations
pursuant to Article XII.
"INTELLECTUAL PROPERTY RIGHTS" means any and all of the following used in
or related to the Business: (i) trade secrets, inventions, ideas and conceptions
of inventions, whether or not patentable, whether or not reduced to practice,
and whether or not yet made the subject of a patent application or applications,
(ii) United States, international and foreign patents, patent, applications and
statutory invention registrations, all rights therein provided by international
treaties or conventions and all improvements thereto, (iii) trademarks, service
marks, certification marks, collective marks, trade dress, logos, domain names,
product configurations, trade names, business names, corporate names, and other
source identifiers, whether or not registered, whether currently in use or not,
including all common law rights, and registrations and applications for
registration thereof, all rights therein provided by international treaties or
conventions, and all reissues, extension and renewals of any of the foregoing,
(iv) copyrightable works, copyrights, whether or not registered, and
registrations and applications for registration thereof in the United States or
any foreign country, and all rights therein provided by international treaties
or conventions, (v) Software, (vi) technical and business information, including
know-how, manufacturing and production processes and techniques, research and
development information, technical data, financial, marketing and business data,
pricing and cost information, business and marketing plans, and customer and
supplier lists and information, whether or not confidential, (vii) copies and
tangible embodiments of all the foregoing, in whatever form or medium, (viii)
licenses and sublicenses (whether as licensee, sublicensee, licensor or
sublicensor) in connection with any of the foregoing, and (ix) all goodwill
associated with the foregoing and all rights to sue or recover and retain
damages and costs and attorneys' fees for past, present, and future infringement
or breach of any of the foregoing; provided that Intellectual Property Rights
shall not include readily available commercial products such as off-the-shelf or
publicly vended software programs.
"JUDGMENT" means any judgment, ruling, order or decree.
"KNOWLEDGE" by a Person of a particular fact or matter means that a member
of senior management of such Person (i.e., a senior vice president or more
senior officer), after reasonable investigation, is actually aware of such fact
or matter, provided that any such member of senior
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management shall be presumed to know such fact or matter based on facts,
circumstances or information contained or described in the books, records or
files of such Person.
"LAW" means any order, writ, injunction, decree, judgment, ruling, law,
decision, opinion, statute, rule or regulation of any governmental, judicial,
legislative, executive, administrative or regulatory authority of the United
States, or of any state, local or foreign government or any subdivision thereof,
or of any Governmental Agency, including, without limitation, any federal, state
or local fair lending laws.
"LEASE" means any lease, sublease, easement, license, right-of-way or
similar interest in real or personal property.
"LIEN" means any lien, easement, encumbrance, mortgage or other
conflicting ownership or security interest in favor of any third party.
"LITIGATION" means any action, suit, claim, proceeding, investigation or
written inquiry by or before any Governmental Agency, court or arbitrator.
"LOAN GUARANTY CERTIFICATE" means the certificate evidencing a VA Guaranty
Agreement.
"LOAN-TO-VALUE RATIO" or "LTV" means with respect to any Mortgage Loan as
of any date of determination, the ratio on such date of the outstanding
principal amount of the Mortgage Loan to the Appraised Value of the Mortgaged
Property.
"MATERIAL ADVERSE EFFECT" or "MATERIAL ADVERSE CHANGE", with respect to
any party or with respect to the Business, means any change, occurrence or
effect, direct or indirect, that would have a material adverse effect on the
business, operations, properties (including tangible properties), financial
condition, assets, obligations or liabilities (whether absolute, accrued or
contingent) of such party and its subsidiaries taken as a whole or of the
Business taken as a whole, as the case may be.
"MORTGAGE" means the mortgage, deed of trust or other instrument creating
a lien on Mortgaged Property securing the Mortgage Note.
"MORTGAGE INSURANCE CERTIFICATE" means the certificate evidencing an FHA
Insurance Contract.
"MORTGAGE LOANS" means (i) the mortgage loans (including subprime loans)
and Pipeline Loans owned by Seller or the Subsidiaries and (ii) without
duplication, the mortgage loans for which Seller or a Subsidiary owns the
related Servicing Rights, in each case as identified on the Mortgage Loan
Schedule, and all of Seller's or a Subsidiary's rights and benefits with respect
thereto, including without limitation rights with respect to related payments
and proceeds (including real estate acquired in respect of a mortgage loan).
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"MORTGAGE LOAN SCHEDULE" has the meaning assigned in Section 4.10(b).
"MORTGAGE NOTE" means the original executed note or other evidence of the
Mortgage Loan indebtedness of a Mortgagor.
"MORTGAGED PROPERTY" means the Mortgagor's real property securing
repayment of a related Mortgage Note.
"MORTGAGOR" means the obligor on a Mortgage Note, the owner of the
Mortgaged Property and the grantor or mortgagor named in the related Mortgage
and such grantor's or mortgagor's successors in title to the Mortgaged Property.
"NET PURCHASE PRICE" has the meaning assigned in Section 3.01(a).
"OWNED MORTGAGE LOANS" means those mortgage loans referred to in clause
(i) of the definition of "Mortgage Loans".
"PERSON" means an individual, a corporation, a limited liability company,
a partnership, an unincorporated association, a joint venture, a government or
Governmental Agency or another entity or group.
"PRE-CLOSING SERVICING OBLIGATIONS" has the meaning assigned in Section
2.03.
"PIPELINE LOAN" means each pending mortgage loan to be secured by
residential real property by a mortgage lien (i) with respect to which Seller or
its Subsidiaries has (a) issued a commitment or otherwise agreed with an
applicant to fund, (b) determined to fund, (c) committed to a specified interest
rate or (d) issued a commitment (including, without limitation, bulk commitments
or assignments of trades) or otherwise agreed with a broker or correspondent
originator or purchaser to purchase and (ii) which has not closed or been
purchased from a correspondent as of the Closing Date.
"PRIMARY INSURANCE POLICY" means a policy of primary mortgage guaranty
insurance issued by an insurer acceptable to FNMA, FHLMC and any private
investor.
"PURCHASED ASSETS" has the meaning assigned in Section 2.01(a).
"QUICS" has the meaning assigned in Section 2.03.
"REFINANCED MORTGAGE LOAN" means a Mortgage Loan the proceeds of which
were not used to purchase the related Mortgaged Property.
"RELATED DOCUMENTS" means all other agreements and instruments described
in this Agreement that are to be executed and delivered at or prior to the
Closing in connection with the transactions contemplated hereby.
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"RETAINED LIABILITIES" has the meaning assigned in Section 2.04.
"SELLER IPR" means all Intellectual Property Rights owned by or licensed
to the Seller or a Subsidiary.
"SERVICING RIGHTS" means the right, title and interest of the Seller and
each Subsidiary in and to the servicing of the Mortgage Loans.
"SOFTWARE" means computer software and subsequent versions thereof
developed or currently being developed, manufactured, sold or marketed by the
Seller or any Subsidiary or acquired from third parties, including without
limitation, source code, object code, objects, comments, screens, user
interfaces, report formats, templates, menus, buttons and icons, and all files,
data materials, manuals, design notes and other items and documentation related
thereto or associated therewith.
"SUBSERVICED MORTGAGE LOANS" means the mortgage loans identified as such
on the Mortgage Loan Schedule.
"SUBSERVICING RIGHTS" means the right, title and interest of the Seller
and each Subsidiary in and to the subservicing of the Subserviced Mortgage
Loans.
"SUBSIDIARIES" means Central Pacific Mortgage Corporation ("CPM"), CMC
Insurance Agency, Inc., MHMC Insurance Agency, Inc., SOMSC Services, Inc. and
Source One Mortgage Corporation ("SOM"), the wholly owned subsidiaries of the
Seller.
"TAXES" (including, with correlative meaning, the term "TAXABLE") means
all taxes, charges, fees, duties, levies, or other assessments imposed by any
federal, state, local or foreign taxing authority, including without limitation
federal, state, local and foreign income, profits, franchise, gross receipts,
environmental, customs duty, severances, stamp, payroll, sales, use, employment,
unemployment, disability, property, withholding, backup withholding, excise,
production, occupation, service, service use, leasing and leasing use, AD
VALOREM, value added, occupancy, transfer, and other taxes, of any nature
whatsoever, together with all interest, penalties and additions imposed with
respect to such amounts and any interest in respect of such penalties and
additions.
"TAX RETURNS" means all returns and reports, information returns, or payee
statements (including, but not limited to elections, declarations, filings,
forms, statements, disclosures, schedules, estimates and information returns)
required to be supplied to a Tax authority relating to Taxes.
"THIRD PARTY IPR" means the rights possessed by the Seller or any
Subsidiary in any other Person's Intellectual Property Rights, including without
limitation, patents, copyrights, trademarks, or trade secrets, which relate to
or are used in the Business and which are not owned by the Seller or any
Subsidiary.
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"TRADE SECRETS" means each trade secret included in the Intellectual
Property Rights.
"TRADEMARK ASSIGNMENT" means a duly executed trademark assignment in
substantially the form of Exhibit D hereto.
"TRANSFER INSTRUCTIONS" means the transfer instructions identified on
Schedule 8.08.
"TRANSITION SERVICES AGREEMENT" has the meaning assigned in Section 10.12.
"VA GUARANTY AGREEMENT" means the obligation of the United States to pay a
specific percentage of a Mortgage Loan (subject to a maximum amount) upon
default of the Mortgagor pursuant to the Serviceman's Readjustment Act, as
amended.
"VA LOAN" means a Mortgage Loan which is the subject of a VA Guaranty
Agreement as evidenced by a Loan Guaranty Certificate.
"VA NO-BID" means a VA no-bid or a VA buydown.
"YEAR 2000 COMPLIANT" means, with respect to an internal system, that at
all times before, during and after January 1, 2000, such internal system
accurately processes and handles date and time data from, into and between the
twentieth and twenty-first centuries, and the years 1999 and 2000, including,
without limitation, leap year calculations, to the extent that other information
technology used in combination with such internal systems and such products and
services properly exchange date and time data with it.
ARTICLE II
TRANSFER OF ASSETS AND
ASSUMPTION OF LIABILITIES
Section 2.01 ASSETS TO BE SOLD.
(a) Upon the terms and subject to the conditions of this Agreement, at the
Closing, the Seller shall sell, convey, assign, transfer and deliver to the
Purchaser all of the properties, Contracts, Approvals, rights and assets (of
every kind, nature, character and description, real, personal or mixed, tangible
or intangible, accrued, contingent or otherwise, and wherever situated) of the
Seller, other than the Excluded Assets. Such assets and property shall include,
without limitation, all right, title and interest of the Seller in all land,
offices, buildings (together with improvements, appurtenances, licenses and
permits), motor vehicles, equipment, furniture and fixtures, supplies,
stationery, cash and cash equivalents, Owned Mortgage Loans, other loans, the
Servicing Rights, the Subservicing Rights, accrued interest, interests in real
estate investment conduits, securities, hedging instruments (other than hedges
relating to the Servicing Rights), accounts receivable (including written-off
accounts), bank accounts (including escrow accounts), credits, deferred
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charges, security deposits, advance payments, prepaid expenses, deposits,
Approvals of any Governmental Agency or other third party, claims (including
insurance claims), suits and judgments against third parties (including warranty
claims relating to goods, equipment or real property sold to the Seller and
claims arising from the infringement of any Intellectual Property Right), all of
the outstanding capital stock of the Subsidiaries, the Seller's investment in
MERSCORP, Inc., the right to receive mail, payments on loans and accounts
receivable and other communications, Software and licenses and other rights to
use Software, lists of customers and suppliers, other files and business
records, advertising materials, customer application forms, Seller IPR, Third
Party IPR, the Seller's right, title and interest in Contracts and the goodwill
associated with the foregoing, but shall not include the Excluded Assets. All
the assets to be transferred pursuant to this Agreement are referred to
collectively herein as the "Purchased Assets". The Purchased Assets shall
include, without limitation, all assets in the categories described on Schedule
2.01(a) owned by the Seller immediately prior to the Closing. For purposes of
this Agreement, except where the context requires otherwise, the properties,
contracts, rights and assets of the Subsidiaries shall be considered Purchased
Assets.
(b) Notwithstanding anything to the contrary in this Agreement, the
Purchased Assets shall not include any of the following (the "Excluded Assets"):
(i) any deferred Tax assets and current Tax receivables relating to the Seller
and the Subsidiaries; (ii) any claims, refunds, credits or overpayments with
respect to any Taxes paid or incurred by the Seller and its Affiliates, or any
related interest received from the relevant taxing authority for periods ending
prior to the Closing Date, and the appropriately prorated portion thereof for
periods commencing prior to the Closing Date and ending on or after the Closing
Date; (iii) the rights of the Seller under this Agreement and the Related
Documents; (iv) the minute books, stock transfer books, seal and general
corporate accounting records of the Seller; (v) Contracts relating to any
Employee Plans (other than those relating to post-Closing benefits provided to
or for the benefit of persons who are employees of CPM on the Closing Date) and
Contracts to make any payment to an employee, officer or director of the Seller
or an Affiliate; (vi) Contracts between the Seller on the one hand and the
Parent or its Affiliates (other than the Subsidiaries) on the other hand, and
any claims or rights of the Seller thereunder, except as provided in the
Transition Services Agreement; (vii) insurance policies (other than financial
guarantee or similar policies insuring other Purchased Assets); (viii) any
capital stock of, or other investments in, Financial Security Assurance Holdings
Ltd. ("FSA"), US West Inc., Northwest Pacific Mortgage Company ("Northwest
Pacific") or any other corporation of which the Seller owns less than all of the
outstanding capital stock (except for the Seller's investment in MERSCORP,
Inc.), and the Seller's interest in Insurance Partners L.P.; (ix) any mortgage
loans or servicing or subservicing rights not identified on the Mortgage Loan
Schedule; (x) hedging instruments related to the Servicing Rights; (xi) prepaid
expenses related to any of the foregoing; (xii) recorded goodwill; and (xiii)
without duplication, all assets listed on Schedule 2.01(b).
(c) The sale, conveyance, assignment, transfer and delivery of the
Purchased Assets shall be effected by delivery by the Seller to the Purchaser at
the Closing or otherwise in accordance with the Transfer Instructions of (i) the
Bill of Sale and the Trademark Assignment, (ii) good and sufficient warranty
deeds in recordable or registrable form, with respect to all real property owned
by the Seller and included in the Purchased Assets, (iii) certificates
representing all
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of the outstanding stock of each of the Subsidiaries, duly endorsed in blank or
accompanied by stock powers duly endorsed in blank, (iv) endorsements in blank
(or otherwise as required by Applicable Requirements) of Mortgage Notes and
Assignments of Mortgage with respect to the Seller's and the Subsidiaries'
Mortgage Loans sufficient to transfer all of the Seller's and the Subsidiaries'
right, title and interest in the Mortgage Loans and (v) such other instruments
of conveyance and transfer as the Purchaser shall reasonably request in
accordance with the Transfer Instructions or otherwise.
Section 2.02 NONASSIGNABLE PERMITS, LICENSES, LEASES AND CONTRACTS.
(a) To the extent that any Contract or Approval to be included in the
Purchased Assets would be subject to termination or restriction or is not
capable of being assigned, transferred, subleased or sublicensed without the
consent or waiver of the issuer thereof or the other party thereto or any third
party, or if such assignment, transfer or sublease would constitute a breach
thereof or a violation of any Law, this Agreement shall not constitute an
assignment, transfer, sublease or sublicense thereof.
(b) The Seller agrees to use Commercially Reasonable Efforts prior to the
Closing to obtain the consents and waivers and to resolve any impracticalities
of assignment referred to in Section 2.02(a) and to obtain any other consents
and waivers necessary to sell, convey, assign, transfer and deliver title to
such Purchased Assets to the Purchaser at the Closing, subject to Section
10.05(b).
(c) To the extent that the consents and waivers referred to in Section
2.02(a) are not obtained by the Seller, or until the impracticalities of
transfer referred to therein are resolved, and subject to Section 10.05(b), (i)
the Seller shall use Commercially Reasonable Efforts (x) to provide to the
Purchaser the benefits of any Contract or Approval intended to be included in
the Purchased Assets, (y) to cooperate in any arrangement, reasonable and lawful
as to the Seller and the Purchaser, designed to provide such benefits to the
Purchaser and (z) at the Purchaser's request, to enforce for the account and at
the expense of the Purchaser any rights of the Seller arising from the Contracts
and Approvals intended to be included among the Purchased Assets, including the
right to elect to terminate or not renew in accordance with the terms thereof on
the advice of the Purchaser, which termination shall, upon becoming effective,
relieve the Seller of any further obligation under this Section 2.02(c) with
respect to such Contract or Approval, and (ii) after the Closing, the Purchaser
shall use Commercially Reasonable Efforts to perform the obligations of the
Seller arising under such Contracts and Approvals, to the extent the Purchaser
receives the benefit thereof. The Seller and the Purchaser shall cooperate with
each other to take such actions, including entering into subservicing agreements
or similar arrangements, as are reasonably calculated to effectuate the intent
of the preceding sentence. Notwithstanding anything to the contrary in the
foregoing, the Purchaser may determine, in its reasonable discretion, that any
Contract (except with respect to servicing or subservicing agreements) or
Approval for which the required consents and waivers referred to in Section
2.02(a) are not obtained by the Seller, or the impracticalities of transfer
referred to therein are not resolved, by the Business Day prior to the Closing
Date, shall not be a Purchased Asset, and in that event all rights and
obligations with respect to such Contract or
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Approval shall be retained by the Seller. The Purchaser shall give notice to the
Seller of any such determination on or within 30 days after the Closing Date,
provided that at the time of such notice such consents and waivers have not been
obtained, and such impracticalities of transfer have not been resolved. The
Purchaser shall, upon request of the Seller, use Commercially Reasonable Efforts
to provide the following assistance to the Seller in connection with its
attempting to obtain any consents or waivers required hereunder: (i) providing
reasonable access to an appropriate employee or employees of the Purchaser
solely for the purpose of speaking with third parties (from whom any consents or
waivers are requested by the Seller) concerning the general nature of the
business of the Purchaser to the extent it relates to the Purchaser's
obligations to acquire the Purchased Assets and the Contracts and (ii) the
provision of financial information concerning the Purchaser, subject to
customary confidentiality arrangements.
Section 2.03 LIABILITIES ASSUMED BY THE PURCHASER. Upon the terms and
subject to the conditions of this Agreement, the Purchaser agrees to assume as
of the Closing Date the following liabilities of the Seller (collectively, the
"Assumed Liabilities"), and only such liabilities: (i) the liabilities set forth
on Schedule 2.03, including without limitation the Seller's obligations under
$92 million principal amount of 9% debentures due June 1, 2012 (the
"Debentures"), $18.723 million principal amount due October 15, 2001 (the
"Notes") and $55.976 million principal amount of quarterly income capital
securities (the "QUICS"), provided that such liabilities and obligations that
accrue, or arise out of or are based on acts or omissions occurring, prior to
the Closing Date shall be Assumed Liabilities only to the extent they are
reflected on the Adjustment Schedule; (ii) the liabilities and obligations of
the Seller that accrue based on services performed on or after the Closing Date
under all Contracts and Approvals included in the Purchased Assets; (iii)
subject to Section 12.02(d), liabilities relating to VA No-bids in connection
with Mortgage Loans originated or committed prior to the Closing Date; and (iv)
subject to Section 12.02(e), obligations ("Pre-Closing Servicing Obligations")
with respect to (A) customary representations and warranties made in connection
with Mortgage Loans sold prior to the Closing Date, with Servicing Rights
retained by the Seller and (B) performance by the Seller prior to the Closing
Date of its duties under the Servicing Rights in accordance with their terms.
For the avoidance of doubt, it is understood that Pre-Closing Servicing
Obligations shall not include (i) any credit-related or other recourse,
indemnification or similar obligations (other than for breaches of customary
representations and warranties) and (ii) any liabilities or obligations of the
Seller based on or arising out of any violations of Law (provided that the
failure of an individual Mortgage Loan to conform to the Applicable Requirements
shall not be considered a violation of Law for these purposes) or any
intentional or bad faith violation of the Seller's contractual obligations. The
assumption of the Assumed Liabilities shall be effected by delivery by the
Purchaser to the Seller at the Closing of the Assumption Agreement, whereby the
Purchaser shall assume and agree to pay and discharge in accordance with their
terms the Assumed Liabilities.
Section 2.04 LIABILITIES NOT ASSUMED BY THE PURCHASER. All obligations and
liabilities of the Seller not constituting Assumed Liabilities, including any
other obligations and liabilities that arise before, on or after the Closing
Date based on or arising out of an act or omission occurring before the Closing
Date (whether or not disclosed to the Purchaser), are hereinafter referred to as
the "Retained Liabilities". Retained Liabilities shall include, but not be
limited to, (i) any deferred
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Tax liabilities and current Tax liability relating to the Seller and its
subsidiaries, except for current Taxes payable attributable to periods beginning
before the Closing Date and ending after the Closing Date, (ii) any pension or
employee benefits liabilities, (iii) any obligation of the Seller under any
servicing sale agreement (including, without limitation, servicing transfer
obligations at the expiration of interim or subservicing agreements, repurchase
or indemnification provisions, or purchase price adjustments due to prepayments,
delinquencies or document deficiencies), (iv) any obligations to repurchase, or
otherwise indemnify or reimburse any third party for losses or claims with
respect to, mortgage loans (other than the Pre-Closing Servicing Obligations),
(v) any VA-vendee indemnifications, and (vi) any liabilities arising out of
Litigation which is pending on the Closing Date or which arises after the
Closing Date based on an act or omission occurring before the Closing Date. In
addition, any obligations and liabilities of the Subsidiaries (other than the
normal operating liabilities of the Subsidiaries set forth on Schedule 2.04,
which shall be treated as Assumed Liabilities for purposes of the Closing
Statement and the Adjustment Schedule) that arise before, on or after the
Closing Date based on an act or omission occurring before the Closing Date
(including, without limitation, all liabilities of the types referred to in the
preceding sentence) shall be Retained Liabilities for all purposes of this
Agreement. Notwithstanding anything to the contrary in the foregoing, any
liabilities of the Subsidiaries arising out of Litigation which is pending on
the Closing Date or which arises after the Closing Date based on an act or
omission occurring before the Closing Date, whether or not described on Schedule
2.04, shall be Retained Liabilities for all purposes of this Agreement. The
obligations and liabilities of the Subsidiaries which are Retained Liabilities
as described in this Section 2.04 shall be assumed by the Seller and the Parent
at the Closing pursuant to an appropriate assumption agreement. The Purchaser
shall not assume or be liable with respect to the Retained Liabilities.
ARTICLE III
PAYMENT
Section 3.01 CALCULATION OF PAYMENT.
(a) (i) In consideration of the transfer of the Purchased Assets and the
covenants of the Seller and the Parent in this Agreement, the Purchaser shall
deliver or cause to be delivered to the Seller at the Closing the Assumption
Agreement, and the Purchaser shall pay to the Seller, by wire transfer of
immediately available funds to an account designated by the Seller, the amount
reflected on a statement (the "Closing Statement") prepared in accordance with
the procedures detailed on Schedule 3.01(a), which amount (the "Net Purchase
Price") shall be equal to: (A) the value of the Servicing Rights plus (B) the
GAAP Book Value (except as otherwise indicated on Schedule 3.01(a)) of the other
Purchased Assets plus (C) $65 million minus (D) the GAAP Book Value of the
Assumed Liabilities minus (E) (without duplication with (D)) the mark-to-market
adjustment for the debt obligations included in the Assumed Liabilities;
provided, however, that the Purchaser shall retain $2,000,000 as a holdback
amount. The Purchaser shall reimburse itself from the holdback amount for
amounts owing from the Seller to the Purchaser under this Agreement or any
Related Document in accordance with Section 12.04 (Procedures for Making Claims
Against Indemnifying Party). At the time the Adjustment Amount is paid pursuant
to Section 3.01(d), the
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Purchaser shall pay to the Seller the amount, if any, by which the holdback
amount (taking into account all reimbursements previously made to the Purchaser
from such amount and any amounts owing to the Purchaser in respect of the
Adjustment Amount) exceeds $500,000. Thereafter, within three Business Days
after the end of each month, the Seller will make any payment to the Purchaser
required to keep the holdback amount at $500,000 until the first anniversary of
the Closing Date. On the first anniversary of the Closing Date, the Purchaser
shall remit to the Seller any monies remaining in the holdback amount less any
amounts for pending claims identified by the Purchaser. Retention of the monies
until the first anniversary of the Closing Date and release of any remaining
funds after such anniversary in no manner abrogates or modifies the
indemnification or other obligations of the Seller or the Parent under this
Agreement.
(ii) The provisions of Section 2.02(c) shall apply with respect to
any Contract if the parties have not received, by the Business Day before the
Closing Date, the written consent of each other party to that Contract to the
assignment of the Seller's rights thereunder to the Purchaser; provided that if
consents have not been so obtained with respect to the subservicing agreements
with Chase Manhattan Mortgage Corp. ("Chase"), for all purposes of calculating
the purchase price under this Agreement, including for purposes of the Closing
Statement and the Adjustment Schedule, the value of the Purchased Assets shall
be reduced by $8 million (the "Chase Amount"). The Chase Amount will be
allocated to each of the four Chase subservicing agreements in accordance with
Schedule 3.01(a)(ii), which the Purchaser and the Seller will jointly prepare
within five Business Days after the Closing Date. The Purchaser will pay to the
Seller 1/24th of the amount allocated to each Chase subservicing agreement for
each month such agreement has not been terminated by Chase after the Closing.
Such payment shall be made by wire transfer of immediately available funds no
later than the third Business Day after the end of the relevant month. If, after
the Closing Date, Chase consents to the assignment of a subservicing agreement,
the Purchaser will pay to the Seller the remainder of the Chase Amount allocated
to that agreement; if Chase terminates an agreement, the Purchaser will retain
the remainder of the portion of the Chase Amount allocated to that agreement.
Notwithstanding anything to the contrary in the foregoing, if Chase terminates
any subservicing agreement because of a breach of such agreement by the Seller
or its Affiliates occurring prior to the Closing, the Purchaser will retain (or
the Seller will repay to the Purchaser) the unearned portion of the Chase Amount
allocated to that agreement, and if Chase terminates any such agreement because
of a breach of such agreement by the Purchaser or its Affiliates occurring after
the Closing, the Purchaser will pay (or the Seller will retain) the unearned
portion of the Chase Amount allocated to that agreement to the Seller.
(b) The Seller shall prepare the Closing Statement as of a date no more
than five Business Days prior to Closing and (except as otherwise described in
Section 3.01(a)) as if the Closing had occurred on such earlier date, provided
that the GAAP Book Value of the Purchased Assets and the Assumed Liabilities
(other than the "mark-to-market" debt adjustment) shown thereon shall be
determined as of the last day of the prior month. The Closing Statement shall be
delivered to the Purchaser no less than two Business Days prior to the Closing
Date. The Purchaser and its representatives shall have full access to the
accounting records from which the Closing Statement was prepared.
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(c) Not later than 30 calendar days after the Closing Date, the Purchaser
shall prepare or cause to be prepared a statement of the items shown on the
Closing Statement (the "Adjustment Schedule"). The Adjustment Schedule shall be
prepared in the same manner as the Closing Statement, except that all amounts
shall be determined as of the Closing Date, and the Adjustment Schedule shall
reflect the reduction of the holdback amount in accordance with Section
3.01(a)(i). The Seller and its representatives shall have full access to the
accounting records from which the Adjustment Schedule was prepared.
(d) Subject to Section 3.01(e), the Seller shall pay to the Purchaser the
Adjustment Amount (as defined below) if such amount is a negative number, and
the Purchaser shall pay to the Seller the Adjustment Amount if such amount is a
positive number, in either event promptly after its determination, by wire
transfer of immediately available funds equal to such excess, together with
interest thereon for each day after the Closing Date to the date of such payment
at 5% per annum (the "Interest Rate"), to an account to be designated in writing
by the Purchaser or the Seller, as the case may be. "Adjustment Amount" means a
positive or negative number equal to (i) the Net Purchase Price reflected on the
Adjustment Schedule (as modified pursuant to Section 3.01(e), if appropriate)
minus (ii) the Net Purchase Price reflected on the Closing Statement.
(e) If, within 30 calendar days after the delivery of the Adjustment
Schedule to the Seller pursuant to Section 3.01(c), the Seller determines in
good faith that the Net Purchase Price reflected therein is inaccurate, the
Seller shall give notice to the Purchaser within such 30-day period (i) setting
forth the Seller's determination of the Net Purchase Price and (ii) specifying
in reasonable detail the Seller's basis for its disagreement with the
Purchaser's computation of the Net Purchase Price. The failure by the Seller so
to express its disagreement within such 30-day period shall constitute
acceptance of the Net Purchase Price reflected on the Adjustment Schedule. If
the Seller and the Purchaser are unable to resolve their disagreement within 30
days after receipt by the Purchaser of notice of such disagreement, the items in
dispute shall be referred to independent accountants selected by the Purchaser
and the Seller (the "Accountants"). The Accountants shall make a determination
(which shall not constitute an audit or valuation with respect to the Adjustment
Schedule or any item thereon) as to each of the items in dispute, which
determination shall be (A) in writing, (B) furnished to each of the Seller and
the Purchaser as promptly as practicable after the items in dispute have been
referred to the Accountants and (C) final, conclusive and binding on the parties
hereto. The Adjustment Schedule shall thereupon be modified in accordance with
the Accountants' determination. The fees and expenses of the Accountants shall
be shared equally by the Seller and Purchaser. Within three Business Days after
either (i) the expiration of the 30-day period referred to in this Section
3.01(e) if the Seller does not within such period give the notice of
disagreement provided for above, or (ii) the date on which the Accountants
furnish to the Seller and the Purchaser such firm's written determination, the
appropriate party shall make payment in accordance with Section 3.01(d) hereof.
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ARTICLE IV
REPRESENTATIONS AND WARRANTIES
OF THE SELLER AND THE PARENT
The Seller and the Parent, jointly and severally, represent and warrant to
the Purchaser as follows:
Section 4.01 ORGANIZATION OF THE SELLER AND THE PARENT. Each of the Seller
and the Parent is a corporation duly organized, validly existing and in good
standing under the laws of the State of Delaware, with the requisite corporate
power and authority to own, operate and lease its properties and to carry on its
business as now being conducted.
Section 4.02 SUBSIDIARIES.
(a) The Seller owns, beneficially and of record, all of the capital stock
of each Subsidiary, free and clear of all Liens. The outstanding stock of each
Subsidiary has been validly issued and is fully paid and non-assessable. There
are no outstanding options, rights or warrants to acquire any equity interest in
any Subsidiary. Each of the Subsidiaries has been duly organized and is validly
existing and in good standing under the laws of its jurisdiction of
organization, with the requisite corporate power and authority to own, operate
and lease its properties and to carry on its business as now being conducted.
(b) Other than (i) the investments identified as Excluded Assets in
Section 2.01(b), (ii) shares of the capital stock of the Subsidiaries and the
Seller's investment in MERSCORP, Inc. and (iii) interests, acquired and held in
the ordinary course of the Business, in real estate investment conduits and
other entities organized for the exclusive purpose of holding mortgage loans,
the Seller does not, directly or indirectly, own, control or have the power to
vote any equity securities of any other corporation, partnership, joint venture,
trust or other business entity.
Section 4.03 POWER AND AUTHORITY. Each of the Seller and the Parent has
the requisite corporate power and authority to execute and deliver this
Agreement and the Related Documents to which it is or will be a party and to
perform the transactions contemplated hereby and thereby to be performed by it.
All corporate action on the part of the Seller and the Parent, necessary to
approve or to authorize the execution and delivery of this Agreement and the
Related Documents to which it is a party, and the performance of the
transactions contemplated hereby and thereby to be performed by it, has been
duly taken. This Agreement is a valid and binding obligation of the Seller and
the Parent, enforceable in accordance with its terms.
Section 4.04 NO CONFLICTS. Except as may be required under the
Hart-Scott-Rodino Antitrust Improvements Act (the "HSR Act") and except as set
forth in Section 4.04 of the Disclosure Schedule (which Section the Seller
agrees to provide to the Purchaser within five Business Days after the date of
this Agreement), neither the execution or delivery by the Seller and the Parent
of this Agreement or any Related Document to which it is or will be a party nor
the performance of the transactions contemplated hereby or thereby to be
performed by it shall:
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(i) conflict with or result in a breach of any provision of the
Certificate of Incorporation (or other charter documents) or Bylaws of the
Parent, the Seller or any Subsidiary;
(ii) violate any Law applicable to the Parent, the Seller or any
Subsidiary or by which the Parent, the Seller or any Subsidiary or any of their
properties is bound; or
(iii) constitute an event of default under, permit the termination
of, give rise to a right to accelerate any indebtedness under, or otherwise
violate, breach or conflict with, any material Contract or Approval binding on
the Parent, the Seller or any Subsidiary, or by which any material asset which
will be a Purchased Asset is bound, or result in the creation of any Lien upon
any asset which will be a Purchased Asset, other than such Liens that may be
imposed by or as a result of any action of the Purchaser or any of its
Affiliates; or require any consent, approval, authorization or other order or
action of, or notice to, or declaration, filing or registration with any
Governmental Agency or other third party.
Section 4.05 LITIGATION; COMPLIANCE WITH LAWS.
(a) To the Seller's Knowledge, neither the Seller nor any Subsidiary (i)
is in violation of, or has received any notice alleging a violation of, any
applicable Law or any Approval issued or required to be obtained thereunder or
(ii) has any unsatisfied liability or obligation in respect of any such
violation. The Seller and the Subsidiaries own or possess in the operation of
the Business all Approvals which are necessary for the conduct of the Business.
(b) Except as set forth in Section 4.05(b) of the Disclosure Schedule,
there is no pending or, to the Knowledge of the Seller, threatened Litigation by
or before any Governmental Agency, court or arbitrator, to which the Seller or
any Subsidiary is a party or by which any asset that will be a Purchased Asset
may be bound or affected, nor, to the Knowledge of the Seller, is there any
reasonable basis therefor. Since January 1, 1996, no Governmental Agency has
initiated any proceeding or, to the Seller's Knowledge, any investigation into
the business or operations of the Parent, the Seller or any Subsidiary, except
for routine audits and similar proceedings that did not result in the
determination of any violations, criticisms, citations or exceptions that, if
not cured, would have a Material Adverse Effect on the Business. There are no
unresolved violations, criticisms, citations or exceptions by any Governmental
Agency with respect to any examinations of the Seller or any Subsidiary that, if
not cured, would have a Material Adverse Effect on the Business.
(c) Except as set forth in Section 4.05(c) of the Disclosure Schedule, on
the date hereof, neither the Seller nor any of its Subsidiaries is a party to
any consent decree and, to the Knowledge of the Parent and the Seller, none are
threatened, pending or contemplated.
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Section 4.06 FINANCIAL STATEMENTS; SEC REPORTS.
(a) Since January 1, 1997, the Seller has filed all required reports,
schedules, forms, statements and other documents (including exhibits and all
other information incorporated therein) with the Securities and Exchange
Commission (the "SEC"). As of their respective dates, such documents (the
"Seller SEC Documents") complied in all material respects with the applicable
requirements of the Securities Act of 1933, as amended, and the Securities
Exchange Act of 1934, as amended, and the rules of the SEC applicable to such
Seller SEC Documents, and no Seller SEC Document when filed contained any untrue
statement of a material fact or omitted to state a material fact required to be
stated therein or necessary in order to make the statements therein, in light of
the circumstances under which they were made, not misleading.
(b) Attached hereto as Appendix I is a draft of the Seller's financial
statements for the year ended December 31, 1998 (the "1998 Financial
Statements"). The 1998 Financial Statements include a balance sheet of the
Seller and its consolidated subsidiaries as of December 31, 1998 (the "1998
Balance Sheet"), together with related statements of operations, changes in
shareholder's equity and cash flows of the Seller and its consolidated
subsidiaries (and notes thereto) for such period. The 1998 Financial Statements
fairly present, and the Seller's audited 1998 financial statements as filed with
the SEC will fairly present, in all material respects the consolidated financial
position and the consolidated results of operations and cash flows of the Seller
and its consolidated subsidiaries for the period therein identified in
conformity with GAAP (except as may be indicated in the notes thereto).
(c) Except for (i) liabilities or obligations incurred by the Seller or
its consolidated subsidiaries in the ordinary course of business and not
required by GAAP to be set forth on the 1998 Balance Sheet (all material known
items of which are described in Section 4.06(c) of the Disclosure Schedule) and
(ii) liabilities of and obligations incurred by the Seller and the consolidated
subsidiaries in the ordinary course of business since December 31, 1998 (none of
which known items could reasonably be expected to cause a Material Adverse
Effect on the Business), there is no material liability or obligation (whether
absolute, accrued or contingent) that is not set forth on the 1998 Balance
Sheet.
(d) The Seller has previously delivered to the Purchaser copies of the
Seller's internally prepared accounting reports for January 1999, and will
deliver such reports for February 1999 when available (such reports
collectively, the "Internal Reports"). The statements of income for the months
ended January 31 and February 28, 1999 and the balance sheets as of January 31
and February 28, 1999 included in the Internal Reports were or will be prepared
consistently with the 1998 Financial Statements in accordance with GAAP as
appropriate for the preparation of interim reports of that type.
(e) Since December 31, 1998 there has been no Material Adverse Change in
the operations, business or financial condition of the Business (other than as a
result of changes in general economic, political or industry conditions
including, without limitation, rises and falls in interest rates and/or
prepayment rates or forecasts or changes due to military action or war). Since
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December 31, 1998, except as identified on Section 4.06(e) of the Disclosure
Schedule, there has been no action taken by the Seller or any of its
Subsidiaries of the type described in Section 10.04(a).
Section 4.07 PURCHASED ASSETS; REAL PROPERTY; LEASES AND OTHER CONTRACTS;
INSURANCE.
(a) Except as described in Section 4.07(a) of the Disclosure Schedule, the
Seller has good and marketable title to the Mortgage Loans included in the
Purchased Assets, and good and indefeasible title to, a leasehold interest in or
the right to use all other Purchased Assets, and at the Closing will (subject to
Section 2.02) have the right to convey and transfer to the Purchaser, all
Purchased Assets, and the Subsidiaries have good and indefeasible title to, a
leasehold interest in or the right to use all their assets, in each case free
and clear of all Liens, except for Liens for Taxes not yet due and payable or
which are being contested in good faith by appropriate proceedings. All of the
tangible assets which will be Purchased Assets and the assets leased or licensed
under Contracts which will be Purchased Assets are in good operating condition
and repair, reasonable wear and tear excepted. The assets that will be Purchased
Assets and Excluded Assets, taken together, include all material properties,
Contracts, rights and assets which are being used in the conduct of the Business
at the date hereof. The Purchased Assets, together with any Contracts otherwise
excluded from the definition of "Purchased Assets" pursuant to Section 2.02(c)
and 3.01(a), comprise all the material properties, Contracts, rights and assets
required by the Seller and its Subsidiaries to conduct the Business. The
Purchased Assets are not subject to any option to purchase or right of first
refusal.
(b) Section 4.07(b) of the Disclosure Schedule contains a brief
description of all real property owned in fee simple or held pursuant to a Lease
by the Seller or a Subsidiary that will be included in the Purchased Assets,
other than REO properties. Except as set forth in Section 4.07(b) of the
Disclosure Schedule, (i) no condemnation proceedings have been instituted or, to
the Knowledge of the Seller, threatened with respect to any such real property,
and (ii) the Leases are all in full force and effect and no notices of default
have been given or received thereunder. Section 4.07(b) of the Disclosure
Schedule accurately sets forth all payment obligations under the Leases,
expiration dates of the Leases and options to renew or cancel the Leases.
(c) Section 4.07(c) of the Disclosure Schedule contains a complete and
correct list of all Contracts that will be included in the Purchased Assets or
the Assumed Liabilities. Except as set forth in Section 4.07(c) of the
Disclosure Schedule, all such Contracts listed or required to be listed pursuant
to the preceding sentence are in full force and effect and are valid and binding
obligations of the Seller or a Subsidiary and, to the Seller's Knowledge, of the
other parties thereto. The Seller has provided to the Purchaser true and
complete copies of all such Contracts. Except as set forth in Section 4.07(c) of
the Disclosure Schedule, no party to any such Contract is in default in any
material respect under any such Contract; nor to the Knowledge of the Seller,
does there presently exist any event or condition which, with the passage of
time or giving of notice or both, would be reasonably expected to constitute
such a default. The accounts receivable of the Seller and the Subsidiaries to be
reflected on the Closing Statement represent bona fide amounts receivable for
services rendered in the ordinary course of the Business. The values at which
accounts receivable,
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net of reserves, are carried on the books and records of the Seller and the
Subsidiaries reflect the amounts deemed collectible in accordance with GAAP.
(d) Section 4.07(d) on the Disclosure Schedule contains a complete and
correct list of (i) all material insurance policies under which the Seller or a
Subsidiary is a named insured and that provide coverage with respect to the
Purchased Assets and (ii) any outstanding claims under such insurance policies
related to the Purchased Assets. Neither Seller nor any Subsidiary has received
notice of cancellation of any such policies.
Section 4.08 EMPLOYEE BENEFIT AND PENSION PLAN MATTERS.
(a) Section 4.08(a) on the Disclosure Schedule lists all material pension,
retirement, profit sharing, deferred compensation, stock option, stock purchase,
stock ownership, stock appreciation right, savings, bonus, severance, vacation,
incentive, medical, dental or health, life, accident, disability or other
employee benefit plans, programs, agreements, understandings or arrangements,
including, without limitation, all employee benefit plans as defined in Section
3(3) of the Employee Retirement Income Security Act of 1974, as amended
("ERISA"), for the benefit of any of the present or former directors or
employees of the Business or their beneficiaries or dependents, or which are
maintained or sponsored by the Seller or a Subsidiary, or to which the Seller or
a Subsidiary makes, or is required to make, contributions (collectively,
"Employee Plans").
(b) Except to the extent that any of the following would not, individually
or in the aggregate, have a Material Adverse Effect on the Business, (i) each of
the Employee Plans and its administration and operation are in compliance in all
material respects with all applicable Laws and, except as otherwise permitted or
required by applicable Law, the provisions of such Employee Plan and (ii) all
contributions, premiums, benefits or other payments required to be made to or
with respect to any Employee Plan which is a welfare plan within the meaning of
Section 3(1) of ERISA for all periods preceding the Closing Date and for the
period including the Closing Date have, or prior to the Closing Date will have,
been made.
Section 4.09 LABOR RELATIONS. With respect to any employees of the
Business, neither the Seller nor any Subsidiary is a party to any collective
bargaining agreement with a labor organization certified by the National Labor
Relations Board (the "NLRB"), and (a) there is no unfair labor practice charge
or complaint against the Seller or a Subsidiary pending before the NLRB, (b)
there is no labor strike, or organized dispute, slowdown, work stoppage or other
form of collective labor activity actually pending or, to the knowledge of the
Seller or a Subsidiary, threatened against or affecting the Seller or a
Subsidiary, (c) there is no union representation claim or petition pending
before the NLRB and (d) neither the Seller nor any Subsidiary has experienced
any organized dispute, slowdown, work stoppage or other form of collective
activity in the past three years.
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Section 4.10 MORTGAGE LOANS.
(a) Except as otherwise described with respect to SOM in Section 4.10(a)
of the Disclosure Schedule, each of the Seller, CPM and SOM is (i) an approved
seller/servicer of mortgage loans for Fannie Mae ("FNMA") and Freddie Mac
("FHLMC") in good standing, (ii) a Department of Housing and Urban Development
("HUD") approved mortgagee pursuant to Section 203 of the National Housing Act,
(iii) authorized by Government National Mortgage Association ("GNMA") as an
eligible issuer/servicer and in good standing to service GNMA loans and (iv) a
Federal Housing Administration ("FHA") approved mortgagee and (except for SOM) a
Veterans Administration ("VA") approved lender in good standing to originate and
service FHA and VA loans. Neither the Seller nor either such Subsidiary has been
suspended as a mortgagee or servicer by the FHA, the VA, FHMLC, FNMA or GNMA,
and each of the Seller and CPM has facilities, procedures and experienced
personnel necessary for the sound servicing of FHA, VA, FHMLC, FNMA and GNMA
loans. No event has occurred, including but not limited to a change in insurance
coverage, which would make the Seller or either such Subsidiary unable to comply
with FNMA, FHLMC, HUD, GNMA, FHA or VA eligibility requirements or which would
require notification by the Seller or either such Subsidiary to FNMA, FHLMC,
HUD, GNMA, FHA or VA.
(b) In connection with the execution of this Agreement, Seller has
delivered to Purchaser in a computer tape format reasonably acceptable to
Purchaser, a report that identifies the Mortgage Loans (and which identifies the
Mortgage Loans that are Owned Mortgage Loans) and the Subserviced Mortgage Loans
(the "Mortgage Loan Schedule," which term includes, except where the context
requires otherwise, the updated schedule to be prepared and delivered in
accordance with Section 10.15 (Updated Mortgage Loan Schedule)). The Mortgage
Loan Schedule identifies each Mortgage Loan owned, or serviced by the Seller and
the Subsidiaries and each Subserviced Mortgage Loan subserviced by the Seller
and the Subsidiaries (identifying any third party owner or servicer) and sets
forth the following information with respect to each such Mortgage Loan and
Subserviced Mortgage Loan (or, with respect to each Pipeline Mortgage Loan, such
of the following information as is then available) as of the close of business
on the last day of the preceding month (the "Cut-off Date"): (1) the Seller's
mortgage loan identifying number; (2) the mortgagor's first and last name; (3)
the street address of the mortgaged property including the state and zip code;
(4) a code indicating whether the mortgaged property is owner-occupied; (5) the
type of dwelling constituting the mortgaged property; (6) the original term to
maturity in months; (7) the original date of the mortgage; (8) to the extent
available, the LTV at origination; (9) the mortgage interest rate in effect on
the Cut-off Date; (10) the date on which the first monthly payment was due; (11)
the stated maturity date; (12) the amount of the monthly payment of principal
and interest at origination; (13) the amount of the monthly payment as of the
Cut-off Date; (14) the last due date on which a monthly payment was actually
applied to the unpaid principal balance; (15) the original principal amount;
(16) [reserved]; (17) to the extent available, a code indicating the purpose of
the loan (e.g., purchase financing, rate/term refinancing, cash-out
refinancing); (18) the mortgage interest rate at origination; (19) to the extent
available, a code indicating the documentation style (i.e., full, alternative or
reduced); (20) a code indicating if the Mortgage Loan or Subserviced Mortgage
Loan is subject to a Primary Insurance Policy; (21) a code indicating if the
Mortgage
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Loan or Subserviced Mortgage Loan is an FHLMC, FNMA or GNMA loan, is owned by
the Seller or a Subsidiary or has been sold to private investors; (22) a code
indicating if the Mortgage Loan or Subserviced Mortgage Loan is an FHA or VA
loan; (23) a code indicating if the mortgage loan servicing is owned, interim
serviced or subserviced, (24) to the extent available, the appraised value of
the mortgaged property as of a given date; (25) to the extent available, the
sale price of the mortgaged property, if applicable; (26) the actual unpaid
principal balance of the Mortgage Loan or Subserviced Mortgage Loan as of the
Cut-off Date; (27) the servicing fee, including any excess servicing fee
retained by the Seller; (28) any guarantee fees; (29) whether the Mortgage Loan
or Subserviced Mortgage Loan is in foreclosure (provided that this information
will be included on the updated Mortgage Loan Schedule only) or is an REO
property; and (30) with respect to each adjustable rate Mortgage Loan: (i) the
first adjustment date; (ii) the applicable index and margin; (iii) the maximum
mortgage interest rate; (iv) the minimum mortgage interest rate; (v) the
periodic rate cap; (vi) the first adjustment date following the Cut-off Date;
and (vii) a code indicating whether the Mortgage Loan is a convertible mortgage
loan. With respect to all such Mortgage Loans and Subserviced Mortgage Loans in
the aggregate for each investor or owner or servicer, the Mortgage Loan Schedule
sets forth the following information, as of the related Cut-off Date: (1) the
number of Mortgage Loans; (2) the aggregate principal balance; (3) the weighted
average mortgage interest rate; and (4) the weighted average maturity. The
information set forth in the Mortgage Loan Schedule is complete, true and
correct in all material respects as of the date hereof.
(c) The Mortgage Loans have been underwritten, originated, held and
serviced in compliance in all material respects with all Applicable
Requirements. In the case of all Mortgage Loans described in the Mortgage Loan
Schedule or the Seller's and the Subsidiaries' books and records as FHA Loans or
VA Loans, the related Mortgage is guaranteed by the VA to the maximum extent
permitted by law or fully insured by the FHA, all necessary steps have been
taken to make and keep such guarantee or insurance valid, binding and
enforceable, and the related FHA Insurance Contract or VA Guaranty Agreement is
the binding, valid and enforceable obligation of the VA or the FHA, as the case
may be, without surcharge, set-off or defense.
(d) The Mortgage Notes evidencing the Mortgage Loans and the notes and
other evidences of indebtedness and related security agreements for all other
loans to be included among the Purchased Assets are correct in original amount,
genuine as to signatures of makers and endorsers, and accurate as to lien
priority and in all material respects as to description of collateral; the
related mortgages and other liens have been recorded and perfected in accordance
with the Applicable Requirements; and such notes and other evidences of
indebtedness and related security agreements were given for valid consideration
and constitute legally binding and enforceable claims against the makers and
endorsers thereof (except as enforceability may be limited by bankruptcy,
insolvency and other laws relating to creditors' rights generally or by general
equitable principles), without any set-off, defense or counterclaim, for the
full amounts shown on the books and records of the Seller and the Subsidiaries.
All insurance products for which the Seller or a Subsidiary has acted as agent
have been underwritten, marketed and sold in compliance with applicable Law and
constitute legally binding and enforceable claims against the insurer and the
insured (except as enforceability may be limited by bankruptcy, insolvency and
other laws relating to creditors' rights generally or by general equitable
principles).
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(e) The Parent and its subsidiaries have not, and the Seller and the
Parent have no Knowledge that any other person has, taken any action or omitted
to take any reasonably required action, which action or omission would impair
the rights of the Seller, the Subsidiaries or (after the Closing) the Purchaser
in the Mortgage Loans or prevent any such person from collecting any amounts due
thereunder.
(f) Except as disclosed in Section 4.10(f) of the Disclosure Schedule, the
Seller has no Knowledge that any taxes, ground rents, water charges, sewer
rents, assessments (including assessments payable in future installments),
insurance premiums, leasehold payments or other outstanding charges affecting
the related Mortgaged Properties with respect to any Mortgage Loan, in each case
that are due, have not been paid.
(g) The terms of each Mortgage Note and each Mortgage with respect to any
Mortgage Loan have not been impaired, waived, altered or modified in any
respect, except (i) in the case of a Conventional Mortgage Loan, by written
instrument, recorded in the applicable public recording office if necessary to
maintain the lien priority of the Mortgage, and the substance of any such
waiver, alteration or modification has been approved by the insurer under the
Primary Insurance Policy, if any, and the title insurer, to the extent required
by the related policy, and (ii) in the case of an FHA Loan or a VA Loan, by
written instrument, and the substance of any such waiver, alteration or
modification has been approved by the FHA or the VA, as the case may be, to the
extent required by the applicable insurance agreement, and in each case, the
substance of any waiver, alteration or modification is reflected on the Mortgage
Loan Schedule. No instrument of waiver, alteration or modification has been
executed, and no Mortgagor has been released, in whole or in part, except in
connection with an assumption agreement approved by the insurer under the
Primary Insurance Policy, if any, and the title insurer, to the extent required
by the policy, and which assumption agreement has been delivered to the
custodian and the terms of which are reflected in the Mortgage Loan Schedule.
(h) No Mortgage with respect to any Mortgage Loan has been satisfied,
cancelled, subordinated or rescinded, in whole or in part, and the related
Mortgaged Property has not been released from the lien of the Mortgage, in whole
or in part, nor has any instrument been executed that would effect any such
satisfaction, cancellation, subordination, rescission or release, except in
connection with an assumption agreement which has been delivered to the related
custodian and which has been approved (a) in the case of a Conventional Mortgage
Loan, by the insurer under the Primary Insurance Policy, if any, and (b) in the
case of an FHA Loan or a VA Loan, by the FHA or the VA, as the case may be, to
the extent required by the applicable insurance agreement; and, in any event,
any such release is reflected on the Mortgage Loan Schedule.
(i) Each Mortgage with respect to any Mortgage Loan is a valid, existing
and enforceable first lien on the related Mortgaged Property (except for those
identified in Section 4.10(i)(A) of the Disclosure Schedule, all of which are
valid, existing and enforceable second liens subordinate only to a first lien),
including all improvements on the Mortgaged Property, subject only to (i) the
lien of current real property taxes and assessments not yet due and payable,
(ii)
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covenants, conditions and restrictions, rights of way, easements and other
matters of the public record as of the date of recording being acceptable to
mortgage lending institutions generally and the FHMLC, FNMA, GNMA, HUD, FHA or
the VA, as the case may be, and any private investor and specifically referred
to in the lender's title insurance policy or attorney's opinion of title
delivered to the originator of the Mortgage Loan and which do not adversely
affect the Appraised Value of the Mortgaged Property, and (iii) other matters to
which like properties are commonly subject which do not materially interfere
with the benefits of the security intended to be provided by the Mortgage or the
use, enjoyment, value or marketability of the related Mortgaged Property and
which shall not in any way prevent realization of the benefits of any FHA
Insurance Contract or VA Guaranty Agreement, if applicable. All of the Mortgage
Properties securing the Mortgage Loans are residential properties, except for
those identified in Section 4.10(i)(B) of the Disclosure Schedule. Except to the
extent identified in Section 4.10(i)(A) of the Disclosure Schedule, any security
agreement, chattel mortgage or equivalent document related to and delivered in
connection with any such Mortgage Loan establishes and creates a valid, existing
and enforceable first lien and first priority security interest on the property
described therein and the Seller has full right to sell and assign the same to
the Purchaser. Except to the extent identified in Section 4.10(i)(A) of the
Disclosure Schedule, the Mortgaged Property was not, at the time of origination
of the Mortgage Loan, subject to a mortgage, deed of trust, deed to secure debt
or other security instrument creating a lien subordinate to the lien of the
Mortgage, which subordinate lien could cause such Mortgage Loan not to be
saleable to FHLMC, FNMA or GNMA.
(j) Except for Mortgage Loans identified in Section 4.10(j) of the
Disclosure Schedule, the proceeds of each Mortgage Loan have been fully
disbursed to or for the account of the related Mortgagor and there is no
obligation for the Mortgagee to advance additional funds thereunder and any and
all requirements as to completion of any on-site or off-site improvement and as
to disbursements of any escrow funds therefor have been complied with. All
costs, fees and expenses incurred in making or closing each Mortgage Loan and
the recording of the Mortgage have been paid, and the related Mortgagor is not
entitled to any refund of any amounts paid or due to the Mortgagee pursuant to
the Mortgage Note or Mortgage.
(k) Each Mortgage Loan is covered by an American Land Title Association or
similar lender's title insurance policy (or a title commitment or title binder
committing the title company to issue such title insurance policy) or, where
customary, an attorney's opinion of title, in each case meeting the Applicable
Requirements, issued by an insurer acceptable to FNMA, FHLMC, HUD, GNMA, FHA or
VA, as applicable, and any private investor and qualified to do business in the
jurisdiction where the Mortgaged Property is located, insuring the Seller or a
Subsidiary, its successors and assigns as to the lien of the Mortgage in the
original principal amount of the Mortgage Loan and against any loss by reason of
the invalidity or unenforceability of the lien. Additionally, such lender's
title insurance policy affirmatively insures (or, for Pipeline Loans, will
insure at the Closing Date or when the Mortgage Loan is closed) ingress and
egress to and from the Mortgaged Property, and against encroachments by or upon
the Mortgaged Property or any interest therein. The Seller or a Subsidiary is
(or, for Pipeline Loans, will be at the Closing Date or when the Mortgage Loan
is closed) the sole insured of each lender's title insurance policy, and each
lender's title insurance policy is (or, for Pipeline Loans, will be at the
Closing Date or when the
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Mortgage Loan is closed) in full force and effect and will be in full force and
effect upon the consummation of the transactions contemplated by this Agreement.
To the Seller's and the Parent's Knowledge, except as disclosed in Section
4.10(k) of the Disclosure Schedule, no claims have been made under a lender's
title insurance policy, and no prior holder of the related Mortgage, including
the Seller, has done, by act or omission, anything which would impair the
coverage of any lender's title insurance policy.
(l) Each appraisal made in connection with the origination of a Mortgage
Loan was performed in accordance with the requirements of the Financial
Institutions Reform, Recovery and Enforcement Act of 1989. Except as disclosed
in Section 4.10(l) of the Disclosure Schedule or to the extent otherwise
permitted or required by the Applicable Requirements, each Conventional Mortgage
Loan (other than second mortgage loans identified on Section 4.10(i)(A) of the
Disclosure Schedule) with an LTV at origination in excess of 80% is subject to a
Primary Insurance Policy, which insures as to payment defaults that portion of
the Mortgage Loan in excess of the portion of the Appraised Value of the
Mortgaged Property required by FNMA and FHLMC, whether or not such Mortgage Loan
has been sold to FNMA or FHLMC. All provisions of such Primary Insurance Policy
have been and are being complied with, such policy is in full force and effect,
and all premiums due thereunder have been paid. Except as disclosed in Section
4.10(l) of the Disclosure Schedule, any Mortgage subject to any such Primary
Insurance Policy obligates the Mortgagor thereunder to maintain such insurance
and to pay all premiums and charges in connection therewith. The Mortgage
Interest Rate for the Mortgage Loan does not include any such insurance premium.
(m) (i) No material error, omission, misrepresentation, negligence, fraud
or similar occurrence with respect to a Mortgage Loan has taken place on the
part of any Person, including without limitation the Mortgagor, any appraiser,
any builder or developer, any correspondent or broker, any employee of the
Seller or a Subsidiary, or any other party involved in the origination of the
Mortgage Loan or in the application of any insurance in relation to such
Mortgage Loan, and (ii) no action has been taken or failed to be taken, no event
has occurred and no state of facts exists or has existed on or prior to the
Closing Date (whether or not known to the Seller on or prior to such date) which
has resulted or will result in an exclusion from, denial of, or defense to
coverage under any Primary Insurance Policy (including, without limitation, any
exclusions, denials or defenses which would limit or reduce the availability of
the timely payment of the full amount of the loss otherwise due thereunder to
the insured) whether arising out of actions, representations, errors, omissions,
negligence, or fraud of the Seller, the related Mortgagor or any party involved
in the application for such coverage, including the appraisal, plans and
specifications and other exhibits or documents submitted therewith to the
insurer under such insurance policy, or for any other reason under such
coverage, but not including the failure of such insurer to pay by reason of such
insurer's breach of such insurance policy or such insurer's financial inability
to pay.
(n) The brokers and correspondents involved in the origination of any
Mortgage Loan have complied in all material respects with all internal policies
and procedures of the Seller or CPM with respect to the origination of such
Mortgage Loans.
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(o) To the Seller's Knowledge, all contracts or agreements between the
Seller or any Subsidiary on the one hand, and any broker or correspondent on the
other hand, require any such broker or correspondent to repurchase from the
Seller or a Subsidiary the Mortgage Loans originated by such broker or
correspondent on terms and conditions substantially identical to the related
repurchase obligations of the Seller or a Subsidiary to FNMA, GNMA, FHLMC, HUD,
FHA, VA or any private investor with respect to such Mortgage Loans.
(p) The Seller has no Knowledge, with respect to any Mortgage Loan, that
the Mortgaged Property is not in material compliance with all applicable
environmental Laws, including, without limitation, Laws relating to asbestos and
other Hazardous Materials. The Seller has not, and the Seller has no Knowledge
that the related Mortgagor has, received any notice of any violation or
potential violation of any such Law.
(q) Except as disclosed in Section 4.10(q) of the Disclosure Schedule, the
Seller has no Knowledge that the file relating to a serviced Mortgage Loan does
not contain all documentation necessary for the Purchaser to service such
Mortgage Loan following the Closing.
(r) Except as disclosed in Section 4.10(r)(i) of the Disclosure Schedule,
all Mortgage Loans have been initially certified, finally certified and/or
recertified in accordance with Applicable Requirements. All Mortgage Loans
listed in Section 4.10(r)(i) of the Disclosure Schedule have no impediment to
final certification and/or recertification by the applicable deadline, giving
effect to any available extension. The mortgage loan documents to be delivered
to the Purchaser will include all documents necessary (other than Assignments of
Mortgage that are to be delivered after the Closing Date and other than
documents identified in Section 4.10(r)(ii) of the Disclosure Schedule) in order
for the Purchaser's document custodian to finally certify or recertify, as
applicable, the Mortgage Loans by applicable deadlines, giving effect to any
available extension. Each Mortgage Loan included in a mortgage loan pool meets
all the eligibility requirements of the investor for inclusion in such mortgage
pool. After reconciliation required hereunder, each security of each mortgage
pool will be balanced to the collateral and the expected cash will be deposited
in the applicable custodial account.
(s) All flood and hazard insurance policies and flood certifications with
respect to Mortgage Loans were obtained where required, are in compliance with
applicable Laws and remain in full force and effect.
(t) Except for Mortgage Loans that are delinquent or in default, or which
have been foreclosed, the Seller has no Knowledge of any circumstances or
conditions with respect to the Mortgage, the Mortgaged Property, the Mortgagor
or the Mortgagor's credit standing that can reasonably be expected to cause
institutional investors investing in loans of the same type as a Mortgage Loan
to regard such Mortgage Loan to be an unacceptable investment or adversely
affect the value of the Mortgage Loan.
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(u) Except for Mortgage Loans disclosed in Section 4.10(u) of the
Disclosure Schedule, all of the Mortgage Loans have been sold to investors, and
are being serviced, without recourse to the Seller or any Subsidiary (other than
for breaches of customary representations and warranties).
(v) With respect to the Subserviced Mortgage Loans:
(i) The Subserviced Mortgage Loans are being subserviced in
compliance in all material respects with the provisions of the applicable
subservicing agreements.
(ii) The Parent and its subsidiaries have not, and the Seller and
the Parent have no Knowledge that any other person has, taken any action
or omitted to take any reasonably required action, which action or
omission would impair the rights of the Seller, the Subsidiaries or (after
the Closing) the Purchaser in the Subserviced Mortgage Loans or prevent
any such person from collecting any amounts due thereunder.
(iii) Except as disclosed in Section 4.10(v)(iii) of the Disclosure
Schedule, the Seller has no Knowledge that the file relating to a
Subserviced Mortgage Loan does not contain all documentation necessary for
the Purchaser to subservice such Subserviced Mortgage Loan in accordance
with the related subservicing agreement following the Closing.
(iv) All of the Subserviced Mortgage Loans are being subserviced
without recourse to the Seller or any Subsidiary (other than for breaches
of customary representations and warranties).
Section 4.11 [RESERVED]
Section 4.12 TRANSACTIONS WITH AFFILIATES. Since January 1, 1997, except
as set forth in Section 4.12 of the Disclosure Schedule, neither the Seller nor
any Subsidiary has purchased, acquired or leased any property or services from
or sold, transferred or leased any property or services to, or lent or advanced
any money to, or borrowed any money from, or acquired any capital stock,
obligations or securities of, or made any management consulting or similar fee
agreement with the Parent or any other Affiliate of the Parent or any officer,
director or employee of the Seller or any Affiliate of the Seller.
Section 4.13 INTEREST RATE RISK MANAGEMENT INSTRUMENTS. All interest rate
swaps, caps, floors and option agreements and other interest rate risk
management arrangements entered into for the account of the Seller or the
Subsidiaries were entered into in the ordinary course of business and in
accordance with prudent business practice and applicable rules, regulations and
policies of any Governmental Agency and with counterparties believed to be
financially responsible and are legal, valid and binding obligations of the
Seller or one of the Subsidiaries and, to the Seller's Knowledge, of the other
parties thereto, enforceable against the Seller or the applicable Subsidiary,
and to the Seller's Knowledge, in accordance with their terms (except as
enforceability may be limited by bankruptcy, insolvency and other laws relating
to creditors' rights generally or by general equitable
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principles), without any set-off, defense or counterclaim, and are in full force
and effect with respect to the Seller or the applicable Subsidiary and, to the
Seller's Knowledge, the other parties thereto. The Seller and the Subsidiaries
have duly performed all of their material obligations thereunder to the extent
that such obligations to perform have accrued, and there are no breaches,
violations or defaults or allegations or assertions of such by any party
thereunder.
Section 4.14 INTELLECTUAL PROPERTY.
(a) Section 4.14(a) of the Disclosure Schedule sets forth a list of all
trademarks, trade names, service marks, copyrights and patents, or applications
therefor, which constitute material Seller IPR. The Seller IPR constitutes all
of the Intellectual Property Rights necessary to conduct the Business. Except as
set forth in Section 4.14(a) of the Disclosure Schedule, the Seller or one of
the Subsidiaries is the sole owner of all right, title and interest in, or a
valid right to use, the Seller IPR, free and clear of all Liens. All renewal
fees and actions reasonably required to be taken for the maintenance or
protection of the Seller IPR have been paid and taken. Except as set forth in
Section 4.14(a) of the Disclosure Schedule, the Seller or one of the
Subsidiaries has the exclusive, unqualified right to use the Seller IPR and to
transfer the Seller IPR to the Purchaser. Neither the Seller nor the Parent has
received any charge, complaint, claim, demand or notice alleging that the
ownership or use of the Seller IPR constitutes any interference with or
infringement or misappropriation of any rights of any Person, and the Seller has
no Knowledge of any reasonable basis therefor. To the Seller's Knowledge, no
Person has interfered with, infringed or misappropriated any Seller IPR. The
Seller IPR is not subject to any outstanding Judgment or Contract prohibiting or
restricting the use thereof by the Seller or its Subsidiaries with respect to
the Business or prohibiting or restricting the licensing or transfer thereof by
the Seller and its Subsidiaries to the Purchaser or any other Person, or
restricting the use thereof by the Purchaser or any other Person.
(b) The Seller and its Subsidiaries have the unqualified right to use the
Third Party IPR in connection with and for the Business, and there is no
prohibition or restriction against the Purchaser's use of any of the Third Party
IPR following the Closing, except to the extent that the right to use such Third
Party IPR arises under a Contract which is deemed to be an Excluded Asset
pursuant to Section 3.01(a).
(c) Except to the extent set forth in Section 4.14(c) of the Disclosure
Schedule, neither the Seller nor any Subsidiary has entered into any agreement
to indemnify any Person against any charge of infringement of any Intellectual
Property Right or misappropriation of any trade secret.
(d) Except as set forth in Section 4.14(d) of the Disclosure Schedule, all
Software, computer hardware and other systems currently used in the Business are
Year 2000 Compliant. Except as set forth in Section 4.14(d) of the Disclosure
Schedule, each third party whose systems interface with the Business' internal
systems has advised the Seller that such third party's systems will be Year 2000
Compliant, and by the Closing Date, the Seller will have used Commercially
Reasonable Efforts to verify the accuracy of such advice.
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(e) The Seller and each of the Subsidiaries have taken all reasonable,
customary and usual measures to protect the trade secrets used in or related to
the Business. To the extent that information of a confidential nature has been
used in relation to the Business in the five-year period prior to the date of
this Agreement, such information (except insofar as it has fallen into the
public domain through no fault of the Seller or the Subsidiaries) has been kept
strictly confidential and has not been disclosed otherwise than subject to a
customary confidentiality agreement.
(f) Except as set forth in Section 4.14(f) of the Disclosure Schedule, all
records and systems (including without limitation computer systems) and all data
and information of the Business is owned by the Seller or one or more of the
Subsidiaries, and is recorded, stored, maintained or operated or otherwise held
by the Seller or one or more of the Subsidiaries and is not wholly or partly
dependent on any facilities which are not under the exclusive ownership or
control of the Seller or one or more of the Subsidiaries and which are included
in the Purchased Assets.
(g) None of the operations of the Business involve the unlicensed or
unauthorized use of confidential information. To the Seller's Knowledge, the
processes employed, the services provided, the business conducted and the
products used or dealt in by the Seller and each of the Subsidiaries in the
conduct of the Business do not infringe any Intellectual Property Rights of any
unaffiliated Person. Except as set forth in Section 4.14(g) of the Disclosure
Schedule, none of the operations of the Business give rise to any royalty or
like payment obligation for the use of any Third Party IPR.
(h) Neither the Seller, any Subsidiary nor, to the Seller's Knowledge, any
Person with which the Seller or any Subsidiary have contracted, is in breach in
any material respect of any license, sublicense, Contract or assignment granted
to or by it with respect to any Intellectual Property Rights, including but not
limited to the use, maintenance, or support of any Software or hardware, nor
does the Seller have any Knowledge of any disputes or disagreements with respect
thereto.
(i) There are no issued patents or registered copyrights included in the
Intellectual Property Rights. All marks included in the Intellectual Property
Rights ("Marks") that have been registered with the United States Patent and
Trademark Office are currently in compliance with all formal legal requirements
(including the timely postregistration filing of affidavits or use and
incontestability and renewal applications), are valid and enforceable, and are
not subject to any maintenance fees or taxes or actions falling due within 90
days after the Closing Date, except where the failure thereof would not
reasonably be expected to result in a Material Adverse Effect on the Business.
All products and materials containing a Mark bear the proper federal
registration notice where permitted by law, except where the failure thereof
would not reasonably be expected to result in a Material Adverse Effect on the
Business.
(l) The Seller and its Subsidiaries have taken all reasonable customary
and usual precautions to protect the secrecy, confidentiality, and value of
their Trade Secrets. The Seller or one of its Subsidiaries has good title and an
absolute right to use the Trade Secrets. To the Seller's Knowledge, none of the
Trade Secrets are part of the public knowledge or literature, or have been
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used, divulged, or appropriated either for the benefit of any Person (other than
the Seller or its Subsidiaries) or to the detriment of the Seller or one of its
Subsidiaries. No Trade Secret is subject to any adverse claim or, to the
Seller's Knowledge, has been challenged or threatened in any way.
Section 4.15 ENVIRONMENTAL LIABILITY. Neither the Seller nor, to the
Seller's Knowledge, any third party has engaged in the generation, use,
manufacture, treatment, transportation, storage or disposal of any Hazardous
Material on any of the properties included in the Purchased Assets, and the
Seller has no Knowledge that any such properties, as currently used and
occupied, do not comply in all material respects with applicable Laws and
Approvals, including those relating to land use, pollution, Hazardous Materials
and the environment. There is no Litigation and there are no private
investigations or remediation activities or governmental investigations pending
or, to the Seller's Knowledge threatened, seeking to impose, or that would
reasonably be expected to result in the imposition, on the Seller or any
Subsidiary of any material obligation or liability under any Law relating to
pollution, Hazardous Materials or the environment, nor does the Seller know of
any reasonable basis therefor.
Section 4.16 BROKERS. Neither the Parent nor any Affiliate has retained
any broker or finder, and no broker or finder has acted on behalf of the Parent
or any Affiliate in connection with this Agreement or the transactions provided
for hereby (other than Cohane Rafferty Securities, Inc., all of whose fees and
expenses are for the Seller's account).
Section 4.17 INFORMATION SUPPLIED; ACCURACY OF DATA.
(a) The written materials (including computer tapes and disks) identified
in Section 4.17 of the Disclosure Schedule provided by or on behalf of the
Parent, the Seller, any of its Subsidiaries or any of their Affiliates to the
Purchaser or any of its Affiliates in connection with the negotiation of this
Agreement and the consummation of the transactions contemplated hereby are true,
complete and correct in all material respects; provided, however, that all
forward-looking information (including, without limitation, forecasts and
budgets) shall be excluded from the purview of this Section 4.17(a); and,
provided, further, that in the event that any matter identified in Section 4.17
of the Disclosure Schedule is covered specifically by any other representation
and warranty made by the Seller and Parent hereunder, such other representation
and warranty shall control.
(b) The records (including computer records), files and other information
in written or recorded form relating to, or used by the Seller and the
Subsidiaries in connection with, the Business accurately reflect in all material
respects the information supplied to the Seller by third parties and the actions
taken by the Seller. To the Seller's Knowledge, all servicing accounts
maintained by or on behalf of Seller or any of its Subsidiaries accurately
reflect all transactions in such accounts and all information supplied to the
Seller by third parties.
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Section 4.18 TAXES. (a) With respect to Taxes:
(i) for the purposes of this Section 4.18, the term "Sellers" shall
include the Seller and each of the Subsidiaries, the capital stock of which is
included among the Purchased Assets;
(ii) all Income Tax Returns that are required to be filed by or with
respect to the Parent or the Sellers have been timely filed, and all Income
Taxes required to be shown thereon as owing have been paid, except where the
failure to file Income Tax Returns or to pay Income Taxes would not have a
Material Adverse Effect on the Sellers;
(iii) except to the extent disclosed on Section 4.18(a)(iii) of the
Disclosure Schedule, no adjustments relating to Taxes of the Subsidiaries have
been proposed by the Internal Revenue Service or any state, local or foreign
taxing authority, whether informally or in writing, and to the Sellers'
Knowledge no basis exists for such an adjustment;
(iv) to the Seller's Knowledge, there are no pending or threatened
actions or proceedings for the assessment or collection of Taxes against the
Subsidiaries, other than as set forth on Section 4.18(a)(iii) of the Disclosure
Schedule;
(v) to the Seller's Knowledge, there are no Tax liens on any
Purchased Assets other than for taxes that are not yet due and payable, or for
Taxes that are being contested in good faith and that are properly reflected on
the Closing Statement;
(vi) no Subsidiary has been, at any time, a member of any
partnership or joint venture or the holder of a beneficial interest in any trust
for any period for which the applicable statute of limitations for any Income
Tax has not expired;
(vii) except as disclosed in Section 4.18(a)(vii) of the Disclosure
Schedule, no waivers of statutes of limitation have been given by the
Subsidiaries or requested with respect to any Tax Return of the Subsidiaries;
(viii) there are no requests for information by any Governmental
Agency currently outstanding relating to the Taxes of the Subsidiaries;
(ix) to the Seller's Knowledge, there are no proposed reassessments
of the Purchased Assets or any property owned by the Subsidiaries, or other
proposals that could increase the amount of Tax to which the Subsidiaries would
be subject; and
(x) Except as disclosed in Section 4.18(a)(x) of the Disclosure
Schedule, no penalties under Section 6721, 6722 or 6723 of the Code have been
assessed against the Seller or any of the Subsidiaries, or if penalties have
been assessed, all such penalties have been abated.
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(b) Sellers have delivered to the Purchaser a true and complete copy of
each Tax sharing, Tax allocation or Tax payment agreement or arrangement
involving the Subsidiaries, and a true and complete description of all such
unwritten or informal agreements or arrangements.
(c) Except as otherwise provided in this Agreement, on the Closing
Statement reserves and allowances will have been provided, adequate to satisfy
all liabilities for Taxes relating to the Subsidiaries for periods through the
Closing Date.
ARTICLE V
REPRESENTATIONS AND WARRANTIES
OF THE PURCHASER
The Purchaser represents and warrants to the Seller and the Parent as
follows:
Section 5.01 ORGANIZATION OF THE PURCHASER. The Purchaser is a corporation
duly organized, validly existing and in good standing under the laws of the
State of Delaware and has the requisite power and authority to own, operate and
lease its properties and to carry on its business as now being conducted.
Section 5.02 POWER AND AUTHORITY. The Purchaser has the requisite power
and authority to execute and deliver this Agreement and the Related Documents to
which it is or will be a party and to perform the transactions contemplated
hereby and thereby to be performed by it. All corporate action on the part of
the Purchaser necessary to approve or to authorize the execution and delivery of
this Agreement and the Related Documents to which it is or will be a party and
the performance of the transactions contemplated hereby and thereby to be
performed by it has been duly taken. This Agreement is a valid and binding
obligation of the Purchaser, enforceable in accordance with its terms.
Section 5.03 NO CONFLICTS. Except as may be required under the HSR Act and
except as set forth on Schedule 5.03, neither the execution or delivery by the
Purchaser of this Agreement or the Related Documents to which it is or will be a
party nor the performance by the Purchaser of the transactions contemplated
hereby or thereby to be performed by it, shall:
(i) conflict with or result in a breach of any provision of the
Certificate of Incorporation or Bylaws of the Purchaser;
(ii) violate any Law applicable to the Purchaser or by which the
Purchaser or any of its properties is bound; or
(iii) require any consent, approval, authorization or other order or
action of, or notice to, or declaration, filing or registration with, any
Governmental Agency or other third party.
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Section 5.04 BROKERS. The Purchaser has not retained any broker or finder,
and no broker or finder has acted on behalf of the Purchaser, in connection with
this Agreement or the transactions provided for hereby.
Section 5.05 LICENSES. The Purchaser is (i) an approved seller/servicer of
mortgage loans for FNMA and FHLMC in good standing, (ii) a HUD approved
mortgagee pursuant to Section 203 of the National Housing Act, (iii) authorized
by GNMA as an eligible issuer/servicer and in good standing to service GNMA
loans and (iv) a FHA approved mortgagee and a VA approved lender in good
standing to originate and service FHA and VA loans. The Purchaser has not been
suspended as a mortgagee or servicer by the FHA, the VA, FHLMC, FNMA or GNMA,
and the Purchaser has facilities, procedures and experienced personnel necessary
for the sound servicing of FHA, VA, FHLMC, FNMA and GNMA loans.
ARTICLE VI
EMPLOYEES AND EMPLOYEE-RELATED MATTERS
Section 6.01 BASIC EMPLOYMENT MATTERS.
(a) Effective as of the Closing Date, the Purchaser or an Affiliate of the
Purchaser (the "Employer") shall offer to employ, at their then-current rates of
base pay, all employees of the Seller employed in the Business on the day before
the Closing Date, but excluding (i) any employees who are absent from work due
to an approved leave of absence (but excluding any absence reasonably expected
to be of short duration taken in accordance with Seller's standard policy for
such absences, including, but not limited to, vacation, jury duty, bereavement
and illness) or on corrective action or job discontinuance, (ii) any employees
identified on Schedule 6.01(a), which the Purchaser agrees to deliver to the
Seller at least ten Business Days before the Closing Date, and (iii) at the
Employer's discretion, any persons referred to as "excluded employees" in
Section 10.04(a)(vi). The employees to whom the Employer is obligated or
otherwise elects to offer employment pursuant to the preceding sentence and who
accept such employment are referred to collectively herein as the "Employees,"
which term, unless the context requires otherwise, includes the employees of the
Subsidiaries employed in the Business on the Closing Date (it being understood
that, as of the Closing and for purposes of this Article VI, such employees of
the Subsidiaries will continue to participate in any applicable separate
employee benefit and compensation plans maintained by the employing Subsidiary,
rather than the Employer's corresponding plan).
(b) Notwithstanding anything to the contrary in the foregoing, any
employee of the Seller referred to in clause (i) of Section 6.01(a) employed in
the Business who is absent from work on the Closing Date due to a leave of
absence as referred to above and who, within six months after the commencement
of such absence, reports for employment and is able to return to active
employment with the Employer, shall be eligible to return to his or her former
position if it is then available or, if such position is not available, shall be
eligible to seek another position with the Employer for a 30-day period (and
shall be offered employment by the Employer for at least such
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30-day period at the same rate of base pay); provided, however, that employees
referred to in this sentence shall be considered Employees for purposes of this
Agreement from and after the time they report for employment and are able to
return to active employment with the Purchaser.
(c) The Seller will pay all targeted bonuses and any other incentive
compensation to the Employees for the period between January 1, 1999 and the
Closing Date in accordance with the Seller's and the Subsidiaries' existing
incentive compensation plans. With respect to those employees listed on Schedule
6.01(c), the Employer shall "reinstate" their prior service with Seller upon the
first anniversary of their reemployment date with Seller (as set forth on
Schedule 6.01(c)) for purposes of this Article VI.
(d) The Employer will, subject to changes necessitated by or in response
to regulatory considerations, business performance or matters of fairness and
equity, maintain incentive compensation plans substantially consistent with the
Seller's existing plans (other than any bonuses or other compensation in respect
of the sale of the Business). Subject to this Article VI, after the Closing
Date, the Employer may modify, alter or terminate, in its sole and exclusive
discretion, any of the terms and conditions of employment of the Employees.
Nothing in this Agreement shall prevent the Employer from terminating the
employment of any Employee at any time after the Closing Date, in its sole and
exclusive discretion. Any non-competition agreements between an Employee and the
Seller or any of its Affiliates shall terminate as of the time such Employee
commences employment with the Employer.
Section 6.02 DEFINED BENEFIT PLANS. Effective as of the day before the
date the person becomes an Employee, such Employee shall cease to be an active
employee for purposes of the Seller's Retirement Plan (the "Retirement Plan").
As of the date the person becomes an Employee (for each such person, the
"Employment Date"), the Employer shall cause such Employee who participated in
the Retirement Plan to participate and commence to accrue benefits under the
Employer's pension plan on the same terms and conditions applicable to other
comparably situated employees of the Employer and its participating Affiliates.
The Employer shall grant past service credit for purposes of eligibility for
participation and vesting (but not for purposes of benefit credit) under the
Employer's pension plan to such Employee for all service credited as of the
Employment Date under the Retirement Plan.
Section 6.03 DEFINED CONTRIBUTION PLANS. Effective as of the day before
the Employment Date, each Employee shall cease to be an active employee for
purposes of the Seller's Savings Incentive Plan (the "SIP"). As of the
Employment Date the Employer shall cause each Employee who was eligible to
participate in the SIP to be eligible to participate in the Employer's savings
investment plan on the same terms and conditions applicable to other comparably
situated employees of the Employer and its participating Affiliates. The
Employer shall grant past service credit for purposes of eligibility and vesting
to each Employee under the Employer's savings investment plan ("ESIP") for all
service credited to such Employee as of the Employment Date under the SIP. The
Employees shall be eligible to make direct rollovers from the SIP to the ESIP in
the form of cash and participant notes held by the SIP.
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Section 6.04 SEVERANCE ARRANGEMENTS. From the Employment Date until the
date which is six months after the Closing Date, each Employee shall be entitled
to severance benefits in accordance with the Seller's existing severance
program. After the date which is six months after the Closing Date, the Employer
shall provide each Employee with the Employer's severance program (as the same
may be amended) on the same basis as applicable to other comparably situated
employees of the Employer and its participating affiliates providing benefits in
the event of termination of employment. The Employer will grant past service
credit for all purposes under its severance program to each Employee for all
service credited to such Employee as of the Employment Date under the
corresponding severance programs of the Seller. The Seller and the Purchaser
shall share, in accordance with the following sentence, the obligation for all
severance benefits in the aggregate payable in accordance with the Seller's or
the applicable Subsidiary's severance plans ("covered severance payments") to
(i) all Employees whose employment with the Employer and its Affiliates is
terminated within six months after the Closing Date and (ii) all employees to
whom the Employer is not required to offer employment because they are
identified on Schedule 6.01(a) and whose employment with the Seller or its
Affiliates is terminated within six months after the Closing Date. The Seller
shall be responsible for the first $1,500,000 of covered severance payments; the
Seller shall be responsible for 75%, and the Purchaser shall be responsible for
the balance, of covered severance payments between $1,500,001 and $2,500,000;
the Purchaser and the Seller shall each be responsible for 50% of covered
severance payments between $2,500,001 and $3,500,000; the Purchaser shall be
responsible for 75%, and the Seller shall be responsible for the balance, of
covered severance payments between $3,500,001 and $4,500,000; and the Purchaser
shall be responsible for all covered severance payments above $4,500,000. Each
party shall reimburse the other promptly after receipt of reasonable documentary
evidence for amounts owed pursuant to the preceding sentence. The Employer and
its Affiliates will not hire or rehire any such employee in respect of whom the
Seller has made any portion of such severance payments, and the Parent and its
Affiliates will not hire or rehire any such employee in respect of whom the
Purchaser has made any portion of such severance payments (other than Employees
whose employment with the Employer and its Affiliates has been terminated), in
either case until the first anniversary of such employee's termination.
Section 6.05 OTHER EMPLOYEE BENEFITS.
(a) As of the Employment Date, the Employer shall cause each Employee to
participate in the welfare benefit plans (as defined in Section 3(1) of ERISA)
sponsored or maintained by the Employer and its participating Affiliates on the
same terms and conditions applicable to other comparably situated employees of
the Employer and its participating Affiliates. The Employer will waive any
pre-existing conditions clause and will grant past service credit for all
purposes under each such welfare plan, other than retiree medical, to each
Employee for all service credited as of the Employment Date under the
corresponding welfare plans of the Seller. The Employer shall also cause the
welfare benefit plans referred to in this Section 6.05(a) to give each Employee
credit for the portion of 1999 deductibles that were satisfied prior to the
Employment Date. Notwithstanding anything herein to the contrary, the Seller
shall be responsible for (i) all covered welfare benefit claims under its and
the Subsidiaries' employee benefit plans by each Employee or eligible dependents
that arise for treatment received prior to the Employment Date, and with respect
to
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Employees or their eligible dependents who were hospitalized on the Closing
Date, that arise by reason of events occurring before such Employees or eligible
dependents are discharged from the hospital and (ii) workers' compensation
payments in respect of events occurring prior to the Closing Date.
(b) During 1999, the Employer shall grant to all Employees the number of
vacation days for which they would be eligible had they continued to be
employees of the Seller, except for any days which have been used as of the
Employment Date. Starting as of January 1, 2000, the Employer shall provide the
Employees with vacation time under the vacation policies applicable to other
comparably situated employees of the Employer and its Affiliates and will grant
past service credit for all purposes under such policies to Employees for all
service credited as of the Employment Date under the vacation policies of the
Seller.
ARTICLE VII
CLOSING
Section 7.01 THE CLOSING. The Closing shall be held at 10:00 a.m. on the
earliest date that is five Business Days after the satisfaction or waiver of all
of the conditions to Closing set out in Articles VIII and IX hereto (other than
any condition to be satisfied or waived at the Closing) at the offices of the
Purchaser at 750 Washington Boulevard, Stamford, Connecticut, or at such other
time and place as may mutually be agreed upon by the parties hereto. At the
Closing, the appropriate parties shall take all other actions not previously
taken but required to be taken hereunder on or prior to the Closing Date. The
transfer of the Purchased Assets to the Purchaser and the assumption of the
Assumed Liabilities by the Purchaser shall be deemed to occur at 12:01 a.m. on
the Closing Date.
ARTICLE VIII
CONDITIONS TO OBLIGATIONS OF THE PURCHASER
TO CONSUMMATE THE TRANSACTION
The obligations of the Purchaser to be performed at the Closing shall be
subject to the satisfaction or waiver, at or prior to the Closing, of the
following conditions:
Section 8.01 REPRESENTATIONS AND WARRANTIES; COMPLIANCE WITH COVENANTS.
The representations and warranties of the Seller and the Parent contained in
this Agreement shall be true and correct in all material respects on and as of
the Closing Date with the same force and effect as though such representations
and warranties were made at the Closing except for changes expressly permitted
or contemplated by this Agreement; the covenants required to be performed by the
Seller and the Parent at or prior to the Closing pursuant to the terms of this
Agreement shall have been duly performed in all material respects; and the
Purchaser shall have received a certificate of the President or a Vice President
of each of the Seller and the Parent to that effect.
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Section 8.02 NO INJUNCTION. No Judgment shall have been rendered in any
Litigation which has the effect of enjoining the consummation of the
transactions contemplated by this Agreement.
Section 8.03 APPROVALs. All Approvals required from any Governmental
Agency in order to consummate the transactions contemplated by this Agreement
and to conduct the Business following the Closing shall have been obtained
(other than Approvals of which the failure to obtain, individually or in the
aggregate, would not have a Material Adverse Effect on the Business), and all
applicable waiting periods under the HSR Act and other applicable Laws shall
have expired or been terminated, without the imposition of any materially
burdensome restrictions or conditions on the Purchaser.
Section 8.04 THIRD PARTY CONSENTS. Each of the Approvals set forth in
Schedule 8.04 of this Agreement shall have been obtained.
Section 8.05 BILL OF SALE, ETC. The Seller shall have duly authorized,
executed and delivered to the Purchaser the Bill of Sale and the Trademark
Assignment, each dated as of the Closing Date, and the deeds and other
instruments of conveyance referred to in Section 2.01(c).
Section 8.06 SURVEY; TITLE POLICIES. The Purchaser shall have received the
surveys and commitments to issue title policies with respect to the real
property owned by the Seller, as specified in Section 10.14.
Section 8.07 EMPLOYMENT AGREEMENT. Those persons identified on Schedule
8.07 shall have executed employment agreements with the Purchaser effective as
of the Closing Date, in form and substance satisfactory to the Purchaser,
provided that (i) the Purchaser will offer each such person comparable
compensation and benefits to those he or she has currently and will not require
relocation as a condition of such employment and (ii) unless the Purchaser
notifies the Seller within 30 days after the date of this Agreement that it
elects to terminate this Agreement on account of the failure of this condition
(in which event the Agreement shall be deemed to have been terminated by the
parties' mutual consent pursuant to Section 13.01(a)), this condition shall be
deemed to have been waived by the Purchaser.
Section 8.08 TRANSFER INSTRUCTIONS. The Transfer Instructions identified
on Schedule 8.08 to be completed prior to the Closing Date shall have been
completed in all material respects.
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ARTICLE IX
CONDITIONS TO OBLIGATIONS OF THE SELLER
AND THE PARENT TO CONSUMMATE THE TRANSACTION
The obligations of the Seller and the Parent to be performed at the
Closing shall be subject to the satisfaction or waiver, at or prior to the
Closing, of the following conditions:
Section 9.01 REPRESENTATIONS AND WARRANTIES; COMPLIANCE WITH COVENANTS.
The representations and warranties of the Purchaser contained in this Agreement
shall be true and correct in all material respects on and as of the Closing Date
with the same force and effect as though such representations and warranties
were made at the Closing except for changes expressly permitted or contemplated
by this Agreement; the covenants required to be performed by the Purchaser at or
prior to the Closing pursuant to the terms of this Agreement shall have been
duly performed in all material respects; and the Seller shall have received a
certificate of the President or a Vice President of the Purchaser to such
effect.
Section 9.02 NO INJUNCTION. No Judgment shall have been rendered in any
Litigation which has the effect of enjoining the consummation of the
transactions contemplated by this Agreement.
Section 9.03 APPROVALS. All Approvals required from any Governmental
Agency in order to consummate the transactions contemplated by this Agreement
shall have been obtained (other than Approvals of which the failure to obtain,
individually or in the aggregate, would not have a Material Adverse Effect on
the Seller or the Parent), and all applicable waiting periods under the HSR Act
and other applicable laws shall have expired or been terminated, without the
imposition of any materially burdensome restrictions or conditions on the
Seller.
Section 9.04 THIRD PARTY CONSENTS. Each of the Approvals identified on
Schedule 9.04 shall have been obtained.
Section 9.05 ASSUMPTION AGREEMENT. The Purchaser shall have duly
authorized, executed and delivered to the Seller the Assumption Agreement, dated
as of the Closing Date, and shall have acknowledged the Bill of Sale.
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ARTICLE X
COVENANTS
Section 10.01 HSR FILINGS. As soon as practicable after the execution of
this Agreement, the parties shall make all filings with the appropriate
Governmental Agencies of the information and documents required or contemplated
by the HSR Act with respect to the transactions contemplated by this Agreement.
The Seller and the Parent, on the one hand, and the Purchaser, on the other
hand, shall use their respective best efforts to comply as expeditiously as
possible with all lawful requests of such Governmental Agencies for additional
information and documents.
Section 10.02 INJUNCTIONS. If any court having jurisdiction over any of
the parties hereto issues or otherwise promulgates any restraining order,
injunction, decree or similar order which prohibits the consummation of any of
the transactions contemplated hereby or by any Related Document, the parties
hereto shall use Commercially Reasonable Efforts to have such restraining order,
injunction, decree or similar order dissolved or otherwise eliminated as
promptly as possible and to pursue the underlying Litigation diligently and in
good faith. Notwithstanding anything to the contrary contained in this
Agreement, nothing contained in this Section 10.02 shall limit the respective
rights of the parties to terminate this Agreement pursuant to Section 13.01 or
shall limit or otherwise affect the respective conditions to the obligations of
the parties set forth in Articles VIII and IX hereof.
Section 10.03 ACCESS TO INFORMATION. Between the date of this Agreement
and the Closing Date, the Seller shall, and shall cause its Affiliates to, upon
reasonable request by the Purchaser, (i) provide the Purchaser and its
accountants, counsel and other authorized representatives reasonable access,
during normal business hours and under reasonable circumstances, to any and all
premises, properties, Contracts, commitments, books, records and other
information of or relating to the Business and to the officers, employees and
agents of the Business and (ii) cause its officers to furnish to the Purchaser
and its authorized representatives any financial, environmental, health and
safety, technical and operating data and other information pertaining to the
Business, as the Purchaser shall from time to time reasonably request and which
is either normally available to the Seller in the ordinary and usual course of
business or which may be obtained or produced by the Seller at a de minimis cost
to the Seller; PROVIDED, HOWEVER, that such access may be limited to the
location at which the relevant information is normally maintained and shall not
unreasonably interfere with the operations of the Seller and its Affiliates, and
the Seller and its Affiliates shall not be required to give the Purchaser access
to any information relating solely to the Excluded Assets.
Section 10.04 NO EXTRAORDINARY ACTIONS BY THE SELLER.
(a) In each case except as (x) consented to or approved by the Purchaser
in writing (which consent shall not be unreasonably withheld, bearing in mind
the Purchaser's plans to operate the Business after the Closing), (y) required
by this Agreement or the Related Documents or (z) related to the Excluded Assets
or the Retained Liabilities, from the date hereof until the Closing, the Parent
and the Seller shall not take any action that would cause their representations
and warranties herein to be untrue in any material respect and shall conduct the
Business only in the
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ordinary course and in accordance with its present policies and procedures
(including loan collection and chargeoff practices) and use Commercially
Reasonable Efforts to preserve intact its present business organization, keep
available the services of its present management and employees and preserve its
relationships with suppliers and customers and others having business dealings
with it (including, to the extent consistent with the provisions of this
Agreement, the Parent and its Affiliates) so that the Business shall not be
impaired in any material respect, and the Seller and the Subsidiaries will not
(and the Parent will cause the Seller and the Subsidiaries not to):
(i) Permit or allow any of the assets that will be Purchased Assets
to be subjected to any Lien, except as set forth in Section 4.07 of the
Disclosure Schedule and except for Liens for Taxes not yet due and payable or
which are being contested in good faith by appropriate proceedings;
(ii) Sell, transfer or otherwise dispose of or agree to dispose of,
or acquire or agree to acquire, any material assets that would be Purchased
Assets except in the ordinary course of business, or sell, transfer or otherwise
dispose of or agree to dispose of any material servicing rights, other than
pursuant to Contracts identified on Section 4.07(c) of the Disclosure Schedule
or extensions thereof on substantially similar terms. To the extent the Seller
needs to sell servicing rights in the ordinary course of business, the Seller
shall sell such servicing rights to the Purchaser in accordance with the flow
matrix set forth on Exhibit A to Schedule 3.01(a)(i)(A);
(iii) Grant any general increase or implement any general decrease
in the compensation of officers or employees (including any such increase
pursuant to any bonus, pension, profit-sharing or other plan or commitment) or
grant any increase in the compensation payable or to become payable to any
officer or employee, other than (A) in the ordinary course of business or
pursuant to promotions or (B) bonuses payable by the Seller in connection with
the consummation of the transactions contemplated by this Agreement;
(iv) Other than as set forth in Schedule 10.04(a)(iv), make any
single capital expenditure or commitment in excess of $50,000 for additions to
property, plant, equipment or intangible capital assets that would be included
in the Purchased Assets or make aggregate capital expenditures and commitments
for such purposes in excess of $200,000;
(v) Enter into any agreement for real estate tax service or any
other agreement (other than Mortgage Loans or commitments to make Mortgage
Loans) for a non-cancelable term in excess of one year or involving aggregate
payments by the Seller in excess of $25,000; or
(vi) Except as set forth in Schedule 10.04(a)(vi), hire any person
who would become an Employee, provided that the Seller may hire (A) any
non-exempt employee to fill a vacancy or (B) any other person, it being
understood that (x) any person described in this clause (B) to whose employment
the Purchaser has not consented shall be an "excluded employee" to whom the
Employer will not be required to offer employment under Section 6.01 and (y) the
Seller will advise each such employee to that effect in connection with its
offer of employment.
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(b) The Parent and the Seller agree to cooperate with the Purchaser
throughout the period prior to the Closing to meet with employees of the
Business at such times as shall be approved by a representative of the Parent or
the Seller, for purposes of retaining such employees.
(c) From the date hereof until the Closing or the earlier termination of
this Agreement, the Seller and the Parent will not, and will cause their
officers, directors, employees and agents not to, initiate contact with, solicit
any inquiries from, request or invite submission of any proposal or offer from,
or provide any confidential information to, or participate in any negotiations
with, any third party in connection with any possible proposal by such third
party regarding a sale of all or any substantial portion of the assets of the
Business, provided that the provisions of this paragraph shall not apply to any
assets that would be Excluded Assets.
Section 10.05 COMMERCIALLY REASONABLE EFFORTS; FURTHER ASSURANCES.
(a) Upon the terms and subject to the conditions hereof, the Seller and
the Parent, on the one hand, and the Purchaser, on the other hand, agree to use
Commercially Reasonable Efforts to take or cause to be taken all actions, and to
do or cause to be done all things, necessary, proper or advisable to ensure that
the conditions set forth in Articles VIII and IX are satisfied and to consummate
and make effective the transactions contemplated by this Agreement and the
Related Documents (including without limitation, the preparation of supplemental
indentures and other documents in connection with assumption of the Debentures,
the Notes and the QUICS), insofar as such matters are within their respective
control.
(b) Except as otherwise expressly provided for in this Agreement, through
the date which is 180 days after the Closing Date (i) each of the Purchaser and
the Seller shall, and shall cause each of their respective Affiliates to, use
Commercially Reasonable Efforts to obtain at the earliest practicable date,
whether before or after the Closing Date, all consents required to be obtained
by it for the performance of the transactions contemplated by this Agreement and
the Related Documents, (ii) the Seller shall use Commercially Reasonable Efforts
to obtain, whether before or after the Closing Date, any amendments, novations,
releases, waivers, consents or approvals with respect to all outstanding
Contracts of the Seller which are necessary either to cure any defaults
thereunder existing immediately prior to the Closing Date or for the
consummation of the transactions contemplated by this Agreement and the Related
Documents, and (iii) each party hereto shall execute and deliver such
instruments, certificates and other documents and take such other actions as any
other party hereto may reasonably require in order to carry out this Agreement
or any of the Related Documents and the transactions contemplated hereby and
thereby; PROVIDED, HOWEVER, that (A) in obtaining any such amendments,
novations, releases, waivers, consents or approvals, no party hereto shall, or
shall permit any of its Affiliates to, agree to any amendment of any such
instrument which imposes any obligation or liability on another party without
the prior written consent of such other party, and (B) except as otherwise
expressly provided by this Agreement, no party hereto shall be obligated to
execute any guarantees or undertakings or otherwise incur or assume any expense
or liability (other than for filing fees and similar costs required in
connection with the purchase and sale of the Purchased Assets) in obtaining any
such release, novation, approval, consent, authorization or waiver.
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(c) The Purchaser, on the one hand, and the Seller and the Parent, on the
other hand, shall provide such information and cooperate fully with each other
party hereto in making such applications, filings and other submissions which
may be required or reasonably necessary in order to obtain all approvals,
consents, authorizations and waivers as may be required from any Governmental
Agency or other third party in connection with the transactions contemplated by
this Agreement and the Related Documents and shall promptly use Commercially
Reasonable Efforts to make each such application, filing or other submission,
including without limitation, any supplemental filing.
Section 10.06 BULK SALES LAWS. The Purchaser hereby waives compliance by
the Seller with the provisions of the "bulk sales" or similar laws of any
jurisdiction and all bulk sales tax provisions in all states. The Seller and the
Parent shall indemnify the Purchaser and hold it harmless from and against any
and all claims, losses, damages, liabilities, costs and expenses incurred by the
Purchaser or any of its Affiliates as a result of any failure to comply with any
such laws.
Section 10.07 INSURANCE AND BENEFITS CONTRACTS. The Seller shall use
Commercially Reasonable Efforts to maintain all insurance policies and binders
relating to the Business in full force and effect at all times up to and
including the Closing Date and shall pay all premiums, deductibles and
retro-adjustment billings, if any, with respect thereto covering all periods,
and ensuring coverage of the Business, up to and including the Closing Date.
Section 10.08 USE OF NAMES.
(a) As soon as reasonably practicable after the Closing, the Seller shall
(i) change its corporate name to one not including the words "Source One" or any
confusingly similar words and (ii) cease to use (including use through the
internet) any written materials, including, without limitation, signs, labels,
packing materials, letterhead, advertising and promotional materials and forms,
which include the words "Source One" or any trademark, trade name, domain name,
service mark or trade dress owned by the Seller and the Subsidiaries prior to
the Closing Date.
(b) As soon as reasonably practicable after the Closing, the Purchaser
shall cease to use any written materials, including, without limitation, labels,
packing materials, letterhead, advertising materials and forms, that identify
the Business as an Affiliate of the Parent; PROVIDED, HOWEVER, that the
Purchaser may use signs, inventory, checks, application forms, sales literature,
letterhead, business cards or the like in existence as of the Closing Date until
the earlier of the exhaustion of such materials or the date six months after the
Closing Date.
Section 10.09 TRANSFER OF MORTGAGE LOANS. The Seller shall, both before
and after the Closing, at its expense, complete the steps required by the
Transfer Instructions in accordance with the applicable timetable and take all
such other actions and pay such other costs as are, in the Purchaser's
reasonable judgment, necessary to effect and evidence the transfer of all of the
Seller's and the Subsidiaries' right, title and interest in and to the Mortgage
Loans.
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Section 10.10 MAIL RECEIVED AFTER CLOSING. Following the Closing, (i) the
Purchaser may receive and open all mail addressed or directed to the Seller at
the offices of the Business, (ii) to the extent that such mail and the contents
thereof relate to the Purchased Assets, the Business or to any of the Assumed
Liabilities, the Purchaser may deal with the contents thereof in its sole
discretion and (iii) the Purchaser shall forward any other such mail to the
Seller.
Section 10.11 CONFIDENTIALITY; PUBLICITY. Each party shall hold, and shall
use its best efforts to cause its employees and agents to hold, in strict
confidence all information concerning another party furnished to it by such
other, all in accordance with the Confidentiality Agreement previously executed
and delivered by the parties in connection with the transactions contemplated
hereby, which shall remain in full force and effect and shall survive any
termination of this Agreement for a period of one year. Any release to the
public of information with respect to the matters contemplated by this Agreement
(including without limitation any termination of this Agreement) shall be made
only in the form and manner approved by the Purchaser, the Seller and the
Parent, provided that if a party is required by law to make any disclosure
concerning such matters, such party shall discuss in good faith with the other
parties the form and content of such disclosure prior to its release.
Section 10.12 TRANSITION SERVICES. At the Closing, the parties will
execute and deliver an agreement substantially in the form of Exhibit C (the
"Transition Services Agreement").
Section 10.13 ACCESS TO RECORDS AFTER THE CLOSING.
(a) The Seller, on the one hand, and the Purchaser, on the other hand,
recognize that subsequent to the Closing they may have information and documents
which relate to the Business, its employees, its properties, the Purchased
Assets, the Excluded Assets, the Retained Liabilities, the Excluded Liabilities
and Taxes and to which the other party may need access subsequent to the
Closing. Each party shall provide the other party access, during normal business
hours on reasonable notice, to all such information and documents, and to such
of its employees, which such other party reasonably requests. The Purchaser, on
the one hand, and the Seller, on the other hand, agree that prior to the
destruction or disposition of any such documents or any books or records
pertaining to or containing such information at any time within five years (or,
in any matter involving Taxes, until the later of the expiration of all
applicable statutes of limitations (including extensions thereof) or the
conclusion of all litigation (including exhaustion of all appeals relating
thereto) with respect to such Taxes) after the Closing Date, each party shall
provide not less than 30 calendar days prior written notice to the other of any
such proposed destruction or disposal. If the recipient of such notice desires
to obtain any such documents, it may do so by notifying the other party in
writing at any time prior to the scheduled date for such destruction or
disposal. Such notice must specify the documents which the requesting party
wishes to obtain. The parties shall then promptly arrange for the delivery of
such documents. All out-of-pocket costs associated with the delivery of the
requested documents shall be paid by the requesting party.
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(b) With respect to audits conducted by federal, state and local taxing
authorities, Purchaser agrees to provide Parent with responses to information
document requests presented by such taxing authorities within 30 calendar days.
Such information document requests may include, but shall not be limited to, all
tax matters related to Seller and subsidiaries for all tax years currently open
under the relevant jurisdictions' statute of limitation.
Section 10.14 TITLE COMMITMENTS; SURVEYS.
(a) The Seller shall, not less than 30 days prior to the Closing Date,
deliver to the Purchaser a commitment of a title insurance company reasonably
satisfactory to the Purchaser to issue an owner's policy of title insurance on a
standard American Land Title Association form covering title to each parcel of
real property owned by the Seller described in Section 4.07(b) in an amount
reasonably satisfactory to the Purchaser naming the Purchaser as the insured.
The Seller agrees to pay the cost of such title insurance commitments.
(b) As soon as reasonably practicable after the execution of this
Agreement, the Seller shall, at its expense, furnish to the Purchaser a current
on-the-ground staked "as-built" survey of the owned premises included in the
Purchased Assets made in accordance with the "Minimum Standard Detail
Requirements for ALTA/ACSM Land Title Surveys" jointly established by ALTA and
ACSM in 1992 and meeting the accuracy requirements of an Urban Class Survey, as
defined therein, including Items 1-44, 6-11 and 13 on Table A contained therein
(the "Survey") prepared by a registered land surveyor licensed in the state
where such premise is located (the "Surveyor"), and which survey shall otherwise
be acceptable to the Purchaser, in its reasonable discretion, and the title
company for deletion of the exceptions pertaining to areas and boundaries. The
Survey (including specifically the certificate of the Surveyor forming a part
thereof) shall be in form and substance acceptable to the Purchaser, in its
reasonable discretion, and to the title insurance company and shall locate all
existing improvements, easements and rights-of-way (which shall show recording
data, if applicable), encroachments, conflicts and protrusions affecting such
premises, water, sewer, gas and electric lines, telephone and television cable
lines and the size and capacity thereof, parking spaces and the size of each,
shall set forth the outside perimeter of the premises, shall contain a metes and
bounds description of the premises and shall set forth the acres included within
the premises. The Survey shall contain a statement on the face thereof
certifying as to the Zone Designation by the Secretary of Housing and Urban
Development with reference to the appropriate Flood Insurance Rate Map Number
(which Flood Insurance Rate Map Number shall be the current Flood Insurance Rate
Map for the community in which the premises is located). In the event the Survey
shows any easement, right-of-way, encroachment, conflict or protrusion affecting
the premises that is unacceptable to the Purchaser, in its reasonable
discretion, the Purchaser shall within 20 days after receipt of such Survey, the
title commitment and a legible copy of each exception document, notify the
Seller in writing of such fact. The Seller shall then promptly undertake to
eliminate or modify such unacceptable matters to the satisfaction of the
Purchaser, as determined in its reasonable discretion. In the event the Seller
is unable to do so prior to the Closing, the Purchaser may accept such title to
the premises as the Seller can deliver and receive a credit against the purchase
price in an amount reasonably acceptable to the Purchaser.
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Section 10.15 UPDATED MORTGAGE LOAN SCHEDULE. Within five Business Days
after the Closing Date, the Seller shall deliver to the Purchaser an updated
copy of the Mortgage Loan Schedule as of the Closing Date. The information set
forth in such updated Mortgage Loan Schedule shall be complete, true and correct
in all material respects as of its date.
Section 10.16 SYSTEM UPGRADE. Prior to the Closing Date, the Seller will
complete the upgrade of its investor accounting system in accordance with
Schedule 10.16 to the extent the timetable on such Schedule would require
completion by such date.
Section 10.17 FINAL CERTIFICATION AND RECERTIFICATION, ETC.
(a) The Seller shall use Commercially Reasonable Efforts prior to the
Closing Date to (i) obtain final certification or recertification, as
applicable, of any Mortgage Loan pool and (ii) obtain any Mortgage Loan
documents that are missing.
(b) The Seller shall use Commercially Reasonable Efforts prior to the
Closing Date to ensure that all investor reporting is fully reconciled and
balanced. The Seller will reimburse the Purchaser for any reasonable
post-Closing out-of-pocket expenses required to reconcile and balance investor
reporting in respect of the Mortgage Loans and to maintain such reconciliation
until the scheduled completion of the investor accounting upgrade contemplated
by Section 10.16, or arising out of the failure of such reporting to be
reconciled and balanced on the Closing Date.
(c) From the date of this Agreement until the Closing Date, the Seller
shall provide reports and documentation to the Purchaser every two weeks
regarding the status of the matters referred to in this Section 10.17.
Section 10.18 REPURCHASE OF MORTGAGE LOANS.
(a) If the Purchaser determines that a Mortgage Loan will or may be
required to be repurchased from a third party or may be subject to a claim for
indemnification pursuant to Section 12.02, in either case arising out of (x) the
Pre-Closing Servicing Obligations or (y) a breach of the representations and
warranties contained in Section 4.10, then in order to mitigate any losses the
Seller may bear with respect to such Mortgage Loan, the Purchaser shall take
such steps as it would take with respect to other comparable mortgage loans in
its own portfolio. Such steps shall include using Commercially Reasonable
Efforts to enforce any contractual remedies that may be available to the
Purchaser under any agreement with any broker or correspondent; provided,
however, that no failure of a broker or correspondent to perform its obligations
under the applicable Contract shall relieve the Seller of its obligations
hereunder. Such steps may also include entering into indemnification agreements
with the applicable investors in lieu of repurchase; provided, however, that as
a condition of entering into any such indemnification agreement with an
investor, the Purchaser may require that the Seller provide to the Purchaser a
"back-to-back" indemnification agreement with respect to the applicable Mortgage
Loan(s).
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(b) If the Purchaser repurchases a Mortgage Loan as contemplated by the
first sentence of the preceding paragraph, the Seller shall purchase such
Mortgage Loan from the Purchaser for the price paid by the Purchaser to
repurchase such Mortgage Loan. The Purchaser shall service each Mortgage Loan so
repurchased by the Seller pursuant to a Services Agreement in form agreeable to
the parties. In addition, with respect to each such repurchased Mortgage Loan,
the Purchaser shall, at the Seller's request, exercise any contractual remedies
that may be available against any applicable broker or correspondent. The
Seller's obligations under this Section 10.18(b) shall terminate on the date
which is eight years and six months after the Closing Date. For purposes of the
monetary limitation described in Section 12.05(c) on the Seller's
indemnification obligations with respect to Mortgage Loan Claims after the
seventh anniversary of the Closing Date, only actual monetary losses incurred by
the Seller upon complete liquidation of a Mortgage Loan repurchased pursuant to
this Section 10.18 (rather than any gross repurchase price paid to the
Purchaser) shall be considered Purchaser Indemnifiable Losses arising out of
Mortgage Loan Claims.
(c) After the Closing Date, the Seller may repurchase mortgage loans in
connection with the Retained Liabilities and request the Purchaser to service
such mortgage loans on the Seller's behalf. In the event the Seller requests the
Purchaser to perform such servicing, the Seller and the Purchaser shall enter
into a Services Agreement in form agreeable to the parties.
(d) The Seller shall indemnify the Purchaser for any losses or
out-of-pocket costs or expenses incurred by the Purchaser in performing its
duties under Section 10.18, except for any such losses, costs or expenses
arising from the negligence or willful misconduct of the Purchaser.
Section 10.19 AGREEMENT NOT TO COMPETE; NON-SOLICITATION.
(a) Each of the Parent and the Seller agrees that during the period ending
on the fifth anniversary of the Closing Date, neither the Parent nor the Seller
nor any other entity of which the Parent or the Seller owns, directly or
indirectly, 25% or more of the voting stock or other similar equity interests
(collectively, the "Parent's Affiliates"; provided that FSA and any of its
majority-owned subsidiaries will not be considered a Parent's Affiliate unless
Parent directly or indirectly (x) owns 50% or more of FSA's voting stock or
similar equity interests or (y) otherwise has the power to elect, or has
designated, a majority of FSA's board of directors) will engage in the business
of originating, selling or servicing residential mortgage loans in the United
States (the "mortgage business"). Nothing in this paragraph (a) shall restrict
any Parent's Affiliate from investing in the debt or equity securities of, or
lending funds or rendering advice or other services to, any other entity, or
from engaging in any other business activity, except in each case as
specifically provided in the preceding sentence.
(b) Notwithstanding anything to the contrary in paragraph (a) of this
Section 10.19, any Parent's Affiliate may acquire any entity or business which
engages in the mortgage business (a "covered business"), provided that (i) such
acquired entity or business is primarily engaged in one or more non-mortgage
businesses and (ii) if more than 25% of such acquired entity's gross revenues
are derived from the covered business during the twelve full calendar months
immediately
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preceding such acquisition, then within one year after the date of such
acquisition, the Parent's Affiliate shall have ceased conducting the covered
business or shall have entered into a binding agreement (which may be an
agreement with the Purchaser) for the disposition of the covered business. If
any such binding agreement shall terminate prior to the completion of the sale
of the covered business, the Parent's Affiliate shall cease conducting the
covered business or enter into a new binding agreement for its disposition
within three months after the date of such termination.
(c) Each of the Seller and the Parent agrees that (i) from the date of
this Agreement to the Closing Date, it will not solicit any customers of the
Business or use any list of customers, suppliers, brokers, correspondents or
other business contacts of the Business maintained by the Seller or any of its
Subsidiaries for any purpose except to promote the Business, and from and after
the date of this Agreement it will not allow any unaffiliated party to use such
lists or information for any purpose, (ii) from and after the Closing Date, it
will not solicit on a targeted basis any person who became a customer of the
Seller or any of its Subsidiaries in connection with the Business or use any
list of customers, suppliers, brokers, correspondents or other business contacts
maintained by the Seller or any of its Subsidiaries in connection with the
Business and (iii) from the date of this Agreement until the third anniversary
of the Closing Date, the Parent and its Affiliates not engaged in the Business
will not, and from the Closing Date until the third anniversary of the Closing
Date, the Seller will not, solicit for employment or employ any employee of the
Business, other than any such employee who will not be or has not been offered
post-closing employment pursuant to Section 6.01 or whose employment with the
Seller or the Purchaser has otherwise been terminated, whether voluntarily or
involuntarily; provided that this provision shall not be violated by any general
solicitation or advertising not directed at any such employee or group of
employees.
Section 10.20 PARENT GUARANTEE. The Parent hereby unconditionally and
irrevocably guarantees all of the obligations of the Seller pursuant to this
Agreement and the Related Documents.
Section 10.21 REDEMPTION OF QUICS. The Seller will cause notice of
redemption of the QUICS to be sent to the holders thereof on the Closing Date,
and will use Commercially Reasonable Efforts in order to cause the QUICS to be
redeemed as soon as reasonably practicable following the Closing Date.
Section 10.22 COLLECTION OF RECEIVABLES.
(a) The Seller will indemnify the Purchaser and hold it harmless against
any losses arising out of the failure of any accounts receivable included in the
Purchased Assets to be collectible in accordance with their terms. The Purchaser
agrees to use Commercially Reasonable Efforts after the Closing to collect such
accounts receivable. The Purchaser may require the Seller to comply with this
Section 10.22 by repurchasing at the face amount plus accrued interest any such
accounts receivable which have not been collected by 180 days after their due
date (or such other date as is shown on Schedule 10.22).
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(b) For purposes of this Section 10.22, the Purchased Assets shall include
the right to receive interest at 7% per annum on the face amount of those
receivables included in the Purchased Assets related to sales of mortgage loans
or mortgage loan servicing prior to the Closing Date, provided that the Seller
shall receive a credit against the amount of such interest for any interest
received by the Purchaser in accordance with the terms of such receivables. Such
interest shall be computed from the Closing Date to the date each such
receivable is (i) collected by the Purchaser or (ii) repurchased by the Seller
in accordance with Section 10.22(a). The Purchaser may deduct amounts owing
under this Section 10.22(b) from the holdback amount or request such amount from
the Seller in accordance with Section 12.04.
Section 10.23 SOM. The Seller will use Commercially Reasonable Efforts to
obtain all Approvals for SOM listed on Section 4.10(a) of the Disclosure
Schedule and Schedule 10.23. The Purchaser will cooperate with and assist the
Seller in obtaining such Approvals and shall reimburse Seller for its reasonable
out-of-pocket costs and expenses incurred in seeking such Approvals (including
up to $150,000 for such costs and expenses paid or incurred prior to the date of
this Agreement); provided that any such reimbursed amounts shall not be included
in the value of the Purchased Assets for purposes of the Closing Statement and
the Adjustment Schedule. If the parties determine that such Approvals will not
be obtained before the Closing, the Purchaser and the Seller will cooperate in
using Commercially Reasonable Efforts to make alternative arrangements.
Section 10.24 PRIVATE LABEL SUBSERVICING CAPABILITY. Prior to the Closing,
the Seller will use Commercially Reasonable Efforts to complete and test
enhancements to its servicing system sufficient to enable customer service,
collections, delinquency and default management of Subserviced Mortgage Loans
under a name different from that used in connection with the servicing of the
Mortgage Loans (or any subset thereof). The Seller will reimburse the Purchaser
for its reasonable and necessary expenses (including but not limited to the
incremental internal and external costs to complete the aforementioned
enhancements). The parties agree that if Chase terminates a subservicing
agreement on account of a failure to so complete and test such enhancements, the
Seller shall pay to the Purchaser, as liquidated damages and not as a penalty,
the unearned portion of the Chase Amount allocated to such agreement, and the
Purchaser shall not be entitled to any other remedy from the Seller or the
Parent for such termination or the resulting loss of prospective benefits or
advantages. The previous sentence notwithstanding, the Seller shall indemnify
the Purchaser for any out-of-pocket losses arising out of a failure of the
servicing system to operate in a manner substantially similar to the manner in
which it operated prior to the implementation of the enhancements contemplated
by this Section 10.24.
Section 10.25 NORTHWEST PACIFIC. Prior to the Closing, the Seller will
transfer the stock of Northwest Pacific, in a manner that will not adversely
affect the operation of the Business after the Closing, so that such stock is
directly owned by the Seller or will liquidate Northwest Pacific in a manner
that its assets and liabilities are transferred directly to the Seller and will
be Excluded Assets and Retained Liabilities.
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ARTICLE XI
TAX MATTERS
Section 11.01 ALLOCATION OF RESPONSIBILITY.
(a) All Taxes based on the ownership of property (other than any sales,
use, transfer, income or franchise Taxes) imposed with respect to the Purchased
Assets for a tax or assessment period that included the Closing Date shall be
apportioned between the Seller and the Purchaser, with the Seller bearing a
portion of such taxes based on the number of days in the tax or assessment
period prior to the Closing Date and the Purchaser bearing a portion of such
Taxes based on the number of days in the tax or assessment period on or after
the Closing Date.
(b) Taxes described in Section 11.01(a) shall initially be timely paid as
provided by applicable Law and the paying party shall be entitled to
reimbursement from the non-paying party in accordance with the obligations of
the parties described in such Section except that the Purchaser shall not be
entitled to reimbursement until the amount of Taxes described in Section
11.01(a) to be reimbursed by the Seller to the Purchaser exceeds the amount of
the "real estate taxes payable" and "personal property taxes payable" recorded
on the Adjustment Schedule. The paying party shall promptly notify the
non-paying party in writing of the payment of any such tax and the non-paying
party shall make such reimbursement within ten business days after it receives
such notice. Any payment not made within such time shall bear interest at a rate
per annum equal to the Interest Rate.
(c) Seller shall pay all sales, use, transfer, real property transfer,
recording, gains, stock transfer and other similar taxes and fees ("Transfer
Taxes") arising out of or in connection with the transactions effected pursuant
to this Agreement, and shall indemnify, defend, and hold harmless the Purchaser
(and its Affiliates) against Transfer Taxes in excess of such amount. Seller
shall file all necessary documentation and Tax Returns with respect to such
Transfer Taxes, and Purchaser shall cooperate with Seller with respect to such
filings.
Section 11.02 TAX RETURNS.
(a) Parent and Seller shall join and Seller shall cause the Subsidiaries
to join, for any taxable year or portion thereof ending on or prior to the
Closing Date, in (i) the consolidated federal Income Tax Returns and (ii) any
combined, consolidated or unitary state or local income or franchise tax returns
with respect to which the Seller and the Subsidiaries are required to be
included or have been included in accordance with the most recent past practice
of the Seller. Seller shall properly prepare (or cause to be prepared) and
timely file (or cause to be timely filed) all applicable separate company state,
local, and foreign Income Tax Returns of the Seller and the Subsidiaries for any
taxable year ending on or before the Closing Date, and Seller or the
Subsidiaries, as applicable, shall timely and fully pay all Income Taxes shown
thereon. Purchaser shall, subject to Seller's consent (which shall not be
withheld unreasonably), properly prepare (or cause to be prepared), and
Purchaser shall file (or cause to be timely filed) all separate company income
and franchise tax returns of the Subsidiaries for any taxable year or period
commencing prior to the Closing Date and ending subsequent to the Closing Date.
Purchaser shall provide drafts
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of such returns to Seller for Seller's review and comment no later than 30 days
prior to filing. Purchaser shall accept all reasonable comments of the Seller
with respect to such Tax Returns. All such returns shall be consistent with the
most recent equivalent returns filed with respect to such Subsidiaries. Seller
shall, upon written notice from Purchaser, provide Purchaser with funds to
timely pay the portion of the tax liability shown on such income or franchise
tax returns which is described as being the responsibility of the Seller under
this Agreement, and Purchaser shall timely pay over (or cause to be paid over)
such amounts to the appropriate authority.
(b) Subject to Seller and the Seller's Subsidiaries making or causing to
be made the payments required by it and providing the information it is required
to provide or cause to be provided hereunder, Purchaser shall prepare and file
all other Tax Returns required of Seller and Seller's Subsidiaries (including
without limitation all information returns and payee statements required under
the Code or applicable state law for the entire calendar year), shall cause to
be paid all Taxes payable with respect thereto, and shall cause to be reported
on such Tax Returns any transactions or payments by or relating to Seller, and
Seller's subsidiaries occurring after the Closing Date.
Section 11.03 TAX SHARING AND TAX PAYMENT AGREEMENTS.
(a) Any amounts (including deferred taxes which become current through the
end of the Closing Date by virtue of the transactions which are the subject of
this Agreement) that would be required to be paid pursuant to any Tax Sharing or
Tax Payment Agreement to which either the Seller or the Seller's Subsidiaries is
a party shall be paid prior to the Closing Date and all such agreements shall be
terminated as to the Seller, and the Seller's Subsidiaries as of the Closing
Date, and the Seller and the Seller's Subsidiaries shall have no further
obligations thereunder, provided all such payments have been made. For purposes
of this section the term "Tax Sharing Agreement" and "Tax Payment Agreement"
includes any agreement or arrangement, whether or not written, providing for the
sharing or allocation of liability for Taxes of the parties thereto.
Section 11.04 ASSISTANCE AND COOPERATION. After the Closing Date Seller
and Purchaser shall:
(a) assist in all reasonable respects (and cause their respective
affiliates to assist) the other party in preparing any Tax Returns or reports
for which such other party is responsible for under this Agreement;
(b) cooperate in all reasonable respects in preparing for any audits of,
or disputes with taxing authorities regarding, any Tax Returns of the Seller and
the Subsidiaries;
(c) provide timely notice to the other in writing of any pending or
threatened tax audits or assessments of the Seller and the Subsidiaries for
Taxable periods for which the other may have a liability under this Agreement;
and
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(d) furnish the other with copies of all correspondence received from any
taxing authority in connection with any tax audit or information request with
respect to such Taxable period.
Section 11.05 RECORD RETENTION. After the Closing Date Seller shall
retain, until the applicable statutes of limitation (including extensions) have
expired, copies of the Subsidiaries' separate company returns, supporting work
schedules, and other records or information in the possession of the Seller
which may be relevant to such returns for all tax periods or portions thereof
ending before or including the Closing Date and shall not destroy or otherwise
dispose of any such records without first providing the Purchaser with a
reasonable opportunity to review and copy the same.
Section 11.06 CONTEST. Purchaser shall have the right to exercise, at
Purchaser's expense, complete control of any issue raised in any inquiry,
examination or proceeding with respect to Taxes imposed on or with respect to
the assets purchased by the Purchaser, and the Taxes of Seller's Subsidiaries
for which the Purchaser is required to bear the tax burden hereunder or for
which Purchaser gets the tax benefit hereunder of any refund or credit, except
that prior to settling any issue in any way that affects the tax benefits
available to the Seller for any time period after the Closing Date, Purchaser
will consult with the Seller. Seller shall have the right to exercise, at
Seller's expense, complete control of any issue raised in any inquiry,
examination or proceeding with respect to Taxes imposed on or with respect to
the assets purchased by the Purchaser, and the Taxes of the Seller's
Subsidiaries for which the Seller is required to bear the tax burden hereunder
or for which Seller gets the tax benefit hereunder of any refund or credit,
except that prior to settling any issue in any way that affects the tax benefits
available to the Purchaser for any time period up to the Closing Date, Seller
will consult with the Purchaser. Each party shall notify the other in writing
upon learning of that any such issue has been raised.
Section 11.07 SECTION 338(h)(10) ELECTION.
(a) Seller, the Subsidiaries and Purchaser shall jointly make timely and
irrevocable elections under Section 338(h)(10) of the Code and, if permissible,
similar elections under any applicable state or local income tax laws, and
Purchaser shall make timely and irrevocable elections under Section 338(g) of
the Code. Seller and Purchaser shall report the transaction consistent with such
elections under Section 338(g) and Section 338(h)(10) of the Code or any similar
state or local tax provisions (the "Elections"), and shall take no position
contrary thereto unless and to the extent required to do so pursuant to a
determination (as defined in Section 1313(a) of the Code or any similar state or
local tax provision).
(b) To the extent possible, Seller and Purchaser shall execute at or prior
to the Closing any and all forms necessary to effectuate the Elections
(including, without limitation, Internal Revenue Service Form 8023 and any
similar forms under state and local income tax laws (the "Section 338 Forms")).
In the event, however, any Section 338 Forms are not executed at the Closing,
the Seller and the Purchaser shall prepare and complete each Section 338 Form no
later than 60 days prior to the date such Section 338 Form is required to be
filed. Seller and Purchaser
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shall each cause the Section 338 Form to be duly executed by an authorized
person for Seller and Purchaser in each case, and shall duly and timely file the
Section 338 Forms in accordance with applicable Tax laws and the terms of this
Agreement.
Section 11.08 ALLOCATION OF PURCHASE PRICE.
(a) After giving effect to the allocation required by Section 3.01,
Purchaser and Seller shall act together in good faith to determine and agree
upon the amount of the MADSP (as defined under Treasury Regulation Section
1.338(h)(10)-1(f)) and the allocation of such MADSP among the Purchased Assets.
The tax allocation of the Purchase Price among the Purchased Assets (as
determined by Section 3.01 of this Agreement, except that with respect to the
Seller's Subsidiaries, the Purchase Price shall be allocated to the assets of
the Seller's Subsidiaries) shall be made by Purchaser and Seller acting together
and in good faith, all in accordance with Section 1060 of the Code, the
applicable regulations thereunder and with Treasury Regulation Section
1.338(h)(10)-1(f). Any issue that remains unresolved with respect to the amount
or allocation of the Purchase Price on the date that is 120 days prior to the
date on which the Section 338 Forms are required to be filed shall be referred
to a nationally recognized accounting firm jointly selected by Seller and
Purchaser (the "Neutral Auditors"), and the Neutral Auditors shall resolve such
issue no later than 60 days prior to the date on which the Section 338 Forms are
required to be filed. The fees and expenses of the Neutral Auditors shall be
borne equally by Seller and Purchaser. Seller and Purchaser shall (i) be bound
by such allocation for purposes of determining any Taxes, (ii) prepare and file
all Tax Returns to be filed with any taxing authority in a manner consistent
with such allocation and (iii) take no position inconsistent with such
allocation in any Tax Return, any proceeding before any taxing authority or
otherwise. Appropriate adjustment shall be made to such allocation to specific
categories of assets to reflect any Purchase Price adjustment pursuant to this
Agreement or other adjustment required pursuant to law. In the event such
allocation is disputed by any taxing authority, the party receiving notice of
such dispute shall promptly notify the other party of such dispute, and Seller
and Purchaser shall cooperate in good faith in responding to such challenge in
order to preserve the effectiveness of such allocation.
(b) Each of the Purchaser and the Seller shall timely file a Form 8594
Asset Acquisition Statement of Allocation consistent with the Adjustment
Schedule, shall provide a copy of such form to the other party hereto and shall
file a copy of such form with its federal income Tax Return for the periods that
includes the Closing Date. Each of the Purchaser and Seller further agrees not
to take any position inconsistent with the allocations contemplated by this
Section for any Tax purpose.
Section 11.09 PURCHASER ACTIVITY ON CLOSING DATE AND POST-CLOSING.
(a) On the Closing Date, Purchaser shall cause the Subsidiaries to conduct
their business in the ordinary course in substantially the same manner as
presently conducted and shall not permit the Subsidiaries to effect any
extraordinary transactions (other than any such transactions expressly required
by applicable law or by this Agreement) that could result in Tax liability in
excess of the Tax liability associated with the conduct of its business in the
ordinary course.
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(b) Purchaser shall not, with respect to any Taxable year or period ending
on or before the Closing Date (or, with respect to any Taxable year or period
beginning before and ending after the Closing Date, the portion of such taxable
period ending on and including the Closing Date) (a "Pre-Closing Period", and
any Taxable year and period (or portion thereof) not included in a Pre-Closing
Period, a "Post-Closing Period"), (i) file any amended Tax Return with respect
to the Subsidiaries, (ii) carry back any loss or other Tax attribute of the
Subsidiaries, or (iii) take any position with respect to Taxes of the
Subsidiaries that would have the effect of shifting income from a Post-Closing
Period to a Pre-Closing Period unless, in each case, Seller shall have consented
in writing to such action by Purchaser, provided, in each case, Seller's consent
shall not be withheld unreasonably.
Section 11.10 LIABILITY FOR TAXES AND RELATED MATTERS.
(a) Except to the extent of any amounts reserved for Taxes (other than
reserves for deferred taxes, if any) on the Closing Statement, Parent and Seller
shall be responsible for and indemnify and hold harmless Purchaser, against any
and all liability (including reasonable fees for attorneys and other outside
consultants incurred in contesting or otherwise in connection with any such
liability as reasonably agreed to by Seller and parent) for (i) Taxes of the
Subsidiaries for any Taxable year or period ending on or before the Closing
Date, (ii) Taxes relating to the Purchased Assets for any Taxable year or period
ending on or before the Closing Date, (iii) with respect to any Taxable year or
period beginning before and ending after the Closing Date, Taxes of the
Subsidiaries and Taxes relating to the Purchased Assets for the portion of such
taxable period ending on and including the Closing Date, (iv) all income,
franchise or similar Taxes measured by income or gain realized on the deemed
sale of assets resulting, directly or indirectly, from the Elections, (v) all
liability for income Taxes of Seller or any affiliate (other than liability for
Income Taxes of the Subsidiaries arising out of a Post-closing Period) thereof
arising from the application of Treasury Regulations ss. 1.1502-6 or any
analogous state or local tax provision. Seller shall be entitled to all refunds
with respect to Taxes for which Seller has responsibility hereunder, other than
refunds resulting from carrybacks from taxable years beginning after the Closing
Date.
(b) Purchaser shall be liable for and indemnify Seller for the Taxes (and
reasonable fees for attorneys and other outside consultants incurred in
contesting or otherwise in connection with an such liability as reasonably
agreed to by Purchaser) that are not allocated to Seller pursuant to Paragraph
(a).
(c) For purposes of Sections 11.10(a) and 11.10(b), whenever it is
necessary to determine the liability for Taxes of the Subsidiaries or Taxes
relating to the Purchased Assets for a portion of a Taxable year or period that
begins before and ends after the Closing Date, the determination of such Taxes
for the portion of the year or period ending on, and the portion of the year or
period beginning after, the Closing Date shall be determined by assuming that
the Seller, or the Subsidiaries, as applicable, had a Taxable year or period
which ended at the close of the Closing Date, except that (A) exemptions,
allowances or deductions that are calculated on an annual basis, such as the
deduction for depreciation, and (B) all taxes that are imposed on a periodic
basis with
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respect to the Purchased Asset or otherwise measured by the level of any item
such Taxes or items shall be apportioned pro rata by day. For purposes of
Section 11.10(a) and 11.10(b), any state net operating losses that are available
as of the Closing Date shall, to the extent permitted by applicable law, be
applied first to reduce the gain realized for state Tax purposes on the deemed
asset sale resulting from the Elections.
(d) Parent, Seller and Purchaser will treat any payment by Purchaser or
Seller under this Agreement as an adjustment to the Purchase Price unless
otherwise required by a final and non-appealable decision, in which case any
such payment shall be made on an after tax basis.
(e) The indemnity set out above in this Section 11.10 shall, anything in
this Agreement to the contrary notwithstanding, survive until the expiration of
the applicable statutes of limitation, including extensions thereof, and Article
XII hereof shall not apply to Taxes.
ARTICLE XII
SURVIVAL AND INDEMNIFICATION
Section 12.01 SURVIVAL. The representations and warranties in Article IV
and Article V hereof shall survive the Closing but shall terminate and be of no
further force and effect on the third anniversary of the Closing Date; provided
that the representations and warranties in Section 4.10 (Mortgage Loans) shall
terminate and be of no further force and effect on the date which is eight years
and six months after the Closing Date. Unless a specific period is set forth in
this Agreement (in which event such specified period shall control), all other
covenants and agreements contained in this Agreement shall survive the Closing
and remain in effect indefinitely. With respect to a claim for indemnification
that may fall under more than one provision of Section 12.02 or 12.03, the
expiration of the survival period for a claim under one applicable provision
shall not impact in any way a party's right to bring a claim under another
applicable provision, the survival period of which has not yet expired.
Section 12.02 INDEMNIFICATION BY THE SELLER. On the terms set forth
herein, the Seller and the Parent, jointly and severally, shall indemnify,
defend and hold harmless the Purchaser, each of its Affiliates and each of their
respective past, present and future directors, officers, agents and
representatives (together, the "Purchaser Indemnitees") from and against any and
all liabilities, obligations, claims, suits, damages, civil and criminal
penalties and fines, out-of-pocket costs and expenses, including without
limitation any reasonable and necessary attorney's and other professional fees,
after deducting any insurance proceeds received by the Purchaser Indemnitees in
connection therewith ("Purchaser Indemnifiable Losses"), relating to, resulting
from or arising out of the following:
(a) any breach of any representation, warranty, covenant or undertaking by
the Seller or the Parent contained in this Agreement or any Related Document;
(b) any Retained Liabilities or any matters related to the Excluded
Assets;
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(c) any claim by any Employee based on or arising out of matters occurring
before the Closing Date;
(d) any VA No-bids relating to Mortgage Loans originated or committed
before the Closing Date; provided that the Seller's and the Parent's obligations
pursuant to this clause (d) shall expire on the second anniversary of the
Closing Date; and
(e) any Pre-Closing Servicing Obligations; provided that the Seller's and
the Parent's obligations pursuant to this clause (e) shall expire on the date
which is eight years and six months after the Closing Date.
The items described in clauses (a) through (e) above are collectively
referred to herein as "Purchaser Claims".
Section 12.03 INDEMNIFICATION BY THE PURCHASER. On the terms set forth
herein, the Purchaser shall indemnify, defend and hold harmless the Seller, each
of its Affiliates (including the Parent), and each of their respective past,
present and future directors, officers, agents and representatives (together,
the "Seller Indemnitees"), from and against any liabilities, obligations,
claims, suits, damages, civil and criminal penalties and fines, out-of-pocket
costs and expenses, including without limitation any reasonable and necessary
attorney's and other professional fees, after deducting any insurance proceeds
received by the Seller Indemnitees in connection therewith ("Seller
Indemnifiable Losses") relating to, resulting from or arising out of any of the
following:
(a) any breach of any representation, warranty, covenant or undertaking of
the Purchaser contained in this Agreement or any Related Document;
(b) any Assumed Liabilities;
(c) any matters related to the Purchased Assets based on or arising out of
matters occurring after the Closing Date; and
(d) any claim by any Employee based on or arising out of matters occurring
on or after the Closing Date.
The items described in clauses (a) through (d) above are collectively
referred to herein as "Seller Claims".
Section 12.04 PROCEDURES FOR MAKING CLAIMS AGAINST INDEMNIFYING PARTY.
(a) Except with respect to third party claims made under Section 12.06
(which shall be governed by that Section), from time to time on or before the
first anniversary of the Closing Date, in the case of Section 3.01(a), or the
expiration, if any, of the applicable indemnification obligation, in the case of
Section 12.02 or Section 12.03, the Purchaser or the Indemnified Party, as the
case
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may be (a "claimant"), may give notice in substantially the form of Exhibit E
hereto to the Seller or the Indemnifying Party, as the case may be, specifying
in reasonable detail the nature and dollar amount of any deduction the Purchaser
has made from the holdback amount under Section 3.01(a) or any claim under
Section 12.02 or Section 12.03 of this Agreement (each a "claim"); a claimant
may from time to time make more than one claim (including any supplements
thereto) with respect to any underlying state of facts. If the Seller or the
Indemnifying Party, as the case may be, gives notice disputing any claim (a
"counter notice") within 30 days following receipt of the notice regarding such
claim, such claim shall be resolved as provided in Section 12.04(b). If no
counter notice is received by the claimant within such 30-day period, then the
dollar amount of the claim as set forth in the original notice shall be deemed
established for purposes of this Agreement and, at the end of such 30-day
period, in the case of a claim under Section 12.02 or Section 12.03, the
Indemnifying Party shall make a payment to the Indemnified Party in the dollar
amount claimed in the notice. Any claim pending at the expiration of the
indemnification period under Section 12.01, Section 12.02(d) or Section 12.02(e)
shall be tolled until such claim has been resolved and the Indemnifying Party
has made any required payments to the Indemnified Party.
(b) If the counter notice as described in Section 12.04(a) is timely
received with respect to a claim, the parties shall attempt in good faith to
agree on resolution of the disputed amount. The Indemnifying Party shall pay to
Indemnified Party all non-disputed amounts in accordance with the time period
specified in Section 12.04(a). Any amount mutually agreed upon or awarded to the
Indemnified Party under a final and non-appealable Judgment of a court of
competent jurisdiction shall be paid by the Indemnifying Party within five
Business Days following agreement or Judgment, as applicable. If the parties'
agreement or the Judgment determines that a withdrawal of monies from the
holdback under Section 3.01(a) was not appropriate, the Purchaser shall replace
those monies in the holdback amount, or if the time for maintaining the holdback
has expired under Section 3.01(a), pay those monies directly to Seller within
five Business Days after such determination.
Section 12.05 LIMITATIONS AND RULES OF CONSTRUCTION REGARDING
INDEMNIFICATION OBLIGATIONS.
(a) Notwithstanding any other provision in this Agreement, the liability
of an Indemnifying Party to indemnify the Purchaser Indemnitees or the Seller
Indemnitees, as the case may be (the "Indemnified Party") pursuant to Section
12.02 or Section 12.03 against any Indemnifiable Losses arising out of a breach
of a representation or warranty included in Article IV or Article V or pursuant
to Section 12.02(d) (relating to VA No-bids) or Section 12.02(e) (relating to
Pre-Closing Servicing Obligations) shall be limited to claims as to which the
Indemnified Party has given to the Indemnifying Party written notice of a claim
within the survival period set forth in Section 12.01, Section 12.02(d) or
Section 12.02(e), as the case may be, whether or not any such Indemnifiable
Losses have then actually been sustained.
(b) For purposes of Section 12.02 and Section 12.03, in determining
whether a representation or warranty included in Article IV (except for Section
4.15) or Article V has been breached, any qualification in such representation
or warranty with respect to the Indemnifying
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Party's Knowledge shall be disregarded (i.e., a breach shall be deemed to have
occurred whether or not the Indemnifying Party had Knowledge of the facts giving
rise to the breach). For purposes of Section 12.02, in determining whether a
representation or warranty included in Article IV has been breached, the
Sections of the Disclosure Schedule identified on Schedule 12.05(b) shall be
disregarded (i.e., a breach shall be deemed to have occurred whether or not the
relevant Section of the Disclosure Schedule gives notice of exceptions to the
representation or warranty).
(c) Notwithstanding anything to the contrary in this Agreement, (i) the
Parent's and the Seller's liability for any Purchaser Claims arising out of a
breach of the representations and warranties contained in Article IV (other than
Section 4.10), and the Purchaser's liability for any Seller Claims arising out
of a breach of the representations and warranties contained in Article V, shall
be limited as follows: the Indemnifying Party shall be liable for (A) 90% of the
first $1,000,000 of all related Indemnifiable Losses, and all such Indemnifiable
Losses in excess of $1,000,000, to the extent such Indemnifiable Losses arise
from claims made on or before the first anniversary of the Closing Date, (B) 80%
of the first $1,000,000 of all related Indemnifiable Losses, and all such
Indemnifiable Losses in excess of $1,000,000, to the extent such Indemnifiable
Losses arise from claims made after the first anniversary of the Closing Date
and on or before the second anniversary of the Closing Date and (C) 50% of all
related Indemnifiable Losses to the extent such Indemnifiable Losses arise from
claims made after the second anniversary of the Closing Date and on or before
the last date on which claims may be made pursuant to this Agreement, and (ii)
the Parent's and the Seller's aggregate liability for Mortgage Loan Claims (as
defined below) made after the seventh anniversary of the Closing Date and on or
before the last date on which claims may be made pursuant to this Agreement
shall be limited to the amount, if any, by which $15 million exceeds the amount
of all Mortgage Loan Claims previously determined to be Purchaser Indemnifiable
Losses pursuant to this Agreement (including, without limitation, pursuant to
Section 10.18(b)). "Mortgage Loan Claims" means any Purchaser Claims arising out
of (x) a breach of the representations and warranties contained in Section 4.10
or (y) the Pre-Closing Servicing Obligations.
Section 12.06 DEFENSE OF CLAIMS.
(a) If an Indemnified Party shall receive written notice of the assertion
of any third party claim with respect to which an Indemnifying Party is
obligated under this Agreement to provide indemnification, such Indemnified
Party shall give the Indemnifying Party prompt notice thereof; PROVIDED,
HOWEVER, that the failure of any Indemnified Party to give such notice shall not
relieve any Indemnifying Party of its obligations under this Article XII, except
to the extent that such Indemnifying Party is actually prejudiced by such
failure to give notice. Such notice shall describe the claim in reasonable
detail, and, if practicable, shall indicate the estimated amount of the
Indemnifiable Loss that has been or may be sustained by such Indemnified Party.
(b) An Indemnifying Party, at such Indemnifying Party's own expense and
through counsel chosen by such Indemnifying Party (which counsel shall be
reasonably satisfactory to the Indemnified Party), may elect to defend any third
party claim; and if it so elects, it shall, within 20 Business Days after
receiving notice of such third party claim (or sooner, if the nature of such
third
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party claim so requires), notify the Indemnified Party of its intent to do so,
and such Indemnified Party shall cooperate in the defense of such third party
claim. Such Indemnifying Party shall pay such Indemnified Party's reasonable
out-of-pocket expenses incurred in connection with such cooperation. After
notice from an Indemnifying Party to an Indemnified Party of its election to
assume the defense of a third party claim, such Indemnifying Party shall not be
liable to such Indemnified Party under this Article XII for any legal or other
expenses subsequently incurred by such Indemnified Party in connection with the
defense thereof; PROVIDED, HOWEVER, that such Indemnified Party shall have the
right to employ one counsel to represent such Indemnified Party and all other
persons entitled to indemnification in respect of such claim hereunder (which
counsel shall be reasonably acceptable to the Indemnifying Party) if, in such
Indemnified Party's reasonable judgment, either a conflict of interest between
such Indemnified Party and such Indemnifying Party exists in respect of such
claim or there may be defenses available to such Indemnified Party which are
different from or in addition to those available to such Indemnifying Party, and
in that event (i) the reasonable fees and expenses of such separate counsel
shall be paid by such Indemnifying Party and (ii) each of such Indemnifying
Party and such Indemnified Party shall have the right to direct its own defense
in respect of such claim. If any Indemnifying Party elects not to defend against
a third party claim, or fails to notify an Indemnified Party of its election
within a reasonable period of time, such Indemnified Party may defend,
compromise and settle such third party claim; PROVIDED, HOWEVER, that no such
Indemnified Party may, without the prior written consent of the Indemnifying
Party (which consent shall not be unreasonably withheld), settle or compromise
any third party claim or consent to the entry of any Judgment which does not
include as an unconditional term thereof the delivery by the claimant to the
Indemnifying Party of a written release from all liability in respect of such
third party claim. The Indemnifying Party may defend, compromise and settle any
third party claim on such terms as it deems appropriate, PROVIDED, HOWEVER, that
no Indemnifying Party may, without the prior written consent of the Indemnified
Party (which consent shall not be unreasonably withheld), settle or compromise
any third party claim or consent to the entry of any Judgment which does not
include as an unconditional term thereof the delivery by the claimant to the
Indemnified Party of a written release from all liability in respect of such
third party claim.
Section 12.07 REMEDIES EXCLUSIVE. The remedies provided to the parties in
this Article XII for the matters set forth in this Article XII shall be
exclusive and shall preclude assertion by them of all other rights and the
seeking of all other remedies for such matters against any other party hereto;
provided that any party hereto shall not be precluded from (i) seeking specific
performance or any other available remedy for a breach of a covenant or
agreement contained in this Agreement or in any Related Document or (ii) seeking
any other remedy explicitly provided by any other provision of this Agreement or
a Related Document.
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ARTICLE XIII
TERMINATION
Section 13.01 TERMINATION. This Agreement may be terminated at any time
prior to the Closing:
(a) by mutual consent of the parties hereto;
(b) upon written notice by any party hereto, if (i) any court of competent
jurisdiction in the United States or any other Governmental Agency shall have
issued a Judgment or taken any other action restraining, enjoining or otherwise
prohibiting the transactions contemplated by this Agreement and (ii) such
Judgment or other action shall have become final and nonappealable; or
(c) upon written notice at any time on or after June 30, 1999 by the
Purchaser or the Seller, if the Closing has not occurred by such date, provided
that the failure to close is not the result of a material breach of this
Agreement by the terminating party.
Section 13.02 OBLIGATIONS SHALL CEASE. In the event that this Agreement
shall be terminated pursuant to Section 13.01 hereof, all obligations of the
parties hereto under this Agreement shall terminate and there shall be no
liability of any party hereto to any other party except (a) for the obligations
with respect to confidentiality and publicity contained in Section 10.11 hereof
and (b) as set forth in Section 13.03; provided that nothing contained in this
Section shall relieve any party of liability for its bad faith or willful
violation of the provisions of this Agreement.
Section 13.03 FEES AND EXPENSES. Except as otherwise specifically provided
herein, each party hereto shall pay all of the fees and expenses incurred by it
in connection herewith.
ARTICLE XIV
MISCELLANEOUS
Section 14.01 COMPLETE AGREEMENT. This Agreement, the Related Documents,
the Confidentiality Agreement and the exhibits attached hereto and thereto and
the documents referred to herein and therein shall constitute the entire
agreement between the parties hereto with respect to the subject matter hereof
and thereof and shall supersede all previous negotiations, commitments and
writings with respect to such subject matter.
Section 14.02 WAIVER, DISCHARGE, ETC. This Agreement may not be released,
discharged, abandoned, waived, changed or modified in any manner, except by an
instrument in writing signed on behalf of each of the parties hereto by their
duly authorized representatives. The failure of any party hereto to enforce at
any time any of the provisions of this Agreement shall in no way be construed to
be a waiver of any such provision, nor in any way be construed to affect the
validity of this Agreement or any part thereof or the right of any party
thereafter to enforce each and every
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such provision. No waiver of any breach of this Agreement shall be held to be a
waiver of any other or subsequent breach. If any provision of this Agreement
shall be declared by any court of competent jurisdiction to be illegal or
unenforceable, the other provisions shall not be affected, but shall remain in
full force and effect.
Section 14.03 NOTICES. All notices, requests and demands to or upon the
respective parties hereto shall be in writing, including by telecopy, and,
unless otherwise expressly provided herein, shall be deemed to have been duly
given or made (a) if delivered by hand (including by courier), when delivered,
(b) in the case of mail, three Business Days after deposit in United States
first class mail, postage prepaid and (c) in the case of telecopy notice, when
receipt has been confirmed by the transmitting telecopy operator. In each case
notice shall be sent to the address of the party to be notified, as follows, or
to such other address as may be hereafter designated by the respective parties
hereto in accordance with these notice provisions:
If to the Purchaser, to:
Citicorp Mortgage, Inc.
15851 Clayton Road
Ballwin, Missouri 63011
Telecopy: (314) 916-7201
Attention: Legal Department
With a copy to:
Citigroup Inc.
Corporate Legal Department
425 Park Avenue - 2nd Floor
New York, New York 10043
Telecopy: (212) 793-4401
Attention: Stephen Dietz
If to the Seller or Parent, to:
Source One Mortgage Services Corporation
114 Goodwives Road
Darien, Connecticut 06820
Telecopy: (203) 655-6044
Attention: James H. Ozanne
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With a copy to:
Fund American Enterprises Holdings, Inc.
80 South Main Street
Hanover, NH 03755
Telecopy: (603) 643-4562
Attention: Terry L. Baxter
Section 14.04 GOVERNING LAW; WAIVER OF JURY TRIAL.
(a) This Agreement shall be governed by and construed in accordance with
the laws of the State of New York, without regard to conflict of law principles.
(b) Each party waives, to the fullest extent permitted by applicable law,
any right it may have to a trial by jury in respect of any action, suit or
proceeding arising out of or relating to this Agreement or any Related Document.
Section 14.05 HEADINGS. The descriptive headings of the several Articles
and Sections of this agreement are inserted for convenience only and do not
constitute a part of this Agreement.
Section 14.06 SUCCESSORS. This Agreement and all of the provisions hereof
shall be binding upon and inure to the benefit of the parties hereto and their
respective successors and permitted assigns. Neither this Agreement nor any of
the rights, interests or obligations hereunder shall be assigned by any of the
parties hereto except with the prior written consent of the other parties or by
operation of law, provided that without such consent the Seller may assign its
rights and obligations hereunder to the Parent or any of the Parent's direct or
indirect wholly owned subsidiaries, and the Purchaser may assign its rights and
obligations hereunder to Citigroup Inc. or any of its direct or indirect wholly
owned subsidiaries, in which event such assignee shall be substituted for the
assignor for purposes of this Agreement to the extent appropriate, but without
affecting any liability of the assignor hereunder.
Section 14.07 THIRD PARTIES. Except as specifically set forth or referred
to herein (including, without limitation, in Article XII), nothing herein
expressed or implied is intended or shall be construed to confer upon or given
any person or entity, other than the parties hereto and their successors and
permitted assigns, any rights or remedies under or by reason of this Agreement.
Section 14.08 COUNTERPARTS. This Agreement may be executed in two or more
counterparts, all of which shall be considered one and the same instrument and
each of which shall be deemed an original.
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IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement
to be executed by its duly authorized representatives as of the day and year
first above written.
SOURCE ONE MORTGAGE SERVICES
CORPORATION,
as Seller
By:
-------------------------------
Name:
Title:
FUND AMERICAN ENTERPRISES HOLDINGS, INC.,
as Parent
By:
-------------------------------
Name:
Title:
CITICORP MORTGAGE, INC.
as Purchaser
By:
-------------------------------
Name:
Title:
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Exhibit 10(gg)
TRANSITION SERVICES AGREEMENT
This Transition Services Agreement (this "Agreement"), dated as of March
25, 1999 is entered into by and among Source One Mortgage Services Corporation,
a Delaware corporation ("Seller"), and Citicorp Mortgage, Inc., a Delaware
corporation ("Purchaser").
RECITALS
A. Seller, Fund American Enterprises Holdings, Inc., a Delaware
corporation and the direct or indirect owner of all of the common stock of
Seller, and Purchaser have entered into an Asset Purchase Agreement, dated as of
March 23, 1999 (the "Asset Purchase Agreement"), pursuant to which Purchaser
will (i) acquire from Seller substantially all of the assets used in the
Business and (ii) assume certain obligations and liabilities of Seller related
to the Business.
B. Seller and Purchaser desire to enter into this Agreement in order to
facilitate an efficient transition of the Business of Seller to Purchaser and to
assist Seller following the Closing Date.
NOW, THEREFORE, in consideration of the premises and the covenants,
conditions and agreements contained herein, and for other good and valuable
consideration, the receipt and sufficiency of which are hereby acknowledged, the
parties hereto hereby agree as follows:
Section 1. DEFINED TERMS. Capitalized terms not otherwise defined in this
Agreement shall have the meanings assigned to them in the Asset Purchase
Agreement.
Section 2. SERVICES RENDERED. Purchaser or its designee shall provide
services to Seller as described herein and in the schedules hereto for the
compensation, duration and subject to any limits set forth in the applicable
schedule. The party providing a service hereunder may be referred to herein as a
"providing party" and the party receiving a service hereunder may be referred to
herein as a "receiving party." The description of the services to be provided
hereunder, the expected timing of the provision thereof, and the manner of
performance of any services hereunder do not in any way modify or amend any
party's obligations under the Asset Purchase Agreement or any Related Document.
(a) SPECIAL SERVICES.
(i) SCHEDULE I hereto sets forth services to be provided by
Purchaser to Seller that require the specific employment of specialized
personnel at the providing entity and are charged at the hourly rates set forth
on SCHEDULE V. Prior to the Closing Date, services of the type set forth in
SCHEDULE I were performed by Seller using Seller's personnel.
(ii) The hourly rates listed in SCHEDULE V have been set based
upon the Seller's representation that such amounts are calculated in a manner
consistent with the Seller's past practices with respect to their own internal
cost allocations.
<PAGE> 2
(b) SERVICING ADMINISTRATION. SCHEDULE II hereto sets forth services
(the "Servicing Administration Services") to be provided by Purchaser to the
Seller that the Seller requires Purchaser's assistance to perform in respect of
(i) certain of Seller's obligations under the Asset Purchase Agreement and (ii)
trailing document and pay-off follow-up services with respect to loans paid off
prior to the Closing Date.
(c) FREE SERVICES. SCHEDULE III hereto sets forth services to be
provided by Purchaser to Seller without charge to Seller.
Section 3. [Reserved.]
Section 4. SCHEDULE AMENDMENTS. The parties contemplate that from time to
time a need may arise for transition services not specifically contemplated
under this Agreement or the Schedules hereto that both parties deem to be
reasonable and appropriate to be provided hereunder, in which event the parties
may, but shall have no duty to, amend the appropriate schedule as necessary. The
amended schedule shall be initialed by a duly authorized individual from each of
Purchaser and Seller.
Section 5. MANNER OF PERFORMANCE AND ACKNOWLEDGMENT. Purchaser agrees that
it shall cause its personnel providing services under this Agreement to perform
such services with the same degree of care, skill, confidentiality and diligence
with which its personnel perform similar services for Purchaser and in a manner
consistent with the level of care given to Purchaser's business. Purchaser shall
provide all services under this Agreement in accordance with the reasonable
written instructions provided by the authorized representatives of Seller, or
their designees, or, in the absence of such instructions, as such services have
been performed for Seller in the past. Purchaser shall cease providing any
services upon the reasonable written instructions of the Seller's authorized
representatives or designees to that effect. Purchaser shall be entitled to rely
upon any written instructions received from such authorized representatives or
designees. The parties hereto acknowledge that services provided hereunder are
not being provided at standard commercial rates for such services but (without
limiting the prices set forth on the Schedules hereto) are being provided at
amounts considered for these purposes to be at cost to most efficiently permit
the transition to occur; the parties further acknowledge that Purchaser is not
in the business of providing the services rendered under this Agreement. Seller
shall reimburse Purchaser for reasonable third-party costs and expenses charged
to Purchaser in connection with Purchaser's performance of its duties under this
Agreement.
Section 6. PRORATION, INVOICING AND PAYMENT.
(a) PRORATION. In any month during which any services with monthly
fees set forth on the applicable Schedule are provided for less than a complete
month, such fees shall be prorated on a daily basis based on the actual number
of days in the month that such services are provided.
(b) INVOICING. The Purchaser shall submit an invoice to the Seller
prior to the tenth day of each month for all services provided hereunder by the
Purchaser during the prior calendar month. Amounts invoiced shall be calculated
or otherwise determined in accordance
-2-
<PAGE> 3
with the applicable Schedules. Upon termination of this Agreement, each
providing party shall submit a final invoice to the respective receiving parties
within thirty (30) days of such termination.
(c) PAYMENT. Each invoice received by the Seller shall constitute a
"claim" under Section 12.04 of the Asset Purchase Agreement. Prior to the first
anniversary of the Closing Date, such invoice shall be subject to, and shall be
paid in accordance with, the procedures set forth in Section 12.04 of the Asset
Purchase Agreement for claims under Section 3.01(a) thereof regarding deductions
from the holdback amount. On and after the first anniversary of the Closing
Date, such invoice shall be subject to, and shall be paid in accordance with,
the procedures set forth in Section 12.04 of the Asset Purchase Agreement for
claims under Sections 12.02 and 12.03 (without regard to any provisions of
Section 12.04 which reference the expiration of any indemnification obligation
or the tolling of any indemnification period under those sections). If the
Seller disputes any invoice pursuant to the provisions of Section 12.04(b), the
Purchaser shall nevertheless continue to perform all of its obligations under
this Agreement pending resolution thereof. If the Seller fails to timely pay
invoices (other than with respect to amounts disputed in good faith pursuant to
Section 12.04(b)), the Purchaser may, at any time not less than 30 days after
the Purchaser has furnished notice to the Seller of its intent to do so, cease
to provide the compensated services to be provided by the Purchaser under this
Agreement until all undisputed amounts have been paid.
Section 7. RECORDS MAINTENANCE AND AUDITS. Purchaser shall make available
to Seller or its representatives access to or copies of Purchaser's records for
the purpose of verifying the accuracy of the invoices submitted by Purchaser
regarding amounts due such party.
Section 8. INDEMNIFICATION. Purchaser agrees to indemnify and hold Seller
harmless for one year following the provision of services under this Agreement
from and against any and all claims, actions, liabilities, losses, damages,
costs or expenses (including court costs and attorneys' fees) arising out of
Purchaser's or its affiliates' gross negligence or willful misconduct in the
provision by Purchaser or its affiliates of any services under this Agreement.
This indemnity shall survive any termination of this Agreement.
Section 9. RELATIONSHIP OF PARTIES. Purchaser shall act as an independent
contractor, and nothing herein shall at any time be construed to create the
relationship of employer and employee, partnership, principal and agent, broker
or finder, or joint venturers as between Seller and Purchaser. Except as
expressly provided herein, no party shall have any right or authority, and no
party shall attempt to enter into any contract, commitment or agreement nor
incur any debt or liability of any nature, in the name or on behalf of any other
party.
Section 10. CONFIDENTIALITY. Each party acknowledges that in connection
with its performance under this Agreement, it may gain access to confidential
material and information which is identified by the other party as confidential
and proprietary to the other party. Each party agrees to maintain the
confidentiality of all such information. The requirements under this Section 10
shall survive for a period of eighteen (18) months following the provision of
the service out of which such confidential information was acquired.
-3-
<PAGE> 4
Section 11. [Reserved.]
Section 12. TERMINATION. At any time, either party may terminate any one
or more of the individual services being provided by Purchaser enumerated in
this Agreement due to the non-performance of the other party of its obligations
hereunder by giving the other party written notice to that effect.
Section 13. ASSIGNMENT. No party shall assign, in whole or in part, any of
the rights, obligations or benefits arising under this Agreement without the
prior written consent of the other parties; provided, that any party may at any
time assign any of its rights or benefits arising under this Agreement to any of
its affiliates capable of fulfilling the obligations hereunder upon written
notice thereof to the other parties.
Section 14. GOVERNING LAW. This Agreement shall be governed by and
construed in accordance with the laws of the State of New York without giving
effect to the conflict of laws rules or choice of laws rules thereof.
Section 15. NOTICES. All notices, requests and demands to or upon the
respective parties hereto shall be in writing, including by telecopy, and,
unless otherwise expressly provided herein, shall be deemed to have been duly
given or made (a) if delivered by hand (including by courier), when delivered,
(b) in the case of mail, three Business Days after deposit in United States
first class mail, postage prepaid, and (c) in the case of telecopy notice, when
receipt has been confirmed by the transmitting telecopy operator. In each case
notice shall be sent to the address of the party to be notified, as follows, or
to such other address as may be hereafter designated by the respective parties
hereto in accordance with these notice provisions:
If to the Purchaser, to:
Citicorp Mortgage, Inc.
15851 Clayton Road
Ballwin, Missouri 63011
Telecopy: (314) 916-7201
Attention: Legal Department
With a copy to:
Citigroup Inc.
Corporate Legal Department
425 Park Avenue B 2nd Floor
New York, New York 10043
Telecopy: (212) 793-4401
Attention: Stephen Dietz
-4-
<PAGE> 5
If to the Seller or Parent, to:
Source One Mortgage Services Corporation
114 Goodwives Road
Darien, Connecticut 06820
Telecopy: (203) 655-6044
Attention: James H. Ozanne
With a copy to:
Fund American Enterprises Holdings, Inc.
80 South Main Street
Hanover, New Hampshire 03755
Telecopy: (603) 643-4562
Attention: Terry L. Baxter
Section 16. SEVERABILITY. In the event that any portion of this Agreement
shall be found by a court of competent jurisdiction to be illegal, unenforceable
or invalid, that portion of this Agreement will be null and void and the
remainder of this Agreement will be binding on the parties as if the illegal,
unenforceable or invalid provisions had never been contained therein.
Section 17. WAIVER. No waiver by any party of any term or any breach of
this Agreement shall be construed as a waiver of any other term or breach
hereof, or of the same or a similar term or breach on any other occasion.
Section 18. AMENDMENT. Except as contemplated by Section 4, no
modification or amendment of this Agreement shall be binding upon any party
unless in writing and signed by all parties hereto.
Section 19. ENTIRE AGREEMENT. This Agreement, together with the Asset
Purchase Agreement and all Schedules and Exhibits attached hereto and thereto,
constitutes the entire agreement between the parties pertaining to the subject
matter hereof, and supersedes all prior agreements, understandings, negotiations
and discussions, whether oral or written, of the parties hereto regarding the
subject matter hereof.
Section 20. COUNTERPARTS. This Agreement may be executed in one or more
counterparts, each of which shall be deemed an original, but all of which shall
constitute one and the same instrument.
[Remainder of Page Intentionally Left Blank]
-5-
<PAGE> 6
SOURCE ONE MORTGAGE SERVICES
CORPORATION
By:___________________________________
Name:_________________________________
Title:________________________________
CITICORP MORTGAGE, INC.
By:___________________________________
Name:_________________________________
Title:________________________________
-6-
<PAGE> 7
Schedule I C Special Services
Purchaser shall cause its personnel to perform the following services, and shall
be reimbursed on an hourly basis in accordance with the rates set forth in
SCHEDULE V.
- --------------------------------------------------------------------------------
Service Description
- --------------------------------------------------------------------------------
PERSONNEL SERVICES - A. Purchaser shall cause its personnel, with respect to
Seller's obligations related to the calendar year 1998 and any stub period
between January 1, 1999 and the Closing Date of the Asset Purchase Agreement
(the "Reporting Period"), to (i) provide or assist in providing complete
payroll services to Seller and (ii) perform all related subsequent year-end
and stub period reporting to individuals, regulators and agencies, as applicable
(collectively, the "Payroll Services").
- --------------------------------------------------------------------------------
PERSONNEL SERVICES - B. Purchaser shall cause its personnel, with respect to
Seller's obligations related to the Reporting Period, to (i) administer or
assist in the administration of all Seller employee benefit programs including,
without limitation, Seller 401(k) Plan, medical benefits, life and disability
insurance benefits, flexible spending accounts and Deferred Compensation Plan,
(ii) perform all related subsequent year-end and stub period reporting to
individuals, regulators and agencies, as applicable, (iii) assist in the
transition of former employees of Seller off of Seller's benefit programs
(including any required reporting obligations), and (iv) assist in the 401(k)
audit for the 1998 plan year as soon as practicable after the Closing Date
(collectively, the "Benefit Plan Services").
- --------------------------------------------------------------------------------
PERSONNEL SERVICES - C. Purchaser shall cause its personnel, with respect to
Seller's obligations related to the Reporting Period, to assist Seller in
performing its reporting obligations under the Securities Exchange Act of
1934, as amended.
- --------------------------------------------------------------------------------
PERSONNEL SERVICES - D. Purchaser shall cause its personnel, with respect to
Seller's obligations after the Closing Date, to assist Seller in performing its
obligations under Section 10.05(b) of the Asset Purchase Agreement.
- --------------------------------------------------------------------------------
PERSONNEL SERVICES - E. Purchaser shall cause its personnel to fulfill, under
third-party servicing sale agreements, the transfer of servicing obligations.
- --------------------------------------------------------------------------------
PERSONNEL SERVICES - F. Purchaser shall cause its personnel to provide certain
functions to the Seller following the Closing Date. These services include, but
are not limited to, assistance with the following:
Preparation of Seller's full 1998, and 1999 short period, tax
returns (including, but not limited to, income and franchise tax
returns)
Responses to federal and state tax audits, including
recalculation of servicing amortization
Final resolution of loan repurchases (including, but not
limited to, dealing with the initial seller/correspondent)
-2-
<PAGE> 8
Schedule II C Servicing Administration
Purchaser shall cause its personnel to provide the following services. Where
flat fees are indicated below, such fees are best estimates of the projected
cost of providing the related services. To the extent such services vary
materially from those estimates, the parties agree to renegotiate these fees.
1. TAX REPORTING SERVICES. Purchaser shall cause its personnel to provide
such tax information reporting services as may be required for the 1999
tax year, including but not limited to annual reporting on tax forms 1098
and 1099, for every loan Seller serviced or subserviced during calendar
year 1999. Such services include customer call support, IRS tape
generation, customer year-end information, IRS corrections and follow-up.
These services shall be provided at a rate of $0.58 per loan (estimated
total fee of $61,224.00).
2. TRAILING DOCUMENTS. Purchaser shall cause its personnel to fulfill
Seller's obligations to follow-up on and resolve existing trailing
documents as of the Closing Date (the "Trailing Documents"). Seller shall
pay for certain full-time employees in accordance with SCHEDULE VI for the
periods set forth therein. Following such periods, Purchaser shall offer
to provide assistance with Seller's obligations with respect to any
remaining Trailing Documents on an hourly rate basis under "Miscellaneous
Support" below. With respect to the services provided pursuant to this
item 2, Purchaser's indemnity of Seller shall survive for a period of 365
days following the provision of the service from which a claim arises.
3. PAYOFF FOLLOW UP. Purchaser shall cause its personnel to fulfill Seller's
obligations to complete mortgage loan payoffs, including processing any
filing releases and satisfaction, processing escrow refund checks,
cancellation of mortgage guarantee insurance policies, and customer call
support for paid in full loans as of the Closing Date. These services
shall be provided at a rate of $9.35 per loan (estimated total fee of
$140,250.00).
4. ASSIGNMENTS. Purchaser shall cause its personnel to fulfill Seller's
obligations under the Asset Purchase Agreement to prepare and record
Assignments of Mortgage. Seller shall pay for the cost of preparing and
recording such Assignments of Mortgage. Purchaser will charge Seller the
hourly rates set forth on SCHEDULE V for performing these services.
5. FILE STORAGE. Purchaser will provide storage, access and retrieval
capabilities with respect to stored inactive loan files for loans that
were serviced by Seller and that became inactive prior to the Closing
Date. Such storage will continue in accordance with the time periods set
forth on SCHEDULE IV. These services shall be provided at a monthly rate
of $0.25 per box. Final destruction of such records (at the times
indicated on SCHEDULE IV) shall be provided at a rate of $0.77 per box.
-1-
<PAGE> 9
6. MISCELLANEOUS SUPPORT. Purchaser shall cause its personnel to provide
certain functions to the Seller following the Closing Date. Purchaser will
charge Seller the hourly rates set forth on SCHEDULE V for performing
these services. These services include, but are not limited to, assistance
with the following:
Research and follow-up on prior year-end reporting
Research and follow-up on NSF and misapplied payments
Final bank reconciliations
Responses to audit requests
Research and follow-up on loan-level litigation, which will
require, as necessary and by way of example and not limitation,
Purchaser's personnel to participate in litigation as witnesses
Research and follow-up on inactive loans
Research and follow-up on investor repurchase requests
Final agency pool reconciliations (Test of Expected P&I
balanced to the custodial bank accounts) for all pools delivered
prior to Closing Date
Final FHLMC, FNMA and GNMA pool to security balance
reconciliations for all pools delivered prior to Closing Date
Research and follow-up on outstanding custodial account items
Research and follow-up on outstanding checks (e.g., escrow
refunds, GNMA security holder remittances, tax and insurance
disbursements)
Research and final resolution of investor loan-level
discrepancies
Research and final resolution of outstanding customer
investigations
7. SPECIAL PROJECTS. Seller may make requests for other services or for
special reports or information, and Purchaser will provide an estimate of
the cost and completion date.
-2-
<PAGE> 10
SCHEDULE III - Free Services
1. UPDATED MORTGAGE LOAN SCHEDULE. Purchaser shall cause its personnel to
perform, on behalf of Seller, Seller's obligations under Section 10.15 of
the Asset Purchase Agreement.
2. PRORATION OF CHASE AMOUNT. Within five (5) business days after the Closing
Date, Purchaser shall calculate the proration of the Chase Amount as
required by Section 3.01(a)(ii) of the Asset Purchase Agreement and shall
deliver Schedule 3.01(a)(ii) of the Asset Purchase Agreement to Seller.
3. OTHER SCHEDULES. To the extent that Seller is unable to prepare schedules
or updates thereto required under the Asset Purchase Agreement on and
after the Closing Date, Purchase shall cause its personnel to perform, on
behalf of Seller, Seller's obligations to prepare such schedules or
updates.
-3-
<PAGE> 11
SCHEDULE IV - File Retention Schedule
The following are the agency guidelines that currently exist for retention of
archive records, i.e., Payoffs and Foreclosures.
FHA
All servicing files must be retained for a minimum of the life of the mortgage
plus three years. Each claim review file must be retained for at least three
years after final or the latest supplemental claim settlement.
VA
VA regulations do not require holders to retain records for any fixed period of
time after a Claim is paid, although, it is recommended that they be retained
for three years.
GNMA
GNMA has no specific requirements that relate to retention of archive storage
records.
FNMA
After a mortgage is liquidated, the servicer must keep the individual mortgage
records for at least four years, measured from the date of payoff or the date
that any applicable claim proceeds are received.
FHLMC
The servicer must maintain the mortgage file while FHLMC retains an interest in
the applicable mortgage and for at least three years from the date FHLMC's
interest in the mortgage is satisfied. If the mortgage was foreclosed upon, the
servicer must maintain the mortgage file for at least six years from the date
FHLMC's interest in the mortgage was satisfied.
The following are the SOMSC's guidelines that currently exist for retention of
archive records, i.e., Payoffs and Foreclosures.
DEPARTMENT TYPE RETENTION
- ---------- ---- ---------
Foreclosure Completed GNMA/FNMA B Four Years
FHLMC B Six Years
Reinstated GNMA/FNMA/FHLMC B Three Years
Payoffs Paid In Full GNMA/FNMA/FHLMC B Four Years
A detailed listing of the archive records exists detailing the destruction dates
for each box.
-4-
<PAGE> 12
SCHEDULE V - Hourly Rates
The fee for any services performed on an hourly rate will be based upon the
division of the related personnel, and whether such personnel are management or
staff, based upon the following rates:
- -------------------------------------------------------------------------------
Division Management Hourly Rate Staff Hourly Rate
- -------------------------------------------------------------------------------
Financial $37.00 $22.00
- -------------------------------------------------------------------------------
Servicing $32.00 $14.00
- -------------------------------------------------------------------------------
Front Line Production $54.00 $16.50
- -------------------------------------------------------------------------------
Back Room Operations $32.00 $14.50
- -------------------------------------------------------------------------------
Human Resources $52.00 $24.00
- -------------------------------------------------------------------------------
Legal $52.00 $19.00
- -------------------------------------------------------------------------------
Records Management $20.00 $11.00
- -------------------------------------------------------------------------------
Acquisitions $26.00 $12.00
- -------------------------------------------------------------------------------
-5-
<PAGE> 13
SCHEDULE VI - Trailing Document Cost Structure
- -------------------------------------------------------------------------------
Documents
- -------------------------------------------------------------------------------
Insuring:
$60,350
$21,900 one time
cost
$82,250
FTE 60 additional days
- -------------------------------------------------------------------------------
Source One Loan File Set Up:
$19,000
- -------------------------------------------------------------------------------
Document Retrieval & Corrections:
$140,000
TBD one time cost
- -------------------------------------------------------------------------------
Shipping
- -------------------------------------------------------------------------------
Document Control:
$252,900
$50,000 one time cost
- -------------------------------------------------------------------------------
Records Management
- -------------------------------------------------------------------------------
New Production: Hourly rates in
accordance with
SCHEDULE V
$ 67,768
$ 17,702
Loan Sale Exceptions:
- -------------------------------------------------------------------------------
Investor Reporting Misc. Follow Up
- -------------------------------------------------------------------------------
Hourly rates in
accordance with
SCHEDULE V
- -------------------------------------------------------------------------------
Financial
- -------------------------------------------------------------------------------
Hourly rates in
accordance with
SCHEDULE V
- -------------------------------------------------------------------------------
SubPrime
- -------------------------------------------------------------------------------
$ 19,500
-6-
F-27
<PAGE> 1
TO OUR SHAREHOLDERS, EMPLOYEES AND CUSTOMERS
The consolidation in the mortgage banking business continued to gain speed
in 1998. The largest originator produced over $100 billion of mortgage
loans. Over 15 consolidating acquisitions were completed during the year.
This consolidation activity has contributed to intense price competition.
Smaller independent mortgage banks such as Source One Mortgage Services
Corporation will survive in this environment by focusing on high quality
service, tightly defined niches and entrepreneurial origination structures
such as Central Pacific Mortgage (CPM), our net branch subsidiary.
With those business factors in mind, Source One had a very successful 1998.
Not only did we follow a closely structured business plan, but we
implemented a number of successful changes. Due to those efforts, we are
pleased to report record results in 1998.
OPERATING RESULTS
Source One achieved new loan production of $12 billion, making it a record
year. Further, we achieved our highest return on equity in the 13 years of
Fund American ownership. The mortgage operation's GAAP ROE for 1998 was
25%. Net income applicable to common stock was $42.2 million, also a
record. The residential mortgage loan business was fueled by a very strong
economy and declining interest rates. These external factors coupled with
our strategic initiatives in 1997 and 1998 produced an outstanding result
for Source One.
We reached the #5 position in GNMA market share in a market dominated by
highly capitalized banks. We reduced our common equity base by sending $104
million of capital to Fund American. We squeezed our costs in the face of
record volume and found $4 million of cost savings.
HIGH QUALITY SERVICE
Source One has been one of the most efficient servicers and subservicers in
the mortgage banking industry over the past decade while, at the same time,
continually focusing on the specific needs of our customers (mortgagors,
investors and servicers). For example, Source One has been recognized in
annual cost surveys as one of the lowest cost servicers of all loan types.
We have also been a pioneer in such areas as the use of voice response
units and power dialers, a payoff imaging system, totally automated fax
response capabilities, behavioral scoring, and loss mitigation.
Consequently, Source One has been able to provide quality service at a low
cost.
Standard & Poor's and Fitch IBCA performed detailed servicing evaluations
of our servicing operations in 1998. Both independent organizations issued
reports concluding that Source One is a superior mortgage loan servicer.
In fact, the Chase subservicing agreement was extended for two additional
years, due in part to the excellent service Source One provides. We also
added seven new subservicing customers. These favorable evaluations are a
credit not only to our experienced servicing team, but also to the
excellent automation systems that support this group.
PRODUCTION
The strong production market resulted in a volume of $12 billion. We
continued with our plan of concentrating on higher margin government
production, bringing our product mix up to 70% government.
All of our production areas have focused on selling niche products in 1998.
In addition, Source One opened 34 new branch offices in 1998 reaching a
total of 163 offices at year end (up 26% from year end 1997).
Early in 1998 Source One recognized a unique opportunity within the
high-margin mortgage marketplace and quickly capitalized by creating an
independent subprime (B-C) operation located in Lagrangeville, NY. This
state-of-the-art facility is fully staffed with mortgage professionals who
are responsible for the origination, sales, and subservicing of subprime
loans.
We felt the need to bolster our existing product lines with some
high-margin niche programs including subprime in order to augment our
conventional production during economic shifts and market downturns. Based
upon our solid name recognition and dedicated effort, the up-start Subprime
Division has quickly established itself as a formidable contender in the
often volatile B-C marketplace.
Our overall goal of increasing our niche and high margin products proved
successful. Source One produced $374 million of new product volume in 1998,
up from $65 million in 1997.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 1
<PAGE> 2
TO OUR SHAREHOLDERS, EMPLOYEES AND CUSTOMERS
TECHNOLOGICAL ADVANCEMENTS
Source One purchased the Empower Loan Origination System from Eastern
Software in the fall. This product is a state-of-the art client/server
system that handles the full scope of origination activities, from lead
management through setup on the servicing system to post-closing. The
system is an "open architecture" format that allows the individual
production units to customize their workflows for both sales and operations
to increase productivity and reduce expense.
The system is unique in that it is designed to support different lines of
the mortgage business, including broker, retail, subprime, telemarketing
and correspondent.
The system was rolled out in our New York Subprime Division late in 1998.
Further rollout of the system to the remainder of the Source One production
units should be complete in 1999.
Amid our system upgrades we have paid detailed attention to the Year 2000
Compliance issue. We are confident in reporting that Source One's computer
system is at 100% compliance. In fact, a review by independent consultants
in November of 1998 revealed all of our systems are prepared to handle
business as usual on January 1, 2000.
SENIOR MANAGEMENT
Melinda Cain was promoted to Senior Vice President in 1998 and is
responsible for overseeing Capital Markets, Portfolio Management and
backroom operations.
Thomas Marshall was promoted to Senior Vice President in 1998 and is
responsible for aspects of Secondary Marketing. This includes pipeline
hedging, pool delivery, loan pricing and gestation repo programs.
Mike Muldoon joined the Company in 1998 as a Senior Vice President
responsible for the Subprime Subservicing Unit in Lagrangeville, NY.
John Jansen, Senior Vice President of Human Resources, retired in January
1999. He was replaced by Greg Ghilardi, Senior Vice President.
SUBSEQUENT EVENTS
In late March 1999, Source One and Citicorp Mortgage, Inc. reached an
agreement under which Citicorp Mortgage, Inc. will purchase substantially
all of the mortgage-banking-related assets, assume certain liabilities, and
employ substantially all of the employees of Source One. Closing is
contingent upon receipt of various regulatory and agency approvals. The
successful execution of our strategic plan and our operational success in
1998 have been material contributors to the successful positioning of
Source One. We are very pleased with this transaction and look forward to
watching our small part of the largest financial institution in the world
grow in the years to come.
Sincerely,
Frank Mohan James Ozanne
- ----------------- ------------
Frank Mohan James Ozanne
President and CEO Chairman
March 29, 1999
2 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 3
SELECTED CONSOLIDATED FINANCIAL DATA & CORPORATE INFORMATION*
<TABLE>
<CAPTION>
===================================================================================================================================
INCOME STATEMENT DATA
- -----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1998 1997 1996 1995 1994
(in thousands, except per share amounts)
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total revenue $ 208,368 $ 89,993 $ 141,423 $ 148,595 $ 142,493
Total expenses 138,215 101,140 136,296 105,313 137,215
Income (loss) before income taxes,
extraordinary loss and cumulative
effect of accounting change 70,153 (11,147) 5,127 43,282 5,278
Income tax expense (benefit) 24,243 (3,617) 9,453 16,132 4,474
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before extraordinary
loss and cumulative effect
of accounting change 45,910 (7,530) (4,326) 27,150 804
Extraordinary loss on retirement of debt -- (5,975) -- (902) --
Cumulative effect of accounting change (a) -- -- -- -- (44,296)
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 45,910 $ (13,505) $ (4,326) $ 26,248 $ (43,492)
Less dividends on preferred stock 3,707 3,707 3,707 7,634 6,642
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) applicable to
common stock $ 42,203 $ (17,212) $ (8,033) $ 18,614 $ (50,134)
- -----------------------------------------------------------------------------------------------------------------------------------
Basic net income (loss) per common share: (b)
Before extraordinary loss and cumulative
effect of accounting change $ 13.14 $ (3.78) $ (3.57) $ 7.55 $ (1.65)
Basic net income (loss) per common share 13.14 (5.79) (3.57) 7.20 (14.21)
- -----------------------------------------------------------------------------------------------------------------------------------
Cash dividends per common share (c) $ 32.39 $ -- $ -- $ -- $ --
Cash dividends declared on common shares 104,033 -- -- -- --
Payment for common shares repurchased -- 2,638 -- 120,000 122,000
Issuance of common shares -- 119,040 -- -- --
===================================================================================================================================
COMPREHENSIVE INCOME STATEMENT DATA (d)
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 45,910 (13,505) $ (4,326) $ 26,248 $ (43,492)
Other comprehensive income (loss) 19,294 41,102 546 3,519 (3,779)
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income (loss) $ 65,204 27,597 $ (3,780) $ 29,767 $ (47,271)
- -----------------------------------------------------------------------------------------------------------------------------------
Basic comprehensive income
(loss) per common share (b) $ 19.15 8.03 $ (3.33) $ 8.57 $ (15.28)
===================================================================================================================================
OPERATING DATA
- -----------------------------------------------------------------------------------------------------------------------------------
Total mortgage loan production (e) (in millions) $ 10,866 4,403 $ 3,831 $ 2,852 $ 4,586
Servicing portfolio at end of year: (f)
Balance (in millions) $ 25,112 26,546 $ 29,201 $ 31,831 $ 39,568
Number of loans serviced (g) 384,466 438,261 478,779 494,051 543,428
Weighted average interest rate (g) 7.99% 8.45% 8.48% 8.33% 8.14%
Weighted average net servicing fee (g)(h) .397% .420% .422% .419% .410%
Percent delinquent (g) 7.07% 6.35% 6.24% 5.28% 4.07%
Percent in process of foreclosure 1.50% 1.18% .93% .80% .77%
Servicing rights acquisitions (in millions) $ -- 36 $ 2,789 $ 4,674 $ 3,707
Sale of servicing rights (in millions) $ 10,647 17,018 $ 3,302 $ 10,973 $ 3,868
Number of employees at end of year 2,212 1,572 1,682 1,680 2,055
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA
December 31, (in thousands)
- -----------------------------------------------------------------------------------------------------------------------------------
Mortgage loans receivable $ 676,317 519,247 $ 314,937 $ 381,028 $ 210,472
Capitalized servicing (net) (i) 169,688 181,025 410,939 397,071 530,450
Total assets 1,517,977 1,304,690 1,131,054 1,135,029 1,210,012
Senior debt 814,593 686,906 643,262 661,846 647,251
Subordinated debt 55,771 55,153 54,535 54,786 --
Total liabilities 1,105,464 849,641 816,297 812,785 733,925
Total stockholders' equity 412,513 455,049 314,757 322,244 476,087
===================================================================================================================================
</TABLE>
* See accompanying notes to selected consolidated financial data.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 3
<PAGE> 4
NOTES TO SELECTED CONSOLIDATED FINANCIAL DATA & CORPORATE INFORMATION
(a) The 1994 amount reflects the cumulative after tax effect, as of January 1,
1994, of a change in the methodology used to measure impairment of the
purchased mortgage servicing rights asset.
(b) Basic net income (loss) and basic comprehensive income (loss) per common
share amounts for all years presented are based on the weighted average
number of common shares outstanding.
(c) Cash dividends per common share were computed based on the total number of
common shares outstanding as of the dividend record dates.
(d) Comprehensive income (loss) includes net income (loss) and the net change
in after tax unrealized investment gains (refer to Note 1 to the
consolidated financial statements for further discussion).
(e) Excludes mortgage loan production originated by the Company's retail
branches that is sold directly to third parties on a whole loan basis
totaling $1,201 million, $680 million, $496 million and $390 million for
the years ended December 31, 1998, 1997, 1996 and 1995, respectively.
(f) Includes loans subserviced for others having a principal balance of $15.9
billion, $14.9 billion, $2.8 billion, and $4.0 billion as of December 31,
1998, 1997, 1996, and 1995, respectively, except as noted.
(g) Excludes interim servicing of loans having a principal balance of $1.7
billion as of December 31, 1994.
(h) Excludes loans subserviced for others as noted in (e) above.
(i) Reflects a $68.1 million cumulative pretax adjustment to the purchased
mortgage servicing rights asset as of January 1, 1994 relating to a change
in the methodology used to measure its impairment.
FORM 10-K
- --------------------------------------------------------------------------------
The financial information contained in this report substantially conforms
with the information required in the "Form 10-K" Annual Report filed by the
Company with the Securities and Exchange Commission at the end of March
1999. Certain supplemental information appears in such Form 10-K that is
not necessarily disclosed within this document. Copies of such Form 10-K
(without exhibits) are available, without charge, upon request to the
Corporate Secretary's Office, Source One Mortgage Services Corporation,
27555 Farmington Road, Farmington Hills, Michigan 48334-3357 (telephone:
(248) 488-7000).
BUSINESS
- --------------------------------------------------------------------------------
The Company primarily engages in the business of producing and selling
conforming and subprime residential mortgage loans, servicing conforming
residential mortgage loans and subservicing residential mortgage loans for
third parties. In response to increased industry competition for producing
and servicing conforming mortgage loans, the Company decided to broaden its
product line by offering higher margin products. The Company began to
produce 203(k) (FHA home improvement) loans, manufactured housing loans,
subprime loans and high loan-to-value ("high LTV") second mortgage loans in
late 1997. The 203(k) loans and the manufactured housing loans are being
sold into agency pools with servicing retained. The subprime and high LTV
loans are being originated for a fee and sold to third parties on a
servicing released basis. The Company is currently subservicing subprime
loans and has the capability to service and subservice subprime and high
LTV loans. Although these higher margin products are a new focus for the
Company, they accounted for less than 4% of total production in 1998 and
are currently expected to account for approximately 8% of total production
in 1999. The Company's primary sources of revenue are net servicing
revenue, net interest revenue, net gain on sale of mortgages, net gain on
sale of servicing, earnings from unconsolidated affiliate and other
revenue.
The Company is also engaged, through certain of its subsidiaries, in the
sale of credit-related insurance products (such as life, disability,
health, accidental death and property and casualty insurance).
MARKET FOR STOCK AND RELATED MATTERS
- --------------------------------------------------------------------------------
There is no established public trading market for the Company's common
stock. As of March 31, 1999, there were two holders of the 3,211,881 shares
of the Company's issued and outstanding common stock, White Mountains
Holdings, Inc. ("White Mountains") (formerly Fund American Enterprises,
Inc.), and its parent Fund American Enterprises Holdings, Inc. ("Fund
American").
During the year ended December 31, 1998, the Company declared and paid cash
dividends on its common stock totaling $104.0 million. The Company did not
declare or pay cash dividends on its common stock during the years ended
December 31, 1997 or 1996. The Company's secured revolving credit
facilities contain covenants which limit its ability to pay dividends or
make distributions on its capital to holders of its common stock. In
addition, the Company must comply with certain financial covenants provided
in its secured revolving credit facilities, including restrictions relating
to tangible net worth and leverage. The Company is currently in compliance
with all such covenants.
4 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 5
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
SUMMARY - The Company reported net income of $45.9 million for the year
ended December 31, 1998 compared to a net loss of $13.5 million for the
year ended December 31, 1997. The 1998 results include a $15.2 million
pretax gain on sale of servicing, $13.8 million pretax equity in earnings
of an unconsolidated affiliate and a $14.8 million pretax charge for
impairment of the Company's capitalized servicing asset, which was offset
by a $20.4 million pretax net gain on financial instruments. The 1997
results include an $8.0 million pretax loss on the sale of servicing to a
third party and the related assumption of subservicing, $9.5 million pretax
equity in earnings of an unconsolidated affiliate and a $21.2 million
pretax charge for impairment of the Company's capitalized servicing asset,
which was partially offset by a $11.3 million net gain on financial
instruments. The 1997 results also include the following one-time charges:
a $9.2 million pretax extraordinary loss on the early retirement of debt, a
$3.0 million pretax charge related to loans held for investment which were
identified for sale and marked down from amortized cost to current market
value, $3.1 million of pretax restructuring and compensation charges and
$2.1 million of other miscellaneous charges.
The Company reported comprehensive income (which includes the net change in
after tax unrealized investment gains) of $65.2 million for the year ended
December 31, 1998 compared to $27.6 million in 1997. The Company's
unrealized investment gains are associated with its investment in Financial
Security Assurance Holdings Ltd. ("FSA"), which it acquired during 1997
(refer to Note 2 to the consolidated financial statements for further
discussion).
Total mortgage loan production for the years ended December 31, 1998 and
1997 was $10.9 billion and $4.4 billion, respectively. The significant
increase in 1998 mortgage loan production reflects lower market interest
rates and a corresponding increase in refinance activity throughout 1998 as
compared to 1997. Production related to refinancing activity made up
approximately 61% of the Company's total production for 1998 as compared to
approximately 40% for 1997.
During the first quarter of 1999, interest rates increased from year end
1998 levels. The increase in interest rates has resulted in a slight
decrease in the Company's 1999 first quarter mortgage loan production
volume from the fourth quarter of 1998. There can be no assurance that
these results will continue, however, since management cannot predict the
interest rate environment for the remainder of 1999.
Although 1998 production increased significantly, the Company's total
mortgage servicing portfolio decreased to $25.1 billion as of December 31,
1998 from $26.5 billion as of December 31, 1997. Consistent with its goal
to minimize exposure to interest rate risk inherent in its capitalized
servicing asset, the Company sold the rights to service $10.6 billion of
its nonrecourse mortgage servicing portfolio to third parties during 1998.
The Company continues to service $4.1 billion of these loans pursuant to
the subservicing agreement discussed below. During 1997, the Company sold
the rights to service $17.0 billion of its nonrecourse mortgage servicing
portfolio to a third party ("the 1997 Servicing Sale") and continues to
service the loans pursuant to a subservicing agreement ("the 1997
Subservicing Agreement"). In December 1997, the 1997 Subservicing Agreement
was amended to extend the Company's subservicing responsibilities for one
additional year at less favorable terms than the original agreement
provided. In early November 1998, the Company amended the 1997 Subservicing
Agreement again to extend its subservicing responsibilities for two
additional years at slightly more favorable terms than the first amendment
provided. As a result, the Company will continue to service these loans at
least until March 2001, June 2001 and August 2001 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 following table summarizes the Company's portfolio of mortgage loans
serviced as of December 31, 1998 and 1997:
<TABLE>
<CAPTION>
========================================================================================================================
December 31, (in millions) 1998 1997
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Mortgage servicing portfolio owned $ 9,197 $ 11,627
Mortgage servicing portfolio serviced for others 15,915 14,919
- ------------------------------------------------------------------------------------------------------------------------
Total mortgage servicing portfolio $ 25,112 $ 26,546
========================================================================================================================
</TABLE>
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 5
<PAGE> 6
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Mortgage loan payoffs for the years ended December 31, 1998 and 1997 were
$4.9 billion and $3.0 billion, respectively. The average prepayment rate of
the Company's total servicing portfolio was 21.2% for 1998 as compared to
10.5% for 1997. The increase in payoffs also reflects lower market interest
rates and the corresponding increase in refinance activity in 1998 as
compared to 1997, the effects of which were offset by a smaller average
owned servicing portfolio.
REVENUE- Mortgage servicing revenue decreased to $78.1 million in 1998 from
$95.0 million in 1997. The decrease in mortgage servicing revenue is
primarily the result of (i) the 1998 and 1997 servicing sales; (ii) lower
subservicing revenue resulting from the first amendment to the 1997
Subservicing Agreement and (iii) the recognition of the remaining deferred
gain on the Company's 1994 sale of servicing in 1997 as discussed below.
Amortization of capitalized servicing was $55.2 million and $68.0 million
for the years ended December 31, 1998 and 1997, respectively. Amortization
includes the change in the valuation allowances for impairment of the
Company's capitalized servicing asset as indicated in the following table:
<TABLE>
<CAPTION>
=========================================================================================================================
Year ended December 31, (in thousands) 1998 1997
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Scheduled amortization of capitalized servicing $ 40,420 $ 46,417
Increase in valuation allowances for impairment 14,759 21,614
- -------------------------------------------------------------------------------------------------------------------------
Total amortization of capitalized servicing $ 55,179 $ 68,031
=========================================================================================================================
</TABLE>
The impairment charge in 1998 is primarily the result of increased market
consensus prepayment rates and a corresponding decrease in the fair value
of the Company's capitalized servicing asset during 1998. The impairment
charge in 1997 is primarily the result of increased market consensus
prepayment rates and a corresponding decrease in the fair value of the
Company's capitalized servicing asset during 1997. Excluding the effects of
these charges, 1998 amortization expense decreased by $6.0 million from
1997. This decrease is primarily due to the reduction in amortization of
the Company's subservicing asset. The net carrying value of the
subservicing asset, which relates to the 1997 Servicing Sale, was reduced
in connection with the first amendment to the 1997 Subservicing Agreement.
The remaining balance is being amortized on a straight-line basis over the
subservicing period and tested for impairment.
In 1994, the Company sold the rights to service $3.9 billion of mortgage
loans to a third party and continued to service these loans pursuant to a
subservicing agreement. The gain of $19.9 million was deferred and was
being recognized over the five-year life of the subservicing agreement. In
the fourth quarter of 1997, the third party sold the rights to service the
remaining portfolio of loans subserviced by the Company. As a result, the
Company recognized the remaining $4.4 million balance of the deferred gain.
The Company recognized deferred gain totaling $6.9 million in 1997 which
was included in mortgage servicing revenue in the 1997 consolidated
statement of income.
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,
the Company invests in various financial instruments. 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, interest rate swap agreements and
principal-only swap agreements.
The Company recognized a net gain on its financial instruments of $20.4
million for the year ended December 31, 1998. The 1998 net gain includes a
net realized gain of $3.6 on the sales of financial instruments, realized
gains of $4.7 million from net cash flows received and $12.1 million in
unrealized gains due to a net increase in the fair value of the various
financial instruments. The Company recognized a net gain on its financial
instruments of $11.3 million for the year ended December 31, 1997. The 1997
net gain includes a net realized gain of $.1 million on the sales of
financial instruments, realized gains of $.1 million from net cash flows
received and $11.1 million in unrealized gains due to a net increase in the
fair value of the various financial instruments (refer to Note 10 to the
consolidated financial statements for further discussion).
Interest income increased to $85.4 million in 1998 from $45.8 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 $70.2
million and $35.4 million for the years ended
6 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 7
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
December 31, 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 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 $2.2 million for the year
ended December 31, 1998 compared to a net investment loss of $1.0 million
for the year ended December 31, 1997. The 1998 gain is primarily the result
of a realized gain from a distribution received on a partnership
investment. The 1997 loss is primarily the result of the write-down of
certain investments to realizable value.
In mid-March 1997, the Board of Directors of 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 of its investment
in FSA to the Company in exchange for shares of the Company's common stock.
The Company recognized $13.8 million and $9.5 million of equity in earnings
of FSA as a result of its investment for the years ended December 31, 1998
and 1997, respectively (refer to Notes 2 and 9 to the consolidated
financial statements for further discussion).
Net gain on mortgage sales increased to $86.8 million in 1998 from $21.5
million in 1997. This increase is primarily the result of increased
mortgage loan sales volumes and the related increase in capitalized
originated mortgage servicing rights ("OMSR") income and gains on mortgage
sales. The 1997 net gain on sale of mortgages also includes 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 (refer to Note 7 to
the consolidated financial statements for further discussion).
The Company recorded a $15.2 million pretax gain on sale of servicing
during 1998, which reflects the sales of the rights to service
approximately $10.6 billion of the Company's nonrecourse mortgage servicing
portfolio to third parties and adjustments to previous sales. During the
fourth quarter of 1998, the Company recorded a $4.9 million pretax gain on
sale of servicing, which included adjustments of approximately $2.6 million
primarily related to servicing sales prior to the fourth quarter. The
Company recorded a $4.3 million pretax loss from the sale of the right to
service $17.0 billion of its nonrecourse mortgage servicing portfolio and
the related assumption of subservicing in the first half of 1997. The
Company recorded an additional loss of $3.7 million in the fourth quarter
of 1997 in connection with the first amendment to the 1997 Subservicing
Agreement.
Other revenue was $31.9 million and $19.1 million for the years ended
December 31, 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 $78.7 million and
$54.8 million for the years ended December 31, 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>
==========================================================================================================================
Year ended December 31, (in thousands) 1998 1997
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Unadjusted salaries and employee benefits expense $ 115,854 $ 74,405
GAAP net origination revenues (37,162) (19,611)
- --------------------------------------------------------------------------------------------------------------------------
GAAP salaries and employee benefits expense $ 78,692 $ 54,794
==========================================================================================================================
</TABLE>
An increase in loan origination revenues, reflecting the significant
increase in retail mortgage loan production during 1998 as compared to
1997, partially offset the increase in unadjusted salaries and employee
benefits expense. Excluding the effects of loan origination revenue,
unadjusted salaries and benefits expense increased 56%. This increase is
primarily due to the increase in loan officer commissions associated with
the significant increase in 1998 mortgage loan production and increased
headcount due to an expansion of the production network.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 7
<PAGE> 8
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The provision for loan losses was $3.8 million and $4.7 million for the
years ended December 31, 1998 and 1997, respectively. 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. A valuation allowance
of $2.6 million was included in the December 31, 1996 allowance for loan
losses for this property.
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 work force, primarily in overhead areas, by approximately 100
employees during the second quarter of 1997 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 (refer to Note 12 to the consolidated financial statements
for further discussion).
Other operating expenses were $42.5 million and $26.6 million for the years
ended December 31, 1998 and 1997, respectively. The increase in 1998 is
primarily due to increased loan processing and general office expenses
related to the increased production volumes and additional travel,
advertising and promotional expenses incurred in 1998 related to the
Company's subprime and high loan-to-value business entered into in 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 of
1997.
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1996
- --------------------------------------------------------------------------------
SUMMARY - The Company reported a net loss of $13.5 million for the year
ended December 31, 1997 compared to a net loss of $4.3 million for the year
ended December 31, 1996. The 1997 results include an $8.0 million pretax
loss on the sale of servicing to a third party and the related assumption
of subservicing, $9.5 million pretax equity in earnings of an
unconsolidated affiliate and a $21.2 million pretax charge for impairment
of the Company's capitalized servicing asset, which was partially offset by
a $11.3 million net gain on financial instruments. The 1997 results also
include the following one-time charges: a $9.2 million pretax extraordinary
loss on the early retirement of debt, a $3.0 million pretax charge related
to loans held for investment which were identified for sale and marked down
from amortized cost to current market value, $3.1 million of pretax
restructuring and compensation charges and $2.1 million of other
miscellaneous charges. The 1996 results include a $10.1 million pretax gain
on the sale of servicing, a $29.1 million pretax charge for the write-off
of the Company's goodwill and other intangible assets and a $8.2 million
pretax charge for impairment of its capitalized servicing asset, which was
offset by a $9.9 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 $27.6 million for the year ended
December 31, 1997. The Company's 1997 unrealized investment gains are
associated primarily with its investment in FSA, which it acquired during
1997. For the year ended December 31, 1996, the Company reported a
comprehensive loss of $3.8 million. The Company's 1996 unrealized
investment gains are associated with its investment in common equity
securities.
Total mortgage production for the years ended December 31, 1997 and 1996
was $4.4 billion and $3.8 billion, respectively. Production related to
refinancing activity made up 40% of total production for 1997 as compared
to 33% for 1996. The increase in mortgage loan production in 1997 reflects
overall lower market interest rates during 1997 and a corresponding
increase in refinance activity from 1996.
8 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 9
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The Company's total mortgage servicing portfolio decreased to $26.5 billion
as of December 31, 1997 from $29.2 billion as of December 31, 1996. During
the year ended December 31, 1997, the Company purchased the rights to
service $.04 billion of mortgage loans from third parties. In addition, the
Company sold the rights to service $17.0 billion of its nonrecourse
mortgage servicing portfolio to a third party ("the 1997 Servicing Sale")
during 1997 and continues to service these loans pursuant to a subservicing
agreement. The following table illustrates the change in the Company's
mortgage servicing portfolio mix primarily as a result of the sale:
<TABLE>
<CAPTION>
======================================================================================================================
December 31, (in millions) 1997 1996
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Mortgage servicing portfolio owned $ 11,627 $ 26,410
Mortgage servicing portfolio subserviced for others 14,919 2,791
- ----------------------------------------------------------------------------------------------------------------------
Total mortgage servicing portfolio $ 26,546 $ 29,201
======================================================================================================================
</TABLE>
During the year ended December 31, 1996, the Company purchased the rights
to service $2.8 billion of mortgage loans from third parties and sold the
rights to service $3.3 billion of its mortgage servicing portfolio to third
parties.
Mortgage loan payoffs for each of the years ended December 31, 1997 and
1996 were $3.0 billion. The average prepayment rate of the Company's total
servicing portfolio was 10.5% for each of the years ended December 31, 1997
and 1996. The Company's prepayment experience is significantly influenced
by fluctuations in mortgage interest rates, although the effect is not
immediate. While overall, mortgage interest rates were lower during 1997
than in 1996, there was a significant decline in rates in December of 1997.
Therefore, the average prepayment rates for 1997 do not fully reflect the
decrease in interest rates as of year end 1997. The average prepayment
rates for the months of January and February 1998 were 11.6% and 21.9%,
respectively.
REVENUE- Mortgage servicing revenue decreased to $95.0 million in 1997 from
$139.6 million in 1996. The decrease in mortgage servicing revenue is
primarily due to the 1997 Servicing Sale, slightly offset by increased
subservicing revenue generated as a result of the sale. The subservicing
fees, however, are significantly lower than the servicing fees earned on
the Company's owned servicing portfolio. Amortization of capitalized
servicing was $68.0 million and $79.1 million for the years ended December
31, 1997 and 1996, respectively. Amortization includes the change in the
valuation allowances for impairment of the Company's capitalized servicing
asset as indicated in the following table:
<TABLE>
<CAPTION>
================================================================================================================================
Year ended December 31, (in thousands) 1997 1996
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Scheduled amortization of capitalized servicing $ 46,417 $ 69,932
Increase in valuation allowances for impairment 21,614 9,261
- --------------------------------------------------------------------------------------------------------------------------------
Total amortization of capitalized servicing $ 68,031 $ 79,193
================================================================================================================================
</TABLE>
The 1997 impairment charge is primarily a result of increased market
consensus prepayment rates and a corresponding decrease in the fair value
of the Company's capitalized servicing asset during 1997. Excluding the
effects of these charges, 1997 amortization expense decreased by $23.5
million from 1996. This decrease in amortization expense is primarily the
result of a smaller servicing asset due to the 1997 Servicing Sale.
In 1994, the Company sold the rights to service $3.9 billion of mortgage
loans to a third party and continued to service these loans pursuant to a
subservicing agreement. The gain of $19.9 million was deferred and was
being recognized over the five-year life of the subservicing agreement. In
the fourth quarter of 1996, the third party sold the rights to service
approximately $1.0 billion of these mortgage loans, representing
approximately 25% of the total loans subserviced by the Company for this
third party. Accordingly, the Company recognized an additional $2.4 million
of the deferred gain in 1996, representing approximately 25% of the
deferred balance at the time of sale. In the fourth quarter of 1997, the
third party sold the rights to service the remaining portfolio of loans. As
a result, the Company recognized the $4.4 million remaining balance of the
deferred gain. In 1997 and 1996, the Company recognized deferred gains
totaling $6.9 million and $6.1 million, respectively, as part of mortgage
servicing revenue in the consolidated statements of income.
The Company recognized a net gain on its financial instruments of $11.3
million for the year ended December 31, 1997. The 1997 net gain includes a
net realized gain of $.1 million on the sale of financial instruments,
realized gains of $.1 million from net cash flows received and $11.1
million in unrealized gains due to a net increase in the fair value of the
various financial instruments. The Company recognized a net gain on its
financial instruments of $9.9 million for the year ended December 31, 1996.
The 1996 net gain includes $8.2 million in realized gains from
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 9
<PAGE> 10
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
net cash flows received and $1.7 million in unrealized gains due to a net
increase in the fair value of the various financial instruments.
Interest income increased to $45.8 million in 1997 from $40.8 million in
1996. The increase in interest income is primarily the result of interest
income earned on the outstanding receivable balance from the 1997 Servicing
Sale and an increase in interest income from pool loan purchases due to a
higher average asset balance. Interest expense was $35.4 million and $36.0
million for the years ended December 31, 1997 and 1996, respectively.
In 1997, the Company realized a $.3 million gain from the transfer of its
remaining common equity securities to White Mountains in exchange for
shares of the Company's common stock held by White Mountains, which were
then retired by the Company. The 1996 realized loss of $.9 million was a
result of the Company selling certain common equity securities to White
Mountains for cash. All of the equity securities involved in such
transactions were actively traded, readily marketable, listed on a national
exchange and, for purposes of such transactions, were valued at their
closing prices on the day preceding the date of each transaction.
The Company realized a net investment loss of $1.0 million for the year
ended December 31, 1997 compared to a net investment gain of $.6 million
for the year ended December 31, 1996. The 1997 loss is primarily the result
of the write-down of certain investments to realizable value. The 1996 gain
reflects realized gains related to a partnership investment, offset by the
write-down of certain investments to realizable value.
The Company recognized $9.5 million of equity in earnings of FSA as a
result of its investment for the year ended December 31, 1997 (refer to
Notes 2 and 9 to the consolidated financial statements for further
discussion).
Net gain on mortgage sales decreased to $21.5 million in 1997 from $38.3
million in 1996. This decrease is primarily due to decreased capitalized
originated mortgage servicing rights ("OMSR") income as a result of a
change in the Company's mortgage loan production mix which included a
proportionately higher volume of correspondent production, which generates
lower OMSR income. The decrease in the 1997 gain also reflects a $3.0
million pretax charge relating to mortgage loans held for investment which
were identified for sale and marked down from amortized cost to current
market value during the second quarter of 1997.
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. The
Company recorded an additional loss of $3.7 million in the fourth quarter
of 1997 in connection with the first amendment to the 1997 Subservicing
Agreement. During 1996, the Company recorded a pretax gain of $10.1 million
from the sales of the rights to service $3.3 billion of the Company's
mortgage servicing portfolio.
EXPENSES - Salaries and employee benefits expense was $54.8 million and
$56.3 million for the years ended December 31, 1997 and 1996, 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>
===========================================================================================================================
Year ended December 31, (in thousands) 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Unadjusted salaries and employee benefits expense $ 74,405 $ 76,114
GAAP net origination revenues (19,611) (19,820)
- ---------------------------------------------------------------------------------------------------------------------------
GAAP salaries and employee benefits expense $ 54,794 $ 56,294
===========================================================================================================================
</TABLE>
The slight decrease in loan origination revenues, reflecting lower retail
mortgage loan production during 1997 as compared to 1996, slightly offset
the decrease in unadjusted salaries and employee benefits expense. The
decrease in unadjusted salaries and employee benefits expense primarily
reflects decreased headcount as a result of the Company's restructuring
plan implemented in the second quarter of 1997, partially offset by an
increase in the long term incentive plan accrual.
10 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 11
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The provision for loan losses was $4.7 million and $3.0 million for the
years ended December 31, 1997 and 1996, respectively. 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. A valuation allowance
of $2.6 million was included in the December 31, 1996 allowance for loan
losses and $.9 million was charged to the 1996 provision for this property.
The 1996 provision also includes $.3 million of gain on the disposition of
a commercial real estate owned property during 1996.
In the fourth quarter of 1996, the Company wrote off the remaining carrying
value of goodwill and certain other intangible assets totaling $29.1
million. It is the Company's policy to account for goodwill and other
intangible assets at the lower of amortized cost or fair value. On an
ongoing basis, management reviews the valuation and amortization of these
assets. As a part of its ongoing review, management estimates the fair
value of the Company's intangible assets, taking into consideration any
events and circumstances which might have diminished their value. During
1996, the Company had been re-evaluating the recoverability of goodwill and
certain other intangible assets and considered the impact of the following
factors on its forecast of future operations (i) increased competition and
industry consolidation which had adversely impacted the value of the
Company's mortgage loan production and servicing operation; (ii) the
attainment of a definitive agreement in the fourth quarter of 1996 to sell
approximately $17.0 billion of the Company's mortgage servicing portfolio
at essentially book value and (iii) a reduction in interest rates in the
fourth quarter of 1996. Based on such valuation, the Company had determined
that its projected results would not support the future amortization of the
Company's remaining goodwill and certain other intangible assets of $29.1
million at December 31, 1996 and, therefore, wrote-off such assets.
The Company recorded $1.7 million in restructuring charges during the
second quarter of 1997 as a result of a restructuring plan implemented in
the second quarter of 1997.
Other operating expenses were $26.6 million and $34.3 million for the year
ended December 31, 1997 and 1996, respectively. The decrease in 1997 is
primarily due to the elimination of amortization expense related to
goodwill and certain other intangible assets, which were written off at
year end 1996.
The Company's income tax provision for the year ended December 31, 1996 was
adversely impacted by the write-off of goodwill and other intangible assets
at year end 1996. The total pretax write-off of these assets was $29.1
million and the related tax benefit was $3.2 million.
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 of
1997.
LIQUIDITY AND CAPITAL RESOURCES
- --------------------------------------------------------------------------------
The Company's primary cash flow requirements relate to funding mortgage
loan production and investing 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, cash flow from operations and
cash from the sale of servicing. 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.
The Company amended and restated its $701.0 million secured revolving
credit agreement in July 1998, to increase its borrowing capacity and
flexibility. The provisions of the amended agreement increased its
borrowing capacity from $701.0 million to $800.0 million, which allows the
Company to meet higher borrowing requirements resulting from increased
production volumes. 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. Borrowings under the
facility are secured primarily by the Company's mortgage loans receivable
and pool loan purchases. The revolving credit facility expires on July 9,
1999. As of December 31, 1998, there was $650.5 million outstanding under
this facility. As of December 31, 1997, there was $559.0 million
outstanding under the previous facility.
The Company entered into a new secured credit agreement in May 1998, to
fund 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 December 31, 1998, there was $21.6 million outstanding under
this facility.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 11
<PAGE> 12
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The Company entered into an additional secured credit agreement in July
1998, 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. As of
December 31, 1998, there were no outstanding borrowings under this
facility.
The Company must comply with certain financial covenants provided in its
secured revolving credit facilities, including restrictions relating to
tangible net worth and leverage. In addition, there are certain covenants
which limit the Company's ability to pay dividends or make distributions of
its capital to holders of its common stock. 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.
Central Pacific replaced its existing $15.0 million unsecured revolving
credit agreement with a new mortgage warehousing agreement in April 1998,
to fund the origination or acquisition of mortgage loans. Under this
agreement, Central Pacific could borrow up to $25.0 million through April
15, 1999. Borrowings under this new facility are secured by the underlying
loans. In July 1998, Central Pacific amended this new agreement to increase
its borrowing capacity to $40.0 million. In February 1999, the agreement
was extended to June 1, 1999. As of December 31, 1998, there was $25.1
million outstanding under this agreement. As of December 31, 1997, there
was $10.5 million outstanding under the previous agreement.
Central Pacific must comply with certain financial covenants provided in
its secured credit agreement, including restrictions relating to tangible
net worth and leverage. Central Pacific is currently in compliance with all
such covenants.
Effective December 8, 1995, the Company exchanged and retired 2,239,061
shares of its 8.42% cumulative preferred stock, Series A, for $56.0 million
in principal amount of 9.375% subordinated interest deferrable debentures
("subordinated debentures"), due December 31, 2025. Interest on the
subordinated debentures is paid quarterly in arrears at the annual rate of
9.375% on the last business day of each March, June, September and
December. The purpose for the exchange was to improve the Company's
after-tax cash flow since the interest payable on the subordinated
debentures is deductible for federal income tax purposes, whereas dividends
payable on the preferred stock are not.
The subordinated debentures are redeemable at the option of the Company, in
whole or in part, at any time on or after May 1, 1999. On or after such
date, the subordinated debentures may be redeemed at the option of the
Company at a price equal to 100% of the principal amount redeemed ($25 for
each $25 principal amount of subordinated debenture), plus accrued and
unpaid interest to the date fixed for redemption.
In June 1992, the Company issued $100.0 million of 9% debentures due June
2012 under terms of a $250.0 million shelf registration statement filed
with the Securities and Exchange Commission ("SEC") in April 1992. The
debentures may not be redeemed by the Company prior to maturity. The
proceeds were used for general corporate purposes. In January, 1999 the
Company repurchased and retired $8.0 million of these debentures.
In October 1991, the Company issued $160.0 million of 8.875% medium-term
notes due October 2001. During 1995 and 1997, the Company repurchased and
retired $21.6 million and $119.6 million in principal amount, respectively
of these notes.
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. During 1998, the Company declared and
paid cash dividends on its common stock totaling $104.0 million which have
been reflected as reductions in paid-in capital. The Company did not
declare any dividends on its common stock during 1997.
Quarterly cash dividends are paid on preferred stock at an annual rate of
8.42% or $2.105 per share, if declared by the Board of Directors, in
arrears on the first day of each February, May, August and November. During
1998, 1997 and 1996, the Company declared and paid annual cash dividends of
$3.7 million on its preferred stock.
12 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 13
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The preferred stock is not redeemable prior to May 1, 1999. On or after
such date, the preferred stock may be redeemed at the option of the Company
at a price of $25 per share, plus accrued and unpaid dividends to the
redemption date.
In January 1997, the Company transferred its remaining common equity
securities with a market value of $2.6 million to White Mountains in
exchange for 21,239 shares of the Company's common stock held by White
Mountains, which were retired by the Company.
During 1998, the Company sold the rights to service approximately $10.6
billion of its nonrecourse mortgage servicing portfolio to third parties
for net proceeds of $227.9 million. During 1997, the Company sold the
rights to service $17.0 billion of its nonrecourse mortgage servicing
portfolio to a third party for net proceeds of $266.9 million. The Company
has used the proceeds of $425.4 million received from the 1997 and 1998
sales to reduce outstanding short-term debt, retire medium-term notes, pay
dividends on its common stock and for general corporate purposes. The
remaining balance of $73.8 million, including $4.4 million of accrued
interest, is included in other assets in the consolidated statement of
condition as of December 31, 1998. Under circumstances deemed appropriate
by management, additional sales transactions may occur in the future.
Although there have been continuing sales in 1999, there can be no
assurance that additional sales will occur.
During 1996, the Company sold the rights to service a total of $3.3 billion
of mortgage loans to a third party for net proceeds of $55.9 million, which
were used for general corporate purposes.
In March 1997, the Board of Directors of Fund American approved a corporate
restructuring plan involving several of its subsidiaries including the
Company. In accordance with this plan, the Company contracted to receive
capital infusions from White Mountains of approximately $139 million
(approximately $119 million net of associated tax liabilities and other
adjustments) consisting primarily of common stock, convertible redeemable
preferred stock and options to acquire common stock of FSA. Subsequently,
the Company issued 881,120 shares of its common stock to White Mountains in
exchange for 3.5 million shares of FSA common stock, 2.0 million shares of
FSA convertible redeemable preferred stock and options to acquire 2.6
million shares of FSA common. In addition, the Company issued 105,000
shares of its common stock to Fund American for cash proceeds of $12.7
million. The capital infusions were undertaken to improve the Company's
debt ratings and reduce the Company's borrowing costs.
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 that the Company currently believes are
necessary to achieve a year 2000 date conversion with no material adverse
effects to its 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. The Company has
substantially completed the testing phase for all information technology
("IT") systems and is currently concentrating efforts on testing outside
constituents. Additionally, non-IT systems have also been reviewed for
affects of the Year 2000 dilemma. Non-IT systems influenced by Year 2000
date conversion will be upgraded or replaced by the second quarter of 1999.
During 1998, the Company engaged an independent consultant to perform an
assessment of the Company's Year 2000 readiness. The assessment confirmed
that the Company was in the final stages of completion and that the Company
was a low risk entity for adverse Year 2000 incidents.
The total pretax cost of achieving Year 2000 compliance, including $1.0
million for hardware and software upgrades, is approximately $2.5 million.
To date, the Company has incurred approximately $2.4 million in costs.
These costs have been expensed as incurred, with the exception of hardware
costs, which were capitalized in accordance with GAAP. The Year 2000
project has accounted for less than 15% of the total IT budget for the
years ended December 31, 1998, 1997 and 1996.
The Company has been closely monitoring the Year 2000 issues of its third
party constituents with whom it voluntarily interacts (e.g. customers,
suppliers, reinsurers, creditors, borrowers). These third party
constituents were requested to demonstrate their ability to become Year
2000 compliant by year-end 1998. For those constituents who either failed
to respond to this inquiry or were deemed to be unlikely to remedy their
own Year 2000 issues in a timely manner, the Company is in the process of
establishing similar relationships with new parties that expect to be Year
2000 compliant.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 13
<PAGE> 14
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The failure to identify or correct significant Year 2000 issues could
result in an interruption in, or a failure of, certain normal business
activities or operations concerning the Company. Such failure could
adversely affect the Company's results of operations, liquidity and
financial condition. Due to general uncertainties inherent in the Year 2000
problem, resulting in part from uncertainty of potential business
interruptions caused by third party constituents in which the Company must
interact (including but not limited to the suppliers of electric power,
various private and public markets for equity and debt securities, certain
agencies of the Federal government and states in which the Company conducts
business), the Company is unable to determine at this time whether the
consequences of any Year 2000 failures will have a material impact on its
results of operations, liquidity or financial condition. However, the
Company currently believes that, with the implementation of its Year 2000
plan (which is in the final stages of completion), the possibility of
significant interruptions of normal business activities due to Year 2000
issues should be reduced. In addition, the Company is currently in the
process of developing and updating Business Continuance Plans, to
facilitate continued operations in the event of adverse Year 2000
incidents.
INFLATION
- --------------------------------------------------------------------------------
Inflation and changes in interest rates can have differing effects on
various aspects of the Company's business, particularly with respect to
marketing gains and losses from the sale of mortgage loans, mortgage loan
production, the value of the Company's servicing portfolio and net interest
revenue. Historically, the Company's loan originations and loan production
income have increased in response to falling interest rates and decreased
during periods of rising interest rates. Periods of low inflation and
falling interest rates tend to reduce loan servicing income and the value
of the Company's mortgage loan servicing portfolio because prepayments of
mortgages increase and the average life of loan servicing rights is
shortened. Conversely, periods of increasing inflation and rising interest
rates tend to increase loan servicing income and the value of the Company's
mortgage loan servicing portfolio because prepayments of mortgages decline
and the average life of loan servicing rights is lengthened. In an attempt
to mitigate the Company's exposure to changes in market interest rates, the
Company utilizes various derivative financial instruments (refer to Note 10
to the consolidated financial statements).
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 14
<PAGE> 15
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS
SOURCE ONE MORTGAGE SERVICES CORPORATION
We have audited the accompanying consolidated statements of condition of
Source One Mortgage Services Corporation and subsidiaries ("the Company")
as of December 31, 1998 and 1997, and the related consolidated statements
of income, comprehensive income, stockholders' equity, and cash flows for
each of the years then ended. 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
did not audit the financial statements of Financial Security Assurance
Holdings Ltd. ("FSA") (a 11.6 percent owned equity investee company). The
Company's investment in FSA at December 31, 1998 and 1997, was $120 million
and $104 million, and its equity in earnings of FSA was $13.8 million and
$9.5 million for the years ended December 31, 1998 and 1997, respectively.
The financial statements of FSA were audited by other auditors,
PricewaterhouseCoopers LLP, whose report has been furnished to us, and our
opinion, insofar as it relates to the amounts included for FSA, is based
solely on the report of the other auditors. The accompanying consolidated
financial statements of the Company for the year ended December 31, 1996,
were audited by other auditors whose report thereon dated January 30, 1997,
on those statements included an explanatory paragraph that described the
change in the Company's method of accounting for mortgage servicing rights
discussed in Notes 1 and 3 to the consolidated financial statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits and
the report of the other auditors provide a reasonable basis for our
opinion.
In our opinion, based on our audits and the report of the other auditors,
the 1998 and 1997 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Source
One Mortgage Services Corporation and subsidiaries as of December 31, 1998
and 1997, and the results of their operations and their cash flows for each
of the years then ended in conformity with generally accepted accounting
principles.
KPMG LLP
Detroit, Michigan
February 12, 1999,
except for Note 23
as to which the date is
March 29, 1999
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 15
<PAGE> 16
CONSOLIDATED STATEMENTS OF CONDITION
<TABLE>
<CAPTION>
========================================================================================================================
December 31, (in thousands, except for share amounts) 1998 1997
- ------------------------------------------------------------------------------------------------------------------------
ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash $ 16,410 $ 3,134
Investments 78,477 86,239
Investment in unconsolidated affiliate (net) 234,071 192,137
Mortgage loans receivable 676,317 519,247
Pool loan purchases 164,952 149,791
Loans held for investment 1,707 5,191
Capitalized servicing (net) 169,688 181,025
Mortgage claims receivable and real estate acquired
(net of allowance for loan losses of $11,500 in 1998 and $12,800 in 1997) 33,121 41,199
Premises and equipment 23,303 22,171
Other assets 119,931 104,556
- ------------------------------------------------------------------------------------------------------------------------
Total assets $1,517,977 $1,304,690
========================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------------------------
Liabilities:
Senior debt $ 814,593 $ 686,906
Subordinated debt 55,771 55,153
Accounts payable and other liabilities 235,100 107,582
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities 1,105,464 849,641
- ------------------------------------------------------------------------------------------------------------------------
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 December 31, 1998 and 1997 18 18
Common stock, $.01 par value, 8,000,000 shares authorized,
3,211,881 shares issued and outstanding as of
December 31, 1998 and 1997 32 32
Paid-in capital 358,447 462,480
Accumulated other comprehensive income 60,396 41,102
Retained deficit (6,380) (48,583)
- ------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 412,513 455,049
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $1,517,977 $1,304,690
========================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
16 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 17
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
============================================================================================================================
Year Ended December 31, (in thousands, except for per share amounts) 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------
REVENUE
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Mortgage servicing revenue $ 78,064 $ 94,952 $ 139,578
Amortization of capitalized servicing (55,179) (68,031) (79,193)
Net gain on financial instruments 20,431 11,271 9,904
- ----------------------------------------------------------------------------------------------------------------------------
Net servicing revenue 43,316 38,192 70,289
- ----------------------------------------------------------------------------------------------------------------------------
Interest income 85,393 45,754 40,826
Interest expense (70,201) (35,362) (36,018)
- ----------------------------------------------------------------------------------------------------------------------------
Net interest revenue 15,192 10,392 4,808
- ----------------------------------------------------------------------------------------------------------------------------
Net realized investment gain (loss) on sale and
exchange of securities with affiliates -- 326 (855)
Net realized investment gain (loss) 2,212 (1,048) 623
Equity in earnings of unconsolidated affiliate 13,774 9,507 --
Net gain on sale of mortgages 86,780 21,497 38,346
Net gain (loss) on sale of servicing
and assumption of subservicing 15,240 (8,032) 10,080
Other 31,854 19,159 18,132
- ----------------------------------------------------------------------------------------------------------------------------
Total revenue 208,368 89,993 141,423
============================================================================================================================
EXPENSES
- ----------------------------------------------------------------------------------------------------------------------------
Salaries and employee benefits 78,692 54,794 56,294
Office occupancy and equipment 13,181 13,289 13,619
Provision for loan losses 3,820 4,729 3,003
Write-off of goodwill and other intangible assets -- -- 29,128
Restructuring charges -- 1,727 --
Other operating expenses 42,522 26,601 34,252
- ----------------------------------------------------------------------------------------------------------------------------
Total expenses 138,215 101,140 136,296
- ----------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and extraordinary loss 70,153 (11,147) 5,127
Income tax expense (benefit) 24,243 (3,617) 9,453
- ----------------------------------------------------------------------------------------------------------------------------
Income (loss) before extraordinary loss 45,910 (7,530) (4,326)
Extraordinary loss on repurchase of debt
(net of $3,217 income tax benefit) -- (5,975) --
- ----------------------------------------------------------------------------------------------------------------------------
Net income (loss) 45,910 (13,505) (4,326)
Less dividends on preferred stock 3,707 3,707 3,707
- ----------------------------------------------------------------------------------------------------------------------------
Net income (loss) applicable to common stock $ 42,203 $ (17,212) $ (8,033)
============================================================================================================================
Basic net income (loss) per common share:
Before extraordinary loss $ 13.14 $ (3.78) $ (3.57)
Extraordinary loss -- (2.01) --
- ----------------------------------------------------------------------------------------------------------------------------
Basic net income (loss) per common share $ 13.14 $ (5.79) $ (3.57)
============================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 17
<PAGE> 18
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
============================================================================================================================
Year ended December 31, (in thousands, except for per share amounts) 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income (loss) $ 45,910 $(13,505) $ (4,326)
Other comprehensive income, net of tax
Unrealized gains (losses) on investments:
Unrealized holding gain (loss) arising during year
(net of income tax expense (benefit) of $10,389, $22,245
and $(5) for 1998, 1997 and 1996, respectively) 19,294 41,314 (10)
Less: reclassification adjustment for (gains) losses
included in net income (net of income tax (expense) benefit
of $(114) and $299 for 1997 and 1996, respectively) -- (212) 556
- ----------------------------------------------------------------------------------------------------------------------------
Other comprehensive income 19,294 41,102 546
- ----------------------------------------------------------------------------------------------------------------------------
Comprehensive income (loss) 65,204 27,597 (3,780)
Less dividends on preferred stock 3,707 3,707 3,707
- ----------------------------------------------------------------------------------------------------------------------------
Comprehensive income (loss) applicable to common stock $ 61,497 $ 23,890 $ (7,487)
- ----------------------------------------------------------------------------------------------------------------------------
Basic comprehensive income (loss) per common share $ 19.15 $ 8.03 $ (3.33)
============================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
18 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 19
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
====================================================================================================================================
Year ended December 31, 1998, 1997 and 1996
(in thousands, except for per share amounts)
- ------------------------------------------------------------------------------------------------------------------------------------
Accumulated Total
Other Retained Stock-
Preferred Common Paid-In Comprehensive Earnings holders'
Stock Stock Capital Income (Deficit) Equity
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances at January 1, 1996 $ 18 $ 22 $ 346,088 $ (546) $(23,338) $ 322,244
Net income -- -- -- -- (4,326) (4,326)
Change in unrealized
investment gain (net) -- -- -- 546 -- 546
Preferred dividends declared
of $2.105 per share -- -- -- -- (3,707) (3,707)
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 18 22 346,088 -- (31,371) 314,757
Net loss -- -- -- -- (13,505) (13,505)
Change in unrealized
investment gain (net) -- -- -- 41,102 -- 41,102
Repurchase of 21,239 shares of
common stock, $.01 par value,
from parent -- -- (2,638) -- -- (2,638)
Issuance of 105,000 shares
of common stock, $.01
par value, to parent -- 1 12,674 -- -- 12,675
Issuance of 230,293 shares
of common stock,
$.01 par value, to parent -- 2 27,797 -- -- 27,799
Issuance of 650,827 shares of
common stock, $.01 par value,
to parent -- 7 78,559 -- -- 78,566
Preferred dividends declared
of $2.105 per share -- -- -- -- (3,707) (3,707)
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 18 32 462,480 41,102 (48,583) 455,049
Net income -- -- -- -- 45,910 45,910
Change in unrealized
investment gain (net) -- -- -- 19,294 -- 19,294
Common stock dividends paid -- -- (104,033) -- -- (104,033)
Preferred dividends declared
of $2.105 per share -- -- -- -- (3,707) (3,707)
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1998 $ 18 $ 32 $ 358,447 $60,396 $ (6,380) $412,513
====================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 19
<PAGE> 20
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
=============================================================================================================================
Year ended December 31, (in thousands) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income (loss) $ 45,910 $ (13,505) $ (4,326)
Noncash items included in the determination of net income (loss):
Amortization of capitalized servicing 55,179 68,031 79,193
Write-off of goodwill and other intangible assets -- -- 29,128
Net unrealized gain on financial instruments (12,140) (11,072) (1,670)
Provision for loan losses 3,820 4,729 3,003
Depreciation and amortization 3,931 6,586 8,825
(Gain) loss on sale of financial instruments (3,551) (46) --
Write down of loans held for investment identified as held for sale -- 3,000 --
Amortization of goodwill -- -- 2,090
Net realized (gain) loss on investments (1,943) 722 232
(Gain) loss on sale of servicing and assumption of subservicing (15,240) 8,032 (10,080)
Gain on sale of permanent investments (769) -- --
Amortization of deferred gain on sale of servicing -- (6,885) (6,139)
Undistributed earnings from unconsolidated affiliate (12,251) (8,668) --
Mortgage loan production (10,866,289) (4,403,281) (3,831,639)
Mortgage loan sales and amortization 10,709,219 4,198,971 3,897,730
Additions to financial instruments (6,090) (2,292) (2,885)
Net proceeds from sale of financial instruments 24,987 760 --
Net increase (decrease) in accounts payable and other liabilities 95,752 15,950 (15,002)
Net decrease in other assets 13,355 31,154 5,433
Net change in current and deferred income taxes receivable
and payable 23,164 (12,160) (10,158)
Extraordinary loss on repurchase of debt -- 5,975 --
- -----------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by operating activities 57,044 (113,999) 143,735
- -----------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
- -----------------------------------------------------------------------------------------------------------------------------
Collections on and sales of pool loan purchases,
mortgage claims receivable and real estate acquired 278,390 274,158 175,289
Additions to pool loan purchases, mortgage
claims receivable and real estate acquired (296,884) (285,100) (205,745)
Additions to capitalized mortgage servicing rights (249,128) (139,500) (88,578)
Net proceeds from sales of servicing 182,809 242,628 11,706
Net proceeds from sale of permanent investments 13,537 -- --
Additions to long-term investments (5,044) (52,426) (3,453)
Collections on note receivable 7,000 -- --
Principal payments received on long-term investments 3,799 385 408
Net decrease (increase) in short-term investments 8,261 24,141 (14,354)
Proceeds from sale of common equity securities to affiliates -- -- 514
Net (acquisition) disposition of premises and equipment (4,188) 914 (1,410)
Net (increase) decrease in loans held for investment (1,713) 9,793 2,517
- -----------------------------------------------------------------------------------------------------------------------------
Net cash (used) provided by investing activities (63,161) 74,993 (123,106)
- -----------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
- -----------------------------------------------------------------------------------------------------------------------------
Proceeds from issuance of commercial paper -- 5,785,634 5,140,110
Repayments on commercial paper -- (6,147,814) (5,034,543)
Net increase (decrease) in credit agreement borrowings 127,133 524,301 (20,497)
Retirement of debt -- (129,872) (104,350)
Net proceeds from issuance of common stock -- 12,675 --
Dividends paid (107,740) (3,707) (3,707)
Other -- -- (865)
- -----------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 19,393 41,217 (23,852)
- -----------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 13,276 2,211 (3,223)
Cash at beginning of year 3,134 923 4,146
- -----------------------------------------------------------------------------------------------------------------------------
Cash at end of year $ 16,410 $ 3,134 $ 923
=============================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
20 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
ORGANIZATION
- --------------------------------------------------------------------------------
Source One Mortgage Services Corporation (together with its subsidiaries,
the "Company") was incorporated in 1972 and is the successor to Citizens
Mortgage Corporation, which was organized in 1946. The Company is a
wholly-owned subsidiary of White Mountains Holdings, Inc. ("White
Mountains") (formerly Fund American Enterprises, Inc.) and its parent Fund
American Enterprises Holdings, Inc. ("Fund American"), a Delaware
corporation organized in 1980, which was formerly known as The Fund
American Companies, Inc. and Fireman's Fund Corporation.
The Company is one of the largest mortgage banking companies in the United
States that is not affiliated with a commercial bank. As of December 31,
1998, the Company had a mortgage loan servicing portfolio totaling $25.1
billion, including $15.9 billion of loans subserviced for others, which is
serviced on behalf of approximately 213 institutional investors and
numerous other security holders. As of December 31, 1998, the Company had
163 retail branch offices in 31 states and Puerto Rico and originated $10.9
billion in mortgage loans for the year then ended.
As a mortgage banker, the Company primarily engages in the business of
producing and selling conforming and subprime residential mortgage loans,
servicing conforming residential mortgage loans and subservicing
residential mortgage loans for third parties. Its sources of revenue are
net servicing revenue, net interest revenue, net gain on sale of mortgages,
net gain on sale of servicing, earnings from unconsolidated affiliate and
other revenue. Through subsidiaries, the Company also provides
credit-related insurance products (such as life, disability, health,
accidental death and property and casualty insurance).
BASIS OF PRESENTATION
- --------------------------------------------------------------------------------
The accompanying consolidated financial statements of the Company include
the accounts of Central Pacific Mortgage Company, a wholly-owned subsidiary
of the Company, (together with its subsidiaries, "Central Pacific") and all
other subsidiaries, and have been prepared in accordance with generally
accepted accounting principles ("GAAP"). Significant intercompany
transactions have been eliminated in consolidation. The financial
statements include all adjustments considered necessary by management to
fairly present the financial position, results of operations and cash flows
of the Company. The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Certain
amounts in prior year financial statements have been reclassified to
conform with the current year presentation.
Fund American acquired the stock of the Company in 1986. The purchase price
paid for the Company in 1986 was in excess of historical book value of the
Company's net assets. The excess purchase price allocated to identifiable
assets was amortized primarily over 5 to 20 years depending on asset type
and prior to December 1996, the portion allocated to goodwill was amortized
over 20 years. During 1996, the Company had been re-evaluating the
recoverability of goodwill and certain other intangible assets. The Company
considered the impact of the following factors on its forecast of future
operations (i) increased competition and industry consolidation which had
adversely impacted the value of the Company's mortgage loan production and
servicing operation; (ii) the attainment of a definitive agreement in the
fourth quarter of 1996 to sell approximately $17.0 billion of the Company's
mortgage servicing portfolio at essentially book value and (iii) a
reduction in interest rates in the fourth quarter of 1996. Based on such
valuation, the Company had determined that its projected results would not
support the future amortization of the Company's remaining goodwill and
certain other intangible assets of $29.1 million at December 31, 1996 and,
therefore, wrote-off such assets.
ACCOUNTING STANDARDS RECENTLY ADOPTED AND ISSUED
- --------------------------------------------------------------------------------
In December 1996, the Financial Accounting Standards Board ("the FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 127,
"Deferral of the Effective Date of Certain Provisions of SFAS No. 125".
SFAS No. 127 deferred the adoption of certain transfer and collateral
provisions of SFAS No. 125 to periods beginning after December 31, 1997.
The adoption of SFAS No. 127 did not have a material effect on the
Company's current financial position or results of operations.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 21
<PAGE> 22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company adopted the provisions of SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information" as of December 31, 1998.
SFAS No. 131 superseded SFAS No. 14, "Financial Reporting for Segments of a
Business Enterprise". SFAS No. 131 establishes standards for the way that
public business enterprises report information about operating segments in
the annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports.
SFAS No. 131 also establishes standards for related disclosure about
products and services, geographic areas and major customers. The Company was
not previously subject to SFAS No. 14, and therefore, segment information
had not previously been disclosed. Segment information is presented for 1998
only (See Note 19 to the consolidated financial statements).
The Company adopted the provisions of SFAS No. 132, "Employers' Disclosure
about Pensions and Other Post Retirement Benefits" as of December 31, 1998.
SFAS No. 132 standardizes disclosure requirements for pensions and other
postretirement benefits. The statement resulted in no change to the
recognition or measurement of the plans. Restatement of disclosure for
earlier periods provided for comparative purposes is required, therefore,
amounts for 1997 and 1996 have been restated and are directly comparable to
1998 amounts.
The adoption of SFAS No. 131 and SFAS No. 132 resulted in a change to
financial statement disclosure only and had no effect on the Company's
financial position or results of operations.
In March 1998, the American Institute of Certified Public Accountants ("the
AICPA") issued Statement of Position ("SOP") 98-1, "Accounting For the Cost
of Computer Software Developed or Obtained For Internal Use". The Company
plans to adopt the SOP effective January 1, 1999. The SOP will require the
capitalization of certain costs incurred after the date of adoption in
connection with developing or obtaining software for internal use. The
Company currently expenses a majority of such costs as incurred. The
adoption of SOP 98-1 is not expected to have a material impact on the
Company's financial position or results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which establishes accounting and
reporting standards for derivative instruments and hedging activities. SFAS
No. 133 requires companies to record all derivatives on the balance sheet as
either assets or liabilities and measure those instruments at fair value.
The manner in which 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 beginning in 2000 with earlier adoption permitted. The Company
expects to adopt SFAS No. 133 in 2000. The Company has not yet evaluated the
impact of adopting SFAS No. 133.
In October 1998, the FASB issued SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained After the Securitization of Mortgage
Loans Held for Sale by a Mortgage Banking Enterprise". SFAS No. 134 requires
that after the securitization of a mortgage loan held for sale, an entity
engaged in mortgage banking activities classify the resulting
mortgage-backed securities or other retained interest based on its ability
and intent to sell or hold those investments. SFAS No. 134 is effective for
fiscal quarters beginning after December 15, 1998. The adoption of SFAS No.
134 is not expected to have a material impact on the Company's financial
position or results of operations.
INVESTMENTS
- --------------------------------------------------------------------------------
Investments primarily consist of the following: short-term investments
stated at cost; investment partnership interests reported using the cost
method of accounting since the Company's interests are minor (less than 5%);
and a fixed maturity investment considered available for sale and stated at
fair value with unrealized gains and losses, if any, reported net of tax, as
a component of accumulated other comprehensive income in stockholders'
equity. The discount on the investment is being amortized into income over
the anticipated life of the investment.
DERIVATIVE FINANCIAL INSTRUMENTS
- --------------------------------------------------------------------------------
The Company uses interest rate floor contracts, interest rate swap
agreements and principal-only swap agreements in order to manage the
exposure to interest rate risk inherent in its capitalized servicing asset
(collectively "financial instruments"). In accordance with SFAS No. 115,
such financial instruments are considered to be held for trading purposes.
The financial instruments are carried at fair value and are included in
investments in the consolidated statements of condition. Unrealized gains
and losses arising from changes in the value of these instruments are
recorded in net gain on financial instruments in the consolidated statements
of income. Gains and losses occurring from the termination, maturity, sale
or extinguishment of the financial instruments are recorded immediately in
net gain on financial instruments in the consolidated statements of income.
22 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INVESTMENT IN UNCONSOLIDATED AFFILIATE
- --------------------------------------------------------------------------------
Investment in unconsolidated affiliate consists of the Company's investment
in common stock, redeemable preferred stock and options to acquire common
stock of Financial Security Assurance Ltd. ("FSA"). The Company accounts
for its investment in FSA common stock using the equity method. The Company
accounts for its investment in FSA preferred stock and options under the
provisions of SFAS No. 115 whereby, the investments are classified as
available for sale and reported at fair value as of the balance sheet date,
with related unrealized investment gains and losses excluded from earnings
and reported, net of tax, as a component of accumulated other comprehensive
income in stockholders' equity.
MORTGAGE LOANS RECEIVABLE
- --------------------------------------------------------------------------------
Mortgage loans receivable are stated at the lower of aggregate cost or fair
value, including the fair value of commitments to originate and commitments
to sell mortgage loans. Conventional mortgage loans are placed on a
nonaccrual basis when delinquent ninety days or more as to interest or
principal. Interest on delinquent Federal Housing Administration ("FHA")
insured loans is accrued at the insured rate beginning on the sixty-first
day of delinquency. Interest on delinquent Veterans Administration ("VA")
guaranteed loans is accrued at the loan rate during the period of
delinquency.
RECOGNITION OF REVENUES RELATED TO MORTGAGE LOANS RECEIVABLE
- --------------------------------------------------------------------------------
Discounts from the origination of mortgage loans receivable are deferred and
recognized as adjustments to gain or loss on sale. Gains and losses from the
sale of mortgage loans are recognized when proceeds are received. Loan
origination fees, net of certain direct costs, have been deferred and are
recognized as income when the related mortgage loans are sold.
POOL LOAN PURCHASES
- --------------------------------------------------------------------------------
Pool loan purchases, which are carried at cost, represent FHA insured, VA
guaranteed and conventional loans which were either delinquent or in the
process of foreclosure at the time they were purchased from Government
National Mortgage Association ("GNMA"), Federal National Mortgage
Association ("FNMA") or Federal Home Loan Mortgage Corporation ("FHLMC")
mortgage-backed security pools that the Company services. Following the
purchase of these loans, interest is accrued at a rate based on expected
recoveries.
LOANS HELD FOR INVESTMENT
- --------------------------------------------------------------------------------
Loans held as permanent investments are stated at the lower of cost or
market value determined at the time the permanent investment decisions were
made.
CAPITALIZED SERVICING
- --------------------------------------------------------------------------------
Capitalized servicing includes certain costs incurred in the origination and
acquisition of mortgage servicing rights ("originated and purchased
servicing") which are deferred and amortized over the expected life of the
loan. The total cost of acquiring mortgage loans either through origination
activities or purchase transactions, is allocated between the mortgage
servicing rights and the loans based on their relative fair values. The fair
values of mortgage servicing rights are estimated by calculating the present
value of the expected future net cash flows associated with such rights,
incorporating assumptions that market participants would use in their
estimates of future servicing income and expense. A current market rate is
used to discount estimated future net cash flows. Impairment of mortgage
servicing rights is measured on a disaggregated basis by stratifying the
mortgage servicing rights based on one or more predominant risk
characteristics of the underlying loans. Impairment is recognized through a
valuation allowance for each individual stratum. The valuation allowance for
the Company's principal recourse portfolio includes a reserve for estimated
losses on the corresponding loans.
Through 1996, capitalized servicing also included, as a separate component,
the present value of future servicing revenue in excess of normal servicing
revenue on loans sold with servicing retained ("excess servicing") which was
deferred and amortized using a method that relates the anticipated servicing
revenue to total projected servicing revenue to be received over the
expected life of the loan. Impairment tests for excess servicing were
performed on a disaggregated basis. The original discount rate was used to
discount excess servicing future cash flows (refer to Note 3 to the
consolidated financial statements for further discussion).
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 23
<PAGE> 24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RECOGNITION OF REVENUES RELATED TO SERVICING MORTGAGE LOANS
- --------------------------------------------------------------------------------
Mortgage servicing revenue represents fees earned for servicing real estate
mortgage loans owned by investors and late charge income. The servicing fees
are calculated based on the outstanding principal balances of the loans
serviced and are recognized together with late charge income when received.
COMMON EQUITY SECURITIES
- --------------------------------------------------------------------------------
Common equity securities are classified as available for sale and carried at
fair value. Unrealized gains and losses, net of tax, are recorded as a
separate component of stockholders' equity with no corresponding credit or
charge to net income. Realized gains and losses from sales of common equity
securities are based on the specific identification method.
MORTGAGE CLAIMS RECEIVABLE AND REAL ESTATE ACQUIRED
- --------------------------------------------------------------------------------
Mortgage claims receivable represent claims filed primarily with FHA and VA
and are carried at cost less an estimated allowance for amounts which are
not fully recoverable from claims filed with the underlying mortgage
insuring agencies.
Real estate acquired is stated at the lower of fair value less estimated
selling costs or the recorded balance satisfied at the date of acquisition
determined on an individual property basis. Costs relating to holding the
properties are charged to expense as incurred.
The allowance for loan losses is based upon an analysis of the mortgage loan
servicing portfolio and reflects an amount which, in management's judgment,
is adequate to provide for estimated losses.
PREMISES AND EQUIPMENT
- --------------------------------------------------------------------------------
Premises and equipment, including leasehold improvements and systems and
programming software, are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are computed on a straight-line
basis over the estimated useful lives of the related assets or over the
lease terms, whichever period is shorter.
BASIC NET INCOME PER SHARE
- --------------------------------------------------------------------------------
Basic net income per share amounts were computed based on the weighted
average total number of common shares outstanding. There were 3,211,881,
2,973,999, and 2,247,000 weighted average common shares outstanding for the
years ended December 31, 1998, 1997 and 1996, respectively.
DIVIDENDS PER SHARE
- --------------------------------------------------------------------------------
Cash dividends per share were computed based on the total number of common
shares outstanding as of the dividend record dates.
NOTE 2. INVESTMENT IN UNCONSOLIDATED AFFILIATE
In March 1997, the Company issued 230,293 shares of its common stock to
White Mountains in exchange for 1.0 million shares of the common stock of
FSA valued at $27.8 million. The value of the Company's common stock
represented the book value of the stock as of December 31, 1996. The value
of the FSA common stock represented White Mountains' equity carrying value
of such assets at that time. Additionally, the Company agreed to issue
shares of its common stock to White Mountains in exchange for the remainder
of its FSA holdings, the value of which was determined at that time.
Effective the second quarter of 1997, upon receipt of insurance regulatory
and lender approvals, the Company received White Mountains' remaining FSA
holdings. The Company issued an additional 650,827 shares of its common
stock to White Mountains in exchange for 2.5 million shares of FSA common
stock, 2.0 million shares of FSA convertible redeemable preferred stock and
options to acquire 2.6 million shares of FSA common stock valued at $78.5
million, net of associated tax liabilities and other adjustments.
At December 31, 1998 and 1997, the Company owned 3.5 million shares of FSA
common stock. This represented approximately 11.6% and 12.1% of the total
shares of FSA common stock outstanding at those times. In addition, Fund
American had voting rights to an additional 3.9 million shares of FSA common
stock at December 31, 1998 and 1997, raising the consolidated entity's
voting control of FSA to approximately 23.1% and 24.0%, respectively. At
December 31, 1998 and 1997, the Company also owned FSA options and preferred
stock which, in total, give the
24 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company the right to acquire up to 4.6 million additional shares of FSA
common stock for aggregate consideration of $125.7 million.
The Company accounts for its investment in FSA common stock using the equity
method. FSA is a leading Aaa/AAA writer of financial guaranty insurance
whose common stock is publicly traded on the New York Stock Exchange
("NYSE"). The market value of the FSA common stock as of December 31, 1998
and 1997, as quoted on the NYSE, exceeded the Company's carrying value of
the FSA common stock on the equity method. The Company accounts for its
investments in FSA options and preferred stock under the provisions of SFAS
No. 115 whereby the investments are reported at fair value as of the balance
sheet date, with related unrealized investment gains and losses, net of tax,
excluded from earnings and reported as a component of accumulated other
comprehensive income in stockholders' equity.
The following table summarizes financial information for FSA, which was
derived from the audited financial statements of FSA as of and for the
periods indicated:
<TABLE>
<CAPTION>
=================================================================================================================
(in millions) 1998 1997
- -----------------------------------------------------------------------------------------------------------------
FSA balance sheet data
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Total investments $ 1,875 $ 1,432
Total assets 2,406 1,901
Deferred premium revenue 722 595
Loss and loss adjustment expense reserves 64 75
Preferred shareholder's equity 1 1
Common shareholders' equity 1,073 882
- -----------------------------------------------------------------------------------------------------------------
FSA income statement data
- -----------------------------------------------------------------------------------------------------------------
Gross premiums written $ 319 $ 236
Net premiums written 220 173
Net premiums earned 138 110
Net investment income 79 72
Net income 117 101
=================================================================================================================
The following table summarizes the amounts recorded by the Company:
=================================================================================================================
(in millions) 1998 1997
- -----------------------------------------------------------------------------------------------------------------
Investment in FSA common stock $ 120 $ 104
Investment in FSA options and preferred stock 114 88
- -----------------------------------------------------------------------------------------------------------------
Total investment in FSA 234 192
- -----------------------------------------------------------------------------------------------------------------
Equity in earnings from FSA common stock (a) 14 10
Equity in net unrealized investment gains (losses)
from FSA's investment portfolio, before tax (b) 3 2
Unrealized investment gains on FSA options
and preferred stock, before tax (b) 27 61
=================================================================================================================
</TABLE>
(a) Recorded net of related amortization of goodwill.
(b) Recorded directly to stockholders' equity as a component of accumulated
other comprehensive income.
NOTE 3. CAPITALIZED SERVICING
For the years ended December 31, 1998, 1997 and 1996, the Company estimated
the fair values of its mortgage servicing rights by calculating the present
value of the expected net future cash flows associated with such rights. In
making those estimates, the Company incorporated assumptions that market
participants would use in their estimates of future servicing income and
expense.
The Company evaluated the predominant risk characteristics (prepayment,
default and operational) on its owned servicing portfolio. The Company
stratified the portfolio by interest rate, loan type (investor), original
term to maturity and principal recourse. In 1996, as a result of the pending
sale of $17.0 billion of the Company's nonrecourse mortgage servicing
portfolio, the Company valued the $17.0 billion portfolio as one stratum
using the market price as determined by the third party purchaser. The
Company measured impairment of its owned servicing portfolio using
assumptions that market participants would use to value their estimates of
future net servicing
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 25
<PAGE> 26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
revenue. In estimating fair value, the Company used market consensus
prepayment rates and discounted the net future cash flows using discount
rates that approximated the current market rates of 10.5% for conventional
loans, 12.0% for insured loans and 21.0% for recourse loans for those years.
The fair value of each stratum was computed and compared to its recorded
book value to determine if an impairment valuation allowance, or recovery of
a previously established allowance, was required.
As a result of the February 1997 sale of $17.0 billion of nonrecourse
mortgage servicing rights, the Company's principal recourse portfolio became
a more significant component of its total remaining owned servicing
portfolio. In determining the fair value of its principal recourse portfolio
as of December 31, 1998 and 1997, respectively, the Company included a $5.2
million and $8.2 million reserve for estimated recourse losses on the
corresponding loans in its calculation for measuring impairment of its
capitalized servicing asset.
The discount rate and prepayment assumptions are significant factors used in
estimating the fair value of the Company's mortgage servicing rights and
could be significantly impacted by changes in interest rates. Accordingly,
it is likely that management's estimate of the fair value of the mortgage
servicing rights could change in the near term due to changes in interest
rates.
In 1997, the Company adopted certain provisions of SFAS No. 125 which
eliminated the distinction between "normal" servicing rights and excess
servicing receivables. Therefore, in adopting SFAS No. 125, the Company
combined its "normal" mortgage servicing rights and its excess servicing
receivables. The Company estimated the fair value of the combined asset
based on the methodology described above, which did not materially affect
the Company's 1997 results.
Prior to the adoption of SFAS No. 125, the Company estimated the fair value
of its capitalized excess servicing asset by discounting the anticipated
future cash flows over the estimated life of the related loans. In making
these estimates, the Company used "interest only strip" interest rates as
quoted by market participants to determine the appropriate discount rates
and prepayment speed assumption rates that are based on interest rates, loan
types and original term to maturity. The discount rate used to capitalize
excess servicing ranged from 12.0% to 12.6% for 1996. For the year ended
December 31, 1996, the weighted average discount rate inherent in the
carrying amount of the capitalized excess servicing asset was 10.4%.
The following table summarizes the fair value of mortgage servicing rights
and certain characteristics of the Company's servicing portfolio related to
those mortgage servicing rights as of December 31, 1998:
<TABLE>
<CAPTION>
=========================================================================================================================
Fair Value Weighted
Mortgage Principal Average Weighted Weighted
Servicing Balance Interest Average Average
Rights Serviced Rate Maturity Service Fee(a)
Loan Type (in thousands) (in millions) (in percent) (in months) (in percent)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fixed Rate:
Insured $ 117,446 $ 4,901 7.47% 334 .50%
Conventional 32,956 1,573 7.78 271 .39
Recourse 25,845 1,787 8.43 202 .47
Adjustable Rate 1,723 106 7.89 256 .41
- -------------------------------------------------------------------------------------------------------------------------
Total $ 177,970 $ 8,367 7.74% 293 .47%
=========================================================================================================================
</TABLE>
(a) Includes servicing fees assigned to mortgage loans receivable for valuation
purposes of .25% for conventional fixed rate loans, .44% for insured fixed
rate loans and .375% for conventional adjustable rate loans.
The above table excludes $830 million of principal balance of mortgage loans
serviced, of which $635 million relates to originations not capitalized
prior to the adoption of SFAS No. 122 and $195 million relates to
originations funded not yet capitalized.
26 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes changes in the Company's capitalized servicing
asset:
<TABLE>
<CAPTION>
===================================================================================================================================
Deferred Total
Mortgage Valuation Gain on Sale Capitalized
(in thousands) Servicing Allowance Subservicing of Servicing Servicing
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balances at January 1, 1996 $ 438,063 $ (27,968) $ -- $ (13,024) $ 397,071
Additions 125,514 -- -- -- 125,514
Scheduled amortization (69,932) -- -- -- (69,932)
Impairment/unscheduled
amortization (1,076) (8,185) -- -- (9,261)
Amortization of deferred gain -- -- -- 6,139 6,139
Recourse loan losses -- 7,257 -- -- 7,257
Sales (45,849) -- -- -- (45,849)
- -----------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 446,720 (28,896) -- (6,885) 410,939
Additions 90,412 (1,259) -- -- 89,153
Scheduled amortization (37,537) -- (8,880) -- (46,417)
Impairment/unscheduled
amortization -- (21,151) (463) -- (21,614)
Amortization of deferred gain -- -- -- 6,885 6,885
Recourse loan losses -- 3,881 -- -- 3,881
Sales (273,667) 2,285 9,580 -- (261,802)
- -----------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 225,928 (45,140) 237 -- 181,025
Additions 240,780 -- -- -- 240,780
Scheduled amortization (38,624) -- (1,796) -- (40,420)
Impairment/unscheduled
amortization -- (14,759) -- -- (14,759)
Recourse loan losses -- 2,741 -- -- 2,741
Sales (221,213) 21,534 -- -- (199,679)
- -----------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1998 $ 206,871 $ (35,624) $ (1,559) $ -- $ 169,688
===================================================================================================================================
</TABLE>
In connection with the February 1997 servicing sale and related subservicing
assumption, the Company recorded a subservicing asset of approximately $13.3
million. The value of the asset represented the net present value of
projected net cash flows over the subservicing period including a profit
margin. In December 1997, the subservicing agreement was amended to extend
the Company's subservicing responsibilities for one additional year at less
favorable terms than the original agreement provided. Accordingly, the net
carrying value of the subservicing asset was reduced by approximately $3.7
million which represented the net present value of projected net cash flows
over the extended subservicing period including a profit margin. In November
1998, the subservicing agreement was amended again to extend the Company's
subservicing responsibilities for two additional years at slightly more
favorable terms than the first amendment provided. Based upon an updated
analysis of the net present value of projected net cash flows, the net
carrying value of the subservicing asset was not adjusted. The remaining
negative asset is being amortized on a straight-line basis over the
corresponding subservicing period and tested for impairment.
In 1994, the Company sold the rights to service $3.9 billion of mortgage
loans to a third party and continued to service these loans pursuant to a
subservicing agreement. The Company recorded a $19.9 million deferred gain
on the sale which was being recognized over the five-year life of the
subservicing agreement as mortgage servicing revenue. In the fourth quarter
of 1996, the third party sold the rights to service approximately $1.0
billion of these mortgage loans, representing approximately 25% of the total
loans subserviced by the Company for this third party. Accordingly, the
Company recognized an additional $2.4 million of the deferred gain in 1996,
representing approximately 25% of the deferred balance at the time of the
sale. In the fourth quarter of 1997, the third party sold the rights to
service the remaining portfolio of loans. As a result, the Company
recognized the remaining $4.4 million of the deferred gain.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 27
<PAGE> 28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4. COMMON EQUITY SECURITIES AND INVESTMENTS
In June 1997, the Company acquired an investment in U S WEST, Inc. ("U S
West") redeemable preferred stock from Fund American for cash proceeds of
$49.3 million. The investment, which is classified as available for sale, is
a fixed maturity investment which is redeemable in September 2004 and may be
redeemed at the option of U S West beginning in September 1999. The discount
on this investment is being amortized over the anticipated life of the
investment. The carrying value of this investment, which approximates fair
value, totaled $49.8 million and $49.4 million as of December 31, 1998 and
1997, respectively. The Company recognized income from this investment of
approximately $3.8 million and $2.2 million in 1998 and 1997, respectively,
which is included in interest income in the consolidated statements of
income.
In January 1996, the Company sold its then remaining $1.4 million of common
equity securities to White Mountains for cash proceeds of $.5 million. The
Company realized a pretax loss of $.9 million on the sale. In December 1996,
the Company received shares of certain common equity securities with a
market value of $2.3 million as a return of a partnership investment. The
resulting gain of $1.4 million is included in the determination of income in
1996. In January 1997, the Company transferred these shares to White
Mountains in exchange for 21,239 shares of the Company's common stock held
by White Mountains, which were retired by the Company. The Company realized
a pretax gain of $.3 million on the transfer. All of the equity securities
involved in the above transactions were actively traded, readily marketable,
listed on a national exchange and, for purposes of such transactions, valued
at their reported closing prices on the day preceding the date of each
transaction. As of December 31, 1997, the Company had no remaining common
equity securities.
The change in net unrealized investment loss on the Company's common equity
securities was charged to stockholders' equity as follows:
<TABLE>
<CAPTION>
=====================================================================================================================
Year ended December 31, (in thousands) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net unrealized investment loss at beginning of year $ -- $ -- $ (546)
Decrease in gross unrealized gains -- -- --
Decrease in gross unrealized losses -- -- 840
Decrease in deferred income tax expense -- -- (294)
- ---------------------------------------------------------------------------------------------------------------------
Net unrealized investment loss at end of year $ -- $ -- $ --
=====================================================================================================================
</TABLE>
NOTE 5. MORTGAGE LOANS RECEIVABLE
The following table summarizes mortgage loans receivable:
<TABLE>
<CAPTION>
=================================================================================================================
December 31, (in thousands) 1998 1997
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Adjustable rate mortgage loans, weighted average interest rates of 6.39% and
6.36% as of December 31, 1998 and 1997, respectively $ 15,110 $ 51,589
Fixed rate 5 year through 25 year mortgage loans, weighted average
interest rates of 7.10% and 7.68% as of December 31, 1998 and 1997,
respectively (a) 239,879 60,382
Fixed rate 30 year mortgage loans, weighted average interest rates of 7.33%
and 7.76% as of December 31, 1998 and 1997, respectively (b) 420,395 404,996
- -----------------------------------------------------------------------------------------------------------------
675,384 516,967
Net premiums 933 2,280
- -----------------------------------------------------------------------------------------------------------------
Total mortgage loans receivable $ 676,317 $ 519,247
=================================================================================================================
</TABLE>
(a) Includes $4,333 and $1,497 of subprime mortgage loans with a weighted
average interest rate of 11.64% and 10.93% as of December 31, 1998 and
1997, respectively.
(b) Includes $15,508 and $1,549 of subprime mortgage loans with a weighted
average interest rate of 10.78% and 10.58% as of December 31, 1998 and
1997, respectively.
28 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6. POOL LOAN PURCHASES
The following table summarizes pool loan purchases:
<TABLE>
<CAPTION>
=======================================================================================================================
Principal Balance
(in thousands) Number of Loans
December 31, 1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Loan Type:
FHA $ 119,558 $ 103,067 1,640 1,781
VA 45,259 43,349 550 669
Conventional 135 3,375 4 45
- -----------------------------------------------------------------------------------------------------------------------
Total pool loan purchases $ 164,952 $ 149,791 2,194 2,495
=======================================================================================================================
</TABLE>
NOTE 7. LOANS HELD FOR INVESTMENT
During 1997, the Company identified for sale a majority of its mortgage
loans held for investment and marked them down from amortized cost to
current market value. The Company recognized a $3.0 million pretax charge to
net gain on sale of mortgages as a result of establishing a valuation
allowance for these loans. As of December 31, 1997, these loans totaled
approximately $10.2 million, net of the valuation allowance, of which $4.5
million were included in loans held for investment and $5.7 million were
included in mortgage claims receivable and real estate acquired in the
consolidated statement of condition. During 1998, the majority of these
loans were sold. The remaining balance of approximately $1.2 million, net of
a $.2 million valuation allowance, are classified as loans held for
investment in the December 31, 1998 consolidated statement of condition.
NOTE 8. SENIOR AND SUBORDINATED DEBT
Senior and Subordinated Debt consists of the following:
<TABLE>
<CAPTION>
=======================================================================================================================
December 31, (in thousands) 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Credit agreements, weighted average interest rates of 5.79%
and 6.34% as of December 31, 1998 and 1997, respectively $ 697,229 $ 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) (1,564) (2,110)
- -----------------------------------------------------------------------------------------------------------------------
Total senior and subordinated debt $ 870,364 $ 742,059
=======================================================================================================================
</TABLE>
CREDIT AGREEMENTS
- --------------------------------------------------------------------------------
The Company amended and restated its $701.0 million secured revolving credit
agreement in July 1998, to increase its borrowing capacity and flexibility.
The provisions of the amended agreement increased its borrowing capacity
from $701.0 million to $800.0 million, which allows the Company to meet
higher borrowing requirements resulting from increased production volumes.
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. Borrowings under the facility are secured primarily by the
Company's mortgage loans receivable and pool loan purchases. The revolving
credit facility expires on July 9, 1999. As of December 31, 1998, there was
$650.5 million outstanding under this facility. As of December 31, 1997,
there was $559.0 million outstanding under the previous facility.
Under the credit agreement described above, the Company receives interest
expense credits as a result of holding escrow and custodial funds in trust
accounts at lender or non-lender banks.
The Company entered into a new secured credit agreement in May 1998, to fund
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 December 31, 1998, there was $21.6 million outstanding under this
facility.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 29
<PAGE> 30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company entered into an additional secured credit agreement in July
1998, 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. As of
December 31, 1998, there were no outstanding borrowings under this facility.
The Company must comply with certain financial covenants provided in its
secured revolving credit facilities, including restrictions relating to
tangible net worth and leverage. In addition, there are certain covenants
which limit the Company's ability to pay dividends or make distributions of
its capital to holders of its common stock. 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.
Central Pacific replaced its existing $15.0 million unsecured revolving
credit agreement with a new mortgage warehousing agreement in April 1998, to
fund the origination or acquisition of mortgage loans. Under this agreement,
Central Pacific could borrow up to $25.0 million through April 15, 1999.
Borrowings under this new facility are secured by the underlying loans. In
July 1998, Central Pacific amended this new agreement to increase its
borrowing capacity to $40.0 million. In February 1999, the agreement was
extended to June 1, 1999. As of December 31, 1998, there was $25.1 million
outstanding under this agreement. As of December 31, 1997, there was $10.5
million outstanding under the previous agreement.
Central Pacific must comply with certain financial covenants provided in its
secured credit agreement, including restrictions relating to tangible net
worth and leverage. Central Pacific is currently in compliance with all such
covenants.
MEDIUM-TERM NOTES AND DEBENTURES
- --------------------------------------------------------------------------------
In June 1992, the Company issued $100.0 million of 9% debentures due June
2012 under terms of a $250.0 million shelf registration statement filed with
the Securities and Exchange Commission ("SEC") in April 1992. The debentures
may not be redeemed by the Company prior to maturity. The proceeds were used
for general corporate purposes. In January 1999, the Company repurchased and
retired $8.0 million of these debentures (refer to Note 23 to the
consolidated financial statements).
In October 1991, the Company issued $160.0 million of 8.875% medium-term
notes due October 2001. In May 1997, the Company repurchased and retired
$119.6 million of these medium-term notes. As a result, the Company
recognized an extraordinary loss of approximately $6.0 million, net of
approximately $3.2 million of associated income tax benefit. In 1995, the
Company repurchased and retired $21.6 million of these medium-term notes.
SUBORDINATED DEBENTURES
- --------------------------------------------------------------------------------
Effective December 8, 1995, the Company exchanged and retired 2,239,061
shares of its 8.42% cumulative preferred stock, Series A, for $56.0 million
in principal amount of 9.375% subordinated interest deferrable debentures
("subordinated debentures"), due December 31, 2025. Interest on the
subordinated debentures is paid quarterly in arrears at the annual rate of
9.375% on the last business day of each March, June, September and December.
The subordinated debentures are redeemable at the option of the Company, in
whole or in part, at any time on or after May 1, 1999. On or after such
date, the subordinated debentures may be redeemed at the option of the
Company at a price equal to 100% of the principal amount redeemed ($25 for
each $25 principal amount of subordinated debenture), plus accrued and
unpaid interest to the date fixed for redemption.
Aggregate maturities of medium-term notes, debentures and subordinated
debentures, excluding discount, premium and issuance costs, for the five
calendar years after December 31, 1998 are as follows:
<TABLE>
<CAPTION>
=================================================================================================================================
(in thousands) 1999 2000 2001 2002 2003 Thereafter Total
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
$ -- $ -- $ 18,723 $ -- $ -- $ 155,976 $ 174,699
=================================================================================================================================
</TABLE>
30 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9. STOCKHOLDERS' EQUITY
During 1998, the Company declared and paid cash dividends on its common
stock totaling $104.0 million which represented a return of capital. The
Company did not declare or pay cash dividends on its common stock during
1997.
The Company's secured revolving credit facility contains restrictions that
limit its ability to pay dividends or make distributions on its capital.
Generally, dividends may be paid as long as the Company maintains the
tangible net worth requirements outlined in the financial covenants of the
credit agreement. Effective July 10, 1998, the provisions of the Company's
credit facility were amended to allow the payment of approximately $64.1
million in dividends on common stock. As of December 31, 1998, the Company
has dividend capacity of approximately $40.2 million remaining (refer to
Note 23 to the consolidated financial statements).
In March 1997, the Company issued 105,000 shares of its common stock to Fund
American for cash proceeds of $12.7 million. In addition, the Company issued
230,293 shares of its common stock to White Mountains in exchange for 1.0
million shares of the common stock of FSA valued at $27.8 million. The
Company issued an additional 650,827 shares of its common stock to White
Mountains effective in the second quarter of 1997 in exchange for 2.5
million shares of FSA common stock, 2.0 million shares of FSA convertible
redeemable preferred stock and options to acquire 2.6 million shares of FSA
common stock valued at $78.5 million, net of associated tax liabilities and
other adjustments. Stockholders' equity includes accumulated other
comprehensive income composed of unrealized gains and losses on the
investments in FSA convertible redeemable preferred stock and options to
acquire FSA common stock, net of tax.
In January 1997, the Company transferred its remaining common equity
securities with a market value of $2.6 million to White Mountains in
exchange for 21,239 shares of the Company's common stock held by White
Mountains, which were retired by the Company.
At December 31, 1998, the Company had 1,760,939 shares of 8.42% cumulative
preferred stock, Series A ("preferred stock") issued and outstanding. The
Company is authorized to issue 12,000,000 shares of preferred stock.
The preferred stock is not redeemable prior to May 1, 1999. On or after such
date, the preferred stock may be redeemed at the option of the Company at a
price of $25 per share, plus accrued and unpaid dividends to the redemption
date. The preferred stock ranks senior to the common stock as to dividends
and upon the distribution of assets in the event of any liquidation,
dissolution, or winding up of the Company. Issued and outstanding shares of
the preferred stock are subordinate as to dividends and upon liquidation, to
the outstanding debt of the Company.
Quarterly cash dividends are paid on preferred stock at an annual rate of
8.42% or $2.105 per share, if declared by the Board of Directors, in arrears
on the first day of each February, May, August and November. Dividends on
the preferred stock accrue on a daily basis whether or not there are funds
legally available for the payment of such dividends and whether or not such
dividends are declared.
NOTE 10. FINANCIAL INSTRUMENTS
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
- --------------------------------------------------------------------------------
The Company utilizes derivative financial instruments in the management of
interest rate risk. The Company's use of derivative financial instruments is
primarily limited to commitments to extend credit, mandatory forward
commitments, interest rate floor contracts ("floors"), interest rate swap
agreements ("I/R swaps") and principal-only swap agreements ("P/O swaps").
Although SFAS No. 115 requires that these financial instruments be
classified as held for trading purposes the Company does not consider these
investments to be speculative holdings.
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 and reduce its own exposure to fluctuations in interest rates.
These financial instruments primarily include commitments to extend credit
and mandatory forward commitments. Those instruments involve, to varying
degrees, elements of credit and market risk in excess of the amount
recognized in the consolidated statements of condition. The contract or
notional amounts of those instruments reflect the extent of risk the Company
has in the instruments.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 31
<PAGE> 32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's exposure to credit loss in the event of nonperformance by the
counterparty to the financial instrument for commitments to extend credit
("mortgage loan pipeline") is represented by the contractual notional amount
of those instruments. The Company's locked mortgage loan pipeline that is
expected to close totaled $608.3 million and $284.5 million as of December
31, 1998 and 1997, respectively. Fixed rate commitments result in the
Company having market risk as well as credit risk. Variable rate commitments
result primarily in credit risk. The amount of collateral required upon
extension of credit is based on the Company's credit evaluation of the
mortgagor and consists of the mortgagor's residential property.
The Company obtains mandatory forward commitments of up to 120 days to sell
mortgage-backed securities to hedge the market risk associated with a
substantial portion of the mortgage loan pipeline that is expected to close
and all mortgage loans receivable. As of December 31, 1998 and 1997, the
Company had approximately $1,805.3 million and $776.8 million of mandatory
forward commitments outstanding, respectively. If secondary market interest
rates decline after the Company obtains a mandatory forward commitment for a
loan, the loan may not close and the Company may incur a loss from the cost
of covering its obligations under such commitment. If secondary market rates
increase before the Company obtains a mandatory forward commitment for a
loan and the loan closes, the Company may realize a loss when the loan is
subsequently sold.
The Company's risk management function closely monitors the mortgage loan
pipeline to determine appropriate forward commitment coverage on a daily
basis in order to manage the risk inherent in these off-balance-sheet
financial instruments. In addition, the risk management area seeks to reduce
counterparty risk by committing to sell mortgage loans only to its eighteen
approved dealers, with no dealer having in excess of 20% of current
commitments.
The Company sells loans either through mortgage-backed securities issued
pursuant to programs of GNMA, FNMA, FHLMC or through whole loan sales to
investors. Most loans are aggregated in pools of $1.0 million or more, which
are purchased by institutional investors after having been guaranteed by
GNMA, FNMA or FHLMC.
Substantially all GNMA securities are sold without recourse to the Company
for loss of principal in the event of a subsequent default by the mortgage
borrower due to underlying FHA or VA insurance. Prior to December 1992,
substantially all conventional securities were sold with recourse to the
Company to the extent of insufficient proceeds from private mortgage
insurance, foreclosure and other recoveries. Since December 1992,
conventional loans have been sold without recourse to the Company.
Servicing agreements relating to mortgage-backed securities issued pursuant
to the programs of GNMA, FNMA and FHLMC require the Company to advance funds
to make the required payments to investors in the event of a delinquency by
the borrower. The Company expects that it would recover most funds advanced
upon default by the borrower or at foreclosure. However, in connection with
VA partially guaranteed loans and certain conventional loans (which may be,
at most, partially insured by private mortgage insurers), funds advanced may
not cover losses due to potential declines in collateral value. The Company
is subject to limited amounts of principal risk with respect to these loans
since the insurer has the option to reimburse the servicer for the lower of
fair market value of the property or the mortgage loan outstanding, in
addition to the VA guarantee on the loan. In addition, most of the Company's
servicing agreements for mortgage-backed securities typically require the
payment to investors of a full month's interest on each loan although the
loan may be paid off (by optional prepayment or foreclosure) other than on a
month-end basis. In this instance, the Company is obligated to pay the
investor interest at the note rate from the date of the loan payoff through
the end of that calendar month without reimbursement.
As of December 31, 1998, 1997 and 1996, the Company serviced approximately
$4.0 billion, $5.4 billion and $13.5 billion of GNMA loans in its owned
servicing portfolio, respectively, and $1.7 billion, $2.5 billion and $2.9
billion of conventional loans with recourse, respectively.
In order to cover loan losses that may result from these servicing
arrangements and other losses, the Company has provided an allowance for
loan losses of $11.5 million and $12.8 million as of December 31, 1998 and
1997, respectively. In addition, the valuation allowance for the Company's
capitalized servicing asset related to its principal recourse portfolio
includes a $5.2 million and $8.2 million reserve for estimated losses on the
corresponding loans as of December 31, 1998 and 1997, respectively.
Management believes these amounts are adequate to cover unreimbursed
foreclosure advances and principal losses, including losses on loans with
recourse.
32 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, the Company
invests in various financial instruments. 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 such financial
instruments decreases. The financial instruments utilized by the Company
include interest rate floors, I/R swaps and P/O swaps.
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. Some of the floor contracts cap the
payments by specifying a second rate that is less than the floor rate. If
the prevailing interest rates fall below this rate, payments will not
increase. 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 in the floors. During 1998, the Company
entered into floor contracts with a notional value of $1.2 billion for an
initial investment of $6.1 million. In addition, during 1998 the Company
sold floors with a carrying value of $8.3 million and a notional value of
$814.6 million for proceeds of $11.3 million and realized a net gain of $3.0
million. As of December 31, 1998, the Company's open floors had a total
notional value of $1.1 billion, an original cost of $5.3 million and a
carrying value of $9.9 million. The floors have remaining terms of
approximately 5 to 10 years with floor rates ranging from 3.54% to 5.05%.
During 1997, the Company entered into floor contracts with a notional value
of $264.6 million for an initial investment of $2.3 million. In addition,
during 1997 the Company sold floors with a carrying value of $.7 million and
a notional value of $550 million for proceeds of $.8 million and realized a
net gain of $.1 million. As of December 31, 1997, the Company's open floors
had a total notional value of $.7 billion, an original cost of $4.7 million
and a carrying value of $8.2 million.
The I/R swaps are derivative contracts which entitle the Company to receive
interest at a fixed rate and obligate it to pay interest at a variable rate
based on a contracted notional amount. The Company's exposure to losses on
the agreements is related to the differences, over the life of the contract,
between the contracted fixed interest rates and the variable interest rates.
During 1998, the Company entered into I/R swap agreements with a total
notional value of $290.0 million. As of December 31, 1998, these I/R swaps
had a carrying value of $4.8 million. The I/R swaps have remaining terms of
5 to 10 years.
The P/O swaps are derivative contracts, the value of which is determined by
changes in the value of the underlying 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
underlying P/O security, multiplied by a floating rate indexed to the London
Interbank Offered Rates for U.S. dollar deposits ("LIBOR"). The Company's
exposure to loss in the P/O swaps is related to changes in the market value
of the underlying P/O security over the life of the contract. During 1998,
the Company entered into P/O swap transactions with a notional value of
$50.0 million. In addition, during 1998 the Company sold P/O swaps with a
carrying value of $13.1 million and an original notional value of $98.1
million for proceeds of $13.7 million and realized a net gain of $.6
million. As of December 31, 1998, the Company's open P/O swap agreements,
with an original notional value of $50.0 million had a carrying value of
$2.7 million. The P/O swaps have remaining terms of approximately 5 years.
During 1997, the Company entered into P/O swap transactions with a notional
value of $48.1 million. As of December 31, 1997, the Company's open P/O swap
agreements, with an original notional value of $98.1 million had a carrying
value of $12.5 million.
The floors, I/R swaps and P/O swaps are carried at market value and are
included in investments in the consolidated statements of condition.
Realized and unrealized gains and losses are recorded in net gain on
financial instruments in the consolidated statements of income.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 33
<PAGE> 34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FAIR VALUE OF FINANCIAL INSTRUMENTS
- --------------------------------------------------------------------------------
The Company determines the estimated fair value of its financial instruments
using appropriate market information and valuation methodologies.
Considerable judgment is required to interpret the market information to
develop the estimates of fair value. As a result, the estimates provided
herein are not necessarily indicative of the amounts that could be realized
in a current market exchange.
The following methods and assumptions were used by the Company to estimate
the fair value of each class of financial instruments for which it is
practicable to estimate that value:
Cash and Investments
For cash, short-term investments and fixed maturity investments the
carrying value equals or approximates fair value.
For interest rate floors, I/R swaps and P/O swaps, fair value is estimated
based on quoted market prices for those or similar investments and is equal
to the carrying value.
For investment partnership interests fair value is determined as the equity
method value calculated from the audited partnership financial statements.
Mortgage Loans Receivable
For mortgage loans receivable, fair value is estimated using quoted market
prices for securities backed by similar loans.
Pool Loan Purchases
For pool loan purchases, fair value is estimated based on discounted cash
flow analyses, using the Company's short-term incremental borrowing rate,
quoted market prices for securities backed by similar loans or actual prices
at which the loans were subsequently sold.
Loans Held For Investment
In 1997, the Company identified for sale the majority of its loans held for
investment and marked them down from amortized cost to current market value,
and therefore, the carrying amount for these loans equals fair value.
Receivables From Sales of Servicing
For receivables from sales of servicing, carrying value equals or
approximates fair value.
Loans in Foreclosure and Mortgage Claims Receivable
For these financial instruments, fair value is estimated by discounting
anticipated future cash flows using the Company's short-term incremental
borrowing rate.
Debt
For credit agreements (short-term debt), the carrying amount approximates
fair value. For debentures and medium-term notes (long-term debt), fair
value is estimated by discounting future cash flows using the Company's
incremental borrowing rates for similar types of borrowing arrangements. For
subordinated debentures (long-term debt), fair value is based on quoted
market prices.
Off-Balance-Sheet Financial Instruments
Fair value for commitments to sell mortgage loans is based on the current
settlement values of those commitments, net of the face amounts of the
commitments. Fair value for commitments to extend credit is based on current
quoted market prices for securities backed by similar loans, net of the
principal amounts of the commitments.
34 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The estimated fair values of the Company's financial instruments are as
follows:
<TABLE>
<CAPTION>
=============================================================================================================
December 31, 1998 1997
- -------------------------------------------------------------------------------------------------------------
Carrying Fair Carrying Fair
(in thousands) Amount Value Amount Value
<S> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------
Financial Assets:
Cash $ 16,410 $ 16,410 $ 3,134 $ 3,134
Investments
Interest rate floor contracts 9,860 9,860 8,153 8,153
Interest rate swap 4,849 4,849 -- --
Principal-only swaps 2,745 2,745 12,508 12,508
Other 61,023 67,542 65,578 75,092
Mortgage loans receivable 676,317 679,998 519,247 529,260
Pool loan purchases 164,952 165,146 149,791 150,175
Loans held for investment 1,707 1,707 5,191 5,191
Receivables from sales of servicing 73,825 73,825 27,324 27,324
Loans in foreclosure and mortgage
claims receivable (net) (a) 27,058 26,530 35,579 34,905
- -------------------------------------------------------------------------------------------------------------
Financial Liabilities:
Short-term debt $ 696,959 $ 696,959 $ 569,399 $ 569,399
Long-term debt 173,405 171,853 172,660 186,978
Off-Balance-Sheet Financial Instruments:
Mandatory forward commitments n/a 559,527 n/a 1,642
Commitments to extend credit
expected to close (pipeline) n/a 11,139 n/a 6,498
=============================================================================================================
</TABLE>
(a) Excludes $5.9 million and $5.6 million of real estate owned in 1998 and
1997, respectively.
The Company's investments in FSA options and preferred stock are not
presented in the table above. These financial instruments are accounted for
under the provisions of SFAS No. 115 and are carried on the consolidated
statements of condition at fair value (refer to Note 2 to the consolidated
financial statements).
NOTE 11. MORTGAGE SERVICING
The Company's portfolio of mortgages serviced, including loans subserviced
and excluding loans sold but not transferred, totaled $25.1 billion, $26.5
billion and $29.2 billion as of December 31, 1998, 1997 and 1996,
respectively. The Company's portfolio of mortgages serviced as of December
31, 1998 is summarized below:
<TABLE>
<CAPTION>
==========================================================================================================================
Weighted Average
------------------------------------------------------------------------
Principal Net Remaining
Balance Loan Interest Servicing Contractual
Serviced Balance Rate Fee Rate Life
Loan Type (in millions) (in thousands) (in percent) (in percent) (in months)
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Residential
Conventional $ 3,929 $ 64 8.14% .396% 237
FHA 2,486 75 7.74 .398 334
VA 2,736 81 7.26 .400 331
Commercial 46 927 7.16 .189 173
- --------------------------------------------------------------------------------------------------------------------------
$ 9,197 $ 72 7.76% .397% 291
Subservicing 15,915
- --------------------------------------------------------------------------------------------------------------------------
Total mortgage servicing portfolio $25,112 $ 65 7.99% (a) 270
==========================================================================================================================
</TABLE>
(a) This amount 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.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 35
<PAGE> 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The servicing fee rates in the table above are shown after deducting any
guarantee fees. Guarantee fees, when applicable, range from six basis
points for governmental loans up to approximately thirty basis points for
certain conventional loans. Certain loans sold to private investors have no
guarantee fees.
The following table summarizes the Company's owned mortgage servicing
portfolio by interest rate range:
<TABLE>
<CAPTION>
==================================================================================================================================
December 31, 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted
Number Principal Average Number Principal Average
of Balance Interest Rate of Balance Interest Rate
Interest Rate Range Loans (in millions) in percent) Loans (in millions) (in percent)
- -------------------------------------------------------------------------------------------------------------------=--------------
<S> <C> <C> <C> <C> <C> <C>
5.99% and lower 438 $ 35 5.17% 843 $ 66 5.41%
6.00%-6.49% 1,193 127 6.22 1,823 159 6.13
6.50%-6.99% 10,870 1,111 6.64 4,166 319 6.66
7.00%-7.49% 28,036 2,337 7.08 12,968 729 7.17
7.50%-7.99% 30,928 2,550 7.58 29,240 2,455 7.63
8.00%-8.49% 15,778 1,155 8.12 27,989 2,280 8.13
8.50%-8.99% 17,999 809 8.62 32,178 1,867 8.59
9.00%-9.49% 5,934 275 9.12 13,452 722 9.07
9.50%-9.99% 7,580 339 9.64 29,142 1,420 9.55
10.00% and above 9,574 459 10.73 32,488 1,610 10.49
- ----------------------------------------------------------------------------------------------------------------------------------
Total 128,330 $ 9,197 7.76% 184,289 $11,627 8.52%
==================================================================================================================================
</TABLE>
The following table summarizes the Company's owned mortgage servicing
portfolio by location of property:
<TABLE>
<CAPTION>
====================================================================================================================================
December 31, 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
Percentage Percentage
of Principle of Principle
Number Principal Balance of Number Principal Balance of
of Balance Servicing of Balance Servicing
State Loans (in millions) Portfolio Loans (in millions) Portfolio
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
California 17,617 $ 1,795 19.5% 20,459 $ 1,889 16.3%
New York 17,572 935 10.2 22,118 1,162 10.0
Texas 11,448 676 7.4 15,655 736 6.3
Washington 5,033 486 5.3 7,889 690 5.9
Florida 7,849 471 5.1 12,894 663 5.7
Michigan 7,810 393 4.3 10,773 520 4.5
Maryland 4,159 377 4.1 5,020 362 3.1
New Jersey 5,145 364 4.0 7,088 503 4.3
Ohio 4,461 298 3.2 6,658 357 3.1
Illinois 3,441 260 2.8 6,335 420 3.6
Other* 43,795 3,142 34.1 69,400 4,325 37.2
- ------------------------------------------------------------------------------------------------------------------------------------
Total 128,330 $ 9,197 100.0% 184,289 $ 11,627 100.0%
====================================================================================================================================
</TABLE>
* No other state constitutes more than 2.8% of the Company's owned servicing
portfolio as of December 31, 1998.
The above tables exclude loans subserviced for others having a principal
balance of $15,915 million and $14,919 million as of December 31, 1998 and
1997, respectively.
During 1998, the Company sold the rights to service approximately $10.6
billion of its nonrecourse servicing portfolio to third parties for net
proceeds of $227.9 million. The Company recognized a $15.2 million pretax
gain on these sales and adjustments to previous sales. During 1997, the
Company sold the rights to service $17.0 billion of its nonrecourse
servicing portfolio to a third party for net proceeds of $266.9 million. The
Company recognized a $8.0 million pretax loss on the sale. As of December
31, 1998 and 1997, the Company had outstanding receivables from servicing
sales totaling approximately $73.8 million and $27.3 million, respectively,
which are included in other assets in the consolidated statements of
condition.
36 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Escrow funds of approximately $207.9 million, $196.8 million and $207.8
million as of December 31, 1998, 1997 and 1996, respectively, relating to
mortgages serviced and subserviced, are held in non-interest bearing
accounts at non-affiliated banks and are not included in the consolidated
financial statements.
The Company has in force an errors and omissions policy in the amount of $20
million. Primary fidelity coverage up to a limit of $30 million is provided
under a Fund American master policy, for which the Company pays a portion of
the premium.
NOTE 12. RESTRUCTURING CHARGES
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 work force, primarily in overhead areas, by approximately 100 employees
during the second quarter of 1997 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. The amount included approximately $1.6 million of employee separation
costs, including severance payments, health care coverage and postemployment
education benefits and $.1 million of miscellaneous expenses. As of December
31, 1998, no liability remains in connection with this plan. As of December
31, 1997, $.1 million remained accrued in the Company's consolidated
statements of condition.
In 1994, the Company implemented a restructuring plan to bring its mortgage
loan production network in line with anticipated levels of mortgage loan
production as a result of a contracting mortgage loan origination market. As
of December 31, 1998, no liability remains in connection with this plan. As
of December 31, 1997, $.2 million remained accrued in the Company's
consolidated statements of condition relating to future lease expenses for
closed facilities.
NOTE 13. LEASE COMMITMENTS
The Company has entered into a number of noncancelable operating lease
agreements with respect to premises and equipment. The minimum annual rental
commitments under these leases as of December 31, 1998 are as follows:
<TABLE>
<CAPTION>
====================================================================================================
(in thousands) 1999 2000 2001 2002 2003 Total
<S> <C> <C> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------
$ 2,693 $ 2,593 $ 2,136 $ 1,504 $ 1,284 $ 10,210
====================================================================================================
</TABLE>
Total rental expense for the years ended December 31, 1998, 1997 and 1996
was $5.2 million, $3.9 million, and $4.5 million, respectively. Some leases
contain escalation clauses that correspond with increased real estate taxes,
other operating expenses and/or renewal options that call for increased
rents when the leases are renewed.
NOTE 14. OTHER OPERATING EXPENSES
The following table summarizes other operating expenses:
<TABLE>
<CAPTION>
=========================================================================================================================
Year ended December 31, (in thousands) 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Professional services $ 5,456 $ 3,587 $ 3,376
Advertising 5,276 1,537 1,088
Telephone 5,083 3,948 4,316
Travel and entertainment 3,397 1,989 1,885
Postage 3,141 1,812 2,119
Office supplies and printing 2,917 1,903 2,063
Software systems 2,580 1,501 1,669
Loan Processing Expense 2,547 1,136 1,873
Amortization of goodwill -- -- 2,090
Other 12,125 9,188 13,773
- -------------------------------------------------------------------------------------------------------------------------
Total other operating expenses $ 42,522 $ 26,601 $ 34,252
=========================================================================================================================
</TABLE>
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 37
<PAGE> 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15. INCOME TAXES
The Company files a consolidated federal income tax return with Fund
American. Federal income tax expense is provided substantially on a separate
return basis. As of December 31, 1998, the Company had recorded $53.8
million of deferred tax liability relating to accumulated unrealized gains
and equity in earnings of an investment in an unconsolidated affiliate. As
of December 31, 1997, this amount was $39.1 million, of which $13.9 million
was recorded as part of the initial exchange. The Company files state income
tax returns on a stand-alone basis.
The following table summarizes federal income taxes due from or (to) Fund
American:
<TABLE>
<CAPTION>
==============================================================================================
December 31, (in thousands) 1998 1997
- ----------------------------------------------------------------------------------------------
<S> <C> <C>
Net current taxes $ (9,164) $ 9,058
Net deferred taxes (32,549) (17,219)
==============================================================================================
</TABLE>
Total income tax expense (benefit) is as follows:
<TABLE>
<CAPTION>
==========================================================================================================================
Year ended December 31, (in thousands) 1998 1997 1996
<S> <C> <C> <C>
- --------------------------------------------------------------------------------------------------------------------------
Current income taxes:
Federal $ 18,222 $ (4,396) $ 17,280
State and local 1,079 1,352 144
Deferred expense (benefit) 4,942 (573) (7,971)
- --------------------------------------------------------------------------------------------------------------------------
Total income tax expense (benefit) $ 24,243 $ (3,617) $ 9,453
==========================================================================================================================
</TABLE>
The current federal income tax benefit for the year ended December 31, 1997,
as shown above, excludes a benefit of $3.2 million which relates to the
extraordinary loss on the repurchase and retirement of debt which has been
reported as an amount, net of tax, in the consolidated statement of income.
Deferred tax expense (benefit) for the years ended December 31, 1998, 1997
and 1996 represents the net change in the deferred tax asset or liability
during the year. Deferred income taxes arise from temporary differences
between the tax bases of assets and liabilities and their reported amounts
in the consolidated financial statements. The net deferred tax expense
(benefit) for the years ended December 31, 1998, 1997 and 1996, shown above,
excludes deferred tax expense of $10.4 million, $22.1 million and $.3
million, respectively. The 1998 and 1997 expenses are associated with
unrealized gains on the Company's investment in an unconsolidated affiliate
which were recorded directly to stockholders' equity, net of tax. The 1996
expense is associated with unrealized gains and losses on common equity
securities, which was recorded directly to stockholders' equity, net of tax.
The following table summarizes the types of temporary differences giving
rise to the net deferred tax assets and net deferred tax liabilities:
<TABLE>
<CAPTION>
=====================================================================================================================
December 31, (in thousands) 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
Deferred Deferred Deferred Deferred
Tax Tax Tax Tax
Assets Liabilities Assets Liabilities
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Purchase accounting adjustments $ -- $ 4,822 $ -- $ 5,520
Unrealized gain on investment in
unconsolidated affiliate (net) -- 46,391 -- 36,002
Equity in earnings of unconsolidated
affiliate -- 7,383 -- 3,095
Unrealized gain on financial instruments -- 4,254 -- 4,597
Capitalized servicing 21,097 -- 26,163 --
Allowance for loan losses 4,252 -- 4,803 --
Depreciation -- 2,259 -- 2,159
Deferred bi-weekly income 1,360 -- 969 --
Accrued postretirement benefits 1,300 -- 1,279 --
Other, net 12,038 7,487 7,921 6,981
- ---------------------------------------------------------------------------------------------------------------------
Total $ 40,047 $ 72,596 $ 41,135 $ 58,354
=====================================================================================================================
</TABLE>
38 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred
tax assets will not be realized. The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Based upon
the level of historical taxable income and projections for future taxable
income over the periods in which the deferred tax assets are deductible,
management believes it is more likely than not the Company will realize the
benefits of these deductible differences. Accordingly, no valuation
allowances have been provided as of December 31, 1998 and 1997.
A reconciliation of taxes, calculated using the federal statutory rate of
35%, to income tax expense (benefit) follows:
<TABLE>
<CAPTION>
=====================================================================================================================
Year ended December 31, (in thousands) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Tax expense (benefit) at federal statutory rate $ 24,553 $ (3,902) $ 1,795
Write-off of goodwill and other intangible assets -- -- 6,960
Purchase accounting adjustments -- -- 732
Dividends received deduction (1,230) (706) --
State taxes 701 879 94
Other, net 219 112 (128)
- ---------------------------------------------------------------------------------------------------------------------
Total income tax expense (benefit) $ 24,243 $ (3,617) $ 9,453
=====================================================================================================================
</TABLE>
NOTE 16. PENSION PLAN
The Company has a defined benefit pension plan covering most of its
employees. Benefits under the plan are based on years of service and the
employees' highest average compensation over five consecutive years in their
last ten years of employment. The Company's policy is to fund the pension
plan in amounts which comply with the minimum funding requirements specified
by the Employee Retirement Income Security Act. Plan assets primarily
consist of common stock and corporate bond mutual funds.
In the fourth quarter of 1997, the Company's Board of Directors approved
certain amendments to the Company's pension plan. The approved amendments
included the expansion of eligibility requirements for early retirement from
age 55 with ten years of service to the earlier of age 55 with ten years of
service or age 50 with fifteen years of service for retirements beginning on
or after January 1, 1997. In addition, the accrual rate for years of benefit
service was reduced from 1.6% to 1.2% for years of service credited on and
after January 1, 1998. The Company expects the net effect of these
amendments will be to reduce the future cost and funding requirements of the
plan.
The following table sets forth the change in the plan's projected benefit
obligation and plan assets and the plan's funded status:
<TABLE>
<CAPTION>
=====================================================================================================================
Year ended December 31, (in thousands) 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Benefit obligation at beginning of year $ 26,975 $ 23,724
Service cost 895 1,448
Interest cost 1,857 1,718
Amendments -- 645
Actuarial loss 1,206 60
Benefits paid (644) (620)
- ---------------------------------------------------------------------------------------------------------------------
Benefit obligation at end of year 30,289 26,975
- ---------------------------------------------------------------------------------------------------------------------
Fair value of plan assets at beginning of year 24,669 20,942
Actual return on plan assets 4,530 3,752
Employer contribution -- 595
Benefits paid (644) (620)
- ---------------------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of year 28,555 24,669
- ---------------------------------------------------------------------------------------------------------------------
Funded status 1,734 2,306
Unrecognized net gain 2,413 931
Unrecognized prior service cost 14 87
- ---------------------------------------------------------------------------------------------------------------------
Accrued pension cost included in accounts payable and other liabilities $ 4,161 $ 3,324
=====================================================================================================================
</TABLE>
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 39
<PAGE> 40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the components of net periodic pension cost is as follows:
<TABLE>
<CAPTION>
=======================================================================================================================
Year ended December 31, (in thousands) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost for benefits earned during the year $ 895 $ 1,448 $ 1,578
Interest cost on projected benefit obligation 1,857 1,718 1,633
Amortization of unrecognized transition obligation -- 11 45
Expected return on plan assets (1,842) (1,678) (1,382)
Amortization of unrecognized prior service cost (73) (139) (130)
Amortization of unrecognized net loss -- 27 361
- -----------------------------------------------------------------------------------------------------------------------
Net periodic pension cost $ 837 $ 1,387 $ 2,105
=======================================================================================================================
</TABLE>
Weighted-average assumptions used in the determination of the projected
benefit obligation were:
<TABLE>
<CAPTION>
=======================================================================================================================
December 31, 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Discount rate 6.75% 7.0% 7.25%
Rate of increase in compensation levels 4.5% 4.5% 5.0%
Expected long-term rate of return on assets 8.5% 8.5% 8.0%
=======================================================================================================================
</TABLE>
Note 17. POSTRETIREMENT BENEFITS
The Company has an unfunded postretirement benefit plan which provides for
postretirement health care and life insurance benefits. Postretirement life
insurance benefits are provided to substantially all employees.
Postretirement health care benefits are provided to substantially all
employees hired prior to January 1, 1991. The Company provides for term life
insurance coverage based on the employees' annual earnings and length of
service. Postretirement health care benefits are contributory, whereby the
Company provides for 87.5% of medical costs to retirees who retired prior to
January 1, 1993. Effective January 1, 1993, the plan was amended to provide
for a portion of monthly retiree medical costs, based on years of service,
to retirees who retire on or after January 1, 1993.
<TABLE>
<CAPTION>
=====================================================================================================================
Year ended December 31, (in thousands) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Benefit obligation at beginning of year $ 3,795 $ 3,410 $ 3,379
Service cost 78 94 110
Interest cost 268 256 239
Amendments -- 157 --
Actuarial loss/(gain) 180 52 (127)
Benefits paid (228) (174) (191)
- ---------------------------------------------------------------------------------------------------------------------
Benefit obligation at end of year 4,093 3,795 3,410
Plan assets at fair value -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Benefit obligation in excess of plan assets 4,093 3,795 3,410
Unrecognized prior service cost (139) (157) --
Unrecognized net (loss)/gain (166) 15 67
- ---------------------------------------------------------------------------------------------------------------------
Accrued postretirement cost included in accounts payable and
other liabilities $ 3,788 $ 3,653 $ 3,477
=====================================================================================================================
</TABLE>
A summary of the components of net periodic postretirement benefit cost is
as follows:
<TABLE>
<CAPTION>
=====================================================================================================================
Year ended December 31, (in thousands) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost $ 78 $ 94 $ 110
Interest cost 268 256 239
Amortization of unrecognized prior service cost 17 -- --
Net periodic postretirement cost $ 363 $ 350 $ 349
=====================================================================================================================
</TABLE>
A discount rate of 6.75% and 7.0% was used to determine the accumulated
postretirement benefit obligation as of December 31, 1998 and 1997,
respectively. An 8.2% annual rate of increase in the per capital costs of
covered health care benefits was assumed for 1999, gradually decreasing to
5.0% by the year 2007 and remaining at that level thereafter.
40 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A one-percent change in assumed health care cost trend rates would have the
following effects:
<TABLE>
<CAPTION>
================================================================================================================
Year ended December 31, 1998 1% increase 1% decrease
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Effect on total service and interest cost 4.21% (3.73%)
Effect on postretirement benefit obligation 4.88% (4.32%)
================================================================================================================
</TABLE>
NOTE 18. STOCK PLANS
Effective October 1, 1996, the Company amended its Employee Stock Ownership
Plan ("ESOP") to include employees of White Mountains as eligible employees
and to add an employee savings plan feature under Section 401(k) of the
Internal Revenue Code of 1986. Eligible employees may contribute to the plan
up to 14% of their salary not to exceed the maximum allowable under Internal
Revenue Service guidelines. Contributions are invested at the direction of
the employee in one or more funds or can be directed to purchase common
stock of Fund American at fair market value.
In the fourth quarter of 1997, the Company's Board of Directors approved
certain amendments to the Company's ESOP to be effective as of January 1,
1998. The most significant of the amendments provided for the Company's ESOP
contribution to be changed to a 401(k) matching contribution. The matching
contribution is equal to a certain percentage of employee contributions, up
to a maximum of 5%, which is dependent on the Company's annual return on
equity. In addition, the amendment provided for the transfer of all of the
participant accounts in the ESOP portion of the plan to the 401(k) portion
of the plan. This will allow the participants to direct the investment of
the Company's contributions among the various investment options.
The Company has long-term incentive plans which provide for the granting of
stock-based and cash incentive awards to key management employees of the
Company. Awards under the plans are payable upon the achievement of
specified financial goals covering overlapping three-year periods beginning
January 1, 1994, 1995, 1996, 1997, 1998 and 1999.
In 1998, the Company established an Incentive Compensation Plan ("ICP") for
certain key executives and directors of the Company. Under this plan,
participants were provided the opportunity to invest in simulated equity
shares of the Company. The value of the shares represents the calculated
fair value of the Company as defined by the plan which was equal to $42.783
per share at the time of issuance in May 1998. The Company issued
approximately 50,253 shares in exchange for cash proceeds of $2.2 million.
Concurrent with the purchase of each equity share, the participants were
granted five simulated equity options. The value of the options is equal to
the appreciation in the value of the equity shares over the strike price.
The initial strike price is equal to $42.783 per share and increases each
January 1 by 4% beginning in 1999. The Company issued approximately 251,267
options which vest over a three-year period beginning May 1, 1998. In
September 1998, the Company established a second Incentive Compensation Plan
("ICP II") for certain other key employees of the Company. Under this plan,
the Company issued approximately 31,900 options with an initial strike price
of $49.198 which vest over a three-year period beginning September 1, 1998.
The strike price increases each September 1, by 4% beginning in 1999. During
1998, the Company recognized compensation expense relating to these plans
totaling approximately $3.5 million. As of December 31, 1998, the Company's
accrued liability relating to these plans, including the initial investment
in simulated equity shares, was approximately $5.6 million.
NOTE 19. REPORTABLE SEGMENTS
The Company has determined that its reportable segments include Production
and Servicing. The Production segment originates and sells into the
secondary market a variety of residential loan products, including
conventional, government, subprime, manufactured housing, 203 (k) and high
LTV loans. The Servicing segment services conforming residential mortgage
loans and subservices residential mortgage loans for third parties.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. The Company accounts for any
intersegment activity as if it were with third parties, that is at estimated
market prices.
The Company determined its reportable segments based upon the organization
of information provided to its board of directors. Each segment is a
strategic business unit that offers either a product or a service. The
segments are managed separately because each requires different technology
and strategies.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 41
<PAGE> 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Segment information is provided for the year ended December 31, 1998 only.
During 1997, the Company experienced a fundamental reorganization and
redesigned its internal financial reporting methodologies for information
that is provided to its board of directors. Consequently, comparative
information is not available.
<TABLE>
<CAPTION>
=====================================================================================================================
Year ended December 31, 1998 (in thousands)
- ---------------------------------------------------------------------------------------------------------------------
Production Servicing Other (a) Total
---------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues from external customers $ 124,758 $ 79,557 $ 7,893 (b) $ 212,208
Intersegment revenues (2,614) 2,614 -- --
Interest revenue 65,418 13,341 2,537 81,296
Interest expense (54,138) (8,578) (9,085) (71,801)
Depreciation expense (1,268) (443) (1,376) (3,087)
Other significant non-cash items:
OMSR income 72,597 -- -- 72,597
Amortization of capitalized servicing -- (55,179) -- (55,179)
Segment profit 42,588 22,054 (15,902) 48,740
Segment Assets (c) 676,317 334,640 211,593 1,222,550
=====================================================================================================================
</TABLE>
(a) Primarily represents unallocated overhead.
(b) Primarily represents unallocated net gain on sale of pool loan purchases and
loans held for investment and gain on sale of servicing.
(c) Management does not typically review segment assets information. The only
segment assets reviewed or monitored by management are mortgage loans
receivable, pool loan purchases and capitalized servicing. `Other' segment
assets include all other mortgage-banking related assets.
The following reconciles the above table to the amounts shown on the
consolidated financial statements as of and for the year ended December 31,
1998:
<TABLE>
<CAPTION>
=====================================================================================================================
(in thousands)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C>
Revenue:
External revenues for reportable segments $ 212,208
Interest revenue for reportable segments 81,296
Interest expense for reportable segments (71,801)
Adjustments to revenue
Amortization of capitalized servicing (55,179)
Net gain on financial instruments 20,431
Non mortgage-banking-related revenues 21,413 (a)
- ---------------------------------------------------------------------------------------------------------------------
Total revenue $ 208,368 (b)
- ---------------------------------------------------------------------------------------------------------------------
Interest revenue:
Interest revenue for reportable segments $ 81,296
Interest revenue from non mortgage-banking-related investments 4,097 (a)
- ---------------------------------------------------------------------------------------------------------------------
Total interest revenue $ 85,393
- ---------------------------------------------------------------------------------------------------------------------
Interest expense:
Interest expense for reportable segments $ (71,801)
Interest expense and capital charges allocated to segments (c) 1,600
- ---------------------------------------------------------------------------------------------------------------------
Total interest expense $ (70,201)
- ---------------------------------------------------------------------------------------------------------------------
Income before income taxes:
Income before income taxes for reportable segments $ 48,740
Non mortgage-banking-related income before income taxes 21,413 (a)
- ---------------------------------------------------------------------------------------------------------------------
Total income before income taxes $ 70,153
- ---------------------------------------------------------------------------------------------------------------------
Total assets:
Total assets for reportable segments $ 1,222,550
Non mortgage-banking-related assets 295,427 (a)
- ---------------------------------------------------------------------------------------------------------------------
Total assets $ 1,517,977
=====================================================================================================================
</TABLE>
(a) Relates to the Company's investment in unconsolidated affiliate and other
investments.
(b) Approximately 48% of the Company's total consolidated revenue is generated
from sales of loans to GNMA, FNMA and FHLMC and the related servicing of
those loans.
(c) Represents allocated interest expense and capital charges related to the
Company's investment in unconsolidated affiliate and other investments.
42 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20. CONTINGENCIES
Various claims have been made against the Company in the ordinary course of
business. Management believes that any liabilities which could result would
not materially affect the Company's financial position or results of
operations.
NOTE 21. RELATED-PARTY TRANSACTIONS
As discussed in Notes 4 and 9, the Company had various related-party
transactions with Fund American and White Mountains. The Company also has a
tax allocation agreement with Fund American.
The Company believes that all of the above transactions were on terms that
were reasonable and competitive. Additional transactions of this nature may
be expected to take place in the ordinary course of business in the future.
NOTE 22. 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>
=================================================================================================================
Year ended December 31, (in thousands) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest paid $ 80,502 $ 44,809 $ 57,172
- -----------------------------------------------------------------------------------------------------------------
Income taxes paid $ 650 $ 8,268 $ 18,650
- -----------------------------------------------------------------------------------------------------------------
Noncash investing and financing activities:
Exchange of common equity securities for
shares of common stock from parent (Note 4) $ -- $ 2,638 $ --
Receivable from sale of servicing rights 73,825 27,324 --
Capital contribution from parent in exchange for
investment in unconsolidated affiliate (Note 2) -- 106,365 --
Acquisition of common equity securities as a return
of partnership investment, net (Note 4) -- -- 2,312
=================================================================================================================
</TABLE>
NOTE 23. SUBSEQUENT EVENTS
In January 1999, the Company repurchased and retired $8.0 million of its 9%
debentures due 2012. As a result, the Company recognized a $.3 million
pretax loss on the repurchase and retirement of debt.
During the first quarter of 1999, the Company declared and paid dividends
on its common stock totaling $11.9 million.
In late March 1999, the Company and Citicorp Mortgage, Inc. ("Citicorp")
reached a definitive agreement under which Citicorp will acquire
substantially all of the mortgage-banking-related assets and assume certain
liabilities of the Company. In addition, Citicorp will employ substantially
all of the Company's employees. The transaction is contingent upon the
receipt of various regulatory and agency approvals.
Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report 43
<PAGE> 44
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Selected quarterly financial data for 1998 and 1997 is shown in the
following table. The quarterly financial data includes, in the opinion of
management, all necessary recurring adjustments for a fair presentation of
the results of operations for the interim periods.
<TABLE>
<CAPTION>
====================================================================================================================================
Quarters Ended March June September December
(in thousands, except for per share amounts) 31 30 30 31
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998
Total revenue $ 47,997 $ 49,783 $ 50,876 $ 59,712
Net income 13,120 10,492 9,978 12,320 (b)
Comprehensive income (loss) 31,146 22,475 (17,699) 29,282
- ------------------------------------------------------------------------------------------------------------------------------------
Basic net income per common share (a) $ 3.80 $ 2.98 $ 2.82 $ 3.55
Basic comprehensive income (loss) per common share (a) 9.41 6.71 (5.80) 8.83
- ------------------------------------------------------------------------------------------------------------------------------------
1997
Total revenue $ 24,752 $ 17,179 (c) $ 23,385 $ 24,677
Income (loss) before extraordinary loss 187 (6,291)(c) 1,088 (2,514)(d)
Extraordinary loss -- (5,975) -- --
Net income (loss) 187 (12,266)(c) 1,088 (2,514)(d)
Comprehensive (loss) income (120) 1,154 (c) 23,504 3,059 (d)
- ------------------------------------------------------------------------------------------------------------------------------------
Basic net (loss) income per common share
before extraordinary loss (a) $ (.33) $ (2.25) $ .05 $ (1.07)
Extraordinary loss per common share -- (1.86) -- --
Basic net (loss) income per common share (a) (.33) (4.11) .05 (1.07)
Basic comprehensive (loss) income per common share (a) (.47) .07 7.03 .66
====================================================================================================================================
</TABLE>
(a) After deducting dividends on preferred stock.
(b) Includes approximately $2.6 million of pretax income primarily related to
adjustments to servicing sales prior to the fourth quarter of 1998.
(c) Includes a $3.0 million pretax write-down of loans held for investment, $1.7
million of pretax restructuring charges and a $1.1 million pretax loss on
the February 1997 servicing sale and related assumption of subservicing.
(d) Includes a $3.7 pretax million loss related to the February 1997 servicing
sale and related assumption of subservicing and $1.4 million pretax of
various one-time charges.
44 Source One Mortgage Services Corporation and Subsidiaries 1998 Annual Report
<PAGE> 45
BOARD OF DIRECTORS
Michael C. Allemang
Executive Vice President and Chief Financial Officer
Source One Mortgage Services Corporation
Raymond Barrette
Executive Vice President and Chief Financial Officer
Fund American Enterprises Holdings, Inc.
Terry L. Baxter*
President
White Mountains Holdings, Inc.
Robert R. Densmore
Executive Vice President
Source One Mortgage Services Corporation
Mark A. Janssen
Executive Vice President and Secretary
Source One Mortgage Services Corporation
Francis X. Mohan*
President and Chief Executive Officer
Source One Mortgage Services Corporation
James H. Ozanne*
Chairman
Source One Mortgage Services Corporation
Roger K. Taylor
President and Chief Operating Officer
Financial Security Assurance Holdings Ltd.
*Member of the Executive Committee of the Board
SENIOR OFFICERS
Francis X. Mohan
President and Chief Executive Officer
Michael C. Allemang
Executive Vice President and Chief Financial Officer
Robert R. Densmore
Executive Vice President
Servicing
Mark A. Janssen
Executive Vice President - Production & Capital Markets
and Secretary
Susan L. Bowen
Senior Vice President
Production Division
Melinda F. Cain
Senior Vice President
Capital Markets
John J. Cleary
Senior Vice President
Loan Administration
Kathleen M. DeFrances
Senior Vice President
Residential Division
Gregory J. Ghilardi
Senior Vice President
Human Resources
Patrick D. Gillies
Senior Vice President
Delinquency Administration
Thomas J. Marshall
Senior Vice President
Risk Management
Michael E. Muldoon
Senior Vice President
Subprime Servicing
Pablo Sanchez, Jr.
Senior Vice President
Subprime Division
Charles D. Taylor
Senior Vice President
Information Services
Central Pacific Mortgage Company
John A. Courson
President and Chief Executive Officer
[SOURCE ONE LOGO]
27555 Farmington Road
Farmington Hills, Michigan 48334-3357
(248) 488-7000
www.somsc.com
<PAGE> 1
EXHIBIT 13(b)
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Source One Mortgage Services Corporation
We have audited the consolidated statements of income, comprehensive income,
stockholders' equity, and cash flows of Source One Mortgage Services Corporation
and subsidiaries (the Company) for the year ended December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of operations and cash flows of
Source One Mortgage Services Corporation and subsidiaries for the year ended
December 31, 1996, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Detroit, Michigan
January 30, 1997,
except for Notes 7 and 22,
as to which the date is
March 21, 1997
<PAGE> 1
EXHIBIT 23(a)
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Source One Mortgage Services Corporation
We consent to incorporation by reference in this Annual Report on Form 10-K of
Source One Mortgage Services Corporation of our report dated February 12, 1999,
except, for note 23, as to which the date is March 29, 1999, relating to the
consolidated statements of condition of Source One Mortgage Services Corporation
and subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of income, comprehensive income, stockholders' equity, and cash flows
for each of the years then ended, which report appears in the December 31, 1998
Annual Report to Shareholders of Source One Mortgage Services Corporation.
We consent to incorporation by reference in the registration statement (No.
33-47025) on Form S-3, the registration statement (No. 33-71924) on Form S-3 and
the registration statement (No. 33-62765) on Form S-4 of Source One Mortgage
Services Corporation, and in the related Prospectuses, of our report dated
February 12, 1999, except for note 23, as to which the date is March 29, 1999,
relating to the consolidated statements of condition of Source One Mortgage
Services Corporation and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of income, comprehensive income, stockholders'
equity, and cash flows for each of the years then ended, which report is
incorporated by reference in the December 31, 1998, Annual Report on Form 10-K
of Source One Mortgage Services Corporation.
/s/ KPMG LLP
Detroit, Michigan
March 29, 1999
<PAGE> 1
EXHIBIT 23(b)
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in (1) the Registration Statement
(Form S-3, No. 33-47025) pertaining to the Source One Mortgage Services
Corporation Medium Term Notes Series B; (2) the Registration Statement (Form
S-3, No. 33-71924) pertaining to the Source One Mortgage Services Corporation
Series A Preferred Stock; (3) the Registration Statement (Form S-4, No.
33-62765) pertaining to the Source One Mortgage Services Corporation Quarterly
Income Capital Securities ("QUICS") of our report dated January 30, 1997,
(except for Notes 7 and 22, as to which the date is March 21, 1997), with
respect to the consolidated financial statements of Source One Mortgage Services
Corporation incorporated by reference in the Annual Report (Form 10-K) of Source
One Mortgage Services Corporation for the year ended December 31, 1998.
/s/ Ernst & Young LLP
Detroit, Michigan
March 29, 1999
<PAGE> 1
EXHIBIT 23(c)
CONSENT OF INDEPENDENT AUDITORS
We consent to incorporation by reference (from the 1998 Annual Report on Form
10-K filed by Financial Security Assurance Holdings Ltd. ("FSA") - in which
filing our report was incorporated by reference from FSA's Annual Report to
Shareholders) in the Registration Statements, as amended, pertaining to
Medium-Term Notes Series B (Form S-3, No. 33-47025), Series A Preferred Stock
(Form S-3, No. 33-71924) and Quarterly Income Capital Securities ("QUICS") (Form
S-4, No. 33-62765) of Source One Mortgage Services Corporation of our report
dated January 26, 1999 with respect to the consolidated financial statements of
Financial Security Assurance Holdings, Ltd. And Subsidiaries as of December 31,
1998 and 1997 and for each of the three years in the period ended December 31,
1998.
/s/ PricewaterhouseCoopers LLP
New York, New York
March 29, 1999
<PAGE> 1
EXHIBIT 24
SOURCE ONE MORTGAGE SERVICES CORPORATION
KNOW ALL MEN by these presents that Michael C. Allemang does hereby
make, constitute and appoint Mark A. Janssen, Robert R. Densmore, and Francis X.
Mohan, and each of them, the true and lawful attorney-in-fact of the
undersigned, with full power of substitution and revocation, for and in the
name, place and stead of the undersigned, to execute and deliver the Annual
Report on Form 10-K of Source One Mortgage Services Corporation for the year
ended December 31, 1998, and any and all amendments thereto; such Form 10-K and
each such amendment to be in such form and to contain such terms and provisions
as said attorney or substitute shall deem necessary or desirable; giving and
granting unto said attorney, or to such person or persons as in any case may be
appointed pursuant to the power of substitution herein given, full power and
authority to do and perform any and every act and thing whatsoever requisite,
necessary or, in the opinion of said attorney or substitute, able to be done in
and about the premises as fully and to all intents and purposes as the
undersigned might or could do if personally present, hereby ratifying and
confirming all that said attorney for such substitute shall lawfully do or cause
to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument
as of the 29th day of March, 1999.
/s/ Michael C. Allemang
------------------------------------
Michael C. Allemang
<PAGE> 2
EXHIBIT 24
SOURCE ONE MORTGAGE SERVICES CORPORATION
KNOW ALL MEN by these presents that Raymond Barrette does hereby make,
constitute and appoint Mark A. Janssen, Michael C. Allemang, and Robert R.
Densmore, and each of them, the true and lawful attorney-in-fact of the
undersigned, with full power of substitution and revocation, for and in the
name, place and stead of the undersigned, to execute and deliver the Annual
Report on Form 10-K of Source One Mortgage Services Corporation for the year
ended December 31, 1998, and any and all amendments thereto; such Form 10-K and
each such amendment to be in such form and to contain such terms and provisions
as said attorney or substitute shall deem necessary or desirable; giving and
granting unto said attorney, or to such person or persons as in any case may be
appointed pursuant to the power of substitution herein given, full power and
authority to do and perform any and every act and thing whatsoever requisite,
necessary or, in the opinion of said attorney or substitute, able to be done in
and about the premises as fully and to all intents and purposes as the
undersigned might or could do if personally present, hereby ratifying and
confirming all that said attorney for such substitute shall lawfully do or cause
to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument
as of the 29th day of March, 1999.
/s/ Raymond Barrette
--------------------------------------
Raymond Barrette
<PAGE> 3
EXHIBIT 24
SOURCE ONE MORTGAGE SERVICES CORPORATION
KNOW ALL MEN by these presents that Terry L. Baxter does hereby make,
constitute and appoint Mark A. Janssen, Michael C. Allemang, and Robert R.
Densmore, and each of them, the true and lawful attorney-in-fact of the
undersigned, with full power of substitution and revocation, for and in the
name, place and stead of the undersigned, to execute and deliver the Annual
Report on Form 10-K of Source One Mortgage Services Corporation for the year
ended December 31, 1998, and any and all amendments thereto; such Form 10-K and
each such amendment to be in such form and to contain such terms and provisions
as said attorney or substitute shall deem necessary or desirable; giving and
granting unto said attorney, or to such person or persons as in any case may be
appointed pursuant to the power of substitution herein given, full power and
authority to do and perform any and every act and thing whatsoever requisite,
necessary or, in the opinion of said attorney or substitute, able to be done in
and about the premises as fully and to all intents and purposes as the
undersigned might or could do if personally present, hereby ratifying and
confirming all that said attorney for such substitute shall lawfully do or cause
to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument
as of the 29th day of March, 1999.
/s/ Terry L. Baxter
-----------------------------
Terry L. Baxter
<PAGE> 4
EXHIBIT 24
SOURCE ONE MORTGAGE SERVICES CORPORATION
KNOW ALL MEN by these presents that Robert R. Densmore does hereby
make, constitute and appoint Mark A. Janssen, Michael C. Allemang, and Francis
X. Mohan, and each of them, the true and lawful attorney-in-fact of the
undersigned, with full power of substitution and revocation, for and in the
name, place and stead of the undersigned, to execute and deliver the Annual
Report on Form 10-K of Source One Mortgage Services Corporation for the year
ended December 31, 1998, and any and all amendments thereto; such Form 10-K and
each such amendment to be in such form and to contain such terms and provisions
as said attorney or substitute shall deem necessary or desirable; giving and
granting unto said attorney, or to such person or persons as in any case may be
appointed pursuant to the power of substitution herein given, full power and
authority to do and perform any and every act and thing whatsoever requisite,
necessary or, in the opinion of said attorney or substitute, able to be done in
and about the premises as fully and to all intents and purposes as the
undersigned might or could do if personally present, hereby ratifying and
confirming all that said attorney for such substitute shall lawfully do or cause
to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument
as of the 29th day of March, 1999.
/s/ Robert R. Densmore
----------------------------------------
Robert R. Densmore
<PAGE> 5
EXHIBIT 24
SOURCE ONE MORTGAGE SERVICES CORPORATION
KNOW ALL MEN by these presents that Mark A. Janssen does hereby make,
constitute and appoint Michael C. Allemang, Robert R. Densmore and Francis X.
Mohan, and each of them, the true and lawful attorney-in-fact of the
undersigned, with full power of substitution and revocation, for and in the
name, place and stead of the undersigned, to execute and deliver the Annual
Report on Form 10-K of Source One Mortgage Services Corporation for the year
ended December 31, 1998, and any and all amendments thereto; such Form 10-K and
each such amendment to be in such form and to contain such terms and provisions
as said attorney or substitute shall deem necessary or desirable; giving and
granting unto said attorney, or to such person or persons as in any case may be
appointed pursuant to the power of substitution herein given, full power and
authority to do and perform any and every act and thing whatsoever requisite,
necessary or, in the opinion of said attorney or substitute, able to be done in
and about the premises as fully and to all intents and purposes as the
undersigned might or could do if personally present, hereby ratifying and
confirming all that said attorney for such substitute shall lawfully do or cause
to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument
as of the 29th day of March, 1999.
/s/ Mark A. Janssen
--------------------------------------
Mark A. Janssen
<PAGE> 6
EXHIBIT 24
SOURCE ONE MORTGAGE SERVICES CORPORATION
KNOW ALL MEN by these presents that Francis X. Mohan does hereby make,
constitute and appoint Mark A. Janssen, Michael C. Allemang, and Robert R.
Densmore, and each of them, the true and lawful attorney-in-fact of the
undersigned, with full power of substitution and revocation, for and in the
name, place and stead of the undersigned, to execute and deliver the Annual
Report on Form 10-K of Source One Mortgage Services Corporation for the year
ended December 31, 1998, and any and all amendments thereto; such Form 10-K and
each such amendment to be in such form and to contain such terms and provisions
as said attorney or substitute shall deem necessary or desirable; giving and
granting unto said attorney, or to such person or persons as in any case may be
appointed pursuant to the power of substitution herein given, full power and
authority to do and perform any and every act and thing whatsoever requisite,
necessary or, in the opinion of said attorney or substitute, able to be done in
and about the premises as fully and to all intents and purposes as the
undersigned might or could do if personally present, hereby ratifying and
confirming all that said attorney for such substitute shall lawfully do or cause
to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument
as of the 29th day of March, 1999.
/s/ Francis X. Mohan
------------------------------------
Francis X. Mohan
<PAGE> 7
EXHIBIT 24
SOURCE ONE MORTGAGE SERVICES CORPORATION
KNOW ALL MEN by these presents that James H. Ozanne does hereby make,
constitute and appoint Mark A. Janssen, Michael C. Allemang, and Robert R.
Densmore, and each of them, the true and lawful attorney-in-fact of the
undersigned, with full power of substitution and revocation, for and in the
name, place and stead of the undersigned, to execute and deliver the Annual
Report on Form 10-K of Source One Mortgage Services Corporation for the year
ended December 31, 1998, and any and all amendments thereto; such Form 10-K and
each such amendment to be in such form and to contain such terms and provisions
as said attorney or substitute shall deem necessary or desirable; giving and
granting unto said attorney, or to such person or persons as in any case may be
appointed pursuant to the power of substitution herein given, full power and
authority to do and perform any and every act and thing whatsoever requisite,
necessary or, in the opinion of said attorney or substitute, able to be done in
and about the premises as fully and to all intents and purposes as the
undersigned might or could do if personally present, hereby ratifying and
confirming all that said attorney for such substitute shall lawfully do or cause
to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument
as of the 29th day of March, 1999.
/s/ James H. Ozanne
------------------------------------
James H. Ozanne
<PAGE> 8
EXHIBIT 24
SOURCE ONE MORTGAGE SERVICES CORPORATION
KNOW ALL MEN by these presents that Roger K. Taylor does hereby make,
constitute and appoint Mark A. Janssen, Michael C. Allemang, and Robert R.
Densmore, and each of them, the true and lawful attorney-in-fact of the
undersigned, with full power of substitution and revocation, for and in the
name, place and stead of the undersigned, to execute and deliver the Annual
Report on Form 10-K of Source One Mortgage Services Corporation for the year
ended December 31, 1998, and any and all amendments thereto; such Form 10-K and
each such amendment to be in such form and to contain such terms and provisions
as said attorney or substitute shall deem necessary or desirable; giving and
granting unto said attorney, or to such person or persons as in any case may be
appointed pursuant to the power of substitution herein given, full power and
authority to do and perform any and every act and thing whatsoever requisite,
necessary or, in the opinion of said attorney or substitute, able to be done in
and about the premises as fully and to all intents and purposes as the
undersigned might or could do if personally present, hereby ratifying and
confirming all that said attorney for such substitute shall lawfully do or cause
to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument
as of the 29th day of March, 1999.
/s/ Roger K. Taylor
----------------------------------------
Roger K. Taylor
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 16,410
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 23,303
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,517,977
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
18
<COMMON> 32
<OTHER-SE> 412,463
<TOTAL-LIABILITY-AND-EQUITY> 1,517,977
<SALES> 0
<TOTAL-REVENUES> 208,368
<CGS> 0
<TOTAL-COSTS> 138,215
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 3,820
<INTEREST-EXPENSE> 70,201
<INCOME-PRETAX> 70,153
<INCOME-TAX> 24,243
<INCOME-CONTINUING> 45,910
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 45,910
<EPS-PRIMARY> 13.14
<EPS-DILUTED> 0
</TABLE>
<PAGE> 1
EXHIBIT 99
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
<TABLE>
<CAPTION>
PAGE
-------------
<S> <C>
A. 1998 YEAR END FINANCIAL STATEMENTS
Report of Independent Accountants.............................................................. F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997................................... F-3
Consolidated Statements of Income for the Years Ended December 31, 1998, 1997 and 1996......... F-4
Consolidated Statements of Changes in Shareholder's Equity for the Years Ended December 31,
1998, 1997 and 1996.......................................................................... F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996..... F-6-F-7
Notes to Consolidated Financial Statements for the Years Ended December 31, 1998, 1997 and
1996......................................................................................... F-8-F-27
</TABLE>
The New York State Insurance Department recognizes only statutory accounting
practices for determining and reporting the financial condition and results of
operations of an insurance company, for determining its solvency under the New
York Insurance Law, and for determining whether its financial condition warrants
the payment of a dividend to its stockholders. No consideration is given by the
New York State Insurance Department to financial statements prepared in
accordance with generally accepted accounting principles in making such
determinations.
F-1
<PAGE> 2
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholder and Board of Directors
of Financial Security Assurance Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, changes in shareholder's equity, and cash
flows present fairly, in all material respects, the financial position of
Financial Security Assurance Inc. and Subsidiaries (the Company) at December 31,
1998 and 1997, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
New York, New York
January 26, 1999
F-2
<PAGE> 3
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Bonds at market value (amortized cost of $1,631,094 and $1,192,771).................. $1,683,928 $1,235,441
Equity investments at market value (cost of $34,250 and $20,405)..................... 37,268 20,762
Short-term investments............................................................... 92,241 103,926
------------ ------------
Total investments................................................................ 1,813,437 1,360,129
Cash................................................................................. 2,729 11,235
Deferred acquisition costs........................................................... 199,559 171,098
Prepaid reinsurance premiums......................................................... 217,096 173,123
Reinsurance recoverable on unpaid losses............................................. 3,907 30,618
Receivable for securities sold....................................................... 1,656 20,535
Other assets......................................................................... 105,379 72,901
------------ ------------
TOTAL ASSETS................................................................... $2,343,763 $1,839,639
========== ==========
LIABILITIES AND MINORITY INTEREST AND SHAREHOLDER'S EQUITY
Deferred premium revenue............................................................. $ 721,699 $ 595,196
Losses and loss adjustment expenses.................................................. 63,947 75,417
Deferred federal income taxes........................................................ 56,672 59,867
Ceded reinsurance balances payable................................................... 31,502 11,199
Payable for securities purchased..................................................... 105,749 72,979
Long-term debt....................................................................... 120,000 50,000
Minority interest.................................................................... 20,388
Accrued expenses and other liabilities............................................... 119,215 77,121
------------ ------------
TOTAL LIABILITIES AND MINORITY INTEREST........................................ 1,239,172 941,779
------------ ------------
COMMITMENTS AND CONTINGENCIES
Common stock (500 and 528 shares authorized, issued and outstanding; par value of
$30,000 and $28,391 per share)..................................................... 15,000 15,000
Additional paid-in capital........................................................... 694,788 617,870
Accumulated other comprehensive income (net of deferred income tax provision of
$19,904 and $15,059)............................................................... 36,964 27,968
Accumulated earnings................................................................. 357,839 237,022
------------ ------------
TOTAL SHAREHOLDER'S EQUITY..................................................... 1,104,591 897,860
------------ ------------
TOTAL LIABILITIES AND MINORITY INTEREST AND SHAREHOLDER'S EQUITY............... $2,343,763 $1,839,639
========== ==========
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
F-3
<PAGE> 4
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
REVENUES:
Net premiums written....................................................... $ 219,853 $ 172,878 $ 121,000
Increase in deferred premium revenue....................................... (81,926) (63,367) (30,552)
---------- ---------- ----------
Premiums earned............................................................ 137,927 109,511 90,448
Net investment income...................................................... 76,023 69,643 62,728
Net realized gains......................................................... 21,667 6,023 1,851
Other income............................................................... 381 10,774 502
---------- ---------- ----------
TOTAL REVENUES......................................................... 235,998 195,951 155,529
---------- ---------- ----------
EXPENSES:
Losses and loss adjustment expenses........................................ 3,949 9,156 6,874
Policy acquisition costs................................................... 35,439 27,962 23,829
Other operating expenses................................................... 28,502 20,717 14,852
---------- ---------- ----------
TOTAL EXPENSES......................................................... 67,890 57,835 45,555
---------- ---------- ----------
Minority interest............................................................ (388)
----------
INCOME BEFORE INCOME TAXES................................................... 167,720 138,116 109,974
---------- ---------- ----------
Provision (benefit) for income taxes:
Current.................................................................... 54,942 29,832 28,208
Deferred................................................................... (8,039) 8,025 911
---------- ---------- ----------
Total provision............................................................ 46,903 37,857 29,119
---------- ---------- ----------
NET INCOME............................................................... 120,817 100,259 80,855
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period (net of deferred
income tax provision (benefit) of $12,428, $12,268 and $(5,057))....... 23,080 22,784 (9,392)
Less: reclassification adjustment for gains included in net income (net
of deferred income tax provision of $7,583, $2,108
and $648).............................................................. (14,084) (3,915) (1,203)
---------- ---------- ----------
Other comprehensive income (loss)........................................ 8,996 18,869 (10,595)
---------- ---------- ----------
COMPREHENSIVE INCOME....................................................... $ 129,813 $ 119,128 $ 70,260
========== ========== ==========
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
F-4
<PAGE> 5
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
UNREALIZED
ADDITIONAL GAIN (LOSS)
COMMON PAID-IN ON RETAINED
STOCK CAPITAL INVESTMENTS EARNINGS TOTAL
--------- ---------- ------------- ---------- ------------
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995....................... $ 15,000 $ 681,470 $ 19,694 $ 73,822 $ 789,986
Net income....................................... 80,855 80,855
Dividends paid on common stock................... (18,000) (18,000)
Net change in accumulated comprehensive income
(net of deferred income tax benefit of
$5,705)........................................ (10,595) (10,595)
Stock repurchase................................. (27,000) (27,000)
Adjustment to prior-year disposal of
subsidiary..................................... 86 86
--------- ---------- ------------- ---------- ------------
BALANCE, December 31, 1996....................... 15,000 654,470 9,099 136,763 815,332
Net income....................................... 100,259 100,259
Net change in accumulated comprehensive income
(net of deferred income taxes of $10,160)...... 18,869 18,869
Stock repurchase................................. (39,500) (39,500)
Deferred equity payout by Parent................. 2,900 2,900
--------- ---------- ------------- ---------- ------------
BALANCE, December 31, 1997....................... 15,000 617,870 27,968 237,022 897,860
Net income....................................... 120,817 120,817
Net change in accumulated comprehensive income
(net of deferred income taxes
of $4,844)..................................... 8,996 8,996
Stock repurchase................................. (8,500) (8,500)
Capital contribution from Parent................. 80,000 80,000
Deferred equity payout by Parent................. 5,418 5,418
--------- ---------- ------------- ---------- ------------
BALANCE, December 31, 1998....................... $ 15,000 $ 694,788 $ 36,964 $ 357,839 $ 1,104,591
========= ========== =========== ========== ============
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
F-5
<PAGE> 6
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Premiums received, net................................................. $ 247,229 $ 171,145 $ 124,540
Policy acquisition and other operating expenses paid, net.............. (81,559) (50,046) (49,261)
Recoverable advances received (paid)................................... 1,473 (7,629) 10,213
Losses and loss adjustment expenses recovered (paid)................... 10,989 (6,463) (15,473)
Net investment income received......................................... 67,268 63,207 59,923
Federal income taxes paid.............................................. (52,210) (27,080) (33,297)
Interest paid.......................................................... (22)
Other.................................................................. (877) 2,142 1,330
----------- ----------- -----------
Net cash provided by operating activities............................ 192,313 145,276 97,953
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds........................................... 1,735,585 1,071,845 1,095,929
Proceeds from sales of equity investments.............................. 22,571 3,568
Proceeds from maturities of bonds...................................... 32,468 2,965
Purchases of bonds..................................................... (2,098,264) (1,196,117) (1,139,129)
Purchases of equity investments........................................ (37,034) (24,662)
Gain on sale of subidiaries............................................ 9,486
Purchases of property and equipment.................................... (1,071) (2,985) (2,081)
Net decrease (increase) in short-term investments...................... 15,857 (45,661) (3,675)
Other investments...................................................... 20,037
----------- ----------- -----------
Net cash provided by (used for) investing activities................. (342,319) (152,058) (45,991)
----------- ----------- -----------
Cash flows from financing activities:
Stock repurchase....................................................... (8,500) (39,500) (27,000)
Surplus notes issued................................................... 70,000 50,000
Capital contribution................................................... 80,000
Dividends paid......................................................... (18,000)
----------- ----------- -----------
Net cash provided by (used for) financing activities................. 141,500 10,500 (45,000)
----------- ----------- -----------
Net increase (decrease) in cash.......................................... (8,506) 3,718 6,962
Cash at beginning of year................................................ 11,235 7,517 555
----------- ----------- -----------
Cash at end of year...................................................... $ 2,729 $ 11,235 $ 7,517
=========== =========== ===========
</TABLE>
F-6
<PAGE> 7
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Reconciliation of net income to net cash flows from operating activities:
Net income............................................................... $ 120,817 $ 100,259 $ 80,855
Increase in accrued investment income.................................. (3,939) (1,811) (842)
Increase in deferred premium revenue and related foreign exchange
adjustment........................................................... 82,530 62,101 29,622
Increase in deferred acquisition costs................................. (28,461) (24,865) (13,282)
Increase (decrease) in current federal income taxes payable............ 2,732 (519) (5,090)
Increase (decrease) in unpaid losses and loss adjustment expenses...... 15,240 2,596 (8,023)
Increase in amounts withheld for others................................ 81 133 52
Provision (benefit) for deferred income taxes.......................... (8,039) 11,296 911
Net realized gains on investments...................................... (21,667) (6,023) (1,851)
Depreciation and accretion of bond discount............................ (3,540) (1,736) (1,616)
Gain on sale of subsidiaries........................................... (9,486)
Minority interest...................................................... 388
Change in other assets and liabilities................................. 36,171 13,331 17,217
----------- ----------- -----------
Cash provided by operating activities.................................... $ 192,313 $ 145,276 $ 97,953
=========== =========== ===========
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
F-7
<PAGE> 8
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. ORGANIZATION AND OWNERSHIP
Financial Security Assurance Inc. (the Company), an indirect wholly owned
subsidiary of Financial Security Assurance Holdings Ltd. (the Parent), is an
insurance company domiciled in the State of New York. The Company is engaged in
providing financial guaranty insurance on asset-backed and municipal
obligations. The Company's underwriting policy is to insure asset-backed and
municipal obligations that it determines would be of investment-grade quality
without the benefit of the Company's insurance. The asset-backed obligations
insured by the Company are generally issued in structured transactions and are
backed by pools of assets such as residential mortgage loans, consumer or trade
receivables, securities or other assets having an ascertainable cash flow or
market value. The municipal obligations insured by the Company consist primarily
of general obligation bonds that are supported by the issuers' taxing power and
special revenue bonds and other special obligations of states and local
governments that are supported by the issuers' ability to impose and collect
fees and charges for public services or specific projects. Financial guaranty
insurance written by the Company guarantees scheduled payments on an issuer's
obligation. In the case of a payment default on an insured obligation, the
Company is generally required to pay the principal, interest or other amounts
due in accordance with the obligation's original payment schedule or, at its
option, to pay such amounts on an accelerated basis.
The Company expects to continue to emphasize a diversified insured portfolio
characterized by insurance of both asset-backed and municipal obligations, with
a broad geographic distribution and a variety of revenue sources and transaction
structures. The Company's insured portfolio consists primarily of asset-backed
and municipal obligations originated in the United States, but the Company has
also written and continues to pursue business in Europe and the Asia Pacific
region.
At December 31, 1996, the Parent was owned 40.4% by U S WEST Capital
Corporation (U S WEST), 11.5% by Fund American Enterprises Holdings, Inc. (Fund
American), 6.4% by The Tokio Marine and Fire Insurance Co., Ltd. (Tokio Marine)
and 41.7% by the public and employees. At December 31, 1997, the Parent was
owned 42.1% by U S WEST, 12.0% by Fund American, 6.7% by Tokio Marine and 39.2%
by the public and employees. At December 31, 1998, the Parent was owned 40.5% by
MediaOne Capital Corporation (MediaOne), formerly U S WEST, 11.6% by Fund
American, 6.4% by Tokio Marine, 5.5% by XL Capital Ltd (XL) and 36.0% by the
public and employees.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles (GAAP), which differ in certain
material respects from the accounting practices prescribed or permitted by
insurance regulatory authorities (see Note 5). The preparation of financial
statements in conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities in the Company's consolidated
balance sheets at December 31, 1998 and 1997 and the reported amounts of
revenues and expenses in the consolidated statements of income during the years
ended December 31, 1998, 1997 and 1996. Such estimates and assumptions include,
but are not limited to, losses and loss
F-8
<PAGE> 9
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
adjustment expenses and the deferral and amortization of deferred policy
acquisition costs. Actual results may differ from those estimates. Significant
accounting policies under GAAP are as follows:
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company
and its direct and indirect subsidiaries, FSA Insurance Company, Financial
Security Assurance International Ltd., Financial Security Assurance of Oklahoma,
Inc. and Financial Security Assurance (U.K.) Limited (collectively, the
Subsidiaries). All intercompany accounts and transactions have been eliminated.
Certain prior-year balances have been reclassified to conform to the 1998
presentation.
INVESTMENTS
Investments in debt securities designated as available for sale are carried
at market value. Equity investments are carried at market value. Any resulting
unrealized gain or loss is reflected as a separate component of shareholders'
equity, net of applicable deferred income taxes. All of the Company's long-term
investments are classified as available for sale.
Bond discounts and premiums are amortized on the effective yield method over
the remaining terms of the securities acquired. For mortgage-backed securities,
and any other holdings for which prepayment risk may be significant, assumptions
regarding prepayments are evaluated periodically and revised as necessary. Any
adjustments required due to the resulting change in effective yields are
recognized in current income. Short-term investments, which are those
investments with a maturity of less than one year at time of purchase, are
carried at market value, which approximates cost. Realized gains or losses on
sale of investments are determined on the basis of specific identification.
Investment income is recorded as earned.
The Company holds derivative securities, including U.S. Treasury bond
futures contracts and call option contracts, that are not accounted for as
hedges and are marked-to-market on a daily basis. Any gains or losses are
included in capital gains or losses.
PREMIUM REVENUE RECOGNITION
Gross and ceded premiums are earned in proportion to the amount of risk
outstanding over the expected period of coverage. Deferred premium revenue and
prepaid reinsurance premiums represent the portion of premium that is applicable
to coverage of risk to be provided in the future on policies in force. When an
insured issue is retired or defeased prior to the end of the expected period of
coverage, the remaining deferred premium revenue and prepaid reinsurance
premium, less any amount credited to a refunding issue insured by the Company,
are recognized.
LOSSES AND LOSS ADJUSTMENT EXPENSES
A case basis reserve for unpaid losses and loss adjustment expenses is
recorded at the present value of the estimated loss when, in management's
opinion, the likelihood of a future loss is probable and determinable at the
balance sheet date. The estimated loss on a transaction is discounted using
current risk-free rates.
F-9
<PAGE> 10
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The general reserve is calculated by applying a loss factor to the total net
par amount outstanding of the Company's insured obligations over the term of
such insured obligations and discounting the result at risk-free rates. The loss
factor used for this purpose has been determined based upon an independent
rating agency study of bond defaults and the Company's portfolio characteristics
and history. The general reserve is available to be applied against future
additions or accretions to existing case basis reserves or to new case basis
reserves to be established in the future.
Management of the Company periodically evaluates its estimates for losses
and loss adjustment expenses and establishes reserves that management believes
are adequate to cover the present value of the ultimate net cost of claims. The
reserves are necessarily based on estimates, and there can be no assurance that
the ultimate liability will not differ from such estimates. The Company will, on
an ongoing basis, monitor these reserves and may periodically adjust such
reserves based on the Company's actual loss experience, its future mix of
business, and future economic conditions.
DEFERRED ACQUISITION COSTS
Deferred acquisition costs comprise those expenses that vary with and are
primarily related to the production of business, including commissions paid on
reinsurance assumed, compensation and related costs of underwriting and
marketing personnel, certain rating agency fees, premium taxes and certain other
underwriting expenses, reduced by ceding commission income on premiums ceded to
reinsurers. Deferred acquisition costs and the cost of acquired business are
amortized over the period in which the related premiums are earned.
Recoverability of deferred acquisition costs is determined by considering
anticipated losses and loss adjustment expenses.
FEDERAL INCOME TAXES
The provision for income taxes consists of an amount for taxes currently
payable and a provision for tax consequences deferred to future periods
reflected at current income tax rates.
SEGMENT REPORTING
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 131, Disclosure about Segments of an
Enterprise and Related Information, establishing standards for the way that
public business enterprises report information about operating segments in
annual and interim financial statements and requiring presentation of a measure
of profit or loss, certain specific revenue and expense items and segment
assets. The Company has no reportable operating segments as a monoline financial
guaranty insurer.
3. INVESTMENTS
Bonds at amortized cost of $11,481,000 and $11,025,000 at December 31, 1998
and 1997, respectively, were on deposit with state regulatory authorities as
required by insurance regulations.
F-10
<PAGE> 11
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
3. INVESTMENTS (CONTINUED)
Consolidated net investment income consisted of the following (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Bonds........................................................ $ 69,216 $ 65,149 $ 61,130
Equity investments........................................... 830 376 14
Short-term investments....................................... 7,376 5,452 3,525
Investment expenses.......................................... (1,399) (1,334) (1,941)
--------- --------- ---------
Net investment income........................................ $ 76,023 $ 69,643 $ 62,728
========= ========= =========
</TABLE>
The credit quality of the fixed-income investment portfolio at December 31,
1998 was as follows:
<TABLE>
<CAPTION>
PERCENT OF FIXED-INCOME
RATING INVESTMENT PORTFOLIO
- --------- -------------------------
<S> <C>
AAA 68.7%
AA 21.3
A 9.3
BBB 0.4
Other 0.3
</TABLE>
The amortized cost and estimated market value of bonds were as follows (in
thousands):
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
------------ ----------- ----------- ------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1998
- -----------------------------------------
U.S. Treasury securities and obligations
of U.S. government corporations and
agencies............................... $ 134,910 $ 2,297 $ (337) $ 136,870
Obligations of states and political
subdivisions........................... 1,041,718 42,265 (637) 1,083,346
Mortgage-backed securities............... 261,322 3,911 (180) 265,053
Corporate securities..................... 162,663 5,510 (463) 167,710
Asset-backed securities.................. 30,481 493 (25) 30,949
------------ ----------- ----------- ------------
Total................................ $ 1,631,094 $ 54,476 $ (1,642) $ 1,683,928
============ ========= ========= ============
</TABLE>
F-11
<PAGE> 12
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
3. INVESTMENTS (CONTINUED)
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
------------ ----------- ----------- ------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1997
- -----------------------------------------
U.S. Treasury securities and obligations
of U.S. government corporations and
agencies............................... $ 120,314 $ 800 $ (436) $ 120,678
Obligations of states and political
subdivisions........................... 777,042 40,187 (135) 817,094
Foreign securities....................... 8,252 (562) 7,690
Mortgage-backed securities............... 195,567 2,213 (28) 197,752
Corporate securities..................... 72,388 1,375 (1,093) 72,670
Asset-backed securities.................. 19,208 349 19,557
------------ ----------- ----------- ------------
Total................................ $ 1,192,771 $ 44,924 $ (2,254) $ 1,235,441
============ ========= ========= ============
</TABLE>
The change in net unrealized gains (losses) consisted of (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
--------- --------- ----------
<S> <C> <C> <C>
Bonds....................................................... $ 10,164 $ 28,671 $ (16,299)
Equity investments.......................................... 2,661 357
Other....................................................... 1,017
--------- --------- ----------
Change in net unrealized gains (losses)................. $ 13,842 $ 29,028 $ (16,299)
========= ========= ==========
</TABLE>
The amortized cost and estimated market value of bonds at December 31, 1998,
by contractual maturity, are shown below (in thousands). Actual maturities could
differ from contractual maturities because borrowers have the right to call or
prepay certain obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED MARKET
COST VALUE
------------ ------------
<S> <C> <C>
Due in one year or less........................................... $ 1,002 $ 1,006
Due after one year through five years............................. 135,398 137,917
Due after five years through ten years............................ 211,500 219,185
Due after ten years............................................... 991,391 1,029,818
Mortgage-backed securities (stated maturities of
1 to 30 years).................................................. 261,322 265,053
Asset-backed securities (stated maturities of 3 to 30 years)...... 30,481 30,949
------------ ------------
Total......................................................... $ 1,631,094 $ 1,683,928
============ ============
</TABLE>
F-12
<PAGE> 13
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
3. INVESTMENTS (CONTINUED)
Proceeds from sales of bonds during 1998, 1997 and 1996 were $2,132,146,000,
$1,124,848,000 and $1,096,568,000, respectively. Gross gains of $26,373,000,
$11,702,000 and $13,420,000 and gross losses of $4,156,000, $6,007,000 and
$11,569,000 were realized on sales in 1998, 1997 and 1996, respectively.
Proceeds from sales of equity investments during 1998 and 1997 were
$22,571,000 and $3,568,000, respectively. Gross gains of $973,000 and $33,000
and gross losses of $1,323,000 and $7,000 were realized on sales in 1998 and
1997, respectively.
4. DEFERRED ACQUISITION COSTS
Acquisition costs deferred for amortization against future income and the
related amortization charged to expenses are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Balance, beginning of period............................. $ 171,098 $ 146,233 $ 132,951
---------- ---------- ----------
Costs deferred during the period:
Ceding commission income............................... (27,693) (18,956) (15,956)
Assumed commission expense............................. 22 31 38
Premium taxes.......................................... 8,081 5,554 3,718
Compensation and other acquisition costs............... 83,490 66,198 49,311
---------- ---------- ----------
Total................................................ 63,900 52,827 37,111
---------- ---------- ----------
Costs amortized during the period........................ (35,439) (27,962) (23,829)
---------- ---------- ----------
Balance, end of period................................... $ 199,559 $ 171,098 $ 146,233
========== ========== ==========
</TABLE>
5. STATUTORY ACCOUNTING PRACTICES
GAAP for the Company differs in certain significant respects from accounting
practices prescribed or permitted by insurance regulatory authorities. The
principal differences result from the following statutory accounting practices:
- Upfront premiums on municipal business are recognized as earned when
related principal and interest have expired rather than over the expected
coverage period;
- Acquisition costs are charged to operations as incurred rather than as
related premiums are earned;
- A contingency reserve (rather than a general reserve) is computed based on
the following statutory requirements:
(i) For all policies written prior to July 1, 1989, an amount equal to
50% of cumulative earned premiums less permitted reductions, plus;
(ii) For all policies written on or after July 1, 1989, an amount equal
to the greater of 50% of premiums written for each category of insured
obligation or a designated percentage of principal
F-13
<PAGE> 14
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
5. STATUTORY ACCOUNTING PRACTICES (CONTINUED)
guaranteed for that category. These amounts are provided each quarter as
either 1/60th or 1/80th of the total required for each category, less
permitted reductions;
- Certain assets designated as "non-admitted assets" are charged directly to
statutory surplus but are reflected as assets under GAAP;
- Federal income taxes are provided only on taxable income for which income
taxes are currently payable;
- Accruals for deferred compensation are not recognized;
- Purchase accounting adjustments are not recognized;
- Bonds are carried at amortized cost;
- Surplus notes are recognized as surplus rather than a liability.
A reconciliation of net income for the calendar years 1998, 1997 and 1996
and shareholder's equity at December 31, 1998 and 1997, reported by the Company
on a GAAP basis, to the amounts reported by the Subsidiaries on a statutory
basis, is as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
------------ ---------- ---------
<S> <C> <C> <C>
Net Income:
GAAP BASIS............................................... $ 120,817 $ 100,259 $ 80,855
Premium revenue recognition.............................. (16,411) (23,130) (5,518)
Losses and loss adjustment expenses incurred............. 12,938 4,653 (2,138)
Deferred acquisition costs............................... (28,461) (24,865) (12,482)
Deferred income tax provision (benefit).................. (8,039) 8,025 911
Amortization of bonds.................................... 56 566
Accrual of deferred compensation, net.................... 33,268 26,681 12,737
Other.................................................... 100 (61) 1,404
------------ ---------- ---------
STATUTORY BASIS.......................................... $ 114,212 $ 91,618 $ 76,335
============ ========== =========
<CAPTION>
DECEMBER 31,
------------------------
1998 1997
------------ ----------
<S> <C> <C> <C>
Shareholder's Equity:
GAAP BASIS............................................... $ 1,104,591 $ 897,860
Premium revenue recognition.............................. (91,297) (74,863)
Loss and loss adjustment expense reserves................ 47,250 34,313
Deferred acquisition costs............................... (199,559) (171,098)
Contingency reserve...................................... (367,454) (287,694)
Unrealized gain on investments, net of tax............... (55,851) (43,027)
Deferred income taxes.................................... 56,672 59,867
Accrual of deferred compensation......................... 70,022 41,451
Surplus notes............................................ 120,000 50,000
Other.................................................... (14,118) (12,841)
------------ ----------
STATUTORY BASIS SURPLUS.................................. $ 670,256 $ 493,968
------------ ----------
SURPLUS PLUS CONTINGENCY RESERVE......................... $ 1,037,710 $ 781,661
============ ==========
</TABLE>
F-14
<PAGE> 15
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
6. FEDERAL INCOME TAXES
The Parent, the Company and its Subsidiaries (except Financial Security
Assurance International Ltd.) file a consolidated federal income tax return. The
calculation of each member's tax benefit or liability is controlled by a tax
sharing agreement that bases the allocation of such benefit or liability upon a
separate return calculation.
The cumulative balance sheet effects of deferred tax consequences are (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
Deferred acquisition costs.............................................. $ 69,079 $ 59,884
Deferred premium revenue adjustments.................................... 10,354 8,424
Unrealized capital gains................................................ 20,749 16,998
Contingency reserves.................................................... 46,260 38,037
--------- ---------
Total deferred tax liabilities...................................... 146,442 123,343
--------- ---------
Loss and loss adjustment expense reserves............................... (16,613) (12,009)
Deferred compensation................................................... (34,020) (20,328)
Tax and loss bonds...................................................... (38,726) (30,520)
Other, net.............................................................. (411) (619)
--------- ---------
Total deferred tax assets........................................... (89,770) (63,476)
--------- ---------
Total deferred income taxes............................................. $ 56,672 $ 59,867
========= =========
</TABLE>
No valuation allowance was necessary at December 31, 1998 or 1997.
A reconciliation of the effective tax rate with the federal statutory rate
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Tax at statutory rate................................................... 35.0% 35.0% 35.0%
Tax-exempt interest..................................................... (8.1) (7.9) (8.9)
Other................................................................... 1.1 0.3 0.4
--- --- ---
Provision for income taxes.............................................. 28.0% 27.4% 26.5%
--- --- ---
--- --- ---
</TABLE>
7. DIVIDENDS AND CAPITAL REQUIREMENTS
Under New York Insurance Law, The Company may pay a dividend without the
prior approval of the Superintendent of the New York State Insurance Department
only from earned surplus subject to the maintenance of a minimum capital
requirement. In addition, the dividend, together with all dividends declared or
distributed by it during the preceding twelve months, may not exceed the lesser
of 10% of its policyholders' surplus shown on its last filed statement, or
adjusted net investment income, as defined, for such twelve-month period. As of
December 31, 1998, the Company had $65,726,000 available for the payment of
dividends over the next twelve months.
F-15
<PAGE> 16
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
7. DIVIDENDS AND CAPITAL REQUIREMENTS (CONTINUED)
In 1998, the Company repurchased $8,500,000 of its shares from the Parent,
representing the balance remaining of $75,000,000 that had been approved for
repurchase by the New York Insurance Department.
8. CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES
The Company has a credit arrangement aggregating $150,000,000 at December
31, 1998, which is provided by commercial banks and intended for general
application to transactions insured by the Company and the Subsidiaries. At
December 31, 1998, there were no borrowings under this arrangement, which
expires on November 23, 1999. In addition, there are credit arrangements
assigned to specific insured transactions. In August 1994, the Company entered
into a facility agreement with Canadian Global Funding Corporation and Hambros
Bank Limited. Under the agreement, which expires in August 2004, the Company can
arrange financing for transactions subject to certain conditions. The amount of
this facility was $186,911,000, of which $44,974,000 was unutilized at December
31, 1998.
The Company has a standby line of credit commitment in the amount of
$240,000,000 with a group of international Aaa/AAA-rated banks to provide loans
to the Company after it has incurred, during the term of the facility,
cumulative municipal losses (net of any recoveries) in excess of the greater of
$230,000,000 or 5.75% of average annual debt service of the covered portfolio.
The obligation to repay loans made under this agreement is a limited recourse
obligation payable solely from, and collateralized by, a pledge of recoveries
realized on defaulted insured obligations in the covered portfolio, including
certain installment premiums and other collateral. This commitment has a term
beginning on April 30, 1997 and expiring on April 30, 2004 and contains an
annual renewal provision subject to approval by the banks. No amounts have been
utilized under this commitment as of December 31, 1998.
At December 31, 1998, the Company has borrowed $120,000,000 from its Parent
in the form of Surplus Notes. These notes carried a simple interest rate of 5.0%
per annum. Principal of and interest on the Surplus Notes may be paid at any
time at the option of the Company, subject to prior approval of the New York
Insurance Department and compliance with the conditions to such payments as
contained in the New York Insurance Laws. These notes have no stated maturity.
The Company did not pay interest in 1998 or 1997.
9. EMPLOYEE BENEFIT PLANS
The Company maintains both a qualified and a non-qualified non-contributory
defined contribution pension plan for the benefit of all eligible employees. The
Company's contributions are based upon a fixed percentage of employee
compensation. Pension expense, which is funded as accrued, amounted to
$2,380,000, $2,312,000 and $1,977,000 for the years ended December 31, 1998,
1997 and 1996, respectively.
The Company has an employee retirement savings plan for the benefit of all
eligible employees. The plan permits employees to contribute a percentage of
their salaries up to limits prescribed by the Internal Revenue Service (IRS
Code, Section 401(k)). The Company's contributions are discretionary, and none
have been made.
Pursuant to the 1993 Equity Participation Plan, 1,810,780 shares of the
Parent's common stock, subject to anti-dilutive adjustment, were reserved for
awards of options, restricted shares of common stock, and performance shares to
employees for the purpose of providing, through the grant of long-term
incentives, a
F-16
<PAGE> 17
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
9. EMPLOYEE BENEFIT PLANS (CONTINUED)
means to attract and retain key personnel and to provide to participating
officers and other key employees long-term incentives for sustained high levels
of performance. Shares available under the 1993 Equity Participation Plan were
increased from 1,810,780 to 2,110,780 in December 1995. The 1993 Equity
Participation Plan also contains provisions that permit the Human Resources
Committee to pay all or a portion of employees' bonuses in the form of shares of
the Parent's common stock credited to the employees at a 15% discount from
current market value and paid to employees five years from the date of award. Up
to an aggregate of 10,000,000 shares may be allocated to such equity bonuses.
Common stock to pay performance shares, stock options and equity bonus awards is
acquired by the Parent through open-market purchases by a trust established for
such purpose.
Performance shares are awarded under the Parent's 1993 Equity Participation
Plan. The Plan authorizes the discretionary grant of performance shares by the
Human Resources Committee to key employees of the Company. The number of shares
of the Parent's common stock earned for each performance share depends upon the
attainment by the Parent of certain growth rates of adjusted book value per
outstanding share over a three-year period. At each payout date, each
performance share is adjusted to pay out from zero up to two common shares. No
common shares are paid out if the compound annual growth rate of the Parent's
adjusted book value per outstanding share was less than 7%. Two common shares
per performance share are paid out if the compound annual growth rate was 19% or
greater. Payout percentages are interpolated for compound annual growth rates
between 7% and 19%.
Performance shares granted under the 1993 Equity Participation Plan were as
follows:
<TABLE>
<CAPTION>
OUTSTANDING GRANTED EARNED FORFEITED OUTSTANDING MARKET
AT BEGINNING DURING DURING DURING AT END PRICE AT
OF YEAR THE YEAR THE YEAR THE YEAR OF YEAR GRANT DATE
------------ --------- --------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
1996.............. 1,109,150 282,490 17,300 1,374,340 $ 25.2500
1997.............. 1,374,340 253,057 201,769 59,253 1,366,375 35.5000
1998.............. 1,366,375 273,656 229,378 26,145 1,384,508 46.0625
</TABLE>
The Company applies APB Opinion 25 and related Interpretations in accounting
for the Parent's performance shares. The Company estimates the final cost of
these performance shares and accrues for this expense over the performance
period. The accrued expense for the performance shares was $39,480,000,
$28,439,000 and $12,737,000 for the years ended December 31, 1998, 1997 and
1996, respectively. In tandem with this accrued expense, the Parent estimates
those performance shares that it expects to settle in stock and records this
amount in shareholders' equity as deferred compensation. The remainder of the
accrual, which represents the amount of performance shares that the Parent
estimates it will settle in cash, is recorded in accrued expenses and other
liabilities. The Company recognized a benefit for the difference between the
market value of the Parent's common stock and the cost of the stock when it was
purchased by the independent trustee (which amount was reimbursed by the Company
to its Parent) for shares distributed under the performance share plan. This
benefit was recorded by the Company as a capital contribution which totaled
$5,418,000 and $2,900,000 in 1998 and 1997, respectively. In 1996, the Parent
adopted disclosure provisions of SFAS No. 123. Had the compensation cost for the
Parent's performance shares been determined based upon the provisions of SFAS
No. 123, there would have been no effect on the Company's reported net income.
F-17
<PAGE> 18
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
9. EMPLOYEE BENEFIT PLANS (CONTINUED)
In November 1994, the Parent appointed an independent trustee authorized to
purchase shares of the Parent's common stock in open market transactions, at
times and prices determined by the trustee. These purchases are intended to fund
future obligations relating to equity bonuses, performance shares and stock
options under the 1993 Equity Participation Plan and other employee benefit
plans and are presented as treasury stock in these financial statements. During
1998, 1997 and 1996, the total number of shares purchased by the trust was
496,940, 162,573 and 529,131, respectively, at a cost of $23,907,000, $5,434,000
and $14,111,000, respectively. In 1996, the Parent also repurchased stock from
its employees in satisfaction of withholding taxes on shares distributed under
its restricted stock plan.
The Company does not currently provide post-retirement benefits, other than
under its defined contribution plans, to its employees, nor does it provide
post-employment benefits to former employees other than under its severance
plans.
10. COMMITMENTS AND CONTINGENCIES
The Company leases office space and equipment under non-cancelable operating
leases, which expire at various dates through 2005.
Future minimum rental payments are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------------------------------------------------------------------
<S> <C>
1999............................................................................... $ 2,489
2000............................................................................... 2,327
2001............................................................................... 2,014
2002............................................................................... 1,739
2003............................................................................... 1,739
Thereafter......................................................................... 3,333
---------
Total.............................................................................. $ 13,641
=========
</TABLE>
Rent expense for the years ended December 31, 1998, 1997 and 1996 was
$4,025,000, $3,708,000 and $3,383,000, respectively.
During the ordinary course of business, the Company and its Subsidiaries
have become parties to certain litigation. Management believes that these
matters will be resolved with no material financial impact on the Company.
F-18
<PAGE> 19
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
11. REINSURANCE
The Company reinsures portions of its risks with affiliated (see Note 13)
and unaffiliated reinsurers under quota share and first-loss treaties and on a
facultative basis. The Company's principal ceded reinsurance program consisted
in 1998 of two quota share treaties, one first-loss treaty and four automatic
facultative facilities. One treaty covered all of the Company's approved regular
lines of business, except U.S. municipal obligation insurance. Under this treaty
in 1998, the Company ceded 6.75% of each covered policy, up to a maximum of
$13,500,000 insured principal per policy. At its sole option, the Company could
have increased, and in certain instances did increase, the ceding percentage to
13.5% up to $27,000,000 of each covered policy. A second treaty covered the
Company's U.S. municipal obligation insurance business. Under this treaty in
1998, the Company ceded 6% of each covered policy that is classified by the
Company as providing U.S. municipal bond insurance as defined by Article 69 of
the New York Insurance Law up to a limit of $16,000,000 per single risk, which
is defined by revenue source. At its sole option, the Company could have
increased, and in certain instances did increase, the ceding percentage to 30%
up to $80,000,000 per single risk. These cession percentages under both treaties
were reduced on smaller-sized transactions. The first-loss treaty applied to
qualifying U.S. mortgage-backed transactions. Under the four automatic
facultative facilities in 1998, the Company at its option could allocate up to a
specified amount for each reinsurer (ranging from $4,000,000 to $40,000,000
depending on the reinsurer) for each transaction, subject to limits and
exclusions, in exchange for which the Company agreed to cede in the aggregate a
specified percentage of gross par insured by the Company. Each of the quota
share treaties and automatic facultative facilities allowed the Company to
withhold a ceding commission to defray its expenses. The Company also employed
non-treaty quota share and first-loss facultative reinsurance on various
transactions in 1998.
In the event (which management considers to be highly unlikely) that any or
all of the reinsuring companies were unable to meet their obligations to the
Company, the Company would be liable for such defaulted amounts. The Company has
also assumed reinsurance of municipal obligations from unaffiliated insurers.
F-19
<PAGE> 20
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
11. REINSURANCE (CONTINUED)
Amounts reinsured were as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Written premiums ceded........................................................... $ 99,413 $ 63,513 $ 55,965
Written premiums assumed......................................................... 935 1,352 1,873
Earned premiums ceded............................................................ 55,939 41,713 38,723
Earned premiums assumed.......................................................... 4,271 5,121 6,020
Loss and loss adjustment expense payments ceded.................................. 22,619 2,862 29,408
Loss and loss adjustment expense payments assumed................................ 3 2 3
Incurred (recovered) losses and loss adjustment expenses ceded................... (4,673) 3,605 (2,249)
Incurred (recovered) losses and loss adjustment expenses assumed................. (139) 161 38
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1998 1997
------------- -------------
<S> <C> <C>
Principal outstanding ceded........................................................ $ 32,914,844 $ 24,547,361
Principal outstanding assumed...................................................... 1,360,916 1,670,468
Deferred premium revenue ceded..................................................... 217,096 173,123
Deferred premium revenue assumed................................................... 10,799 14,128
Loss and loss adjustment expense reserves ceded.................................... 3,907 30,618
Loss and loss adjustment expense reserves assumed.................................. 723 865
</TABLE>
12. OUTSTANDING EXPOSURE AND COLLATERAL
The Company's policies insure the scheduled payments of principal and
interest on asset-backed and municipal obligations. The principal amount insured
(in millions) as of December 31, 1998 and 1997 (net of amounts ceded to other
insurers) and the terms to maturity are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------------- -------------------------
TERMS TO MATURITY ASSET-BACKED MUNICIPAL ASSET-BACKED MUNICIPAL
- ---------------------------------------------- ------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
0 to 5 Years.................................. $ 8,468 $ 2,756 $ 7,553 $ 2,230
5 to 10 Years................................. 7,516 7,495 5,637 5,683
10 to 15 Years................................ 5,661 12,427 2,858 8,257
15 to 20 Years................................ 670 20,265 524 14,340
20 Years and Above............................ 15,308 24,107 11,917 16,479
---------- --------- ---------- ---------
Total..................................... $ 37,623 $ 67,050 $ 28,489 $ 46,989
========== ========= ========== =========
</TABLE>
F-20
<PAGE> 21
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
12. OUTSTANDING EXPOSURE AND COLLATERAL (CONTINUED)
The principal amount ceded as of December 31, 1998 and 1997 and the terms to
maturity are as follows (in millions):
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
-------------------------- -------------------------
TERMS TO MATURITY ASSET-BACKED MUNICIPAL ASSET-BACKED MUNICIPAL
- ---------------------------------------------- ------------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
0 to 5 Years.................................. $ 2,727 $ 1,157 $ 3,828 $ 965
5 to 10 Years................................. 1,859 2,143 2,118 1,693
10 to 15 Years................................ 1,116 3,022 553 2,078
15 to 20 Years................................ 591 4,852 257 3,005
20 Years and Above............................ 3,230 12,218 3,373 6,677
--------- --------- ---------- ---------
Total..................................... $ 9,523 $ 23,392 $ 10,129 $ 14,418
========= ========= ========== =========
</TABLE>
The Company limits its exposure to losses from writing financial guarantees
by underwriting investment-grade obligations, diversifying its portfolio and
maintaining rigorous collateral requirements on asset-backed obligations, as
well as through reinsurance. The gross principal amounts of insured obligations
in the asset-backed insured portfolio are backed by the following types of
collateral (in millions):
<TABLE>
<CAPTION>
NET OF AMOUNTS CEDED
CEDED
DECEMBER 31, DECEMBER 31,
-------------------- --------------------
TYPES OF COLLATERAL 1998 1997 1998 1997
- --------------------------------------------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C>
Residential mortgages.............................. $ 15,647 $ 12,928 $ 3,324 $ 3,665
Consumer receivables............................... 12,539 10,659 3,663 4,601
Government securities.............................. 821 787 267 120
Pooled corporate obligations....................... 6,776 3,004 1,388 540
Commercial mortgage portfolio:
Commercial real estate........................... 15 98 49 418
Corporate secured................................ 42 55 314 481
Investor-owned utility obligations................. 757 643 464 229
Other asset-backed obligations..................... 1,026 315 54 75
--------- --------- --------- ---------
Total asset-backed obligations............... $ 37,623 $ 28,489 $ 9,523 $ 10,129
========= ========= ========= =========
</TABLE>
The asset-backed insured portfolio, which aggregated $47,146,604,000
principal before reinsurance at December 31, 1998, was collateralized by assets
with an estimated fair value of $53,754,485,000. At December 31, 1997, it
aggregated $38,618,244,000 principal before reinsurance and was collateralized
by assets with an estimated fair value of $44,382,716,000. Such estimates of
fair value are calculated at the inception of each insurance policy and are
changed only in proportion to changes in exposure. At December 31, 1998, the
estimated fair value of collateral and reserves over the principal insured
averaged from 110% for commercial real estate to 181% for corporate secured
obligations. At December 31, 1997, the estimated fair value of collateral and
reserves over the principal insured averaged from 100% for commercial real
estate to 172% for corporate secured obligations. Collateral for specific
transactions is generally not available to pay claims related to other
transactions. The amounts of losses ceded to reinsurers are determined net of
collateral.
F-21
<PAGE> 22
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
12. OUTSTANDING EXPOSURE AND COLLATERAL (CONTINUED)
The gross principal amount of insured obligations in the municipal insured
portfolio includes the following types of issues (in millions):
<TABLE>
<CAPTION>
NET OF AMOUNTS CEDED
CEDED
DECEMBER 31, DECEMBER 31,
-------------------- --------------------
TYPES OF ISSUES 1998 1997 1998 1997
- -------------------------------------------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C>
General obligation bonds.......................... $ 25,337 $ 17,101 $ 4,517 $ 3,182
Housing revenue bonds............................. 2,509 1,770 1,108 955
Municipal utility revenue bonds................... 9,218 5,892 5,489 2,294
Health care revenue bonds......................... 5,812 3,924 3,348 2,175
Tax-supported bonds (non-general obligation)...... 14,731 11,210 5,238 3,526
Transportation revenue bonds...................... 2,937 1,972 2,154 1,041
Other municipal bonds............................. 6,506 5,120 1,538 1,245
--------- --------- --------- ---------
Total municipal obligations................... $ 67,050 $ 46,989 $ 23,392 $ 14,418
========= ========= ========= =========
</TABLE>
In its asset-backed business, the Company considers geographic concentration
as a factor in underwriting insurance covering securitizations of pools of such
assets as residential mortgages or consumer receivables. However, after the
initial issuance of an insurance policy relating to such securitization, the
geographic concentration of the underlying assets may not remain fixed over the
life of the policy. In addition, in writing insurance for other types of
asset-backed obligations, such as securities primarily backed by government or
corporate debt, geographic concentration is not deemed by the Company to be
significant given other more relevant measures of diversification such as issuer
or industry.
The Company seeks to maintain a diversified portfolio of insured municipal
obligations designed to spread its risk across a number of geographic areas. The
following table sets forth, by state, those states in
F-22
<PAGE> 23
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
12. OUTSTANDING EXPOSURE AND COLLATERAL (CONTINUED)
which municipalities located therein issued an aggregate of 2% or more of the
Company's net par amount outstanding of insured municipal securities as of
December 31, 1998:
<TABLE>
<CAPTION>
NET PAR PERCENT OF TOTAL CEDED PAR
NUMBER AMOUNT MUNICIPAL NET PAR AMOUNT
STATE OF ISSUES OUTSTANDING AMOUNT OUTSTANDING OUTSTANDING
- ---------------------------------- ----------- ----------- --------------------- -----------
<S> <C> <C> <C> <C>
(IN (IN
MILLIONS) MILLIONS)
California........................ 517 $ 10,233 15.3% $ 3,103
New York.......................... 388 5,836 8.7 4,137
Pennsylvania...................... 356 4,821 7.2 834
Texas............................. 414 4,128 6.1 1,441
Florida........................... 130 4,091 6.1 1,616
New Jersey........................ 275 3,475 5.2 1,486
Illinois.......................... 359 3,125 4.7 628
Massachusetts..................... 126 2,259 3.4 976
Michigan.......................... 217 2,161 3.2 511
Wisconsin......................... 252 1,685 2.5 228
Indiana........................... 103 1,461 2.2 162
Minnesota......................... 146 1,340 2.0 191
All Other States.................. 1,453 20,993 31.3 6,812
Non-U.S........................... 32 1,442 2.1 1,267
----- --------- ----- ---------
Total......................... 4,768 $ 67,050 100.0% $ 23,392
===== ========= ===== =========
</TABLE>
13. RELATED PARTY TRANSACTIONS
Allocable expenses are shared by the Company and its Parent on a basis
determined principally by estimates of respective usage as stated in an expense
sharing agreement. The agreement is subject to the provisions of the New York
Insurance Law. Amounts included in other assets at December 31, 1998 and 1997
are $1,625,000 and $4,702,000, respectively, for unsettled expense allocations
due from the Parent.
The Company ceded premiums of $23,838,000, $21,216,000 and $19,890,000 to
Tokio Marine for the years ended December 31, 1998, 1997 and 1996, respectively.
The amounts included in prepaid reinsurance premiums at December 31, 1998 and
1997 for reinsurance ceded to Tokio Marine were $62,422,000 and $53,603,000,
respectively. Reinsurance recoverable on unpaid losses ceded to Tokio Marine was
$612,000 and $613,000 at December 31, 1998 and 1997, respectively. The Company
ceded losses and loss adjustment expenses of $603,000, $1,095,000 and $232,000
to Tokio Marine for the years ended December 31, 1998, 1997 and 1996,
respectively. The Company ceded premiums of $7,297,000 and $15,000 to X.L.
Insurance Company, Ltd., a subsidiary of XL, for the years ended December 31,
1998 and 1997, respectively. The amounts included in prepaid reinsurance
premiums at December 31, 1998 and 1997 for reinsurance ceded to X.L. Insurance
Company, Ltd. were $5,306,000 and $6,000, respectively.
The Company ceded premiums of $25,862,000, $16,890,000 and $15,409,000 on a
quota share basis to affiliates of MediaOne (Enhance Reinsurance Company, Asset
Guaranty Insurance Company and Commercial Reinsurance Company) for the years
ended December 31, 1998, 1997 and 1996, respectively. The
F-23
<PAGE> 24
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
13. RELATED PARTY TRANSACTIONS (CONTINUED)
amounts included in prepaid reinsurance premiums for reinsurance ceded to these
affiliates were $61,088,000 and $51,980,000 at December 31, 1998 and 1997,
respectively. The amounts of reinsurance recoverable on unpaid losses ceded to
these affiliates at December 31, 1998 and 1997 were $1,755,000 and $24,195,000,
respectively. The Company ceded losses and loss adjustment expenses (recoveries)
of $(11,956,000), $2,105,000 and $(3,316,000) to these affiliates for the years
ended December 31, 1998, 1997 and 1996, respectively.
14. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following estimated fair values have been determined by the Company
using available market information and appropriate valuation methodologies.
However, considerable judgment is necessary to interpret the data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amount the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
Bonds--The carrying amount of bonds represents fair value. The fair value of
bonds is based upon quoted market price.
Short-term investments--The carrying amount is fair value, which
approximates cost due to the short maturity of these instruments.
Cash, receivable for investments sold and payable for investments
purchased--The carrying amount approximates fair value because of the short
maturity of these instruments.
Deferred premium revenue, net of prepaid reinsurance premiums--The carrying
amount of deferred premium revenue, net of prepaid reinsurance premiums,
represents the Company's future premium revenue, net of reinsurance, on policies
where the premium was received at the inception of the insurance contract. The
fair value of deferred premium revenue, net of prepaid reinsurance premiums, is
an estimate of the premiums that would be paid under a reinsurance agreement
with a third party to transfer the Company's financial guaranty risk, net of
that portion of the premiums retained by the Company to compensate it for
originating and servicing the insurance contracts.
Installment premiums--Consistent with industry practice, there is no
carrying amount for installment premiums since the Company will receive premiums
on an installment basis over the term of the insurance contract. Similar to
deferred premium revenue, the fair value of installment premiums is the
estimated present value of the future contractual premium revenues that would be
paid under a reinsurance agreement with a third party to transfer the Company's
financial guaranty risk, net of that portion of the premium retained by the
Company to compensate it for originating and servicing the insurance contract.
F-24
<PAGE> 25
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
14. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Losses and loss adjustment expenses, net of reinsurance recoverable on
unpaid losses--The carrying amount is fair value, which is the present value of
the expected cash flows for specifically identified claims and potential losses
in the Company's insured portfolio.
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
-------------------------- --------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
(IN THOUSANDS) AMOUNT FAIR VALUE AMOUNT FAIR VALUE
- ------------------------------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Assets:
Bonds.............................. $ 1,683,928 $ 1,683,928 $ 1,235,441 $ 1,235,441
Short-term investments............. 92,241 92,241 103,926 103,926
Cash............................... 2,729 2,729 11,235 11,235
Receivable for securities sold..... 1,656 1,656 20,535 20,535
Liabilities:
Deferred premium revenue, net of
prepaid reinsurance premiums..... 504,603 417,130 422,073 347,855
Losses and loss adjustment
expenses, net of reinsurance
recoverable on unpaid losses..... 60,040 60,040 44,799 44,799
Notes payable...................... 120,000 120,000 50,000 50,000
Payable for investments
purchased........................ 105,749 105,749 72,979 72,979
Off-balance-sheet instruments:
Installment premiums............... 163,239 116,888
</TABLE>
F-25
<PAGE> 26
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
15. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company's liability for losses and loss adjustment expenses consists of
the case basis and general reserves. Activity in the liability for losses and
loss adjustment expenses is summarized as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
--------- --------- ----------
<S> <C> <C> <C>
Balance at January 1........................................ $ 75,417 $ 72,079 $ 111,759
Less reinsurance recoverable................................ 30,618 29,875 61,532
--------- --------- ----------
Net balance at January 1.................................... 44,799 42,204 50,227
Incurred losses and loss adjustment expenses:
Current year.............................................. 8,049 5,400 5,300
Prior years............................................... (4,100) 3,756 1,574
Recovered (paid) losses and loss adjustment expenses:
Current year.............................................. (192) (2,850) --
Prior years............................................... 11,484 (3,711) (14,897)
--------- --------- ----------
Net balance December 31..................................... 60,040 44,799 42,204
Plus reinsurance recoverable................................ 3,907 30,618 29,875
--------- --------- ----------
Balance at December 31.................................... $ 63,947 $ 75,417 $ 72,079
========= ========= ==========
</TABLE>
During 1996, the Company increased its general reserve by $6,874,000, of
which $5,300,000 was for originations of new business and $1,574,000 was to
reestablish a portion of the general reserve that had previously been
transferred to case basis reserves. During 1996, the Company transferred
$9,012,000 from its general reserve to case basis reserves associated
predominantly with certain residential mortgage and timeshare receivables
transactions. Giving effect to these transfers, the general reserve totaled
$29,660,000 at December 31, 1996.
During 1997, the Company increased its general reserve by $9,156,000, of
which $5,400,000 was for originations of new business and $3,756,000 was to
reestablish a portion of the general reserve that had previously been
transferred to case basis reserves. During 1997, the Company transferred
$4,503,000 from its general reserve to case basis reserves associated
predominantly with certain residential mortgage transactions. Giving effect to
these transfers, the general reserve totaled $34,313,000 at December 31, 1997.
During 1998, the Company increased its general reserve by $3,949,000, of
which $8,049,000 was for originations of new business offset by a $4,100,000
decrease in the amount needed to fund the general loss reserve because of
recoveries on certain commercial mortgage transactions. During 1998, the Company
transferred $18,403,000 to its general reserve from case basis reserves due to
those recoveries on commercial mortgage transactions. Also during 1998, the
Company transferred $9,414,000 from its general reserve to case basis reserves
associated predominantly with certain consumer receivable transactions. Giving
effect to these transfers, the general reserve totaled $47,251,000 at December
31, 1998.
F-26
<PAGE> 27
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
15. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED) Reserves for
losses and loss adjustment expenses are discounted at risk-free
rates. The amount of discount taken was approximately $16,029,000, $19,779,000
and $17,944,000 at December 31, 1998, 1997 and 1996, respectively.
16. RECENTLY ISSUED ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. SFAS No. 133 is effective January 1, 2000.
The Company is in the process of determining the effect of these standards
on its financial statements, but management does not believe that it will have a
material effect on the Company's financial condition.
17. FINANCIAL SECURITY ASSURANCE INTERNATIONAL LTD. AND MINORITY INTEREST
On November 3, 1998, the Parent funded the Company's $80,000,000 investment
in Financial Security Assurance International Ltd. (International), a new
Bermuda-based financial guaranty insurer.
In November 1998, XL made a minority investment in International for
$20,000,000. This interest is in the form of Cumulative Participating Voting
Preferred Shares, which in total have a minimum fixed dividend of $1,000,000 per
annum. For the period ended December 31, 1998, the Company recognized minority
interest of $388,000.
F-27
